The Asia-Pacific agrochemicals sector looks set to gradually recuperate in 2024. This will be underpinned by the inelastic, improving demand and moderating inventory levels globally.
That said, S&P Global Ratings believes any recovery in profitability could be moderate, following a tough comedown in 2023 from the 2022 peak. This is because some major challenges remain. These include significant supply surplus, primarily from China, and an uncertain pace of restocking in a volatile market environment.
Industry conditions deteriorated materially last year, on overcapacity coupled with soft demand amid prolonged destocking. Prices hit historically low levels for major products.
We downgraded India's UPL Corp. Ltd. (BB/Negative/--) last month and held a webinar on the action, where we discussed the industry dynamics and outlook on some major players' credit profiles.
In this piece, we address some frequent queries from investors. These cover supply-demand dynamics, competition, trade tensions, and the credit implications for the region's agrochemical firms.
Frequently Asked Questions
Will supply-demand imbalances improve for Asia-Pacific agrochemicals in 2024?
Yes, but only moderately. We anticipate another year of supply surplus in 2024. Demand should slowly pick up amid gradual stock replenishment, while significant supply pressure will unlikely ease in the short run.
China should remain the world's largest crop-protection producer and exporter, and it has been exporting over 60%-80% of its output. The country's agrochemical industry has been in an over-supplied situation over the years, following capacity expansions amid elevated product prices, including over 2021-2022.
Hence we expect the supply-demand imbalances to remain this year, despite gradual restocking globally and China's easing-up of investment spending from 2024 (see chart 1). Stricter environmental and safety regulations will also tighten supply.
Chinese producers will, in our view, lower production utilization rates as needed. This was seen last year with utilization rates falling to 65% for major crop-protection products, comparable to the last downturn over 2014-2016.
Chart 1
International trade conflict risk for the Chinese agrochemical producers is rising, amid soft product prices and abundant supply from China. Partly mitigating this risk is China's diversified products and sales markets globally. For example, the main markets of its crop protection products include the Regional Comprehensive Economic Partnership (RCEP) countries, Latin America, and Africa. We also anticipate that Chinese players will continue to enhance product quality and offerings, such as greener products, in the international market.
Increasing international demand, higher overseas sales amid domestic oversupply, and border reopening in 2023 have driven exports in recent years.
Chart 2
What is the industry landscape in the long run?
Over the next five to 10 years, competition in the Asia-Pacific agrochemical industry should be fiercer. Hence, in our opinion, China will continue to gradually phase out obsolete and uncompetitive capacity to overcome overcapacity issues, and upgrade product portfolios to maintain its well-established global market position.
At the same time, we see rising competition from some other countries such as India. The Indian government recognizes its agrochemical industry as one of its top-12 industries to achieve global leadership. The country targets annual growth of 8%-10% through 2025. India has become the world's second largest agrochemical exporter since 2022.
On the demand side, agrochemicals, such as crop protection and seeds products, should see long-term growth. This is underpinned by population growth and need to improve crop yields.
Chart 3
How are the Chinese crop-protection players coping with the downcycle and domestic overcapacity?
We expect the firms to continue to take various measures in the domestic highly fragmented and competitive industry. Earnings fell across the industry last year, including Syngenta Group Co. Ltd. Ltd. (BBB+/Stable/--) by our estimates, and many players were loss-making.
Measures include actively managing working capital including inventories, controlling costs and capital spending, exploring the overseas markets and diversifying sales markets, and adjusting production-utilization rates.
For the next three to 10 years, these companies will, in our view, continuously lengthen their industrial chain. They will also invest in research and development (R&D) to upgrade and differentiate their offerings, focusing on ones with good growth prospects--such as environmentally friendly products. Such moves could help them counter industry cyclicality.
Additionally, market consolidation and elimination of the weaker, smaller, and less green producers should continue, as encouraged by the Chinese government.
What is the credit outlook for Asia-Pacific rated players in 2024? And why is UPL underperforming versus the rated peers at the moment?
Overall, we view the industry fundamentals as resilient and underpinned by inelastic demand. China's Syngenta and Australia's Nufarm Ltd. (BB/Stable/--) should be able to navigate the downturn.
The credit strengths of Syngenta and Nufarm should be supported by their improved balance sheets over the past years. They've demonstrated prudent capital management and enhanced their working-capital management.
Syngenta's credit profile is also bolstered by its global leadership in the crop-protection and seeds products with strong R&D capabilities and its expanding business in China. This is in addition to the parent support from Sinochem Holdings Corp. Ltd., which is owned by the Chinese government.
The negative rating outlook on UPL reflects our expectation that the company has limited prospects for a full earnings recovery over the next 12 months. This follows its particularly weak and volatile 2023 compared with the rated peers. That performance was partly due to its higher sales exposure to Latin America with soft demand and lengthier working capital cycles. And the use of rebates to attract sales, which eroded profitability.
Are the issues faced by UPL industry-wide or more company specific?
Both.
Like its peers, UPL is faced with oversupply, and depressed prices of post-patent crop protection products. Moreover, a notable industry recovery is yet to be visible.
For company-specific matters, UPL's wider exposure into emerging markets (40% revenue exposure in Latin America), post-patent product portfolio (around 70% of total revenue), and higher leveraged versus the higher rated peers make it more vulnerable to industry volatility. Furthermore, we believe elevated levels of working capital and the absence of long-term committed credit lines are risks for its liquidity.
Why does S&P Global Ratings think UPL could face challenges in returning its EBITDA margins to its pre-2023 level of 20%?
Because of the ample supply in the market. With China's border reopening since early 2023, substantial supplies from China have flooded the market, which drove down product prices, as well as sales volume for companies like UPL. It should take some time for the demand to digest the supply.
For UPL to maintain and recover its sales volume, we believe the company will continue to use rebates to gain back its market shares, which would pressure the company's profitability. We expect EBITDA margins to improve towards high teens level by fiscal 2027.
Why is UPL's liquidity less than adequate if the short-term debt can be rolled over?
Although short-term credit facilities are generally rolled over to fund working capital of many cyclical and commodity companies, we do not recognize them as reliable and sustainable liquidity sources. This is because they are uncommitted in nature and subject to periodic credit approvals by lenders. We assess UPL's liquidity as less than adequate, because this increases refinancing risk in risk-off periods, notwithstanding the historical track record of roll overs.
Chart 4
How is Nufarm dealing in the difficult operating environment? And what's to come?
Like for peers, volatile and challenging market conditions have negatively affected Nufarm. Rising product supplies combined with higher interest rates have led customers to opt for a "just in time" strategy as they deplete their own stocks. As such, channel inventories are relatively low across most of Nufarm's key operating regions, and inventories are more elevated at the manufacturer level.
The result has been a slower-than-normal unwinding of working capital. Having said that, we anticipate a return to Nufarm's more normal supply-and-demand dynamics in the second half of fiscal 2024 (year-end Sept. 30, 2024), as channel stocks run lower. An uplift in demand for crop protection products should help the company right-size its working capital position and repair its balance sheet.
The company's exit from its South American business will also continue to ease earnings volatility. The divestment in 2020 reduced Nufarm's scale and geographic diversity. However, it has also reduced earnings volatility, working capital intensity, and exposure to lower margins associated with this region.
What steps has Nufarm taken to minimize the impact of changes in market conditions and earnings volatility? Are they effective in the current downturn?
The company has revised its capital-management framework and refinanced its working-capital facilities. We think these measures have helped and will continue to help Nufarm counter the volatile market environment.
In our view, Nufarm revised its capital-management framework in 2021 to prioritize balance-sheet strength and free cash flow ahead of shareholder returns. The framework also prevents payment of debt-funded dividends, has strengthened the group's capital structure, and enhanced its capacity to accommodate inherent earnings and cash flow volatility in its businesses.
Moreover, Nufarm's refinancing of its working-capital facilities has helped to underpin a more flexible and durable capital structure. This accommodates the funding requirements for the inherent volatility in the company's working capital cycle.
Nufarm's refinanced five-year revolving asset-based lending facility in 2022 is drawn upon during periods of heightened working capital. This has resulted in less reliance on the company's supply-chain financing arrangements, and enables it to manage through periods of liquidity pressure and working-capital swings.
Related Research
- UPL Corp. Downgraded To 'BB' On Weak Cash Flow And Poor Operating Environment; Outlook Negative, Feb. 8, 2024
- China Commodities Watch: Upstream Will Hold Up, Downstream Will Suffer, Jan. 15, 2024
- China Commodities Outlook 2023: An Uneven Recovery For Chemical Companies, Feb. 27, 2023
This report does not constitute a rating action.
| Primary Credit Analysts: | Betty Huang, Hong Kong (852) 2533-3526; betty.huang@spglobal.com |
| Shawn Park, Singapore + 65 6216 1047; shawn.park@spglobal.com | |
| Sam Playfair, Melbourne + 61 3 9631 2112; sam.playfair@spglobal.com | |
| Secondary Contacts: | Annie Ao, Hong Kong +852 2533-3557; annie.ao@spglobal.com |
| Danny Huang, Hong Kong + 852 2532 8078; danny.huang@spglobal.com |
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