Fertiliser stocks have been outperforming market benchmarks, so far. But things do not appear too bright going ahead, as the industry’s fortunes are wedded to policy reforms
STOCKS OF fertiliser companies have been rising steadily for over a year now and have also outperformed the broader market benchmarks in the current turbulent times. While the problems faced by the industry are hardly a secret, expectations of a better policy environment are driving up valuations. In face of the shortage of fertilisers in the country, the government is mulling policy changes to induce investments in the sector, which are likely to be introduced in the near future. A few policies have been already announced, which are favourable for the industry. However, considering the nature of the industry and political compulsions, radical changes are not expected. Hence, doubts remain as to whether fertiliser manufacturers will be able to sustain their current rich valuations. Investors are advised to observe extra caution while dealing in these scrips.
GROWTH PANGS:
The government took a number of policy decisions for the fertiliser industry in June ’08. It has reduced the prices of complex fertilisers while maintaining the retail prices of urea, muriate of potash (MOP), diammonium phosphate (DAP) and single super phosphate (SSP). The recent policy on potassic and phosphatic fertilisers recognises a number of costs while calculating subsidy for the industry, which will enable the companies to recover their costs fully. Although these policies will not improve the industry’s operating profits, companies can benefit from higher production. The industry is still waiting for the investment policy on brownfield and greenfield expansions.
The expectations of an improved policy environment are reflecting in the performance of most fertiliser scrips. Over the past 12 months, the ET Fertiliser index has outperformed the BSE Sensex by a wide margin. The ET Fertiliser index has generated over 56% returns since June ’07, while the Sensex returns are at a mere 6%. In the same period, the ET Fertiliser index witnessed a steady growth in its price-to-earnings (P/E) multiple, indicating growing investor confidence. The P/E of ET Fertiliser index grew from 8.5 in June ’07, peaked at 25 in the first week of January ’08 before easing down to 12 currently — still higher than the level in June ’07. On the contrary, the Sensex P/E, which was at 20.7 in June ’07 and crossed 28.5 at its peak in January ’08, has fallen to 17.2 now — below last year’s level.
While investors have been betting on a better future for the fertiliser industry, the growth in its aggregate results has not been impressive. For the year ended March ’08, the aggregate net profit of 15 fertiliser companies was almost flat at Rs 1,477 crore, despite a 17% growth in sales. Even the growth in operating profits was restricted at 5%, indicating a pressure on operating margins. The industry, which had posted operating margins of 12.7% during the year ended March ’06, recorded a margin of 10.5% in FY07 and just 9.4% in FY08.
Due to rigid policies, the fertiliser industry has become highly unattractive for fresh investments. As a result, rising demand has outpaced stagnating supplies and India today has to depend on costly imports for its fertiliser needs. The unsustainability of the current scenario is forcing the government to introduce policy reforms, which are likely to benefit both the industry, as well as the government. Considering the expected spurt in the availability of natural gas in India, the policy reforms appear long overdue.
IT’S ALL ABOUT GAS:
Over the next six months, as Reliance Industries’ (RIL) KG basin starts producing gas, the domestic availability of natural gas will go up by nearly 75%. Sufficient and continuous supply of natural gas will ensure higher production of fertilisers — particularly urea — and reduce the government’s subsidy burden. Natural gas is an important feedstock for manufacturing urea and the lack of adequate availability forces domestic manufacturers to use naphtha, which is a costly feedstock. Similarly, natural gas can also replace expensive fuels such as fuel oil and low sulphur heavy stock (LSHS). However, cheap natural gas will lead to a reduction in the government’s subsidy burden and no significant benefit will accrue to the manufacturers.
National Fertilisers, Gujarat Narmada Valley Fertilisers (GNFC), Gujarat State Fertilisers (GSFC), Tata Chemicals, Chambal Fertilisers, Rashtriya Chemicals and Fertilisers (RCF), Southern Petrochemical Industries (SPIC) and Mangalore Chemicals are the important urea manufacturers in India. Fertiliser and Chemicals Travancore (FACT), SPIC, TCL, Coromandel Fertilisers and Rama Phosphates manufacture phosphatic fertilisers. Higher availability of natural gas will provide volume-led growth to companies, expanding the capacity of companies like Tata Chemicals and Aditya Birla Nuvo. Tata Chemicals is expanding its urea capacity to 1.2 million tonnes (mt) from the current 0.875 mt by October ’08. But the plant will remain shut for a month subsequently for integration purpose.
Again, not everyone is likely to get access to natural gas in the near future. Fertiliser plants located in South India do not have any gas connectivity. The government plans to provide gas connectivity to all fertiliser plants by FY12. Fertiliser companies such as Goa-based Zuari Industries, Kochi-based FACT, Mangalore-based Mangalore Chemicals & Fertilisers (MCFL), Tuticorin-based SPIC, Chennai-based Madras Fertilisers and three plants of National Fertilisers — at Panipat, Nangal and Bhatinda — are awaiting gas connectivity.
GREENER PASTURES:
Over the past few years, most fertiliser companies have diversified into other chemical businesses to create value for their shareholders, as the fertiliser business stagnated. The most noteworthy example is probably Nagarjuna Fertilisers, which is setting up a petroleum refinery in Tamil Nadu.
Similarly, companies such as Deepak Fertilisers and Oswal Chemicals have ventured into the real estate business. Chambal diversified into textiles, shipping and food processing, while Rama Phosphate entered the soya oil business. Today, almost all the domestic fertiliser companies, barring National Fertilisers and Coromandel Fertilisers, have diversified into chemicals or other businesses to improve cash flows and drive growth.
The fortunes of fertiliser companies depend on the government’s policy reforms. The changes introduced so far, which encourage domestic manufacturers to produce more, have met the industry expectations. However, investors must realise that considering its nature, the fertiliser industry is unlikely to become fully de-regulated in the foreseeable future. Hence, the current prices of fertiliser stocks appear to have a downside risk.
STOCKS OF fertiliser companies have been rising steadily for over a year now and have also outperformed the broader market benchmarks in the current turbulent times. While the problems faced by the industry are hardly a secret, expectations of a better policy environment are driving up valuations. In face of the shortage of fertilisers in the country, the government is mulling policy changes to induce investments in the sector, which are likely to be introduced in the near future. A few policies have been already announced, which are favourable for the industry. However, considering the nature of the industry and political compulsions, radical changes are not expected. Hence, doubts remain as to whether fertiliser manufacturers will be able to sustain their current rich valuations. Investors are advised to observe extra caution while dealing in these scrips.
GROWTH PANGS:
The government took a number of policy decisions for the fertiliser industry in June ’08. It has reduced the prices of complex fertilisers while maintaining the retail prices of urea, muriate of potash (MOP), diammonium phosphate (DAP) and single super phosphate (SSP). The recent policy on potassic and phosphatic fertilisers recognises a number of costs while calculating subsidy for the industry, which will enable the companies to recover their costs fully. Although these policies will not improve the industry’s operating profits, companies can benefit from higher production. The industry is still waiting for the investment policy on brownfield and greenfield expansions.
The expectations of an improved policy environment are reflecting in the performance of most fertiliser scrips. Over the past 12 months, the ET Fertiliser index has outperformed the BSE Sensex by a wide margin. The ET Fertiliser index has generated over 56% returns since June ’07, while the Sensex returns are at a mere 6%. In the same period, the ET Fertiliser index witnessed a steady growth in its price-to-earnings (P/E) multiple, indicating growing investor confidence. The P/E of ET Fertiliser index grew from 8.5 in June ’07, peaked at 25 in the first week of January ’08 before easing down to 12 currently — still higher than the level in June ’07. On the contrary, the Sensex P/E, which was at 20.7 in June ’07 and crossed 28.5 at its peak in January ’08, has fallen to 17.2 now — below last year’s level.
While investors have been betting on a better future for the fertiliser industry, the growth in its aggregate results has not been impressive. For the year ended March ’08, the aggregate net profit of 15 fertiliser companies was almost flat at Rs 1,477 crore, despite a 17% growth in sales. Even the growth in operating profits was restricted at 5%, indicating a pressure on operating margins. The industry, which had posted operating margins of 12.7% during the year ended March ’06, recorded a margin of 10.5% in FY07 and just 9.4% in FY08.
Due to rigid policies, the fertiliser industry has become highly unattractive for fresh investments. As a result, rising demand has outpaced stagnating supplies and India today has to depend on costly imports for its fertiliser needs. The unsustainability of the current scenario is forcing the government to introduce policy reforms, which are likely to benefit both the industry, as well as the government. Considering the expected spurt in the availability of natural gas in India, the policy reforms appear long overdue.
IT’S ALL ABOUT GAS:
Over the next six months, as Reliance Industries’ (RIL) KG basin starts producing gas, the domestic availability of natural gas will go up by nearly 75%. Sufficient and continuous supply of natural gas will ensure higher production of fertilisers — particularly urea — and reduce the government’s subsidy burden. Natural gas is an important feedstock for manufacturing urea and the lack of adequate availability forces domestic manufacturers to use naphtha, which is a costly feedstock. Similarly, natural gas can also replace expensive fuels such as fuel oil and low sulphur heavy stock (LSHS). However, cheap natural gas will lead to a reduction in the government’s subsidy burden and no significant benefit will accrue to the manufacturers.
National Fertilisers, Gujarat Narmada Valley Fertilisers (GNFC), Gujarat State Fertilisers (GSFC), Tata Chemicals, Chambal Fertilisers, Rashtriya Chemicals and Fertilisers (RCF), Southern Petrochemical Industries (SPIC) and Mangalore Chemicals are the important urea manufacturers in India. Fertiliser and Chemicals Travancore (FACT), SPIC, TCL, Coromandel Fertilisers and Rama Phosphates manufacture phosphatic fertilisers. Higher availability of natural gas will provide volume-led growth to companies, expanding the capacity of companies like Tata Chemicals and Aditya Birla Nuvo. Tata Chemicals is expanding its urea capacity to 1.2 million tonnes (mt) from the current 0.875 mt by October ’08. But the plant will remain shut for a month subsequently for integration purpose.
Again, not everyone is likely to get access to natural gas in the near future. Fertiliser plants located in South India do not have any gas connectivity. The government plans to provide gas connectivity to all fertiliser plants by FY12. Fertiliser companies such as Goa-based Zuari Industries, Kochi-based FACT, Mangalore-based Mangalore Chemicals & Fertilisers (MCFL), Tuticorin-based SPIC, Chennai-based Madras Fertilisers and three plants of National Fertilisers — at Panipat, Nangal and Bhatinda — are awaiting gas connectivity.
GREENER PASTURES:
Over the past few years, most fertiliser companies have diversified into other chemical businesses to create value for their shareholders, as the fertiliser business stagnated. The most noteworthy example is probably Nagarjuna Fertilisers, which is setting up a petroleum refinery in Tamil Nadu.
Similarly, companies such as Deepak Fertilisers and Oswal Chemicals have ventured into the real estate business. Chambal diversified into textiles, shipping and food processing, while Rama Phosphate entered the soya oil business. Today, almost all the domestic fertiliser companies, barring National Fertilisers and Coromandel Fertilisers, have diversified into chemicals or other businesses to improve cash flows and drive growth.
The fortunes of fertiliser companies depend on the government’s policy reforms. The changes introduced so far, which encourage domestic manufacturers to produce more, have met the industry expectations. However, investors must realise that considering its nature, the fertiliser industry is unlikely to become fully de-regulated in the foreseeable future. Hence, the current prices of fertiliser stocks appear to have a downside risk.
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