– Q1 result impacted by weak demand offtake in agrochemicals
– Major projects receive environment clearance
– Change in sourcing strategy for methanol to help tide over Iran sanctions impact
– Growth to pick up in H2
The stock of Balaji Amines (CMP: Rs 319, Mcap – Rs 1034 crore), a leading manufacturer of Aliphatic Amines in India, has been among the worst impacted in the last six months on account of scores of profit warnings from the global chemical majors such as BASF and ADAMA. Further, its key end-markets – agrochemicals and API (active pharmaceutical ingredient) – have been witnessing subdued growth. In addition, sourcing of methanol, a key raw material, had raised a few concerns due to the sanctions on Iran. The company’s Q1 results reflected some of these headwinds.
We believe that most near term growth concerns are already in the stock price and the company has taken care of challenges posed by the Iran sanctions. Additionally, we believe that the street is yet to factor in multiple tailwinds such as recent environmental clearances for key projects and the resultant volume growth expected in the near term.
Chart: Q1 financials
Q1 FY20 sales declined by 11 percent YoY mainly on account of lower volume offtake in the agrochemical end-market. Sales volume for the first quarter was 20,149 tonnes, down 7.1 percent YoY.
EBITDA margins contracted to 16 percent (from 22.5 percent in Q1 FY19) largely due to high cost raw material (methanol) inventory and the high base of last year.
Recently, company got the environmental clearance for the capacity expansion of key products – Acetonitrile, Morpholine and Di Methylamines HCI (DMA HCL), along with other offerings.
Acetonitrile and Morpholine, which are used for antibiotic drugs and rubber chemicals, respectively, would add to incremental sales in FY20. The company plans to manufacture Morpholine (capacity: 10,000 tonnes) at 80 percent and Acetonitrile (capacity: 9,000 tonne) at 50 percent utilization. On account of volatility in prices of Acetonitrile, company also plans to benefit from the production of a fungible product called Tetrahydrofuran (capacity: 8000 tonne) which has applications in pharma and agrochemicals. Tetrahydrofuran can be manufactured on the same manufacturing line as Acetonitrile.
Note that DMA HCL is used as a pharma ingredient for Ranitidine and Metformin (diabetic drug). However, new capacity of DMA HCL would be utilised later when the market situation improves.In case of its subsidiary, Balaji Speciality Chemicals, where it has 55 percent stake, the firm has got the environment clearance on June 2019. The subsidiary has commenced production of specialty chemicals such as Ethylene Diamine (capacity: 22,000 tonnes), Piperazine (PIP) and Diethylenetriamine (DETA) which have been imported so far in India. The key application for Ethylene Diamine (EDA) is for fungicide Mancozeb. It is noteworthy that India imports about 29,000 tonne EDA every year. Among the likely domestic clients for EDA are Coromandel, UPL and Indofil. Coromandel has added a 10,000-tonne capacity in the Mancozeb segment, last year, taking the total installed capacity to 45,000 tonnes..
One key product where in the production capacity is not optimally utilized is DMF (Dimethylformamide). This is due to huge dumping of goods in India. In FY19, India imported 46,000 tonnes of DMF at lower prices. On an annual basis, Balaji Amines manufactures around 6,000-7,000 tonnes of DMF while having capacity of 30,000 tonnes.
Second, the company plans to start land digging for a greenfield project soon. Production is likely to start fifteen months later. In the first phase (capex of Rs 200 crore), company is adding capacity for ethyl amines (18,250 tonnes) and either Mono Isopropyl Amine or Isopropyl Amine (20,000 tonnes). There is heavy import dependency in India for Isopropyl Amine which is used for herbicides/pesticides and pharma drugs catering to cardiovascular aliments.
Except for DMF, the company is currently operating at a capacity utilization of 80-85 percent for most products. In addition, environment clearance for products such as Acetonitrile and Morpholine has recently arrived. This provides a leeway for 10 percent volume growth in FY20 mainly backed by improved demand during the second half of current fiscal. The management provided a sales guidance of Rs 1,050 crore for the standalone business which we expect to be largely achieved through volume growth. Further, the management expects Balaji Speciality Chemicals to contribute about Rs 90 crore sales in FY20 as it would be in full swing towards the latter half of FY20.
Second, changes in raw material procurement strategy is expected to help Balaji tide over uncertainty in sourcing methanol from Iran. About one-third of requirement is now sourced from Saudi Arabia and the rest through domestic traders who in turn source it from other countries. The company is now purchasing it on a spot basis which should also help it to avoid inventory losses in the near future. Based on this, we expect Balaji to report 18-20 percent EBITDA margins in the medium term.
Over a longer term, we remain positive on the company’s strategy of targeting new product capacities focused on import substitution. The next growth lever for the company comes from its greenfield project. It is likely to contribute meaningfully from FY22 onwards. The project is expected to add about Rs 400 crore to top line in FY23.
Another structural factor which continues to favour Balaji Amines is China’s clampdown on polluting industries and stricter regulation on operational safety. This will lead to a favorable demand-supply situation. As a follow up to the industrial explosion at a chemical plant in China’s Jiangsu province in March 2019, China plans to close 9 chemical parks and 1431 chemical companies in the province.
Further, Balaji will also be among the key beneficiaries of the corporate tax cut in India.
The stock is trading at 6.5x FY21 estimated earnings which is at a sharp discount to its peers. While it has recovered from its 52-week lows, we believe recent developments for the stock in terms of various environment clearances and stable sourcing of raw materials are still not fully priced in.