GHCL (Gujarat Heavy Chemicals Ltd) is a multibagger stock in the making. It is among India’s three largest soda ash manufacturers. It reports Ebitda (earnings before interest, taxes, depreciation and amortisation) margins ranging from 28 per cent to 33 per cent.
GHCL’s Ebitda margins are higher than that of its closest rival Tata Chemicals for 2014-15.
Moat in soda ash business
GHCL has the big advantage that the business has a huge moat. There is a large amount of capital expenditure necessary to set up a soda ash plant. An investment of Rs 2,500 crore is required to set up a soda ash plant of 500,000 tpa.
Soda ash prices have been on an uptrend in the past few years. This has enabled all soda ash manufacturers to report high profits.
GHCL has the additional advantage of having diversified into the business of home textiles. It has integrated yarn spinning into the manufacture of home textiles. The textile division is also generating huge profits today for GHCL.
GHCL has also been able to increase its capacity utilisation in the textiles division from 70 per cent in 2013-14 to 85 per cent in 2015-16. GHCL has a number of marquee clients like Target, Bed Bath & Beyond, Revman and Wal-Mart (Mexico).
GHCL is investing about Rs 375 crore to increase the installed capacity of the soda ash plant. The expansion will be funded through internal accruals.
It is also stated by GHCL that it intends to reduce the debt burden from Rs 1,297 crore as of 31st December 2015 to Rs 1,100 crore. The reduction in debt will mean that the Company enjoys higher profits as the interest savings will be massive.
Strong cash flows
GHCL has utilized cash flows for repaying overseas debt. In the last two years, GHCL has embarked on a capacity expansion plan of the soda ash segment, textiles and has also installed wind turbine systems. The major focus from FY18 will be debt reduction and paying investors dividend or shares buyback.
Dividend distribution policy
In FY16, GHCL declared dividend of Rs 420 mn at 16.4% gross payout. As per the dividend distribution policy, there will be a 15%-20% gross payout of standalone profits. Further, the company has also introduced ESOPs to reward employees. The company has appointed S R Batliboi (E & Y) as its statutory auditors. These steps will create value for shareholders in the long run.
Valuations are compelling
GHCL’s revenue will grow 6% while the EBITDA will grow 10%/ CAGR during FY16-18E. The company will focus on significant debt reduction from FY18E. The valuations are attractive because the stock is trading at 4.4x FY18E EPS of Rs 38, EV/EBIDTA of 3.2x and P/BV of 1.1x. The Company has significant re-rating potential given its strong earnings growth of 21%, RoCE / RoE of 26%/28% and strengthening balance sheet with D/E of 0.6x (FY18E).
Robust Q1FY17 results
In Q1FY17, the sales increased 17% while the operating profit surged 41%. There was an increase of 67% in the net profit. The FY17/18E EPS require to be upgraded by 8%/5% respectively.
The stock deserves higher target multiple of 7xFY18E EPS in view of strong visibility of earnings and improvement in return ratios coupled with sustained reduction in debt. The stock can still be bought with the increased target price of Rs 280 based on 7x FY18E EPS of Rs 40.