There is no business like urea manufacturing in Pakistan; and of all companies, Fauji Fertilizer Company (FFC) narrates it best. The largest urea producer, as it always has been, met the market estimates announcing that its profits increased by 25 percent.
The only major surprise was that of a lower than expected payout of 80 percent, as the company announced a full year dividend of Rs13/share, against the expectation of Rs16/share.
It is rather astonishing that never in the past ten years have FFCs gross margins slipped on a year-on-year basis, and CY10 was no exception. The floods and gas curtailment both played in favour of the market leader as it allowed more room to raise the product price, which more than offset the potential production losses.
Other than the solid top line growth, the contribution from FFBL in the form of dividend income extended support to FFCs bottom line again, as FFBLs superior performance during the period allowed FFC to reap dividends.
The real story lies in the lower dividend payout, which historically has been near 100 percent in the past many years. There are no points for guessing, though, that the firm has held it back to finance the future acquisition of Agritech, which has been in the plans since August 2010.
Recalling the history, the managers at FFC are not fond of being entirely dependent on debt to finance capacity expansions or acquisitions. They have every reason to finance the acquisition through internal generation as their cash cycle remains strong and FFC sits on a huge cash balance, which often leads them to be termed as a ank in some circles. Rumour has it that FFC might go for right issues to finance the Agritech acquisition.
And the decision to cut the payout might well have been a last minute decision as the Competition Commission of Pakistan coincidentally issued the NOC to FFC for the proposed acquisition, just a day prior to the result announcement.
Clear of all hurdles now, FFC is expected to fast-track the acquisition. The CCP, though, has issued the NOC on strict conditions, some of which are clear while others ambiguous. That FFC will not be allowed to brand the target companys product as the existing Sona brand for two years is clear. It should not be a problem for FFC to market the product since it has a well established distribution network across the country.
Another condition which the CCP wants FFC to fulfil is capping the price increase of the target companys brand for one year post-acquisition. This may seem a bit harsh on the acquirer as the feedstock cost is expected to increase considerably during CY11, which will put pressure on margins in case of price capping.
However, FFC is expected to bring effectiveness to Agritechs urea production as the current plant runs low on efficiency. Therefore, even a minimal increase in price may offset the potential loss of price capping through improved plant efficiency.
Moreover, CCP has asked FFC to intimate any price increase with reasons to the Commission for three years on all its fertilizer products. For the most part, the FFC may not have a problem as the price increase is mostly based on input cost hike, which is justifiable.
What should be of greater concern for FFC is the explanation of the rationale of a price increase, when it is not based on input cost increase. The fertiliser companies have in the past, increased urea prices on occasion, merely based on the hike in international urea price or maintaining a certain price differential to the global price. Will this be acceptable to the CCP is yet to be seen. Will the FFC pay this price for a small acquisition is also yet to be seen. But reading from the CCP letter, one is rest assured that the profit margins for fertiliser companies are bound to come down.
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FFC P&L
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Rs mn CY09 CY08 chg
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Sales 44,874 36,163 24%
Cost of sales 25,310 20,515 23%
Gross profit 19,564 15,648 25%
Gross margins 44% 43% 1%
Finance cost 1,087 945 15%
Other income 3,153 2,801 13%
PAT 11,029 8,823 25%
EPS (Rs) 16.25 13.00
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Source: KSE notice
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