Fatima Fertilizer needs to answer more questions

Public offerings on KSE have become a rarity of late but the IPO of Fatima Fertilizer is all set to break the jinx in a few days time. The said offering of Rs2 billion is the largest on KSE in more than two years as the company intends to offer 50 million shares through the IPO and the remaining 75 percent through the book building process with the base price of Rs10/share.
The company has set up plants for four different types of fertilizers - urea, CAN, NP and NPK - which has a combined capacity of 1.58 million tons with urea having the largest share of 32 percent followed by 27 percent that of CAN fertilizer. The projects total cost is estimated at a staggering Rs59 billion.
There should be no doubts over the firms ability to sell its entire urea produce from the very month of commencement i.e. January 2010, given the shortfall of nitrogen fertilizer in the domestic market. What adds to the benefit of the urea segment is the fact that the company will be entitled to the all important feedstock gas at concessional rates for the first 10 years of plant commencement. This, coupled with the pricing power enjoyed by urea manufacturers in the country, bodes well for the segments gross margins in the future.
But thats only one-thirds of the story as the remaining two-thirds seems to be under dark clouds of uncertainty. The companys CAN plant that has already commenced operations creates doubts regarding the products demand in the country.
The other CAN producer in Pakistan which has a 0.45 million tons per annum capacity already operates at lower capacity level of 75 percent. The products demand in the last three years has hovered around 0.34 million tons per annum, which defies the logic of having 0.87 million tons of CAN capacity.
The NP and NPK projects are no different either, as the combined capacity addition of 0.66 million tons will lead to 1.12 million tons of capacity in the country. It is pertinent to note that demand for NP and NPK has been in the range of 0.44 million tons - never allowing the already installed capacity to operate at optimal level. The rationale behind the decision to have capacities over and above the demand requires some serious explanation.
In its offering document, the companys management, nevertheless, has painted a rosy picture of its future predicting an optimistic annual bottom-line growth of 30 percent for the next five years. This seems to be based on the assumption of high sales growth from 2011 when the NP and NPK plants will be operational. Moreover, gross margins predicted by the company are on a higher side as two-third of the products is of high margin nature.
There is no indication of the exports of its products by the company which strengthens the fear of non-materialization of its optimistic forecasts as the gross margins as high as 55 percent would never be achieved through urea alone - which is the only product rest assured to be sold entirely. If the company fails to create demand for CAN, NP and NPK fertilizers, not only would it hamper the revenue but would also strike a huge blow to overall gross margins.
Naturally, the fair value of Rs20/share provided by the management seems skewed on the higher side and also beats the consensus by a good 25 percent. The fact that the project has a relatively high debt equity ratio of 56:44, any drop in gross profits caused by the weak fundamentals is bound to hit the bottom line hard because of the high financial charges which have to be born irrespective of sales revenue. The company itself estimates staggering Rs4.7 billion financial charges per annum for the next five years.
However, what goes in the favor of the company is its expertise in fertilizer business and that its sponsor group has a strong financial muscle in the domestic circuit. Barring this, the project leaves one too many concerns unaddressed which may turn the biggest IPO in two years a flop at the box office.

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FATIMA FERTILIZERS PLANNED PRODUCT PORTFOLIO

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Product                             Capacity     Commencement

                                   (000 tons)

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Calcium Ammonium Nitrate (CAN)           420           Nov-09

Ammonia                                  500           Jan-10

Nitric Acid                              500           Jan-10

Urea                                     500           Jan-10

Nitro Phosphate (NP)                     360           Dec-10

Nitro Phosphate Potash (NPK)             300           Dec-10

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Source: Fatima Fertilizer offer document

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