Tata Chemicals: Buy

Rising prices of soda ash and tight supplies, and policy changes that will lift profitability for the urea business may help the company.



Companies with a large overseas leg to their operations may look unappealing to investors after recent global events, but Tata Chemicals may prove to be an exception. Through a series of acquisitions, the company has managed to secure the supply of inputs and substantially reduce costs for both its chemicals and fertiliser businesses.

These should pay off in the form of improved margins and better resilience to economic downturns over the next three-four years. Subsidiary Rallis India, fast growing player in pesticides, seeds and micronutrients, also holds great promise.

At its current market price of Rs 335, the Tata Chemicals stock trades at a modest price-earnings multiple of about 13 times its trailing 12-month earnings. The price discounts expected earnings for 2011-12 by about 10 times.

Soda ash: Pricing improves

Soda ash accounts for about 38 per cent of Tata Chemicals' consolidated revenues and is used in the manufacture of glass, detergents and other industrial chemicals. After its acquisitions, Tata Chemicals has emerged the second largest soda ash manufacturer in the world with facilities spread across North America (General Chemicals), Europe (Brunner Mond UK), Africa (Magadi Soda) and India. The buyouts have allowed it to manufacture nearly 70 per cent of its soda ash through the natural route, making it one of the lowest cost producers of soda ash in the world.

This has also endowed Tata Chemicals with a diversified user base across four continents, helping ride out cyclical blips in demand. For instance, while Tata Chemicals' European operations took a hit from a severe winter over the past two quarters, North American operations delivered strong growth, with 30 per cent-plus profit margins.

Globally, tight supplies of soda ash have resulted in producers taking a price increase in July 2011, the third such rise since last year.

Higher realisations at Tata Chemicals' European and African operations may help offset pressures from spiralling energy costs. Recently concluded repairs at Brunner Mond Europe and the April 2011 acquisition of British Salt (which ensures brine supplies to this plant) may improve the cost structure at the European operations, even if demand remains muted.



Fertilisers: Linkages secured



If Tata Chemicals' soda ash buyouts helped it diversify, its moves in the fertiliser business aim at securing raw material availability for its Indian fertiliser business, which brings in 36 per cent of its top line.

Tata Chemicals currently manufactures urea, phosphatic and complex fertilisers. The company's 33 per cent stake in IMACID, a phosphoric acid venture in Morocco, has recently been supplemented by a stake in EPM Mining Ventures — a large potash miner in Canada. This secures availability of two key inputs for complex fertilisers in a scenario of global shortages and rising feedstock prices.

The fertiliser business offers scope for sustained volume growth, given the large domestic deficit of fertilisers. Though recent policy moves to free pricing of fertilisers has resulted in a blip in phosphatic fertiliser sales, this may prove temporary. An extended monsoon, recently increased procurement prices for output and the inclusion of urea in the Nutrient Based Subsidy (NBS) umbrella may result in demand staging a revival over the next few months.

NBS is designed to link manufacturing costs for each fertiliser product to import parity prices, with the difference being reimbursed as flat subsidy to producers.

The ability to produce urea at globally competitive costs will, thus, hold the key to profit margins post-NBS. Tata Chemicals is well-placed on this score, as a gas-based producer with the highest energy efficiency among domestic players.

This apart, a big shot in the arm may come from the company's decision to invest $290 million to acquire a 25.1 per cent stake in two 1.3 tonne per annum urea projects at the Republic of Gabon. This project enjoys access to natural gas through a 25 year fixed price contract with additional sops such as a 10-year tax holiday. The Gabon project may enable Tata Chemicals to participate actively in the global fertiliser market at a time of rising prices and demand. The company estimates each urea project to generate $300-350 million in annual operating profits, of which 25 per cent (roughly Rs 350-400 crore) will flow to it.

Finally, the consumer products business made up of iodised salt, low cost water purifier and recently pulses, provides steady cash flows and a non cyclical element to the company's operations.

No balance-sheet worries

Though it has pursued overseas acquisitions with fervour, healthy profitability of its foreign subsidiaries and the sizeable cash flows have kept Tata Chemicals' balance sheet in good health.

The company's net debt:equity stood at a moderate 0.74:1 by end- June 2011, down from 1.11:1 levels three years ago, as the company paid down debt and expanded equity, even as it made new acquisitions. Interest costs have steadily fallen in the last six quarters, with the interest cover at a comfortable 5.5 times.

The company remains well-placed to fund its capex programmes at existing facilities. Its consolidated sales have averaged an 18 per cent growth and operating profits a 14 per cent growth over the last five years, while the per share earnings have vaulted from Rs 14.7 to Rs 26.1.

Operating profit margins on a consolidated basis (17-19 per cent) have consistently remained higher than those for the parent company.

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