May 4, 2004|
Fertilisers: The way forward
The last three to four years have been a difficult phase for the agricultural sector. Realising the importance of the sector in terms of employment opportunities (direct and indirect) and its impact on the economy's growth, the government talked about the second green revolution. If it were to materialise, agriculture related sectors could see a fillip. Fertilisers is one among them. While growth prospects are promising, is it going to be a smooth ride?
Before going any further, a brief look at the historical sector performance is of significance. We would restrict our analysis to urea for now. Production and consumption of urea, post the deregulation era has grown at a CAGR of 3.6% and 2.9% respectively (FY92-FY03). However, consumption of urea grew at a faster pace in the first half of 1990s as compared to the later half. In the last five years, as per industry statistics, urea consumption has declined owing to various reasons like fall in area under cultivation, poor rainfall and decline in farm output. But how has the industry performed over a much longer term horizon?
A look at the graph above clearly reflects the state of the Indian agricultural sector. While urea consumption grew at a robust pace in the 1970s and the early 1980s (this was the first green revolution period), in the last decade, growth has tapered down significantly. The reasons for the same are not different from what we have mentioned for the decline in urea consumption in the last five years. Obviously, lack of adequate irrigational facility and the consequent dependence on monsoons have had a impact on the agricultural sector and on urea consumption. As per the agricultural ministry, average yield per hectare for food grain has seen a meager 2.5% CAGR in the last ten years.
Having looked at this historical snapshot, what lies ahead of the fertiliser industry? As per the tenth plan of the Fertiliser Ministry, demand for fertilisers, as a whole, is likely to grow at CAGR of 4.1% over the next five years. The reason to cheer also stems from the fact that demand is likely to outstrip supply in the next three years and as a result, efficient players are likely to benefit from such a trend. As per Indo-Gulf, the shortfall is estimated to the tune of 0.3 million tonnes over the next 2 to 3 yrs. So, one has no second thoughts about demand prospects. But whether this growth is likely to be profitable or not is the moot point.
Fertiliser sector involves subsidies and where there are subsidies involved, there are grey areas in government policies. Without going into the complexities of the fertiliser policy, the industry has transitioned into a second phase of de-regulation. Under this policy, the subsidy to be paid to those efficient urea manufacturers will be the same as the inefficient ones (classified on the basis of groups). So, even if players like Tata Chemicals and Indo Gulf are efficient in terms of energy usage, for the next two years, the current policy is likely to be unrewarding for these manufacturers. So, how will it impact performance?
For one, we see demand growing at a faster rate in the next five years. While volume sales will be higher, manufacturers are likely to witness pressure on margins owing to reduction in various subsidies.
Margin pressure is also likely to be a result of the de-regulation in the gas sector. The ministry has been contemplating of increasing gas prices for some time now and if it were to happen, cost related pressure could increase. Natural gas consumption accounted for 38% of sales for Indo Gulf.
Considering the fact that natural gas based urea plants are far more cost efficient, the existing naphtha based units are likely to convert into gas based plants in the future. Those units that do not have access to gas in a cost-efficient manner are likely to shut shop. The government could thus allow efficient players to increase capacity utilisation to compensate for the decline on the supply side instead of imports. So, industry leaders are likely to benefit.
Having looked at the broader industry trends, what should the retail investor do? First, it has to be understood at this sector is likely to grow at a steady rate of 4% to 5% in the future. Expectations have to be toned down from this perspective. Like the telecom industry, the process of de-regulation is likely to be painful and to that extent, it is a very long-term sectoral play. The industry is also vulnerable to competition from imports (though there is a 40% gap in prices at this juncture, it is likely to narrow in the long-term). Therefore, the most efficient players are likely to be the major beneficiaries.
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