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Gujarat State Fertilizers & Chemicals
We initiate coverage on Gujarat State Fertilizers & Chemicals Ltd (GSFC) with
“ACCUMULATE” recommendation and target price of `357, based on 6x FY12E
EPS of `59.4. GSFC manufactures fertilizers and industrial products, which contribute
71% and 29% respectively, for FY10 revenue. GSFC has a large market share of
63% in Gujarat for DAP (Di-ammonium phosphate). DAP contributed 71% of total
fertilizer revenue in FY10, having total capacity of 0.8 million tonnes. In industrial
products segment, caprolactam contributed ~50% of the total revenue in FY10.
We expect DAP revenue to grow at CAGR of 5% during FY10-FY12E on back of
introduction of NBS policy by the government. Caprolactam revenue is expected
grow at CAGR of 15% due to increase in the prices.
Investment rationale
Benefits from nutrients based subsidy
We expect, GSFC to be benefit from the introduction of the nutrient based subsidy
(NBS) policy, as it is beneficial to the complex fertilizers producers like GSFC. DAP
contributed on an average 71% of the fertilizer revenue in past five years (FY06-
FY10). After NBS policy, margins from the fertilizers segment had improved for the
company. During the H1FY11, revenue has increased by 13% to `23,674 million
compared to H1FY10, whereas EBIT margin improved from 6% to 18% in the similar
period. Going forward, we expect the EBIT contribution to increase from 46% to in
FY10 to 54% in FY12E.
Joint venture for raw materials
GSFC has formed joint venture with Groupe Chimique Tunisien (GCT) and Compagnie
des Phosphates de Gafsa (CPG), both Tunisian companies and Coromandel Fertilisers
Ltd (CFL). The joint venture company, Tunisian Indian Fertilizers (TIFERT) will
produce 360,000 tonnes of phosphoric acid per annum. The production will be
divided 50% between CFL and GSFC. This will help GSFC to run DAP plant at full
capacity. The project is expected to be operational in Q1FY12. However, due to lack of
information, we have not considered any benefits out of joint venture in our valuation.
Leader in caprolactam
GSFC is a leader in the manufacturing of caprolactam with capacity of 70,000 tonnes
per annum. Caprolactam contributed close to 50% of the industrial revenue in the
past five years (FY06-FY10). We expect revenue contribution to be 16% and 17%
in FY11E and FY12E respectively, on back of increased in the price of caprolactam.
Valuation
GSFC’s revenue is expected to grow at CAGR of 8%, from `40,192 million in FY10 to
`46,503 million in FY12E. However, PAT is expected to increase at a CAGR of 36%
during FY11E and FY12E on account of improvement in margin for both fertilizers
and industrial products segment. The NBS policy on complex and pottasic fertilizers
had positive impact on the sector, as seen in the GSFC result for the first two quarters
of FY11. We expect, EPS to grow at CAGR of 36% during FY10 to FY12E from
`31.9 to `59.4. At CMP of `334, stock is trading at 5.1x and 5.6x of FY11E and
FY12E EPS of `65.5 and `59.4 respectively. We initiate coverage on GSFC with
a “ACCUMULATE” recommendation and a target price of `357, assigning PE
multiple of 6x to FY12E EPS of `59.4.
Company Background
In 1962, Government of Gujarat promoted Gujarat State Fertilizers and Chemicals
Ltd (GSFC). Currently, it is holding close to 38% in the company. GSFC operates into
two business segments, fertilizers and industrial products. Fertilizer products include
urea, Di-Ammonium Phosphate (DAP) and other complex fertilizers. Industrial
products include caprolactam, nylon 6 and other chemicals.
GSFC has product presence with more than 24 brands of fertilizers, petrochemicals,
industrial gases, plastics, fibers and other product
Industry
Agriculture plays a significant role in the country like India and the government
plays important role for development of the sector. However, after green revolution
there was no significant capacity addition in the fertilizer sector, which lead to higher
dependency on imports.
Over the years (1950-51 to 2009-10), share of agricultural in GDP has declined from
55% to 15%, whereas for industry it has increased from 15% to 28% and for services
it has increased from 30% to 57%. However, agriculture plays an important role in
Indian economy as it employs ~60% of Indian population in one form or the other.
From the time of green revolution, the government of India is emphasizing on selfsufficiency
in food grains production.
Fertilizer
A fertilizer is a material - organic or inorganic, natural or synthetic that supplies one
or more elements required for plant growth. The plants need around sixteen nutrients
for growth, which can be obtained from atmosphere and soil. The different kind of
fertilizers includes bio-fertilizers, organic fertilizer and chemical fertilizers.
Types of fertilizers
The fertilizers can be classified on the basis of nutrient content. The primary nutrients
are nitrogen (N), phosphorous (P) and potassium (K), which are required in large
quantities and supplied through chemicals fertilizers. Whereas, sulphur (S), calcium
(Ca) and magnesium (Mg) are secondary nutrient required in smaller quantities but
important for plant growth. Apart from these nutrient, micronutrients like iron, zinc,
manganese, copper, boron, molybdenum and chlorine are also essential for different
plant growth. The grade of fertilizers are expressed in three numbers in terms of
percentage of N,P and K present.
The chemical fertilizers differ from one another in terms of nutrients contents and
its use on different crops. Different crops require different proportion of N, P and K,
for example, one tonne of paddy absorbs 9.74kg, 3.12kg and 3.26kg of nitrogenous,
phosphatic and potassic nutrients respectively, from soil. While, one tonne of wheat
absorbs 15.96kg, 1.89kg and 3.43kg of nitrogenous, phosphatic and potassic nutrients
respectively, from soil. The quantity of nutrient absorbed also varies in different
kinds of soil. Although, the ideal NPK usage ratio is 4:2:1. In India, the usage of ratio
differs between regions due to soil type, crops grown and farmer price preference. In
2008-09, the average ratio in India was 4.6:2.0:1.0. Usage of fertilizer is primarily
driven by farmer preference. In India, farmer prefers consumption of nitrogenous
fertilizers compared to phosphatic and potassic, due to cheaper availability of urea
compared to others and immediate visibility of results.
Consumptions of Fertilizers
The global fertilizer consumption has grown CAGR of 3.8% from 30.03 million
tonnes nutrients in 1960 to 168.7 million tonnes nutrients in 2007. However, due to
global slowdown, production declined 5.1% to 159.6 million tonnes in 2008 over
previous year.
India contributes ~15.4% in the global fertilizer consumption for all nutrients
(NPK) of 162.5 million tones. The share of European countries in the consumption
of fertilizer was higher (in 1985 it was 28%), however it declined over the years
and Asian countries have emerged as the largest consumer. This was due to large
consumption base in India and China. In 2008, Asia, Europe, N America, L America
and others accounted for 60%, 14%, 13%, 9% and 4% respectively, of the world
nutrient consumption pattern.
Drivers for the fertilizer sector
The Indian fertilizer sector is primarily impacted by production capacity, raw material
availability, agriculture (as mentioned above), international market and government
policies.
A) Production capacity
India is the third largest fertilizer manufacturer in the world with an installed capacity
of ~13 million tonnes of nitrogen and ~6 million tonnes phosphatic nutrients. However,
with increasing nutrients requirement the demand for fertilizers are met through
imports due to unavailability of the raw materials
India is largely dependent on imports to meet its fertilizer requirement especially
the complex fertilizers. Due to higher imports (except for nitrogen), India is largely
exposed to international prices of phosphatic and potassic fertilizers. The table shows
that, there is no significant capacity addition of any kind of fertilizer in past eight
years. In 2008-09, the total fertilizer capacity in India in terms of nutrients was 19.3
million tonnes, while actual production was 14.3 million tonnes and total consumption
in terms of nutrient was 24.9 million tonnes.
Out of ~13 million tonnes of nitrogenous fertilizers capacity, utilization level was 84%
in 2008-09, which declined in past three years. In phosphatic fertilizers, condition is
even worst as against capacity of ~6 million tonnes in 2008-09; utilization level was
only 55%. Major reason for lower utilization level is unavailability of raw material
namely, phosphatic acid, rock sulphate etc.
In 2008-09, nitrogenous fertilizers accounted for close to 61% of total nutrient
consumption in India, out of which urea contributed 98% of consumption. Phosphatic
fertilizer was 26%, out of which DAP contributed over 56%. The share of potassic
nutrients was marginal (13.3%) of total consumption, as there was no potassic capacity
in India and entire requirement is imported.
In the past, usage of Urea (Nitrogen) was higher, due to lower cost compared to other
fertilizers and lack of knowledge among the farmers. High usage of urea resulted in
deficiency of important nutrient in soil over the years, which deteriorated the land
fertility. The ideal NPK ratio is 4:2:1. Historically, nutrient consumption ratio was
largely in favor of N (Nitrogen) due to higher usage of urea, which moved towards a
balance scenario with NPK ratio improving from 5.3:2.2:1.0 in 2005-06 to 4.6:2.0:1.0
in 2008-09, showing increasing consumption of phosphatic and potassic fertilizers.
The NPK ratio is expected to be 5.2:2.2:1.0 and 4.8:2.2:1.0 in FY11E and FY12E,
respectively, assuming normal rainfall.
To provide greater importance towards balance nutrient, the government announced
new pricing policy of complex fertilizers based on nutrient content. Earlier, subsidy
was based on international prices of fertilizer and feedstock. Therefore, government
subsidy bill was determined by the floatation in the international prices of fertilizers.
In 2008-09, fertilizer subsidies touched high of `958 billion due to increase in prices
of feedstock and international fertilizer prices.
B) Raw material availability
Availability of raw material and limited tie-ups for raw materials with global players
has been key factor for lower utilizations levels of the fertiliser capacity in India.
For Indian fertilizers industry, feedstock plays an important role, as it contributes
almost 50-60% of net sales. Therefore, appropriate choice of feedstock is critical for
a fertilizer company. The feedstock used by the manufacturer determines the cost
of production, subsidy allocation and also profitability of the plant. The different
manufacturer uses different feedstocks. Factor affecting the selection of feedstock
are availability, pricing, technology, commercial viability, alternative uses and
government policies.
●● Availability: Uninterrupted supply of feedstock is important for maintaining the
utilization rates along with the profitability. Considering this, some of the players
have opted for the dual feedstock plants (GSFC is having the dual plant of both
natural gas and naphtha).
●● Pricing: Raw material is the major cost of production for the fertilizer companies.
Significant change in prices of raw materials like, Naphtha, fuel oil and LSHS (low
sulphur heavy stock) etc, affects the industry and government in terms of subsidy.
●● Technology: Earlier, ammonia was produced from naphtha, but now natural gas
is preferred as the technology available has high production efficiency as well as
low energy consumption.
●● Viability: The commercial viability of natural gas as feedstock is higher due
to lower price, lower consumption of energy and water, ease in storage, easy
transportation compared to other feedstock.
●● Alternative uses: Availability of the feedstock of natural gas also depends on
its alternative industrial uses (natural gas also used by power and petrochemical
players).
●● Government policies: During 1980s, large reserves of natural gas were discovered
and to promote the gas usage, government started insisting on gas usage compared
to other feedstock.
As on Nov 2009, domestic nitrogenous capacity was 85% based on captive ammonia
production, whereas 15% was procured externally. Out of captive ammonia capacity,
73% is based on natural gas, 17% on naphtha and 10% on fuel oil and rest on others
(coal, LSHS, caprolactam). Although the capacity under captive ammonia production
has remained constant, the contribution of natural gas as feedstock for nitrogenous
has improved. This was on back of continuous efforts of government and industry
players to switch from costly feedstock (naphtha) to natural gas.
For manufacturing urea, the Hydrogen and Carbon requirement is met from
Hydrocarbon, which is also used as fuel for urea manufacturing. Natural gas, Naphtha
and fuel oil are the different feeds available for Hydrocarbon. However, natural gas
is the most preferred feedstock compared with others.
Naphtha
Naphtha is important feedstock used for manufacturing nitrogenous fertilizers. It is
used in power generation, fertilizers and petrochemical. Over the years, use of naphtha
by fertilizer players is declining considering natural gas as preferred feedstock. With
new findings of natural gas, share of naphtha in the feedstock is expected to decline.
Additionally, as per the new urea pricing policy, the non-gas units have to convert to
gas by 2010. But, since a number of plants are yet to have pipeline connectivity, we
expect the government to extend the deadline.
As urea producers are paid subsidy on the basis of their cost of production and thus
a higher production cost (with use of naphtha and fuel oil) means higher subsidy
payout for the government. Government will benefit the most, as industry players are
moving towards gas based units. Cost of producing one tonne of urea using naphtha
is ~`22,000-24,000, whereas using natural gas it is ~`10,500-12,000/tonne
Natural gas
Natural gas is a preferred feedstock, contributing more than 60% of urea capacity,
as it is energy efficient and economical.
During 1981-82 fertilizer was the main consumer of natural gas. However, with large
discovery of natural gas reserves (during 1977-84) power plants were set up based on
natural gas. As a result, during 1990-2007, power sector became a dominant consumer
compared to the fertilizer sector.
In 2008-09, demand for natural was estimated at 139mmscmd (million standard cubic
metres per day). However, supply was limited to 93.2mmscmd, resulting in a deficit
of around 46mmscmd. As demand was higher, ministry of petroleum and natural gas
allocated initial 40mmscmd of RIL KG basin natural gas to various industries based
on gas utilization policy.
According to Crisil, supply of natural gas is expected to improve due to increase
in LNG import and domestic gas finds by Reliance, ONGC and GSPC. In 2008-
09, supply of natural gas was 93.2mmscmd and expected to reach 215mmscmd in
2013-14. Demand from fertilizer sector is expected to increase from 38.6mmscmd
in 2009-10P to 52.9mmscmd in 2013-14P.
Ammonia
Out of the total fertilizer capacity less than 15% use purchased ammonia as feedstock.
Private players who are manufacturing complex fertilizers such as DAP, ammonium
sulphate or ammonium chloride utilize the external ammonia. The reason is that the
production volumes do not justify investment in captive ammonia plants
Feedstock for phosphatic fertilizer
Phosphatic acid is a key raw material used to manufacture DAP and SSP. Industry
players can purchase phosphatic acid or produce it using rock phosphate and other
inputs. Phosphoric acid is manufactured from processing rock phosphate with sulphur,
sulphuric acid, nitric acid, smelter gases, or pyrites. Almost 46% of phosphatic
fertilizer capacities are utilizing imported phosphoric acid and balance 54% are based
on captive production of phosphoric acid using rock phosphate and sulphuric acid.
Although, a large share of capacities being captive for producing phosphatic acid,
high prices of rock phosphate resulted in high import of phosphoric acid. India obtains
phosphatic acid mainly from Morocco, South Africa, Senegal, Jordan, Tunisia and
USA (all six accounting for more than 96% of import in 2008-09).
Rock phosphate is the material used for making SSP and DAP. There are four
companies in India who manufacture rock phosphate. Demand for rock phosphate
is higher compared to production, therefore imports of rock phosphate has been
going up due to large demand of complex fertilizers. Imports are mainly sourced
from Jordan, Algeria, Togo, China, Egypt, Vietnam and Morocco (accounting for
98% of total imports).
Sulphur can be purchased by manufacturer and processed into sulphuric acid, which
is further converted to rock phosphate and then into phosphoric acid
C) International market
International market plays an important role for domestic fertilizer industry, as it is
highly dependent on imports. India accounts for 15% of global fertilizer consumption
of 162.5 million tonnes for all nutrients in 2008.
The consumption pattern of three nutrients (N,P,K) used in fertilizers remain almost
similar for India and world. Earlier, during 1985 share of European countries was
43% and Asian countries was 28%, which changed over the years on back of high
consumption base in India and China.
D) Government Regulation
Government of India is directly responsible for supply of fertilizer with subsidized
rates to the Indian farmers. The fertilizers consumption grew rapidly after green
revolution due to larger use of fertilizers, high yield variety seeds, irrigation and
usage of tractors.
Fertilizer policy
The primary reason for regulated fertilizer sector is to ensure food availability
at affordable prices on time. The basis of policy choices and changes by Indian
government are,
Fertilizer at reasonable rates: Fertilizer plays an important role for development of
agriculture, as it employs close to 60% of population. Due to lower income, farmers
can’t afford high fertilizer prices. Therefore, fertilizer sector needs to be regulated.
There is huge difference between, cost of production of fertilizer and price at which
farmer can afford. Therefore, the government fixes the price and difference between
cost and price is paid as subsidy to fertilizer players. The price at which farmers
buys fertilizers is called subsidized MRPs.
Over the years the there was no significant increase in the urea farm gate price
amounting higher subsidy burden for government of India. In 2008-09, significant
increase in complex fertilizer subsidy was due to decline in complex fertilizers prices
and increase in feedstock prices.
Controlling the cost: High dependence on imported fertilizer represent high
dependence on international demand supply leading to increase in the fertilizer/
feedstock prices.
Using balance nutrients: The government policies are based on objective of
encouraging balance usage of nutrients (ratio of usage 4:2:1 for N,P and K). However,
ratio is highly concentrated on nitrogenous fertilizer due to cheaper availability of
urea and faster result for vegetative growth.
In November 2010, Government of India notified subsidy rates applicable for 2011-12.
The government has reduced subsidy rates for all major nutrients. Maximum decline
was in sulphur with 34%. This was done by the government to reduce subsidy burden.
However, volumes and margin of complex players producing complex fertilisers is
expected to decline in FY12E, due to lower subsidy realization and higher growth
seen in the first half of FY11.
Over the years government of India made many changes in policy for development
of fertilizer sector and attempted to reduce the subsidy burden.
Highlights of existing policy for Urea
The new pricing scheme (NPS) stage-III was announced in January 2007 effective
from Oct 2006 to Mar 2010. This policy was driven towards greater efficiency in
feedstock usage. The MRPs was fixed for end consumers (currently it is `5,310/
tonne), which was at discount rate to the actual cost and the difference was paid
by the government as subsidy. Units, which are operating on other high cost fuel,
are required to shift to natural gas till 2010. Transportation cost of gas will be paid
separately. The government will control movement of urea up to 50% of production.
(Detailed policy details refer Annexure)
New investment policy for urea
In Sept 2008, the government announced policy related to investment in new urea
plants based on IPP (import parity price) with floor and ceiling price fixed at USD250/
tonne and USD450/tonne respectively. It included the revamp, expansion, revival of
existing plant and Greenfield projects. The revamping of existing plant means increase
in capacity of existing plant through investment up to `10 billion and additional urea
production will be recognized at 85% of IPP.
Expansion of project means utilizing some of common utilities and setting up of new
ammonia/urea plant at existing fertilizer plant. The investment for expansion project
should be in excess of `30 billion. The urea produce from the expansion unit will be
recognized at 90% of IPP.
The revival (sick) unit realization linked at 95% of IPP and for Greenfield projects
price of urea will be determined through bidding route. (For detailed of new investment
policy refer annexure)
Highlights of current policy for complex fertilizer
To adopt balance nutrients for all fertilizers, government introduced nutrient based
subsidy scheme (NBS) for complex fertilizers. The pricing of fertilizers was based
on their nutrients contents. The lower MRP of complex fertilizer was aimed at
encouraging usage among consumer. To encourage balance nutrients, sulphur was
included in the balance nutrient ratio and it is treated same as nitrogen, phosphorous
and potassium (N:P:K:S).
Expectation from policy change
During the past fifteen years, nitrogenous fertilizer contributed two third of the total
nutrients consumption in India, where urea is a dominant nutrient. Urea accounts in
for more than 60% of total fertilizer subsidy over past ten years (grown at a CAGR
of 17% to `339 billion in 2008-09). The consumption pattern in India suggests higher
consumption of urea compared with complex fertilizers as it is cheaper and impact
is immediately visible. The pricing policy for urea (NPS-III) was applicable till Mar
2010 and government is in the process of formulating a new policy. Over the years,
the government had not increased the price of urea, as it is largely consumed by Indian
farmers, resulting in huge amount of subsidy burden for the government. Additionally,
higher feedstock prices, railway freight, electricity charges and international prices
of feedstock further increased the subsidy burden.
Expectation
The aim of government is to ensure availability of food at affordable price. Therefore,
fertilizer sector is highly regulated. Over the past ten years, there was no significant
increase in the farm gate price of urea, and the difference between cost of production
and farm gate price was paid as subsidy to the farmers (e.g. Cost of producing one
tonne of urea using natural gas is ~`10,500-12,000/tonne, compare to farm gate price
of ` 5,310/tonne). We expect government to bring in an investor friendly policy for
urea, so as to reduce the subsidy burden. Government has already introduced NBS
policy for complex fertilizers. After NBS, prices of phosphate and potassic fertilizer
have increased by ` 600/tonne and urea by ~10% to `5,310/tonne.
Looking at the past history, the government cannot totally de-regulate urea, as it
is largely consumed by farmers as well as it is a politically sensitive subject. The
government is expected to de-control urea in a phased manner or bring the under
NBS, similarly like complex fertilizer. We expect the government to increase urea
price by 10-15% as seen in the past or bring it under NBS.
Impact
We expect that the total de-control of urea will increase the competition. Currently,
there is limited competition in the urea sector, as it is driven by the government
policies. The fertilizer sector is highly capital intensive. The average cost of
setting up a Greenfield urea project is ~`33,000/tonne based on natural gas. The
average construction period for the same is close to 35-40 months. In addition, the
feedstock requirement, technology use, adequate monsoon etc are the important
factors determining the profitability for the urea players. All these factors lead to the
low margin, low investment by the urea players and higher subsidy burden for the
government.
In the de-control scenario, the government has to keep in mind the natural gas
requirement from the urea players. Some of the players are still running the plant
based on naphtha due to inadequate pipeline facility for the natural gas, resulting in
lower profitability.
We expect that de-control of urea will be done in the phased manner and GSFC will
marginally benefit as urea contributes only 6% to its FY10 revenue. The players like
Chambal Fertilizers, Nagarjuna Fertilizers, GNFC are likely to benefit most from
the urea de-control as it is contributing 52%, 35% and 11% to the revenue of FY10.
Even a 15% per tonne increase in the farm gate price of urea by the government will
not significantly change our estimate for GSFC. A 15% increase in farm gate price
will lead to EPS of `59.8 and target price of `359.
Outlook for fertilizer
The demand/supply expectation for important fertilizer, urea and DAP.
Domestic
Historically, the nutrient consumption was higher towards nitrogen (N) due to its
availability, lower farm gate price and higher self-sufficiency of urea. However,
over the years we had seen movement towards balance nutrient. The nutrient
consumption ratio improved to 4.6:2:1 in 2008-09 from 5.3:2.2:1 in 2005-06. The
nutrient consumption ratio is expected to decline to 5.2:2.2:1.0 in 2010-11P and in
time reach to 4.3:2.2:1.4 in 2013-14P.
Like nutrient consumption, product consumption is also concentrated on urea, which
is moving towards balanced usage of complex/potassic fertilizers. Urea’s share in
total consumption declined in 2008-09 to 52.9% from 56.5% in 2007-08. Whereas,
consumption of DAP increased to 18% from 16% in the same period. The urea’s
consumption is expected to increase to 30.8 million tonnes (50.4% share) in 2013-
14P. DAP and other complex fertilizers are expected to grow to 11.9 million tonnes
and 9.7 million tonnes respectively, in 2013-14P.
Urea
Due to lack of clarity from government’s urea policy, the urea capacity has always failed
to match demand. The demand for urea increased to 27 million tonnes in 2008-09 from
22 million in 2005-06, whereas capacity has increased from 19.7 million tonnes to 20.3
million tonnes in same the period. Therefore, part of the urea demand was imported.
The urea demand is expected to decline 2% in 2009-10P to 26.2 million tonnes and
imports are also likely to decline to 5.7 million tonnes compared to previous year.
However, decline in imports are due to debottlenecking activities by certain players.
The demand for urea is likely to recover from 2010-11E due to higher usage (as DAP
is costlier then urea). Urea consumption is expected to grow at CAGR of 3% during
2009E-2014P to 31 million tonnes from 27 million tonnes. Import is expected to
grow at CAGR of 3% during the same period.
DAP
In 2008-09, domestic DAP production declined as international price of DAP declined
without corresponding fall in raw material price of rock phosphate and phosphoric
acid. Therefore, there was increase in consumption of imports. India is largest importer
of DAP in the world.
Assuming the normal rainfall, DAP consumption is expected to increase at a CAGR
of 5% during 2008-09E to 2013-14P. The increase in the consumption is likely to
sustain by imports, which is expected to grow to 8 million tonnes in 2013-14P. DAP
and the other complex fertilizers can be manufactured in the same unit. Therefore,
players are likely to produce other complex fertilizers to meet supply.
Business overview
GSFC operates two business segments, fertilizers and industrial products which
contributed 71% and 29% to the total revenue in FY10. In the fertilizer segment,
major contributor was Di-Ammonium Phosphate (DAP) which contributed ~47% in
FY10. While others like urea, ammonium sulphate (AS) and ammonium phosphate
sulphate (APS) contributed 6%, 6% and 9% (of the total revenues) respectively in
FY10. In the industrial products, major revenue contributor was caprolactam with
~15% contribution, while other chemicals contributed on an average of 1% to total
revenue in FY10.
Fertilizer Segment
In the fertilizer segment, DAP contributed 70% of total fertilizer revenue, while AS,
Urea and APS contributed 8%, 9% and 13% respectively in FY10.
GSFC is manufacturing nitrogen and phosphate based fertilizers. For nitrogen it has
product base of fertilizers like urea and ammonium sulphate (AS) and for phosphate
based fertilizers, it has product base like Di-ammonium phosphate (DAP) and
ammonium sulphate phosphate (ASP).
Urea
GSFC has an installed capacity of 0.36 million tonnes for manufacturing urea, with
average utilization of 72% over past five years (FY06-FY10). GSFC is categorized
into mixed category under new pricing scheme (NPS), where it uses naphtha and
natural gas as its feedstock for manufacturing urea
Urea is manufactured at high temperature and high-pressure condition with chemical
reaction between ammonia and carbon dioxide. For hydrogen and carbon raw material
requirement is natural gas/naphtha, while for nitrogen and oxygen, air is available.
The retail farm gate price of urea has been increased by 10% to `5,310/tonne. This
move is expected to reduce the urea subsidy for the Government. GSFC would benefit
marginally from the price hike as urea contributes only 9% to the fertilizer revenue
(6% of the total sales) in FY10.
DAP
GSFC has strong presence in phosphorus-based fertilizers (DAP) in India. For DAP,
GSFC has highest market share of 63% in Gujarat. DAP contributed 70% of total
fertilizer revenue in FY10 with total capacity of 0.8 million tonnes. Out of the total
production of 2.99 million tonnes of DAP in India, GSFC produced 0.68 million
tonnes during 2008-09. GSFC has capacity of 0.8 million tonnes per annum with 7%
share in total capacity of 8.9 million tonnes per annum in India
Industrial Products
In addition to fertilizer, GSFC has considerable presence in industrial products
segment contributing an average of 31% over past five years. Industrial products has
higher margin compared to fertilizer space. Fertilizer has an average EBIT margin of
8.15% over past five years (FY06-FY10) compared to 20.23% for industrial products.
In the industrial products segment, caprolactam contributes almost 50% to the total
revenue of industrial products. The other products contributed on an average of
two percent (nylon 6 10%, melamine 7%, ammonia 5% and cyclohexanone 5% in
industrial segment space) in FY10, in the industrial products segment.
Caprolactam
Caprolactam is a base material for manufacture of nylon 6 and it is used to manufacture
nylon 6 fibre for textiles, tyre chord, moulding engineering components and other
extrusion profiles etc. Captrolactam is manufactured from benzene having input
output ratio of 0.89 for GSFC in FY10 (i.e. one tonne of benzene gives 0.89 of
caprolactam). The two major manufacturers of Caprolactam in India are GSFC,
which has an installed capacity of 70,000 tonnes per annum, and Fertilisers &
Chemicals, Travancore (FACT), with an installed capacity of 50,000 tonnes per
annum. Caprolactam prices are volatile since it is derivative of benzene, which is a
downstream product of crude oil. Any increase/decrease in global crude prices has
a cascading effect on caprolactam prices.
Key Positives
A) NBS policy to benefit
We expect players like GSFC to be a beneficiary of the Nutrient Based Subsidy (NBS)
policy, as DAP is contributing on an average 71% of the fertilizer revenue in past five
years (FY06-FY10). GSFC is expected to gain from this step, as growth in complex
fertilizers is likely to be higher in FY11E and FY12E. After NBS policy, margins
from the fertilizers segment had improved for the company. The fertilizer segment
EBIT margin improved to 13% and 20% in Q1FY11 and Q2FY11 respectively.
Similarly, EBIT contribution was 63% and 59% for this segment in the same period.
Going forward, we expect the EBIT contribution to increase from 46% in FY10 to
54% in FY12E.
B) Joint Venture for Raw Materials
India is not self sufficient in raw material (ammonia, rock phosphate, phosphoric
acid, potash, sulphur) used for complex fertilizer. Therefore, raw material linkage for
manufacturing complex fertilizers decides revenue visibility going forward. Therefore,
in 2006, GSFC had formed joint venture along with Groupe Chimique Tunisien
(GCT) and Compagnie des Phosphates de Gafsa (CPG), both Tunisian companies
and Coromandel Fertilisers Ltd (CFL). The joint venture company, Tunisian Indian
Fertilizers (TIFERT) will produce 360,000 tonnes of phosphoric acid per annum. The
70% shareholding is with both Tunisian companies and 15% each with GSFC and
CFL. The production will be divided 50% between CFL and GSFC. This will help
GSFC to run DAP plant at full capacity. The project is expected to be operational
in Q1FY12. However, due to lack of information, we have not considered this into
our valuation.
C) Leader in Caprolactam
GSFC is leader in the manufacturing of caprolactam with the installed capacity of
70,000 tonnes per annum.
Over the past five years, the average capacity utilization in caprolactam was 111%
with capacity of 70,000 tonnes per annum. Caprolactam contributed close to 50%
of the revenue in the industrial product segment over past five years (FY06-FY10).
Similarly, it contributed on an average of 16% in the total revenue over last five
years. We expect revenue contribution to be 16% and 17% in FY11E and FY12E
respectively, on back of increased in the price of caprolactam.
Price of caprolactam has been trading in range of `137,000/tonne in the past six
month (April 2010-Oct 2010). Price of caprolactam largely depends on the price of
raw material (benzene), accounting close to 40% of caprolactam cost (Source: Crisil).
Any change in price of benzene has direct effect on prices of caprolactam. Price of
benzene has been trading in the range of `45,000/tonne in past six months period
(May 2010-Oct 2010). The increase in price is reflected in the price of caprolactam.
Key Concerns
●● In Nov 2010, Government of India notified subsidy rates applicable for 2011-12.
The government has reduced subsidy rates for all major nutrients. This move
of government was to reduce the subsidy burden. However, margin of players
producing complex fertilisers is expected to decline in FY12E, due to lower
subsidy realization. The company has to either reduce the cost by negotiating with
global suppliers or increase the prices to the consumer; otherwise it would put
pressure on GSFC’s profitability. However, we have computed FY12E earning
on basis of revised subsidy per kg on all four nutrients.
●● GSFC is exposed with various types of risk in fertilizers and chemicals area.
This includes raw material price movement and change in pricing policy by
the government. The availability of natural gas is important for production of
fertilizers. GSFC derives average 16% of total revenue in last five years from
caprolactam. Any change in price of raw material, would impact profitability of
GSFC. For the company, a normal rainfall, continuous and cheaper raw material
availability and timely reimbursement of subsidy by the government would be
important to sustain operating profitability.
Peer Group
The urea producer’s performance depends on capacity additions, utilization,
operational efficiency, capital structure and working capital management. As highly
regulated sector, competition between urea players is limited. However, in complex
fertilizers, the producers compete on basis of raw material sourcing, plant location
and operational efficiency. Most of the complex fertilizer players focus on one or
few grades with large marker share. GSFC is the market leader in Gujarat for DAP.
Fertilizer sector is highly regulated by the government, so growth in earning is limited.
Therefore, most of the players have diversified business areas.
Financial Performance
Sales
GSFC’s revenue is expected to grow at CAGR of 8%, from `40,192 million in FY10 to
`46,503 million in FY12E. The growth will be higher from industrial product segment
i.e. 29% in FY10 to 33% in FY12E (as price of caprolactam increased in the past six
months). However, during FY06-FY09, revenue contribution from industrial products
showed a declining trend on account of volatile price of caprolactam (contributing
~50% in industrial product segment)
We are expecting stable growth for urea with CAGR of 3% and CAGR of 5% for
DAP during FY10-FY12E. Further, any addition in capacity by GSFC would lead to
high revenue contribution from DAP going forward. Due to lack of information from
the company on capacity additions, we have not factored the same in our projections.
The fertilizers segment is expected to remain stable compared with chemical business
due to volatile prices of commodities. We are assuming almost same level of capacity
utilization for urea, DAP and caprolactam during FY11E and FY12E. However,
revenue is expected to decline in FY12E (2% compared to FY11E) on back of reduced
subsidy rates determined by the government, and thereby lower realization.
In the past five years (FY06-FY10), EBIT contribution of fertilizer segment was an
average of 46% and 54% for the industrial products segment. In FY09, The EBIT
contribution (6%) from the industrial segment showed a sharp decline on account of
low caprolactam price (price touched low of `79,000/tonne in April 2009 from high of
`129,500/tonne) during Aug 08-Feb 09 with lower volumes. However, due to global
recovery, the EBIT contribution had increased in FY10 to 54% with EBIT Margin of 19%.
For the industrial products, we are expecting EBIT contribution of 42% and 45% for
FY11E and FY12E respectively. Whereas, we are expecting EBIT contribution from
fertilizer segment to increase to 55% and 54% in FY11E and FY12E respectively,
on account of higher margin due to introduction of NBS policy. During the Q1 and
Q2 of FY11, GSFC has an average EBIT margin of 17%. The PAT margin for GSFC
is expected to be stable at 11% and 10% in FY11E and FY12E respectively, due to
stable growth seen in both, industrial product and fertilizers segment.
GSFC’s earning has been very volatile due to volatile nature of industrial products
segment. Additionally, bad monsoon and availability of raw material (particularly,
in fertilizers segment, availability of phosphoric acid for DAP) is driving factor for
GSFC’s earning. However, we expect the normal monsoon and stable crude oil price
to keep GSFC’s earning stable. Both, ROCE and ROE is expected to improve in
FY11E and decline in FY12E.
Valuation
GSFC’s revenue is expected grow at CAGR of 8%, from `40,192 million in FY10 to
`46,503 million in FY12E. However, PAT is expected to increase at a CAGR of 36%
during FY11E and FY12E on account of improvement in margin for both fertilizers
and industrial products segment. The NBS policy on complex and pottasic fertilizers
had positive impact on the sector, as seen in the GSFC result for the first two quarters
of FY11. We expect, EPS to grow at CAGR of 36% during FY10 to FY12E from
`31.9 to `59.4. At CMP of `334, stock is trading at 5.1x and 5.6x of FY11E and
FY12E EPS of `65.5 and `59.4 respectively. We initiate coverage on GSFC with
a “ACCUMULATE” recommendation and a target price of `357, assigning PE
multiple of 6x to FY12E EPS of `59.4.
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