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Company Background

Oriental Carbon & Chemicals Ltd (Oriental Carbon), 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 39,500 MTPA of IS at its plants at Dharuhera, Haryana and Mundra, Gujarat. Not only Oriental Carbon is India`s only producer of IS where it commands a ~60% domestic market share, it is amongst the only few 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

Slowdown in domestic and international demand impacted topline

* During Q1FY23, Oriental Carbons sales from chemicals business reported a ~63% yo-y growth at Rs 1,363.5 mn on account of high volumes and better realisation. The Company witnessed moderately stable demand from both international and domestic markets, inspite of high inflation and supply chain disruptions. ~89% of the Companys consolidated revenues are contributed by the chemicals business.

* With completion of phase-I capacity expansion, the management is confident of gaining new orders and increasing wallet share from new prospective clients. Oriental Carbon is continuously striving to increase its penetration in US market. North America continues to remain its key market and its endeavour is to increase market share to 10% in next 3 years. Management highlighted that overall demand for commercial vehicles is expected to remain favourable supported by accelerated economic activities. Automotive and tyre demand shall improve with the expected moderation in inflationary pressures and gradual improvement in geopolitical sentiments, thereby creating demand for Insoluble Sulphur.

* The Company is well positioned for growth in coming years. We have built in revenue growth of ~44%, and ~12% for FY23E and FY24E respectively keeping in view the Company’s robust track record and expectations of rise in demand pickup post normalization of business conditions.

Standalone EBIDTA margins set to stabilize ~28%

* During Q1FY23, consolidated EBIDTA margins decreased by 310 bps y-o-y to 19.5% at Rs 297.7 mn. However, it witnessed a significant increase q-o-q by 410 bps on the back of a price hike taken by the Company due to a continuous rise in RM prices during the quarter. Further, from July onwards, Oriental Carbon is witnessing correction in sulphur prices which is expected to get stabilised, going forward. The Company has also witnessed correction in freight rates during Q2FY23. The management is focused on improving its operational efficiencies and is taking every step to control costs. Usually, cost increase is passed with a lag of 3-6 months.

* We expect Oriental Carbons standalone CU to reach ~77% on its capacity of 45,000 MTPA. We remain cautiously optimistic while estimating margins for FY23E and FY24E as geopolitical scenario remains extremely volatile with large fluctuations in international crude prices and currency, and remain hopeful of normalcy in margins returning back to ~28% by FY24E, with the gradual improvement in business scenario.

Proposed demerger of Chemicals business

* In order to address investors concerns related to investments of late, the management has approved the scheme of arrangement for demerger of chemical business, which includes insoluble sulphur, acid and oleum business, into a separate company named OCCL Ltd (resulting company). OCCL Ltd will exclusively focus on chemical business, while Oriental Carbon (the demerged company) will continue to be in the business of investments (including DEL) and intents to initiate trading business such as commodity trading etc.

* Upon the scheme becoming effective, subject to approval of requisite regulatory authorities, the existing shareholders will get 5 shares of Rs 2/- paid-up of OCCL Ltd for every 1 share of Rs 10 paid up of Oriental Carbon.

* Thus, demerger will enhance management approach for pursuing revenue growth, expansion opportunities in the respective business verticals and will also provide better flexibility in accessing capital & attract business specific partners/investors.

* The demerger process is progressing smoothly as per the timeline.

Valuation

Oriental Carbon is one of the only few globally recognized IS players. However, a semblance of competition is emerging from China. With the revival of the automotive segment, we expect the Company 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 and demerger of the chemical business. We have valued Oriental Carbon on PE basis, assigning a multiple of 11x to FY24E EPS of Rs 111.5. We maintain „Buy on the stock with the target price of Rs 1,227/- (~38%) in 18 months.

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