PI Ind Edelweiss June2011

8/6/2019 PI Ind Edelweiss June2011

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1 Edelweiss Securities Limited

PI Industries (PI), a fast growing agrochemicals company is expected todeliver strong profit CAGR of 42% and robust ROEs of more than 25% overFY11 13, driven by strong order book and margin expansion.

Custom synthesis to channel progressPI is a preferred partner for global MNCs for custom synthesis on account of itscompetencies in process research and manufacturing. With its well established, non-compete and IP driven business model, PI has amassed a strong order book of ~USD300 mn to be executed within the next 3-4 years. We estimate the revenue

contribution from this division to go up to 45% over next 3-4 years as against thecurrent 37%. PI has outlined a capex plan of INR 1.25 bn for the next two years to setup new capacity in an SEZ in Gujarat to cater to the growing custom synthesis business.

Agri input division sports positive outlookRevenue from the agri-input division is primed for a surge on account of the stronggrowth of newly launched products and pipeline of 7-8 in-licensed products onexclusive marketing rights basis, which are currently under evaluation and registration.Of these, plans are afoot to launch two products in FY12. The product mix in thissegment would improve as the revenue share of such products is poised to rise from40% to 50% over next few years, boosting EBIDTA margin expansion.

Strong growth, margin expansion to lift profits over FY12 13PI posted a consol. profit CAGR of 118% over FY08-FY11 due to a surge in both revenue(25% CAGR) and EBITDA margin (8.7% to 17.3%). Management guides for a muchstronger revenue growth of ~40% CAGR over the next two years in both the businesses.Also, the EBITDA margin is likely to expand to 19.1% in FY12E and 19.8% in FY13E.

Outlook and Valuations: Strong fundamentals; Initiating with `BUYThe stock is available at 10x and 6.9x consolidated P/E for FY12E and FY13E respectivelyand at P/BV of 1.8x and ROAE of 29.8% for FY13E. Based on DCF valuation, we arrive ata fair value of INR 995/share and initiate coverage on PI with a BUYrecommendation.

Varun Guntupalli+91-22-6623 [email protected]

Manoj Bahety, CFA+91-22-6623 [email protected]

May 24, 2011

Edelweiss Research is also available on www.edelresearch.com,Bloomberg EDEL , Thomson First Call, Reuters and Factset.

Edelweiss Securities Limited

PI INDUSTRIES Growth, custom made

INITIATING COVERAGE

India Equity Research | Agriculture I n d i a M i d c a p s

Absolute Rating BUY

Investment Characteristics Growth

MARKETDATA (R: PIIL.BO, B: PI IN)

CMP : INR 715

Target Price : INR 995

52-week range (INR) : 797 / 311

Share in issue (mn) : 12.5

M cap (INR bn/USD mn) : 9.0 / 199.7

Avg. Daily Vol. BSE (000) : 3.8

SHAREHOLDINGPATTERN (%)

* Promoters pledged shares : NIL(% of share in issue)

RELATIVEPERFORMANCE(%)

BSEMidcap Stock Stock OverIndex Index

1 month (8.3) (1.2) 7.1

3 months 4.5 35.6 31.1

12 months 2.4 118.9 116.5

EDELWEISSRATING

FinancialsYear to March FY10 FY11 FY12E FY13ENet revenues (INR mn) 5,425 7,202 8,897 11,529Revenue growth (%) 17.2 32.8 23.5 29.6EBITDA (INR mn) 871 1,245 1,703 2,281Core profit (INR mn) 419 651 907 1,311Diluted shares (mn) 13 13 13 13EPS (INR) 33.2 51.5 71.8 103.8EPS growth (%) 45.6 55.5 39.3 44.6P/E (x) 21.6 13.9 10.0 6.9EV/EBITDA (x) 10.2 8.0 6.3 4.5ROAE (%) 33.8 35.4 30.7 29.8

Promoters*64.0%

MFs, FIs &Banks9.0%

FIIs7.0%

Others20.0%


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Investment Rationale

Custom synthesis key to growthWith a strong revenue visibility, the custom synthesis division emerges as the principalgrowth driver for PI as India continues to be the preferred destination for outsourcingcustom synthesis and contract manufacturing related projects. With over 14 years of experience, PI has acquired strong competencies in custom synthesis scaling up quickly tocommercial manufacturing besides gaining the trust of its clients (a vital element given thatmost of these products are patented). PIs core competence in process research andmanufacturing has helped it partner global MNCs for custom synthesis whereas its non-compete and IP driven business model has earned it the confidence of clients. Moreover,India is a preferred destination for most of the global MNCs due to the cost advantages inmanufacturing. PI has worked with several clients over the last few years and currently got~30 active clients for agro-chemical, pharma and specialty chemicals. Over the years, it has

proven its capabilities by working with more than 300 molecules at various stages of processdevelopment with up to 15 stage chemical reactions.

In FY11, this division contributed ~37% of the consolidated revenue (excluding the polymerbusiness revenue) i.e. ~INR 2.5 bn, which is now poised to soar substantially over the nextfew years fueled by a strong order book growth. As on March 31, 2011, the customsynthesis order book stands at USD 300 mn, to be executed over the next 3-4 years. Thisorder book is ~5.4 times of the custom synthesis revenue in FY11. The order book basedbusiness accounts for 55-60% of the total custom synthesis business and the rest isaccounted by the annual orders. The company intends not to sign long term agreements forsuch business so as to sustain the flexibility of its operations.

On account of new contracts signed with some leading European companies for customsynthesis of their IP products on a multi-year basis, PI is setting up a new manufacturing sitefor which it has acquired 22.3 acre land in the Sterling SEZ located at Jambusar in Gujarat. Ithas a capex plan of INR 1.25 bn to set up multi-product plants for its custom synthesisbusiness over the next two years.

The EBITDA margin of custom synthesis division is the highest across business divisions of PIat 21% and the management expects it to increase to over 25% in the next few years onaccount of an improvement in the product mix and operating leverage. We haveconservatively assumed an EBITDA margin of 22% in FY12 as well as FY13.

Management guides for a 40% revenue CAGR in custom synthesis business over the nexttwo years (which had a revenue CAGR of ~28% over last three years), while we haveassumed a revenue growth of 40% in FY12 and 35% in FY13.

Strong order book of ~USD 300mn to be executed within the next3-4 years

To incur a capex of INR 1.25 bnover the next two years to appendcapacities


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Fig 1: Custom synthesis workflow

Source: Company, Edelweiss research

PI is currently working with its key customers on their strategic projects where assurance of success, long term business and growth potential is quite high. Given PI's niche in complexchemistry, low-volume and high-value products, and diversified applications of theseproducts, growth in this business is likely to be sustainable.

PI maintains its leadership position in the custom synthesis in the agro-chemicals space inIndia with additional business coming from its existing and new clients. The company is

poised to achieve a strong growth from its existing customers on the back of strongrelationships with these innovator companies in areas like agro-chemicals, pharmaceuticalsand fine chemicals in the geographies of Europe, US and Japan which would help it enhancerevenues from developing new compounds, adding new products and expanding thevolume of existing products.

With regard to the R&D requirements for the custom synthesis business, PI has more than100 researchers and chemists and to handle these assignments and allocates dedicatedteams of researchers. To give an impetus to its research efforts, PI has inaugurated the PI-Sony Research Centre at Udaipur in January 2011. In this research centre, PI and SonyCorporation would jointly undertake research in the area of synthetic organic chemicals forapplications in the electronics industry. This is a first of its kind research centre where SonyCorporation has decided to undertake a collaborative project in India.

Custom synthesis is expected to be a strong growth driver for PI over the next few years onaccount of the strong order book, multi-year contracts and expansion of capacities whichare likely to contribute substantially to revenues and profitability of the company.

Positive outlook for agri inputs divisionFrom being a generic manufacturer of the reverse engineered off-patent agro-chemicalproducts, PI has moved to having strong relationships with global MNCs and havingexclusive marketing rights to distribute their products in India. Agri-input division accountedfor ~58% of the consolidated revenue in FY11 i.e. ~INR 4.2bn. Out of this, ~40% is on

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Working with key customers ontheir strategic projects whereprospects of success, long termbusiness and growth potential arehigh

Strong order book, multi-yearcontracts and expansion of capacities to drive the growth forcustom synthesis

Agri-input product mix toimprove with the revenue shareof in-licensed products going upto over 50% from current 40%


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account of sales of in-licensed products on an exclusive sales agreement basis and the restdue to generics. This product mix is likely to improve further over the next few years, withthe in-licensed products revenue contribution likely to cross 50%, which would also improve

the EBITDA margin for this business division.

PI has a strong association with reputed companies such as Bayer, BASF, Chemtura and alsoa robust pipeline of exclusive co-marketing arrangements with top Japanese agrochemicalcompanies.

To support the growth for agri-input business, it has got a strong distribution network toachieve the targeted growth with five zonal offices, 24 branches, 220 sales staff, 800 fieldstaff, over 1,500 distributors and over 20,000 retailers.

Despite no new launches in FY11, PI had a robust revenue growth of 38% in this division.During FY10, PI launched a new rice herbicide in India - Nominee Gold which had got atremendous response from the farming community and has even been activelyrecommended by many state agricultural universities for adoption in rice cultivation. PI isexpecting this product to achieve status of the largest rice herbicide in the coming years,contributing significantly to the growth of the company. PI currently has 7-8 molecules inpipeline under evaluation and registration stages and is targeting to launch two newproducts in FY12.

The strategy in this business division has been to create leadership positions in all categoriesit operates in. Most of PIs products rank first or second in their respective segments.

Table 1: Key agri input products of PI


Currently India is amongst the lowest per capita consumers of pesticides at 380 gms perhectare while it is 2 kg/ha for China, 1.9 kg/ha for Europe and 1.5 kg/ha for the US. Also, outof the total crop area for rice, wheat and cotton in India, only 35-40% is treated withpesticides which indicates that the low penetration is likely to drive consumption of pesticides in India. This is also likely to be complemented by the increasing cash flows andhigher awareness levels for Indian farmers. The sustained price rise of all major food cropsin the last two years has made agriculture more profitable for farmers, encouraging them to

Product category Insecticides Fungicides Herbicides Plant nutrientsKey products Acephate Iprobenfos Atrazine Seaweed

Buprofezin Metiram Bispyribac SodiumCarbofuran Tricyclazole GlyphosateChlorfenapyr ImizathapyrCypermethrinDichlorovousEthionImidaclopridIndoxacarbMetaldehydeMonocrotophosPhorate

ProfenofosPropargiteThiamethoxam

Sale of the non-synergic and lowmargin polymer division to help PIfocus on core business andexpand EBITDA margin

Strong growth to be backed bylaunch of two new products inFY12


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protect the crop in a better manner. These should further aid the volume growth of agrochemicals.

Sale of polymer division to aid consolidation, enhance product mix The polymer division, which has not got any synergies with other two divisions, was sold byPI in FY11 to French multinational Rhodia SA. The EBITDA margin for this division had beenat ~10% and going forward, without this low margin business in its portfolio, the margin islikely to expand on account of the better product mix. Proceeds from this transaction areexpected to help the company take care of capex and working capital requirements forcustom synthesis and agri-input divisions. Management has guided for proceeds of ~INR 700mn from this sales transaction.

Chart 1: Proportion of revenue from polymer segment for PI

Source: Edelweiss research

The sale of the polymer division also included the transfer of its industrial facility, ~80people employed in division, R&D capabilities, customer base and logistics network in India.

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Valuations We estimate PI to post EPS of INR 71.8 and INR 103.8 in FY12 and FY13 respectively, on aconsolidated basis. PI is currently available at 10x and 6.9x consolidated P/E of FY12E andFY13E, respectively. On EV/EBITDA basis, the stock is trading at 6.3x and 4.5x consolidatedEV/EBITDA of FY12E and FY13E respectively.

Based on DCF valuation, we arrive at a fair value of INR 995 per share. Our DCF assumptionsare 15.2% cost of equity, 7% post tax cost of debt, WACC of 11.92% and a terminal growthrate of 3%. We have explicit forecast till FY15 after which we have assumed a high growthperiod of four years with a rate of 10% and a period of four years beyond that for thetransitory period. At our target price of INR 995 per share, PI trades at just 9.6x FY13E EPS.

Even comparing with its peers - Rallis India and United Phosphorous- PI looks very attractive

for its current valuations, high return ratios and high growth rate over the next two years.

On account of a strong visibility in the custom synthesis business from the robust orderbook besides a strong expected growth in its agri-input business, PI has firm growthprospects for revenue and profit over FY12E and FY13E. We initiate the coverage on thestock with a BUYrecommendation.

Table 2: Comparison of valuation with peers

Source: Bloomberg, Edelweiss research

Note: Bloomberg consensus estimates considered for Rallis India; Edelweiss research estimates considered for United Phosphorus

Chart 2: One year forward P/E band


CompanyMarket cap

(INR bn)EPS CAGR

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FY11 13 FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY11PI 9.0 41.9 13.9 10.0 6.9 8.0 6.3 4.5 35.4 26.4

United Phosphorus 74.0 27.4 12.8 9.0 7.9 6.9 5.5 4.6 18.1 19.0Rallis India 26.4 13.9 16.0 15.8 12.5 10.4 9.8 7.8 28.8 23.9

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Chart 3: One year forward EV/EBITDAband


Chart 4: One year forward P/BV band


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Key Risks

Delay in setting up new capacities

Any execution delay in setting up new capacities would impact the growth in the customsynthesis business.

Poor monsoon could impact growth

Indian agriculture is largely dependent on monsoon hence poor monsoon could be ademand dampener for the agri-input division.

Poor liquidity

On account of the very low liquidity in the stock, it might act very volatile.

Currency fluctuation

USD/INR volatility may impact export revenues as well as margins.


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Financial Outlook

Consolidated net revenue to post CAGRof 26% over FY11 13EWe estimate PIs consolidated net revenue to register a strong CAGR of 26% over FY11-13Edriven by a surge in the agri-product as well as the custom synthesis divisions despite theabsence of polymer revenue in FY13 (polymer revenue contributed ~7% to revenue in FY11).Over FY08-11, the company has posted consolidated net revenue CAGR of 24.7%.

Chart 5: Consolidated revenue and revenue growth trend


EBITDAmargin to expand robustly on improving product mixPIs consolidated EBITDA margin has expanded significantly from 8.7% in FY08 to 17.3% in FY11driven by a margin expansion in both agri-inputs as well as custom synthesis divisions on theback of an improved product mix. Currently the EBITDA margin in agri-input division is ~16%while it is ~21% in custom synthesis. An expansion in both segments is highly likely hence weestimate the consolidated EBIDTA margin for PI to be at 19.1% in FY12 and 19.8% in FY13.

Chart 6: Consolidated EBITDAand EBITDAmargin trend


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Net profit to post 42% CAGRover FY1113EConsolidated net profit rose at a CAGR of 118% over the past three years on account of thenear doubling of the EBITDA margin. We estimate the company to post a net profit CAGR of 42% over FY11-13E on account of the 26% CAGR in revenue coupled with its marginexpansion plans.

Chart 7: Consolidated net profit and net profit margin trend


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Financial Statements

Income statement (INR mn)Year to March FY09 FY10 FY11 FY12E FY13ENet revenues 4,629 5,425 7,202 8,897 11,529 Raw material costs 2,799 3,183 4,204 5,155 6,604 Gross profit 1,830 2,242 2,998 3,742 4,925 Employee expenses 397 445 565 725 935 Other expenses 787 926 1,188 1,314 1,709 Operating expenses 1,185 1,371 1,754 2,039 2,645 Total expenditure 3,984 4,554 5,958 7,194 9,248 EBITDA 645 871 1,245 1,703 2,281 Depreciation & amortisation 112 129 157 203 248 EBIT 533 743 1,088 1,500 2,033

Interest expense 222 183 181 221 184 Other income 8 11 7 - - Profit before tax 318 572 914 1,279 1,849 Provision for tax 76 153 263 372 537 Core profit 242 419 651 907 1,311 Extraordinary/ Prior period items - - - 500 - Profit after tax 242 419 651 1,407 1,311 Equity shares outstanding (mn) 10.6 10.6 11.2 12.6 12.6 EPS (INR) basic 22.8 39.4 58.2 71.8 103.8 Diluted shares (mn) 10.6 12.6 12.6 12.6 12.6 EPS (INR) diluted 22.8 33.2 51.5 71.8 103.8 CEPS 36.4 53.4 77.2 87.9 123.4 DPS - 1.4 4.5 4.5 4.5 Dividend payout (%) - 4.2 9.0 4.7 5.1

Common size metrics (% net revenues)Year to March FY09 FY10 FY11 FY12E FY13ECost of goods sold 60.5 58.7 58.4 57.9 57.3 Operating expenses 25.6 25.3 24.3 22.9 22.9 EBITDA margins 13.9 16.1 17.3 19.1 19.8 Depreciation & amortisation 2.4 2.4 2.2 2.3 2.1 Interest 4.8 3.4 2.5 2.5 1.6 Net profit margin 5.2 7.7 9.0 10.2 11.4

Growth metrics (%)

Year to March FY09 FY10 FY11 FY12E FY13ERevenues 24.6 17.2 32.8 23.5 29.6 EBITDA 99.2 35.1 42.9 36.8 33.9 PBT 225.9 79.5 59.9 39.9 44.6 Net profit 283.7 72.9 55.5 39.3 44.6 EPS 283.7 45.6 55.5 39.3 44.6


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Balance sheet (INR mn)As on 31st March FY09 FY10 FY11E FY12E FY13ETotal equity capital 35 71 112 126 126

Total preference capital - 206 81 - - Reserves & surplus 903 1,269 1,944 3,645 4,890 Shareholder's equity 939 1,546 2,137 3,772 5,016 Secured loans 1,894 1,053 1,554 1,800 1,600 Unsecured loans 138 444 924 150 150 Total debt 2,032 1,498 2,478 1,950 1,750 Deferred tax liability (net) 250 270 326 326 326 Sources of funds 3,221 3,313 4,941 6,047 7,092Gross fixed assets 2,590 2,924 3,634 4,734 5,484 Accumulated depreciation 798 923 1,080 1,283 1,531 Net fixed assets 1,792 2,001 2,554 3,451 3,953 Capital work in progress 74 86 321 80 80 Total fixed assets 1,866 2,087 2,875 3,531 4,033 Investments 4 5 5 5 5 Inventories 1,042 1,028 1,410 1,553 1,990 Accounts receivable 923 1,034 1,766 1,950 2,211 Cash and cash equivalents 51 54 84 196 406 Loans and advances 305 347 503 503 503 Current assets 2,321 2,463 3,763 4,202 5,110 Current liabilities 950 1,189 1,568 1,624 1,990 Provisions 23 53 134 66 66 Current liabilities & provisions 973 1,243 1,702 1,691 2,057 Net current assets 1,347 1,221 2,061 2,511 3,054 Miscellaneous expenditure 4 - - - - Uses of funds 3,221 3,313 4,941 6,047 7,092Book value per share (INR) 88 145 191 299 397

Free cash flow (INR mn)Year to March FY09 FY10 FY11E FY12E FY13ENet profit 243 419 651 1,407 1,311 Add: Depreciation 112 129 157 203 248 Add: Interest and other non-cash items 274 199 174 (279) 184 Gross cash flow 629 747 982 1,331 1,743 Less: Changes in working capital (317) 131 (810) (339) 332 Operating cash flow 312 877 172 993 1,411 Less: Capex 331 363 945 859 750 Free cash flow (19) 514 (773) 133 661

Cash flow metricsYear to March FY09 FY10 FY11E FY12E FY13EOperating cash flow 312 877 172 993 1,411 Financing cash flow 24 (519) 780 (522) (451) Investing cash flow (316) (355) (922) (359) (750) Net cash flow 20 3 30 112 210 Capex (331) (363) (945) (859) (750) Dividends paid - (17) (58) (66) (66)


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Profitability ratiosYear to March FY09 FY10 FY11E FY12E FY13EROACE (%) 18.0 22.8 26.4 27.3 31.0

ROAE (%) 29.7 33.8 35.4 30.7 29.8 ROA (%) 8.2 12.8 15.8 16.5 20.0 Current ratio 2.4 2.0 2.2 2.5 2.5 Receivables (days) 71 66 71 76 66 Inventory (days) 112 119 106 105 98 Payables (days) 118 123 120 113 100 Cash conversion cycle (days) 66 62 57 68 64 Debt-equity (x) 2.2 1.0 1.2 0.5 0.3 Debt/EBITDA 3.2 1.7 2.0 1.1 0.8 Adjusted debt/Equity (x) 2.2 1.0 1.2 0.5 0.3 Long term debt / Capital employed (%) 63.1 45.2 50.2 32.2 24.7 Total debt / Capital employed (%) 101.1 90.8 91.2 65.6 58.3 Interest coverage (x) 2.4 4.1 6.0 6.8 11.0

Operating ratios (x)Year to March FY09 FY10 FY11E FY12E FY13ETotal asset turnover 1.6 1.7 1.7 1.6 1.8 Fixed asset turnover 2.8 2.9 3.2 3.0 3.1 Equity turnover 5.6 4.4 3.9 3.0 2.6

Du pont analysisYear to March FY09 FY10 FY11E FY12E FY13ENP margin (%) 5.2 7.7 9.0 10.2 11.4 Total assets turnover 1.6 1.7 1.7 1.6 1.8 Leverage multiplier 3.6 2.6 2.2 1.9 1.5 ROAE (%) 29.7 33.8 35.4 30.7 29.8

Valuation parametersYear to March FY09 FY10 FY11E FY12E FY13EDiluted EPS (INR) 22.8 33.2 51.5 71.8 103.8 Y o Y growth (%) 283.7 45.6 55.5 39.3 44.6CEPS (INR) 36.4 53.4 77.2 87.9 123.4 Diluted P/E (x) 31.4 21.6 13.9 10.0 6.9 P/BV (x) 8.1 4.9 3.7 2.4 1.8 EV/Sales (x) 2.0 1.6 1.4 1.2 0.9 EV/EBITDA (x) 14.4 10.2 8.0 6.3 4.5 Dividend yield(%) - 0.2 0.6 0.6 0.6

Documents

PI Ind Edelweiss June2011