IPCL: There it goes again… - Views on News from Equitymaster

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IPCL: There it goes again…

Feb 23, 2002

After contemplating entry for more than a decade, the Government set up Indian Petrochemicals Corporation Ltd. (IPCL) with the mandate of building India's petrochemical industry. The company commissioned the first aromatics and olefins unit in 1973 and '78 respectively. Eyeing the performance of the public sector, private enterprise, by the mid-eighties, ventured into the new sunrise industry.Originally, India's foray into the new industry was planned through Oil & Natural Gas Commission (ONGC) in association with international majors, the likes of Dow Chemicals & Union Carbide. However, negotiations fell through on majority holding. The Government believing in the future of the industry incorporated IPCL in 1969. The company, for most of the next decade and a half, operated on its 130,000 tonnes per annum (TPA) ethylene unit at Baroda. By mid-eighties, the country was beginning to see the first signs of economic de-control. Anticipating higher growth in the industry, and the entry of private competition is likely to have led to the decision to augment capacity.

In 1989, IPCL commissioned its 300,000 TPA gas cracker at Nagothane, which was expanded by 100,000 TPA in 1998. The company followed this expansion with a 300,000 TPA gas cracker at Gandhar in 2000. The aggregate ethylene capacity of the company stands at 830,000 TPA, majority of which was commissioned in the previous decade. With the Government pushing ahead on infrastructure, growth in telecom is likely to rise. Also, growth in other user industries like packaging and consumer durables is slated to register robust growth, as the country experiences its version of consumerism. To meet this rise in demand, IPCL has indicated plans to raise ethylene capacity at Nagothane and Gandhar. Over a two-phase expansion, capacity at each of the locations is likely to be increased to 600,000 TPA. This will be accompanied with corresponding increase in downstream capacity. However, it seems, that a large percentage of the expansion is based more on how markets shape out over the medium term.

The wait and watch strategy seems to be guided by the uncertainty in market demand, excess domestic capacity, especially with the current slowdown and possibility of lower import duties on polymers. Currently, polymer intermediates and polymers attract a duty rate of 35%. The Government is talking of brining maximum duty rate down to 20% over the next three years. Having said that, the company operates close to its nameplate capacity in downstream polymers and augmenting capacity is the only way out to enhance volumes.

With a little more than a quarter of sales generated by polyester intermediates and chemicals, the company financials seem to be more susceptible to cyclical turns. The low interest cover further exacerbates volatility in earnings. In the current fiscal, for the first nine months, polymers have also seen a drop in prices with PP, PE and PVC declining by 8%, 13% and 19% respectively, YoY. Consequently, for the nine months ended, IPCL reported a 9% and 63% drop in topline and bottomline respectively.

With many believing the global and domestic economy are pulling out of the slowdown, and with Asia (excluding Japan) recovering at a faster pace, the regional commodity cycle could turn for the better. Month on month polymer prices, though premature to make a reversal judgement, have improved in February. The fourth quarter performance will be interesting to watch. Expectations are for the cycle to gain momentum in FY04, which could boost earnings. Due to the characteristics mentioned earlier, the company could see an equally sharp turn in earnings over the next two years, as exhibited in FY00 and FY01. The upturn coupled with a likely capacity addition of 150,000 TPA at Nagothane could lead to a double lift in financials.

Disinvestment was always a key trigger but there was some bad taste in the month, as the Government earlier vacillated on the issue. Under the first attempt, in FY99, the disinvestment plan fell through after completing the due diligence stage leading to the scrip severely under-performing the benchmark indices, as valuation retracted to reflect fundamentals. Several investors burnt their fingers. In the second attempt, IPCL disinvestment ran into rough weather with negotiations between India Oil Corp. (IOC) and IPCL reaching stalemate over valuations for the Baroda plant.

As per media reports, the Government now intends to sell IPCL in the current fiscal. Post IBP and VSNL divestment, confidence in the process has significantly improved. This has resulted in markets ramping up the stock price. At Rs 81, the scrip is trading on a multiple of 27.1x 9mFY02 annualised earnings, which seems like deja vu. That said, IOC is once again playing troublemaker. The oil giant has objected to RIL bidding for IPCL, as it will result in a monopoly. The book value of the scrip is Rs 126/ share. The bidding price, based on some back of the envelope calculations, could be close to Rs. 117 per share.

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