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Company Background

Mangalore Chemicals and Fertilisers Ltd. (MCFL), a part of Adventz Group of Mr Saroj Poddar, is amongst India’s most integrated fertilizer companies, manufacturing Urea, DAP, NPK and other complex fertilizers; at its plant located near Mangaluru, Karnataka, with an installed capacity of ~681,500 MTPA, sold under ‘Mangala’ brand, having strong presence in South India. It also sells externally sourced products like DAP, MOP, specialty fertilizers, and other agri inputs like water soluble fertilisers and micro-nutrients, through its extensive retail distribution network. It also has small presence in industrial products viz. SNF and ABC.

Investment Rationale

Topline to grow at a CAGR of ~19% over FY21-24E

* During Q3FY22, MCFL reported consolidated net sales at Rs 7.62 bn, registering a robust growth of 132.9% y-o-y mainly due to rise in volumes and realisation. Volumes of Urea and 20:20:00:13 (owned manufactured) increased significantly by 327% and 59% at 112,528 MT and 42,343 MT respectively. However, volumes of DAP (owned manufactured) decreased by 52% at 15,006 MT during the quarter. Urea production was lower last year because of a temporary shutdown of plant from October 5, 2020 to December 12, 2020 due to the conversion of plant from Naphtha to Gas. Realisation was higher due to high pooled gas prices and a rise in subsidy of non-Urea fertilisers by GoI due to higher fertiliser prices in international markets. MCFL has temporarily stopped trading in fertilisers as it became unviable due to high international prices of fertilisers.

* High demand for fertilisers in Latin America and North America followed by export restrictions by China and export quota imposed by Russia has led to a continued surge in prices of DAP, MOP and NPK in international market. However, GoI has supported the industry by revising the subsidy during Q3FY22, inspite of which, overall industry imports remained low due to further increase of prices in international market. Industry is in interaction with Department of Fertilisers (DoF), GoI and believes that Government is flexible to review subsidy prices.

* MCFL’s strategy is to leverage Urea distribution network to enhance its trading sales, going forward. However, production and trading volumes of DAP for FY22E is expected to remain muted as Company has temporarily discontinued both, since October 2021. However, it has started production of DAP from December 2021 onwards with low volumes. MCFL has increased its volumes of 20:20:00:13 during the year vis-à-vis last year. So, we have factored in a ~30% decline in trading sales in FY22E at Rs 920 mn. We presume the scenario to improve by H1CY22 end, led by a correction in key input and international fertiliser prices, and thus, expect a good pickup in non-Urea volumes in FY23E. Volumes from Urea will remain muted due to capacity constraints.

EBIDTA Margins improved by 150 bps y-o-y at 8.7%

* EBITDA margins during Q2FY22 increased by 150 bps y-o-y to 8.7% whereas it remained flat on q-o-q basis. The Company has been able to sustain margins due to temporary discontinuation of production and trading of unviable products like DAP due to high input costs. EBITDA margin of Urea improved due to conversion from Naphtha to Gas and a rise in gas prices.

* PAT margin improved significantly by 380 bps y-o-y to 4.1%, mainly due rise in operating margins and lower interest outflow. Interest outgo for the quarter declined by ~40% y-o-y to Rs 105.1 mn, mainly on account of disbursement of prior year subsidy by GoI during Q4FY21. GoI has budgeted for Rs 1.05 tn subsidy for FY23 vis-à-vis Rs 1.4 tn for FY22 which is expected to be adequate with the assumption that fertiliser prices will correct in international market, going forward.

* Outstanding subsidy of MCFL as on December 2021 stood at Rs 8.33 bn vis-à-vis Rs 5.68 bn during September 2021.

* With no near term visibility of reversal in raw material prices, we expect EBITDA margins for FY22E to remain under pressure led by lower contribution from non-Urea fertilisers (owned production and traded fertilisers).

Naphtha to Gas conversion + implementation of EIP to take profitability to new orbit

* In December last year the Company has successfully converted its plant from Naphtha to Gas, resulting in lower energy consumption (from 6.35 GCal/MT to 6.25 GCal/MT) and higher assured subsidy redemption from GoI (from 6.902 GCal/MT to 7.356 GCal/MT). With this, margin has increased, resulting in incremental EBITDA of ~Rs 600-800 mn/pa till December 14, 2025.

* In order to mitigate the risk of lower margins post December 14, 2025, MCFL is undertaking an energy improvement project (EIP) at a cost of ~Rs 3.95 bn (D/E of 70%/30%) to further reduce energy consumption for Urea manufacturing from current 6.25 GCal/MT to 5.5 GCal/MT, resulting in incremental EBITDA of ~Rs 1 bn/pa. The capex is expected to be completed by end-Q1FY23.

* With improvement in margin contribution from Urea manufacturing due to conversion of plant from Naphtha to Gas and successful implementation of EIP program coupled with expected correction in key input costs of non-Urea fertilisers by H1CY22 end, we expect improvement in overall EBIDTA margins to ~10.9% and ~11.2 % in FY23E and FY24E respectively.

VALUATION

MCFL has a strong brand recall, robust distribution network and has planned a well-timed capex to improve energy consumption of its Urea unit resulting in plant efficiency, energy saving and profitability, on top of Conversion from Naphtha to Natural Gas. It is well-placed to reap benefits of reforms like DBT of fertilizer subsidy, clearance of past years’ subsidy backlog by GoI, etc. However, the long term big picture is more attractive. Continuous rise in raw material prices may have a bearing on demand of its products amongst farmers; response by GoI, fertilizer industry and the Company needs to be seen. In view of this, we have currently valued the stock at a P/E of 7x of FY24E EPS of Rs 17.1 and recommend BUY on the stock with a target price of Rs 120 (~50% upside) in 18 months.

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