Ideas for Profit I NOCIL: Trade war a growth opportunity for rubber chemical major; Buy

Source: Moneycontrol Research

Rubber chemicals opportunity size – Tyre industry key driver

As per Rubber Statistical Bulletin’ estimates global rubber consumption is of the order of 290 lakh tonne with the annual addition of about 7.5 lakh tonne. This translates to 30,000 tonne of additional requirement for the rubber chemicals every year as rubber chemicals constitute about 4 percent of the rubber consumption. Globally, current rubber chemical demand stands at 12 lakh tonne, while that for Indian market is about 75,000 tonne.

Tyre industry, the largest consumer of rubber chemicals, is expected to grow at a CAGR of 12-14 percent for next five years. Both global and domestic tyre industry have committed expansion plans to the tune of $7.5 billion and Rs 1,650 crore respectively. NOCIL supplies to major tyre manufacturers and draws 65 percent of its  revenue from the tyre industry. Therefore, it is likely to benefit from the growing production for tyres in coming years.

Also, demand for high performance tyre, automotive and industrial products and the need for extended life is likely to increase rubber processing chemical loadings in the products.

Table: Rubber chemicals

Source: company

Manufacturing capacity and capex plan

The company’s legacy manufacturing capacity of 55,000 tonnes is operating at an optimum level and hence its multiphase expansion plans (Rs 425 crore) to meet incremental demand is expected to double capacity. The phase 1 (Rs 170 crore) of expansion is partly complete and Dahej expansion is expected to start production in the current quarter (Q3 FY19), while Navi Mumbai expansion was commissioned in Q1FY19 . In the next phase (Rs 255 crore), company is also focusing on intermediates used for making rubber chemicals. This phase is expected to commission by end of H1 FY20. Overall capex announced are expected to have asset turnover of 2x i.e. a peak sales potential of Rs 900 crore.

Improving export opportunities

NOCIL gets 29 percent of revenue from exports and commands a 5 percent market share. Its participation in the global market is improving by two ways. One, NOCIL is already an approved supplier for global tyre manufacturers like Bridgestone and Michelin which gives it an opportunity to participate in the any new global capacity envisaged by these players. Secondly, ongoing US-China trade war also bestows opportunities in the export market. For instance, rubber chemical imports to the USA from China attracts additional 10 percent import duty (effective from September 2018). This is further expected to escalate by another 15 percent if trade talks fails. On account of this various global tyre manufacturers having US plants have already approached company for sourcing of rubber chemicals.

Strong financials- Zero Debt Company

NOCIL's strong margin profile over the years has been aided by operating leverage, cost optimization and higher share of value added portfolio. Further robust cash flows in last few years helped company payoff entire debt in FY18.

Improving margin profile

Source: Company

Note: Value addition = Revenue (-) cost of raw materials consumed (-) cost of traded goods (-) change in inventories

Risk: Anti-dumping duty extension and raw material prices

Currently, the company benefits from the anti-dumping duty imposed on rubber chemicals imported from China and Korea. This is in force till July 2019, after which its extension would be evaluated. It expects a 4 percent EBIDTA margin impact in case antidumping duty is revoked.

Another operational risk to monitor is crude oil linked raw material prices particularly that of benzene which witnessed about 30 percent price increase in second half of FY18. While company’s margins were maintained during that period due to product mix, inventory management and product pricing, this is one aspect to watch out for. Off late, benzene prices have eased which company has also passed on to end clients.

Outlook

NOCIL is expected to maintain its dominant presence in Indian market on account of its technological leadership and client relationship. It is noteworthy that lengthy process for the product approval (~ 2 years) and the indispensable characteristic imparted by the rubber chemicals ensures a certain level client stickiness. Further, revenue share contribution from the exports can increase due to focus on specialty products and ongoing trade disruptions. Given this context company seems well positioned to meet the increasing demand in near term through its capex plan which translates to 21 percent sales CAGR (FY18-21e)

Operating margins are expected to moderate if the antidumping duty is not extended. Taking that into consideration EBITDA margins can contract by 100 bps in FY20e and can possibly settle at around 25-26 percent in the medium term (from 29 percent currently).

The stock is currently trading at around 9.8x FY21e earnings and 5.4x EV/EBITDA for FY21e which seems attractive given the growth outlook.

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