Stock Fundamentals

Why you should accumulate Deepak Nitrite shares

Sai Prabhakar Yadavalli BL Research Bureau | Updated on September 18, 2021

Integrated operations will act as a leverage for growing value-added product basket

Deepak Nitrite’s (DNL) stock has had a strong run in the last one year following commercialization of its Phenols and Acetone plant in mid-FY19 DNL now addresses half of the domestic demand in the two products generating 60 per cent of FY21 revenues.

The other two segments in base business, Basic chemicals and Fine and Speciality chemicals , also added capacities and improved utilizations. The combined effect of greenfield and brownfield expansion, at a time of higher realizations and operating leverage, helped DNL post strong EBITDA margin growth from 12 per cent in FY18 to 28 per cent in FY21.

DNL now intends to explore valued added products from its base business and add downstream products to its Phenols and Acetone business.

This next leg of expansion involves investing ₹1,000 crore, in the next two-three yearsin addition to continued brownfield expansion.

While the scope of expansion is strong and prospects appear bright, execution risk into new products, combined with volatility of margins should be considered, after the strong run in stock price. We recommend investors to accumulate the stock on dips to provide margin of safety for execution risk and margin fluctuation.

Deepak Phenolics, a 100 per cent subsidiary of DNL, commercialized 200,000 TPA/120,000 TPA capacity for Phenols and Acetone by FY19 at estimated capex of ₹1,700 crore. The plant is now running at 115 per cent capacity utilisation by FY21. An incremental capex of ₹200-250 crore over the past year will add 30-40 per cent additional capacity for the two, further cementing its domestic market share and also add capacity to supply downstream products. DNL aims for a captive use ratio of 30-35 per cent from existing phenols and acetone, in developing further downstream products. The first downstream product, Iso-propyl alcohol (IPA), primarily used in sanitizers was leveraged in the pandemic period with 30,000 TPA capacity and is now expected to double its capacity by the end of FY22 (even as margins may soften). The next leg announced recently, outlined a sizeable investment of ₹700 crore, aimed to developed solvents for paints and coating industry based on its Phenols capacity.

The base business is debottlenecking existing capacities at a capex of ₹100 crore, with revenue expected to contribute from H2 of FY22. The company also announced setting up Deepak Clean Science at its Dahej site with land available. A subsidiary developing environmental friendly process, leveraging its capabilities at Deepak Nitrite and Deepak Phenols, at a proposed capex of ₹300 crore. Deepak Clean Science will add chemistries based on fluorination and photochlorination to serve intermediates in pharma and agrochem initially.

Margin growth

Operating leverage from added capacities, higher domestic demand, firm pricing for end products, and cost efficiency in operations in Phenols were some of the factors that aided strong margins. . The end-user market facing logistical issues last year also helped sustaining margins for DNL. The diversified applications for its products in 50 industries allowed DNL to shift the product mix in its favor as well. Mainly supported by product mix and operating leverage, EBITDA margins gradually scaled up - 15.3/24.3/28.6 per cent in FY19/20/21, respectively. The strong improvement in FY21 was influenced by phenols segment (60 per cent of revenues) reporting around 30 per cent EBITDA margin in the period. Last year may have favoured established players such as DNL as customers valued supply quality and time, over cost. With normalization in demand from pharmaceuticals, sanitizers and continued weakness in textile sector, compounded by expected clearance in worldwide logistical issues, DNL may witness some margin erosion in the next two-three years. However, the modern phenols plant along with the expected value added products, is expected to offset further weakness in its margin profile.

Financials, valuation

DNL reported revenue and EBITDA growth from ₹1,676/196 crore in FY18 to ₹4,359/1,247 crore in FY21. The EPS improvement at a CAGR of 112 per cent supported the valuation multiple expansion - from 18 times one year forward earnings in 2018 to 29 times FY22 EPS. DNL’s valuation at these levels, is still at the lower end of industry peers which range from 30-60 times one year forward earnings. DNL has also delevered significantly and now has a net debt to EBITDA ratio of 0.24x in FY21. Even as Deepak added significant capacities in phenols reiterating its execution capabilities, foray into new chemistries has to deliver a marketable product portfolio starting from FY23 for valuations to sustain.

Published on September 18, 2021

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