Chembond Chemicals- A Perfect Misvalued Bet


(adityanahata) #1

Chembond is the leading manufacturer and supplier of Specialty Chemicals to diverse sectors of industry such as automobile, steel mills, fertilizers, refineries and petrochemicals, power plants and infrastructure projects such as metro systems, bridges and expressways.
Chembond has identified Water as the major area of thrust and has taken steps with the formation of JV - H2O Innovation India Ltd to offer ‘State of Art Technology’ that provides complete solution to water problems - from RW treatment to waste water recycling.
Some Companies are always like tortoise, hiding the most exiting part of their business under a shell called either subsidiaries or joint ventures till a critical size is achieved. When such business grows these subsidiaries will eventually merged with the main company or de-merged to unlock the valuation. Till such a merger/de-merger happens, the main company will known for its boring business and enjoying low valuation. But on merger/de-merger the entire picture rapidly changes and catch the market fancy in a short period . Meanwhile, utilizing the low valuation as an opportunity ,promoters may mop up the entire floating stock from market .CHEMBOND CHEMICALS is such a play which is unnoticed by most of the market participants ,even if its main business is growing decently.Even if this company have six divisions including its subsidiaries and joint ventures ,it is known as a Construction Chemical manufacturer.
Under this fold company is making construction chemicals, water proofing compounds, concrete repair products…etc.Major clients of this division includes RDC Concrete Ltd, J K Laxmi RMC ,Birla Readymix , Larsen & Tubro Ltd., Oriental Structural Enginerring Quark City India Pvt. Ltd., Sunway Constructions Ltd. , Unitech Ltd. ACC RMC , Hindustan Construction company, Nagarjuna Construction Company , Gammon India DLF Laing O" Rourke India Ltd…etc. Chembond have a nationwide distributor network and known as a quality producer in this category. Another division of the company is Coatings division which is making corrosion protection coatings for structural s and industrial floor coatings materials. Under the trading division company offering various types of construction chemicals and representing ‘Peramin AB’ of Sweden ,a leader in this industry- in India. Chembond’s biotech division is through an associate company –Chembond Enzyme Company Ltd- supplying products which are widely used in industries like Textile,Distillary and Animal feed. Company also having a joint venture with chemical major Henkal for manufacturing metal treatment chemicals known as Henkal Chembond Surface Technologies Ltd.
The promising part of Chembond is its increasing presence in the Water,Waste water and Effluent treatment business. Chembond Ashland Water Technologies is a company jointly promoted with Chembond Chemicals (55 %) and Ashland Inc of USA .This company is manufacturing various type of water treatment chemicals for cooling water treatment,boiler feed water treatment,waste water treatment…etc and finds applications in industries like Chemicals,Power generation.
In the beginning of 2010, Company started a 51 % joint venture (H2O innovations India Ltd) with H2O Innovations Inc of Canada for equipment based solutions for Water treatment ,recycle and re-use. This industry having tremendous potential in India and the overwhelming response to other companies like VA tech Wabag is a true indicator of the fact. Within a short span of time this new company already received prestigious orders.

The company commands almost a monopoly in it’s business and with it’s small concentrated equity capital there is a possibility for the stock to command a 10x valuations even from the current levels.
Financials:
Company is performing very well in financial front and rewarding share holders accordingly. For the financial year ended March 2015 ,Chembond posted a turnover of Rs.216.75Cr and a net profit of Rs.5.78 Cr.- Company has been maintaining a healthy dividend payout of 43.45%
Well,to end it all, at current levels I feel it’s a definite buy given the value that’s yet to be unlocked.

Disclosure: Looking to start adding positions on Monday and further as the story progresses


(Vivek Mashrani, CFA) #3

The company is generating poor ROCE and wafer thin net margins…it is already trading at c. 20x 2016e PE. There are better players in specialty chemical sector like Vinati Organics, Aarti industry, Dai-ichi and Omkar Specialty with significantly better return ratios and still some of them are trading at reasonable valuations.


(vikas kukreja) #4

Company seems worthy of further investigation and study. Seems a promising company that is out of investors radar.
However, yearly profits are 13 crs (consolidated) and 5 crs (Standalone).
So on turnover of 300 crs, 13 crs seem fine, NP margin= 4%, p/e = 25 (expensive).
Their profit margins seem to shrink in last couple of years, dragging their ROE and cashflows.


(adityanahata) #5

The company has a lot of subsidiaries, the results of which is not completely visible. There is only a very little floating stock in the markets and all the existing holdings are in good hand. Once the susbsidiary businesses come into the limelight and the market notices it, it would be very difficult to get a hand on the stock.


(Sunny) #6

hi aditya,

I liked your analysis. Will be able to comment after through analysis.


(Anindya) #7

Hi Aditya,
I think you have to mention your holding details and risks(for a more balanced discussion) when initiating a thread.
@manish962 already mentioned this at several other threads.
Thanks,
Anindya


(Manoj) #8

@adityanahata,

The company commands almost a monopoly in it’s business and

I beg to differ on this point. Can you please add more details ? Source of data and what exact chemical is a monopoly ?


(adityanahata) #9

There water treatment chemicals command 57% market share globally.


(Anup Agarwal) #11

Company has earned rs 117.5 cr from the sale of 49% in HCSTL. Can we expect some big dividends.


(GreyCells) #12

I have seen many a times that shareholders expect hefty dividends after a sale of business/land etc. But is it desirable? Asking because I am not competent to understand it.

If company has alternatives to build capacity in related or same business or they have capability to invest in business and make more money for us then I do not want one time dividend. If it is idle then I want it.

Thanks
Amol


(Abhishek shah) #13

Hi aditya,

Where did you get this figure from - 57% market share? Who are the other competitors in this niche?

Disc: Not invested.


(adityanahata) #14

This was mentioned somewhere in their website or through their concall.

Direct competition would be companies as Omkar, Gulshan Polyols, Grauer etc

Disc: Invested


(TT) #15

Does anyone here have any insights as to why the company has not been able to get into higher margin products? A 7% EBIDTA margin is indicative of commodity chemicals and not specialty chemicals as the Company claims to be producing. Regardless, any views?


(drganesh) #16

chembond recently acquired additional 49% share in chembond water sdn, malaysia in which they had 51% already there by holding entire 100% should be consider as significant move


(TT) #17

How can you say so? Do you know the turnover and profitability of this entity? It could also be that the entity wasn’t performing well and the JV partner did not see any point in continuing in it.


(drganesh) #18

you may be correct also , but i just expressed my understanding.


(Rohan) #19

Did anyone attend the AGM? Would like to know what the management shared in the meeting

Disc: Tracking position


(adityanahata) #20

http://www.chembondanimalhealth.com/ The company recently enetered Animal Health and aquaculture space
Chembond’s Animal Health Division has several novel products for use in the poultry, aqua, and livestock industry based on in-house and international research and development. The major product groups in the Animal Health and Nutrition area are:-
•Enzymes
•Prebiotics and Probiotics
•Acidifiers
•Disinfectants and Water Sanitizers
•Organic Minerals
•Vitamin Premixes
•Toxin Binder
•Growth Promoters
•Dairy Feed Supplement
•Other Feed Supplements

Major part of the mcap is equivalent to investments and cash… 40 year old company http://www.chembondindia.com/index.php

I feel once people recognize this it can go 3-4x. Disc: Own 76000 shares


(Manohar T. Patil) #21

Hello Aditya, Could you provide some specific about cash & investment being equivalent to market cap.


(ANANT JAIN) #22

I think @adityanahata has done a good job in describing what Chembond does. Here is my take on the story:

Chembond was established in 1975 and got listed on BSE in 1995. It provides speciality chemicals and solutions. This is how the company has evolved since incorporation:

The company was founded by Dr Vinod Shah and is currently being managed by Mr. Nirmal Shah and Mr. Sameer Shah, Dr. Vinod’s son. During the last two decades the company partnered with multiple MNCs and has ventured into various segments ranging from Metal treatment (partnership with Henkel), Water Chemicals (partnership with Ashland/Solenis), Water equipment, Construction Chemicals, Enzymes, Animal Nutrients, Polymaides, Industrial coatings, Adhesives and Sealants etc.

On a first glance it looks that a company with 300 cr turnover is trying to too many things at a time. But for most of the things that company is doing there seems to be some thread emerging out of current existing business. For example the company one had an Enzyme division which it used to supply to Wockhardt and this business lead them into the animal nutrient business.

Key Events in last few years:

Divesting Stake in Henkel JV: Chembond divested its entire stake in JV for 184 cr. As part of this the company retained the manufacturing operations and started doing contract mfg. for Henkel at zero margins. The no compete and supplying agreement will come to an end in this quarter.

Acquiring the remaining 45% stake from Solenis in water treatment chemicals JV: Post divestment in Henkel the company acquired 45% stake from Solenis in April 2017 for around 50 cr.

Buying Phiroze Sethna Private limited (PSPL) : Chembond bought a private company which supplies sealants and adhesive to auto oems a related area in which Chembond operates. CHembond paid around 40 cr for PSPL.

Both the acquisitions are profitable with high ROCE’s and great price paid and full cash indicating good capital allocation.

R&D focus: At first glance Chembond looks like a company with 300 cr sales and into too many different and unrelated areas. But if one looks deeply one can find threads leading from one area to another for example the animal nutrition business emerged from the enzyme business which the company used to do for Wockhardt at one point of time. The way I see it is the company has seeded multiple business and have consistently tinkered around and have come up with newer innovative products at the same time keeping the balance sheet healthy with working capital ranging between 45/60 days. If one looks inside ARs one can see the various products that company has innovated every year.

For example from FY17 AR:

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From FY16 AR:

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From FY15 AR


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The company has two R&D labs one at Dudhiwada focusing on Polymers and the other at Mahape, Mumbai.

How do I look at the company?: The company does too many things but the way I look it is to focus on the higher order bits and what is changing. This is from the company’s latest presentation:

Assuming an annual topline of 300 crores this is the current split:

Toll 96
Water Technologies 126
Construction 18
Industrial Technologies 18
Animal Nutrition 30
Trading 12

Chembond has many subsidiaries but except for water technologies most have negligible contribution. The standalone business which is of around 170 cr consists of everything from the above list except Water technologies. Ignoring other income operationally standalone business has contributed pretty much nothing in last 2/3 years and this is due to the fact that the toll business operates at zero margins and other business are also incubating. The water technologies subsidiary can be looked at individually:

In the standalone numbers although there are no operational profits but there is a payout of 1.25 cr and 3 cr for FY16 & FY 17 respectively in terms of Legal & Professional Fee to Dr. Vinod Shah for his services in the Henkel deal. . This fee has ended in the September 2017 qtr and wont recur going forward.

Chembond purchased PSPL, if one looks at the books of PSPL, PSPL had an operational PAT of 3 cr in FY17 and sales of 30 cr…

Along with the above Chembond still carries around 40cr/50cr cash on its books.

All the above should constitute the base income and the historic growth rate has been around 12%.

What is changing?:

Animal Nutrition: The current share of animal nutrition in 9M is 10%. In an earlier presentation post Q1 the animal nutrition had a share of 6% assuming an annual sales of Chembond at 300 cr the animal nutrition business has had a run rate of 8/10 cr for last two quarters. An initial look at the products suggest that there is little Indian competition.

Revival in the water treatment segment driven by NTPC and other PSUs: The water treatment segment can grow very sharply for the next two to three years since the govt is now becoming extremely focused on pollution control. Anyone tracking GE Power would be aware of NTPC tenders related to pollution control norms. The other aspect here is that government bodies & PCBs have become extremely stringent with matters related to effluent discharge/recycling/reuse. As per MoEF the following are the newer water norms:

Chembond is a market leader in the coolant technologies.

Exports of water chemicals Earlier due to agreement with Ashland the company was not allowed to go into markets outside South Asia. A lot of opportunities are now opening up for company in export markets too.

Polyamides: The company in a recent disclosure stated that they have been successfully able to commercialize PA 610. From the company’s disclosure:

The company is looking to setup an initial production facility with a capex of around 10 cr. The R&D on these polyamides is being carried out at Dudhiwada near Baroda. The company might also be working on more polyamides. They have been testing this product for a while now and now that they have commercialised it they have big plans over the next 2-3 years for this business in regards to capex.

Synergy between PSPL and existing coatings business: : PSPL and Chembond’s coatings and adhesive business are complimentary and both supply to auto OEMs but in different segments. Going ahead this could help Chembond

Toll Business going away: Post Henkel buying out the company’s stake in JV the company had a 3 year no compete clause and also that the company would do toll manufacturing for Henkel at zero margin. This is the last quarter for this arrangement and after quarter the company can launch and market its own product. The plant capacity is fungible.

Risks
As mentioned earlier the company is into speciality chemicals and solution what this implies is that unlike bulk chemical companies which have large operating leverage coming by the incremental margins would be more limited. Management has been quite clear of not investing in any commodity business.

Some of the bulk chemical companies like Atul/Aarti have done exceptionally well in the last decade and have grown significantly. Chembond’s track record as compared to some of the leaders is mediocre.

The management is attempting to do too many things which can lead to unnecessary diversions. Some of their forays like the one into construction chemicals have not done well. This is the only business which has been around for long and hasn’t picked up but the reason for the same is the biz requires capital and lot of Working capital requirement and you have to let go margins, which Chembond is not comfortable with hence letting it run the way it is without infusing more capital.

Although I see some of the segments at tipping point over the next two to three quarters there could still be some parts moving (Henkel toll going away)which can impact P&L.

The demand due to NTPC and PSU generally gets delayed and is far more unpredictable.

Company’s earlier attempt to commercialize PA 610 faced competitive pressures due to the prices of alternate raw materials coming down. The development and success of PA segment should be monitored over a period of time and cannot be taken for granted.

Due to toll business going away the company could face topline erosion and building inroads and competing with Henkel can also take significant time.

Purely from a valuation perspective it is difficult to see how market values it. Generally there is a significant conglomerate discount.

Finally I think it would be really helpful if we can pick a segment and disseminate it. Focusing on individual segments/relevant products (out of a plethora) and looking at the opportunity and competitive intensity can help us move forward here.

Discl: Holding forms more than 5% of my portfolio.