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Aarati Krishnan

EID Parry: Pare exposures Coromandel Fertilisers: Buy

The restructuring may pay off for Coromandel Fertilisers if there is a recovery in the farm sector.

GIVEN the strong inter-linkages between their operations, there was never much doubt that the fertiliser businesses of EID Parry and Coromandel Fertilisers would eventually be brought under one roof. The only uncertainty was about the timing and the manner in which the consolidation would be structured. With EID Parry now announcing that its farm inputs division would be hived off and merged with Coromandel Fertilisers (CFL), this consolidation is set to take formal shape.

Given that the farm inputs division was a key contributor to EID Parry's revenues and earnings, the hive-off of the division would negatively impact both its revenues and earnings.

The company has sought to compensate shareholders by offering them one share in CFL for every three held in EID Parry.

This will ensure that EID Parry shareholders are not completely deprived of the earnings from the farm inputs division due to the hive-off.

The fresh issue of equity will see CFL's equity base go up from Rs 19.5 crore to Rs 25.4 crore, a 30 per cent expansion.

Advantage Coromandel

The swap ratio is roughly in sync with the pre-tax profits of the two entities in 2002-03. In 2002-03, CFL's profit before taxes (Rs 59 crore) was roughly thrice EID Parry's farm inputs division (Rs 19.8 crore).

But to evaluate the swap ratio based on the 2002-03 numbers may distort the picture as EID Parry's profits in 2002-03 were impacted by quite a few one-off factors. In 2001-02, a reasonably good year for the farm sector, EID Parry's farm inputs division generated Rs 44 crore in pre-tax profits, which was roughly 40 per cent of CFL's pre-tax profits for that year.

This suggests that CFL's per share earnings could benefit significantly from the merger, if the fertiliser business stages a recovery.

Strategic benefits

For CFL, there are also strategic benefits from the merger. Until now, the profit margins from the fertiliser operations were distributed between the two companies. After the de-merger, all the farm input operations would be integrated with CFL.

With a larger scale of operations and a formidable distribution network in the southern markets at its command, CFL would be in a better position to take on competition, at a time when the industry is bracing to meet the challenges of free markets.

A blip for EID Parry

On the other hand, the immediate financial impact of the de-merger on EID Parry could be negative. For one, the de-merger is likely to reduce the revenues of EID Parry by a greater extent than it would add to CFL's. This is because the bulk of complex fertilisers produced by CFL are now marketed through EID Parry. In 2002-03, the farm inputs division contributed as much as Rs 736 crore to the Rs 1,376 crore revenues of EID Parry. But Rs 392 crore of this revenue came from the marketing of CFL's produce.

Therefore, the hive-off may reduce EID Parry's revenues, post-demerger, by as much as 53 per cent. The net addition to CFL's revenues would be at a much lower Rs 344 crore. The impact of the hive-off on EID Parry's profits could also be sizeable. In 2002-03, the farm inputs division contributed Rs 19.84 crore (34 per cent of PBT) to the company's profits before taxes. This was after a sharp fall in offtake of farm inputs due to drought and a one-time impact from downward revision in subsidies on fertilisers.

In this respect, the timing of thehive-off is probably convenient for EID Parry. As 2002-03 was a particularly bad year for the farm inputs division, the blip in earnings as a result of the transfer may be lower than it would have been under normal circumstances.

Mitigating factors

A couple of factors may help soften the negative impact for EID Parry shareholders. The company has proposed to merge two wholly-owned (profit-making) subsidiaries — Parry and Company, and Mofussil Trading and Warehousing Company — with itself. The merger would bring the ownership of brands such as Parryware within the listed company's fold. The company plans to sell some of the assets acquired from this merger to retire debt for interest cost savings. But whether these measures will help compensate for the sizeable drop in earnings post-demerger, is uncertain.

Prospects

It is clear that sugar and sanitaryware would be the two key revenue drivers for EID Parry. With an established brand name in the business, and a slew of innovative new products, EID Parry has managed to post a healthy sales growth in the sanitaryware business over the past three years. The prospects for this division, therefore, appear quite bright.

However, sugar continues to be the company's largest source of revenues and the pressures on this business may weigh on the overall performance of the company in the near term. In 2002-03, the sugar division recorded a steep fall in both revenues and pre-tax profits, due to pricing pressures and higher costs. Given the downward drift in sugar prices in the recent times and the substantial stocks carried forward from the previous season, the immediate prospects for the sugar business appear sedate. In the circumstances, it may be difficult for EID Parry to make up for the loss in earnings from the hive-off in the immediate future. Prospects for the division may look up over the longer term, once the benefits from forward integration into cogeneration and ethanol begin to flow in fully.

Overall, investors with an investment horizon of less than a year may be better off taking advantage of the recent spike in its stock price to reduce exposures to the EID Parry stock, given the company's subdued earnings prospects. Given the potential for higher earnings and better valuations from the integrated fertiliser operations, investors can take fresh exposures in the CFL stock at this juncture.

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