Sudarshan Chemical Industries Limited (506655) Earnings Call Transcript & Summary

Good evening, friends, and welcome to Sudarshan Chemical Industries Q3 FY '20 Post Results Earnings Call. As usual, we'll start the call with the initial discussion from the management on the quarterly performance, followed by an interactive Q&A session. From the management side, we have with us Mr. Rajesh Rathi, Managing Director; Mr. Vivek Thakur, GM Finance; and Mr. Amey Athalye, Deputy GM Finance. Over to you, Mr. Rathi, for your initial comments.

Thank you, Ankur and Axis Capital, for hosting our earnings call this quarter. Good evening, ladies and gentlemen. Welcome to Sudarshan Chemical's Q3 and 9 months ended December 2019 earnings conference call. Our quarterly presentation has already been uploaded on the stock exchange and Sudarshan website for your ready reference. I hope you have been able to access it. Before talking about the quarterly performance, I would like to highlight that the financial results for the quarter include results from Rieco Industries, which was earlier classified under discontinued operations. Currently, the mandate given for sales were down as the first focus is to turn around this business. And hence, the financial results for this subsidiary have now been included in the consolidated results, and previous quarter numbers have been restated very well necessary. On the quarterly performance, on a consolidated basis, the total income from operations is at INR 424 crore as compared to INR 391 crore for the corresponding period for the previous year, up 8.3% on Y-o-Y basis. Operating profit has recorded a significant growth of 58% this quarter with margins at 14.9% as compared to 10% for the corresponding period of the previous year. Profit after-tax for the quarter is at INR 28 crores as compared to INR 18 crores for the same period last year. Profit margins has been -- has nearly doubled from 4.2% in our last quarter to 7.1% in this quarter. I will now focus on the performance highlights of our core pigment business. The top line growth for pigments has been at 12% with revenues at INR 3 91 crore as compared to INR 3 49 crore in the same period last year. Traditionally, Q4 has been a soft quarter for pigment sales. Despite this, I'm happy to share that we've had a broad-based growth this quarter, driven by both our specialty and non-specialty pigment portfolio. Both segments grew double digits with our specialty pigments. Our portfolio growing at 13% year-on-year, and our non-specialty pigments portfolio growing at 10% year-on-year. Our initiatives on implementing sales network and country-specific go-to-market strategies continuing additions to our new products has helped us achieve the results. Our continuous -- also our continuous focus on cost reduction. I would like to reiterate that we are confident of the growth continuing in the upcoming quarters given our competitive advantage across products, process reliability and [ the industry ] standards. Our gross margins has now stabilized at around 43% for the quarter, similar to what we delivered in the previous quarter. On a Y-o-Y basis, our gross margin has improved by 300 bps at the back of our efforts on price improvements and cost optimization. For the financial year, the 9 months financial gross margin stands at 42.4% as compared to 41.2% for the corresponding period of the same previous year. Raw material prices were fairly stable this quarter. However, with the worsening of coronavirus, this -- we may see some adverse movement in prices of a few raw materials. Most of our Chinese vendors have resumed their production. However, material movement from the plant to port is expected to resume only after the highway is open, which is about mid-February. We continue to monitor the situation very closely. We expect to have a very normal quarter without much disruptions. We also expect that this may give good opportunity for Sudarshan in the midterm and long term for us. The EBITDA margins for the quarter is at about 14.9% as compared to 10.2%, an improvement of 470 bps. Improved gross margins and continued control over costs helped us maintain these numbers. We expect our -- the CapEx spend we expect to complete by this financial year. Projects were about INR 230 crores. We remain committed to deploying capital and invest in our business given our confidence in the long-term demand for our products. I'm also happy to share with you, during this quarter, we've incorporated a wholly owned subsidiary in Japan, Sudarshan Japan. We'll finally be engaged in the sale of color pigments in Japan. I would like to restate that Sudarshan is well placed to continue on its rapid growth trajectory at the back of our focus on the go-to-market strategy, innovation of new products, adjacency businesses and our cost leadership. With this, we at least continue to be a very important level for us. With this, I'm now open -- I open the floor for questions. Thank you.

[Operator Instructions] The first question is from the line of Ritesh Gupta from AMBIT Capital.

So just on the new capacities that you have been putting out for the specialty pigment, could you just give us an update on that? I think you had commissioned a plant during this quarter. So has the dispatches from that particular plant and like the product has got accepted from the clients, et cetera? Or how are we there? And could we see improvement in the growth trajectory once this INR 230 crore of CapEx gets fully commissioned and probably you start getting some approvals there?

Sure. Once the INR 230 crores is commissioned, we definitely expect a good growth trajectory. And the -- if you -- I'm assuming you're referring to the last quarter of year pigment, which we had launched.

Correct.

That, I think, that we are kind of beginning to -- we're going to begin sampling now to a customer. We had to go through some tests, et cetera. So -- and that's more on the higher end. So that will take some time for getting results. But in all, I think all these investments into new molecules are going to make us -- definitely going to help our growth.

Got it. And so that particular molecule, as you say, in that particular plant, as I said, will go through some bid approval and probably will take 2 to 3 quarters before probably start showing up in the revenues. And this quarter, there was no impact of that, I'll say, into the number?

No, no.

And when does this INR 230 crore get commissioned?

This INR 230 crores will get -- and we're expecting this to get commissioned by March end.

March end this quarter?

Yes.

And some part of it is backward integration as well, right? So not all of it is revenue-generating FX?

In this INR 230 crores, I think mostly is revenue-generating and EBITDA-generating.

Okay. So either it benefits you on revenues? Or does it benefit you on the cost side? What do you think?

Yes.

And just on coronavirus bit, do you expect some minor disruption coming in? Because I think last 1 or 2 years also in China, prices had gone up. I think you actually faced some challenges on the gross margin side. So while some of it has gone up completely in the last 1 or 2 quarters, but do you see some of those challenges may come back again, probably, let's say, maybe intermittently, about a quarter or 2? But what -- you gave some commentary there, but probably on dispatches also is -- and what is the data view there is, could there be a chance that you might actually struggle for the -- so is it just a pricing impact that you would see or you can actually see a complete disruption in the production because some of the intermediates are just not available?

So right now, what we understand is only at the epicenter. At the epicenter, we have only 1 of our suppliers located. All our other suppliers are very much already have begun production. Right now, the movement of material in China is a problem. That's expected to kind of open up after 10 -- some say 10 February, some say 15 February. So given the current assessment, we don't see any major disruption coming up. However, this does give us a long-term advantage in the sense from a perspective that -- from a competitive advantage perspective, China did have a political issue, environment issue and now a health issue. So that makes supplier out of India maybe stand out a little more. And strategically, when global players are looking at their buying decisions, we're hoping that this will be more in favor of India and Sudarshan.

Sure. And that's more on the side of non-specialty portfolio?

Yes. Yes. On the specialty side of the portfolio, so sorry.

The next question is from the line of Abhijit Akella from IIFL.

Congrats on a good quarter. So this last quarter, I thought we had indicated about INR 300 crore CapEx plan for this year. So is that now being revised down a little bit to INR 230 crores? And if so, is there a delay and a spillover of CapEx into FY '21 now?

Actually, I thought you won't pick that up. So no. So yes, you're right. I think our earlier estimates was about INR 300 crores, but I think some of our equipment, also some comes from China, which got delayed, and some of the process stabilization may take longer, and that's why our current estimates is to be that we would complete somewhere around INR 225 crores to INR 230 crores. The same -- the balance would get spillover for the next year.

Okay. And so in that context, is there a number for FY '21 that we can work with in terms of full year CapEx?

Just a second, please. Yes. So I think, for next year, we have a similar number.

INR 230 crores to INR 250 crores again for next year?

Yes.

Okay. And sir, I also just wanted to check, when we first announced this INR 1,000 crore plan maybe about close to 3 years ago, I think, we initially went rather slow in the first couple of years. We did only about INR 200 crores in the first couple of years. But now in this year, there seems to be a marked acceleration. And then next year, again, you're talking about a similar number. So what really has changed? Are we getting more traction from customers in terms of product approvals? Is that what is giving us the confidence to go ahead with enhanced CapEx?

So I think I would say it's more -- you have to remember, we had to develop this entire technology in-house, right? So developing the technology in-house, making sure that, environmentally, we are completely compliant, then designing the plant, then installing the plant, so that's the time which kind of -- that's the time which it could kind of take to make things happen. The customers are extremely engaged with us. And it was a matter of stabilizing the technology and the process and then kind of going -- making sure that we are very confident on the investment.

Understood, sir. And last piece from my end. Post the acquisition of BASF's business by Sun Chemical, I guess, Sun Chemical is now on the verge of becoming by far the #1 in the pigment industry. Are we seeing that given the scale of their business, which is probably more than $1.5 billion, that customers are maybe a little bit uncomfortable with how large they are? And therefore, there is some deconsolidation measures whereby new business could get awarded to other vendors like Sudarshan down the line? So any signs of any such things?

There is -- like I said last time, there were a lot of favorable wins towards us. It's the -- it's not just the size of their business, but also generally, in an acquisition like this, there's a lot of portfolio rationale which goes on. There's a lot of internal focus in getting things right and which does impact customer service. So customer -- given that -- given the second [indiscernible] is also looking to divest, there is definitely favorable towards wins. On top of this, what a few of the Chinese, there has been an environmental issue, as you know, and now the coronavirus with the Chinese players. So given this, there is definitely favorable wins towards Sudarshan or any player out of -- like us.

The next question is from the line of Anand Bhavnani from Unifi Capital.

So I have 2 questions. One was about new product launch. I understand in Q3 -- in Q2, you had mentioned about product launch in June of 2020. So is that product launch coming along on time? Or are there any updates on that, which you can share?

Yes. I think that's still going on, on time.

Okay. And secondly, you had spoken about pearlescent pigment in the last con call. You had mentioned in the import quite a bit of it, and we were planning a CapEx for it. So any on-ground development as to how much is the CapEx underway? What's the likely time line by which you will be able to do the sampling for pearlescent pigments?

For pearlescent segments, we should be able to sample -- the CapEx is in progress, and we should be able to -- by Q1 -- by the end of Q1, we should be able to sample from that.

So roughly, in June, we'll have the pigment HPP launch and also the pearlescent would around be that time?

Yes.

Okay. And this pearlescent capacity would be roughly what percentage of overall capacity?

So we don't -- this is public. This is sensitive information. So yes.

Okay. Sure. And lastly, sir, we had changed the plans on the industrial mixing business. We are now planning to continue it. If you can help us understand what were the drivers for us to change our mind around this? And now is it fair to assume that, let's say, next 3, 5 years, we'll continue to hold this business? So what's the current thought process? And what led to change in last 3, 6 months on this?

So we were looking for a good potential setup. I think we were not able to get the right value for the business, mainly because the business needed to be turned around, right? The numbers were not good at all. So right now, the focus is on turning around the business. The Board is actively looking at it and very closely monitoring that. And there is no midterm or long-term decision being taken on that as to how many years work to do, et cetera. Our primary focus is just to kind of make sure that the numbers turn around.

Sure. So this turnaround that we are trying to make this happen, would it require any capital investment? And if you can give us some sense of how much incrementally you would have to invest in this business for it to turn around.

No. No. I think if you see the numbers this quarter, it's already turned around. It was more of operational discipline. And so the numbers have already turned around. We don't expect to make any investment [indiscernible] right now -- further investments.

The next question is from the line of Anurag Patil from Roha Asset Managers.

So sir, the CapEx of INR 230 crore, how much will be for the backward integration? And how much will be for the products team?

So I think that roughly indicated last time, about 70% would be revenue generating.

70%. And sir, this revenue generating part, so margin profile will be similar to current profile? Or it will be higher or lower?

For the new investments?

Yes. For new CapEx.

We expect a better margin profile.

The next question is from the line of Chetan Thacker from ASK Investment Managers.

So I just wanted to understand these new CapExes that are being approved. Is there an internal set benchmark for the kind of ROCE that you're looking at and below which these CapExes will not be commissioned? And what would that number be ballpark?

Just one second.

Yes. So normally, when we look at investment decision, we look at about 3 to 4 years payback period while evaluating CapEx proposals. So that's what we target and then make a decision.

So this INR 230 crore would also qualify in that [ CapEx ]?

Yes. All investments go through that parameter.

The next question is from the line of [indiscernible] from [indiscernible]

You mentioned that Q4 will not see any major impact. But how about the supply in Q1, what kind of inventory if the raw material initiatives [indiscernible]

Can you repeat your question? We're not able to hear you clearly.

Sir, you had mentioned in the call that Q4 business is not being impacted on China virus that -- but what about Q1 numbers? How performance will be in Q1?

So it's very difficult to predict right now how this -- how the virus gets affected, and it should become -- how much is the effect of it. We -- currently, we -- currently, like I said, our current estimates is only 1 of our suppliers is affected. And if this does not -- if this is at the same state, we don't expect any disruptions in Q1. However, if this does get worsened, we may get affected.

So the quantity, which is being supplied by that particular supplier, do we source it from other suppliers also?

Yes. There are a few cases, but the -- obviously, we have full supply, but it doesn't mean that our 1 supplier will be able to supply the entire quantities. [indiscernible] 2 product keys.

And one observation on results that last year, Q3 FY '19, our tax rate was lower. And at this time, it's around [indiscernible]. Any specific reason why that [indiscernible] has been around 14%, I think, last year, and 13% now?

Yes. [indiscernible] there was a change in the tax regime in September quarter. And under that tax regime, there was an option, which was given to corporates to either move on to a lower tax rate or continue under the old regime. We have evaluated that and decided to continue under the old regime as of now. When this option is evaluated, companies also required to evaluate that in future when we expect to move to the new regime and, accordingly, remeasure their deferred tax. Accordingly, deferred tax, there was some positive change to the tax number. Deferred tax liability got reduced and which was adjusted for the 6 months in the last quarter. So that's why there was a normal reduction in the last quarter.

Sir, I am comparing Q3 FY '19 with Q3 FY '20, not Q2 FY '20 with Q3 FY '20. So I'm guessing December-December period.

Yes. Sorry, I got your question incorrectly then. From last year, last year Q3, there was -- when we filed the returns, the returns and books are reconciled and, accordingly, tax rate expense are passed on. So if you refer to our note, there is a [ 90-lag ] tax expense of the prior years, which was posted in that period.

Okay. But if you adjust that also the tax [indiscernible] last year as compared to current year?

No. The -- in fact, this year, we have less tax, also existing for the [indiscernible] benefit. We have started availing this year. So tax rate this year is lower.

The next question is from the line of [indiscernible] from [indiscernible] Holdings.

Sir, if I missed it earlier, you said that one of the raw material supplier out of the 2 are impacted by Chinese virus, right? But you don't think your operations would get much impacted. So is it you're sitting on inventory or the other one covers the shortfall from the first one?

I said, amongst all our suppliers, probably 1 is affected right now.

Okay. So...

There are several suppliers there.

Okay. There are several suppliers. So you don't see any issues in raw material. And in terms of pricing of these raw materials, sir, what are the price trends, both in raw -- key raw materials and also on the pigment finished product side? After this virus, how the prices have moved?

So right now, like I said, after this virus, China has not opened up yet. We don't expect much movement in prices. As I mentioned, the production of most of our suppliers is on because they are not located in the highly affected areas. So we don't expect right now much impact.

Okay. And on the finished good prices, since, obviously, the China exports would have also slowed down or expected to slow down over the next couple of months, so do you see opportunities? Or do you see your European or U.S. clients inquiring more of the product? And is there any sense if you have seen any inquiries during last month or so?

So sir, from a perspective of -- it's too kind of -- we are looking at -- we do come across with looking at several good inquiries, which we are getting. However, too fast to run to a conclusion that this is going to be a long-term or a midterm kind of opportunity. So I think it has to kind of -- China, anyway, like I said, it was coincidence that it was shut for Chinese New Year, right? So it's just opening up. So I think...

But they already extended their company holidays by another 12, 13 days or so.

So that won't give you -- that's too small a period to [indiscernible] what's happening. So let's see that -- yes.

The next question is from the line of Sundip Nag from Ashmore.

Yes. If we look at the last 4 quarters of income from operations, the run rate has been roughly about INR 400 crores. Should we start expecting an uptick only post commissioning of the new capacity? And if so, how much will that be? That's my first question. Second question is, for the full year FY '21, what growth rate should we be thinking of from Sudarshan?

Yes. Just a second. Sure. Of course, given the CapEx and looking at new molecules, our growth rate should be a great stimulus for our growth. Given that, we don't give guidance for the future. I wouldn't be able to kind of give you a number as to saying that, but I would say that the numbers should look much better.

And the reason why we've seen this rough run rate of about INR 400 crores is only because that -- is only because we had a few technological challenges we were figuring out because of the new tech and because this capacity got a little [ delayed ] and hence, the number was at this run rate, correct?

So I think from a perspective, we didn't have technology challenges, I would say. This was a planned kind of CapEx, which was to come out. There are a few [indiscernible] because of very aggressive CapEx plan. From a perspective, I would say, to answer your question, yes, on new products or the adjacency businesses have not contributed to the current INR 400 crores, what you're talking about for growth. So this is all growth based on our streamlining our go-to-market strategies, et cetera.

I see. And last question from my side. The bulk of the additional CapEx that culminates into revenues will be high-performance pigment revenues? Or will they continue to be the existing mix?

High-performance effects is also.

The next question is from the line of Sreemant Dudhoria from Unifi Capital.

So I understand that in FY '19, we had attempted to set up sales for -- to [indiscernible] better in European and North American market. If you can give us some sense of how that strategy is panning out. And is it -- is there any change in that strategy?

So we have a good change team in several of the geographies. The latest one, which we have added, is Japan now. And otherwise, that's where -- that's how we are reaching out to our customers.

Okay. And is there any specific client that we have added both not having foot on the ground in Europe, North America? Has there been any additional incremental business that has come?

We've added several customers. Of course, I can't name a particular customer, but we have added several customers.

And with regards to the yellow pigment now, it's about 5, 6 months that the samples have been kind of shared. Is it fair to expect that it will take 3, 6 more months? And maybe from H2 of FY '21, we might start seeing it contributing to revenues. Is that a fair expectation?