Sumitomo Chemicals India Ltd Research Report By Nirmal Bang

Emerging MNC proxy in Indian CPC growth story

We initiate coverage on Sumitomo Chemicals India Ltd (SCIL) with a Buy rating and a target price (TP) of Rs348, based on a target PE of 38x on FY23E EPS. The stock’s valuation looks reasonable at 32.41PE on FY23E at CMP despite its more than 40% rally in the last 11 months since listing. SCIL has access to new innovator products and global distribution reach of its Japanese parent Sumitomo Chemicals Co. Ltd., Japan (SCC) across several markets in Asia, EU, NA and LatAm. The company gets close to 29%/71% of its revenue from Specialty/Generic Products and 80%/20% from domestic/export sales. SCIL has delivered healthy growth with a CAGR in revenue/PAT of 12.6%/27.4% over FY18-20. SCIL in August 2019 took over and merged the CPC business of Excel Crop Care (ECC), promoted by the Shroff family (led by A.C. Shroff).

The seeds of this merger were planted in CY16 when SCC had acquired a 65% stake in ECC, which had enjoyed 9%/27% average annual growth in revenue/PAT over FY11-FY15. ECC stock’s valuation had started getting rerated over this period from 5.1x to 16.6x on 1 year forward PE. ECC got rerated further to 23.7x-41.2x PE over FY16-FY18 (on average EPS growth of 15% p.a), driven by its MNC parentage. We expect SCIL to deliver compelling stock returns in future underpinned by (a) Indian farm sector reforms and (b) record monsoon supporting healthy soil conditions and a favourable crop outlook that will be positive for near double-digit growth in domestic segment and (c) new product launches and dealer network supported by the parent that will aid export growth. Potential increase in high margin Specialty segment (29% of revenue) and new business from SCC Japan are added positives.

Domain expertise in innovator chemicals in AI/Formulations: SCIL with the support of parent SCC brings domain expertise in the CPC business, including innovator molecules in AI and Formulations across various crops as well as categories, much as Insecticides dominates the share at 47%. Parent SCC’s efforts in bio solutions through its US arm ValentBioSciences could also eventually give SCIL access to new products in biopesticides, which represents the next gen in CPC.

Healthy growth prospects for CPC business: The Global CPC industry is likely to grow from US$57.79 in CY19bn to US$62.8bn by CY25, driven by India, China, LatAm, US and EU. The thrust in India is likely to be on herbicides and fungicides, as in both these segments India has favourable factors such as labour shortage in the former and global lead in fruits & vegetable crop at over 300mn tpa.

Earnings CAGR of 19.6% over FY21E-23E: We estimate revenue CAGR of 9.6% over FY21-23E, driven by 9.4%/10.4% growth in domestic/exports, along with EBITDA margin of 19%/21.6% in FY22E/FY23E.

Healthy balance sheet and return ratios: SCIL has delivered average ROE of 17.7% over FY18-20 post merger vs. ECC’s 15.5% over FY11-17. The balance sheet remains strong as we see net cash rising from Rs1.8bn to Rs8.3bn over FY20-23E. We expect attractive return ratios – ROIC of 31.4%/33.7% and RoE of 23%/24.8% over FY22/23E.

Key risks: Crop/infestation growth being less than expected, delayed launch of new products and regulatory issues, lower-than-expected access to parent’s innovator molecules and global reach and potential levy of royalty by parent. Risk to good rains repeating in FY22 following two consecutive years of above average rains, which has happened only once before, as per global industry consultant Argus Media.

Rating rationale

Our Buy call is based on a favourable risk-reward at CMP based on attractive earnings growth, healthy return ratios and a net cash balance sheet.

Improving farm sector fundamentals are also likely to provide tailwinds for Indian CPC demand and growth prospects for SCIL in the longer term. This is based on the farm friendly policies of the government including the hike in MSP in crop marketing year FY20, the proposed farm sector reforms. Two successive monsoons have supported healthy sowing and crop output, improved prices and growth in consumption of agri-inputs including CPC.

The record rains this year have boosted reservoir water levels and soil moisture. This along with the increase in farm incomes YTD is positive for the curent Rabi season and offtake of CPC in 2HFY21 as per industry experts.