Right Blend - Tata Chemicals

It is said that in ‘iffy’ markets the thumb rule is to go for higher dividend yield companies. But higher dividend yield alone cannot be the guiding factor as growth is equally important. And looking at the current situation, Tata Chemicals seems to be the right blend for the investors. Among the compelling reasons for making the recommendation at current levels is dividend yield (ex-dividend) of 5.45 per cent and commendable financial performance for H1FY09. Strong geographical presence, firm soda ash prices, favourable government policies in the fertilizer segment, expansion and de-bottlenecking of capacities at the right time and, last but not the least, new businesses will also drive growth in the longer term. On the valuation front also, the scrip seems to be well-placed, with the CMP of Rs 175 discounting its FY09E consolidated earnings by just 5.53x and even the EV/EBITDA of just 3.40x making the scrip look more lucrative.

TCL’s business is divided into inorganic chemicals (54 per cent of revenues in FY08) and fertilizers (46 per cent). While inorganic chemicals include soda ash (second-largest producer in world with around 5.5 million tonnes per annum capacity), in fertilizers it has presence in all the key agro-nutrients. In the fertilizer segment, the urea consumption is growing rapidly and the current domestic gap is unlikely to be met in the next two years. As a result, TCL is going in for de-bottlenecking of its urea plant with a capex of Rs 200 crore (internal accruals) which will add 3.40 lakh tonnes (around 39 per cent of current capacity) and is expected to come on stream till January 2009. We are of the opinion that de-bottlenecking of urea will be benefitted by the IPP-linked urea policy.  Even the spurting phosphoric acid prices are also expected to improve the profitability.

In the inorganic chemicals segment, soda ash is expected to boost its performance. The soda ash prices have remained firm in the last two years and hence the realization has increased. In last two years, soda ash prices have increased from Rs 9,800-10,000 per tonne to Rs 13,000 per tonne. Now with the recent acquisition of General Chemical Industrial Products Inc., U.S.A. (GCIP), TCL’s natural soda ash capacity has increased from just about 14 per cent to 59 per cent. As the cost of producing natural soda ash is half that of synthetic one, TCL’s margins are expected to improve going ahead. TCL is also investing around Rs 50 crore for ethanol capacity of 30,000 kilo litres per day and is expected to get operational by January 2009. But it will be too early to comment on the earnings from the new initiative.

As for the financial performance, despite adjusting Rs 308 crore as loss on restatement of long-term foreign borrowings the company has managed to post good growth in bottomline for H1FY09. Looking at the H1 performance, we expect the company to post a bottomline of Rs 715 crore resulting in an EPS of Rs 31 and P/E of 5.70x, giving the scrip scope for upward movement. Hence, we recommend investors to buy the scrip at the current level with a target price of Rs 220 in the next one year.