HOLD

Company Update Aarti Industries Target Price

16th June 2020 Specialty Chemicals 968

Termination of contract a near term hiccup (CMP as of June 15, 2020)

Aarti Industries received an early termination notice from its customer for the 1st multiyear deal CMP (Rs) 879

to supply high-value agro chemical intermediary to be used in a Herbicide. The contract was Upside /Downside (%) 10%

estimated to generate revenue of Rs. 4,000cr over 10 year period. The contract termination is High/Low (Rs) 1,192/662

owing to change in customer’s (Bayer Crop) business strategy of sourcing the finished Market cap (Cr) 15,313

molecule from the open market rather than manufacturing it themselves. A one time Avg. daily vol. (6m) Shrs. 3,92,031

termiantion compensation of USD 120-130mn (approx. Rs. 900-975cr) more than offsets the No. of shares (Cr) 17.4

loss in business that would have emerged owing to the termination instead it opens up other
Shareholding (%)
opportunities for AIL. AIL invested ~Rs. 350 crore of the total Rs. 400cr capex to set up the
Mar-20 Dec-19 Sep-19
plant that partially commenced operations from Q4FY20. Although, long term appears
Promoter 47.8 48.3 48.3
promising as global players look for reducing dependency on China to source their
FIIs 8.3 7.4 7.7
requirements, near term growth challenges persist. We lower our Revenue/PAT estimates for
MFs / UTI 14.9 15.2 15.0
FY21/22 by -3.7%/-3.6% and -4.1%/+1% resp. However, maintain HOLD rating on the
Banks / FIs 0.0 0.0 0.0
stock with TP of Rs. 968/share valuing it at 24x FY22E EPS.
Others 29.0 29.0 28.9
Our Take On Event based Concall
• Early termination of a long term contract from a global agro-chemical player (Bayer Crop)
Financial & Valuations
Y/E Mar (Rs. Cr) 2020 2021E 2022E
suggests a sharp decline in prices of the end product in the open market lerading to change
Net Sales 4,186 4,272 5,242

•
in strategic business plan for the customer.
EBITDA 986 987 1,295
Although this contract has been terminated, AIL mentioned that it’s share of business with
Net Profit 536 481 708
the same customer (Bayer Crop) is expanding in some of the other products and that there
EPS (Rs.) 30.8 27.6 40.7

•
is no loss of customer as such.
PER (x) 32.0 31.1 21.1
Termination compensation is part of the contractual agreement and thus amount is not
EV/EBITDA (x) 19.0 16.2 12.1
negotiable. Compensation to be received by AIL in a staggered manner over FY21/22.
P/BV (x) 5.8 4.3 3.7
Company would make USD 20mn at EBITDA level after production cost. Payment to be
ROE (%) 18.8 14.7 18.6
received in parts as USD 20mn in FY21, USD 20mn in FY22 and balance USD 80mn by

•
end March 2022. Change in Estimates (%)
AILs management remains hopeful of capturing inherent growth opportunities in this high Y/E Mar FY21E FY22E
value agro-chemical intermediate and is well prepared to cater to market requirements if Sales (3.7) (3.6)

•
any. This will lead it to fully utilize its capacities over the next 4-5 years., EBITDA (2.4) 0.5

•
There are no changes in other 2 multi-year deals AIL has and these projects are on track. PAT (4.1) 0.9
We believe near term is marked by uncertain growth environment in the Specialty Chemical
business which contributed to ~83% revenues for FY20 as challenges would emerge from Axis vs Consensus
the non-essential segment where demand is likely to remain subdued in FY21 as per EPS Estimates 2021E 2022E
management. Axis 27.6 40.7
Consensus 34.6 44.6
Our view: While, over long term remain positive, the near term could be under pressure owing to
Mean Consensus TP (12M) 1,023
growth challenges for the company’s non-esserntials segment forming ~40% of the total
revenues on the Sepcialty Chemicals side. Further, securing new customers for the terminated
contract and/or reworking the growth trajectory for the said intermediate product could pull down Relative performance
FY21 earnings profile. Further the challenging global growth outlook will likely lead to under 200

utilization of new capacity despite being compensated for the contract in the near term. This 150
results in tweaking of our Revenue/PAT estimates for FY21/22E -3.7%/-3.6% and -4.1%/+1%
100
respectively. We retain HOLD rating and TP of Rs. 968/share valuing the stock at 24x P/E
basis its FY22E EPS. 50

Key Financials (Consolidated) 0

Dec-18 Jun-19 Dec-19 Jun-20
(Rs. Cr) FY19 FY20 FY21E FY22E
Aarti Industries Ltd BSE Sensex
Net Sales 4,167.6 4,186.3 4,272.0 5,242.3
Source: Capitaline, Axis Securities
EBITDA 967.2 986.2 987.3 1,295.4
Net Profit 491.7 536.1 481.3 708.4
EPS (Rs.) 28.2 30.8 27.6 40.7
PER (x) 26.8 32.0 31.1 21.1 Suvarna Joshi
Sr. Research Analyst
EV/EBITDA (x) 15.0 19.0 16.2 12.1
P/BV (x) 5.0 5.8 4.3 3.7 Call: (022) 4267 1740
email: suvarna.joshi@axissecurities.in
ROE (%) 22.8 18.8 14.7 18.6
Source: Company, Axis Research

1
Other Key Concall Takeaways
1) Contract termination by customer: We note there is no reputational loss for Aarti Industries as the contract has been terminated by the
customer. Demand for the product has not reduced. Decision to terminate the contract and also not pursue its own expansion plan for the
said molecule was based on;
 feasibility of outsourcing versus own manufacturing of the key end use product
 availability of continued supplies as against an earlier assessment of irregular supplies
 existence of multiple manufacturers for the said intermediate and the active ingredient used in manufacture of final product
 Company will roughly make Rs. 160 cr EBITDA with or without supplying the product as it depends on customers for offtake of
this product.
 Allows AIL to start supply/sales to new customers with immediate effect.
2) Termination compensation: AIL to receive the compensation of USD 120mn-130mn in a staggered manner as USD20mn EBITDA in
FY21E, 2nd tranche of USD 20mn EBITDA in FY22 and balance USD 80mn to be received as one-time payment before March 2022
thereby recovering the entire amount by March 2022. The compensation amount more than offsets the loss in revenues for Aarti caused
by termination of the contract. The sums received will be utilized for more capex and growth projects as there are lot of growth
opportunities for India which is placed in a sweet spot.
3) Other growth opportunities and options: Management highlighted that the AIL can sell its products to other customers with immediate
effect and the contracts terms do not restrict it from catering to market requirements. AIL will look to 1) connect with the suppliers of these
active ingredients although size of business is unlikely to be of the scale of the contract; 2) get into active ingredient tolling by supplying
the said intermediate; 3) consider forward integration that could aid in AIL becoming the lowest cost manufacturer with supply advantages
as AIL is totally backward integrated.; 4) look to explore new products through its R&D.
4) Capacity utilization: Company will hit full capacity utilization over 4-5 years. In the medium term it aims to achieve a 15-20% capacity
utilization albeit no clarity was given on the breakeven sales volumes/margins given the dynamics of manufacturing and competing in the
market would change this.
5) Capex: Aarti has already spent ~Rs. 350cr on expansion of this project of the total Rs. 400cr. Some advance from customer towards the
capex has been received by the company, however, the amount wasn’t disclosed by AIL. Aarti’s capacity will contribute to ~30-40% of
global capacity. From an asset point of view, the company has received ~70-80% of NPV, while there could be a loss of 20-30% is the
asset is not utilized at all.
6) Margins: Initially the margins will likely be lower as compared to the contract where op. margins were 40%. Advantage for AIL will be its
readiness with the plant , fully backward integrated capacities in India (1 player in China has fully integrated capacities)
7) Long term guidance maintained: Management categorically mentioned that they still look to achieve a 15-20% earnings growth over the
long term over 3-4 years. Although the near term growth will be marred by uncertain growth environment on the back of reevaluation of
contract and opportunities and COVID-19 led demand slowdown.
8) Impact of US Court ruling on the contract if any: Management denied any connection with the ban on Dicamba herbicide by US courts
and thus there is no impact of the regulation on the decision to terminate the contract.

2
Change in Estimates (Rs Cr)
Revised Old %Change
FY21E FY22E FY21E FY22E FY21E FY22E
Revenue 4,272 5,242 4,438 5,437 (3.7) (3.6)
EBITDA 987 1,295 1,012 1,289 (2.4) 0.5
PAT 481 708 502 702 (4.1) 0.9
EPS 27.6 40.7 29.0 40.4 (4.8) 0.6
Source: Company, Axis Research

Valuation & Outlook

While, the termination of its 1st multi-year contract by the customer came as a surprise to us, we note that the termination compensation is more
than sufficient to cover for the business loss and the amount invested in the project. However, pandemic led growth uncertainty is expected to
drive decline in earnings growth for FY21 with a sharp rebound in FY22 aided by a favourable base and normalization of the economy domestically
and globally. To factor in the uncertain FY21 outlook and potential delays in multiyear contracts we marginally tweak our FY21/22E Revenue/ PAT
estimates by -3.7%/-3.6% and -4.1%/+1% respectively. Maintain BUY with unchanged TP of Rs. 968/share valuing the stock at 24x P/E basis its
revised FY22E EPS. While, near term growth outlook is uncertain, we believe over the long term, AIL could be a beneficiary of the structural shift in
global supply chain that is independent of China, growing contribution from value added products from new chemistries and strengthening position
as a global partner of choice for global companies through multi-year deal wins and newer chemistries.

3
Financials (consolidated)
Profit & Loss (Rs Cr)
Y/E March FY19 FY20E FY21E FY22E
Net sales 4,168 4,186 4,272 5,242
Other operating income 2 9 9 11
Total income 4,170 4,195 4,281 5,253

Cost of goods sold 2,962 2,955 3,044 3,667

Contribution (%) 28.9% 29.4% 28.8% 30.1%
Advt/Sales/Distrn O/H 240.9 254.2 249.9 290.9

EBITDA 967 986 987 1,295

Depreciation 163 185 266 305
Interest & Fin Chg. 183 125 134 127
Pre-tax profit 622 676 587 864
Tax provision 118 129 106 156
(-) Minority Interests 12 11 0 0
Other Comprehensive Income 0.0 0.0 0.0 0.0
Adjusted PAT 492 536 481 708
Source: Company, Axis Securities

Balance Sheet (Rs Cr)

Y/E March FY19 FY20P FY21E FY22E
Total assets 5,217 5,738 6,623 7,016
Net Block 2,147 2,561 3,224 3,570
CWIP 794.6 1,417.6 584.2 279.3
Investments 33.2 37.0 37.0 37.0
Wkg. cap. (excl cash) 1,438 1,475 1,472 1,779
Cash / Bank balance 804.2 247.3 1,306.3 1,350.9
Misc. Assets 0.0 0.0 0.0 0.0

Capital employed 5,217 5,738 6,623 7,016

Equity capital 87.1 87.1 87.1 87.1
Reserves 2,543 2,984 3,369 3,962
Pref. Share Capital 0.2 0.0 0.0 0.0
Minority Interests 84.0 94.6 94.6 94.6
Borrowings 2,309 2,361 2,861 2,661
Def tax Liabilities 193.0 211.0 211.0 211.0
Source: Company, Axis Securities

4
Cash Flow (Rs Cr)
Y/E March FY19 FY20P FY21E FY22E
Sources 1,362 768 879 828
Cash profit 849 857 882 1,140
(-) Dividends 98 106 96 115
Retained earnings 752 750 785 1,024
Issue of equity 46.5 (0.0) 0.0 0.0
Change in Oth. Reserves 735.2 10.8 0.0 0.0
Borrowings 46 114 228 -70
Others -217 -107 -134 -127

Applications 1,362 768 879 828

Capital expenditure 700.7 1,757.7 95.6 346.1
Investments (14.1) 3.9 0.0 0.0
Net current assets (225.8) 0.5 (275.3) 437.1
Change in cash 901.0 (993.9) 1,059.0 44.6
Source: Company, Axis Securities

Ratio Analysis (%)

Y/E March FY19 FY20P FY21E FY22E
Sales growth 9.5 0.4 2.0 22.7

OPM 23.2 23.5 23.1 24.7

Oper. profit growth 36.8 2.0 0.1 31.2
COGS / Net sales 71.1 70.6 71.3 70.0
Overheads/Net sales 5.8 6.1 5.9 5.6
Depreciation / G. block 4.8 4.2 5.0 5.1
Effective interest rate 9.1 6.4 6.5 5.7
Net wkg.cap / Net sales 0.27 0.26 0.25 0.24
Net sales / Gr block (x) 1.2 1.0 0.8 0.9

RoCE 17.8 14.7 11.8 14.5

Debt / equity (x) 0.8 0.6 0.7 0.5
Effective tax rate 18.9 19.1 18.0 18.0
RoE 22.8 18.8 14.7 18.6

EPS (Rs.) 28.2 30.8 27.6 40.7

EPS Growth (31.1) 9.0 (10.2) 47.2
CEPS (Rs.) 37.6 41.4 42.9 58.2
DPS (Rs.) 5.1 6.1 5.0 6.0
Source: Company, Axis Securities

5
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