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Tata Chemicals: Well-set, go!

Jul 5, 2006

Tata Chemicals (TCL) is the largest soda ash manufacturer in the country (35% market share) and also has a presence in fertilisers (urea and phosphatic fertilisers), salt (nearly 50% market share) and cement. The company has grown at a good pace over the past few years. Recent initiatives taken by the management have the potential to take the company to another level, in terms of diversification of risk, size and global market presence. In this write-up, we take a brief overview of TCL’s main businesses, viz. fertilisers and chemicals, and gauge as to how well the company is positioned for the future.

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.

Basically, three main types of nutrients are present in fertilisers – nitrogen, phosphorus and potassium. These are collectively known as NPK. TCL has a presence in nitrogenous (urea) and phosphoric fertilisers. The company’s urea plant at Babrala has an installed capacity of 864,000 tonnes per year, accounting for nearly 12% of the total urea produced by the private sector. The plant is amongst the most efficient players in the industry as regards energy consumption, at 5.13 G Cal/MT (Giga calories per metric tonne) of urea. In fact, even by international standards, this is impressive, as the average energy consumption of gas-based urea plants in China is around 6.29 G Cal/MT. TCL also manufactures di-ammonium phosphate (DAP) and complex NPK fertilisers.

A major positive for TCL, apart from the energy efficiency of its Babrala plant, is the fact that the company has tied up the supply of phosphoric acid in the future. This has been done through a tie-up with Indo Maroc Phosphore SA, Morocco (IMACID), a company that manufactures phosphoric acid. TCL has acquired a 33.3% stake in the company, along with 2 other partners, Office Chérifien des Phosphates, Morocco, and Chambal Fertilisers and Chemicals. It should be noted that most of India’s phosphoric acid is imported and, in fact, in FY05, TCL’s performance was impacted, owing to inadequate supply. There are also domestic policy-related issues on this front, with the government yet to release the subsidy for phosphatic fertiliser manufacturers. Thus, the tie-up with IMACID insulates the company from the global tight supply of rock phosphate and phosphoric acid.

Business outlook
Based on our interactions with the industry association and urea companies like TCL, urea consumption touched 20.4 MMT (million metric tonnes) in FY05, representing a 3.4% YoY growth from FY04. At 100% capacity utilisation, the industry can produce 19.5 MMT, which results in a shortfall in production to the tune of 0.9 MMT. Demand is expected to increase by another 3% YoY in FY06 and beyond, resulting in an increase in the shortfall. The government can resort to imports, which, however, are a much more costly option, since imported prices of urea are over 30% higher and the government will have to bear the subsidy burden.

Therefore, a more logical step would be relaxing the capacity utilisation limits for urea manufacturers, especially for efficient manufacturers like Tata Chemicals. The company has applied for a de-bottlenecking exercise, for which approval is awaited (delayed because of political reasons). This, we believe, could be the next major policy initiative that could drive growth for TCL in future. However, given that this industry is so highly dependent on government policy, there is a risk to that extent. The industry’s high dependence on the annual monsoons also exposes it to a greater degree of risk. The government’s delay in fixing the subsidy for phosphoric fertilisers is also a concern.

TCL is India’s largest manufacturer of soda ash, with a 34.7% market share at the end of FY06. The company also makes sodium bicarbonate, iodised salt and cement and is, thus, highly backward integrated in this regard. Soda ash is used in a variety of industries, notably glass, soaps and detergents, chemicals and construction. TCL makes the only branded, food-grade cooking soda in the marketplace, ‘Tata Samunder’. Recently, TCL acquired a UK-based chemical company called Brunner Mond. Brunner Mond is one of the largest soda ash manufacturers in Europe, with three major facilities in the UK, the Netherlands and Kenya. The Kenya facility is natural soda ash (dredged from a lake), which is low cost. TCL also recently started exporting iodised salt under the ‘Topp’ brand name in the Gulf region.

Business outlook
The chemicals business of TCL is one that is expected to see much action, going forward. With the acquisition of Brunner Mond, the combined entity is now the third-largest soda ash maker globally. The acquisition also gives TCL a presence in the low cost natural soda ash segment. The expansions under way include increasing the capacity at Lake Magadi in Kenya from the current 350,000 tonnes to 700,000 tonnes. This will take the total soda ash capacity to 2 MMT. Apart from this, TCL will also get access to new markets, such as Pakistan, Malaysia, Vietnam and the Philippines, apart from counties in Europe and Africa.

The pricing outlook for soda ash appears favourable, as can be gauged from the tight availability of supply in Europe. This trend is expected to continue in the medium-term. Therefore, this could also aid margins of the company. Back-of-the-envelope calculations reveal that the acquisition could add around 23% to the existing entity’s bottomline, thus making it earnings-accretive. In fact, in it’s FY06 annual results release, TCL’s consolidated numbers, including the financials of Brunner Mond for the March quarter, and the IMACID financials from May 2005, show a more favourable picture as compared to the standalone numbers, with topline increasing by nearly 15%, margins expanding by 170 basis points and the bottomline increasing by over 21%.

In fact, these figures take into account Brunner Mond’s financials for just one quarter. We believe that the full impact of this acquisition will be seen in FY07. The expected reduction in import duty on soda ash from the current level of 16% to 8% will also be negated due to the acquisition.

What to expect?
At the current price of Rs 210, the stock is trading at a price to earnings multiple of 14.3 times FY06 earnings (standalone), and at a P/E multiple of 11.8 times its consolidated EPS. The board has recommended a dividend of Rs. 7 for FY06 (dividend yield of 3.3%). We remain positive on TCL’s long-term growth prospects. The Brunner Mond acquisition during the last quarter of FY06 is expected to have a positive impact on the chemicals business. A strong demand environment and a firm price scenario in the medium term leads us to believe that TCL’s Inorganic chemicals business’ growth prospects appear bright in the medium term.

As regards TCL’s fertiliser business, improved efficiencies and the IMACID joint venture are undoubtedly two major positives, while the highly regulated nature of the industry is the major negative. Also, the uncertain domestic policy environment on the phosphoric acid side, as well as the business’ high dependence on the annual monsoons, are two major risks that TCL’s fertilisers business faces.

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