Tata Chemicals offloads an underperforming asset

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The Tata Chemicals stock gained 8.77% on BSE on Wednesday after the company agreed to sell its urea business for Rs.2,670 crore. The price is lower than the $1 billion or Rs.6,600 crore it was reportedly seeking for the whole fertilizer business a year ago.

The sale does not include the complex fertilizers business. Also, the sale price can change depending on the level of subsidy receivables on the date the deal is consummated.

Even if the complex fertilizers division—the returns from which are perceived to be more volatile—fetches a similar amount, the total sale consideration would be lower than what the Street was estimating.

Nevertheless, investors are not complaining. If anything, they are happy Tata Chemicals has begun exiting the fertilizer business, which has become a drag on finances. Last fiscal year, the division generated 39% of revenues but contributed only 13% of the operating profit.

Profitability has been hit by government control on prices. From about 9% in 2011-12, operating margin (earnings before interest and taxes) at the division fell below 4% last fiscal year. So, even though operating margins remained healthy at 18% at the core chemicals division, they fell below 10% at the company level last fiscal year due to the weak fertilizer business.

Further, inordinate delays in subsidy payments are stretching working capital. This is driving up interest costs, crimping return ratios. The sale, once concluded, will reduce finance costs as Tata Chemicals will no longer have to borrow for subsidy receivables, which stood at Rs.1,479 crore at the end of June.

The sale would also strengthen the company’s balance sheet and provide funds for growth opportunities it is pursuing in the consumer products segment. In a conference call with analysts, the management said Tata Chemicals is “transitioning” itself into a company focused on consumer products and is looking for options in the sector. This means it is open to growing the consumer business through the inorganic route.

Many analysts were expecting Tata Chemicals to use the divestment proceeds to pare debt. Though the current debt-to-equity ratio of around 1 is comfortable, much depends on the kind of growth opportunities the company will pursue.

According to an analyst at a domestic broking firm, if the sale proceeds are deployed judiciously, the divestment can trigger re-rating of the stock as the company will now be left with higher-margin non-subsidy farm inputs and chemical businesses, which are showing signs of stabilization after a long period of restructuring.

“Management is confident of improvement in Europe and Magadi (Africa) operations in the coming quarters while US soda ash business will benefit from ramp-up in production,” Emkay Global Financial Services Ltd said in a note.