Time to sow?

Time to sow?

SPECIAL REPORT

Jitendra Kumar Gupta / Mumbai July 7, 2008, 0:36 IST

The latest policy announcement points to a positive beginning, which along with a demand-supply mismatch scenario and the aim to achieve food security should benefit domestic fertiliser companies.

Off late, fertiliser stocks, which were deserted by investors mainly due to the highly regulated environment, are once again in the news.

The fertiliser companies, which have underperformed the BSE Sensex over the last three years, have turned out to be outperformer in the last one year gaining 33 per cent as against the Sensex's decline of about 6 per cent. Even since mid-April 2008, most of the fertilizer company stocks have outperformed the Sensex.

Higher global inflation, rising agri-commodity prices and growing need for food security has led to an immediate need for increased supply of agriculture produce globally as well as in India.

This is also partly responsible for increase in fertiliser prices globally, which have gone up two-three times compared to a year ago. However, a major part of this increase in prices is due to the rising fuel (input) prices.

In India, which is among the largest consumer of fertiliser, the problems have compounded as there has been hardly any capacity addition in the last one decade.

As a result of this the country has to heavily depend on imports. However, with prices of the key inputs going up in overseas markets and selling price of fertilisers regulated, even imports became a difficult choice for the companies.

Typically, the difference between the selling price and the cost of production was paid as subsidy by the government. But this further led to increase in working capital for companies and a soaring subsidy bill for the government.

Also, it was considered that even after the payment of the subsidy, the companies were not making adequate profits due to the rising international prices.

In these contexts, the visible impact of these has been seen on demand for the fertilizer, which continues to outstrip the supply in the country thus, threatening to slow down the already paltry agriculture growth due to the non availability of the fertilises.

Meanwhile, fertiliser stocks have shown some strength, thanks to the markets expectation of concrete reforms for the sector.

The policy Though just a beginning, the government has approved the new fertiliser policy, wherein the domestic price of based on phosphorus and potash based fertilisers will be linked to import price parity.

Under the new scheme, the companies will be paid the difference based on the international prices and the domestic selling prices.

Industry experts say that if a company is importing phosphorous at $100 a tonne and the average international price worked out by the government is $120 a tone, then 65 per cent of savings of $20 will be paid to the companies by the government over and above their actual cost of $100.

This will largely benefit companies who have tie ups or raw material linkages. Thus, benefiting efficient players and leading to an improvement in their Return on equity (RoE).

Triggers ahead Besides these policy announcements, the industry is also expecting the urea policy to be declared soon.

"Currently the international urea prices are at about $725 per tonne and if add another $35-40 freight cost is added, then the landed cost works out to $760-770 per tonne. However, the cost of the domestic production of the urea is just about $240 per tonne, which is a huge difference," says Prakash Gaurav Goel, analyst at ICICI Securities.

Though this difference exists in the prices, lack of sufficient capacities is forcing companies to import; also, there is no clarity or concrete policy that will promote investments in new capacity, which takes about two to three years.

Experts say that the new policy should aim at new investments in the country by way of fiscal incentives and the tax benefits.

Meanwhile, urea companies should be allowed to produce beyond 110 per cent of their installed capacities, without prior approval from the government. Also, the incremental production should be linked to import parity prices, resulting in better ROE for the companies.

Also, as the industry has been given priority status with regards supply of gas availability, it stands to gain. According to the industry estimates, the new supply of gas is expected to at about 40 mmscmd from Reliance Industries' KG Basin, which is expected to start in the second half of 2008.

This will be further increase to 80 mmscmd in 2009 and peak at around 160 mmscmd by 2010. The increased availability of natural gas will ensure uninterrupted supply as well as help companies to increase capacity utilisations and avail incentives linked with higher capacity utilisations.

While the benefits of cheaper gas will have to be passed on, companies will gain from prospective investments (including de-bottlenecking of existing plants) into fresh capacities.

Currently, the fuel input being used as feed stocks is mixed with a part of this being liquid fuel (costs about $11 per mmbtu) as against RIL's gas, which is expected to cost $6.3 mmbtu. Companies in perspective Considering these developments, many believe that the need of the hour is to undertake further reforms and initiate policies which will promote long term investments in the sector, address the pricing issues of the DAP, Urea as well as ensure availability of cheaper feed-stocks.

If the sector undergoes significant changes as desired, it will not only help the companies, farmers and the government, but it will also reward the company's shareholders in the form of higher stock returns. DEBOTTLENECKING CAPACITIES Company Urea capacity (MTPA) Debottlenecking expected Capex (Rs crore) Inc in PAT (Rs crore) Chambal Fertiliser 2 By April '09; capacity to rise by 0.14mtpa 300 58 RCF 2 By October '09; capacity to rise by 0.3 mtpa 450 106 Nagarjuna Fertiliser 1.4 By October '09; capacity to rise by 0.2 mtpa 200 90 Tata Chemical 1 By October '08; capacity to rise by 0.2 mtpa 150 95 Source: Company, I-Sec Research, Note: mtpa is million tonne per annum

Meanwhile, here are four stocks that may be considered for investment, which not only have decent growth prospects but also offer good dividend yields.

Chambal Fertilisers & Chemicals Chambal Fertilisers is the largest private sector manufacturer of Urea in India with an installed capacity of 1.73 million tonne per annum. Analysts believe that Chambal Fertilisers could benefit on the back of earnings from debottlenecking and improvement in energy costs.

As per estimates, the ongoing de-bottlenecking at Chambal's facilities of about 0.14 million tonne of capacity could add another Rs 58 crore to its bottom line as against the whole year profit of Rs 132.1 crore in FY08.

Also, if the much awaited policy on Urea is announced and the pricing is based on the import price parity then the company will benefit; it may also go in for further debottlenecking that may increase its capacities by another 20 per cent.

Analysts say that assuming a 90 per cent import parity price of $452 a tonne, these moves can add about Rs. 3.5 per share to the current EPS of Rs 4.5 per share.

Besides, the company will also benefit out of its joint venture with IMACID, where it holds 33.3 per cent. IMACID manufacturers phosphoric acid (raw material used for producing diammonium phosphate or DAP). The prices of phosphoric acid have gone up significantly from about $400 to about $1,400 per tonne over the last one year. This should help improve realisations and also contribute by way of higher income to the consolidated profits of Chambal Fertilisers.

On the basis of the estimated sales and net profits of IMACID in FY09, the addition to Chambal Fertiliser's EPS works out to Rs 2.2 as against Re 0.6 in FY07. Overall, considering these facts, the consolidated EPS of the company works out to Rs 10.5 in FY09 as compared to Rs 3.1 per share in FY08.

In the long run, the receipt of approval for its 2,600 mw power plant is also positive. At Rs 63.95, the stock trades at 6.1 times its estimated FY09 consolidated earnings. HOW THEY COMPARE Rs Crore 2008 2008 2008 PE (x) Dividend Yield (%) Net sales % chg Net profit % chg OPM (%) Price (Rs) Aries Agro 103.4 39.6 11.2 32.1 18.4 86.3 10 1.4 Madras Fert. 1140.1 -5.8 -134.9 17.5 -1.12 2756.1 - - Mangalore Chem. 1623 18.4 40.9 48.9 5.54 19.2 5.6 - R C F 5140.3 47.4 158.2 6.3 7.48 47.9 16.7 2.1 Natl. Fertilizer 4140.6 7.1 108.7 -38.3 6.32 53.9 24.3 1.2 Coromandel Fert. 3757.3 81.9 209.8 108.2 12.12 118.9 7.9 2.9 Zuari Industries 2618 9.2 73.4 -81.3 6.05 234.8 9.4 1.3 Tata Chemicals 4075.6 2.3 949.2 113.7 32.34 278 6.9 3.2 GSFC 3557.7 7.2 238.5 -10.7 15.33 146.1 4.9 3.1 GNFC 3433.9 25.4 372.9 14.2 20.02 114.6 4.8 3.7 Deepak Fertilser 1040.9 24.9 100.3 7.9 20.38 85.6 7.5 4.1 Chambal Fertiliser 2720.1 5 203.8 16.1 20.03 64 13.1 2.8 Nagarjuna Fertilser 2193.6 20.8 22.5 -29.1 14.74 31.2 59.4 - Oswal Chemical 629 230.4 249.8 156.5 44.54 180.3 18.5 - Source: BS Research. Note: % ch is over 2007.

Coromandel Fertilisers Coromandel Fertilisers, a leading player in the domestic fertiliser sector producing complex fertilisers including DAP, will also be a key beneficiary of the new policy.

As the company imports almost 90 per cent of its raw material requirement, the benefits of import price parity would directly reflect in its margins and higher RoE going forward.

The company has taken several strategic initiatives to optimise its cost structure. It has in the past secured sourcing of key raw materials such as rock phosphate by acquiring stakes in large global suppliers like Foskor, a leading global manufacturer of phosphoric acid.

Besides, the company has been investing to grow inorganically, where it has completed several acquisitions including EID Parry's farm inputs division, Godavari Fertilisers (phosphate producer) and pesticide maker Ficom Organics. This has not only helped the company to scale up its business and diversify, but also enhanced its distribution network in the country.

Meanwhile, the company is increasing its phosphate capacity to 3.3 million tonnes by 2009 as against the current capacity of 2.5 million tonne. The benefits of this will also be reflected in better efficiency due to economies of scale and higher volumes.

Put together, the strategic steps, growth initiatives, thrust on increasing margins and volumes coupled with favourable policy on DAP, will drive the future growth and in a more profitable manner. At Rs 118.9, the stock is trading at 5.4 times its FY09 estimated earnings.

Gujarat State Fertilizers & Chemicals Gujarat State Fertilizers and Chemicals (GSFC) is more diversified player and generates a part of its revenue from value added chemicals that enjoy operating margins between 15-40 per cent. Its fertiliser business accounts for 65 per cent of revenues and has wide product basket with exposure to Urea, DAP and so on.

GSFC is the second-largest DAP producer in India and would be the key beneficiary of the recent policy announcement. For it's DAP capacities, the company has secured supply of phosphoric acid from its joint venture with JCT, Tunisia.

This will not only increase the utilisation, but also help improve margins in the light of new policy. Also, as gas availability improves, it should lead to higher the utilisation of about 110 per cent, thus benefiting from import parity pricing.

The company is also the country's largest producer of caprolactum, a critical industrial chemical used in textile yarn, tyre cord and as specialty chemicals for the textiles and leather industries.

Accounting for about 80 per cent of total revenues of the chemicals division, contribution of the caprolactum business should rise as the company plans to expand its capacity of 70,000 tonne per annum to 120,000 tonne per annum by setting fresh capacities.

Additionally, the company is debottlenecking its existing caprolactum capacities by about 10 per cent at a cost of Rs 100 crore. The benefits of these expansions will be visible post FY10. Meanwhile the benefits of debottlenecking and the cheaper availability of the gas would drive growth. The stock is currently trading at 3.6 times its FY09 estimated earnings. Tata Chemicals Tata Chemicals generates about 46 per cent of its revenue from fertilisers, which includes urea and complex fertilisers, while the rest is contributed by other chemicals products and edible salt (non fertiliser division).

The company is taking organic and inorganic initiatives, which should result in higher growth in the years to come. It recently acquired General Chemical Industrial Products Inc (GCIP) in the USA for a consideration of $1 billion.

With this acquisition, the company has emerged as the world's second largest soda ash company with a global market share of 35 per cent (in soda ash) and an enhanced annual capacity of 5.5 million tonne.

Through GCIP, Tata Chemicals will now be able to tap new markets including Latin America for its existing products. GCIP's estimated turnover is about $375mn (about Rs 1,600 crore).

Besides, Tata Chemicals is expected to scale up DAP utilisation (currently at 50 per cent) as the availability of phosphorus is increasing on the back of its stake in Indo Maroc Phosphore S.A. (IMACID), Morocco, where it has acquired a strategic equity stake of 33.3 per cent (Chambal Fertilisers is also a partner in this joint venture).

The stock is currently trading at attractive valuations of 8 times its expected consolidated FY09 earnings and 6.4 times of FY10 earnings.