AMBIT INSIGHTS

Specialty Chemicals POSITIVE

Advantage India as China goes green Quick Insight
The sector reported a big boost in capex announcements in the past 50 days
led by NOCIL, Navin Fluorine, Nagarjuna Agrichem and Aarti. This trend has Analysis 
been helped by Chinese supply disruptions and should only accelerate. While
Meeting Note 
fundamentals are bright for Indian chemicals players, valuations are possibly
close to their peak. Hence, investors need to pay attention to sustainable News Impact
earnings stories rather than those with one-time price jumps as we believe
these sharp spikes caused by the Chinese shutdowns will fade. Capacities
should come back sooner than later (in China or elsewhere) albeit with a
more level playing field for Indian players. Valuations of chemicals microcaps
have gone through the roof in the frenzy, but we urge investors to not take
their eyes off the ability to build scale. We prefer players with management
bandwidth, mastery over niche processes, global standard manufacturing
assets, and ability to build new products/processes. We reiterate BUY on
Aarti, PI Industries, Vinati Organics and SRF.
Deflationary trends in chemicals are coming off
Over last decade, China disrupted the global chemicals procurement supply chain by:
(i) flooding the markets with large scale capacities which were backward integrated
and (ii) not spending much on emission control and pollution treatment. This was
helped by funding through capital subsidies and availability of cheap debt. Though
China is focusing on putting its house in order, multiple disruptions have been rocking
the boat, which will increase the landed price of chemicals across the globe and make
Indian manufacturers more competitive. These disruptions in China include:
 Raw material availability has become limited. Mining/production of many toxic
materials such as yellow phosphorus has been banned, which has impacted
multiple forward products.
 Many capacities are being asked to shift from provinces such as Jiangsu, Hebei
and Shandong to provinces such as Inner Mongolia. This is creating a temporary
disruption in production of 12-36 months. However, these shifts will materially
increase logistics costs and these plants will need high capex and will involve high
capital costs.
 At multiple places, companies are being asked to shift plants from coal to natural
gas (LNG), which have been substantially increasing power costs. Many have been
asked to tighten their SHE (Safety, health, emission) standards, which are leading
to an increase in invested capital by 20-25%.
 Inefficient plants which don’t even make enough money to service their debt are
being asked to shut down, eliminating excess capacity.
Priorities have changed at the top
Chinese President Xi Jinping mentioned “environment” 89 times during his speech at
the 19th Congress and “economy” just 70 times (that too to put focus on quality of
economic growth). A few changes over the last one year are:
 District-level cadres are being incentivised/punished for meeting/missing their
emission targets like they used to be for achieving their GDP growth targets.
 Promotion of local government officials doesn’t really depend on economic growth
targets but their ability to support the government on its green drive.
Research Analyst
 Xi Jinping’s speech at the 19th Congress suggests China’s focus has shifted to
providing better quality of life rather than double-digit economic growth. Ritesh Gupta, CFA
ritesh.gupta@ambit.co
 Introduction of an Environmental Protection Law that will levy new pollution taxes Tel: +91 22 3043 3242
on manufacturers. It replaces a 38-year-old pollution discharge regulation which
had loopholes and exemptions that made it easy for companies to avoid
payments.
Ajay.Rao@ambit.co
Ambit Capital Pvt Ltd 16 January 2018
 AMBIT INSIGHTS

 40% of Chinese manufacturing capacities were temporarily shut in 2017 as per

ICIS while 12000 local government officials were disciplined for not discharging
their duties properly during Jan-Nov 2017.
The capacity shutdowns will go all the way up to 2025
The Chinese government has clearly mentioned that toxic plants need to be relocated
out of densely populated regions (source: ICIS)
 All small to mid-sized chemicals plants that fall in the toxic category must
complete relocation by end-2020, and if they haven’t started work yet, this must
begin next year.
 All the larger plants classified as producing toxic chemicals must relocate by end-
2025, and the process must start no later than 2020.
 Plants can also be re-engineered to produce non-toxic products or must be
permanently closed if re-engineering or relocation is not possible.
Capex of Indian players has been rising to meet growing demand
We see multiple opportunities for Indian chemicals players as the disruption discussed
above plays out. The Indian chemicals market at US$180bn forms just 4% of the
global chemicals market while China accounts for nearly half. We expect significant
market share gains over next few years as Indian players’ ramp up capacity as well as
product capabilities.
Exhibit 1: Recent capex announcements by Indian chemical players
Capex
Announcement
Amount Purpose & Other Details
Date
(Rs mn)
For expansion of its production facilities for Rubber Chemicals (including intermediates captively consumed
towards manufacture of rubber chemicals) at Dahej/Navi Mumbai. This is Phase - 2. The said investment is
NOCIL 1,680 20-Dec-17
expected to maintain the Asset turnover ratio of 2: 1. The said capex is expected to be completed during Q1 FY
2019-20. Significant portion of CAPEX will be financed through internal accruals.
This capex is for creating additional cGMP capacity and associated infrastructure at its Dewas Facilities. The
expanded capacity will be utilised to satify the increasing demands for company's Contract Manufacturing
Navin 1,150 21-Dec-17
business (for value added complex chemicals and fluoro intermediates manufactured for innovator pharm
companies across the globe).
Aarti has tied up with a global chemical major to supply specialty chemicals with annual revenues of
Rs5/5.5bn for the next 20 years. Capex for this project, US$35-40mn (~Rs2.5bn, implying an asset turn of
~2x), will be funded by the client as interest-free advance that will be adjusted against revenues from annual
Aarti 5,500 29-Dec-17
supplies. This project will build on existing technology with Aarti while using an add-on technology to be
provided by Aarti’s global client. This model (cost of capital arbitrage and faster ramp-up) can be replicated
meaningfully for multiple clients of Aarti.
Nagarjuna
3,000 02-Jan-18 NACL will put up new capacities to manufacture agrochemicals
Agrichem
Source: Company, Ambit Capital

Exhibit 2: Vinati will treble its gross Exhibit 3: Aarti too will double its gross Exhibit 4: amlin Finesciences too will
block over the next 5 years (Rs mn) block over the next 5 years (Rs mn) treble gross block in the next 5 years
(Rs mn)

15,978 48,169
14,978 44,529 9,849
13,978 41,029
12,978 8,722
36,029 7,794
9,978 31,029 7,033
26,529
20,814 4,972
5,978 16,851 3,5973,952
4,123 4,851 2,951
FY15

FY16

FY17

FY18E

FY19E

FY20E

FY21E

FY22E

FY18E

FY19E

FY20E

FY21E

FY22E
FY15

FY16

FY17

FY15

FY16

FY17

FY18E

FY19E

FY20E

FY21E

FY22E

Source: Company, Ambit Capital Source: Company, Ambit Capital Source: Company, Ambit Capital

Ajay.Rao@ambit.co
Ambit Capital Pvt Ltd 16 January 2018
 AMBIT INSIGHTS

Opportunities in India
 Most chemicals are used as intermediates for final goods. Growth in consumption
of chemicals can easily cross 1.5x GDP growth (source: Avalon Consulting) over
the next few years. As consumption of final products increases, the chemicals
sector will also post strong growth. India is short of chemicals capacities and
hence has to import a lot.
 Many MNCs present in China are considering shifting their manufacturing base to
India or are considering setting up new capacities (expansion projects) In India.
Many global chemical companies (especially Japanese, European and Korean) are
at various stages of setting up business in India as PE investors, through buyouts
or by setting up greenfield capacities. The local Indian companies will also have
ample opportunity to grow in their niches/segments.
 Most chemical companies were established in India in late 1970s or 1980s. The
second generation is (i) more educated; (ii) has global exposure; (iii) is ready to
engage with professionals; (iv) has right attitude and technical skills; and (v) is
willing to invest in capacities and R&D. Many such companies are ready to expand
operations or are in the process of launching new products (like Aarti Industries).
In many cases, the second generation is not interested in continuing with the
business. These companies represent good targets for PE players.
 The Indian government is open to supporting the industry with anti-dumping
duties. In cases where India has executed FTA, the government is also open to
imposing non-tariff barriers like restrictions in quantum of imports and packaging.
 In India too many companies are increasingly under pressure to comply with
green regulations. For e.g. many companies in MIDC (Maharashtra Industrial
Development Corporation) have been forced to shut down. India is also setting up
big industrial parks for chemical companies with all facilities needed for efficient
running of chemicals units.
Exhibit 5: Recent rupee appreciation headwinds are waning; rupee may depreciate on
the back of rising government spends ahead of elections and expensive crude imports

10.4
10.2
10
9.8
9.6
9.4
9.2
Jan-14
Mar-14
May-14
Jul-14
Sep-14
Nov-14
Jan-15
Mar-15
May-15
Jul-15
Sep-15
Nov-15
Jan-16
Mar-16
May-16
Jul-16
Sep-16
Nov-16
Jan-17
Mar-17
May-17
Jul-17
Sep-17
Nov-17

Source: Company, Ambit Capital

Indian SHE compliance: perform or perish

Our discussions across experts suggest that SHE (Safety, Health and Emission
compliance) is now a key differentiator amongst different companies. India clearly has
a lot of SME players in chemicals that are now exiting the business given it has
become difficult to operate under tougher compliance for safety, health and emission
parameters. Many such companies have also gone under transformation and
upgraded themselves over the last few years. Growing exports focus too has clearly
helped. Independent ratings such as ecoVadis and Responsible care have become key
differentiators for global player to choose their suppliers in India.

Ajay.Rao@ambit.co
Ambit Capital Pvt Ltd 16 January 2018
 AMBIT INSIGHTS

Where do we go from here?

We reiterate our Positive stance on the specialty chemicals sector. We believe exports
will continue to clock faster growth than the domestic business. Given the pressure to
outsource manufacturing is high, due to environmental reasons and cost compulsions,
the growth runway for the Indian specialty chemicals industry may last another
decade easily. By that time Indian consumption too would start dominating. The high
share of China in the chemicals supply chain is also making global players look for
alternative supply sources. The key criteria to screen chemicals names are
management bandwidth, asset discipline, command over niche chemical processes,
global standard manufacturing assets, and ability to innovate in terms of new
products and processes. We have four BUYs in the space – PI Industries, SRF Limited,
Vinati Organics and Aarti Industries.
Exhibit 6: India Chemicals – our top picks
Company Stance TP Upside FY19E target multiple
PI Inds BUY 1,100 10 25.0
SRF BUY 1,950 (0) 17.0
Aarti Inds. BUY 1,300 14 22.0
Vinati Organics BUY 1,070 10 26.0
Source: Company

Exhibit 7: Relative benchmarking – we continue to focus on top-tier companies within the chemicals space
Capital Product/Process Global Cash Total
Margins Scalability
Efficiency Capabilities orientation Conversion score
PI Industries
SRF Ltd.
Vinati Organics Ltd.
Atul Ltd.
Aarti Industries Ltd.
Navin Fluorine International Ltd.
Oriental Carbon & Chemicals Ltd.
Camlin Fine Sciences Ltd.
Fair Finechem Ltd.
Omkar Speciality Chemicals Ltd.
Gujarat Fluorochemicals Ltd.

Source: Ambit Capital Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Ajay.Rao@ambit.co
Ambit Capital Pvt Ltd 16 January 2018
 AMBIT INSIGHTS

Exhibit 8: Relative valuations – Vinati is now one of the most expensive names in the chemicals space
EV/EBITDA (x) P/E (x) P/B (x) ROE CAGR (FY18-20)
Name of the Company Mcap ADTV 6M
FY18 FY19E FY20E FY18 FY19E FY20E FY18 FY19E FY20E FY18 FY19E FY20E Sales EBITDA PAT
(US$ mn) (US$ mn)
UPL 6,279 18.6 12.2 10.7 9.5 19.4 16.0 13.5 4.4 3.6 3.0 25% 24% 24% 12.3% 13.4% 20.1%
Bayer CropScience 2,627 1.3 35.5 28.2 23.6 47.5 38.5 32.0 8.2 7.0 6.1 17% 20% 21% 15.6% 22.6% 21.8%
PI Industries 2,156 3.4 23.4 20.1 17.4 32.2 27.6 23.9 7.0 5.8 4.8 23% 22% 22% 14.1% 16.0% 16.0%
SRF 1,748 6.5 14.2 11.1 9.6 25.2 18.5 15.8 3.2 2.8 2.4 13% 16% 17% 12.1% 21.9% 26.4%
Solar Industries India 1,665 0.6 26.4 21.5 16.8 45.2 36.1 28.1 9.5 4.7 3.6 22% 23% 24% 24.8% 25.4% 26.8%

BASF India 1,527 1.3 25.7 19.3 18.0 83.4 42.9 27.5 7.9 6.7 5.9 10% 16% 19% 9.7% 19.5% 74.2%
Aarti Industries 1,455 1.0 16.0 12.8 10.6 28.6 21.3 17.5 6.9 5.6 5.0 22% 24% 23% 15.5% 22.9% 28.0%
Atul 1,383 1.0 17.0 13.1 11.4 28.4 21.0 17.9 3.9 3.3 2.8 14% 17% 17% 10.2% 22.3% 26.0%
Himadri Specialty Chemical 1,267 5.4 24.9 18.1 14.5 41.0 29.9 20.5 6.6 5.4 4.2 18% 19% 22% 19.5% 30.8% 41.4%
Rallis India 824 2.3 17.2 14.7 12.4 27.4 22.5 19.1 4.2 3.7 3.3 16% 17% 18% 13.4% 17.7% 19.5%

Vinati Organics 771 0.4 20.2 15.7 11.0 31.2 23.4 18.8 6.0 4.9 3.6 19% 21% 24% 28.3% 35.7% 29.0%
Monsanto India 706 0.4 24.2 20.1 18.9 27.1 22.4 19.1 7.7 6.6 NA 30% 30% 32% 11.2% 13.3% 19.3%
Navin Fluorine International 637 0.8 18.3 15.8 13.6 26.0 22.1 19.2 4.5 3.9 3.5 18% 18% 18% 13.5% 16.0% 16.6%
Sharda Cropchem 658 0.2 13.2 10.2 NA 22.0 17.5 NA NA NA NA 19% 20% NA NA NA NA
Dhanuka Agritech 613 0.3 21.3 17.7 15.5 29.8 25.9 22.4 6.2 5.4 4.6 23% 22% 22% 13.7% 17.2% 15.3%
NOCIL 546 4.6 15.6 14.3 NA 26.5 24.2 NA 4.1 3.3 NA 18% 17% NA NA NA NA

Meghmani Organics 482 7.1 9.7 8.2 7.7 22.8 18.6 16.9 3.6 3.0 2.7 17% 18% 17% 10.4% 12.1% 16.2%
Sudarshan Chemical 486 0.9 15.8 12.8 11.9 30.9 23.4 20.9 6.9 5.8 NA 23% 26% 24% 10.1% 15.0% 21.7%
Insecticides India 268 1.0 11.9 10.1 8.1 19.5 16.4 13.3 3.2 2.7 2.3 17% 19% 19% 14.5% 21.8% 21.2%

Source: Bloomberg, Ambit Capital research

Ajay.Rao@ambit.co
Ambit Capital Pvt Ltd 16 January 2018