Sowing the seeds

(Article first published in Business India on July 5-18, 2004)

Deepak fetilisers and petrochemicals lines up a number of projects, including a real estate venture.

Sailesh Mehta is a keen listener. At a recent analysts' meet, as managing director of the Rs. 496 crore Deepak Fertilisers and petrochemicals Corporation (DFPC), he was asked several questions on the company's performance the new projects lined up and his unrelated diversification.

In the company's latest annual report, he could have transcribed part of the proceeding and included it in the mandatory MDA (management discussion and analysis). Instead, in this years annual report he chose to include a couple of Q&A pages addressing the 'What and why'. "The idea was to give shareholders an interesting and contextual perspective to the contents of the report rather than load them with data, facts and figures to meet the statutory, perfunctionary and age old traditional needs," he says.

Incorporated in the end - 70s, DFPC embarked on projects worth Rs. 350 odd crore (to be completed in the next 18 months), which will add another Rs. 225 crore to its topline. The company started production of ammonia in the early 80s using natural gas as feed stock. It was the first in the private sector to have its own 40 km gas pipeline in Maharashtra, from Uran to its facility at Taloja. In the end 80s, it integrated forward to manufacture methanol. In the early 90s the company began producing low density ammonium nitrate, nitro phosphatic fertilizers, dilute nitric acid and concentrated nitric acid.

Today, DFPC's product lines can be broadly classified into industrial chemicals and fertilizers, with 60 per cent (inclusive of 5 per cent in traded revenues) of turn over coming from the former, thus making a strong statement that the company is more than just fertilizers. Little wonder, the company's stock gets a multiple of just about four times, which most companies in the fertilizer business have to live with. Its total market capitalization stands at Rs. 308 crores, against gross fixed assets of Rs. 640 crore. Hopefully , things should change for the company in the coming years as its strategy to move up the value chain bears fruit.

For starters, DFPC has flagged off its isoprophy alcohol (IPA) plants with a capacity of 70000 tpa at a cost of Rs. 205 crore. To be commissioned by November 2005, the plant would have an IRR of 18.85 per cent with a payback period of 3.93 years. IPA is a valueadded solvent similar to methanol which is an import substitute product used in pharmaceuticals, paints, printing and inks and organic chemicals. According to Mehta, the company has centered into an exclusive licensing arrangement with Equister-Lyndell, through Kvaerner of the US and pact with BPCL for its key raw material, propylene requirement. Once huming, this plant is expected to add Rs. 200 crore to the topline in the first full year of operation.

DFPC is also putting up a 9 MW captive co-generation power plant with two gas turbines and steam generators at a cost of Rs. 48 crore. This plant, according to Mehta, would be commissioned by September 2004 and would bring about substantial saving on power costs. "We should end up saving at least Re1 per unit" he adds. The payback is estimated to be about 2.4 years with an IRR of 42 per cent. While this is not going to add to the topline, the saving in power cost would go straight in boosting the bottomline.

From speciality chemicals to 'Specialty malls' that's the route Mehta has chosen to diversify. This is Rs. 100 crore (including land) 'specialty mall' to be situated in Pune would be targeted on a specific concept of catering to the needs of architects, interior designers, builders and developers, home and office owners, et al, equipped with design studios and exhibition arena all under one roof.

However, corporate watchers are sceptical about the company's entry into an unrelated area. " There is a total disconnect," says on of them. Mehta bags to differ. "The group has demonstrated its project management capabilities in construction and development activity," he says, possibly referring to the software park set up in Pune by the group.

But a major driver could be DFPC's acquisition of Smartchem Technologies in December 2003. This Rs. 63 crore acquisition would help the company consolidate its position in nitric acid and ammonium nitrate space. The 40000 tpa capacity located at Srikakulam (Andra Pradesh) and Valsad (Gujarat), would cater to the southern and eastern region. For the year to March 2004, Smartchem posted a Rs. 4.7 Crore profit on sales of Rs. 47.7 crore. This project could possibly see a joint venture partner being roped in at a future date.

How does Mehta go about funding these project? There is no doubt that the company has strong cash flows. Its generates about Rs. 75 crore cash annually and has more than Rs. 100 crore parked with mutual funds as per the latest balance sheet. Besides, it boosts a low debt to equity ratio of 0.4:1. "We would be looking at a combination of NCDS, project funding and ECB route. Funding would not be an issue as we could go up to 1.5:1 as per industry norm. but there won't be a need to even stretch to that level," he says confidently.

The Key raw material

Be that as it may, while all these project seem to suggest that DFPC is moving up the value chain, the root of its problem lies in the base raw material, natural gas. It is a key raw material to produce its main products ammonia and methanol, which further go on to produce other chemical products besides fertilizers, which contribute about 30 per cent to total revenue (the balance comes from trading). The company suffered a 15 per cent drop in availability of natural gas and 30 per cent below the firm contracted allotment.

Little wonder, DFPC's performance has been fluctuating from Rs. 586 crore in 1999-2000 to Rs. 471.4 crore for the year to March 2004. Over the previous year, while total revenues have dropped 9 per cent to Rs. 496 crore, net profit has improved 8.7 per cent to Rs. 69.7 crores. Mehta justifies the drop in revenues to a reduction in trading valumes from Rs. 114 crore to Rs 69 crore in the current year. However, the bottomline improved despite the shortage of gas and ammonia, which resulted in under utilization of the capital assets in the fertilizer segment.

According to fertilizer industry sources, through there is little doubt about the demand for fertilizers in the country, in the long run once the sector is decontrolled with zero subsidies, fair feedstock pricing and market-determined prices for the commodity, the industry would thrive. But that is unlikely to happen in the near future as its is politically sensitive issue.

Mehta understands the sensitivity of the issue but says that all these issue "would be behind us once gas availability improves" he is banking on the just operational Gail petronet LNG terminal at Dahej and the upcoming g shell's LNG terminal. He expects things to improve by mid next year when the Dahej-Uran-Pune pipeline is in place. Besides, he says once the national gas grid linking KG basin to the west coast is laid, "gas would be in available in abundance."

Meanwhile, DFPC has wherever possible converted some utilities and fuel applications to dual fuel to facilitate usage on naphtha. Besides, it has worked out an arrangement for the supply of ammonia so that its downstream products based on ammonia do not get hit. According to analysts tracking this sector, these are expensive options, which would eat into margins.

Performance-wise, Mehta hopes to grow at about 10-15 per cent in the coming year in terms of topline, but is unwilling to harzard a guess on the bottomline. With about 10-15 per cent rise in capacities generated through retrofits and debottlenecking, together with the power plant getting operational in the second half of the current year and the chemical business looking up, DFPC should close the year with a growth rate of about 20 per cent in post - tax profit (from Rs. 70 crore currently).

A report prepared by angel broking states that with the chemical business continuing its momentum and the fertilizer division "is expected to post lower loss or minor profit as gas availability would increase and result in better capacity utilization... the company can post an EPS of Rs. 10 in FY 05." At a price of Rs. 33-34, the stock is a safe bet for the long term investor as it offers a good dividend (Rs. 2.2 per share) yield of 6.5 per cent. Any capital appreciation thereafter should be viewed as reaping rich dividends.

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