Research of the Day: Sitara Chemical Industries Limited – Potential demand warrants significant upside – Global Research
Yousuf Rahman,firstname.lastname@example.org (+9221 3245 7543)
Global Securities Pakistan Limited
BUY with a Jun14 TP of PKR 290/sh
Our DCF based Jun14 TP of PKR 290/sh offers an upside of 30% from its last close of PKR 223/sh.
Stellar earnings growth
Sitara Chemical Industries Limited’s earnings have grown considerably during the past 2 years. The company’s earnings, which were PKR 428mn during FY11, grew at a 3Yr CAGR of 56% to reach PKR 1,036mn by FY13.
§ Increasing capacity utilization to drive earnings
The caustic soda plant operates at a 55% utilization rate, revival in industry in Faisalabad could increase its capacity utilization and hence, earnings.
§ GSP plus status to further contribute to utilization
With Pakistan being granted GSP+ status, which allows duty free access to 3,500 Pakistani products to the EU, demand for Pakistan’s textile will likely increase. Higher textile production will result in improved demand for caustic soda.
30MW coal-fired power plant in the works
The company is also planning to set up a 30 MW coal based power plant. Preliminary estimations using prevalent international coal prices suggest production cost of ~PKR 8.00/kWh, which will still be lower than obtaining electricity from WAPDA. To finance this project, the company is considering sellling off a portion of its land to raise ~ PKR 1.55bn. Moreover, the company also plans to issue a Participation Term Certificate (PTC) to further raise upto ~PKR 1.5bn. These PTCs will be convertible into 4.44mn ordinary shares (shares without voting rights), likely diluting the company’s earnings once the conversion takes place.
30MW gas fired captive power plant
Sitara Chemical Industries Limited has a 30MW inhouse gas fired captive power plant, allowing the company to produce low cost electricity at ~PKR 6.0/kWh compared with industrial tariff of ~PKR 15.0/kWh.
De-levered balance sheet to improve earnings
Because of improved cash flows, the company has started repaying its debt. As a result, the company’s long term loans have declined from PKR 2.79bn to PKR 0.73bn in 3 years.
Circular debt transaction likely a boon
SITC was located in Faisalabad likely to cater to the textile industry situated in the city. Faisalabad textile industry shutdown due to power crises and SITC was forced to cater to the industry in the south; thus facing higher transportation charges. The Faisalabad industry could resume its operations as the GoP is intent on reviving industry by solving the power crisis.
Significant discount to peers
SITC trades at an FY14 PE of 4.4x, a significant discount to Global’s Chemical universe PE of 15x. In addition, the scrip also offers a dividend yield of 5%
Rising energy prices to increase production cost
Sitara Chemical Industries Limited partly relies on FESCO for its power requirements. The recent power tariff hike has increased tariff from ~PKR 9/kWh to PKR 15/kWh. As Caustic soda production is an extremely energy intensive process and approximately 1MT of caustic soda requires ~2,300kW of electricity, the increase has impacted the margins. Moreover, SITC relies on its gas power plant to fulfill ~50% of its electricity requirement. Gas tairiff was also hiked by 17% to PKR 573/mmbtu in Aug13. Gas curtailment could further raise costs.
Unable to compete with EPCL because of transport costs
EPCL’s location in Karachi allows it to deliver caustic soda to textile companies in the southern region without incurring high transport costs. Because of of higher costs, SITC is unable to compete with EPCL in terms of pricing power as EPCL can afford to reduce prices to increase demand while SITC cannot.
Very illiquid stock
The stock is highly illiquid with a free float of just 7.5mn shares. In addition, average daily turnover is less than 20K shares. As the stock is quite illiquid, it may be difficult to build or liquidate positions without moving the share’s price considerably.
Reduction or abolishment of caustic soda import duty
At present, import duty on caustic soda is 20% and PKR 4,000/MT for solid and liquid, respectively. These duties allow the caustic soda producing companies to sell their products at a premium to international prices. If these import duties are reduced or abolished, caustic soda companies will have to reduce their prices to stay competitive; thereby, denting their margins and overall profitability.
Storage affecting product quality
Discussions with textile industry experts revealed that many textile companies prefer EPCL’s caustic soda over SITC’s because of EPCL’s higher quality product. They feel that SITC’s storage negatively affects the quality and effectiveness of its caustic soda.
View Detailed Report>>SITC-Sitara Chemicals