fertilisers note

7/31/2019 Fertilisers Note

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ICRA Rating Services Page 1

Indian Fertiliser Industry: Subsidy policy changes to determine the industry

growth trajectory

Contacts

Anjan [email protected]+91-22-30470006

K. [email protected]

+91-44-45964301

Ankur [email protected]+91-124-4545347

Websitewww.icra.in

SUMMARY OPINION

The Indian fertiliser industry has registered a modest demandgrowth at a compounded annual growth rate (CAGR) of 5.02%over the last five-year period from FY 2004-05 to FY 2009-10.The modest demand growth along with stagnant domesticproduction led to a sharp increase in imports, reflecting aCAGR of 28.53% along the aforementioned period. ICRAexpects healthy growth in the demand for fertilisers, especially

phosphatic and other complex fertilisers, on the back ofpromotion of a more balanced nutrient consumption, with thenew nutrient-based subsidy (NBS) policy of the Government ofIndia (GoI) that is effective from 1 April 2010.ICRA expects major policy changes for urea such as the newurea investment policy; modification of the New PricingScheme (NPS)-III subsidy policy or adoption of NBS in thenear term. Subject to regulatory clarity, ICRA expects thenear-to-medium term outlook for the existing operations ofcost-efficient urea manufacturers in India to remain stable.The existing urea policy has failed to encourage investmentsin brownfield and greenfield projects because several issuesincluding rising gas prices have not been fully addressed. TheGoI is, therefore, working on new policy changes to proposeincrease in floor prices; improvement in percentagerelationships with the import parity price (IPP) and linking ofthe latter to gas prices. These changes are expected to beannounced in the near term.

Assured availability and competitive prices of natural gas arecritical for the viability of new urea projects. As for the gasallocation policy of the GoI, the urea sector has beenaccorded the highest priority. Despite the high priority in gasallocation, which provides some comfort, there is alsodependence on Regassified Liquified Natural Gas (R-LNG) forthe shortfall. The higher average price on account of risinggas prices results in higher subsidy burden for the GoI withinthe current framework. However, under the import-parity-based subsidy for new projects and eventual implementationof NBS, the price increase will have to be borne by therespective companies, thus making a negative impact on theprofitability of the fertiliser industry. The GoI is consideringimplementation of a uniform gas pricing policy (throughpooling mechanism), which would mitigate the impact ofconsumption of high-cost gas.In ICRAs view, the credit risk profiles of a few ureamanufacturers could deteriorate in the near-to-medium termand their capital structures could be under downwardpressure, if they were to finalise their large-scale, capital-

intensive, brownfield/greenfield projects, which may beprimarily debt-funded.

ICRA

RatingF

eature

February2011
mailto:[email protected]://www.icraindia.com/http://www.icraindia.com/mailto:[email protected]


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ICRA Rating Feature Industry Outlook: Fertilisers


Move towards nutrient based subsidy (NBS) in non-urea fertilisers is an important measure by theGoI towards curtailment of subsidy and attainment of a stronger bargaining position in pricenegotiations with foreign suppliers of inputs and fertilisers. ICRA views the NBS as a long-termpositive for the industry owing to lower reliance on subsidy and higher pricing freedom. ICRA alsoconsiders the encouraging demand response despite the farm gate price hike as a positive

development for the fertiliser industry.ICRA notes that GoIs move to reduce NBS subsidy benchmarks (for FY12) in order to negotiatelower input and fertilisers prices by flexing its bargaining power was not successful. Thenorthward movement in the international prices created divergence with the subsidy benchmarks,thereby leading GoI to roll back the subsidy in order to protect the interests of the industryparticipants and the farmers. While NBS originally was aimed at a stable subsidy regime, on thestrength of the latest development, ICRA expects GoI to intervene and make adjustments tosubsidy in a scenario when international price movements and negotiated prices are in majordivergence with prefixed benchmarks, atleast over the short to medium term. As a result, theprofitability outlook for the phosphatic & complex fertiliser manufacturers should be stable overthe medium term.

Over the longer term, the interplay of international fertiliser prices; negotiations with suppliers;

gradual hike of farm gate prices and subsidy adjustments would determine the profitability ofparticipants in the phosphatic and complex fertilisers industry. ICRA expects the modestinfluential position of India in the international fertilisers market and strengthening supplierrelationships to increasingly contribute towards parity between NBS benchmarks and internationalprices over the longer term.

The provisioning and timeliness of subsidy payment by the GoI in the Union Budgets haveremained relatively adequate in the recent past. Going forward, gradual farm gate price decontroland direct payment of subsidy to the needy farmers, although the idea is riddled with severalchallenges, should help contain subsidy outflows and improve the liquidity position of thecompanies over the longer term.

With the strategic importance of the fertiliser industry in ensuring food security for the country and

price sensitivity associated with the farming community, ICRA expects GoI to continue to controlthe fertiliser industry over the long term even while initiating reforms (on a limited scale) to thebenefit of cost-competitive industry participants.

BACKGROUND

The Indian fertiliser industry can be broadly divided into three categories depending on nutrientcomposition, namely, nitrogenous (N), phosphatic (P) and potassic (K). Due to the political sensitivityof fertiliser prices, the industry has been heavily regulated for decades by the Government of India(GoI). Such regulations have covered among others the farm gate price (FGP); types of fertiliserseligible for subsidy; distribution pattern and returns that can be earned by manufacturers. The level ofcontrol varies with the segments, with urea being the most controlled fertiliser. Urea is the key fertiliserconsumed within the nitrogenous fertilisers segment and accounts for around 50% of all fertilisers

consumed in India. Phosphatic fertilisers are consumed in the form of complex fertilisers with varyinglevels of NP [that is, mixtures of Nitrogen and Phosphorous including Di Ammonium Phosphate orDAP], and NPK [that is, mixtures of Nitrogen, Phosphorous & Potassium]. Pottassic fertilisers mainlycomprise Muriate of Potash (MOP), which is not manufactured in India and is entirely imported.

KEY TRENDS & RATING IMPLICATIONS

Healthy demand growth and stagnancy in production due to policy and pricing uncertaintiesresult in higher dependence on imports of fertilisers. Demand growth has been aided by priceprotection of fertilisers in a volatile commodity price scenario. However, improved farmeconomics provide scope for gradual increase in prices and reduction in subsidy.

The domestic demand growth for fertilisers has remained healthy on the back of healthy crop pricesand rising nutrient application rates. On the other hand, domestic production of fertilisers hasstagnated on account of lack of encouraging policies for fresh investments and constraints with


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respect to availability and prices of raw materials. Consequently, there has been higher dependenceon imported fertilisers and, therefore, an increase in the subsidy bills of the GoI, particularly duringtimes of spikes in commodity prices.

The demand growth has been aided by the stable farm gate price regime over the last decade. Thefarm gate prices of fertilisers in India have remained largely constant in 2000-2010 even duringperiods of sharp fluctuations in fertiliser and input prices, thus leading to a high level of subsidisation.Nevertheless, the rising crop/grain prices should enable farmers to absorb the higher prices offertilisers, as reflected to a moderate degree in 2010-11, when fertiliser demand posted a robustgrowth despite a 5-10% rise in prices.

Chart 1&2: Trend in Farm Gate Prices and International Prices of Urea and DAP

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DAP MRP (Rs/MT) DAP Imported price (Rs/MT)

Source: FAI; ICRA Analysis

With the above industry backdrop, the perspective of ICRA on the demand for key fertilisers is asfollows:

Urea: The domestic consumption of urea has grown steadily at a CAGR of 5.2% during the periodfrom 2004-05 to 2009-10. The production of urea in this period remained stagnant at around 20-21million MT due to feedstock constraints and lack of fresh capacity on account of policy uncertainties.Due to stagnancy in indigenous production, the imports grew at a significant rate. Even the recent

increase in farm gate prices (by 10%/ Rs. 480/MT with effect from 1 April 2010) has not affectedconsumption levels, as the prices remained unchanged over the last decade while foodgrain pricesincreased manifold during the same period. Urea consumption witnessed an increase of 5% in theperiod from April 2010 to November 2010 (8M 2010-11) over the same period in the previous year.ICRA expects the demand growth in urea to be moderate at around 3% due to the potential for movetowards a more balanced nutrient consumption.

Chart 3: Demand-Supply Gap of Urea in India

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Domestic Consumption Domestic Production Imports Imports % of Demand


DAP: The dependence of India on DAP imports increased significantly to 60% in FY 2009-10 from

10% in FY 2004-05 on account of a steady rise in demand and stagnancy in domestic production dueto raw material constraints as well as price volatility. The domestic production witnessed a moderatedecline during the period from 2004 to 2008 on account of raw material constraints (mainly


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phosphoric acid and rock phosphate), while a significant decline was witnessed in FY 2008-09 due toproduction cutback in a scenario of crash in DAP prices in H2, FY 2008-09, which normalised in 2009-10. While production levels have remained volatile, consumption has shown a consistently highgrowth of 23% in 2008-09 and 13% in 2009-10. The demand growth slowed down to 5% during 8M2010-11 over the corresponding period in the previous year due to greater substitution by complexfertilisers. ICRA expects domestic demand for DAP to grow at 5% a year while high importdependence should continue in the medium term due to lack of any major capacities.

Chart 4: Trend in Domestic Production, Consumption and Imports of DAP

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Lakhtonnes

Domestic Consumption Domestic Production Imports Imports % of Demand

Source: FAI, Industry, ICRA Analysis

Complex Fertilisers: The demand for complex fertilisers has averaged at around 6% over FY 2008-10. The trend in production for complex fertilisers differs from that of DAP due to substitution betweenthe two, depending upon subsidy and international price levels, as reflected in the varyingconsumption patterns. A positive development has been the opening up of imports of complexfertilisers with effect from 1 April 2010 and the move towards NBS, which has encouraged theconsumption of customised complex fertilisers. As a result of healthy demand growth and higheravailability, the demand for complex fertilisers increased by 33% in 8M 2010-11 over 8M 2009-10.

The resilience in demand growth in a period marked by an increase in complex fertiliser prices byaround Rs. 1,000/tonne proves the underlying potential in the sector, according to ICRA.

Chart 5: Trend in Domestic Production, Consumption and Imports of Complex Fertilisers

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Domestic Consumption Domestic Production Growth in demand

Source: FAI, Industry; ICRA Analysis


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Changes in Subsidy Framework for Different Fertilisers and Related Issues

UREA:

Urea industry functions under normative cost plus return based subsidy mechanism (that is,NPS); modifications to the prevailing NPS-III expected to be announced in the near term: Theurea units in the country function under the New Pricing Scheme (NPS), wherein they are divided intosix groups depending on their feedstock and plant vintage. The subsidy (above the farm gate price) islinked to the actual Retention Price (RP) of the units or the group average RP, whichever is lower.Under NPS-III (which was functional with effect from 1 April 2006), the normative parameterspertaining to capacity utilisation and energy consumption were tightened and capital related charges(CRC) and conversion costs were further rationalised as compared to NPS II. These had offset someof the positive features like higher reimbursement of energy savings, update of freight costs andreimbursement of actual taxes on inputs, thus leading to a marginal decline in profitability for theindustry. (See Charts 6 & 7.).

Chart 6 & 7: PBIT Margins & RoCE of Major Urea Manufacturers in India

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PBIT Margin

PBITMar

gin(%)

Chambal (Fert division) IFFCO

KRIBHCO NFL

RCF (Thal Urea division) Zuari

Median Linear (Median)

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Median Linear (Median) Source: Annual Reports; ICRA Analysis

While urea units are assured a return of 12% post-tax RoE, their actual performance depends upon

their RP in relation to group average; energy consumption in relation to their own pre-set norm;capacity utilisation levels and under recoveries on certain operational expenditure and taxes. Themedian return on capital employed (RoCE) of above six urea players has been 12.5% over the lastfour years, whereas efficient players such as Chambal Fertilisers and RCF have turned in RoCE ofaround 18-19% during the same period.

Although NPS-III expired on 1 April 2010, GoI has extended it further on a provisional basis. Amodified version of NPS is expected to be announced in the near term, a key expectation from whichis increase in the fixed cost component of RP by Rs. 350/tonne so that the actual rise in fixed costswill be defrayed to some extent. As the fixed cost part of RP has not been revised since 2002-03, amarginal increase in the same will be a positive for the industry.

Conversion of liquid fuel based urea units into gas is essential to reduce overall subsidy

outflow; however, significant delays have occurred due to constraints on gas availability andpipeline connectivity to such units. In order to reduce overall subsidy outflow, the GoI mandatedconversion of high-cost, liquid fuel (naphtha, Furnace Oil (FO), Low Sulphur Heavy Stock (LSHS)based units into natural gas under NPS-III. The original deadline (of 31 March 2010) laid down underNPS-III for conversion was extended by the GoI due to non-availability and connectivity of gas formost of these units. Upon expiry of the deadline, subsidy to such units was to be restricted toprevailing import parity price or their own RP, whichever is lower. In order to assist the units toachieve completion, the GoI has ensured gas availability and connectivity to such units. Among suchunits, the naphtha-based units (such as ZIL, MCFL and MFL) are supposed to recover theirinvestments through energy savings (for a period of 5 years), as their energy consumption normswould not be revised during this period. Besides, the units would also benefit from lower workingcapital (due to lower cost of feedstock) and excess ammonia production. However, in case of FO-LSHS based units (such as GNFC and NFL), the capital expenditure required for conversion is

relatively steep in relation to the naphtha-based unit; and energy savings alone are not sufficient toensure viability. As a result, the GoI has announced a provision for special fixed cost reimbursementper tonne of urea for five years for such units, which in combination with the energy savings are


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targeted to generate a 12% post-tax equity return for the project. While returns under such projectsare assured on paper, ICRA expects the key determinants for the same to be the achievement of thetarget level of energy savings and timely completion of projects without any cost overruns.

Expansion of urea capacities essential to promote self-sufficiency for India and insulateagainst international price cycle. Indigenous gas-based urea is competitive against imports.Lack of an encouraging investment policy has discouraged investment in urea, thus resulting in higherreliance on imported urea (of about 20% in 2009-10) and the consequent high subsidy outgo,particularly during times of higher urea prices. Therefore, it is in the interest of the Government ofIndia to promote self-sufficiency in urea, as the cost of indigenous, gas-based urea has been largelycompetitive as compared to imported urea and is expected to remain so in the future. As seen inChart 8, indigenous urea has been competitive in relation to imported urea over the period from 2003-04 to 2018-19, even after factoring in the high-cost urea from liquid, fuel-based units. It may be notedthat the cost of indigenous urea was marginally higher than imported urea in 2009-10 due tomoderation in international urea prices (average of US$275/tonne in 2009-10) and increase indomestic gas prices, which has however reversed in 2010-11 with the upturn in urea prices toUS$400/tonne. Nevertheless, the rising use of higher cost gas (such as R-LNG) remains a concern inthis regard.

Chart 8: Comparison of Subsidy on Imported and Indigenous Urea

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...However, the current urea investment policy fails to encourage brownfield and greenfieldinvestments: The existing urea investment policy was announced in August 2008. It allows forrealisation equivalent to 90% of the import parity price (IPP) for brownfield and greenfield projects and85% of IPP in case of debottlenecking/revamp projects, wherein the IPP (under both cases) is subjectto a floor of US$ 250/MT and a cap of US$ 425/MT. The new investment policy resulted in anincrease in indigenous urea capacity by 1.5 million MT, (that is, 7% of domestic capacity) by way ofrevamped projects. Although many companies announced brownfield expansion plans, theinvestment policy has failed to encourage finalisation of these plans. This is due to the fact that theviability of such projects is uncertain on account of increasing gas prices and inadequatecompensation corresponding to the same; under-recovery in gas transportation and lack of assuranceregarding gas availability in certain cases. The two key variables affecting the viability of projectsunder the current policy are international urea prices and gas costs. According to ICRAs estimate, thecost of production (including interest & depreciation) of urea is estimated at US$270/tonne, assumingthe landed cost of gas to be US$7/mmbtu, which means the international price (FOB) of urea has tobe at least US$300/tonne for such expansion projects to break even (considering the 90% linkage).

Although global urea prices have shown a gradual recovery from the bottom of the commodity cycle ofUS$200/tonne (CFR India) in November 2008 to around US$ 400/tonne (CFR India) in January 2010,the long-term (10-year average) prices remain lower at US$256/tonne (CFR India). ICRA expectsurea prices to correct in the medium term due to capacity additions leading to higher surplus. As perseveral independent consultant reports, the potential global urea surplus is expected to increase to 19million MT in 2014 from 4.4 million MT in 2010. This is likely to put pressure on urea prices and theviability of these projects unless the policy is modified.


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Chart 9: Urea Brownfield Project IRR with Landed Chart 10: Cost of Production of Urea from aCost of Gas at US$6.55/mmbtu1 Brownfield Project at Various Gas Prices

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Chart 11: Trend in Urea Prices over the Last 10 Years

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GoI considering modifications in urea investment policy upon the requests of industryparticipants; the ability of the new policy to address the issue of rising gas costs is critical:

Due to uncertainties with respect to project returns with the current policy, given the rising gas prices,the GoI is considering changes to the policy, upon the requests of industry participants, such as: 1)increase in floor prices 2) linking of import parity urea prices to gas prices 3) increasing percentagelinkage and 4) inclusion of other expenses such as custom duty, handling and bagging expenses inaddition to the bare IPP. The GoI is expected to announce the changes to the policy in the near term.While ICRA awaits clarity on the new policy, it believes that the manner in which the new policyaddresses the issue of rising gas costs would be most critical. Therefore, the GoI is also activelyconsidering implementation of uniform gas pricing (through pooling mechanism), which could reducethe uncertainty covering the viability of such projects.

Availability of natural gas is critical for the urea industry:The availability of gas is critical for thegrowth of the urea industry and assumes greater importance, given the rising demand from existingoperations (that is, conversion of liquid fuel based units) and incremental capacities. In this regard,

the highest priority accorded by the GoI to the urea sector in its gas allocation policy serves as asource of comfort.

Capital structures of urea manufacturers are likely to get depressed due to expansion plans:Many urea manufacturers have envisaged expansion plans, which are expected to be finalised uponannouncement of the new investment policy. ICRA notes that urea operations are capital-intensive,with estimated investment for a minimum economic size urea project (of 1 million MT) ranging fromRs. 4000 crore to Rs. 4500 crore. Consequently, companies that opt to finalise their expansionprojects should witness an increase in their financial risk profiles.

1Note: The key assumptions for the project viability are: Project cost at Rs. 42 billion for a 3,500 tpd urea plant;

Energy consumption at 5.2 Gcal/tonne of urea; LCV of gas at 8,100 Kcal/m3; Rs/US$ = 45


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Table 1: Capital Structure of Urea Companies Contemplating Expansion Projects

31 March 2010 Gearing (times) Net Gearing (times) Net Worth (RsCrore)

Chambal Fertilisers 1.88 1.59 1,390

IFFCO 2.70 2.45 4,271

KRIBHCO 0.01 -0.34 2,697RCF 0.82 0.06 1,837

Zuari Industries Limited 1.01 -0.02 1,069

Tata Chemicals Limited 0.81 0.42 4,283

National Fertilisers Limited 0.37 -0.19 1,408

Source: Annual Reports; ICRA Analysis

GoI contemplating introduction of NBS in urea; however, conversion of all liquid fuel-basedunits into gas is a pre-requisite for uniform implementation of NBS:The Government of India isalso contemplating introduction of nutrient-based subsidy (NBS) for urea and decontrol of its MRPwith effect from April 2011 along with decanalisation of imports. The urea industry is heterogeneouson account of varying feedstock, plant vintage and energy consumption, thereby resulting in large

variations in the cost of production for each unit. As a result, the uniform adoption of NBS for ureamay lead to disparity in gains amongst units. Further, due to delay in conversion of liquid fuel-basedunits, universal and standard implementation of NBS would be difficult to achieve in the near term.ICRA notes that even after these units are converted into gas, their energy consumption would be onthe higher side, which coupled with dependence on high-cost R-LNG raise concerns about theircompetitiveness in a scenario of NBS and low import parity urea prices. Nevertheless, there is also aschool of thought that proposes heterogeneous adoption of NBS in urea, wherein separate subsidycould be paid to liquid, fuel-based units prior to their conversion. While ICRA believes that gas-basedurea is expected to be competitive in relation to imported urea (as discussed earlier), clarity is awaitedon the phasing of industry towards decontrol through the NBS scheme.

PHOSPHATIC AND COMPLEX FERTILISERS

Move from cost plus mechanism to import parity pricing (IPP) regime (during FY09 and FY10)introduced volatility in the performance of fertiliser companies by linking them to the vagariesof commodity price cycles: As opposed to urea, the subsidy policy for phosphatic fertilisers hasundergone various changes over the last three years from 2008-09 to 2010-11, which along with thedynamic global price environment caused volatility in the financial performance of manufacturers aswell as traders. Until March 2008, a cost plus based subsidy regime resulted in a separate subsidyscheme for indigenous DAP and imported DAP. The subsidy for manufacturers was based on theprices of P (rock phosphate and phosphoric acid) and N (ammonia), depending upon their levels ofintegration and feedstock. However, the Government of India modified the subsidy policy for DAP toimport parity price

2(with effect from 1 April 2008, which lasted until 31 March 2010) as compared to

the previous cost plus mechanism, thereby equalising the subsidy on imported and indigenous DAP.In case of complex fertilisers, the subsidy calculation derived the price of P

3, that is, phosphoric acid,

from the landed cost of imported DAP as opposed to the industry negotiated price. The cost of N andK for complexes continued to be assessed as before. However, the implementation of IPP coincidedwith a period of high volatility in the prices of DAP and inputs in 2008-09. As a result, themanufacturers made abnormal gains by virtue of commodity price upcycle in the first half of the year2008-09, previously unseen in the cost plus regime. However, the crash in DAP prices in H2 2008-09and anomaly in the price parity between DAP and phosphoric acid resulted in negative and low profitsduring H2 2008-09 and 2009-10, respectively.

2Monthly concession for import/indigenous DAP was based upon average of high/low of DAP prices published in FMB &

Ferticon from US Gulf fob plus Tampa-Mundra freight for the previous to previous month or actual weighted average of

landed price for the current month whichever is lower. In addition, it included interest for 105 days, normative handling &

distribution charges (Rs 730/MT), return component (Rs 50/MT) and dealers margin.3P was derived as: (Delivered cost of Imported DAP less Conversion costs (Rs. 1979/MT) less dealer margin less cost of 18

N in DAP)/46


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Introduction of NBS in DAP and complexes with effect from FY11, primarily aimed at reducingGoIs subsidy bill and commanding stronger position in price negotiations with foreignsuppliers: With effect from 1 April 2011, the Government of India announced a move towardsnutrient-based subsidy for non-urea fertilisers by fixing the level of subsidy for each nutrient (acrossnon-urea fertilisers) before the start of the year based on certain price benchmark. Although the movewas also accompanied by decontrol of farm gate prices, the same has been limited to the extent of8% increase in MRP, as the same continues to be determined in consultation with the GoI. The NBSregime marks a departure from fixed MRP and variable subsidy to fixed subsidy and variable MRPregime. The move is primarily aimed at reducing GoIs subsidy bill, besides impart ing pricing freedomto manufacturers as well as encouraging balance nutrient consumption. NBS also aims at keeping anindirect check on international prices of fertilisers/inputs by bringing out a fixed price benchmark (forsubsidy determination), which can be used as a tool by the industry for price negotiations withindustry suppliers. ICRA believes that the move towards NBS is positive for the industry over the longterm due to lower reliance on subsidy and higher pricing freedom. While, scenarios such as increasein raw material prices (with fixed subsidy and farm gate prices) pose a threat to profitability of industryparticipants, GoI is expected to make moderate adjustments to subsidy to protect the interests of theindustry. ICRA also expects improved certainty with regard to the profitability of fertiliser tradingoperations under the NBS regime because prior knowledge of subsidy can help importers takeinformed business decisions.

Chart 12: Trend in International Prices of DAP and Phosphoric Acid

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Box No; 1: HOW ARE SUBSIDY RATES CALCULATED UNDER NBS?

Under NBS, GoI derives subsidy rates for N, P and K based on benchmark price of imported commodities: Urea,DAP and MOP, respectively. The MRP of the fertiliser is deduced from the benchmark import parity price to calculatebenchmark subsidy. From the benchmark subsidy, the subsidy for the nutrient is extracted from the product subsidybased on the percentage nutrient content in the latter. An estimated derivation of the subsidy for each nutrient forFY11 is presented below:


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NBS positive for manufacturers of SSP and customised fertilisers: The manufacturers of singlesuper phosphate (SSP) have benefited significantly from implementation of NBS, as the latter hasequalised the subsidy on the P content in SSP with that in DAP. In the past, discriminatory regulationsdue to lower subsidy for P content as compared to DAP and inadequate price revisions resulted inweak profitability in certain years for the SSP industry. However, with the recent policy measures,ICRA expects consumption of SSP to get a fillip, resulting in increased interest by fertilisermanufacturers in this product line. Further, with inclusion of separate subsidy for micro-nutrientcarrying customised fertilisers, their production and consumption should also be boosted.

Profitability of manufacturers of phosphatic and complex fertilisers improves in 2010-11 due toadequate price benchmarks and stable raw material prices. The profitability ofphosphatic/complex fertiliser manufacturers increased in H1 2010-11, as the level of subsidyannounced under NBS for 2010-11 was higher than the previous regime, the latter having beeninfluenced by subdued price environment. Moreover, the prices of key inputs -- phosphoric acid androck phosphate -- remained relatively stable in the current year.

Chart 13 & 14: Trend in Quarterly PBIT Margins of Phosphatic Fertiliser Manufacturers andtheir Median in India

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ZIL GSFC (Fert division)

Deepak Fertil isers (Fert division) Liberty Phosphates

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MedianPBITMargin(%)

Source: Press Releases

GoIs attempt to flex its bargaining power by reducing subsidy benchmarks for FY12unsuccessful due to sharp rise in international prices, subsequent subsidy rollback is apositive for the industry participants and farmers:In November 2010, GoI announced its subsidyunder NBS in advance for FY 2011-12, which marked around an average of 20% reduction in subsidyversus FY 2010-11 levels by fixing lower price benchmarks for DAP, urea and MOP. The step wasaimed at negotiating lower prices with international suppliers. However, since the subsidy benchmarkswere at a steep discount (25-30%) to the international prices, the industry feared decline in profitabilitybecause of inability to negotiate lower prices with suppliers and raise farm gate prices accordingly. Asa result, GoI rolled back the subsidy cuts and brought the subsidy benchmarks within 5-10% discountof the prevailing international prices, thus significantly reducing the requirement for negotiating lowerprices or raising farm gate prices. On the strength of the latest development, ICRA expects GoI to

intervene and make adjustments to subsidy in a scenario when international price movements andnegotiated prices are in major divergence with prefixed benchmarks, over the short to medium term.While, over the longer term, increasing of farm gate prices in order to reduce subsidy levels would berelevant.


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Chart 15 & 16: Comparison of NBS benchmarks & International prices for FY11 & FY12E

310 509 375

60 (16%)

41 (7%)

0

0

100

200

300

400

500

600

Urea (N) DAP (P) MOP (K)

$/Tonne

NBS Benchmark: FY11 Discount to Avge prices of 9M FY11

350 580 390

55 (14%)

50 (8%)

10 (3%)

0

100

200

300

400

500

600

700

Urea (N) DAP (P) MOP (K)

$/Tonne

NBS Benchmark: FY12 Discount to current prices

Source: Industry, ICRA Analysis

As shown in charts above, the relation between NBS benchmarks & international prices for N & P forFY12 are largely in line with 9M FY11, ie discount of 14-16% in case of N and 7-8% in case of P. As aresult, the profitability levels in FY12 should remain in line with 9M FY11 if the current internationalprices and their relation with feedstock prices are to sustain in FY12. It is be noted that discount tointernational prices as shown in charts above, does not directly impact the profitability of

manufacturers as their input prices (natural gas & ammonia for N and phosphoric acid for P) remainmore stable than their benchmark product.

Longer term interplay of global prices, gradual phasing towards price decontrol and subsidyadjustments to determine industry profitability: ICRA expects the interplay between internationalfertiliser prices, negotiations with suppliers and gradual decontrol of farm gate prices and subsidyadjustments to determine the profitability in the phosphatic and complex fertiliser industry in the longrun. While, the current global demand supply dynamics and upward movement in international pricesprevented the industry from bargaining lower prices to mitigate the subsidy reduction, Indiasimproving position in the international phosphate market should allow it to achieve price gains overthe long term. Strengthening supplier relationships (major global suppliers such as OCP and GCThave joint ventures with Indian majors) should also assist in this regard.

Table 2: Indias share in worlds export of fertiliser nutrients and inputs

CY 2008/ 'Milliontonnes

India's Import World's Exports India's Import as % of World Exports

Nutrient wise

N 3.8 27.7 14%

P205 3.1 12.8 24%

K20 3.4 27.6 12%

Total All nutrients 10.2 68.1 15%

Product wisePhosphoric acid 2.0 4.2 48%

Rock Phosphate 5.0 30.6 16%

MOP 4.1 41.2 10%

Ammonia 1.7 18.7 9%

Source: FAI, ICRA Analysis

As witnessed in Table 2, India plays a significant role in the international market, particularly inphosphoric acid where it accounts for 48% of total world exports.

Timeliness of subsidy payments critical for the liquidity position of fertiliser manufacturers;

gradual move towards price decontrol and lowering dependence on subsidy should partlymitigate the same over the longer term: In general, the liquidity position of the fertilisermanufacturers is influenced significantly by the timeliness of subsidy disbursement. Robust demand


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growth, multi-fold increase in imports and rising commodity prices have caused fertiliser subsidy toincrease by around 300% over the period from 2004 to 2010. It may be noted that the subsidy billwitnessed a 2.5 fold increase in 2008-09 over 2007-08 due to peaking of commodity prices, therebystressing the finances of the GoI. Fertiliser subsidy is expected to show an increase of around 30%from Rs 62000 crore in 2009-10 to Rs 80,000 crore in 2010-11 due to one time hike in APM gasprices for urea plants and significant rise in consumption of complex fertilisers. Fertilizer subsidyaccounts for around 40% of GoIs total subsidy budget, which covers food, fertilizer and petroleumproducts. During 2007-08 and 2008-09, the GoI started payment of subsidy through bonds, whichsuffered from poor liquidity and discount to face value, thus affecting the liquidity position of fertilisercompanies further, while they were later discontinued upon the requests of industry participants.Nevertheless, ICRA takes comfort from the fact that the subsidy disbursals have been fairly prompt in2009-10 and 9M 2010-11 due to stability in prices and accurate subsidy estimation due to NBS,respectively. Going forward, part price decontrol and direct subsidy payment to the needy farmers,although the idea is riddled with several challenges, should assist in containing the subsidy outflowsof the GoI over the long term.

Chart 18: Subsidy Bill of the GoI since 2004

15779 18299

25952

40338

95849

62000

80000

0

20000

40000

60000

80000

100000

120000

2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11E

RsCrore

Source: Industry Reports; ICRA Analysis

The GoI has a longer-term goal of making subsidy payments directly to farmers instead ofmanufacturers/traders. The same is prevalent in China, Malaysia and the Philippines. However, thiscould be cumbersome, given the administrative hassles involved with payment of subsidy to individualfarmers.

CONCLUSION

ICRA expects the outlook for the credit risk profiles of urea operations of rated entities to remainstable under the current normative, cost-plus-return regime, which is expected to continue in the nearterm with minor modifications. While uniform implementation of nutrient-based subsidy (NBS) in ureawould be difficult in the near term, heterogeneous adoption of the same along with farm gate pricedecontrol is an increasing possibility. However, the approach of the expected new urea investmentpolicy changes towards addressing the issue of increasing gas prices would be critical, as many ureamanufacturers have envisaged brownfield expansion plans. Nevertheless, such manufacturers couldwitness an increase in their financial risk profiles if they finalise such largely debt-funded capacityexpansion programmes. The Government of India is also considering implementation of uniformpooled prices for gas, which could address problems related to high prices of gas with urea expansionprojects.

With regard to DAP and complex fertiliser business, ICRA is of the opinion that the trend towards NBSis positive for the profitability of cost efficient industry players over the long term. Moreover, the recentdemonstrated support of the GoI to the industry by way of subsidy adjustments lends confidence tothe sustainability of NBS and accords visibility to the profitability in the near term. As a result, outlookfor phosphatic and complex fertiliser business remains stable.

February 2011


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ANNEXURE

Table 1: Portfolio of ICRA Rated Fertiliser Companies

Company Products Ratings Outstanding*

Aditya Birla Nuvo Limited (ABNL)^ Urea LAA+/A1+Bohra Industries Limited SSP LBB(Stable)/A4

Chakradhar Chemicals Private Limited Zinc Sulphate LBB(Stable)/A4

Chambal Fertilisers & Chemicals Limited Urea A1+

Deepak Fertilisers & PetrochemicalsCorporation Limited

Complex fertilisers LAA(Stable)/A1+

Gujarat Narmada Valley Fertilizers CompanyLimited

Urea, Complex fertilisers LAA-(Stable)/A1+

Gujarat State Fertilizers & Chemicals Limited DAP, Urea, Complex fertilisers A1+

Liberty Phosphates Limited SSP LB+/A4

Mosaic India Private Limited DAP A1

Paradeep Phosphates Limited DAP, Complex Fertilisers LBBB(Stable)/A2

Rashtriya Chemicals & Fertlizers Limited Urea, Complex Fertilisers LAA-(Stable)

Subhash Fertilizers Private Limited Complex fertilisers LBB-(Stable)/A4

Zuari Industries Limited Urea, DAP, ComplexFertilisers

LA+(Stable)/A1

Note: ^:ABNLis a diversified company with interests in carbon black, viscose filament yarn (VFY), flaxyarn and linen fabric, garments, fertilisers and insulators.

Source: ICRA Limited


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Contents may be used freely with due acknowledgement to ICRA.

ICRA ratings should not be treated as recommendation to buy, sell or hold the rated debt instruments.ICRA ratings are subject to a process of surveillance, which may lead to revision in ratings. Pleasevisit our website (www.icra.in) or contact any ICRA office for the latest information on ICRA ratingsoutstanding. All information contained herein has been obtained by ICRA from sources believed by itto be accurate and reliable. Although reasonable care has been taken to ensure that the informationherein is true, such information is provided as is without any warranty of any kind, and ICRA inparticular, makes no representation or warranty, express or implied, as to the accuracy, timeliness orcompleteness of any such information. All information contained herein must be construed solely asstatements of opinion, and ICRA shall not be liable for any losses incurred by users from any use ofthis publication or its contents.
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