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Capex plans intact amid near term demand headwinds

Clean Science’s 1QFY24 earnings print was weaker than our and consensus expectation. During the quarter, reported EBITDA was ~17% lower than JMFe and consensus likely on account of end-product inventory mark downs amid continued fall in its raw material prices. Currently, Clean is also facing demand challenges amid the global chemicals slowdown. Going forward, we believe that demand recovery will be gradual especially in its key products like MEHQ, BHA, and ramp-up of HALS would also be slightly delayed than we had earlier anticipated. As a result, factoring in demand slowdown and a gradual recovery over the next couple of quarters along with slower ramp-up of HALS, we lower our FY24E/FY25E/FY26E EBITDA and EPS estimates by 18%/14%/8% and 15%/13%/9% respectively. As a result, our Sep’24 TP is revised to INR 1,995 (from Jun’24 TP of INR 2,325 earlier). Despite the demand slowdown, company is not pushing back its capex plans, especially the recent announcement of INR 2.0bn for new products. Although we agree that near term weakness will remain and EPS growth for FY24 could turn out to be a flattish to low single digit, we expect Clean to register ~31% EPS CAGR over FY24E-26E (after a likely subdued FY24) as additional newer projects (at a capex of INR 2.0bn) start kicking in from mid FY25E. Hence, we maintain BUY as we look beyond near-term weaknesses and focus on long-term growth trajectory.

* Lower Gross margins and lower sales lead to PAT miss: Clean Science’s 1QFY24 consolidated gross profit was 13% below JMFe at INR 1.15bn (down 24%/19% QoQ/YoY) as revenues were 4% below JMFe and stood at INR 1.9bn (down 13%/20% QoQ/YoY) as gross margins were significantly lower than anticipated at 61.4% (vs. JMFe of 68.0% and 70.4% in 4QFY23) because of a substantial dip in closing prices over opening inventory. As a result EBITDA margins fell to 40% (vs. JMFe of 47% and 48% in 4QFY23) with EBITDA coming in 17% below JMFe and consensus at INR 761mn (down 28%/17% QoQ/YoY). PAT was 18%/13% below JMFe and consensus and stood at INR 589mn (down 27%/ 6% QoQ/YoY).

* Demand headwinds across verticals: During the quarter, management indicated that there were demand challenges in all of its verticals. However, pain in the performance chemical segment was much compared to other segments. Capacity utilisation for performance chemicals stood at 60% during the quarter due to lower off-take of MEHQ and BHA. The FMCG segment was relatively better placed with 72% capacity utilisations thanks to steady demand growth. The Pharma segment offtake was under pressure as recent product recalls of cough syrups from several countries like Indonesia, Iran and Iraq and subsequent bans by the Indian government on Indian manufactures due to health and safety concerns has led to reduced demand for Guiacol. The management however expects that the Guaiacol demand will bounce back in few months, either through domestic players or through exports to Chinese and Vietnamese companies.

* Expect 22% EPS CAGR over FY23-26E; maintain BUY: Management indicated that lower demand for master batches has led to reduced capacity utilisations (30%) of exiting HALS capacity (at Unit 3). Domestic imports have also reduced by 50% from long term average demand of ~3,000tons. The management expects utilisations to pick up to 50% over the next 2 quarters and for the new plant (Unit 4) to be commissioned in Q4FY24. With a few months post commissioning to solve teething issues at the plant, and another quarter to receive customer qualifications, full ramp is expected only in H2FY25. The 2 products to be launched from the new plant will be catering to both the domestic and export market, unlike current the import substitute products. Factoring in demand slowdown and a gradual recovery over the next couple of quarters along with concerns on HALS offtake we lower our FY24E/FY25E/FY26E EBITDA and EPS estimates by 18%/14%/8% and 15%/13%/9% respectively. We maintain BUY with a revised Sep’24 TP of INR 1,995 (from Jun’24 TP of INR 2,325 earlier).

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