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Indo Gulf: To the limit

Apr 29, 2005

Performance Summary
Indo Gulf announced its results for the fiscal year ended March 2005. Though it may seem that the company's net profit has fallen significantly, the performance has to be viewed in the context of highly regulated nature of the sector and extraordinary income last year. On the balance, in our view, the FY05 performance is commendable. The sales growth of the company is higher than our estimates owing to better than expected capacity utilisation and higher net realisation per MT.

(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net sales 1,436 1,716 19.5% 5,315 6,784 27.6%
Expenditure 1,212 1,536 26.7% 4,336 5,749 32.6%
Operating profit (EBDITA) 224 180 -19.5% 979 1,035 5.7%
EBDITA margin (%) 15.6% 10.5%   18.4% 15.3%  
Other income 12 60 390.2% 260 204 -21.8%
Interest 5 5 -3.9% 17 14 -14.5%
Depreciation 97 99 1.8% 404 400 -1.1%
Profit before tax 134 136 1.9% 819 825 0.7%
Extraordinary income/(expense) 280 - - 470 - -
Tax 141 (13) - 387 255 -33.9%
Profit after tax/(loss) 273 149 -45.3% 903 569 -36.9%
Net profit margin (%) 19.0% 8.7%   17.0% 8.4%  
No. of shares (m) 45.1 45.1   45.1 45.1  
Diluted earnings per share (Rs)* 24.2 13.2   20.0 12.6  
Price to earnings ratio (x)         9.0  
(* annualised)            

What is the company's business?
Indo Gulf, an Aditya Birla Group Company, has presence in the urea segment with an assessed capacity of 865,000 MT (metric tonne). 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 is accounted for by the Northern and Eastern markets.

What has driven performance in FY05?
Industry clocks 6% production growth: Industry urea production grew by more than 6% in FY05 while consumption was higher by 3%. Demand for urea during the rabi season was higher than the khariff season in line with the rainfall. In this backdrop, Indo Gulf managed to increase urea production by more than 14% during this fiscal owing to a strong rise in number of on-stream days of production (up 8% YoY). Clearly, at the topline level, the company has outperformed our estimates. Not only has capacity utilisation was higher, net realisation also improved owing to higher volume sales of value-add products, where the discounts are lower. We had marginally lowered discounts per MT in our FY05 estimates. But the performance has been better on this aspect as well.

The raw material pressure…
(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Change in stock 2 10 - 71 (58) -
% sales 0.1% 0.6%   1.3% -0.9%  
Raw materials 682 932 36.6% 2,475 3,661 47.9%
% sales 47.5% 54.3%   46.6% 54.0%  
Power and fuel 204 269 32.1% 723 1,012 40.1%
% sales 14.2% 15.7%   13.6% 14.9%  
Salaries 115 133 15.6% 352 400 13.5%
% sales 8.0% 7.8%   6.6% 5.9%  
Other expenses 209 191 -8.6% 715 734 2.7%
% sales 14.6% 11.1%   13.5% 10.8%  

Margins do not reflect the true picture: While operating margins have declined sharply in 4QFY05, investors have to remember that this does not reflect the true picture. Since some of the input costs are pass through in nature (like the use of naphtha, which is reimbursed by the government and booked as revenues), the topline gets inflated. To that extent, operating margins tends to fall faster. Having said that, the fact that higher usage of naphtha and lowering of support prices have reduced margins cannot be understated. Going forward, the company has entered into an agreement with GAIL for supply for natural gas, which we believe will benefit the company in FY06 itself. We have factored in lower naphtha costs and higher gas prices in our estimates for FY06 and to that extent, the margin outlook for FY06 is positive.

PBT grows: Despite margin pressure and lower other income, the profit before tax has increased marginally reflecting the benefit from better sales realisation and robust capacity utilisation. The decline in net profit has to be viewed in the context of extraordinary income last year, which is non-recurring in nature (depends on government policy). Overall, the company's net profit was almost 30% higher than our estimates. This performance is commendable, despite the highly regulated nature of the sector.

What to expect?
The stock currently trades at Rs 114 implying a price to earnings multiple of 9 times FY05 earnings. We remain positive about the company's prospects from a three year perspective owing to the de-bottlenecking and the capacity expansion plans. While these are subject to government approvals, the direction is clear. Demand is expected to grow at 4% per annum and there is shortage of supply in the domestic market. Since Indo Gulf is one of the most efficient manufacturers of urea in the country, any relaxation in government policy will benefit the company immensely. We maintain our Buy view on the stock from a long-term perspective and in a sector like fertilisers, patience is the virtue of the game.

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