Tata Chemicals: Something special

Investors with a two to three year perspective can consider buying Tata Chemicals. The sale of the urea business in August indicates that the management wishes to reduce dependence on commoditised businesses where the pricing power is low while growing the share of value-added products such as speciality chemicals.

The sale of urea business also helps remove the uncertainty regarding government policy changes and gas availability, and its balance sheet position improves with reduction in debt. Also, better monsoon after a lull of two years is expected to improve rural demand for its fertiliser, pesticides and seeds businesses.

At a price of ₹547, the stock quotes at a price to earnings multiple of 17.9, mid-way between its 5-year PE band.

The stock is reasonably priced considering that its urea business is off the books, and it is increasingly de-risking its portfolio. About 47 per cent of the company’s revenue was from its inorganic chemical business (soda ash, salt, sodium bi-carbonate, marine chemicals and cement), while agri-inputs and consumer business (food business) constituted another 50 and 3 percent respectively. However, in terms of profitability, inorganic chemical’s contribution was much higher at 85 per cent in 2015-16, with its share increasing over the years.

Urea contributed about 12 per cent of the company’s overall revenues in FY-16. However, during 2015-16, its urea business suffered because of tough market conditions and delayed subsidy payment from the government. The divestiture of urea business for ₹2,670 crore would help de-risk the company from policy-related uncertainties.

Tata Chemicals is the world’s second largest producer of soda ash — with footprints in the US, Africa, the UK and India, through its subsidiaries. Asia is its biggest market (72 per cent revenue share), while America and Europe constitute another 14 and 9 per cent respectively.

Its low-cost natural soda-ash — roughly 70 per cent of its overall production capacity — helps save on energy costs as against synthetic soda ash.

A sluggish global economy and a flat demand from China for glass have slowed down demand for soda ash. However, its margin has improved in the first quarter of 2016-17 with fall in input costs. About 21 per cent of soda ash volumes are from India while the rest are from the US, followed by Africa and Europe.

Muted global growth can dampen the revenue from this segment in the immediate future, but domestic demand can help buttress this segment’s prospects. In India, the sale of detergents and glass — the main user industries — is expected to get a leg up with improved rural demand and infrastructure spends of the government into roads, railways and urban development.

Expected improvement in rural spends after two consecutive years of drought is expected to better demand for agro-chemicals such as pesticides, specialty nutrients, seeds and agri-services through its subsidiary, Rallis India, and Metahelix. The company has plans to double sales of de-regulated businesses from its current levels by 2020. It also expects to grow its food portfolio substantially by FY-2020.

TCL’s sales were up 3 per cent to ₹17,708 crore in FY-16 and down 8.5 per cent during the first quarter of 2016-17. Its profit after tax was up 31 per cent to ₹780 crore in FY-16, thanks to lower input prices.

During the first quarter of 2016-17 too, PAT was up by 32 per cent to ₹280 crore compared to the previous year.

Revenue in the coming quarters is expected to fall, once the urea business is excluded. But the company’s profitability will improve with this sale. While the EBIDTA margin of the fertiliser business was 3.4 per cent in FY-16, operating margin for the company as a whole was 12 per cent.

The company debt-to-equity ratio was 1.5 as of March 2016 as against 1.4 the previous year. As of March 2016, the company’s total borrowings were ₹8,378 crore, out of which 15 per cent were borrowings caused by delayed subsidy payment. The cash generated by the sale of the urea business can help bring down the borrowing.

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