Coal profits

PENNY WISE

Himadri Chemicals is India's largest coal tar pitch manufacturer with a 70 per cent market share. The company processes coal tar to make coal tar pitch, creosotes and chemical oils.

While coal tar pitch is used in the making of aluminium and graphite electrodes, creosotes are used as an industrial wood preservative. Napthalene, a chemical oil derivative, finds application in the dyestuff and pharmaceutical sectors.

Expansion

The company has three distillation plants in India with a combined coal tar distillation (a process of extracting compounds from coal tar) capacity of about 1.69 lakh metric tonnes per annum (mtpa). The company intends to increase this to a million mtpa by FY10 combining organic and inorganic initiatives.

The expansions are being carried out in India as well as China. The company intends to more than double its capacity at Indian operations to 4 lakh mtpa by FY10. Its foray into the Chinese market is expected to start with an acquisition of a plant with a capacity of 50,000 mtpa, estimated to cost $15-20 million.

Thereafter, the company will expand the Chinese plant's capacity to 1.5 lakh tonnes and further to 3 lakh mtpa by FY10. The company is also looking at growing organically in China and will set up a greenfield unit which will have a capacity of 3 lakh mtpa.

In totality, all these plans, including China foray, expansion and new unit, is expected to cost about Rs 630 crore. In short, by FY10, of the company's targeted capacity of 1 million mtpa, 60 per cent will come from China and the rest from India.

The company is focussing on China because it is the largest manufacturing base of coal tar (raw material) and coal tar pitch (final product). A large manufacturing base in China will give the company access to raw material, as China has a large coke industry.

Coke, which is used by the steel industry for the purification of iron ore, is processed from coal, and coal tar is the by-product of this transformation. Coal tar pitch manufacturers like Himadri, thus, depend on the steel sector for raw material, and prefer to be located close to these plants and have long-term supply contracts. Due to the concentration of steel manufacturing in Asia, 57 per cent of coal tar is produced in this region, and this is expected to move up to 62 per cent by FY09.

User demand

Coal tar pitch is used as binding material for manufacturing anodes required for smelting of alumina into aluminium. The aluminium sector is the largest consumer of coal tar pitch and good growth prospects are a positive for Himadri. Indian aluminium producers such as Hindalco, Nalco and Vedanta are on an expansion spree and the aluminium production in India, which is at 1 million tonnes per annum, is expected to quadruple to 4 million on the back of investments to the tune of Rs 100,000 crore by aluminium majors.

Demand for aluminium is expected to grow between 6-8 per cent per annum in India over the next three years. This will help maintain the growth rates for Himadri in the country. Large demand from China will also help increase its sales as it accounts for a significant chunk of the planned aluminium capacity globally.

While the Chinese aluminium sector recorded an astonishing 37 per cent growth in 2007, it is expected to grow between 27-30 per cent in 2008 to touch volumes of about 16 million tonnes. Himadri also intends to export coal tar pitch to the Middle East, which along with China accounts for 60 per cent of the planned capacity for aluminium globally.

Value-added products

Of the products manufactured by the company, creosote oils are at the bottom of the value chain, with margins improving as we move up the value chain. Of the 1.69 lakh mtpa capacity, coal tar pitch accounts for nearly 1.2 lakh mtpa, creosotes capacity is at 40,000 mtpa and chemical oil (naphthalene) capacity is at 8,000 mtpa. While coal tar pitch contributes 74 per cent of the topline, creosote oil and naphthalene contribute 21 and 5 per cent respectively.

The company has been able to bring down the contribution of coal tar pitch from 80 per cent last fiscal to sub-75 per cent this fiscal and increase the contribution of napthalene from 4 per cent to 5 per cent.

To tap the high demand for napthalene in India, as currently 35,000 to 40,000 metric tonnes are being imported, the company intends to increase napthalene capacity to 70,000 mtpa by FY10. While the realisation per metric tonne of coal tar pitch and creosote oil is Rs 23,000 and Rs 20,000 respectively, it is about Rs 60,000 for napthalene.

In January 2008, the company moved a step forward when it started production of mesophase pitch, a coal tar pitch derivative and a critical input for manufacture of lithium ion batteries. It has tied up with Osaka Gas Chemical, to sell the product in the key markets of Japan and China.

The expansion in the capacity of mesophase pitch from 120 metric tonnes now to 1,000 metric tonnes by end of FY09 should help in improving its revenues as well as earnings, since mesophase pitch sells for about Rs 8 lakh per metric tonne.

Investment rationale

The company reported good numbers for the December quarter with sales increasing 4 per cent to Rs 90.10 crore, while the operating profit was up 22.6 per cent to Rs 33.60 crore compared with September 2007. For nine months ended December 2008, while sales were flat at Rs 249 crore, operating profit was up 20 per cent to Rs 89.20 crore. The marginal growth and flat sales in the topline was on account of lower realisations on coal tar pitch, while operating profit was higher on better product mix.

At Rs 634, the stock is trading at around 18 times its estimated FY09 earnings of Rs 35""after adjusting for the dilution in equity post the issue of warrants worth Rs 117 crore in January 2008 and an expected FCCB issue of $80 million. Economies of scale and a better product mix should help the company maintain its operating margins in the range 35-39 per cent. 
 

GOING GLOBAL
Rs cr	9MFY08	FY08	FY09	FY10
Net sales	249.00	332.00	597.60	1075.68
Operating profit	89.20	118.93	225.97	429.35
Net profit	60.20	80.27	144.48	260.06
EPS (Rs)		23.47	35.06	63.12
P/E (x)		27.01	18.08	10.04

The company is the only large organised player in the country, contributing to 70 per cent of the aluminium sector requirements. Globally, its major competitors are also at a disadvantage given that they have a higher production cost per metric tonne.

Thus, going forward the story should only get better due to higher volumes, lower operational costs and product pricing flexibility (ability to pass on spikes in raw material costs). With all these positives to play out over the next few years, investors can expect a 30 per cent return in the next one year.