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Indo Gulf: Top down, bottom up! - Views on News from Equitymaster
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Indo Gulf: Top down, bottom up!
Feb 13, 2006

Performance summary
Indo Gulf Fertilisers recently announced its financial results for the third quarter and nine-month period ended December 2005. Due to a fall in volumes compared to the same period last year, sales recorded a small dip. However, savings on key cost items resulted in margin expansion, which was reflected in the bottomline as well. This was aided by considerably higher other income, lower depreciation charges, interest and taxes. The performance in the nine-month period is almost a mirror image of this quarter’s performance.

Financial performance: A snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Sales 1,737 1,670 -3.9% 5,068 4,840 -4.5%
Expenditure 1,385 1,326 -4.2% 4,207 3,927 -6.6%
Operating profit (EBDITA) 353 345 -2.4% 861 913 6.0%
Operating profit margin (%) 20.3% 20.6%   17.0% 18.9%  
Other income 47 71 52.8% 144 156 8.3%
Depreciation 101 95 -6.1% 301 285 -5.1%
Interest 6 5 -8.9% 16 16 1.9%
Profit before tax 293 316 7.9% 688 767 11.5%
Tax 114 102 -10.4% 268 235 -12.4%
Profit after tax/(loss) 179 213 19.5% 420 532 26.7%
Net profit margin (%) 10.3% 12.8%   8.3% 11.0%  
No. of shares (m) 45.1 45.1   45.1 45.1  
Diluted earnings per share (Rs)*         15.1  
P/E ratio (x)*         15.2  
* P/E ratio calculated on a trailing 12-month basis

What is the company’s business?
Indo Gulf, an Aditya Birla Group Company, has presence in the urea segment with a capacity of 864,600 MT (metric tonnes). The manufacturing facility is located in Jagdishpur (Eastern India), which is towards the end of the HBJ gas pipeline of Gas Authority of India Limited (GAIL). Therefore, Indo Gulf has access to gas, which makes its operations relatively cost-effective. The company’s presence in the Eastern market is of significance because of the fact that almost 60% of the urea consumption in India is accounted for by the Northern and Eastern markets.

What has driven performance in 3QFY06?
Lower volumes drag topline: During 3QFY06, Indo Gulf sold 241,000 MT of urea, as compared to 243,000 MT in 3QFY05 (fall of 0.8% YoY). This does not compare favourably to another player, Tata Chemicals, whose urea volumes grew at a rate of 6.4% YoY. The company’s production of 238,000 MT of urea represented a 110% capacity utilisation, a result of almost full on-stream days operation. The company has, of late, been focusing more on the sales of value-added products like its neem-coated urea brand ‘Krishidev’, where discounts are lower and such products are more effective in terms of higher farm yields. In 9mFY06, sales of ‘Krishidev’ amounted to 25% of total sales, as compared to 18% in 9mFY05.

Cost control and operational efficiencies drive margin expansion: During 3QFY06, Indo Gulf’s focus on operational efficiencies resulted in a 31 basis points margin expansion. Savings in raw material costs, which reduced as a percentage of sales to 50.3% in 3QFY06 compared to 54.0% in 3QFY05, were the main drivers of the good margin performance, despite lower sales. Power and fuel costs were also lower, both as a percentage of sales as well as on an absolute basis. The company has said that the availability of gas, including regassified LNG was more or less satisfactory. We believe that Indo Gulf’s increased usage of gas as the feedstock is the primary contributor to this efficient performance on the raw materials front.

Cost structure: The gas effect!
  3QFY05 3QFY06  
  Rs m % of sales Rs m % of sales Change
Decrease/(increase) in stock-in-trade (51) -2.9% 3 0.2% -106.5%
Consumption of raw materials 938 54.0% 840 50.3% -10.4%
Power & Fuel 249 14.3% 229 13.7% -8.2%
Staff cost 83 4.8% 83 5.0% 0.0%
Other expenditure 166 9.5% 171 10.2% 3.1%
Total expenditure 1,385 79.7% 1,326 79.4% -4.2%

Margin expansion, higher other income, lower costs power profits: The margin expansion was aided by an over-50% rise in other income, as well as lower depreciation charges, interest costs and a considerably lower effective tax rate. These factors combined to result in a 19.5% YoY increase in net profits, causing a 250 basis points jump in net profit margins.

What to expect?
At the current price of Rs 230, the stock is trading at a price to earnings multiple of 10.2 times our expected FY08 earnings. Indo Gulf has applied for approval for de-bottlenecking its urea capacity from 2,620 metric tonnes per day (MTPD) to 3,310 MTPD. Once this comes through, it will be a major driver of increased revenues, going forward. Given the fact that the company had applied for this in April 2004, we believe that the timing of the approval is unpredictable. However, the direction is correct. Going forward, given the favourable weather conditions, the rabi crop is expected to be good and the increase in acreage under rabi crops will also help demand for fertilisers. We expect urea demand to grow by 3% to 4% overall and given Indo Gulf’s position as one of the most cost efficient manufacturers of the fertiliser as well as its presence in the key Eastern and Northern markets of India, the company is expected to be a major beneficiary.

The shareholders of Indo Gulf and Aditya Birla Nuvo Limited (ABNL), formerly Indian Rayon And Industries Limited, at the court-convened meetings held on 28 November 2005 and 16 November 2005, respectively, have approved the Scheme of Amalgamation between the company and ABNL and their respective shareholders and creditors. Upon effectiveness of the scheme, the business of the company will be transferred to ABNL on going concern basis and as consideration for the transfer, ABNL will issue equity shares to the shareholders of the company as on the record date (to be determined in terms of the scheme) in the ratio of one fully paid-up equity share of Rs 10 for every three fully paid-up equity shares of Rs 10 each held in the company.

We had recommended a ‘Buy’ on Indo Gulf in May 2005 at Rs 124 with a target price of Rs 170 from an FY07 perspective. The stock has gained as much as 85% since then, comfortably meeting and exceeding our target. Although we remain positive on the company from a longer-term perspective, current valuations warrant caution.

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