Speculation on likely listing of Tata Sons has resonated in group stocks in the last two weeks and more so on the stock of Tata Chemicals. In the last two weeks, Tata Chemicals stock has rallied 40 per cent from Feb-29 to Mar-7 and has shed 11 per cent today, gaining an overall 25 per cent.

Also read: Deepak Nitrite, Navin Fluorine, SRF, Tata Chemicals — A health check on speciality chemicals

As expectations of an IPO of Tata Sons started making the rounds, investors have started ascribing a value to the 3 per cent stake Tata Chemicals owns in its promoter Tata Sons as per the reports. Even as other entities may own a stake in Tata Sons including Tata Motors and Tata Steel, the soda ash maker owing to its relatively lower market cap of ₹30,000 crore, gained the most driven by the proportion of the impact. According to analyst estimates based on current numbers, if Tata Sons lists, it could have a market cap of around ₹7 lakh crore. This implies, a 3 per cent stake held by Tata Chemicals in Tata Sons, could be worth around ₹20,000 crore, which is equal to 70 per cent of Tata Chemicals’ current market cap.  Tata Chemicals rallied on hopes of value unlocking from listing and receded sharply today as news of Tata Sons avoiding an IPO are doing the rounds. Now that the cat is out of the bag, any valuation of Tata Chemicals will have to factor the stake of Tata Sons, with or without an IPO.

Monetisation plan key to assigning value

But, we recommend that unless a clear path of monetisation of the stake is chalked out, the stake in Tata Sons should not warrant a high valuation and the recent rally should not distract from the valuation of Tata Chemicals’ core business. If the stake in Tata Sons residing with Tata Chemicals can be compared with cash, investors must acknowledge that the cash component generally gets a discount in company valuations. Cash component can rise to as much as 80 per cent of a company’s value in certain cases as investors discount its value significantly and only the core business gets valued despite high cash base. Similarly, stakes held in listed companies are assigned huge holding company discounts which are sometimes even as high as 80-90 per cent.

Hence, unless management announces a special dividend to investors or spins off stakes in listed companies to investors, the value of cash/assets is generally tied to plans on utilisation of these assets, the return expectations and the allied discount to the operational risk of execution.

Value of core business

Tata Chemicals has expanded its capacity in the recent past and is facing slowdown in demand currently and may not be likely to propose a new phase of investment. The management in its recent 3QFY24 results, reported a 10 per cent y-o-y revenue decline and a 54 per cent y-o-y PAT decline. The management indicated a 12-18 month slowdown in demand as US and Europe are facing a slowdown. The excess Chinese production has also pressured prices, exacerbating the impact. The situation is akin to commentary coming from wider speciality chemical companies and the impact of base chemicals manufacturers like Tata Chemicals (Soda ash manufacturing) will be more pronounced.

Two years back, in our bl.portfolio edition dated 20th February, 2022, we had recommended investors accumulate the stock when it was trading at ₹886 . Considering the sharp rise in valuations currently after the recent rally and the difficult business outlook, investors can book profits from the stock. Compared to past five year average of 13 times of one year forward earnings, the stock is trading at 27 times due to speculation on value of its stake in Tata Sons..

Also read: Tata group shares rally on prospects of Tata Sons’ IPO value unlocking

With lot of uncertainty on listing of Tata Sons and complete lack of clarity on how and whether it will be monetised at all post listing, staying invested in the stock based on speculated value of its stake in Tata Sons appears risky.