Fairchem Speciality - Previously "Adi Finechem"


(JatinK) #1

Adi Finechem is in the business of manufacturing of specialty fine chemicals namely Oleochemicals & Neutraceuticals.

Oleochemicals are chemicals derived from Plant and Animal Fats. This includesFatty Acids, Fatty Acid Methyl Esters (FAME), Fatty Alcohols, Fatty Amines and Glycerol. Adi Fine is a leader in this segment. These products find applications inPaints, ink, Liquid Soap,Amines, Amides etc.

This segment contributed 97 crs revenues in FY14.

Nutraceutical is the term appliedto products that range from isolated nutrients, dietary supplements and herbal products, specificdiets, genetically modified food, and processed foods such as cereals, soups, and beverages. This finds application inFood Industry,Pharmaceuticals,Cosmetic Industry,Natural Vitamin E etc.

This segment contributed 55 crs revenues in FY14.

Bullish Viewpoints-

  1. **Monopoly- **Company claims to be sole manufacturer of oleochemicals in India. They even talk of business having high entry barriers thanks to sourcing advantage, having m/c which can take inferior raw materials but still gives high quality product.

  2. **Pricing Power- **They also claim to be having pricing power- having ability to pass on raw material price increases to the customers.

In FY14, raw material prices fell but this wasn’t passed to the customers, hence Pat grew much more than sales, 3 year revenue growth is higher than volume growth… so seems either their claim is true or they are having a good time.

  1. **Capacity Expansion- **They are going to increase their capacity from25,000 MT p.a. to45,000 MT p.a in next 2 years (18K to 25K was done in FY14).

Bearish Viewpoints-

  1. Wheat or Chaff- Without the benefit of management interview or research reports, its tough to say whether this a Wheat or Chaff looking like Wheat.

  2. One ex-promoter is selling his stake through open-market sale. That may put pressure on the stock.

My View)- Numbers look good. Not even 1 year of sales de-growth in the last 10 years indicate that the demand is there. With nearly doubling of capacity, stock has potential to double in 2 years provided margins sustain at current levels.

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PS- AR14 is out. Please read especially Page 6 & 7.

See HDFC reports Here and Here.

Disclosure- Bought recently & looking to add in case of more clarity.


(Sagar Saxena) #2

Jatin,I too,like this company & have been tracking it from past 2 quarters.The margins seem to be on the rise,on account of various initiatives taken by the management,as outlined in the AR.Sometime back,there was a comprehensive report on AFL by Nirmal Bang.
http://www.nirmalbang.com/nb-research/research-reports.aspx

The results have beaten estimates & the company may continue to deliver the goods.Moreover,there is consistency in numbers,which should lead to sustaining current multiples.Your doubts about the management are justified,however,as long as the company continues to improve on return ratios & margins in an understandable manner,there shouldn’t be any trust deficit.The prospects for this one look very exciting.

Disc.: Have a small investment in AFL


(Rakesh Chandak) #3

Worth reading before one invests in Adi Finechem:

http://www.hbjcapital.com/riddhi-siddhi-just-be-prepared-for/

Promoter-MD of riddhi siddhi is on board of Adi finechem.


(P Sharma) #4

The title sums it well. It is a business having a good time.

The two reports above cover most that there is to know about the business.

The business is riding the wave of ever increasing prices of Vitamin E. This rising price is a combination of both increasing demand and a reduction in the key raw material, deodorized distillate.

The increasing demand is due do the stated beneficial effects of natural Vitamin E as an anti-oxidant and hence used in food supplements and cosmetics. Unless until there is a damning and influential report suggesting otherwise that Vitamin E is not useful or worse harmful, the demand will keep rising.

On the raw material side, the increasing awareness of the ill effects of trans fats in diet is forcing the vegetable oil manufacturers to lower the processing temperature to reduce the quantity of trans fats being generated in the oil. This has resulted in the already small quantity of deodorized distillate being produced to be further lowered thereby further tightening the raw material supply.

The risk to this business is the risk of substitution. 80% of the natural Vitamin E being produced is being used as animal supplement and the rest for human consumption. Given the rising prices of natural Vitamin E, there is an increasing possibility that synthetic vitamin E would be used in greater quantities for animal supplements which is primarily pork and poultry.Synthetic Vitamin E costs about one fourth of natural vitamin E to produce. However, one needs to consume twice the quantity of synthetic vitamin E to reach the same level of absorption as natural vitamin E. Even then, the price is in favour of synthetic vitamin E. There have been some fringe studies which suggest that consuming synthetic vitamin E causes prostate cancer. However, these are very preliminary studies and in my opinion don’t carry a lot of weight but the seed to doubt has been sown. Will the governments allow synthetic vitamin E in animals which will ultimately end up in the human food chain?

Most of the natural vitamin E is produced by the distillate of soya oil.The other risk is if someone develops a process to use some other oil like palm oil to synthesise natural vitamin E. Though the possibility is less, it cannot be ruled out. The issue with the other oils is that the tocopherols quantity in these oils is very less as compared to soya oil.

All the other products being produced dimer acid, fatty acids etc are all commodities with no pricing power.

The global market for natural vitamin E is around $600-$700 million projected to grow to around $1 billion by 2020. Therefore the opportunity in front of the company is huge.

This is a good business to own as long as the prices of natural vitamin E keep rising or stay steady at the current prices. The only variable that they need to control is keep increasing their capacity. The other key components like raw material sourcing, process knowledge to process the distillate and customer relationships are already there.

The fewer the variables that the management needs to control, better it is as management competence is then not so vital. The management has shown the capability to keep increasing capacity and stabilise the process. They should hopefully be successful in this latest expansion too.

The valuations have run up quite a bit in the last year and at this level it looks fairly valued.

There seems to be increasing interest in this stock from the institutions with seemingly some fund buying in the past few weeks. SBI emerging fund invested recently. The management has also been issuing bonus shares for the past few years. NSE listing also seems to be in the works which will further help in driving volumes.

Disc- Invested from much lower levels.


(Niranjan) #5

Hi,

Would be great if seniors, invested / following Adi finechem can answer my query.

WIll falling crude prices have a negative impact on the profitability of ADi as the competitors will now have the cost advantage as well?

Regards,

Niranjan

Disc:not invested


(Amitayu) #6

AFL will not either benefit or loose from falling crude price . Because the RM which it uses are by products of veg oil like soya , sunflower , cotton or corn which is not changed much . Also If RM price increased , AFL has a good pricing power and able to pass its raw material increased cost to market through the price increases and if the RM price fall it will add in the margin.


(Niranjan) #7

Thanks Amitayu. I agree that AFL wont be directly impacted for the same reasons mentioned by you.

I wanted to know about the indirect effect a.k.a its competitors, as now they would have falling crude price as advantage. AFL could lose some market share or business?

-Niranjan


(P Sharma) #8

Niranjan,

Synthetic Vitamin E is derived from petrochemicals and hence reducing oil prices gives this product an advantage.

However, synthetic Vitamin E is already one fourth the price of natural vitamin E. The two products are not competing on price but on the perceived benefits, specifically relating to the superior absorption of natural vitamin E in the body as compared to synthetic vitamin E. In fact there are some studies that even suggest that synthetic vitamin E is not absorbed in the body at all and is totally expelled. The chemical structure of the two also varies.

The impact of reducing prices of synthetic vitamin E will have almost no impact on Adi Finechem’s business.


(Niranjan) #9

Thanks P Sharma.


(Abhishek) #10

To me, this seems like a business with some degree of competitive advantage. The fact that they are the only company to use by-products as raw materials gives them some degree of cost advantage. Ofcourse, cost advantages are the weakest kind of moats but they nevertheless have one and it definitely isn’t very easy to replicate as it requires years of know-how to convert inconsistent scrap raw materials to consistent finished products.They seem to be doing things differently as compared to competition. Further, their products seem to be import substitutes and clearly their marketing team is able to easily sell out capacity.

In their last con call, management indicated that apart from their greenfield expansion, they will also be developing some value added products with higher margins. This should provide higher ROCE’s both through increased margins as well as increased asset turnover(increased capacity with very little capital outlay). They have done bare minimum capital expenditure to almost double their capacity this quarter. Hopefully, they should be able to ramp up capacity next quarter onwards.

Results were less than spectacular

Sales down from Rs. 36.63 crores to 33.25 crores (down 9%)

Gross Margins down from 34.8% to 33.8%

Net Profit down from Rs. 3.92 crores to Rs. 3.48 crores (down 11%)

They have done well to bring down debtors from 51 days in March to 30 days presently although no production in the last 20 days might have played a role here.

The poor performance of the company is due to the temporary shutdown of approx. 2 weeks (16 days) in the month of August and September in order to ramp up capacity. Trials, stabilisation and ramp up back to even original capacity would have taken a few days after that. I would assume they would have lost anywhere close to 20 odd days (approx. 20-25% capacity). I personally feel confident about future quarters since gross margins have essentially remained intact at approx. 34-35% which means business hasn’t deteriorated. With the added capacity in the next quarter, they should be back on the path of growth.

At approximately 18 times PE, I believe the counter is fairly valued but the near term (next 7-8 quarters) prospects definitely look bright to me.

Disc: Heavily invested and therefore might be biased. I will probably look to add to my position if the stock drops more than 15%.


(Sagar Saxena) #11

Very well rounded up Abhishek. :slight_smile:

What is striking about the company,is that they didn’t raise a single penny for their expansions.This is commendable for a co. of their size.The capital allocation under the new management has been excellent & so has been the cash generation.

Chemicals will more or less be in a sweet spot,given receding Chinese competition,so the premium seems justified.Add to that: A niche product(Dimer Acid),cost advantage,high RoCE,healthy exports & as per the management,their products aren’t so easy to manufacture(reflected in much higher margins than the Industry leader: Atul Ltd.) So,that,coupled with the strategic use of by-products/intermediates,can help sustain margins.It is now a question of improving topline…margins will follow.Minimal Capex in the coming years,can lead to better payouts too.

Though,I do expect a down tick in early trade tommorrow.I will use all 15-20%+ dips to add.

Disc.: Invested.


(Abhishek) #12

Thanks Sagar! Somehow, I feel this stock is being given a lot less attention that it deserves on the valuepickr forum!

Its one of those few companies which has an easily identifiable moat, great return ratios, great triggers aheads, under-researched and under-owned by institutions! The only negative ofcourse is a lower degree of pricing power. However, looking at their constant gross margins for the past few years, it seems they might be in a better position to influence prices than I think!

All in all, while it might not be a type C company like Page or a PolyMed or a Nestle, with the new management, it is definitely a Mayur or Astral type hard worker where you can expect constant (or consistent) returns on capital over time

Abhishek.


(Sagar Saxena) #13

You are right Abhishek.But considering the returns VP stocks have given over the past years,there is little incentive to look outside that ‘basket’.I have observed that guys like: Ayush,Hitesh bhai,Donald,Rudra,Dhwanil,etc. have a cult following here(& rightly so!) In case,any one of them posts something here…the participation will rise manifold. :slight_smile:

Also,the fact that this company is little known to markets & falls under the pseudo ‘commodity’ chemicals space,there is lower interest.Coming back to the company,they are constantly sweating their assets & making a differentiation in that sense.There is some good news on the prices side too,which may go away anytime.That concern aside,the company is very well managed & seems like a lean organisation.So,demand is sustainable & its very little known to the markets.I have seen that this leads to great multiple expansion,once ‘discovery’ happens.So,understanding a company before the markets is certainly an advantage.Being a small co.,growth isn’t such a big concern…what is of great importance,is the management & its quality.They had already guided for a sedate Q2 & that has happened…I believe that this adds to their credibility.Very few cos. of Adi’s size take pains to conduct a concall & ‘explain’ themselves(though Nirmal Bang surely has a role in this) To me,looks good for 3-4 more quarters atleast.

Great recovery on the stock today from the lows.Opened LC & closed only 2-3% lower,amid heavy volumes.

Disc.: Invested…views maybe biased.


(Narinder Yadav) #14

@Abhishek, Sagar,

OPM margins reduced drasticallyfrom 20%+ to less than5%during 2007 to 2009. Though now they have recovered again to 20%+. Can you elaborate the reasons for the fall in margins? Rise In commodities??

regards


(Narinder Yadav) #15

Disc : Not invested but in watchlist :slight_smile:


(Basil) #16

One of the independent director is on the board of Nirma and another one is on the board of Riddhi Siddhi. Two companies notexactlydear to minority shareholders. This is the only thing I could find against the company.

Disclosure - Not invested but on watchlist


(Abhishek) #17

Dear Narinder, I look at this company in 2 parts. 1 before the new management took over and 1 after. Since 2010, the company has been doing fairly well. If you look at the scale of operations prior to 2008 it was approx 8K which was not full asset utilization. Between 2008 to 2010 company expanded capacity from 8kT to 18kT with basic de-bottlenecking and minimal CAPEX. Prior to this, fixed costs as a percentage of total turnover was fairly high due primarily to lower economies of scale. You will notice that with the green field expansion the company has been able to increase operating margins as power and manpower which are largely fixed become a lower percentage of the total revenues. This will further improve as the company has gone from 25kT to 45kT in the last quarter.


(Amitayu) #18

Thanks Abhishek for clearing one of the negatives of adi finechem (margin fall during 07-09) . Also if you/sagar or any other senior members can put some light on the management issue raised by Basil and Rakesh Chandak , would be great help of us. Could it be a serious issue of corporate governance in future?


(Narinder Yadav) #19

Thanks Abhishek :slight_smile:


(Sagar Saxena) #20

Key Concall Takeaways:

  1. Production was affected for ‘effectively’ 25 days & thus,both the topline & the bottomline contracted.However,all the upgradation has been done now & no further shutdowns are foreseen in the coming quarters.

  2. The company expects NSE listing by year end.The company will also report to the exchanges/investors about some new products…‘very soon’.

  3. The entry barriers for the company remain high.Adi is one of the ONLY cos. in the world to both,produce Oleochemicals & export Tocopherol.The required Raw Materials are difficult to procure on the scale that Adi does.The procuring is a result of long-term relations with refineries,etc.

  4. The company doesn’t experience any ‘margin pressure’ due to supplying to MNCs like Asian Paints,since the costs are very low for cos. of that size.Rather,the company is able to extract some premium in selling its products,due to quality.

  5. The company feels that Tocopherol prices have bottomed out,& the only way now,is up.There is NO effect of Crude Oil prices in the overall scheme of things.Also,there is no issue on the pricing part,i.e.,giving lower prices to clients…since,in that scenario,the RM costs are also low & everything evens out.

  6. The company expects to get back on its growth trajectory.They have guided for 18% EBITDA margins in Q3.The guidance remains 16-18%,but they are now ‘gunning for more’.

The management was quiet bullish/confident throughout the Concall.The company has not guided for better payouts,but will try their best to ‘keep investors happy’.

Amitayu,from the time I am tracking this company,my belief in the Management team,has only risen.The fact that all their expansion was funded by internal accruals,speaks volumes about their quality.Moreover,there has been consistent financial improvement & to its credit,the company had already guided for a sedate Q2.Conducting conference calls is another good measure.Thus,from what all is available,I don’t see any management concerns.

Disc.: Invested.