Tata Chemicals: Weak Q2; capital infusion in high margin business could trigger a re-rating

Tata Chemicals (TCH) reported a subdued set of Q2 FY19 earnings, with compressed margin, despite a decent 10 percent year-on-year uptick in revenue. Earnings before interest, tax, depreciation and amortisation (EBITDA) saw a 5.6 percent dip, with a 340 basis point (100 bps = 1 percentage point) margin contraction owing to high input cost, weakness in the international operations, one-offs in the US and Africa and high energy costs. Net profit growth of 17 percent YoY was facilitated by a sharp surge in other income and lower tax expenses.

With the consumer business coming on track, the management announced plans to invest in building capacity to manufacture lithium ion batteries, which could be the next turning point for the company in the longer run.


Domestic operations: Domestic business saw a healthy 23 percent YoY revenue growth on the back of healthy volumes and strong growth in the consumer business. Higher operational efficiencies helped mitigate part of the impact of higher energy costs. However, earnings before interest, tax, depreciation and amortisation (EBITDA) margin remained compressed.

Performance in the consumer business saw robust growth owing to a small base and growing demand for branded products. While the pulses business seems to be on track, the company want to focus more on capturing market share in the spices segment. The company also expects high growth in the non-animal protein business, which is seeing rapid growth globally.

Europe: Higher fixed input costs impacted profitability of the European business. Lower trading of soda ash in the region also impacted performance during Q2, with soda ash volume declining 22 percent YoY. Strong realisation helped save the show.

North America: Q2 registered strong demand from the region. However, with tighter pollution control norms, the company installed new environment equipment, which impacted production and led to 50,000 million tonne volume loss.

Africa: After floods in Magadi, the company had to incur higher expenses for repair of damaged plant and machinery, which impacted profitability. However, the region is witnessing strong demand and should see decent performance in Q3.

Rallis India reports decent performance
Rallis reported a marginally improved performance on the back of traction from international operations and price hikes, despite the overhang of high input costs. Build-up of low cost inventory towards FY18-end helped maintain gross margin. However, higher other expenses on account of higher fuel and transportation costs and some mark-to-market forex losses led to erosion in EBITDA margin. Metahelix (seeds business), whose portfolio is majorly focused on the Kharif season, reported a 3 percent growth in topline. However, margins remained compressed.
Upcoming capital expenditure plans
The company is planning a capex of around $370 million at its Mithapur plant over the next 3 years for capacity enhancement in cement (by 300,000 MT), soda ash (200,000 MT) and salt (400,000 MT). The company is also looking to start a 35,000 MT capacity to manufacture pharma grade bicarbonate.
TCH is also working on upgrading its silica plant to make it complaint with environment norms, the work for which is expected to begin in November. The plant at Nellore, catering to the company’s nutritional solution business, is currently in investment phase and is expected to start in Q4 FY19.

Foray into battery manufacturing
Given the upcoming demand for electric vehicles in India, the management announced plans to enter the lithium ion battery manufacturing space. TCH has already signed two memorandum of understanding’s (MoU) to source technology and is working on setting up a plant with an initial target of 4GW capacity. Total upcoming demand is estimated around 40GW, of which TCH aims to capture 25 percent in the long run.
OutlookThe management indicated that after supply constraints from China, growing Turkish capacity is getting fully absorbed and tightness in the market still continues. This would enable them to pass on higher input costs in various geographies. With most contracts up for renewal towards Q4 FY19, the benefit of this should flow in from that quarter and would provide margin relief.

With one-offs already recorded, the company is now positioned to capture benefits of strong demand in North America and Africa. The consumer product business is the high growth segment for the company and TCH plans to expand it rapidly with new launches every quarter.


The stock has corrected 11 percent in the last two months and is 14 percent below its 52-week high. It is trading at FY19e price-to-earnings of 13 times and an enterprise value-to-EBITDA of 9.3 times. Stabilisation after one-off incidents across geographies would be something to watch out for. A successful deployment of capital in high margin businesses can improve earnings and trigger a re-rating for the stock.