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INSTITUTIONAL EQUITY RESEARCH

Specialty Chemical Industry Conclave Key takeaways: Reaffirms long‐term value‐growth

Page | 1 | PHILLIPCAPITAL INDIA RESEARCH

4 October 2016

We organised a ‘Specialty Chemicals Industry Conclave on 28th September 2016 in Mumbai. In this day‐long event, we hosted the following eminent dignitaries from the Indian specialty chemicals’ sector in a panel discussion followed by board‐room meetings with participating companies. Panel participants • Leading specialty chemicals consultant from Shanghai, China • Mr Shekhar Khanolkar, MD, Navin Fluorine International • Mr RK Agarwal, President, All India Plastics Manufacturers Association • Mr Sanjeev G Patil, Group CFO & Hd ‐ Strategy, Fairchem Specialty (Adi

Finechem) • Mr KA Ramakrishnan, Director, Avalon Global Research ‐ Global specialty

chemicals consultant

Boardroom meeting participants:

Navin Fluorine International Leading Chinese consultant Vikas Eco‐Tech Hikal Shree Pushkar Fairchem Specialty (Adi Finechem) Meghmani Organics I.G. Petrochemicals DCW Apcotex AIPMA (Mr RK Agarwal, President) Avalon Global Research

Surya Patra (+ 9122 6667 9968) [email protected] Mehul Sheth (+ 9122 6667 9996) [email protected]

SPECIALTY CHEMICAL INVESTORS’ DAY KEY TAKEAWAYS

Takeaways from the panel discussion Reassures sustained accelerated value growth for Indian specialty chemicals The panel discussion and a detailed presentation on the Chinese chemical industry by one of China’s leading chemical consultants reaffirmed our thesis of “Accelerated value growth for the Indian industry”. The panellists believed that the Indian specialty chemicals industry is set to sustain growth because of healthy domestic demand, backed by strong GDP progress, and rising per capita income. However, the panel emphasised the need to invest in technology platforms, R&D, and IPR, in order to differentiate, create greater customer value, and develop strategic partnerships with customers. Additionally, a presentation by one of the leading chemical consultants from China on the ongoing challenges of the Chinese chemical industry confirmed the incremental exports opportunity for the Indian specialty chemicals industry. Key highlights about China and the inferences for the Indian industry are detailed below:

• China´s emerging middle classes are health conscious and forcing the government to fight pollution; as a consequence, regulation of the chemical industry in China has tightened in the recent past

• China’s government has made it mandatory for chemical plants to operate

from chemical parks. Since only ~45% of that country’s chemical industry is currently based out of such parks, it implies major plant shutdowns or relocations over the next couple of years.

Inference for the Indian industry: With the implementation of strict environment policies in 2015, the Chinese chemical industry has already seen over 1,000 plant shutdowns and ~15% yoy decline in chemical exports in CY15. Such a scenario is likely to continue for a couple more years as a major part of the Chinese industry is likely shift to the green belt. Since Chinese export of specialty chemicals is ~10‐times larger than the Indian industry, a visible slowdown in China could multiply the size of the Indian specialty industry over the next couple of years.

The Chinese chemical industry hasalready seen over 1,000 plantshutdowns and ~15% yoy decline inchemical exports in CY15

• Two important themes from China’s new five‐year plan emerge – (1)

innovation, and (2) implementation of environmental protection. Under innovation, the focus is on moving up in the value chain by reducing heavy industry (implying pressure to cut overcapacity in basic chemicals) and developing R&D capability in selected specialty chemicals.

• While the Chinese government has come down harshly the polluting

chemicals industry, it is keen to provide adequate facilities for complex chemistry R&D. Within this, its focus is towards segments that can achieve global scale, but not on segments that require more customisation.

Inference for the Indian industry: China’s planned efforts to reduce overcapacity in basic chemicals could reduce dumping of many chemicals in the near future, leading to stabilisation in prices of various basic chemicals. Additionally, it would supplement those Indian companies looking for mega basic‐chemicals projects as a strategy to play on import substitution; for example, Deepak Nitrite’s mega phenol plant with an investment of over Rs 10bn would benefit. Although the Chinese government is keen to supplement innovation towards complex chemistry, its core focus remains on scalable segments. Conversely, the Indian industry has been focused on customised products. Therefore, we believe that



with its strategic focus on benzene derivatives and more on customised products of a large portfolio, Aarti Industries (ARTO IN; our top pick, TP of Rs 740) should benefit.

• European chemical companies in China also fear being affected by increased regulation concerning (1) penalties imposed on pollutants, (2) excessive data requirements for new intermediates, and (3) clarity about hazardous chemicals and their handling.

• Salaries as well as operating costs in China are rising relative to

neighbouring countries. Inference for the Indian industry: China’s excessive restrictions on its chemicals industry has already made MNCs start thinking about India as an alternate source, resulting in rapid flow of foreign direct Investment (FDI) into India. We believe this could lead to consolidation and improve the operating efficiency of the fragmented Indian industry.

• Focus areas for China include – organosilicon, organic fluorine compounds (not refrigerants), engineering plastics, thermoplastic elastomers, composite materials, polyurethane, synthetic rubber (isoprene rubber), high‐performance carbon fibre, membranes for water treatment, coal chemicals including downstream derivatives, water‐treatment chemicals and solutions, and electronic chemicals.

Inference for the Indian industry: In its focus areas (see paragraph above) China would offer tough competition to Indian peers, as the Chinese government is likely to facilitate business for these areas. On the other hand, the above mentioned segments are the future area of growth as China –the global manufacturing hub of chemical – believes so. However, India’s industry is favorably placed in the following segments – agrochemicals, coatings (particularly solvent‐based), colours and dyes, intermediates, leather chemicals, refrigerants, rubber additives, and textile chemicals. The players like SRF and Navin Fluorine will be benefited from visible growth opportunities in fluoro‐specialty (For pharma and agro applications due to the innovation involved in the business). On the contradictory Gujarat fluoro might face tough competition from china.



Navin Fluorine International Focus towards fluoro‐specialty to drive value growth About the company: NFIL is into fluorine chemistry –, producing refrigeration gases, some basic building block fluorides, and specialty organofluorine. Its inorganic fluorides offer a portfolio of products that have applications in industries such as stainless steel, glass, oil and gas, abrasives, and electronics. In specialty chemicals, it manufactures fluorine‐based molecules for pharmaceuticals, agrochemicals, and petrochemicals industries. It offers CRAMS for custom‐chemical synthesis of fluorinated compounds for pharma, agro‐chemicals, and specialty chemicals. Key takeaways from the conference: Refrigerant gas segment • Refrigerant gas segment contributed ~34% of sales in FY16, but the HCFC gas

phase‐out will not have any major impact on volumes in the near term. However, NFIL does not have any diversification plans that would de‐risk the phase‐out.

• NFIL indicated a stable R‐22 pricing scenario in the domestic market, but expects pricing pressure in exports to continue, largely due to Chinese dumping. It expects stable demand and pricing scenario in the near future.

Specialty chemicals • It is focusing on developing a strong portfolio of value‐added specialty fluoro‐

intermediates and introducing novel molecules to expand its product offerings. • Successfully commercialised ~15 new fluorinated compounds over the last few

years. • NFIL indicated that the slowdown in its agrochemicals business would continue

for the next few years; hence, it is focusing more on pharma. CRAMS • By leveraging its skills in fluorination chemistry, NFIL will see strong traction from

CRAMS business for pre‐clinical trials and R&D supplies. Many top global pharma innovators are its key customers.

• Key global competitors include Wuxi (China), Lonza (Europe), and Arkema (Europe) – all much bigger than NFIL.

• The company sees 2.5x assets turnover (ATO) from Dewas by FY19. • Its R&D strength: ~160 at Dewas, 30‐35 at the Surat R&D centre, and 20‐25 at

MOL (Manchester organics limited). Others • JV with Piramal is on track; expects to start commercial production by Q4. It sees

1.2x ATO within 12‐18 months of commercialisation. • Expects financial closer of JV with GMDC for fluorspar by the end of FY17. • Sees no major capex in the near term (annual maintenance capex of Rs 250‐

300mn). • There has been a management change in the MafatLal group (Hrishikesh

Mafatlal completely moved out of NFIL and Vishal Mafatlal will be heading it). It does not expect any operational impact due to these changes.



Hikal New proprietary products to lead profitable growth About the company: Hikal is a reliable long‐term partner to companies in the pharmaceuticals, crop protection, and specialty chemicals industries. It supplies research services, active ingredients, and intermediates, manufactured using stringent global quality standards for its global customers. Crop‐protection facilities are located at Taloja and Mahad (Maharashtra). Hikal’s R&D facilities are located at Pune. Its pharmaceutical manufacturing facilities are situated in Jigani (Bangalore) and Panoli (Gujarat). Key takeaways from the conference: • Hikal expects to double revenues in 4‐5 years at a sustainable EBITDA margin of

20‐22%, with both pharma and agri‐chem businesses contributing to growth. • In pharma, it anticipates launching four new products – which would drive near‐

term growth. • In agri chemicals, Hikal grew by 6% in FY16 while other companies contracted by

8‐10% – which shows the strength of the company and its products. • Hikal expects new products to form 20% of revenues after three years. • It is the largest supplier of gabapentin, where Divi’s is a competitor. In agri chem,

PI Industries is its domestic competitor. • In its matured product segments, competitors are backing off. Therefore, Hikal

sees better volumes as well as value prospects here. • Capex of Rs 1.5bn almost equally distributed towards pharma and agri‐chem in

the last three years. • Current pharma utilisation is ~80% while it is ~60% for agri chem. • Asset turnover is low since Hikal is fully backward integrated for most of its

products. It is also looking to outsource few products, especially in the pharma space, to increase its asset turnover.

• Hikal has become more aggressive and is looking at expanding its presence in new markets such as Latin America and the Middle East.

I.G. Petrochemicals Product leadership to sustain growth momentum About the company: I.G. Petrochemicals (IGPL) is a leading manufacturer of phthalic anhydride (PA) from India and claims to be the third largest in the world with a capacity of 170,000 tonnes annually. It is amongst the lowest‐cost PA manufacturers in the world. PA has a wide range of application in end‐user industries such as textile dyes, printing inks, plastic products, paints, and packaging materials. For IGPL, in FY16, plasticiser contributed the highest to sales (41%) followed by paints (16%), CPC pigments (10%), polyester resin (14%), and others (19%). Key takeaways from the conference: • IGPL is one of the largest producers of PA globally. PA is a downstream product

of orthoxylene (OX) – a basic petrochemical used in plasticizers, unsaturated polyster resins, alkyd resins/polyols. It has application in industries including packaging materials, paints, textile dyes, printing inks, and plastic pipes. Its key customers include Berger, Kansai Nerolac, AkzoNobel, and Meghmani Organics.

• Phthalate plasticizer is the largest application segment of PA, accounting for ~60% of PA being used by the PVC industry. Pigment (blue and green) and UPR are other significant end users of PA.

• IGPL has three units at MIDC and Taloja in Raigad with a total capacity of 169,250 MTPA. It commands more than half of India’s total installed capacity of ~300,000 MTPA.




• Global PA consumption stands at 5.5mn tonnes, out of which 50% account for Asia‐Pacific consumption. Demand in the Asia‐Pacific region is expected to show 6.4% CAGR until 2019, while the India PA industry is likely to grow at 7‐8% annually.

• IGPL’s competitive advantages are– (1) it is a low‐cost producer, and (2) it has low customer concentration (no client accounts for more than 10% of its sales).

• Out of its total annual sales contracts with Indian customers, 30‐40% are fixed‐margin.

• The anti‐dumping duty levied on imports of PA has ensured that the domestic market is insulated; however, imports originating from Turkey and Belarus pose a challenge to India’s PA industry.

Meghmani Organics Improvement in capacity utilisation will be the key to growth About the company: MEGH is a well‐diversified chemicals player operating in three segments, i.e., pigments, agrochemicals, and basic chemicals. Pigments account for 33% of its net sales, agrochemicals 31%, basic chemicals 28%, and others 8%. MEGH is now present in 75 countries with over 400 clients. Its pigments business enjoys strong global presence with exports accounting for 72% of net sales. Customers comprise mainly of MNCs such as Sun‐DIC, Flint Group, Akzo Nobel, DuPont, and PPG Industries – 90% business coming from repeat customers. Key takeaways from the conference: • MEGH is the largest manufacturer of phthalocyanine‐based pigments in the

world, with a global volume market share of ~7%. Its vertically integrated facilities for CPC blue and end products such as pigment green and pigment blue give it a competitive advantage – the pigments are crude derivatives and their prices are relatively stable despite sharp correction in crude.

• MEGH has invested Rs 5.6bn over FY11‐16 to build capacities in all three segments; however, there are no major CAPEX plans over the next two years. Maintenance and product registration CAPEX would be around Rs 300‐400mn in FY17.

• It has recently expanded its distributors and dealers chain to 2,300 (from 1,000 in FY15) across 17 states. Moreover, it plans to expand its dealer network further to 7,000–8,000 – to have a PAN‐India presence in the next two years.

• In pigments, MEGH is focusing on high‐margin paint and plastic markets, whereas in basic chemicals it has added a new caustic potash facility at Dahej with an investment of Rs 650mn with a revenue potential of Rs 1.25bn

• MEGH’s closing debt stand at Rs 2.81bn; it plans to repay Rs 600mn in FY17. • It indicated no additional long‐term debt entering the balance sheet, as it has no

new major capex plans for the next two years. • China movement has no major impact on its business, as MEGH is mainly into

pigments and insecticides and China is a net importer of these chemicals.

Vikas Eco Tech Ramp up in specialty additives is the key About the company: Vikas was incorporated in 1984. It is into manufacturing and distribution of specialty polymer compounds and additives since 1998. It manufactures high‐end products used in agriculture/infrastructure components, wires & cables, auto parts, textiles, electrical goods, medical goods, writing instruments, organic and inorganic chemicals, footwear, and packaging, among others.


Key takeaways from the conference: • Its business segment includes specialty rubber/plastic compounds (~59% of

sales), specialty additives (22%), and trading (19%). • In FY16, it had sales of 500MTPA to domestic markets and exports of 1058MTPA.

It expects sales to jump to 800‐900MTPA in domestic and exports at 1600MTPA in FY17.

• Vikas has planned an investment of Rs 300mn to add a new organotin stabilisers capacity of 1200MTPA by October 2016 (current capacity at 1800MTPA) and another 6000MTPA capacity addition in Dahej (land acquired and civil work started), as well as 5,000MTPA capacity addition in special polymer by FY18.

• It faces global competition from two large companies – Galatin and PMC. • Its products are priced at 2‐4% discount to the US manufacturers’ prices, and at a

slight premium to Chinese ones. • Its current list of clients includes Prince, Bassillprompt, and Apollo Pipes. • Its working capital cycle was 180 days in FY16, which it plans to reduce to 3‐4

months soon. • It has developed R&D capability to meet international standards of quality,

resulting in several interests from the LatAm market. It has initiated trial orders for one of Mexico’s leading petrochemical giants for organotin stabilisers.

• It is focused on acquiring new clients from PVC pipes, footwear, automobiles, and packaging sectors in India (to supply specialty additives and plastic compounds).

Fairchem Specialty (Adi Fine chemicals) Business in safe hands for strong growth About the company: Fairchem Specialty is a merged entity of Adi Finechem (AFC) and Privi Organics (PO). AFC is an India‐based company manufacturing oleo chemicals and intermediate neutraceuticals. It manufactures products such as linoleic acid, dimer and monomer acid, and nutraceutical intermediates such as natural mixed tocopherol concentrate. It has a manufacturing unit at Sanand in Ahmedabad, Gujarat. Privi Organics is one of the leading manufacturers of aroma chemicals such as Amber Fleur, dihydromyrcenol (citrus character), and citral derivatives. The combined entity will be renamed Fairchem Specialty. Privi enjoys a dominant position and economies of scale in all its product categories. Moreover, its new production site (Unit‐3 at Mahad) began commercial production and would provide long‐term stability to the business. Key takeaways from the conference • Fairfax acquired 45% stake in the company in February 2016 and the company

will be renamed Fairchem Speciality Ltd after its merger with Privi organics. • In consideration of the merger, Adi will issue 27 equity shares of Rs 10 each and

27 compulsory convertible preference shares of Rs 10 each for every 40 equity shares of Rs 10 each of Privi. The swap ratio is based on Privi’s post‐money equity value of Rs 7,250mn and Adi’s market cap of Rs 3,969mn.

• The two companies Adi and Privi produce 60+ types of high performance niche chemicals with end use in varied industries such as paints, adhesive, inks, FMCG, and perfumes.

• The merged company will develop processes to add value to various by‐products formed in the manufacturing process, leading to further expansion of operating margins.

• After the merger, it expects turnover to double in 4‐5 years with Adi contributing Rs 1.7bn and Privi contributing Rs 7.7bn.

• Adi Finechem has expanded its capacity to 45,000MTPA in 2016 from 8,000MTPA in 2010, and Privi Organics has an installed capacity of 22,000MTPA (four manufacturing plants).



• With a strong 60‐member R&D team, Fairchem will develop alternate and more competitive manufacturing routes and then scale up its process – from grams to kilograms, to metric tonnes.

• Fairchem is working towards scale up of a green enzymatic fat‐splitting technology that will provide cost advantage over the traditional process. Privi is setting up a unique modern pilot plant at Navi Mumbai in collaboration with the Institute of Chemical Technology – the first of its kind in India to undertake various researches under one roof.

Apcotex Industries New acquisition to provide fillip to growth About the company: Apcotex was started as a division of Asian Paints in 1980. It was spun off as a separate company in 1991 as Apcotex Lattices. It changed its name from "Apcotex Lattices" to "Apcotex Industries" in June 2005. Apcotex Industries is one of the leading producers of performance emulsion polymers in India. Its manufacturing facility is at Taloja, 25 kilometres from Mumbai. Its product range includes VP latex, carboxylated and non‐carboxylated SB latexes, acrylic latex, nitrile latex, and synthetic rubber. Its latex product range is used for paper/board coating, carpet backing, concrete (concrete modification, water proofing), tyre, paint, textile finishing, and automotive components. Its synthetic rubber product range is used for footwear and other products. It has an ISO certification and has received several awards for manufacturing. Key takeaways from the conference: • Apcotex recently acquired Omnova Solutions. • It produces both synthetic rubber (~35% sales) and nitrile rubber (~65% sales). • Apcotex expects nitrile rubber growth to be strong (10‐15%) in the medium term

due to its huge potential in domestic and export markets; synthetic rubber growth would be flat in the medium term.

• Going forward, Apcotex plans to manufacture synthetic rubber in Taloja. • Omnova Solutions, at the time of acquisition, had negative EBITDA margin;

currently it has an EBITDA margin of 3‐4% and Apcotex plans to bring it to 12‐14% in the medium term.

• Apcotex has 42% market share in paper & paperboard coating, 25% share in tyre coating, 60%+ share in carpet backing, 85% share in synthetic rubber, and is also strong in construction chemicals, footwear soles, and textile finishing.

• It plans to invest Rs 400mn out of which Rs 300mn will be invested on the Valia plant (Gujarat).

• It expects volumes to increase by 10‐15% every year.

Shree Pushkar Chemcials & Fertilisers Diversification in the right direction About the company: Recently, SPCFL concluded an IPO worth Rs 700mn for setting up of a plant for manufacturing reactive dyes along with plants for manufacturing of h‐acid and vinyl sulphone ester on a new plot of land near its existing works at MIDC Lote Parshuram, district Ratnagiri. Its capacity expansion includes – 750tpa of h‐acid, 1,000tpa of vinyl sulphone, and 10,000tpa of sulphate of potash (SOP) for fertiliser. Capex on these three projects would be Rs 480mn. SPCFL manufactures dye intermediates with a capacity of 7,836TPA. Its product line comprises of dye intermediates (gamma‐acid, k‐acid, vinyl sulphone, h‐acid), acids (sulphuric acid, oleums), cattle‐feed supplement (di calcium phosphate‐DCP), and



fertilisers (single super phosphate‐SSP, soil conditioner). Capacity – 3,000tpa for dyes, 750tpa for h‐acid, and 1,000tpa for vinyl sulphone. Domestic clients include Vinati Organics, Atul, DCM Shriram, Megmani Dyes, and Amul; Huntsman among international clients. It has an exclusive marketing arrangement with Shriram Chemical & Fertilizers for SSP in Maharashtra and Karnataka and has tied up with Shivam Chemicals for marketing of DCP in Karnataka. It has also launched its own soil conditioner brand named Dharti Ratna. It has 125 dealers. Key takeaways from the conference: • Dye intermediates have a 74% share, fertiliser 16%, and DCP/sulphuric acid 8% in

terms of both value and volumes. • The dye business results in acid production along with significant waste, but the

company created demand for its by‐products and converted its waste into commercially viable products – which made it a zero‐waste player, thereby improving its operating efficiency.

• It began operations for new reactive dyes plant with a capacity of 3,000MTPA and additional vinyl sulphone capacity of 1,000MTPA in Q1FY17. It also plans to expand its dyes capacity further to 6,000MTPA by the end of Q3FY17.

• To meet its captive requirement, SPCFL will add two plants for dye intermediates and planned h‐acid capacity of 750MTPA is likely to be commissioned in Q2FY17.

• It has received a license for manufacturing mixed fertiliser NPK in Maharashtra. It has a marketing tie‐up with DCM Shriram, which it launched under the brand ‘Shriram Urja Mix’ in Maharashtra.

• In August 2016, it commissioned Sulphate of Potash (SOP) with a capacity of 10,000MTPA; commercial production will begin from September 2016. It is also setting up a calcium‐chloride plant with a capacity of 7000MTPA to utilize HCL (hydrochloric acid) generated in Sulphate of Potash.

• SPCFL is looking at exploring a growth opportunity in the textile auxiliary chemicals space, for which it has created a capacity and expects to start commercialisation in FY18.




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1 Whether compensation has been received from the company(ies) covered in the Research report in the past 12 months for investment banking transaction by PCIL

No

2 Whether Research Analyst, PCIL or its associates or relatives of the Research Analyst affiliates collectively hold more than 1% of thecompany(ies) covered in the Research report

No

3 Whether compensation has been received by PCIL or its associates from the company(ies) covered in the Research report No4 PCIL or its affiliates have managed or co‐managed in the previous twelve months a private or public offering of securities for the

company(ies) covered in the Research report No

5 Research Analyst, his associate, PCIL or its associates have received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in the Research report, in the last twelve months

No

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