Tata Chemicals-Indorama deal: Why it is a win-win for both

Tata Chemicals (TTCH) recently announced that it has entered into an exclusivity agreement with Indorama Holdings BV, Netherlands (subsidiary of Indorama Corporation, Singapore), till October 31 and is in advance talks for the potential sale of the last leg of its fertilizer manufacturing business in India for a consideration of Rs 400-500 crore, according to its stock exchange filing. Expectations were rife for a while as this is part of the mega restructuring plan being undertaken at Tata group companies since a new management has taken charge in Bombay House.

As per sources, the deal would include the sale of fertilizer manufacturing plant at Haldia, West Bengal along with the trading business of bulk and non-bulk fertilizers but will exclude the outstanding subsidy amounts. The move comes at a time when the Haldia unit is facing operational headwinds and the sector continues to be plagued by regulatory pressures and delays in subsidy payments.

The deal background

Ever since the change of guard in the Tata Group, there has been a planned initiative to exit non-core businesses and the fertilizer business had been identified as a non-core segment for TTCH. Under the strategic exit plan, the company had already sold off the urea business to Norway’s Yara for Rs 2,670 crore. A spin-off of the remaining fertilizer business had been much anticipated and Tata had been actively looking for a buyer.

The Haldia fertilizer manufacturing plant, which is the core part of the deal with Indorama, had been witnessing hitches over the last couple of months and was closed down for a majority of Q1 due to non-compliance with environmental laws. Although the plant is now up and running, the closure impacted earnings in Q118, with revenues from the fertilizer segment falling a whopping 76 percent year-on-year (YoY). Consolidated revenues were down 20 percent YoY and there was 25 percent YoY decline in net profits.

The fertilizer manufacturing sector is highly regulated and fertilizer sales are subsidized in India. TTCH was facing several issues in the fertilizer business including regular delays in subsidy payments from the government due to which substantial capital was locked up (Rs 870 crore outstanding subsidy in FY17) in working capital financing. This led to additional interest burden for the company. The proposed deal will facilitate deleveraging, in line with management’s aims for a net debt-free standalone business by end of FY18.

What it means for Tata Chemicals’ financials

The fertilizer business contributes approximately 18 percent to consolidated revenues but only around 7 percent to consolidated profits. The FY17 results of the company suggest that an exit from the fertilizer business would reduce overall revenue by around Rs 2200 crore and EBIT by close to Rs 115 crore. Being a low-margin business, the exit from fertilizers would be a positive for the company’s EBIT and PAT margins which we expect would improve by approximately 2 percent.

The company has been looking at expansion in the consumer and specialty segments and proceeds could be utilised for the proposed expansion. A switch from low-margin capital intensive business to high margin asset-light businesses would definitely improve the valuation outlook for Tata Chemicals.

Indorama Corporation is currently one of the largest manufacturers of phosphoric acid and phosphate fertilizers in Sub Saharan Africa. The company recently entered into a partnership with Dhunseri Petrochem for manufacturing PET resin (light weight plastic) in India and has been keen to expand presence. Over the past few months, Indorama has been actively evaluating options for shopping in the Indian fertilizer manufacturing space and was reportedly in talks with the Birla Group as well.

Although the sector remains highly regulated, for Indorama, the deal provides it with an opportunity for forward integration. The company is already a big player in manufacturing phosphoric acid, a key ingredient for fertilizers. It could import raw materials from its facilities in Africa to feed fertilizer manufacturing units in India. With access to raw materials, Indorama would be in a better position to scale up manufacturing operations and make viable returns.

While the exact contours of the deal is still awaited, it prima facie looks like a win-win proposition for both and for investors of Tata Chemicals it looks like the beginning of a re-rating journey.