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Aarati Krishnan

STOCKS of fertiliser producers such as Tata Chemicals have been pegged up sharply over the past year, on the expectation that the progression towards urea decontrol would benefit efficient private players.

But recent announcements from the new government create uncertainties about whether the decontrol will proceed as charted out earlier. Investors with a three-year investment horizon may hold on to the Tata chemicals stock, in the light of its strong fundamentals, but fresh exposures may be avoided. At Rs 132, the stock trades at a price-earnings multiple of about 13 times its 2003-04 earnings.

Performance: Impacted by one-off factors

Tata Chemicals' numbers for 2003-04 are, on the face of it, disappointing, especially as they capture the first year of operations, post merger of Hind Lever Chemicals. But the numbers have been impacted by a few one-off factors. Both immediate and medium-term earnings prospects for the company appear bright.

The Net sales of the merged entity was Rs 2,544 crore, up 65 per cent over 2002-03 when Tata Chemicals was a stand-alone entity. But operating profits for 2003-04, post-merger, were just 10.6 per cent higher than that for the previous year. Post-tax profits grew 12.2 per cent, as savings from interest costs were partly offset by a higher tax outgo.

A sharp decline in Tata Chemicals' operating profit margins after the merger was certainly expected, given the lower margins on Hind Lever Chemicals' operations. But profit margins were further dented in 2003-04by the exceptional spike in prices of such inputs as ammonia and phosphoric acid. Only part of this was compensated by higher subsidies .

Brighter days ahead

The pressure on input costs such as of ammonia could ease as their prices fall from the highs. The sharp jump in fertiliser sales in March-May , after the sedate volume growth of 2003-04, would also boost significantly Tata Chemicals' revenues and profits in the coming quarter.

Over the medium-to-long term, Tata Chemicals can be expected to benefit from the marketing and distribution opportunities opened up by the merger. Hind Lever Chemicals' product portfolio, consisting of phosphatic fertilisers, would complement Tata Chemicals' nitrogenous fertiliser operations.

Its distribution network, which spans the deficit eastern markets, may widen the distribution reach and allow cross-selling of products by the merged entity. Offtake of STPP, a detergent input, would also lend stability to revenues and profits and complement Tata Chem's soda ash business.

Policy in limbo

On the negative side, it appears the payoffs expected to accrue to Tata Chemicals from the dismantling of controls on urea may not materialise anytime soon.

There have been mixed signals from the new government on this issue. On the one hand, it has indicated that it will review the gradual freeingup of urea distribution. This is a negative for players.

The new government may flag off expansion projects.

Also negative are indications that sick fertiliser capacities will be revived. The closure of unviable capacities was expected to open up the field for low-cost producers such as Tata Chemicals.

With gas availability low and the issue of LNG pricing yet to be sorted out, cost pressures on urea operations will persist for now.

However, a few policy signals that appear as positives for Tata Chemicals. One is the new government's stated intention of driving up fertiliser availability, in spite of spiralling subsidies.

This may pave the way for strong volume growth through higher output and de-bottlenecking projects, which have been on hold over the past few years.

Quite apart from all this, the TCS float, which will bolster the market value of Tata Chem's investment book by at least Rs.80-100 crore, may also provide it with additional cushion to fund any capex programme.

Tata Chem's investment book features about 11 lakh shares in TCS and over 10,000 shares in Tata Sons Limited.

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