Updated: Feb 8
Company Name – Deepak Nitrite Limited (Deepak Nitrite)
Current Share Price – INR 1,944 (January 5, 2023)
Market Cap – INR 26,510 cr
1. What is interesting about the stock?
Modern life would not be possible if it were not for chemicals, nor would modern natural gas production.
-- Aubrey McClendon (American Businessman)
Chemicals are all around you. You're sitting on chemicals, breathing in chemicals, eating chemicals, and sleeping with chemicals. And no, you don't need to run away screaming: the natural world is made up of chemicals, too. While plants and animals are made up of chemicals, the biggest impact of chemistry on the world is the ability to make new, artificial ones. There's a modern feeling that artificial chemicals are bad, but that isn't completely true. Artificial chemicals have saved billions of lives, increased human productivity, and completely changed the way we live.
Deepak Nitrite has built its growth on an “import substitution strategy” of manufacturing chemicals used by a wide range of industries like colorants, petrochemicals, agrochemicals, rubber, pharmaceuticals, paper, textiles, detergents, etc. A further “shot in the arm” came during Covid-19 when global players adopted a “China Plus One” strategy – build an additional supplier based in countries other than China. Company generates 17% revenue from exports in Q2FY23.
Deepak Nitrite is a 51 years old intermediate chemicals company, with a diversified business of Basic Chemicals, Fine and Specialty Chemicals, and Performance Products. The company also manufactures phenol, acetone, and isopropyl alcohol (IPA) through its wholly-owned subsidiary – Deepak Phenolics (DPL). It is also expanding its footprint in High-Value Intermediates (fluorination and photo-chlorination platforms) to capitalize and synergize with DPL and has announced a new subsidiary called Deepak Clean Tech. It is one of the top 3 global players in xylidines, cumidines, and oximes, and a leader in India for inorganic intermediates and phenols.
It retails in more than 30 countries including North America, South America, Europe, and Asia. It is a preferred supplier to multinational companies like BASF, CIBA, Monsanto, and Bayer Crop Sciences.
DPL accounts for more than 60% of the revenue and profitability of the Company in FY22. Phenolic business is cyclical and saw a contraction in EBITDA margins from 28% in FY21 to 19% in FY22 due to raw material costs going up and the revocation of Anti Dumping Duty (ADD) for imports from the EU, South Korea, and Singapore. Company had the advantage of high phenol prices in FY21 and partly in FY22, primarily driven by supply chain uncertainty thereby expanding the ROE/ROCE significantly, but that is unlikely to be sustainable in the medium term. Globally, phenol is an oversupplied commodity and further phenol capacity is set to be commissioned over the next three years in South East Asia and Europe. This could create pressure on Company growth and margins as seen in Q2FY23.
Chemical businesses come with risks like the fire incident which happened at Nandesari in Vadodara on June 2, 2022. This incident led to the damage of certain property, plant, equipment, and inventory & has interrupted business for a month.
Why invest in Deepak Nitrite?
The key investment arguments summarized would be:
Diversified product portfolio with historical market leadership in quite a few of them
Debottlenecking capex across subsidiaries to result in high revenue growth rates for the next few years
Experienced management team
2. Key Historical Financials
Company has grown tremendously since FY2019 with revenue (TTM) and net profit becoming 2.5x and 6x primarily due to the Phenol business which also led to significant margin expansion. However, the EBITDA margins have come down in Q1/Q2FY23 due to higher input prices, power cost and a reduction in phenol prices. Deepak Nitrite operates at a high ROE/ROCE level of around 40%.
Cash flow conversion was poor in FY22 due to an expansion in working capital (receivables and inventory levels). Company is looking to invest INR 1,400-1,450 cr over FY2022-FY2024 towards the capacity expansion of some existing products, new product addition, and backward integration and cost-saving measures. Management is looking to raise INR 2,000 cr using QIP.
3. What is my view on company valuation?
The Company is a high-growth import substitution story that is undertaking significant investments over the next few years to increase capacity. As the capacity comes onstream, expect the revenue growth to be strong.
The investment in research and development (R&D), capex, and development of new platforms are going to impact the margins of the Company in the medium term. Also, given that the Company currently trades at a P/E of 29x vs a 5-year P/E of 21x.
The stock price has fallen ~20% since our first analysis in Jan 2022. It is still overvalued at current levels.
Company’s majority of revenues and profitability comes from commodity business – it will be very difficult to sustain current levels of ROE/ROCE. So investors should be cautious in buying the stock at the current market price which factors high level of ROE/ROCE to continue in the long term. I expect a reversion to sustainable EBITDA margins of ~15%.
4. What are the risks to the investment analysis?
Risks to the analysis are:
Raw material prices are volatile and can lead to fluctuating margins
Any impact on the supply chain (lack of availability of containers in 2021) can impact sales
Environmental activism on the part of regulators can affect operations significantly
Capex getting delayed or suffering from cost overruns outside reasonable limits
Process obsolescence can lead to the nimbler competition taking away market share through aggressive pricing
About the Author
I have over 17 years of experience in private equity and public markets. I am an engineer by background an MBA from a premier institute in India.
I have had 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.