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Aarati Krishnan

The inorganic route that Coromandel Fertilizers has taken to further its growth plans comes with a dose of risk. But the company appears to have made all the right moves to mitigate these risks, says Aarati Krishnan.

THE Coromandel Fertilisers (CFL) stock hasover the past couple of months shrugged off the uncertainties relating to its takeover of Godavari Fertilisers.

It has put on close to 66 per cent since end-October 2003, with its price-earnings multiple at 11 times the 2002-03 earnings.

Viewed from the perspective of the valuation levels historically accorded to CFL, and to fertiliser stocks, this may seem expensive. But history may not be a good guide while evaluating CFL's prospects.

Inorganic growth

The company has embarked on an aggressive acquisition spree. Its recent acquisition of Godavari Fertilisers (Godavari), an ailing phosphatic fertiliser maker, and the proposed merger of EID Parry's farm inputs division, promise to transform CFL's balance-sheet in the coming fiscal.

The inorganic route that CFL has chosen to take to further its growth ambitions, certainly comes with a dose of risk. It will add to CFL's debt burden in the near term and can dent earnings, if the acquisitions fail to deliver.

But CFL appears to have made all the right moves to mitigate the risks which come with this acquisition.

Godavari acquisition: Debt burden manageable

When CFL initially announced that it had bid Rs 124 per share for the Andhra Pradesh Government's stake in Godavari, there were apprehensions that CFL was overpaying for the deal. But it now appears that CFL's balance-sheet can absorb the cost of acquisition without too much of a strain.

CFL has paid out a total of Rs.162 crore to acquire the Andhra Pradesh Government's stake in Godavari Fertilisers and to make the mandatory open offer to Godavari's public shareholders. CFL has indicated that roughly two-thirds of this sum will be funded by fresh borrowings.

This will mean an addition of around Rs 108 crore to the existing debt of Rs 178 crore carried on CFL's balance-sheet in March 2003. While this may lead to a spike in CFL's interest costs in the near term, it may not impose any undue strain on CFL's finances, even in the near term. Even after the addition of fresh debt, CFL's debt:equity ratio stands at a fairly comfortable 1.2:1. Though this is higher than the present ratio of 0.8:1, it is by no means an unmanageable burden.

Given that CFL generates net cash flows of over Rs 100 crore from its operations in its good years, it should be a position to whittle down the debt substantially within the next fiscal.

Foskor-GCT stakes, added sweetener

What may make CFL's task even easier now, is its recent deals with two overseas bidders to offload part of its stake in Godavari Fertilisers. In two separate deals, CFL will offload 10 per cent of its recently-acquired stake in Godavari to two raw material suppliers, Foskor of South Africa and Groupe Chimique Tunisien (GCT) of Tunisia.

As these stakes have been sold at Rs.124 per share, they may net CFL around Rs 39 crore, which it can deploy in the modernisation-expansion project at Godavari, without materially diluting its control over Godavari. These deals also bring CFL some additional sweeteners in the form of long-term supply contracts for the key raw materials used in the manufacture of complex/phosphatic fertilisers.

Given the high material component in their cost structure, margins of phosphatic fertiliser manufacturers are quite vulnerable to swings in the global prices of inputs. In this context, CFL's arrangements with Foskor and GCT which are, incidentally, two of the largest suppliers of phosphatic raw materials in the world, may help reduce its cost structure and hasten a turnaround at Godavari. CFL also plans to substantially add to and modernise Godavari's facilities at the cost of Rs 20 crore. These initiatives are expected to bring down Godavari's cost structure.

An uncompetitive cost-structure has been the key reason behind the company's lacklustre financial performance in the recent times. So, these initiatives may help put Godavari firmly on the turnaround path. That CFL has fertiliser capacities of close to two million tonnes, by virtue of this acquisition, may also endow it with significant bulk buying advantages.

Improving climate

Even without factoring in any of the benefits from acquisitions, the current fiscal promises to be a good one for CFL's own business. The lag effect of a good monsoon is just beginning to show up in despatches of complex and phosphatic fertiliser products and this is likely to ramp up CFL's sales performance in the second half of 2003-04. The change in the subsidy calculation, which has muted CFL's profit growth in the first half, could continue to be a factor in the second half of 2003-04 as well.

But this could be offset to some extent, by the ramp up in sales volumes, as the rabi season offtake for fertilisers gathers steam. Godavari Fertilisers has shown an improvement in its performance in the September quarter of 2003, with a significant growth both in its profits and sales.

With the Government currently working out the modalities for streamlining subsidy calculations for phosphatic fertilisers, the uncertainties in the policy environment are also likely to get sorted out within the next few months.

Gaining scale

Even if CFL's financial performance in the near term is weighed down by its recent acquisitions or policy-related uncertainties, its long-term prospects appear quite bright. The proposed merger of EID Parry's farm inputs division with CFL, which recently received the legal go-ahead, will add to this advantage (Business Line, May 30).

This merger is structured to give CFL complete control over EID Parry's fertiliser manufacturing and marketing functions, at the cost of a modest expansion in its equity base. With this CFL will have a practical stranglehold over the southern markets for phosphatic/complex fertilisers.

Given these factors, the impact of recent events does not appear to be fully captured in CFL's current stock price, even now. Shareholders in the CFL stock can, therefore, hold on to their exposures as the stock has the potential to deliver reasonable capital appreciation over the long term. But those contemplating fresh exposures should probably wait for a decline in stock price. If CFL's near-term performance turns out to be sedate, it could curb the strong recent momentum in the stock price.

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