ASIAN CASE RESEARCH JOURNAL, VOL.

23, ISSUE 2, 313–330 (2019)

ACRJ
Engro Fertilizers Limited:
This case was prepared by
Dr. Fazal Jawad Seyyed Cost of Capital and Valuation
and Hafsa Ashfaq of Lahore
University of Management
Sciences, Pakistan, as a basis A few days after Engro Fertilizers Limited (EFERT) announced
for classroom discussion rather its financial results for 2016, Qasim Ahmad, a senior equity
than to illustrate either effec-
tive or ineffective handling of analyst at Intermarket Securities Limited (IMS) began working
an administrative or business
situation.
on preparing the Intermarket Pulse report on Pakistan’s fertil-
izer sector. The upcoming report, due on February 16, 2017,
Please send all correspon-
dence to Dr. Fazal Jawad
required a comprehensive analysis. Qasim gathered the back-
Seyyed, Visiting Faculty, ground information on the fertilizer sector in Pakistan as well
Suleman Dawood School of
Business, Lahore University as EFERT. He had to compute EFERT’s cost of capital and
of Management Sciences, then work on preparing the cash flow forecast to determine
Lahore cantt. 54792,
Lahore, Pakistan. E-mail:  the stock’s target price.
fazal.jawad@lums.edu.pk

INTERMARKET SECURITIES LIMITED

Intermarket Securities Limited (IMS) was the flagship of the

Intermarket Group and was established in the early 2000s
after the acquisition of ING Barings Pakistan operations. It
was a leading full-service brokerage house offering trade
execution, investment banking and advisory, and equities
and economic research. Its vision was to ‘become a preferred
brokerage firm in Pakistan while playing a positive role for
capital market development leading to enhancement in the
country’s investor base’.1
The research department of IMS provided comprehen-
sive overview of the economy as well as coverage of the key
sectors of Pakistan. The research team comprised five equity
analysts with sell-side as well as buy-side research experi-
ence, and three database and support personnel. The research

© 2019 by World Scientific Publishing Co. DOI: 10.1142/S0218927519500123

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 314  ACRJ

department prepared a wide range of reports to meet the

needs of the clients. These reports included daily briefs and
flash notes for breaking developments; detailed initiation
of coverage and updates; reports on key economic issues,
budget analysis, strategy notes on the Pakistani market and
sectors, and weekly reviews.
Qasim had covered the fertilizer sector for IMS. The
EFERT financial results, announced on February 8, 2017,
showed lower than expected earnings for the last quarter of
2016 and 40% year-on-year (YoY) decline in earnings but the
final dividend per share of PKR 2.52 exceeded analysts’ expec-
tations. On the day the financial results were announced,
Qasim expressed a neutral opinion on EFERT stock in the
Intermarket Intel report. “The result was mainly undermined
by substantial increase in distribution expenses during 4Q
2016, which jumped 45% YoY,” Qasim noted.
The next IMS report, the Intermarket Pulse report on
Pakistan’s fertilizer sector, was due on February 16, 2017.
Qasim had to do a thorough analysis of EFERT financials and
its economic environment to recommend the stock. He assem-
bled the required information on EFERT and updated the fer-
tilizer sector data in preparation for his analysis and valuation.

FERTILIZER SECTOR

Agriculture played an important role in the economy of

Pakistan. Over the years, availability of water and cultivable
land, adoption of high-yielding crop varieties and intro-
duction of government policies in the form of commodity
support prices and subsidies to farmers had led to increased
usage of fertilizers in the country.

Fertilizer Types and Usage

Fertilizers, in the form of plants and soil nutrients, namely,

nitrogen (N), phosphorous (P) and potassium (K), were used

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 ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  315

to enhance the yield capacity of the agricultural land. The

nitrogen fertilizers included ammonia, urea and nitrates. Urea
was the most widely used nitrogen fertilizer. Different nitrate
compounds included ammonium nitrate (AN) and calcium
ammonium nitrate (CAN). Phosphorous providing fertilizers
included mono-ammonium phosphate (MAP), di-ammonium
phosphate (DAP) and single superphosphate (SSP); and
potassium bearing fertilizers were muriate of potash (MOP),
potassium nitrate and potassium sulphate. NPK fertilizers
were complex ones and contained various combinations of
nitrogen, phosphorous and potassium.
In Pakistan, fertilizer consumption had been tilted
towards nitrogen primarily due to higher prices of phos-
phate fertilizers. The N, P and K consumption proportion in
Pakistan was 74%, 25% and 1%, respectively as compared to
the global average proportions of 60%, 23% and 17%.3 Around
70% of the fertilizers consumed in Pakistan were domestically
produced, supplying 75% of urea, 54% of DAP and 29% of
potash fertilizers.4

Fertilizer Sector Overview

Pakistan began importing fertilizers in 1950s. Later, strategic

manufacturing investments were made to build the domestic
fertilizer sector. Pak-American Fertilizers, now known as
Agritech, was established in 1958 as a joint venture with a
foreign company. The burden of imports was reduced grad-
ually by increasing the national fertilizer supply. Since 1971,
the growth of domestic fertilizer production remained higher
than the growth of fertilizer consumption in Pakistan. The
fertilizer sector of Pakistan was highly regulated until 1986.
Gradual deregulation of fertilizer prices accompanied by a
series of successive fertilizer policies in 1989 and 2001 played
a crucial role in the development of the sector. The local
manufacturers were offered incentives for new projects and
expansions along with agreements for guaranteed availability
of gas at concessionary rates.

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 316  ACRJ

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Sources: Engro Fertilizers Limited, Analyst Briefing FY (2016); Fauji Fertilizer Bin Qasim Limited, Annual Report (2016).

Figure 1. Fertilizer Sector Market Share (FY 2016).

The sector had an oligopolistic market structure in

Pakistan. Nine companies operated in the sector, for produc-
tion and marketing of various fertilizer products, with power
concentrated among three major players, Fauji Fertilizer
Company (FFC), Fauji Fertilizer Bin Qasim Limited (FFBL)
and Engro Fertilizers Limited (EFERT). These companies had
a total share of 82% in the urea market and 70% in the DAP
market in 2016 (Figure 1). There were 18 fertilizer manufac-
turing plants in Pakistan, 11 in Punjab, 6 in Sindh and one in
Khyber Pakhtunkhwa (KPK) (Exhibit 1). Excess supply and
fierce competition in the sector had left the manufacturers
with limited pricing power.

Input for Fertilizer Production

The development strategy of Pakistan’s fertilizer sector had

been premised on the perceived abundance of natural gas
supply, the major raw material for fertilizer production.
There were three sources of gas supply in Pakistan: two net-
works of Sui (SSGCL and SNGPL) with a dual consumer base
(domestic and industrial) and Mari network supplying only
to the industrial sector. Gas was used both as fuel (fuelstock)

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 ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  317

and as the major raw material (feedstock). Fuelstock and

feedstock accounted for about 55% and 30%, respectively, of
the fertilizer production costs. The fertilizer manufacturers
enjoyed substantial subsidies on gas prices with more gen-
erous subsidy on feedstock.
The fertilizer sector faced serious gas curtailment issues
since 2009 due to inconsistent supply from the Sui network.
The local manufacturers suffered huge production losses and
two fertilizer plants were temporarily closed. In early 2016
the gas was permanently reallocated gas back to the fertilizer
companies to whom it was originally allocated. The govern-
ment also decided to import Liquefied Natural Gas (LNG) in
2015. A 15-year agreement was signed with Qatar to import
around 3.75 million tons of LNG per year.
The local fertilizer manufacturers benefited from low
gas prices in the past. However, hikes in gas prices and impo-
sition of Gas Infrastructure Development Cess (GIDC) since
2012, to support the LNG projects, increased the pressure on
local manufacturers and affected their margins due to rising
cost of production. The GIDC was, however, expected to be
removed for the manufacturers enjoying the concessionary
feedstock gas, i.e., for EFERT and Fatima Fertilizers, as it
was in direct contradiction of the concessionary gas supply
agreement.

Fertilizer Supply-Demand

The domestic demand for fertilizers typically followed a

cyclical trend with peaks during the Rabi season (October
to March) and troughs during the Kharif season (April to
September). In 2015, domestic fertilizer production stood at
approximately 7.6 million tonnes while around 1.8 million
tonnes of fertilizers were imported.5 The rising production
trend resulted in excess supply of urea in 2016 as the local
demand for urea fell by 2% whereas its local production saw
an increase of 13%.6 At the end of 2016, the government had
planned to export excess urea.

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 318  ACRJ

The fertilizer demand saw a slowdown in 2016. Weak

crop dynamics and price uncertainty resulted in low fertilizer
sales in the first half of the year. Sales picked up in the third
quarter of 2016 as a result of subsidy announced by the gov-
ernment in the 2016–17 federal budget and discounts offered
by companies to clear their stocks. A stable demand was
expected in 2017 owing to improvements in farmer economics
and government support measures.

Fertilizer prices and subsidies

Gas shortages contributed to low domestic fertilizer pro-

duction and the overall fertilizer supply-demand gap was
met sporadically via expensive imports. A sharp decline in
international urea prices, on the back of global oversupply,
brought down the international prices to be at par with the
domestic prices. The competitive prices of imported urea
coupled with the rising domestic production costs had put
greater pressure on the margins of the local manufacturers.
Fluctuations in international fertilizer prices also affected
domestic consumption patterns and resulted in delayed
domestic buying in expectations of price cuts.
Government subsidies on local and imported fertilizers
acted as local demand catalyst. In the 2016–17 federal budget,
the government reduced the sales tax from 17% to 5% and
provided subsidies on various fertilizers.

Imbalanced fertilizer use

The use of fertilizers in Pakistan was based primarily on

the financial capacity of the farmers rather than the require-
ments based on soil analysis and crop need. Nitrogenous and
phosphoric fertilizers were more commonly used. However,
the use of potashic fertilizers was very limited. The imbal-
anced application of fertilizers had adversely affected the crop
yields and productivity. Limited access to agricultural credit
had discouraged the farmers from adopting best practices in
the use of inputs and technology.

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 ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  319

ENGRO FERTILIZERS LIMITED

Engro Fertilizers Limited (EFERT) was a renowned name in

the fertilizer sector of Pakistan. It was established in 2009 as
a result of divesting of the fertilizer segment from its parent
company Engro Chemical Pakistan Limited. Engro Chemical
was converted into the holding company, Engro Corporation,
and the fertilizer business was formed as a subsidiary, Engro
Fertilizers Limited. The company’s journey into fertilizers,
however, dated back to 1957 (Exhibit 2).
EFERT had a vast production and marketing network
and produced leading fertilizer brands for local cultivation
needs and demand. The company was also a leading importer
and seller of phosphate fertilizers. It offered urea, DAP and
NPK (potash/zarkhez) fertilizers under seven brands with an
outreach to 2 million farmers. Owing to its trusted fertilizer
brands and ongoing farmer training and advisory support,
the company enjoyed a loyal customer base across Pakistan.
The company had three fertilizer plants, two in Daharki
(base plant and Enven plant) and one in Karachi (NPK
plant). EFERT became a leading urea manufacturer following
the construction of Enven, the second plant at Daharki,
which started commercial production in 2011. To ensure full
capacity utilization, the company had entered into agree-
ments with the government for the required gas supply.
High oil prices and severe power outages in the country led
to higher allocation of indigenous gas to the power sector.
Despite the sovereign guarantees, the company started facing
gas curtailments in 2012. The required gas supply to run the
new plant was not provided as committed which resulted in
a delay in urea production. The company decided to divert
the gas supply from its old plant to the new plant for efficient
production. Efforts to restore the total required gas supply
for both the plants were made while the base plant oper-
ated on temporary gas allocation. The reallocation of gas in
2016 along with other available gas streams was sufficient to
ensure continued operations in both plants.
EFERT had been the urea price setter in the sector. It
increased prices during periods of production cuts stemming

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 320 ACRJ

from gas shortages. This situation reversed in March 2015

with the approval of concessionary gas supply and continued
gas supply from Guddu power plant; and EFERT became the
price follower.7 After 2015, EFERT had been facing declining
trend in profitability. In Qasim’s opinion, this was attribut-
able to crippling pricing power and consistent over-supply in
the urea market. He added, “EFERT faces various challenges
similar to other fertilizer manufacturers in Pakistan. That,
coupled with lack of clarity on additional gas allocation and
its pricing, has kept its stock performance in check.”
In 2016, EFERT’s urea production declined by 4% from
the previous year and urea sales was 12% lower leading to
a decline in its urea market share from 34% to 30% in one
year. The reduction in urea market share was primarily due
to higher production in the system as a result of smooth
operations of LNG based fertilizer plants, and better gas
availability to the fertilizer sector. The company’s phosphates
sales registered a 41% YoY increase in 2016, as a result of
the subsidy and lower international DAP prices, whereas
the sales of NPK and potash-based fertilizers declined by
16%. EFERT had a long-term credit rating of AA- and short
term credit rating of A1+ in 2016.6 See Exhibit 3 for EFERT’s
financial statements.
In EFERT’s board meeting, the management had
expressed its commitment to continue negotiating for more
favorable gas prices in the future. Moreover, the LNG based
urea production was not very attractive at the current levels
of crude oil prices given that there was already an oversupply
in the market. The company was optimistic about the urea
export potential and believed that exports would relieve the
company of its piled up inventories. However, further decline
in urea prices and hikes in gas prices could bring the margins
under additional pressure.
Qasim believed that despite the over-supplied fertilizer
market and limited pricing power, EFERT would continue
to serve as a high dividend-yielding stock, trading at +10%
forward dividend yield. He reflected, “With medium-term
fertilizer sector outlook less than sanguine, EFERT would con-
tinue to face the challenges stalking the sector. However, the

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 ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  321

magnitude of such challenges would be limited for EFERT as

the company enjoys a competitive edge of concessionary gas
pricing on about 50% of its total gas allocation.”

COST OF CAPITAL ESTIMATION AND VALUATION

The Intermarket Pulse report was due in two days. Qasim

opened the EFERT file to start his analysis. He had to develop
a valuation model for EFERT’s stock and compare it with
the 2016 year-end stock price. The first step was to calculate
the cost of capital of EFERT. He believed that estimating the
appropriate discount rate for the company’s cash flows was
critical for his analysis. As he flipped through the pages to
assemble the relevant data on EFERT, Qasim asked a junior
analyst, recently hired by IMS, to prepare an estimate of
EFERT’s cost of capital and share the results with him before
the end of the day.
“This file contains the financial statements of EFERT
and other financial information that you might need to com-
pute the cost of capital. I am sending you the daily market
data of EFERT stock and KSE 100 index in excel. Feel free to
make appropriate assumptions to compute the cost of capital.
We currently use the market risk premium of around 6%.
Moreover, the default spreads of AAA and AA-rated corpo-
rate bonds over the risk-free rate are in the ranges of 0.55%
to 0.75% and 0.80% to 0.90%, respectively,” Qasim said as he
handed over the relevant documents on EFERT.
Qasim headed out for a meeting while the new hire
started the analysis with the review of capital market data
and other information as provided in Exhibits 4 to 6. He care-
fully drafted a brief report containing his calculations and
estimates of EFERT’s cost of capital (Exhibit 7) and forwarded
it to Qasim.
When Qasim came back from the meeting, he found the
report on his desk. He gave a quick look at the various com-
ponents of the estimates and decided to verify the numbers
the next day. He first estimated EFERT’s cost of capital. Then,
he projected EFERT’s free cash flows and compiled market
data on its comparable firms to determine stock’s fair value.

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 322 ACRJ

“The concessionary gas pricing agreement with EFERT

is valid for the next 10 years. Therefore, I shall use the fore-
cast period until 2026 to capture the impact of concessionary
pricing. As the subsidy would lapse, the cost of goods sold
for the company would rise and negatively affect the margins
of the company,” Qasim reasoned as he compiled a set of
assumptions shown in Exhibit 8 for the valuation model.
The fertilizer sector had been under pressure in the
past. There was hope for the sector to recover in the future.
Qasim believed that EFERT’s competitive advantage over
other players in the market would enable it to recover faster
than the other players. However, the growth would average
at around 2.8% once the concessionary gas supply agreement
expired.
Qasim had to finalize the report by the end of the day.
He reverted to the Excel file on the computer to forecast the
cash flows. He wondered whether the EFERT stock was over-
valued or undervalued at the 2016 year-end stock price of
PKR 67.98.

ENDNOTES

1 Intermarket Securities Limited, Company’s Vision & Mission,

http://www.imsecurities.com.pk/vision-mission/, accessed August 
23, 2017.
2 During 2016, the average exchange rate for the US dollar to
the Pakistani Rupee was 104.66. Source: State Bank of Pakistan,
www.sbp.org.pk/ecodata/ibf_arch.xls, accessed December 2017.
3 Pakistan Insight, LLC, Pakistan Fertilizers Untying the Gordian
Knot, October 03, 2016, http://insightsec.com.pk/wp-content/
uploads/2016/11/Pakistan-fertilizers-Untying-the-Gordian-
Knot.pdf, accessed August 23, 2017.
4 David J. Spielman, Sohail J. Malik, Paul Dorosh, and Nuzhat
Ahmad, Pakistan’s Fertilizer Sector: Structure, Policies, Perfor-
mance, and Impacts, in  Agriculture and the Rural Economy in
Pakistan: Issues, Outlooks, and Policy Priorities, (International Food
Policy Research Institute, 2016), pp. 219–272.
5 Waqas Munir, Fertilizer Industry, JCR-VIS Sector Update
(December 2016) JCR-VIS Credit Rating Company Limited,

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 ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  323

http://jcrvis.com.pk/docs/Fertilizer201612.pdf,
accessed August 23, 2017.
6 Engro Fertilizers Limited, 2016 Annual Report,
http://engrofertilizers.com/wp-content/uploads/2017/03/
engro-fertilizers-annual-report-2016.pdf,
accessed August 23, 2017.
7 Intermarket Securities Limited, Intermarket Perspective - Pakistan
Fertilizers, September 16, 2015. 

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 324  ACRJ

Exhibit 1

Fertilizer Plants in Pakistan

Company Location Province Product Annual

Manufactured Capacity
(metric tons)
Fauji Fertilizer Limited
(FFC)
Plant – I Goth Machi, Rahim Yar Khan Punjab
Plant – II Goth Machi, Rahim Yar Khan Punjab Urea 2,048,000
Plant – III MirpurMathelo, Ghotki Sindh
Fauji Fertilizer Bin Qasim
Limited (FFBL)
Plant – I Bin Qasim, Karachi Sindh Urea 551,000
Plant – II Bin Qasim, Karachi DAP 650,000

Engro Fertilizers Limited

Plant – I Daharki Urea 2,275,000
Plant – II Bin Qasim, Karachi Sindh NPK
Plant – III Daharki Urea
Dawood Hercules Chemicals Sheikhupura Punjab Urea 445,000
Limited (DAWH)
Pak Arab Fertilizers Limited
(PFL)
Plant – I Multan Punjab Urea 92,000
Plant – II NP 305,000
450,000
Plant – III CAN
Fatima Fertilizers Company
Limited
Plant – I Rahim Yar Khan Punjab Urea 500,000
Plant – II CAN 420,000
360,000
Plant – III NP
Agritech Limited Mianwali Punjab Urea 467,000
Hazara Phosphate Fertilizers Haripur KPK SSP
Limited (HPFL)
Lyallpur Chemicals & Jaranwala Punjab SSP
Fertilizers Limited (LCFL)
Source: “Fertilizer Sector, Despite soft global outlook, local industry to remain upbeat.” Arif Habib Limited (November 18,
2015).

S0218927519500123.indd 324 06-04-20 2:16:57 PM

S0218927519500123.indd 325
Exhibit 2

Engro Fertilizer’s Journey and Key Milestones

Source: Engro Fertilizers Limited — Company Presentation.

ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  325

06-04-20 2:16:58 PM
 326  ACRJ

Exhibit 3

Engro Fertilizers Limited — Financial Statements

     

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Source: Bloomberg.

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 ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  327

Exhibit 4

Fertilizer Industry Data

Company Name Price as Shares Total Debt Revenue EPS Beta

at Dec 31, Outstanding (million PKR) (million PKR) (PKR)
2016 (PKR) (million)
Engro Fertilizer 67.98 1,330.9 36,461 69,537.3 7.0  
Fatima Fertilizer 36.9 2,100.0 34,964 33,764.6 4.7 0.91
Fauji Fertilizer Co. 104.4 1,272.2 54,368 75,377.9 9.4 0.86
Fauji Fertilizer Bin Qasim 51.2 934.1 66,740 49,222.2 1.0 1.04
Source: Bloomberg.

Exhibit 5

Capital Market Data and Other Related Information

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Source: Authors’ notes.

S0218927519500123.indd 327 06-04-20 2:16:59 PM

 328  ACRJ

Exhibit 6

Daily Market Price and Index Dataa

KSE 100 EFERT

16-Jan-14 26730.24 28.25
17-Jan-14 26913.85 29.66
20-Jan-14 27000.95 31.14
21-Jan-14 27104.70 32.69
22-Jan-14 27015.12 34.32
23-Jan-14 27064.34 36.03
24-Jan-14 27002.89 37.83
27-Jan-14 26670.60 39.72
28-Jan-14 26653.73 41.70
29-Jan-14 26595.63 43.78
30-Jan-14 26607.64 45.96
31-Jan-14 26784.34 48.25

1-Dec-16 42907.36 64.95

2-Dec-16 43270.90 65.53
5-Dec-16 43739.97 67.74
6-Dec-16 44199.40 68.51
7-Dec-16 44494.99 69.43
8-Dec-16 44741.98 66.70
9-Dec-16 45387.23 68.24
13-Dec-16 45857.89 67.95
14-Dec-16 46185.27 67.42
15-Dec-16 46358.35 66.73
16-Dec-16 46584.53 65.77
19-Dec-16 46938.59 65.58
20-Dec-16 47210.06 65.47
21-Dec-16 46993.31 65.04
22-Dec-16 46699.78 65.25
23-Dec-16 46633.99 65.41
26-Dec-16 46689.73 65.86
27-Dec-16 46920.47 66.22
28-Dec-16 47424.63 67.47
29-Dec-16 47666.66 68.29
30-Dec-16 47806.97 67.98

a
Complete data is available in the student Excel File.

Source: Bloomberg.

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 ENGRO FERTILIZERS LIMITED: COST OF CAPITAL AND VALUATION  329

Exhibit 7

Cost of Capital Estimation Report


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Source: Authors’ notes.

S0218927519500123.indd 329 06-04-20 2:17:00 PM

S0218927519500123.indd 330

330 ACRJ
Exhibit 8

Assumptions for Discounted Cash Flow Analysis

CY17F CY18F CY19F CY20F CY21F CY22F CY23F CY24F CY25F CY26F

Revenue growth 7% –1% 5% 3% 3% 3% 4% 3% 2% 2%

Gross margin 30% 31% 31% 31% 30% 30% 30% 29% 21% 18%
Operating margin 19% 20% 20% 19% 17% 17% 17% 17% 10% 8%
Tax rate 22% 24% 23% 24% 25% 25% 25% 24% 19% 14%
Dep & Amort/sales 2% 5% 4% 4% 3% 3% 3% 3% 2% 2%
Capex as % of sales 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%
Current assets/sales 48% 48% 48% 48% 48% 48% 48% 48% 48% 48%
Current liabilities/sales 52% 52% 52% 52% 52% 52% 52% 52% 52% 52%

Source: Authors’ notes.

06-04-20 2:17:00 PM