Aarti Industries' Q2FY20 results (Outperformer) - Broadly-in-line

Q2FY20 results

• Aarti Industries’s (AIL) revenues declined by 17%yoy to Rs10.76bn (vs est of 2% yoy growth); Notably, Aarti had demerged its HPC segment, hence revenue growth to that extent is not comparable. Impact on revenues due to sharp fall in RM prices was 7% as Aarti passes on the raw material price increase/decrease to its customer. Moreover, temporary shortage of nitric acid (a key raw material) impacted volumes of base chemicals.
• Speciality chemicals (83% of revenues) declined by 14%yoy, while the Pharma segment (17% of revenues) declined by 5%.
• Gross margins improved by 990bps to 48.8% (est: 43%) largely led by increasing contribution of downstream products and lower RM costs. The sharp expansion of gross margins is reflective of  management guidance of progressive shift in the specialty chemical business model towards value added products vs earlier model of volume driven growth
• Higher employee costs (up 40% yoy) restricted further margin expansion. Aarti has enhanced its manpower across functions in addition to R&D team. EBITDA margins improved by 497bps to 23.6% (est: 18.8%). EBITDA increased by 5%yoy to Rs2.54bn (in line with est : Rs2.49bn).  
• Despite  higher depreciation ( up 18% yoy ) , lower interest costs ( down 39% yoy  )  coupled with lower tax ( 17% vs 19.2% in Q2FY19) and  higher other income   led to 24% increase in PAT to Rs1.5bn  (above est : Rs1.38bn)

Impact on financials: EPS estimates maintained

Valuations & view

AIL’s performance in Q2FY20 benefitted from increase in contribution from downstream value added products. While in the near term, management expects moderation in PAT growth owing to macro uncertainty, its long term guidance of 15-20% CAGR PAT growth remains intact.  We believe AIL is in a pole position to capitalise new opportunities in the Indian specialty chemical space. AIL’s aggressive capex plan of Rs10-12bn over FY20-2021E (~40% increase in gross block over FY14-18), three multi-year contracts with global players exhibit AIL’s potential. We estimate 6%/23% revenue/PAT CAGR, respectively, over FY19-21E, with potential upside from new contract wins. At 16x FY21E earnings, we see room for upside, given AIL’s strong earnings visibility and healthy return ratios. Maintain Outperformer with target price of Rs1,013 (22XFY21E EPS)