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November 2014

AGRI INPUTS

Ritesh Gupta, [email protected]: +91 22 3043 3242

Analyst:

The new dawn!

Agri Inputs

November 24, 2014 Ambit Capital Pvt. Ltd.

CONTENTS

SECTOR

The new dawn! …………………………………………………………………………………3

India agriculture inputs – At an inflection point..................................................... ….4

Agrochemicals and seeds – The mostattractive available………..………………………. 8 opportunities in the agri inputs space

Pesticides – Rising farmer awareness and private efforts to drive growth…….……… 10

Exports a credible large opportunity……………………………………………………..... 14

Indian seeds industry - multiple drivers for growth……………………………….…….. 17

Fertilizers – low returns make the opportunity unattractive……………………….…… 24

Agri Inputs Competitiveness Framework………....……………………………….……... 28

Valuation—rich sustainable multiples, EPS growth to be the …………………………. 36 primary stock return driver Appendix………………………………………………………………………………………. 42

COMPANIES PI Industries (BUY): On a multi-year growth path……………………………………….. 43

Rallis India (BUY): Strong reach and brand……………………………………………….. 73 Insecticides India (NOT RATED): A recovery play?................................................. 101

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

The new dawn!

Transition of Indian farming to commercial from sustenance and continued thrust for farmer awareness by MNCs/local agri input companies should lift growth rates of Indian agrochemicals consumption (14% over FY08-14) furthermost within overall agri inputs. Apart from crop yield boost, specialty needs will be the key change; seeds is also a large opportunity but we fail to see any major sustainable competitive advantages built by a specific player; fertilisers is our least-preferred segment. We map the companies on business model strength, execution, financial/operating efficiency and corporate governance and find PI the strongest (our TOP idea) despite its relatively smaller but quality scalable agrochem business; Rallis (BUY) and Bayer are the next best.

Low penetration rates of agri inputs to support growth rates India has the second-largest arable land but has one of the lowest agri productivities (3 tonne/ha vs 7/6.5 in US/China). Yield enhancement will increase demand for all agri inputs; pesticides/commercial seeds are used only in 30%/25% of arable land and per hectare use is 20% of global average. Rising farmer awareness (access to technology and driven by participants) and labour cost (structural) and shifting consumption patterns (processed food needs) will fast pace the adoption of quality agri inputs.

Agrochemicals is the most preferred sector followed by seeds We assess agri inputs sub-sectors on existing penetration levels, market/product disruption risks, sources of competitive advantages and risks from government policies. We prefer agrochemicals (pesticides) industry (FY14: US$4.2bn revenues, FY08-14 CAGR of 14%), wherein distribution and farmer connect (brand) are the key competitive advantages followed by innovation, which can be supplemented by in-licensing. Lack of systematic approach towards R&D in hybrid seeds would impact the success sustainability of individual players in this space. Government intervention curbs our hopes for the fertilisers sector.

4P star framework—Sieving for the best business model/strength Whilst farmer connect, distribution and brand are the best for Bayer and Rallis, PI stands out as the best for business model strength (strong manufacturing capabilities, leadership in attractive segments) and strong execution track record (effective foray into CSM); Bayer’s relatively weak manufacturing footprint weaken its competitiveness from strong brand/parentage. We find Rallis to be relatively weaker on products and market positioning. Dhanuka stands out as relatively average.

Sustainable rich multiples; manufacturing/reach pose upside risks Our top idea is PI (BUY, TP `580, implied 19x FY17 EPS); PI’s earnings growth and RoCE will remain the highest amongst peers, as in-licensing focus and CSM offer two discernible large opportunities with relatively lower competitive threats. We are also BUYers of Rallis (BUY, TP `275, and implied 19x FY17 EPS), wherein we see earnings recovery from the refreshed R&D focus/alliances-led product launches and improving Metahelix margins aiding growth rates.

THEMATIC AGRI INPUTS November 21, 2014

Agri InputsPOSITIVE

Key Recommendations PI Industries BUY

Target Price: 580 Upside: 32%

Rallis India BUY

Target Price: 275 Upside: 23%

One-year forward P/E - Rallis

Source: Bloomberg, Ambit Capital research

One-year forward P/E – PI Industries


Analyst Details

Ritesh Gupta, CFA

+91 22 3043 3242 [email protected]

8

16

24

32

Nov-09

Nov-10

Nov-11

Nov-12

Nov-13

Nov-14

One-yr fwd P/E 5-yr avg P/E

- 5

10 15 20 25

Nov-09

Nov-10

Nov-11

Nov-12

Nov-13

Nov-14


India agri inputs: 4-Point Star Framework

Parameter Bayer Rallis PI Industries Dhanuka Insecticides

India Kaveri Seeds

Business Model Strength

Execution Track Record

Financial And Operating Efficiency

Corporate Governance

Overall Strength

Source: Company, Ambit Capital research

Agri Inputs


India agri inputs – At an inflection point The Indian agri inputs sector is at an inflection point, with rising awareness amongst Indian farmers to move away from sustenance farming to commercially oriented farming. This rising awareness is a function of improved information access, rising affordability, and entry of an educated new generation of farmers.

Increased efforts from the private sector to educate farmers about the benefits of using quality agri inputs have helped the farmers to derive better commercial value from their produce. In addition, rising MSPs and government spends have benefited sector growth. As a result, the adoption of quality agri inputs (such as agrochemicals, hybrid seeds, and specialty fertilisers) has increased. Factors such as rising labour costs and growing demand for high-quality produce from food processors/organised retailers are leading to higher adoption of quality agri inputs.

Extremely low penetration rates of quality agri inputs except for bulk fertilisers: India’s per hectare pesticide use is significantly lower than the global average (see the exhibit below). Similarly, adoption of hybrid seeds and specialised fertiliser is also low. Only 25% of Indian farmers use commercial seeds; penetration of hybrid seeds is even lower in some crops. Only 40% of India’s arable land is able to take two crops a year due to lack of irrigation and electricity facilities.

India pesticide use is quite low vs global averages Exhibit 1:

Source: FICCI, Ambit Capital research

Only 25% of seeds sown are commercial seeds Exhibit 2:

Source: Ambit Capital research

The key growth drivers for growth in the sector are improved telecom penetration, rising road connectivity, increased intensity on introduction of new products and education of farmers by private players.

Improved adoption of farm inputs Exhibit 3:

Factor Description

Affordability Farmers’ farm economics has improved with better crop realisations, improved availability of credit, better rural connectivity and income supplement from MNREGA growth. Rural connectivity has helped in lowering farm wastage and increasing price realisations.

Better information flow Information flow to farmers has also got better with better road connectivity, enhanced efforts by private players, and higher telecom penetration.

Availability of quality products Product availability too has increased with improved economics for large players, and enhanced distribution reach of organised players.


7

13

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3

0 5 10 15

USA

China

India

World

Agrochemical usage (kg/ha)

Commercial seeds,

25%

Farm saved, 75%

Only 40% of India’s arable land is able to take two crops a year due to lack of irrigation and electricity facilities.

Agri Inputs


Yield improvement - The only way to improve agriculture output With the amount of arable land largely remaining stagnant, per capita availability of land has gone down significantly over the last few years. With limited availability of arable land, the only source of enhancing India’s food production is to improve yields, which would be driven by growing adoption of quality agri inputs and improvement in infrastructure. The Government and private players have taken incremental efforts to push higher penetration of agri inputs in India. India also has a large export opportunity in foods export with efficient utilisation of its arable land which is the second largest in the world.

The amount of arable land in India has been flat Exhibit 4:(mn hectares)


Per capita arable land will decline (in acres) Exhibit 5:


We believe improving yield for India is not structurally too difficult, as agronomic practices in large parts of the country continue to be basic in nature. India’s agriculture productivity is fairly low. India loses as high as a third of its crop yield due to pest attacks whilst India is able to sow two crops only in just 30% of its arable land due to lack of irrigation facilities. India can double up its yield in non-wheat crops with better seed varieties, improved irrigation facilities, improved pesticide incidence, and adoption of better agronomic practices such as soil testing and mechanisation.

India’s yields are one of the lowest in the world Exhibit 6:(tonne/ha)


Indian yields as a percentage of World average Exhibit 7:yields


119

143 141 139 142

1951 1991 2001 2010 2011

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1951 2001 2025 2030

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7 7 6.55 4.5 4 3.8

3

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ium

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USA

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a

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ld

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a

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Rice

Wheat

Corn

Soybean

Rapeseed

Agri Inputs


Growing food demand to put more pressure on yield requirement

Indian food preferences too are changing from direct grain consumption to indirect grain consumption (such as meat, poultry, and dairy) which along with rising affluence will increase per capita food consumption.

ICAR estimates that India’s food grain requirements would jump from 192MT in 2000 to 355MT by 2030 (CAGR of 2%). The required growth in fruits and vegetable would be even higher at a CAGR of 3% (see the exhibit below).

Food demand (MT) Exhibit 8:

Source: Planning Commission of India, Ambit Capital research

Horticulture and dairy demand (MT) Exhibit 9:


Foods exports opportunity to rise

Apart from this, many countries will look towards India to meet their food production shortage, as their yields are already at a substantially high level and arable land has already stagnated. This will provide a huge export opportunity to India, provided it can substantially improve its agricultural productivity.

Policy actions and adoption of quality agri inputs necessary to drive yield improvement

Any action on policy work such as disbanding of APMC Acts, guidelines on contract farming/farming on lease basis, allowing trials for GM crops, attracting investments in food processing and retail, rationalisation of fertiliser subsidy and a broader shift from the subsidy model to the investment model will further spruce up agricultural growth rates.

Agriculture growth gaining steam Whilst India’s agriculture growth has lagged the overall GDP growth, it has gained steam over the last decade. Many factors have continued to this growth such as road network and irrigation development, better adoption of agri inputs, and government stimulus such as higher MSPs and NREGA spends. We take a look at how the broader agricultural practices evolved in India. Phase 1: FY50-65 Growth was driven by increase in the sown area. Land reforms resulted in conversion of fallow land to arable land. Agriculture accounted for nearly 55% of GDP and 70% of workforce. However, growth rates declined from 2.8% in FY51 to 1% in FY68 in the absence of any mechanism to improve yields. Phase 2: FY65-80 With the focus on deriving self-sufficiency in food production, the Government started working on yield improvement programmes. Government intervention led to introduction of high-yield varieties, improvement in irrigation facilities and higher mechanisation, driving improved productivity. Change in yields significantly improved farm output. Changing cropping patterns too contributed to higher agricultural growth. This period is called the Green Revolution.

14

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156

355

Pulses

Cereals

Wheat

Rice

Foodgrains

2030

2000

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93

76

15

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Meat

Fish

Eggs

Fruits

Vegetables

Milk

2030

2000

Agri Inputs


Phase 3: FY1980-2000 Spread of green revolution technologies to newer regions, increased investments in irrigation and infrastructural growth led to improvement in yield. However, post the green revolution, reforms and hence growth saw a slowdown. Average growth rates declined from 3% in the 1980s to 1.5% by 1991. The Government started to emphasise more on pesticides in the early 1990s. With the opening up of the markets, duty on imports of active ingredients declined significantly, leading to improved quality of pesticides in the market. As a result, the pesticides market in India saw tremendous growth in the early to mid-1990s before the severe drought in the South led to rising inventories towards the late-1990s and weaker profitability for agri inputs sector. Phase 4: FY2000 – Current Introduction of BT cotton in 2002 led to a big jump in the potential of the seed market. There was significant education given to farmers by private companies on the importance of better input-led farming rather than just subsistence farming. Another key landmark was that after almost 35 years of the process patent system, which encouraged R&D efforts in reformulation and process engineering/re-engineering for generics, India moved to the product patent regime which promoted protection of intellectual property rights (IPR). As MNCs became more confident on IPR, they started to focus on the Indian market and launched many of their global blockbuster products in India. Many Indian companies too started to source patented agrochemical actives/formulations from Japanese and European innovators, leading to much improved product availability to farmers. Productivity of agriculture has also been rising, wherein GDP grew by 3% in FY05-FY09 whilst employment in agriculture declined by 6% during the same period.

Gradual shift in Agri GDP growth rates Exhibit 10:

Source: GoI

Agri GDP growth rates have accelerated over Exhibit 11:the last 10 years


Formal employment in India agriculture is on a Exhibit 12:decline, driving improved productivity


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After almost 35 years of the process patent system, which encouraged R&D efforts in reformulation and process engineering/re-engineering for generics, India moved to the product patent regime which promoted protection of intellectual property rights (IP`)

Agri Inputs


Agrochemicals and seeds – The most-attractive available opportunities in the agri inputs space The India agri inputs space presents a wide array of investible opportunities. We take a top-down approach to choose the right sub-sector for agri inputs. We will focus on four segments on the agri inputs side—seeds, pesticides, micro irrigation equipment and fertilisers. We believe seeds and pesticides adoption is a structural story in India even without government intervention. We like the seeds and pesticides segments, with a positive bias towards pesticides.

The subsidy burden has impacted the business models of fertilisers and micro irrigation players. Micro irrigation is a smaller but promising segment though farmer adoption is low, as the subsidy model for equipment purchase has not worked out for private players. Fertilizers is the largest sub-segment; however, it is impacted by lower returns due to significant government intervention on pricing and delay in subsidy payments. We will wait for some positive actions on the policy front, which could improve the RoCEs for the sector and then we would turn positive on the fertilizer space.

Framework for picking the right sector

The below framework assesses the broader opportunity on key parameters such as growth rates, penetration levels, market share risks from product disruption by competition, competitive advantage from distribution, and risks from government policies.

Agri inputs - Investment plays Exhibit 13:

Supply-side inputs Market

Size (̀ bn)

Growth Rates Penetration

Pricing Cap/Subsidy

Support

R&D a differentiator?

Distribution a differentiator?

Policy Interference

Attractiveness of Space

Seeds 150 Mid 12-14%

25% (commercial

seed penetration)

Limited High Medium Medium Medium

Pesticides 240

(50% exports)

Mid 12-14% 30% No Medium High Low High

Fertilizers 500 Low

single digits

80% High Low Medium High Low

Irrigation 50 15-20% 40%

Very low for micro irrigation

High Medium Medium High Medium

Credit NA Medium Low High Low Medium High Medium

Information Services NA High Low High High High High High

Labour/Mechanisation NA High Low Limited Medium Medium Low High

Source: Industry, Ambit Capital research

Agri inputs – Key drivers and plays Exhibit 14: Drivers Public Listed Plays

Seeds Allowance of BT seeds in other crops Improved adoption of Hybrid seeds K Kaveri Seeds, Monsanto

Pesticides Increased farmer awareness Introduction of more off patent products Rallis, PI Industries, Dhanuka Agritech, IIL, Bayer Cropscience

Fertilisers Faster release of government subsidies Shift in subsidy model to direct cash transfer

Coromandel Fertilizers, RCFL

Irrigation Shift in subsidy model to direct cash transfer or a better model to partially fund adoption of micro irrigation equipment Jain Irrigation

Credit Improved risk models Government discipline on not providing farm loan waiver PSU banks

Information Policy action by Government and improved business model by private companies NA

Mechanisation Rise in farm labour wages, better know-how to farmers M&M, VST Tillers


We believe seeds and pesticides adoption is a structural story in India even without government intervention

Agri Inputs


I. Agrochemicals – Growing awareness to drive growth We expect a structural growth story to play out in the agrochemical sector in India given the lower penetration and consumption levels in India. We anticipate the segment to generate healthy double-digit growth rates driven by improving adoption of agrochemicals, higher consumption per user and value enhancement through use of more value-added pesticides. We expect pesticide adoption to improve consistently driven by improving affordability, introduction of new products and awareness enhancement initiatives from both government and private players. India’s consumption per capita for pesticides is very low at 0.6kg/ha vs the world average of 3kg/ha and it clearly has significant room to grow.

Availability of crop/pest specific chemistries will drive higher value growth: Larger and technologically oriented players are launching improved chemistries which are highly effective against a particular pest menace but are 2-4x more expensive than the current solutions. Over the last few years, there have been incremental instances of adoption of such products till the time they could offer value beyond the cost. Products such as Rynaxypyr (Dupont) and Nominee Gold (PI Industries) have successfully reached `2bn+ revenue size in a significantly short time.

Growing in-licensing tie-ups: The Indian market is full of generic products which account for nearly 80% of the market. The market would likely move towards specialised patented products and/or proprietary off-patented chemistries. Most of the listed players have started moving towards patented or off-patented proprietary molecules through parent R&Ds or tie-ups with other global majors.

Improved adoption of herbicides due to manual labor shortage, and improved adoption of fungicides due to enhanced demand for quality fruits and vegetables will further drive consumption level.

Enhanced environment regulations and government crackdown on lower grade pesticides or bulk pesticides will also drive adoption of better products. We believe the larger listed plays will benefit from them, as their products are relatively safer and technologically superior.

II. Seeds market growing faster than its historical pace driven by hybrids The Indian seeds industry is valued at ~`150bn and it has recorded a 14% CAGR over the last five years; most of the industry growth has been driven by increased adoption of BT cotton hybrids, single-cross corn hybrids and hybrid vegetables. Penetration of commercial seeds continues to be quite low at ~25%.

Whilst the current cotton arable penetration seems to have peaked out, seed use per acre has still some room to grow. Introduction of RR flex and mechanization will provide a key driver to industry growth beyond FY15. Corn and rice are other two major crops where significant growth could happen over the next few years driven by improving adoption (for rice) and up gradation to single cross hybrids (for corn) . Fruits and vegetables are growing at a rapid pace albeit over a smaller base. MNCs are focusing on respective niches—Syngenta in corn and horticulture and Bayer in rice, mustard, and millets. There is a significant scope of improvement in R&D practices of Indian players which will decide their long-term sustainability.

Agri Inputs


Pesticides – Rising farmer awareness and private efforts to drive growth India pesticides industry structure India’s crop protection industry has recorded a CAGR of 14% over the last 5 years to reach a market size of `255bn (or ~US$4.3bn). The top-10 players grew at ~18% over the last 5 years. Currently, half of the market is export revenues and the other half is domestic revenues. Both the domestic as well as the exports markets are growing in healthy double-digit growth rates historically in INR terms. Going forward, we would expect the exports market to expand 200-300bps higher than the domestic segment. The market is expected to record a 12% CAGR, as FICCI estimates. We would expect the market consolidation to continue and larger organised players to continue to grow in healthy double digits.

India pesticides market (` bn) Exhibit 15:


Pest infestation a key reason for crop losses; should propel pesticides growth rates consistently over long term

As per various estimates nearly three-fourth of crop losses are due to infestation of various pests and diseases. The remaining one-fourth is due to poor storage and other reasons. Amongst pest infestation, weeds account for the highest 33% and insects account for 26% of crop losses. There is a clear case for pesticide consumption in India. Cost benefit analysis by leading research institute, IARI, suggests that the benefits for pesticide use are much higher than their costs. In key crops such as fruits, vegetables, sugarcane, maize and pulses, the benefit is anywhere between 4x and 7x.

Clear case for pesticide consumption in India Exhibit 16:

India Crop Yield Avoidable Loss Cost: Benefit

Cotton (non BT) 40-90 1:7

Paddy 21-51 1:7

Mustard 35-75 1:12

Sunflower 36-51 1:8

Groundnut 29-42 1:26

Maize 20-25 1:3

Pulses 40-88 1:4

Sugarcane 8-23 1:13

Vegetables 30-60 1:7

Fruits 20-35 1:4

Source: IARI

72128

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2010 2011 2012 2013 2014

Agri Inputs


Low penetration of pesticides is a big opportunity We believe only 30% of the arable area is under pesticide treatment. States like Punjab, Haryana, and Andhra Pradesh lead the pesticide consumption whilst regions such as UP, MP, and Orissa lag on the consumption curve. Farmer awareness is on the rise, as the younger generation is more educated. Also, private efforts on educating farmers have been rising. This is driving increased use of pesticides. Indian market is largely generic India’s crop protection industry is mostly generic, with around 80% of the molecules (vs 50% globally) being generic with a distribution network and brand image acting as the product differentiator. However, the patented or proprietary off-patent segment is growing at a rapid pace. After India became TRIPS compliant and started giving product patent protection, MNCs became more comfortable, launching their patented products into India. Indian companies too have been able to in-license many patented products from global innovators in this better IP environment. Crop protection chemicals are manufactured as technical grades and subsequently formulated for agricultural use.

India pesticides segment breakup Exhibit 17:

Source: FICCI

Worldwide pesticides segment breakup Exhibit 18:

Source: FICCI

Market dominated by insecticides… The Indian market segmentation is quite different from the global market. The agrochemicals markets in India dominated by insecticides which account for ~60% of the market. Fungicides and herbicides contribute 18% and 16% respectively. Bio pesticides and other formats such as rodenticide contribute ~4% of the market. Globally fungicides are the largest sub segment, contributing about 27% of the market whilst insecticides contribute much lower than the Indian market at 22%.

…though herbicides growing at a faster clip

Herbicides account for nearly 15% of the Indian market vs 44% globally. This is primarily on account of smaller land holdings (which make it easy to pluck weeds manually) and availability of cheap labour historically. However, herbicide adoption is increasing at a rapid pace driven by rising labor costs.

Rising fruits and vegetable demand will drive growth for fungicides

Rising demand for quality fruits and vegetables is drawing improved adoption in fungicides. The growing presence of modern retailers and the food processing industry is driving demand for high quality products across fruits and vegetables spectrum.

Cotton accounts for the largest share of pesticides consumption

Cereals, millets and oilseeds account for 58% of Indian arable land but contribute only 7% of pesticide consumption in India. Similarly, paddy which accounts for 24% of India’s net sown area contributes only 18% to India’s pesticide consumption. However, fruits and vegetables and cotton account for a much higher proportion. Our conversation with industry experts suggests that this is linked to the net realisable

Insecticides, 65

Herbicides, 15

Fungicides, 16

Biopesticides and

Others, 4

Herbicides, 44

Fungicides, 27

Insecticides, 22

Others, 7

After India became TRIPS compliant and started giving product patent protection, MNCs have turned more comfortable launching their patented products into India; Indian companies too have been able to in-license many patented products from global innovators in this better IP environment

Cotton accounts for 50% of pesticides consumption in India whilst paddy and fruits and vegetables are the other two biggest crops driving pesticides consumption in India

Agri Inputs


value of the crop. Many of the small farmers who have smaller pieces of land sow cereals and paddy for their own consumption. They usually are quite risk-averse and are not much interested in buying expensive pesticides or external seeds. However, fruits and vegetables have much lower cultivation cycles, resulting in an immediate return on investment. Additionally, these crops have seen much faster price growth over the last few years given the rising affluence of the Indian population.

India pesticides consumption by crop Exhibit 19:

Source: Industry

India sown area by crop (2012) Exhibit 20:

Source: Industry

State-wise distribution of pesticide consumption Exhibit 21:

Source: Industry

Change into pest-specific chemistry another big driver

Farmers are incrementally moving to target pest-specific chemistries rather than general ones. This is driving tremendous change in value realisations as well as effectiveness of products.

To break-up the growth in the agrochemicals space – nearly 60% would be due to improved chemistries and 40% would be from increase in treated area. However, the long gestation period of registration of ~ 5-10 years is a big challenge in terms of bringing new products to the market.

With strong growth over the last couple of years, many companies have aggressively been launching new products. MNCs have launched a couple of blockbuster products from their parent’s portfolio whilst Indian companies too have been aggressive on licensing from other MNCs which do not have a strong Indian distribution.

Cotton, 50

Plantation Crops, 8

Paddy, 18

Others, 1

Cereals, Millets,

Oilseeds, 7

Fruits and Vegetable

s, 14

Sugarcane, 2 Cotton, 5 Plantation

Crops, 2

Paddy, 24

Others, 6Cereals, Millets,

Oilseeds, 58

Fruits and Vegetable

s, 3

Sugarcane, 2

Tamil Nadu, 5% Bihar, 5%

Karnataka, 5%

Gujarat, 6%

Haryana, 6%

MP & Chattisgarh, 6%

West Bengal, 8%Uttar Pradesh,

10%

Punjab, 11%

Maharasthra, 13%

Erstwhile AP, 21%

Others, 4%

Andhra Pradesh, Maharashtra, and Punjab account for nearly half of pesticide consumption in India

Agri Inputs


We highlight below the key factors for such a drive towards higher-value chemistries.

Hindu Business Line, Aug 28, 2014 - Interview with Rik L Miller, Global President, Dupont Corp Protection Pvt Ltd "Company sees no issues with country’s IPR regime DuPont says that it will introduce in India one new pesticide product every year over the next decade. India’s intellectual property rights regime has registered ‘marked improvement’ in recent times. Although the prosecution and enforcement mechanism here may not be as strong as in the US and Western Europe, it is encouraging enough for an MNC such as DuPont to operate and introduce new products based on our proprietary chemistry. In 2013, sales of Rynaxypyr crossed $1 billion globally, of which more than a tenth came from India. “No crop protection molecule in history has achieved annual sales of over $1 billion in such a short period of time.”

Drivers for high-value chemistries Exhibit 22:

Reason Explanation

Better affordability Rural affordability for higher-priced agri inputs is on the rise driven by better realisation over the last few years. Farmers incrementally focus on better yields and invest more if they see some signs of a benefit. Availability of credit too has improved.

Improved farmer awareness Improved effort of agrochemical companies to educate farmers about advanced chemistries has led to increased adoption of high-value agrochemicals. Significant proportion of this pesticide consumption is non-specific in nature, commanding lower value. Crop and pest-specific solutions are still limited despite much growth over the last decade.

Availability On the supply side, both Indian and foreign players have been launching new products and are focusing on engaging with farmers. Companies have improved their distribution reach which has led to far deeper availability of branded products.

Environmental concerns Only 35% of pesticides used for crop protection are absorbed by crops in the field and the remaining 65% goes into the environment and rivers.


India is significantly underpenetrated in terms of molecules available. Whilst the US has 755 molecules registered for pesticide use, India has only 210 molecules registered for pesticide use.

Number of molecules registered for use as pesticides Exhibit 23:

Source: Phillip Mcdougall

755

600

210

0 100 200 300 400 500 600 700 800

USA

Europe

India

Agri Inputs


Exports a credible large opportunity Indian agrochemicals exports have recorded a 17.5% CAGR over the last 4 years to ~US$2bn in size. Post the tsunami, Japanese players are incrementally looking to diversify their manufacturing base away from their home country. European players too are constrained by environmental norms and high costs to look at outsourcing the manufacturing need. Similar to pharmaceuticals, India also scores an advantage vs other manufacturing destinations such as China due to better IP protection and engineering talent. Industry participants quantify that India’s cost of setting up a plant is 50% cheaper than developed countries, resulting in competitive pricing. Apart from the cost advantage, environment stringency in developed countries has increased significantly. India’s environment laws are still more accommodating.

India agrochemical export opportunity drivers Exhibit 24:

Driver Details

Cost advantage Industry participants quantify that India’s cost of setting up a plant is 50% cheaper than developed countries, resulting in competitive pricing.

Stricter environmental laws Environment stringency in developed countries including China has increased significantly. Indian laws are still more accommodating in terms of environment.

Business model shift Global agrochemical players are turning more and more innovative to defend their market share. They are focusing more on core areas such as R&D and marketing.

IP protection Improved IP protection after India became TRIPS-compliant. Also, the proportion of generic molecules is on a rise, leading to lower IP protection concerns.

Concentration risk Post the tsunami, Japanese players are incrementally looking to diversify their manufacturing base away from their home country.


Global agrochemical players are turning more and more innovative to defend their market share. They are focusing more on core areas such as R&D and marketing.

India agro-chemicals export market (US$ bn) Exhibit 25:


Value of Agro-chemicals going off-patent over Exhibit 26:2014-2020 (US$ bn)


Globally generic market is rising

The generics market in pesticides has been growing as a percentage of the overall market. Industry statistics suggest that the market has grown from 33% in 2000 to 52% in 2013. In addition, there are products with a market size of ~US$6bn which are going off-patent. With more products going off-patent, there is an increasing likelihood for this market to grow further at a rapid pace. India is currently the thirteenth-largest exporter of pesticides, most of which are off-patent in nature.

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1.2

1.6

0.4

0.7

0.2

2014 2015 2016 2017 2018 2019 2020

Agri Inputs


Global pesticides market – breakup (2000) Exhibit 27:


Global pesticides market – breakup (2013) Exhibit 28:


MNCs focusing on farmer engagement More MNCs are now actively targeting the Indian markets. Bayer and Syngenta have been in the market for a long time and they are as local in their approach to the Indian market as Indian companies. They also score high on their approach on market development. The pace of introduction of novel molecules has clearly increased over the last few years. Our discussions with some MNC executives suggest that they have seen increased adoption of high-value products. India is one the fastest-growing markets after the Latin American geographies.

Many MNCs are running high-quality farmer awareness programmes to drive adoption of agrochemicals using Exhibit 29:‘show and tell’.

Program Description

Monsanto Farm AgVisory Services (MFAS)

This service offers a toll-free number that farmers can call to speak directly with an advisor. MFAS provides useful information direct to farmers on a variety of topics related to agricultural practices for the right input for crops and improving crop yield. From seed selection to land preparation to weather forecasts and more, educated advisors provide useful insights on six crops (cotton, corn, hot pepper, tomato, cabbage and cauliflower) in seven languages to farmers in 16 Indian states.

Push notifications also are sent out to registered growers who wish to receive customised messages on their cell phones throughout the season.

Bayer Labhsutra

The programme helps farmers achieve better RoI by adopting Bayer’s ‘Seed to Harvest’ packages. The company conducted more than 1,000 field demonstrations to explain this concept to farmers in geographies across India.

The company reports that farmers have seen convincing results from Bayer Labhsutra, in the form of an increase in quantity and quality of produce and increased net profits.

Dupont Samruddhi

BASF reaches out to ~230,000 soybean farmers. BASF advises farmers on pesticides use, soil preparation, and technical know-how and on how to plant, harvest, and sell their product. The company has employed ~700 employees to run the programme. As per PwC audited figures, farmers who participated in the Samruddhi programme increased their income by 36% after expenses


Generic Product,

33%

Patented Product,

30%

Off-Patent Proprietary Product,

37%

Generic Product,

52%

Patented Product,

22%

Off-Patent Propreitary Product,

26%

Agri Inputs


Porter analysis of the Indian agrochemical industry Exhibit 30:


Competitive intensity

MEDIUM

More than 500 formulators are present in the industry, with a large number of unorganised and regional manufacturers given the high use of non-patented products.

Large companies continuously invest in R&D and development of new pesticide varieties which the smaller players cannot replicate.

A brand once established provides long-term revenue visibility and cannot be easily corroded by competition.

Threat of substitution

MEDIUM

Chemical pesticides can be substituted by bio-pesticides in the long run though their effectiveness is limited as of now.

Generic pesticides can be replaced by more crop-specific pesticides.

Use of GM seeds (with pest-resistant traits) can substitute pesticides in the long run.

Barriers to entry

HIGH

A key competitive advantage of pesticide companies is the brand and the distribution reach, which are very difficult for a new entrant to build.

Whilst it is relatively easier to develop a generic molecule, developing a novel molecule is extremely difficult, as it requires strong R&D capabilities which most of the domestic manufacturers’ lack.

Deteriorating Unchanged Improving

Bargaining power of suppliers

HIGH

Most of the raw material requirements (active ingredients) are imported from large global chemical manufacturers.

These companies supply to agrochemical companies globally and hence have strong pricing power.

Bargaining power of buyers

HIGH

Given the generic nature of the Indian pesticide industry, farmers can shift from one brand to another if prices are hiked materially.

Farmers’ bargaining power has improved in recent years, as several new products were launched in recent years by mid-sized players, reducing the dominance of large manufacturers.

Agri Inputs


Indian seeds industry - Multiple drivers for growth 1988 and 2001: The landmark years Whilst the Indian seeds industry has existed for more than five decades, private participation picked up only from the late-1980s, as the National Seed Policy allowed and encouraged FDI (foreign investors were allowed equity participation up to 51% in the seeds sector), liberalised imports of planting materials/new seed varieties, and encouraged MNCs to set-up establishments in India.

Furthermore, the Protection of Plant Variety and Farmers Right Act (PPV&FR) was enacted in 2001 to provide an effective system for patent protection of plant varieties, and to encourage cultivation of new plant varieties. This Act led to rising confidence among innovators to invest in research and development in India, due to better patent protection alongside stringent registration norms.

Industry structure: Three-fourth non-commercialised The seeds sector in India can be broadly categorised into two parts: (a) farm-saved — non-commercial, which are mainly seeds saved by the farmers from previous years’ production and (b) commercial — sales by companies, both varietal and hybrid. The public sector accounts for 25% of the industry and is largely focussed on high-volume low-value seeds like wheat and pulses. The private sector constitutes of three types of companies: (a) the innovators — R&D-driven companies with a national brand and crop-focussed approach (Kaveri, Nuziveedu, Mahyco, etc), (b) regional players — no material R&D capabilities, primary marketers of outsourced production, and (c) unorganised players — non-branded players with low pricing, primarily servicing the varietal seed demand. The private players focus on high-value low-volume seeds, typically in the hybrid seeds segment.

Structure of the Indian seeds industry Exhibit 31:


Size of Indian seeds industry at `150bn (14% CAGR) The Indian seeds industry revenues were ~`150bn and it has recorded a 14% CAGR over the last five years; most of the industry growth has been driven by increased adoption of BT cotton hybrids, single-cross corn hybrids and hybrid vegetables. Below are the crop-wise details of the size of the industry (based on the estimates of Dr Pramod Agarwal, a renowned seed expert).

Structure of the Industry

Farm Saved (75%) Commercial (25%)

Public Sector (25%) Private Sector (75%)

National Seed Corporations (2) State Seed Corporations (14)

Regional (45%) National (55%)

Agri Inputs


The growth of the seeds industry has been sharp over the last six years Exhibit 32:

Source: Industry data

India has become a key market for most of the global MNCs. Most of the MNCs, Monsanto, Syngenta, and Bayer, are active in India and have ambitious launch plans for India.

Crop-wise details of the industry (including hybrids and non-hybrids) Exhibit 33:

Particulars Area (mn Ha) Area under commercial seeds (%)

Area under improved seeds (mn ha)

Seed rate (Kg/ha)

Total seed sold (mn kg) `/kg Revenue

(̀ mn)

Cotton 11.1 100 50* 800** 40,000

Soybeans 8.4 70 5.8 75 441 40 17,640

Maize hybrids 7.8 60 4.7 20 94 100 9,400

Sorghum hybrids 8.3 90 7.5 10 75 100 7,500

Pearl millet hybrids 9.3 100 9.3 5 47 100 4,700

Gram pulses 7.3 5 0.36 75 27.4 80 2,193

Groundnuts 6.3 3 0.188 150 28.3 52 1,472

Sunflower hybrids 2.1 80 1.6 5 8.3 150 1,248

Mustard 6.7 25 1.6 5 8.3 100 837

Castor hybrids 0.9 100 0.8 5 4.3 175 752

Mung beans 2.8 20 0.56 12 6.8 100 681

Urd beans 2.7 20 0.53 12 6.4 100 640

Lentils 1.4 10 0.14 30 4.1 80 331

Pigeon peas 3.6 10 0.35 10 3.5 80 284

Jute 0.9 30 0.27 10 2.7 70 191

Paddy 43.8 28 75 811 222 21,798

Research 30 13.1 30 394 50 9,700

Cer/Truth 30 13.1 30 394 22 8,668

Hybrid 60 1.5 15 23 150 3,430

Total size of the crop seed Industry 131,465

Vegetable Seed industry 20,000

Grand Total 151,465

Source: Dr Pramod Agarwal’s research, Ambit Capital research. Note: *million packets sold

40

60

80

100

120

140

160

FY08 FY09 FY10 FY11 FY12 FY13 FY14

(Rs bn) Size of the seed industry

Agri Inputs


Future growth drivers Whilst the Indian seeds industry is the fifth largest in the world, with a 4.5% global market share, a large part of the industry is non-commercialized (farmers retain the seeds of major crops like wheat, rice, sorghum, millet, corn and pulses). Replacement rates and use of hybrid seeds is extremely low (with cotton and certain vegetables being the exceptions).

Industry experts highlight the following key industry trends and growth drivers for the coming years:

(1) The cotton growth story still has a long way to go Cotton acreages may have maxed out but the launch of Roundup-ready flex (RR Flex) BT cotton will change the landscape

Industry experts highlight that cotton acreages have no room to grow from the present levels of 11mn hectares. However, its two major drivers: (1) launch of RR flex to improve realisations and (2) High density cultivation to drive volumes.

Cotton seed market drivers Exhibit 34:Driver Details

Launch of Roundup-ready flex (RR flex) will drive realisation growth

Currently, only BT-II variety has been launched in India, whereas BT-V varieties have been launched globally. Monsanto is in the advanced stages of launching the RR flex (BG-II) BT gene in India, which will not only provide protection against bollworms but also offer insect resistance and weed management. This launch will also improve realisation for cotton seeds where prices are capped at ` 850/packet. Monsanto has already conducted field trials in several states and would likely launch it in the next 12-15 months.

High density cotton cultivation will provide volume growth

Seed companies highlight that a sharp increase in labour costs (60% of overall costs) will lead shift towards mechanised farming, given the increase in cotton-picking costs. This can potentially lead to an increase in seed use per acre to 4-6 packets as against 1.6 packets currently. Whilst mechanisation may take 5-6 years to gather pace in India, seed intensity (packets used per hectare) could rise in the near term to improve the yield.


Cotton seed intensity has increased but it still has room to expand Exhibit 35:


(2) Shortening of the seed replacement cycle Seed replacement is the use of certified seeds as against saved seeds from the previous year. Experts highlight that hybrid seeds need to be replaced every year, whereas varietal seeds can be used for 2-3 years, depending on the crop. Industry participants expect replacement rates to improve, especially for crops like paddy, wheat and pulses, given that private players have spent large amounts on developing superior hybrid qualities. Furthermore, there is a large disparity of replacement rates within states. For instance, whilst the SRR in maize is 100% in Karnataka, it is as low as 5% in Odisha.

1.2 1.3

11.2

1.6

1.9

1.2

1.5

Maharashtra AP Gujarat India

Packets per acre

FY08 FY14

Experts highlight that ‘agronomic manipulation’ such as increasing seed or fertiliser use is highly likely given the stagnating cotton yield

Industry participants expect replacement rates to improve, especially for crops like paddy, wheat and pulses, given that private players have spent large amounts on developing superior hybrid qualities

Agri Inputs


SRR is extremely low in crops like paddy and wheat Exhibit 36:

Crop

India Highest SRR states Lowest SRR states

Average (%) State % State %

Paddy 33 AP 82 Uttarakhand 9

Wheat 25 Maharashtra 42 J&K 11

Maize 50 Karnataka 100 Orissa 5

Jowar 26 AP 65 Tamil Nadu 11

Bajra 63 Gujarat 100 Karnataka 29

Sunflower 43 AP 100 MP 8

Source: Nuziveedu Seeds Presentation, Ambit Capital research (3) Hybridisation - A large opportunity

Whilst hybrid seed use is ~95% in cotton, 55% in corn and 60% in soyabean, it is extremely low in certain key crops like wheat and paddy, which account for 18% and 30% of cultivated area in India.

Hybridisation in field crops Exhibit 37:

Crop Market size (̀ bn) % hybrid

Cotton 40 95

Corn 20 55

Rice 15 5

Soyabean 17 60

Millet 4.5 43

Sunflower 1.1 > 95

Sorghum 5.5 > 95

Source: , National Seeds Association; Note: * packets of 450gms

Hybridisation in vegetables Exhibit 38:Crop Market size (mt) % hybrid

Okra 900 23

Gourds 130 15

Watermelon 70 40

Cabbage 50 85

Tomato 50 20

Cauliflower 40 11

Chilli 40 14

Cucumber 25 3

Egg plant 25 8

Source: National Seeds Association

Rice hybridisation could increase to 10-12% Whilst the private sector companies have increased the impetus on rice hybrid seeds in India in recent years, it still accounts for a paltry 5% of total rice seeds as against more than 50% in most developed countries and 58% in China.

Industry experts highlight the following issues:

Availability of rich varietal seeds: India already has a very rich varietal seed inventory, especially in states like Andhra Pradesh and Karnataka.

Stickiness and aroma: The quality of the rice is not acceptable for Indian taste, as it has a tendency to become sticky. There is a general lack of acceptance in southern parts of the country, due to region-specific requirements for grain quality: the grains of current rice hybrids are sticky in nature (with consumer preference being for free flowing rice grains), and the rice has an aroma which is not preferred in many parts of the country.

Low yield differentiation: One major reason for this low adoption is the unattractive yield advantage that this technology offers. It is a mere 1.0-1.5 t/ha over varieties. Hence, currently the cultivation is restricted to a few areas of eastern Uttar Pradesh, Bihar, Jharkhand, Chhattisgarh, Punjab and Haryana.

Way forward

Better hybrids will likely be developed to give a yield advantage over the research varieties of at least 3-4 t/ha, with an enhanced ability to fight drought and diseases. Most of India’s hybrid rice is developed by using CMS or the 3-line system. CMS is 25A, which provides stickiness. There is hence a need to find a good alternative to 25A. If this is achieved, the area under hybrid rice may reach 10–20 % of the total area under rice in India in the next five years.

Mr R. Suresh Babu, head of rice research in India for Syngenta, in a media interview highlighted: “The cooking quality of hybrid rice is a problem for some people. If you cook and leave it for 2-3 hours it becomes sticky, like a paste almost. Indian customers don't like it; hybrid rice is also often broken, which millers don’t like.”

Agri Inputs


Corn: A large opportunity with upgrade to higher yielding varieties Maize is the third most-important crop in India after rice and wheat. It is not only used for human food and animal feed but it is also widely used for corn starch industry, corn oil production, baby corn, etc. Current hybridisation levels are ~60% for corn. However, only 30% of area is under single cross hybrids which offer nearly 2x yields of other varieties. Price realisation for single cross hybrid seeds is nearly 2.5x of the double cross hybrid varieties which will drive value growth for the seed market.

Experts highlight that the introduction of hybrid seeds that can survive low winter conditions, off-season diseases and pests, alongside high productivity has made maize a profitable alternative even for small farmers in UP, Bihar, Andhra Pradesh and Karnataka.

Rising alternative use driving corn demand

Globally, there is a supply deficit of maize, especially with rising alternative use like production of motor fuel and poultry feed. It is not only used for human food and animal feed but it is also widely used for corn starch industry, corn oil production, baby corn, etc.

Maize production in India has recorded a CAGR of 5.5% over the last ten years from 14mn tonnes in FY04-05 to 23mn tonnes in FY13-14, making India the fourth-largest maize area under cultivation and the fifth-largest maize producer. India’s maize exports have grown at 24% CAGR over the last ten years.

Single cross hybrids a bigger opportunity

Maize hybrids are a large opportunity for seed companies in India, particularly in single-cross hybrids (used in the Rabi season) as compared to the double-cross hybrids used in India, as they offer a better yield, require less water and have superior pest resistance. Single-cross hybrids have better pest resistance and lower water requirement and hence they could be the main driver of industry growth.

Currently India’s yields are nearly two-fifths of the world average

Yield/hectare is the lowest in India, amongst Exhibit 39:the top-six maize-producing countries

Country Maize area (mn ha)

Production (mn tonnes)

Yield (t/ha)

World 160 817 5.1

USA 32 333 10.3

Argentina 2 13 5.6

China 30 163 5.4

Brazil 14 51 3.7

Mexico 7 20 2.8

India 8 17 2.1

Source: National Seeds Association; Note: * packets of 450 gms

State-wise maize yields have significant Exhibit 40:

disparities

State Area (million ha) Production (million tonnes)

Yield (kg/ha)

Andhra Pradesh 0.85 4.15 4.9

Tamil Nadu 0.29 1.26 4.4

West Bengal 0.09 0.34 3.8

Punjab 0.15 0.51 3.4

Karnataka 1.07 3.03 2.8

Bihar 0.64 1.71 2.7

Himachal Pradesh 0.3 0.68 2.3

Jammu & Kashmir 0.32 0.63 2.0

Rajasthan 1.05 1.83 1.7

Uttar Pradesh 0.8 1.2 1.5

Gujarat 0.5 0.74 1.5

Jharkhand 0.22 0.3 1.4

Madhya Pradesh 0.84 1.14 1.4

Others 0.41 0.64 1.6

All India 8.17 19.73 2.4

Source: National Seeds Association

Agri Inputs


(4) Genetic modification: A possibility in other crops?

Whilst the use of the BT gene in cotton has been a success story, it is important to highlight that cotton is not a food crop and hence not as critical as paddy, wheat and pulses, which are used for consumption by the Indian population. The proponents of GM crops argue that: “It is essential for ensuring higher yield and food security as it can increase productivity and help farmers meet food needs of ever increasing population. GM crops are more robust against biotic and abiotic stresses, can resist disease, insects, weeds and climatic changes and are also better in value and nutrient composition. They are capable to tide natural vagaries like droughts, floods and climatic change conditions.”

Global status of GM crops: As per industry sources, ~12% of the global arable land is under GM crops of soybean, corn, cotton and canola across 28 countries, and within that the US accounts for ~40% of the overall area, followed by Brazil. Note that there has been no adverse impact in the US where GM crops have been used for over two decades. In a World Health Organisation report, the Food and Agriculture Organisation (FAO) declared that GM crops are as safe as conventional crops.

Consolidation set to increase with rising complexities DuPont, Monsanto and Syngenta control 70% of the market share of the global seeds industry (http://goo.gl/x31T4C), as their strong patent-protected seed portfolios are developed over years of intensive R&D. These companies were the early movers in the seeds industry and they re-invested the initial free cash flows in R&D every year and have hence developed unmatched capabilities. These companies continue to spend large sums on R&D (Monsanto’s expenditure on R&D in CY13 was equivalent to 80% of the size of the Indian seeds industry). Monsanto and Syngenta have spent 10% of their revenues in the last decade on R&D, and the global companies’ R&D expense has recorded a CAGR of 8% over the last ten years.

What does this mean for Indian companies?

The Indian seeds industry is fairly fragmented, with 45% of the market share controlled by regional (non-branded) players with weak R&D capabilities. These companies primarily leverage advantages like low cost and labour-intensive breeding alongside distribution in specific regions of operations. We believe that as manufacturing complexities increase with the adoption of modern farming techniques and adoption of GM crops, these companies would not have the strength to wade off competition from the global behemoths. The current barriers to entry that inhibit innovation are largely related to the high costs and time delays associated with regulatory approval for GM crops, uncertainty about IPR enforcement, and uncertainty in the regulatory approval process; however, these concerns will abate as the industry matures.

Agri Inputs


Porter analysis of the Indian seeds industry Exhibit 41:


Competitive intensity

HIGH

There are ~500 players in the Indian seed industry including the MNCs, domestic leaders and unorganised players. Hence, competition is extremely high.

Large seeds companies continuously invest in R&D and development of new seed varieties, and launch of novel products by peers can lead to market share losses for other seed companies.

Threat of substitution

LOW

Seeds are paramount for crop cultivation and hence a threat of substitution is almost negligible.

However, the older seed varieties are substituted by new novel launches and to that extent there is a substitution risk.

Barriers to entry

HIGH

A key competitive advantage of seed companies is the brand and the distribution reach, which are very difficult for a new entrant to build.

Furthermore, the gene bank and R&D capabilities are built over several years and hence cannot be emulated by a new entrant.

Deteriorating Unchanged Improving

Bargaining power of suppliers

HIGH

There are two types of suppliers for Indian seeds companies:

(a) The seed growers: They undertake seed production on the companies’ behalf, and have no written anti-competitive agreements.

(b) Gene suppliers: Large MNCs like Monsanto are the key gene suppliers and have a monopoly. Kaveri is dependent on such players for their seed portfolio.

Bargaining power of buyers

HIGH

The farmers have a high bargaining power, given the fragmented nature of the Indian seeds industry. Several seeds are available in the market and farmers can switch from one brand to another.

Seed prices are not key determinants of a farmer’s decision (as seed prices form a small component of overall cultivation costs), and farmers are more focussed on quality.

Agri Inputs


Fertilisers – Low returns make the opportunity unattractive Historically increased fertiliser use played an important yield in improving crop yields. Fertiliser prices have been heavily subsidised by the Government. However, this pricing of subsidised fertilisers led to higher use of straight fertilisers and skewed use of nutrients. This overuse of fertilisers impacted healthy soil and led to nutrient imbalance and micro-nutrient deficiency. India nearly meets 80% of its urea requirement from domestic production though it is dependent on imports for its potassic and phosphatic fertiliser requirements.

Urea (which is a nitrogen-based fertiliser) is highly subsidised. Out of the total price, farmers pay ~`5,360/tonne whilst the government gives a subsidy of `11,760/tonne. The subsidy on urea is fixed as underlying costs + a minimal assured return on capital investments. The subsidy regime has led to stagnation of private investment in the sector, especially in urea. Since 1999, no new urea plant has been commissioned in India. This has in turn has led to increased reliance on imports.

Urea consumption is also artificially increased by illegal trade across borders, as urea prices in India (US$98 per tonne) are much below neighbouring countries such as China (US$348), Pakistan (US$344) and Bangladesh (US$250).

Higher receivables continue to put pressure on fertiliser balance sheets

Challenged by rising deficit, the Government has been under-budgeting for fertiliser subsidies, which has led to a higher amount of receivables on the books of fertiliser companies. This has created significant pressure on the working capital needs of the fertiliser companies. The exhibit below shows that subsidy receivables days have gone up to ~2.5x over the last 3 years. Total arrears for fertiliser subsidies will likely go up by `450bn this year.

Subsidy receivables are rising Exhibit 42:

Source: Industry Reports. Note: Aggregation of 9 large manufacturers accounting for more than 70% of domestic production

8294

115

206

0

50

100

150

200

250

0

50

100

150

200

250

300

FY11 FY12 FY13 FY14

Subsidy Receivables (Rs bn) Receivables as Days of Sales

The recent economic survey noted: “the current trends in agricultural output reveal that the marginal productivity of soil in relation to the application of fertilisers is declining,” highlighting the subsidy model is creating more harm than good now to Indian agriculture

Agri Inputs


Fertilizers subsidy receivables continue to be rise Exhibit 43:(` bn)


Total fertiliser subsidy has remained elevated (` Exhibit 44:

bn)


FY09 witnessed a major spike in fertiliser subsidies due to a significant uptick in market prices. Launch of NBS in FY11 led to fertiliser subsidies remaining at `~700bn over the next few years.

Nutrient-based subsidy (NBS) policy a step in the right direction but it has done more harm than good

The Government initiated the nutrient-based subsidy scheme (NBS) in 2010. The move was to rationalise the subsidy regime on fertilisers. Whilst the subsidies on P and K fertilisers were capped under the NBS regime, nitrogen-based fertilisers including urea were left outside the NBS regime. Urea accounts for nearly half of the fertiliser consumption in India. Under the NBS regime, the Government pays a fixed subsidy whilst fertiliser prices are left at the mercy of supply and demand. As a result, P and K fertiliser prices have increased significantly over the last three years on account of higher input prices. At present, farmers pay 61-75% of its delivered cost whilst the rest is subsidised by the Government. As a result, the price gap in urea and other P and K fertilisers increased substantially. This led to unbalanced use of nitrogen fertilisers.

The NPK ratio has significantly deteriorated to 8:3:1 in 2013 vs a recommended level of 4:2:1. The ratio is far worse in states such as Bihar, Haryana, and Punjab.

NPK application ratio has deteriorated Exhibit 45:

Source: Coromandel Fertilizers Presentation

Fertiliser subsidy challenge to continue

We believe these challenges will continue in the absence of any effective policy regime. Urea subsidy provides immediate benefit to nearly half of India’s population which is dependent on agriculture. Removal of subsidies for urea will require substantial government will and hence the challenges for fertilizers companies are unlikely to go down any time soon.

316

350

450

FY13

FY14

FY15E

262400

966

640 658738 680 660

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

5.8

6.3

8.9

6.9

4.3

6.9

7.7

1.9

2.6

2.7

2.96

2

3.1

3

1

1

1

1

1

1

1

0 2 4 6 8 10 12 14

1980

1990

1994

2000

2011

2012

2013

N P K

Agri Inputs


Mechanisation India’s current level of farm mechanisation averages around 25% as against more than 90% in developed countries. The adoption of mechanisation is also very different across states. The biggest markets for the tractor industry include States like Uttar Pradesh (UP), Andhra Pradesh (AP), Madhya Pradesh (MP), Rajasthan, and Maharashtra, which together accounted for around 50% of the total tractor sales in India. According to the ICAR, the economic benefit of adoption of improved implements is about `800bn per annum.

Various factors such as urban migration and other opportunities in the rural ecosystem have led to a decline in the availability for agriculture labour. As a result, wages have shot up significantly in rural areas. This is driving incrementally better economics for use of weedicides. Newer generations are also less keen on doing manual labour and they look for weedicide solutions to get rid of weeds. The percentage share of the rural population has declined from 75% in 1991 to 67% in 2014, leading to increased pressure on improving agriculture productivity.

Blue-collar wage inflation in India has been recorded at a staggering CAGR of 15% or more over the past few years despite the recent deceleration in headline GDP growth. Given that consumer inflation over this period has been around 10% per annum, such wage growth points to a very real increase in the purchasing power of the vast majority of Indians.

Wage inflation in rural India has risen at an Exhibit 46:average of 19% YoY over FY11-FY14YTD

Source: RBI, Ambit Capital research

The improvement in literacy levels has been Exhibit 47:the most profound in ‘labour-supplier states’

Source: CEIC, Ambit Capital research.

Area under irrigation remains low India’s area under irrigation has seen healthy improvement over the last few years. The net irrigated area increased to 45% by FY11 vs 39% in FY01. As a result cropping, intensity too improved from 131% to 140% since FY01. Apart from irrigation, improved availability of electricity too helped improve the real situation in irrigation. The per capita annual availability of electricity has increased from 112.7KWH in 2008-09 to 142.4KWH in 2011-12.

1%

10%

19%

2%

10%

19%

FY01-05 FY06-10 FY11-14(ytd)All

-In

dia

ave

rag

e ru

ral

wa

ge

gro

wth

(Y

oY

cha

ng

e, i

n %

)

Ploughing Unskilled Labourers

0%

4%

8%

12%

16%

20%

Biha

r

Jhar

khan

d

UP

MP

Indi

a

Uttar

akha

nd

Cha

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ease

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cy rate

s

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Y11

v/s CY0

1)

Pawan Goenka, President, FES, describes the company’s recent acquisition as wanting to go beyond selling tractors and promoting farm mechanisation and becoming an end-to-end provider in the Agriculture space

Agri Inputs


Net irrigated area as a percentage of net sown Exhibit 48:area


Cropping intensity has shown some Exhibit 49:improvement due to improving irrigation


Rising telecom density aiding information adoption Deeper penetration of mobile phones into the countryside has helped rural agriculture in several ways. Firstly, by giving farmers access to crop prices in the urban wholesale markets, mobile phones have either allowed the larger farmers to disintermediate the middle or, and this is more likely, get a better deal from the middle man. Secondly, improved telecom penetration has made it easier for agri input companies to stay in touch with farmers. Many companies now run extensive farmer information programmes through mobile.

Rural teledensity has increased by 7x over FY07-Exhibit 50:12, with growth in Bihar, WB and MP being greater than the national average

Source: CEIC, Ambit Capital research

Rural teledensity in AP, UP , MP and Exhibit 51:Bihar is still lower than the national average

Source: CEIC, Ambit Capital research

18%22%

34%39%

45% 45%

FY51 FY71 FY91 FY01 FY10 FY11

111% 118%130% 131% 136% 140%


12

98 7 7 6 5

02468

101214

Biha

r

WB

MP

Mah

aras

htra

All

Indi

a AP

UP

(Eas

t & W

est)

Incr

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tele

de

nsi

tyo

ver

FY0

7 t

o F

Y12

(x)

52%42% 39% 39%

32%26% 26%

0%

15%

30%

45%

60%

75%

Mah

aras

htra

WB

All

Indi

a

AP

UP

(Eas

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MP

Biha

r

Ru

ral t

ele

de

nsi

ty in

FY1

2 (

in

%)

Agri Inputs


Agri inputs competitiveness framework We measure all the agri input companies on our four point competitive framework to ascertain their competitive strengths.

Four point framework Exhibit 52:

Business Model Strength Execution Track Record

Financial/ Operating Efficiency


Segment attractiveness 5 year revenue growth Working Capital Management Quality of Board Market positioning Margin expansion Net Debt to Equity Professional Management Distribution and Farmer engagement 5 year average ROCE Gross Asset Turnover Management Depth Manufacturing Capabilities Ability to incubate new business ideas Capital Allocation Dividend Payout Ratio Product development/ Sourcing capabilities Pre-tax CFO/EBITDA Accounting Checks

Risks to current market positioning Minority Treatment

Source: Company

Our discussions with various industry experts led us to develop our proprietary framework to choose the winners from the Indian agrochemicals space.

Business model strength Segment attractiveness: We prefer players that have their portfolio aligned to

segments witnessing higher growth rates such as agrochemicals (weedicides), seeds (fruits and vegetables). We prefer agrochemicals over seeds due to the uncertainty associated with the seeds segment. Specifically, we believe it would be difficult for a seeds player to be strong on a pan-India basis given the different soil conditions and wide variety of crops in India. We expect weedicides to witness the fastest growth rates amongst agrochemicals.

Market positioning: We measure the competitive strength of the company in the segment it has a presence in through a mix of market share, pricing power, and brand recall.

Distribution and farmer engagement: We measure the distribution reach, quality of distribution, and the quality of farmer engagement as assessed from our channel checks on the ground. With rising penetration of telecom, distances have no longer remained a barrier. Helpline numbers and social media groups have become an important way to engage.

Consistency in maintaining communication with farmers is deemed to be important. The quality of a crop advisor’s knowledge too is a key differentiator. Crop advisors who work along with farmers for the full cycle of the crop tend to be much more influential than the ones (more specifically for smaller domestic companies) who are mostly seen during the sowing season.

Manufacturing facilities: Exports now account for nearly half of India’s agrochemical revenues. Strong systems and processes at a supplier’s end are important not only from a cost perspective but also from the point of protection of IP and quality of the product. More evolved manufacturing practices also help in better formulation and speed to market. In the domestic business, owned manufacturing facilities provide better gross margins than outsourcing manufacturing processes.

Technology development/sourcing capabilities: India is largely a generics market. However, the demand for differentiated and high-value products is on the rise. We believe this trend will continue to gain prominence. Global MNC players such as Bayer and Syngenta have strong support from their parent’s strong R&D capabilities and they source many of their new products from the parent. Players such as Dhanuka and PI have also gone aggressive and acquired novel molecules through in-licensing from global innovators.

Risks to current market positioning: We ascertain the key risks to business which could weaken market share such as technology obsolescence and resistance to the product by pests.

Agri Inputs


Execution track record We measure this parameter through the quantitative measures below:

5-year revenue growth – as a driver of earnings

Margin expansion – as a driver of earnings

5-year average RoCE – as a measure of capital employment efficiency

Pre-tax CFO/EBITDA – as a measure of cash conversion of book profits

Ability to incubate new business ideas – we measure if the management has been able to organically build new expansion into adjacencies effectively.

Financial/Operating efficiency Working capital management: The Indian pesticides and seeds industry suffers

from higher inventory days, as the demand is governed by the monsoons. The years where monsoons are weak lead to lower sowing or lesser buying of expensive seeds. This leads to higher inventory at dealers. And as sowing for most of the crops only happens once, this pushes the use of unsold inventory to the next year. In most of the cases, unsold inventory has to be taken back by the company. Another key issue is the higher number of creditor days. Farmers normally pay for seeds and pesticides once they have harvested the crop and sold it in the market. This results in a creditor period of ~6 months for retailers. Due to this, companies also have a receivables cycle of ~3-4 months.

Gross asset turnover: Gross asset turnover is a measure of the operating efficiency of the company. Given the different business models of various companies, gross asset turnovers are not directly comparable; however, we ascertain the same based on the improvement in asset turnover over the years.

Capital allocation: We measure the company on sources of cash (higher the operating cash flows, the better it is) and utilisation of cash (better use in capex or otherwise in dividends).

Net debt to equity: Measure of leverage used by the management.

Corporate governance Quality of Board: When most of the companies are in the early stage of their

growth, a quality board is clearly an advantage. Independence of the board better protects minority shareholders, and moreover board members with varied functional expertise steer the company in the right direction.

Professional management: Professional management with their expertise can steer the organisation.

Management depth: A strong second line of management is necessary to execute well, as an organisation continues to undergo a high growth trajectory.

Dividend payout ratio: As management pays any excess cash which is not required by the business, any potential misuse of piled up cash on balance sheet is avoided.

Accounting checks: We check for any unclassified loans and advances, related party transactions, contingent liabilities, auditors’ quality, etc. to check the quality of accounts.

Minority treatment: Apart from the points highlighted above, we also check for any strategic steps which lead to minority shortchanging on voting rights or profits.

Agri Inputs


PI emerges as our top pick We evaluate the agri inputs business on four key parameters. PI emerges as our top pick in our 4P quality framework. We also like Bayer Cropscience and Rallis as the other two plays in the agri space.

4P quality framework Exhibit 53:

Parameter Bayer Rallis PI Industries Dhanuka Insecticides India Kaveri Seeds





Overall Strength

Source: Ambit Capital research; Note: 1 is superior positioning, 2 is above intermediate positioning, 3 is intermediate positioning, 4 is inferior positioning

Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Business model strength – PI stands out as the best

On business model strength we prefer PI given its presence in the high-growth CSM business. We believe the CSM business over the next few years would continue to grow faster than the domestic agrochemicals business. In addition, it is relatively insulated to the vagaries of the monsoon.

We also like Rallis and Bayer in terms of business model strength; however, we rate them lower than PI due to: (1) underperformance of Rallis in the domestic agrochemical segment over the last five years vs listed peers. (2) Bayer moving away from manufacturing its own products and acting as a trading entity for 85% of its business. We rate Kaveri lower due to its lack of pan-India distribution and over-dependence on one crop. In addition, the cotton hybrids commercialisation and its success keeps changing every 2-4 years which adds risks to Kaveri’s current market positioning. On product development, we rate Bayer as the best given the support from the parent. PI and Dhanuka are aggressively into in-licensing of molecules from global innovators and have been able to introduce new products into the market on a consistent basis.

Business model strength Exhibit 54:


Segment attractiveness

Market positioning

Distribution

Manufacturing Capabilities

Product development/ Process capabilities for exports

Risks to current market positioning

Overall Score

Source: Ambit Capital research; Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Cotton hybrids commercialisation and its success keeps changing every 2-4 years

Agri Inputs


Segment attractiveness and competitive positioning Exhibit 55:

Business Model Attractiveness Competitive Positioning

Bayer Formulated Agrochemicals High High

Technical - Patented Medium High

Rallis Formulated Agrochemicals High Medium

International Exports- Generics Low High

Seeds Medium Medium

Plant Growth Nutrients High High

PI Industries Formulated Agrochemicals High Medium

Fine Chemicals Custom Manufacturing High High

Dhanuka Formulated Agrochemicals High Medium

IIL Formulated Agrochemicals High Low

Technical - Generics Low Low


Strong execution track record

PI and Kaveri have registered the strongest revenue growth over the last 5 years. Rallis’s revenue growth rates have lagged that of its peers despite its entry into many other new segments such as seeds, plant growth nutrients, and contract manufacturing business.

Execution track record Exhibit 56:


5 year revenue growth

Margin expansion

5 year average ROCE

Ability to incubate new business ideas

CFO/EBITDA

Overall



Rallis has seen the slowest revenue growth amongst its peers (` mn) Exhibit 57:

Company/Metric FY09 FY10 FY11 FY12 FY13 FY14 5 year CAGR Rank

Bayer 13,940 17,254 21,392 22,723 27,253 32,452 18.4% 2

Dhanuka 3,368 4,081 4,910 5,292 5,823 7,384 17.0% 3

Insecticides India 2,634 3,774 4,501 5,218 6,167 8,641 26.8% 2

Kaveri Seeds 1,231 1,621 2,337 3,724 7,120 10,111 52.4% 1

PI Industries 4,629 5,425 7,200 8,791 11,514 15,955 28.1% 2

Rallis 8,562 9,005 10,934 12,749 14,582 17,466 15.3% 4

Source: Company reports

Over the years, Rallis has lost its margin leadership in the agri inputs space due to the acquisition of the Metahelix business whilst others have grown their margins driven by higher share of in-licensing revenues. PI and Dhanuka have been to expand market share driven by higher share of high-value molecules (in case of both Dhanuka and PI) and growing share of the higher-margin CSM business (in case of PI)

Agri Inputs


EBITDA margin expansion has been on an uptrend for Dhanuka and PI Exhibit 58:Industries Company/Matrix FY10 FY11 FY12 FY13 FY14 Rank

Bayer 13.6% 11.1% 11.5% 13.7% 13.3% 3

Dhanuka 14.4% 16.0% 15.1% 15.3% 17.0% 2

Insecticides India 9.3% 9.7% 10.8% 11.3% 9.5% 4

Kaveri Seeds 21.8% 23.1% 20.7% 19.6% 21.9% 1

PI Industries 16.1% 16.2% 16.5% 15.9% 18.2% 1

Rallis 18.5% 18.2% 15.9% 14.4% 15.1% 3

Source: Company

Similar to margins, PI and Dhanuka have gradually expanded their RoCEs whilst Rallis’ RoCEs have come down due to the Metahelix acquisition. Bayer’s RoCEs have also come off significantly due to rising cash and lower margins. PI’s RoCEs have been consistently rising, reaching the best amongst its peers in FY14.

RoCE (post-tax) has been improving gradually for Exhibit 59:PI Industries Company/Metric FY10 FY11 FY12 FY13 FY14 Rank

Bayer 25.7% 19.3% 22.1% 19.6% 15.9% 4

Dhanuka 25.0% 22.6% 22.2% 22.0% 25.1% 2


Kaveri Seeds 16.8% 24.2% 25.4% 39.8% 43.1% 1

PI Industries 16.9% 19.5% 17.6% 16.2% 23.9% 2

Rallis 24.9% 26.2% 20.3% 20.3% 21.6% 3

Source: Company data

RoCE (post-tax) has been improving gradually for Exhibit 60:PI Industries Company/Metric FY10 FY11 FY12 FY13 FY14 Rank

Bayer 25.7% 19.3% 22.1% 19.6% 15.9% 4

Dhanuka 25.0% 22.6% 22.2% 22.0% 25.1% 2


Kaveri Seeds 16.8% 24.2% 25.4% 39.8% 43.1% 1

PI Industries 16.9% 19.5% 17.6% 16.2% 23.9% 2

Rallis 24.9% 26.2% 20.3% 20.3% 21.6% 3


Rallis has one of the best cash conversion cycles amongst its peers, leading to a better pre-tax CFO:EBITDA ratio.

Kaveri, Rallis and PI Industries have the best cash conversion Exhibit 61:

Company/Metric FY10 FY11 FY12 FY13 FY14 5 year Average Rank

Bayer 70.6% 79.7% 71.5% 72.5% 105.4% 82.5% 2

Dhanuka 48.0% 2.0% 91.0% 73.0% 46.0% 52.0% 3

Insecticides India 4.3% 109.6% -47.8% 13.5% 56.3% 27.4% 4

Kaveri Seeds 61.2% 100.4% 152.1% 78.7% 86.0% 95.7% 1

PI Industries 114.2% 33.4% 101.6% 76.7% 100.7% 87.4% 2

Rallis 169.1% 79.8% 66.5% 85.8% 89.0% 95.0% 1


Financial and operating efficiency Exhibit 62:Parameter Bayer Rallis PI Industries Dhanuka Insecticides India Kaveri Seeds

Working Capital Management

Net Debt to Equity

Gross Asset Turnover

CFO/EBITDA

Capital Allocation

Overall


Agri Inputs


Rallis’ working capital management is a benchmark for its peers. The company has seen no bad debts in the last 6 years. It has focused significantly on improving its working capital post 2002 and it has gradually emerged as the best in working capital management by a wide margin vs its peers. In our discussion with the management, the CFO clearly emphasised the need to tightly manage working capital and avoid any window dressing on quarterly numbers as a key step to retain long-term profitability in the business. PI also has been able to bring down its working capital. Bayer has significantly lower creditor days, as most of its raw material is procured from group entities.

Cash conversion cycle; PI has been able to bring down its cash conversion cycle Exhibit 63:

Company/Metric Average Debtor days Average Inventory days Average creditor days Average cash conversion cycle

FY11 FY12 FY13 FY14 FY11 FY12 FY13 FY14 FY11 FY12 FY13 FY14 FY11 FY12 FY13 FY14

Bayer 43 45 40 42 70 78 69 61 59 55 32 28 54 68 78 75

Dhanuka 87 100 95 79 94 97 94 93 35 37 31 23 146 160 158 149

Insecticides India 58 59 61 52 99 115 127 113 97 101 100 97 60 73 87 68

Kaveri Seeds 60 32 25 14 229 229 204 180 203 230 209 178 86 31 20 16

PI Industries 71 72 69 59 62 66 67 64 70 68 75 82 62 71 61 41

Rallis 31 31 34 35 65 73 68 63 101 98 86 77 -5 6 17 22

Median 59 52 51 47 82 87 82 79 84 83 80 79 61 69 69 55


Rallis has had healthy gross asset turnover; however, the turns came down post the addition of Metahelix and the new Dahej facility. PI has been able to improve its asset turnover from 2.2x in FY10 to 2.7x in FY14. Dhanuka’s gross asset turnover is low due to the company only having formulation units. Kaveri Seeds’ asset turnover too has increased at a good pace.

Gross fixed asset turnover on an upward trend Exhibit 64:

Company Matrix FY10 FY11 FY12 FY13 FY14

Bayer 3.7 4.2 4.5 6.2 7.3

Dhanuka 8 8.1 8.2 7.3 7.7

Insecticides India 13.3 13.7 11.0 5.8 5.0

Kaveri Seeds 2.2 2.1 2.9 4.6 5.3

PI Industries 2.2 2.4 2.5 2.4 2.7

Rallis 3.9 2.8 2.3 2.5 2.8

Median 3.8 3.5 3.7 5.2 5.2


Most of the players except for Insecticides India Exhibit 65:are virtually debt-free.

Company/Matrix FY10 FY11 FY12 FY13 FY14

Bayer 0.1 -0.4 -0.5 -0.5 -0.3

Dhanuka 0.6 0.3 0.1 0.1 0.1


Kaveri Seeds 0.2 0.1 0 0 0

PI Industries 0.9 1 0.7 0.3 0.1

Rallis -0.3 0.1 0.2 0 0.1

Median 0.2 0.2 0.2 0.1 0.1


PI and Rallis had prudent cash allocation

Cash flow from operations has been the primary source of cash for Rallis. The company used the cash flow to fund the capex, Metahelix acquisition, and payment of dividends. The management’s past capital allocation decisions have been prudent, as capex was incurred for increasing manufacturing/research capability and improving product portfolio which contributed to higher revenue/profitability. Metahelix gave Rallis an entry into the seeds space and the acquisition seem to be doing well.

PI has generated most of its cash from operating cash flows (three-fourths) and equity issuance (one-fourths). Amongst use of cash, capex to build manufacturing facilities accounted for 62% of cash flows and 28% of cash flows were used to repay debt or to service the debt.

Dhanuka has mostly used its cash on dividend payments and capex. Cash has been generated largely through cash flow from operations and equity issuance.

IIL has incurred a capex of ~` 2.4bn over the last 6 years which is largely debt-funded (75%) and partly equity-funded (12%). Weaker operating cash flows are a cause for concern. Note that 15% of the total cash flow generated was used in the

Agri Inputs


payment of interest, which means operating cash flows were not even enough to pay the interest.

Bayer Cropscience did not have any capex requirement, as the company has been moving away from manufacturing in-house to other group entities and third-party vendors. It used its cash for loans to other corporates and share buybacks. High amount of loans and advances on the company’s books is a concern.

Corporate governance/minority treatment

Rallis and PI emerge as the best in terms of corporate governance. The company has the highest dividend payout ratio amongst its peers. PI Industries has the best quality board followed by Rallis. Both of them have fairly reputed professionals on their board. The presence of two individuals from the UB Group out of the 4 independent directors on Bayer’s board is a concern. The presence of lesser-known directors on Dhanuka, IIL and Kaveri Seeds is a concern.

We rate Rallis and Bayer higher on management depth given the strong talent pool available from their parent entity. Dhanuka pays out nearly 10% of its PBT to promoter family members, which is a concern.

Corporate governance/minority treatment Exhibit 66:


Quality of Board

Professional Management

Management Depth

Dividend Payout

Accounting Checks

Minority Treatment

Overall



Dependent and independent directors Exhibit 67:

Dependent Independent Auditors

Bayer 5 4 Price Waterhouse

Rallis 3 6 Deloitte Haskins & Sells LLP

PI Industries 3 6 SS Kothari Mehta & Co

Dhanuka 5 9 Dinesh Mehta & Co

Insecticides India 3 5 Mohit Parekh & Co

Kaveri Seeds 6 6 P.R.Reddy & Co


Dividend payout ratio for Rallis is the best Exhibit 68:

Company/Metric FY10 FY11 FY12 FY13 FY14

Bayer 12% 12% 12% 2% 7%

Dhanuka 18% 19% 19% 22% 21%

Insecticides India 9% 10% 10% 11% 10%

Kaveri Seeds 2% 2% 2% 3% 16%

PI Industries 4% 8% 12% 14% 14%

Rallis 22% 31% 43% 38% 31%


Managerial remuneration as a proportion of PBT Exhibit 69:- comparison with peers

Company/Metric FY10 FY11 FY12 FY13 FY14

Bayer 4.4% 3.3% 3.0% 2.4% 2.4%

Dhanuka 7.7% 7.9% 10.1% 10.6% 10.1%

Insecticides India 1.4% 1.4% 2.1% 2.7% 3.1%

PI Industries 5.0% 4.0% 3.2% 3.6% 3.4%

Rallis 0.9% 1.3% 1.3% 1.4% 1.3%


Agri Inputs


Valuation - Rich sustainable multiples, EPS growth to be the primary stock return driver The sector has seen a significant re-rating over the last few years driven by healthy earnings growth for the sector and consistent improvement in RoEs by most of the players. Most of the agrochemical players like Rallis India, Dhanuka Agritech, PI Industries, and Bayer are trading at 18-21x. IIL trades at a discount due to its weaker competitive positioning in the space. Our top idea is PI (BUY, TP `580, and implied 19x FY17 EPS); PI’s earnings growth and RoCE will remain the highest amongst its peers, as in-licensing focus and CSM offer two discernible large opportunities with relatively lower competitive threats. We are also BUYers of Rallis (BUY, TP `275, and implied 19x FY17 EPS), wherein we see earnings recovery from the refreshed R&D focus/alliances-led product launches and improving Metahelix margins aiding growth rates.

Relative valuations – MNCs trading at a premium Both Bayer and Monsanto trade at a premium vs their domestic peers given superior product capabilities, strong farmer engagement programmes and brand recall. In Monsanto, there is positive sentiment driven around launch of RR flex and continued adoption of herbicides (Glyshophate). Kaveri Seeds trades at a discount to agrochemical players driven by the inherent risks of the seeds business and dependence on one region/crop. We believe Rallis could see some valuation upside with improvement in domestic business growth rates. PI may too see further re-rating, as its RoCEs continue to improve.

Most of the agrochemical peers of PI have slightly dissimilar business models, and hence relative valuations need to be seen in the right context.

PI multiples – re-rating potential

PI trades at 19x FY16 EPS, relatively cheaper to Rallis and Bayer; we believe this differential will remain in near term given PI’s relatively lower share of domestic brand/distribution-led revenues.

Better RoEs than peers: We believe the discounts are largely due to the slightly more capital intensity of the business. However, we would like to point out that the business now generates much better RoEs as well as ROCEs vs its agrochemical peers.

B2B nature of business: We believe PI is gradually emerging from a bulk vendor of raw materials to a more strategic partner for its clients.

More diversified business: With more than 60% of earnings now coming from the export-led CSM business, the business is well insulated from the vagaries of monsoon.

Superior growth profile: PI’s EPS CAGR of 27% is the best amongst agrochemical players (23% for Dhanuka and Rallis, and 26% for Bayer).

Quality management and corporate governance: We believe PI’s management has done well on executing its strategy to build a superior business model for the future. In corporate governance, PI scores better than most of its peers (except Rallis).

Rallis – premium valuations to sustain

Rallis is one of the most-diversified agri inputs companies in the space. However, we have concerns over the aggression of the company in capitalising on opportunities. A case in point is the lagging growth of Rallis vs its peers in the domestic pesticides business. Even in exports, Rallis was the best-positioned player to capture the Indian agri exports opportunity. However, the company lagged here in seizing the opportunity vs other domestic players such as PI Industries and UPL.

Agri Inputs


Rallis currently trades at a premium of ~5-10% vs its domestic peers based on its distribution strength and its longstanding association with Indian farmers. Whilst we expect EPS growth rates to pick up to mid-20% rate, relative premium could not expand if its growth rates remain lower than peers.

RoEs weaker than peers: Rallis’ RoEs are close to median RoEs in the space, with PI, Dhanuka, Kaveri and Monsanto India delivering better RoEs than the company. However we expect the ROEs to inch up as Metahelix business scales up and margins come up to 20% levels (as per management’s

Business well diversified but ability to grow ahead of industry growth will be key: Rallis has been able to diversify its business well, with ~30% revenues flowing from non-pesticides portfolio. However, with too many business segments, the management’s capability to grow them ahead of industry growth rates would be a challenge.

Superior growth profile: Rallis is likely to record earnings CAGR of 23% driven by the Metahelix scale up (which has significantly lower margins currently vs its established peers).

Comparative valuation sheet Exhibit 70:

Company Name

Market Cap (USD

mn)

ADVT - 6m

(USD mn)

P/E P/B EV/EBITDA ROE CAGR (FY14-FY17)

FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E Sales EBITDA EPS

Global Agri Majors

Monsanto 58,055 7.3 20.4 17.6 15.2 7.4 6.2 4.8 12.5 11.3 9.9 36.1 40.7 40.3 6.1% 10.2% 11.2%

Dow Chemicals 60,602 7.1 17.4 14.8 12.6 2.3 2.2 2.0 8.8 8.4 7.6 14.4 16.5 17.8 2.9% 14.6% 0.1%

FMC Corp 7,467 1.4 14.3 12.7 11.2 4.4 3.6 3.2 10.1 8.9 8.1 31.8 30.1 32.0 7.4% 12.6% 31.2%

Syngenta 30,962 1.4 16.9 15.2 13.6 2.9 2.7 2.5 12.3 11.2 10.0 17.2 18.1 19.0 4.0% 6.5% 10.0%

Bayer AG 118,311 3.2 18.8 16.5 14.6 4.1 3.7 3.3 11.5 10.2 9.3 21.7 20.8 21.6 5.7% 5.6% 26.9%

BASF 81,884 3.4 12.8 12.1 11.2 2.3 2.1 2.0 7.7 7.4 7.0 18.2 17.9 18.0 -2.5% 4.2% 6.3%

Domestic Agro Chemical Players

PI Industries 974 1.1 23.9 18.4 14.5 6.9 5.3 4.1 16.3 12.7 9.8 30.0 30.4 29.8 20.4% 25.2% 26.8%

Rallis India 700 1.7 25.3 19.2 15.7 5.3 4.5 3.8 14.4 11.3 9.3 22.8 25.8 26.8 15.1% 18.9% 22.9% Bayer CropScience 1,817 1.0 31.9 26.7 19.5 5.4 4.6 3.7 21.3 17.9 13.8 18.7 18.5 20.6 17.6% 23.0% 25.8%

UPL Ltd 2,445 10.6 12.8 10.9 9.7 2.4 2.1 1.8 7.8 6.9 6.4 20.1 19.8 19.1 10.7% 10.6% 17.1% Dhanuka Agritech 457 0.6 26.1 20.9 16.4 6.8 5.5 4.3 19.7 15.6 12.5 28.4 28.4 28.1 19.6% 23.7% 22.7%

Insecticides India

178 0.9 18.4 13.0 9.7 3.6 2.9 2.3 12.5 9.6 8.0 21.8 24.9 26.4 18.4% 28.5% 41.6%

Excel Crop Care 203 0.3 12.9 10.9 DNA 3.6 3.0 DNA 8.5 7.3 DNA 27.8 27.4 DNA DNA DNA DNA

Domestic Seeds Players

Kaveri Seeds 1,058 3.1 21.7 17.4 13.9 8.7 6.2 4.6 20.6 16.8 13.7 46.5 40.8 37.3 21.2% 28.2% 31.2%

Monsanto India 805 2.6 31.2 24.5 20.0 10.1 7.9 7.6 27.2 21.7 18.1 36.4 36.2 42.3 18.4% 21.8% 26.5%

Source: Company, Ambit Capital research, Consensus; Note: DNA= Data Not Available

Identifying winners in the agri inputs space Exhibit 71:

Source: Company. Ambit Capital research. Note: Size of bubble represents RoE.

PI Industries

Rallis India

Bayer Cropscience

UPL Limited

Dhanuka Agritech

Insecticides India

Kaveri Seeds

15%

20%

25%

30%

35%

40%

45%

10 12 14 16 18 20 22 24

EPS

CA

GR

(FY1

4-F

Y17

)

12-month Agri Inputs Stock Price Returns

Source: Company; Ambit Capital research

40 70

112 113

180 188

235 235

305 327

Rallis IndiaBayer…

PI IndustriesUPL Ltd

Advanta LtdKaveri Seeds

Excel Crop CareDhanuka…

Monsanto India

Agri Inputs


Stock Mapping Insecticides India, PI Industries, and Rallis India Exhibit 72:

are attractive on EPS CAGR and P/E screen.

Source: Ambit Capital research. Note: Size of bubble shows RoE

PI Industries, Rallis India and Bayer Cropscience Exhibit 73:are attractive on a mapping of our competitive advantage framework and valuation

Source: Ambit Capital research. Note: Size of bubble shows revenue size.

Insecticides India and Dhanuka Agritech turn Exhibit 74:unattractive on account of poor CFO:EBITDA

Source: Ambit Capital research. Note: Size of bubble shows ROCE

PI and Bayer Cropscience look attractive on a Exhibit 75:combination of innovation index and domestic business revenue CAGR

Source: Ambit Capital research. Note: Size of bubble shows India revenue.

How have the companies re-rated?

The sector has largely seen a re-rating driven by improving farmer adoption due to a variety of factors and continued thrust for farmer awareness by MNCs/local agri input companies.

PI Industries has seen a significant re-rating over the past few years driven by consistently healthy earnings growth and improvement in RoEs. Rallis has been trading largely at historical valuations.

PI Industries

Rallis India

Bayer Cropscienc

e

UPL Limited

Dhanuka Agritech

Insecticides India

Kaveri Seeds

15%

20%

25%

30%

35%

40%

45%

10 12 14 16 18 20 22 24

EPS

CAG

R (%

)

PI Industries

Rallis IndiaBayer

Cropscience

UPL Limited

Dhanuka Agritech

Insecticides India

Kaveri Seeds

0

1

2

3

4

5 10 15 20 25 30Business Fram

ework Rating

Bayer

Dhanuka Agritech

Insecticides India

Kaveri SeedsPI

Industries

Rallis

UPL

20%

40%

60%

80%

100%

5% 10% 15% 20% 25%

5 Ye

ar a

vera

ge C

FO:

EBIT Margin

PI IndustriesRallis

Bayer Cropscienc

e

UPL Limited

Dhanuka Agritech

Insecticides India

Kaveri Seeds

0%

10%

20%

30%

40%

50%

60%

70%

80%

0 1 2 3 4Innovation Index

Indi

a 3

Yea

r Re

venu

e C

AG

R

Agri Inputs


Sectors RoEs have been healthy at 20%; PI’s Exhibit 76:RoEs appear lower due to falling debt levels


RoCEs for PI have materially improved over the Exhibit 77:last six years whilst Bayer has slipped


Cash conversion (CFO:EBITDA) has been healthy Exhibit 78:for all the names except IIL


PI has largely led the EPS growth Exhibit 79:


Bayer continues to trade at a premium vs the Exhibit 80:rest of the pack


PI Industries has gradually re-rated whilst Exhibit 81:Rallis’ multiples have largely remained flat


11%

16%

21%

26%

31%

36%

FY09

FY10

FY11

FY12

FY13

FY14

PI Industries Rallis

Bayer Insecticide

9%

18%

27%

FY09

FY10

FY11

FY12

FY13

FY14


Bayer Insecticide

-50%

0%

50%

100%

150%

200%

FY10

FY11

FY12

FY13

FY14


Bayer Insecticide

-20%

30%

80%

130%

180%

FY09

FY10

FY11

FY12

FY13

FY14


Bayer Insecticide

0

2

4

6

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14

Rallis PI industries Insecticide Bayer

2

10

18

26

34

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14

Rallis PI industries Bayer Insecticide

Agri Inputs


Agri Inputs/Pharma/Consumer – Similarities and differences Agrochemicals—akin to pharma on chemistry but to consumer on importance of distribution

We believe agri input - agrochemicals multiples should trade somewhere between pharma and consumer staples. Whilst we acknowledge product-related risks in agri inputs – agrochemicals is very similar to pharma; however, regulatory risks are lower. Also if we look at product mix, pharma has a higher share of generic product exports which is largely B2B whilst most of the agrochemical companies have lower to zero exposure to the exports segment and are mostly B2C.

We reckon that most of the Indian companies operate on in-licensing model for patented molecules. Global innovators usually do this to tap a big market like India, only one player distribution cannot fully capture the revenue opportunity. In addition many innovators do not have an existing distribution network in the country. Hence, the product risks are taken care to a certain extent, though relationships or the ability to procure new molecule remain the key. However, in this case, agrochemicals MNCs should get better multiples than domestic players.

In addition, brand and distribution advantages are clearly much higher in case of agri vis-a-vis pharma similar to staples. Creating a distribution network in rural hinterland which is much more fragmented is difficult similar to FMCG companies.

Creating a brand in agri inputs space is difficult also because of limited availability of national influencer such as television media. In case of agri inputs, building a brand is a slow process driven by a mix of BTL activities and farmer engagement activities.

In case of pharma and consumer staples, distributor involvement is lower because dealer/retailer does not play an important part in influencing the choice of the end consumer. In case of agrochemicals, distributor/retailers play an important role.

Seeds—high replacement risks, should keep multiples lower to agrochem

In case of seeds, product replacement risks are high. In case of agrochemicals, where a company would have more than 50 products, in case of seeds there would be one or two major hybrids which will be driving success for the company. Hence their multiple will be lower than agrochemicals. Also given bio diversity of Indian soil, it is difficult for a player to become a pan-India player.

In case of seeds, word-of-mouth publicity for a particular seed variety is a key demand driver apart from distribution and farmer engagement. Usually every hybrid variety has a 3-4-year cycle and then the product starts losing its market share.

Comparison between Agri Inputs, Pharma, and Consumer Staples Exhibit 82: Agri Inputs - Agrochem Agri Inputs - seeds Pharma Consumer Staples

Distribution Important Less Important Less Important Important

Key Influencer Dealer, Farmer engagement Dealer, Farmer engagement Doctor TV media Engagement with end Consumer Medium Medium Low High

Driver of Engagement Field Advisors, BTL activities.

National Media is limited

Field advisors. Word of mouth is also an important

influencer

Medical representatives, Doctor incentives

National Media, BTL activities

Product obsolescence risk Medium Medium Medium Low

Product concentration risk Low High Medium Low

Discretionary nature of demand Somewhat low - consumption levels

per acre go down in case of agrochemicals

No No Somewhat – down trading

is possible

Exports portion Medium None High None

Longevity of earnings

Regulatory risks Medium Medium High Low

Working Capital Mid to High High High Negative WC

FY16 P/E Multiples 20x 17x -25x 17-22x 26-28x


Agri Inputs


Our DCF-based valuation drivers Indian agrochemical space: Indian agrochemicals should witness healthy growth rates of ~12-14% over the next ten years driven by growing awareness amongst farmers to move away from sustenance farming to commercial farming. Growing initiatives by private and public stakeholders, improved road connectivity and telecom penetration are also key catalysts in the growth of the market. Rising farm realisations driven by MSP hikes and growing demand from organized food players is supporting affordability amongst farmers. Historically, Indian agriculture GDP growth rates have been at 3-3.5%; however, growth rates picked up to 4.5% over the last five-year plan. We believe the growth rates might further accelerate under new the political regime. In addition to industry growth rates, organised players grow 300-400bps higher than industry growth. Our aggregated revenues of 15 agrochemical companies have grown at 18% over the last 6 years vs reported industry growth of 12-14%. We expect PI Industries to grow faster than Rallis in domestic business given relatively smaller size and sustained performance of in-licensed products (see exhibits below). We expect Rallis’ growth in domestic business to be driven by scale up in seeds business and plant growth nutrients and some recovery on domestic agrochemical business.

CSM business: Custom synthesis and manufacturing business for fine chemicals is globally estimated at US$ 85bn and is likely to grown at a CAGR of 12%. PI Industries have emerged as a quality player in the space driven by its impeccable record in project execution and clean record on IP safeguarding. We build in average growth rate of 22% over the next 3 years and then 15% growth until FY26. We believe there is a significant room for PI Industries to grow, given its impeccable track record and growing preference for India as a manufacturing destination. At our growth rates, PI would still be a 1% market share player for fine chemicals by FY27.

We estimate 15% growth rate for Rallis’ exports business (contract manufacturing) over FY14 to FY17. We don’t build anything substantial from CRAMS business.

PI - Revenue assumptions Exhibit 83:

Particulars (̀ mn unless mentioned) FY14 FY15E FY16E FY17E

Change (%)

FY15E FY16E FY17E

Growth Rate Domestic Business 8,860 10,100 11,918 13,944 14% 18% 17%

International Business 9,771 11,725 14,304 17,737 20% 22% 24%

Net Sales 15,955 19,061 22,995 27,896 19% 21% 21%


Rallis - Revenue assumptions Exhibit 84:

Particulars (̀ mn unless mentioned) FY14 FY15E FY16E FY17E

Change (%) FY15E FY16E FY17E

Growth Rate Domestic Pesticides Business 10,161 10,669 12,269 14,110 5% 15% 15%

International Pesticides Business 5,079 5,824 6,673 7,597 15% 15% 14%

Seeds Business 2,378 3,210 3,853 4,623 35% 20% 20%

Plant Growth Nutrients 581 755 981 1,275 30% 30% 30%

Financials Net Sales 17,466 19,718 22,937 26,630 13% 16% 16%


Agri Inputs


Rallis vs PI Industries assumptions comparison Exhibit 85:

FY14-17 Rallis PI Industries Comments

Revenue Growth 15% 19% We expect PI to grow faster driven by better performance of CSM business and outperformance on domestic agrochemical business

EBITDA Growth 19% 25%

Margin Expansion 15%-17% 18%-20% We assume similar margin expansion for both the companies driven by: (1) PI Industries: rising salience of higher margin CSM business and improving operating leverage (2) Rallis India: Improving margins for Metahelix to boost overall margin profile

PAT Growth 23% 27% We assume tax benefits from tax exempt Dahej/Jambusar facility

WC Cycle 22-20 41-37 We assume working capital improvement for PI driven by rising share of CSM revenues

GB Turnover 2.2-2.5 2-2.5

WACC 14.5% 15% Our WACC is 50bps lower for Rallis given longer operating history and strong parentage

Terminal Growth 6% 5%

We believe terminal growth for Indian agri input players to be 6% given significantly low penetration of agri inputs in the country which has the second largest arable land in the world. We assume 6% terminal growth rate for Rallis. PI’s terminal growth is kept at 5% given higher share of CSM business.

Implied P/E 19x 19x At our 12 month target price, implied FY17 P/E is 19x in line with current FY16 valuations

FY17-26 Rallis PI Industries

Revenue 13% 15% We assume growth rates to be healthy given lower penetration levels

EBITDA Growth 15% 18%

Margin Expansion 17%-19% 20%-24% EBITDA margin expansion driven by operating leverage and rising salience of more profitable segments (seeds in case of Rallis and CSM business in case of PI Industries)

PAT Growth 17% 19%

WC Cycle 20 37-34 We assume some WC improvement for PI driven by rising salience of CSM business

GB Turnover 2.5-3.1 2.5-3.5


Relative Financials (` mn) Exhibit 86:Name Revenue EBITDA PAT

FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17

PI Industries (A) 15,955 19,061 22,995 27,896 2,910 3,696 4,661 5,718 1,912 2,371 3,082 3,900

Rallis India (A) 17,466 19,718 22,937 26,630 2,636 3,004 3,724 4,434 1,522 1,750 2,305 2,829

PI Industries 15,955 19,045 23,265 27,357 2,942 3,583 4,554 5,422 1,880 2,347 3,030 3,618

Rallis India 17,466 19,810 23,206 26,874 2,730 3,014 3,705 4,490 1,519 1,780 2,235 2,734 Bayer CropScience 32,452 37,697 43,945 52,872 4,267 5,136 6,106 7,939 2,895 3,539 4,247 5,768

UPL Ltd 107,709 120,307 133,964 146,029 20,484 22,725 25,395 27,735 9,498 11,768 13,753 15,245 Dhanuka Agritech 7,384 8,386 10,323 12,628 1,209 1,432 1,809 2,288 931 1,086 1,330 1,722

Insecticides India 8,641 10,600 12,756 14,367 837 1,139 1,476 1,776 399 599 845 1,133

Kaveri Seeds 10,111 12,445 14,919 18,028 2,213 3,085 3,785 4,659 2,090 3,011 3,753 4,716

Monsanto India 5,752 6,790 7,947 9,557 1,470 1,766 2,214 2,657 1,229 1,596 2,035 2,488

Source: Company, Bloomberg, Ambit Capital research. Ambit estimates are indicated by (A), rest are based on Bloomberg Consensus.

Relative Financials Exhibit 87:Name EBITDA MARGIN (%) PAT MARGIN (%) ROE


PI Industries (A) 18.2 19.4 20.3 20.5 12 12.4 13.4 14 31.2 30 30.4 29.8

Rallis India (A) 15.1 15.2 16.2 16.7 8.7 8.9 10.1 10.6 22.8 22.8 25.8 26.8

PI Industries (C ) 18.4 18.8 19.6 19.8 11.8 12.3 13 13.2 30.7 29.4 29.6 28.4

Rallis India (C ) 15.6 15.2 16 16.7 8.7 9 9.6 10.2 22.7 22.5 24.2 24.5 Bayer Crop Science 13.1 13.6 13.9 15 8.9 9.4 9.7 10.9 15.8 18.7 18.5 20.6

UPL Ltd 19 18.9 19 19 8.8 9.8 10.3 10.4 19.2 20.1 19.8 19.1 Dhanuka Agritech 16.4 17.1 17.5 18.1 12.6 12.9 12.9 13.6 31.3 28 28.1 28.1

Insecticides India 9.7 10.7 11.6 12.4 4.6 5.6 6.6 7.9 17.4 21.8 24.9 26.4

Kaveri Seeds 21.9 24.8 25.4 25.8 20.7 24.2 25.2 26.2 48.6 46.5 40.8 37.3

Monsanto India 25.6 26 27.9 27.8 21.4 23.5 25.6 26 32.7 36.4 36.2 42.3

Source: Company, Bloomberg, Ambit Capital research. Ambit estimates are indicated by (A), rest are based on Bloomberg Consensus.

Agri Inputs


Appendix Indian patent process India became a signee to TRIPS agreement in 1995. Under the various exemptions, India moved from a process patent regime to a product patent regime in 2005. This led to protection of IP of foreign players. In India, there are two kinds of registrations which are allowed on agrochemicals, as summarised below. On an average it takes ~ 2-3 years for a fresh registration.

Type of registrations Exhibit 88:

Activity 9(4) - "Me Too" registration

9(3) and 9(3b) - Fresh Registration

Documentation and Form 1 and other documents verification by legal 0.5 month 1 month

CIB&RC analysis, covering: Chemistry Bioefficacy Toxicology Packaging

1 - 3 months 6 - 12 months

Sample submission, collection & Analysis 2 - 6 months 2 - 6 months

MR L Fixation (Ministry of Health) 1 - 2++ months 3- 12 months

Registration Certificate Issuance 2 months 2 months

Overall Process Minimum 6 months Minimum 24- 36 months

Source: Industry

Process of registration Exhibit 89:

Source: Industry

Applicant

2. CIB & RC, Minsitry of Agriculture (Registration & Scrutiny )Submit

applicationalong with

data

Deficiency report

Admin Office

Legal Chemistry Bioefficacy

Registration Commitee Packaging Toxicology

3. ICAR

4. Ministry of Health (M RL Fixation)

Secretariatscrutunizesresidue pro

forma

SCPRstudies data

andrecommends the MRL

CCFS studiesSCPR

recommendationapproves MRL

5. Central InsecticidesLaboratory (Testing)

For Products Manufactured in IndiaInsepector

visits site andcollect the

sample

Sampleanalysis

For Imported Technicals

Submitsamples

Sampleanalysis


On a multi-year growth path

PI has emerged as the best hybrid business model to capitalise on the rising specialty chemicals exports opportunity plus the underpenetrated agri inputs sector. PI has built a strong business model by focusing on in-licensing for unique pesticides and capitalising on the complementary CSM opportunity (60% of revenues). Industry-leading execution (28% FY09-14 revenue CAGR, 14% to 24% FY09-14 RoCEs) and effective capital allocation provide comfort on franchise strength; 2-3 launches and CSM order book of 3.5x FY14 revenues provide strong visibility for continued revenue growth (20% over FY14-17) and RoCE expansion to 29% by FY17. We do not expect multiple expansion (TP implies 19x FY17 EPS) but industry-leading earnings growth (27% CAGR).

Competitive position: STRONG Changes to this position: POSITIVE Differentiated business model with strong competitive advantages PI’s domestic business (40% share) has a differentiated approach of in-licensing new molecules from global innovators, thus providing it with superior growth rates, better margins, and increased ‘pull’ effect for its products. In CSM business, PI has perfected the model by building strong relationships with global innovators through flawless execution of 18 commercialised molecules, clean record on IP protection and manufacturing facilities of global standards.

High-quality execution, operating efficiency and board quality We credit the management for strong execution—28%/37%/50% Sales/EBITDA/PAT CAGR driven by 17%/46% CAGR in domestic/CSM business over FY09-14. RoCE improved from 14% to 24% driven by improvement in asset turnover and EBITDA margins over the last five years alongside superior cash conversion (90% CFO/EBITDA). Importantly, global talent on board provides a strong relationship/knowledge base to direct its growth effectively.

Product innovation, expanding addressable market to support growth

PI is expanding its ambit from agrochemicals to other speciality chemicals (30% of current pipeline, none in existing order book) and is expanding its addressable market. Sizable order book of US$520mn (3.5x the current CSM revenues) provides significant revenue visibility. On the domestic side, it introduced two new products in FY14 and is looking to introduce one more in 3QFY15. Nominee Gold (30%+ of domestic sales) is growing well, driven by improving adoption of direct seeded rice. Osheen (rice insecticide) also is gaining traction gradually. Margin expansion to drive earnings, multiples to remain rich PI trades at 19x FY16 EPS, relatively cheaper to Rallis and Bayer; we believe this differential will remain, given PI’s relatively lower share of domestic brand/distribution-led revenues. PI’s EBITDA margin will expand to 30.5% from 18.2% driven by rising CSM share and operating leverage. As a result, FY14-FY17E EPS will expand at 28% CAGR and RoCE by ~500bps. Key risks include slowdown in CSM revenues and higher competition for Nominee Gold.

INITIATING COVERAGE PI IN EQUITY November 21, 2014

PI IndustriesBUY

Agrochemicals

Recommendation Mcap (bn): `57/US$0.95 6M ADV (mn): `68/US$1.1 CMP: `441 TP (12 mths): `580 Upside (%): 32

Flags Accounting: GREEN Predictability: GREEN Earnings Momentum: AMBER

Catalysts

Commissioning of Jambusar Phase 2 in 2HFY16

Revenue jump in FY16 from the newly launched products in domestic business

Success in commercialisation of non-agrochemical molecules in CSM business over next 12 months

Stock price performance


150

250

350

450

550

18,000 20,000 22,000 24,000 26,000 28,000 30,000

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

SENSEX PI Industries

Analyst Details

Ritesh Gupta

[email protected]

Tel: +91 22 3043 3242

Key financials Year to March (̀ mn) FY13 FY14 FY15E FY16E FY17E Operating Income (̀ mn) 11,514 15,955 19,061 22,995 27,896 EBITDA (` mn) 1,826 2,910 3,696 4,661 5,718 EBITDA margin (%) 15.9% 18.2% 19.4% 20.3% 20.5% EPS (`) 7.6 15.0 18.6 24.2 30.7 RoCE 16.2% 23.9% 25.8% 27.9% 28.9% EV / EBITDA (x) 34.0 20.9 16.3 12.9 10.5 P/E (x) 58.0 29.3 23.7 18.2 14.4


PI Industries


Snapshot of Company Financials PI Industries P&L account (` mn) Matrix FY14 FY15E FY16E

Net revenues 15,955 19,061 22,995

EBITDA 2,910 3,696 4,661

Depreciation 316 394 473

Interest expense 139 136 98

Adjusted PBT 2,613 3,340 4,280

Tax 733 969 1,198

Adjusted net profit 1,912 2,371 3,082

Reported net profit 1,880 2,371 3,082

Profit and Loss Ratios EBITDA Margin (%) 18.2% 19.4% 20.3%

Net profit margin (%) 12.0% 12.4% 13.4%

EV/ EBITDA (x) 20.9 16.3 12.9

P/E on adjusted basis (x) 29.3 23.7 18.2

EV/Sales (x) 3.8 3.2 2.6


PI Industries Balance Sheet (` mn) Matrix FY14 FY15E FY16E

Total Assets 13,084 15,384 17,959

Fixed Assets 5,692 6,798 7,874

Current Assets 7,388 8,581 10,079

Investments 5 5 5

Total Liabilities 13,084 15,383 17,959

Total networth 6,945 8,844 11,457

Total debt 1,223 1,223 223

Current liabilities 4,480 4,880 5,842

Deferred tax liability 437 437 437

Balance Sheet ratios RoCE 24 26 28

RoE 31 30 30

Gross Debt/Equity (x) 0.2 0.1 0.0

Net debt (cash)/ Eq (x) 0.1 0.0 (0.1)

P/B (x) 8.6 6.8 5.2


PI Industries Cash Flows (` mn) Matrix FY14 FY15E FY16E

PBT 2,613 3,340 4,280


Tax -743 -969 -1,198

Net Working Capital -81 -535 -489

CFO 2,188 2,512 3,051

Capital Expenditure -640 -1,500 -1,550

Interest received 138 174 191

CFI -502 -1,326 -1,359

Issuance of Equity 34 -82 0 Inc/Dec in Borrowings -1,097 - -1,000

Net Dividends -272 -390 -468

Interest paid -115 -136 -98

CFF -1,451 -608 -1,566

Net change in cash 236 577 125 Closing cash balance 1,548 1,012 1,501


PI is a leading agrochemicals company in India with two lines of business: (1) domestic agrochemicals – 40% of revenues (2) custom synthesis and manufacturing (CSM) business – 60% of revenues.

Under the custom synthesis business, the company offers process research, analytical development, scale-up and large-scale manufacturing needs of agrochemical giants and other leading global innovators.

In the domestic business, it has been focusing on niche in-licensed molecules which are patented or off-patented. PI’s domestic business has a strong marketing and distribution network that covers more than 35,000 retail points and 8,000 distributors/direct dealers across all major agricultural areas of India.

PI has three formulation units and six multiproduct plants across manufacturing sites at Panoli (near Ankleshwar) and Jambusar (near Bharuch) in Gujarat and Jammu in J&K. It is also building two more manufacturing plants in the Jambusar facility.

RoCE trend


Revenue growth trend (%)


5 5 7

14 17

20 18 16

24

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

25%

17%

33%

22%

31%

39%

15%

22%

29%

36%

43%

0

4,000

8,000

12,000

16,000

20,000


Domestic International CSM Growth (RHS)

PI Industries


Company background Exhibit 1: Domestic product portfolio (40% of revenues, FY14: ̀ 8.9bn)


Exhibit 2: Gross revenue growth trend (%) |


Exhibit 3: PI – Key products portfolio

Trade Name Type Common Name Type Description

Nominee Gold Herbicides Bispyribac Sodium In-licensed Post emergent, broad spectrum systemic herbicide for all types of rice cultivation i.e. direct sown rice, rice nursery and transplanted rice. It controls major grasses, sedges and broad leaf weeds of rice.

Osheen Insecticides Dinotefuran In-licensed Osheen is new systemic insecticide of a third generation of Neonicotinoid group. The molecules have been sourced from Japan. Osheen provides protection against Brown Plant Hoppers in rice.

Foratox Insecticides Phorate Generic Foratox is a versatile insecticide effective for controlling several foliar and soil pests of agricultural crops such as sucking insects, leaf miner, internal feeders (borers), white grubs, viral vectors and mites.

Fosmite Fungicides Ethion Generic Fosmite is an ethion formulation which is one of the oldest and largest selling acaricide and insecticide in the world. Fosmite formulations are applied on the foliage for effective control on a wide variety of insects.

Biovita Fungicides Ascophyllum nodosum Licensed

Biovita is based on seaweed Ascophyllum nodosum. It enables plants to receive direct benefits from the naturally balanced nutrients and plant growth substances available in seaweed extract.

Roket Insecticide Combination of Profenofos and Cypermethrin

Generic Roket is a combination product. Roket is a non-systemic insecticide having contact and stomach action. It is effective against several insect pests (both chewing and sucking types).


Herbicide, 35%

Fungicide, 15%

Insecticide, 50%

25%

17%

33%

22%

31%

39%

15%

22%

29%

36%

43%

0

4,000

8,000

12,000

16,000

20,000


Domestic International CSM Growth (RHS)

PI Industries


Strong execution capabilities and business model strength PI emerges as strongest player amongst its peers on our quality framework driven by a solid business model and strong execution capabilities.

Exhibit 4: PI emerges as the best player on our Quality framework






Overall Strength


Business model strength Exhibit 5: Business model strength



Market positioning

Distribution




Overall Score

Source: Company, Ambit Capital Research Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Segment attractiveness and market positioning: PI has gradually shifted its business model in the domestic business (40% of overall revenues) from generics to in-licensed molecules (now contributing ~ 65% of its revenues vs 40% only two years back). One of its in-licensed products - Nominee Gold, a post-emergent rice herbicide - has been very successful and has already become one of the leading brands in the Agrochem space in India. In-licensed molecules provide better margins as well as create better brand recall for the company. Osheen and Biovita are other two most successful products. Apart from existing players, it will incrementally be difficult for new players to build a pan-India distribution network and a wide product portfolio.

Its custom synthesis business (60% of overall revenues) will grow at a faster pace than the domestic market which is impacted by seasonal vagaries of monsoons. The CSM segment is very challenging to build and has strong entry barriers. However, PI has built in strong process capabilities and manufacturing strength over the last few years. PI has been able to build strong trust factor amongst its clients driven by superior execution along with flawless record on IP violation. As per our checks, PI’s manufacturing facilities for the CSM business are of world standard and compliant with global norms on environment safety and pollution. PI has built its strength over a period of 20 years and for any new player it will take time to build quality infrastructure, process chemistry and engineering knowledge, and trust with innovators.

PI Industries


Distribution: PI has a strong marketing and distribution network which covers more than 35,000 retail points and 8,000 distributors/direct dealers across all major agricultural nodes. The company is particularly strong in the north, west, and east regions. PI is gradually expanding its reach, though it is behind the reach of Rallis and Bayer Cropscience. PI’s success is still driven by the effectiveness of its products; the company still needs to work better on farmer engagement programs.

Manufacturing: PI has three formulation units and six multiproduct plants across manufacturing sites at Panoli (near Ankleshwar) and Jambusar (near Bharuch) in Gujarat and Jammu in J&K. Jambusar has a total capacity of six plants and currently has one multi-product facility in operation and two more multi-product plants under construction.

Exhibit 6: PI’s manufacturing facilities Name Type Description

Ankleshwar (Gujarat)

Agri inputs CSM

PI has fully integrated manufacturing facilities spread in 90,000 sq mt in GIDC, Ankleshwar (Gujarat). This manufacturing site is accredited ISO 9001:2000 for quality management system, ISO 14001 for Environment Management System and OHSAS 18001 for Occupational Health and Safety System Regularly audited by large customers for QA and EHS systems Analytical Labs at process development center and commercial plant are certified ISO 17025 and GLP for analytical abilities.

Jammu (J&K) Agri Inputs Formulation unit

Jambusar (Gujarat) CSM

The Jambusar facility has 90,000 sq m area and situated in ~3,000 acres of Sterling Biotech SEZ The company currently has one multiproduct plant in the facility but overall capacity is ~5-6 plants The development of the second phase of the Jambusar facility is underway and is expected to be commissioned by 3Q2015, which will accelerate company growth

R&D Centre – Udaipur Five batch analysis for registration purpose under GLP conditions, which is acceptable with registration authorities of most of the countries across the globe Formulation development lab started at Udaipur during FY13

Source: Company, Ambit Capital Research

Product development/sourcing capabilities

In the domestic segment, PI is working mostly on in-licensing of molecules from global majors for the domestic business. The domestic R&D work is largely towards development of formulation. However, R&D plays an important part in generating revenues under the CSM business. PI’s R&D is involved in synthesis and development of new molecules in agrochemicals, fine chemicals, specialty chemicals and photographic chemicals - end products as well as intermediates on the basis of in-house research. In FY14, PI filed seven process patents. The company’s R&D has more than 110 employees including 35 PhDs and master’s degree holders.

Risk to current business model

We believe both the domestic and CSM business are reasonably under penetrated. A low penetration of even generic molecules, good relationships with global innovators, and a wide distribution will allow PI to continue generating a healthy growth momentum. On the CSM side, India is incrementally turning attractive for global manufacturers to outsource their process research and manufacturing. Given its more than 20 years of an early head-start in the CSM business, PI will remain a strong beneficiary of this emerging trend.

Execution track record has been strong Exhibit 7: Execution track record



Margin expansion

5 year average ROCE


CFO/EBITDA

Overall

Source: Ambit Capital Research. Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

PI’s Jambusar facility is world-class and is comparable to the best-in-class global facilities for manufacturing, as per our checks; many experts we spoke to believe that the plant is as good as any of the global manufacturing facilities of global pharma and agrochemical manufacturers

PI Industries


PI has delivered the fastest growth rate amongst its peers (except Kaveri Industries) driven by the strong scale up in its CSM business. We believe the company would continue to grow at a faster pace than most of its peers driven by continued growth in the CSM business.

PI has witnessed a healthy scale up in margins from 16.1% in FY10 to 18.2% in FY14 driven by improved product mix and operating leverage. PI’s RoCEs have also improved sharply driven by improved margins and better asset utilisation...

Exhibit 8: RoCE (post-tax) has been improving gradually for PI Industries Company/Metric FY10 FY11 FY12 FY13 FY14 Rank

Bayer 25.7% 19.3% 22.1% 19.6% 15.9% 4

Dhanuka 25.0% 22.6% 22.2% 22.0% 25.1% 2


Kaveri Seeds 16.8% 24.2% 25.4% 39.8% 43.1% 1

PI Industries 16.9% 19.5% 17.6% 16.2% 23.9% 2

Rallis 24.9% 26.2% 20.3% 20.3% 21.6% 3


Ability to incubate new businesses

PI has successfully built its CSM business over the last 20 years. The company has also successfully transformed its domestic business model from generics to R&D-driven licensed molecules.

Cash flow conversion for the company has been healthy at a 5-year average of ~87%.

Exhibit 9: Financial and operating efficiency



Net Debt to Equity


CFO/EBITDA

Capital Allocation

Overall

Source: Ambit Capital research. Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Financial and operating efficiency

PI’s working capital efficiency is gradually improving. It is better than other domestic players such as Dhanuka and Insecticides India; it needs to improve when compared to Rallis. However, with growing salience of its exports business, PI will see further improvement in working capital.

Exhibit 10: Cash conversion cycle; PI has been able to bring down its cash conversion cycle Company/Metric Average Debtor days Average Inventory days Average creditor days Average cash conversion cycle


Bayer 43 45 40 42 70 78 69 61 59 55 32 28 54 68 78 75

Dhanuka 87 100 95 79 94 97 94 93 35 37 31 23 146 160 158 149


Kaveri Seeds 60 32 25 24 229 229 204 180 203 230 209 178 86 31 20 26

PI Industries 71 72 69 59 62 66 67 64 70 68 75 82 62 71 61 41

Rallis 31 31 34 35 65 73 68 63 101 98 86 77 -5 6 17 22

Median 59 52 51 47 82 87 82 79 84 83 80 79 61 69 69 55


PI has delivered a healthy CFO:EBITDA behind Rallis and Kaveri

Company/Metric 5 year Average Rank

Bayer 82.5% 2

Dhanuka 52.0% 3

Insecticides India 27.4% 4

Kaveri Seeds 95.7% 1

PI Industries 87.4% 2

Rallis 95.0% 1


PI Industries


PI’s gross asset turnover is not directly comparable with its peers given the asset intensity of its CSM business. However, the business has been gradually bringing up its asset turns. PI’s asset turnover looks low vs agrochemical peers but it is quite good when compared to other players in contract manufacturing players (Divis, Jubilant, and Hikal at 1x-2x).

PI now has virtually a debt-free balance sheet, in line with most of its peers.

Capital allocation is prudent

PI has generated most of its cash from operating cash flows (three-fourths) and equity issuance (one-fourths). Amongst use of cash, capex to build manufacturing facilities accounted for 62% of cash flows and 28% of cash flows were used to repay debt or to service the debt.

Exhibit 11: Source of cash – last 5 years


Exhibit 12: Use of cash – last 5 years


Corporate governance/minority treatment PI has the best quality board amongst home-grown names with a diverse experience from different backgrounds. There are only three non-independent or executive directors on PI’s board including two promoters - Mr Salil Singhal and Mr. Mayank Singhal (son of Mr. Salil) - and Mr. Rajnish Sarna who is the key operational person.

We would like to get more comfort on the depth of the second line of management. Our checks suggest that PI has been gradually hiring professionals from other high-quality companies.

We have not seen any minority being shortchanged on account of related party transactions.

Exhibit 13: Corporate governance/minority treatment


Quality of Board


Management Depth

Dividend Payout

Accounting Checks

Minority Treatment

Overall

Source: Ambit Capital research. Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

CF from Operation

s, 73%

Interest & Dividend Income,

4%

Issue of Shares,

23%

Net Capex, 62%

Investments, 0%

Repayment of Debt,

15%

Interest Paid, 13%

Dividend Paid, 7%

Increase in Cash & Cash

Equivalent, 4%

PI Industries


Quality of Board a key differentiator PI’s board comprises experienced veterans in the fields of agri inputs, pharmaceuticals, finance, corporate strategy and marketing, thereby building a strong relationship and knowledge base to direct its growth effectively.

Most of our checks which include long-term investors, ex-employees and competitors paint a very positive picture about the quality and effectiveness of PI’s strategy to tap the market. Our checks suggest PI’s board has played an important part in developing the thought process. Note that 6 directors out of 9 directors are independent and they are experts in their own areas which include strategy and finance. Three of them bring in lot of connections and sector expertise which has definitely helped in fine-tuning the company’s strategy. The board consists of nine directors, out of which six are non-executive directors and three are executive directors.

Exhibit 14: Brief summary of Independent Board of Directors

Age Year of Appointment Profile Other

Directorships

Narayan Seshadri 57 2006

Mr. Sheshadri is a Chartered Accountant with specialised knowledge in areas of financial and consultancy services. He has worked with Arthur Anderson and later became the managing partner of the business advisory practice of KPMG. Our checks seem to suggest he has also played a key role in strategy formulation for PI’s business.

13

Bimal Kishore Raizada 70 2010

Mr. Raizada has been a veteran at Ranbaxy. He was part of the core team at Ranbaxy which saw the rapid growth of Ranbaxy, having diverse businesses of drugs and pharmaceuticals, custom synthesis, diagnostics, etc.

3

Pravin Laheri 69 2010 Mr. Laheri is a retired IAS of 1969 batch. He has been in key administrative positions with the Gujarat government including the top-most bureaucratic position of the State’s Chief Secretary. He brings in lot of relationships in Gujarat where company’s plants are located.

9

Ms. Ramni Nirula 62 2010

Ms Nirula holds a Bachelor’s Degree in Economics and MBA from Delhi University. She has more than three decades of experience in the financial sector, including her role as MD and CEO of ICICI Securities Limited. She has also been part of various government banking groups and corporate agri groups of ICICI Bank.

11

Anurag Surana 49 1998

Mr. Surana is an old hand at PI Industries. He has over 27 years of experience in the agro-chemical industry and has been associated with the company for the past 20 years. He worked with the firm until 2012. During his tenure, he managed the entire manufacturing operations and projects.

3 (2 are other related

companies of PI Industries)

Dr. Venkatrao Sohoni 72 2012

Mr. Sohoni is an IIT Kharagpur graduate and a PhD from IIT, Mumbai. He has over 48 years of experience with MNCs in India and US and has spent over 30 years in senior leadership roles in the agrochemical and pharmaceutical industry. He has also served as MD of Rallis India and is credited with the turnaround of the business during the mid-2000s.

2

Raj Kaul (Resigned recently) 72 2008

Mr. Kaul is an industry veteran who has had many senior leadership level at Bayer in India and globally. He has also served as the head for Bayer’s crop protection business in India. He has also executed more than 60 M&A transactions for Bayer AG in his capacity as M&A head.

Nil


PI Industries


Evolution of an exemplary agrochem franchise Early evolution phase: 1960-1970

The company started its agrochemicals operations in 1963 under the ambit of its parent organisation, Mewar Oil and General Mills. The parent business was edible oils business, which was later closed down. The current Chairman, Mr Salil Singhal has been involved in the agrochemical business right from the company’s inception. The initial phase was difficult, as most of the supplies were sold to the Government, which in turn sold to farmers at a subsidy. There were limited branding opportunities and profits were limited. The company then started its own distribution under the VEGFRU brand in the late 1960s, catering to the north-west states of Rajasthan, Gujarat, Haryana and Punjab. Rajasthan and Gujarat were two states which emerged as a natural choice due to their proximity with the company’s head office in Udaipur. Punjab and Haryana were the other chosen states, as they were early adopters of pesticide products and were subsidy-free.

Expansion of business: 1970-1990

The company continued to build its distribution and manufacturing capabilities during these two decades. The company also gradually started to invest in R&D. In the 1970s, distribution expanded further into West Bengal and the southern states.

The company which used to just do formulations till the early 70s, eventually started manufacturing active ingredients by 1980 with indigenous R&D. The company’s R&D facilities were recognised by the Ministry of Science and Technology during this period. In the 1980s, the company also added a technical plant for phorate, further adding to its manufacturing facilities and technical capabilities. The company also set up a technical plant in Iran during this phase.

The promoters ventured into two other unrelated business during this phase. In the 1970s, the company entered into the mining and mineral processing business. This business was later hived off into a separate company named as Wolkem India Ltd. In the 1980s, it diversified into the energy metering business, which was later hived off to a separate company named Secure Meters Ltd.

The pace of expansion was slow as the initial government thrust was on fertilisers and developing indigenous varieties of seeds. Pesticides were still considered to be a dangerous substance to be used on soil.

Entry into CSM: 1990-2005

The domestic agrochemicals business started to scale up with improving adoption of pesticides by Indian farmers. However, there were volatilities in the business driven by climatic variations and cropping patterns. The management started to look into diversifying its agrochemical business. It entered the polymer compounding and CSM business during this period in 1995.

The Chairman, Mr Salil Singhal, said in an interview with VC Circle (http://www.youtube.com/watch?v=u70Km0sAOQs):

“We wanted to derisk the business from vagaries of monsoons, commodity prices, and variability of pest incidence. In the mid-90s, as an organisation we realised two strengths: R&D capabilities and quality of integrity and transparency, confidence and trust of its stakeholders. This was our strongest point. Company was in-licensing certain molecules from a Japanese player. On one of the business trips, I realised many countries had high costs including Japan. We met an executive from a large trading company Mitsubishi. He told me that if you are patient enough, maybe over 5-7 years you would see a big success. Our first order was 890k dollars. It required an investment of `250mn. They said if you successfully supply this, we will give you far bigger orders however there is no guarantee if you don’t deliver well. This was the turning point of our company and the onset of the CSM business. We took the risk, and rest is history.”

“We do not do anything extraordinary. Whatever we do, we do it with integrity, transparency and with an understanding of customer needs. This is no special mantra. If you understand the customer needs, and work in a transparent manner with integrity, business will follow. And this is true for any business.”

— Salil Singhal, Chairman, PI Industries in an interview

http://kjcommoditynews.com/agrifreenews.php?nid=255087&t=IN

PI Industries


As business continued to scale up, the company set up its Panoli manufacturing facility during the 1990s and then the Jammu facility in the late 2000s. The company also changed its name to PI Industries Limited and later on shifted its corporate office to Gurgaon from Udaipur. It was also accredited with ISO 9002 and 14001 Certifications.

The company continued to strengthen its processes and systems. It moved to the SAP system. PI expanded its Udaipur R&D facility and also established PI Life Science Research.

Significant improvement in RoCE: 2005-2014

PI’s business moved into a new trajectory from FY05 onwards. Years of work in building the CSM business gradually started paying off and started to reflect in RoCEs and revenue growth. Domestic growth was also supported well by the success of Nominee Gold and Osheen. The share of in-licensed revenues grew to ~65% in FY14. The company commercialised ~18 molecules during the period under the CSM business. All of this combined provided a healthy revenue growth coupled with strong expansion in EBITDA margins. Pre-tax RoCEs for the business improved from 7% to as high as 24% by FY14.

The company divested its polymer compounding business which did not fit into the long-term strategy of the company. It also entered into a tie-up with Sony Corp for research on chemicals related to electronics. The stock price too followed, witnessing a massive re-rating coupled with strong earnings CAGR.

Exhibit 15: PI’s RoCE and revenue growth trend


Exhibit 16: SWOT analysis Strengths Weaknesses

Good relationships with global innovators along with commercialisation experience of more than 18 molecules

Strong pan-India distribution network (~8,000) along with a strong product portfolio of ~30 products

Strong manufacturing capabilities with four formulation plants and six multi-product plants

Weaker second line of management to manage future growth

Farmer engagement programmes’ effectiveness lower than its MNC peers and Rallis

Asset-intensive business (Gross asset turnover of 2.5x)

Opportunities Threats

Global CSM opportunity is more than US$85bn in size and PI just commands 0.5% of the overall market; there is a significant opportunity for PI to expand its share in the global CSM market

Domestic agrochemicals penetration is ~30% and consumption levels per hectare are well below global averages

Unrelated diversification to other areas such as seeds

Global acquisitions to fuel growth rates

Launch of new products by competition targeting market share of Nominee Gold


7%

14%

17%

20%

18%

16%

24%

5%

10%

15%

20%

25%

0

4,000

8,000

12,000

16,000

20,000


Domestic International CSM RoCE (RHS)

PI Industries


International business – Multi-year growth story PI Industries has established itself as a leading contract research and manufacturing services (CSM) player in the agrochemical space over the last 20 years. The firm has demonstrated a strong track record in terms of high-quality project execution and flawless IP protection track-record. The CSM opportunity in India is growing rapidly driven by global innovators looking to focus on R&D and marketing themselves and to outsource manufacturing and other related synthesis processes to firms like PI.

Evolution of PI’s CSM business

The company started this business in the early 90s when the promoter during one of his foreign visits realised that more and more companies are looking to lower their manufacturing costs as well as increase their product research and marketing by outsourcing development work and manufacturing to low-cost destinations.

The initial phase scale-up was slow, as it took time to build trust and evolve processes to deal with innovators (as it involved crucial IP sharing). The business picked up significantly post 2008. Now, the company is working with leading innovators across the world with a higher proportion of revenues from Europe and Japan.

India becoming TRIPS compliant in 2005 was also a turning point which significantly helped in comforting global innovators to outsource such critical processes to quality players like PI.

Exhibit 17: Growth of the international business has been exemplary


Exhibit 18: Salience of international business is on the rise despite healthy growth in the domestic business


Differentiated focus on CSM business

PI follows a differentiated business strategy of focusing on custom synthesis and manufacturing for patented molecules that are in the early stage of commercialisation. Today it derives 95% of its CSM revenues from patented molecules. Once PI partners with a global innovator for a new molecule, it has multi-year visibility on a particular product, as 3-5 years are required to bring a molecule to commercialisation and then there is a patent protection window of ~5-10 years until new molecules are discovered or resistance to a particular product is developed. The CSM business’s EBITDA margin at ~20% in FY14 is fairly healthy and has been expanding steadily driven by improving product mix and operating leverage.

64%

39%

25%

53%61%

54%

0%

10%

20%

30%

40%

50%

60%

70%

-

2,000

4,000

6,000

8,000

10,000

12,000


International Revenues (in Rs mn) Growth (RHS)

24%

32%38% 36%

45%

55%62%

0%

10%

20%

30%

40%

50%

60%


“In the value chain, the [multinational] innovators are happily focusing on discovery and marketing. They are outsourcing these in-between processes from process research to commercial manufacturing more and more.”

— Rajnish Sarna, executive director of PI Industries, in an interview with Farm Chemicals International

Over the years, PI has built in-house capabilities and immense experience in process research, plant engineering, efficient manufacturing and product registration

PI has commercialized ~18 molecules so far and expects to commercialize 2-3 molecules every year given a strong pipeline.

PI Industries


Exhibit 19: Product lifecycle of a molecule


Exhibit 20: What are the competitive advantages for the CSM business?

Advantage Description

Non-compete business model and respect for IP

PI follows an in-licensing model for molecules in domestic business whilst staying away from reverse engineering or sourcing from some other competitors which may be in conflict of interest with global innovators. Currently in-licensed molecules account for more than 65% of domestic business and are likely to go up gradually. Many Indian manufacturers have earlier been involved in reverse engineering of patented products in the pre-2005 era and hence the global innovators are skeptical of partnering with them. In the long history of ~ 20 years of being in CSM business, PI has not been accused of any potential IP violations.

Strong track record on execution capabilities

The company now has an experience of commercializing more than 18 molecules, which brings in a lot of experience and comfort to customers in terms of PI’s capability to execute. In addition, the company has a solid pipeline of more than 20 molecules which are in various stage of commercialization.

Good experience on chemistry and process engineering

Over the years, PI has built in-house capabilities and immense experience in process research, plant engineering, efficient manufacturing and product registration. 20 years+ of keenly observant experience in CSM business brings in strong knowledge of process chemistry and other processes to bring a patented molecule to commercialisation. Also, our channel checks suggest PI also scores well on the environmental safety and emission standards of global innovators.

Long-term relationships with clients

PI has managed to forge strong relationships with the innovators because of its reputation of a non-generic player with a strong process research, manufacturing capability and faster response time. The company also has more than 20 years of experience now in terms of working with overseas innovators which makes them a known name in the field. Many of the relationships cultivated over the years have also resulted in repeat orders for the company. PI’s business model is collaborative in nature and the company takes pride in being called partners to global innovators. The company has paid judicious attention to strengthen its processes in order to ensure time-bound deliveries and quality control. PI’s management believes such factors play an important role in enhancing the margin profile of the business and help in commanding better pricing premium for the company.

Cost advantage

With substantial scale up, PI clearly has much more cost advantage vs other domestic players. Most of company’s plants are multi-product facilities which lead to improved utilisation of their plants. A large set of PI’s competition is based in developed countries wherein PI and other Indian players have a clear cost advantage, provided they deliver similar high-end quality products.

Source: Company

Lead molecule identified

LaunchExpiry

Discovery research Pre launchOn patent growing

Off patent matureOff patent

Discovery Development Full scale Manufacturing

Research biology &Chemistry

Pre- Ph Ph Ph PhClinc l ll a ll b lll

Contract Research Contract Manufacturing

PI Industries


Exhibit 21: What experts say about competitive advantages for the CSM business

Source Comment

Expert 1 – Sales and Marketing Head of a competitor

“PI is engaged by leading innovators as a solitary/one of the few suppliers worldwide for one of their products. The technical acumen and knowledge of complex chemistry that is required to scale up this kind of business is very important and difficult to replicate.”

Expert 1 – Sales and Marketing Head of a competitor

Many of the existing generic players do not have the requisite infrastructure or capabilities which create an entry barrier for PI. PI has been able to crack Japanese clients who take a long time to build trust but are very reliable partners once you strike a relationship with them. PI’s asset turnover is something really admirable for other companies.”

Head of Marketing at a competitor

“Given that amount of interactions with client is relatively very high, it clearly requires strong client handling skills. PI’s ability to manage difficult clients such as Japanese is clearly differentiated. PI has also been able to cross sell its process research quite well. These strong relationships with global innovators will also help in sourcing molecules for its domestic business.”

Expert 2 – Ex-CEO of the Indian arm of a leading MNC crop science company

“Most of the Indian fine chemicals contract manufacturers do low value molecules or generic intermediates where cost is the only advantage while PI has demonstrated capabilities to work on complex chemistries as well. India can’t compete that much with the cost advantage as most of the raw materials are anyways sourced from China. This makes India’s cost equal to Chinese player’s costs plus cost of working capital cost of ~150 days (product in transit and then holding up large quantities of raw material to lower freight costs).”

PI’s management during a conference call

“PI is a natural go-to for the innovators, not only on account of best-in-class practices that we follow but also because we have institutionalised respect for IPR.”

Source: Company

Strong order book gives enhanced visibility on revenues

PI secures order on an annual contract or long-term contract basis (average tenure of ~3years). Long-term contracts account for nearly 60-70% of PI’s annual revenues whilst annual contracts account for the rest.

In a way, PI’s order book includes current contracts for the rest of the year and long-term contracts which are to be executed over 2-5 years. Many of the contracts in the order book have a 'Take-or-Pay' clause which brings the risk of the end demand fluctuation to the innovator and de-risks PI’s stream of revenues. Certainly these contracts are built on a minimum offtake basis for the new molecule which provides an upside if the product becomes successful and gets commercialised in other countries.

Exhibit 22: Order book for CSM business (US$ mn)


What are the entry barriers for CSM business?

PI follows a superior business model in contract research and manufacturing which focuses on patented and early lifecycle molecules, de-risking it from the adversities of the business. A limited number of companies follow similar early lifecycle CSM business models except for a few in Europe and China given the significant complexities involved. This model is similar for pharmaceutical companies but a limited number of companies are present in the specialty chemicals and agrochemicals domain.

305 307334

365

395

435

520

3.05 2.582.35

2.402.56 2.77

3.44

2

3

3

4

4

300

350

400

450

500

550

Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15

Order Book UDS mn Order book to trailing 12 month CSM sales (RHS)

“We have always given guidance that for the next three, four years, we see quite a good visibility and have guided for 25% to 30% kind of growth. Beyond that we will certainly have to look at more ways to sustain the higher growth rates.”

— PI’s management during a recent conference call

PI’s management during a conference call “To get the business related to patented or early lifecycle molecules, a sound and rigorous internal control and quality system has to be in place which requires many years; IPR-respect is the prime criteria for such business-relationship and it has to be depicted by building relationship with the innovator over many years. A company wishing to procure patented or early-lifecycle molecules related business has to go through a strict evaluation process by the innovator company at many levels which takes at least 2-3 years.”

PI Industries


Since the molecule is innovative and patented, the client keeps only one or a maximum of two suppliers in the early stage because of the confidentiality involved which makes the company (PI Industries) critical in the client's molecule launch roadmap.

Further, the probability of emergence of any competition in the near future is also very low because of intense entry barriers as well as tremendous efforts required to establish such a business model.

Exhibit 23: PI is gradually expanding the ambit of its operations Matrix Deal

Expansion into fine chemicals other than agrochemicals

PI is also moving onto other chemical processes away from agrochemicals and entering into the broader ambit of finer chemicals such as pharma, imaging chemicals, etc. Such orders now comprise ~ 22-25% of current R&D pipeline.

Partnership with Sony Corporation

The company has steadily been adding on to its R&D capabilities. PI industries entered into collaboration with Sony Corp in January 2011 to invent organic chemicals to be used in futuristic products like flexible televisions and Solar. PI Industries will be a joint patent-holder along with Sony for that and a key supplier for the same once it goes for commercialisation.


PI’s ability to scale up client is admirable The process from molecule to commercialisation requires significant capabilities on process research, plant engineering, process optimisation, and effective sourcing. The scale up of the business from enquiry to full-fledged long-term contract takes ~3 years. Even the commercial orders take their own time to ramp up. Initially a smaller quantity is ordered, with continuous customer satisfaction on delivery. Orders usually ramp up over 2-3 years.

The company’s plants by architecture are multi-product plants which can be utilised for other similar products in case the demand for the original product goes down.

Exhibit 24: Custom Synthesis – a multi-step long gestation process


Customer Enquiry

Process Evaluation

Desktop Costing

Customer Approval

Pilot / Kilo Lab

Process & cost review

Customer Approval / Agreement

Plant Erection & Installation

Raw Material Procurement

Commercial Production

Pre-Feasibility Study Sample Validation

Sign Secrecy Agreement SOP & Plant Design

Bench Scale Trials Detailed Plant Engg.

PI Industries


Jambusar expansion another long-term driver Jambusar is a 90,000 sq meter facility with a capacity of ~5-6 multi-product plants for the CSM business. The company has built one plant so far with an investment of ~`2bn and the major portion of this investment is in common infrastructure.

The company avails a full 10-year tax break on products produced from these plants. Custom duty on raw material for these plants will also be waived off. We believe more than 70% of the incremental profits will be produced from this plant and will attract no tax for the next 5 years and 50% tax for another 5 years. This will significantly drive up the profitability for the company, which had a tax rate of nearly 32% in FY14.

Its initial asset turnover is lower, as PI is not able to leverage this common investment in common infrastructure. With new plants under construction, the profitability will increase, as nearly 60% of the costs are incurred on shared infrastructure. Margins will also benefit from the leverage on these fixed shared costs between various plants. Every plant would incur capex of `1,200mn-1,300mn, driving close to `2,500mn-3,000mn of revenues at full utilization.

The company is currently in the process of building two more plants and is expecting these plants to come up for commissioning in 3QFY16. The first phase expansion capacities for the company are now at ~90% utilization.

The management has guided for ~20% growth in FY15 for the CSM business despite near full utilisation for phase 1. The growth would largely be driven by improved product mix (higher value product, keeping the volumes at the same level) and by capacity expansion aided by process improvement and equipment rebalancing which will de-bottleneck certain capacity in the system.

Exhibit 25: Jambusar’s revenues (` mn)


Manufacturing efficiency is a key differentiator The company has gradually been improving its gross block turnover, leading to better asset utilisation. The company currently generates an overall asset turn of 2.5x (which should have in the normal case gone up due to the relatively asset-heavy CSM business).

Asset turnover in the contract manufacturing industry is the key, as it speeds up the payback period. Similarly, gross asset to EBITDA of the company has gradually ramped up to 0.45x, almost 3x of what it was 8 years back driven by improved efficiency and better profitability.

12% 13% 19%

33%

0%

5%

10%

15%

20%

25%

30%

35%

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

FY14 FY15 FY16 FY17

Jambusar Revenues (Rs mn) % of CSM revenues

PI Industries


Exhibit 26: Gross block turnover


Exhibit 27: Payback period in case of new capacities is 2-3 years (indexed number) Yr 0 Yr 1 Yr 2 Yr 3

Capex (assumed) -100 Revenue (at 2-3 x gross block) 200 250 300

EBITDA @ 20% 40 50 60 Financial Cost (all investment at debt) -12 -8 -4

Net Outstanding -72 -30 11


Industry participants in a similar domain suggest that 2.5-3x gross asset/turnover is a good ratio, as most other players in the contract manufacturing business in India have a gross asset turnover ratio of ~1.5-2x. The management believes there is a significant scope for these asset turnover ratios to improve driven by process improvement projects and better product mix. We believe there is a significant upside in improving the mix of the plants, as PI’s current operating margins of ~20% are lower than the 30-40% commanded by other pharma players. Capital employed turnover has also improved significantly aided by improved working capital turnover and gross asset turnover.

Exhibit 28: Capital employed turnover (x) significantly improved


1.6 1.8 1.8

1.9 2.0

2.2 2.3 2.2

2.5

0.15 0.16 0.15

0.27 0.32

0.36 0.37 0.35

0.45

-

0.10

0.20

0.30

0.40

0.50

1.5

1.7

1.9

2.1

2.3

2.5

2.7


Gross block turnover (x) Gross Asset/EBITDA

1.4 1.4 1.4

1.5

1.7 1.6

1.7

1.6

2.0

1.2

1.4

1.6

1.8

2.0

-

2.0

4.0

6.0

8.0


Working capital turnover (x) Capital Employed Turnover

PI Industries


EBITDA margins on a gradual uptrend EBITDA margins have gradually improved driven by improved leverage benefits and improved gross margins. Gross margins improved aided by rising share of in-licensed products (driven by success of Nominee Gold and Osheen). Leverage benefits too aided the overall margins though addition of the Jambusar plant had its own drag on margins. Jambusar which contributes nearly 8-9% of sales is still at high single/low double-digit EBITDA margins.

Gross margins have improved from 38% in FY07 to 42% by FY14. Improvement in gross margins is despite the adverse product mix. The CSM business is a lower gross margin business (but higher EBITDA margin) whilst the domestic business which is a higher gross margin business is witnessing a decline in its salience to overall revenues.

Exhibit 29: EBITDA margins (%) are on a structural uptrend


Exhibit 30: Employee costs and other operating costs have seen a steep leverage


Rising share of CSM business to drive margins

The CSM business is more profitable than the domestic business and commands 300-400bps higher margins than the domestic agrochemicals business.

Exhibit 31: Margin drivers

Driver Description

Scale up to higher value molecules This is a less quantified margin driver but as demand increases, PI’s management will use its discretion and choose only to work on higher-margin molecules. The management has been indicating the same during conference calls.

Rising share of CSM business The CSM business has ~20% margins whereas the domestic business has 18% margins.

Increasing proportion of in-licensing revenues In domestic business, PI has gradually been increasing its share of in-licensed molecule (65% now vs 40% two years back). In-licensed revenues contribute ~30% margins whilst the margin in generic molecules is limited to ~10-15%.

Operating leverage

Jambusar margins are still in single digits. We will see Jambusar margins gradually scaling up once the second phase capacity comes in 2HFY16. In addition, rising scale of the overall business will drive overall leverage on fixed costs.


8.7 9.1 8.6

13.916.116.216.515.9

18.219.420.320.5

5.0

10.0

15.0

20.0

25.0

6.5%

7.5%

8.5%

9.5%

16.0%

18.0%

20.0%

22.0%

24.0%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15E

FY16E

FY17E

Other Operating Expenses as % of sales (LHS)

Employee Costs as % of sales (RHS)

PI Industries


Domestic business outperforming competition PI’s domestic agri-input portfolio consists of in-licensed products, which are newly launched/patented molecules by innovators. Some of the key brands comprise Nominee Gold, Osheen, Foratox, Fosmite, Biovita and Roket. The company’s top-5 products accounted for 55% of revenues in FY14.

The company also produces and markets branded generic agri input products. PI pioneered the introduction of granular formulations in India and, over the years, emerged as a market leader and the largest producer of molecules like Profenofos, Ethion and Phorate.

The company has ~30 products in its domestic portfolio. This is much lower than the 70-80 product portfolio held by Rallis and Dhanuka.

PI has developed a differentiated business model in domestic agri-inputs that is focused on increasing its share of in-licensed and co-marketed products that offer global innovators access to the fast-growing Indian agrochemicals market. Whilst most Indian companies focus on generics to drive volume and sales growth, PI focusses on in-licensed patented molecules for which it has exclusive distribution rights in India.

Over the years, the company has entered into exclusive co-marketing and distribution agreements with global agro-chemical majors. This association with reputed innovator companies has been built on trust, credibility and PI’s respect for IPR. Its differentiated business model is based on a focused portfolio of 10-12 brands, which are leaders in their categories, with an emphasis on innovative products at the start of their lifecycles. PII is looking to expand its product range to introduce newer molecules by signing agreements with patent-holding companies in India, especially in herbicides and fungicides.

Our conversation with various on-the-ground sales officers and dealers suggests that PI is doing well on all the key requirements of building a successful business in pesticides i.e. continuous innovation, good product and strong distribution reach. PI’s model is unique because it works with innovator companies, and is difficult to replicate, as: (1) The registration process in India requires substantial time and effort; (2) there is also a three-year exclusive data-protection period for the 9(3) registration products in India post registration; and (3) considerable cost and time is required for brand building and marketing.

New product launches

On the product side in the domestic agri business, the company launched about 10 products over the last three years. Out of the products launched in FY12 and FY13, Fluton and Osheen are in-licensed products whilst Voltage, Sanipeb, Cuprina and Clutch are under co-marketing arrangements. Wicket and Oval were under generics. Thus, out of the 8 products, 2 were in-licensed and 4 were under co-marketing.

The company also launched two more products, Pimix and Melsa, in FY14, which would gradually scale up over the next 2-3 years.

Exhibit 32: New product launches in FY14 Trade Name Type Common

Name Formulation Crop Description

PIMIX Herbicides

Metsulfuron Methyl 10% + Chlorimuron Ethyl 10%

WP Rice PIMIX is a broad spectrum herbicide effective for the control of different broad leaf weeds and sedges in transplanted and direct seeded rice.

MELSA Herbicides Pinoxaden 5.1% EC Wheat

MELSA is a post-emergence herbicide which provides effective integrated weed management in the wheat crop. MELSA effectively controls Phalaris minor and Avena spp. MELSA is currently the most-effective solution for the management of grass weeds in wheat.


PI focuses on launching of new innovative products in collaboration with multinational innovators (in-licensing) throughwhich PI gets exclusive rights to manufacture and sell products under its own brand for Indian market

PI’s product portfolio breakup


Herbicide, 35%

Fungicide, 15%

Insecticide, 50%

PI Industries


PI currently has 7-8 products at different stages of development. Every year one or two products are likely to get registration and be introduced in the market.

Non-compete with global innovators

PI’s domestic business is hinged on protection of the IP model, wherein the company licenses patented molecules/bulk formulations from the global innovator and then markets them over their distribution channel.

Focus on in-licensing is a key part of strategy driven by better margins

The management believes that generic molecules will always remain a large proportion of the Indian pesticide market as patented products get off-patent. However, PI industries wants to continuously reduce the mix of generic sales in overall sales, as margins are lower. The company is cutting sales of ‘me-too’ products and is in the process of registering 6-8 new molecules in the next two years.

Cost an easy pass-through for innovative molecules

The management believes there is an easy cost pass-through for established brands and especially licensed popular products like Nominee Gold. The company is focused to in-license patented products at an early lifecycle so that they can generate sales from the molecule over a longer period of time.

Focus on Japanese innovators The company chooses those MNCs that have 2-3 highly successful products and are looking to expand in the emerging markets without committing capex. Hence, majority of their partners are Japanese pesticide manufacturers that do not have a manufacturing set-up in India.

Industry growth to remain strong with rising share of environmental safe molecules Industry will likely sustain its strong growth rates with the improvement of rural income and demand for better quality (low-volume high-value pesticides). With labour costs turning high, demand for selective herbicide products is rising. Additionally, rising penetration of organised retail is demanding high-quality fruits and vegetables, thereby promoting the use of fungicides.

Small but effective product portfolio Currently PI generates 65% of its revenues from in-licensed molecules. Given that the company has refrained from me-too products, it generates nearly an equivalent amount of sales with 30 molecules vs 70-80 molecules of other domestic companies such as Rallis and Dhanuka. The company’s domestic formulation business has grown at CAGR of 21% vs 17% for Dhanuka and 13% for Rallis over the last four years.

Exhibit 33: Rising share of in-licensed revenues by the company


Exhibit 34: PI delivered the fastest CAGR amongst listed peers in domestic agrochemicals business

FY10 FY11 FY12 FY13 FY14 4 YR CAGR

Rallis Domestic 6,323 8,421 8,181 8,835 10,161 13%

PI 4,140 5,800 6,133 6,869 8,860 21%

Dhanuka 4,456 5,412 5,762 6,464 8,291 17%

Bayer Domestic 12,629 17,247 18,841 21,826 26,743 21%

Actives 1,029 3,992 4,634 5,543 6,292 57%

Formulation 11,599 13,255 14,207 16,283 20,450 15%

Source: Company, Ambit Capital research. Note: Rallis data adjusted for Rs1,000mn of discontinued toxic (Red triangle) products in FY10.

4550

65

0

20

40

60

80

FY12 FY13 FY14

“What I can understand is in the domestic market PI has the best of molecules. They have a pool to launch 3-4 molecules each year. Hence to say, they are safe for thenext 7-8 years in domestic market. After that how management will do that’s the challenge.”

— Marketing Head of a competitor

PI Industries


What makes Nominee Gold a big success? PI introduced post emergent herbicides such as Nominee Gold for the rice crop in India in FY10. The product is outsourced from Kumiai Chemical Co Ltd. The product has been a blockbuster success with tremendous response from farmers. Many agricultural universities and government agencies have also been recommending the product for weed control in rice.

Exhibit 35: What makes Nominee Gold a very relevant product for Indian farmers

Advantage Description

High effectiveness of product in direct seeded rice state

Nominee Gold is also driving higher adoption of directly sown rice by providing good control of weeds which was the key benefit of transplanted rice. Earlier, farmers could lose as much as 90% of their crop due to a lack of effective control over weeds in direct seeding of rice. However, the product is highly effective in weed control. Nominee Gold has seen good traction in areas where there is water scarcity and farmers are largely dependent on the monsoons. Government agencies are also promoting the product in drought areas. The company has seen good success with the brand in rain-fed states such as UP, Bihar, Orissa, Eastern states, and MP.

Saving of manual labour and water

Transplanted rice requires a lot of water and manual labour in transplanting, leading to higher costs and limits sowing the transplanted crop to certain monsoon-dependent states. PI in fact tied up with various NGOs along with government extension machinery to promote the product, as it saves human labour cost and water. PI is actively working with State Agriculture University, state agriculture departments and NGOs by free distribution of DSR planters for promoting direct seeding of rice amongst farmers.

Source: Company

Exhibit 36: Benefits of directly seeded rice vs transplanted Rice

Directed Seeded Rice Transplanted rice (TPR)

Timeliness of the control operation at early crop growth stages

Good control of the preceding crops Crop yield losses up to 90% due to weed

competition in poorly managed fields

Weed management is conducted just before transplant

Rice has a significant size and competitive advantage over subsequently emerging weeds

Source: Cirrimyt, Ambit Research

PI was also nominated under the category of ‘Best Marketing Campaign’ for its rice herbicide brand ‘Nominee Gold’, where it shared nominations with BASF Corporation, Arysta Life Science and Dow Agro Sciences, among others in the Agrow Awards.

Osheen, another big success? Osheen is a specialised insecticide that kills rice hoppers specially the Brown Plant Hopper which is the most damage-causing insect for rice. The product has been in-licensed through Mitsui Chemicals of Japan. The company has spent ~6 years on the development of this product. The company has also extended it to cotton and is looking to extend to vegetables as well.

The product competes with the likes of ‘Applaud’ from Rallis and ‘Confidor’ from Bayer Cropscience.

Nominee Gold is likely to be contributing more than `2.5bn in revenues and contributing ~30% of PI’s domestic revenues currently

One of the dealers we spoke to says: “The product is very effective in case of directly sown rice where manual weeding is quite difficult due to random distribution of seeds unlike transplanted rice. More than 50% of Indian rice acreages are from directly sown rice.”

“Osheen has been doing very well. The product has high effectiveness against hopper and white fly for crops such as Rice, Vegetable, Cotton, and Mango. The product is expected to reach `1bn-1.5bn this year. It did close to ` 0.8bn in FY14.” Sales Officer of a competitor

PI Industries


Financial assumptions Exhibit 37: Financial assumptions Particulars (̀ in mn unless mentioned)

FY14 FY15E FY16E FY17E Change (%)

Comment FY15E FY16E FY17E

Growth Rate

Domestic Business 8,860 10,100 11,918 13,944 14% 18% 17% We expect domestic growth rates to remain ahead of industry growth rates driven by new product launches and scale up of existing products

International Business 9,771 11,725 14,304 17,737 20% 22% 24% International business would grow well at 20% growth rates driven by strong order book of US$ 530mn and commercialisation of new molecules

Financials

Net Sales 15,955 19,061 22,995 27,896 19% 21% 21% Growth rates to be aided by healthy growth in both domestic and CSM business

Adjusted EBITDA 2,910 3,696 4,661 5,718 27% 26% 23%

Adjusted EBITDA margin (%) 18.2 19.4 20.3 20.5 120 bps 90 bps 20 bps EBITDA margins to scale up driven by improving

segment mix and operating leverage

Depreciation 316 394 473 527 25% 20% 11% Higher depreciation in FY16 and FY17 due to new capacity addition

Interest 139 136 98 58 -3% -28% -41% Interest cost to gradually go down driven by decreasing debt. Company turned net cash positive in 1HFY16

PAT 1,912 2,371 3,082 3,900 24% 30% 27% Healthy PAT growth aided by improved margins and lower tax rates due to tax exemption at Dahej facility

Pat margin (%) 12.0 12.4 13.4 14.0 50 bps 100 bps 60 bps

Cash Flow Parameters

CFO 2,188 2,512 3,051 3,855 15% 21% 26% We conservatively build higher working capital days in FY15 due to a weak monsoon year

Capex (640) (1,500) (1,550) (500) 134% 3% -68% Capex in FY15 and FY16 for new capacity addition in Dahej. We assume similar capex for FY17.

FCF 1,548 1,012 1,501 3,355 -35% 48% 124% FCF continues to remain healthy

Turnover Ratios

Cash Conversion Cycle 41 42 39 37 2% -7% -5%

Gross Block Turnover 2.5 2.5 2.5 2.8 3% 0% 9% We don’t build in any improvement in asset turnover due to new capacity addition in FY15 and FY16

Capital Employed Turnover 0.5 0.5 0.5 0.5 -4% -2% -1%

Profitability Ratios

RoCE 23.9 25.8 27.9 28.9 190 bps 200 bps 100 bps ROCE expansion to continue driven by improving margins

RoE 31.2 30.0 30.4 29.8 -110 bps 30 bps -60 bps ROEs expected to remain healthy at 30%+

RoIC 24.8 28.0 30.8 35.3 320 bps 290 bps 450 bps ROICs will move sharply


PI Industries


Sustainable multiples, industry-leading growth PI trades at 19x FY16 EPS, relatively cheaper to Rallis and Bayer; we believe this differential will remain given PI’s relatively lower share of domestic brand/distribution-led revenues. PI’s EBITDA margin will expand to 20.5% from 18.2% driven by rising CSM share and operating leverage. As a result FY14-17E EPS will expand at 27% CAGR and RoCE by ~500bps. We prefer a DCF-based valuation for PI Industries, because we believe that this is the best way to value a company that is relatively asset-intensive but has a high-growth trajectory in a large potential market/opportunities. Our 12-month forward DCF-based valuation of `580 implies 19x FY17E EPS. Key risks include slowdown in CSM revenues and higher competition for Nominee Gold.

DCF methodology We value PI Industries using a DCF methodology with a WACC of 15%. Key things to look into PI’s DCF model are revenue growth of the international business, working capital intensity, gross asset turnover, and EBITDA margins. We have defined growth rates in two phases: For FY14-18 (phase 1) we assume active growth rates, and we gradually fade away the growth rates from FY18 to FY26 (phase 2). FY26 onwards we assume 5% growth rates.

Revenue growth rates

Phase 1 (FY14-18): We assume revenue CAGR of 21% over FY14-18 driven by 16% growth rates (vs 22% over FY10-FY14) in the India business and 23% growth rate in the export-led CSM business (vs 48% in FY10-14). Post the new capacity addition in FY16, we believe there might be some upside in our CSM business revenue growth estimate. Phase 2 (FY18-26): We conservatively assume revenue CAGR of 15% over FY18-26 with average domestic business growth rate of 13% and CSM business growth rate of 15%. At our assumed growth rates, the CSM businesses will just double its market share in Global CSM market from 0.2% to 0.4% over FY14-26. Our assumed domestic rate is also in line with industry growth rates for this phase. Phase 3 (FY26 onwards): We assume terminal growth rate of 5%. Given lower penetration of agrochemicals (25%) and even further consumption (in terms of value), we believe 5% growth rates are very conservative.

Exhibit 38: Revenue growth rates


EBITDA margin improvement

Phase 1 (FY14-18): We assume margin improvement of 270bps from 18.2% in FY14 to 20.9% in FY18. We believe with business gaining scale and other process

0%

10%

20%

30%

40%

50%

60%

FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY26

India Business Growth (%) CSM Growth (%) Overall Growth (%)

PI Industries


improvement projects we would see some leverage over fixed costs. They key drivers are: (1) the positive mix impact from the CSM business which is 250-300bps higher than the domestic business at the EBITDA margin level, (2) rising share of in-licensed molecules will drive up domestic business margins, (3) Improving mix within the CSM business due to a comfortable order book level and due to the management saying no to less-profitable projects. We draw comfort from the fact that management has been guiding for 20% margins in FY15 itself after more than doubling its margins from 8.6% to 18.2% in FY08-14.

Phase 2 (FY18-26): We assume margins to expand from 21% in FY18 to 23% by FY26 driven by the reasons highlighted above. As PI scales up its business and improves its process efficiency and starts taking up more complex projects in the CSM business, there might be some further upside to our margin estimates. Some of its pharma peers such as Divi’s Labs generate EBITDA margins of ~40%.

Phase 3 (FY26 onwards): We assume margins to remain stable at 23%.

Exhibit 39: EBITDA margin trend


Exhibit 40: We assume working capital days to go down from 41 days in FY14 to 37 days in FY17 driven by improvement in receivable days on account of rising share of CSM business.


Gross asset turnover and capex

We expect gross asset turns to improve marginally from 2.5x in FY14 to 3.1x by FY18 driven by improvement in product mix and process improvement projects. We expect operating cash flows to take care of future capex needs. Free cash flows will rise as incremental capex continues to become a smaller part of existing gross block.

Exhibit 41: Capex will be funded by internal accruals (` mn)


18 19 20 20 21 22 22 23 23 24 24 24 24

FY14 FY16E FY18E FY20E FY22E FY24E FY26E

30

40

50

60

70

80

90

FY14

FY15E

FY16E

FY17E

FY18E

FY19E

FY20E

FY21E

FY22E

FY23E

FY24E

FY25E

FY26E

Working Capital Days Inventory Days

Receivable Days Payable Days

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

(5,000)

-

5,000

10,000

15,000

20,000

FY14

FY15

E

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

FY21

E

FY22

E

FY23

E

FY24

E

FY25

E

FY26

E

Capex OCF FCF Gross Asset Turns (RHS)

PI Industries


Terminal growth rate of 5%: We have taken a terminal growth rate of 5% for the company post FY26 which is conservative in our opinion. PI’s revenues have never declined on a YoY basis in the last 15 years and we do not think agrochemicals penetration will reach a level that will pull PI’s growth lower to 5%.

WACC of 15%: We assume Cost of Equity of 15%. Our WACC comes at 15% in the absence of any debt. Our 12-month DCF-based valuation of ` 550/share implies 19x FY16E and 14.5x FY15E EPS.

Exhibit 42: PI Industries’ 12-month forward DCF valuation summary (` mn)

Parameter Value

Total PV of free cash flow (a) 37,706

PV of terminal value (b) 41,256

EV (a) + (b) 78,962

Net debt 208

Equity value 78,754

No. of shares 136.1

Implied share price (̀ ) 580

Current share price 441

Upside 32%


Exhibit 43: Sensitivity analysis of TP to terminal growth and WACC estimates

Cost of Equity

Ter

min

al G

row

th

rate

13.0% 14.0% 15.0% 16.0% 17.0%

3.0% 663 586 523 471 426

4.0% 707 619 548 490 442

5.0% 761 659 580 514 460

6.0% 831 709 615 541 481

7.0% 924 773 662 575 507


Cross-cycle valuation: Premium to historical valuations justified PI Industries’ stock along with other major agrochemical peers has witnessed a significant re-rating over the last few years. The stock is trading near its all-time high on one-year forward P/E and EV/EBITDA multiples, though recently it witnessed some correction on profit booking and likely concerns on a weaker FY15 due to weaker monsoons and other factors. We believe such premium valuations are justified due to the improved outlook for the agri inputs space in India and growing competitiveness of Indian companies for chemical intermediates exports.

We believe a comparison of the three-year historical cross-cycle valuations can be deceiving. Over the last six years, PI has gradually improved its RoCE driven by superior margin expansion and improved asset turnover. The company delivered healthy revenue growth of 28% and profit growth of 66% over the last 6 years. Thus, PI’s rerating of P/E and EV/EBITDA multiples is justified, in our opinion. We believe there is further potential for a rerating underpinned by strong revenue CAGR of 20% and profit CAGR of 28% (on a large base) in FY14-17, which will generate sufficient operating cash flow to fund capital expenditure and still generate a healthy free cash flow.

PI Industries


Exhibit 44: One-year forward P/E


Exhibit 45: One-year forward EV/EBITDA


We believe PI will be able to generate ~20% growth in the CSM exports business over the next 10 years due to its miniscule 0.2% share in the overall global CSM market. We expect the share to double up to 0.4% over our fade phase until FY26.

PI Industries operates in two major segments: (1) Indian agrochemicals space (~30% of current earnings, 40% of revenues) and (2) IP-driven custom synthesis and manufacturing business (~70% of current earnings, 60% of sales). Both the segments have significant potential to grow from hereon.

Exhibit 46: One-year forward P/B


Exhibit 47: EBITDA Growth & RoCE


Exhibit 48: EPS growth and RoE


Exhibit 49: PI Industries’ revenue growth rates


-

5

10

15

20

25

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14


-

3

6

9

12

15

18

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14

One-yr fwd EV/EBITDA 5-yr avg EV/EBITDA

- 1 2 3 4 5 6 7

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14

One-yr fwd P/B 5-yr avg P/B

34%

24%

26%

59%

27%26%

23%

20%

18% 16%

24%26%

28%29%

15%

20%

25%

30%

20%

30%

40%

50%

60%

FY11

FY12

FY13

FY14

FY15E

FY16E

FY17E

EBITDA Growth RoCE (RHS)

56%

25% 17%

96%

24% 30% 27%

35%

30%

23%

31%

30%

30%

30%

20%

25%

30%

35%

40%

10%

30%

50%

70%

90%

110%

FY11

FY12

FY13

FY14

FY15E

FY16E

FY17E

EPS Growth RoE (RHS)

29%

14%18% 17%

54%

20% 22% 24%

0%

10%

20%

30%

40%

50%

60%

FY14 FY15 FY16 FY17

Domestic Business CSM Business

PI Industries


Key catalysts Commissioning of Jambusar Phase 2 in 2HFY16

PI is nearly fully utilizing its existing facilities in Jambusar. The commissioning of two plants under phase 2 at Jambusar will help the company drive the new growth phase under the CSM business. We expect 2HFY16 and FY17 growth to benefit as a result with 22% and 24% growth respectively in CSM business.

Success of newly launched products in domestic business

Further scale up of Osheen or other new launches such as Melsa (wheat weedicide) or Pimix (rice herbicide) would be a key driver for future earnings and further market share gains by PI Industries. Company is also launching is an in-licensed broad-spectrum insecticide in the current quarter which is a 9(3) registration. Our current estimates of 16% FY14-FY17 CAGR for domestic agrochemicals would have upside risks if any of these products shows a healthy traction.

Successful diversification to non-agrochemical molecules in CSM business

PI has so far commercialized 18 molecules, all of which are intermediates or AIs for agrochemicals. We believe given PI’s expertise on chemistry and process engineering, PI should be able to expand into other fine chemicals as well. PI currently has ~30% product pipeline in CSM business from non-agrochemicals; however, it has not yet commercialized any molecule. Any successes on that front will clearly increase the addressable market for PI. We would expect that catalyst to play out over next 1-2 years.

Key risks Underutilisation of new capacities may drag margins: PI is setting up two new plants in 2HFY16; Underutilization could adversely impact EBITDA margins. However, company has a strong order book of US$ 530mn and current capacities are fully utilized. We will assign a low probability to underutilization to happen more than 1-2 quarters. We expect 2HFY16 margins to largely remain unaffected.

Slowdown in global agriculture input markets: Weak commodity prices, climate changes and lower pest incidence may lead to lower agrochemicals demand globally and in India, which can impact both the CSM and domestic businesses.

Investments in seeds: Any diversification into seeds could be a take away management bandwidth and may impact PI’s most important asset – execution.

Other risks: Regulatory changes in key markets such as India, Russia/CIS, Africa, Latin America and the US could adversely affect profitability. Quality deficiency concerns in CSM business, plant closure due to accidents, and INR appreciation against USD are few other risks.

Accounting checks

PI scores well on most accounting parameters and does better than its peers on most parameters.

Exhibit 50: Explanation for the flags on the first page

Segment Score Comments

Accounting GREEN On our forensic accounting screener of 16 agrochemicals and seeds stocks, PI ranks in the top quartile due to high CFO/EBITDA (90% conversion ratio), low audit fees and no material unclassified loans or contingent liabilities.

Predictability GREEN PI’s management has been guiding conservatively and has mostly delivery better than expectations.

Earnings momentum AMBER

Consensus EPS estimates recently saw some minor downward revisions post Q2 results. Prior to Q2, they have been revised upwards by 15% in the last six months.

Source: Company, Bloomberg, Ambit Capital research

PI Industries


Exhibit 51: Ambit vs Consensus (` mn)

Matrix Ambit Consensus Deviation Comments

Sales FY15E 19,061 19,045 0.1%

Our estimates are at the median of consensus estimates. We believe there could be an upside in our number post commissioning of phase 2 in Jambusar. FY16E 22,995 23,265 -1.2%

FY17E 27,896 27,357 2.0%

Reported EBITDA FY15E 3,696 3,583 3.2%

Our margin estimates are slightly higher than consensus; however, they are lower than management guidance for 20% EBITDA margins in FY15. FY16E 4,661 4,554 2.3%

FY17E 5,718 5,422 5.5%

Reported EBITDA margin FY15E 19.4% 18.8% 60bps

Our estimates are 60-70bps higher than consensus estimates. FY16E 20.3% 19.6% 70bps

FY17E 20.5% 19.8% 70bps

Reported EPS FY15E 18.6 17.2 8.1%

Our tax rates are lower due to growing share of Jambusar revenues which will be giving tax benefits until FY22. FY16E 24.2 22.2 9.1%

FY17E 30.7 26.5 15.6%

Source: Company reports, Consensus, Ambit Capital research

PI Industries


Income statement (` mn)

Year to March (̀ mn) FY13 FY14 FY15E FY16E FY17E

Net Sales 11,514 15,955 19,061 22,995 27,896

% growth 31.0% 38.6% 19.5% 20.6% 21.3%

Operating expenditure 9,688 13,045 15,364 18,334 22,178

EBITDA 1,826 2,910 3,696 4,661 5,718

% growth 26.0% 59.4% 27.0% 26.1% 22.7%

Depreciation 220 316 394 473 527

EBIT 1,606 2,595 3,302 4,187 5,191

Interest expenditure 238 139 136 98 58

Non-operating income 82 158 174 191 210

Adjusted PBT 1,450 2,613 3,340 4,280 5,343

Tax 477 733 969 1,198 1,443

Adjusted PAT 974 1,912 2,371 3,082 3,900

% growth 19.7% 96.2% 24.0% 30.0% 26.6%

Extraordinary income/ (expense) (1) (44) - - -

Reported PAT after minority interest 973 1,880 2,371 3,082 3,900


Balance Sheet (` mn) Year to March (̀ mn) FY13 FY14 FY15E FY16E FY17E

Shareholders' equity 135 136 136 136 136

Reserves and surpluses 5,182 6,809 8,708 11,321 14,597

Total net worth 5,317 6,945 8,844 11,457 14,733

Debt 2,172 1,223 1,223 223 (0)

Deferred tax liability 483 437 437 437 437

Total liabilities 7,972 8,605 10,503 12,117 15,170

Gross block 6,178 6,829 8,329 9,879 10,379

Net block 4,781 5,267 6,373 7,449 7,423

CWIP 605 425 425 425 425

Investments (non-current) 5 5 5 5 5

Cash & cash equivalents 161 438 1,015 1,140 3,800

Debtors 2,625 2,568 3,081 3,591 4,203

Inventory 2,418 3,188 3,394 4,032 4,891

Loans & advances 695 1,194 1,090 1,316 1,521

Total current assets - - - - -

Current liabilities 5,900 7,388 8,581 10,079 14,416

Provisions 3,026 4,113 4,282 5,166 6,267

Total current liabilities 224 324 555 633 789

Net current assets 3,250 4,437 4,837 5,799 7,056

Miscellaneous expenditure - - - - -

Total assets 7,972 8,605 10,504 12,117 15,170


PI Industries


Cash Flow Statement (` mn)


Net profit before tax 1,450 2,613 3,340 4,280 5,343

Depreciation 220 316 394 473 527

Others 155 84 (38) (93) (152)

Tax (380) (743) (969) (1,198) (1,443)

(Incr)/decr in net working capital (425) (81) (215) (411) (420)

Cash flow from operations 1,020 2,188 2,512 3,051 3,855

Capex (net) (1,510) (640) (1,500) (1,550) (500)

(Incr)/decr in investments - - - - -

Other income (expenditure) 63 138 174 191 210

Cash flow from investments (1,447) (502) (1,326) (1,359) (290)

Net borrowings (402) (1,097) - (1,000) (223)

Issuance/buyback of equity 1,181 34 (82) 0 0

Interest paid (251) (115) (136) (98) (58)

Dividend paid (76) (272) (390) (468) (625)

Cash flow from financing 452 (1,451) (608) (1,566) (905)

Net change in cash 25 236 577 125 2,660

Free cash flow (before investments) (490) 1,548 1,012 1,501 3,355


Ratio analysis Year to March FY13 FY14 FY15E FY16E FY17E

PBT margin (%) 12.6% 16.4% 17.5% 18.6% 19.2%

Net profit margin (%) 8.5% 12.0% 12.4% 13.4% 14.0%

Dividend payout ratio (%) 13.1% 13.3% 13.4% 12.4% 13.0%

Net debt: equity (x) * 0.38 0.11 0.02 (0.08) (0.26)

RoCE (post-tax) (%) 16.2% 23.9% 25.8% 27.9% 28.9%

RoIC (%) 16.5% 24.8% 28.0% 30.8% 35.3%

RoE (%) 22.7% 31.2% 30.0% 30.4% 29.8%

Working Capital Turnover 6.0 8.7 9.9 9.9 10.6

Gross Block Turnover 2.2 2.5 2.5 2.5 2.8


Valuation Parameters

Year to March FY13 FY14 FY15E FY16E FY17E

EPS (`) 7.7 15.0 18.6 24.2 30.7

Diluted EPS (`) 7.6 15.0 18.6 24.2 30.7

Book value per share (`) * 39.1 51.0 65.0 84.2 108.2

Dividend per share (`) 1.0 2.0 2.5 3.0 4.0

P/E (x) 58.0 29.3 23.7 18.2 14.4

P/BV (x) 11.3 8.6 6.8 5.2 4.1

EV/EBITDA (x) 34.0 20.9 16.3 12.9 10.5

EV/EBIT (x) 38.6 23.4 18.2 14.4 11.6

EV/Sales (x) 5.4 3.8 3.2 2.6 2.2


PI Industries


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Strong reach and brand

Rallis has an 8% market share in the `125bn Indian pesticides market (12% CAGR in FY09-14). Rallis’ 15% revenue and PBT CAGR in FY09-14 was driven by the Metahelix acquisition (seeds), new launches in agrochemicals and capacity addition for contract manufacturing. We like Rallis for its wide distribution network, balance sheet strength, operating efficiencies, and growing non-pesticides business. Weaker growth in domestic pesticides for the past few years is a cause for concern though its aggression on new agrochemical launches and higher R&D will be the key catalysts alongside the scale-up in Metahelix. Our TP of `275 implies stagnant 19x FY17 EPS; expanding earnings growth and RoE (27% in FY17) will sustain these rich multiples.

Competitive position: MODERATE Changes to this position: STABLE Well-diversified business with growing non-pesticides portfolio Rallis has gradually de-risked its business model from season-led volatilities. Its share of non-pesticides portfolio increased from single digits in FY07 to ~31% in FY14 driven by expansion of contract manufacturing, and entry into seeds and plant growth nutrients. Within three years of acquisition, Metahelix will triple its revenues to `3bn in FY15 (15% revenue share); alongside, its international business has grown at 26% CAGR over the last three years. Widest reach, exemplar cash conversion, strong governance Rallis’ unmatched distribution network of ~40,000 retailers across more than 80% districts in India, its >150-year presence and continued (albeit slow) product innovation support a strong connect/brand recall with the farmers. This in turn has kept its debtor days (35) and also its cash conversion cycle (22 days) the lowest. Strong board/management pool has kept capital allocation primarily for capacity scale-up, the required seeds acquisition and dividends.

Stepping up R&D and product launches

Rallis’ core domestic agrochemical business (55% revenue share) has lagged peers (9% revenue FY10-14 CAGR vs peers’ 20%). Recently, Rallis has marginally loosened its debtor days, stepped up formulation R&D (1.6% of FY14 revenues) and will launch five new products in FY15 to step up growth; 3 already launched with ‘Origin’ being a unique offering. In-licensing, partnerships with incumbents and CRAMS will be the near-term catalysts. Step up in margins and resultantly earnings, RoE and multiples Despite stepping up R&D expense, we expect Rallis’ EBITDA margin to expand to 16.7% (FY17) from 15.2% (FY14) driven by better utilisation for the Dahej facility (17% growth in international exports), distribution/product expansion-led operating leverage in Metahelix (17% of FY17 revenues). Resultantly, over FY14-17, we expect revenue/EBITDA/EPS CAGR of 15%/19%/22% but more importantly RoCE/RoE improvement of ~400-500bps. Key risks include sustained weakness in domestic business and margin drag from Metahelix.

INITIATING COVERAGE RALI IN EQUITY November 21, 2014

Rallis IndiaBUY

Agro Chemicals

Recommendation Mcap (bn): `42.7/US$0.7 6M ADV (mn): `103/US$1.7 CMP: `223 TP (12 mths): `275 Upside (%): 23

Flags Accounting: GREEN Predictability: AMBER Earnings Momentum: RED

Catalysts Metahelix margin reaching double

digit in FY15

New order wins for CRAMS business

by late 2HFY15

Good performance of new launches

such as ‘Origin’ in FY16

Stock Price Performance


120 140 160 180 200 220 240 260

18,000 20,000 22,000 24,000 26,000 28,000 30,000

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

SENSEX Rallis India (RHS)

Analyst Details

Ritesh Gupta

Tel: +91 22 3043 3242

[email protected]

Key financials Year to March (̀ mn) FY13 FY14 FY15E FY16E FY17

Net Sales 14,582 17,466 19,718 22,937 26,630

EBITDA 2,106 2,636 3,004 3,724 4,434

EBITDA (%) 14.4% 15.1% 15.2% 16.2% 16.7%

EPS (`) 6.1 7.8 9.0 11.9 14.5

RoCE (%) 20.3% 21.6% 21.9% 24.5% 25.9%

RoE (%) 20.2% 22.8% 22.8% 25.8% 26.8%

P/E (x) 37.9 28.5 24.8 18.8 15.3


Rallis India


Snapshot of company financials Profit and Loss Year to March (̀ mn) FY14 FY15E FY16E Net revenues 17,466 19,718 22,937 EBITDA 2,636 3,004 3,724 Depreciation 407 450 483 Interest expense 150 130 67 Adjusted PBT 2,144 2,493 3,250 Tax 617 723 910 Adjusted net profit 1,522 1,750 2,305 Reported net profit 1,519 1,750 2,305 Profit and Loss Ratios EBITDA margin (%) 15.1% 15.2% 16.2% Net profit margin (%) 8.7% 9.0% 10.2% P/E on adjusted basis (x) 28.5 24.8 18.8 EV/ EBITDA (x) 20.1 17.7 14.3


Company Background Rallis has been operating in India for more than 150 years and has gone through many cycles of diversifications and divestments. In its current form, Rallis is a leading agri inputs company in India and manufactures pesticides and seeds and presently markets key brands such as Contaf, Contaf Plus, Fateh, Takumi, Applaud, Ralligold, and Asataf. Recently the company acquired a seeds business as well, expanding its customer association. Rallis, through its 40,000 retailer network across the length and breadth of India, covers all crop geographies. With factories across Akola, Lote, Turbhe, Ankleshwar and Dahej, Rallis has a manufacturing capacity of 10,000MT of technical grade pesticide and 30,000 tonne litres of formulations per annum. International business of the company accounts for 28% of revenues and is primarily involved in selling bulk active ingredients to Africa, Latin America

Balance Sheet Year to March (̀ mn) FY14 FY15E FY16E

Total Assets 12,972 14,688 16,703 Fixed Assets 6,252 6,803 7,020 Current Assets 6,468 7,634 9,433 Investments 251 251 251 Total Liabilities 12,972 14,688 16,703 Total networth 7,285 8,440 9,972 Total debt 768 768 568 Current liabilities 4,603 5,164 5,848 Deferred tax liability 315 315 315 Balance Sheet ratios RoCE 22% 23% 27% RoE 23% 23% 26% Gross Debt/Equity (x) 0.1 0.0 (0.1) Source: Company, Ambit Capital Research

Cash flow Year to March (̀ mn) FY14 FY15E FY16E

PBT 2,144 2,493 3,250


Tax (591) (723) (910)

Net Working Capital (274) (364) (21)

CFO 1,756 1,917 2,793

Capital Expenditure (584) (1,000) (700)

CFI (759) (931) (624)

Inc/Dec in Borrowings (546) - (200)

Net Dividends (521) (614) (809)

Interest paid (124) (130) (67)

CFF (1,191) (744) (1,076)

Net change in cash (194) 241 1,093

Free Cash Flow 2,341 2,917 3,493


Revenue salience of non-pesticides portfolio is on the rise; management targets share of non-pesticide sales to rise to 40% over the next few years (including contract manufacturing)


One-year forward P/E – Rallis’ multiples have not seen a re-rating unlike its peers given lagging performance of domestic business; we believe a revival of growth rates in domestic business/Metahelix margin scale-up will be a key catalyst for multiple re-rating for Rallis


78% 74%61% 59% 55% 52%

20% 22%28% 27% 28% 28%

1% 2% 9% 11% 13% 16%1% 2% 2% 3% 3% 4%

15%

17%

19%

21%

23%

25%

27%

29%

0

0

0

1

1

1

FY10 FY11 FY12 FY13 FY14 FY15E

Domestic Pesticides International ExportsSeeds Plant Growth NutrientsROE (RHS)

-

10

20

30

40

Oct-09

Feb-10

Jun-10

Oct-10

Feb-11

Jun-11

Oct-11

Feb-12

Jun-12

Oct-12

Feb-13

Jun-13

Oct-13

Feb-14

Jun-14

Oct-14


Rallis India


Rallis - A leading Indian pesticide player Rallis is primarily an agri inputs company with a presence in pesticides, seeds, and plant growth nutrients. The Tata Group through Tata Chemicals owns a 50% of Rallis. Apart from selling pesticides and seeds in India, the company sells active ingredients/formulations and intermediates through contract manufacturing or alliance-based sales to agrochemical players across key agricultural countries. The company also has been focussing on getting pesticide registrations in its name in the overseas markets. In the domestic market, the company has been focusing on high quality patented/off-patented products which are environmentally safe and provide better control on pests.

Exhibit 1: Rallis – Key business divisions

Key brands/Geographies FY14 gross

revenues (̀ bn)

Revenue contribution

Segment CAGR over

FY10-14

Significance to overall profitability

Domestic pesticides Contaf, Contaf Plus, Applaud, Takumi, Taqat, Asataf 10 52% 9% Relatively the most profitable segment

International pesticides Africa, Latin America, Bulk sales of active ingredients 5 28% 28%

Seeds Metahelix range in Rice, Corn, Millets 2.5 16% NA Presently margins in high single digits

Plant growth nutrients Ralligold, Tata Bahaar, Tata Upahaar RDS, Solubor, Tracel and Gluco Beta 0.6 4% 45% Small business but

offers better margins

TOTAL 18.1 18% EBITDA CAGR:12% EBIT CAGR: 11%


Exhibit 2: EBITDA margins have gone down post Metahelix acquisition but are likely to scale up gradually


Exhibit 3: RoCEs are likely to gradually scale up with improving gross block turnover


18.2%

15.9%

14.4%

15.1%

15.2%

16.2%

16.7%

12%

14%

16%

18%

20%

0

5,000

10,000

15,000

20,000

25,000

30,000

FY11

FY12

FY13

FY14

FY15E

FY16E

FY17E

Revenues EBITDA Margin (RHS)

2.0

2.5

3.0

3.5

4.0

10

15

20

25

30

FY13 FY14 FY15E FY16E FY17E

Working capital TurnoverRoCE (%)Gross Block Turnover (RHS)

Rallis India


Rallis India’s transformation and evolution 1998-2002: Unrelated diversifications in pursuit of growth

Post liberalisation, easier imports of chemical intermediaries increased the use of agrochemicals and pesticides; the Government’s thrust to improve the quality and production of the nation's agro products led to a boom for the pesticides industry in mid-90s. Rallis posted double-digit growth rates during this period. However, in the late 1990s, severe drought conditions in the south adversely impacted the industry and Rallis’s revenue growth decelerated to 4% in 1998 from 27% in 1995. In desperate moves to revive growth, Rallis diversified into many related and unrelated businesses (animal healthcare—feed additives, preventive care and therapeutic segments).

Exhibit 4: Rallis’ tie-ups over 1998-2000 Company Details

Acquisition of Oriental Seritech – a leading silk producer Rallis undertook research in farming and production of silk yarn

Acquisition of Oriental Floratech – grew roses and carnations Exports to Europe, Middle East and Far East

Caps of Zimbabwe – 40% stake purchase (for ` 0.5bn) Launched an ayurvedic range of products in Zimbabwe

Tie-up with Madras Fertilisers, Abbott, Cargill, and Norsk Hydro Distribution of fertilizers, backend procurement of wheat for Cargill

Tie-up with Monsanto Distribution of the entire range of Monsanto’s products in India

Tie-up with FMC Production and marketing of some of FMC’s agrochemical products in India

Tie-up with Dabur group and Sanat Products Distribute herbal over-the-counter products in Africa and Sri Lanka


However, growth and profitability continued to suffer; its fertilisers business’ subsidy bill receivables led to rising leverage and losses (`300mn in FY01).

Exhibit 5: Rallis’s debt spiraled in 1998-2001 leading to a D/E of 3.7x in FY01


Sensing deeper issues, the Tata Group brought in Rajeev Dubey and made him the CEO in September 2000. Wider reorganisation of resources, a more agile decision-making and divestments led to debt reduction to `3.4bn and debt/equity of 2.8x.

Exhibit 6: Rallis’ turnaround

Year Area Impact

2001 Operational Rallis merged five of its agriculture-related wholly owned subsidiaries - Ralchem, Rallis Finance and Investment Co, Rallis Hybrid Seeds, Rallis Farm Management Services and Sankhya Garments.

Early 2000s Operational Exited from its interests in cement and paints businesses and cut staff at the managerial level, and suspended operations of two subsidiaries, Oriental Seritech and Pazchem, to check losses

Early 2000s Operational Rallis divested many of its non-core businesses. The gelatin business was sold to Sterling Biotech for `0.47bn. Farm-related activities were sold to Tata Chemicals. The knowledge services business including the R&D centre at Bangalore was sold to Advinus Therapeutics, another Tata company.

2001 Financial Rallis sold properties across the country especially Mumbai to reduce debt

2001 Financial The company's high interest convertible debentures were converted into preference shares

2003 Financial Tata Sons subscribed to preference shares of Rallis, thus injecting `880 million to reduce its high interest loans.

Source: IIM Indore Case (Bowonder, Kumar, et al), Ambit Capital research

-30%-20%-10%0%10%20%30%40%50%

0

10000

20000

30000

40000

50000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Debt (in Rs Mn) Revenue Growth(RHS)

Rallis India


2003-2008: The struggle continues and strong steps taken

FY03 turned out be another bad year with losses requiring cleaning up of its books.

Rallis Annual Report 2003 – Chairman’s Message: “The growing market also led to overstocking in the trade and a proliferation of dealers. With the leveling off of the market from 1999, some of these actions became constraints to profitable growth. This has happened to many companies in many sectors. The legacy issues faced by the Company from 1999 were not entirely unique to Rallis, but part of a larger pattern in the economy. It is precisely to neutralise the deleterious effects of this overhang that during the last three financial years, your Company has made large-scale provisions in the accounts. It would be unfair to attribute Rallis’ poor results only to external factors and legacy issues. Those have indeed been factors, but it is the responsibility of management to cope with such issues through positive leadership and actions. That is why your Board has constantly directed the senior team to implement much sharper cost control, cash collection, debt reduction and old stocks. While actions had indeed been initiated, the results demonstrate the lack of depth and sustainability as anticipated and expected by the Board.” Management changes and aggressive actions sow seeds for a turnaround The company brought in a Tata and Unilever veteran, Mr. R Gopala Krishnan, on the board of Rallis as the Chairman who then brought Dr Venkat Sohoni (that time 28 years plus of experience in the agrochemicals/pharma; now on the board of PI Industries) as the MD of the company. Part of Mr. Sohoni’s compensation was dependent on a successful turnaround of the business over the next three years.

Management identified following steps for a successful turnaround: (1) sharpening of business and product portfolios, (2) improving cash management, (3) introduction of new products, (4) reducing costs throughout the value chain, and (5) strengthening controls and business processes. In FY04, 90% of its revenues came from the pesticides business; however, profits remained weak over the next few years.

Exhibit 7: Rallis’ RoCE trend


2009-14: ‘Rallis Poised’ transforms the company into a high-quality franchise

Rallis’ management decided to reduce its dependence on monsoons and its severe seasonality. Rallis launched its ‘Rallis Poised’ growth agenda in May-07, targeting seven growth drivers, viz. Contract Manufacturing, Brand Premium, Value Enhancement (known as ‘DISHA’ initiative), Overseas market expansion (named ‘Apollo’), Agri Services, Sustainability and Accelerating Growth. This required exiting commodity highly toxic “red triangle” labeled products (30-35% of FY07 revenue), entry into seeds and specialty fertilizers, scale up of the contract manufacturing business and more importantly focused reduction in working capital. Resultantly, non-pesticides portfolio increased from single digits in FY10 to 31% in FY14; seeds accounted for 13% revenues in FY14 and working capital days reduced to 22.

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

-25%

-15%

-5%

5%

15%

25%

35%

FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

ROCE (LHS) Revenue Growth

Rallis India


Strong business model but core weakening Rallis ranks among the top-3 companies on our business quality framework. On the positive side, the company has a longstanding association with Indian dealers and farmers which provides it with a strong brand recall. It also has one of the best working capital cycles amongst Indian agrochemical players and has a debt-free balance sheet. Rallis also benefits from strong talent availability from its parent, the Tata Group.

However, we find that Rallis has not been able to effectively chase new segments for growth; its domestic business has lagged peers. Margins and RoCEs also have been adversely impacted by Metahelix acquisition; we expect these to improve however over the next couple of years.

Exhibit 8: 4-Point Quality Framework






Overall Strength


Business model strength Exhibit 9: Business model strength



Market positioning

Distribution




Overall Score


Segment attractiveness and market positioning: Rallis has a presence across seeds, pesticides and specialty fertilisers (plant growth nutrients). However, Rallis’ competitive positioning in domestic agrochemicals is relatively inferior to its MNC peers. In pesticides, Rallis’ growth rates have lagged that of its peers for the last 6 years; its innovation index is now ~15% vs a healthy 25% over FY07-10. Similarly in exports, Rallis operates in the relatively lower-margin generic contract manufacturing segment vs custom synthesis by PI Industries. Rallis is trying to take PI’s course but this requires a much longer gestation period of 15-20 years.

Rallis India


Exhibit 10: Segment attractiveness and competitive positioning

Business Model Business Model Attractiveness Competitive Positioning

Bayer Formulated Agrochemicals High High

Technical - Patented Medium High

Dhanuka Formulated Agrochemicals Medium Medium

IIL Formulated Agrochemicals High Low

Technical - Generics Low Low

PI Industries Formulated Agrochemicals High Medium

Fine Chemicals Custom Manufacturing High High

Rallis Formulated Agrochemicals High Medium

International Exports- Generics Low High

Seeds Medium Medium

Plant Growth Nutrients High High


Its top-five and top-ten products contributed 40% and 65% of FY14 revenues. The company generates nearly 25% of its domestic pesticides sales through herbicides whilst fungicides and insecticides contribute to 30% and 45% respectively.

Exhibit 11: Rallis – Asataf is the largest brand for Rallis Product Technical Category Description Competition

Asataf 75% SP formulation of Acephate Insecticides

Sucking and chewing insects of tobacco, sugarcane, cotton, chillies, vegetables, fruits and cereals

Starthene (Swal), Lancer (UPL)

Contaf 5% EC Hexaconazole Fungicide Sheath blight of paddy, leafspots and blights on all types of crops and powdery mildew of crops like grapes and chillies

Sitara (Indofil)

Contaf Plus 5% SC Hexaconazole Fungicide

Controls powdery mildews, rusts and leaf spots in cereals, oil seeds, horticultural and plantation crops and also for the effective control of Rice Sheath Blight

Danzole Plus (Cheminova)

Applaud Buprofezin 25 SC Insecticide Homopterous pests such as plant hoppers, leaf hoppers, white flies, scales and mealy bugs; Tribune (Crystal), Dinetofuron (PI), Ulala (UPL)

Takumi Flubendiamide 20% WDG Insecticide Heliothis in cotton and rice stem borer Coragen (DuPont), Fame (Bayer)

Taqat 50% WP formulation of Captan Fungicide Broad spectrum fungicide Saaf (UPL)

Ralligold Plant growth nutrient Local players

GeoGreen Plant growth nutrient Local players


Distribution - Rallis is the best but behind MNCs! Rallis has one of the best agrochemicals distribution network behind global MNCs. Its distribution network covers more than 80% districts in India, with ~2,500 dealers and 40,000 retailers all over India. Rallis being one of the oldest players has some of the best-quality dealers, which has in a way aided it to sustain its working capital at one of the best levels in the industry. Rallis has over ~200 field staff and more than 1,200-1,300 crop advisers; it has 25 depots to fully service its dealer across India. Rallis has a presence in almost all key agri states including AP, Gujarat, Maharashtra, Punjab and Haryana. Our dealer checks suggest that Rallis has very strong relationships with its dealers. Dealers are happy to be associated with a Tata brand and they find Rallis to be very professional vs other domestic companies. However, some of the common dealers admitted that the quality and stability (relatively higher attrition) of field officers and dealers is below that of Bayer and Syngenta.

Manufacturing - Targeting more from exports: Rallis India has four manufacturing facilities spread across India, in Akola, Ankleshwar, Dahej and Lote. The company manufactures 10,000MT of technical grade pesticide, and about 30,000 tonnes/litres of formulations. Rallis has one of the best manufacturing capabilities amongst Indian companies and is now targeting incremental revenues from CRAMS.

Rallis India


Product development/sourcing capabilities: Increased R&D to bear fruits soon. Rallis specializes in developing cost-effective processes for molecules that are off-patented or to be off-patented soon. It holds many patents on such processes in India and globally. After a gap of 2-3 years in R&D, company has stepped up its focus on R&D and increased its spends. The cycle of R&D is long; it takes 4-5 years for the product to get commercial and we expect results will start showing from now FY15-16. Currently, spends of Rallis are one of the highest amongst Indian companies. Rallis has also been able to tie-up with other global majors to procure proprietary molecules. Currently, such traded products account for ~15% of overall sales.

Exhibit 12: Rallis tie-ups with global majors

Company Product Description

Nihon Fujione Insecticide for control of blast in rice

Syngenta Preet, Parlac, Sartaj

Bayer Tata Mida, Spiro

Gharda Chemicals Fateh Leading herbicide in wheat segment

Makhteshim Captan, Atrazine Another product ‘Nova’ being launched to control pests in cotton


Risk to current business model: Rallis has seen various cycles of agrochemical demand in India and has persevered. Given the distribution strength and brand recall enjoyed by the company, we believe it is well positioned to capture the long-term growth in the agri input space. However, it is unlikely to grow at a faster pace than its peers.

Execution track record has been strong Exhibit 13: Execution track record



Margin expansion

5 year average ROCE


CFO/EBITDA

Overall


Rallis’s revenue growth rates have lagged that of its peers despite entry into many other new segments such as seeds, plant growth nutrients, and contract manufacturing business.

Exhibit 14: Overall Sales (in ` mn) - Rallis has seen the slowest growth amongst its peers

Company/Metric FY09 FY10 FY11 FY12 FY13 FY14 5 year CAGR Rank

Bayer 13,940 17,254 21,392 22,723 27,253 32,452 18.40% 2

Dhanuka 3,368 4,081 4,910 5,292 5,823 7,384 17.00% 3

Insecticides India 2,634 3,774 4,501 5,218 6,167 8,641 26.80% 2

Kaveri Seeds 1,231 1,621 2,337 3,724 7,120 10,111 52.40% 1

PI Industries 4,629 5,425 7,200 8,791 11,514 15,955 28.10% 2

Rallis 8,562 9,005 10,934 12,749 14,582 17,466 15.30% 4


Over the years, Rallis has lost its margin leadership in the segment. Rallis’ margins have taken a hit due to the acquisition of the Metahelix business whilst others have grown their margins driven by higher share of in-licensing revenues. RoCEs too have

After a gap of 2-3 years in R&D, company has stepped up its focus on R&D and has spent around `800mn per annum on formulation R&D

Rallis India


taken a hit due to the Metahelix addition. Similar to margins, PI and Dhanuka have gradually expanded their RoCEs whilst Rallis’ RoCEs have declined.

Ability to incubate new businesses: Rallis has been able to enter new businesses such as seeds, plant growth nutrients, and generics-based contract manufacturing. We rate them well on this parameter.

Rallis has been able to sustain its working capital cycle, leading to better pre-tax CFO:EBITDA ratio.

Exhibit 15: Financial and operating efficiency



Net Debt to Equity


CFO/EBITDA

Capital Allocation

Overall


Rallis’ working capital management is a benchmark for the peers. The company has seen no bad debts in the last 6 years. It focused significantly on improving its working capital post 2002 and gradually emerged as the best in working capital management by wide margin vs its peers. In our discussion, the CFO clearly emphasised the need to tightly manage working capital and avoid any window dressing on quarterly numbers as a key step to retain the long-term profitability in the business.

Exhibit 16: Rallis has the best cash conversion cycle amongst its peers



Bayer 43 45 40 42 70 78 69 61 59 55 32 28 54 68 78 75

Dhanuka 87 100 95 79 94 97 94 93 35 37 31 23 146 160 158 149


Kaveri Seeds 60 32 25 24 229 229 204 180 203 230 209 178 86 31 20 26

PI Industries 71 72 69 59 62 66 67 64 70 68 75 82 62 71 61 41

Rallis 31 31 34 35 65 73 68 63 101 98 86 77 -5 6 17 22

Median 59 52 51 47 82 87 82 79 84 83 80 79 61 69 69 55


Best-in-class working capital, a function of consistent and unique farmer engagement and distribution

Our primary data checks suggest Rallis would be amongst the top-3 for its consumer engagement programmes. During our dealer and farmer checks, many examples were cited wherein Rallis’ intervention led to reduced input costs and improved quality and yields. Better quality also led to better realisations for the crop produce. Rallis runs many consumer engagement initiatives such as Rallis Kisan Kutumb, Samrudh Krishi Programme, and Grow more pulses. Rallis has pioneered a number of unique relationship-building initiatives like technical field agronomists for disseminating the latest practices for crop cultivation, using focused group discussions for understanding emerging requirements of farmers, and systematically chalked field campaigns.

Further, Rallis’ 2,300 distributors reach more than 40,000 retail counters across India, covering more than 80% of India’s districts; this resulted in Rallis connecting to around 0.7mn farmers through the Rallis Kisan Kutumb programme.

“Strong trust on the “Tata” brand and years of quality association with Indian farmers give Rallis a formidable advantage vs competitors.”

- Field officer of a competitor

Rallis India


Exhibit 17: Farmer engagement initiatives by Rallis

Program Description

Rallis Kisan Kutumb RKK farmers are regular contacts throughout the crop cycle, organising crop seminars, product demonstrations, farmer exchange programmes (Prerna), Focused Group Discussions (FGDs) and advisory services.

Samrudh Krishi Programme

Under this programme, Rallis provides text alerts on crop prices, weather and possible disease outbreak; company also services farmers on their queries through the call centre which is offered in 15 local Indian languages. Rallis has engaged with grape farmers in Nasik, and with cumin farmers in Gujarat under this programme. Rallis also initiated work in Orissa for mechanical transplantation of paddy. This has resulted in up to 15% higher paddy yields, and saving in irrigation water. Use of hybrid paddy seeds increased the capability of the crop to withstand weather pressures.

Grow more pulses Rallis is actively engaged with farmers in increasing the productivity of pulses, and helps them in marketing the produce through Tata Chemicals. The company currently is running the programme in Karnataka, TN, and Maharashtra and more recently in MP. Rallis claims to have reached ~0.4mn farmers through this programme.


Case study – Grow More Pulses (MOPU)

The company further strengthened its farmer relationship with Grow More Pulses, an initiative from Tata Chemicals, which seeks to increase India’s pulse production. Rallis is involved with the farmers along the entire chain of activity, right from providing seeds to providing advice on cultivation and even buying back the pulses at competitive rates. Engagement levels under this programme have increased from 30,000 farmers three years back to nearly 500,000 farmers across India. The company has plans to take this number to 5 million over the next seven years.

Rigorous focus of the management on working capital management Rallis has seen no bad debts in the last 6 years. Our checks suggest that Rallis is one of the few companies that will not mind reporting a bad 1Q number in a weaker monsoon year, as the company postpones its product placement to the channel. The company’s CFO Mr. Ashish Mehta was one of the eight chartered accountants hired in the earlier 2000s at the time of the crisis. Mr Mehta clearly emphasized the need to tightly manage working capital and avoid any window dressing on quarterly numbers as a key step to retain the long-term profitability in the business.

Receivables - Strict management and effective use of channel financing: Rallis offers 30 days credit to its dealers and has a policy is to encash dealer cheques on the 30th day itself. Rallis has tied up with banks (Channel Financing) to give 60 days credit to dealers at lower credit cost, which eases working capital for Rallis. Rallis does not incur any cost as part of this nor does it give any guarantee as part of the process apart from the goodwill and help on some process-related documentation. On exports side, receivable situation is comfortable with company receiving 70% of export payment by end of the 2nd week.

Inventory - Avoids channel stuffing: Most products sold are used throughout the year. Usually the product’s shelf life is close to two years and it remains with the dealer for that time. Management is extra cautious on stuffing dealer inventory to avoid any liquidation later; cost of liquidation for agrochemicals is high, as product expiry required incineration in the factory. Hence, products are placed very close to the consumption season.

Payables: Rallis makes the payment of imports in no less than 60 days. No early payments are made. The cost of debt in most developed countries is hardly 2-3%. Hence, no cash discount for early payment is availed.

Exhibit 18: Rallis’ working capital cycle

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Inventories - Turnover 81 80 74 65 62 65 73 68 63 Sundry Debtors - Turnover 54 52 52 48 40 31 31 34 35 Sundry creditors -Turnover 77 72 60 60 77 83 79 65 60 Other current liabilities -Turnover 29 48 36 14 18 18 19 20 17 Working Capital Days 30 13 31 39 7 (5) 6 17 22


Rallis has had healthy gross asset turnover; however, the turns came down post the addition of Metahelix and the new Dahej facility. Alongside, Rallis remains virtually debt-free, in line with most of its peers.

With multinationals having established a formidable presence in the domestic market, Rallis realised that rather than vie for a piece of the existing pie, it would do itself more good by growing the market itself

Rallis India


Exhibit 19: Gross fixed asset turnover on an upward trend

Company Matrix FY10 FY11 FY12 FY13 FY14

Bayer 3.7 4.2 4.5 6.2 7.3

Dhanuka 8 8.1 8.2 7.3 7.7


Kaveri Seeds 2.2 2.1 2.9 4.6 5.3

PI Industries 2.2 2.4 2.5 2.4 2.7

Rallis 3.9 2.8 2.3 2.5 2.8

Median 3.8 3.5 3.7 5.2 5.2


Prudent capital allocation

Cash flow from operations has been the primary source of cash for Rallis. The company used the cash flow to fund the capex, Metahelix acquisition, and payment of dividends. The management’s past capital allocation decisions have been prudent, as capex was incurred for increasing manufacturing/research capability and improving product portfolio which contributed to higher revenue/profitability. Metahelix gave Rallis the entry into the seeds space and the acquisition seems to be doing well.

Exhibit 20: Source of cash – last 5 years


Exhibit 21: Use of cash – last 5 years


Corporate Governance/Minority Treatment Exhibit 22: Corporate governance/minority treatment


Quality of Board


Management Depth

Dividend Payout

Accounting Checks

Minority Treatment

Overall

Source: Ambit Capital Research. Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Operating Cash Flows

97%

Interest & Dividend Income

2%

Decrease in Cash

1%

Purchase of Fixed Assets43%

Investment in

Subsidiaries

21%

Interest Paid6%

Dividend Paid27%

Repayment of Debt

3%

Rallis India


Rallis is the best amongst its peers in terms of corporate governance. The company is the highest dividend paying company in the space with an average payout of one-third of its earnings whilst using the rest in prudent acquisitions and capex. The company is a professionally run company with good management depth. The Board has adequate reputed independent directors (70% independent directors). Their attendance is satisfactory. Management remuneration at 1.3% of PBT is satisfactory and better than best practices. Please see pages 34 –35 of our thematic for more details on this.

Management depth and bandwidth, a clear differentiation Management depth and bandwidth is a clear differentiation in case of Rallis. Rallis being a Tata Group company is able to attract quality talent from other industries including MNCs, which is a challenge for other home-grown companies except PI. The ability of the company to source talent from other group companies in case of a crisis is also significant. Agriculture being a relatively lower pay master had challenges attracting the best quality talent. However, Rallis due to its reputation as a Tata Group company has been able to attract high-quality talent from premier institutes.

Exhibit 23: Rallis – Key management

Name Designation Profile

R Gopala Krishnan Chairman of the Board

He is an IIT Kharagpur graduate and has done advanced management programme from Harvard Business School. He has a wide array of experience working with Unilever and Tata Group in a wide array of roles across geographies. His career spans 46 years with ~31 years in Unilever and 15 years in Tata.

V Shankar MD He is a CA, CS, ICWA, LLB by qualification. He was an all India Ranker in CA examination. He has had 18 years of career with Unilever. He joined the Tata Group when Hind Lever Chemicals merged with Tata Chemicals. For the last 10 years, he has been with the Tata Group in a wide array of roles.

K R Venkatadari COO – Agri business

He is a graduate of IIM Lucknow. He worked with Unilever for ~13 years before moving to Tata Chemicals. He has been with Rallis for last 8 years in a wide array of roles across the domestic and international businesses.

Ashish Mehta CFO He is a qualified Chartered Accountant and has ~20 years of experience. He joined Rallis in early 2000s as a mid-level manager and has risen through ranks. He is credited with significant improvement in Rallis balance sheet over the years.


Exhibit 24: SWOT analysis Strengths Weaknesses Presence across agri inputs space including seeds, pesticides, specialty

fertilisers, soil conditioners Strong distribution network covering more than 80% of districts in India

through 40,0000 retail points 8% market share in pesticides; second-largest player with a wide product

portfolio of brands across all the crops grown Access to quality talent pool and financial backing of Tata Group; debt

free balance sheet Best working capital (22 days) in the industry Strong knowledge of organic chemistry, batch processing and special

chemical reactions to support contract manufacturing growth

Despite being the oldest brand and having a wide reach, domestic agrochemical revenue growth rates of 12% have lagged peers’

Lack of aggression on in-licensing or identifying new molecules relevant to Indian markets from global innovators

The company operated in generic contract manufacturing as against customs synthesis

Opportunities Threats Low penetration of both commercial seeds, pesticides and poor agronomic

practices in India promise a strong long-term opportunity base to be harnessed

Agrochemicals export opportunity growing at mid-teens growth rates driven by rising preference of global innovators to outsource their manufacturing needs; working on -5 new projects for CRAMS business

Metahelix can scale up significantly from current market share of just 2% given Rallis’ distribution strengths and Metahelix’s R&D strengths

Stepped up R&D spend should yield innovative products International direct distribution opportunities in South East Asia and Africa

Significantly expensive acquisition to acquire product capabilities in seeds or pesticides

Global acquisitions to fuel growth rates Rising competition in the domestic agrochemicals space Inability to launch new products tough in-licensing or own

R&D


Rallis India


Well-diversified business with growing non-pesticides portfolio Rallis has gradually been working on de-risking its business model from season-led volatilities. It has expanded its share of non-pesticides portfolio from single digits in FY07 to ~31% in FY14 driven by expansion of contract manufacturing, seeds, and specialised fertilisers. Scale up of contract manufacturing business in Dahej and international expansions will be the next growth drivers for the company. We believe apart from PI, Rallis is the second-best option for any global player for contract manufacturing/CRAMS given Rallis’ deep understanding of organic chemistry, batch processing and special chemical reactions and expertise in developing low-cost manufacturing solutions for generic molecules.

Contract manufacturing driving international business growth With rising cost of labor and environment compliance in China, more and more global innovators are now looking to shift some contract manufacturing work to India. Currently majority of contract manufacturing happens in China. Even if India and eventually Rallis gains a smaller proportion of this, it will translate into a bigger opportunity. Rallis has a deep understanding of organic chemistry, batch processing and special chemical reactions such as isomerisation, azolyl methylation and reductive alkylation. Further, it has expertise in developing low-cost manufacturing solutions for generic molecules. We believe apart from PI, Rallis is the second-best option for any global player for contract manufacturing.

Exhibit 25: International business sales (` mn)


The company undertook a capex of ~`1.5bn over the last 5-6 years in the Dahej facility. Total area of the plot is~80,000 sqmt, out of which nearly half is constructed, leaving nearly half of the land for future development. Rallis currently has three lines operating at nearly full efficiency and it is undertaking `0.5bn capex for the addition of another line in FY15.

CRAMS business – Rallis has the right combo of knowledge and low cost manufacturing experience

Rallis is looking at contract manufacturing (custom synthesis) as a big opportunity to diversify its revenues away from the domestic business. In addition, given Rallis’ experience in manufacturing, this is another synergistic way to leverage its manufacturing capabilities. The company currently has got one order for CRAMS, though it is working on other 5-6 projects which are in their final stages.

International registrations

Rallis is also building up a gradual direct distribution model for overseas geographies. It is gradually entering into other Asian and African geographies on its own and setting up its own offices there. The company is also leveraging the

1,901 2,547

3,770 4,109

5,079

-

1,000

2,000

3,000

4,000

5,000

6,000


The Dahej plant is a multi-purpose technical manufacturing facility for a number of crop protection products

Current revenues from contract manufacturing are ~`2.5bn business

Rallis India


presence of Tata Africa and has launched brands such as Contaf Plus and Tata Panida in Nigeria. Contaf Plus was recently launched in Asia in FY14. Rallis is looking for a host of new registrations, which are likely to be received over the next 3-5 years. The pace of international registrations has significantly increased over the last few years. However, the proportion of registered product sales overseas to overall sales still remains low. Under the exports business, the company is also focusing on its alliance partnership with key customers in the European Union and Latin America.

Exhibit 26: International new Product registrations trend


Plant growth nutrients and soil conditioner—rising opportunity Soil imbalances have become quite common in Indian farm land aided by years of subsidies on bulk fertilisers. As farmers get more evolved, the demand for products which provide balanced nutrients or re-create the balance of the soil is increasing. Over the last few years, Rallis has gradually built a portfolio of plant growth nutrients (or specialised fertilizers) through product sourcing agreements with various smaller players. The business now contributes ~3% of overall consolidated sales of Rallis and has been growing at ~35% CAGR over the last five years. Ralligold, Tata Bahaar, Tata Upahaar RDS, Solubor, Tracel and Gluco Beta are the major products for the company in this segment.

This segment does not suffer from seasonality, as demand is derived from crops during crop season and for soils post season. Rallis is educating farmers to be aware of these nutrients and the impact these products could have on improving soil health.

Rallis procures products from MNCs when it can become the sole distributor or from local entrepreneurs who have a good product but do not have a strong pan-India distribution.

Exhibit 27: Plant growth nutrient product portfolio

Product Use

Tata Bahaar 100% organic growth promoter. A Green Organic Amino acid product from vegetable source with Gluconates and Lactates fortified with micronutrients which was launched to replace Aminos, a chemically synthesized amino acid product.

Gluco Beta A unique blend of carbon, proteins, primary nutrients (N and K), secondary nutrients (Ca and Mg) and micro nutrients (Zn, Fe and B) in organic form.

Ralligold Reduces fertiliser consumption by enabling crops to better utilise the applied phosphorus; will not only help the famer increase his income, but will also help in arresting soil deterioration due to imbalanced use of chemical fertilisers.

GeoGreen

Scientifically prepared organic compost derived out of wastes from sugar industry; vastly improves soil structure, is rich source of ‘organic carbon’ capable of supporting and enhancing biological activities in soil, increases water holding capacity, increases uptake of soil nutrients, helps fight diseases and reduces stress factors. It has been very well received by farmers who are able to see crop productivity improvement by its use.

Tata Uphaar –RDS New delivery mechanism in convenient soluble pouch.


74

6 57

2

12

20

16 17

0

5

10

15

20

25

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Product Registration

The company’s revenue in the plant growth nutrient segment is ` 600mn; the overall market for this type of product is significant at ` 30bn and the segment has high gross margins of 30-40%.

Rallis India


Exhibit 28: Plant growth nutrients – Sales (` mn) and revenue salience (%)


Soil conditioner: Rallis holds a 51% stake in Zero Waste Agro Organics Limited (ZWAOL), an organic manure and soil conditioners manufacturing company with three manufacturing facilities in Maharashtra and one in Uttar Pradesh. ZWAOL manufactures scientifically prepared organic compost, a soil conditioner and has recorded a four-fold growth in its sales volumes, as its high-quality organic compost ‘GeoGreen’ gained market acceptance since acquisition. Rallis had initially acquired a 23% stake in the company in FY13 for `100mn. This company generated `80mn in revenues in FY14.

Metahelix – Improving but cotton remains a gap Metahelix has good presence in rice, maize, millets and vegetable seeds and strong research capabilities

In December 2010, the company acquired a majority stake of 53.5% in Metahelix Life Sciences, a Bengaluru-based seeds research company, in an all-cash acquisition of `995million, 2X one-year forward sales. Later, Rallis infused `250mn to raise its stake to 59% on a diluted basis. Prior to this, Rallis had a very small presence in the seeds segment; Metahelix brought in a good portfolio of rice, maize, millets and vegetable seeds. Our checks suggest that Metahelix has a strong bank of germplasms and breeding technology which helps in generating good hybrids. Primary experts suggest that Metahelix has a good R&D but sales and marketing was a challenge in its growth. This acquisition by Rallis clearly enhanced its footprint, hence sales more than doubled FY12-14.

However, BT cotton technology of Metahelix turned out to be damp squib: One of the key reasons for the Metahelix acquisition was the commercialisation of Metahelix’s proprietary Bt trait cry1C, which did not materialise as planned. Rallis still does not have a presence in BT cotton which is a big part of the market.

Exhibit 29: Metahelix revenues are likely to become 3x of FY12 revenues in just 3 years (in ` mn)

Source: Ambit Capital research, Company

Exhibit 30: Metahelix gross margins are comparable to other prominent seed companies

Source: Ambit Capital research, Company

0.0%

1.0%

2.0%

3.0%

4.0%

-

100

200

300

400

500

600


PGN Sales % of sales

1,081

1,537

2,248

2,923

-

1,000

2,000

3,000

FY12 FY13 FY14 FY15E

72%65% 65% 63% 65%

Nuz

eev

eedu

Aje

etSe

eds

Vib

ha

Kav

eri

Met

ahel

ix

“Metahelix provides us a definitive entry into seeds. Seeds and crop protection are two sides of the same coin. Seeds also have the potential to bring new technology into agriculture. Our intention is that seeds should grow to be a substantial part of the Rallis portfolio.”

— Mr Girish Nadkarni, ex Rallis’ CFO

Our checks suggest that Metahelix has a strong bank of germplasms and breeding technology which helps in generating good hybrids

Rallis India


Addressing lack of successful products; stepping up R&D and partnerships Muted recent past… Rallis’ underperformance on domestic sales was primarily due to: (1) Rallis’ adherence on working capital management has cost some sales growth to the company. Its competitors have expanded revenues partly after some compromise on working capital; we find caution on this front prudent. (2) Rallis significantly lowered its R&D spends which also impacted new product development; though management highlights that it gradually stepped up R&D spends to boost product innovation; and (3) B2B sales declined with more and more MNCs entering the segment and Rallis defocusing on some of the high receivable business.

Visible poor launches and hence innovation turnover

Rallis’ growth in the domestic pesticides business has lagged over the last few years; the company’s key growth engines have primarily been inorganic growth such as Metahelix and ramp up of capacities in Dahej. Pace of new product launches significantly slowed down in FY13 and FY14 with just three launches in total and one launch in formulations.

In addition, none of the new product launches were successful. Its innovation index as a result declined, with revenues from products launched over the last four years declining from >25% in FY02-10 to 11-20% over the last four years.

Exhibit 31: Rallis’ pace of new product launches in domestic business likely to pace up from FY15


Exhibit 32: Rallis’ Innovation Turnover Index has been subdued over recent years


During the same period, the company’s competitors such as Dhanuka, PI and Bayer continued to expand at healthy growth rates. Rallis grew at an adjusted growth CAGR of 13% (for discontinued red triangle products) in FY10-14 vs PI and Dhanuka which registered a growth of 21% and 17% respectively during the same period. Bayer too grew at a healthy pace of 21% led by the actives (57% CAGR) and formulation business (15% CAGR) despite a much higher base. In terms of scale too, PI and Dhanuka are approaching the size of Rallis’s domestic business.

6 6

34

3 3 3

10

21

5

0

2

4

6

8

10

12

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

24

2825

31

2528

30 29 30 31

20

1114 15

0

5

10

15

20

25

30

35

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Rallis India


Exhibit 33: Rallis’ domestic business sales growth has lagged that of peers (` mn)

FY10 FY11 FY12 FY13 FY14 4 YR CAGR 2 YR CAGR

Rallis Domestic 7,323* 8,421 8,181 8,835 10,161 13%* 11%

PI Domestic 4,140 5,800 6,133 6,869 8,860 21% 20%

Dhanuka 4,456 5,412 5,762 6,464 8,291 17% 20%

Bayer Domestic 12,629 17,247 18,841 21,826 26,743 21% 19%

Actives 1,029 3,992 4,634 5,543 6,292 57% 17%

Formulation 11,599 13,255 14,207 16,283 20,450 15% 20%

Source: Ambit Capital research, Company annual reports. Note: * We have adjusted for Rs1 bn sales loss in FY12 due to discontinuation of Red triangle products for calculating CAGR

Preparing for the next blockbuster launch and improve domestic growth Three prong strategy to improve domestic growth 1. In-licensing the products, buy bulk formulation, and give them the company

brand. 2. Partner with the existing company (Alliance business) 3. Introduce products through reverse engineering through the company’s own R&D.

R&D—focus on development; stepping up its higher than peers spend Rallis specialises in developing cost-effective processes for molecules that are off-patented or to be off-patented soon. Rallis holds a significant number of patents on such process in India and globally. In addition, Rallis’ R&D undertakes various process improvements, thereby improving formulation types/strengths projects to improve the cost effectiveness of products. After a gap of 2-3 years, Rallis increased its focus on R&D in FY10 and given that the commercialization of R&D efforts takes 5 years, the positive impact may start to be visible from FY15. FY15 is likely to be a strong year in terms of product launches; Rallis has already launched three of these five products.

Good product development capabilities

Amongst domestic companies, Rallis focuses a lot on product development. Rallis does not focus much on research of active ingredients, and it does lot of work on formulation technologies. In FY05-FY09, Rallis R&D spends moderated which impacted innovation rates FY10 onwards. Company stepped up its R&D again post FY10. The company spends around `80mn on formulation R&D; the cycle of R&D is long and it takes 4-5 years for the product to get commercial. We expect innovation rates to improve FY15 onwards.

Exhibit 34: Rallis innovation index saw a sharp decline in FY10-FY14 period post sharp cuts in R&D spends from FY05-FY09

Source: Company data, Ambit Capital research

Exhibit 35: Rallis R&D spends are one of the highest amongst peers

Source: Company data, Ambit Capital research

0%5%10%15%20%25%30%35%

0.0%

0.5%

1.0%

1.5%

2.0%

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

R&D expenses as % of Sales Innovation Index

0.0%

0.5%

1.0%

1.5%

2.0%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

PI Inds Rallis Dhanuka

“Process Development (Reverse Engineering) was one of the key activities undertaken and several process patents are being filed for protecting the technologies.”

- Rallis’ Annual Report 2012

Rallis R&D spends have increased since FY10


98 81 72 5325

6092 90

236 255

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

R&D Spends (Rs Mn)

Rallis India


New launches in FY15 – three launched with one of it a potential big success

The company has already launched three products: (1) Origin (insecticide + fungicide combo), (2) Duton (herbicide), and (3) Hunk (insecticide for sucking pests in paddy). These products are likely to enhance revenues from FY16 onwards.

‘Origin’ is the most promising amongst these, as it is the first of its kind in the Indian market. The product controls both insects and fungal diseases in paddy. Origin is also credited with phytotonic character, which improves the overall crop health apart from improving yield and productivity of paddy. The combination product will also help in reducing costs for farmers. The product has a 9(3) registration, providing the company with four years of exclusivity on the product.

The company also plans to launch two insecticides and one more fungicide product this year. These will be a mix of technologies sourced from overseas and developed in-house.

RICH to augment Rallis abilities in CRAMS

Rallis added a new facility in Bangalore, the Rallis Innovation Chemistry Hub in FY13. The management believes that it provides a unique opportunity for interaction and synergy to all sections of the R&D Department, resulting in greater efficiencies.

The management stated: “Many multinational companies have visited the RICH facility for potential contract manufacturing and alliance opportunities. A state-of-the-art Pilot Plant has been set up at Dahej to scale up the processes, which is the backbone of commercialization, developed by RICH.”

RICH also worked jointly with Tata Chemicals’ Innovation Centre at Pune for developing nano-based granules and slow release formulations to offer new solutions as innovative products to the farmer. With the efforts of the R&D team, Rallis became the first company in India to offer a combination of an insecticide and a fungicide (launched in FY15), bringing greater convenience to the farmer. The difficulty in developing the combination was to have a unique solvent base which can immerse both insecticide and fungicide actives.

International Product registration and domestic launches


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FY05

FY06

FY07

FY08

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FY10

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FY14

Product RegistrationLaunches (RHS)

Rallis India


Valuations - Rich and can remain so Rallis’ growth rates for revenues and earnings are set to recover as the recently stepped up R&D and launches in FY15 will positively impact revenue growth in FY16 and beyond. Simultaneously, increased scale for CRAMS should be supplementary as the projects under works fructify. This widening of product portfolio in India and abroad and scale up of CRAMS using its chemistry skills should expand earnings based multiples marginally from the presently rich 19X FY16 EPS.

Our 12-month forward DCF-based valuation of `275 implies 23x FY16E EPS and 19x FY17E EPS; we assume revenue CAGR of 15% over FY14-17 driven by 12% growth for the domestic pesticides business, 14% for the exports business and 25% for Metahelix seeds business. Multiples should remain rich for this quality franchise given the strong brand/ distribution in this industry with a large potential; whilst Rallis is addressing innovation, we find comfort in its competitive advantages, which are difficult to replicate in short period of time.

DCF methodology We value Rallis using a DCF methodology with a WACC of 14.5%. Key things to look into Rallis’ DCF model are the revenue growth trajectory, working capital intensity, gross asset turnover, and EBITDA margins.

We have defined growth rates in two phases: For FY14-18 (phase 1) we assume active growth rates, and we gradually fade away the growth rates from FY18 to FY26 (phase 2). From FY26 onwards we assume 5% growth rates.

Revenue growth rates

Phase 1 (FY14-18): We assume revenue CAGR of 15% over FY14-18 driven by 13% growth rates (vs 9% over FY10-14) in the domestic pesticides business and 14% growth rate in FY14-18 (vs 28% in FY10-14) in the exports business. We expect the Metahelix seeds business to register 24% CAGR over FY14-18.

Exhibit 36: Growth rate assumptions

FY10-14 FY14-18E Comments

Domestic Pesticide Business 9% 13% We expect growth rates to improve driven by improved thrust on R&D and in-licensing partnerships

Exports Business 28% 14%

Our estimates may have upside risks if CRAMS business starts showing promise which we don’t build much contribution as of now. Though we believe that it will be a relatively longer haul

Seeds Business (Metahelix) 163% 24% Seeds business will continue to scale up given company’s pan India distribution and good R&D capabilities

Plant Growth Nutrients 45% 29% Continued scale up from a low base

Soil Conditioners New business 21% Growth to be driven by improving adoption and awareness amongst farmers

Source: Company, Ambit Capital research. Note: * Pre Metahelix, the seeds business was quite small

Exhibit 37: Growth rate assumption segment-wise

FY11 FY12 FY13 FY14 FY15E FY16E FY17E FY18E

Domestic Pesticide Business 15% -3% 8% 15% 8% 13% 13% 13%

Exports Business 34% 48% 9% 24% 15% 16% 15% 13%

Seeds Business 44% 32% 25% 25% 25% 12%

Plant Growth Nutrients 80% 34% 34% 35% 25% 25% 25% 25%


Phase 2 (FY18-26): We assume revenue CAGR of 13% over FY18-26 with average domestic pesticide business growth rate of 13% and exports business growth rate of 11%. We also expect 14% CAGR for the seeds business.

Rallis India


Phase 3 (FY26 onwards): We assume terminal growth rate of 5%. Given lower penetration of agrochemicals (25%) and even further consumption (in terms of value), we believe 5% growth rates are very conservative.

EBITDA margin improvement

Phase 1 (FY14-18): We expect Metahelix and in turn consolidated margins to gradually scale up, as inherently the margins for the seeds business are better. The Metahelix business’ EBITDA margin is currently at ~6% vs Kaveri Seeds’ 30%. Overall margins are likely to improve from 15.3% in FY14 to 17.4% in FY18 driven by scale benefits from Metahelix.

Exhibit 38: Rallis’ EBITDA margins have been volatile


Phase 2 (FY18-26): We expect margins to largely remain reach around 19% driven by rising scale of the business and improved product mix.

Phase 3 (FY26 onwards): We assume margins to remain stable at 19%.

Working capital

We expect working capital days to go up in FY15 and then gradually come down to remain close to 20 days.

Exhibit 39: Rallis’ working capital cycle

FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E FY18E

Inventories - Turnover 62 65 73 68 63 72 65 65 65

Sundry Debtors - Turnover 40 31 31 34 35 35 35 35 35

Sundry creditors -Turnover 77 83 79 65 60 63 61 62 62

Other current liabilities -Turnover 18 18 19 20 17 19 18 18 18

Working Capital Days 7 (5) 6 17 22 26 21 20 20


6.1%

11.9%

15.6%

19.0% 18.7%

16.2%14.6% 15.3% 15.4%

16.4% 16.8%

0.0%

5.0%

10.0%

15.0%

20.0%

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

Rallis India


Capex needs

We expect capital employed turnover to improve marginally from 2.2x in FY14 to 2.4x by FY18 driven by improvement in product mix. We expect operating cash flows to take care of the future capex needs. Free cash flows will rise, as incremental capex continues to become a smaller part of the existing gross block.

Exhibit 40: Capex will be funded by internal accruals (` mn)


Terminal growth rate of 6%: We have taken a terminal growth rate of 6% for the company post FY26. We take comfort from the fact that US agrochemicals market grew at 8% CAGR from 1976 (where Indian market is now in terms of market size) for 20 years period. With Rallis’ strength of franchise, a long history, and low penetration levels for agri inputs we believe 6% terminal growth is fair.

Exhibit 41: US Agrochemical Market size

US$ Mn Implied CAGR 9 Yr Moving Average CAGR

1934 28 1937 33 6% 1940 41 8% 1943 52 8% 7%

1946 69 10% 9%

1949 118 20% 12%

1952 188 17% 15%

1955 174 -3% 11%

1958 230 10% 8%

1961 302 10% 5%

1964 383 8% 9%

1967 609 17% 11%

1970 898 14% 13%

1973 1308 13% 15%

1976 1801 11% 13%

1979 2677 14% 13%

1982 4007 14% 13%

1985 4297 2% 10%

1988 4328 0% 5%

1991 5565 9% 4%

1994 6806 7% 5%

1997 8360 7% 8%

Median 10%

Source: Center for Integrated Pest Management, North Carolina State University

(2,000)

(1,000)

-

1,000

2,000

3,000

4,000

FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

Cash flow from operations Capex (net) Free cash flow

Rallis India


Using a WACC of 14.5% for Rallis, our 12-month DCF-based valuation of ` 275/share valuation implies 23x FY16 and 19x FY17 EPS estimates.

Exhibit 42: Rallis’ 12-month forward DCF valuation summary (` mn)

Parameter Value

Total PV of free cash flow (a) 20,197

PV of terminal value (b) 33,098

EV (a) + (b) 53,295

EV (US$ mn) 874

Net debt 187

Equity value 53,108

No. of shares (million) 195

Implied share price (̀ ) 275

Current share price 223

Upside 23%


Exhibit 43: Sensitivity analysis of TP to terminal growth and WACC Equity estimates WACC

Term

ina

l Gro

wth

ra

te

275 12.5% 13.5% 14.5% 15.0% 16.0%

3.0% 310 270 238 224 201

4.0% 338 291 254 238 211

5.0% 375 317 275 255 224

6.0% 426 352 298 276 240

7.0% 426 352 298 276 240


Cross-cycle valuation: Premium to historical valuations justified Rallis currently trades at 21x one-year forward, in line with its five-year average P/E of 20x. We believe further expansion from current levels will be limited as these are rich valuations and hence need superior delivery on various fronts. Over the last 5 years, Rallis has disappointed consensus estimates, delivering a PAT CAGR of just 15% with a drop in standalone margins along with the addition of the Metahelix business.

Currently we build in 23% CAGR in EPS growth over the next three years, building in: (1) margin expansion in the Metahelix business; (2) scale up of CSM business in Dahej; (3) sustained revenue growth momentum in Metahelix; and (4) improvement in growth rates of domestic business. Multiples will expand only when the 2HFY15/FY16 growth shows signs of improvement from the new launches and CRAMS business starts contributing materially to revenues.

Rallis India


Exhibit 44: One-year forward P/B


Exhibit 45: EBITDA Growth vs RoCE


Exhibit 46: EPS Growth vs RoE

Company, Ambit Capital research

2

3

4

5

6

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14


19%

2%4%

25%

14%

24%

19%

26%

20% 20%

22%

22%

25%

26%

18%

20%

22%

24%

26%

28%

0%

4%

8%

12%

16%

20%

24%

28%

FY11

FY12

FY13

FY14

FY15E

FY16E

FY17E

EBITDA Growth RoCE (RHS)

18%

-13%

5%

33%

15%

32%

23%

27%

19% 20%

23%23%

26%

27%

18%

20%

22%

24%

26%

28%

-14%

-4%

6%

16%

26%

36%

FY11

FY12

FY13

FY14

FY15E

FY16E

FY17E

EPS Growth RoE (RHS)

Rallis India


Financial Assumptions Exhibit 47: Financial Assumptions

Particulars (̀ in mn unless mentioned) FY14 FY15E FY16E FY17E

Change (%) Comments

FY15E FY16E FY17E

Growth Rate

Domestic Pesticides Business 10,161 10,669 12,269 14,110 5% 15% 15% We expect innovation index to improve from current 15% and drive growth in FY16 and FY17

International Pesticides Business 5,079 5,824 6,673 7,597 15% 15% 14%

International business to be driven by continued momentum on growing agrochemical exports strength of India and strong manufacturing capabilities of Rallis

Seeds Business 2,378 3,210 3,853 4,623 35% 20% 20%

We expect Metahelix business to continue gaining market share on a small base, new launches and improved distribution

Plant Growth Nutrients 581 755 981 1,275 30% 30% 30% The business will continue to grow well driven by improving awareness amongst farmers

Financials

Net Sales 17,466 19,718 22,937 26,630 13% 16% 16% Overall growth supported by growth in non-pesticides portfolio and better performance of domestic business

EBITDA 2,636 3,004 3,724 4,434 14% 24% 19% Expect margins to improve behind rising scale of Metahelix business

EBITDA margin (%) 15% 15% 16% 17% 14 bps 101 bps 41 bps Depreciation 407 450 483 541 11% 7% 12% Interest 150 130 67 47 -13% -49% -30% PAT 1,522 1,750 2,305 2,829 15% 32% 23% PAT margin (%) 8.7% 8.9% 10.1% 10.6% 16 bps 118 bps 57 bps Cash Flow Parameters CFO 1,756 1,917 2,793 3,084 9% 46% 10% Capex (584) (1,000) (700) (1,200) 71% -30% 71% FCF

1,172

917

2,093

1,884 -22% 128% -10% Ratios

Cash Conversion Cycle 22 26 21 20

Cash conversion cycle to see some improvement with rising sales of seeds and international business which has better working capital norms

Gross Block Turnover 2.2 2.2 2.3 2.5 Gross block turnover to improve with improved utilisation of Dahej facility

Capital Employed Turnover 2.2 2.3 2.3 2.4 Profitability Ratios

RoCE 22% 22% 25% 26% 28 bps 268 bps 140 bps ROCEs would improve drive by improved EBITDA margins and capital employed turnover

RoE 23% 23% 26% 27% 4 bps 298 bps 94 bps RoIC 22% 23% 27% 31% 119 bps 429 bps 391 bps Source: Company, Ambit Capital research

Rallis India


Key catalysts Specific catalysts over the next 6-18 months Revival of domestic agrochemical business growth with success of new products launched in FY15

Rallis has recently launched three new products in India and it plans to launch two more in 2HFY15. The company’s innovation index has been stagnant at 15% over the last two years. As a result, the domestic business has lagged that of its peers. The recovery of domestic sales growth would drive re-rating of the stock.

Scale up of Metahelix margins

Metahelix’s margins scaling up to healthy double digits would be a key catalyst. Kaveri seeds generate EBITDA margins of ~22% despite generating gross margins similar to Metahelix seeds. Gradual bridging up of difference (from current mid to high single digit EBITDA margin for Metahelix) would be driving overall profitability growth from hereon. We are building in a scale up in margins to the early double digits by FY17. Anything incremental from there would be an upside.

New order wins for CRAMS business in FY16

We currently do not build in anything material from CRAMS business as we believe such a business takes time to scale up. Any meaningful contribution FY16 onwards would add upside to earnings and drive stock price.

Good Rabi season

Delayed recovery on monsoons this year augurs well for the Rabi season. Good Rabi sowing would translated into better 2HFY15 revenues which will clearly be a positive for stock price.

Generic long-term catalysts and specific catalysts Sustained trend in scale up of Metahelix business

The Metahelix business currently operates in non-cotton crops such as rice, corn, vegetable and millets. It does not have much presence in cotton. Any new technology invention or acquisition which could give Rallis a scaled-up presence in the cotton seed market would clearly propel the business into another high growth trajectory. This will also give the required margin flip to Rallis.

Government thrust on infrastructure development for agriculture

Under the new political regime, any improvement in irrigation, better availability of power, removal of APMC Acts, clear policies for contract farming, and better storage facilities will lead to improved agricultural productivity which will lead to better per capita spends on high-quality agri inputs. Shift from sustenance farming to a more commercial approach to farming will clearly step up agri inputs growth rates.

Key risks Sustained bad performance in domestic business Rallis has been underperforming its peers over last few years. We notice the pick-up in R&D spends over last few years and uptick in new launches (five launches in FY15) as increased sings of aggression on improving innovation rates for the company which stagnated to 14-20% over last three years. We build in 15% growth in FY16 and FY17 vs. 9% CAGR over FY10-FY14 driven by uptick in innovation rates. Sustained underperformance will be detrimental for our EPS estimates as well as multiples for the stock.

Metahelix business continues to drag overall margin performance

Rallis India


Metahelix business which has been scaling up well is expected to witness margins improvement over next few years. Metahelix margins failing to move up due to lower sales or higher R&D/field trial expenses for new launches over FY15-FY17 could pose risks to earnings estimates. Though assign a very low probability for the same to happen.



Accounting GREEN We find Rallis to be clean on our accounting checks driven by best in class working capital, high cash conversion ratio. Company is also audited by a quality audit company.

Predictability AMBER Earnings are volatile, depending on the monsoons and other climatic conditions. The business also has strong seasonality, leading to volatility in margins.

Earnings momentum RED

Consensus EPS estimates have been revised downwards post recent quarter miss on earnings


Ambit vs consensus Our revenue and EBITDA estimates are broadly in line with consensus estimates as we do not build in much upside to international revenues from CRAMS scale up. Rallis would have upside risks if CRAMS business and domestic business start showing upward traction. We assume marginally lower tax rates given rising salience of Metahelix seeds business which attracts zero tax rates due to accumulated losses in the past.

Exhibit 49: Ambit vs. consensus (` mn)

Sales Ambit Consensus Deviation

FY15E 19,718 19,810 -0.5%

FY16E 22,937 23,206 -1.2%

FY17E 26,630 26,874 -0.9%

Reported EBITDA

FY15E 3,004 3,014 -0.3%

FY16E 3,724 3,705 0.5%

FY17E 4,434 4,490 -1.2%

Reported EBITDA margin

FY15E 15.2% 15.2% 0.0%

FY16E 16.2% 16.0% 0.3%

FY17E 16.7% 16.7% -0.1%

Reported EPS (in ̀ )

FY15E 9.0 9.1 -1.5%

FY16E 11.9 11.5 3.3%

FY17E 14.5 14.1 3.4%


Rallis India


Consolidated P&L Statement


Net Sales 14,582 17,466 19,718 22,937 26,630

% growth 14.4% 19.8% 12.9% 16.3% 16.1%


EBITDA 2,106 2,636 3,004 3,724 4,434

% growth 3.8% 25.2% 13.9% 24.0% 19.1%

Depreciation 315 407 450 483 541

EBIT 1,791 2,230 2,554 3,241 3,893



Adjusted PBT 1,723 2,144 2,493 3,250 3,933

Tax 535 617 723 910 1,062

Adjusted PAT 1,188 1,527 1,770 2,340 2,871

% growth 18.0% 28.5% 15.9% 32.2% 22.7%

Reported PAT after minority interest 1,190 1,519 1,750 2,305 2,829


Consolidated Balance Sheet Statement Year to March (̀ mn) FY13 FY14 FY15E FY16E FY17E



Total net worth 6,254 7,285 8,440 9,972 11,850

Debt 1,314 768 768 568 368


Gross block 7,507 8,368 9,368 10,068 11,268

Net block 5,554 6,042 6,592 6,809 7,468

Cash & cash equivalents 258 89 330 1,423 2,154

Debtors 1,648 1,679 1,847 2,168 2,508

Inventory 2,672 3,295 3,844 4,039 4,692

Loans & advances 305 428 459 508 606

Total current assets 5,800 6,468 7,634 9,433 11,491

Total current liabilities 4,047 4,603 5,164 5,848 6,888


Total assets 7,850 8,369 9,524 10,855 12,534


Rallis India


Cash Flow Statement


Net profit before tax 1,723 2,144 2,493 3,250 3,933

Depreciation 315 407 450 483 541

Others 103 71 61 (9) (40)

Tax (360) (591) (723) (910) (1,062)

(Incr)/decr in net working capital (333) (274) (364) (21) (288)

Cash flow from operations 1,447 1,756 1,917 2,793 3,084

Capex (net) (349) (584) (1,000) (700) (1,200)

(Incr)/decr in investments 34 (76) - - -

Other income (expenditure) (84) (99) 69 76 87

Cash flow from investments (399) (759) (931) (624) (1,113)

Net borrowings (227) (546) - (200) (200)

Interest paid (179) (124) (130) (67) (47)

Dividend paid (496) (521) (614) (809) (993)

Cash flow from financing (899) (1,191) (744) (1,076) (1,240)

Net change in cash 149 (194) 241 1,093 731

Free cash flow (before investments) 1,098 1,172 917 2,093 1,884


Ratio Analysis

Year to March FY13 FY14 FY15E FY16E FY17E

PBT marigin (%) 12.0% 12.4% 12.8% 14.3% 14.9%

Net profit margin (%) 8.3% 8.8% 9.1% 10.3% 10.9%

Dividend payout ratio (%) 37.6% 30.7% 30.0% 30.0% 30.0%

Net debt: equity (x) 0.14 0.06 0.02 (0.11) (0.17)

RoCE (post-tax) (%) 20.3% 21.6% 21.9% 24.5% 25.9%

RoIC (%) 17.9% 21.6% 22.8% 27.1% 31.0%

RoE (%) 20.2% 22.8% 22.8% 25.8% 26.8%

Working Capital Turnover (x) 22 17 16 17 19

Gross Block Turnover (x) 2.0 2.2 2.2 2.3 2.5


Valuation Parameters Year to March FY13 FY14 FY15E FY16E FY17E

EPS (Rs) 6.1 7.8 9.0 11.9 14.5

Diluted EPS (Rs) 5.9 7.8 9.0 11.9 14.5

Book value per share (Rs) * 31.9 36.9 42.8 50.4 59.9

Dividend per share (Rs) 2.3 2.4 2.7 3.6 4.4

P/E (x) 37.9 28.5 24.8 18.8 15.3

P/BV (x) 7.0 6.0 5.2 4.4 3.7

EV/EBITDA (x) 25.2 20.1 17.7 14.3 12.0

EV/EBIT (x) 29.7 23.8 20.8 16.4 13.6

EV/Sales (x) 3.6 3.0 2.7 2.3 2.0


A recovery play? Insecticides India (IIL) has aggressively expanded its manufacturing capacities and hence revenues but its cash flows and RoCEs have been sub-par and have relatively lagged its peers for the last few years. To re-rate as a quality play in the Indian agrochemicals space, IIL will have to: (1) improve its working capital; (2) build a contract manufacturing business from scratch; and (3) improve its gross margins through a higher revenue share of in-licensed molecules. IIL is showing signs of improvement, with improving utilisation of the Dahej facilities and good offtake for its recently in-licensed products such as Hakama and Pulsor; the stock is trading at 12.5x FY16 consensus EPS, a 40% discount to its peers. Convergence of this discount requires better margins/cash flows.

Competitive position: MEDIUM Changes to this position: POSITIVE Emerging player with a wide portfolio but not a strong portfolio or recall! On our framework, IIL is weak on every parameter, despite posting 23% revenue CAGR (1.7x that of sector) over FY10-14; whilst new launches and entry into B2B technical sales brought revenues, its business model has still not become strong. IIL has an extensive portfolio of 120 products across insecticides, herbicides, and fungicides but 90% of its revenues are from generic molecules. Its pan-India network of over 4,800 distributors/60,000 dealers needs better products. Fast growing but no credible cash generation and declining RoCE Poor cash conversion (pre-tax CFO/EBITDA) of 26% over FY10-14 due to rising working capital led to weaker RoCEs (~13% in FY14). Alongside, IIL undertook an aggressive capex of ~`2.4bn (nearly 85% of the current gross block, 6.5x of cumulative CFO over FY08-14) to build capacities in Dahej and an R&D facility in Chopanki, which have raised debt:equity to 1:1, the highest leverage amongst its peers. Poor gross margins and poor working capital could keep RoCE low.

In-licensed products, improving Dahej utilisation offer hope The company entered into a tie-up with Nissan Chemicals for two products—‘Hakama’ and ‘Pulsor’. ‘Hakama’ is a selective herbicide (exclusive tie-up) and ‘Pulsor’ is a patented fungicide. Hakama has the same technical as Targa Super (Dhanuka’s blockbuster product). In addition, to boost R&D capabilities, it has entered into a JV with OAT Agrio, Japan. IIL is also improving the utilisation of the Dahej facility (where IIL intends to build its CRAMS business) which will aid in margin expansion and in turn RoCE improvement.

Consensus EPS CAGR of 41% over FY14-17 Consensus expects an EPS CAGR of 41% driven by revenue growth of 19%, EBITDA margin expansion of ~300bps, and decreasing interest payouts. Whilst revenue growth is possible, we are skeptics of a major EBITDA margin expansion and cash flow generation. Consistent margin expansion and gradual debt reduction are the key things to watch out; 1HFY15 offers no signs yet.

VISIT NOTE INST IN EQUITY November 21, 2014

Insecticides IndiaNOT RATED

Key financials – Rising scale, stagnant margins and declining RoCEs

Year to March (̀ mn) FY10 FY11 FY12 FY13 FY14

Net Sales 3,774 4,501 5,218 6,167 8,641

EBITDA 353 436 564 693 818

EBITDA (%) 9.3% 9.7% 10.8% 11.3% 9.5%

EPS (`) 22 25 26 28 31

RoCE (%) 23.3% 19.8% 16.3% 13.0% 13.1%

RoE (%) 24.9% 22.9% 19.6% 17.9% 17.4%

P/E (x) 32.1 28.1 27.4 25.6 22.7


Analyst Details

Ritesh Gupta +91 22 3043 3242 [email protected]

Agro Chemicals

Recommendation NOT RATED Mcap (bn): `8.96/US$0.15 3M ADV (mn): `45.5/US$0.7 CMP: `792

Flags Accounting: RED Predictability: AMBER Earnings Momentum: GREEN

Performance


2000022000240002600028000

200375550725900

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Insecticide SENSEX (RHS)

Insecticides India


Background - Young and fast-growing Insecticides (India) (IIL), an insecticides manufacturer headquartered in Delhi has four formulation plants in Chopanki (Rajasthan), Udhampur (J&K), Samba (J&K) and Dahej (Gujarat) and has two technical synthesis plants at Chopanki (Rajasthan) and Dahej (Gujarat); its R&D Centre is based out of Chopanki in Rajasthan. Whilst IIL has a presence across India, the north and south are its primary markets.

IIL has an extensive portfolio of 120 products, constituting of insecticides, herbicides, fungicides and Plant Growth Regulators (PG`) among others. The company has nine key brands: Lethal, Victor, Thimet, Hakama, Pulsor, Monocil, Hijack, Xplode and Nuvan. Its pan-India presence is through its extensive network of over 4,800 distributors and more than 60,000 dealers. Over FY10-14, the company’s sales and profits have recorded a CAGR of 23% (1.7x of sector average) and 14% respectively primarily led by new launches, entry into B2B technical sales and a relatively smaller scale.

Growing through partnerships with global innovators

The company has entered into multiple tie-ups with global innovators to increase the share of in-licensed molecules in its product portfolio. Of the total revenue, 78% is contributed by formulations and 22 % by technical actives.

Exhibit 1: Tie-ups with different global partners

Global Partner Purpose for tie-ups

AMVAC, Netherlands A technical collaboration agreement to manufacture and market its products - Thimet and Nuvan - in India.

Nissan Corporation, Japan To manufacture and market two of its specialised molecules in the Indian markets. Molecules are branded as Hakama and Pulsor.

OAT Agri Co., Japan A joint venture (JV) to set up a R&D facility focusing on discovery of new innovative agrochemical molecules.


The company has aggressively added to its capacities in the recent past, adding about 85% of its current gross block over the last four years.

Exhibit 2: Capex funded from CFO and debt; some respite in leverage in FY14


Exhibit 3: Gross block (` mn) growing at a fast pace, gross block turnover has declined due to additional capex


0.07

0.20

0.74

0.92

0.90

-

0.20

0.40

0.60

0.80

1.00

(600)

(400)

(200)

-

200

400

600


Capex CFO net debt:equity (x)

13

14 11

6 5

4

6

8

10

12

14

200

500

800

1,100

1,400

1,700

2,000

2,300


Gross block Gross block t/o (RHS) (RHS)

Insecticides India


Evolving into a quality generics player Insecticides (India) Limited has a product portfolio of more than 120 products, with five leading brands namely Lethal, Victor, Thimet, Monocil and Nuvan; Thimet and Monocil contributed to 14% of revenues in FY14. Over the years, IIL has evolved from a mere trading player to an R&D-focused agrochemicals player.

2001-2005: Establishment and stepping up manufacturing capabilities

Mr Hari Chand Aggarwal (the current Board Chairman) registered the company in 1996 but the company started its operations in 2001. Commercial production started in March 2002 at the company’s Chopanki unit in Rajasthan. It acquired a relatively established pesticides brand from Montari Agrochem (a Ranbaxy group company) in 2003. With growing demand, it commissioned a second formulation plant in Samba (Jammu) which was in a special tax benefit zone in 2004. In 2005, the company also set up an R&D laboratory in Chopanki for reverse engineering of generic molecules.

2006-2012: Consolidation as its branded generics business

In order to boost its margin profile, the company entered into the in-licensing of innovative molecules with the launch of Thimet in collaboration with AMVAC (2006). The company raised `369mn through an IPO in 2007 to expand its capacities and R&D facilities; its technical manufacturing plant commenced its operations in the same year. In 2011, two new formulation plants in Dahej and Udhampur commenced operations. The company also launched a new product, Nuvan, in collaboration with AMVAC In 2012.

2012-2014: Entry into the R&D-led specialised molecules segment

The company had a presence in generics and was doing fairly well but the management realised that the margin profile and capital returns were mediocre. Like other top-rung Indian generic players, the company entered into a tie-up with Nissan Chemicals for an exclusive marketing tie-up of two products. One of the two products ‘Hakama’ is a selective herbicide whilst the other one ‘Pulsor’ is a patented fungicide. ‘Pulsor’ is an exclusive tie-up with IIL whilst ‘Hakama’ was provided by Nissan to Dhanuka Agritech (branded as Targa Super). In order to boost its R&D capabilities, it entered into a JV with OAT Agri, Japan, for the invention of new agricultural chemicals; in 2013, its technical plant commenced operations in Dahej.

Exhibit 4: Insecticides India – Key products and revenue contribution

Product Name Generic Name Launch Type Revenue Contribution Application

Thimet Phorate 10% CG FY07 Insecticide 8% Thimet is used for control of chewing as well as sucking insects on a wide range of food crops, oil seeds, pulses, fibre crops, and horticulture crops.

Monocil Monocrotophos 36% SL FY12 Insecticide 6% Monocil is a generic insecticide used for a broad spectrum of pests in a wide range of crops.

Nuvan Dichlorvos 76% EC (DDVP) FY13 Insecticide 6%

Nuvan is a widely used generic insecticide to control household pests, and protect stored products from insects. It is effective against mushroom flies, aphids, spider mites, caterpillars, thrips, and whiteflies in greenhouse, outdoor fruit, and vegetable crops.

Hijack Glyphosate 41% SL FY10 Herbicide 4% Hijack is a widely used variant for Glysophate herbicide.

Lethal Chlorpyriphos 50% EC FY06 Insecticide 4% Lethal works on controlling sucking and chewing insects on cotton. It also helps in controlling insects in paddy & vegetables.

Victor Imidacloprid 17.8% SL FY06 Insecticide 3% Victor comprises active ingredient Imidacloprid which is used for controlling sucking pests, hoppers and termites in cotton, paddy, vegetables and sugarcane.

Hakama Quizalofop-ethyl 5% E.C. FY13 Herbicide 2% Hakama is a selective herbicide for grassy weeds (narrow leaf weeds) used in broad leaf crops like soybean, cotton, groundnut, blackgram, onion, jute and mentha.

Racer Pretilachlor 50% EC FY05 Herbicide 2% Racer is a biological insecticide used in organic agriculture.

Pulsor Thifluzamide 24% SC FY13 Fungicide 1% Pulsor is a selective post emergent herbicide for the control of a wide range of broadleaf weeds in cereals, clover, new pasture and peas.


Insecticides India


Revenue growth impressive but poor cash flow conversion and RoCEs IIL’s growth rates are one of the best in the industry, with ~ 28% revenue CAGR over the last 6 years vs the industry average of ~18% driven by new launches, entry into B2B actives sales, and expanded distribution.

Exhibit 5: India domestic agrochemicals growth rates (in ̀ mn)

FY08 FY09 FY10 FY11 FY12 FY13 FY14 6 Year CAGR

BASF India Ltd - Agri 3,702 3,277 4,863 6,309 7,914 9,229 10,448 19%

Bayer CropScience - Agrochem 6,421 9,825 11,599 13,255 14,207 16,283 20,450 21%

Bayer CropScience - Actives 1,251 1,657 1,029 3,992 4,634 5,543 6,292 31%

Dhanuka Agritech Ltd. 2,486 3,368 4,081 4,910 5,292 5,823 7,384 20%

Excel Crop Care Ltd. 5,342 7,009 6,486 7,394 6,950 7,791 9,841 11%

Gharda Chemicals Ltd. 8,433 8,433 8,948 9,864 10,583 11,591 11,591 5%

Insecticides (India) Ltd. 1,976 2,637 3,774 4,501 5,218 6,167 8,641 28%

Meghmani Organics Ltd. 6,001 7,914 8,163 10,451 10,622 10,585 11,783 12%

Nagarjuna Agrichem Ltd. 4,148 6,054 6,529 5,701 6,431 6,006 6,358 7%

PI Industries Ltd. – Domestic Business 3,703 4,057 4,140 5,800 6,133 6,869 8,860 16%

Rallis India Ltd. – Domestic Pesticide Business 5,002 6,052 7,323 8,421 8,181 8,835 10,161 13%

Sabero Organics Gujarat Ltd. 2,073 3,773 4,303 4,108 3,584 5,148 7,240 23%

Syngenta India Ltd. 11,927 13,802 17,553 20,771 25,399 29,617 30,686 17%

UPL Ltd. - India 8,011 10,326 11,970 14,940 17,190 18,050 22,710 19%

Agrochemicals 70,475 88,184 100,761 120,417 132,338 147,538 172,445 16%


Further, IIL’s operating cash flows have been significantly weaker than peers and on an absolute level as well. FY14 was a good year driven by the good monsoons; however, FY15 will likely be another challenge, with weaker offtake putting pressure on working capital.

Exhibit 6: But operating cash flows have been weak (in ` mn)


Poor cash flow conversion, worst amongst the peers IIL’s working capital is significantly stretched and is next only to Dhanuka Agritech. The company’s inventory days are the highest across the industry, leading to significantly lower cash conversion as measured by CFO/EBITDA. The company has had very poor conversion of pre-tax CFO to EBITDA of just 27% vs the peer average of 83%.

-7%

59%

7%44%

4%

110%

-48%

14%

56%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

(400)

(300)

(200)

(100)

-

100

200

300

400

500


CF from Operations pre tax CFO/EBITDA

Insecticides India


Exhibit 7: Pre-tax CFO as a percentage of EBITDA

Company/Metric Pre-tax CFO as a % of EBITDA

5-year average FY10 FY11 FY12 FY13 FY14

Insecticides (India) Ltd. 5.0% 110.0% -48.0% 14.0% 56.0% 27.4%

Peers Bayer CropScience Ltd. 71.0% 80.0% 72.0% 72.0% 105.0% 82.5%

Dhanuka Agritech Ltd. 48.0% 2.0% 91.0% 73.0% 46.0% 52.0% PI Industries Ltd. 114.0% 33.0% 102.0% 77.0% 101.0% 87.4% Rallis India Ltd. 169.0% 80.0% 66.0% 86.0% 89.0% 95.0%

Syngenta India Ltd. 37.0% 66.0% 51.0% 31.0% 139.0% 69.2%

Peer group Median 71.0% 66.0% 72.0% 73.0% 101.0% 82.5%

Divergence from Median -66.0% 44.0% -120.0% -59.0% -45.0% -55.1%


High inventory days make the cash conversion poor

IIL’s inventory day at 113 days in FY14 was one of the weakest amidst its peers. Our channel checks suggest that IIL has been aggressive in sales, which has led to pressure on working capital with higher sales returns. The company did improve its cash conversion cycle in FY14 (which was a good year for farmers and for companies); a bad year like FY15 will create further challenges on working capital for the company.

Exhibit 8: Cash conversion cycle; relatively better in debtor days but poor in inventory days



Bayer 43 45 40 42 70 78 69 61 59 55 32 28 54 68 78 75

Dhanuka 87 100 95 79 94 97 94 93 35 37 31 23 146 160 158 149


Kaveri Seeds 60 32 25 24 229 229 204 180 203 230 209 178 86 31 20 26

PI Industries 71 72 69 59 62 66 67 64 70 68 75 82 62 71 61 41

Rallis 31 31 34 35 65 73 68 63 101 98 86 77 -5 6 17 22

Median 59 52 51 47 82 87 82 79 84 83 80 79 61 69 69 55


In the business which inherently generates lower margins and in turn weaker cash flows, operating cash flows take a further hit to fund the expanding inventory base and receivables.

Exhibit 9: Working capital changes eat up most of the cash flows (` mn)

FY10 FY11 FY12 FY13 FY14 Cumulative % of OCF

CFO Before Working Capital Changes 356 439 566 628 711 2,700 100%

Working capital changes (340) 40 (839) (534) (251) (1,925) -71%

Inventory (217) (77) (766) (229) (863) (2,153) -80%

Debtors (303) (172) (86) (273) (114) (947) -35%

Other Current Assets (122) 20 (171) (63) (124) (460) -17%

Short Term Loans & Advances - - - (187) 4 (183) -7%

Long Term Loans & Advances - - - (23) 9 (14) -1%

Sundry creditors 313 224 190 122 729 1,578 58%

Other Current Liabilities 5 - - 117 107 229 8%

Provision for Expenses (17) 45 (6) 1 2 26 1%

CFO After Working Capital 16 478 (273) 94 460 776 29%


Insecticides India


Low cash generation led to large debt intake for expansions The company has incurred a capex of ~` 2.4bn over the last six years which is largely debt-funded (75%) and partly equity-funded (12%). Weaker operating cash flows (contributing just 12% to overall funds source, see Exhibit 10) are a cause for concern. Note that 15% of the total cash flow generated was used in the payment of interest, which means operating cash flows were not even enough to pay the interest.

Exhibit 10: Source of cash


Exhibit 11: Application of cash


DuPont analysis – Low margins the main reason for declining RoEs

Insecticides India’s RoEs are lower than the peer average despite its higher financial leverage. This is largely because of the lower and declining PAT margins from a mix of: (1) weaker pricing power of its products; and (2) lower utilisation of capacity. The company’s total asset turnover is good but has been impacted slightly over recent years due to lower utilisation at the new capacity in Dahej.

Exhibit 12: DuPont Analysis

Company Matrix/Matrix ROE % PAT Margin % Total Asset turnover (x) Financial leverage (x)


Insecticides (India) Ltd. 19.6% 17.9% 17.4% 6.3% 5.7% 4.6% 2.0 1.6 1.9 1.0 1.6 1.4

Bayer CropScience Ltd. 15.0% 21.2% 23.3% 6.1% 9.7% 8.9% 1.6 1.4 1.8 1.0 1.0 1.0

Dhanuka Agritech Ltd. 29.7% 27.0% 31.3% 10.8% 11.1% 12.6% 1.4 1.4 1.6 1.1 1.0 1.0

PI Industries Ltd. 30.2% 22.7% 31.2% 9.3% 8.5% 12.0% 1.2 1.2 1.4 1.1 1.2 1.1

Rallis India Ltd. 19.0% 20.3% 22.8% 8.8% 7.9% 8.8% 1.9 1.9 2.1 1.1 1.1 1.1

Syngenta India Ltd. 16.5% 20.5% 17.7% 6.6% 8.3% 8.3% 1.4 1.4 1.3 1.0 1.0 1.0

Peer group Median 19.0% 21.2% 23.3% 8.8% 8.5% 8.9% 1.4 1.4 1.6 1.1 1.0 1.0

Divergence from Median 0.6% -3.2% -5.9% -2.4% -2.7% -4.3% 0.6 0.2 0.3 -0.1 0.5 0.3


Significant capacity expansion leading to idle capacities Insecticides India has aggressively added new capacities in Dahej. The company undertook an ambitious `2bn expansion over the last four years (2010-2014). At present, the company has the capacity to produce 59,250MTs of formulations and 11,800MTs of technical products. It has also set up a new R&D facility in Dahej for a JV with Otsuka which is likely to become operational in FY15. Currently, the overall utilisation rates of the Dahej facility is ~35% and the management expects the utilisation rates to go up to 75% over the next 12-14 months.

CF from Operations,

12%

Interest & Dividend

Income, 1%

Increase in Debt, 75%

Equity Raising ,

12%

Net Capex, 73%

Interest Paid, 15%

Dividend Paid, 6%

Change in Cash , 2%

Investments, 3%

Insecticides India


Exhibit 13: Significant addition in gross block has created idle capacities (` mn)


Our view: Improving capacity utilisation in a profitable manner will be a challenge In order to improve the cash flow generation quality, the company would have to improve the utilisation of its idle capacities. Secondly, there is a growing structural demand for contract research and manufacturing from India; whether IIL is able to profitably capture on that opportunity is yet to be seen.

The CRAMS business is not an easy business to build in a short duration; it took PI Industries more than 10 years (1995-2008) to build a CRAMS business that could have a sizable profitable impact of CRAMS on its P&L. Even one of our primary data sources working with a leading Indian agrochem company suggested that whilst Rallis is trying to build a CRAMS business, it would take Rallis some years to build a quality franchise which garners a healthy margin business. The quick option with IIL in that case would be to improve the utilisation levels with the lower-margin generics manufacturing business and benefit from operating leverage without any major improvement in gross margins.

Mr. Rajesh Aggarwal, MD of the company says: “Insecticides (India) Ltd., since its commencement, has been working on enhancing its manufacturing capabilities. Automated plants and machines with least human touch has been a characteristic of its plants. The Company has successfully made itself ready with its technical synthesis capacities that provide the wide range of technical with the multi stream facilities.

Today with 4 state-of-the-art formulation facilities, IIL is spearheading to become one of the largest formulation capacities in the industry. IIL is equipped with capacity for CRAMS and Contract Manufacturing and is looking for more such suitable opportunities to grow and enhance its market viability. All the international tie-ups that it has been doing are strategically in line with the long-term objectives of making its mark in the industry and emerging as a leader in its segment. Its technical plants are capable of running 10 different streams of technical synthesis at relative ease.”

-

5

10

15

20

-

500

1,000

1,500

2,000


Gross Block (in Rs mn) Gross Block Turnover (RHS)

Insecticides India


Entry into licensed products to drive margin expansion IIL historically has been largely involved in the branded generics space; however, over the last 2-3 years, it has focused on getting in-licensed molecules from global innovators.

In 2012, IIL in-licensed two molecules, Hakama and Pulsor, from Nissan Chemicals (Japan) for marketing in India and it also entered in a technical collaboration with US-based American Vanguard Corporation (AMVAC) for the manufacturing and marketing of its product (NUVAN) in India. IIL also acquired the MONOCIL brand from Nocil in 2012.

Low operating margin challenges The challenge on operating margins for IIL is two-fold: (1) structurally lower gross margins at 30% vs peer average of 40% despite well-integrated manufacturing; and (2) higher fixed overheads due to significant addition in new capacities which are significantly under-utilised as of now.

Our understanding of the industry and our channel checks combined suggest that: (1) the company, in pursuit of growing its revenues at a rapid pace, offered higher discounts; (2) the share of high-value specialised molecules has been low, given the company’s historical focus on branded generics; and (3) most of the product portfolio of IIL falls under the me-too category.

Lower gross margins are a structural challenge in margin recovery for IIL

The company’s gross margins are the lowest amongst its peers (lower by ~1,000-1,200bps) due to the lower pricing power for its products, in our view. Bayer’s gross margins are lower because it does not manufacture 80% of its products and compensates it by lower depreciation charges. However, IIL manufactures most of its products, which clearly indicates a pricing problem.

Exhibit 14: Gross margin Company/Matrix FY10 FY11 FY12 FY13 FY14

Insecticides (India) Ltd. 28.7% 31.5% 31.4% 32.8% 30.4%

Peers Bayer CropScience Ltd. 35.5% 33.2% 30.6% 33.9% 33.3%

Dhanuka Agritech Ltd. 42.1% 45.4% 46.2% 44.6% 46.7%

PI Industries Ltd. 41.3% 41.6% 44.0% 41.4% 42.4%

Rallis India Ltd. 42.9% 38.2% 42.9% 40.3% 42.8%

Syngenta India Ltd. 37.5% 35.0% 34.3% 39.5% 41.4%

Peer group Median 41.3% 38.2% 42.9% 40.3% 42.4%

Divergence from Median -12.6% -6.7% -11.5% -7.5% -12.0%


Exhibit 15: Gross margins have been on a downward trend despite new launches


37.4%36.4% 35.9%

33.1%

28.7%

31.5% 31.4%32.8%

30.4%


Insecticides India


Financial assumptions We believe IIL’s 1H numbers are on track to meet consensus expectations for FY15. However, working capital and rising debt continue to remain a concern. IIL’s working capital witnessed a 49% increase in 1HFY15 on a y/y basis with just 22% growth in sales due to significant increase in inventory.

Debt too has increased largely due to rising working capital (w/o much increase in fixed assets) from 0.9x at FY14 end to 1.1x at 1HFY15 end.

Exhibit 16: IIL’s 1HFY15 results summary (` mn)

1HFY15 1HFY14 Y/Y

Sales 6,544 5,380 22%

EBITDA 695 504 38%

PAT 403 280 44%

Gross Margin (%) 32% 29% 300bps

EBITDA Margin (%) 11% 9% 200bps

Working Capital 30 Sep'14 30 Sep'13 Y/Y

Payables 3,462 2,855 21%

Inventory 3,661 2,357 55%

Receivable 3,431 2,927 17%

Net Working Capital 3,630 2,429 49%

Debt Situation 30 Sep'14 31 Mar'14

Debt 3,222 2,426

Equity 2,862 2,466

Cash 27 90

D/E 1.1 0.9

Source: Company data, Ambit analysis

Exhibit 17: Consensus estimates for IIL

Particulars (̀ in mn unless mentioned) FY14 FY15E FY16E FY17E

Change (%)

FY15E FY16E FY16E

Financials Net Sales 8,641 10,600 12,756 14,367 23% 20% 13%

Adjusted EBITDA 837 1,139 1,476 1,776 36% 30% 20% Adjusted EBITDA margin (%) 9.7% 10.7% 11.6% 12.4% 105 bps 82 bps 79 bps

Depreciation 67 125 141 137 88% 12% -2%

PAT 399 599 845 1,133 50% 41% 34%

PAT margin (%) 4.6% 5.6% 6.6% 7.9% 102 bps 98 bps 126 bps Cash Flow Parameters CFO 771 1,014 1,335 1,639 32% 32% 23%

Capex (462) (250) (250) (250) -46% 0% 0%

FCF (242) 334 365 583 -238% 9% 60%

Profitability Ratios EPS 31.5 47.2 66.7 89.3 50% 41% 34%

RoE 17% 22% 25% 26% 439 bps 310 bps 150 bps

BVPS 194 238 298 378 22% 25% 27%


Insecticides India


Relative valuation IIL trades at 13x FY16 consensus estimates (a 35% discount to its peers) primarily due to weaker RoEs and poor cash conversion vs peers historically. The stock has seen a significant re-rating over recent months driven by increased consensus expectations on earnings recovery and strong 1HFY15 P&L performance by the company. We believe future performance of the stock would be driven by continued earnings delivery aided by margin improvement, reduction in working capital and debt on the books. The 1HFY15 performance was good on account of the P&L; however, the working capital cycle and debt both increased, raising concerns on the sustainability of such earnings growth.

Exhibit 18: Comparative valuation sheet

Company Name

Market Cap (USD

mn)

ADVT - 6m

(USD mn)

P/E P/B EV/EBITDA ROE CAGR (FY14-FY17)

FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E Sales EBITDA EPS

Global Agri Majors

Monsanto 58,055 7.3 20.4 17.6 15.2 7.4 6.2 4.8 12.5 11.3 9.9 36.1 40.7 40.3 6.1% 10.2% 11.2%

Dow Chemicals 60,602 7.1 17.4 14.8 12.6 2.3 2.2 2.0 8.8 8.4 7.6 14.4 16.5 17.8 2.9% 14.6% 0.1%

FMC Corp 7,467 1.4 14.3 12.7 11.2 4.4 3.6 3.2 10.1 8.9 8.1 31.8 30.1 32.0 7.4% 12.6% 31.2%

Syngenta 30,962 1.4 16.9 15.2 13.6 2.9 2.7 2.5 12.3 11.2 10.0 17.2 18.1 19.0 4.0% 6.5% 10.0%

Bayer AG 118,311 3.2 18.8 16.5 14.6 4.1 3.7 3.3 11.5 10.2 9.3 21.7 20.8 21.6 5.7% 5.6% 26.9%

BASF 81,884 3.4 12.8 12.1 11.2 2.3 2.1 2.0 7.7 7.4 7.0 18.2 17.9 18.0 -2.5% 4.2% 6.3%

Domestic Agro Chemical Players

PI Industries 974 1.1 23.9 18.4 14.5 6.9 5.3 4.1 16.3 12.7 9.8 30.0 30.4 29.8 20.4% 25.2% 26.8%

Rallis India 700 1.7 25.3 19.2 15.7 5.3 4.5 3.8 14.4 11.3 9.3 22.8 25.8 26.8 15.1% 18.9% 22.9% Bayer CropScience 1,817 1.0 31.9 26.7 19.5 5.4 4.6 3.7 21.3 17.9 13.8 18.7 18.5 20.6 17.6% 23.0% 25.8%

UPL Ltd 2,445 10.6 12.8 10.9 9.7 2.4 2.1 1.8 7.8 6.9 6.4 20.1 19.8 19.1 10.7% 10.6% 17.1% Dhanuka Agritech

457 0.6 26.1 20.9 16.4 6.8 5.5 4.3 19.7 15.6 12.5 28.4 28.4 28.1 19.6% 23.7% 22.7%

Insecticides India 178 0.9 18.4 13.0 9.7 3.6 2.9 2.3 12.5 9.6 8.0 21.8 24.9 26.4 18.4% 28.5% 41.6%

Excel Crop Care

203 0.3 12.9 10.9 DNA 3.6 3.0 DNA 8.5 7.3 DNA 27.8 27.4 DNA DNA DNA DNA

Domestic Seeds Players

Kaveri Seeds 1,058 3.1 21.7 17.4 13.9 8.7 6.2 4.6 20.6 16.8 13.7 46.5 40.8 37.3 21.2% 28.2% 31.2%

Monsanto India 805 2.6 31.2 24.5 20.0 10.1 7.9 7.6 27.2 21.7 18.1 36.4 36.2 42.3 18.4% 21.8% 26.5%

Source: Company, Ambit Capital research, Consensus; Note: DNA= Data Not Available

Insecticides India


Cross-cycle valuation Insecticide currently trades at 14x one-year forward, re-rating significantly since March 2014, higher than its five-year average P/E of 10x. In FY09-11 too the company saw significant re-rating and then again was de-rated due to a continued dip in RoCEs.

In order to re-rate as a quality play in the Indian agrochemicals space, the company will have to: (1) improve its working capital; (2) build a contract manufacturing business from scratch; and (3) improve its gross margins through a higher revenue share of in-licensed molecules.

Exhibit 19: IIL’s P/E has significantly re-rated in anticipation of improved growth outlook


Exhibit 20: ….and so has its EV/EBITDA


Exhibit 21: But RoEs have been on a downward trend


Exhibit 22: … and so have RoCEs


-

4

8

12

16

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14


3

5

7

9

11N

ov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14

One-yr fwd EV/EBITDA 5-yr avg EV/EBITDA

25%23%

20%

18%

17%

36%

14%

2%7%

13%

0%

10%

20%

30%

40%

10%

15%

20%

25%

FY10

FY11

FY12

FY13

FY14

ROE % PAT GROWTH %

23%

20%

16%

13% 13%9%

10%

11%

11%

9%

8%

9%

10%

11%

12%

10%

15%

20%

25%

FY10

FY11

FY12

FY13

FY14

ROCE % EBITDA margin % (RHS)

Insecticides India


Exhibit 23: One-year forward P/B has also recovered




Accounting RED The company ranks in the bottom quartile of our accounting frame work due to poor cash conversion, poor capital allocation, and relatively lesser known auditors

Predictability AMBER Predictability is low as the company’s margin performance has been quite volatile

Earnings momentum GREEN Consensus earnings have seen upgrades post a good 1HFY15 results


-

1

2

3

4

Nov-09

Mar-10

Jul-10

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

Jul-12

Nov-12

Mar-13

Jul-13

Nov-13

Mar-14

Jul-14

Nov-14


Insecticides India


Balance sheet




Total net worth 1,262 1,547 1,822 2,122 2,466

Debt 219 343 1,534 2,001 2,426

Deferred tax liability 17 20 29 102 133


Gross block 292 365 584 1,530 1,896

Net block 255 314 513 1,403 1,706

CWIP 71 592 920 449 537

Investments (non-current) 50 - - - 111

Cash & cash equivalents 87 37 178 47 90

Debtors 634 806 892 1,165 1,279

Inventory 1,181 1,258 2,024 2,254 3,117

Loans & advances 260 307 531 779 710

Total current assets 2,297 2,528 3,771 4,469 5,560

Current liabilities 1,051 1,350 1,547 1,847 2,724

Provisions 124 174 272 250 165

Total current liabilities 1,175 1,524 1,818 2,097 2,889


Total assets 1,498 1,911 3,385 4,225 5,025


Income statement Year to March (̀ mn) FY10 FY11 FY12 FY13 FY14

Net Sales 3,774 4,501 5,218 6,167 8,641

% growth 43.3% 19.3% 15.9% 18.2% 40.1%


EBITDA 353 436 564 693 818

% growth 32.6% 23.8% 29.2% 23.0% 18.0%

Depreciation 12 15 24 58 67

EBIT 341 421 540 635 751



Adjusted PBT 328 413 429 464 487

Tax 46 90 99 111 87

Adjusted PAT 282 322 330 353 399

% growth 35.9% 14.2% 2.5% 7.0% 13.1%

Reported PAT after minority interest 282 322 330 353 399


Insecticides India


Cash flow statement


Net profit before tax 328 413 429 464 487

Depreciation 12 15 24 58 67

Others 17 11 110 106 158

Tax (36) (104) (83) (107) (84)

(Incr)/decr in net working capital (340) 40 (839) (534) (251)

Cash flow from operations (19) 374 (359) (13) 377

Capex (net) (87) (597) (551) (467) (459)

(Incr)/decr in investments 122 50 - - (111)

Cash flow from investments 47 (545) (550) (465) (567)

Net borrowings 81 161 1,198 503 437

Interest paid (25) (10) (111) (119) (159)

Dividend paid (30) (30) (37) (37) (45)

Cash flow from financing 26 122 1,049 347 234

Net change in cash 54 (49) 140 (131) 43


Ratio analysis

Year to March FY10 FY11 FY12 FY13 FY14

PBT Margin (%) 8.7% 9.2% 8.2% 7.5% 5.6%

Net prof. (bef min int) margin (%) 7.5% 7.2% 6.3% 5.7% 4.6%

Dividend payout ratio (%) 9% 10% 10% 11% 10%

Net debt: equity (x) * 0.07 0.20 0.74 0.92 0.90

RoCE (pre-tax) (%) 23% 20% 16% 13% 13%

RoIC (%) 27% 26% 24% 16% 16%

RoE (%) 25% 23% 20% 18% 17%

Working capital turnover 5.8 6.1 5.0 4.2 5.3

Gross block turnover 13 14 11 6 5

Source: Company, Ambit Capital research, Note: * excluding revaluation reserve

Valuation parameters

Year to March FY10 FY11 FY12 FY13 FY14

Diluted EPS (`) 22.3 25.4 26.0 27.9 31.5

Book value per share (`) * 99.52 122.01 143.63 167.33 194.40

Dividend per share (`) 2.00 2.50 2.50 3.00 3.00

P/E (x) 32.1 28.1 27.4 25.6 22.7

P/BV (x) 7.2 5.9 5.0 4.3 3.7

EV/EBITDA (x) 25.7 20.8 16.1 13.1 11.1

EV/EBIT (x) 26.6 21.5 16.8 14.3 12.1

EV/Sales (x) 2.4 2.0 1.7 1.5 1.0

Source: Company, Ambit Capital research, Note: * excluding revaluation reserve

Insecticides India


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Aditya Bagul Consumer (022) 30433264 [email protected]

Aditya Khemka Healthcare (022) 30433272 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) 30433202 [email protected]

Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Real Estate (022) 30433205 [email protected]

Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Retail (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Midcaps – Chemical / Retail (022) 30433242 [email protected]

Ritesh Vaidya Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Sandeep Gupta Media / Midcaps (022) 30433211 [email protected]

Tanuj Mukhija, CFA E&C / Infra / Industrials (022) 30433203 [email protected]

Utsav Mehta Technology (022) 30433209 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction

Insecticides India


Explanation of Investment Rating Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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6. This Research Report is issued for information only and should not be construed as an investment advice to any recipient to acquire, subscribe, purchase, sell, dispose of, retain any securities. Recipients should consider this Research Report as only a single factor in making any investment decisions. This Research Report is not an offer to sell or the solicitation of an offer to purchase or subscribe for any investment or as an official endorsement of any investment.

7. If 'Buy', 'Sell', or 'Hold' recommendation is made in this Research Report such recommendation or view or opinion expressed on investments in this Research Report is not intended to constitute investment advice and should not be intended or treated as a substitute for necessary review or validation or any professional advice. The views expressed in this Research Report are those of the research analyst which are subject to change and do not represent to be an authority on the subject. AMBIT Capital may or may not subscribe to any and/ or all the views expressed herein.

8. AMBIT Capital makes no guarantee, representation or warranty, express or implied; and accepts no responsibility or liability as to the accuracy or completeness or currentess of the information in this Research Report. AMBIT Capital or its affiliates do not accept any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of this Research Report.

9. Past performance is not necessarily a guide to evaluate future performance. 10. AMBIT Capital and/or its affiliates (as principal or on behalf of its/their clients) and their respective officers directors and employees may hold positions in any securities mentioned in this Research

Report (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). Such positions in securities may be contrary to or inconsistent with this Research Report.

11. This Research Report should be read and relied upon at the sole discretion and risk of the recipient. 12. The value of any investment made at your discretion based on this Research Report or income therefrom may be affected by changes in economic, financial and/ or political factors and may go down as

well as up and you may not get back the full or the expected amount invested. Some securities and/ or investments involve substantial risk and are not suitable for all investors. 13. This Research Report is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied in whole

or in part, for any purpose. Neither this Research Report nor any copy of it may be taken or transmitted or distributed, directly or indirectly within India or into any other country including United States (to US Persons), Canada or Japan or to any resident thereof. The distribution of this Research Report in other jurisdictions may be strictly restricted and/ or prohibited by law or contract, and persons into whose possession this Research Report comes should inform themselves about such restriction and/ or prohibition, and observe any such restrictions and/ or prohibition.

14. Neither AMBIT Capital nor its affiliates or their respective directors, employees, agents or representatives, shall be responsible or liable in any manner, directly or indirectly, for views or opinions expressed in this Report or the contents or any errors or discrepancies herein or for any decisions or actions taken in reliance on the Report or inability to use or access our service or this Research Report or for any loss or damages whether direct or indirect, incidental, special or consequential including without limitation loss of revenue or profits that may arise from or in connection with the use of or reliance on this Research Report or inability to use or access our service or this Research Report.

Conflict of Interests 15. In the normal course of AMBIT Capital’s business circumstances may arise that could result in the interests of AMBIT Capital conflicting with the interests of clients or one client’s interests conflicting with

the interest of another client. AMBIT Capital makes best efforts to ensure that conflicts are identified and managed and that clients’ interests are protected. AMBIT Capital has policies and procedures in place to control the flow and use of non-public, price sensitive information and employees’ personal account trading. Where appropriate and reasonably achievable, AMBIT Capital segregates the activities of staff working in areas where conflicts of interest may arise. However, clients/potential clients of AMBIT Capital should be aware of these possible conflicts of interests and should make informed decisions in relation to AMBIT Capital’s services.

16. AMBIT Capital and/or its affiliates may from time to time have investment banking, investment advisory and other business relationships with companies covered in this Research Report and may receive compensation for the same. Research analysts provide important inputs into AMBIT Capital’s investment banking and other business selection processes.

17. AMBIT Capital and/or its affiliates may seek investment banking or other businesses from the companies covered in this Research Report and research analysts involved in preparing this Research Report may participate in the solicitation of such business.

18. In addition to the foregoing, the companies covered in this Research Report may be clients of AMBIT Capital where AMBIT Capital may be required, inter alia, to prepare and publish research reports covering such companies and AMBIT Capital may receive compensation from such companies in relation to such services. However, the views reflected in this Research Report are objective views, independent of AMBIT Capital’s relationship with such company.

19. In addition, AMBIT Capital may also act as a market maker or risk arbitrator or liquidity provider or may have assumed an underwriting commitment in the securities of companies covered in this Research Report (or in related investments) and may also be represented in the supervisory board or on any other committee of those companies.

Additional Disclaimer for U.S. Persons 20. The research report is solely a product of AMBIT Capital 21. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report 22. Any subsequent transactions in securities discussed in the research reports should be effected through J.P.P. Euro-Securities, Inc. (“JPP”). 23. JPP does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports. 24. The research analyst(s) preparing the research report is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that therefore the analyst(s) is/are

not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

Additional Disclaimer for Canadian Persons 25. AMBIT Capital is not registered in the Province of Ontario and /or Province of Québec to trade in securities nor is it registered in the Province of Ontario and /or Province of Québec to provide advice

with respect to securities. 26. AMBIT Capital's head office or principal place of business is located in India. 27. All or substantially all of AMBIT Capital's assets may be situated outside of Canada. 28. It may be difficult for enforcing legal rights against AMBIT Capital because of the above. 29. Name and address of AMBIT Capital's agent for service of process in the Province of Ontario is: Torys LLP, 79 Wellington St. W., 30th Floor, Box 270, TD South Tower, Toronto, Ontario M5K 1N2

Canada. 30. Name and address of AMBIT Capital's agent for service of process in the Province of Montréal is Torys Law Firm LLP, 1 Place Ville Marie, Suite 1919 Montréal, Québec H3B 2C3 Canada.

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