Gas Price Hike to Affect Fertiliser Companies' Profitability - India Ratings

India Ratings & Research (Ind-Ra) expects the operating profitability of urea manufacturers to decline significantly post the recent revision in gas prices to USD8.4/mmbtu from USD4.2/mmbtu, primarily due to lower operating profits from sales above the cut-off quantity. The revision in gas prices could also lead to an additional burden of INR83bn on the government of India (GoI) towards higher subsidy outgo.

Ind-Ra believes that operating profits will be maintained on an absolute basis for urea sales up to the cut-off quantity because fuel cost is a pass-through in the urea subsidy till the cut-off quantity under the retention pricing scheme.

However, a majority of the profits for urea manufacturers comes from urea sales above the cut-off quantity as the subsidy is linked to import parity price (IPP). Under the current urea manufacturing policy, urea manufacturers are paid subsidy assuming a retention price of 85% of IPP for the quantity sold above the cut-off level to incentivise higher production. Simultaneously, for production above the cut-off quantity, these plants use non-APM and non-PMT gas like KG-D6, R-LNG among others. Gas prices are not pass-through in the subsidy for urea sales above the cut-off quantity. As a result, the operating profits of such urea manufacturers could take a hit from FY15 once the higher gas prices kick in. The operating margins on this portion of urea sales could decline sharply to 12% from the current level of 46%.

For existing urea plants, the retention price is estimated to increase to INR16200/MT (USD270/MT) from INR10,400/MT (USD173/MT) purely on account of the gas price increase at USD/INR60 compared with the IPP price of USD350/MT in May 2013. If the IPP prices were to decline or rupee to appreciate, India can see increased imports.

The impact of the revision in gas prices would be greater for players with higher energy consumption. Indian Farmers Fertiliser Cooperative Ltd's (IFFCO, 'IND AA'/Stable) has higher energy consumption at 5.79Gcal/MT compared with 5.31Gcal/MT for Tata Chemicals Limited ('IND AA'/Stable) and hence would see a higher fall in margins. The absolute fall with energy consumption being equal will be higher for manufacturers producing above the cut-off level.

Source : Equity Bulls

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