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1 Dimensional Securities Pvt Ltd. Ion Exchange Ltd. Initiating Coverage Date: 20 th March, 2017 CMP: 363 Price Target: Rs. 443 Recommendation: HOLD MARKET DATA NSE TICKER IONEXCHANG Networth FY17 (Rs in Crs) P/BV Ratio (FY17E) (x) 2.7X EPS (TTM )(Rs.) 17.8 Market Price (Rs.) 363 P/E Ratio (TTM) (x) 20.2X 52 Week High (07/03/2017)(Rs) Week Low (22/11/2016)(Rs) Market Capitalisation (Rs. Cr) Ion Exchange Ltd. (IEL) is an end-to-end water solution provider to industries and municipalities with capabilities around constructing the water treatment plant, its operations and maintenance and manufacturing and supplying the required water chemicals. The company operates through three segments i.e. Engineering, Specialty Chemicals and Consumer products. AVERAGE MONTHLY VOLUME ( 000) BSE 15.2 SHARE HOLDING PATTERN Promoter 44.0 FII 0.0 DII 1.1 Public RETURN (%) 3M 6M 12M Ion Sensex * FY16 revenue break-up Key triggers for the stock: harsh.shah@dimensional.in Engineering Division to gain traction after trudging for years: IEL s engineering division which experienced sluggish growth of mere 4% CAGR over last 5 years is finally expected to gain traction with the $200 mn Sri Lankan project finally getting green signal after being stuck for nearly 2 years. This along with other orders in hand will help company register sales growth of ~23% CAGR over FY16-FY19 period. EBITDA Margins are expected to improve by 140 bps to 5.4% by FY19. Specialty Chemicals to continue the strong growth: The Chemicals Division has been growing healthily at 15% CAGR over last 5 years and it will continue to be Company s focus area. USFDA approval for manufacturing resins for pharmaceutical use is a big boost for the company and will open up huge EU and American market Consumer Product business poised for a turnaround: IEL s consumer business has been struggling for a few years and in order to turn this business around, the company is augmenting its team and is also planning to launch new products. The focus would be on expanding ground water treatment solutions and designing products to meet specific requirements Valuation: By using SoTP method, we have arrived at a value of Rs. 443 per share as at FY19 for Ion Exchange Ltd. Our price target represents an upside of 36% from the CMP of Rs. 370 which translates into CAGR return of ~11%. The recent rally in the stock has factored in the near term growth prospects of the company with limited upside visible. Accordingly we recommend a HOLD on the stock, and can be bought on dips 1

2 Key thesis: Among few integrated water treatment players: As seen in above chart, the water treatment chain has three main elements viz., Engineering (EPC), Specialty Chemicals and O&M. Generally all the major players are present in the EPC and O&M space while Ion Exchange is an integrated player present across all the segments of value chain. This gives them an added advantage compared to its peers. Moreover, while the entry barrier in EPC and O&M space is low, specialty chemicals business, due to technology and quality requirement, is difficult to break into. IEL is a well-established player and with its facilities getting approved by USFDA will help them gain more business especially in export markets VA Tech Wabag, L&T, Siemens, NCC, Nalco. Aarti Indsutries, Chembond, Vasu Chemicals Thermax, Ion Exchange Engineering Division to gain traction after trudging for years: Under Engineering Division (53% of company s revenues), IEL designs, engineers, manufactures and sells medium and large size equipment for water and waste water treatment plants. It also engineers and commissions the entire water and sewage treatment plants for municipalities. The Engineering segment caters to industrial, municipal and institutional segment and also includes O&M Services IEL s engineering division has had a sluggish growth of mere 4% CAGR over last 5 years. This was mainly due to lower order inflows (and that too of small ticket size) and execution delays. The profitability was also impacted due to cost overruns and several write-offs leading to margin contraction from 4.6% to 3.0%. However this division is expected to gain traction with the $200 mn Sri Lankan project finally getting green signal after being stuck for nearly 2 years. IEL was awarded the Sri Lankan project by the Sri Lanka Water Board in But due to political reasons, there were delays in getting the required approvals causing delays in execution. However, all the roadblocks are now cleared and company has begun with documentation to commence the project. The revenue booking is expected to start from Q1FY18 and will spread over three financial years (in estimated ratio of 30:35:35). This execution will also lead to margin expansions owing to scale and accordingly we expect margins to improve by 170 bps to 5.7%. Besides the Sri Lankan order, company has other orders worth Rs. 550 crore in hand and they have bid for another Rs crore. The management is seeing some traction in order inflow and expects better times ahead. Also with execution of Sri 2

3 Lankan Project, the company would be in good position to secure and execute such big municipal projects going ahead, the area where they were dormant earlier. Water Treatment Industry, a big opportunity in times to come: Water is a finite resource and with rapid consumption and faster depletion of available resource, conserving and recycling of water becomes critical. According to UN data, around 1.2 billion people live in areas of physical scarcity and 500 million people are likely to face this situation in the near future. This is also because of uneven water supply leaving the densely populated countries with little water reserves. This throws significant opportunities around water treatment and wastewater reuse as only 3% of the water is being recycled globally. The global water industry including sectors like desalination, wastewater treatment and water-efficiency technologies, is expected to touch $ 529bn in Desalination alone is expected to emerge as a US$ 41 billion industry by Domestically, India which houses nearly 20% of world s population has only 4% of global water reserves which puts additional strain of the available sources making it paramount to look for alternate sources like recycling. According to report by HPEC investment of Rs lakh crore is estimated to be required for water supply and sewage treatment over while another Rs. 8 lakh crore is estimated to be needed for O&M services. Capital expenditure on water and wastewater infrastructure in India is set to increase by 83% over the next five years itself. With a long coastline of 7,600 kms, opportunity in desalination can be tremendous for India The industry can be divided into three segments; - Municipalities- which build treatment and effluent plants for providing clean water to communities. Though they use low cost technology, the size of the projects is huge ranging from Rs crore. (Before Sri Lankan project, Ion Exchange worked on project size of ~Rs cr) - Industrial Customers- This includes customers from manufacturing industries like Automobiles, Pharmaceuticals, Power, Chemicals, Metals & Mining, etc. They - Retail Customers- This includes household customers or institutions like schools, hospitals, etc. They form a very small pie of the entire industry. Ion Exchange is pre-dominantly present in the industrial segment and does small projects for Municipalities. After bagging this Sri Lankan project, they will move up the chain and bid for more such big projects from the municipalities. Specialty Chemicals to continue the strong growth: IEL is engaged in manufacturing of water treatment chemicals, ion exchange resins and other specialty chemicals like Polyelectrolytes, Boiler Water Treatment Chemicals, Cooling Water Treatment Chemicals, etc. which finds application in cooling water treatment, boiler water treatment, membrane water treatment etc. Company derives ~50% revenues from resins and another 50% from industrial chemicals. 3

4 The Chemicals Division has been growing healthily at 15% CAGR over last 5 years and it will continue to be Company s focus area. The revenues from this segment have grown from Rs. 156 crore in FY11 to Rs. 320 crore in FY16. Recently they have expanded the capacity of their chemical division and they are expecting the division to continue to grow at historical rate. During FY16, IEL successfully renewed the WHO-GMP certification for its Pharma facility at Ankleshwar. Further, it also received USFDA approval for manufacturing resins for pharmaceutical usage. This will open up a huge market for the company. With this approval, IEL plans to tap the US and Europe resin market. Globally, the resins market is estimated to be worth $1.4 bn and is expected to grow at ~4% CAGR to $2.2bn by FY22. Due to lower commodity prices and higher export revenues going forward, the margin profile is also expected to improve. Global water & wastewater treatment chemicals market is estimated to be valued at $26.5 Bn as at 2016 and the same is expected to grow at 4.5% CAGR to $38 Bn by Higher demand from the municipalities and limited availability of water for industrial applications is expected to support growth of water treatment chemicals used in manufacturing industries, especially in the oil & gas, power, and mining sectors which forms ~49% of total demand. In India, the water chemicals market has grown at a CAGR of 12% from $200 mn in 2009 to $400 mn from FY10-FY16. By FY20 the market size is expected to increase to $ 800 mn. Consumer Product business poised for a turnaround: Under the Consumer segment, IEL sells various products like Non-Electric Purifiers, Water Softeners and RO Purifiers under its brand Zero B. The target segment includes homes, hotels, spas, educational institutions, hospitals, laboratories, realty sector and defense establishments. While IEL was one of the first players to be present in this segment but it never made its mark while other players like HUL, Eureka grew rapidly. This business has gone nowhere in last 5 years and have reported a paltry 1.5% CAGR growth on top line to Rs. 88 crore in FY16 with EBIT loss of ~4 crore. In order to turn this business around, the company is augmenting its team and is also planning to launch new products. The focus would be on expanding ground water treatment solutions and designing products to meet specific requirements. 4

5 Valuations: By using SoTP method, we have arrived at a value of Rs. 443 per share as at FY19 for Ion Exchange Ltd. Our price target represents an upside of 22% from the CMP of Rs. 363 which translates into CAGR return of ~10.5%. The recent rally in the stock has factored in the near term growth prospects of the company with limited upside remaining now. Accordingly we recommend a HOLD on the stock, and it can be bought on dips between levels. Segment Multiple Assigned Value per Share Engineering Division (EPC): FY19E BV per Share Rs P/BV of 1.5X* Rs. 149 Specialty Chemical: FY19E EPS Rs P/E of 12X Rs. 254 Consumer Business: FY19E EPS Rs. 3.4 P/E of 12X Rs. 40 Total Value per Share Rs. 443 per share * We have valued EPC Division on P/BV basis because it s a project specific division. Though orders in the normal course of business would keep coming, there is no assurance that larger orders, like the current Sri Lankan one, would keep coming on regular basis. Thus in the absence of visibility to redeploy capital consistently at high RoCE we have valued it at nominal P/BV of 1.5X rather than valuing it on P/E approach. Risks & Concerns: Over next 2-3 years, company would be reporting strong numbers due to the large Sri Lankan projects. Continuance of such strong growth would depend on company s ability to secure such large orders on regular basis. The competition intensity in water treatment industry is increasing with presence of larger players like L&T, Va Tech Wabag, NCC, Nalco, Siemens, etc. This will put pressure on margins and return ratios. Competition in consumer segment is high due to presence of players like Eureka, Tata and HUL. Specialty Chemicals business is vulnerable to fluctuations in crude prices. IEL has very high debtor days of 150 which can cause stress on its balance sheet. Some comfort can be derived from the fact that its payables days are upwards of 200 days. 5

6 Financials: 6

7 ANALYST CERTIFICATION I ( Harsh Shah), Research Analyst, author and the name subscribed to this report; hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: Dimensional Securities Private Limited (DSPL) is engaged in the business of stock broking and distribution of financial products. This Report has been prepared by Dimensional Securities Private Limited (DSPL) in the capacity of a Research Analyst having SEBI Registration No. INH and distributed as per SEBI (Research Analysts) Regulations The information and opinions in this report have been prepared by DSPL and are subject to change without any notice. 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