Sell stocks of Gujarat State Fertilizers; target Rs 350

“Gujarat State Fertilizers Company (GSFC), caprolactam-benzene spreads have declined by 50% in US$ / 30% in INR to $1175/mt by June’12 which is likely to have 30%yoy drop in FY13 earnings. Despite attractive valuations, sharp drop in company’s earnings and absence of any positive trigger will put pressure on the stock in near term. We downgrade our FY13 earnings estimates by 10% to Rs 65.6 (20% below consensus) and downgrade the stock from Accumulate to REDUCE with revised price target of Rs 350. sharp reversal of Caprolactam-Benzene spread and announcement of any special dividend are key risks to our recommendation.”

“Company’s chemicals segment contributes 1/3rd to total revenues while contribution to profit is 2/3rd. Caprolactam contributes ~70% to chemical revenues / profits and hence company’s earnings closely follow its Caprolactam Benzene spread. (Kindly refer to chart on next page). On account of sharp drop in spreads, we expect GSFC to enter into earnings degrowth phase in FY13 with each quarter reporting earnings drop of 20%- 40%. This earnings degrowth phase along with no positive trigger in near term is likely to keep pressure on company’s stock price.”

“We downgrade our FY13E EPS est by 10% to Rs 65.6, which is 20% below consensus est, on account of sharp decline in chemical segment margins. Historically we have seen company’s stock price following its chemical business profitability and downward pressure on chemical segment margins is likely to keep the stock price under pressure. We downgrade our recommendation from Accumulate to REDUCE and wait for improvement in Caprolactam-Benzene spread. However we expect GSFC to benefit marginally from higher ammonia prices,” says Emkay Global Financial Services research report.