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Margin: The issue of the past, a concern of the future!

* The prices of Aniline, a key raw material for NOCIL, have shot up by 20% MoM in Nov’21 (up 44% QoQ and 149% YoY) due to a supply crunch and other reasons mentioned below. This could result in a normalization of margin for NOCIL (recorded a peak margin of INR55/kg in the no Anti-Dumping Duty environment in 1QFY22).

* As the price of Aniline increases, the ability of the company to pass through the entire increase subsides (as highlighted in Exhibit 2), resulting in a margin compression.

* In the current environment, where: 1) the Centre has not accepted the Directorate General of Trade Remedies’ (DGTR) recommendation to impose ADD on one of its key products, PX-13; and 2) there exists a risk of increased dumping from China (China Sunshine would complete its expansion over the next 1-2 quarters), the stock may be under pressure in the near term.

* We maintain our Buy rating on the stock, given: a) the management’s confidence in achieving the optimal utilization rate of expanded capacity by 1HFY24 (we expect the same by FY24 – translating in a revenue/EPS CAGR of 26%/44% over FY21-24E), and b) relatively cheap valuation (at 15x FY24E EPS) after the recent correction.

Aniline demand and supply – overview and forecast

* Aniline is primarily used as a feedstock for producing Methylene Diphenyl Diisocyanate (MDI). By end-user market, it is primarily used in the Building and Construction space (constitutes 55% of the total consumption), followed by Auto (16%), rubber chemicals (11%), and Consumer Goods (10%).

* MDI prices continue to witness an uptrend in the North American market, backed by consistent demand from the Housing sector, downstream plasticizers, and insulator. The number of houses authorized for construction, but not yet started, touched a 15-year high in Oct’21 due to a shortage of materials. The pent up demand for Housing is likely to keep MDI demand strong in the medium term.

* Resumption of MDI capacities (by BASF and Covestro – the top two players globally) post shutdowns/force majeure in the last quarter, along with various other capacities in the US due to hurricanes, would keep demand for Aniline high in the near term.

Valuation and view – maintain Buy

* We build in an EBITDA/kg of INR35 for 2HFY22 (in line with the last three-year’s average), with an improvement to INR45/INR50 over FY23E/FY24E, as capacity ramp-up and raw material prices normalize from current higher levels.

* For NOCIL, the priority would be to undertake debottlenecking at existing units in the near term, while long-term planning is under evaluation. Specialized products form 25% of total revenue, and any new capex announcement in this category would be both realization and margin accretive.

* NOCIL has an asset turnover of ~0.7x in FY21 (set to increase to 1.1x in FY24E). We expect return ratios to recover to 16-17% over FY23-24E (up from 7% in FY21). Valuing the stock at 22x Dec’23E EPS, we arrive at a TP of INR320. We maintain our Buy rating.

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