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Rising like a Phoenix!

*  “They will rise from the ashes, but the burning comes first. For this part, they must be brave.” ATLP has burned for three long years (FY22-24) and it is a classic case of valuations perched higher despite a significant decline in earnings. During FY22/FY23/ FY24, EBITDA declined 1%/15%/18% YoY and earnings declined 9%/15%/39% YoY. Margin contracted sharply by 11.1pp from the high of 24.6% in FY21. Weak demand in end-user markets and significant pricing pressure amid Chinese supplies were the main reasons for this downfall during FY22-24. Accordingly, the stock price tanked ~48% (in absolute terms, as of May’24) from its peak in Oct’21.

*  During this time, the management has been berated on multiple occasions by the investor community on capital misallocation for setting up commodity chemical capacities instead of specialty ones after it generated a record amount of FCF (INR9b) during FY20-21. However, the management has reiterated several times that these are sound investments and will be beneficial for the overall business.

*  That said, with the capex cycle (INR19.7b during FY22-24) almost over and teething problems in some capacities put to rest, we believe that ATLP is ready to make a comeback in the next 2-3 years, glimpses of which we have seen in 1QFY25 earnings. Investments are set to be supported by a gradual recovery in the sub segments that ATLP operates in and the management’s efforts to expand its capacities for key products and for debottlenecking the existing ones. We upgrade our rating to BUY.

Getting better with cyclical recovery kicking in

*  The Life Science Chemicals segment was affected (negative CAGR of 13% during FY22-24) by a double whammy of demand weakness and price erosion due to a glut from Chinese supplies leading to pricing pressure. It is recovering gradually, with crop protection segment (domestic business is 53% out of which 56% is retail business, see exhibit 9) supporting the sequential uptick as seen in the 1QFY25 earnings. During Jun-Jul’24 to date, the country has seen a rainfall surplus of ~2%, which bodes well for the domestic agrochem industry. The Indian pharma market (IPM) recorded decent growth YoY in the previous three months, while the aromatics segment is being supported by the Personal and Fragrance industry.

*  n the Performance & Other Chemicals segment, bulk chemicals, colors and polymers witnessed a negative CAGR of 10%, 17% and 4%, respectively, during FY22-24 as global capacities resumed and supply chain constraints eased across the world in the post-Covid recovery. There was a downturn in commodity prices as well after the peak prices seen during the supply chain disruption. Currently, we are seeing a good demand recovery on the discretionary side of the portfolio and the commodity cycle is turning positive with prices largely bottoming out for most players in the industry. Backward integration into Caustic Soda would help ATLP become a fully integrated player in the subsegments of bulk chemicals and intermediates.

*  The capex cycle is almost over for the company and the unrealized sales potential currently stands at INR17.1b from existing capacities. Incremental sales of INR8b could be contributed by various projects at different stages of commissioning currently. Total revenue potential stands at INR72.4b currently (FY24 revenue at INR47.3b).

Sub-segments offer opportunity for rapid growth

*  During Jun-Jul’24 to date, the country has seen a rainfall surplus of ~2% (24% for South Peninsula and 12% for Central India). North West India and East & North East India has accounted for 16%/14% deficit of rainfall in the country during the same period. This bodes well for domestic agrochem companies and should result in a strong recovery in the sector this year. UPL, in its 4QFY24 concall, indicated that demand was gradually improving and could normalize in 2HFY25. Sharda Cropchem in its 1QFY25 call noted that prices in the agrochemicals segment would improve gradually.

*  IPM grew 6.7% YoY in Jun’24 (vs. 9.8% in May’24 and 5.3% in Jun’23). For the 12 months ending in Jun’24, IPM grew 7.6% YoY. Growth was led by pricing/new launches, which contributed 4.2% YoY/2.9% YoY to overall growth. This comes on the back of strong growth in May’24 and Jun’24. Dapsone (50% market share of ATLP) is used to treat various medical issues, primarily leprosy, a persistent bacterial infection of the skin and nerves.

*  India produced a higher number of cars in 4QFY24 and ATLP management is confident that all the products sold to the tyre industry have a bright outlook. As per Grasim, international average caustic soda prices remained range-bound in 4QFY24 at USD451/mt and they appear to have bottomed as the rates have gradually improved during the latter part of FY24. As per a recent news article, caustic soda prices have surged in Jul’24 as Hurricane Beryl disrupts supply chains.

*  Destocking position has come to an end and a gradual recovery is visible. Prices have bottomed out completely in the dyestuff industry. Recently, Heubach GmBH also filed for insolvency, which could prove beneficial for ATLP. The polymer market expanded 8-10% YoY in 1QFY25 and is expected to grow more than 10% YoY in 2QFY25. Reliance Industries has also indicated that demand for Polymer and Polyester remains strong amid robust economic activities. Polymer deltas have been improving due to better realization amid stable demand.

Faster-than-anticipated recovery led to strong 1QFY25

*  ATLP reported higher revenue than our estimate in 1QFY25, with a 21% QoQ growth in the life science chemicals segment and a 7% rise in the performance & other chemicals segment. Gross margin came in at 50%, while EBITDAM expanded 150bp YoY to 16.9%.

*  he Life Science Chemicals segment’s contribution to EBIT expanded to 44% in 1QFY25 (from 37% in 1QFY24), whereas the contribution of Performance & Other Chemicals declined to 53% in 1QFY25 (from 62% in 1QFY24). Life Science EBIT margin expanded 180bp YoY to 16.8%, while that of Performance and Other Chemicals declined 110bp YoY to 9.1% in 1QFY25.

*  The management highlighted that all the capex programs completed in the previous few years have an unrealized sales potential of INR11b for the standalone business and INR6.1b for subsidiaries. The peak revenue potential from the new capex programs that are at various stages of implementation is INR8b. The total revenue potential for ATLP (consolidated) stands at INR72.4b in the next 2-3 years (see exhibit 2).

*  Due to the outperformance in 1QFY25 and a sustained recovery in sight, we raise our EBITDA/EPS estimates by 22%/37% for FY25 and 29%/32% for FY26. We also introduce FY27 estimates in our model and estimate a CAGR of 13%/28%/38% in revenue/ EBITDA/PAT during FY24-27.

Valuation and view

*  End-user market demand has picked up and we believe that overall demand will also pick up in 2HFY25. The company is undertaking various projects and initiatives aimed at improving plant efficiencies, expanding its capacities for key products, debottlenecking its existing capacities, capturing a higher market share and expanding its international presence.

*  ATLP is set to commission its liquid Epoxy resins plant of 50ktpa capacity in FY25 (revenue potential of INR8b). Its Caustic Soda plant (300tpd) also faced teething issues in Dec’23, which were largely resolved in 1QFY25. Anaven (Monochloro Acetic acid) is also expected to ramp up its plant for optimum utilization due to better offtake in FY25.

*  The stock is trading at 35x FY26E EPS of INR214 and 20x FY26E EV/EBITDA. We value the stock at 40x Jun’26E EPS (discount of 11% to five-year average of 45x) to arrive at our TP of INR9,100. We upgrade our rating to BUY on ATLP. The upside risk could be a faster-than-expected ramp-up of new projects and products. Downside risks include weaker-than-expected revenue growth and margin compression amid further delays in the commissioning of new projects.

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