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Buy Neogen Chemicals Ltd For Target Rs. 1085

Next growth phase to emanate from pharma venture

Neogen Chemicals reported topline growth of 13% YoY to | 92.7 crore against our expectation of | 87.1 crore. The growth was driven by higher growth in the inorganic chemical segment (up 31% YoY) largely on account of better volume growth. Revenue from organic chemical was up 7% YoY to | 72 crore. Growth from organic chemical segment remained subdued owing to capacity constraint. OPM for the quarter expanded 80 bps YoY to 20% leading to EBITDA growth of 17% YoY to | 18.5 crore vs.

our estimate of | 17.2 crore. Gross margins expanded 386 bps YoY, 196 bps QoQ to 43.5%, largely on account of higher realisation and better product mix. Lower taxes (30% vs. 35% in Q4FY20) boosted bottomline growth, which was up 28% YoY to | 9.3 crore against our estimate of | 8.4 crore.

New capacity to drive incremental growth for organic chemical

Both phase 1, 2 expansion at Dahej would expand organic chemical capacity by 3x with a capex of | 130 crore. This would translate into incremental revenue of | 350-375 crore at peak utilisation against overall revenues of | 306 crore currently. We expect the Dahej facility to largely cater to the custom synthesis opportunity with the Vadodara plant catering to advanced intermediates market. Given both these segments have better gross margins compared to the base business, increase in the share of these segments is likely to expand group gross margins and, thereby, OPM and return ratios.

WC cycle to improve, going forward, thereby FCF

Since Neogen is working on many organic molecules and size of the same is materially lower, it has to keep large WIP inventory to curb manufacturing cycle time. Going forward, with an increase in custom synthesis deliveries and garnering large custom synthesis contracts as witnessed recently, the company can keep dedicated glass lined reactors. Thus, WIP inventories can be restricted significantly. Further, higher bromine consumptions could lead to more bargaining power for Neogen, which can lift the payable cycle. This would improve cash conversion cycle and thereby FCF.

Valuation & Outlook

Since the Dahej capacity would largely cater to the custom synthesis opportunity, we expect gross margins of the business to expand considerably in the years to come given that custom synthesis should have a superior margin profile than the base business. We value the company at 38x PER of FY23E (~0.8x PEG). We arrive at a target price of | 1085 (earlier | 1040). We maintain our BUY rating on the stock.

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