BackGas shortages cloud margin outlook for Deepak Fertilisers
The increasing share of the trading business and a weak outlook for own manufacturing means margins can remain weak for some time
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The unavailability of gas supplies has adversely affected Deepak Fertilisers and Petrochemicals Corp. Ltd in the June quarter.
Natural gas is required to produce ammonia, a key ingredient for the chemicals and agriculture-inputs Deepak Fertilisers manufactures. As the government discontinued domestic gas supply, the company was not able to manufacture sufficient quantities of ammonia. This hit chemicals and fertilizer production.
To make up for the production losses, the company stepped up trading—more than doubling its trading business compared with the year-ago period.
The firm tactically bought specialty fertilizers at lower prices, which helped it make good money on trading. So, even though production fell, operating profit, or earnings before interest, taxes, depreciation and amortization (Ebitda) grew 12% from a year ago.
A higher proportion of trading, however, meant the firm has to compromise on margins. Traded goods offer substantially lower margins than own manufacturing. As a result, Ebitda margins softened 154 basis points (bps) to a little over 11%. One basis point is one-hundredth of a percentage point.
The pressure on margins will continue for some more time. The company does not expect the unusually high trading margins to continue on a sustainable basis as it was mostly boosted by tactical purchases.
Higher own manufacturing can help Deepak improve margins. But that can be done only when ammonia supplies rise, which in turn is contingent on a resumption of domestic gas supplies. Alternatively, the firm can import ammonia. But imported ammonia is costlier than in-house manufacturing. Also, Deepak does not have sufficient infrastructure facilities to handle higher amounts of ammonia imports immediately. It is looking to augment handling facilities, which can take time.
The company has petitioned the Delhi high court against the discontinuation of the domestic gas supplies. Even if supplies resume, the inevitability of the gas price hike means the company’s costs are bound to rise. “Even if supply is restored, we believe domestic gas price will be increased to $7.2/mmbtu (vs $4.2) from H2 and lack of pricing power will dent profitability," HDFC Securities Ltd said in a note.
To supplement income, Deepak is scaling up the trading business. It is tapping existing customers to sell traded goods. The market for the core chemical product—technical ammonium nitrate, or TAN—is also improving. While there are no worries on the demand scenario, the increasing share of the trading business and a weak outlook for own manufacturing (unavailability of domestic gas, dependence on costly, imported ammonia) means that margins can remain weak for some time.
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