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Indo Gulf: Undervalued?

Jan 2, 2001

Indo Gulf Corporation, a part of the Aditya Birla group, is engaged in the manufacture of urea and copper. We did a valuation exercise of its stock price based on both the earnings multiple approach and the replacement theory approach. The current year has been a tough year for urea manufacturers. (This division contributed 27% to the company's turnover in the first half). Besides, there is uncertainty about the government policy with regard to the retention pricing scheme in the current year. This is accompanied by the fact that opening up of imports post April 2001 is likely to put pressure on the domestic fertiliser manufacturers in the coming year.

The company's diversification into copper two years back has helped the company to stabilise its earnings. FY99 marked the commissioning of Indo Gulf`s 100,000 tpa copper smelter at Dahej, Gujarat. This division is expected to account for almost 70% of its revenues and profits in the current year.

Fertiliser business
(Rs) Indo Gulf Tata
Urea production (tonnes per annum) 1,000,000 1,000,000
DAP Capacity (tonnes per annum) 400,000
Approx. replacement value per share* 104.0
CMP 43.0
P/E of comparable companies (X) 9.7
Estimated per share profit of fertiliser business 2.2
Estimated price per share (approx) (A) 20.0
*$500 mn for urea and DAP capacity

In the current year the company commissioned a precious metal refinery and a 400,000 tonne Di-Ammonium phosphate plant. While the precious metal refinery refines gold and silver from the anode slime generated by the copper plant for sale in the domestic market, the DAP plant utilises the phosphoric acid generated by the copper division.

Copper Business
(Rs) Indo Gulf Sterlite
Capacity (tonnes per annum) 100,000 120,000
Approx. replacement value per share* 62.0
P/E of Sterlite Industries (X) 3.8
Estimated per share profit of the copper business 6.3
Estimated price per share (approx) (B) 24.0
* approx. $ 300 m for 100,000 capacity

If one were to go by the annualised earnings based on the half-yearly results, the expected divisional post tax profits and comparative earnings multiples of the company's competitors the stock seems fairly valued. However, if one were to go by the replacement theory and takes into account the capital cost of setting up the fertiliser and the copper facilities the intrinsic price works out to Rs 166 per share.

Current Market Price 48.0
Price based on P/E approach (A+B) 44.0
Price based on replacement value 166.0

The market however seems inclined to go by the profits that the assets generate. And while the copper and precious metal divisions are expected to do well in FY2002 too, the prospects of the urea division seem uncertain.

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