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Novel chemistry at play

* Clean Science and Technology (CSTL) recently concluded its IPO via an offer for sale of INR15.5b, priced at INR900/share. Post the IPO the promoter shareholding stands at 78.5%.

* CSTL has emerged as the global leader in most of its product categories on the back of niche product offerings catering to polymer inhibitors / superabsorbents, anti-oxidants for the Food/Feed industry, pharma, home, and personal care. It has further bolstered its value chain through novel manufacturing technology based on green chemistry for one of the key raw materials.

* CSTL’s streak is driven by its strong R&D capabilities – in both plant technological /engineering development as well as process innovation (based on greener chemistries). This has led to the gross margin expanding to 76% in FY21 from 62% in FY16 (the EBITDA margin expanded from 33% to 50.5% over FY16–21).

* The company has posted a robust revenue CAGR of ~29% in the last five years. We expect CSTL’s revenues to grow at a CAGR of ~23% over FY21–24 (on the back of capacity additions at Unit-III in phases over FY22). The company plans to capture higher market share for its products.

* Its EBITDA margin is likely to remain robust at ~49%, with the gross margin at ~70% over FY21–24 – as the company continues to improve the yield of its products and processes. In view of its dominating product market share and ability to sustain the highest margins in the industry, we value the company at 50x FY24E EPS (as the company commands ROIC of ~75%) to arrive at Target Price of INR1,700/share. We initiate coverage on CSTL with a Buy rating.

* In our recently-released sector initiating report “Genie is out”, we had highlighted that normally, companies with a higher proportion of specialty chemicals command richer valuations.

Largest manufacturer of multiple specialty chemicals

* CSTL is the largest producer of Monomethyl ether of hydroquinone (MEHQ), Butylated Hydroxy Anisole (BHA), and 4-Methoxy Acetophenone (4-MAP) globally. Furthermore, it has backward integrated into producing Anisole, a key raw material, and has even become the largest producer of Anisole globally. CSTL is also one of the top three global producers of the remaining three products.

* MEHQ is CSTL’s largest selling product (48% of total revenue); the company holds a 52% global market share, which it expects to increase further to ~65% over the next 2–3 years.

* Most players in the Indian Specialty Chemicals industry view China as a competitor. However, CSTL rather sees the Chinese market as an opportunity as it supplies its products to this country – which contributed ~37% to its revenues in FY21 and is the biggest market for the company.

R&D – a key differentiator

* The company started producing Anisole through the liquid phase technology (an unclean and inefficient route) in 2017. Through its in-house R&D, the company developed a greener route, vapor phase technology in 2018 (making it the only company globally to manufacture via this process).

* Continuing its pursuit of process innovation through catalytic technology, CSTL has forayed into the Hindered Amine Light Stabilizers (HALS) series. Applications for the same are in diverse end industries such as Polymerization Inhibitor, Water Treatment, Paint, Coatings, etc. The estimated global market size for HALS is USD1b and CSTL would be the first company to develop HALS series in India.

* While many companies in the space only have a single R&D center, CSTL has a separate one for all its manufacturing facilities. It is also setting up an R&D center at its third unit, where it proposes to install R&D equipment to synthesize new products and certain catalysts under development.

Focus on process innovation to aid margins

* The introduction of (cost-effective) vapor phase technology and continued process innovation aided EBITDA margin improvement to 50.5% in FY21 from 33% in FY16 - resulting in an EBITDA CAGR of 40% over FY16–21 (a 53% CAGR in the last three years, led by the commissioning of the Anisole capacity in FY18).

* Unit-III (which would get commissioned in phases over FY22) would focus on Anisole (already commissioned in 1QFY22) and certain performance chemicals (although, the management has not provided any capacity bifurcation).

* Unit-III would also have the first line of production dedicated to HALS series (expected to be commercialized by 2HFY23), while additional production lines would be installed in Unit-IV.

* Additional capacity expansion would drive further growth for the company, accompanied by low margin volatility, due to:

* Challenges faced in terms of competing on the cost and margins fronts, leading to likely consolidation or shutdowns at units globally

* Further downstream/forward integration by CSTL into high-value products, which would offset any potential threat to its current high margins

Expansion of capacities for existing products to drive growth

* The global market for MEHQ, Anisole, and AP is expected to grow approximately ~6% over the next five years. For BHA, 4-MAP, and DCC, the market is expected to grow by ~4% over the same period.

* As we deep-dive into CSTL’s segmental analysis below (and a review of its product offerings), we expect continued market share gains on the back of its developed expertise (despite mid-single digit market growth for its products).

* In order to meet the growing demand from end user industries, CSTL is in the process of expanding its capacities by at least 20,000mt at Unit-III (in addition to its two existing units at Kurkumbh with total capacity of 29,900mt). Its capacity utilization at end-FY21 was ~72%.

* CSTL has also acquired land for Unit-IV, which would focus on stabilizers and other downstream intermediates for Pharma and Agro.

Valuation and view – initiate with Buy

* CSTL is an integrated player for its key products and is likely to grow at a faster rate than the industry due to its cost advantage as well as the introduction of new products. On this consideration, we forecast a revenue/EBITDA/PAT CAGR of 23%/22%/22% over FY21–24.

* CSTL is likely to generate FCF of INR6.4b over FY22–24E, with capex of INR3b planned over this period (INR1.5b each for units III and IV) – thus funding its capex purely via internal accruals and remain net cash going forward as well.

* CSTL has guided for a dividend payout policy of ~15% in view of its better cash generation. It also completed buyback of equity share worth INR491m in FY20.

* The key risks to our recommendations are (a) the lack of innovation in future – which has helped CSTL differentiate itself from others until now, (b) rising prices of key raw materials such as Phenol, which could suppress its gross margins, (c) any adverse ruling on the usage of any of its key products, which could affect global demand and, in turn, sales.

* We value the company at 50x FY24 EPS (as it commands ROIC of ~75%) to arrive at Target Price of INR1,700/share and recommend a Buy rating on the stock.

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