UBS:: Coromandel International-- Agri-input leader and innovator

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UBS Investment Research
Coromandel International 
Agri-input leader and innovator 

„ Leading agri-input company in India
We initiate coverage of Coromandel International (CIL) with a Buy rating. CIL, a
leading agri-input company in India, has products ranging from conventional
fertilizers (DAP and complex fertilizers) to an increasing number of non-subsidised
products (organic compost, crop protection, specialty nutrients and rural retail).


„ Business model likely to benefit from growth and deregulation
We believe CIL is well placed to benefit from growing demand for
complex/customised fertilizers in India (key to higher yields for Indian farmers,
and favourable government policies)—supported by its low-cost, flexible
manufacturing, raw material security, first-mover advantage in specialty nutrients,
and rural retail store expansion. Management’s strategy is underpinned by the
increasing mix of non-subsidised product businesses (higher margins and lower
regulatory risk) from 30% to 50% of the total gross margin in three to four years.

„ Strong earnings and ROE growth
We forecast a 25% EPS CAGR for FY10-13, driven by a 16% CAGR in fertilizer
volumes and increasing mix of higher-margin non-subsidised product businesses.
We forecast 29-34% ROE in FY10-13E, and a net-cash balance sheet.

„ Valuation: price target of Rs733.00
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool (12.56% WACC, 0.97 beta
and 1.9% terminal growth), implying FY12E PE of 14.7x and EV/EBITDA of
8.9x. We believe the differentials in growth and ROE (historical and forecast) and
a more robust business model will result in CIL trading at a significant premium to
peers and will drive the re-rating further.



We initiate coverage of Coromandel International (CIL) with a Buy rating
and a price target of Rs733.00, 28% above the current share price. We
believe the current price is attractive, with implied FY12E PE of 11.1x,
based on our 25% earnings CAGR and 29-34% ROE forecasts for FY10-12.
CIL, part of the reputable Murugappa Group, is a leading agri-input
company in India with products ranging from conventional fertilizers to nonsubsidised products. We believe CIL is better placed to grow and manage

risk than its peers, given its focus on non-subsidised product businesses,
stronger raw material integration and access and flexible and advanced
manufacturing facilities.

According to the company, demand for fertilizer in India is growing 4-5% pa,
driven by the increasing need for nutrients to sustain growing demand for food
grains because of limited acreage growth (agri-nutrient consumption in India
is lower than in other parts of Asia). The company expects stronger demand
for complex/customised fertilizers than conventional ones, driven by higher
yields for farmers. The government’s NBS (nutrient-based subsidy) policy is
to encourage products with optimum nutrient mix.

We believe CIL is well placed to benefit from growing demand for
complex/customised fertilizers in India. Its key competitive advantages are its
1) low-cost manufacturing  of phosphate and complex fertilizers; 2) flexible
manufacturing of any combination at short notice; 3) raw material security (a
14% stake in FOSKOR and a 15% stake in TIFERT Tunisia ensuring assured
supply of 0.45m mt of phosphoric acid); 4) first-mover advantage in
micronutrients and organic compost; and 5) distribution of products through
rural retail stores (423 shops).

Management’s strategy is underpinned by the increasing mix of nonsubsidised product businesses (higher margins and lower regulatory risk) from
30% to 50% of the total gross margin in three to four years. With its technical
knowhow and understanding of farmers’ needs, CIL plans to increase
complex/customised fertilizers in its product mix.

We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool (12.56%
WACC, 0.97 beta and 1.9% terminal growth). At our price target, the stock
would trade at FY12E PE of 14.7x and EV/EBITDA of 8.9x. CIL’s EPS
CAGR for the past four was 45% compared with the 7% median for peers; its
ROE was 33% compared with the 19% median for peers. We forecast a FY10-
12 EPS CAGR of 23% for CIL (compared with 18% consensus for peers) and
ROE of 32% (compared with 16% consensus for peers). We believe CIL
should trade at a significant premium to peers because of the differentials in
growth and ROE, which will lead to further re-rating, as CIL establishes itself
as a leader in agri-input market in India



Key catalysts
Strong earnings growth: We forecast a 25% EPS CAGR for FY10-13 (FY11
to grow 30% YoY) and for ROE to range from 34% to 29%. We expect CIL’s
ability to deliver strong earnings growth, coupled with an increasingly robust
and profitable business model, to be a key catalyst.
New product success: The company has new customised/complex fertilizers,
specialty nutrients and organic compost products that could increase the gross
margin of the non-subsidised product businesses. These have higher margins
and lower regulatory risk. We think the success of these initiatives will be a key
catalyst for a stock re-rating from current levels.
Customised product deregulation: Customised fertilizers could be an
attractive opportunity for CIL. These products are designed for specific soil and
crop type and also a particular crop stage. The current policy requires sourcing
of inputs from the market rather than use of captive production. A change in
policy could also be a key catalyst.
FOSKOR listing: CIL holds a 14% stake in FOSKOR (acquired primarily as
sweat equity to help enhance operations). FOSKOR has lucrative phosphate
rock reserves and it also manufactures DAP. A listing of this entity should
unlock value in CIL’s investment—we do not include this business in our
valuation. A FOSKAR listing could be a big catalyst, but the company has
indicated that a listing is unlikely in the near term.


Risks
NBS subsidy cut: The government has lowered the NBS subsidy for FY12 by
17-20% for key fertilizers. This has emerged as a recent concern for investors as
it implies that CIL may need to hike prices by 25-30% to maintain margins.
Forex: The company sources raw materials outside India (94%) and its product
prices are globally determined, exposing local currency pricing to international
price movements. Thus, forex remains key risk to our forecasts.
Competition: CIL has first-mover advantage in some products, especially in
non-subsidised products. Given attractive opportunities in the sector, we think
more companies are likely to enter the non-subsidised product market from the
conventional fertilizer segment.
Weather risk: Demand for fertilizers in India depends on crop output, which in
turn, is dependent on the weather, especially the monsoon. Hence, CIL’s growth
remains sensitive to weather patterns.


Valuation and basis for our price target
We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool. Our key
assumptions are: WACC of 12.56%, beta of 0.97, and a 1.9% terminal growth
rate. We initiate coverage with a Buy rating and a price target of Rs733.00. At
our price target, the stock would trade at FY12E PE of 14.7x and EV/EBITDA
of 8.9x.
We believe CIL is better placed to grow than its peers given its focus on nonsubsidised product businesses, stronger raw material integration and access and
flexible and advanced manufacturing facilities (with integrated infrastructure
such as jetties, power generation and storage facilities). We compare CIL with
other private fertilizer companies in India, government-owned fertilizer
companies and crop protection/chemical companies. CIL has had a higher EPS
CAGR over the past four years of 45% compared with the 7% average for peers.
Its ROE was 33% over the same period compared with the 19% average for
peers. We forecast a 23% FY10-12 EPS CAGR for CIL (compared with
consensus’ 18% for peers) and 32% ROE (compared with consensus’ 16% for
peers).
We believe these differentials in earnings growth and ROE will help CIL trade
at a significant premium to peers and  lead to a further re-rating as CIL
establishes itself as a leader in the agri-input market in India.
The higher contribution from the non-subsidised product businesses in the gross
margin mix and sustained high ROE should also help the stock trade at a
premium to peers, in our view. Non-subsidised product businesses have higher
margins and lower regulatory risk, implying strong and steady earnings
contribution.