News Analysis

India Pesticides IPO: Wait and watch

Sai Prabhakar Yadavalli | Updated on June 22, 2021

Look for clarity on sustainability of earnings in coming quarters

India Pesticides (IPL) is a niche pesticides manufacturer deriving around 78 per cent of its revenues from technicals (active ingredients for formulations) and balance from formulations. Exports account for around 57 per cent of revenues. IPL’s initial public offer (IPO) consists of ₹100 crore fund raise via fresh issue of shares and ₹700 crore fund-raise through offer for sale, at a price band of ₹290–296 per share, valuing it at ₹3,400 crore or 24.5 times its FY21 earnings. IPL has low debt but working capital investments are higher and fresh proceeds from IPO will be utilised for working capital purposes. IPL posted revenue and EPS CAGR of around 38 and 75 per cent respectively for the two years into FY21.

 

While recent revenue growth is impressive, it has been driven by capacity expansion which is a key requisite to sustain higher growth in the industry. In the midst of China +1 (global supply chain reducing reliance on China) - based rally in chemical company stocks and the enthusiasm around such companies, long-term investors in IPL’s IPO need to ascertain its sustainable revenue growth before taking a call on the stock. Also, two key technicals of the ten that IPL actively markets domestically are in the ban list that the government proposed in 2020. The management is confident of low impact from the proposal but considering potential impact to highly concentrated product mix; the risks even though might be low, cannot be completely ignored. Given these factors, long term investors can wait for incremental clarity on the ban list and more data points from subsequent quarterly results on sustainable growth rates before investing.

Regulatory proposals an overhang

In May 2020, government proposed a ban on 27 pesticides and in January 2021, an expert panel was constituted to examine any objections. IPL’s Captan, a key technical, and Ziram, included in the list, generated 18 per cent of FY21 revenues from sales in India. The management expects low risk from the ban in domestic markets even as exports are cleared. It cites widespread domestic usage, usage across countries and significant industry exports to dilute the government’s stance. Even without an outright ban, the need to diversify IPL’s product basket is evident from government actions which is aiming to reduce the dependence on older and harmful pesticides. Of the ten technicals in which IPL has established a leading presence, a remote prospect of threat to even two products translates significantly, and this risk needs to be factored-in.

 

Capacity-driven growth

IPL posted a modest revenue growth of 4 per cent in FY16-18 compared to 38 per cent in FY19-21 driven by its technical segment whose production also grew at 37 per cent CAGR in the period. IPL is planning to introduce 8 technicals across categories utilising 10,000 MT of additional capacity which will sustain the revenue momentum in the short term and add the much needed product diversification. The total installed capacity grew from 16,000 MT in FY19 to 26,000 MT in FY21. But capacity expansion is an exhaustible source of growth in an industry where turnover growth is linked to capacity expansion.

Also read: Pesticide residue in paddy: Centre to develop SOP for two formulations, but exporters want more

Crop protection industry lacks a market for innovation and is increasingly reliant on older generics, owing to familiarity and price constraints, limiting the scope for new products or price-based growth. Comparatively, the domestic pharmaceutical industry, which is also largely generic, drives close to 10 per cent annual growth largely from price hikes and new products or volumes. The basis for long term top line growth beyond capacity expansion is muted for the industry and may also prove to be a major hindrance if the expected China diversification does not play out as expected.

Margin sustainability to be seen

IPL management stresses on the productivity of its R&D team in driving yield improvement which in turn drove margin improvement of 800 bps in FY21 to 29 per cent (20-21 per cent in FY19-20). The R&D department not only covers molecule registrations and off-patent molecule research but also focusses on yield improvement, all achieved within a shoe-string budget of 0.3 per cent (₹2 crore) of revenues in the last two years. IPL’s peers who expend around 1 – 2 per cent of revenue on R&D and global players who spend around 8 – 10, operate at low 20 per cent EBITDA margins. Hence, while the margin growth of IPL is impressive, to gain confidence on its sustainability, investors can track how well the industry leading margins from company sustains as it starts reporting quarterly results as a listed company. Investors also need to see if the company faces risks from input cost volatility as it has to rely on a quarter’s lag and certain thresholds for price movements in renegotiating prices.

Published on June 22, 2021

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