Buy SRF Ltd For Target Rs.3,540 by Motilal Oswal Financial Services Ltd
Outlook improves for the Chemicals business
Operating performance above our estimates
* SRF posted a decent overall performance in 3QFY25. However, the Chemicals business and the Packaging Films business displayed material improvement during the quarter. Margins for the Chemicals business improved 120bp/ 620bp YoY/QoQ, while the same for the Packaging Films business improved 240bp/70bp YoY/QoQ.
* The overall macro scenario is showing some signs of revival for the Chemicals business (67% EBIT mix in FY25E), coupled with management’s expectation of strong sequential growth in 4QFY25 with further improvement from FY26. This will be led by a healthy launch pipeline and demand recovery in specialty chemicals, a ramp-up of exports/domestic volumes in the Fluorochemicals business and pricing improvement in the overall chemicals business.
* Factoring in the improving macro scenario and healthy near-term outlook in the Chemicals business, we raise our FY25/FY26/FY27E EBITDA by 4%/5%/ 10%.
* We earlier downgraded the stock following its 4QFY21 results, anticipating a slowdown in overall business momentum. SRF has underperformed the overall indices during the last three years (SRF’s share price CAGR has been 3.6% vs. Nifty/Sensex CAGRs of ~10.2%/10.6%). However, considering the healthy business outlook across segments, we upgrade SRF to BUY (from Neutral) valuing the stock on an SoTP basis to arrive at our TP of INR3,540.
Margin improvements in Chemicals and Packaging drive performance
* SRF reported an overall revenue of INR34.9b (in line) in 3QFY25, up ~14% YoY. EBITDA margins contracted 40bp YoY to 18.7% (est. of 17.1%). EBITDA stood at INR6.5b (est. of INR6.1b), down 12% YoY. Adj. PAT grew 12% YoY to INR3.1b (est. of INR2.6b), adjusted for a forex loss of INR342m in 3QFY25.
* Chemicals' revenue (43%/69% of total sales/EBIT in 3QFY25) grew 7% YoY to INR15b, while EBIT grew YoY to INR3.6b. EBIT margin expanded 120bp YoY to 24.3%. The Specialty Chemicals business saw a gradual increase in demand, and the Fluorochemicals business gained strong OEM support for refrigerants domestically, while the Chloromethanes segment remained stable.
* Packaging Film's revenue (40%/17% of total sales/EBIT in 3QFY25) grew 27% YoY to INR13.8b, while EBIT grew 2x YoY to INR904m. Margin expanded 240bp YoY to 6.5%. The Packaging Films business reported healthy growth, with SRF maintaining a strong industry position. However, Aluminum Foil margins faced pressure due to lower-cost imports from China and Thailand.
* Technical Textiles' revenue (15%/11% of total sales/EBIT in 3QFY25) grew 11% YoY to INR5b. EBIT declined 14% YoY to INR589m. EBIT margin contracted 350bp YoY to 11.6%. The Technical Textiles business underperformed due to weak demand and margins in Belting Fabrics, while the Polyester Industrial Yarn segment achieved full capacity utilization.
Highlights from the management commentary
* The Chemicals business is witnessing a revival with further recovery in 4QFY25. The company is expecting strong growth in Specialty chemicals led by healthy launch pipelines of Active Ingredients (AIs). Further, the PTFE segment is likely to see positive traction from FY26. In HFCs, SRF is seeing price improvements both in domestic and global markets that are likely to improve further.
* The Packaging business faces a demand-supply imbalance in BOPET (which is softening now), while BOPP margins may decline. Hungary is expected to benefit from increased sales and lower energy costs. The aluminum foil is likely to contribute positively in FY26E.
* Capex: For FY25 the company has plans to incur a capex of ~INR15b, and going forward on future projects, the capex will be in the range of ~INR15b-20b.
Valuation and view
* The Chemicals business (Fluorochemicals and Specialty Chemicals) has started witnessing recovery and is expected to further improve (CAGR ~29% over FY25- 27E). The Specialty Chemicals segment is seeing demand recovery, pricing improvement, and a better product pipeline (3-4 AIs were registered), while the Fluorochemicals business is showing strong traction in the domestic market, with ramp-up of export volumes and growth in PTFE.
* Improving the business scenario of the Chemicals business is also expected to drive up the margins led by operating leverage, a higher mix of VAP, and improving realization. EBIT margin is expected to recover to ~27%/28.5% by FY26/FY27 from 23% in FY25.
* The packaging business has also shown improvement (Demand-supply imbalance to continue in BOPET, albeit softening), while the Technical Textiles business is likely to continue the current growth momentum. We expect packaging/technical textile business revenue CAGR to be ~14%/8% over FY25- 27E. Packaging margins are expected to improve to 9%/12% in FY26E/FY27E vs. 6.5% in FY25E led by a higher VAP mix, while Technical textile margins too will see some improvement to 16%/17% vs. ~13% in FY25E respectively.
* We earlier downgraded the stock following its 4QFY21 results, anticipating a slowdown in overall business momentum. SRF has underperformed the overall indices during the last three years (SRF’s share price CAGR has been 3.6% vs. Nifty/Sensex CAGRs of ~10.2%/10.6%). However, considering the healthy business outlook across segments, we build in revenue/EBITDA/Adj. PAT CAGR of 20%/36%/53% over FY25-27E.
* We upgrade SRF to BUY from Neutral, valuing the stock on an SoTP basis to arrive at our TP of INR3,540.
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