Initial Public Offering. Why you can give a miss to Chemcon IPO

Investors can give the initial public offer (IPO) of Chemcon Speciality Chemicals (Chemcon) a miss, considering the stretched working capital cycle and mercurial prices of end products.

Further, pending litigations against the promoters of the company are a dampener.

The firm’s robust revenue growth of 29 per cent (compound annual growth rate-CAGR), profit growth of 36 per cent, over FY18 to FY20, and strong return on equity (over 30 per cent) stand out.

However, it may be better to play it safe and take a call after a few quarters when the uncertainty over the pandemic eases and there is more clarity over the sustainability of the company’s earnings growth.

At the price band of ₹338-340, Chemcon is valued at 25-26 times (post-issue) its FY20 earnings. The company has no direct listed peers (it is the sole manufacturer of certain pharma intermediates in India). Most stocks in the speciality chemicals space have rallied sharply and seen their valuations expand in the last six months.

In the light of this, the valuation of Chemcon cannot be considered expensive. But there is uncertainty over growth prospects in the near term.

The promoters are looking to divest 14 per cent stake in the company through the IPO.

The offer also comprises a fresh issue worth ₹165 crore (total issue is of ₹317-318 crore).

The proceeds of the IPO will be used for capacity expansion and working capital requirements.

Products

The company’s revenue predominantly comes from the sale of pharmaceutical chemicals (64 per cent of FY20’s revenues) and oilwell completion chemicals (33 per cent). It has a manufacturing facility in Manjusar, Gujarat that currently has seven operational plants.

About 40 per cent of revenues come from exports. Its top five clients contribute about 59.4 per cent to the revenues.

The two main chemicals supplied to pharmaceutical companies are Hexamethyldisilazane (HMDS) and Chloromethyl Isopropyl Carbonate (CMIC) — important intermediates for the manufacturing of penicillin group drugs and anti-AIDS/Hepatitis B drug (Tenofovir), respectively. Two other products are in their developmental stage. The chemicals used for oilwell completion and cleaning include inorganic bromides such as those of zinc, calcium and sodium.

The company is the sole manufacturer of HMDS and zinc bromide chemicals in the country and is among the industry leaders globally, in terms of installed capacity and actual production, for most of the chemicals in its product portfolio.

Despite this, near-term capacity limitations — new plants may take about 1.5 years to be commissioned — extremely volatile prices of HMDS, stiff competition from global peers, and the reduced demand for oilwell chemicals (post-Covid) dent the prospects.

In FY20, for instance, due to increasing demand in the HMDS product, the company resorted to utilising the capacities of CMIS and oilwell completion chemical plants. As a result, while the production volumes of HMDS spiked by 74 per cent in FY20, the volumes of CMIC and oilwell completion chemicals dropped by 32 per cent and 27 per cent, respectively.

Further, that year the extreme volatility in HMDS prices also acted as a bummer — since the international prices of HMDS almost halved from the year-ago levels, the revenue from the segment grew by a meagre 1 per cent (y-o-y) to ₹131 crore (50.1 per cent of total revenues) in FY20.

In FY20, the overall revenue for the company dropped by 14 per cent (y-o-y) to ₹262 crore, owing to this capacity rejig.

However, operating margins remained 27-28.6 per cent over FY18 to FY20. This is because, while the prices of end products are highly volatile, they move in tandem with the base raw material prices, thereby resulting in largely stable margins. Add to this, Chemcon saw margin gains in FY20, owing to technological improvements that helped achieve efficiency in raw material consumption. That apart, a 41.7 per cent (y-o-y) drop in employee expenses due to rejig of management compensation, also aided in margin expansions.

Working capital stretch

The working capital requirements of the company spiked by 54.7 per cent in FY20, to ₹138.5 crore. While the recent changes in credit policies of its customers (particularly in China), on one hand, stretched the receivables cycle to 124 days in FY20, (from 77 days in FY19), the advances to suppliers, on the other hand, saw a 16-fold jump in FY20.

As a percentage of net profits, Chemcon’s operating cashflows (net) weakened from 54 per cent in FY18 to just 21 per cent in FY20.

To bridge the gap in the working capital, the company resorted to heavy borrowings.

However, the debt-equity ratio remained at 0.3 times, owing to 36 per cent CAGR in net profits over FY18-20.

Certain members of the promoter group of the company have pending litigations against them by SEBI and RBI. That apart, one of the promoters, Naresh Vijaykumar Goyal, has filed an appeal in relation to a criminal proceeding filed against him by the CBI at CBI Special Court, Jaipur.

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