Supreme Petrochem has very strong business model. Buy for target price of Rs 561 (51% upside): SMIFS

Supreme Petrochem Ltd
Capacity expansion & downstream focus to create value

Supreme Petrochem (SPL) has very strong business model in Polystyrene (PS) & Expandable Polystyrene (EPS) along with its downstream derivatives like XPS & SPC. The company is expanding its capacity in all business segments viewing the growth opportunities available post closure of business of its nearest competitor in India, increasing demand growth & strong balance sheet to fund capital expenditure. The company is dynamically shifting its focus from lesser margin PS products to margin accretive businesses like EPS, XPS, SPC & ABS. Also, exports is a huge opportunity & with SPL expanding capacity export share will increase in the long term. With expansion in existing capacity, the company is well poised to grow its presence further & getting greater visibility in international market. The business also has a strong moat because it requires handling of volatile raw materials like styrene & setting up a polystyrene business requires huge capital investment, government approvals are very difficult to crack & getting required customer approvals are lengthy & difficult which makes it impossible to dislocate any existing player in PS business. The company has very strong balance sheet, huge cash pile which will be deployed in expansion & stronger ROCE (25% average from FY15-22) & robust FCF yield (9% average from FY15-22). Considering the positives, we value the stock on 15x FY25 EPS of Rs 37.4 arriving at Rs 561 per share, upside of 51%.

Legacy business capacity expansion of PS will increase its foothold in domestic & exports market

▪ Historically, the company’s volume growth in the PS business has been ~3% CAGR from from FY15-20 which suddenly grew by ~22% CAGR from FY20-22 because of shutdown of LG polymers capacity of 1,50,000 TPA. Shutdown of LG Polymers led to shift in volumes towards Supreme Petrochem and its capacity started operating at peak utilization levels. Earlier, the company had nameplate capacity of 2,72,000 TPA (Effective capacity of ~2,20,000 TPA).

▪ In order to capitalize on the opportunity, the company has completed its capacity expansion of 80,000 TPA which will support volume growth going ahead. With this expansion, the nameplate capacity has been expanded to 3,52,000 TPA (effective capacity 3,00,000 TPA).

▪ Post capacity expansion & improvement in spreads from H1FY23 levels, we expect PS business to grow at 7% CAGR from FY23E-25E.

Focus on downstream brownfield expansion to unlock business opportunities

▪ The company is expanding into EPS (Expandable Polystyrene) & downstream derivatives like XPS (Extruded Polystyrene) & SPC (Special Polymer Compounds) to enter into value added products & derisk itself from mere polystyrene manufacturer & also diversifying its end use applications.

▪ In EPS business, the company has expanded its phase 1 capacity by 35,000 TPA post which its capacity is ~107,100 TPA. Post phase 2 capacity expansion which is scheduled to be completed by Sept 24, the capacity will be expanded to 1,30,000 TPA. Considering the niche applications of EPS in packaging & insulation, capacity expansion & strong demand, we expect EPS business to grow at ~19% CAGR from FY22-25E.

▪ The company is setting up second line of Extruded Polystyrene Board with annual capacity of 1,00,000 cubic meter. This line will have the facility to produce boards with width of 1200 MM which are now being imported. Currently the company is manufacturing less than 1200 MM boards from its existing capacity in XPS. The said expansion plan is expected to be completed by March 2024. We expect post expansion, XPS business to grow at 25% CAGR from FY22-25E.

▪ In SPC business, the company is expanding its capacity from 25,000 TPA to 75,000 TPA in phases by FY25E at capex of Rs600-700mn. Post capacity expansion, increase in utilization would lead to strong volume growth & hence we expect SPC business to report revenue CAGR of 33% from FY22-25E. Greenfield expansion in mass ABS will drive the growth going ahead

▪ The company is setting up a mass ABS Project of 1,40,000 TPA at their Amdoshi plant in two phases of 70,000 TPA each. Phase I is scheduled to go on stream by June 2024 and second Phase by March 2025. Mass ABS process is clean and environmentally friendly compared to conventional emulsion process, due to elimination of water pollution. The company has entered into an agreement for License and Basic Engineering Design with M/S Versailis – Eni Chemicals Group. The total project cost is estimated at Rs8.5bn for both phases.

▪ The company’s focus is on import substitution because roughly 1.1-1.2 lakh of ABS is imported and the market is consolidated with only 2 players in India. Entry of SPL will likely increase the competitive intensity in the ABS space.

▪ ABS is the preferred engineering plastic when it comes with automotive applications as it is extensively used in manufacturing automotive parts. Consumer durables including small appliances, household goods, toys are the major applications of ABS. Valuation

▪ Currently, the stock is trading at FY25E P/E of ~10x. We value the stock on forward P/E multiple of 15x owing to increasing share of speciality business, robust volume growth & strong exports growth and, thereby, arrive at target price of Rs 561 per share which offers upside of 51% from current valuations.