Rashtriya chemicals & fertilizers

Recommendation-Buy Target-Rs118 *CMP- Rs84.95

Industry Analysis
Industry Overview: Fertilizer sector is very crucial for Indian economy because it provides a very important input to agriculture. The fertilizer industry in India has played a pivotal role in achieving self sufficiency in food grains as well as in rapid and sustained agriculture growth. India is the third largest producer and consumer of fertilizer in world after China and USA. The growth of the fertilizer highly dependent on govt. policies. The govt. exercise extensive controls on pricing, distribution and movement of fertilizers. Determinants of fertilizer demand:Rainfall and irrigation facilities: Diversified and adequate rainfall gives farmers confidence to invest in fertilizers. Apart from this, well irrigation facility is needed. Relative prices of fertilizers: Indian fertilizer industry is characterized by smallholdings and demands to be price-sensitive. If there is any significant change in or price differentiation between fertilizers, demand will drift towards cheaper fertilizers. Cropping pattern: It determines the need and timings of fertilizer purchases. Government policy: Government has strong control on policies and framework to influence pricing, production and distribution. Rising demands in fertilizer: There has been significant growth in the consumption of fertilizers in last three years due to overall good monsoon. The growth in NPK consumption was 9.50% in 2004-05, 10.60 % in 2005-06 and 8.40% per cent in 2006-07.The robust growth in consumption of domestic fertilizer production has remained in range, from last decades. Fertilizers output grew by a modest 6.50 per cent during 2006-07. The surge in fertilizers demand and stagnant to modest increase in production has widened the gap between consumption and production, causing larger dependence on imports. Therefore, the rising demand for fertilizers is providing ample scope for the companies in this sector to increase their production capacity and volumes thereby, driving the growth of fertilizer. Chart:1 Demand Demand Supply Gap Demand of Year Supply N+P N+P+K N+P+K K 2007-8 16950 23125 8835 2660 2008-09 17585 24085 9305 2805 2009-10 18595 25035 9405 2965 2010-11 19912 25960 9178 3130 2011-12 19965 26900 10235 3300 Source: FAI

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Fertilizer Industry Rashtriya chem.&Fertilizer

Chart:2 Fertilizer index: Performance

Source: Company Research Future outlook: The fertilizer sector in last few months has shown some upward trend on the ground that government may come out with policies favoring the sector, which would provide boost to the companies in this sector. The sector looks attractive, as there can be unlimited opportunity to increase the volumes to fulfill the gap between supply and demand. The companies with huge capex plans are in queue just waiting for the node of DoF(Department of fertilizers), and once the sector get ground clearance from DoF than we can see new highs for this sector as a whole. Therefore, we are bullish on the sector with the time horizon of 1-2 years and expect that sector would outperform the broad market in coming years.

Company Background: -

Rashtriya Chemicals & Fertilizers (RCF) could emerge as a key beneficiary

of the rising availability of natural gas in India. As additional capacities become available, dependence on subsidies will decrease. All this, along with positive policy changes, makes RCF an attractive bet for a long-term investor.

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Fertilizer Industry Rashtriya chem.&Fertilizer

Business: Mumbai-based RCF is one of Indias largest producers of fertilizers and industrial chemicals. It has two operating locations, one at Trombay near Mumbai and the other at Thal in Raigarh district.RCF is Indias third-largest fertilizer producer. It makes urea and complex fertilizers and has a combined capacity of 25.1 lakh tones per annum (TPA). It also produces chemicals such as methanol, methylamines, nitric acid and ammonium bicarbonate. RCF also imports and sells urea, muriate of potash (MoP) and diammonium phosphate to support its product portfolio. Investment Rationale: Growth Drivers: RCF is set to receive an immediate boost from increased availability of natural gas It is to get 3.05 million cubic meters per day (mcmd) of gas from Reliance Industries, which will enable it to restart its 3.3-lakh-TPA urea plant at Trombay by this month-end and cut down naphtha consumption at its Thal plant. By September, it will also restart its 3.2-lakh-TPA complex fertilizer plant at Trombay, which was closed due to an accident. RCFs Rapid wall project to produce low-cost pre-fabricated walling systems from gypsum produced at Trombay will start operations by end-April and the company is also revamping its methanol plant to add more capacity and cut energy consumption. All these initiatives will raise output, raising turnover and boosting bottom line. Lower costs will bring down its subsidy bill. The lower dependence on government payments, typically made two to three months after actual production, will help cut RCFs short-term borrowings and interest costs. In the long run too, RCF has various expansion projects planned to drive growth. It has set up a joint venture with Rajasthan State Mines & Minerals (RSMML) to set up a 3-lakh-TPA diammonium phosphate (DAP) fertilizer plant in Rajasthan at a total estimated cost of Rs 900 crore. This project involves a 2:1 debt-equity ratio. The company is also de-bottlenecking its Thal plant to scale up urea manufacturing capacity to 20 lakh TPA by mid-2010 from 17 lakh TPA now. At Thal, it is also considering a 1.2-million-TPA brownfield urea expansion. RCF has also entered into a joint venture with Gail for a coal-bedmethane project and with National Fertilizers and KRIBHCO for revival of a defunct fertilizer plant. UREA: Strong market position: RCF is one of the leading manufacturers of urea in India with a share of 9.6% in the countrys production capacity. The companys market share is relatively higher at 13.73%, as it undertakes significant sale of imported urea. With significant increase in trading activities, the company has been able to bolster its urea market share in the last few years. RCF supplies to about ten states in the western, central and southern parts of India. The company has an established position in these markets on the back of its strong brand strength (Ujjwala) and wide distribution network.

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Fertilizer Industry Rashtriya chem.&Fertilizer

Chart:3 Percentage share of urea producers in total production of India in 2008-09

Source: -Fertilizers Association of India Healthy operating efficiency at Thal unit: Urea units in the country currently function under the New Pricing Scheme (NPS), wherein the subsidy (over the farm gate price) is given to individual units based on the lower of actual retention price (RP) or the group average RP. RCFs Thal unit falls under Group-VI (mixed feedstock), which includes GSFC-Baroda and IFFCO-Kalol units. RCFs Thal urea operations (which accounts for 84% of total urea capacity) has achieved healthy operating efficiency, with high capacity utilization and moderate energy consumption at 6.297 Gcal/MT of urea (in 2009-10) being well within the pre-set norm (6.983 Gcal/MT). The Thal unit has dual feed flexibility. While it was dependent upon mix of gas and naphtha (around 50:50) until 2008-09, it switched over completely to gas from May 2009 with adequate availability following commencement of RILs KG basin gas supply to the unit. The use of gas has also resulted in reduction in energy consumption by 0.3 Gcal/tonne, besides freeing up of working capital and surplus ammonia production. However, the benefits were partly offset by lower urea production due to lower availability of carbon dioxide and reimbursement of energy savings at lower weighted average rate. Thal units ROCE improved in 2009-10 (over 2008-09) due to the aforesaid benefits arising from the complete dependence on natural gas. ICRA believes that the Thal units healthy operating efficiency and access to adequate natural gas should enable it to be competitive against imports even in a scenario of decontrol. Hike in retail prices of urea is expected to have a marginal impact: The Government of India has recently announced a hike in MRP of urea by 10% with effect from April 1, 2010. The hike in MRP of urea by 10% should not have a significant impact on the profitability of the urea business of RCF, as it would lead to a corresponding reduction in subsidy and also the release in working capital would be only marginal. ICRA also notes that a new subsidy/pricing policy for urea is due with effect from April 1, 2010, on which clarity is awaited to evaluate the impact on the business risk profile of RCF. 19th August, 2010 Page 4

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Fertilizer Industry Rashtriya chem.&Fertilizer

Stagnancy in domestic production led to high import dependence in the past. However, augmentation of gas supplies results in increase in urea production in FY10, leading to lower imports. Domestic consumption of urea has grown steadily at a CAGR of 5.2% in the period from 2004-05 to 2009-10. While, the growth was strong till 2008-09, the urea consumption declined by 0.8% in 2009-10 (over 2008-09) due to poor monsoon in majority of the states and conscious decision of GoI to import lower quantities to contain subsidy bill. The total domestic production of urea in this period has remained relatively stagnant over the last 5 years due to feedstock constraints and lack of fresh capacity on account of policy uncertainties. Stagnancy in production led to significant rise in imports till 2008-09. However, urea production increased by 5% in 200910 (over 2008-09) due to higher gas availability, which coupled with a minor decline in demand led to decline in imports. However, with increasing area under irrigation and rise in cultivation of hybrid crops and horticulture varieties, the demand for urea is expected to remain strong. The availability of gas is critical to the growth of the urea industry particularly considering the conversion of naphtha and FO based urea units to gas over the next 3 years. GoI has accorded fertilizer sector the highest priority in its gas allocation policy, which is positive for the urea industry.

Source: Industry Capital expenditure (Capex) Plans: In FY11, the company has lined up a capex of Rs 4,400 crore for its ammonia plant at Thal, spread over a period of three years to expand capacity to 3.2 million tonnes (mt) from current 2 mt. Also, the company plans a Rs 500-crore expenditure towards revamping its existing Thal plant. RCFs debt-to-equity position is expected to stand at 3:1. Furthermore, the company is planning to set up urea plants in African countries such as Ghana and Mozambique. 19th August, 2010 Page 5

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Fertilizer Industry Rashtriya chem.&Fertilizer

RCF has a number of projects in the pipeline including the Rapid Wall Project and Clean Development Mechanism (CDM) project. Considering the high 92.5% government stake holding, RCF could approach the capital market again with a follow-on public offer during the year. With a dividend of Rs 1.1 per share, the dividend yield works out to be 1.28% at the current market price. FY09 Financial Performance Review RCF achieved a turn over of Rs. 5697.18 crore compared to Rs. 8455.32 Crore in the previous year. The turnover is lower by Rs 2758.14 crore during the year compared to previous year mainly due to lower imports of urea by Government of India and discontinuance of costly feed stock of Naptha leading to less subsidy realization. The total income from operations was Rs. 5826.25 crore as against Rs. 8538.43 crore during the previous year. Company achieved a gross profit of Rs.439.66 crore as against, Rs.487.20 crore. The net Profit before Tax at Rs. 344.21 crore as against Rs. 325.70 crore registered an increase of 5.68% despite lower gross profit mainly due to substantial reduction in the net interest. The Net Profit after Tax during the current year is higher at Rs. 234.87 crore as against Rs.211.58 crore in the previous year registering an increase of 11% over previous year. The net Interest cost during the year has beenRs.19.87 crore compared to Rs.74.93 crore during the previous year due to good treasury and foreign currency management which ensured reduction in interest cost and gain in foreign exchange transactions. Company received 'MOU Excellent' rating for 2008-2009 and is likely to get the same for 2009-10 from Ministry of Heavy Industries and Public Enterprises. Valuation: RCFs stock is valued at around 22 times its trailing 12-month earnings per share and is valued stock in the sector. Company has posted a net profit of Rs 344.21 crore in FY10, which translates to a forward P/E of 7.5 at the current market price. Other major urea manufacturers such as National Fertilizers and Chambal Fertilizers are trading at P/E of 13.2 and 11.1 respectively. At the current market price of Rs.84.50 the stock trades at a P/E of 20.4x. On the basis of relative valuation EV/EBDITA, the stock trades at 12.12 x FY 10.respectively. Price to Book Value of the stock is expected to be at 2.57 for FY 10. Price to Earnings (PE) is 18.26% of this stock.

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Fertilizer Industry Rashtriya chem.&Fertilizer

Chart:5 Peer Group Comparison

Fertilizers Companies Cash and Market Bank Capitalisat balances( Entrprise EV/Net ion(Rs Cr.) Debt (Cr) Cr.) value Net sales sales 4,708 2,802 1,327 1,862 2,375 1,315 5,707 2,094 1,330.84 2,615.97 731.2 355.9 324 977.35 264.87 319.76 Market price(Rs) (as on EV/EBITDA 06/08/2010) Networth EBITDA 84.95 67.5 150.2 119.8 298.45 30.65 116.1 705 1,837.14 1,390.06 930.39 2,014.12 1,931.48 1,582.77 1,470.70 927.4

Company Name Rashtriya Chemicals & Fertilizers Ltd. Chambal Fertilizers & Chemicals Ltd. Deepak Fertilisers & Petrochemicals Corp. Ltd. Gujarat Narmada Valley Fertilisers Co. Ltd. Gujarat State Fertilizers & Chemicals Ltd. Nagarjuna Fertilizers & Chemicals Ltd. National Fertilizers Ltd. Zuari Industries Ltd.

No. of shares(Rs. Cr) BV P/BV DPS EPS D/E 551 33.3 2.55 1.1 4.26 0.26 416.21 33.4 2.02 1.9 5.98 0.32 88.2 105 1.42 4.5 19.5 0.23 155.44 130 0.92 3.3 7.97 0.41 79.7 242 1.23 4.5 31.9 0.14 465.39 490.58 34 0.9 0.5 1.55 0.32 30 3.87 0.6 3.5 0.17 3 53 0.06

84.54 5,954.3 5,656.66 1.05261762 491.23 12.121206 30 5,388.0 3574.5 1.50733529 708.06 7.6094822 206.24 1,852.0 1273.99 1.45366918 348.47 5.3145464 52.02 2,165.9 2921.78 0.74128785 500.96 4.323459 33.8 2,665.2 5881.66 0.45313738 919.95 2.897114 39.18 2,252.9 1987.91 1.13329577 388.05 5.8056694 17.6 5,954.3 5127.1 1.16133292 304.67 19.543342 16.15 2,397.6 6090 0.39369622 204.22 11.740329

29.44 315 2.24

Source: -Flourish Fin cap Pvt.Ltd.Research-cell. Chart:6 Key Financial Indicators: 2009Particulars: 10 Net Sales 56,331 Operating Income 57,615 OPBDIT 3,592 PAT 2,349 Net Cash Accruals 2,697

200809 83,660 84,491 7,411 2,116 2,208

200708 51,406 51,980 3,748 1,541 1,769

Source: -Annual reports (Company Analysis)

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Fertilizer Industry Rashtriya chem.&Fertilizer

Financial Overview P&L Account as on Chart :7 31st March, 2010 (In Cr.) Revenue Other Income Total Income 2009 - 10 5,642.11 129.07 5,771.18 2008 2007 2006 2005 09 08 07 06 8,365.98 5,140.27 3,487.99 3,046.83 83.11 8,449.09 7,961.83 -74.93 412.33 -86.63 325.7 -114.12 211.58 5.82 2.53 96.09 5,236.36 4,851.79 -59.32 325.25 -83.18 242.07 -83.92 158.15 7.48 3.08 84.98 3,572.97 3,209.16 -46.93 316.88 -75.42 241.46 -92.72 148.74 10.43 4.26 68.06 3,114.89 2,847.54 -0.8 266.55 -68.53 198.02 -67.71 147.96 8.77 4.86

Expenditure -5,301.54 Interest -19.87 PBDT 449.77 Depreciation -105.56 PBT 344.21 Tax -109.34 Net Profit 234.87 OPM % 8.32 NPM % 4.16 All figures are in Cr)

Risk Factors: The company may have to write off mark-to-market loss on the bonds, which it is unable to sell due to their illiquid nature. Note: -*As on 6th,August 2010 Disclaimer: -The information in this publication/ document or any other means of communication is confidential and intended solely for the addressee and is not for public distribution and has been furnished to the recipient solely for his information and must not be reproduced or redistributed to any other person. The opinions, forecasts, assumptions, estimates, derived valuations and target price(s) contained in this material are as of the date indicated, are based on the information / views available to the public but no independent verification has been made nor is its accuracy or completeness guaranteed and are subject to change at any time without prior notice. While its the endeavour of the Company to update the information herein on reasonable basis and their directors and employees do not hold out any representation or warranty of correctness or completeness or promise of return under this document, and do not accept any liability for any views expressed herein or for the result of any actions taken on the basis of this document or for any error or omission.

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Contact: -

Research Analyst-Ashish kumar jha E-mail: ashish.mdu@gmail.com Flourish Fincap Pvt. Ltd. Member: NSE, F&O, MCX, NCDEX, MCX-SX, DSE, and UPSE 409,416,Essel House, 10 Asaf Ali Road, New Delhi-110002 Phones:011-23238521,23233965,Fax:011-23238344 Mob No.-+91-9810020399. E-mail: flourishfincap@yahoo.com Website: flourishfincap.com

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