Aarti Industries report Final

Aarti Industries Ltd. BUY

- 1 - Tuesday, 29th

December, 2015

This document is for private circulation, and must be read in conjunction with the disclaimer on the last page.

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Target Price `678 CMP `518 FY17E P/E 13.0x

Index Details Aarti Industries Ltd (Aarti) is strategically placed to exploit growth

opportunities in the chemical industry with products available across

value chains of benzene, toluene and ethylene, and nitro toluene. With

16 manufacturing units in Gujarat and Maharashtra, the company has

customers spread across the globe in 60 countries with a major

presence in USA, Europe, Japan and India. Aarti has aggressive

expansion plans not only in its specialty chemicals segment, but also in

the pharmaceuticals and the personal care space.

We expect revenues to grow at a CAGR of 13.5% to Rs 3,743 crore by

FY17 on the back of growth across all segments. The EBITDA margins

are expected to grow from 16% in FY15 to 19% by FY17 amounting to Rs

716.6 crore due to a reduction in operating expenditures and an

improvement in utilization levels. PAT is expected to grow at a robust

27% to Rs 333 crores by FY17 on account of lower interest costs and a

reduction in taxes.

We are upbeat on the prospects of Aarti given that:

The Indian Specialty Chemical Industry is expected to reach $60-

70bn by 2020 from $23bn in 2013. With more than 80% of revenues

being accounted for by specialty chemicals, Aarti with its strong

knowledge of chlorine derivative chemistry and largest nitro-

chlorobenzene capacity in India, is best placed to maximize the

available opportunity. We expect the revenues to grow to Rs 3,060

crore by FY17 (CAGR of 13%).

Debottlenecking and expansion activities have facilitated growth in

pharma volumes. Going forward, newly commissioned capacities

for Caffeine manufacturing, dedicated to meet the demand form

cola/energy drinks manufacturers, are expected to bring in

incremental revenues. We expect the revenue contribution of the

pharma segment to go up marginally to 11% over the next two

years. The segment revenues are expected to grow to Rs 415 crore

by FY17 (CAGR of 17%).

Sensex 26,034

Nifty 7,925

Industry Chemicals

Scrip Details

MktCap (` cr) 4,315

BVPS (`) 108.6

O/s Shares (Cr) 8.3

AvVol 6156

52 Week H/L 585/247

Div Yield (%) 1.1

FVPS (`) 5.0

Shareholding Pattern

Shareholders %

Promoters 54.8

DIIs 12.8

FIIs 3.0

Public 29.4

Total 100.0

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of Key Financials (` in Cr)

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Sales EBITDA PAT

EPS

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EPS

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EV/EBITDA

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2014 2,632.5 401.5 151.6 18.3 7.9 17.0 17.5 28.3 14.0 2015 2,908.0 465.7 188.5 23.2 26.7 17.5 19.1 22.3 12.4 2016E 3,268.9 601.5 253.6 32.2 38.5 19.9 21.0 16.1 9.2 2017E 3,742.9 716.8 317.0 39.9 23.9 20.9 21.8 13.0 7.8

- 2 - Tuesday, 29th December, 2015


In the home and personal care segment, Aarti is focusing on growing

its export market. We expert margins to recover to ~4% from the

current levels with pharma revenues growing at a CAGR of 14% from

Rs 206 crore in FY15 to Rs 268 crore by FY17.

We initiate coverage on Aarti Industries Ltd as a BUY with a price

objective of Rs 678 representing a potential upside of 31% from the CMP

of Rs 518 over a period of 15 months. We have used the PE multiple

approach to value Aarti Industries and assigned a multiple of 17x on FY17

EPS of Rs 39.9 to arrive at the target price. There exists scope for further

value unlocking post the demerger of its business units. We have not

built this into our valuation model and remains an upside risk to our

estimates.



Company Background

Aarti is one of the leading suppliers to global manufacturers of dyes, pigments,

agrochemicals, pharmaceuticals and rubber chemical manufacturers. Aarti has

acquired world- class expertise in the development and manufacture of these

chemicals and is amongst the largest producers of benzene based basic and

intermediate chemicals in India.

Key Investment Highlights

Capacity expansion to bolster revenue growth Over the next three years Aarti is undertaking a capex of ~Rs 500 crore to

expand capacities across benzene, toluene and ethylene, and nitro toluene

based value chains. These capacities are planned to capitalize on opportunities

emerging from

growing end-user markets,

capacity shut downs in developed markets and reduced global supplies

from China.

firm off-take commitments from global agrochemical majors for exclusive

supply.

Aarti’s manufacturing facilities

Source Aarti Industries Ltd, Ventura Research



With the help of these enhanced capacities we expect revenues to grow at a CAGR of 13.5% to Rs 3,742.9 crore by FY17. With several value added products coming on stream we expect margin expansion of over 300 bps to 19% by FY17. In turn, PAT is expected to experience faster growth of ~ 27% to Rs 333 crores over the same period aided by lower interest costs and lower tax rates.

Expertise across Benzene based value chain

Source Aarti Industries Ltd, Ventura Research

Expertise across Toluene based value chain

Source: Aarti Industries Ltd, Ventura Research



Global leadership in the fast growing specialty chemicals

The Indian Specialty Chemical Industry is expected to reach $60-70bn by 2020

from $23bn in 2013. With more than 80% of revenues being accounted for by

specialty chemicals, Aarti with its strong knowledge about chlorine derivative

chemistry and largest nitro-chlorobenzene capacity in India, is best placed to

maximize the available opportunity.

Aarti has a varied product profile with cost competency and consistent supply

history, because of which the company enjoys the status of "Strategic Supplier" with

many MNCs. Aarti provides speciality chemicals to 800+ clients having end-user

applications in polymers, additives, pigments, paints, dyes, agro chemicals, etc The

company provides more than 100 products to MNCs globally (enjoying the top 5

ranks for most of its key products globally) and nearly half of the revenue from this

segment is export led.

Segmental sales over the years

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Speciality Chemicals Pharma Home & Personal Care

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The specialty chemical segment has grown at a CAGR of 18% from Rs 1,228 crore

in FY11 to Rs 2,397 in FY15. We expect the revenues to grow to Rs 3060 crore by

FY17 (CAGR of 13%). We expect the company to maintain its EBIT margin of 17-

17.5% for this segment over the next two years as well.

Strong growth in pharmaceuticals segment is expected to continue

Currently pharmaceuticals contribute ~10% of the total revenue with exports

contributing ~51% (previous year 47%) to the pharmaceutical revenues. Of the

exports ~60% is to the lucrative regulated markets of USA and EU. Debottlenecking

and expansion activities have facilitated growth in pharma volumes. We expect the

revenue contribution of the pharma segment to go up marginally to 11% over the

next two years.

The pharmaceutical segment revenues have clocked a CAGR of 23% from Rs 131

crore in FY11 to Rs 303 in FY15. The segment revenues are expected to grow to

Rs 415 crore by FY17 (CAGR of 17%). Going forward, newly commissioned

capacities for caffeine manufacturing dedicated to meet the demand for cola /

energy drinks manufacturers are expected to bring in incremental revenues. Since

major fixed costs are already built‐in, incremental volumes will result in a significant

increase in segmental profits. We expect the EBIT margin to expand by 300 bps to

15% by FY17 over the next two years due to complete absorption of fixed costs.

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Exports to propel home and personal care revenue growth

Due to stiff competition, the home and personal care segment (contributing 6-

7% to the top line) has witnessed a fall in EBIT margins over the last 4 years

from 5.3% in FY11 to 1.5% in FY15. Of the total sales, export contribution was

a paltry 15%. However, with Aarti focusing on growing its export market, we

expect margins to recover to ~4% from the current levels. We expect the home

and personal care revenues to grow at a CAGR of 14% from Rs 206 crore in

FY15 to Rs 268 crore by FY17.

Sales growth of Pharmaceuticals segment

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Financial Performance

The company reported muted numbers during Q2FY16. Its net sales declined by

13.8% YoY to Rs. 656.5 crores due to the fall in benzene prices. However, EBITDA

increased by 8% YoY to Rs. 131.7 crores, led by a decrease in raw material costs

(down 26.7% YoY). Operating margin also expanded by 410 bps YoY to 20.1%.

PAT increased by 20.7% YoY to Rs. 61.2 crores. Reduction in interest cost and tax

outgo and an increase in non-operating income supported PAT growth during the

quarter.

In FY15, Aarti Industries net sales stood at Rs. 2,870.7 crores, registering a growth

of 9% YoY. Its EBITDA increased by 15.4% YoY to Rs. 456.5 crores, while margins

expanded by 90 bps YoY to 15.9%. PAT grew by 26.3% YoY to Rs. 187.8 crores,

led by a decrease in depreciation by 10% YoY to Rs. 78.7 crores and a onetime

exceptional gain of Rs. 3.5 crores due to a change in the method of depreciation.

Consolidated Quarterly Financial Performance (Rs crores)

Description Q2FY16 Q2FY15 FY15 FY14

Net Sales 646.7 750.3 2824.1 2598.7

Growth (%) -13.8 8.7

Total expenditure 524.8 639.2 2414.2 2237.3

EBITDA 131.7 122.0 456.5 395.5

Margin (%) 20.4 15.3 15.5 15.1

Depreciation 22.6 19.1 78.7 87.4

EBIT (Ex. OI) 109.1 102.9 377.8 308.1

Non-Operating Income 0.5 0.3 2.0 10.4

EBIT 109.6 103.2 379.8 318.5

Margin (%) 16.9 13.8 13.4 12.3

Finance Cost 29.7 35.9 137.5 117.5

Exceptional Items 0.0 0.0 3.5 0.0

PBT 79.9 67.2 245.8 200.9

Margin (%) 12.4 9.0 8.7 7.7

Provision for Tax 18.7 16.5 58.0 52.3

Profit after Tax 61.2 50.7 187.8 148.7

Margin (%) 9.5 6.8 6.6 5.7




Financial Outlook:

With capacity expansion across segments, the growth trajectory in revenues (2 Yr

CAGR of 13.5% to Rs 3,743 by FY17) should continue. Aarti has a varied product

basket and diversified client portfolio which reduces the dependency of the

company on a single product or a single client. We expect Aarti Industries’ revenues

to grow at a 2 year CAGR of 13.5% to Rs 3,743 crores by FY17E while net

consolidated profit after tax is expected to grow at a CAGR of 27% to Rs 332.3

crore over the same period. The EBITDA margins (ex OI) and PAT margins are

expected to be at 19.2% and 8.9% respectively.

The merger of associate entities with Aarti will lead to cancellation of 2.64 crore

shares resulting in Aarti’s net shareholding falling to 41.66 crore from 44.3 crore.

This will further enable improvement in RoE and RoCE of the company.

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- 10 - Tuesday, 29th

December, 2015


Valuation

We initiate coverage on Aarti Industries Ltd as a BUY with a price objective of Rs

678 representing a potential upside of 31% from the CMP of Rs 518 over a period

of 15 months. We have used the PE multiple approach to value Aarti Industries and

assigned a multiple of 17x on FY17 EPS of Rs 39.9 to arrive at the target price. We

are upbeat on the company prospects due to:

Capacity expansion which will drive volume growth,

Diversified product portfolio significantly reducing risk and

Merger of associate entities which will reduce the total share capital thereby

improving the return ratios.

Significant value unlocking from demerger of its business unit

Aarti is looking to demerge all its segments viz Specialty Chemicals,

Pharmaceuticals and Personal Care into three independent entities. The

board has already approved the demerger and the process is expected to

start in early FY17 and expected to be completed by end of FY17. This

should lead to substantial value unlocking as we believe that the specialty

chemical segment should demand high valuations independently. However,

we have not built this into the valuation model and remains an upside risk to

our estimates.

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EV 3.5X 5.5X 7.5X 9.5X 11.5X



December, 2015


Financials and Projections

Y/E March, Fig in ` Cr FY14 FY15 FY16E FY17E Y/E March, Fig in ` Cr FY14 FY15 FY16E FY17E

Profit & Loss Statement Per Share Data (Rs)

Net Sales 2632.5 2908.0 3268.9 3742.9 Adj. EPS 18.3 23.2 32.2 39.9

% Chg. 10.5 12.4 14.5 Cash EPS 28.3 32.5 46.9 56.7

Total Expenditure 2231.0 2442.3 2667.4 3026.2 DPS 4.7 5.9 7.1 8.8

% Chg. 9.5 9.2 13.4 Book Value 98.3 114.7 145.6 175.2

EBDITA 401.5 465.7 601.5 716.8 Capital, Liquidity, Returns Ratio

EBDITA Margin % 15.3 16.0 18.4 19.2 Debt / Equity (x) 1.2 1.2 1.0 0.9

Other Income 11.0 5.5 5.6 6.4 Current Ratio (x) 1.0 1.1 1.3 1.5

PBDIT 412.4 471.2 607.1 723.2 ROE (%) 17.0 17.5 19.9 20.9

Depreciation 88.5 82.0 122.7 139.9 ROCE (%) 17.5 19.1 21.0 21.8

Interest 117.8 138.0 135.6 147.7 Dividend Yield (%) 0.9 1.1 1.4 1.7

Exceptional items 0.0 0.0 0.0 0.0 Valuation Ratio (x)

PBT 206.1 251.3 348.8 435.6 P/E 28.3 22.3 16.1 13.0

Tax Provisions 54.0 61.0 94.2 117.6 P/BV 5.3 4.5 3.6 3.0

Reported PAT 152.1 190.2 254.6 318.0 EV/Sales 2.1 2.0 1.7 1.5

Minority Interest -0.5 -1.7 -1.0 -1.0 EV/EBIDTA 14.0 12.4 9.2 7.8

PAT 151.6 188.5 253.6 317.0 Efficiency Ratio (x)

PAT Margin (%) 5.8 6.5 7.8 8.5 Inventory (days) 85.0 87.1 90.0 90.0

Other opr Exp / Sales (%) 0.4 0.2 0.2 0.2 Debtors (days) 57.2 52.5 60.0 65.0

Tax Rate (%) 26.2 24.3 27.0 27.0 Creditors (days) 47.4 46.5 40.0 40.0

Balance Sheet Cash Flow Statement

Share Capital 44.3 44.3 41.7 41.7 Profit Before Tax 206.1 251.3 348.8 435.6

Reserves & Surplus 826.5 972.1 1171.3 1418.0 Depreciation 88.5 82.0 122.7 139.9

Minority Interest 4.3 5.9 6.9 7.9 Working Capital Changes -34.0 -68.8 -174.3 -180.7

Long Term Borrowings 255.3 419.1 476.2 565.2 Others 54.4 75.1 41.5 30.1

Deferred Tax Liability 84.7 102.7 141.3 176.4 Operating Cash Flow 315.0 339.5 338.6 424.9

Other Non Current Liabilities 267.9 306.0 348.8 414.1 Capital Expenditure -290.9 -303.1 -222.3 -289.9

Total Liabilities 1482.8 1850.0 2186.1 2623.3 Other Investment Activities 0.0 5.4 0.0 0.0

Gross Block 1477.0 1685.1 1907.4 2197.3 Cash Flow from Investing -290.8 -297.7 -222.3 -289.9

Less: Acc. Depreciation 650.8 718.2 840.8 980.7 Changes in Share Capital 0.0 0.0 0.0 0.0

Net Block 826.2 966.9 1066.6 1216.6 Changes in Borrowings 138.0 201.8 58.0 89.0

Capital Work in Progress 117.4 193.0 171.7 191.7 Dividend and Interest -159.7 -224.8 -194.7 -220.8

Other Non Current Assets 117.2 139.2 128.8 128.8 Cash Flow from Financing -21.7 -23.0 -136.7 -131.8

Net Current Assets 37.5 109.9 332.5 529.0 Net Change in Cash 2.4 18.9 -20.4 3.2

Long term Loans & Advances 384.4 441.1 486.5 557.3 Opening Cash Balance 12.4 14.9 33.7 13.3

Total Assets 1482.8 1850.0 2186.1 2623.3 Closing Cash Balance 14.9 33.7 13.3 16.5


December, 2015


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Research Analyst (RA) involved in the preparation of this research report and VSL disclose that neither RA nor VSL nor its associates (i) have any financial interest in the company which is the subject matter of this research report (ii) holds ownership of one percent or more in the securities of subject company (iii) have any material conflict of interest at the time of publication of this research report (iv) have received any compensation from the subject company in the past twelve months (v) have managed or co-managed public offering of securities for the subject company in past twelve months (vi) have received any compensation for investment banking merchant banking or brokerage services from the subject company in the past twelve months (vii) have received any compensation for product or services from the subject company in the past twelve months (viii) have received any compensation or other benefits from the subject company or third party in connection with the research report. 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Aarti Industries report Final

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