>FERTILIZER SECTOR: Emerging from regulatory shackles... (HDFC)

Fertilizer sector stocks have recovered due to the allocation of KG D-6 gas, which has reduced cost and increased utilization levels of fertilizer plants. Many of these plants ran on expensive naphtha or FO / LSHS feedstock. Closed units are also likely to open due to this cost reduction. High population density per unit of arable land and low yields have been the bane of Indian agriculture and one of the most efficient ways to abate the condition is by proper nutrient management of the soil. The consumption of fertilizers in India is expected to grow by 4% CAGR till FY12. Urea is expected to witness a supply deficit of 5.4mmtpa by FY12.

■ Limited land, rising population to drive fertilizers growth
With one of the highest population densities per unit of arable land, farm productivity will have to improve dramatically if national food security is to be ensured. Better nutrient management thus becomes critical. Fertilizer demand is expected to grow at a CAGR of 4% till FY12. But a deficit of 5.4mmt in urea, the most widely consumed fertilizer, is expected by FY12. Phosphatic and potash fertilizers also remain matters of concern due to the lack of indigenous raw materials. While indigenous sources form 5- 10% of raw material requirement for phosphatic fertilizers, there are no known commercial sources of potassium salts in India, raw materials for potash fertilizers.

■ Availability of cheaper feedstock (natural gas) to bring down costs
The use of natural gas will bring down the feedstock cost by over 60% for urea plants running on naphtha or FO / LSHS. This will not only increase utilization of underutilized gas based plants, but help revive closed plants. The reduced cost will also ease the subsidy burden of the government already saddled with a high fiscal deficit.

■ A step towards deregulation and freeing of fertilizer prices
While Urea was under mandatory pricing control under the New Pricing Scheme, Stage-III, the government recommended an MRP for DAP, MOP, MAP, TSP, SSP, Ammonium Sulphate and 11 other complex fertilizers under the Concession Scheme. Recently, the government hiked the retail price of urea and introduced nutrient based subsidy with effect from Apr 1, 2010. Though there have been no further details on the magnitude of subsidies, we believe subsidy per unit of nutrient will be set in such a way that subsidy levels remain virtually unchanged. The new nutrient based subsidy mechanism will prove an important step towards complete deregulation of the sector.

■ Recommendations
We initiate coverage on four fertilizer companies – Deepak Fertilizers (HOLD), Chambal (BUY), Coromandel (HOLD) and Zuari (BUY). Our valuations are based on one year forward EV/EBITDA multiples of the stocks.

To read the full report: FERTILIZER SECTOR