Gujarat State Fertilizers & Chemicals Management Meet Note

We, at DSIJ, visited the plant of Gujarat State Fertilizers and Chemicals (GSFC) at Fertilizernagar in Vadodara on March 27, 2012. We also met up with the management to get a better insight into the current scenario of the fertilisers and chemicals industry and to understand the company’s future growth prospects.

The following are the key takeaways from the management meet:-

• At present, the foremost concern that is lurking over the entire fertilisers space is the availability and allocation of natural gas as a major feedstock, and GSFC is no exception to this. However, the management has assured that from the company’s point of view, the availability of gas is secured. In fact, the dependence on imported LNG and the troubled KG-D6 basin operated by Reliance Industries has been kept at its minimum. Out of its total requirement of 2.4 mmscmd, GAIL supplies 1.2 mmscmd of Adjusted Price Mechanism (APM) gas. 0.8 mmscmd is met from the RIL operated KG-D6 basin and the remaining 0.4 mmscmd is met either through supplies from the Panna-Mukta Tapti fields or through spot LNG procurements. While dependence on RIL’s KG-D6 gas still poses some concern, the management has said that it has not witnessed any sort of supply discrepancies from KG-D6 and that they are contracted with RIL to receive gas supply till the year 2014. According to management estimates, the weighted average cost of gas at present is roughly around Rs 11 per scm.

• The company is benefited by its captive ammonia expansion with a capacity of 0.45 MTPA, which protects it from the volatility in global ammonia prices and helps it achieve a competitive edge over its peers. With global ammonia prices bouncing up back to USD 410 per tonne from its low of USD 300 per tonne in Jan 2012, the company has been largely benefited by its backward integration plan for producing captive ammonia. GSFC also pumps all its natural gas into the ammonia plant, which then caters to all its other production activities, thereby helping the company achieve higher efficiency and reduce wastage.
  
  
• The management has indicated that its capacity expansion plans across various product verticals are well on track, and much of it would go live in near future. One project which is expected to be commissioned as soon as Jun 2012 is the 173000 MTPA Methanol plant. As per company estimates, this would add Rs 350 crore to its topline in FY13. GSFC is also in the process of extending its nylon-6 chips manufacturing capacity by setting up a new plant at the Vadodara complex with installed capacity of 15000 MTPA at cost of Rs 125 crore. This plant, which is expected to be commissioned by Feb 2014, would use caprolactam internally. It is expected to add Rs 285 crore to the topline in the years to come.

• The company is also undertaking a modernisation-cum-modification activity costing Rs 90 crore at its caprolactam plants, which would help reduce the consumption of benzene in caprolactam production by 5%. This would in turn help it to keep its industrial segment margins stable, as in recent times the prevailing spreads between caprolactam and benzene prices have witnessed a high amount of volatility, leading to significant margin erosion. With the global caprolactam demand expected to grow at 5%-6% p.a., the management is confident about meeting all its requirements with its current capacities.
  
  
• After significant delay owing to the civil unrest in Tunisia, the infamous Tunisian JV company, TIFERT, is expected to be commissioned by Jul 2012. As per an agreement with Coromandel International, GSFC would procure 0.18 MT of phosphoric acid from this JV at the prevailing market rates to power its DAP production activities. While there will not be any price benefits from this deal, the company can be assured of a regular supply of phosphoric acid, which will help it achieve better capacity utilisation rates for its DAP production. Going forward, the TIFERT JV would help GSFC achieve higher production volumes in DAP. This has been showing a falling trend in recent times due to the uncertainty over the procurement of key feedstock like phosphoric acid.
  
  
• Moving on to the more long-term expansion plans, the company management is very upbeat about its Rs 7000 crore Dahej expansion plan. This would have a Urea plant of 1 MTPA capacity, as well as caprolactam capacity of 0.1 MTPA and a melamine facility to produce 40000 MTPA. As per the latest interaction, the company has received all the pre-requisite approvals from the GoI, and is currently undertaking land allocation and tendering of work activities.
  
  
• The commissioning of the 4^th DAP train of 0.4 MTPA capacity at Sikka is expected to go live by H2FY15. This would take the company’s total DAP manufacturing capacity to 1.5 MTPA.
  
  
• Most of company’s capacity expansion projects would enjoy the benefits of the proposed investment linked capex at an enhanced rate of 150 per cent as against the present 100 per cent announced in the current budget session by the FM.
  
  
• Almost all the capex plans would be funded through internal accruals. The management has guided that the company’s Debt-to-Equity ratio would be maintained at comfortable levels of 1.1-1.3x post expansion.

Despite the numerous growth opportunities highlighted by the management, there are some near-term concerns surrounding GSFC which, in our view, pose a risk. In our previous update on the company (Gujarat State Fertilizer and Chemical Conference Call Update – dated 2^nd Feb 2012), we had raised the issue of the massive inventory pile-up that the company reported in its Dec 2011 quarter results. The management has cautioned that inventories have gone up massively on an all-India basis during this quarter, and the company is in a more comfortable position given its brand recognition and absence of any trading activities. However, GSFC does have a considerable quantity of DAP in its inventory, which, if unsold, would lead to a revaluation loss on account of unclaimed subsidies.

Further, any further rise in input costs or rupee depreciation would grievously affect the company, as it doesn’t seem to have much room left for price hikes given the already dampened demand scenario.

Despite the near-term risks to the company though, we maintain our bullish stance on the counter. Keeping in mind certain compelling near-term growth drivers like the start-up of the methanol plant, the backward benefits of TIFERT commissioning and the modernisation of the caprolactam plant, we believe that the company would wade through the rough waters without much trouble.

At a PE of 4.6x its annualised EPS of Rs 88.2 and a P/BV of 1.1x its FY11 book value of Rs 355, we advise readers to stay invested in the counter from a long-term perspective. The future prospects of GSFC remain very promising.