• Another bad quarter, earnings well below consensus; reiterate Sell SAFCO’s 1Q2016 results showed further earnings deterioration, down to SAR286 million (-24% Q-o-Q, -52% Y-o-Y). While the weak results were broadly in-line with our estimates (+3.4% vs EFGe), the market is likely to be disappointed by these numbers as consensus earnings (ex-EFGe) missed by 17%. Overall, we remain bearish on nitrogen fertilisers and believe that SAFCO remains one of the more expensive names out there today. We estimate that SAFCO is trading at a 2016e P/E of c20x or on an even richer 24x based on annualised 1Q earnings. What’s more, we believe it is likely to cut dividends this year, which is likely to weigh heavily given that the market largely sees it as a dividend play. We reiterate our sell rating.
• Margins likely squeezed on weak prices and higher costs Operationally, gross profit and operating income saw a 25% decline Q-o-Q, despite higher volumes during the quarter (according to the earnings release), which we had expected. Full financial results have yet to be released, but we believe margins were likely squeezed considerably in the quarter on i) weaker nitrogen fertiliser prices (urea: -17% Q-o-Q, -34% Y-o-Y; Ammonia: -28% Q-o-Q, -35% Y-o-Y); and ii) higher feedstock costs (methane is priced at USD1.25/mmbtu versus USD0.75/mmbtu previously)
• Market oversupply is here to stay; expect weak earnings to continue The outlook for nitrogen fertilisers remains gloomy as the global market remains significantly oversupplied. Despite the easing in China's urea exports so far in 2016, we believe that ample supply remains in the system. Adding to this oversupply is new capacity coming from North America in the coming years. On the marginal cost level, coal-based producers in China have seen lower coal prices (-27% Y-o-Y), which has further weighed on urea prices. Hence, we believe that nitrogen fertiliser companies in MENA will face severe earnings pressure in 2016.

Ahmed Hazem Maher
Youssef Husseini