Aarti Industries (ARTO IN) A structural specialty chemical growth play

INSTITUTIONAL EQUITY RESEARCH Aarti Industries (ARTO IN) A structural specialty chemical growth play INDIA SPECIALTY CHEMICALS Company Update We recently visited ARTO s plant in Jhagadia (Gujarat). This is the leading manufacturing base for ARTO s specialty chemical business having manufacturing operations for hydrognation, PDA, nitro toluene, hydrogen gas generating plant, and calcium chloride. Following are the key findings from the plant visit: ARTO s Jhagadia plant visit takeaways The Jhagadia manufacturing plant is one of the most important site of ARTO out of its nine manufacturing sites in India. It has integrated manufacturing units with zero effluent discharge. The revenue share of the Jhagadia plants is about 20% of ARTO s consolidated revenues (Rs 38bn in FY18) as they manufacture over 25 products and employ over 900 people. Key manufacturing units at the site include: (1) Hydrognation (with a capacity of 24,000 MTPA), (2) PDA (Polydiacetylene, 12,000 MTPA), and (3) nitro toluene (30,000 MTPA). Additionally, it has a hydrogen gas (H2) generating plant (3,000 NM3/hour) to secure 50% of its own input requirement and a calcium chloride plant (30,000 MTPA) that uses the waste by product of HCL from its benzene operations. The upcoming projects in Jhagadia include: (1) A chlorination plant (65,000 MTPA, implying 50% expansion) and (2) a hydrognation plant (18,000 MTPA; implying 50% expansion) primarily for the toluene plant. Both of these plants are likely to get commissioned by the end of FY19. Also, ARTO is coming up with nitration capacity for backward integration of its important product 2,5 DCNB (DiChloro Nitro Benzene). While the upcoming hydrognation plant would forward integrate its recently diversified operation of toluene derivatives manufacturing (product chain 2), the upcoming chlorination plant will play a critical role of backward integration for its multiyear supply deals (expected to be commercialised in FY20/21; product chain 2) (See below) ARTO achieved 50% capacity utilisation for its nitro toluene plant at Jhagadia (that was at 40% in Q1FY19). It sees a gradual ramp up in utilisation and expects it to reach 80 90% in FY20. ARTO expects a revenue visibility of Rs 3.5 4.0bn per annum on optimal utilisation. The Jhagadia operating site has a land area of ~100acres, out of which: (1) ~32 acres are currently used for manufacturing, (2) ~25 acres are utilised for upcoming projects, and (3) balance ~43 acres of land is available for future expansions. Additionally, it has a land parcel of ~75 acres at a different site (3km away from the current plant) for future projects/expansion plans. Capex for Q1 was at ~Rs 1.53bn (Rs 6 7bn capex for FY19). ARTO has initiated capex for its 10 year agrochemical supply deal at Dahej SEZ after getting environmental clearance and expects to commercialise it in H2FY20. It is also in the process of debottlenecking its NCB capacity in FY19. Outlook and valuation: We estimate 30% EPS CAGR over FY18 20 and likely robust earnings growth in FY21 and beyond led by the commencement of multi year supply pacts. We are incrementally enthused about the visible manufacturing shifts to India (after China s clampdown) will ensure the strong revenue and earnings growth for the near future. We maintain our conviction BUY with a target of Rs 1,550 i.e., 14x FY20 EBITDA. 8 October 2018 BUY (Maintain) CMP RS 1245 TARGET RS1550 (+24%) COMPANY DATA O/S SHARES (MN) : 81 MARKET CAP (RSBN) : 101 MARKET CAP (USDBN) : 1.4 52 WK HI/LO (RS) : 135 / 851 LIQUIDITY 3M (USDMN) : 0.7 PAR VALUE (RS) : 5 SHARE HOLDING PATTERN, % Jun 18 Mar 18 Dec 17 PROMOTERS : 53.1 51.1 53.6 FII / NRI : 4.4 4.1 4.4 FI / MF : 13.8 13.7 13.0 NON PRO : 15.3 17.7 15.2 PUBLIC & OTHERS : 13.5 13.5 13.7 PRICE PERFORMANCE, % 1MTH 3MTH 1YR ABS 8.0 3.4 42.8 REL TO BSE 2.2 6.7 34.4 PRICE VS. SENSEX 280 230 180 130 80 Apr/16 Nov/16 Jun/17 Jan/18 Aug/18 Aarti BSE Sensex KEY FINANCIALS Rs mn FY18 FY19E FY20E Net Sales 38,061 45,315 52,743 EBIDTA 6,991 8,701 10,549 Net Profit 3,330 4,498 5,673 EPS, Rs 41.0 55.3 69.8 PER, x 30.4 22.5 17.8 EV/EBIDTA, x 17.4 14.0 11.6 P/BV, x 6.4 5.0 3.9 ROE, % 21.9 23.1 22.7 Debt/Equity (%) 132.0 103.6 87.1 Source: Phillip Capital India Research Surya Patra (+ 9122 6246 4121) spatra@phillipcapital.in Mehul Sheth (+ 9122 6246 4123) msheth@phillipcapital.in Rishita Raja (+ 9122 6246 4137) rraja@phillipcapital.in Page 1 PHILLIPCAPITAL INDIA RESEARCH

Product Chain 1: Toluene based value chain Product Chain 2: Benzene based value chain Design capacities at the Jhagadia plant Facilities Designed Capacity (MTPA) Hydrogenation 36000 PDA (Included in Hydrogenation) 12000 Nitro Toluene 30000 Hydrogen Gas 3000 NM3/Hr Nitration Complex Cannot be aggregated Calcium Chloride 30000 Source: Company, PhillipCapital India Research Estimates Upcoming Projects Chlorination Complex Hydrogenation for Nitro Toluene Nitration for 25DCNB Page 2 PHILLIPCAPITAL INDIA RESEARCH

Financials Income Statement Y/E Mar, Rs mn FY17 FY18 FY19e FY20e Net sales 31,635 38,061 45,315 52,743 Growth, % 5 20 19 16 Total income 31,635 38,061 45,315 52,743 Raw material expenses 17,433 21,815 26,283 30,327 Employee expenses 1,523 1,901 2,130 2,479 Other Operating expenses 6,144 7,353 8,202 9,388 EBITDA (Core) 6,535 6,991 8,701 10,549 Growth, % 14.2 7.0 24.4 21.2 Margin, % 20.7 18.4 19.2 20.0 Depreciation 1,225 1,462 1,631 1,910 EBIT 5,310 5,529 7,070 8,639 Growth, % 12.1 4.1 27.9 22.2 Margin, % 16.8 14.5 15.6 16.4 Interest paid 1,173 1,317 1,355 1,452 Other Non Operating Income 20 78 91 105 Pre tax profit 4,156 4,290 5,806 7,292 Tax provided 881 829 1,161 1,458 Profit after tax 3,275 3,461 4,644 5,834 Net Profit 3,275 3,461 4,644 5,834 Growth, % 22.9 5.4 35.1 26.1 Net Profit (adjusted) 3,158 3,330 4,498 5,673 Unadj. shares (m) 82 81 81 81 Wtd avg shares (m) 82 81 81 81 Balance Sheet Y/E Mar, Rs mn FY17 FY18 FY19e FY20e Cash & bank 285 321 526 688 Debtors 5,247 5,908 6,923 8,058 Inventory 5,714 7,473 8,645 9,963 Loans & advances 1,687 2,248 2,266 2,347 Other current assets 1,923 2,512 2,512 2,512 Total current assets 14,856 18,461 20,872 23,567 Investments 470 472 472 472 Gross fixed assets 26,546 31,007 35,679 41,428 Less: Depreciation 9,576 11,028 12,658 14,568 Add: Capital WIP 2,695 4,362 5,800 5,800 Net fixed assets 19,665 24,341 28,821 32,660 Total assets 34,991 43,275 50,165 56,699 Current liabilities 3,256 3,805 6,335 5,860 Provisions 278 310 310 310 Total current liabilities 3,534 4,116 6,645 6,171 Non current liabilities 17,193 22,604 22,620 24,111 Total liabilities 20,727 26,720 29,266 30,281 Paid up capital 411 407 407 407 Reserves & surplus 13,214 15,378 19,722 25,241 Shareholders equity 14,263 16,555 20,899 26,418 Total equity & liabilities 34,991 43,275 50,165 56,699 Cash Flow Y/E Mar, Rs mn FY17 FY18 FY19e FY20e PAT 3,158 3,330 4,498 5,673 Depreciation 1,225 1,462 1,631 1,910 Change in WC 1,248 2,988 324 3,008 Cash flow from operating activities 3,135 1,804 6,453 4,575 Capital expenditure 5,297 6,128 6,110 5,749 Misc Exp 262 671 0 0 Cash flow from investing activities 5,559 6,798 6,110 5,749 Equity 226 4 0 0 Dividends 21 154 154 154 Debt 2,722 5,192 16 1,490 Investments 57 3 0 0 Cash flow from financing activities 2,419 5,031 138 1,336 Net chg in cash 5 36 205 162 Opening cash balance 290 285 321 526 Closing cash balance 285 321 526 688 Valuation Ratios FY17 FY18 FY19e FY20e Per Share data EPS (INR) 38.5 41.0 55.3 69.8 Growth, % 22.9 6.5 35.1 26.1 Book NAV/share (INR) 165.9 194.1 247.6 315.5 FDEPS (INR) 38.5 41.0 55.3 69.8 CEPS (INR) 53.4 58.9 75.4 93.3 CFPS (INR) 42.8 25.6 80.1 56.9 Return ratios Return on equity (%) 24.0 21.9 23.1 22.7 Return on capital employed (%) 16.9 14.3 16.5 17.3 Turnover ratios Asset turnover (x) 1.1 1.1 1.1 1.1 Sales/Total assets (x) 1.0 1.0 1.0 1.0 Sales/Net FA (x) 1.8 1.7 1.7 1.7 Working capital/sales (x) 0.4 0.4 0.3 0.3 Receivable days 60.5 56.7 55.8 55.8 Working capital days 130.5 137.5 112.9 117.8 Liquidity ratios Current ratio (x) 4.6 4.9 3.3 4.0 Quick ratio (x) 2.8 2.9 1.9 2.3 Interest cover (x) 4.5 4.2 5.2 6.0 Total debt/equity (%) 114.8 132.0 103.6 87.1 Net debt/equity (%) 112.7 129.9 101.0 84.4 Valuation PER (x) 32.4 30.4 22.5 17.8 PEG (x) y o y growth 1.4 4.7 0.6 0.7 Price/Book (x) 7.5 6.4 5.0 3.9 EV/Net sales (x) 3.7 3.2 2.7 2.3 EV/EBITDA (x) 18.0 17.4 14.0 11.6 EV/EBIT (x) 22.1 22.0 17.2 14.2 Source: Company, PhillipCapital India Research Estimates Page 3 PHILLIPCAPITAL INDIA RESEARCH

Stock Price, Price Target and Rating History 1600 1400 1200 B (TP 1400) 1000 800 600 B (TP 700) B (TP 700) B (TP 740) B (TP 740) B (TP 740) B (TP 1400 B (TP 1200) B (TP 980) B (TP 1150) B (TP 1150) B (TP 980) 400 200 0 J 16 F 16 A 16 M 16 J 16 A 16 O 16 N 16 J 17 F 17 A 17 B (TP 980) J 17 A 17 O 17 N 17 J 18 F 18 A 18 M 18 J 18 Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition BUY >= +15% Target price is equal to or more than 15% of current market price NEUTRAL 15% > to < +15% Target price is less than +15% but more than 15% SELL <= 15% Target price is less than or equal to 15%. Page 4 PHILLIPCAPITAL INDIA RESEARCH

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