July 2003

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Industryoutlook
Vol. I - 1 May, 2003

Credit opinions on industri

Article #1

Dormant risks in the seed industry

T. S. Ramakrishnan rts@crisil.com

The adage, what you sow is what you reap, couldn't be more true for the
Indian agricultural sector. After all, agriculture is a key driver of the Indian
economy, contributing around 25% of the gross domestic product (GDP) and
providing livelihood to two-thirds of the population. India has the second-
largest area under cultivation and leads in the production of crops like rice,
wheat and pulses. Yet, in terms of yields, the country ranks abysmally low in
comparison with the rest of the world. For instance, it is ranked 52nd in the
world in terms of the yield on rice and 147th in terms of the yield on oil crops
(see India's global ranking in agriculture). That's largely because of poor
seed quality, high dependence on the monsoons, low farm mechanization,
minuscule land holdings and the lack of understanding of improved
farming methods.
July 2003

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Hybrid seeds could, however, be one way of improving the agricultural industry in India is far smaller than that in many other countries (see Size
sector's productivity. Today, of the around 140 million hectares under of seed industry)
cultivation, only 12% are under hybrid seeds. With increasing population
putting more pressure on the available land, farmers are bound to shift from In terms of value, the Rs. 40 billion seeds market is dominated by private
conventional to hybrid seeds. This promises tremendous growth for the players, who have a 70% share, while the remaining share is held by
country's hybrid seed industry. public varieties developed by government-funded organizations like the
agricultural universities. In terms of volume, however, the situation is
India's global ranking in agriculture
quite the reverse as public varieties are popular in food crops like paddy
Crop Production Area Yield and wheat where seed prices are low whereas private players are mainly
active in crops like cotton, cereals and vegetables, where realizations are
Rice 2 1 52
relatively higher.
Wheat 2 1 38
Coarse grains 4 3 125
Only a few companies like Nuziveedu Seeds Ltd, Mahyco and Paras Extra
Pulses 1 1 138 Growth Seeds have a turnover of over Rs. 1 billion. Many MNC seed
Oil Crops 5 2 147 conglomerates are also active in India through tie-ups or subsidiaries like
Cotton Seed 4 1 77 Monsanto, which is present through Monsanto Mahyco, and Bayer
Cropscience with ProAgro.
Seed industry - An overview
The Indian seed industry began developing with the green revolution in Although the seed industry has an enormous growth potential, it carries
the 1960s. Initially, government-funded agencies developed and some unique risk factors that need to be considered from a credit
distributed hybrid seeds. Private sector players only started participating perspective.
in a large way in this sector around 15 years ago after the Seed Act 1988
lifted many restrictions on seed development and trade. Over-dependence on cotton: Cotton is one of the few crops, which gives
both volumes and better realizations and more than one-fourth of the
Currently, there are around 400 players in the industry catering to a wide industry's turnover comes from cotton hybrids. The importance of cotton for
variety of crops from cotton and cereals to vegetables and fruits. Although the topline of any seed company can be gauged from the fact that high-
the industry has significant growth potential, growth rates are low at 3- yielding hybrid cotton seeds fetch around Rs. 400 per packet while similar
4% as a result of low awareness and adaptability of farmers and the maize, bajra and jowhar seeds sell for less than Rs. 35. This has resulted in
dearth of effective hybrid varieties in each crop that are suitable for the more private and MNC seed companies getting into cotton. In fact, all the big
country's various agro-climatic conditions. Consequently, the seed seed companies with a turnover of over Rs. 1 billion are largely into cotton.
Size of Seed Industry Some of these companies depend on one or two high-performing hybrids for
6000
a major chunk of their revenues.
4000
Million $

2000
This high dependence on cotton exposes the companies to the risk of lower
demand due to:
0 l Changes in area under cotton cultivation, which, in turn, depends on the
USA

China

Japan

CIS

France

Bazil

Germany

Argentina

India

Italy

prevailing and expected prices of cotton.

Country l Competitors coming out with better hybrids and hampering the prospects
of other players.
Number of major hybrids
Crop Pvt Sector Public Sector
These risks can be mitigated by having a wide product portfolio so that even
Cotton 150 15 if there is a drop in demand for one crop, the topline is protected to a certain
Maize 67 3 extent and farmers too are retained within the company's fold.
Bajra 60 6
Sorghum 41 5 Research & Development: R&D is the first and most critical endeavor of a
Sunflower 35 6 seed company. It typically takes Rs. 50 to 100 million over a period of seven to
Rice 12 4 eight years to commercialize a hybrid. With most Indian seed companies
Source : Seed Association of India being small, R&D efforts are not very effective. Even after a hybrid is
July 2003
successful, challenges remain in the form of retaining the purity of the hybrid
season after season, which requires proper maintenance breeding of the
parent variety.
Also, the R&D effort need to be market oriented to take into account the
needs of the end user (say in cotton, the needs of the textile industry in terms
of whiteness, lustre, staple length and strength or in vegetables, consumer
preferences in terms of colour, size and taste) so that when the variety is
launched after incurring so much expenditure, it is accepted by the market.
R&D is a key differentiator in this industry and companies with good R&D
facilities are better placed to succeed than others.
Lifecycle risk: On an average, the lifecycle of a hybrid is eight to ten years
after which, newer and better varieties typically outperform older ones.
Hence, even though a particular hybrid variety might achieve high sales and
better margins in the introductory period, these may not be sustainable for
long. To remain ahead of the market, the company has to keep churning out
better varieties at least once every four years. In the long run, then, only those
seed companies with adequate R&D infrastructure and where the
management is committed to developing better varieties have a higher
chance of survival.
Long production periods: Hybrid seed production takes place in two stages:
preparation of foundation seeds and production of hybrid seeds from the
foundation seeds by crossing the two vareties. As each stage is seasonal,
production has to be planned two seasons ahead, which, in the case of crops
like cotton, can be as long as two years. Hence, no changes in seed
production can be carried out based on the current demand estimates as the
actual production has begun much earlier.
In contrast with the long production period, sales typically take place within a
few weeks prior to the sowing season. For example, cotton seed sales take
place in May and June. This short sales window increases the company's
vulnerability to fluctuations in demand. The inflexibility on the production
side and the extremely short sales period exposes companies to a sudden
inventory pile-up if sales do not take place as projected, which could lead to
liquidity problems. It also increases costs in terms of storage and the
consequent risks of damage unless the company has a good storage facility.
Here, the risk mitigants could be better forecasting abilities, better working
capital management and the financial strength to withstand shocks in
demand patterns.
Risks in contract farming: Unlike abroad, in India, hybrid seed production
from the basic foundation seeds is outsourced to thousands of contract
farmers, most of whom have miniscule land holdings. Many such farmers do
contract production for more than one seed company besides growing their
normal varieties. This enhances the possibility of unintended cross-
pollination, resulting in poor hybrid quality.
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In such a scenario, meticulous testing of hybrids is a must to maintain the
promised yield. But unlike other industries, where quality controls takes a
few minutes or hours, in seeds, it takes months because the genetic purity of
a hybrid can only be ascertained at the flowering stage. This necessitates a
grow out test (GOT) wherein a sample is grown in trial fields till the flowering
stage to ascertain the hybrid's quality. Apart from this, moisture content and
vigor also need to be checked. Any lapse on the quality front can spell
disaster for both farmers (due to poor yields) and the seed company.
The risk mitigants could be strong long-term relationships with contract
farmers and geographical diversity in contract farming.
If the seed industry carries these unique risks, on the bright side, it also has a
lot of positive aspects and opportunities for growth. For one, the scope for
expansion in India is huge, which despite having the second-largest area
under cultivation, has a fairly small seed industry. Also, seeds being a critical
input, farmers are ready to pay more for a better yielding hybrid, which
means meritorious seed companies are sure to be rewarded with better
realizations. Moreover, sales are mostly on a cash and carry basis, which is in
direct contrast with other agricultural inputs like pesticides, where
receivables are very high. Cash realizations reduce the liquidity pressure on
seed companies, which otherwise would have been higher given the long
production periods
Export Opportunities: Currently, seed exports from India are minuscule
compared to the actual potential. Valued at Rs. 1 billion, they account far less
than 1% of global seed exports. The lack of highly productive and widely
compatible seeds is the main reason for this dismal export performance. Yet,
the country's varied
Seed Exports - Worldwide ($ 3640 Mn)
agro-climatic
2%
11% conditions and cheap
8%
31%
Horticultural Crops labour force can be
Other Agri Crop utilized to convert it
Maize
Herbage crop
into a seed hub with
12%
Beet the help of initiatives
Potato from private sector
Wheat
15%
players and favourable
21%
government policies.
Source: Seed Association of India
The Road Ahead: The Indian seed industry is still in a nascent stage. The
growing demand for agricultural products, driven by the ever-increasing
population and pressure on land, could result in the rapid growth of hybrid
varieties in the coming decades. This, coupled with export opportunities and
favorable legislations, can take this industry to fresh heights. CRISIL believes
that although the industry's credit risk is moderately high today, going
forward, seed companies having good R&D, distribution and storage
facilities and a wide product portfolio are likely to emerge stronger.