From a bulk commodity products manufacturer, Deepak Nitrite Ltd. (DNL) (NSE: DEEPAKNTR, BSE: 506401) has evolved into a specialty chemical company operating in four key divisions viz; Basic Chemicals, Fine and Specialty Chemicals, Performance Products and Phenol – Acetone with facilities located at Dahej, Nandesari, Roha, Taloja and Hyderabad. The end use applications of DNL’s products vary from agrochemicals, dyes and pigments to pharmaceuticals, rubber chemicals, refinery, textile and colorants.

Basic Chemicals

• DNL’s basic chemicals division is characterized by high volume products across organic and inorganic chemicals.
• The key products in Basic Chemicals are: Sodium Nitrite consumed in dyes/pigments, pharma intermediates, colorants, Nitro Toluene which are consumed in colorants, agro-chemicals & rubber chemicals and Fuel additives used in refinery.
• The company holds a leading position in Sodium Nitrite and Nitro Toluene.
• The Basic Chemicals segment is currently operating at 90% capacity utilization levels.
• Growth in this segment is expected to be driven by capacity expansion and introduction of value-added products.

Performance Chemicals

• The performance products division majorly consists of two products, viz., Optical Brightening Agents (OBA) and Di-Amino Stilbene Di-sulphuric Acid (DASDA).
• DNL is the only fully integrated manufacturer of OBA with vertical integration from toluene to para nitro toluene (PNT) and further into DASDA and OBA. Key application area for OBA are detergents, paper and textiles.
• The performance chemicals segment is a key focus area of the company as DNL is targeting optimum mix of product and customers for higher margins.
• Capacity utilization is expected to improve from 45-50% currently to 60% going forward. The company also plan to expand capacity in DASDA.

Fine and Specialty Chemicals (FSC)

• The Fine and Specialty Chemicals division (FSC) product profile includes xylidines, cumidines, oximes, nitro oxylene, which having applications in agrochemicals, pharmaceutical intermediaries and personal care sectors.
• Agrochemicals demand is expected to be robust as domestic and export markets are expected to grow at ~7.3% and ~8.6% CAGR respectively over 2016-2025 (Source: FICCI).
• DNL is the sole manufacturer of thermal paper chemical in India.
• FSC division is currently operating at 90% utilization levels. Revenue from FSC segment is expected to grow as the company look to expand product offerings on back of continuous R&D, capacity expansions and growth in overall Agrochemicals sector.
• DNL is also planning to enter the specific Pharma intermediates segment, Anti- aging segment which is growing at 12.5-15% globally.

Phenol – Acetone

• India is one of the major importers for phenol and acetone with ~80% of the demand being catered through imports and remaining 20% by domestic players like Hindustan Organics Ltd and Schenectady Herdillia Ltd (SI Group).
• With the new facility being operational, DNL is expected to capture 63% of total market share in phenol and 60% market in acetone.
• The commercial production of Phenol-Acetone started in November 2018 and reached utilization levels of 100% within the first five months of operation.
• Phenol consumption is largely driven by phenolic resins (76%) while other end-user industries include pharma, dyes & agro-chemicals etc.
• Key consuming sectors for Acetone are pharma, paints, adhesives and thinners etc. As per the management, 65-70% acetone is consumed by the pharma industry in India.

Financial and Business Performance

• DNL’s topline over the last 10 years has been growing at a CAGR of 14.4%. The company only had de-growth in FY17.
• Operating profit and net profit over the same period have been growing at a CAGR of 24.9% and 23.9% respectively.
• Debt to equity ratio has been improving and at the same time interest coverage ratio has been increasing thus providing the company, room for debt financing.
• Domestic sales continue to contribute 60-70% of the total revenue.
• In FY19, the debtor days, inventory days and payables days stood at 66.8, 59 and 79.7 respectively.

Peer Comparison

Deepak Nitrite Ltd.	FY15	FY16	FY17	FY18	FY19
ROE (%)	25.83	15.39	16.25	9.65	17.42
ROCE (%)	19.8	13.63	14.4	9.46	17.02
Operating Margin (%)	10.65	12.26	10.86	12.77	16.01
Net Margin (%)	3.98	4.57	6.97	4.75	6.39
EPS (INR)	5.06	5.39	7.37	5.79	12.73
Debt to Equity	1.58	1.12	1.01	1.07	1.11
Aarti Industries Ltd.	FY15	FY16	FY17	FY18	FY19
ROE (%)	20.54	24.9	26.21	23.55	23.96
ROCE (%)	19.03	20.65	19.91	17.02	18.51
Operating Margin (%)	16.20	19.23	20.72	18.57	20.55
Net Margin (%)	6.65	8.90	10.35	9.08	10.71
EPS (INR)	11.62	15.42	19.23	20.48	28.37
Debt to Equity	1.18	1.14	1.15	1.32	0.91
Atul Ltd.	FY15	FY16	FY17	FY18	FY19
ROE (%)	24.08	20.33	17.8	13.16	17.42
ROCE (%)	27.61	26.16	22.96	19.15	27.20
Operating Margin (%)	15.49	19.03	19.83	16.11	19.85
Net Margin (%)	8.45	10.26	11.04	8.34	10.58
EPS (INR)	81.14	92.24	108.89	93.22	145.73
Debt to Equity	0.29	0.20	0.09	0.01	0.02
Sudarshan Chemicals Ltd.	FY15	FY16	FY17	FY18	FY19
ROE (%)	22.48	24.25	29.17	20.64	26.81
ROCE (%)	16.54	18.84	21.93	18.73	24.9
Operating Margin (%)	12.65	13.03	14.85	13.35	13.11
Net Margin (%)	4.38	4.91	6.68	5.11	8.03
EPS (INR)	7.86	10.10	14.64	12.24	19.52
Debt to Equity	1.65	1.37	1.14	0.98	0.65

DNL’s future looks optimistic due to the following

• Continued dominance in key products.
• Capacity expansion and introduction of value - added products will aid in the growth of revenues from Basic chemicals and Fine and Specialty chemicals segments.
• The management believes that Performance chemicals have headroom to grow. The utilization levels are expected to go up to 60-65% with focus on key products offering sustainable margins aiding profitability.
• The full - blown effect of Phenol – Acetone segment will be visible in FY20 when the plant has been operating for the full year.
• On back of robust demand for DNL’s products, the company has decided to focus on capacity expansion. A total capex of INR 350-400 crore is pegged for FY20 of which INR 200-250 crore is to be utilized for expanding capacities across Basic Chemicals, Fine & Specialty and DASDA. The balance INR 100-150 crore is to be incurred for downstream Phenol chain products.
• Slowdown in Chinese chemical industry due to stringent environmental norms and increasing operational costs
• Growth in end – user markets
• Strong margin profile, high return ratios, favorable macros and strategic decision making in product selection aided by strong R&D is expected to lead to a re-rating of the stock.
• Promoters have been increasing their share by buying from open market.
• Despite having high debt, the company has not pledged any of their shares, implying creditors having comfort in the debt servicing capability of the company as well as excellent negotiation capability.

Key Risks

• Adverse volatility in raw material prices can impact the margins.
• Pricing competition from China as well as from the domestic players can adversely affect realizations.
• Increasing demand for bio – based acetone.
• Unfavorable changes in import duty norms for Phenol products could impact the growth prospects for Phenol - Acetone offtake.

Given the commoditized nature, the management has been focusing on forward integration. The belief that full integration will lead to cost leadership has been the driving force behind the company’s new expansion plans. DNL’s financial performance and return ratios are in line with marque peers such as Aarti Industries Ltd, Atul Ltd and Sudarshan Chemicals Ltd. While these players command premium valuations, DNL is available (at a CMP of INR 377.9 as on March 20, 2020) at a PE of 9.78 thereby providing an opportunity for re-rating.

Team 3C Capitals

Sources:

• Value Research Online
• Screener