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Over the last 6-8 months, Clean Science’s stock price has corrected over ~25-27%. Hence, the stock is currently trading at 31x FY25E EPS. We believe this is because of pessimism built around overall margin contraction led by launch of HALS series of products. In our view, in FY25E, CMP is factoring in a sharp ~5% YoY EBITDA margin fall while 4% contraction is built into consensus estimates. In contrast, we believe Clean will be able to get away with 2% contraction, resulting in 26% EBITDA CAGR over FY23-25E (vs. 16%/18% built into CMP/consensus). Our optimism stems from our belief of Clean making 48% gross margin in HALS in FY25E and gradually ramping it up to 56% by FY28E. Also, even after considering new product launches (aniline and phenol derivatives) over FY25-28E, we estimate Clean to register 20%/25% EBITDA/EPS CAGR over FY25-28E (considering lower tax rate for Unit-4). So, we recommend buying into the current correction for a structural 25% EPS CAGR over FY23-28E. We reiterate BUY with an unchanged Mar’24 TP of INR 2,255.

* HALS margin conundrum: As per our calculations, Clean could make 55-58% gross margin in HALS products on a steady state basis. However, given that yields could be lower in the initial year along with marketing discounts, we believe Clean could make 48% gross margin in HALS in FY25E and gradually ramp that up to 56% by FY28E. Currently, for HALS, consensus estimates suggest 44% gross margin in FY25E, gradually ramping up to 52% in FY28E (Exhibit 2). Also, CMP seems to be factoring in the worst as it suggests 40% gross margin in HALS, ramping up to 50% by FY28E (Exhibit 1).

* leading to contribution of new products launches getting ignored: Clean has roughly 10 products in its R&D. Some of them have been publicly announced, such as phenothiazine and other aniline derivatives. Besides this, we believe it could come up with several other phenol derivatives amongst others. This additional contribution from new products (besides HALS) is getting ignored and not getting factored in the CMP, in our view. We believe that even if Clean does a relatively small INR 800mn additional capex in FY25E for these new products, it would at least be able to generate INR 1.4bn of sales from them by FY28E

* EBITDA margin could stabilise at 40%; reiterate BUY: Over FY25-28E, considering a steady 66% gross margin in the existing business, 50% gross margin in the upcoming business, and a gradual ramp-up from 48% to 56% in the HALS business, we believe Clean’s gross/EBITDA margins could be stabilise at ~60%/40%. So, over FY25-28E, it could show 22%/20% CAGR of Revenue/EBITDA while on account of lower tax rate it could report 25% EPS CAGR. Hence, we believe Clean would be able to make a clean strike by managing the margin contraction arising on account of HALS and new product additions. In our view, the recent correction provides a buying opportunity to capture the structural EPS CAGR of 25% over FY23-28E. Besides this, Clean has been generating ample free cash flow, which gives it the wherewithal for inorganic acquisitions to support earnings growth. We keep our estimates unchanged and maintain BUY with an unchanged Mar’24 TP of INR 2,255/share.

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