Buy DEEPAK FERTILISERS AND PETROCHEMICALS Margins surprise; Edelweiss

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DEEPAK FERTILISERS AND PETROCHEMICALS
Margins surprise; revenues disappoint



􀂄 Net revenue below estimate; core PAT slightly ahead
Deepak Fertilisers and Petrochemicals Corporation (DFPCL) posted standalone
revenue growth of 2.2% (below estimate due to low fertiliser revenues) and
EBIDTA growth of 19.8%, Y-o-Y, in Q3FY11. PBT grew strongly at 30.9% Y-o-Y.
Core profit was at INR 436 mn in Q3FY11 vis-à-vis INR 272 mn in Q3FY10. DFPCL
has taken a one-time hit of INR 34 mn in Q3FY11 in the reality segment, towards
assets restructured in Ishanya vis-à-vis a gain of INR 257.1 mn in Q3FY10 on
account of sale of leasehold land. EBIDTA margin was a positive surprise in
Q3FY11, at 21.8% (estimated 19.3%), up 320bps Y-o-Y and 310bps Q-o-Q.

􀂄 Chemicals surprise; fertilisers disappoint
On account of strong realisation of IPA, methanol and strong volumes of TAN in
Q3FY11, DFPCL’s PBIT margin expanded 50bps Y-o-Y and 420bps Q-o-Q,
compensating for lower revenue from the fertiliser segment. DFPCL has taken a
price hike of ~15% on TAN in January 2011 to counter the increased raw material
prices; the impact is expected to flow Q4FY11 onwards. The fertiliser segment
was hit due to disruption in phosphoric acid supplies and lower traded volumes,
coupled with lower realisation for MOP. However, the manufactured fertilisers
segment is expected to be back on track in Q4FY11.

􀂄 Disappointment from new TAN plant due to delay in commercial production
Though the new TAN plant of 300,000 MT per annum is complete on schedule, its
commercial production is pushed to March 2011 due to some issues in stabilising
operations. Hence, the management has cut its guidance for production to
~15,000 MT in FY11, but maintained it at ~210,000 MT in FY12 from the new
plant. We have assumed production of 15,000 MT and 180,000 MT from this plant
in FY11 and FY12, respectively. This plant is expected to have been completed at
a lower cost of INR 6,000 mn against the earlier estimate of INR 6,550 mn.
􀂄 Outlook and valuations: Awaiting new TAN plant volumes; maintain ‘BUY’
Taking into consideration: a) The new TAN plant’s delayed commercial production;
b) lower-than-expected fertiliser revenues; c) price hike in TAN; and d) possible
margin pressure on new TAN margins (assuming 23% vis-à-vis 25% earlier) due
to higher global ammonia prices, we have revised downwards revenue estimates
for FY11 by ~6%, while maintaining FY12 revenues. Also, we have revised down
EPS estimates by ~2% for FY11 and ~4% for FY12. Currently, DFPCL is available
at 6.3x and 5.3x consolidated P/E and at 4.0x and 3.2x consolidated EV/EBITDA
of FY12E and FY13E, respectively. We maintain ‘BUY’ recommendation on the
stock, with a target price of INR 206 per share based on 5x FY12E EV/EBIDTA.


EBITDA margin improved in Q3FY11 vis-à-vis Q2FY11 on account of:
- Improvement in IPA and methanol realisation
- Higher contribution from TAN
- Lower volumes of traded fertilisers
􀂄 Chemicals
􀂃 Revenue from manufactured chemicals grew 23.3% Y-o-Y, driven by 8.6% volume
growth and the rest by higher realisations.
􀂃 Contribution of IPA, technical ammonium nitrate (TAN) and methanol was ~INR
1,000 mn, INR 630 mn and INR 370 mn, respectively, in Q3FY11 vis-à-vis INR 770
mn, INR 600 mn, and INR 180 mn in Q3FY10.
􀂃 PBIT margin of chemicals increased to 30.4% in Q3FY11 vis-à-vis 29.9% in Q3FY10
and 26.2% in Q2FY11.
􀂃 The increase in margin was predominantly due to higher realisation of IPA and
methanol and higher sales volume of the high margin TAN.
􀂃 Against the management guidance of 210,000 MT production of TAN from new
plant in FY12, we have assumed 180,000 MT in our numbers. Assuming a much
bearish scenario, we estimate TAN production not to be less than 150,000 MT, at
which level, the downside risk for FY12 EPS is ~5%.


􀂄 Fertilisers
􀂃 Revenue from manufactured fertilisers increased 8.8% Y-o-Y, predominantly driven
by higher realisations despite a volume dip of 21.8%. Revenue from traded
fertilisers has dipped 36.6% on account of lower trading volumes and realisations
of MOP (a major product in DFPCL’s traded fertiliser basket).
􀂃 ANP production declined significantly Q-o-Q as well as Y-o-Y, on account of
disruption of phosphoric acid supplies due to diverting of ship on account of oil
spillage in Arabian sea. However, the management guided for bounce back of ANP
volumes in Q4FY11.
􀂃 PBIT margin of fertilisers increased to 3.5% in Q3FY11 vis-à-vis 3.0% in Q3FY10,
but declined from 6.3% in Q2FY11.


􀂄 Other highlights
􀂃 Inventories at INR 1,257 mn as at December 2010 end vis-à-vis INR 1,243 mn Qo-
Q.
􀂃 Price of natural gas at INR 9.5 per scm in Q3FY11 vis-à-vis INR 7 per scm in
Q3FY10.
􀂃 Ishanya has signed for leasing an additional 100,000 sq ft with existing and new
tenants, which is expected to improve occupancy from the current 40% to over
60% by end of CY11.


􀂄 Company Description
DFPCL was incorporated in 1979 by Mr. C.K. Mehta as a private limited company. It is
currently one of the leading manufacturers of industrial chemicals and fertilisers in India.
The company operates in three business segments—chemicals, agribusiness, and
specialty retailing. It has emerged as an integrated multi-product company
manufacturing ammonia, iso propyl alcohol, methanol, nitric acid, low-density prilled
ammonium nitrate, and nitro-phosphate fertilisers in its state-of-the-art plants operating
with world class technology.
􀂄 Investment Theme
DFPCL is the leader in the Indian Technical Ammonium Nitrate (TAN) market, with 30%
share. The company has increased its TAN capacity further by 300,000 MT from 132,000
MT, at a capex of ~INR 6 bn. With increased capacity, DFPCL’s market share in TAN is
estimated to rise to ~70% in FY12 by replacing the cheaper grade TAN imports. Also, the
company is set to benefit from the increasing TAN demand on account of the growing
demand for coal and limestone production.
With better gas availability, Ammonium Nitrophosphate (ANP) fertiliser capacity
utilisation is poised to increase from 25% in FY09 to ~70% in FY12. Also, the capacity
utilisation of Methanol is expected to increase from 12% in FY09 to 80% in FY12. DFPCL
is well connected to the National Gas Grid to receive gas from multiple sources like
Panna-Mukta-Tapti (PMT) gas field, Krishna-Godavari (KG) Basin and ONGC.
􀂄 Key Risks
Delay in capacity scale up in new TAN plant
Any delay in scaling up of operations of the new TAN plant will cause opportunity loss for
the company and downside risks to our estimates.
Raw material supply side issues
Though the company has tied up with Middle East suppliers for ammonia and for natural
gas with multiple sources in India, any issues on this front may pose a risk for DFPCL.
The company’s long-term contracts with these suppliers could, however, mitigate the
mentioned risk to a great extent.
Volatility of crude prices
High volatility in crude prices could adversely impact the company’s raw material costs
and, hence, its profitability.
Poor monsoon could hit fertiliser demand
Even today, Indian agriculture is largely dependent on monsoon. Poor monsoon could,
therefore, be a demand dampener.
Delay in payment of fertiliser subsidies by GoI
Any delay in the payment of subsidies by GoI or payment of the same by means of
fertiliser bonds, could strain the company’s working capital cycle. The Indian finance
minister has, however, assured that the entire subsidy amount will be paid in cash and
not bonds.
Currency fluctuation
INR volatility may impact the operating margin of the chemicals segment of DFPCL