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Chemcon Speciality Chemicals, incorporated in 1988 and manufacturer of speciality chemicals primarily catering to the pharmaceutical industry is coming to the markets with its IPO on September 21st 2020. In this post, we look at the business of Chemcon and see if the issue is worth subscribing.
Short Answer: Chemcon is the only manufacturer of HDMS and largest manufacturer of CMIC in India, a key input to the manufacture of antibiotics and antivirals. The EPS for FY15 was Rs 15, at the price of 340, we are paying 23X earnings. Revenues and profits have grown by 29% and 36% over the last 3 years. However, there are headwinds as well in the form of dependence on the oil & gas industry, a slow-growing core market. Investors should track operational performance over a few quarters after listing and not buy right now.
Key points covered in this post
- Details of the offer
- Industry structure of the products sold by Chemcon
- About Chemcon – industries it caters too and product profile
- Financials metrics of the company
- Important updates from the RHP
The Offer
Issue – 93,52,940 shares of which
- Fresh issue of 48,52,940 shares
- Offer for sale (OFS) of 45,00,000 shares
Price band – Rs 338-340/share
Offer value – 318 Cr
Offer for retail – 35%
Equity shareholding post the issue – 3.66 Cr shares
Offer dates – 21st September,2020 – 23rd September,2020
The offer for sale is by two promoters – Kamalkumar Rajendra Aggarwal and Naresh Vijaykumar Goyal for 22.5 lakh shares each. The shareholding pattern prior to the issue is as below
Source: Chemcon, DRHP
The fresh issue of 165 Cr will be used for CAPEX, meeting working capital requirements and general corporate purposes.
Source: Chemcon, DRHP
Industry
Chemcon speciality chemicals has two lines of businesses manufacturing
- Chemicals used as pharmaceutical intermediates and
- Oil well completion chemicals
Pharma intermediates are chemical compounds that form the building block of manufacturing active pharma ingredient (API). The pharma value chain is as below
Source: Chemcon, DRHP
The global market for chemicals used as pharma intermediates was $27 billion in 2019. North America and Europe are the biggest and the 2nd largest pharmaceutical markets. Asia Pacific will be the fastest growing market for these intermediates as this region is the hub for contract manufacturing. Drivers that will propel the intermediate markets will be higher production of APIs and patent expiration, leading to the growth of generic drug markets.
Some of the major players in this space are Vertellus holdings, A R life sciences, Dishman group, Midas pharma, Lianhetech, Cycle pharma, BASF, Easter chemicals and Chemcon speciality chemicals.
The domestic consumption of chemicals used as pharma intermediates is estimated to be Rs 334 billion in FY19, the industry has grown by 7% CAGR since FY13. Imports constitute 58% of domestic consumption in FY19 as compared to 65% in FY13. Imports have dropped on the back of withdrawal of customs duty exemption on drugs and intermediates in FY17 and tightening environmental regulations in China.
Exports of these chemicals from India was Rs 265 billion in FY19, exports have grown by 10% CAGR in the FY13-19 period.
Chemcon manufacturers three products used as intermediates by the pharmaceutical industry
- Hexamethyldisila Zane (HMDS)
- Chloromethyl Isopropyl Carbonate (CMIC)
- 4 chlorobutyryl chloride (4 CBC)
4 CBC is a newly launched product by Chemcon, the company made its first sale in July,2020.
All of its revenues from the pharma vertical come from HMDS and CMIC. Let us briefly look at the characteristics of these products – its usage, global capacity, demand and manufacturers.
The HMDS and CMIC Landscape
HMDS
HMDS is used in manufacturing of antibiotics such as penicillin, cephalosporins and other types of penicillin derivatives. Some of the drugs where HMDS is used are Cefprozil – used to treat bronchitis, ear infections, skin infections and Cefaclor – used to treat pneumonia and infections of the ear, lung, skin, throat. The global antibiotics market was estimated to be $ 44.8 billion in 2019, cephalosporins have the largest market share at 26% amongst all antibiotics.
HMDS is also used in anti-viral and antiretro viral medications. Some of drugs where HMDS is used are Sofosbuvir – used to treat hepatitis C and Emtricitabine – used for treatment of HIV infection in adults. The global market for anti viral drugs was estimated to be $ 61.9 billion in 2019 and is expected to grow at 6% CAGR until 2023.
HMDS is also used in the semi conductor electronics and rubber industry.
50% of the capacity in 2019 is with China – 17,800 MT. North America is the second largest with 20% of capacity. India had capacity of 2,400 MT, 7% of global capacity in 2019.
On the demand front, North America and Europe are the two biggest markets for HMDS. 60% of the demand in 2019 was from these countries. Below is the country wise global demand from 2013-19.
We can observe from the above table that India has demand for 4,000 MT, however its capacity in 2019 WAS 2,400 MT. 40% of India’s demand is imports from China and Germany. 97% of the imports are from China and 3% from Germany. 93% of India’s HMDS demand is from the pharmaceutical industry. On the global scale, 68% of the global demand is from the pharmaceutical industry. The Indian demand is expected to grown by 11% CAGR over the next few years.
China is the largest producer of HMDS, 41% of total production is from China. The second largest producer is North America with 21% of production. Below is the HMDS production by country from 2013-19.
China’s average capacity utilization is the lowest over the 7 years at 59%. Europe, Japan and India are at about 75% each, whereas North America’s average capacity utilization has been 66%.
Xinyaqiang Silicon from China is the top producer, meeting 19% of the global demand, followed by DOW from the USA catering to 17% of demand. Chemcon is the only player from India meeting 10% of the global demand.
The primary raw material used to manufacture HMDS are trimethyl chlorosilane (TMCS), ammonia and hydrochloric acid. TMCS is used as the base chemical to manufacture HMDS, however HMDS can also be manufactured by using HMDO as input. HMDO is the residual product, which comes out during the use of HMDS by customers.
Below is the quarterly changes in HMDS prices in comparison toTMCS price movements for the 2013-19 period
Source: Chemcon, DRHP
CMIC
CMIC is mainly used as a key intermediate for anti-aids and anti-hepatitis B drug Tenofovir. Tenofovir is a anti-viral drug developed by Gilead Corporation,USA. CMIC can also be used in synthesis of other anti-viral drugs. 99% of the CMIC demand is an intermediate for HIV/Hepatitis B drugs.
India and China are the only countries than manufacture CMIC. 60% of the capacity is with China and 40% with India. In terms of production 64% of the global production happens out of China and 36% from India.
65% of demand of CMIC is from India, followed by North America and China with 21% and 13% of demand.
Shanghai Twisun is the leader in production of CMIC, 34% of the production in 2019 was met by the company. There are 3 Indian companies which manufacture CMIC – Chemcon, Anshul Specialty and Paushak. Atul used to manufacture this product, but has stopped since the last 2 years. Below is the production of CMIC for the 2013-19 period by manufacturers
India’s demand for CMIC in 2019 was 2,530 MT, 62% of the domestic demand was met by imports. Exports from the country were 465 MT. Imports are primarily from China. Domestic demand is expected to grow at 11% CAGR until 2023.
Methyl Chloroformate (MCF) and Isopropyl Alcohol (IPA) are the key raw materials for CMIC. Below is the quarterly price trend of CMIC,MCF and IPA for the 2013-19 period.
Source: Chemcon, DRHP
Oil well completion chemicals
What are oil well completion chemicals?
Oil well completion chemicals are used in the well completion process. Well completion is the final step in the oil well construction process. These chemicals are salty solutions made of chlorides and bromides. Oil well chemicals are used to cleaning the wellbore, after the drilling and it is also used to control the pressure, prior to and while well completion operations are in progress.
Different types of well completion chemicals are
- Water based fluids
- Oil based fluids
- Clear brine fluids
Clear brine fluids are widely used in drilling and well completion processes. These work well in high pressure and high temperature wells. Among chlorides and bromides, bromides are widely used as they meet these requirements.
There are 3 types of bromides used in the well completion process
- Sodium bromide
- Zinc bromide
- Calcium bromide
These bromides have certain characteristics than find specific applications. For instance, sodium bromide liquid is useful when used in formations that are known to have sensitivity towards calcium.
The global clear brine fluid market was estimated to be $ 860 million in 2019, 65% of the clear brine fluid market is with North America. Global market for bromides (calcium, zinc, sodium) was $ 417 Mn in 2019.
Some of the companies in this space are – Israel chemicals, Albemarle corporation, Chemtura corporation and Tetra. India is the net exporter of bromides. Chemcon is the leading manufacturer of calcium bromide and zinc bromide, OC specialties is the leading manufacturer of sodium bromide.
Important metrics of the bromides market
In this section we look at some of the important metrics of the bromides market – overall demand, regions with the highest demand and worldwide manufacturers of bromides.
Calcium bromide constitutes +50% of bromides demand. 53% of the demand is from North America. The demand for bromides in India is negligible, this is the reason why India is the net exporter of bromides.
Production of bromides in 2013 and 2019 by region and manufacturer
39% of the bromides production happens in North America, the highest demand is also from this region. North America has to rely on imports to meet its demands. Israel chemicals is the largest manufacturer meeting 35% of global bromide demand.
Bromide production in India for the 2013 and 2019 period
Chemcon and Agrocel export their calcium bromides to Middle East, North America and Asia Pacific. India’s domestic demand is met through imports. OC specialties exports its entire production to the Middle East.
The key raw material to manufacture bromides is hydrobromic acid. Price of this depends on price of liquid bromine, this is also the costliest component in manufacturing bromine derivatives. There is no direct correlation between bromides and crude oil prices, however these are used in the oil & gas industry. An important indicator of bromine demand would be the rigs that are being drilled at a point of time, drilling rigs is a function of crude oil prices.
The current pandemic has heavily impacted the oil & gas industry. Oil exploration activities are at a low and this has impacted the demand for oil well completion chemicals.
We had covered about the chemical industry last year, it can revisited here.
The Company: Chemcon Chemicals
Chemcon chemicals was incorporated as Gujarat Quinone pvt ltd in Gujarat in December,1988. The company manufacturers pharmaceutical chemicals used in the pharma industry and oil well completion chemicals (inorganic bromides – calcium, zinc and sodium).
The company has 3 products in the pharma business
- HMDS and ancillary products (including hi-purity HMDS)
- CMIC
- 4 CBC
4 CBC is a new product, which the company has started selling in July,2020. It has one more product – 2,5 DHT, commercial production of which needs to start.
In the oil well completion chemicals vertical, the company offers
- Calcium bromide (solution and powder)
- Zinc bromide (solution)
- Sodium bromide (solution and powder)
Chemcon is the only manufacturer of HMDS in India and 3rd largest producer in the world in 2019. It is the largest manufacturer of CMIC in India and the 2nd largest player in the world in 2019. The company is the only manufacturer of Zinc bromide and largest manufacturer of Calcium bromide in India.
Chemcon supplies its products in the domestic market and exports to countries including USA, Italy, South Korea, Germany, China, Japan, UAE, Serbia, Russia, Spain, Thailand and Malaysia. Revenues from exports in FY20 stood at 40% of total revenues. Export revenues have grown by 18% in the FY18-20 period.
Key customers in the pharma business are – Laurus labs, Aurobindo pharma, Ind Swift labs, Hetero labs, Vivin drugs and Macleods pharma. In the oil well completion chemical space, key customers include Shree Radha Overseas, Water systems speciality chemical DMCC and CC Gran LLC.
Chemcon has its manufacturing facility at Manjusar, near Vadodara in Gujarat. They have seven operational plants at this facility. Two plants are dedicated to manufacturing HMDS and allied products, two plants each to manufacture CMIC and oil well completion chemicals and one plant is a multipurpose plant. The company has three warehouses and one laboratory at the facility.
In the pharma business, to be enlisted as a supplier takes a long time. Also pharma companies have stricter regulations and have to submit regular fillings. Any change in the companies suppliers will have to be recorded in the fillings, the process of then changing suppliers frequently costs time and opportunity to the customer. Hence in a way revenues for a supplier are sticky if it is able to deliver quality product to the customer, this is one of the biggest advantage the companies operating in this space enjoy.
Raw materials such as bromine, MCF and TMCS are highly corrosive and toxic in nature and need to be handled with expertise.
Capacity of the companies products as on July,2020 is as below
Financials
In FY20 revenues were 262 Cr, revenues have grown by 29% CAGR in the FY18-20 period. Below is the split of revenues between the pharma and oil well completion chemicals in the FY18-20 period.
64% of the revenues in FY20 were from the pharma vertical and 36% from the oil well completion chemical segment. 84% or 140 Cr of revenues from the pharma business in FY20 were from exports, while 16% were domestic sales. Further, 87% of the HMDS and 70% of CMIC revenues in FY20 were from exports. In the oil well chemical segment, 88% of revenues in FY20 were from exports.
59% of the FY20 revenues were from the top 5 customers and 72% from the top 10. Below is the breakup of the top 10 customers in FY20
Source: Chemcon, DRHP
Quarter of the revenues come from the oil chemical space, the revenues from oil well in FY20 were 88% Cr, 26% of total revenues is 68 Cr. 77% of the revenues in the oil well segment come from one single customer. The client concentration risk is high in this segment.
GPMs in FY20 were 43%, margins for FY18 and FY19 were 51% and 39%. We see wide fluctuations in GPMs. The company procures its raw materials for the pharma business mainly from China and India. Below is the location of the top 5 suppliers for the pharma and oil well chemical business.
Source: Chemcon, DRHP
20% of RM purchases in FY20 were from China. Below is the details of RM imported from China in the FY18-20 period
Source: Chemcon, DRHP
Cost of RM purchased in FY18,19 and 20 was Rs 90,209,151 Cr.
Operating profits in FY20 were Rs 66 Cr, margins of 25%. EBIT has grown by 24% CAGR in the FY18-20 period and average margins for the last three years are 24%.
Net profits for the year stood at Rs 49 Cr, margins of 19%. PAT has grown by 36% CAGR in the FY18-20 period and average net margins stood at 17%.
The balance sheet of Chemcon is working capital heavy. 60% of the assets in FY20 constituted of inventories and receivables. Cash on the books at the end of FY20 was Rs 14 Cr, 6% of the assets. Below is the working capital requirement of the company for the FY18-20 period
Working capital requirements have gone by 83% CAGR in the above period, whereas sales have grown by 29%. There is a hug jump in receivables, as a percentage of sales these are 34% in FY20 as compared to 19% in FY18.
Borrowings at the end of FY20 stood at Rs 43 Cr, the debt/equity ratio was 0.3. The company is on a comfortable position on this front. Borrowings constitute 19% and equity 65% of the equity and liability section.
ROE and ROCE at the end of FY20 was 33% and 29%. The 3 year average was 42% and 37%
Although the company has positive CFOs for all of the last 3 years, the cumulative CFO and net profits are way off. The cumulative CFOs for the 3 years are Rs 36 Cr as compared to net profits of Rs 118 Cr, the company is unable to convert its accounting profits into cash profits. This is primarily on the back of increase in receivables. The cumulative CFO/Net profit ratio is 0.3, in other words for every 1Re of accounting profits, cash profits or CFO is Rs 0.3.
Other Important Updates
There are few points that we have come across in the RHP and would like to highlight here.
Non Compliance
The promoters in the past have failed to make certain disclosures under SEBI insider trading regulations in relation to their holdings in Overseas Synthetics Limited (OSL), part of the promoter group.
Source: Chemcon, DRHP
Criminal Proceedings
There are criminal proceedings against one of the promoter Naresh Vijaykumar Goyal.
Source: Chemcon, DRHP
Promoter group company complaint against promoter group member
Super scientific works private limited (SSWPL), a promoter group entity has filed a complaint with SEBI against Naresh Vijaykumar Goyal, member of the promoter group.
Source: Chemcon, DRHP
RBI has initiated proceedings against Rudra Fincorp Private Limited, a company part of the promoter group.
Final Thoughts
The EPS for FY20 was Rs 15, at the price of 340, we are paying 23X earnings. This is not bad given that revenues and profits have grown by 29% and 36% over the last 3 years. The companies debt is manageable and its ROE and ROCE profile is impressive.
The company is also the only manufacturer of HDMS and largest manufacturer of CMIC in India. These products are essential in producing antibiotic and anti viral drugs. The company will also benefit from customers wanting to move their supplies from China. The US China trade tensions can also prove to be beneficial to the company.
However on the other side, points to consider
- 26% of the revenues in FY20 were from one customer in the oil well chemical segment, the oil and gas segment will face headwinds going ahead
- Top 10 customers contribute 72% of revenues, a wider customer base would be better
- The global CMIC market is $27 million and HMDS $ 243 million, these are very small markets. If the size of the industry does not increase, the existing competition will fight for the same size of the pie
- Drastic increase in working capital requirements, primarily on the back of increase in receivables. Poor conversion of accounting profits to CFO
- Corporate governance – non compliance, criminal proceedings and issues with group companies
Looking at the above issues we feel it is better to skip this issue and track important metrics – working capital, industry growth, corporate governance and customer base after the company has been listed as the company primarily caters to the pharmaceuticals industry, which is at an inflection point.
Since our analysis is purely about the IPO, and does not consider your specific financial goals and risk profile, please consult an Investment Advisor before taking any action.
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