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Financing capital expenditure through debt instrument to maintain high dividend payment to existing shareholders

By SHABBIR H. KAZMI
Nov 26 - Dec 02, 2001

Over the years Engro Chemical Pakistan Limited (ECPL) has relied mainly on borrowing to finance its capital expenditure. To ensure more borrowing, paid-up capital has been increased through successive bonus issues. However, this time the management has chosen to finance the capital expenditure by floating term finance certificates (TFCs) amounting to Rs 1.5 billion, the first tranche being for Rs 500 million. Out of this Rs 400 million have been committed through private placement and TFCs worth Rs 100 million will be offered on November 26 and 27 to general public for subscription. The public issue has been fully underwritten by Khadim Ali Shah Bukhari & Company (KASB), Atlas Investment Bank, First Credit and Discount Corporation, Jahangir Siddiqui & Company and Orix Investment Bank Pakistan.

PURPOSE

ECPL plans to issue a secured TFC up to Rs 1,500 million in three tranches to finance its capital expenditure. The first tranche of Rs 500 million is being issued in year 2001 and remaining two tranches are planned to be issued in year 2002. The Company has an annual recurring capital expenditure programme of approximately US$ 5 million. This programme is for the maintenance of ECPL's operations and approximately 90 per cent is dedicated to the upkeep and development of the plant. ECPL is also undertaking an energy conservation project at an estimated cost of US$ 9 million. This two-year programme is essentially a modification in the ammonia and urea plants to improve overall energy efficiency.

REDEMPTION

No redemption reserve is being created for redemption of TFCs. The Company is expected to have adequate funds to meet its financial obligations arising from the issue of TFCs. The redemption schedule for the set of TFCs, having an aggregate face value of Rs 5,000 is as follows:

Redemption Tenor 5 years
Profit Rate  Base Rate (R) + 1.15% (Floating rate of Profit)
Floor 13% per annum
Cap 17% per annum
Principal Repayment Principal to be repaid in 4 semi-annual installments in arrears after a grace period of 36 months from the date of issue.

 The Base Rate (R) is the weighted average of the last three cut-off rates of the 5-year Pakistan Investment Bonds and will be set on the last working day before the issue date and subsequently on the last working day prior to the beginning of each semi-annual period for the profit due at the end of that semi-annual period.

The issue contains an embedded call option, resting with the Company. The call option is exercisable at par; in part or whole, any time after third year from the date of issue with a three months notice. The TFC holders shall not have the right to ask the Company for early redemption of the TFCs other than as specified in the redemption schedule.

TFCs will be listed at Karachi Stock Exchange and declared as eligible security through the CDS of Central Depository Company. Stamp duty on initial issuance will be borne by the Company. Subsequent transfers shall be made in accordance with the Central Depository Act, 1997.

OUTLOOK

The fertilizer industry in Pakistan is poised for growth, as even at present, there exists a supply deficit. According to a recent study by National Fertilizer Development Centre, there is the possibility of a critical shortfall in the supply of fertilizer by year 2010 if local production is not increased. However, the recently announced Fertilizer Policy does not offer desired incentives for setting up grass-root projects. At the best, BMR and expansion of existing units may be achieved. ECPL has, for the time being, shelved its plans for capacity expansion by 100,000 tonnes having an estimated project cost of US$ 35 million. However, the Company is focusing on undertaking projects that would improve its operating efficiency.

With an increase in the proportion of low-margin imported products in its incremental sales volume and steady withdrawal of gas subsidy, the Company's profitability is expected to take a hit. However, the magnitude of sales is expected to significant growth, and as the investments in associated companies begin yielding generous dividends, in absolute terms, the net profit is expected to treble over the next five years. Even though, debt servicing remains a hafty outflow throughout the tenor of the TFC, the projected cashflows for the tenor of the TFC provide adequate coverage for financial charges as the debt-equity ratio continues to improve.

First Tranche

Private Placement (Rs in million)
Habib Bank AG Zurich Rs 100.0
First Women Bank 25.0
Pakistan Oilfields 20.0
Pak-Libya Holding Company 20.0
EFU Life Assurance 10.0
Atlas Investment Bank 7.5
Commercial Union Life Assurance 5.0
Khadim Ali Shah Bukhari & Company 5.0
Muslim Insurance Company 5.0
Orix Investment Bank Pakistan 5.0
Saudi Pak Leasing Company 5.0
The Aga Khan University Foundation 5.0
KASB Premier Fund 2.9
Shirazi Investments 2.5
Employees Provident Funds etc. 182.1
General Public 100.0
Total 500.0