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Earnings hit by sharp decline in phenol spreads

Deepak Nitrite’s 2QFY23 earnings print was weaker than anticipated on account of sharp decline in phenolics business profitability. This was due to a) high inventory carrying cost; and b) purchase of key raw material (cumene) from the market due to shutdown of the BPCL plant. The management expects some of this impact to flow through in 3QFY23 as well. Moreover, weakness in the standalone business was driven by i) partial operations at its Nandesari plant (started operations from early Jul’22 in a phased manner, and ii) usage of expensive natural gas instead of coal. Going forward, the management expects revenue and margin trajectory to improve in 2HFY23 in its standalone business. In the long term, the company envisages doubling of its topline along with margin expansion in the standalone business. Further, Deepak’s capex plans of INR 15bn over FY23-24 remain on track. We cut our FY23/24/25 estimates by ~10%/2%/1% to account for the 2QFY23 results and management commentary. We maintain BUY with a revised Sep’23 TP of INR 2,845/shr (from INR 2,895/shr) as we believe it will continue to maintain its leadership position in upcoming downstream products due to its inherent advantage of in-house basic chemicals’ capacities.

* Sharp decline in Phenolics EBIT a negative surprise: Deepak Nitrite’s 2QFY23 gross profit came in 21% below JMFe at INR 5.9bn (down 15%/6% QoQ/YoY) on account of lowerthan-anticipated revenue of INR 19.6bn (5% below JMFe while flat vs. consensus, down 5% QoQ but up 17% YoY) and a sharp decline in gross margin to 30% (vs. 36% of JMFe and 34% in 1QFY23). As a result, EBITDA missed JMFe/consensus estimates by 31%/20% and stood at INR 2.7bn (down 24%/30% QoQ/YoY) despite a decrease in other expenses to INR 2.4bn (vs. JMFe of INR 2.7bn and INR 2.6bn in 1QFY23). Hence, PAT came in 33%/21% below JMFe/consensus and stood at INR 1.7bn (down 31%/26% YoY/QoQ). Deepak’s phenolics EBIT was lower than anticipated and stood at INR 1.1bn (vs. JMFe of INR 2.1bn and INR 1.9bn in 1QFY23) as phenolics EBIT margin declined to 8% (vs. JMFe of 16.0% and 14.1% in 1QFY23) while revenue was largely in line with our estimates at INR 12.8bn (vs. JMFe of INR 12.9bn and INR 13.3bn in 1QFY23). This indicates that the company was unable to make higher spreads despite the sharp jump in global benchmark based phenol-acetone spreads

* Advanced intermediates (AI) EBIT also disappoints: Deepak’s advanced intermediates EBIT came in below our expectation at INR 1.4bn (vs. JMFe of INR 1.7bn and INR 1.3bn in 1QFY23) as AI revenue was 15% below JMFe at INR 6.9bn (down 6% QoQ still up 26% YoY) and EBIT margin was also below JMFe at 20.2% (vs. JMFe of 21.5% and 18.2% in 1QFY23).

* Cut FY23/25/25 estimates by ~10%/2%/1%; maintain BUY: We cut our FY23/24/25 estimates by ~10%/2%/1% to factor in ~30% EBITDA miss in 2QFY23 and gradual recovery in the coming quarters. Hence, our Sep’23 TP is revised to INR 2,845/share (from INR 2,895 earlier) (based on 28x Sep’24E EPS) as we believe it will continue to maintain its leadership position in upcoming downstream products due to its inherent advantage of in-house basic chemicals’ capacities. We estimate ~12% EPS CAGR over FY22-25E taking into account long-term average phenol spreads.

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