LAHORE: Escalating cost of inputs may push urea price to new highs as an onerous taxation regime has already eroded the profitability of the sector. According to an analysis, in the event of a rise in gas costs, which is very much likely or a move toward reforming tariff structure by adopting weighted average cost of gas (WACOG), further urea price increases cannot be ruled out. Introduction of WACOG aims at curtailing gas circular debt. The proposed WACOG reform envisages allowing Oil & Gas Regulatory Authority (OGRA) to charge weighted average on cost of indigenous gas and imported re-gasified liquefied natural gas (RLNG) to consumers. It may be noted that output tax on the fertiliser sector has been made exempt making input tax a part of cost as per the Finance Act 2022. This will increase manufacturing costs for the sector and will reflect in financials from 3QCY22 onwards. Companies have already passed on the impact of the aforementioned by increasing urea prices during the outgoing month taking the retail price of urea to around Rs2,200/bag with Rs350/bag plus increase. “The capacity of fertiliser manufacturers to pass on cost pressures will be crucial, given the government’s pushback on urea prices, the last time the sector went for a price increase,” said Muhammad Waqas Ghani of JS Research. Going forward, he added, changes in the sector's gas pricing were expected where in the event of an increase in gas costs or move toward WACOG, “we do not rule out further price increases”. “The pricing power of fertiliser manufacturers to pass on cost pressures will be crucial,” Ghani observed. On the other hand, he said, the profitability for the big three fertiliser companies declined by 54 percent YoY in 2QCY22, primarily due to higher tax charge and exchange loss on foreign payables. “Dubbed as Super Tax, the one-time high tax charge of 10 percent on CY21 earnings wiped out 50 percent of the earnings this quarter, and is not a recurring event,” Ghani explained. Owing to such a dismal scenario, Fauji Fertilizer Company Limited (FFC), Engro Fertilizers Limited (EFERT), and Fauji Fertilizer Bin Qasim Limited (FFBL) witnessed a decline in earnings, Ghani stated. “It is being seen that despite increasing fertiliser prices and stable offtake during the quarter, the three companies reported a significant drop in profits mainly due to the imposition of Super tax. Recall that in the Federal Budget FY23, the sector was subjected to a 10 percent Super Tax on its CY21 income and a 4 percent tax on income from CY22 onward, resulting in a one-time higher tax charge in 2QCY22.” Ghani continued to say that FFC had reported unconsolidated earnings of Rs2.64/share, a decrease of 7 percent YoY. “The result is broadly consistent with our projections. The company's top-line for 2QCY22 came in at Rs28.4 billion, while gross margins at 41 percent on the back of higher urea prices and better margins in the DAP business. Similarly, Engro Fertilizers Limited (EFERT) posted a loss of Rs98 million (LPS of Rs0.07) during 2QCY22 vis-à-vis PAT of Rs4.8 billion (EPS of Rs3.57) in 2QCY21. The company showed a slight increase of 1ppt QoQ at the gross margin level in 2QCY22, mainly due to better retention prices. Finance cost for the quarter came in higher due to higher interest rates. The company also booked higher other expenses owing to exchange loss on DAP shipments to the tune of Rs700 million. Higher tax charges were however the biggest culprit. The Board of EFERT did not announce any dividend for the quarter, he maintained. Fauji Fertilizer Bin Qasim (FFBL) posted 2QCY22 unconsolidated earnings of Rs1.8 billion (EPS: Rs1.38), down 32 percent YoY due to the implication of Rs2.7 billion Super Tax charge. On a YoY/QoQ basis, finance cost increased by 49 percent/28 percent in tandem with rising interest rates. Other income clocked in 31 percent YoY higher at Rs3.2 billion mainly due to dividend from PMP Morocco.