Review Of 5 Top Specialty Ingredients Stocks By Nirmal Bang

Ignore the noise; structural story intact

India specialty ingredients space has been witnessing challenges like container unavailability, sharp increase in key raw material prices, delay in pass-through on account of the disruptions caused by Covid-19, delay in new launches on account of travel restrictions etc. While all these hurdles are affecting the quarterly earnings growth of these companies and are likely to persist for some more time, we believe that these are industry-related concerns globally and not company-specific issues.

Also, we see these challenges as an opportunity for the established businesses, as there is scope for consolidation. For example, in Oleochemicals, FINEORG and GALSURF are the leaders in their respective end-user segments and the current challenging situation might throw up lucrative M&A opportunities in future. Strong balance sheets with net cash reserves should enable these companies to go for acquisitions comfortably, in our view. ROSSARI’s back-to-back acquisitions at reasonable valuations are the testimony of the same.

We believe that nothing changes on the opportunity side and these specialty ingredients continue to remain the backbone of majority of the end-user industries. We roll forward our coverage valuation to Sept’23E earnings. We continue to like oleochemicals names and have a Buy rating on Fine Organic (FINEORG) and Galaxy Surfactants (GALSURF). We have upgraded GALSURF to Buy. Apart from that, we maintain Buy on Camlin Fine Sciences (CFIN) and Accumulate rating on Rossari Biotech (ROSSARI) and Advanced Enzyme (ADVENZY) after revision in earnings and multiples.

What are the near-term challenges? Raw material prices have risen across the board over the last 1 year and this spike is primarily linked to Covid-19 related disruptions, logistic challenges and select climatic adversities. These ingredients form very small portion of the end products. Immediate pass-through becomes a challenge, especially in case of long-term contracts and all companies (including global names) are struggling to cope with the unprecedented volatility in input prices. Second most important hurdle is the freight cost, which has surged by as much as 5x over the same period on account of serious container availability issues. This again is a global issue and not specific to any company. Thirdly, because of the travel restrictions caused by Covid-19, new launch activities and marketing of the recent launches have been delayed.

Challenging environment could be an opportunity for select companies to gain market share: As discussed in the above point, these supply challenges are affecting all companies. We do not see market share gains by peers from these Indian specialty ingredients companies. Managements of oleochemical companies are quite confident in terms of long-term opportunities. In fact, during the pandemic, FINEORG has witnessed some market share gain in select products. Since these businesses have strong balance sheets, they have an edge over peers (including global companies) in a challenging environment.

We expect consolidation in the industry: Discussions with a few industry experts suggest that there could be consolidation in the ingredients space wherein businesses with weak financial profile, no succession planning etc would like to exit. This might throw up lucrative M&A opportunities for the established players. ROSSARI’s back-to-back acquisitions at reasonable valuations are the testimony of the same.

Margins have bottomed out: While the supply challenges are still not over, we believe that margins have bottomed out and expect a sequential improvement. While business growth is not back to normal, pass-through impact and change in the freight model (FOB + actual freight) would help some of these companies to report EBITDA margin expansion. In CFIN, higher utilisation at Dahej and new product launches will lift the company’s margin profile. ADVENZY’s margin could be under pressure considering the tepid growth guidance during the year.

Valuation and outlook: Oleochemicals stocks have not corrected (in fact, they have gone up) despite weak quarterly growth. We believe that the structural growth story is intact and hence we still see value (backed by DCF calculation) in these names. We like ROSSARI on account of multiple growth avenues with focus on core chemistries, but do not see a meaningful upside from a 1-year perspective. CFIN and ADVENZY are trading at relatively lower valuations; consistency in earnings delivery and better execution could be re-rating triggers.