By Mahaveer Jain

India Ratings and Research (Ind-Ra) has undertaken the following rating action on Smartchem Technologies Limited’s (STL) bank facilities:

Instrument Type

Date of Issuance

Coupon Rate (%)

Maturity Date

Size of Issue (million)

Rating/Outlook

Rating Action

Bank facilities

-

-

-

INR1,000

IND A1+

Assigned

Ind-Ra has taken a standalone view to arrive at the rating, as one of the demerger rationale is to invite a strategic partner in STL. This will weaken the linkages between STL and its parent Deepak Fertiliser and Petrochemicals Ltd (DFPCL). STL has primarily been formed through the demerger of the technical ammonium nitrate (TAN) and fertiliser divisions of DFPCL.

KEY RATING DRIVERS

Strong Business Profile: STL is among the leading producers in both domestic and global TAN markets. STL claims that it holds a dominant share in the markets for bentonite sulphur, water soluble and nitrogen phosphate potash (NPK) complex fertilisers in Maharashtra. TAN and NPK fertilisers are value-added products that command higher margins compared with urea and phosphate fertilisers. FY18 EBITDA contributions from TAN and bulk fertilisers are likely to be 55%-60% and 40%-45%, respectively. NPK fertilisers face lower regulatory risks than those faced by urea, as prices are decontrolled. STL, along with its parent, benefits from vertical integration, with an option to use captive inputs, including ammonia and nitric acid. STL has moderate scale of operations. Its revenue was INR23.6 billion in FY17 (FY16: INR29.5 billion). Furthermore, it has a long track record of over three decades in fertiliser and chemical manufacturing and trading.

Incremental EBITDA from New Capacity: Ind-Ra expects STL’s operating profitability to recover in FY18 (FY17 and FY16 EBITDA margin: 9.8% and 8.6%, respectively), considering steady natural gas spot prices and higher available capacity. At FYE17, STL’s NPK and bentonite sulphur fertiliser manufacturing capacity levels increased by 300,000 tonnes to 600,000 tons and by 32,000 tonnes to 57,000 tonnes, respectively. The management expects the NPK fertiliser capacity to increase to 1.1 million tonnes by FYE18. The incremental capacity is likely to substantially increase EBITDA in FY18, thereby improving credit metrics during the period. Furthermore, an increase in the area sown and a good rainfall are likely to improve overall demand for fertilisers. Demand outlook for TAN is likely to be underpinned by an uptick in mining and infrastructure activities. STL’s fertiliser division’s EBIT improved to INR112 million in 4QFY17 and INR261 million in 1QFY18, driven by a rise in capacity utilisation and a fall in natural gas prices.

Likely Improvement in Credit Metrics in FY18: Ind-Ra expects a substantial improvement in STL’s credit metrics, with net leverage standing at about 3.0x in FY18 (FY17: 5.8x) and operating cash flows registering strong growth during the period. EBITDA gross interest cover, which stood at 3.5x in FY17 (FY16: 3.2x), is likely to decline to 3.0x in FY18 and thereafter improve to above 3.5x in FY19. Net adjusted leverage, net of subsidy receivables, was 3.6x in FY17 (FY16: 2.0x).

The deterioration in net adjusted leverage was owing to a delay in subsidy receivables due to a dispute with the Department of Fertilizers (DoF), the Ministry of Chemicals and Fertilizers, which claimed that STL received an undue benefit and severed the natural gas supply. The DoF has withheld INR3.1 billion in subsidies due to STL, alleging an undue gain realised by the company on account of supply of cheap domestic gas. The DoF has advised releasing the subsidies only against a bank guarantee. This led to a backlog of receivable over FY15-FY17, leading to an increase in debt and a decline in operating performance of the fertiliser division.


Constrained Financial Flexibility: The dispute with the DoF and Gail (India) Limited (GAIL) are significant outstanding contingent liabilities. GAIL has also raised an INR3.57 billion claim, alleging usage of domestic natural gas for manufacturing products other than urea. The agency has not factored in any cash flow impact in its base case financial projections and rating will be reactive to the outcome of the disputes.

Inherent Risks: Inherent industry risks include agroclimatic conditions, seasonal demand, dependence on regulatory raw-material supply, input price volatility and import dependency that affect cash flow generation and visibility. Industry participants will continue to face a moderate regulatory risk, as regulatory agencies influence critical raw material input supplies, quantum of subsidies and timing of the release of subsidies. Moreover, industry participants’ dependence on imported natural gas introduces volatility to margins.  Both key products, TAN and NPK, of STL could face a moderate import threat.


RATING SENSITIVITIES

Negative: Continued dependence on natural gas supply under spot prices or adjusted net leverage exceeding 3.5x on a sustained basis may lead to a negative rating action.


COMPANY PROFILE

As of March 2017, STL had a TAN production capacity of 429,000 tonnes and a bulk fertiliser manufacturing capacity of 6000,000 tonnes.

STL’s fertiliser division produces and trades in prilled nitro phosphate fertiliser, a variety of NPK, and other bulk fertilisers.


FINANCIAL SUMMARY

Particulars

FY17

FY16

Revenue (INR million)

23,582.10

29,540.40

Operating EBITDA (INR million)

2,312.60

2,537.90

Operating EBITDA margin (%)

9.8

8.6

Closing net debt (INR million)

13,479.60

13,142.70

Operating EBITDA/gross interest expense (x)

3.5

3.2

Net debt/operating EBITDA (x)

5.8

5.2

Source: STL, Ind-Ra



COMPLEXITY LEVEL OF INSTRUMENTS

For details on the complexity levels of the instruments please visit https://www.indiaratings.co.in/complexity-indicators.

SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in. The ratings above were solicited by, or on behalf of, the issuer, and therefore, India Ratings has been compensated for the provision of the ratings. 

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

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Applicable Criteria

Analyst Names

  • Primary Analyst

    Mahaveer Jain

    Director
    India Ratings and Research Pvt Ltd Wockhardt Towers, 4th Floor, West Wing, Bandra Kurla Complex, Bandra East,Mumbai - 400051
    +91 80 46666817

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121