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Reform of subsidy system bodes well for fertiliser sector stocks

Reform of subsidy system bodes well for fertiliser sector stocks

The Cabinet Committee on Economic Affairs on Thursday approved a urea investment policy that is likely to incentivise fertiliser firms to set up new plants and expand existing capacity. We take a look at a few fertiliser stocks that you can bet on.

Your recent investments in fertiliser stocks may not have borne the desired fruit. Out of 21 fertiliser companies listed on the Bombay Stock Exchange, 14 have given negative returns this financial year.

Between April 1 and October 31, stocks of companies that make nitrogen-based fertilisers tanked the most. Zuari Global, for instance, fell 76 per cent to Rs 121, followed by Southern Petrochemicals Industries Corporation (16 per cent to Rs 15), Gujarat State Fertilizer and Chemicals (15 per cent to Rs 74) and Chambal Fertilisers and Chemicals (13.5 per cent to Rs 67). Urea is the most commonly used nitrogenous fertiliser.

The profit of 11 fertiliser companies that had declared their second-quarter results till October 31 fell 21 per cent in April-September from the year-ago period.

One big reason for the industry's troubles is subsidised pricing of nitrogen-based fertilisers, which account for 51 per cent of the global fertiliser market. Though the companies are compensated for these losses by the central government, late payments often affect operations. Zuari Global, Coromandel International and Tata Chemicals are some of India's biggest urea producers.

There was some relief for the industry after the Cabinet Committee on Economic Affairs gave its nod to an increase of Rs 50 per tonne (less than 1 per cent) in the retail price of urea in the second week of October. The industry says this is not sufficient to improve sentiment about their stocks.

"This is a token effort by a government that wanted to seem like acting on reforms and fiscal deficit fronts but is bound by political compulsions on this issue," says Ravindra Rao, head, commodities, Motilal Oswal Securities.

The government's move to increase urea prices will reduce its fertiliser subsidy bill.

AK Prabhakar, senior vice president, equity research, Anand Rathi Financial Services, says, "This is just an incentive for retailers but shows some hope of a price increase."

CHALLENGES

Highly Regulated: The sector depends on the government to make up for losses due to subsidised pricing.

"Payment delays can block productive working capital of fertiliser companies, which can reduce the return on equity," says Rao of Motilal Oswal Securities.

25 per cent
is the fall in the market capitalisation of Gujarat State Fertilizers & Chemicals in the one year till 6 November 2012.

"Since it is a subsidy-driven industry, the stock performance tends to be price-sensitive. Agricultural commodity prices and global demand-supply situation also have a bearing on the sector," says Prabhakar of Anand Rathi.

Rising input cost: India depends on imports for phosphatic (P) and potassic (K) raw materials for making P&K fertilisers, except Single Super Phosphate, where half the rock phosphate used as raw material is from domestic sources. In urea, close to two-thirds raw material used is produced in India.

Experts say the sector is facing higher input costs due to currency fluctuation and lower demand on account of extreme climatic conditions. The rupee has fallen 7 per cent since the start of the financial year. It was at 54.12 on October 31 as against 50.56 on April 3. In 2011-12, urea consumption in India was 29 million tonnes compared to 28.2 million tonnes a year ago. Imports were 7.83 million tonnes in 2011-12 and 6.6 million tonnes in the year before that.

OPPORTUNITIES

Prices of P&K fertilisers have been decontrolled. The two were brought under the nutrient-based subsidy (NBS) scheme in April 2010. Under the NBS, the government fixes subsidy based on nutrient content. Companies are paid a fixed amount for each nutrient, irrespective of the production cost. But prices of nitrogenous urea are yet to be decontrolled.

The price of Di-Ammonium Phosphate (DAP) rose from Rs 18,200 a tonne before April 2012 to Rs 24,000 a tonne in June this year. DAP was at Rs 17,200 per tonne in the second half of 2011 compared to Rs 9,920 per tonne in the year-ago period. Likewise, prices of muriate of potash, which were Rs 4,440 per tonne in 2010, rose to Rs 11,300 per tonne in 2011. In June 2012, they were at Rs 16,800 a tonne.

S Ranganathan, head of research, LKP Securities, says, "We believe that urea companies with large operations, raw material linkages and operational efficiencies will benefit from the NBS scheme."

INVESTMENT OPTIONS

In contrast to urea makers, stocks of non-nitrogenbased fertiliser firms Bharat Agri Fert & Realty and Liberty Phosphate rose over 140 per cent each to Rs 121 and Rs 172, respectively, in April-October. The reason was a spike in prices of P&K in the global markets.

75 per cent
is the fall in the price of Zuari Global stock between April 1 and October 31.

However, experts are not bullish on these stocks, as they have already risen sharply.

Ranganathan of LKP says, "We used to fancy Liberty Phosphate, but after the recent rise, it is fairly valued."

Here are a few stocks you can bet on.

Gujarat State Fertilizers & Chemicals (GSFC):

GSFC is the largest producer of caprolactam-used to make nylon-in India, with a capacity to make 70,000 million tonnes annually, followed by Fertilisers & Chemicals Travancore with 50,000 million tonnes.

Despite regulations, it has managed to keep operating profit margin above 13 per cent and net margin above 7 per cent for the last seven years.

"Phosphoric acid from the Tunisian Indian Fertiliser (TIFERT) joint venture (0.18 million tonnes per annum) is likely to flow from the third quarter of 2012-13. This will increase the proportion of manufactured products and hence margins. Most negatives have been priced in. We expect improvement from the fourth quarter of 2012-13. Any correction is an opportunity to accumulate the stock," says Prabhakar of Anand Rathi Financial Services.

TIFERT is a joint venture between India's Coromandel and GSFC and Tunisia's Groupe Chimique Tunisian and Campagnie Des Phosphate De Gafsa.

In the September quarter, GSFC registered net sales of Rs 1,416 crore, up 121 per cent from Rs 1,264 crore in the corresponding quarter a year ago. However, operating profit fell 28 per cent to Rs 2,485 crore, compared to Rs 347 crore in the same quarter last year. On November 1, the stock was at Rs 74.45, with a price-toearnings, or PE, ratio of 4.10.

Tata Chemicals:

"Tata Chemicals is trading at moderately attractive valuations and can be bought on declines," says Alex Mathews, head of research, Geojit BNP Paribas Financial Services. The stock has fallen 8 per cent since the start of 2012-13 and was at Rs 316 on October 31 as against Rs 344 on April 2. The return on equity is 11.69 per cent, the operating profit margin is 10.41 per cent, while the PE ratio is 11.09. In the past one year, the market capitalisation of the company has plunged 3.35 per cent to Rs 8,123 crore on 6 November 2012 against Rs 8,404 crore on 8 November 2011.

Coromandel International:

This has been a challenging year for the company due to disruption in supply of phosphoric acid on account of civil unrest in Tunisia and operational issues at South Africa's Foskor, in which it has a stake. The stock has risen 0.3 per cent since April. It was at Rs 282 on October 31.

Experts say the stock may bounce back in the next financial year as it is trading at a reasonable 10 times 2012-13 and 2013-14 estimated earnings. Coromandel is the most economical producer of complex fertilisers in India with a 28 per cent return on equity, the highest among peers.

Ranganathan of LKP Securities says, "Coromandel's strategy of increasing its share of the non-fertiliser business will help it reduce regulatory dependence. It has turned around its subsidiary, Sabero Organics, and we expect the Kakinada expansion to go on stream in the third quarter of the financial year."

Edelweiss Institutional Equities said on October 23 the stock could touch Rs 367 in the next few quarters in anticipation of a rise in demand for fertilisers in the upcoming rabi season.

Commissioning of new fertiliser and TIFERT facilities in the third quarter of 2012-13, turnaround of Sabero, a subsidiary, and strong growth in the non-subsidy business will be the growth drivers in 2013-14.

The company posted a net profit of Rs 233 crore in the quarter ended September, down 16 per cent from Rs 278 crore in the same period a year ago.

Gujarat Narmada Valley Fertilizers & Chemicals (GNGC):

During the September quarter, the company posted a net profit of Rs 72 crore, down 10.5 per cent from Rs 80 crore in the same period a year ago. However, net sales rose 14 per cent to Rs 1,165 crore from Rs 1,021 crore in the same period a year ago.

According to an Emkay Global Financial Services report on November 6, GNFC has been on an expansion drive by spending close to Rs 4,000 crore over the last couple of years. The capital expenditure plan is likely to be completed by the end of 2013-14.

The TDI project, with a capital expenditure of Rs 2,000 crore, is likely to be completed by March 2013 and generate incremental revenue of Rs 800 crore and a profit of Rs 100 crore. The stock can touch Rs 105 in the next few quarters. On November 6, it was at Rs 82, with a PE ratio of 4.82.