Indian Specialty Chemicals Sector Report

8/17/2019 Indian Specialty Chemicals Sector Report

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O

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INDIAN SPECIALITY CHEMICALS

Formulating for sustained growthJuly 03, 2014

ndian specialty chemical sector

has emerged as one of the keybeneficiary of high growth in enduser industry and growth is likely toaccelerate as India gains advantageover China

The sector is expected to grow at aCAGR of 17% in next 5 years asexports have emerged as keygrowth driver with encouragingopportunities in domestic market

Companies with strong focus onR&D, diversified product profile andarge customer base are likely to

benefit from this emerging growthopportunities in medium to longerm

We believe that Atul Ltd, Aartindustries and Vinati Organics toemerge as winners with earningsCAGR of 25-30% over next 2-3 yearsand potential return of 50-80%

Chetan Thacker

[email protected]+91-22-66121272

Rohan GuptaSenior Research [email protected]+91-22-66121248

Research Analyst


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Emkay Research July 3, 2014 2

Contents

Investment rationale................................................................................................................................................................................. 5

Financial performance to remain strong..................................................................................................................................................... 9

Valuations...............................................................................................................................................................................................10

Global specialty chemical industry to grow at a CAGR of 5-6% ................................................................................................................12

Indian specialty chemical industry has grown at a CAGR of 11-13% in the last 5 years..............................................................................14

Paints and coatings segment ............................................................................................................................................................17

Construction chemicals......................................................................................................................................................................18

Colorants...........................................................................................................................................................................................19

Exports: Emerge as a new growth opportunity..........................................................................................................................................20

Specialty chemical and base chemicals: The key differentiators................................................................................................................26

Indian specialty chemical players: Riding the wave...................................................................................................................................28

Risk and Concerns.......................................................... ........................................................................................................................31

Financial snapshot of Specialty Chemical Companies ..............................................................................................................................32

Companies

Aarti Industries – Steady growth with stable margins ...............................................................................................................................33

Atul Ltd. – Product innovation, cost rationalization are the key .................................................................................................................43

Vinati Organics – Return ratios and margins best in the industry ..............................................................................................................52

Indian specialty chemicals Specialty Chemicals Sector Report


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Your success is our success

Emkay

S p e c i a l t y C h e m i c a l s S e c

t o r R e p o r t

Emka Global Financial Services Ltd. 3

Indian specialty chemicals

Formulating for sustained growth

July 3, 2014

Aarti Industries

Price Performance

(%) 1M 3M 6M 12M

Absolute 35 77 125 176

Rel. to Nifty 29 54 82 108

Source:Bloomberg

Relative price chart

60

83

106

129

152

175

May-13 Jul -13 S ep-13 Nov-13 Jan-14 M ar -14 May-14

Rs

-40

-24

-8

8

24

40%

Aarti Industries (LHS) Rel to Nifty (RHS) Source: Bloomberg

Atul Ltd.

Price Performance

(%) 1M 3M 6M 12M

Absolute 10 107 107 182

Rel. to Nifty 6 81 67 112

Source:Bloomberg


250

345

440

535

630

725

M ay-13 Jul -13 S ep-13 Nov-13 Jan-14 M ar -14 M ay-14

Rs

-30

-10

10

30

50

70%

Atul Ltd (LHS) Rel to Nifty (RHS) Source: Bloomberg

Vinati Industries Organics

Price Performance

(%) 1M 3M 6M 12M

Absolute 25 11 66 219

Rel. to Nifty 19 -3 34 141

Source:Bloomberg


80

124

168

212

256

300

M ay-13 Jul -13 S ep-13 Nov-13 Jan-14 Mar-14 May-14

Rs

-40

-8

24

56

88

120%

Vinati Industries (LHS) Rel to Nifty (RHS) Source: Bloomberg

Chetan Thacker


Rohan Gupta


n Indian specialty chemical sector has emerged as one of the

key beneficiary of high growth in end user industry and growth

is likely to accelerate as India gains advantage over China

n The sector is expected to grow at a CAGR of 17% in next 5

years as exports have emerged as key growth driver with

encouraging opportunities in domestic market

n Companies with strong focus on R&D, diversified product

profile and large customer base are likely to benefit from this

emerging growth opportunities in medium to long term

n We believe that Atul Ltd, Aarti Industries and Vinati Organics

to emerge as winners with earnings CAGR of 25-30% over next

2-3 years and potential return of 50-80%

Encouraging growth opportunity

India’s specialty chemical sector is likely to deliver a growth of 17-18% on the back of

buoyant domestic demand and encouraging export opportunities. This sector has posted a

growth of 12-15% in the last 4-5 years, while increase in end-user demand on the back of

growing base of the middle-class, growing consumption intensity; as India’s per capita

consumption of specialty chemicals is low; and improving standards for consumption in

various industries offers enormous growth potential.

India gaining advantage over China unfolds export potential

China has been scoring higher than India in the chemical industry (fourth largest exporter

globally), but our analysis of leading Chinese manufacturers indicates increasing cost

pressure in China. Factors such as appreciating currency (Yuan appreciation against US

dollar), increasing cost of labour & power, and tightening pollution control norms havediluted the cost advantages enjoyed by Chinese manufacturers earlier. India is rightly

placed to benefit from this emerging opportunity and can register multifold growth in exports

market going forward.

Finding winners – Atul Ltd., Aarti Industries and Vinati Organics may benefit

In our view, the companies with a diversified product and client portfolio with high degree of

forward- integration are likely beneficiaries of this sustained growth opportunity in the

industry. Going forward, the companies that have been investing in strengthening their

R&D capabilities and meeting pollution control norms are more likely to benefit. Though

specialty chemicals is a wide industry, with companies having a distinct profile, expertise

and specialization, our initial screening suggests that companies like Atul Ltd., Aarti

Industries and Vinati Organics are well equipped to benefit from this compounding growthstory. Our interaction with the management provides us concrete growth plans.

Companies to benefit from sustained earnings growth re-rating potential

We believe the current valuation of the sector does not factor in complex nature of the

industry and strong entry barriers enjoyed by this sector. These companies command

stable margins, with an expected PAT growth of 25-30% and return ratios (RoCE) of 18-

22%. On the one hand, we see an earnings growth of 25-30% per annum over the next 2-3

years and also foresee a re-rating opportunity in this sector.

Company snapshot

Company CMP

Market Cap

(Rs bn) D/E

RoCE

(%)

RoE

(%) P/E

EV/

EBITDA P/B

Potential

Upside

Aarti Industires 219 19,400 1.1 17.0 20.0 11.9 7.1 2.2 50-60%

Atul Limited 921 27,300 0.3 27.7 25.7 12.4 8.3 2.9 60-80%

Vinati Organics 322 15,900 0.2 30.3 31.3 18.7 11.0 5.2 50-70%

Source: Company, Emkay Research


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Exhibit 1: Financial Snapshot

Year Revenue EBITDA EBITDA Margin APAT EPS RoCE D/E P/E EV/EBITDA P/BV

Aarti Industries

FY11 14,572 2,021 13.9 815 10.6 13.9 1.3 20.5 11.5 3.3

FY12 16,769 2,529 15.1 1,033 13.1 14.7 1.3 16.7 9.9 2.9

FY13 21,000 3,650 17.4 1,344 17.0 16.8 1.4 12.8 7.6 2.3

FY14 26,325 4,015 15.3 1,624 18.3 17.0 1.1 11.9 7.1 2.2

CAGR (FY11-14) 22% 26% 26% 20%

Expected Growth 22-25% 25-30%

Atul Limited

FY11 15,851 2,038 12.9 902 30.4 19.0 0.5 30.2 14.9 4.8

FY12 18,048 2,174 12.0 911 30.7 17.3 0.6 29.9 14.3 4.2

FY13 20,631 2,726 13.2 1,198 40.4 20.0 0.5 22.8 11.3 3.6

FY14 24,578 3,637 14.8 2,192 73.9 28.0 0.3 12.4 8.3 2.9

CAGR (FY11-14) 16% 21% 34% 34%

Expected Growth


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Investment rationale

Specialty chemical sector offers attractive growth opportunity

Specialty chemicals are high-value/low-volume chemicals known for end-use applications,

unlike commodity chemicals, where the focus is on high volume and cost efficiency.

Specialty chemicals provide the required solution to meet customer application needs and

is a knowledge-driven industry, with raw materials cost (a % of sales) much lower than forcommodity chemicals. Driven by customer orientation and backed by knowledge-driven

processes, we believe established players in this industry will benefit from emerging growth

opportunity in the specialty chemical sector.

Globally specialty chemical sector accounts for ~22% of the total chemicalindustry and has grown at a CAGR of 3.7%

The global specialty chemical industry size is pegged at around $740bn (FICCI Specialty

Chemical report and 12th Five-Year Plan document) accounting for roughly 22% of the

global chemical industry. This industry has grown at a CAGR of 3.7% during 2006-11,

despite contracting by around 7% in 2009, due to the global financial crisis. Going forward,

the industry is expected to grow at a CAGR of about 5.4% annually to reach $970bn by

FY16. Asia-Pacific and the Middle Eastern countries are expected to contribute to the bulkof the future growth for the sector.

The growth of Indian specialty chemical sector has been higher at 13%...

The Indian specialty chemical industry size is pegged at $17.7bn (excluding agrochemicals

and dyes & pigments). The growth in India has been higher than the world average. The

high rate of growth for the segment is driven by faster growth in end-user industries such

as paints & coatings, specialty polymers, and home care surfactants, among others.

… While the same is expected to accelerate further to 17% (FY12-17E)

Though Indian specialty chemical sector has demonstrated strong growth of around 13%,

industry growth is expected to accelerate further, as FY12-17E CAGR is pegged at 17%

(source – FICCI, Ex Colourants and Agrochemicals). This is supported by both domesticand export opportunities. We expect the encouraging growth opportunity in sectors like

paints & coatings, specialty polymers, construction chemicals and water chemicals to

support the higher industry growth.

Exhibit 2: India specialty chemical industry sub-segment

Industry FY11 FY14E FY17(P) Growth

Paints and coatings 3.6 5.4 8.2 15%

Specialty polymers 2.3 3.5 5.3 15%

Construction chemicals 0.6 0.7 1.4 15%

Paper chemicals 0.4 0.5 0.9 14%

I&I cleaners 0.2 0.3 0.5 16%

Others 5.7 8.7 13.2 15%Plastic additives 0.9 1.2 1.7 11%

Textile chemicals 0.8 1.1 1.5 11%

Water chemicals 0.6 0.9 1.1 11%

Cosmetic chemicals 0.5 0.7 0.9 10%

Flavors & fragrances 0.4 0.6 0.8 12%

Printing inks 0.4 0.6 0.8 12%

Rubber chemicals 0.2 0.3 0.4 12%

Agro chemical 3.8 5.3 7.7 12%

Home care surfactants 1.1 1.7 1.7 8%

Colourants 3.4 4.5 6.0 10%

Total 24.9 36.2 52.1 13%

Source: Emkay Research, Industry

Export opportunity and growing

domestic consumption for en

user industry offers attractivegrowth opportunity for domestic

specialty chemical companies

Indian specialty chemical

industry has grown at 13%

CAGR in the last 5 years, with

growth expected to accelerate

to 17% driven by stronge

domestic growth and stable

exports


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Growing domestic consumption offers enormous growth opportunity, whileemerging opportunities in exports to boost industry growth

Increase in end-user demand with growing base of the middle-class, growing consumption

intensity, as India’s per capita consumption of specialty chemicals is low, and improving

standards for consumption are expected to support growth of the domestic industry.

Our interaction with various company management and industry experts suggest that Indiais gaining popularity as an attractive hub for outsourcing. China had an edge over other

countries earlier and had been a preferred destination. However, appreciating currency

(Yuan appreciation against US dollar), increasing cost of labour & power and tightening

pollution control norms have diluted the cost advantage enjoyed by Chinese manufacturers

earlier. As exports offer an enormous growth opportunity, we believe India is well placed to

reap the benefit from it.

Exhibit 3: Growth drivers

Huge growthpotential for thedomestic export

market

World classengineering and

strong R&Dcapabilities

Rising powercost and tightening

pollution controlnorms in China

Low-costmanufacturing

Rise in GDP andpurchasing

power

India gaining edge over China

China has emerged as a low-cost manufacturing destination for chemicals. Chinese

chemical exports grew at a CAGR of 20.5% over 2000-12, which increased from $12bn in

2000 to $113bn in 2012. As a result, China’s share of global exports increased from 2% in2000 to 6% in 2012. Although chemical exports from India, too, increased in the same

period, India’s export share in global chemical exports grew merely from 1% in 2000 to 2%

in 2012, with the country’s exports increasing from $4bn in 2000 to $35bn in 2012.

Cost pressure on Chinese manufactures is favourable to India

Our analysis of a few leading Chinese manufacturers indicate the rising cost pressure,

which the industry is going through. Deterioration in gross profit margins by around 300bps,

driven by cost increases and rising debt on the company’s balance sheet has adversely

affected the fundamentals of Chinese manufactures. China has also lacked strong IPR

protection to proprietors, while India enjoys a strong IPR regime. In our view, this offers an

opportunity to Indian manufacturers.

Strong underlying factors such

as increasing demand for en

user industry, low consumption

intensity and tightening

standards and norms to drive

domestic growth

Tightening export pollution

norms, increasing cost

pressures and appreciating

yuan provides an edge to India

over China as a favore

sourcing destination


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Exhibit 4: GoI Initiatives

InfrastructureR&D and

TechnologyFeedstock Sustainability Regulations

Ÿ Developmentof the first setof chemical

usagestandards forthe industryaddressingkey issuesrelated towater supply,environmentalimpact, rawmaterialssupply, safetyover lifecycle,and energyuse

Ÿ

Ÿ

Ÿ

Committee toframeregulatory

structure andeliminateredundancies

Rationalisationof taxes andduties for thesector (to beimplementedby 2014)

Setting up of anationalchemicalinventory

Ÿ

Ÿ

Make PCPIRsa reality

Provide

infrastructuresupport to theindustry byconstructingroads, portsand othersimilarfacilities

Ÿ Implementationof strategy forsourcing and

allocation offeedstock

Ÿ

Ÿ

Setting up oftechnology up-gradation fund

of USD100million

Allocation of10 percentshare of theUSD1 billionNationalInnovationFund tochemicals

A small shift from China to India can lead to big-size opportunity for India

China has emerged as the fourth largest exporter of chemicals (Germany ranks first,

closely followed by the US and Belgium) and accounts for about 6% to global trade, with

estimated exports of US$113bn in FY12. This is as against India’s total consumption of

US$100bn of chemicals. With India’s smaller share of a mere 2% of global trade, we

believe that even a small shift in opportunity from China to India can lead to a significant

opportunity for India in the export market. We project that if India’s market share increases

from 2% to 4% by FY17, the export market can increase from US$35bn (in FY12) to

US$140bn.

Exhibit 5: India Chemical export opportunity ($bn)

2012 2017E

2%

4%

$35bn

$70bn

70 $bn

105 $bn

140 $bn

35 $bn

$140bn


Note – Since specific data on global trade of specialty chemicals is not available, we have used overall

commodity chemicals to understand the broader industry trends.

Indian chemical industry size is

equivalent to Chinese globa

exports, thus a small shift can

provide significant opportunity

for Indian players


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India is slowly moving towards higher chemical exports than imports

Our analysis of the available data on export/import of chemicals indicates that India is

slowly moving towards higher exports than imports. The country’s exports increased at a

CAGR (FY09-12) of 23%, while import growth is slower at 18%. This is as against 25%

growth witnessed in exports (FY03-08), while imports during this period increased at a

much sharper rate of 38%. We believe this emerging trend is clear indication of replacing

imports by domestic production, and we expect the trend to continue.

Exhibit 6: India-Exports and imports ($ bn)

0

10

20

30

40

50

2006 2007 2008 2009 2010 2011 2012

Export Import


Companies with presence in diversified segment and forward-integrationare likely beneficiaries of this sustained growth opportunity

Specialty chemicals cater to the needs of various sectors, with varied specific requirements

and customization. Paints and dyes, pigments, construction chemicals, agro chemicals,

pharma, etc., are the key user industries. We believe the companies having a presence in

diversified segments mitigate the risk of single-sector dependency. They also cater to

larger customer base and enjoy leadership in their respective field of specialization.

Forward-integration helps companies in better utilization of by-products and ensures stablemargins. The companies that are equipped with such characteristics have an edge over

others and are likely to benefit from the sustained growth opportunity in the sector.

Exhibit 7: Sizing growth opportunity by segment

Flavors &

fragrances

Specialty

polymers

Water

chemicals

I&I cleaners

Construction

chemicals

Plastic

additives Cosmetic

chemicals

Paper

chemicals

Paints and

coatings

Home caresurfactants

Specialty

polymers

Rubber

chemicalsPrinting inks

6%

8%

10%

12%

14%

16%

18%

20%

Entry barriers

G r o w t h


Strong R&D capabilities backed by investment in complying pollution normsto bear fruit in the future

Being a knowledge-driven industry, specialty chemicals industry focuses on R&D. Hence,

improvement in processes and improving efficiency are the mantra for success. Of late,

pollution control norms have been tightened in India, and hence securing approvals for new

facilities are getting tough. The unorganized sector or companies that are not fully

equipped to meet such norms are most likely to face challenges in operating their plants. As a result, we believe that companies that have been significantly investing in green

chemistry are better placed to reap the benefit in the future.

Indian chemical exports have

been growing at a faster clip

vis-à-vis imports thereby

reducing the trade gap

Companies with diversifie

portfolio and strong forwar

integration to benefit going

forward


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Financial performance to remain strong

Domestic industry on capex mode to benefit from this growth opportunity

Domestic companies have accelerated their capex plans to benefit from this growth

opportunity. We have analyzed the financial performance of the three leading players in the

sector: Atul Ltd., Aarti Industry and Vinati Organics. All these players have accelerated the

investment in the sector in last 2 years, driven by strong growth opportunity in the sector.Our interactions with the management of the companies suggest that there are attractive

growth opportunities for both domestic and exports.

Exhibit 8: Aggregate capex (Rs bn)

0

1

2

3

4

5

6

7

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14


Previous five-year revenue CAGR at 14%, while margin expansion of 200bpsboosted profitability

On an aggregate basis (based on three companies covered in our analysis), they have

reported a revenue CAGR of 16% (FY09-14), while their aggregate EBITDA margins have

improved by 200bps to 17% over the same period.

Free cash flow generation in the sector to remain limited; however, earningsgrowth is the key

The specialty chemical sector is characterized by high investments, as the industry enjoys

an asset turnover of 1.5-2.5x. Further, with continuous investments in working capital to

meet the demand of growing industry, we expect free cash flow generations of industry

players to remain limited. However, we believe, attractive growth opportunities in the sector

will keep the top line growth buoyant, while margins are likely to improve further.

Exhibit 9: Aggregate revenues (Rs bn)

0

10

20

30

40

50

60

70

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

CAGR

17%


Exhibit 10: Aggregate PAT (Rs mn)

0

500

1000

1500

2000

2500

3000

35004000

4500

5000


CAGR 22%


High capex intensity in the last

three years provides high

revenue growth visibility

Free cash flow generation to

remain limited as companies

continue to invest for future

growth


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Valuations

Valuation of the specialty chemicals sector must consider complex natureof the industry

In our view, the knowledge and process-driven specialty chemical sector enjoys strong

entry barriers and benefits from high degree of customer stickiness. This is also reflected in

stable margins of the industry players unlike commodity chemicals, where margins sufferfrom the cyclicality of the product. Though the specialty chemical industry need not go

through strict and stringent regulatory approvals like in the case of pharma, agrochemicals

or food industry, it supplies critical materials used in these industries. These high-

value/low-volume products contribute a small percentage of the total cost of the end-

product. But they enjoy a high level of clients’ stickiness.

Exhibit 11: Comparative industry valuations

Parameters

Pharma -

CRAMS Agrochemicals

Organic

chemicals

Inorganic

chemicals Chlor Alkali

Dyes &

Pigments

Specialty

Chemicals

Entry Barriers Very strong Very strong Weak Weak Weak Weak Very strong

Regulatory

approvalsHigh High Low Low Low Low Low

Customer profileToll

manufacturers

Toll / open

arrangementsOpen markets Open markets Open markets

Open markets to

sticky customers

Toll / open

arrangements

Customer stickiness Very high Very high Low Low Low Moderate Very high

End product pricingFixed

arrangements

Fixed

arrangements

with pass on

clause

Market driven Market driven Market driven

Fixed

arrangements

with market

forces

Fixed

arrangements

with pass on

clause

No of suppliers

for same product

1 to 3 supplier

with main supplier

catering 70-80%

of requirement

1 to 3 supplier

with main supplier

catering 70-80%

of requirement

Many suppliers Many suppliers Many suppliers Many suppliers

2 to 4 suppliers

key supplier

catering 85-90%

Financial metrics Asset turnover 2-2.5x 2x 0.8-1.4x 0.8-1.4x 0.8-1.4x 1-1.5x 2-2.5x

Return ratios 22-30% 20-25% 12-20% 12-20% 12-20% 15-20% 18-22%

EBIDTA margins 18-22% 15-18% 5-20% 5-20% 5-20% 10-18% 15-18%

Sector valuations

P/E 15-20x 14-22x 6-12x 6-10x 6-10x 6-10x 10-12x

EV/EBIDTA 8-10x 8-12x 4-7X 4-6X 4-6X 4-6X 6-9x

Source: Emkay Research

Current valuations provide re-rating opportunity

We believe that supported by strong entry barriers, high level of customer stickiness, stable

margins and high process and knowledge-dependency, it should enjoy a valuation

premium over commodity chemicals. The sector valuation should reflect high and stable

return ratios at 18-22% enjoyed by established players and encouraging growth opportunity

of 20-30% at the bottom line. In our view, at current valuations of 12-15x for the companies

covered offers scope for a re-rating along with earnings growth.

Sector is poised for strong growth; companies like Atul Ltd., Aarti industriesand Vinati organics to emerge as clear winners

We are convinced that the specialty chemical sector offers strong growth opportunity in

medium-to-long term, and companies with a presence in diversified segments, a large

customer base and leadership in their areas of expertise, along with significant investments

in meeting pollution control norms, are likely to emerge as clear winners in the sector. In

our opinion, among such companies, players like Atul Ltd., Aarti Industry and Vinati

Organics offer strong growth potential, and are likely to report revenue growth of 20-25%per annum and a PAT growth of 25-30% for the next 3-4 years.

Valuations for the sector do not

consider the complex nature of

the industry which provides

stable margins in stark contrast

to other base chemicals

Current valuations do not

consider the complex nature ofthe industry which provides a

re-rating opportunity

Sector is poised for strong

growth both on top line an

bottom line thereby providing

re-rating opportunity


11/59



Exhibit 12: Comparative analysis

Company Key strength Growth drivers Financials

Aarti Industry

Leader in benzene based chemistry and

enjoys the benefit of complex plant

structure. Diversified product portfolio and

sticky customers helps to mitigate the risk

of volatility in revenues and earnings

Invested significantly in previous two

years in new plant and expected to reap

the benefit in near term. Operating

leverage to drive profitability and return

ratios

Expect revenue growth of 20-22% and

driven by margin expansion PAT growth

of 26-28%. With improved asset turnover,

ROCE is likely to go up to 20%+

Atul Ltd

Enjoys leadership position in fast growing

segment of aromatics. Significant

presence in other markets like colours,

crop protection etc helps product

diversification.

Thrust on branded formulations in

agrochemicals, introductions of new

products coming off patent and focus on

enhancing cost efficiencies

Expect revenue growth of 20%+pa and

margin expansion on back of

improvement in product mix with growing

share of branded portfolio.

Vinati Organics

It has limited product portfolio but enjoys

leadership position worldwide in its key

products like IBB and ATBS used

primarily in pharma and paints and

construction chemicals.

Improved utilisation of existing facilities in

leading products like IB, IBB and ATBS

Asset turnover ratio to improve as

utilisation level at new facilities remains at

~60%.



12/59



Global specialty chemical industry to grow at a CAGR of 5-6%

The global specialty chemical industry size is pegged at around $740bn (FICCI Specialty

Chemical report and 12th Five-Year Plan document) accounting for 20-22% of the global

chemical industry.

Specialty chemicals are defined as a group of relatively high-value/low-volume chemicals

known for their end-use applications and/or performance-enhancing properties. In contrast

to base or commodity chemicals, specialty chemicals are recognized for ‘what they do’ and

not ‘what they are’. Specialty chemicals provide the required ‘solution’ to meet the

customer application needs. It is a highly knowledge-driven industry, with raw material

costs (measured as percentage of net sales) much lower than that of commodity

chemicals. The critical success factors for the industry include understanding of customer

needs and product/application development to meet them at a favourable price-

performance ratio.

Global specialty chemicals have grown at a CAGR of 3.7% during 2006-11, despite

contracting by around 7% in 2009, due to the global financial crisis. Going forward, the

industry is expected to grow at a CAGR of about 5.4% annually to reach $970bn by FY16.

Asia-Pacific and Middle Eastern countries are expected to contribute to the bulk of the

future growth for the sector.

Exhibit 13: Global specialty chemical size ($ bn)

0

200

400

600

800

1000

1200

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16


Exhibit 14: Regional share of global specialty chemical industry

Asia Pacific

37%

USA

32%

Europe30%

Others1%


Global specialty chemical

accounts for ~22% of global

chemical market size and is

expected to grow at a CAGR of5.4% to reach $970bn by FY16


13/59



Fine chemicals sub-segment has the largest share, followed by paints &coatings

Globally, the fine chemicals sub-segment has the largest share of 29%, followed by paints,

coatings and surface treatments, which have a share of 23%. Advance polymer, adhesives

and sealants have a share of 19%.

Exhibit 15: Share by segment: Global specialty chemicals

Others8%

Pigments & Inks

10%

Additives

11%

Advanced

polymer,adhesives and

sealants

19%

Paints, coatings

and surfacetreatment

23%

Fine chemicals

29%


Fine chemical and paint an

coating segment account fo

~52% of global specialty

chemical market


14/59



Indian specialty chemical industry has grown at a CAGR of 11-13% in the last 5 years

The Indian specialty chemical industry-size is pegged at $17.7bn (excluding agro-

chemicals and dyes & pigments). The high rate of growth for the segment is driven by

faster growth in end-user industries such as paints & coatings, specialty polymers, and

home care surfactants, among others.

Unlike global markets, paints & coatings sub-segment accounts for about 20% of the

industry-size, followed by specialty polymers, which accounts for a 13% share.

Exhibit 16: Indian specialty chemical-share by sub-segment (FY11)

34%20%

13%6%

5%5%

3%3%

3%2%2%2%

0% 5% 10% 15% 20% 25% 30% 35% 40%

OthersPaints and coatingsSpecialty polymersHome care surfactants

Plastic additivesTextile chemicals

Construction chemicalsWater chemicals

Cosmetic chemicalsFlavors & fragrances

Paper chemicalsPrinting inks


Growth rate to remain strong at around 17% (CAGR) in the next 5 years

The Indian specialty chemicals sector is expected to grow at a faster clip of 17% (CAGR)

during FY11-17 (ex-agro chemicals and colourants), driven largely by higher growth of the

end-user industry such as paints & coatings, specialty polymers, construction chemicals,

and paper chemicals.

Indian specialty chemical

market size is pegged at

~$36bn FY14E and has grown

at a CAGR of 11-13% in the

last 5 years

Growth rate for the sector is

expected to accelerate to 17%

CAGR in the next 5 years

driven by domestic and export

opportunity


15/59



Exhibit 17: Specialty chemical industry sub-segment

Sub-Segment Growth Driver User Industry

Has grown at 1.5-2x GDP growth rate with a CAGR of 13.5% inthe last five years and growth is likely to remain 15%+Paints and coatings

Growth in plastic demand resulting from increased usage inpackaging, construction and automotive sectorsSpecialty polymers

Current expenditure on admixtures in India stands at very lowrelative to other countriesConstruction chemicals

Paper industry is expected to report growth of 8-10% on growingdemandPaper chemicals

Textile industry significantly benefited from currency depreciationand has strong growth potentialTextile chemicals

Water treatment and purification is growing need with scarce waterresources and growing urbanizationWater chemicals

The market for personal care ingredients is becoming increasinglysophisticated and increasing awareness and evolving consumersdriving growth

Cosmetic chemicals

India has lagged behind in synthetic flavors and fragrance and israpidly catching upFlavors & fragrances

Strong growth in CRAMS and domestic agrochemicals industry asindia's pesticide consumption remains at lower levelAgro chemical

Though surfactant industry is highly penetrated, growth isprimarily driven by increasing consumptionHome care surfactants

Exciting opportunities in exports market as exports contribute

around 85% of total consumptionColorants

Construction, Automotive

Packaging, Automotive

Infrastructure, Real Estate

Printing, Packaging

Apparel, Technical textile

Industrial water, municipal water

Bath & Shower, hair care

Food processing, Personal care

Agriculture, Exports

Laundry care, dishwashing

Textile, Exports


16/59



Faster growth rate of the sector in the coming years to bedriven by the following factors

Increase in end-user demand

Increase in GDP in the medium term is expected to lead to a significant increase in the size

of the Indian middle-class. According to the 12th Five-Year Plan document, the size of

middle-income households is expected to increase from 31mn in 2008 to 148mn in 2030.This will not only lead to a faster rate of urbanization, but it will also result in a significant

rise in consumption, creating increased demand for end-user industries.

Increase in consumption intensity

Compared to other advance countries, the India’s per capita consumption of specialty

chemicals is low, which provides ample growth opportunity in the medium-to-long term.

Segments such as construction additives and construction chemicals currently form a very

small proportion of the specialty chemical industry compared to global averages, which

provides ample room for consumption growth in the medium-to-long term.

For example, concrete admixtures improve the fluidity of concrete, provide a smoother,

more even finish, and help avoid cracks. Consequently, concrete admixtures can help

reduce maintenance and repair costs, and therefore, the total cost of ownership of

construction projects in India. India’s current expenditure on admixtures is only $ 1/ m3 of

concrete, compared to $ 2/ m3 in China and $ 4.5/ m3 in US. This is primarily due to the

lack of awareness of admixtures in the Indian construction industry. With increasing

demand for higher quality construction and increasing awareness of concrete admixture

benefits, the industry could double the intensity of admixture consumption in India.

Improving standards for consumption

The government plays a crucial role is setting standards for products in a particular country.

Standards are policy-driven and evolve along with growth and evolution of the country. As

the size of a nation grows, policies for consumption standards improve, as consumers

become more aware of what they are consuming and its impact. Measures such as Bharat-

IV for reduced emission and water treatment guidelines, among others, lead toimprovement in standards. This, in turn, fuels demand for specialty chemicals, which can

be leveraged to achieve these standards. Given that India is still a young developing

country, there are various areas in which it lags behind developed nations as far as setting

high quality standards are concerned. This in itself is expected to lead to a sustained

increase in consumption of specialty chemicals as the policy environment evolves to

achieve higher standards of consumption.

Exhibit 18: End-user industry growth drivers

Sector Demand drivers

Paints and coatings

Increasing urbanization – middle-income households expected to increase

from 31mn in 2008 to 148mn in 2030

High replacement demand at 45-50%

Textiles

Increasing per capita income

Increasing Indian exports: Exports have increased at a CAGR of 8% over

2000-12 from $11.6bn to $29.1bn

Construction

Increasing rate of urbanization and higher disposable income

Current expenditure on admixtures (construction chemicals) in India stands

at $1 per metric cube vs. $2 per metric cube in China and $4.5 per metric

cube in the US

Home care Penetrated category leading to moderate growth


Increase in domestic growth to

support stronger growth for theend user industry of paints,

construction, home care,

specialty polymers etc

Increase in consumption

intensity to drive growth as pe

capita consumption of specialty

chemical remains low


17/59


18/59



Construction chemicals: Gaining significance

Construction chemicals are chemical compounds used in existing construction projects to

speed construction work or in new projects to provide durability and strength to structures.

The chemicals though increase the cost of the project by 2-5% but with multi-fold benefits.

Certain chemical products help in minimizing the quantity of cement and water used.

Construction chemicals can be broadly categorized as follows:

Exhibit 21: Construction chemical sub segments


Exhibit 22: Construction chemicals sub-segments

Others

31%

Repair & Rehab

9%

Waterproofing

10%

Flooring

15%

Admixtures

35%


Industry structure

The construction chemical market is highly competitive with an increasing number of globalconstruction companies making a foray into manufacturing operations in India. The overall

market is fairly consolidated but there is considerable fragmentation of individual products

and application areas. The top 5 players account for 50% of the market. Key players in

construction chemical industry include BASF and Pidilite Industries along with other private

players such as Sika India Pvt Limited and SWC Pvt Limited.

The construction chemical industry per se in India is still in its nascent stage as compared

to other countries such as China ($8bn market) and other larger developed and developingcountries. The industry size is small due to lack of consumer awareness and constructors

preference for low cost chemicals. In the past there has been considerable change in the

market share of companies with medium sized and regional manufacturers gaining

considerable market share.

Strong structural demand drivers provide high growth visibility:

§ Growth in end user market: Current stock of physical infrastructure is insufficient tomeet the current needs of the country which points to sustained spending required in

developing new physical infrastructure stock. According to the 12 th Five Year Plan, the

country needs cumulative infrastructure spending of $1 trn which in itself provides longterm growth visibility for construction chemicals industry

§ Increased penetration: Increasing awareness about quality of construction materialssuch as performance enhancing products among customers and builders is likely to

fuel faster growth for the segment

§ Changing regulatory environment and increasing compliance to internationalmanufacturing standards: Regulatory changes such as energy efficient buildings,

green buildings will drive the demand for innovative protective coatings and safechemicals. Further as more and more construction company’s move towards

complying with international standards, it will fuel demand for performance enhancing

and low polluting construction chemicals.

Low usage intensity to drive

faster growth for the

construction chemical industry

Construction chemical industry

in India at a nascent stage

compared to other developing

and developed countries

Construction Chemicals

Concrete

Admixtures

Waterproofing

chemicalsMiscellaneous

Repair &

Rehabilitation

Flooring

compounds


19/59



Colorants: Gaining global market share

Colorants have inherent element of value addition to a wide variety of products like textiles,

leather, paper, food products, cosmetics, plastic, paints, inks and high tech applications like

optical data storage, solar cells, medical diagnostics, security inks, lasers etc. The colorant

sub segments comprise of dyes and pigments.

The pigment market is estimated at ~$970mn out of which carbon black and TiO2 accountsfor 90% of the total pigment demand. Globally, there has been a structural shift in the

industry with manufacturing base of colorants shifting from Europe, USA and Japan to

Asian countries such as China, India, Taiwan, Thailand and Indonesia. India and China

have gained global prominence as far as colorants are concerned while India now has an

edge over China due to tightening pollution norms in China, an area in which Indian

manufacturers were more or less compliant with tight pollution control norms.

Given these structural changes, exports have grown at a faster clip as compared to

domestic industry. Out of the total industry size of $3.4bn (FY11), exports accounted for

~68% of the market at ~$2.3bn. There has been a significant growth in exports which have

increased from a mere $30mn in 1990 to $2.3bn in FY11. During the last decade, exports

have grown at a CAGR of 14.5% and are expected to grow at a relatively faster clip going

forward.

Exhibit 23: Exports of colorants ($bn)

0.6

2.3

4.9

0

1

2

3

4

5

6

FY01 FY11 FY17(P)


Industry overview:

The world market of colorants stood at ~$27bn comprising of dye, pigments and

intermediaries. During the last decade, the global industry has grown at 2-3% p.a,

however, Asian growth for Asian countries has been faster due to shifting manufacturing

bases. The share of India in the global colorant markets stood at 12.5% and is expected to

increase as export sales grow faster than global growth.

The Indian dyestuff industry is highly fragmented and characterized by a large number of

players in the unorganized sector. The industry comprises of about 950 units with 50 unitsbeing large scale and organized while the remaining being small scale and largely

unorganized. Textiles account for ~60% of the domestic demand for dyestuff while the

remaining is shared between leather, paper and other consumer industries.

As far as pigments are concerned, the main consumer industries are printing inks, paints,

plastics, rubber etc which account for 70% of the end use. Pigments are broadly classified

as organic (70%) and inorganic (30%). Large portion of the organic pigments produced is

exported.

Shift towards specialty products:

Given the commodity nature of the industry and over supply in installed capacities, global

manufacturers are focusing more on specialized products which command a premium

pricing and provide value addition. As a result, global manufacturers are investing in R&Dto improve specialty end of their portfolio. There is growing global trend towards providing

colour solutions rather than just colorant. Further, tightening global environment norms

(such as REACH), the industry is moving towards low effluent high performing products.

Indian exports in the colorant

industry gaining dominance as

Chinese players impacted by

tighter pollution control norms

where in India has been largely

compliant


20/59



Exports: Emerge as a new growth opportunity

Structural eastward shift of global chemical industry continues

The size of the global chemical industry is pegged at $3.8trn in FY10, which grew at a

CAGR of 7% annually over 2001-11. The industry is witnessing a gradual eastward shift for

the following two key factors: (i) increase in consumption in the emerging markets of Asia

and (ii) to leverage greater manufacturing competitiveness of emerging Asian economies.Over the past 10 years, the share of Asia in the global chemical industry has increased

from 31% in 1999 to 52% in 2011. China has emerged as a leader in the global chemical

industry accounting for roughly 27% of the total production in value terms, with the industry-

size pegged at around $1trn.

Repositioning of Indian specialty chemical industry

Indian Specialty chemical is on transition phase and is likely to reposition itself as a

strategic partner for growth in knowledge based, processed driven chemicals. This change

is likely widen prospects for the industry as various leading global players look for

opportunities to join hand with Indian manufacturers.

Exhibit 24: Changing perception about Indian Chemical industry

1900-2000 2000-2005 2006-20082009 andbeyond

CommoditySupplier

OutsourcingHub

PotentialEnd-use Market

StrategicPartner

Ÿ

Ÿ

Ÿ

Basic chemicalsfocus

Lowinvestments andR&D

focus on exports

Ÿ

Ÿ

Ÿ

Basic chemicalsfocus

R&D for processoptimization

Outsourcing

initialization

Ÿ

Ÿ

Ÿ

Ÿ

Specialtychemicals focus

Growth in R&Dinvestments

Increased focus

on domesticmarket

Growth inoutsourcing

Ÿ

Ÿ

Ÿ

Ÿ

Knowledgechemicals focus

Product focus inR&D

Global outlook

Transforming asstrategic partner

Source: Industry, Emkay Research

The market-size of India’s chemical industry is pegged at $108bn, representing 3% of the

global market size. The Indian chemical industry has significant potential to capture a larger

global pie due to the growing domestic demand and attractiveness as a manufacturing

base. According to the 12th Five-Year Plan, the Indian chemical industry is expected to

grow at a CAGR of 11% between FY12 and FY17 to reach a size of $224bn.

India gaining strategic advantages over China, which can aid in fastergrowth

Clearly, China has taken a lead over India as far as the global chemical industry is

concerned, primarily due to the vast government support and clear cost advantages.

However, there have been structural shifts in China, which have forced global players to

look at India as an emerging manufacturing destination:

§ Tightening of pollution control norms in China: Growing levels of pollution in Chinahave forced the government to act strictly against polluting industries. This has led to

increased pressure on high-polluting sectors to implement corrective actions, which

have led to an increase in capex, thereby reducing their competitiveness.

§ Appreciation in Yuan: The structural appreciation of the Yuan ever since it wasallowed to float in a range has been critical in restoring the lost competitiveness of the

Indian manufacturing sector. The steady appreciation in Yuan is expected to continue.

Yuan has appreciated by around 10% in the last 5 years.

Structural eastward shift of the

chemical industry continues

benefiting China and India

China has identified 58

chemicals to act upon to reduce

pollution, shifting its focus from

pollution control to pollution

elimination


21/59



§ INR depreciation: While Yuan has appreciated steadily in the last 5 years, INR, on theother hand, has depreciated by 22% in the same period, which is beneficial for

companies looking to shift manufacturing locations. The inverse movement in the

currencies implies that on relative terms, INR has depreciated by 36% vis-à-vis Yuan.

§ Weaker IPR protection: India has a much stronger track record in IPR protectioncompared to China, which makes it a better fit as far as R&D-intensive, early

technology lifecycle production is concerned. According to the International PropertyRights Index report 2013, India’s standing in terms of both IPR and legal rights is better

than that of China. In terms of ranking, India stood at 55 out of 130 countries globally,

while China stood at 59 out of 130 with respect to IPR. On legal rankings, too, India

fairs better than China, with a ranking of 71 of 130 compared to 76 for China.

The Indian Government has announced a number of measures to improve competitiveness in the sector

§ Industrial licensing has been abolished for most sub-sectors (except a small list of hazardous chemicals)§ Approval is granted for FDI up to 100 per cent in the chemicals sector§ The government is continuously reducing the list of reserved chemical items for production in the small-scale sector, thereby facilitating

greater investment in technology up-gradation and modernisation

§ Policies have been initiated to set up integrated Petroleum, Chemicals and Petrochemicals Investment Regions (PCPIR). PCPIR will bean investment region spread across 250 square kilometres for manufacturing of domestic and export-related products of petroleum,

chemicals and petrochemicals

§ New initiatives are likely to attract large investments, both domestic and foreign, with requisite improvements in infrastructure andcompetition


China – Estimating the size and opportunity

Global chemical exports stood at around $2trn in 2012 dominated by developed economies

of Germany, the US and Belgium.

In the last decade, China has emerged as a dominant player in the global chemical

industry, both in terms of domestic consumption and exports. The country has emerged as

the 4th largest exporter in 2012 as against 2006 ranking of 10.

Exhibit 25: Country ranking for global chemical exporters

Country 2012 2006

Germany 1 1

United States 2 2

Belgium 3 3

China 4 10

France 5 4

Netherlands 6 5

Switzerland 7 8

United Kingdom 8 6

Japan 9 7

Ireland 10 9

India 18 21


China continued to exert dominance in the last decade, while India laggedbehind

China has emerged as the largest chemical market in the world on the back of growing

consumption and higher exports. Similar to other manufacturing sectors, China has

emerged as a low-cost manufacturing destination for chemicals. As a result, Chinese

chemical exports grew at a CAGR of 20.5% over 2000-12, which increased from $12.1bn in

2000 to $113.5bn in 2012. The Chinese share of global exports during the period increased

from 2% to 6% in 2012.

China dominated India in

chemical exports, though India

gaining relative market share as pollution control norms an

appreciating yuan impact

relative competitiveness


22/59



Although chemical exports from India, too, increased in the same period, the Indian

chemical exports were not able to capture a larger pie of global exports. India’s export

share in global chemical exports increased from 1% in 2000 to 2% in 2012, with the

country’s exports increasing from $4.3bn in 2000 to $34.5bn in 2012.

Exhibit 26: China exports ($ bn) and Share of global exports

0

20

40

60

80

100

120

140

2006 2007 2008 2009 2010 2011 2012

0%

1%

2%

3%

4%

5%

6%

7%

China Export Share of global exports


Exhibit 27: India exports ($ bn) and Share of global exports

0

5

10

15

20

25

30

35

40

2006 2007 2008 2009 2010 2011 2012

0%

1%

2%

India Exports Share of global exports


Increase in cost puts pressure on margins of Chinese players

Chinese chemical manufacturers have witnessed significant pressure on margins in the last

3-4 years on the back of increase in cost pressures. EBITDA margins of top-8 players

contracted from 9% in FY09 to 6% in FY13. The contraction in margins has been driven by

contraction in gross profit margins from 10% in FY09 to 7% in FY13. On the other hand,

debt of top-10 players increased significantly from $7.8bn in FY08 to $16.6bn in FY13.

Consequently, the debt-to-EBITDA ratio deteriorated from 5x in FY09 to 6x in FY13. PAT

margins, too, have been under pressure and deteriorated from 4% in FY09 to 2% in FY13.

Exhibit 28: Aggregate EBITDA Margin (Top 8)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%10%

FY09 FY10 FY11 FY12 FY13

Source: Emkay Research, Bloomberg

Exhibit 29: Aggregate Gross Margin (Top-8)

0%

2%

4%

6%

8%

10%

12%



Exhibit 30: Aggregate PAT Margin (Top-8)

0%

1%

1%

2%

2%

3%

3%

4%

4%

5%

5%



Exhibit 31: Aggregate Debt to EBITDA (Top-8)

0.0

2.0

4.0

6.0

8.0



Our analysis of top 8 Chinese

chemical players clearly shows

increasing cost pressures.

EBITDA margins of top 8

players contracted by ~300bps

between FY09 to FY13


23/59



Exhibit 32: Debt-to-Equity (Top-8)

0.90.9 0.9

1.2 1.1

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4


Source: Bloomberg, Emkay Research

Increasing cost pressures in China, currency appreciation and lower IPRprotection provide opportunity to Indian firms

Indian chemical players, who have been at a disadvantage earlier due to higher costs of

operations and infrastructure bottlenecks, are all set to garner higher market share from

their Chinese counterparts both in domestic and export markets. A steady increase in coststructures in China (both labour and power cost), tightening pollution control norms,

currency appreciation and lower IPR protections provide an opportunity to Indian players to

achieve a higher share of global chemical exports trade.

Further, India currently imports roughly $5.6bn (FY13) worth of inorganic and organic

chemicals from China. Although the pace of chemical imports from China reduced

considerably in FY13, with chemical imports growing at 9% yoy in FY13 as against 18% in

FY12. For the first 9 months of FY14, Indian chemical imports from China stood at an

annualized $6bn, which signifies an even slower growth of 7% yoy, which points to

reducing dependence on Chinese imports.

Put together, India’s imports from China and the total Chinese exports to rest of the world

together point to a $114-bn opportunity, which is equivalent to the size of the Indianchemical industry. Thus, these underlying shifts in macro factors provide ample

opportunities to domestic chemical industry players.

Exhibit 33: India import of chemicals from China ($ bn)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

FY09 FY10 FY11 FY12 FY13 FY140%

5%

10%

15%

20%

25%

30%

Chemical imports from China Growth y-o-y


Increasing cost pressures in

China, appreciating Yuan an

lower IPR protection provide

opportunity to Indian firms


24/59



China takes stern measures to address environmental challenges

China has taken stern measures to address growing environmental pollution across various industries and residential waste disposal.

Continuing with its Energy and Climate Goals, the Chinese government has taken various measures and initiatives to reduce pollution.

These measures are targeted across the board and not only to specific sectors or industries. State Council has released the Energy Saving

and Low Carbon Development for 2014-2015 Action Plan in the month of May-14 to further its Five Year Plan objectives. The salient

features of the action plan are as follows:

Exhibit 34: Salinet features of the Action Plan

China Energy Saving and Low Carbon Development for 2014-15 Action Plan

Sector Initiatives

Steel Reduction of capacity production by 15 million tonnes by the end of 2015

Cement Reduction of capacity production by 100 million tonnes by the end of 2015

Plate glass Reduction of capacity production by 20 million tonnes (in “weight cases”) by the end of 2015

Coal

§ Coal share of energy to decrease§ Beijing, Tianjin, the Yangtze River Delta region and the Pearl River Delta region need to

achieve negative growth, to return to 2012 consumption levels

§ Non-fossil fuel to comprise 11.4% of primary fuel consumption by end of 2015Coal-fired boilers are to be ugraded and some closed

Autos 6 million old vehicles to be phased out in 2014

Incinerators

§ Residential solid waste that is incinerated must have dioxin emissions below 0.1nanogram per cubic meter

§ Soil, construction material and normal industrial waste that is incinerated (more than 100metric tons processed) must keep dioxin levels below 0.1 nanogram per cubic meter

§ Current incinerators must comply with the standards by 1 January, 2016 and facilitiesbuilt after this must comply from the date they begin operation

Pollution control headlines

Strengthen Environmental Impact Assessment (EIA) Process EIAs are to be strictly implemented

Punitive Pricing, Penalties & Green Financing

The plan discusses the addition of a punitive tariff policy to the already existing tiered

pricing scheme. Companies that lag in energy savings could be charged more. Green

financing is also encouraged as is the improvement of sewage treatment fees and more

research into sludge treatment & wastewater treatment costs

Air emissions reduction

he plan maps the installation of desulphurisation and denitrification equipment by province.

It also pushes to strengthen the management of hydroflurocarbons emissions and accelerate

their destruction

Urban sewageThe plan specifies by the end of 2015 the daily processing capacity urban sewage

treatment will be 16 million tonnes

Water emissions reductionFor boilers, incinerators & some refineries, new limits to be set for COD, total phosphorus,

total nitrogen, ammonia nitrogen and other heavy metal pollutants, such as mercury



25/59



Export revenues have grown at a faster clip for leading players

Specialty chemical companies have witnessed robust growth in the last 5-6 years, driven

by both exports and domestic revenues. Total revenues for the three leading domestic

specialty chemical companies, Atul Limited, Aarti Industries and Vinati Organics, have

grown at a CAGR of 15% over FY06-13. Export revenues have grown at a faster clip of

17.7% in the same period, while domestic revenues have grown at a CAGR of 14.%. The

share of export revenues has increased from 45% in FY06 to 50% in FY13.

Exhibit 35: Aggregate revenue and share of exports

0

10

20

30

40

50


38%

40%

42%

44%

46%

48%

50%

52%

Aggregate revenue Exports as a % of revenue

Source: Company, Emkay Research, Capita Line

Currency depreciation has aided in faster revenue growth in FY13

Faster growth in exports is also driven by currency depreciation in the recent fiscals. Export

revenues for the leading three companies have grown at a faster clip of 28.7% yoy in FY13.

The sector has been in a sweet spot in the past couple of fiscals on account of currency

depreciation, as adjustment in pricing is with a lag, which has helped these companies

register faster growth in exports.

Exhibit 36: Aggregate export revenue and yoy growth

0

5

10

15

20

25


-20%

-10%

0%

10%

20%

30%

40%

Aggregate export revenue Growth y-o-y


Our analysis of leading Indian

specialty chemical companies

shows that export revenues

have grown at a relatively faster

clip of ~18% CAGR as

compared to domestic

revenues


26/59



Specialty chemical and base chemicals: The key differentiators

Exhibit 37: Key Differentiators: Specialty and base chemicals

Differentiation Specialty Chemical Base chemical

Market Structure Oligopoly Competitive

Basis of differentiation § R&D capability

§ Quality consistency§ Timeliness of delivery

Pricing

Type of product Customized products Standard Products

Customer stickiness High

§ Customer approval systems and process are highly elongated§ Tedious approval processes with high quality and consistency requirement§ Switching suppliers is difficult due to long approval processes

Low

§ Customers look for lower price suppliers,as products are standardized

Nature of contract Long-term volume contracts with clauses for pass-through of cost escalation

de-escalation

Short term contracts

Core strategy for success High process R&D capability Cost leadership strategy

Margin profile Stable margins due to escalation de-escalation clauses in contract Volatile margins depended on chemical cycle

Benefits of scale economies Limited due to large number of low volume high value products Significant due to standardized products


Exhibit 38: Limited revenue contraction in the financial crisis years

0

10

20

30

40

50

60

70


-10%

0%

10%

20%

30%

40%

Aggregate revenue Growth y-o-y


Exhibit 39: Stability in margins due to oligopolistic structure

6%

8%

10%

12%

14%

16%

18%


Aggregate EBITDA margins


The key difference between specialty chemical and base chemical industries is the fact that

the latter is much more cyclical in nature, due to a large number of players manufacturing

standardized products. The key to succeed in such a business is cost leadership. This has

been evident by the fact that the global chemical industry has witnessed an eastward shift,

especially China, which now accounts for around 27% of global chemical industry.

Specialty chemicals in this respect differ significantly from base chemicals due to limited

number of players, competing purely on the basis of knowledge of chemistry and consistent

quality as opposed to the base chemical industry. The key differentiators between the base

and specialty chemical industry are as follows:

R&D-focused industry

The specialty chemical industry is a knowledge-based sector competing on the basis of

R&D capabilities and understanding of chemistry, rather than one with a standardized

product approach for base chemicals. Specialty chemicals, as highlighted above, are

chemicals differentiated on the basis of “what they do,” rather than “what they are,” which

translates into low-volume/high-value products, as these products are intermediaries for the

final product performance, which can greatly vary depending on the purity and chemistry of

the intermediate products.

Companies in this space compete on the basis of their R&D capability and quality

consistency as opposed to pure cost-based competition as in the case of base chemicals.

Unlike base chemical industry,

specialty chemical industry is

R&D focused which acts as an

entry barrier


27/59



Stickiness of customers

Customer approval systems and process are highly elongated as far as specialty chemicals

are concerned, as customers need to be certain about the following two key aspects while

freezing on their suppliers: (i) quality of the product – ensuring that products exactly meet

specifications and (ii) consistency of order delivery.

The long approval processes thus lead to a high level of customer stickiness as opposed tobase chemicals. This is also evident from the fact that despite a year-on-year contraction in

revenues of 8% in FY10 for the leading three specialty chemical companies, revenues

surpassed the pre-crisis levels in FY11.

Oligopolistic nature of the industry

Given the long gestation period, R&D focus requirement and lower volumes, the number of

suppliers are limited. This leads to an oligopolistic structure for the industry, with a few

players manufacturing these products. Advantages of economies of scale are limited, as

the industry largely deals in low volume products. As a result, companies have limitation in

terms of size that they can achieve.

Further, given the key role that these chemicals play in the performance of the end-product

buyers typically restrict the number of suppliers to two or three, which provides betterbargaining power to suppliers. As a result, most players have a high proportion of long-term

contracts vis-à-vis short-term contracts as in the case of base chemicals.

Long-term contracts ensure lower margin volatility

The long-term contracts signed between customers and suppliers provide for better terms

of trade for both parties. Given that most of these long-term contracts would have pass-

through clauses for raw material costs; margins for specialty chemical players are typically

stable unlike base chemicals. While on the one hand it limits the ability of the company to

sustain high levels of margins, as most benefits would be passed on to end-customer, on

the other, it protects companies from large volatility in raw material prices.

Benefits of this arrangement were clearly visible in the post-crisis years, wherein despite

contraction in almost all chemical realizations; margins for the leading three specialtychemical players remained stable.

Focus on delivering quality with

consistency which leads to a

sticky customer profile as

compared to base chemical

companies which compete

purely on cost leadership

Limited number of suppliers

globally for each product leads

to an oligopolistic industry

structure

Long term contracts ensure low

volatility of margins due to

cost/benefit pass through


28/59



Indian specialty chemical players: Riding the wave

Revenue growth driven by both exports and domestic business

Indian specialty chemical players have been the key beneficiaries of the underlying growth-

drivers. The leading three specialty chemical players, Aarti Industries, Atul Ltd. and Vinati

Organics, have witnessed a cumulative revenue growth of 17% (CAGR) over FY06-14.

Their exports grew at a faster clip of 18% (CAGR) during the period FY06-13, whiledomestic revenues increased at a CAGR of 14% in the same period.

Exhibit 40: Aggregate domestic and export revenues (Rs bn)

0

10

20

30

40

50

60

70


38%

40%

42%

44%

46%

48%

50%

52%

Aggregate revenue Exports as a % of revenue


Sustained capex drives volume growth

The faster revenue growth has been driven by sustained capex in the last 6-7 years. The

three leading players have cumulatively spent Rs21bn between FY07 and FY14 in

augmenting its capacities, both by means of setting up new capacities and de-

bottlenecking existing capacities. The capex spend has been higher in FY12, FY13 and

FY14, with the three companies cumulatively spending a total of Rs14bn the benefits of

which will continue to accrue going forward.

Exhibit 41: Aggregate capex (Rs bn)

0

1

2

3

4

5

6

7


Source: Emkay Research, Company, Capita Line

Operating leverage aids in gradual margin expansion

Given the oligopolistic nature of the industry, with long-term supply arrangements, gross

margins and EBITDA margins have remained steady between FY06 and FY14. Despite the

global financial crisis in FY08, EBITDA margins remained stable in the range of 15-16%.

EBITDA margins have been supported by operating leverage, which has ensured stable

margins, despite a steady increase in raw material costs. RM costs have expanded by

around 500bps between FY06 and FY13, while operating leverage has led to a reduction in

employee cost and other expenses as a percentage of revenue, aiding in stable margins.

Revenues for the three leading

companies analyzed by us

have grown at a CAGR of 17%

between FY06-FY14 driven by

both domestic and export

revenues

Sustained capex to drive

revenue growth, capex intensity

has increased in the last 3

years


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Exhibit 42: Cost components as a percentage of total income

0%

10%

20%

30%

40%

50%

60%

70%


Employee cost P&F cost Other expenses RM cost


Working capital requirement has increased in tandem with revenue growth

The working capital requirement has increased in tandem with revenue growth. Despite

high revenue growth, the companies have focused on working capital management,

leading to a reduction in debtor days from 74 days in FY06 to 63 days in FY14, whileinventory days decreased from 85 days in FY06 to 81 days in FY14. Payable days have

remained steady at ~45 days. Thus, working capital days has witnessed a gradual

improvement reducing from 117 days in FY06 to 100 days in FY14.

Exhibit 43: Working capital cycle (number of days)

0

20

40

60

80

100


Debtor days Inventory days Creditor days


Leverage position comfortable, despite sustained capex

Overall, leverage for the companies has remained comfortable, despite the sustained

capex, as the capex has been funded by a mix of internal accruals and debt. Net debt has

increased from Rs6.5bn in FY06 to Rs 13bn in FY14; however; net debt-to-equity has

improved from 1.2x in FY06 to 0.6x in FY14. Net debt-to-EBITDA has improved from 3.7x

in FY07 to 1.4x in FY14, while the interest coverage ratio has improved from 3.1x in FY07to 5.4x in FY14.

Exhibit 44: Aggregate Net debt and net debt-to-equity

0.0

4.0

8.0

12.0

16.0

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY140.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Net Debt Net Debt to Equity


Exhibit 45: Aggregate Interest coverage ratio

0.0

1.0

2.0

3.0

4.0

5.0

6.0



Working capital cycle has been

managed well by the three

companies thereby not strainingcash flows

Overall leverage position for the

three companies remains

comfortable below 1x net debt

to equity


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Stable dividend payout ratio

The dividend payout ratio for the sector has broadly remained stable, with a consistent

history of dividend payments. The dividend payout ratio has remained in the range of 18-

20% in the last few years. With the exception of Atul Ltd., the dividend payout has

improved for Vinati Organics and Aarti Ltd. from 12% and 24% in FY11 to 18% and 28% in

FY13, respectively.

Exhibit 46: Aggregate dividend payout ratio

0%

5%

10%

15%

20%

25%

30%



Return ratios have shown steady improvement, due to improving margins

Return ratios at an aggregate level for the sector have improved steadily on the back of

higher revenue growth and margin improvements. RoCE, at an aggregate level, has

increased from 10% in FY07 to 22% in FY14, while RoE improved from 9% in FY07 to 22%

in FY14. The improvement in RoCE has been sharpest for Vinati Organics from 14% in

FY07 to 36% in FY14, driven largely by faster growth and improved margins. The RoCE

was Atul Ltd. has increased from 9% in FY06 to 28% in FY14.

Exhibit 47: Aggregate RoCE and RoE

0%

5%

10%

15%

20%

25%


RoCE RoE


Sector is poised for strong growth; companies like Atul Ltd., Aarti industriesand Vinati organics to emerge as clear winners

We are convinced that the specialty chemical sector offers strong growth opportunity in

medium-to-long term, and companies with a presence in diversified segments, a large

customer base and leadership in their areas of expertise, along with significant investments

in meeting pollution control norms, are likely to emerge as clear winners in the sector. In

our opinion, among such companies, players like Atul Ltd., Aarti Industry and Vinati

Organics offer strong growth potential, and are likely to report revenue growth of 20-25%

per annum and a PAT growth of 25-30% for the next 3-4 years.

Current valuations provide re-rating opportunity

We believe that supported by strong entry barriers, high level of customer stickiness, stable

margins and high process and knowledge-dependency, it should enjoy a valuation

premium over commodity chemicals. The sector valuation should reflect high and stable

return ratios at 18-22% enjoyed by established players and encouraging growth opportunity

of 20-30% at the bottomline. In our view, at current valuations of 12-15x for the companies

covered offers scope for a re-rating along with earnings growth.

Companies have a stable

dividend pay out ratio of 20-

25%

RoCE and RoE has improve

from 10% and 9% in FY07 to

22% each in FY14


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Risk and Concerns

Significant currency appreciation

Significant appreciation in the currency could impact growth as competitive advantages vis-

à-vis China could reduce thereby slowing the pace of shifting of volumes from China to

India. Further, some of the products are priced on IPP which also could be impacted by

significant currency appreciation.

Slow down in end user industry growth

The slow down in growth of end user industry such as paints & coatings, specialty

polymers, construction chemicals etc could impact the overall growth for the sector.

Slow down in global growth

The slow down in global growth could impact the performance of the industry adversely as

exports contribute significantly to the overall industry revenues. Any slow down in the

global growth impacting the end user industry growth will have an adverse impact on the

overall growth for the sector.

Tightening pollution control norms in the company

Companies have invested significantly in pollution control equipments; however, any further

tightening of the pollution control norms across the country or by state Pollution Control

Boards could have a negative impact on account of increase in capital allocation for

meeting the tighter environmental guidelines. Further, product specific restrictions may also

impact performance of specific companies.


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Exhibit 48: Financial snapshot of Specialty Chemical Companies

Rs mn FY14FY11-14

CAGR

Company Sales PAT EBIDTA % Sales PAT MCAP

Export

share ROCE P/E Company profile

Aarti Inds. 25987 1487 15.6% 22% 31% 17751 47% 18.3 11.9Diversified product profile with leadership position in benzene

based chemistry

Atul Ltd 23065 2128 16.6% 15% 33% 26528 48% 29.8 12.5 Leading player in colours, Agrochemicals, Dyes

Balaji

Amines6101 335 15.3% 21% 8% 1974 24% 18.2 5.9

Leading manufacturers of aliphatic amines in India. BAL has

been consistently adding capacities and fine tuning process to

provide quality products at lowest cost to the customers.

BASF India 44187 1279 6.4% 13% 3% 37839 11% 12.8 29.6

Manufactures polymers, tanning agents, leather chemicals and

auxiliaries, crop protection, textile chemicals, construction

chemicals etc along with many other specialty chemicals

Clariant

Chemical14350 1668 17.5% 14% -18% 22484 28% 19.8 13.5

Leading specialty chemicals companies with leadership in

Pigments, biocides for Paints and Master batches

Deepak

Nitrite12574 383 9.0% 23% 14% 9826 43% 10.2 25.6

It has portfolio of wide spectrum of products with diverse

applications ranging from Agrochemicals, Rubber,

Pharmaceuticals, Paper, Textile, Detergent, Colourants,

Petrochemicals to Specialty and Fine Chemicals.

GujFluorochem 11349 744 22.5% 5% -34% 49792 56% 20.8 66.9

Leading manufacturer of Polytetrafluoroethylene (P

Indian Specialty Chemicals Sector Report

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