Stock Pick From Commodity Chemicals Industry

Here is why:

• Chemical industry undergoing structural shift.
• Year-on-year strong financial performance.
• Expansion of capacity.
• Strong margins sustainable.
  

For the last few months, crude oil prices have remained subdued. The lower crude oil prices are expected to benefit companies which use it to produce raw materials. Further, India is the third-largest chemical market in Asia, implying strong growth potential for domestic chemical companies such as Aarti Industries (AIL).

AIL is engaged in the business of specialty chemicals (contributes 84 per cent revenue), pharmaceutical APIs (10 per cent) and home care chemicals (6 per cent). In specialty chemicals, the company operates in key derivatives involving benzene as a raw material. Benzene being a natural constituent of crude oil, the company is likely to derive maximum benefit of lower crude oil prices, which can clearly be seen from its increasing profitability. Further, AIL owns a state-of-the-art plant near Mumbai and is recognised as a star trading export house by the Government of India. The products of the company are exported to various countries such as United States, United Kingdom, Germany, Spain, Italy, Switzerland, Belgium, Japan, Korea, China, and Russia.

Anticipating the demand potential for the chemicals, AIL is planning to invest Rs 4.2 billion during FY15-17 to upgrade or expand its capacity. Considering 3 to 4 times’ asset turnover, the planned capex is likely to support 20 to 24 per cent earnings’ CAGR over the next 3 to 4 years. Further, AIL expecting to enhance its operational efficiency by increasing 50 per cent capacity utilisation of its new caffeine plant in Q2 FY16 and Q3 FY16. Currently, caffeine sales contribute around 40 per cent revenue to the pharmaceutical segment. Based on the recently concluded favourable USFDA inspection report, AIL expects USFDA approvals for four products, which will result in higher sales to regulated markets.

On the financial front, AIL posted an outstanding performance in FY15; the total income increased by 10.46 per cent to Rs 2,908 crore in FY15 compared to Rs 2,632.49 crore in FY14. The EBITDA increased by 16 per cent to Rs 465.69 crore as against Rs 401.48 crore on a yearly basis. The EBITDA margin expanded by 76 basis points to 16 per cent. Even with an increase in finance cost and tax expenses, the net profit rose by 26.74 per cent to Rs 205.88 crore in FY15 compared to Rs 162.44 crore in FY14. Interestingly, the net profit margin expanded by 88 basis points to 6.66 per cent in FY15 on a yearly basis. The sales turnover grew by CAGR of 17.69 per cent and the net profit of AIL grew by CAGR of 22.4 per cent over the past 8 years.

Speciality chemicals have clocked good volumes for the company in recent times. Further, as there is increased consumption in Asian region and India in particular, the volume growth estimates for the speciality chemicals’ segment is much higher in the near future. Improved profitability across speciality chemicals due to benefits of operating leverage and improved product mix may lead to better financial performance in days to come. Hence we recommend buying this stock.