Chemcon Speciality Chemicals Ltd – Red Herring or True Value?

Synopsis: In-depth stock analysis of Chemcon Speciality Chemicals. It makes HDMS and CMIC – key intermediates used in drugs to treat HIV / AIDS, Hepatitis B & C

Background

Chemcon Speciality Chemical Limited (CSCL) was originally incorporated as Gujarat Quinone Private Limited at Vadodara, Gujarat on 15 Dec 1988. The current promoters completed the acquisition of 100% of the Equity Share capital of the Company in 2004 from the shareholders of the Company at the time. Chemcon Engineers Private Limited” (“CEPL”) was incorporated at Vadodara, Gujarat, India as a private limited company in April 1996, and it was owned by current promoter group. Both the companies were merged and the entity was renamed as Chemcon Speciality Chemicals Pvt Ltd. Subsequently the company was converted to a public limited company in Nov 2018.

Company is headquartered in Vadodara, Gujarat. It has its manufacturing plant located in Vadodara.

Business Overview

CSCL is engaged in the business of manufacturing, marketing and supplying of the Pharmaceutical Chemicals and the Oilwell Completion Chemicals. They manufacture specialised chemicals, such as HMDS and CMIC which are predominantly used in the pharmaceuticals industry, and inorganic bromides, namely Calcium Bromide, Zinc Bromide and Sodium Bromide, which are predominantly used as completion fluids in the oilfields industry.

CSCL is an ISO 9001:2015 certified company. Its manufacturing plant is located in Manjusar, near Vadodara. As on date, they have 5 manufacturing plants at their manufacturing site, of which one plant is dedicated to manufacturing of HDMS and ancillary products, 2 plants dedicated to manufacturing of CMIC, and remaining 2 plants are dedicated to manufacturing of Oil well completion chemicals. They have 3 warehouses for storage of raw materials and finished goods. The total installed capacity is as follows. HMDS – 2400 MT per annum. CMIC – 1800 MT per annum. Oil well Chemicals 14,400 MT per annum. Their total volumetric reactor capacity is 236.65 KL.

Products & Their Applications

Currently, CSCL product portfolio is limited to Pharmaceutical Chemicals, mainly HMDS and CMIC and Oilwell Completion Chemicals, namely Calcium Bromide (solution and powder), Zinc Bromide (solution) and Sodium Bromide (solution and powder). These products are widely used in a variety of applications, as listed below.

Table 1: CSCL Products by Application

As seen from the table above, CSCL’s pharma products are used as key ingredients in life-saving drugs for treatment of HIV / Hepatitis C / Hepatitis B and several Anti-biotics.

Business Analysis

Financial data for CSCL is available for only last 3-4 years. In these years, it has shown explosive growth, especially in its pharma chemicals business. It has been able to find its niche within the pharma chemicals space and has positioned itself to be a leading player in this niche.

Although CSCL has a limited basket of products, it is well positioned in the market for these products. In HMDC, it is the ONLY manufacturer in India, and the 8^th largest producer in the world, as of FY18. For CMIC, it is the LARGEST in India, and the 2^nd LARGEST producer in the world. Thus, it has been very successful establish itself within its niche, within a relatively short period of time.

Industry-wise Revenue

CSCL business caters to 2 major segments – Pharmaceuticals and Oil & Gas Exploration industry. Of these Pharma contributes almost 2/3 of the revenue and remaining 1/3 is contributed by Oil Well Completion Chemicals business. A minuscule part of revenue comes from other industries such as semi-conductor and rubber.

Table 2: CSCL Revenue by Industry

Product-wise Revenue

Breaking down the revenue product-wise, we can see that almost 40% of its revenue comes from its biggest product, HMDS, while the bromide family of products contribute about 35%.  So it has a huge dependence on HMDS for its revenue.

Table 3: CSCL Revenue by Products

*Services revenue of 2.90% for FY19 is not counted in this.

Domestic Vs Export Revenue

Table 4: CSCL Revenue by Export / Import

CSCL has demonstrated a very strong growth in both domestic as well as exports sales. While its total revenue has grown to almost 4 times in these 2 years, its export sales have growth to almost 2 times, while the domestic sales have grown by a massive 8 times in such a short period. CSCL has been able to scale up its business to take advantage of the growing demand for its products.  

Business from Top Customers

CSCL is hugely dependent on its top 5 customers for a significant part of their revenue. As seen in the table below, 45% of their revenue comes from top 5 customer, and this jumps to 67% from their top 10 customers. Their dependence on top 5 customers is even more in Oil well chemicals segment with 90% of revenue coming from top 5 customers. This is quit risky, though the consolation is that the customer concentration has been gradually trending downwards.

Not only is CSCL dependent heavily on its top customer, but it does not even have any long term contracts with them. In effect, the certainty of repeat revenue from the top customers is highly dependent on the nature of relationship with the customer.

Table 5: CSCL Industry-wise Revenue from Top 5 Customers

Table 6: CSCL Revenue from Top 10 Customers

* Confidential

Market Share

As mentioned earlier, CSCL is India’s only HMDS manufacturer, and 8^th largest globally.  It has a global market share of 5.61% in HMDS.

Figure 1: HMDS Manufacturers Market Share Globally (2018)

In CMIC segment, CSCL has an even bigger market share of 28% globally, making it the 2^nd largest producer of CMIC in the world.

Figure 2: CMIC Manufacturers Market Share Globally (2018)

 It is important to note that with the proposed major capacity expansion, CSCL is likely to further consolidate its position in the pharma chemicals segment (HMDS & CMIC)

Similarly in the Oil Well Chemicals segment, CSCL has done very well, from 0 market share in 2013, it has managed to grab a global market share of 2.67% in the bromides product family.

Figure 3: Oil Well Chemical (Bromides) Manufacturers Market Share Globally (2018)

Capacity Utilization

Currently, the HMDC plants are running at a very high utilisation rate of 93%, albeit on a reduced capacity due to fire in one of the plants, in 2018. Also HMDC being their best-seller product, it is prudent to have additional capacity for it, in order to ensure healthy growth in top and bottom lines.

Similarly, CMIC production is also seen at almost 96% capacity utilization in FY19, though the capacity added in Fy19 should serve well for FY20 too. As we can see, there has been a rapid capacity expansion for CMIC, with 600 MT capacity added in FY18 and FY19, thus indicating a healthy growth in CMIC production.  

The positive impact of capacity addition and its higher utilization is clearly seen in the explosive revenue growth seen since FY17 in both the products HMDC and CMIC.

Table 7: CSCL HMDS Capacity Utilization

* One of the plants was damaged in fire in Jan 2018, due to which capacity reduced in Fy2019

Table 8: CSCL CMIC Capacity Utilization

*New capacity of 600 MT / annum was commissioned in Mar 2019, hence available for 1 Month in FY19

Table 9: CSCL Oil Well Chemical (Bromides Solution) Capacity Utilization

Table 10: CSCL Oil Well Chemical (Bromide Powder) Capacity Utilization

Promoters

Promoters of the CSCL are Kamalkumar Rajendra Aggarwal, Navdeep Naresh Goyal and Shubharangana Goyal.  KR Aggarwal is the Chairman and MD. He is 56, and holds a diploma in Petrochemical Technology from Sayaji university in Baroda. He has 23 years of experience in chemical industry. He has been on board since 2004. Navdeep Goyal, 29, is designated deputy MD.  Shubharangana Goyal, 57, holds master’s degree in political science from Meerut University.

The promotors have a stake in another listed company in India. They have several other unlisted ventures such as Medicap Healthcare, Kana Real estate Pvt Ltd, Overseas Synthetics Limited, Supertech Fabric Pvt Ltd, Shivam _Petrochem Industries etc, totalling about 19 entities.  As per SEBI definition of group companies, 3 entities viz. Super Industrial Lining Pvt Ltd, Supertech Fabrics Pvt Ltd and Kana Real Estate Pvt Ltd are qualified as group companies.

Of these, SILPL (engaged in manufacturing of Industrial Linings) had a revenue of 19.7 Cr in FY18 with profit of 0.5 Cr. Supertech Fabrics Pvt Ltd (engaged in manufacturing of technical textiles) had a revenue of 6.2 Cr in FY18 with a profit of 0.8 Cr.  Kana Real Estate (engaged in real estate business) has no sales and a loss of 0.29 Cr in FY 18.  There are some negative observations relating to these companies.  In SILPL, it has granted unsecured loans to another promoter venture without clarity of interest rate and repayment terms. In case of Supertech Fabrics, there is dispute / law suit contending the purchase of a land parcel. In Kana Real Estate, the networth of the company has been fully eroded.

In addition, there are couple of other minor red flags

• CSCL Promoters, Kamalkumar Rajendra Aggarwal, Shubharangana Goyal and Navdeep Naresh Goyal and certain members of the Promoter Group, namely, Naresh Vijaykumar Goyal and Minal Kamal Aggarwal (collectively, the “PG OSL Shareholders”), have filed a settlement application dated March 10, 2019 with SEBI in relation to their inadvertent failure to make certain disclosures required under the Takeover Regulations and the SEBI Insider Trading Regulations in relation to their holdings in Overseas Synthetics Limited (“OSL”), a company listed on BSE Limited, which is a member of the Promoter Group. Incidentally, this company has zero revenue for last 5 years, and is practically doing no business.
• Further, pursuant to a criminal complaint (“Complaint”) filed by the Central Bureau of Investigation (Jaipur) (“CBI”), the CBI Special Court, Jaipur (“CBI Court”), vide an order dated December 24, 2018 (“CBI Court Order”), has convicted and sentenced inter alia a member of the Promoter Group, Naresh Vijaykumar Goyal (in his capacity as a director of Super Scientific Works Private Limited) to (i) rigorous imprisonment for two years with a fine of ₹10,000 for commission of offences under Section 120-B of the Indian Penal Code, 1860; and (ii) rigorous imprisonment for three years and fine of ₹ 20,000 each for commission of offences under Section 13(1)(d)(ii) of the Prevention of Corruption Act, 1988.

So, other than the success of CSCL itself, the track record of the promoters across their other ventures is not too flattering, and can be termed as moderate at best. Probably, the presence of 2 non-promoter, whole-time Directors contributes immensely to the success of CSCL over last 20 years. Mr Himanshu Purohit, who holds a master’s degree in inorganic chemistry, has been with the company for last 20 years, and is currently Director – Production, taking care of critical functions such as Product Development, Production, and Material management. Similarly, Mr Rajesh Gandhi, CFO and Whole-time director, has been with the company for 20 years, and is in charge of key functions such as Finance & accounting, Export-Import, Compliance etc. Together, they seem to have played a key role in the success of CSCL.

Objectives of the IPO

The primary objectives of the IPO are to raise money for the capital expenditure towards expansion of the manufacturing facility, and to meet the working capital requirements.

Currently, CSCL has five operational individual plants for the production of their Products, within the manufacturing facility. Their total volumetric reactor capacity is 236.65 KL. They intend to build 3 additional plants with a total volumetric capacity of 376.20 KL. These additional plants shall be utilised for manufacturing of chemicals which are primarily used in pharmaceutical industry.

The utilization of fresh capital raise of Rs 165 crores is planned as follows

Table 11: CSCL Planned Utilisation of IPO Proceeds

 [●]  To be finalised – All figures in Rupee Million

Growth Runway

The Global HMDS market in 2018 was valued at 345 USD Mn with a demand of ~24 KT. Of this, China currently accounts for 50% of global HMDS capacity, thus being the largest exporter of HMDS in the world. However, due to the environment concerns, the regulatory restrictions placed on chemical manufacturer in China since last few years, has resulted in reduction in capacity utilization. This is potentially a boost for Chemcon.

Figure 4: Global HMDS Demand by Region / Country (2013 – 2018)

Frost & Sullivan report estimates that demand for HMDS has shown good growth trajectory with a CAGR of 3% globally, with higher CAGR of 3.5% seen in Japan and 8.5% in underdeveloped countries.

The same report predicts a much higher CAGR growth of 4.5% globally for HMDS use within Pharma industry, and an even steeper CAGR of 5.6% for HMDS demand within India between year 2019 and 2023. Interestingly, in India, the highest CAGR of 6.5% is predicted to be in the pharma segment, during the same period (please see graphs on next page). They key drivers of this growth are seen to be as follows

1. Rising incidence of HIV and use of HMDS in Anti-HIV treatments.
2. HMDS is also key ingredient in the new advanced DAA therapies to treat Hepatitis B & C.
3. In recent times, some of these drugs are being licensed for manufacturing by Indian   

Currently, India is a net importer of HMDS. About 52% of India’s current domestic demand is met by imports, majorly from China and Germany.

Figure 5: Global HMDS Demand by Application / Industry (2013 – 2023P)

Figure 6: India HMDS Demand by Application / Industry (2013 – 2023P)

Figure 7: India HMDS Market by Source (2013 – 2023P)

Figure 8: India HDMS Market Outlook (2018 – 2023P)

Being the only HMDS producer in India, Chemcon is in a unique position to leverage this opportunity to achieve explosive growth.

India and China are only 2 countries in the world that produce CMIC. In 2018, India had 45% and China had 55% in CMIC production globally.  India is also the LARGEST consumer of CMIC, accounting for 65% of the global demand. Market for CMIC based drugs is growing in India, due to declining cost of drugs as well as rising demand for better healthcare.

Figure 9: Global CMIC Demand by Region / Country (2018 – 2023P)

Figure 10: India CMIC Demand (2018)

Global demand for CMIC is expected to grow at an CAGR of 12.5% between 2018 and 2023. Within this, demand in India is predicted to grow at an even higher CAGR of 14%, while demand in China is seen to grow at CAGR of 13.8% within the same time period.

Currently, India is a net importer of CMIC. About 50% of India’s domestic demand is met by imports from China.

With CMIC being critical intermediate for HIV/HBV drugs which are critical for saving lives, future of CMIC looks quiet bright. Chemcon being the largest producer of CMIC in India, is well positioned to capture the opportunities available from growing market for CMIC.

Figure 11: India CMIC Market Outlook (2018 – 2023P)

Summary of Growth Opportunities

1. HMDS demand in India is projected to grow at CAGR of 5.6% in next 3 years. India is currently net importer of HMDS, with 52% of its demand in 2018 met by imports, mainly from China. Chemcon is the only HMDS manufacturer in India. Hence, by substituting imports and catering to India’s HMDS market, Chemcon has an opportunity to grow at a CAGR of ~20% between 2018 and 2023 in the HMDS Segment.
2. India and China are the ONLY 2 countries in the world to make CMIC. India has 45% market share, and China has 55% market share of global production.
3. India has the largest demand for CMIC, with 65% of global consumption. This demand is growing very fast. CMIC is critical input for HIV / Hepatitis B life-saving drugs. Demand for these drugs has been rising due to lowing prices and rising demand for better healthcare.
4. Demand for CMIC is predicted to grow at CAGR of 12.5% between 2018 and 2023, with demand in India expected to grow at 14% CAGR in the same period. Currently, India is a net importer of CMIC, with 50% of its demand being met through imports from China.
5. Chemcon being leading producer of CMIC in India, is well positioned to substitute imports from China and hence has an opportunity to grow at a CAGR of more than 25% in CMIC segment between 2018 and 2023.
6. Chemcon has planned to more than double its manufacturing capacity from 236 KL, by adding another 376 KL by using the proceeds of IPO to set up 3 additional plants. All of the additional capacity is planned to be added to HMDS and CMIC. Thus,  post-expansion, CSCL will be in great position to grow its revenue by meeting the rising demand of HMDS and CMIC.
7. If CSCL is able to achieve its expected growth CAGR of ~20% over next 3 years in HMDS & CMIC segment (currently 62%+ of its revenue ~200 Cr), it can easily double its revenue from the pharma segment in this period, to about 400 Cr.

Competitors

In each of its major product segments, is the top manufacturer within India. Globally, CSCL faces strong competition from several players, but the size of the market is quiet large for all the players to enjoy a healthy market share. Moreover, the domestic demand for CSCL’s products is growing at a very healthy rate and it is expected to continue in the coming 5 years, providing CSCL an opportunity to continue growing at a very aggressive rate. In HMDS, its leading competitors are Dow Chemicals (18.19% global market share), Xingyaqian Silicon (China, 20.68% market share), Zheijiang Sorbo (China, 10.22% share), Shin-Etsu (Japan, 10.44% share). 

In CMIC segment, Shanghai Twisun leads with a global market share of 33.46%, followed by Chemcon, trailed by Anshul Speciality (India, 11.26% global share) and Inner Mongolia Saintchem at 14.8% share.

In Oil Well Chemicals segment, its biggest competitors are Israel Chemicals Limited, Albermarle, LANEXESS, TETRA and PPC.

Competitive Moat

Though CSCL has seen great success only in the last decade or so, it has already build and enjoys some competitive moats. Let’s look at quick summary of these

1. It is India’s ONLY producer of HMDS and 8^th largest producer globally with 5.6% market share globally
2. It is India’s largest and world’s 2^nd largest producer of CMIC, with a global market share of over 28%
3. CMIC is only produced in 2 countries across the world – China and India. No other country produces CMIC currently.
4. It is world’s 6^th largest producer of bromides used as Oil Well chemicals
5. Speciality chemicals industry enjoys a high barrier to entry due to several reasons
   1. Involvement of complex chemistry in manufacture of products, which are difficult to commercialize on a large scale
   2. Long gestation period to be enlisted as a supplier with the reputed customers of Pharma industry and Global chemical groups
   3. Industry is highly knowledge intensive
   4. Given the nature of the end application of products, the processes and products are subject to and measured against high quality standards and very stringent impurity specifications. These are extremely difficult to achieve for new entrants
   5. Further, end products manufactured by firm’s customers, where the company’s products are used, and where such use has been formally recognised in filings with regulatory agencies, any change in the vendor may require significant time and cost for the customer. Hence customer acquisition involves a long gestation period, resulting in very few players being involved in manufacturing of products.
   6. Some of the products used in manufacturing of Speciality chemicals are corrosive and toxic, and handing these materials requires a very high degree of technical skill and expertise, the operations involving these have to be undertaken by well trained and experienced personnel, which is not easy to obtain.
6. Obtaining environmental clearances from government agencies to set up and expand capacities for manufacturing these chemicals is time-consuming and difficult process. Even for established players, obtaining permission often proves to be elusive. New players thus find it very difficult to get a foot-hold.

Risks

Raw Material Import Risk: CSCL is heavily dependent on imports for its raw materials. As of FY19, 50.89% of company’s raw materials were imported. This exposes it to cost escalations due to currency exchange fluctuations.  Also, a large part of its raw materials are sourced from china. Given the recent escalations in border dispute between India and China, any trade relationship breakdown / embargo between the two countries will have a big material impact on revenue and profitability of CSCL.

Product Concentration Risk: As of now, 40% of CSCL’s revenue comes from one product – HMDS, used mainly for its applications in pharmaceutical industry.  Revenue of CSCL depends on success of its customers end-products. Any change in that will have a very big impact on CSCL’s revenue and profitability. 

Industry Concentration Risk: CSCL relies on Pharma and Oil and Gas Exploration industry for almost all of its revenue. Any down-cycle or headwinds experienced by these industries will have a very massive impact on CSCL’s revenue and profitability.

Customer Concentration Risk: As we have already seen earlier in this analysis, CSCL has massive dependence on its top 5 and top 10 customers. Any negative turn in relationship with  any of these customers will have an immediate large impact on revenue and profit of CSCL.

Regulatory / Environmental Clearance Risk:  Obtaining environmental clearance in India is difficult. Any delays / problems in getting clearance for capacity expansion can have a direct and material impact on the growth and financial performance of CSCL.

Execution Risk: If CSCL fails to execute on its strategy, failing to utilise the growth potential, it may have a big impact on its financials.

Market Risk: If the growth in demand for CSCL’s customer’s end products does not rise as expected, it would have a significant impact on financial performance of CSCL.

Financials

Balance Sheet

Figure 12: Balance Sheet

1. PPE has seen a steady rise in the last 2 years,  clearly indicating continuous focus on capacity expansion
2. Inventory levels have been more than doubling YpY, once again indicating growing need for working capital, leading into higher sales volumes
3. Trade receivables have shot up massively too, especially over the last year, though it’s in proportion the jump in sales
4. Long term borrowings are minimal at 4.92 million. Short term borrowings are 297 million
5. Equity and reserves stand at 970.3 million
6. Overall it’s a moderately solid balance sheet, with low leverage and ample room for growth

Profit & Loss Statement

Figure 13: Profit & Loss Statement

1. Revenue is growing at a break-neck pace, rising almost 4x between 2017 and FY2019, at a CAGR of 83.95%
2. EBIDTA in the same period has grown from 86.6 million to 679.21 million at a CAGR of 180.06%
3. PAT has jumped from 28.24 million in FY17 to 430.41 million in FY19, growing at CAGR of 290.39%
4. Correspondingly, EPS has jumped 15 fold from Rs 0.89  to Rs 13.54
5. It enjoys very healthy RoE and RoCE ratios (please refer to the  (Ratios section)

Cash Flow Statement

Figure 14: Cash Flow Statement

1. Cash flow from operations has declined slightly to 113.71 million, down from 139.97 in FY18.
2. Decline is mainly due to significant rise in inventory levels to the tune of 248.78 million
3. Rising trade receivables, up by 345.63 million  also have pulled down the CFO
4. Cash and cash equivalents at the end of the year, stand at 115.89 million

Key Financial Ratios

Table 12: CSCL Key Financial Ratios

Valuation

DHRP does not contain the updated financial statements for FY20. So based on FY19 EPS, and the issue price on the upper side of the band at Rs 340, the scrip is valued at PE of 25.11. From the summary of financial statement available on internet, the FY20 EPS stands at about Rs 15.36, which translates to a multiple of 22.15, thus assigning fair valuations to the stock. Most of the peers in the Speciality Chemical sector are attracting far richer valuations at PE of over 30.

At the price of 340, the market cap, of the company will be about 1272 crores, assigning it a very conservative Market Cap to sales ratio of about 3.

Final Assessment

1. Business Quality – CSCL has found itself a very profitable and unique niche. With critical end-use of its products and rising demand, it looks to be on a unhindered growth path for the next 2-3 years. It has got itself in leadership position in its product segment within India and has made an impact globally as well.
2. Growth Opportunity – With projections from Frost & Sullivan report indicating strong growth for its products in next 3 years, CSCL finds itself in an exciting space. Barring some extreme internal mismanagement or an external black swan event, it looks to be on track to achieve significant growth and leverage on the growth opportunity available to it.
3. Promotor / Management Quality: CSCL Promotor quality is not top-notch, with several of their side ventures not being successful. Presence of couple of red flags (indicated in this report earlier) does not inspire confidence either. Though they have been in this domain for many years, they have not demonstrated innovation. Hopefully, the professional executives in the management team continue to drive the company to success, as they have done in recent past. 
4. Conclusion: In its present state of business and with its products finding sweet-spots, CSCL is poised and on the cusp of a strong growth phase. At current valuations (offered in IPO), it offers good value and has chances of significant listing gains. One can hold the stock for the medium term for significant gains, but keeping the less than stellar quality of management, keeping a close eye on its performance, growth and financials periodically is very important.

Ratings

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Company History	* * *
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Financials Performance	* * *
Growth Opportunities	* * * * *
Valuation	* * * *
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