Fertilizer Sector Analysis Report

• India is the third largest producer and consumer of fertilizers in the world with close to 60 large size plants in the country manufacturing a range of fertilizers. The most widely used fertilizers include nitrogenous (N), phosphatic (P) and potassic (K). Potassic fertilizer is not manufactured in India and is imported. The installed capacity of fertilizer industry in the country is about 12 m MT of nitrogen and 5.1 MT of phosphatic nutrients.
• Urea (85% of N fertilizer consumption) constitutes 58% of the total fertilizer consumption in the country. Di-ammonium phosphate (DAP) accounts for approximately 66% of India's consumption of phosphatic fertilizers.
• The nitrogenous fertilizer segment is regulated through price controls. The government fixes two prices: the price at which the manufacturers should sell to the farmers and the retention price, which the manufacturer should have received from the farmer. The government reimburses the difference in the selling price and the retention price in the form of a subsidy.
• In view of the mounting fertilizer subsidy bills, government has finally announced a Long Term Fertilizer Policy in the form of Group Concession Scheme (GCS). This scheme will come into effect from FY04 and will be implemented in three phases. In the first phase (FY04), government plans to neutralize the cascading impact of subsidy by paying the same on the basis of Group weighted average retention price as on April 1st '03, or the retention price, whichever is lower. 'Outliers' i.e., units with very high retention price will however be given concessions. In the second phase (FY05 and FY06), the group concession rates will be modulated by stipulated energy norms and the special treatment accorded to 'Outliers' will be discontinued. In the third phase (FY07 onwards), the urea sector will be fully decontrolled. However, this will depend upon the success of the first two phases.
• The retention price is fixed so as to enable the company to earn a 12% post tax return on net worth. It depends on the feedstock used (whether naphtha, fuel oil, gas or coal) and takes into account the conversion costs, selling costs, interest on debt, and depreciation and capacity utilization of the plant itself. For instance, the capacity utilization norm for a gas-based plant has been fixed at 90%. So if a plant were to operate at 110%, the effective post tax return would work out to 14.67% (12/90*110). Since the price fixed is based on capacity utilization and the cost of production, there are different retention prices for each plant. The above policy is a big positive for the fertilizer industry as it encourages efficient operations and low cost production.
• Also a higher capital cost implies a higher retention price for a plant provided the company is able to meet its capacity utilization norms. This led to the gold plating of costs and understatement of nameplate capacities. Consequently, the production cost of urea in India varies from $100 to $300 per tonne as against a current import parity price, which is almost half of that.
• Natural Gas is used both as fuel and as a feedstock and constitutes as much as 40% of variable cost of manufacture. With increasing use of gas in other industries like power and petrochemicals, the fertilizer industry is facing a shortage of gas. Between 1980 and 2000 while the landfall prices of gas have gone up nine times, urea prices have increased only three times.
• The industry relies heavily on imports for its requirement of raw material. Hence any devaluation of the rupee could inflate its import bill. Since the N-based fertilizers are protected by the retention price system (so far), the increased costs will affect P and K fertilizer manufacturers.

• Supply
• High dependence on imports. Government regulations restrict the production and disallow exports.
• Demand
• Seasonal, depends heavily on monsoon.
• Barriers to entry
• Highly capital intensive and uncertain, government regulations. However undifferentiated products allow new entrants relatively easy entry.
• Bargaining power of suppliers
• High, since the main feedstock, gas, has alternative uses in industries such as power and petrochemicals.
• Bargaining power of customers
• High, as industry/farmers lobby is powerful.
• Competition
• Manufacturers compete on prices.

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• Poor monsoon has adversely affected agricultural production and consequently, the performance of the Indian fertilizer industry. While the food grain production has dropped 13.6% to 183 m tonnes, the fertilizer consumption has fallen by almost 7.1%. Urea demand also fell by over 5.6%. The situation was further dampened by government regulations that have put cap on production and also disallowed exports.
• With all bids falling way below the reserve price fixed by the government, the divestment of National Fertilizers (NFL) has been deferred by atleast two years. Indo Gulf Fertilizers, Chambal Fertilizers and IFFCO were in the race to acquire NFL.

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• Monsoon holds the key to the future prospects of the fertilizer industry. A good monsoon will spurt foodgrains production and consequently the demand for fertilizers.

A long way to go...

Country	Nutrients consumption per hectare of arable land (kg)
South Korea	407
Japan	301
China	254
Bangladesh	156
Pakistan	135
India	98

• As can be seen from the table, India has one of the lowest per hectare of arable land consumption of nutrients. Urea demand is expected to reach 240 lakh tonnes by FY07. At the current capacity levels of 200 lakh tonnes, the demand supply gap is expected to be around 40 lakh tonnes. Moreover, if new capacities are not added, the gap is expected to mount to an astronomical 90-lakh tonnes. The above factors indicate a huge potential of growth for the fertilizer industry.
• The Long Term Fertilizer Policy announced by the government could have significant implications on the fertilizer industry going forward. While, in the medium term, it encourages the switch over from naphtha/fuel oil based units to gas based ones and creation of a regulator to allocate feedstock, over the long term it plans to withdraw the setting of selling price and concession scheme.
• Around 30% of India's fertilizer production, which is based on naphtha and fuel oil could become unviable, with the changes made in the new energy consumption norm. Only the gas-based units will be able to survive the deregulated era. The likely closure of many naphtha and fuel oil based units could disturb the demand supply position in the country and the Indian government may have to import its urea requirements a higher costs.
• Naphtha and natural gas are the key feedstocks for the fertilizer industry. The prices of natural gas have not been increased in the past five years. Although a 12% hike in the natural gas prices has been recommended, the same has not been implemented. Hence, there is a very high probability of the prices being hiked going forward. This could affect production and profitability of the companies in this sector.
• Moreover, in the second phase of The Long Term Fertilizer Policy, the capital related charges will be reduced. Retention price is made up of variable cost and capital related charges. Thus a reduction in the capital related charges could adversely affect the performance of companies with post-1992 gas and naphtha based units.

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		31/03/2003	31/03/2004	31/03/2005
		12	12	12
Net Sales	Rs m	22,105	31,226	36,865
Sales Growth	%	0	41.3	18.1
Gross profit margin	%	70.6	43.1	32.4
PAT	Rs m	3,695	3,106	3,974
PAT Growth	%	0	-12.4	22.4
Working Capital to Sales	%	49.8	43.6	48.5
RoCE	%	51.2	29.3	22.9
RoNW	%	47.9	27.2	26.5
Debt to equity ratio	x	0.2	0.1	0.4
Mkt Cap	Rs m	11,631	24,284	33,955
Mkt Cap / Sales	x	1.0	2.1	2.1
Enterprise Value	Rs m	16,798	37,425	51,709
P/E ratio	x	6.0	13.3	17.5
Price/Book value ratio	x	0.9	1.7	2.3

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Related Links for Fertilizer Sector
Quarterly Results | Sector Quote | Over The Years