Stock Fundamentals

Why you should accumulate Tata Chemicals stock

Sai Prabhakar Yadavalli |BL Research Bureau | Updated on: Feb 19, 2022

Favourable demand-supply gap and cost control record augurs well for the stock trading at ₹886 levels

After posting many years of flat to negative growth, impacted by the pandemic, restructuring of divisions (salt and urea business de-merged) and demand-supply imbalance in soda ash, Tata Chemicals Ltd. (TCL) can be expected to report good revenue growth in FY22-23. The accompanying EBITDA margins are also expected to report a growing trajectory despite higher input costs. Global demand recovery and cost control measures underline the optimism for TCL. The recent re-rating has factored much of the optimism, but investors can accumulate the reasonably priced basic chemicals stock (17 times FY23 earnings), which can be a proxy to industrial and consumer growth with a better handle on input costs.

TCL is the 3rd largest global soda ash manufacturer (primary product) operating from plants in India, the US, the UK and Kenya. Soda ash is a basic chemical commodity used across industries and is synthetically manufactured using limestone and salt brine. It finds applications in glass making, detergents, food additives, pharmaceuticals, and construction. Basic chemistry segment - 80 per cent of the business is derived from Soda ash, sodium bicarbonate, and salt. The specialty business (20 per cent) reflects its controlling stake in Rallis (crop protection and seeds), prebiotics and silica.

Demand growth

The pandemic impacted the demand for soda ash in FY21 with the sales volume declining by 11 per cent in the period. The company recovered with volumes growing at 27 per cent in 9MFY22, despite a maintenance shutdown in Q3FY22 across facilities in US, Kenya, and India.

The company management is confident of sustaining the higher base owing to demand-supply gap in global soda ash. Against the global operational capacity of close to 61 million tonnes the company estimates that close to 3.8 million tonnes or 5 per cent of existing capacity is the shortfall. This allows for higher utilisation amongst existing capacities as the next round of green/brown field expansion could take around 2 years to materialise. The company’s optimism may have been based on pollution concerns in developed and Chinese industries, similar to the theme across specialty chemicals. As Chinese economy targets a spot higher along the value chain in manufacturing, combined with pollution drive across the country, it may turn a net importer. In Q2FY22 TCL reported that it started supplies to Chinese markets, which previously had been a net exporter in soda ash as close to one million tonnes of capacity was closed early this year as well. Across developed markets as well, Europe for instance, pollution concerns for industries using fossil fuels is driving a high carbon cost, which escalated drastically in the last one year. On supply side large producing regions are constrained by regulation.

On the demand side, probable post-pandemic individual consumption growth and governments infrastructure push may add to the normal 1-1.5 per cent global demand growth in soda ash. Solar glass and lithium batteries also utilise soda ash (to the tune of 2-2.5 million tonnes.) in their manufacturing which can be another lever for growth as their applications in green solutions increases.

Factors affecting margin

In FY21 margins were impacted by weaker demand, supply chain costs, and energy prices, the impact of which was felt across US, UK, and Indian operations. The unabsorbed fixed costs from lower production were exacerbated by higher energy costs and shortage of freight capacity across sea and roadways. Higher input costs continue into FY22 even as demand correction and supply issues may have softened. US operations faced lower export volumes (lower shipping availability) compared to US domestic volumes, whose recovery has helped absorb incremental fixed costs. UK in particular, faced high carbon costs which, had inflated from EUR 25 to around EUR 75 per tonne of carbon and continues to have a high impact even in Q3FY22. The company had installed a carbon capture mechanism and has entered hedging contracts, which should mitigate the costs going forward.

The company announced renewed contracts across US and UK which should translate well for margin trajectory. Firstly, the new multi-year contracts are at a higher price and should be expected to flow through starting from Q4FY22. Also, the company aims for a price pass through in contracts, above a certain threshold, which should take care of future price volatilities in energy or other input prices as well.

Overall, global demand outpacing supply should sustain higher margins for TCL, which is also investing in debottlenecking capacities and thus deriving higher leverage from fixed cost base. But in commodities, the timing of input price volatility cannot always be matched with price pass through while ensuring volume growth.

Other lines

Covid pandemic and ensuing focus on conservative capital spend is reflected in TCL’s expansion plans. Debottlenecking and expanding capacities by 20-30 per cent across soda ash and salts in Mithapur, India, with an investment of ₹2,400 crore is expected to be completed by FY23-24. Expansion in Rallis and nutrition segment is also on the cards, all of which is in line with TCL’s intention to focus on segments with clear demand visibility. TCL added nutrition products (prebiotics) and high-grade silica used in tyre manufacturing which are expected to scale up in the next two years. The plans mentioned earlier (pre-pandemic), with no new incremental updates, included increasing speciality contribution to close to 50 per cent and battery cell plans for which land was also acquired.

Finances and valuation

TCL carries significant debt at 2.7 times FY21 net debt to EBITDA, but the company has strong cash flows (CFO/EBITDA at average of 1.13 times last two years) and the company has been intent on bringing the debt down as well. TCL re-rated in mid-2020 in the pandemic and has sustained the growth in valuations since at 17 times FY23 earnings. TCL offers mid-teens revenue growth expectations and improvement in margins by 150-200 basis points by FY23 (Bloomberg consensus) from 18 per cent in 9MFY22 supporting higher valuations. Investors can accumulate the stock which offers relatively better ability to pass on inflation and be exposed to higher growth.

Healthy growth outlook
Higher margins to sustain
Strong cash flows
Published on February 19, 2022

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