Edelweiss Investment Research

Trading BUY: Deepak Nitrite Ltd. CMP INR: 280

Rating: BUY
Target Price INR: 360
A quiver full of growth catalysts Upside: 29%

New acetone-phenol plant set to revitalise business dynamics FY20 onwards Neha Agarwal
To take advantage of the demand–supply gap, DEN has initiated an INR 1,400 crore Research Analyst
[email protected]
acetone-phenol project in FY17. With trial runs due in Q4FY18 and seed marketing
on, we anticipate commercial production to commence from Q1FY19 with nearly Jigar Jani
65% utilisation levels during the first year of operations. While we do not expect DEN Research Analyst
[email protected]
to enjoy major pricing differential or quality advantage over imports, lower logistics
cost and better inventory management (leading to improvement in working capital
cycle) will be sufficient incentives for import substitution. We estimate the company
to generate cash flows from FY20 from this 16% EBITA business. Overall, we expect
this project to revitalise DEN’s business dynamics with robust RoCE and margin
accretion.

Improving product mix, efficiency to drive performance products business

DEN, market leader in the INR 500 crore domestic optical brightening agents (OBA)
market, has also expanded its footprint internationally by entering US, Latin America,
Bloomberg: DN:IN
South East and Far-East Asia. Its OBA plant achieved EBITDA breakeven in Q2FY18.
At peak utilisation, while OBA has the potential to generate INR 550 crore sales with 52-week
12-13% EBITDA margin, Di-amino Stilbene Di-sulphuric acid (DASDA) can generate 286.00 / 96.90
range (INR):
sales of INR 130 crore with a steady state EBITDA margin of 8-9%. Moreover,
development of new high-margin chemicals has spearheaded surge in DEN’s fine Share in issue (cr): 14

and specialty chemicals business. The company is focused on expanding its

M cap (INR cr): 3,051
footprint in high-value intermediates, especially for the pharma API and personal
care industry and also pursue contract manufacturing opportunities for Avg. Daily Vol.
504
agrochemical majors. This significantly burnishes growth prospects. BSE/NSE :(‘000):

Promoter
Outlook and valuations: Low valuations for a strong cash flow generating business Holding (%)
46.59
With commencement of the acetone-phenol project, DEN’s revenue is estimated
to double and margins quadruple, leading to a complete change in business
dynamics. Although the company’s debt-equity levels are expected to soar 2x, we
estimate RoCE to expand from current 7% to 17% by FY20. This, coupled with annual
cash flow of more than INR 200 crore from FY20, leaves ample scope for forward
integration as well. Our earnings estimates per share for FY18/FY19/FY20 are INR
3.5/14.6/18.0, respectively. We value the company at 20x FY20E EPS of INR18 and
initiate with ‘BUY’ recommendation and target price of INR360/share.

Year to March FY16 FY17 FY18E FY19E FY20E

Revenues (INR Cr) 1,373 1,360 1,541 3,092 3,534
Rev growth (%) 3.4 (0.9) 51.2 100.7 14.3
EBITDA (INR Cr) 164 137 151 438 517
Net Profit (INR Cr) 60 94 48 201 248
P/E (x) 54.4 39.0 81.0 19.2 15.6
EV/EBITDA (x) 23.1 32.1 34.4 12.1 9.2
RoACE (%) 12.5 7.3 5.3 14.6 17.1
RoAE (%) 14.6 15.8 6.5 24.1 24.6
Date: 08th January 2017

1 GWM
 Deepak Nitrite is expected to have a strong start of its acetone-phenol project in FY19 with nearly 65% utilisation on the back of strong seed
marketing initiatives taken by the company during FY18 and competitive pricing to imports. Additionally, the fine and specialty chemicals and
OBA businesses are also expected to contribute substantially to the incremental profitability owing to improving product-mix towards high margin
products. At an inexpensive valuation of 13.5x FY20 earnings estimates with augmenting ROCE (expected to expand from 7% in FY17 to 17% in
FY20), DEN provides high margin of safety to investors.

Acetone-phenol project to Free cash flows from FY20

expand the base revenues Debt funded capex to with scope for forward
and profitability by multiple generate healthy returns integration
times

FY16 FY17 FY18E FY19E FY20E FY16 FY17 FY18E FY19E FY20E Multiple Price Target
Revenue 1373 1360 1541 3092 3534 16x 288
ROACE (%) 12.5 7.3 5.3 14.6 17.1
EBITDA 164 137 151 438 517 BAL
Debt to 20x 360
EBITDA Margin (%) 12 10 10 14 15 1.1 1.0 1.8 1.6 1.3
equity ratio
PAT margin (%) 4 7 3 6 7

Free cash flow

generation to lead to
PAT CAGR of 38%
Entry = INR 280 an exit multiple of
over FY17-20E
FY20E 20x

Upside of
28%

2 GWM
 Our target price is arrived at by assigning an 20x P/E multiple to DEN on an EPS
Price Target 360 of INR 18 in FY20E on augmenting ROCE and cash flows.

DEN is at the cusp of initiating operations of its acetone-phenol project from

FY19. Having complete import substitution potential, the company could
Bull
414 achieve as high as 75-80% utilisation (against over expectation of 65% during
23x 2020E EPS
1st year) in 12-18 months of operations. This makes for a compelling bull case
scenario with a potential rerating

Base We value the company at 20x FY20 earnings estimate of INR 18/share and
360
20x 2020E EPS initiate our ‘BUY’ recommendation with a target of INR360/share.

In the bear case scenario, we have assumed a slow ramp up in new capacity
Bear utilization due to aggressive competition from imports and domestic resistance
240
15x 2020E EPS to shift. Assigning a lower multiple of 13x FY20E on an EPS of INR 16 gives us a
target price of INR 240/share, downside limited to 14% from CMP.

3 GWM
Average Daily Turnover (INR cr) Stock Price (CAGR) Relative to Sensex, CAGR (%)

3 months 6 months 1 year 1 year 3 years 5 years 10 years 1 year 3 years 5 years 10 years
10 8 5.7 79% 51% 55% 45% 64% 45% 42% 30%

While the basic chemicals industry is highly commoditised with realisations and overall demand linked
to crude, among other raw materials, the specialty chemicals industry has low volume customised
Nature of Industry
production. DEN is also a prominent player in OBA (optical brightening agents) industry, which entails
highly customised demand and customer stickiness.

Opportunity size of the base business is expanding given DEN’s multi-product facilities. The company
can customise production to withstand any sub-sector headwinds. Going forward, the acetone-
Opportunity Size
phenol project that the company is venturing in to offers an INR 2,300 crore opportunity with potential
for 100% import substitution.

DEN has completed INR1,400 crore green field capex for acetone phenol project with 60% debt
Capital Allocation
funding and balance via QIPs and internal accruals.
Business Value Drivers

Predictability Regulatory hindrances and limited information from secondary markets preclude predictability.

Difficult to dislodge clients due to high switching costs (quality checks and approvals required for
Sustainability
specialty chemicals and performance products); scope to expand globally will ensure sustainability.

Disproportionate Addition of acetone-phenol to the base chemicals business will ensure future performance in terms of
Future return ratios will be better than the past as asset turnover and margins will improve steadily.

Business Strategy &

Current focus is on ramping up existing capacities and recent expansion.
Planned Initiatives

Strong visibility for 38% CAGR bottom line growth along with 457 bps improvement in operating
Near-Term Visibility
margin over FY17-20E

Long-Term Visibility To become one of the largest domestic chemicals players with market dominance in select products.

4 GWM
 Focus Charts – Story in a nutshell

Commercial production to be successful with margin of

Successful funding of acetone-phenol project with 60% debt
safety in product spreads
Internal accurals
70
60
9% 8% QIP @ INR 70.9 with 10% 50
dilution
6% 40
11% Land Sale 30
6%
20
10
Term debt for 13 years @
10.75% with 4.5 years 0

01-03-2013

01-09-2013

01-03-2014

01-09-2014

01-03-2015

01-09-2015

01-03-2016

01-09-2016

01-03-2017

01-09-2017
moratorium period
QIP @ INR 104 with 12%
dilution
60%
Remaining
Spread (in INR/kg)

Feasible level for project

Linear (Spread (in INR/kg))

Steady ramp-up in global markets for OBA owing to While its basic chemicals business has nearly matured,
customised requirements DEN has more to extract from the other two segments....
400
Lower DASDA
revenue despite
DASDA facility shut
down owing to
6% 1500 Revenue 200 Profitability/EBIT
record volumes complaince issues
350 OBA plant
due to globally raised by Telangana 4% 4% 266 274
commissio 253 97 85
n at Dahej
subduesd prices State Pollution Board 1000 150
300 326 393
2% 2% 364
In INR corer

in 1
64
250 Q4FY2014
in INR crore

0% 750 100
500 675 666
200 -1%
-2% 91
-2% 83 80
150 50
-3% 0
100
-4%
FY15 FY16 FY17
Performance Products (FWA)
50 -6% -6% 0
Fine & Specialty Chemicals -9 -14
0 -8%
(FSC)
FY2014 FY2015 FY2016 FY2017 FY2018E FY2019E FY2020E -50
Basic Chemicals (BCC)
FY15 FY16 FY17
Performance Products (FWA) EBITDA margin (RHS)

60% debt funded acetone-phenol project changed the Yet, quick ramp-up to ensure strong cash flows FY20
debt/equity dynamics of DEN onwards
1600 1.8 2.0 300 261
1.6 1.8 250
1400 1.6
1.6 200
1200
in INR crore

1.2 1.4 150

1.1 107 107
1000 1.2
1.0 100 66 70
(INR Cr)

800 1.0 29 33 42
50 27 25
0.7 0.8
600 0
0.4 0.4 0.6
400 -50
-30
0.2 0.4 -45
-100
200 0.2
FY18E

FY19E

FY20E
FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

0 0.0
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E
CFO
Total Debt Net Debt Net Debt/Equity (RHS)

Source: Edelweiss Investment Research

5 GWM
 I. Phenol-acetone: DEN’s new plant to bridge demand-supply gap
Phenol and acetone are organic compounds derived from benzene and propylene (crude
derivatives). Both compounds are versatile in nature and used as intermediates for diverse
applications. While phenol finds application in laminates, paints, automotive lining, rubber
adhesives, pesticides, mouldings, among others, acetone is used in healthcare, paints, thinners,
inks, acrylic sheets, etc. The market for phenol and acetone is estimated to clock 8.5% and 6.0%
CAGR over FY17-20, respectively, riding robust demand from end-user industries.

Laminates (30-35%)

Foundry/Mould
(28-33%) 9%
7.50%
Automobile lining
(5-6%)
Phenolic Resin
Paints & Vanishes
(74-78%) Past 5 year CAGR Next 5 years CAGR
(2-3%)
Rubber adhesives
(2-3%)
Phenol (100%)
0.87unit Others
(2-4%)
1.0unit
Benzene
5% 3.50%
Surfactants & Rubber
Alkyl phenol (5-6*) (2-3%)
Past 5 year CAGR Next 5 years CAGR
7% 7%
Drugs & Dyes
Rubber & Sulpha drugs
(8-10%)
Cumene Hydro Past 5 year CAGR Next 5 years CAGR
Cumene Agro-chemicals 9%
Peroxide Pesticides
7.50%
(3-5%)
1.31unit Past 5 year CAGR Next 5 years CAGR

7.0% 7%
Propylene Pharma (67-70%)
Past 5 year CAGR Next 5 years CAGR
0.47unit 4.0% 2.50%
Direct use Paints, Adhesives &
Thinners (8-10%)
Past 5 year CAGR Next 5 years CAGR
2.5% 2%
Others (5-10%)
0.612unit Past 5 year CAGR Next 5 years CAGR

1.5% 5%
Acetone Paints, printing ink etc.
Aldol Chemicals (2-3%)
Past 5 year CAGR Next 5 years CAGR

1.5% 0.50%
MMA Acrylic sheets
Past 5 year CAGR Next 5 years CAGR
Past 5 year CAGR Next 5 years CAGR

Source: Edelweiss Investment Research

Globally, about 47% of phenol is used for Bisphenol-A, which is subsequently used in plastic
products. However, domestic demand is majorly concentrated in phenolic resins used as an
adhesive and binding agent in various industries. Nearly 32% of global demand for acetone
emanates for solvents which are used as thinners across industries. However, domestic demand is
spearheaded by pharmaceuticals industry, followed by paints and thinners.

6 GWM
 a. While phenol and acetone consumption has posted 7-year CAGR of 9% and 3%,
respectively, domestic supply has been declining consistently

180 Acetone
350 Phenol
160
300
140
in '000 MT/annum

in '000 MT/annum
250
120
200
100
249 282 294 101 117 127 157
150 123 147 173 214 200 80 78 138 136
80 80 96
93 68
100 60
50 40
0 20

FY18E
FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17
0
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E

Domestic Imports Domestic Imports

Source: Edelweiss Investment Research

Currently, India imports phenol and acetone—over 80% requirement imported. Taiwan, Korea,
Thailand, Singapore and the US comprise major exporting countries with Asian countries
contributing lion’s share due to significant capacity additions. There are only two entities
manufacturing these products in India—Hindustan Organics (HOCL) and SI Group (erstwhile
Schenectady Herdiliia). Technology obsolescence, working capital constraints and low
capacities have rendered it uneconomical for domestic players to match import landed costs.
This has led to significant gap between domestic and landed costs, resulting in utilisation levels of
domestic players like SI Group and HOCL plummeting from 70-75% in FY09 to nearly 50% in FY17.

b. DEN to bridge domestic supply gap; to generate 23% project RoCE with economies of scale
To take advantage of this demand-supply gap, DEN is setting up an acetone-phenol plant in India
with 200,000 MTPA phenol and 120,000 MTPA acetone capacities under its wholly-owned
subsidiary Deepak Phenolics in PCPIR (Petroleum, Chemicals and Petrochemicals Investment
Region), Dahej. The company is anticipated to plug domestic players’ efficiency gaps via
economies of scale. Presence in PCPIR will further enhance operational efficiencies of the project
due to waste treatment, transportation and power support.

While we do not expect DEN to enjoy major pricing differential or quality advantage over imports,
lower logistics cost and better inventory management (leading to improvement in working capital
cycle) will be sufficient incentives for import substitution.

Anti-dumping duty on phenol to augment phenol project’s IRR

Year Event
March, 2012 Anti-dumping from USA, Taiwan and Korea revoked
August, 2014 Gol imposed duty on Korea and USA again
July, 2015 Anti-dumping duty imposed on South Africa

7 GWM
 c. With its project nearing completion and funding requirements met up to 90% of estimations;
DNL is all set to take the plunge
DEN is spending an estimated INR 1,400 crore for the acetone-phenol project funded via a blend
of debt, equity and internal accruals. Post sourcing nearly INR 1,250 crore funds in the past 2 years
from multiple channels, the company will require nearly INR 150 crore of additional funding for
project completion. We expect the same to be sourced through another round of Qualified
Institutional Placement (QIP).

Internal accurals
9% 8%

6% QIP @ INR 70.9 with 10% dilution

11%
6%
Land Sale

Term debt for 13 years @ 10.75% with

4.5 years moratorium period

QIP @ INR 104 with 12% dilution

Remaining
60%

Source: Edelweiss Investment Research

Easy feedstock availability from domestic sourcing…. ….with spreads at significantly above feasibility levels

70
60
5000
50
4000 40
in '000 MTPA

30
3000
20
2000 10

1000 0
01-03-2013

01-09-2013

01-03-2014

01-09-2014

01-03-2015

01-09-2015

01-03-2016

01-09-2016

01-03-2017

01-09-2017
0
Benzene Propylene
16% 2%
Required by DNL at peak Spread (in INR/kg) Feasible level for project

Reliance IOCL Haldia Petrochem BPCL Linear (Spread (in INR/kg))

Source: Edelweiss Investment Research

DEN’s feedstock requirement can be met locally or through imports from China, US or Western
Europe. Further, the input-output cost and conversion ratios give a 5-year average spread of INR
42/kg or USD 650/MT. Post consideration of the cost dynamics disclosed by the company, we
estimate the project to be feasible up to a spread of INR 18/kg or USD 275/MT entailing overall low
risk profile of the project.

8 GWM
 d. Imports spread across countries to reduce risk of aggressive price competition

Top 5 countries form 80% of phenol imports…. ……export to India is significant only for China and Thailand

Other Brazil Others

Asia, nes 4% 2% USA
6%
Thailand
South Rep. of
Africa Korea
7% 21% Singapore

Singapore
8% Rep. of Korea

China
Thailand 20% China
15%

- 50,000 1,00,0001,50,0002,00,0002,50,0003,00,0003,50,0004,00,0004,50,000
USA
17%
India ROW

Source: Edelweiss Investment Research

Top 4 countries form 90% of acetone imports….. ……with export to India being significant for only Thailand

Russian China
Federation 5%
6% Thailand

Singapore
8% Singapore
Thailand
30%
Russian Federation

Other Asia, nes

Rep. of
Korea
23% Rep. of Korea
Other
Asia, nes 0 50000 100000 150000 200000 250000 300000
28%
India ROW

Source: Edelweiss Investment Research

Exports to India are highly significant for China and Thailand, constituting over 90% and 50% of
their respective total acetone-phenol exports volumes. However, import prices have remained at
par with global prices despite the countries having surplus capacities.

Going forward, with DEN putting up capacities equivalent to 80-90% of acetone-phenol imports,
imports from these countries are likely to face a threat, triggering a temporary price war in the
domestic market. However, we estimate the same to stabilise over 12-18 months with overall
domestic demand also expanding by ~7% annually.

9 GWM
 Excerpts from channel checks
 ‘Can buy phenol from DEN, but not fully as supply concentration could be risky.’; very large
domestic importer/supplier

 ‘We have been approached by DEN and have given our consent to participate.’; very large
domestic importer/supplier

 ‘DEN has strong brand name and it will not be surprising if they replace up to 80% of imports’;
one of the prominent domestic distributor s

 ‘DEN has strong brand recognition and it is win-win deal for traders as well considering their
working capital will reduce. 60-70% of importers/traders can be expected to come on board’;
one of the prominent domestic distributor s

Project financial estimates

(in INR crore) FY19 FY20 FY21

Phenol Capacity (MT) 200000 200000 200000
Utilization Rate (%) 65% 80% 90%
Phenol Produced (MT) 1,30,000 1,60,000 1,80,000
Acetone Produced (MT) 79,560 97,920 1,10,160
Sales 1452 1787 2010
RM Costs 908 1117 1257
Power cost 155 191 215
as % 11% 11% 11%
Fuel Cost 29 36 40
as % 2% 2% 2%
Gross Profit 359 442 498
Gross Margin (%) 24.80% 24.80% 24.80%
Other Expenses 123 145 160
Other Expenses (%) 8% 8% 8%
EBITDA 236 297 337
EBITDA margins 16.30% 16.60% 16.80%
Depreciation 50 50 50
EBIT 186 247 287
Interest 100
Interest Rate 11%
PBT 186 247 187
Source: Edelweiss Investment Research

10 GWM
 II. Base business: Changing product mix to gain stability and growth
a. Performance products: Taking the front seat in optical brightening agents
DEN’s performance products (PP) division majorly consists of two products, viz., optical brightening
agents (OBA) and Di-amino Stilbene Di-sulphuric acid (DASDA). The company is the only fully
integrated manufacturer of OBA in the world with vertical integration from toluene to para nitro
toluene (PNT) and further into DASDA and OBA.

OBA Manufacturing Value Chain

Nandesari Nandesari Hyderabad Dahej

Nitrotoluene PNT DASDA OBA

DASDA: In 2007, DEN acquired Hyderabad-based Vasant Chemicals’ DASDA division for INR 50
crore. DASDA is the basic raw material used for manufacturing OBA. Currently, DEN sources its
entire DASDA requirement for its OBA plant in Dahej from the Hyderabad unit. After meeting its
captive requirements, the balance is sold commercially in domestic and international markets,
thereby enhancing cost economics of its OBA plant.

OBA: In Q4FY14, DEN commissioned the OBA plant at Dahej (Gujarat) by investing INR 280 crore,
marking the company's entry in the performance chemicals segment. OBA is a brightener
commonly used in industries like paper (65%), detergent (20%) and textiles (15%). Depending on
the customer's need, the active chemical of OBA is blended with other formulations, either in liquid
or solid form. In the OBA space, DEN faces competition from Archroma and BASF in the domestic
market and TFM, Transfar, Archroma & 3V in global markets.

Robust growth potential with backward integration-led cost advantage

Complete backward integration renders DEN immune to the price volatility in intermediates like
PNT and DASDA. Additionally, it enables the company to customise raw materials at each stage
as per customer requirements (liquid, solid or powdered state). Entire requirement of DASDA to
manufacture OBA is met internally, while the balance output is sold in the open market to other
OBA manufacturers. The company plans its DASDA output based on internal needs and external
demand.

Domestic market leader expanding global footprint

DEN is already a market leader in the INR 500 crore domestic OBA market with nearly 75% share.
The company has also expanded its footprint internationally by entering US, Latin America, South
East and Far-East Asia. By FY17, it has 100 plus customers (domestic and internationally) spread
equally across paper, detergents and textile segments.

11 GWM
 Steady ramp-up in global markets owing to customised requirements
400 6%
Lower DASDA
revenue despite DASDA facility shut
350 OBA plant
4%
commission at
record volumes due down owing to 4%
to globally complaince issues
Dahej in
300 subduesd prices raised by Telangana
Q4FY2014
State Pollution Board 2% 2%
250

in INR crore
0%
200 -1%
-2%
-2%
150
-3%
-4%
100

50 -6% -6%

0 -8%
FY2014 FY2015 FY2016 FY2017 FY2018E FY2019E FY2020E

Performance Products (FWA) EBITDA margin (RHS)

Source: Edelweiss Investment Research

Despite commencing operations 2-3 years ago, DEN’s utilisation has been moderate at 40-45%
due to specific product requirements and subsequently long waiting period to establish a supply
agreement. Going forward, we expect gradual scale up (from current 15-20% of customer
requirements) post successful quality checks. However, there remains a possibility of delayed take-
off owing to customer receptiveness about quality standards and lengthy validation cycle.

The company’s OBA plant achieved EBITDA breakeven in Q2FY18. At peak utilisation, while OBA
has the potential to generate INR 550 crore sales with 12-13% EBITDA margin, DASDA can generate
sales of INR 130 crore with a steady state EBITDA margin of 8-9%.

12 GWM
 b. FSC segment eyeing pharma intermediates entry
The fine and speciality chemicals segment includes niche products manufactured at relatively
lower volumes and are customised to specific customer requirements. The segment produces
xylidines, cumidines, oximes, nitro oxylene, etc., which find application as ingredients in
colourants, pigments, pharmaceutical intermediaries and agrochemicals.

Development of new high-margin chemicals led to strong surge in the company’s fine and
specialty chemicals business. Further, DEN is focused on expanding its footprint in high-value
intermediates, especially for the pharma API and personal care industry and also pursue
contract manufacturing opportunities for agrochemical majors.

600 Supply disruption due to fire 30%

accident at Roha facility in
500 25%

400 20%
in INR crore

300 15%

200 10%

100 5%

0 0%
FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Revenues EBIT Margin

Source: Edelweiss Investment Research

13 GWM
 c. Basic chemicals to sustain moderate growth rate
DEN’s basic chemicals division is characterised by high volume and moderate margin products
across organic and inorganic chemicals.

 Organic chemicals produced include nitro toluene and ortho toluene which are used to
manufacture intermediates for colourants, rubber production, pharmaceuticals, explosives,
dyes & agrochemicals and fuel additives used in refineries.

 Inorganic chemicals produced include sodium nitrites & sodium nitrates with sodium nitrite
used in colourants, pharma, electroplating & rubber chemicals and sodium nitrate used in
industrial explosives, glass industry & heat-treating chemicals.

Brownfield expansion, multi-product capacity buoy margin despite down cycles

The basic chemicals segment not only entails limited margin, but is also exposed to crude price
volatility, leading to unpredictable revenue. Margins are lower as chemicals are made to
standard specifications and not unique as per customer preferences. Segment sales have
remained range-bound since FY13, while EBIT has expanded 67% post brown field expansion in its
Nandesari plant in FY14. With 90% utilisation levels, future growth in basic chemicals is expected to
be led by improving product-mix and efficiency.

900 Expansion at Nandesari plant 20%

800
15%
in INR crore

700
10%
600
5%
500

400 0%
FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Revenues EBIT Margin (RHS)

Source: Edelweiss Investment Research

14 GWM
 III. Financial Analysis
a. While its basic chemicals business has nearly matured, DEN has more to extract from the
other two segments....
200 Segmental profitability/EBIT
1600 Segmental revenues

1400
97 85
266 274 150
1200 253
1
64
1000
In INR corer

326 393 364

800 100

750 91
600 675 666 83 80
400 50

200

0 0 -9
-14
FY15 FY16 FY17 FY15 FY16 FY17

Basic Chemicals (BCC) Fine & Specialty Chemicals (FSC)

Performance Products (FWA) -50

Source: Edelweiss Investment Research

...Fine & specialty chemicals and performance products bsuinesses have room for growth at
current asset base
1200 2.5

1000
2.0
Gross Assets (in INR cr)

800

Asset turnover
1.5
600
1.0
400

0.5
200

0 0.0
FY13 FY14 FY15 FY16 FY17
Basic Chemicals Fine & Specialty Chemicals (FSC)
Performance Products (FWA) Basic Chemicals
Fine & Specialty Chemicals (FSC) Performance Products (FWA)

Source: Edelweiss Investment Research

15 GWM
 b. 60% debt funded acetone-phenol project changed the debt/equity dynamics of DEN
1600 1.8 2.0
1.6 1.8
1400 1.6
1.6
1200
1.2 1.4
1000 1.1
1.0 1.2

(INR Cr)
800 1.0
0.7 0.8
600
0.4 0.4 0.6
400
0.2 0.4
200 0.2
0 0.0
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E
Total Debt Net Debt Net Debt/Equity (RHS)

Source: Edelweiss Investment Research

DEN has raised INR 840 crore via debt to fund its INR 1,400 crore acetone-phenol project in FY18.
As a result, the company’s net debt-equity ratio jumped to 1.8x with repayment expected to
commence from FY20 on generation of surplus cash flows.

300 261
250

200
in INR crore

150
107 107
100 66 70
33 42
50 29 27 25

-50
-30
-45
-100
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

CFO

Source: Edelweiss Investment Research

16 GWM
 c. Working capital cycle to strech with the start of acetone-phenol project in FY19
120
100
80
60
40
20
0
-20
-40
-60
-80
-100
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Debtor Days Inventory Days Payable Days Cash Conversion Cycle

Source: Edelweiss Investment Research

While FY17 debtor days worsened on account of higher credit extended in the base business, it
was offset by larger working-capital borrowing from banks. Going forward, we expect the working
capital cycle to remain streched on account of the acetone-phenol project.

d. Increasing contribution of profitability to ROE

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Sales/Assets Asset/Equity Net Profit Margin

Source: Edelweiss Investment Research

With changing product-mix in favour of high-margin products, there has been higher contribution
of profitability to RoE. Acetone-phenol, being a margin accretive business right from
commencement of operations, is expected to add to the phenomenon.

17 GWM
 IV. Valuations
In our view, DEN is set to reap benefits of capacities in the acetone-phenol project as well as
performance products business. Ergo, we estimate spectacular revenue and margin spurt with
higher utilisation levels and business expansion.

Our earnings estimates per share for FY18/FY19/FY20 are INR 3.5/14.6/18.0, respectively. We value
the company at 20x FY20E earnings of INR18/share and initiate with ‘BUY’ recommendation and
target price of INR360/share.

Steep rise in trailing P/E as acetone-phenol project comes near completion

250

200
P/E multiple

150

100

50

0
Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17

5x 8x 10x 13x 15x Deepak Nitrite

Source: Edelweiss Investment Research

18 GWM
 Risks and concerns
 Acetone-phenol spread volatility: The profitability in the acetone-phenol business is closely
linked to the spread between global prices of acetone-phenol and benzene propylene.
Hence, any major fluctuation in the spreads may impact our estimates from the business.
Additionally, this is spot business with negligible contract-based hedge.

 Delay in base-business take off: We expect the base business of DEN to be also contributing
positively to incremental profitability. However, various factors such as order book flow and
improving product mix are key drivers here. Any delay in order flow or slower ramp-up in new
product-mix xould be detrimental to growth.

 Import competition: Acetone-phenol project, being driven by import substiution demand, may
face price competition from major exporting countries such as China and Thailand. Any
aggressive competition can temporarily impact our near-term estimates.

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 Details of subsidiaries and associates

Deepak Phenolics Ltd. Deepak Nitrite Corporation, Inc. Deepak Gulf LLC

● 100% subsidiary ● 100% subsidiary ● 49% shareholding

● Dedicated to acetone-phenol ● Caters to the marketing ● No commercial operations

project requirements in the US and looks out undertaken yet
for expansion potential
● Commercial production to
commence from FY19

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Financials
Income statement (Consolidated) (INR crs) Balance sheet (INR cr)
Year to March FY16 FY17 FY18E FY19E FY20E As on 31st March FY16 FY17 FY18E FY19E FY20E
Income from operations 1,373 1,360 1541 3092 3534 Equity share capital 23 26 28 28 28
Direct costs 944 948 1094 2236 2558 Preference Share Capital 0 0 0 0 0
Employee costs 119 126 142 167 178 Reserv es & surplus 450 691 728 884 1,077
Other expenses 266 275 296 418 459 Shareholders funds 473 717 756 912 1,105
Total operating expenses 1,209 1,224 1390 2654 3017 Secured loans 465 654 1,305 1,305 1,305
EBITDA 164 137 151 438 517 Unsecured loans 64 89 178 178 178
Depreciation and amortisation 40 43 48 96 97 Borrowings 529 744 1,484 1,484 1,484
EBIT 124 94 102 341 419 Minority interest 0 0 0 0 0
Interest expenses 40 37 42 64 64 Sources of funds 1,002 1,461 2,239 2,396 2,589
Profit before tax 86 133 71 299 370 Gross block 899 918 1,918 1,938 1,958
Prov ision for tax 26 39 23 99 122 Depreciation 301 328 376 472 570
Core profit 60 94 48 201 248 Net block 598 591 1,542 1,466 1,388
Extraordinary items 0 0 0 0 0 Capital work in progress 36 353 0 0 0
Profit after tax 60 94 48 201 248 Total fixed assets 634 944 1,542 1,466 1,388
Adjusted net profit 60 94 48 201 248 Unrealised profit 0 0 0 0 0
Equity shares outstanding (mn) 11.6 13.1 14 14 14 Inv estments 87 117 117 117 117
EPS (INR) basic 5.2 7.2 3 15 18 Inv entories 123 138 160 339 387
Diluted shares (Cr) 11.6 13.1 14 14 14 Sundry debtors 313 360 401 847 968
EPS (INR) fully diluted 5.2 7.2 3 15 18 Cash and equiv alents 6 14 159 65 570
Div idend per share 1.2 0.0 1 3 4 Loans and adv ances 57 68 68 68 68
Div idend payout (%) 23.3 0.0 22 22 22 Other current assets 0 0 0 0 0
Total current assets 499 580 788 1,319 1,993
Common size metrics- as % of net revenues (INR crs) Sundry creditors and others 208 264 296 593 678
Year to March FY16 FY17 FY18E FY19E FY20E Prov isions 22 6 6 6 7
Operating expenses 88.1 90.0 90.2 85.8 85.4 Total CL & prov isions 230 269 302 599 684
Depreciation 2.9 3.1 3.1 3.1 2.8 Net current assets 269 311 487 719 1,309
Interest expenditure 2.9 2.7 2.7 2.1 1.8 Net Deferred tax -57 -66 -66 -66 -66
EBITDA margins 11.9 10.0 9.8 14.2 14.6 Misc expenditure 73 159 159 159 159
Net profit margins 4.4 6.9 3.09 6.49 7.01 Uses of funds 1,006 1,465 2,239 2,396 2,907
Book v alue per share (INR) 41 55 55 66 80

Growth metrics (%)

Cash flow statement (INR cr)
Year to March FY16 FY17 FY18E FY19E FY20E
Year to March FY16 FY17 FY18E FY19E FY20E
Rev enues 3.4 (0.9) 51.2 100.7 14.3
Net profit 60 94 48 201 248
EBITDA 19.4 (16.6) 108.6 190.7 18.0
Add: Depreciation 40 43 48 96 97
PBT 31.9 54.2 35.3 321.1 23.5
Add: Misc expenses written off -27 -87 0 0 0
Net profit 17.5 56.8 26.0 321.1 23.5
Add: Deferred tax 10 9 42 0 0
EPS 5.6 39.5 (4.5) 321.1 23.5
Gross cash flow 83 59 138 297 345
Less: Changes in W . C. -23 17 31 327 84
Ratios Operating cash flow 107 42 107 -30 261
Year to March FY16 FY17 FY18E FY19E FY20E Less: Capex 76 353 651 20 20
ROAE (%) 14.6 15.8 6.5 24.1 24.6 Free cash flow 30 -311 -544 -50 241
ROACE (%) 12.5 7.3 5.3 14.6 17.1
Debtors (days) 83 97 95 100 100
Current ratio 2.2 2.2 2.6 2.2 2.9
Debt/Equity 1.1 1.0 2.0 1.6 1.3
Inv entory (days) 33 37 38 40 40
Payable (days) 55 71 70 70 70
Cash conv ersion cycle (days) 61 63 63 70 70
Debt/EBITDA 3.2 5.4 9.9 3.4 2.9
Adjusted debt/Equity 1.1 1.0 1.8 1.6 0.8

Valuation parameters
Year to March FY16 FY17 FY18E FY19E FY20E
Diluted EPS (INR) 5.2 7.2 3.5 14.6 18.0
Y-o-Y growth (%) 5.6 39.5 (4.5) 321.1 23.5
CEPS (INR) 9 10 7 22 25
Diluted P/E (x) 54.4 39.0 81.0 19.2 15.6
Price/BV(x) 6.9 5.1 5.1 4.2 3.5
EV/Sales (x) 2.8 3.2 3.4 1.7 1.4
EV/EBITDA (x) 23.1 32.1 34.4 12.1 9.2
Diluted shares O/S 11.6 13.1 13.8 13.8 13.8
Basic EPS 5.2 7.2 3.5 14.6 18.0
Basic PE (x) 54.4 39.0 81.0 19.2 15.6
Div idend yield (%) 0.4 0.0 0.3 1.2 1.5

21 GWM
 Edelweiss Broking Limited, 1st Floor, Tower 3, Wing B, Kohinoor City Mall, Kohinoor City, Kirol Road, Kurla(W)
Board: (91-22) 4272 2200

Vinay Khattar

Head Research

[email protected]

Rating Expected to

Buy appreciate more than 15% over a 12-month period

Hold appreciate between 5-15% over a 12-month period

Reduce Return below 5% over a 12-month period

900
800
700
600
(Indexed)

500
400
300
200
100
0
Jul-14

Oct-14

Jul-15

Oct-15

Jul-16

Oct-16

Jul-17

Oct-17
Jan-14

Apr-14

Jan-15

Apr-15

Jan-16

Apr-16

Jan-17

Apr-17

Jan-18
Deepak Nitrate Sensex

22 GWM
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23 GWM
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