Case 046Macro and commodity sensitivityWarm up

Rainfall is 10% below normal. Kheta Agri Inputs' volumes historically fall 0.6% for each 1% rainfall shortfall. With a 12% EBITDA margin and 40% of costs fixed, what happens to volumes and profit?

The situation

Kheta Agri Inputs sells crop protection chemicals and seeds to farmers through dealers. Revenue is Rs 2,500 crore and EBITDA Rs 300 crore, a 12% margin. Of its Rs 2,200 crore of costs, 40% are fixed in the short run: plants, staff and the field force. Over the last ten years its volumes have moved about 0.6% for every 1% that rainfall missed or beat the long-run normal.

The weather office now expects this season's rainfall to finish 10% below normal. Prices are expected to hold.

Your task

What happens to Kheta's volumes, revenue and EBITDA, and how much would you trust the answer?

Quick check

Rainfall is 10% short. Roughly how far does EBITDA fall?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Volumes fall about 6% and EBITDA about 24%, from Rs 300 crore to about Rs 229 crore, with the margin down from 12% to about 9.8%. The first link is the 0.6 elasticity: a 10% shortfall cuts volumes 6%. The second is operating leverage: 40% of costs stay, so each 1% of volume carries about 3.9% of EBITDA. Trust the direction more than the decimal: in the worst past drought volumes fell harder than the line predicts.

Step 1How do you chain two sensitivities?

A tea stall near a college loses customers in the holidays, and the owner still pays rent and his helper. Fewer students means fewer cups, and fewer cups means much less profit. Take one link at a time: rainfall to volume, then volume to profit, and multiply. Rainfall 10% short times 0.6 is volumes down 6%. Revenue falls to Rs 2,350 crore. Variable costs, Rs 1,320 crore, fall 6% too, but Rs 880 crore of fixed costs stay, so EBITDA drops to about Rs 229 crore.

Chain the sensitivities one link at a timeRainfall-10%vs normalVolumes-6%tonnes soldEBITDA-23.6%Rs 300 to 229 crorex 0.6elasticityx 3.9operatingleverageElasticity 0.6: from ten years of rainfall against volumes. Operating leverage: 47.2% contributionmargin over 12% EBITDA margin, because 40% of costs stay when volume falls.
Rainfall 10% below normal cuts Kheta's volumes 6% through an elasticity of 0.6, and operating leverage of about 3.9 turns that into an EBITDA fall of 23.6%, from Rs 300 crore to Rs 229 crore.
The relationship
ΔEBITDA=−10%×0.6⏟volume×47.2%12%⏟operating leverage≈−23.6%\Delta\text{EBITDA} = \underbrace{-10\% \times 0.6}_{\text{volume}} \times \underbrace{\frac{47.2\%}{12\%}}_{\text{operating leverage}} \approx -23.6\%
0.6volume elasticity to rainfall, from ten years of history
47.2%contribution margin: revenue less variable costs, as a share of revenue
12%EBITDA margin before the shortfall
What it says in wordsThe profit change is the rainfall shortfall times the volume elasticity times the operating leverage.
Step 2How much should you trust the 0.6?

It is a line fitted through ten points, so treat it as an average, not a law. The worst drought year sits below the line: at 15% below normal, volumes fell 11.5%, not the 9% the slope suggests, because farmers skip whole applications when a crop is already lost. Rainfall is also a blunt measure; when and where the rain falls matters more than the season's total. A 10% shortfall concentrated in the sowing months would hit harder than the same shortfall spread evenly. So present 24% as the central case with more room on the downside than the upside.

Where the 0.6 comes from: ten years of rainfall against volumes-10%-5%+5%slope about 0.59Worst drought: below the lineThis year: -10%-15%-10%-5%0%+5%+10%Rainfall against the long-run normalVolume change
Across ten years Kheta's volumes moved about 0.59% for each 1% of rainfall deviation, but in the worst drought, 15% below normal, volumes fell 11.5%, more than the fitted line predicts.

Finish with the second-order effects an analyst would check. Dealers who sold on credit may struggle to collect from farmers, so receivables and bad debts rise. Unsold stock carried into the next season ties up cash. Neither shows up in the EBITDA arithmetic, and both are what a lender or a portfolio manager will ask about next.

Where candidates lose it

The common loss is stopping at the first link and cutting EBITDA 6%, or skipping the elasticity and cutting it 10%. Each sensitivity is a separate multiplication; saying them out loud one at a time keeps you from merging them.

The second is presenting the answer to one decimal place. An elasticity fitted on ten years, with a drought year sitting off the line, supports a direction and a range, and the interviewer is listening for that caution.

What the interviewer asks next

  • Rainfall is 5% above normal instead. What happens, and is the effect symmetric?
  • How would you adjust the elasticity if irrigated area has grown over the decade?
  • Kheta could cut its field force by 10% in a bad season. How much EBITDA does that save?

Company names and figures are illustrative.