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Demand cutback seen: deterrent to growth opportunities?

* Irrespective of volatility in raw material prices and stressed margins, demand from the end-user industries remained undeterred over the past year.

* However, today, we are noticing demand cutbacks in various regions the company operates in.

* Although prices of key raw materials—Fatty Alcohol and Ethylene Oxide—for the company have been on a decline, which comes as a boon for the company, the demand cut back that is being seen could pose a threat to growth opportunities in FY23 itself.

* The management has guided for an EBITDAM of INR16-18/kg with a bias on the higher side of the band. We forecast the margin to normalize over the next two quarters, although we expect it to be INR20/kg for FY23, owing to the outperformance in 1QFY23.

* Despite the above, we reiterate our Buy rating on the stock, given: a) robust volume growth trajectory, and b) its continued focus on expansion, especially in the specialty care products segment that should aid in margin expansion. We value the company at 40x FY24E EPS of INR89 to arrive at our TP of IN3, 556.

Key raw material prices on the wane…

* The key raw material for the company is Fatty Alcohol and Fatty Acids, which constitute 60-65% of the total raw materials that GALSURF uses. These are derived from Palm Kernel Oil and Coconut oil (which forms part of the Oleo chemical chain) and the company procures its RMs locally through Adani Wilmar and Godrej Industries.

* In 2QFY23, Fatty Alcohol prices have corrected 31% QoQ to USD1575/mt (USD2288/mt in 1QFY23) and 17% YoY (USD1895/mt in 2QFY22). The same is true for Ethylene Oxide, which is another key raw material for GALSURF. Over the same period, the prices have corrected 17% QoQ to USD6618/mt (from USD7946/mt in 1QFY23) and 12% YoY (USD7943/mt in 2QFY22).

* This bodes well for the company as this would help ease margin pressures that the company has been facing, owing to record raw material prices in the past one year. Freight rates have also cooled off from their highs. We expect the EBITDAM to be at INR20/kg for FY23, mainly driven by the outperformance in 1QFY23 and INR18/kg for FY24.

…although demand cutback could neutralize the positive effect

* Revenues from exports were 62% in FY22 with the company being a player in major markets such as USA, Europe, Egypt, and AMET. Revenue mix across India, AMET, and RoW stood at 38%/31%/31% in FY22, while the same was 40%/26%/34% in 1QFY23 for the company. Volumes have been on a declining trend in the AMET region over the past five quarters.

* Not only this, the volumes declined for the first time in seven quarters for the RoW market as well in 1QFY23 (by 6% YoY). Even though the Chinese competition is of miniscule importance to its operations, Europe contributes 10% to the overall revenues. Owing to inflation and the ongoing gas crisis, consumption, in general, has taken a hit in the continent, thereby, affecting the demand for the specialty products in the continent.

* Although the easing in the raw materials prices from record high comes as a blessing in disguise for GALSURF, the demand cut back would neutralize the positive effect and dent the ability of the company to grow its volumes as per its own guidance in FY23 itself.

Valuation and view – reiterate Buy

* The continued focus on R&D (with an annual expenditure of INR400- 500m) and increased wallet share from its existing customers is likely to drive volume growth and expand EBITDA margin. Although the company plans expansion of products across the board, its focus would be mainly on the specialty care products segment.

* The stock is trading at 32x FY24E EPS and 20x FY24E EV/EBITDA. We value the company at 40x FY24E EPS of INR89 to arrive at our TP of INR3, 556. We reiterate our Buy rating with a 25% potential upside.

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