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Sunday, Dec 18, 2005

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Aarti Industries: Buy

Alagappan Arunachalam

INVESTORS can consider taking exposures in the Aarti Industries stock which, at Rs 150, trades at 11 times its trailing 12-month earnings. The chemicals company is on investment mode and plans to raise about Rs 110 crore from the overseas market.

Over the past four years Aarti Industries recorded an impressive revenue growth of 25 per cent. It should maintain this growth rate with its active pharmaceutical ingredients (API) facility set to commence operations by the end of FY-06. Better realisations in its key products, para-nitro-chloro-benzene and ortho-nitro-chloro-benzene, coupled with lower prices of benzene in the third quarter of FY-06 could improve its margins. Cash flow from operations also appears to be back on track with improved management of inventory and receivables.

Aarti Industries derives about 90 per cent of its revenues from specialty and basic chemicals. Agrochemicals and pharmaceuticals account for the balance.

The company has in recent times been focusing on specialty chemicals and pharmaceuticals.

Aarti Industries proposes to obtain approval from the US FDA for the manufacture of API.

Aarti Industries, a leading manufacturer of downstream benzene derivatives, has a more than 50 per cent market share of the domestic market. Large scale of operations, and the resulting economies of scale keep it ahead of its peers. Over the past three years it has invested about Rs 100 crore in its end-user segments. Its move downstream is expected to expand its margins in the long run.

The company is also expanding its presence in the global market. Export incomes have nearly doubled in the past two years and accounted for a third of the total revenues in FY 05. Though the realisations from exports are lower than from domestic sales, the former provide volumes and act as a cushion against slowdown in the latter.

A diverse end-user profile, spread across industries such as pharmaceuticals, dyes and pigments, surfactants and agro-chemicals, insulates it from a down turn in one segment. Forward integration into pharmaceuticals should reduce risks.

The susceptibility of raw material prices is a risk factor. Raw materials account for 75 per cent of manufacturing costs; benzene accounts for a large part of this. Prices of benzene, a derivative of crude oil, are prone to fluctuations. With crude oil stabilising at about $60-a-barrel mark, benzene prices are expected to be less volatile.

In the first half of FY-06, Aarti Industries maintained its earnings growth achieved over the past four years, posting a 29 per cent jump.

Though margins remained flat, the volume growth in basic and specialty chemicals segments helped it post a 20 per cent growth in revenues during the same period.

Aarti Industries has called off the proposed merger with itself of its subsidiaries, Aarti Healthcare and Avinash Drugs. Aarti Industries proposes to split its shares into five rupee shares; this could improve liquidity in the stock.

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