For investors seeking to play the agri-theme in India, the fertiliser industry must surely rank as the least attractive, with the government controlling selling prices of the end-product at artificially low levels (even in ‘decontrolled’ fertilisers), production losses met by Central subsidies, high import dependence for raw materials and the vagaries of the monsoon deciding sales.
But Coromandel International (refer our call dt January 14, 2021 in Prime Stocks list), one of India’s largest fertiliser makers, has honed its skills at navigating this minefield. It has built scale wholly through internal accruals, used backward integration to gain control of margins and flexibly changed its product mix to navigate the tricky regulatory environment, in the process delivering steady improvements in profit margins, high return on capital employed, earnings and dividend per share growth in the last five years.
Despite the stock price vaulting 2.5 times in the last five years, the stock’s trailing price-earnings ratio has remained unchanged at 18 times, thanks to its per share earnings growing from Rs 16.4 in FY17 to Rs 45.6 in FY21 (FH) on a trailing 12-month basis. The stock makes for a sound portfolio addition for long-term investors.
#1 Bright agricultural prospects
Coromandel International’s revenues and sales volumes from its nutrient and crop protection businesses are directly dependent on the spatial and temporal spread of the monsoon. Two consecutive years of good South-West monsoons both in 2019 and 2020, have led to strong product offtake both over FY20 and the first six months of FY21 – despite Covid-related hiccups.
In the first half of FY21, the company’s phosphatic and complex fertiliser sales (about 80% of revenues) grew by 15% year on year to about 19.5 lakh tonnes. This was on the back of a 4% growth to 31.4 lakh tons in the whole of FY20. The crop protection business saw a 35% growth.
With post-monsoon showers bolstering reservoir storage, the ongoing Rabi season is expected to see good sales momentum too. While sales growth over the longer term will depend on monsoon performance, Coromandel has in the past demonstrated an ability to hold onto its topline by focussing more on crop protection products and specialty nutrients businesses, at times offtake in the core fertiliser business is uncertain.
#2 Positive policy tweaks
Despite much talk of ‘reform’ and ‘decontrol’ of India’s fertiliser industry for a decade now, actual reforms in the sector have moved at a snail’s pace. Very little progress has been made on correcting the nutrient imbalance by nudging farmers to use less urea and more of complex (NPK) and phosphatic fertilisers (DAP and SSP). With selling prices fixed at one-fourth of costs, urea remains far cheaper than complexes and continues to be the preferred nutrient. While complex and phosphatic fertilisers are ‘decontrolled’ on paper, they are sold below cost of production with the Government compensating manufacturers through a Nutrient-Based Subsidy (NBS). The quantum of this subsidy sets selling prices, depriving producers of pricing power.
Disintermediating the industry from the subsidy equation and making payments directly to farmers via Direct Benefit Transfers (DBT) is in the works. Should this move materialise, it would force both urea and NPK makers to substantially raise selling prices as their subsidy payouts from the Centre would vanish. While this would definitely cause immediate upheavals, as a phosphatic fertiliser maker, Coromandel could eventually benefit if farmers switch to more balanced fertiliser use; among NPK producers its cost efficiency could help Coromandel hang on to its market share.
While big-ticket reforms that would really free up the industry and endow it with pricing power haven’t seen the light of the day yet, many small-ticket changes have worked in favour of producers like Coromandel in the last five years. A move to NBS where the government pegs its subsidy payouts for N,P and K to input prices, a bridge loan facility for producers to tide over subsidy delays, the use of Point of Sale terminals to track and rein in urea consumption and the use of DBT on a pilot basis have made life easier for producers. Recent PM Kisan payments and the focus on improving far incomes have also helped.
Going forward, while one cannot expect miracles from the new farm laws, a holistic focus on farm incomes rather than support prices and better market prices for farm produce would augur well for Coromandel.
#3 Protecting margins
Despite subsidy delays and uncertainties, Coromandel has retained control of its EBIDTA margins through multiple strategic moves.
- One, it has tilted its production capacity in favour of NPKs, while importing low-margin DAP to sustain some pricing power. It has added nurtured unique NPK combinations in its portfolio (such as 28:28:0) that allow for both branding and pricing power. Unique products accounted for 37% of revenues in FY21.
- Two, it has made conscious efforts to increase the contribution of non-subsidy products like crop protection chemicals, neem-based bio pesticides and water soluble nutrients. Over five years, the share of such products in revenues have risen from 17 to 21% with a higher share of EBIDTA. Coromandel has built traction in crop protection through inorganic acquisitions, working on a pipeline of off patent molecules and investing in manufacturing facilities for new molecules. In FY20, for instance, it commissioned three new facilities to manufacture Pymetrozine, Pyrosufuron and Mancozeb WDG.
- Three, it has tried to shield its EBIDTA margins from wild swings in the prices of inputs like phosphoric acid by acquiring overseas stakes in phosphoric acid suppliers and investing in backward integration into phosphoric acid. This gives it a cost edge over rivals who rely on imported inputs. The sharp spike in Coromandel’s EBIDTA margins from 11% in FY19 to 16% in FY21 FH appears to be the result of unusually low phosphoric acid and ammonia prices triggered by Covid and may normalise to 12-13%. But product mix flexibility and backward integration may help it hang on to some margin gains for good.
A tight rein on inventories and working capital, positive cash flows from operations and a focus on paying down debt have led to a sharp lightening of the debt on Coromandel’s balance sheet in the last couple of years with borrowings dipping from Rs 2957 crore in FY19 to just Rs 143 crore by FY21 FH. The resulting interest savings have bolstered net profit margins. Going forward, the company budgets for capex of Rs 400-500 crore a year towards debottlenecking of its fertiliser units, but this can be managed from internal cash flow generation.
Despite operating in a cyclical industry prone to payment delays (from the Government), Coromandel has maintained stringent financial discipline, never diversifying into unrelated areas, keeping a check on debt-equity and not resorting to frequent equity dilution. Like other Murugappa group firms, it has also been regular in sharing profits with shareholders through rising dividend distributions, with dividends per share rising from Rs 4.5 to Rs 12 over five years. The financial discipline has delivered significant improvements in Return on Equity (from 17% to 24%).
Coromandel International is the second largest phosphatic and complex fertiliser producer in India with a manufacturing capacity for 45 lakh tonnes. It has a NPK (nitrogen phosphorous and potassium fertilisers) market share of 16%, with its flagship brand Gromor enjoying strong brand recall across South, East and West India. Apart from fertilisers, it has manufacturing capacity for 80,000 tons per year of crop protection products and exports to 81 countries with 1000-plus product registrations. It’s a market leader in neem-based bio pesticides and water-soluble nutrients and makes organic fertilisers as well. It has 16 manufacturing plants and markets its products through a nationwide network of 20,000 plus dealers and 750 rural retail outlets with direct connects with 30 lakh farmers.
Risks to recommendation
- Agri-inputs being highly regulated, any sudden about-turn in government policies favouring chemical fertilisers or knee-jerk regulatory actions (such as the proposal to ban 27 ‘old’ pesticide molecules) can pose speedbumps to Coromandel’s profitability and growth. So far though, the political sensitivities of alienating farmers have stayed the Government from pushing ahead, after announcing such measures.
- Volatile prices of global inputs such as phos acid and ammonia or government intervention in pricing pose key risks to profitability.
- Bad monsoons can contribute to a year or two of muted growth or profitability.
- A switch to direct transfers of subsidies could lead to short-run upheavals in offtake and thus sales and profits.
Despite operating in a cyclical industry, Coromandel has managed predictable financial performance. The stock has delivered good returns with low volatility relative to the market, with half the beta of the Nifty50. This makes the stock a moderate risk addition to your portfolio.
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