The credit metrics of fertilizer manufacturers in general and urea manufacturers, in particular, are likely to improve meaningfully in FY22 due to the strong likelihood of clearance of subsidy backlogs after allocation of an additional Rs 62,600 Cr fertilizer subsidy in the revised estimate of FY21, India Ratings and Research (Ind-Ra) said on Friday.

It will substantially reduce working capital debt and interest expenses. This will also encourage industry players to increase the capital intensity to further improve their operating efficiencies, said Ind-Ra.

Urea manufacturers will specifically benefit as their share of subsidy is generally 70  pc of revenues as opposed to 30  pc for nitrogen phosphate potash manufacturers. Besides, while the subsidy budget estimate for FY22 is 11.5  pc higher at Rs 79,500 Cr than the FY21 BE of Rs 71,300 Cr, the urea subsidy BE has been increased by 22.9  pc to Rs 58,800 Cr and NPK subsidy BE has been reduced by 11.7  pc to Rs 20,800 Cr.

Ind-Ra estimates the fertilizer sector debt to be in the range of Rs 53,500 Cr to Rs 56,500 Cr at FYE20, up from around Rs 49,500 Cr in FY17. The debt is primarily working capital in nature and corresponds to an increase in subsidy receivables outstanding to Rs 47,000 Cr to Rs 49,500 Cr in FY20 from about Rs 45,500 Cr in FY17.

However, the additional subsidy allocation is likely to substantially increase the sector's cash flow from operations and free cash flows in FY22 from an estimated Rs 5,500 Cr and negative Rs 400 Cr respectively in FY20. Ind-Ra said it does not expect any significant capex in the industry, other than for urea efficiency improvement for some players and regular maintenance and up-gradation capex in the near term.

Accordingly, clearance of full subsidy backlogs in FY22 will result in the sectoral net leverage declining to around 2x and interest coverage moving upwards of 5x.In addition, the resultant savings in interest expense are likely to improve return on equity for sector entities especially urea manufacturers up to double digits from the current range of 4 to 7  pc.

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