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Aarati Krishnan

Leveraging technology to benefit farmers.

A FAVOURABLE change in the subsidy regime and strong volume growth in each of its businesses, point to a revival of earnings growth at Tata Chemicals after sedate performance in the first quarter of 2004-05.

Investors can continue to hold the stock, which trades at a price-earnings multiple of about 12 times its trailing earnings. Those with a long-term perspective can also take fresh exposures, especially on declines, at Rs 110-115 levels. Though some of the company's businesses continue to be haunted by concerns over spiralling input costs, the company is initiating measures to contain input price volatility, which could pay off over the medium term.

Volumes on a roll

Each of Tata Chemicals' key businesses are experiencing strong volume growth on the back of robust demand. The fertiliser business, accounting for about 54 per cent of sales, has experienced robust double-digit volume growth in the past six months due to the lag effect of 2003's good monsoon and reasonable rainfall in the company's target markets. The soda ash business (21 per cent of sales) has benefited from healthy domestic and export demand for glass-making, which has revived due to booming construction activity. Volume offtake for other chemicals such as STPP and caustic soda is also likely to look up, on the back of capacity augmentation in user industries.

The outlook for volume growth in each of these segments also appears bright. In fertilisers, the closing gap between demand and supply could work to the favour of low-cost producers such as Tata Chemicals. The company has also made market share gains in each of its key businesses, be it fertilisers, soda ash or cooking salt.

A sharp spike in the prices of key raw materials had, however, prevented the strong volume growth from filtering down to the bottomline in the recent quarters. In the June quarter of 2004-05, the company's net profits actually fell by 7 per cent, despite a sales growth of 25.6 per cent. A two-fold rise in prices of coke, an input for the soda ash, and a spike in prices of key phosphatic fertiliser inputs such as rock phosphate, ammonia and sulphur appear to have dented profit margins.

Relief on inputs front

But a couple of recent developments may help moderate price spirals in some of Tata Chemicals' inputs. After some prolonged wrangling, the Government recently cleared phosphoric acid imports by the industry for 2004-05 at prices close to those contracted by the industry. This would provide significant relief to the company's phosphatic fertiliser business, which it had acquired from the merger of Hind Lever Chemicals, as these costs would now be reimbursed in full by the subsidy. With the business being a big contributor to profits, this development has potential to relieve some of the pressures on the company's profitability. Prices of inputs such as ammonia and sulphur have also cooled off from their peaks, which could also help reduce concerns on profitability.

In the case of inputs such as coke, the tight supply situation could continue to fuel prices. However, Tata Chemicals has recently initiated moves to protect its profit margins from volatile raw material prices. The company is exploring the possibility of securing raw material supplies through long-term contracts.

Cost-cutting and efficiency improvement measures, which have already helped contain a decline in profits in the first quarter, are also in place. Over the medium term, these measures may help reduce the volatility in earnings performance.

Good long-term outlook

The long-term earnings prospects for Tata Chemicals continue to be bright. In the chemicals business, the company's strong market shares, scale economies and forays into high potential segments such as dense soda ash for glass-making, may help impart stable volume growth. In the fertiliser business, the closing gap between demand and supplies, and the shut down of unviable capacities, is likely to ensure stable, but moderate, sales growth rates.

The policy dispensation for the sector also seems to be taking a turn for the better, given the recent resolution of the phosphatic subsidy issue and the ongoing deliberations on LNG prices. The latter will be crucial for the long-term earnings prospects of the urea business.

With the merger of Hind Lever Chemicals, the company's financial parameters have also improved. The addition of Hind Lever Chemicals reserves have brought down the gearing levels significantly and perked up its operating cash flows.

A large investment book and low debt servicing obligations, the company has room to step up its distributions to its shareholders. Tata Chemicals closed 2003-04 with a per share earnings of Rs 10.25, on an equity base expanded by the merger.

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