I think sharda cropchem business model of buying raw materials from china in dollars and selling in Europe in Euros are responsible for current business headwinds due to dollar appreciation and freight cost increase. These headwinds are going to stay for few quarters. Mr. Market will give much better opportunity in sharda cropchem in terms of lower share prices. Ukraine russia war and climate change in europe are fuelling the headwinds.
Dis. Not invested will keep close watch.
Topline grew by 32%, however gross margins were severely impacted due to Euro weakening vs USD. Management is confident of recouping margins and is guiding for 15-20% sales growth & 18-20% EBITDA margins in FY23. Concall notes below.
- Expect sales growth of 15-20% with 18-20% EBITDA margins in FY23, expect significant margin revival going forward
- Gross margin impacted due to Euro weakening against dollar, PAT was impacted by higher depreciation and forex losses. Confused as what to do as Euro weakening was very unexpected. Don’t want to move all the Chinese supply contracts to Euro as Euro can also strengthen and company doesn’t want to lose that benefit if it happens
- Hoping to end FY23 with gross margins similar to FY22
- This Euro weakening against dollars benefit Indian suppliers tremendously, especially those who have lower import dependence i.e. their cost base is in INR and not USD
- Gross margin breakup for agchem: EU (31% vs 42% last year), NAFTA (24% vs 25% last year), LATAM (17%, same as last year), ROW (23% vs 31% last year)
- Agchem volumes: 4mn vs 3.5mn in EU, 2mn vs 2.4mn in NAFTA, 1.1mn vs 1.5mn in LATAM, 300’000 vs 340’000 in ROW
- Demand for agchem division is good in Europe, there has been pressure on demand in NAFTA due to weather. Not seeing much pricing pressure
- Contribution for Western Europe is higher than Eastern Europe for agchem
- Capex: 102 cr. (special focus is on expanding biocide registrations). This is expected to be in the same range or increase slightly
- Sales growth components for entire sales: Volume (-) 2.5%, Price (+) 38% and (-) 3.3% through forex loss. Is most of price increase due to non-agro division? Yes
- What is contributing to such high growth in non-agro business? Marketing strategy is helping where Sharda is supplying tailor made products to customers, also quality of products is much better. Additionally, Chinese suppliers had higher bandwidth to fulfill these orders. Margins have improved from 14% to 22% due to passing on of higher freight rates
Disclosure: Invested (position size here, sold few shares in last-30 days to bring position size closer to model portfolio)
Dear @harsh.beria93 , we would like to hear from you about the current headwinds in business which Sharda cropchem is facing. As far as We know you follow Agrochemical sector very closely. I have positions in Agrochemical sector through Meghmani Organics. MOL results of this quarter are very much superb looking at its valuation. What’s your take on Sharda cropchem valuation with current business headwinds.
@harsh.beria93 - The key aspect is - Management has tried to clarify - attributing the disastrous Q1 margins to Euro vs Dollar. But the key question is - Is that all true :)…does it make full sense or management is hiding something beyond the currency headwind and freight cost issues.
During this quarter, the miss was on gross margin which management blamed on cross currency headwinds (Euro weakening vs Dollar).
To give a bit of historical context, reduction of gross margins happened since FY18 when market derated Sharda Cropchem (from 2-3x EV/sales to 1-2x EV/sales). There were two main reasons for gross margin compression:
Sharda targeted USA as its next growth frontier, where they started offering products at lower realizations (thereby lower gross margins). This is a common business strategy, to sell at lower prices to break in the market, and over time establish credibility and increase prices
Chinese pollution issues started cropping up which meant Sharda’s suppliers demanded higher costs from Sharda
In agrochemical market, prices are set by innovators and the generic cos generally undercut these innovators. In 2019, innovators were offering ludicrous prices, which management pointed out aptly in FY19 concalls. Thus, Sharda was squeezed on both sides.
During this quarter, gross margins was at decadal lows (25%), and market has duly penalized the stock.
From industry perspective, Indian agchem exports have been growing very well since FY18. This is the second good cycle that this sector is witnessing (first was 2013-16 which then slowed down in 2017). So that we have had 3-4 bumper years of growth, its quite possible that growth slows down for a couple of years. Also, for a few cos, most growth has come due to realizations and they will get hit massively. This was somewhat visible in quarterly numbers of Rallis and Astec. Actually, next few quarters will help us understand which company has robust sourcing networks. Those whose margins are massively hit will likely have much higher dependence on Chinese suppliers (likes of Astec, Sharda, even Rallis to an extent). Whereas integrated players (like Meghmani, Heranba) should show lower margin pressure. As Meghmani’s numbers are out, we can clearly see that they haven’t faced margin pressures, so they actually have more indigenised sourcing of RM. Lets see what Heranba reports.
For Sharda, all this doesn’t make a lot of difference as their growth is a function of registrations. About margins, USD to Euro is still close to parity which implies Sharda’s hedge acts against it. Anyway, company has no control over currency fluctuation and I feel they shouldn’t waste a lot of time on this.
Valuation wise, I feel they can only trade at 2014-17 valuations if gross margins go back to 35% levels, which I am not sure about. The good thing with a company like Sharda is their business is becoming more diversified (both in terms of markets they sell in and the product range). Their non-agchem business has now grown past 200 cr. in quarterly revenues (just for context, the biggest belt exporter from India does lower sales). Also, Sharda was able to pass on freight cost increase in non-ag division, as a result of which margins have increased to 20%+. Lets see what the future unfolds.
Disclosure: Same as before
@harsh.beria93 - Is it fair to see Sharda as a Krsnna diagnostic of Agrochem. Having a different business model than the rest within the sector. I am not sure if the rest of the players revenue varies based on the no. of registrations?
I don’t think Krsnaa is an opt comparison. Sharda’s business model is that of a pure marketeer, who outsources manufacturing and spends money on registration of its products and on marketing. If you want a peer from a different industry, cos like Chaman Lal Setia (basmati rice), Symphony (coolers) or Dash Pharma (US generic pharma) come to mind, where manufacturing is outsourced and company is only responsible for marketing.
Yes, a company needs to register its products to sell in regulated markets (EU, NAFTA, LATAM). The difference in other cos is they only register a few products (which they manufacture in their factories) in multiple geographies. Whereas, Sharda registers multiple products in multiple geographies, as they are not manufacturing them and don’t have to spend money in building dedicated lines for any product. In a way, Sharda’s business model is akin to a trader, where the entry barrier is distributor relationship and registration.
In its early days, Ajanta Pharma also used to do this, i.e. register products which are in demand in a given market and then get it manufactured with a third party.
Hope this is of some help.
Hi @harsh.beria93 I am studying the whole thread of sharda cropchem in valuepicker about its business model. Asset light model based on buying from china and selling to highly regulated market of US ,Europe and other latin american country through registration. Getting registration from developed countries are very difficult and have long gestation period.Risk of forex losses due to currency price fluctuation is also understood. But one thing which is difficult to predict is whether we are in uptrend of agrochemical cycle or at its peak of cycle? Please help newbie person like us in predicting where we are currently in agrochemical cycle?
Disclaimer: Studying before putting my hard earned money.
Rising gas prices in EU should benefit Sharda right? Wondering why the stock hasn’t reacted positively to this development.
Is this company really cyclical?Its opm has been pretty stable over the years…My point is it seems to be well managed.
In any cyclical sector, its hard to tell if we are at peak of a cycle. However, we can say with reasonable certainty whether we are in higher part or lower part of the cycle. For global agrochemicals, we have had a couple of very good years and are definitely towards the higher end of the cycle. Also, I have a feeling that we also crossed the peak as realizations of a number of technical grade pesticides have fallen off in the past few weeks. This has come on the back of droughts in China and a very hot summer in Europe. So, the post covid boom is probably over and we might be in for a couple of flat years. This is my current understanding.
While rising gas prices in EU shifts more business towards Asia, it has also impacted Euro in an adverse way. Sharda realizes half of its sales from Europe and procures in USD. The adverse currency movement has impacted Sharda significantly.
If you go back and read this post, you will see that margins have been adversely impacted since 2018. In last few quarters, it seemed that gross margins would revive but that has been reversed in Q1FY23. Its agchem margins are definitely cyclical.
Disclosure: Invested (position size here, no transactions in last-30 days)
Thoughts on results?
Heard the conference call recording post Q2. The biggest highlight of this quarter’s result is forex losses due to dollar strengthening vs euro.
During last 35-40 years(referring the chart below). Such a depreciation of euro against dollar have taken place only on two occasions. Around 1985 (Sharda did not exist then) and around 2002 (Sharda must be quite smaller back then)
Sharda’s business is facing quite a rare situation. The war between Russia and Ukraine along with interest rate hardening by US-Fed is likely to keep dollar stronger. Not withstanding what company has mentioned in the investor presentation and the impression they try to give during the investor conference, there are only few things that I think are happening to get forex situation normalized for Sharda
- The company wait for dollar to euro equation to normalize - less probable in near term
- Company re-negotiate with customers for better pricing - Thankfully they don’t have very long term contracts with customers(as mentioned during the last conf. by Mr. Bubna)
- Company increase the proportion of their revenue from NAFTA region. - again this would be gradual. But there are green shoot, for agro-chem as well as non-agro-chem they have shown more than 15% YoY revenue growth in NAFTA whereas For Europe, there have been 11% growth in Agrochem & 22% degrowth in Non-Agrochem segments.
There is slight increase in profitability in Q2 compared to Q1. But pre-Q1 level profitability seems to be few quarters away from now.
@harsh.beria93 Would appreciate your thoughts on - how do you see company’s trajectory for growth and profitability
Won’t they hedge forex like IT companies do? I’ll be surprised if they didn’t.
Based on management’s below mentioned comments during the concall. It implies that they are not in position to do the hedging at the point in time. I don’t believe they would be able to do it based on the narrative I heard on the call.
Options for hedging are very limited. They are not able to get clear views(about exchange rates). Vigilant to do hedging when there are clear view
IT companies are working with hedging for over past 15 years. I would be surprised if Sharda cropchem has any expertise on this. They have just started to think on hedging during last 3-4 months. I think, It will take time for them to figure it out
Topline grew by 12%, gross margin pressure continued due to adverse movement of Euro vs USD. Management continue their guidance of 15-18% growth in revenue and EBITDA for FY23. Concall notes below.
- Guiding for 26-30% gross margins for FY23. Expect 15-18% growth in revenue and EBITDA for FY23
- Capex: 230 cr. in H1FY23
- Demand situation in Europe is good and has improved from last quarter
- Sourcing from multiple manufacturers in India and China. Don’t have long term agreements for sales or procurement. Everything is done on spot basis
- For Q2, volume (-) 23%, price (+) 34%
- For H1, volume (-) 13%, price (+) 36%
- Agchem quarterly volumes: 3mn vs 3.4mn in EU, 1.9mn vs 2.35mn in NAFTA, 0.6mn vs 1.4mn in LATAM, 0.75mn vs 1mn in ROW (overall volume declined by ~22.7%)
- Higher realizations are because of better product mix where company is benefitting from newer molecules that have higher realizations, even though blended volumes are lower because of older molecules whose volumes are high but realizations are low
- Gross margin breakup: EU (29% vs 33% last year), NAFTA (26% vs 28% last year), LATAM (24% vs 15% last year), ROW (30% vs 20% last year)
Changes made to counter forex issues
- Focusing more on NAFTA region (shown in increase in contribution to 40% of agchem sales which is almost same as EU). NAFTA + EU accounted for 81% of agchem sales in Q2FY23
- Sourcing more in Euro, not easy to simply change currency of procurement
- Improving hedging
- Passing on price increase to customers
Its good that most of these forex issues have happened in first half of the year, as Sharda gets most of its business during second half of the year (mostly in Q4).
About other points being made on hedging, I dont think it will be as beneficial as its being made out to be as Sharda’s core business is to play on currency differential. They buy products in USD and sell them after a few months in Euro, so a large part of their margins in captured in this differential. They will need to pay 3-6% on hedging and also will need to take a directional call on currency. Currently, they are getting the stick which can also get reversed in the future. Over longer periods, this is not what they should optimize for.
Their focus should be on getting more registrations, increasing customer base, and improving contribution from better markets (in terms of realization and working capital). They have done all this, their US + EU contribution was 80% of Q2 agchem sales which speaks a lot about business execution. Also, given the fact the biggest quarter is still sometime away, the full year nos can change significantly.
Disclosure: Invested (position size here, no transactions in last-30 days)
There was a recent interview with Sharda cropchem management who said that the currency losses they had faced in H1 are likely to reverse due to increasing Euro vs USD. If we look at Euro vs USD, Euro has recovered somewhat in the last 30 days.
More importantly, their nos are Q4 heavy. If Euro keeps on strengthening, not only will H1 losses reverse, but they will be benefitted from higher revenues in H2FY23. Lets see how future unfolds. Notes below.
- Euro is recovering against USD, H1 currency losses of 82 cr. are notional in nature and should reverse if Euro keeps on strengthening
- In constant currency, they had 20% growth in H1FY23
- Agchem sales are growing very well in Europe and USA
- Non-agchem products are doing better than agchem in terms of sales and margins
- Capex will be ~450 cr. in FY23 and will be maintained in 400-500 cr. in next 2-3 years
Disclosure: Invested (position size here, bought shares in last-30 days)
@harsh.beria93 - The Covid lockdown in China which is a primary supplier of the material for Sharda, can probably cause dent in the Sharda’s performance?
Looks quarter results are good and agchem has recovered well.