Vinati Organics

Background

Vinati Organics Limited was promoted by first generation entrepreneur Vinod Saraf in 1989 to manufacture specialty organic chemicals. Vinati is a niche player but has already achieved global recognition and size.

With ATBS, Vinati has broken into the exclusive club of ATBS manufacturers. There are only three other manufacturers of ATBS globally viz. Lubrizol (USA) ~14000 TPA, Toagosei (Japan) ~8000 TPA and a Chinese company with small capacity of ~2000 TPA.


Main Products/Segments

  • Iso Butyl Benzene (IBB) – largest manufacturer – 14,000 TPA – 60% global market share
  • 2-Acrylamido 2-methylpropanesulfonic Acid (ATBS) – 2nd largest manufacturer – 12,000 TPA -25% global market share.

In FY 2010 IBB contributed 54% , ATBS contributed 44% while Others contribute 2% of the Sales mix. Contribution from ATBS has been steadily growing over the years and in 1Q FY 2011, ATBS has already overtaken IBB contributing ~57% to the Sales mix.


Main Markets/Customers

Domestic market for its products is small, the Company exports bulk of its products to USA, Europe, Australia, Middle East and China. Export contribution in FY 2010 is ~75%

  • IBB – is the primary raw material for the popular painkiller Ibuprofen – supplied directly to Ibuprofen manufacturers like BASF (largest Ibuprofen manufacturer), Shashun Chemicals, Biocause (China) the other large scale Ibuprofen Manufacturers.
  • ATBS, Na-ATBS and other derivatives that the Company makes are specialty monomers having wide applications mainly in acrylic fibre manufacturing, adhesives, and personal care products. These are supplied to polymer manufacturers who then sell the polymers to users through their distribution channels. Direct sales of ATBS are only to acrylic fiber industry.
  • New Applications like Enhanced Oil Recovery & Water Treatment hold substantial potential for growth of ATBS and global demand is expected to go up 2-3 fold (Source: company)
  • Some of the key clients are BASF, AkzoNobel, Ciba, Perrigo, Rohm & Haas, Clariant, NALCO, Shasun Chemicals

Bullish Viewpoints

  • Competitive edge in niche specialty chemicals – Cost leadership & scale economies in IBB and technological entry barrier in ATBS are strategic advantages. VOL is making its presence felt in specialty chemicals where there is less competition globally, technology is not easily available and large players are probably not interested due to relatively smaller global market size of the products.
  • Most impressive track record in last 5 years – The growth snapshot shows while Sales have grown at a compound annual growth rate (CAGR) of 41.78%, EBITDA has grown at an accelerated pace of 73% CAGR over the last 5 years. EPS (adjusted for stock splits) has galloped away at over 112% CAGR on expanding margins. The profitability analysis shows Operating Margins have gone up from 10% in FY 2006 to over 22% in FY 2010. Net Margins have done better going up from 3.4% in Fy 2006 to over 17% in FY 2010. RoEis over 40% and RoCE at ~34% in FY 2010 from single digit figures in FY 2006.
  • Ranked #14 among India’s top 100 fastest growing companies -Economic Times, Oct 2009
  • Focus on high-margin ATBS – The worldwide demand for ATBS is about 30,000 TPA and is growing at about 10-15% annually.  Vinati has seen its ATBS business growing at 40%  in FY10 and sees this trend continuing in FY11. Moreover, it is expected that the demand of ATBS could double over the next 2-3 years due to its application in enhanced recovery oil polymers. Plans are on to expand ATBS capacity to 18000 TPA from current 10000 TPA by December 2011. Margins from ATBS are around 25-30% while those for IBB are around 15-20%.
  • Backward Integration into Isobutylene – The company has completed a backward integration project of ATBS by manufacturing Isobutylene (IB) a key ingredient. The IB plant with a capacity of 12000 TPA has commenced production in June 2010. Hitherto IB was imported from Europe & Taiwan in pressurized tanks. The freight cost per kg of IB is about Rs. 20. One kg of ATBS requires about 0.35 kg of IB. In FY11, VOL’s demand for IB could be atleast 3,000-4000 MTPA. Thus, the cost savings based on freight and captive consumption of IB alone could be to the tune of Rs. 6-8 cr.
  • Replace Import demand of IB in domestic market – ~4000 TPA of IB would be used for captive consumption while the remaining would be sold off in the market. Currently, the only domestic manufacturer of IB is Savla Cemicals who has a capacity of 5,000 MTPA. The demand for IB in the domestic market (not including VOL’s demand) is about 10,000 MTPA. The demand supply mismatch is currently being met by imports.
  • New products to add to revenue stream –  Several new products in pipeline are also coming onstream in 2HFY11 which include ATBS capacity expansion, Tertiary Butyl Acrylamide (TBA), Tertiary Octyl Acrylamide (TOA), Di-Acetone Acrylamide (DAAM). The new capacities of TBA, TOA and DAAM could help the company to improve turnover significantly by FY12.
  • Proximity to Mumbai and JNPT port – greater ease of logistics and access to advanced infrastructure facilities.
  • Environment-friendly operations include waste product recycling. With the aim to be a zero-effluent company, VOL has focused on recycling and monetising waste byproducts of ATBS like TOA, TBA, and DAAM as mentioned above.

Bearish Viewpoints

  • Highly dependent on two products – Currently VOL derives its revenue from two products – namely IBB and ATBS. Thus the company is highly sensitive to any additional capacities, market changes etc. affecting either of these two products.
  • Muted growth for IBB – IBB is the primary raw material for Ibuprofen a mature product with expected growth of ~3-5% CAGR. Capacity expansion and newer capacities from players like IOL Chemicals & Pharmaceuticals limited (6000 TPA) has started impacting margins.
  • Lower than expected offtake of IB – VOL has a 12,000 TPA facility of IB. Requirement for captive use of IB in ATBS is 3000-4000 MT. This is expected to go upto 6000 MT when ATBS capacity reaches 18000 MT by FY11 end. The company has been unable to sell the balance in the domestic market. Savla Chemicals the other domestic manufacturer of IB is a competitor.
  • Aggressive Capex plans – As per FY 2010 Annual Report, VOL is carrying out capex of about Rs. 77 Cr in FY 2011. Also there is a 5MW co-generation plant (coal based) expected to be operational by end of FY11 involving a capex of around Rs. 33 Cr. While operational leverage takes time to kick in, there is a possibility of increased interest and depreciation costs, and lower capacity utilisations having a negative impact on bottomline. Execution risks remain significant as more aggressive plans have been announced and re-iterated in this August 2010 Analyst Meet.
  • Higher Tax payout from FY 2012 – ATBS manufacturing facility at Lote, Maharashtra enjoys 100% EOU tax exemption. Such tax breaks are available till March 2011. From FY12 onwards tax payout will see a big jump which will impact net margins significantly.
  • Volatility in crude oil prices – The main raw materials required for the manufacture of IBB and ATBS are crude oil derivatives such as toluene and propylene. Any major fluctuations in the prices of crude oil could adversely affect VOL’s performance (due to the 3 months time lag in passing on the increase in cost to its customers) especially for fixed price orders.
  • Foreign currency fluctuations – VOL exports ~75% of Sales. Thus, it is a net receiver of foreign exchange. It procures raw materials through imports and local purachases, where local purchases track import parity price.Thus raw materials and the FCNR loan it has taken provides a partial natural hedge. Unforeseen sharp fluctuation in the value of the Rupee could affect its realization and margins at least temporarily. Long Term contracts have provisions for shared currency risks.

Barriers to entry

  • ATBS technology is exclusively licensed from National Chemical Laboratories (NCL) Pune. The process developed by NCL is protected by two US patents (6,504,050 and 6,660,882). A third PCT application has been filed. Development of Process Technology for SMAS & ATBS
  • IBB technology is licensed from Institut Francais du Petrole (IFP) France. With 60% market share VOL enjoys cost leadership & scale economies in IBB
  • Its not easy to manufacture these products to exacting requirements of quality. It took Vinati 4 years to get the quality right on ATBS.
  • Since these are niche products with only a few large scale suppliers, major customers usually enter into long term contracts. BASF had entered into a 5yr contract for IBB (till FY 2011). ATBS contracts are of 1-3 years durations.

Interesting Viewpoints

  • The worldwide demand for ATBS is about 30,000 MTPA and is growing at about 10-15% p.a. Moreover, it is expected that the demand of ATBS could double over the next 2-3 years due to its application in enhanced recovery oil polymers. (Source: company, HDFC Securities)
  • Backward integration into IB may assist in VOL’s quest for leadership position in ATBS
  • The company is further de-risking its product profile by investing in a new product Para Amine Phenol (PAP). A key ingredient in manufacture of paracetamol, PAP is being produced in a pilot plant using a new NCL Pune developed technology, (single step catalytic hydrogenation of nitrobenzene) since there are issues of large amount of effluent generated and technological gaps in the existing conventional technology. The technology is meant to be environment friendly and competitive internationally with other technology
  • The company has already invested around Rs 4 crore on R&D and hopes to complete the pilot trials on PAP by October 2011 when more clarity would emerge. Once the pilot runs are successful, VOL could set up the plant which would take another 18 months to go onstream. If successful the prospects of VOL could further improve from here on.

Disclosure(s)

Donald Francis: No Holdings in the Company;


Vinati Organics

Company Background

Vinati Organics Limited was promoted by first generation entrepreneur Vinod Saraf in 1989 to manufacture specialty organic chemicals. Vinati is a niche player but has already achieved global recognition and size.

  • Iso Butyl Benzene (IBB) – the primary raw material for the popular painkiller Ibuprofen. It is the largest manufacturer with a 14,000 TPA manufacturing facility and has ~ 60% global market share
  • ATBS (2-Acrylamido 2-methylpropaneargest manufasulfonic Acid) – It is the 2nd largest manufacturer with a 12,000 TPA capacity and a 25% global market share. Vinati has broken into the exclusive club of ATBS manufacturers. There are only three other manufacturers of ATBS globally viz. Lubrizol (USA) ~14000 TPA, Toagosei (Japan) ~8000 TPA and a Chinese company with small capacity of ~2000 TPA.

Domestic market for its products is small, the Company exports bulk of its products to USA, Europe, Australia, Middle East and China. Export contribution in FY 2010 is ~75%. In FY 2010 IBB contributed 54%, ATBS contributed 44% while Others contribute 2% of the Sales mix. Contribution from ATBS has been steadily growing over the years and in 1Q FY 2011 ATBS has already overtaken IBB, contributing ~57% to the Sales mix.

Main customer segments:

  • IBB – is the primary raw material for the popular painkiller Ibuprofen – supplied directly to Ibuprofen manufacturers like BASF (largest Ibuprofen manufacturer), Shashun Chemicals, Biocause (China) the other large scale Ibuprofen manufacturers.
  • ATBS, Na-ATBS and other derivatives that the Company makes are specialty monomers having wide applications mainly in acrylic fibre manufacturing, adhesives, and personal care products. These are supplied to polymer manufacturers who then sell the polymers to users through their distribution channels. Direct sales of ATBS are only to acrylic fiber industry.
  • Some of the key clients are BASF, AkzoNobel, Ciba, Perrigo, Rohm & Haas, Clariant, NALCO, Shasun Chemicals

As per the company, New Applications like Enhanced Oil Recovery & Water Treatment hold substantial potential for growth of ATBS and global demand is expected to go up 2-3 fold.


Growth Snapshot

We can’t just look at a series of past growth rates and assume that they will predict the future – if investing were that easy, money managers would be paid much less, and this stock analysis would be much shorter. It’s critical to investigate the Sources of a company’s growth.
Variable FY06 FY07 FY08 FY09 FY10
Sales Turnover (Rs. Cr.) 65.20 90.46 161.36 203.47 238.44
Sales Growth Year on Year 43.07 78.34 30.19 21.65
3yr Average Sales Growth 50.53 43.39
3yr Sales CAGR 59.73 52.37 25.85
5yr Average Sales growth 43.31
5yr Sales CAGR 41.78
Profit After Tax (PAT) (Rs. Cr.) 1.95 3.51 15.20 25.13 40.04
Adjusted EPS 0.40 0.71 3.08 5.09 8.11
EPS Growth Year on Year 80.00 333.05 65.33 59.33
3yr Average EPS growth 159.46 152.57
3yr EPS CAGR 179.19 167.57 62.30
5yr Average EPS growth 134.43
5yr EPS CAGR 112.87

Vinati Organics has made rapid progress over the last 5 years. The 5yr CAGR growth record is impressive- Sales have grown at over 40% annually, while EPS has grown at an astonishing 112%. What is behind this impressive growth?

Sources of Growth

Vinati Organic’s story has been primarily an export-led growth with strategic capacity build-up in carefully chosen product niches. Capacity so far has been expanded judiciously in tandem with market success and demand growth.

  • IBB was the key growth driver initially – may be muted from here on

In FY06 Vinati’s IBB capacity was 10,000 TPA which was increased to 14000 TPA by FY08. In FY07 it had signed up a long term 5yr deal (till 2011) with BASF that required BASF (the largest Ibuprofen manufacturer) to source majority of its IBB requirements from Vinati. As per the company monthly selling price of IBB is adjusted based on monthly world prices of key raw materials and USD/INR exchange rate, thus minimizing the Company’s risk exposure. By FY2008, Vinati was manufacturing 60% of the global IBB requirements. IBB is a mature product and worldwide growth is now projected at 3-5%. Since FY08, there has been no expansion in IBB capacity.

  • Growth kicker from ATBS

Vinati is one among 3 players worldwide to have access to ATBS manufacturing technology (protected by patents) and it is the 2nd largest manufacturer with 12000 TPA capacity. ATBS capacity in FY06 was 3000 TPA, which was expanded to 5000 TPA in FY08 and further enhanced to 10000 TPA by FY09. Current expansion announced to 18000 TPA, to be completed by May 2011, will make it the largest manufacturer in the world. ATBS capacity had trebled in last 5 yrs, and by FY12 slated to go up 6x in seven years! As per the company ATBS contracts have a quarterly pass-on of key raw material and USD/INR exchange rate exposure. Currently ATBS contributes 57% to the Sales mix.

  • Backward Integration/by-products/power co-generation

In FY10, Vinati has also completed a backward integration project for one key ingredient of ATBS, Isobutylene (IB) with a installed capacity of 12000 MT. This project was completed in June 2010 and will start contributing to the bottomline in FY11 as this finds captive use and import replacement demand in IB domestic market . Keeping in mind the increased energy consumption arising because of new facilities and expanded capacities, Vinati decided to setup a captive 6MW co-generation plant. The 6MW co-generation plant (coal based) is expected to be operational by end of FY11. Besides, a Diacetone Acrylamide (DAAM) plant of 1,000 MT capacity is being commissioned and a lot of capacity expansions are on the anvil: expanding the capacity of ATBS plant from 10,000 MT to 18,000 MT; of TBA plant from 300 MT to 900 MT; of ATFE capacity from 1,000 MT to 3,500 MT. Majority of the expansion program is to be completed by FY11 and would require an approximate capex of Rs. 120 Cr, as announced by the company.

  • Frenetic pace of expansion – cause for some concern

Annual Report FY2010 had announced a capital expenditure outlay of 77 Cr. But this has been been enhanced now to 120 Cr, as announced earlier and re-iterated in this August 2010 Analyst Meet . This will be funded through a mix of debt and internal accruals as announced by the company. Admittedly as per this conference call, the company is already operating at 90-95% ATBS capacity, but the frenetic pace of expansion carries significant execution and market risks. Company’s current debt burden is ~60 Crs. If these plans have to be funded, the company may have to take on sizeable debt exposure as cash flow accruals are around ~30 Crs. Debt/Equity levels may climb higher to 1.5 or so.


Profitability Snapshot

Profitability is the second, and in many ways, the most crucial, part of our Analysis framework. How much profit is the company generating relative to the amount of money invested in the business – the returns? This is the real key to separating a great company from average ones -the higher that return, the more attractive that business. Net profit Margins and comparing cash flow from operations to reported earnings per share are good ways to get a rough idea of the company’s profitability (because cash flow from Operations represents real profits!). But neither account for the amount of capital that’s tied up in the business, and that’s something we cant ignore. We need to know how much economic profit the company is able to generate per dollar/rupee of capital employed because it will have more excess profits to re-invest which will give it an advantage over less-efficient competitors.
Variable FY06 FY07 FY08 FY09 FY10
Operating Profit Margin 10.11 10.14 17.30 17.38 22.74
Net Profit Margin 3.40 4.28 10.39 13.19 17.28
Fixed Asset Turnover 1.56 2.28 3.58 4.26 2.91
Asset Turnover 1.15 1.48 1.90 1.64 1.43
Return on Assets 3.91 6.31 19.75 21.69 24.67
Financial Leverage 1.82 1.86 1.80 1.79 1.64
Return on Equity 7.14 11.74 35.63 38.72 40.37
Return on Capital Employed 8.43 13.49 34.32 30.36 34.63
Debtor Days 84.39 87.64 55.05 53.50 56.49
Inventory Days 68.39 48.95 42.00 32.87 43.37
Cash from Operating Activities (Rs. Cr.)
Operating Cash Flow to Sales
Capital Expenditure 3.25 17.07 39.61 34.80
Free Cash Flow
Free Cash Flow to Sales
Equity Dividend (Rs. Cr.) 0.66 0.79 1.97 2.47 4.94
Dividend per share 0.20 0.24 0.40 0.50 1.00
Adjusted DPS 0.13 0.16 0.40 0.50 1.00
Dividend Growth Year on Year 19.70 149.37 25.38 100.00
3yr DPS CAGR 72.77 76.82 58.35
5yr DPS CAGR 65.40
Dividend Payout 33.85 22.51 12.96 9.83 12.34

 

Vinati Organics 5yr profitabilty snapshot looks impressive. However, this achievement is on a very small base, and typical risks associated with small companies of this size, apply. Please see Bearish Viewpoints in our stock story section, for the overall picture.

On the margins front, Operating Profit Margin (OPM) has steadily improved year on year to reach ~23% in FY10 from just about 10% in FY06. In FY10, operating margins have seen a big jump by over 5%. This is on the back of an unusually good year for IBB (20-25% margins). This will probably be hard to sustain in FY11 as IBB margins (usually 15-20%) have started to get hit because of increased supply from new competitors like IOL with a 6000 TPA IBB capacity. The falling margins may be compensated by somewhat higher margins (usually 20-25%) enjoyed by ATBS, its increasing contribution to sales mix, and the backward integration benefits from IB.

The Net Profit Margin (NPM) record is better, showing a steady climb form 3.4% to over 17% in FY10. This is on the back of a steadily reducing interest burden and debtors and inventory levels. Its great to see debtor days coming down from ~84 days in FY06 to ~56 days in FY10. Similarly Inventory days have come down from ~68 days in FY06 to ~43 days in FY10. This is good working capital management and confirms the Management focus on operational efficiency. Net margins may lower a bit from current levels in FY11 due to higher depreciation and interest costs incurred in the year consequent with the pressure on Operating margins.

Although Asset Turnover has declined gradually over the last 3 years due to rapid capacity expansions, the rising net profit margins have ensured that Return on Assets (RoA) climbed from ~4% in FY06 to over 24% in FY10. We can think of ROA as a measure of efficiency. Companies with high ROAs are better at translating Assets into Profits.

The rising net profit margins and asset turnover (with a gradually declining Financial Leverage) has ensured Return on Equity (RoE) has climbed from ~7% to over 40% by FY10. RoE is a good measure of overall profitability as it measures the efficiency with which a company uses shareholders’ equity. We can think of it as measuring profits per rupee of shareholders’ capital. The Return on Capital employed record is similar going up from 8% in FY06 to over 34% in FY10.

Although cash flows has improved substantially from FY06 levels, the company does not have a good a record on Operating Cash flows which has mostly lagged behind Net profits, even if increasing over the years. The company is also far from recording any Free Cash Flow (FCF) as business growth has necessitated continuous capacity expansion. It needs to be noted that Capital Expenditure (Capex) of some 120 Cr is slated for FY11 on several expansion projects. This is roughly 3x the capital expenditure incurred in earlier years, and carries execution risks and much higher debt exposure.

Dividend payments have been steadily rising to register a 5yr DPS CAGR of over 65%. Vinati Organics is a good dividend payer with a consistent track record – infact dividend per share doubled in FY10 over FY09.


Common size P&L Statement

Can we dig deeper to see what else we can understand about how this company makes money? A good way is to look at the common size profit and loss statement. Common size statements are great tools for evaluating companies because they put every line item in context by looking at each of them as a percentage of Sales.
Variable FY06 FY07 FY08 FY09 FY10
Common Size Sales 100.00 100.00 100.00 100.00 100.00
Common Size Raw Material 66.40 66.58 65.76 63.70 59.52
Common Size Power & Fuel 3.33 3.91 3.68 3.99 5.18
Common Size Employee Cost 7.22 6.17 4.24 4.64 4.96
Common Size COGS 73.43 74.61 71.97 70.29 68.60
Gross Profit Margin 26.57 25.39 28.03 29.71 31.40
Common Size Depreciation 4.15 3.30 2.00 1.71 2.13
Common Size Interest Cost 2.16 2.40 2.23 1.73 1.91
Common Size SG&A 13.51 14.61 12.01 12.04 10.87
Operating Profit Margin 10.11 10.14 17.30 17.38 22.74

Raw material as a percentage of Sales has been coming down over the years with good reductions in FY09 & FY10 which has helped boost Operating Margins. The company claims its long term contracts terms allow it to pass on raw material price escalations to the customers after a time lag. For IBB it can resort to monthly price revisions, whereas for ATBS it can pass on revisions after a quarter.

Power and fuel costs had ranged from 3-4%, but has risen sharply in FY10 to over 5%. The company seems to be seized of this as it has announced plans to set up a 6MW co-generation plant. Interest and Depreciation costs played within a 2% range for last 3 years or so. This is due to see a jump up in FY11.

Selling & General Administration overhead costs have seen a gradual declining trend from ~14% to about 11% in FY10. This is a good trend as the company is able to probably leverage its existing customer relationships and has better visibility in its market.

The increased depreciation & interest costs in FY11 may be a bit of a dampner to the overall picture. However the record points to a focused management that seems to be knowing & running its business well. It has made significant improvements in managing overhead costs. The raw material price revision clauses protect it from big surprises and it has initiated steps to bring power & fuel costs back in line.


Financial Health Snapshot

Once we have figured out how fast (and why) a company has grown and how profitable it is, we need to look at its financial health. Even the most beautiful home needs a solid foundation, after all.
Variable FY06 FY07 FY08 FY09 FY10
Financial Leverage 1.82 1.86 1.80 1.79 1.64
Debt to Assets 0.45 0.46 0.45 0.44 0.39
Debt to Equity 0.82 0.86 0.80 0.79 0.64
Interest Coverage 3.39 3.81 8.10 10.69 12.72
Interest Cost to Total Debt 5.51 7.67 9.51 6.46 7.00
Current Ratio 2.12 2.26 2.54 2.79 3.60
Quick Ratio 1.47 1.72 1.87 2.11 2.59
Cash to Assets 2.77 1.58 1.78 1.63 1.10

 

Vinati Organics financial health over the last 5 years presents a decent picture.

Debt to Equity has been decreasing gradually over the years from 0.82x in FY06 to 0.64x in FY10. Financial Leverage and Debt to Assets mirror the same trends. Interest Coverage has been steadily rising over the years from ~3x in FY06 to ~12x in FY10, and thus its unlikely that it will run into difficulty in meeting debt liabilities if earnings should fall unexpectedly.

Liquidity measures like Current ratio and Quick ratio are comfortable, showing that the company is able to source enough cash to meet near-term liabilities. Cash to Assets position has however been declining and is pretty thin at ~1% of assets in FY10.

Overall it emerges that Vinati Organics has a decent balance sheet and is in a comfortable situation, on the financial front. It should be able to leverage its balance sheet to part finance its aggressive capital expenditure plans in FY11. This is the first time in last 6 years that Debt to Equity may shoot up over 1x and may touch ~1.5x. How well it executes its plans and its ability to manage the higher debt-exposure, remains to be seen.