"Tata Chemicals could be a fantastic stock to own but only if you remove the fertiliser business or the regulated business," says a value investor, who owns the stock but does not want to be identified. If one reads the company’s FY16 annual report, the company is planning to do exactly that. For instance, its says the company will be “increasing its focus on non-regulated and organic fertilisers to protect cash flows” and plans “to double the sales from current levels for the de-regulated business by 2020."
Strategic shift
The fertiliser business has, for long, been a cause of concern within its portfolio due to low growth, cash flow issues and the regulated environment. Though the segment accounts for 40% of its revenues, it contributes only 12% to earnings before tax and interest indicating high overhead charges. An accounts receivables span of 75 days along with delayed subsidy payments means there are working capital and debt issues for the company to contend with. (Tata Chemicals currently has a debt to equity ratio of 1.5x) To further put things in perspective, in FY16, the business generated an earnings before interest and tax of 7% on Rs.3,187 crore capital employed. In contrast, the company's stronghold and money spinner, the inorganic chemicals sector (soda ash and salt) made 17%.
Thus, there is little surprise that the market is upbeat about the company selling its urea business at an enterprise value of Rs.2,670 crore, almost 12x its EBITDA. While urea accounts for only 40-45% of the total fertiliser business, it will reduce some burden; taking away close to Rs.900 crore of working capital requirement. Besides, it will also result in improved liquidity and debt reduction.
The move is also likely to have a positive rub-off on its valuation says Abhijit Akella, analyst, IIFL. "In our previous sum of parts (SOTP) valuation for Tata Chemicals, we assigned a value of Rs.1,500 crore for the entire fertiliser business, whereas Tata Chemicals has now obtained an enterprise value of Rs.2,670 crore for just the urea component. The resultant increase in our SOTP (net of tax) is close to Rs.40 per share (market price of Rs.504). Importantly, the sale also means that the predictability of Tata Chemical’s residual earnings stream is enhanced because the regulatory risk is now significantly lowered," he explains.
Besides, the sale will also probably pave way for investment in other segments, especially consumer products. While Tata Salt already enjoys a market share of 60%, Tata Chemicals has ventured into food ingredients sector with new products. In October last year, it launched Tata Sampann spices, roping in Sanjeev Kapoor as the brand ambassador. The brand was initially launched in Punjab, Haryana and Himachal Pradesh, but the company has since then extended its presence to NCR and other northern states. Today, it is present in 13 states, reaching out to about 1.2 lakh consumer touchpoints.
A few other products launched under the brand were high protein unpolished pulses and low oil absorbing besan made 100% from chana dal. Considering that India consumes close to 22 million tonne of pulses, at an average price of Rs.80 per kg, this is an annual market of close to Rs.180,000 crore.
The plan with both these sub-segments is to leverage the existing distribution network that serves 13.5 crore households. Besides, even though the non-salt business with annual sales of Rs.467 crore, may be just 6% of its standalone revenues, it is growing fast — at 63% in FY16. The segment’s losses too have dropped from Rs.144 crore in FY15 to Rs.64 crore.
In addition, the company is also aggressively pushing its affordable water purifier, Tata Swach, in the mass segment. While the opportunities are,huge in the consumer segment, building a brand will need more investment. The business is therefore expected to take another 1-2 years to break even.
Talking return
Nevertheless, the market is reading these developments positively. "Sale of the fertiliser business can drive further rerating, with a leaner balance sheet. It could potentially reduce net debt to less than half of the current level. Given the low profitability of the fertiliser segment, merely deleveraging of the balance sheet would mean that the sell-off is EPS accretive," says Prakash Goel, analyst, ICICI Securities in a recent note.
Reflecting the mood, the stock has already appreciated close to 20% in the last two months. With a market capitalisation of Rs.12,764 crore, which is 16x FY16 earnings; and a ROCE of less than 10%, it will be hard to get a higher multiple. But monetising inefficient businesses and investing in segments such as consumer products could improve both cash flows and return ratios. Given that the company has already started treading this path, it bodes well for the long haul.
