Fertilizer Industry Faces Double Whammy of Rising Costs and Falling Subsidies

India’s fertilizer industry is bracing for a potential squeeze on profitability in the coming months due to a combination of rising input costs and reductions in government subsidies based on declining international prices.

According to industry analysts, prices of key inputs like ammonia, phosphoric acid, potassium and sulfur have rebounded strongly over the past two months after hitting multi-year lows earlier in 2022. However, the nutrient-based subsidy (NBS) rates set by the Government of India are based on the average international prices over the preceding six months.

This implies that despite the recent recovery, input costs are still likely to be lower on a six-month average basis, leading to sharp reductions in NBS rates. The government revises NBS rates every six months, with the next reset due on October 1.

In the last revision in May, NBS rates were cut by 22-54%, resulting in inventory losses of Rs. 2,000-3,050 crore for companies like Paradeep Phosphates and Coromandel International in the June quarter.

According to IIFL Research, ammonia prices are up 35% since end-August while phosphoric acid contracts for the December quarter are being finalized 14% higher. Meanwhile, urea and DAP prices have increased 6-9% over the past month.

“This divergence between the six-month average and current spot prices means fertilizer companies are likely to face margin pressure in the second half of FY24 as input costs rise but subsidies fall,” IIFL Securities noted.

The industry is carrying high inventory levels, which means the upcoming subsidy reset could lead to further one-time inventory losses. This happens when, because of regulatory changes, the price of the stocks in inventory have to be written down. Industry-wide stock of DAP and complex fertilizers at end-August was 50-65% higher on year.

While firms will seek to pass on higher costs through price hikes, the government is expected to restrict increases considering state elections in the coming months.

“With polls approaching, we think the government will limit the pass-through of higher input costs into fertilizer prices,” the analysts said. “This will impact profitability, in addition to the inventory losses.”

The silver lining is that lower subsidies could ease the tight working capital cycles that the industry has faced over the past year, reducing interest costs. The government has also been timely in clearing subsidy arrears so far in FY23.

However, the confluence of rising input prices and declining subsidies has emerged as a fresh challenge for the fertilizer industry, which is critical to India’s food security. The sector has already been grappling with high energy costs and supply chain disruptions this year.

Companies with backward integration such as Coromandel International are expected to be in a better position to weather this storm. Analysts also highlight Chambal Fertilisers as better placed relatively considering its full integration in urea and focus on exports.

“We remain positive on the long-term growth prospects of the agri-input sector given low per hectare fertilizer consumption in India. But near-term headwinds require a watchful eye and prudent working capital management,” the analysts warned.