The valuers, who had earlier valued Tomco, have arrived at a swap ratio of 2:5 for Industrial Perfumes' proposed merger with Hindustan Lever (HLL), its holding company. Industrial Perfumes has three shareholders including HLL and Unilever. The third shareholder owns just 100 shares of the company. Each of these shareholders will be alloted two shares of HLL for every five shares held by them in Industrial Perfumes. Though the proposed swap ratio will result in an insignificant hike in Unilever's stake in HLL, doubts have been raised regarding the subsidiary's value.

In 1998, Industrial Perfumes had Rs 24.63 crore invested in GoI securities and Rs 11 crore in cash. Total capital employed during the year was Rs 40.34 crore. It earned a net profit of Rs 7.16 crore, lower than the Rs 9.59 crore earned in 1997. Other income of Rs 4.86 crore (Rs 3.51 crore) contributed 53 per cent of the pre-tax profit. The track record of the company does not appear to justify the swap ratio (in 1996,other income exceeded pre-tax profit). However, valuation is normally done on the basis of discounted future cash flows. Due weightage is given to the asset base but what matters more is the return on assets.

The valuation has been done by two of the most respected valuers in the country. Though there is always an element of subjectivity involved, the fact that the swap will lead to a very marginal hike in Unilever's holding in HLL there is little reason to be apprehensive. Further, the transaction will involve only an insignificant equity dilution for HLL. Yet it is surprising that the valuation of the subsidiary has not been factored into the price of HLL's shares in the market.

IPCL

The petrochemicals stocks, seems to be one of the market outperformers in the last three weeks from 28 th April onwards. While the sensex seems to have gained by 26 per cent, these stocks have appreciated by more than 54 per cent. IPCL has seen a rise of 36 per cent from that day. Obviously rise in sensex hasplayed a major part in rise in share price of petrochemical stocks especailly Relaince which is treated by many as one of the pivotals in the market.

Apart from this, the other major reason cited by industry experts have been the rise in product prices by 10 per cent and the expectations of a further rise in prices this year. Infact most of the traders selling polyster fibres and yarn expect Reliance to announce another price hike in polysters next week by five to ten per cent. Being a dominant player in the industry, the price detremined by Reliance sets the Industry standards both in polymers and polysters.

But product price rise of products cannot cause a drastic change in earnings of the company and hence there is a question mark over the sustainability of these rise in the stock prices. To probe into the issue consider a simple example. The rise in commodity prices is basically because of supply cuts. Form the day the OPEC started supply cuts, crude oil prices almost doubled, while price of (refinedproduct) naptha increased by 62 per cent and the prices of interemdeiate products PTA and paraxylene increased by 10- 20 per cent. Finally the product prices of PSF improved from Rs 40.5 to Rs 45 per kg and POY improved from Rs 53 to Rs 55 per kg.

Seeing the value chain, it is easy to draw a consulsion that higher value added products have seen far less percentage rise in price. But at operating levels the net effect is still positive for the companies. Naptha prices have risen by $ 55 per tonne, while PSF prices have risen by $ 46 per tonne and PFY prices have risen by $ 107 per tonne - resulting in positive margins for the company, but not to the extent which shows such a phenomenol rise in stock price.

A look at the behaviour of cotton prices also shows that it would be difficult for polyster companies to raise prices in the coming weeks as Gujarat government has allowed to give subsidy of Rs 2000 per cindel to the cottn federation to import medium staple cotton, which may remove the supply shortageof quality cotton.

In addition the slack season for fibres and yarn would start from June till August 15th and thus offtakes at present higher prices would be quite low.

For polymer products, the price rise is due to bundling of closures of polymers units in South korea, Malaysia and Thailand. Petrochemical Co-operation of South Korea plans a 40 day shut down in middle of June, while Chandraachi in South Korea has just started production after a 55 day shut down. All these shut downs would get over by August 15 and prices after that would be anybody guess.

Furthermore the rise in polymer prices may reduce the ability of producers to push for more subsitutions of wood, glass, packaging items by polymers and hence the growth rate in demand of polymers may be less than 29 per cent. Incidently RIL had obtained 29 per cent growth in PP sales when they had first commissioned its plant. In PE the situation is slightly bad as GAIL has also commissioned its plants. The net effect may be only 10 per cent growthin offtake.

The net result is that most of the analyst except that earnings for RIL may be in the region of Rs 1875 to Rs 1925 crore for fiscal 1999-00. This is a only 10-12 per cent higher and may not justify the present price of petrochemical stocks. For IPCL earnings expectations are of mere Rs 200 to Rs 250 crore and rise in price is more due to the expectations that the disinvestment process would be completed in next six months.

DAP Subsidy

News reports indicate that the union government has increased the price concessions on indigenous and imported DAP by Rs 200 and Rs 300 per tonne respectively. The total price concessions now stand revised at Rs 4,600 per tonne on indigenous DAP and Rs 3,300 per tonne on imported DAP. Considering the forthcoming elections, it was widely expected that fertiliser subsidies would be hiked and the industry had been demanding an additional subsidy of Rs 200 per tonne on indegenous DAP and Rs 500 per tonne on imported DAP.

The revision has met theexpectations of domestic producers and companies such as Godavari Fertilisers & Chemicals and GSFC are likely to benefit the most. Though the hike in subsidy for imports is higher, companies like Hind Lever Chemicals and SPIC which import substantial quantities of DAP are unlikely to benefit as much. Importers had been expecting a much bigger hike because the subsidy on imported DAP had recently been revised downwards as a result of which their margins were adversely affected. Yet, as DAP imports have been declining and even large importers such as Hind Lever Chemicals have been expanding their indigenous capacities, the government's decision is likely to be welcomed by all the players in the industry.

The government, on its part, had little option but to hike subsidies. The acute shortage of the nutrient at the start of the rabi season was largely blamed on faulty policy. As the price concessions announced by the concerned ministry had fallen short of the industry's expectations, both indigenous producersand importers had restricted their operations. Consequently, the price support was revised upwards, but that too had fallen short of industry expectations. Under the circumstances, there were only two choices left to the government. One, to increase subsidies further to fully compensate for the increase in costs and two, to free prices so that higher realisations would be possible. Given the political considerations just before elections, the government could ill-afford a rise in DAP prices and has, therefore, chosen to allow the subsidy-bill to swell by at least another Rs 50 crore.

The stock markets have, nevertheless, appreciated the decision. The Godavari Fertilisers and GSFC scrips closed the day at Rs 15.50 and Rs 51.20 respectively, 9.15 per cent and 7.9 per cent higher than the previous close on the BSE. SPIC and Hind Lever Chemicals have also seen their stocks appreciate by 6.93 per cent to Rs 27.75 and by 4.34 per cent to Rs 481.95 respectively.

(With contributions from Urmik Chhaya, ManishSaxena & Sarad Saraf)