GSFC’s chemicals business gets profitability boost

If caprolactam prices remain at current levels, analysts expect the GSFC stock to see earnings upgrades


Graphic: Prajakta Patil/Mint
Graphic: Prajakta Patil/Mint

Shares of Gujarat State Fertilizers and Chemicals Ltd (GSFC) surged after reports that caprolactam prices have hit a two-year high.

With a 56% share, GSFC is the leader in India's market for caprolactam. It is the primary product of GSFC’s industrial products business. It is used to produce nylon fibres for textiles, engineering resins and films.

In fiscal 2015, around 38% of GSFC’s revenues were generated from the industrial products business.

But as caprolactam rates fell, tracking the slump in global commodity prices, GSFC’s industrial products business came under pressure. So much so that the segment slipped into losses in the second half of the previous fiscal.

However, things began improving from the July-September quarter. From $600 per metric tonne (mt) in January-March and $625 in the June quarter, caprolactam-benzene spreads improved to $735 in September, Emkay Global Financial Services Ltd said in an update note on GSFC.

With caprolactam now reaching $1,830 per mt, estimates are that caprolactam-benzene spreads have reached $1,000 per mt. Benzene, a derivative of crude oil, is feedstock for caprolactam. The spread or the price difference is used to gauge profitability in the caprolactam business.

With spreads at $1,000 per mt, analysts see a sharp rebound in profitability of GSFC’s industrial products business. If caprolactam prices remain at current levels, analysts expect the stock to see earnings upgrades.

But the only headwind is there is no clear visibility on demand recovery in the end market yet. A report from S&P Global Platts says apart from capacity cuts, rise in feedstock prices and shortage of spot cargoes has also played a role in the recent price rise. Demand for nylon 6, which uses caprolactam as a raw material, remained largely unchanged, the report points out.

This shows caprolactam rates are seeing cost-push led price rises. Nevertheless, given the tight supplies and capacity cuts in global markets, an analyst with Emkay expects the caprolactam-benzene spreads to hover at $950-1,000 per mt for some time. With the firm having the benefit of a favourable base, and the fertilizer business also seeing the benefit of soft raw material costs, analysts expect strong earnings in the coming quarters. “We believe the firm will witness strong earnings growth in subsequent quarters, driven by both segments,” Emkay said in a note.

While the stock, at around 12 times the current fiscal earnings per share estimate, is not expensive, stable caprolactam-benzene spreads and an improvement in fertilizer business will be key for continuation of positive momentum. “If you see historical data, the stock by and large moved in tandem with caprolactam-benzene spreads. So, yes, caprolactam prices will be a key variable,” says another analyst. 

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