Neogen Chemicals is breaking into the next orbit with a bang: HDFC Sec

Breaking into the next orbit with a bang

Neogen Chemicals Ltd (NCL) is a leading manufacturer of bromine and lithium-based derivatives in India with technocrat promoters at the helm. We believe the improvement in the share of custom synthesis manufacturing (CSM) and advanced intermediates will result in strengthening of the balance sheet and manifest earnings visibility. The tripling of its organic chemicals manufacturing capacity will not only allow it to fulfil commitments of the two long-term contracts, but also bestow flexibility in selection of new molecules. Capacity expansion will accelerate the pace of growth, which was previously curtailed by limited infrastructure. We expect strong EBITDA and PAT CAGRs of 35/47% over FY22-24E. We initiate coverage on NCL with a BUY and target price of INR 1,220, (WACC 10%, terminal growth 5%). The stock is trading at 43.4/28.0 on FY23/24E EPS.

Contribution from CSM to total revenue to reach 20% by FY24E

In custom synthesis, the focus is on chemistry-oriented sales rather than product-oriented sales. NCL has strong competencies in certain chemistries and technologies and offers a wide range of products, which can be manufactured using this matrix of chemistries and technologies. It differentiates itself and commands an edge over others in custom manufacturing by additionally offering process innovation, which generally reduces the overall operating costs for the customers. Revenue from this business has jumped up from ~INR 2mn in FY16 to ~INR 336mn in FY21, while the share of this in the total revenue has increased from 0.2% in FY16 to 10% in FY21. We expect it to further jump up to 20% by FY24E on the back of an already signed long-term contract.

Capacity addition to drive growth

The organic chemicals capacity will rise from 1,30,400 litres to 3,90,000 litres with the commissioning of the ongoing expansion project by Oct-21. Post this expansion, ample capacity will be available with NCL to allow it to fulfil commitment given in the two long-term contracts and those that are expected to be signed in the near future. The current capacity expansion has a potential to generate a revenue of INR 6.50-6.75bn by FY24E. The company has >40 acre of freehold land available for future expansion at Dahej and Vadodara. At this juncture, it has invested in capacity building, and now onwards, it is time for it to tap new customers and enter more industries and markets.

Improving return ratios, strong balance sheet

We expect expansion in RoCE from 11.3% in FY21 to 16.6% in FY24E, driven by improvement in profitability. The working capital cycle should improve with reduction in inventory days. The net debt to EBITDA will fall from 3.4x in FY22E to 1.9x in FY24E. NCL is expected to generate an FCF of INR 698mn over FY23-24E in the absence of any major Capex.