Indo Gulf announced its fourth quarter and full year results for the year ended March 31, 2004 on Wednesday. Excluding the receipt of subsidy arrears in 4QFY03, the company has posted good results on a YoY basis for 4QFY04 and FY04. Considering the limitations in capacity utilisation and a controlled pricing environment, the company's performance for FY04 is commendable.

(Rs m)	4QFY03	4QFY04	Change	FY03	FY04	Change
Net sales	2,903	1,716	-40.9%	6,752	5,785	-14.3%
Other income	44	12	-72.6%	257	260	1.4%
Expenditure	917	1,212	32.1%	3,812	4,336	13.7%
Operating profit (EBDITA)	1,986	504	-74.6%	2,940	1,449	-50.7%
Operating profit margin (%)	68.4%	29.4%		43.5%	25.1%
Interest	12	5	-59.6%	25	17	-33.9%
Depreciation	137	97	-28.9%	435	404	-7.0%
Profit before tax	1,881	414	-78.0%	2,737	1,289	-52.9%
Extraordinary items	-	-	-	-	-	-
Tax	694	141	-79.6%	1,009	387	-61.7%
Profit after tax/(loss)	1,188	273	-77.0%	1,728	903	-47.8%
Net profit margin (%)	40.9%	15.9%		25.6%	15.6%
No. of shares (m)	45.1	45.1		45.1	45.1
Diluted earnings per share (Rs)*	105.4	24.2		38.3	20.0
P/E ratio (x)					5.5
(* annualised)

Understanding of the key characteristics of the industry is of relevance before moving on to the numbers. The fertiliser sector is a highly controlled one because it comes under the purview of the Essential Commodities Act.

Therefore, the industry is faced with issues like limit in capacity utilisation (100%), ceiling on retail price of urea and re-imbursement of subsidy. Here, subsidies is a critical issue. Without getting into the complexities of the fertiliser policy, the industry has moved to the Phase II of reforms wherein subsidies are declared on the basis of the group of manufacturers.

This phase II, which is likely to last for two years, will be unrewarding for efficient producers like Indo Gulf in the current form.

Given this backdrop, production of urea in FY04 for Indo Gulf was at the ceiling of 0.9 MMT (100% utilisation). However, sales were higher by 2% in the same period. But the decline in sales in 4QFY04 and in FY04 has to be viewed with respect to the receipt of subsidy arrears last year. Excluding the impact of this receipt in FY03 and FY04, topline growth is 7% YoY. Much of the growth is on account of higher price realisation.

Considering the constraints at the topline level, manufacturers like Indo Gulf have to focus on saving cost to boost bottomline, which the company has done successfully in FY04. Almost 8% of profit before tax in FY04 was on account of savings in energy and transportation cost.

The company has changed its distribution plan to lower transportation cost and the initiative is paying good dividends. Having said that, this has been negated by the cost incurred on account of transition into the Group Concession Scheme wherein manufacturers are rewarded on the basis of group average (Rs 370 m is the loss). Ideally, the most efficient players like Indo Gulf deserve more subsidy than the group average.

Having looked at the financial performance in FY04, how is the industry shaping up? Considering the cap on capacity utilisation, growth in topline could be derived from expanding capacity and acquisition.

Indo Gulf has initiated a de-bottlenecking exercise, which could potentially increase capacity from the current 0.9 MMT to 1.1 MMT. Secondly, the company is likely to participate in the disinvestment of government owned fertiliser unit, especially National Fertilisers. While we expect the company's topline to grow at a faster rate in FY05, operating margin will be under pressure. The de-regulation of the natural gas sector could increase the cost of gas (38% of sales and 60% of expenses).

Without any corresponding increase in prices or in subsidy to gas-based urea manufacturers, it will be difficult to sustain margins till FY06.

The stock currently trades at Rs 110 implying a P/E multiple of 5.5x FY04 earnings (price to book value at 0.9x). The company has declared a dividend of Rs 2.8 per share (dividend yield of 3%). While valuations may appear attractive, there are reasons for the same.

High government interference continues to hamper the industry growth prospects. Though de-regulation is likely to transform industry fortunes, it is sometime away and to that extent, investors need to have patience.

The main concern area, in the medium term, is with regard to the de-regulation of the gas prices and the consequent impact on the same on Indo Gulf's margins.

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