Initiating coverage: Aarti Industries (Outperformer) - Entering into a new orbit

Aarti Industries Limited (AIL) is a leading player in benzene-based intermediate products, and an integral part of value chain for several global chemical majors. AIL’s backward/forward-integrated and diversified business model, which involves the supply of ~125 products to 700-800 customers across geographies, underpins its competitiveness. Despite significant forex and crude volatility, AIL posted 15%/20% EBITDA/PAT CAGR over FY14-18 with 21.6% RoE in FY18, which reflects its robust business model. We anticipate a step-up in growth with steady 12-15% volume growth in core benzene segment and diversification into toluene compounds, with the company recently signing Rs140bn of two long-term contracts. We estimate 22%/24% revenue/PAT CAGR, respectively, over FY18-21E, with potential upside from new contract wins. We initiate coverage on the stock with an Outperformer rating and target price of Rs1,572 (20x FY21E earnings).

Diversified business model: AIL’s focus on developing integrated product chains versus standalone products and creating diversified product portfolios are key pillars of its strategy. These measures have enabled the company to become a global leader in benzene-based intermediates. While adding to its benzene capacities, AIL is also venturing into new chemistries, e.g., toluene-based compounds and stepping up R&D investments to explore opportunities in speciality chemicals. The company expects to invest Rs7-8bn/pa over FY18-21E, which would drive 12-15% CAGR volume growth.

Volumes to drive EBITDA growth: AIL has a cost-plus pricing model that insulates it from crude price volatility. This is because EBITDA growth is a factor of volumes and not linked to end-product pricing. We estimate 22% EBITDA CAGR over FY18-21E (versus 15%+ EBITDA growth per annum), as the company is expected to initiate the supply of specialised intermediates as per its 2 large multi-year agreements, FY21E onwards.

Growth platform in place: AIL’s business has morphed from import substitution to exports. The company now partners global chemical players, which reflects management’s strong execution capabilities. We believe AIL is in a pole position to capitalise new opportunities in the Indian specialty chemical space. Two multi-year contracts (worth Rs140bn) with global players exhibit AIL’s potential. At 16.6x FY21E earnings, we see room for upside, given AIL’s strong earnings visibility and healthy return ratios. We initiate coverage with an Outperformer.