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Fatty Alcohol price on the boil, may scald margins!

The price of Fatty Alcohol, a key raw material for GALSURF, surged 52% YoY in 4QFY22 (up 16% QoQ) due to supply-related issues.

Freight rates have also increased 300-1,000% from the pre-pandemic levels, while lead time still remains high for supply of raw materials (at 2-3 weeks).

The management has already guided for a normalization of margin to INR16-18/kg from a high of INR20.5/kg in 3QFY21. However, the current high raw material prices may cause a dent in GALSURF’s margins in the short-term.

Nonetheless, despite the likely short-term pressure on margins, we maintain our BUY rating on the stock, given its: a) robust volume growth trajectory, and b) continued focus on expansion, especially in the specialty care products segment, which should underpin margin expansion. We value GALSURF at 40x FY24E EPS of INR91 to arrive at our TP of INR3, 632, implying 22% potential upside.

Palm oil: a precursor to Fatty Alcohol

The whole value chain of extracting Fatty Alcohol consists of two completely different processes: one is through the Palm Kernel Oil (which forms a part of the Oleo chemicals value chain) and the other from the crude oil extraction process. Currently, Oleo chemicals form 70% of the total raw materials of the company while petro products form 30%

Southeast Asia (Indonesia and Thailand) produces around 80% of the world’s natural Fatty Acids and Fatty Alcohols, with growth of both sectors being mostly driven by developing economies such as India. Detergents, cleaners and soap companies are the largest users of both the products and account for about 48% of Fatty acid demand and 55% of Fatty Alcohol demand.

Though recovering industrial activities have pushed up the demand for Fatty Alcohol significantly, the price has remained elevated due to supply tightness. Further, Indonesia’s announcement to restrict its outbound shipments of Palm Oil should prolong this supply crunch, in our opinion.

Sustained focus on R&D and higher demand from customers to fuel growth

We model an EBITDA/kg of INR12.7 for 4QFY22 (below the last five-year average of INR16.3/kg), although we expect an improvement to INR18/kg over FY23-24 due to better contribution from the specialty products segment.

The management has guided for a capex of INR4b over FY22-24E with an outlay of INR1.5b already done for 9MFY22. Expansion of products is likely to be across the board but focus would remain mainly on the specialty care products segment. Further, continued focus on R&D (with an expenditure of INR400- 500m every year) and increased wallet share from existing customers are likely to drive volume growth.

The stock is currently trading at 33x FY24E EPS and 21x FY24E EV/EBITDA. We value the company at 40x FY24E EPS of INR91 to arrive at our TP of INR3,632. We maintain our BUY rating with a 22% potential upside.

Downside risks to our call: 1) demand may not pick up in congruence to the capacity expansion taking place in the Specialty Care segment; and 2) rising feedstock prices and freight rates may lead to underperformance of the stock.

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