Demerger will help maintain focus and direction for both segments – Aarti industriesMaitreyee Vaishampayan
Update on the Indian Equity Market:
On Tuesday, Indian stocks closed in the green aided by positive global cues, and positive U.S. vaccination news. Nifty 50 ended at 16,625 (+0.8%) led higher by BAJAJFINSV (+7.8%), HINDALCO (+3.9%), and ADANIPORTS (+3.8%). The top laggards were BRITANNIA (-1.4%), NESTLEIND (-1.4%), and ASIANPAINT (-1.1%). Among the sectoral indices, METAL (+2.9%), MEDIA (+2.0%), and PSU BANK (+1.8%) led the gainers. Typically considered defensives, FMCG (-0.7%), and IT (-0.2%) led the laggards.
The Board of Aarti Industries recently approved the demerger of its pharma business. Mr. Rajendra Gogri, MD, Aarti Industries (AARTIIND) discussed the rationale behind this move with Economic Times on 24th August 2021:
- In the last few years, the pharma business revenues have almost doubled and EBIT has grown four times, with EBIT margins around 20 percent plus. The company foresees a significant opportunity in both, the pharma and specialty chemicals businesses. It has been decided to have a separate company so that there can be a separate focus and strategic direction for both the segments.
- The process for demerger is expected to be completed in the next 9-15 months depending on the Covid situation.
- Earlier AARTIIND had announced a Rs 50bn capex plan, out of which Rs7.5 bn will now be spent on the pharma division, and the balance on chemicals.
- Both the segments have separate manufacturing facilities as well as R&D centres. The customer base also is separate. There is virtually no overlap in manufacturing as well as R&D in the market between both the segments.
- In pharma, they are looking to add more than 50 products in the next 5-6 years. For pharma intermediates and API, a new greenfield expansion at Atali, Gujarat is being set up.
- With a strong customer base across the world, AARTIIND expects a sizeable revenue growth over the next few years. In the next five years, the Company is looking at top line 2.5 to 3.5 times and three to four times at EBIT level for both the segments.
- AARTIIND is totally backward integrated, especially in the Chemicals segment. Benzene is a key raw material which is domestically available and the Company does not foresee any raw material shortages but container freight is an issue. Usually, AARTIIND is able to pass on the freight increase to the customers but the availability of containers is impacting exports.
Asset Multiplier Comments
- China had imposed penalties on chemical companies causing pollution and environmental damage. As a result, many chemical companies’ plants have been shut or relocated outside China. Additionally, with Covid-19 imposed restrictions, supply chain challenges have increased. Chemical companies in India have emerged as a beneficiary due to these challenges under the China+1 strategy.
- AARTIIND is able to pass on the freight cost hikes to domestic customers almost immediately. There is a quarter’s lag while passing on the freight hikes to overseas customers. As the freight cost is eventually passed fully to the customers, the Company is able to maintain and improve its bottom line.
Consensus Estimate: (Source: market screener website)
- The closing price of AARTIING was ₹ 920/- as on 24-August-2021. It traded at 43x/ 34x/ 33x the consensus earnings estimate of ₹ 21.3/ 26.7/ 28.0 for FY22E/ 23E/ 24E.
- The consensus target price of ₹ 927/- implies a PE multiple of 33x on FY24E EPS of ₹ 28.0/-.
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