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Aarati Krishnan

DIVESTMENT hopes have once again led to a sharp spike in the stock price of the once-neglected fertiliser major, Rashtriya Chemicals and Fertilizers. The stock doubled from Rs 15 to Rs 30 in a month. Last week, the Government has invited bids from investment bankers for acting as advisors to the proposed strategic sale of its 92.5 per cent stake in RCF, to private bidders. This appears to have renewed speculative interest in the stock.

Given its large gas-based urea capacities, the strategic location of its units and the undervalued real estate assets which the company carries in its books, a strategic sale could indeed unlock substantial value for investors in the stock. But the divestment exercise is still at a very early stage (even the advisors are yet to be appointed) and may be a long drawn out process. In the intervening period, given its sedate financials, the stock carries substantial downside risks. Investors with some appetite for risk can hold on to the stock in the hope of further appreciation resulting from the ongoing divestment process. But risk-averse investors should use the recent spike in stock price to pare exposures to the stock, given the existence of downside risk.

Several factors make RCF an attractive divestment candidate. RCF has urea capacities of around 18.8 lakh tonnes distributed over two locations at Thal and Trombay, making it the largest domestic producer. RCF also has the potential to be a low-cost producer of urea, due to the vintage of the two units and the fact that they use natural gas (rather than naphtha) as feedstock. Cost-competitiveness may be crucial to ensure survival, at a time when urea producers are moving from a cost-plus system of subsidy to a flat rate of subsidy across units. The company also holds large tracts of land in Trombay (in Mumbai) which are not carried at full value in its books. These factors may ensure good response to any process of strategic sale of the government's equity, in the company.

But on the flip side, the company's present financials are not very robust. Both revenues and profits have suffered sharp swings over the past five years. The profitability ratios have been consistently much lower than those of private competitors such as Indo Gulf Fertilisers and Tata Chemicals. The equity base of Rs 551 crore is also high compared to private players, even when adjusted for its capacities.

There may be potential for a ramp-up in earnings under a new management, if the divestment goes through. But in the absence of divestment-related interest, the stock price could adjust to more normal valuation levels, of six to seven times the latest per share earnings. Shareholdersshould factor in this risk while making their s decision.

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