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Sudarshan Chemical Industries’ (SCIL) Q4FY23 print showed early signs of demand revival across categories. SCIL sees tailwinds from recovery in demand; it is receiving good response for its new products, which are niche chemistries; ramp up in new capacity to provide pigment segment revenue visibility of Rs30-33bn and softening raw material prices will help normalise margins. SCIL has already started its margin-recovery journey, and expects further improvement in next few quarters as inflation in other expenses drop. We believe the company has remarkably worked on improving its balance sheet which will benefit from proceeds of land sales (Rs3.6bn) and stable net working capital at 20% of sales (down from 24-25%). We expect net debt / EBITDA to dip to ~1x by FY24. We have raised our adjusted EPS estimates by 4- 14% over FY24-25, and accordingly, increased target price to Rs550 (from Rs405), valuing the company at 18x FY25E EPS (prior: 15x). We upgrade the stock to BUY (from Add). Key risks: Major softness in demand, and slower margin recovery.

Pigment revenue rose 6.3% YoY (22.8% QoQ). Revenue from pigment business stood at Rs5.9bn on increased demand across geographies and categories of plastics and coatings. Domestic pigment sales were up 4.9% YoY (up 19.9% QoQ) to Rs3bn. Export revenue rose 7.7% YoY (26.3% QoQ) to Rs2.9bn. The company benefited from reduced competitive intensity from China; however, it continues to be hurt from anti- dumping duty on India phthalocyanine by China. SCIL expects gradual recovery in sales with the commissioning of entire capex, and expansion of new product portfolio. It has now expanded presence in niche chemistries with colors such as yellow, violet etc. It anticipates to reach total pigment sale of Rs30-33bn in next three years.

* Margin recovery kickstarts; enough tailwinds for improvement. SCIL’s gross profit margin rose 120bps QoQ to 42% on softening raw material prices. It expects margin recovery to continue for pigment segment where margin in Q4FY23 stood at 41.2% vs 43.5% in FY22 driven by softening raw-material cost. EBITDA dipped 1.3% YoY to Rs847mn (up 2x QoQ) and EBITDA margin improved by only 440bps QoQ to 12.3% as other expenses rose 25.6% YoY due to forex losses, new plants commissioning cost, higher coal cost and rise in travel and exhibitions. The company expects inflation to reduce significantly in FY24. Net profit dipped 27% YoY to Rs326mn in Q4FY23.

* Other highlights. 1) SCIL has sold its Pune land for Rs3.6bn. The proceeds will be used to reduce debt; 2) company has commissioned the entire capex planned in FY23 with new product lines and new chemistries majorly in specialty pigments; 3) it does not expect incremental impact from China and it has been equally competitive in specialty; 4) it sees significant tailwind for business from industry consolidation, preference for India-based producers, falling raw-material prices, and company preparedness with wide range of products, and capacities; 5) net working capital is 20% of total assets (down from 24-25%) which it expects to remain stable; 6) net debt was Rs8bn in FY23 and SCIL expects to drop net debt below Rs5bn in FY24 from land proceeds and strong FCF generation; and 7) FY24 capex will be largely for maintenance.

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