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Lower asset turns to weigh on capital efficiency…
Oriental Carbon & Chemicals (OCCL) manufacturers insoluble sulphur, an essential compound used as a vulcanisation agent in manufacturing tyres. It is a direct play on domestic and global tyre industry. Hence, with a steady state replacement market for tyres and increasing pace of radialisation, OCCL’s business prospects are firm. It operates in an oligopolistic market structure with only three credible players in the international market & OCCL being sole player domestically. Its global market share is ~10% (market size ~3,00,000 tonne) while domestic market share is ~55-60% (market size ~20,000 tonne). It operates in a business segment where asset turnovers are typically low (<1x). This, along with ~28% margins & ~90 days working capital cycle tend to lower RoCE to <20%. Given the present muted demand scenario as well as surplus capacity (~50,000 tonne) globally, there exists limited opportunity for OCCL to augment margins/return ratios.
Next level of expansion underway, first phase by FY21E end
OCCL has a manufacturing capacity of 34,000 tonne of insoluble sulphur and 46,000 tonne of sulphuric acid; with the former forming ~93% of sales with exports constituting ~60% of sales. In the past, OCCL had successfully commissioned 11,000 tonne of insoluble surplus and has already attained the optimum utilisation levels. Sensing steady demand prospects, OCCL has formulated and is currently executing a new capex plan. They intend to install 11,000 tonne of insoluble sulphur (two lines of 5,500 tonne each) at Dharuhera (Haryana) coupled with 42,000 tonne of sulphuric acid plant at a total outlay of | 216 crore at a targeted IRR of ~20%. OCCL expect first phase i.e. 5,500 tonne to commissioning by FY21 end.
Global ambitions, steady state EBITDA margins
OCCL has been targeting international markets to sell its incremental capacity and has made considerable progress especially in North American markets (largest market for insoluble sulphur). It aspires to attain a market share of ~10% in North American market in tandem with its overall global market share. Post a volume dip in FY20-21E, we expect it to post double digit volume growth starting FY22E. EBITDA margins have been quite resilient, with OCCL clocking 25% + EBITDA margins on a consistent basis.
Valuation & Outlook
Beyond the short term disruption, OCCL possesses a quality franchise and strong B/S. OCCL has a net debt of < | 40 crore as of FY19 with consequent net debt: equity comfortably placed at ~0.1x. On the valuation front, however, we are constrained by the limit to capital efficiency parameters at OCCL. Hence, we maintain HOLD rating to the stock, with a target price of | 715, valuing OCCL at 12x P/E on FY22E EPS of | 59.6. It clocks consistent positive CFOs but needs intermittent heavy capex for expansion.
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