Tata Chemicals: Ahoy America

Buy will improve the firm's margins and give access to cheap raw material.

Tata Chemicals bought US-based natural soda ash producer General Chemical Industrial Products (GCIP) for a little over $1 billion. Its combined capacity will increase from 3 million tonne a year to 5.5 million tonne a year, and make it the second largest soda ash player globally.

Apart from the scale, the acquisition will benefit Tata Chemicals in terms of access to cheap raw material and improvement in margins. GCIP has access to natural soda ash mines in the US, which are expected to last for 100 years.

This will be advantageous for Tata Chemicals as the production cost of natural soda ash is cheaper by 40-45 per cent compared with synthetic soda ash, which is power intensive.

After the acquisition, natural soda ash will contribute more than 50 per cent of the total combined capacity. Globally, natural soda ash earns an operating margin of about 30 per cent compared with 17-18 per cent in case of synthetic soda ash, say Emkay Research's Rohan Gupta.

Its purchase of UK-based Brunner Mond in 2005 has strengthened Tata Chemicals' reach in Europe and West Asia, while GCIP will provide access to the Americas. The acquisition seems to be well timed as soda ash prices have moved up over the past three years, and are 30 per cent higher y-o-y at present.

Higher demand from Asia for glass and detergents "" its biggest applications "" is responsible for the price increase.

While the operational benefits of the acquisition are clearly visible, at about 2.5 times revenues, the price appears on the higher side. Also, how Tata Chemicals will finance this purchase will be crucial.

If the company finances the entire amount through debt, its debt-equity ratio will go up to 1.9, which is quite high.

The company has indicated a mix of debt and equity, and assuming that 75 per cent of the purchase will be funded by debt and the rest by a mix of equity and internal accruals, then its debt-equity ratio will be more manageable at 1.2 times compared with 0.7 times in FY07.

To its advantage, its cash balance and investments are estimated at Rs 2,000 crore.

At Rs 292, the stock trades at 10 times for FY09 estimated consolidated earnings without accounting for this recent acquisition. This looks attractive considering the future benefits of the acquisition and the strong soda ash cycle.