Date: 9th March 2020

Equity Research Pick of the Week – Retail Research

Fairchem Speciality Ltd

Market leader in a niche industry Proposed restructuring to create focused business

Strong raw materials sourcing capabilities segments
Robust growth expected in Flavours & Fragrance Moving up the value chain
segment Expanding global presence

INDUSTRY ADD ON DIPS TO

Chemicals Rs 540-545

CMP SEQUENTIAL TARGETS

Rs 605.45 Rs 690-750 Rs 494

RECOMMEND TIME HORIZON

ed ed

Buy at CMP and add on declines 4 quarters

Investors may sell 60-65% of their holdings on first target being achieved and later keep a stop loss of first target for the balance holdings, in case the second target takes time to be achieved.
Investors may also maintain Rs 494 as level below which investment position needs to be reviewed, including the possibility to exit Page 2
 Equity Research Pick of the Week – Retail Research

Investment rationale:
 Market leader in a niche industry
 Strong raw materials sourcing capabilities
 Robust growth expected in Flavors & Fragrance segment
HDFC Scrip Code FAISPEEQNR  Proposed restructuring to create focused business segments
 Expanding global presence
BSE Code 530117
FAIRCHEM Concerns:
NSE Code
 Availability and pricing of raw materials
Bloomberg FAIRCHEM IN  Competition from low cost Chinese products
CMP (Mar 6, 2020) 605.45  Product obsolescence and substitution risks
 Compliance with strict pollution control norms
Equity Capital (cr) 39.06  Volatility in foreign exchange
Face Value (Rs) 10
Company profile:
Eq- Share O/S(cr) 3.91 Fairchem Speciality Ltd. (FSL - formerly known as Adi Finechem Ltd.) is a speciality oleochemicals and aroma chemicals
manufacturing company. The company utilises state of the art technology with critical equipments acquired from Germany and
Market Cap(Rs cr) 2365.05
Switzerland. Fractions of natural oils and fats such as soyabean, sunflower and cottonseed are the source of the company's fine
Book Value (Rs) 167.48 chemical products. Its main products are mixed tocopherols, sterols, linoleic acid, monobasic acid and dimer acid for polyamides
29,500 and printing ink industry. In Nov-2015 Fairfax India (FIH) acquired 44.9% stake in the company. In Jul-2016 FIH acquired 51% of
Avg.52 Wk Volume
Privi Organics India Ltd. (POIL) engaged in the business of manufacturing aroma chemicals and later made it a wholly owned
52 Week High 748.05 subsidiary of FSL in Oct-2016. FSL manufactures more than 65 products and possesses manufacturing capacity of 45000 MTPA
52 Week Low 400.25 of Adi and 22000 MTPA of Privi located in Western India.
View and valuation:
FSL is the largest manufacturer of aroma chemicals in India, an industry which is witnessing robust growth on account of change
Shareholding Pattern % (Dec 31, 2019)
in consumer preferences, healthy and green sustainability package among the consumers and growth in end user markets. It is
Promoters 74.1 looking to move up the value chain and manufacture speciality chemicals which fetch a higher margin. It has been expanding its
product range through its in-house R&D facilities. The Company enjoys cost efficiencies as most of its raw materials are derived
Institutions 2.2
from waste products.
Non Institutions 23.8
The market for FSL products is growing by 10-15% p.a. The management expects to grow at 15-20% by gaining market share
Total 100.0 from others and launching new products. It has initiated two capex projects 1) a plant to manufacture sterols and higher
concentration tocopherols and 2) a plant to manufacture bio-diesel using three by-products of its manufacturing process:
palmitic acid, monomer acid and residue. The company has spare capacity in existing products giving it considerable room to
grow. The topline and margins have improved sharply in FY19 and FY20 and we expect the growth to continue at a slightly lower
FUNDAMENTAL ANALYST pace. The proposed demerger of two businesses having different growth potential and margins could lead to value unlocking.
Atul Karwa
atul.karwa@hdfcsec.com
We feel investors could buy the stock at the CMP and add on dips to Rs 540-545 band (9x FY22E EPS) for sequential targets of
Rs 690 (11.5x FY22E EPS) and Rs 750 (12.5x FY22E EPS) in 4 quarters. At CMP of Rs 605.45 the stock quotes at 10.1x FY22E EPS.

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Financial Summary
Key Highlights YE March (Rs cr) Q3FY20 Q3FY19 YoY (%) Q2FY20 QoQ (%) FY19 FY20E FY21E FY22E
Net Sales 390.1 378.2 3.1 389.9 0.1 1341.0 1703.6 2001.7 2291.9
EBITDA 74.0 62.8 17.8 45.2 63.7 212.7 274.3 330.3 387.3
 FSL is the largest aroma chemical
manufacturer in India, an industry APAT 38.7 8.9 333.3 28.8 34.5 85.2 142.7 190.3 234.5
growing at CAGR of 6.2%. it has Diluted EPS (Rs) 9.9 2.4 7.4 21.8 36.5 48.7 60.0
expanded its product portfolio in P/E (x) 27.8 16.6 12.4 10.1
F&F to over 50 products which could EV / EBITDA (x) 13.3 10.4 8.5 6.9
help the company to increase its RoE (%) 15.9 22.4 24.2 24.0
market share (Source: Company, HDFC sec)

 FSL is the only producer of dimer

acid in India and enjoys a market
share of ~70%.
 It is the only Asian company to set-
up a refinery for processing waste
from pulp & paper industry to
produce key building blocks for
aroma chemicals. has tied up its
procurement of CST directly from
over 30 mills across Europe and
North America
 FSL is looking to expand in the
global market. It has established
subsidiaries in US and Netherlands.
 Proposed business restructuring
could create two niche, dedicated
and focused business segments
Company profile:
Fairchem Speciality Ltd. (FSL - formerly known as Adi Finechem Ltd.) is a speciality oleochemicals manufacturing
company. The company utilizes state of the art technology with critical equipments acquired from Germany and
Switzerland. Fractions of natural oils and fats such as soyabean, sunflower and cottonseed are the source of the
company's fine chemical products. Its main products are mixed tocopherols, sterols, linoleic acid, monobasic acid and
dimer acid for polyamides and printing ink industry.
In Nov-2015, Fairfax (India) Holdings Corporation (FIH) – investment arm of Fairfax Group incorporated in Canada and
managing over $38bn in assets - acquired about 45% of the equity capital in erstwhile Adi Finechem Limited (AFL),
listed on the Indian bourses. Equity shares were acquired in a secondary market transaction from the existing
promoter-shareholders of AFL. Mr. Nahoosh Jariwala, Founder and Managing Director and Utkarsh Shah, Chairman of
AFL continued to lead the Company in their respective positions.
In Jul-2016, FIH acquired about 51% equity of Privi Organics India Ltd. (POIL) comprising secondary sale by existing
Private Equity Investor, one of the existing shareholders and by infusion of the primary capital into the Company.
Simultaneously, the Board of Directors of POIL and AFL unanimously decided to enter into a scheme of arrangement
to merge the Aroma chemical business of POIL with AFL. Mr. Mahesh Babani, and Mr. D B Rao, Founder, Managing
Director and Executive Director of POIL continue to lead the business with Mr. Babani assuming additional role of
Managing Director of FSL and Mr. Rao as a Director on the Board of FSL.

Post the arrangement and allotment of shares to Fairfax, their shareholding rose to 48.7%. Apart from FSL, the
erstwhile Indian promoters (of AFL and POIL) also continue to hold a stake of 25.3% in FSL. Totally promoters hold, a
stake of 74.06% in FSL. In Oct-2016, in line with the revised plans and scope of activities on hand, name of AFL was
changed to Fairchem Speciality Ltd.

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Headquartered in Toronto, Canada, Fairfax India was founded in 2014 by Mr V Prem Watsa (CEO of Fairfax group). The investment portfolio of Fairfax India includes
India Infoline Finance Limited, Thomas Cook (India) Ltd., Quess Corp Ltd., National Collateral Management Services Ltd., Bangalore Intl. Airport Ltd. amongst others.

FSL has perfected the business model of procuring waste generated in the oil refining mills and then using state of the art process equipment to isolate and purify a
variety of components from the waste. Some of these components are used as building blocks to make further value-added products like Dimer acid. FSL is India’s only
manufacturer of Dimer acid used in many consumer products including paints, printing inks, epoxy hardeners, drilling chemicals and moulds. FSL also processes
Tocopherol which is used in formulating Natural Vitamin-E.

POIL manufacturers aroma chemicals, which are blended together by formulators to impart fragrance in day to day products like soaps, detergents, shampoos, and
fine fragrances. A significant portion of POIL’s aroma chemicals are made from the waste generated in the Pulp & Paper mills – mostly located in Europe, the US and
Canada. ~70% of POIL’s products are exported across the globe.

Thus, both companies are mostly working on renewable sources of raw materials, mostly waste from another industry and convert that into value added products.

FSL has long association with its customers in domestic as well as export markets. Moreover, majority of its clientele enjoy leading position in their respective industry
segments. Furthermore, FSL has a diversified client base with top 10 customers contributing around 48% of total income during FY19.

Key company milestones

(Source: Company)

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Business segments
Aroma Chemicals: About 1/3rd of the aroma chemicals produced globally are made from chemicals obtained from a Pine tree. Stems of Pine tree is also used globally
as a raw material for making pulp and paper. Chemical building blocks required for making aroma chemicals are thrown out as waste while manufacturing paper/pulp.
Privi (100% subsidiary of FSL) is one of the 4 global companies, and only Asian company to have developed a process to isolate and purify building blocks. Thus, Privi is
fully integrated manufacturer of Pinene based aroma chemical, which constituted about 60% of the revenue as of FY17. POIL is working on developing processes to
create value added products from by-products of its manufacturing processes.

Oleo Chemicals: Oleo Chemicals are chemicals derived from Plant and Animal Fats. The formation of basic oleochemical substances like Fatty Acids, Fatty Acid Methyl
Esters (FAME), Fatty Alcohols, Fatty Amines and Glycerol are by various chemical and enzymatic reactions. FSL is a leading producer of Fatty Acids from natural oils
and fats derived from renewable raw materials such as Soya, Sun Flower, Corn and Cotton. FSL has developed and mastered the process of manufacturing its entire
product range of acceptable local and international quality from waste/by product streams of natural vegetable oils. Its manufacturing unit set up in 1995 at
Ahmedabad is one of the largest processing capacities for Natural Soft Oil based Fatty acids in India with a capacity of 45,000 MTPA.
Nutraceuticals: The term is applied to products that range from isolated nutrients, dietary supplements and herbal products, specific diets, genetically modified food,
and processed foods such as cereals, soups, and beverages. FSL currently produces (natural) Tocopherols and Sterols – intermediate nutraceuticals and they are
exclusively exported to the Nutraceutical and Health Care Industries abroad. Tocopherols have anti-oxidant properties. Tocopherols, after they are further
concentrated by customers, are then used in (a) Pet Food, (b) food as it prevents rancidity. Tocopherols when converted into Natural Vitamin E finds the application
in Pharmaceutical, cosmetic etc. Sterols after they are further concentrated, finds its use in making of Cortico Steroids and as food additive.
Product Portfolio

(Source: Company)

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Revenue breakup

(Source: Company, HDFC sec)

Investment Rationale
Market leader in a niche industry
POIL is the largest aroma chemical manufacturer in India with a production capacity of 22,000 MTPA spread across four manufacturing facilities in Maharashtra and
Gujarat. Globally it is the second largest player in the pine tree fragrance segment, with a market share of 20-25%. According to Transparency Market Insights, the
global Aroma Chemicals market was valued at $4.09bn in 2016 and expected to grow at a CAGR of 6.2% to reach $6.6bn by 2024. Factors like change in consumer
preferences, healthy and green sustainability package among the consumers and growth in end user markets are boosting the market growth.

Post 2000, Aroma Chemicals has been the fastest growing segment within Flavours & Fragrance (F&F) industry at CAGR of ~6.21% as compared to F&F growth of ~5%.
The aroma chemicals market is driven by high-demand in the end-user industries, coupled with changing preferences of consumers from toxic chemical products to
natural products. Owing to changing consumer preferences, manufacturers are investing more in R&D facilities as they are under pressure to develop innovative
solutions to meet the customer demand. Aroma Chemicals is the fastest growing segment within F&F industry, with an estimated market size of US$ 5bn.

In terms of consumption, North America accounts for majority (33%) of consumption of overall F&F market followed by Europe and Asia Pacific region.

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Global Aroma Chemical Market (US$ bn) Geographic consumption split

(Source: Company, Industry estimates, HDFC Sec)

POIL is the leading manufacturer of aroma chemicals such as Amber Fleur and Dihydromyrcenol (citrus character) which are important ingredients in the manufacture
of Fragrances. It has expanded its product range from 2 products in 1992 to 50+ high performance chemicals in 2016 based on in-house R&D. This could help the
Company to increase its market share not only for its key products but also for the new products as its key customers would prefer to buy a basket of products from
one stop shop. It is the only Asian company to set-up a refinery for processing waste from pulp & paper industry to produce key building blocks for aroma chemicals.
POIL has been supplying to the top 10 global fragrance companies for over 10 years and has direct relationships with global FMCG giants like P&G, Henkel etc. In FY19,
FSL exported its first consignment of Terpene-4-OL to BASF which would be used in the production of Herbicides and has a lot of potential to add value to the topline
and bottomline of the company.
Indian fragrance market by end use

(Source: Company)
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Strong raw materials sourcing capabilities

POIL is mainly into manufacturing aroma chemicals mainly from terpene molecules (Pine based) that serve as building blocks in the Flavours & Fragrance (F&F)
industry. These can procured from i) tapping a pine tree to get Gum Turpentine Oil (GTO) or ii) using the waste from a Pulp and Paper industry -Crude Sulphate
Turpentine (CST).

Manufacturing process for Aroma Chemicals

(Source: Company)

China is the leader for GTO and the prices are very volatile. CST is a waste product in making pulp and it can be sourced with six month to one year fixed price contracts.
POIL has developed the Sulphur separation process (sulphur is an impurity in CST) and has tied up its procurement of CST directly from over 30 mills across Europe and
North America. FSL continues to be the largest single CST processing site in Asia, which is invariably the reason for survival and growth under the current volatile
situation in respect of raw materials.

POIL operates in four different segments viz. Pinene based, Citral Based, Specialty products and Phenol Based that account for 49%, 23%, 16% and 12% of the revenue
respectively in FY17 and 63%, 9%, 5% and 22% of the volumes. Exports account for ~2/3rd of revenues. Over the last 4 years aroma chemicals revenues have grown at
CAGR of 18.5% to Rs 1077cr in FY19, while oleochemicals have grown at 13.4%.

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GTO producing countries CST producing countries

(Source: Company)

The erstwhile AFL manufactured a range of oleo chemicals (high grade fatty acids) like dimer, monomer, linoleic acid and tocopherols from the waste products
generated during refining of edible oils. It has one of the largest processing capacity of natural edible oil based fatty acids in India. The products are used in
manufacturing of paints, inks, detergents, surfactants, shampoos, soaps, plastics and so on. Its longstanding customer base includes BASF, ADM, Cargill, Arkoma &
Asian Paints.
Manufacturing process for Oleochemicals

(Source: Company)

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Currently, FSL is the only producer of dimer acid in India and enjoys a market share of ~70% while having competitive advantage for other products over its peers.
Share of dimer acid in its total revenues has increased from 16% in FY13 to 38% in FY19. Dimer Acid is used for making two kinds of polyamides i.e. Non-reactive and
reactive. Non-reactive polyamides are used by manufacturers of printing inks, adhesives, paper coatings etc. Rising demand from industries such as printing inks,
adhesives and paper coatings may drive global dimer acid market size for non-reactive polyamide resins. The demand for Reactive polyamide resins application will
be driven by increasing surface coatings & adhesives demand in marine and construction. FSL has also started exporting Dimer Acid to nearby countries in FY19.

In the Nutraceuticals segment the company produces (Natural) Mixed Tocopherol Concentrate/Natural vitamin E which it supplies in the Nutraceutical and Health
Care Industries. The said product is exclusively exported. The Company is working on an improved version of the product, as well as isolating and marketing other
nutraceutical products. During FY20, FSL has planned to focus on this segment. It has carried out lab trials for achieving higher concentration of tocopherols and as a
result thereof obtain separate stream of sterols which can further be processed for getting highly concentrated sterols. It exports these streams

Robust growth expected in Flavors & Fragrance segment

Worldwide consumption of F&F products is expected to grow at an average annual rate of almost 5% during the next five years. Demand for F&F products is fairly
mature for most applications in the developed countries, but there is potential for growth in China, Other Asia (especially India), the Middle East, and Latin America.
GDP growth, urbanization, the expansion of the middle class, and increased demand for consumer products will drive consumption growth in developing countries.
Some of the key demand drivers are:
• Increased interest in healthy eating. Demand for “better-for-you” foods—foods with wholesome ingredients and reduced salt, fat, or sugar content—is growing.
Sophisticated flavor systems can help food manufacturers reduce the salt or calorie content of their products without sacrificing taste.
• Consumer preference for natural (as opposed to artificial) ingredients. Many consumers believe that natural ingredients are safer, healthier, and better for the
environment than their synthetic counterparts. Demand for foods and beverages that are free of artificial or chemical-sounding ingredients, including artificial
flavors, colors, and sweeteners, is growing. Although the preference for natural ingredients is especially apparent in the food industry, it affects the personal care,
home care, and fabric care product industries as well.
• Strong demand for convenience foods, including microwaveable and prepared foods, in developed markets. This trend has generally increased the demand for
flavors.
• The growing influence of social media, consumer activists, advocacy groups, and retailers in framing the discussion about ingredients in food and personal care
products.

Moving up the value chain

Most of the Indian ingredient providers are suppliers of oleoresins or aroma chemicals to the Flavours & Fragrances houses in India or exporters of the same. Many
of the synthetic aroma chemicals are not differentiated and as a result there is stiff price competition in this space. Some natural extracts and oleoresins may command
a premium; however, they are seasonal in nature and are beginning to face price competition from the Chinese. As a result, manufacturers of bulk aroma chemicals
or oleoresins typically experience relatively low margins (15-25% gross margins) compared to the global Flavours & Fragrances houses which have much higher
profitability. Moving up the value chain may not be an urgent imperative for Indian ingredient manufacturers, but may be a key differentiator in the long term.

Restructuring to create focused business segments

The Board of Directors of FSL and POIL at their respective meetings held on May 22, 2019, have, inter alia, subject to various approvals, considered and approved a
composite scheme of arrangement and amalgamation, for:
• Demerger of the speciality oleo chemicals and nutraceuticals business of FSL into Fairchem Organics Limited (FOL, a wholly owned subsidiary of FSL).

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• Amalgamation of POIL, manufacturers of aroma chemicals, a wholly owned subsidiary of FSL, into and with FSL.
In consideration of the demerger, FOL will issue 1 fully paid up equity share of Rs 10 each for every 3 equity shares of Rs 10 of FSL. Thus, each FSL shareholder, while
continuing to hold its shares in FSL, will get additional shares of FOL.
Both the businesses – that of oleo chemical and nutraceuticals; and aroma chemicals require different skill sets, business strategies, R&D support and capital assets.
The nature of risk, competition, challenges, opportunities and business methods for both the businesses are distinctly different. As each business requires significantly
different operating and financial strategies, the management believes that their individual potential will be best realized if the businesses are operated separately and
independently. The restructuring would create two niche, dedicated and focused business segments without any risk or overlap of one business over the other. It would
also eliminate inter corporate dependencies, minimize the administrative compliances and maximize shareholders value.
Transaction structure (Pre & Post)

The foreign and Indian promoters have entered into share

purchase agreements as it seems that ex POIL promoters do not
wish to stay in oleochemicals business and ex AFL promoters do
not want to stay in aroma chemicals business. Provided all the
option agreements interse promoters in the scheme of
arrangement and share purchase agreement are exercised, the
revised shareholding of the resulting companies would be as
under:

Proposed Proposed
(%) Current Stake
stake in FSL stake in FOL
FIH 48.76 38.92 66.60
Ex POIL prom. 22.67 35.13 0.00
Ex AFL prom. 2.62 0.00 7.45
Total 74.05 74.05 74.05

(Source: Company HDFC sec)

Expanding global presence

FSL is looking to expand in global market. It has established a 100% subsidiary in the US market and looking to grow its market share by penetrating North and South
American markets. FSL has set up its own office in Netherland and also targeting to set up an office in South America. It has made inroads into the developing markets
(Nigeria, Egypt, UAE, Pakistan, South Africa) by seeking more and more customers. The strategic long term business relationship forged with leading companies in
F&F industry, like Givaudan, Firmenich, IFF and with well-known global leading FMCG producers, like P&G, Henkel, Colgate and the latest acquisition of Reckitt
Benckiser as a customer in FY19, has the potential to contribute ~$40mn to the topline.
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Industry Overview
Flavors and fragrances are integral components of a wide range of consumer goods. Natural and synthetic flavor compositions are responsible for the fruity taste of
cherry cola and the cool mint flavor of toothpaste. Fragrance compositions add the fresh scent of pine to household cleaning products and exotic top notes to fine
perfumes. Worldwide consumption of flavor and fragrance (F&F) products—flavor and fragrance compositions as well as the essential oils, natural extracts, and aroma
chemicals that serve as starting materials—exceeded $30 billion in 2016 (merchant sales of F&F products only).
The use of aroma chemicals (which are primarily synthetic) has increased at the expense of essential oils and extracts of natural origin. Synthetic aroma chemicals
generally offer security of supply and price stability, whereas essential oils and natural extracts can be subject to supply shortages and price volatility. Mature
markets—North America, Western Europe, and Japan—accounted for less than half of 2016 consumption; developing markets—Latin America, Central and Eastern
Europe, the Middle East, Africa, China, and Other Asia—made up the remainder.
World consumption of flavour and fragrance products (2018)

(Source: IHS Markit, HDFC Sec)

Consumption patterns show similarities as well as differences across the regions. Sales of flavor compositions generally exceed sales of fragrance compositions; in Other
Asia, however, the opposite is true. Sales of aroma chemicals typically exceed sales of essential oils and natural extracts; in Japan, however, sales of essential oils and
natural extracts exceed those of aroma chemicals. Japan’s consumption of fragrance compositions is much smaller than its consumption of flavor compositions, and
thus demand for aroma chemicals—the raw materials for compounded fragrances—is smaller. For similar reasons, consumption of essential oils and natural extracts is
larger than consumption of aroma chemicals in the Middle East and Africa. Several factors have contributed to the widespread acceptance of flavors and fragrances in
consumer products, including the following:
• The industrialization of the worldwide economy, leading to the large-volume production of flavored or scented products such as processed foods and beverages,
soap, personal care products, laundry detergents, household cleaners, and oral hygiene products. This allowed the incorporation of sizable quantities of flavors and
fragrances, which, in turn, justified the emergence of a specialized F&F industry.
• Social developments tied to economic affluence that increased the number of people who could afford the expenditure for flavored or scented consumer products.

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• Considerable sophistication in the art, science, and technology of manufacturing, compounding, and use of flavor and fragrance raw materials; rapid developments
in the field of analyzing, identifying, and preparing new and important F&F ingredients; and the development of functionally improved synthetic flavors and
fragrances that could economically replace those derived from natural sources.

Q3FY20 Results Review

Operating income of the company increased by 3% YoY to Rs 390cr. Revenues from the oleochemical and nutraceutical business grew by 8% to Rs 80cr while aroma
chemical business witnessed a 2% growth to Rs 310cr. EBITDA increased by 17.8% to Rs 74cr while EBITDA margins expanded 236bps to 19.0% on account of decline
in raw material prices. Capex programme undertaken by the company in FY19 has led to higher depreciation and interest expenses which grew by 40% and 42% yoy
respectively. PAT declined by 45% to Rs 39cr as there was an insurance claim received in the corresponding quarter last year. Adjusting for the exceptional item, PAT
was up 333% while PAT margins expanded 750bps to 9.9%.

Particulars (Rs Cr) Q3FY20 Q3FY19 YoY (%) Q2FY20 QoQ (%) 9MFY20 9MFY19 YoY (%)
Operating Income 390.1 378.2 3.1 389.9 0.1 1232.2 899.5 37.0
Material consumesd 233.1 249.9 -6.7 254.0 -8.2 769.5 579.3 32.8
Employee expenses 18.9 16.8 12.7 20.0 -5.6 58.2 49.1 18.6
Other expenses 44.8 29.3 52.8 50.3 -11.0 147.9 95.5 54.8
Total expenses 316.1 315.4 0.2 344.7 -8.3 1037.1 775.1 33.8
EBITDA 74.0 62.8 17.8 45.2 63.7 195.1 124.4 56.8
Depreciation 16.6 11.9 40.0 14.2 17.3 45.2 34.8 29.7
Other Income 5.4 0.2 3340.5 11.7 -54.2 21.6 1.4 1436.3
EBIT 62.7 51.1 22.8 42.7 46.8 171.4 90.9 88.5
Interest 10.5 7.4 42.0 7.6 38.6 26.9 18.8 42.7
Exceptional Item 0.0 61.3 -100.0 25.0 -100.0 25.0 -10.5 -337.2
PBT 52.3 105.1 -50.3 60.2 -13.1 169.5 61.6 175.4
Tax expenses 12.9 14.3 -10.2 13.3 -3.3 43.7 18.1 140.8
Reported PAT 38.7 8.9 333.3 28.8 34.5 154.1 30.9 399.0
EPS 9.9 2.4 317.2 7.4 34.5 39.5 8.2 380.5

EBITDA (%) 19.0% 16.6% 236 bps 11.6% 737 bps 15.8% 13.8% 200 bps
PAT (%) 9.9% 2.4% 755 bps 7.4% 254 bps 12.5% 3.4% 907 bps
(Source: Company, HDFC sec)

Concerns
Availability and pricing of raw materials
Prices of key raw material like vegetable oil distillate and acid oil, which are by-products of soya and sunflower oils refining process, have been volatile in the past. Also
availability of some raw material is limited in India and have to be imported. The prices of such raw material could increase in times of shortage which might impact
the company’s margins. Spread of coronavirus could temporarily hamper supply of raw materials from China.

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Competition from low cost Chinese products

The industry size for Dimer acid and Linoleic acid is relatively small compared to the overall size of chemical industry which limits the growth of the company. Further,
FSL faces stiff competition from the low cost products from China especially in Dimer acid which it has been able to counter with its apt marketing strategy.
Product obsolescence and substitution risks
FSL operates in the niche specialty chemical segment. Development of alternative technologies and introduction of newer products could result in obsolescence and
substitution of products. Although FSL has expanded its R&D capabilities which facilitate launching of new derivatives, it might not be able to adapt to those changes
in time or at a reasonable cost.
Compliance with strict pollution control norms Regulations regarding water discharge
There is stringent pollution control regulation laid down for chemical processing units under the Gujarat Pollution Control Board (GPCB) norms. For instance,
wastewater discharge during the production of various synthetic aroma chemicals consists of many effluents, which need to meet applicable regulations for such
discharge. FSL also expected to commission multi effect evaporator shortly which would reduce its liquid waste. Delays in compliance with such norms could impact
its growth trajectory.
Volatility in foreign exchange
A significant portion of revenues comes from exports to other countries and FSL is exposed to currency risk due to the movement of exchange rates.

Peer Comparison
CMP MCap Net Sales EBITDA PAT EPS RoE P/E DPS
FY19
(Rs) (Rs cr) (Rs cr) (%) (%) (Rs) (%) (x) (Rs)
Oriental Aromatics 176.4 593.7 754.7 14.9% 7.6% 17.0 14.6% 10.4 1.0
Fairchem Speciality 605.5 2365.1 1341.0 15.9% 7.0% 24.1 17.6% 25.1 2.5
Galaxy Surfactant 1588.3 5631.3 2763.0 12.8% 6.9% 53.9 21.8% 29.5 8.0
S H Kelkar & Co. 93.7 1323.5 1048.6 12.7% 8.4% 6.1 10.2% 15.3 0.0

View and valuation

FSL is the largest manufacturer of aroma chemicals in India, an industry which is witnessing robust growth on account of change in consumer preferences, healthy and green
sustainability package among the consumers and growth in end user markets. It is looking to move up the value chain and manufacture speciality chemicals which fetch a
higher margin. It has been expanding its product range through its in-house R&D facilities. The Company enjoys cost efficiencies as most of its raw materials are derived from
waste products.
The market for FSL products is growing by 10-15% p.a. The management expects to grow at 15-20% by gaining market share from others and launching new products. It has
initiated two capex projects 1) a plant to manufacture sterols and higher concentration tocopherols and 2) a plant to manufacture bio-diesel using three by-products of its
manufacturing process: palmitic acid, monomer acid and residue. The company has spare capacity in existing products giving it considerable room to grow. The topline and
margins have improved sharply in FY19 and FY20 and we expect the growth to continue at a slightly lower pace. The proposed demerger of two businesses having different
growth potential and margins could lead to value unlocking.
We feel investors could buy the stock at the CMP and add on dips to Rs 540-545 band (9x FY22E EPS) for sequential targets of Rs 690 (11.5x FY22E EPS) and Rs 750 (12.5x
FY22E EPS) in 4 quarters. At CMP of Rs 605.45 the stock quotes at 10.1x FY22E EPS.

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 Equity Research Pick of the Week – Retail Research

Financials: Income Statement (Rs cr) FY18 FY19 FY20E FY21E FY22E
Income from operations 1024.3 1341.0 1703.6 2001.7 2291.9
Material Cost 662.6 826.9 1059.6 1235.0 1404.9
Employee Cost 56.8 71.3 81.8 98.1 114.6
Other expenses 174.7 230.2 287.9 338.3 385.0
Total expenses 894.1 1128.4 1429.3 1671.4 1904.6
EBITDA 130.2 212.7 274.3 330.3 387.3
Depreciation 43.3 46.9 61.2 67.0 73.2
EBIT 102.9 171.5 238.6 291.3 343.9
Other Income 16.0 5.7 25.6 28.0 29.8
Interest 23.9 29.0 37.0 34.2 27.1
Profit before tax 79.0 151.6 226.6 257.1 316.9
Tax Expenses 25.6 57.3 58.9 66.9 82.4
Profit After Tax 53.3 94.2 167.7 190.3 234.5
Adj. PAT 53.3 85.2 142.7 190.3 234.5
Adj EPS 14.2 21.8 36.5 48.7 60.0

Cash Flow (Rs cr) FY18 FY19 FY20E FY21E FY22E

Profit Before Tax 79.0 151.6 201.6 257.1 316.9
Depreciation 43.3 46.9 61.2 67.0 73.2
Others 20.1 32.4 27.2 26.8 19.9
Change in working capital -17.4 -180.0 -83.5 -93.4 -78.1
Tax expenses -18.5 -29.9 -58.9 -66.9 -82.4
CF from Operating activities 106.5 21.0 147.6 190.6 249.5
Net Capex -93.4 -169.8 -125.0 -65.0 -78.0
Other investing activities 11.1 3.8 0.0 0.0 0.0
CF from Investing activities -82.2 -139.2 -125.0 -65.0 -78.0
Proceeds from Eq Cap 0.0 0.0 0.0 0.0 0.0
Borrowings / (Repayments) 7.4 161.7 5.0 -80.0 -110.0
Dividends paid -4.5 -6.8 -18.8 -19.5 -23.4
Interest paid -22.0 -33.1 -37.0 -34.2 -27.1
CF from Financing activities -19.1 121.7 -50.7 -133.7 -160.5
Net Cash Flow 5.3 3.4 -28.1 -8.1 11.0

(Source: Company, HDFC sec)

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 Equity Research Pick of the Week – Retail Research

Balance Sheet (Rs cr) FY18 FY19 FY20E FY21E FY22E

EQUITY AND LIABILITIES
Share Capital 37.6 39.1 39.1 39.1 39.1
Reserves and Surplus 455.3 536.6 660.6 831.3 1042.3
Shareholders' Funds 493.0 575.7 699.6 870.4 1081.4
Long Term borrowings 114.3 210.3 180.3 140.3 95.3
Deferred Tax Liabilities (Net) 24.6 28.7 28.7 28.7 28.7
Other Long Term Liabilities 0.0 0.0 0.0 0.0 0.0
Long Term Provisions 8.6 10.5 12.9 15.1 17.3
Non-current Liabilities 147.4 249.5 221.9 184.1 141.3
Short Term Borrowings 215.4 280.5 315.5 275.5 210.5
Trade Payables 150.1 214.6 276.7 336.0 384.7
Other Current Liabilities 46.2 104.0 138.4 162.6 186.1
Short Term Provisions 0.8 1.5 1.9 2.2 2.5
Current. Liabilities 412.5 600.6 732.4 776.2 783.8
TOTAL 1052.9 1425.7 1653.9 1830.7 2006.5
ASSETS
Net Block 434.9 497.7 589.9 607.8 626.5
Capital work-in-progress 51.4 94.7 66.3 46.4 32.5
Non current Investments 0.0 0.0 0.0 0.0 0.0
Long-Term Loans and Advances 0.0 8.1 8.4 9.9 11.3
Other Non-current Assets 25.9 24.2 33.7 39.6 45.3
Non-current Assets 25.9 32.3 42.1 49.4 56.6
Current Investments 3.0 0.0 0.0 0.0 0.0
Inventories 233.9 364.2 447.4 536.5 614.3
Trade Receivables 230.4 330.7 428.9 514.8 589.5
Cash and Bank Balances 24.1 23.1 -5.0 -13.1 -2.1
Short-Term Loans and Advances 0.0 0.6 1.4 2.2 2.5
Other Current Assets 49.4 82.4 83.0 86.7 86.9
Current Assets 540.8 801.0 955.7 1127.1 1291.0
TOTAL 1052.9 1425.7 1653.9 1830.7 2006.5

(Source: Company, HDFC sec)

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 Equity Research Pick of the Week – Retail Research

Key Ratios Particulars FY18 FY19 FY20E FY21E FY22E

EPS (Rs) 14.2 21.8 36.5 48.7 60.0
Cash EPS (Rs) 25.7 33.8 52.2 65.9 78.8
BVPS (Rs) 131.1 147.4 179.1 222.8 276.8

PE (x) 42.7 27.8 16.6 12.4 10.1

P/BV (x) 4.6 4.1 3.4 2.7 2.2
Mcap/Sales (x) 2.3 1.8 1.4 1.2 1.0
EV/EBITDA (x) 20.5 13.3 10.4 8.5 6.9

EBITDAM (%) 12.7 15.9 16.1 16.5 16.9

EBITM (%) 10.0 12.8 14.0 14.6 15.0
PATM (%) 5.2 6.4 8.4 9.5 10.2

ROCE (%) 13.2 18.2 21.1 23.5 25.7

RONW (%) 11.5 15.9 22.4 24.2 24.0

Current Ratio (x) 1.3 1.3 1.3 1.5 1.6

Quick Ratio (x) 0.7 0.7 0.7 0.8 0.9
Debt-Equity (x) 0.7 0.9 0.7 0.5 0.3

Debtor days 72.9 77.3 82.4 87.1 89.0

Inventory days 86.5 82.4 88.0 90.8 92.7
Creditor days 50.6 50.2 53.3 56.5 58.1

Daily Closing Price Chart 700 6000

600
5000
500

400
4000
300

200 3000
Mar-19 Jun-19 Sep-19 Dec-19 Mar-20
FSL Nifty Midcap

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 Equity Research Pick of the Week – Retail Research

Fundamental Research Analyst: Atul Karwa (atul.karwa@hdfcsec.com)

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