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Tata Chemicals: Dismal quarter, good year! - Views on News from Equitymaster

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Tata Chemicals: Dismal quarter, good year!
Jun 5, 2006

Performance Summary
Tata Chemicals recently announced its audited financial results for the year ending March 2006 (FY06). For the full year, healthy volume growth has been the major driver of the good topline performance. On the bottomline front, however, the hardening of raw materials (254% YoY increase in 4QFY06) has stunted the growth for the full year to a muted 4% YoY over FY05. Operating margins for FY06 have fallen by 60 basis points. However, on an overall basis, the performance for FY06 has been enthusing.

Financial performance (Standalone): A snapshot
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 7,196 7,531 4.7% 30,081 35,175 16.9%
Expenditure 5,862 6,494 10.8% 24,926 29,355 17.8%
Operating profit (EBDITA) 1,334 1,037 -22.2% 5,155 5,820 12.9%
EBDITA margin (%) 18.5% 13.8%   17.1% 16.5%  
Other income 116 46 -59.9% 709 562 -20.7%
Interest (net) 53 9 -82.6% 246 93 -62.2%
Depreciation 352 357 1.4% 1,377 1,389 0.9%
Profit before tax 1126 918 -18.5% 4550 5156 13.3%
Extraordinary items (6) (20) 239.0% (21) (47) 127.7%
Tax 9 254 2755.1% 1,124 1,578 40.4%
Profit after tax 1,111 644 -42.0% 3,406 3,530 3.7%
Net profit margin (%) 15.4% 8.6%   11.3% 10.0%  
No. of shares (m) 215.2 240.3   215.2 240.3  
Diluted earnings per share (Rs)       14.2 14.7  
Price to earnings ratio (x)         14.8  

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 FY06?
Volumes and realizations score: Tata Chemicals ended FY06 with a near-17% YoY growth in its topline. The performance was largely driven by the same percentage (i.e. 17% YoY) growth in both its major business segments (Inorganic chemicals and Fertilisers). In the Inorganic chemicals segment, volumes of the soda ash business grew by 4% YoY, from 683,000 metric tonnes (MT) in FY05 to 707,000 MT in FY06. The increase in soda ash volumes can be attributed to the increase in the domestic demand for the product. This is apparent from the fact that exports have fallen by 25% YoY over the previous period. The company continues to be the market leader in this segment, with a 34.7% market share. In order to attain maximum capacity utilization, the company has modernized its Mithapur facility. At the end of the year, it attained over 92% capacity utilization as a result of this.

Thus, the Inorganic chemicals business has performed well for TCL during FY06, and with the Brunner Mond acquisition, growth prospects appear strong, given that it is now the third-largest manufacturer of soda ash globally. End-product prices in Europe continue to remain firm, due to tight supply in that region, and these are expected to sustain over the medium term on the back of strong demand, thus, resulting in continued strong growth for this segment. However, weakness in Chinese prices could have an adverse impact on its business. For the Food additives business (Tata Salt), volume sales have grown almost 2% YoY. Production, however, declined by nearly 6% YoY, largely due to the shut down of its facility at Mithapur for modernization. The company continues to remain the market leader in this space, with a near-50% market share of the National Branded Segment. It should be noted that the definition of this segment has been amended to include only those brands that are available across the country.

TCL’s Fertilisers’ segment has also performed well during FY06, with revenues growing at 17% YoY. In the Urea business, the company continues to be the most energy-efficient producer in the industry. As an energy resource, it uses natural gas and R-LNG as opposed to the traditional usage of naphtha. The joint venture with IMACID of Morocco is yielding benefits for the company, with the supply of phosphoric acid being secured amidst an uncertain domestic policy regime. Due to this factor, even though there has been a shortage of rock phosphate and phosphoric acid globally, production of its phosphatic fertilisers business has not been hampered in FY06. With its thrust on high-value NPK fertilisers, sales volumes for these grew by as much as 40% YoY, while production volumes grew by as much as 53% YoY.

Segmental Revenue
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Inorganic Chemicals            
Revenues 3,197 3,740 17.0% 11,353 13,266 16.8%
% of Net Sales 44.4% 49.7%   37.7% 37.7%  
PBIT 695 654 -5.9% 2,223 3,214 44.6%
PBIT margins 21.7% 17.5%   19.6% 24.2%  
Fertilizers            
Revenues 3,999 3,791 -5.2% 18,728 21,909 17.0%
% of Net Sales 55.6% 50.3%   62.3% 62.3%  
PBIT 486 121 -75.1% 2,078 2,007 -3.4%
PBIT margins 12.2% 3.2%   11.1% 9.2%  
Total            
Total Revenues 7,196 7,531 4.7% 30,081 35,175 16.9%
PBIT 1,180 775 -34.4% 4,301 5,220 21.4%
PBIT margins 16.4% 10.3%   14.3% 14.8%  

Margins squeezed: In FY06, TCL’s Fertilizer business PBIT margins have been under pressure, falling by 190 basis points (1.9%). The company has attributed the squeezing of PBIT margins in the fertilizer business to the increase in trading volumes during the period. Given that trading of fertilisers is a lower margin business, this has adversely impacted the PBIT margins for the segment. PBIT margins in the Inorganic chemicals business, however, saw an impressive expansion of 460 basis points, resulting in an overall positive impact on total PBIT margins. However, overall operating margins contracted by 60 basis points in FY06, due mainly to higher cost of goods sold.

Over the last few quarters…
  1QFY06 2QFY06 3QFY06 4QFY06
Sales growth (%, YoY) 2.0 36.7 21.1 4.7
OPM (%) 23.9 18.7 13.6 13.8
Net Profit growth (%, YoY) 42.3 44.4 1.3 -42.0
Inorganic Chemicals growth (%, YoY) 14.1 26.2 10.7 17.0
Fertilizers growth (%, YoY) -17.4 42.6 25.2 -5.2

Bottomline subdued: Due mainly to a considerably higher effective tax rate of 30.6% in FY06 (24.7% in FY05), the growth at the net profit level was just under 4% YoY, despite lower interest costs and depreciation charges. The fringe benefits tax also contributed to lower profits this fiscal.

The consolidated picture: From the table below, it is amply evident that TCL is benefiting significantly from the Brunner Mond acquisition, as well as the IMACID joint venture. While the topline increases by nearly 15% with the consolidation, the impact on the company’s operating margins are significant, resulting in margins improving by around 170 basis points. The impact on the EPS is over 20%. Thus, the de-risking strategy of TCL to target new markets in terms of geographies appears to be paying off.

Consolidated snapshot: The Brunner Mond effect!
(FY06) Standalone Consolidated Difference
Sales (Rs m) 35,175 40,290 14.5%
Operating profit (Rs m) 5,820 7,360 26.5%
Operating margins (%) 16.5% 18.3% 1.7%
Net profit (Rs m) 3,530 4,283 21.3%
Diluted earnings per share (Rs) 14.7 17.8 21.3%
Price to earnings ratio (x) 14.8 12.2  

In fact, it should be noted that in FY06, the financials of Brunner Mond were consolidated only for the last quarter, given that TCL acquired the company in December 2005, while the IMACID financials were consolidated with effect from May 2005. Given continued buoyancy in soda ash prices in Europe, the expected completion of the Magadi expansion by 1HFY07, a presence in the low cost natural soda ash segment and the company’s continued leadership in this business, the full benefits of the Brunner Mond acquisition are expected to filter through only in FY07.

What to expect?
At the current price of Rs 218, the stock is trading at a price to earnings multiple of 14.8 times FY06 earnings. The board has recommended a dividend of Rs. 7 for FY06 (dividend yield of 3.2%), which is subject to the approval at the AGM. Going forward, the Brunner Mond acquisition during the last quarter of FY06 will have a positive impact on the chemicals business, as it would enable it to compete with international players. Apart from this, improved efficiencies at the Mithapur plant and the expansion of the Magadi facility would enhance efficiencies. The management has indicated that going forward, soda ash volumes would grow by 10%, undoubtedly a positive for the company. Combined with a strong demand environment and firm price scenario in the medium term, leading to expectations of strong realisations, this bodes well for TCL’s Inorganic chemicals business for FY07.

As regards TCL’s Fertiliser business, improved efficiencies and the IMACID joint venture are undoubtedly two major positives. However, government restrictions are a negative. The regulated nature of the fertiliser sector, combined with an uncertain domestic policy environment on the phosphoric acid side, as well as the business’ high dependence on the annual monsoons, are arguably the biggest risks that TCL faces in this business. Nonetheless, we remain positive on TCL from a long-term perspective, and believe that the benefits from the key Brunner Mond acquisition are not fully reflected in the current market price.

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