We reiterate our ‘Buy’ stance on Engro Corporation (ENGRO) with a Dec-2024 Target Price (TP) of Rs490/share, offering a potential upside of 63%. Our liking for ENGRO primarily stems from (1) anticipation of potential special dividend through the sale of its Thermal Energy portfolio, (2) likely implementation of Weighted Average Cost of Gas (WACOG) to benefit EFERT, (3) expanding Enfrashare (Tower) business along with declining interest rates to enhance profitability, and (4) anticipated resurgence of construction activities leading to an increase in EPCL earnings.

Potential one-time special dividend: ENGRO has entered into discussions with Liberty Power to reduce its exposure to thermal energy assets, which includes Engro Powergen Qadirpur (EPQL), Engro Powergen Thar Limited (EPTL), and Sindh Engro Coal Mining Company (SECMC).

Based on our channel checks, ENGRO plans to sell most of its stake in thermal assets for a cash consideration of around Rs30-40bn. The net cash inflows after tax would be Rs26bn (Rs48/share) as per our estimates. Assuming no major projects and a recent history of paying all excess cash as dividends, we anticipate ENGRO announcing a one-time special dividend of Rs45/share in 2025, bringing the total dividend to Rs91/share for the year.

Implementing WACOG to benefit EFERT: EFERT is poised to emerge as the primary beneficiary of implementing the WACOG mechanism. EFERT is currently being charged US$5.6/mmbtu (Rs1,600/mmbtu) under Petroleum Policy 2012 (PP-12) on the feed gas at its base plant, which accounts for ~40% of its total urea production compared to other fertilizer players at US$2/mmbtu (Rs580/mmbtu).

Since EFERT is already procuring ~40% of its total gas required in feed gas at higher rates, following the increase in Urea price post-WACOG implementation, which is in line with other players, EFERT is expected to have a positive impact of Rs6/share on its bottom line.

Tower expansion & expected decline in interest rates to revive Enfrashare’s profitability: The business has progressed well in the last 5-years, with its portfolio of 4,000 towers by the end of 2023. Going forward, ENGRO plans to extend its tower network by addition of around 750 towers every year, aiming to reach around 8,000+ towers by the end of 2028 with a tenancy ratio of 1.2-1.25x.

Due to record high interest rates Enfrashare is expected to post a loss of Rs1.7bn in 2023. However, with expectation of decline in average 6-month KIBOR from 21.6% in 2023 to 18.7% in 2024 and 17% in 2025, we expect the segment’s losses to decrease to Rs0.1bn in 2024, turning into profits of Rs1bn in 2025 and Rs3.6bn in 2026.

Revival of construction activities will lead to an Increase in PVC sales: In anticipation of a decline in interest rates in 2024, we envisage a pickup in construction activities, leading to an increase in PVC demand. We expect EPCL’s PVC sales to increase at a 5-year (2022-2026) CAGR of 5% to 285k tons. The current annual capacity of PVC is 295K tons. However, per our discussion with the management, the site can increase production to 400K tons by incurring optimal capex.

Attractive valuation: Our Dividend Discount Model (DDM) based TP of Rs490/share offers a potential upside of 63%. We have assumed WACOG implementation from July 2024. If that doesn’t happen, Engro still remains a Buy with a TP of Rs430/share, a 43% upside.

ENGRO, on its SOTP value of Rs495/share, is trading at a discount of 39% compared to the last 5-year average of 29%. We expect this to reduce as the company makes progress to unlock value and announce a cash dividend.

Moreover, Engro has an attractive estimated dividend yield of 20% for 2024 and 31% for 2025, which is far higher than our universe dividend yield of 10% for 2024 and 12% for 2025. ENGRO is currently trading at 2023E/2024F PE of 4.8x and 4.0x vs. last 5-year and 10-year average PE of 8.4x and 10.9x, respectively.

Key Risks: (1) Higher than expected delays in conclusion of divestment of majority stake in Thermal Energy Assets, (2) delays in WACOG implementation, (3) significant drop in international Urea price, (4) lower than expected decline in interest rates. These risks may not impact the current base performance but rather dent the potential upside mentioned.

Courtesy – Topline Pakistan Research