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Too much optimism built in!

Downgrade to Neutral

* Tata Chemicals (TTCH)’s consolidated EBITDA came in below our estimates – largely dragged down by North America (NA) and Europe – due to the absence of operating leverage and one-time costs.

* In the last six months, TTCH has rallied ~126%, whereas the Nifty has appreciated by ~20%. This outperformance is largely attributable to its plans to enter into the Energy Science biz. (EV cell manufacturing) – GOI has announced the PLI incentive for the EV Battery business, but plans are yet to be finalized (highlighted by the mgmt. during the 4QFY21 call).

* These future plans have led to higher valuation multiples; TTCH currently trades at EV/EBITDA of 11.9x/9.1x FY22/FY23E, implying a premium of 22%/27%/41% to its 3-/5-/10-year average one-year forward EV/EBITDA multiple.

* Execution risk persists in the Energy Science biz, coupled with the risk of margin pressure due to increasing RM prices; particularly, energy costs in soda ash pose a risk to near-term performance.

* Based on these factors, we downgrade TTCH from Buy to Neutral.

North America, UK drag down overall performance

* TTCH reported an overall revenue increase of 11% YoY to INR26.4b (v/s est. INR25.2b) in 4QFY21. The EBITDA margin contracted 610bp YoY to 10.7% (v/s est. 17%) due to gross margin contraction of 590bp. EBITDA fell 29% YoY to INR2.8b (v/s est. INR4.3b). Adjusted PAT declined 94% YoY to INR118m (v/s est. INR1,702m).

* Higher gas price (net) of INR450m in 4QFY21, due to the Polar Vortex, was reported as a one-off item – which impacted EBITDA in its North America operations. Adjusted for the same, EBITDA was down 18% YoY to INR3.3b.

* Revenue / EBITDA / Adjusted PAT declined 2%/23%/68% YoY in FY21.

* India’s standalone revenue grew 15% YoY to INR8.4b. The EBITDA margin expanded 40bp YoY to 19.5%, and EBITDA grew 17% YoY to INR1.6b. Soda ash / Salt volumes rose 16%/4% YoY and blended realization 4% YoY.

* In North America (NA), revenue was largely in-line (+1% YoY) owing to a) 3% YoY growth in volumes, as exports rose 20% YoY, whereas domestic volumes declined 12% YoY, and b) currency benefit (+5% YoY). Realization, on the other hand, fell 6% YoY (to USD192/mt). Reported EBITDA/mt declined 17% YoY (to USD15), with EBITDA contracting 69% YoY (to INR630m). This was attributable to (a) higher gas price due to the Polar Vortex, (b) lower absorption of fixed costs due to lower production, (c) certain fixed costs from 3QFY21 being carried forward to 4Q, and (d) higher exports yielding lower margins.

* In Europe, revenue grew 5% YoY on currency benefit (+8% YoY) and improved blended realization (2% YoY in GBP), offset by 5% decline in sales volumes. EBITDA de-grew 63% YoY to INR190m on lower realization, higher freight costs, and higher plant spend due to the floods in Jan’21.

* Africa’s soda ash volumes de-grew 9%, whereas realizations (in USD) grew 5% YoY and the currency benefit was +5% YoY – leading to flat YoY revenue. EBITDA was up 82% YoY to INR200m.

 Rallis’ revenue was up 38% YoY on higher sales volumes in Crop Care, Seeds, and the domestic and international businesses. EBITDA stood at INR200m v/s loss of INR120m last year.

Highlights from management commentary

* Soda Ash market: Demand for soda ash has fully recovered, except for container glass. While the Container Glass biz remains soft, it is expected to bounce back fairly soon with the revival in tourism. Several expansion plans in Soda Ash have been postponed for the next 3–4 years, in turn leading to an increase in spot prices.

* Soda ash royalty reduction: In CY12, the US government increased the soda ash royalty rate from 2% to 6%. However, the government recently slashed the rate (for environmental purposes) from 6% to 2% once again for the next 10 years. TTCH expects a USD7–10/mt impact on the soda ash pricing. Also, further clarity is expected once the company has chalked out fresh mining plans.

* Capex: TTCH incurred capex of INR12.5b in FY21, of which (a) INR2.5b was put toward NA operations, (b) INR2.7b toward Europe, (c) INR1.6b toward Rallis, and (d) INR5.5b toward India standalone. Capex for FY22 would be at similar levels

Valuation and view

* In the last six months, TTCH has rallied ~126%, whereas the Nifty has appreciated by ~20%. This outperformance is largely attributable to its plans to enter into the Energy Science biz. (EV cell manufacturing) – GOI has announced the PLI incentive for the EV Battery business, but plans are yet to be finalized (highlighted by the mgmt. during the 4QFY21 call).

* On a one-year forward basis, TTCH has historically traded at an avg. EV/EBITDA of 9.7x/9.3x/8.4x in the last 3/5/10 years. It is now trading at 11.9x FY22 EV/EBITDA, thus implying a premium of 22%/27%/41%. Notably, TTCH’s past multiples have factored in earnings from the Branded Consumer business (salt and other consumer sales) – which commands a higher multiple than the existing Chemicals business. Thus, the implied premium would widen further.

* Execution risk persists in the Energy Science biz, coupled with the risk of margin pressure due to increasing RM prices; particularly, energy costs in soda ash pose a risk to near-term performance.

* Factoring in the current quarter’s performance, we reduce our FY21/FY22 earnings estimates by 25%/6%.

* Thus, in our view, optimism on the street around the Energy Science business’ performance is still a long way off. Moreover, near-term concerns of higher RM prices pose a risk to earnings.

* Thus, we downgrade TTCH from Buy to Neutral, arriving at SOTP-based TP of INR628.

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