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Agri-input/Chemicals: Q2FY20 Review - H2 seems promising

Q2FY20 was a mixed bag for agri-input/specialty chemicals companies within our coverage universe . PI, Rallis, SRF (chemicals business) and UPL reported strong double digit revenue growth on healthy uptick in exports, Aarti and FOIL benefited from margin expansion (benign raw material prices and product mix improvement) Sharda and SH Kelkar disappointed on all fronts. Our read-through from Q2FY20 financials of companies within our universe point to the following trends:

Domestic agchem companies report subdued growth, but hopeful on Rabi prospects: Most domestic agrochemical (agchem) companies reported subdued Q2FY20 performance, owing to erratic rainfall, low pest infestation and liquidity constraints at farmers’ ends. Farmers shifted to short-duration crops, given market uncertainties, hampering overall pesticide consumption. However, managements remain upbeat on Rabi prospects, thanks to healthy reservoir levels (higher than 10-year average) across regions and improving commodity prices

Encouraging response to new product launches: Agchem players (PI, Dhanuka, Rallis and Kaveri) are well placed to capitalise on the expected favourable Rabi, supported by new product launches. (In FY19, product launches for most co’s were relatively weak).  Dhanuka and Rallis have already received encouraging response to its recently launched products, notwithstanding the tough market conditions, as sales for these products surpassed companies’ targets. While Dhanuka’s management sees immense opportunity for its new insecticide, Largo, which has proved to be fairly effective against fall armyworm in field trials, Rallis’ management too is upbeat on the value proposition that its product, Zygant (used to control rice stem borer) and Ayaan (to control sheath blight disease in paddy) could offer to farmers, as it is effective for a longer duration. PI also launched a new generation herbicide –Awkira targeting wheat crop and expects a positive impact on volume growth.

Volatile raw material prices hamper gross margins: Few agchem players like Dhanuka, Sharda and Rallis, witnessed sharp decline in gross margins, given the volatility in raw material prices and their inability to pass on the increase to farmers. However, backward integrated players, such as UPL, or companies with lower dependence on China for their raw material sourcing, such as PI remained insulated. However, most management expect gross margins to improve in the ensuing quarters, on ebbing raw material prices.

Strong exports growth: Almost all companies (PI, UPL, SRF) recorded strong double-digit export growth, supported by a pick-up in the global agrochemical market and diminishing channel inventory. While weakness in North America had some adverse impact on such companies, positive trends in Latin America and Asia helped mitigate some of the softness in these geographies. SRF, Sharda and UPL managements expect the US market to recover by Q4 and provide the further boost to export growth.

Increased business shift from China to India: Indian players seem to be making most of the uncertainties arising from the US-China trade war and manufacturing disruptions (stringent pollution control) taking a toll on China. Management commentaries (PI, UPL and Aarti) cite increased enquiries from global innovators looking to reduce dependence on China, thereby acknowledging capabilities of Indian players. Aarti’s management further highlighted the situation as structural, as increased cost of production has made it unviable for companies in China to operate below a certain scale.

We prefer companies with 1) balanced exposure to domestic as well as export markets, 2) backward integrated capabilities and, 3) diversified product portfolio with limited reliance on select products.      Top picks: UPL, SRF and PI Industries