Retained Prices

With a bleak outlook in urea and soda ash, the Tata Chem scrip has been seeing a free fall recently.

The future is hinged on government policy and possible future diversification. A closer look

Tata Chemicals is now facing the music in the stock market as 85 per cent of its business is in doldrums. Urea and soda ash contribute 48 per cent and 37 per cent to the turnover and both are doing badly. The results for the first half had pushed the stock price up to Rs 155 from Rs 138. After a brief correction, it rose again to the Rs 155-level, but the subsequent drop has been steep at the current level of Rs 123. The reason being the recent decision of the government to reduce its urea offtake, apart from the glut in the soda ash market.

A journey through the retention price scenario can explain this better. Initially, when a plant becomes operational, the base price, that is, the ad hoc price is decided. This was fixed at Rs 6,300, the basic assumptions being 100 per cent gas of standard heating value and standard price of inputs. The retention price is determined by adding the escalation to this base price. This escalation varies from company to company as it is derived from the plants day-to-day operations and is computed quarterly.

The problem started with the government not finalising the retention price on urea for almost four years. Instead, a provisional price of Rs 7,300 was decided for Tata Chemicals, on the basis of which, the realisations were determined for the year 1996-97.

For the earlier years, the company used a final price calculated by them. It was based on the annual cost data submitted to the Fertiliser Industry Co-ordination Committee (FICC). Since, the results for 1994-95 and 1995-96 were determined on this price, the financials appeared inflated, higher by Rs 197 crore.

If the urea tonnage and sales for 1995-96 are taken as the basis, the price of urea works out to an average level of Rs 9,900 per tonne. By recasting the 1995-96 sales on the provisional price of Rs 7,300, the total sales growth in 1996-97 works out to 21.57 per cent against the actual 5.49 per cent.

For comparison between the first half results ending September 1997 and September 1996, the company has reworked the latter on the basis of the provisional price of urea. This change shows a 47.5 per cent increase in its net profit for the first half. The company however, expects the profit to increase further once the final retention price is determined. As of now, the stalemate continues and the Hanumanthha Rao committee has been working on the price fixation.

The feedstock is another story in itself. The availability of natural gas which is a superior input is a problem. It is more cost efficient than naphtha (see Naphtha vs natural gas), but with insufficient quantities, even a dual feedstock flexibility like that of Tata Chemicals which ideally would prefer gas to naphtha, does not help.

Naphtha, which is now linked to international prices has been seeing its ups and downs. In September 1997, the naphtha prices were prevailing at a peak of $210 per tonne. Consequently, the government raised the naphtha prices by 57.5 per cent and gas prices by 16 per cent in September 1997.

The impact on the fertiliser industry was a burden of Rs 1,950 crore, Rs 1,500 crore attributed to naphtha and Rs 450 crore to gas, which would ultimately have to be translated into the retention price. Since then, the international prices have crashed by 20 per cent to $160 in February 1998. Thus, imported naphtha would now work out cheaper. For Tata Chemicals, this could be a cheaper option in the absence of natural gas.

But overall, the damage has been done. The delay in determining the pricing policy of urea coupled with the feedstock availability problems has put brakes on the expansion plans of Tata Chemicals urea facilities in Babrala, Uttar Pradesh.

These issues have now been surmounted by the governments latest decision to limit its offtake to 115 per cent of the annual capacity from companies which have a retention price of Rs 7,000 and above. In fact the rise in Naphtha prices saw the Government raising the retention prices beyond Rs 7000 for several units including Tata Chemicals in October, 1997. So, Tata Chemicals with a retention price of Rs 7,300 and a capacity utilisation of 130 per cent is on the firing line. According to Dr Manu Seth, managing director, Tata Chemicals, the offtake would be reduced by around 10,000-12,000 tonnes only. The ruling is effective for the period between October 1, 1997 and March 30, 1998.

So, by operating at 125 per cent capacity utilisation in the second half, with the normative capacity at 2375 tonnes per day, the total output for 182 days will work out to 540,312 tonnes of urea. Dr Seth appears to be quite confident, Whatever is excess, over and above the specified limit, will be offloaded in April, so the impact will be minimal.

Financially, the impact on urea revenues could work out to Rs 50.65 crore. (The price is assumed at Rs 7,300 per tonne and the offtake is based on nameplate capacity of 2,250 tonnes per day and the capacity utilisation 115 per cent. The difference in the sales value of the offtake and of the amount expected to be produced (540,312 tonnes) works out to Rs 50.65 crore.)

As such, the financials are very different from what they appear. The company has not capitalised the interest paid out on the capital expenditure owing to delay in project implementation. It has treated it as deductible expenditure for tax purpose but as per Income Tax authorites, the tax assessment works out to a tax demand of Rs 155.28 crore for the years ended March 1992, 1993 and 1994. Although the company does not acknowledge this as a claim and has not made provision, a sudden outflow will put it in a quandry in spite of the funds in the contingency/general reserves.

Apart from these ticklish issues, soda ash, the next big revenue contributor has been facing dumping from China. The industry has faced overcapacity since the second half of 1995-96. Dr Seth counters saying that, The capacity is balanced more or less with the demand. The main capacities at that point of time, had shut down; Tata Chemicals had a boiler problem, Gujarat Heavy Chemicals plant was shut while Saurashtra Chemicals had a lock-out. As a result, soda ash was unavailable.

Imported soda ash at that point of time ranged from 30,000 tonnes to 120,000 tonnes, so as soon as these plants became operational, there was a glut. The main suppliers were the Chinese and the Americans. The US cartel, American Natural Soda Ash Corporation (ANSAC), dumped soda ash at its 10-year low prices. With due representation this cartel is being curtailed, however, the landed cost of the Chinese imports is Rs 400-500 per tonne cheaper than the domestic cost.

The consumption pattern in the user industries of glass and detergents does not look very encouraging either. While glass industry is suffering from lack of demand, it is also increasingly resorting to recycling. The soda ash consumption in detergents has reduced as salt is being used as a filler in detergents. For cheaper brands like Wheel, salt content is upto 40 per cent. With greater domestic capacities coming up, the prices will remain under pressure.

The by-product of soda ash, namely fly ash, is utilised in manufacturing cement. This integration coupled with captive power supply are responsible for low cost of cement production. Through a marketing arrangement with ACC, it has been selling Pozzolana Portland Cement and ordinary cement. Masonry cement, a cheaper variety, is another such area on which it is working.

With the glut in cement industry and the tough competition in Gujarat, the companys cement sales have gone down by 9.4 per cent and margins have come under pressure. This year, sales are expected to remain stagnant and margins will continue to be low.

The only product which is giving it maximum margins is vaccum salt. The iodised Tata salt having become a household name, promises good returns in future. In caustic soda, in spite of global oversupply, Tata Chemicals has managed to show a 102 per cent growth in 1996-97. The main cost factor is power, which has been taken care of by its captive supply. So, it has a price advantage in a highly competitive market.

In a snapshot, the companys diversfication into fertilisers has not given it much of an edge. The idea was to avert uncertain returns from its core area of soda ash, since the retention price scheme assures a 12 per cent return on the net worth. But, the failure in fixing a suitable pricing policy, does not augur well for the companys future.

The dismantling of ureas price regulation will only add to its woes, because then the price will be market determined, threatened by cheaper imports. In such a scenario, the Babrala expansion plan makes sense, but unless the governments stand becomes clear, the expansion cannot happen.

In spite of this, the companys future is not as uncertain as it is made out to be. Competitively, it is well positioned and perhaps more diversification is in the offing. Dr Seth confirms, A committee has been set up and it is looking into various investment options in the process industry. The scrip has been totally discounted by the market and the future cannot be worse.