ICI Pakistan is a chemical manufacturer that has been operating for the greater part of the 70 years. It consists of five divisions or "Businesses" catering to a mix of industrial and consumer goods: Polyester, Soda Ash, Paints, Life Sciences and Chemicals. The Company has been seeing steady growth since its inception that has transformed it into a behemoth in the domestic chemical market with a market capitalisation of nearly Rs 20 billion.
After the 1HCY11 results for ICI Pakistan were posted, the future looked bright for the chemicals powerhouse. Rising cotton prices had strengthened PSF demand, the fruit of which ICI was reaping. Burgeoning regional markets had also aided the Soda Ash business which had performed better than the expectations of analysts. The report for 9MCY11 paints is different picture altogether. Though net sales surged by 19 percent compared to 9MCY10, still there was a colossal increase in the cost of sales by 25 percent compared to the previous period owing primarily to rising energy costs which hurt the PSF and Soda Ash businesses in particular.
In light of the gas outages, the Company resorted to using furnace oil for power generation, which being notoriously expensive, shot up costs such that the additional cost to the PSF and Soda Ash businesses alone; this period over the previous period was in excess of Rs 650 million.
The result of these increased costs included a decline in gross margins by almost 4 percentage points to 15.3 percent in the 9 months ending September 2011 from 19.2 percent for the 9 months ending September 2010, and a reduction in operating profit by 20 percent on a year-on-year basis. Net margins declined from 7.2 percent to 5.1 percent between 9MCY10 and 9MCY11, respectively.
PSF The PSF business saw an increase in raw material costs, PTA and MEG-two key materials used in manufacturing PSF. Regional PSF prices also rose over the nine-month period, partially cushioning the Company's mark up against the rise in costs and allowing some respite from cheap regional imports. Cheaper regional prices had previously enabled producers to import PSF from China to the detriment of local producers.
Falling cotton prices, on the other hand, dealt damage to the PSF segment's performance during the 9 months ending September 2011, relative to the performance in the comparable period last year.
A strong relationship between the prices of cotton and PSF exists, as the latter is looked upon as a substitute for cotton, and also complements cotton through the production of blended yarn. The strong performance of the PSF segment in previous quarters can be attributed to local cotton prices reaching highs over the previous year.
An expected bumper cotton crop in Pakistan for the season of 2011-2012, alongside depressed cotton prices on the NY exchange reduced local cotton prices significantly. Local cotton prices revolve around the prices on the New York exchange; a sluggish international market has affected Pakistan as well. This, along with the aforementioned increase in PSF prices has arguably reduced demand for ICI's PSF product.
Additionally, increased gas outages hurt production significantly, with the number of gas-zero days for 9MCY11 more than doubling from the comparative period last year. Consequently, additional furnace oil costs exceeding Rs 300 million had to be incurred compared to the previous period, contributing to the increment of 33 percent in PSF cost of sales relative to the same period of last year.
These factors all contributed towards the reduction in net margins for the PSF business to 6 percent for the nine months ending September 2011, from a margin of 11 percent in the last comparable period.
Soda Ash The reliance on alternative fuels such as furnace oil to substitute for the energy crisis hit the Soda Ash segment as well. The gross margin for 9MCY11 decreased 9 percentage points to 16 percent from 25 percent in 9MCY10 on the heels of rising energy costs. Unlike the natural production process in the USA, Soda Ash in Pakistan is produced synthetically.
Therefore, it is a capital-intensive industry and is unable to absorb rising energy costs due to gas outages. The number of gas-zero days in the 9 months ending September 2011 increased from 91 days to 135 days in the 9 months ending September 2010. The corresponding increment in furnace oil costs amounted to Rs 350 million for the Soda Ash business over the previous period. The outlook for this segment is not too bright either; gas outages have no end in sight.
Additionally, an anti-dumping investigation has been sanctioned by National Tariff Commission to determine whether Soda Ash imports from Kenya are unfair and render domestic Soda Ash uncompetitive. According to ICI, dumping from abroad has also contributed to the lost sales volume over the past couple of years.
Paints Though net sales increased in the Paints division, the operating profit for 9MCY11 declined by 13 percent compared to the same period of last year. Sales volumes declined due to monsoons and security issues in the south, but price increases contributed to offsetting the lost margins. The net result was a decline in operating margin by 1 percentage point to 3 percent over the previous 9- month period.
A perennial problem with regard to the paints industry has been the change in painting maintenance cycle from a historical average of 3 years to 5 years. This is primarily attributed to inflation and the subsequent reduced purchasing power in the country.Paints Demerger
AkzoNobel, the Dutch holding company of ICI, early last year announced plans to demerge ICI's Paint business. AkzoNobel is to issue at par 46,443,250 ordinary shares at PKR10 each; the allotment shall be made in proportion to the shares of ICI held by the registered shareholders of the Company. Accordingly, the reduction in the issued and paid-up share capital of ICI would lead to 92,359,050 ordinary shares of PKR10 each. Therefore, each shareholder shall be allocated 66.54 shares of ICI Pakistan and 33.46 shares of AkzoNobel.
The Paint Business has felt the brunt of inflation and a reduced purchasing power over the past couple of years. The floods in Q3CY10 hurt the domestic market and operating profit declined by over 50 percent compared to Q3CY09. Though the Paints division has made a recovery since, the focus put on the Paints products vis-à-vis the new entity may serve to consolidate ICI's standing in the new market.
The common denominator for most of these troubles is the energy crisis. Gas outages require the Company to shift to expensive substitutes, such as furnace oil. Additionally, the gas outage problem was anticipated to hit its peak in Q4. Though the results have not been published yet, the effect may likely be seen in a further shrinking of margins for the last quarter of 2011.
In response to the crisis, ICI sanctioned a project on coal-fired boilers earlier this year for steam generation at a cost of Rs 2 billion. The project includes two 45tpd boilers that are fuelled by coal and a 3MW steam turbine for electricity generation. The project is on track and is expected to be complete by mid-2013. That may finally bring some respite to the shocks faced by ICI in its Paints and Soda Ash division.
Leverage and Operational Performance ICI operates with minimal debt, choosing equity to be the springboard for its operations. This allows the Company to keep interest charges minimal; financial charges for the 9MCY11 were 4 percent of operating profit.
Additionally, the Company's liquidity seems to be improving. Current, quick and cash ratios have been increasing steadily over recent times. The improved liquidity and minimal debt may be factors that enable the Company to sanction large projects such as the coal-fired boilers for power generation.
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ICI PAKISTAN
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(Rs mn) 9MCY11 9MCY10 chg
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Net sales 30,472 25,550 19%
Cost of Sales 25,822 20,635 25%
Gross Profit 4,651 4,915 -5%
Gross Margin 15.30% 19.20%
Distribution Costs 1,347 1,237 9%
Operating Profit 2,308 2,873 -20%
Operating Margin 7.60% 11.20%
Profit After Taxation 1,543 1,848 -16%
Net Margin 5.10% 7.20%
EPS (Rs) 11.1 13.3
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Source: Company accounts
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RATIO ANALYSIS
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2003 2004 2005 2006 2007 2008 2009 2010
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Debt to Equity % - 1.39 - 0.04 - - - -
Debt to Capital Ratio 40:60 0.11 0.07 0.07 0.07 0.07 0.07 0.07
Interest Cover Times 3.11 5.36 6.82 8.44 28.42 32.29 - -
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Source: Company accounts
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