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Indo Gulf: Still waiting… - Views on News from Equitymaster
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  • Oct 26, 2004

    Indo Gulf: Still waiting…

    Performance summary
    Indo Gulf, one of the most cost efficient manufacturers of urea in the country, reported encouraging numbers for 2QFY05 at the topline level. Owing to higher raw material costs, primarily arising out of higher naphtha prices, operating margins are lower in 2QFY05 as well as in 1HFY05. Given the contraints with which fertiliser manufacturers operate in India, it is a commendable performance.

    (Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
    Net sales 2,166 2,384 10.0% 2,570 3,330 29.6%
    Expenditure 1,721 2,040 18.6% 1,968 2,826 43.6%
    Operating profit (EBDITA) 446 343 -22.9% 602 504 -16.2%
    EBDITA margin (%) 20.6% 14.4%   23.4% 15.1%  
    Other income 55 32 -41.6% 175 97 -44.5%
    Interest 3 3 -9.4% 7 6 -17.8%
    Depreciation 102 100 -2.5% 198 200 0.8%
    Profit before tax 395 273 -30.9% 572 396 -30.8%
    Extraordinary income/(expense) - - - - - -
    Tax 119 111 -6.4% 173 154 -10.7%
    Profit after tax/(loss) 277 162 -41.4% 399 242 -39.4%
    Net profit margin (%) 12.8% 6.8%   15.5% 7.3%  
    No. of shares (m) 45.1 45.1   45.1 45.1  
    Diluted earnings per share (Rs)* 24.5 14.4   17.7 10.7  
    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 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 2QFY05?
    The topline is restricted:  Due to limitations on the capacity utilisation for urea manufacturers (100%), even cost efficient manufacturers like Indo Gulf do not have adequate incentive to optimally utilise the urea manufacturing facilities. Like 1QFY05, capacity utilisation in 2QFY05 also stood at marginally over 100% levels. The company's initiative to increase contribution from value-add urea products has been paying off well over the last three quarters. We do not foresee any significant growth in the topline, unless the de-bottlenecking plan of the company is approved.

    The raw material pressure...
    (Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
    Change in stock 738 521 -29.4% 20 (18) -
    % sales 34.1% 21.9%   0.8% -0.5%  
    Raw materials 537 947 76.4% 1,107 1,791 61.8%
    % sales 24.8% 39.7%   43.1% 53.8%  
    Power and fuel 148 255 72.0% 333 494 48.5%
    % sales 6.8% 10.7%   13.0% 14.8%  
    Salaries 97 107 10.8% 170 184 8.2%
    % sales 4.5% 4.5%   6.6% 5.5%  
    Other expenses 201 210 4.4% 338 375 11.0%
    % sales 9.3% 8.8%   13.1% 11.3%  

    Where is the gas?  One of the most cost efficient feedstock used in the manufacture of urea is natural gas. However, due to supply limitations, the company had no option but to use naphtha, which is a high cost alternative. With crude prices ruling firm, naphtha prices have increased significantly and this explains the reason for the rise in raw material cost as a percentage of sales in 2QFY05 and 1HFY05. Even in FY04, the company faced similar difficulties. Besides higher raw material costs, as per the stage-II of the fertiliser policy, there was a reduction in prices to the tune of Rs 120 per MT, which impacted margins further.

    Reality bites:  Though the graph above suggests that there has been a significant decline in margins of the company over the last few quarters, it is actually not the case. In FY04 and in FY03, the company received one-time settlements from the government for the arrears (a part of the topline) that were non-recurring in nature. If we adjust for that, we believe that current operating margins are more realistic. Unless the current anomolies in the fertiliser subsidy are changed, we will have a downward bias on margins going forward. This is because the cost of natural gas could be much higher than the past.

    What to expect?
    The stock currently trades at Rs 196 implying a price to earnings multiple of 9 times, 1HFY05 annualised earnings. While the long-term growth prospects are encouraging in light of increased fertiliser consumption per hectare and the government's outline for the agricultural sector (as per the common minimum programme), the near-term prospects is clouded with some uncertainity. The natural gas pricing policy is a crucial factor to watch out for. Having said that, considering the steady rise in demand for urea, the lack of cost effective manufacturing facilities in India and the government objective to prune the subsidy bill, the government may relax the capacity utilisation cap for players like Indo Gulf. The company's board has already approved the de-bottlenecking plan, which is pending for approval on the government's side. If it is okayed, the benefits to the company will be significant.



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