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Indo Gulf: Waiting for a kicker

Aug 6, 2004

Introduction to results
Indo Gulf, one of the country's most cost efficient producers of urea, reported a sharp rise in sales in 1QFY05. Though the topline growth was significant, the bottomline fell by 35% due to lower other income and pressure on operating margins owing to higher raw material and power cost.

(Rs m) 1QFY04 1QFY05 Change
Sales (MT) 0.7 1.4 111.9%
Net sales 403 947 134.8%
Other income 120 65 -45.9%
Expenditure 247 786 218.0%
Operating profit (EBDITA) 156 161 2.9%
Operating profit margin (%) 38.7% 17.0%  
Interest 4 3 -24.4%
Depreciation 96 100 4.2%
Profit before tax 176 123 -30.4%
Extraordinary items - - -
Tax 54 43 -20.3%
Profit after tax/(loss) 123 80 -34.9%
Net profit margin (%) 30.4% 8.4%  
No. of shares (m) 45.1 45.1  
Diluted earnings per share (Rs)* 10.9 7.1  
P/E ratio (x)   15.0  
(* annualised)      

Background
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 pipleline 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 1QFY05?
Production static but sales volume doubles: Urea manufacturers have constraints due to cap in capacity utilisation, which is restricted to 100% (a company cannot produce beyond this limit). While the production of urea in 1QFY05 was more or less the same as last year (2.38 MT in 1QFY05 as compared to 2.37 MT in 1QFY04), the company has managed to more than double volume sales in 1QFY05. This is one of the key reasons behind the spurt in volumes. We do not expect this trend to continue in the forthcoming quarters. Value sales have increased owing to sales of higher-value added products, despite restriction on prices of urea.

Margins suffer: One of the key raw materials used in the manufacture of urea is natural gas. Due to supply constraints from GAIL (Gas Authority of India), raw material costs have escalated in 1QFY05. As opposed to using gas (cost effective as compared to naphtha), the company is being forced to depend on naphtha as a source of energy, which is the key reason for operating margin pressure. In FY04 for instance, raw material cost as a percentage of sales rose to 45% (38% in FY03) due to higher naphtha purchases. The concern going forward is not only availability but also prices, which are likely to be increased given the spurt in crude prices globally.

Lower other income impacts bottomline: Other income contributed to as high as 98% of net profit of Indo Gulf in 1QFY04. Due to lower returns from debt mutual funds, this figure has fallen, impacting the overall net profit margins. We expect this trend to continue in the rest of the quarters as well. Though operating margins seem to have declined sharply from the previous year's level, the company had extraordinary income from previous arrears. We had factored in margin decline in our assumption and therefore, it is not a key cause of concern.

What to expect?
The stock currently trades at Rs 106 implying a P/E multiple (price to earnings) of 15x annualised 1QFY05 earnings. While the growth prospects for urea manufacturers are promising in light of low usage in the agricultural sector and structural improvement in demand, concerns are also higher. Possibility of a rise in gas prices, availability of gas and firmness in crude prices in the international market (this would result in increase in naphtha prices) and unfavorable government policies increases the risk profile of the stock. However, the company has applied for de-bottlenecking of existing capacity, which if approved, will propel growth in the near-term.

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