Tata Chemicals - Time for a breather

Tata Chem has outperformed the index by 40% since November. Positive news on the US acquisition and fertiliser policy changes seems to have played out. We cut our target price to Rs387 and await further signals on long-term soda ash pricing for 2009.

Strong 1Q09 result; but some of the gains may not sustain
Tata Chem saw the fertiliser division's consolidated operating profit improve from just Rs461m in 1Q08 to Rs1,872m in 1Q09. Most of this was contributed by the DAP division, which was able to take advantage of import parity pricing for 1Q09 even while it had locked in rock phosphate prices for the quarter. Going forward, we believe international rock phosphate suppliers are likely to increase prices to claw back some of the margin gains made by phosphoric acid producers and Indian DAP producers such as Tata Chemicals in 1Q09.

New urea pricing policy has a positive impact on FY10F
The Ministry of Fertiliser has announced a new urea pricing policy linked to import parity prices for new domestic capacity additions. Tata Chem has planned a debottlenecking at its Babrala urea plant, which should increase its capacity by about 0.2Mtpa starting December 2008. Under the new policy, we believe this new unit will generate an additional US$30m of operating profit and thus we boost our FY10F EPS estimate by 10%.

Stock has had a good run; clouds forming on the horizon
Tata Chem has outperformed the index by about 40% since November 2007 and, in our view, much of the anticipated positive news flow on the fertiliser policy has played out. We now see a few clouds on the horizon, which include a potential rise in working capital requirements on the fertiliser side and the impact of any potential slowdown in the Chinese economy, post-Olympics, on the global soda-ash cycle.

We reduce our target price to Rs387
We lower our target price from Rs450 to Rs387 as we adjust our India risk-free rate in our DCF model from 8.2% to 9.2% and increase the holding company discount for TTCH's investment portfolio from 30% to 50%. At this target price, the stock would trade at an FY10F PE of 9.4x, in line with similar cyclical commodity exposures. So, while we still see upside potential, the riskreward is becoming more balanced and we await clearer signals on 2009 soda-ash contract pricing.