Sharda Cropchem Ltd Management Discussions.

Agrochemicals sales are expected to increase up to 2% per year over global GDP until 2035, making it among the fastest growing parts of the chemical industry.

Economic Overview

After a strong growth in 2017 and early 2018, the second half of 2018 experienced a slowdown. Global economic growth softened to 3.6% in 2018, and is projected to decline further to 3.3% in 2019.1 The slowdown in global expansion is due to challenges like escalation of US-China trade tensions, credit tightening in China, macroeconomic stress in Argentina and Turkey, disruption in the auto sector in Germany, and financial tightening in larger advance economies.

However, growth is expected to pick up in the second half of 2019, driven by an absence of inflationary pressure and monetary policy accommodations by major economies. Moreover, the fiscal and monetary policy stimulus by China has helped to counter the looming negative effects of imposed trade tariffs, improving the outlook for US – China trade tensions.

Indias economy grew by 7.2%2 in the fiscal year 2017-18 and is projected to grow around 6.9-7.0% in 2019 due to weaker economic momentum. The slowdown has been driven by cooling activity growth in the manufacturing sector and, to a lesser extent, agriculture. The IMFs WEO forecast projects that Indias economy is poised to pick up in 2019, benefiting from stable oil prices and a slower pace of monetary tightening than previously expected, as inflationary pressures ease. Additionally, India has recorded a jump of 23 positions in the Ease of Doing Business metric since 2017, to be placed at the 77th rank among 190 countries assessed by the World Bank.

With the slowdown of global trade, the economic activity moderated in the second half of 2018 and output in some Member States of European Union were adversely affected by temporary domestic factors, such as disruptions in car production, social tensions and fiscal policy uncertainty. The start of 2019 saw a subdued economic momentum. However, the European economy is set to continue to benefit from improving labour market conditions, favourable financing conditions and a slightly expansionary fiscal stance. The euro area GDP growth is projected to be 1.3% in 2019 and 1.6% in 2020, while the EU GDP growth is projected to fall to 1.5% in 2019 and 1.7% in 2020.3

In September, the United States, Mexico, and Canada announced the completion of negotiations toward a new United States-Mexico-Canada Agreement (USMCA). According to the Government of Canada, the outcomes preserve key elements of this trading relationship and incorporate new and updated provisions focused on trade issues and on promoting opportunities for the nearly half-a-billion people who reside in North America.

The new agreement replaces the North American Free Trade Agreement (NAFTA), which in 1994 created the worlds largest free trade region. And while Canada, U.S.s second largest trading partner, was initially left out when the U.S. and Mexico reached a preliminary deal in late-August to revamp NAFTA, it later collaborated with its two trading partners to develop the USMCA.4

Registering a regional growth rate of 2.2%, Latin Americas full-year growth prospects were left intact as of the end of this financial year. With sluggish growth prospects, U.S. - China trade tensions and major central banks shift toward a more dovish policy stance, the growth in Latin America is expected to weaken, and delaying any plans across the region to tighten monetary policy. During late 2018 and early 2019, the growth momentum was weaker than expected across several large economies like Argentina, Brazil, and Mexico. Lower statistical growth carry-over, lingering policy uncertainty, weaker external demand, and several other idiosyncratic factors are expected to negatively impact growth forecasts for the regions two largest economies: Brazil and Mexico.

The IMFs World Economic Outlook report of April 2019 projected China to grow by 6.3%, which is higher than the previous forecast of 6.2%%. Despite the headwinds, IMF raised the growth forecast of China citing Beijings effort to support the economy and improved outlook of US-China trade tensions. Furthermore, China has also ramped up its fiscal and monetary stimulus to counter the negative effects of trade tariffs.

The Agrochemical Industry6

The global market for crop protection sales increased from US$54.2 billion to US$56.5 billion in 2018, an increase of 4.2%. Rising demand for pesticides and increasing consumption of agrochemicals in liquid form are some of the key factors expected to boost the demand for agrochemicals in the global market. According to the estimates by Roland Berger, agrochemicals sales are expected to grow by up to 2% per year over global GDP until 2035. At that rate, the sector would likely be among the fastest growing parts of chemical industry.

Currently, at 36%, the herbicide segment constitutes the largest market share. The segment is expected to retain its position until 2024, due to the large-scale adoption of herbicide-resistant crops in North and South America.

At the end of 2026, the pesticides segment of agrochemicals is anticipated to grow and become 1.54 times its value size in 2018. This segment is projected to create an incremental dollar opportunity of nearly US$67.19 billion by 2026. The fertiliser segment of agrochemicals is projected to grow with 3.9% CAGR, in terms of value from 2017 to 2024.

The global crop protection chemical industry has been transforming over the years, with robust growth, coupled with changing crop mix trends and environmental regulations. Growing populations, the decline in arable land, and food security are the primary focus areas for all countries, driving the demand for higher agricultural output, augmenting the global growth of the pesticide industry.

Increase in Global Demand for Biocides

Global biocides market is expected to surpass $13 billion by 2024, at a CAGR of around 5% over the period of 2018 – 2024. The market is driven by the increasing number of water treatment plants and the replacement of traditional disinfectant such as chlorine by biocides owning to rising health and environmental concerns is another vital growth factor contributing towards the growth. The growing awareness in agricultural sector globally is likely to act as an opportunity for the biocides.

North America is dominating the global biocide market, primarily driven by demand in the US. This is due to the presence of a large number of companies in the region – specialising in nearly every industry including food and beverages, water purification and painting and coating, all of which are the largest consumers of biocides.

Key Market Trends

Huge opportunity for generic pesticide players

Products worth $6.3 billion are going off patent between 2014 – 2020. This has led to a shift from the use of high value patented products to generic agrochemicals, enabling a huge growth opportunity in the market. Out of the total crop protection market, approximately 60% of it is generic pesticide market and remaining share comes from proprietary off patent and patented pesticides. As per the Enigma report, 19 more agrochemical active ingredients (AIs) will lose patent protection between 2019 and 2026. With so many products coming off patent, industry players have the opportunity to choose the right off-patent/generic AIs for their product development strategies.

Over last 20 years, there has been a decline in the discovery of new active ingredients. At the same time, there has been a substantial increase in the number of mixture products entering the market. It is projected that, from 2019 to 2026, approximately 70 mixture products will lose the patent protection.7

Growing Population and Food Demand with Diminishing Arable Land

Growth in demand for food grains owing to increasing global population coupled with reducing per capita farmland due to surging urbanisation and industrialisation is one of most dominant driver of global agrochemicals market.

7Source - Agropages

The global population was pegged at 7.6 Billion in 2017 with a change of 1.12% during 2016-2017. High population growth has fuelled food consumption globally, which has surged the demand for agricultural products. Thus, the use of agrochemicals such as fertilisers and pesticides has become a necessity to meet the growing demand for food. By 2030, the per capita farmland is expected to decrease from 2,200 m in 2005 to 1800 m. Various crop pests contribute to yield loss, causing global crop loss of 10-16% annually. In the past 8 years, the total crop area harvested has declined with a significant CAGR of approximately 3.5%.

With diminishing arable land, North America crop protection chemical market, dominated by the US and Canada, is anticipated to contribute tremendously towards the development of the overall crop protection chemical market. The market for crop protection is expected to grow at 7.05% of CAGR by volume during 2019-2027. Per hectare consumption (4.5kg/hectare) of Agrochemicals in North America is highest among all regions.

China and India are major exporters of agrochemicals in Latin America, the Asia Pacific, and other regions. Such factors are projected to create a robust platform for the growth in the Chinese and Indian agrochemicals markets.8

Technological improvements leading to efficient methods of agriculture

The rapidly growing world population and proportionately declining arable land have led to the need for improvement in agricultural production. Advancements in new breeding technologies claim to improve yields, as well as increase the lifespan of crops. For instance, genetic modifications improve the crop yield by increasing fertiliser absorption capacity. However, these crops still require agrochemicals such as pesticides because they are not completely pest resistant. Therefore, the requirement of pesticides will increase with the rise in the adoption of GM crops.

The development of efficient methods of farming will result in causing less harm to the environment and human health. Therefore, new technological advancements will further drive the global agrochemicals market during the forecast period.

Industry Outlook

Europe

The European crop protection product sales grew by 3.2% to $12.8 billion in 2018. The European market was a tale of two halves with negative weather in western EU countries being offset by growth in new member states in the East and major ex-soviet nations. Those markets continue to grow, led by cereal growing areas driven by exports.9

The Western European region is an established market for agrochemicals and has a good market growth, while France and Germany represent the largest agrochemicals markets of the European region followed by Italy, Spain and the UK.10

NAFTA

Crop protection sales in the NAFTA region increased by 3.2% in 2017 to reach $11.11 billion. Growth was driven by strong prices in North America. Part of this derives from a product mix effect as the glyphosate share continues to decline and more expensive herbicides replaces it. The other factor was price hikes from China.

The growth was also driven by increased planted areas of soybeans, canola and cotton, as well as improved conditions in California, where the region showed some recovery following the drought experienced in 2016.11

LATAM

The Latin American (excluding Mexico) crop protection market grew by 6.0% to $13.4 billion in 2018. Phillips McDougal anticipates the growth of 6% in Latin America, led by Brazil. Most leading companies have reported growth in this region. However, Argentina experienced some problems with drought. Relatively low disease pressures and glyphosate resistance were further dragging on the market.12 However, volatile commodity prices combined with weak Brazilian real or unfavourable weather conditions could be negative for the agrochemicals sector.13

Globally, the Latin American market is the second fastest-growing crop protection chemicals market, and it accounts for nearly 24% of the global market share. Joint ventures and new product launches are the major strategies followed by the Latin American companies. The pesticides market in Latin America is consolidated, with top 10 companies holding the major share, whereas, the bio-pesticide market is fragmented.14

Rest of the World

Asia Pacific grew by 4.6% in 2018, as the good weather condition boosted the sales in India and China. The Indian pesticides market was worth र 197 billion in 2018. The market is further projected to reach a value of र 316 billion by 2024, growing at a CAGR of 8.1% during 2019-2024. The significance of pesticides has been rising over the last few decades, catalysed by the requirement to enhance the overall agricultural production and the need to safeguard adequate food availability for the countrys growing population.

Chinese manufacturers stand to gain from exports of pesticides to other markets, since overall demand for them is on a growth trajectory. China Crop Protection Chemicals Market is expected to grow at a CAGR of 8.12% from 2015-2020. Droughts in Australia and Indonesia, and excessive inventory in Vietnam depressed those markets. The market across Middle East/Africa region increased by 1.9%, lagging the other regions.

Business Overview

Sharda Cropchem Limited is a fast-growing global agrochemical Company with a unique asset light business model. The Company is engaged in the marketing and distribution of a wide range of formulations and generic active ingredients globally. Our key business differentiator is our timely presence in developed markets, with entry barriers that have a high cost of registration, and stringent testing standards with prolonged approval timelines. The Company has a strong foothold in the advance economies of European countries and US markets. Over the years it has also gained a significant presence in other regulated markets such as LATAM and Rest of the World. Geographically, the Company is segmented into 4 markets; Europe, NAFTA, LATAM and RoW.

We operate within 2 business verticals: agrochemicals and non-agrochemicals.

Agrochemicals

The Company is primarily a crop protection chemical company engaged in the marketing and distribution of a wide range of formulations and generic Active Ingredients (AIs) across Fungicides, Herbicides and Insecticides. Our Company operates across Europe, the NAFTA region, Latin America and the rest of the world.

Non-Agrochemicals

The Company is involved in the order-based procurement and supply of non-agrochemical products having a product profile of belts, general chemicals, dyes and dye intermediates. The Company procures these non-agrochemical products, primarily, from the manufacturers in China or India and supply them in over 30 countries across Europe, North America, Latin America, Australia, and Asia.

Our Business Model

Differentiating ourselves from the companies following typical agrochemical value chain framework, Sharda Cropchem Limited follows a unique asset-light business model, through which we are able to market and distribute a diversified range of formulations, without incremental manufacturing capex.

The agrochemical industry is highly regulated across markets and one of the strong entry barriers is seeking registrations. The Companys asset light business model allows our efforts to focus on the identification of generic molecules and registration opportunities, preparing dossiers, and seeking registrations for formulations and generic active ingredients.

The Company procure formulations and generic active ingredients in their finished form from third party manufacturers for sale, and also engages in third party formulations. This enables us to offer a diversified range of formulations and generic active ingredients in the fungicide, herbicide and insecticide segments. These formulations and molecules protect different kind of crops, serve turf and specialty markets, and include disinfectants in the biocide segment, thereby catering to a variety of market needs..

Competitive Strengths

Unique Asset Light Business Model

Sharda Cropchem follows a unique asset light business model whereby it keeps its competitiveness in identifying generic molecules, preparing dossiers, seeking registrations, marketing and distributing formulations through third party distributors or using its own sales force. The asset light business model helps the Company to pay unfettered attention, invest capital and time, thereby driving their portfolio of registrations and generic active ingredients. This differentiates it from an innovator company, which expends capital, time and resources primarily towards R&D.

Core Competency in Registration

Sharda Cropchems core competency lies in identifying opportunities in generic molecules and corresponding formulations and generic active ingredients, preparing dossiers and seeking registrations in the relevant jurisdictions. As a result of the focused efforts in seeking registrations in different countries, along with the investment of time and capital towards this objective, the library of dossiers and the number of registrations owned by the Company has increased progressively. The legal and procedural requirements for seeking registrations differ in each jurisdiction. Over the years, the Company has focused and navigated through the regulatory requirements in these jurisdictions, which has now equipped it to anticipate potential issues and prepare for complying with the regulatory requirements in an efficient manner.

Strong registrations in Pipeline

Sharda Cropchem currently has 2,297 registrations, out of which 89% are formulations and the remaining 11% are active ingredients. The Company has a pipeline of 1,028 registrations across Europe, NAFTA, Latin America and Rest of World. Historically, the Company received 100-150 registrations each year and these registrations came from a portfolio of over 150 molecules. It continues to focus on adding more registration and these registrations will act as a catalyst in the growth of the Company.

De-Risking Sourcing Capabilities

The Company has maintained relationship with multiple manufacturers in the agrochemical industry, mainly in China, from where it sources and with various formulators mainly from Europe and the US. This helps in de-risking the Company, as it is not being dependent on single or limited supplier, which in turn helps in getting optimal price from the market.

The Companys relationship with the third-party manufacturers and third-party formulators provide it with flexibility to adjust orders in accordance with the fluctuating demands and the Companys strong sourcing capabilities enables it to seek supply of formulations or generic active ingredients at competitive market prices.

Strong Global Distribution Network

With an objective to increase its presence in the agrochemical value chain, the Company has set up its own sales force in Europe, USA, Canada, Mexico, Colombia, South Africa, and other jurisdictions, in addition to third party distributors. By doing so, Sharda Cropchem will be able to increase the penetration of its formulations and generic active ingredients in various countries.

Strong Geographic Spread and Product Portfolio

Sharda Cropchem has grown by spreading its business operations in more than 80 countries, across Europe, NAFTA, Latin America and Rest of the World, offering diversified range of formulations and generic active ingredients in fungicide, herbicide, insecticide and biocide segments. With the presence in multiple geographies, the Company has diversified its revenue sources and at the same time developed knowledge about the local weather and soil conditions, which enables to foresee and satisfy the local demand. Also, its library of dossiers provides the opportunity to venture into newer markets.

Proficient and Professional Management

The Promoters and the Management of the Company have a rich experience in the agrochemical business and have played a key role in developing the business. Sharda Cropchem believes that the domain knowledge and experience provides the Company with a significant competitive advantage as it seeks to grow in existing markets and enter new geographies. Furthermore, a qualified, experienced and capable management team leads the business and its operations. The Companys ability to attract and retain the key management personnel and the in-house team has enabled it in streamlining the registration process thereby economising the registration costs and the time involved.

Financial Overview

The total revenue of Sharda Cropchem increased by 17.26%, from र 17,065.89 million in FY18 to र 20,011.42 million in FY19. Revenue from Europe, NAFTA and Rest of the World have grown by 14.0%, 20.5%, 64.2% respectively, while revenue from LATAM decreased by 18.8%.

The agro-chemicals division of the Company grew by 13.79% from र 14,812.98 million in FY18 to र 16,855.49 million in FY19. The revenues from non-agro division grew by 40.08% from र 2,252.91 million in FY18 to र 3,155.94 million in FY19.

The total number of registrations increased by 140 from 2,157 as of March 31, 2018 to 2,297 as of March 31, 2019. The Company has another 1,028 registrations in pipeline across geographies. The Company has a strong net cash position of र 3,355 million as of March 2019.

Ratio Analysis

2018-19 2017-18 Variance
Debtors Turnover
2.34 2.17 7.76%
Ratio
Inventory Turnover 3.10 2.80 10.86%
Interest Coverage Ratio 29.01 60.08 (51.72)%*
Current Ratio 1.88 1.56 20.64%
Debt Equity Ratio 0.00 0.15 (99.95)%**
Operating Profit Margin (%) 12.16% 17.11% (28.92)%***
Net Profit Margin (%) 8.81% 11.18% (21.17)%
Return on Networth 13.73% 16.81% (18.30)%

*Due to higher debt period in FY2019 as compared to FY2018

**Repayment of debt in current year from Internal Accruals

***Due to higher depreciation and write-off of Intangible assets and Intangible asset under construction

Business Strategy and Outlook

Leveraging the strategies in place, Sharda Cropchem plans to sustain the market position and maintain the growth that the Company has demonstrated over the years. During the year we have improved our balance sheet position significantly by improving the working capital, which in turn improved our cash reserves. The strategies in place are aimed towards maintaining double-digit growth through the next financial year.

Going forward, we plan to strengthen our own sales force network, as we believe that marketing and distribution are an integral part of the agrochemical value chain. Sharda Cropchem is expanding the reach of its sales force in Poland, Italy, Portugal, Spain, Hungary, USA, Canada, Mexico, Columbia and India, to reduce reliance on third party distributors. Along with this, we plan to grow our biocides business and we will continue to market and distribute it in various countries such as Spain, France, Italy, Hungary, Croatia, United Kingdom, Slovakia, Slovenia, Belgium, Bulgaria, Greece, Poland, and Czech Republic.

Through smart IP management, we continue to identify generic molecules going off patent and focus on seeking registrations to increase our portfolio of formulations and generic active ingredients across Europe, NAFTA, LATAM and Rest of the World. By leveraging the existing dossiers and portfolio of formulations and generic active ingredients, we plan to develop new composition of formulations.

With the established market presence and execution capability, we plan to adopt a factory-to-farmer approach and to become a one stop solution provider. This will enable the Company to increase the margin and portfolio penetration as well as serve efficiently.

Key Risks and Concerns

By structuring and continuously identifying, assessing and deciding on responses, the Company mitigates key risks across all levels of operations.

Exchange rate fluctuations

The Company, being a global player, has foreign currency revenue exposure primarily, in US Dollars and Euros. Due to the timing difference, the foreign exchange rate at which a sale is recorded in the books of account may not be the same with the foreign exchange rate at which the cash is realised by the Company, resulting in foreign currency gain or loss, depending primarily on the depreciation or appreciation of the US Dollar.

The Companys huge exports act as natural hedge against imports and the Company also takes plain vanilla hedge against their orders to reduce its exposure. The results of operation, cash flows, liquidity, and financial condition of the Company can be adversely affected if there is any adverse movement in the foreign exchange rates.

Extension of Patents

The Company faces high risks from patents laws, as it is a global generic agrochemical player having exposure in various countries. This may lead to unnecessary delays in formulations and generic active ingredients, and adversely affect the business. Introduction of formulations and generic active ingredients might get delayed if there are undue extension of patent terms, or the extension of exclusivity in the marketplace by the respective regulatory authorities, which will adversely affect the business.

Changes in government policies

Having a global presence, the Company has to comply by the laws, rules and regulations of many countries, which impacts the decision-making process. Any changes in the governmental policies related to agriculture and any adverse alterations in policies relating to agro sector — like a reduction in government expenditure in agriculture, a reduction in incentives and subsidy systems, a change in the export policy for crops, a change in the price of commodities — will affect the Companys business. It may also affect the ability of farmers to realise minimum support prices for their process, which will lead to inability of the farmers to spend on agrochemical input products. This could thereby affect the Companys market demand and sales.

Weather conditions like Droughts and reduced pest attacks can lower demand for agrochemicals

The agrochemical business is largely dependent on the weather patterns and pest attacks and the demand for agrochemicals is adversely impacted by droughts and fewer pest attacks, resulting in inventory build-up. All these factors make the sector unpredictable and making it difficult to forecast the exact levels of production of a crop relative to past production. Accordingly, the overall effect of weather conditions makes the Companys operations relatively unpredictable and seasonal.

Resistance development reduces life of product

The effective life of agrochemicals reduces over a period of time, as targeted pests develop resistance. The constant introduction of new agrochemicals is essential for effectively eliminating pest attacks. To mitigate this risk, Sharda Cropchem keeps obtaining registrations for new products, enhancing the portfolio in different geographies.

Pollution Control Measures in China

The Chinese government is paying greater attention to environmental protection and as Chinas fight against pollution is getting fiercer, the environmental protection measurements are affecting the agrochemicals industry and its international players including Sharda Cropchem. The pollutant discharge permit system can be regarded as a long-term environmental protection supervision system in China.

Internal Controls

The internal controls of the Company are being reviewed from of the leading and reputed external agency. This results in unbiased and independent examination of the adequacy and effectiveness of the internal control systems to achieve the objective of optimal functioning of the Company. The scope of activities includes safeguarding and protecting the Companys assets against unauthorised use or disposition, maintenance of proper accounting records and verification of authenticity of all transactions.

The Company has an effective compliance management system, which gives preventative warnings in case of any violations. To ensure that it is in conformance with the overall corporate policy and in line with predetermined objectives, the independent Audit Committee and/or the Board of Directors regularly review the performance of the Company. The Companys Internal auditors are renowned M/s. S. H. Bathiya & Co. LLP during FY2018, to provide guidance in smooth functioning of risk management policies, building a organisation wide awareness of risks, across businesses and corporate functions; developing formal reporting and monitoring processes; building risk management maintenance plans that would keep the information updated and refreshed; deploying an ERM framework in key business areas and corporate functions; aligning risk management with the business planning exercise and aligning the role of assurance functions.

Human Resources

The domain knowledge and experience of the Companys Promoters and management team provides Sharda Cropchem with a significant competitive advantage as it seeks to grow in our existing markets and enter new geographies. The Company has hired qualified professional management and key personnel, which will enable the Company to run independently. The overall employee engagement has allowed the Company to retain the top talent within it.

Cautionary Statement

Statements made in the Management Discussion and Analysis describing the Companys objectives, projections, estimates, expectations may be "Forward looking statements" within the meaning of applicable securities laws and regulations. Actual results could differ from those expressed or implied. Important factors that could make a difference to the Companys operations include economic conditions affecting demand supply and price conditions in the domestic and overseas markets in which the Company operates, changes in the government regulations, tax laws and other statutes & other incidental factors.