Next Big Stock Idea for the month of May-2016.

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Content Index S.No. Title Page No.

1 Vinati Organics Stock information 4

2 Core investment Thesis 5

3 Specialty Chemicals Industry Overview 6

4 Company Section 9

5 Business Overview of the company 22

6 Financial performance of the company 32

7 Risks & Concerns 36

8 Valuation & Conclusion 37

9 Appendix: Financials 38

Vinati Organics - Stock Information

*As on 05-05-2016

Buy Range Rs.450-470

Market Cap. 2372cr.

Codes BSE: 524200

NSE: VINATIORGA

No. of shares 5.15cr

Face Value Rs.2

52week high/low Rs.664/371

P/E

17.09x

EV/EBITDA

11.6x

P/B 4.1x

Core Investment Thesis

With strong moats of low cost manufacturing, large market share in the world (Capacity and Turnover) and oligopoly nature of its products, Vinati Organics Limited established itself as a global leader in the specialty chemical industry. With ROE & ROCE of greater than 35% and 25% respectively, and EBITDA Margins greater than 29% (FY15), company strongly positioned to create value for its stake holders by moving towards making of value added products. With the fair valuations of 17x P/E and 11.6x EV/EBITDA, company is looking very attractive against its potential in the coming years.

Specialty Chemical Industry Overview

Industry Overview

Indian specialty chemicals have posted a growth of 12%-15% in the last 4-5 years, backed by increase in end user demand on the back of growing consumption intensity.

Specialty chemicals are high value and low volume chemicals known for end-use applications, unlike commodity chemicals, where the focus is on high volume and cost efficiency.

Driven by customer orientation and backed by knowledge driven processes, established players in this industry will benefit from emerging growth opportunities in the specialty chemical sector.

Specialty chemicals require less (as a percentage of sales) raw material as compared to commodity chemicals. The critical success factor for this industry is to understand the customer needs and development of product to meet the customer’s demand at favorable prices.

Specialty chemicals are relatively high valued; their demand is rapidly growing an catering to a diverse end-product market.

One of the key components of this ecosystem is chemicals, which go into every product that one can imagine. In fact, development of any economy or country is directly linked to the per capita consumption of chemicals.

Indian Chemical Industry’s Evolution

Source: IBEF

Chemicals – India’s Advantage

Source: IBEF

Consumption & R&D to Drive growth

Increase in consumption: Compared to other countries, India’s per capita consumption of specialty chemical is low, which provides ample growth opportunity in the medium to long term for Indian specialty chemical industry. Segments such as construction additives and construction chemicals currently form a very small proportion of the specialty chemical industry to global averages. This provides an ample opportunity to VOL for growth in the medium to long term.

Major cost centre in the industry is not feedstock or raw material, but product development and marketing activities. Specialty chemicals industry is not much about economies of scale (like in case of commodity chemicals), but about economies of scope as same product (specialty chemical) can be used for multiple applications. The scope is vast, limited only by one’s imagination. Companies can use specialty chemicals to develop new products to give them competitive edge in the market place. R& D focused industry: Since specialty chemical industry is knowledge based industry, research and development (R&D) is essential for the success of specialty chemical companies - even for small-scale firms - as most of the products offered by these companies are meant for meeting specific requirements of the customers. Global companies invest in India as market for specialty chemicals is driven by consumerism and requires certain degree of investment in R&D - a focal point for any leading company.

Specialty Chemical Industry - Key growth drivers

Industry Analysis

Industry Analysis

Rivalry among existing players: Low to medium VOL produces specialized chemical products that require state-of-art technology available only to a few in the world. It has global oligopoly in the two products that it manufactures (IBB and ATBS). Only other two players in ATBS segment are Lubrizol, US (14,000 tpa) and Toagosei, Japan (6000tpa). While Lubrizol uses ATBS for captive consumption, ATBS is not a key product for Toagosei. Similarly, only other major IBB producers are IOL Chemicals, India and SI group. While IOL Chemicals uses IBB for captive consumption, IBB is not a key product for SI group Buyer power: Low to Medium An over dependence on a handful of customers could prove detrimental in the event of their attrition. The Company’s strong client list comprises of brand enhancing international and domestic companies. The Company’s product customization capability in the specialty chemicals business has resulted in strong customer growth and satisfaction. Since there are handful of players who can makes these chemicals with consistent quality, buyer power is low to medium. Threat from new entrant: Low High gestation periods, strong technological barriers, long term customer contracts and strong R&D capabilities requirement make threat from new entrant very low. Supplier power: Low VOL has taken leadership role in ensuring supply of one of its major raw material through the setting up of the IB plant. The other major raw materials required are easily available, both locally and internationally. Further, VOL also enters into annual contract with its suppliers to protect itself from the vagaries of price and supply. As a result, supplier power is very low in case of VOL. Threat from substitutes: Low VOL makes specialized chemicals used for very specific purposes. There are no substitutes for these products.

Company Section

Company Profile Vinati Organics Ltd. (VOL) was established in 1989 to manufacture specialty organic chemical.

VOL is a specialty chemical company manufacturing aromatics, monomers, polymers and other specialty products. Today, the company is a leader in its field and has a strong market presence in over 22 countries.

VOL is the world’s largest manufacturer of Isobutyl Benzene (IBB) and 2-Acrylamido 2-Methylpropane Sulfonic Acid (ATBS).

VOL is now representing the country’s IBB export volumes in IBB and ATBS. Expertise in producing superior quality chemical based products, coupled with strong marketing strategies has led the company to become a market leader in its segment.

The import of IBB has been completely stopped and on the contrary, VOL is now leading the country’s IBB export volumes.

Together IBB and ATBs constitutes almost 62% of the revenues of the company. 65% global IBB market share and 45% global ATBS market share is held by VOL. Exports accounts for more than two-third of its total revenue.

VOL stays updated with the latest technology trends in the industry and it was the first company to commercially manufacture IBB with technology collaboration of the renowned Institut Francais du Petrole (IFP), France; successfully scaling up to become the manufacturer of IBB.

Products & Application 2-acrylamido 2-methylpropane sulphonic acid (ATBS) It is a highly versatile molecule and has applications in a wide range of industries due to its excellent hydrolytic and thermal stability. It is a unique molecule that imparts properties such as divalent cationic stability, lubricity, enhanced performance at high temperature and much more to its polymers. It is an important ingredient to manufacture polymers for Enhanced Oil Recovery (EOR). Applications of the product are: • Water treatment chemicals • Emulsions for paint and paper coatings • Adhesives • Textiles auxiliaries and acrylic fiber • Detergents and cleaners • Oil field and mining chemicals • Construction chemicals Sodium salt of 2-acrylamido 2-methylpropane sulphonic acid (NaATBS) This is normally a 50% liquid solution which is convenient to handle, thereby, making it easy to get desired flexibility in formulations to create high performance polymers. Application of the product is quite similar with that of ATBS. Iso Butyl Benzene (IBB) IBB is a basic raw material used in the pharmaceutical and perfumery industries, and VOL has a record purity level of 99.8% as against the prevailing international standard of 99.5%. IBB is used as a basic raw material manufacturing Ibuprofen, an anti-inflammatory analgesic bulk drug.

Products & Application Isobutylene (IB) IB is a carbon branched olefin obtained from petrochemical or refinery manufacturing processes. The derivatives of isobutylene are some of the most widely used and industrially important intermediates. The output from the company’s IB plant is used for captive consumption as raw material for the manufacture of ATBS and HP-MTBE and also for merchant sales. It is used in Butyl rubbers, anti oxidants, fuel additives, fragrances and perfumes, insecticides and pesticides, personal care, monomers. High Purity-Methyl Tertiary Butyl Ether (HP-MTBE) HP-MTBE is an oxygenated solvent miscible with a variety of hydrocarbons such as ketones and alcohol, among others. It is a substitute for diethyl ether, iso propyl ether, tetrahydrofuran and other solvent. Used as a relatively low cost solvent in organic synthesis with properties matching diethyl ether. Also used as an extractant solvent for pharmaceutical synthesis and also in the synthesis of Grignard’s reagent. VOL is the largest manufacturer of High Purity- Methyl Tertiary Butyl Ether (HP-MTBE) in India.

Business overview of the company

Business Model

Business with strong entry barriers

Specialty chemicals business is knowledge as well as process-driven. It takes years of knowledge and trial and error to develop the chemistry to meet not only international purity standards but also achieve a favorable price-performance ratio. Also, specialty chemicals are required to meet customized needs of different customers.

One of VOL’s products, IBB, which is used as a raw material for manufacturing ibuprofen,

demands a purity level of 99.5%, as per international standards.

Given its usage in making drugs, consistency in quality is of utmost importance. Although VOL started its business in1992 by setting up an IBB plant in Mahad with an initial capacity of 1,200mt, it took eight years of concentrated efforts to get the commitment from its client.

Starting 1998, VOL was able to sell at the most 100mt of IBB to clients. However, consistent improvement in IBB quality and multiple visits to US-based clients finally gave VOL its first major IBB order in late 2006.

VOL not only meets, but also beats industry standards in purity by manufacturing IBB with purity ratio of 99.8%, the highest level globally. VOL has technical partnership with renowned global player Institut Francais du Petrole (France) for manufacturing IBB with a perpetual non-exclusive licence.

Business with strong entry barriers

VOL’s another product, ATBS, had to go through a rigorous process before the company could come up with a marketable product. Since December 2002, production of ATBS has been streamlined and the first batch of commercially manufactured ATBS was shipped to VOL’s clients globally.

However, clients rejected the ATBS produced by VOL because of quality problems. VOL then started providing 18 different parameters for its product on the basis of which the quality of ATBS could be accessed. The learning process lasted till 2005 when it finally made a breakthrough.

The acceptable quality of ATBS for Enhanced Oil Recovery (EOR), one of the areas where ATBS is used, is even higher than its usage in other applications. Weight of ATBS should be higher than 400,000amu for it to be used for EOR.

The company’s ATBS product successfully achieved high purity standards with a purity tolerance level of ~0.5% against the accepted global tolerance level of ~3.0%. VOL, in a tie-up with National Chemical Laboratory or NCL under the guidance of Dr. Barve, was able first to achieve this feat in India. NCL has exclusively licensed this technology to VOL. The process developed by NCL is protected by two US patents.

VOL’s other two major products - IB and HP-MTBE - are of equally superior quality. company’s IB product achieved a 99.85% purity standard, which is among the highest in the world. HP-MTBE achieved a purity standard of 99.95%, accepted as one of the highest globally. Hence, we believe that given the time and complexity involved in making these products, it is extremely difficult for a new entrant to foray into this business.

Favorable structural advantages

Firstly, specialty chemicals that VOL produces accounts for a tiny portion of total raw material costs of its clients.

Hence, the incentive for clients to change its supplier is very low unless the supplier is not able to provide good and consistent quality products.

Secondly, very few players are present in this segment. It takes a long time to build quality products that are acceptable at the global level. Hence, a small player can’t start from scratch because the gestation period is very high.

A bigger player may not like to get into this business as it is completely value-driven and not volume-driven. Revenue from specialty chemicals would make up tiny portion of total revenues of a big player. Hence it will be less beneficial for them to get into this space.

The above two factors give companies like VOL tremendous pricing power. Even if VOL decides to marginally increase its prices, the impact of that increase on the bottom-line of clients will be minimal. This is evident from VOL’s highly consistent margin profile since the past five years.

Key Points

Current year under consideration: While the company focuses on maintaining leadership positions in each of its products, new product launches are expected to contribute in total revenue from 2HFY17. We expect overall volume to decrease 7% YoY in FY16 due to lower crude oil prices and therefore almost no demand of Enhanced Oil Recovery (EOR) chemicals (15% of ATBS revenue). However, we also believe demand scenario to turn favorable from FY17E onwards on the back of new product launches and expectation of higher demand from user industries with favorable business dynamics. Robust Client base: VOL’s 68% sales is from export sales to US, Europe and Asia. It caters to some of the world’s largest manufacturing companies including BASF, Dow Chemicals, Nalco Company (USA), AkzoNobel, SNF Floerger, Ciba and Clariant Chemicals among many others. Future plans to drive growth and lower input costs: VOL is planning to invest INR 150cr by FY17. A co-gen power plant at its Lote facility at INR50cr is expected to lower electricity costs by upto INR 8cr per yr. Debottleneck existing capacities and adding capacities for IB based derivatives could contribute INR 200cr (25% of revenues in FY15) once full capacity is achieved . In the medium term, ATBS is likely to drive growth with enough scope to increase utilization levels.

Moving towards value added products

Although VO is globally known for ATBS and IBB, it has an integrated portfolio of 15 products; for many of these, it is the largest manufacturer in India. In order to further its growth plans, it is undertaking capital expenditure of Rs.2bn over FY16‐17 to expand existing products and to introduce new downstream products.

VO has entered into long‐term tripartite agreements with USA and Japan‐based chemical companies for supplying customized product, which it expects will contribute incremental sales of Rs 450mn in FY17, and should see a scale‐up subsequently. We expect its new initiatives to sustain value growth and estimate these to contribute Rs 1bn in FY18.

Financial performance of the company

Revenue growth over the last few years

Operating sales grown at a CAGR of 25% during FY11-FY15. We expect the revenue to grow at a CAGR of 12% during FY13-FY17E. We expect a muted growth during FY16E on the back of falling crude prices that could affect the ATBS realization. Of late, we expect that the recovery of crude prices and increase in demand of its products other than ATBS could pull the sales.

During H1FY16, its revenue de-grew by 17% y-o-y basis but expected to recover during H2FY16E. Net sales realisation may decrease due to falling crude prices but we expect that volume could rise for each top line product during the said period.

Revenue Contribution

The revenue share from its two products-IBB and ATBS, have fallen from almost 70% of its net sales in FY12 to approximately 62% of its net sales in FY15. This is quite positive for the company in our view, as its diversifying its product portfolio through new launches, and at the same time not losing its market share worldwide.

65% of the global Iso Butyl Benzene (IBB) market share is held by the company in FY15, as compared to 60% in FY12. 45% of the global 2-acrylamido 2-methylpropane sulphonic acid (ATBS) market share is held by the company in FY15 as compared to 30% in FY12.

New launches will enable the company to better utilize its by-product and generate higher revenue in coming years, without losing its market share of its existing products.

IBB to sustain with moderate growth

Isobutyl Benzene (IBB) was VO’s first product. It is a specialty chemical widely used as an intermediate in the preparation of Ibuprofen, an anti‐inflammatory/antiarthritic/analgesic medicine for pain relief. Ibuprofen is primarily manufactured in India, China, and in the USA.

It is also used in the perfume industry. VO is a market leader in IBB with >70% global market share. It has the largest IBB manufacturing capacity in the world at 14,000TPA at Mahad, Maharashtra. It has acquired the technology to produce IBB from Institut Francais du Petrole (IFP), France.

This is a mature product with demand of ~20,000 TPA globally, growing at ~5% p.a. We estimate 6% sales CAGR over FY16‐18 to Rs 1.98bn.

Profits and Profit margins

Thus, increased contribution from high-margin products is going to expand blended margins by 300bps from 26% in FY15 to 29% in FY18E. As a result of high margins, we expect EBITDA to post a CAGR of 18% over FY16E-FY18E.

During FY15, the company recorded net profit of Rs.1160 mn registering a growth of 35.0%. We expect the growth momentum to be maintained by the company with PAT margin expansion by 2%. During H1FY16, it has seen a margin expansion by 6%.

Capital Efficiency and Balance sheet strength

VOL’s RoE and RoCE are likely to be around 25% and 37% during the next couple of years respectively. During FY15, the company has cleared its debt by 65%. During FY14, VOL was carrying a debt of Rs.1099

mn which reduced to Rs.372 mn during FY15; and we expect that in the long term, it will further reduce its long term debt. VOL is expected to meet all its capex from its internal accruals.

Liquidation and Dividend Analysis

Historically, VOL has already maintained a current ratio above 2x. We expect that it can maintain its working capital management on a sustainable basis.

Working capital or WC days (cash conversion cycle) for VOL remained in the range of 85-105 over FY12- FY15. We expect WC days to remain in a similar range over FY16-FY18E with the number of days at 106/86/84, respectively.

VOL is a good proxy for dividend. Historically, it pays dividend on a regular basis.

Risks & Concerns

High reliance on two products: While overtime the company has moved from being a single product manufacturer, ATBS and IBB account for more than 75% of its business. While both the businesses have historically contributed to robust growth, it may be difficult to maintain the growth momentum with the existing products. It would be good to see the company successfully adding more products, as it will not only mitigate product concentration risk but client concentration risk as well (currently around 60% of the revenues come from top 10 clients). Regulatory concerns: Since around two thirds of the company's revenues come from exports, any kind of adverse developments, such as with regards to dumping duties and product quality could impact business prospects. New product launches may not take off: While VOL tends to stick to what it knows best, the long term growth of the business will depend on its ability to launch newer products to drive growth. While the success ratio has been good so far, one cannot take it for granted that the same will continue in all its future. It's not just the inclusion of new products, but their profitability as well that will determine future business prospects.

Valuation & Conclusion

With its unique business model and excellent operational performance, we believe that Vinati Organics will maintain its sector leadership scale and turnover supported by its proven global volume/value leadership in ATBS and IBB, visible lower crude price and capex plan for forward integrated products. We estimate Vinati Organics to deliver 20%/25% revenue/profit CAGRs over FY16‐18 to touch Rs9.21/2.25bn in FY18. Considering its industry leadership in terms of earning efficiency and with future growth led by continuing expansions into value‐added downstream products we believe that company has more potential to create value. With the strong moat and revenue visibility we expect the company sustain its current growth level of 20%+ in the coming years. We suggest our clients start buying at the current market price with holding period of 4 to 5 years.

Appendix: Financials

Profit & Loss Statement

Balance Sheet (Liabilities)

Balance Sheet (Assets)

Key Ratios

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