Page 1
AtulLtdIndia|DyesandPigmentsIndustry|InitiatingCoverageAboutthecompany• Establishedsince1947,thiscompanyisoneoftheoldestandleadingplayers
intheindustry.• Theproductprofileofthecompanyisverybroadincludingaromatics,bulk
chemicalsandintermediates,colours,pharmaceuticalsandintermediates,cropprotection/agrochemicalsandpolymers.
• ThekeytoAtul’ssteady-goingfinancialperformanceisitsglobalpositioninginaromatics,ledbyP-cresolandderivatives,coloursbecauseofsulphurblackandvatdyesandpolymersepoxyandsulphonesandbycropprotectionthroughformulationof2,4D
MacroeconomicOutlook• Sizeofworldchemicalindustryis4.4trillion$anditgrewby2%in2015:Indian
Chemicalindustry(sizeUS$103bn)grewby3%,butisstillranked7afterChina(sizeUS$1.5tn),theUSA(sizeUS$630bn),Germany(sizeUS$198bn),Japan(sizeUS$190bn),SouthKorea(sizeUS$165bn)andFrance(sizeUS$107bn).Accordingtoaleadingconsultingfirm,IndiahasthepotentialtogrowitsSpecialityChemicalsindustryat9%.
• Thechemicalindustryisheavilydependentonoilandoilproductsasrawmaterial.Alotofproductsarecommoditiesandlackpricingpower.CompanieswhichspendonR&DandareabletogeneratesustainableholdonValueproductslikespecialtychemicals,createanedgeoverothers.
• SomeGrowthDriversfortheindustryare:
1. Rise in global GDP and purchasing power worldwide, leading to increasedconsumptionandrelatedproducts
2. Low cost manufacturing , refining processes to cut costs, also environmentrelatedcompliancesandcosts
3. 100%FDIbringinginmoreinvestment,infrastructureandtechnology4. Governmentsupportininfrastructure,policiesandR&D
DEMANDSIDEECONOMICS SUPPLYSIDEECONOMICS• Aschemicalisamajorinputinalot
industriesvaryingfromcropstoconstructiontoadhesivestoaromatics,itsdemandformostoftheproductsaredeterminedbytheindustrialgrowthdriversofgrowthinGlobalGDPandincreaseinconsumptionanddemandoftheseproducts.
• SpecificallyforATULltd.Upturninglobaleconomicscenarioplaysamajorroleas55%ofitssalesarefromExports.
• ButanindustryplayersuchasAtulcanincreasesalesandcreateamoat:
1. Creatingcomplex,valueaddedproductsthroughfocusonR&D.
2. CreatingmoreBrandstocreateproductdifferentiation
3. Enhancingcapacityandcostleadershipinthoseproductstokeepthemoatsustainable
• Crudeisthemaincomponentofrawmaterialandfluctuationinitspricesplaysanimportantroleintotalsales.
• Crudepricesfluctuatedbetween22$-66$in2015-2016.SuchlowlevelsofrawmaterialpricesresultedinlowerTotalSalesasAtulltd.wasnotabletoretaintheadvantageofdecreaseinvalueofrawmaterialsduetolackofpricingpowerinlargenumberofsegmentsandproducts,duetotheircommoditynature.
• Percentageimportofrawmaterialsis28%oftotalpurchasesindicatinglowerimpactofrupeedepreciationonitsrawmaterialcost.
• Furtherstabilityandupturninoilpriceswillboostsalesgrowth.
27August2016
SELLCMP:Rs.2118
COMPANYDATAO/SShares(Cr.) 3
MARKETCAP(RSCr.) 6284
52WKLOW/HIGH 1150-2299
PARVALUE(Rs.) 10
FY16 FY15 FY14
NETSALES 2601 2656 2458EBITDA 456 391 364NETPROFIT
269 226 220
D/E 0.3 0.3 0.4ROE 22.82 21.80 24.96
SHAREHOLDINGPATTERN
Dec‘15 Sep‘15 June‘15
Promoters 50.8 50.8 50.7FII/NRI 6.3 6.9 7.0FI/MF 13.0 13.6 13.4NONPRO 29.9 10.0 9.8PUBLIC&OTHERS
0.0 18.7 19.1
Page 2
PORTER’SFIVEFORCES
THREATOFNEWENTRANTS-Lowtomoderate
• Hugecapitalrequiredtostart• Patentprotectionbycompaniesaddsgreatvaluetovariousproductsdevelopedbythem.• Varioussafetymeasurestofollowwhicharecostlyandtoughtoimplement• Theindustryasawholehavehighentrybarriers,complexproductsandprocesses,Manycomplex
productsaremanufacturedthroughR&Dandincludestoughprocesseswhicharehardtooperate• R&Dandpollutioncontrolprocessesneedgovernmentapprovalandsupport• Customerprocessandproductapprovalsystemarehighlyelongatedandtedious.Testingprocessto
finalapprovaltakes1-2years,thuscreatingstickycustomerbaseandwhichhelpinmaintainingstablemarginsandleadingtohighentrybarriers
THREATOFSUBSTITUTES-Low
• Buyersusuallyhaveaspecificchemicalrequirement.• Thusthereisnodirectsubstituteeventhoughit’sacommodity.• Also,specialtychemicalsprovide-
a) Valueadditionb) Productdifferentiation
COMPETITIVERIVALRY-High
• Chemicalindustryishighlyfragmented,cateringtovariousindustriesandcommoditizedproducts• Governmenthasallowed100%FDIinthissector,sonowtheyhavetocompetewithbothdomestic
andinternationalplayers.• ThereisathreatofthesecompaniesdumpingtheirproductsinIndiaatlowprices,reducingthe
demandfordomesticplayers.• MoreoverChinabeingtheleaderintheindustrycausesmajordisruptioninpricesanddemands
fromtimetotime.
BARGAININGPOWEROFSUPPLIERS-High
• Crudeisthemajorrawmaterialhere.• Itissuppliedmainlybyfewlargepetrochemicalplants.• Suppliershavehighbargainingpowergiventhefragmentedplayersinchemicalindustry.• Also,thereisnomajorsubstitutepresentfortherawmaterials.
BARGAININGPOWEROFBUYERS-High
• Sincethechemicalindustryisfragmented,thebuyershavealotofsuppliers.• Chemicalcommodityproductsarenotdifferentiated,thusgivingbigbuyersanupperhandat
negotiations.• Also,thesechemicalcompaniesaresometimesboundbylongtermcontractssotheyhaveveryless
chanceofmovingtoamoreprofitablesource.• However,somespecialtychemicalshavesomepricingpowerandsupplytonicheindustries,inthat.
LikevinatiorganicssuppliesATBSandisabletomaintainitspricing.
Page 3
MajorProducts
1. Aromatics:ThesizeofworldfragranceindustryisestimatedatUS$11bnandisgrowingatabout14%.ThoughearliertheproductusedtobemanufacturedonlyinUKandUSA,ChinaandIndiaarenowthemajorsuppliersoftheproduct.Themainuserindustries,namely –fragrance andpersonal care are growingwell becauseof improvingstandardofliving.KeyProductsp-cresolandderivativesmarkets:Atulisthelargestmanufacturerp-Cresolanditsderivativesincludingp-anisicaldehyde(p-AA)andP-anisolalcohol(p-AAI)intheworld.Exportsrevenuecontributestoover70%oftotalaromaticsales.Marketofpcresolisestimatedat63,000mtandisgrowingabout2%.PricingPowerThecompanyhoweverhasverylowpricingpowerasitisheavilydependentonoil.In2015-16,growthonaccountofvolumewas3%butthetotalsalesdeclineby10%total.ProjectsThe company completed 1 project under this head and has undertaken 1projectforimplementation.
2. PolymersandtheirbrandsWorldmarketforEpoxyResinsandHardenersisestimatedatUS$6.3bnandisgrowingatabout2%andIndianmarketisestimatedatUS$250mnandisgrowingatabout6%.WorldmarketforSulphones(ahardener)isestimatedatUS$320mnandisgrowingatabout4%.Theuserindustries,Construction,Defence,ElectricalandElectronics,PaintandCoatingsandWindEnergyaregrowingwell,particularlyinIndia.AtulisthelargestmanufacturerofsulphonesinworldandlargestmanufacturerofepoxyinIndia.ItalsohasanumberofBrandsunderthissegmentgivingitproductdifferentiationopportunitiesandbrandrecognition.Themajorproductof this segment runsunder thebrandnameofLapoxandPolygrip.
Page 4
PricingPowerGrowth on account of volume was 6%, however the total increase in salesamounted to just 1%, which indicates the company’s low pricing power,thoughitisnotaslowasaromatics,showingbettermarginopportunitieshere.ProjectsThecompanycompleted3projectsunderthissegmentandundertook2moreprojectsforimplementation.
3. Cropprotection
Atulisamongtheworld'sfiveleadingmanufacturersof2,4dderivativesusedinherbicides.Ithascapacityof10,000tn.However,itlacksbargainingpower.TheindustryisestimatedatUS$52bnandisgrowingatabout4%.
Pricingpower
Thecompanyhoweverhaslowpricingpowerasthegrowthinvolumeis34%,butthetotalsaleshasincreasedby22%,showingthatthecompanyhadtoreducepricestomatchcompetitionandboostsales.
Projects
Thecompanycompleted3projectsunderthisheadandhasundertook1anotherforimplementation.Thecompanyisalsodeepeningitpresenceinothercountries,especiallyinAfricaandSouthAmerica.
4. Colours
AtulisthelargestmanufacturerofsulphurblackinIndiaandoneofthelargestmanufacturersofvatdyesintheworld.
ThesizeofworldDyestuffindustryisestimatedatUS$6bnandisgrowingatabout3.5%.WorldmarketforhighperformancepigmentsisestimatedatUS$4.3bnandisgrowingatabout2.7%.
Thisgroupcompromisesofaround550products.Green1,PRedandSulpharBlackaresomeofthekeyproducts.
PricingPower
Thecompanyhaslowpricingpowerbecausethecompanyfaceddecreaseinsaleof23%whereasdecreaseinvolumewas18%,showingareductioninprices.
ProjectsTheCompanycompleted4projectsandundertook2projectsforimplementationthisyear.
Page 5
5. Pharma
ThesizeofworldAPIindustryisestimatedatUS$150bnandisgrowingatabout7%..
Thecompanyfaceddegrowthonaccountofvolumeof1%.
AtulBioscienceLtd,a100%subsidiaryofthecompanyfocusedonproductionofadvancedAPIintermediates,increaseditssalesby17%,from47to55crprimarilybecauseofvolumes.
PricingPower
Totalsalesdecreasedby1%.Degrowthonaccountofvolumewas1%.Thisindicatesthatthatpharmasegmenthassomeamountofpricingpowerandatleastmuchbetterthanothersegments.Breakthroughsinthissectorcancontributetomajorrevenuesinfuture.
Projects
ThecompanyhassuccessfullycompleteditssecuredUSFAinspectionforoneofitsproductsandisintheprocessofexpandingitsAPIplant.
Thecompanyundertook1projectforimplementation.
Page 6
BusinessModel
AtulLtdconsistsof2segments:
i. LifeSciencesii. Performanceandotherchemicals
-
LifeScience
CropProtecjon-Consjtutes16%ofsalesinFY15-16comparedto14%lastyear.-Herbicidesegmentandformulajonssuchas2and4daremajorvariantsofcropprotecjon.
Pharma-Consjtutes12.6%ofsalesinFY15-16comparedto13%lastyear.-Itconsjtutesabout50productsincludinganjdepressants,anj–diabejc,anj-infecjve.
Page 7
Performanceandotherchemicals
Aromafcs-Consjtutes18%ofsalesin2015-2016comparedto21%lastyear.
PolymersConsjtutes27%ofsalescomparedto28%lastyear.
ColoursConsjtutes15.3%ofsalesinFY15-16
comparedto19%lastyear
BulkchemicalsContributes3.38%ofsalescomparedto4%
lastyear.
Page 8
FinancialPerformance
CapitalStructure
• Longtermdebt:hasbeendecreasingfrom2010andhascomedownto5%levelsofsalesfrom33%levelsofsales10yearsback.
• Shorttermdebts:havebeenincreasingconsiderably,theyarestilllowenoughtokeepthedebt/equityratioatonly0.3.ShorttermborrowingshavebeenIncreasingduetolowinventoryturnoverandthushighworkingcapitalrequirementsofthebusinessoveraperiodoftimeduetoincreasinglevelofsalesandWorkingcapitalneeds.weseefromthetableshorttermdebtas%ofsaleshasbeenfluctuatingbetween7%-10%,apartfrom2yearswhereworkingcapitalneedswerelessandthusnoworkingcapitalshorttermloanwastakenbythecompany.Moreoveritcanalsobeseen%ofshorttermloantoworkingcapitalisprettyinalmostalltheyears,indicatingthathighdemandofworkingcapitalanditsvolatilityaffectsshorttermdebt.
• Interestcoverageratio(EBIT/Interestcost):itisprettyhigh,showingCo.ismorethancapableofmeetingthem.Also,nocapitalizedinterestcostispresentinthebalancesheetofthecompany.
• Thecompanyrightnowis• expandingbyusingitsownearnings,itsCFO.• Ifthecompanyeverneedsdebttoexpandorrecoverfromsloweconomiccycles,theystillwill
haveadebtcapacityof1118cr.• Calculationssupportingtheabovementioned:
o Bank’susualinterestcoverageof3.DividingitbyEBITof428cro Givesaninterestexpenseof143cro Atul’scurrentloancostfromIndianbanks=6.99%to7.49%o Beingconservative,eventakingdebtcostas12%,thecompany’sdebtcapacityof1,118
cro Atulwithit’sconsistentprofitscanmanagetopaythisoff.
Page 9
ReturnRatios
1.ROIC which measures efficiency of operatingassets (say core business quality) has been on theup consistently barring this year. We see a slightdeclineduetoincreaseinnetblockandcapitalWIPduetoCAPEXundertaken,butoverallthenumberisprettydecentat32.
2. ROE has also increased over the years to areasonably good level of 22.82 and importantlygrowth has not come from leverage effect butthrough consistently increasing net profit marginsand stable asset turnover. Also, some amount ofdebt is slightly beneficial as it is gives boost toequityholders returnandat thesametime isverymuchmanageable in case of fall in revenues to ahighextent.
3. ROA is increasing similar to ROE as it does nothaveahighpercentageofdebt.
4.ROIIC- In FY2008-2009 and 09-10 have seen bigreductioninoperatingcapemployed,thisisduetothe freeing up ofworking capitalwhich in turn isbecauseofdecreaseindebtorsin08-09anddrasticincrease in payables and short term borrowings in09-10. Despite reduced working capital, EBIT hasincreasedorremainedstable.
The ROIIC figure has shown a strong increasingtrend from FY12-13 to FY 14-15 suggesting evenfurther the efficient use of allocated incrementalcapital.ThiswasduetoincreasingsalesintheFY13-14 and in FY14-15 due to freeing up of workingcapital toa largeextentwhichwasbecauseof theincrease in creditors and short term borrowings.TheFY15-16thefigurehasgonedownduetoheavyCAPEXwhichhasbeenundertaken,otherwiseinthelast5yearsthecompanyhasseenhealthyreturnonincrementalinvestedcapital..
The RoIIC figures have been a bit volatile as thecompany’sbusiness isdependentoneconomyandconsumerdemand,making itcyclical, thusworkingcapitaldemands fluctuateasper thecyclicalneedsofthebusiness.
Page 10
GrowthPercentages
Atulltd.hasshownconsistentYOYgrowthinnetsales.
ThemajorgrowthsinFY10-11majorlyduetonegativegrowthinpreviousyearwhichgivesitsmallerbaseandFY13-14dueglobalupturnindemands.
Thisyearhasseendegrowthafteralongtimemajorlyduetotworeasons:
1) Lowercrudepricesandunabletoretainduetocommoditynatureofproducts2) Globaleconomicdownturnandthuslowerdemand,sounabletoincreasevolumeto
offsetthedecreaseinprice.
ThoughthesaleshavedecreasedthisyeartheEBITDAandEBITgrowthhaveseenimprovementfrompreviousyear.ThoughitshouldbeseenthatthebaseofpreviousyearwascomparativelylowandthegrowthisstilllessFY12-13andFY13-14levels.Overallitstillshowsimprovingoperatingefficiency.NetprofitmarginshaveimprovedduetoreducingpercentageofLongtermdebtincomparisontosales.
HighnetprofitgrowthisvisibleinFY13-14andFY10-11duetosignificantincreaseinsales,EBITDAandEBITmarginswhichhavetrickleddowntoPAT.
MoreoverifwetakeAverageofEBITmarginsoveraperiodof5yearseachinthelast10yearswegetanaverageof5.62%fromtheperiodFY06-07toFY10-11andAveragemarginfromFY11-12toFY15-16standsat11.52%,Thehighermarginsaremorlyduetothelast3yearsofindicatingimprovedefficiencyaswellasmajorimpactofreductiononrawmaterialprices(ofwhichsomebenefitswereretained).Buthowlongwillthehighmarginsbesustainabledependsonthecrudeoilpricesandfurtherefficiencieswhicharelimited.ThusanaverageEBITmarginoflast10yearsof8.5%isanumberwhichshouldbegivenmoreweightageto.
Page 11
SalesandoperatingPerformance
Itcanbeseenfromabovenumbersthatalltheprofitabilitymarginshavebeencontinuouslyandconsistentlyincreasing.WhileagoodincreaseinGrossProfitmargininFY15-16canbeattributedtolowpricesofcrude,thisisthemajorrawmaterialforthecompany.HoweverconsistentimprovementsinEBITmarginsreachingalmost15%thisyearshowsimprovingoperatingefficienciesandbettercostmanagementinalmostallareasofexpenditure.Netprofitmarginimprovementismajorlyduetodecreasinglongtermdebtovertheyearswhichhasgonedownconsiderablyduringthisperiod.
The,assetturnoverhasbeenmarginallyincreasingexceptFY15-16(whichwasdownduetolowersales)despiteofconsistentCAPEX.Despitetheincrementitisstillbetweentherangesof1.3to1.45inthelast5years,whichshowscapitalintensivenatureofthebusiness.
NetFixedAssetturnoverhaveshowngoodjumpinFY10-11andhavebeenincreasingsincethen,exceptthisfinancialyear(againduetolowsalesandrelativelyhighCAPEX),whichshowstheCo.HasbeenabletoboostuprevenuewithoutdoingalargeamountofCAPEXconsistently.AscanalsobeseenbyCAPEX/salesratiowhichhasbeenconsistentintherangeof5%-7%untilFY14-15.After10yearsthatisthisyearCAPEXhasalmostdoubledto14%asexpansionprojectsworth213cr.havebeencompletedandRs98cr.morehavebeenundertakentoboostupgrowthinexistingproducts.
Comingtoworkingcapitalmanagementasitcanbeseencashconversioncyclehasdeterioratedsincelast5years,whilethisincreaseisaconsequenteffectofincreaseinsales
Page 12
levelfromFY11-12,itshouldalsobenotedthatbettermanagementofinventoryisneeded.DebtorturnoverdayshavebeendecreasingandthenconsistentsinceFY11-12andwellabovethedaysofpayables,thoughhavedecreasedbymajornumberssinceFY11-12.ThemajorareasofWorkingcapitalmanagementforAtulltd.Comesininventorymanagementwhichhasseenconsistenthighnumberofconversiondaysandhavesignificantlydeterioratedto117inFY15-16from107inpreviousyearandthusareamajorholdupintheimprovementofcashconversioncycleaswellasforfreeingupcashflow.
Toaddtoit,itshouldalsobenotedthatWorkingcapitalmanagementandspeciallyinventoryturnoverisprettylowforthewholespecialtychemicalindustry.ForreferenceifweseetheinventoryturnoverdaysofitspeerArtiltd.Italsocomescloseto110days.Buteventhoughmajorlybeinganindustryproblem,Atulltd.certainlyneedstobetteritsinventorymanagementforloweringshorttermborrowingcostsandfreeingupmorecash.
Atul’sbusinessmodelhasbeenabletoconvertprofitstocashascanbeseenbycomparingcumulativeCFO(cCFO)oflast10yearswithcumulativePAT(cPAT)oflast10years,withcCFObeing1586crandcPATbeing1168cr,indicatinghealthyconversionofprofitstocashoveralongperiod.
MoreoveritsCFO/EBITDAratiohas10yearaverageof0.8whichshowsahealthyconvergencebetweenprofitsandcashflowswiththedifferencemainlyduetoworkingcapitalchanges.
CFOhaveshownsignificantincrementfromFY13-14duetobetterprofits,thoughworkingcapitalmanagementhasbeenfluctuatingbetweenbadandgoodintheseyearsasWCchangeinFY13-14was-155crandhasimprovedinFY15-16to17cr.Withbetteringprofits,bettermanagementofworkingcapitalspeciallyinventorywouldfurtherboostupCFO.
AlltheseyearsCAPEXhasbeenself-fundedandtotheextentthattheyhavebeencoveredbyCFOitselfexceptthe2years,sofreecashflowsituationismostlypositiveandhealthybarring2years.ThusthisshowsAtulltd.canexpandevenfurtherwithouttheneedofanydebt.
Page 13
Ø PROFITMARGINS:themarginforlifescienceshasbeenstableataround20%andperformancehasamarginofaround13%.
Ø SALES/ASSETS:thisratioforlifescienceshasdroppeddownby6%whereasforperformance,ithasdrasticallydroppedby22%.Thisindicatesthatperformancesegmentisonadeclineinabletoconvertit’sasset’sefficiencyintosales.
Ø SALES/ADDITONALCAPEX:thisratioindicatesastohowwelltheadditionalCAPEXisabletogeneratesalesinthefutureyears.Lifesciencesisdoingadecentjobwithastablerateof25times.But,performancesegmenthasdroppeddownsignificantlyby10%inthecurrentyear.
Ø KEYPOINT:ifAtulltdisabletoaddafewspecialtyandvalueaddedproductsinlifesciences,itcangeneratehighersaleshere.Currently,performanceholdsabout70%ofthetotalsalesrightnow.Itcanallocatecapitalinabalancedwaybetweenthe2sectors,itcanseeanincreaseinthevolumeandtotalsalesfigureaswell.Alsoifitcancreatemorespecialityandkeyproductsinlifesciences,thenitcouldfurtherboostupsalesduetobettermarginsinthatsector.
Ø OTHERSECTOR:thissectorincludesproductsthatarenotrelatedtothemajorproducts.Thefuturesalesfigurewillgiveusabetteroutlookonthissector.Also,thissectoraccountsforaveryminusclepercentageoftotalsalessoitisnotgoingtoaffectthegrowthsignificantly.
SegmentalPerformance
Page 14
ManagementQuality
• Thecompanyhasnosignificantrelatedpartytransactions,noranyhugeamountshavebeenlenttoanyexecutiveoranyorganization,anexecutivemayberelatedwith.
• ThepromoterorhisfamilyareisnotrelatedtoasimilarbusinessoutsideAtulLtd.• Allthepatentsareunderthecompany’snameandeverythingisbeingprofessionally
run.• Thecapitalallocationforthecompanyhasbeendoneefficiently.• Thepromoterishighlyeducated,qualified,leadsasimplelifestyleandhasaclean
record.• Thepromoterwithdrawsatotalsalarywhichis240.06timesthemedian
remunerationoftheemployees;thistotalamounthoweverisnotmorethan4%PAT.• Themanagementiscompetentandhasbeencandidaboutitsmistakesand
performances.• Thepromotershareholdinghasafavourablenumberandtherehasbeennopledging
orissueofwarrants.• Thetopmanagementisquitestableandtheelectionofrevolvingdirectorsisbeing
carriedoutintime.• Therehasbeennodecisiontakenagainsttheminorityshareholders.
AdditionalPoints
1)Hedging:Atulltd.hedgedaround3.5crofforeignexposureinFY2015-2016andhasaround4.62cr.ofexposureunhedged.Regardingthehedgingofitsrawmaterials,asthepricesareveryvolatiletheCompanydoesnotgoforcommoditypriceriskhedgingactivitiesasitdoesnotexpectsignificantadvantageinmediumtolong-termhorizon.However,forminimisingprocurementriskforshortduration,itentersintoannualpurchasecontractsforkeyrawmaterialslinkedtoinputcosts2)Cyclicnatureofbusiness:Beingaproviderofindustrialproductswhichareenablersforotherindustries,thedemandforthechemicals,especiallyspecialitychemicalsthatcontributestoAtulLtd’smajorrevenuesaredependentondemandoftheendconsumerproductslikefragrances,paints,tyresetc.Thusbeingdrivenbyconsumerspendingandpurchasingpower,thecompanyfacescyclesofmedium,highgrowthandnegativegrowth.Moreovertheinputbeingacommodity(oil)alsohasamajorimpactoncompany’stotalsales,astrendoftotalsaleschangeswithchangesinthetrendofoil.(negativegrowthinsalesduetolowcrudeprices)Alsoasobservedfromthesalesfiguresabove,ina4-5yearcycle,thecompanyshows2-3yearsofmediumgrowth,followedby1-2yearsofgreatgrowthandthenayearofdegrowth.
Page 15
3) PricingPower:Asillustratedabovethecompanydoesn’thavepricingpowerinmostofitsproducts,exceptPharmasegment.Thisismajorlyduetocommoditynatureofproductsduetointensecompetitionbetweentheseproductsworldwide.MorefocusonR&Dandcostefficiencywouldhelpreducethisproblem.AlsotheCo.measureitsinventoryonweightedaveragecostbasis.Intheindustryandcompanytheendproductpricingisfixedwithpassonclausei.e.theextracostofincreaseinrawmaterialwillbepassedontothecustomeraswellasreducedrawmaterialcostswillalsohavetobepassedon(thuskeepingmarginsstableatmostlyalltimes.SolackofPricingpowerispartlybecauseofglobalcompetitionandpartlybecauseofcustomercontractsthatnullifytheeffectofrawmaterialpriceVolatility.Thusexpectancyofhugemarginsarelowandsimilarlychancesofmarginsshrinkingdrasticallyduringrecessionarealsolowleadingtostabilitybutnogreatscopetoincreasemargins.
Valuations:
ReverseDCFModel
Page 16
Usinga31%growthrateforthenext10years,weseetheintrinsicvaluedrawclosetothecurrentmarketprice.Thisonlyshowshowthemarkethasaccordedanirrationallyhighgrowthtothecompany.Reviewingthemarket,thisindustryandcompanyinparticularwillwitnessdecentgrowthincoming2-3yearsbutahighgrowthrateof31%isbiasedtosomeextent.Asofnow,wewouldn’tenterthecompanybutwhenthemarkethasbrokenthisvalueandsubsequentlydrawsdownthepriceshowcasingagrowthbelow15-16%,thenthatwouldbeagoodtimetoenterthecompanyasthenitwouldprovidegoodreturnsalongwithmaintainingmarginofsafety.
ExitMultipleApproach
ThisapproachtakesintoP/Eof20,withanassumptionthatattheendof10yearsP/Eofcompanywillbearound20,thusifP/Ereratesdownfromcurrentlevelstoaround20,withaprojectedEPSandwithourexpectedgrowthof18%innext5yearsand12%forfurther5years,thenitwillvaluethecompanyatapprox.Rs7314after10years.
Giving13%CAGRfromthispricepointwhichisbelowourdesiredreturnof20%.Thuswewouldwaitforthemarkettocorrectpricestoattainaminimumofthatreturnontheinvestment,consideringthebusinesscyclicalityrisk.
Page 17
BRIEFOUTLOOK:
GENERALOVERVIEW
• Atulltdmajorsincommoditymarketwhichhappenstobecyclicalinnature.So,itiscloselylinkedtotheeconomiccycle.Supportingtheabove,itisatabusinessendwhereanymotionintheotherendwillcauseturmoilinthiscompany.
• Thecompanyhaslowersalesfigureinthecurrentyearwhichisduetodecreaseininputpriceswhichithadtopassonduetolackofpricingpower.Also,theincreaseinvolumewasnotenoughtocanceltheeffect.(volumegrowththisyearwas3%ascomparedto5%oflastyear).
• Thecrudeoilpriceshavegonedownbutitdoesnotshowasustainableapproachtoconsideritfortheforecast.
• Theoperatingefficiencyseemsgoodasthemanagementwasabletoachieveahigherprofitmarginevenafterhavingadecreaseinsalesfigure.Tellsusthatthecompanyisgoodatcostcuttingbutwhichagainisnotsustainableforthelongterm.
• Thereisnomanipulationbythemanagementandinrelatedpartytransactions.• Theindustryasawholehavehighentrybarriers,complexproductsandprocesses,stable
returnsandmargins,lowdebt.Specialitychemicalsarehighvalue–lowvolumeproducts.(willgoinportersrule)
• Itisaknowledgebasedindustry,needspecializedknowledgeableprocess,establishedindustriesbetterpositionedtotakeadvantageofgrowthinincountrydemandandofexports.
• Customerprocessandproductapprovalsystemarehighlyelongated,tedious.Thusstickycustomerbaseandthushelpinmaintainingstablemargins.Testingprocesstofinalapprovaltakes1-2years,thussticky.Leadingtohighentrybarriers.(porter’srule)
• Supplementingtheabovewithvaluation,theCMPofAtulltdisR.2,120.Butaspervaluationthemarketiscurrentlygivingitgreatgrowthwhichinourviewisoverestimatedandthusthestockseemsovervalued.Asthegrowthpredictedbyusinthenext4-5yearsismaximumaround18%andbeyondthatatalevelofabout12%foranother5years
TREND(previous2-5years):
• Indianspecialitychemicalshavegrownat13%CAGRfrom2009-2014.Thegrowthinlast2yearshavebeenrelativelydownduetolowoilpricesandlackofglobaldemandtoo.
• Butinthelast3-4yearsIndianchemicalindustryhasbeengainingadvantageoverchina,whichisamajorcompetitor.Chinawasandstilltoalargeextentisfacingcostpressureduetohighcostsoflabour,fuel,power,andmostimportantlystricterenvironmentalregulations(2majorchemicalfactoriesofatwodifferentbigchemicalcompanieshavebeenrelocatedinrecentyears).Alsoappreciatingyuanhadbeendampeningtheirexportsduringthattime.
• Moreover , according to industry experts, the cost of production of India’s specialty chemicals works out to 10-15% lower than that in China after China’s investment in environmental protection
• WhetherthisadvantagewillsustainforlongfromthecurrenttimedependsonthegrowthofChineseeconomy,theirpoliciesregardingenvironmentandcurrency
Page 18
devaluation.Thusitisdifficulttopredicthowlongwillsuchadvantageprevail,unlessIndiancompaniesbecomehugelycostefficientduringtheperiod.
• CurrencydepreciationaidedrevenuegrowthinFY13• CAPEXincreasedgraduallyfrom11-12TO14-15andzoomedin15-16forAtulLtd.and
itspeers–AartiLtd.andVinatiOrganics.• AllCAPEXhasbeendonethroughinternalsourcesi.e.surplusoftheyearsandthusdebthas
beenatconsistentlevelsforAtulLtd.,thusbringingdownD/Eataround0.3(surplushavebeenincreasingandaccumulatingduringtheperiod)
KeyGrowthDrivers:
• Indianspecialitychemicalsectorhasgrown13%inthelast5yearsandisexpectedtogrowat17%CAGRover2014-2015to2019-2020,duetohigherexports,strongerconsumermarketsinindiaandgainingcompetitiveadvantageoverchinaasperEmkayglobal’sreportonIndianSpecialitychemicalsectorpublishedinJune,2014.But,uptillnowthegrowthinthesegmenthasbeenmuchbelowthepredictedlevels,duetolowerpricesofcrudeandlowglobaldemands,thusthefigureneedstoberevisedasthegrowthhasbeendowntojust8%inFY14-15and-2%inFY15-16
• AlsoIndia'sshareinglobalspecialtychemicalindustryisestimatedtogrowfromabout2.8percentin2013to6-7percentin2023withmarketsizeintherangeof$80-100billion.ThusgrowthopportunitiesareprevalentforAtulLtd.inthenearfuture.
• Specialitychemicalsconsistof22%oftotalchemicalintheworld.ThisisexpectedtoincreasewithgreaterexportpenetrationbyIndianCompaniesandweakeningglobalcompetitioninshapeofChina.RightnowSpecialitychemicalsinindiaoccupyverysmallproportionofchemicalsascomparedtoglobalaverageandasqualityoflifeandstandardoflivingimproves,theirdemandwillincreasetoo.InthisaspectIndiamarketpresentsgreatgrowthpotentialduegrowingeconomy,increaseInconsumptionrate,improvingstandardsoflivinginthecountry,aidingitsdemand.ThiscouldbeachievedthroughincreasingapplicationsthroughR&Dandenhancingtheknowledgeofendconsumers.ThekeydriversforpickupinthepercapitaconsumptionareriseinGDPandpurchasingpowerwhichgenerateshugegrowthpotentialforthedomesticmarket,low-costmanufacturing,afocusonnewsegmentssuchasspecialty&knowledgechemicalsandWorld-classengineeringandstrongR&Dcapabilities.
• Govt.Initiativeslike100%FDIhasbeenallowed• Another advantage is India has better IPR laws than china, thus better protection and
promotion to R&D• Chemical sector to be major beneficiary of upcoming Smart Cities • On a macro-level, there are fivebroad critical elements of any Smart City - water
management systems, infrastructure,transportation and energy , all of which require large amount of speciality chemicals.
• Visible growth in user industries and brands, cushions polymer businessPolymers is Atul’s flagship segment with ~27. Polymer business is largely domestic market oriented and accounts for ~65% of total sales. SO for polymers domestic market is key, in which signs are positive as Indian economy and consumer spending are on up, so this is a segment which can see decent growth, also more penetration in exports will give good
Page 19
performance though it lacks bargaining power, a10% CAGR for next 2 years can be expected in it.
• Aromatics being a key segment for Atul, is seen to bring value due to its leadership in p-cresol and derivatives.However, the recent economic slowdown impacted volumes while prices softened due to lower crude. Still, considering a likely gradual pick up in user industries (dyestuff, flavours & fragrance, pharma, personal care), a 10% CAGR for Atul’s aromatic sales over FY16�18 (of which over 80% is led by P�cresol)
MajorRisks&Downsides
• Intheindustryandcompanytheendproductpricingisdecidedwithpassonclausei.e.theextracostofincreaseinrawmaterialwillbepassedontothecustomeraswellasreducedrawmaterialcostswillalsohavetobepassedon(thuskeepingmarginsstableatmostlyalltimes).SolowPricingpowerispartlybecauseofglobalcompetitionandpartlybecauseofcustomercontractsthatnullifytheeffectofrawmaterialpriceVolatility.
• Thusexpectancyofhugemarginsarelowandsimilarlychancesofmarginsshrinkingdrasticallyduringrecessionarealsolowleadingtostabilitybutnogreatscopetoincreasemargins.
• Nomajorstructuralchangeisaworry,speciallyinglobalscenario,whilethepositiveisthattheincountrydemandmightrise,china’scompetitionandinabilitytolowercosttolowlevelspertainstheriskofdeclineinexports.
• AtulLtd.hasconsistentlybeenmakingitsoperationsmoreefficientthushavingabenefitsofoperatingleverage.Butlargescalefurtheroperatingleverageisunlikelyinnearfuture,saleswillbekeysourceofbottomlinegrowth.
• ColorsisanintegratedoperationforAtul,withleadingpositioninsulphurblackinIndiaandvatdyesintheworld.Thisdivisionsawhealthy25%CAGRinFY13-15primarilyledbyspikeinthepricesofdyesanddyeintermediatesandajumpintheexportvolumes.However,overalldyepriceshavesoftenedabitinFY16;simultaneously,exportsdemandforvatdyes(aleadingproductforAtul)seemstohavecorrectedmeaningfully,ledbyglobalslowdown,makingtheoutlookbleak.Indianexportofvatdyesfell~35%overthelast12months(verymuchdependentonglobalpricesandglobaldemands)
• Diversificationisstagnatinggrowthhere,assomesectorsareonupandcolorsandaromaticsareseeingdowntrend
• SpecialitychemicalsegmentandAtul’sgrowthwhichhadreallypickedupintheyears11-12to13-14,havereallydampenedinthelast2financialyears
• Theindustrybeingdependentuponthedemandofendproductsandcrudeoilbeingamajorrawmaterial,facescyclicalitywhichtranslatestofluctuatingrevenuegrowth
Page 20
PeerAnalysis(AARTIINDUSTRIES)
Asageneralreview,AartiLtd’sfinancialsintherecent4yearsascomparedtoAtulLtd.showanequivalentlevelsofsales,withAartihavingslightlymoreatarounf2900crlevelsforFY2014-2015against2650cr.ofAtul’s.ThegrowthinsaleswerebetterinAartiLtdintheyearsascomparedtoAtul’ssalesgrowthofaround13%,20%and8%.YOYgrowthinEBIT,PAThasalsobeenbetterinAarti,partlybecauseofbettergrowthinSales.
Whenitcomestomargins,AtulLtd’smarginsaremuchbettertoAarti’sinallaspectsinthelast2years.WhileAartiLtd’smarginshavebeenconsistent,AtulLtd’shavebeenconsistentlyonanupwardstrendandhavebetteredAaarti’sinthelast2years,showingimprovingefficiencies.
Workingcapitalcycleofboththesecompanieshavelongcashconversioncyclesduetolowinventoryturnover.Thisismajorlyduetothetypeofindustrytheyoperatein.EventhenAtul’scashconversioncyclerangesbetween90-97days,whileAarti’shavebeensignificantlymore,showingpoormanagementinAtul’scomparision.
TheperformanceratiosshowsapicturewhereROEisalmostsameforboththecompanies,butthemajordifferenceisthatROEofAartiLtd.IsboostedbyhigherleverageascomparedtoAtul’swhichwaspredominantlyhigherduetomarginsandassetturnover.ThisisfurtherbackedbyROA,whichshowsabetterpictureinAtulltdinrecentyears.
Thus,eventhoughwithbettergrowththanAtul,AartiLtd.isnottobetteritsoperatingefficienciesasshownbylowerassetturnover,lowermargins,lowerinventoryturnoverandhigherlevelsofdebt.ThisshowsinthePATfiguresof(109,140,174,216)croresforAartiwhicharelowerthanAtul’sinthelast2years(95,128,220,226)croreseventhoughhavingabettersales,indicatingAtul’soperatingefficiencyimprovementwhichIslackinginAartiLtd.
Thusthoughthecompaniesarecloseinmanyaspects,themajordifferentiatingfactorswouldbe:1)Operatingefficiency2)Globaldemandoftheirkeyproductsbasedontheenduserdemandintheeconomyandconsumptionlevels.
Page 21
Highlightsaboutthekeyproducts:
1. BENZENEBASEDINTERMEDIATESAARTIisamongstthelargestmanufacturerofBenzenebasedintermediatesinIndiawithproductsclassifiedintothefollowingcategories:
• CHLORINATIONofBenzeneintoMCB,ODCB,PDCB&TCB.AARTIpresentlyhasachlorinationcapacityof70,000tonsperannum-LargestinIndia.
• AMMONOLYSISofNitroChlorocompoundssuchasPNCB,ONCB.AARTIisthelargestmanufacturerofAminationproductsinIndiaandismakingvariousAminocompoundssuchasPNA,ONA,OCPNA,PCONA,etc.
2. SULPHURICACID&IT'SALLIEDPRODUCTS.AARTI'sSulphuricAcidplanthasacapacityof1,75,000tonsperannum.AARTIhasmostbackwardintegratedplantforDIMETHYLSULPHATE(thekeymethylatingagent)i.e.startingfromSulphur&Methanol.
3. ActivePharmaceuticalIngredient(API)-AARTImanufacturesvariousBulkPharmaceuticalsintherangeofAnti-asthma,Anti-hypertensive,Anticancer,CNS,DermatologyattheTarapurplant.TheplantisUSFDAapproved,EUGMPcertifiedbyTheGermanHealthAuthorityfromHamburgandalsohasAccreditationCertificateofForeignDrugManufacturerfromJapaneseHealthAuthorities.
4. BULKPHARMACEUTICALS:AARTIismakingvariousBulkPharmaceuticalsintherangeofAntidiarrhoeals,Antiinflammatory,Vitamins,Antiasthama,AntiHIV,Antijetlag/SleepDisorder,AceInhibitor,Antibiotics&Antidiabetics.
5. AGROCHEMICALS:ThesecompriseofQuinalphos&Carbendazim.
6. DYES:AARTIhasstartedgettingdyesmanufacturedoncontractbasisfromthelocalmanufacturersexclusivelyforexports.Theyareabletosupplychromiumfreedyesinpowder&liquidformforSwimmingPool&Spaapplications.Also,supplyliquiddyesinEcofriendlypackingofIBCTunner&powderinbiodegradablecorrugatedboxes.
Thus,thoughthespecialtychemicalscharacteristicofLowPricingpowerandCyclicityarepresentinboththecompanies,theproductsthattheyleadinaredifferentandusedfordifferentpurposes,thusmakingthemspecialty.Sointhelongtermwhichcompanyshowsasignificantbettergrowthoverotherisalittledifficulttosayasbothdependonconsumerspendingoftheirrespectiveproducts.Butitcanstillbesaidthatthegrowthinspecialtychemicalsaspredictedwillnotleadtoamassivedifferenceasbothhavesomenicheproductsthattheyareleadersin.
Page 22
AARTIINDUSTRIESVALUATION
ThususingthereversedcfmodelforAarti,itisevidentthemarketisgivingitagrowthofabout30%forthenext10yearsandexpectingtoearn20%returnsfromthis,whichinourviewiscertainlyovervalued.AsAarti’sgrowthwillsomewherebearounfAtul’s,ratheralittleless,comparingtheproductprofile,managementefficiencyandhigherdebtonboththecompany’sbalancesheet.
Thoughbothofthesestocksareonthevergeofgrowthboostduetopredictedgrowthinspecialtychemicalsinthecomingyears,Atul’simprovingoperatingefficiencyandleadershipinvariousproductsgivesitabitofedgeoverAartiLtd.buttakingintothecyclicnatureofbusiness,ahighermarginofsafetyshouldbemaintainedaswellasbuyingshouldbedonewhenpricecorrectsitselftoagrowthrateofbelow13-14%.
Page 23
Broaderpicture:
ViewingandanalyzingthecriticalaspectsofthespecialtychemicalindustryaswellasAtulLtd.,itcanseenthatthesectorasawholehascertainpotentialbenefitslikegrowingIndianEconomy,consumerdemandandimprovinglivingstandardsalongwithincreasingeffortstolowercostsbythecompany.Lowdebtsandgoodinternalaccrualsarealsoprettygoodsignsofstability.
Buttherevenuesbeingcyclicalduetoitbeingdependentonglobaldemandsandvolatileoilprices,diversificationcreatingtheneedformultiplefactorsinmultiplesegmentstogointhesamefavorabledirection,alongwithlowscopeofmarginexpansionduetoescalationandde-escalationclausesandwithnomajorstructuralchangeoracatalysttocreatethat,alongtermholdwouldnotbesuggestedbyusaswebelievelongtermreturnsofabout5-7yearswillbefluctuatingandwillnotgiveanyextraordinaryreturnsduetocyclicityandmutedgrowthduetodiversification.ThoughstablereturnscanbeexpectedasAtulhasbeenproducingthroughout,duetoefficientoperationsandgoodmanagementagreatoraboveaveragereturnsasexpectedfromlongtermholdingslookdifficult.Moreoverthecurrentvaluationsaresteepandthestockhasalreadygrownby128%inlast2years,discountingfuturegrowthwhichhasnottranslatedinthe2years.
Thusseeingalltheseaspectswerecommenda“SELL”asinourviewtherearelowchancesthatstockwouldgivethedesiredreturnoraconsiderableupsideonourminimumrequiredreturnforthelongterm(i.e.atleast20-25%returnsforalongtermonaconsistentbasis)
KeyTrackables–
• Structuralchangeindicatorslike,hugedomesticdemand,considerableincreaseinlivingstandardsofpeopleinIndia,gainingsustainableadvantageoverChinaandshiftofproductiondemandfromcountireslikeChinaandJapantoIndia
• AmountofCAPEXdonebycompanyandinwhichsegments.Potentiallyhighgrowthsegmentscanboostrevenue
• Aneyeonnewpatents,R&Defficienciesoraproductderivedwithgreatpotentialornewprocesseswhichcanbringgreaterefficienciesthancompetitors
• Growthinpaints,polymerandaromaticindustry,these3beingthebiggestcontributorsandnewadvancementsinPharmasegmentasithassomerelativepricingpower
• Directionincurrencymovements,continualdepreciationofcurrencyagainstdollarwouldbeverybeneficialforexports
• Acheckonmovementofoilpricesandanymajorchangesincontractswithsupplierswhichcouldleadtomajorchangeinmargins.
• Anymajorautomationofprocessestolowercosts,thatcanprovetobeabigdifferentiatorbetweenAtulanditscompetitorsworldwide.
Page 24
Theabovereporton“AtulLtd.’’hasbeenpreparedby:
AkshaySahani,SrishtiAgarwal,SmitNaikandBansriJuneja
References&Sources:Annualreports,Emkayglobalfinancialservicesreport,PhilipCapitalreport,HDFCreportonIndianChemicalsector,Analystmeetpresentations