Dhunseri Petrochem Ltd (DPL) – Multibagger Stock with huge upside and limited downside risk

Background – DPL, promoted by Kolkata-based Dhanuka group, operates like a holding company with cash & cash equivalents of INR 222 crore as on Sep 30, 2018 and 50% stake in two operating PET resin unit along with the world’s largest PET resin manufacturer (Thailand-based Indorama Ventures Public Company Ltd). The details of two operating units in which DPL owns 50% stake is provided below:

a) IVL Dhunseri Petrochem Industries Private Ltd: operating 696 ktpa PET resin capacity in two locations – Haldia & Panipat

b) Egyptian Indian Polyester Company S.A.E: operating 540 ktpa PET resin capacity in Egypt. Restarted operation in August 2018 onwards.

Investment Rationale

  1. Limited downside risk – DPL holds unencumbered cash & cash equivalents of INR 222 crore as on Sep 30, 2018 in its standalone balance sheet as against current market capitalization of INR 400 crore. Please refer to the audited balance sheet and H1FY18 result for reference purpose.

  2. Second largest PET resin manufacturer in India (after Reliance) and top 15 PET resin manufacturer in the world

  3. Highly profitable Indian operation (IVL Dhunseri Petrochem Industries Ltd) – The company owns 50% stake in a PET resin manufacturing operation in India, which is a cash generating business. The Indian business unit is generating quarterly profit of around $6-7 mn, translating to around INR 50 crore.

For FY16 & FY17 – please refer to http://www.careratings.com/upload/CompanyFiles/PR/IVL%20Dhunseri%20Petrochem%20Industries%20Pvt%20Ltd.-01-19-2018.pdf and

For quarterly data – please refer to quarterly MD&A section of Indorama Ventures: http://www.indoramaventures.com/en/investor-relations/downloads/mdna

  1. Restart of operation of Egyptian subsidiary ( Egyptian Indian Polyester Company S.A.E): The Egyptian subsidiary restarted operation in August 2018 and currently running at 50% capacity utilization. The plant is expected to run at full utilization by March 2019. At full capacity utilization, the plant is expected to generate topline of $500 mn and generate profit in the range of INR 100-200 crore.

  2. Promoter accumulating stock from open market since June 2016 and near to 75% holding limit - https://beta.bseindia.com/stock-share-price/disclosures/insider-trading-2015/523736/

  3. Valuation

Replacement cost model: The replacement cost of a new PET plant is estimated to be $600/t. Based on that the replacement cost of the Indian & Egypt JV unit is estimated to be INR 5400 crore. DPL has 50% stake in Indian & Egypt business, which comes to be INR 2700 crore. In addition, the company hold cash & equivalents of INR 222 crore. Egyptian subsidiary has no term loan and Indian subsidiary has limited term loan. Thus, the company’s valuation comes to be around INR 3000 crore. Assuming 50% holding company discount, the company can get a valuation of INR 1500 crore vs current market cap of INR 400 crore.

P/E model: The combined PAT of Indian & Egypt JV unit is estimated to be more than INR 300-400 crore in FY21, of which 50% DPL stake is estimated to be INR 150-200 crore. Applying 10x P/E multiple, DPL can get a valuation of around INR 1500-2000 crore. Assuming 50% holding company discount, the company can get a valuation of around INR 1000-1200 crore vs current market cap of INR 400 crore.

  1. Key Risks: Sharp volatility in crude oil prices or forex, extended winter season in western countries, poor corporate governance practices (ex- multiple restructuring in the past, poor information disclosure standards), low liquidity in the stock (as roughly 75% is owned by the promoters).

Disclosure: I have vested interest in the stock due to investments made through family members.

In the Pet resin industry, Reliance and Dhunseri Petrochem are the only two major producers in India. The export statistics of PET resin from India indicate quite interesting trend for DPL (HS Code - 390760 and 390761)

Year - Exports (Rs. cr) - % change (y-o-y)
FY16 - 4608 - 67.59%
FY17 - 5538 - 20.18%
FY18 - 6722 - 21.38%
H1FY19 - 4027 - 49.77%

One immediate question:
Why was the ROE low in the past few years? Even the book value growth is not there. The only factor I can quickly see is the Egyptian subsidiary stopping operations (not sure when it stopped).

Possible to point out the source/ methodology of replacement cost? This will be helpful for my learning.

Edit: My bad. Below ROE plot was for stand alone.
ROE (standalone) plot:

ROE Consolidated

Book value consolidated:

Please refer to chain of events for your reference:

  1. DPL holding 100% interest in Indian Pet Resin unit
  2. Egypt plant became operational in FY14 (holding 70% stake along with Egyptian government) but it was shut down in FY15 due to losses incurred and working capital constraints.
  3. Sold 50% stake in Indian Pet resin unit in Haldia in Feb 2016 to Indorama Group at Rs.418 crore. Indorama Group is the world’s largest producer of PET resin, holding roughly 25% of global PET capacity
  4. Acquired 50% stake in Indorama Pet resin unit in Panipat at Rs.110 crore in Feb 2016. This resulted in industry consolidation and better discipline in the domestic PET resin market.
  5. Acquired 30% stake of Egyptian government in Egypt unit and sold 50% stake to Indorama Group in H1FY19 and started Egypt plant in August 2018.

The low ROE till FY15 (when it was holding 100% interest in Indian unit and 70% interest in Egyptian subsidiary) is mainly due to a) low global industry spread, and b) losses incurred in Egyptian subsidiary. After sale of PET resin in Feb 2016, the company’s asset got revalued and it was mainly just receiving a) dividend income from its operating Indian JV and b) treasury gain on its investment books. Thus, the correct ROE picture will not get reflected based on DPL financials (both standalone and consolidated). We need to analyze the financials of its operating subsidiary to get hold on the correct return ratios. As highlighted in the above post, DPL’s operating subsidiary is currently generating quarterly PAT of Rs.50 crore (i.e. annualized PAT of Rs.200 crore as against current market cap of ~Rs.400 crore).

With the start of Egyptian subsidiary, the profitability of the company is expected to significantly improve going ahead as the industry spread in Egypt currently is significantly higher than India (~$240/t vs India spread of ~$140/t) with almost equal capacity (Egypt capacity is 540 ktpa vs India is 696 ktpa) and lower debt.

Have sourced current replacement cost of PET resin plant from this video (1.06.10 time): https://youtu.be/SUkwZZ5yQNo