Meghmani Organics Ltd Management Discussions.

Global Economy

After a strong growth in 2017 and early 2018, the second half of 2018 experienced a slowdown. Global economic growth softened to 3.6% in 2018 and it is projected to decline further to 3.3% in 2019. International trade and investments are moderating, trade tensions remain elevated, and financing conditions are tightening. Amid recent episodes of financial stress, growth in emerging markets and developing economies have lost momentum, with a weaker-than-expected rebound in commodity exporters accompanied by deceleration in commodity importers. Downside risks have become more acute. Financial market pressures and trade tensions could escalate, denting global activity.

However, growth is expected to pick up in the second half of 2019, driven by the absence of inflationary pressure and monetary policy accommodations by major economies. Moreover, the fiscal and monetary policy stimulus by China has helped to counter the looming negative effects of imposed trade tariffs, improving the outlook for US-China trade tensions.

Indian Economy

Indias GDP growth for FY2019 is expected at 7.2%. The Index of Industrial Production (IIP) grew by 3.6% in FY2019 and was majorly driven by growth in Infrastructure/Construction goods sector. Furthermore, inflation has remained well in control. The Wholesale Price Index (WPI) and Consumer Price Index (CPI) based inflation was at 3.18% and 3.41% respectively in FY2019. Additionally, the Reserve Bank of India (RBI) announced multiple rate cuts to ease the liquidity tightening. The Repo rate now stands at 6%.

The Indian economy grew steadily on account of various reforms like recapitalisation of public sector banks, amendments to goods and service tax, clean-up of Non-performing assets through National Company Law Tribunal (NCLT), implementation of Insolvency and bankruptcy code.

Company Overview

Meghmani Organics is a leading diversified chemical company poised for growth across its three (Pigment, Agro Chemicals and Chlor- Alkali & Derivatives) high potential business. Across the three sectors, the Company is one of the leading global pigment players along with a vertically integrated Agro Chemical player and a leading low cost Caustic-Chlorine player in India. The Company operates 7 facilities in Gujarat, including 3 major facilities for Pigments, Agro Chemicals and Chlor- Alkali & Derivatives in Dahej, the chemicals zone of Gujarat. Over the years, the Company has built an extensive pan-India and global footprint with presence in more than 75 countries and a portfolio of over 400 clients.

Meghmani Organics delivered another year of strong performance with the consolidated growth of 16% YoY to INR 20880 million. Sale of high margin products and favourable demand supply situation has resulted in expansion of 220 bps in the EBITDA margin reaching 26.1%. EBITDA for the period increased by 26% to INR 5445 million. The company reported the highest ever PAT of INR 2513 million, increased by 47%. It is continuing to enjoy the strong return ratio, with Return on Equity of 26.3% and Return on Capital Employed of 29.2%.

Agro Chemical Market

Global chemical-based crop protection sales increased by 4.2%, from $54.2 billion in 2017 to $56.5 billion 2018. Rising demand for pesticides and increasing consumption of Agro Chemicals in liquid form are some of the key factors expected to boost the demand for Agro Chemicals in the global market.

Recovery in the Brazilian market (one of the largest Agro Chemical consumers in the world), is the major driver of growth in 2018. The excessive crop protection inventories, which resulted in the 2017 decline have been addressed and are no longer such an issue.

High crop protection prices are mainly on the account of supply shortages, particularly higher prices of products originating from China as a result of the environmental pressures from government, consolidation in the national industry and shifting of all chemical production in chemical zone/parks. Higher prices have also driven higher tariffs imposed by the US on some Chinese chemical products. As a result, industry has passed on the higher price to consumers.

Huge opportunity for Generic Pesticides players:

Agro Chemical worth $6.3 billion are going off patent between 2014-2020 and more Agro Chemical active ingredients (AIs) will lose patent protection between 2019- 2026. With so many products coming off patent, industry players have the opportunity to choose the right off-patent/generic AIs for their product development strategies.

India Agro Chemical Industry:

Indian pesticides market valued at INR 197 billion in 2018 and expected to reach INR 316 billion by 2024, growing at CAGR of 8.1% between 2019-2024. The significance of pesticides has been rising over the last few decades catalysed by the requirement to enhance the overall agricultural production and the need to safeguard adequate food availability for the continuously growing population in the country. In India, pests and diseases, on an average eat away around 20-25% of the total food produced.

Key growth driver of pesticides:

• Due to increasing urbanisation levels, per capita arable land has been reducing in recent years and expected to reduce further in coming years. Driven by rising population levels, food demand is expected to continue increasing in the coming years and pesticides to play a key role in increasing the average crop yields.

• Government initiatives to provide credit facilities to farmers is expected to provide a strong boost to the pesticides industry. Increasing availability, low interest rates on farm loan and farm loans waivers are expected to encourage farmers to use more pesticides in order to improve yields.

• Increasing awareness of pesticides among farmers.

• The penetration levels of pesticides in India are significantly lower than other major countries such as the US and China and world average. This indicates that the market for pesticides is still un-penetrated India.

Business Overview

Meghmani Organics is a leading vertically-integrated Agro Chemicals player with the presence in entire value chain — Intermediate, Technical grade and Formulations (bulk and branded). The Companys vertical integration of business allows Meghmani Organics to effectively manage raw material costs and assure a constant supply of consistent quality.

The Agro Chemicals industry is highly regulated, and the Company enjoys competitive advantage via presence in entire value chain (less dependent on raw material) and 268 export registrations, 238 registrations in pipeline, 348 CIB registrations, and 35 registered trademarks. The Company has a strong global client base with exports accounting for 74% of its Agro Chemical sales. The Company exports Technical as well as Formulation (bulk and branded) products to Africa, Brazil, Latam, the US and European countries.

Major products include 2,4D, Cypermethrin, Bifenthrin, Permethrin, Chlorpyrifos and Profenophos. In branded formulations, the Company has established a strong pan-India presence with about 3000 stockists, agents, distributors, and dealers spread across pan India. Key brands include Megastar, Megacyper, Megaban, Synergy, Courage, Correct and Mega Claim.

The Company has three state-of-the-art manufacturing facilities where capacities have been increased via debottlenecking. These are located at:

• GIDC Ankleshwar, (6,420 MTPA)

• GIDC Panoli, (7,200 MTPA)

• GIDC Dahej, (14,640 MTPA)

Performance of Agro Chemical Segment:

Meghmani reported a strong performance in FY2019 and the net sales grew by 23%, to INR 7707 million from INR 6,273 million in FY 2018. This was driven by robust growth of 36% in exports. Volumes for the year stood at 16430 MT. EBITDA was significantly increased by 83%, from INR 981 million in FY 2018 to INR 1796 million in FY 2019, on the back of positive market conditions and better price realisations. EBITDA margin for the period also increased to 22.7% from 15.3% in FY 2018. Utilisation level for the year stood at 66%. FY 2019 was a strong year on account of favourable market condition, better realisation and product mix.

Outlook and Strategy :

FY 2019 was a strong year for the Agro Chemicals segment on the back of favourable market conditions.

FY 2020 shall also sustain the same growth levels as the raw material prices from China has increased significantly affecting the margins, but, Meghmanis backwards integration facilities put it in an advantageous position and thus, we are constantly improving the margins. Going forward, the Company plans to double the capacity of 2,4D by adding 10,800 MTPA with capex of ~INR 1.27 billion and it is expected to be operational by Q1 FY 2021.

Risks, Concerns and Threats

Despite strong growth drivers, the Indian Agro Chemicals industry faces challenges in terms of dependenance on the monsoon. Erratic rainfall affects crop acreages, pest application and overall productivity, directly impacting the Companys sales performance.

The Company exports its products to various countries. Thus, any adverse changes in the political, climatic, economic, regulatory or social conditions of these countries might impact the Companys business prospects in these countries. Any change in the policies implemented by the Governments of these countries, which result in currency and interest rate fluctuations, capital restrictions, changes in duties & taxes and a registration regime detrimental to the Companys business could adversely affect its operations and future growth. Increase in crude prices will also impact the costs and prices of various products.

Pigment:

Industry Overview :

The global pigment market was valued at $29 billion (organic as well as inorganic Pigments) in 2017 and is expected to grow at 4.5% CAGR to reach $43 billion by 2026.

The global pigment market is driven by the rise in demand for packaging ink, paints & coatings and plastic industry. Paints and coatings are used in various end-user industries such as aerospace, automotive, architectural & refinishing and building & construction. Rise in population coupled with increase in per capita income has boosted the consumption of paints and coatings in decorative and industrial paints, automotive, and consumer goods industries over the last few years. This, in turn, generated considerable demand for pigments in the paints & coatings segment, making it the leading end-user segment.

Plastics are one of the major consumers of pigments. It imparts unique appearance and styling effect to plastic products. Hence, rise in the production of plastics plays a key role in driving the demand for pigments. Consumption of plastics has increased substantially in both developed and developing countries over the last few years. Factors such as economic growth, rise in disposable income, and rapid urbanisation in developing countries such as China, India, Brazil, and South Africa are expected to drive the demand for plastics.

In recent years, due to the rise of the Internet, global publications with organic pigments show a downward trend, but high- performance pigments and packaging ink pigments are growing year by year. Global packaging and printing market are expected to grow by 4.9% CAGR to reach $19.27 billion in 2026. Asia-Pacific region, such as China and India and other emerging economies are the key drivers for the development of packaging and printing market.

Business Overview

Meghmani Organics is amongst the top 3 (capacity wise) global pigment manufacturers of Phthalocyanine-based Pigments. The Company has vertically integrated facilities manufacturing CPC Blue (an upstream product, which too is sold to other Pigments manufacturers) and end products — Pigment Green and Pigment Blue. These Pigments products are used in multiple applications, including paints, plastics and printing inks.

The Companys Pigments business enjoys strong global presence with exports accounting for 82% of net sales. The Companys relationship with its clients is consistent, with 90% business arising from repeat customers. The Company has global presence in more than 65 countries with subsidiary in the US which helps in maintaining a front-end presence along with the ability to work closely with end user customers.

Meghmani Organics has three dedicated manufacturing facilities for Pigments products. These are located at:

• GIDC Vatva, Ahmedabad, (2,940 MTPA) where Pigment Green is manufactured

• GIDC Panoli, near Ankleshwar, (17,400 MTPA), where CPC Blue, Alpha and Beta Blue are manufactured

• Dahej SEZ Ltd, (12,600 MTPA) where CPC Blue, Alpha and Beta Blue are manufactured

Performance of Pigments Segment :

Pigments business delivered net sales growth of 2.5% in FY 2019 and reached at INR 5893 million in FY 2019 from INR 5,747 million in FY 2018. Export sales stood at 81% in FY 2019. Sales volumes were at 15999 MT in FY 2019 compared to 16,090 MT in FY 2018. Utilisation levels remain at 76.6% in FY 2019. EBITDA during FY 2019 stood at INR 818 million. EBITDA margin slightly declined by 90 bps to 13.5% in FY 2019, primarily on account of higher prices of raw materials and competitive pressure from industry, company was not able to fully transfer higher prices to end consumer.

Outlook and Strategy :

Meghmani Organics currently is one of the largest producers for the Copper Phthalocyanine Pigment and going forward, the Company is looking to diversify by adding new Pigments. The Company continues to focus on increasing its domestic presence and increase the market share, given the significant market opportunities.

Risks, Concerns and Threats

Drastic changes and continuous fluctuations in the prices of key raw materials are critical challenges to the growth of this industry. As the Companys revenue comprises a significant portion of business from exports, volatility of the rupees vis-a-vis the Dollar and the Euro may affect realisations. The Company is engaged in a business involving different areas such as procurement, backward and forward integration, quality, technical competence, logistics facilities, after-sales service and customer relationship. Changing competitive landscape and emergence of new technologies may impact the Companys business and prospects.

Chlor Alkali Industry

Globally, Chlor- Alkali market represents one of the largest chemical industries. Chlor- Alkali market is expected to reach $124.6 billion by 2022, growing at CAGR of 6.8% between 2016-2022. The market is broadly categorised into three segments namely Caustic Soda (NaOH), Chlorine & Soda Ash, which are collectively known as Chlor- Alkali chemicals. The main application areas of Chlor- Alkali chemicals are in soap & detergent industry, paper and pulp, textiles, water treatment, plastic industry, industrial solvents, alumina, pharmaceuticals etc.

Sector wise Global Caustic Soda Consumption (FY 2018)

Indian Chlor- Alkali Industry:

The Indian alkali industry is regarded by global peers as among the most efficient, eco-friendly and progressive industries. It is to the industrys credit that its constituent units had taken a unified stand to move ahead of other countries in phasing out mercury and adopting the latest energy-efficient and eco-friendly membrane cell technology for producing caustic soda.

During financial year 2018, caustic soda capacity stood at 3.8 MMTPA (Million Metric Tonne Per Annum) with capacity utilisation of 84%. Over last 5 years, despite increase in capacity from 3.3 MMTPA to 3.9 MMTPA between FY 2014-2018, industry continuously operating above 80% and demand remains higher than the production. Caustic soda capacity expected to increase by 329,450 MTPA (up by 8.5%) and 205,950 MTPA (up by 4.9%) during FY19 and FY20 respectively.

Significant growth potential for Alkali and Chlor-Vinyl industry in next 5 years as the alkalis are the basic building blocks that find application in product of everyday use including aluminium, paper, textile and plastic. With growing aspirations of a rising middle class, higher disposable income and currently low level of penetration, demand for these products is bound to grow. There is a vast untapped market, which will significantly drive demand. India has one of the lowest per capita consumption of 1.9 kg caustic soda, 2.3 kg soda ash and 2.0 kg PVC compared to 32.0 kg, 28.0 kg and 12.7 kg in the US and 12.0 kg, 11.0 kg and 10.0 kg in China for caustic soda, soda ash and PVC respectively.

Business Overview

Meghmani Organics is one of the most efficient manufacturers of Caustic Soda with the Caustic soda capacity of 166,600 MTPA and Caustic Potash capacity of 21,000 MTPA. The Company has its own integrated captive power plant of 60MW and expanding it to 96MW. It is strategically located with proximity to the ports (importing coal) and customers (Caustic Soda and Chlorine supplied via pipeline), leading to lower logistic cost. It uses the latest fourth generation ‘Membrane Cell Technology sourced from Asahi Kasei Chemical Corp, Japan, (one of the most established technology providers of Chlor Alkali products). Since power cost accounts for 60% of total raw material cost in Caustic Soda production, Captive Power Plant provides power at lower cost resulting in high margins.

The Companys planned capex of INR 6.4 billion involving 3 projects are in-line with its strategic intent of expanding the chemicals business. The first is the CMS project of 40,000 MTPA, which will produce MDC, Chloroform and Carbon Tetra Chloride. This is expected to be commissioned by Q1 FY 2020. The second project expand capacity of Caustic Soda plant to 2,71,600 MTPA and increase the Captive Power Plant capacity to 96MW from 60 MW and is expected to get operational by Q3 FY 2020. The third project is to set up a Hydrogen Peroxide capacity of 60,000 MTPA which will also be commissioned by Q3 FY 2020

Performance of Basic Chemicals

FY 2019 proved to be a much better year than FY 2018 with net sales of Basic Chemicals growing at 19% to INR 710.4 million in FY 2019 from INR 5,975 million in FY 2018, driven by favourable demand and supply scenario, which has led to improvement in ECU prices. Sales volumes for the year stood at 156298 MT. EBITDA increased by 22% YoY from INR 2,554 million in FY 2018 to INR 3117million in FY 2019. EBITDA margin also increased by 120bps to 43.9% in FY 2019.

Outlook and Strategy

The Companys strategic investment in three projects are progressing as per plan. CMS project is expected to be operational in Q1 FY 2020. The basic advantage of CMS plant at Dahej facility is in-house availability of Chlorine, which will help to reduce the cost of production and improve the profitability. Caustic soda capacity expansion and Hydrogen peroxide projects are expected to be operational by Q3 FY 2020. Successful operation of all three projects and coupled with continued strong performance by Caustic Soda, will be the key drivers for profitable growth of the Basic Chemicals.

Risks, Concerns and Threats

We operate in a competitive environment and compete with international as well as domestic players on various fronts, such as quality, technical competence, distribution channels, logistics facilities, after-sales service and customer relationships. New Capacity additions and dumping of Caustic Soda from neighbouring countries might impact realisations of the Electrochemical Unit (ECU).

Internal Control System

The Company has a proper and adequate system of Internal Controls commensurate with the size and nature of its operations to ensure that all assets are safeguarded against unauthorised use or disposal, ensuring true and fair reporting and compliance with all applicable regulatory laws and company policies. Internal Audit Reports are reviewed by the Audit Committee of the Board.

The following ratios reflect the consolidated financial performance for the year in relation to the previous year.

Particulars (Rs mn) FY 2018 FY 2019
Net Sales 18,034 20,880
EBITDA 4,312 5,445
PBT 3,257 4,086
PAT before Minority Interest 2,379 2,943
PAT after Minority Interest 1,713 2,513
Key Ratios
Net Sales Growth 27% 16%
EBITDA Margin 24% 26%
ROE 24% 26%
ROCE 24% 29%
D/E ratio 0.35 0.62