Meghmani Finechem - Underrated multibagger?

Hello VP family. This is my first detailed report on some company and Since I couldn’t find any dedicated page for Meghmani finechem, I am presenting my research work here on the same. Although Meghmani organics had been discussed in details in VP but after demerger, no updates and valuation data are discussed for Meghmani finechem.

About the Company

Meghmani Finechem is a chemical company and was incorporated in year 2007. Their plant is located in Dahej (Gujarat). It was subsidiary of Meghmani organics i.e. MOL since 35 yrs till 2021 and for value unlocking (as MFL is into specialty chemicals also), the management decided to go ahead for the demerger. MFL is currently producing:

  1. Chlor Alkali
  2. Chloromethane
  3. Hydrogen peroxide

All of these products are used in Textiles, Dyes & Pigments, Agrochemicals, Soap & Detergents, Paints, Refinery etc. We can see that all of these industries are High growth industries and as per MFL presentation, the addressable market for MFL is growing @10-13% in the next 5 years giving it a huge headroom for growth.

Investment Thesis

The company is growing at a good pace and has shown CAGR of 21% on yearly basis in last 5 years. EBIDTA has always been above 32% and had reached 44% in FY19. In concalls, management has shown confident that they would be able to sustain the EBIDTA of 30% for coming years. The positives which I have understood after studying the details of company are:

1. High EBIDTA sustainability

This is mainly due to forward and backward integration + good location (all the clients are nearby)

2. CAPEX for new products which are ECH (Epichlorohydrin) and CPVC and thereby transitioning from normal chemical to Value added products

Management has aptly evaluated the right opportunity in the market for Import substitution for 2 products i.e. ECH and CPVC. These two products are being imported currently and have high margins and come in the category of Value added products. Point to be noted is currently the PE rating of Meghmani finechem is around 28 and as of now is of chemical industry PE instead of speciality chemicals/Value added products. Once these products come in line (within 1.5 -2 yrs) the PE re rating seems inevitable. Capex shall be completed by 2nd quarter of FY2023.

3. Management guidance of 2000 Cr Revenue by FY 2024E (Currently 829 Cr)

Management has shown confidence in achieving the CAGR of 34% for next 3 years and thereby making the company 2.5 times in 3 years. Which means if we talk of PAT the same can be as high as 50% CAGR considering the fact that these value added products will give high margin and thus higher impact in PAT.

TAILWINDS

Note: I have taken the below extract from goindiastocks.com as the same was very detailed and informative article. Hope it helps to understand the tailwind.

ARTICLE STARTS
Caustic Soda prices bottom out, outlook bright: Caustic Soda prices after peaking at US$775/t in Oct’17 has been on steady decline and bottomed at US$238/t in Feb’21. It has since climbed to US$376/t but this rally could possibly extend given the underinvestment in the caustic soda capacity internationally. Caustic Soda demand globally is expected to improve by 2.5%c cagr in line with Global GDP growth, however capacity additions have been muted. According to Mr Charles Fryer, Chairman of Tecnon Orbichem, by 2024, global caustic soda industry will have to operate at 88% capacity utilisation, the maximum potential to meet the global demand. Demand supply situation is likely to tighten unless new capacities are undertaken now.

Across the world, there has been a trend to close down environmentally unfriendly technology-based units. In caustic soda, there are few mercury-based and diaphragm-based capacities operating in US, Europe and Asia. There capacities are likely to be phased out and will create further tightness in global demand and supply position. Fortunately, in India, industry has already moved to membrane-based cell capacity which is environment friendly. A repeat of 2017 rally in caustic soda prices is possibly on cards.

It could be double party: Chlor-alkali chemistry has 2 outputs, caustic soda and chlorine . Internationally, chlorine is the main product while caustic soda is the by-product. It’s inverse in India. Chlorine is mostly used in making vinyls used in PVC pipes and its demand is driven by housing and infrastructure sector. This makes Chlorine an early economic recovery cycle product. So, chlorine demand and consequently prices recover much faster as economy comes out of recession and same is happening currently. Once chlorine prices peak out, which means caustic soda production has also maxed out, caustic soda prices start to improve . The cycle continues with caustic soda prices recovering and chlorine prices reducing. Mr Vikram Shriram, MD of DCM Sriram has very succinctly made this point in the earnings call. He mentions that sometimes both caustic and chlorine are bullish together and one has a full blast. We believe that current situation is potentially opportune for this double blast to play out. Given the global fiscal support, infra and housing boom is likely to last longer while demand for caustic soda has already started to recover. Next 1-2years could be best time for Chlor-alkali producers globally.

India’s exports of Caustic Soda surge: India has been operating at optimum capacity utilisation of 83-84% till FY19 before a surge in capacity increase pushed capacity utilisation down in FY20 and then Covid led to demand collapse in FY21. However, now the capacity expansion plans have been pushed out by most players and demand is picking up strongly. Major user of caustic soda is alumina and textile industry, both of which are booming due to global shortages as well as China+1 strategy. India because of it’s very competitive cost structure was able to increase exports despite very low caustic soda prices. And with global demand supply turning favourable, India will have additional market to push it’s production. India’s caustic soda demand continues to grow at a steady pace of 5% cagr. India is just 5mnt capacity as compared to global capacity of 75-80mnt and with minor exports, it will be able to operate at full capacity.

Derivative products driving value addition: All Indian chlor-alkali players are trying to move up the value chain and adding capacities of derivative products to use by-products chlorine and hydrogen . India’s chlorine consumption is actually increasing at a faster pace than caustic soda due to chemical boom. Main usage of chlorine is PVC and India is importing 2mnt of PVC. And even the production of PVC in India is from an intermediate product EDC, which means the whole demand of 3.5mnt of PVC is based on imported chlorine. Two main value-added products where industry is focussed is Hydrogen Peroxide to utilise hydrogen and Chloromethane to use chlorine. Our client company Meghmani Finechem Ltd (MFL) is running fully integrated and very efficient operations. It’s portfolio of value-added products will increase to 56% by FY24 once it’s expansion of ECH and PVC is complete.

ARTICLE ENDS

RISKS

  1. High Debt of 0.8x.

This is the only risk as per my study because when debt is high and if any unfortunate event like sudden increase in raw material price etc occurs then company won’t be able to generate the revenue expected. Although it seems unlikely situation but still is primary risk

  1. Corporate Governance

In 2019 there had been an issue related to corporate governance which was very much highlighted and it’s one of the major reason of low PE rating of Meghmani organics. But I would say that after that i havent seen any major issue and management understands that to earn few bucks here and there they have lost a majority of wealth in PE rating and institutions interest. In several concalls, management has shown its commitment to never repeat the same feat which is a good sign.

Conclusion:

To me , Meghmani finechem looks a very good opportunity both in short as well as long term looking its past growth trajectory and successful capexes being done from time to time. The transition from normal chemical to value added products brings a PE rerating opportunity also. Their backward and forward integration is a high EBIDTA generator and their whole path reminds the Deepak Nitrite case. When company is in nascent stage, no one looks at it but later on everyone rides it even at higher valuations.

Disc: Invested

Comments are most welcome.

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my notes on meghmani finechem

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management integrity and practices are a big problem in this one …

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Its true that promoters did shady things in the past. But that’s also one reason why the co is trading cheaply compared to its peers. Personally feel, that the import substitution trend is a tailwind and given the container rates, cos like Meghmani will continue to command premiums in the short to medium term. Improved cash flows should also aid the debt profile.

Another point here is that backward integration gives Meghmani an advantage.

D - Invested.

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Thanks @dhruvbhim, This article captures many good recent cases and should be included in below thread.

reposted it there.

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Yes you are right but thats why it’s available at cheaper valuations and I already covered it in my earlier post. Moreover every one deserves a second chance and the management now is second generation and is different from that in 2018-19. They have walked the talk in previous 2-3 yes and have shown commitment towards the targets. Just for one incident, one can’t ignore this promising company.

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This is more like 2nd quarter of Q2FY23,

Thnx for pointing out. Typing mistake.

I was reading about this company and then i saw this post :grinning:
While the company plan looks quite impressive, there is competition also to be considered. DCM shriram is coming up with ECH plant of 51KTPA and H2O2 plant of 52KTPA as well post expansion of caustic soda facility to 255KTPA. Infact on caustic soda, all major players are building capacity so supply side needs to be analyzed. The debt plan is quite aggressive but what disappointed me the most was asset turns guidance of 1.5 to 1.75, infact if you see 2017-19 it is close to 1-1.2, this business is a money guzzler, the only reason for high ROCE has been their class leading EBIDTA margin which i understand will be lower for these value added products(thats an oxymoron :grin:), i will avoid it as of now.

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Probably more good news for Indian Chemical manufacturers, as now China is faced with Power shortages?

I am concerned about the domestic increase in coal prices too. If i recall correctly MFL has a 100MW odd captive coal fired power plant and fuel costs for them are a major factor. Coal India hiked prices by around 10% recently.

But at the same time, caustic soda prices have risen by more than that. So the net bottomline impact depends entirely on how quickly is MFL able to adjust its caustic soda prices AND how much do derivative prices change as a result of caustic soda prices since MFL is now 30% value added products.

This might interests you further on my point made earlier.

Disclosure: Invested last week.

Just one observation: My understanding is that MFL is into bulk chemicals and not into specialty chemicals as mentioned in the article. There could be volatility in profits.

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this is true … but one thing which will work for them is that they are increasingly backward integrating which will help them arrest ebitda margins % drop during downcycle of bulk chemicals pricing …

disclosure - no interest in stock due to promoter patchy history

Outstanding Q2 results by Meghmani Finechem. Growing Y-o-Y and Q-o-Q. Q2 EPS at 11.31.
Margin guidance of 28-32% is well maintained in spite of RM inflation. Overall plant utilization at 90% in Q2. Demand seems to be very robust and the management expects to continue this demand going forward. All expansion projects on track and management is confident of achieving 2000cr by Fy24.

03be3d14-6d96-401d-bbdb-e50c5320e388.pdf (118.1 KB)

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Just checked. DCM Shriram will commission the H2O2 & ECH plants in Q4FY23, which is fairly far as of now. MFL has a runway for more than a year. That said what is the current demand supply mismatch in terms of CAGR if anyone has those? That should indicate about how additional capacities may impact end realisations.

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How are the valuations of meghmani finechem vs its peers?

If we were to predict some ball park topline for next 2-3 quarters, how would that look like? Is any part of new capacity coming into utilization in next 2 quarters at all, bcz they are already running at optimal current capacity,
image
From the calls, I kind of thought the increase in the pricing of their products will mostly be reflected in next 1-2 quarters, so if topline has to be higher is it only from increased realization?

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Not Invested

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Thanks for this. To answer @Maheshcm 's question, I think he is broadly right that incremental production capacity in H2FY22 is limited so topline growth may be more price driven than volume driver.

Key monitorable here again is the progress on capex. Both CPVC and ECH capacities are scheduled to be operational in Q1FY23, which will give a substantial boost.