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Company Background

Oriental Carbon & Chemicals Ltd (OCCL), part of Duncan JP Goenka Group led by Mr Arvind Goenka, Managing Director, entered into manufacturing of Insoluble Sulfur (IS), a rubber vulcanizing agent used by radial tyre manufacturers and sold under ‘Diamond Sulf’ brand, in 1994. Currently, it has a capacity to produce 34,000 MTPA of IS at its plants at Dharuhera, Haryana and Mundra, Gujarat. Not only OCCL is India’s only producer of IS where it commands a ~55-60% domestic market share, it is amongst the only three globally recognised players in IS, with ~10% global market share. Sulfuric Acid and Oleum are its other products. Duncan Engineering Ltd (DEL; erstwhile Schrader Duncan Ltd), its subsidiary, is engaged in the manufacturing of pneumatic products such as hydraulic and pneumatic cylinders, pneumatic valves and accessories.

Investment Rationale

Strong q-o-q recovery in sales with gradual uptick in automobile industry

* During Q3FY21, OCCL’s topline from chemicals business reported a ~29.6% y-o-y growth to Rs 1,168.7 mn led by strong revival of replacement demand of tyres, particularly driven by factors like pent-up demand, shift towards personal mobility trends, positive rural economy and increasing vehicle utilization trends. Restrictions of import of tyres, higher demand from road construction, mining and e-commerce have further propelled demand. This has led to more than 90% capacity utilisation of IS plants, at both the locations, during the quarter. Domestic tyre companies are operating at optimum levels and management highlighted that buoyancy in tyre demand is expected to continue going forward. With expected strong revival in commercial vehicle demand resulting in higher tonnage growth for tyre players, demand for IS looks promising.

* ~93-94% of OCCL’s standalone revenues are contributed by chemicals business. It reported 12.3% decline in standalone revenue at Rs 2,553.9 mn during 9MFY21 on the back of subdued Q1FY21. DEL witnessed a topline growth of 19% at Rs 119.6 mn.

* We have factored in a ~4% dip in FY21E topline on the back of subdued Q1FY21 and expect sustained recovery going forward with the rise in replacement and OEM demand for tyres, both in domestic and international markets. Going forward, we expect OCCL net sales to grow at ~27% and ~11% to ~Rs 4.7 bn and ~Rs 5.3 bn during FY22E and FY23E respectively.

EBIDTA margins set to stabilize ~30%

* During Q3FY21, consolidated EBIDTA margins increased significantly by 830 bps to ~35% due to optimum capacity utilisation, reduction in raw material prices (RMP) and other operating efficiencies achieved due to prudent cost control measures undertaken by the Company. However, RMP has started hardening significantly during Q4FY21 which is expected to continue in Q1FY22 as well. The Company witnessed EBIDTA margin of ~31% during 9MFY21 inspite of subdued performance in Q1FY21. PAT margins during the quarter increased significantly from 18.2% in Q3FY20 to 24.8%, led by increase in operating margin. Interest cost decreased by ~43% to Rs 13.7 mn.

* We expect OCCL’s (standalone) capacity utilization to touch ~73% by FY23E, on its capacity of 45,000 MTPA and EBIDTA margins stabilizing at ~31.5% by FY23E. This is due to better economies of scale, post commissioning of 11,000 MTPA of IS capacity

Planned capex of Rs 2.16 bn - to increase IS capacity by 11,000 MTPA

* OCCL is incrementally enjoying a favourable market positioning as the ‘Second Alternate Supplier’ in global markets, particularly in the West. The Company is increasing it’s IS and Sulfuric Acid capacity by 11,000 MTPA and 42,000 MTPA respectively at Dharuhera. The total capex is estimated at ~Rs 2.16 bn, of which IS expansion is estimated at ~Rs 1.83 bn, funded through a mix of debt and internal accruals of 2:1. IS expansion comprises two equal phases of 5,500 MTPA each.

* With COVID outbreak, Phase-I has been delayed due to suspension of civil work and labour availability issues faced by the Company. With this delay, Phase-I capacity of IS and the entire capacity of Sulphuric Acid is expected to get commissioned in July 2021 (earlier expected by the end of Q1FY22). The Company will undertake Phase-II expansion, after commissioning of Phase-I, depending on automotive market conditions.

Valuation

* OCCL is one of the only three globally recognized IS players. However, a semblance of competition is emerging from China. With the revival of the automotive segment, we expect OCCL to emerge as a strong player with its focus to enhance its footprint across all domestic and global consumers and remain in a strong position to capture higher market share with its new incremental capacities. OCCL is consistently delivering in-line with the highest global standards.

* We have valued OCCL on PE basis, assigning a multiple of 15x to FY23E EPS of Rs 99.1, lowering it down from 17x earlier on the back of intensifying competition. We maintain ‘Buy’ on the stock with the target price of Rs 1,487/- (~56%) in 18 months.

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