G Chokkalingam, Head of Research at ESDPL approaching inflation from an equity market perspective, thinks there are significant opportunites in the midcap space. The rising crop prices offer opportunities in midcap sugar, paper, plantations, cotton and textiles.

He is also positive on fertilizers due to thrust on agri sector.

Excerpts from CNBC-TV18's exclusive interview with G Chokkalingam:

Q: Let us just talk about a couple of sectors that you think are good bets right now, first the fertilizer space and why that represents an interesting buy to you?

A: Within fertilizers, we like the phosphatic fertilizer segment basically because the application of this particular fertilizer is not adequate. Secondly the government has to encourage the domestic leaders in the segment to maximize the production because whenever India and China enter the global markets to purchase fertilizers, the price shoots up abnormally. There are indications that the subsidies can go up from Rs 60,000 crore to anywhere around Rs 1,00,000 crore, so it is in the interest of the government to encourage the efficient producers and the producers who have port handling facilities, have minimum conversion cost.

At Enam, we developed a simple tool to identify the leaders in terms of cost efficiency. We have taken the net sales without the subsidies and then we have taken the operating expenses and we have taken the difference between the sales and operating expenses to find out the deficit, because invariably any fertilizer company will have deficit without including the subsidy. We have taken this as operating deficit and then we have taken subsidy on the numerative and taken the ratio of subsidy to operating deficit. This is a good benchmark to identify the leaders in terms of cost efficiency. Any company whose ratio of subsidy to operating deficit is coming down and at the same time is able to grow its operating profit, is really leader in the segment.

According to the 11th five-year plan, there is going to be a shortage of 20 million tonne of fertilizer in the country. So it is in interest of the government to minimize the subsidy bill by encouraging the efficient producers who operate below industry average cost and you allow them to maximize the production quantity. So by encouraging them and discouraging the players who are operating above industry average cost, you can minimize on the subsidies.

As far as phosphatic fertilizers are concerned, there is no alternative path available to the government because the application is not adequate and secondly, you cannot disappoint farmers. Farmers have to get the fertilizer in the market place and right now there is a huge shortage. Therefore we like phosphatic fertilizer segment and within that the leaders in terms of cost efficiency and using this ratio of subsidy to operating deficit and also the growth in the operating profits.

Q: According to your ratios, which are the leaders in the listed fertilizer space?

A: As a policy, we do not talk about individual companies, we have given you the thought process, it is easy for any investors to identify.

Q: You like paper as well, tell us why?

A: Before coming to this particular sector theme, I will speak on four-five major themes emerging on the global front. All of us know about India’s economic growth story and the pattern of global growth itself is changing. The emerging theme is 'agflation', the agri crop prices are shooting up, and the crude oil prices are soaring. Cultivable land across the world is also coming down. According to statistics produced in Lok Sabha recently, the cultivable land has come down in absolute terms in the last 25 years, whereas the population has grown by about Rs 40 crore in last 25 years. If you consolidate these five themes, we feel that there is going to be a tremendous amount of demand pressure on various commodities, food grains. Therefore, we have zeroed in on three-four sectors starting from fertilizers, paper and sugar and based on the growth story, old private sector banks.

Having explained these five themes, in the paper industry also the per capita consumption of India is 1/7th of China or 1/8th of world average. All of us in another community know that whenever we do research, we start with this parameter of per capita consumption comparing with the peer group and most of the times we have gone wrong. But now I feel that the time has come to focus once again on the per capita consumption parameter because apart from India, China the growth has taken place once again in the highly populated economies like Russia, South Africa. So this has upset the demand supply forces in many sectors, which have to do with the day-to-day life of human beings. In fact in the last five years, the consumption of four major grains have gone up by 18 billion tonne; this is going to happen across all commodities that form the necessities of the citizens. Therefore we are bullish on paper and within India, we are more bullish on paper because there is a strong entry barrier particularly in the organized segment of quality papers.

At Enam we have done some sensitivity analysis, we found out that to start any Greenfield plant of 1 lakh tonne capacity, you need anywhere around Rs 1,000 crore. You take a debt equity ratio of either 1:1 or 4:1, your average cost has to be anywhere between Rs 8,000 and Rs 14,000 per tonne of paper produced and surprisingly all the existing players are making an average Rs 4,000 as an operating profit, per tonne of paper produced.

So you cannot have any new players, the price appreciation is at around 3.3% per annum. On the other hand, paper within that PWP segment is growing at a healthy trend of 7% per annum in the last five-ten years. 

Disclosures:

It is safe to assume that my clients & I may have an interest in the stocks/sectors discussed.