Brief Company Overview/Description

ENGRO: Evolution of the Giant The company was incorporated in 1965 as ‘Esso Pakistan Fertilizer Company’ with the name changed to Exxon Chemical Pakistan Ltd. later. After the exit of Exxon (75% stake) in 1991, the company underwent an employee led buyout and continued as ENGRO Chemicals Pakistan Ltd. The core activities of ENGRO pertain to the manufacturing and marketing of Urea and NPK fertilizers, which are sold under the brand names of ‘ENGRO Urea’ and ‘Zarkhez’ besides sales of imported fertilizers. Urea production commenced from 1968, with plant located at Dharki with a rated annual Urea capacity of 173k tons. Successive de-bottlenecking and capacity expansions have resulted in increasing present Urea capacity to 975k tons. The NPK plant is located at Port Qasim and was commissioned in 2002 with an annual rated capacity of 160k tons. Moreover, the company has been quite active in investing in new business ventures, which are expected to bear fruit going forward Core Operations: Engro Chemical Pakistan Limited is the second largest producer of Urea fertilizer in Pakistan. The core business of the company is manufacturing, purchasing and marketing of fertilizers. ENGRO; having acquired the market share of 25.3%, is the second largest producer of Urea and the largest NPK fertilizer manufacturer in the country. Urea expansion of 1.3mntons is expected to come online, by mid-2011; it will make ENGRO the largest producer of fertilizer with 35% market share and with the production capacity of 2.27 mtpa. Furthermore, the company sells imported fertilizer such as DAP/MAP. The core business is valued at RS 93.1per share, which is 60% of the value in the firm's SOTP valuation. Urea accounts for around 65% of the total revenue mix within ENGRO’s core business. Zorawar (DAP) and Zarkhez have 26% and 8% of ENGRO’s total revenue mix, while Zingro and other micro nutrients have a 1% share. Going forward we expect DAP’s revenue share to increase to 30% in the shorter term (till 2010) untill the new urea plant will come online, after which we expect its share to go down.

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Financing Expansion: Engro's expansion of 1.3 mtpa urea plant is expected to be operational by mid-2011. Total cost of the project is estimated at USD970mn with a debt to equity ratio of 2.95 (79:21). The debt to equity mix is presented in the table below: Thus far, the company ha arranged all the debt financing of $750 mn (Rs. 45 bn), from a mix of Local Currency (LCY) of USD515mn and Foreign Currency (FCY) of USD235mn loans. And for the internal financing the company issued right shares worth of Rs. 3.1bn at Rs. 125 per share in CY07 while another issue of 10% right shares was announced at the end of CY07. Entire interest amount due from the new loan will be capitalized by the company since the plant becomes operative in CY11. Company To Post Higher Margins After Expansion: The feed gas expense would not be high until 2011, due to fixed tariff of $ 0.7 per MMBTU for 10 years, and after 2011 the tariff would increase to $ 1.10 MMBTU. But with the post expansion increase in consumption of gas will result in economies of scale and eventually lower cost of production and higher margins. Post expansion bottom line is expected to be increased by almost 57% engendered by an increase in the market share of the company to 35%. Subsidiaries--- Adding Value ENGRO has diversified its investment portfolio in various sectors in the form of different subsidiaries and joint ventures. The cumulative value of these subsidiaries is Rs 63.4/share, which represent 40% of total value. Diversified investment into attractive business segments is expected to boost ENGRO dividend income.
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ENGRO’s diversification is expected to enhance shareholder value in the following ways:
i.

Dividend income to prop up the bottom-line. Provide synergetic sales opportunities especially in the case of EPCL and EVTL,

ii.

ENGRO and EEPL, and ENGRO and EFL. iii. Smooth out earnings during CY11-12 when financial charges accruing from Urea expansion loans, hit the bottom-line. Here is the list of subsidiaries and joint ventures of ENGRO Chemicals. LIST OF SUBSIDIARIES

ECPL is set to increase investment in these subsidiaries as taking through a number of projects; promising tremendous future returns. ENGRO Expected Project Completion Time Table:

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Each subsidiary has been discussed in detail in latter part of this report.

Description and Valuation of Subsidiaries
EEPL: Engro Eximp Pvt Ltd. EEPL holds 100% equity of Engro Eximp. Engro Eximp deals in the business of imported fertilizer The Company offers value to ECPL as the company gets imported fertiliser at less cost than it would have to bear otherwise. The imported fertiliser demand is expected to continue at a growth rate of 30% till 2010 and after that import of fertiliser will be almost zero as the capacity expansion of 1.8 mtpa by Fatima Fertiliser and Engro Chemical Pakistan will become operational by 2011. The value of the EEPL is Rs.5.7 in total subsidiaries’ value of 63.4. Engro Foods Limited (EFL): set to jump higher EFL is the 100% owned subsidiary of ENGRO. The company's milk production capacity is 700k litters per day. Moreover an investment plan of $ 3.4 bn in Engro Foods has been approved by the board for: expanding UHT capacity to 900 k lpd, expanding milk powder capacity to 70 kpd, import of 1000 cows and an ice cream plant. The company is all set for growth as the milk business profitability is increasing due to increasing consumption of milk and increasing prices of dairy products. Besides selling milk, the company also sells the company also sells related products such as creams and unbranded products such as ghee, and recently introduced a milk whitener; namely "Tarang". Currently, the company is incurring losses due to expansionary activities. The value of the EFL is Rs.36 in total subsidiaries value of 63.4.
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ENGRO Energy (EEL): ECPL holds 100% equity of EEL. The plant is expected to commence production by 2009. The plant has production capacity of 217 MW is located at Qadirpur (Ghotki

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District). The plant will cost US $ 205 m; of which 75% is to be raised through offshore debt financing while rest to be raised through an equity issue. The value of the EEL is Rs.10.7 in total subsidiaries value of 63.4.

Engro Innovative Automation Pvt Ltd (EIAL): ECPL holds 63% of EIAL. The core business of EIAL is to provide process control solutions to leading industrial units. During CY07, the company has acquired 70% stake in a US based Automation and Engineering company named Advanced Automation LP (AALP). Engro Polymer and Chemical Limited (EPCL): EPCL is a joint venture between Engro Chemicals and Mitsubishi Corporation of Japan. EPCL's facility is designed to produce 100k tones of PVC resins; the plant is located at Port Qasim. The company is going through expansion of PVC manufacturing capacity after which the production capacity will increase to 150k tpa. The plant is being setup at a cost of $220 mn and would be completed by 1H-CY09. For financing purposes ECPL injected equity worth Rs. 1.5 bn. The designed facility will also be able to produce additional intermediary products and caustic soda. The company is showing increasingly high numbers in its bottom line and it's a great source of dividend revenue for ECPL. The company paid a dividend of Rs. 229 million in CY07. Engro Vopak Terminal Limited (EVPL): It is a joint venture with Royal Vopak of Netherlands. Engro holds 50% of equity. The core business of the company is storage and handling of chemicals. The Engro Vopak has entered into an agreement with EPCL for ethylene storage services, and plans to construct first cryogenic storage facility, which would cost $ 30 mn. All the financing will be raised from debt issue.

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The company paid a dividend per share of Rs. 5 in CY07. The profit of the company is expected to grow by 18-20% and the company is expected to maintain a payout of 92% going forward. The value of the EVPL is Rs.11 in total subsidiaries’ value of 156.5.

Significant Progress
Engro accomplished significant progress not only in its base urea fertilizer business but also in diversification projects. Urea production was increased from an annual capacity of 270,000 tons in 1991 to 850,000 tons in 2001. Further expansion plans are being developed to debottleneck plant capacity to 1.2 million tons in stages. In addition, Engro has over thirty years of experience of fertilizer marketing in Pakistan with an elaborate dealer network. Construction of Engro’s 100,000 tons p.a. capacity NPK fertilizers plant at Port Qasim at a cost of US $10 million was completed in 2001. The plant is in production and considerably benefiting the country’s agriculture by providing balance nutrition to improve farm yields.

Economic/Macro
Fiscal policy affect • DAP fertilizer is an essential input that enhances crop yields. The step increase in its international prices is discouraging the use of this important fertilizer and thereby adversely affecting productivity. Our government will more than double the subsidy on DP from Rs470 per bag to Rs1000 per bag. Subsidy on other fertilizers will also continue. A total allocation for subsidy on fertilizers has been increased from Rs25 billion to Rs32 billion. • Complete exemption from sales tax and other duties on imported and local supply of fertilizers and pesticides, so that the farmers can get these at much cheaper prices. The effect of exemption form duties in respect of both fertilizers and pesticides is Rs6 billion.

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Shortage of Urea in the domestic market led to price flare up creating significant stress on the Industry, which worked in close coordination with Government at federal, provincial and district levels to manage the situation.

Monetary policy affect • • • • • Agriculture credit increasing over years. Involvement of commercial banks. SBP’s Initiatives towards Promotion of agriculture Credit Handbook on Agri-Finance Products of Banks Specialized Training Programs

Relative Performance of Engro
Eepa K Nar nS Gi e c E Rer e O f t 1 rv m 0 l o o0 t

Source: Bloomberg

Industry Analysis
Industry Moving in the Right Direction The agricultural sector plays a key role in Pakistan’s macroeconomic growth by contributing approximately 21% to the GDP. Increases in crop support prices and enhanced water availability has resulted in improved agricultural output. Hence,
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fertilizer demand remains strong with an anticipated demand-supply gap of 1.3mn tons by 2010, however, the current capacity of 5.8mn tons is expected to increase to 7.7mn tons by then which will partially bridge this shortfall. Moreover, the fertilizer prices are anticipated to rise gradually (6%) due to increasing gas prices and overall inflationary pressures.

Contributor to the Economy A successful agricultural setup is essential for the country’s overall growth due to its 21% contribution to the GDP. GoP, in the recent past has taken some positive steps to boost the industry. The overall credit disbursements to the agriculture sector has grown consistently; water distribution has improved and the product pricing has been looked upon well. We believe it is essential for the GoP to continue it’s support towards the sector for the betterment of the overall economy. Snapshot of the Fertilizer Industry Demand for fertilisers is strong in Pakistan. Farmers increasingly look towards increased fertiliser applications to firstly maintain and secondly improve crop yields. Generous subsidies in the form of lower gas feed stock prices and direct subsidy on Potash and Phosphatic based fertilizers have made this commodity within the reach of most farmers. Urea and DAP sales are forecasted to rise by an average of 3% per annum for the foreseeable future. Limited availability of gas has capped the investment in the fertiliser manufacturing. Present rated Urea capacity stands at 4.5mn tons while that of DAP stands at 0.445mn tons per annum. 2011 forecast Urea capacity forecast to climb to 6.11mn tons per annum following the expansions of ENGRO and Fatima fertilizer. Changing Trends

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Fertilizer industry in Pakistan is mostly dominated by fertilizer, having a market share of 66%. Considering the nature of Pakistani soil, the advisable Nitrogen: Phosphate application ratio is 1:0.66, whereas the current ratio stands at around 1:0.27. Major reasons for this disparity include phosphoric nutrients being relatively expensive to their nitrogenous counterparts and lack of education amongst farmers about the importance of balanced fertilization. However considering the GoP’s commitment towards promoting balanced fertilization, (by announcing a subsidy of PKR 470 per bag) and an expected increase in farmer education regarding the benefits of balanced fertilization, a change in trend can be anticipated. But at the same time soaring prices of DAP in international markets, forcing farmers to rely more on Urea rather than DAP. Another subsidy for DAP is expected this year; to get it accessible for the formers at reasonable price. Players in the Fertilizer Sector The fertilizer sector in Pakistan currently comprises of 10 companies 6 of which are in the public sector while 4 are in the private sector. Fertilizer sector recorded 24 percent net profit of Rs 13.7 million in FY08 as against Rs 11 billion in the same period last year. In terms of earnings growth in percentage terms, Engro stood first with 34 percent growth in profit after taxation. FFC recorded 22 percent, FFBL earnings grew by 14 percent whereas DAWHs earnings declined by 70 percent.

Growth Drivers/Catalysts/Positives/Issues

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Market Position
Currently, Engro market share is 25.3% and it expected to grow in future by 35% until 2011 because of two main reasons, which includes Urea expansion plan and the other reasons is that the agricultural sector in Pakistan is growing. Therefore, being one of the largest fertilizer companies of Pakistan, Engro would be able to increase its market share in the coming years.
Other
Market Share

Engro, 20%

Growth of company’s businesses
Brands of the Company Engro is an agri based company. Its core business includes manufacturing and marketing of chemical fertilizers. Engro is Pakistan’s one of the largest producers of urea fertilizer which is manufactured at Daharki and marketed under brand name Engro. They also produce crop specific NPK fertilizers at the plant at Port Qasim Karachi and these are marketed under the brand name of “Zarkhez". Engro also markets imported MAP fertilizer under the brand name of "Zorawar" and imported DAP fertilizer. The company also markets micronutrients Zinc Sulphate branded as "Zingro" and Boron branded as "Zoron". Production and Offtake

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Pricing

Government Subsidy to Fertilizer Sector Subsidy remained at Rs.470/bag of DAP during the first half of the year. The government in the second half of the year increased the subsidy amount to Rs. 2,200/bag. Despite a significant increase in the subsidy amount, local DAP prices went up from Rs. 1,685 at the start of the year to Rs.3,050/bag at the end of the year due to the increase in global fertilizer prices. The subsidy for urea is:

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Company Operating Performance
Industry urea sales were 5.5 million tons during 2008, growing 12% from 2007 whereas national urea production during 2008 was 4.98 million tons which is 5% higher than 2007. In 2008, Engro produced 995KT, a bit less than target of one million tons. Engro has urea market share of 19.2%. During 2008, industry saw unprecedented urea shortages due to late arrival of imports. To minimize the impact of shortage, Engro extensively coordinated with government at federal, provincial and district levels.

Expansion project is progressing well with an overall progress of 47%. Total project cost has increased to $1.05 billion because of increase in interest rates, devaluation of rupee and a minor design change to increase capacity.

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In 2008, industry sales dropped to 0.8 million tons from1.461million in 2007. This huge decrease is attributed to highest ever phosphate prices, liquidity crunch, uncertainty on subsidy and support prices for produce. Engro sold 128KT of phosphate in 2008 against 514KT in 2007 and achieving 16% market share. This decline is because of industry dropped by 45%, local production share of FFBL increased and two new urea producing private importers participated in the market. On the other hand Zarkhez prices are also shooting up in 2008, owing to increase in prices of phosphate and potash. Thus Zarkhez sales dropped to 69KT, a 28% decline from 2007. Poor crops of sugarcane and potatoes, which absorb 36% of Zarkhez sales had a negative impact. In 2008, company achieved highest ever Zingro sales that is 1,781 metric tons against the plan of 1500 metric tons.

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Risks/Concerns of Valuation
• The agriculture growth factors such as water availability, farm credit, and farm income can lead to agriculture growth slowdown and thereby affect fertilizer offtake.

Timely completion of expansion projects: Deteriorating security situation in the country may delay project expansions going forward.

Availability of gas: Persistent gas shortages in the face of demand/supply gap may inhibit production. Consequently, if the IPI pipeline reaches completion by 2011, it may encourage further investments in the Urea manufacturing and result in a supply glut situation post 2011.

GoP’s support for balanced fertilizer usage regime: the level of subsidy given on Phosphatic fertilizers is going to influence farmer usage of DAP/ MAP fertilizers.

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Fertilizer Value Cost Ratio (VCR) for major crops: Defined as the incremental benefits received by the farmer in the form of increased yields over the additional cost of fertilizer. It is used, a ratio greater than 1 would suggest that farmers will continue applying increased fertilizer successively thus sustaining demand growth and vice' versa.
2005A 2006A 17,60 2 13,36 5 2007A 23,18 3 18,26 3 2008A 23,31 7 17,12 1 2009E 22,73 0 14,42 6 8,30 2010E 29,26 2 19,94 3 9,31 9 37% 3,19 1,302 1,145 287 280 1,482 1,339 287 363 1,642 1,831 339 535 1,658 2,754 580 1,509 8 1,31 3 58 1 67 3 5,16 7 2,44 8 65 2 63 4 5,83 4 23% 1287 3878 20% 1261 4574 0 19% 2094 6706 1 8,80 9 16% 1837 6351 4 3,27 8 8,18 5 19% 2371 7804 9 1,26 9 7,25 7 10,17 32% 4,64 0 2,72 6 1,51 6 8,85 7 40% 7,45 4 3,09 6 1,79 2011E 45,33 3 27,27 6 18,05 4 44% 7,83 9 3,40 6 21,70 1 47% 8,23 0 28,10 1 25,66 2012E 49,81 3 29,09 2013E 54,75

Net Sales Cost of Sales

18,276 14,333

Gross Profit gross margins Selling and Distribution Expenses Other Income Other operating Charges Finance Costs

3,943 22%

4,237 24%

4,920 21%

6,197 27%

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Profit before taxation

3,220 18% 900 2319

3,445 20% 897 2547

4,236 18% 1081 3155

5,205 22% 964 4240

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Taxation Profit after taxation

Prices of grains: Grain prices, especially wheat is going to influence farmer fertilizer usage in future.

Financials
Profit and Loss Account

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Cashflow Statement

2008A Net cash inflow from operating activities Net cash used in investing activities Net cash inflow from financing activities CCE beginning Net increase in cash and cash equivalents CCE end Short term finance CASH BALANCE

2009E

2010E

2011E

2012E

2013E

5,488 (22,257) 15,534 7,771 (1,235) 1,687 1,711 3,398

7,798 (29,470) 19,997 1,687 (1,674) 13 3,077 3,090

8,789 (23,111) 17,102 13 2,780 2,793 3,077 5,870

9,261 (1,712) (4,105) 2,793 3,445 6,238 3,077 9,315

7,899 (1,432) (8,675) 6,238 (2,208) 4,029 3,077 7,106

11,631 (1,333) (12,974) 4,029 (2,677) 1,353 3,077 4,430

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Balance Sheet
2006A Share Capital and Reserves Issued, subscribed and paid up Reserves Unappropriated Profit Total Equity Non current liabilities Long term loans Others Total Non current liabilities Current liabilities Current portion of long term loans Short term borrowing Trade and other payable 0 8 8 2,96 0 1,80 1,16 3 8 17,41 5 15,42 1,98 7 8 31,20 7 27,75 3,44 2 6 46,30 8 45,27 1,03 2 6 61,82 7 60,79 1,03 1 6 55,52 9 54,49 1,03 3 6 44,94 0 43,91 1,03 5 6 32,40 31,36 1,03 2 8 0 0 9,37 2 1,68 5,49 2,19 1 7 15,48 4 5 1,93 9,43 4,11 5 1 23,08 3 8 2,12 14,04 6,91 5 4 30,44 2 4 6,38 14,04 10,01 5 3 34,10 6 4 6,38 14,04 13,67 5 7 38,79 2 4 6,38 14,04 18,36 5 3 43,24 5 4 6,38 14,04 22,81 5 6 48,70 4 6,38 14,04 28,27 2007A 2008A 2009E 2010E 2011E 2012E 2013E

6 0 2

1,10 1,30 1,08

9

1,31 3,75

5 1 5

9 1,71

8 7

51 3,07

4 7

3,01 3,07

3 7

7,22 3,07

1 7

11,03 3,07

6 7

12,94 3,07

3

3,87 9

2,21 6

2,85 5

4,42 2

4,86 4

5,34

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15 Others Total current liabilities Equity & Liabilities 4 3,64 2 15,98 1 3 5

19 8 5,26 9 38,15 7 9

31 8 5,99 2 60,28 2

31 8 6,13 82,88

31 8 9,26 6 105,19 6 3

31 8 15,04 109,36 5

31 8 19,28 8 107,47 9

31 21,68 6 102,79 1

Non current assets Net fixed assets Intangible assets Long term investments Long term loans, advances Total Non current assets Current assets Stores, spares and loose tools Stock in trade Trade debts Loans, advances, other recievables Cash and equivalent Total current assets TOTAL ASSETS 9 3 3 4 5 5,68 4 15,98 1 1,64 1,80 0 8 7 38,15 7 8 16,39 3 60,28 2 92 62 9 9,94 1,61 3 7 15,32 1 82,88 68 1 0 2,69 1,40 2 7,64 1,68 0 3 7,57 74 7 1 4,68 26 8 3,89 1 5 3 8,98 3 105,19 5 95 2 5 1,74 1,10 6 3,21 2,79 9 8 2 109,36 5 17,36 72 3 3 1,44 91 9 4,13 6,23 2 9 19,24 9 107,47 9 52 5 7 1,85 1,17 7 6,41 4,02 6 3 17,83 1 102,79 1 3,85 0 7 2,87 1,82 8 7,04 1,35 4,01 0 1 3,16 2,00 4,17 8 8 8 6 3 10,29 6 6,55 1 3,65 2 4 4 9 9 4 21,75 13,81 13 7,76 6 3 2 5 5 35 44,96 33,39 12 11,09 9 6 2 4 1 21 75,31 63,86 13 11,09 8 7 2 5 2 27 96,21 84,70 13 11,09 7 8 2 7 3 42 92,00 80,34 13 11,09 0 9 2 9 9 46 88,22 76,53 13 11,09 3 0 2 5 0 51 84,96 73,21 14 11,09

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Ratios
2005A PROFITABILITY RATIOS Profit Margin Gross profit margin Return on Assets Return on Equity LIQUIDITY RATIOS Current Ratio DEBT MANAGEMENT RATIOS Debt to Asset Debt to Equity Ratio Long Term Debt to Equity MARKET RATIOS Earning per share Price/Earnings Ratio Dividend per share Book value per share Price/BV ratio .78 13 .84 11 48 2.23 7 .55 60 12. 8 59 17 10. 10. 3 7 7.5 6 77 1.39 14.2 2 27 8. 13.0 5 02 7. 15.3 51 78 4. 22. 32 05 5. 21. 19 11 4. 26. .48 .91 .53 0 0 .71 .32 0 .41 0 0 46 12 0 59 1. 1. 1 5 0. 2 1.6 1.3 72 52 0.6 63 1. 1. 08 81 0. 68 2. 1. 82 43 0. 65 1. 1. 49 04 0. 60 1. 1. 11 67 0. 53 1. 0. 0. 2006A 2007A 2008A 2009E 2010E 2011E 2012E 2013E

12.7% 21.6% 16.4% 31.4%

14.5% 24.1% 15.9% 27.2%

13.6% 21.2% 8.3% 20.4%

18.2% 26.6% 7.0% 18.4%

17.1% 36.5% 4.7% 12.7%

15.6% 31.8% 4.3% 13.4%

14.8% 39.8% 6.1% 17.3%

12.8% 43.6% 5.9% 14.7%

14.3% 46.9% 7.6% 16.0%

1.79

1.56

3.11

2.55

1.23

0.97

1.15

1.00

0.82

9 56 1.93

7 80 1.35

1 102 1.05

1 114 0.94

3 130 0.83

3 145 0.74

4 163 0.66

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FAIR VALUE CALCULATION
Dividend yield method is used to calculate fair value of shares of Engro.
FAIR VALUE (Dividened Yield Method) No. of shares Rate of Dividend Industry Rate of dividend* Value per share
* FFC rate of dividend is considered

212816 0.2 0.1357 PKR 199.48

Though every investor has a different point of view towards fair value of any share, we estimate the company’s stock fair value to be at least Rs. 199.48. We expect handsome earning growth as we saw the future expansion. We recommend a BUY for ENGRO at current price. Currently, the stock price of ENGRO limited moving around to Rs 135.35.

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Recommendation
It is expected that the company will be able to perform well because of its future expansion plan which will increase the market share from current 25% to 35%. EPS is also showing the increasing trend. One more thing which is favorable for company is its diversification projects and investment horizon. If the company would be able to continue its current stability and investments in profitable projects then the company would be able to increase its market share as well as Profitability. We recommend “BUY” for the scrip, and according to our fair valuation we dig out to the fair value of Rs. 199.48.

Conclusion
We foresee growth in earrings of fertilizer companies in the years to come. Similarly the said position will be with ENGRO. We expect positive earnings of ENGRO in the coming years; currently we maintain our stance by recommend “BUY” on ENGRO.

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