Corporate Finance

Financial Analysis of Fertilizer

Industry
Fatima Fertilizer
Fauji Fertilizer
Fauji Fertilizer Bin Qasim
Group # 5 - Members
Anwar Ul Hassan
Syed Muzzamil Imam
Muhammad Arsalan Ahmed

TABLE OF CONTENTS
Executive Summary ...........................................................................................................................3
Risk Profile ..........................................................................................................................................5
Investment Analysis ............................................................................................................................5
Capital structure .................................................................................................................................5
D i v i de n d po l i c y .................................................................................................................................7
V a l u a t i o n ...........................................................................................................................................7
Introduction ....................................................................................................................................7
Brief description of the companies .....................................................................................................8
Fatima Fertilizer .............................................................................................................................8
About the company ....................................................................................................................8
Final Products..............................................................................................................................9
Intermediary Products ................................................................................................................9
Cost estimates & Plant Performance ..........................................................................................9
Fauji Fertilizer Company Limited ................................................................................................ 11
About the Company ................................................................................................................. 11
Largest Urea producer ............................................................................................................. 11
Production Efficiency .............................................................................................................. 12
MIRPUR MATHELO-Urea Production (met Tons/Year) .......................................................... 14
Vast distribution networks an important plus point ............................................................... 14
Low leverage levels .................................................................................................................. 14
Gas curtailment more than offset by price hike ...................................................................... 15
Mulling purchase of Agritech Ltd ............................................................................................. 15
Wind power project expected to commence in 1qCy12 ......................................................... 15
Benefits from Engros cost increase and margin push ............................................................ 16
Management compensation ........................................................................................................ 16
Social responsibility ........................................................................................................................ 18
FFC CSR ....................................................................................................................................... 18
Relief ........................................................................................................................................ 18
Rehabilitation .......................................................................................................................... 19
Fatima Fertilizer CSR .................................................................................................................. 19
Fatima Fertilizer Welfare Hospital (FFWH) .............................................................................. 20
Clean Development Mechanism ............................................................................................ 20
Market risk and return .................................................................................................................. 20
Slope of the regression Beta ..................................................................................................... 22
R - squared .................................................................................................................................. 22
S t a n da r d e r r o r s ......................................................................................................................... 22

Cost of equity ................................................................................................................................ 22

Cost of debt ..................................................................................................................................... 24
Cost of capital .................................................................................................................................. 26
M a r k e t v a l u e o f e q ui t y ............................................................................................................ 26
D e bt a n d E q u i t y r a t i os ............................................................................................................ 26
Measuring Returns ..................................................................................................................... 27
ROE and ROC........................................................................................................................... 27
Future outlook ......................................................................................................................... 28
C o n c l u s io n s .................................................................................................................................... 30
Current financing mix ...................................................................................................................... 31
FFBL .............................................................................................................................................. 31
FATIMA......................................................................................................................................... 31
FFBL .............................................................................................................................................. 31
Current Cost of Capital / Financing Mix.......................................................................................... 48
Cost of Capital at Different Financing Mixes .............................................................................. 49
Quantitative Analysis ...................................................................................................................... 50
Current Dividend Policy .............................................................................................................. 50
Fatima Fertilizer .......................................................................................................................... 58
FFC BIN QASIM ............................................................................................................................. 58
Valuation models ............................................................................................................................ 58
Valuation model and inputs. ....................................................................................................... 59
FATIMA Fertilizer:........................................................................................................................ 59
FAUJI Fertilizer Limited ............................................................................................................... 60
FAUJI Fertilizer Bin Qasim ........................................................................................................... 61
Appendix .......................................................................................................................................... 68
Fatima Fertilizer Balance Sheet ................................................................................................. 68
Fatima Fertilizer Income Statement .......................................................................................... 70
Fauji Fertilizer Bin Qasim Limited Balance Sheet ..................................................................... 71
Fauji Fertilizer Bin Qasim Profit & Loss Account ....................................................................... 73
Fauji Fertilizer Company Balance Sheet ................................................................................... 73
Fauji Fertilizer Profit & Loss Account ......................................................................................... 76

EXECUTIVE SUMMARY
21% of Pakistans GDP is backed by the agriculture sector and a hefty 62% of countrys population is
directly or indirectly dependent on agriculture. The Agriculture sectors strong linkages with the rest of
the economy are not fully captured in the statistics. While on the one hand, the sector is a primary
supplier of raw materials to downstream industry, contributing substantially to Pakistans exports, on
the other, it is a large market for industrial products such as fertilizer, pesticides, tractors and
agricultural implements. A thriving agriculture sector is also essential to the prosperity of
manufacturing sector of the economy which mainly consists of agro based industries such as textiles,
sugar, food etc.
Fertilizers are substances added to soil to improve the growth of plants, as well as their yield. Fertilizer
industry in Pakistan is dominated by two main products; urea (nitrogen based product, accounting for
66% market share) and DAP (phosphorus based product, having 19% market share). Countrys annual
urea demand is approximately 6.5mn tons with local manufacturing capacity being 5.0mn tons. Delta
demand is met through imports. While Fauji Fertilizer Bin Qasim is the sole producer of DAP in
Pakistan, accounting for 42% of local DAP market share, whereas the remaining 58% demand is met
through imports.
Due to this high dependence ratio on agriculture sector, Government has always maintained a
transparent and consistent policy for fertilizer industry regarding, a) fresh investments, b) input prices,
c) supply of inputs. After domestic consumers, fertilizer industry is placed at priority list when it comes
to rationing of gas. The largest domestic urea producing companies receive their gas supply from Mari
Gas field. Mari field gas is not pipeline quality due to which there is limited risk of gas diversion, even if
there is shortage of gas in other segments.
The government sets minimum purchase prices of major crops (wheat, paddy, sugarcane). In the
absence of a commodity exchange, support prices ensure a fair return to the farmers, thus giving them
incentives to invest in these crops. Besides this, the farmer income is exempt from corporate and
general sales tax.
Pakistan is currently deficient in urea production by 1.5mn tons, but the scenario will change in the
next few months once Fatima Fertilizer and Engro plants comes online. The total urea capacity of two
plants will be around 1.8mn tons. The concerns that the country may face excess capacity in domestic
market leading to under utilizations or price wars is exaggerated as new urea capacity of 1.8mn tons is
only 0.3mn tons above the current deficit. The gas load shedding is estimated to reduce domestic
fertilizer production by 0.3-0.6mn tons at least. Looking at current local demand supply balance,
imports, future expansions and gas curtailment, it is likely that Pakistan will face urea shortage from
2012 and onwards on a conservative basis.
Flash floods so far depict a devastating picture. While final numbers would take time to shape up, the
situation is dire and macro targets for FY11E are destined to change. In a nutshell we see demand for
both urea & DAP will be soft in 2010E and should correct in 2011E. The last instance of excessive
flooding in Pakistan (c. Sep 1992 i.e., FY93) resulted in FY93 agricultural growth of -5.3% (from +9.5%
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in FY92). Likewise, the year following 1992 floods, nitrogen application growth slowed down to +1%
while phosphate demand slipped to -5%. A potential positive for the longer term is that the present
increase in dams water level may actually bode well for agricultural growth and fertilizer demand one
year out where lower than mean water availability has stunted growth in major crops in the last couple
of years.

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RISK PROFILE

FIGURE 1: RISK PROFILE

We used beta to estimate the exposure of each company to market risk. The results reflect the
fundamental characteristics of each company and in particular variance of earnings and leverage.
The riskiest company as measured by historical regression beta is Fauji Fertilizer Bin Qasim and the
least risky is Fauji Fertilizer Limited (FFC). Because of the historical character of the regressions beta
and high standard errors of the estimates we used bottom-up betas in our further analysis.
In addition, returns on capital of each company with relation to its risk have been calculated. The top
performing companies were Fauji Fertilizer Limited and Fatima Fertilizer Limited (FFL).

INVESTMENT ANALYSIS
We used accounting measures of return to analyze the return on typical investment projects
at which the companies are investing in fertilizer sector, such as ROC and ROE. Fauji Fertilizer Bin
Qasim (FFBL) proved to be the company with highest returns on equity. In addition we assessed the
future prospects of each company, analyzing the sustainability of its competitive advantages. This
analysis was used as a basis for the valuation of the
Firms.

CAPITAL STRUCTURE
The three companies adopt very different policies with regards to their capital structure, ranging
from the highly over levered FFBL with debt ratio of 75:25 to highly equity financed FFC with debt
ratio of 15:85. Taking into account the potential benefits and disadvantages from the use of debt
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we computed optimal capital structures for each firm and assessed the impact on the WACC from
moving from the current capital structure to the optimal. The result was an average of 3-5%change
in the WACC value of the firms, most of this decrease comes from FFC.

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DIVIDEND POLICY
All three companies are dividend paying companies, although for very different reason,
FFC and FFC Bin Qasim pays out all almost profit in its dividend .This exhibits a great potential to
invest in both of these companies for short term gains. On the other hand Fatima Fertilizer
Limited (FFL) pays half of its profits as dividends.

VALUATION
The results from our valuations are presented in the table below:

FIGURE 2: VALUATION

The valuation models are based on the results from our analysis as presented in the following pages.

INTRODUCTION
The current report examines major trends in the Fertilizer sector focusing on 3 major production
companies Fatima Fertilizer Limited, Fauji Fertilizer Company and Fauji Fertilizer Bin Qasim
Limited. The companies reviewed operate in same businesses, Fertilizer production industry,
utilize different business models and are at different stage of their life cycle. The purpose of the
report is to analyze different aspects of their corporate finance policies and to assess the effect of
these policies on the value the managements of these firms create for their shareholders.
Summary information for each company is presented in Figure 1.
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FIGURE 3: COMPANY INFORMATION

Throughout the report analysis has been presented based on information gathered from
various public sources, including statutory filings with regulatory authorities in the respective
jurisdiction, company annual reports, management presentation and other publicly available
information. We have tried to acknowledge each source of information where possible. Figures
and data that are not referenced to any source has been result of our own analysis.
For computational ease the analysis for each company has been undertaken in the reporting
currency under which the company reports annual results.

BRIEF DESCRIPTION OF THE COMPANIES

FATIMA FERTILIZER
ABOUT THE COMPANY
Fatima Fertilizer is a joint venture of Fatima Group and Arif Habib Group. Fatima Group and Arif Habib Group
also own Pak Arab Fertilizers Limited which produces CAN, NP and UREA having a total capacity of 0.85mn
tons/annum. Fatima Fertilizer is setting up largest fertilizer complex with production capacity of 1.58 Million
tons/annum. 110 MMCFD gas has been allocated from Mari Gas Company Limited for ten years which can be
extended afterwards. China National Chemical Engineering Corporation (CNCEC) was the main Civil,
Mechanical and commissioning contractor.

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FIGURE 4

CAN and Urea have already started production. NP plant is projected to start commercial production from
December this year. The project is located on 947 Acres of land acquired at Plant site Mukhtar Garh
Sadiqabad, Rahim Yar Khan in the Punjab Province.

FINAL PRODUCTS

Urea plant 1,500 TPD

Calcium Ammonium Nitrate Plant (CAN) 1,400 TPD
Nitro Phosphate Plant (NP) 1,200 TPD

INTERMEDIARY PRODUCTS

Ammonia Plant 1,500 TPD

Nitric Acid Plant (NA) 1,500 TPD

COST ESTIMATES & PLANT PERFORMANCE

Commercial production for the urea and CAN plants had started in Apr-10, while the NP/NPK plant is slated
to come online by Dec-10. As per NFDC, urea and CAN production for the first two months (Apr-May) stood
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at 69.4k tons and 23.9k tons. As per the mgmt., current utilization of both urea and CAN plants stands at
107% and 94% respectively.

Page 10 of 47

FAUJI FERTILIZER COMPANY LIMITED

ABOUT THE COMPANY
Fauji Fertilizer Company (FFC) was incorporated in 1978 as a private limited company, in a joint
venture between Fauji Foundation (a leading charitable trust in Pakistan) and Haldor Topsoe A/S of
Denmark. Present share capital of the company stands at PKR6.8bn. FFC has 51%, 12.5% and 13.5%
stake in Fauji Fertilizer Bin Qasim Limited (formerly FFC-Jordan Fertilizer Company Limited), Pak
Maroc Phosphor (PMP) and Fauji Cement Company Limited (FCCL) respectively. FFC commenced
commercial production of urea in 1982 with designed annual capacity of 570k tons, which has been
subsequently augmented to 1.9mn tons at present. FFC currently has 678.5mn shares outstanding
out of which 44% shares are held by Fauji Foundation, being the largest shareholder of the
company.
FFC is involved in manufacturing & sale of urea, and also imports and sells phosphate fertilizers.
Fauji holds 50.88% share in Fauji Fertilizer Bin Qasim (FFBL), a listed company involved in
manufacturing and sale of urea and DAP. FFBL is the only DAP manufacturer in the country. FC also
has joint-venture investment with OCP of Morocco in phosphoric acid manufacturing operations
(Pak Maroc Phosphore). PMP is a USD 240mn project with FFC holding 12.5% of the equity.
SONE UREA

Most widely used fertilizer in the country. Fertilizer is white in color, free flowing, readily soluble in
water and both contain 46% Nitrogen. Because of its high solubility, it is suitable for solution
fertilizers.

SONA DAP

is the most concentrated phosphate fertilizer containing 46% P 2O5 and 18% Nitrogen. It is the
widely used phosphate fertilizer in the world as well as Pakistan. The solubility of DAP is more than
95%. Its nitrogen to phosphorus ratio (1: 2.5) makes it an ideal fertilizer, to meet the initial
requirement of most of the crops.

SONA SOP

This fertilizer is an important source of Potash, which is a quality nutrient for production of crops
especially fruits and vegetables. Potash improves the resistance of the plants against pests, diseases
and stresses like water.
LARGEST UREA PRODUCER
FFC is currently the largest urea manufacturer in the country (Engro, after its 1.3mn ton expansion
will overtake FFC to become the largest urea manufacturer in 2010) with a market share of 42%.
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The company has a production capacity of approximately 1.9mn tons. Being the largest urea
manufacturer, FFC benefits from economies of scale, and as a result has the best gross, operating
and net margins in the industry.

FIGURE 5: FIVE YEAR AVERAGE MARGIN

PRODUCTION EFFICIENCY
GOTH MACHHI-Urea Production (met Tons/Year)
Base Unit

Expansion Unit

Total

Years

Production

Capacity
Factor
(% Production
Design)

1982

325,452*

93.86

325,452

93.86

1983

566,771

99.43

566,771

99.43

1984

589,258

103.37

589,258

103.37

1985

598,694

105.03

598,694

105.03

Capacity
Factor
Design)

(% Production

Capacity
Factor
Design)

(%

Page 12 of 47

1986

594,901

104.36

594,901

104.36

1987

632,079

110.89

632,079

110.89

1988

637,737

111.88

637,737

111.88

1989

632,972

111.04

632,972

111.04

1990

652,665

114.50

652,665

114.50

1991

629,266

110.39

629,266

110.39

1992

648,178

102.55

648,178

102.55

1993

657,376

94.58

477,339**

95.85

1,134,715

100.41

1994

678,114

97.57

659,526

103.86

1,337,640

100.57

1995

680,062

97.85

700,031

110.24

1,380,093

103.76

1996

710,862

102.28

695,749

109.56

1,406,611

105.76

1997

773,048

111.22

734,275

115.63

1,507,323

113.33

1998

742,599

106.84

682,969

107.55

1,425,568

107.18

1999

726,723

104.56

734,689

115.69

1,461,412

109.88

2000

729,864

105.01

695,938

109.59

1,42,5802

107.20

2001

737,607

106.13

756,417

119.12

1,494,024

112.33

2002

801,825

115.43

713,889

112.38

1,515,714

113.97

* Start-up of commercial production on 14 June 1982

** Start-up of commercial production on 21 March 1983

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MIRPUR MATHELO-UREA PRODUCTION (MET TONS/YEAR)

Base Unit

Expansion Unit

Years

Production

Capacity
Factor
Design)

2002

59,886*

102.91

(% Production

Capacity
Factor
Design)
-

Total

(% Production

590,886

Capacity Factor
(% Design)
102.91

* FFC acquired 100% management control of PSFL-Mirpur Mathelo

effective from July 1,2002

Source: http://www.ffc.com.pk/contents/manfacturing.htm

VAST DISTRIBUTION NETWORKS AN IMPORTANT PLUS POINT

FFC being the current market leader in urea, has the most stretched out distribution network. The
company has its outreach in all four provinces with market leadership in Punjab, Baluchistan and
NWFP provinces, whereas the companys prime competitor Engro only has a strong hold in Sindh
region. FFC also markets FFBLs products through its distribution setup. The company charges
commission for marketing these products. This ensures that FFBL is able to cost efficiently and
effectively sell its produce throughout the country, which indirectly benefits FFC through dividend
income.

LOW LEVERAGE LEVELS

One of the strongest points for FFC is its low level of leverage. In the current environment of high
interest rates, this attribute gives FFC an edge over its competitors which are suffering from high
finance costs. FFC, currently does not have any significant expansion plans in sight other than BMRE
on plant 1 (this would not require any significant financing requirement). Hence, the debt level is
expected to remain low. However, in case of any attractive future investment plans, FFC could
easily leverage its balance sheet to fund the investments.

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GAS CURTAILMENT MORE THAN OFFSET BY PRICE HIKE

FFC and Engro have more than offset the negative impact of lost production by raising urea prices
by PKR 75/50kg bag. The price increase was calculated on the assumption of 12% gas curtailment
on Mari field based plants whereas the actual curtailment during 1h2010 has been only 4-5%. Mari
field based fertilizers plants have witnessed margin increased during 2q2010 due to lesser than
expected gas curtailment.

MULLING PURCHASE OF AGRITECH LTD

FFC is reportedly contemplating bidding for Agritech Ltd (AGL) and its 100% owned subsidiary
Hazara Phosphate Fertilizers (HPFL), as Azgard Nine Ltd, the majority shareholder of Agritech, has
decided to completely divest its 80% equity stake in the company. Agritech currently has the
capacity to produce 0.38mn tons of urea and 0.1mn tons of single super phosphate (SSP) per
annum. The company plans to increase urea capacity to approx 0.46mn tons / annum through BMR
in Cy10.
While the details on the proposed transaction are not yet available, simplistic calculation indicates
that FFC can easily fund its acquisition through leverage due to companys low current leverage.
Assuming acquisition price is equal to prevailing market price of approximately PKR 23/share, FFC
would require approx PKR 9bn to purchase 100% equity of the target company. Given that cash and
liquid investments amounted to PKR 3.8bn as at Mar 31, 2010, out of which payment of ~PKR 2.7bn
would have been made for the 1qCy10 dividend, FFC would be left with PKR 1.1bn in
cash/investments. Assuming this as minimum cash balance required for working capital needs, it is
likely that the company takes on PKR 9bn (100%) worth of debt to fund the acquisition.
Furthermore, given FFCs strong internal cash generation, it is plausible that the company funds the
acquisition through financing. As such, additional annual financial charges of PKR 1,350mn
(assuming 15% cost of debt), is hardly significant compared to companys average annual EBITDA of
Rs15bn.

WIND POWER PROJECT EXPECTED TO COMMENCE IN 1QCY12

Financial close for the USD 130mn, 50MW wind power project proposed to be set up at Jhimpir,
Thatta is now expected to be achieved in Sept-2010 against earlier expectation of June-2010. The
project is likely to start commercial production approx 16 months after financial close (1qCy12).

Page 15 of 47

FIGURE 6: FREE CASH FLOW TO EQUITY

BENEFITS FROM ENGROS COST INCREASE AND MARGIN PUSH

To mitigate its rising expansion costs, stemming from depreciating Rupee and higher financial
charges, Engro has been pushing for increase in urea selling prices. This as a result has directly
benefited FFC, as the company has followed Engros price hikes. The above has resulted in margin
increase for the company. During CY07 and CY08, local urea prices have increased by approximately
PKR170/bag, while FFCs gross margins have increased by 800 bps over the same period. We expect
Engro to continue with price hikes, (at least till local supply demand scenario remains favorable
for manufacturers) which will continue to benefit FFC.

MANAGEMENT COMPENSATION
Management compensation does not appear to be an issue at any of the companies
analyzed. All CEO, directors and executives are getting market competitive compensations. None
of the CEOs own a significant stake in their companies. Details about the CEOs, their
compensations and the composition of the Board are presented in Figure below.

Page 16 of 47

FIGURE 7: FAUJI FERTILIZER MANAGEMENT COMPENSATION

FIGURE 8

Page 17 of 47

FIGURE 9: FAUJI FERTILIZER BIN QASIM MANAGEMENT COMPENSATION

SOCIAL RESPONSIBILITY

FFC CSR
For Fauji Fertilizer Company Limited, social responsibility means facilitating communities and
empowering its people. Sustainability shall always remain quintessential for the performance of
CSR. Historically, FFC has always been socially a responsible corporate entity. The Company
started its CSR per se as early as in 1982 by introducing Agri-Services thus helping in poverty
alleviation of common farmer and assisting them in sustained empowerment. Gradually FFC
started interventions in most of the defined sectors and has developed a history of about 30 years
of contributions to the society. FFC, further plans to bring sustainability in its interventions and
desires to achieve international standards by aligning CSR with our business objectives. FFC is also
committed to improve quality and quantum of its interventions by maximizing on the available
resources.
Since FFC has become member of covenants like UNGC, the CSR has to be aligned with
international guidelines. It is necessary to standardize the interventions and monitor the quality
of interventions at a central level. We need to stay committed to its principles. Keeping the vision
of responsible corporate entity in mind, FFC has moved in this direction. FFC has made quality as
its core value when it comes to CSR intervention at any level, and in future this will remain as the
prime objective.
RELIEF
Page 18 of 47

In districts Rahim Yar Khan and Ghotki, flood had crippled the lives of people of the area.
FFC thus took the task of shouldering its share of responsibility initially in flood relief effort
for the affected natives of District Rahim Yar Khan and Ghotki. Some of these relief efforts
were:

Distribution of cooked food

Dry ration for families

Transport for Evacuation

Mineral & FFC filtered Drinking Water

Tents/ shelters

Cloths, Blankets & Shoes for the affected families

Soap & Washing Powder

Crockery

FFC employees voluntarily made remarkable contribution in their respective plant sites
which amounts to millions. Food, drinking water, beddings, shelters and clothing was
provided to the flood affectees in the relief phase of the operation. Medical teams from
FFC medical units performed day night service for the flood affectees in Rahim Yar Khan
and Ghotki, saving many precious lives.
REHABILITATION

FFC has taken up the challenge of reconstructing 3 villages of districts Rahim Yar Khan and
Ghotki. The intervention is planned in Reconstructing of Houses, Education, Health,
Shelter, Water and Sanitation and Infrastructure. This project of rehabilitation and
reconstruction will cost 102 million (PKR) out of which 50% will be contributed by FFC.

A project has been devised to construct Houses, water supply, pathways & sanitation
facility for the affected natives of Muaza Chacharan, Mohib Shah (Rahim Yar Khan) and
Chuttoo Chachar (Ghotki). FFC while acting as a responsible corporate entity has lead from
the front in this time of national grief and has played an exemplary role for other entities
to come forward and contribute their share.
FATIMA FERTILIZER CSR

At Fatima Fertilizer Company, CSR revolves around a self-regulating mechanism and adheres to the laws,
ethical standards and internal values.

FATIMA FERTILIZER WELFARE HOSPITAL (FFWH)

Fatima Fertilizer Welfare Hospital (FFWH) is a key project of Company's vision towards community welfare.
The Company, under the guidance of Government of Punjab has undertaken to establish a modern welfare
hospital in the vicinity of Plant site, to cater for the needs of underprivileged of the area.
This is the first ever initiative of its kind and magnitude in private sector.

CLEAN DEVELOPMENT MECHANISM

Global warming has become the most important challenge the world is facing in the 21st century. A lot of
research and development is being done for curtailing greenhouse gas emissions. Following its accession to
the Kyoto Protocol of the United Nations Framework Convention on Climate Change (UNFCCC) in January
2005 Pakistan made the Ministry of Environment the Designated National Authority (DNA) for CDM under
the protocol. A CDM cell was created in the Ministry in August 2005.
In order to care for the environment and greenhouse effect, the Management has installed a Clean
Development Mechanism (CDM) Project on its Nitric Acid plant.
It is expected that about 1.3 million CER's per annum will accrue from the start of the project up to 2020.
Mitsubishi Corporation has assisted in implementation of the project and is now in the process of
registration of Fatima Fertilizer's CDM Project with the United Nations.
UHDE has provided the technology and equipment and also helping with the implementation of CDM for
Fatima Fertilizer.

MARKET RISK AND RETURN

In analyzing the risk characteristics of the three companies we first looked at their returns
over a two year period compared them to the returns of a broad based market index of
KSE 100. Figure below presents the rebased share prices of all three companies and the
level of the KSE 100

100.00%
80.00%
60.00%
Fatima

40.00%

FFC

20.00%

FFBL

-20.00%
-40.00%

3-Jan-12
3-Feb-12
3-Mar-12
3-Apr-12
3-May-12
3-Jun-12
3-Jul-12
3-Aug-12
3-Sep-12
3-Oct-12
3-Nov-12
3-Dec-12
3-Jan-13
3-Feb-13
3-Mar-13
3-Apr-13
3-May-13
3-Jun-13
3-Jul-13
3-Aug-13
3-Sep-13
3-Oct-13
3-Nov-13
3-Dec-13

0.00%

KSE

-60.00%
FIGURE 10

In general, none of the three firms did better than the market. These results w e r e exp ected for all
three as due to severe economic crises fertilizer sector facing as a whole.
To analyze

the market risk of the three firms we regressed their returns against broad based

market index and used the coefficient of the regression as a measure of market risk. We u s e d t w o
year daily returns for t h e r e g r e s s i o n . The choice of index reflected the marginal investor in each
company, assuming that each

investor

is exposed to the same market risks in their respective

market.

Focuses on the regression coefficient (beta), the regression constant (alpha) and the regression Rsquared. The results from the regressions are summarized in Figure below
Risk profile
Regression Beta
Reference index

Fatima
0.72
KSE-100

Average Risk free

rate
Alpha

12.8%
-0.0081

R2 of Regression
Standard Error of
Beta

FFC
0.55
KSE-100

FFBL
0.83
KSE-100

17.54%

12.8%
-0.0015
4.044%

12.8%
-0.00133
19.37%

0.0131

0.0212

0.0142

FIGURE 11: RISK RETURN CHARACTERISTICS

SLOPE OF THE REGRESSION BETA

The coefficients of the individual regressions are the companies betas and are used as a
measure of the company exposure to market risk. The analysis indicates that FFBL is the company
with highest exposure to market risk (regression beta of 0.83). This is a reflection of high
indebtedness and negative and volatile earnings. FFC on the other hand have regression beta
much lower than the other two companies in the industry. The reasons behind the different risk
profiles of each firm will be examined in greater details further in the report.

R - SQUARED
R-squared of the regression provides information as to what proportion of the variability in
returns could be explained by the regression. The market non-diversifiable risk represents 17.54%,
4.044 % and 19.37% for Fatima, FFC, and FFBL respectively. The remainder is company specific,
non-diversifiable risk. While the relatively high R-squared for Fatima and FFBL could be explained
by the fact that they were small, fast growing companies during the observed period and were
facing numerous company specific challenges in establishing their business models.

STANDARD ERRORS
The standard errors of the regression betas appear to be in between 1-2%, suggesting a 1%
interval for the possible values of the beta..

COST OF EQUITY
The cost of equity has been calculate using the Capital Asset Pricing Model and includes the following
inputs:

Risk free rate of return (Rf) -in estimating the cost of equity we have used long term
government bond to come up with the risk free. The c u r r e n t 10 year bond yields were used i n
the analysis. The 10 year m a t u r i t y of t h e T r e a s u r y bond used reflects the l o n g term investment
horizon of t h e l i k e l y projects. Other periods should be considered for s h o r t e r term p r o j e c t s .

Market risk premium (Rp)- this measure reflects the excess return to which an investor is

entitled as a compensation for the higher risk he / she undertakes by investing in risky security rather
than a riskless one

Beta as computed above.

The cost of equity, for all companies, is defined as:
Ke = Rf + x Rp

The cost of equity computation is summarized in Figure below

FIGURE 12: CALCULATION OF COST OF EQUITY

Cost of Equity
Risk Free Rate
Beta
Risk Premium
Country Risk

Fatima Fertilizer
12.8%
0.72
7%
-

Cost of Equity

17.86 %

Fauji Fertilizer
12.8%
0.55
7%
16.63%

FFBL
12.8%
0.83
7%
18.63%

COST OF DEBT
The other important component of the cost of capital is the cost of debt. It reflects the
perceived risk of the companies by lenders and debt investors, or its credit risk. The two
components of credit risk are default risk (or the probability that a company will cease making
payments as agreed in the credit agreement) and non-recovery risk (or the probability of
recovery of the capital provided, once the company goes in default).
The cost of debt for each company has two components a risk free rate of return and
compensation for the credit risk associated with the company. In estimating the credit risk for
each company we took __ approaches:

After obtaining the respective credit ratings we looked at the credit default spreads
corresponding to each rating, which is a measure of the risk premium required. For all companies
we used the credit default spread embedded in current yields of publicly traded debt. We
computed the cost of debt for each by adding the default spread to the risk free rate for the
respective company. The results are presented in Figure below.
Cost of debt
Pre-tax Cost of Debt

Fatima Fertilizer
12.8%

Marginal Tax Rate

After Tax Cost of Debt (c) * (1-tax rate)

35.00%
8.32%

FFC
12.5%
12.50%
8.13%

FFBL
12.5%
30.00%
8.13%

FIGURE 13: CALCULATION OF COST OF DEBT

24

After computing the cost of debt for each firm we computed the after tax cost of debt. The after tax cost of
debt reflects the fact that interest payable on debt is deductible from the operating income for tax purposes
and results in tax savings for the firms.

25

COST OF CAPITAL

MARKET VALUE OF EQUITY

The market value of equity for each firm has been estimated by multiplying the
number of shares outstanding for each company by the current share price. The market values of
equity are presented in Figure below
Figure 20 Market values of equity place from excel file
Value of Equity (million)
American Airlines
Fatima
Market Value of Equity (million)

67,200

FFC
143,762

BAA
FFBL
37,364

DEBT AND EQUITY RATIOS

FIGURE 14

Comparing the debt ratios for the analyzed companies to the industry average we observe
that FFBLs financial leverage is higher than that of the other two companies in the sector.
These inputs are used in computing the cost of capital for each firm. The weighted
average cost of capital is computed as follows:
W A C C = K e x E / ( D + E ) + K d x D /( E + D )
The inputs and results are summarized in

26

FIGURE 15: CALCULATION OF COST OF CAPITAL

The company with highest cost of capital is Fauji Fertilizer. The lowest cost of capital,
i s that of F a u j i F e r t i l i z e r B i n Q a s i m .
The ability of each firm to grow and create value for its stockholders ultimately
depends on its management capability to identify and undertake projects that generate
returns exceeding the cost of capital employed. In this section we will analyze the quality of
the projects that the three companies undertake ad review the past performance of the
companies as measured by indicators such as Return on Capital (ROC) and Return on Equity
(ROE).

MEASURING RETURNS

ROE AND ROC

For each of the company we compared the Return on Equity (ROE) and Return on Capital (ROC) as
follows:

27

FIGURE 16: ROC & ROE

FUTURE OUTLOOK
The ability of any of the companies to generate positive excess returns depends on its
competitive advantages and their sustainability in the medium and long term. In this section we
look at some key indicators for the Fertilizer sector, which could help us to understand how the
companies are positioned for the future.

28

FAUJI FERTILIZER

FATIMA FERTILIZER

FFC BIN QASIM

29

CONCLUSIONS
In conclusion, we believe that in the medium term FFC and FFBL can sustain competitive
advantages which will allow the company to earn return on capital in excess of its cost of capital.
Fatima Fertilizer in the other hand has been keen to invest in expansion programs aimed to
increase its capacity.

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CURRENT FINANCING MIX

Summary of the current debt structure of all three companies has been given below. As can be
observed, the three companies employ very different kinds of debt:

FFBL
FFC has outstanding a variety of debt notes, from bank debt. On one hand this is driven by the
necessity to tailor the debt to match the companys cash flow profile and risk, which is very
specific. On the other hand this is a symptom of the financial difficulties the company has been
going through and the need to raise capital in any form it was available.

FATIMA
fatima also has debt outstanding and this is a reflection of both the early stage of the life cycle is in and
its ability to generate cash flows, thus funding growth largely with internal funds. we expect the financing
mix to change as the company continues to expand.

FFBL
ffbls debt is almost all made up by loan in the form of assistance form government of Pakistan.

31

Fatima

Fauji Fertilizer

Fauji Fertilizer Bin Qasim

FIGURE 17

Based on the above analysis, we draw the following conclusions:

FFC and FFBL have the ability to carry higher debt ratios given the relative stability of their cash
flow profile compared to Fatima. Whereas Fatimas debt ratio is at the correct level. FFBLs debt
ratio is clearly too high.
VIII.

Optimal Capital Structure

CURRENT COST OF CAPITAL / FINANCING MIX

In the table below we computed the current cost of capital for each of our companies,
with the cost of equity based on their betas and using market values to compute the debt/equity
weights. As expected given their operating and financial profiles, FFC has the highest cost of
capital and FFBL the lowest.

48

FIGURE 18

COST OF CAPITAL AT DIFFERENT FINANCING MIXES

As the next step in our analysis to estimate the optimal capital structure we used the
cost of capital approach to compute a different WACC at each debt ratio for our companies. The
table below summarizes the result.

FIGURE 19

IX.

Mechanics of moving towards the optimal

49

QUANTITATIVE ANALYSIS

CURRENT DIVIDEND POLICY

All three companies that we are analyzing, all of them pay dividends:

FFC has kept a stable dividend policy over the past several years, with an average
dividend payout ratio of 90%.

FIGURE 20

50

FATIMA FERTILIZER
The company generates and still have a dividend payout ratio of 65%. the companys
ROC is higher than its cost of capital and it is rapidly accumulating excess cash.

FIGURE 21

FFC BIN QASIM

The company pays out almost all of its profit in dividends.

VALUATION MODELS
Based on the analysis presented above we proceeded to perform valuation of the
market value of the equity of all three companies. Table below summarizes the choice of
our valuation model and the results.

FIGURE 22

The choice of growth period reflects the sustainability of competitive advantages of each
firm as outlined in above Investment Returns and Future prospects.
VALUATION MODEL AND INPUTS.
The valuation assumptions are.
Sales growth is only due to increase in prices due to inflation. Terminal Growth is minimal for all three
firms. Firm will refinance its existing loan at the same cost of financing.

FATIMA FERTILIZER:

FIGURE 23

FIGURE 24

FIGURE 25

FAUJI FERTILIZER LIMITED

FIGURE 26

FIGURE 27

FAUJI FERTILIZER BIN QASIM

FIGURE 28

FIGURE 29

APPENDIX
FATIMA FERTILIZER BALANCE SHEET

FIGURE 30

FIGURE 31

FATIMA FERTILIZER INCOME STATEMENT

FIGURE 32

FAUJI FERTILIZER BIN QASIM LIMITED BALANCE SHEET

FIGURE 33

FIGURE 34

FAUJI FERTILIZER BIN QASIM PROFIT & LOSS ACCOUNT

FIGURE 35

FAUJI FERTILIZER COMPANY BALANCE SHEET

FIGURE 36

FIGURE 37

FAUJI FERTILIZER PROFIT & LOSS ACCOUNT

FIGURE 38