March 2, 2023
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DEEPAK NITRITE, Headwinds to persist as new capacities are added
Call & Research Report by Motilal Oswal
Sector: Commodity Chemicals
CMP Rs. 1789, Target Rs. 1890 (7% upside potential)
Target Period: 12 Months
● The phenol/acetone spread over raw materials has declined 16% YoY to INR90/kg during 2HFY23 till date (v/s INR107/kg in 2HFY22) on account of China’s Covid-related lockdowns, which resulted in stockpiling of Phenol and disruption in trade activities.
● China’s stepstoward self- sufficiency in phenol and increased competition in the region could result in a structural glut in the overall market, in turn leading to the downtrend in phenol margins to continue.
● DN’s planned capex of INR15b in FY23-24 aimed partly for backward integration and partly towards downstream products of Acetone (MIBK/MIBC) should drive growth in the near term. Moreover, the recently announced INR10b expansion into Polycarbonate compounding & Nitrite project in Oman would drive growth in the medium term.
● Although the company has aggressive growth plans, the commodity nature of its products does not leave much upside for investors. If it forays into specialty products or complex commodities, it would certainly command a better valuation multiple. We reiterate our Neutral recommendation with a target price of INR1,890.
Phenolic division margins expected to remain under pressure
● EBIT margins of DN’s phenolic segment slipped to 8% in 2QFY23, the lowest level since 4QFY20. While margins improved sequentially to 11% in 3QFY23, they remain below the long term average of INR96/kg. With the phenol/acetone spread remaining flat QoQ at ~INR90/kg in 4QFY23 till date, margins are also expected to remain subdued.
● According to World Integrated Trade Solution (WITS), China is the single largest importer of phenol globally and accounted for ~52% of the top ten global phenol importing countries in CY20. With China moving toward selfsufficiency through capacity additions supported by increased feedstock availability (benzene & propylene) due to Beijing refinery restructuring, phenol realizations may see structural weakness going forward.
● Additionally, increased competition in the Asian phenolic market, due to the entry of global giant INEOS through Mitsui Chemicals’ acquisition, may also lead to a glut if demand does not keep up pace with supply.
Downstream products to lead next leg of volume growth
● Upcoming capacities of MIBK (40ktpa), MIBC (8ktpa) and Polycarbonate should drive volume growth going ahead. While we do not expect margin accretion since the products are commodities in nature, vertical integration may lead to some reduction in margin volatility.
● MIBK is primarily used as a solvent for resins used in the paints and coatings industry. It could be an ideal import substitution play, considering India’s entire MIBK demand of ~30,000mtpa is exclusively met through imports.
● Polycarbonate is a transparent thermoplastic polymer widely used in the electrical/electronics industry due to its excellent heat and electrical resistance property. According to ChemAnalyst, India’s Polycarbonate demand stood at 180,000mtpa in FY22 and is expected to grow by ~4% over the next decade, driven by the building and construction materials end market.
● Covestro, the world leader in Polycarbonate, expects a 4% CAGR in the global polycarbonate market till CY26, while the supply is expected to grow by 5-6% during the same period, led by major capacity additions in China by Hainan Huasheng, ZPC, SABIC-Sinopec, Wanhua and Shemna.
Valuation and View
● The company aims to become the largest player in Solvents, with a play on import substitution. It has already announced its foray into MIBK (40ktpa), MIBC (8ktpa) and Polycarbonate.
● Despite a capex of INR20b over the next three years, DN is expected to turn net cash positive by FY24 with FCF generation of INR16.5b over FY23-25. Return ratios are expected to be at 24-27%, significantly lower than that of FY22.
● The company is on an aggressive path for backward as well as forward integration. However, the complete basket of products is commodity and the current valuation appears rich. We maintain our Neutral rating with a TP of INR1,890, valuing DN at 20x Dec’24E EPS of INR95.
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