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Company Background

Oriental Carbon & Chemicals Ltd (OCCL), part of Duncan JP Goenka Group led by Mr Arvind Goenka, Managing Director, entered into manufacturing of Insoluble Sulfur (IS), a rubber vulcanizing agent used by radial tyre manufacturers and sold under „Diamond Sulf‟ brand, in 1994.

Currently, it has a capacity to produce 34,000 MTPA of IS at its plants at Dharuhera, Haryana and Mundra, Gujarat. Not only OCCL is India‟s only producer of IS where it commands a ~55-60% domestic market share, it is amongst the only three globally recognised players in IS, with ~10% global market share. Sulfuric Acid and Oleum are its other products. Duncan Engineering Ltd (DEL; erstwhile Schrader Duncan Ltd), its subsidiary, is engaged in the manufacturing of pneumatic products such as hydraulic and pneumatic cylinders, pneumatic valves and accessories.

Investment Rationale

Buoyancy in tyre demand resulted in better volumes

* During Q1FY22, OCCL‟s sales from chemicals business reported a ~92% y-o-y growth to Rs 812 mn due to lower base, however it declined by 22% q-o-q on the back of COVID-19 second wave induced lockdown in many states during April and May, thereby impacting volumes majorly in domestic markets. According to the Management, there is not much slowdown in export markets as demand from US and Europe was normal.

* North America is largest market for IS with potential to increase market share. In domestic and European markets, the automobile sector is booming with a rise in personal mobility which augurs well for IS industry in general and OCCL in particular. The Company added new customers worldwide, during the quarter. Further, demand for IS is expected to benefit from the completion of a strong capex undertaken by the domestic tyre industry and expected strong recovery in commercial vehicle demand.

* ~92% of OCCL‟s standalone revenues are contributed by the chemicals business. DEL witnessed a topline growth of 143% y-o-y and de-growth of ~18% q-o-q at Rs 110.4 mn during the quarter.

* OCCL is well positioned for growth in coming years. We have built in a revenue growth of ~22 and ~19% for FY22E and FY23E respectively and keeping in view OCCL’s robust track record and expectations of rise in demand pickup post ease of lockdown restrictions. Further, our estimates are contingent upon the future uncertainties of COVID-19 disruptions which might impact our forecasts.

Standalone EBIDTA margins set to stabilize ~32%

* During Q1FY22, consolidated EBIDTA margins decreased significantly by 1,170 bps q-o-q to 20.4% at Rs 188.1 mn due to continuous rise in raw material prices which could not be passed on to the customers. Management said that it takes 3-6 months to pass on the prices; however, the Company has taken a price hike in the month of July to mitigate this. Also, power and fuel, packaging expenses and freight has significantly increased during the quarter vis-à-vis corresponding period last year.

* We expect OCCL‟s (standalone) capacity utilization to touch ~75% by FY23E, on its capacity of 45,000 MTPA and EBIDTA margins to stabilize ~32.5% by FY23E. This is due to better economies of scale, post commissioning of 11,000 MTPA of IS capacity.

Planned capex of Rs 2.16 bn - to increase IS capacity by 11,000 MTPA

* OCCL is incrementally enjoying a favourable market positioning as the „Second Alternate Supplier‟ in global markets, particularly in the West. The Company is increasing it‟s IS and Sulfuric Acid capacity by 11,000 MTPA and 42,000 MTPA respectively at Dharuhera. The total capex is estimated at ~Rs 2.16 bn, of which IS expansion is estimated at ~Rs 1.83 bn, funded through a mix of debt and internal accruals of 2:1. IS expansion comprises two equal phases of 5,500 MTPA each.

* The Company has spent Rs 1.35 bn till June 2021. Phase-I capacity of IS and the entire capacity of Sulphuric Acid is expected to get commissioned in October 2021 (earlier expected by July 2021). The Company will undertake Phase-II expansion, after commissioning of Phase-I, depending on automotive market conditions.

Change in Dividend Policy; Treasury Investments

* OCCL has formulated a new dividend policy under which the Company has decided to pay 50% of free cash flow (FCF) as dividend, showing its commitment to its shareholders. Historically, the Company‟s dividend pay-out was 20% of PAT.

* Further, OCCL has invested ~Rs.300 mn of its treasury in alternative investments till March 2021 with a commitment to invest another ~Rs. 300mn. The Management has expressed comfort to invest upto 20% of its net worth in such avenues in its desire to generate optimal treasury gains, albeit carrying relevant risk. In the past, it has returned surplus liquidity to the shareholders through a Buy Back during FY19.

Valuation

* OCCL is one of the only three globally recognized IS players. However, a semblance of competition is emerging from China. With the revival of the automotive segment, we expect OCCL to emerge as a strong player with its focus to enhance its footprint across all domestic and global consumers and remain in a strong position to capture higher market share with its new incremental capacities.

* We have valued OCCL on PE basis, assigning a multiple of 14x to FY23E EPS of Rs 115.3. We maintain „Buy‟ on the stock with the target price of Rs 1,614/- (~53%) in 18 months.

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