Did a write up on SRF
“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return—even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”- Charlie Munger
There are primarily 3 types of businesses that exist. First type of business earns Low Return on Capital employed, Second type of business earns a moderate to Good ROCE. That is, returns between 15-20% on capital, and finally the third type of business can earn Returns on capital which are upwards of 20%+.
To make it simpler for you, think of Bharti Airtel. It’s a business which definitely has entry barriers, as no college student will tomorrow wake up and say i want to spend tens of thousand crores to put up Telecom towers and compete with Bharti or Reliance. However, the key problem arises for Bharti when we look at its ROCE:-
Second types of businesses have good ROCE/ROE but can keep reinvesting for N numbers of years to create the effect of intrinsic compounding. Adding to earnings due to past earnings being re-deployed in the business 
Think about HDFC Bank for a second here, HDFC Bank has made a ROE of more than 15% for more than 2 decades now. This ensures the PAT keeps growing at 18-20% and the bank keeps diluting at higher valuations :).
Third type of businesses are those which make more than 20% ROCE, but can keep redeploying incremental capital at similar or better rates of return. Here I will be spotlighting SRF’s chemical division with you. Where the capital deployed has grown by nearly 10x in the last 10 years, Chemical division has grown by 4x+ in the last 4 years, and ROCE has crossed 25% in the Quarter that just went by.
Hold this thought in your mind. I will cover the reasons for this growth in SRF’s journey later. Let’s come to all the reasons why SRF is under the spotlight today
“The biggest risk is not taking any risk. In a world that’s changing really quickly, the only strategy that is guaranteed to fail is not taking risks.” - Mark Zuckerberg
A windfall gain for all 3 Siblings
Let’s start with the first one. For those investors who are reading this blog and have been in the markets long enough. Will always remember-
A) SRF as a technical textile company, and doing something in Refrigerant Gases.
B) Navin Fluorine as a Mafatlal company doing something in commodity chemicals and Refrigerant Gases.
C) Gujarat Fluorochem an INOX group company doing something in commodity chemicals, Refrigerant Gases, Movie halls and Wind Energy.
This was the ideal impression of the investor community as Chinese peers were dominant in Fluorine chemistry all over the world.
2 Major events happened due to which things started to change in favor of these Fluorine Players in India:-
First- Kyoto Protocol outlined a plan to phase out the use of HFC’s(A type of Ref Gases). These are a type of Ref Gases, which are one the most harmful Greenhouse Gases. All 3 companies- Gujarat Fluorochemicals, SRF and Navin were awarded Carbon Credits by the United Nations between 2006-2013 as a form of compensation for phasing out the most harmful HFC’s like HFC23.
Gujarat Fluorochemicals sold Carbon credits worth 1000 CRORES, yes you read that right. Between 2006-2009. This is at a time when its own topline was 182 crores in 2006.
SRF benefitted and sold Carbon Credits worth 500 crores alone in 2007. Kept selling Carbon credits in the subsequent years as well.
Navin on the other hand, sold carbon credits worth 330 crores+ alone in 2012-2013.
This was a huge windfall gain, which these 3 companies used uniquely in their own ways to expand more in the businesses which are non commoditized and much higher margins in nature.
Eg:-
SRF used the windfall gains and established a 293 Acres speciality complex at DAHEJ and announced a 1000 crores capex in 2010 in its Speciality chemicals business.
Gujarat Fluorochemicals used the capital to establish its Fluoropolymers capacity at DAHEJ in 2007. It has been the sole manufacturer and exporter of PTFE and other fluoropolymers ever since then from India. (SRF has announced capacities here recently).
Navin Fluorine used the windfall gains to purchase Manchester Organics which has a catalog of more than 40,000 molecules, cGMP plant at Dewas and Finally a Multi purpose plant at Surat to manufacture chemicals.
Second Major event that happened is that China which was the largest manufacturer of Fluorine based chemicals between 2000s-2010s, decided to shut down its Fluorspar mines due to environmental concerns, and China ended up exhausting a lot of its viable Fluorspar mines due to the tremendous growth of the industry between 2000-2010. This made the Indian Players more cost competitive when it comes to competing with the Chinese companies.
This can be seen in the growth of Indian Fluorine Players vs the Chinese ones in that period:-
A Conglomerate Using the Cash Flows:-
SRF was established in 1970 as a manufacturer of Technical textiles- which majorly includes Nylon Tyre Cord Fabric. Currently SRF has 3 business divisions:-
Packaging Films(Cyclical)-Technical Textiles(Stagnant) & Chemicals(Growing business).
I will discuss packaging films later. But you might stop and wonder why hasn’t the management demerged the technical textile business from the chemical one, if it’s a stagnant pond.
This is the reason why:- Excerpt from Forbes article on SRF
“ Both Ashish and Kartik are clear about not wanting to demerge the company across its business lines. While that may make sense from a market positioning standpoint, a unified structure allows them to keep the cash flows fungible. The nylon tyre cord business is a sunset industry with growth of no more than a percent or two every year. Still, in the nine months of FY21 it made an EBITDA profit of ₹104 crore at a 12.4 percent margin. If this was demerged not only would it get a poor valuation in the market, its profits could only be invested post payment of tax.”
Over the last 12 years, SRF has taken the cash flows from the technical textiles business and has aggressively deployed that in the Chemicals and the Packaging business. Just see the Capital employed and its growth in all the three segments of the company:-
This shows careful capital allocation by the management from stagnant ponds to growing business segments. What is it that they have done differently in chemicals vs the peers you might wonder?
Building Differentiation in Chemical Business:-
A) Widest Portfolio of Ref Gases: USA has imposed Anti Dumping duties on Refrigerant Gases coming from China. This has created a market vacuum for both SRF and Gujarat Fluorochemicals. SRF’s Ref Gases portfolio is the widest in the industry. This market vacuum can help these players grow, till these Gases get phased out for more environmentally friendly Ref Gases or new age Refrigerant Gases. For Example:- This has created a huge opportunity in H32. Where all 3 Indian players have announced expansions:- Navin with a 4k tonne expansion, GFL with a 10K Tonne and SRF with a 15,000 tonne expansion lined up.
B) Why does the chemical business stand apart?:-
Within the Chemicals business, SRF manufactures Refrigerant Gases and Fluorine Based chemicals i.e. Fluorospeciality. In Fluorospeciality, SRF manufactures intermediates for Agrochemicals and Pharmaceuticals.
Fluorine as a chemistry has gained much more relevance over the past few years, due to it being much cleaner vs the likes of Bromine and Chlorine. According to a couple of experienced people from the Chemical industry. Another inherent advantage of being in fluorine chemistry is that fluorine can be easily extracted from Effluents. Thereby, making it much cleaner vs other chemistries! (I didn’t know this before talking to a friend of mine who has worked in this industry for 2 decades). Moreover, Fluorine has found increasing relevance in the Pharma and the Agrochemical industry. More than 70% of new agrochemical molecules and 50% of Pharma molecules have one fluorine atom in them, as it improves the efficacy and Biological activity of the molecule discovered.
Increasing relevance can only be understood with the help of this example from agchem industry:-
Globally what has happened is that fungus has evolved and adapted to the old generation of fungicides(used to control fungal infection in crops). To counter this, global innovators like Syngenta, Bayers, BASF etc(research companies) launched SDHI fungicides. Global SDHI market has grown at more than 10% in the last decade to reach $2 billion. One of the main intermediates suppliers for SDHI has been SRF, and their market share in plenty of these products might be north of 30% as per some brokerages.
One more interesting fact about SRF’s chemical business is that there are many entities which claim to be suppliers to Global Innovators like BAYERS, SYNGENTA OR BASF. Yet only few stand out in the chemical industry when we look at the margins and the scale up:- Pi Industries, Deccan, and SRF. All these companies have consistently reported EBITDA Margins that are upwards of 20%. Deccan has the highest at 28%, SRF consolidated at 25%, and PI at 24%. Compare this with generic manufacturers like Astec or Punjab chemicals, where margins are highly volatile, and in mid teens.
SRF has built local economies of scale. As the business model is fully integrated right from the key raw materials to the final end products. This is partly due to two huge land parcels it owns, and operates in Rajasthan and Dahej. Imagine making your raw material (bulk chemicals) in the same manufacturing site, where your high end value added products are produced. Cost structure will keep falling, as this is a fully integrated business model. Even during the agrochemicals downturn between 2016-2018, SRF kept investing and did a Capital expenditure of 2000+ crores, in order to build capacities for the next upturn.
C) Establishing the Chemicals Technology Group:-
Another source of competitive advantage arises from SRF’s ability to handle chemistries just beyond Fluorination. This has been possible due to the establishment of the Chemical Technology Group. Within the industry, SRF is known as a company which can handle complex chemistry projects, and for its engineering capabilities.
This has been partly made possible due to the establishment of Chemical Technology Group, where 430+.
Finally, continuity at the top and head of the business verticals have been with SRF for multiple decades now. I use linkedin to check the quality of the team. I will suggest any young man to do so
A roadmap for the future:-
Here are two excerpts from the Credit rating report of SRF:-
“ SRF has invested around Rs. 1,500 crs p.a. on average on capex building in the last 5 years and the company has a further capex plan of Rs. 3,000-3,300 crs for FY23.”
“The combined capex for FY23 and FY24 is expected at Rs 5,500-6000 crore and should be funded largely by internal accrual and some through debt.”
Going forward here is what the path looks like as per multiple management meet notes, announced plans:-
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More dedicated plants for their customers:- The Speciality chemical business has now grown to the scale of 14 dedicated plants, along with 5 multi-purpose plants (MPPs). The unit is working on commissioning 5 more dedicated plants within the next year, along with one Pharma Intermediate Plant, which has recently been commissioned. Around 6-7 years ago, Chemical Business used to produce only 6-7 products; this has now scaled up to 40-45 products.
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15,000 Crore Capex planned for next 5 years, out of which 75-80% is for the chemical business and the remaining for the Poly Films business.
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Unit Economics of the Dahej site will improve further- as currently 5500 crore of investment has gone into the Dahej site, asset turns have become 1-1.1x. This used to be below 0.7x in 2017. There is potential to put up more plants, and further improve the local economies of scale at Dahej.
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Entry into the high growth market of Fluoropolymers: This is an area where Gujarat Fluorochemicals has clearly taken the lead. The market size for fluoropolymers is close to $8.7 Billion in size. SRF has announced its entry into PTFE with a 5k MTPA capacity. This is more in commodity grades initially, and SRF just like its Peer GFL is fully integrated here. Other fluoropolymers where it has announced expansions include:- PVDF, FKM and FEP. Both these investments will cost upwards of 1000 crores combined, and the PTFE plant will be commissioned in Q1FY24. This will be an interesting area to watch out for, as uses of Fluoropolymers are found in Solar industry, Semiconductors, Auto, Electric Vehicles and other new age applications.
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Within the chemical business, the current mix is 90% Agro and 10% Pharma. Going forward, the plans include to shift this mix and bring Pharma to at least 25% of the product mix over the next 3-5 years.
Here is how the chemical business has grown in the last 5 years, and going forward given the capex plans and new products. Management has given a guidance of 20-25% growth over the next 3-5 years within the chemicals division.
Stage Analysis and Which trend?
-Post the Stage 2 Mark up, Stock is currently undergoing a period of consolidation since the last 18 months. Currently ADX is below 20 on a weekly time frame, which again signals a period of time correction or consolidation that is happening at the moment.
-Primary reason for consolidation seems that the Poly packaging business margins have blown up due to adverse turn in cycle. As the entire industry is going through a period of excess capacity at the moment. It will take some time before margins normalise within this business division.
EBIT margins of the SRF’s packaging business:-
-Entire Chemical sector stocks have gone in Stage 4 due to headwinds. Yet, SRF is consolidating and is one of the better companies when it comes to sustenance of growth rates. Another real risk is a sustained downturn in the Agro industry.
Things that can make the markets excited again fundamentally include:-
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Better execution of capex in Chemicals going forward.
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Continued scale up in the chemical business and growth surprising on the upside along with TAM expansion activities with launch of newer grades of Fluoropolymers.
Key risks include:- any downturn in the agrochemicals industry, prices of Refrigerant Gases falling, and any industrial accident which have become common within the chemical industry.
Valuations wise, SRF trades at a PE multiple of 32.8 times. With the chemical business growing at 20-25%+ and the other parts of the business including PFB business are going through a soft patch in demand and an oversupply situation in the industry.
