Economics of Pakistan’s beleaguered fertilizer industry may benefit Fatima

Last month Lahore-based Fatima Fertilizer Company Limited (FFCL) appointed BNY Mellon depository bank for its OTC ADR program in which ordinary shares of the firm will ultimately be listed under the symbol “FTMFY”. Each Fatima ADR will represent 50 ordinary shares that have traded hitherto on all three stock exchanges (Karachi, Lahore and Islamabad) in Pakistan.  “With over 22 million hectares under cultivation, agriculture is the mainstay of Pakistan’s economy, and Fatima Fertilizer is a significant step in attaining fertilizer self-sufficiency.  As Fatima Fertilizer grows and expands, a key milestone in our goals is the creation of this ADR program,” commented CEO Fawad A. Mukhtar.  “We will now be able to garner more international exposure and investment to continue to fund our future plans.”  These plans to date have centered on completing a Mukhtar Garh, Sadiqabad-based fully integrated fertilizer complex “capable of producing two intermediate products–i.e. ammonia and nitric acid–and four final products, Nitro Phosphate (“NP”), Nitrogen Phosphorous Potassium (“NPK”), Calcium Ammonium Nitrate (“CAN”), and Urea that will produce a projected output of 2.2m metrics tons (MT) by the end of the year, making it the country’s largest compound fertilizer manufacturer.

It is interesting to note that even prior to last summer’s devastating floods the government explicitly addressed the need for more domestic production in order to relieve escalating import costs:  as The Economist noted, “Pakistan’s fiscal troubles are antediluvian. It is one of the most lightly taxed countries in the world. Fewer than a quarter of the country’s firms declare any taxable revenues, and only 11 out of every 1,000 of its citizens pay tax on their incomes, according to the World Bank.  As a result, tax revenues amount to a mere 10% of GDP.”  Specifically, per one analysis, “total fertilizer demand in Pakistan is  roughly 8.9m MT, of which nitrogenous fertilizers (Urea & CAN) account for ~78%, phosphatic and mixed fertilizers (DAP, NP and NPK) ~22%, while domestic production meets around 75% of current fertilizer demand (nitrogenous ~79%, phosphatic and complex ~40%).  The shortfall is being met through imports.”  As for the near-term outlook, Fatima looks set to capitalize on robust nitrogenous trends: analysts with Arif Habib, for instance, foresee Urea demand to reach 6.45m tons in 2011, a rise of 5.3% y/o/y (and compared with 4.917m in 2007 and 5.481 in 2008, for context) despite rising prices (up 37% y/o/y in part reflecting a 17% GST).  Meanwhile, credit analysts with the state’s rating agency wrote last December that “the market response to Fatima Fertilizer’s trial production of CAN has been encouraging. CAN–with certain inherent advantages over traditional Urea–should be attractive to farmers, [though] they have a strong traditional association with Urea.”   Meanwhile, Fatima’s NP may be set to make strong inroads on DAP use: “NP’s price affordability, nutrient mix and convenient availability [may] give it an edge over imported DAP, provided Fatima Fertilizer manages requisite infrastructure and runs affective campaign among the farmers community,” analysts note.  To that, Arif Habib speculated a few weeks ago that “currently, retail DAP prices are hovering around 4,000 per bag.  This could force farmers to use substitutes [such as NP and NPK] which are trading at discount of 1500/bag to DAP prices.”

Pakistan sukuk: more yield, please

Pakistan’s impending 13-fold rise in sukuk sales in 2011 will go towards financing a budget deficit expected to range anywhere between 6-8% of GDP (versus the government’s 4% target) depending on how much oil prices rise.  And per a Bloomberg piece from earlier in the week, even that may not be enough to soak up the huge cash inflows waiting to be deployed by Islamic funds and banks.  “The government has relied too much on the conventional debt market without realizing how much liquidity is in the Shariah-compliant industry,” opined Sajjad Anwar, one fund manager.  Yet as The Economist points out, there is very little happening on either the fiscal or monetary front to suggest that Pakistan’s economy is not in fact “slouching towards another financial crisis.”  Fiscally the situation looks as dour as ever: prime minister Yusuf Raza Gilani’s 180 on a short-lived 9 percent price increase in fuel gave his beleaguered PPP party a lifeline, but in the process made it look both spineless and shortsighted since the reversal “robbed the exchequer of 5 billion rupees ($58m) a month” and also further infuriated the IMF, essentially biting the hand that feeds it.  In the meantime donors have pledged just a fifth of what is needed, per estimates, to address this past summer’s flood devestation, while tax revenues remain one of the lightest in the world.  Against this backdrop inflation continues to spiral (average inflation rate is 15 percent over the past three fiscal years), tempered only by a hitherto robust rate of remittances.  Nevertheless Pakistan’s central bank increased its key policy rate to 14 percent in November, the third consecutive hike in six months due primarily to government borrowing from the State Bank of Pakistan which in turn obliges by printing new rupees, and will likely raise that by 50 basis points when it meets next on January 29th.  And many observers opine the spiral is destined to accelerate: current inflationary pressures in the agriculture sector, which accounts for roughly 21% of GDP, can be traced back to a PPP decision in 2008 to sharply raise the price it paid to farmers for wheat to encourage supply growth; “The bottom line is inflation is here to stay for at least the next two years,” said Sakib Sherani, a former senior economic adviser to the government.   Thus, against the backdrop of rising rates, inflation and fiscal uncertainty, it will be interesting to note the spread investors require for Pakistan’s sukuk offerings over that of say, Malaysia’s, the regional defacto benchmark (given in part its liquidity) which has rallied ever since Europe debt worries temporarily subsided and expectations grew of impending debt restructuring among certain state-owned firms in Dubai.  As Josh Brolin’s character from the Wall Street sequel would say, only “more” may be enough.

Urea, phosphate producers should benefit from prolonged supply dislocation

China’s recent decision to extend a 35 percent temporary tax and a 75 percent special tax on the export of fertilizer including urea and diammonium phosphate (DAP) until next June in order to help control inflation and to guarantee fertilizer production and supply to domestic farmers will likely “create potential supply shortages in both nutrient groups that should cause nitrogen and phosphate prices to go higher, benefitting global nitrogen and phosphate producers,” according to a research note from Barclays Capital.  China was responsible for roughly 14% of the global supply of urea in Q12010.

Urea is formulated by a reaction between liquid anhydrous ammonia–a form of nitrogen–and carbon dioxide at high temperature and pressure.  And in a write-up on Saudi Arabian Fertilizer Company (SAFCO), TAIB Securities, a brokerage, reiterated that producers in the Middle East are at a particular cost advantage in terms of production given their relatively cheaper access to raw material like natural gas (ranging from S$0.70 /MMBTU to US$1.5/MMBTU per one estimate, versus $4.5 and rising, for instance, on the New York Mercantile Exchange).  In addition to SAFCO, Arab Potash and Qatar Industries are regional players that, as one analyst notes, are not only attractive given their dividend yields but also may trade at a discount to global producers.  Finally, producers in Pakistan (namely the country’s two dominant firms, Fauji Fertilizer and Engro) both expect strong final quarters due in part to peak demand (stabilized by post-flood recovery and state-run farming subsidies) augmented by yet another supply shortage in the run-up to Rabi season that producers say is a direct result of the government’s gas curtailment policy in which gas has been diverted to power plants.   That shortage will be met through imports, though for Engro in particular the gas shedding policy may curtail projected earnings related to the opening of its new plant.  Yet Karachi’s JS Global Capital kept the firm as a ‘buy’ recently, concluding that “although the fertilizer industry was hit hard in August with depressing urea offtake (down 8%YoY in 8M2010) due to the floods, we expect the numbers to improve in the coming months.”

Engro Chemical a play on cheap fertilizer production

Bloomberg relays Citigroup’s sentiment that frontier markets, which trade at roughly 13x earnings (compared with emerging markets at 20x) and many of whom still trade at 50% or more below their 2007-2008 highs, are due for a “good year” on the back of low interest rates and rising commodity prices.

One of Citigroup’s favorite frontier stocks is Karachi-based Engro Chemical Pakistan Limited, the country’s second-largest urea maker which, aside from spending $1.7 billion to expand its operations into milk and consumer goods (Engro Foods) in the past three years, announced in November that it would construct a $1b phosphate fertilizer plant in North Africa in order to further fuel demand in both Pakistan and Western Europe. The company also deals in energy, polymer and bulk handling. Yet fertilizer remains the firm’s cash cow, BMA Capital explained last fall in the linked research piece, and will continue to provide the impetus for future growth:

Protection of agrarian policies by the government and stable gas supply has greatly helped the fertilizer arm making it stable, profitable and secure. Urea is locally available at a significant discount to the international landed price of the product. Current retail prices of PKR797/bag compared to international landed cost of PKR1,200/bag means that locally available urea will continue to be preferred. Engro will become the largest urea producer of Pakistan by mid-CY10E with additional capacity to the tune of 1.3mtpa coming online.

China says ‘no’ to African farmland

Financial Times reported this morning that according to Niu Dun, China’s deputy agriculture minister, Beijing will distance itself from nations such as Saudi Arabia and South Korea by choosing to depend on its own land for self-sufficiency in grain.  China is the world’s biggest agricultural economy and its largest consumer and producer of cereals.  The growing trend by some to snap up foreign farmland is seen as a response to last year’s spike in agricultural commodity prices and trade restrictions which lead some to question the long term viability of the global food market and to proactively seek alternatives.  For example, Pakistan is now offering 1m acres of farmland, to be protected by a special security force, for lease or sale.  Gulf Arab nations, heavily reliant on food imports, have reportedly expressed interest.

Ukraine, Pakistan to receive more largesse

Per the Financial Times, under a soon-to-be-unfrozen IMF plan, “Kiev will use half of a second $2.8bn (€2.1bn, £1.9bn) tranche to service its budget deficit. The rest will be directed towards traditional currency stabilisation and balance of payment needs.”  Bonds markets reacted well to the news; Ukraine’s 6.58% dollar bonds due 2016 rose on Friday, pushing the yield down 54.4 basis points to 17.162%, the lowest since Oct. 9.

Meanwhile, Pakistan won commitments for $5.28bn in aid over two years from more than 20 countries in order to help stabilize its rapidly fleeting economy (Pakistan’s rupee plunged 22% last year and the benchmark stock index tumbled 58%) and support investment in healthcare, education and infrastructure development.  The Pakistan Donors’ Conference, co-hosted over the weekend by Japan and the IMF in Toyko, also reaffirmed $15bn (€11.5bn, £10.1bn) already committed to existing aid programs.  The new funds come on top of a $7.6bn loan provided by the IMF in November to help Pakistan avoid defaulting on its foreign payments.

Pakistan hopes to raise $500 million in the next 12 months through bonds aimed at Middle East investors as a debt sale in other overseas markets would be too expensive, according to central bank Governor Syed Salim Raza.  Such Islamic bonds, known as sukuk, comply with Shariah law by using asset returns to pay investors instead of interest.  Sales of the securities may rise to a record this year, led by issuers from the Persian Gulf, as higher yields attract investors, Saudi Arabia-based NCB Capital opined last month.

Habib Bank grows revenue, profit

Karachi-based Habib Bank Ltd., Pakistan’s largest by the number of branches, reported an increase in revenue to 79.7 billion rupees from 60.5 billion rupees in the year ended Dec. 31, as well as a 54% rise in profit after higher lending and rising interest rates.  Shares of the company have risen 21.8% this year.  Pakistan’s central bank raised interest rates four times last year to the highest levels in Asia.  Moreover, lending expanded by just under 20% in 2008, led by demand from energy companies and textile manufacturers, according to CEO Zakir Mahmood.

Pakistan cites overseas interest in its energy sector, but security concerns loom

Pakistan’s Investment Minister Waqar Ahmed Khan said this week that he hopes to ignite the country’s economy by raising a record $10 billion in overseas investment this year as companies from the Middle East build power plants and pour money into fuel exploration. However, given the country’s questionable security, commitment to rid itself of militants, and strained relations with India, the goal may be a tad lofty. “Getting half this target is more realistic,” said Muzzammil Aslam, an economist at KASB Securities Ltd. in Karachi. “There is definitely overseas interest in the energy sector but the government will have to improve security.”

Khan says that the government plans to attract investment in thermal, coal-run and wind-power generation to meet the electricity shortfall by the end of the year. Hitherto, electricity shortages have sparked riots and caused textile makers, which account for two-thirds of exports, to threaten to shut down. In addition to tackling its home grown militants, the government’s Pakistan Peoples Party (PPP) is dealing with a record current account deficit. Foreign-exchange reserves held by the central bank fell 75% to $3.5 billion in October, which caused many to anticipate an impending default. But reserves increased to $6.65 billion this month after the IMF injected $3.1 billion–the first installment of a $7.6 billion bailout loan–into the government’s coffers. Meanwhile, the tribal areas along the Afghanistan border remain lawless and indeed a root cause for instability in Afghanistan. So much for return on investment.

Fears of default in Argentina, Pakistan cause credit-default swaps to rise

Bloomberg reports today that the cost of protecting corporate bonds from default surged to a record on concern Argentina and Pakistan may default, worsening global economic turmoil.  Swaps on the benchmark Markit iTraxx Crossover Index surged above 800 basis points for the first time, and they rose 9 points on the CDX North America Investment Grade Index of contracts that is linked to 125 companies in the U.S. and Canada.

In Argentina, President Cristina Kirchner’s planned takeover of pension funds heightened concern the government is headed for its second default this decade.  The probability the country will fail to meet its commitments has soared to 94 percent.  And in Pakistan, even the possible bailout by the IMF (a meeting was scheduled for today in Dubai) may not be enough to save it from [another] credit-rating cut according to Standard & Poor’s, which already cut the nation’s debt rating on Oct. 6 to CCC+, seven levels below investment grade.  Bloomberg notes as well that “Pakistan is also expected to seek financial support from the ‘Friends of Pakistan’ group, which is due to meet next month in the United Arab Emirates.  The group, which was established last month to help Pakistan stabilize its economy, includes the U.S., U.K., China and Saudi Arabia.”  Meanwhile, the country suffers from increased political instability due to omnipresent volatility in its lawless [FATA] tribal region which provides cover to legions of Islamic militants including Taliban from both Pakistan and Afghanistan, as well as al-Qaeda fighters.