GSFC- Chemical segment margins at all time high: Buy; Target: Rs 530: Emkay

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GSFC

Chemical segment margins at all time high

BUY

CMP: Rs 327                                       Target Price: Rs 530

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n     Q3FY11 APAT growth of 77% yoy to Rs 2 bn (adjusted for Rs379 mn related to previous year) marginally ahead of estimates - driven by strong results of chemicals segment

n     Chemicals segment margins notched upto all time high of 40% (against historical average of 20%) may remain at current levels in the short term (model FY12 margins at 24%)

n     Fertiliser segment EBIT margins remain buoyant at 16% with company benefiting from its low cost ammonia production

n     Upgrade FY11E estimates by 16% to Rs 81.9, maintain FY12E at Rs 66.3. Re-iterate BUY on compelling valuations at FY11 EV/EBITDA of 1.9x and P/BV of 1x   

GSFC posted PAT growth >70% - 5th quarter in a row

GSFC maintains its strong performance in Q3FY11 results too (5th consecutive quarter

with PAT growth > 70%) with APAT growth of 77% yoy to Rs 2 bn which was ahead of

our estimates of Rs 1.84 bn. Both the segments – fertilisers and chemicals, contributed

to robust performance during the quarter. Overall revenues increased by 7.5% yoy to Rs

12.3 bn mainly driven by growth in company’s chemicals segment (+27% yoy to Rs 3.9

bn) while fertiliser segment revenues remained flat at Rs 8.4 bn (adjusted for Rs 379 mn

of subsidy received relating to previous year).

Chemical segment margins at 40% are at all time high levels

We have earlier argued in our note (All time high Caprolactam spread to drive earnings)

that GSFC’s chemicals segment is likely to post strong results on the back of rising

Caprolactam and Nylon – 6 prices. Chemical segment EBIT margins at 40% are at all

time levels and above the company’s historical average of 20%. Resulting EBIT from

chemicals increased by 4x to Rs 1.5 bn, contributing 53% of total EBIT. Spread between

Caprolactam and Benzene (raw material) is expected to remain firm in the current

quarter too, although we expect it to decline in FY12 (our assumption models 24%

chemical EBIT margins).

Fertiliser margins at 16% despite adjusting for Rs 379 mn subsidy related

to previous year

GSFC’s fertiliser business continues to post strong results on account of it benefitting

from captive ammonia with fertiliser segment margins at 16% (6.7% in FY10) which is in

line with our estimates. Q3FY11 fertiliser EBIT declined by 11.5% yoy to Rs 1.35 bn

(which is adjusted for Rs 379 mn subsidy related to previous year).

Revise FY11 estimates by 16%, maintain FY12E estimates - re-iterate BUY

As chemical segment spread – which is likely to remain stable in Q4FY11 also, we are

upgrading our FY11 estimates by 16% to Rs 81.9 (previous Rs 70.4). With strong

valuations at FY11 EV/EBITDA of 1.9x and P/BV of 1x along with investment book of Rs

9.5 bn (Rs 118 per share), though strategic in nature, we find the stock extremely

attractive and re-iterate our BUY recommendation with price target of Rs 530.

Revision Table

We expect the benefit of favourable chemical spread is likely to continue in Q4FY11 as well,

thus driving GSFC’s Q4FY11 results. Hence we are revising our FY11 estimates upwards

by 16% to Rs 81.9 from Rs 70.4. However we believe that the current spread in chemicals

segment is unlikely to sustain in the long term and is likely to contact in FY12. Therefore,

we maintain our assumption of 24% EBIT margins in the chemical segment in FY12 and

keep our FY12 estimates unchanged.

Fertiliser segment benefited from NBS scheme

Fertiliser segment posted strong performance which was in line with our estimates.

Revenues remained flat at Rs 8.4 bn (which is marginally ahead of our estimates of Rs 8.2

bn). Current quarter results (revenues and EBIT) have been adjusted for Rs 379 mn of

subsidy received relating to previous year).

Adjusted EBIT declined by 12% yoy to Rs 1.4 bn (as estimated by us) with EBIT margins at

16.1%. Complex fertiliser industry has benefited from the Nutrient Based Subsidy (NBS)

scheme introduced (Apr ’10) – which has helped efficient players in improving their fertiliser

margins. GSFC enjoys benefits of captive ammonia production, as a result of which its EBIT

margins in fertiliser segment improved from 6.7% in FY10 to 16.6% in 9MFY11.

Chemicals segment EBIT increased by 4x

Chemicals EBIT increased sharply by ~4x to Rs 1.5 bn against expected Rs 1.35 bn.

Spread between Caprolactam (finished product) and Benzene (raw material) increased upto

US$ 1,825 / mt in Q3FY11 as against H1FY11 of US$ 1,660 / mt. Spread in Dec ’10

remained at US$ 1870 / mt, which should have favourable impact on GSFC’s Q4FY11

results. On the back of favourable spread in caprolactam, chemical segment reported EBIT

margins of 40% in Q3FY11 (against 9.9% in Q3FY10 and 32.6% in Q2FY11) which is at all

time high levels.