Aarati Krishnan

Modest valuations Spillover effect from good monsoon Crop and geographical diversification to pay Alliances and exports offer promise

As the second largest company in the crop protection space, Rallis is well placed to ramp up its business through geographical diversification.

Rallis India appears to be a good "value" stock to accumulate at current price levels. At Rs 310, the stock trades at a modest price-earnings multiple of about 10 times its trailing 12-month earnings. This is at a substantial discount to multiples of about 20-22 times enjoyed by both the multinational crop protection companies, such as Monsanto and homegrown ones, such as Excel Crop Care.

Though the Rallis' earnings suffered a setback in the December quarter on account of problems related to excess rains, the medium-term outlook appears positive. The good monsoon for the just-concluded year is likely to have a positive spill-over effect on offtake of agricultural inputs over the next two-three years.

As the second largest company in the crop protection space, Rallis is well placed to ramp up its business through geographical diversification, an expanding basket of off-patent products and alliances with multinationals for contract manufacturing and distribution. The company's pedigree — its association with the Tata group — is an additional comfort factor.

The past couple of years have seen Rallis India transform from a conglomerate operating a medley of unrelated businesses into a focused play on agricultural inputs. It has hived off businesses such as pharmaceuticals, gelatine and fertiliser trading and redeployed the proceeds in its core business of vending agricultural inputs, mainly crop protection chemicals. These initiatives have improved the quality of earnings and contributed to a turnaround in profitability from the year 2004-05. Though threats do exist in the form of expanding acreage of GM crops and pricing pressures on older products, the company does have a multi-pronged strategy in place to deal with these threats.

Alliance route

India's transition to a product patent regime with effect from 2005 has reduced the opportunities for companies such as Rallis India to generate new products through reverse engineering of the manufacturing process. But the company has managed the initial phase of this transition well.

The company has tackled this by entering into alliances with large global players such as Bayer, Syngenta and DuPont to source and co-market products. The company boasts an extensive distribution network that is an asset to global players looking to establish a national footprint. This has helped counter the loss of business because of the patent regime.

Diversification

The expanding acreage of Bt cotton and the pricing pressure on commodity agrochemicals have reduced realisations and shrunk the markets for some of the large crop protection chemicals in the domestic market. Rallis is addressing this through crop and geographical diversification. The rapid expansion in Bt cotton has shrunk the market size for insecticides that target the bollworm — a key cotton pest. The company has addressed this by focusing on sucking pests that afflict cotton and rolling out more products for crops such as paddy and wheat as also fruits and vegetables. In 2004-05, six new products were added to the domestic portfolio, generating about a fifth of the year's revenues.

Given its strength in low cost manufacture of generic products, exports also offer a big business opportunity for Rallis India. The company has maintained a largely domestic focus until recently, while competitors such as United Phosphorus have built up a large export presence. With about 65 per cent of the global market for agrochemicals representing off-patent products, the opportunities in this market are substantial. Exploring this opportunity involves a long gestation period as the process of data generation, approval and registration in each addressable market, tends to take considerable time. But the company has set this process in motion. Export revenues, though accounting only for 20 per cent of revenues in 2004-05, have registered a robust growth in the past two years.

Cost savings

Capital infusion from the group by way of preference capital has helped the company make progress on its debt restructuring programme, with interest costs cut by nearly half over the past couple of years. With more cash being released by recent exits from non-core businesses, there appears to be further scope for interest cost savings from a continuation of debt restructuring efforts.

After registering a robust 80 per cent growth in post-tax profit on the back of a 15 per cent sales growth in the first half of this fiscal, Rallis has received a sharp setback to both revenues and profit in the December quarter.

This has been an industry-wide phenomenon as excess rains in the post-monsoon period contributed to unusually low incidence of pests during this season. However, these problems appear to be of a one-time nature. Over a two/three-year time frame, given the slew of new business initiatives that the company is exploring, earnings growth could pick up to healthier levels.

On this score, the excess rains in the just-concluded year offer room for optimism. Good rains have improved the water table and bolstered the storage position in major reservoirs. This, combined with the significant ramp up in public spending on rural infrastructure, could help reduce the rural economy's dependence on the monsoon over the next couple of years.

Risks

However, investors in agrochemical stocks have to be prepared for volatile earnings as they depend on only on the state of agricultural output, but also on pest incidence in a particular season, which is always a wild card.

However, the modest valuation multiple enjoyed by the Rallis India stock may make it more resilient to downside.

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