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Revenue mix improvement pushes margin up

Three highlights from Sumitomo Q3FY21: (1) The company has focussed on premium products in 9MFY21 as there were multiple production constraints due to covid. Higher revenue share of premium products has led to 520bps higher EBITDA margin, (2) It has also continued its focus on reducing the working capital. We expect the working capital to steadily reduce to 104 days in FY23 from 112 days in FY20 and (3) The company is on track to gain market share in FY21-23 from smaller players. Sumitomo will benefit from its parent’s R&D support and distribution expansion in India. Due to 25% stock price performance over past five months, we downgrade the stock to ADD from BUY with DCF-based target price of Rs340 (implied target P/E 40x FY23E; Earlier TP- Rs325).

* Q3FY21 results: Sumitomo reported revenue, EBITDA and PAT growth of 7.2%, 70.6% and 108.3%, respectively. The EBITDA margin expanded 520bps due to (1) focus on high margin products, (2) lower input prices and (3) cost saving initiatives post covid. Rabi sowing was higher by ~3%. It also helped the company to drive growth. Sumitomo introduced three new insecticides and one PGR during 9MFY21.

* Improvement in EBITDA margin continues: Sumitomo’s EBITDA margin has steadily improved from 11.5% in FY18 to 17.2% in FY21E. Key reasons for improvement in margins were (1) synergy benefits post-merger of Sumitomo and Excel crop care, (2) focus on higher margin products and (3) operating leverage. However, we believe the EBITDA margins to stabilise ~17% over FY22-23.

* Expect market share gains in FY22-23: The smaller agrochemical companies account for ~30% of the agrochemical industry in India. We expect Sumitomo to gain market share in FY22-23 from these smaller players. Its current market share is ~5%. We expect Sumitomo to benefit from strong R&D support of its parent and steady distribution expansion in India.

* Limited capex over FY21-23 indicates strong FCF generation: With five manufacturing units, Sumitomo does not require any major investment in new production units in FY21-23. It also plans to reduce the net working capital days with strengthening distribution network and launches of differentiated products. We expect its net working capital days to reduce to 104 in FY23 from 112 in FY20. We model Sumitomo’s FCF conversion to be upwards of 70% over FY21-23.

* Downgrade to ADD: We model the company to report revenue and PAT CAGRs of 13.9% and 16.3%, respectively, over FY21-FY23. We downgrade the stock to ADD from BUY due to 25% stock price performance over past five months. We value the stock at a DCF-based target price of Rs340, implying a target P/E of 40x FY23E

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