Rising Caustic Soda prices to push GACL’s earnings
Gujarat Alkalies & Chemicals (GACL) is one of the largest producers of caustic soda in India with a present installed capacity of 429,000 tonnes. The company has 14% market share in Chlorine Alkali market in India. GACL is a multi-product Company, having 36 products in its basket, yet the major revenues come from Caustic Soda group and therefore, market scenario of Caustic Soda and Chlorine is of utmost importance. Caustic soda is used in various applications such as finishing operations in textiles, manufacturing of soaps and detergents, alumina, paper and pulp, control of pH (softening) of water, general cleansing and bleaching. The aluminium industry is the biggest demand driver for caustic soda.
The size of the Indian chlor-alkali industry at 7 million tonnes is 4% of world market (170 million tonnes). China has the highest caustic soda capacity of 40 million tonnes, accounting for 46% of world capacity. North America has a capacity of 16 million tonnes. China and Middle East are fast emerging as key production hubs for caustic soda. It is expected that there would not be any significant capacity additions in developed countries like North America and Western Europe, primarily due to unattractive cost structures and flat demand.
In India Caustic soda imports have increased over the last five years at a CAGR of 28.4% while demand has grown at a CAGR of 4.5%. Capacity and production during the same period have grown only at 1% and 3.2% CAGR, respectively. Imports have been increasing over the past few years at a rate faster than capacity addition. The increased arrival of imports has resulted in lower average capacity utilization of 85% for the domestic caustic soda industry.
The caustic soda market is expected to remain tight for the coming two years, as significant capacity changes are expected by the end of 2017 (as per media reports), with several large Chlor alkali plants likely to be closed as a result of phasing out of mercury cell technology in December 2017 in Europe. Net caustic soda capacity closures between 8,63,000 tonnes/year and 1.1m tonnes/year is expected in Europe during 2017. Few of the capacities would be coming back on stream in 2017, as they were closed either due to conversion work (Changing Mercury Cell Technoloy), which can impact the prices in the near term.
On the back of closure of capacities, caustic soda prices rose sharply from the month of September 2016 onwards (from US$ 321/tonne to US$429/tonne by the end of March 2017). We expect the prices to remain firm due to local tightness in central European and Spanish market. Other major plants scheduled to close in 2017 are Spolana, Czech Republic site owned by Unipetrol, (which will switch to imported feed stocks to produce polyvinyl chloride (PVC) in June) and Ercros (also closing capacity at two of its sites in Spain towards the end of 2017).
Given the closure of few chlor alkali plants globally as a result of phasing out of mercury cell technology coupled with strong demand, caustic soda prices rose by 34% to US$429/tonne in the last six months. We expect the prices to remain firm for the next two years, which should drive earnings for GACL in FY18E & FY19E. As the company is already operating at over 90% capacity utilisation, volume growth is likely to remain in the range of 3-4% for FY18E & FY19E. Post this, the benefit of expansion plan would flow in. We expect net sales to grow at a CAGR of 10% during FY16-FY19E, supported by higher realisation. EBITDA margins would also remain strong at 27.5% for the next two years.
The company has undertaken an aggressive capex plan of Rs30 bn, spread over the next 3 years to increase the capacity of Phosphoric acid, Caustic Potash and few other products. The capex also includes setting up the new Chloromethane plant with a capacity of 300 tonnes per day. This would further strengthen its product mix and increase the capacity of value added products to consume chlorine captively. Strengthening the product basket, with higher consumption of chlorine in-house would help the company to garner better margins. Currently, the company is highly dependent on a single product i.e Caustic Soda, which accounts for 60% of the company revenue.
Net sales during 9MFY17 for the company grew 8% YoY to Rs15.4 bn backed by higher realisation. Average realisation during the period stood at Rs21,976/tonne. EBITDA during the period grew by 70% YoY to Rs3.4 bn and margin expanded to 22.2% as compared to 14.1% in 9MFY16. The company reported PAT of Rs2.2 bn. We are expecting, the company to report strong Q4FY17, with an operating margin of 30%. For FY18 & FY19E, we believe that the volume growth to be in the range of 3-4% and strong realisation to drive the growth. Revenue is expected to grow at 10% CAGR during the FY16-FY19E period, while EBITDA is expected to grow at 29% CAGR, with an EBTIDA margin of 27.5% or the next two years. We expect PAT to grow at 30% CAGR during the same period and RoE and RoCE to expand to 13.7% and 12.6% by the end of FY19E from 9.6% and 9.1% in FY16, respectively.