Fertilisers - Budget extends investment-linked deduction to sector; Edelweiss

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n  Benefits of investment-linked deduction extended to fertiliser sector

·         In Budget 2011, the fertiliser sector has been included in specified business entitled for investment allowance under section 35 AD. Incremental capex (excluding land, goodwill, and financial instruments) will be eligible for 100% deduction against taxable profits, subject to commencement of production out of a new unit on or after April 1, 2011.

·         This deduction will be eligible for set off against profits of any other specified business; hence, capital expenditure of new fertiliser units can be set off against taxable profits of existing fertiliser units.

n  New provision will be cash flow positive, P&L neutral, encourage new investments

·         The above move will be cash flow positive to the extent of 33% of incremental capex for capacity expansion.    

·         However, it will be P&L neutral because of provision for deferred tax liability to the extent of incremental exemption. This is due to non-availability of depreciation allowance (in future) under the Income Tax Act to the extent of capital expenditure for which tax benefits are claimed.

n  Complex fertiliser companies to be immediate beneficiaries

·         Coromandel (BUY) and Zuari (BUY) are expected to benefit the earliest among fertiliser companies on account of their capex outlay for capacity expansion in the next 12-18 months.

·         Other companies like Chambal (HOLD), Tata Chemicals (Not rated), RCF (Not rated) etc., which have announced capex plans for new urea units will get the benefit post commissioning of new urea units, which may take 3-4 years post capex infusion (which is subject to conducive policies from government, which are awaited and also allocation of natural gas).

·         Coromandel and Zuari, with a capex outlay of INR 3,300 mn and INR 800 mn, respectively, until FY12 end for capacity expansion of their complex fertiliser manufacturing capacities, are set to benefit to the extent of
INR 1,000 mn and INR 240 mn, respectively, in the next two years.

·         We expect the above policy to encourage capacity expansion, especially by net cash positive companies like Coromondel and Zuari.

n  Additional capital investments in fertiliser sector will get infrastructure status

·         Capital investment in fertiliser production to be included under infrastructure sub-sector. This should facilitate low cost funds for incremental capex.