The Next Big Theme – A Series To Learn Together

The Next Big Theme – A Series To Learn Together

Well, this has been big question on everyone’s mind all the time & honestly there is no right answer for this. With household debt surging to 20% from 2% in 2000 and saving rates dipped to 8% from 12% in 2008 – constant question is investment vs consumption or financials?

A great investor taught me that half the battle is won in the equity markets if someone is able to catch the right trend. Market goes through various cycles and if you caught the right cycle and was invested in a good co (High RoCEs, CFO/EBIDTA above 50% at least, D/E doesn’t increase substantially with capex) – you could have made tons of money. Importance of cycles: 1996-2000 belonged to TMT (Technology, Media & Telecom), 2003-2007 belonged to Real Estate, Power, Infra, Commodity businesses, 2009-2015 belonged to Pharma, FMCG, Consumption & 2015 – 2018 we saw strong cycle in NBFC, Financials, Auto. Remember that if you invested in a good IT company in 2000, there were no returns made for next 10-15 years due to valuations. Similarly, if you invested in FMCG in 1995, there were no returns for next 10 years. So good company is not always a good investment. Cycles remains very important. Big question is “what next?”

Also, what we have learnt is that in the mature sector there will always be 2-3 leaders and don’t try to find any other company which will take their space. If you want to invest in private sector banks – it will always be HDFC Bank, ICICI Bank, Kotak Bank. In paints – it will always be Asian Paints, Berger Paints. In cement – it will always be Shree Cement, Ultratech. The beauty about India is that there are many new sectors which are opening & still not mature & lots of space to grow. So, if you want to fund the NEW leader – focus on that segments. Retail saw rise of D-mart. Exchanges saw rise of MCX. Insurance saw rise HDFC Life, ICICI Pru Life. Asset management saw HDFC Asset Management. Wealth management is opening up. Diagnostics space is opening up. And mind you that all these are spaces which are still growing and have lots of room to grow with 4-5 players and many fighting to come into the top 3 club. Basic point is that we want to focus on new areas where the industry itself can grow +10%. As Prashant Jain of HDFC MF said “Consumer stocks trade at life time high. Soaps, Shampoo, Toothpaste are reasonable mature businesses in India. Per Capital income of India & China was same in 1990 & now China is 5 times India. Don’t expect massive return from consumption sector”. Prashant is clearly betting more on investment outgrowing consumption going ahead.

Let’s start to learn about 1st theme and focus on chemicals as a sector

Manufacturing: Can import substitution be a big theme going ahead & especially with corporate rate taxes cut by India. Imagine, India’s manufactured exports is roughly USD 300 billions which is equivalent to the size of counties like Vietnam, Thailand or Indonesia & China is USD 1.5 trillion. Our Sensex composition has no major manufacturing company. Nearly 30% is financial, 20% global cyclicals like IT, Pharma, Oil & Gas, 20% consumer discretionary. Economies like Japan, Korea, Germany, China all grew with focus on exports & which led to growth in GDP. We have been very bullish on import substitution themes like chemicals, APIs, electronic manufacturing as a disclosure.

Chemicals: China moved from 6% of Global Chemical Industry in 1990 to 41% in 2018. India moved from 1% to 3% in same time frame. China’s growth has slowed from 25% CAGR in 2003-2008 to 13% in 2008-20016. India has picked up with 5% share of global chemical industry from 3%. The global speciality chemical industry is expected to touch nearly USD 1 trillion by 2022 with India expected to receive nearly USD 25-30 billion of absolute demand which means CAGR industry growth of 12-13% annually. Not surprisingly, big boys in the chemical space has been building war chest and doing huge capex since last 2-3 years. Capital spending is likely to grow ~ Rs 20,000 cr over FY19-21E as against ~14,600 cr over last 5 years. Change in gross block of companies like Aarti Ind, Atul Ltd in last 5 years has been more than previous 15 years put together & without taking any significant debt. Cos like Aarti Ind (Leader in Benzene based derivatives with integrated operations), Atul Ltd (integrated chemical co with focus on life science chemicals (32% of revenues), performance & other chemicals (68% of revenue) have grown over 10 times in last 20 years and yet kept RoCE around 20-25% level with no major change in D/E (Atul zero debt) & also controlled working capital days. Alkyl Amines (market leader in aliphatic amines), Sudarshan Chemicals (India’s largest (~35% market share) and world’s fourth largest pigment manufacturer) have done capex lately and show good growth in last 3-5 years. Fairchem Speciality (Renewable Speciality Chemicals with focus on aroma chemicals & oleo chemicals) is a v niche business with emphasis on renewable feedstocks. We will discuss about some stocks below for learning purpose. SRF, PI Ind, Vinati, Divis have crafter the art of entering into complex chemistry (where synthesis process is above 20 times) and becoming the leaders in specific products with cost optimization & long-term supply chain contracts. Because of very strong relationship with the buyers, the working capital is controlled consistently (last 20 years average is less than 1.5-2 months & never increased – data in the chart below) & asset turnover maintained 1.5-2 times, thus enabling strong cash flows which are re-invested into the business & hence we don’t see major equity dilution or increase in the debt (Divi’s has never done equity dilution since listing and remains a debt free co). As per me, that’s the key for any manufacturing company.

Another big learning for us has been to study the past rather focusing on the future projections. Last 20 years data for below mentioned chemical cos teaches us P/L, Cash flows, Balance Sheet together. We can see that which are the cos which have grown not at the expense of high debt or constantly raising equity & have kept RoCE maintained in various cycle and controlled working capital cycle.

The below charts tells about change in gross block and which are the companies who have been investing in the business with an eye on the future. Also, it helps to understand the smart management who saw the big opportunity ahead and started investing in the right time.

Look at chemicals cos in the sub-sector


Some example for study purpose: cos which are leaders, have complex chemistry & not banking on single product

Aarti Ind: RoCE 18%, D/E: 0.6, trades at 20x FY21e EPS

Largest producer of benzene derivatives with market share of various products ranging from 25-40%.

84% of the revenues come from speciality chemicals; 16% from pharma

200+ products, 400+ global customers, 700+ domestic customers, 15 manufacturing plants, 11 zero liquid discharged plants, 3 R&D facilities; +170 engineers & scientists


  1. The biggest driver for co has been its ability to maintain market share and leadership in the products it sells due to strong customer base
  2. Integrated operations across product chain of Benzene and Toluene
  3. 75% of its specialty chemicals products commanding a position in Top-4 globally in chlorination
  4. Very strong chemistry process – 4th in the world in nitration, globally second in ammonolysis, second largest in the world in hydrogenation, and is the first and only player in India to commercialise manufacture of flouro compounds via Halex chemistry
  5. No single company/customer accounting for more than 5% revenue. 85% revenue in FY19 was from customers of over 5 years
  6. Latest contracts signed: 10-year supply contract with agrochemical co for contract value at $ 620 mn (40% EBIDTA margin), 20-year supply contract with speciality chemical co for contract value at $ 1540 mn (10% PAT margin) & 10-year supply contract with a new specialty chemical intermediate for contract value of $125 mn (35% EBIDTA margin)

Outlook: For Aarti, FY20 should be a year of consolidation, before growth accelerates in FY21 given new contract manufacturing projects (Worth 900 cr in revenues commissioning in 4QFY20). RoCE could fall 1-2% in FY20 but should recover in FY21E post commissioning of the capex. Management had reiterated FY20 revenue growth guidance of 15-20% and PAT growth guidance of 12-20%. Capex guidance of Rs 1000-1200 cr in FY20 and Rs 500-600 cr in FY21. The co has additional new 100+ acre greenfield site in Gujarat in addition to the existing 100 acres available at Jhagadia


Alkyl Amines: RoCE 28% (which is not sustainable but anything above 23-25% is good), D/E: 0.2x

Zero pledge, 74% promoter holding, no equity dilution since listing, no related party transactions, sold 30.4% stake in Diamines and Chemicals to focus on the core business

Valuations – 15x on FY21e EPS (HDFC Sec expects EPS of Rs 75 in FY21)

India’s 2nd largest organized aliphatic amines manufacturer with nearly 50% market share. Revenue contribution from 3 main products: Ethyl Amine: 33%, Methyl Amine: 30%, Acetonitrile: 27 – 28%

Despite incrementally strong capex in last few years they have been able to maintains ROCE Co has successfully been able to maintain tight margin band

Year       FY14      FY15      FY16      FY17      FY18      FY19

Capex   -26.3      -41.0      -35.3      -66.0      -135.6    -69.5

ROCE     27.4        24.9        25.1        23.7        23.9        28.0

Gross Margins

EBIDTA Margins

Promoters have never diluted equity. Note: Bonus shares of  1:1 was given in the year 1997

Promoter holding: Hold 74.2% and NIL Pledge


The co plans to spend 300 cr to expand its Methyl Amines and Acetonitrile capacity and derivatives of Methyl Amines over FY20-22E at their Dahej and Kurkumbh facilities. This will support volume growth. Backed by robust demand by the Pharma industry, enhanced capacity addition of Methyl Amines at Dahej, and Acetonitrile capacity, will help the co garner market share. Key monitorable: Further ramp-up at Dahej

There are few good reports from Ambit, HDFC Sec on the aliphatic amines industry which one should study for sure


Fairchem Speciality

ROCE: 18%, D/E: 0.75x, Trade at 15x FY21e EPS

Renewable Speciality Chemicals with focus on aroma chemicals & oleo chemicals

The actual story for the co started since 2016 when Prem Watsa came in the picture – sales grew from Rs 152 cr in FY16 to Rs 1341 cr in FY19. D/E has been less than 1 time since last 10 years

History: Company was called Adi Finechem before Prem Watsa bought 45% in the co. for Rs 145cr and merged with Privi which he bought in 2016 for 370cr (51% stake). An old presentation to understand the structure:

Niche: Procures waste from the pulp & paper mills across the globe to produce aroma chemicals. The co is focused on Pinene based products. Started with 2 products and has now 40- 50 products.

  1. Leader in Amber Fleur and Dihydromyrcenol – important ingredients in the manufacture of Fragrances
  2. The co’s feed stock is from processing of pulp & paper waste – this gives them edge over competitors ((largest single crude sulphate turpentine (CST) processing site in Asia, which is one of the reasons for survival and growth under the current volatile situation in respect of raw materials.).
  3. Long term relationship of more than 10 years with world’s leading companies (Givaudan, Firmenich, IFF, Symrise, Takasago and in FMCG industry – P&G, Henkel, Colgate). Recently they added Reckitt Benckiser also as a customer ((has the potential to contribute to an approximate topline revenue of USD 40 million going forward))
  4. The co has been spending strongly on R&D. The members in the R&D team has increased from 10 -15 few years back to 80 members now

Outlook: The co has guided for at-least 15% CAGR growth with RoE expected around 18% and margins to improve 16% plus. The co is also going through demerger of Adi Finechem. The co has been doing aggressive capex in last 2-3 years.

KEY message from case studies: Above respective cos are leaders in their own space, RoCE expanding along with expansion, D/E is manageable or negligible for all cos, no promoter pledge, margins has been in a tight band with low fluctuations, long term contracts with dependable & big buyers who cannot afford to disturb their supply chain & imp doing complex chemistry business which requires process innovation & strong R&D.

DISCLOURE: Our PMS has holding in the cos discussed above


Some example for study purpose: cos which saw huge rise in stock prices but dependent on single products & hence leads to HUGE volatility in margins

National peroxide

CMP – 1454

52 week high/low:  4532/1272

Hydrogen peroxide is the key product of the company and the price of which has fallen from 115/kg in 2018 to 41 currently. EBIDTA margins have fallen from 65% in Q2FY19 to 11% in Q2 FY20

Last 3 yrs stock chart – stock has fallen from high of 5100 levels to 1450 levels

Sadhna Nitro Chem

Play on nitro benzene

CMP- 107

52-week H/L: 480/78

Sales have fallen from 83 cr  in q2 FY19 to 34 cr  to q2 FY20  3 year chart of Sadhna Nitro

Gujarat Alkalies

CMP- 381

52-week H/L – 595/370

Major product of the company has been caustic soda, prices of which have fallen from 46/kg in feb 2018 to 24.5 currently. Ebidta margins of the company have fallen from 42% n Q4Fy18 to 22% in Q2 FY20.

Stock has fallen from 890 in Jan 2018 to 380 currently

Excel industries

CMP- 793

52-week H/L: 1510/733

Diethylthiophosphoryl chloride (DETC) is the main product with  a market share of 60% in India  – it’s an agrochemical intermediate. Although the company tried to diversify into different products but haven’t received environment clearance thus continuing with focus only on DETC thus impacted by fall in price of the product. Margins have fallen from high of 34% to 22%.

Key Message: It is not that above are not good companies but their over-dependence of single product leads to HUGE volatility in margins.

Like in any business, the leaders in chemical space will be cos with processes, people & long-term contracts. Smaller chemical cos may benefit & have benefitted but dare me say that longevity of earnings will be question mark.  Cos which some a niche, promoters’ skin in the game, huge experienced team with focus on chemistry, long term clients & ability to maintain tight margins with focus on volumes will emerge as leaders. One question I am always asked in CHINA coming back & impacting the industry. The answer is very simple that I don’t know & nobody knows. We search for companies who have performed over last 1-2 decades in good & bad cycles whether China or not. Even when China was growing, these cos grew in the past & have long term clients. Let’s try & invest in a great co as the opportunity size over next 3-5 years could be $20-25 billion or nearly Rs 1.5 lakh or more. Only 2-3 chemical cos in India have sales above Rs 5000 cr….so there is a long way to go. 

PS: We don’t claim to know all & open for any feedback, criticism which will lead all of us to learn more.

Some reading material

Global Business Report on Chemical Ind

Aarti Ind Presentation

HDFC Sec on Chemical Ind

JM Fin on Chemical Ind

Edelweiss on Chemical Ind

(Update- 04/01/2020)-  Specialty Chemicals in  India by AVENDUS

Varinder Bansal

Managing Partner, Pantomath Asset Management. Ex-Corporate Editor & Head of Research, CNBC-TV18

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