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. The Thal and Trombay plants operated at an energy level of 5.98 and 7.12 Gcal (giga calorie)/tonne (energy norms of 6.50 and 8.54 Gcal/tonne), respectively, during fiscal 2020. Further, overall plant utilisation was 115% during the fiscal. While overall profitability moderated during fiscal 2020 due to an increase in energy consumption, it is expected to remain moderate in fiscal 2021 due to tightening of energy norms for the Trombay plant (to 6.5 from 8.54 Gcal/tonne).

The company has operated at a lower energy consumption rate during the first quarter of fiscal 2021 vis-a-vis fiscal 2020, and this has resulted in higher operating profit during the quarter. The revised energy norms were applicable from April 1, 2020. However, the government has also provided some relief by delaying the tightening of energy norms by six months. The revised norms will now be applicable from October 1, 2020. While the implementation of energy saving projects in the Trombay plant is delayed due to the national lockdown to contain the Covid-19 pandemic, they are expected to be completed by January-February 2021, thus supporting operating profitability from fiscal 2022. However, any further delay in the implementation of these projects will remain a key rating sensitivity factor.

Moreover, the government 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. As this benefit is to be provided retrospectively, from fiscal 2015, it has led to additional realisations in fiscal 2020.

* Healthy financial flexibility
Financial flexibility is 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 61% (including commercial paper) during the 12 months through July 2020 (bank limit: Rs 4,300 crore). Further, healthy cash accrual, driven by strong operating efficiency, and access to low-cost financing from banks/financial markets add to the overall financial flexibility.

Weaknesses
* Leveraged capital structure
The gearing increased to 1.51 times as on March 31, 2020, from 1.14 times a year earlier, primarily due to higher working capital borrowing to fund subsidy receivables and receivables towards import of urea on government account, and long-term borrowing to fund ongoing capital expenditure (capex). Further, planned debt-funded capex (towards energy efficiency and maintenance) of around Rs 500 crore and investment of around Rs 1,100 crore in joint ventures over the next two years will increase the leverage. Any other debt-funded capex or investment leading to weakening of the 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 previous 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, the 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, the government tightens energy consumption norms periodically, impacting profits of urea players unless they improve energy efficiency. The revised energy norms for RCF's Thal plant was applicable from April 1, 2018, whereas for the Trombay plant it will be applicable from October 1, 2020. This is partially 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 borrowing, leading to large interest costs and remains a key rating sensitivity factor.

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