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CD Equisearch Pvt Ltd Nov 28, 2018

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Aarti Industries Ltd

No. of shares (m) 81.30

Mkt cap (Rs crs/$m) 12125/1710

Current price (Rs/$) 1491/21.0

Price target (Rs/$) 1704/24.0

52 W H/L (Rs.) 1519/875

Book Value (Rs/$) 207/2.9

Beta 0.7

Daily volume NSE (avg. monthly) 56580

P/BV (FY19e/20e) 6.3/5.1

EV/EBITDA (FY19e/20e) 15.2/12.6

P/E (FY19e/20e) 27.4/21.9

EPS growth (FY18/19e/20e) 5.0/35.3/25.0

OPM (FY18/19e/20e) 18.4/18.2/17.7

ROE (FY18/19e/20e) 22.4/25.4/25.8

ROCE(FY18/19e/20e) 13.3/15.1/15.4

D/E ratio (FY18/19e/20e) 1.3/1.2/1.1

BSE Code 524208

NSE Code AARTIIND

Bloomberg ARTO IN

Reuters ARTI.NS

Shareholding pattern %

Promoters 53.0

MFs / Banks / FIs 13.9

Foreign Portfolio Investors 4.2 .3 Govt. Holding 0.0

Public & Others 28.9

Total 100.0

As on Sep 30, 2018

Recommendation

ACCUMULATE

Analyst

KISHAN GUPTA, CFA, FRM

Phone: + 91 (33) 4488 0043

E- mail: [email protected]

Consolidated (Rs crs)

FY16

FY17 FY18 FY19e FY20e

Income from operations (gross) 3006.59 3163.46 3806.06 5102.93 6320.39

Other Income 5.94 1.96 7.77 4.32 2.32

EBITDA (other income included) 578.20 655.46 706.89 931.43 1121.35

Profit after MI 256.43 315.14 327.62 443.21 554.02

EPS(Rs) 30.78 38.38 40.30 54.52 68.15

EPS growth (%) 36.0 24.7 5.0 35.3 25.0

Company Brief

AIL is one of India's leading manufacturers of chemicals and pharmaceutical

intermediates: dyestuff; pigment; agro chemicals; speciality chemicals; active

pharmaceutical ingredient (API); intermediates of API

Quarterly Highlights � Thanks to higher raw material prices and increasing share of high margin

products, Aarti's speciality chemicals gross revenues rose 50.4% (volume

growth just 10%) to Rs 1039.10 crs ($148.4m), probably the highest level

ever; nitrochlorobenzene production barely budged last quarter ,

underscoring impact of high value addition and pass-through of higher raw

material prices. Despite MTM loss of Rs 22.59 crs ($3.2m) on forward

contracts, EBIT margin surged to 20.2% from 18.6% in the same period a

year back (17.5% in Q1FY19). Volume off take was scarcely suppressed by

production shift to India which led to higher demand from domestic end

users.

� Robust volume growth across markets - achieved on existing capacity -

coupled with entrenched benefits of operating leverage helped its

pharmaceuticals business to report top decile profit last quarter - EBIT

margins expanded nearly 130 bps to 15.2% compared to 13.9% in the same

quarter a year ago. Lag effect of cost pass through would help further

margin expansion in the coming quarters. To augment volumes, Aarti

would continue to focus on off-patented generics in regulated markets.

� Demerger of HPC business, whose margins in Q2 suffered not least due to

increasing costs and change in product mix, is expected to be consummated

by the end of the current fiscal. Aartis' fund raising plan of Rs 750 crs

would help fund its expansion in its existing product lines such as

Nitrochlorobenzene derivatives, chlorobenzene derivatives, nitrotoluene

derivatives and ethylated compounds, fuel additives etc, as well as other

new downstream products.

� The stock currently trades at 27.4x FY19e EPS of Rs 54.52 and 21.9x FY20e

EPS of Rs 68.15. Earnings reboot hinges on strong volume growth and stable

margins for its various products across the integration value chain. Return

on capital would be supported by robust earnings growth (35.3% in FY19

and 25% in FY20) and high leverage. Effective hedging strategies would

only circumvent increased volatility in fx markets. On balance we maintain

our accumulate rating on the stock with revised target of Rs 1704 (previous

target: Rs 1034) based on 25x FY20e earnings (forward PEG:1) over a period

of 9-12 months.

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CD Equisearch Pvt Ltd


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Outlook & Recommendation

Global specialty chemicals update

According to latest update of Prescient & Strategic (P&S) Intelligence, a leading provider of market research & consulting

services, the global specialty chemicals markets is estimated to grow to at a CAGR of 5.1% during 2018-2023 to reach $782.2 bn

by the terminal year, driven by increasing demand of these chemicals in emerging economies, ongoing technological

advancements and rising penetration of end use industries. During the forecast period, lubricants and oilfield chemicals would

offer the highest growth in specialty chemicals markets - CAGR of 7% - largely due to rising use of such chemicals in oilfields

of major oil producing nations like US, Russia, Venezuela and Brazil. Region wise, APAC holds the forte - with revenue

contribution of over 40% contribution - triggered by rising demand for crop protection chemicals and accelerating growth of

construction chemicals - fallout of rising demand for public, residential and commercial buildings.

Besides, shifting manufacturing bases from stricter environment norms following European and North American region to less

vigilant APAC region has also propelled growth. Demand from emerging economies has also got leg up from growing middle

class population and rising urbanization in food, agriculture, cosmetics etc. As a result, enhanced off take of speciality

chemicals is perceptible from China, India and Brazil. Yet ever-changing regulations in chemical industry and fluctuating cost

of raw materials pose noteworthy risks. Chemical regulations are dynamic and thus constantly change as per compliance

requirements. International chemical companies struggle to comply with differing regulations and requirements of countries.

According to IHS Markit, growth prospects of some of the segments of specialty chemicals industry, most notably electronic

chemicals, nutraceutical ingredients and oil field chemicals appear favorable. Rising levels of disposable income in developing

worlds and increasing consumer spending in North America, Western Europe and Japan would galvanize demand for

nutraceuticals, cosmetic chemicals and flavors and fragrances. It reckons that both India and China have emerged as strong

manufacturing hubs in global specialty chemicals sweepstakes, but the concept of China as a low cost producer is gone because

of its shifting focus from exports to meeting domestic demand for higher value downstream products.

India's domestic specialty chemicals off take too support buoyant outlook -Indian specialty chemical industry estimated to

double by FY25. Rising demand for speciality chemical end use industries such as textile, automotive, personal care,

construction chemicals and agro chemicals would support high growth momentum in the medium term, reckons India Ratings,

a credit rating agency. Implementation of strict environmental norms in China has reduced competitive advantages for Indian

firms, thus favoring Indian exporters of specialty chemicals. However, the agency posits that sharp increase in oil prices,

uncertainty about feedstock procurement and uptick in global capacity expansion would negatively impact the sector.

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Financials & Valuation

Little diminishing opportunities in global specialty chemicals industry, most particularly from the recent clampdown on

polluting Chinese firms, has much o offer to cost conscious Indian firms, who boast of adequate feedstock availability, better

manufacturing standards and stronger IP protection. Chinese specialty chemicals exports have suffered of late no least due to

weak cost competitiveness and production disruption due to shutdown of some large plants. Thus, global firms facing wrath

of high costs and capacity constraints in other markets, especially China, have started to outsource their processes to India, an

opportunity little avoided by Indian chemical firms.

To buttress its stock of capital goods, Aarti's plans to add fixed assets worth nearly Rs 700 crs in several projects including

specialty chemical complex at Jhagadia, acid reconstruction plants, debottlenecking and expansion of API & pharmaceutical

intermediates, R&D facility and capex for Rs 4000 crs multi-year supply deal. Construction for Rs 4000 crs deal facility in

Dahez has already commenced. Investments in R&D and Innovation facility in Navi Mumbai is aimed at expanding its

capabilities to develop high end value added products and chemistries. It has reported gradual ramp up in its nitro toluene

facility at Jhagadia over the last few quarters - from 25% in September last year to over 40% in Q1to 45% in Q2.

Bagging of multi-year global deals is not only aimed at consistent revenue generation but also at entering new chemistries.

The most recent deal running 20 years enables total revenue generation of Rs10000 crs over the contract period for supply of

high value specialty chemical intermediate. As part of the contract AIL would invest $35-40m to set up dedicated

manufacturing facility for this contract with the client providing necessary technology. Yet uncertainty over off take by client

barely wanes as the contract is of no smallish tenor.

Ramp of nitrotoluene facility (80-90% capacity utilization expected by FY20) coupled with expansion of NCB capacities would

barely restrict revenue accretion for its speciality chemicals business, whose revenues is estimated to grow by 24.3% on stable

margins; besides nitrotoluene facility also feeds its captive ethylation product chain. Tangible plans to develop niche

chemistries like condensation, fluorination, cyclisation etc are yet to be unveiled. Yet long gestation periods of such projects

doubtlessly inhibit innovation, not to count regulatory setbacks.

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Focus on off-patent products in regulated markets, forward integrating in to APIs and increased vendor approvals for new

generics (to enable non - China supply source) has been one of the cornerstones of its pharmaceutical business strategy.

Better product mix and higher capacity utilization (currently at 80%) would enable margin gains - though stable EBIT margin

estimated for FY20. No little has been its focus to foray in to high margin therapy areas such as oncology and diabetology for

the expansion of its intermediate as well as API business.

The stock currently trades at 27.4x FY19e EPS of Rs 54.52 and 21.9x FY20e EPS of Rs 68.15. Gargantuan expansion plans (at

least Rs 700 crs for next fiscal), foray in to new chemistries - such as chlorotoluene and no belittling focus on mega supply

deals would restrict earnings growth slowdown. Renewed focus on domestic supplies emanating from clampdown on

polluting Chinese chemical plants would help reduce its fx exposure. Yet challenges looms over meeting ever tightening

regulations of developed markets, which would require modifications to its existing manufacturing infrastructure. On balance

we maintain our accumulate rating on the stock with revised target of Rs 1704 (previous target: Rs 1034) based on 25x FY20e

earnings (forward PEG:1) over a period of 9-12 months. For more info refer to our November report.

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Cross Sectional Analysis

Company

Equity (Rs crs)

CMP (Rs crs)

Mcap (Rs crs)

Inc. from ops.

(Rs crs)

Profit (Rs crs)

OPM (%)

NPM (%)

Int. coverage

ROE (%)

Mcap / IO P/BV P/E

Aarti Inds. 41 1491 12125 4398 387 17.9 8.8 3.9 24.8 2.8 7.2 31.3 Atul Ltd 30 3595 10663 3566 369 16.9 10.4 98.5 16.9 3.0 4.4 28.9 Deepak Nitrite 27 256 3485 1618 91 14.0 5.6 4.3 10.5 2.2 3.6 38.5 Sudarshan Chem 14 352 2439 1428 94 13.7 6.6 8.0 20.5 1.7 4.4 25.9

calculations on ttm basis; Aarti income from operations approximated Companies not truly comparable due to product dissimilarity

Not so tepid increases in prices of some of the raw materials accentuated partly by sharp rupee depreciation impacted profitability

of Sudarshan's pigments business last quarter - 12.2% decline in EBIT; EBIT margins shrunk by over 300 bps. Resultantly, PBT from

continuing business rose by a somber 13.3%, necessitating need for cost pass through, which is being rapidly pursued in Q3.

Proceeds from sale of agro formulation brand business and stake sale in its wholly owned subsidiary, Prescient Color Limited,

would be used to fund backward integration and pigment capacity expansion projects worth some Rs 200 crs. To prop up exports,

Sudarshan has set up a sales office in Shanghai to locally source raw materials and cater to needs of its Asia Pacific customers, much

like offices set up for its American and European customers.

No stymied improvement in all its businesses helped Deepak Nitrite post some 34% growth in overall operating profit and 23.7% in

net profit last quarter. Driven by higher volumes of high margin products, its basic chemicals business post nearly 250 bps

expansion in EBIT margins on some 19% growth in top line, while positive demand for some key products in FSC segment helped

galvanize its earnings (up 42% in Q2); earnings momentum for both basic chemicals and FSC segments to aid from planned brown

field expansions. Performance products business also bucked the trend to post remarkable turnaround in profitability - Rs 14.16 crs

Vs Rs .04 crs. Trial runs for its game changing phenol and acetone project has been successful and the company expects to achieve

commercial production soon.

Fortified by not tepid growth in margins of both life science chemicals (LSC) and performance and other chemicals (POC) - LSC's

expanded by ~340 bps; PoC 's by ~450 bps - Atul's post tax earnings surge by a dizzying 69.9% last quarter; margin gains have

been barely timid in H1. Sales for one of its key segment - crop protection - surged remarkably last fiscal buffeted by hefty

demand for one of its herbicides , while revenues for its bulk chemicals & intermediates business also rose by 27% (though volume

growth remain subdued at 8%). But it did face some stress in its pharmaceuticals and aromatics business where sales grew by just

7% (volume growth benign at 6%). Adding capacities, introducing new capacities and forging long term alliances would help

overcome looming stress in this business.

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Financials

Quarterly Results -Standalone Figures in Rs crs

Q2FY19 Q2FY18 %

chg. H1FY19 H1FY18 % chg.

Income from operations (gross) 1299.52 887.89 46.4 2378.00 1679.70 41.6

Other Income 0.24 0.11 118.2 3.64 0.20 1720.0

Total Income (gross) 1299.76 888.00 46.4 2381.64 1679.90 41.8

Total Expenditure 1057.43 727.61 45.3 1948.01 1381.03 41.1

EBIDTA (other income included) 242.33 160.39 51.1 433.63 298.87 45.1

Interest 51.31 31.38 63.5 97.41 60.62 60.7

Depreciation 38.85 33.00 17.7 76.57 64.69 18.4

PBT 152.17 96.01 58.5 259.65 173.56 49.6

Tax 29.25 17.50 67.1 47.45 32.00 48.3

PAT 122.92 78.51 56.6 212.20 141.56 49.9

Extraordinary Item - - - - - -

Adjusted Net Profit 122.92 78.51 56.6 212.20 141.56 49.9 EPS (F.V. 5) 15.12 9.56 58.1 26.10 17.24 51.4

Segment Results Figures in Rs crs

Q2FY19 Q2FY18 % chg. H1FY19 H1FY18 % chg.

Segment Revenue (Gross)

Speciality Chemicals 1039.10 690.98 50.4 1887.57 1317.16 43.3

Pharmaceuticals 192.25 136.86 40.5 341.92 242.93 40.7

Home & Personal Care Chemicals 68.17 60.05 13.5 148.51 119.61 24.2

Total 1299.52 887.89 46.4 2378.00 1679.70 41.6

Segment EBIT

Speciality Chemicals 209.81 128.64 63.1 358.14 241.57 48.3

Pharmaceuticals 29.18 19.04 53.3 55.18 32.65 69.0

Home & Personal Care Chemicals -3.75 -0.76 393.4 -1.76 -0.18 877.8

Total 235.24 146.92 60.1 411.56 274.04 50.2

Interest 51.31 31.38 63.5 97.41 60.62 60.7

Other Unallocable Exp. (net of income) 31.76 19.53 62.6 54.50 39.86 36.7

PBT 152.17 96.01 58.5 259.65 173.56 49.6

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Financials

Income Statement - Consolidated Figures in Rs crs

FY16 FY17 FY18 FY19e FY20e

Income from operations (net) 3006.59 3163.46 3806.06 5102.93 6320.39

Growth (%) -3.7 5.2 20.3 34.1 23.9

Other Income 5.94 1.96 7.77 4.32 2.32

Total Income 3012.53 3165.42 3813.83 5107.25 6322.71

Total Expenditure 2434.33 2509.96 3106.94 4175.82 5201.36

EBITDA (other income included) 578.20 655.46 706.89 931.43 1121.35

Interest 116.98 117.34 131.65 195.61 223.87

EBDT 461.22 538.12 575.24 735.82 897.48

Depreciation 98.50 122.52 146.23 168.35 195.12

Tax 94.63 88.06 82.88 109.80 135.91

Net profit 268.09 327.54 346.13 457.66 566.45

Minority interest 11.22 11.76 13.17 14.45 12.43

Net profit after MI 256.87 315.78 332.96 443.21 554.02

Extraordinary item 0.44 0.64 5.34 - -

Adjusted Net Profit 256.43 315.14 327.62 443.21 554.02

EPS (Rs.) 30.78 38.38 40.30 54.52 68.15

Segment Results Figures in Rs crs


Segment Revenue

Speciality Chemicals 2430.36 2569.29 2985.49 4027.62 5007.03

Pharmaceuticals 425.76 426.07 556.22 767.58 959.48

Home & Personal Care Chemicals 150.47 168.10 264.35 307.72 353.88

Total (gross) 3006.59 3163.46 3806.06 5102.93 6320.39

Segment EBIT

Speciality Chemicals 503.64 565.75 581.07 778.70 950.95

Pharmaceuticals 38.80 48.13 79.20 125.41 155.92

Home & Personal Care Chemicals -0.24 0.77 2.75 1.85 2.65

Sub Total 542.20 614.65 663.02 905.96 1109.52

Interest 116.98 117.34 131.65 195.61 223.87

Other Unallocable Exp. (net of income) 62.50 81.72 102.36 142.88 183.29

PBT 362.72 415.59 429.01 567.46 702.36

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Consolidated Balance Sheet Figures in Rs crs


SOURCES OF FUNDS

Share Capital 41.66 41.06 40.65 40.65 40.65

Reserves 1095.64 1321.40 1537.78 1974.59 2430.60

Total Shareholders Funds 1137.30 1362.46 1578.43 2015.24 2471.25

Minority Interest 52.09 63.85 77.02 91.47 103.90

Long term debt 526.76 596.44 908.27 826.25 759.50

Total Liabilities 1716.15 2022.75 2563.72 2932.96 3334.65

APPLICATION OF FUNDS

Gross Block 2081.44 2654.61 3100.69 3775.69 4475.69

Less: Accumulated Depreciation 835.48 957.59 1102.79 1271.15 1466.27

Net Block 1245.96 1697.02 1997.90 2504.54 3009.42

Capital Work in Progress 313.01 269.52 436.23 450.00 450.00

Investments 41.26 46.96 47.22 50.62 50.62

Current Assets, Loans & Advances

Inventory 495.19 571.41 747.30 866.87 996.90

Sundry Debtors 523.40 524.67 590.75 673.46 740.80

Cash and Bank 28.99 28.50 32.10 28.68 32.19

Other Assets 186.41 192.61 250.79 299.17 355.25

Total CA & LA 1233.99 1317.19 1620.94 1868.17 2125.14

Current liabilities 1102.59 1292.57 1555.29 1970.06 2366.80

Provisions 20.50 27.83 31.04 36.32 42.19

Total Current Liabilities 1123.09 1320.40 1586.33 2006.38 2408.99

Net Current Assets 110.91 -3.21 34.61 -138.21 -283.85

Net Deferred Tax (net of liability) -127.06 -155.44 -177.41 -195.35 -214.35

Other Assets (Net of liabilities) 132.08 167.91 225.18 261.36 322.82

Total Assets 1716.15 2022.75 2563.72 2932.96 3334.65

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Key Financial Ratios


Growth Ratios

Revenue (%) -3.7 5.2 20.3 34.1 23.9

EBIDTA (%) 23.5 13.3 7.0 33.0 20.4

Net Profit (%) 27.9 22.9 4.0 35.3 25.0

EPS (%) 36.0 24.7 5.0 35.3 25.0

Margins

Operating Profit Margin (%) 19.0 20.7 18.4 18.2 17.7

Gross Profit Margin (%) 15.3 17.0 14.9 14.4 14.2

Net Profit Margin (%) 8.9 10.3 9.0 9.0 9.0

Return

ROCE (%) 14.9 15.4 13.3 15.1 15.4

ROE (%) 23.5 25.3 22.4 25.4 25.8

Valuations

Market Cap / Sales 1.4 2.0 2.4 2.4 1.9

EV/EBIDTA 9.6 11.9 16.2 15.2 12.6

P/E 16.8 19.9 28.5 27.4 21.9

P/BV 3.8 4.6 5.9 6.3 5.1

Other Ratios

Interest Coverage 4.1 4.5 4.2 3.9 4.1

Debt-Equity Ratio 1.1 1.1 1.3 1.2 1.1

Current Ratio 1.1 1.0 1.0 0.9 0.8

Turnover Ratios

Fixed Asset Turnover 2.7 2.1 2.1 2.3 2.3

Total Asset Turnover 1.9 1.7 1.7 1.9 2.1

Debtors Turnover 6.2 6.0 6.8 8.1 8.9

Inventory Turnover 4.7 4.7 4.7 5.2 5.6

Creditors Turnover 8.8 8.3 9.5 11.8 14.7

WC Ratios

Debtor Days 58.4 60.5 53.5 45.2 40.8

Inventory Days 78.5 77.6 77.5 70.5 65.4

Creditor Days 41.5 44.0 38.6 30.9 24.8

Cash Conversion Cycle 95.4 94.0 92.3 84.8 81.4

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Cumulative Financial Data Figures in Rs crs FY09-11 FY12-14 FY15-17 FY18-20e Income from operations (gross) 4460 6883 9293 15229

Operating profit 647 1012 1692 2745

EBIT 515 792 1397 2243

PBT 317 507 1025 1692

Profit after MI 234 391 772 1325

OPM (%) 14.5 14.7 18.2 18.0

NPM (%) 4.9 5.3 8.4 9.0

Interest coverage 2.6 2.8 3.8 4.1

ROE (%) 19.0 18.7 23.1 23.7

ROCE (%) 13.9 13.4 14.7 14.7

Debt-equity ratio* 1.0 1.2 1.1 1.1

Fixed asset turnover 3.6 3.3 2.8 2.7

Debtors turnover 5.9 5.9 6.4 8.0

Inventory turnover 5.1 4.3 4.3 5.3

Creditors turnover 10.9 7.7 7.6 12.7

Debtors days 62.4 61.7 57.0 45.5

Inventory days 71.0 84.0 84.8 68.8

Creditor days 33.5 47.2 48.2 28.8

Cash conversion cycle 99.8 98.5 93.7 85.5

FY09-11 implies three years ending fiscal 11; *as on terminal year

Surge in revenues of late precipitated by barely subdued expansion in speciality chemicals business (revenues up over 43% in

H1FY19) would help overall cumulative revenues to jump by nearly 64% in FY18-20e period from that in the previous three year

period, indisputably the fastest growth in recent history (see table). Propelled by increased demand for intermediates, Aarti's

pharmaceutical too has shown little signs of whittling for its revenues too have shown increased traction in recent past. Increased

roll out of high margin products in speciality chemicals business has scarcely stymied margins so far this fiscal - EBIT already up

by 70 bps in H1, thus triggering little subdued expansion in OPMs.

Ballooning interest expenses would barely help suppress expansion in earnings for post tax earnings is estimated to surge by

72% in FY18-20e period. Higher leverage (DER~1) coupled with rapid earnings growth would doubtlessly support return on

capital - ROE to jump by at least 60 bps in FY18-20e from that in the previous three year period. Better working capital

management - reflected in improved debtors and inventory turnover ratios - would further help improve cash conversion cycle

(see table).

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Financial Summary – US dollar denominated

million $ FY16 FY17 FY18 FY19e FY20e

Equity capital 6.3 6.3 6.2 5.7 5.7

Shareholders funds 171.5 208.6 241.2 270.4 334.7

Total debt 194.7 241.2 320.2 343.8 389.4

Net fixed assets (incl CWIP) 235.0 303.3 374.2 416.7 487.9

Investments 6.2 7.2 7.3 7.1 7.1

Net current assets 16.7 -2.0 3.8 -33.3 -53.9 Total assets 258.7 310.4 392.6 399.8 456.5

Revenues (Gross) 459.3 471.5 590.6 719.7 891.4

EBITDA 88.2 97.6 108.6 131.4 158.1

EBDT 70.4 80.1 88.2 103.8 126.6

PBT 55.3 61.8 65.5 80.0 99.1

Profit after MI 39.2 47.0 50.8 62.5 78.1

EPS($) 0.47 0.57 0.63 0.77 0.96

Book value ($) 2.06 2.54 2.97 3.33 4.12

income statement figures translated at average rates; balance sheet and cash flow at year end rates; projections at current rates(Rs 70.91/$). All dollar denominated figures are adjusted for extraordinary items.

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Exchange Rates Used- Indicative

Rs/$ FY14 FY15 FY16 FY17 FY18

Average 60.5 61.15 65.46 67.09 64.45

Year end 60.1 62.59 66.33 64.84 65.04

All $ values mentioned in the write-up translated at the average rate of the respective quarter/ year as applicable. Projections converted at

current exchange rate. Cumulative dollar figure is the sum of respective yearly dollar value.

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