Bodal Chemicals: Weak quarter but correction provides an opportunity

Bodal Chemicals‘ quarterly results reflected GST transition hurdles at the end markets. While this dents topline growth for the current fiscal year, ongoing capacity expansion and initiatives for vertical integration puts the company on an accelerated growth path in the next few years. The valuation remains attractive from a long-term entry perspective.

Quarterly results – disappointing

Bodal Chemicals’ performance for Q2 FY18 was disappointing as it witnessed revenue de-growth of 23 percent due to lower demand from end markets, particularly textile industry on account of GST transition issues and competition.

EBITDA margin, however, improved to 18.2 percent (vs 17.8 percent in Q2 2017) due to higher contribution of dyestuff business (compared to dye intermediates). Product pricing also moderated during the quarter, particularly for basic chemicals and dye intermediates. However, in the current quarter, management opines that business has improved to pre-GST levels and the product pricing is also better sequentially.

Additional dyestuff capacity available in Q4 FY18

The company has nearly completed its first phase of dyestuff capacity expansion (12,000 MT) and it is expected to be operational in Q4 this fiscal year.

Additionally, key projects of the company like co-generation power project and Thionil Chloride (36,000 MT; raw material for vinyl sulphone) are also on track and expected to contribute from Q1 and Q2 of FY19, respectively. All these projects are expected to bring ~ 200 bps margin benefit.

Teething problems sorted for the additional production of ‘vinyl sulphone’ 

A 4200 MT vinyl sulphone plant in SPS processors (70 stake) is completed and the teething problem of supply of ethylene oxide feedstock from Reliance seems to be over. By Q4 FY18, production of vinyl sulphone from the new plant is expected to commence taking the company’s total capacity of vinyl sulphone to more than 16000 MT.

While there are some positive tractions on the above projects, there has been delay in the progress for the business of Trion Chemicals (Speciality chemical for water purification) and LABSA (Linear Alkyl Benzene Sulphonic Acid)

Valuation and projections

Taking account of weak financial performance in H1 FY18, we have revised our projections. We take note of the management’s unchanged guidance for the FY20 revenue (Rs 1950 crore –Rs 1550 crore), for sustenance of higher margins as new projects of backward and forward integration takes place.

Bodal Chemicals is currently trading at 11.3x/8.4x 2019/2020e earnings which is attractive, given the multiple growth drivers. In our view, current phase of consolidation and post result correction provides an opportunity, as increasingly vertically integrated Bodal Chemicals is well placed for the growth opportunity in the sector.

Bodal

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Alufluoride gains from the improving prospects for end market aluminum

Alufluoride (market cap: Rs 98 crore) is one of the few manufacturers of specialty chemical (raw material for the aluminum production) – aluminum fluoride. While the end market – aluminum – is witnessing secular uptrend, the aluminum fluoride market is also witnessing tailwinds of supply tightness and improved pricing.

Alufluoride, which like its industry peers, was struggling with a weak pricing environment for the last few years, has witnessed a good traction in its earnings. Its healthy balance sheet, along with a niche production process (non-dependence on imported raw material) positively positions it for an investment assessment.

Aluminum fluoride: usage and production methods

Aluminum fluoride is used in the production process of aluminum manufacturing as it lowers the consumption of electricity required in the smelting process and thereby helps in the reduction of production costs of aluminum. Aluminum producers (smelters) are the main users of aluminum fluoride.

There are two methods of producing aluminum fluoride. The first method (80 percent of world production), requires processing natural raw material resources like Fluorspar and Sulphur.

In the other method, it is sourced from the fertilizer complex by reacting alumina hydrate with hydro-fluosilicic acid, generated from the fluorine recovery unit.  This means that this process is not dependent on import of raw materials and hence relatively cost effective.

Global demand and the opportunity

Global aluminum fluoride demand is pegged at 1.5 million metric tons while for India it is at 64,400 tons. This is based on an industry thumb rule that for a one ton production of aluminum, 23-24 kg aluminum fluoride is required.

prodSource: Care ratings, Rain Industries, Moneycontrol research

For the Indian aluminum fluoride industry in India, the domestic capacity is quite limited and a few players are involved – Tanfac Industries, Alufluoride, SPIC (Southern Petrochemical Industries Corp). Navine Fluorine is one the biggest in fluorochemical industry but it is only involved in a similar compound, ammonium bifluoride, which has a different application.

Earlier, Tanfac Industries (Fluorspar method) had a huge capacity of 15,600 MT but over the years their production tapered off as it could not compete with the Chinese supply. Looking at the implied production levels, Tanfac Industries and Alufluoride, together cater to only ~14 percent of Indian demand. Hence, there is a huge scope for import substitution and creation of capacity in the scenario of sustenance of improved pricing.

Import trends, themselves suggest a huge uptick in domestic demand for the aluminium flouride. The current run rate suggests about 80-85 percent demand is met by imports.

Imports

Source: Trademap.org

Industry-wide tailwinds

Aluminum fluoride gets further tailwinds from global developments. Earlier this year, one of the key manufacturers in China – Do-fluroide (120,000 MT capacity) — highlighted that strict environmental protection policy has restrained the supply of aluminum fluoride and prices are expected to rise further. In addition, key raw material — fluorspar — prices have also surged and the aluminum demand cycle remains on an uptrend. While looking at the imported landed price from China, on average, fluorspar prices have risen by about 28 percent in last two quarters.

Improving pricing and volume trends

Earlier, Alufluoride had been impacted by industry-wide headwinds on account of higher Chinese supply, lower pricing power and company’s own issues with sourcing raw material. However, the last few quarterly results suggest easing of most of the concerns. The company’s capacity utilization has improved and production is higher by more than 20 percent in 2017 compared to the situation in 2013-16.

Further, the company has been able to keep tabs on the cost of materials aiding margins and return ratios. Additionally, even the prevailing rates of aluminum fluoride have also improved recently after being stagnant in the range of Rs 60-70/kg for the last so many years.

Table: Alufluoride financials

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*Sales (MT) values implied from approx. per unit price 

If the pricing trend available from the Shanghai Metals Market, indiamart.com are any indication, then per unit price for aluminum fluoride is hovering over Rs 100/kg, which is more than 40 percent jump from last year average.

As per Roskill, a metals/chemicals consultancy firm, export prices for Aluminum Fluoride from China have sharply increased in H2 2017.

Chart: One year chart of ALF price (RMB/Mt)

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Source: Shanghai Metals Market

Key risks: Sourcing of raw material & new supply from other regions

As per company’s annual report, though the company has an agreement with Coromandel Fertilizers for the supply of 4000 TPA of hydrofluosilicic acid this supply has been uncertain and lower than required. Hence the company pursued a policy for diversifying its supplier base (Paradeep and fertilizer complex from other location). Improved sales traction suggest that supply constraints are easing.

Further, while the Chinese supply may further shrink, new supply from other regions like the Middle-East (Gulf Fluor – 60,000 MT capacity) can cap the pricing improvement.

Strong Balance sheet

The company is virtually debt free and with cash and current investment constituting 48 percent of total asset provides a lot of headroom in the balance sheet for expansion.

Valuation

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Based on pricing trend prevailing in last two quarters and a stable production volume, we expect 28 percent sales CAGR for 2017-19E. There is an upside risk to projections if production cut in China intensifies and the pricing trend prevailing in the current quarter (~ 20 percent higher than that assumed for the forecast) prevails for a longer term. The stock is currently trading at 14.1x 2019e earnings which is well below the multiple for the chemical sector.

Other than pricing trend, another trigger to look at is capacity expansion plan. Though company has mentioned this earlier but no concrete plan on capacity expansion has come to fore. Sustenance of improved pricing environment could be the right catalyst for the same.

A tweak in our Diwali Portfolio: Switch to Vidhi Specialty Food Ingredients from Bhansali Engg Polymers

The Diwali Portfolio has generated an alpha of 15.3 percent in a little over fifty days (14.9 percent absolute return against minus 0.4 percent for Nifty). Such outperformance beckons continuous scrutiny to live up to the expectations of the investors.

In our Diwali portfolio, we are making a small change from Bhansali Engineering Polymers to another specialty chemical company – Vidhi Specialty Food Ingredients. The sharp run-up for Bhansali leaves little valuation comfort in the near term.

Vidhi Specialty Food Ingredients is one of two listed players in the food and beverage colour industry in India. In this oligopolistic industry wherein a few companies are up the scale in technical knowhow, quality control and regulatory requirements, Vidhi Specialty seems well placed to increase market share as it embarks upon capacity expansion in 2018. Based on more than doubling of capacity to ~9000 MT, and improved product mix, the management expects Rs 500 crore turnover in CY 2020.

We expect 27 percent CAGR in EBITDA for next four years based on topline growth and margin expansion of 210 bps (2017-21E). Stock is currently trading at a multiple of 15x 2020e earnings which is attractive in our view, given the significant barriers to entry and a secular demand visibility from the end market.

In case of Bhansali Engineering Polymers, we remain positive on the business which is well placed for market share gain in the ABS (Acrylonitrile butadiene styrene) plastics aided by fourfold increase in manufacturing capacity (by FY 2022). However, post significant run-up, we suggest to wait for a reasonable price level to consider a re-entry.

Table: Diwali portfolio stocks

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US tax code: Windfall fiscal incentive to aid US companies’ competitiveness

The US tax code is primed for an overhaul as Donald Trump is closer to clinch his first major legislative victory since his election in November, 2016. Last Saturday, the US Senate passed the crucial tax bill which aims to significantly reduce the US corporate taxes to 20 percent from 35 percent.

While re-rating of US equities in last one year partially reflects the execution of corporate reforms, significant improvement in US domestic companies’ competitiveness, on account of fiscal incentives, is arguably underway. Indian equity investors need to keep this development on their radar.

Broad provisions of US tax bills positive for economy

Both Senate and House of Representatives have broadly cleared similar tax bills, except for some nuances. Though both bills ask for corporate tax rate reduction, in case of Senate’s bill, 20 percent rate takes effect from 2019 onwards.

For the individual tax payers, it nearly doubles the standard deductions but eliminates personal exemptions and thus for larger families it reduces the positive effect of deductions significantly.

Among the sectors which would specifically benefit are asset management firms, industrials, telecom (enhanced deductions for capital expenditure). Retail sector, as well, is expected to benefit from higher discretionary income for the individual tax payers.

However, given the slew of caps on interest expenses, R&D expense, domestic firms with low debt appear to be key beneficiaries.

Higher returns for the shareholders through buybacks

Companies in sectors having a significant level of cash parked outside USA – pharma, IT companies benefit from paying reduced tax on the repatriated earnings.

As per the research institute The Institute on Taxation and Economic Policy (ITEP), US MNCs are holding more than USD 2.6 trillion of reinvested profits offshore to avoid taxes. If today, these companies decide to repatriate money, a tax of 35 percent deducted for tax credit equal to tax paid to foreign government needs to be paid. As substantial portion of this foreign subsidiaries are registered in tax havens so net tax applicable on repatriation is of the order of ~25 percent. However, after legislation of current proposals, tax rate applicable would be ~14 percent.

As for many of these companies, cash holdings in the domestic entities are also high so a few of them can return part of their cash holdings to investors in the form of buybacks and dividends.

Nevertheless, a combination of tax rate reduction and lower rates for repatriation, would help IT and pharma companies to be more competitive.

Joint Committee on Taxation estimate net revenue loss

While tax proposals pitch for a growth boost that would take care of the tax revenue loss, the Joint Committee on Taxation raises red flag. It estimates that there could be revenue loss for the government of about USD 1 trillion over 10 years. While the tax cuts measures are expected to raise GDP by 0.8 percent on an average over 10 years, this would only reduce the deficit by USD 407 billion.

Next Step

Now the process of merging Senate’s bill with the version from the House of Representatives would start this week, leading to further deliberations on the fine print.

Events are dollar positive

Tax legislation proposals are expected to be net USD supportive. In an email conversation, Giles Keating, Chair of Investor Advisory Firm Werthstein Institute, opine that while 70-80 percent of off-shore cash holdings could already be held in USD, even 20 percent of this holdings makes a significant chunk.

Further, this fiscal stimulation could prompt the Federal Reserve to further tighten monetary policy, which aids the dollar. Though, export-oriented Indian companies can benefit from currency tailwinds improved US companies’ competitiveness can possibly offset more than that.

For food color cos, the next trigger will be adding capacity, after a robust earning season

Food and beverages colour industry, a niche segment of dyes and pigment industry, not only benefits from secular growth from the end market but also possess significant barriers to entry due to regulatory needs. As a result, industry has an oligopolistic structure wherein a few companies are in the lead with technical knowhow and quality control which help in offering a palette of colour solutions vetted by necessary regulatory requirements in different geographies and client approvals.

In this secular demand driven industry, there are two listed players in India which are witnessing earnings traction – Vidhi Specialty Food Ingredients and Dynemic Products. While Vidhi Speciality is pricing in an earnings visibility from capacity expansion plan, Dynemic Products looks interesting on valuations, given similar scale of operations.

 Global food colour industry/ major players

Global food and beverages colour market size is estimated to be about USD 2.4 billion, with about 55 percent share constituted by natural food colours and rest synthetic. It’s a small segment compared to global dyes and pigment market of about USD 35-40 billion, yet underpinned by secular growth trends. Market researchers forecast about 7-8 percent CAGR growth in the next seven years driven by regulatory requirements, urbanization and structural demand scenario for the food and beverage industry.

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Source: researchnester.com, marketsandmarkets.comMoneycontrol research

Key global manufacturers of food colors are Sensient Technologies Corporation, CHR Hansen, GNT, Roha Dyechem and DyStar Hilton Davis Corp. The largest manufacturer from India is an unlisted player – Roha Dyechem, having operations at India and Spain. Interestingly, another global player – DyStar Hilton Davis Corp — is a part of DyStar group, in which Indian dyes and pigment major Kiri Industries has a stake of ~38 percent.

Vidhi Speciality (market cap: Rs 471 crore) and Dynemic Products (Rs 218 crore) are the key pure listed players in this segment in India. Other unlisted companies in India having FDA approval and exposure to food colors are Neelikon Food Dyes (plant at Dhatav).

Table: Select manufacturers production capacity

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Source: Moneycontrol Research, Valuepickr.com, annual reports

Food colour usage

Food colour usage is for categories like confectionary, bakery products, desserts, dairy products, seasonings, beverages, pet foods. Purpose varies from enhancing naturally occurring color, masking natural variation in colours, and to protect flavours and vitamins from environmental damage.

Listed Indian companies and capacity

Both Vidhi Specialty (incorporated in 1994) and Dynemic Products (established in 1990) are leading manufacturers of synthetic and natural food grade colors. While Vidhi Specialty’s also has a trading business of food colors (45 percent of FY17 sales), Dynemic Products is mainly into manufacturing and sales of synthetic food colors (74 percent of sales).

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As per the annual report of Dynemic Products, it is in the process of setting up of its third plant in Dahej, for which it is awaiting environmental clearance. It’s currently having a capacity of about 5700 MT (24,000 sq feet facility) in Gujarat.  Vidhi Specialty is aiming to double its capacity to 8,400 MT by 2020 and thus intending to capture market share of about 20 percent among the major players. Its current manufacturing facilities are at Dhatav, Raigad.

Stellar quarterly result

Dynemic Products witnessed improved topline growth of 19 percent YoY basis. Net profit margin rallied 51 percent benefitting from higher operating performance and lower other expenses. Vidhi Speciality posted double-digit growth in both topline and bottomline. Comparable margins for Vidhi Specialty was lower due to higher contribution of lower margin trading volumes.

Industry leader, USA based Sensient Technology Corp also reported a good set of numbers with improved pricing and volume growth in recent quarters.

Table: Dynemic Products

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Table: Vidhi Speciality

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Technology and broad product portfolio – barriers to entry

Usage of colors in food is closely regulated and varies from region to region. It is reported that about 14 colors are permitted for use in food in Europe, 6 in USA and 8 in India. Roha Dyechem mentions that there are some colors permitted in Europe, USA but not allowed in India (like Allura). So continuously maintaining various approvals (BIS, FDA, EU & WHO), certifications (Kosher & Halal) backed by an appropriate lab with testing facilities is an ongoing requirement.

Secondly, availability of broad product portfolio is helpful for tapping all needs to major end-client customers. Here, product offerings and capabilities for natural colors gets crucial as demand is picking up this segment.

Key risk – raw material and currency fluctuations

As a majority of products in this segment are exported currency fluctuation along with volatility in raw material cost (~50 percent of sales) are key risks. However, there is some natural hedge as a good part of raw material is imported (64 percent in case of Vidhi Specialty in FY17). With respect to raw materials, availability and price of dye intermediates from China is a key concern. Further, a long gestation period in the product approval by customer and success rate are the additional risks.

Promoters’ creeping higher share in Dynemic Products

The promoter stake in the Dynemic Products is about 39.8 percent as per September quarter records. Promoters have been engaged in incrementally increasing their holding in the current quarter as well. In case of Vidhi Speciality, promoter stake is already high at 64.3 percent currently.

Competitive sector – scale and investment matters

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Source: Thomson Reuters

This niche segment of dyes and pigment benefits from the promising trends for the end marketTrading multiples for Vidhi Specialty is in line with the global leader while the latter has a better margin profile (EBITDA 18 percent vs. 13 percent for Vidhi Specialty) and a broader range of product portfolio (including natural colors).

However, expanding capacity for the Indian players makes them ready for the growth in terms of market share gains. In this regard, progress status of capacity expansion would be a near-term trigger for the companies. Both the companies have witnessed improved margin and return ratios over the last three years. The balance sheet has also strengthened and both the companies have reduced their net borrowings recently. Dynemic products appear relatively better placed with a similar earnings trajectory, capacity but better multiples, in our view.

Aliphatic amines makers: Margin upside limited, earnings growth to come from volumes

Balaji Amines (Market cap: Rs 2060 crore) and Alkyl Amines (Rs 1189 crore) dominate the aliphatic amines industry in India with about 90-95 percent of domestic market production. Industry faces significant barriers to entry due to the need for high R&D acumen, ability to handle hazardous chemicals and offer a range of products – amines (~50 percent of sales), amine derivatives (30 percent) and specialty chemicals (20 percent). Other major organized players in amines industry is RCF (~5 percent market production share).

Globally, as well, there are very few manufacturers (outside of China) such as BASF, Huntsman, Arkema, Mitsubishi. Having said that imports play a significant role in maintaining pricing discipline.

Chart: Import-Export of aliphatic amines (USD in ’000s)

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Source: http://www.trademap.org

High exposure to pharma and agrochemicals

Volume growth in aliphatic amine industry is governed by prospects of end markets (pharma, agrochemicals, dyes, rubber chemicals) and the consequent capacity expansion plans. In the recent earnings call, Alkyl Amines management said that among the end markets, pharma is stabilizing and is expected to improve. At the same time, agrochemicals are picking up on the back of two consecutive decent monsoon years. Other specialty chemical end markets are also witnessing structural demand.

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Capacity expansion on the anvil

Both the companies are at the verge of a major capacity expansion. Alkyl Amine’s Dahej facility is expected to be operational by Q4 2018, wherein the methylamine capacity of 33,000 MT would be available which would be more than double its existing capacity. This enhanced capacity is expected to free its Patalganga facility for value-added products. The company also has a plan to increase its acetonitrile capacity. However, in this case capacity might come alive in some time by 2020.

Balaji Amines is looking for capacity expansion by about 20 percent. While it is making a move for Acetonitrile, it is further enhancing its global dominant position in the manufacture of DMA HCL (Di Methyl Amine Hydrochloride) used as pharma ingredient for ranitidine and metformin (diabetic drug).

In case of Acetonitrile (domestic market size: 16,000 MT), Balaji is initially targeting 6000 MT production in the first year with an aim to reap benefits from the international market (export share ~50 percent). Alkyl is already a major player in this segment wherein the international market size is about 100,000 MT.

Balaji’s morpholine capacity expansion has already happened and awaiting environmental clearance. Interestingly, Balaji Amines is one of three global suppliers (other than Chinese manufacturers) for it but still pricing pressure has been such that there was an anti-dumping duty till recently.

Balaji Amines’ recent decision of investment (55 percent stake, Rs 66 crore) in Balaji Speciality chemicals  provides exposure to specialty chemicals like ethylene diamine (EDA), piperazine and diethyleneteramine (DETA) specialty chemicals having applications such as fuel additives, rubber additives and pharma industry.

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Quarterly result: Benefitting from margin expansion

Both Balaji Amines and Alkyl Amines witnessed a sequential improvement in margins. However, a part of this may be erroneous from a comparison point of view to the earlier quarters due to GST accounting. For example, earlier “other expenses” included excise duty expenses as well. Alkyl amines reported 18 percent volume growth and improved value growth of 22 percent on YoY basis. Increase in cost of material was in line with value growth implying increased cost was largely passed on to end customers. Balaji Amines witnessed 8-10 percent volume growth.

Pricing and volume benefits was visible for a specialty chemical, Di methyl Formaldehyde, where there was an improved global pricing trend. This is interesting as Balaji Amines have been contesting for the application of anti-dumping duties in the past for this particular category.

Table: Balaji Amines

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Table: Alkyl Amines

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Raw material prices

Key raw materials are methanol, ammonia, ethyl alcohol and acetic acid. While ammonia and ethyl alcohol (distilleries, sugar companies) are mainly sourced domestically, methanol is largely sourced from the Middle East. Methanol prices have been volatile in the past and are expected to track oil prices but, by and large, companies are able to pass on the input prices surge to end customers. While ammonia prices are expected to remain subdued, acetic acid prices have surged recently and that needs to be closely watched.

In the near term, the management expects raw material prices to remain stable and believe good supply available to meet current and future demand.

Further valuation rerating contingent on pricing power

While comparing trading multiple with the multiples derived for the companies depending on their end market exposure, one finds that there is still some room left for rerating. In the medium term, companies’ effort towards increasing contribution of amine derivatives and specialty chemicals in the topline growth would aid margins as some of them have a better demand in international markets. About 20 percent of sales of both the companies come from exports.

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However, here one needs to keep in mind that even though this industry is oligopolistic, pricing power is limited. EBITDA margins may not sustain beyond the 20 percent on a longer term.  While companies enjoy duopoly kind of dominance in Indian market, but competition from MNC suppliers and Chinese imports keep a cap on margin expansion for a few of their products. Hence, going forward, volume-led earnings growth is expected to be the key driver for the amine companies.

Apcotex Industries: Improved product & capacity expansion to aid market share gain

Apcotex Industries (market cap: Rs 985 crore) is one the leading producers of polymer products — synthetic latexes and rubber — in India. A spun-off company from Asian Paints, Apcotex is the only manufacturer for nitrile rubber, post its acquisition of Omnova Solutions. The company’s recent results highlight a turnaround in capacity utilization partly aided by process improvements in the plants. We like the company for its capacity expansion plans and R&D capabilities which help it to meet international standards in a global market dominated by chemical majors.

Product portfolio and usage

Apcotex’s legacy business offers synthetic latex and high styrene rubber (HSR) through its Taloja facility. In 2016, Apcotex acquired Omnova Solutions (Apcotex solutions) which makes it the only producer of nitrile rubber in India, through its Valia plant. In case of HSR, as well, Apcotex is the largest manufacturer.

Applications include tyre cord dipping, paper and paperboard coating, carpet backing, concrete modification, water proofing, textile finishing etc. Key clients include end market industry leaders like MRF, ITC, Relaxo, Pidilite, SRF, Obeetee Industries.

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Chart: Key clients and industry

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Synthetic latex – application for varied end markets

Synthetic latex applications are varied and the company caters to end markets like paper, construction and tyre industry. In case of construction chemicals, the company caters to requirements for water proofing, concrete admixtures and flooring solutions. Recent government infra initiatives for smart cities, affordable housing along with increasing urbanization and redevelopment activities are expected to create a sustained demand in near future.

Company’s strong R&D helps it to be among the leading supplier for all the end markets of synthetic latex, wherein it competes with BASF, Dow chemicals.

Chart: Legacy business revenue contribution

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Source: Company

Growth area – Nitrile butyl rubber (NBR)

Post-acquisition of Omnova in 2016, Apcotex is the sole domestic manufacturer of Nitrile rubber which is otherwise import dependent. For a domestic market size of ~50 kT, Apcotex currently commands about 18-27 percent market share. Rest is imported. After capacity expansion, this share is expected to go to the range of 40 percent. The company is expected to benefit not only from the secular domestic consumption growth in the segment but also expected to partially substitute imports as it implements process and product improvisations.

In the medium term, we expect low double digit domestic demand led by industrial capex revival.

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Source: CPMA India

Improving financials

The company’s immediate capacity expenditure (Rs 60 crore) are funded through internal accruals and its improving cash flow profile and healthy balance sheet keeps it ready for the plans for expansion.

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Key risk – raw material

A key risk for the company arises from volatility in raw material prices (Butadiene, Styrene and Acrylonitrile). The company usually follows a monthly pricing cycle but in case of sharp changes in the raw material prices, the company can be impacted.

Additionally, an ongoing concern is that order flows from one of the largest paper customers, which was contributing about 5 percent to the overall revenue, still remain uncertain.

Capacity expansion for NBR

The company is undergoing the first phase (to be completed by Q4 FY18) of capex (Rs 30 crore) for the improvements in Valia plant which would not only reduce the operating costs but also improve product quality mainly for the NBR products.

Further, setting up of power plant at Valia (to be completed by December 2017) is expected to substantially reduce power and fuel costs. In addition, the next phase of capex (another Rs 30 crore) would be utilized for the debottlenecking leading to improved capacity of NBR plant by around 25 percent to about 21,000 MT (In FY19).

The company is also working on plans to further increase NBR capacity to 36,000 MT. Similarly, capacity expansion for latex is also under study. These capacity expansion plans hold significance as company’s existing facilities are near optimum utilization,

Valuation/ recommendation

While management is targetting gross revenues in the range of Rs 550-600 crore, we are also positive on the traction so far this year and the turnaround opportunity NBR product business is undergoing. Backed by improved utilization in the current year and capacity expansion later next year, we pencil in 21 percent CAGR for 2017-2020E.

The management expects an improved margin profile in the near-term. A pre-acquisition operating margin range of 13-14 percent would be feasible as the company moves past acquisition costs and the efficiency measures bear results in the next 2-3 years. A higher share of exports along with process improvements and commissioning of the power plant at Valia unit are expected to aid margins. We expect + 476 bps margin expansion by FY20.

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Based on our projections, the stock is trading at 16x 2020E earnings, which is ahead of its global peers but in line with its closest domestic peer – BASF India. Having said that, given the multiple tailwinds – industry dominant position, exposure to growth industries and internal efficiency plans — we consider stock could be accumulated for a longer term investment horizon.