Gujarat State Fertilizers & Chemicals Ltd.

Business Aspect:

Products (Revenues):

Main products of the company include: DAP, Ammonium Phosphate Sulphate and Caprolactum

With the increasing push of Nutrient Based Subsidy, consumption of complex fertilizers will increase vis-a-vis Urea. CRISIL expects a growth of around 9% of DAP and 16% of other complex fertilizers. On that top of that, India is dependent on imports in case of fertilizers. With a weakening Rupee, the cost of import is to increase further and thus will help domestic industries. Weakening rupee will also increase cost of raw materials (Phosphorus and Phosphoric Acid are mainly imported). However, GSFC, according to its annual report has been hedged against any fluctuations in rupee depreciation.

There are only two producers of Caprolactum in the country. Caprolactum is required for Nylon 6 which is in turn required for the production of Tyre. With the supply demand balance in favor of GSFC, it is in a price setting position.

Raw Materials (Costs):

They Key raw material costs that are of concern to GSFC are Natural Gas and Phosphorous / Phosphoric Acid. Natural prices are relatively stable, however, they are expected to increase with producers such as Reliance pushing for deregulation. Phosphorous prices on the other end are very fluctuating and might be a concern in the valuation. With the deregulation in the DAP and other complex fertilizer prices, we can assume that GSFC in a better position to pass on these costs to farmers. Because of the strong farmer lobby in the country, these will be an increase in subsidy if there are any significant changes in the prices of raw materials. Thus, even though raw material prices might have some impacts on the EBITDA margins there is no major impact expected from this.

Regarding Valuation:

A 6 year DCF analysis of the company assuming following inputs:

Revenue growth of 8.8% (last year growth was 19%), EBITDA margins of 20% (last year was 26%), terminal EV/EBITDA multiple of 5 (as compared to peers; current is 3.5), Beta of the stock is 0.5, risk free rate = 8%, MRP = 10%.

This gives an upside of 30%.

Looking at multiples, the company has a P/E ratio of 4.5 which is quite low when compared to the peers that have the multiple of around 10. The company is high growth and is almost un-levered. These factors again warrant a high P/E ratio. The low P/E can be explained by three reasons:

1. Government is the major stakeholder

2. DAP has been a regulated product and thus margins were typically less. Also, complex products have been used in less than optimal proportion vis-a-vis Urea due to the erstwhile subsidy structure

3. Fluctuating raw material prices

Quality of results should not be doubted because of the clean annual report of the company and the fact that it is government owned and thus the incentive structure of the employees doesn't warrant any major wrong doing (inflating books, etc) on their part.

Growth Drivers:

1. Nutrient Based Subsidy

2. Supply deficient market

3. Farmer Lobby in the country

4. Presence in high growth products - supply is chasing demand

5. Presence in Oligopoly markets

Key Risks:

1. Raw material prices

2. Dependence on subsidies

3. Dependence on monsoons

Exit:

A 30% increase in price keeps the exit price at Rs 650 in case the underlying assumptions stay the same. However, as long as the company keeps on growing and is able to maintain its position in the individual product segments, one should keep invested in the company till it achieves a P/E of around 10.