Fertilisers Industry – Mar 2012 Quarter Preview

The Dec 2011 quarter was a major disappointment for the fertilisers sector. Despite reporting a 32 per cent (YoY) rise in the topline, the bottomline performance of the 27 companies analysed by us was seen under tremendous pressure, declining by 23 per cent owing to the rise in borrowing costs, soaring input prices and sharp rupee depreciation. While globally, the prices of fertilisers like Di-ammonium Phosphate (DAP) and Muriate of Potash (MOP) have shown a declining trend over the past couple of months and the rupee has also gained some ground against the dollar, the scenario for our domestic fertiliser companies is far from positive.

As a result of the vast difference between the prevailing domestic prices of nitrogen-based urea fertilisers and other NPK variants, including DAP and MOP, Indian farmers have switched to using urea as a chief source of nutrients for crop cultivation. This has significantly affected the demand for complex fertilisers, and subsequently led to a pile up of inventory on the books of the manufacturers. In an earlier update, we had raised caution on the inventory pile up and its ill-effects on the fertiliser companies’ financial performance in the quarters to come. You can read more on this in our previous article (Massive Stock Pile-Up Indicates Towards Fading Fertilizer Demand Scenario – dated Feb 28, 2012 ).

Moving on, this dismal trend is expected to be carried into the Mar 2012 quarter results. While the cyclical nature of the sector can be an evident reason for witnessing a poor quarter, the government’s decision to cut down on its subsidy burden by slashing its Nutrient Based Subsidy (NBS) rates will also strain the realisations of fertiliser companies, which would be left with very little headroom to pass on the prices to farmers under such a weak demand scenario.

A key factor to watch out for in the upcoming Mar quarter results would be the ability of the fertiliser manufacturers to maintain their current margins, and to improve them on a sequential basis if possible, as the prices of major feedstock (raw materials) like ammonia and phosphoric acid have also seen a decline along with that in the global fertiliser prices.

While the brunt of an unfavourable business environment would be borne by the complex fertiliser manufacturers, the nitrogen-based urea fertiliser companies are expected to do well owing to its wider acceptance among farmers, led by cheaper retail prices. However, the major urea manufacturers like RCF and Chambal Fertilisers have been facing problems of their own, which has unfortunately clouded their performance. Chambal Fertilisers is faced with woes in its shipping and IT businesses, while RCF is faced with shutdowns at its units.

Going forward, while the near-term outlook for the fertilisers space in the upcoming Mar 2012 quarter remains muted and weak, we advise investors with a long-term horizon to adopt a contrarian approach and pick up some fundamentally strong counters in this space. Our conviction stems from the strong impetus given to the fertilisers sector by the FM in the recent Union Budget 2012-13, coupled with the cyclical turnaround of the business environment as the monsoon season approaches. Some of our favoured bets are GSFC, Zuari Industries, Coromandel International and Liberty Phosphate.