October 26, 2017 Chambal Fertilizers and chemicals Ltd. Bridging structural demand supply gap for growth CMP INR 141 Target INR 228 Initiating Coverage – Buy Key Share Data Company Background Face Value (INR) 10.0 Chambal Fertilizers and Chemicals Ltd (Chambal), promoted by Late K K Birla in Equity Capital (INR Mn) 4162.1 1985, now professionally managed under Chairmanship of Mr Saroj Poddar, is Market Cap (INR mn) 58685.3 India’s largest private sector urea manufacturer. Its two hi-tech nitrogenous fertilizer plants are located at Gadepan, District Kota, Rajasthan, with an installed capacity of 52 Week High/Low (INR) 157/54 ~2 mtpa, sold under ‘Uttam Veer’ brand, primarily in North & West India. It trades in Avg. Daily Volume (BSE) 229,282 complex fertilizers like DAP, MOP, NPK fertilizers, crop protection chemicals BSE Code 500085 (insecticides, fungicides & herbicides), seeds, sulphur, micro-nutrients, complex NSE Code CHAMBLFERT fertilisers and city compost etc. Reuters Code CHMB.NS Investment Rationale Bloomberg Code CHMB:IN Largest private urea manufacturer with robust distribution network Shareholding Pattern (Sept 30, 2017) Chambal is the largest domestic private urea manufacturer with ~6% market share (4th largest in capacity). It has a vast marketing network comprising ~11 regional offices, ~1,500 dealers and ~20,000 village level outlets, through which it caters to farmers in ~10 states in northern (80%), central and western regions 21% of India. To broaden its product offerings, Chambal trades in P&K fertilizers, specialty fertilizers, pesticides, seeds and micro nutrients. Promoters Well timed capex to bridge structural demand supply gap FII With no new capacity addition during the last 2 decades (except revamp of few 13% 58% DII existing plants), India is now a urea deficit market where it produces ~24 mn mt against demand of ~32 mn mt. With a view to bridge this gap, and 8% Government’s favourable New Investment Policy, Chambal is setting up 1.34 mtpa brownfield urea plant at Gadepan, Rajasthan (named as Gadepan III) at a capex of USD 917 mn (~Rs 59.4 bn) of which ~USD 711 mn is being funded through debt. The plant is expected to commission by January 2019. Post Key Financials (INR mn) expansion, Chambal’s urea capacity will increase from 2.01 mtpa to 3.35 Particulars FY17 FY18E FY19E FY20E mtpa, further strengthening its leadership position in the industry. Net Sales 75,534.5 81,784.3 88,002.0 112,590.7 Chambal has entered into long term agreement w.e.f. April 1, 2018 with GAIL Growth (%) -28.2% 8.3% 7.6% 27.9% for supply of natural gas for Gadepan III unit. The gas can also be used in EBT 5,656.3 8,056.4 8,337.9 14,505.9 existing plants Gadepan I & Gadepan II. PAT 2,092.1 5,268.1 5,452.2 9,485.4 Easing/favourable Government regulations augurs well Growth (%) -3.2% 151.8% 3.5% 74.0% The fertilizer industry is highly regulated and with an aim to boost investments, EPS (INR) 5.0 12.7 13.1 22.8 GoI has initiated policy steps that could structurally improve fertiliser industry’s BVPS (INR) 51.0 61.4 72.2 92.7 dynamics with schemes like gas price pooling, DBT, NPS III, Modified NPS III, Key Financials Ratios New Investment Policy, and New Urea policy. The manufacturers get subsidy based on the policies slated in these schemes. Particulars FY17 FY18E FY19E FY20E P/E (x) 28.1 11.1 10.8 6.2 Gas price pooling seeks to change industry dynamics by levelling gas costs for P/BVPS (x) 2.8 2.3 2.0 1.5 all players. The scheme encourages competition among fertilizer manufacturers Mcap/Sales (x) 0.8 0.7 0.7 0.5 mainly on the basis of energy efficiency and production volume and not on price of natural gas input. EV/EBITDA (x) 13.3 15.0 15.2 7.8 ROCE (%) 10.1% 8.2% 7.3% 11.4% Under DBT, the government aims to transfer the subsidy amount directly to ROE (%) 9.9% 20.6% 18.1% 24.6% manufacturers and importers on the basis of actual sales made by retailers to EBT Mar (%) 7.5% 9.9% 9.5% 12.9% beneficiaries. Currently, pilot projects are being conducted and pan-India DBT PAT Mar (%) 5.0% 6.4% 6.2% 8.4% rollout will take some time. Post DBT implementation, we believe companies Debt - Equity (x) 2.2 2.7 2.8 2.3 across the sector are likely to benefit in terms of better working capital cycle. Source: Company, SKP Research Sale of non-core business to turn Chambal a pure urea company As part of long-term strategy, Chambal has divested its non-core businesses Price Performance Chambal vs BSE 500 (textiles, shipping and BPO/BPM arm of IT business solutions). These three 180% businesses were either loss-making or had relatively lower margins, but 160% Chambal 140% BSE 500 accounted for ~30% of the company’s capital employed. 120% The business reorganisation has enabled Chambal to focus on its core 100% 80% business of urea manufacturing and trading in complex fertilisers, where it is 60% planning an aggressive expansion. 40% 20% Valuation 0% Chambal is the largest private urea manufacturer with robust distribution 16 16 17 17 16 16 17 17 17 17 -20% 17 17 17 - - - - - - - - - - - - - network and has planned a well timed capex to bridge structural demand supply Jul Jan Jun Oct Sep Feb Apr Sep Dec Aug Nov Mar May gap in the industry. Post FY19, it is well placed to reap the benefits of reforms Analysts: Nikhil Saboo such as DBT of fertilizer subsidy and possible steps towards removing price Tel No: +91-33-40077019; Mobile: +91-9330186643 regulations on urea in the long term. Its earnings and margins profile is also e-mail: [email protected] likely to improve substantially. VineetAgrawal We have valued the stock at a P/E of 10x of FY20E EPS of Rs 22.8and Tel No: +91-22-49226006; Mobile: +91-9819510575 recommend buy on the stock with a target price if Rs 228 (~62% upside) in 18 e-mail: [email protected] months. SKP Securities Ltd www.skpmoneywise.com Page 1 of 26 Chambal Fertilizers and Chemicals Ltd. Fertilizer industry – an overview Fertilizer is defined as any organic and 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. Thus, the 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 life in small quantities to orchestrate a range of physiological functions. Micronutrients are as important to plant nutrition as primary and secondary macronutrients, though plants don't require as much of them. 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.skpmoneywise.com Page 2 of 26 Chambal Fertilizers and Chemicals Ltd. Demand drivers for fertilizers 1. Scarcity of nutrients creates demand for fertilizers: Deficiency of nutrients that are essential for plant growth can lead to lower plant yield. More than 50% of districts in India are deficient in essential plant nutrients, as shown in the diagram below: Source: Investor Roadshow Presentation – May 2017 – Coromandel Fertilizers As per the estimates of ‘Indian Institute of Soil Science’, about 90 mn hectare land is affected by various soil related deficiencies and around 41% of the Indian soil are deficit in Sulphur content leading to stunted plant growth and subsequent lower yields. This creates demand for fertilizers and opportunities for players like Chambal. 2. Unbalanced nutrient applications: Though India ranks amongst the largest agriculture economies globally, its crop yields remain marginal. Nutrient application, a major determinant to crop productivity, has been grossly inadequate and unbalanced, affecting soil health and output quality. Against the ideal NPK nutrient application ratio of 4:2:1, fertiliser usage is divergent towards N, recording nutrient ratio of 7.8:3.2:1 in 2015-16. The main reason behind this imbalance is availability of urea at subsidised price (Rs 5,360/ton), leading the farmers to use urea in unbalanced way. This has also led to illegal export of urea to neighbouring countries. Potash and Phosphate fertilizers are available at ~Rs 24,000/ton and are currently under a decontrolled regime (sold at indicative maximum retail prices). Once decontrolled, there was a steep hike in P&K fertilizers resulting in decline in their demand, causing nutrient imbalance in the soil.