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Dormant risks in the seed industry: The adage, what you sow is what you reap, couldn't be more

true forIndian agricultural the 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 secondlargest area under cultivation and leads in the production of crops like rice, and wheat pulses. Yet, in terms of yields, the country ranks abysmallycomparison with the rest of the low in world. For instance, it is ranked 52nd in world in terms of the yield on rice and 147th in terms of the the yield on oil crops India's global ranking in agriculture). (see 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. Hybrid seeds could, however, be one way of improving the agricultural sector's productivity. Today, of the around 140 million hectares under cultivation, only 12% are under hybrid seeds. With increasing population putting more pressure on the available land, farmers are bound to shift from conventional to hybrid seeds. This promises tremendous growth for the country's hybrid seed industry. India's global ranking in agriculture: Crop Rice Wheat Coarse grains Pulses Oil crops Cotton seed Production 2 2 4 1 5 4 Area 1 1 3 1 2 1 Yield 52 38 125 138 147 77

Seed industry - An overview: The Indian seed industry began developing with the green revolution 1960s. Initially, the in government-funded agencies developed and distributed hybrid seeds. Private sector players only started participating a large way in this sector around 15 years ago after the Seed Act 1988 in lifted many restrictions on seed development and trade.

Currently, there are around 400 players in the industry catering to a wide variety of crops from cotton and cereals to vegetables and fruits. Although

the industry has significant growth potential, growth rates are low at 34% as a result of low awareness and adaptability of farmers and the dearth of effective hybrid varieties in each crop that are suitable for the country's various agro-climatic conditions. smaller than that in many other countries In terms of value, the Rs. 40 billion seeds market is dominated by private players, who have a 70% share, while the remaining share is held by public varieties developed by government-funded organizations like the agricultural universities. In terms of volume, however, the situation is quite the reverse as public varieties are popular in food crops like paddy and wheat where seed prices are low whereas private players are mainly active in crops like cotton, cereals and vegetables, where realizations are relatively higher. Only a few companies like Nuziveedu Seeds Ltd, Mahyco and Paras Extra Growth Seeds have a turnover of over Rs. 1 billion. Many MNC seed conglomerates are also active in India through tieups or subsidiaries like Monsanto, which is present through Monsanto Mahyco, and Bayer Cropscience with ProAgro. Although the seed industry has an enormous growth potential, it carries some unique risk factors that need to be considered from a credit perspective. 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 industry's turnover comes from cotton hybrids. The importance of cotton for the top line of any seed company can be gauged from the fact that highyielding hybrid cotton seeds fetch around Rs. 400 per packet while similar maize, bajra and jowhar seeds sell for less than Rs. 35. This has resulted in more private and MNC seed companies getting into cotton. In fact, all the big seed companies with a turnover of over Rs. 1 billion are largely into cotton. Some of these companies depend on one or two high-performing hybrids for a major chunk of their revenues. This high dependence on cotton exposes the companies to the risk of lower demand Consequently, the seed industry in India is far

due to: Changes in area under cotton cultivation, which, in turn, depends on the prevailing and expected prices of cotton. Competitors coming out with better hybrids and hampering the prospects of other players. These risks can be mitigated by having a wide product portfolio so that even if there is a drop in demand for one crop, the top line is protected to a certain extent and farmers too are retained within the company's fold. Research&Development: R&D is the first and most critical endeavor of a seed company. It typically takes Rs. 50 to 100 million over a period of seven to eight years to commercialize a hybrid. With most Indian seed companies being small, R&D efforts are not very effective. Even after a hybrid is 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 color, 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 life cycle 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. 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 agro-climatic conditions and cheap labour force can utilized to convert it in to a seed hub with the help of initiatives from private sector players and favorable government policies. 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 legislation, 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.

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