Sudarshan Chemical Initiating Coverage Research Report By HDFC Sec (Vijay Kedia Portfolio Stock)

Sudarshan Chemical

Leaping into the league of giants

For the period over August-16 to November-20, the stock of Sudarshan Chemical Industries Ltd (SCIL) was merely up by 10%, despite EBITDA expanding at a 10% CAGR, and PAT doubling at a 19% CAGR. This is after considering the 48% stock rally from its March-20 lows until November. SCIL plans to become the third-largest pigment manufacturer globally by developing R&D capabilities, operational efficacy, and expanding to new geographies. Global scale is the key to success in the pigment business.

Two major global players shifting away from the pigment business could act as a tailwind for Indian pigment manufacturers. We believe SCIL is in a sweet spot to seize this opportunity by offering products similar to those of global players. We initiate coverage on the stock with a BUY recommendation. Our DCF-based target price of INR 550/sh (WACC of 10% and terminal growth rate of 3%) implies an upside of 21.5% from the current level (implied PE of 24x).

On the path to becoming the third-largest pigment manufacturer globally

In India, SCIL is the largest pigment manufacturer (with >35% market share) while globally, it is the fourth-largest. We believe it is positioned well to achieve the top-3 status by focusing on its core business, developing R&D, expanding to new markets, and improving manufacturing and operations. We also believe that having this global scale is essential to success in pigments as it leads to sustainable growth, cheaper feedstock, and access to cutting-edge technologies.

Capex to focus on high-value products and new product launches

SCIL’s current Capex cycle was started in FY17. It has incurred INR 5.5bn over FY17-20 and planned for INR 3.5bn over FY21-FY22E. While a significant portion of Capex targets growth, some part of it is targeting margin expansion. We expect asset-turnover to be ~2.3-2.5x at peak utilisation.

Further, SCIL is enhancing its product mix towards higher-margin and higher-realisation speciality products such as azo pigments, cosmetics and pigment dispersions vs. non-speciality ones. It plans to launch ~25 products globally.
Earnings to grow at a 20% CAGR, and return ratios to improve over FY21-24E

We expect revenue to grow at a 14.8% CAGR over FY21-24E given SCIL’s plans for geographical expansion and new product offerings, while, APAT CAGR would be ahead of revenue growth at 20%. SCIL will generate OCF/FCF yield of 7.5/4.2% in FY24E. RoE and RoIC to expand from 19.0/11.5% in FY21E to 23.9/15.3% in FY24E. Valuations are contextually moderate at 22.8/17.9x FY22/23E EPS.