Agrochemical industry: Despite near-term challenges, 2023 outlook positive

Lower liquidation of stock, inventory build-up, higher sales returns and weak export demand likely to impact December quarter earnings. However, price hike-led growth, increased sowing acreage and remunerative prices expected to help in 2023.

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The Indian crop-protection industry seems to have run into turbulent weather, with inventory build-up at dealer levels and higher sales returns creating headwinds in both the domestic as well as export markets.

This might dent the performance of the agrochemicals and fertiliser companies for the December 2022 quarter.

However, price hikes by companies seem to be holding up well. The rabi-sowing season took off on a strong note (+4 percent YoY increase in sowing area) and remunerative crop prices provide a healthy outlook for 2023.

Experts say the domestic industry should be able to achieve a mid-high single-digit growth in H2FY23 (as well as during the remainder of CY23).

“The growth in domestic agrochemical and fertilizer industries in 2023 is likely to be ~5-8 percent on the year, led by price growth as volumes are expected to take a hit amidst slightly uncertain demand conditions,” Himanshu Binani, Research Analyst, Prabhudas Lilladher Pvt Ltd, told Moneycontrol.

Challenges for pure-play domestic players

Industry experts see more challenges for pure-play domestic players, which are likely to witness strong headwinds on both the revenue and margin growth fronts.

“The challenges for the domestic plays are compounding primarily on the back of a higher base of last year, coupled with higher inventory provisions amidst a falling raw material cost scenario and higher sales return (particularly in the insecticides grades, which, in turn, is likely to exert pressure on margins in the near term),” added Binani.

Agrochemical inventories have been at elevated levels after the kharif season because demand was significantly impacted by erratic rainfall. This led to crop damage, low levels of pest infestation and loss of sprays because farmers tend to not spray during rains, as pesticides applied to crops can get washed away.

Channel checks by Kotak Institutional Equities also suggest that the correction in prices of vegetables and fruits has led to a weak demand from this segment during the rabi season.

Consequently, the agrochemical industry faces the risk of sales returns by channel partners. “We note that some inventories have probably been in the channel for the past two years, given that last year’s kharif season was also impacted by unseasonal rains, and, therefore, some unsold products might be nearing their expiry date and may necessarily need to be taken back,” a note from Kotak said.

Exports demand hitting a bump

Demand from the exports market also hit turbulence, possibly driven by customers aggressively up-stocking last year, amidst supply-chain uncertainties and lower-than-expected demand from Europe and the US due to adverse climatic conditions.

These, in turn, have reportedly led to high channel inventories in certain important regions, including Europe, North America, and Latin America. Consequently, “ordering from Indian suppliers appears to have slowed for a broad range of products and players like UPL and Bayer reported YoY declines in sales volumes during the September quarter,” Jatin Damania, Research Analyst PCG Research, Kotak Securities Ltd, told Moneycontrol.

Buyers must also be reluctant to stock up further amidst the ongoing correction in prices of agrochemicals. Raw material prices for both agrochemicals and fertilizers have been in a downward trajectory for the last few months, led primarily by adverse weather conditions in certain key geographies like the US and Europe – resulting in lower demand — and also due to better availability of raw materials, with China opening up after COVID-19 related lockdowns.

“A wild card could be fresh lockdowns in China after the rapid spread of COVID. That could disrupt supply chains and drive agrochemical prices upward. However, any such disruption is not yet visible, and agrochemical prices continue to head southward,” added Damania.

India’s exports of agrochemicals fell 17 percent YoY in volume terms during October 2022, and commentary and/or data from numerous companies to point at demand softness.

Outlook

The major factors that remain largely supportive for the domestic industry are sowing in the ongoing rabi season starting on a strong note this year (up 4 percent YoY as per industry data), and crop acreages remaining healthy, with all major crops like wheat, paddy, maize, and pulses showing a positive trend.

However, “while warm winters till date didn’t have any major impact on standing crops, if it continues, it would have an impact on the crop yields, going forward (likely to be witnessed in Jan-March period),” cautioned Binani.

The reservoir levels are up 4 percent on year and up 19 percent as compared to the averages for the past 10 years. Data shows that water storage levels in India’s 143 reservoirs stood at 81 percent of the total capacity.

Higher reservoir levels and better soil moisture have helped improve crop acreages under the current rabi season.

The industry had resorted to price hikes in H1FY23 and product prices in the domestic market remain at elevated levels for most of the molecules, barring a few, whose raw material prices have corrected significantly.

“We are of the view that as long as crop prices remain remunerative, the industry is in a better position to pass on the inflated cost to farmers”, said Binani.

Though the December quarter earnings will likely get impacted, with the help of these supportive factors, the Indian industry can still grow in the mid-high single digits in H2FY23 and CY23.

Top picks

UPL Ltd and PI Industries are the preferred stocks in the agrochemicals space.

“Demand for pesticides continues to be healthy, with the herbicides category continuing to lead the pack, followed by fungicides, which are likely to benefit UPL and PI industries”, says Binani.

He has a ‘buy’ call for UPL with a target price of Rs 1,070 based on 14x September FY24 EPS.

The guidance given by PI Industries does not indicate a slowdown in demand. “PI continues to show strong numbers, which may be because of its most important product pyroxasulfone appears to be gaining share from glyphosate in the world markets,” says Damania.

Pyroxasulfone is a selective herbicide for controlling annual grasses, sedges, and annual broadleaf weeds. It was a patented product of PI Industries, the demand for which has been on the rise in global markets given its effectiveness. It became off-patent recently but given the technology and economies of scale for PI, it will continue to lead the competition for the coming few years.

Geojit BNP Paribas has a ‘buy’ on PI Industries’ stock with a target price of Rs 3,860, based on 45x FY24 adjusted EPS. “We expect the positive momentum in volume growth to continue with a strong order book and new innovative products in the pipeline,” a note from Geojit BNP Paribas said.

The stock that found an expert’s preference in the fertilizer space is Coromandel International. “The company is expected to report stable margins over the longer term backed by efficient sourcing of raw materials, benefits of backward integration, a rising share of unique grades and product innovation and capacity expansion,” Binani told Moneycontrol.

He maintains a ‘buy’ with a target of Rs 1,200 based on 18xFY25 EPS.

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