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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 carbon black in Asia-ex China) and seventh largest in the world, having an aggregate installed capacity of 5,71,000 MTPA and cogeneration power capacity of 76 MW spread over four locations viz. Durgapur (W.B.), Palej & Mundra (Gujarat), and Kochi (Kerala). CB is used as a reinforcement material providing tensile strength to tyre and other industrial rubber goods and forms 23% by volume of tyre weight and 10% by value of tyre cost.

Investment Rationale

Buoyancy in tyre demand & shift towards personal mobility resulted in better volumes

* During Q3FY21, PCBL net sales remained flat y-o-y at Rs 7,694 mn, on account of lower realization due to lower raw material (RM) mainly crude prices. The Company witnessed encouraging demand pickup during the quarter reflected by ~16.2% y-o-y growth in sales volume. Domestic sales volume was at 84,819 MT, witnessing a robust growth of ~19.5% yo-y. Export sales volume also increased by ~7.7% y-o-y to 29,706 MT. During the quarter, CB realizations softened by ~13.8% y-o-y but increased ~12.2% q-o-q to Rs 65,443/tonne mainly on account of lower crude prices. With enhanced demand for packaging material and engineered plastic goods, sales volume of specialty grade CB (SCB) stood at 7,185 MT in Q3FY21 against 5,337 MT in Q2FY21.

* Management highlighted that domestic tyre sector did relatively better due to buoyancy in tyre demand and shift towards personal mobility which is expected to continue going forward. Domestic tyre companies are operating at optimum levels. With expected strong revival in commercial vehicle demand resulting in higher tonnage growth for tyre players, CB demand looks promising. We have upgraded PCBL sales volumes compared to our earlier estimates (~3,90,000 MT against ~3,70,000 MT in Q2FY21) and have now built in a ~18% decline in FY21E top-line mainly on account of muted realisations. 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

* PCBL recently undertook a de-bottlenecking exercise wherein it converted its 30,000 MTPA of CB capacity into SCB capacity, resulting in reduction of its overall capacity by 14,000 MTPA. This has strengthened its higher margin SCB portfolio (EBITDA/tonne for specialty black is 3-5x that for rubber black.) It is also undertaking a brownfield expansion at an investment of Rs 2.3 bn, which will increase SCB capacity by 32,000 MTPA; of which 12,000 MTPA capacity was commissioned in Q3FY21. Remaining 20,000 MTPA capacity is expected to commission by FY21 end. Also, the Company has planned to increase its power capacity by 22 MW which will commission between FY21-22E.

* 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.

Margins to remain stable at ~19%

* During Q3FY21, PCBL reported higher EBITDA/tonne to Rs 16,203/tonne vs. Rs 9,482/tonne reported in Q2FY21 owing to lower RM prices. EBITDA margins improved by 883 bps y-o-y to 24.1%. Going forward, impact of lower RM prices will help in operating margin and working capital situation. Though EBITDA/tonne reported in Q3FY21 is not sustainable.

* Going forward, brownfield nature of expansion will kick in; operating leverage benefits coupled with increasing share of speciality grade CB are expected to lead to EBITDA/tonne of ~Rs 13,750/tonne 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 FY20, 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 in FY23E. The Company has a vision to become debt free in next few years.

Valuation

* PCBL is on a strong footing led by buoyancy in tyre demand coupled with operating leverage benefits and strong cash flow generation. Going forward, we have valued the stock on the basis of P/E - method of relative valuation - of 10x of FY23E earnings of Rs 24.3/share upgrading it from 9x on back of robust tyre demand and recommend a “BUY” on the stock with a target price of Rs 243 (upside of 28%) in 18 months.

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