HSBC expects fertiliser producers in Gulf to record healthy margins
The low-cost fertiliser producers – including those based in the Gulf – should generate healthy margins in a depressed energy price environment, said HSBC.
To assess new market supply for urea, the HSBC report said the bulk of supply is coming on stream in the Middle East (11.2mtpa) and China (15mtpa), from 2009 to 2012.
HSBC believes new supply from the Middle East will hit the market as planned despite the news of project delays. The fertiliser sector has not escaped recent global economic and financial turmoil as demand and use dropped in the fourth quarter. This trend is likely to persist through 2009 but it could rebound strongly towards year-end, said the bank research.
HSBC forecast in an industry-focused report that fertiliser demand would come under pressure as credit conditions for farmers in the West become tighter.
However, contrary to consensus expectations, it is the Asian consumer that is the key demand determinant for nitrogen fertiliser.
Following highly volatile financial markets and economic slowdown in September and October 2008, the volume of fertiliser trade slowed tremendously, and the sudden lack of demand drove both nitrogen and phosphate prices down by 70 per cent. Potash held firm, maintaining spot prices at levels close to summer 2008 highs, but with almost no volumes traded at all.
The report projected that the weighted global fertiliser volumes will fall by 0.9 per cent in 2009, led by a 12.1 per cent drop in potash, and weak growth in nitrogen and phosphate demand, which the bank expects to be only 1.2 per cent and 1.9 per cent year-on-year, respectively.
This contrasts with historical growth rates of 3.0 per cent for all three nutrients.
An extreme example of the widespread drop in demand is Latin America, dominated by Brazilian agriculture, where usage in December 2008 fell by 37 per cent.
According to IFA data, the largest share of nitrogen fertiliser is consumed by Asia (68 per cent), with China and India alone accounting for 46 per cent of 2007 demand; the United States and Europe jointly consumed a much lower share.
The World Fertiliser Organisation estimates that by 2012, East Asia and South Asia will account for larger shares of 34.2 per cent and 30.5 per cent, respectively, of the change in world nitrogen fertiliser consumption, versus falls of 2.0 per cent and for Western Europe and 3.0 per cent for North America.
Due to high oil prices, prices of staple food increased across the globe which resulted in riots and protests in Asian, Africa and Middle Eastern countries.
The report, however, projected that the stage is set for a return of nutrient demand towards end-2009 as Latam farmers regain their financial footing and Asian food demand remains relatively unhurt by the global downturn.
Nitrogen stocks may rally in the near term following a sharp urea price recovery.
As soft commodity prices fell, farmers became more cautious in their use of high-priced nutrients. The lack of credit available to Brazilian farmers intensified this trend in Latin America. Volumes for nitrogen, phosphates and potash have weakened, as have prices, with the exception of potash.
The fertiliser stocks have fallen by 30.6 per cent to 67.4 per cent over the past five months, following deflation of asset prices, investors shifting out of commodity-linked companies and shortening investment horizons, HSBC said in the report. Inventory de-stocking and farmer caution lead to expected volume contraction of 0.9 per cent in 2009.
Inventory de-stocking and perceived risks to farmer profit margins have driven the fertiliser industry into a period of high uncertainty and low short-term visibility.
According to the estimates by Food and Agriculture Organisation of United Nations, there are 963 million malnourished people in the world as the last year saw an increase of 40 million. "This signifies that right now there are almost one billion who are hungry, out of the 6.5 billion who make up the world population," the agency said.
The UN body called for an investment of $30 billion (Dh110.1bn) per year in agriculture of developing countries to double food production by 2050 and ensure the basic right to food for all people.
HSBC believes that economic downturn has only moderate impact on food demand. However, investors fear that current economic distress could change consumers' nutritional habits. If there is less money to go around, perhaps consumption of "luxury" animal protein will fall in Asia, causing demand to drop for grain for animal feed for pigs, cattle and poultry, with a knock-on effect for fertiliser demand.
Although a drop in protein consumption was recorded during the Asian financial crisis of 1997, HSBC does not believe this will be the case in 2009.
The economic contraction expected in Asia (with the greatest impact on marginal food and fertiliser consumption) in 2008-2009 should not be as large as in 1997-98, and in the intervening decade, prosperity and better diets have reached more people than ever before. The higher proportion of Asians involved in the trend of increasing prosperity give Asia more stability in the face of economic challenges. Asian demand for food should continue to be a driving force for greater agricultural production, providing a strong underpinning for global fertiliser demand.
Based its views that demand for fertiliser will rise to feed the growing population with more and better food, HSBC thinks this trend is intact, even in the global economic downturn.
The classic case for higher fertiliser use centres on people in emerging markets eating greater quantities of higher-quality food; specifically, the focus was on greater animal protein consumption in Asia.
A kilo of animal protein needs a higher amount of animal feed to produce it, further accelerating the amount of grain required to feed Asia's population.
In examining the effect of economic malaise on food consumption, the market tends to make direct comparisons between the Asian financial crisis of 1997 and today. Indeed, in 1997-1998, a decrease in the amount of meat consumed was recorded, implying that a similar drop could occur as a result of the current difficulties. However, HSBC believes the comparison between Asia of 1997 and 2008-2009 to be inappropriate.
To begin with, the economic contraction expected in Asia in 2008-2009 should not be as large as in 1997-98. During these years, a dramatic destruction of wealth occurred, while in 2008-2009, Asia is experiencing a relatively moderate slowdown rather than a complete crash.
In the intervening decade, the Asian economies have expanded significantly, spreading more prosperity to more people than ever before.
According to HSBC's Asian economics team, the regular consumption of 'luxury' protein may have been limited to an estimated 1 per cent of a nation's population in 1997-1998; but given economic improvements since then, perhaps 10 per cent to 15 per cent of people in a given country may now be regular consumers.
Annual symposium in Abu Dhabi
The second annual Middle East Fertiliser Symposium will be held in Abu Dhabi from March 2 to March 5, which will discuss the challenges facing the industry due to the financial crisis.
With the competitive advantage of low-cost feedstock, the Middle East fertiliser industry is in an advantageous position to grow and develop; however, political, health, safety and environmental concerns pose significant challenges.
Key topics to be discussed at the meeting include challenges for regional producers and future scope for expansion; assessing the evolving horizon of the Middle East fertiliser sector; feedstock and raw materials: impact on the region's fertiliser sector; fertiliser plant operations – overcoming HSE, maintenance and efficiency challenges; financing options for expansion projects in the Middle East; technologies for the Middle Eastern market and project expansions.
How and where it will hit
The share value of Orascom Construction Industries (OCI) has lost 22 per cent year to date.
HSBC believes positive industry developments have yet to be reflected in the market, as urea prices have risen by more than 60 per cent due to strong demand.
HSBC has rated OCI stock as overweight with a target price of EGP305. It said the key company-specific downside risk is that the Egyptian Government may opt to impose a levy on exports, as an indirect way of recouping money on its low gas selling price.
Arab Potash Company: High exposure to contract business means global volume downturn has had only a minor impact on APC's potash sales. Contractor delays may push out capacity expansion from H2 2009 to 2010.
HSBC reduced 2009 production forecast by 225kt. It also reduced target price from JOD95 to JOD64 per share, and reiterating Overweight rating on the stock.
Jordan Phosphate Mines: HSBC expects inventory write-downs as key inputs were down 85 per cent in the fourth quarter whereas producers have been unable to pass through costs. JPMC is relatively well positioned among global peers; margins are intact but absolute returns could suffer. HSBC has cut target price from JOD42.0 to JOD21.8 but has raised rating from underweight to neutral.
Industries Qatar: Industries Qatar's fertiliser business, Qafco, continues to generate strong earnings across its varied businesses, despite a challenging economic environment and depressed crude prices.
With its strong profitability profile and cost advantages over its peers, HSBC thinks first quarter is well positioned to navigate near-term earnings and product price weakness. It reiterated overweight rating and target price of QAR108.
Saudi Arabian Fertiliser Company: Fundamentals remain positive over the medium to long term despite near-term challenges for this virtual pure-play, urea-based fertiliser company. Low-cost producers such as Safco should still generate healthy margins in a depressed energy price environment. HSBC reiterated target price of SAR110 and neutral rating.
Gubretas: The company is still the largest by sales turnover and most profitable listed fertiliser play in Turkey. But it has been caught with high gearing during the global liquidity turmoil and HSBC expects currency losses and interest expenses to weigh on 2009 results.
The bank takes a more cautious stance given potential balance-sheet risks and downgrades it to neutral from overweight with a target price of TRY6.7.
Tekfen Holding: Tekfen's market leader, Toros, will take a hit from falling worldwide prices and weak demand; we forecast the fertiliser segment's contribution to profit will fall to 39 per cent in 2009 from 73 per cent in 2008.
HSBC views a price upturn as the key potential catalyst for a re-rating of the business, most likely from H2 2009.
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