Management Speak: Aarti Industries (Outperformer) - Long-term prospects strong; Cautious FY20 outlook

Presented are core arguments from our meeting with Aarti Industries (AIL), in which management has highlighted strong growth prospects.

• Healthy revenue but conservative PAT guidance: Post strong 31.7% revenue and 45% PAT growth in FY19, AIL’s management has guided healthy 15-20% revenue growth in FY20E, supported by rising proportion of downstream value-added products. However, management guided conservative PAT growth of 12-15% for FY20E, owing to higher overhead expenses associated with the commissioning of various projects. Currency volatility and uncertainty in China too could impact profitability.
• Strengthening manpower: Over last 10 years, AIL has been increasing presence in niche chemistries and downstream value-added products, courtesy higher R&D investments. Base processes (chlorination and nitration), which contributed >50% of revenues 10 years ago now constitute mere 30% of revenues, as these are increasingly being used to manufacture value-added downstream products. Moreover, the company has enriched its manpower (senior level professionals across functions in addition to R&D team) in a bid to introduce niche process chemistries and manage larger projects.
• Capex to yield results FY22E onwards: AIL has embarked on an aggressive Rs10-12bn capex for various projects in FY20E, which are at different stages of development. The full impact of these expansions would be visible FY22 onwards. Management does not foresee any execution challenges on these projects, reiterating 15-20% PAT growth visibility over next 4-5 years.

Valuation and View

AIL’s business model has metamorphosed from import substitution to exports. The company has put in place strategies to partner global players, which reflects management’s strong execution capabilities. AIL is in pole position to capitalise new opportunities in the Indian specialty chemical space, as seen from three multi-year contracts (worth ~Rs150bn) signed over 3 years with global players. As a global leader in benzene-based products, AIL has delivered stable 20%+ earnings growth (FY15-19) despite crude price volatility, boosted by: 1) large-scale integrated product chains, 2)diversified customer base 3) cost-plus pricing model, 4) world-class facilities. At 18.6x  FY21E earnings, we see room for upside, given AIL’s strong earnings visibility and healthy return ratios. Maintain Outperformer rating with a target price of Rs2,025.