Deepak Nitrite Ltd- a future wealth creator or a multibagger of past?

Company Profile:

1. Incorporated in 1970, Deepak Nitrite Ltd manufactures Basic Intermediates, Fine & Specialty Chemicals, Performance Products, and Phenolics.
2. 30+ Products, 1000+ Customers, export to 45+ countries, 56+ applications supported worldwide
3. Largest producer of Phenols & Acetone (Commodity) in India since 2019, Amongst TOP Global players for Xylidines, Cumidines and Oximes
4. 6 modern mfg facilities across 5 locations in 3 states
5. 35% Revenue from Export
6. Dedicated R & D facility at Nandesarai, Gujarat, team of 70 scientists , 2.24% of PAT on R & D expd. In FY21. New R & D centre established in Vadodara in Q1Fy24.

Business Verticals:

Company has a portfolio of over 100 products, divided into two segments viz.

1. Phenolics segment: 62% revenue & %2% EBIT contribution in FY23
2. Advanced intermediates: 38% Revenue & 48% EBIT contribution in FY 23
3. Phenolics segment: High volume import substitute. It can be subdivided into:
   A) Phenolics (62% of FY22 revenue): Deepak Phenolics (a wholly-owned subsidiary of the Company) commenced commercial production of Phenol and Acetone at Dahej in 2019.The company manufactures Phenol, Acetone, and IPA. User industries are pharmaceuticals, paints, adhesives, thinners, ply, laminates, foundry, etc. The division was operational at a capacity utilization of 135% as of Q1FY23.In phenolics segment Company aims to increase their capacity to 150% by eliminating bottlenecks.
   B) Basic Intermediates (18%): The company manufactures nitrites, nitrogen toluidines, and fuel additives used in Colorants, Petrochemicals, rubbers, Agrochemicals, Pharmaceuticals, and other industries. These chemicals are manufactured and sold in high volumes with higher price sensitivity.
4. Advanced intermediates: It can be subdivided into:
   C) Fine & Speciality Chemicals (12%): This division manufactures Xylidines, Oximes, and Cumidines among other specialty chemicals. These products are specially tailored to the client’s specifications and are manufactured in lower volumes, but command a higher value with their application in Agrochemicals, Colors & Pigments, Paper, Personal Care, Pharmaceuticals, etc.
   D) Performance Products (8%): Key products of this division are Optical Brightening Agents and DASDA, which are used in Paper, Detergents, Textiles, Coating Applications in Printing, and Photographic Paper.

New Products Introduced:

1. MIBC & MIBK & other solvents as downstream of Phenol & acetone.
2. Polycarbonate as forward integration of phenol.
3. Bisphenol to be produced in newly established Deepak Chemical

Geographical Revenue Distribution:

On consolidated basis, Domestic – 80%, while Exports (mainly contributed by Europe, the US, and Asia-Middle East) – 20% (Source: Annual Report of FY23).
For Deepak phenolics, in Fy 23, Domestic and Exports Revenue mix stood at 95:5.

Clientele:

Bayer Crop, Unilever, Indian Oil, Rallis, BASF, L’Oreal, Lubrizol, Reliance Industries, Nirma

Deepak Nitrite Phenols Value Chain:

(Source: Value Educator )

Key Growth drivers for the next 5 years/Future Growth Prospects:

1. Downstream products to lead next leg of volume growth. Company has announced investment aggregating to ₹ 2,500 Crores for expanding its capacity.

2. Upcoming capacities of MIBK (40ktpa), MIBC (8ktpa) and Polycarbonate should drive volume growth going ahead. While margin improvement is not expected, since the products are commodities in nature, vertical integration may lead to some reduction in margin volatility.

3. MIBK is primarily used as a solvent for resins used in the paints and coatings industry. It could be an ideal import substitution play, considering India’s entire MIBK demand of ~30,000mtpa is exclusively met through imports.

4. Polycarbonate is a transparent thermoplastic polymer widely used in the electrical/electronics industry due to its excellent heat and electrical resistance property Greenfield expansion in polycarbonate segment will help capture niche market of specialized demand in 5g Boxes, EV batteries, medical devices etc… According to ChemAnalyst, India’s Polycarbonate demand stood at 180,000mtpa in FY22 and is expected to grow by ~4% over the next decade, driven by the building and construction materials end market. Covestro, the world leader in Polycarbonate, expects a 4% CAGR in the global polycarbonate market till CY26,while the supply is expected to grow by 5-6% during the same period, led by major capacity additions in China by Hainan Huasheng, ZPC, SABIC-Sinopec, Wanhua and Shemna

SWOT Analysis:

Strength:

i. Diversified product portfolio reduces obsolesce of any particular product.
ii. Economics of scale and process innovation like integration has ensured cost optimization. ensuring raw material availiabilty through backward integration
iii. Deep rooted partnership & wide reach due to customer centric approach.

Weakness: volatile input cost of raw materials and utility such as energy and fuel could have negative impact on performance.

Opportunity: Large potential for Import substitution (company focusing on introduction of value-added downstream products to substitute imports), favourable govt policies such as PLI scheme, China+1 Theme.

Threats: External challenges , geo political development, threat of product obsolecne due to introduction of newer technologies and methods.

(Source: Page 118 of Annual Report, FY23)

Investment Thesis:

1. Estimation of bright Sector Growth: The Indian chemicals industry stood at US$ 178 billion in 2019 and is expected to reach US$ 304 billion by 2025 registering a CAGR of 9.3%. The demand for chemicals is expected to expand by 9% per annum by 2025. The chemical industry is expected to contribute US$ 383 billion to India’s GDP by 2030.

2. Business Moat: DNL group is the market leader in most of its businesses. In basic chemical business, the group is the largest player in India for supplying sodium nitrite/nitrate (market share decreased recently to 70% from earlier 80%), fuel additives (75%) and nitro-toluene (50%). Its market position in the Performance Products business (market share of 75% in optical brightening agents) is supported by large capacity, integrated operations (backward integration to Diamino Stilbene Disulfonic Acid (DASDA)) and receipt of customer approvals. Its subsidiary, Deepak Phenolics, similarly commands over ~56% of the market share for Phenol, Acetone & IPA. With expanded capacity of IPA Plant, your Company is able to reduce import dependency of IPA>In the Fine and Specialty Chemicals (FSC) segment, continuous investment in R&D, and integrated operations have helped DNL establish and maintain relationships with key customers in pharma, personal care and agro-based chemicals segment

3. Business Diversification: The group supplies to diverse end-user industries such as polymer additives, pigments, dyes, paints, pharmaceuticals, agrochemicals, refineries, ply, laminate and fast-moving consumer goods, and is insulated from downturn in any particular industry. Also, one fourth of its net revenue is from exports, providing geographical diversity. The group maintained a strong revenue growth rate (CAGR of ~36% in the past five fiscals). DNL group will sustain its healthy market share, given its leadership position, established track record, and large R&D capability leading to technical expertise.

4. Expansion of Core competency: As mentioned in concall Q1Fy24, Deepak is stepping into photo chlorination and fluorination. So, these now become part of technical toolbox and when they invest into this larger capex, they will become part of core competency.

5. Focus Area by R & D Team: team focusses on innovating new compounds/value-added products, improving processes of existing products, recovery of products from effluents

6. Key factors driving growth: focus on esg & sustainability; focus on import substitution in india & add new foreign customers, greenfield capex; Adding new chemistries and process technologies with significant focus on high value products that limited manufacturers produce globally; Strategic investments towards developing products for new range of specialty chemicals that find applications across diverse and faster growing end user industries. Moreover, Structural shift from China, favourable govt policies like focusing on self-reliant India I,e, import substitution, 100% FDI in chemical sector through automatic route, Make in Indian and PLI scheme augur well for the industry growth as a whole.

7. Risk mitigation through Integration: Company is highly forward and backward integrated. This high level of backward integration will help company to ensure uninterrupted supply of raw material, reduce logistics cost and mitigate the shock of raw material price volatility

8. Strategic Investment: Strategic investment of 51% in the equity of a chemical plant in Oman due to various advantages like lower price of power, availability of natural gas for energy, availability of attractive priced ammonia through pipeline, Free Trade Agreement with USA, availability of caustic soda locally.

Risk Factors:

1. Volatility of raw material prices and competition from imports: The raw material prices are linked to movement in crude oil prices for some of the major products. Also, with increased contribution to phenol segment, DNL group’s profitability will remain vulnerable to volatility in spreads between the pricing of feedstock (benzene and propylene) and finished products. The domestic phenol sector also faces competition from imports contributing 40% of domestic demand. Any changes in anti-dumping duty impacting demand-supply situation of some of its products may remain key monitoring factor.

2. Global geo-policy and monetary risk, risk of supply chain disruption.

3. As company plans to become a diversified chemical entity, overall margin may gradually settle down.

4. Unforeseen accidents like the one in Nandesarai plant will adversely impact product output.

Valuation:

As on 02-09-23, company is trading at a P/E of 39.6 which is on a higher side. 62 % revenue of Company comes from Phenol segment. Phenol being a bulk commodity doesn’t get high margin. Even company also focusing on volume play in Phenol segment, not margin. So company at current P/E of 39.6 looks overvalued. Company 5 year median P/E is 27.9. So buying in in the P/E range of 25 to 30 may be favourable.

Conclusion:

DNL is making itself more and more integrated via backward and forward integration. By backward integration and diversifying the supply sources DNL is reducing its supply side constraint. Company is foraying into new products like polycarbonate which has immense use in modern day tech like 5G. Moreover, the management have proven their mettle. Moreover, company is playing on the theme on “Self Reliant India” and import substitution. So, in my personal opinion, DNL may be a good wealth creator if bought at fair value.

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