GSFC: Buy

The party in stocks of companies with a Gujarat connection started much before the final election verdict was out. But despite the rally in the last month, here’s one pick from the stable which is still available cheap. At ₹67, the stock of Gujarat State Fertilisers and Chemicals (GSFC), one of the leading fertiliser producers in the country, trades at an attractive four times its one-year forward earnings. Besides, the current value of GSFC’s investment in other state-owned firms such as GNFC, Gujarat Alkalies and Gujarat Industries Power stands at ₹12 a share.

Healthy growth prospects, expansion initiatives, a strong balance-sheet and a re-rating potential make the stock a good buying opportunity for investors with a one-to-two year horizon. After a lacklustre show over the last few quarters, GSFC’s performance has improved significantly in the March quarter. The company took a slew of initiatives to prune costs. This coupled with higher realisation for its fertiliser and chemical products led to a 55 per cent jump in its operating profit during the March quarter compared to the same period a year back. The company is likely to continue its healthy performance in 2014-15, aided by a few factors.

First, concerns in the fertiliser business have begun to recede. The high fertiliser inventory in the distribution channel in 2012-13, which impacted volume growth in 2013-14, has normalised now. The current inventory of di-ammonium phosphate (DAP) fertiliser with dealers has reduced from about 45 lakh tonnes in early 2013-14 to about 20 lakh tonnes now. This should help GSFC post higher DAP sales in the current fiscal.

Also, the supplies of phosphoric acid from the company’s joint venture Tifert commenced last year. Tifert — a three-way joint venture between GSFC, Coromandel International and two Tunisian state owned companies — will sell 1.8 lakh tonnes of phosphoric acid to GSFC annually. This should aid the company’s higher complex fertiliser production and sales in 2014-15. GSFC has increased the selling price of select fertilisers in the last two quarters. The selling price of ammonium sulphate and ammonium phosphate sulphate has been increased by 12 per cent and 16 per cent respectively, which will also aid profit growth.

The risk to the fertiliser segment’s performance may be a weak monsoon. However, barring a drought-like situation, marginal deviation in rainfall may not have a material impact on fertiliser volumes.

Second, GSFC’s chemical business is also showing signs of stability. The market dynamics of methanol, a key product, has changed for the good in the last few months. Reduction in dumping by Iran, a leading producer, due to sanctions and expansion into other value-added products has helped. This should enable GSFC sell more methanol at reasonable prices in the curent year. The margins for GSFC’s key product, caprolactum, moderated during the second half of 2013-14 due to a sharp rise in the price of its key raw material, benzene. But now, with an increase in benzene supply from the US refineries, input prices are expected to moderate. GSFC has also made investment in the caprolactum facility at Baroda to reduce benzene consumption. These factors should help the company improve its efficiency and profitability from the chemicals segment.

Third, an increase in power costs, which impacted the company’s operating profit margin last year, may abate in 2014-15. GSFC has added 32 MW of wind power capacity last year, taking its total capacity to 152.8 MW — this should reduce the company’s outgo on fuel cost.

Fourth, the company’s expansion initiatives should start paying off by early 2015-16. GSFC’s water soluble fertiliser plant with an annual capacity of 20,000 tonnes is expected to commence operations by the end of 2014-15. Also, the company’s 15,000 tonnes high-grade nylon chip plant is expected to be operational by the end of the year. These should add to revenues next fiscal.

In addition, GSFC is increasing its fertiliser and chemical capacity, which should aid revenue growth over the medium term (three to five years).

Expansion initiatives include an additional complex fertiliser unit with an annual capacity of 0.5 million tonnes at Sikka (Gujarat) with a capex of ₹600 crore. Likewise, the company plans to augment its melamine capacity by setting up a new plant with an annual capacity of 40,000 tonnes at Dahej at a cost of ₹1,100 crore and a new caprolactam plant with an annual capacity of one lakh tonnes in Vadodara entailing investment of ₹4,000 crore.

A portion of the above mentioned capex will be met through borrowings. But GSFC’s is well-placed to leverage its balance sheet given its cash reserves of ₹386 crore as of March 2014, much more than its long-term debt of ₹224 crore.