While the subsidy cut on complex fertilisers could impact margins in the near term, any move towards price decontrol should prove positive in the long run.
A Crisil Research report says, “As a part of the move towards total decontrol of the sector, the government is attempting to ensure that demand-supply factors influence the pricing of fertiliser products to a greater extent. Overall, this is an attempt by the government to reduce the subsidy burden.”
“We believe this sharp reduction in subsidy is indicative of the government moving towards complete decontrol of the fertiliser sector in the country and lowering the subsidy burden by increasing the fertiliser prices for farmers in the long run,” says Rohan Gupta, research analyst at Emkay Global.
Lower margins, earnings
Analysts believe this is a good move, considering that it will help in the long run for the sector to get rerated and attract new investments. Meanwhile, the reduction in subsidy by 20 per cent means that this will have a negative impact on the companies that manufacture complex fertilisers. In the case of DAP and MAP, the subsidy has been reduced by 20-21 per cent to Rs 12,960 and Rs 12,770 per tonne respectively.
“We believe the move will have a negative impact on companies like Coromandel International, Zuari Industries, RCF, Tata Chemicals, Deepak Fertilisers and GSFC. Urea manufacturers such as Chambal Fertilisers, Nagarjuna Fertilisers, etc will not be impacted,” says Gaurav Dua, head of research, Sharekhan.
| VALUATIONS | |||
| FY12E EPS (Rs ) | CMP (Rs ) | PE (x) | |
| Coromandel Int. | 50.2 | 574 | 11.4 |
| GSFC | 55.9 | 334 | 6.0 |
| Tata Chemicals | 35.7 | 355 | 9.9 |
| GNFC | 22.4 | 123 | 5.5 |
| Deepak Ferti. | 25.2 | 174 | 6.9 |
| Chambal Ferti. | 8.6 | 91 | 10.6 |
| E analyst estimates | |||
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Analysts believe companies which manufacture complex fertilisers could see some pressure on operating margins if they are unable to pass on the price increases to the farmers or to control their manufacturing cost. Says Rohan Gupta, “There will be likely pressure on Ebitda margins by Rs 500 per tonne. As part of the Rs 3,200 per tonne cut in subsidy, the companies will be able to compensate by way of bringing down their raw material cost Rs 1,200 per tonne and another Rs 1,500 per tonne by way of increasing prices for farmers.”
| FALLING SUBSIDIES | |||
| Subsidy (Rs per kg) | |||
| 2010-11 | 2011-12 | % chg | |
| Nitrogen | 23.22 | 20.11 | -13.4 |
| Phosphorous | 26.27 | 20.3 | -22.7 |
| Potassium | 24.48 | 21.38 | -12.7 |
| Sulphur | 1.78 | 1.17 | -34.3 |
| Source: Department of Fertilisers | |||
Hence, given the net impact of Rs 500 per tonne on Ebitda, companies like Coromandel International and GSFC could see their estimated earnings for 2011-12 come down 13-16 per cent. Only if they are able to mitigate the full impact of the cut in subsidies (through cost reduction and price rises), do analysts expect their earnings to decline next year.
Beneficiaries
In the light of the evolving situation, the companies in the urea business are considered to be in a better position as they could benefit on account of a shift in volumes from complex fertilisers to urea. This is also a reason that analysts at this point prefer companies in the urea space, including Chambal Fertilisers. Additional gains could accrue on account of likely positive announcements in the forthcoming meeting of government officials on the road map for urea price decontrol.
Fertiliser Secretary Sutanu Behuria has reportedly said the decision on urea price decontrol is likely to be taken by the end of the current financial year. Analysts do not expect a complete decontrol of urea prices. That is because the government pays a large amount of the subsidy which, if removed, would lead to a significant rise in prices and hurt farmers. They expect a gradual and phased subsidy cut so that the impact on farmers is not immediately seen.