Regarding your points,
(1) I think you haven’t gone into the company in detail w.r.t. RM and production processes…will explain you in brief here and then come to your inference…
you see it’s not like a simple inorganic chemistry where two or more RMs are mixed in definite proportions and via a chemical reaction or other route you get a definite quantity of finished product…Here, in ADI’s case, products are extracted/manufactured from natural source where proportions of likely finished products are not fixed as well as the said finished products only form 10-50 % of the RM. What you need to do is extract maximum yield from RM which by itself is not of a standard quality. Although theoretically this can be written down in few sentences but practically its a complicated business to be in and to carve out success in such complicated business terrain is itself a commendable thing…let me explain you in slight detail below :
– As you know, company uses AO and DoD as RM – AO and DoD are byproducts of vegetable crude oil refining process (in our case Soy, Sunflower, Cottonseed & Corn). AO & DoD’s compositions and characteristics depend on a number of factors like :
type of oil processed,
mode of refining (chemical/physical),
operating conditions applied during refining process, etc.
Now, in a country like India you know the operating conditions used as well as tweaking of production methods adopted to maximize profits (forget here the dominant share of unorganised segment). Based on this you can imagine the varied qualities of RM procured by the company — company uses such varied qualities of RM to produce standard quality finished products.
Now, in this RM you have tocopherol, sterols, fatty acids, tri-, di-, mono- acylglycerols, etc. in different proportions. Have already touched upon before in this thread regarding content of tocopherol & sterol in DoD (total max. 30 % combine) ; in AO too the content of Fatty Acids is average 60-70 % and out of these Fatty Acids you have
Stearic and other Acids in varied proportions
out of these only Oleic and Linoleic Acids can be used to produce Dimer Acids and that too via a dimerisation process.
So, in effect refer following indicative AO contents :
From above, it is pretty much clear that out of AO used, its only maximum average 35-40 % by weight of AO that can be used to produce Dimer Acid. (avg. 60-70 % FFA out of which average 65 % Linoleic/Oleic Acid which is RM for Dimer Acid)
We have already discussed before in this thread, out of DoD used, its only max. average 20-30 % that we can extract tocopherol/sterol.
So, now I will come to your inference — as you must have referred before, we know that its Toco, Sterol, DImer, Linoleic/oleic that are high margin products for the company — so for producing these high margin products it produces on an average 60 % of the ‘Other Products’ from AO and 70 % of the ‘Other Products’ from DoD
----what company does of these ‘Other Products’ ??
It sells them by making them most appropriate for their end application — these ‘Other Products’ carry a negative indicative gross margin that you refer;
Hence, your inference that “management has continued to invest in ‘Other Products’ which carry negative GM” is actually a misinterpretation as it is actually because of concentration on high margin products that you are seeing increased production of ‘Other Products’ as well. Also, I want to draw your attention to the word ‘indicative’ as it’s not the True’ GM and never substitute the correct blended picture with a rough exercise that we do to assess a company from varied angles. Its only meant to assess the (approximation of) importance of each product to the company’s margins.
When we assess a company’s strategy, we need to look at in entirety rather than looking at separate pieces as if a company wants to continue with the high margin products,the so-called ‘Other Products’ come embedded with that because of the nature of the business. What we need to note is the way company ventured into one high realisation oleo derivative - Dimer Acid-- manufactured from so-called ‘Other Products’ of that time, can it venture into other derivatives from today’s ‘Other Products’…
Oleochemical is a vast field and ADI has just scratched the surface of it – it is present in basic oleo and only one specialised derivative i.e. Dimer — You must have studied the evolution of the company – still to tell in brief – it started as a single product company focussing only on Toco and it is this expertise of producing toco from Soya DoD that company extended to venture into Oleochemicals (Toco can also be termed as Oleochemical)…Now, to venture into Oleochemical field by itself is not such a great thing but its the route applied that is unique – majority of Oleochemical players used Palm oil byproducts but company used Soya, Sunflower, Corn & Cottonseed oil byproducts — with this it made perfect use of two things
– first, it already required Soy & Sunflower Oil byproducts for Toco so it was just an extension
second – its location Gujarat which is one of the largest refiners of Soya & Cottonseed oil.
There are many specialised derivatives like Dimer Acid which include Pelargonic Acid, Azelaic Acid, Isostearic Acid, methyl ether sulfonate, etc. but with the current nature of RM used and ‘Other Products’ profile, in which derivatives it could venture into that is unclear – but all that is sometime away as current capacity expansion only seems to expand current products – Toco, Sterols, Dimer & Lineo…and this is the reason why I believe "Toco & Crude Oil price drop seems a blessing in disguise for this company "…coupled with this price drop as also Fairfax inputs, greenfield project can be planned in such a way to extract maximum long term returns for the shareholders — RM can be tweaked to use Palm byproducts, technology can be acquired so as to make maximum use of expanded capacities (in terms of extracting derivatives from basic olechemicals), etc. — inorganic route will be key to watch out for — if its in totally unrelated field which is in broad field of chemicals but is not in anyway related to oleochemical it might not add that much value but if its in oleochemical field or for that matter any field which aims at replacing petroleum-based products with innovation then it might catapult the company into next orbit…
Why I am inclined towards this company is because its current expanded capacity is atpresent rated in its bad times and entire real expansion in terms of greenfield project as well as inorganic move is still unknown…I made a constant currency realisation study for Toco – company’s key export product – and just see the chart below :
Toco USD realisations have already touched 8 year lows in FY16 and if I count a bad-period average – i.e. a 10 year average from FY02-FY11 and exclude FY12-FY14 the best period for Toco realisation, then also current FY16 realisation is just 17 % above such FY02-FY11 bad-period average (FY16 realisation assumed at INR 1,72,000 per MT with INR/USD average FY16 rate of INR 65.36).
Before going into addressing your second point, for your info of assessing scope of oleochemicals, attaching below two references, one from Wilmar’s 2015 presentation and another from 2013 study of Tata Strategic Management Group –
(2) On your second inference, since I have not studied Camlin Fine too closely so it will be improper for me to comment on that, but, as far as ADI is concerned, its not the global leadership but the Indian leadership that is compelling and its the global leaders’ compulsion to keep India as one of its source that makes this company the most desired choice – will explain you below :
you must have noted in my replies before in this thread – DoD is the basic raw material required to produce Tocopherol & Sterols — and DoD is generated in the refining process of crude vegetable oil – Soybean & Sunflower —DoD is generated on an average 0.25 % of the weight of crude oil – i.e. to produce 1 MT of DoD, ~400 MT of crude oil required to be processed/refined — Now, on this basic info, just refer following data –
– Data is considered only from FY05 – the time from which firm relationships with RM suppliers were established by the company,
– Although company must be using Soya as well as Sunflower DoD, still, since Gujarat is major hub for Soya oil, only that oil is considered – also, to compensate for Sunflower DoD generation, we have assumed full production as well as full import oil figure as being processed whereas in realty, only maximum ~80 % of the oil might be processed and therefore generate DoD – hence, in that way total DoD generated figure shown might be inflated and actual figure might be lower.
– Since, from FY12, company’s separate RM – DoD used – figure is not available, so we have assumed highest 30 % yield of tocopherol for FY12, FY13 & FY15 and average 22.48 % yield in FY14 since in that year sterol was also produced – and on these assumptions we have arrived at DoD used figure for the company for that 4 years. Hence, in that way, DoD used by the company figures shown for the said four years might have been deflated and actual figure might be higher.
Now, as you can see from above calculation, company has been purchasing/using on an average 39 % of the DoD generated in India. For this RM, it is paying on an average 70 % of such RM’s actual cost i.e. if 1 MT of Oil costs 50,000 INR, 0.25 % of it is DoD i.e. cost for 0.25 % (or 0.0025 MT) DoD to refiner can be assumed at INR 125 – company is consistently paying INR 88 for this (from the trend known till FY11).
So, when you have an established company who already is purchasing 40 % of the RM produced in a country like India – and India is 4th largest producer of the said RM in the world – there is only minor chance that any other company can come and just threaten its position — evenif any such competition comes, company might be very well positioned to tackle it as it can easily raise the purchase price of its RM to 100 % from 70 % and no rationale competition will be able to pay higher than that –
Yes – tomorrow if Wilmar comes in India to produce tocopherol then ADI could face some formidable competition as Adani Wilmar is supplying 30 % of its RM requirement – but, remember its only 30 % and other 70 % of RM is still procured from other refiners — also, Wilmar still has only Basic Oleo facility in India and so far it has even not ventured into Oleo Derivatives here forget toco.
In addition to above, managing different quality of RM (which is actually treated as scrap by refiners) is not easy in a country like India where hardly few refiners use completely hygenic refining environment and have a truely professional set-up — It is such varied quality of RM company uses to produce export-quality Toco & Sterols and other finished products and it is not easy to replicate such capability.
Lastly, key implied notable thing is that company has already spent and is likely to further spend 7-10 cr. by 1HFY17 to upgrade its DoD processing (Toco-manufacturing) facilities to match world standards. Now, as you know, Toco contributed highest ~40 cr. to company’s revenues and no rationale company spends 25-30 % of the revenue on upgradation unless it wants to penetrate deep into the market — Also, if you have studied niche contract manufacturers in detail before then you must be aware that such spendings are normally a precursor to long-term MNC-contracts as they are basic necessity to clear client audits which are usually done many times before outsourcing a major manufacturing contract.
Discl. - Invested in ADI Finechem.