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Look beyond near-term weakness

Clean Science’s 4QFY23 EBITDA was 5% below JMFe as lower sales were partly offset by gross margin expansion and decline in power and fuel cost. GM expansion was mainly on account of quick fall of raw material prices amid relatively gradual end-product price decline. The company will have to pass on this fall in RM prices in the coming quarters. As a result, sequential margin contraction could be on the cards. However, on a full year basis, for FY24, we expect only 70bps gross margin decline factoring in HALS ramp-up. Further, Clean has indicated some demand slowdown in 1QFY24 and possibly in 2QFY24. As a result, we have lowered our FY24/25 EPS estimates by 3%/2%. However, with the announcement of INR 2.0bn capex for new products (we had highlighted in our recent note that the market is ignoring this additional capex), Clean seems to be on track to achieve ~26% EPS CAGR over FY23-26E. We maintain BUY with a revised Jun’24 TP of INR 2,325 (from Mar’24 TP of INR 2,255 earlier) as we look beyond near-term weaknesses and focus on long-term growth trajectory.

* Gross margin expansion partly offsets lower sales: Clean Science’s 4QFY23 consolidated gross profit was 4% below JMFe at INR 1.53bn (down 4% QoQ while up 14% YoY) as revenue was 9% below JMFe and stood at INR 2.1bn (down 9% QoQ while up 6%YoY) while gross margin was 345bps better than anticipated at 70.5% (vs. JMFe of 67.0% and 67.2% in 3QFY23).This gross margin expansion helped offset the moderation in sales. Moreover, due to lower expenses of INR 349mn (vs. JMFe of INR 360mn and INR 396mn in 3QFY23), EBITDA margin was higher than expected at 48.5% (vs. JMFe of 46.8% and 45.5% in 3QFY23). As a result, EBITDA came in 5% below JMFe at INR 1.1bn (down 3% QoQ still up 26% YoY) and PAT came in 4% below JMFe and consensus and stood at INR 805mn (down 4% QoQ still up 29%YoY).

* Demand could pick up in 2HFY24: During the quarter, there wasn’t much of end-product price decline while raw materials prices fell sharply. As a result, gross margin expanded. However, the company will have to undertake price cuts. This could result in a sequential moderation in gross margin. Besides this, demand slowdown might hamper volume growth in the current quarter and, to some extent, in 2QFY24 as well, as per the management. However, we believe with the liquidation of excess inventories, 2HFY24 should witness robust demand.

* Expect 26% EPS CAGR over FY23-26E; maintain BUY: HALS from Unit 3 could reach 100MT/year run-rate by Dec’23, as per the management. In our view, this along with demand recovery of PBQ and additional volume of existing products should help deliver growth in FY24. The company has indicated INR 1.8bn capex for FY24 most of which would be toward HALS in Unit 4 (commercialisation likely by 1QFY25) while some could be for new products (anti-retroviral intermediate, water treatment and polymerisation inhibitor). These products are likely to be commercialised in mid-FY25 at a capex of INR 2.0bn. Factoring in imminent demand slowdown, we lower our FY24E/FY25E EPS estimates by 3%/2%. We maintain BUY with a revised Jun’24 TP of INR 2,325 (from Mar’24 TP of INR 2,255 earlier).

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