GSFC: Buy :: Business Line

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If one were to get hold of a stock with robust fundamentals and strong growth drivers at dirt cheap valuations, why not buy it? Gujarat State Fertilisers and Chemicals (GSFC) is one such stock, which despite the company's healthy track record and strong growth visibility for the next three-five years, is still the cheapest in the fertiliser space. Let's discuss the investment rationale in greater detail.

VOLUMES TO DRIVE GROWTH

GSFC has been one of the key beneficiaries of the NBS (nutrient-based subsidy) scheme for complex fertilisers unveiled in April 2010. Since the de-regulation of sale price of phosphatic fertilisers, the company's fertiliser segment performance has witnessed sharp improvement. This has enabled GSFC post a strong jump in the operating margins to 22 per cent, a 12 percentage point increase between the period 2009-10 and 2011-12. Similarly, the return on capital employed has improved by 14 percentage points to ˜25 per cent currently.

Inclusion of ammonium sulphate (a by-product of caprolactam) under the ambit of NBS bodes well for GSFC and has aided profit growth. Despite a favourable policy, industry-wide phosphate fertiliser volumes were impacted in FY12 due to disruption in phosphoric acid supplies, on the back of political issues in Tunisia, Morocco and the North Arabian Peninsula. However, most of these issues have been resolved now.

For GSFC, specifically, the commencement of phosphoric acid supplies from its joint venture — TIFERT — will help ramp up volumes. Supplies are likely to commence by second half of FY13. GSFC has invested Rs 120 crore in the JV and is entitled to 1.8 lakh tonnes of phosphoric acid annually. This will help the company increase its di-ammonium phosphate (DAP) production by 50 per cent to 12 lakh tonnes in FY14.

CHEMICALS: STABLE PERFORMANCE

The company has an impressive chemical portfolio which includes niche products such as caprolactam and melamine in addition to others like nylon 6 and cyclohexanone, to name a few.

GSFC is the largest manufacturer of caprolactam in India with an annual capacity of 70,000 tonnes, followed by FACT which has an annual capacity of 50,000 tonnes. Strong demand coupled with financial stress on the competitor helped GSFC strengthen its presence in this segment and garner a 60 per cent share of the market.

GSFC is the sole manufacturer of melamine in India, with a 40 per cent market share. Backward integration and prudent investment in improving energy efficiency has helped the company maintain margins in the chemical segment, despite volatility in the international prices. In this segment, exports by China and moderation in global prices pose a risk to realisations, though GSFC may be assured of stable volumes.

GROWTH DRIVERS

The company has lined up expansion initiatives which will entail investment of Rs 7,500 crore over the next five years. The first phase includes a greenfield urea plant with an annual capacity of 11 lakh tonnes, melamine plant with a capacity of 40,000 tonnes per annum and additional complex fertiliser train at Sikka.

In the second phase, the company proposes to construct a greenfield caprolactam facility with an annual capacity of one lakh tonnes. Given the healthy cash flow generation, these projects will likely be funded by a combination of debt and internal accruals.

REGULATORY CONTROL

Though the companies selling complex fertilisers are free to fix their sale price, a substantial portion of the realisation continues to be reimbursed by the government as subsidy, thereby posing policy risks. However, recent changes in fertiliser policy suggest that the government is leaning towards encouraging local manufacture of fertilisers. This should ensure a friendly policy regime.

The price realisation for chemical products is linked to international prices. Similarly significant portion of key fertiliser raw materials such as ammonia, phosphoric acid, and so on, are imported. Imported raw materials account for 52 per cent of GSFC's total spend on raw materials.

Hence, volatility in the international prices and exchange rate will have a bearing on the company's profitability. However, in the past, the company has efficiently weathered the volatility in the international prices.

The stock currently trades at 4.8 times one-year forward earnings, which is a whopping 50 per cent discount to its competitor Coromandel International, which is at 10.3 times the one-year forward earnings.

Adjusting for the Rs 950 crore (as of December 2011) cash in hand, the stock trades at four times its one-year forward earnings. With increasing contribution from fertilisers (from 67 per cent last fiscal to 77 per cent this year), the stock valuation should at least track the sector average of nine times.

Interestingly, in the last one year, the institutional holding in the stock has increased by 3.1 percentage points to 39.2 per cent currently.

Hence, it is opportune time for investors, who missed the 89 per cent rally in GSFC over the last two years, to participate in the growth story of the country's third largest phosphatic fertiliser producer.