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Apart from a few selective names like Bajaj finance, HDFC only chemical stocks have not disappointed in terms of earnings growth and there are strong reasons why chemical companies in India will continue to do good in the near foreseeable future.
Why is it so?
The reason is
a) Due to rising labor costs in China, Indian chemical companies are far more competitive compared to their Chinese counterparts.
b) The U.S China trade war helping Indian companies to win long term contracts from end-users in the U.S and in U.K / Europe.
c) and of course due to pollution in China lots of supply has been taken out temporarily.
Why are we comparing w.r.t China?
because the enormous base that China’s chemical industry now constitutes— around $1.5 trillion of sales in 2017, amounting to nearly 40 percent of global chemical-industry revenue—means that, there is a lot to gain for Indian chemical companies from China if we compare to the size of Indian chemical market which is just USD 163 billion in FY18.
Historically chemical manufacturing has shown a consistent trend of moving away from Developed economy to Growing economies due to reasons like cheap labor and pollution discussed above.
There is a huge opportunity for India to move from a relatively small base of 3.5% ( as shown above) today to may by 15-30% in a decade or so, especially when labor costs in China have gone up significantly compared to India as shown below –
On top of that the US-China trade war have also impacted the production growth in China. Currently, the US accounts for nearly 15% of China’s export basket.
Which might shift to India as U.S companies trying to de-risk their supply chain.
All these factors are pushing the CAPEX and OPEX costs upwards, making Chinese chemical companies less competitive in the export market.
Okay, So what’s so special about Chemcrux Enterprise Ltd?
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The reason is this company is just trading very cheap, perhaps the most important reason for all before buying any stock.
The Market Cap: Rs 49.86 Cr.
In Fy19 company did Revenue of Rs 55 Cr ( not even trading 1x sales) and Net profit was about Rs 9.2 Cr.
The management is working towards 3 digit revenue over the next 3 years, That means if margins are maintained company will do around Rs 20 Cr of profit i.e, trading around 2.5 times Fy 22 earnings.
Here the guidance from the promoters –
Well, there is nothing new here, For good reasons Stocks do trades 1x sales, 2.5 x forward earnings, what’s the catch here?
I don’t know if markets know something that I don’t know and it might trading cheap for a good reason, let’s try to brainstorm on this –
The possible reasons why a company trades 1x sales or 2x earnings If markets think the following –
1) Over time company revenue/ profits going to become half and half and so on –
That means the company is trading very expensive (even at 1x sales) w.r.t 10 years forward earnings – There are good reasons to believe that’s not the case with ChemCrux ( we will see later on why.)
2) Another reason why stocks trade cheap if its run by dishonest management –
For these companies, any multiple is high as all the profit earned never going to find its way to minority shareholders, this too not the case with ChemCrux as well (we will see later on why.)
3) Third reason you might find 1x sales or 2.5x net profits stocks if its a highly cyclical business operating at its best-ever margins and markets believe the tide is going to turn over the next couple of years –
This I am not sure and we will have to contemplate but even if margins cyclically go half in the next 3 years the company still trading at 5x Fy22 earnings. so, it’s all priced in.
4) The fourth reason might be as simple as just liquidity, because of lack of liquidity it might just happen to be trading at a significant discount to its fair value –
This I believe could be the case as it’s listed in the SME platform and It trades in lot size of 2000 shares ( about Rs 2 lacs per lot) and float of just 13 lac shares in the market. That means a total of 650 lots are there with the public, no more than 650 shareholders are possible.
Alright! sounds good. So, What this company does?
This is from their DRHP –
Interesting thing about their business is –
1. They do chemical processes like Oxidation, Chlorosulfonation, Nitration and Acetylation forb for bulk drugs, dyes and pigments ( higher up in the value chain of chemicals ).
2. They also undertake customer-specific processing activities & also manufacture as per customer requirement (that’s actually specialty chemical in my view).
You know this is a buzz word nowadays, What is actually specialty chemical?
Good question, This is what street believes what it means –
Street believes all the downstream chemicals towards the end of the value chain are specialty chemicals.
I don’t agree with the street definition of Speciality chemicals. it should be something special custom made for the customer, It’s not a good idea to have a generic definition to define something special.
So, for me, it’s not something which is going into for example Shampoo, Speciality
should be something tailor-made as per end customer (Eg – J&J) requirement to go into a (J&J) baby shampoo explicitly and I am sure J&J for its baby shampoo won’t be buying something from open commodity chemical market.
Okay got it, what’s so special about Chemcrux Enterprise?
From ChemCrux IPO DRHP –
We develop new products based on customers requirements (looks like some kind of specialty chemical as per our definition)
Our foundation is in process-based manufacturing and not product-based manufacturing.
The company has a multipurpose process-driven plant, which they can use to produce any product they want using the very same in house developed processes.
This is what management mentioned in one of the magazine interviews –
“Our strength of In-house technology development and versatile design of plant, machinery, and infrastructure of the company assures very high versatility for product changeover. This helps us to adapt to the market demand easily. “
Hold on, I am confused here, what all are those processes & what kind of products have done in the past?
Okay, They do processes like Oxidation, Chlorosulfonation, Nitration, and Acetylation forb and as per IPO DRHP in 2017 they did the products like bulk drugs, dyes and pigments shown below – All kinds of Choro Benzenes.
That means the company has process-oriented ( not product-oriented ) plant, this gives them flexibility/nimbleness to change product mix as per markets dynamics
but I believe this might restrict them also to build scale to the very large volume production (where you want to do the same thing over and over again.)
What is the capacity they got and any plan for Capex?
The installed overall capacities for oxidation, nitration, chlorosulfonation, and other products as of now are 2500 MT per year.
Here is what management said about future Capex plan –
From IPO DRHP –
This looks good but why there is a dip in capacity utilization during Fy13-14 and 14-15? What really happened? Can it happen again?
A good observation, This is something that happened before IPO and I cannot and any information related to this in any public documentation related to the company, something investors should clarity from the management.
Okay, If we assume what they project is what they achieved in Fy18 & Fy19. Then from where the growth in Fy19 came from as capacity utilization levels look the same? Did they beat their own capacity utilization estimates?
Yes, you are right in Fy19 their revenue grew 76% but net profits grew about 300%. The reason for the growth has been put out by management shown below –
There is a mix of reasons for both Revenue Improvement by 76% and Marginimprovement from 7.3% to 16% as mentioned above.
Revenue improved due to –
a) The production capacity was optimally utilized as a plant ran for full-year compared to 10 months in Fy18.
b) Better pricing of niche products which contributed about 20% share in revenue growth.
and they took a series of majors to improve the margins –
a) Debottlenecking of the processes –
What they mean by this? One reason I could think of is the backward integration CAPEX they did in Fy18.
One of the raw material they used to outsource is ICE and availability of ice is as crucial as anything else as mentioned in the risks section of DRHP shown below –
there could be an instance of non-availability of ice affecting production or margins in past and in DRHP they mentioned fixing this dependency by expanding the internal capacity of chilling plants which might have helped to improve cost efficiency.
and one more reason for margin improvement is due to better value-added products CAPEX they planned in Fy18, a note from DRHP below –
and they might have realized better prices due to growth in exports as well – The total percentage of exports in total revenue has been 15% on average in the last three years. Value-wise, the company has registered continuous growth in exports and the company’s exports have increased in absolute terms by 22% in FY2018-19 vis-à-vis FY2017-18.
That sounds okay, who are really the end-users?
Strong client base across various sectors like pharma, pigment, dyes assures a consistent demand for the company’s various products from the niche product basket. We have a strong client base of MNC pharma majors in the domestic & overseas markets
Cool that’s interesting, then why the company is trading this cheap? How about the balance sheet? Arey they heavily leveraged, Is it because they are walking on a very tight rope?
Not at all, In Fact, the balance sheet looks clean and healthy –
The Liquidity and Return Ratios looking extremely good –
And the most wonderful thing is this business has a negative net trade cycle, Generally, businesses that get paid in advanced have this quality.
Link for the financial data –
How is the outlook looks like?
And what about management?
The promoters own 72% of the company, they seem to be from a very modest background. They have done master’s in chemical engineering from IIT B and IISC Bangalore.
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Thanks, Dhruva Pandey Email : email@example.com Download BuffettoMungology App – BuffetoMungology Twitter : https://twitter.com/Dhruvapandey Twitter Handle : @Dhruvapandey