>India Edible Oil Outlook 2010 (FITCH RATINGS)

Fitch Ratings has a stable outlook on the Indian edible oil sector in 2010 — in the wake of continuing improvement in demand, driven by India’s growing per capita GDP. Those operators with conservative hedging and inventory policies, strong raw material sourcing arrangements, and geographically dispersed plants (which keep logistical costs optimal), are likely to present stable credit profiles. However, many are entering the branded edible oil segment, where margins will be lower during the entry phase due to the associated sales and marketing expenses. This will also result in higher working capital requirements. Some operators, anticipating higher prices, are believed to have built up inventories — which could constrain liquidity and have an adverse impact during any price decline. Aggressive inventory strategies would remain a rating concern.

The oil seed deficit in the Indian market is likely to continue, with the ongoing shortage in production together with strong demand growth. To meet this increased demand, the government has reduced duties on crude edible oils, a process which Fitch believes is likely to continue. The agency believes that the higher duties on refined oils (in the range of 7.3% to 7.75%) relative to crude oil (nil import duties) will continue to support the margins of edible oil refiners.

With a shift in consumption patterns in India towards the relatively cheaper palm oil, many larger operators are increasingly shifting their focus towards palm oils. Fitch expects that the larger entities such as KS Oils Limited (KSO, ‘BBB+(ind)’/Stable/‘F2+(ind)’) will eventually have the flexible capacity to process both palm and soya oils which, together with mustard oil, accounts for around 70% of Indian edible oil consumption.

With the increased consumption of palm oil, some companies like KSO and Ruchi Soya Ltd have plans to set up palm plantations in South‐East Asia, for backward integration. Although this exposes them to execution risk during the implementation phase, this should on completion support margin stability for these
firms.

Fitch expects tightly balanced global demand/supply dynamics for palm oil, as incremental production is expected to be lower than demand growth — with prices likely to remain at current levels (in the region of USD700/tonne). With other edible oils typically moving in tandem, Fitch expects the prices of other key oils
like soya and mustard to also remain firm.

Integrated players which are present primarily in smaller oils like mustard, ground nuts, coconut, and, to a lesser extent, soya, will continue to exhibit relatively stable margins. With the relative shortage of mustard seed production during Q110, mustard seed prices have remained firm — which Fitch expects to continue over 2010. The agency believes that for larger players, this additional cost could be partly offset by an increased proportion of higher‐margin branded products and growing demand.

Stable Credit Profiles
Fitch expects revenue growth across the industry. Although increased branded sales from large companies could lead to wider margins, the positive impact could be partly offset by the corresponding higher inventory and receivables due to the Market sources indicate that there could be an increase in inventory levels across
the sector in anticipation of further price increases; although, as these inventories are sold during the year to meet demand, they could revert to “normal” levels during 2010. Commodity and currency hedging policies remain critical given the previous volatility. The industry has traditionally required substantial investments
in working capital; although with the expectation of stable prices and strong demand growth, further liquidity pressures appear unlikely — barring any sharp build‐ups in inventory in expectation of future price movements. Fitch expects any negative surprises to primarily come from working capital fluctuations.

The agency also notes that large players like KSO, Ruchi Soya and Liberty Oil Mills (‘BBB‐(ind)’/Stable/‘F3’) have either recently completed — or are expanding — their refining capacity in order to meet the growing demand. However, the impact on credit profiles would depend on the relative scale of these expansions and
funding patterns. KSO has funded a large part of its expansions using equity infusions, and has completed its entire domestic refining capacity expansion in the third quarter of financial year 2010 (Q3FY10).

With players like Ruchi Soya and KSO investing in backward integration in palm plantations, Fitch expects a substantial rise in the share of palm oil in Indian consumption. On completion of these initiatives over the medium‐term, Fitch expects these companies to benefit from the added margins, as well as higher resilience to any future price volatility. However, in the interim, they remain exposed to execution risk to an extent.

Global Palm Oil Production
Market estimates indicate Malaysian crude palm oil (CPO) production in 2010 at similar levels as 2009, in the region of 17–18 million tonnes (mt), although adverse weather conditions like El Nino could curtail production in H210. Furthermore, the Malaysian government‐backed replanting programme could further lower production by up to 0.5mt in 2010. Yet, with the palm trees recovering from bad weather, yields are expected to improve in 2010.

In Indonesia, CPO production is expected to be marginally higher than in 2009 (around 20mt). However, with global palm oil demand rising faster than supply — primarily driven by India and China, which have significant edible oil deficits — palm oil prices are likely to remain firm in 2010. Palm oil prices have been rangebound at between MYR2,200 and MYR2,600 since mid‐2009. However, seasonal variations will continue, eg in H210 during the soya harvest season. Fitch notes that soya and palm oil prices have traditionally moved in tandem, with soya trading at a premium to palm.

Raw Material Dynamics
Indian oil seed production is expected to remain largely stable during 2010 for key oil seeds such as mustard and soya. Whilst mustard seed production could be slightly lower than in 2009, demand growth has driven mustard prices substantially higher. Fitch believes that the bulk of the impact will be felt by the unbranded segment, which may find it challenging to pass on the price increases to consumers — in light of the relatively lower palm oil prices. However, branded players will retain a cushion due to brand premiums.

Industry estimates indicate that the soya crop is likely to marginally grow from 2009’s levels, although prices should remain the same. Many firms are preferring to refine crude soya oil rather than using their soya crushing capacity due to the nil import duties on crude soya oil. This would continue as long as there is no change in the current duty structure.

To read the full report: EDIBLE OIL