AGROCHEMICALS INDUSTRY - WEAKENING FINANCIAL PERFORMANCE

TO RESULT IN SHAKEOUT
Business Diversity and Capital Structure are Key Rating Determinants
The domestic agrochemicals industry has been going through a difficult time over the last few years,
despite the general expectations of favourable industrial prospects. The industrys hopes were pinned on
the increased role of pesticides in addressing concerns over domestic food and fibre security. However,
adverse weather conditions leading to crop failures and variations in pest incidence, intense competition
unleashed by the presence of a large unorganised sector and the increasing commodity nature of the
industry, have impacted the financial risk profile of most of the pesticide companies.
While a shake out in the industry appears imminent, it is difficult to predict a timeframe for the same. As
in many other sectors, CRISIL expects the larger existing companies to eventually emerge stronger. In
pesticide industry where profitability variations are inherent, solid business diversity and capitalisation
would continue to be key determinants for the stability of the credit profile of the companies.
The past few years have witnessed volatility in operating margins of most of the agrochemicals
companies depending on their exposure to products, crops and states. Return on capital employed has
also been declining due to higher working capital requirements , primarily driven by higher credit
periods to dealers and customers. However, the susceptibility to monsoons is exemplified in the
performance in 2000-01. The table below gives the summarised results for the first half of 2000-01 for a
sample of nine agrochemical companies. While the declining performance is also due to certain
extraordinary factors (e.g. excess inventory of past years being taken back, some voluntary retirement
schemes etc.), the dominant reason for sub-par results is the poor monsoons.
2000-01
(first half)
1999-00
(first half)
Sales Rs. Bn. 25.30 26.41
PBDIT Rs. Bn. 2.68 4.42
Operating Margin % 10.6 16.8
PAT Rs. Bn. 0.73 1.48
Net Margin % 2.9 5.6
Expectation of Favourable Growth Prospects
The Rs. 3 billion Indian agrochemicals industry has been anticipating favourable growth prospects since
mid '90s. India's pesticide usage per hectare is among the lowest in the world and there is a low level of
market penetration. CSIR (Council of Scientific and Industrial Research) estimates that 20-30 % of the
total crop production is lost due to pests and diseases, and increasing usage of pesticides will play a key
role in shaping India's concerns over self-sufficiency in food and fibre. Also, pesticide consumption in
India is skewed towards insecticides, as against the international preference for herbicides. This is
because weeds have traditionally been removed by low cost labour in India. However, increasing rural
labour costs and the demonstrated benefits of herbicides have made this a fast growing segment in the
domestic market. Global opportunities for pesticide manufacturers have also opened up, and with
exports picking up and Indian products getting recognised internationally, India is being considered as a
possible pesticide-manufacturing base for requirements around the world. In this context, and with the
maturing of several world markets (the global pesticide industry is estimated at over US $ 30 billion),
India is seen as a growth opportunity. This has prompted companies to invest in the domestic
agrochemical sector.
Dogged by Intense Competition
With rapid growth in the early 90s, the competition has also intensified. To start with, there is the
presence of a large and active unorganised sector; it is estimated that there are more than 500
manufacturers who manufacture formulations in the small scale sector and over a 100 manufacturers
who can make bulk products both in the organised and small scale sectors. Encouraged by low capital
costs, liberal environmental norms and the Indian expertise in process chemistry, some of the larger ones
have backward integrated into manufacturing bulk products. The competitive effect has continued into
the large Indian and multinational companies in this business; traditionally, Indian companies have
leveraged on their manufacturing capability, and multinational companies on their brand building
ability. With the globalisation and capacity expansion of the pesticide sector in the early 1990s, the bulk
prices started declining significantly in the latter half of the decade. This led to increasing competition in
the formulations business, which has been reflected in higher discounts and increased credit periods to
dealers and customers.
High Dependence on Agro-Climatic Conditions
The external environment in India has also played a spoilsport. The agriculture industry in India,
especially in non-paddy and wheat segments, is highly dependent on the monsoons as area under
irrigation is relatively low. While the focus has been on the quantum of rainfall (leading to a discussion
on average rainfall levels), time and geographical distribution of rainfall are also important components.
For example, high amounts of rainfall affected crops in 1996-97 leading to crop losses, and affected the
ability of the farmer to make payments. Similarly, in 1998-99, there was low incidence of pest attack in
Andhra Pradesh due to long periods of sunshine between rains, which led to lesser pesticide sales.
Failure of the monsoons in Andhra Pradesh, a state which accounts for around a third of the domestic
pesticide consumption, can also affect the industry significantly. These vicissitudes of the monsoons and
acts of God continue to play a key role in the pesticide industry, exaggerating the competition-induced
volatility. Other factors such as Government policies on crop procurement (e.g. monopoly cotton
procurement scheme in Maharashtra) also affect the cash flows to the farmers, which in turn affects the
financial position of agrochemical companies.
Few other Impediments and Risks
Other singular effects in the domestic market have been the prevalence of spurious product
manufacturers, overuse of pesticides (in some cases) and high dependence on cotton crop. The presence
of manufacturers of spurious products (starting right from seeds to pesticides) has been reported
extensively. Several efforts by the industry have still not resulted in tangible benefits. There is also, to
some extent, overuse of pesticides by farmers leading to pest resistance and resurgence. Unlike the
pharmaceutical industry, the evolution of speciality products with demonstrated cures has not yet caught
on in the agrochemical industry. This has led to increased commoditisation of the industry, with credit
and price being the key selling factors. The limited ability of the Indian farmers to pay for more
expensive products has also been a key factor in limiting the market. The cotton crop also accounts for
over 40% of insecticide consumption, and the results of the cotton season roughly parallel the industry
scenario.
Shake out Imminent
Given the fact that the last few years have been unfavourable even for larger players, CRISIL feels that a
shake out appears imminent with smaller players exiting the business. There used to be an excise duty
differential of 8% between the price of bulk material and that of the formulation which aided formulators.
This has since been equalised, which should also aid the shake-out process.
However, in Indian markets it is always difficult to predict when this will happen. As of now, there have
been no major consolidation efforts in the industry among the larger players, and the industry is
fragmented to allow meaningful consolidation. Most domestic mergers and acquisition developments
follow trends set by international parents of multinational companies. In the period leading up to some
degree of consolidation, CRISIL expects companies in less competitive segments (such as herbicides and
fungicides) to be at an advantageous position as compared to the companies only in the highly
competitive insecticides segment. Further, as seen in many other industries, CRISIL expects larger and
well-capitalised players to emerge stronger once the shake out happens.
Strong Business Diversity and Capitalisation are Key Rating Determinants
The volatility in the domestic agrochemical industry and low level of control over external factors leads
to stringent requirements from corporates in order to get a high rating. CRISIL has key expectations on
the business and financial profiles of companies that are rated highly; these are driven by diversity in
business profile as well as high level of capitalisation.
The key expectation from the business front would be solid business diversification, both in products and
markets, backed by a large size and reach. Product diversification is important as Government
regulations play a major role in the industry, and ban on any particular product can affect sales
significantly. United Phosphorous Ltd offers this model of strong diversity in products and markets.
Many multi-national companies also use their Indian operations for sourcing products, thereby reducing
the volatility effect. Business diversity into related agricultural (such as the seeds business by Syngenta
India Ltd) or non agrochemical sector where there are stability in earnings (such as speciality chemicals)
are also considered positive. While BASF India Ltd has a high degree of diversity by its presence in
speciality chemicals, Excel Industries Ltd has this diversity to a lesser extent. It has also been seen that
companies operating in the herbicide sector have been subject to lower volatility, as they have tried to
spread into irrigated areas with crops like wheat and paddy where crop stability is higher.
Over the past few years, it is seen that the financial position of most of the pesticide companies has been
affected. While profitability variations are traditional and typical of this business, balance sheet
distortions have become increasingly evident over the last few years. Increasing credit periods both in
exports and domestic sales (see table below) have placed pressure on working capital financials.
Companies that have geared up to meet competition or for investment purposes have suffered
significantly during the downturn. Accordingly, CRISIL expects highly capitalised companies or
companies with strong parentage to have a relatively stable credit profile. Such highly rated companies
use debt as a cash management tool during the busy season rather than a major funding source.
Debtors (Days)
2000 1999 1998 1997
Average for key industry players 84 80 74 57