Morning Shout Pakistan Daily Notes EFERT: Increased confidence on gas supply; upgrade to Buy! We upgrade our rating on EFERT to Buy with new PO of PRs66/sh implying 20% upside. At current levels, the stock is trading at a 2015E P/E of 7.7x and is currently our top pick in the fertilizer sector. Our liking for EFERT has increased post unexpected continuation of gas supply in 2H14 which we believe has set the stage for meaningful earnings upside and aggressive deleveraging in 2014. Furthermore, recent govt decision of diversion of priority gas allocation of gas to the fertilizer sector can work in EFERT's favor. EFERT is expected to post net earnings of PRs5.1bn (EPS:3.89/sh) during 9M14. While the currency devaluation is expected to add the sour flavor during 3Q14 in the shape of forex losses, any tax losses may result in an earnings surprise. The stock has underperformed the KSE-100 index by 1.6%/16% in the past 3/6M, making it much attractive at CY15E P/E of 7.7x. PO lifted to PRs66/sh; Upgrade rating to Buy We have raised our PO for Engro Fertilizers (EFERT) by 12% to PRs66/sh and have upgraded the stock to Buy from Neutral. Unexpected continuation of gas supply into 2H14 resulting in earnings upside and aggressive deleveraging, coupled with relative underperformance of stock in 3/6mth vs KSE-100 index have strengthened a case for rating upgrade, in our view. At CY14/15E P/E of 10.3x/7.7x, EFERT trades at 10% discount to its peers. Moreover, the govt’s move to divert gas towards the fertilizer sector will likely increase confidence in the longevity of Guddu gas to EFERT and lead to narrowing of valuation discount. 10 October 2014 Ameet Daulat Ameet.daulat@kasb.com KASB Securities Limited +92 21 111 222 000 Current Price PRs55.04 Price Objective PRs66 KATS Reuters Bloomberg EFERT ENGR.KA EFERT PA Shares Outstanding 1318.3mn Market Cap PRs72562mn (USD705.51mn) EFERT Valuation Snapshot ...however absence of concessionary prices leads to earnings cut PRsmn 2013A 2014E 2015E We have also trimmed our earnings projections for 2014/15E by -2%/-21% on account of delay in the billing of concessionary gas rate to 2H15. Our previous forecast incorporated US$0.7/mmbtu gas prices for feedstock portion from Mari field in 4Q14 which we believe has become irrelevant given likely continuation of gas supply from Guddu, enabling the company to successfully run both the plants during 2H14. Revenue %∆ PAT %∆ EPS (PRs) P/E (x) 50,129 14% 5,497 NM 4.17 13.19 57,619 15% 7,021 28% 5.33 10.33 48,379 -16% 9,476 35% 7.19 7.65 0.00 0% 2.89 22% 5.83 1.00 2% 2.26 22% 5.30 2.00 4% 1.80 24% 4.70 Optimism from the government reigniting faith in sustained gas supply Not long ago in May-14, the government diverted the gas from the fertilizer sector to the power sector which has played its part in narrowing the demand-supply gap to 242k tons, the lowest during 2014. Consequently, the latest news flow suggests that in order to address the demandsupply gap and reducing the subsidy needed for imported fertilizer, the government aims to promote the fertilizer sector up the priority list over the power sector. This move has reignited faith in the profitability levels of the fertilizer sector which seems set to end the year on a high note. Aggressive deleveraging and enhanced gas supply from Guddu to boost earnings EFERT’s earnings are expected to continue their prolific run where we expect the company to post PAT of PRs1.8bn (EPS: PRs1.33) in 3Q14. As a result, EFERT is expected to clock in hefty growth (59% YoY) in 9M14 to post PAT of PRs5.1bn (EPS: PRs3.89). While the key trigger for this growth seems to be the gas diverted from Guddu power plant, the aggressive deleveraging which is expected to result in a 33% YoY dip in the financial charges also contributes largely for this robust growth in 9M14. From the 2013 level of 55%, given the handsome amount of cash the company holds (excluding any GIDC payment), we expect the D/A ratio of EFERT to plunge down to 39%. Consequently, we expect the company to abide by the IFC covenants of dividend payment much earlier than expected. Moreover, on the back of strong operations we believe that EFERT will be successful in maintaining this healthy cash position, going forward, enabling it to retire its debt by 2018. Refer to important disclosures on page 3 DPS (PkR) Yield (%) P/BV (x) ROE EV/EBITDA Source: KASB Research Earnings sensitivity 2015E 2016E Base case 7.19 10.45 Worst case 5.03 5.92 PRs EPS PO Base case 66.00 Worst case 48.00 Source: KASB Research Page 1 morning shout PRs mn 9M14E 9M13 YoY 3Q14E 3Q13 YoY Sales Gross Profit 43,589 15,287 34,422 18,727 27% -18% 15,932 5,414 13,903 7,655 15% -29% EBITDA EBT 12,248 7,558 15,679 4,799 -22% 57% 4,277 2,655 6,513 2,747 -34% -3% 5,127 3.89 3,234 2.45 59% 59% 1,752 1.33 1,808 1.37 -3% -3% PAT EPS (PRs) KSE-100 Intra-day Movement 30,125 High 30,122 30,097 30,069 30,041 30,013 GIDC saga: far from over The future of GIDC collection continues to remain uncertain as series of court cases have opened many battle fields for the government. The government attempted to bypass Peshawar High Court’s verdict against GIDC through a Presidential Ordinance. However the Lahore High Court and the Sindh High Court have given unfavorable verdicts, implying that the government might take some time to disentangle itself from legal challenges. From EFERT’s perspective, the decision on GIDC is unlikely to have major brunt on our investment thesis though market had earlier become jittery on potential levy of GIDC on EFERT’s feedstock gas supply. We opine the issue was given undue importance as EFERT’s peer, Fatima Fertilizer which has similar pricing arrangement for feedstock has obtained a stay order from court. This has raised possibility of EFERT receiving a similar favorable verdict from the courts. No major downside in worst-case scenario for EFERT In our base case scenario, we have assumed the concessionary gas rate to clock in from 2H15 onwards, however the absence of concessionary gas rate in the long run (worst case scenario) will make it a different ball game altogether dwindling the profitability levels of EFERT. Our preliminary sensitivity analysis suggests that in such a scenario, 2015 earnings are likely to be slashed by 30% to PRs6.6bn (EPS: PRs5.03) and PO down to PRs48/sh or 13% below current stock price. Foreign reserves up by US$190mn (BR) Pakistan’s total liquid foreign reserves rose by US$190mn to US$13.4bn as on 3 October, compared to US$13.2bn a week earlier. The increase can primarily be attributed to inflow of Coalition Support Fund (CSF).. Technical View Ahmed Hanif ahmed.hanif@kasb.com KSE-100: Resistance holds; back towards the 29,300-29,500 area The index yet again broke the 30,000 level and gave a closing below that, suggesting that it could retest the 29,300-29,500 area. The index has failed to break the 30,300 level multiple times and has formed a strong resistance at 30,150-30,200. 29,985 Low 29,963 29,957 9:30 AM 10:53 AM 12:16 1:39 PM 3:01 PM PM Source: KSE Index Data & Volume Leaders KSE30 KSE100 KSE All Share MARI PPL PSO ICI GLAXO Close 20,296.32 29,978.94 % Chg -0.7% -0.4% Vol. US$ mn 31.20 44.46 21,930.92 493.36 223.26 353.40 541.27 203.15 -0.7% 2.2% -1.2% -1.6% 2.8% 0.1% 56.90 6.95 5.32 2.70 2.44 2.39 Source: KSE KSE-100: Top Gainers & Losers JDWS HUMNL ARM GRAYS SHFA TRG HBL OGDC Only a closing above 30,300 could guide the index further towards 31,500-32,000 area. PCAL It is recommended to liquidate trading positions on strength and wait for the index to close above 30,300 to accumulate positions. PAKT -6% -2% 2% 6% Source: KSE Page 2 morning shout World Markets and Commodity Prices International Equity Markets Asian Markets (Closing Rates) Price All Ordinaries Shanghai Composite Hang Seng BSE 30 Jakarta Composite KLSE Composite Nikkei 225 NZSE 50 Straits Times Seoul Composite Taiwan Weighted KSE-100 Index Abs. Chg. 5,293.30 2,375.28 23,534.53 26,637.28 4,993.88 1,829.73 15,478.93 5,266.04 3,259.25 1,965.25 8,966.44 29,978.94 51.7 48.9 271.2 390.5 35.4 5.4 -117.0 20.1 32.5 0.0 11.3 -124.3 % Chg. 1.0 2.1 1.2 1.5 0.7 0.3 -0.8 0.4 1.0 0.0 0.1 -0.4 European Markets (Last Trading Session’s Rates) Price Abs. Chg. ATX BEL-20 CAC 40 DAX AEX General Swiss Market FTSE 100 % Chg. 2,114.58 3,092.71 4,141.45 9,005.02 402.66 8,482.90 6,431.90 -8.6 -7.3 -26.7 9.7 -0.8 -34.4 -50.3 -0.4 -0.2 -0.6 0.1 -0.2 -0.4 -0.8 16,659.25 4,378.34 4,041.12 1,928.21 -335.0 -90.3 0.0 -40.7 -2.0 -2.0 0.0 -2.1 American Markets Dow Jones Ind. Average NASDAQ Composite NASDAQ -100 S&P 500 Index, RTH Source: Bloomberg Foreign Portfolio Investment in Equities Country Day (US$mn) Pakistan India Indonesia Japan Philippines South Korea Sri Lanka Taiwan Thailand Vietnam Abu Dhabi Qatar (2.9) (193.5) (19.8) N.A (11.2) (136.3) (0.1) 1.2 45.5 (4.4) (6.4) (8.6) WTD (US$mn) 9.4 (200.2) (38.0) 1,699.2 (155.3) (641.9) (0.2) (256.2) (31.7) (8.8) (13.1) 31.4 MTD (US$mn) 7.2 (105.2) (263.7) 1,699.2 (198.5) (1,194.3) 20.8 (559.6) (40.6) (17.8) (24.3) 86.8 YTD (US$mn) 12M (US$mn) 431.1 13,708.4 3,963.7 (5,524.4) 1,124.5 6,903.1 71.3 10,617.5 (128.4) 205.0 1,063.3 2,406.0 495.5 19,807.7 3,085.9 45,488.7 726.1 7,890.7 86.2 13,163.2 (2,761.4) 308.9 1,316.8 2,664.3 Date 09-10 08-10 09-10 26-09 09-10 09-10 09-10 09-10 09-10 09-10 09-10 02-10 Source: Bloomberg, NCCPL Forex and Money Market snapshot 6-Month KIBOR (Offer) 12-M T-Bill (Average) 10- year PIB (Average) PkR/ US$ Current Previous Chg. 10.19 10.08 13.40 102.85 10.19 10.08 13.38 102.54 0.00 0.00 0.02 0.31 Abs. Chg. % Chg. -1.5 -1.8 3.2 -1.0 0.3 -0.4 Source: KASB Money Market Commodity Prices Price WTI (Crude Oil) Gold CRB Index 85.77 1,224.31 276.41 Source: Bloomberg KASB Securities Limited, 5th Floor, Trade Centre, I.I. Chundrigar Road, Karachi This report has been prepared by KASB Securities Ltd. and is provided for information purposes only. Under no circumstances is to be used or considered as an offer to sell or solicitation of any offer to buy. While all reasonable care has been taken to ensure that the information contained therein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and it should not be relied upon as such. From time to time KASB Securities Ltd. and any of its officers or directors may, to the extent permitted by law, have a position, or otherwise be interested in any transaction, in any securities directly or indirectly subject of this report. This report is provided solely for the information of professional advisers who are expected to make their own investment decisions without undue reliance on this report and the company accepts no responsibility whatsoever for any direct or indirect consequential loss arising from any use of this report or its contents. In particular, the report takes no accounts of the investment objectives, financial situation and particular need of individuals, who should seek further advice before making any investment. This report may not be reproduced, distributed or published by any recipient for any purpose. The views expressed in this document are those of the KASB Securities & Economic Research Department and do not necessarily reflect those of KASB or its directors. KASB, as a full-service firm, has or may have business relationships, including investment-banking relationships, with the companies in this report. Page 3