Buy Aarti Industries, target Rs 2,000: Phillip Capital (India)

Phillip Capital (India) has a buy call on Aarti Industries with a target price of Rs 2,000.

The current market price of Aarti Industries is Rs 1,372.20.

Time period given by the brokerage is one year when Aarti Industries price can reach the defined target.


Investment rationale by the brokerage:
Signed third multiyear supply deal with global MNC: ARTO entered into a $125mn (c. Rs 9bn) exclusive supply agreement with a global chemical conglomerate for a high value specialty chemical intermediate for a period of 10 years. The said deal is the 3rd multiyear supply deal by the company over last 20-months period. Earlier multiyear supply pacts for specialty chemical intermediates include - (1) a 10 year supply pact with a European Agrochemical giant (signed in June 2017) with revenue potential of Rs 40bn over the contracted period (likely to commission in H2FY20) and (2) 20 year exclusive supply agreement (signed in December 2017) with revenue potential of Rs 100bn over the contracted period.

Relatively smaller deal but it is a qualitative project: As per the agreement, supplies are expected to begin from Q4FY21 and should generate incremental revenues of $12.5mn per annum almost evenly over the contract term of 10 years. While the supply pact is a relatively smaller one than previous deals but it is a qualitative project as it requires scale up of a new specialty chemical intermediate from R&D lab levels to commercial quantities. The said intermediate product was developed by the joint R&D of ARTO and the customer. With this the company enters into a new chemistry range and the said product is not a part of ARTO's existing product range.

The pact will have limited earnings impact but positions ARTO for more such global pacts: Since the supply project involves R&D and scale up of a newly developed intermediate from laboratory levels to commercial scale, the product will have superior earnings profile compared to its existing business operation. While the earnings implication seems limited (annual sales of $12.5mn (with a capex of US$15mn) implying nearly 2 per cent incremental sales in FY22 over FY21), it is the testimony of the upgraded service capability (developing & manufacturing of customised complex product) of ARTO to global chemical industry. This will certainly help it grab more such deals led by the visible “Country De-Risking” initiatives of global chemical peers having large procurement dependency on China.

Multiyear deals improves share of customised sales mix sustained sales visibility and assured profitability: While the multiyear deals improve the product mix of ARTO towards high value down steam products (away from base product of nitro-chloro-benzene), it further enhances its customized product sales mix (which is already >80 per cent). Incidentally, the customized products provide sustained sales visibility and assured profitability.

Stock correction offers >50 per cent upside; Reiterate our conviction BUY with a target price of Rs 2,000: ARTO’s stock price has already corrected 23 per cent over last 13 trading sessions despite healthy Q3 results (53 per cent yoy jump in earnings) possibly due to concern over softening product prices. We believe the large part of price softening is due to sharp crude correction recently and that would result in improved margin scenario consequently. Additionally, supported by the multiyear customized/exclusive supply agreements with global companies, supply disruption in China and timely capacity expansions; we estimate 30 per cent earning CAGR over FY18-21 to Rs 89/share in FY21. We continue to value ARTO at 2,000 i.e., 14x FY21 EBITDA. Maintain conviction BUY with a target price of Rs 2,000.