Morning Call about Fauji Fertilizer Company Limited – Arif Habib Limited

Karachi: All Geared Up to perform

Higher earnings now offers a 29.8% upside potential
According to Arif Habib Limited, it has increased its Jun’12 target price for Fauji Fertilizer Company Limited to PKR 239/share from previous PKR 214/share. This is due to revised projection of company’s earnings by 9% and 17% to PKR 24.90/share and PKR 27.69/share in CY11E and CY12F, respectively. Higher earnings forecast is primarily driven by the recent hike in Urea price by PKR 174/bag to PKR 1,366/bag, higher dividend income from its subsidiary, FFBL and decrease in cost of equity assumption due to the latest cut in benchmark interest rate by 150bps to 12%.

Solid performance projections very likely, based on record earnings growth
In CY11 YTD, the stock of FFC has recorded a massive gain of 82.8%, outperforming the benchmark KSE-100 index by a whopping 82.9% due to higher profit margins and healthy Urea off-take. Arif Habib Limited believes the stock is all set to perform further from here onwards, primarily due to expected record full year earnings of PKR 24.90/share for CY11E and outstanding dividend yield of 14% based on CY12 earnings. Furthermore, the stock is currently trading at a PER multiple of 6.65x against Arif Habib’s implied PER of 8.63x, implying a return of 29%.

Gross profit margins on a rise in CY11 on back of further price hike in Urea
FFC has been the major beneficiary of the gas curtailment issue as the company has suffered lowest gas outage when compared to its peers, while simultaneously benefits on the pricing gains. Since beginning of CY11 urea price has surged by 63% to PKR 1,366/bag. As a result of this FFC’s gross margin has improved to 56% in 1HCY11 compared to 44% seen in CY10. Chances of additional price hikes in winter season cannot be ruled out, thus FFC is very much likely to stand out as a major beneficiary again. Arif Habib’s estimates suggest that every 100/bag increase in Urea price increases Company’s EPS by roughly PKR 0.78/share. Record 3QCY11 earnings expected FFC is estimated to announce its 3QCY11 financial result by end October 2011. Arif Habib Limited expects the company to record healthy earnings’ of PKR 6.39/share for the period, an increase of 33% QoQ and 66% YoY. Along with the results the company is likely to declare third interim dividend of PKR 6.0/share taking total DPS to PKR 15.25/share. Rise in QoQ earnings would primarily emanate from 15% YoY surge in Urea prices coupled with 7% rise in Urea sales to 660 kT. In addition to this, FFBL’s dividend will contribute PKR 1.14/share to the bottom line in 3QCY11 compared to in PKR 0.63/share seen in the previous quarter.

Chances of price reverting back are feeble
Chances of price being reverted in the short term are slim as Urea plants on Sui Northern Gas Pipeline (SNGPL) could stay non operational for more than the planned level of 45 days, thus possibility of another price hike might be under the pipeline.

Going forward, Arif Habib Limited believes that the Urea prices can be reverted but partially if fertilizer manufacturers think no major outages are expected given OGDC operated field KPD-TAY comes online. Furthermore, government is thinking of transferring 50mmcfd of gas from SSGC network to the SNGPL network which will aide in softening gas supply concerns.

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