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Company Background & Product Highlights

Phillips Carbon Black Limited (PCBL), incorporated in 1960 in collaboration with Phillips Petroleum Company, is a part of RP-Sanjiv Goenka Group. It is the largest manufacturer of carbon black (CB) in India (~10% market share in Asia-ex China) and seventh largest in the world, having an aggregate installed capacity of 6,03,000 MTPA and co-generation power capacity of 84 MW spread over four locations viz. Durgapur (W.B.), Palej and Mundra (Gujarat), and Kochi (Kerala). CB is used as a reinforcement material providing tensile strength to tyres and other industrial rubber goods and forms 23% by volume of tyre weight and 10% by value of tyre cost.

Investment Rationale

Steady performance amidst lockdown restrictions

* During Q1FY22, PCBL net sales increased by a whopping 179.2% y-o-y (lower base) and 15.8% q-o-q to Rs 10,038.5 mn, on account of better CB volumes and higher realization led by higher crude prices. The Company reported a steady performance despite domestic demand taking a short term blip due to regional lockdowns, which encouraged management to increase volumes in export markets. Domestic sales volume increased by 122.7% y-o-y, while it declined by 11.4% q-o-q at 73,074 MT. Export sales volume increased by 96.4% yo-y and 19.2% q-o-q to 36,350 MT. During the quarter, CB realizations increased by ~32.3% y-o-y and 20.2% q-o-q to Rs 90,274/tonne mainly on account of higher crude prices. With enhanced demand for packaging material and engineered plastic goods, sales volume of specialty grade CB (SCB) stood at 7,283 MT in Q1FY22. For FY21, SCB sales volume stood at 23,969 MT. During the quarter, PCBL continued to expand its product portfolio of high-performance high-margin grades for both rubber and specialty black applications.

* Management highlighted that Company is witnessing robust recovery in demand from tyre manufacturers post easing of regional lockdown restrictions and CB industry in general and PCBL in particular is expected to benefit from the completion of a strong capex being undertaken by the domestic tyre industry. Further, with expected strong revival in commercial vehicle demand, resulting in higher tonnage growth for tyre players, CB demand looks promising. We believe PCBL will clock CB sales volume of 4,50,000 MT and 4,95,000 MT during FY22E and FY23E against 3,89,261 reported in FY21. Realisation is also likely to remain firm on account of higher crude prices. However, our estimates are contingent upon future uncertainties of COVID-19 disruptions, which might impact our forecasts.

Timely capex for capacity addition to propel growth and lend visibility

* During FY21, PCBL enhanced its SCB capacity by 32,000 MTPA to 72,000 MTPA at an investment of Rs 2.3 bn, resulting in further strengthening of high margin SCB portfolio (EBITDA/tonne for specialty black is 3-5x of rubber black). The Company also planned to increase its power capacity by 23 MW, of which 8 MW capacity at Mundra, Gujarat was commissioned during the quarter. Remaining 7 MW capacities each at Palej and Kochi are expected to be commissioned over next few quarters.

* PCBL(TN) Ltd, a wholly owned subsidiary of PCBL has been incorporated for implementing the greenfield project of 1,50,000 MTPA of CB and 25 MW of CPP over 60 acres of land in Tamil Nadu at a total investment of ~Rs 6 bn. The plant is expected to be commissioned by 2023, benefits of which will start reaping from FY24E onwards. As of now the project is progressing well with land under possession and lease agreements fully executed.

EBITDA/tn to stable at ~15,750/tn by FY23E

During Q1FY22, PCBL reported EBITDA/tn to Rs 14,404/tn vs. Rs 7,425/tn reported in Q1FY21 owing to higher CB volumes and better operational efficiencies. However, EBITDA/tn declined by Rs 1,521/tn on a q-o-q basis. While during the quarter, the Company swiftly moved to increase volumes in the export markets to optimize CU, the same impacted margins on account of higher freight rates on spot contracts. EBITDA margins improved by 510 bps y-o-y while declined by 506 bps q-o-q to 15.7%. Going forward, brownfield nature of expansion will kick in; operating leverage benefits coupled with increasing share of SCB are expected to lead to EBITDA/tn of ~Rs 15,750/tn by FY23E.

Deleveraging balance sheet and focus on rewarding shareholders

PCBL accumulated substantial debt with peak debt at Rs 12.2 bn in FY15 due to declining profitability and an elongated working capital cycle. In FY21, debt stands at ~Rs 5.5 bn. Going forward, with strong operational performance and consequent cash flow generation, we expect leverage (debt-equity) to further improve to 0.2x by FY23E.

Valuation

PCBL is on a strong footing led by buoyancy in tyre demand coupled with operating leverage benefits and strong cash flow generation. We have valued the stock on the basis of P/E - method of relative valuation - of 11x of FY23E earnings of Rs 28.7/share, upgrading it from 10x on account of buoyancy in automobile demand and recommend a “BUY” with a target price of Rs 315 (upside of 27%) in 18 months.

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