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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 ~28% over FY21-24E

* During Q1FY23, MCFL reported consolidated net sales at Rs 10.2 bn, registering a growth of ~49% y-o-y driven by strong realisation from Urea and non-Urea segments. Realisation from Urea increased due to rise in pooled gas price which has increased from USD 11.4/MMBTU in Q1FY22 to USD 24/MMBTU for the quarter. The Gas prices in the international market remained high due to geopolitical tension between EU and Russia. Realisation of non-Urea fertilisers increased due to recent subsidy increase given by GoI for the Khariff season led by higher fertiliser prices in international markets. Volumes of Urea declined to 0.74 LMT during the quarter from 1.15 LMT in Q1FY22 due to shutdown of Urea unit from June 2022 onwards for implementation of EIP. The Company continued to adopt prudent manufacturing strategy by maintaining suitable balance between DAP and N20 volumes. Volumes for DAP got doubled to 0.42 LMT whereas N20 volumes declined by 20% at 0.4 LMT. Production volumes are expected to skew towards N20 during rest of the year as manufacturing DAP is unviable in the present business scenario.

* MCFL also refrained from trading of fertilisers during the quarter; is expected to start once business conditions become viable. Urea Volumes will remain muted due to capacity constraints. ? Demand for fertilisers remained robust globally, throughout the quarter. However, availability was low internationally due to 1) export restrictions by China and export quota imposed by Russia; and 2) supply side constraints due to geopolitical uncertainties because of Russia-Ukraine war; which has kept the prices of critical RM and finished fertilisers high in international market inspite of correction in the prices of fertilisers being witnessed during the quarter. ? GoI has budgeted a fertiliser subsidy of Rs 2 tn for FY23. However market expects subsidy to remain in the vicinity of Rs 2.5 tn for FY23 due to elevated RM and finished product prices.

EBIDTA Margins declined by 150 bps y-o-y at 6.6%

* EBITDA margins during Q1FY23 decreased by 150 bps y-o-y to 6.6% on the back of higher Urea sales price led by higher gas prices, which is a complete pass on. Prices of Ammonia also remained elevated. The Company remained profitable in P&K fertiliser segment due to a prudent volume mix in non-Urea production and temporary discontinuation of trading volumes.

* PAT margin has declined by 130 bps y-o-y to 2.2%, mainly due to a decline in operating margins and high interest outflow. Interest outgo for the quarter increased by ~84% y-o-y to Rs 194.8 mn, mainly on account of delay in the payment of subsidy by GoI due to administrative reasons which has led to increase in short term debt by Rs 5,120 mn. Outstanding subsidy of MCFL as on June 2022 stood at Rs 8.71 bn vis-à-vis Rs 4.56 bn during June 2021. However, Government has cleared subsidy for non-Urea fertilisers in the month of July 2022 by making payment of Rs 1.85 bn. Outstanding subsidy for Urea is also expected to get cleared soon. MCFL’s long term debt also increased by Rs 1,850 mn during the quarter due to EIP program undertaken by MCFL.

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

* In December 2020, 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 has reached at an advanced stage of implementation and production of Urea is expected to resume shortly.

* 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 FY24E, we expect improvement in overall EBIDTA margins to ~7.8% and ~8.8% in FY23E and FY24E respectively.

* The above EIP program will also result in the gradual increase in the production of Ammonia by ~180 MT/day, increasing the capacity to 880 MT/day. This excess Ammonia will be either used to produce DAP & other fertilisers or open market sale, depending on market conditions. However, in our FY23E & FY24E projections, we have not build in any revenue from sale of excess Ammonia.

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. We have currently valued the stock at a P/E of 8x, increasing it from 7x, due to completion of EIP project, thereby providing profitability visibility, of FY24E EPS of Rs 16.7 and recommend BUY on the stock with a target price of Rs 142 (~22% upside) in 18 months.

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