GSFC well ahead of competitors

Gujarat State Fertilizers and Chemicals (GSFC) held an analysts' presentation on Dec 16, 2011 in Mumbai. The main objective of this meet was to initiate a dialogue with the investor community, present on the table the company's growth prospects, outline the proposed ventures into new segments within the universe of fertilisers and chemicals and finally, to provide some much-needed clarity on the future of the sector going forward.

GSFC has envisaged a robust plan to expand its business activities and garner a larger share in the overall fertilisers and chemicals sector. The company plans to set up new capacities for methanol, nylon and phosphoric acid production. This, according to company estimates, would yield an additional turnover of Rs 1900 cr in the times ahead. Most of these projects are slated to go live over the next 1-2 years, and the preferred route of funding has mainly been through internal accruals.

The company has also drawn plans to expand its DAP production capacity at Sikka by 0.4 MT at a total capex investment of Rs 250 cr. It also plans to operate a methyl ethyl ketone capacity of 24000 MTPA and another phosphoric acid plant, both of which would cost around Rs 1200 cr. However, all of these plans are currently under various stages of approvals and discussion, and hence, we cannot provide any clarity on them as of now.

Going forward, one of the mega projects that GSFC has eyed with much content is setting up an integrated fertiliser and petrochemicals complex at Dahej (Gujarat). This complex would contain a urea plant of 1 MTPA capacity, a caprolactam unit of 0.1 MTPA and a melamine production plant of 40000 MTPA. The total capex for the same is estimated to be around Rs 7000 cr, which would be funded through a mix of internal accruals and debts. As of now, the initial project study has been completed, and the company is under the process of land acquisition and tendering.

A look into the company's last quarter results shows that its topline fell marginally by 3% on a yearly basis as a result of a 13% decline in its fertilisers income. This was mainly because the company was not able to procure phosphoric acid in time to power its DAP production activities. However, a 20% jump in the industrial products segment, led by higher caprolactam revenues that were boosted by higher spreads, helped the company to post a 3% growth in its bottomline (YoY). Despite lower revenues, performance on the PAT level was fueled by lower interest and depreciation expenditure. In fact, thanks to the high prices of caprolactam and increasing spreads, the EBIT margins of the industrial segment also improved from 32% to 34% on a YoY basis.

Moving on, it has been noticed that since Sept 2011, the prices of caprolactam have fallen sharply as a result of lower downstream demand in its user industries, following a bearish and weak global economic outlook. This sharp fall witnessed over the past 2 months will affect the company’s realisations on caprolactam going forward. The previously enjoyed high spreads between caprolactam and its raw material benzene have also been eroded, and the company may see a fall in its industrial segment margins in the coming quarters.

With a view to mitigate this fall, the company has managed to shore up its fertilisers business by successfully completing its procurement of phosphoric acid as a feedstock to power its DAP production in the coming quarters. Moreover, since GSFC consumes caprolactam captively for the production of nylon chips, the company is likely to benefit on account of backward integration. However, given that the contribution of nylon chips to its total revenues is less than that of caprolactam, the benefits of backward integration are limited.

The management has also emphasised that the current spreads prevailing between caprolactam and benzene are pretty much above its break-even levels, and that they will comfortably sustain the current tide, given that their products command a premium in the market.

On the financial and valuations front, the company is well ahead of its industry peers on most counts. While the average industry EBIDTA margins are around 16%, GSFC commands 27%. In comparison to industry PAT margins of 9%, the company is well ahead at 17%. With comfortably high return ratios, it must also be noted that the company is virtually a debt-free entity. At a CMP of Rs 340, the counter is available at 3.81x its annualised EPS of Rs 89.06. On a P/BV basis, the counter appears to be trading at 0.95x its book value of Rs 355 per share, which looks attractive.

Having said all this, currently the fertilisers and chemicals sector seems to be going through some though times as a result of high input costs, flagging demand in complex fertilisers and a soaring subsidy burden on a weak govt. Though GSFC seems to have kept its input costs in check with its ability to transfer costs to consumers, the recent downtrend seen in its industrial segment and the gloomy outlook for the fertilisers business does seem to have had an impact on the company in the short run. We advise investors to adopt a wait-and-watch strategy on the company till the next batch of results are out.