Fertilizer industry remained under considerable pressure during 2017 due to huge inventory. The pressure was eased after the Government of Pakistan (GoP) allowed export of nearly half a million tons urea. While the manufacturers succeeded in exporting urea at whatever price they could get, the GoP didn’t pay the promised subsidy to urea manufacturers/exporter. Despite all odds the manufacturers got two immediate benefits: 1) reduction in supply glut and 2) earn extra foreign exchange for the country. A look at the earnings of two top manufacturers may help in understanding the prevailing industry dynamics and coming up with a comprehensive Fertilizer Policy.
Fauji Fertilizer Company Limited (FFC) posted unconsolidated profit after tax of Rs4.78 billion (EPS: Rs3.78) for 4QCY17 as compared to net profit of Rs4.28 billion (EPS: Rs3.36) for 4QCY16, an increase of 12%YoY. The increase in 4QCY17 earnings resulted from: 1) a 17%YoY growth in topline on account of higher urea prices and healthy offtake to 824,000 tons and DAP to 176,000 tons, 2) decrease in distribution and finance cost and 3) lower effective tax rate of 27% for 4QCY17 as against 30% for 4QCY16. For CY17 FFC posted net profit of Rs10.71 billion (EPS: Rs8.42) as compared to profit of Rs11.78 billion (EPS: Rs9.26) for CY16, down by 9%YoY.
EFERT posted unconsolidated net profit of Rs3.44 billion (EPS: Rs2.59) for 4QCY17 as compared to net profit of Rs3.36 billion (EPS: Rs2.52) for 4QCY16, an increase of 2%YoY. On a cumulative basis, CY17 earnings rose to Rs10.14 billion (EPS: Rs7.60) as compared to Rs9.03 billion (EPS: Rs6.78) for CY16, up 12%YoY. The hike in full year earnings could be attributed to: 1) improvement in gross margins (GMs) to 36.6% on account of higher urea prices and lower mix of low margin DAP sales in topline, 2) increase in offtake of urea to 1.80 million tons and DAP to 531,000 tons, 3) decrease in distribution cost and 4) decrease in finance cost on account of swift deleveraging and low interest rate environment.
The year 2018 started on a positive note with fertilizer/urea offtake posting substantial growth of 30%/33%YoY in January and continued upward gains in February as well. According to the figures released by NFDC, total fertilizer sales in February rose to 619,000 tons, up 28%YoY. In tandem, urea sales have also increased by 44%YoY to 370,000 tons. Furthermore, DAP sales also registered growth of 33%MoM/25%YoY to 122,000 tons. On cumulative basis, Urea off-take posted impressive growth in 2MCY18 (up 37%YoY), where EFERT, FFC and FFBL emerged as clear winners. Going forward, sector experts anticipate further improvement on the back of: 1) reducing inventories, 2) improving international prices and 3) reducing discount levels.
|Company-wise sales in tons|
In tandem, sales 2MCY18 jumped to 407,000 tons from 380,000 tons for 2MCY17. DAP off-take also remained on the higher side, rising by 35%YoY to 215,000 ton for 2MCY18. In this regard, importers sold 143,000 tons of DAP (up 58%YoY) while FFBL sales were reported at 72,000 tons (up 5%YoY).
Higher demand on account of improved farm incomes along with export of urea and lower production from local players led to significant drop in urea inventory towards the end of CY17. Declining consistently every month, urea inventory was reported at now stands at just 273,000 tons, down 77%YoY at February end (lowest in last two years and significantly lower than last four year average of 572,000 tons).On the back of overall improvement is sector dynamics that include: 1) lowest inventory levels, 2) higher international urea prices and 3) Pak Rupee depreciation, discount offerings have now reduced significantly, thus improving margins.
Despite CY 17 not being a good year for fertilizer industry, it helped GoP in earning the most needed foreign exchange amounting to US$125 million, as it allowed one time export of urea. New Fertilizer Policy should allow for blanket approval for exports whenever inventories exceed the buffer stock, 300,000 tons. Investment in crop research and development is a must for improving production and productivity. Therefore, incentives should be offered to companies undertaking projects focused on farmers outreach and education about balanced use of fertilizer. Conducive environment should be created to attract fresh investment for setting up manufacturing facilities for other types of fertilizers.
Some of the critics are against offering any incentive to fertilizer industry, as they believe that manufacturers are minting huge profits and not passing on the benefits to farmers. For their information and putting the facts in right perspective it is necessary to reiterate the following facts: 1) Pakistan is an agrarian economy where only 28% out of a total of 80 million hectares is cultivated, 2) agriculture sector contributes 20% to the GDP, 3) employs 42% of labor force and 4) provides livelihood to 66% of the population of the country
The Fertilizer Policy 2001 was nitrogen focused and has yielded the following benefits: 1) fresh investments in the fertilizer sector amounting to Rs162 billion and installed urea manufacturing capacity increased by 40% to 1.8 million tons, 2) collective efforts after 2001 resulted in 42% increase in consumption of nitrogen based fertilizers, 3) bulk of the urea being produced locally at a substantially lower price than the international market, 4) reduced GoP’s burden of payment of subsidy on urea and 5) farmer benefited by Rs522 billion (2010-2016) as manufacturers continued to supply below the international prices. The irony is that the industry received Rs80 billion as gas subsidy over the past 7 years, whereas it passed on Rs422 billion benefit to the farmers.
For smooth operation fertilizer industry needs uninterrupted supply of gas at competitive price. Under the Fertilizer Policy 2001, the GoP dedicated Mari Shallow reserves for the fertilizer industry, whereas deep deposits were earmarked for power sector. However, in 2016, the GoP diverted 110mmcfd gas from Mari Shallow reserves to the Guddu power plant. The shift in policy will result in faster depletion of Mari Shallow reserves. To contain faster depletion of Mari Shallow reserves and develop a sustainable solution for national food security by ensuring optimum gas supply to fertilizer industry for longer period: 1) gas supply to Guddu power plant should be stopped immediately, 2) Mari Deep and other new indigenous gas discoveries should also be dedicated to fertilizer sector, 3) dedicate Mari Shallow for fertilizer feedstock only and meet fuel demand of fertilizer industry from any other source and provide subsidy for utilizing expensive alternate fuel.
To restore competitiveness of local fertilizer manufacturers, feedstock should be supplied as subsidized rate. One should not be surprised on this demand because in almost every country fertilizer sector gets gas at subsidized rate to achieve the ultimate objective of achieving food security. The general perception is that fertilizer manufacturers get gas at subsidized rate in Pakistan. The following table completely negates this perception. On the contrary gas tariff for fertilizer manufacturers in Pakistan is significantly higher as compared to other regional players.
The above stated tariff does not take into account the cost incurred by fertilizer manufacturers for installation of compressors. Manufacturers have invested about Rs15 billion on compressors since 2009 to overcome low pressure of gas supplied from gas fields. Cost of gas can also be contained by taking the following measures: 1)reduce or at least stop gas price increase, 2) the GoP reimburses cost of compression incurred by fertilizer manufacturers and 3) all new indigenous gas allocation should be priced as per Fertilizer Policy 2001.
Fertilizer Policy issued in 2001 has certainly yielded enormous benefits for the farmers and the GoP. The time has come to make fertilizer industry more robust to meet country’s ever increasing crop nutrients demand to achieve the ultimate objective of food security. The proposed policy should focus on ensuring uninterrupted supply of gas at competitive price and immediate curtailment of gas supply to power plants from Mari gas field.