Aarti Industries' Q3FY20 results (Outperformer) - Stable performance despitechallenges, guidance intact

Q3FY20 results

• Aarti Industries’s (AIL) revenues declined by 3.9% to Rs12.18bn (above est: Rs11.7bn); Notably, Aarti had demerged its Home and Personal care segment in July, hence revenue growth to that extent is not comparable. Increase in crude linked RM prices led to higher realisations as AIL adopts a cost plus model. However temporary nitric acid shortage and macro challenges continued to impact volumes.
• Speciality chemicals (86% of revenues) grew by 2.8%yoy, while the Pharma segment (16% of revenues) registered by 3% growth.
• Gross margins improved by 428bps to 45.4% (however was below our est: 47% due to volatility in crude prices). The margin expansion largely led by increasing contribution of downstream products. The 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 33% yoy) restricted further margin expansion. Aarti has enhanced its manpower across functions in addition to R&D team. EBITDA margins improved by 138bps to 20.9% (est: 22.8%). EBITDA increased by 2.9%yoy to Rs2.54bn (marginally below est : Rs2.66bn).  
• Despite  higher depreciation ( up 16% yoy) , lower interest costs ( down 39% yoy )   led to 7.4% increase in PAT to Rs1.42bn  (below est : Rs1.56bn)

Impact on financials: Cut FY20/21E EPS by 9%/9.2% respectively to factor in corporate restructuring and lower than expected gross margins. Introduce FY22 EPS of Rs48.4/share

Valuations & view

During 9MFY20. Aarti Industries continued to report stable performance despite macro challenges (Nitric acid supply shortage, extreme weather conditions in US and automobile slowdown). Going forward , in the near term ( FY20E) we believe AIL will be able to  meet its growth guidance of 10-15%  PAT growth for FY20E driven by increase in contribution from value added products .In the long run , 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, three multi-year contracts with global players exhibit AIL’s potential, in our view. We estimate 6%/23% r     evenue/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 Rs1,163 (24XFY22E EPS).​