Active Stocks
Tue Mar 19 2024 15:58:41
  1. Tata Consultancy Services share price
  2. 3,977.55 -4.03%
  1. Tata Steel share price
  2. 148.65 -0.64%
  1. Bharti Airtel share price
  2. 1,227.85 0.23%
  1. Power Grid Corporation Of India share price
  2. 258.95 -2.28%
  1. ITC share price
  2. 409.50 -1.89%
Business News/ Market / Mark-to-market/  No reason for investors to be excited in fertilizer stocks yet
BackBack

No reason for investors to be excited in fertilizer stocks yet

Rising raw material costs, worsening of the working capital situation due to GST and DBT implementation mean investors in fertilizer stocks would do well to prepare for earnings challenges in the near future

In the current scheme of things, subsidy payments are delayed for weeks and months once the budgeted amount is exhausted. Graphic: Naveen Kumar Saini/MintPremium
In the current scheme of things, subsidy payments are delayed for weeks and months once the budgeted amount is exhausted. Graphic: Naveen Kumar Saini/Mint

When you realize the impossibility of major reforms, you make do with the available possibilities. That seems to be the motto of investors in fertilizer stocks. They drove up fertilizer shares last week after the government extended the urea subsidy scheme till 2019-20.

The development is nothing to be excited about. Rather, the government notification explicitly says that urea prices will be capped till 2020, dashing any hopes of a pricing reform in the near future akin to what we saw in the petroleum sector. Nor is there any clarity on how the government plans to clear pending subsidy dues estimated to be about Rs23,000 crore.

Perhaps investors are counting the benefits from the roll out of the direct benefit transfer (DBT) scheme and the government thrust on substituting urea imports with local production through revival of stalled projects and other means. Under DBT, the manufacturer is stipulated to receive the subsidy amount within seven days of registering the sale.

In the current scheme of things, subsidy payments are delayed for weeks and months once the budgeted amount is exhausted. Similarly, encouragement to local production can help urea manufacturers step-up production beyond their reassessed capacity, extracting better returns.

But investors may well be overestimating the benefits. For one, the DBT while fast-tracking the subsidy disbursement process, also worsens the working capital situation of urea makers. In the existing system, sale is reported when the fertilizers are sold to wholesalers and retailers. Under the DBT, sale would be registered only when it is made to the farmer or end user. The cost of inventory, in the meantime, will have to borne by the manufacturers. “This in turn would lead to significant increase in the carrying cost of inventory for the industry, besides some amount of lumpiness in sales recognition in the books," K. Ravichandran, senior vice-president and group head-corporate ratings, Icra, pointed out in a statement.

Further, the DBT scheme implementation, which itself is facing hiccups, comes amid the uptick in raw material costs and after-effects of the goods and services tax. Due to slow refunds, a significant amount of money is getting stuck in the tax system, worsening the working capital situation, complain manufacturers.

Similarly, the other perceived benefit—a possible rise in production beyond the reassessed capacity—may not materialize now. As India Ratings and Research points out, the recent rise in natural gas prices (key for urea production) makes it uneconomical for urea plants to step up production beyond their reassessed capacity, unless the government rejigs the way it calculates the costs. It is cheaper for the government to import urea than to purchase such produce. “In such a situation, plants which used to make higher contribution margins from sales beyond reassessed capacity would see a compression in the contribution margins," India Ratings says.

Overall, the situation warrants caution instead of exuberance. The DBT may be the first step in resolving the structural problems being faced by the fertilizer sector. But rising raw material costs, a worsening of the working capital situation due to GST and the DBT implementation mean investors would do well to prepare for earnings challenges in the near future.

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 19 Mar 2018, 07:44 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App