Aarti Industries: Striking a chemistry

Stocks of many specialty chemical companies have had a stellar run over the last five years, primarily led by domestic consumption. However, FY 2017-18 was not favourable for many companies due to multiple headwinds, including a weak global commodities cycle, relatively stronger rupee and supply-side bottlenecks.

Aarti Industries has delivered spectacularly over the past few years. Its share price has risen at a compounded annualised rate of 70 per cent over the past five years.

The company has charted a strong growth path so far on the back of efficient execution strategies, long-standing client relationships with global players and aggressive capex plans. The company’s growth prospects look robust, given its strong presence in the benzene derivatives segment, traction in pharma business, aggressive capacity expansion and growing R&D capabilities.

Investors with a two- to three-year time horizon can consider buying the stock. The share price is down 12 per cent from its April 2018 highs, making it an attractive option from a valuation perspective.

At the current price of ₹1,191, the stock trades at about 17 times its estimated 2019-20 earnings, compared with the 13-plus times that peer SRF enjoys. The premium valuation of Aarti is justified, given its superior earnings growth, pick-up in the nitro toluene segment and recent agreements for multi-year contracts, which can provide a leg-up to long-term revenue and earnings prospects. Aarti’s valuations are cheaper than that of Vinati Organics.

As global chemical manufacturers diversify their outsourcing universe and the restrictions get imposed on chemicals manufacturing in the US, Europe and even China, there is a good opportunity for the specialty companies in India such as Aarti.

Stable business

Aarti Industries is one of the India’s leading producers of benzene-based specialty chemicals and derivatives. The company supplies dyes, pigments, agro-chemicals, pharmaceuticals and rubber chemicals to Indian and global manufacturers. It has a diversified product portfolio of about 125 products and serves more than 500 domestic customers and 150 export clients across 60 countries.

The company is ranked among the four largest global companies in nearly 75 per cent of its key products. Aarti generates more than 80 per cent of its revenues from the 5+ years customers. The company derives about half its revenues from exports.

Aarti operates primarily in three segments — speciality chemicals, pharmaceuticals and home and personal care.

Its specialty chemicals business that accounts for around 78 per cent of the overall revenue has grown by 7 per cent CAGR over the last five years. The company makes a variety of products from benzene.

In FY-18, the company achieved about 92 per cent capacity utilisation. It expects its specialty chemicals business to grow at 12-15 per cent in FY-19 on the back of rising demand from the agrochemical sector (herbicides).

The primary source of raw material is crude; any fluctuation in price will impact the company’s revenue. However, Aarti follows a raw material cost-plus delta pricing model, wherein the raw material cost is passed onto the consumers.

Multi-year contracts

Aarti has forayed into the toluene segment, which adds a new revenue stream (around ₹400 crore annually) and creates additional cross-selling opportunities with existing customers.

In the last one year, the company has bagged two multi-year contracts — one from a global agriculture company, worth ₹4,000 crore, for supplying high-value agrochemical intermediary for 10 years, and, two, from a global chemical conglomerate worth ₹10,000 crore for 20 years. The supply will commence from FY-20 and FY-21, respectively. Such orders provide revenue visibility.

Traction in pharma

The company’s pharma business that accounts for 15 per cent of the revenue has seen significant traction in the recent quarters.

It has been aggressive on capex expansion and has doubled its gross block over the past four years. It now plans an annual capex of ₹600-700 crore over the next two years into new chemistries, besides setting up an R&D centre.

Strong financials

The company’s consolidated revenue and net profit grew 10 and 20 per cent CAGR respectively, over FY14-18. In FY-18, its consolidated revenue and net profit was ₹3,806 crore and ₹331 crore respectively. In FY-18, the operating margin was 18.5 per cent. Net debt-to-equity was 1.3 due to capex of the last five to six years.

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