- Wealth PMS (50L+)
The chemical industry is enjoying tailwinds due to customers increasing sourcing their supplies from India. The major player in the chemical space is China, sales of chemicals (ex pharmaceuticals) from China in 2017 was EUR 1,293 billion or 37% of global sales. Stricter environmental norms and increase in wages in China is narrowing the competitive gap with other countries and customers also do not want to depend on one major supplier. Due to these reasons, companies in India stand to benefit and the Indian chemical industry is 2% of the global chemical market.
We did a deep dive into the Indian Chemical Industry here.
Given how the chemical industry is placed we believe that Indian chemical companies will do well going forward. However, it is important to identify which companies will benefit.
Aarti Industries (AIL), which has integrated itself across the benzene value chain should do well and we are adding this to our Long Term MultiCap Portfolio.
The TTM revenues stood at Rs 4,585 Cr, at the current market cap of 14,900 Cr, the company trades at 3.25 sales. Sales have been flat in Q1 and fallen by 22% in Q2 FY20, however, revenues are not the right metric to track this business. This is because any increase/decrease in raw materials is passed on to the customer. We should then see the operating profits and see the absolute growth in the same.
The YOY EBIT growth in Q1FY20 was 31%, however, EBIT declined by 4% in Q2FY20. The de-growth was on the back of increase in fixed expenses. The TTM operating profits are Rs 794 Cr. Operating margins have increased in both the quarters this year at about 19%. The average margins over the last 10 years are 14%. The increase in margins is due to the shift towards higher value-added products.
The TTM profits of the company are Rs 537 Cr, PAT margins stood at 14% in the recent quarters. The average PAT margins for the last 10 years were 7%.
Recently there are IT raids on the premises of the company, we haven’t received any clarification from the company on the same. Given their track record, this is hopefully only a minor blip, however if these turn out to be serious we will have to exit the positions.
The promoter shareholding has also been reducing. The latest promoter shareholding is 48.29%. During the recent concall the management said that the extent of the sales is less than 2% and there is nothing serious on this front.
Aarti’s products are used in agro chemicals, engineering polymers (auto, aero and electrical), dyes, pharma and in rubber chemicals and fuel additives. Hence it is very important to check the trend in the end user industry. The agrochemical market has been flat, the auto industry is seeing a slowdown throughout the world, the dyes and pharma markets across the globe are seeing growth.
The US – China trade war will impact the manufacturers in India, how this will shape up will determine if it benefits Indian manufacturers. China may also relax its environmental norms to give a fillip to its domestic industry.
The average pre tax ROIC and ROE for the last 10 years is 18% respectively. AIL has posted positive cash flow from operations in each of the last 10 years and the CFOs are higher than the net profits by 1.53X. The enterprise value of AIL as of today is Rs 16,800 Cr, the company trades at 21X operating earnings and earning yield of 5%. The book value plus EPV (discounting the TTM EBIT by 10%) gives a value of 10,800 Cr, hence at market cap of 14,900 we are going to pay up for growth. The TTM PE of AIL stands at 28X, which is close to what its average PE has been over the last 3 years. Given the runway ahead we will go ahead and rate this as a buy and add this to our Long Term MultiCap Portfolio.
We add the stock at 870
Disclosure: Some Capitalmind authors may own the above company in their stock portfolios. There is no other relationship between Capitalmind and the above company. Please do not consider this article as a recommendation, It is purely for informative purpose only.