The Hindu Business Line : Fertilise your portfolio

AFTER hibernating for quite some time, fertiliser company stocks woke up to the stock market rally of 2003. Stocks such as Indo Gulf Fertilisers, Tata Chemicals and Chambal Fertilisers were re-rated, with their valuations climbing from 3-4 times their earnings, to 7-8 times their trailing earnings per share, at present. Investors with a long investment horizon can view the recent decline as a buying opportunity in the stocks of Indo Gulf Fertilisers (Rs 97) and Tata Chemicals (Rs 120), as these companies appear well-placed to benefit from the eventual decontrol of the sector.

However, even these companies are unlikely to display linear growth in their profits. In the near term, lower subsidies and rising input costs could exert pressure on profit growth for these companies, even if the spillover from a good monsoon does result in good sales growth. Equity expansion is also a possibility, with both companies mulling capex plans and preparing to bid for PSU fertiliser capacities which are on the block.

GNFC (Rs 58) and Chambal Fertilisers (Rs 19) have registered reasonable profit growth in 2003-04. Their cost structures also compare well to others within their group. But to make a successful transition to the decontrolled regime, these companies will have to switch over from feedstock such as fuel-oil and naphtha, respectively to natural gas or LNG. As the subsidy regime is tightened, consolidation within the industry appears increasingly likely. Economies of scale will certainly become important if players are to compete with imports. This could trigger the acquisition of the smaller stand-alone units by those which manage larger capacities.

With capacities of 3-4 lakh tonnes per annum, the urea facilities of Shriram Fertilisers at Kota, Zuari Agro at Goa, Mangalore Chemicals and SPIC at Tuticorin, and GSFC at Baroda may become part of the consolidation process within the private sector.

The future of loss-making units, such as Duncans Industries, Nagarjuna Fertilisers (Rs 7.3) and Oswal Chemicals (Rs 6), may also be decided over the next three-four years. Their turnaround will hinge on the success of the debt restructuring measures already initiated by them and on the unfolding feedstock scenario.

Given their reasonable scale of operations and scope for improvement in their cost structure, investments in stocks such as Nagarjuna Fertilisers, Oswal Chemicals at current levels may pay off over the long term. But this is a very risky proposition, as the group-pricing regime will put the profitability of these companies through the wringer in the near term. Investors in these stocks can certainly hold their exposures in the hope of an unlocking of value over the long term.

The pace of consolidation in the industry may also be set by the progress of the PSU divestment programme. RCF appears the most attractive of the PSUs in terms of the urea capacities which are set to be put on the block. But National Fertilisers and Madras Fertilisers, in that order, may also be desirable acquisition candidates due to their large capacities and the geographical spread of their operations, which are not matched by the private players.

The Zuari-Chambal group, the Tatas, the Aditya Birla group and the Murugappa group appear to be the four major contenders for these capacities among the domestic players. But if all of the three PSUs are divested in quick succession, this may leave these acquirers with very little appetite for any fresh acquisitions from the private sector. This could postpone any unlocking of value in the smaller and loss-making urea units in the private sector..

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