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IPCL: Taxing times

Apr 27, 2006

Performance Summary
Petrochem and polymers major, IPCL, has declared results for the fourth quarter and fiscal ended March 2006. The results for 4QFY06 has been dismal with bottomline falling 26% YoY on the back of a 13% YoY fall in topline. However, operating margins for the quarter have improved. On the full year basis, however, while the topline has registered a growth of 3% YoY, the year has ended with a handsome bottomline growth of 28% aided by improvement in operating margins. However, it must be noted that the above numbers include the effect of extra-ordinaries.

Financial snapshot…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 26,430 22,980 -13.1% 81,990 84,690 3.3%
Expenditure 21,130 18,100 -14.3% 65,750 67,170 2.2%
Operating profit (EBDITA) 5,300 4,880 -7.9% 16,240 17,520 7.9%
EBDITA margins 20.1% 21.2% 19.8% 20.7%
Other income 390 260 -33.3% 1,320 1,360 3.0%
Interest expenses 290 310 6.9% 1,620 1,180 -27.2%
Depreciation 1,660 1,290 -22.3% 5,060 4,800 -5.1%
Profit before tax 3,740 3,540 -5.3% 10,880 12,900 18.6%
Extraordinary item (620) - (620) 1,200
Tax (240) 1,050 537.5% 2,400 4,050 68.8%
Profit after Tax 3,360 2,490 -25.9% 7,860 10,050 27.9%
Net profit margin 12.7% 10.8% 9.6% 11.9%
No. of shares (m) 249 249 249 249
Diluted earnings per share 31.7 40.5
Price to earning ratio (x) 6.5

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. The company has been increasing its production of polymers on the back of strong prices and domestic demand. Together with RIL, which has a 46% stake, the company accounts for 70% of the petrochemicals capacity in the country.

What has driven performance in FY06?
Realisations saves the day: Beginning with the company's 4QFY06 performance, the net turnover decreased by 13% over the corresponding period of last year, which was on account of 20% lower volume sales and a 7% rise in realisations. For the full year, IPCL has registered a minuscule growth of 3% in topline, which could be attributed to the 4% improvement in realisations, thus offsetting the impact of a marginal decline in sales volume. Increase in selling price was primarily on account of higher price of PE, PP, LAB, PBR and Caustic Soda, partially offset by lower prices of PVC and MEG. The decrease in sales volume was primarily on account of lower sales of acrylic fibers.

Margins show some improvement: Despite rising input prices (largely related to crude oil), IPCL managed to increase it's operating margins by about 1% in both the periods under consideration. It must be noted that price of major inputs like naphtha and propane has increased by 27% and 14% respectively, which is reflected in raw materials as % of sales, which has increased from under 46% in 4QFY05 to 50% in 4QFY06. However, benefits on account of stock adjustments, lower staff costs and other expenditure as percentage of net sales has more than compensated for the rise in raw material costs.

Cost break up…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
(Increase)/decrease in stock 4,330 (110) (30) (2,410)
% Sales 16.4% -0.5% 0.0% -2.8%
Consumption of raw material 9,930 11,270 13.5% 37,430 42,300 13.0%
% Sales 37.6% 49.0% 45.7% 49.9%
Staff cost 1,340 970 -27.6% 4,600 3,690 -19.8%
% Sales 5.1% 4.2% 5.6% 4.4%
Other expenditure 5,530 5,970 8.0% 23,750 23,590 -0.7%
% Sales 20.9% 26.0% 29.0% 27.9%
Total expenses as% of sales 79.9% 78.8% 80.2% 79.3%

Bottomline: While for the quarter and year ending March 2006, the company has reported a decline of 26% YoY and an increase of 28% YoY in net profits respectively, it must be noted that the true picture is somewhat different. This includes the effect of extra-ordinaries, without which the respective net profit growth numbers are a decline of 35% and 11% YoY in the respective periods. It must be noted that while the extraordinary expense of Rs 620 m in 4QFY05 pertains to VRS, the Rs 1,200 m extraordinary income in FY06 pertains to the termination of a contract with Gujarat Chemicals Port Terminal. Further, FY06 numbers include Rs 1,270 m as tax write-back. After adjusting for all this, IPCL's bottomline for FY06 has actually fallen by 11% YoY. The benefits of higher other income and lower interest outgo were negated entirely by the rise in tax provisioning.

Performance over last 4 quarters…
(%) 1QFY06 2QFY06 3QFY06 4QFY06
Net sales growth -25% 3.1% 4.8% 7.2%
Operating profit margin 21.3% 20.4% 19.8% 21.3%
Net profit growth* -43.47% -18.7% 24.6% 9.2%
* Net profit taken is net profit before extraordinary items.

What to expect?
At Rs 264, the stock is trading at a price to earnings multiple of 6.5 times trailing twelve months earnings. We believe that with petroleum products and natural gas (major feedstocks) commanding higher prices, margins going forward would be under pressure.

Further, the company has also announced the merger of 6 polyester manufacturing companies with itself resulting in forward integration into petrochemical chain. These 6 companies are manufacturers of polyester staple fibre (PSF) and polyester filament yarn (PFY) which has feedstock in form of Mono Ethylene Glycol (MEG). IPCL is manufacturer of MEG and considering the global demand-supply dynamics of MEG; it is advantageous to convert MEG into higher value products rather than selling it off at intermediate level. Thus, the proposed merger will perpetuate operational synergies going forward in the form of assured feedstock utilization and enhanced value chain presence. These six companies has sales equivalent to 31% of sales of IPCL and would lead to diversified revenue base of the company and thereby reduce the risk.

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