New Age in Fertilizers

World over, the issue of global warming has assumed paramount importance. Environmentalists are at loggerheads with industrialists, traffic cops are gunning at soot emitting vehicles, developed nations are in a war of words with developing and underdeveloped countries on the issue of global warming and its ill effects on the world ecosystem.

The increased concern and awareness on global warming has led to adoption of bio fuels as a viable alternative to the burgeoning energy demands of the world. With crude oil at $137 per barrel, bio fuels are slowly emerging as a viable alternative. Bio fuels emit 75% less CO2(Carbon Dioxide) when compared with the fuel variants of crude oil. As a result, the increased demand for bio fuels has over the last few years led to agricultural land being diverted towards ethanol and other bio fuels production. These bio fuels can be produced from corn. So farmers have shifted their harvesting activities from producing foodgrains to producing corn. Corn production requires increased usage of fertilisers and has led to the upshot in fertiliser prices internationally. The resultant fall in supply of foodgrains has resulted in the recent food crisis engulfing the globe with demand spiking unabated in a disproportionate manner. Food prices have hit the roof and have spearheaded the inflationery scenario prevailing all over. The global fall in foodgrain production has brought back renewed focus into agriculture. We all know that land is not a cultivable asset. We cant create more land. Therefore with its limited availability, what can be done is to increase the productivity of land, which in turn requires balanced usage of fertilisers.

In all this melee, the ones laughing all the way to the bank are the corn farmers and global companies engaged in fertiliser business. The price of corn has moved up from $3.05 per bushel to $4.28 per bushel in the space of 12 months, so have the prices of fertilisers like Urea, phosphates, DAP and MOP which have trebled in the last one year. When prices of fertilisers go up, the positive sentiment will also be echoed by fertiliser stocks listed in the capital markets. Even though, Indian fertiliser industry is still highly regulated, fertiliser stocks listed on the NSE and BSE have given returns ranging from anywhere between 60-120% in the last one year from May 2007 to May 2008 whereas the Sensex has yielded only 12%. Some standing examples are Tata chemicals, Chambal fertilisers and GNFC.

Lets analyse the reasons for investor interest in these fertiliser stocks and the issues plaguing the industry in general:

The Indian fertiliser industry has been the government's holy cow for times immemorial. It has suffered from a controlled regime with archaic regulations plaguing its growth and development. Agriculture is expected to grow in India @4% p.a and therefore fertiliser industry can also be expected to grow at a similar rate in the country. The demand -supply dynamics prevailing internationally for fertilisers will not be applicable to India due to the fact that fertiliser as a segment has not yet been decontrolled. Its still subject to government fiat and pricing. Therefore there is no proper price discovery for fertiliser products in the country. The domestic farmers are protected from the vagaries of international fertiliser prices,which to the government is more important than the bleeding fertiliser manufacturers who are forced to sell at below cost,at MRP (Max retail prices) fixed by the the former.The MRP for different categories of fertilisers are determined through a complex formula under the NEW pricing Scheme (NPS)that works proportionately to import parity pricing but ultimately forces fertiliser manufacturers to sell their produce at below cost price. As we all know vote bank politics holds sway over reforms in our democracy. The difference or underrecoveries as they are called is compensated in the form of bonds by the GOI.

Urea, DAP and MOP come under the controlled regime of the government whereas potash and phosphatic fertilisers were decontrolled a few years ago. Due to the government's subsidy schemes for Urea, farmers began deploying it excessively for their crops without regard to the soil texture leading to depletion in quality. The right targetting of subsidies and delivering the same on nutrient based needs would have gone a long way in improving agricultural output in the country. Successive governments have clearly missed the bus here.

There has virtually been no capacity addition in fertiliser production for the last fifteen years due to the unfavourable policies of the government. Export of fertilisers is also banned by the government, inspite of which we face a supply shortage which is assiduosly met through imports by government agencies like STC and FCI.The internal demand for fertilisers has pushed up the global demand and the concomitant rise in international fertiliser prices.

Major industrial players as well as existing corporates in this sector are shying away from fresh investments due to the following reasons:

1. Archaic fertiliser policies of the government
2. Non availability of feedstock for urea and phosphaic inputs
3. Cost plus pricing with huge underrecoveries for fertiliser producers resulting in
losses and thereby lack of investor attention
4. Uncertainity on receipt of government subsidy and lack of adequate compensation
through cash. Almost a significant portion of the government subsidy is granted
through bonds which are not highly liquid and have to be liquidated at a discount
to meet under-recoveries.

So after perusing through all the above points, the immediate question popping up in the reader's mind would be "How is it that the fertiliser stocks are outperforming the Sensex despite the above concerns??" Read further for your answers:

The government's fertiliser subsidy burden has risen from Rs.11,000 crore in 2003-2004 to an estimated Rs.90,000 crore as per the latest figures available. With its fiscal targets going awry, food crisis deepening and food inflation going out of control, the government has finally decided to wake up from its long slumber and has started looking at framing a new fertiliser policy by next month. Even if this gets tabled in the parliament soon, i dont think we would have concrete reforms happening in this sector until elections get over. As a first step to attract investments, this sector has been placed under priority list. The non availability of gas as a feedstock has been hampering the growth of this sector for a long time. However with gas expecting to flow from the KG basin by mid 2009, this problem gets addressed. Moreover, the government has asked all fertiliser plants to convert to gas based plants from existing naphtha based plants to reduce the cost of feedstock and make fertilisers more affordable to one and all. The advantage is that gas is cheaper than naptha by over 2.5 times.

Some of the appealing schemes proposed under the policy are :
1. Change in investment policies for Urea and phosphates, capital subsidy and fiscal
benefits for capacity expansion
2. Revival of sick public sector units engaged in fertiliser production
3. Decontrol of Urea and correcting the nutrient imbalance
4. Subsidy targetting through cash on a monthly basis instead of bonds wherever
required.

The most important issue of "pricing" has however not been touched upon so far. Most of the industry players are asking for an "import parity pricing" until domestic production comes on steam. However the sector as such being a sensitive one for any government, pricing aspects will continue to be controlled to protect the interests of farmers. The government will atmost tinker around with the pricing to the extent of reducing its subsidy burden to manageable levels.

Notwithstanding the above negativities, the fertiliser stocks are fancied upon and will continue to be fancied by investors for one or more of the following reasons:

1. Most fertiliser companies have over the years derisked their business model by
venturing into the chemicals business. Most companies derive only 50% of their
revenues from fertilisers now and the balance from chemicals. Internationally,
prices of soda ash have skyrocketed and firmed up, boosting the bottomline of
these companies.

2. Supply of gas from KG basin by 2009 which will ease out supply concerns.

3. The promising future that beholds agriculture and its allied sectors like
fertilisers

4. Stable cash flows from fertilisers and chemicals, attractive dividend yield even
if the rise in international fertiliser prices have not benefited Indian
companies .

5. Share prices have also run up based on expectations from the government on the
new fertiliser policy and the attractive schemes and measures that it may contain
to attract private investments into this sector.

6. Growth Rates in this industry are expected to outperform growth rates in
agriculture. The fact that even bio fuels would require usage of fertilisers has
almost lead to demand rising by 10% p.a globally.


All in all, fertile times ahead in the horizon for both industry players and investors.