Rating Rationale

Strengths
* Established position in the fertiliser industry and diversified revenue
RCF is the third-largest player in the domestic urea industry in terms of production capacity'accounted for 10% in fiscal 2020. The company has a strong position in its primary markets of Maharashtra, Karnataka, and Andhra Pradesh. Revenue is diversified across urea, complex fertilisers, and industrial chemical products. This protects profitability from unfavourable conditions in any particular segment and adds stability to cash flows.

* Healthy operating efficiency in the urea business
Healthy profitability is driven by energy consumption for both Thal and Trombay urea units (both in Maharashtra) operating well within the norms set by the Government of India (GoI). As the pre-specified norms form the basis for reimbursement of feedstock costs to fertiliser companies, lower energy consumption results in better profitability. Thal and Trombay plants operated at an energy level of 5.98 and 7.12 Gcal/tonne (energy norms of 6.50 and 8.44 Gcal/tonne), respectively, during fiscal 2020. Further, overall plant utilisation was 115% during the year. While overall profitability moderated during fiscal 2020 due to year-on-year increase in energy consumption and is expected to remain at moderate levels during fiscal 2021 due to revision in energy norms for the Trombay plant (at 6.5 Gcal/tonne) from April 1, 2020. Profitability is expected to improve fiscal 2022 onwards post completion of the energy saving projects during fiscal 2021. However, any delay in the implementation of energy saving projects will remain a key sensitivity factor.

Moreover, the GoI has approved the additional fixed cost for urea players; RCF is entitled to receive additional fixed cost of Rs 350 per tonne of urea till the reassessed capacity. This will support profitability. Since this benefit is to be provided retrospectively, from fiscal 2015; it has led to additional realisations for RCF in fiscal 2020.

* Healthy financial flexibility
RCF enjoys high financial flexibility driven by the availability of large unutilised bank lines to support any funding requirement, considering the regulated nature of the fertiliser industry. The average bank limit utilisation remained low at 9% (39% including commercial papers [CPs]) for 12 months through May 2020 (bank limits: Rs 4,300 crore). Further, healthy cash accrual driven by strong operating efficiencies and access to low cost financing from banks/financial markets adds to the overall financial flexibility.

Weaknesses
* Leveraged capital structure
The capital structure moderated, with gearing at 1.51 times as on March 31, 2020, as against 1.14 times a year ago, primarily due to increase in the working capital borrowings to fund subsidy receivables and long-term borrowings to fund ongoing projects and investment in joint ventures (JVs). Further, planned debt-funded capex (towards energy efficiency & maintenance capex) of around Rs 500 crore and investment in JVs of around Rs. 1,100 crore over the next two years will lead to increased leverage. Any other debt funded capex or investment, leading to weakening of capital structure will be a key rating sensitivity factor.

* Cyclicality in the industrial products business
The industrial chemicals business is highly commoditised and cyclical in nature. This results in susceptibility to movements in the international prices and import duty structure for the key product, methanol. This has resulted in earnings before interest and tax (EBIT) losses in fiscal 2020 as compared to 6.3% EBIT margin last fiscal. Moreover, profitability in the complex fertiliser business remains exposed to availability and prices of key raw materials in the international market. Profitability of the industrial chemicals and complex fertiliser businesses will remain vulnerable to intense competition from cheaper imports and availability of raw material in the international market, respectively.

* Exposure to risks related to the regulated nature of the fertiliser industry
Given the government's thrust on self-sufficiency in food grain production, the fertiliser industry is strategic but highly controlled. Of late, government has focused on reducing subsidy without increasing prices by urging companies to adopt more efficient methods of urea production. In-line with these measures, government tightens energy consumption norms periodically, impacting profits of urea players unless they improve energy efficiencies. The revised energy norms for RCF's Thal plant was applicable from April 1, 2018. Change in energy norms for Trombay plant is applicable from April 1, 2020 and is expected to impact its profitability till the energy saving project gets completed. This is partly offset by the agreed additional fixed cost of Rs 350 per tonne to all urea manufacturers by the government. However, delay in disbursement of subsidy results in higher reliance on working capital borrowings, leading to large interest costs and remains a key rating sensitivity factor.

In addition, RCF also has an ongoing dispute with GAIL (India) Ltd regarding use of subsidised gas for its non-urea operations from fiscal 2006 onwards. Any adverse judgement/material liability on the dispute will be a key rating sensitivity factor.