Analysis: Sharda Cropchem Ltd

The current section of the “Analysis” series covers Sharda Cropchem Ltd, a trading company focusing on agrochemicals, conveyor belts etc. that has taken registrations for selling agrochemicals in many countries.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

To benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

Sharda Cropchem Ltd Research Report by Reader

Hello Dr Malik,

I am a big fan of your blog and I have learned a lot from your analysis. I have analyzed Sharda Cropchem Ltd. Please review and provide feedback. Thank you,

Abhijit Dutta

Financial Analysis:

1. a) Sales Growth – Sharda Cropchem Ltd had a consistent sales growth of YoY > 15% in the last 10 years except for FY2014 and FY2020 (1.6% and 0.27% respectively). Sales growth CAGR 10 Years: 16.34%, 7 Years: 17.17%, 5 Years: 14.41% and 3 Years: 11.97%
2. b) Profitability – Net profit margin (NPM) varies from 8% to 14% in the last 10 years.
3. c) Tax payout ratio has been above 25% in most of the years except FY2020 where it was just 11%.
4. d) Interest coverage ratio has always been high in the last decade.
5. e) Debt to equity ratio has always been minimal
6. f) Current ratio is 2.08, which is a healthy sign.
7. g) Cash flow: It has had a positive cash flow in the last 8 years. Total cash flow from operations (CFO) in the last 10 years is ₹1,546 Cr
8. h) Cumulative profit after tax (cPAT) ~ cumulative cash flow from operations (cCFO) – Cumulative CFO is little more than cumulative PAT in the last 10 Years.

Valuation Analysis:

• P/E ratio – 20
• PEG ratio – 2.68
• Earnings yield (EY) – 5%
• P/B ratio – 3.73
• Price to sales ratio (P/S) – 1.90
• Dividend yield (DY) – 0.75%

Business & Industry Analysis:

1. a) Comparison with industry peers: Sales growth is higher than peers)
2. b) Conversion of sales growth into profits – operating profit margin (OPM) is higher than sales growth.
3. c) Conversion of profits into cash – Past 8 Years: cPAT: ₹1,361 cr and cCFO: ₹1,546 cr
4. d) Creation of value for shareholders from the profit retained – 2 times (as of March 2021). However, if we calculate until date, then it would be 5 times.

Management Analysis:

1. a) Background check of promoters & directors – Nothing suspicious found.
2. b) Management succession plan – Ms Sharda Bubna and Ashish & Manish Bubna are actively engaged in the business for the last few decades. Therefore, a succession plan is in place.
3. c) Consistent increase in dividend payments – The dividend payout ratio fluctuates from 16% to 22%.
4. d) Promoter shareholding – 74.82%
5. e) Promoter buying the shares – A minimal share purchase by promoters in FY2020. Since promoters hold a maximum allowable percentage of shares, we can ignore this insider buying.
6. f) FII shareholding – 1.69%

Other Business Parameters:

1. a) Product diversification – A pure play. It is mainly in the agrochemical business. Non-agrochemical business is order based.
2. b) Govt influence – No govt influence

The margin of safety (MoS):

7. a) MoS in the purchase price – EY is 5% and 10-year G-Sec yield is 7.2%
8. b) Self-Sustainable Growth Rate (SSGR): SSGR was higher than the sales growth until FY2019. However, in the last 2 years, it has come down to 9-12%, which is almost the same as the 3-years sales growth CAGR. As a result, we are seeing some amount of increase in debt in FY 2018 and FY 2021.
9. c) Free Cash Flow – FCF/CFO ~ 22%

Credit Rating Analysis:

2017. a) Credit Rating History – CRISIL has assigned it a rating of A1+ since FY2017.

Thanks,

Abhijit Dutta

Dr Vijay Malik’s Response

Dear Abhijit,

Thanks for sharing the analysis of Sharda Cropchem Ltd with us! We appreciate the time & effort put into the analysis.

While analysing the history of Sharda Cropchem Ltd, an investor notices that over the years, the company had many subsidiaries both in India and overseas to conduct its business. As per the Q4-FY2022 results announcement, pages 3-4, on March 31, 2022, Sharda Cropchem Ltd had 41 subsidiaries.

We believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire company including its subsidiaries, joint ventures etc. The consolidated financials of a company present such a picture.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Therefore, in the case of Sharda Cropchem Ltd, we have analysed the consolidated financials of the company.

With this background, let us analyse the financial performance of Sharda Cropchem Ltd.

Financial and Business Analysis of Sharda Cropchem Ltd:

Sales of Sharda Cropchem Ltd have grown at a pace of 18% year on year from ₹778 cr in FY2013 to ₹3,580 cr in FY2022. Moreover, sales have increased every year since FY2013.

The operating profit margin (OPM) of the company has fluctuated within the range of 17% to 23% during this period with periods of declining OPM like FY2015 when the OPM decreased to 17% from 20% in FY2014 and FY2018-FY2020 when the OPM declined to 17% in FY2020 gradually from 23% in FY2017. During the same period, the net profit margin (NPM) of Sharda Cropchem Ltd decreased from 14% in FY2017 to 8% in FY2020.

To understand the reasons for the financial performance of Sharda Cropchem Ltd, an investor needs to read the publicly available documents of the company like its annual reports, conference calls, credit rating reports, and red herring prospectus (click here), as well as its corporate announcements. Then she would understand the factors leading to the increase in its revenue and the fluctuations in its profit margins as well as the reasons for the decline in profitability in certain periods.

After going through the above-mentioned documents, an investor notices the following key factors, which influence the business of Sharda Cropchem Ltd, which she needs to keep in her mind before making any predictions about the performance of the company.

1) No pricing power over its customers (distributors):

Sharda Cropchem Ltd sells off-patent (generic) agrochemicals. However, despite being off-patent, most of the market share of these agrochemicals is still with the innovator, large-multinational companies (MNCs). As per Sharda Cropchem Ltd, about 75% of the market share is held by large multinational innovator companies.

Due to the market dominance of MNCs, Sharda Cropchem Ltd has to sell its products at a discount to MNC products. The company does not have the power to price its products higher or equal to the prices of MNC products because then the customers would simply buy the products of MNCs.

Conference call, July 2018, page 6:

Ramprakash V. Bubna:…Sharda is a very small player in the entire international market. So, we cannot determine the prices, we have to follow. In most of the markets innovators are still having 70%-75%-80% of the market share…and after we get the registrations we follow the multinational. We offer a price of about 10% to 15% as a discount to the multinational

Conference call, May 2021, pages 4-5:

Ramprakash V. Bubna:…we do not decide our selling prices independently on our own. We are only following the footsteps of multinationals…we cannot increase the prices beyond certain limits because we cannot exceed the prices of the multinational. The market always gives preference for the multinationals

Due to this lack of pricing power, Sharda Cropchem Ltd suffered significantly during FY2018-FY2020. The cost of its raw material was increasing due to supply chain disruptions in China; however, it was not able to increase prices to its customers. This is because the MNCs did not want to lose market share and refused to increase the prices of their products.

Conference call, May 2017, pages 8-9:

Rohan Gupta:…we have been able to pass on to the end customer or not?

Ramprakash V. Bubna: Not in all the cases…Because we are to follow the footsteps of the multinationals and multinationals are also very conscious of not losing their market share and they do not pass and they do not increase

During FY2018-FY2022, Sharda Cropchem Ltd suffered a lot of pressure on its profit margins because despite increasing costs, the MNCs instead of increasing their prices, decided to decrease them to maintain their market share.

Conference call, January 2021, page 11:

Ramprakash V. Bubna:…They are not increasing their prices…even at making a loss or no profit situation, they continue to choose their prices downwards rather than upwards. These are very strange situation, but it is a fact.

While listening to the management of Sharda Cropchem Ltd, the frustration of the company clearly comes out due to its lack of pricing power and near-total dependence on MNCs for its pricing.

Conference call, October 2018, page 6:

Ramprakash V. Bubna: Sir this is very unfortunate. Innovators are not increasing. I was travelling to some country last week and I am told by my customers that companies like Syngenta and BASF they are trying to reducing the prices, which is very discouraging…I cannot understand why. I am sure they are also taking a big hit, but then that is their strategy and our strategy is purely a followup on their strategies.

Therefore, an investor is not surprised to see that the operating profit margins of Sharda Cropchem Ltd declined significantly from 23% in FY2017 to 17% in FY2020. The biggest role in this decline was of the European market where due to the refusal of MNCs to increase prices, its profit margins declined from 45% to 30%.

Conference call, October 2019, page 12:

Chetan Thakkar: Europe gross margins that you mentioned, earlier we used to operate at 40% to 45% range, it has now shifted to 30%, so is it purely on account of higher raw material cost or there is some pressure on pricing also?

R V. Bubna: Sir, it is both put together, the pricing is not increasing there, unfortunately because of the approach of multinational companies and on the other side the costs are going up, so that is impacting the gross margins.

As a result, an investor would appreciate that even though Sharda Cropchem Ltd is among the few generic players holding registrations for any molecule in these markets, still, the pricing power is in the hands of innovators/multinational companies who continue to hold about 75% market share.

In fact, at times, the MNCs buy active ingredients (AI) for their final products from the company at a cheaper price and then give Sharda Cropchem Ltd strong competition in its target markets.

Conference call, October 2020, page 7:

Ramprakash Bubna: The AIs have increased in the last year or before last year mainly because of the demand from many multinational companies who were not able to secure the AIs on their own and we were able to supply them at competitive prices

Therefore, the pricing and business strategy of Sharda Cropchem Ltd is highly dependent on the large MNC competitors.

Further advised reading: How to do Business Analysis of Agrochemical (Pesticide) Companies

2) Sharda Cropchem Ltd works mainly with smaller distributors:

The market situation faced by Sharda Cropchem Ltd is such that the large distributors do not encourage generic players. This is because the MNCs provide them with many financial incentives, which makes it difficult for smaller generic players like Sharda Cropchem Ltd to convince them to stock their products.

In FY2018, Sharda Cropchem Ltd attempted to break into large distributors; however, they asked for low prices, which hit the profit margins of the company.

Conference call, July 2017, page 7:

Conrad Fernandes:…we have started being little more aggressive and proactive. We were finding that the potential is very huge, only if we are able to match up the price requirements to the distributors…So we have changed our approach to this extent that we have become more aggressive at the cost of the margins

Nevertheless, its attempts did not seem to succeed and it communicated the challenging situation to its shareholders in June 2020. The company found that large distributors are content with the business from MNCs and do not eagerly await the business from smaller players.

Conference call, June 2020, page 14:

R.V. Bubna: Opening the door for the distributors it is not so easy Sir, because most of the distributors are fairly well off, multinational companies reward them …We have to push ourselves into their office, they do not come to us and then they are not so much dependent upon small molecules or small companies, multinationals take care of them.

Another challenge that Sharda Cropchem Ltd faced while dealing with distributors was that the large MNCs were willing to give them extended credit periods without pushing them to make payments, which small companies find difficult to match.

Conference call, October 2019, page 10:

Ramprakash V. Bubna: The MNCs are not very keen and they do not press the customers for the payments and are very liberal, they give very liberal extensions and on the contrary, smaller companies like us, we are having pressure on cash flow so we put the pressure on them to make the payments

Moreover, Sharda Cropchem Ltd also realized that it could not match the MNCs in terms of very long credit periods to distributors even if it wants to. This is because Sharda Cropchem Ltd being an Indian company is not allowed to give very long credit periods.

Conference call, January 2020, page 16:

R.V. Bubna: No, we cannot match with them because they are in a different atmosphere, we have lot of regulations and we have to comply with our regulations in India. So we cannot give very long credit even if we feel that the customer is safe.

Therefore, Sharda Cropchem Ltd is caught in a difficult situation where it is not able to get a large opportunity with big distributors as the MNCs have created strong barriers due to their existing relationships with them.

An investor may estimate the restrictions faced by Sharda Cropchem Ltd in the business environment when she gets to know that in the USA, the big 4 distributors hold about 75% of the market share. The generics companies are only fighting for the remaining 25% share.

Conference call, January 2020, page 11:

R.V. Bubna: …somehow the market is very complicated. The big four distributors control more than 75% market and the generics are fighting for the balance 20%-25% market share.

Therefore, when any investor estimates the future growth of Sharda Cropchem Ltd, then she should keep in her mind the difficult distribution situation present in its key markets of Europe and North America.

3) Almost complete dependence on China for its business:

China is the world’s largest agrochemical producer and supplies about 75% of the world’s demand for agrochemicals.

Conference call, January 2017, page 14:

Ramprakash V. Bubna:…I think China is meeting the demands of more than 75% of the world agrochemical demands.

Sharda Cropchem Ltd sources more than 95% of its material from China and is almost completely dependent on it. As per the company, there is no alternative to sourcing from China. India does not produce even half of the chemicals required by Sharda Cropchem Ltd. Moreover, the price of Indian producers is not as competitive as the prices of Chinese producers. Therefore, it is either source material from China or stop doing business altogether.

Conference call, October 2020, page 7:

Ramprakash Bubna: At present, that alternative does not exist. The local industries are not able to produce the quantities that are required for the international market and also the product mix. Our portfolio is much bigger not more than 45% of those are not manufactured in India, so we have to either not supply or supply it from China.

Conference call, June 2015, page 17:

R. V. Bubna: …the Indian prices are not as competitive as Chinese in terms of dollars.

During one interaction, the company intimated to the shareholders that for a few chemicals, China alone has a manufacturing capacity, which is much larger than the entire world’s demand.

RHP, September 2014, page 115:

There is also an excess of capacity for agrochemicals in China. For example, China now has 60 companies registered to manufacture imidacloprid with a total capacity of 25,000 tons of AS, however actual output in 2009 in the region of 12,000 tons with 8,000 tons exported for a world market of 18,000 tons.

As a result, in the rest of the world, not many agrochemical-manufacturing capacities have developed in the last few decades.

Conference call, July 2018, page 4:

Ramprakash V. Bubna: See, those alternatives do not exist in our opinion as of now. China is the factory to the world and everybody is sourcing from China. There are no new capacities or new alternatives in terms of hardware that has been added significantly in the last 10-15 or 20 years.

As there are no other alternatives for sourcing agrochemicals when the Chinese govt. started its crackdown on the industry to control pollution, then there was a shortage of agrochemical raw material and Sharda Cropchem Ltd faced significant cost pressure as well as challenges in availability of material.

Conference call, January 2018, page 6:

Ramprakash V. Bubna: See today it is a sellers’ market so increasing the quantity does not excite the supplier because he is already stressed up with his and he has more demands than what he can produce.

The situation was further complicated by the fact that Sharda Cropchem Ltd had not entered into any long-term supply arrangement with its suppliers. It deals with both its suppliers as well as customers on a transaction-to-transaction basis.

Conference call, June 2015, page 25:

R.V. Bubna: No, we don’t enter into any supply agreement, we negotiate them with them from order to order basis because this is to our advantage.

The company avoids long-term supply agreements with its suppliers because it thinks that in a long-term agreement it would have to accept delivery of products even if its customers’ demand declines due to poor weather etc. The company fears that in such a situation, it would be stuck with unsold inventory.

Conference call, June 2015, pages 25-26:

Gautam Arora: Also I would be put at a disadvantage if I enter into long term supply arrangements with supplier because the products that we deal in are very sensitive to weather conditions across the globe so in case I have any kind of a tie up for specific volumes to be picked up from my supplier and the weather turns bad in a particular region then I will be tied down with this inventory and with nowhere to go.

However, such a strategy relies on everything being normal in the entire supply chain. During FY2018-FY2020, when the Chinese govt. came down heavily on polluting industries, which disturbed entire Chinese production, then this strategy of only doing spot buying hurt Sharda Cropchem Ltd. This was because it had to accumulate excess inventory that too at higher prices and it had no other alternative.

Moreover, once registration is granted, then it becomes difficult for Sharda Cropchem Ltd to change the supplier country because it has already mentioned China as the supplier country in the registration application form.

Conference call, October 2019, page 7:

R V. Bubna: If Sharda wants to import the product from any other country, it is being prohibited by the registration law. As per the registration rules, we have to source the products only from the registered source, which is declared in our registration application or registration document and this is applicable to every supplier in USA.

In addition, once a source country is finalized in the registration, then it becomes difficult to change it later on because, at times, it may involve repeating the entire trial. Moreover, in almost all cases, changing/adding a new supplier is a time-consuming process.

Conference call, October 2019, pages 10-11:

Vishnu Kumar:…how easy is it for you to add another supplier let us say coming from India or some other countries

R V. Bubna:…in Europe, it is not so easy, it does take time, in USA, it is possible to add that process is not so lengthy, but it takes time there also.

Vishnu Kumar: Is it costly or is it like just a procedural aspect we are going to spend too much money.

R V. Bubna: In some countries we may have to repeat the trials then it becomes costly, other countries if they accept the laboratory results then it is not so costly…

Therefore, Sharda Cropchem Ltd is almost completely dependent on China without any alternative.

Conference call, October 2019, page 13:

R V. Bubna: We have to depend upon China, and it is very difficult to find an alternative.

As a result, when the Chinese supply chain faced challenges, then the complete dependence of Sharda Cropchem Ltd on China affected its costs, which coupled with its inability to increase prices to its customers, hurt its profit margins during FY2018-FY2020.

FY2018 annual report, page 36:

Gross margins and EBITDA margins (excluding foreign exchange impact) were marginally lower at 33.2% and 20.2% respectively on account of higher procurement cost and supply constraints in China due to the clamp on manufacturers in view of environment issues.

Advised Reading: How to study the Annual Report of a Company

4) Vulnerability to foreign exchange fluctuations:

Sharda Cropchem Ltd does almost its entire business in overseas locations where it sources most of its material from China and sells it primarily in Europe, North and Latin America and a bit in the rest of the world.

Almost all of its purchases from China are in US Dollars (USD) whereas the majority of its sales are from Europe, which is in Euro (EUR). Therefore, Sharda Cropchem Ltd is highly vulnerable to the movement of the Euro and USD relative to each other.

The dependence of Sharda Cropchem Ltd on the EUR/USD is such that during FY2015 when the Eurozone was under crisis and the value of the Euro declined significantly, then its profit margins were impacted significantly. The OPM of Sharda Cropchem Ltd declined from 20% in FY2014 to 17% in FY2015.

Conference call, June 2015, page 3:

Gautam Arora: Gross margins as a percentage of total income from operation in the fourth quarter ended March 2015 was at 34.84% and the same was lower as compared to 39.60% in the fourth quarter of the previous finical year, decline of 476 basis points. Primarily due to depreciation of the Euro against the dollar during this period.

The company is not able to escape this dependence on the volatility of EUR/USD because the Chinese suppliers quote their prices in USD. When Sharda Cropchem Ltd requested the Chinese suppliers to accept payments in Euro, then they quoted an exchange rate, which was not good for the company.

Conference call, November 2015, page 12:

Gautam Arora: No normally the sourcing in China is in US dollars. Some suppliers after lot of pursuance can accept sourcing currency to Euros but no other currencies and even that they want to use a very favorable exchange rate to their advantage.

Moreover, as the business of Sharda Cropchem Ltd is in foreign countries where its customers also have to convert their local currencies into US Dollars (USD) to make payments to the company; therefore, whenever, the local currencies of its customers decline in value against USD, then the company faces trouble. This is because with the devaluation of the local currency, the agrochemicals sold by Sharda Cropchem Ltd become costly for the customers, as they had to pay more local currency to buy the same number of USD. As a result, the purchasing ability of the customers decrease and they start asking for discounts from Sharda Cropchem Ltd, which hurts its business.

Conference call, February 2016, page 9:

Ramprakash V. Bubna: Sir not only LATAM, all the countries where the currencies have devaluated even in say Canada, Mexico, South Africa we have to take the price reduction.

As a result, the volatility of cross currency pairs is one of the key risks highlighted by the company to its investors.

Conference call, January 2019, page 13:

Ramprakash V. Bubna: One of the biggest risk factors for our business is the cross currency foreign exchange rate, Euro versus US Dollars, Canadian Dollar versus US Dollars and some of the European currencies and the Central American currencies versus US Dollar

An investor should always keep this risk in her mind whenever she analyses Sharda Cropchem Ltd.

5) The demand for agrochemicals is seasonal and cyclical:

The agrochemicals sold by Sharda Cropchem Ltd are relevant for specific crops/pests etc.; therefore, their demand peaks up during the season when a particular crop is grown. As a result, the business performance of Sharda Cropchem Ltd is seasonal. The Jan-March (Q4) is usually the best quarter for the company followed by April-June (Q1) and July-Sept (Q2). The Oct-Dec (Q3) quarter is the weakest quarter in its business performance.

Conference call, May 2018, page 4:

R. V. Bubna: See our business is a seasonal business, and this has been the practice for the last 8 to 10 years. But the Q4 is the best quarter for our business, Q1 is the second best, Q2 is the third best and Q3 is the weakest

One problem in a highly seasonal business is that if the company is left with an unsold inventory of any chemical, then it has to wait for almost 8-9 months for the next season before it can sell it. Therefore, if there is any problem in inventory sourcing/logistics and the products arrive late in the season, then the company is stuck with inventory for a long time.

Conference call, May 2017, pages 16-17:

Ramprakash V. Bubna: …it does take time to get rid of the inventories in agrochemical business these are seasonal businesses for some reason because of the weather or any other impact there has been a less demand, the companies are compelled to carry their inventory forward and then the next time is possibly after six or eight months.

The company faced this issue in FY2019 when due to supply chain issues in China, its suppliers delayed sending the products and it was saddled with unsold inventory.

Conference call, May 2019, page 5:

Ramprakash V. Bubna: Mr. Resham, last year has been a little bit of an aberration because of very difficult situation in China and late deliveries by the suppliers. So by the time we shift the goods and landed in the various regions, it was bit late for that season. So we are left with the lot of unsold inventories.

When a company has unsold inventories from the previous season, then it carries the risk of inventory losses because of the volatility in the product prices.

Apart from regular seasonality, the sale of agrochemicals is also cyclical in nature due to its high dependence on weather, monsoon, soil conditions, drought etc., which lead to periods of good harvest followed by poor harvests and vice versa. These factors make the demand for agrochemicals unpredictable.

FY2016 annual report, page 25:

agrochemical business is primarily dependent on appropriate weather conditions. Weather conditions are cyclical in nature and dependent on factors such as amount of rainfall, varying soil conditions, climatic conditions, varying seasons and temperature changes. These factors make the overall performance of the agricultural sector unpredictable.

The unpredictability of demand affected Sharda Cropchem Ltd multiple times; however, the most severe was in Q2-FY2019 when the company reported a loss. As per the company, reduced demand due to adverse weather was the key reason for losses.

Conference call, October 2019, page 3:

R V. Bubna: The main reason has been adverse weather factor. In NAFTA region, the winter was very much extended which has resulted into contraction of the spring season and application of agrochemicals. Similarly, in Europe region also there was some adverse weather

In FY2016, the entire global agrochemical industry witnessed a decline contributed by adverse weather conditions including a weaker monsoon due to El Nino.

FY2016 annual report, page 21:

The global agrochemicals market declined by 8.6% YoY to US$51.8 billion at the distributor level in 2015 driven by…variable weather patterns including a weak monsoon as a result of the El Nino phenomenon. Crop protection sales in almost all regions declined, with the deepest falls occurring in Europe and Latin America.

Once again, in 2019, the global agrochemical industry declined due to adverse weather conditions.

FY2020 annual report, page 19:

global market for crop protection products contracted by 0.8% to US$59.8 billion in 2019 owing to extreme global weather conditions from severe flooding in North America to dry conditions and drought across major areas of Europe and the Asia Pacific.

Therefore, an investor should always remember that the business of Sharda Cropchem Ltd is dependent on weather conditions and would contain an element of unpredictability. She should keep it in her mind before assigning any certainty to her projections about its future performance.

Advised reading: How to analyse New Companies in Unknown Industries?

6) Agrochemicals industry shows the potential of only moderate growth:

Agrochemicals are known to enter the food chain and affect all consumers. Therefore, there are continuous studies to assess the harmful impacts of agrochemicals on humans, other animals and the environment. This leads to a frequent ban on various agrochemicals, which has become a routine practice in the industry.

In May 2022, Sharda Cropchem Ltd also intimated to its shareholders that a ban on the products is a very normal occurrence in the agrochemicals industry and investors should not be surprised by it.

Conference call, May 2022, page 16:

Ramprakash V. Bubna: it is a normal process, the process of banning will continue because as and when the product becomes older the technical experts find some weaknesses in those products which affect the quality of the application on the agri products and they are slowly getting banned

To reduce the harmful impacts due to the use of agrochemicals, nowadays, research is driven towards genetically modifying seeds/crops in such a way that they do not need agrochemicals for a good harvest. As a result, after the introduction of GM crops, the agrochemicals industry witnessed a long-term decline, which was evident from 1998 to 2006.

RHP, September 2014, page 46:

Following the initial introduction of GM crops in 1996, the market experienced a period of decline in real terms between 1998 and 2006. This reflected the increase in uptake of GM technology, particularly in North America and Latin America where a rapid switch to crop varieties containing traits conferring glyphosate tolerance and insect resistance led to declines in selective herbicide and insecticide applications

Genetically modified (GM) seeds have achieved a significant share in some key crops like cotton, corn and soybeans.

FY2015 annual report, page 11:

As of 2013, GM seed weightings in the US have reached 90% for corn, 90% for cotton, and 93% for soybeans.

Therefore, an investor should note that due to the harmful effects of the use of agrochemicals on the food chain and environment, there would be frequent bans on products and in general a trend to reduce their use in the crops. She should have an open mind while projecting the demand for agrochemicals in the future.

Overall, Sharda Cropchem Ltd seems to be highly dependent on MNCs for its pricing and China for its sourcing. It does not seem to have any pricing power over its counterparties. The business is exposed to seasonality, cyclicity, vagaries of nature/weather as well as the movement of foreign exchange. An investor must assess all these aspects in her analysis of Sharda Cropchem Ltd.

Over the years, the tax payout ratio of Sharda Cropchem Ltd has been in the range of standard corporate tax rate except in a few instances where the payout ratio was low because of the business conducted by the Dubai subsidiary, which is in a tax-free zone.

Conference call, November 2015, page 7:

Ramprakash V Bubna: The effective tax rate, the only thing that we can off hand guess is that may be last year the volume on our subsidiary in Dubai that have been higher where there is no tax liability

Sharda Cropchem Ltd reported a low tax payout ratio of 11% in FY2020, which was primarily due to choosing the new corporate tax rate for its deferred tax liabilities.

FY2020 annual report, page 185:

Company has applied the lower income tax rates on the deferred tax assets / liabilities to the extent these are expected to be realised or settled in the future period when the Company may be subjected to lower tax rate and accordingly reversed net deferred tax liability of INR 3,522.84 lakhs.

As per the company, it may continue with the old tax rate regime for a few more years until it exhausts its minimum alternate tax (MAT) credit entitlements.

Conference call, June 2020, page 14:

R.V. Bubna: Not for the next two years because we have a lot of minimum alternative tax (MAT)to be recovered for which we have credit entitlement. So, we will not adopt the new tax regime atleast for the next one or two years.

Operating Efficiency Analysis of Sharda Cropchem Ltd:

a) Net fixed asset turnover (NFAT) of Sharda Cropchem Ltd:

Sharda Cropchem Ltd follows a very asset-light business model where it focuses only on getting the registrations/approvals to sell agrochemicals in different countries. The company has completely avoided investing in any manufacturing or R&D facility. Its business model involves taking registrations for off-patent agrochemicals and then sourcing them from outside third parties in countries like China and then selling them into its target markets.

Therefore, it is primarily a trading company with the rights to sell agrochemicals in different countries.

FY2017 annual report, page 77:

The Company does not conduct any manufacturing activity and is a trading company

Net fixed asset turnover (NFAT) does not provide any significant insights for such a trading business, which does not depend on fixed assets for its sales.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio of Sharda Cropchem Ltd:

The inventory turnover ratio (ITR) of Sharda Cropchem Ltd has declined from 9.1 in FY2013 to 5.0 in FY2022. A declining ITR indicates that the inventory utilization efficiency of the company is declining over the years.

The ITR witnessed a sharp decline over FY2017-FY2018 when it reduced to 4.2 in FY2018 from 8.2 in FY2016. The company increased its inventory in FY2017 in anticipation of high sales as it had received new registrations in the USA.

Conference call, May 2017, page 4:

Ramprakash V. Bubna: We have received number of new registrations in United States of America and we wanted to prepare ourselves with sufficient inventories because in many of these countries when they give the order they want the product yesterday. This has built up the inventories and we are very happy

However, the inventory levels continued to stay high and did not come down even in the next 6-months. The company stated that it is now accumulating inventory as there are supply disruptions in China and the prices are increasing every week. It said that in the previous 3-months, the prices of its raw material had risen by 50%.

Conference call, October 2017, pages 7-8:

Ramprakash V. Bubna: The uncertain situation in China, we have been predicting that Chinese prices will go up and the Chinese prices are going up every week. We are trying to cover and there is no availability of the product. So we are very happy with the strategy.

Ramprakash V. Bubna: We will be in a better position compared to competition, who would be buying in the normal course only. The prices have gone up by 50% in the last three months.

Moreover, the company was also forced to buy excess inventory at a high price because due to its strategy of remaining a completely trading company, it had lost control of its supply chain. The crackdown of the Chinese govt. on polluting industries had disrupted the supplies of agrochemical. Chinese suppliers were taking 3-4 times more to ship the goods. If Sharda Cropchem Ltd had to meet its customers’ expectations, then it did not have any other option but to buy goods at a high price.

Conference call, January 2018, page 5:

Ramprakash V. Bubna: we are increasing the level of inventories keeping in mind the time lag or delay in the supplies from China. Earlier we used to get the products shipped within two to three weeks of our order. Today it takes about one and half to two months.

The company seemed very happy with its strategy of accumulating excess inventory. However, carrying excess inventory exposes companies to write-downs when prices fall. This risk is increased in the case of agrochemicals, whose sales are seasonal in nature and a company is stuck with unsold inventory for 6-8 months during which time, the prices can be very volatile.

Within a year, Sharda Cropchem Ltd faced the risks of excess inventory and suffered a drop in its profit margins as it had accumulated inventory at high prices whereas now the prices had come down.

Conference call, October 2018, page 8:

Rohan Gupta: Actually, rather than we benefiting from the inventory gain, we actually have lost

Ramprakash V. Bubna: I will not say we have had a loss. We had lesser margins.

Advised reading: Why We cannot always Trust What Management Claims

In FY2019, the company had to write off about ₹4.28 cr of inventory (FY2019 annual report, page 177).

The effect of inventory buildup was also seen in FY2020 when players were trying to get rid of the inventory even at lower prices.

Conference call, January 2020, page 5:

R.V. Bubna: I would say an element of frustration on the part of many players who want just to get rid of their stocks at beaten down the prices.

In FY2020 as well, the company had to write down some of its inventory.

Nevertheless, the business model of Sharda Cropchem Ltd is such that it has to keep a lot of inventory as it has obtained many registrations, which it claims to supply. As a result, to meet customers’ expectations of immediate delivery, the company ends up maintaining an inventory of a large number of products. Otherwise, it would lose its customers.

Conference call, August 2020, page 13:

R.V. Bubna: Most of our customers in North America, if they want a product they want it immediately and if you tell them that the goods are in transit and it will be coming after a week then they do not call up next time and they get it from somebody else.

As a result, to keep an inventory of numerous agrochemicals, the company ends up having a large inventory with itself, which makes its business working capital intensive.

Credit rating report by CRISIL, July 2021:

Working capital-intensive operations: Sharda group’s working capital requirement is typically higher than that of its peers because of wide product portfolio and geographic reach. Inventory is large due to numerous stock-keeping units and seasonality in the geographies that the group operates in.

Going ahead, an investor should keep a close watch on the inventory utilization efficiency of Sharda Cropchem Ltd to understand if it is able to bring any improvement in the same.

Further advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Sharda Cropchem Ltd:

Receivables days of Sharda Cropchem Ltd have improved from 180 days in FY2013 to 138 days in FY2022. Even though in FY2022, receivables days have declined to 138 days; however, over most of the last 10-years, the receivables days have been in the range of 155 to 170 days, which is high.

From the above discussion on the business analysis of Sharda Cropchem Ltd, an investor would remember that the key competitors of the company, which are MNCs, give very liberal credit periods to the distributors. As a result, generic companies like Sharda Cropchem Ltd also need to provide the longest possible credit period to their distributors; otherwise, the distributors would source all of their requirements from MNCs.

In addition, especially the business done by Sharda Cropchem Ltd in Latin American (LATAM) countries exposes it to significant delays in receivables collection. This is because the economies of most of the Latin American countries are stressed by high inflation and declining currencies. As a result, the customers in LATAM countries ask for a long credit period and then delay payments further.

The company intimated to its shareholders that in LATAM and Mexico, the credit period for collection is about 240 days.

Conference call, August 2015, page 19:

Gautam Arora: So Europe is roughly about 135 days, US is close to about 90-100 days, NAFTA and LATAM is close to about 240-odd days

As per the credit rating agency, CRISIL, outstanding receivables in LATAM countries make its business model working capital intensive.

Credit rating report by CRISIL, July 2021:

Working capital-intensive operations:…Additionally, there are substantial receivables from certain overseas markets, especially Latin America.

In fact, during FY2018, the working capital requirements of Sharda Cropchem Ltd increased so much that it had to urgently take unsecured loans from its promoters.

Conference call, May 2018, page 6:

R. V. Bubna: See this is only because we don’t have any borrowings in the company. So, this is only to meet the temporary requirement of working capital which has been inflated due to inventories and receivables…the funds have come from the promoters, which came in at a notice of one or two days.

The working capital requirements of the company increased so much that in FY2019, the company reduced its investments in filing registrations so that it could spare money to fund its working capital.

Conference call, July 2018, page 16:

Resham Jain: Is there any flexibility for us to reduce some of the CAPEXs to ease out the working capital requirement that is what I wanted to understand?

Ramprakash V. Bubna: That is the strategy exactly which we have been working on.

In FY2019, Sharda Cropchem Ltd reduced its expenditure on registrations to about ₹105 cr from ₹214 cr in FY2018.

The situation of a long credit period to customers by Sharda Cropchem Ltd becomes risky because most of its receivables are not backed by sureties like a letter of credit or bank guarantees.

RHP, September 2014, page 25:

majority of our agrochemical and non-agrochemical sales are not supported by letters of credit or bank guarantee.

In the past, after facing challenges in the collection of receivables from LATAM countries, the company had done a course correction and reduced its business there.

Conference call, July 2017, page 6:

Ramprakash Bubna: We will be mainly focusing on US and Europe. LATAM countries are not very comfortable in terms of their economies and the receivables are also under pressure.

However, as per the recent disclosures, Sharda Cropchem Ltd again intends to increase its exposure to LATAM countries.

Conference call, October 2021, page 11:

Ashok Vashisht: The major focus earlier was on Europe. Now we have been putting equal focus on NAFTA and Latin America regions as well.

Going ahead, an investor should keep a close watch on delays in receivables beyond 6-months and the write-off of bad debt to assess whether Sharda Cropchem Ltd is able to collect its money on time.

Further advised reading: Receivable Days: A Complete Guide

When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Sharda Cropchem Ltd for FY2013-2022, then she notices that over the years (FY2013-FY2022), the company has converted its profit into cash flow from operations.

Over FY2013-22, Sharda Cropchem Ltd reported a total net profit after tax (cPAT) of ₹1,794 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹1,813 cr.

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than the PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Learning from the article on CFO will indicate to an investor that the cCFO of Sharda Cropchem Ltd is higher than the cPAT due to the following factors:

• Depreciation expense of ₹903 cr (a non-cash expense) over FY2013-FY2022, which is deducted while calculating PAT but is added back while calculating CFO.

The Margin of Safety in the Business of Sharda Cropchem Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it can convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

An investor may calculate the SSGR using the following formula:

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• SSGR = Self Sustainable Growth Rate in %
• Dep = Depreciation rate as a % of net fixed assets
• NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
• NPM = Net profit margin as % of sales
• DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

SSGR estimation depends significantly on net fixed asset turnover (NFAT). However, in the case of Sharda Cropchem Ltd, which is a pure trading company without any manufacturing facility, NFAT is not a very significant parameter. Therefore, while analysing the business of Sharda Cropchem Ltd, SSGR does not provide best of the results.

Therefore, an investor should focus on the free cash flow (FCF) analysis of Sharda Cropchem Ltd.

b) Free Cash Flow (FCF) Analysis of Sharda Cropchem Ltd:

While looking at the cash flow performance of Sharda Cropchem Ltd, an investor notices that during FY2013-FY2022, it generated cash flow from operations of ₹1,813 cr. During the same period, it did a capital expenditure of about ₹1,517 cr.

Therefore, during this period (FY2013-FY2022), Sharda Cropchem Ltd had a free cash flow (FCF) of ₹296 cr (=1,813 – 1,517).

In addition, during this period, the company had a non-operating income of ₹122 cr and an interest expense of ₹105 cr. As a result, the company had a total free cash flow of ₹313 cr (= 296 + 122 – 105). Please note that any capitalized interest is already factored in as a part of the capex deducted earlier.

Sharda Cropchem Ltd has used this money primarily to pay dividends to its shareholders.

Going ahead, an investor should keep a close watch on the free cash flow generation by Sharda Cropchem Ltd to understand whether the company continues to generate surplus cash from its operations.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of Sharda Cropchem Ltd:

On analysing Sharda Cropchem Ltd and after reading annual reports, RHP, its credit rating reports and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

1) Registration requirements prove to be a strong entry barrier for companies:

Sharda Cropchem Ltd has stated in multiple disclosures that its key business strength is its registrations/approvals in different countries. As per the company, getting registration is a costly and time-consuming process where the outcome is very uncertain.

Even if a company invests a lot of money to gain registrations, then it may not get an appropriate value if it decides to exit the business by selling the registrations.

Conference call, October 2021, page 17:

Ramprakash V. Bubna: Mr. Sonal please understand that the process of registrations requires a lot of patience and a heavy amount of capital and a lot of time. These three factors reduce the competition very considerably…The risk involved in the intangible asset registrations is very high and uncertainty of getting any value if they want to get out

Another factor related to the registration process, which is very time consuming is getting access to the laboratory & field studies’ data related to the product that a generics company wants to register. Either the company can conduct fresh laboratory tests and field trials, which would be very expensive and time-consuming or it can purchase data from someone else who already owns it. Most of the time, these data owners are the innovators, the large MNCs.

Therefore, to save on time, the generics companies purchase the data from the data-owners and use it in their registration application. In return, the generics companies pay data compensation charges to the data owners. However, gaining access to the data is not a simple and quick negotiation.  At times, these negotiations with the data owners can take even up to 12 years.

Conference call, May 2019, page 12:

Ramprakash V. Bubna: As I told you for some molecules it took us about 11 to 12 years to complete the negotiation. In some of the cases we did in a matter of 1, 2 to 3 years. It all depends how fast the data owner responds to our reply and how our experts and data owner experts have time to meet and progress the negotiation.

Therefore, an investor may appreciate how uncertain and prolonged a registration process can be.

Moreover, in key European markets like Germany, the success rate of getting a registration even for a seasoned player like Sharda Cropchem Ltd is very low.

Conference call, July 2017, page 10:

Ramprakash Bubna: in Germany the things are very difficult. Our rate of success of registrations in Germany is very, very low.

Moreover, nowadays, the cost of registrations is going up because the governments have started looking at them as a revenue-generating activity.

Conference call, October 2020, page 11:

Ramprakash Bubna: The cost of registrations is exponentially high. The government authorities, the sourcing authorities, who used to charge nominal fees, they now started at looking some more kind of profits in these regions because they feel the operators and players in the market are getting profits then why not the government

In fact, Sharda Cropchem Ltd has mentioned the increasing cost of registrations as one of the key reasons for a decline in ratios like return on equity.

Tushar Sarda: What steps are we taking to address the reason for decline in the ROCE and ROE?

Ramprakash Bubna: The reasons are increase in the capex and surge in the cost of registrations.

As a result, registrations become a critical entry barrier for new companies.

RHP, September 2014, page 50:

the process of preparing dossiers and seeking registrations is fairly time consuming. In addition, capital investment required for preparing dossiers and seeking registrations is also a critical entry barrier for a generic agrochemical company.

An investor learns about the difficulties in obtaining registrations when Sharda Cropchem Ltd intimated to its shareholders that it has decided not to renew the registration of Quizalofop-Ethyl in Europe. This agrochemical was a very profitable product for the company bringing in revenues of about EUR 1.5 million per year. However, looking at the challenges in obtaining the registration, Sharda Cropchem Ltd decided that it would be too much of an effort and the company would be better off pursuing other opportunities.

Conference call, July 2017, pages 8, 9:

Ramprakash Bubna: We lost one registration of Quizalofop-Ethyl, which was selling very well with good margins. This registration was open through some me-too registration based on some registration in other country. The original registration was expired and we also lost that registration…The cost of investment on this molecule would have been very high and it is not just a question of spending, it also is a factor of time. If we renew it, it will take us at least three, four years to generate all the data

Ramprakash Bubna: Well it must have generated about 1.5 million Euros approximately

The instance of Sharda Cropchem Ltd giving up on a significantly profitable product because the renewal of its registration would be a highly cumbersome & time-consuming process tells an investor that the process of registration is a real entry barrier for generic agrochemical companies.

In fact, the difficulty in obtaining registrations becomes a benchmark for the profit margins earned by the agrochemical companies in different geographies.

The registration process is the most difficult in Europe; therefore, companies earn maximum profit margins in Europe. This is followed by North America and then Latin America and the rest of the world.

Conference call, May 2022, page 12:

Ramprakash V. Bubna: See in the financial year 2022 the gross margins in Europe is 35.7%, NAFTA 29%, LATAM 15.4% and rest of the world 22.6%.

In fact, when different countries in Latin America and the Rest of the world relaxed their registration requirements, then the increased competition made these markets non-attractive for Sharda Cropchem Ltd. As a result, the company reduced its focus on these markets.

Conference call, May 2022, page 4:

Ramprakash V. Bubna: You see the rest of the world is getting slowly and slowly less important for us because the registrations barriers are not so strong and the margins are less and it requires an equal amount of efforts so it is receiving lesser attention from us.

Conference call, July 2017, page 4:

Sumant Kumar: The third question is the revenue declined by 16.8% in LATAM region

Ramprakash Bubna: There the registration process is getting little simpler and more competition is entering the field

Therefore, the tough process of obtaining registrations for agrochemicals is acting as a good entry barrier and a source of decent profit margins for the industry in key geographies.

In fact, the tough process of obtaining the registration motivated Sharda Cropchem Ltd to focus solely on registrations and getting other approvals and remove its entire focus from manufacturing. The company now operates as a completely trading company that has approvals for selling multiple products in different countries.

As per the company, outsourcing entire manufacturing saves it from being tied to any particular product. The company wants to keep its business highly flexible and does not want to be in a situation where it has to manufacture a product even if there is no demand for the same. In case, the demand for any one product declines or is banned altogether, then Sharda Cropchem Ltd wants to quickly move over to other products, which have a strong demand instead of being stuck with a plant manufacturing a product that no one wants to buy.

Conference call, June 2015, page 24:

Gautam Arora:…most of the other serious player in the market are also manufacturers of these products so they would largely want to focus on those products which they have a manufacturing capability for because they would like to recover the plant overheads by way of getting registrations for these products. Now, players like us who don’t have any manufacturing capabilities of our own have a strong operating leverage here because we are not tied down to any one particular product nor are we under any kind of a compulsion to sell any kind of a product if its’ a loss making product we can always pick and choose those products which we want to deal in.

Sharda Cropchem Ltd could take such a strategy of outsourcing entire manufacturing and instead specialize in getting registrations only because the registration process is very cumbersome and acts as an entry barrier.

As per the company, the manufacturing process is the least value-adding step in the entire agrochemical value chain. Most of the value in the entire supply chain is enjoyed by the marketing entities.

Conference call, May 2022, page 17:

Ramprakash V. Bubna: Mr. Gandhi if you take the total margin from the stage of manufacture in the factory or from the raw materials to the consumer the manufacturing stage contributes very small part from the total margin. Most of the margins come from marketing and from sales so there could be some saving in the cost for the manufacturing but the manufacturing has also lot of disadvantages mainly to continue their factory running during off season.

However, Sharda Cropchem Ltd faced the downside of the strategy of total outsourcing of manufacturing during FY2018-FY2020 during the Chinese crackdown on polluting units. The company could not be certain of getting its products ready for shipment to customers. As a result, it had to store an excess inventory that too at high prices and the promoters had to infuse loans in the company because no bank would be willing to give money to a company, which does not have any physical assets.

Conference call, August 2018, page 10:

Ramprakash V. Bubna: Yes, for fund-based limits the company should have some tangible assets to give us a collateral, which our company does not have.

Nevertheless, Sharda Cropchem Ltd is relying on its extremely asset-light strategy of outsourcing all manufacturing due to the strong entry barriers provided by the capital-intensive, time-consuming and cumbersome registration process.

Further advised reading: How to do Business Analysis of a Company

2) Not all registrations are profitable investments for Sharda Cropchem Ltd:

From the above discussion, an investor would feel that getting registrations is difficult; therefore, getting as many of them as possible should be a great strategy. However, the case of Sharda Cropchem Ltd indicates that a lot of its investment in the registrations did not bear fruit. Instead, a significant amount of money spent by it on registrations was written off when it did not provide requisite returns. In fact, many of the registrations were written off even during the process of pendency of a grant of the registration i.e. in the capital work in progress (CWIP) stage.

Conference call, January 2019, pages 3-4:

Ramprakash V. Bubna:…there have been a lot of changes in the agrochemical environment in the world, many products, which were considered good are getting banned or they are getting faced out and the ministries have also stopped registering many of these products. Some of the products, which when picked up for registration were appearing to be very attractive and then slowly down the line, we found that the margins are getting depleted and there is a lot of crowding and the products were becoming commodities. Considering these factors, we have a written off that CWIP of those products and we do not want to spend more money on this.

In fact, during FY2019-2022, the company wrote off almost ₹135 cr of investment done on registrations.

• In FY2020, it wrote off about ₹55 cr of intangible assets (FY2020 annual report, page 194)
• In FY2019, it wrote off about ₹42 cr of intangible assets (FY2019 annual report, page 156)
• In FY2021, it wrote off about ₹38 cr of intangible assets (FY2021 annual report, page 202)

The write-off of the investments done for the registration process was one of the key reasons for the decline in the profit margins of the company during FY2019 and FY2020.

Conference call, May 2019, page 3:

Ashish Lodha: Profit after tax declined by 7.6% from Rs.191 Crores to Rs.176 Crores in FY2019. This was mainly on account of CWIP write off of Rs.42.2 Crores in FY2019.

FY2020 annual report, page 32:

PAT declined by 6.61% from last year due to Intangible Assets & Intangible Assets under Development write off & higher depreciation

Sharda Cropchem Ltd has mentioned that going ahead; every year, it may have to keep writing off about ₹30-50 cr of its investments in registrations.

Conference call, May 2021, page 9:

Himanshu Binani: …intangible write offs which has been now a constant feature…So, going forward how one may look at this number?

Ramprakash V. Bubna:…it will be in the same range of Rs. 30 to 50 Crores. Sometimes, the government authorities ban some registrations while we have already made the investments.

Such a substantial write-off of the investment done in registration indicates that the due diligence done by Sharda Cropchem Ltd for its product selection leaves scope for improvement. The company highlighted that while selecting products for registration, it primarily relies on the feedback of the market participants.

Conference call, October 2021, page 16:

Sonal Minhas: Just want to understand how do you qualify filing in some molecule or let us say a product success and what gets defined basically so is there like internal metrics of return on capital…

Ramprakash V. Bubna: Mr. Sonal we do not do so much of analysis from the feasibility front or return on capital because the final prices that we will get from the market or we will sell at are never defined that whenever fixed…All we go and select the product after getting a feedback from our customers or distributors and the market…

Going ahead, an investor should keep a close watch on the write-offs done by the company from its intangible assets. It is necessary to track whether the company is allocating its capital efficiently or not.

Advised reading: How to Identify if Management is Misallocating Capital

3) Regulatory risk is the biggest risk faced by Sharda Cropchem Ltd:

Regulators play a very important role in the business of agrochemical companies. Their decisions play a very important role in the fate of companies’ businesses. Regulators’ decisions related to grant of registration, the process of registration, approving or banning products as well as their thought process about the priority of statutory protection to companies seen in the light of greater public good significantly influence the companies.

In the earlier discussion, we noted instances like the relaxation of registration requirements in Latin American countries that led to increased competition in those markets and a decline in the profit margin for existing agrochemical companies.

We also noted that when regulators increased the registration fees to generate profits from the registration process, then the return on equity of Sharda Cropchem Ltd declined.

We would also want to highlight another incidence in the case of Sharda Cropchem Ltd when the change in the approach of the regulators affected two different companies. In the case of Quizalofop-Ethyl, despite it being a good profitable product, Sharda Cropchem Ltd had decided to let go of its registration because the process of renewal would prove to be too cumbersome and time-consuming.

Sharda Cropchem Ltd mentioned that it did not own the original registration for Quizalofop-Ethyl. Instead, one of its competitors owned a registration for it. Luckily, for a brief period, to ensure easy availability of Quizalofop-Ethyl, the regulators allowed other companies to get registrations for Quizalofop-Ethyl at a very low cost even if they do not own the original registration.

As a result, Sharda Cropchem Ltd got the approval to sell Quizalofop-Ethyl in Germany and earn good profits for almost 6 years before the registration came for renewal and the company realized that it could not renew it without the special concessional window by the regulator.

Conference call, July 2017, pages 8, 10:

Ramprakash Bubna: Quizalofop, which I mentioned this was based on somebody else’s registration where some window was open and we were able to make an entry… so we got this registration about six years back at a very low cost and it was a very good opportunity that we were enjoying.

The above incidence shows the regulatory risk, which worked out negatively for the original registered owner of Quizalofop-Ethyl, who had to lose a lot of sales and market share to generic players like Sharda Cropchem Ltd who got easy registration due to a temporary change in regulations. Similarly, when the regulatory window expired and regulators did not allow the concessional registration, then Sharda Cropchem Ltd had to let go of its registration.

Therefore, any investor should always be aware of the significant impact that regulators can have on the business of any agrochemical company like Sharda Cropchem Ltd (“stroke of a pen” risk).

For example, in FY2017, the European regulators decided to go slow on registrations of agrochemicals. It led to a significant impact on the growth plans of Sharda Cropchem Ltd in Europe and its growth rate in the region declined significantly.

FY2017 annual report, page 11:

Europe…we faced certain challenges unique to this region. Generally, we faced more than normal delays in getting registrations approved through respective regulators and agencies. This decelerated our growth rate for this region during the year.

Regulatory risks for agrochemical companies also arise in the form of liabilities for damage to the environment.

Sharda Cropchem Ltd faced two different instances where it faced litigations when it was alleged that its products damaged crops and trees. In July 2013, it settled a case in South Africa where it was claimed that its product damaged trees and crops.

RHP, September 2014, pages 330-331:

a claim filed by Plaaskem Pty Limited, South Africa…in respect of the generic active ingredients supplied by Hockley International Ltd. (“Hockley”) alleging that the said formulation caused damage to the trees and crops of its end users. The generic active ingredients used by Plaaskem to formulate the formulations were supplied to Hockley by the Company….this matter was settled in July 2013

Another case against the company’s subsidiary in Europe claiming damage to plants from its products was pending at the time of IPO.

RHP, September 2014, page 338:

Societa Agricola Allasia Plant s.s. (“SAAP”) has filed a case…in relation to damage caused to its plants cultivated, by the use of Dessicash 200 SL (the “Product”) provided by Sharda Europe…This matter is pending.

An investor may contact the company directly to know the status of this case.

Going ahead, an investor should keep in mind the risk of failing to meet regulations as well as changing regulations while she assesses Sharda Cropchem Ltd. This is because even if the company is able to successfully defend a case against it, it still consumes a lot of resources of the company in terms of money, management’s time and brand value.

RHP, September 2014, page 23:

Even unsuccessful product liability claims would likely require us to incur substantial expenses on litigation, divert management’s time, adversely affect our goodwill and impair the marketability of formulations.

To make the matters worse, agrochemical companies are not able to get proper product liability insurance. So the risk of loss of resources due to litigations whether successful or unsuccessful remains high.

RHP, September 2014, page 23:

From time to time, the agrochemical industry has experienced difficulty in obtaining desired product liability insurance coverage.

Another way in which the regulatory risk expresses itself is through trade barriers. At times, the governments in the target markets of Sharda Cropchem Ltd may decide to reduce imports from specific countries by imposing various duties or increasing import tariffs. In such instances, Sharda Cropchem Ltd may have to bear the cost of such high import duties, if its customer is not willing to pay them.

Sharda Cropchem Ltd was affected by high import duties in FY2020 during the US-China trade war when under the leadership of President Donald Trump; the USA imposed high duties on imports from China including agrochemicals. At that time, the customers of Sharda Cropchem Ltd refused to absorb the impact of these high duties and as a result, the company had to take a hit on its margins.

Credit rating report by CRISIL, April 2020:

Recently in USA, higher import duties were imposed on goods originated from China. Since SCL imports about 97% of the goods from China, the gross margins were impacted by 200 basis points

Advised Reading: Credit Rating Reports: A Complete Guide for Stock Investors

Therefore, the entire strength of the business model of Sharda Cropchem Ltd comes from the cumbersome and time-consuming registration process, which dissuades many competitors from entering this field. The business strength is not due to any proprietary technology or any difficult-to-manufacture product, which no one else can produce.

This business strength is effectively granted to Sharda Cropchem Ltd by regulators due to their difficult approval process. Therefore, the regulators can take away this business strength overnight, by making the registration process easy and simple (“stroke of a pen” risk).

An investor should always remember this fragility in the business model of Sharda Cropchem Ltd while projecting its financial performance.

4) Management Succession of Sharda Cropchem Ltd:

Sharda Cropchem Ltd is a part of the Bubna family and currently, the founder-promoter couple, Mr Ramprakash V. Bubna, CMD. (aged 75 years) and Mrs Sharda R. Bubna, WTD, (aged 69 years) along with their sons, Mr Ashish R. Bubna, WTD, (aged 49 years) and Mr Manish R. Bubna, WTD, (aged 47 years) are present on the board of directors.

FY2016 annual report, page 65:

Mr. Ramprakash V. Bubna: Husband of Mrs. Sharda Bubna, Father of Mr. Ashish Bubna and Mr. Manish Bubna

Therefore, an investor would note that currently, the next generation of promoter-brothers has also joined the company and been working for Sharda Cropchem Ltd for a significant amount of time.

The presence of younger family members at executive positions within the group, while the senior members are still handling responsibilities, looks like a good succession plan. This is because the young members can learn about the fine nuances of the business under the guidance of senior members until the seniors decide to take retirement.

Going ahead, an investor may keep a close watch on the relationships among the sons of the founder-promoters to understand whether any ownership issues arise between them.

Until now, the promoters have managed the equations between the two brothers; Mr Ashish R. Bubna and Mr Manish R. Bubna, by making them draw an exactly equal salary from the company every year.

• In FY2016, both the brothers took home a salary of ₹22,995,405 each (FY2016 annual report, page 60)
• In FY2017, both the brothers took home a salary of ₹30,043,982 each (FY2017 annual report, page 55)
• In FY2018, both the brothers took home a salary of ₹31,414,273 each (FY2018 annual report, page 61)
• In FY2019, both the brothers took home a salary of ₹34,302,081 each (FY2019 annual report, page 61)
• In FY2020, both the brothers took home a salary of ₹32,504,953 each (FY2020 annual report, page 58)
• In FY2021, both the brothers took home a salary of ₹32,895,142 each (FY2021 annual report, page 63)

An investor may contact the company directly for any clarifications about any ownership issues between the promoter-family members.

Further advised reading: How to identify Promoters extracting Money via High Salaries

5) Risks/Scope for improvement in relation to brands, trademarks and registrations:

Sharda Cropchem Ltd disclosed in the RHP in September 2014 that it has not registered its brands in the foreign countries and as a result, there is a risk that some competitors may launch products under the same brand name. The company only believed that the regulators would not grand registration to any competitor under the same brand name.

RHP, September 2014, pages 28-29:

While we believe that the authority granting us registration for a particular formulation or generic active ingredient would not grant a registration for such formulation or generic active ingredient under the same label and name to another applicant, the said label or name is not registered under any specific intellectual property rights.

It seems that by not registering the brand names, Sharda Cropchem Ltd is exposing itself to avoidable litigations.

In the RHP, Sharda Cropchem Ltd also intimated that it has taken registrations in the names of its distributors, consultants and other third parties. The company has done all the spending for these registrations and it derives economic benefits from them; therefore, it sells its products under the licenses received in the names of consultants and distributors. However, the company does not have any binding agreement with such third parties.

RHP, September 2014, pages 29-30:

we also undertake sale of formulations and generic active ingredients pursuant to registrations owned by third parties being our distributors, consultants and our Group Company, Sharphil Inc.. We have incurred expenditure towards obtaining such third party registrations and we currently derive beneficial interest from sales based on such registrations. However, we do not have any agreements with such third parties for availing the beneficial interest of sales based on such registrations. There can be no assurance that such third parties will not engage with our competitors

Such an arrangement exposes it to the risk where any deterioration in the relationship of the company with the third party i.e. consultant or distributor would deprive it of the sales channel as well as the right to sell the product in a market.

Therefore, it seems that the arrangements done by Sharda Cropchem Ltd regarding its brand names, trademarks, registrations etc. leave scope for improvement. An investor may contact the company directly to know the current status of these trademarks and registration agreements with third parties.

Further advised reading: How to do Management Analysis of Companies?

6) Weaknesses in the internal processes and controls at Sharda Cropchem Ltd:

In the past, there have been many instances where Sharda Cropchem Ltd has been found lacking in its internal controls and processes.

As per the RHP, September 2014, pages 27-28, the company failed to make necessary filings with RBI when it received foreign investment. At the same time, it also failed to comply with FEMA regulations while incorporating subsidiaries and making investments outside India.

In accordance with the requirements of the FEMA Regulations, we were required to make the prescribed filings with the RBI at the time of making remittance and certain annual filings in relation to the overseas investments. In the past, there have been instances of delay and failure in making the necessary filings with the RBI…We have also received foreign investment in our Company…in this regard, there has been a delay in making the necessary filings with RBI.

The RHP on pages 31-32, also states that from FY2010 to FY2013, the company did not have an internal audit system. The RHP did not comment on the presence of an internal audit before FY2010; therefore, an investor may contact the company directly for any clarifications in this regard.

In 2011, Sharda Cropchem Ltd was penalized by customs officials for wrongfully taking the duty-free clearances of imported goods.

RHP, September 2014, page 338:

Our Company has, in 2011, paid a penalty imposed by the Commissioner of Customs (Export), Jawaharlal Nehru Custom House, Nhava Sheva, Maharashtra, in relation to wrongful availment of duty free clearances of imported goods

Previously, in 2007, Sharda Cropchem Ltd did a delay of one year and 10 months in appointing a full-time secretary.

RHP, September 2014, page 36:

Pursuant to an increase in our paid-up capital in March 2007…we were required to appoint a whole-time secretary of our Company. However, the Company appointed a whole-time secretary in January 2009 resulting in delay in the appointment of the whole-time secretary for a period of one year and 10 months.

In addition, there have been multiple instances where Sharda Cropchem Ltd failed to make timely disclosures to stock exchanges and directors, which have been pointed out by the secretarial auditor of the company in its annual reports.

In 2015, the company did not timely disclose to the stock exchanges that in its board meeting, it would also consider a declaration of dividend.

FY2016 annual report, page 46:

Board meeting held on 30th May, 2015…proposal for recommendation of dividend was considered by the Board of Directors. However…Company has inadvertently missed out this information in the prior intimation made to Stock Exchange(s) with regard to recommendation of dividend and the same was clarified later on to National Stock Exchange of India Limited.

The company repeated the same mistake in FY2021 and the stock exchanges penalized the company with a fine.

FY2021 annual report, page 51:

The Company had conducted a Board Meeting on October 28, 2020…to consider and declare the interim dividend…the company was required to intimate the stock exchanges at least two working days in advance…however the Company intimated to the stock exchanges only 1 working day prior…hence the Company was non-compliant…for which the Bombay Stock Exchange (“BSE”) and National Stock Exchange (“NSE”) levied fine on the Company

In FY2017, Sharda Cropchem Ltd delayed sharing the signed minutes of its board meeting to its directors.

FY2017 annual report, page 44:

The certified copy of the signed Minutes of Board meetings and its committee meetings…has not been circulated to all the Directors of the Company within the period of 15 (fifteen) days after the minutes were signed.

In the FY2017 annual report, the company did not provide the Board’s response to the secretarial auditor’s observations.

FY2018 annual report, page 51:

The report of Board of Directors for the financial year ended 31st March 2017 did not contain the explanation or comments by the Board in respect of the qualification made by the company secretary

In addition, the company did not furnish a required declaration needed as a part of the audited financial result and therefore, the stock exchanges issued notices to the company.

FY2018 annual report, page 51:

The Company has not furnished a declaration…for which the Company had received the notices from BSE Limited and National Stock Exchange of India Limited

In FY2020, the company delayed the disclosure of related party transactions to stock exchanges by 117 days.

FY2020 annual report, page 47:

There was a delay of 117 days in filing of disclosure of related party transactions for the half year ended September 30, 2019

In addition, there was a delay in submitting the annual report to the stock exchanges.

FY2020 annual report, page 47:

There was a delay of 1 day in submission of copy of the Annual report to the stock exchanges

During FY2010, FY2012 and FY2013, the company had delayed the deposit of undisputed statutory dues to the govt. authorities (RHP, September 2014, pages 31-32).

An investor may contact the company directly for clarifications about the steps taken by the company to reduce such instances of noncompliance.

Another instance of weakness comes across when an investor visits the website of Sharda Cropchem Ltd. The website of the company does not have a security certificate. It is opened via an “HTTP” connection instead of an “HTTPS” connection. As a result, it is labelled “Not secure” by the web browsers. The cost of a security certificate for a website to make it secure is about ₹1,000/- per year, though various open-source free alternatives also exist.

Going ahead, an investor should keep a close watch on the signs indicating weaknesses in the internal controls and processes of Sharda Cropchem Ltd.

The Margin of Safety in the market price of Sharda Cropchem Ltd:

Currently (May 31, 2022), Sharda Cropchem Ltd is available at a price to earnings (PE) ratio of about 19 based on consolidated earnings of FY2022.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, which takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be a sign of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

• 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
• How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
• Hidden Risk of Investing in High P/E Stocks

Analysis Summary

Overall, Sharda Cropchem Ltd seems a company, which has grown its sales at a decent rate of 18% year on year for the last 10 years. The growth has been associated with fluctuating profit margins; however, until now, the operating profit margins have not fallen below 17%.

Sharda Cropchem Ltd has modelled its business around obtaining more and more registrations to sell agrochemicals in many countries and has completely avoided owning any manufacturing facility. It is a pure trading company, which sources all of its products from third parties, mainly from China. The business strength in relying only on registrations comes from the cumbersome and time-consuming registration process, which acts as an entry barrier for generics agrochemical companies.

Nevertheless, this business strength is a direct result of procedural obstacles in obtaining registrations and it can vanish if the regulators make the approval processes smooth and simple. Sharda Cropchem Ltd faced this situation in Latin America when the regulators made the registration process easy leading to higher competition and declining profit margins.

In addition, not all the registrations lead to profitable outcomes. Sharda Cropchem Ltd has written off a significant amount of money invested in the registration process where it could not realize any significant profits.

Generics agrochemical players including Sharda Cropchem Ltd do not have any pricing power over their customers. They only follow the pricing strategy of large MNCs that own 75% of the market share. When MNCs refuse to increase prices even when costs are going up, in order to maintain their market share, then Sharda Cropchem Ltd suffers significantly on its profit margins. The MNCs pamper large distributors with incentives and rewards and as a result, they do not entertain generics players; therefore, companies like Sharda Cropchem Ltd have to primarily rely on smaller distributors limiting their market reach.

Sharda Cropchem Ltd is stuck with suppliers in China for its products because there is no alternative. Even if it wants to switch to a new supplier, the registration regulations do not allow an easy switch. Therefore, it is like either supply from China or do not supply. As a result, when Chinese agrochemical production came under stress in FY2018-FY2020, then Sharda Cropchem Ltd had to buy an excess inventory at high prices to ensure that it does not lose its customers. In the end, the company suffered due to excessive unsold inventory when prices declined later on.

Sharda Cropchem Ltd has a high receivables days due to twin factors of MNCs giving very long credit period to distributors, which puts pressure on Sharda Cropchem Ltd as well to match and secondly, due to long-stuck receivables in Latin America where many economies and their currencies are performing poorly.

The company has a succession plan where the sons of the promoter are playing an active role in the company; however, it remains to be seen whether the two brothers would keep on collaborating.

There seem many weaknesses in the internal processes, controls, management of trademarks etc. of Sharda Cropchem Ltd. The company has not registered its brand names in its target markets exposing it to disputes. It has taken registrations in the names of distributors, consultants etc. without having any binding agreement with them. They can easily collaborate with its competitors and shut the doors on Sharda Cropchem Ltd.

Sharda Cropchem Ltd has numerous instances of delaying important disclosures to stock exchanges, RBI, the deposit of undisputed dues to authorities, employment of secretary, sharing of documents with the board etc. Even the website of the company is “not secure”. The internal controls and processes at Sharda Cropchem Ltd seem to leave scope for improvement.

Going ahead, an investor should keep a close watch on the regulatory developments regarding registrations in its target markets because any adverse change can take away its business advantages (“stroke of a pen” risk). She should closely monitor its profit margins as well as write-offs of intangible assets to ascertain whether Sharda Cropchem Ltd is able to allocate capital efficiently. She should keep a watch on its inventory and receivables days to see if the company is able to keep its working capital under control. The investor should look for signs whether its internal processes and controls show weakness.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Sharda Cropchem Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

I, Vijay Malik, am a SEBI-registered Research Analyst (Regn. No. INH100008364). This article is for educational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. Investors should do their own research before making any investment decisions.

I, or my immediate relatives, do not have any financial interest in the companies discussed as on the date of publication of this article, nor do we hold one per cent or more of the securities of such companies at the end of the month immediately preceding it. I do not have any material conflict of interest and have not received any compensation or other benefits from the companies or any third party in relation to this article during the 12 months preceding its publication. I have not served as an officer, director, or employee of the subject companies, nor have I been engaged in market making activity for them.