sh-2014-q1-1-icra-fertilisers

Subsidy

Urea MRP

Profits

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The NBS Trajectory, Urea and Subsidy Woes

for the Fertiliser Industry

I C R A L I M I T E D

SUMMARY

Activity on the regulatory front, but movement on retail price of urea awaited; demand outlook better as global prices

favourable, though challenges abound for industry as subsidy delays to rise going forward

Non-urea fertiliser channel inventories getting cleared although inventory remains moderately high; regulatory measures, difficult operating environment and subsidy

delays lead to pressure on industry financials: FY14 was an year of transition for the fertiliser industry as well as for all the stakeholders, particularly in the non-urea segment.

While urea sales volumes continued to grow at a stable long-term average of 3%, non-urea fertilisers witnessed a significant volume decline when one looks at the company level

data, even though retail sales may not have been impacted as significant amount of channel inventory got cleared. The decline in fertiliser inventory and sales volumes is

expected to be positive for the industry going forward as companies look at revival of demand for improving profitability that has been significantly impacted over FY13-FY14,

particularly for the P&K segment. The aggregate operating profitability of the eleven listed entities has declined from an average of 13% over FY06-FY11 to 10.9% in FY13 and

8.1% in 9m FY14. Net profitability has witnessed a further decline from an average of 6.4% over FY06-FY11 to 3.6% in FY13 and a meagre 1.9% in 9m FY14 as companies faced

higher interest costs due to high working capital borrowings to fund high trade and subsidy receivables as well as significant forex losses incurred by the companies over H1

FY14. While demand outlook has improved, inventories at the retailer level continue to remain moderately high. This may lead to relatively moderate volume growth in FY15

depending on the monsoon scenario. However, ICRA Research anticipates that imports of non-urea fertilisers will post a 15-20% growth in FY15, although overall volumes may

not cross FY13 levels. Companies carrying inventory from 2012-13 have been impacted in terms of profitability as the DoF induced reduction in prices led to 2012-13 inventory

being sold at lower MRPs. While this measure led to extra-ordinary losses for the industry in FY14, ICRA Research believes that it will have a positive impact in the coming years

as the responsibility of managing systemic inventory levels while managing competitive pressures has been imposed on the industry by the DoF, which may lead to some

cooperation in the industry despite the tough competition. It should also lead to rationalisation of imports by the fertiliser industry, given that proliferation of cheap imports has

been partly responsible for increased systemic inventories in FY13 and YTD FY14. Going forward, collective action at the industry level to control inventories may help the

industry avoid liquidity-related issues it has faced over the past two years. Nevertheless, subsidy delays by the GoI on account of pressure on the fiscal deficit have led to

increased regulatory risks for the industry and significantly impacted the industry profitability in recent years.

International urea prices to remain low due to Chinese oversupply, while increase in urea retail prices appear imminent as gas prices rise: Global urea prices increased

post Oct’13 as the low Chinese export tax window came to a close in October 2013, which led to a temporary spike in international urea prices over Nov’13-Feb’13. However, with

the Government of China having set new export tariffs for fertiliser products, which are significantly lower than the earlier levels and with Chinese urea capacity in significant

oversupply (~30% of the Chinese capacity), it is expected that urea prices would continue to remain under pressure in the near-to-medium term. ICRA Research estimates that

urea prices over the Chinese peak season will remain at relatively lower levels and are not expected to touch USD 400/MT as seen over the past few years, barring in case of a

substantial rise in coal prices given that Chinese urea is primarily based on coal gasification. Further, the oversupply situation is expected to continue in the medium term as

annual capacity additions are likely to exceed consumption growth. In view of these Chinese developments impacting international prices and high gas prices, the domestic

industry would be hesitant with regard to adding new facilities without a government commitment on providing reasonably priced gas over the long-term.

The GoI has taken a few regulatory measures, which should aid the profitability of the urea industry to some extent. Fixed costs for urea have been hiked by Rs. 350/MT for an

year, while a gross margin of USD 40/MT has been fixed for production beyond cut-off quantity for revamped units. Further, the GoI seems to have taken a view of the pressure

on global prices and lack of availability of domestic gas while amending the New Urea Investment Policy 2012. While the contours are not clear pending notification of the

amended policy, the onus would be on the industry to sell urea domestically to become eligible for subsidy as the provision for guaranteed buyback of domestically produced urea

has been removed. While demand-supply gap exists, the DoF has kept open the option with itself to import urea in case of substantially low international prices. On the other

hand, with the increase in domestic gas prices, urea subsidy is anticipated to increase by ~60-80% of current subsidy levels per MT of urea. This would lead to further pressure on

the liquidity position of the companies. Besides, subsidy budgeting in the interim budget has only partly accounted for the increased subsidy levels. ICRA Research believes that

the subsidy gap will only rise by end-FY15 unless any reform measures are implemented for the industry. With the gas price hike and liquidity pressures on the industry, increase

in urea retail prices appear imminent post the general elections, possibly from FY16 onwards as the increase in fixed costs would be for an year, i.e. for FY15 only.


Subsidy delays likely to continue in the medium term; pressure on industry profitability and liquidity: The interim budget for 2013-14 has provided for a subsidy of Rs.

680 billion for 2014-15 – at the same level as the revised estimates for 2013-14. The subsidy provisioning is substantially lower than the estimated requirement of ~Rs. 1.05

trillion. With part of the Special Banking Arrangement to be cleared from the budgeted subsidy and increased subsidy for higher gas costs and rise in fixed costs of urea players,

ICRA Research anticipates the subsidy requirement for FY15 to be of the order of ~Rs. 1.1 trillion (including carryover subsidy). Hence the subsidy gap will rise from ~Rs. 370

billion as of end-FY14 to ~Rs. 410 billion as of end-FY15 unless any reform measures are implemented for the industry. The impact of increased debt requirements over FY12-

FY14 has put pressure on the industry finances. Aggregate gearing of listed fertiliser companies rose from 0.69 times in FY11 to 1.37 times as of end-FY13, with significant rise

in short-term debt levels, while the aggregate interest coverage declined from 8.08 times in FY11 to 2.75 times in 9m FY14. With subsidy delays likely to continue leading to high

borrowings and weak liquidity, the financial performance of the industry is expected to continue to remain subdued in the near-to-medium term.

The NBS cycle over FY11-FY14 and diverse response from various stakeholders: The transition period post the implementation of nutrient-based subsidy for non-urea

fertilisers throws several key conclusions for the various stakeholders – domestic and international fertiliser entities, the GoI and the consumers. The role played by India in the

P&K fertiliser space has been accentuated by the recent decline in global prices due to weak demand from India. It has become imperative for both suppliers and customers to

cooperate on a long-term basis for sustainable benefit and financial performance. International players have witnessed weakened financial performance recently as substantially

high prices in previous years led to lower volume off-take. ICRA Research believes that better coordination between suppliers and customers may be mutually beneficial to

maintain a healthy supply-demand balance going forward. Further, the role of subsidies was to act as a cushion for farmers to absorb the high prices of fertilisers. Instead, global

and domestic players have tried to use the subsidy structure to their advantage at times, leading to the DoF acting to protect its own interest. This has hurt the profitability of the

domestic industry. It has also shifted the focus of managing inventories and competition on the industry. This will prove to be a significant challenge for the industry going forward

as it will need to coordinate to control market inventories while competing for higher market share. Finally, the end customers have witnessed significant price volatility, which

was reflected in reduced demand of various fertilisers. To protect the long-term interests of all stakeholders by achieving the right balance of pricing that aids demand while

ensuring profitability for the industry will be a key focus of both the GoI and the industry going forward. Stable prices may help ensure relatively stable demand, which again

depends on the ability of the industry to tie up resources on a long-term basis at reasonable prices.

Removal of guaranteed buyback to raise risks for investments in the urea sector: The CCEA has cleared the amendment of the NUIP-2012 by removing the word

‘guaranteed buyback’ for new urea projects. Consequently, in case of excess supply, subsidy would be paid only for actual sales of urea in the domestic market. For investors

setting up new plants, this would increase marketing risks as the companies would need to ensure optimum capacity utilisation for setting up such highly capital-intensive

projects. The DoF appears to have taken the decision to ensure that excess capacities do not get set up, leading to excess subsidy outflow from the GoI. Further, with import

prices likely to rule low in the foreseeable future, the DoF would have anticipated limited subsidy outflow even in case imports were to increase – particularly given the scenario

that gas in adequate measure would not be available domestically and many of the projects will likely depend on imported R-LNG.

Better demand outlook anticipated for FY15 but industry performance may remain muted: The industry performance has remained weak over the past two years due to

various issues affecting the industry – demand slowdown, forex volatility, subsidy delays and excessive channel inventory. While demand outlook for FY15 appears better, the

industry will contend with a lot of uncertainties in FY15: (i) Increase in gas prices (ii) Continuing weak rupee (iii) Subsidy delays. Nevertheless, there are positives in terms of

weak global prices of fertilisers and raw materials, which should lead to lower prices of P&K fertilisers and aid demand to some extent. Increase in fixed costs for urea is also a

positive and will aid industry profitability. Liquidity issues are likely to remain as subsidy delays are likely to continue. Any reforms on the urea retail pricing front post the general

elections will benefit the industry. ICRA Research believes that reforms on the urea pricing front are imminent in view of increased gas costs, subsidy burden on the GoI and

liquidity pressures. Further, changes taking place in the global demand-supply order should lead to some stability in terms of prices and volumes in the years to come, which may

help the Indian industry. Overall, while demand outlook appears positive, the industry faces significant challenges, particularly on the subsidy front in FY15.


Subscribe to the Full Report for details on the following...

I. Brief update of the Indian Fertiliser Sector

Trends in fertiliser consumption in 11m FY14 vis-a-vis 11m FY13

Impact of regulatory actions on industry financials in FY14

Demand and pricing outlook for P&K fertilisers in FY15

How Chinese urea oversupply will impact Indian urea investments

II. Outlook on Urea Prices

Increase in urea fixed cost compensation and pricing policy for revamped units

Impact of increased gas costs on projected subsidy levels

Why price outlook for the urea sector appears imminent

III. The NBS Trajectory: Actions of and Impact on Stakeholders

Actions of the GoI, domestic and international industry and farmers to each other’s actions post NBS implementation

India’s role in international trade

Impact of subsidies on global prices

Impact of NBS on domestic industry and farmers

IV. Subsidy Woes for the Fertiliser Industry

Interim Budget, Special Banking Arrangement and Projected Subsidy Levels

V. New Urea Investment Policy: Amendments & Industry Outlook

VI. Brief Coverage on the following fertiliser majors

1. Chambal Fertilisers & Chemicals Limited

2. Coromandel International Limited

3. Deepak Fertilisers & Petrochemicals Corporation Limited

4. Gujarat Narmada Valley Fertilizers & Chemicals Co. Ltd.

5. Gujarat State Fertilisers & Chemicals Limited

6. Mangalore Chemicals & Fertilizers Limited

7. National Fertilizers Limited

8. Nagarjuna Fertilizers & Chemicals Limited

9. Rashtriya Chemicals & Fertilizers Limited

10. Tata Chemicals Limited

11. Zuari Agro Chemicals Limited

VII. A Primer on Subsidy Framework for Fertilisers

Subsidy rates for 2013-14 and changes in subsides for various fertilisers


Please contact ICRA to get a copy of the full report

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