Scrip Code: 524200 / VINATIORGA

CMP: Rs. 465.35; Market Cap: Rs. 2,400.79 Cr; 52 Week High/Low: Rs. 591.00 / Rs. 360.95

Total Shares: 5,15,91,025 shares; Promoters : 3,73,03,247 shares – 72.31 %; Total Public holding : 1,42,87,778 shares – 27.29 %; Book Value: Rs. 109.63; Face Value: Rs. 2.00; EPS: Rs. 25.50; Dividend: 175.00 %; P/E: 18.39 times; Ind. P/E: 16.35; EV/EBITDA: 11.45 times.

Total Debt: Rs. 65.30 Cr; Enterprise Value: Rs. 2,438.95 Cr.

VINATI ORGANICS LIMITED: The Company was founded in 1989, Vinati Organics Limited (VOL) is an India-based company, which manufactures specialty organic intermediaries and Monomers. The Company is engaged in manufacturing of speciality organic intermediates and monomers, including IBB (Isobutyl Benzene), ATBS (2 Acrylamido 2Methylpropane Sulphonic Acid), NaATBS(Sodium Salt of 2 Acrylamido 2Methylpropane Sulphonic Acid, Diacetone Acrylamide and Isobutylene. The company gave bonus in November 2007 in ratio of 1 new share for every two shares held and then company split face value of its shares from Rs. 10 to Rs. 2 in October 2009. IBB finds application in the manufacturing of Ibuprofen, while ATBS is a specialty monomer with multiple applications such as industrial water treatment, oil field applications, construction chemicals, hydrogels for medical applications, personal care products, emulsion polymers, detergents, textile print pastes, adhesives and sealants, thickeners and paper coatings. In an effort towards backward integration, VOL executed a project for its ATBS plant to manufacture isobutylene (IB), which is one of the major raw materials. The IB plant in India is the largest plant with a capacity of 12000 TPA. Besides, VOL also manufactures Normal Butylbenzene (NBB), Sodium Salt of 2-Acrylamido 2- methylpropanesulfonic Acid (NaATBS), N-Tertiary Butyl Acrylamide (TBA), Hexenes and other industrial monomers on a small scale. The recent addition to its product portfolio includes isobutylene, high purity methyl tert butyl ether (MTBE) and methanol. The company’s products are exported to customers across the US, Europe and Asia. VOL is a market leader in its chosen product categories with presence across more than 22 countries globally. Company has plants in Mahad-Raigad which the biggest IBB manufacturing facility in the world. This plant has specialized equipment for the production of IBB that adheres to the highest standards of quality and purity. Company’s Ratnagiri plant has customized equipment for the manufacture of ATBS, TBA, IB, HPMTBE, DAAM and other speciality chemicals. ATBS is engaged in Emulsions for paints and paper coatings, water treatment chemicals, adhesives, hydrogels and absorbents, textile, auxiliaries, detergents and cleaners, acrylic fibre, construction polymers and oil field polymers. VOL’s products are Speciality Monomers 2-acrylamido 2-methylapropane sulphonic acid (ATBS) Sodium salt of 2-acrylamido-2-methylpropane sulphonic acid (NaATBS) N-Tertiary Butyl Acrylamide (TBA); N-Tertiary Octyl Acrylamide (TOA); Diacetone Acrylamide (DAAM) Specialty Aromatics Iso Butyl Benzene (IBB) Normal Butylbenzene (NBB). C 10 Aromatic Solvent, Hexene; its other Speciality Products includes Isobutylene (IB); Methanol; High Purity- Methyl Tertiary Butyl Ether (HP-MTBE); Miscellaneous Polymers; Vinflow HT; Vinplast 245 (Acrylic Super Plasticizer). Vinati Organics Ltd is locally compared to IOL Chemicals and Pharmaceuticals Ltd, Deepak Nitrite Ltd, Paushak Ltd, Dharamsi Morarji Chemical Co Ltd, Navin Flurine Industries, Panama Petrochem Ltd, Manali Petrochemicals Ltd, Adi Finechem ltd, Camphor and Allied Products Ltd, Resonance Specialties Ltd, Camlin Fine Sciences Ltd, Diamines And Chemicals Ltd, and globally with BASF, AkzoNobel, Clariant, Evonik, Cognis, Kemira, Lanxess, Rhodia, Wacker and Croda from Europe, Huntsman, Ashland, Chemtura, Rockwood, Albemarle, Cabot, W.R. Grace, Ferro Corporation, Cytec Industries and Lubrizol of USA.

Investment Rationale:

Established in 1989, Vinati Organics Ltd is a speciality chemical company producing aromatics, monomers, polymers and other speciality products. It is the world’s largest manufacturer of Isobutyl Benzene (IBB) and 2-Acrylamido 2- Methylpropane Sulfonic Acid (ATBS). The company’s products are exported to customers across US, Europe and Asia. VOL is a market leader in its chosen product categories with presence across more than 22 countries globally. Global Chemical Industry Chemicals are an essential part of our modern life and have a wide range of product based applications. In fact, the global chemical output, valued at $171 billion in 1971, is estimated to have increased to about $3.9 trillion value-wise in 2015. This industry faced a number of initial challenges, with the most important ones being in the form of the global meltdown of 2009 and the consequent economic headwinds. However, a series of cost-cutting measures, along with cash management, deleveraging of balance sheets, and divestment of underperforming businesses helped it to counter this scenario. The volume of global chemical output was expected to increase by 2.4 % in 2015 as against 2.7 % in 2012. The growth is likely to improve further to 3.8 % in 2016, given the improving economic conditions. According to the American Chemistry Council (ACC), the regions that are expected to lead this growth include the Asia Pacific, the Middle East, and Africa. The global speciality chemicals market is expected to grow at a CAGR of 5.16 % over the period 2013 to 2018. One of the key factors contributing to this market growth is the increasing demand for specialty chemicals products in the rapidly developing countries of the APAC region. The global specialty chemicals market has also witnessed an increase in merger and acquisition related activity, as key market players increase their attempts to penetrate the emerging markets. However, the increasingly stringent health and environmental regulations could pose a challenge to the future growth of this market. India’s growing per capita consumption and demand for agriculture-related chemicals offers a goldmine of opportunities for the domestic chemicals industry. With an increased focus on improving products and the usage intensity of speciality chemicals, the industry is poised to record strong future growth. The total market size of the domestic chemicals industry is expected to grow from US$ 108 billion in 2011 to US$ 290 billion in 2017. This segment includes dyes and pigments, leather chemicals, personal care ingredients and other speciality chemicals (excluding pharmaceuticals and agrochemicals). In 2015, the Indian chemical industry earned revenues in the range of US$ 155-160 billion. It is likely to grow further at a rate of 11 % to 12 % over the next two to three years. Indian Specialty Chemicals Market including knowledge chemicals as active ingredients in agrochemicals and pharmaceuticals has the potential to grow at a rate of 15 % p.a. to reach USD 40 billion by FY 2017. This growth potential is significantly higher than the projected 3 % p.a. growth rate for the global chemical industry or even the 10 % p.a. growth rate envisaged for the domestic sector. The chemicals industry in India is the largest consumer of its own products, consuming as much as 33 % of its total output. Given the promising growth trends witnessed in the chemicals industry, this internal consumption is all set to rise even further. The Indian chemicals industry has a diversified manufacturing base that is characterised by world-class product offerings. There is a substantial presence of downstream industries in all segments. At the same time, this large and expanding domestic chemicals market also boasts of a large pool of highly-trained technical personnel. Promising Export Potential Chemicals constitute 5.4 % of the overall domestic export volumes. India already has a strong presence in the export market in the sub-segments of dyes, pharmaceuticals and agro chemicals. India exports dyes to Germany, the UK, the US, Switzerland, Spain, Turkey, Singapore and Japan. Vinati Organics Ltd entered ATBS manufacturing by getting technology developed from National chemical Laboratories, Pune, and setting a manufacturing plant with an initial capacity of 1,200tpa in 2002. VOL was the third company globally to enter ATBS after Lubrizol and Toagosei. Acrylamide tertiary butyl sulfonic acid is a vinyl polymer. Led by its excellent hydrolytic and thermal stability properties, ATBS finds wide application in emulsions for paints and paper coatings, water treatment chemicals, adhesives, hydrogels and super absorbents, textile auxiliaries, detergents and Cleaners, acrylic fiber, construction polymers, and oil field polymers. But due to the captive manufacturing practice of Lubrizol and Toagosei, ATBS was not available at the right price-quantity for other applications. Leveraging the short‐supply position in ATBS, VOL continuously expanded its capacity to 26,000tpa in FY13 and emerged as the largest manufacturer of ATBS in the world with over 45 % of global market share. Its robust client base across various markets, including the US, Europe, Asia, the Middle East, and China, has been a key to VOL’s success in ATBS. It has some of the world’s largest specialty chemical companies in its client list, including BASF, Dow chemicals, Nalco Company (USA), AkzoNobel, SNF Floerger, Ciba, and Clariant chemicals, among many others. Vinati would be launching 4 new products next year- PTBT/ PTBBA (Para Tertiary Butyl Toluene / Para Tertiary Butyl Benzoic Acid), IBAP (Isobutyl AcetoPhenone), TB Amine (Tertiary Butyl Amine), 1 niche customized product. PTBT/PTBBA is an IB derivative which would be sold in the domestic market. Currently it is imported in India. The company claims to have a better & cost effective technology for these products and aims to entirely capture the domestic market by substituting the imported products and repeat the success story of IBB. With IBAP, Vinati would be forward integrating from IBB. IBAP is subsequently used in making Ibuprofen. Vinati claims to have a better and cost effective technology for IBAP too. While steady expansion in geographic reach and client base offered scale to VOL’s ATBS operation, its strategic backward integration to IB (Isobutylene) manufacturing made it the price Leader. VOL is the only backward‐integrated ATBS manufacturer in the world. VOL’s price leadership in ATBS contributes 46 % of its total sales is a key to its sector leadership in profitability. VOL launched innovative and cost competitive products like ATBS, IBB, and IB, supported by its technological tie‐ups with National Chemical Laboratories (India), Institut Francais du Petrole (France), and Saipem S.p.A. (Italy), respectively. Its continued captive research on productivity and efficiency earned it global leadership in ATBS and IBB. VOL is the largest manufacturer of IB India. Leveraging its in‐house research, it introduced new products, which like N‐Tertiary Butylacrylamide (TBA), NTertiary Octyl Acryl amide (TOA), High purity Methyl‐Tertiary Butyl Ehter (HP‐MTBE) and Diacetone Acryl amide (DAAM) and these new product lines make up about 15 % of its revenue share. The new products are fully integrated with existing ones as by‐products, co‐products, or their further processed products, which make VOL the most cost‐effective producer of these products. In its product pricing pattern, Vinati charges mark up as absolute value per kg which ensures consistent profit for its irrespective of general pricing trend of its raw material or finished product. IBB and IB pricing is negotiated with clients on a monthly basis whereas ATBS pricing is revised with a lag of one quarter. VOL has renowned clientele like BASF, Nalco, Shasun Chemicals, SMF, Clariant Chemicals are among its top 10 clients. The top 10 clients account for 50 % of revenue. Vinati's customer count is more than 60 and it exports to 22 countries. And its Export contributes around 66 % of revenue. All of its exports are dollar denominated. Leadership in sector capacity expansion and pricing power makes Vinati Organics a strong player in the Specialty Chemicals segment and with strong management it will surely prove its leadership.

Outlook and Valuation:

Vinati Organics, a leader in specialty chemicals, follows the strategy of becoming the market leader in whichever product it deals in and enters into a new product only if it has a better technology. It has a product portfolio of 15 products of which IBB (Isobutyl Benzene), ATBS (2-acrylamido 2-methylpropane sulphonic acid), IB (Isobutylene) and HP MTBE (High Purity- Methyl Tertiary Butyl Ether) garner 90 % of revenue. Specialty chemicals business is knowledge as well as process-driven. It takes years of knowledge and trial and error to develop the chemistry to meet not only international purity standards but also achieve a favourable price-performance ratio. Also, specialty chemicals are required to meet customized needs of different customers. One of VOL’s products, IBB, which is used as a raw material for manufacturing ibuprofen, demands a purity level of 99.5 %, as per international standards. Given its usage in making drugs, consistency in quality is of utmost importance. Although VOL started its business in 1992 by setting up an IBB plant in Mahad with an initial capacity of 1,200mt, it took eight years of concentrated efforts to get the commitment from its client. Starting 1998, VOL was able to sell at the most 100mt of IBB to clients. However, consistent improvement in IBB quality and multiple visits to US-based clients finally gave VOL its first major IBB order in late 2006. VOL not only meets, but also beats industry standards in purity by manufacturing IBB with purity ratio of 99.8 %, the highest level globally. VOL’s another product, ATBS, had to go through a rigorous process before the company could come up with a marketable product. Since December 2002, production of ATBS has been streamlined and the first batch of commercially manufactured ATBS was shipped to VOL’s clients globally. However, clients rejected the ATBS produced by VOL because of quality problems. VOL then started providing 18 different parameters for its product on the basis of which the quality of ATBS could be accessed. The learning process lasted till 2005 when it finally made a breakthrough. The acceptable quality of ATBS for Enhanced Oil Recovery (EOR), one of the areas where ATBS is used, is even higher than its usage in other applications. Weight of ATBS should be higher than 400,000 amu for it to be used for EOR. The company’s ATBS product successfully achieved high purity standards with a purity tolerance level of 0.5 % against the accepted global tolerance level of 3.0 %. VOL, in a tie-up with National Chemical Laboratory or NCL under the guidance of Dr. Barve, was able first to achieve this feat in India. NCL has exclusively licenced this technology to VOL. The process developed by NCL is protected by two US patents. VOL’s other two major products - IB and HP-MTBE - are of equally superior quality. The company’s IB product achieved a 99.85 % purity standard, which is among the highest in the world. HP-MTBE achieved a purity standard of 99.95 %, accepted as one of the highest globally. Hence, it is believed that given the time and complexity involved in making these products, it is extremely difficult for a new entrant to foray into this business. The specialty chemicals which VOL produces accounts for a tiny portion of total raw material costs of VOL’s clients and hence, the incentive for clients to change its supplier is very low unless the supplier is not able to provide good and consistent quality products. There are very few players present in this segment. It takes a long time to build quality products that are acceptable at the global level. Hence, a small player can’t start from scratch because the gestation period is very high. A bigger player may not like to get into this business as it is completely value-driven and not volume-driven. Revenue from specialty chemicals would make up tiny portion of total revenues of a big player. Hence it will be less beneficial for them to get into this space. The above two factors give companies like VOL tremendous pricing power. Even if VOL decides to marginally increase its prices, the impact of that increase on the bottom-line of clients will be minimal. This is evident from VOL’s highly consistent margin profile since the past five years. Isobutyl Benzene (IBB) was VO’s first product. It is a specialty chemical widely used as an intermediate in the preparation of Ibuprofen, an anti‐inflammatory/antiarthritic/ analgesic medicine for pain relief. Ibuprofen is primarily manufactured in India, China, and in the USA. It is also used in the perfume industry. VO is a market leader in IBB with more than 70 % global market share. It has the largest IBB manufacturing capacity in the world at 14,000TPA at Mahad, Maharashtra. It has acquired the technology to produce IBB from Institut Francais du Petrole (IFP), France. This is a mature product with demand of 20,000 TPA globally, growing at 5 % p.a. Vinod Banwarilal Saraf (a BITS Pilani graduate and an industry veteran) has been the key driving force behind the successful introduction of products such as IBB/ATBS and in the scaling up to global levels. He has hands‐on expertise in Grasim Industries in new chemical and petrochemical projects identification, technical tie‐ups, and feasibility studies. He worked as Managing Director in Mangalore Refinery & Petrochemicals Ltd. Mr Saraf’s decades of hands on industry expertise helped VO deliver 5‐8‐fold growth in revenue/profits over the last eight years. His leadership would ensure sustained business progress. Vinati Organics has capex of Rs. 200 Cr to be complete in FY17. The new products are likely to be launched throughout FY17 in a phased manner and ramp up will happen in subsequent 6months. At peak utilisation, Vinati is eyeing asset turnover of 2- 2.5x from these products. VOL has 5 MW Co-gen power plants in which it is investing Rs. 50 Cr, which would result in savings of Rs. 8 Cr in power costs starting FY18.While the company focuses on maintaining leadership position in each of its products, new product launches are expected to contribute to total revenue from 2HFY17. Reduction in prices of crude oil will lead to almost no demand for EOR (Enhanced Oil Recovery) chemicals. EOR constitutes 15% of ATBS revenue, which will lead to volume decrease in FY16 for VOL. And it is believed that the demand scenario to turn favourable from FY17E onwards on the back of new product launches and expectation of higher demand from user industries with favorable business dynamics. VOL's revenues and profits have grown at a CAGR of 24 % and 22 % over FY 11-15 respectively. The return ratios (ROE, ROCE) of the company have remained above 30 % over FY 11-15, despite a drop in leverage to 0.2x in FY15 from around 1x in FY13. The company's margins also have remained in low to mid 20s which was 26.5 % in FY15. VOL is looking to fund its current expansion worth Rs. 150 Cr through internal accruals. And as a diversified specialty chemicals company, VOL is a play on three key emerging trends like rising demand for specialty chemicals in India which is expected to be at 15 % CAGR from FY15-FY20E, the migration of global chemical manufacturing from China to India where Asia is expected to have 70 % production share by 2030 and established product positioning & lowest cost producer. The promoters of VOL currently holds 72.31 % stake in company and they have informed stock exchanges that they intend to increase their stake to 75.00 % which is to purchase 9 lakh shares at a price sub Rs. 500 per share from the secondary market from June 7, 2016 to December 6, 2016, if price goes above Rs. 500 they will refrain from buying. This buyback from the promoter is to offset the dilution done due to conversion of FCCB. At the current market price of Rs. 465.35, the stock is trading at a PE of 24.11 x FY16E and 19.88 x FY17E respectively. The company can post Earnings per share (EPS) of Rs. 19.30 in FY16E and Rs. 23.40 in FY17E. It is expected that the company’s surplus scenario is likely to continue for the next three years keeping its growth story in the coming quarters also .

KEY FINANCIALS	FY15	FY16E	FY17E	FY18E
SALES (₹ Crs)	766.30	604.70	718.90	841.00
NET PROFIT (₹ Cr)	115.80	99.40	120.90	149.60
EPS (₹)	22.40	19.30	23.40	29.00
PE (x)	17.60	20.50	16.90	13.60
P/BV (x)	4.70	4.00	3.30	2.80
EV/EBITDA (x)	11.10	12.10	10.00	7.90
ROE (%)	26.70	19.40	19.80	20.30
ROCE (%)	33.00	25.70	26.80	28.00

As I always say, I am a long term believer in markets & I do respect the markets and will keep a strict stop loss of 8 % on every purchase. (Why Strict stop loss of 8 % ?) -

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*As the author of this blog I disclose that I do not hold VINATI ORGANICS LTD in my any of the portfolios.

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