Meghmani Organics Ltd Management Discussions.

The Financial Year 2017 was another year of steady profitable growth for Meghmani Organics with 7% growth in revenue and EBITDA margin maintained at 21%. This was despite the setback caused by the fire at the Companys Beta Blue plant during the year. The Rs. 6.5-bn mega capacity expansion done over the past 5 years across our businesses, i.e. Pigments, Agrochemicals and Basic Chemicals, has put the Company in good stead. The Company has developed a growing basket of higher-value-added and high-margin products, along with an extensive pan-India and global presence. Meghmani is now present in 75 countries with over 400 clients.

During the year, the Company witnessed continued growth in the Pigments and Agrochemicals businesses. Meghmani Organics is among the top 3 players in the world in Blue Pigment, with an increased market share of 8%. Following capacity expansion, the Company has increased its focus on the domestic pigments market. The Companys focus on building its branded agro formulations business has resulted in an expanded distribution network consisting of 2807 stockists, agents, distributors, and dealers, compared to 2370 in FY16. The Caustic Potash plant which began operations at the beginning of the year ramped up slowly due to technical issues, which have now been fully sorted out. So, the Company will now be able to quickly ramp up the plant to optimum utilisation. Meghmanis Return on Capital Employed (ROCE) continues to increase as the Company has consistently been reducing debt as per plan.

The year also saw the Company embark on its next landmark capex plan involving Rs. 5.4 bn of investments over the next 2-3 years. The project will be a major growth-driver, going ahead. It involves 3 projects. The first is the Companys CMS Project of 40,000 MTPA which will result in captive consumption of 41,000 MTPA of Chlorine (Co-product of the Companys Caustic Soda production), which currently has a negative realisation. So, this project will help the Company achieve better realisation in the Caustic Chlorine segment. The final product of this project is MDC (which mainly used by Pharma and Agro Chemical Industries and India is currently a net importer of the same), Chloroform and Carbon Tetra Chloride (CTC). This is expected to be commissioned by March 2018 and add Rs. 1.4 bn of revenue in the full year of operations. The Companys second project involves 50% capacity expansion of the Caustic Soda Plant to 2,40,000 MTPA using Zero Gap Membrane cell technology and increase the Companys Captive Power Plant capacity to 90MW from 60 MW now. Meghmanis third project is to set up a Hydrogen Peroxide (50%) project of 25,000 MTPA, which also used in Pharma & Agro Chemical Industries. The expansion of the Caustic Chlorine facility along with Power Plant and Hydrogen Peroxide projects will involve investments to the tune of Rs. 4 bn. These are expected to be commissioned by June 2019 and add Rs. 3 bn in revenue in the full year of operations.

During the year, the Company continued its efforts to increase production and capacity utilisation across segments. In fact, volumes have registered good growth in Pigments and Agrochemicals. The synchronisation process of the Caustic Potash facility had some impact on the Caustic Chlorine facility along with Power Plant utilisation and production.

FY18 looks to be more promising with all segments expected to progress: Agrochemicals with better industry demand driven by better monsoon in FY17 and expected good monsoon in FY18 along with the proposed key reforms and increased funds in Budget FY17, Pigments with increasing share of higher-value-added products as the Beta Blue plant is fully ramped up, and Basic Chemicals with increased utilisation of Caustic Potash.

FY17 witnesses continued momentum of profitable growth

The Company delivered revenue growth of 7% in FY17 on the back of good growth in Pigments and Agrochemicals, which increased 10% and 11%, respectively, despite challenges, such as subdued exports and a fire at the Beta Blue plant, pricing pressure in Agrochemicals due to channel inventory following 2 years of drought. Revenue from Basic Chemicals was stable on account of lower utilisation due to synchronisation of the Caustic Potash plant.

In terms of geography, domestic sales delivered revenue growth of 11%, whereas export revenue grew by 3%.

EBITDA for the period increased 11% to Rs. 2,888 mn on the back of improved operational performance, higher production and increased share of value-added products. This resulted in expansion of 77 bps in EBITDA margin to 20.6%. PAT grew by 6% to Rs. 878 mn on the back of improved financial leverage due to debt reduction, taking the PAT margin to 6.3%. Exceptional loss, resulting from the loss due to fire at the Beta Blue plant, was Rs. 38 mn.

The Company has reduced its long-term debt by Rs.1,171 mn this year and plans to further pay off Rs. 910 mn in FY18. The interest coverage ratio improved to 3.9X from 2.9X in FY16, thanks to better performance and lower cost of debt. The Companys Debt Equity ratio too was further reduced to 0.6X in FY17 from 0.9X in FY16.

Business Segments

I. Pigments

(a) Industry Opportunity

Global Pigments market is expected to reach ~$32 bn by 2023

The size of the global Pigments market in 2016 was $24 bn and is expected to rise to $32 bn by 2023, growing at a CAGR of 3.8%. Asia Pacific is expected to make up the lions share of the global geographical market with approximately 47% share in 2023.

The global paints & coatings market is projected to grow at a CAGR of 5.5% during the forecast period of 2017-2022. This is expected to give a strong boost to the global pigments market. Per capita paint consumption in emerging countries is less than in the developed countries; economic development in the Association of Southeast Asian Nations (ASEAN), China, India, and the Gulf Cooperation Council (GCC) is expected to improve the trend.

Pigments are a critical element in the plastics industry because of their aesthetic and colouring effects, superior compatibility, moisture & heat resistance, and capability to increase stability in plastics. Being a major consumer of pigments, the growing plastics industry could offer some great opportunities for players in the global pigments market.

Organic Pigment: A key constituent of growth in the industry

The global organic pigments market is expected to grow at a CAGR of more than 3% between 2017 and 2021. In terms of geography, Asia Pacific (APAC) is the largest and dominating region in the global market due to the presence of several manufacturers who offer pigments at lower costs in comparison to other regions. APAC is anticipated to lead the market in terms of consumption over the next four years due to increase in infrastructure activities that require paints and coatings with functional benefits. Upsurge in development of textile and plastic industries and expansion of the middle class in Asia-Pacific are other factors which are expected to boost the demand for organic pigments in the region.

The printing inks segment was the largest application segment of organic pigments in 2016 and will continue its dominance during the forecast period.

Indian Dye and Pigment Industry: Ready for the future

The highly fragmented Indian colorant industry, valued at $6.8 bn, exports nearly 75% of its production. Exports have grown in double digits over the last few years.

The Indian dyestuffs and pigments industry has transformed from being import-dependent to export-driven. To support the growth of the industry, developed countries are now focusing on sourcing dyestuffs and pigments from cost-effective Asian markets, owing to stringent measures taken on environmental issues back home.

The decorative paints market is expected to witness a CAGR of 12.7% and the industrial paints market a CAGR of 9.5% (2015-2020), according to the Indian Paint Association (IPA).

The packaging Industry is expected to grow at 18% per annum till 2020, since the per capita packaging consumption in India is low at 4.3 kg, compared to developed countries like Germany and Taiwan where it is 42 kg and 19 kg, respectively.

(b) Business Overview

Meghmani Organics is one of the largest manufacturers of Phthalocyanine-based pigments with a global market share of ~8% in volume terms. The Company has vertically integrated facilities manufacturing CPC Blue (an upstream product which too is sold to other pigment manufacturers) and end products Pigment Green and Pigment Blue. These pigment products are used in multiple applications, including paints, plastics and printing inks.

The Companys pigments business enjoys strong global presence with exports accounting for ~68% of net sales. Customers comprise mainly MNCs, such as Sun-DIC, Flint Group, Akzo Nobel, DuPont, and PPG Industries. The Companys relationship with its clients is sticky, with 90% business arising from repeat customers. The Company has a global distribution network of 70 overseas distributors. Its direct presence (with subsidiaries in the US, Europe, Indonesia, and Dubai) helps it to maintain a front-end presence and the ability to work closely with end - user customers.

The Company also has warehouses in Belgium, Turkey, Russia, USA, and Uruguay.

Meghmani Organics has three dedicated manufacturing facilities to manufacture Pigment products. These are located at:

• GIDC Vatva, Ahmedabad, (2,940 MTPA) where Pigment Green 7 products are manufactured

• GIDC Panoli, near Ankleshwar, (17,400 MTPA), where CPC Blue, Alfa and Beta Blue, Pigment Blue 15 products are manufactured

• Dahej SEZ Ltd, (10,800 MTPA) where CPC Blue, Alfa and Beta Blue are manufactured

(c) FY17 Performance and Outlook

The pigments business delivered strong growth in FY17, with net sales growth of 10%, to Rs. 5,143 mn. This was driven by robust performance in both domestic and export markets which grew at 29% and 12%, respectively. Volumes increased by 7% at 14,462 MT, driven by higher production and higher realisation. EBITDA margin increased to 17% from 13% in FY16, due to higher production, higher realisation, lower fuel cost and lower other expenses. Utilisation levels have increased to 66% in FY17 from 63% in FY16.

4. Outlook and Strategy:

Going forward, the Company expects the share of value-added products to increase, led by its fully ramped up Beta Blue plant. The Company is also focusing on the high-margin paints and plastics market by improving the product-mix and developing specialty pigment products for international markets to maintain the growth in exports. The Company continues to focus on increasing its domestic presence, given the significant market opportunities. Meghmani Organics, being a leader in the Indian pigments market, is well placed to monetise this opportunity.

To summarise, Pigments is expected to deliver continued growth with improved profitability on account of increased share of value-added products, higher utilisation and good opportunities in the export and domestic markets.

(d) Risks, Concerns and Threats

Fluctuating and volatile prices of key raw materials, including benzene and toluene, coupled with an increasingly stringent regulatory environment, are critical challenges to the growth of this industry. Since the Company derives a significant portion of business from exports, volatility of the rupees vis-a-vis the dollar and the euro may affect realisations. The Company competes in the areas of quality, technical competence, backward integration, logistics facilities, after-sales service and customer relationship. Changing competitive environment may impact the Companys business and future prospects.

II. Agrochemicals

1. Industry Structure

Global Agrochemicals market is expected to cross $266 bn by 2021

The global agrochemicals market should cross $266 bn by 2021, up from $213 bn in 2016, growing at a CAGR of 4.5% from 2016 to 2021. The growing global population is the major growth-driver for the agrochemicals market. Agricultural land is limited, and due to the expanding population and rising demand for food, land previously used for other purposes is rapidly undergoing degradation. Asia-Pacific is, by far, the largest market for agrochemicals. The region comprises about 30% of the earths land area and its population represents nearly 60% of the global total. Both these factors are driving growth of its market. The global market for fertilisers is expected to grow to $188 bn in 2021 from $155 bn in 2016 at a CAGR of 4.0%. Similarly, the global market for pesticides is expected to grow to $78 bn in 2021 from $58 bn in 2016 at a CAGR of 6.0%.

Huge Potential in the Indian Agrochemicals Market with a CAGR of 11.7%

FY17 was a progressive year for the Agrochemical Industry, which experienced a healthy monsoon after 2 years of drought. Budget 2017-18 gave a big fillip to the Indian Agri sector it has pitched for more reforms in agriculture and increased funds for insurance and irrigation schemes, along with various other measures to boost farm income and to double it in the next five years.

India has become the fourth-largest producer of agrochemicals in the world, trailing only the US, Japan and China. This manufacturing segment is expected to grow at 10-12% annually to reach $6.8-7.4 bn by FY19. Approximately half of the demand comes from domestic consumers and the rest from exports. In FY17, the agrochemical industry in India was temporarily affected by demonetisation. The cash crunch led to farmers not being able to purchase fertilisers and other chemicals.

Opportunities and Key growth drivers for the Indian Crop Protection Market:

1. Budget 2017-18 gave a big fillip to Indian Agriculture, and in turn, to the Agrochemicals sector.

• For 2017-18, a target of disbursing Rs.10 tn in farm credit has been set, up from Rs. 9 tn last year.

• For the flagship crop insurance scheme Pradhan Mantri Fasal Bima Yojana, the allocation has been increased to Rs. 90 bn in 2017-18 from Rs. 55 bn (in Budget 2016-17). The target next year is to bring 40% of the cropped area under insurance and ramp it up to 50% next year.

• To improve access to irrigation, an additional Rs. 200 bn has been provided for the long-term irrigation fund under NABARD.

All the proposed schemes will address working capital requirements of farmers and should therefore support growth in sales of Agrochemicals.

2. Prediction of good monsoon following 2 years of drought.

3. GST (Goods and Services Tax) Bill, to be implemented from July 2017, resulting in the unification of tax rates and India emerging as a single market, will provide companies an opportunity to optimise their supply chains and warehouse locations.

4. Agrochemicals worth $4.1 bn are expected to go off-patent by 2020. This will provide significant export opportunities for Indian companies which have expertise in manufacturing generic products.

5. New genetically modified crops have increased the use of herbicides, with a rise of 15% per year over the next five years. Growth in fungicides has been 7.5% over the last five years, and this growth is expected to continue due to shortage of labour and high labour costs.

6. Consumption of pesticides is the lowest in India, at 0.6kg/ha compared to 13kg/ha in China. This is bound to increase in order to help boost yields.

7. Other drivers, such as rising population, decreasing per capita availability of arable land and focus on increasing agricultural yield will fuel the demand for agrochemicals.

2. Business Overview

Meghmani Organics is a leading vertically-integrated Agrochemicals player with product offerings encompassing the 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 agrochemicals industry is highly regulated and the Company enjoys competitive advantage via 227 export registrations, 496 registrations in pipeline, 354 CIB registrations, and 35 registered trademarks. The Company has a strong global client base with exports accounting for 69% of its agrochemical sales. The Company exports technical as well as branded products to Africa, Brazil, LatAm, the US, and European countries.

Meghmani Organics produces commonly-used pesticides for crop and non-crop applications, such as for public health, insect control in wood preservation and foodgrain storage. Major products include 2, 4-D, Cypermethrin, Permethrin, Metaphenoxy, Benzaldehyde, Chlorpyrifos and Profenophos. In branded formulations, the Company has established a strong pan-India presence with about 2807 stockists, agents, distributors, and dealers spread across 17 states. Key brands include Megastar, Megacyper, Megaban, Synergy, and Courage.

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

• GIDC Ankleshwar, (6,240 MTPA)

• GIDC Panoli, (7,200 MTPA up from 3,600 MTPA in FY16)

• GIDC Dahej, (13,740 MTPA up from 10,260 MTPA in FY16)

3. Performance of Agrochemicals Business

Net sales from Agrochemicals increased by 11% to Rs. 4,730 mn in FY17, from Rs. 4,262 mn in FY16 driven by robust growth of 34% in domestic markets coupled with stable exports. Volumes witnessed robust growth of 27%. However, realisations declined due to change in product mix to match demand in the market. Margin for the period was down at 10% on account of lower realisation and lower utilisation.

Going forward, in Agrochemicals, the Company expects the domestic market to further grow in FY18, driven by a better monsoon as the channel inventory after 2 years of drought has cleared up. The Company has focussed its efforts on strengthening its distribution network which was earlier not being pursued very aggressively due to subdued market conditions. Further, pollution issues in China, wherein many plants are closing down, are expected to result in lower imports from China, while the ‘Make in India initiative by the Government of India is expected to boost growth. The Companys export markets are already reviving and Meghmani Organics is witnessing increasing demand for its higher-value products which will result in higher realisations and better margins.

To summarise, Agrochemicals is expected to deliver strong growth with higher margins as market opportunities in export and domestic segments materialise along with strong support from the Government in the form of increased funds and key reforms.

4. Risks, Concerns and Threats

Despite strong growth drivers, the Indian Agrochemicals industry faces challenges in terms of low awareness levels among farmers about agrochemical products and their usage. Also, rising sale of spurious pesticides and spiked bio pesticides pose major threats to industry growth.

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.

The Company operates in a competitive environment and faces competition from international as well as domestic players on various fronts, such as quality, technical competence, distribution channels, logistics facilities, after-sales service and customer relationships.

The performance of the Indian agrochemical industry is dependent on the monsoon. Erratic rainfall affects crop acreages, pest application and overall productivity, directly impacting the Companys sales performance.

III. Basic Chemicals

(a) Industry Structure

Global Chlor-Alkali Industry to grow at 5-5.5% CAGR (2017-21)

According to Research and Markets, the global Chlor-Alkali market is projected to grow at a CAGR of between 5.0% and 5.5% from 2016 to 2022. The consistent global demand for alumina, pulp and paper, vinyls and other derivatives provide positive growth opportunities for the Chlor-Alkali market. Furthermore, heavy investments in the alumina industry are expected to provide growth opportunities for the Chlor-Alkali market, as caustic soda is a major raw material for the alumina refining process.

The demand for chlorine is leading many Chlor-Alkali manufacturers to upgrade technology as well as their manufacturing facilities to improve the production of allied products and attain optimum output, as these should help in the growth of the market.

Indian Chlor-Alkali Industry poised to grow

According to the IMF, Indias FY18 GDP growth is projected to increase to 7.2%. Basic Chemicals Chlor- Alkalis and PVC are basic building blocks that find application in products of everyday use, including aluminium, paper, textiles and plastic. These industries are expected to witness increase in volume consumption of chlor-alkali chemicals, which will boost the Indian chlor-alkali market in the coming years. Moreover, with growing aspirations of a rising middle class, higher disposable incomes and the current low level of penetration, demand for these products is bound to grow.

There is a vast untapped market, especially in the rural areas, which will significantly drive demand. To illustrate, India has a low per capita consumption of 1.85 kg of caustic soda compared to 32 kg in the US and 12 kg in China. Similarly, the ‘Make in India programme of the Indian Government is expected to provide a fillip to domestic manufacturing and value addition, provided the right ecosystem is put in place to bring in investments and augment the domestic manufacturing capacity.

Particulars (MT Lakhs) Caustic Soda Chlorine
2015 2016 % Change 2015 2016 % Change
Production 27.6 28.7 4% 24.4 25.4 4%
Installed capacity 33.9 33.7 -0.6% 22.4 22.9 2.2%
Export 0.8 1.1 40.3% 0.0 0.0 61%
Import 5.1 5.7 11.8% 0.0 0.0 -25.6%

(b) Business Overview

The Company entered the Basic Chemicals segment in 2009 with capacity of 119,000 MTPA at Dahej. It expanded capacity by 40% in FY15 to 166,600 MTPA, and became the fourth-largest Caustic Soda Flakes producer in India. The current product portfolio includes Caustic and Hydrogen.

Meghmani is one of the most efficient manufacturers of Caustic with an integrated Captive Power Plant of 60MW. 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 production, captive power plant provides power at lower cost resulting in high margins. The Dahej facility is strategically located due to its proximity to the port, providing ease of importing coal and proximity to chemical manufacturers. The Company is supplying Caustic and Chlorine via pipeline to select buyers, thus substantially reducing its logistics costs. The Company has recently changed the membrane of its existing Caustic Soda Plant.

The Companys new Caustic Potash facility at Dahej of 60 TPD capacity which commenced production at the beginning of the year is ramping up slowly due to technical issues, which have now been sorted out. The Company is positive about quickly ramping up the plant to optimum utilisation levels. Caustic Potash is one of the very few chemicals that find universal application with makers of Soaps, Detergents, Fertilizers and Chemicals.

The Companys planned capex of Rs. 5.4 bn involving 3 projects over the next 2-3 years is in-line with its strategic intent of expanding the chemicals business. The first Project is the CMS Project of 40,000 MTPA which will produce MDC (which mainly used by Pharma and Agro Chemical Industries and India is currently a net importer of same) Chloroform and Carbon Tetra Chloride(CTC) . This is expected to be commissioned by March 2018 and add Rs. 1.4 bn of revenue in the full year of operations. The second Project involves 50% capacity expansion of the Companys Caustic Soda plant to 2,40,000 MTPA using Zero Gap Membrane Cell technology and increase the Captive Power Plant capacity to 90MW from 60 MW now. The third Project is to set up a Hydrogen Peroxide (50%) project of 25,000 MTPA capacity which also used in Pharma and Agro Chemical Industries. Expansion of the Caustic Soda and Hydrogen Peroxide projects will involve Rs. 4 bn investments, and are expected to be commissioned by June 2019.

(c) Performance of Basic Chemicals

Net sales of Basic Chemicals were marginally down at Rs. 3,953 mn on account of lower volumes due to the synchronisation process of Caustic Potash facility which took place during the year. The Company also upgraded its Caustic Soda plant to zero gap technology in FY17. Blended realisation for the segment was stable. EBITDA margin was at 36%, above the guided range of 30-35%, but lower than the previous year on account of lower utilisation and higher fuel cost.

In FY18, the Caustic Potash plant, which is now getting ramped up, coupled with continued strong performance by Caustic, will be the key drivers for profitable growth of the Basic Chemicals segment.

5. Risks, Concerns and Threats Basic Chemicals

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. Dumping of Caustic from neighbouring countries might impact realisations of the Electrochemical Unit (ECU).

Internal Control System

The Company has a proper and adequate system of Internal Control 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 (mn) FY16 FY17
Net Revenue from Operations 13,322 14,229
EBITDA 2,608 2,888
PBT 1,464 1,558
PAT before Minority Interest 1,113 1,162
PAT after Minority Interest 825 878
Key Ratios
Net Sales Growth 5.1% 6.8%
EBITDA Margin 19.9% 20.6%
ROCE 15.3% 16.6%
D/E ratio 0.9 0.6
EPS Rs. 3.2 3.5