Dynemic Products - a relatively undervalued chemical stock!

[salonihemnani011]

About the Company:
Dynemic Products (Mcap - Rs. 314 cr) is one of India’s leading manufacturer and exporter of a complete range of Synthetic Food colours, Lake colours, Blended colours, & Dye Intermediates.

Product Profile:
The company manufactures:

1. Synthetic Food colours (used to enhance the original colours associated with a given product),
2. Lake colours (more stable than water-soluble colours, so widely used in the cosmetic and pharma industry),
3. D&C colours, Salt-free dyes, Dye intermediates which are used as an essential ingredient in the food, drug, cosmetic, personal care and FMCG industry.

Existing Capacity:

Industry:

• Global transition in the manufacturing base from developed countries to countries like India, China, Taiwan, etc. has taken place over the last 1-2 decades. Global players are not able to meet Indian peer in costing and hence, they are looking for Indian manufacturer to partner with for contract manufacturing.
• China is not interested in manufacturing food colours because of low volume and they are also unable to match the quality as the core focus is on dumping via high volume productions.
• US is the biggest market for food colours. Many large players in the US like Sensient buys intermediate from the market and produces food colour themselves.
• Europe is stringent regarding synthetic food colours but it’s not a very big market.

Size: The world market size for food colours is 50,000 MTPA growing at 8-10%.

Oligopolistic nature: The industry has an oligopolistic structure wherein a few companies are in the lead with technical knowhow and quality control. Currently, India has three big players in food colours: Roha Dyechem (12,000 MTPA) followed by Vidhi Specialty Food Ingredients (>3,600 MTPA) and Dynemic Products (2,940 MTPA).

Export Oriented and Volume-based Model: Food Colours export market account for 80% of the sales for all three players. All the companies have established distributor networks in foreign countries to sell their products on tonnage basis.

The misconception of Natural Food colours taking over Synthetic Food Colours: Synthetic Colours are perceived as harmful due to which there has been a notion that gradually, natural food colours would take over synthetic food colours.

However, there are certain disadvantages to natural food colours:

• Entire demand for synthetic colours can’t be replaced by natural colours as natural colours are 2-3x more expensive than food colours.
• Any customized colour could be made from a synthetic colour. In natural colours, very limited colour options are available.
• Natural colour doesn’t have stability- can’t last longer more than 6 months.
• As per the management’s experience and surveys, synthetic food colours market would expand rather than be replaced by natural colours. Many newer applications for synthetic food colours are coming which were not prevalent earlier. Hence, the management doesn’t see the synthetic market shrinking.

Promoters:
It is a family run business with founder and promoter Mr Bhagwan Das Patel as the Managing Director of the company. Other members of the family like Ramesh Patel and Dixit Patel are also involved in day-to-day affairs of the company and are whole time Executive Directors. Current promoter shareholding has decreased from 41.53% in June’20 to 35.81% in Sep-Dec’20. It’s because one of the partners, Dashrathbhai Patel decided to get out of the company in 2019 and has been selling shares slowly in the market, some of which has been bought by the promoters in 2020. Reputation of the promoters has been impeccable and they are known to be quite conservative people.

Drivers:
1.Capacity Expansion
The company has two manufacturing units in Ankleshwar, Gujarat and it intends to set up a 3rd unit in Dahej and will undertake expansion by setting up three plants. Dynemic had bought land at Dahej in Feb 2014 for capex of Rs. 9 crores. However, there was a delay in getting environmental clearance. It finally received EC in Sep 2018.

The company, like all industry players, was dependent entirely on China for RM supply. Majority of the capex is done on the backward integration side out of which 40% would be captively consumed and 60% would be sold commercially. Post capex, the company would be almost 100% backward integrated.

Peers like Vidhi and Roha are also doing capex. But, Vidhi’s capacity will take 1-2 years to come on stream and Roha’s capex is largely in pigments segment.

The company has spent Rs. 103 crores already from FY18 to Sep 2020. The total amount of capex up till FY19 AGM was Rs. 100 crores (80% Debt funded). But recently in FY20 AGM, the management has revised the cost upwards to Rs. 165 crores due to various reasons, including the increase in additional capacity, for which I could not get specific details.

The capex was planned to be 80% debt funded (80 cr out of 100 cr). After the increase in the capex, long-term debt is expected to increase from 80 cr to 120 cr. The interest cost is low, given that majority of it is either in foreign currency/ PCFC for bill discounting (acting as a natural hedge towards export sales).

Total potential revenue expected to be around Rs. 550-600 crores within 3-4 years with increased margins.

2.Increased Margins
The last 3-4 years have witnessed really good growth in operating margins ranging from 14-15% to 19-20% with TTM margins being 21%. The management expects an even further improvement and stability in margins due to backward integration.

3.Valuation Comfort
Even after the recent run-up since March 2020, the stock is trading at an EV/EBITDA of 10x with an EV of Rs. 407 crores. Assuming 500 crore sales in the next three years with an EBITDA margin of 22% (taking it this high as the management has always performed precisely to whatever they’ve said in their AGMs over the last 4-5 years) gives us EBITDA of 110 cr which at 9x would lead to Rs. 990 cr EV.

Risks:
1.The capex has already been delayed a lot – first due to consultants in 2015, and then due to Covid and late delivery of equipment in 2020. April-2021 is the timeline we have to track.
2.Dashrathbhai’s stake has been reduced from 12% to 6%. Supply of 6,92,050 shares is going to come in the market. Bhagwanbhai and Rameshbhai’s group bought a few shares in early 2020 but not considerable enough to absorb the selling. Due to this, the net shareholding has come down to 35.81% which is really low.

Queries:
1.Despite such a low promoter holding, the daily volume in the stock isn’t that high.
2.I could not get the specific answer from the company regarding what additional capacity will come on board after the revision in capex.

Disc.:
Even though I tried to make my research as fact-based as possible, I have been holding this stock for close to 2 years, so take my limited opinions with a pinch of salt.

Resources:
ARs – Dynemic and Vidhi
EC Docs – Dynemic, Vidhi, Roha
Credit Rating – all 3 cos.
AGM notes – Dynemic and Vidhi
Conversations with the management

[salonihemnani011]

Amazing Q3 Results by the company today:
Sales growth 25% YoY.
EBITDA Margin of 22% improvement entirely due to other expenses.
Looks like it is on track.

Regarding one of the queries I had asked above regarding low float, with the help of Ayush Sir, I was able to see that in 2007, the company was 61% promoter owned with 570 no. of holders in promoter holding consisting of n number of small holders which reduced to the main holders shown now in next qtr. So, overall looks like the ownership is distributed early on with a lot of family/community groups.

[Donald]

Am a little surprised, that we haven’t paid attention here - i.e. taken forward the excellent work put up so far. It’s early days for me in this business, but nevertheless will start recording my observations here. Hoping that this just might spur us into devoting more time to take this work - to a logical conclusion (as much as possible).

Source: Sensient 4Q-2020 Investor Presentation

Disclosure: Not Invested

[Donald]

Note at least 4 Indian players find mention as key global players in this Natural Food Colours Market Report

The key players operating in the global natural food colors market are CHR Hansen Holding A/S (Denmark), Koninklijke DSM N.V. (Netherlands), Sensient Technologies Corporation (U.S.), Archer Daniels Midland Company (U.S.), Döhler Group (Germany), D.D. Williamson & Co., Inc. (U.S.), Naturex S.A. (France), Aromata Group S.r.l (Italy), Kalsec Inc. (U.S.), FMC Corporation (U.S.), BASF SE (Germany), (Israel), Lycored Ltd. (Israel), GNT Group b.v. (Netherlands), San-Ei Gen F.F.I., Inc. (Japan), Phinix International (India), Kolorjet Chemicals Pvt. Ltd. (India), Vinayak Ingredients India Pvt. Ltd. (India), IFC Solutions. (U.S.), and INCOLTEC (Spain) among others.

May NOT be that difficult for Dynemic to make that transition in 2-3-5 years (when they have a bigger BS/CFO)? Opportunistically, this is the time (next 2-3 years) to milk the Synthetic Food Colour vacuum (China abdicated)?

Key Players
Chr. Hansen S/A (Denmark), Archer Daniels Midland Company (US), Sensient Technology Corporation (US), D.D. Williamson & Co. Inc. (DDW) (US), Kalsec Inc. (US), Doehler Group (Germany), FMC Corporation (US), DuPont (US), Koninklijke DSM N.V. (Netherlands), Naturex (France), AromataGroup SRL (Italy), Frutarom Industries Ltd. (Israel), Lycored (US), Ajanta Chemical Industries (India), Sunfoodtech (India) are some of the key players in the global food color market.

2 other Indian players mentioned in this Report

[Donald]

Grandview Research Global Food Colourants Market Report (a bit dated)
The market is expected to exhibit a low threat of new entrants on account of extensive portfolio offered and distribution network operated by existing players, which results in a high entry barrier for the new entrants. Besides, the high switching cost for the buyers makes it difficult for new players to gain a significant market share, thereby lowering the threat of new entrants.

[Donald]

Again a dated but comprehensive presentation, I found some slides useful. Extracts

Further References:
This presentation has useful education on Synthetic Colours used in Indian Sugar based Confectionery products.

More Technical details here (Brief comprehensive PDF freely downloadable)

[Donald]

[Donald]

From Sensient 2020 AR (recently published).

The Company believes that its ability to reformulate its products and the general availability of alternate sources of materials would generally enable it to maintain its competitive position in the event of an interruption in the supply of raw materials from a single supplier.

Competition
All Company products are sold in highly competitive markets. While no single factor is determinative, the Company’s competitive position is based principally on process and applications expertise, quality, technological advances resulting from its research and development, and customer service and support. Because of its highly differentiated products, the Company competes with only a few companies across multiple product lines and generally encounters different competitors in different product lines.

Flavors & Extracts.
Competition in the flavors, extracts, and fragrances industries continues to have an ever-increasing global nature. Most of the Company’s customers do not buy their entire flavor and/or fragrance products from a single supplier and the Company does not compete with a single supplier in all product categories. Competition for the supply of flavors, extracts, and essential oils is based on the development of customized ingredients for new and reformulated customer products, as well as on quality, customer service, and price. Competition to supply dehydrated vegetable products is present through several large and small domestic competitors as well as competitors from other countries. Competition for the supply of dehydrated vegetables is based principally on product quality, customer service, and price.

Color.
Competition in the color market is diverse, with the majority of the Company’s competitors specializing in either synthetic dyes and pigments or natural colors or coloring foodstuffs (in Europe). The Company believes that it gains a competitive advantage as the only major basic manufacturer of a full range of color products, including synthetic dyes and pigments as well as natural colors. Competition in the supply of cosmetic colors and ingredients, and pharmaceutical and nutraceutical ingredients and excipients is based on the development of customized products and solutions as well as quality, customer service, and price. The Company believes that its reputation and capacity as a color producer as well as its product development and applications expertise give it a competitive advantage in these markets.

This above is a very significant statement. The only major player manufacturing both synthetic colours and natural colours.

The Corollary: The Synthetic Dyes & Pigments space has been progressively vacated by the major multinational manufacturers. So Dynemic has an easier field to compete in - Sensient plus other Indian/Chinese manufacturers.

And that must be the reason for the aggressiveness, in the backdrop of fully backward-integrated claims? The Developed Markets would not encourage synthetic colours. The Developing Economies will continue to indulge lower-cost food products (in part possible due to lower cost synthetic colours use)??

[Donald]

From Sensient Transcript Oct 2020

[Donald]

From Sensient Transcript Feb 2021

[Donald]

Artificial Food Color Market

[Donald]

Quick & Dirty Summarised View for me (as on date) for me: (I could be wrong, waiting to get this validated by quizzing Domain Experts/those who have worked on Dynemic before

1. Synthetic Food Colours marketspace vacated by all major MNC manufacturers, except Sensient
2. The Addressable Market is all Developing Economies dominated by AsiaPac (characterised by requirement of lower cost food & beverages - kinda rules out extensive (expensive) natural colouring/vibrancy/ stability solutions
3. Advantage Dynemic - by virtue of recent expansion and the claimed 100% backward integration achieved for medium term
4. Sustainability for 3-5 years and more, becomes a given - if above 1-3 are true?

Have asked for help from our data-digger experts Sandeep Patel & Vishnu to help specifically establish the Market for “Global Synthetic Dyes & Pigments Market for Food & Beverages” from Reports like as below

Synthetic Dye Global Market Report 2021

[YachnaBhatia]

Overall thesis on the Company looks good. Following Industry characteristics are quite clear:

• Industry is dominated by few large players and there is a clear trend amongst MNCs to move to natural colours.
• Colour cost is very small portion of the final product; Switching suppliers is a hassle. Customer relationships tend to be sticky.

Further work required on following aspects:

• Shift from artificial to natural colours - While the shift is more pronounced in developed countries (where all major food and beverage producers are shifting to natural colours), I found multiple reports indicating the same is true for Asia (in particular China) as well. The links and extract detailed later below.
• China + 1 may not be the theme here for food colors as China is probably an imported of food colours not exporter (Need to further check on this). In Intermediates China substitution will work given supply side issues, Atmanirbhar.
• Large capex – stabilisation issues etc., plus impact of operating costs currently being capitalized

Data sources

APAC Food Colors Market | 2022 to 2027 | India, China, Japan, South Korea,...

Yahoo Search - Web Search This article mentions that synthetic food colours market is declining.

https://www.globenewswire.com/news-release/2020/06/15/2047905/0/en/Natural-Food-Colors-Market-Worth-3-2-Billion-by-2027-Growing-at-a-CAGR-of-8-4-from-2019-Global-Market-Opportunity-Analysis-and-Industry-Forecasts-by-Meticulous-Research.html

On the contrary, some reports indicate that this shift from synthetic to natural colours will take place over a very long period of time (as the shift to natural colours is not easy – less vibrant colours, difficult to handle, more expensive, no exact match, etc.):

https://www.foodprocessing.com/articles/2016/fing-future-of-synthetic-colors/

Another report from Sensient removes myths related to natural colours that they are difficult to handle, expensive, less vibrant etc. Have a look at this one.

Five myths about natural food colors

Below report says that shift from synthetic to natural can be slightly difficult but not necessarily expensive.

2016-PMCA-Making-the-Move-from-Synthetic-to-Natural-Colors-M-Jelavich.pdf

In China – natural colours growth far outpaced synthetic colours. Thus this is not restricted to developed countries - true for Asia as well. But point to note is that synthetic color market is still growing

https://iacmcolor.org/documents/2018/11/2018-gcc-presentation-wenjin-zhang-application-and-regulation-of-natural-food-colors-in-china.pdf/

Looking for more convincing data to establish the demand side.

Disclosure: Invested

[Donald]

Source: CHR Hansen 2018 Capital Markets Presentation

Rough estimates for Global Synthetic Food Colours Market
(assuming conversion volumes for North America (25%), LatAm (25%), EMEA (60%) and AsiaPac (30%) from above CHR Hansen presentation) and a simplistic 5% CAGR for each market)

Dynemic/Other India-based addressable Market (Synthetic Food Colours) assuming dominance in LatAm, Apac, and other developing economies would still be healthy and upwards of US$500-600 Mn? Separately the Intermediates Market should be very significant in India itself (Import substitution)?

Time to corroborate/refine these rough estimates with domain experts we come across.
Thanks a lot Vishnu (@crazymama) for the important flag up on CHR Hansen presentation as a good reference point to start with.

Somewhat different Market Estimates from a Naturex Oct 2016 CMD presentation
Surprising data on penetration levels of Natural Colours in 2016??

[Donald]

Time for some Counterpoints:
1.Employee Cost/Sales has been historically very low.
Not unusual in the Dyes & Pigments industry. But among the lowest, currently

However (probably) this indicates the kind/quality of Employee Profile being used.
Moving up the value-chain won’t be that easy. Certainly for what is expected say for natural colours & flavours extraction, a few years down the line? Claims of entering adjacent areas like Vet & Human APIs need to be quizzed accordingly.
Median Remuneration in FY20 was ~1.88 Lakhs, or ~16000 per month

2.Capital Intensity of the Business: (Historically) High
If we look closely at the nature of Dynemic business, it strike us as a business that is pretty capital intensive - both on the Fixed Capital Re-investment rate and Working Capital Re-investment Rate (Incremental Investment required for every rupee of Incremental Sales). (Ignore/moderate the excel induced averages -negative incremental sales/investment, and the spikes due to current ramp up).

This may well change in the future with movement up the value chain. Merits some comparatives with other listed players to see how much of headroom exists for improvement?

PS: [Will keep editing/adding to this post, as I actively try to think through counterpoints to the Story]

[Donald]

Dynemic Natural Colour Portfolio (as per website).

EU-approved-for-use product portfolio is advertised by Dynemic. Its NOT as if they can’t manufacture some natural colours (track non-caramel colours, as of now), so is that because Synthetic Colours sales is a low-hanging fruit, whereas Natural Colours Sales might require Product Innovation/Support apart from significant market-reach investments?

Anyone has any data points on current Sales/Lab Samples exported?

[YachnaBhatia]

Summary of AGM held for the year FY 20

1. Dahej new capex coming onstream by FY 21 end – Increase in turnover from new facility can be 300 – 400 crs and margins will also progressively increase – capacity to be ramped up fully within 3-4 years.
   a. FY 21 targets turnover 185 crs PBT 34 crs PAT 26 crs ? (Why so low numbers, being conservative?)
   b. FY 22 contribution from new plant can be 150-200 crs.
   c. Total turnover 550-600 crs in 3-4 years conservatively (when probed further, said possible in 2-3 years too) (Overall asset turnover of 2.3-2.5x of capex possible)
   d. Gross Margin can increase from c. 45 – 50% over 3-4 years
   e. EBITDA margin can potentially increase from c. 20-21% by c. 3-4% over 3-4 years.
   f. Backward integration will help in improve years. Dependency on suppliers will reduce, plus control over quality.
   g. How confident are you of FY 22 numbers – Offtake numbers are negotiated with distributors (though not committed). Very confident.
2. Synthetic food colours market size – 50,000 MT, India market share c. 40%. Competitors – Vidhi (8-90 crs capex, 4000MT, will take 2-3 years to get ready), Roha (capex only in pigments not in food colours), Neelikon (300 crs capex). But competitors not doing backward integration – Helps in controlling quality, pricing better, plus China reliability issues will be sorted. After Dahej, will be mostly backward integrated (barring basic material freely available).
3. Natural vs synthetic colors – Synthetic easier to use – complete replacement of synthetic not possible. Blending of natural colors not possible. Synthetic colors demand growing 8-10% globally.
4. Sep’20 end – Of 100 crs capex, loan was 80 crs as per plan. Capex cost increased to 165 crs due to increase in raw material prices. To be funded partly through increased debt say c. 120 crs and balance through accruals.
5. Dye intermediates – significant increase in capacity - 40% captive and 60% for sale –will target domestic market for sale. Atmanirbhar push replacing China largely.
6. Employee cost increase post new plant commissioning – proportionate to production.
7. One of the promoters selling – is a personal perspective, can’t comment. Eventual shareholding post sale will be 30% - its low, planning to add from time to time.
8. Sales can be directly to big MNCs or distributors (for distribution to smaller companies)
9. Environmental clearance – new products for 2nd phase post dahej – we have r&d capabilities
   a. APIs – pharma and animal
   b. Food preservatives
10. Plan to look at increasing lake color capacity in FY 22 sometime from say 15MT/month to 30MT/month.
11. USP of the company – Relationship, competitive prices, quality
12. Dahej – spare land is available for future capex

[YachnaBhatia]

My biggest concern in this thesis is the industry tailwinds are towards natural colours and not synthetic colours (extracts from Sensient transcript).

1. Majority of new launches have natural colours - See US data below. This is not limited to US. See China data in an earlier post.
   

   

2. Rest of the world tends to follow US. Trend towards is evident in Asia, Middle East etc as well.
   

   
   
   
   

3. Trend is expanding to not only new launches but existing products as well.
   

   
   
   
   

Do we have any historical numbers to see how the split has been between natural and synthetic colors say over last 5 years, and what has been India’s share of the same? It was mentioned in the AGM that synthetic colors are growing at 5% p.a… It will be helpful to see global numbers and India’s share of the same.

Sensient 4Q16-Earnings-Transcript.pdf (91.5 KB)

Also see this article by Sensient on natural vs synthetic colors

Five myths about natural food colors

[Donald]

The Key issues to focus on (as per my current understanding):

1. Synthetic Food Colour Market still >1 Bn$
   Addressable easily by Dynemic? Need to establish that the runway exists for 2-3-5 years
2. Since Sensient is NOT expansing synthetic capacities, does it place Dynemic in a much better position to take a better grip (aided by backward integration cost reductions
3. What is the status of backward integration capacities (available, planned expansions) with other big players in the synthetic dye industry like Roha
4. How easy or difficult it is to address Natural Food Colour opportunities (Since Dynemic already has a Portfolio of EU approved 14 natural colours). Why haven’t they looked to gradually address significant contribution. What is hindering?

• is it a more costly market addressal/distribution aspect
• Is it a more difficult raw material sourcing aspect
• Is it a Technology/Innovation issue and hence higher skilled manpower aspect
• there are at least 4-5 Indian players named in market research reports for Natural Food Colours Global Market. If they can do it, so can Dynemic?
• Or, is it that there is so much demand for Synthetic Market currently, that Dynemic has its hands full harnessing the current opportunity (market getting vacated by MNCs but still growing) and does not to strategise/focus on Natural Colours for next 3 years at least.

5. At least 50% of expansion will cater to Intermediates and that itself is a very big market? Need to establish the contours here

Looking to refine this further (by talking to those already invested in Dynemic). In a bid to get ready to talk to domain experts.

[salonihemnani011]

Yes, China doesn’t make food colour itself because of technical requirements. It produces intermediates that go into food colours and exports to food colour giants of the world.