Muted performance by agrochemical companies over the past two quarters has whittled down the valuations of stocks in this fancied sector. The stock of Bayer CropScience India, at Rs 761 now, discounts the company's trailing 12-month earnings by about 20 times. This is at a discount to its historic valuation (average 22) and well below its high of 32 times. Yet, prospects for companies such as Bayer CropScience are quite promising over a 2-3 year timeframe, making this a good opportunity to buy the stock.
A sharp increase in foodgrains output, the resulting pressure on prices and uncertainties relating to the monsoon led to poor off-take of agrochemicals in the September and December quarters of 2011. However, these problems appear to be transitory.
Structural drivers such as rising support prices for crops, intensifying pressure on agricultural yields and rising costs of farm labour may see growth of crop protection products bounce back to 10-12 per cent over the medium term.
Multinational players such as Bayer CropScience India appear to be in a particularly sweet spot, with their focus on high-end formulations and access to the parent's vast product pipeline. This helps protect margins from ever-present pricing pressures in generic agrochemicals.
For instance, even as domestic insecticide demand took a hit due to the expanding acreage of Bt cotton, Bayer CropScience has kept its annual sales growing at 20 per cent (to Rs 2,038 crore) and profits at 39 per cent (Rs 131 crore) in the three years to 2010-11. (Profits again vaulted 18 per cent in the first half of this fiscal.)
Bayer seems to have managed this growth through an increasing focus on target crops such as rice, tea, potato and vegetables. It has also made a string of new insecticide, fungicide and weedicide launches, with newer molecules such as Fenoxaprop, Flubendiamide and Tebuconazole.
A unique facet of Bayer's operations is its presence in public health and professional pest control as well. This insulates sales from the agricultural cycle. These factors perhaps explain why the company's operating profit margins have held at 11-12 per cent levels in recent years, despite erratic monsoons and rising costs due to a significant import component.
Like most multinationals, Bayer CropScience has negligible debt, a tight working capital cycle and strong cash reserves (buttressed by recent land sales). It has consistently managed a return on equity of over 20 per cent in recent years. While 60 per cent of the company's inputs are imported, currency risks are partly offset by exports and partly protected through currency hedges. A recent drive by the parent, Bayer AG to boost Asian sales should result in higher capital and R&D investments being routed to the Indian arm.