Sunidhi Sec picks GSFC, Zuari Ind from fertiliser space

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Sunidhi Sec picks GSFC, Zuari Ind from fertiliser space

Tarun Surana, Research Analyst (Institutions), Sunidhi Securities & Finance Limited suggests that though the depreciation of the rupee is increasing the costs of production for fertilizer companies, it is still sensible to buy GSFC and Zuhani.

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Excerpts from After the Bell on CNBC-TV18 Watch the full show » ALSO READ See what other experts are saying about markets See what FIIs are saying about the markets See what Udayan Mukherjee is saying about the markets

Tarun Surana, Research Analyst (Institutions), Sunidhi Securities & Finance Limited suggests that though the depreciation of the rupee is increasing the costs of production for fertiliser companies, it is still sensible to buy GSFC and Zuari .

He recommends a hold on Coromandel since it is difficult to be bullish on gas due to stringent norms. However, one needs to wait and watch the urea based companies which fall under regulated policy.

Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying video for more.

Q: Your recent note states that you are a bit worried about the performance of fertilizer stocks. Is INR depreciation a big negative for them?

A: Yes, the currency depreciation increases the cost. Most of the fertilizer companies are big importers and the costs of raw materials are in dollar denomination. So a 4-5% jump in the cost due to INR depreciation is a cause to worry. Added to that they are unable to pass on the cost pressures to the farmers due to political compulsions. You have elections in five states due to which there might be some understanding that  prices should not be raised until the elections are over.

For this purpose as well as for Q4 we expect pressure on margins on account of INR depreciation. Fertilizer companies' profitability is anyways very low. A complex fertilizer company makes about 7-9% at operating level. Likewise in urea the margins are also very low due to the prices being regulated and the ROE is anyways controlled. So 4-5% depreciation in INR will obviously eat away a lot of margins for these companies.

Q: We have seen a very sharp rally recently in most of the fertilizer stocks. Also you have downgraded the sector recently. Are you advising your clients to lighten up positions and could we see a further fall from current levels?

A: Most of the rally has happened on account of hopes of the new Urea Investment Policy. Most of the rally is in stocks like RCF, NFL and Chambal which are primarily urea based plays. I would be more worried about the complex fertilizer segment, because there the cost pressures are not passed through, whereas in urea, the government repays most of the cost to the companies. So the margin pressures on urea companies are unlikely to be a cause of worry as in the case of the complex fertilizer companies.

However prices at this point of time have corrected by 15-25% in the last one quarter compared to the highs that existed earlier. So a lot of negatives are already in control. Though our recommendations may not change because even if we revise our earnings and target prices downwards, we have a couple of stocks that will still be rated as buy.

Q: The author of the Urea Investment Policy, Dr Chaudhuri spoke to us about how gas will really be a pass-through. That there will be a ceiling and floor price for various levels of gas prices with of course USD 14 being the ceiling. Beyond that government will not accept to pay the subsidy. Given that kind of a situation would you expect investments? Also would that be any reason to go bullish on the stock?

A: Gas prices are again controlled by the government in India. On controlling a commodity which is the raw material for one sector and not giving freedom in terms of MRP to urea companies, it is unfair to expect companies to pour in a billion dollars just for one plant. Also what happens if prices go beyond USD 14 or what happens if for low cost gas such as RIL or ONGC, the production does not ramp-up. Then they have to depend on imported LNG until the plant comes after three or four years.

Imported LNG today costs above USD 15 per mmbtu whereas the government is not permitting gas cost to pass-through above USD 14. They also will not allow price decontrol. So beyond USD 14 what do companies do? They cannot raise prices or control gas cost. So they will have no option but to shut down the plant at that point of time if the gas costs are beyond USD 14. How can one expect an investment to come for such a high magnitude of almost a billion dollars for just 1.2 million tonne from a plant?

Q: So what should one do if an investor is looking to stay invested in the fertilizer companies? Which companies would you advise the investor to stay invested in at the moment?

A: Our top picks are GSFC and Zuari Industries. Both these companies are primarily complex fertilizer companies. Though I have my worries on the complex fertilizer for the next two quarters, the valuations of these companies are very attractive.

Both are trading at around four and five times on PE multiples respectively, whereas the sector leader Coromandel is still getting PE multiple of about 11 times. So I believe that this gap will narrow down ultimately. Either Coromandel de-rates to some extent because of all these worries or while all these worries are there, the worries are more than factored in the price of GSFC and Zuari.

So I would advice a buy on GSFC and Zuari and would recommend a hold on Coromandel. Since urea based stocks are typically a policy play, once its time for policy finalization which is attractive enough to bring in investments then I would recommend investors to buy RCF or Chambal as well.