Buy Tata Chemicals, target Rs 709: Motilal Oswal Financial Services

Motilal Oswal Financial Services has given a buy recommendation on Tata Chemicals (TTCH) with a target price of Rs 709.

Shares of Tata Chemicals traded at Rs 608 around 12:30 pm on 18 July, 2019. The brokerage has set a one-year horizon for the stock to hit the target price.

Investment rationale by the brokerage:

Soda ash – India only region to deliver revenue growth; Europe/NA/Magadi under pressure
Among the various geographies where TTCH operates its soda ash business, only India delivered revenue growth (up 16 per cent) in FY19, driven by a realization improvement.

Tata Chemicals North America (TCNA) revenue declined 4 per cent to $476 million in FY19 owing to a 5 per cent drop in volumes due to production breakdown, partly offset by a 1 per cent improvement in realization.

UK operations turnover was down 6 per cent to 158 million pounds in the year due to a decline in soda ash and sodium bicarbonate volumes by 18 per cent and 5 per cent, respectively, partly offset by an 11 per cent improvement in blended realization. Lower volumes can be attributed to the planned reduction in sales of low-margin imported soda ash.

Tata Chemicals Magadi (TCML) revenue was down 4 per cent to $73.8 million on account of a 15 per cent decline in volume, partly offset by a 13 per cent improvement in realization.

However, in the rupee terms, the company exhibited revenue growth across these regions due to appreciation in the dollar and the pound by 9 per cent and 7 per cent, respectively.

Foreign operations dent operating performance as well
Consolidated Ebitda margin shrank 280bp to 18.5 per cent in FY19, mainly on account of the weak performance across foreign operations and a 210bp contraction in the standalone Ebitda margin to 24.5 per cent.

However, the contraction in the standalone margin appears optically higher owing to the regrouping of freight and forwarding charges, which are included in revenue under Ind-AS. Adjusting for the same, the margin contraction stands at 100bp.

TCNA’s Ebitda declined 8 per cent to $98 million (Ebitda/MT declined 3 per cent YoY to $44.1/MT), mainly on account of higher energy prices and maintenance cost. However, in the rupee terms, Ebitda declined by a mere 1 per cent.

UK operations Ebitda declined 43 per cent to 15 million pounds; Ebitda/MT was down 33 per cent YoY to 33.6 pounds/MT, despite an 11 per cent improvement in realization.

Additionally, Ebitda/MT was on a downtrend from Q4FY18 to Q3FY19, but bottomed out thereafter and doubled to 28.3 pounds/MT in Q4FY19 (Ebitda/MT includes soda ash, bicarb, salt and power, whereas volume includes soda ash and bicarb).

TCML’s Ebitda declined 25 per cent to $10 million due to lower sales volume, higher fixed costs and increased rail haulage charges. However, in the rupee terms, Ebitda was down by a lesser 19 per cent.

Tata Salt’s sweet success to continue
India continues holding the third position in the production of salt, after China and the US (total salt production in India was 29MMT in FY18).

Tata Salt continues to be the market leader (more than 25 per cent market share in edible salt market and 65 per cent market share in branded salt market) and one of the most trusted food brands in India.

Tata Salt Lite, low sodium salt and Tata Salt Crystals are also the leading salt brands in the market in their respective segment.

TTCH achieved a landmark by crossing 1MMT of iodized salt production in Mithapur in FY19 (up 9 per cent to 1.07MMT).

Tata Salt sales volume increased 11 per cent to 1MMT in FY19.

It continues to be the largest distributed brand reaching 1.9m retail outlets across India. Tata Salt Lite sales volume grew 13 per cent YoY to 22,821MT in the year.

I Shakti salt continued addressing the iodization movement, complementing Tata Salt with sales of 81,039MT in FY19.

CFO declines due to higher cash conversion cycle; earmarks capex of Rs 3,200 crore
CFO declined 25 per cent to Rs 1,970 crore in FY19 on the back of a rise in the cash conversion cycle to 90 days from 43 days in the previous year.

TTCH has earmarked capex of Rs 2,400 crore toward debottlenecking and capacity expansion across products at the Mithapur plant (highest capacity increase planned in salt capacity – by 400kMT (or 47 per cent) to 1.25MMT).

The board of Rallis (a subsidiary) has approved capex of Rs 800 crore for expanding formulation capacity and building technical and associated intermediary products manufacturing capacity for backward integration.

This will enable it to cater to growing demand and reduce dependency on imports.

Valuation and view
"We maintain our estimate of a CAGR of 11 per cent in revenue and 13 per cent in PAT over FY19-21," said the brokerage.

The board of TTCH has approved the demerger of its consumer products business and the transfer of the same to Tata Global Beverages (TGBL).

This, in turn, is likely to help the company to focus on growing its chemical and specialty business arm, unlocking value for its consumer business.

The company’s cash-cow businesses (soda ash and sodium bicarbonate) are expected to remain steady on the back of a favorable demand-supply scenario.

"Our SOTP-based target price stands at Rs 709 (17 per cent upside) – implied EV/Ebitda of 8 times," the brokerage added.