Decontrolled fertilisers: Stunted by policy

Anup Menon

``This is the first time that the fertiliser and bulk chemicals business of the company have declared a loss for circumstances beyond its control...'' -- Statement by Hind Lever Chemicals on its dismal performance in 2000-01 first half.

THIS IS a case of an industry, though catering to the vital agricultural sector, reeling under pressures of an unfriendly policy framework. As a direct consequence, profitability of most companies has been affected, leading to poor valuations in the market. The beating the major fertiliser stocks, both phosphatic and nitrogenous, have taken over the last few years has no doubt left investors wondering if there is at all any prospect of making gains even over the very long term.

Considering the burgeoning population and the need to produce more food with little prospect of increasing the area under cultivation, fertiliser use has to perforce improve. But this has not been reflected in the performance of the companies. Fertiliser-use is an important determinant, and studies have been done also to arrive at the right mix of nitrogen, phosphate and potash for best yields. Yet, this recommended mix is not followed, mainly because of the policy framework.

Distortion affects decontrol

Urea is one of the major nitrogenous fertilisers and at present the only one under government control. Di-ammonium phosphate (DAP) and single super phosphate (SSP) are the other major nutrients. DAP and other complex fertilisers were decontrolled in 1992. At that time, prices of DAP and other decontrolled fertilisers started rising rapidly and the farmers sacrificed the right mix for cost considerations. The government decided to intervene, and artificially fix the price. This led to the present piquant situation.

Telling effect on performance

A key indicator of the state of an industry is the performance of its major players. The performance of most of the fertiliser majors-- SPIC, Hind Lever Chemicals, Coromandel Fertilisers, GSFC, EID Parry and Godavari Fertilisers -- for 1999-2000 was not impressive, mainly because the industry has been going thorough a turbulent phase.

For instance, Hind Lever Chemicals, a leading player in eastern India, reported a loss of Rs. 11.60 crores in 2000-01 first half compared to a profit of Rs. 17.9 crores in the corresponding previous period. The loss can be attributed to the reduction in the subsidy on DAP and the delays associated with its payments by the government.

Or, take the case of Deepak Fertiliser. In a volume-dependent industry, the company's performance has not been heartening. Sales revenues remained steady at Rs. 127.12 crores for the quarter ended June 2000, a marginal dip of around Rs. 64 lakhs compared to the corresponding previous period. The company reported a net profit of around Rs. 11.22 crores compared to Rs. 14.44 crores.

The future also does not appear bright as the impact of policy changes is likely to be more pronounced in the coming years. Thus, fertiliser companies have realised that depending on revenues from this source alone may cause problems for the future. Hence, many, such as GSFC and Deepak Fertilisers, have diversified into related businesses such as chemicals.

Thus, GSFC's performance was not very volatile because the company derives around 20 per cent of its revenues from the chemicals business. Further, it also has the advantage of catering to the market in western India, which is a deficit region.

Role of micronutrient mix

Have the trends in production and consumption of decontrolled fertilisers changed over the last couple of years? A key factor here would be the determination of the NPK ratio. The universally accepted ratio is 4:2:1. The weight attached to phosphates in the overall mix works out to around 29 per cent. However, trends in the actual mix show some skew. The NPK ratio in India for 1998-99 was 8:3:1. Effectively, this translates to around 25 per cent of phosphatic fertilisers, which is lower than the prescribed minimum.

This may pose a problem in the long run on crop yields. Fertilisers are used basically to improve yields. For instance, the average national food production increased from around 640 kg per hectare in the mid-1960s to around 1,650 kg in 1998-99, with a tremendous growth in the consumption of fertilisers. Yet, the average nutrient consumption, at around 89 kg/hectare, is still much lower than that in some developed countries such as the US, the UK and France.

This may have a serious negative impact on soil fertility and re-usability over the long term. In fact, scientists have confirmed that Indian soil is deficient in nitrogen. Studies have also shown that in most States the phosphate content in Indian soil ranges from medium to low.

Problem of skew

This problem is mainly because of the skewed NPK ratio. Why are farmers not inclined to using phosphatic fertilisers? The main reason is in terms of cost differentials. With urea costing half that of DAP, there has been a widespread switch from the latter to the former. This means the soil will be deficient in micro-nutrients, critical for yield sustainability.

Trends in production and consumption

But the usage pattern seems to be changing for the trends in consumption indicate improved usage of phosphatic fertilisers, especially DAP. The compounded annual growth rate (CAGR) of DAP consumption over the last 10 years has been around 4 per cent, which is quite healthy. At the same time, the CAGR of SSP and of muriate of potash (MoP) has been around 0.46 per cent and a negative growth of 0.07 per cent respectively.

Production has also been on the rise. DAP output increased at a compounded rate of around 6 per cent over the last seven years. Capacity addition grew at a CAGR of around 2 per cent during this period.

An important question is whether increasing capacity in this market pays off? This is a not an easy decision for managements. On the one hand, the Government fixes the selling price and the subsidy levels. This implies that companies have to generate profits through volumes. On the other, capacity enhancement calls for capital investment. With the state the industry is in, raising funds at competitive rates is not going to be easy.

Imports, dumping and the rupee

Given the situation in the market on account fixed prices, manufacturers also rely on imports to help boost margins. International prices of DAP has been falling consistently. For instance, since November 1995, DAP prices have fallen from $247 per tonne to $148 in March 2000.

For some firms imports constitute nearly 40 per cent of the total turnover. The landed cost (including freight) works out to Rs. 10,500 per tonne. After taking into account the selling price and the subsidy receipts, the importer is left with a profit of around Rs. 1,200 per tonne. Thus, many companies started importing DAP. In 1999-2000, out of the estimated demand of around 6 million tonnes, around 3.3 million tonnes were imported.

But the profitability of the import route is also coming under pressure. According to industry sources, there has been dumping by foreign manufacturers. This has led to offer of massive discounts, which domestic producers are unable to match, affecting their operations. This has strained the margins of most producers. The recent depreciation of the rupee is only likely to aggravate the negative impact on their profitability levels.

The feedstock conundrum

Among the problems faced by the manufacturers of DAP and other complexes is that of the availability of feedstock -- phosphoric acid and ammonia. With the domestic availability of these products low, most companies depend on imports. The existing total capacity of for manufacturing phosphatic acid is 8.76 lakh tonnes per annum. An additional 9.69-lakh-tonne capacity is under implementation. This means that the total capacity will be around 18.46 lakh tonnes.

In the international market, the prices of ammonia and phosphoric acid have been more volatile than that of rock phosphate and naphtha. Hence, it may be worthwhile for companies to integrate backwards and produce phosphoric acid. This has been one of the critical success factors of Coromandel Fertilisers. The company had partially integrated backwards and to some extent insulated itself from adverse movements in prices of phos acid.

With the recent fall in prices, there may be no cost advantage, but it still is not a settled state to feel comfortable about. For instance, prices of phos acid fell from around $420 per tonne about a year back to around $350. But prices could move back to $400 levels, in the near term, once again highlighting the benefit of having an integrated plant.

Though many companies would like to integrate backwards, fertiliser companies may find it difficult to do so now, given the lack of interest in the sector. The main problem for many of these companies is that they may not be able to raise funds at reasonable costs (equity or debt) to proceed with the retrofitting.

Key factors to watch

Though the picture is not rosy, what is important is that there exists scope for growth for the industry; the fertiliser demand is sure to keep rising. But the availability of key raw materials would be a critical factor determining the viability of most firms.

Since the country is short on such raw materials as rock phosphate and sulphur, companies such as SPIC have set up units abroad as joint ventures. The key factor here is the ability of the company to negotiate reasonable prices in these joint ventures; the pricing is linked to international rates and also depends on the rupee value. Thus, this may not give a company any significant benefits as importing may be a better option.

The other key factor to valuation is the government policy which must be clear so as to ensure some certainty in the operations of the industry. This means the government has to determine whether the higher level of farmgate prices will affect the farmers. Industry sources feel that the impact on the large farmers is likely to be minimal; the marginal farmer would be the worst hit. But given the politically sensitive nature of the issue, this may not be possible. This is something the government will have to look into and support over the next few years. But, ultimately, this may turn out to be the only way for the industry to get out of the quagmire of low profitability affecting growth prospects.

Decontrol -- Hangman's noose

Though the phosphatic and complex fertilisers industry has been decontrolled since 1992, development is still impeded. The Government still fixes selling price and concessions, implying that the companies do not have the flexibility to pass costs on to consumers.

In June, the Cabinet Committee of Economic Affairs (CCEA) reduced the base rate of concession for indigenous di-ammonium phosphate (DAP) and single super phosphate (SSP) for 2000-01. To keep the subsidy bill from rising, the base rate of concession for indigenous DAP was reduced by Rs. 900 to Rs. 2,800 per tonne with effect from April 1, 2000. However, for muriate of potash (MoP) the base rate rose Rs. 105 to Rs. 2,800 per tonne.

In the 2000-01 Budget, the Government announced its decision to raise the selling price of fertilisers. Following this, DAP prices rose by 7 per cent and MoP by 15 per cent. This means DAP prices effectively rose to Rs. 8,900 per tonne and MoP's slid to Rs. 4,255 per tonne.

In the present system, companies sell their products at a fixed selling price that is normally lower than the cost of production. The subsidy covers the additional cost incurred by the company. Since the subsidy levels are fixed and determined on ad hoc basis, the margins of a company could be affected if its overall costs go beyond the determined subsidy levels.

The average cost of production of DAP works out to about Rs. 12,000 per tonne. The manufacturer recovers Rs. 8,900 per tonne on selling price and will receive Rs. 2,800 per tonne as subsidy. Hence, the producer bears an additional cost of Rs. 300 per tonne. Given that the financial stability of most fertiliser companies, with the exception of some top players, is questionable, it is only a matter of time before the smaller units become unviable.