Can The Fertiliser Industry Reap A Rich Harvest?

The recent energetic performance of the fertiliser stocks has raised doubts as well as anticipation, tempting some investors to foray into this territory. Anthony Fernandes takes a retrospective look at this beleaguered sector to know if the government’s recent policies and the forthcoming Union Budget have put wind in its sails 

After an almost lacklustre performance for the past couple of years, the fertiliser industry has come into the reckoning with many stocks bouncing back sharply from their lower levels. This has put a number of stocks from this industry into the limelight just before the upcoming Union Budget 2020. It has also drawn our attention to the returns this industry has given in and around the budget for the last couple of years to determine whether one can bet on these stocks. However, before we go on to analyse how these stocks have performed, we need to have a brief overview of this industry and understand the role the government has played in its development and the challenges it currently faces.

With more than 1.3 billion people or roughly 18 per cent of the world’s population, India is the second-most populous country in the world after China. However, in comparison to its population, the agricultural land and freshwater resources in the country are pitifully low, accounting for a mere 4 per cent of the global resources. This understandably results in a lot of pressure on the resources of the country to produce enough food, livestock feed and fibre for its massive population. However, this challenge also presents a massive opportunity for companies such as those in the fertiliser business to play a critical role in the endeavour of feeding the country.

India is the second-largest consumer of fertilisers in the world. Among the various types of fertilisers used, urea is by far one of the most consumed in India as a source of nitrogen. The Indian government is working towards increasing production of urea in order to achieve self-sufficiency and end imports by 2022. On the other hand, DAP, which is the second most widely used fertiliser after urea accounts for just 9-11 per cent of the production in India. Thus, there is a glaring lack of balance in the use of urea and other nutrient-based fertilisers. 

Government Support Measures
Considering the role the fertiliser industry plays in terms of assuring food quality for the country, it should come as no surprise that this industry is highly regulated and monitored by the government. The sale, price and quantity of fertilisers have been regulated by the Fertiliser Control Order (FCO) which lays down what substances qualify for use as fertilisers in the soil, product-wise specifications, and procedure for obtaining registration as a manufacturer of fertilisers. Additionally, the government has been offering heavy subsidies to this industry over the years by reimbursing the difference between the cost of production and the price at which the fertiliser is sold to the beneficiaries.

According to the FY20 budget, Rs.79,996 crore was allocated to the fertiliser industry to be given as subsidy which included Rs.53,629 crore set aside for urea subsidy and Rs.26,367 crore designated for nutrient-based subsidies. On the whole, subsidies have been incrementally increased by Rs.10,000 crore for FY20 or 14.1 per cent. In March 2019, the industry received Rs.10,000 crore under a special banking arrangement. However, there is still a significant subsidy backlog of Rs.30,000 crore in the industry.

Apart from subsidy support, the government has also launched several initiatives to promote the development of this sector. Some of the initiatives are mentioned below. In May 2015, the government introduced a new urea policy which came into effect from June 2017 with the main purpose of ensuring that maximum production of indigenous urea was undertaken by putting energy to its most efficient use, which in turn would help rationalise and bring down the subsidy burden. This policy aims to make the domestic urea sector competitive in terms of energy efficiency by linking incentives with annual energy consumption.

The cost of gas is the most important component for the production of urea and its prices vary due to differential rates at which it is imported and the cost of transportation. To combat this issue, in July 2015, the Gas Pooling for Fertiliser Sector Policy was launched with the intent of bringing down the cost of fuel for manufacturers and providing natural gas at uniform delivery prices to all natural gas-connected urea manufacturing plants. 

Perhaps the most important initiative taken by the government is the Direct Benefit Transfer (DBT) program in the form of pilots in 14 states in 2018. Under this program, farmers make purchases at subsidised rates from input dealers using their Aadhaar identity cards for authentication at the point of sale. The payment on account of subsidy is credited to the fertiliser companies using a dedicated electronic device only after the retailer has completed the sale. This program is expected to help curb the issues related to diversion and smuggling of fertilisers and will ensure that government subsidies directly benefit the Indian farmer. Besides providing greater transparency, accountability and efficiency in the system, this program will also provide vital information on trends in fertiliser purchase. 

Pritam Deuskar
Fund Manager, Bonanza Portfolio

Outlook on Fertiliser Stocks
The real problem of this sector is the imbalance in the policy for fertiliser subsidization: while urea is subsidised to the extent of 75 per cent of its cost, this is only 25 per cent for phosphorous and potassium-based fertilisers. If used in excess, it can damage the fields, leading to low fertiliser-to-grain response ratio and degrading soil and underground water. I hope they incentivise the natural fertiliser procurement to considerably encourage usage and have better soil. There were speculations that the fertiliser subsidy would double to Rs.1.42 lakh crore in 2020-21 compared to the revised amount, which we feel is too optimistic. The subsidy demand requirement of the fertiliser companies, both state-owned and private, is Rs.1.12 trillion. Considering that the government may touch up to Rs.80,000 crore, it should further be combined with smooth digital systems to increase the efficiency of subsidy transfers to the farmers through DBT. 

Challenges
One of the major challenges facing the industry as a whole is the concept of zero-budget farming, which is a set of farming methods that involve zero credit for agriculture and no use of chemical fertilisers. There has been an increased adoption in states such as Andhra Pradesh and Himachal Pradesh that have been aggressively driving the shift to this model. This concept has been gaining prominence and could pose a threat to the chemical fertiliser, especially after the finance minister’s emphasis during the budget of FY20 that zero-budget farming will help double farming in days to come. Besides the looming threat of zero-budget farming, the industry also faces a common issue of not getting subsidy amount on time due to budget constraints. 

As mentioned earlier, subsidies of almost Rs.30,000 are yet to be disbursed by the government. This has led to an increase in borrowings which has, in turn, led to a deficiency of working capital for the companies in this industry.

A lot is being said about DBT and the revolution it will bring about in this industry but there have been conflicting reports about its usefulness. The underlying problem being that under DBT the sale would be registered only when it is made to the farmer or the end-user. This leads to the manufacturers bearing the cost of inventory. Moreover, the implementation of this program is facing hiccups amidst the uptick in raw material and after-effects of GST. The slow refunds are not making things easier either, with significant money stuck in the tax system, thus worsening the working capital situation.

Financials of Fertiliser Companies

To find out the effect these government initiatives and subsidies have on the industry over the last few years, we have studied the financials of 24 companies in the industry. 

The performance of the companies in this industry largely depends on various factors such as variability in the rainfall, the type of crop being sowed (Kharif or Rabi), the change in subsidy support for that year, and the channel inventory level. The implementation of DBT, which was launched officially pan-India in March 2018, led to an increase of revenue of 11.74 per cent in FY18. This was largely on account of the sales being recorded and streamlined via the issued POS machines, curbing any misappropriation of the government subsidies. Further stabilisation of the system during FY19 has led to an additional increase of 17.31 per cent during this period. On the profitability front, DBT has helped in faster subsidy clearance for the manufacturers of fertilisers. However, the increase in the cost of key inputs like natural gas and phosphoric acid during FY19 led to a decline in the profit margins for the companies in this sector.

Empirical Study
If we look at the data for returns given by companies in the fertiliser sector during the periods of the Union Budget for the past five years, we find that the stocks have not given adequate returns post the budgetary announcements. With the exception of 2016 and 2017 where fertiliser stocks gave positive returns, the stocks gave negative returns post budgets in 2018 and 2019 despite government intervention through subsidies. This indicates that other factors such as the level of rainfall in the country and prices of raw materials such as natural gas – which is a key source of fertilisers in the form of ammonia and urea – played a more definitive role when it comes to returns from stocks in this industry. 

Outlook
DBT may be the first step in resolving the structural problems being faced by the fertiliser sector. However, the government has to take steps to deal with the rising raw material costs and the worsening of the working capital situation due to GST and DBT implementation. Increasing the domestic production of fertilisers and reducing dependence on imports is said to be the prime areas for focus in the Union Budget of 2020 for the fertiliser industry. The government may cut import duty on raw material like rock phosphate and sulphur used for manufacturing of DAP, one of the fastest-growing fertilisers. There has also been talk of deregulation of urea prices which will help with overcoming the issue of skewed fertiliser application on an inter-regional, inter-state and inter-district level. If the government can usher in these fundamental reforms and move towards direct cash transfers to the intended beneficiaries, it will go a long way in setting this sector on a sustainable growth path.