Dharamsi Morarji Chemical Company (BOM: 506405)- On A Strong Growth Trajectory !

Summary

• Company is a pioneer in the chemicals industry in India.
• Strong opportunities are available within the areas being targeted.
• Long term sticky relationships with customers act as entry barriers, leading to long term nature of contracts with predictable revenue stream.
• Upcoming capex can propel growth over next many years.
• Trades at 7x PE- much lower than peers.

BACKGROUND

Incorporated in 1919, Dharamsi Morarji Chemical Company (DMCC) was the first producer of Sulphuric Acid & Phosphate Fertilizers in India. It was predominantly known for Single Superphosphate (fertilizer) for almost entirety of its life. Fertilizer business at one time contributed to ~ 75% of the revenues.

From 2000 onwards, the company started incurring losses in the fertilizer segment (as highly dependent on Govt, policy) and soon ran into financial trouble.

In 2009 the company decided to exit the fertilizer business and undergo restructuring.

The company decided to shift its focus to the Sulphur chemicals business, and its downstream products.

A shift in vision and strategy happened later towards specialty chemicals with low competition. Decisions were taken to deploy incremental funds only towards expanding specialty chemicals segment.

DMCC currently is a fully-integrated chemical player in Sulphur, Boron and Ethanol chemistries.

With strong focus on research and development, the company is seeking to expand its product portfolio in the specialty chemicals segment- an inherently high margin high growth business.

To expand its capacity in the specialty chemicals segment the company has planned a capital expenditure at its available land parcel in Dahej, Gujarat.

INVESTMENT SUMMARY

Company is a pioneer in the chemicals industry in India. Came out of restructuring, and now on a growth path. Strategy of targeting high margin speciality chemicals in niche areas could lead to high, profitable growth. Strong opportunities are available within the areas being targeted. Long term sticky relationships with customers act as entry barriers, leading to long term nature of contracts with predictable revenue stream. Upcoming capex can propel growth over next many years. Trades at 7x PE- much lower than peers.

INVESTMENT ARGUMENTS

Focus on Specialty

The company through its strong research and development skills has been working on products that individually are small in market size with very limited or no competition. These are specialty chemicals that offer higher and stable margins.

Company has stated policy of venturing into chemicals where it can target a net profit margin of 30% + and a payback period of < 3 years.

In order to keep the pipeline healthy- Company spends 1%- 2% of its topline on R&D related spending.

Company’s policy of being a fully backward integrated player in all of its speciality chemicals helps in becoming a low-cost manufacturer and in controlling the entire value chain. This overall helps in realising higher margins.

Majority of the specialty chemicals sales are under long term sales contracts, with pass-through clauses (for RM fluctuations) with a delay of just one quarter. This leads to strong revenue predictability.

The product portfolio is developed with proprietary manufacturing processes that are both, environmentally sustainable and cost-effective.

All the incremental Capital to be deployed only towards specialty and downstream products.

The focus towards higher margins is clear on new product introductions being planned.

Company recently turned around a loss making subsidiary in the commodity Boron chemicals- Borax Morarji. With cost rationalisation being complete the runway is set for venturing into speciality chemicals on the Boron side as well.

Upcoming expansion

Company has planned capex of 100 crores over next few years (~ 2x the current Gross Block). Capex includes 50 crore for its key raw material - Sulphuric acid (additional 300 MT/day planned), and 50 crore for building multi purpose plants, speciality chemicals plants and debottlenecking its existing facility at Roha.

Company will manufacture Benzene Sulfonyl Chloride, range of Thio Compounds and add capacity for manufacturing of Sulfones (a new product for the company) & derivatives for paper & polymers industry.

Amalgamation of Borax Morarji with the company facilitated the availability of unutilized land parcel at Dahej- the site of the upcoming plant.

Company will borrow funds to the tune of 70 crores (Current Debt/Equity at only 0.10x) and the rest will be supported from internal accruals.

This capex is expected to come online by H2FY21.

Expansion in Sulphuric acid will be a one-time investment only. It will take care of captive needs for downstream products for the foreseeable future. No more expansion in commodity chemicals is being planned.

The new facility is strategically located at Dahej- bringing the company closer to its suppliers leading to savings in logistical costs.

Upcoming capex will lead to strong growth in revenues aided by increasing margins as share of specialty products picks up.

Sticky relationships

Because of the technical and complex nature of the products, customer approvals in this business are tough to get. However, once the relationship is established, it becomes difficult for any new/existing players to take market share. This acts as a big entry barrier in this business.

Due to its long track record of relationships built over last many years, DMCC enjoys a long-standing relationship with majority of its customers.

25% of revenues are derived from exports. Multinational companies like BASF, Lanxess and Arkema are key clients.

Lead by an able technocrat

Bimal Goculdas is the current Managing Director and Chief Executive Officer. Took over as CEO in 2008 after disastrous losses in the company from legacy businesses. Focussed on cost rationalisation and product optimisation.

Identified company’s movement into sulphur downstream products and prioritised investments in R&D.

Merged a subsidiary company (Borax Morarji) to rationalise supply chain operations and utilise land bank more efficiently.

Movement from China to India

China’s Chemical Market Size is roughly USD3.50 trillion(35% of the global market)–largest in the world. In some of the segments of Chemical sectors like dyes, pigments, agrochemicals, pharma APIs –China has almost 70–80% market share of the world. Chinese Government started implementing stricter environmental protection from January, 2015. The norms have got stricter every passing year.

India can become a major beneficiary of the ‘Green’ issues in China due to:

•Availability of low cost and skilled labour

•Already has strict environmental policy in place

•Strict IPR

This movement could benefit players like DMCC in a big way.

VALUATION

Company trades at 7x FY23E PE. Comparables with much larger share of commodity chemicals trade at much higher valuations.

Key financials	FY16	FY17	FY18	FY19	FY20	FY21E	FY22E	FY23E
Net Revenues (CR)	108	175	178	234	188	225	293	395
% growth		62.8%	1.6%	31.5%	-19.8%	20.0%	30.0%	35.0%
Operating Profit (CR)	16	30	23	53	28	33	47	67
% Opg margin	15.0%	16.9%	12.9%	22.9%	14.8%	14.5%	16.0%	17.0%
% Growth		83.8%	-22.9%	133.9%	-47.9%	17.3%	43.4%	43.4%
Net Profit (CR)	12	17	12	46	32	32	44	63
% Net margin	11.1%	9.7%	6.9%	19.7%	16.8%	14.0%	15.0%	16.0%
% Growth		42.2%	-28.0%	275.7%	-31.6%	15.0%	50.0%	50.0%
Diluted EPS	5.6	7.8	4.9	18.5	12.6	12.6	17.6	25.4
RoE (%)	29%	37%	21%	44%	21%	18%	20%	22%
P/E (X)								6
Current Price								154

RISKS

Chinese competition- Company competes with China in most its products. Incremental subsidies by Chinese government towards local industry leads to lower cost competitiveness for Indian companies.

Demand weakening: If the present disruptions due to Coronavirus (lockdown) persist for long, demand will be significantly impacted.

Rise of protectionism due to Coronavirus-related disruptions: Coronavirus has globally led to both supply chain disruptions and demand softening. These can lead to rise in protectionism to reduce supply chain disruptions risk and to promote investments closer to home.

APPENDIX

Product Portfolio

Bulk Chemicals

The company is one of the oldest manufacturers of Sulphuric acid in the country. Products are sold domestically, within a limited radius from the manufacturing site. Almost 50% of the production is sold in the markets and rest is consumed captively.

Key Products:

• SulphuricAcid
• Sulphuric Anhydride
• Oleum
• Chloro Sulphonic Acid

Applications:

Detergents, Dyes, Fertilizers, etc.

Speciality Chemicals

The Sulfonating agents manufactured by the company are reacted with organic substrates like Phenol, Benzene, and Methanol to get downstream products. 65-70% of these products are exported. Company is backward integrated in these processes.

Key Products:

• Benzene Sulfonyl chloride
• Benzene Sulfonic Acid
• Phenol Sulfonic Acid
• Sodium Benzene Sulfonate
• Sodium Phenol Sulfonate
• Menthyl Lactate
• Thiophenol
• Lasamide
• Diethyl Sulfate
• Diphenyl Sulfone
• Sodium Vinyl Sulfonate

Applications:

Agro-chemicals, Detergents, Dyes, Pigments, Thermal Power Stations, Detergents, Ceramic, Pharmaceuticals, Cosmetics, etc.

Boron Chemicals

Boron Chemistry is handled by Borax Morarji (recently merged). Company is working to add downstream products in Boron Chemistry.

Applications:

Thermal Power Stations, Detergents, Ceramic & Tiles, Steel, Electroplating, etc.

Just a side note: I’ve been tracking this stock since many years now. I hold this stock since stock price 113. Despite the runup the long term story is still very promising!