Analysis on Gujarat Narmada Valley Fertilizer and Chemicals Company (GNFC)

[john20050]

Line of Business

GNFC is a state owned fertilizer and chemical company. It's revenues are 70% from chemicals and rest 30% from fertilizers. Chemical catalogue consists of multiple products like weak nitric acid, acetic acid, TDI etc. It is also the only manufacturer of TDI in SEA.[sup]\[/sup]1])

Financials

Company is generating consistent net profits of rs. 100 crores plus for every quarter since September 2017. Trailing 12 month profits stands at rs 1039 crores. With an EPS of rs. 66.83 the P/E ratio stands at around 5. The company is also debt free so there's no debt servicing costs and the opportunity of future leveraging if the need be.[sup]\[/sup]2])

Credit Ratings

Crisil ranks GNFC commercial paper at A1+. The rating continues to reflect GNFC's market leadership and established regional presence in the industrial chemicals and fertiliser (urea and ammonium nitro phosphate [ANP]) businesses, respectively. The ratings also factor in strong financial risk profile marked by comfortable debt metrics, healthy capital structure in absence of long term debt and ample liquidity, supported by unutilised bank limits. These strengths are partially offset by risks related to price volatility in the chemicals, primarily toluene di-isocyanate (TDI) business, and exposure to risks related to regulated nature of the fertiliser business. CRISIL will continue to monitor sustainability of operations and profitability of the company's TDI plant, the company's overall performance in the fertiliser segment, and any higher than expected debt-funded capital expenditure (capex), which may adversely impact its financial risk profile.[sup]\[/sup]3])

Valuation

This has been tricky. The company is predominantly involved in chemicals but the peer comparison available on the internet is mostly against fertilizer companies. This isn't an apples to apples comparison but this is the best I have right now. The P/E and EPS comparison in one of the peer group comparison shows GNFC to have the lowest P/E with highest EPS and profits.[4] However, these companies will have very different product portfolie so I am not sure how good the valuations compare. But nonetheless the P/E of 5 seems to reflect the stock is at a discount imo.

Is someone else following this stock? What are your opinions on this one?

 

[profmaliki]

@john20050

Chemical catalogue consists of multiple products like weak nitric acid, acetic acid, TDI etc. It is also the only manufacturer of TDI in SEA.

Just focussing on the industry structure here, is the market confusing this company for a fertilizers company, or is it right about the company being a large scale commodity chemcials company?

Just being a chemicals company doesn't mean there is a low barrier to entry (because of effluent treatment and other pollution control norms). So either of these two reasons might not be a reason for low PE.

So, who are the competitors, both locally and internationally?

And what are the end-uses for the chemicals it produces? Is the usage cyclical?

 

[john20050]

@profmaliki I think it is a chemical company first. The first source (investor presentation) says that chemicals contribute 70% of revenues. I’m not able to find a breakup of this revenue by different products on the internet though. Still searching.

For a lot of products, the company holds majority of market share. TDI (65%), Aniline (60%), Formic Acid (58%), Technical grade urea (51%). For other products like acetic acid (16%), Ethyl Acetate (20%) the market share is lesser.

End use varies from paint and foam for TDI, Aniline for rubber etc.

Also, world bank pension fund is one of the institutional investors. I am assuming these funds would have higher due diligence requirement before they add a stock in the fund.

I’m still researching the company and I will add information on competitors, breakup of revenue etc. once I get it!

 

[profmaliki]

@john20050

I think it is a chemical company first. The first source (investor presentation) says that chemicals contribute 70% of revenues. I’m not able to find a breakup of this revenue by different products on the internet though. Still searching.

Yeah, but like my other comment shows, the receivables dont exactly show this. Proportionally, more capital seems to be "stuck" in fertilizers than in chemicals.

For a lot of products, the company holds majority of market share. TDI (65%), Aniline (60%), Formic Acid (58%), Technical grade urea (51%). For other products like acetic acid (16%), Ethyl Acetate (20%) the market share is lesser.

End use varies from paint and foam for TDI, Aniline for rubber etc.

A lot of these chemicals appear to be used in industries that are cyclical by themselves. TDI for instance is used in manufacture of polyurethane foam, which finds usage in furniture and bedding (consumer discretionary), as insulation in refrigerators (consumer discretionary) and in automobiles (cyclical, and consumer discretionary). So, earnings from TDI is dependent on the fortunes of the end-user industries. Demand growth is possible in PU foam, since some of the end-usage is linked to a rising middle class and GDP growth, unless a replacement material is found that doesnt need TDI to produce it.

Similarly, Aniline, through MDI foams, is eventually consumed by the automotive industry, and possibly in construction; Indian construction patterns might not be the same as North America, where foam is used in insulation.

Also, world bank pension fund is one of the institutional investors. I am assuming these funds would have higher due diligence requirement before they add a stock in the fund.

Yes, those are buy-and-hold investors. The mutual funds also seem to be adopting a longer view.

The company seems to capture some of the growth in the underlying economy, especially in the automobile, furniture and bedding industries. But, at the same time, it is vulnerable to problems in the end-user industries, since a drop in demand in downstream industries will cause a supply-demand mismatch resulting in sharper drops in earnings. Inventory stocking and destocking of chemicals done by downstream industries, tends to cause variance in revenues from the chemicals segment.

What would be worth looking at, are the buyers of its chemicals products. That would help in determining whether there are long-term contracts in place, and whether there are risk-mitigation measures put in place to handle supply and demand side shocks.

 

[profmaliki]

@john20050 Regarding the shareholding structure and company management, I see the promoters are a couple of state companies - Gujarat state Investments Ltd and Gujarat state Fertilizers & Chemicals Ltd. The market might be assigning a lower PE because of state ownership - the stock may have done well because of the previous CEO, so it might be worth digging into details, on how CEOs are chosen, and how their performance is measured.

 

[profmaliki]

@john20050 Regarding balance sheet strength, trade receivables account for around 15.5% of the consolidated balance sheet of the company. The management has broken this down into ordinary receivables and subsidy receivables. The latter account for around 9% of the balance sheet. Knowing how the market views fertilizer companies and their relationship with subsidies, it's possible the market is not treating this company as a 30% fertilizer business, because some capital is locked away in such receivables.

The "ordinary" trade receivables are around 40% of the receivables, while the subsidy one accounts for around 58%. So, the market may not be comfortable with the fertilizers business dragging the performance of the chemicals business.

 

[profmaliki]

@john20050 Summarising my comments in the entire thread, with some updates based on Q3 2019 results:

• Market is assigning this company a 5-10 PE valuation and no more for various reasons.
• Subsidy receivables from the fertilizers segment are considered somewhat doubtful, even though subsidy is granted through a government program. Q3 notes to accounts indicate that the company is not able to fully recover all receivables from Ministry of Chemicals and Fertilizers.
• Feedstock raw material prices are volatile resulting in volatility in expenses.
• End-user industries are somewhat cyclical in nature, so even earnings are cyclical. In the long-term earnings growth for the company is expected to match GDP growth because the end-user industry demand mimics GDP growth. Highly cyclical nature of the industry with a somewhat commoditised nature implies the market wont be willing to give the company a high earnings multiple.
• Promoters being government entities acts as an overhang on this stock. It can do well, when everything is going right for the company, but the converse is also true.

 

[john20050]

@profmaliki Agreed. Q3 results were bad and justifies the selling in the market today. Coupled with TDI slowdown, the whole subsidy business with govt, slowdown in chemical and general elections are all going to impact this stock in the near future. Also, the quarter was particularly bad because of some shutdown for 27 days and subsidy write off. The fundamentals do not seem worrying and the stock could see a turnaround if the numbers can be generated in the quarters to come and if Modi Govt. gets a second term.
A stock worth keeping an eye on for now, not worth keeping the money though for sometime IMPO currently.

Disclosure: I’m not an expert. More of a novice.

 

[profmaliki]

@john20050

Also, the quarter was particularly bad because of some shutdown for 27 days and subsidy write off.

Plant closures for maintenance etc can be more frequent when the demand is down. It's more prudent that way, since increasing capacity utilization wont necessarily result in increasing earnings. Conversely, prudent managements will also increase capacity utilization and attempt for least downtime when the company and industry is doing well.

edit: What I mean is, one shouldn't assume Q4 results will automatically be better because of this one-off effect of plant shutdown.

The fundamentals do not seem worrying and the stock could see a turnaround if the numbers can be generated in the quarters to come and if Modi Govt. gets a second term.

The same government did not release the subsidy amount to the company on time. The market will price in doubtful subsidies regardless of who's at centre, because realizing receivables in an election year is pretty much doubtful. Why would any government release money towards a company in an election year, when government expenditures will rise for that fiscal year?

My opinion is that a valuation with a margin of safety can be arrived at doing a SOTP valuation of the three units - chemicals (5-10 earnings multiple), fertilizers (5? earnings multiple) and the small IT division in nuCode (5? earnings multiple). If you want to avoid doing a SOTP valuation, if this company is trading at 5 PE on a forward basis, it can be a good buy, but one also needs to be agile enough to sell it.

 

[john20050]

@profmaliki Your participation in this post has been really informative. Thanks!

 

[profmaliki]

@john20050 Your contribution is not bad either. This post will provide a benchmark on how we as mods want to shape discussion on stocks. We're expecting redditors to drive the discussion, allowing for multiple viewpoints and a balanced discussion, so as to avoid one-sided conversations and a herd mentality.

 

[oldschooljenny]

@profmaliki How to do such analysis, any recommendations to learn ?

 

[profmaliki]

@oldschooljenny It's a 5 year long learning process. A few words wont cover everything.

You can start with the list of the books in the weekly discussion thread. I would recommend One Up on Wall Street from that list, but there are other books that might also help you. At least then you can figure out how to avoid most of the "bhangaar" cap stocks.

And if you find a company interesting, you can put up a basic analysis like the one OP did, and ask for opinions. The more nuanced opinions come only with time. Those are formed when you build your own mental abstractions or borrow mental abstractions used by others to describe why one company attribute is more appealing than another. It's something that management consultants do on a day to day basis, but anyone with aptitude can do the same.

 

[midushi]

@john20050 I don't know much but I can point you to detailed discussion on it.

http://forum.valuepickr.com/t/gnfc-the-big-becoming-bigger/4551

 

[tessaherrin]

@john20050 Being a govt. Co. can be a draw back these days.

 

[resjudicata]

@john20050 Bc no one actually saying if they will buy or stay away.

 

[profmaliki]

@resjudicata "Tell me whether to buy, sell or hold. Nothing else matters."

Found the tailcoat investor.