By the first week of March 2020, it had dawned on investors that COVID-19 was going to be more than China-centric. By April 1, the Sensex had the biggest quarterly fall in its history and so did the Nifty. The worst hit sector were financials, followed by automobile, real estate and metal. The walls were caving in, but there was one little corner that was holding out and even thriving — agri-inputs.
Agrochemical stocks such as UPL and PI Industries rallied on April 15, after the government announced new guidelines allowing agricultural activity to continue despite the initial 21-day lockdown. This sector was already on its way to recovery, thanks to generous rainfall. This abundance has benefitted the kharif crop and has helped fill reservoirs that will be beneficial to the rabi crop. Kedar Kadam, head of research, Cholamandalam Securities expects “new record output of food grain in 2020-21.” The prime beneficiaries of this would be agri chemicals and related suppliers.
The Indian agro-chemical market, largely trading in herbicides and pesticides, is expected to be worth $4.7 billion by FY25, at 8% CAGR. The prominent players in this sector are BASF, PI Industries, Bayer Cropscience and UPL, by revenue. Despite the role it plays, analysts are split on the long-term prospects of this sector, due to unpredictability of monsoon and intense competition.
Ten-year heat wave
The agri-chemical sector has had a tumultuous decade. The 2010-14 period saw a gold rush. There were a few Indian companies with IP (intellectual property), and so whatever came to the market, did well. This drew more companies, including MNCs, into the fray and this led to more of the same thing. That is, the market was growing but there was little by way of product differentiation. To meet the growing demand, local manufacturers began importing molecules from China to formulate in India. It just added to the glut. “Cheaper Chinese imports led to price erosion of around 300-400 basis points gross margin depreciation; some companies also saw their in-licensed products becoming generic and witnessed pricing decline due to competition. The exclusive in-licensing model is gone and hence some of the drop in gross margins is permanent,” says Ritesh Gupta, director-consumer discretionary and chemicals research, Ambit Capital.
As the sector was coming to terms with this oversupply, it was hit with uncertainty. Over the past three years, 2016-19, the sector has had to deal with erratic monsoon, fluctuating agri-commodity prices, and the disruptions caused by demonetisation and the Goods and Services Tax rollout. Just as it was trying to steady itself in 2020, the sector came face-to-face with COVID-19. The pandemic disrupted the supply chain and impacted delivery. In January and February, prices of raw material had shot up 15-20% but, even for those willing to pay, stocks were not available for shipping from China to India. Then, there was the trouble in transporting the material from the port to the factory and the finished good from the factory to the consumer. Domestic and international freight costs had risen in Q1FY21 by around 20%. It is easy to see why the plentiful monsoon would have come as a relief.
“Most companies have hiked prices to pass on the additional expenditure. Because of the robust season, the market has largely absorbed it,” says an Emkay Global analyst, who did not want to be named.
Mid-May, the government announced a set of reforms that have since been termed the ‘1991 moment for agriculture’. As a caveat, let us add, this claim has been hotly contested in many quarters. The reforms, which included an outlay of Rs.1.63 trillion and amending the Essential Commodities Act (ECA) to allow freer trading of various kinds of produce, have improved market sentiment, especially towards agri inputs.
Prabhudas Lilladher’s Prashanth Biyani, in his report, says, “One of the most important measures announced was to formulate a Central law enabling interstate trade, thereby giving freedom to farmers for selling at an attractive price.” He believes this will go a long way in attracting private investment to agriculture, to strengthen supply chain and warehousing. A May 2020 report by Elara Capital’s Pratik Tholiya echoes the sentiment and adds, “Private investment in warehousing was negligible as ECA restrictions weighed in on revenue visibility. Lower warehousing resulted in lower development of food processing industries and agri supply chain.”
With the new developments, such as increased participation of private sector, easier interstate trading and encouraging formation of farmer collective, Biyani sees formalisation of the sector, which could lead to predictability in cropping patterns and better prices for produce. The higher disposable income, the Elara Capital’s report notes, will encourage farmers to purchase high quality and branded agri inputs. According to them, preliminary assessment shows that most of the benefits would accrue over the medium term (beyond two years), since a lot of agri infra needs to be created. “Large corporates/retailers would enter once they are confident of the system and the implementation of laws,” says the report.
While in other sectors, the virus and the resultant lockdown caused havoc, in agri-inputs, they brought welcome change. For one, it made imports from China nearly impossible. This meant a heavier dependence on local products. The Emkay Global analyst says, “Based on my interaction with companies — both listed and unlisted — this is the first time the government has had discussion with the companies on what they import from China and how these products can be substituted with local ones. How they finally execute it (the suggestions) is crucial.”
The pandemic also caused the migration of thousands of workers, who literally walked away from farming states such as Andhra Pradesh, Telangana and Punjab. This labour drain led farms to adopt new techniques, which increased the demand for agri inputs. “Paddy or rice is the larger kharif crop and a lot of farmers have resorted to direct seeding because it requires less labour. But direct seeding causes an increase in weeds, hence the sale of herbicides has gone up,” explains the Emkay Global analyst.
This will benefit companies such as Dhanuka Agritech, an established player in the under-penetrated, herbicide segment. The stock price of Dhanuka and Rallis India have doubled in the past six months. This is despite Rallis’ product portfolio not moving beyond the traditional line-up. Amit Khurana, head-equities, Dolat Capital says, "The company's traditional portfolio is one of the key reasons the company has not been able to maintain margins and growth.
Ambit’s Gupta explains investors are flocking to agri-focused businesses because they look safer now. “In general, investor options have been limited, so there has been a flow of money towards this sector. The backdrop of a good monsoon and relatively defensive earnings in a Covid environment meant that these stock got lot of traction,” he says. But, the good times may not last long as Gupta believes that valuations have turned rich. “Earnings visibility tends to be low — it is erratic (due to monsoons) and unpredictable. The market never consolidates as entry barriers are weak. You cannot pinpoint on what works in the segment or how it will play out,” he says.
The Emkay Global analyst, however, believe the sector holds promise in the long term. Earlier, the consumption was mainly concentrated in Punjab, Haryana, Andhra Pradesh, Telangana and Maharashtra. Now, states such as UP, Bihar, MP, West Bengal, Gujarat and those in the North East have also started consuming agro-chemicals. He explains, “This has made the revenue base more broad-based for the industry. Hence, weather vagaries have relatively lesser impact on revenue today than they did 10 years ago.”
Industry analysts may be divided on how long to stay invested in the sector but there is no denying the bonanza the good monsoon brought in for those who got in early. For those still wondering if agri-input stocks are a good bet, keeps a close watch on the fickle weather and the promises made.