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India Ratings and Research (Ind-Ra) has said that the credit metrics of fertiliser manufacturers in general and urea manufacturers in particular are likely to improve meaningfully in FY22 due to strong likelihood of clearance of subsidy backlogs after allocation of an additional Rs 62,600 crore fertiliser subsidy in the revised estimate of FY21. It will substantially reduce working capital debt and interest expenses. This will also encourage industry players to increase capital intensity to further improve their operating efficiencies.

Urea manufacturers will specifically benefit as their share of subsidy is generally 70 per cent of revenues as opposed to 30 per cent for nitrogen phosphate potash manufacturers. Besides, while the subsidy budget estimate for FY22 is 11.5 per cent higher at Rs 79,500 crore than the FY21 BE of Rs 71,300 crore, the urea subsidy BE has been increased by 22.9 per cent to Rs 58,800 crore and NPK subsidy BE has been reduced by 11.7 per cent to Rs 20,800 crore.

Ind-Ra estimated the fertiliser sector debt to be in the range of Rs 53,500 crore to Rs 56,500 crore at FYE20, up from around Rs 49,500 crore in FY17. The debt is primarily working capital in nature and corresponds to an increase in subsidy receivables outstanding to Rs 47,000 crore to Rs 49,500 crore in FY20 from about Rs 45,500 crore in FY17. The subsidy receivables contribute 85 to 90 per cent to the sector level debt. Accordingly, the sector's net leverage was high at around 6.6x in FY20 and interest coverage was modest at 2.2x.

However, the additional subsidy allocation is likely to substantially increase the sector's cash flow from operations and free cash flows in FY22 from estimated Rs 5,500 crore and negative Rs 400 crore respectively in FY20. Ind-Ra said it does not expect any significant capex in the industry, other than for urea efficiency improvement for some players and regular maintenance and upgradation capex in the near term. Accordingly, clearance of full subsidy backlogs in FY22 will result in the sectoral net leverage declining to around 2x and interest coverage to moving upwards of 5x.In addition, the resultant savings in interest expense are likely to improve return on equity for sector entities especially urea manufacturers up to double digits from the current range of 4 to 7 per cent.