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Carbon black on the cusp of an upcycle?

PCBL’s Q4FY22 EBITDA disappointed on higher other expenses, but gross profit/kg improved QoQ which is good. PCBL’s management sounded bullish on the carbon black cycle with favourable demand supply, and anticipates an upside risk to both volumes and spreads in the coming period. It sees 10ktpa incremental volumes in specialty; post Chennai plant commissioning, it anticipates overall incremental volume growth of >50ktpa. It also sees the possibility of an upside risk to spreads for carbon black in exports market with supply restriction from Russia and China. The company expects more specialty product launches, and likely another line addition with 20ktpa capacity soon. We expect it to announce more capacity expansion in rubber carbon black if demand from exports markets sustains, which should increase volume growth visibility. We have increased our EPS estimates by 10-15% over FY23- 24E on better volumes and spreads assumptions. Accordingly, we have increased our target price to Rs170 (from Rs147; unchanged 12x FY24E EPS). Maintain BUY. Downside risk: Crude price rising significantly from current price of ~U$100/barrel.

Early signs of an upcycle in carbon black. 1) Russia and China, the two key exporting countries, are seeing supply constraints. Russia has 1.1mnte capacity with 70% exports to Europe, and is hit by sanctions. China is seeing feedstock restriction and industry consolidation; 2) demand looks steady and is normalising. Thus, PCBL anticipates a favourable demand-supply situation; 3) it is looking at faster ramp-up of new capacity, and more line commissioning / announcement in specialty; and 4) early signs of spread improvement, particularly in exports market.

Carbon black volumes flattish YoY but down 3.6% QoQ at 112.5kte. PCBL’s volume growth is restricted due to peak capacity utilisation, and QoQ dip is from two lower working days in Q4FY22. It is in the process to commercialise greenfield capex in Chennai with 150ktpa carbon black plant likely to start production from Dec’22. India volumes dipped 6.7% YoY to 77kte on weak demand; company sold higher export volumes, which grew 16.2% YoY to 35kte. Specialty volume growth has accelerated at 22.7% YoY to 9.3kte, and has now contributed 8.3% of total volumes. PCBL is seeing rising demand particularly from exports market, as Russia supply is hit from sanctions and China situation.

Gross profit/kg dips 10.7% YoY / up 3.3% QoQ to Rs28. Gross profit/kg was hurt from delay in pass-through of feedstock inflation, and lower contribution from power (power production dipped QoQ on two lower days). Rising and sticky high crude prices are a concern for the company. However, it is seeing silver lining for improvement in spreads from tightening supply on Russia and China situation and demand normalisation. It would also benefit from rising contribution of specialty carbon black and power (due to higher realisation and volume growth with new capacity addition).

Cost inflation hit EBITDA, which dipped 27.9% YoY to Rs1.3bn. Revenue grew 40% YoY led by higher realisation which rose 41.2% YoY to Rs106/kg. Gross profit dipped 11.1% YoY to Rs3.15bn on contraction in spreads. Employee cost rose 20.7% YoY on investment in R&D personnel and annual hikes. Other expenses were up 4% YoY on higher freight cost, and QoQ increase is for CSR / other annual adjustment. Net profit was down 30.7% YoY to Rs883mn.

Earnings call highlights. 1) Chennai plant will be commissioned by Dec’22 with capacity of 150ktpa. The plant commission should help drive volume growth; 2) PCBL plans to add 40ktpa in specialty, and is in the process of announcing additional 20ktpa soon with new product launches; 3) pass-through in input inflation should help spreads in coming quarters; 4) power realisation should also improve with renewal of contracts; 5) company anticipates 10ktpa incremental specialty volumes sales, and post Chennai plant commissioning, overall volume addition should cross 50ktpa; 6) it believes ramp-up in Chennai plant could be faster than earlier anticipated of three years; 7) tax rate may remain at 20-21%; 8) specialty volumes are 70% exported; and 9) capex of Rs10bn for FY23/24E, and sees an upside risk from the likely advancing of capacity expansion.

Change in estimates. We have slightly increased volume off-take on favourable market, and revenues have mainly benefited from higher realisation on sticky and high feedstock. Our gross profit/kg assumption has seen an uptick from likely better spreads, and higher contribution of specialty volumes. Our EBITDA assumption has seen an uptick of 8.5% / 12.7% for FY23E / FY24E, and EPS increase by 10.2% / 15.2%, respectively.

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