Favourable base, new plant to help Deepak Fertilisers; concerns stay
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Shares of Deepak Fertilisers and Petrochemicals Corp. Ltd closed flat on Tuesday after gaining 11% on Monday after the company over the weekend reported a strong March quarter profit.
Net profit for the quarter more than doubled as profitability got a boost from margin expansion at the chemicals business. More importantly, the management sounded optimistic about earnings prospects.
Deepak Fertilisers has commissioned a new complex fertilizer plant which can produce multiple grades of complex fertilizers. As part of market development, the company was importing and trading these new grades of fertilizers. With the products receiving good response, it now plans to replace them with its own produced fertilizers. This is expected to improve the profitability of the fertilizers segment, driving earnings performance in future.
“We raise our FY18/19 EPS (earnings per share) estimates by 26%/18% on the back of better earnings visibility in the fertiliser segment post the doubling of capacity to 0.6 million metric tons (MT) and which will further increase to 1.1 million MT by FY19 and higher capacity utilization in TAN,” Emkay Global Financial Services Ltd said in a note. TAN is technical ammonium nitrate, used in mining and infrastructure sectors.
To recap, the government discontinued the supply of administered gas to the company in 2014 due to low domestic gas production. Non-availability of gas impacted fertilizer production at the old plant (the new plant uses ammonia, which is sourced from the market as fuel). As a result, profitability at the fertilizer business was eroded.
But as the price of the gas and also ammonia fell in the international markets, Deepak Fertilisers resumed fertilizer production gradually. This, along with a favourable court verdict on resumption of gas supply, drove up the stock, which more than doubled over the last two years.
Still, with gas supplies yet to be restored by the government, Deepak Fertilisers remains exposed to volatility in energy prices. From the cost point of view, domestic gas is cheaper vis-à-vis the imported fuel. For the old plant to see sustainable improvement in utilization and profitability, access to affordable fuel is crucial. “Delay in restoration of gas supply is the key overhang; however, falling gas prices have enabled resuming manufacturing at more competitive rate,” added the Emkay note.
The company’s performance and management commentary are driving up the stock. But investors would do well to note that the outlook is aided by a favourable base and raw material prices. Any sharp rise in fuel prices or further delay in resumption of administered gas supplies by the government can weigh on the fertilizer business.