Sharda Cropchem: Entry barriers not high enough

Sharda Cropchem, which markets and distributes crop protection chemicals outside India, intends to raise Rs 327-352 crore through an offer for sale (25 per cent of equity capital) by existing strategic investor HEP Mauritius and the promoters. The company derives 80 per cent of its revenue from agrochemical products with the rest coming from conveyer belts and dyes. The company's key assets are registrations it has procured for various molecules and those that are under development. It has received 1,200 registrations including 534 in Europe, while another 500 is in the pipeline. Besides, a wide sales network spanning 60 countries, largely through third-party distributors.

The key hurdle for competition is the process involved in procuring approvals which starts with identifying generic molecules, preparing dossiers and seeking registrations with regulatory authorities of various countries, a process which can take anywhere three to seven years per molecule. The cost of registration of each molecule across various countries is high at over Rs 15 crore.

The key worry is lack of a manufacturing base and threat of new competition given the relatively low barriers. The company sources all its products from Chinese companies (62 per cent of revenues come from trading activity) and has refrained from getting into manufacturing of the products given the seasonal nature of the business, intense competition, low margin in production activities and the need to maintain high utilisation. While this asset-light model helps in keeping the balance sheet light, new competition could put pressure on realisations.

Although the net working capital cycle has been trending down from 126 days in 2010 to 94 days, it is still more than Indian peers and is another cause for concern. Notably, while the company has applied to trademarks, it is yet to receive approval which is a risk.

However, despite the apparent lack of hurdles (except the slow, tedious and costly registration process) for new players, the company has been able to improve revenues at an annual rate of 23 per cent, profits both at the operating and net level between 28-38 per cent over the last five years. Ebitda margins on an average during this period have been steady at about 20 per cent. An asset light model has also helped achieve healthy capital efficiency ratios of 19-25 per cent, which however is marginally lower than most Indian peers. The muted growth in FY14, however, was due to a one-off order in FY13.

The company's net cash position (Rs 140 crore) though provides comfort. While the company is diversifying its product base (top five products account for 36 per cent of sales), adverse regulatory actions, weather and market based changes (like shift to GM crops or disease resistant seeds) can impact its prospects.

Over the next five years, the company will be focussing on the European market (61 per cent of revenues) given that margins are almost double that of the Latin American market (20 per cent of revenue). To increase margins, it also aims to sell directly to retailers. It has set up its own distribution network in select geographies.

On the valuations front, the stock is trading at 13 times its FY14 earnings on the upper price-band. This is lower than most of its peers like PI Industries, Rallis and Dhanuka Agritech. While Sharda's wide distribution reach, high growth rates and registrations portfolio are also positives, the trading nature of business and low entry barriers do not provide comfort. Investors with a high risk appetite may subscribe.