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IPCL: Signs of weakness

Jan 19, 2006

Performance summary
IPCL, among the leaders in the polymers and other related petrochemical products, announced its 3QFY06 performance. With polymer demand growing at a robust pace in the domestic market in 9mFY06, the company's sales volumes grew at 15.8% YoY in this period. Price increase was marginal. In fact, there was a 4.6% decline in average realisations in 3QFY06. While raw material pressure persisted, lower interest expense enabled the company to grow its net profits at a faster rate.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 19,270 21,430 11.2% 55,560 61,710 11.1%
Expenditure 15,330 17,190 12.1% 44,620 49,070 10.0%
Operating profit (EBDITA) 3,940 4,240 7.6% 10,940 12,640 15.5%
EBDITA margin (%) 20.4% 19.8%   19.7% 20.5%  
Other income 370 360 -2.7% 930 1,100 18.3%
Interest 340 270 -20.6% 1,330 870 -34.6%
Depreciation 1,150 1,190 3.5% 3,400 3,510 3.2%
Profit before tax 2,820 3,140 11.3% 7,140 9,360 31.1%
Extraordinary items - -   - 1,200  
Tax 930 860 -7.5% 2,640 3,000 13.6%
Profit after tax/(loss) 1,890 2,280 20.6% 4,500 7,560 68.0%
Net profit margin (%) 9.8% 10.6%   8.1% 12.3%  
No. of shares (m) 249.0 249.0   249.0 249.0  
Diluted earnings per share (Rs)*         41.5  
Price to earnings ratio (x)         6.2  
(*trailing twelve months earnings, excluding extraordinary items)

What is the company's business?
IPCL is the second largest producer of polymer products (PP, PVC and PE) and has a market share of 27%. Polymers form a major portion of the topline (70%) and are expected to remain the same in the future, with demand surging from various spheres of the economic activities viz. packaging, automobile and construction industry. Increased spending by the government on infrastructure facilities is another reason for the uptrend in production. The company has been increasing its production of polymers on the back of strong prices and domestic demand. Together with RIL, which is a 46% stakeholder, the company accounts for 70% of the petrochemicals capacity in the country.

What influenced performance in 9mFY06?
Domestic demand robust: As per the company, the domestic demand for polymers grew at a healthy pace of 21% in the first nine months of the fiscal (the growth in 1HFY06 was 12% YoY). However, it has to be remembered that domestic polymer demand decreased 3% in 9mFY05 due to high prices and inventory corrections in the downstream industry. To that extent, the growth in demand is magnified. Coming to IPCL's performance, while domestic sales increased by 6% YoY in 9mFY06, exports grew at a much faster rate of 35% YoY (21% of sales as compared to 17% in the same period last year). During 3QFY06, as mentioned earlier, there was a decline in product prices in line with international markets (PVC prices fell by as much as 14% YoY in 3QFY06).

Higher gas cost subdues margins: Following the upward revision of natural gas prices towards the end of June 2005, the cost of natural gas for IPCL has gone up by 50%. While better availability of gas (from PMT fields) has resulted in substitution of the high-cost propane, considering the fact that the company has two gas-based cracker plants (Gandhar and Nagothane), the overall negative impact is apparent from the expenditure table below. Not only natural gas, but also the prices of naphtha (another key raw material) have increased (19% YoY in 9mFY06). The reduction in manpower count over the last two years has helped IPCL reduce staff cost as a percentage of sales in 9mFY06.

Expenditure table
(%) of sales 3QFY05 3QFY06 9mFY05 9mFY06
Consumption of raw materials 40.6% 48.7% 41.7% 46.6%
Staff cost 5.9% 4.2% 5.9% 4.4%
Other expenditure 33.0% 27.3% 32.7% 28.6%

Net profit boosted by one-time income: Net profit in 9mFY06 has risen by 68% YoY owing to one-time extraordinary income in 2QFY06, which represents the write-back of the provision of Rs 1,200 m pertaining to Take or Pay agreement entered into with Gujarat Chemicals Port Terminal Company Ltd (GCPTCL). If one were to exclude the same, the growth in net profit is lower at 41% YoY. The sharp fall in interest cost has been a trend ever since Reliance acquired IPCL (gross debt was reduced by 35% in FY05).

Over the last few quarters: As is evident from the graph, demand for polymers has been volatile in the recent past, owing to both domestic and global factors. The company has been of the view that with capacity addition growing at a slower rate as compared to demand, prices are likely to be remunerative in FY06. But the actual increase in realisation in 9mFY06 has been marginal at around 2.5% YoY increase in 9mFY06. Despite higher input cost, IPCL has been able to maintain operating margins at the same level largely on account of control over other expenses.

What to expect?
At Rs 257, the stock is trading at a price to earnings multiple of 6.2 times trailing twelve months earnings (excluding extraordinary items). Since petrochemical sector is global in nature i.e. prices are governed more by global factors, it is difficult to take a view on prices, as volatility is likely to be the name of the game. Also, we believe that the scope for reduction in costs is likely to be slower going forward. With raw material prices continuing to remain firm, the pressure on margins is likely to be amplified.

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