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Subdued performance; benefit of capex pushed

Sudarshan Chemical Industries’ (SCIL) Q2FY23 revenue grew 6.1% YoY which was largely driven by pricing, while volumes have declined. Demand headwind has been across segments - domestic volume was hurt by de-inventorising in polymer, and coatings from extended monsoon. Exports were hurt from slowdown in Europe and China, where problems have persisted. New products pipeline has been strong, and yellow pigment has started receiving approvals; however, off-take was impacted by demand headwinds. Gross profit margin was impacted from high cost inventory, and cautious price increase. SCIL is now guiding for more gradual recovery in margins, and China aggression remains a key risk. SCIL is nearing completion of large capex of Rs7.5bn by Dec’22. We have cut our EPS estimates to 52% for FY23 and 20% for FY24E as we build gradual recovery. Accordingly, we have reduced the target price to Rs410 (from Rs510), valuing the stock at 17x FY24E EPS. Maintain ADD.

Pigments revenue grew 6% YoY (down 9.5% QoQ). Revenue from pigments stood at Rs4.8bn on volume decline across geographies. Domestic pigment sale was down 1.7% YoY (12.3% QoQ) to Rs2.4bn. Plastics segment performance was tepid due to Indian buyers destocking on falling polymer prices, which impacted the company’s pigment sales. Coating segment was hurt by lower sales in premium category due to extended monsoon. Company has witnessed some green-shoots in domestic volume recovery from Q3FY22. Exports revenue rose 15.8% YoY (down 6.2% QoQ) was lower due to slowdown in Europe (largest geography for SCIL) and China. China slowdown has repercussion in international competitive intensity and creates additional headwinds. Exports market continues to remain challenging. Specialty pigments revenue rose 9.6% YoY to Rs3.3bn while non-specialty was down 0.7% to Rs1.5bn.

* Inventory losses and demand headwind hurt margins. SCIL’s gross profit margin dipped 170bps QoQ to 38.7% due to 1) high-cost inventory while raw-material prices have dipped; and 2) company has been cautious in taking price increase to avoid demand disruption. It expects gradual margin recovery as raw-material prices stabilise. Gross profit declined 2.9% YoY (down 8.6% QoQ) to Rs2bn, EBITDA dipped 18.9% YoY to Rs429mn and margin was just 8.1%. SCIL is planning for more cost optimisation measures to help reduce fixed cost. Net profit fell 80% YoY to Rs45mn

* Other highlights. 1) SCIL is yet to capitalise Rs2bn of capex, which should complete by Dec’22. It has two lines of production, and will largely go for a new product launch. New capacity utilisation is low despite product approvals from clients due to underlying demand challenges. SCIL expects peak utilisation in 3-4 years; 2) yellow pigment, which finds application in coating industry, has started receiving approvals. Margin has been lower initially due to high production cost which will reduce; 3) SCIL has built strong product portfolio which is now equal to No 1 and No 2 pigment players combined and has built very strong technical capabilities and marketing; and 4) China has levied provisional ADD on Indian phthalocyanine pigment at 14-19%

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