ACCUMULATE 10 Jan, 2011 Key Data (`) CMP 334 Target Price 357 Key Data Bloomberg Code GSFC IN Reuters Code GSFC.BO BSE Code 500690 NSE Code GSFC Face Value (`) 10 Market Cap. (` mn) 26,618 52 Week High (`) 413 52 Week Low (`) 192 Avg. Daily Volume (6m) 275,603 Beta (Sensex) 0.53 Shareholding Pattern (%) As on Sept-10 Promoters 37.8 Mutual Funds 15.4 Financial Institutions/Banks 12.8 Foreign Institutional Investors 6.3 Bodies Corporate 10.8 Individuals 15.2 Others 1.7 Total 100.0 (` mn) FY10 FY11E FY12E Revenues 40,192 47,292 46,503 EBIDTA 5,627 9,458 8,789 EBIDTA Margin (%) 14.00 20.00 18.90 PAT 2,545 5,224 4,737 PAT Margin (%) 6.33 11.05 10.19 EPS (`) 31.9 65.5 59.4 Analyst Deepak Chitroda research@acm.co.in Tel: (022) 2858 3411 Gujarat State Fertilizers & Chemicals Ltd We initiate coverage on Gujarat State Fertilizers & Chemicals Ltd (GSFC) with ACCUMULATE recommendation and target price of `357, based on 6x FY12E EPS of `59.4. GSFC manufactures fertilizers and industrial products, which contribute 71% and 29% respectively, for FY10 revenue. GSFC has a large market share of 63% in Gujarat for DAP (Di-ammonium phosphate). DAP contributed 71% of total fertilizer revenue in FY10, having total capacity of 0.8 million tonnes. In industrial products segment, caprolactam contributed ~50% of the total revenue in FY10. We expect DAP revenue to grow at CAGR of 5% during FY10-FY12E on back of introduction of NBS policy by the government. Caprolactam revenue is expected grow at CAGR of 15% due to increase in the prices. Investment rationale Benefits from nutrients based subsidy We expect, GSFC to be benefit from the introduction of the nutrient based subsidy (NBS) policy, as it is beneficial to the complex fertilizers producers like GSFC. DAP contributed on an average 71% of the fertilizer revenue in past five years (FY06- FY10). After NBS policy, margins from the fertilizers segment had improved for the company. During the H1FY11, revenue has increased by 13% to `23,674 million compared to H1FY10, whereas EBIT margin improved from 6% to 18% in the similar period. Going forward, we expect the EBIT contribution to increase from 46% to in FY10 to 54% in FY12E. Joint venture for raw materials GSFC has formed joint venture with Groupe Chimique Tunisien (GCT) and Compagnie des Phosphates de Gafsa (CPG), both Tunisian companies and Coromandel Fertilisers Ltd (CFL). The joint venture company, Tunisian Indian Fertilizers (TIFERT) will produce 360,000 tonnes of phosphoric acid per annum. The production will be divided 50% between CFL and GSFC. This will help GSFC to run DAP plant at full capacity. The project is expected to be operational in Q1FY12. However, due to lack of information, we have not considered any benefits out of joint venture in our valuation. Leader in caprolactam GSFC is a leader in the manufacturing of caprolactam with capacity of 70,000 tonnes per annum. Caprolactam contributed close to 50% of the industrial revenue in the past five years (FY06-FY10). We expect revenue contribution to be 16% and 17% in FY11E and FY12E respectively, on back of increased in the price of caprolactam. Valuation GSFC s revenue is expected to grow at CAGR of 8%, from `40,192 million in FY10 to `46,503 million in FY12E. However, PAT is expected to increase at a CAGR of 36% during FY11E and FY12E on account of improvement in margin for both fertilizers and industrial products segment. The NBS policy on complex and pottasic fertilizers had positive impact on the sector, as seen in the GSFC result for the first two quarters of FY11. We expect, EPS to grow at CAGR of 36% during FY10 to FY12E from `31.9 to `59.4. At CMP of `334, stock is trading at 5.1x and 5.6x of FY11E and FY12E EPS of `65.5 and `59.4 respectively. We initiate coverage on GSFC with a ACCUMULATE recommendation and a target price of `357, assigning PE multiple of 6x to FY12E EPS of `59.4. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 1
Index Particulars Page Company background 3 Industry 3 Introduction to fertilizers 4 Drivers for fertilizers 6 Production capacity 6 Raw material availability 8 International market 13 Government regulation 14 Outlook for the fertilizers Industry 18 Business overview 20 Fertilizer segment 20 Industrial products 21 Investment rationale NBS policy to benefit 23 Joint venture for raw material 23 Leader in caprolactam 23 SWOT 24 Key concerns 24 Peer group 24 Financial performance 25 Financials 28 Annexures 30 Gujarat State Fertilizers & Chemicals Ltd ACMIIL 2
Company Background In 1962, Government of Gujarat promoted Gujarat State Fertilizers and Chemicals Ltd (GSFC). Currently, it is holding close to 38% in the company. GSFC operates into two business segments, fertilizers and industrial products. Fertilizer products include urea, Di-Ammonium Phosphate (DAP) and other complex fertilizers. Industrial products include caprolactam, nylon 6 and other chemicals. GSFC has product presence with more than 24 brands of fertilizers, petrochemicals, industrial gases, plastics, fibers and other products. Manufacturing Unit Location Activity Fertilizernagar Baroda Urea, ammonium sulphate, DAP, ammonia, sulphuric acid, phosphoric acid, caprolactam and other industrial chemicals and gases Nandesari Baroda A polymer unit at Baroda for manufacturing wide range of acrylic monomers & polymers Kosamba Surat A fibre unit to manufacture nylon yarn and nylon-6 chips and engineering plastic grade chips Sikka Jamnagar A DAP unit at Jamnagar, where GSFC established a coastal DAP plant based on imported ammonia and phosphoric acid Source: Company, ACMILL Research Industry Agriculture plays a significant role in the country like India and the government plays important role for development of the sector. However, after green revolution there was no significant capacity addition in the fertilizer sector, which lead to higher dependency on imports. Over the years (1950-51 to 2009-10), share of agricultural in GDP has declined from 55% to 15%, whereas for industry it has increased from 15% to 28% and for services it has increased from 30% to 57%. However, agriculture plays an important role in Indian economy as it employs ~60% of Indian population in one form or the other. From the time of green revolution, the government of India is emphasizing on selfsufficiency in food grains production. Fertilizer consumption in India ( 000 tonnes) Nitrogenous Urea Complex DAP Potassic SSP Total 1999-00 21,338 20,278 11,569 6,937 2,066 3,601 38,575 2000-01 20,112 19,186 10,780 5,885 1,839 2,860 35,591 2001-02 20,712 19,917 11,229 6,181 2,011 2,605 36,556 2002-03 19,182 18,493 10,366 5,473 1,931 2,499 33,978 2003-04 20,524 19,767 10,458 5,625 1,863 2,544 35,389 2004-05 21,460 20,665 11,827 6,256 2,432 2,549 38,268 2005-06 23,100 22,298 13,518 6,764 2,759 2,756 42,133 2006-07 25,103 24,338 14,220 7,381 2,613 2,910 44,847 2007-08 26,490 25,963 14,218 7,497 2,911 2,288 45,906 2008-09 27,158 26,649 16,260 9,231 4,107 2,617 50,142 Source: Crisil Gujarat State Fertilizers & Chemicals Ltd ACMIIL 3
Fertilizer A fertilizer is a material - organic or inorganic, natural or synthetic that supplies one or more elements required for plant growth. The plants need around sixteen nutrients for growth, which can be obtained from atmosphere and soil. The different kind of fertilizers includes bio-fertilizers, organic fertilizer and chemical fertilizers. Types of fertilizers The fertilizers can be classified on the basis of nutrient content. The primary nutrients are nitrogen (N), phosphorous (P) and potassium (K), which are required in large quantities and supplied through chemicals fertilizers. Whereas, sulphur (S), calcium (Ca) and magnesium (Mg) are secondary nutrient required in smaller quantities but important for plant growth. Apart from these nutrient, micronutrients like iron, zinc, manganese, copper, boron, molybdenum and chlorine are also essential for different plant growth. The grade of fertilizers are expressed in three numbers in terms of percentage of N,P and K present. Nutrients Purpose Type Nitrogenous (N) fertilizers Used to colour plants and increase their vegetative growth Urea and calcium ammonium nitrate (CAN) are the main fertilizers, expressed in 46-0-0 and 25-0-0 respectively. Phosphatic (P) fertilizers Used to strengthen the plant roots Single super phosphate (SSP) is the main fertilizer expressed in 0-16-0 Potassic (K) fertilizers Provide plant with resistance to protect from drought and diseases Muriate of potash (MoP) express in 0-0-60 Complex fertilizers Chemical combination of two or more nutrients (N and P or N, P and K) Di-ammonium phosphate (DAP) is the main fertilizer express in 18-46-0 Source: Industry Fertilizers nutrient content Nutrient Mix Relative consumption share in 2008-09 (%) Fertilizers N P K Nitrogenous fertilizers Ammonium sulphate 21 0 0 0.8 CAN 25 0 0 0.2 Urea 46 0 0 53.4 Phosphatic fertilizers Single super phosphate 0 16 0 5.2 Potassic fertilizers Muriate of potash 0 0 60 8.2 Complex fertilizers Di-ammonium phosphate 18 46 0 18.5 10-26-26 10 26 26 4.7 12-32-16 12 32 16 1.7 14-35-14 14 35 14 0.3 15-15-15 15 15 15 1.0 16-20-0 16 20 0 0.3 17-17-17 17 17 17-19-19-19 19 19 19 0.1 20-20-0 20 20 0 5.0 23-23-0 23 23 0 0.1 28-28-0 28 28 0 0.4 Source: FAI, Crisil Gujarat State Fertilizers & Chemicals Ltd ACMIIL 4
The chemical fertilizers differ from one another in terms of nutrients contents and its use on different crops. Different crops require different proportion of N, P and K, for example, one tonne of paddy absorbs 9.74kg, 3.12kg and 3.26kg of nitrogenous, phosphatic and potassic nutrients respectively, from soil. While, one tonne of wheat absorbs 15.96kg, 1.89kg and 3.43kg of nitrogenous, phosphatic and potassic nutrients respectively, from soil. The quantity of nutrient absorbed also varies in different kinds of soil. Although, the ideal NPK usage ratio is 4:2:1. In India, the usage of ratio differs between regions due to soil type, crops grown and farmer price preference. In 2008-09, the average ratio in India was 4.6:2.0:1.0. Usage of fertilizer is primarily driven by farmer preference. In India, farmer prefers consumption of nitrogenous fertilizers compared to phosphatic and potassic, due to cheaper availability of urea compared to others and immediate visibility of results. Consumptions of Fertilizers The global fertilizer consumption has grown CAGR of 3.8% from 30.03 million tonnes nutrients in 1960 to 168.7 million tonnes nutrients in 2007. However, due to global slowdown, production declined 5.1% to 159.6 million tonnes in 2008 over previous year. Source: IFA, Crisil India contributes ~15.4% in the global fertilizer consumption for all nutrients (NPK) of 162.5 million tones. The share of European countries in the consumption of fertilizer was higher (in 1985 it was 28%), however it declined over the years and Asian countries have emerged as the largest consumer. This was due to large consumption base in India and China. In 2008, Asia, Europe, N America, L America and others accounted for 60%, 14%, 13%, 9% and 4% respectively, of the world nutrient consumption pattern. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 5
Drivers for the fertilizer sector The Indian fertilizer sector is primarily impacted by production capacity, raw material availability, agriculture (as mentioned above), international market and government policies. A) Production capacity India is the third largest fertilizer manufacturer in the world with an installed capacity of ~13 million tonnes of nitrogen and ~6 million tonnes phosphatic nutrients. However, with increasing nutrients requirement the demand for fertilizers are met through imports due to unavailability of the raw materials. Nitrogenous fertilizers capacity, production (000 tonnes)& Utilization (%) Urea Prices ($/tonne) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Capacity Production Capacity utilization (%) 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 120 100 80 60 40 20 0 900 800 700 600 500 400 300 200 100 0 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Source: FAI, Crisil, and Bloomberg Note: Potassic fertilizers are not manufactured in India. Urea price - Granular Bulk US Gulf FOB Spot Price. Source: FAI, Crisil, and Bloomberg. DAP - Phosphate DAP Bulk US Gulf fob Spot Price India is largely dependent on imports to meet its fertilizer requirement especially the complex fertilizers. Due to higher imports (except for nitrogen), India is largely exposed to international prices of phosphatic and potassic fertilizers. The table shows that, there is no significant capacity addition of any kind of fertilizer in past eight years. In 2008-09, the total fertilizer capacity in India in terms of nutrients was 19.3 million tonnes, while actual production was 14.3 million tonnes and total consumption in terms of nutrient was 24.9 million tonnes. Out of ~13 million tonnes of nitrogenous fertilizers capacity, utilization level was 84% in 2008-09, which declined in past three years. In phosphatic fertilizers, condition is even worst as against capacity of ~6 million tonnes in 2008-09; utilization level was only 55%. Major reason for lower utilization level is unavailability of raw material namely, phosphatic acid, rock sulphate etc. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 6
Fertilizer trends in nutrients consumption (000 tonnes) 30,000 25,000 20,000 15,000 10,000 5,000 0 1995-96 1996-97 Source: IFA, Crisil 1997-98 1998-99 1999-00 2000-01 Nitrogenous 2001-02 In 2008-09, nitrogenous fertilizers accounted for close to 61% of total nutrient consumption in India, out of which urea contributed 98% of consumption. Phosphatic fertilizer was 26%, out of which DAP contributed over 56%. The share of potassic nutrients was marginal (13.3%) of total consumption, as there was no potassic capacity in India and entire requirement is imported. In the past, usage of Urea (Nitrogen) was higher, due to lower cost compared to other fertilizers and lack of knowledge among the farmers. High usage of urea resulted in deficiency of important nutrient in soil over the years, which deteriorated the land fertility. The ideal NPK ratio is 4:2:1. Historically, nutrient consumption ratio was largely in favor of N (Nitrogen) due to higher usage of urea, which moved towards a balance scenario with NPK ratio improving from 5.3:2.2:1.0 in 2005-06 to 4.6:2.0:1.0 in 2008-09, showing increasing consumption of phosphatic and potassic fertilizers. 2002-03 Phosphatic 2003-04 2004-05 Potassic 2005-06 Trends and outlook on nutrient consumption ratio 2006-07 2007-08 2008-09P 7 6 5 4 3 2 1 0 5.9 5.5 5.2 4.6 4.9 4.8 4.5 4.3 4.2 2.4 2.1 2.0 2.2 2.2 2.2 2.2 2.2 2.2 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 2006-07 2007-08 2008-09 2009-10E 2010-11P 2011-12P N P K Source: Crisil, ACMIIL Research 2012-13P 2013-14P 2014-15P The NPK ratio is expected to be 5.2:2.2:1.0 and 4.8:2.2:1.0 in FY11E and FY12E, respectively, assuming normal rainfall. To provide greater importance towards balance nutrient, the government announced new pricing policy of complex fertilizers based on nutrient content. Earlier, subsidy was based on international prices of fertilizer and feedstock. Therefore, government subsidy bill was determined by the floatation in the international prices of fertilizers. In 2008-09, fertilizer subsidies touched high of `958 billion due to increase in prices of feedstock and international fertilizer prices. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 7
B) Raw material availability Availability of raw material and limited tie-ups for raw materials with global players has been key factor for lower utilizations levels of the fertiliser capacity in India. Feedstock required for Urea and DAP Product Feedstock Urea Natural Gas/Naphtha/Fuel oil/lshs/coal DAP Sulphuric acid and rock phosphate Source: Industry, ACMIIL Research For Indian fertilizers industry, feedstock plays an important role, as it contributes almost 50-60% of net sales. Therefore, appropriate choice of feedstock is critical for a fertilizer company. The feedstock used by the manufacturer determines the cost of production, subsidy allocation and also profitability of the plant. The different manufacturer uses different feedstocks. Factor affecting the selection of feedstock are availability, pricing, technology, commercial viability, alternative uses and government policies. Availability: Uninterrupted supply of feedstock is important for maintaining the utilization rates along with the profitability. Considering this, some of the players have opted for the dual feedstock plants (GSFC is having the dual plant of both natural gas and naphtha). Pricing: Raw material is the major cost of production for the fertilizer companies. Significant change in prices of raw materials like, Naphtha, fuel oil and LSHS (low sulphur heavy stock) etc, affects the industry and government in terms of subsidy. Technology: Earlier, ammonia was produced from naphtha, but now natural gas is preferred as the technology available has high production efficiency as well as low energy consumption. Viability: The commercial viability of natural gas as feedstock is higher due to lower price, lower consumption of energy and water, ease in storage, easy transportation compared to other feedstock. Alternative uses: Availability of the feedstock of natural gas also depends on its alternative industrial uses (natural gas also used by power and petrochemical players). Government policies: During 1980s, large reserves of natural gas were discovered and to promote the gas usage, government started insisting on gas usage compared to other feedstock. Source: FAI, Crisil, *for external supply Gujarat State Fertilizers & Chemicals Ltd ACMIIL 8
Sectoral Naphtha consumption (%) As on Nov 2009, domestic nitrogenous capacity was 85% based on captive ammonia production, whereas 15% was procured externally. Out of captive ammonia capacity, 73% is based on natural gas, 17% on naphtha and 10% on fuel oil and rest on others (coal, LSHS, caprolactam). Although the capacity under captive ammonia production has remained constant, the contribution of natural gas as feedstock for nitrogenous has improved. This was on back of continuous efforts of government and industry players to switch from costly feedstock (naphtha) to natural gas. For manufacturing urea, the Hydrogen and Carbon requirement is met from Hydrocarbon, which is also used as fuel for urea manufacturing. Natural gas, Naphtha and fuel oil are the different feeds available for Hydrocarbon. However, natural gas is the most preferred feedstock compared with others. Naphtha Naphtha is important feedstock used for manufacturing nitrogenous fertilizers. It is used in power generation, fertilizers and petrochemical. Over the years, use of naphtha by fertilizer players is declining considering natural gas as preferred feedstock. With new findings of natural gas, share of naphtha in the feedstock is expected to decline. Additionally, as per the new urea pricing policy, the non-gas units have to convert to gas by 2010. But, since a number of plants are yet to have pipeline connectivity, we expect the government to extend the deadline. As urea producers are paid subsidy on the basis of their cost of production and thus a higher production cost (with use of naphtha and fuel oil) means higher subsidy payout for the government. Government will benefit the most, as industry players are moving towards gas based units. Cost of producing one tonne of urea using naphtha is ~`22,000-24,000, whereas using natural gas it is ~`10,500-12,000/tonne. Naphtha demand and supply (000 tonnes) 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0-2000-01 2001-02 Fertilisers Petrochem Source: Crisil 2002-03 2003-04 Power plants 2004-05 Steel plants 2005-06 Others 2006-07 2007-08 Private party sales 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 1990-91 1992-93 1994-95 1996-97 1998-99 Production 2000-01 2002-03 Consumption 2004-05 2006-07 2008-09P Gujarat State Fertilizers & Chemicals Ltd ACMIIL 9
Natural gas Natural gas is a preferred feedstock, contributing more than 60% of urea capacity, as it is energy efficient and economical. Natural gas industry wise consumption (million cubic metres) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09P Power generation Industrial fuel Tea plantation Domestic fuel Fertiliser Petrochemicals Others* Source: Crisil During 1981-82 fertilizer was the main consumer of natural gas. However, with large discovery of natural gas reserves (during 1977-84) power plants were set up based on natural gas. As a result, during 1990-2007, power sector became a dominant consumer compared to the fertilizer sector. In 2008-09, demand for natural was estimated at 139mmscmd (million standard cubic metres per day). However, supply was limited to 93.2mmscmd, resulting in a deficit of around 46mmscmd. As demand was higher, ministry of petroleum and natural gas allocated initial 40mmscmd of RIL KG basin natural gas to various industries based on gas utilization policy. KG basin gas allocation (mmscmd) 14 18 3 5 Source: Crisil Existing gas-based fertiliser plants Existing gas-based power plants Existing CGD players Existing gas-based LPG and petrochemical plants According to Crisil, supply of natural gas is expected to improve due to increase in LNG import and domestic gas finds by Reliance, ONGC and GSPC. In 2008-09, supply of natural gas was 93.2mmscmd and expected to reach 215mmscmd in 2013-14. Demand from fertilizer sector is expected to increase from 38.6mmscmd in 2009-10P to 52.9mmscmd in 2013-14P. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 10
Ammonia Out of the total fertilizer capacity less than 15% use purchased ammonia as feedstock. Private players who are manufacturing complex fertilizers such as DAP, ammonium sulphate or ammonium chloride utilize the external ammonia. The reason is that the production volumes do not justify investment in captive ammonia plants. Source: FAI, Crisil Feedstock for phosphatic fertilizer Phosphatic acid is a key raw material used to manufacture DAP and SSP. Industry players can purchase phosphatic acid or produce it using rock phosphate and other inputs. Phosphoric acid is manufactured from processing rock phosphate with sulphur, sulphuric acid, nitric acid, smelter gases, or pyrites. Almost 46% of phosphatic fertilizer capacities are utilizing imported phosphoric acid and balance 54% are based on captive production of phosphoric acid using rock phosphate and sulphuric acid. Although, a large share of capacities being captive for producing phosphatic acid, high prices of rock phosphate resulted in high import of phosphoric acid. India obtains phosphatic acid mainly from Morocco, South Africa, Senegal, Jordan, Tunisia and USA (all six accounting for more than 96% of import in 2008-09). Phosphoric acid supply (000 tonnes) 3,000 2,500 2,000 1,500 1,000 500-1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08P 2008-09P Production Imports Imports as a%of total supply Source: FAI, Crisil 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Gujarat State Fertilizers & Chemicals Ltd ACMIIL 11
Rock phosphate is the material used for making SSP and DAP. There are four companies in India who manufacture rock phosphate. Demand for rock phosphate is higher compared to production, therefore imports of rock phosphate has been going up due to large demand of complex fertilizers. Imports are mainly sourced from Jordan, Algeria, Togo, China, Egypt, Vietnam and Morocco (accounting for 98% of total imports). Source: FAI, Crisil Sulphur can be purchased by manufacturer and processed into sulphuric acid, which is further converted to rock phosphate and then into phosphoric acid. 2,200 2,050 1,900 1,750 1,600 1,450 1,300 1,150 Import of Sulphur (000 tonnes) 1,000 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008P Source: FAI, Crisil Gujarat State Fertilizers & Chemicals Ltd ACMIIL 12
C) International market International market plays an important role for domestic fertilizer industry, as it is highly dependent on imports. India accounts for 15% of global fertilizer consumption of 162.5 million tonnes for all nutrients in 2008. Source: FAI, Crisil Source:Crisil, FAI Phosphoric acid ($/tonne) The consumption pattern of three nutrients (N,P,K) used in fertilizers remain almost similar for India and world. Earlier, during 1985 share of European countries was 43% and Asian countries was 28%, which changed over the years on back of high consumption base in India and China. Raw material prices movement Price movement of raw materials is given below. Ammonia price ($/tonne) 500 450 400 350 300 250 200 150 100 50 - Apr-06 Sep-06 Feb-07 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 1,200 1,000 800 600 400 200 - Apr-06 Sep-06 Feb-07 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Source:Bloomberg, Phosphoric acid - Fertilizer Grade India Cost & Freight Cash Price, Sulphur - Vancouver fob Spot Price Gujarat State Fertilizers & Chemicals Ltd ACMIIL 13
Rock phosphate price ($/tonne) Sulphur ($/tonne) 2,500 2,000 1,500 1,000 500 - Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 900 800 700 600 500 400 300 200 100 0 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Source: ACMIIL Research, Crisil, Benzene - Landed Cost (`/tonne), FOB Korea ($/tonne) D) Government Regulation Government of India is directly responsible for supply of fertilizer with subsidized rates to the Indian farmers. The fertilizers consumption grew rapidly after green revolution due to larger use of fertilizers, high yield variety seeds, irrigation and usage of tractors. Fertilizer policy The primary reason for regulated fertilizer sector is to ensure food availability at affordable prices on time. The basis of policy choices and changes by Indian government are, Fertilizer at reasonable rates: Fertilizer plays an important role for development of agriculture, as it employs close to 60% of population. Due to lower income, farmers can t afford high fertilizer prices. Therefore, fertilizer sector needs to be regulated. There is huge difference between, cost of production of fertilizer and price at which farmer can afford. Therefore, the government fixes the price and difference between cost and price is paid as subsidy to fertilizer players. The price at which farmers buys fertilizers is called subsidized MRPs. Changes in farm gate price of urea Period Farm gate price (`/tonne) Pre Aug 1992 3,060 Aug 1992 - Jun 1994 2,760 Jun 1994 Feb 1997 3,320 Feb 1997 - Jan 1999 3,660 Jan 1999 Feb 2000 4,000 Mar 2000 Feb 2002 4,600 Mar 2002 Jan 2003 4,830 Feb 2003 5,070 Mar 2003 Mar 2010 4,830 Apr 2010 till date 5,310 Source: Crisil Gujarat State Fertilizers & Chemicals Ltd ACMIIL 14
Subsidy given to fertilizer sector ( ` bn) 700 600 500 400 300 200 100-1998-99 1999-00 Source: Crisil, FAI 2000-01 2001-02 Urea 2002-03 Over the years the there was no significant increase in the urea farm gate price amounting higher subsidy burden for government of India. In 2008-09, significant increase in complex fertilizer subsidy was due to decline in complex fertilizers prices and increase in feedstock prices. Controlling the cost: High dependence on imported fertilizer represent high dependence on international demand supply leading to increase in the fertilizer/ feedstock prices. Using balance nutrients: The government policies are based on objective of encouraging balance usage of nutrients (ratio of usage 4:2:1 for N,P and K). However, ratio is highly concentrated on nitrogenous fertilizer due to cheaper availability of urea and faster result for vegetative growth. Subsidy per nutrients (`/kg) Nutrients 2010-11 2011-12 % Change N 23.227 20.111-13% P 26.276 20.304-23% K 24.487 21.386-13% S 1.784 1.175-34% Source: Department of fertilizer Subsidy for complex fertilizers (`/tonne) Fertilizer 2010-11 2011-12 Change % DAP 16,268 12,960-20% MAP 16,219 12,770-21% Triple Super Phosphate 12,087 9,340-23% Muriate of Potash (MOP) 14,692 12,832-13% Single Super Phosphate 4,400 3,378-23% 16:20:0:13 9,203 7,431-19% 20:20:0:13 10,133 8,236-19% 23:23:0 11,386 9,295-18% 10:26:26 15,521 12,851-17% 12:32:16 15,113 12,332-18% Ammonium Sulphate 5,195 4,413-15% Source: Department of fertilizer 2003-04 2004-05 2005-06 Complex fertilisers 2006-07 2007-08 2008-09 Gujarat State Fertilizers & Chemicals Ltd ACMIIL 15
In November 2010, Government of India notified subsidy rates applicable for 2011-12. The government has reduced subsidy rates for all major nutrients. Maximum decline was in sulphur with 34%. This was done by the government to reduce subsidy burden. However, volumes and margin of complex players producing complex fertilisers is expected to decline in FY12E, due to lower subsidy realization and higher growth seen in the first half of FY11. Over the years government of India made many changes in policy for development of fertilizer sector and attempted to reduce the subsidy burden. Highlights of existing policy for Urea The new pricing scheme (NPS) stage-iii was announced in January 2007 effective from Oct 2006 to Mar 2010. This policy was driven towards greater efficiency in feedstock usage. The MRPs was fixed for end consumers (currently it is `5,310/ tonne), which was at discount rate to the actual cost and the difference was paid by the government as subsidy. Units, which are operating on other high cost fuel, are required to shift to natural gas till 2010. Transportation cost of gas will be paid separately. The government will control movement of urea up to 50% of production. (Detailed policy details refer Annexure) New investment policy for urea In Sept 2008, the government announced policy related to investment in new urea plants based on IPP (import parity price) with floor and ceiling price fixed at USD250/ tonne and USD450/tonne respectively. It included the revamp, expansion, revival of existing plant and Greenfield projects. The revamping of existing plant means increase in capacity of existing plant through investment up to `10 billion and additional urea production will be recognized at 85% of IPP. Expansion of project means utilizing some of common utilities and setting up of new ammonia/urea plant at existing fertilizer plant. The investment for expansion project should be in excess of `30 billion. The urea produce from the expansion unit will be recognized at 90% of IPP. The revival (sick) unit realization linked at 95% of IPP and for Greenfield projects price of urea will be determined through bidding route. (For detailed of new investment policy refer annexure) Highlights of current policy for complex fertilizer To adopt balance nutrients for all fertilizers, government introduced nutrient based subsidy scheme (NBS) for complex fertilizers. The pricing of fertilizers was based on their nutrients contents. The lower MRP of complex fertilizer was aimed at encouraging usage among consumer. To encourage balance nutrients, sulphur was included in the balance nutrient ratio and it is treated same as nitrogen, phosphorous and potassium (N:P:K:S). Expectation from policy change During the past fifteen years, nitrogenous fertilizer contributed two third of the total nutrients consumption in India, where urea is a dominant nutrient. Urea accounts in for more than 60% of total fertilizer subsidy over past ten years (grown at a CAGR of 17% to `339 billion in 2008-09). The consumption pattern in India suggests higher consumption of urea compared with complex fertilizers as it is cheaper and impact is immediately visible. The pricing policy for urea (NPS-III) was applicable till Mar 2010 and government is in the process of formulating a new policy. Over the years, the government had not increased the price of urea, as it is largely consumed by Indian farmers, resulting in huge amount of subsidy burden for the government. Additionally, Gujarat State Fertilizers & Chemicals Ltd ACMIIL 16
higher feedstock prices, railway freight, electricity charges and international prices of feedstock further increased the subsidy burden. Expectation The aim of government is to ensure availability of food at affordable price. Therefore, fertilizer sector is highly regulated. Over the past ten years, there was no significant increase in the farm gate price of urea, and the difference between cost of production and farm gate price was paid as subsidy to the farmers (e.g. Cost of producing one tonne of urea using natural gas is ~`10,500-12,000/tonne, compare to farm gate price of ` 5,310/tonne). We expect government to bring in an investor friendly policy for urea, so as to reduce the subsidy burden. Government has already introduced NBS policy for complex fertilizers. After NBS, prices of phosphate and potassic fertilizer have increased by ` 600/tonne and urea by ~10% to `5,310/tonne. Looking at the past history, the government cannot totally de-regulate urea, as it is largely consumed by farmers as well as it is a politically sensitive subject. The government is expected to de-control urea in a phased manner or bring the under NBS, similarly like complex fertilizer. We expect the government to increase urea price by 10-15% as seen in the past or bring it under NBS. Impact We expect that the total de-control of urea will increase the competition. Currently, there is limited competition in the urea sector, as it is driven by the government policies. The fertilizer sector is highly capital intensive. The average cost of setting up a Greenfield urea project is ~`33,000/tonne based on natural gas. The average construction period for the same is close to 35-40 months. In addition, the feedstock requirement, technology use, adequate monsoon etc are the important factors determining the profitability for the urea players. All these factors lead to the low margin, low investment by the urea players and higher subsidy burden for the government. In the de-control scenario, the government has to keep in mind the natural gas requirement from the urea players. Some of the players are still running the plant based on naphtha due to inadequate pipeline facility for the natural gas, resulting in lower profitability. We expect that de-control of urea will be done in the phased manner and GSFC will marginally benefit as urea contributes only 6% to its FY10 revenue. The players like Chambal Fertilizers, Nagarjuna Fertilizers, GNFC are likely to benefit most from the urea de-control as it is contributing 52%, 35% and 11% to the revenue of FY10. Sensitivity analysis for urea in FY12E % Increase in farm gate price 0% 5% 10% 15% EPS 59.4 59.6 59.7 59.8 Even a 15% per tonne increase in the farm gate price of urea by the government will not significantly change our estimate for GSFC. A 15% increase in farm gate price will lead to EPS of `59.8 and target price of `359. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 17
Outlook for fertilizer The demand/supply expectation for important fertilizer, urea and DAP. Domestic Historically, the nutrient consumption was higher towards nitrogen (N) due to its availability, lower farm gate price and higher self-sufficiency of urea. However, over the years we had seen movement towards balance nutrient. The nutrient consumption ratio improved to 4.6:2:1 in 2008-09 from 5.3:2.2:1 in 2005-06. The nutrient consumption ratio is expected to decline to 5.2:2.2:1.0 in 2010-11P and in time reach to 4.3:2.2:1.4 in 2013-14P. Source: FAI, Crisil Like nutrient consumption, product consumption is also concentrated on urea, which is moving towards balanced usage of complex/potassic fertilizers. Urea s share in total consumption declined in 2008-09 to 52.9% from 56.5% in 2007-08. Whereas, consumption of DAP increased to 18% from 16% in the same period. The urea s consumption is expected to increase to 30.8 million tonnes (50.4% share) in 2013-14P. DAP and other complex fertilizers are expected to grow to 11.9 million tonnes and 9.7 million tonnes respectively, in 2013-14P. Urea Due to lack of clarity from government s urea policy, the urea capacity has always failed to match demand. The demand for urea increased to 27 million tonnes in 2008-09 from 22 million in 2005-06, whereas capacity has increased from 19.7 million tonnes to 20.3 million tonnes in same the period. Therefore, part of the urea demand was imported. Source: FAI, Crisil Gujarat State Fertilizers & Chemicals Ltd ACMIIL 18
The urea demand is expected to decline 2% in 2009-10P to 26.2 million tonnes and imports are also likely to decline to 5.7 million tonnes compared to previous year. However, decline in imports are due to debottlenecking activities by certain players. The demand for urea is likely to recover from 2010-11E due to higher usage (as DAP is costlier then urea). Urea consumption is expected to grow at CAGR of 3% during 2009E-2014P to 31 million tonnes from 27 million tonnes. Import is expected to grow at CAGR of 3% during the same period. DAP In 2008-09, domestic DAP production declined as international price of DAP declined without corresponding fall in raw material price of rock phosphate and phosphoric acid. Therefore, there was increase in consumption of imports. India is largest importer of DAP in the world. Assuming the normal rainfall, DAP consumption is expected to increase at a CAGR of 5% during 2008-09E to 2013-14P. The increase in the consumption is likely to sustain by imports, which is expected to grow to 8 million tonnes in 2013-14P. DAP and the other complex fertilizers can be manufactured in the same unit. Therefore, players are likely to produce other complex fertilizers to meet supply. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 19
Business overview GSFC operates two business segments, fertilizers and industrial products which contributed 71% and 29% to the total revenue in FY10. In the fertilizer segment, major contributor was Di-Ammonium Phosphate (DAP) which contributed ~47% in FY10. While others like urea, ammonium sulphate (AS) and ammonium phosphate sulphate (APS) contributed 6%, 6% and 9% (of the total revenues) respectively in FY10. In the industrial products, major revenue contributor was caprolactam with ~15% contribution, while other chemicals contributed on an average of 1% to total revenue in FY10. Revenue contribution (%) 120% 100% 80% 60% 40% 20% 0% FY06 FY07 FY08 FY09 FY10 Fertilizers Industrial Products Source: Company, ACMIIL Research Fertilizer Segment In the fertilizer segment, DAP contributed 70% of total fertilizer revenue, while AS, Urea and APS contributed 8%, 9% and 13% respectively in FY10. Source: Company, ACMIIL Research GSFC is manufacturing nitrogen and phosphate based fertilizers. For nitrogen it has product base of fertilizers like urea and ammonium sulphate (AS) and for phosphate based fertilizers, it has product base like Di-ammonium phosphate (DAP) and ammonium sulphate phosphate (ASP). Urea GSFC has an installed capacity of 0.36 million tonnes for manufacturing urea, with average utilization of 72% over past five years (FY06-FY10). GSFC is categorized into mixed category under new pricing scheme (NPS), where it uses naphtha and natural gas as its feedstock for manufacturing urea. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 20
Manufacturing process for Urea Source: ACMIIL Research Urea is manufactured at high temperature and high-pressure condition with chemical reaction between ammonia and carbon dioxide. For hydrogen and carbon raw material requirement is natural gas/naphtha, while for nitrogen and oxygen, air is available. The retail farm gate price of urea has been increased by 10% to `5,310/tonne. This move is expected to reduce the urea subsidy for the Government. GSFC would benefit marginally from the price hike as urea contributes only 9% to the fertilizer revenue (6% of the total sales) in FY10. DAP GSFC has strong presence in phosphorus-based fertilizers (DAP) in India. For DAP, GSFC has highest market share of 63% in Gujarat. DAP contributed 70% of total fertilizer revenue in FY10 with total capacity of 0.8 million tonnes. Out of the total production of 2.99 million tonnes of DAP in India, GSFC produced 0.68 million tonnes during 2008-09. GSFC has capacity of 0.8 million tonnes per annum with 7% share in total capacity of 8.9 million tonnes per annum in India. Manufacturing process for DAP Rock Phosphare Sulphuric Acid Phosphoric Acid Gypsum Hydrofloric Acid Phosphoric Acid Ammonia Water DAP Source: ACMIIL Research Industrial Products In addition to fertilizer, GSFC has considerable presence in industrial products segment contributing an average of 31% over past five years. Industrial products has higher margin compared to fertilizer space. Fertilizer has an average EBIT margin of 8.15% over past five years (FY06-FY10) compared to 20.23% for industrial products. In the industrial products segment, caprolactam contributes almost 50% to the total revenue of industrial products. The other products contributed on an average of two percent (nylon 6 10%, melamine 7%, ammonia 5% and cyclohexanone 5% in industrial segment space) in FY10, in the industrial products segment. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 21
Revenue mix for industrial products in FY10 10% 7% 6% 5% 5% 5% 14% 49% Caprolactam Nylon-6 Ammonia Cyclohexanone Source: Company, ACMIIL Research Caprolactam Melamine Nylon Chips Nylon Filament Yarn Others Caprolactam is a base material for manufacture of nylon 6 and it is used to manufacture nylon 6 fibre for textiles, tyre chord, moulding engineering components and other extrusion profiles etc. Captrolactam is manufactured from benzene having input output ratio of 0.89 for GSFC in FY10 (i.e. one tonne of benzene gives 0.89 of caprolactam). The two major manufacturers of Caprolactam in India are GSFC, which has an installed capacity of 70,000 tonnes per annum, and Fertilisers & Chemicals, Travancore (FACT), with an installed capacity of 50,000 tonnes per annum. Caprolactam prices are volatile since it is derivative of benzene, which is a downstream product of crude oil. Any increase/decrease in global crude prices has a cascading effect on caprolactam prices. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 22
Key Positives A) NBS policy to benefit We expect players like GSFC to be a beneficiary of the Nutrient Based Subsidy (NBS) policy, as DAP is contributing on an average 71% of the fertilizer revenue in past five years (FY06-FY10). GSFC is expected to gain from this step, as growth in complex fertilizers is likely to be higher in FY11E and FY12E. After NBS policy, margins from the fertilizers segment had improved for the company. The fertilizer segment EBIT margin improved to 13% and 20% in Q1FY11 and Q2FY11 respectively. Similarly, EBIT contribution was 63% and 59% for this segment in the same period. Going forward, we expect the EBIT contribution to increase from 46% in FY10 to 54% in FY12E. B) Joint Venture for Raw Materials India is not self sufficient in raw material (ammonia, rock phosphate, phosphoric acid, potash, sulphur) used for complex fertilizer. Therefore, raw material linkage for manufacturing complex fertilizers decides revenue visibility going forward. Therefore, in 2006, GSFC had formed joint venture along with Groupe Chimique Tunisien (GCT) and Compagnie des Phosphates de Gafsa (CPG), both Tunisian companies and Coromandel Fertilisers Ltd (CFL). The joint venture company, Tunisian Indian Fertilizers (TIFERT) will produce 360,000 tonnes of phosphoric acid per annum. The 70% shareholding is with both Tunisian companies and 15% each with GSFC and CFL. The production will be divided 50% between CFL and GSFC. This will help GSFC to run DAP plant at full capacity. The project is expected to be operational in Q1FY12. However, due to lack of information, we have not considered this into our valuation. C) Leader in Caprolactam GSFC is leader in the manufacturing of caprolactam with the installed capacity of 70,000 tonnes per annum. Caprolactam production, sales and utilization (%) 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 - FY08 FY09 FY10 FY11E FY12E Production (MT) Sales (MT) Capacity Utilization % Source: ACMIIL Research 120% 115% 110% 105% 100% 95% 90% Over the past five years, the average capacity utilization in caprolactam was 111% with capacity of 70,000 tonnes per annum. Caprolactam contributed close to 50% of the revenue in the industrial product segment over past five years (FY06-FY10). Similarly, it contributed on an average of 16% in the total revenue over last five years. We expect revenue contribution to be 16% and 17% in FY11E and FY12E respectively, on back of increased in the price of caprolactam. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 23
Caprolactam price ( `/tonne) Prices for Benzene 160,000 70,000 1,400 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 60,000 50,000 40,000 30,000 20,000 10,000 - Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 1,200 1,000 800 600 400 200 Landed Cost FOB Korea - Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Source: ACMIIL Research, Crisil, Benzene - Landed Cost (`/tonne), FOB Korea ($/tonne) Price of caprolactam has been trading in range of `137,000/tonne in the past six month (April 2010-Oct 2010). Price of caprolactam largely depends on the price of raw material (benzene), accounting close to 40% of caprolactam cost (Source: Crisil). Any change in price of benzene has direct effect on prices of caprolactam. Price of benzene has been trading in the range of `45,000/tonne in past six months period (May 2010-Oct 2010). The increase in price is reflected in the price of caprolactam. SWOT Strengths Diversified business Leader in caprolactam Weakness Volatile industrial business High dependence on imports for raw material Opportunities Foreign tie-ups for supply of raw material Threats Highly regulated industry In a highly politically sensitive space Key Concerns In Nov 2010, Government of India notified subsidy rates applicable for 2011-12. The government has reduced subsidy rates for all major nutrients. This move of government was to reduce the subsidy burden. However, margin of players producing complex fertilisers is expected to decline in FY12E, due to lower subsidy realization. The company has to either reduce the cost by negotiating with global suppliers or increase the prices to the consumer; otherwise it would put pressure on GSFC s profitability. However, we have computed FY12E earning on basis of revised subsidy per kg on all four nutrients. GSFC is exposed with various types of risk in fertilizers and chemicals area. This includes raw material price movement and change in pricing policy by the government. The availability of natural gas is important for production of fertilizers. GSFC derives average 16% of total revenue in last five years from caprolactam. Any change in price of raw material, would impact profitability of GSFC. For the company, a normal rainfall, continuous and cheaper raw material availability and timely reimbursement of subsidy by the government would be important to sustain operating profitability. Peer Group The urea producer s performance depends on capacity additions, utilization, operational efficiency, capital structure and working capital management. As highly regulated sector, competition between urea players is limited. However, in complex fertilizers, the producers compete on basis of raw material sourcing, plant location and operational efficiency. Most of the complex fertilizer players focus on one or few grades with large marker share. GSFC is the market leader in Gujarat for DAP. Fertilizer sector is highly regulated by the government, so growth in earning is limited. Therefore, most of the players have diversified business areas. Gujarat State Fertilizers & Chemicals Ltd ACMIIL 24
Company Zuari Industries Tata Chemicals Nagarjuna Fertilizers Chambal Fertilizers Deepak Fertilizers GSFC Source: ACMIIL Research Diversified business area Cement Soda ash and cement Oil exploration, power Shipping, textiles Realty, chemicals Industrial products i.e. chemicals FY11E FY12E D/E^ PB^ ROE^ ROCE^ M Cap TTM Company PE (x) (x) (x) (%) (%) (` mn) Revenue (` mn) EBITDA Margin (%) PAT Margin (%) Fertilizers Revenue contribution Chambal Fertilisers 11.7 10.8 1.9 2.1 14.4 5.6 32,880 43,712 18 6 54 Coromandel International 6.7 5.5 1.3 2.1 32.7 19.1 81,414 74,478 16 9 100 Deepak Fertilisers 8.5 6.8 0.8 1.5 15.4 9.3 15,881 15,559 26 13 33 GNVF 11.5 6.5 0.3 0.9 24.1 21.4 18,464 24,422 11 3 61 GSFC* 5.1 5.6 0.3 1.2 11.9 14.9 26,618 42,913 20 11 71 Nagarjuna Fertilizers 8.2 6.6 3.3 1.3 4.1 2.1 13,209 25,843 17 4 100 RCF 21.4 19.7 0.9 2.6 6.9 6.2 50,424 53,614 9 4 80 Tata Chemicals 12.7 10.3 1.1 2.0 17.5 8.4 96,005 59,549 16 6 43 Zuari Industries 7.5 6.3 1.2 1.6 17.3 16.0 19,345 53,924 5 3 93 Average 10.4 8.7 1.2 1.7 16.0 11.4 15 7 71 Source: Bloomberg, CMIE, ACMIIL Research, *ACMIIL estimates, ^for FY10 Financial Performance Sales GSFC s revenue is expected to grow at CAGR of 8%, from `40,192 million in FY10 to `46,503 million in FY12E. The growth will be higher from industrial product segment i.e. 29% in FY10 to 33% in FY12E (as price of caprolactam increased in the past six months). However, during FY06-FY09, revenue contribution from industrial products showed a declining trend on account of volatile price of caprolactam (contributing ~50% in industrial product segment) Revenue contribution (%) 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY08 FY09 FY10 FY11E FY12E Fertilizers Industrial Products Source: ACMIIL Research (%) Gujarat State Fertilizers & Chemicals Ltd ACMIIL 25