Phillips Carbon Black

The passenger car industry is on a strong growth path. Although commercial vehicles have posted a more tentative recovery, a near 5 per cent year-to-date growth in domestic sales from the steep declines last year offers hope of an early recovery .

While tyre makers are set to cash in on this revival, Phillips Carbon Black, which makes the carbon black used in tyres, could benefit too. After recording a loss last fiscal, the company returned to profitable operations beginning FY-10.

Investors with a high-risk appetite and a two-year horizon can consider buying the stock. Trading at Rs 158, the stock discounts its expected per share earnings for FY-11 by 4 times.

This leading producer of carbon black, part of the RPG group, commands a market share of 41 per cent in India and is also the largest exporter in Asia. It operates in two business verticals — carbon black and power, with the former accounting for over 90 per cent of revenue.

Carbon black is mostly used as a reinforcing agent for rubber and finds extensive use in the manufacture of automotive tyres as it provides high resistance to abrasion, thereby increasing their life span and enhancing their grip. Carbon black accounts for almost 16 per cent (by value) of the raw material for tyre manufacture.

Apollo Tyres, Ceat, Bridgestone, JK Tyres and MRF are some of the important customers in the Indian market. Its major overseas clients include the Bridgestone Group, and Goodyear. The company enjoys a well-diversified client base.
Constraints

Challenges faced by the automobile sector in the second half of last fiscal resulted in demand for carbon black declining by 35 per cent globally and by 25 per cent in India. The industry encountered the following problems in India: First, the demand slump led to production cuts during the second half of FY 09.

Second, raw material costs shot up sharply. Carbon Black Feed Stock (CBFS), the primary ingredient in carbon black production, is a residual oil from distillation of crude and its pricing is related to that of crude oil.

Though crude oil prices have recovered from their lows they are currently at about half the peak levels. The three-month lag between crude oil price movements and their impact on CBFS suggests that Phillips Carbon Black may continue to benefit from lower raw material costs in the near term. Third, cheap imports pushed Phillips Carbon Black into an operating loss of Rs 82.92 crore and net loss of Rs 64.84 crore during 2008-09.
Improving picture

Sharp decline in input costs over the June and September quarters of 2009-10helped expand operating profit margins from 9.6 per cent in the September quarter of 2008 to 18.7 per cent in the same quarter of 2009. This,despite a flat sales volume and a decline in realisations.

Though crude oil prices have more than doubled from December lows, inventory overhang and a slow pace of global recovery may pre-empt any sharp rise from current levels. The recently concluded anti-dumping investigation against import of carbon black from countries such as Thailand, Australia and Chinamay also favour Indian companies and reduce the threat of cheap imports.

Volume revival

In October, Phillips Carbon Black expanded production capacity by 90,000 million tonnes per annum (to 450,000 million tonnes), at a newly commissioned plant in Mundra. Proximity to the port may help it save on transportation costs, as more than 80 per cent of its CBFS requirement is imported.

The expansion is also well-timed to capture the revival in the automobiles tyres industry.

According to a recent CARE report, the tyre industry recorded a production growth of 4.1 per cent for the period April-August 2009, when compared to the same period last year.

While the replacement market expanded, OEM market witnessed a decline. However the recent numbers released for August 2009, indicate 3.1 per cent growth in original equipment manufacturers segment.

Exports too increased in August 2009 . With key challenges adequately addressed, the company appears well placed to show an improving profit trajectory. Contributions from its power business may also augment revenues and profits.
Power points

Phillips Carbon Black generates power using the flue gases released as a by-product of carbon black manufacture. Its capacity of 60.5 MW is used for in-house requirements; surplus power is sold to electricity boards.

Though the power plants contribute only 10 per cent to the total sales, they account for 30 per cent of the total profits. Expansion of power plants in Kochi and Mundra will further augment revenues.
Risks

Given that both profits and sales for Phillips Carbon Black are highly commodity driven, earnings are quite cyclical. Investors need to exercise caution and book profits on target returns on this stock.

via BL