Saudi Arabian Fertilizer Co. -Equity Report -27-03-2018

Saudi Arabian Fertilizer Co. (SAFCO) disclosed its results for FY2017, which registered a decline of 3.4% YoY in revenue, attributed to a 13% drop in sales volume caused by the maintenance shutdown of some plants. However, recovery in urea prices during Q4 2017 helped to partially offset the effect of the drop in sales volume. Net profit for the period declined 15.2% YoY to SAR 879mn. This can be ascribed to an upsurge in fixed costs and depreciation & amortization expenses, driven by the amortization of shutdown and turnaround costs for the period.

SAFCO’s sales volumes are expected to recover in 2018 as capacity returns to normal levels. Additionally, steady dividend payouts with zero financial leverage ring well with investors. However, considering countervailing factors such as volatility in urea prices, the effect of subsidy removal on feedstock costs, and possible cash conservation ahead of an acquisition, we assign a ‘neutral’ rating to the stock, with a target price of SAR 65.6 per share.

Utilization rates to improve on fewer plant shutdowns
In FY2017, SAFCO’s utilization rates dropped to 87% (FY2016: 100%) as it halted operations at the SAFCO 4 turnaround enhancement reliability project for ammonia plant; it also scheduled a maintenance shutdown of SAFCO 5 plant. This had a negative bearing on the company’s operating margin, which declined by 4.6 percentage points to 29.9% in 2017. However, SAFCO’s management said there would be fewer plant shutdowns in 2018, including the shutdown of SAFCO 2 and SAFCO 3 facilities for seven and three days, respectively, during Q2 2018 and a 30-day maintenance scheduled for Ibn Al-Baytar plant during Q4 2018. Utilization rates should therefore recover to 95% with a recovery in sales volumes.

Urea price swings might lead to net income volatility
Urea prices are extremely volatile and highly dependent on Chinese exports, with major demand arising only from India. In December 2017 alone, urea prices declined 11.0% MoM, driven by excess supply, before rising 2.3% MoM in January due to a decline in Chinese production. This volatility in urea prices impacts SAFCO’s interim results; in Q2 2017, a 21% QoQ decline in urea prices caused a 19.7% QoQ drop in SAFCO’s top line. We believe these price swings would result in greater net income volatility as urea prices remain the key driver to SAFCO’s top line.

Steady dividend payouts bode well for investors, but uncertainties prevail
SAFCO maintained an average payout ratio of 87% over the past four years which has been captured by its share price movement. However, the management might shift its focus to growth and seek investments into new markets thereby hampering the dividend payments. Moreover, if SAFCO decides to use some of its cash in the Ibn Al-Baytar acquisition, dividend payouts might be impacted. Valuation: We valued SAFCOusing the DCF Approach to arrive at a fair value of SAR 65.6per share. We considered WACC at 8.6%, with a terminal growth rate of 2.0%.