Chemfab Alkalis - Well-poised for the Caustic Soda/Chlorine cycle?

Chemfab Alkalis


FY12 FY13 Growth
Sales 76.52 115.19 50.54%
EBITDA 18.75 41.61 121.92%
PAT 7.47 23.48 214.32%

Positives:
1. Debt-free company showing impressive growth. Cash & Current Investments ~29 Cr. Dividend Yield >6%, quoting at <3x.
2. Industry-beating Margins. Backward integration in Salt and cost advantages on 2 key ingredients -Electricity & Water.
3. Promoter Holding ~75%

Risks:
1. Unimpressive/Poor past track-record
2. Caustic-Soda positive cycle may be nearing the end?
3. Threat of Imports - currently though, anti-dumping duty is in force on caustic soda imports for 5 years, till 2016-17


This is another company Ayush is invested in from lower levels, among his several such interesting bets. But what made us sit up and take serious notice is the serious improvement on the numbers front - even someone like me had to sit up and take notice. (Yet again for a chemicals commodity-probably cyclical play:) - to understand what's going on).

Couple this with the fact that this is a debt-free company, and has current investments and cash totaling ~29 Cr as on 31st Mar '2013. Operating margins have been on a continuous upswing for last 2 years - going up from ~20% to now ~33% - something that we have come to value highly. And at <3x Earnings valuations were cheap enough to compel us to try and seek some answers -beyond the obvious - it's a cyclical play. Sure, we said, but something was telling us, there must be more!

Chemfab Alkalis (http://www.chemfabalkalis.com/about.htm)isn't a big player in the Indian Chlor-Alkali market. It barely makes it to the list of the 15 largest players. But it did come to our notice that this guys are the pioneers of the more cost-effective membrane-technology for Caustic Soda production in India.CALwas incorporated in June, 1983. It established India's first Membrane Cell Caustic Soda Plant and commenced production from July, 1985. The Company is the first in the country to introduce Pollution-free Membrane Cell Technology which became the trendsetter in the Chlor-Alkali Industry.After seeing the successful performance ofCAL, the Government of India took a policy decision that :

"No more Caustic Soda Plant using Mercury Cell will be permitted to expand nor set up.
All future Caustic Soda Plants in the country will use only MEMBRANE Cell Technology".


A little bit of digging established that Chemfab probably enjoys the best margins in the industry. GACL the 2nd largest player (and 10x CAL capacity) had OPMs of ~24% vs CAL's 33%. Some factors could be seen to be contributing to this:

Electricity, Water and Salt are cited as Key ingredients for the Chlor-Alkali industry.

a) Salt -CALhas gone for backward integration and put up a salt field about 40 km from Chlor-Alkali plant site.CALis getting good quality salt for membrane cell Electrolyser at very low cost with reduced transport costs.

b) Water Availability - First to set-up a de-salinisation plant

c) Cheaper Electricity costs - reportedly Puducherry provides Electricity at Rs. 3.5 per unit - one of the lowest rates in the country

The main question that remained for us:

a) What has caused margins to be continuously on the upswing? And is this sustainable?

b) In the Chlor-Alkali business cycle, where exactly are we in that NOW? Can we be on top of the Chlor-Alkali cycle, easily?

Quoting at <3x FY13 earnings, valuations seem attractive. With Rs.5 per share dividend declared in Q4, Yield is 6.6%.Larger Peers in the same industry like GACL quote at 6-7x earnings.

Chemfab may be cheap -for a reason- the long term track record is unimpressive - even poor. Let's got on the job to establish the investment-worthiness vis-a-vis current valuation, one way or the other.
Cheers
Donald
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A good backgrounder on the Industry is available from 2 articles at Capitaline.

http://www.derivatives.capitaline.com/newsdetails.aspx?sno=557510&opt=HP&secid=21&subsecid=0&SelDt=
http://www.derivatives.capitaline.com/newsdetails.aspx?sno=601157&opt=HP&secid=21&subsecid=155&SelDt=
Some selected excerpts:
Background

The Chlor-Alkali Industry produces Caustic Soda, Chlorine, Hydrogen and Hydrochloric Acid. Hydrogen and Chlorine, the bye-products of Caustic Soda manufacture, are used to produce Hydrochloric Acid. These products are being used in various industrial sectors, either as raw materials or intermediate or auxiliary chemicals. Among them Caustic Soda and Chlorine are the most important inorganic chemicals used by almost all industries for one or the other purpose. Caustic soda is produced in a liquid form, which is called âlye', and is converted into flakes or solids through an evaporation process. Though caustic soda is sold in both liquid and solid forms, lye accounts for a major portion of sales, as most companies prefer the aqueous solution.

Globally for Chlor-Alkali Industry, Chlorine is the driving product whereas, in India, Caustic Soda is the driving product. Hence, Indian Industry faces competition from cheaper imports. The domestic demand for Caustic Soda and Chlorine is about 2.9 Million Tonnes and 2.4 MT respectively. The growth in demand for Caustic soda and Chlorine is linked to GDP growth with Chlorine growing slowly vis--vis Caustic soda.

Chlorine and caustic soda are co-products that are evenly produced by the chlor-alkali industry. Since chlorine cannot be stored, chlor-alkali plants are operated in line with demand for chlorine.

Indian Chlor-Alkali capacity constitutes 4% of global Chlor-Alkali capacity.

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Demand for alumina, paper and textiles drives caustic soda industry and these three industries alone constitute about 60% of the total demand.

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Source: Planning Commission

Major chlorine consuming sectors are vinyl, CPW, pulp & paper and chemicals constituting over 80% of demand. Chlorine is used in industry segment such as PVC, Pulp & Paper, Pesticides, Chloromethanes, Refrigerant Gases, Water Purification, Stable Bleaching Powder, Aluminium Chloride, Chlorinated Solvents etc. Hydrochloric Acid is used in industry segment such as Steel Pickling, Water Treatment, Effluent Treatment in Chemical Process Industries, Thermal Power Plants etc.

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Source: Planning Commission

Aditya Birla Group is the market leader in Indian chlor alkali sector, though company wise, Gujarat Alkalies & Chemicals remains the market leader. GACL has 429000 Metric tonne (MT) of Caustic Soda and has about 18% share in the domestic Chlor-Alkali market in India. Moreover caustic soda business segment alone constitutes around 60% of its sales and profit. The other major producers are Grasim Industries, Aditya Birla Chemicals, Aditya Birla Nuvo, DCM Shriram Consolidated, Reliance Industries, Sree Rayalseema Alkalies & Allied Industries, Chemplast Sanmar, Meghmani Finechem etc.

Major Players in the Indian caustic soda sector
As On Capacity (Units in MT)
Grasim 31-Mar-11 258000
Aditya Birla Chemicals* (AB Chemicals) 16-Apr-11 220000
Aditya Birla Nuvo (AB Nuvo) 31-Mar-11 91250
Aditya Birla Group 569250
Gujarat Alkalies & Chemicals 31-Mar-11 429000
DCM Shriram Consolidated (DSCL) 31-Mar-11 274670
Reliance Industries 31-Mar-11 168150
Sree Rayalseema Alkalies 31-Mar-11 123950
Gujarat Flurochemicals 31-Mar-11 117000
Chemplast Sanmar 31-Mar-11 113850
Meghmani Finechem 31-Mar-11 110000
Punjab Alkalies 31-Mar-10 99000
Lords Chloro 31-Mar-11 84150
Mawana Sugars 31-Mar-11 82500
Travancore-Cochin Chemicals 31-Mar-10 57750
Tamil Nadu Petro Products 31-Mar-11 56100
Jayshree Chem. 31-Mar-11 53200
Chemfab Alkalies 31-Mar-11 42000
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Chlor Alkali: Tightness in supplies help firmness in Caustic soda prices

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Global chlorine production has improved, that had seen cut back in production towards the end of 2011, due to lower chlorine demand. Chlorine and caustic soda are co-products that are evenly produced by the chlor-alkali industry. Since chlorine cannot be stored, chlor-alkali plants are operated in line with demand for chlorine.

Domestic caustic prices have remained firm as the capacity utilization in the chlor-alkali industry capacity was affected due to the low chlorine offtake and also due to high international prices. On the other side chlorine prices had declined to abnormal levels. Electro Chemical Unit (ECU) realizations of chlor-alkali players have grown at a healthy pace in the last one-year upto March 2012, due to higher caustic prices. However, the ECU realizations have dipped for some players during the quarter ended March 2012, when compared with the previous quarter. Though the caustic soda prices have increased in the last one-year, it has been offset by higher cost.

The factors that had lead to the increase in price over the last one year have been the increase in energy and salt cost for the manufactures. On the other hand, anti-dumping duty imposed on caustic soda imports led to prices strengthening in the short term. Moreover, the sharp rupee depreciation, lead to rise in the landed cost of import, enabled companies to raise domestic prices.

Sequentially, retail average caustic soda flake prices remains elevated on y-o-y basis for 18 months in succession since December 2010 through May 2012. Sequentially prices have been gyrating, with intermediate ups and downs.

Chlor-alkali breaks the cycle

11 June 2012 00:00

http://www.icis.com/Articles/2012/06/11/9567461/chlor-alkali-breaks-the-cycle.html

The chlor-alkali industry is a cyclical business where the ECU value, which is the combined value of chlorine andcaustic soda, tends to move up and down with a cycle of about three years. With regard toethylenedichloride (EDC) prices and therefore the chlorine equivalent, the trend is usually counter cyclical to caustic soda. That is, when caustic soda prices are high, chlorine prices are low and vice versa.

Those interested in tracking the ECU value/cycle can read more in the above article.

-Donald

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http://www.greenbuildingcongress.com/site/superdirectory/sector.jsp?sector=3

Another compact report on the Chlor-Alkali Industry from CII. Key additional information here is the Energy Consumption trend by the Industry.

ENERGY CONSUMPTION TREND

Energy costs represent 50-65% of the total cost of production, based on the cost of power.

Chlor-Alkali industry is power-intensive as Power is used as a raw material in Electrolysis process of Sodium Chloride solution. 85%-90% power is required for electrolysis and balance 10-15% power is required for running equipments i.e. Auxiliary Power. So it is very important to monitor the electrolysis process very closely to minimise power consumption.

http://google.brand.edgar-online.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=4281027-10835-127158&SessionID=mN3HHjneTZJAo47

Read this Annual Report of Pioneer Inc. with lot of interest. ARs of US companies are a delight to read - mandatory disclosures about issues affecting the industry, market outlook, competition are pretty exhaustive. Helps us come to terms with the main issues quickly:)

Issues/Observations

1). Caustic soda and chlorine are co-products which are produced simultaneously through the electrolysis of salt water in a fixed ratio of approximately 1.1 to 1. An Electrochemical Unit, which the industry refers to as an aECUa, consists of 1.1 tons of caustic soda and 1ton of chlorine.

2). Transport costs are significant. Chlorine is also hazardous to transport. Mostly it is consumed locally. Every region must be having local suppliers - AP guys buy within AP, Team Hyderabad reports.Chemfabmust be selling only in TN/Pondicherry. And if it doesn’t have much local competition, than sustainability is easier!

3). As we can see in the Pioneer AR filing above, Availability of Salt & Transportation Costs are again considered significant Competitive Advantage/Disadvantage

4). Power - considered the most costly RM ( water & Salt are others) is also very significant.Chemfabmight have a big advantage because of Pondicherry power -which is cheaper at Rs 3.5/unit?

5). Chlorine vs Caustic Soda - Balancing Demand/Production

On the other hand, when chlorine demand declines so that available storage is filled, production operations must be curtailed, even if demand for caustic soda increases.

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Summarising key takeaways:

1). Should not be too difficult to keep on top of Chlor-Alkali cycle. If not this time round, we can take advantage of the workdone, next time round:)

2). Prices have gone up from ~27000 per tonne in July 2011 to ~39000 per tonne in Dec 2012 - that is the key reason foruptickin margins across the industry

3). Margins had started decelerating for major players over last 3-4 quarters - due to higher energy and salt costs. On the other hand Chemfab margins have held and/or improved during last 3-4 quarters ( due to capped costs on Salt &^ Electricity?).

4). Transportation costs are key and/or is hazardous/unviable across states . So competition is mostly local. There might be space for all to grow in TN/Pondicherry

5). Is this too good to last? Where exactly are we in the cycle??

Caustic Soda: Caustic Soda Price Dips

http://www.derivatives.capitaline.com/newsdetails.aspx?sno=621166&opt=HP&secid=21&subsecid=156&SelDt=

Outlook

US chlorine operating rates are expected to creep up through the next few months as the chlorine season develops, especially as the US economy appears to be continuing to show progress. Chlor-alkali operating rates remain lower across Asia due to weak chlorine demand. The outage season is just about to get underway and this will restrict production over the next few months.

Producers in the US have announced caustic soda price increases aimed at Q2 CY 2013. After seeing prices reduce in recent months, there now seems to be a reversal in the trend in the Asian market as producers turn down rates and fight to recover margins at a time when the vinyls market also seems to be changing direction.

Domestic caustic soda prices are expected to decline in the near term due to oversupply conditions and also due to fall in aluminium production.

Retail Prices: Caustic Soda (Flakes)

FY'14

FY'13

FY'12

FY'11

Price

% Chg.

Price

% Chg.

Price

% Chg.

Price

% Chg.

Apr

27

-30

39

43

27

38

20

-32

May

39

50

26

25

21

-25

Jun

37

49

25

45

17

-36

Jul

38

32

29

57

18

-12

Aug

38

23

31

68

19

3

Sep

37

16

32

68

19

-9

Oct

35

12

31

68

19

-4

Nov

41

29

31

43

22

-2

Dec

36

6

34

44

24

13

Jan

36

2

35

49

24

27

Feb

31

-5

33

27

26

34

Mar

29

-20

36

48

24

28

Prices is Rs per Kg

Price for the month of April 2013 is provisional

Source: Capitaline Database

Retail Prices: Caustic Soda (Lye)

FY'14

FY'13

FY'12

FY'11

Price

% Chg.

Price

% Chg.

Price

% Chg.

Price

% Chg.

Apr

24

-19

30

26

24

35

18

-27

May

31

17

27

34

20

-15

Jun

32

31

25

47

17

-29

Jul

35

25

28

71

16

-13

Aug

37

42

26

60

16

11

Sep

33

32

25

63

16

-4

Oct

32

19

27

70

16

-2

Nov

32

15

28

51

19

3

Dec

31

7

29

32

22

25

Jan

28

2

28

26

22

39

Feb

27

-3

28

22

23

45

Mar

25

-10

27

34

20

28

Prices is Rs per Kg

Price for the month of April 2013 is provisional

Source: Capitaline Database

Domestic Caustic Soda Production ( Tons)

Month

FY'13

FY'12

FY'11

Production

% Chg.

Production

% Chg.

Production

% Chg.

Apr

179,434

-4

186,832

7

174,825

2

May

183,141

-1

185,477

6

175,572

0

Jun

174,985

2

172,334

10

156,986

-8

Jul

175,637

-4

183,620

5

175,523

-1

Aug

188,226

2

184,691

-3

190,129

8

Sep

173,589

-4

180,174

-4

188,130

7

Oct

183,762

-3

189,175

2

185,090

8

Nov

179,510

-2

182,846

2

179,040

6

Dec

189,579

-2

192,535

5

183,052

-1

Jan

180,465

-7

193,955

4

186,086

3

Feb

--

0

181,171

1

179,522

7

Mar

--

0

178,384

-8

194,046

7

Source: CSSPRO

Domestic Liquid Chlorine Production ( Tons)

Month

FY'13

FY'12

FY'11

Production

% Chg.

Production

% Chg.

Production

% Chg.

Apr

124,555

0

124,852

4

120,193

4

May

125,628

2

123,645

2

120,842

0

Jun

120,310

6

113,259

-3

116,978

-1

Jul

118,095

-5

124,796

3

120,661

-1

Aug

126,310

1

124,671

-4

130,098

7

Sep

117,997

-3

121,610

-3

125,999

4

Oct

124,877

-3

128,538

0

128,894

13

Nov

121,738

-1

122,579

2

120,197

6

Dec

130,593

0

129,997

7

121,047

-5

Jan

124,308

-5

130,507

-1

131,750

6

Feb

--

0

119,918

-4

124,850

7

Mar

--

0

120,541

-10

133,580

7

Source: CSSPRO

In Apr 2013, prices at Rs 27000 per tonne are back to Apr 2011 levels. The story no longer seems as charming:), or is it?

Picture abhi baki hain mere dost!

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Think we have most of the issues now out in the open.Industry professionals/Chemicals Export/Import Agents can help us nail this picture better - get on top of the Chlore-Alkali cycle.

Request everyone interested/tracking/invested in Chemfab to help us solve this puzzle by contacting industry professionals and Chemicals export/import agents.

We are shooting for a Management Q&A in Chennai next month. Meeting with Management will surely throw more light - but we can be better prepared to quiz with industry/competition/pricing data in hand.

Please help us plug the holes in this story with local scuttlebutt and contacts with industry professionals.

Cheers

Donald

Hi Donald,

Good to see your interest here and the digging part.

Yes, the fall in the prices over last few months is concerning while if one observes the march 13 qtr results, the co has once again done very well despite the correction in prices.

Perhaps the biggest thing here is cheap electricity. We should try to understand more on the sustainability of the same.

Ayush

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Hi Ayush,

Casualinquiriesreveal scope for margins sustainability for Chemfab.

1). ECU value - which is the combined value of Chlorine & Caustic Soda - is expected to remain stable. Generally if Caustic Soda goes down, Chlorine prices go up and vice versa

2). Electricity cost advantages are real for Chemfab. As is the backward integration for Salt which is a key raw material

It seems we can get to the bottom - of this puzzle - once we interview Management.

Meanwhile please continue efforts to validate this ECU value stability in the near to medium term. Also, are you clear about the growth prospects for the company, roadmap for expansion of capacities, etc.

-Donald

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According to the AR, electricity costs are expected to increase 35% from April 13.

Aditya Birla Chemicals acquires Solaris Chemtech’s Chlor-Alkali business

1.http://www.thehindubusinessline.com/companies/aditya-birla-chem-buys-solaris-chemtechs-chloralkali-business/article4775300.ece

2.http://articles.economictimes.indiatimes.com/2013-05-31/news/39655890_1_aditya-birla-chemicals-acquisition-vsf

Mallikarjun

Has anyone checked out AR 2013? It shows some commitments which are not accounted for.

One of them is 50 Cr. commitment for purchasing tangible assets. Perhaps it is for the expansion or replacements/modifications. Whatever the purpose, its can’t be achieved with accruals alone. So will it take on Debt?

We also need to watch out for commissions paid to directors/promoters this year since the results are down compared to last year. Need to see signs that commissions are tied to the company’s performance in terms of net profit not sales! The dividend is 1/4th of what it was last year. So the commissions also ought to be! (overall remuneration also needs to be checked this year.) It would give a clear idea, I guess, of whether shareholders’ money is being siphoned off.

Any thoughts?

I had found this company interesting and was looking into it. But was put off because of the information that I got from the below article in equitymaster.

(http://www.equitymaster.com/outsideview/detail.asp?date=07/29/2013&story=12&title=Chemfab-Alkalis–Not-a-professionally-run-firm-Luke-Verghese)
Note:Below is a July 2013 article.

Chemfab Alkalis: Not a professionally run firm

_A company which waxes and wanes intermittently as the years’ pass by

On the roll again

__Chemfab Alkalis__ is a low key operator of 30 years vintage with its factory at Puducherry. The company did sparkle briefly under the arc lights some 2 decades ago, before hastening to seek cover under the shade for whatever reason. The company is a member of the Chlor Alkali industry which involves the manufacture of caustic soda, chlorine, hydrogen, sodium hypo chlorate and hydrochloric acid. The company per-se manufactures caustic soda lye, chlorine and an item categorised as aothers’ for sale. The last mentioned is a significant contributor to revenues. So how does it qualify for the tag of others please? The three key ingredients for the successful functioning of the plant are consistent power supply, a reasonable power tariff, and a good domestic market is the learned observation of the present chairman, Suresh Krishnamurthy Rao, son of the late founder chairman. One cannot fault the chairman’s observations on this count.

The accounts however have some interesting notes on two of the chairman’s observations. One, it did export finished products. The company exported finished goods worth Rs 7.2 m during the year-good domestic market or not. But at the same time the export effort was minimalistic given that the gross revenues from operations for the year amounted to Rs 1.3 bn. On the other it has contingent liabilities of Rs 19.8 m for disputed fuel surcharge under The Electricity Act which is now lying with the Appellate Tribunal.

Iron clad grip

One may add here that the promoters have an iron clad grip on the company, and boy oh boy are they enjoying quite a bit of fun while the sun is still shining on the Rao empire. They hold directly or indirectly a shade less than 74.99% of the outstanding equity of Rs 45.86 m. Thus the __floating stock__ is limited to put it mildly. (It appears that the company has not made a single bonus issue in its lifetime). This holding pattern does not however fully cover the extent of the grip that the management wields. There are three closely held group companies which exercise a significant influence over the company. They are Dr Rao Holdings Pte Ltd based out of Singapore, Titanium Equipment and Anode Manufacturing Company Ltd and Teamec Chlorates Ltd. The latter two appear to be based out of India. These companies benefit in myriad ways. The Singapore concoction is a significant holder of the promoter’s equity, and benefited to the tune of Rs 22.85 m by way of dividend during the year. Titanium Equipment bought and sold plant and machinery to / from the company and Chemfab also gave corporate guarantees of Rs 6 m or is it Rs 7.5 m to the customs on behalf of Titanium Equipment. Chemfab also bought revenue goods worth Rs 8.9 m from Titanium. Further, Chemfab paid an annual maintenance charge of Rs 6.7 m to Titanium. This is really swell-the way the promoters have engineered the deal! Titanium also received dividends to the tune of Rs 4.4 m due to the promoters. Further, Chemfab has deposited Rs 30 m as rental deposit with Titanium.

The other group company Teamec Chlorates is also a significant beneficiary. Chemfab sold plant and machinery to Teamec and bought revenue goods from the parent. It also placed an inter-corporate deposit of Rs 100 m with Teamec. What on earth does this pertain to please? There is a rental deposit of Rs 30 m --the same as previously --paid to Titanium Equipment And Anode Manufacturing Company. This is money for jam. What is the need to pay such a deposit to closely held group company please? Then there are the dividends paid to the present chairman and his mother Mrs K M Padma - but that is basically due to their shareholding in the company. Besides, the new chairman gets a commission of Rs 2.5 m for services rendered to the company. The total commission to all directors added up to Rs 10 m. Several of the directors are well into their 70’s. It is all in the family and it is all planned right down to the letter T.

A finely tuned ship

But one must also add that the company is a finely tuned ship at the end of the day. For starters the piddling paid up capital is backed up by humungous reserves of Rs 1 bn plus. The gross revenue from operations was sharply higher at Rs 12.95 bn against **Rs 8.64 bn **previously. (The sales in the preceding year were affected due to the chlorine gas leak and the subsequent closure of the factory). The company was able to achieve the higher sales figure on significantly lower raw material input costs. The total consumption cost of materials including stock in trade fell to Rs 59.4 m from Rs 100 m previously. In this the consumption basket the cost of salt fell to Rs 30 m from Rs 66.4 m previously. It also consumed Rs 5 m worth of caustic soda to make the caustic soda lye.

For power intensive units like caustic soda (or soda ash, aluminium, or charge chrome also known as ferro chrome, or steel produced by electric arc furnaces for that matter) the largest revenue cost by far is the cost of power consumed. The cost of power amounted to Rs 4.63 bn against **Rs 2.85 bn **previously, and is the single largest revenue expense. Does the change in the consumption pattern of raw materials have anything to do with the company changing the manufacturing technology from membrane cell to what the company calls the latest bi-polar BiTAC technology? The company also adds that the present caustic soda concentration plant is also being changed to the state of the art caustic soda concentration plant with flaker unit.

Anyways, during the year, the company deleted Rs 138 m worth of gross block (the retirement includes Rs 108 m worth of P&M) and added** Rs** 145 m worth of gross block (Rs 59.4 m of P&M, and significantly Rs 75.6 m of additional land). The additional land input would imply that the company is also simultaneously expanding capacity or something. The retirement also includes the sale of land valued at Rs 4.4 m for **Rs 17 m **resulting in a profit

of** Rs 12.6 m. **The gross block at year end stood at Rs 1.43 bn with capital work in progress of Rs 20 m, and capital advances of Rs 46.3 m.

The other income factor

The company also generated sizeable other income of Rs 36.3 m against a lower Rs 21.1 m previously. The largest constituent of other income is dividend income of Rs 18.5 m followed by profit on sale of fixed assets of Rs 8.7 m. There is also the interest of Rs 4.6 m on inter-corporate deposits that it has affected.The company is not only debt free but is also __cash rich__ like hell which enables it to toss money over to group affiliates like confetti for self conceived reasons. At year end it boasted investments in mutual funds to the tune of Rs 2.63 bn besides the ICDs mentioned earlier. Separately, it also had cash resources of Rs 28 m at year end. The gross block expansion is being financed entirely through internal generation of resources. The company generated net cash of Rs 311 m from operations, and it was more than sufficient to defray the capex costs of Rs 182 m for the year.

After all expenses the company toted up a pre-tax profit of Rs 348 m against Rs 119 m previously. After tax provision of Rs 113 m against Rs 43.8 m previously, the net profit amounted to** Rs 235 m **against Rs 74.7 m previously. The earnings per share was a very healthy Rs 25.60 .The share price oscillated form a low of Rs 37.25 in May 2012 to a high of Rs 108 in January 2013. The company paid a dividend of Rs 5 per share on a face value of Rs 5.

In spite of the promoter management indulging in self aggrandisement schemes to fatten closely held group companies; this is a share that can be looked at closely._

_A company which waxes and wanes intermittently as the years’ pass by

On the roll again

__Chemfab Alkalis__ is a low key operator of 30 years vintage with its factory at Puducherry. The company did sparkle briefly under the arc lights some 2 decades ago, before hastening to seek cover under the shade for whatever reason. The company is a member of the Chlor Alkali industry which involves the manufacture of caustic soda, chlorine, hydrogen, sodium hypo chlorate and hydrochloric acid. The company per-se manufactures caustic soda lye, chlorine and an item categorised as aothers’ for sale. The last mentioned is a significant contributor to revenues. So how does it qualify for the tag of others please? The three key ingredients for the successful functioning of the plant are consistent power supply, a reasonable power tariff, and a good domestic market is the learned observation of the present chairman, Suresh Krishnamurthy Rao, son of the late founder chairman. One cannot fault the chairman’s observations on this count.

The accounts however have some interesting notes on two of the chairman’s observations. One, it did export finished products. The company exported finished goods worth Rs 7.2 m during the year-good domestic market or not. But at the same time the export effort was minimalistic given that the gross revenues from operations for the year amounted to Rs 1.3 bn. On the other it has contingent liabilities of Rs 19.8 m for disputed fuel surcharge under The Electricity Act which is now lying with the Appellate Tribunal.

Iron clad grip

One may add here that the promoters have an iron clad grip on the company, and boy oh boy are they enjoying quite a bit of fun while the sun is still shining on the Rao empire. They hold directly or indirectly a shade less than 74.99% of the outstanding equity of Rs 45.86 m. Thus the __floating stock__ is limited to put it mildly. (It appears that the company has not made a single bonus issue in its lifetime). This holding pattern does not however fully cover the extent of the grip that the management wields. There are three closely held group companies which exercise a significant influence over the company. They are Dr Rao Holdings Pte Ltd based out of Singapore, Titanium Equipment and Anode Manufacturing Company Ltd and Teamec Chlorates Ltd. The latter two appear to be based out of India. These companies benefit in myriad ways. The Singapore concoction is a significant holder of the promoter’s equity, and benefited to the tune of Rs 22.85 m by way of dividend during the year. Titanium Equipment bought and sold plant and machinery to / from the company and Chemfab also gave corporate guarantees of Rs 6 m or is it Rs 7.5 m to the customs on behalf of Titanium Equipment. Chemfab also bought revenue goods worth Rs 8.9 m from Titanium. Further, Chemfab paid an annual maintenance charge of Rs 6.7 m to Titanium. This is really swell-the way the promoters have engineered the deal! Titanium also received dividends to the tune of Rs 4.4 m due to the promoters. Further, Chemfab has deposited Rs 30 m as rental deposit with Titanium.

The other group company Teamec Chlorates is also a significant beneficiary. Chemfab sold plant and machinery to Teamec and bought revenue goods from the parent. It also placed an inter-corporate deposit of Rs 100 m with Teamec. What on earth does this pertain to please? There is a rental deposit of Rs 30 m --the same as previously --paid to Titanium Equipment And Anode Manufacturing Company. This is money for jam. What is the need to pay such a deposit to closely held group company please? Then there are the dividends paid to the present chairman and his mother Mrs K M Padma - but that is basically due to their shareholding in the company. Besides, the new chairman gets a commission of Rs 2.5 m for services rendered to the company. The total commission to all directors added up to Rs 10 m. Several of the directors are well into their 70’s. It is all in the family and it is all planned right down to the letter T.

A finely tuned ship

But one must also add that the company is a finely tuned ship at the end of the day. For starters the piddling paid up capital is backed up by humungous reserves of Rs 1 bn plus. The gross revenue from operations was sharply higher at Rs 12.95 bn against **Rs 8.64 bn **previously. (The sales in the preceding year were affected due to the chlorine gas leak and the subsequent closure of the factory). The company was able to achieve the higher sales figure on significantly lower raw material input costs. The total consumption cost of materials including stock in trade fell to Rs 59.4 m from Rs 100 m previously. In this the consumption basket the cost of salt fell to Rs 30 m from Rs 66.4 m previously. It also consumed Rs 5 m worth of caustic soda to make the caustic soda lye.

For power intensive units like caustic soda (or soda ash, aluminium, or charge chrome also known as ferro chrome, or steel produced by electric arc furnaces for that matter) the largest revenue cost by far is the cost of power consumed. The cost of power amounted to Rs 4.63 bn against **Rs 2.85 bn **previously, and is the single largest revenue expense. Does the change in the consumption pattern of raw materials have anything to do with the company changing the manufacturing technology from membrane cell to what the company calls the latest bi-polar BiTAC technology? The company also adds that the present caustic soda concentration plant is also being changed to the state of the art caustic soda concentration plant with flaker unit.

Anyways, during the year, the company deleted Rs 138 m worth of gross block (the retirement includes Rs 108 m worth of P&M) and added** Rs** 145 m worth of gross block (Rs 59.4 m of P&M, and significantly Rs 75.6 m of additional land). The additional land input would imply that the company is also simultaneously expanding capacity or something. The retirement also includes the sale of land valued at Rs 4.4 m for **Rs 17 m **resulting in a profit

of** Rs 12.6 m. **The gross block at year end stood at Rs 1.43 bn with capital work in progress of Rs 20 m, and capital advances of Rs 46.3 m.

The other income factor

The company also generated sizeable other income of Rs 36.3 m against a lower Rs 21.1 m previously. The largest constituent of other income is dividend income of Rs 18.5 m followed by profit on sale of fixed assets of Rs 8.7 m. There is also the interest of Rs 4.6 m on inter-corporate deposits that it has affected.The company is not only debt free but is also __cash rich__ like hell which enables it to toss money over to group affiliates like confetti for self conceived reasons. At year end it boasted investments in mutual funds to the tune of Rs 2.63 bn besides the ICDs mentioned earlier. Separately, it also had cash resources of Rs 28 m at year end. The gross block expansion is being financed entirely through internal generation of resources. The company generated net cash of Rs 311 m from operations, and it was more than sufficient to defray the capex costs of Rs 182 m for the year.

After all expenses the company toted up a pre-tax profit of Rs 348 m against Rs 119 m previously. After tax provision of Rs 113 m against Rs 43.8 m previously, the net profit amounted to** Rs 235 m **against Rs 74.7 m previously. The earnings per share was a very healthy Rs 25.60 .The share price oscillated form a low of Rs 37.25 in May 2012 to a high of Rs 108 in January 2013. The company paid a dividend of Rs 5 per share on a face value of Rs 5.

In spite of the promoter management indulging in self aggrandisement schemes to fatten closely held group companies; this is a share that can be looked at closely._

@donald. At the outset, thanks for sharing those links here. All those links were very enlightening to read.

Initially, I had looked at this company last year. It was just a casual glance - looking up the numbers and reading their annual report. It got my attention recently as it has corrected ~50% from those levels.

My initial view last year was that the caustic soda price cycle has eased off and this will be a bad thing for players such as Chemfab. After going through the articles posted here and also doing some more desk-research that seems to be really the case.

Take for instance the following comment in Olin’s Q1 result.

chlorine prices increased for the first time in four years and the first quarter 2015 ECU netbacks improved from the fourth quarter 2014 levels*

http://www.prnewswire.com/news-releases/olin-announces-first-quarter-2015-earnings-300072829.html.

As per my understanding so far chlorine and caustic soda prices move in opposite direction, thus it could be the start of falling cycle of caustic soda prices globally. We also know that India is vulnerable to imports due to low power costs outside. Net -net the realizations may be affected in the sector.

Pasting the monthly domestic prices of caustic soda (lye), prices have cracked 12% since the start of the year.

I am yet to do a detailed cost comps of chemfab and others in this sector to validated the hypothesis that they are indeed one of the lowest cost players.

An open question I have for @Donald and others who have looked at this company is on duration of the cycle?

How long does a cylce typically last. One of the articles you had posted mentions that its a 3 year cycle. So it would be good to understand how long the cycle will last…

But overall looks interesting as the falling realizations may give an opportunity to enter at attractive valuations.

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Reigniting this thread after a long time.

Just to summarize:

  • Simple business into chlor alkali
  • Low cost producer reflected in healthy margins despite being small compared to industry leaders
    Reason: Backward integration, better capacity utilizations, low power costs (in Pondicherry), technology advantage (recently commissioned 50 Cr high energy efficient Bipolar BiTAC® Electrolysers Plant from CEC, Japan. It can save 40 to 50% of total energy consumption of the company reflected in last 2 qtr results)
  • Caustic soda demand dependent on GDP growth but import competition; anti dumping applicable till 2017 however likely to be extended due to political reasons and strong lobby
  • Chlorine demand increase slow but highly local due to transportation challenges
  • Difficult to predict cycle turnaround although in general its 3 years and should improve by Q2 2016 based on past record

Some numbers:

  • Worst case EBITDA 14 crores in 2010 at lowest end of cycle; currently at 23 cr TTM
  • Expected EBITDA for FY 17 30 Cr after energy efficient technology kicks in completely post stablization
  • Current EV at 80 Cr
  • High ROCE and cash generating business
  • Current cash equivalents ~20 Crores
  • Expected dividend of 5 Rs in 2017 i.e. dividend yield of ~6%

Conclusion:

  • Highly under valued
  • Strong promoter background and high stake ~75%
  • Even the worst case situation looks promising

Risks

  • Caustic soda cycle and anti-dumping duty

Discl. Invested

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Hi Rohit, could you please guide on source for domestic prices of caustic soda?

Hello Experts,

Could someone please share the source of Caustic Soda price. Majority of websites providing the price are subscription based.