Aarti Crisil

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    Enhancing investment decision

    Independent Equity Research

    Indepth analysis of the fundamentals and valuation

    Co r p o ra te Go ve r na n ce

    e c B u s i n s s P ro s p e t s

    E va t io n o f g e t l ua Ma na e m n

    n n i l P e r m a n c e F i a c a f o r

    Aarti Industries Ltd

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    CRISIL Independent Equity Research TeamSenior DirectorS. Venkataraman

    Chetan Majithia [email protected] +91 (22) 6644 4148Suresh Guruprasad [email protected] +91 (22) 6691 3531

    Vishal Rampuria [email protected] +91 (22) 6691 3525Sagar Parikh [email protected] +91 (22) 6691 3502Nihag Shah [email protected] +91 (22) 6691 3533Bhaskar Bukrediwala [email protected] +91 (22) 6644 1983Ravi Dodhia [email protected] +91 (22) 6691 3508Urmil Shah [email protected] +91 (22) 40978135Neeta Khilnani [email protected] +91 (22) 6644 1882

    Nagarajan Narasimhan [email protected] +91 (22) 6691 3536 Ajay D'Souza [email protected] +91 (22) 6691 3567Manoj Mohta [email protected] +91 (22) 6691 3554Sachin Mathur [email protected] +91 (22) 6691 3541Sridhar C [email protected] +91 (22) 6691 3546Sudhir Nair [email protected] +91 (22) 6691 3526

    Vishal Thakkar [email protected] +91 98 201 86264 Vinaya Dongre [email protected] +91 99 202 25174Sagar Sawarkar [email protected] +91 98 216 38322Sejal Kothari [email protected] +91 99 206 25746Gayathri S [email protected] +91 98 864 98175

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    Explanation of CRISIL Fundamental and Valuation (CFV) matrix

    Fundamental Grade

    CRISIL Fundamental Grade Assessment

    Valuation Grade

    CRISIL Valuation Grade Assessment

    Disclaimer:

    The CFV Matrix (CRISIL Fundamental and Valuation Matrix) addresses the two important analysis of an

    investment making process - Analysis of Fundamentals (addressed through Fundamental Grade) and Analysisof Returns (Valuation Grade)

    CRISIL's Fundamental Grade represents an overall assessment of the fundamentals of the company graded in relation toother listed equity securities in India. The grade facilitates easy comparison of fundamentals between companies,irrespective of the size or the industry they operate in. The grading factors in the following:

    Business Prospects: Business prospects factors in Industry prospects and company's future financialperformanceManagement Evaluation: Factors such as track record of the management, strategy are taken intoconsiderationCorporate Governance: Assessment of adequacy of corporate governance structure and disclosure norms

    The grade is assigned on a five-point scale from grade 5 (indicating Excellent fundamentals) to grade 1 (Poorfundamentals)

    5/5 Excellent fundamentals4/5 Superior fundamentals3/5 Good fundamentals2/5 Moderate fundamentals1/5 Poor fundamentals

    CRISIL's Valuation Grade represents an assessment of the potential value in the company stock for an equity investorover a 12 month period. The grade is assigned on a five-point scale from grade 5 (indicating strong upside from the currentmarket price (CMP)) to grade 1 (strong downside from the CMP).

    5/5 Strong upside (>25% from CMP)4/5 Upside (10-25% from CMP)3/5 Align (+-10% from CMP)2/5 Downside (negative 10-25% from CMP)1/5 Strong downside (

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    List of companies under coverage

    Sl. No. Company Name Fundamental grade

    1 Aarti Industries 3/52 ABG Shipyard Ltd 3/53 Apollo hospitals 4/54 DLF 3/55 Dolphin Offshore 3/56 EID Parry 4/57 Everest Kanto 4/58 Hero Honda 5/59 Indiabulls Securities 4/510 JBF Industries 3/511 JM Financial 4/512 NTPC 5/513 Pantaloon Retail (India) 4/514 Phoenix Mills 2/515 UTV Software Communications 3/5

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    1

    Independent Research Report arti Industries LtdGood Fundamentals and Strong Upside Industry: Chemicals

    Date: 4 December 2009

    Leading player in benzene-based derivative productsAarti Industries Ltd has been able to establish a dominant market position in benzene-basedspeciality products, due to the business acumen and technical expertise of its promoter,

    Chandrakant Gogri.

    Good operating efficiencies developed through technical expertiseProcess-based production competency has helped Aarti be the most competitive,operationally, as well have economies of scale. Given its technical expertise, the companyhas the capability to change the product mix, based on demand. Its capacity to producespeciality products in small batches competitively, gives it a distinct advantage over others.

    Diversified revenue profile offers stable revenuesAartis products serve a variety of segments and have a wide customer base, therebyowering the risk of dependence on a particular segment. Further, its revenues are fairly

    balanced between domestic and export markets (that are also diversified). Revenue growthhas shifted from low-margin basic chemicals to speciality chemicals and pharmaceutical

    products, lending stability to revenues and margins.

    Foray into pharmaceuticals to benefit in the medium termThe US food and drug administration (USFDA) approved Aartis active pharmaceuticalngredients (API) unit in May 2008. Aarti filed 19 drug master files (DMFs) and has been

    working on 30 lifestyle-related drugs such as steroids and those for hypertension and cancer.Pharmaceuticals contribution is set to increase from around 6.5% now to 9.8% in FY14, afive-year CAGR of 14%.

    Revenue growth to be annually 11%; margins to remain stablen line with the decline in chemicals prices, we expect the top line to de-grow in FY10 before

    picking up from FY11 onwards, mostly driven by volume growth. Specialty chemical revenuesare expected to grow 1 1 % annually over the next four years; and EBITDA margins are likely

    o be stable as Aarti follows a cost plus margins pricing model. Overall margins will improveslightly as pharma margins will pick up. We expect Aarti to post a profit after tax (PAT) of Rs754 Mn and Rs 901 Mn in FY10 and FY11, respectively.

    Challenges include feedstock price volatility, limited margin upside andconstant innovationAs Aartis raw materials are derived from crude oil, its revenue and profitability are highlyinked to movements in crude oil prices. Due to the cost plus margins nature of its business,ts margins are stable, but upside is limited. Also, specialty chemical players are required to

    develop new products to meet changing applications and client needs, which necessitateconstant innovation.

    We assign Aarti 3/5 on fundamental and 5/5 on valuation

    Aartis fundamental grade of 3 indicates that its fundamentals are Good relative to otheristed securities in India. This grading factor in Aartis experienced management and technical

    prowess. However, the fundamental grade is tempered by the volatility in chemical industryand low bargaining power of mid-sized players. A valuation grade of 5 indicates Strongupside (fundamental value of Rs 56) to the current market price.

    Key forecast(Consolidated financials)(Rs Mn) FY08 FY09 FY10E FY11E FY12EOperating Income 8,881 14,434 11,984 13,307 14,787EBITDA 1,295 2,513 1,977 2,196 2,451Net Income 476 990 754 901 1,057EPS-Rs 6.5 13.6 9.9 11.9 13.9EPS growth (%) 56% 108% -27% 19% 17%BV per share (Rs) 41 50 57 66 77PE (x) 6.7 3.2 4.4 3.7 3.1P/BV (x) 1.1 0.9 0.8 0.7 0.6ROCE(%) 14.8 26.9 17.3 17.9 18.7ROE(%) 16.8 29.8 18.8 19.3 19.5EV/EBITDA (x) 5.7 3.2 3.8 3.3 2.9Source: Com an CRISIL E uities Forecast

    CFV matrix

    Fundamental grade of '3/5' indicates good fundamentals

    Valuation grade of '5/5' indicates s trong upside

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    Key stock statisticsFundamental Price 56Current Market Price 44Shares outstanding (Mn) 73Market cap (Rs Mn) 3,178Enterprise value (Rs Mn) 7,93952 week range (Rs) (H/L) 57/26P/E on EPS estimate (FY10E)(x) 4.4Beta 1.24Free float (%) 52.8%

    Average daily volumes 188,758

    Share price movement

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    Index

    Aarti Ind. S&P CNX NIFTY

    - Indexed to 100

    Analytical contactChetan Majithia (Head, Equities) +91 22 6644 4148Jitesh Karlekar +91 22 6691 3515Email: [email protected] +91 22 6691 3561

    Please refer CRISIL Disclaimer at the bottom of the last page

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    CRISIL Equities

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    Fundamental Grading Grade:3/5

    We assign Aarti a fundamental grade of 3. This grade indicates that the companysfundamentals are Good relative to other listed securities in India. It also factors in

    several aspects such as: Aarti is a leading player in nitrochlorobenzene (NCB) - based specialty products.It manufactures API, offers 150 products and is a market leader in more than75% of its top 50 products. This product diversity offers stable revenues.It has the largest domestic NCB capacity of 60,000 tonnes per annum with itsclosest competitor capable of 15,000 tonnes only. Aarti offers a wide variety ofproducts, as it can switch production and roll out in small batches. This positiveaspect, backed by economies of scale and integrated operations, offers Aarti acompetitive advantage.NCB-based products cater to varied sectors such as pharma, dyes, pigments,rubber chemicals and agrochemicals. It has lower client concentration as its top-ten clients account for less than 25% of revenues.

    Aarti has followed a forward integration strategy and can offer value-addedproducts. Surfactant Specialties Ltd, which makes products for oral and personalcare was merged with Aarti, leading to increase its presence in the FMCGsegment.Being a specialty chemical player, Aarti follows the business model of innovatingnew products leading to continuous R&D expenses, thus impacting margins.The company has less bargaining power with its raw material suppliers who arelarge petrochemicals players. Prices of the key raw material- benzene, tends tobe volatile due to demand-supply conditions and crude oil price movements.

    However Aarti has been able to pass on the increase in raw material prices as itproduces specialty products and has few competitors.

    Aartis strong R&D skills and advantage in producing API and other pharmaproducts has made it keenly focus on the pharma segment. It has even set upR&D centres in Maharashtra and Gujarat, with 80 technical staff.Revenue is expected to de-grow by 17% in FY10 to Rs 11,984 mn due to lowerrealisation, which is in line with reduction in prices of key raw-materials, but riseto Rs 13,307 Mn and Rs 14,787 Mn in FY11 and FY12, respectively. Over thenext five years, revenue from speciality chemicals and pharmaceuticals isexpected to grow at CAGR of 11% and 14% respectively, mainly on the back ofincreased volumes.

    Aarti has a balanced mix of domestic (62%) and exports (38%) market, adiversification likely to ensure revenue stability.Export revenues are expected to increase at a 3 year CAGR of 6 % due toincreased turnover from its USFDA-approved API unit. Further its foray intolifestyle drugs will boost its exports.We expect the company to post a PAT of Rs 754 Mn and Rs 901 Mn in FY10and FY11; and EPS of Rs 9.9 and Rs 11.9 respectively.

    Aartis management is technically sound and has enough industry experience.Disclosure standards are relatively good.

    Fundamentals are Good relative toother listed securities in India

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    CRISIL Equities

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    Grading Rationale

    Revenues to be driven by growing pharma business

    Revenues from the pharmaceutical segment grew at a CAGR of 35% from Rs 545 Mnin FY07 to Rs 1002 Mn in FY09. This has been due to increasing focus on research,manufacturing APIs and advanced Intermediates for APIs. Pharma segment revenuesare expected to grow from Rs 1,002 Mn in FY09 to Rs 1432 Mn in FY12.

    Figure 1: Pharma segment revenue growth

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    10021083

    1245

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    FY08 FY09 FY10E FY11E FY12E

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    Pharma revenues

    Source: Company annual reports

    Aarti has two API manufacturing units at Dombivli and Tarapur in Maharashtra. TheTarapur facility has been recently awarded the US food and Drug Administration(USFDA) approval. This is likely to lead to higher revenues from exports to regulatedmarkets and out-sourcing contracts from global players. It also has an in-houseResearch and Development (R & D) Centre, which is recognized by the Department ofScientific and Industrial Research (DSIR), Government of India (GOI) employing over80 Doctorates.

    Aarti has filed 19 drug master files (DMFs) and has been working on 30 lifestyle-relateddrugs such as steroids and those for hypertension and cancer. The technical expertise

    and advanced manufacturing facilities is expected to give higher revenues from thepharmaceutical segment.

    Good operating efficiencies developed through technical expertiseThe technical expertise of the promoters has also helped to develop expertise inmanufacturing process, introduce new products and optimize on the energy and utilitiesconsumption by use of indigenous technologies and resources. Aarti is able to offerwide variety of over 150 products. Aarti offers a wide variety of products, as it canswitch production and roll out in small batches. It has the largest domestic NCBcapacity of 60,000 tonnes per annum with its closest competitor capable of 15,000tonnes only. Its capacity to produce speciality products in small batches competitively,gives it a distinct advantage over others.

    Pharma segment to grow at a CAGR

    of 14% led by pharma business

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    CRISIL Equities

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    Diversified revenue profile to provide stable growth in specialtybusinessRevenues of the commodity based chemical players tend to be cyclical on account offluctuation in prices. However, Aarti Industries has been able to ensure stable revenuegrowth by diversifying the product profile by offering variety of specialty chemicalproducts, balanced domestic and export markets, serving varied segments and lowerclient concentration.

    Aarti manufactures both organic and inorganic products in the basic, speciality andpharmaceutical segments. Over the years it has altered its product mix in favour ofmore specialty chemicals which account for 68% of its revenues in FY09 as against64% of its revenues in FY06. Its ability to offer wide variety of products in small batcheshas enabled it to improve revenues as well as maintain stable margins. The specialtybusiness is expected to grow at a CAGR of 11 % over next five years.

    Figure 2: Segment-wise revenue break-up (2008-09)

    Pharmaceuticals6%

    Agro chemicals4%

    Speciality68%

    Basic22%

    (Per cent)

    Note:

    Inter-segment revenues have not been excludedSource: Company annual reports

    Figure 3: Segment wise revenue trend

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    Agro chemicals Pharmaceuticals Basic Speciality

    Source: Company annual reports

    Specialty segment to grow at CAGR of 11% for next three years

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    CRISIL Equities

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    Accordingly, Aartis sales growth is linked to crude oil prices its sales growth lagscrude oil prices by one quarter.

    Figure 5: Aarti Sales growth lags crude oil prices by one quarter

    YoY growth (%)

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    Crude oil prices Sales (one qtr lagged)

    Source: CRISIL Equities and Company data

    As Aarti is into cost plus margins business model, its profit growth is also dependent oncrude oil prices, in line with revenue trends.

    Figure 6: Profitability of Aarti is highly correlated to crude oil prices

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    PBDIT Crude oi l p rices

    Source: CRISIL Equities and Company data

    As Aarti passes on the increase/decrease in feedstock prices to its clients, Aartismargins are relatively range bound. We however, note that the ability to pass on thefeedstock price vagaries is constrained during adverse demand conditions.

    Aartis profitability closely linked tofeedstock prices

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    CRISIL Equities

    Aarti Industries Ltd

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    Figure 7: Stable operating margins despite feedstock pricesfluctuation

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    ($ per tonne)

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    Benzene OPBDIT margins

    Source: CRISIL Research

    The chemical and pharmaceutical markets are dominated by large players whooutsource their production needs to various players. Accordingly, specialty chemicalplayers develop new products to meet changing applications and client needs, whichnecessitate constant innovation and continuous expenditure on research anddevelopment expenditure.

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    CRISIL Equities

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    Financial outlookPharma business to drive topline growth

    Aartis topline grew at a 5 year CAGR of 23% from FY04 to FY09. The high growth wasmainly led by Pharma business which grew from Rs 322 Mn in FY04 to Rs 1,002 Mn inFY09 at a CAGR of 26%.

    The sharp decline in raw material prices and slower demand growth is expected toresult in lower realisations in FY10. Hence, revenues are expected to de-grow fromRs.14.4 Bn in FY09 to Rs 11.9 Bn in FY10. Revenues are expected to grow to Rs 13.3Bn in FY11 and register annual growth of 11% in the next two years. Revenues frompharma business are expected to grow annually by 14% during the same period, whilespecialty segment is expected to grow by 11%.

    Figure 8: Revenue growth

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    Pharma and Agrochemicals Basic chemicals

    Speciality chemicals Total revenues

    Note:

    Inter-segment revenues have not been excluded

    Source: Company and CRISIL Equities

    Operating margin likely to remain stable Aarti has been able to maintain stable operating margins at around 14% for the periodFY04-FY08. The margins improved by 283 basis points (bps) to 17.4% in FY09 onaccount of high demand and rise in prices. Going forward, margins are expected toremain at around 16.5% over the next three years as lower growth and stagnantmargins from other segments would be partially offset by higher margins from pharmabusiness.

    Topline revenue estimated to groannually by 10% led by pharmasector growth

    Operating margins to remain a16.5 % over next three years

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    CRISIL Equities

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    Figure 9: Operating margins (FY08-FY12)

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    Source: CRISIL Equities

    Debt-servicing indicators to improve Aarti Industries has followed aggressive debt funded expansion strategy in the past. Asa result the gearing ratio has been above 1 in past five years. The company has beenrelying heavily on the low cost foreign currency export credit to meet its short termworking capital needs.

    Aarti outstanding debt has been at Rs. 4.8 bn and expected to generate Rs 1 Bn cashaccrual in FY09. Aarti has completed major expansion plans and has no immediateplans for further capital expenditure. Hence, the cash accruals are expected to be usedfor paying the debt resulting in lower gearing in the medium term.

    Figure 10: Expected gearing trend (FY05-FY12E)

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    Source: CRISIL Equities estimate

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    CRISIL Equities

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    Corporate Governance

    CRISIL Researchs fundamental grading methodology includes a broad assessment ofcorporate governance and management quality, apart from other key factors such as

    industry and business prospects, and financial performance. In this context, CRISILResearch analyses shareholding structure, board composition, typical boardprocesses, disclosure standards and related-party transactions. Any qualifications byregulators or auditors also serve as useful inputs while assessing corporategovernance.

    Aartis board meets the minimum requirement as it recently inducted four independentdirectors. The board includes three directors, who are chemical engineers with vastbusiness experience. The minimum corporate governance standards are met which arereflected by the board constitution and by the presence of audit and other committees,which support board processes. Based on the balance sheet disclosures, long cleancorporate existence, attendance record of independent directors and their levels ofengagement in company affairs appears that the corporate governance is reasonablygood and meets the minimum expected standards.

    Board composition: Aartis board comprises 16 directors, of which eight areindependent directors. The board includes three directors, who are chemical engineerswith vast business experience. The independent directors are from legal, banking,accounting and technical fields. Overall, the board comprises professional people withvaried experience.

    Board processes: The balance sheet disclosures indicate that all the processesrelating to committees are in place, with the audit committee chaired by an independentdirector. The roles of chairman and managing director have been segregated, with thenon-executive position held by the chairman.

    Related businessThe promoters have another listed company, Aarti Drugs Industries, operating in thesimilar line of business (pharmaceuticals). The promoter group has 30% stake in AartiDrugs, which makes bulk drugs whereas Aarti Industries prepares lifestyle drugs.Currently, the business operations are in different verticals and have separatemanagement. This leaves scope for a future business conflict, as there has been no

    safeguard mechanism such as non-compete agreement between the two companies.

    Complying with corporategovernance practices

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    CRISIL Equities

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    Management Evaluation

    CRISIL's Fundamental Grading methodology includes a broad assessment of

    management quality, apart from other key factors such as industry and businessprospects, and financial performance. Overall, we believe the management is fairlygood with low appetite for risk.

    Strong experience and established track record Aarti Industries was promoted by Chandrakant Gogri in 1984 after working as a plantengineer and later as a project engineer. Gogri holds a BE from University Departmentof Chemical Technology and gained valuable experience in chemical manufacturing,before starting Aarti. His knowledge has helped the company achieve a uniqueadvantage in the production process. He is also supported by his brother RajendraGogri. Parimal Desai, Director and Rajendra Gogri, Managing Director have experience

    in chemical engineering and management. Shantilal Shah, who has been one of themain promoters, has been handling marketing, finance and administration functions of

    Aarti. Expertise built over the years has helped Aarti produce various specialtychemicals, with economies of scale and increase efficiency by integrating variousprocesses. Aarti emerged as the market leader in India and is among the top five inselect speciality chemicals globally.

    Management keen on revenue diversification Aarti has been keen on expanding its capacity and increasing its product range byforward integration. The expansion plans have been mostly funded through long-termdebt. The company has focused on organic growth but going forward, it may considerthe inorganic route as expansions result in higher cash flows.

    Aartis management has diversified revenue streams by moving into new businessessuch as the more stable pharma, which offers higher margins as well. For this, it hasbeen leveraging its strong R&D skills in chemicals.

    Second-line management Aartis management structure is flat and is led by professionals with sound industry andbusiness experience. Chandrakant Gogri, Chairman and non-executive director,provides direction to the R&D and new projects. The second-level managementcomprises operational heads who report to the Managing Director (MD).

    Experienced board with technicaland management expertise

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    Valuation Grading Grade: 5/5

    Aarti has been operating in the chemicals business, with specialty chemicals providing

    much of the revenue. Aarti has edge over its competitors (Deepak Nitrite, PanoliIntermediates and Industrial Solvents) in terms of capacity, integration and wideproduct range.

    The company has been consistently paying dividend, with payout ratio of around 25%.Based on our estimated dividend per share of Rs 2.7 in FY11, the dividend yield isaround 6%.

    We have used discounted cash flow (DCF) approach to value Aarti, as we believe itscash profile is expected to remain stable over the next few years. Based on DCF, wehave fundamentally valued the company at Rs 56 per share. At our fair value of Rs 56,the stock will be trading at P/E of around 3.7 for FY11.

    Consequently, we initiate coverage on Aarti with a valuation grade of 5, indicating apotential Strong upside.

    Key components of our valuationWe have considered discounted value of the firms estimated free cash flow fromFY10E to FY14E.

    Specialty chemicals are expected to grow annually at 11%, while pharma revenues by

    14%, over next four years.

    We have factored in a higher beta for the company at 1.24 times, considering that thechemical industry is cyclical and is sensitive to movements in prices of crude oil and itsderivatives.

    Table 1 : WACC calculation

    Risk free rate of return 7.00%

    Beta 1.24

    Equity risk premium 6.00%Cost of equity 14.44%

    Cost of debt (post tax) 7.70%WACC 12.02%

    Debt :equity ratio 0.56 timesTerminal growth rate 3.00%

    Our target price objective of Rs 56 is derived by assuming a terminal growth rate of 3%and an equity risk premium of 6%.

    Our fair value indicates potentialstrong upside to the current market

    rice

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    Table 2: Sensitivity analysis

    Cost of Debt (pre-tax)

    9.5% 10.5% 11.5% 12.5% 13.5%

    1% 45 43 41 38 36

    2% 53 50 48 45 43

    3% 63 59 56 53 50

    4% 75 71 67 63 60

    T e r m

    i n a

    l G r o w

    t h R a

    t e

    5% 91 85 81 76 72

    Source: CRISIL Equities Estimates

    Table 3: Sensitivity analysis

    Equity Risk Premium

    4.0% 5.0% 6.0% 7.0% 8.0%100% 93 80 69 60 52

    110% 88 74 63 54 46

    124% 81 67 56 47 39

    130% 78 64 53 44 36

    B e

    t a

    140% 73 60 49 40 32

    Source: CRISIL Equities Estimates

    Figure 11: PE band of Aarti Industries

    15

    25

    35

    45

    55

    65

    75

    M a r - 0 7

    M a y - 0 7

    J u l - 0 7

    S e p - 0

    7

    O c t - 0 7

    D e c - 0 7

    F e b - 0

    8

    A p r - 0 8

    M a y - 0 8

    J u l - 0 8

    S e p - 0

    8

    O c t - 0 8

    D e c - 0 8

    F e b - 0

    9

    A p r - 0 9

    J u n - 0

    9

    J u l - 0 9

    price (Rs) 2 3 4 5

    Source: CRISIL Equities Estimates

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    Company Overview

    Aarti Industries was established by Mr Chandrakant Gogri and Mr Shantilal Shah in

    1984 to manufacture benzene based products. Aarti Industries grew rapidly due to theprofessional and technical expertise of Mr Gogri. Aarti has forward integrated withunique ability to manufacture over 150 products.

    Aarti currently manufactures organic and inorganic chemicals at its facilities at Vapi,Sarigam, and Jhagadia, in Gujarat. It also manufactures APIs at its Tarapur andDombivili units in Maharashtra. Aartis API facility at Tarapur has recently beenawarded the US Food and Drug Administration approval. The company has a strongpresence in benzene-based specialty chemicals. It also has a full-fledged research anddevelopment centre, which is recognised by the Department of Scientific and IndustrialResearch, Government of India.

    Aarti has four subsidiaries Avinash Drugs (merged with Aarti Ind. in 2008-09) and Aarti Healthcare Ltd manufactures drug formulations and intermediaries. AlchemieEurope Ltd is the marketing entity for exports while Aarti Corporate services Ltd, is ashell company.

    Table 04 : Business profile(Rs. Mn) Mar-05 % Share Mar-06 % Share Mar-07 % Share Mar-08 % Share Mar-09 % Share

    Basic Chemicals 2155 26 2403 26 1972 24 2368 23 3609 22

    Speciality Chemicals 5218 64 5926 64 5316 64 6730 65 11265 68

    Pharmaceuticals 356 4 378 4 545 7 839 8 1002 6

    Agro chemicals 447 5 481 5 469 6 402 4 586 4

    Total Sales 8176 100 9188 100 8303 100 10340 100 16462 100

    NoteInter-segment sales has not been excluded from the total salesSource: Company annual reports

    Diversified revenue profile Aarti Industries has been able to stabilise its revenue growth by diversifying its revenueprofile across clients, region, products and enduse segments. Nearly 40% of itsrevenues come from exports to more than 40 countries. It has been able to supplymore than 150 products, with domestic market leadership position in more than top 50products. Aarti has large customer base of around 1,000 customers thereby reducingits dependency on large customers. The diverse products cater to demand from varioussectors such as pharmaceuticals, dyes, pigments, rubber chemicals andagrochemicals.

    Diversified and improving revenue profile

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    Figure 12: Region wise export share (2008-09)

    USA13

    Asia33

    Europe41

    Others

    13

    Source: Company

    Business overview

    Leading domestic player in nitro chlorobenzene based specialty chemicals Aarti is a dominant player in nitrochlorobenzene based specialty products with thelargest domestic capacity of 60,000 tonnes per annum. Companys manufacturingfacility provides flexibility to change the product mix based on the market conditions.This flexibility has enabled it to provide more products over other players. Integratedoperations and economies of scale offer it a competitive edge over others. Aartimanufactures over 150 products and has been a leading domestic player in more than50 products.

    Table 5: Product and process capacityReactions Capacity (tpa) Market position

    India Global

    Chlorination 110,000 1 Top 5Nitration 110,000 1 Top 5

    Ammonolysis 20,000 1 Top 5Reduction 20,000 1

    Reactions Capacity (tpa) Market positionIndia Global

    Dimethyl Sulphate 51,000 1 Top 3Sulphuric Acid and Allied products 200,000Source: Company

    Pharma the high growth segmentRevenues from pharma segment constitute 6.5% of the total revenues, but have beengrowing at a CAGR of 26 % for the past 5 years. Process-based productioncompetency gained in the chemicals industry has helped Aarti to develop its researchcompetency in the pharma related products. The company has set up two APImanufacturing units of which the Tarapur facility has been granted USFDA approval.

    Aarti filed 19 drug master files (DMFs) and has been working on 30 lifestyle-relateddrugs such as steroids and those for hypertension and cancer.

    Dominant player in Benzene based derivative products

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    Figure 13: Pharma segment revenues and growth

    54%

    44%

    19%

    6%11%

    0

    200

    400

    600

    800

    1000

    1200

    FY-05 FY-06 FY-07 FY-08 FY-09

    (Rs. mn)

    0%

    10%

    20%

    30%

    40%

    50%

    60%

    (per cent)

    Revenues Growth rate

    Source: Company annual reports

    Industry outlookDefinitionChemical industry comprises of chemicals produced from natural process or bysynthetic methods. Specialty chemicals and commodity chemicals are used asbenchmarks to classify chemicals based on value add, range of applications andquantity used. Specialty products are value added chemicals with wide variety ofapplications and produced in small quantities to serve certain customers orapplications. They are largely used in final customer products or applications, or toimprove manufacturing processes or the quality of end products. The definition ofspecialty products thus lacks specificity and includes ever increasing variety ofproducts that are developed to meet new applications.

    Globally leading chemicals have shifted from commodity based chemicals to specialtychemicals which provide higher pricing power, have limited competition and offer bettermargins than commodity chemicals.

    Current industry size in IndiaThe domestic chemical industry as per the Department of Chemicals and Fertilisers isestimated to be $30 Bn in 2007-08. The share of specialty chemical accounts for 25%

    of the total industry at $9 Bn. Pharmaceuticals, textiles, dyes and pigments and leatherindustries find major usage of specialty chemicals. The dyes and dye intermediatessegment has traditionally been one of the largest in the industry and continues to becrucial because of its forward and backward linkages with a number of other industriessuch as textiles, leather, paper, printing inks and food processing. Of this, the textilesand leather processing industries consume over 85 percent of all dyes manufactured.

    Industry structureThe specialty chemicals industry is less capital intensive than the commodity chemicalsindustry. Manufacturing plants for specialty chemicals are usually small to medium in

    size. Capacity additions for specialties are commonly small or designed for uniqueproducts, and thus can be done relatively quickly to closely match demand growth.However, specialty chemicals companies may need many manufacturing or distributionsites for the large number of unique, low-volume products that their customers require.

    Specialty segment poised for stablegrowth

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    Specialty chemicals are products designed for specific applications and/or customers,and thus be made in small volumes. Specialty chemicals require higher research anddevelopment (R&D) spending and incur a greater amount of marketing and customer

    service costs than do commodity chemicals.

    Specialty chemicals unlike commodity chemicals witness less cyclical demand as theseare specialised niche products. Pricing volatility is also less dramatic, because theseproducts are distinctive and change in demand supply conditions is gradual. Sellingprices for specialties tend to be set by their value in use, not by costs, giving theirmanufacturers greater control over prices than is exercised by makers of commoditychemicals.

    Companies with products that sell more on performance attributes have greater controlover prices, and thus have more stable profit margins.

    ProfitabilitySpecialty chemical sector is less affected by raw material prices as the product pricesare more dependent on the value add and applications rather than raw material cost.Increase or decrease in raw material prices is typically passed on the customers.

    Accordingly, operating margins of select specialty players have been stable and rangebound.

    Figure 14: Trend in PBDITA and raw material spread

    40

    45

    50

    55

    60

    Mar-02 Mar-03 Mar-04 Mar- 05 Mar-06 Mar-07 Mar- 08 Mar- 09

    (per cent)

    8

    9

    10

    11

    12

    (per cent)

    Raw material spread PBDITA margins

    Source: CRISIL Equities

    OutlookThe demand for specialty chemicals is expected to pick up with growth in textile, dyesand pigments and other consumer related products. Active pharmaceutical ingredientswhich use specialty chemicals is expected to drive higher growth with increasing exportled growth of pharmaceutical products. Specialty segment industry is expected to growat 6-8% over medium term.

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    Indian pharmaceutical market to grow on the back of exportsThe changes in the global market are likely to provide immense potential for Indianpharmaceutical players, due to their key strengths, such as low-cost manufacturing,advanced chemistry skills and complex chemical synthesis. The Indian pharmaceuticalmarket is geared to expand to nearly $37 Bn by FY13E from an estimated $17 Bn inFY08, mainly driven by exports, which are likely to soar at a CAGR of 21% over thisperiod. Exports will be primarily impelled by Indias budding presence in regulatedmarkets. The emerging dominance of exports is evident from the fact that their share intotal pharmaceutical demand augmented from 40% in FY03 to 54% in FY08. Thisshare is expected to increase to around 63% by FY13E.

    Table 6: Indian pharmaceutical industry by key segments Compounded Annual Growth

    (US $ Bn) FY03 FY06 FY08 E FY13P FY03 to FY08 FY08 to FY13P

    Domestic Formulation Consumption (DFC) 3.9 5.4 7.7 13.6 14.6 12.2Formulation Exports 1.4 2.5 4.1 10.1 24.2 19.6Bulk Drug Exports 1.1 2.6 4.8 13.4 33.3 22.8Total market 6.4 10.5 16.6 37.1 20.9 17.5

    E: Estimated, P: ProjectedSource: CRISIL Research, Directorate General of Foreign Trade(DGFT) and Organisation of Pharmaceutical

    Producers of India (OPPI)

    Within regulated markets, North America and Europe are Indias largest markets; theregions jointly account for nearly 97% of the countrys exports. Exports to North

    America witnessed a robust growth of 31% from FY03 to FY08. Exports to Europeregistered a healthy CAGR of 25% to $0.7 Bn in FY08 compared with $0.2 Bn in FY03.Exports to Australia and Japan also witnessed strong growth (CAGR of 27% on a lowerbase) to $0.04 Bn in FY08 from $0.01 Bn in FY03.

    The growth in semi-regulated markets has been supported by healthy growth in Africa, Asia, CIS countries and Latin America. The semi-regulated market grew at a CAGR of21-22% from FY03 to FY08.

    Bulk drug exports riding high on growing genericisation and risingconfidence of innovatorsExport of bulk drugs are likely to present Indian players with considerable growthprospects and help them capture a larger market share in the regulated markets, whilemaintaining their presence in the semi-regulated markets. The generics market in theUS and Europe is expected to expand from $55 Bn in FY08 to $91 Bn by FY13E. This,along with the aggressive cost-reduction initiatives of global pharmaceuticalcompanies, will enable bulk drug exports to increase at a CAGR of 23% by FY13E. Infact, with the API manufacturing opportunity arising from the huge on-patent drugsmarket coupled with rising confidence of innovators on Indian players, India is wellpositioned to garner a higher share of the regulated on-patent drug market, which alsooffers better margins. Interestingly, exports of bulk drugs for manufacturing off-patentdrugs are building up and are expected to out-number overall bulk drug exports to

    semi-regulated markets in the long term. Indias potential lies in the advancedchemistry skills, complex chemical synthesis and low cost manufacturing capabilities ofits manufacturers.

    Bulk drug export to grow at aCAGR of 23% from FY08- FY13E

    Export growth to drive Pharmasector revenues

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    Figure 15: Bulk drug exports growth continues further

    0.020.36

    1.95

    0.38

    2.05

    6.39

    0.75

    2.39

    5.03

    0

    1

    2

    3

    4

    5

    6

    7

    8

    FY03 FY08 E FY13 P

    ( $ b

    n )

    Regulated - on-patent Regulated- off-patent Semi-regulated market

    Source: CRISIL Research Estimates, OPPI

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    Annexure: Financials

    Aarti Industries Ltd (Standalone) Quarterly results

    (Rs Million) 30-Jun-08 30-Sep-08 31-Dec-08 31-Mar-09 FY 2008-09 30-Jun-09 30-Sep-09 H1 FY 09-10Sales;income from operations 3617.8 4279.5 3374.2 2897.0 14168.5 2833.6 3202.8 6036.4

    Excise duty; sales tax etc 240.5 266.0 143.6 104.2 754.3 95.0 107.2 202.2Net Sales 3377.3 4013.5 3230.6 2792.8 13414.2 2738.6 3095.6 5834.2

    Other Income 1.9 11.6 0.9 7.1 21.5 0.7 3.3 4.0Total Income 3379.2 4025.1 3231.5 2799.9 13435.7 2739.3 3098.9 5838.2

    (Increase): Decrease in stock (150.1) (195.0) 350.3 17.4 22.6 1.4 (287.5) (286.1)

    Raw material consumed 1851.8 2274.6 1471.9 1233.7 6832.0 1233.0 1731.9 2964.9

    Traded goods purchased 236.0 300.8 172.4 218.5 927.7 186.0 250.2 436.2

    Staff expenses 58.4 62.4 67.6 93.2 281.6 68.4 79.9 148.3

    Other expenditures 728.1 851.3 754.0 741.7 3075.1 694.2 814.0 1508.2Total expenditure 2724.2 3294.1 2816.2 2304.5 11139.0 2183.0 2588.5 4771.5

    PBDIT 655.0 731.0 415.3 495.4 2296.7 556.3 510.4 1066.7

    Interest 144.8 204.5 227.7 272.3 849.3 148.0 142.5 290.5PBDT 510.2 526.5 187.6 223.1 1447.4 408.3 367.9 776.2

    Depreciation 80.4 84.6 97.3 89.2 351.5 98.5 110.7 209.2PBT 429.8 441.9 90.3 133.9 1095.9 309.8 257.2 567.0

    Provision for tax a: Current 85.5 84.9 11.4 54.9 236.7 64.5 65.5 130.0

    b: Deferred 12.0 15.0 10.5 15.0 52.5 12.5 13.5 26.0PAT 332.3 342.0 68.4 64.0 806.7 232.8 178.2 411.0

    Source: BSE

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    Income Statement(Rs Mn) FY07 FY08 FY09 FY10E FY11E FY12E

    Net Sales 7,556 8,877 14,430 11,981 13,304 14,783Operating Income 7,562 8,881 14,434 11,984 13,307 14,787

    EBITDA 924 1,295 2,513 1,977 2,196 2,451

    Depreciation 304 333 421 468 517 566

    Interest 294 386 915 581 573 551

    Other Income 62 71 143 86 105 87PBT 392 647 1,306 1,014 1,212 1,421

    PAT 306 476 990 754 901 1,057

    Balance Sheet(Rs Mn) FY07 FY08 FY09 FY10E FY11E FY12E

    Equity Share Capital 364 364 364 379 379 379

    Reserves 2,310 2,617 3,305 3,961 4,640 5,431

    Equity (Including reserves) 2,674 2,981 3,669 4,340 5,019 5,810Debt 3,365 4,312 4,836 4,758 4,797 4,303

    Current Liabilities and Provisions 212 1,042 911 859 965 1,087

    Deferred Tax Liability/(Asset) 259 329 403 460 529 609

    Minority InterestTotal Capital Employed 6,509 8,664 9,819 10,418 11,310 11,809

    Net Fixed Assets 2,984 2,999 3,761 3,993 4,177 4,311

    Capital WIP 172 356 158 200 200 200

    Investments 270 337 412 913 1,130 927

    Loans and advances 491 1,119 693 706 701 716

    Inventory 1,490 2,001 2,060 2,142 2,378 2,640

    Receivables 1,015 1,755 2,661 2,362 2,623 2,915

    Cash & Bank Balance 86 98 74 100 100 100Applications of Funds 6,509 8,664 9,819 10,418 11,310 11,809

    RatiosFY07 FY08 FY09 FY10E FY11E FY12E

    Sales growth -3.2% 17.5% 62.6% -17.0% 11.0% 11.1%

    EBITDA growth 54.4% 40.2% 94.1% -21.4% 11.1% 11.6%

    EPS growth -48.9% 55.5% 108.1% -26.9% 19.5% 17.3%

    EBITDA Margin 12.2% 14.6% 17.4% 16.5% 16.5% 16.6%

    PAT Margin 4.0% 5.4% 6.9% 6.3% 6.8% 7.1%

    Return on Capital Employed (RoCE) 11.3% 14.8% 26.9% 17.3% 17.9% 18.7%

    Return on Equity (RoE) 11.8% 16.8% 29.8% 18.8% 19.3% 19.5%Dividend per share 0.8 1.6 3.2 2.2 2.7 3.2

    Dividend yield 2% 4% 7% 5% 6% 7%

    Earnings Per Share (Rs) 4.2 6.5 13.6 9.9 11.9 13.9

    Book Value Per Share (Rs) 37 41 50 57 66 77

    Debt-Equity 1.3 1.4 1.3 1.1 1.0 0.7

    Current Ratio 1.3 1.2 1.5 1.6 1.6 1.8

    Interest Coverage 3.1 3.4 2.7 3.4 3.8 4.4

    Price-Earnings 10.4x 6.7x 3.2x 4.4x 3.7x 3.1x

    Price-Book 1.2x 1.1x 0.9x 0.8x 0.7x 0.6x

    EV/EBITDA 7.0x 5.7x 3.2x 3.8x 3.3x 2.9x

    Source: Company, CRISIL Equities estimate

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    Focus Charts

    Stock movement Vs Market Shareholding as on September 2009

    406080

    100120140160180200

    S e p - 0

    6

    N o v - 0

    6

    J a n - 0

    7

    A p r - 0 7

    J u n - 0

    7

    A u g - 0

    7

    O c t - 0 7

    D e c - 0

    7

    M a r - 0 8

    M a y - 0

    8

    J u l - 0 8

    S e p - 0

    8

    D e c - 0

    8

    F e b - 0

    9

    A p r - 0 9

    J u l - 0 9

    S e p - 0

    9

    N o v - 0

    9

    Index

    Aarti Ind. S&P CNX NIFTY

    Non-institutional43.4

    MFs & FIIs8.8

    Indianpromoters

    47.8

    (Per cent)

    Source: Company, CRISIL Equities Source: Company

    Aarti Sales growth lags crude oil prices by one quarter Profitability of Aarti is highly correlated to crude oilprices

    YoY growth (%)

    -80%

    -40%

    0%

    40%

    80%

    120%

    160%

    M

    a r - 0 1

    S

    e p - 0

    1

    M

    a r - 0 2

    S

    e p - 0

    2

    M

    a r - 0 3

    S

    e p - 0

    3

    M

    a r - 0 4

    S

    e p - 0

    4

    M

    a r - 0 5

    S

    e p - 0

    5

    M

    a r - 0 6

    S

    e p - 0

    6

    M

    a r - 0 7

    S

    e p - 0

    7

    M

    a r - 0 8

    S

    e p - 0

    8

    M

    a r - 0 9

    S

    e p - 0

    9

    Crude oil prices Sales (one qtr lagged)

    Y-o-y growth (%)

    -100%

    -50%

    0%

    50%

    100%

    150%

    200%

    250%

    M a r - 0 1

    S e p - 0

    1

    M a r - 0 2

    S e p - 0

    2

    M a r - 0 3

    S e p - 0

    3

    M a r - 0 4

    S e p - 0

    4

    M a r - 0 5

    S e p - 0

    5

    M a r - 0 6

    S e p - 0

    6

    M a r - 0 7

    S e p - 0

    7

    M a r - 0 8

    S e p - 0

    8

    M a r - 0 9

    S e p - 0

    9

    PBDIT Crude o il p rices

    Source: Company, CRISIL Equities Source: Company,CRISIL Equities

    Gearing levels to improve in medium term Stable dividend payout and high yield

    4 , 3 0 3

    4 , 7

    9 7

    4 , 7

    5 8

    4 , 8

    3 6

    4 , 3

    1 2

    3 , 3

    6 5

    1.261.45

    1.32

    1.100.96 0.74

    -

    1,000

    2,000

    3,000

    4,000

    5,000

    6,000

    FY07 FY08 FY09 FY10E FY11E FY12E

    (Rs mn)

    0.0

    0.2

    0.4

    0.6

    0.8

    1.0

    1.2

    1.4

    1.6(per cent)

    Debt Debt-Equity

    0.8 1.6

    3.2

    2.22.7

    3.21.9

    3.6

    5.1

    6.1

    7.3 7.3

    0.0

    0.5

    1.0

    1.5

    2.0

    2.5

    3.0

    3.5

    FY07 FY08 FY09 FY10E FY11E FY12E

    (Rs)

    0.0

    1.0

    2.0

    3.0

    4.0

    5.0

    6.0

    7.0

    8.0

    (per cent)

    Dividend per share Dividend yield

    Source: Company, CRISIL Equities Estimate Source: Company, CRISIL Equities Estimate

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    Disclaimer:

    This Company-sponsored Report (Report) is based on data publicly available or from sources considered reliable. CRISIL Ltd.(CRISIL) does not represent that the data/report is accurate or complete and hence, it should not be relied upon as such. The data /Report is subject to change without any prior notice. Opinions expressed herein are our current opinions as on the date of this Report.Nothing in this Report constitutes investment, legal, accounting or tax advice or any solicitation, whatsoever. The subscriber / userassumes the entire risk of any use made of this data / Report. CRISIL especially states that it has no financial liability, whatsoever, tothe subscribers / users of this Report. This Report is for the personal information only of the authorized recipient in India only. ThisReport should not be reproduced or redistributed or communicated directly or indirectly in any form to any other person especiallyoutside India or published or copied in whole or in part, for any purpose.

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