Fertiliser Policy Update Lower subsidy - Negative for complex fertiliser players:: Emkay

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Fertiliser Policy Update

Lower subsidy - Negative for complex fertiliser players

n     Government of India (GoI) has negatively surprised by reducing subsidy rates on complex fertilisers by ~20% under Nutrient Based Subsidy (NBS) scheme w.e.f. 1st Apr ’2011

n     Although, the policies indicate GoI moving towards complete decontrol of the fertiliser industry, they are likely to have negative impact on complex fertiliser players in the near term

n     Impact on earnings will mainly depend on 1) company’s ability to negotiate lower prices with global raw material suppliers and 2) price increase to the farmers

n     We estimate FY12E earnings downgrade by 15-20% for Coromandel and GSFC while Tata Chemicals, Chambal, GNFC and Deepak Fertilisers are unlikely be affected  

Possible earnings downgrade - FY12E

Company	Reco	Revised EPS (Rs)	% chg
Coromandel	Buy	50.2	-13%
GSFC	Buy	55.9	-16%

Complex fertiliser subsidy reduced by ~20%
Government of India (GoI) has announced revised rate of subsidies under Nutrient
Based Subsidy (NBS) scheme effective from 1st April ’2011. Under the new subsidy
rates GoI has reduced the per kg subsidy on all the four nutrients viz N (Nitrogen), P
(Phosphate), K (Potash) and Sulphur (S) (please refer table below). As a result
subsidies on all the complex fertilisers are now down by 13-23% across various
categories. For example subsidy on DAP, which is largest used complex fertiliser, is
down by 20.3% (Rs 3,308 / mt) to Rs 12,960 / mt from Rs 16268 / mt (Please refer to
the table in the annexure for the revised subsidy rates on different fertilisers).


Government moving towards complete decontrol of the sector however…
We believe that this sharp reduction in subsidy is indicative of GoI moving towards
complete decontrol of the fertiliser sector in the country and lowering down the subsidy
burden by increasing the fertiliser prices to the farmers in the long run. However we
expect that in the near term such reduction in subsidy is likely to have negative impact
on companies’ profitability. To compensate for lower subsidy (as in case of DAP by Rs
3,308 / mt), companies have to either bring down their cost by negotiating with global
raw material suppliers or increase the prices to the farmers. Under the circumstances
when these companies are not able to compensate this shortfall fully, there will be likely
pressure on their profit margins.

…. Near term profitability may come under pressure
We do not rule out 15-20% earnings downgrade for FY12E based on the assumption
that companies’ EBITDA margins may come down by approximately Rs 500 / mt.
However it will be based on the company’s ability to negotiate for lower raw material
prices and price increase taken to the farmers. Due to current ambiguity in these two
variables we are keeping our estimates unchanged for Coromandel International and
GSFC but we believe that there will be likely pressure on earnings in the near future.



We expect that there will likely pressure on EBITDA margins of Rs 500 / mt. We estimate
that companies will be able to bring down their raw material cost by ~ Rs 1200 / mt and will
be able to increase prices to the farmers by ~Rs 1500 / mt. to compensate for lower subsidy
of Rs 3200 / mt on DAP, we expect that EBITDA / mt will come down by approximately Rs
500 / mt.

How much price increase farmers can absorb?....
Since the introduction of NBS from Apr ’2010, companies have taken price increase for
complex fertilisers by approx 6-10% under different categories. To compensate for the
lower subsidy, we expect that companies can initially increase complex fertiliser prices
further by ~10%. Possibility of further price increase later on, also can not be ruled out.

… And how much raw material cost can be brought down?
India accounts for approximately 40% of global trade for phosphatic fertilisers and
commands strong bargaining power with raw material suppliers due to high import volumes.
However recently phosphatic fertiliser prices have started increasing since DAP prices
increased by 15% to US$ 575 / mt by Nov ’2010 (from Jul-Sep 2010 average prices at US$
500 / mt). We believe that under the rising price scenario, negotiating for lower raw material
prices will involve key challenges for complex fertiliser players and failing which companies
may see adverse impact on their profit margins and subsequently adverse impact on their
earnings.


Base rates assumptions are at significant discount to prevailing global
prices
We believe that the current subsidy rates announced by the GoI assume significant
discount to prevailing global prices. Base rate for DAP (for deriving subsidy on P) assumed
at US$ 450 mt (under the revised rate) is at 22% discount to prevailing global DAP prices of
US$ 575 / mt. Similarly base rate for urea (for deriving subsidy on N) assumed at US$ 280 /
mt is at 27% discount to prevailing global urea prices at US$ 384 / mt. However price taken
in consideration for the previous subsidy rates announcement (effective from 1 Apr ’2010)
were in line with global raw material prices at that time. This wide discount vis-à-vis
prevailing global prices is likely to reduce companies’ ability to bring down their raw material
cost by large amount.


India contributes ~45% to global phosphatic fertiliser trade
India accounts for approximately 45% of the phos acid global trade, ~16% of the global rock
phosphate trade, ~9% of ammonia trade and ~11% of MOP trade. With such a strong
participation on global trade we expect that India should enjoy strong bargaining power with
global raw material suppliers and we expect companies to negotiate for lower raw material
prices for FY12. However negotiations will also depend on their input cost and global
demand – supply scenario. We expect companies may be able to bring down their raw
material cost by approximately by 8% - 15% based on their individual bargaining power with
suppliers.


Will increase in fertiliser prices lead to demand contraction of complex
fertilisers?
We have witnessed that despite the increase in complex fertiliser prices by 6-10%, complex
fertiliser consumption has gone up in H1FY11. DAP consumption has increased by 9% yoy
in H1FY11 and complex fertiliser consumption has gone up by 40% yoy in H1FY11. On the
other hand urea consumption increased marginally by 2% in H1FY11 over last year.