October 3, 2018 Zuari Agro Chemicals Ltd. Integrated solution provider for farmers… CMP INR 243 Target: INR 400 Initiating Coverage: Buy Key Share Data Company Background Zuari Agro Chemicals Ltd. (Zuari), a part of Adventz Group of Mr Saroj Poddar (originally Face Value (INR) 10.0 promoted by Late K.K. Birla in 1967), is amongst India‘s largest pure-play fertilizer companies Equity Capital (INR Mn) 420.6 on a consolidated basis, manufacturing Urea, DAP, NPK and other complex fertilizers. Its eight Market Cap (INR mn) 10220.1 plants are located in Goa, Maharashtra, Karnataka (MCFL) and Odhisa (PPL) with an installed capacity of ~3.5 mtpa, sold under ‗Jai Kisaan‘ brand, with pan India presence. It also sells 52 Week High/Low (INR) 689/220 externally sourced products like DAP, SSP, MOP, specialty fertilizers, and other agri inputs like Avg. Daily Volume (BSE) 28,973 pesticides, seeds and micro-nutrients, through its extensive retail distribution network. It BSE Code 534742 acquired Mangalore Chemicals & Fertilisers Ltd. (MCFL) in 2015. It also owns 40% in its associate Paradeep Phosphates Ltd (PPL), Odhisa. NSE Code ZUARI Investment Rationale Reuters Code ZUAR.NS India’s largest private player in complex fertilizers with strong brand recall and robust Bloomberg Code ZUAC:IN distribution network Shareholding Pattern (Jun 30, 2018) Zuari Group (Zuari, MCFL, PPL) is the largest private complex fertilizer manufacturer in India. It is the largest Water Soluble Fertiliser (WSF) maker with 24% market share and fourth largest private DAP manufacturer with 16% market share. Its robust distribution network comprising of ~8,000 dealers and ~75,000 sub-dealers nationwide with access to ~23 mn farmers, helped Zuari Group retain its industry leadership. 24% Zuari enjoys strong brand recall and healthy relationship with farmers with multiple initiatives like training, soil testing labs, farm demonstration, creating customised products, providing Promoters agriculture equipment, arranging micro finance, crop insurance/loan, etc. DII 1% Zuari is strategically changing its business model from a B2G to B2C player, a FII potentially game changing value creating move. It has introduced its own multi-brand 9% Public & Others agri inputs retail chain of hubs under ‗Jai Kisaan Junction‘ brand, as a one stop agri shop for 66% farmers‘ needs and convenience, helping them to grow high quality products. Over 300 such stores are already operational in Karnataka and Maharashtra of which most are EBITDA positive. Zuari has plans to have 1,000 stores in next 2-3 years. These initiatives have played an important role in fortifying the foundation of the company across various markets, helping it to gain a critical edge over competition. Key Financials (INR mn) A business process rejig has helped improve operational efficiencies like reduction in Particulars FY17 FY18 FY19E FY20E inventory, unlocking valuable working capital in this working capital intensive industry. Strategically located manufacturing facilities with long-term raw material tie-ups Net Sales 63,854.2 72,647.8 87,192.8 98,116.9 All Zuari group manufacturing facilities are strategically located near ports and in proximity Growth (%) -16.1% 13.8% 20.0% 12.5% to inland domestic market, which makes it easier for the company to import raw materials EBIDTA 4,656.6 5,351.3 5,077.5 6,204.2 for its production, complex fertilizers and other agri products for selling to the end PAT (438.7) 1,289.9 887.1 1,682.5 consumer s, saving in logistics and other costs. Growth (%) -64.3% -394.0% -31.2% 89.7% As a major competitive advantage, Zuari has long standing tie-ups with its suppliers for EPS (INR) -10.4 30.7 21.1 40.0 sourcing key raw materials viz. Rock Phosphate, Phosphoric Acid, Ammonia, Potash etc., ensuring timely availability. Procurement price of LNG from GAIL has reduced from USD BVPS (INR) 397.3 351.0 372.1 412.1 16 /MMBTU in 2016 to USD 9/MMBTU, post gas price pooling mechanism. Key Financials Ratios Strategic change in product mix and well-timed capex to increase capacity and meet Particulars FY17 FY18 FY19E FY20E tightened energy saving norms P/E (x) (23.3) 7.9 11.5 6.1 Zuari has made a strategic change in its diverse product mix with a higher focus on complex fertilisers like NPK compared to Urea, for higher pricing flexibility and better margins. With P/BVPS (x) 0.6 0.7 0.7 0.6 complex fertilizer CU of MCFL over 90%, for further long term growth, it is setting up a new Mcap/Sales (x) 0.2 0.1 0.1 0.1 NPK plant with capacity of 800,000 MTPA at Panambur at an estimated capex of Rs. 6 bn to be met through a 70:30 mix of debt and equity, expected to be commissioned by FY22E. EV/EBITDA (x) 10.9 9.7 11.4 10.5 ROCE (%) 6.7% 7.8% 6.5% 7.3% To meet the tightened energy saving norms, Zuari is revamping its Urea unit with an ROE (%) -2.6% 8.7% 5.7% 9.7% investment of Rs 13 bn at Goa, making it more energy efficient and increasing production. Consequently, Urea capacity will increase ~50% from 1,210 MTPD to 1,800 MTPD and EBIDTA Mar (%) 7.3% 7.4% 5.8% 6.3% energy consumption per tonne of Urea will reduce from 6.6 G Cal to 5.39 G Cal by April PAT Mar (%) -0.7% 1.8% 1.0% 1.7% 2020, making Zuari amongst the most energy-efficient plants in India. Debt - Equity (x) 2.5 2.9 3.1 3.2 MCFL is revamping its Urea unit at an estimated cost Rs. 3.5 bn to be met through internal Source: Company, SKP Research accruals and debt. This will reduce energy consumption from 6.65-6.70 G Cal to 5.25 G cal Price Performance Zuari vs BSE Small Cap by April 2020, though capacity will remain unchanged at 1,150 MTPD. Zuari plans to raise funds by making a Rights Issue of Compulsory Convertible Debentures, 50% Zuari BSE SMALLCAP not exceeding Rs 5 bn and a Foreign Currency Convertible Bonds issue or other similar 40% securities upto Euro 32 mn, on private placement basis. 30% 20% Valuation 10% Amongst India‘s largest pure play fertilizer manufacturers, Zuari has a strong brand recall, 0% robust distribution network and has planned a well-timed capex to expand capacity, improve -10%03-Oct-17 03-Jan-18 03-Apr-18 03-Jul-18 efficiency, productivity and energy saving. Strategic creation of a large retail network to provide -20% integrated solutions to farmers needs at one place, can be a game changing value enhancer. It -30% is well-placed to reap benefits of reforms like DBT of fertilizer subsidy, etc. Although the long -40% term big picture is more attractive, uncertainties have been created in the near term by the -50% recent devaluation of INR. Zuari has significant imports. Rising prices may have a bearing on -60% demand of its products amongst farmers; response by GoI, fertilizer industry and the company Analysts: Vineet Agrawal needs to be seen. In view of this, we have currently valued the stock at a P/E of 10x of FY20E Tel No: +91-22-49226006; Mobile: +91-9819510575 EPS of Rs 40 and recommend buy on the stock with a target price of Rs 400 (~65% upside) in E-mail: [email protected] 15 months, subject to future re-rating as clarity emerges. SKP Securities Ltd www.skpsecurities.com Page 1 of 36 Zuari Agro Chemicals Ltd. Fertilizer Industry –An Overview Fertilizer is defined as any organic or inorganic substance, natural or artificial in nature, supplying one or more of the chemical elements/nutrients required for plant growth. Categories of nutrients: Sixteen plant nutrients are necessary for plant development. These are classified into three categories viz. primary (macro) nutrients, secondary nutrients and micro-nutrients. Application of essential plant nutrients in right proportion, with the use of correct method and time of application helps in increasing crop production. Category Nutrients Comments Nitrogen (N) These are basic nutrients Primary nutrients Phosphorus (P) needed in large quantity Potassium (K) Calcium (Ca2+) Secondary nutrients Magnesium (Mg2+) Needed in small quantity Sulfur Iron, Cobalt, Chromium, Lack of micronutrients may Micronutrients Copper, Iodine, Manganese, hamper plant growth Selenium, Zinc, etc. Source: SKP Research Primary nutrients: Primary nutrients are Nitrogen (N), Phosphorus (P), Potassium (K), Ammonium (NH4+), Dihydrogen Phosphate etc. NPK are frequently required in a crop fertilization programme and are needed in larger quantity by plants. Indian Fertilizer Industry majorly focuses on primary nutrients. Secondary nutrients: Calcium (Ca2+), Magnesium (Mg2+) and Sulfur are secondary nutrients for plants, but are as important as other essential plant nutrients. Micronutrients: Micronutrients which includes Iron, Cobalt, Chromium, Copper, Iodine, Manganese, Selenium, Zinc and Molybdenum, are nutrients required by plants throughout their life in small quantities to orchestrate a range of physiological functions. Although required in smaller quantity, micronutrients are as important to plant nutrition as primary and secondary macronutrients. A lack of any one of the micronutrients in the soil can limit growth, even when all other nutrients are present in adequate amounts. SKP Securities Ltd www.skpsecurities.com Page 2 of 36 Zuari Agro Chemicals Ltd. Industry and Trends Currently, there are 144 large fertilizer plants in India producing various nitrogenous, phosphatic and complex fertilizers. Of these, 31 plants (29 in operation) produce Urea and 33 plants produce DAP and complex fertilizers. In addition, there are about 80 small & medium scale plants in operation manufacturing Single Super Phosphate (SSP).