Jitendra Kumar Gupta Moneycontrol Research
In an otherwise overheated market, it is difficult to find a company that is in the right business at the right price – I G Petrochemicals happens to be one such interesting name. The company caters to the high growing segment of plastics. While the stock had a stellar run, the valuation still looks reasonable. Finally, the company has invested in improving growth and margin that stand to support earnings.
Long-term Prospects
As against per capita plastic use of 108-140 kg in developed countries like US, Europe and Japan, India’s per capita plastic consumption at 10 kg is minuscule. The government is now targeting to take this to 20 kg per person by the end of 2020, which is still small compared to global average per capita plastic consumption of 45 kg.
IG Petrochemicals is the largest manufacturer of phthalic anhydride (PAN), controlling 47 percent of India’s production capacity followed by Thirumali Chemicals holding close to 40 percent of total capacity. PAN is a chemical compound, which finds its applications in flexible plastics such as cables, pipes, leather products, packaging films and paints industry.
The advantages of captive power and proximity to ports has helped the company in keeping the costs low and the company is the lowest cost producer enjoying 11.3 percent operating margin as against 10.7 percent operating margins reported by its competitor Thirumalai Chemicals.
Interestingly, despite being in B2B (business to business), which is normally construed as a commodity business, the strength of the company is well reflected in its return on equity (ROE) of close to 24 percent. The company has reported asset turnover ratio of 2.5 times asset and debtor days of 38 days of debtors (46 days in the case of Thirumalai Chemicals). The duopoly structure of the industry that is dominated by two large players has aided the superior fundamentals.
Demand Drivers
While traditionally industry growth tends to mirror the GDP growth, in coming few years, the growth could be higher on account of increasing usage of plastics helped by changing lifestyle, urbanisation and innovative product applications like new forms of packaging etc.
The size of the Indian PAN market is close to 3.5 lakh tonnes; out of this around 85,000 tonnes of domestic requirements were met through imports. Gradually, the share of imports is expected to come down as domestic players expand their capacity.
IG Petrochemicals is looking beyond natural growth. It has taken steps to forward-integrate both in the international and domestic markets by investing in Maleic Anhydride (MA) manufacturing. Maleic Anhydride is used for producing fiberglass plastics which find its applications in the fixture and other applications like automobile, pipe, roofing and tanks.
In 2015, the company entered into a JV with Dubai Natural Oil Company to set up 45000 tonne per annum Maleic Anhydride (MA) unit which will be operational in FY19. Similarly, it recently acquired 3500 tonnes facility of MA manufacturing from Mysore Petrochemicals for Rs 74.5 crore. Both these initiatives will not only drive top line growth but help in higher profitability as a result of the benefit of integration.
Valuation Comfort
The company recently reported its full-year financial FY17 numbers with the sales growth of 8.9 percent. Importantly, profits grew by 68 percent on a year-on-year basis to Rs 101.2 crore led by expansion in margins as a result of better pricing environment due to capacity constraints in the domestic market.
On the basis of FY17 reported earnings of Rs 32.86 a share, stock at Rs 402 is trading at 12 times, which is reasonable for a company operating in a growth industry, having negligible debt (0.3 times), high return ratios and offering a dividend yield of 1 percent. Interestingly, last year (FY16), IG Petrochemicals made close to Rs 69 crore of cash flow from operations. Out of this money, Rs 44 crore was used for repaying debt and only Rs 3.55 crore was spent on the dividend.
With cash flows growing even higher this year and debt coming down, investors can actually hope for a higher dividend or a possible announcement to increase the capacity.
While expansion of capacity is definitely on the cards, in FY18, the company will focus on de-bottlenecking its capacity by about 7000 tonnes (4 percent of current capacity) and integrating the recently acquired MA plant from Mysore Petrochemicals. This facility is expected to generate EBITDA of about Rs 25-28 crore in FY18, which is about 17 percent of its FY17 operating profit. So, while de-bottlenecking and inorganic strategy will support earnings in the coming couple of years, investors should watch for a capacity expansion announcement that should meaningfully help earnings in the longer term.
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