Hosted by CFA Society of Pakistan Team Institute of Business

hosted by CFA Society of Pakistan Team Institute of Business Administration, Karachi Institute of CFA Institute Research Challenge Business Administration, CFA Institute ResearChemicalch Challenge Industry Karachi Fatima Fertilizer Company Ltd. 15th January 2012

. Ticker: FATIMA:PA . Recommendation: BUY

. Current Price: PKR 24.87 . Price Target: PKR 34.56

. Exchange Rate (PKR/USD): 97.28 . 6 Month KIBOR: 9.46%

. Local CPI: 7.9%

(Mn PKR) 2011 2012 2013 2014 2015 2016 2017 Net Revenue 14,833 29,996 35,844 37,482 39,357 41,324 43,391 EBITDA 9,897 18,238 21,763 22,616 23,203 23,818 24,406 Net Income 4,117 6,311 9,141 10,024 11,058 12,111 13,129 Debt Financing 34,457 29,480 29,480 24,695 18,781 12,867 7,703 (PKR) Earnings Per Share 2.06 3.01 4.35 4.77 5.27 5.77 6.25 Dividend Per Share 1.50 1.65 2.39 2.63 2.90 3.17 4.69 Book Value Per Share 13.36 13.88 15.75 17.79 20.06 22.55 24.00 (%) Net Profit Margins 27.8% 21.0% 24.9% 26.2% 27.5% 28.8% 29.7% Return On Assets 5.9% 8.3% 11.4% 12.5% 14.1% 15.8% 17.2% Return On Equity 17.1% 21.7% 27.6% 26.8% 26.3% 25.6% 26.1%

Dividend Yield 6.6% 9.6% 10.5% 11.6% 12.7% 18.8%

HIGHLIGHTS

FATIMA: A STAR AMONG GIANTS!

 BUY BUY BUY!!! Our fundamental valuation supports a buy side proposal on Fatima with a target price of PKR 34.56 for Dec’13 and upside potential of 39% in 1 year. Our rating for Fatima is premised on its fixed feedstock gas price, consistent supply from Mari Gas field, diversified product portfolio, deleveraging of the balance sheet and debt restructuring. All of these would result in strong cash flows and margin growth for the company from CY13 to CY20.

 Mari Gas: Elixir for Fatima Under the 2001 Fertilizer Policy of Pakistan, Fatima Fertilizer enjoys a preferential fixed tariff on feed gas of USD 0.7/mmbtu for next 7 years, compared to the USD 3.3/mmbtu for other players in the fertilizer sector. Also, it receives a consistent gas supply from Mari gas field with fixed maximum curtailment of 12% unlike its counterparts on the Sui network. This Figure 1: Fatima V/S KSE100 ensures that it has one of the highest profitability margins among its peers.

70%  Diverse Product Portfolio: A Safe Haven 60% Fatima’s diverse product portfolio with Urea, NP and CAN ensures strong off-takes 50% throughout the year. Apart from enjoying an exuberant margin on NP sales, it acts as a 40% hedge against uncertainties arising in the CAN and Urea market. Given this, Fatima is 30% expected to have a strong margin accretion in future with EPS expected to grow at a CAGR of 20% 14.4% till CY17. 10%  Debt: Breaking the Shackles 0% Fatima is projected to have ample cash to achieve the debt free status by 2017, as well as

-10%

Jul-12

Jan-12

Jun-12

Oct-12

Apr-12

Feb-12 Sep-12

Dec-12

Aug-12 Nov-12

Mar-12 provide an excellent dividend growth of 16.6% over the next 8 years. The strong cash flows -20% May-12 are expected to support Fatima's future plans of both local and international expansions. R-Fatima R-KSE100 Source: KSE  Phos Rock: Cost Suppression With its state-of-the-art plant technology, Fatima has the ability to utilize low grade local phos rock raw material to cater 25% of its requirement for NP production. This, along with the stable international phos rock prices provides a bonus to Fatima's profitability in the

future.

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BUSINESS DESCRIPTION

Fatima Fertilizer Company Limited, a fully integrated fertilizer complex, was incorporated on 24th Figure 2: Porter's Model December, 2003 as a joint venture between two major business groups of Pakistan: Fatima Group and Arif Habib Group. The production facility, with a net cost of USD 750 mn is located at Sadiqabad, Rahim Yar Khan, which is geographically situated in the middle of the country’s agricultural belt. The plant’s primary objective is to produce Urea, Calcium Ammonium Nitrate (CAN), Nitro Phosphate (NP) and Nitrogen Phosphorous Potassium (NPK) fertilizers.

The complex has a cumulative capacity of 1.7 mn metric tons per annum with 0.5 mn tons allocated to Urea, 0.42 mn tons to CAN, 0.36 mn tons to NP and 0.42 mn tons to NPK. Fatima commenced trial production from its CAN plant in 2009, Urea plant in 2010 and NP plant in June 2011. Fatima declared the commencement of its commercial operations from July 2011 and has been selling its products under the umbrella brand name of Sarsabz fertilizers. The complex has a 56MW captive power plant in addition to off-sites and utilities.

rd Fatima Fertilizer’s capability as the 3 largest producer of farming ingredients, to produce a mix of well diversified fertilizer products such as NP and CAN, is its unique selling point. As a result,

Fatima can effectively counter the volatility in local fertilizer prices. This mix of production Source: Team Estimate capacity has made Fatima the most diversified fertilizer player in the country. (See Figure 4)

The Company is listed on all stock exchanges in Pakistan, through a successful initial public offering (IPO) in February 2010 to fund the requirement of the project at the time of the listing. Figure 3: Company Ownership In order to develop an international profile and better market itself to international investors, Fatima Fertilizer became the only Pakistan based company qualified by OTC Market Inc. USA for the sponsored level 1 ADRs in March 2011. The ADRs are listed on the OTC market with a ratio of 1:50. Fatima Fertilizer has also recently joined ranks of the local blue chip companies by being added to the Morgan Stanley Capital International Pakistan Index (MSCI).

The visionary management of Fatima Fertilizer is evaluating Algeria and Nigeria as a potential site to set up a USD 1.4bn facility, as part of their long term expansion strategy to tap overseas market. US plant

INDUSTRY OVERVIEW

With about 28.6% of its total land under cultivation, agriculture has for long been the mainstay of Source: Fatima Annual Report Pakistan’s economy and currently contributes 21% to its GDP. Agriculture sector in Pakistan

exhibited a growth of 3.1% in 2011-12. Major crops which include wheat, rice, cotton and sugarcane on average contribute 29% to the value added in agriculture and a significant 6% to the GDP. With the global output projected by the IMF to have a YoY increase from 3.3% to 3.6% in 2013 and Pakistan’s GDP projected to increase by 3.3% in 2013, agriculture sector would have continued significance in the economy of the country.

Fertilizer is the most important and expensive agricultural input in Pakistan. Balanced fertilizer usage contributes to an increase of about 30% to 60% in yield in different crop production areas of the country. Its consumption is inevitable in order to meet the nutritional requirements of a growing population, as all of the country’s soil has been found to be lacking Nitrogen; 80-90% is poor in Phosphorous, while 30% is deficient in Potassium (See Figure 2 & Appendix C for Porter's Five Forces Analysis).

Nitrogen-based Urea is the main fertilizer (68%) used in Pakistan, followed by Phosphorous rich DAP (15%). Pakistan’s fertilizer industry has a total production capacity of 6.8mn tons of urea per annum while the local demand is approximately 5.7mn tons per annum. However,

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due to the natural gas curtailment to the fertilizer plants on the Sui network fertilizer sector has Figure 5: Urea vs CAN Prices been operating below capacity and produced 4.6mn tons of urea in CY12. The difference in supply and demand is fulfilled through imports of urea which are subsidized by the government. 3000 According to media reports, in the 18 months from Jan 2011 to June 2012, government had 2500 imported USD 1.1bn worth of urea and bore a subsidy of PKR 75bn on these imports. Fauji Fertilizer Bin Qasim Limited being the only DAP producer in the country, is able to meet 58% 2000 (CY11) of the country’s DAP demand while the rest is satisfied through imports. However, DAP imports are not subsidized by the government. (See Figure 4)

PKE/Bag 1500 Competitive Advantage 1000 Fatima’s competitive advantage arises from low cost production due to fixed feed gas tariff of USD 0.7/mmbtu under the 2001 Fertilizer Policy while its peers receive gas at the high USD 500 3.3/mmbtu. Moreover, Fatima is the only player in Pakistan’s fertilizer industry that receives

subsidized gas from the Mari field throughout the year enabling it to maintain efficient

9-Sep

Jan-09 Jan-10 Jan-11 Jan-12

Sep-10 Sep-11 Sep-12

May-10 May-11 May-12 May-09 production. Fatima Fertilizer also has the most diversified product portfolio in the market producing three products: Urea, CAN and NP which enables it to sustain earnings and hedge itself Urea CAN against price volatility.

Source: NFDC

Fatima is strengthening its country wide distribution network for its products with 920 sales points and 2,262 business associates. Fatima has also launched “Sarsabz” brand building strategy in 2011 including an advertis0078ement campaign to strengthen retail network, target small Figure 6: DAP vs NP prices dealers and achieve continuously growing the overall reach. Fatima’s role in industry is also 4500 emphasized among end-users of its products as it conducts activities to educate farmers on balanced fertilizer usage to improve farm productivity & profitability. 4000

3500 Other Prominent Players 3000 2500 Fauji Fertilizer Company PKR/Bag 2000 In Pakistan, greatest share of the fertilizer market is held by FFC which is the largest urea 1500 manufacturing company in the country, producing 39% of the country’s total fertilizer and 53% 1000 of the total urea manufactured in CY11. FFC currently has three plants in operation with two at

500 district Rahim Yar Khan and a third that was acquired from Pak Saudi Fertilizer Ltd. at district Ghotki in 2002, raising its total design capacity for urea production up to 2.05mn tons per

Jul-11 annum. FFC was operating at 117% of its design capacity in 2011, receiving a sustainable gas

Jan-09

Jun-09

Oct-12

Apr-10

Sep-10 Feb-11

Dec-11 Nov-09 May-12 supply from Mari throughout the year.

NP DAP Fauji Fertilizer Bin Qasim Limited Source: NFDC FFC holds 50.88% ownership in Fauji Fertilizer Bin Qasim Limited which is the only plant

producing DAP and Granular Urea in the country. However, being on the Sui gas network FFBL’s plant faced overall gas curtailment of 30% in FY11 reducing ammonia and urea production by 12% and 17% respectively as compared to the previous year. The company’s DAP sales also declined by 16% in FY11 owing to the withdrawal of GST exemption by the GoP and rising Figure 7: Fertilizer Offtake CY12 international prices putting upward pressure on domestic DAP prices, therefore resulting in

400 lower consumption. In CY11, the company reported a market share of 66% for DAP and 7% in 375 380 urea.

360 340 330 Engro Fertilizers Limited

Engro has the world’s largest single train urea ammonia plant, EnVen, which commenced 320 300 operations in June 2011 and is capable of manufacturing 1.3mn tons of urea per annum. Production however, has faced a setback due to gas cuts at SNGPL network despite the plant

'000 tons '000 280 being promised a gas supply of 110mmscfd. Engro’s old plant has urea capacity of 975,000 tons 260 250 and has been receiving gas from the Mari field for production, enabling the company to keep a 240 market share in urea of 21%. Engro is also in the manufacturing of NPK fertilizer. 220

200 Dawood Hercules Fertilizers Limited Urea NP CAN NPK Source: NFDC, Team Estimates DHFL’s urea share in the market dropped significantly from about 10% in FY10 to 6.7% in FY11

due to suspension of gas supply for a total of 197 days in the year by SNGPL along with curtailment all year round. Its plant has a capacity of producing 445,000 tons of urea per annum

and the company’s sales are limited to the NWFP and Punjab region.

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Pak Arab Fertilizers Limited Pak Arab Fertilizers Limited was acquired by the Fatima Group and Arif Habib Group in 2005 under the privatization policy of the GoP, and hence can be regarded a sister concern of Fatima Fertilizer Ltd. Apart from manufacturing urea, Pak Arab is the only producer of CAN in Pakistan apart from Fatima Fertilizer. However, unlike Fatima Fertilizers, Pak Arab receives gas from the Sui network and hence suffered shutdowns and gas curtailment reducing production of NP, CAN and Urea by 27%, 31% and 62% respectively in 2011 as compared to the previous year.

The Issues with Gas Government has been subsidizing gas prices for the fertilizer sector as it is the major raw material for production of urea and also a fuel for the plants, at rates ranging from USD 0.7- 3.5/mmbtu. Lower end prices apply to plants that have carried out major capex/BMR or have invested in a green-field project under the 2001 Fertilizer Policy. This contrasts starkly with the local price of USD 5.6/mmbtu for the general industries and international gas prices of USD 4- 12/mmbtu. On the other hand, government imposed the Gas Infrastructure Development Cess (GIDC) in December 2011 last revised on July 2012, on the natural gas supplied to fertilizer plants which currently stands at PKR 197/mmbtu of feedstock and PKR 50/mmbtu of fuel gas. The cost of natural gas to old fertilizer plants rose by around 200% after the imposition of the Gas Infrastructure Development Cess (GIDC) in December 2011. Nonetheless, the GIDC has impacted only the old fertilizer plants while the new plants which include Engro’s Enven plant and Fatima Fertilizer are exempted from the cess.

Figure 9: Feedstock Prices Under the Natural Gas Allocation and Management Policy 2005, GoP had announced fertilizer 450 companies at the system to have third priority after domestic and commercial sector and power 400 generation sector for gas supply while those on independent network had first priority. Fertilizer 350 plants on the independent Mari network which include FFC, Engro’s old plant and Fatima enjoy 300 gas supply with limited gas curtailment of 12%, while other plants on the Sui network including 250 Engro-Enven, Dawood Hercules, Agritech, FFBL and Pak Arab are facing a major setback in

200 production due to variable gas curtailment and unscheduled gas suspensions of up to 7 months. PKR/mmbtu 150 The suspension of gas results in conversion inefficiencies leading to higher production costs for 100 these manufacturers (See Figure 8). 50

Sector Outlook

2014 2015 2016 2017 2018 2019 2020 2013 The fertilizer sector is currently without a feasible solution for the gas crisis, therefore gas

Industry Fatima curtailment is expected to continue in future which would keep production below demand, resulting in the need for expensive imports from the government. While the government would Source: Team Estimates continue importing and subsidizing urea by depleting foreign exchange reserves, fertilizer manufacturing capacity would remain idle within the country. With the prevalent gas crises and high urea prices along with price uncertainty, continued decline in the usage of nitrogenous fertilizers is expected to gradually reduce crop yields raising the anticipation regarding food insecurity. Figure 10: EBITDA Margins (CY11)

23000 Earliest possible restoration of gas is critical for the local industry as it will lead to a reduction in 21000 fertilizer prices increasing its affordability for the farmer. It would also save foreign exchange 19000 due to lower imports and reduce the burden of government subsidy. With the fertilizer usage 17000 expected to restore to earlier levels as prices lower, farmers would attain improved yields to 15000 achieve and sustain food security.

13000 PKR/Ton 11000 9000 INVESTMENT SUMMARY 7000

5000  The Mari Advantage

Urea CAN NP While the companies on the SNGPL network face large unpredictable swings in gas supply leading Source: Team Estimates to detrimental effects on their productivity, Fatima has the advantage of receiving consistent gas from the dedicated Mari gas field whose low BTU gas renders it unsuitable for other commercial and domestic uses unlike Sui gas. According to the agreement with Mari Gas Supply Corporation, Fatima is entitled to receive 110 mmcfd of gas year round with maximum curtailment of 12% and has faced no unscheduled shutdowns. While plants on SNGPL network face higher variable gas

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curtailment along with unscheduled gas suspension of up to 7 months, Fatima’s production with Figure 11: Cash vs Debt gas from Mari remains stable and low cost, improving its margins (See Figure 8). 70  Feed gas price locked in until 2018 60 In accordance with the 2001 Fertilizer Policy, Fatima enjoys the benefit of fixed feed gas tariff of 50 USD 0.7/mmbtu for 10 years since commissioning. This is in sharp contrast with the approximate PKR bn PKR 40 cost of USD 3.3/mmbtu incurred by its peer companies. Furthermore, Fatima is also exempted 30 from the Gas Infrastructure Development Cess giving it further savings of PKR 197/mmbtu on feed gas and PKR50/mmbtu on fuel gas supply. Price increases in urea due to these GIDC 20 charges provide Fatima an added premium on its sales without any costs. A further jump in urea 10 prices of PKR 100 will lead to the 6.7% increase in EPS in 2013. So with the stable and low cost 0 gas supply, Fatima has quite a competitive edge, leading to the highest profitability in the

industry (See Figure 9).

2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 Cash and Bank Balances Long term Debt  Diverse and Strong Product Portfolio Source: Team Estimates By being able to produce three different nitrogen and phosphate based fertilizers namely Urea, CAN and NP, Fatima has managed to diversify its product portfolio well while offering benefits to Figure 12: Cash vs Dividends the farmer. With CAN being sold at 15% discount to Urea and NP at 35% discount to DAP, they 20 are not only cheaper than their traditional counterparts; they are also more suitable for water-

distressed areas. Moreover, even though the nitrogen and phosphate content is lower than in

15 Urea and DAP, CAN and NP release the nutrients more gradually in the soil leading to better nutrient availability and efficient utilization of the fertilizers throughout crop growth (See Figure 10 7).

PKR/Share

5  Strength through NP Fatima Fertilizer, being the only local NP producer apart from Pak Arab, is growing its share to 0 meet the high demand for NP in Pakistan. Its position is further strengthened by the low

production and declining share of Pak Arab due to gas curtailment. Fatima has the technological

2012 2013 2014 2015 2016 2017 2018 2019 2011 edge in production of NP as it is capable of using variable grades of phos rock, the major raw Dividend per share Cashflow per Share material in NP, without compromising on nutrient quality.When Fatima shifts to locally mined phos rock to meet 25% of its raw material requirement from Pakistan Mining Company Limited, Source: Team Estimates also a Fatima Group Company, it will reduce its dependency on imports mainly from Morocco and Egypt, save on transportation costs and foreign exchange and thus expand NP margins further. Lastly, while DAP’s prices are highly volatile due to phos-acid and sulphur prices, phos Figure 13: Price Senstivity to CER 39 rock prices do not fluctuate as much leading to less volatile NP margins (See Figure 10). 38

 Strong cash flows to ensure Debt free status by 2017 37 While the total debt of company stands at PKR 29.5bn in Dec 2012, its strong operating 36 cashflows along with the fundamentals ensure hassle-free debt repayment, eventually freeing 35 up cashflows to payout greater dividends and improve their debt taking capacity at low costs for 34 future expansion projects (See Figure 11 & 12).

Share Price (PKR) Price Share 33

32 Additional Upsides 0 2 4 6 8 10 12 14 16 18 20

USD/ton Source: Team Estimates  Initial Tax Depreciation Allowance Fatima has the advantage of being effectively charged tax rate of 1% of revenue due to deferred Figure 14: Taxation tax benefit till the adjustment of initial tax depreciation. This saves Fatima over PKR 7.4bn in 8 cash taxes over the next 2 years, further improving the company's liquidity (See Figure 14). 7 6  Carbon Emission Reduction (CER) Credits

5 Under the Clean Development Mechanism (CDM) project, Fatima is expected to receive CER

4 credits between CY13 and CY20; equal to twice its nitric acid production. These credits can be

PKR Mn PKR 3 traded in the international market, however at the end of 2012 these credits went to a near

2 junk status trading at USD 0.0042/ton due to ban on their trading in Europe resulting in excess supply all over the world. We expect this situation to continue in future as Australia is also 1 - expected to put this ban in motion next year, resulting in nearly a negligible addition to the company's profitability from these CER credits. However, any USD 1 increase in CER prices will

2013 2014 2015 2016 2017 2018 2012 provide an additional upside of PKR 0.2 per share.

Accounting Taxes Cash Taxes Payable Source: Team Estimates 6

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 Pakistan Rupee Devaluation & International Urea Prices Higher rupee devaluation and increasing gap between the local and international urea prices in the future are expected to pose a higher subsidy burden on the government. Also, any increase Figure 15: EPS, DPS & CPS in rupee devaluation is expected to add to Fatima's profitability as local fertilizer prices are

14 expected to relate to the international ones in the long term. 12 10  Future Growth Projects 8 Fatima already has plans underway for debottlenecking its processes to increase ammonia 6 production capacity in two phases; however this can be hindered by gas constraints in the 4 country. Moreover, as an attempt to gain overseas exposure, Fatima Group is planning a USD PKR/Share 1.4bn investment in the resource rich African countries for fertilizer manufacturing. The Danish 2 0 Industrialization Fund for Developing Countries and Haldor Topsoe of Denmark have already

agreed to partner with Fatima Group for a green field fertilizer complex in Africa. Construction is

2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 expected to start on the project as the funding structure and terms of gas along with phos rock Earning Per Share Cashflow Per Share supply are finalized. Dividend Per Share

Source: Team Estimates Fatima Group has also initiated projects in power generation under the newly incorporated

Fatima Energy, capable of producing 100MW electricity from biogas (biomass, a renewable source) during sugarcane crushing season and also using coal from the Thar coalfields in off- season.

These expansion projects open up new opportunities for Fatima and play a significant role in mitigating the risks the company faces. Given the uncertainty and lack of information, we have not incorporated these ventures in our valuation, however any such expansion is expected to

further add value to the company.

 Expensive Gas In Future

Government of Pakistan expects to add about 750 mmcfd of gas to the national gridline by the end of CY13 from the development of new gas fields such as Reti Maru, Kunar Pasakhi, Bahu, Mari and Makori. Except Kunar Pasakhi, all other fields are expected to have comparatively Figure 16: Total Sales lower quality gas and will be sold at the prevalent market rate for industrial consumers, currently at USD 6/mmbtu. Thus, restoration of gas at higher prices will increase the cost of 55 production leading to higher fertilizer prices and therefore providing Fatima an added premium 50 on its margins (See Appendix J for Forecasted Energy Need of Pakistan).

40 Urea Price 28 Price Dividend Reduction PKR 35 increase

PKR Bn PKR 145/bag by Engro 30 26

25 24 20

2013 2014 2015 2016 2017 2018 2019 2020 Price Source: Team Estimates 20 Expected Discount of add. PKR Lower GIDC 40/bag by 18 fertilizer FATIMA Imposition Sales in 1Q 16 of GIDC

1-Jul-11 1-Jul-12

1-Jan-12 1-Jan-13

1-Jun-12

1-Oct-11 1-Oct-12

1-Sep-11 1-Feb-12 1-Sep-12

1-Apr-12

1-Dec-11 1-Dec-12

1-Mar-12

1-Aug-11 1-Nov-11 1-Aug-12 1-Nov-12 1-May-12

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FINANCIAL ANALYSIS Figure 18: Profitability Margins 80%  Robust Earnings 70% Fatima Fertilizer shows strong projected earnings of PKR 4.35 in CY13; a 45% YoY increase, and 60% are expected to grow at a CAGR of 14.4% for the next six years. Although earnings are expected 50% to take a hit when Fatima’s highly beneficial gas subsidy ends in 2018; falling to PKR 5.74 in CY19 40% from PKR 6.72 in CY18, they are expected to recover swiftly with a stable EPS from CY20 30% onwards due to nil finance costs (See Figure 18). 20% 10%  Stable and Inelastic Demand

All three products of Fatima’s Sarsabz family enjoy a strong local demand, which is expected to

2012 2013 2014 2015 2016 2017 2018 2019 2020 2011 increase the sales in the future with a CAGR of 6.7% till CY20. This stable and strong demand GP Margin EBIDTA Margin NP Margin ensures that Fatima will be able to sell all of its products within a specific year. Thus, the sales Source: Team Estimates will only be limited by production capacity and availability of gas while any fluctuations in sales will be cyclical and covered in the same year. Moreover, a steady expected increase in prices of fertilizer achieved as a result of improved farmer income over the years will be beneficial to Fatima in supporting the growth in sales (See Figure 16).

 Stable Net Profit Margins Attractive sales growth, subsidized feed gas and a 22% YoY decline in finance costs, result in stable net profit margins of 25% to 30% over the next 8 year period. The profitability saved because of the debt free status from CY17 onwards, provides Fatima a buffer against the jump in feedstock prices of up to 300% (See Figure 18).

 Decreasing Finance Costs and Debt-Free Status Fatima plans to achieve debt free status by CY18 and most of the cash generated from operations will be used to pay off debts in the next five years. However, we do not expect this to hamper their ability to pay high dividends. The finance costs will decrease from PKR 5.7bn in CY12 to zero in CY18 showing an average annual decline of 22%.

 Liquidity and Solvency Figure 17: Liquidity and Solvency Fatima is projected to reach the industry average inventory turnover days of 40 and the creditor 7.0 days of 45 in CY15 resulting in a favorable operating cash flow cycle. This will ensure sufficient 6.0 liquidity for operations in the future years. Also, due to debt payoff in the initial years, we expect Fatima to have a comparatively lower current ratio of 1.3x, however it is expected to 5.0 improve in the future due to lower debt burden with a ratio of 6.0x by CY17. Also, the leverage 4.0 ratio is expected to go down to 0.4x by the end of CY17. Given its excellent profitability growth 3.0 of 14.4% and cashflow growth of 16.0%, Fatima is expected to reach dividend payout of 100% by 2.0 CY20. 1.0 -  Attractive Dividend Payouts

Arif Habib Group has a history of paying strong dividends in all of their subsidiaries; Fatima

2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2011A Fertilizer will operate on the same policy. The management will easily reach a payout ratio of Current Ratio 75% and later increase it to 100%. Fatima fertilizer is expected to maintain a payout ratio of 55% Solvency Ratio till CY16. Fatima fertilizer will shift to the desired payout ratio of 75% in CY17. Currently, Fatima Interest Coverage Ratio is expected to pay a dividend yield of 6.67%; however we expect this to increase to 22.7% by the Source: Team Estimates end of CY20 (See Figure 15).

Figure 20: WACC Projection VALUATION 19% 18% 17% Discounted Cash Flow Model: Free Cash Flow to Firm (FCFF) 16% DCF (FCFF) and PER valuation methods are the most suitable for this company, given its 15% changing leverage status and lack of sufficient information available for any other method. Over 14% a period of 8 years, the DCF method takes into account the time value of money on Fatima's 13% returns as well as the future long term growth of the company. It also provides us a view on

Fatima's performance after its feedstock gas subsidy ends in 2018. The base price from DCF

CY14 CY15 CY16 CY17 CY18 CY19 CY20 CY13 valuation is PKR 34.21 per share with a target date of 31st Dec 2013; offering you an attractive WACC Source: Team Estimate upside potential of 37.5%.

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Projected Cash Flow EPS CAGR is expected to be 14.4% for the next 6 years providing a robust growth to Fatima's Figure 21: Product wise Sales cash flows. For CY12, Fatima is expected to have an operating cashflow per share of PKR 2.90 55 with a CAGR of up to 33% over the 8 year valuation period. Though not incorporated in our 50 valuation, Cash tax savings due to the accelerated depreciation of fixed assets is further 45 expected to add to the cash flow of Fatima in the early years. We expect around PKR 7.4bn cash 40 savings from taxes over the next 2 years. 35 PKRBn 30 25 Sales Projection 20 The 10 year base model incorporates a conservative constant fertilizer unit sale given the 15 uncertainty on the production side due to the ongoing gas crisis and production capacity. Thus,

given the production limitations any upside in revenue is expected to come from the price

2014 2015 2016 2017 2018 2019 2020 2013 increases in Urea, CAN and NP. We expect Urea to increase by 5% in the future. International DAP and phos rock prices are expected to remain stable in future years, and thus taking a NP Sales CAN Sales Urea Sales conservative approach we expect the local prices to increase by 5% according to rupee Source: Team Estimates devaluation. (See Figure 22 & Appendix M for Additional Wealth Generated)

Also we do not expect the management to go for debottlenecking of the ammonia plant in the near future due to uncertain gas supply and the investment requirement on this project. In the off chance that the gas is made available to Fatima, we expect the management to use the added ammonia for NP production given its net supply deficit in the market as well as the Figure 22: Product Prices extraordinary margins. This will further add value to the company (See Figure 21). 3500 Stable Margins 3000 We expect Fatima to maintain a constant strong growth from CY12 to CY18 due to the constant

feed stock gas advantage and the high margins on the NP and CAN sales. Gross profit margins 2500 are expected to be stable between 63% and 59% during this period in comparison with an

2000 industry average of 43%. Net profit margins on the other hand are expected to increase from PKR/Bag 26% to 30% over the same period compared to an industrial average of 18% in the current fiscal 1500 year. However, from CY19 onwards we expect a huge jump in the raw material costs due to end of feed gas subsidy. This leads to Fatima's feed gas cost rising to the industry prices of PKR 1000

308/mmcfd, with a 333% jump under one year. This may lead to 15% and 19% fall in gross and

2013 2014 2015 2016 2017 2018 2019 2020 2012 net profit margins respectively. NP CAN Urea Terminal Growth Source: Team Estimates Our terminal growth is based on the average 3.1% and 3.5% growth in Pakistan's agriculture and real GDP over the last decade. However, we have taken a conservative estimate of 3% in this case due to uncertainty on the gas front after the depletion of Mari gas reserves as well as Pakistan's future economic outlook. (See Figure 23 & Appendix N for Price Sensitivity to Terminal Growth). Figure 23: Price Sensitivity to Terminal Growth Cost of Equity 55 Cost of equity was calculated through the CAPM model. The 10 year PIB government bond rate of 11.55% has been assumed as the risk free rate and the risk premium is expected to be at 6% 50 based on the average historic risk free rate and market returns. With an adjusted historical beta of 1.098, the required rate of return is calculated as 18.14%. Furthermore, our valuation 45 assumes constant cost of equity throughout the eight year valuation period. 40 CAPEX 35 Given the unavailability of gas, we do not expect Fatima to expand its production capacity, Share Price (PKR) Price Share however we expect the company to incur maintenance capital expenditure of about PKR 500mn 30 starting from CY14 onwards. This is in line with the costs to its competitors according to their ammonia capacity. Fatima plans to enhance its production capacity in the future through 25

debottlenecking of ammonia plant at an expected cost of PKR 2bn to 2.5bn. Furthermore,

0% 2% 4% 6% 8% 10% Fatima also plans to expand to North Africa in the long term future with a total CAPEX of about Source: Team Estimates USD 1.4bn. However, we have not incorporated these expansions in our valuation due to lack of information and uncertainty on the gas front. If they do materialize, we believe they will further add to the valuation of Fatima.

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Multiple Valuation(s) Price to Earnings multiple accounts for the market valuation of a stock. The local and regional PER methods have been assigned smaller weightages to our valuation because of the uncertainty on the gas front locally and Pakistani market trading at a significant Figure 24: Price Sensitivity to Risk Free Rate discount regionally. Price Sensitivity (PKR) The trailing P/E ratio of Fatima is 8.5x; however it does not represent the future growth Terminal Growth potential of Fatima and is due to the earnings of the company not reaching their maturity level. 2% 4% 6% However, we have priced Fatima based on the mean local PER of 6.71x and mean regional PER of 10.68x arriving at a price of PKR 29.2 and PKR 46.31 respectively. With a leading P/E ratio of Risk Free 11% 34.08 36.66 40.13 Rate 6.1x in CY13, Fatima is at 17.4% and 86.2% discount to its local and regional peers respectively. 11.50% 32.88 35.24 38.38 (See Appendix F for Local and Regional Multiples) 12% 31.76 33.92 36.77 Souce: Team Estimate

PER Bands

45 14x 40 35 12x Figure 25: Valuation Table 30 10x PER 25 20 Method DCF PER (local) (Regional) 8x 15 Price 34.21 29.2 46.31 10 (2013)

2011

Weights 90% 5% 5%

6-Jul-12

7-Jun-12

2-Oct-12

8-Feb-12

9-Apr-12

4-Dec-12

8-Mar-12 17-Jul-12 26-Jul-12

6-Aug-12 2-Nov-12

10-Jan-12 19-Jan-12 30-Jan-12 9-May-12 27-Jun-12

18-Jun-12

11-Oct-12 22-Oct-12

17-Feb-12 28-Feb-12 11-Sep-12 20-Sep-12

18-Apr-12 27-Apr-12

13-Dec-12 24-Dec-12

19-Mar-12 29-Mar-12

16-Aug-12 31-Aug-12 14-Nov-12 23-Nov-12 29-May-12 Weighted 30.79 1.46 2.32 18-May-12 Price Conclusion Final Price 34.56 Fatima is best valued at a price of PKR 34.56 through a weighted combination of the DCF and st So urce: Team Estimate PER valuation method and a target date of 31 December 2013. This provides an upside th potential of 39% on the current price of PKR 24.87 as on 15 January, 2013 (See Figure 25).

INVESTMENT RISK

Company Specific

Figure 26: Fatima Stock Beta 1.6 Improvised Explosive Devices (IED’s) Fertilizers (Level: Medium)

1.4 One of Fatima’s and Pak Arab’s main products Calcium Ammonium Nitrate (CAN) can be used to manufacture Improvised Explosive Devices. This is allegedly responsible for over 70% of the 1.2 roadside bomb blasts against coalition forces in Afghanistan. However, this issue has been put to 1 8-Mar-10 8-Mar-11 8-Mar-12 rest as Fatima is not the sole producer of CAN in the region with Iran, Uzbekistan and Central 0.8 Asian republics being other major players that produce CAN. 0.6

0.4 A scheme of color coding CAN to allow authorities to control its illegal movement is under

0.2 consideration right now. However, in the very unlikely scenario that a full fledged ban on the production of CAN goes into effect in Pakistan, we can expect Fatima Fertilizer to divert its 0 Source: Team Estimates ammonia supply to its Urea and NP plants, and then to its NPK plant. Fatima will recover its earning from this reallocation.

Gas Restoration Risk (Level: Medium) New gas fields and international gas pipelines can lead to a full restoration of gas supply to the fertilizer sector. However, Engro Fertilizer, a key player will receive major proportion of its feed gas at the market rate of USD 6/mmbtu from tight gas reserves, coupled with its highly leveraged capital structure, it is unlikely that it will allow urea prices to fall, which has been a major determinant of Fatima’s boosted earnings. In case Engro does decrease urea prices Fatima is hedged from urea price volatility by its well diversified portfolio, and the impact on EPS will be minimized (See Appendix N for EPS Sensitivity to Product Prices).

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Operational Risks (Level: Low) Our valuation of Fatima is based on its current operations continuing in the future without any major changes. However, any unexpected events such as the change of management or a Figure 27: EPS Sensitivity to Fert. breakdown of production plants can have a sizable impact on its current valuation. Price 4.8 Valuation Risk (Level: Low) Risk free rate and terminal growth are very important assumptions in the DCF as they are 4.6 required to calculate the required return on equity and the terminal free cash flow, which constitutes the major portion of the overall FCFF sum. Our terminal growth rate of 3% is based 4.4 on the real GDP growth of the country given the limitations on the growth of cultivable land. We 4.2 believe that our valuation may be at risk due to the fluctuations in the GDP parameter, thus we

EPS(PKR/Share) have used Monte-Carlo simulation to run a sensitivity analysis of their effect on the DCF 4.0 valuation (See Appendix O For Monte Carlo Valuation of Terminal Growth) . Also, our CAPM calculations are at risk due to the comparatively young history of Fatima's stock. This may distort 3.8

the valuation due to central focus given to unreliable beta by the model (See Figure 26).

25 50 75

(75) (50) (25)

125 150

100

(125) (100) (150) Gas Infrastructure Development Charges (GIDC) Risk (Level: Low) Urea CAN NP Along with the fixed feedstock gas prices, Fatima also enjoys an exemption on the GIDC of PKR Source: Team Estimates 197/mmbtu and PKR 50/mmbtu on feed stock and fuel gas respectively. As these charges are being passed on to consumer by other fertilizer companies, it provides Fatima a huge premium on its profitability margins. Any change in the current GIDC policy may lead to changes in the fertilizer prices in the market. However Fatima’s product portfolio will protect it from any adverse impact on the earnings. A PKR 100 fall in urea prices the expected EPS in 2013 will only fall by 6.5% (See Figure 27 & Appendix N for EPS Sensitivity to Product Prices).

Political Risk (Level: Medium) Figure 28: Fuel Price Growth Government's uncertain gas supply and fertilizer import policies are a significant risk. Also, with Sensitivity 38 the next elections just around the corner, there are chances that the new government's fertilizer 36 policies may not be as favorable for Fatima or the industry.

34 32 Macro Risks 30 28 Interest Rate Risk (Level: Medium) 26 Since Fatima Fertilizer is a young company, it has a high degree of leverage on its books with the

Share Price (PKR) Price Share 24 D/E ratio of 1.18. Currently, Fatima has long term debt of PKR 28.9bn which according to our 22 estimate will be completely amortized by 2017. Monetary easing cycle to promote growth and

20 investment in the country might lead to increased inflation and/or increased government

2% 4% 6% 8%

12% 14% 16% 18% 20% 10% borrowing from the central bank consequently resulting in an interest rate hike. This will have negative impact on Fatima’s earnings in term of higher finance costs. Although it is expected Source: Team Estimates that the interest rates will remain consistent in the future, a 1% increase in KIBOR rates can lead to 2% fall in EPS in 2013. Higher interest rates are also expected to push the rate of return higher for the company leading to further discounting of Fatima's FCFFs in the future.

Figure 29: CPI Sensitivity Inflation (Level: Medium) CPI stood at 9.8% in Dec-12 and is expected to rise in the future due to 6% increase in gas tariffs, 45 increased government borrowing to fill a rising deficit in the budget, 21% increase in CNG and 7% increase in price of flour and other basic food items. Also, IMF expects Pakistan to move back

40 to double digit inflation in the future. This is risky for Fatima due to lower margins from rising 35 expenses, as well as the company's FCFF being further discounted with a somewhat parallel 30 effect on return on equity of the investors. A 1% upward shift in consumer price index is expected to cut the DCF valuation by 3% (See Figure 29 & Appendix M For CPI Sensitivity). 25

20 SharePrice (PKR)

0% 2% 4% 6% 8%

10% 12% 14% 16% 18% 20%

Source: Team Estimates

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Appendix

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Appendix A: Financial Snapshot

Income Statement

Mn PKR 2011 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Net Sales 14,833 29,996 35,844 37,482 39,357 41,324 43,391 45,560 47,838 50,230 Cost of Sales 4,781 12,777 14,983 15,501 16,485 17,522 18,646 19,867 24,852 27,011 Gross Profit 10,052 17,219 20,861 21,981 22,871 23,803 24,745 25,693 22,986 23,219 Other Income 134 48 162 178 196 216 237 261 287 316 Administrative Expenses 377 740 870 974 1,092 1,210 1,343 1,490 1,655 1,838 Distribution Cost 338 1,315 1,460 1,621 1,800 1,990 2,201 2,433 2,691 2,976 Other Operating Expenses 320 398 438 481 530 582 641 705 775 853 Finance Costs 3,063 5,685 4,497 3,981 2,968 1,954 969 - - - 4,098 8,137 7,265 7,058 6,390 5,738 5,153 4,628 5,121 5,667 Profit / (Loss) Before Taxation 6,088 9,130 13,758 15,102 16,677 18,281 19,828 21,326 18,153 17,868 Taxation 1,971 2,818 4,815 5,286 5,837 6,398 6,940 7,464 6,353 6,254 Profit / (Loss) for the year 4,117 6,311 8,943 9,816 10,840 11,882 12,888 13,862 11,799 11,614

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Balance Sheet

Mn PKR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Assets Non Current Assets Property, Plant and Equipment 66,828 65,079 62,071 59,038 55,980 52,897 49,789 46,656 43,498 40,315 Capital work in Progress 1,388 ------Long Term Loans and Deposits 5 ------Long Term Investments - 85 94 103 113 125 137 151 166 183 Total non-current Assets 68,221 65,164 62,165 59,141 56,093 53,022 49,926 46,807 43,664 40,497

Current Asset Stores and Spares 1,931 2,765 3,041 3,345 3,680 4,048 4,453 4,898 5,388 5,926 Stock in trade 1,215 5,342 3,928 4,108 4,313 4,529 4,755 4,993 5,243 5,505 Trade Debts 196 822 982 1,027 1,078 1,132 1,189 1,248 1,311 1,376 Loans, advances, deposits, Pre-Pay 945 1,545 1,699 1,869 2,056 2,262 2,488 2,737 3,011 3,312 Cash and Bank Balances 3,839 2,889 6,830 7,591 8,136 9,849 8,002 14,186 16,841 19,165 Current Assets 8,126 13,363 16,481 17,940 19,264 21,820 20,886 28,062 31,792 35,284

Total Assets 76,347 78,527 78,645 77,081 75,357 74,841 70,813 74,869 75,456 75,781

Liability & Equity Ordinary Shares 20,000 21,000 21,000 21,000 21,000 21,000 21,000 21,000 21,000 21,000 Prefference Shares 4,000 ------Share Premium 790 1,790 1,790 1,790 1,790 1,790 1,790 1,790 1,790 1,790 Accumulated Profit / (Loss) 3,265 6,360 10,385 14,688 19,446 24,667 27,709 29,573 29,912 29,633 28,055 29,150 33,175 37,478 42,236 47,457 50,499 52,363 52,702 52,423

Non Current Liabilities Long Term Finance 34,457 29,480 24,695 18,781 12,867 7,703 - - - - Dividend Payable on preference Shares 1,270 1,839 ------Deffered Taxation 1,704 4,047 7,689 7,677 8,085 9,231 7,950 17,564 16,756 16,879 Employee Retirement Benefits 103 122 140 161 185 209 235 264 297 334 37,534 35,488 32,524 26,619 21,138 17,142 8,185 17,828 17,053 17,213 Current Liabilities Current Portion of Long Term Finance 4,977 4,785 5,914 5,914 5,164 7,703 - - - Short Term Finance - secured - 6,478 5,288 4,098 2,908 1,718 595 595 595 595 Trade and other Payables 4,651 2,625 2,873 2,973 3,162 3,360 3,831 4,082 5,107 5,550 Accured Finance Costs 2,838 ------7,725 14,080 12,947 12,985 11,984 10,242 12,129 4,677 5,702 6,145 76,347 78,527 78,645 77,081 75,357 74,841 70,813 74,869 75,456 75,781

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Cash Flow Statement

Mn PKR 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Cashflow from Operating Activities Profit/(loss) before taxation 6,088 9,130 13,758 15,102 16,677 18,281 19,828 21,326 18,153 17,868 Adjustment for non cash charges Retirement Benefits Accrued 25 25 25 25 25 25 25 25 25 25 Depreciation on owned fixed assets 711 3,424 3,508 3,533 3,558 3,583 3,608 3,633 3,658 3,683 Financial charges 3,063 5,685 4,497 3,981 2,968 1,954 969 - - - 3,734 9,134 8,030 7,539 6,551 5,562 4,602 3,658 3,683 3,708 Operating cashflow b/f capital changes 9,822 18,263 21,788 22,641 23,228 23,843 24,431 24,984 21,836 21,576

Changes in working capital (Increase)/Decrease in Stores & Spares 549 (834) (276) (304) (335) (368) (405) (445) (490) (539) (Increase)/Decrease in Stock in Trade (675) (4,127) 1,414 (180) (205) (216) (226) (238) (250) (262) (Increase)/Decrease in Trade Debts 61 (626) (160) (45) (51) (54) (57) (59) (62) (66) (Increase)/Decrease in Loans, Advances, Deposits & Prepayments 219 (600) (154) (170) (187) (206) (226) (249) (274) (301) Increase/(Decrease) in Creditors, Accrued & Other Liabilities 947 (2,026) 248 99 189 199 471 251 1,024 444 1,100 (8,212) 1,070 (599) (589) (644) (443) (740) (51) (724) Cash generated from/(used in) operations 10,922 10,052 22,859 22,042 22,639 23,198 23,988 24,244 21,784 20,852

Cash (Used In) / Generated From Operations 10,922 10,052 22,859 22,042 22,639 23,198 23,988 24,244 21,784 20,852 Finance Costs Paid (3,166) (5,685) (4,497) (3,981) (2,968) (1,954) (969) - - - Taxes Paid (282) (2,818) (4,815) (4,627) (5,837) (6,398) (6,940) (7,464) (6,353) (6,254) Employees Retirement Benefits Paid (8) (103) (122) (140) (161) (185) (209) (235) (264) (297) Net Cash Inflow/(Outflow) - Operating Acitivities 7,466 1,446 13,424 13,293 13,673 14,661 15,870 16,545 15,167 14,301

Cash Flow From Investing Activities Fixed Captial Expenditure (386) (662) (500) (500) (500) (500) (500) (500) (500) (500) Repayment of long term finance (3,311) (4,977) (5,975) (7,104) (7,104) (6,354) (8,826) - - - Long Term Investment - (85) (9) (9) (10) (11) (12) (14) (15) (17) Net Increase/(Decrease) in Long Term Loans & Deposits 28 (7) ------Net Cash (Outflow) - Investing Activities (3,637) (5,658) (6,484) (7,614) (7,614) (6,866) (9,338) (514) (515) (517)

Cash Flows From Finance Activities Proceeds/Advances Received Against Prefference Shares - (2,000) ------Proceeds From Long Term Finance 44 6,000 ------Increase in Short Term Finance - Net (316) 2,478 - - - - (1,718) - - - Dividends Paid - (3,216) (3,000) (5,027) (5,513) (6,082) (6,661) (9,847) (11,997) (11,461) Net Cash (Outflow)/Inflow - Financing Activities (273) 3,262 (3,000) (5,027) (5,513) (6,082) (8,379) (9,847) (11,997) (11,461)

Net Increase / (Decrease) in Cash and Cash Equivalents 3,557 (950) 3,941 652 545 1,713 (1,847) 6,184 2,655 2,324 Cash and Cash Equivalents At Beginning of the Year 283 3,840 2,889 6,830 7,482 8,027 9,740 7,893 14,078 16,732 Cash and Cash Equivalents At End of The Year 3,840 2,889 6,830 7,482 8,027 9,740 7,893 14,078 16,732 19,056

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DCF Valuation

Target date CY12 CY13 CY14 CY15 CY16 CY17 CY18 CY19 CY20 Terminal 31-Dec-13 31-Dec-12 31-Dec-13 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19 31-Dec-20 EBIT 14,814 18,255 19,083 19,645 20,235 20,798 21,326 18,153 17,868 Depreciation 3,424 3,508 3,533 3,558 3,583 3,608 3,633 3,658 3,683 Cash Tax (5,185) (6,389) (6,679) (6,876) (7,082) (7,279) (7,464) (6,353) (6,254) NWC (8,212) 1,070 (599) (589) (644) (443) (740) (51) (724) Capital Expenditure (1,675) (500) (500) (500) (500) (500) (500) (500) (500) FCFF 3,166 15,944 14,838 15,238 15,591 16,184 16,254 14,906 14,073 14,496

Timeline - 1.000 2.000 3.003 4.003 5.003 6.003 7.005 WACC 15.14% 15.67% 16.28% 16.92% 18.10% 18.10% 18.10% 18.10%

Discount Factor 1.00 0.87 0.75 0.65 0.55 0.47 0.40 0.34

Discounted FCFF 15,944 12,886 11,441 10,067 8,938 7,601 5,903 4,719

Terminal Value Terminal Growth Rate 3.0% Terminal WACC 18.1% Estimated Terminal Free Cash Flow 14,496 Terminal Value (as at end-year 2022) 96,020 Terminal Value (as at 31 december, 2013) 32,196

FCFF Valuation NPV of Forecasts 77,500 NPV of Terminal Value 32,196 Firm Value 109,696 Less: Debt &(cash) 38,046 Deferred Dividend - No. Shares (millions) 2,100,000 Value Per Share 34.21 Current Market Price 24.87 Upside to current price 37.6%

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Financial Ratios

2011A 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Profitability GP Margin 67.8% 57.4% 58.2% 58.6% 58.1% 57.6% 57.0% 56.4% 48.1% 46.2% EBIDTA Margin 66.4% 54.1% 60.5% 60.2% 58.8% 57.5% 56.1% 54.6% 45.5% 42.8% NP Margin 27.8% 21.0% 24.9% 26.2% 27.5% 28.8% 29.7% 30.4% 24.7% 23.1% Operating Margin 61.7% 49.4% 50.9% 50.9% 49.9% 49.0% 47.9% 46.8% 37.9% 35.6%

Liquidity Debtor Days Days 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 Creditor Days Days 75.0 70.0 70.0 70.0 70.0 75.0 75.0 75.0 75.0 Inventory Days Turnover Days 65.0 40.0 40.0 40.0 40.0 40.0 40.0 40.0 40.0 Operating Cash Cycle Days - - 20.0 - 20.0 - 20.0 - 20.0 - 25.0 - 25.0 - 25.0 - 25.0

Current Ratio x 1.1 0.9 1.3 1.4 1.6 2.1 1.7 6.0 5.6 5.7 Acid Test Ratio x 0.9 0.6 1.0 1.1 1.2 1.7 1.3 4.9 4.6 4.8 Cash Ratio x 0.0 0.5 0.2 0.5 0.6 0.7 1.0 0.7 3.0 2.9 Solvency Ratio x 0.11 0.20 0.28 0.34 0.44 0.57 0.82 0.79 0.69 0.67 Accounts Receivables Turnover x 18.0 36.5 36.5 36.5 36.5 36.5 36.5 36.5 36.5 Accounts Payables Turnover x 4.9 5.2 5.2 5.2 5.2 4.9 4.9 4.9 4.9 Inventory Turnover x 2.8 7.6 8.7 8.7 8.7 8.7 8.7 8.7 8.7

Total Asset Turnover x 0.2 0.4 0.5 0.5 0.5 0.5 0.6 0.6 0.6 0.7 Fixed Asset Turnover x 0.2 0.5 0.6 0.6 0.7 0.8 0.9 1.0 1.1 1.2 Total Equity Turnover x 0.5 1.0 1.1 1.0 0.9 0.9 0.9 0.9 0.9 1.0

Solvency Leverage Ratio x 1.6 1.7 1.4 1.1 0.8 0.6 0.4 0.4 0.4 0.4 Gearing Ratio x 1.2 1.0 0.7 0.5 0.3 0.2 - - - - Interest Coverage Ratio x 2.3 2.4 2.6 2.8 3.2 3.9 6.3 Long term Debt to Equity Ratio x 0.6 0.5 0.4 0.3 0.2 0.1 - - - - Long term Debt PKR Mn 34,457 29,480 24,695 18,781 12,867 7,703 - - - - Current Portion of Long Term Debt PKR Mn - 4,977 4,785 5,914 5,914 5,164 0 - - - Cashflow per Share PKR/Share 3.56 0.69 6.39 6.33 6.51 6.98 7.56 7.88 7.22 6.81

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CER Revenue

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

CDM Credits Tonnes - 747,000 747,000 747,000 747,000 747,000 747,000 747,000 747,000 Price US$/Ton 0 0.00420 0.00420 0.00420 0.00420 0.00420 0.00420 0.00420 0.00420 Total Revenues US$ - 2 3,137 3,137 3,137 3,137 3,137 3,137 3,137 Less Expenses UN Admin Fees US$ - 0 63 63 63 63 63 63 63 Other Expenses US$ - 1 784 784 784 784 784 784 784 Net Revenue US$ - 1 2,290 2,290 2,290 2,290 2,290 2,290 2,290 Net Revenue Mn PKR - 0 249 262 275 289 303 318 334 Fatima Share Mn PKR - 0 212 223 234 245 258 270 284 Agency Share Mn PKR - 0 37 39 41 43 45 48 50

Income to Fatima Mn PKR - 0 212 223 234 245 258 270 284 Tax on CER Income Mn PKR - 0 4 4 5 5 5 5 6 Net Tax Income Mn PKR - 0 208 218 229 240 252 265 278

UN Admin Fee 2% Other Expenses 25% Fatima Share 85% Agency Share 15% Taxation on CER Revenue 2%

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Tax Workings

Mn PKR 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Profit Carried Forward - 6,799 (13,986) (1,297) 13,450 30,405 49,399 70,207 92,757 112,355 Add Profit Before Taxation 6,088 9,130 13,758 15,102 16,677 18,281 19,828 21,326 18,153 17,868 Add Dep. Account 746 3,424 3,508 3,533 3,558 3,583 3,608 3,633 3,658 3,683 Less Dep. Tax 35 33,338 4,578 3,888 3,280 2,870 2,628 2,409 2,213 2,036 Less CDM Income Tax(Loss)/Profit 6,799 (13,986) (1,297) 13,450 30,405 49,399 70,207 92,757 112,355 131,870 Taxes Payable 2,131 300 358 5,286 5,837 6,398 6,940 7,464 6,353 6,254 Less Advance Taxes - - 658 - - - - - Net Tax Liability 2,131 300 358 4,627 5,837 6,398 6,940 7,464 6,353 6,254

Accounting Taxes 3,195 4,815 5,286 5,837 6,398 6,940 7,464 6,353 6,254 Cash Taxes Payable 300 358 4,627 5,837 6,398 6,940 7,464 6,353 6,254

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Appendix B: DuPont Analysis (CY12)

From CY12 to CY13 ROE has increased by 7% from 15% to 22% majorly due to increase in overall sales by more than 100% with only a minute increase in the asset base leading to a 3% increase in ROA. From CY12 to CY18 ROE has remain constant more or less hovering between 25% to 27%. During the six years tax burden and operating income margins have remained constant whereas interest burden has been decreasing throughout due to repayment of principal and interest to earn its debt free status by 2017. These repayments have been the primary reason for increase in net profit margins from 25% in CY13 to 30% in CY18. Also during this period heavy increase in asset turnover can be seen this is due to a increases in sales of 5% annually and a mere less than 1% increase in total assets YoY.

From CY13 to C18 return on assets have increase from 8% to 11% owing to the YoY increase in net income of 10% to 12% apart from CY12 to CY13 where the increase is of 41%. After CY18, ROE takes a dip due to the expiry of fixed gas supply from the Mari network based and the fixed feed stock price of USD 0.7/mmbtu under the 2001 fertilizer policy. Net profit margins from CY18 onwards take a hit owing to the increase in cost of production offertilizer for Fatima, reducing to 25% and 23% in CY19 and CY20 respectively, the prime reason for decrease in ROE from 27% in CY18 to 22% in CY20.

Du Pont Analysis 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Tax Burden 69.1% 65.0% 65.0% 65.0% 65.0% 65.0% 65.0% 65.0% 65.0% Interest Burden 61.6% 75.4% 79.1% 84.9% 90.3% 95.3% 100.0% 100.0% 100.0% Operating Income Margin 49.4% 50.9% 50.9% 49.9% 49.0% 47.9% 46.8% 37.9% 35.6% Net Profit Margin 21.0% 24.9% 26.2% 27.5% 28.8% 29.7% 30.4% 24.7% 23.1% Asset Turnover 38.2% 45.6% 48.6% 52.2% 55.2% 61.3% 60.9% 63.4% 66.3% Return on Assets 8.0% 11.4% 12.7% 14.4% 15.9% 18.2% 18.5% 15.6% 15.3% Leverage Ratio 269.4% 237.1% 205.7% 178.4% 157.7% 140.2% 143.0% 143.2% 144.6% ROE 21.7% 27.0% 26.2% 25.7% 25.0% 25.5% 26.5% 22.4% 22.2%

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Appendix C: Porter’s Five Forces – Fertilizer Sector

Rivalry among Competitors- LOW

FFC and Engro can be regarded as price leaders for urea pricing while other players are price followers, so there is no rivalry among the players in the form of price wars. This leads to negligible variability in urea prices set by different manufacturers. Although limited competition arises in terms of nutrient content of fertilizer where Urea manufacturers compete with CAN manufacturers (Nitrogen) and NP manufacturers compete with DAP manufacturers (Phosphate) but since Pakistan is currently a net importer of fertilizer due to gas constraints, the local fertilizer manufacturers sell all their produce and hence the extent of overall rivalry is low.

Bargaining Power of Suppliers- MODERATE

Gas, the major raw material in production of ammonia is supplied by the Sui Gas network or independent suppliers like Mari fields. While the gas price is set by the government, its supply is highly uncertain on the Sui network. This is because the Sui gas has several alternate uses in the high demand commercial, industrial and transport sector and the government manages the shortage through curtailment and rotational agreements with the fertilizer sector. The curtailment of gas is highly variable on the Sui network and is reported to exceed the 20% agreed with ECC along with longer than agreed suspension periods.

Even the new plant of Engro which under 2001 Fertilizer Policy was agreed to be supplied 110mmscd gas through the Sui network could not be supplied and suffered significantly. Since gas is a major raw material in the ammonia manufacture with no substitute, dearth of gas leads to severe plant inefficiencies and scale down of productions. Fauji Foundation, parent company of FFC and FFBL has a 40% stake in the Mari Gas Company so has lower risks in terms of its gas supply. Switching costs between suppliers are high due to long term contracts and significant capital investment required to lay pipelines.

Phos rock is another major raw material required in the production of DAP or NP. FFBL has a joint venture with Officie Cherifien Des Phosphates group Morocco resulting in 25% stake Pakistan Maroc Phosphore S.A. Morocco (PMP) to ensure uninterrupted supply of Phosphoric Acid to its plant. The principal activity of PMP is to manufacture and market phosphoric acid, fertilizer and other related products in Morocco and abroad. Fatima Fertilizer and Pak Arab mainly import the Phos rock from Morocco and Egypt. Their plants have ability to utilize low grade phos rock without compromising quality of fertilizer and hence they seek 25% of Phos rock supply locally from another Fatima Group company, Pakistan Mining.

Bargaining Power of Buyers- LOW

With the large number of buyers (distributors/dealers) and low number of supplier coupled with the lack of differentiation and limited substitutability, the bargaining power of buyers is low for the industry.Furthermore, the significance of fertilizer consumption for agrarian economy makes fertilizer usage indispensible leading to low price elasticity of demand. Yet, there is circular income effect prevalent in the industry where farmer’s income from previous seasons’ produce plays a crucial role in determining his spending power and purchase of fertilizer in the next season. However, with increasing availability of credit and measures to improve financial assistance programs for farmers by the government and the bar for support prices of major crops being set higher this year, farmers are expected to sustain the consumption of fertilizer.

Threat of New Entrants- LOW

The fertilizer industry has high barriers to entry due to significant capital investments required in setting up the manufacturing facilities. Furthermore, the current constraints in natural gas supply in the country with high curtailment particularly on the Sui network act as a further deterrent to new investment in the sector within the country.

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Threat of Substitutes- LOW

Chemical fertilizers have a stronghold in the fertilizer market due to nutrient deficiency in the local soils and the minimal inclination of relying on organic fertilizers that have variable nutrient content.Subsidized imported fertilizer can be regarded as a possible substitute to the locally manufactured fertilizer but this is not a viable or preferred substitute by the government as it puts excessive burden on foreign exchange reserves of the country.

Other External forces - HIGH

There is high government influence on the sector as an external force particularly on gas supply as it subsidizes gas supply to the sector, regulates its pricing and also has imposed Gas Infrastructure Development Cess. Government imports urea to meet the gap in supply and demand and subsidizes the imports which keep a price check on locally manufactured urea. Furthermore, government sets the support prices for the major crops in the country which play a significant role in determining farmers’ income and hence the amount they can spend on fertilizer purchases.

Technological advantage plays a role for newer investments in the sector, such as in EnVen which has highest efficiency in urea manufacture and Fatima being able to use low grade phos rock without compromising on fertilizer quality, enabling greater efficiency and productivity but the outcome is heavily dependent on raw material availability.

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Appendix D: Corporate Governance

Board Structure Fatima’s Board consists of eminent individuals with diverse experience and expertise. It comprises of eight directors, seven of whom have been elected by the shareholders for a term of three years expiring on April 30, 2014 and one director is nominee of National Bank of Pakistan. Other than the Chief Executive Officer (CEO), there are two executive director and five non-executive directors including the Chairman and nominee director. Approximately 60% of the board’s representation by non-executive directors shows the company’s commitment towards giving the ultimate priority to manage and safeguard shareholder interests.

Audit Committee The Audit Committee consists of five members of the Board. Majority of the members of the Audit Committee are non- executive including the Chairman. This builds on the company’s commitment to protect the interests of shareholders by adhering to the highest level of transparency, comprehensiveness and accuracy of financial and non-financial information.

Human Resource and Remuneration Committee The Human Resource and Remuneration Committee consists of four members of the Board. Majority of the members of the Committee are non-executive directors. Having majority independent non-executive directors makes sure that the management is not taking advantage of the company’s booming performance and that the interest of the management are in line with that of the shareholders, the real owners of the company.

The given structure of the board, audit, human resource and remuneration committee makes sure that interests of the shareholders are safeguarded and well protected and the management’s goals are in line with those of the shareholders, working towards the long term sustainable growth of this fertilizer giant while contributing to the society in the most productive manner as possible.

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Appendix E: Corporate Social Responsibility

Corporate Social Responsibility

Fatima Fertilizer is a socially responsible corporate entity working diligently for the welfare of the communities where they operate and the society in general. The Company has a unique and important role to play in promoting sustainable growth for the economy and making a positive impact on the society. The Company’s aim is effective internalization of CSR practices in a manner that fulfills expectations of the society and serves a wider range of human values as well as contributing towards the longevity, endurance and the sustainability of business operations.

Rehabilitation of flood affectees The devastation caused by floods in Pakistan, destroyed hundreds of thousands of homes, washed away entire crops and killed livestock on a massive scale. Along with all the companies under the Fatima Group and Arif Habib Group banner, Fatima Fertilizer actively provided relief goods to flood hit areas of Punjab from the outset. Support was provided to around 14,000 flood victims in Muzaffargarh, Rahim YarKhan, Kot Addu, Bhong, Alipur, Sadiqabad and Liaqatpur. For the rehabilitation of flood victims, a project worth PKR 22million was undertaken to set up Fatima Model Villageat Mehmood Kot District, Muzaffargarh and 50 houses were built.2010’s floods in Sindh, in the South-East Pakistan impacted millions of people, leaving over 300 dead, over550 injured, over a million homes affected and millions of acres of land had submerged in monsoon rains. This included cultivated areas, leaving 80% of the cash crops damaged. Situation in 14 districts of Sindh became dire, with Badin, Naushero Feroz, Nawabshah and Mirpur Khas being the worst affected areas. Given the devastation caused, Fatima Fertilizer Company Limited made significant contributions for the relief and rehabilitation of the victims.

Vaccination Centre On May 15, 2011 the medical Centre including a vaccination center started functioning at Plant site to facilitate neighboring community and the company’s staff. The center provides hepatitis awareness, screening/diagnostic facility for Hepatitis B & C and vaccination for Hepatitis B. To date, more than 50 people have been vaccinated through acquired vaccines on a temporary basis. To ensure regular operations, the Company has invested PKR 100,000 as a one-time non- operational expense and has been providing PKR 322,000 per month as operational expenses. The treatment to the neighboring community would be free through the year. Subsequently, the Company plans to undertake Fatima Fertilizer Welfare Hospital (FFWH), a modern welfare hospital in the vicinity of Plant site, to cater for the needs of underprivileged of the area.

Fatima Fertilizer Welfare Hospital Fatima Fertilizer Welfare Hospital (FFWH) is a key project of the Company's vision towards community welfare. The Company, under the guidance of Government of Punjab has undertaken to establish a modern welfare hospital in the vicinity of Plant site, to cater for the needs of underprivileged of the area. This is the first ever initiative of its kind and magnitude in private sector. FFWH will create an integrated health care facility to be recognized nationally and internationally. The Company is committed to act as a responsible corporate citizen and will continue its social and corporate commitments for the benefits of surrounding populations. At Fatima Fertilizer, corporate social responsibility revolves around a self-regulating mechanism and the business is monitored and adheres to the Laws, ethical standards and internal values.

LUMS – National Outreach Program (NOP) Fatima Fertilizer also participated in the National Outreach Program at the prestigious Lahore University of Management Sciences (LUMS). NOP is an initiative that was launched in 2001 and the objective of this program is to provide educational opportunities to bright students from smaller cities, villages and inner city areas of large urban centers, unable to meet the regular fee requirements. Fatima Fertilizer sponsored 8 deserving students from Southern Punjab through the four year degree program. In 2011, the Company contributed PKR 3.6mn for the development of an Auditorium and to the NOP cause at LUMS.

Contribution to SIUT Fatima Fertilizer contributed PKR 500,000 to the Sindh Institute of Urology and Transplantation. SIUT is a public health sector organization providing comprehensive and modern medical facilities free of cost to patients from predominantly rural and urban strata with virtually no access to medical facilities.

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Contribution to PEN Progressive Education Network (PEN) is an organization working to foster a wider network of schools across Pakistan, improving enrollment and providing quality education to underprivileged children. Fatima Fertilizer contributed an amount of PKR 1 million to further this cause.

Contribution to Karachi Education Initiative Further strengthening its commitment to the education sector of Pakistan, the Company contributed PKR 12.5million to the Karachi Education Initiative. The Karachi Education Initiative (KEI) is a not-for-profit entity registered under Section 42 of the Companies Ordinance. The KEI is the sponsoring and fund raising entity of the Karachi School for Business & Leadership.

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Appendix F: Local and Regional Multiples

Price/Earning Ratio (x) EV/EBITDA (x) Dividend Yield (%) 2012E 2013E 2012E 2013E 2012E 2013E FFC 7.75 6.3 4.12 3.99 11.94 16 FFBL 7.02 7.13 3.84 3.8 5.84 18 FATIMA 8.5 5.7 5.43 3.9 6.7 9.6 China BlueChemical Ltd 9.55 8.03 4.46 3.86 3.43 4.39 Sinofert Holdings Ltd 12.63 8.02 23.7 22.21 0.79 2.12 The Mosaic Company 12.34 9.44 5.36 5.38 1.67 1.08 Agrium Incorporated 10.14 10.41 7.9 5.86 1.87 0.59 Potash Corp 14.18 11.68 8.6 8.25 1.96 1.45 Phosagro 7.66 5 4.26 3.78 2.04 6.01 CF Industries 7.21 8.22 5.13 4.82 0.73 1.04 Yara International 7.45 10.6 5.68 6.52 2.48 3 Incitec Pivot 13.28 9.78 7.9 6.52 5.01 4.25 Israel Chemicals 11.57 16.07 7.57 6.44 7.02 7.42 Saudi Fertilizer 13.51 11.72 10.34 10.18 7.72 7.3 Taiwan Fertilizer 20.7 18.6 35.1 34.6 3 3.8 Nufarm 13.62 11.4 6.7 6.2 0.68 2.6 Urakali 15.49 9.2 10.7 9.2 4.07 5 Soquimich 10.56 11.7 13.5 11.7 5.09 3.6 Syngenta 18.18 10.5 10.6 10.5 2.09 2.8

Average (Local) 7.15 6.21 4.16 3.73 8.53 13.73 Average (Regional) 12.38 10.65 10.47 9.75 3.1 3.53

Source: Bloomberg, Team Estimate

As we see above, according to the leading PER multiple of 5.7x in CY13, Fatima is at around 17.4 and 86.2 discount to its local and regional peers respectively. Also, with an expected dividend of PKR 2.34 per share, it has an expected dividend yield of about 9.4%. Considering these figures, its EV/EBITDA ratio and the current price of PKR 24.87 per share, Fatima is quite an attractive investment opportunity compared to both the local and regional competitors.

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Appendix G: Seasonal Usage of Fertilizer

Source: Company Presentation

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Appendix H: Production Process

Source: Company Presentation

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Appendix I: Fatima's Distribution Network

Source: Company Presentation

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Appendix J: Forecasted Energy Need of Pakistan

Source: Inter State Gas Systems

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Appendix K: Future Gas Projects

Source: Central Eurasia Standards

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Appendix L: Risk Matrix

High Impact

IED Fertilizer Gas Restoration to Competitors Changes in the GIDC policy Low High Probability Probability

Operational Risk Changing Political Landscape Terminal Growth Law and Order Inflation Rate situation Interest Rate Other macro economic variables

Low Impact

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Appendix M: Additional Wealth Generated

In the valuation model the growth in Urea and CAN prices has been taken at a very conservative level of 5%. Historically the growth rate has been between 10% and 12% annually, ignoring the extreme hikes in 2010 and 2011. The team analyzed the effect of a more realistic price increase on the valuation model.

Additional Wealth Generated 18,000 16,000 14,000

12,000 10,000 8,000 PKR PKR Mn 6,000 4,000 2,000

6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5%

13.5% 10.0% 10.5% 11.0% 11.5% 12.0% 12.5% 13.0% 14.0% 14.5% 15.0% Urea Price Growth Source: Team Estimates

The above graph shows that if the future growth in Urea and CAN prices follows the historic trend of 12%, it will lead to a significant additional wealth. The net present value of this additional wealth comes out to be PKR 10bn, translating into a PKR 5 upside per share.

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Appendix N: Sensitivity Analysis Terminal Growth

Terminal Growth 55

35 Target Price Per Share Per Price Target 30

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

As discussed in the report Terminal Growth is a major part of the DCF Valuation model used to price this share. Therefore, an incorrect estimation of this variable can impact the price. We believe that the investor should be able to judge the impact different values of this variable will have on the share price.

For this purpose a sensitivity analysis was performed for the terminal growth rates. The TG rates were varied from 0% to 10% (the value in the base model is 3%), with intervals of 0.5%, and the recalculated share prices were recorded.

The graph shows the observed relationship between the terminal growth rates and the final share price of Fatima Fertilizer Limited. The key findings from this graph are that the share prices are more sensitive to higher values of the terminal growth rate. And most importantly, changing this variable results in very little downside to our valuation. The least share price observed is PKR 30.50, which further strengthens our recommendation.

The risk from this variable is covered more in the following sections.

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Risk Free Rate

Risk Free Rate 70

Target Price Per Share Per Price Target 10

6.00% 5.00% 7.00% 8.00% 9.00%

12.00% 18.00% 10.00% 11.00% 13.00% 14.00% 15.00% 16.00% 17.00% 19.00% 20.00%

As discussed in the report the Risk Free Rate is a major part of the DCF Valuation model used to price this share. Therefore, an incorrect estimation of this variable can impact the price. We believe that the investor should be able to judge the impact different values of this variable will have on the share price.

For this purpose a sensitivity analysis was performed for the risk free rate. The RF rates were varied from 5% to 20% (the value in the base model is 11.5%), with intervals of 0.5%, and the recalculated share prices were recorded.

The graph shows the observed relationship between the risk free rates and the final share price of Fatima Fertilizer Limited. The key findings from this graph are that the share prices are more sensitive for lower values of the risk free rate. This analysis shows a considerable downside to our valuation for very high values of Risk Free Rate. However we believe that there is very little probability of the risk free rate rising with a significant amount in the future. This analysis shows that this share price is undervalued, even if the risk free rate reaches 14%, which is in itself a very unlikely scenario.

The risk from this variable is covered more in the following sections.

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Market Risk Premium

Market Risk Premium 70

20 Target Price Per Share Per Price Target

1% 7% 0% 2% 3% 4% 5% 6% 8% 9%

13% 10% 11% 12% 14% 15%

Another major part of the DCF Valuation model used to price this share is the Market Risk Premium. Therefore, an incorrect estimation of this variable can impact the price. We believe that the investor should be able to judge the impact different values of this variable will have on the share price.

For this purpose a sensitivity analysis was performed for the market risk premium. The market risk premium was varied from 0% to 15% (the value in the base model is 6%), with intervals of 0.5%, and the recalculated share prices were recorded.

The graph shows the observed relationship between the market risk premium and the final share price of Fatima Fertilizer Limited. The key findings from this graph are that the share prices are more sensitive for lower values of the market risk premium. This analysis shows a considerable downside to our valuation for very high values of the market risk premium. The assumed value for this variable used widely in the industry is 6%, which has been assumed in this valuation. However we believe that there is a probability that the market risk premium might deviate from this assumption. This analysis shows that this share price is undervalued up to a market risk premium of 8%.

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Consumer Price Index

Consumer Price Index 45

25 Target Price Per Share Per Price Target 20

0% 2% 4% 6% 8%

10% 12% 14% 16% 18% 20%

Another major part of the projections is the Expected Consumer Price Index (ECPI), which has been assumed to affect a lot of cost heads. Therefore, an incorrect estimation of this variable can impact the price. We believe that the investor should be able to judge the impact different values of this variable will have on the share price.

For this purpose a sensitivity analysis was performed for the expected consumer price index. The ECPI was varied from 0% to 20% (the value in the base model is 10%), with intervals of 0.5%, and the recalculated share prices were recorded.

The graph shows the observed relationship between the expected consumer price index and the final share price of Fatima Fertilizer Limited. The key findings from this graph are that the share prices are more sensitive for higher values of the expected consumer price index. This analysis shows a considerable downside to our valuation for very high values of the consumer price index. So even if the consumer price index reaches a highly unlikely level of 14% the share price is still undervalued.

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Fuel Price Inflation

Fuel Gas Price Growth 38 36 34

32 30 28 26 24

22 Target Price Per Share Per Price Target

0.00% 2.00% 4.00% 6.00% 8.00%

10.00% 12.00% 14.00% 16.00% 18.00% 20.00%

Another major part of the DCF Valuation model used to price this share is the Fuel Gas Price Growth rate since it is a major variable cost for the business which influences the gross profit margin. Therefore, an incorrect estimation of this variable can impact the share price. We believe that the investor should be able to judge the impact different values of this variable will have on the share price.

For this purpose a sensitivity analysis was performed for the fuel gas price growth rate. The fuel gas price growth rate was varied from 0% to 20% (the value in the base model is 8%), with intervals of 0.5%, and the recalculated share prices were recorded.

The graph shows the observed relationship between the fuel gas price growth rate and the final share price of Fatima Fertilizer Limited. The key findings from this graph are that the share prices are more sensitive for higher values of the fuel gas price growth rate. This analysis only shows a considerable downside to our valuation for very high values of the fuel gas price growth rate. So even if the fuel gas price growth rate reaches a highly unlikely level of 17% the share price is still undervalued.

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PKR Devaluation Against USD

PKR Devaluation 75

35 Target Price Per Share Per Price Target 25

0.00% 2.00% 4.00% 6.00% 8.00%

10.00% 12.00% 14.00% 16.00% 18.00% 20.00%

Another major part of the DCF Valuation model used to price this share is the PKR Devaluation rate against the USD. Therefore, an incorrect estimation of this variable can impact the price since it influences the price of imported raw materials and also of the fertilizer imported by government. We believe that the investor should be able to judge the impact different values of this variable will have on the share price.

For this purpose a sensitivity analysis was performed for the PKR Devaluation against the USD. The devaluation rate was varied from 0% to 20% for the first year, and the rates for the later years were 3% lesser that first year’s (the value in the base model is 8% for 2013 and 5% for later years) with intervals of 0.5%, and the recalculated share prices were recorded.

The graph shows the observed relationship between the PKR devaluation against the USD and the final share price of Fatima Fertilizer Limited. The key findings from this graph are that the share prices show similar sensitivity to both higher and lower values of PKR Devaluation rate against USD. However the current economic scenario indicates that the devaluation will continue at a rate at least greater than 5% in the near future, which presents a further upside to our valuation.

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CER Revenue

CER Revenues 39 38 37

36 35 34 33 32

Target PerPriceShare Target 31

2.00 4.00 6.00 8.00

10.00 12.00 14.00 16.00 18.00 20.00

Another major part of the DCF Valuation model used to price this share is the CER Revenues. Therefore, an incorrect estimation of this variable can impact the price. We believe that the investor should be able to judge the impact different values of this variable will have on the share price.

For this purpose a sensitivity analysis was performed for the CER Revenues. The CER Revenues were varied from 0 to 20 USD/ton of credit (the value in the base model is 0), with intervals of 0.5%, and the recalculated share prices were recorded.

The graph shows the observed relationship between the CER Revenues and the final share price of Fatima Fertilizer Limited. The key findings from this graph are that the share prices are equally sensitive to both higher and lower values of CER Revenue. This analysis shows no downside to our valuation for high or low values of CER Revenue because even if the CER Revenues drop to 0, the share price is still undervalued.

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Product Price Sensitivity

EPS Matrix -150 -125 -100 -75 -50 -25 - 25 50 75 100 125 150 Urea 3.87 3.93 3.99 4.05 4.11 4.17 4.22 4.28 4.34 4.4 4.46 4.51 4.57 CAN 3.99 4.03 4.07 4.11 4.15 4.18 4.22 4.26 4.3 4.34 4.38 4.42 4.46 NP 3.92 3.97 4.02 4.07 4.12 4.17 4.22 4.27 4.33 4.38 4.43 4.48 4.53 All 3.33 3.48 3.63 3.78 3.93 4.08 4.22 4.37 4.52 4.67 4.82 4.96 5.11

Target Price Matrix -150 -125 -100 -75 -50 -25 - 25 50 75 100 125 150 Urea 30.47 31.04 31.6 32.17 32.73 33.29 33.86 34.42 34.99 35.55 36.11 36.68 37.24 CAN 31.88 32.21 32.54 32.87 33.2 33.53 33.86 34.19 34.52 34.85 35.18 35.51 35.84 NP 31.2 31.64 32.08 32.53 32.97 33.41 33.86 34.3 34.75 35.19 35.63 36.08 36.52 All 25.83 27.17 28.51 29.84 31.18 32.52 33.86 35.2 36.53 37.87 39.21 40.55 41.89

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EPS (CY13) Sensitivity To Product Prices

4.70 4.60 4.50 4.40

4.30 Urea 4.20 CAN 4.10 NP 4.00 3.90

3.80

75 25 50

(25) (75) (50)

100 125 150

(125) (150) (100)

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2-WAY Sensitivity Analysis

Terminal Growth 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0% 5.5% 50.17 51.54 53.03 54.67 56.48 58.50 60.75 63.27 66.14 69.41 73.18 77.57 82.75 88.96 96.54 105.99 118.11 134.20 156.62 189.98 6.0% 47.93 49.15 50.48 51.94 53.54 55.32 57.28 59.48 61.95 64.75 67.95 71.63 75.93 80.99 87.07 94.47 103.71 115.55 131.28 153.19 6.5% 45.86 46.96 48.15 49.45 50.88 52.45 54.18 56.10 58.25 60.67 63.40 66.53 70.13 74.32 79.28 85.21 92.45 101.48 113.06 128.44 7.0% 43.94 44.93 46.01 47.17 48.45 49.84 51.37 53.07 54.95 57.05 59.41 62.08 65.14 68.66 72.76 77.60 83.41 90.49 99.31 110.63 7.5% 42.16 43.06 44.03 45.08 46.22 47.46 48.83 50.33 51.98 53.82 55.87 58.18 60.80 63.78 67.23 71.24 75.97 81.65 88.57 97.20 8.0% 40.50 41.32 42.20 43.15 44.17 45.29 46.51 47.84 49.30 50.92 52.72 54.73 56.99 59.54 62.46 65.83 69.75 74.38 79.93 86.69 8.5% 38.96 39.70 40.50 41.36 42.28 43.29 44.38 45.57 46.87 48.31 49.89 51.65 53.61 55.82 58.32 61.17 64.46 68.30 72.83 78.25 9.0% 37.51 38.19 38.91 39.69 40.53 41.44 42.42 43.49 44.65 45.93 47.33 48.88 50.60 52.52 54.68 57.12 59.91 63.13 66.88 71.31 9.5% 36.15 36.77 37.43 38.15 38.91 39.73 40.62 41.58 42.62 43.76 45.01 46.38 47.89 49.57 51.45 53.56 55.95 58.68 61.83 65.50 10.0% 34.87 35.44 36.05 36.70 37.39 38.14 38.94 39.81 40.75 41.77 42.89 44.11 45.45 46.93 48.57 50.41 52.47 54.81 57.48 60.56 10.5% 33.67 34.19 34.75 35.35 35.98 36.66 37.39 38.18 39.03 39.94 40.94 42.03 43.23 44.54 45.99 47.59 49.39 51.41 53.70 56.31 11.0% 32.54 33.02 33.53 34.08 34.66 35.28 35.94 36.66 37.43 38.26 39.16 40.13 41.20 42.37 43.65 45.07 46.64 48.40 50.37 52.61 11.5% 31.46 31.91 32.38 32.88 33.41 34.21 34.59 35.24 35.94 36.69 37.51 38.38 39.34 40.38 41.53 42.78 44.17 45.71 47.43 49.36 12.0% 30.45 30.86 31.29 31.76 32.25 32.77 33.32 33.92 34.56 35.24 35.98 36.77 37.63 38.57 39.59 40.70 41.93 43.29 44.79 46.48 12.5% 29.49 29.87 30.27 30.69 31.15 31.62 32.14 32.68 33.26 33.88 34.55 35.27 36.05 36.89 37.81 38.81 39.90 41.10 42.43 43.90 13.0% 28.57 28.92 29.30 29.69 30.11 30.55 31.02 31.52 32.05 32.62 33.23 33.88 34.59 35.35 36.17 37.07 38.05 39.11 40.29 41.59 13.5% 27.70 28.03 28.37 28.74 29.12 29.53 29.96 30.42 30.91 31.43 31.99 32.59 33.23 33.92 34.66 35.47 36.34 37.30 38.35 39.50

Risk FreeRisk Rate 14.0% 26.87 27.18 27.50 27.83 28.19 28.57 28.97 29.39 29.84 30.32 30.83 31.37 31.96 32.58 33.26 33.99 34.78 35.64 36.57 37.60 14.5% 26.08 26.36 26.66 26.98 27.31 27.66 28.02 28.41 28.83 29.27 29.74 30.24 30.77 31.34 31.96 32.62 33.33 34.10 34.94 35.86 15.0% 25.33 25.59 25.87 26.16 26.47 26.79 27.13 27.49 27.87 28.28 28.71 29.17 29.66 30.18 30.74 31.34 31.99 32.69 33.44 34.27 15.5% 24.60 24.85 25.11 25.38 25.67 25.97 26.28 26.62 26.97 27.35 27.74 28.16 28.61 29.09 29.60 30.15 30.74 31.37 32.06 32.80 16.0% 23.91 24.14 24.38 24.64 24.90 25.18 25.48 25.79 26.12 26.46 26.83 27.22 27.63 28.07 28.54 29.04 29.57 30.15 30.77 31.44 16.5% 23.25 23.47 23.69 23.93 24.18 24.44 24.71 25.00 25.30 25.62 25.96 26.32 26.70 27.11 27.54 27.99 28.49 29.01 29.57 30.18 17.0% 22.62 22.82 23.03 23.25 23.48 23.72 23.98 24.25 24.53 24.83 25.14 25.47 25.82 26.20 26.59 27.01 27.46 27.94 28.46 29.01 17.5% 22.01 22.20 22.39 22.60 22.82 23.04 23.28 23.53 23.79 24.07 24.36 24.67 24.99 25.34 25.70 26.09 26.50 26.94 27.41 27.92 18.0% 21.42 21.60 21.78 21.98 22.18 22.39 22.61 22.85 23.09 23.35 23.62 23.91 24.21 24.52 24.86 25.22 25.60 26.00 26.43 26.89 18.5% 20.86 21.02 21.20 21.38 21.57 21.77 21.98 22.19 22.42 22.66 22.91 23.18 23.46 23.75 24.07 24.40 24.74 25.12 25.51 25.93 19.0% 20.31 20.47 20.64 20.81 20.98 21.17 21.37 21.57 21.78 22.01 22.24 22.49 22.75 23.02 23.31 23.61 23.94 24.28 24.64 25.03 19.5% 19.79 19.94 20.09 20.25 20.42 20.60 20.78 20.97 21.17 21.38 21.60 21.83 22.07 22.32 22.59 22.87 23.17 23.49 23.83 24.18 20.0% 19.29 19.43 19.57 19.72 19.88 20.05 20.22 20.39 20.58 20.78 20.98 21.20 21.42 21.66 21.91 22.17 22.45 22.74 23.05 23.38

*In the actual model the Risk Free rate has been taken to be 11.55% to reach a price of PKR 34.21.

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Appendix O: Monte Carlo Simulation

Terminal Growth

Terminal Growth (0%-10%)

Hold (11%) 1200

1000

800 600

Frequency 400 200

40 32 33 34 35 36 37 38 39 41 42 43 44 45 46 47 48 49 More Share Price- Fatima Fertilizer

Monte Carlo simulation was used to judge the effect of different terminal growth rates over the final stock price. The terminal growth rate was allowed to vary randomly between 0% and 10%, and the resulting stock prices were calculated. 10,000 simulations were used for this purpose.

The above graph shows the distribution of stock prices obtained. For the stock prices falling below 32, we have given a hold stance and everything above that is a buy. This implies that in the scenario where the terminal growth can be anywhere within the given range, there is a 89% probability that it will be above PKR 32 (Buy), 11% probability that it will be between PKR 30 and PKR 32 (Hold), and a 0% chance of being less than PKR 30.

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Risk Free Rate

Risk Free Rate 2500 Hold (19%)

2000

1500

1000 Frequency 500

0 28 30 32 34 36 38 40 42 44 46 48 50 More Share Price- Fatima Fertilizer

Monte Carlo simulation was used to judge the effect of different risk free rates over the final stock price. The risk free rate was assumed to follow a normal distribution with a mean of 11.55% and a standard deviation of 1.62%, and the resulting stock prices were calculated. 10,000 simulations were used for this purpose.

The above graph shows the distribution of stock prices obtained. For the stock prices falling below 32, we have given a hold stance and everything above that is a buy. This implies that in the scenario where the risk free rate follows the above stated distribution, there is a 78% probability that it will be above PKR 32 (Buy), 19% probability that it will be between PKR 30 and PKR 28 (Hold), and a 3% chance of being less than PKR 28.

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Stock Price Simulation

Fatima Fertilizer 100

40 Frequency 20

Target Price

A Monte Carlo simulation was used using the lognormal distribution assumption for the stock price using the above mentioned parameters. The above graph was generated as a result. It shows the number of times each stock price would be reached incorporating the stock return variances and a random component for each trading day for a year.

The simulation leads to an average price of PKR 31.40 at the end of 2013

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Appendix P: Abbreviations

NFDC: National Fertilizer Development Corporation GoP: Government of Pakistan KSE: Karachi Stock Exchange GIDC: Gas Infrastructure Development Charges

CAN: Calcium Ammonium Nitrate

FFC: Fauji Foundation Company

FFBL: Fauji Fertilizer Limited

SNGPL: Sui Northern Gas Pipeline Ltd

SSGC: Sui Southern Gas Company

PKR: Pakistan Rupees

USD: United States Dollar

KIBOR: Karachi Inter-Bank Offer Rate

PIB: Pakistan Investment Bonds

LTF: Long Term Financing

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Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Ratings guide: Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Pakistan, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

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