Degree of operating leverage (DOL)
The DOL is derived by dividing the percentage change in operating profits by the percentage change in revenues.
DOL = % change in EBIT/% change in revenues
In the fiscal year 2021/22, Abu Qir’s revenues increased to EGP 16.3 billion, compared to EGP 8.8 billion in the previous year, an increase of around 85%.
However, operating profits (that is, excluding financing expenses and taxes) increased by 165% during the same period, from EGP 4.4 billion to EGP 11.7 billion, almost double the change in revenues.
DOL = 165%/85% = 1.95x
The number 1.95x (or about 2 times) means that whenever Abu Qir’s revenues reach 10%, operating profits reach approximately 20%, and vice versa of course.
Until last September, Abu Qir had a fixed cost for natural gas regardless of the price of the final product.
However, in September 2022, the government decided to switch to using an equation to link the price of gas supplied by GASCO to the price of a ton of urea (chemical) with a minimum of $4.5 per million BTU in the event of a drop in the price of urea.
Implications
This means that DOL has become asymmetric in the sense that it is low in times of rising prices (which is not good for the investor) and high in the case of a sharp drop in prices due to the existence of a lower gas price (which is not good for the investor as well).
To simplify, this means that if Abu Qir’s revenues increased by 50% in the current fiscal year, for example, operating profits could increase by 60% only, but if revenues decreased by 50%, operating profits could decrease by 70 or 80%, and this is for example only.
For that reason, a decline in urea prices globally will exaggerate the impact on the share price as investors fear a sharp decline in profits as a result of the rise in DOL.
This was not written by Thndr and this is not investment advice, you should do your own research before making investment decisions.
