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CD Equisearch Pvt Ltd Jan 22, 2015

Equities Derivatives Commodities Distribution of Mutual Funds Distribution of Life Insurance

Aarti Industries Ltd (AIL)

No. of shares (crore) 8.9

Mkt cap (Rs crs) 2419

Current price (21/1/15) 273

Price target (Rs) 355

52 week H/L (Rs.) 320/87

Book Value (Rs.) 96

P/BV (FY15e/16e) 2.5/2.1

P/E (FY15e /16e) 14.9/11.5

BSE Code 524208

NSE Code AARTIIND

Bloomberg ARTO IN

Daily volume (avg. monthly) 85118

Shareholding pattern % Promoters 59.8

MFs / Banks / FIs 11.7

Foreign 0.4

Govt. Holding 0.0

Non-Promoter Corp. 1.6

Total Public 26.5

Total 100.0

As on Dec 31, 2014

Recommendation

BUY

Analyst

KISHAN GUPTA, CFA, FRM

Phone: + 91 (33) 4488 3043

E- mail: [email protected]

Figures in Rs crs FY12 FY13 FY14 FY15e FY16e

Income from operations 1673.30 2096.25 2632.49 2856.81 2641.78

Other income 3.61 3.76 10.97 1.44 1.44

EBITDA (other income included) 252.88 364.96 412.45 424.04 483.48

Adjusted net profit after MI 101.51 134.05 155.51

51 161.88 209.87

EPS (Rs) 12.83 16.94 17.55 18.27 23.69

EPS growth (%) 23.8 32.1 3.6 4.1 29.6

Equity capital 39.56 39.56 44.30 44.30 44.30

Company Brief AIL is one of India's leading manufacturers of chemicals and

pharmaceutical intermediates: dyestuff; pigment; agro chemicals;

speciality chemicals; active pharmaceutical ingredient (API);

intermediates of API. It supplies to clients in several countries including

USA, UK, Germany, Spain, Italy, Switzerland, Japan and China.

Highlights

� Aarti's mainstream speciality chemical business is expected to benefit

from resurgence in Indian industry sweepstakes. By industry reports,

the Indian speciality chemical industry would reach $42 bn by 2018

from just $23 bn in 2013 helped by growth in end-user industries like

polymers, paints & coatings and emergence of new technologies in

electronics, food, textiles and tools . According to American

Chemistry Council, chemical volume growth in India would surpass

all but China over the next two years before surpassing in 2017; by its

estimates volumes would grow by 8.4% on an average in 2015 and

2016.

� Aarti's benzene based value chain helps it to fling globally ranked

products belonging to various stages of production - second rank in

ammonolysis and hydrogenation; third in nitration; fourth in

chlorination. Integration of production process also furthers its

resolve of effectively managing short supply of isomers.

� Several upcoming expansion projects, including the ethylation unit at

Dahej SEZ, nitration unit for manufacture of nitro toulenes and its

derivatives, calcium chloride granulation project and hydrogenation

unit at Jhagadia would not only prop up sales but also enable margin

expansion through launch of new value added products. For pharma

business, an investment of Rs 60 crs would flow in setting up caffeine

unit, adding of block for intermediates and de-bottlenecking of

USFDA unit.

� The stock currently trades at 14.9x FY15e EPS of Rs 18.27 and 11.5x

FY16e EPS of Rs 23.69. We recommend a buy on the stock with target

of Rs Rs 355 based on 15x FY16e earnings (PEG ratio of 1), over a

period of 6-9 months.

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CD Equisearch Pvt Ltd


Company Profile

Aarti Industries is one of India's leading manufacturers of dyes, pigments, agrochemicals, pharmaceuticals and rubber

chemicals, supplied to over 800 customers across the globe from its plants spanned across Gujarat, Maharashtra, MP

and Silvassa. With customer presence in USA, Europe, Japan, China and India, the company 's products find

application in end - user industries such as agrochemicals, dyes, pigments, paints & printing inks, polymers,

pharmaceuticals, oil & fuel additives, flavors and fragrances, rubber chemicals and FMCG. Apart from producing

various benzene based derivatives through a number of chemical processes, it also churns out a whole host of products

through halex chemistry, phthalates, daizotisation, denitro chlorination, methoxylation, alkylated anilines and

toulidines. Most of its key products rank amongst the top five globally that helps it to bag orders from global chemical

majors like Bayer, Du Pont, Dow Chemicals, Clariant, Huntsman and Apollo Colors Inc. For other businesses, Aarti

boasts of clients like Ranbaxy, Cipla, Teva Pharma, Reckitt Benckiser; Henkel and HUL.

Business Segments

AIL business is classified into three broad categories (segments) namely, speciality chemicals, pharmaceuticals and

home & personal care chemicals.

Speciality chemicals

Polymers & additives

Aarti is one of the largest manufacturers of various polymer intermediates (4,4- dichloro diphynyl sulphone (DCDPS);

4,4- dihydroxy diphenyl sulphone (DHDPS); 4,4- diamino diphenyl sulphone (DHDPS) in India, supplying to global

majors including BASF, Toray and Cheveron Phillips. It intends to expand its capacities of high performance

engineering chemicals sensing sturdy demand from emerging industries - electronics; mobile communications.

Dyes, paints, pigments & printing inks

With renowned clients like Atul, Sudarshan Chemicals, Clariant and BASF, under its fold, the company has emerged as

the largest producer of specialized pigment & paint intermediates in India. Its portfolio of pigment and dystuff

intermediates includes ortho dichloro benzene, meta di nitro benzene, para dichloro benzene, chloro PDA, dichloro

aniline and mono chloro benzene (MCB).

Agrochemicals intermediates & fertilizers

Aarti plans to boost capacities of agrochemical intermediates in wake of increasing demand of pesticides, herbicides etc

globally; currently manufactures intermediates such as di chloro phenol, para nitro phenol, ortho phenylene diamine,

ortho chloro para anisidine and nitro benzene, and supplies to Dow Chemicals, United Phosphorus, Bayer, amongst

others. For fertilizers & nutrients business, the company has emphasized on increasing capacity of di calcium

phosphate, a type of cattle feed.

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Home & personal care chemicals

Aarti's plants at Pithampur (Madhya Pradesh) and Silvassa churn out non - ionic surfactants and concentrates for the

FMCG industry - used in shampoos, soaps, detergents, dish wash etc. Despite catering to the consumer industry with

clients like Henkel, HUL, Cavin Care and Dabur, this business forms just 6% of total revenues and 1.1% of EBIT. Yet it

plans to boost margins by altering product mix and exploring new markets.

Pharmaceuticals

This business handles production of active pharma ingredient (API) and intermediates of API from its bunch of four

facilities; either USFDA approved or WHO GMP approved. Its API, which are sourced mainly by global generic

pharmaceutical companies and branded generic Indian firms, falls in categories such as anti - hypertensive, anti -

asthamatic, anti cancer, cns agent, skin care and analgesic. Aarti has 42 commercial APIs with 33 European DMFs, 27

US DMFs and 15 CEP (of which 4 are under approval); 12 more APIs are under development. Aarti enjoys distinct

advantage of having dedicated USA, Japan and EU regulatory approvals for steroids and anti-cancer products. Some of

its API intermediates include dextromethorphan, bazedoxifene, saxagliptin, rotigotine, and vardenafil.

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Source: Aarti Industries

Investment Rationale

World chemical industry

Sales of global chemical industry (including pharmaceuticals) has

slowed down in last few years thanks to bumpy economic growth in

Europe - after growing at an average pace of 18.75% in 2010 and 2011,

sales grew by just 4% to $5.2 trillion in 2013. Excluding

pharmaceutical sales, the world chemical sales stood grew by 12.8% to

$3.13 trillion in 2012 with China accounting for 30.4% of the total

market and European Union 17.8% (Source: Cefic Chemdata

International). This grand recovery in sales (ex-pharma) in 2012 was

made possible by robust growth in Chinese chemical market (+27.1%).

With the rise in sales in emerging markets in last decade, global

chemical industry has seen a dramatic shift in market stakes.

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According to FICCI, the Indian speciality chemical industry is

expected to reach $42 bn by 2018 from $23 bn in 2013 (average

growth of 13%), driven by fast growth in end-user industries

such as paints & coatings, speciality polymers and home care

surfactants. Export opportunities abound not least because of

Indian chemical industry's global regulation compliance and

manufacturing competitiveness. Emergence of new

technologies in electronics, food, textiles and tools has the

potential to boost demand for speciality chemicals. Further,

the Indian industry would get help from a host of government

induced initiatives: port based chemical parks in SEZ; duty

structure rationalization; relaxation in FDI.

Segment wise, pharmaceuticals volume growth would pick up this year to 3.8% from 1.7% in 2013 with growth

averaging 4.0% in five years ending 2018; Specialties would lead the pack as its volumes would grow by 4.2% in the

same period. Agriculture chemicals though would underperform the overall industry with volume growth on an

average estimated to grow by 3.2% (see table below).

The American Chemistry Council (ACC) estimates that global chemistry production volumes would gain momentum

in 2014 (+3.8%) and 2015 (4.1%) after two lackluster years owing to strong growth in developing nations of Asia -

Pacific, Africa & Middle East, and Latin America. Boost in shale gas production would keep the North American

markets busy too, which would improve global capital utilization in coming years. R&D spending would provide the

much needed boost to the industry as ACC forecast R&D spending to increase to $68.7 bn by 2018 from $58.3 bn in

2014 led by pharmaceutical sector.

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According to Department of Chemicals and Petrochemicals (DCPC),

India, the domestic production of major chemicals in India grew by

1.7% in 2013-14 led by robust growth of production of organic

chemicals (+6.7%), pesticides & insecticides (+13.7%) and dyes &

dyestuffs (+12%) (see table below). Despite being one of the top

chemical markets, India has failed to make a dent in overseas markets

as its share in global chemical exports was pegged at 2.4% in 2013.

Opportunities exist for domestic chemical companies to grow their

markets overseas, particularly in inorganic chemicals and

pharmaceutical products.

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Benzene base value chain Toulene based value chain

Chlorination Nitration Ammonolysis Hydrogenation Others

Well integrated

Aarti is well integrated in its speciality chemicals business for its benzene based production chain enables it to eject

several globally ranked downstream products at different stages (see chart below). Direct integration of chlorination,

nitration and ammonolysis processes not only pushes down costs but also streamlines the production process. The

company also effectively manages short supplies of isomers (joint products) thanks to the integration process. It also

converts by -products from various processes into commercially viable products, thus adding to bottom-line. For

instances, dilute hydrochloric acid, a by -product, produces chloro sulphonic acid and calcium chloride granules,

while the dilute sulphuric acid ejects single super phosphate (SSP) fertilizer and di calcium phosphate (nutrients).

That's not all. The company also boasts of a toulene based value chain capable of discharging several downstream

products, a profit maximizing initiative.

New introductions

Aarti Industries plans to start the first of its kind ethylation unit at Dahej SEZ by 2017 which would enable it to launch

an array of new products. The upcoming continuous nitration unit would not only provide feeder material for the

ethylation plant but also enable it to unveil more downstream products based on nitro - toulene next fiscal. Expansion

of the hydrogenation capacity by early next fiscal would also do its bit to push forward the pipeline of new products.

Yet significant risks abound not least because of shocking fall in crude oil prices over the last few months that would

trigger sharp cuts in realizations of finished products.

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Capex

After incurring record capex last year, Aarti would trim down its capex over the next two years in wake of meltdown in

crude oil prices (see chart). Yet some landmark projects would still go through. The calcium chloride granulation project

- conversion of by -product HCL into commercially marketable product - at Vapi (Gujarat) is one such, though calcium

chloride granules are used extensively in oil exploration and de-icing. Capacity expansion of highly voluminous

polymer intermediate produced through the continuous hydrogenation process (cost: Rs 30 crs) would push higher

exports of this speciality chemical for it finds extensive use in polymers, dyestuffs and additives. Also on anvil is the

start of nitration unit for manufacture of nitro toulenes and its derivatives at Jhagadia involving investment of Rs 60 crs

that would commence in 2015-16. It also plans to expand capacity of nitro chloro benzenes (NCB) by 18000 MT,

furthering its status as one of the world's leading producers. No less worth mentioning is enhancement of annual

capacity of chlorination process by about 15000 mt.

For pharma business, an investment of Rs 60 crs would flow in setting up caffeine unit, adding of block for intermediates

and de-bottlenecking of USFDA unit. In home & personal care chemicals business, the margins would probably improve

owing to expansion of capacity at Pithampur site in Madhya Pradesh by almost half from current levels.

Financials &Valuation

Aarti's speciality business would report slowdowns in revenue growth this fiscal not least due to carnage in crude oil

market globally. Realizations of its finished products would fall to account for the moderation in raw material prices

(derivatives of crude oil) which would shrink revenues by 12% next fiscal, the worst showing in at least four years.

Volumes though would remain strong -averaging 12.5% for two years - galvanized by increasing use of high

performance polymers in transportation, water treatment, electronics and telecommunications, and growing acceptance

of printing inks in developing markets. Pharmaceutical business though would continue its dream run with revenue

growth averaging 13%.

Exports which stood firm for last three years to fiscal 2014 will improve further with recovery on global markets and

strategic tie -ups with key global majors, thus propelling its revenue share by eleven percentage points to 49%. Industry

reports suggest that Indian speciality chemical exports would surge by an average 13% over the next few years to reach

$42 bn by 2018 helped by emergence of new technologies in electronics, food, textiles and tools and GOI's resolve to

boost the competitiveness of the chemical industry.

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Although specialty business EBIT margins has held well so far this fiscal - 16.3% vs 14.2% in H1FY14 - plunge in prices

of benzene and other crude based derivatives would magnify inventory loss. As a result , its EBIT margins would fall

by at least 100 bps this fiscal before rebounding sharply next fiscal thanks to its 'cost plus' pricing model; benzene price

has nosedived to some Rs 55/ kg at the end of last quarter from some Rs 86/kg in Q2.

Though working capital will decline with lower sales, pertinent gains are hard to come by as rise in depreciation costs -

on account of capitalization of assets - would more or less offset savings in interest costs. Return on capital ratios would

fail to toe the rise in asset base mainly due to slump in sales of specialty chemicals, though volumes would still stand

tall. Yet advance in operating margins, arising out of Aarti's 'cost plus' pricing model, would placate slide in revenues.

Notwithstanding near term pressure in profits, average growth in earnings would still average over 16% in two years

ending fiscal 2016. Fixed asset utilization rate would ascend as most of the new capacities in both chemicals and

pharmaceutical business would go on stream next fiscal. Yet the overwhelming rise in equity valuation arising out of

easing equity risk premiums rests on secular upturn in chemical industry and therefore fraught with risks. Adjusting for

underlying risks, we believe the stock appears under valued at 11.4x FY16e earnings. We, therefore, recommend a buy

on the stock with target of Rs 355 based on 15x FY16e EPS of Rs 23.69 (PEG ratio of 1), over a period of 6-9 months.

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Risks & Concerns

Foreign exchange risk

Aarti is exposed to wide fluctuations in foreign exchange for it reported long USD exposure of Rs 773 crs (29.4% of sales)

last fiscal; it has outstanding ECB of $25m. Though the company partially benefits from the current depreciation of the

rupee, rise in volatility pose significant financial risks; it reported hedges amounting to just Rs 3 crs last fiscal.

Working capital

Aartis's business is highly capital intensive as is manifested by its burdensome working capital ratio (over 31% last fiscal).

Though the ratio would improve a bit in the current fiscal thanks to sharp decline in crude oil prices, it won’t result in

massive savings.

Cross Sectional Analysis

Company Equity* CMP

Market

cap* Sales* Profit* OPM NPM

Int.

coverage ROE

Mkt

cap /

sales P/BV P/E

Atul Ltd 30 1360 4034 2569 222 15.1 8.6 12.0 26.2 1.6 4.3 18.2

SudarshanChem 14 110 759 1080 42 11.6 3.9 2.7 15.8 0.7 2.7 18.0

Aarti Industries 44 273 2419 2895 169 15.5 5.8 2.7 21.6 0.8 2.9 14.3

BASF India 43 1292 5595 4702 -16 3.6 -0.3 1.0 -1.3 1.2 4.5 -

* Figures in Rs crs; P/E on TTM basis;

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Financials

Quarterly Results - Standalone Figures in Rs crs

Q2FY15 Q2FY14 % chg. H1FY15 H1FY14 % chg.

Income from operations 761.16 645.35 17.9 1500.93 1238.99 21.1

Other Income 0.27 3.54 -92.4 0.39 5.90 -93.4

Total Income 761.43 648.89 17.3 1501.32 1244.89 20.6

Total Expenditure 639.18 539.33 18.5 1265.98 1056.73 19.8

PBIDT (other income included) 122.25 109.56 11.6 235.34 188.16 25.1

Interest 35.94 27.61 30.2 73.87 53.97 36.9

Depreciation 19.09 21.60 -11.6 37.82 41.81 -9.5

PBT 67.22 60.35 11.4 123.65 92.38 33.8

Tax 16.50 18.00 -8.3 31.50 27.50 14.5

PAT 50.72 42.35 19.8 92.15 64.88 42.0

Extraordinary Item 0.00 0.00 - 0.00 0.00 -

Adjusted Net Profit 50.72 42.35 19.8 92.15 64.88 42.0

EPS (F.V. 5) 5.72 4.78 19.8 10.40 7.32 42.0

Segment Results - Standalone Figures in Rs crs

Q2FY15 Q2FY14 % chg. H1FY15 H1FY14 % chg.

Segment Revenue

Speciality Chemicals 624.91 537.21 16.3 1239.10 1030.03 20.3

Pharmaceuticals 79.20 69.47 14.0 146.65 132.79 10.4

Home & Personal Care Chemicals 57.05 38.67 47.5 115.18 76.17 51.2

Total 761.16 645.35 17.9 1500.93 1238.99 21.1

Segment EBIT

Speciality Chemicals 104.12 82.52 26.2 201.83 146.55 37.7

Pharmaceuticals 12.47 11.79 5.8 18.72 19.08 -1.9

Home & Personal Care Chemicals 0.71 1.93 -63.2 3.30 1.70 94.1

Total 117.30 96.24 21.9 223.85 167.33 33.8

Interest 35.94 27.61 30.2 73.87 53.97 36.9

Other Unallocable Exp. (net of income) 14.14 8.28 70.8 26.33 20.98 25.5

PBT 67.22 60.35 11.4 123.65 92.38 33.8

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Consolidated Income Statement Figures in Rs crs

FY12 FY13 FY14 FY15e FY16e

Income from operations 1673.30 2096.25 2632.49 2856.81 2641.78

Growth (%) 15.2 25.3 25.6 8.5 -7.5

Other Income 3.61 3.76 10.97 1.44 1.44

Total Income 1676.91 2100.01 2643.46 2858.25 2643.22

Total Expenditure 1424.03 1735.05 2231.01 2434.21 2159.73

EBITDA (other income included) 252.88 364.96 412.45 424.04 483.48

Interest 71.84 95.37 117.84 125.76 110.33

EBDT 181.04 269.59 294.61 298.28 373.15

Depreciation 54.85 82.84 88.52 101.71 115.20

Tax 36.16 53.75 54.03 43.25 56.75

Net profit 90.03 133.00 152.06 153.32 201.20

Minority interest 1.08 1.00 0.51 0.51 0.51

Profit/loss of associate 14.31 2.41 10.88 9.07 9.17

Net profit after MI 103.26 134.41 162.43 161.88 209.87

Extraordinary item 1.75 0.36 6.92 0.00 0.00

Adjusted Net Profit 101.51 134.05 155.51 161.88 209.87

EPS (Rs.) 12.83 16.94 17.55 18.27 23.69

Segment Results Figures in Rs crs


Segment Revenue

Speciality Chemicals 1350.28 1757.79 2216.67 2346.98 2055.48

Pharmaceuticals 164.62 186.84 248.98 276.78 318.30

Home & Personal Care Chemicals 158.41 151.62 166.84 233.04 267.99

Net sales 1673.30 2096.25 2632.49 2856.81 2641.78

Segment EBIT

Speciality Chemicals 217.21 318.95 332.62 327.86 363.27

Pharmaceuticals 4.19 9.45 29.75 31.08 36.60

Home & Personal Care Chemicals 4.92 5.03 4.11 6.25 8.04

Sub Total 226.32 333.43 366.48 365.19 407.91

Interest 71.84 95.37 117.84 125.76 110.33

Other Unallocable Exp. (net of income) 28.29 51.30 42.55 42.85 39.63

PBT 126.19 186.76 206.09 196.57 257.95

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Consolidated Balance Sheet Figures in Rs crs


SOURCES OF FUNDS

Share Capital 39.56 39.56 44.30 44.30 44.30

Reserves 550.55 716.70 826.46 933.78 1089.08

Total Shareholders Funds 590.11 756.26 870.76 978.08 1133.38

Minority Interest 3.25 4.26 4.26 4.77 5.28

Long term debt 103.51 117.27 255.25 184.37 111.66

Total Liabilities 696.87 877.79 1130.27 1167.22 1250.32

APPLICATION OF FUNDS

Gross Block 854.86 1236.79 1477.03 1617.59 1868.04

Less: Accumulated Depreciation 411.45 563.14 650.80 752.50 867.70

Net Block 443.41 673.65 826.23 865.09 1000.35

Capital Work in Progress 54.42 68.69 117.44 200.00 50.00

Investments 93.56 95.42 117.24 126.30 135.48

Current Assets, Loans & Advances

Inventory 325.86 462.15 606.12 545.51 556.42

Sundry Debtors 406.98 429.01 443.21 478.67 488.24

Cash and Bank 10.56 12.42 14.85 28.05 27.04

Other Assets 81.78 116.01 160.66 158.95 146.36

Total CA & LA 825.18 1019.59 1224.84 1211.18 1218.06

Current liabilities 710.43 978.86 1157.41 1213.05 1088.63

Provisions 22.10 27.71 29.90 30.81 30.81

Total Current Liabilities 732.53 1006.57 1187.31 1243.87 1119.44

Net Current Assets 92.65 13.02 37.53 -32.69 98.61

Net Deferred Tax (net of liability) -55.62 -70.89 -84.66 -103.77 -128.77

Other Assets (Net of liabilities) 68.45 97.89 116.48 112.29 94.66

Total Assets 696.87 877.79 1130.27 1167.22 1250.32

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Consolidated Cash Flow Statement Figures in Rs crs

FY13 FY14 FY15e FY16e

Net Income (a) 133.00 152.06 153.32 201.20

Non cash exp. & others (b) 97.61 92.05 119.96 139.34

Depreciation 82.84 88.52 101.71 115.20

Profit / loss on sale of assets / inv 0.50 -9.38 0.00 0.00

Dividend income -0.63 -0.56 -0.56 -0.56

Lease income -0.36 -0.30 -0.30 -0.30

Deferred tax & others 15.27 13.77 19.11 25.00

(Increase) / decrease in NWC (c) -90.03 -77.62 41.47 34.07

Inventory -82.82 -143.97 60.61 -10.91

Debtors -22.03 -14.20 -35.46 -9.57

Other assets & liabilities 14.83 80.55 16.31 54.56

Operating cash flow (a+b+c) 140.59 166.50 314.75 374.61

Capex -231.39 -287.85 -211.96 -85.60

Associate & other investments 0.97 -3.83 0.00 0.00

Dividend income 0.63 0.56 0.56 0.56

Lease income 0.36 0.30 0.30 0.30

Investing cash flow (d) -229.42 -290.83 -211.10 -84.74

Net borrowings 127.08 177.27 -36.80 -236.33

Dividends & others -36.38 -50.52 -53.65 -54.56

Financing cash flow (e) 90.70 126.76 -90.45 -290.89

Net change (a+b+c+d+e) 1.86 2.43 13.20 -1.02

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Key Financial Ratios


Growth Ratios

Revenue (%) 15.2 25.3 25.6 8.5 -7.5

EBIDTA (%) 25.7 45.5 10.6 5.2 14.0

Net Profit (%) 27.6 32.1 16.0 4.1 29.6

EPS (%) 23.8 32.1 3.6 4.1 29.6

Margins

Operating Profit Margin (%) 14.9 17.2 15.3 14.8 18.2

Gross Profit Margin (%) 10.7 12.8 10.8 10.4 14.1

Net Profit Margin (%) 5.3 6.3 5.5 5.4 7.6

Return

ROCE (%) 13.2 14.3 13.6 13.2 15.1

RONW (%) 18.5 19.9 19.1 17.5 19.9

Valuations

Market Cap / Sales 0.3 0.3 0.4 0.8 0.9

EV/EBIDTA 4.4 4.1 5.2 8.0 7.1

P/E 4.7 4.8 7.0 14.9 11.5

P/BV 0.8 0.9 1.2 2.5 2.1

Other Ratios

Interest Coverage 2.7 3.0 2.7 2.6 3.3

Debt-Equity Ratio 1.1 1.1 1.2 1.0 0.7

Current Ratio 1.1 1.0 1.0 1.0 1.1

Turnover Ratios

Fixed Asset Turnover 3.9 3.8 3.5 3.4 2.8

Total Asset Turnover 2.5 2.7 2.6 2.5 2.2

Debtors Turnover 4.5 5.0 6.0 6.2 5.5

Inventory Turnover 4.6 4.4 4.2 4.2 3.9

Creditors Turnover 9.1 8.6 7.5 6.4 5.3

WC Ratios

Debtor Days 80.7 72.8 60.5 58.9 66.8

Inventory Days 79.5 82.9 87.4 86.3 93.1

Creditor Days 40.3 42.6 48.8 56.7 68.7

Cash Conversion Cycle 119.8 113.1 99.1 88.5 91.2

Cash Flows (Rs crs)

Operating Cash Flow 49.0 140.6 166.5 314.8 374.6

FCFF -28.8 -18.3 -32.1 198.0 372.6

FCFE 11.7 37.3 56.8 66.9 53.5

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Recommendation

The Indian chemical industry is on the cusp of a dramatic shift with its size estimated to touch $173 bn by 2018, implying an

annual growth of 8%. The specialty chemical industry would account for more than a third of the gains led by India's

increasing urbanization, infrastructure development and cost competitiveness. Emergence of new technologies in

electronics, food, textiles and tools would boost demand for speciality chemicals. Yet poor feedstock availability and

mediocre processes for processing and value addition to feedstock could impede production growth.

The American Chemistry Council (ACC), an industry trade association for Amercian chemical companies, forecast India to

be one of the fastest growing chemicals markets in the world (dwarfed only by China) over the next decade with average

volume growth of over 8%. Indeed, India outpaced the overall volume growth of developing markets by some 80 bps in

2013. Still the country has struggled to make a dent in global sweepstakes for its share in global chemical exports stood at a

shockingly 2.3%.

Structural shift in demand for high performance polymers, capacity enhancements of hydrogenation and nitro chloro

benzene and increased market access due to due to shutdowns of specialized pigment & paint intermediates of a Japanese

company and nitro chloro benzene (NCB) operations of a German enterprise would help Aarti's speciality business to log

atleast 10% volume growth for next few years. Further, rupee depreciation and lessening global majors' concentration on

China would help ramp up exports.

For Aarti's pharmaceutical business, commencement of new production units - caffeine plant; adding block for

intermediates; de-bottlenecking of USFDA unit - and launch of new APIs would further cement its foothold in key US and

European markets; also enjoys dedicated USA, Japan and EU approval for steroids and anti-cancer products. Outsourcing to

low cost countries would gather momentum with ever-growing patent expirations and increasing pressure on governments

in the rich world to reduce healthcare costs.

Integration of benzene based production chain has helped catapult Aarti to global rankings in downstream products: third

largest producer of nitro chloro benzene globally; among the top five globally for nitration, ammonolysis and hydrogenation

products. Margins swell too. Aarti’s speciality business EBIT margin has averaged 16.1% in last four years, though it would

plummet to 14% this fiscal on write down of inventories before springing back next fiscal.

The stock currently trades at 14.9x FY15e EPS of Rs 18.27 and 11.5x FY16e EPS of Rs 23.69. Though the stock seems fairly

priced by historical standards (five year average P/E: 5.3), structural shifts in Indian economy explain much of the fall in

country risk premium. Yet looming risk of slowdown in global economy and deflation in some developed countries cannot

be by any means gainsaid. Factoring such risks, the stock still appears under valued at 11.4x FY16e earnings. We, therefore,

recommend a buy on the stock with target of Rs 355 based on 15x FY16e EPS of Rs 23.69 (PEG ratio of 1), over a period of 6-9

months.

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