Concessionary gas rate to Engro and its implications
-Reportedly, the Ministry of Finance has backed the proposal floated by the Ministry of Petroleum and Natural Resources, which calls for providing gas from Mari gas field via SNGPL to Engro’s new fertilizer plant at a concessionary rate of US$0.7/mmbtu.
-We believe the approval of concessionary gas rate for Engro would sharply reduce urea production costs for the company.
-Our calculations suggest decrease in feedstock gas price for one of Engro Fertilizer’s plants to US$0.7/mmbtu will increase Engro Fertilizer and Engro Corporation EPS for 2014 by 62% and 36%, respectively.
-That said, it is likely that lower feedstock gas price would result in the expectation that Engro will reduce urea prices. This, coupled with expected gas price rationalization for other urea producers could have a double whammy impact on them.
-Our sensitivity analysis suggests that every Rs100/bag change in urea price on an annualized basis would result in an approximate 2014E EPS cut of 16% for FFC, 8% for FFBL, 12% for FATIMA, 15% for ENGRO and 25% for Engro Fertilizer.
Finance Ministry agrees on gas supply at discount to Engro
Reportedly, the Ministry of Finance has backed the proposal floated by the Ministry of Petroleum and Natural Resources, which calls for providing gas from Mari gas field via SNGPL to Engro’s new fertilizer plant at a concessionary rate of US$0.7/mmbtu. To recall, the US$0.7/mmbtu gas rate was offered to Engro via the 2002 Fertilizer Policy as an incentive to invest in domestic urea capacity. The debate on giving Engro the discounted gas price was raised at an Economic Coordination Committee (ECC) meeting, where the ECC had asked the Petroleum Ministry to first seek comments from other ministries including the Finance Ministry and from stakeholders like the Oil and Gas Regulatory Authority (OGRA), Mari Gas Company and SNGPL before taking any decision.
Still a lot to be cleared up…
While the situation is still uncertain and may take some time before clarity emerges, these developments signify the increased probability of Engro Fertilizer being provided gas at concessionary rates. To recall, the company has been fighting for this issue for quite some time now but the last government did not approve the concessionary rate for Engro.
…but sizeable cost savings for Engro on the horizon
Meanwhile if the decision to supply gas to one of Engro’s plants at US$0.7/mmbtu is approved, we expect the same to deliver urea production cost savings to the tune of ~Rs250/bag for Engro Fertilizer. As per our calculations, the decrease in feedstock gas price for Engro Fertilizer, ceteris paribus, is likely to boost 2014E EPS for Engro Fertilizer by ~Rs2.4 and would suggest 45% upside to our current Target Price of Rs32. Meanwhile for Engro Corporation, we anticipate earnings upside of ~Rs6.2/share for 2014 and theoretical valuation upside of 24% (base case TP: Rs161) in case the company gets US$0.7/mmbtu gas for one plant.
What will happen post gas price reduction?
It is still early days to speculate on what Engro’s stance will be post reduction in gas price and how other local producers will react, especially in light of the gas rationalization plan that is likely to be introduced by the end of December 2013. That said, it is likely that lower feedstock gas price would result in the expectation that Engro will reduce urea prices (something the government has demanded for some time now). Potential downward revision in urea prices will halt the windfall gains other urea producers have been enjoying due to gas woes faced by Engro.
May halt windfall gains for other producers
We flag the risk that (1) approval of concessionary gas rate for Engro and (2) gas tariff rationalization for other local urea producers (FFC and FFBL) could have a double whammy impact on other domestic urea producers, provided the Gas Sale Agreement (GSA) tariff remains the same at ~US$4.5/mmbtu. In this scenario, FATIMA because of its subsidized gas agreement (also at US$0.7/mmbtu) would have to bear the burden of margin shrinkage due to urea price reduction but FFC and FFBL may have to deal with the same as well as incremental feedstock gas cost due to tariff rationalization. Our sensitivity analysis suggests that every Rs100/bag change in urea price on an annualized basis, would have an EPS impact of ~Rs2.5/share for FFC (16% of 2014E EPS), ~Rs0.5/share for FFBL (8% of 2014E EPS), ~Rs0.6/share for FATIMA (12% of 2014E EPS), ~Rs2.5/share for ENGRO (15% of 2014E EPS) and ~Rs0.95/share for Engro Fertilizer (25% of 2014E EPS).
We believe the recent news flow suggests increased probability of Engro getting gas at concessionary rates which can translate into hugely positive earnings impact for Engro Fertilizer and Engro Corporation. However, we still await final approval (it may get delayed or shelved as has been the case previously) and its impact on local urea prices before making any adjustments to our financial models.