Should you invest in Chemplast Sanmar IPO?

Chemplast Sanmar Limited (CSL) belongs to The Sanmar Group, one of India’s oldest business houses. CSL holds the domestic chemicals operations of the group which has interests in engineering, shipping and chemicals. This will be CSL’s second tryst with the capital markets after it delisted a decade back. CSL, facing volatile commodity prices post the financial crisis of 2008, delisted in 2012 as the management wanted to restructure the group in a private set-up. In the current form, CSL is the largest manufacturer of speciality paste PVC resin and other allied products along with a growing speciality chemicals business. CSL also merged with it Chemplast Cuddalore Vinyls Limited (CCVL) in FY21, a group entity which manufactures suspension grade PVC.

The IPO aims to raise ₹3,850 crore, consisting of a fresh issue of ₹1,300 crore and ₹2,550 in offer for sale. The funds will be used to reduce debt at company (fresh issue) and group (offer for sale) level. CSL also redeemed its investment in group entities before the IPO. CSL had earlier played its part in such inter-group financing arrangements in a private capacity which it is in the process of winding down. However, this process has hurt its financials and net worth currently.

The IPO values CSL at a PE of 17.6 times FY21 earnings. Finolex industries which is comparable to CSL in product profile within the large speciality chemical group, trades at a PE of 15 times FY21 earnings. The premium takes into account the backward integrated model of CSL and the longer operating history of the company. On an EV/EBITDA basis, both companies trade at a similar 10 times FY21 EBITDA.

Long-term prospective investors would do well to wait and watch the independent course that CSL charts as a listed entity, before investing.

Business

CSL is amongst the leading manufacturers for most of its products. In speciality paste PVC resin (20 per cent FY21 revenues), CSL’s installed capacity of 66,000 tonnes per annum and Finolex, the only other producer with 22,000 tonne capacity, addresses close to half of the domestic demand. Supported by plant closures internationally and higher import duties, domestic market is expected to grow faster at 5-7 per cent CAGR in FY20-25 (3 per cent in FY15-20). CSL also plans on additional capacity of 35,000 tonnes in this segment at a cost of ₹256 crore, operational by 2024. CSL generates revenue from PVC allied products such as caustic soda, hydrogen peroxide and chloromethanes.

CSL’s speciality chemicals segment (4.5 per cent of FY21 revenues) is increasing its traction amongst international pharma and agrochem clients. CSL plans an investment of ₹340 crore here for two multi-purpose facilities operational by 2025, serving its pipeline of commercial stage products.

The suspension PVC product which was merged into CSL accounts for 66 per cent of revenues and CSL plans on improving the capacity by 10 per cent through de-bottlenecking at a cost of ₹23.5 crore.

On a standalone basis, CSL reported a strong margin profile of around 25 per cent EBITDA margins in the last three years, aided by backward integration and product strength. Assuming CCVL’s consolidation from FY19, CSL may have reported EBITDA margins of 13-16 per cent in FY19-20 which later went up to 25 per cent in FY21 driven by surge in CCVL’s margins. CCVL (which is not as integrated as CSL), operated at a EBITDA margin range of 5 per cent in FY20 and 23 per cent in FY21 as demand remained volatile owing to an election year followed by Covid-led surge in prices. The management expects that a stable EBITDA margin for CCVL would be around 20 per cent, which may bring down the consolidated margins to a similar level, going forward. At the bottom line, CSL is expected to gain as the fresh issue proceeds from the IPO which will help repay the outstanding NCDs and significantly lower the interest burden. It now stands at 11 per cent of FY21 revenues.

Financials

The net worth of CSL turned negative in FY21, not based on operational or cash losses, but due to restructuring, primarily in CCVL. The outstanding NCDs of ₹1,238 crore were raised in December, 2019 at 17.5 per cent interest per annum directed towards investing in Sanmar Group International-SGIL(₹482 crore) and repayment of advances received from its promoter Sanmar Holdings limited (SHL) (₹673 crore), with the remaining amount directed towards servicing its debt. CSL has redeemed its investments from SGIL in FY21 and another ₹979 crore investment in a JV with a group entity.

In FY21 even as CSL reported cash flow from operations of ₹1,076 crore and ₹2,151 crore from redemption of investments in associates and JVs, repaying CCVL’s debt owed to group entities largely neutralised cash gains. Also, Sanmar Engineering Services Limited (SESL) which holds SHL, has secured a term loan of ₹1,220 crore by pledging the shares of CCVL, prior to the acquisition. The pledge is continuing and the proceeds from the offer for sale are expected to significantly decrease the debt and resolve the pledged shares. An Egyptian chemicals plant (unrelated to CSL) acquired just prior to the financial crisis of 2008 has weighed heavily on the group’s financials. The debt restructuring of the entity and expected improvement in financials will lower the burden on the group. CSL, by way of closing the inter-group transactions in FY21, is not expected to be part of the activity. Investors should look out for an independent path that CSL takes in future with internally funded expansion plans without any involvement with group companies.

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