But high inventories increase monsoon dependency for fertiliser makers
The reduction in nutrient-based subsidy (NBS) rates announced last week could trim the government’s subsidy bill for phosphatic fertilisers by Rs 5,000 crore next fiscal. The cut, which follows declining international prices of di-ammonium phosphate and ammonia, would influence the contracted price for phosphoric acid, the key raw material, for fiscal 2017.
However, even if domestic manufacturers are able to negotiate a lower contracted price for phosphoric acid, it may not be enough to offset the subsidy reduction because they have been grappling with high NPK (nitrogen, phosphorus and potassium) inventories in the backdrop of stressed farm incomes. As a result, operating margins of phosphatic fertiliser makers could reduce by up to 75 basis points (bps) in fiscal 2017.
To be sure, there is some offset available -interest expenses are expected to decline because of lower working capital needed to finance subsidy receivables.
Two consecutive years of deficient monsoon has burdened the fertiliser industry with excess inventory, estimated ~5 million tonne, which is equivalent to 90-100 days of consumption. That means manufacturers will have limited ability to increase prices to compensate for the reduction in subsidy, which, in turn, increases their dependence on monsoons. They will also be compelled to offer discounts to clear inventory before the upcoming kharif season.
Sudip Sural, Senior Director, CRISIL Ratings, said: “Overall subsidy bill reduction would be Rs. 10,000 crore next fiscal – Rs . 5,000 crore through the cut in NBS rates, and a similar amount in urea subsidy because of lower gas costs. This could help the government bring down its fertiliser subsidy arrears of ~Rs. 35,000 crore that’s being rolled over since fiscal 2012. But achieving a balanced nutrient ratio, which was one of the objectives of NBS, remains a far cry, given the continuing price disparity between urea and phosphatic fertilisers.”
While CRISIL -rated large manufacturers are also likely to face profitability pressures, their flexibility to manufacture different grades of complex fertilisers, backward integration, and strong raw material tie-ups will moderate the impact. Further, their strong brands and entrenched market position provide afford them relatively better pricing flexibility. With no long-term debt, they also enjoy strong financial flexibility –something that will support their credit profiles over the medium term.
The upshot is that the cut in NBS rates for nitrogen and phosphorus nutrients will not have a material impact on credit profile of our large rated players. However, dependence on monsoons, favourable movement in raw material price, and vulnerability to fluctuations in currency will remain the key monitorables.
The Cabinet Committee on Economic Affairs announced NBS rates for phosphatic and potassic fertilisers on March 23, 2016, which were significantly lower than in fiscal 2016. While subsidy rates for nitrogen and phosphatic nutrients have been slashed by Rs.5 per kg and Rs.5.40 per kg, respectively --representing ~25% and 30% reduction, respectively --the subsidy rate for potassic nutrient was kept almost unchanged.
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