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Gross margin guidance revised down; revenue potential intact

* Vinati Organics (VO) reported mixed results, with revenue above our estimate (+20%), while EBITDA came in below our estimate (-8%). The gross margin shrank to 45% – the lowest since 3QFY15. The resultant EBITDA margin stood at 26.3% (v/s our est. of 34.3% and 35.4% in 4QFY21).

* Higher freight costs (by INR100m), along with an increase in Phenol and Acrylonitrile prices, impacted margins. Freight costs were the highest for the US and Europe – they are likely to remain at similar levels for the next few quarters as well. VO is in talks with customers to share the cost increase.

* On these lines, the management has revised down its gross margin guidance to 45–50%, with EBITDA margin normalization at 32–33% going forward (unchanged). Higher efficiencies, led by a ramp-up, would lower operating costs and aid EBITDA margins.

* Factoring in the same, we lower our FY22E/FY23E/FY24E EBITDA and EPS by 15%/11%/5%, with the EBITDA margin at 29%/31%/32% (from 36%/35%/34%). We build in margin improvement hereafter as (a) the pressure of commodity price inflation fades over next 2–3 quarters and (b) Veeral Additives comes on-stream (expected in 4QFY22) – which would consume 50% of Butyl Phenol internally.

* That said, gradual ramp-up in expanded capacity over the next three years would drive huge growth for VO, with further development on the product molecules currently under R&D. With new products such as AO and Butyl Phenol resulting in higher import substitution, we forecast a revenue CAGR of ~38% over FY21–24E (unchanged), translating to an EBITDA and EPS CAGR of 31–32% over this period. Valuing the stock at 43x Sep’23E EPS, we arrive at TP of INR2,220. Maintain Buy.

Lowest gross margin in five years

* Revenue was higher than estimated at INR3.9b (+67% YoY).

* EBITDA came in at INR1b (+4% YoY), with PAT at INR0.8b (+12% YoY).

* Other income includes INR24m in interest income accrued on the loan advance to Veeral Additives. Post the amalgamation, interest income on the loan would be eliminated and 1QFY22 numbers will be restated accordingly.

1QFY22 segmental snapshot and FY22 guidance

* ATBS recorded the highest ever sales in 1QFY22 (up 20–25% YoY); pent-up demand from the Oil & Gas sector would continue this year.

* Butyl Phenol sales are expected at INR1.6–2b in FY22 (~INR400m done in the quarter). Current margins for Butyl Phenol are at their lowest (as phenol prices have risen, while product prices are still down – keeping margins low).

* IBB saw subdued demand in 1QFY22 and is expected to report single-digit overall growth in FY22 as well.

* Isobutylene and other product demand remains strong (revenue mix in 1QFY22 – ATBS: ~50%, IBB: ~15%, and others: ~35%).

Valuation and view – maintain Buy

* The company is in the process of amalgamating VAL with VO, which would produce AOs from Butyl Phenol, thus resulting in further forward integration. VO would become the largest and only doubly integrated manufacturer of AOs. AOs are right now imported into the country, and the domestic market is seeing huge demand for PP, LLDPE, etc. (which would grow at 8% YoY). Management expects AOs to contribute ~25% to total sales 2–3 years down the line.

* Capex over the next three years is projected at ~INR3b. Despite the stated capex, we expect FCF generation of ~INR10.5b over FY22–24E.

* While the massive floods in Mahad have impacted operations (the plant is expected to be closed for 22–25 days), VO has sufficient stock available.

* The stock is trading at 43x FY23E EPS and 31x FY23E EV/EBITDA, with attractive return ratios of 24–25% (+600bps v/s FY21). It has a fixed asset turnover of 1.3x, which is likely to double over the next three years. Maintain Buy.

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