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JS Securities Limited – JS Research (July 29, 2022)

Karachi, July 29, 2022 (PPI-OT): EFERT: Higher tax charge leads to loss in 2QCY22

EFERT announced its 2QCY22 results yesterday, reporting a loss of Rs0.07/sh, compared to a profit of Rs 3.57/sh during the SPLY. The result was lower than street estimates mainly due to higher tax charge and exchange loss on foreign payables.

Contrary to expectations, the Board skipped payout owing to the quarter’s loss, containing 1HCY22 DPS at Rs5.5, likely leading to a downward revision in our CY22 DPS estimates. We expect the company to resume payouts as per its long-term policy of distributing almost all of its profits.

Management, in its post-results Corporate Briefing session, shared that framework for a new fertilizer policy is being discussed with the GoP, aiming to eliminate gas subsidy to the sector and deregulate the industry. This would pave way for a transition towards the weighted average cost of gas mechanism to curtail gas circular debt.

Loss owing to tax charge and other expenses

EFERT posted a loss of Rs98mn (LPS of Rs0.07) during 2QCY22 vis-a-vis PAT of Rs4.7bn (EPS of Rs3.57) in 2QCY21. The company showed a slight increase of 1ppt QoQ at the gross margin level in 2QCY22, mainly due to better retention prices. Finance cost for the quarter came in higher due to higher interest rates. Management shared that the company booked higher other expenses owing to exchange loss on DAP shipments to the tune of Rs700mn.

Higher tax charge was however the biggest culprit, which had three components, (1) 10% super tax on last year’s income, (2) 4% incremental tax on the earnings for 1HCY22 and (3) charge related to deferred tax due to 4% increase in future tax rates (Rs1.6bn).

The Board did not announce any dividend for this quarter but management expects that the company’s long-term dividend policy of distributing most of its profits will continue going forward. Following the skipped dividend in 2Q and production cuts explained below, we would be revising our CY22E dividend downward.

Production loss and higher costs expected in 3QCY22

Management shared that the company’s flagship Enven plant, which had faced a breakdown in June, resulted in loss of production of around 111k tons. The plant has now resumed production. It is expected that 3QCY22 financial results will likely show a higher repair and maintenance charge because of the incident. Management shared that it has also planned a BMR on it Base plant which has a capacity to produce c. 975k tons of Urea per annum. The overhaul will take around 2 months during which the plant will be offline. This measure will help the company improve gas efficiencies.

To recall, output tax on Fertilizers has been made exempt making input tax a part of cost as per the Finance Act 2022. This will increase manufacturing costs for the sector and will reflect in financials 3QCY22 onwards. Company has already passed on the impact of the aforementioned by increasing Urea prices during the outgoing month taking retail price of Urea to ~Rs2,200/bag (+Rs350/bag).

A new fertilizer policy on the cards

The industry is in talks with the government over a new fertilizer policy for the last several months under which there would be no gas subsidy and industry would have a uniform gas rate. It is also being proposed to effectively deregulate the fertilizer industry.

Being a deregulated industry, any increase in gas prices would likely to be passed on by the industry. According to the proposed policy the industry would also be able to export any excess fertilizer in the future. To note, domestic Urea prices are at c. 80% discount to international Urea prices.

Sustainable yields still make Fertilizers a safer bet

Even with the additional one-time tax charge, we believe that given (i) expected increase in wheat crop prices and (ii) government’s increased focus on improving agricultural yields and farmer income evident from the measures taken in the Federal Budget, will help fertilizer sector stay in the limelight. We do not rule out further increase in prices in case of a hike in gas prices or move toward WACOG. Key factor will be the manufacturers’ ability to pass on cost pressures, given government’s pushback on urea prices in the last quarter.

We hence maintain our Overweight stance intact on the Fertilizer sector. The sector’s cash rich position directs at sustainable pay-outs for the future, offering D/Y of 12-13%.

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