Gujarat State Fertilizers & Chemicals - Promising A Bumper Yield

Gujarat State Fertilizers & Chemicals is well regarded as a leading fertilisers and industrial chemical products manufacturer. Recent developments in the fertilisers space will prove to be greatly benefi cial for the company and for investors in the counter, says Prabhat Anantharaman.

KEY POINTS:

• The Nutrient Based Subsidy Scheme (NBS) for complex fertilisers has not only helped in encouraging the use of complex nutrients, but has also helped to power efficient players with the ability to price their products at a global level and exercise total control on their revenues and profitability..
• Over the past 50 years, GSFC has stemmed its position as a market leader in caprolactam, AS and melamine, and it is the second largest manufacturer of  DAP in the country, contributing nearly 10 per cent to the total demand.
• GSFC would be a direct beneficiary of the agricultural reforms and custom duty cuts proposed in the Union Budget 2012, having chalked out a robust capex plan to expand its business activities by setting up new capacities for its DAP, urea and phosphoric acid production.
• In light of the recent fall seen in the international prices of essential feedstock, the company’s financial fortunes are expected to improve as the benefits of  TIFERT commissioning and modernisation at the caprolactam plant help reduce cost pressures.

Investors had always been very skeptical  about the fertilisers space, citing government intervention and regulations as some of the principle negative factors affecting the growth of companies in this sector. However, this has pretty much changed over a period of time.

The Nutrient Based Subsidy Scheme (NBS) for complex fertilisers introduced in April 2010 proved to be a game changer for the industry. Under the NBS, the government decided to provide subsidies on complex fertilisers based on the amount of nutrients contained in the fertiliser sold. This not only helped in encouraging the use of complex nutrients, but has also enabled manufacturers to decide the selling prices of fertilisers and helped power efficient players with the ability to price their products at a global level and exercise total control on their revenues and profitability.

A good number of multi-baggers have emerged from this space over the past couple of years. One such stock is Gujarat State Fertilizers and Chemicals (GSFC). Since the announcement of the NBS, the scrip has yielded returns of more than 100 per cent on the bourses, while the BSE 500 was down four per cent over the same period. This robust performance of the stock has also been backed by a strong fundamental show and a consistent dividend paying history since 2005, with the latest dividend yield working out at two per cent.

Going forward, there are certain compelling factors that, we believe, would work in favour of this company and help it to continue to create wealth for its shareholders as it has done in the past. Before we dig further into the company’s growth prospects though, let us briefly glance through its business.

The Core Of Its Existence

GSFC, as its name suggests, is engaged in the manufacture of fertilisers as well as industrial chemical products. The fertilisers segment includes urea, ammonium sulphate (AS), diammonium phosphate (DAP), ammonium phosphate sulphate (APS) and other NPK nutrients. The industrial chemicals segment comprises caprolactam, nylon-6, nylon filament yarn, melamine and other polymer products. Over the past 50 years, the company has stemmed its position as a market leader in caprolactam, AS and melamine, and it is the second largest manufacturer of DAP in the country, contributing nearly 10 per cent to the total demand.

In terms of the revenue stream, GSFC generates 65 per cent of its revenues from the fertilisers segment, while 35 per cent is contributed by industrial chemicals. The company has positioned itself as a dual player, giving it the ability to not only propel further upwards at a faster clip, but also to provide itself with protection against a slowdown in any of its business segments.

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Government Support

The Union Budget 2012-13 has opened up a number of positive opportunities that would change the future of the chemicals and fertilisers sector and that of the company for good. The proposed agricultural reforms like a higher farm outlay of Rs 202 billion, interest subvention provided to farmers paying loans on time, direct cash subsidy to end users of fertilisers and the boost to the Green Revolution would lead to demand creation for fertilisers and would benefit the companies at large.

Moreover, in order to encourage investments in the sector and a consequent fuel growth, the budget has proposed a string of custom duty cuts on the import of equipments for initial setup or expansions. It has also proposed to provide investment-linked capex at an enhanced rate of 150 per cent as against 100 per cent provided for earlier.

GSFC would be a direct beneficiary of these opportunities, having chalked out a robust capex plan to expand its business activities by setting up new capacities for its DAP, urea and phosphoric acid production. Moreover, in our latest visit to the GSFC plant at Vadodara and on interaction with the management, we have learned that the company’s other capex plans (like the setting up of a new methanol facility and nylon-6 chips manufacturing unit) are well on track, with much of it expected to go live in the near future. To read further on this, we suggest that you refer to the article Gujarat State Fertilizers & Chemicals Management Meet Note published on our website on 28th March, 2012.

Improving Cost Efficiencies

In light of the high volatility seen between the spreads of caprolactam and benzene prices over the past couple of months, GSFC has undertaken a modernisation-cum-modification activity at its caprolactam facilities. This exercise would enable the company to reduce the consumption of benzene in caprolactam production by five per cent, which would in turn help it to keep its industrial segment’s margins stable. Based on GSFC’s current volumes, this would help the company increase its per tonne EBIDTA by Rs 2300, translating into an annual profit of Rs 15 crore in the caprolactam segment. The benefits of this cost reduction would also flow into the manufacturing of products like nylon-6 chips, MEK and other polymer products, as caprolactam is used as feedstock for these.

Moving on, in order to achieve higher efficiency and reduce the cost pressures, GSFC has set up a captive ammonia facility. It pumps all its natural gas into this, which then caters to all its other production activities. This also protects it from the volatility in global ammonia prices, and helps it to achieve a competitive edge over its peers. The commissioning of TIFERT (Tunisian Indian Fertilizers), a JV with two Tunisian companies and Coromandel International, which is expected to happen in July 2012, would also enable the company to secure a regular supply of phosphoric acid, to be used as a major feedstock in DAP production. This would help it to ramp up its DAP volumes in excess of 1 MT by FY13, which has seen a decline in production (FY11 DAP production at 0.7 MT) over the past couple of years owing to the uncertainty of raw material availability.

Financials Expected To Improve

On the financial front, GSFC may report lower-than-expected performance for FY 2011-12, as it faced some headwinds in both the industrial and fertilisers segments owing to high input costs and a slowdown in demand. We expect the company to report a marginal six per cent growth in topline for FY12, while the bottomline may show de growth by eight per cent. Despite some pressure on the margin front over the past one year, with its EBIDTA margin at 23 per cent and PAT margin at 14 per cent, GSFC is in a much better position than its peers.

Going forward, in light of the recent fall seen in the international prices of essential feedstock, we expect the company’s financial fortunes to improve as the benefits of TIFERT commissioning and modernisation at the caprolactam plant help reduce cost pressures. A cyclical turnaround in business dynamics with the start of the monsoons season in the June quarter would help bring about an uptick in the demand for fertilisers. Finally, the near-term commissioning of various other product facilities would also help diversify the revenue stream.

Attractive Valuations

On the valuations front, the shares of GSFC are attractively priced at a PE of 3.7x its FY13E EPS of Rs 117.2. While one may attribute its cheap valuations to the Gujarat government’s proposal directing all state PSUs to share up to 30 per cent of profits before tax for social economic development activity, the management has refuted all such talks and confirmed that it has received no such intimation from the state government till date.

Keeping in mind GSFC’s leadership position in both the industrial chemicals and fertilisers segments, coupled with the high return ratios and robust growth opportunities ahead, we advise readers to pick up this counter at the current levels, with a target price of Rs 520.