India
NRI
Pick Of the Week – State Bank of India
Every week, we recommend a well-researched fundamental equity investment as our ‘Pick of the Week’. Handpicked after a thorough analysis of the business, industry, and economy, this recommendation has a higher potential of earning good returns over a horizon of 6 - 9 months.
Investment Rationale
Specialty Chemicals (SC) segment to benefit in near term due to COVID-19 led supply disruptions: With the outbreak of coronavirus causing prices of some chemicals to move upwards due to short supply that could be positive for Aarti Industries SC division in the near term. We note that AIL does not have any significant imports or exports to and from China. We see that coronavirus led outbreak and ensuing disruptions could become a structural advantage for AIL as leading global players would look to accelerate shifting their supply chain to India thus benefiting AIL’s SC division
Lower crude prices to support Margin performance: Lower crude prices driven by COVID-19 led correction would benefit ARTO to maintain margins in FY21E/22E although dip in absolute revenues could be seen. In Q3FY20, AIL reported EBITDA Margin of 20.6% versus 19.5% in Q3FY19. Further, we believe long term margin drivers like 1) favourable product mix change (75% contribution from value added downstream products) and 2) operating leverage continue to be in place
Pharma segment resilient in the long term, near term impacted: ~20% APIs are imported from China. While, Chinese economy came out of lockdown, we witnessed nationwide lockdown in India that could impact overall business. However, we believe the essential nature of the product could salvage some of the business lost during the lockdown period. From medium to long term perspective, we expect the division to report healthy revenue growth along with margin expansion led by 1) higher contribution of value added products, 2) focus on off-patented generics in regulated markets and 3) healthy new product launch pipeline
High Entry barriers: Given the specialized nature of chemicals, AIL operates in longer approval cycle times between 3 months, upto 2 years depending on customer’s requirements including complex products necessitates a strong balance sheet. Further, a manufacturing plant requires a number of end products to make it economically viable which is amongst the key strengths of AIL owing to its over 35 years experience in the industry
Outlook: Expanding product portfolio, consistent growth capex, acceleration in trend towards shift of supply chain shift to India from China, multi-year contracts won by AIL that could contribute from FY21E onwards. Pharma segment is in the driver's seat with sustainable +20% margins over FY19-21E all point to a steady earnings growth trajectory over FY19-22E. Factoring in the COVID- 19 led pressure on earnings, we now value the stock at 21x its FY22E EPS
We Recommend
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CMP
₹793
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Target Price
₹888
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Potential Upside
12%
* Note: Stock Investment horizon approx. 6-9 months. CMP as on 03rd April, 2020.
Please refer the research report disclaimer before making an investment decision.