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.

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.

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.