Ambit Fertiliser Thematic Too Much Optimism 01mar2018

Fertiliser
NEGATIVE
THEMATIC March 01, 2018
Too much optimism Only 33% of urea subsidies go to small

farmers - the actual beneficiaries
Nothing much will change for the fertiliser industry (neither profitability
nor subsidy reduction) due to the hyped DBT adoption. Mechanism for
urea subsidies doesn’t define both the beneficiary and the entitlement,
making it ineffective unlike in the case of LPG or food subsidy. Working
capital cycle would remain high as receivables reduce but inventory
days increase (by 90+ days) as sales recognition gets deferred to final
sale to the farmer. Subsidy backlog (Rs300bn) is unlikely to be cleared
amid increased public dole and uncertainty over tax collection growth.
Incremental profitability improvement for urea players is primarily a
function of energy efficiencies, with Chambal seeming to be the only Source: Note ‘Redesigning India’s Urea Policy’, Ambit
Capital
listed beneficiary. Coromandel also stands out given its limited WC
problems and a growing non-fertiliser portfolio. Urea players are significantly leveraged to
subsidy receivables
Fertiliser subsidies account for ~7% of India’s tax collections Particulars Cham
GNFC GSFC RCF NFL
India roughly spends US$11bn on fertiliser subsidy. The fertiliser subsidy bill FY17 Rs bn) bal
Subsidy
accounts for ~26% of the overall subsidy bill. These subsidies have grown at Receivable 6.4 26.4 19.3 31.9 40.4
10% CAGR over the last decade. Within fertilisers, though the Government Interest
capped P&K subsidies in 2010, it continues to give subsidies (70% of fertiliser Foregone @
0.5 2.1 1.5 2.5 3.2
8%
subsidies) in an uninhibited manner. However, most of this subsidy is wasteful Tax Rate* 27% 34% 30% 28% 36%
as nearly 36% of fertiliser subsidy gets leaked to other countries or gets used in
Current PAT
industrial applications. Another 22% is given to the undeserving rich farmers 5.2 3.6 4.2 1.8 2.1
Profit
due to lack of effective targeting mechanisms. Scalability% to 7% 39% 41% 103% 100%
Current PAT
Urea subsidy are different from LPG and food subsidies
Source: Ambit Capital
Many investors believe urea subsidy may turn out to be similar to
diesel/petrol/LPG subsidies in reducing WC and improving profitability. Without Fertiliser - a lost opportunity: In current form
properly defining the beneficiary and entitlement, not many benefits can be of DBT, we won’t see much reduction in
realised from DBT. Food subsidy is easier to implement given fixed quantities of subsidies or their targeting
Urea
wheat/rice on every ration card. Neem coating may cut down 5-10% leakages, Fertiliser
P&K LPG Kerose ne Food
though our channel checks suggest pilferage has continued even after these Beneficiary Uni vers al Uni veral Defi ned Defi ned Defi ned
initiatives. Shift in recognition of sale from receipt at the district level to point of Quantum of
Not Not Not
subsi dy per Capped Not Capped
sale will increase inventory days for urea players by 90-100 days and will take uni t
Capped Capped Capped
Quantity of Not Not
away most of the gains from reduced receivables. subsi dy Capped Capped
Capped Capped Capped
Source: Company, Ambit Capital

Energy efficiencies seem the only way to remain viable
Instead of taking price hikes on urea, the Government has resorted to
consistently pushing fertiliser players to reducing fixed and variable costs.
Maximising production, reducing specific energy consumption and minimising
non-energy costs now constitute the only way for fertiliser companies to remain
viable. We note that Chambal and NFL have shown better ability to benefit
from this construct. Chambal and NFL are also putting up new plants which will
aid overall volume growth. We don’t expect much benefit to accrue for fertiliser
players from clearance of pending fertiliser subsidies until 2020 at least.
P&K is the only space worth betting in absence of any major reforms
Fertiliser stocks have seen a sharp re-rating of multiples in anticipation of
subsidy reforms (trailing 2x P/B vs 10-year average of 1x P/B). The re-rating
expected on account of DBT reforms builds in too much optimism. The near- Research Analysts
term catalysts for fertiliser stocks are: a) Government clearing subsidy arrears
Ritesh Gupta, CFA
worth Rs300bn which can reduce interest cost for key players by 20-30% and
ritesh.gupta@ambit.co
increase PAT by 30-60%, which may not play out before 2020; and b) allowing
fertiliser companies to retain energy efficiency gains for a few more years. Tel: +91 22 3043 3242
Bringing urea under NBS is a long-term reform that can help efficient players Kushagra Bhattar
gain market share and improve ROE, though that would need too much kushagra.bhattar@ambit.co
political will. Tel: +91 3043 3062
sajid.merchant@ambit.co, ssmerchant@gmail.com
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Fertilisers
Lost opportunity
Subsidies are an integral part of the Indian public welfare system. They
account for ~2% of India’s GDP across 3Fs, namely food, fertiliser and fuel.
Fertilisers alone account for a staggering US$11bn in subsidies. What was
Fertiliser is an integral part of
initiated as a way to boost India’s food production has now become a key
bottleneck in improving agricultural productivity. In many regions, excessive Government subsidy mechanism.
With more than 1.25bn people
urea consumption has led to a decline in yields.
(~17% of world population) to
Fertilisers played an important part in the Green revolution feed with less than ~4% of global
resources (like agricultural area
Post-independence, India brought a substantial amount of land under agriculture,
which improved production over the 1950s. However, as addition of arable land and water resources), there is
came to a halt, India struggled to meet the food requirements of its ever growing tremendous pressure on India’s
natural resources which is expected
population.
to increase going forward. We
An interesting paper from Harvard University student summaries it aptly: have to think not only to raise
productivity per unit of land but
A book by William and Paul Paddock released around this time, with a name more
also per unit of water. Well, this
suited for reality television, “Famine 1975 – America’s Decision: Who Will Survive?”
would have been easy with
classified countries into three categories: ‘walking wounded’, ‘should receive food’, and
advanced agricultural R&D and
‘can’t be saved’. The brothers believed that the US was the “sole hope of the hungry
better farming practices but given
nations” and India fell squarely in ‘can’t be saved’ category; giving it food was
the current not so advanced farm
equivalent to “throw(ing) sand in the ocean”.
technologies, fertilisers play an
However, focused efforts from the Government on Green Revolution led by important to feed future India.
development of high yielding varieties of wheat/rice led to a sharp 45% increase in
grain production over 1967-1977. Most of these varieties were quite responsive to
fertilisers and hence the Government encouraged indigenous manufacturing of
fertilisers.
Exhibit 1: Fertiliser scenario after Independence but before major reforms!
No Profit No Loss Uniform Price Regime Retention Price Scheme Some Poor Decisions
1. Due to increased production of
1. RPS was introduced to attract
fertilisers, subsidy amount ballooned
1. Fertiliser was declared as essential 1. Uniform price of fertilisers was fixed investment in this sector and thus
resulting in high fiscal deficits. To deal
commodity under Essential Commodities based on the pooled cost of both increase fertiliser production in the
with this situation Government
Act, 1955. domestic and imported fertilisers. country to make India self-sufficient in
increased prices of DAP & MOP by
staple food grains and fertilisers.
~40%.
2. Retention Price equals cost of 2. Urea prices were also increased by
2. Fertiliser Control Order was passed to
2. Increase in prices was passed on to production of a particular plant as ~30% but due to political unrest in the
regulate sale, price and quality of
the farmers assessed by Government + 12% Post country it was immediately reduced by
fertilisers.
Tax RONW ~10% previous levels.
3. Further, there was shortage and thus 3. Action of reducing urea prices to
3. Price was determined based on
Fertiliser Movement Control Order was counter political unrest sent Indian
pooled cost of fertiliser plants. There 3. RPS was also expanded to Phosphatic
passed to bring distribution and inter- political mindset in a loop from which
was no profit incentive for companies and other complex NPK fertilisers.
state movement under Government we have not been able to come out
operating in this space.
control. even after 25 years.
4. Firms use to profit from producing at
cost lower than that set by Government
for calculating subsidy. Some players
4. This resulted in increase in urea
use to show higher capacities to get
demand relative to other fertilisers.
more subsidy. However, it increased
working capital burden on firms due to
subsidy payment delays.
5. This also resulted in increasing
subsidy burden on Government budget
as higher cost resulted in higher subsidy
amounts.
1955-66 1967-77 1978-91 1992-96
Source: fert.nic.in, Ambit Capital
March 01, 2018 Ambit Capital Pvt. Ltd. Page 2

Fertilisers
Exhibit 2: Fertiliser scenario post reforms
Foundation for Decontrol of New Pricing Scheme & Nutrient Based Subsidy Urea subsidy politically
fertilizers Missed opportunities (NBS) Scheme & DBT sensitive; government
Rollout unlikley to go whole hog
1. Govt. started indicating all- 1. NPS was introduced for
India uniform MRP for Urea replacing the RPS in 1. NBS was introduced. Govt. 1. DBT is the primary focus of
fertilizers like DAP, MOP, 2003. Thereafter newer fixed the subsidy on nutrient govt. Though its initial rollout
complex NPK, etc. These MRPs versions with some content (per kg.) of fertilizers. was unsuccessful, govt. is
were revised in Feb 2002 amendments were This scheme covered 22 working on building holistic
which continued up to Mar introduced in 2004 and grades of P&K fertilizers but and robust system
2010 in case of DAP & MOP. 2006 respectively. excluded Urea. It was accommodating all aspects.
mandated for fertilizer While DBT is in its initial
2. Purohit committee was 2. All the reforms suggested companies to write MRP and stages, energy efficiency
constituted to reassess the by ERC like energy efficiency subsidy on fertilizer bad itself. norms are proposed to be
capacities of plants operating norms, , change in revised further as per initial
at high capacities. Based on production for subsidy 2. This action of govt. made recommendations of ERC
their recommendation, govt. calculation were slowly and urea darling of farmers. Urea committee.
reduced retention price of 11 gradually introoduced during was used more as compared
urea manufacturing units. This this phase thourgh revision to other fertilizers and this 2. Govt. played it safe on
hit profit of these 11 firms. in NPS. resulted in deterioration of Budget Day on 1 Feb. 2018
Indian soil. as there were no significant
3. Expenditure Reforms 3. However, one of best announcements for fertilizer
committee (ERC) was formed recommendation of ERC of 3. NPS was modified further sector. Subsidy allocation
whose recommendation of increasing urea prices by 7% to revise fixed cost subsidy was kept similar to prior
phased decontrol of fertilizer every year in real terms provisions which were kept years allocations. It didn't
subsidy is being followed today (during 2001 to 2006), which unchanged since 2003. provision for pending subsidy
also with some modifications. would have resolved majority arrears which was widely
Reforms like decontrolling the of fertilizer subsidy issues, 4. At start of NBS, farmers anticipated to be cleared
distribution system, energy was never implemented. used to bear 25%-40% of cost before beginning of DBT.
efficiency norms and changes of P&K fertilizers which
in fixed cost subsidy are all increased to 60%-68% in span 3. DBT is expected to be now
recommendations of this of 4 years. rolled out from 1st April
committee. 2018. The date has been
5. Govt. also rolled out new already shifted multiple
investment schemes to times.
promote investments,
amended energy efficiency
norms and NPS scheme
among other things
6. DBT was also rolled out on

pilot testing basis but was not
successful.
1997-03 2003-2010 2010-2017 Current

Fertilisers
Unlimited subsidies have distorted the NPK ratio

Nitrogen, Phosphorus and Potassium (NPK) are the three key macro nutrients for soil.
A right ratio defines the health of the soil and improves productivity. The ideal ratio of
NPK fertiliser use in India is generally believed to be 4:2:1. India’s fertiliser subsidy
policy has resulted in deterioration of NPK usage ratio due to biased prices of various
fertilisers (urea becoming the darling of farmers as compared to DAP, MOP and other
complex NPK fertilisers due to cheaper prices). India’s NPK usage ratio was near ideal
in 2009-10. But after the introduction of the NBS regime (fixed subsidies rather than
cost+) for P&K fertiliser in 2010, the prices of these nutrients shot up substantially
while that of urea was controlled and significantly lower.
Exhibit 3: NPK ratios in India are far from the ideal 4:2:1; they deteriorated
substantially after the launch of NBS
Nitrogen Phosphatic Potash
8
6.7
7
6
5 4.7
4
3 2.2 2.4
2
1.0 1.0
1
0
FY10 FY17
Source: GoI, Ambit Capital
Lack of political willpower led to deterioration of soil health To resolve the imbalance of
nutrients, no amount of education
The imbalanced use of fertilisers has caused many problems such as widespread
to the farmers, and even having
deficiency of secondary and micronutrients, spread of salinity and alkalinity etc., all of
soil health cards, will work
which have adversely affected productivity. Excessive use of N (urea) encourages
efficiently and effectively if the
climate change (when lost through de-nitrification) and groundwater pollution (when
prices of NPK remain highly
lost through leaching). Increase in the nitrate content of groundwater in some
skewed in favor of N, as is the case
intensively-cropped areas has been reported, which is obviously due to leaching of
today. It is worth remembering that
nitrates beyond crop root zone. Increase in nitrate content of groundwater is
in a free market system, pricing is a
potentially harmful as it is used for drinking in most rural areas.
great teacher leading to efficient
Also, India is short on micro nutrients in the soil. On a country-wide basis, nutrient use of a product, which ultimately
deficiency of zinc has been found to 48%, sulfur 41%, boron 33%, iron 12% and promotes efficiency and growth of
manganese 5% vs. scientific required levels of these nutrients. that market
Fertiliser consumption can still grow… but in non-urea

Though India is the 2nd largest consumer of fertilisers after China, its consumption per
hectare is considerably higher than that of many countries. North America consumes
less fertiliser compared to India because it has a huge land mass in relation to its
population. Higher doses of fertiliser consumption reflect intensification of
agriculture; India increased its fertiliser consumption per hectare at ~4.2% CAGR,
second only to Indonesia which is marginally ahead at ~4.6% CAGR over 2004-
2014. Considering the huge population and limited resources, we believe fertiliser
consumption growth per hectare will be higher than past trends.

Fertilisers
Exhibit 4: Fertiliser consumption per hectare of arable land (kg/ha)
2002 2014 Growth (RHS)

600.0 565.3 5.0%
500.0 4.0%
400.0 3.0%
279.2
300.0 2.0%
211.8
200.0 165.1 175.2 1.0%
126.6 134.4
100.0 60.6 0.0%
- -1.0%
South Africa Pakistan Brazil Bangladesh
Source: World Bank, Ambit Capital
With increase in fertiliser consumption, imports of fertiliser have also increased

countering the efforts of the Government to reduce import dependence. Even in the
case of urea, India was largely self-sufficient at the start of century but has started
importing significant quantities. In phosphatic and potassic fertilisers, we are net
importers due to lack of natural resources. Therefore, overall, India’s dependence on
imports has increased.
Exhibit 5: Fertiliser subsidies in India
Product FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Urea 7,791 8,522 10,986 12,793 17,721 26,385 33,940 24,580 24,337 37,760 40,016 41,824 54,400 54,500 55,000
Salience 70.7% 71.9% 68.1% 66.0% 63.2% 60.9% 34.1% 38.4% 37.0% 50.6% 56.7% 58.7% 72.5% 71.2% 74.3%
-Indigenous
7,790 8,521 10,243 10,653 12,650 16,450 20,969 17,580 15,081 20,285 20,000 26,500 38,200 38,200 40,000
Urea
-% of Total
100.0% 100.0% 93.2% 83.3% 71.4% 62.3% 61.8% 71.5% 62.0% 53.7% 50.0% 63.4% 70.2% 70.1% 72.7%
Urea Subsidy
-Imported
1 1 742 2,141 5,071 9,935 12,971 7,000 9,256 17,475 20,016 15,324 16,200 16,300 15,000
Urea
-% of Total
0.0% 0.0% 6.8% 16.7% 28.6% 37.7% 38.2% 28.5% 38.0% 46.3% 50.0% 36.6% 29.8% 29.9% 27.3%
Urea Subsidy
P&K 3,225 3,326 5,142 6,596 10,298 16,934 65,555 39,452 41,500 36,809 30,576 29,427 20,667 22,000 19,000
Salience 29.3% 28.1% 31.9% 34.0% 36.8% 39.1% 65.9% 61.6% 63.0% 49.4% 43.3% 41.3% 27.5% 28.8% 25.7%
-Indigenous
2,488 2,606 3,977 4,499 6,648 10,334 32,957 16,000 20,650 20,237 16,000 15,500 12,000 NA NA
P&K
-% of Total
77.2% 78.4% 77.3% 68.2% 64.6% 61.0% 50.3% 40.6% 49.8% 55.0% 52.3% 52.7% 58.1% NA NA
P&K Subsidy
-Imported
737 720 1,165 2,097 3,650 6,600 32,598 23,452 20,850 16,572 14,576 13,927 8,667 NA NA
P&K
-% of Total
22.8% 21.6% 22.7% 31.8% 35.4% 39.0% 49.7% 59.4% 50.2% 45.0% 47.7% 47.3% 41.9% NA NA
P&K Subsidy
Total (in Rs 10
11,016 11,848 16,128 19,390 28,020 43,319 99,495 64,032 65,837 74,570 70,592 71,251 75,067 76,500 74,000
Mns)

Fertilisers
Exhibit 6: Salience of P&K in fertiliser subsidies has reduced over a period of time
indicating the preferential treatment of Urea
65.9%
61.6% 63.0%
49.4%
43.3% 41.3%
27.5% 28.8%
25.7%
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Source: GoI
Under NBS, the fixed rate of subsidy was announced (on Rs/kg basis) on Nitrogen,
Phosphate, Potash and Sulphur on an annual basis. The exhibit below illustrates the
fixed subsidy amount from FY11 to FY15. It can be inferred from the exhibit above
that the fixed subsidy amount per kg has reduced over the years. It is directly
correlated to the strategy of the Government of reducing its subsidy burden over the
years. Thus, we expect these rates to reduce further.
Exhibit 7: NBS rates for nutrients NPKS for the FY11 to FY18 (Rs/kg)
Nutrients 9MFY11 4QFY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18
‘N’ (Nitrogen) 23.2 23.2 27.2 24.0 20.9 20.9 20.9 15.9 19.0
‘P’ (Phosphate) 26.3 25.6 32.3 21.8 18.7 18.7 18.7 13.2 12.0
‘K’ (Potash) 24.5 24.0 26.8 24.0 18.8 15.5 15.5 15.5 12.4
‘S’ (Sulphur) 1.8 1.8 1.7 1.7 1.7 1.7 1.7 2.0 2.2
India needs to depend on global supplies on P&K

India is completely lacking in commercially exploitable potash reserves and the entire
country’s demand for potassic fertilisers (MOP mainly) is met through imports. In the
phosphate sector (mainly DAP), too, there is limited availability of raw materials like
sulphur and rock phosphates and, hence, the bulk of raw materials and
intermediaries are imported. India imports DAP mainly from Canada, China, Jordan,
Morocco, Russia, Saudi Arabia and the USA.
We believe raw material supply has no avenue apart from forming JVs in countries
rich in such resources. It is akin to forming JVs in the case of natural gas procurement
for urea production. The global P&K fertiliser market is expected to remain over-
supplied, with new capacity expected to come up in Belarus, Canada, China, Russia,
Turkmenistan, and the USA.

Fertilisers
Exhibit 8: Potassium Chloride (K2O) demand is expected to be ~85% of global supply

until 2020, lowering the price of Potash fertilisers (mn tons)
K2O Supply for Fertilizers K2O Demand for Fertilizers

Excess as % to Supply
50 20%
40
15%
30
10%
20
5%
10
- 0%
CY15 CY16 CY17 CY18 CY19 CY20
Source: www.fao.org, Ambit Capital
Exhibit 9: Phosphoric Acid (H3PO4) demand is expected to be ~90% of global supply

until 2020, lowering the price of Phosphatic fertilisers globally (mn tons)
H3PO4 Supply for Fertilizers H3PO4 Demand for Fertilizers

50 10%
40
10%
30
9%
20
9%
10
- 8%
Some of recent deals include one with Uralkali (Russian fertiliser producer), which has
agreed to enter a new contract with India for supplying Potash (Potassium Chloride)
through June 2018 at $240/mt (up $13/mt from last year).

Fertilisers
Fertiliser subsidy – the most vexed of 3Fs

Unlike fuel subsidy, fertiliser subsidy will take a long time to get off the
Government’s back. Whereas diesel and petrol subsidies are extended to all
consumers, fertiliser subsidy is only for agriculture. In LPG, too, the
beneficiary is identified and alongside the benefits are also defined (12
cylinders a year). In food subsidy, the ration card holder is defined as the
beneficiary while the amount of rice/wheat/kerosene s/he can buy is defined
per ration card. The current DBT scheme in fertiliser neither defines the
beneficiary nor the benefits to the targeted person.
Urea subsidy are different from LPG and food subsidies
Many investors believe urea subsidy may turn out to be similar to diesel/petrol/LPG
subsidies in reducing WC and improving profitability. Without properly defining the
beneficiary and entitlement, not many benefits can be realised from DBT. Food
subsidy is easier to implement given fixed quantities of wheat/rice on every ration
card. Neem coating may cut down 5-10% leakages, though our channel checks
suggest pilferage has continued even after these initiatives. Shift in recognition of
sale from receipt at the district level to point of sale will increase inventory days for
urea players by 90-100 days and will take away most of the gains from reduced
receivables.
Exhibit 10: Fertiliser - a lost opportunity; in its current form DBT won’t drive much
reduction in subsidies
Urea Fertiliser P&K fertiliser LPG Kerosene Food
Beneficiary Universal Univeral Defined Defined Defined
Quantum of subsidy per unit Not Capped Capped Not Capped Not Capped Not Capped
Quantity of subsidy Not Capped Not Capped Capped Capped Capped

Source: Company, Ambit Capital research
Exhibit 11: Fertiliser subsidies account for ~26% of India’s subsidies (Rs bn)
Food Fertilizer Petroleum Others Fertilizer % of Total
1600 70
1400 60
1200
50
1000
40
800
30
600
400 20
200 10
0 0
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
Source: GoI
Urea leakages amount to ~36% of fertiliser subsidies

Analysis of leakages shows that it’s not border states where leakages are the highest
but states with high manufacturing activity. The highest concentration of farming is in
the Ganga-Yamuna belt, which runs across the Northern states of Punjab, Haryana
and Uttar Pradesh. In these states, urea also finds its way to the manufacture of resin
used by the unorganised ply industry. Interestingly, these states have the lowest levels
of leakages. One reason could be that farmers are a majority in these regions,
making it difficult to smuggle urea. States with high intensity of manufacturing like

Fertilisers
Maharashtra, Kerala and Assam tend to have higher rates of leakage. This could be
because leakages to the industry may be greater than leakages across borders.
Exhibit 12: Urea leakages by state
Source: Note ‘Redesigning India’s Urea Policy’, Ambit Capital. Black area shows no leakages/unavailability of
data.
Volatile fertiliser prices determine the subsidy outgo

Globally, fertiliser prices have been quite volatile due to demand and supply
dynamics. Since most countries have reduced fertiliser subsidy gradually, the global
market became a free market with forces like raw material constraints, change in
demand and global cycles driving prices (see chart below). India’s own imports distort
the global demand curve.
Exhibit 13: India’s urea imports have impacted global urea prices to some extent
International Urea Prices (Rs/MT) Import % of Total Urea Consumption
25,000 50
45
20,000 40
35
15,000 30
10,000 25
20
5,000 15
10
- 5
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
Source: World Bank, Annual Report of Fertiliser Ministry, Ambit Capital
However, fertiliser prices are subsidised in India, resulting in a sharp deviation from
global trends. Volatility in global prices can be correlated to subsidy payments by the

Fertilisers
Government. India could have avoided being an outlier had it followed ERC’s
recommendation of increasing urea prices at ~7% per annum in real terms.
Exhibit 14: International prices during 1967-2017 (USD/MT)
1,200.0 Ethanol, India coming to

import markets and
1,000.0 commodity prices boom
800.0
Global
crash
600.0 First oil India, China
crisis exports
400.0 surge....then
stop
200.0
-
FY67
FY69
FY71
FY73
FY75
FY77
FY79
FY81
FY83
FY85
FY87
FY89
FY91
FY93
FY95
FY97
FY99
FY01
FY03
FY05
FY07
FY09
FY11
FY13
FY15
FY17
Urea DAP MOP
Source: World Bank, Ambit Capital
Exhibit 15: While Indian urea prices have remained Exhibit 16: DAP prices (Rs/MT) have moved towards global
stagnant, global prices range at ~3s the domestic fixed prices after introduction of NBS
MRP; ratio should decline a bit in light of global excess
supply (International prices/MT: Domestic prices/MT – the
gap is subsidies)
4.50 45,000
4.11
4.00 3.61 35,000
3.50 3.57
25,000
3.00
2.67
2.50 15,000
2.04 2.58
2.00
5,000
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
1.50
1.00
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
Domestic Prices International Prices
Source: Ambit Capital research Source: Ambit Capital research
Exhibit 17: Ammonia (NH3) global supplies are expected to be in excess until 2020,
resulting in a decrease in urea prices globally (Mn tonnes)
NH3 Supply for Fertilizers NH3 Demand for Fertilizers

140 16%
120 14%
100 12%
10%
80
8%
60
6%
40 4%
20 2%
- 0%

Fertilisers
India missed an opportunity to reduce subsidy burden in 2009

One of renowned fertiliser experts mentioned in a working paper that Indian policy
makers missed a golden opportunity during 2007-09 when a major alignment was
being done in the domestic prices of basic staples to catch up with their international
levels, but domestic urea prices remained stagnant. Due to this inaction on urea
pricing, fertiliser subsidy reached a peak (relative to % of GDP) in FY09 to USD21bn
due to a spike in the global price of fertilisers.
Exhibit 18: The Government had a golden opportunity to reduce subsidy burden,
which it missed (Rs/MT)
18,000
16,000
14,000
Missed Opportunity
12,000
10,000
8,000
6,000
4,000
2,000
-
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
MSP of Wheat MSP of Paddy (Common) Urea
Source: Govt. of India data, Ambit Capital
Fertiliser movement is controlled but the urea black market prevents it from
reaching marginal farmers
FMS and mFMS systems track fertiliser to the retailer level but the final sale to the
farmer is not captured. Retailers often have monopoly power in the village and
artificially reduce availability in order to redirect farmers to the black market.
Excerpt from ‘Redesigning India’s Urea Policy’ explains the formation of the black
market:
“Bags of urea arrive through the cooperatives at the local Panchayat twice a year,
usually before harvest. In many villages, these are sold out within a day or so.
Entrepreneurial farmers and local shops buy large quantities, as they know they will be
in high demand and can be resold for a profit. Most farmers are also not aware when
urea will arrive. Therefore only those well connected and living close to the Panchayat
is able to secure urea.”
This black market hurts small farmers as large farmers procure the majority of
subsidised urea due to their connections in the market. Marginal farmers end up
paying higher prices in the black market.

Fertilisers
Government has taken various measures

to reduce subsidy
The Government has taken multiple measures to reduce fertiliser subsidy
outgo without causing political unrest, like in 1991 due to increasing of urea
prices by ~30%. At that time, such unrest forced the Government to reduce
urea prices by ~10%, and till date the Government has not been able to
increase urea prices considering it politically sensitive. The reforms so far can
be put into two buckets: a) spending to reduce pilferage and b) improving
efficiencies of existing fertiliser players. Initiatives such as gas pooling have
helped in reducing imports and cutting fixed costs of fertiliser players.
Tightening the belt on energy efficiency norms too have helped in keeping
subsidy levels in check over the last three years. Initiatives for keeping
pilferage in check saw initial success though gradually the industry players
found loopholes in every initiative.
Exhibit 19: Subsidy reduction from the Government standpoint
Subsidy reduction Step Execution
Efficacy Improvement Neem coating Yes
Reduction of urea bags from 50kgs to 45kgs Yes
Diversion/Pilferage Aadhar linkage/digital land record linkage No
Effective Targeting Digital land record linkage No
Reduction in Volumes Fixed quantities based on Soil Health Card No
Cost efficiency improvement Improving energy efficiency of companies Yes

Better utilisation of existing capacities reducing marginal cost of production Yes
New capacities driving reduced imports Yes
Opportunistic sourcing of imports rather than tendering No
Ways to reduce pilferage

Neem coating of Urea: It was introduced with the sole objective of helping the
farmers in terms of improving yield and effective consumption of fertilisers. It will not
control smuggling as neem-coated urea can be smuggled for agricultural use in
Nepal and Bangladesh. Even for industrial applications, initially neem-coated urea
helped in reducing subsidies but gradually the industry found a way to circumvent it.
The article quotes such misuses in Haryana - the state with the largest per acre urea
consumption
"Initially, neem-coated urea made a little bit of difference. But then the industry has
found a way out. We have filed 18 FIRs so far this kharif season against companies for
using subsidised urea meant for farmers,"
Additional Agriculture Chief Secretary in Haryana Government, VS Kundu
Change in bag sizes from 50kgs to 45kgs: Change in the size of bags from 50kgs
to 45kgs was to support neem coating of urea. Due to neem coating lesser quantity
was required for crops, but farmers kept using the same quantity, thereby putting
more urea on the field than required. To stop this, the Government thought of
reducing the bag size by 10%. This move was recently introduced and hence its
effectiveness is yet to be fully measured.
Move to DBT: DBT was initially planned to include the trinity of soil health cards,
land records and Aadhar identification, which would significantly reduce consumption
pilferage. However, the plan has gradually been scaled down meaningfully – now soil
health cards and land record identification are not needed and an infinite amount of
fertiliser bag sale is allowed, which significantly reduces the effectiveness of reducing
pilferage. Overall savings of 5-10% on subsidies are expected from these measures.

Fertilisers
Improving efficiencies of existing fertiliser players

Realising its inability to increase prices, the Government focused on improving
efficiencies of the fertiliser sector. Given urea subsidies are on cost+ basis, gas
pooling provided an important tool to the Government; i.e. focusing on energy
efficiencies of fertiliser players. The Government has brought policies that
progressively put a cap on reimbursements of cost components. Thus, the fertiliser
industry was forced to be efficient in order to sustain operations. Maximising
production, reducing specific energy consumption and minimising costs are now the
only ways for fertiliser companies to remain viable.
Retention pricing scheme (RPS) introduced in 1977 provides assured return to the
investor in the fertiliser sector. It also assures affordable price to farmers. Difference
between retention price for a fertiliser unit (production cost including an element of
return) and retail price call subsidy was reimbursed to the producer.
Thereafter the Government lost sight of the spirit of RPS and got obsessed with
reduction in subsidy. The quantum of subsidy was increasing every year due to near
stagnant retail price of fertilisers and inflationary push to the cost of production. The
Government, without addressing the basic factors responsible for increase in subsidy,
started tinkering with the parameters for determination of cost of production and
transportation. It started bringing out notification of non-recognition of various
legitimate costs, tightening of norms of energy consumption, non-updation of fixed
cost, etc. as detailed below:
Gas pooling mechanism

The Government approved the policy on 31st March 2015 to supply gas at a uniform
delivered price to all fertiliser plants utilising natural gas for the production of urea
through a pooling mechanism.
Why the gas pooling mechanism was put in place? This was introduced as part
Gas Pooling Mechanism has
of an overall strategy to cut energy consumption by fertiliser plants. It brings more
brought more transparency to
transparency to subsidy given for energy consumption. Before this policy, the price of
energy efficiency of urea plants.
gas supplied to fertiliser units varied from plant to plant depending on the
combination of domestic gas and LNG. Thus, there was no uniformity in input price.
Also important is the wide variation in the conversion efficiency of plants measured in
Gcal/MT. As the variation in the final urea production cost is a result of variation in
two factors (gas price and conversion efficiency), it was necessary to separate the two.
A uniform gas price will achieve this objective and will help focus on one single
variable to improve plant efficiency. This focus on plant efficiency is required for
calculating the cost and subsidy related to energy efficiency.
Barring a few, urea players are not making profits. Only after the gas pooling
mechanism were they able to utilise 100% of their capacities. Before that, the players
were under-utilising their capacities and were not in a profitable situation.
Naphtha-based plants to switch to gas

Over a period of time, the Government pushed all the fertilisers to move towards
gas-based fuel. Three naphtha plants viz. Mangalore Chemicals & Fertilisers, Madras
Fertilisers and SPIC have been modified to utilise gas as feedstock and can switch to
gas as soon as pipeline is available.
Why natural gas is preferred over Naphtha as feedstock
It is intrinsically hydrogen-rich and therefore contributes more hydrogen compared to
other feedstock on a unit weight basis. Further, heavier feedstock like coal and oil are
more complex to process and therefore the capital costs are higher compared to
natural gas (until and unless one owns coal mines, as in the case of Chinese fertiliser
manufacturers, for procuring low ash coal).

Fertilisers
Amendments in New urea Policy to support production

beyond reassessed capacities (RAC)
Urea production can be divided into 2 parts, viz. production up to cut-off capacity
(nearly 90 per cent of domestic capacities) and production beyond cut-off capacity
(nearly 10 per cent of domestic capacities).
For production beyond cut-off, the prevailing subsidy was linked to import-parity
prices of urea. But in the last fiscal import-parity price fell, domestic natural-gas
prices rose, and consumption of imported re-gasified LNG increased because of
which production beyond cut-off capacity profit dried up for most manufacturers.
Depending on the domestic-imported gas mix and the absence of any change in
policy, production beyond cut-off had become unviable for some manufacturers. Now
provision has been made for fixed subsidy per ton on production above cut-off.
However, the positive effect of these provisions would depend on the amount of fixed
subsidy and capacity utilised by players.
The ceiling imposed on production beyond RAC during FY17 was raised so as to
enable all urea units to produce additional production, which otherwise they were not
able to do due to low import-parity price.
Tightening the belt on energy efficiency norms

The Group-based New Pricing Scheme (RPS) Stage-I introduced in 2003 divided urea
units in 6 groups and subsidy payable to urea unit was restricted to the group
average price or its own price whichever was lower (no incentive for efficient units). It
did not recognise investments made in plant modernisation just before the
introduction of the scheme and restricted subsidy at average cost of production.
NPS Stage-II was introduced in 2004; the energy benchmark level was fixed as
weighted average energy consumption of the unit during 1999-2002. In NPS Stage-
III, introduced in 2006, the energy benchmark level was fixed as the lowest energy
achieved during 1999-2002 and fixed cost compensation was fixed on 2002-03 cost
data. This policy was intended for three-and-a-half years but continued unchanged
till 2014.
The modified MPS notified in 2014 permitted an increase of Rs 350 per MT of urea in
the fixed cost and allowed a minimum fixed cost of Rs 2300/MT and a special
allowance of Rs150/MT to gas-based plants more than 30 years old. However, this
policy is yet to be implemented.
New Urea Policy was introduced in June 2015. It has two components - variable cost
and fixed cost. For variable cost, energy consumption norms were revised downwards
and gas price was pooled. For fixed cost, it included the provisions of the modified
NPS but was not implemented. The energy consumption norms were revised
downwards vs the NPS-III norms but without providing a window for recovery of
capital expenditure required for such energy reduction.
 Thus the Government has effectively mopped up the energy efficiency achieved in
the last several years while fixing energy consumption norms for 2015-16 to
2017-18.
 From the year 2018-19 only 3 energy groups of 5.5, 6.2 & 6.5 (Gcal per MT of
urea) has been kept.
 It can be seen that urea policy has been only aimed at reducing subsidy burden
of the Government and the reasons for increasing subsidy on urea has not been
addressed.
RPS was formulated with the concept of 12% post-tax returns on net worth at 80%
capacity utilisation and it used to recognise capital investment for revamp including
that for energy saving, and energy norms were revised only in the next pricing period.
In NPS, capital investment is not recognised and the company is allowed to retain the
benefits of energy savings. However, in subsequent policies, the Government revised

Fertilisers
the energy consumption norms downwards under NPS-II, NPS-III, NUP-2015 and did
not take into cognizance the capital investment made for achieving higher energy
efficiency during the last 14 years.
Unlike RPS, there is no pricing period envisaged beyond 2018-19 for which drastic
energy reduction norms will remain valid.
Driving better energy efficiency is the name of the game

 Fertiliser players need to play the energy efficiency theme. For example, say
7.4Gcal/MT was the earlier norm based on which the Government used to
calculate its subsidy amount. Companies used to make profits by consuming only
7.0Gcal/MT energy. Thus, the differential of 0.4Gcal/MT on a large scale made
the huge profit for fertiliser companies.
 Since the Government tightened energy efficiency norms further in 2018,
resulting in higher cost to the companies with some companies incurring losses,
industry players are negotiating with the ministry to revisit the energy efficiency
norms. However, some industry players are of the view that the Government will
think about revisiting the norms only when ~25% of capacities in the industry will
shut. Only players like NFL and RCF and some other big names will survive.
Exhibit 20: Revised energy efficiency norms plant-wise
Group I : Target energy norms of 5.5 Gcal/MT of urea
Actual energy, Gcal/MT
Revised Energy As per NUP 2015, Gcal/MT (for year 2015-16) as
per FICC data
01 June 2015 to 31
S. No. Plants Sector 1 April 2018 onwards
March 2018
1 NFL Vijaipur-I PSU 5.90 5.50 5.76
2 NFL Vijaipur-II PSU 5.57 5.50 5.41
3 IFFCO Aonla-I Cooperative 5.66 5.50 5.57
4 IFFCO Aonla-II Cooperative 5.51 5.50 5.31
5 IFFCO Phulpur-II Cooperative 5.74 5.50 5.57
6 KRIBHCO Hazira Cooperative 5.95 5.50 5.64
7 CFCL Gadepan-I Private 5.59 5.50 5.51
8 CFCL Gadepan-II Private 5.53 5.50 5.35
9 IGFJagdishpur Private 5.50 5.50 5.24
10 KSFL Shahjahanpur Private 5.64 5.50 5.60
11 NFCL Kakinada-I Private 5.69 5.50 5.60
12 NFCL Kakinada-II Private 5.67 5.50 5.60
13 TCL Babrala Private 5.33 5.42 5.18
Group II : Target Energy Norms of 6.2 Gcal/MT of Urea
1 RCF :Thal PSU 6.60 6.20 5.94
2 IFFCO:Kalol Cooperative 6.23 6.20 5.69
3 GNFC:Bharuch State owned 6.30 6.20 6.77
4 GSFC:Vadodara State owned 6.74 6.20 6.35
Group III : Target Energy Norms of 6.5 Gcal/MT of Urea
1 NFL:Bathinda PSU 7.48 6.50 7.05
2 NFL:Nangal PSU 7.10 6.50 7.06
3 NFL:Panipat PSU 7.61 6.50 7.28
4 IFFCO:Phulpur-I Cooperative 7.15 6.50 6.64
5 SFC Kota Private 7.59 6.50 7.26
6 KFCL Kanpur Private 7.85 6.50 7.08
7 RCF:Trombay PSU 8.54 6.50 6.91
8 ZACL:Goa Private 7.31 6.50 6.64
Source: GoI

Fertilisers
Will players be able to outperform on revised norms to generate profits?

 Industry players will be able to comply with new norms. However, additional cost
which they need to incur to comply with these norms will not be reimbursed by
the Government. This leaves little incentive for them to follow this. For example,
NFL’s plants at Nangal and Bhatinda are currently operating at 7GCal/MT and
have been mandated 6.5GCal/MT. This would be possible through use of gas
turbines instead of coal (~20% of energy comes from coal), but putting gas
turbines would require incremental capex of Rs2bn for each such turbine, which
makes the players more reluctant to opt for it.
 So some manufacturers requested to Government to allow them to continue coal-
based production by keeping coal-based plants outside the ambit of the revised How is Urea movement controlled?
energy efficiency norms. Also, some manufacturers confirmed in their quarterly
analyst calls that they are negotiating with the Government for revising the
energy efficiency norms. This leaves us with the new unanswered question – will 1. Ministry along with state
energy efficiency norms be revised? Government estimates
monthly demand for each
district before cropping
Freight subsidy will continue to be provided separately season
Since fertiliser movement is also controlled by the Government, it allows for a 2. Then issues monthly supply
separate freight subsidy. The Government was considering eliminating separate plan and uses the Fertiliser
freight subsidy and making it part of the total cost for the purpose of subsidy Management System (FMS)
calculation. However, this idea is being dropped after considering the fact that P&K to direct fertiliser to various
fertiliser manufacturers are all coast-based, so a removal will result in reduction of districts.
supply to non-coastal areas and North India. Government doesn’t seem to be
prepared to take this bold move wherein freight is integrated with the cost subsidies.
Exhibit 21: Issues faced by fertiliser players – no resolution in sight
Likely no change. Receivables decline counter balanced by Inventory increase. Current form of DBT doesn’t reduced
WC issues
receivables much. In new system, subsidy receivable recognition is at mercy of the retailer
Product imbalances Likely no change in absence of bringing Urea under NBS
Payment of arrears No change. Fiscal situation doesn’t allow release of previous year's arrears
Energy norms tightening Likely to continue

Fertilisers
Effective targeting of urea subsidies is a

key challenge
Urea subsidy needs to be targeted to poor/marginal people just the way
kerosene/food subsidies are. Our discussions with industry bodies suggest
that ~36% of fertiliser subsidies are lost to leakages (to industry or to
neighboring countries) while 22% go to rich farmers. With such ineffective
targeting, reforms on delivery mechanism could have provided a much lower
subsidy burden for the Government. Move to DBT with universal access
without any control on quantities per Aadhar card is unlikely to help in
subsidy reduction. Even WC cycle for companies isn’t likely to improve much
from the current 200 days. At best, we expect improvement of 20-30 days due
to DBT, which also will depend on a glitch-free execution at the retailer.
Extensive amount of leakages exist

Given urea is meaningfully subsidised in India, it makes it an attractive target for
pilferage for a) industrial applications, mainly plywood industry and b) exports to
neighbouring countries – Bangladesh, Pakistan, Nepal where fertiliser prices aren’t
subsidised as heavily as in India. In addition, in the absence of any targeted
subsidies, ~22% of targeted subsidies go to wealthy farmers who clearly are not the
intended beneficiaries. In fact, tight supplies around the cropping season lead to
black marketing of urea bags, leading to more resourceful villagers selling the
fertilisers to marginal farmers at much higher rates.
Exhibit 22: Leakages are substantial in Urea subsidies
Lost to In-efficient
Firms
9%
Acrrues to small
farmers
33%
Lost to Leakage
36%
Lost to Rich
Farmers
22%
Source: HBS study, Ambit Capital
Exhibit 23: Key features of the new system under DBT vs. the old systems
New System
Old System
 Fertiliser is despatched from manufacturing plants as per movement plan

decided by Government.  Fertiliser is despatched from manufacturing plants as per movement
 Receipt is acknowledged at district and is despatched to wholesalers / plan decided by Government.
retailers through mobile / web application.  Receipt is acknowledged at district and is despatched to wholesalers /
 Company submits bills on the basis of receipt at district. The bill is signed retailers through mobile / web application.
by the company representative and Chartered Accountant. 95% (Urea) of  Retailer sells the product by authenticating Aadhar card of the buyer
subsidy and 85-90% (P&K) subsidy is released, subject to availability of and generates an invoice through PoS device
budget.  At the time of sale transaction, farmer will purchase at subsidised MRP.
 Remaining subsidy is released after retailer's acknowledgement in mFMS However the subsidy amount will be paid by the Government on behalf
and issuance of B1 & B2 certificates from State Government. of farmer to the manufacturer on a weekly basis

Fertilisers
Exhibit 24: DBT – A lot of promises but too few are delivered
Reason for not being
Proposed Benefits Current
implemented
Direct subsidy payment Subsidy payment should be
Helps in identifying the right Payment is being done to Not all Aadhar cards are linked
to beneficiary’s done to farmer directly into his
buyers companies to bank accounts
account account
Targeted subsidies to marginal
farmers over a period of time.
Identification of Aadhar based identification Most of the states don’t have
No land record linkage
beneficiary seeded with land records digitised land records
Reduced leakages to other
industries
Targeted subsidies basis soil No defined benefits. Any
Identification of Seeding of Aadhar with Soil Soil health card seeding is
type. Improves nutrient Aadhar card holder can take
benefits Health Cards not done yet
balances. any number of Urea bags
Source: Ambit Capital
Issues in DBT rollout make it ineffective in stopping leakages

The initial pilots on DBT started with parallel authentication from soil health card and
digitised land records. The Government dropped these as: a) farmers resisted the
quantity of fertiliser recommended by soil health card while relying more on their age
old knowledge – this could have led to a political backlash; b) simultaneous checking
with the soil health card database, digitised land record database and Aadhar
database took a lot of time, which impacted overall transaction times. This led to the
Government going only for Aadhar authentication, though this is also leading to
multiple other issues as summarised below.
 Poor Wi-Fi connectivity in rural areas: Our channel checks suggest that
improper Wi-Fi connection in rural areas have proved to be a hindrance in using
POS terminals. Due to poor connectivity, retailers are not able to record sales in
the farmer’s name through Aadhaar verification and sometimes end up recording
total sales at the end of the day against one farmer only (when there is
availability of network) or in their own name. Even to record total sales at the end
of the day, retailers need to travel to places near the city where they can get
better connectivity. Due to this, real farmers’ data is not being captured.
However, these incidences cannot be generalised and the industry has witnessed
better implementation at various places. With DBT rollout finding its place in the
Government’s priority list, we believe DBT is just a matter of time.
 Improper seeding of land records: Land records database is not robust and is
far from encapsulating 100% records of land ownership. Further, majority of farm
owners employ people to work on their farms and these employees go and buy
fertilisers from retailers. So there is a mismatch between land ownership records
and the actual person buying the fertiliser. This renders the whole thesis of
incorporating land ownership records in DBT scheme inefficacious.
 Improper seeding of soil health cards (SHC): 100% coverage of arable land
is still far away. Our conversation with industry executives brings out the same
picture. A picture of inadequate recommendation regarding use of fertilisers on a
particular farm resulting in farmers following their instincts instead of soil health
card recommendation (displayed on PoS machines after considering land records
data, soil health cards and Aadhaar data) regarding the quantity required.
Retailers cannot do anything but go with the farmer’s demand regarding quantity
of fertilisers which otherwise would have resulted in riots since the farmers’ point
was that PoS machines will not take responsibility if yields turn out weak. This left
little room for retailers to convince farmers.
1 The key challenge for the Government would be speedy coverage of all
arable land and issuance of SHCs to all the farmers. In case there is delay by
the time all cards are issued, some of the cards issued earlier will become
outdated since SHCs need to be updated once every 3 years.
 Thumb print problems: Many farmers have their fingerprints rubbed off due to
their field work, rendering Aadhaar-based sales inefficacious.
 Increased administrative work for retailers: In the earlier system, retailers
used to get a fixed amount per kg. Now besides no change in incentives for

Fertilisers
retailers they are loaded with increased administrative work of maintaining

records due to use of POS machines.
 Ineffective IT infrastructure set up by NIC: The Government is not prepared
for DBT rollout. NIC’s (National Informatics Centre) infrastructure for DBT is not
robust and improperly strategised, which is depicted in the improper seeding of
various databases as mentioned above and improper integration with Aadhaar.
Exhibit 25: Complete land record digitisation will take much longer; but key
agricultural states barring Punjab have made good progress and targeted subsidies
can be started with these states first
No. of Completed Ongoing Started Computerised
CLR
villages (%) (%) (%) (%)
Himachal Pradesh 20,694 100% 0% 0% 2%
Karnataka 29,523 100% 0% 0% 0%
Odisha 51,681 100% 0% 0% 0%
Tripura 891 100% 0% 0% 100%
Dadra & Nagar Haveli 72 100% 0% 0% 100%
Lakshadweep 24 100% 0% 0% 0%
Madhya Pradesh 55,070 99% 0% 1% 31%
Maharashtra 44,855 99% 1% 0% 99%
Telangana 10,829 99% 0% 1% 99%
Andaman & Nicobar
209 98% 2% 0% 98%
Islands
Puducherry 130 98% 0% 2% 98%
Andhra Pradesh 17,563 97% 1% 2% 98%
Rajasthan 47,921 97% 0% 3% 8%
West Bengal 42,191 97% 1% 2% 96%
Gujarat 18,531 96% 0% 4% 83%
Uttar Pradesh 1,09,109 96% 0% 4% 73%
Punjab 12,894 94% 0% 6% 30%
Haryana 7,088 93% 4% 3% 93%
Sikkim 417 93% 0% 7% 67%
Chhattisgarh 20,401 89% 6% 5% 90%
Uttarakhand 17,126 87% 0% 13% 37%
India 6,55,502 86% 3% 11% 47%
Daman & Diu 28 79% 14% 7% 93%
Tamil Nadu 16,721 78% 0% 22% 74%
Bihar 46,368 65% 19% 16% 2%
Assam 26,777 52% 0% 48% 62%
Jharkhand 32,752 44% 24% 32% 32%
Kerala 1,674 44% 1% 55% 44%
Chandigarh 16 38% 6% 56% 6%
Jammu & Kashmir 5,733 9% 0% 91% 0%
Manipur 2,743 9% 3% 88% 8%
Arunachal Pradesh 5,590 0% 0% 100% 0%
Goa 425 0% 33% 66% 34%
Meghalaya 6,822 0% 0% 100% 0%
Mizoram 826 0% 0% 100% 0%
Nagaland 1,601 0% 0% 100% 0%
NCT of Delhi 207 0% 0% 100% 0%

Fertilisers
Some alternative measures to reduce the subsidy burden instead of the

current means adopted by Government:
 The Government should allow farmers to participate in the open market rather
than setting up MSP (Minimum Selling Price). MSPs affect the mindset of farmers
and turn agricultural production towards crops which farmers think are more
profitable. If farmers are able to sell the produce and get better prices, they will
be happy to grow a variety of crops and adopt better farming techniques.
However, one key concern of the Government in setting the agricultural produce
market free is exploitation of farmers by middlemen (as used to happen before).
So a better alternative to eradicate the concept of MSP and make agricultural
market a free market would be to apply the Amul model (network of various milk
co-operative societies) to agricultural produce. This will ensure better prices for
farmers and in turn reduce the food subsidy bill along with fertiliser subsidy bill.
 One fertiliser expert suggested providing benefits to small farmers by directly
transferring fixed subsidy based on per hectare basis. How will this work out?
India’s gross cropped area is 190-200mn hectares and net sown area is around
140mn hectare distributed over 120mn farming families. Broadly, it works out to
Rs5,000/ha of gross cropped area and Rs7,100/ha of net sown area. About 85%
of farming families have small and marginal holdings (less than 2ha) but
cumulatively they operate ~44% of area. If all those small and marginal holders
receive Rs5,000/ha as full compensation for the fertiliser subsidy, then the
Government may get political support of these 85% farming families. For the
others, the Government can reduce compensation to Rs4,000/ha, thereby saving
20% of the subsidy on ~56% of the cultivated land.
WC benefits for fertiliser players would be limited

One of the key issues faced by urea players is the high amount of WC days which
include ~200 days on debtors side. Debtors account for nearly 70-80% of fertiliser
companies debt. We believe there are two subsidy receivables for fertiliser players: a)
previous year’s subsidy receivables which amount to nearly Rs300bn and b) the
current year’s subsidy receivables which typically get cleared every year. While the
current year subsidy receivables get cleared in 7 days, the Government needs to do a
one-time extra budgeting for clearing previous year’s backlog. The Government
would need to make adequate provisioning for meeting subsidy payout over the
years when subsidy payouts exceed current provisions.
Exhibit 26: Only Coromandel out of the top 6 players has been able to maintain its working capital days since it is not
affected by urea subsidy
Debtor Days Inventory Days Creditor Days Net Working Capital Days
Particulars
FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17
Coromandel 60 47 48 58 59 65 72 73 93 94 99 110 26 18 22 21
GNFC 99 110 114 103 55 62 58 54 19 23 22 24 135 149 150 134
Chambal 146 126 142 167 40 27 33 42 19 12 16 17 167 140 159 191
GSFC 165 134 156 209 46 45 36 45 38 32 27 40 174 148 165 213
RCF 148 144 172 205 56 42 48 50 34 26 27 32 170 160 193 223
NFL 177 207 231 217 19 15 18 25 16 12 11 17 180 210 238 226
Source: Companies, Ambit Capital Research

Fertilisers
Exhibit 27: Average subsidy receivable days for fertiliser players at 130-140
days
Aggregate Revenue (Rs mn) Aggregate Receivable Days
700,000 146.9 160.0

133.0 127.4 137.3
600,000 123.1 140.0
500,000 120.0
93.1
100.0
400,000
80.0
300,000 46.5 46.4 60.0
39.6 37.4
200,000 40.0
100,000 20.0
- -
FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Source: Companies, Ambit Capital research
Receivable days would reduce…

Currently, a large part of subsidy is recognised when fertiliser reaches the district
nodal office and the rest is released when it reaches the retailers. However, under the
DBT scheme, subsidy is released when the fertiliser sale happens to the farmer. This
will reduce the subsidy payment period to 7 days (from manufacturing to selling to
farmers) from around 90-100 days.
...but inventory days would rise

However, inventory days would increase as point of subsidy recognition changes in
the current DBT scheme from arrival at the district center to the final sale in the hands
of the farmer. Earlier, sales recognition happened around the year while now the sale
will happen only in the key cropping months. This will lead to much longer inventory
days (our estimate is 5-6 months) given fertiliser companies need to produce
throughout the year to meet the stricter energy efficiency norms. Earlier, fertiliser
companies used to sell their products to distributors at regular intervals through the
year and hence inventory days were hardly 30 days.

Fertilisers
Exhibit 28: Urea players are significantly leveraged to subsidy receivable burden (in
Rs mn)
GNFC FY15 FY16 FY17
Subsidy Receivable 11,313 11,621 6,353
Interest Foregone @ 8% 905 930 508
Tax Rate 0% 35% 27%
Current PAT (4,521) 1,727 5,213
Profit Scalability% to Current PAT 20% 35% 7%
Chambal FY15 FY16 FY17
Interest Foregone @ 8% 2,138 2,475 2,115
Tax Rate 39.1% 48.0% 34.2%
Current PAT 2,795 1,061 3,562
GSFC FY15 FY16 FY17
Interest @ 8% 1,140 1,906 1,541
Tax Rate 30% 31% -12%
Current PAT 4,005 4,093 4,195
RCF FY15 FY16 FY17
Subsidy Receivable 30176 39461.6 31869.9
Interest @ 8% 2,414 3,157 2,550
Tax Rate 37% 35% 28%
Current PAT 3,221 1,726 1,793
NFL
Interest @ 8% 3,963 3,683 3,236
Tax Rate 41% 31% 36%
Current PAT 262 1,986 2,082
Fertiliser companies have to run production throughout the year which

means they can’t reduce inventory days
One key thing to note here is that there will not be any change in manufacturing
process as the plant needs to be run throughout the year (except 1 month of repairs
and maintenance). Shutdown of plant entails high energy cost and other incidental
costs (corrosion of cooling pipelines due to chemicals mixed in water running through
those pipes for cooling the plant), rendering fertiliser players ineffective. Thus,
fertiliser players aspire to minimise shutdown time and many have reduced the 1
month period of usual repairs and maintenance to 15-20 days. Also, a lot of
problems occur due to manual mistakes when the plant is re-started.
In the cost calculation for subsidy, there is a built-in cost for working capital
considering 35-40 days of cycle. But since actual working capital has increased to
150 days, players will end up receiving less subsidy than required.
Though DBT is being marketed as if farmers will receive their claims in 7 days but in
reality, the day from which countdown will start has itself been shifted as mentioned
above, resulting in an increase in working capital days.
Currently, payment towards subsidy has been shifted to November from August
earlier because under DBT subsidy is paid once the fertilisers are sold to farmers and
not when fertilisers reach the office of the district nodal office.

Fertilisers
Mismatch in recording subsidy amount could drive further delay/denial of

some subsidy receivables
Since the Government will record subsidy amount in its books based on data
obtained from PoS machines whereas fertiliser players will record subsidy amount to
be received based on their production, there are lot of glitches in the system – dealer
selling the urea but not registering it properly in the system, selling urea which has
not been registered on the central system – which could result in fertiliser players
ending up entitled for subsidy less than they deserve to receive.
Even if the retailer chooses the wrong manufacturing plant (given subsidies are
different across different plants of even the same companies), reconciliation will be
very challenging.
Exhibit 29: Issues faced by fertiliser players – no resolution in sight
Fertiliser Players Problems
Likely no change. Receivables decline counter balanced by Inventory
WC issues increase. Current form of DBT doesn’t reduced receivables much. In new
system, subsidy receivable recognition is at mercy of the retailer
Product imbalances Likely no change in absence of bringing Urea under NBS
Payment of arrears No change. Fiscal situation doesn’t allow release of previous year's arrears
Energy norms tightening Likely to continue

Fertilisers
India set to free itself from urea imports

There was dearth of investments in the urea industry over the past two
decades, which resulted in increase in imports as compared to indigenous
production of fertilisers. However, measures such as gas pooling and
incentivisation on production beyond reassessed capacities helped in
reducing the import burden. With investments in urea capacities rising, India
is set to make itself free of imports of urea.
Exhibit 30: Import salience in total fertiliser consumption increased from levels at the
start of the century
100
80
60
40 41 43 44
34 36 36 37 36
25 27 29 29
20
12 14 12 15
10
-
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
Production (%) Import (%)
Source: Annual Report of Fertiliser Ministry, Ambit Capital
Policy environment turns better; to attract new investments

The Government introduced a new modified investment policy in 2014
(http://fert.nic.in/node/3592). This policy allows new plants to make ROE of 12-20%
on the basis of natural gas price range. Even if natural gas prices inflate beyond
US$14/mmbtu (currently at ~US$11/mmbtu), the floor ROE of 12% would be
protected by increasing the floor prices.
Government entities will play risk takers in this sector, especially in the urea sector. Current Capacities Fertilisers
Amongst private players, Chambal is going for brownfield expansion. Talcher is being production includes 30 Large sized
overtaken by RCF. Three units at Sindri, Baruani and Gorakhpur are taken by IOCL, Urea Manufacturing units (27 are
NTPC and Coal India, respectively. gas based and remaining 3 are
There are 5 revival plants approved by Government naphtha based), 21 DAP and
Complex Fertilisers units, 2 units
 Talcher [of Fertiliser Corporation of India Limited (FCIL)]: Revival through which manufacture Ammonium
nomination route and is likely to be completed by 31 March 2019. JV of Rashtriya Sulphate as by-product and 105
Chemical & Fertilisers Limited (RCF), M/s Coal India Limited (CIL) and M/s Gas medium and small scale units in
Authority of India Limited (GAIL) operation producing SSP (Single
 Ramagundam [of FCIL]: Revival through Nomination route. JV of Engineers Super Phosphate)
India Limited (EIL) and M/s. National Fertilisers (NFL). This is expected to come on
stream by end-FY20, the earliest one to do so of the 5 plants.
 Sindri [of FCIL]: Revival through bidding route.
 Gorakhpur [of FCIL]: Revival through bidding route.
 Barauni [of Hindustan Fertiliser Corporation Ltd (HFCL)]: Revival through bidding
route.
In each of the new plants, 2.4 mmscmd of gas is required. So around 12mmscmd will
be required for all 5 plants (out of total 6 revival plants). Talcher is based on coal.
Chambal recently announced the setting up of a new urea plant with a capacity of
1.3mn tons. So, there would be 6 new plants, taking the total number of urea plants
to 36.

Fertilisers
Further, Matix Fertilisers and Chemicals had started production in October 2017 in its
fertiliser plant located in Panagarh, West Bengal. This is a coal-bed methane urea
plant (first if its kind in the country) and will be key to fertiliser security of north-
eastern states. The company has invested around Rs7,000cr towards the plant. Our
channel checks suggest it will be really challenging for Matix to generate positive IRR
from this project. Total capacity of the plant is 1.3 mn tons and is expected to run at
100% capacity utilisation by the end of FY18. Coal-bed methane will be sourced from
Essar Oil’s Raniganj block (30km dedicated pipeline has already been set up).
What are the other new investments in this sector? One key thing to note here is that
private players are at benefit as
We could witness some new investments by refiners. But that raises concerns as to
compared to PSUs since approvals
why refiners will turn to this sector which has to travel a long bumpy road to become
are faster for investment. Since
value-accretive.
public players need to follow
There are two motivations for doing so: certain prescribed rules and
complete other formalities like
 Increased traction towards DAP.
appointing valuer among others
 Prospective ban on petcoke. they lag behind when time comes
for grabbing newly discovered
All refineries are surplus in sulphur and petcoke, so they go for investments which
opportunity that comes to the
can use these. They will use petcoke for generating steam by using them in boilers.
shore.
And for sulphur, they are planning to convert it to sulphuric acid and then react with
phosphate (rock) to obtain phosphoric acid and gypsum (which consumes the whole
sulphur). Reacting phosphoric acid with ammonia gets DAP. Gypsum will be sold as
input to cement.
Gypsum is required to soften cement. So, instead of selling petcoke (on the verge of
being banned) to cement plants they will send gypsum to cement plants (~5% of
cement content is gypsum). Further, gypsum finds its applications in other industries
like Plaster of Paris among others. The only concern is that gypsum should be of good
quality.

Fertilisers
Valuations of fertiliser stocks are pricing in

an unlikely structural change
The fertiliser sector has seen a meaningful re-rating over the last two years
in anticipation of: a) reforms linked to DBT and b) improved production and
hence profitability after gas pooling started in 2015. We reckon that
Coromandel, GNFC and Chambal are investible names in this space, however
our preliminary belief is that valuations are pricing in most of the key
positives. Key triggers for urea stocks (GNFC and Chambal) would be payout
of outstanding subsidies of ~Rs300bn, which can cut their interest burden by
nearly half. But this may take longer given the general elections in 2019 and
weaker state finances on account of lower-than-expected GST revenues.
Adoption of soil health cards that would boost P&K volume growth is the key
driver for Coromandel though that will be gradual and unlikely to get any
major boost from Government reforms.
We don’t expect much to change in the near future

Urea reforms should touch three objectives: a) target subsidies on an effective basis
without leakages, b) provide subsidies on a uniform basis to all the key nutrients
rather than being biased towards a particular nutrient, and c) ensure a healthy
competitive environment amongst players rather than breeding inefficiencies. We
believe DBT had the potential to resolve point a) though that was an opportunity
missed due to non-linkage to digitised land records and soil health cards. Bringing b)
under NBS means all plants need to be at a similar cost structure, which may take
time and may require the Government to give capital subsidies to old urea plants.
The financial health of fertiliser players has been in bad shape because of
outstanding subsidy receivables of ~200 days for which the Government doesn’t
seem to have the money or the political urgency to clear the receivables fast.
We don’t see any major reforms till the 2019 elections as fertiliser subsidy is
considered as a political move (as evidenced in minimal changes in urea prices in the
past 20 years) and any change towards reducing subsidy will result in loss of seats for
the current Government in the coming elections. In fact, in this year’s Budget there
were no structural changes in fertiliser policy and the subsidy amount was also kept
in the same range of ~Rs700bn.
Coromandel, GNFC and Chambal are better placed

amongst fertiliser players
We note that Coromandel and Chambal have delivered the best growth rates over
last decade. On ROE, too, they fare better than others. Coromandel derives most of
its sales from selling P&K fertilisers and hence is a play on future nutrient balance as
subsidies on urea are curtailed. It is also focused on improving share from its non-
fertiliser businesses (currently ~30%), which should support its growth trajectory.
Chambal’s ROEs are the best amongst the pure fertiliser players and would benefit
from brownfield expansion of its Gadepan facility.

Fertilisers
Exhibit 31: Revenue growth has been subdued across the industry in the past 3 years;
Coromandel and Chambal gained market share and also improved EBITDA margin
Revenue CAGR Rs mn EBITDA CAGR Rs mn
Particulars
FY08-14 FY14-17 FY08-17 FY17 FY08-14 FY14-17 FY08-17 FY17
Coromandel 17.8% 0.5% 11.7% 101,951 11.8% 6.9% 10.1% 9,827
GNFC 5.9% -1.8% 3.3% 45,888 -0.7% 2.0% 0.2% 6,524
Chambal 18.6% -5.4% 10.0% 75,534 4.9% 3.5% 4.4% 7,483
GSFC 7.2% -0.9% 4.5% 52,645 3.1% -4.7% 0.4% 4,866
RCF 4.2% 2.5% 3.7% 70,982 12.2% -11.9% 3.5% 3,730
NFL 11.6% -1.7% 7.0% 76,199 -7.0% 62.6% 12.1% 5,570
Source: Companies, Ambit Capital
Exhibit 32: EBITDA margin reached a trough as capacity utilisation came down by
FY15 due to gas availability issues at some plants; but gas pooling improved
profitability for most fertiliser players; players that conformed better on energy
efficiency norms too did better
Particulars FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Coromandel 11% 9% 11% 14% 11% 9% 8% 8% 7% 10%
GNFC 19% 15% 11% 13% 14% 14% 13% 7% 12% 14%
Chambal 16% 12% 16% 12% 11% 8% 8% 8% 8% 10%
GSFC 13% 15% 11% 25% 21% 13% 10% 11% 11% 9%
RCF 5% 5% 3% 6% 6% 8% 8% 10% 5% 5%
NFL 5% 4% 6% 4% 4% 1% 2% 4% 7% 7%
Exhibit 33: High receivables burden (translating into heavy debt) drives lower PAT
margins
Particulars FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Coromandel 6% 6% 7% 9% 7% 5% 4% 4% 3% 5%
GNFC 11% 8% 5% 9% 7% 6% 6% -10% 4% 11%
Chambal 7% 4% 5% 4% 2% 3% 3% 3% 1% 5%
GSFC 7% 8% 6% 16% 14% 8% 6% 8% 7% 8%
RCF 3% 2% 4% 4% 4% 4% 3% 4% 2% 3%
NFL 3% 2% 3% 2% 2% -3% -1% 0% 3% 3%

Fertilisers
Exhibit 34: ROCEs declined due to decline in margins as an Exhibit 35: A similar trend was seen in ROE….
outcome of Government push for taking away efficiency
gains
35% 60%
30% 50%
25% 40%
20%
30%
15%
20%
10%
10%
5%
0%
0%
FY08FY09 FY10FY11FY12FY13 FY14FY15FY16FY17
-5% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 -10%
-20%
Coromandel GNFC Chambal GSFC RCF NFL
Coromandel GNFC Chambal GSFC RCF NFL
Source: Companies, Ambit Capital research Source: Companies, Ambit Capital research
Exhibit 36: Only Coromandel out of the top 6 has been able to maintain its working capital days since it is not affected by
urea subsidy
Debtor Days Inventory Days Creditor Days Net Working Capital Days
Particulars
FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17 FY14 FY15 FY16 FY17
Coromandel 60 47 48 58 59 65 72 73 93 94 99 110 26 18 22 21
GNFC 99 110 114 103 55 62 58 54 19 23 22 24 135 149 150 134
Chambal 146 126 142 167 40 27 33 42 19 12 16 17 167 140 159 191
GSFC 165 134 156 209 46 45 36 45 38 32 27 40 174 148 165 213
RCF 148 144 172 205 56 42 48 50 34 26 27 32 170 160 193 223
NFL 177 207 231 217 19 15 18 25 16 12 11 17 180 210 238 226
Source: Companies, Ambit Capital Research
Valuations for fertiliser stocks have already re-rated

Fertiliser stocks got re-rated in anticipation of a) improvement in WC cycle post DBT
b) likely arrears of previous subsidy receivables before government rolls out DBT. Both
of which appear difficult to us in current scenario.
Exhibit 37: Coromandel & Chambal trades at a premium to Exhibit 38: Their re-rating is very similar to OMCs (P/B
peers (P/B multiples) multiples)
7 3.5
6 3.0
5 2.5
4 2.0
3 1.5
2 1.0
1 0.5
0 -
Apr-14 Dec-14 Aug-15 Apr-16 Dec-16 Aug-17 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17
CRIN Chambal GSFC RCF NFL BPCL HPCL IOCL
Source: Bloomberg, Ambit Capital Source: Bloomberg, Ambit Capital

Fertilisers
Exhibit 39: Coromandel too has seen sharp improvement in Exhibit 40: GNFC’s re-rating is also linked to increase in
valuations driven by improved profitability and prices for its specialty chemicals portfolio
anticipation of better P&K sales from use of soil health
cards
7 3
6
2
5
4 2
3 1
2
1
1
0 0
Apr-07 Apr-09 Apr-11 Apr-13 Apr-15 Apr-17 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16
PB Ratio Average - 10Y PB Ratio Average - 10Y
Source: Ambit Capital Source: Ambit Capital
Exhibit 41: Chambal too has seen meaningful Exhibit 42: GSFC, RCF and NFL haven’t seen much re-
re-rating given anticipation of fertiliser reforms and rating given weaker ROEs
improved visibility on return ratios of new Gadepan facility
5 3
4
4 2
3
2
3
2
1
2
1 1
1
0 0
Apr-07 Apr-09 Apr-11 Apr-13 Apr-15 Apr-17 Apr-07 Apr-09 Apr-11 Apr-13 Apr-15 Apr-17
PB Ratio Average - 10Y PB Ratio Average - 10Y
Source: Ambit Capital Source: Ambit Capital

Fertilisers
Relative valuations
We don’t see many reasons to own fertiliser stocks except Coromandel and Chambal
even if we ignore valuations given weaker return ratios. While we like the ability to
maintain good return metrics for Coromandel and Chambal in the difficult space, on
a structural basis valuations based on P/B and ROE seem expensive. At 19x FY19E
EPS, Coromandel is expensive to other agri-input players while growth is unlikely to
exceed that of private agrochemical players. Chambal at a P/B valuation of 2.2x
FY19E P/B for ROE of 19% appears expensive. P/E ratios of 12x FY19E EPS for
Chambal appear to be much more expensive than OMCs at 9-10x for ROEs of 22-
25%.
Exhibit 43: Coromandel & Chambal have traded as premium to its peers
ADVT -
Mcap EV/EBITDA (x) P/E (x) CAGR (FY14-17) ROCE P/B (x) RoE
Companies 6m
US$ mn US$ mn FY15 FY16 FY17 FY15 FY16 FY17 Sales EBITDA EPS FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17
COROMANDE
2,506 2.1 13.6 10.4 11.4 40.5 45.5 34.2 12% 7% 10% 10.4% 8.7% 12.0% 7.4 6.2 5.6 18% 15% 17%
L
GNFC 1,034 15.0 13.0 7.8 9.8 NA 39.0 12.9 -2% 0% 21% -4.2% 5.7% 11.0% 2.7 2.1 1.8 -17% 6% 15%
CHAMBAL 1,078 1.9 8.1 7.5 8.3 23.8 31.8 19.4 -5% 1% 14% 5.9% 3.4% 6.8% 3.1 3.8 3.3 14% 11% 18%
GSFC 783 7.2 5.7 5.1 10.8 12.8 12.5 12.2 -1% -6% 7% 8.1% 7.2% 6.6% 1.1 0.9 0.8 9% 8% 7%
RCF 700 8.0 6.2 10.8 14.0 14.2 26.4 25.4 -21% -14% -10% 8.4% 4.4% 4.7% 1.7 1.6 1.6 12% 6% 6%
NFL 459 1.6 20.3 12.0 12.7 115.1 15.1 14.4 -2% 20% 49% 2.5% 4.6% 5.4% 2.0 1.8 1.6 2% 13% 12%
Exhibit 44: Coromandel & Chambal are future favorites as well

ADVT -
Mcap EV/EBITDA (x) P/E (x) CAGR (FY17-20) ROCE P/B (x) RoE
Companies 6m
US$ mn US$ mn FY18E FY19E FY20E FY18E FY19E FY20E Sales EBITDA EPS FY15 FY16 FY17 FY18E FY19E FY20E FY18E FY19E FY20E
COROMANDEL 2,506 2.1 13.5 12.5 11.3 22.4 19.6 17.1 9% 9% 14% 10.4% 8.7% 12.0% 4.8 4.1 3.6 23% 22% 22%
GNFC 1,034 15.0 5.3 4.6 NA 10.2 8.5 NA NA NA NA -4.2% 5.7% 11.0% 1.5 1.3 NA 15% 16% NA
CHAMBAL 1,078 1.9 12.7 12.3 6.3 13.8 13.0 8.3 14% 42% 29% 5.9% 3.4% 6.8% 2.8 2.4 1.9 19% 18% 23%
GSFC 783 7.2 10.6 8.2 7.8 14.1 10.6 10.0 9% 17% 19% 8.1% 7.2% 6.6% 0.8 0.7 0.7 6% 7% 7%
RCF 700 8.0 NA NA NA NA NA NA NA NA NA 8.4% 4.4% 4.7% NA NA NA NA NA NA

NFL 459 1.6 10.2 9.2 NA 13.5 11.9 NA NA NA NA 2.5% 4.6% 5.4% 1.5 1.3 NA 11% 11% NA
Valuations – OMCs vs fertilisers

We reckon that many investors like to compare OMCs with fertiliser players given the
high returns of these stocks as subsidy reforms played out. In OMCs, the Government
just had to face the backlash of increasing pump prices for petrol and diesel. A large
section of petrol and diesel consumers were urban, hence the political sympathies
were slightly lower. In the case of fertiliser, the Government is struggling with a basis
for defining the beneficiary and benefits, which are also an infrastructural challenge.
Different companies have different plants which get different subsidies. In OMCs
inefficiencies of refineries are to be borne by OMCs themselves. In petrol and diesel,
the Government effectively eradicated subsidies but in the case of fertilisers the
Government will never eradicate subsidies. On LPG, benefits and beneficiaries were
well-defined while in the case of fertilisers, the Government is trying to link them to
soil health cards. The effectiveness and quality of soil health cards itself are
questionable.
OMCs’ profitability effectively benefited from a) release of subsidy receivables, and b)
improved profitability on diesel and petrol. On urea, both of the above factors seem
to be a long haul. Profitability improvement in urea is difficult as returns are capped
in the current variable subsidy regime. Multiple reforms would need to come together
to make a re-rating case for fertilisers similar to that of OMCs. All of those look
difficult at least in the near future.

Fertilisers
Exhibit 45: Large part goes towards funding subsidy Exhibit 46: …..Most of the subsidy receivables are funded
receivables (working capital) despite not growing much on from debt
revenues
Inc in Gross Block

Working Increase
Capital 22%
41%
Increase in
Loans
Equity Cash Profit
39%
Dividend from
4% Loans operations
Share
Repayment 59%
Corp.dividen Capital Issue
26%
d Tax Increase in Interim 0% Sale of
1% Investments Dividend Investments
5% 1% 2%
Source: Companies, Ambit Capital Source: Companies, Ambit Capital
Catalysts to our negative view on the sector

Increase in international urea prices
Any increase in international urea prices will increase the subsidy burden of the
Government and in turn increase the receivables for fertiliser players. We don’t think
that in the run-up to the general elections, the Government will hike prices of urea.
Further teething challenges in DBT

There are multiple challenges with DBT in the current situation as discussed in the
note. Given the retailer is not much incentivised to help companies recognise
subsidies receivable, there might be mistakes in recognising or input of details
required for release of subsidies. This can lead to unrecognised subsidies for
companies. This may altogether push the government to scrap DBT in its current
form.
Risks to our negative view

Clearance of subsidy arrears
The Government needs to clear subsidy arrears of ~Rs300bn which have been
pending from previous years. Every year, there is a backlog given old dues are
cleared first and then limited money is left to pay for subsidy payouts pertaining to
that year. If the Government clears these subsidy arrears before moving to direct
benefit transfer (as demanded by the industry); this can help in improving profitability
of key fertiliser players by 20-40%. We doubt this will play out in the near future
given limited availability of fiscal flexibility with the Government.
Digitisation of land records

Digitisation of land records will go a long way in selectively identifying the key
beneficiaries. Some key agricultural states such as Andhra Pradesh and Telangana
have digitised most of their land records. Any move towards targeting subsidies
effectively towards the needy will help the overall reduction in subsidies.

Fertilisers
Bringing urea under NBS

A substantial amount of nutrient imbalance is caused by unlimited subsidies on urea
and capped subsidies on P&K fertilisers. Even from an IT infrastructure point of view,
having different subsidies for different urea plants (under cost+ model) creates a lot
of hassles for the dealers who have to select the right plant in a scroll down menu on
the PoS machine. Having fixed subsidies will incentivise more efficient urea players to
gain market share and drive competitiveness in the sector. Again, this will be a
drastic reform and will need significant willpower given this would translate into
closure of inefficient plants and will link urea prices to the market.
Reduction in urea subsidies
Price hikes in urea have been limited so far. Any cuts in resulting domestic subsidies
payout can reduce subsidy receivables for fertiliser players.

Fertilisers
Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Ambit Capital Private Limited (022) 30433174 saurabh.mukherjea@ambit.co
Pramod Gubbi, CFA Head of Equities (022) 30433124 pramod.gubbi@ambit.co
Research Analysts
Name Industry Sectors Desk-Phone E-mail
Nitin Bhasin - Head of Research E&C / Infra / Cement / Home Building (022) 30433241 nitin.bhasin@ambit.co
Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 aadesh.mehta@ambit.co
Abhishek Ranganathan, CFA Retail / Consumer Discretionary (022) 30433085 abhishek.r@ambit.co
Amandeep Singh Grover Small Caps (022) 30433082 amandeep.grover@ambit.co
Anuj Bansal Consumer (022) 30433122 anuj.bansal@ambit.co
Archit Varshney Consumer (022) 30433275 archit.varshney@ambit.co
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Basudeb Banerjee Automobiles / Auto Ancillaries (022) 30433141 basudeb.banerjee@ambit.co
Bhargav Buddhadev Power Utilities / Capital Goods / Small Caps (022) 30433252 bhargav.buddhadev@ambit.co
Deep Shah Media / Telecom (022) 30433064 deep.shah@ambit.co
Gaurav Khandelwal, CFA Oil & Gas (022) 30433132 gaurav.khandelwal@ambit.co
Gaurav Kochar Banking / Financial Services (022) 30433246 gaurav.kochar@ambit.co
Girisha Saraf Home Building (022) 30433211 girisha.saraf@ambit.co
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Kushagra Bhattar Agri Inputs / Chemicals (022) 30433062 kushagra.bhattar@ambit.co
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Prateek Maheshwari Cement / E&C / Infrastructure (022) 30433234 prateek.maheshwari@ambit.co
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Sudheer Guntupalli Technology / Staffing (022) 30433203 sudheer.guntupalli@ambit.co
Sumit Shekhar Economy / Strategy (022) 30433229 sumit.shekhar@ambit.co
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Name Regions Desk-Phone E-mail
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Dipti Mehta India (022) 30433053 dipti.mehta@ambit.co
Krishnan V India / Asia (022) 30433295 krishnanv@ambit.co
Nityam Shah, CFA Europe (022) 30433259 nityam.shah@ambit.co
Punitraj Mehra, CFA India / Asia (022) 30433198 punitraj.mehra@ambit.co
Shaleen Silori India (022) 30433256 shaleen.silori@ambit.co
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Hitakshi Mehra Americas +1(646) 793 6751 hitakshi.mehra@ambitamerica.co
Achint Bhagat, CFA Americas +1(646) 793 6752 achint.bhagat@ambitamerica.co
Production
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Jestin George Editor (022) 30433272 jestin.george@ambit.co
Richard Mugutmal Editor (022) 30433273 richard.mugutmal@ambit.co
Nikhil Pillai Database (022) 30433265 nikhil.pillai@ambit.co

Fertilisers
Explanation of Investment Rating

Investment Rating Expected return (over 12-month)
BUY >10%
SELL <10%
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Ambit Fertiliser Thematic Too Much Optimism 01mar2018

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Fertiliser

Too much optimism Only 33% of urea subsidies go to small

Source: Company, Ambit Capital

March 01, 2018 Ambit Capital Pvt. Ltd. Page 2

Exhibit 2: Fertiliser scenario post reforms

6. DBT was also rolled out on

1997-03 2003-2010 2010-2017 Current

Source: fert.nic.in, Ambit Capital

March 01, 2018 Ambit Capital Pvt. Ltd. Page 3

Unlimited subsidies have distorted the NPK ratio

Nitrogen Phosphatic Potash

Source: GoI, Ambit Capital

Fertiliser consumption can still grow… but in non-urea

March 01, 2018 Ambit Capital Pvt. Ltd. Page 4

Exhibit 4: Fertiliser consumption per hectare of arable land (kg/ha)

2002 2014 Growth (RHS)

Source: World Bank, Ambit Capital

With increase in fertiliser consumption, imports of fertiliser have also increased

March 01, 2018 Ambit Capital Pvt. Ltd. Page 5

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17

India needs to depend on global supplies on P&K

March 01, 2018 Ambit Capital Pvt. Ltd. Page 6

Exhibit 8: Potassium Chloride (K2O) demand is expected to be ~85% of global supply

K2O Supply for Fertilizers K2O Demand for Fertilizers

Source: www.fao.org, Ambit Capital

Exhibit 9: Phosphoric Acid (H3PO4) demand is expected to be ~90% of global supply

H3PO4 Supply for Fertilizers H3PO4 Demand for Fertilizers

Source: www.fao.org, Ambit Capital

March 01, 2018 Ambit Capital Pvt. Ltd. Page 7

Fertiliser subsidy – the most vexed of 3Fs

Beneficiary Universal Univeral Defined Defined Defined

Quantity of subsidy Not Capped Not Capped Capped Capped Capped

Food Fertilizer Petroleum Others Fertilizer % of Total

Urea leakages amount to ~36% of fertiliser subsidies

March 01, 2018 Ambit Capital Pvt. Ltd. Page 8

Volatile fertiliser prices determine the subsidy outgo

International Urea Prices (Rs/MT) Import % of Total Urea Consumption

Source: World Bank, Annual Report of Fertiliser Ministry, Ambit Capital

March 01, 2018 Ambit Capital Pvt. Ltd. Page 9

1,200.0 Ethanol, India coming to

Source: World Bank, Ambit Capital

Domestic Prices International Prices

Source: Ambit Capital research Source: Ambit Capital research

NH3 Supply for Fertilizers NH3 Demand for Fertilizers

Source: www.fao.org, Ambit Capital

March 01, 2018 Ambit Capital Pvt. Ltd. Page 10

India missed an opportunity to reduce subsidy burden in 2009

Source: Govt. of India data, Ambit Capital

March 01, 2018 Ambit Capital Pvt. Ltd. Page 11

Government has taken various measures

Cost efficiency improvement Improving energy efficiency of companies Yes

Ways to reduce pilferage

March 01, 2018 Ambit Capital Pvt. Ltd. Page 12

Improving efficiencies of existing fertiliser players

Gas pooling mechanism

Naphtha-based plants to switch to gas

March 01, 2018 Ambit Capital Pvt. Ltd. Page 13

Amendments in New urea Policy to support production

Tightening the belt on energy efficiency norms

March 01, 2018 Ambit Capital Pvt. Ltd. Page 14

Driving better energy efficiency is the name of the game

March 01, 2018 Ambit Capital Pvt. Ltd. Page 15

Will players be able to outperform on revised norms to generate profits?