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Tata Chemicals: Robust performance - Views on News from Equitymaster
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Tata Chemicals: Robust performance
Feb 2, 2006

Performance Summary
Tata Chemicals announced its financial results for the third quarter and nine-month period ended December 2005. Driven by good volume growth across its major segments as well as better realisations, the topline witnessed an impressive growth. Stable raw material prices and manufacturing efficiencies resulted in margin expansion. However, due to lower other income and an extraordinary item earned in the corresponding quarter last year, the bottomline growth was only marginal. The performance in the nine-month period has been strong.

Financial performance: A snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Sales 10,391 12,579 21.1% 22,886 27,644 20.8%
Expenditure 9,088 10,873 19.6% 19,064 22,861 19.9%
Operating profit (EBDITA) 1,304 1,706 30.8% 3,822 4,783 25.2%
Operating profit margin (%) 12.5% 13.6%   16.7% 17.3%  
Other income 295 108 -63.5% 593 516 -13.1%
Depreciation 340 346 1.7% 1,025 1,033 0.7%
Interest 62 29 -53.2% 193 84 -56.6%
Profit before tax 1,197 1,438 20.2% 3,196 4,182 30.8%
Extraordinary items 217 (10) -104.7% 213 28 -86.7%
Tax 448 450 0.4% 1,115 1,324 18.8%
Profit after tax/(loss) 966 978 1.3% 2,294 2,886 25.8%
Net profit margin (%) 9.3% 7.8%   10.0% 10.4%  
No. of shares (m) 215.2 239.1   215.2 240.3  
Diluted earnings per share (Rs)*         16.6  
P/E ratio (x)*         14.4  
* P/E ratio calculated on a trailing 12-month basis            

What is the company’s business?
Tata Chemicals (TCL) is the leading manufacturer of inorganic chemicals in the country. The company also manufactures fertilisers and food additives. TCL operates the largest and most integrated inorganic chemicals complex in India, at Mithapur in Gujarat. The company is also the leader in the branded, iodised salt segment. It is also amongst the largest producers of synthetic soda ash in the world. TCL recently acquired a UK-based chemicals company, Brunner Mond, which makes it the third-largest soda ash manufacturer globally and also gives it a presence in the low cost natural soda ash segment, apart from increasing its geographic reach.

What has driven performance in 3QFY06?
Strong volumes and realisations drive the topline: In 3QFY06, TCL reported an impressive 21.1% YoY growth in its topline. This was driven by decent performances from both its major businesses i.e. inorganic chemicals and fertilisers. The inorganic chemicals segment witnessed a 10.7% YoY growth. In the soda ash business, the company continues to be the leader, with a 35.3% market share, higher than the 34.2% share at the end of December 2004. Although sales volumes were slightly lower at 183,000 tonnes compared to 185,000 tonnes in 3QFY05, realisations improved by an average of 5% to 10%. TCL had raised the prices of soda ash in October 2005 by Rs 400 per metric tonne.

In 3QFY06, domestic sales demand grew by just 1.2%. This was partly due to the price wars seen in the detergents market. It should be noted that soda ash depends to a great extent on the detergents industry and when the detergent players start such price wars, there is generally a draw down of stocks and usage of soda ash. However, the management has mentioned in the post-results conference call that it believes that these price wars seem to be over and the market as a whole is looking strong. As regards its food additives business, the company maintained its leadership in the branded salt business. The cement business saw good growth as well, with prices remaining firm.

As regards its fertiliser segment, revenues grew at an impressive 25.2% YoY. This was helped by a good agricultural season. Urea volumes grew by 6.4% YoY. The company put an increased thrust on high-value NPK fertilisers, volumes for which grew by as much as 35.4% YoY. During the quarter, TCL had acquired a 63.5% stake in a UK-based chemicals company called Brunner Mond for Rs 5.1 bn. With this acquisition, the company has now become the third-largest soda ash manufacturer globally and also has access to the low cost natural soda ash segment. Along with significant scale and size, TCL also gets access to newer geographies, including Pakistan, Vietnam, Malaysia and the Philippines, apart from Europe and Africa. The company will be giving out consolidated numbers from the end of May 2006.

Segmental break-up…
(Rs m) 3QFY05 3QFY06 % change
Inorganic chemicals
Revenues 2,972 3,290 10.7%
% of total revenues 28.6% 26.2%  
PBIT 424 896 111.2%
PBIT margins (%) 14.3% 27.2% 13.0%
% of total PBIT 39.2% 52.8%  
Fertilisers
Revenues 7,420 9,289 25.2%
% of total revenues 71.4% 73.8%  
PBIT 657 802 22.0%
PBIT margins (%) 8.9% 8.6% -0.2%
% of total PBIT 60.8% 47.2%  
Total
Revenues 10,391 12,579 21.1%
PBIT 1,081 1,698 57.0%
PBIT margins (%) 10.4% 13.5% 3.1%

Better realisations, stable raw material prices drive margin expansion: As mentioned above, TCL witnessed a strong 101 basis points margin expansion, due partly to the better realisations seen as well as cost control. Raw material prices, particularly coke and coal, remained steady. As regards segmental margins, it was undoubtedly the inorganic chemicals segment that drove the margins higher. PBIT margins for this segment rose by an amazing 13%, while for the fertilisers segment, they actually fell by 23 basis points.

Lower other income, extraordinary items limit profit growth: TCL recorded a mere 1.3% YoY growth in its profit after tax in 3QFY06, despite the strong margin expansion. This was mainly due to considerably lower other income as well as an extraordinary item earned during 3QFY05, thus, pushing up the base. Excluding these items, the net profit grew at an impressive 32.0% YoY.

What to expect?
At the current price of Rs 239, the stock is trading at a price to earnings multiple of 14.4 times trailing 12-month earnings. The business outlook appears to be strong for the soda ash segment, with prices expected to remain firm. The tight supply of the material in Europe is expected to enable prices to remain strong over the medium term, as demand continues to remain firm. With stable prices of raw materials and the company’s ability to increase prices, the prospects of this business seem to be fairly steady. The management expects soda ash volumes to grow between 7% and 10% in FY07, of which around 40% to 45% is expected to be dense soda ash. The company had recently launched its iodised salt brand, Topp iodised salt, in Dubai and Oman and the initial response seems to be encouraging. The company is targeting around 5,000 tonnes of sales over the medium term.

As regards fertilisers, much will depend upon the government policy in the upcoming budget. The company as of now is constrained to selling only what it is permitted to sell. The main issues in this segment will be the government policy, as also tight supply of phosphoric acid and rock phosphate globally. On the second count, Tata Chemicals is well placed, since it has a backward linkage through the tie-up with Indo Maroc Phosphore SA (IMACID), Morocco, a company that manufactures phosphoric acid.

We had recommended a ‘Buy’ on Tata Chemicals in January 2006 at Rs 249 with a target price of Rs 315 from an FY07 perspective. Given the strong performance of the company, its leadership position in most of its segments, strong backward linkages, benefits to accrue from the Brunner Mond acquisition and good business prospects, we continue to remain positive on the company. The main risks would be the highly regulated nature of the fertiliser business and the uncertain government policy on fertilisers, going forward.

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