JG Chemicals is India’s largest manufacturer of Zinc oxide and allied chemicals. Zinc oxide is used primarily in tyres and other industries and the company has built a solid client relationship in the field which acts as a strong entry barrier. The company has expanded capacity in the last two years and future expansion can be expected. However, a correction in zinc prices has impacted profitability recently. On this weakened earnings, the IPO is priced at 35 times annualized 9MFY24 earnings. But based on FY23 earnings, which was not impacted by sharp movements in zinc prices, the IPO is valued at 15 times earnings. In FY21-23, the company managed a stable gross margin/EBITDA margin range of 20/10 per cent as it is able to tide over the commodity related volatility.

The IPO is open till March 7. We recommend that high-risk investors subscribe to the issue as scope for growth is strongin the longer term.

Entry barrier

Zinc oxide, the primary product of the company, is used in tyre industry, which accounts for 90 per cent of the consolidated sales of the company. It is an activator for sulphur vulcanisation for rubber which improves elasticity, resilience, and other properties. Owing to such critical nature and the high degree of customisation involved - which extends to plant design and engineering, there is a significant client stickiness benefitting JG Chemicals. The approval process, which may extend to more than five years, also enhances the barriers to competition.

JG Chemicals’ growth is linked to the automobile industry. Though the industry is cyclical, the company is in a good position as tyres have a big replacement market which will keep sales going even when new vehicle sales is in a downturn. Of the 90 per cent sales to tyre manufacturers, 55 per cent is to replacement sales and 45 per cent to OEM manufacturers currently.

Expansion plans

After having added 17,000 mtpa in December 2022, the total capacity now stands at 77,000 mtpa. The added capacity diversified into Zinc Ingot and Zinc Sulphate. The company has plans to add another 15-20 per cent capacity in Gujarat which will primarily address ceramics industry along with pharma which now accounts for 7 per cent of sales in 9MFY24. This should diversify the customer and client industry base of the company in the next two-three years. Unlike tyre’s, ceramics or other industries have a less than 6 months validation cycle and should aid faster scaling up. As the recently added capacity reaches maximum capacity utilisation, this also drives growth in the interim. From a maximum capacity utilisation of 60 per cent in FY21, the metric has declined to 52 per cent in 9MFY24 owing to gradual ramp-up in added facilities.

Zinc prices

The company passes on the cost of zinc (primary raw material) to its customers on spot price basis and a pre-agreed upon mark up. This implies that JG Chemicals only retains inventory risk for the period it holds the inventory, which is around 50 days. Zinc prices accelerated post-Covid and remained higher in FY23 as well, correcting only 1 per cent YoY (see table).

In 9MFY24, zinc prices have corrected by 26 per cent YoY which impacted profitability. From a Gross and EBITDA Margin average of 20/10 per cent in FY21-23, 9MFY24 margins declined by 250/380 bps, respectively. With zinc prices stabilizing in a $2,400-2,600 per tonne range in the last three months, JG Chemicals can pass through the prices, without an inventory risk from sharp price movements. Expansion and optimal capacity utilisation, diversification to other industries, which are higher value-added products, can further strengthen the margin profile of the company.

From the ₹165 crore expected from the fresh issue, ₹60 crore will be allocated for an R&D facility in Andhra Pradesh. This is to expand the grades JG Chemicals produces — currently 80 grades of Zinc Oxide — and the industrial applications that can be targeted.

Financials and valuation

Based on 9MFY24 earnings, JG Chemicals is valued at 35 times EPS. But based on FY23 earnings, which was not impacted by sharp movements in zinc prices, the IPO is valued at 15 times earnings. While the premium captures a recovery in margins, scope for organic growth can favour investors. JG Chemicals will repay debt (₹25 crore) and add to working capital (₹95 crore) from the fresh issue, which should further reduce the Net Debt to EBITDA, which stands at 0.47 times in 9MFY24 (annualised).

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