BR Research sat down with Ruhail Mohammed back in late August when the news of the firm's IPO aspiration was fresh. Following is a brief excerpt from the meeting where Ruhail talks about Engro's plans to insure long-term gas supplies, the plans for expansions and the issue of Urea pricing in the country. Prior to his current position as the CEO, he was the Chief Financial Officer of Engro Corporation Limited and also the Chief Executive Officer of Engro Powergen Limited.
He holds an MBA degree in Finance from the Institute of Business Administration, Karachi and is also a Chartered Financial Analyst. BR Research: There were many people who at one point had wondered whether Engro Fertiliser was going to be able to manage a turn-around. Tell us a little bit about your stellar come back! Rohail Mohammed: Like you said, the last couple of years have indeed been tough for us. Year 2011 saw us getting gas for only around 6 months and then in 2012 it was even worse and gas supplies lasted for about, maybe, 1.5 months in total.
Last year things came to a head after some senior executives left and we were left with no choice but to buckle up and find a way to improvise with what we had had. Subsequently, the plans to divert the existing gas, we had had, to the new Enven plant emerged. We asked Sui to give us at least 10-15mmcfd if nothing else so that we could improve our production and that went straight to our bottom line.
So, from a place we were losing something like Rs 1.3 billion a quarter pre-tax during the first 3 quarters of FY12, we went even in the 4th quarter. Subsequently, this year in the first half we have already made a profit of 1.4 billion and that has been a combo of even streamlining our own operations and an improved outlook on feedstock availability.
Going forward, I believe that the new government is definitely more focussed in that finding a long-term solution to the gas availability issue has been a priority. However, I still wouldn't discount the efforts of the previous government. Although our aggravation is justified, somehow we can understand the fact that they did have justified political compulsions. Although it doesn't justify a breach of contract, stepping into their shoes does throw the matter into a different light.
BRR: Now that Engro is out of the woods, how do you plan to engage the government in trying to find a permanent solution to the gas supply issue?
RM: Just to give you a perspective, right now Engro Fertiliser is receiving around 30-35mmcfd from the Reti Maru and Mari gas fields. Additionally, around 10-15mmcfd is supplied by SNGPL. Since we need around 75-80mmcfd to run the plant at a healthy capacity so we're basically looking to secure a permanent supply of 35mmcfd. And, there are a few fields we are looking to tap into to fulfil this gap.
And like I said, the government does seem serious in helping us find a permanent solution for it. They've been very clear from day one about the fact that power is their first priority; but, if we can manage to come up with a solution that doesn't affect the SNGPL and the SSGC networks then they are going to do whatever it takes to help us secure the required feedstock supplies. Additionally, we are also very lucky to be situated in an area where there are a number of fields with non-pipeline low btu gas available. So all in all, things are looking up.
BRR: Tell us about the recent debt re-profiling that Engro Fertiliser recently went through!
RM: We only recently concluded the process of a massive restructuring of our balance sheet-probably the largest in the corporate sector's history. Through it, Engro Fertiliser has managed to restructure a majority chunk of nearly Rs 60 billion of its debt, pushing back the repayment schedule for another two and a half years.
But, now that our situation has become better-what with improved feedstock supplies and internal efficiencies-our cash flows are much healthier. Going forward debt servicing will become easier and we expect to be able to make both interest payments and retire principle alongside in these 2.5 years.
BRR: Any plans to introduce any instrument like the Engro Rupiya certificate in the market again?
RM: Well, that depends. As you know, the Engro Rupiya was done at Engro Corp level and will be maturing in January next year. Currently, we are in the process of deciding whether we want to refinance from it partially or fully. However, Engro Corp does have the cash coverage available to retire the TFC if it comes to that and that is an option we're looking into as well.
Going forward we are also going to want to consider the market perception. Last time around, there were some circles who said that we went to the public because we had run out of banks, who wanted to lend to us. So, we might want to escape that perception this time around. Like I said, we're trying to work out a decision at the moment and it will become clearer in the next few months.
BRR: Let's talk about the pricing of urea which remains an issue close to your heart. Do you feel that perhaps there isn't a clear understanding in the market regarding the dynamics of the pricing issue and Engro Fertilizer's role in the nexus? Could you elaborate on it?
RM: I'll give a slightly longish answer to this question so you'll have to bear with me but I do feel that it is important to clear the air about a few things. Let me go back a little in time to 2003-4 when we went through the commodities boom. See for the fertiliser sector in Pakistan the single largest issue we face criticism on is the concessionary feedstock we receive and the perception that we don't pass off the benefits to the consumers.
But, if you look at the numbers you'll see that even when international prices had been at their lowest-even at a time when Russia had been dumping it at $70 during their Rouble crisis-even during those 10 years the average price of domestic urea was about 20 percent lower than international prices. And that 20 percent was given to us in the form of lower gas and we passed it on and the objective was fully achieved. Since 2005 to 2012 if nothing else we must have passed on, as an industry close to Rs 600 to 700 billion to the farmers.
But, in 2011-12, a couple of things happened that literally doubled the price of urea in a very short span of time, taking it from $140 to $280 per ton. Nearly a hundred dollars of this price accretion can be accounted for by increases in prices of inputs. GST was increased then GIDC was applied to the gas prices. Then you have to factor in the inflation which was thrown into the mix. During those years price increases from our end were unavoidable since our annual debt servicing alone was around Rs 18 billion per year. So, while we had had little choice but to make these increases, everyone else simply enjoyed a piggy-ride on our banks and the whole mess with the CCP fining us ensued.
Without digressing further I'll say that we maintain that the price increases from our end were justified because our numbers merited it. How can we be accused of profiteering when our books are in red? It simply doesn't make sense.
BRR: Could you expand on the current demand-supply dynamic of Urea in Pakistan? How do you see it changing in the near-term?
RM: Our urea demand peaked around the year 2009, reaching around 6.2 million tons but it subsequently came down to 5.3 million ton last year. Last year's demand was hit by a few distortions-mainly the lower Cotton prices in the domestic market and the higher input costs. However, we do expect demand to recover to around 5.5 million tons this year.
Opposed to that the current installed production capacity in the country hovers around 7 million tons. Last year the production was only around 4.1 million tons due to supply issues so around 1.4 million tons had to be imported. This year, however, improved gas supplies mean that we expect imports to be much lower.
Then of course, there's carryover stock from last year as well, so factoring in everything, import should be around 6 to 7 lac whereas production should go up to 4.8 million tons.
BRR: Why has the demand been trending lower?
RM: Pricing is probably the biggest culprit I would say-having doubled in the last 3 years. And the lower urea application-combined with a cocktail of other factors-has already started showing an effect on crop production. You've already seen the wheat production gap we've had this year and going forward the land is only going to see more depletion, affecting crop yields. So, I'd say that higher prices have been consistently putting pressure on demand-which isn't a healthy sign.
If you compare our total fertiliser usage with that of a country like India, for instance, you see a huge disparity. India uses about 22 billion tons of urea, 7 to 8 billion tons of DAP and 3-4 billion tons of potash. Pakistan in comparison uses about 5.5 million tons of urea, 1.2 of DAP and Potash usage is only 50,000 tons per year.
BRR: It has been a while since Engro has been trying to create a market for Potash in Pakistan. But, you seem to have run against a wall. Why is that?
RM: Well, we have indeed tried a fair few things to get Potash going in the Pakistani market and I'll agree that we haven't been really successful. One reason for that is simply the fact that Pakistani soil can largely make do without regular application of Potash.
Again drawing a comparison with India-where the percentage of rain fed Baraani area is much higher than the canal-fed area; you see that regular Potash applications are necessary. A majority chunk of the Pakistani agricultural land on the other hand is fed by the canals which bring along substantial mineral deposition.
Having said that experts do tell me that there is still a great margin for improving Potash sales in the market because technically, the Potash level in the soil here is still below the optimal point. But, because it is expensive, it is one of the last things on a farmer's priority list. Whenever they are short on cash, Potash will be the first thing farmers will cut a corner on.
This problem can easily be tackled through the introduction of a subsidy on Potash and we did try to convince the government at one point to do it and it did emerge but then they abandoned it due to pressure.
BRR: Going forward, will Engro Fertiliser be looking to expand the domestic urea business? What about international expansion?
RM: Not really. If anything we just might be forced to shut shop if supplies to one of our plant aren't secured in the long term. Currently, we have about 2,500 people working in the one plant and although we haven't laid-off a single person, even then if in the event that we have to permanently shut up operations we might take the plant and the human resource and relocate abroad. We have looked into a number of countries including Mozambique, Yemen, Nigeria and Iraq for this purpose but again, this will only happen in the event that we have to disinvest here. Hopefully things won't come to that and if things keep running smoothly, we will only look to move into the international markets once we are sufficiently de-leveraged.
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