Rating Methodology for Issuers in the Indian Rice Industry

Transcription

1 March 2016 ICRA Rating Feature This rating methodology is meant to help investors, issuers and other market participants understand the key factors considered by ICRA in assessing the creditworthiness of issuers belonging to the Indian Rice Industry, including entities engaged in milling, processing and/ or trading. Overview Rice is one of the important food crops and is the staple diet for a significant part of the world population. Rice ranks among top three food grains in terms of worldwide production. However, the international trade in rice is restricted to only 7-8% of the production, given that most of the producers face matching domestic consumption. Over 90% of the global rice output and consumption is centered in Asia, led by China and India who are the world s largest rice producers as well as consumers. India is among the three largest exporters of rice in the world and rice export is a significant contributor to India s foreign currency reserves. In India there are a number of rice varieties grown and consumed; however the different varieties could be broadly grouped under two categories, namely basmati and non-basmati. Basmati rice is considered to be the world s finest rice because of its aroma, flavour and non-stickiness and hence commands premium pricing. Majority of the basmati rice production is exported although its domestic consumption is increasing at a healthy pace. On the other hand, non-basmati rice, which accounts for more than 90% of rice production in India, is consumed domestically as a staple. While it is true of most industries, in the case of the Indian rice industry, the exposure to external forces is high. Like other agro commodities, rice witnesses periods of over and under supply as agro climatic factors and farmers preferences impact its cultivation. This can lead to cyclicality in volumes and prices prevailing in the industry. Further, being a net exporter, Indian rice industry is also impacted by the supply of rice from other exporting nations primarily Thailand and Vietnam. Domestically too, the industry is characterized by a large number of producers resulting in stiff competition. However, ICRA has observed that companies with strong fundamentals are able to handle these external challenges better, compared to others. In addition to industry risks, ICRA s rating methodology, therefore, attempts to identify such company-specific factors. ICRA s rating methodology evaluates: 1. Market Related Factors 2. Operational Strengths 3. Management Quality 4. Regulatory Framework 5. Financial Strength And Future Cash Flows 1 Market Related Factors 1.1 Demand Scenario: The demand for rice generally remains stable given that rice is a staple for a large segment of population. With the increase in disposable incomes, the domestic demand for rice, especially basmati rice, has witnessed a healthy growth over the years. In the international market too, there is a healthy demand for rice with basmati rice enjoying a price premium. Basmati rice is produced largely in India and Pakistan, hence faces little competition from other fragrant rice ICRA Rating Services Page 1

2 varieties from other countries. However, non-basmati rice faces stiff competition from other rice exporters primarily Thailand and Vietnam. Moreover, the export of non-basmati rice depends on government policy as the exports could be banned in periods of food shortage as in FY08 when the export of non-basmati rice from India was banned (barring certain exceptions); the ban was lifted subsequently in FY12. Apart from regulations in India, the exports from India are also impacted by the trade policies and incentive regimes in other competing countries. For instance, during FY12, Thailand raised the prices significantly at which it bought paddy from farmers in order to export at higher prices later; however, during the same year, India lifted its ban on export of non-basmati rice and gradually became the world s largest exporter of rice, as Thai rice had become costlier. A large proportion of basmati rice production in India gets exported and thus remains dependent on multiple factors such as - trade policies in the importing countries, economic situation and consumption patterns in the importing countries, socio-political dynamics of international trade and the prevailing foreign exchange rates. For instance, Iran emerged as one of the largest importers of basmati rice from India in recent years (largest share of 37% of India s exports of basmati rice in ), however Iran imposed a ban on basmati rice imports from India in , given Iran s own healthy rice crop and already stocked significant inventory. The ban led to a decline in the proportion of India s basmati rice exports to Iran from 37% in to 24% in and the trend continued in the first half of The ban got removed in November 2015; however Iran imposed a high import duty to limit the imports. These factors are assessed in order to estimate the demand for rice in the domestic and international markets to see the future revenue and profitability potential of the industry. 1.2 Supply Scenario: The key input for the rice industry is paddy, which is milled to produce rice and other by products - husk and bran. The supply of paddy depends on the agro-climatic conditions, as a large portion of area under rice cultivation is dependent on monsoon rains. In the years of weak monsoon/deficit rainfall, the production can decline causing an increase in prices. Further, depending on the market demand, farmers may shift towards or away from rice cultivation impacting the overall supply in the country. This factor is more pronounced for basmati rice, which has a much smaller area under cultivation, wherein the prices tend to exhibit higher volatility depending on export demand. For non-basmati rice, there is some degree of stability in production in the country given its status as a key crop and its staple nature in the food basket. The rating exercise takes into consideration the prevailing supply scenario and the anticipated supply especially depending on the status of the monsoon rainfall. 1.3 Competitive Positioning: The rice industry, more so for the non-basmati rice, is characterized by high competition as the low entry barriers have led to numerous industry players, both in domestic as well as the export markets. This is on account of low upfront capital investment requirements, low technical intensity with largely standardized equipments, low skilled manpower requirement, easy availability of raw material and steady demand. In this context, ICRA evaluates some of the factors, which can enable a company to differentiate itself such as the management quality, operational track record of the company, scale of operations and geographical diversity. 2 Operational Strengths 2.1 Value Chain: The turnover growth and profitability of a player depends on its positioning in the value chain. A rice player can be a miller (converting paddy to semi-processed rice), processor (converting semi-processed rice to finished rice), integrated player carrying out end to end conversion of paddy to finished rice along with processing of by-products like bran oil extraction and captive power generation etc. In addition to the above participants, the industry also includes traders. The turnover growth and profitability of a player largely depends on its positioning within the entire value chain. A trader can report robust revenue growth with modest operating profit margins. However, an integrated player is likely to have better operating profit margins but may require sizeable investment to achieve similar revenue growth levels. ICRA Rating Services Page 2

3 2.2 Brand Presence: In India, rice sales are largely unbranded in nature. However with the increasing penetration of organized retail and customer awareness, the players are making efforts towards establishing brands. This is true especially in the basmati rice industry owing to its premium position in the rice industry. ICRA favourably views sustained efforts by manufacturers towards brand development, as it allows for differentiation in a commoditised industry, makes way for greater market acceptance, and imparts ability to develop a pricing premium in the long term. 2.3 Distribution Network: Given that rice is a staple crop with demand to a large extent driven by domestic consumption, the success of rice players largely depends upon their ability to reach the consumers. Thus, a well established distribution network and wide reach of products is an important rating determinant. A rice player with access to a large market is viewed favourably as it helps cope with the competitive forces easily. ICRA evaluates an issuer s access to distributors and/or direct buyers (both domestic and international), presence in the modern retail format and the depth of the distribution network. 2.4 International Geographic Exposure: The rice industry, both basmati and non-basmati caters to a wide market internationally. ICRA evaluates the geographic diversification of sales and the profile of the countries that a player is supplying to. This determines the regulatory exposure faced by the issuer with regard to the trade policies of respective countries, the risk of delayed payments or bad debts, ease of trade/fund movement etc. For instance, a country may restrict the import of rice depending on its economic condition, or a country may impose very high quality conditions on the rice imported. For Instance, as mentioned above when Iran banned the import of rice in , many rice players who were largely dependent on export to Iran reported significant decline in demand. They faced challenges in liquidating their huge stock of inventory and faced liquidity pressures with some players being unable to meet their debt servicing obligations. 2.5 Cost Efficiencies: Rice being a commodity does not allow much premium pricing and thus most manufacturers are price takers in the markets that they operate in. In such a scenario, control over operating expenses is essential to maintain cost competitiveness and maximise profitability and is therefore one of the important rating determinants. The major operating costs for a rice miller are the cost of its raw material i.e. paddy/semi-processed rice and the cost incurred in holding inventory for long periods for ageing (relevant for the basmati variety) other than the processing costs. Thus, ICRA analyses input/output norms for millers such as paddy-milled/ rice-produced ratio. ICRA also assesses the manufacturer s efforts at reducing input costs through measures such as setting up captive husk-based power plants and increasing automation to reduce wastage. Similarly for traders, the majority of cost consists of traded goods (rice) as there is minimal/nil processing and they also generally do not hold inventory for a longer period. For a trader cost efficiency comes from better sourcing, efficient distribution network and ability to minimise inventory price risk through fast inventory rotation. 3 Management Quality Management quality is an important factor considered while rating issuers in the rice industry. In assessing management quality, ICRA looks at the experience of the promoters in the business, their ability to manage downturns and extending funding support to the business if required from time to time. Given the exposure to agro-climatic conditions and need to maintain sizeable inventory, there is a need to take long term calls on procurement and pricing and management s experience can be crucial in this. ICRA evaluates management strategies/policies with respect to paddy procurement and inventory holding, financial leveraging, and foreign exchange hedging policies, cost rationalisation initiatives, and the ability to gain access to more markets given the commoditised nature of the product. Consistent operating performance and the observance of conservative financial policies, which however do not compromise the company s ability to grow, provide additional comfort in the rating process. ICRA Rating Services Page 3

4 4 Regulatory Framework Basmati rice being a premium commodity faces limited government intervention domestically; whereas non-basmati rice being a staple diet for a large part of the population faces significant government regulation. The non-basmati paddy is procured by millers/traders from farmers on or above a governmentdeclared minimum support price (MSP). Further, usually millers have to mill and supply a fixed percentage of procured non-basmati paddy to the government-owned Food Corporation of India (FCI) at a price fixed by FCI under the Public Distribution System (PDS) of the Government of India (GoI). The percentage of milled rice to be supplied to FCI varies from state to state as it is determined by the respective state governments and it is a key factor impacting the profitability of any miller. The exports of non-basmati rice are permitted depending on the status of buffer stocks in the country, hence generally during the years of low production coupled with low buffer stocks, exports are banned. Further, players catering to the export market are exposed to the regulations prevailing in the respective geographies being catered to by them. 5 Financial Strength and Future Cash Flows The financial strength of a rice producer is an important rating consideration. While assessing the financial position of a rice company, ICRA reviews the Accounting Policies, Notes to Accounts, and Auditors Comments that are part of the Annual Report. Any deviation from the Generally Accepted Accounting Practices is noted and the financial statements of the issuer are adjusted to reflect the impact of such deviations. 5.1 Profitability: The profitability of a rice producer is primarily a function of its cost structure, product mix, brand presence and position in the industry value chain. The cost structure of various players varies depending upon the level of automation, which helps in reducing wastage and improving the product yield. Strong brand recall and strong distribution network allow for some premium pricing and provides relatively higher flexibility in protecting profitability. 5.2 Leverage and Cash Flows: The leverage level of a rice player is a function of its inventory-holding policy. The majority of rice paddy is grown in the kharif season, and the paddy reaches the market during the October to December period. A player may decide to stock the majority of its full year s paddy requirement during this period or buy throughout the year from traders/middlemen (lot of paddy is stocked by intermediaries who then supply semi-processed rice to the industry). The decision to stock paddy/ rice inventory is also determined, among other factors, by the fact that the quality of paddy/ rice improves with ageing (relevant for the basmati variety). In addition, the issuer would have to consider its inventory holding costs and access to capital while formulating its strategy. Usually the issuers fund inventory purchases through cash credit limits and loans against warehouse receipts. Depending on the inventory holding policy, the company s working capital intensity and thus leverage levels get determined. Most of the large to medium sized players or those intending to grow in scale try to stock a significant quantity of paddy. Besides capital structure, ICRA looks at coverage indicators including interest coverage, operating profit and net cash accruals relative to the total debt while evaluating the financial health of an issuer. Given that the issuers tend to have a high proportion of working capital debt, ratios like interest coverage become more important to assess the debt servicing ability of the issuer. Availability of cushion in the form of undrawn bank lines, especially during procurement season, is crucial to judge the liquidity of the company. Moreover, ICRA looks at other sources of financial flexibility available to an issuer, which could be in the form of, among others, a portfolio of liquid financial assets, financial strengths of promoters to infuse funds if required etc. 5.3 Inventory Risk: As mentioned above, most of the large to medium sized players (millers) or those intending to grow in scale try to stock a significant quantity of paddy/rice (especially relevant for basmati rice variety). This exposes the issuers to inventory price risk. A decline in market prices ICRA Rating Services Page 4

5 could lead to significant inventory losses for the issuers thereby affecting the ability to borrow further and instead triggering repayment of borrowings. This could result in cash flow mismatch for the issuers impacting the debt servicing capability. ICRA analyses the inventory risk while looking at the volume of inventory, per unit prices, market price trends and to what extent the inventory is orderbacked to assess the vulnerabilities of the issuer. 5.4 Foreign Currency Related Risks: The foreign currency risk can arise due to export related revenues and receivables, which may be un-hedged. The inputs are predominantly purchased in the Indian currency and some part of the production, especially basmati rice, is exported. Thus, the exporters face the risk of rupee appreciation with respect to their revenues and receivables. The various forex risk mitigating methods include (a) use of working capital funding denominated in foreign currency such as Export Packing Credit and Export Bills Discounting (b) use of forward covers to hedge foreign currency receivables. 5.5 Debt Servicing Track Record: The debt servicing track record of an issuer is an important input for any credit rating exercise. Any irregularities in the past in the repayment of principal or interest payments reduce the comfort with respect to the issuer s future debt servicing capability and willingness. 5.6 Contingent Liabilities and Off-Balance Sheet Exposures: In this case, the likelihood of devolvement of contingent liabilities/off-balance sheet exposures and the financial implications of the same are evaluated. ICRA also looks at the quality of accounting practices followed by an issuer based on interactions with the Statutory Auditors as well as studying the Auditors Report and Notes to Accounts disclosed by an entity in its Annual Report. Some of the key factors looked at includeauditor qualifications with respect to internal control systems and asset liability mismatch; contingent liabilities and other off balance sheet items and the method of revenue recognition and depreciation policy of an issuer in comparison to its industry peers. 5.7 Consolidated Financial Analysis: In the case of groups consisting of companies with strong financial and operational linkages, various parameters such as capital structure, debt coverage indicators, and future funding requirements are assessed at the consolidated/group level. 5.8 Adequacy of Future Cash Flows: Since the prime objective of the rating exercise is to assess the adequacy of the issuer s debt servicing ability, ICRA draws up projections on the likely financial position of the issuer under various scenarios. Besides, ICRA takes into account the commitments of the company towards other group companies, new ventures, and its investments in subsidiaries/special purpose vehicles (SPVs). Apart from cash flow projections, the other ratios used to assess cash flows are Fund Flow from Operations (FFO), interest coverage, FFO debt coverage etc. 6 Summing Up ICRA s credit ratings are a symbolic representation of its current opinion on the relative credit risk associated with the instrument being rated. This opinion is arrived at, based on a detailed evaluation of the issuer s business and financial risks, its competitive strengths, its likely cash flows over the life of the instrument being rated, and the adequacy of such cash flows vis-à-vis its debt servicing obligations. As the note has highlighted, for rice producers and traders, special attention is also paid to the scale of operation, positioning in the industry value chain, geographical diversity, cost competitiveness, management strategies for managing commodity price cycles and an overall approach towards managing liquidity and growth. ICRA Rating Services Page 5

6 ICRA Limited CORPORATE OFFICE Building No. 8, 2 nd Floor, Tower A; DLF Cyber City, Phase II; Gurgaon Tel: ; Fax: info@icraindia.com, Website: REGISTERED OFFICE 1105, Kailash Building, 11 th Floor; 26 Kasturba Gandhi Marg; New Delhi Tel: ; Fax: Branches: Mumbai: Tel.: + (91 22) /53/62/74/86/87, Fax: + (91 22) Chennai: Tel + (91 44) /9659/8080, / 3293/3294, Fax + (91 44) Kolkata: Tel + (91 33) / / / , Fax + (91 33) Bangalore: Tel + (91 80) /4049 Fax + (91 80) Ahmedabad: Tel + (91 79) /5049/2008, Fax + (91 79) Hyderabad: Tel +(91 40) /7251, Fax + (91 40) Pune: Tel + (91 20) /95/96, Fax + (91 20) Copyright, 2016 ICRA Limited. All Rights Reserved. Contents may be used freely with due acknowledgement to ICRA. All information contained herein has been obtained by ICRA from sources believed by it to be accurate and reliable. Although reasonable care has been taken to ensure that the information herein is true, such information is provided 'as is' without any warranty of any kind, and ICRA in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness or completeness of any such information. Also, ICRA or any of its group companies, while publishing or otherwise disseminating other reports may have presented data, analyses and/or opinions that may be inconsistent with the data, analyses and/or opinions presented in this publication. All information contained herein must be construed solely as statements of opinion, and ICRA shall not be liable for any losses incurred by users from any use of this publication or its contents. ICRA Rating Services Page 6