This looks extremely extremely cheap to me. Because of the peculiar structure of the industry and the business model, it is much more important to look at the cash flows than the accounting profits. The operating cash flow for FY17 was around Rs.1500 Crores. Considering the buoyant demand for most of its products, the operating cash flow this year is expected to be more than Rs. 2000 Crores…As against this, the market cap currently is around Rs.6500 Crores. In a market full of so much froth, this look like a beautiful island of value to me. Market Cap/ Operating cash flow of 3x would be a treasure even in bearish market conditions. In the kind of markets that we are currently, this should have been trading substantially higher.
Business Risk Profile: This has been very well explained by the esteemed boarders in this thread. I was gong through the last three con calls and did some scuttlebutt and my sense is that Q3 will be the best ever quarter in the history of the company. In the industrial/ speciality chemical segment, around 70% of the chemicals that it manufactures is trading at highs or close to recent highs. The industrial/ speciality chemicals segment has been chugging along very well. In FY18, the industrial/speciality chemicals segment is expected to contribute to about 65% of the turnover and around 80% of the total profits. So, shouldn’t it be trading at the valuation of more like a speciality chemicals company rather than fertilizer company. It is worth highlighting here that it is actually trading cheaper than most of the fertilizer companies of similar size and pedigree. In the speciality chemical segment also, it manufactures many complex speciality chemicals and is not a 1 or 2 trick pony like many of the storied speciality chemical players trading at exorbitant valuations currently.
Financial Risk Profile: I expect the company to report PAT of around Rs. 500 Crores in FY18. However, as mentioned above, the CFO is expected to be around Rs.2000 Crores and that is where the treasure is. As the management mentioned during the last 2 con calls, the company likes to expense a lot of provision during the good times in line with the best practices. These are essentially non cash items and hence does not impact the cash flows. Hence, optically the PAT would not be as high expected. This sort of conservatism in reporting the numbers surely gives a lot of comfort. With same set of numbers and business conditions, I know many managements in India who would have reported PAT of Rs. 750 Crores in FY17. The dividend payout ratio is consistently increasing and was at 50% in FY17. This being a government owned entity, the dividend is expected to remain high. If you divide the P&L in two parts , the speciality chemical segment performance is as good as any other speciality chemical player currently. The speciality chemical segment top line is growing at 25%, bottom line at ~50% at a margin of around 25%. Now coming to the fertilizer segment, this is where I expect the results to improve substantially in H2 as the Gujarat elections will be done and dusted with. There is no reason why the company should report losses here, despite being one of the most well entrenched and efficient players. Also, from FY16 onwards, under the current dispensation, the subsidy payout timeline has substantially improved, thus reducing the working capital burden of fertilizer companies. The company has stated its intention of being a debt free company by H1 FY19. In fact the total dues and subsidies pending with the government is sufficient to wipe out its entire debt. So, the company should not have any problems in achieving this objective. FY19, in all probability should be a bumper year for the company as the upcoming budget is expected to have strong rural push due to it being a pre- election budget.
The management is very conservative in giving out targets. By observing them in various forums, I feel they want to take the debt off the books on a priority basis and want to be a debt free company.
Overall, I feel it is one of the most efficient players in its segment with a 60-70% share in TDI segment (whose prices are rocketing by the way) and is among the top 2-3 players in all the key speciality segment divisions that it has presence in. Along with the rapidly improving business profile and economics for the fertilizer players, this I feel is great story to play both the rural growth and speciality chemicals boom…and if such a company is available at Market cap/ Cash flow of 3x, it is literally a steal in my humble view.
The key risk here is the sustainability of speciality chemical prices, but that is true for every speciality chemical player in the market. In my view, this is slowly evolving into 2-3 years kind of story with the balance sheet improvement of most of these players. Just check what happened with Avanti feeds from 2012 to 2015. The market kept giving it subdued valuation till FY15 expecting the supply to bounce back in other competing countries, which has still not happened by the way. So, one fine day the valuation moves from 10x to 30x as the markets realized that the supply is not going to come back in a hurry and the growth is sustainable. So these cyclical trends can also evolve in to structural trends sometimes depending on how the demand side of the market behaves. Off course it goes without saying that the management team needs to execute to capitalize fully on the opportunity. Otherwise, all bets are off. I feel at the current valuation, GNFC is one of the very few mid sized companies currently available at such an attractive valuation, considering the wonderful demand scenario for its products and its perpetually increasing market share.