What are Amines?
In very simple language, Amine is one of the chemicals that is used in the production of APIs, Agrochemical, Animal Feeds, Paints, Oil & Gas, Rubber chemicals, Dyes & textiles, etc.
The key raw material, Ammonia is reacted with other key raw materials like methanol and denatured ethyl alcohol in an amine plant to produce Aliphatic amines. Now Aliphatic amines such as Methylamine and Ethylamine can further be used to manufacture value-added products called Amine Derivatives.
Amine Derivatives are much more complex, that’s why they command higher margins relative to Aliphatic Amines.
Both Aliphatic amines and their derivatives can be sold separately in the market. Generally, producers of Aliphatic amines internally consume a majority of the amines produced to manufacture its derivatives.
It’s not necessary to have an Aliphatic amine plant to produce Amine derivatives, one can purchase Aliphatic amines from the open market and still make Amine derivatives.
Application of Amines
Aliphatic amine is an intermediate business, so the amines growth is driven by clients’ growth. The clients are mainly in the Pharma Industry.
The key thing to note is there are no substitutes for Amine in the end-user industries. Even though amines are very critical for the end-user industry, it constitutes a very low percentage of the end-users overall cost.
Currently in India, Pharma (API) and Agrochemical are in the growth phase and the benefit of this can be seen in the Indian Aliphatic Industry.
There are four types of Amines namely;
1. Aliphatic (Alcohol + ammonia),
2. Ethylene amines (EDC + ammonia),
3. Alkanol amines (Ammonia + propylene oxide + ethylene oxide),
4. Fatty amines, etc
Global Aliphatic Amines Industry
This industry represents close to $5bn (0.1%) of the $4,100 bn global chemical industry. This $5bn is anticipated to reach USD 8.70 billion by 2026, registering a CAGR of ~9% as per the sources.
Global growth for the next 10 years is estimated to be 8-9%.
Globally, the Aliphatic Amines industry is oligopolistic with two three producers catering to the majority of demand in a region, except China which has more than 3 players.
Eastman Chemical Company and BASF are the largest players globally. The top six companies account for 50% of the global capacities. China is the largest consumer and producer of Aliphatic amines accounting for almost 60% of the global production.
Indian Aliphatic Amine Industry
Indian Amines Industry size is 2000 – 3000 Cr. Indian aliphatic amines market is substantially consolidated. Balaji Amines and Alkyl Amines account for close to 50% and 45% of the total market share respectively.
Aliphatic Amine Industry in America and Europe is much bigger in size in comparison to China and India. China and India came much later in this industry.
Historically, the Aliphatic Amine industry has been a wealth creator. Over the last 19 years, the Industry size itself has compounded at a CAGR of 17% and the profitability has compounded at a CAGR of 26%.
The outlook for the Indian amines market remains robust considering the scope for increasing import substitution and huge potential for growth of end-user industries. Also, Balaji amines and Alkyl amines can be indirect beneficiaries of the PLI scheme in APIs.
New players in the end-user industries are putting up capacities; Alkyl and Balaji can supply these new players.
Therefore, the factors such as 1) import substitution and 2) the huge growth potential of end-user industries can drive a double-digit growth over the next 3 to 5 years in the Aliphatic Amine industry.
The growth in margin-accretive amine derivatives is likely to surpass the growth in basic amines.
Exports account for 20% of the Industry. For Indian Amine manufacturers, 45-55% of the export revenue comes from Europe alone. USA and Japan are the other key export markets.
Raw-material cost pass-through to end customers is standard practice in the industry.
How the Indian Amine Industry came into existence?
Initially, a large proportion of the Amine requirement was fulfilled through imports. But a few domestic players saw this as an opportunity and started the domestic production of Amines to cater to the domestic demand.
Alkyl Amines tied up with a US company for the technological know-how and Balaji Amines developed the tech in-house.
End users had long-term contracts with foreign amines MNCs. End users had a perception that it will be difficult for an Indian company to make the same quality product locally due to a lack of complex chemistry skills and technology.
So it took a lot of time for the Indian suppliers of Amines to break that perception. But once the end-users were convinced of the product quality then as and when the long-term contracts with an MNC supplier put to an end, these players switched to local sourcing.
To give you an example, Balaji through its subsidiary, came up with three new products which were initially imported, and now they are trying to enter into a contract with the end-users who are procuring it from MNCs.
In 2018, almost 30% of china’s capacities were shut due to pollution issues. This has helped the Indian industry to improve sales as well as margins. Balaji Amines also saw a growth in exports due to China’s environmental issues.
Later the Chinese capacities were back to some extent. But this time China is definitely stricter with environmental issues and the government is penalizing the companies who are not following the guidelines.
The new plants that are coming up in China will definitely have the prices at par with Indian counterparts, because of the additional investment that Chinese players need to make to meet the environmental compliances.
Due to supply disruptions in 2017 and 2020, the Global companies want to reduce their exposure to China over the medium to long term (China + 1 strategy). This is likely to be a silver lining for Indian companies.
Characteristics of the Industry
1. A play on import substitution
- Domestic Procurement by end-users
- Customers, who were earlier importing amines, are buying it domestically due to local availability.
- Reason: Transport of these hazardous products over longer distances is not safe and freight is a big element. Also, one needs to import in bulk to reduce import costs. The advantage of local sourcing is that customers can buy in smaller quantities and just in time is also possible, as a result, your supplier is handling the hazardous inventory for you. Therefore, Low import risk.
- Customers, who were earlier importing amines, are buying it domestically due to local availability.
2. The contracts signed are pass-through in nature
- The contracts are short-term in nature ranging from a couple of months.
- The pricing of the product is based on
- Market conditions and,
- Raw material prices
- If the raw material price increases then the price of the finished good increases as well (lag of 1 month) and vice versa. So your absolute margins are intact.
- What gives an amine player to pass on changes in raw material price?
- A fewer number of suppliers in the industry
- Low cost as a % of the client’s end product.
- Difficult to import (low foreign competition)
- In some conditions due to the shortage of products, the prices might increase even though the raw material price stays the same resulting in higher absolute margins.
3. Growth is dependent on New product development and the growth of the end-user industry.
4. Non-cyclical in nature
- 80% of Aliphatic amines go into defensive sectors like Pharma and Agrochemical.
Porter’s Five forces
Threat of substitutes (Low threat)
- Amine and its derivatives have no substitute, they are critical for the end-user industry.
Threat of new entry (Low threat)
- A duopoly industry
- Safety is a critical factor and hence end-users prefer to work with only 2-3 credible suppliers.
- Plus the size of the industry is so small making it unattractive for any new player to enter the market.
- Bigger players have no motivation to enter this industry due to its smaller industry size, and smaller players find it difficult to enter due to higher capital requirements coupled with higher lead time to convince customers.
- Also, the end-users will not backward integrate. Amines are majorly (80%) used in Pharma and Agrochemical. Pharma industry size globally is $1200 bn, Agrochemical: $50 bn, Amies global size: $5 bn. Amines is a very small industry in comparison to the end-user industry. So,nNo point for Pharma and Agrochemical to backward integrate. (No/low backward integration risk)
- Therefore, the industry will remain an oligopoly, and the threat from new competitors would be limited.
- And in many regions across the world, this industry has remained a duopoly/oligopoly except China.
2. Capital intensive
- This industry is capital intensive in nature with asset turns ranging from 1.5 to 2x.
- The process to produce Aliphatic Amines and their derivatives is complex. Also, the technology is closely guarded in the industry with a few producers.
This industry has high barriers to entry due to its Small size, No substitute, Capital intensiveness, and Complex process.
Buyer power (Low to moderate)
- There are hundreds of buyers of Amines in India. This results in Low client concentration risk and reduces the power of the buyers.
- The contracts are pass through in nature so most of the time the absolute margins of the Amine companies are protected.
- The Amine cost to the overall cost of the end-user is very low, so a few percent changes in the procurement of Amines will not affect them.
Supplier power (Low to Moderate)
- Ammonia, Methanol, and Ethyl Alcohol are key raw materials. Amine players have to pay according to the market prices of these raw materials.
- Neither the suppliers can charge more than the market price nor Amine players can negotiate on raw material prices.
- Even though the Amine players have no control over raw material prices, their absolute margins don’t get affected by changes in prices of raw material because the contracts between the Amine player and buyers are pass through in nature.
Competitive rivalry (Low in India)
- In India, the competitive Rivalry is also low as there are only 2 major players (Alkyl and Balaji) and they don’t try to crowd each other’s product
Balaji Amines Limited (BAL), one of the two major manufacturers of Aliphatic amines, Amine derivatives, and Specialty chemicals with a market share of ~50% in India. Mr. A Prathap Reddy, who is a civil engineer by qualification and Executive chairman of the company, started this company in the year 1988. Mr. Reddy has 45+ years of experience in varied industries. Today, BAL is run by the Reddy family.
BAL has been a consistent compounder of revenue and profits for the last 24 years. From a modest beginning with 3 products and no exports, BAL now has a range of 30 products and exports to 45 countries. About 80% of their products were previously imported into the country.
Products are mainly used in APIs, Agrochemicals, Paint industry, Refineries, and a host of other industries.
Understanding the Business
Our focus will be on the core business which is Amines.
Product selection strategy
BAL has a very simple product selection strategy. They select products for which they will be the first or second manufacturer in India. And will substitute products that are being imported into the country.
This strategy enables BAL to capture market share in India from multinational companies leading to robust growth opportunities over the medium to long term.
Another important criterion is the availability of raw materials. If BAL is able to source raw material adequately and easily, then they will go ahead with the product.
In about 60% of their products, they are the only manufacturer in India. Products like NMP, NEP, GBL, 2P, Morpholine, DEAE, DMAE, DMU, DMF, PVPK-30 are solely produced by BAL.
So the focus is to substitute imports and be among the top 2 suppliers of the selected product. This strategy reduces competition and safeguards offtake.
We have covered only those products in respective categories which significantly affect the performance of the company.
Product category 1: Amines
Methylamine and Ethylamine are very basic chemicals. 2 out of 4 new pharma molecules use Amines.
Sourcing consistent supplies of Raw Materials is key for the Industry. Methanol (raw material) accounts for more than 50% of raw material cost. Balaji has started buying methanol on a spot basis and is only maintaining 1 month’s inventory due to easy availability.
BAL internally consumes 70% of the Methylamine and Ethylamine for the production of Amine derivatives, because Amine derivatives have better realizations and margins.
The industry was affected by the US’s sanctions on Iran, which is one of the dominant manufacturers of methanol in the world. The procurement cost of Methanol has increased as one cannot import raw material from Iran. If the situation improves due to leadership change in the US, then Balaji might benefit.
There is no major dependence on China for raw materials.
Product category 2: Amine Derivatives
Product Category 3: Specialty Chemicals
In the past 2-3 years, the prices of Acetonitrile have significantly increased from Rs. 140/kg in 2018 to Rs. 280/kg currently. The demand for Acetonitrile is expected to stay elevated, as it has emerged as a user-friendly solvent and is being preferred by many end-users over other solvents.
Keeping the raw material price constant, if the price falls below Rs. 150 then it will be difficult to survive.
There are two methods to produce Acetonitrile
1) Synthetic route (direct route)
- Acetonitrile can also be produced through Acetic acid and Ammonia. This method is used by Balaji amines and Alkylamines.
2) By-product of Acrylonitrile
- Acetonitrile is derived as a by-product during the production of Acrylonitrile.
- Acrylonitrile is used in ABS (Anti-lock braking system), which is used in the Auto Industry.
So when the Auto Industry performs, demand for Acrylonitrile increases, and this results in more production of Acetonitrile. Therefore, the higher the supply of Acetonitrile, the lower the price.
Due to the slowdown in Auto Industry in the last 2 years, the production of Acrylonitrile has declined and this has, in turn, resulted in the lower production of Acetonitrile. Now, this is 8th standard Economics, what happens when the supply falls and the demand is constant? Prices rise
Earlier the demand-supply mismatch used to sustain only for a couple of months, but this is the first time that the mismatch has sustained for such a long period. Also, a big foreign company (Ineos) closed its Acrylonitrile plant which also pushed up the Acetonitrile prices.
Pharmaceutical companies have started preferring Acetonitrile that is manufactured via the direct route, due to its superior quality which enables smoother production without disturbances.
Balaji is working towards lowering the cost of this product. The Acetonitrile plant that Balaji has is fungible, meaning it can be used for both Acetonitrile and THF production. THF will be produced for the first time in India and there is a demand of 15,000 tons per annum. Management is working on expansion plans for this product, but will only comment post understanding the ground reality.
BAL is the only manufacturer of DMF in India, they started the production in 2013 with a capacity of 30k tons. Even though the Indian requirement of DMF is 46k tons p.a, still BAL is only able to operate at 30% capacity utilization. The reason for lower utilization is dumping by China and other Manufacturers.
At whatever price China dumps, BAL has to match that price in the domestic market.
BAL has made an application to the Government of India for levying anti-dumping duties on DMF. And as of now, there is no positive update on this.
Nevertheless, in recent months BAL has witnessed better pricing of DMF, which has made the manufacturing of DMF viable. If the price realization remains steady, BAL anticipates gradual improvement in capacity utilization to 60% from around 30% in FY20, which was about 20% in FY19. Capacity utilization in Q3 FY-21 was at 45%.
The realization and capacity utilization have improved due to a reduction in imports and higher demand in the domestic market.
The breakeven for this product is Rs. 70/kg and currently, the realizations are upwards of Rs. 120 per Kg. DMF was the major driver of BAL’s Q3 FY-21 results.
In Q2 FY-21, China and Saudi have increased the prices as DMF as it was under short supply. China was selling at Rs. 88, this is without anti-dumping. BAL could comfortably compete at this price.
Currently, the industry demand is 60k tons. And due to pharma expansion, this 60k import requirement will go to 80-90k in 2 years. BAL is undertaking a capacity expansion of 30,000 tons to take advantage of this opportunity.
Approximately 200 pharma players have put papers to increase capacities, so there is a very good chance that BAL’s DMF capacity will be utilized.
- No USFDA or EU approval is required. Clients visit the inspection facilities.
- More than 50% of revenue is derived from pharma. All their products are used in the manufacturing of essential drugs like metformin which will be manufactured by pharma companies despite pricing pressure/price control.
- Currently, they are witnessing good demand. All major pharma companies are their customers.
- Pass-through contracts
- Both Balaji and Alkyl Amines have the ability to pass on increases/decreases in the prices of raw materials to the end customers.
- 55% of the company’s products go into API and Bulk drugs. A bulk drug sells for Rs. 300-400 per kg. And the cost of BAL’s product for this end-user is Rs. 20-30. Because BAL’s product is a very small proportion of API’s topline, it becomes easier for Balaji to pass on the changes in the prices of raw material to the customers.
- Currently, it takes 2 weeks times to pass on the increase in raw material price as the demand is favorable and the customers need the supply. Earlier it used to take a month to pass on the increase in raw material price.
Subsidiary [Balaji Specialty Chemicals Private Limited (BSCPL)]
Since June 2019, BAL through its subsidiary Balaji Speciality Chemicals Private Limited (BSCPL) has started manufacturing new products such as Ethylene Diamine (EDA), Piperazine (PIP), and Diethylenetriamine (DETA). These products will be primarily used in the Agrochemical industry.
The fortunes of this subsidiary is tied to the performance of the agrochemical industry.
These products were introduced to fulfill the domestic demand through local manufacturing. (Import substitution play
India currently imports 29000 MT of EDA and 7000 MT PIP and 3000 Mt of DETA per annum. Balaji wants to grab these import substitution opportunities in the coming years. These three products are imported into India from various big players like Dow, BASF, Delamine.
EDA’s demand by end-users is expanding at 20-25% per year. The raw material for the same is monoethanolamide and ammonia. EDA goes into agrochemicals for manufacturing mancozeb. UPL, Coromandel and Indofil are major consumers of EDA.
PIP and DETA go into pharmaceutical, polymer, coatings, etc.
The subsidiary’s plant has a capacity of 37,350 TPA for EDA; 4,050 TPA of PIP and 3,150 TPA for DETA. And BAL is the only manufacturer of EDA, PIP, and DETA in India.
BSCPL Undertook capex of about Rs. 250 crore (loan contribution Rs. 150 crores). Balaji made an equity investment of 66 Cr in this subsidiary and has issued a loan of 46 Cr towards the subsidiary.
BAL currently holds 55% of this company. As the performance improves they might merge this subsidiary into the parent.
- Expected revenue at Peak utilization around Rs. 300+ crore.
- This subsidiary is a mega project, which means 50% GST will be refunded back to BAL.
- Received REACH certification from Europe for the supply of DETA products.
- BSC will get all the support from BAL in terms of distributors/sales team and overheads. The additional expenses are going to be less.
BSCPL Performance In Q3 FY-21
- In Q3 FY-21, BSCPL was operating at 40% capacity utilization (CU). A lot of demand came from China. Prices were and will be in an uptrend as the imports have sharply reduced.
- Prospects of Agro-sector are brighter on account of overall improvement in the agricultural sector. There has been an increase in acreage. The reservoir level has improved in the last 5 years.
- The ramp-up will be gradual as potential customers can only switch suppliers once their earlier contracts get over.
- Exporting products such as EDA and DETA to China. These products were previously getting dumped in India. This is the first time that for straight 2 quarters China has imported those products from India which they used to dump earlier. Management is not sure whether the import of these products will continue at this scale and can only comment after seeing the trend for the next two quarters.
- EDA export price: Rs. 150, Domestic price: Rs. 130. Customers are unwilling to pay higher prices in the domestic market.
- Guidance for the next quarter is 50% CU and for the next year is 80-90% CU.
- At peak utilization, this subsidiary can do a 20-22% EBITDA margin.
- Breakeven should be achieved at 50-55% capacity utilization.
Misallocation of capital
CFL business (Liquidated)
- Invested in a subsidiary namely Balaji Greentech Products Limited, which used to manufacture and supply CFLs. Closed down this subsidiary and has liquidated the stock at a loss.
- This subsidiary has 12-13 acres of land worth Rs. 25 Cr and a Warehouse which is given on rent for 9 lakhs per month.
- The company had land available at Solapur and it decided to build a hotel on the land.
- The company felt that Hotel construction could be a way to exploit its land assets and would offer some amount of de-risking to its overdependence on chemicals business.
- Invested Rs. 110 crore in the Hotel Project via a mix of Debt and Equity.
- Commenced Operations in October 2013.
- Hotel Balaji Sarovar Premiere is the only 5-star hotel in Solapur.
- Tied up with Sarovar Group for the Management of the Hotel on Management Fee + Revenue Share model
- This hotel doesn’t contribute much to the topline and profitability.
- Management doesn’t plan on liquidating this business.
- As per Q3 FY-20 concall the valuation of the hotel is Rs. 148 Cr.
Balaji is run by very competent management who belongs from a good educational background and have a cumulative experience of multiple decades in the Aliphatic amines and Specialty chemical industry.
The company has generated massive wealth for its shareholders. The stock is up 55x since 2007. Management has assured the investors that going ahead Balaji won’t invest in non-core business. Promoter holding: 53.7%
In the past, there has been a significant misallocation of capital. In 2013, they invested +100 Cr (1/3 the amount of total fixed assets) in the hotel business. The hotel division has been a loss-making unit since its inception. If this 100 Cr were invested in the core business, then it could have generated more wealth for its shareholders. This is one of the major reasons for the valuation gap between Alkylamines and Balaji amines.
Current capacity & Expansion plans
Balaji has a current capacity of 185,000 tons across 5 Units located in Maharashtra and Telangana. And a capacity of 45,300 tons in BSCPL.
BAL is going to add 1.23 Lakh tons of capacity till 2023. Capacity growth of 66% on the standalone level. At peak utilization, BAL can do 942 Cr more from the new expansion.
Phase I of the Megaproject
- Balaji is coming up with a Megaproject for which it has acquired 90 acres of land. Megaproject status is given when a company spends more than 250 Cr. And some tax refund is provided by the government (a part of the GST is refunded).
- In November 2019, BAL received the environmental clearance for 90-acre at Unit IV in MIDC. Balaji will be coming up with 17 new products in total. In the first phase, they are coming up with 2 products namely Ethylamine and DMC.
- All products are import substitutes. One such product is DMC which is currently imported from China. This product is also used as an alternative to LPG in China. It’s a low-cost product.
- Target is to add a capacity of 1,00,000 tonnes in the next 6 to 7 years.
- In Phase I, BAL has spent Rs.128 cr out of Rs.150 Cr. Majorly funded through internal accruals.
- The peak asset turnover achievable is 2x.
- Ethylamine capacity of 16500 tons will get commissioned by end of 2021. Price: Rs. 120/kg.
- Post expansion, BAL will have the largest Ethyl Amines capacity in India.
- They are installing this capacity to substitute the imports from foreign countries.
- Presently, there is a supply shortfall of about 9,000 TPA of Ethylamines in India, which is expected to increase to about 15,000 TPA in the next two years
- Ethylamine will be sold entirely in the market. BAL has ready customers for this product.
- The production of Di-Methyl Carbonate (DMC) is expected to commence by the end of Q2FY22.
- Capacity: 10000 tons. Current price: Rs. 130-140 per kg
- The demand for Di-Methyl Carbonate is about 8,000 tonnes in India, which is currently met fully by imports.
Phase II of the Megaproject
- To meet increasing captive requirements, BAL plans to set up a separate plant for Methylamines with a capacity of 40,000 to 50,000 TPA under Phase – 2 expansion of Greenfield Project (Unit IV) for which the company has already received environmental clearances.
- BAL anticipates the commissioning of this plant by November 2021. Investment: 200 Cr.
- Methylamines are a key raw material and the base product for value-added derivatives. 80 % of methylamine production will be used captively.
- Pharmaceuticals and agrochemicals are expected to drive significant demand.
- New capacity of 30k tons per annum. Completion time: 18 months. The total DMF capacity will be 60k tons p.a.
- Industry growth: 7-10% per annum.
- Funding sources will be decided soon.
Another major player in the Indian Amine Industry is Alkyl Amines.
Between Balaji and Alkyl 40% of the products are the same and the other 60% are different. Balaji and Alkyl are very careful about which products to enter. They don’t try and crowd the other player’s product market. Earlier Alkyl went for Methylamine expansion, so Balaji went for Ethylamine capacity.
Alkyl’s superior performance in the last 2-3 years is because of Acetonitrile. Alkyl is a leader in Acetonitrile with a capacity of 30,000 tons per annum.
Major competitors of BAL are MNCs like BASF, Eastman, etc. In the current scenario, the pricing is decided by the competition. They will have to match the import pricing.
Impact during COVID
BAL is engaged in the production of essential goods and was operating at 70% capacity utilization during the months of March and April. The capacity utilization was affected owing to varied factors like non-availability of labor, disrupted supplies of packing material, delays in port clearances, limited availability of trucks and tankers for the movement of raw material and finished goods.
Due to COVID-19, they saw good demand in some of the products like NSE, BMA, TEA, Acetonitrile, etc. These go into drugs that are used to treat patients.
Due to lockdown, BAL lost 30-35 Cr of turnover in the last year. As lockdown eased, the company ramped up capacity utilization levels and has sustained to original levels. During June 2020 they touched pre COVID levels.
Balance sheet structure
The above is a standalone balance sheet structure as of 2020. Out of the total assets, 52% (578 Cr) are invested in the core business (Chemical business) at the standalone level and these assets generate revenue of 1070 Cr (1.85 Asset turns) and spit out a 22% EBITDA margin on a sustainable basis. This is a capital-intensive business with high margins.
In the last 5 years, the company has invested 186 Cr (Cash flow statements) in core business on a standalone basis. Currently, we see 71 Cr in CWIP and Capital advances which is towards the Megaproject. We are expecting Capex to continue going ahead as many projects are lined up.
Most of the standalone Capex is funded through internal accruals that’s why we don’t see any long-term debt.
The Hotel business contributes 20 Cr to the top line against which 72 Cr is invested. And is near no profit no loss situation. Hotel division is the primary reason for lower ROA and ROE at the standalone levels. The hotel is currently valued at 140 Cr.
BAL has made a total investment of 112 Cr in BSCPL, which has still not reached the breakeven point. Further, they have given a corporate guarantee of 158 Cr towards the subsidiary. Management claims that in 2022 this subsidiary will operate at 80-90% capacity. And will contribute to the profitability.
If we look at the last 10 years, WC/Sales ratio is at the lower end of the bracket. The reason for this improvement is BAL has slightly improved its collection capabilities over the years. But at the same time, they are paying to their creditors at a faster pace.
As the conversion from earnings to cash is good, the company can easily fund its working capital requirement through internal accruals.
Note: Since COVID hit in Q4 FY-20, the FY-2020 numbers may not give us a correct representation of the true capabilities of the company.
The company has a very comfortable working capital position since it generates positive cash flows from operations. But they have taken a short-term loan of 102 Cr. This loan can be for various reasons such as the money which is lent to the subsidiary or to keep liquidity (47 Cr in Mutual funds).
The loan is not a sign of worry as they have good D/E and ICR ratios.
BAL generates a good amount of cash through its operations but is not able to retain a large proportion of it due to ongoing expansions. The maintenance Capex is approximately 3-4 Cr.
Aggressive expansion over the years. And the plan is to add 1.23 lakh tons over the next 4 years.
BAL has a very strong balance sheet with low debt, a good amount of assets, and a hotel that is valued at Rs. 140 Cr. Liquidity will be an issue as the company will be in expansion mode shortly. But this expansion can be taken care of as BAL generates a good amount of cash.
Profit and Loss
Since this is a converter industry with pass-through contracts and the price of the product is determined by the market forces. The only thing that BAL can control is volume offtake, efficiency, and move towards value-added products.
BAL has compounded its revenue by 12.1% in the last 10 years. And the major proportion of that growth is due to volume growth. Pricing is something which the market decides, BAL can have some control on pricing growth by introducing more value-added products.
Over the years BAL has focused on increasing volumes and dealing in value-added products which have higher realizations and margins.
The key is to focus on Volume growth, So check expansion plans for future growth.
In 2020, BAL lost 30 Cr in revenue due to the Lockdown. This is the reason we see a dip in revenue on a yearly basis.
In the last 4 quarters (TTM), BAL has increased its Volumes and Price per unit by 8.3% and 11.3% respectively despite the slow Q4 FY-20 and Q1 FY-21. And this Volume and pricing growth has resulted in a 20% growth in revenue.
The company has a REACH certificate which enables it to export to the regulated market of Europe. The company has also received a WHO-GMP certificate, which enables the company to export its products to regulated international markets.
Balaji has historically derived almost 20% of its revenues from exports.
In 2018, almost 30% of the Chinese facilities were shut because of the pollution issue. Whoever was using the product from China couldn’t procure it due to the low supply. They started looking for alternative sources. And this is the reason why Balaji did so well in 2018. And in general, this 2018’s China pollution issue was beneficial to Indian Chemical companies.
We see degrowth in 2020 is due to the outbreak of COVID.
As per management’s latest commentary, they were seeing a good opportunity in the export market since the last 4-5 months. COVID’s effect on China has given a plus to India. But they are not sure how the trade war between the US and China will end.
Also, there is some transport issue due to which the export is affected. But management claims that in 1-2 years they will reach 30% of top-line in exports.
This is like a converter industry. They take in a few raw materials, process them, and then make a product out of them which is primarily used in Pharma (API) and Agrochemical Industry. They can pass on an increase or decrease in the prices of raw materials to the customers. In some years despite the volume increase, the revenue might go down due to a fall in raw material prices. So to get a good understanding of the company’s profitability it’s important to look at volume growth and spreads per unit.
The Gross margins have improved from 38% in 2009 to 47.7% in 2021. And this in turn has resulted in higher EBITDA margins. The improvement in margins is a combination of a better product mix (move towards value-added products), high volume growth, and operating leverage.
The improvement in spreads per unit at the gross level is an indication that the company is moving towards value-added products.
Due to the increase in revenue from the Amine division, a focus towards value-added products and reduction in losses from the Hotel division have positively affected the margins on a blended basis. And this has resulted in high profitability which has resulted in significant net-worth growth over the years.
BAL has consistently compounded its PBT and Net-worth at 19.1% and 22% respectively in the last 10 years.
The reason for these margins and return ratios are:
- Inherent characteristics of the industry
- Focus towards Value-added products and Volume expansion (Major impact)
- Continuous capacity expansion
- Catering to end-user industries which defensive in nature.
- Operating leverage (Minor impact, as most costs, are variable in nature)
Du-Pont Analysis (Standalone business)
NPM: Over the years the margins have improved due to a higher proportion of value-added products, reduction in loss of hotel business, and some effects of operating leverage.
ATR: There was a sudden dip in Asset turns once the Hotel Business commenced in 2014. And in 2015 the production fell by 6.6% which might have affected the Asset turns. But as the Revenue started picking up due to 1) an increase in sales of value-added products and 2) higher volumes the ATR started improving.
Leverage: Over the years the leverage ratio has decreased due to higher net worth growth. Which is a result of higher bottom-line growth.
Du-Pont Analysis (Core Business)
Now we will analyze the ROEs of the Core Business (without Hotel division, Other Income, Mutual fund investments, Subsidiary)
ATR: The core business has a very high Asset turn. The reason for this is that the Hotel division pulls down the asset turns at the standalone level.
Leverage: As the Equity lightens up after excluding the Hotel Division, Subsidiary investment, and Mutual Fund units, the leverage improves which in turn results in higher ROEs. Over the years the Leverage has reduced due to higher growth in Equity which is a result of higher profitability.
If we just consider the core business of Balaji then the return ratios are very attractive.
Balaji Speciality Chemicals Private Limited (BSCPL)
BSCPL started operations in 2020, So it’s too early to judge the profitability. At peak utilization, this subsidiary can do 1.5-2x asset turns (300 -400 Cr in topline) and 20-22% EBITDA margins (66-88 Cr)
BSCPL did revenue of 54 Cr in 2020 and 93 Cr in 9m 2021. In Q3 FY-21, this subsidiary did revenue of 37.5 Cr (40% CU). And Management claims that this subsidiary will reach 80-90% capacity utilization by 2022. If it did 37.5 Cr at 40% capacity utilization, then it can do a 300 Cr in revenue at 80% CU on a yearly basis.
Standalone Performance in the last 3 quarters
In Q3 FY-21, BAL saw continuous growth on the product portfolio on account of sustained growth in the Indian pharma industry and on account of the China + 1 strategy adopted by western companies. This has resulted in a better price realization across all their products.
The reason for a 600 bps expansion in EBITDA margin was an increase in volumes, better price realization, operating leverage, and better product mix. A 34% volume growth was mainly because of higher utilization of DMF from 20% to 45% capacity utilization.
Management is very bullish on DMF’s capacity utilization and expects it to go above 60% in the coming quarters.
Margin improvement in Q1 FY-21 and Q2 FY-21 was on account of higher realizations and stable prices. Management claims that ideally, one can expect 20-22% EBITDA margins on a sustainable basis.
- Acetonitrile price at very high levels. Any revival in Auto may affect the prices.
- This is the first time DMF has performed. But if China starts dumping again then there will be significant de-growth from Q3 FY-21 levels for some time.
- Risk of future bans in the Agrochemical industry.
(Why do we like this Industry and this Company)
BAL is in a Duopoly Industry with close to 50% market share (Big fish in a small pond).
Amines are very critical to the end-users industry as there is no substitute for Amines (less threat of substitutes). Also, the majority of Alkyl and Balaji’s products are different (less competitive rivalry)
Amines are mainly used in API and agrochemical which are necessity products and both the industries (API and Ag-chem) are in the growth mode. Amines industry has good ROCEs and stable margins. And as per estimates the Global Amine Industry will itself compound at 8-10% for the next 10 years.
BAL is putting up huge capacities and is constantly introducing new products which will sustain the current level of growth going ahead.
As per management at peak utilization (existing and upcoming capacities), BAL can do a total of Rs. 2000 Cr in topline in the next 4 years.
This industry globally has the ability to pass on an increase in RM price. Management’s product selection strategy is very clear, they select those products which are not currently produced in India. This gives them revenue certainty and a first-mover advantage.
Alkyl and Balaji have some sort of unsaid understanding regarding the product introduction. So the performance of one company may not have an impact on the fortunes of other.
Amines Industry has High barriers to entry as it’s very difficult for others to enter due to process patents, small industry size, complex chemistry, hazardous nature of the product, high capital requirement, and high lead time to lock in the customer.
Amines have a low threat of imports as Amines have huge handling risk and hence it is difficult to transport them, which reduces the threat of imports. Safety is a critical factor and hence end-users prefer to work with only local 2-3 credible suppliers, which further increases the barriers to entry. Clients shift to domestic sourcing due to just in time and higher import costs.
Balaji is a big fish (50% market share) in a small pond (Small industry size) in a Duopoly industry which has High barriers to entry, Low import risk, no substitute risk, reasonable competitive intensity among industry incumbents, low supplier power, and Low buyer power.
BAL has a diversified product basket with sustainable margins at 20-22%, has robust returns on capital, has compounded its PBT and Net-worth at 19% and 22% in the last 10 years, and is a decently levered company, is planning to increase its capacity by 66% in the next 4 years, is available at 26x earnings; thus it is definitely worth a look.
Read us more on Alkyl Amines here.
Disclaimer: We are not SEBI registered Research Analysts. Views may be biased.
Aman Thadani has cleared all three levels of the CFA(US) Program. He is in Equity Research since 2017 with a key focus on deep fundamentals and valuations. He has worked at Consortium Securities (PMS division) and MoneyLife Advisory. He believes in maintaining Health and Fitness as the key requisite to aim for healthy and fit returns. He enjoys playing Chess and Football.