Triggers in place for agri chemicals

While a normal monsoon is key in the short term, innovative products and the government's thrust on agriculture should boost long-term prospects

Given muted rural wage growth and lower crop realisations, coupled with damage due to unseasonal rain, progress of the monsoon will be the key monitorable for stocks in the agri-chemicals segment.

While discretionary spending would be first to get hit in a rural slowdown, agri-chemical entities could suffer if the monsoon is impacted by adverse weather phenomena such as an El Niño. However, unlike other discretionaries, the spending cut would not be as significant, since agri inputs are correlated to the livelihood of farmers.

In the short term, the monsoon will play a key role on the cash flows and purchasing power of farmers. Even so, with the government's focus on improving of soil health and irrigation infrastructure, agri-input compoanies are likely to benefit, as farmers demand higher productivity and more effective crop solutions.

 

Ritesh Gupta of Ambit Capital believes the growth rates for agro-chemical companies would be supported by rising use of high-value molecules, adoption of herbicides due to labour shortage and fungicides on demand for quality output. Sales growth for the top 15 agro-chemical companies is estimated to be 10 per cent in FY15, from 17 per cent in FY14 due to a number of unfavourable conditions. However, analysts expect FY16 growth to be in healthy double-digits.

While long-term prospects are bright for the sector, given the low penetration and consumption levels, valuations in the recent quarters have re-rated significantly, with the expectations of higher net profit growth and return ratios. The Street is already building in FY17 prospects in the prices of PI Industries, Dhanuka Agritech and Bayer. Rallis has corrected and could see a bounce-back, feel analysts.

Generic product entities such as Insecticides India and Excel Cropcare trade at eight to nine times and are not expensive. However, analysts say the generic ones could suffer if realisations continue to fall over the next few years. Here are three stocks that investors can consider.

PI Industries
The company's custom synthesis business, wherein it manufactures technical ingredients and intermediates for the patented portfolio of global players and accounts for 60 per cent of revenue, helps it to register higher growth rates and better margins, and has been the key driver of its revenue and profit.

 

The company is expected to post above-average industry growth in the agri chemical segment with a strong portfolio of new products - seven launches in three years. And, a higher share of in-licensed products. Recently, it introduced two new products, one catering to the fruit and vegetable segment which accounts for a fifth of pesticide consumption in the country.

Current valuations factoring in the near-term positives and the stock trades at 25 times its FY17 estimate. So, investors with a long-term outlook can look at the scrip on correction.

Rallis India
Rallis' stock has been an underperformer to peers, due to a lack of marketing push on innovative products in the domestic market, which fetches 55 per cent of its overall sales. However, the company launched three new products in the first half of FY15.

Contract research and manufacturing services, as well as the seeds business, are long-term growth drivers for the stock. Analysts at Emkay Research believe the margin expansion, driven by improved product portfolio and rising share of the seeds business, will drive net profit growth over FY14-17 by 24 per cent. Earnings growth and higher return on capital employed are likely to trigger a re-rating for the stock, trading at 14 times its FY17 earnings estimate.

UPL
India's largest listed agri-chemical entity is one of the top picks of analysts, with a strong annual earnings growth estimate of 20-plus per cent in the FY15-17 period. Brokerages had upgraded revenue estimates for FY16 and FY17 after strong top line growth in India, Latin America and elsewhere in the December quarter.

Among the key growth areas would be generic opportunity, with $3 billion of products going off-patent, differentiated formulations and branded products. Further, the company allayed investor concerns on excess cash, which had been an overhang. IDFC analysts say a shift in focus from revenue growth to profit, organic growth emphasis, higher return ratios and distribution of cash to shareholders underpin the company's new strategy. The stock is trading at an attractive 11 times the FY17 earnings.