Company Report - EnGRO - 5th Sept 2011

8/3/2019 Company Report - EnGRO - 5th Sept 2011

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ENGRO Corporation (ENGRO)

September 05, 2011

Last Price

PKR 119.99

Target Price

PKR 256

Market Cap

PKR 47.2 bn

Shares Outstanding

393 mn

Company Report

Avg. daily volume

1.9 mn

Free Float

177 mn

Upside

113%

Comments:

Syed Muhammad Kamran, ACCA

Senior Research Analyst

Farrukh Karim Khan, CFA

Head of Research

Email; [email protected]

Executive Summary

We initiate coverage on ENGRO, with a 5 starNext Capital ranking. The stock offers a 113%upside to our target price of PKR 256.

ENGROs share price has fallen by 42% since itsMarch 2011 high of PKR 206. Investors arespooked about the impact that gas load-sheddingon the new plant would have on earnings anddebt servicing capabilities.

Given the uncertainty about gas load-shedding,we have built two scenarios; a base case and abad case.

Our calculations indicate that the recent investorpessimism over the gas load-shedding issue hasbeen over-done. We estimate that even if gasload shedding continues at a high level (the badcase scenario), ENGRO offers an 81% upside toinvestors.

Table 1: ENGRO Target price sensitivity matrix

54% 60% 63%

100% 275 318 252 14%

80% 211 256 211 13%

345 290 180

Gasfactor-

new

plant

KIBOR

No. of days production - new plant

Primary urea margin - existing plant

Earnings decline due to gas load-shedding will becushioned by raising of urea prices. We expectENGRO to post an EPS of PKR 23.2 and PKR 27.3in FY11 and FY12 respectively.

Figure 1: Relative Price Performance.

0%

63%

125%

188%

250%

Aug-09

Oct-09

Dec-09

Feb-10

Apr-10

May-10

Jul-10

Sep-10

Nov-10

Jan-11

Feb-11

Apr-11

Jun-11

Aug-11

ENGRO KSE-100

In terms of debt servicing, ENGROs EBITDA todebt servicing remains above 1 during ourforecast period, which indicates that theirleverage will remain manageable.

The issue of gas load-shedding can and should beresolved. Pakistan enjoys a competitiveadvantage in producing urea, and diverting gasfrom power to fertilizer will be beneficial.

In addition, ENGRO has a water-tight gas supplyagreement with sovereign guarantees in place.Flouting such an agreement for any length of timewould send a very adverse signal to potentialinvestors in the country.

Fertilizer remains the biggest component ofENGROs value, contributing 69% to the targetprice. EPS contribution of fertilizer is projected tobe PKR 13.6 and PKR 15.6 in FY11 and FY12respectively.

Engro Foods (EFOODS) is an evolving successstory. Based on a conservative valuation, EFOODScontributes 14% to ENGROs target price. Themain source of revenue and profits is expected tobe the dairy segment.

Value of other businesses (Eximp, PowerGen,Vopak, and Polymer) contributes 17% to ENGROstarget price.

ENGRO is one of the biggest success stories ofcorporate Pakistan. Its share price, having come

of dramatically over the last few months,provides an attractive investment opportunity.

Figure 2: Shareholding Pattern as of Dec 10

38.1%

3.5%

6.1%1.7%4.7%

8.8%

37.1%

Dawood Hercules Central Insurance Patek (pvt) Ltd.

NIT Public sector co. Financial Institutions

Others

Source: Next Capital Research




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ENGRO Corporation {ENGRO} |

ENGROs Fate: The Throne or the

Gallows?

In a speech delivered in 2009, Asad Umar ended by

quoting a famous verse. There are only two

destinations for freedom-loving people. Eitherthe throne or the gallows. Those words seemprescient; the investment community today cannotseem to determine the fate of the company hemanages. But depending on who you speak to, itseither the throne or the gallows!

Since April 2011, ENGROs share price has taken asevere hammering, having fallen by more than 40%and significantly underperforming the market and

peers. The share price decline owes largely to investorconcerns about the frequent gas shutdowns that arehampering production from ENGROs new fertilizerplant. Investors are concerned about two issues;earnings and debt servicing capabilities.

Amidst the doom and gloom, it is easy to loseperspective. ENGRO remains one of the biggestsuccess stories of corporate Pakistan, and is likely tobecome the countrys pre-eminent multi-national in theyears to come. In ambition, strategy and execution,ENGRO has no equal in corporate Pakistan. Most of itsbusinesses, including fertilizers, foods, and powerhave strong underlying business economics based onthe needs of the Pakistani economy.

The perceived chink in its armor from an investorsperspective is the high amount of leverage it carries,which makes it susceptible to exogenous shocks likethe current unplanned gas load-shedding. FromENGROs perspective, the high level of debt isjustifiable because they are operating in stablebusinesses with strong cash flows.

To put the leveraging in perspective, ENGROs decisionto undertake the urea expansion was based on keyassumptions like availability of gas through a watertight sovereign guarantee agreement, incentivized gasrates as prescribed in the 2001 Fertilizer Policy, andfavorable demand-supply dynamics. These factors ledthe company to take the aggressive route offinancing this investment with a Debt-Equity Ratio of75:25.

Although the fate of ENGROs share price in the short-term is hard to determine, investors with a medium tolong-term horizon have the opportunity to buy a sliceof Pakistans best-run company at a marked downprice. Before delving into the numbers and targetprices debate, our advice is simple; Carpe Diem (seize

the day).

Strong Upside Even if Gas Load-

Shedding Persist

We initiate coverage on ENGRO Corporation

(ENGRO) with a 5 star ranking. The stock offers a

113% upside to our December 2011 target priceof PKR 256.

A Sum-Of-The-Parts (SOTP) valuation has been usedfor ENGRO, which we believe is appropriate given itsconglomerate structure. The primary value drivers arethe fertilizer, food, trading and power operations. Wehave applied a 20% conglomerate discount to theSOTP value of the group.

Table 2: ENGROs SOTP Valuation

SOTP Valuation PKR per share Method of Valuation

Fertilizer 222 Free Cash Flow model

Foods 44 Free Cash Flow model

Eximp 25 Dividend discount model

Powergen Qadirpur 14 Dividend discount model

Polymer 7 Market Value

Vopak 8 Dividend discount model

SOTP Value per hare 320

Conglomerate Discount 64

@ 20%

ENGRO Fair Value per Share 256

ENGRO Corporation

With uncertainty regarding the gas issue persisting,we have built two scenarios; a base case and a badcase for gas load-shedding.

The Base Case Scenario- Assumptions

1. Gas load-shedding at Engros new plant to becontained to 75 days per year, with a gas factor

of 80%

2. Urea margins (on existing plant) to be maintainedat 60% levels. This translates into a urea price of

PKR 1,037 per bag (ex-GST) in FY12.

The Bad Case Scenario- Assumptions

1. Gas load-shedding at Engros new plant at 50%(180 days) per year with a gas factor of 80%.

2. Urea margins to be maintained at current levelsto compensate for lost production. This translates

into a urea price of PKR 1,121 per bag (ex-GST)in FY12.

Our analysis indicates that the pessimism surrounding

ENGRO has been overdone, with regards to bothearnings and debt servicing. The target price in thecase of the base case and the bad case offer an



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upside of 113% and 76% respectively. The basecase target price is PKR 256 and the bad case

target price is PKR 211 per share.

Earnings Decline to be

Cushioned by Higher Prices

Earnings forecasts for the base case and the badcase are shown in Table 3. Based on FY12 projected

EPS, ENGRO is currently trading at a PE of just

above 5x using the base case and 4x using the

bad case. Although fertilizer earnings are adverselyimpacted by the lost production in the bad casescenario, the impact is cushioned through increasedurea prices. Local urea producers continue to enjoy

pricing power as international urea prices are currently104% higher than local prices. ENGRO hasdemonstrated that pricing power in recent months byraising urea prices significantly in response toexcessive gas load-shedding.

Table 3: Earnings Projections for ENGRO

(PKR mn)

Base Bad Base Bad Base Bad

Fertilizer 5,336 4,286 6,153 4,563 8,647 6,715

Foods 690 690 994 994 1,834 1,834

Eximp 1,590 1,590 1,765 1,765 1,730 1,730

Power 1,330 1,330 1,233 1,233 1,139 1,139

Vopak 544 544 571 571 600 600

Others (350) (350) - - - -

TOTAL 9,140 8,089 10,717 9,127 13,949 12,017

EPS 23.2 20.6 27.2 23.2 35.5 30.6

2011 2012 2013

Debt Servicing: Walking a Tight

Rope but Manageable

One of the major concerns spooking investors at themoment is the high level of debt that Engro carries.ENGRO has PKR 18 bn and PKR 17 bn of debt servicingin FY12 and FY13 respectively (including principal andinterest repayments).

Whilst those numbers sound scary, we believe itappropriate to approximate debt servicing capacitywith EBITDA. And as Figure 3 highlights, ENGROsEBITDA to Debt Servicing remain above 1, even in thebad case scenario. Therefore, we are confident thateven if gas outages continue at current levels, ENGROwill manage to service its debt obligations in thecoming years.

A couple of qualitative factors regarding the issue ofleverage are worth bearing in mind. Firstly, ENGRO hasthe ability to raise additional funding through the

balance sheets of ENGRO Corporation and othersubsidiaries, which it is currently doing through theRupiya certificates.

Figure 3: EBITDA to Debt Servicing

1.21.0

1.21.3

1.8

1.2 1.2

1.3

1.5

2.0

0.5

1.0

1.5

2.0

2.5

2011 2012 2013 2014 2015

(xtimes)

B ad Ca se B ase Ca se

Secondly, we have included principal repayments indebt servicing calculations. However, as has been the

case in many corporate restructurings recently, banksare more than willing to roll-over/extend maturities aslong as interest payments are being made. If pushcomes to shove, debt restructuring can be done withthe banks.

Thus, whilst ENGRO will be walking a tight rope inmanaging its debt servicing obligations over the nextcouple of years if gas shortages persist, the companyhas options at its disposal to manage its liquidityrequirements.

Gas Issue Can and Should BeResolved

Although ENGRO can ride out the storm, resolution ofthe gas curtailment issue is important from theperspective of the overall economy. The country isfacing a gas shortage of around 20-25%, but theSNGPL network faces an even higher shortage of up to40%. Gas load shedding in the fertilizer sector startedin April 2010 when the government decided to divertgas supplies to power plants in order to reduceelectricity load shedding.

The fertilizer plants on the SNGP network, includingENGROs new plant, Dawood Hercules, Pak Arab andPak American are bearing the brunt of the gas load-shedding, with production hampered significantly.




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With competing uses for gas, the gas allocation shouldnot be done through a random nows-your-turnpolicy, but on the basis of economic value. Currently,the fertilizer sector offers a higher economic value forgas consumed in comparison to the power sector.

0%

35%

70%

105%

140%

31-Mar-11

7-Apr-11

14-Apr-11

21-Apr-11

28-Apr-11

5-May-1

1

12-May-11

19-May-11

26-May-11

2-Jun-1

1

9-Jun-1

1

16-Jun-1

1

23-Jun-1

1

30-Jun-1

1

7-Jul-11

14-Jul-11

21-Jul-11

28-Jul-11

4-Aug-1

1

11-Aug-1

1

18-Aug-1

1

ENGRO FFC FFBL FATIMA KSE100

05April:Gas

supply cut offto new plant

due topipeline fault

14April: ENGRO

increase urea priceby PKR 60/bag

21April: Gas

supply restored

27April: SHC gives

interim order forgas supply

maintenance

17May:

Gas supplysuspended

19May: ENGRO

files contempt ofCourt notice

against SNGPL

03 June: ENGRO

returns below-minimum load

gas to SNGPL

20 June: Plant

starts full-scaleproduction on 80

MMCFD

24 June: ENGRO

announces CODof new plant

14 July: Gas supply

suspended, ENGROincrease urea prices

by PKR 125/bag

28 July: Gas supply

restored at 80 MMCFD

01 August: Govt.

deciding to endunplanned

loadshedding

Source: KSE, Company news, Next Capital Research

Source: NEPRA, Company Sources, Next Capital Research

Figure 4: Gas Load-Shedding and the Impact on Stock prices

Annual Power generation capacity on 100 MMCFD (kWh) 4,818,000,000

Plant availability factor 90%

Plant load factor 70%

Annual power generation (kWh) ( a ) 3,035,340,000

Latest Adjusted Fuel Cost per unit - Gas (PKR per kWh)* ( b ) 2.5158

Latest Adjusted Fuel Cost per unit - FO (PKR per kWh)** ( c ) 12.881

Annual Fuel Cost - Gas (PKR mn) ( a ) X ( b ) 7,636

Annual Fuel Cost - FO (PKR mn) ( a ) X ( c ) 39,098

Additional Cost to the economy (PKR mn) 31,462

ENGRO's annual urea production capacity - new plant (tons) ( d ) 1,300,000

Import parity price - Current (US$ per ton) ( e ) 561.23

Landed Cost of imported urea (PKR mn) ( d ) X ( e ) 63 ,110

Cost of urea in case of ENGRO's full production (PKR mn) *** ( f ) 23,400

Additional Cost to the economy (PKR mn) 39 ,710

Net Savings to the economy in case of full gas alloc ation to ENGRO (PKR mn) 8,248* Revised tariff of S aif Power Limited

** R evised tariff of Atlas Power Limited

***Assumption of a normalized urea selling price of PKR 90 0 per bag

Table 4: Pakistan Enjoys a Competitive Advantage in Producing Urea


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In Table 4 below, we calculate that the overallsavings of allocating 100 mmfcd of gas from the

power to the fertilizer sector is PKR 8.2 bn. Whilst

the additional cost of importing 1.3 mn tons of urea ascompared to local production is PKR 39.7bn, theadditional cost of importing High Speed Furnace Oil(HSFO) for power generation as compared to gasbased power generation is PKR 31.4 bn. This amountsto a saving of PKR 8.2 bn if 100mmcf is allocated toproducing urea instead of power. We believe that thegovernment will eventually prioritize gas to thefertilizer sector, because Pakistan has a competitiveadvantage in producing urea.

Fertilizer Value Hinges on Gas

Supply

Despite diversifying into other businesses, fertilizercontinues to be the mainstay of ENGROs earnings andvaluation.

Our base case fertilizer valuation for ENGRO is

PKR 222 per share, based on plant load shedding of75 days per year and a gas factor of 80%. In thisscenario, fertilizers contribution to ENGROs target

price is 69%. The bad case fertilizer valuation isPKR 166 per share, based on 180 days of gas load-

shedding per year, and a gas factor of 80%. Whilst wehave used the base case value to determine ourtarget price, investors who are more conservativeabout gas supply can use the bad case valuation asthe benchmark.

Table 5: ENGRO Fertilizers Valuation

Key Valuation Assumptions

Risk Free Rate 14%

Equity Risk Premium 6%

Cost of Equity 20%

Cost of Debt 15%

Target Debt to Equity 50:50Tax Rate 35%

Long term growth rate 1%

WACC 15%

Valuation (PKR mn)Sum of PV of FCFF (Forecast period) 105,960

PV of Terminal Value 50,787

Enterprise Value 156,746

Net Borrowing (69,494)

Equity Value 87,253

ENGRO's share of Value (@ 100%) 87,253

Fertilizer's contribution to ENGRO's SOTP V aluation 222

*based on ENGRO's no. of shares

EPS projections for the fertilizer business are shown inFigure 5. Fertilizer earnings are lower in the badcase scenario because we believe that ENGROs

pricing power in the urea market has limits. Ureaprices at substantially higher (than current levels) arelikely to begin destructing demand. Therefore,earnings are reduced in the bad case scenario ascompared to the base case scenario.

Figure 5: EPS Projections for ENGRO Fertilizer

13.615.6

22.0

27.6

10.9 11.7

17.2

21.5

0.0

7.5

15.0

22.5

30.0

2011E 2012F 2013F 2014F

(PKR)

Fertil izer (Base Case) Ferti lizer (Bad Case)

Table 6 shows a comparison of revenue and primarymargins between ENGROs new and old plants. Theimportant point to highlight is that owing to higherefficiency and lower gas prices, ENGROs new plantmargins are significantly superior to that of the oldone.

Table 6: New Plant Has Better Margins

(PKR mn) 2010A 2011E 2012F 2013F 2014F

Revenue

- Existing 19,018 21,780 23,408 27,728 30,910

- New - 11,003 17,904 20,679 23,911

Primary margin

- Existing 56% 58% 60% 59% 58%

- New N/A 87% 85% 85% 86%

EFoods An Evolving Success

Story

EFOODS is an evolving success story. Having mademajor inroads in the dairy and ice-cream segmentswithin its first few years of operations, EFOODS plans

an aggressive PKR 41 bn capex in the next five yearsto invest in existing and new businesses.

In its initial phase, the company has rightly focused onbuilding brands and capturing market share. However,since 2010, EFOODS bottom-line has turned green, andwe expect the companys contribution to ENGROsearnings to increase in the coming years.





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Figure 6: EPS Contribution of EFOODS

0.5

1.9

2.8

5.2

8.7

- 2.5 5.0 7.5 10.0

2010A

2011E

2012F

2013F

2014F

(PKR)

2010A 2011E 2012F 2013F 2014F

We value EFOODS at PKR 44 per share of ENGRO,

contributing 14% to ENGROs target price

A three-stage DCF valuation has been used to capturethe impact of the high capex phase (FY11-FY15),followed by a high growth phase (FY16-FY20), and theeventual maturity phase.

Free cash flows are projected to be negative till 2014due to the companys aggressive capex plans.However, from 2015 onwards, capex is reduced, andcash flows become significantly positive.

Table 7: EFOODS Valuation

Key Valuation Assumptions

Risk Free Rate 14%Equity Risk Premium 6%

Cost of Equity 20%

Cost of Debt 15%

Target Debt to Equity 47:53

Tax Rate 35%

Long term growth rate 3%

Additional growth rate (High-growth period) 7%

WACC 15%

Valuation (PKR mn)

Sum of PV of FCFF (Forecast period) (7,667)

Sum of PV of FCFF (High-growth period) 12,426


Enterprise Value 24,647

Net Borrowing (5,380)

Equity Value 19,267


Foods' contribution to ENGRO's SOTP Valuation* 44


Ambitious Long Term Strategy Multiple

Frontiers in Sight

EFOODS has enjoyed unprecedented early success,and the future looks even brighter as the companylooks to expand both geographically and product-wise.

Dairy Segment existing business: The companyhas planned a massive PKR 12 bn capex in itsexisting dairy segment during the next five years

(2011-2015). We expect that bulk of this expenditurewould be incurred to enhance production capacities ofUHT milk processing, powdered milk, juices andnectars and brand development of juices and nectarsand powdered tea whitener.

Dairy Segment new business: In order tocomplete its coverage of the dairy spectrum, thecompany is planning to extend its reach to the mostlucrative powdered milk sub-segments of infantnutrition and Growing Up Milk Powder (GUMP) wherecurrently Nestle Pakistan dominates the market. Inaddition, the company also plans to enter the chilled

dairy niche (e.g. fruit yogurt) where currently NestlePakistan controls the majority of the market. The capex

earmarked for these projects is PKR 10 bn during thenext five years.

Ice cream Segment: The company plans to incur acapex of PKR 4 bn in its ice cream segment duringthe next five years with major emphasis onconsolidating its position as the no. 2 player, branddevelopment and extension of outreach to all majorcities of Pakistan.

Rice Segment: Perceiving substantial opportunities in

this segment, Foods has planned a massive PKR 14 bncapex for this segment during the next five yearswhich would mainly be directed to the expansion ofprocessing and storage capacity of the plant alongwith other civil works. We expect that this capexwould result in a multi-fold increase in the rice plantsprocessing capacity from the existing 28 k tons to 158k tons by 2015.

Figure 7: EFOODS Capex (2011-2015) by Segment

11,793

10,3234,482

974

13,568

Dairy - Existing Dairy - New Ice cream Farm Rice

Dairy segment Promising Prospects

Whilst EFOODS in totality has no clear cut peer groupin Pakistan, in terms of its dairy operations, NestlePakistan is a good benchmark, being a market leader

in milk and juices. Nestls operating performance

has been nothing short of sensational, with


Source: Next Capital Research Source: Investors Presentation, Next Capital Research


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average ROEs over the last decade of 62%. Salesand PAT have grown have a 10 year CAGR of 20%

and 27% respectively. Apart from the strong growth,

worth highlighting is the stability in Nestle Pakistansoperating profit margin, as can be seen in Table 8. Thisindicates that business economics of the marketleader in the dairy segment are very attractive.

Table 8: Nestle Pakistans Sensational Performance

NESTLE PAKSITAN (PKR mn) FY06 FY07 FY08 FY09 FY10

Revenue 22,031 28,235 34,184 41,156 51,487

Operating profit 2,640 3,511 4,105 5,575 6,858

Operating profit margin 12.0% 12.4% 12.0% 13 .5 % 13 .3 %

PAT 1,363 1,805 1,553 3,005 4,113

ROE 62.0% 54.4% 36.5% 68.2% 82.2%

We are confident that EFOODs will also enjoy highROEs in its dairy business as it matures. It has alreadybecome the market leader in UHT milk (current marketshare of 40%+), and plans to follow Nestle in the fullrange of dairy products.

Table 9 shows revenue and profit forecasts for thedairy segment of EFOODS. Over the next four years(FY11-FY15), revenue and PAT are projected to grow ata CAGR of 29% and 43% respectively.

Table 9: EFOODS Dairy Segment

PKR mn 2011 2012 2013 2014 2015

Revenue 26,518 35,368 45,938 58,858 74,088

Profit After Tax 1,106 1,271 1,873 2,834 4,619

Net Margin 4% 4% 4% 5% 6%

Capex 3,337 6,647 5,769 4,818 1,545

Ice cream segment More of a Mixed Bag

In the ice-cream segment, ULEVERs Walls is theclosest benchmark to EFOODS. However, the historicalprofitability of Walls is not as impressive as that of thedairy segment of Nestle. As shown in table 10, Wallsoperating margins are neither as stable nor as high asNestles.

Table 10: Walls Pakistans Financial Performance

WALLS Pakistan (PKR mn) FY06 FY07 FY08 FY09 FY10

Revenue 2,852 3,074 3,824 4,163 5,548

Operating profit 512 179 (13) 277 269

Operating profit margin 17.9% 5.8% -0.3% 6.6% 4.9%

EFOODS, however, appears quite sanguine about theprospects of the ice-cream business, which is evidentby their focus on developing the Omore brand and the

expansive capex plans. Since launch in 2009, Omorehas already captured a 17% market share.

However, we have been conservative in our revenueand earnings projections for EFOODS ice-creamsegment, considering that the overall market size is

currently not that large, and margins are alsomoderate.

Table 11 shows our revenue and profit forecasts forthe ice-cream segment. Revenues are expected togrow through the next few years, although profitabilityis expected from 2013.

Table 11: EFOODS Ice-Cream Segment

PKR mn 2011 2012 2013 2014 2015

Revenue 2,633 3,718 4,949 6,647 8,918

Profit After Tax (132) (78) 64 366 788

Net Margin -5% -2% 1% 6% 9%

Capex 1,091 1,025 751 808 807

Rice segment expansion mantra all the way

The rice segment of Foods is managed by ENGROFoods Supply Chain (Pvt) Limited (EFSL), a subsidiary ofFoods, which was created as a specialized supplychain company to focus on one of the most criticalelements of the overall value chain. EFSL has set up arice processing plant in Muridke with an initial riceprocessing capacity of 28 k tons. The processed ricefrom the plant is being sold (at market prices) to

ENGRO Eximp for export to premium customers inregional markets and beyond.

Pakistan currently lies at the heart of world riceconsumption with two of the worlds top three riceimporters i.e. Philippines and Iran situated inproximity. The company is focused on Basmati rice andtargets high-value commercial customers in the region.In 2010, the first order of 5,000 tons was dispatched tocustomers in Middle East.

With its competitive advantage in terms of strategiclocation and economies of scale in terms of logistics,

we foresee the rice segment to make bettercontributions towards Foods overall profitability incomparison to the ice cream segment despite muchlower sales. With exception of a loss in 2011 and2012, we expect increasingly positive bottomline forthe rice segment during the next five years.

Table 12: EFOODS Rice Segment

PKR mn 2011 2012 2013 2014 2015

Revenue 640 1,451 2,185 3,011 4,214

Profit After Tax (224) (50) 183 286 784

Net Margin -35% -3% 8% 10% 19%

Capex 2,263 2,420 1,860 3,310 3,715

Source: NESTLE Annual Accounts, Next Capital Research


Source: ULEVER Annual Accounts, Next Capital Research




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Eximp Leveraging the

Expertise

As a wholly owned subsidiary of ENGRO, Eximpimports and sells fertilizers such as DAP, MAP, MOP,SOP and micro-nutrients like Zinc Sulphate. Inaddition, Eximp has also established a fast growingrice trading business. The company will procurefinished rice from EFSL and export it to premiumbusiness-to-business customers all over the world.

According to the internal arrangements, Eximp used tosell its fertilizer imports (upon arrival) to EngroFertilizer at prevailing local prices which kept Eximpimmune to any unfavorable price movements in the

domestic fertilizer market. During the last three years,Eximps EPS has averaged PKR 4.6 (based on ENGROsshares) with an average dividend payout of 88%.

Figure 8: Engro Eximps EPS and DPS History

5.6

3.7

4.4

5.6

3.6

2.8

0.0

1.8

3.5

5.3

7.0

2008 2009 2010

(PKR)

E ar ni ng s Di vi de nd s

As the largest importers of phosphates in Pakistanwith a demand-supply gap in excess of 50%, thefuture of Eximp is largely tied to the performance of itsDAP business. After group restructuring, Eximpsimmunity to unfavorable local price movements hasdiminished because of removal of the importedfertilizer business from Engro Fertilizers ambit. Thus,

Eximp will bear price risk in the future.

For the rice segment, after a negligible level of sales in2010, the rice segment of Eximp is expected toincrease sales in 2011 and would gain sizeabletraction during next five years.

We have assumed trading margins of 7% for Eximp,which are significantly lower than what they earned inthe last 3 years. However, we have been conservativedue to the change in ENGROs internal pricingstructure and the addition of the rice business, wheremargins are less certain at the moment.

Figure 9: Engro Eximp Revenue and Profit Projections

-

750

1,500

2,250

3,000

-

8,750

17,500

26,250

35,000

2011 2012 2013 2014 2015

Fertilizer sales Rice sales Profit

We have used the Dividend Discount Model (DDM) tovalue Eximp because of consistently high dividendpayout history of the company. Our key valuation

assumptions include Cost of Equity at 20% andterminal growth rate of 0%. The value of Eximp based

on ENGROs shares outstanding is PKR 25 per share.

Table 13: Engro Eximp Valuation

Valuation (PKR mn)Sum of PV of Dividends 4,737


Equity Value 9,678


Eximp's contribution to ENGRO's SOTP Valuation* 25


Powergen Stable Cash Flows

Coupled with Efficiency Gains

ENGRO Powergen (EPL) is a 95% owned subsidiary ofENGRO and has set up a 220 MW gas fired powerplant near Qadirpur. The power plant utilizes low basepermeate gas from Qadirpur gas field which waspreviously not being utilized.

Like other Independent Power Projects commissionedunder the 2002 Power Policy, the 25-year tariffstructure of the project implies a guaranteed US$equity return of 15% above all costs of generation(including debt servicing). The plant achieved its CODat the end of March 2010 and has been successfullyoperating since with near maximum operationalavailability.

Like other new IPPs, ENGRO Power Gen earnings arebeing significantly boasted by efficiency gains/lowerO&M charges. We forecast that these gains willcontinue to augment the bottom-line for the next threeyears, albeit at lower levels.

Source: Annual Accounts, Next Capital Research




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Figure 10: Engro Power Gen EPS Projections

2.8

3.63.3

3.02.8

0.0

1.0

2.0

3.0

4.0

2010A 2011E 2012F 2013F 2014F

(PKR)

Given the low risk and stable cash flow stream and theexpectation of a high dividend payout, we have usedDDM to value EPL. Key valuation assumptions include

Cost of Equity at 20%. ENGROs shareholding inthe company is valued at PKR 14 per share.

Table 14: Engro Power Gen Valuation

Valuation (PKR mn)Sum of PV of Dividends (remaining life) 5,680

Equity Value 5,680


EPL's contribution to ENGRO's SOTP Valuation* 14


Vopak Icing on the Cake

The first of its kind in Pakistan in liquid bulk logistics,ENGRO Vopak (Vopak) is a joint venture between RoyalVopak of Netherlands and ENGRO. The company wasformed for setting up an integrated liquid chemicalterminal and storage farm and was granted exclusiverights to handle and store all liquid chemicals andgaseous liquid chemicals entering the Port Qasim areafor 30 years by the Port Qasim Authority. Vopaksterminal currently handles several products of

divergent nature like, Paraxylene, Acetic acid, VCM,Ehtylene, MEG, Phos acid and LPG. The companysmajor customer is Lotte Pakistan PTA (LOTPTA) forParaxylene and Acetic Acid, followed by Fauji FertilizerBin Qasim (FFBL) for Phos acid.

Table 15: Engro Vopak Customers

Products Customers

Paraxylene LOTPTA

Acetic acid LOTPTA

VCM EPolymer

Ethylene EPolymer

MEG-Tank Storage PET Resin producers

Phos acid FFBLLPG LPG marketing companies

As the only company in Pakistan providing storage andhandling solutions for products of this nature, thebusiness economics of ENGRO Vopak are very

attractive. In the backdrop of continuous growth in thechemical and petrochemical industry of Pakistan, thedemand for Vopaks services has remained above parwith revenue components of the companydenominated in US$.

Figure 11: Engro Vopak EPS and DPS

2.3

2.8 2.82.9

3.1

0.0

1.0

2.0

3.0

4.0

2009A 2010A 2011E 2012F 2013F

(PKR)

Earnings Dividend

Vopak has a history of maintaining almost a 100%dividend payout and we have taken this assumptiongoing forward in our DDM based valuation. Keyvaluation assumptions include cost of equity at 20%

and a terminal growth rate of 0%. Engro Vopak

contributes PKR 8 per share to ENGROs SOTPvalue.

Table 16: Engro Vopak Valuation

Valuation (PKR mn)Sum of PV of Dividends 4,188


Equity Value 6,605


Vopak's contribution to ENGRO's SOTP Valuation* 8


Polymer riling through

operational issues

ENGRO Polymer (Polymer) is the sole manufacturer ofPVC Resin in Pakistan with an annual capacity of 150 ktons. As part of a recent expansion, the company nowhas an integrated facility with the capability tomanufacture EDC, VCM, Chlorine and Caustic Soda inaddition to PVC Resin.

Pricing policy of the companys main segment i.e. PVC

Resin is governed by international prices and its mainraw material i.e. Ethylene (used for production of EDCand VCM) is also imported which exposes the







10/12

10


companys primary margins and profitability to trendsin the international markets.

Prior to undergoing the expansion and integrationproject, Polymer had a history of regular profitability.However, unfavorable price movements have led to adeterioration of the bottom-line in the last two years.

Figure 12: Engro Polymer: From Green to Red

-1,000

-600

-200

200

600

0

3,750

7,500

11,250

15,000

2006 2007 2008 2009 2010

(PKRmn)

(PKRmn)

Revenue Profit/(Loss)

The uncertainty on the performance of the integratedoperations still exists and only a demonstratedperformance for an extended period of time and itstranslation into profits would revive the investorsconfidence in the company. Considering this

uncertainty, we have valued Polymer at its current market price which gives a contribution of PKR 7per share to ENGROs SOTP based value .

Table 17: Engro Polymer Valuation

Valuation (PKR mn)Current Market price (PKR per share) 8

Equity Value 5,195


EPQL's contribution to ENGRO's SOTP Valuation* 7


Invest for the Long HaulThe recent price correction in ENGRO is a window ofopportunity for long-term investors to acquireshareholding at extremely attractive valuations.ENGROs business economics remain strong, itsmanagement is best in class, and the price isattractive. Those who are able to invest amid thecurrent doom and gloom are likely to be well rewardedas the ENGRO juggernaut goes from strength tostrength in the future.




11/12

11


ENGRO Corporation (ENGRO)

Current Price 120.0

Dividend Yield (FY10) ENGRO

Current PE 11.4

1.9%

Current P/B 2.0

Market Cap (PKR mn) 47,217

1 Yr Avrg daily Val (PKR mn) 366.2

Oustanding shares (mn) 3931Yr High Price 205.8

1Yr Low Price 111.9

Free Float (%) 45%

Free Float (mn) 177.0

T o ta l Retu rn 7 D a ys 30 D a y 90 D a y 365 D a yENGRO 2% -16% -39% -11%

KSE100 2% -9% -10% 16%

KSE30 1% -9% -11% 13%

F Y 9 8 F Y 9 9 F Y 0 0 F Y 0 1 F Y 0 2 F Y 0 3 F Y 0 4 F Y 0 5 F Y 0 6 F Y 0 7 F Y 0 8 F Y 0 9 F Y 1 0 * * V a lu at ion6.0 11.7 8.9 8.3 9.0 9.2 10 9.6 13.9 15.1 12.5 10.6 9.4 Price/earnings (year avg)

1.9 2.5 1.9 1.7 1.9 2.5 3 3.0 3.8 3.1 2.5 1.6 1.8 Price /book (year avg)

8.0 6.0 7.5 9.8 9.2 1.0 2 1.5 1.5 1.5 6.0 6.0 6.0 Dividend per share

10.8% 6.8% 9.8% 13.0% 11.3% 9.7% 8.6% 8.3% 4.9% 3.1% 2.8% 4.3% 3.3% Dividend yield

8,986 12,218 9,975 8,816 10,146 14,263 16,730 22,201 35,293 47,548 53,047 41,886 60,320 Market cap (year avg)

10,881 17,459 9,599 7,919 14,086 15,621 21,765 27,682 32,715 56,588 20,540 54,635 63,519 Market cap (year end)

118.3 141.5 127.5 83.3 94.9 102.6 133 179 239 297 374 187 213 Share price (High)

44.7 69.7 49.5 42.6 50.3 77.1 89 108 156 170 96 96 166 Share price (Low)P r of i t & L oss

8,366 8,628 8,394 8,220 10,893 12,173 12,798 18,276 17,602 23,183 23,317 30,172 79,976 Sales

3,226 3,364 2,935 2,742 3,550 3,863 3,269 3,912 4,237 4,920 6,197 6,931 20,274 Gross profit

2,230 1,980 1,914 1,736 2,327 2,534 2,233 2,641 2,756 3,279 4,539 4,986 11,984 Operating profit

105 142 219 199 231 39 2 558 1,145 1,339 1,831 2,754 1,973 897 Other Income

123 106 99 98 147 231 190 287 287 33 9 58 0 424 958 Other Expenses

405 674 68 4 646 576 37 2 286 280 36 3 53 5 1,509 1,321 4,201 Financial Charges

1,807 1,342 1,350 1,191 1,836 2,323 2,315 3,220 3,445 4,236 5,205 5,215 8,277 Profit before tax

319 294 224 127 703 766 704 900 89 7 1,081 96 4 1,258 1,836 Tax

1,488 1,048 1,126 1,064 1,133 1,557 1,611 2,319 2,547 3,155 4,240 3,957 6,441 Profit after tax

3.78 2.66 2.86 2.71 2.88 3.96 4.10 5.90 6.48 8.02 10.78 10.06 16.38 EPS (Besed on curr paid up)B al anc e Sheet

8,087 8,287 8,457 8,413 8,875 8,640 8,583 9,100 10,296 21,759 45,123 82,961 131,082 Fixed assets

2,796 2,800 3,106 4,010 5,408 4,225 4,603 5,012 5,684 16,397 12,042 10,749 33,696 Current assets

469 256 65 9 75 2 804 1,295 1,617 2,211 2,042 11,133 6,043 4,353 (4,055) Working capital

1,653 1,923 1,694 2,575 4,098 2,371 1,683 710 2,406 1,319 2,611 2,392 5,716 Short-term debt

3,470 2,908 3,071 2,992 3,322 3,236 2,580 2,890 1,800 15,423 27,757 58,565 89,171 Long-term debt

1,008 1,209 1,209 1,390 1,390 1,529 1,529 1,529 1,682 1,935 2,128 2,979 3,277 Paid up capital

4,616 4,939 5,219 5,240 5,330 5,664 6,586 7,376 9,370 15,482 21,054 26,888 34,115 Shareholders equity

101 121 121 139 139 153 153 153 168 193 213 298 328 Shares outstanding11.7 12.6 13.3 13.3 13.6 14.4 16.7 18.8 23.8 39.4 53.5 68.4 86.7 BVPS (Based on current paid up)

Cash F l ow s97 3 2,057 1,634 1,323 1,757 1,846 998 1,380 1,380 1,542 (117) 6,089 (142) Cash flow from operations

(1,905) (435) (503) (333) (491) (128) 28 (227) (689) (10,367) (20,797) (36,218) (19,741) Cash flow from investing

(78) (1,184) (757) (1,030) (533) (1,408) (816) (2,177) (1,238) 15,863 13,187 34,296 16,624 Cash Flow from financing

(1,010) 437 37 4 (40) 733 310 210 (1,024) (547) 7,038 (7,727) 4,167 (3,259) Net change in cashRat i os

0.0% 3.1% -2.7% -2.1% 32.5% 11.7% 5.1% 42.8% -3.7% 31.7% 0.6% 29.4% 165.1% Sales growth

38.6% 39.0% 35.0% 33.4% 32.6% 31.7% 25.5% 21.4% 24.1% 21.2% 26.6% 23.0% 25.3% GP margin

26.7% 22.9% 22.8% 21.1% 21.4% 20.8% 17.4% 14.5% 15.7% 14.1% 19.5% 16.5% 15.0% Operating profit margin

21.6% 15.6% 16.1% 14.5% 16.9% 19.1% 18.1% 17.6% 19.6% 18.3% 22.3% 17.3% 10.3% PBT margin

17.6% 21.9% 16.6% 10.7% 38.3% 33.0% 30.4% 28.0% 26.0% 25.5% 18.5% 24.1% 22.2% Tax rate

17.8% 12.1% 13.4% 12.9% 10.4% 12.8% 12.6% 12.7% 14.5% 13.6% 18.2% 13.1% 8.1% NP margin

0.0% 21.9% 22.2% 20.3% 21.4% 28.3% 26.3% 33.2% 30.4% 25.4% 23.2% 16.5% 21.1% ROE

0.0% 9.5% 9.9% 8.9% 8.5% 11.5% 12.4% 17.0% 16.9% 11.7% 8.9% 5.2% 5.0% ROA

CAG RS 1 yr 3 yr 5 yr 10 yrSales 165% 51% 34% 26%

Gross profit 192% 60% 39% 22%

Operating profit 140% 54% 35% 21%Net profit 63% 27% 23% 20%

C/F from operat -102% -145% -163% n.a

Dividends 0% 59% 32% -5%

Book value 14% -17% -10% 0%

Sa l es Q 1 Q 2 Q 3 Q 4 Fu l l yea rFY09 5,733 4,974 10,143 9,321 30,172

FY10 16,859 16,865 19,845 26,407 79,976

FY11 21,848 24,236 - - 46,084

P AT PKR mn Q 1 Q 2 Q 3 Q 4 Fu l l yea rFY09 695 349 1,556 1,358 3,957

FY10 1,805 1,392 86 1 2,383 6,441

FY11 2,042 1,274 - - 3,316

E q u i ty P KR mn Q 1 Q 2 Q 3 Q 4 Fu l l yea rFY09 20,469 25,609 26,043 26,888 26,888

FY10 26,989 31,942 32,260 34,115 34,115

FY11 35,749 38,271 - - -

* n.a = Not Available

* N/A = Not Applicable

** Consolidated figures

Current Dividend Yield

6.0

11.7

8.9

8.3

9.0

9.2

10

9.6

13.9

15.1

12.5

10.6

9.4

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10**

P/E

1.9

2.5

1.9

1.7

1.9

2.5

3

3.0

3.8

3.1

2.5

1.6

1.8

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10**

P/B

0

50

100

150

200

250

300

Jan-07

Mar-07

May-07

Jul-07

Aug-07

Oct-07

Dec-07

Feb-08

Apr-08

Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Aug-09

Oct-09

Dec-09

Feb-10

Apr-10

Jun-10

Aug-10

Oct-10

Dec-10

Feb-11

Apr-11

Jun-11

Aug-11

ENGRO K SE100


12/12


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Documents

Company Report - EnGRO - 5th Sept 2011