Aarti Industries' Q1FY20 results (Outperformer) - Good quarter; cautious outlook

Q1FY20 results

• Aarti Industries (AIL) reported flattish revenue growth to Rs10.86bn; notably, Aarti had demerged its HPC segment in July, hence revenue growth to that extent is not comparable).
• Adjusting for the demerger, revenue growth was 8.8% yoy led by 5.5%yoy in speciality chemicals (82% of revenues), while the Pharma segment (18% of revenues) grew by 28%. In constant RM prices speciality chemicals revenues grew by 9.4%
• Gross margins improved by 760bps to 46.4% (est:41.7%) largely led by increasing contribution of downstream products. Sharp GM expansion is reflective of  management guidance of progressive shift in the speciality chemical business model towards value added products vs earlier model of volume driven growth
• Higher operating expenditure (up 12% yoy) and employee costs (up 30% yoy) restricted further margin expansion. Aarti has enhanced its manpower across functions in addition to R&D team. EBITDA margins improved by 340bps to 21.8% (est: 18.5%). EBITDA increased by 26%yoy to Rs2.36bn (est : Rs2.25bn).  
• Lower interest costs ( down 34% yoy )  and higher other income (+27% yoy)   drove 54% increase in PAT to Rs1.37bn (est: Rs1.07bn)
• Given slowdown in global agrochem and automotive sectors, mgt has guided potential softening of growth in H2FY20. However, they asserted that the long term business drivers stay intact.

Impact on financials: EPS estimates maintained

Valuations & view

AIL’s performance in Q1FY20 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 17%/24% 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 Rs2025 (22XFY21E EPS)