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1 Nov 17, 2015 Atul Ltd No. of shares (m) 29.7 Mkt cap (Rs crs/$m) 4850/733 Current price (Rs/$) 1635/24.7 Price target (Rs/$) 1988/ week H/L (Rs.) 1811/1035 Book Value* (Rs/$) 392/5.9 P/BV (16e/17e) 2.9/2.5 P/E (16e/17e) 16.8/14.8 EPS growth (FY15/16e/17e) 13.8/27.5/13.4 ROE (FY15/16e/17e) 24.1/24.7/22.7 Beta 0.9 Daily volume (avg. monthly) BSE Code NSE Code ATUL Bloomberg ATLP IN Reuters ATLP.BO Shareholding pattern % Promoters 50.8 MFs / Banks / FIs 13.6 Foreign 7.6 Non-Promoter Corp. 4.1 Public & others 23.9 Total As on Sep 30, 2015 Recommendation BUY Analyst KISHAN GUPTA, CFA, FRM Phone: + 91 (33) E- mail: kishan.gupta@cdequi.com Company Brief Atul Ltd manufactures value added chemicals by blending basic chemicals and natural resources for diverse industries -agriculture, construction, textiles, pharmaceuticals and automobiles - from its plants in Valsad, Bharuch (Gujarat) and Thane (Maharashtra). Quarterly Highlights Led by stupendous growth in its life science chemicals, Atul reported just 2.9% fall in net sales in Q2FY16 (-9.4% in Q1FY16) compared to a year ago period. After reporting declining revenues for last four quarters (y-o-y). Atul's life science chemicals business bucked the trend by posting 20.3% rise in sales - buoyancy in crop protection business explains much of the rise. Revenue of its performance & other chemicals business slid (-11.7% y-o-y) for the second consecutive quarter. OPM's inched up 470 bps to 19.3%, the highest level in at least ten quarters, driven by startling expansion in margins of life science chemicals business i.e. 24.2% vs 16.6% in Q2FY15; margins were up 430 bps q-o-q too. As a result, its EBIT jumped three-fourths to Rs crs from Rs crs in the same period a year ago. Trampled by softening crude oil prices, performance & other chemicals business continues to reel for its profits slid 3.7% last quarter and 1.9% in the first half. However, its margins have risen for last four quarters bps at the last count. Helped by healthy off take of crop protection and polymers business, EBITDA (adjusted) rose by 32.1% and net profit by 38.5% to Rs crs from Rs crs in the same quarter last year. Net profits in the first half of the current fiscal are up just 19.3%. The stock currently trades at 16.8x FY16e EPS of Rs and 14.8x FY17e EPS of Rs Better than expected outcome of the life science chemicals business forced us to revise upwards our earnings estimates (FY16 up by 14.2% ; FY %), implying average annual growth of 20.2%.Yet there is little evidence that buoyancy in Atul's life science chemicals business would be sustained (a low probability occurrence). We retain our buy rating on the stock with target of Rs 1988 ($30; previous target: Rs 1600) based on 18x FY17e earnings (peg ratio: 0.9 vs 1.1 earlier) over a period of 9-12 months. Consolidated figures (Rs crs) FY13 FY14 FY15 FY16e FY17e Income from operations Other Income EBITDA (other income included) Net Profit after MI & EO item EPS (Rs) EPS growth (%) * adjusted for market value of quoted equity sitting in the books

2 [ [ CD Equisearch Pvt Ltd Outlook & Recommendation US gaining strength According to Year End 2014 Chemical Industry Situation and Outlook published by The American Chemistry Council (ACC), global chemistry production volumes would grow by 3.6% in 2015 and 3.9% in 2016 driven by robust growth in developing nations of Asia-Pacific and Africa & the Middle East. US too would grow at a fast clip not least due to dollar appreciation coupled with increased supply of unconventional oil and gas putting downward pressure on oil prices. However, as per ACC's Mid-year 2015Chemical Industry Situation and Outlook, US chemistry volumes would grow at 3.2% in 2015 and 3% in slightly down from ACC's 2014 estimates of 3.7% and 3.9% respectively. Excluding pharmaceuticals, production growth would be 4.1% and 3.4% respectively. It reckons that "continued recovery in end-use markets, sustained competitiveness and the eventual return of global economic growth will lift demand for American chemistry over the next several years". With the development of shale gas and the surge in natural gas liquids supply, US has moved from being a high-cost producer of key petrochemicals and resins to among the lowest-cost producers globally. According to Cefic Chemicals Trends Report, published by the European Chemical Industry Council (Cefic), European chemical output grew just 0.2 per cent during the first half of 2015 compared to the same period of Chemical makers in European Union remain affected by lower prices and sluggish demand. Chemical prices, which fell 1.8% in the European Union, last year, remain under pressure. It now expects European chemical output to rise 1% this year after a measly 0.3% rise in 2014 buffeted by high energy costs and weak R&D investments. European chemical output would remain battered for some more time due to slowdown in China, where the economy remains affected by tepid property market and weak infrastructure investment growth. [ [ 2 2

3 New initiatives If its unveiled plans are any indication, then Atul is brimming with volumes -boosting ideas ranging from introduction of new products and formulations to adding new capacities to entering new business segments. With rising competition in India and abroad, its crop protection business is planning to strengthen its reach overseas, particularly in Africa and South America. To recall, overall volumes of this business plunged 20% last fiscal buffeted by massive fall (37.3%) in overseas dispatches (value wise). Other initiatives include unveiling new products coming off-patent, entering plant growth regulators & seeds business and increasing CRAMS related business. For pharmaceutical business, Atul not only plans to form strategic alliances but also grow via acquisitions. Apart from growing in Japan and select countries in Europe, it aspires to enter new markets in Russia, Iran and Korea. It also aims to increase its CRAMS business with strategic customers. To alienate its performance & other chemicals business from vagaries of commodity prices, it plans to introduce high margin polymers and boost sales of high performance pigments and digital printing inks. Also on avil are plans to introduce new dyes and pigments for non-textile applications and aromatic products in personal care and flavors & fragrance industries. Gaining market share in select epoxy hardeners and Vat, sulphur and reactive dyes is no less important. Capex Atul expects to add a fifth to its current sales count of nearly 2650 crs by commissioning projects worth Rs 321 crs over the next couple of years - expected to generate sales of nearly Rs 550 crs. Handful of projects completed last fiscal would also add nearly Rs 150 crs to the sales tally. Few of the projects in colors business which were commissioned last fiscal include the solvent recovery plant, formulation facility for digital inks and pilot plant for HPPs. Others include the multi-purpose plant for bulk actives (colors) intermediate expansion project (colors) and BLR expansion project (polymers). Most striking, Atul's Dapsone API plant got the US FDA approval last fiscal. For the current fiscal the pipeline of projects nearing completion is no small. It targets to finish expansion of API and intermediates, epoxy resins and formulations (polymers), epoxy hardeners and intermediates (polymers) and reactive diluents. Also afoot are plans to commence the herbicide formulations capacity (crop protection) and intermediate capacity for colors. Risks Atul's businesses suffer from a plethora of insurmountable risks. It ranges from fluctuations in crude oil prices to variations in foreign exchange rates to shortage of key raw materials to growing external competition. While most of its businesses are affected by relentless fall in crude oil prices, some like aromatics and polymers are more trampled. Margins may squeeze for epoxy resins and hardeners not least due to cheaper imports. Atul reckons that piercing fluctuations in foreign exchange rates could impact most of its businesses. Its crop protection business faces headwinds from rising usage of GM crops and increasing presence of international generic companies in India, while its color business has been suffering from falling demand for niche Vat dyes. Its puny portfolio of HPP has failed to provide the much needed shield to its colors business. 3 3

4 % change in overall EBIT (allocable) % change in overall EBIT (allocable) Financials & valuation Atul's revenues would barely grow by 3% (7.8% cut from the previous estimate) not least due to incessant fall in crude oil prices. Due to stress in crude oil markets, revenue of its performance & other chemicals slid 11.2% in the first half of current fiscal. Worse still EBIT decreased by some 2%, belying hopes of margin expansion making up for most of the loss in profits due to lower sales realizations. Its life science chemicals business has recovered some lost ground mainly due to sturdy dispatches of crop protection business last quarter. Sparked by higher capacities and foray in new regions, Atul's pharmaceuticals business would grow in low teens over the next two years. Volumes of performance and other chemicals business sub-segments - aromatics, colors, polymers and bulk chemicals - would grow by 5-12%. Fall in product realizations have taken sheen off from its aromatics business - volumes grew by breathtaking 16% last fiscal. Despite India and China emerging as key suppliers of p-cresol globally, its aromatics business would barely grow (in value terms) over the next two years. Polymers business though could show some resilience. Margins though have risen: performance & other chemicals up 352 bps; life science chemicals up 144 bps in the first half of current fiscal. We reckon that if crude oil prices recover somewhat next fiscal (a high probability event) margins could come off a bit. However, overall margins could also get a lift from Atul's allegiance to launch high margin products, particularly in polymers and colors businesses and debottlenecking capacities - did that for two and a half dozen products last fiscal. 4 4

5 Free cash flows would increase not least because of large operating cash flows. So would the return on capital ratios. All rests on Atul's effiency in managing working capital and modest recovery in crude oil prices. Risks related to vagaries of monsoons, sharp fluctuations in foreign exchange rates and threat of cheaper imports could beset estimates and sour business plans. The stock currently trades at 16.8x FY16e EPS of Rs and 14.8x FY17e EPS of Rs Better than expected outcome of the life science chemicals business goaded us to scale up our earnings estimates (FY16 up by 14.2%; FY17's 10.5%), implying average annual growth of 20.2%. Yet there is little evidence that buoyancy in Atul's life science chemicals business would be sustained (a low probability occurrence); that is why we have assumed lower EBIT margins for next fiscal. Yet current valuation favours defensive investors. We therefore retain a buy rating on the stock with target of Rs 1988 ($30; previous target: Rs 1600) based on 18x FY17e earnings (peg ratio: 0.9 vs. 1.1 earlier) over a period of 9-12 months. (For more information, please refer to our report dated May 26, 2105). Cross Sectional Analysis Company Equity* CMP Mcap* Sales* Profit* OPM NPM Int. coverage ROE Mcap / sales P/BV P/E Aarti Inds Atul Ltd BASF India Sudarshan Chem TTM P/E; * Figures in Rs crs; Companies in the exhibit not exactly comparable as their product portfolios are dissimilar. 5 5

6 Financials Standalone Quarterly Results Figures in Rs crs Q2FY16 Q2FY15 % chg. H1FY16 H1FY15 % chg. Income from operations Other Income Total Income Total Expenditure PBIDT (other income included) Interest Depreciation PBT Tax PAT Extraordinary Item Adjusted Net Profit EPS (F.V. 10) Segment Results Figures in Rs crs Q2FY16 Q2FY15 % chg. H1FY16 H1FY15 % chg. Segment Revenue Life Science Chemicals Performance & Other Chemicals Sub Total Inter - Segment Revenue Net Segment Revenue Segment EBIT Life Science Chemicals Performance & Other Chemicals Sub Total Interest Other Unallocable Exp. (net of income) PBT

7 Consolidated Income Statement Figures in Rs crs FY13 FY14 FY15 FY16e FY17e Income from operations Growth (%) Other Income Total Income Total Expenditure EBITDA (other income included) Interest EBDT Depreciation Tax Net profit Minority interest Profit/loss of associate Net profit after MI Extraordinary item Adjusted Net Profit EPS (Rs.) Segment Results Figures in Rs crs FY13 FY14 FY15 FY16e FY17e Segment Revenue Life Science Chemicals Performance & Other Chemicals Others Net sales Segment EBIT Life Science Chemicals Performance & Other Chemicals Others Sub Total Interest Other Unallocable Exp. (net of income) PBT

8 Balance Sheet Figures in Rs crs FY13 FY14 FY15 FY16e FY17e SOURCES OF FUNDS Share Capital Reserves Total Shareholders Funds Minority Interest Long term debt Total Liabilities APPLICATION OF FUNDS Gross Block Less: Accumulated Depreciation Impairment Net Block Capital Work in Progress Investments Current Assets, Loans & Advances Inventory Sundry Debtors Cash and Bank Other Assets Total CA & LA Current liabilities Provisions Total Current Liabilities Net Current Assets Net Deferred Tax Other Assets (Net of liabilities) Total Assets

9 Cash Flow Statement Figures in Rs crs FY13 FY14 FY15 FY16e FY17e Net Income (a) Non cash exp. & others (b) Depreciation Investment income Others (Increase) / decrease in NWC (c) Inventory Debtors Payables Other assets (net) Operating cash flow (a+b+c) Capex (net of sale) Investment income Others Investing cash flow (d) Net borrowings Dividends paid Others Financing cash flow (e) Net change (a+b+c+d+e)

10 Key Financial Ratios FY13 FY14 FY15 FY16e FY17e Growth Ratios Revenue (%) EBIDTA (%) Net Profit (%) EPS (%) Margins Operating Profit Margin (%) Gross Profit Margin (%) Net Profit Margin (%) Return ROCE (%) RONW (%) Valuations Market Cap / Sales EV/EBIDTA P/E P/BV Other Ratios Interest Coverage Debt-Equity Ratio Current Ratio Turnover Ratios Fixed Asset Turnover Total Asset Turnover Debtors Turnover Inventory Turnover Creditors Turnover WC Ratios Debtor Days Inventory Days Creditor Days Cash Conversion Cycle Cash Flows (Rs crs) Operating Cash Flow FCFF FCFE

11 Financial Summary US dollar denominated million $ FY13 FY14 FY15 FY16e FY17e Equity capital Shareholders funds Total debt Net fixed assets (incl CWIP) Investments Net current assets Total assets Revenues EBITDA EBDT PBT PAT EPS($) Book value ($) Operating cash flow Investing cash flow Financing cash flow *income statement figures translated at average rates; balance sheet and cash flow at year end rates; projections at current rates 11 11

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