The urea goldmine

You are a smart investor, if you invested in Fauji Fertilizer Company a year ago. Fewer investors in the local market or elsewhere would be as happy as the ones that banked on FFC, as the stock yielded a whopping 121 percent return (dividends included) in a year. The stock price closed at Rs171.8/share yesterday - its highest-ever level on an adjusted basis - nearly touching the upper circuit barrier.
FFC has rationally been considered a defensive stock, which, by definition, is a low risk, high dividend yielding stock without much capital gain. The stock price perfectly fits the bill on first two criteria as it is perceived as an almost risk-free investment in the market and has always traditionally had a payout ratio of close to 100 percent.
But delightfully for investors, in sharp contrast to traditional defensive stocks, FFC has also offered a healthy capital gain. This is where it leads the way not only amongst its peers but also in the whole market.
But the rise of the stock has strictly fundamental reasons attached and not mere speculation which is generally behind such massive increases.
The market leader in the fertiliser business has of late tasted the luck of being at an advantageous geographic location. The fertiliser industry enjoys immense pricing power on urea as local prices are less than half of the international prices - which enables them to pass on to consumers any increases in costs without a second thought.
The advent of Engros new fertiliser plant and the subsequent gas curtailment on its new plant has forced the company to increase urea prices every now and then. FFC on the other hand receives gas from the Mari network, which faces much less curtailment, but still follows the price hike decisions of its competitors- resulting in considerably improved margins.
Interestingly, since the advent of Engros new plant, whenever there is a price increase announced by Engro, analysts raise the valuations for FFC. Although Engro still keeps its margins intact, by passing on the impact of gas curtailment, the market views it as an opportunity for FFC, which is why the earnings estimates for FFC are tweaked upwards.
Engros share price on the other hand, has only risen by one percent in a year despite its fundamentals having improved from previous years. In fact, it was the first time in more than a decade that Engros share price actually fell below that of FFC on adjusted basis. Engro is no more seen as a fertiliser stock due to its hugely diversified business nature, but the share price triggers have almost always come from fertiliser related developments.
The fundamentals still seem tilted more towards FFC in relative terms, as there is still room for a massive price hike in urea should the feedstock subsidy end. The technical chartists though seem to be on the cautious side and advise realising gains at current levels. Still, investors in FFC have had their share of luck and perhaps wouldn mind a slight correction, before they make a sell or hold decision.