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Indo Gulf: Is it a fair valuation?

Jul 22, 2002

In a resturcturing proposal approved by the boards of Hindalco and Indo Gulf Corporation, a consolidation of Indo Gulf's copper business has been approved with Hindalco. The fertiliser business of Indo Gulf would be transferred to a new company 'Indo Gulf Fertilisers'. Do Indo Gulf shareholders tend to benefit from value unlocking? First the facts of the deal.

A swap ratio of 1: 12 for copper business. In other words, 1 share of Hindalco for every 12 shares of Indo Gulf for transfer of copper business to Hindalco. This includes DAP (Di-Ammonia Phosphate), the precious metal refinery and assets of Dahej Harbour and Infrastructure Ltd (DHIL), which is a wholly owned subsidiary of Indo Gulf Corporation. A swap ratio of 1:5 for fertiliser business. In other words, 1 share of Indo Gulf Fertilisers (IGF) for every 5 shares of Indo Gulf Corporation (IGF).

At Friday's close, Indo Gulf Corporation and Hindalco shares were trading at Rs 60 and Rs 678 respectively. Let us first analyse, what is the per share valuation of Indo Gulf's copper business for its shareholders. Considering the swap ratio of 1:12, it would effectively mean, a per share value of Rs 57.

Copper Business
No. of Shares (In m) 225
Effective shares of Hindalco (as per swap ratio) (In m) 18.8
Current market price of Hindalco (Rs) 678
Therefore, Valuation accorded to Indo Gulf Copper business (Rs m) 12,713
Per share value of copper business for current Indo Gulf Shareholders (Rs) 56.5

Indo Gulf currently has a copper production capacity of 150,000 tonnes. However, the company is contemplating another brownfield expansion, which could be an addition of 100,000 tonnes. In our projections, we expected the company to complete the expansion by the end of the current financial year. On account of synergies with the copper business, the segment includes DAP and precious metal business in copper revenues. Thus, considering a market capitalisation of Rs 12,713 m accorded to the copper business, the market cap/ sales ratio for FY02 is 0.6, which compares favourably with its peer Sterlite Industries. However, the same becomes lackluster after considering the capacity expansion going forward.

Price/ Sales Ratio of Copper Business
  Capacity (In mt) Production (mt) Sales (Rs m) Price/ Sales (x)
Copper Sales - FY02 150,000 151,445 22,380 0.6
Copper Sales - FY03 E 150,000 187,500 28,832 0.4
Copper Sales - FY04 E 250,000 275,000 39,949 0.3

The urea business of Indo Gulf would be transferred to a new company, Indo Gulf Fertilisers Ltd. We have tried to analyse a worst case and best case value unlocking for Indo Gulf shareholders from the fertilisers business. The urea business logged sales of Rs 4,678 m in FY02. Considering the production cap and the current fertiliser policy of the government, the turnover from the fertiliser business is expected to remain stagnant. In the worst case scenario, per share valuation of the fertiliser business would be Rs 6.2 considering a price to sales ratio of 0.3x. In the best case scenario, the same would be Rs 10 per share, considering a price to sales ratio of 0.5x.

Expected Valuation of Indo Gulf Fertilisers P/Sales - 0.3 P/Sales - 0.4 P/Sales - 0.5
Sales- FY02 (Rs m) 4,678 4,678 4,678
Market Capitalisation of Indo Gulf Fertilisers (Rs m) 1,403 1,871 2,339
Per share value for current Indo Gulf Corporation Shareholders (Rs) 6.2 8.3 10.4

Considering the above valuations for implied valuation of copper business and derived valuation of fertiliser business, Indo Gulf shareholders do not seem to be unlocking much value from the consolidation move. This is ignoring any valuations for Dahej Harbour assets. Even in the best case scenario, the implied valuation given by the board for Indo Gulf seems to be Rs 67, 11% over the current market price. Considering the ongoing expansion plans of the company, this does not seem to be attractive. We would be soon updating this report with more detailed analysis.

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