Tata Chemicals: Buy

After drifting aimlessly in the first half of 2014, the Tata Chemicals stock has gained over 30 per cent in the last four months.

Expectation of a turnaround in the agri-input major’s operations in Kenya and the UK, improvement in the urea segment’s profitability and healthy growth in other businesses — consumers (salt and pulses) and agrochemicals (Rallis India) have aided this. At ₹394, the stock trades at about 10 times its estimated 2015-16 earnings.

Though the stock rules close to the upper end of its historical band of 8-11 times, improving prospects for the international soda ash business and recovery in the phosphatic fertiliser segment by early next fiscal can lead to its re-rating. Investors can buy the stock.

Restructuring efforts at its Kenya and UK soda ash plants, which commenced last year, will start paying off from the second half of this year.

Tata Chemicals has completed a VRS scheme for over 200 employees at the Kenya plant; the $8-9-million charge for this will reflect in the September quarter results. The cost saving on account of this will be visible from the December quarter; Kenya operations are expected to turn profitable at the operating level this year, and at the net profit level by 2015-16.

Likewise, efforts to trim costs in the UK business by closing the Winnington soda ash plant last year, and the ongoing steam turbine project may boost profitability from this year.

Soda ash demand in Europe is picking up on the back of an improved economic outlook. Domestically, a pick-up in construction activity and auto sales should aid soda ash volumes.

Soda ash realisations in the US market are expected to trend up in the forthcoming quarters, following upward revision of contract prices, to adjust for higher gas prices.

The volume improvement, coupled with cost rationalisation efforts in key markets, have helped the company improve the operating margin for its inorganic chemicals.

From 6.7 per cent in June 2013 quarter, the segment’s operating margin has improved to 8.2 per cent this year; thanks to the the cost-cutting measures, margins may move up further in 2015-16.

Despite higher gas costs and lower margin on the urea produced beyond 100 per cent of the capacity (that is linked to international prices), the urea segment performance has been stable in the June quarter.

The industry has been pushing for a modification in the policy for additional production achieved through revamp to compensate urea-makers for gas cost escalation. If this happens, it can boost Tata Chemicals’ profitability.

If gas prices are finalised below $8/mmbtu and availability of domestic gas improves, that may also lift the company’s profit margin.

Revenues of the company’s consumer goods division (salt, pulses and Swatch water purifier) continue to grow at a steady pace. Tata Chemicals’ market share in the branded salt segment stands at 57 per cent.

Despite the weak monsoon this year, revenues for Tata Chemicals’ crop protection subsidiary, Rallis India, grew 14 per cent to ₹465 crore in the June quarter, helped by two product launches and healthy growth in export sales. Strong operating performance enabled Rallis grow its net profit by 35 per cent to ₹37 crore.

While the rising phosphoric acid price is a challenge for the company, the operating margin for complex fertilisers has improved significantly in the latest June quarter compared with the year-ago period.

From 6.7 per cent in June 2013, the overall fertiliser segment’s operating margin improved to 8.2 per cent this June.

Tata Chemicals’ revenues grew 27 per cent to ₹2,116 crore in June quarter, compared with the same period last year.

Operating profit margin, after declining for over four quarters, improved by 2 percentage points to 13.2 per cent. Net profit grew 27 per cent to ₹170 crore.