Tata Chemicals Initiating Coverage Research Report By Motilal Oswal

Tata Chemicals (TTCH) is a 78-year-old commodities company, reinventing itself as a specialty and consumer products company.

It has a diversified portfolio of businesses: (a) soda ash and sodium bicarbonate, where it enjoys global leadership, (b) fertilizers, which it is exiting from, (c) agricultural inputs, through subsidiary, Rallis India, (d) consumer products such as branded iodized salt, pulses and spices, and (e) a fledging specialty products business – materials such as highly dispersible silica (HDS) and nanomaterial, and nutritional products like oligosaccharides and polyols.

It also has sizable financial investments that it can liquidate to fund its growth.

Flight of rebirth

Transforming into a growth company; re-rating imminent

 TTCH is using its cash cows – soda ash and sodium bicarbonate – to build growth businesses such as consumer and specialty products.

In the consumer business, it enjoys leadership in the domestic table salts market and is fortifying its pulses and spices portfolios. In the specialty products business, it is developing nanomaterial and nutritional solutions.

 Massive cash generation of INR39.7b via divestment of the urea and phosphatic fertilizers business and sale of investments coupled with steady accruals from the soda ash business would help TTCH repay debt. Its interest outgo is likely to decline from INR4.1b in FY17 to INR2.1b in FY20.

 As TTCH scales up its growth businesses and deleverages its balance sheet, we expect its consolidated RoCE to improve considerably, in turn driving a stock rerating.

We believe it would be fair to assign ~30% premium to its five-year average EV/EBITDA of 7.5x. Our SOTP-based target price of INR940 (implied EV/EBITDA of 9.7x FY20E) implies 36% upside. We initiate coverage with Buy.

Using cash cows to invest in growth businesses

TTCH is the global leader in soda ash and sodium bicarbonate. These are mature, commodity businesses, growing at 3-4% per year and yielding consistent cash flows.

TTCH is using these cash cows to build growth businesses such as consumer and specialty products. The company should be able to enhance focus on these businesses following its exit from the regulated fertilizer business.

We expect the contribution of specialty and consumer products to increase from 27% in FY17 to 33% by FY20, based on the progress in its existing portfolio, though the company’s internal target is to reach 50% via the launch of new products.

TTCH enjoys leadership in the domestic table salts market and will continue focusing on growing its other specialty and consumer products, including nutraceuticals and silica.

We expect specialty and consumer products revenue to grow at a CAGR of ~14%, outpacing the overall growth of 9% over FY18-20.

To be net debt-free by FY20; RoCE to improve considerably

Divestment of the fertilizer business and sale of Tata Global Beverages shares should result in cumulative gross cash inflow of ~INR39.7b in FY18. Internal accruals would add further to cash flows. TTCH is also focusing on working capital, which has reduced by INR21b in two years.

Strong cash flows will allow part repayment of debt and also help invest in higher-RoCE businesses like specialty and consumer products.

TTCH is investing in manufacturing facilities for new materials (such as HDS and nanomaterial) and nutritional solutions (such as oligosaccharides and polyol).

At full potential, these businesses should generate RoCE of 20-25%.

We expect the company to be net debt free by FY20 from net-debt-to-equity of 0.7x in FY17. Interest outgo should reduce from INR4.1b in FY17 to INR2.1b in FY20, enabling 22% CAGR in continuing business profitability over FY18-20.

Focus now on consumer…

TTCH has been a pioneer in developing the market for iodized salt in India, and enjoys a share of 25% in the country’s powdered salt market. It has a distribution network of 1.7m retail outlets, reaching 143m households across India.

Compared to the other prominent FMCG companies in India that have an average retail reach of 5m-6m outlets, we believe TTCH has ample headroom available for growth. Leveraging on the network, TTCH has expanded its horizons to include branded pulses, spices, besan (pulse flour) and water purifiers, where it is yet to realize full potential.

…and specialty products

TTCH is also entering nutritional solutions. We believe nutraceuticals presents a huge global opportunity, with an estimated B2B market size of ~USD60b in 2016 and B2C market size of ~USD182b, which is expected to grow at 9% CAGR till 2021. At full utilization, we expect the current planned nutraceuticals capacity addition (likely to be commercialized by 1QFY20) to contribute 4% of consolidated sales and 5% of consolidated EBITDA.

This would increase to 9% of consolidated sales and 10% of consolidated EBITDA on doubling capacity, and 13% of consolidated sales and 15% of consolidated EBITDA on tripling capacity, with global B2B market share at just 0.1- 0.3%.

Besides, it is foraying into yet another technology-enabled, differentiated business – highly dispersible silica (HDS). HDS is a substitute for carbon black, which had a market of INR50b in India in 2016.

Initiating coverage with a Buy rating

TTCH has traded at a one-year forward EV/EBITDA of 7.5x (average) for the last five years. Our SOTP-based target price is INR940 (implied EV/EBITDA of 9.7x).

Considering the increased focus/business transformation toward higher-RoCE segments (specialty and consumer products) and the divestment of a regulated business (fertilizers), we believe it is fair to assign ~30% premium to its five-year average EV/EBITDA. We expect TTCH to continue its journey to become a larger specialty and consumer play.

As at the end of FY17, net debt stood at INR52b. We expect the company to become net-debt-free by FY20, with (i) cash generated from the divestment of the fertilizer business, (ii) sale of investment in Tata Global Beverages shares, (iii) internal accruals, and (iv) potential sale of investment in group companies.

Average free cash flow yield over FY19-20 is estimated at ~9%. We initiate coverage with a Buy rating and a target price of INR940 –36% upside.