Cautious on Mangalore Chem; buy Deepak Fertilizers: Quant

Himanshu Nayyar, agri sector analyst at Quant sees the likelihood of a bidding war between Deepak Fertilizers and Zuari Agro Chemicals for the stake in Mangalore Chemicals, wherein he feels the former is better placed.   

He says Deepak Fertilizers has Rs 300 crore cash on books, while Zuari balance sheets looks stressed out with high debt and receivables. Nayyar is cautious on getting into Mangalore Chemicals and recommends buying Deepak Fertilizers with long term perspective. Also read: Deepak Fertilizers up 4% on stake buy in Mangalore Chemical Below is the verbatim transcript of his interview to CNBC-TV18 Q: How would you approach in the first place Mangalore Chemicals and Fertilisers, would you expect that there is some kind of a bidding war here? The last numbers we got from Mangalore Chemicals and Fertilisers were nothing much to write to home about but now it has to be analysed on a different plane, would you buy it at all? A: I will be quite cautious on getting into Mangalore Chemicals and Fertilisers now that the stock has already run up from Rs 40 about a month back to Rs 55-60 levels. If you see the valuations also, the stock is now trading at more than one-time book. For any urea company in today’s environment with the issues on subsidy gas price etc, I think paying more than one time book would be quite expensive. However, in case a bidding war emerges, you cannot say as to how high the prices can go. The probability of a bidding war between both these entities is emerging now. That Deepak Fertilizers and Petrochemicals Corporation has surprisingly bought a much bigger stake than Zuari Agro Chemicals in the company. Q: What were your key takeaways from what HS Bawa, Executive Vice Chairman of Zuari Agro Chemicals said and did not say? A: If they are looking to put in a higher bid and they are looking to buy a higher quantity of shares obviously they would not say at this moment. However, but looking at just the financials of the two companies as of FY13 end, I would say Deepak Fertilisers and Petrochemicals Corporation is better placed in case there is a bidding. As of now Deepak Fertilisers and Petrochemicals Corporation already has Rs 350 crore of cash on books with a debt of only Rs 1,000 crore. Zuari Agro Chemicals is under a lot of balance sheet stress at the moment with more than Rs 4,500 crore of debt on books. So, in case the bidding war emerges Deepak Fertilisers and Petrochemicals Corporation looks in a relatively better balance sheet position. Q: For Mangalore Chemicals and Fertilisers itself, you said that given the kind of run up you would not be very hopeful about the stock moving up higher but in terms of earnings potential what kind of earnings potential does Mangalore Chemicals and Fertilisers have for FY14 because in FY13 we saw huge deterioration in the margin performance? A: One key thing which will change for Mangalore Chemicals and Fertilisers going forward is they have completed their feedstock convergence process whereby going forward they will be using natural gas as the feedstock rather than naphtha and fuel oil and they have entered into an agreement with Indian Oil Corporation (IOC) whereby they will be getting imported liquefied natural gas (LNG) from the Kochi terminal of Petronet LNG. Obviously, this will improve the margins, they normally do just 5-6 percent margin. So once this process comes into place, I am expecting the margins can jump up to 9-10 percent, which will give you a lot of benefit. Second thing is that once the government pays up with subsidy receivables which in Mangalore Chemicals and Fertilisers case would be close to about a Rs 1,000 crore as of now, your interest cost would also come down. Factoring these two benefits from about Rs 65 crore of profits that they did in FY13, you can easily see this profit go up to anywhere close to Rs 90-100 crore. At the current marketcap of about Rs 650 crore, the stock is trading at close to 6-7 times earnings, which is not expensive. _PAGEBREAK_ Q: Since you do believe that Deepak Fertilisers and Petrochemicals Corporation is in a better place to go for the hostile takeover and now if they acquire controlling stake, they will get a hold of urea and non-urea capacities, access to newer markets etc, do you advise buying Deepak Fertilisers and Petrochemicals Corporation at this price? A: I would say that in the longer run, Deepak Fertilisers and Petrochemicals Corporation would be a good stock to buy at current prices. In any case it is trading at 0.6 times with not a lot of debt. There were concerns on high ammonia prices. However, in the current environment we have seen ammonia prices correct by 20-25 percent. This would help improve their chemical business margins. Purchasing asset like Mangalore Agro Chemicals would also give them much stable earnings because urea companies tend to report very stable earnings and not very volatile like complex fertilisers. So, their earnings profile will become more stable. They will become majorly a fertiliser company than a chemical company that they are now. Overall, I can see some sort of re-rating for Deepak Fertilisers and Petrochemicals Corporation from a one to two years perspective. Currently, the stock is trading at just about six times earnings. If they become primarily a fertiliser entity, you can see their multiples move up anywhere close to 9-10 times from 6 times currently. Q: You do not expect the further purchase of Mangalore Agro Chemicals to strain their balance sheet or profit and loss (P&L)? A: In the short-term obviously it will impact, but not that big an impact. They have Rs 350 crore of cash on books and have spent about Rs 180 crore yesterday. Even if they were to come out with an open offer and buy another 25 percent at similar prices as what they have paid, it will be an outlay of other Rs 180-200 crore. They currently have Rs 350 crore of short-term investments on books. So, it will reduce their other income. However, the benefits on earnings per share (EPS) front going forward would be much higher than that.