Crop protection firms may face headwinds due to extreme weather conditions

With the exception of Sumitomo Chemical India, the stocks of the agricultural input (crop protection) makers have been on a downtrend since the start of September. UPL and PI Industries, the largest listed players have underperformed, having shed 6-8 per cent even as the benchmark BSE Sensex has been flat over this period.

Brokerages believe that companies in the sector could face near-term headwinds due to the extreme weather conditions, spike in gas costs and its impact on demand, both in the domestic and international market. Say Abhijit Akella and Prasenjit Bhuiya of Kotak Institutional Equities, “We would expect some pressure on agrochemical sales volumes in the near term, both in India and in international markets. Excessive and unseasonal rainfall in India, leading to crop damage, probably points to a challenging September quarter for the 2022-23 financial year (Q2FY23) for the domestic agrochemical market. Meanwhile, dry weather in parts of the world, including Europe and the US, will be a headwind for volume growth in those markets.”

This could be the second consecutive quarter of tepid volume growth after the poor show in the June quarter (Q1) due to delayed monsoons and inventory destocking. Most companies reported low single-digit or flat volumes for the quarter. While volume growth was low, revenue growth for most players was upwards of 25 per cent. Most of the incremental growth came from price hikes taken to offset the rise in input costs.

Despite the price hikes, margins continued to be under pressure in the quarter. Barring PI Industries, which saw a 200 basis points expansion year-on-year (YoY), most other companies either saw a sharp decline in margins or a flattish performance in the quarter.

Commenting on the Q1 performance, Sharekhan Research highlighted that UPL and PI Industries were best performers in both revenues and margin sections, given exposure to global or export markets, while Sumitomo Chemical India and Insecticides (India) had mixed performance as revenue beat got offset by margin miss due to high raw material cost and change in revenue mix.

While margins were under pressure in the previous quarter, the decline in input costs since then should help improve profitability going ahead. Says Ramesh Sankarnarayanan of Nirmal Bang Research, “The decline in prices is positive for the crop protection chemical (CPC) sector, which will gain from rising demand, as CPC prices are cut to pass on the fall in input prices. Further, there is potential for expansion in gross margins if the CPC industry is able to retain part of the savings from lower input costs.” There is expectation that the cost savings could be passed on to consumers to boost volumes and operating leverage.

While there are demand worries, given the disruption and volatility in weather conditions across the globe, brokerages believe that the outlook for the sector remains positive as long as crop prices continue to remain elevated. Most crop prices in global markets (like the US) are up over 20 per cent, as compared to the year ago quarter with corn, rice and wheat prices trending higher month-on-month as well. Sharekhan Research believes that recent recovery in global crop prices, government support for farm produce at minimum support price and expectation of surplus monsoon bodes well for volume growth and continued strong pricing or margin environment for agri-input companies.

Though most brokerages are positive on the outlook for the sector, given the uncertainty on the demand front, investors should await clarity on volume/margin trends before considering the stocks.