Company Name – Aarti Industries Limited (Aarti Industries) Current Share Price – INR 548 (March 6, 2023) Market Cap – INR 19,853 cr |
1. What is interesting about the stock?
While preparing for the engineering entrance exams, one of the subjects which I feared was Organic Chemistry. Why? It has a lot of rules and exceptions to those rules. I had an excellent teacher in Dr. BV Rao who was exceptional. But neither did I remember the rules leave alone the exceptions. I survived for the next 20-odd years of my life but organic chemistry came back when I started looking at Aarti Industries.
Organic chemistry is a complex field of study that deals with the chemical structure, properties, and reactions of compounds containing carbon. Carbon is unique in its ability to form multiple covalent bonds with other atoms, resulting in an infinite variety of organic molecules with diverse chemical properties and functions. The complexity of organic chemistry arises from the fact that there are millions of known organic compounds, and new ones are being synthesized all the time.
Furthermore, the behavior of organic compounds can be influenced by a wide range of factors, including temperature, pressure, solvent polarity, and the presence of other chemicals. Predicting how a molecule will behave under different conditions can be challenging, and often requires a combination of experimental and computational methods.
With this handicap, let’s get into Aarti Industries.
Organic compounds are important for all of us. Most of them are derived from petroleum (oil) or natural gas. From organic compounds present in petroleum and natural gas are obtained an amazing variety of products that includes many kinds of plastics, synthetic fibers, elastomers, drugs, surface coatings, solvents, detergents, insecticides, herbicides, explosives, gasoline additives, and countless specialty chemicals.
Aarti Industries is a leading Indian chemical company that specializes in the production of specialty chemicals. The Company was founded in 1975 by Mr. Chandrakant V. Gogri and is headquartered in Mumbai, India.
The Company produces a wide range of specialty chemicals, including benzene-based intermediates (organic compounds!!), specialty polymers, surfactants, and specialty additives. It also had a pharmaceutical business that was demerged into Aarti Pharmalabs in January 2023.
In addition to its manufacturing capabilities, Aarti Industries also has a strong research and development division that focuses on developing new products and improving existing ones. The company's R&D facilities are located in Vapi and Mumbai, India.
Aarti Industries has a global presence and exports its products to over 60 countries. The Company has manufacturing facilities in India, the Netherlands, and the United States, and it has established strategic partnerships with leading chemical companies around the world. Revenue from exports was 48% in Q3FY23.
Company derives 50% of its revenue from essential industries like Agrochem, Pharma, and FMCG, and the remaining 50% from Discretionary (Dyes, Pigments, Printing Inks, Polymer & Additives, Fuel Additives, etc.). Key customers are:
Company has signed a binding term sheet for nitric acid offtake and supply arrangement valued at over INR 8,000 crore for 20 years. It mitigates supply chain risk concerning the availability of nitric acid, which is a critical raw material for the Company.
Global companies are looking to diversify their supply chains away from China, which is likely to boost the exports of Indian players. Aarti Industries is investing INR 2,500-3,000 cr in capex over the next couple of years to benefit from China + 1 narrative. Management is looking at EBITDA growth of 20% in FY24 and 30% in FY25.
Why invest in Aarti Industries?
Diversified product portfolio: Aarti Industries has a diversified product portfolio and this diversification has helped the company weather industry fluctuations and reduces its dependence on any one product or market.
Strong manufacturing capabilities: Aarti Industries has state-of-the-art manufacturing facilities in India, the Netherlands, and the United States. The company has a track record of consistently delivering high-quality products to its customers.
Robust R&D capabilities: Aarti Industries has a strong research and development division that focuses on developing new products and improving existing ones. The Company's R&D facilities are equipped with advanced equipment and staffed by a team of qualified scientists and engineers.
Global presence: Aarti Industries has a global presence, with customers in over 60 countries. The Company has established strategic partnerships with leading chemical companies around the world and has a strong distribution network.
2. Key Historical Financials
Company demerged the Pharma business in Jan 2023. Pharma business used to contribute ~20% of revenue. So, the historical financials before the demerger may not be relevant for the remaining company.
Management has provided results of the remaining company for Q3FY23 duly adjusted for the demerger.
Aarti Industries grew revenue by 12% in Q3FY23 on a YoY basis with the EBITDA margin increasing from 14% to 16%.
Management is targeting EBITDA of INR 1,100 cr in FY23 which seems doable
3. What is my view on company valuation?
The Company trades at P/E (annualized 9MFY23) multiple of 37x vs a 5-year median of 27x and a chemical industry median of 22x. So, the valuation is expensive relative to the historical median and peers.
On an overall basis, Company looks quite exciting and is expected to grow given the significant capex investment in the next couple of years. Long-term investors could evaluate investing at significantly lower valuations.
4. What are the risks to the investment analysis?
Risks to the analysis are:
Benzene and its derivatives industry are cyclical. This is because the demand for benzene and its derivatives is influenced by various factors that are cyclical, such as changes in economic conditions, industrial production, and consumer spending.
High working capital – The Company needs to maintain an inventory of around 6 months.
Exposed to the volatility in commodity prices. The main raw material, benzene is a crude derivative, the prices of which remain susceptible to any sharp volatility in crude prices.
About the Author
I have over 17 years of experience in venture capital, private equity, and investment banking across various sectors in India and the Middle East. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the Middle East, to look after investments, M&A, and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB), and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.
I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).
I am an Insignificant Investor in the public market and co-founder of SocInvest.
Disclosure
I have no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI registered advisor. This article is purely for educational purposes and is not to be construed as investment advice. Please consult your financial advisor before acting on it.
I have used publicly available information while writing this article.