Sudarshan Chemical Industries Limited (506655) Earnings Call Transcript

Ladies and gentlemen, good day, and welcome to the Q2 FY '21 Earnings Conference Call of Sudarshan Chemical Industries Limited, hosted by Anand Rathi Share and Stock Brokers. [Operator Instructions]. Please note that this conference is being recorded. I now hand the conference over to Mr. Nav Bhardwaj from Anand Rathi. Thank you, and over to you, sir.

Thank you. Good afternoon, friends, and welcome to the Sudarshan Chemical Industries Q2 and H1 FY '21 Earnings Call. We have with us Mr. Rajesh Rathi, Managing Director; Mr. Nilkanth Natu, Chief Financial Officer; Mr. Vivek Thakur, GM Finance; and Mr. Amey, Deputy GM Finance. We will start with the initial remarks from Mr. Natu, and then we can open the floor for Q&A. Mr. Natu, over to you, please.

Thank you, Mr.Bhardwaj. Am I audible?

Yes, sir, you're audible.

Yes, sir, you're audible.

Thank you. Good evening, ladies and gentlemen. Welcome to Sudarshan Chemical Industries Limited Q2 FY '21 Earnings Conference Call, and thank you for your continued interest in our company. Our investor presentation has already been uploaded on the stock exchange and the company website for your ready reference. I hope you have been able to access it. We will start with an update of the business and the key developments for the quarter. We entered the quarter with our Roha plant being impacted for initial 2 weeks due to the presence of COVID-19 cases. It also had led to some noncore disruption. We'll alter our operations gradually to more normalized levels of production after the mandatory shutdown and sanitization treatment. Our Q2 performance is reflective of the same. The team has worked tirelessly and adopted remarkably to the new norms around social distancing, et cetera, and we remain that we should be able to maintain our production level. We saw demand picking up significantly from August onwards in the domestic market to pre-COVID levels after being subdued for initial few months. Our Q2 FY '21 domestic business is up 70% as compared to Q1 FY '21, which is reflective of the broader economy in India now coming back to the normal. We have seen good traction across the portfolio with coating, plastics and inks, particularly doing well. Exports continue to remain strong and accounted for approximately 56% of our business for the first half against 48% for the same period last year. Moving to the split between Specialty and non-Specialty Chemicals, we have seen good growth this quarter in the non-specialty segment as demand came back after this being subdued early on. Specialty continues to remain strong, and this is reflective of our strong technical capabilities that we have invested in over the years. Looking at the consolidated financial performance for the quarter and the half year, the total income from operations for Q2 is at INR 429 crores as compared to INR 425 crores for the corresponding period of the previous year, up by 1% on year-on-year basis. Growth in value and volume at a similar level. Please note that we were impacted in the early weeks of Q2, and we would have reported better growth if it was not the disruption due to the temporary plant closure. For the half year, our sales are down at -- to INR 781 crores against INR 836 crores, given the severe impact of COVID-19 in Q1, which we had estimated to be INR 45 crores of loss revenues. Adding this, our H1 performance would be in line with last year. Our gross margin has inched up this quarter to 44.2% against 43.1% last year. This improvement in gross margin is because of our continuous improvement in the product mix. Raw materials have remained relatively stable during the quarter. EBITDA for the quarter was at INR 68 crores and a margin of 15.8%. Both these have improved on quarter-on-quarter as well as year-on-year basis on improved operational efficiencies. The COVID-19 pandemic resulted in certain cost-cutting majors and other optimization efforts. There is now a greater focus on the conversion costs and our overall SG&A effort. We expect these measures to continue as we revert to more normal levels of business as the country embarked on unlock 4 and more. Depreciation for this quarter was at INR 21.9 crores was higher by INR 4.8 crores as compared to Q2 FY '20, given the CapEx over the last 12 months. For the half year, depreciation was at INR 43 crores versus INR 34 crores last year. Our outflow towards CapEx projects for the first 6 months was at INR 106 crores against INR 95 crores last year. We had around INR 585 crores of CapEx plan for FY '20 and FY '21. Out of this, we have already completed INR 225 crores during FY '20. As per the current depreciation plan, we estimate to complete projects worth INR 225 crores by end of this fiscal. Project worth INR 110 crores will spill over to FY '22, H1. We continue to believe that long-term demand for our products remains unaffected, and we'll be continuing with our CapEx and the new product plans as stated. However, nearer term, we face challenges on getting the technicians to fly from abroad to help with installation and testing. As compared to the situation 3 months ago, we are progressing better on the CapEx project. We would also like to share an update on the Yellow pigment. Based on the feedback certain modifications were required. From March to September '20, due to COVID-19, all the modifications were put on hold and only manufacturing activities were allowed. October '20 onwards, we have restarted working on this with full rigor and expect to relaunch by mid-December. Finally, profit after tax for the quarter was at INR 30 crores and for the half year, INR 48.5 crores. During the current quarter, the company has reassessed the underlying assumptions based on the current business scenario, and expansion plans and has decided to offer new tax regions. Moving to the balance sheet. We remain very strong and liquid. This quarter, we took additional steps to improve our cash balances with strong focus on collections and inventory management. I would now like to give you an update on how we are seeing the business evolve the next few quarters. Traditionally, Q3 remains softer. However, given the recent uncertainties in Q1 and Q2, we expect some level of pent-up demand from domestic size to flow through into the quarter. In addition, we continue to actively monitor the extent of the Wave 2 of the pandemic as some of the European cities are now headed back into the lockdown. We are also monitoring this development to assess, is this the real demand as against the order to fill up the supply chain. At the moment, the demand from both domestic and export looks healthy, and we are seeing good level of inquiries from both the segments. Raw material prices remain stable, and we are well stocked so we will continue to remain alert. Our manufacturing level at the plant is back to normal. Supply side issues and logistics have recovered well and our overall business is on much stronger position than 6 months ago. Our balance sheet remains strong. The business is well funded. We look forward to continuing to grow and deliver value to all our stakeholders. With this, we now open the floor for questions. Thank you.

[Operator Instructions] The first question is from the line of Ritesh Gupta from AMBIT Capital.

I just wanted to get a sense on the -- how the rest of the year looks like? I know you've mentioned it a bit in your opening remarks, but it's not very clear that we say that Q3 is seasonally weak. But given that there will be some bit of pent-up demand in the end market, in the Q3 business should be strong. And then the second 1 is on the CapEx that you have done almost close to INR 200, INR 250-odd crores in the last 2 years and probably even more. We see an impact of that coming into depreciation, but how fast can you go through the product approval cycle and how long that will take to ramp up?

Of course, this is Rajesh Rathi. And I think -- so I think from our perspective, I think what we are saying is, we're seeing demand in the domestic back to pre-COVID levels. We are just kind of a little -- we want to make sure that we just want to tender a caution that it's not just filling up the supply chain, but it's really consumer demand, which is increasing, right, and which will be sustained demand. So that's a little bit of the caution we want to see. We do see that before the volume, we have good demand, post Diwali, the demand does drop in India. And -- but we feel -- we still feel that we should have a strong December to March, right? So that's on the demand side. Exports is, again, fairly upbeat right now, and we hope this trend kind of continues, right? While we are staying cautious, we're already seeing large waves of COVID coming into several countries, et cetera. And we are not sure how the economies would react to that, et cetera. On the CapEx front, I think Mr. Natu explained on the whole front that we've completed our CapEx. There is some spillover of CapEx into the next year because of the COVID situation. We do feel that there are certain CapExs, which are -- where we are now other than the yellow 138, all are -- rest of our CapEx is -- we have been able to kind of leverage well. So there are 2 CapExs, which we see from the Jan quarter, we should be able to do slightly better on them.

Sir, got the point that CapEx are ramping up well, but ideally, I mean that kind of asset investment should at some point and start contributing to your top line goes into our EBITDA growth as well. So unless the base business is doing very widely, I mean, this should have resulted and should result at least in the coming quarters. At some point in time, it should start delivering much better EBITDA growth, right?

So I think if you see our EBITDA margins have improved, there has been -- because of COVID, in spite of losing 5, 6 weeks, we've still been able to -- we've been marginally down in the 6 months. From that perspective, we do feel we are catching up. So if you look at what happened in Q2, already Q2, we have matched last year's numbers.

So basically you're saying that the base business has been a bit weak and kind of whatever, 5% growth or whatever single growth we're seeing a bit as attribute new product?

So It's new product. It's -- partially, we had to hold off like the yellow pigment, we had to kind of hold off the entire -- due to COVID, we had to held up in modification in the product on multiple situations. And in Q2, like I said, we had almost 3 to 4 weeks of demand or supply issues. We've still been able to kind of maintain that. In all, I think the first half of the year was on getting back to kind of operations and kind of focusing now. Now we are back on track to kind of leverage our driver CapExs and back on the growth story, right? So I think in the next 6 months, we should be able to see this kind of -- see a better result from that.

Got it. And just last 1 clarification there. I mean, you're not waiting for any product approvals, et cetera, which I think in the last quarter, you had said that new product approvals have been delayed due to COVID. That 1 thing, this is a challenge anymore?

Sure. I think the question on Yellow 138 is, on the yellow pigment is that people have given us feedback, we want some modification, et cetera, right? So we are modifying the products, which we will complete. That's what I've mentioned by -- and Mr. Naku jee has mentioned by December, and we expect to complete that because we've just started that again. We have completely put a hold on that. So with that, we should be able to -- we should be in a better place to drive that.

The next question is from the line of Amar Mourya from AlfAccurate Advisors.

Now sir, about a little bit more clarity on the CapEx. You said that around INR 550 crores of CapEx is yet to be -- I mean, yet to be planned, right?

Nilkanth here. So I will clarify. So what we said is we had the CapEx approval of INR 585 crores. Out of this INR 225 crores of CapEx we completed in FY '20. Balance INR 250 crore of CapEx, we will complete by end of this fiscal and there has been a spillover of INR 100-plus crore CapEx to next year fiscal FY '22 H1.

Okay. Okay. Okay. Fair enough, sir. And secondly, sir, what would be the export and domestic mix in this particular quarter? Or you can indicate the growth of the export or the domestic?

So for the current year, H1, domestic is at 44%. Export is at 56%.

[Operator Instructions] The next question is from the line of Sanjay Jain from ICICI Securities.

Two questions from my side. One on the new product. Last year in 4Q earnings call, we mentioned of 2 products, which were in the pipeline. One, we were expecting to launch in June and other words, probably in the 3Q or 4Q. Any update on the new product launch of which we were planning? And how are we looking at the new product pipeline from here on?

Sir, due to COVID, I think we had delayed all our commissioning of CapExs where the new products are going to come from are delayed. I think 1 of the products, we do expect to kind of launch by March end, and the other product, we expect by our H2 to September end.

So, okay. September '21 you're talking about?

Yes. So by March '21 and the second part of -- March '21 and the second by September '21. October or the Q3 quarter where we launched.

Got it. So it's roughly delayed by almost 9 months because of the COVID?

Yes, yes.

And these are product tested with the customer or these are the fresh -- where we will go for the approval like Yellow pigment or we have done some initial test out there?

So I think, like we said, we have done some initial tests, but I think the final approval does come through when we are distilling the plant. And when I'm talking about we've built in some approval time from the customers also in this.

Got it. Got it. 2, just number keeping question. What is the capacity utilization for [indiscernible] in Q2? And again, to rephrase the question, which was asked earlier. If you can give what was the mix of domestic and export for Q2 specifically, not for 1H.

So from a utilization perspective, I think we almost lost full of July. Partly July, we were completely closed our [indiscernible] plant. And partly, it was working at I would say 30%, 40% capacity. Rest of the area, the rest of the month, we are at about 80%, 85% capacity utilization. Q2 split. And on the Q2 split between domestic and export, domestic is at 49% -- 51%, and export is at 49%. So it is the same kind of mix.

The next question is from the line of [ Kunal Mehta ] from Balam India Discovery Fund.

And sir, I have a single question on the CapEx. So could you -- in simple words, could you please help me understand the CapEx of INR 550 crores, which we have planned -- or which we have planned and out of which you've mentioned that INR 225 crores is there on the balance sheet right now and the rest, you're working on it. So just -- I've been through everything you have put out in the public domain in the last few years. And I just want to understand this CapEx is INR 550 crores CapEx. Could you please help us understand regarding what sort of products will this address to? And in this whole CapEx, including the 1 which is there on the balance sheet and 1 which will come on the balance sheet, how much of it is related to the products you already supply to the -- and how much of it is related to new products? And regarding the new products, could give us an understanding? And yes, that would be very helpful. So I'm sure just -- I understand the sum part of it is about the yellow pigment, which -- for which we have been giving information in the last few quarters in the earnings calls. Am I audible?

Just a second. Just a second, please.

Yes, yes.

Sorry. Yes. So, our major -- so as we have mentioned, our CapEx can be divided into 3 areas: One is the growth CapEx; one is margin improvement; and third is the infrastructure. Major portion of the CapEx is towards the growth CapEx. Growth CapEx includes both existing volume, existing products where the volumes go up and new products included in that, right? And so that's where we are kind of driving this together.

Okay. Sir, if I have to split the quantum of CapEx between growth CapEx and, I would say, backward integration. So 70% of the CapEx is growth CapEx, would you put that number? Or what is the mix between these 3 buckets?

So I think from a perspective, right now, our major emphasis is still on growth. The backward integration CapEx is still not started because we've kind of -- there are 2, 3 kind of projects which are on. But there are other improvements in terms of like the utilities, et cetera, where we are looking at margin improvements. [indiscernible] growth.

Okay. And out of the INR 225 crores CapEx, which we have capitalized and where we have commercialized, the majority of this is related to yellow pigment product. Is that the correct assessment? Or it's really to the whole basket, one-off, which is a new product -- the new product yellow pigment?

The whole basket and 1 portion of it is only the yellow pigment.

Okay. And the FY '20 -- the CapEx in FY '21, which is under INR 225 crores that is also primarily major related to capacity addition and new product addition. That is right? And the last level of CapEx, which you would do, that will be primarily for your margin improvement in backward integration. Is that the right way to look at it sir?

So that adds a little bit of margin improvement, really is not so much of backboard integration yet. There are 1 or 2 small ones, but the major phase of backward integration would come after this.

In FY '22?

Yes.

Okay. And regarding the new products, barring the yellow pigment, which you have announced in your public -- in the -- publicly. All the other products, would you announce on the later date when those plants are set up? Or could you mention it right now?

There are several high-performance pigments, which we are planning on. And I think we would kind of -- as we launch the products, we will kind of talk a little more about it, yes?

The next question is from the line of Abhijit Akella from IIFL.

I just had first 1 clarification regarding the September commentary we've given in the presentation. We've said that in September, we reached 1 of our highest ever production volumes. And then the month wise revenue chart that we have given on Slide 9 also shows that September revenues are much higher than those in the previous months. So if you could just help us understand what the reason for this was? Was it because of some pent-up demand following the closure of the plant in June and July? And did this come largely from the domestic market? Or was it also increased strength in the export side of the business?

No. I think the point of the graph is to demonstrate that like I mentioned, H1 was all on the supply side, right? Demand was never a concern. What that graph demonstrates, and I think that's the way we should look at it, is that how we are coming back in a full force on the supply side, right? So that was demonstrating that August was a month where we crossed or August is the month which we brought last year sales. And then September, we did far better. And that's the trend we expect now to go on, right? So that's the area. That's -- so it's more of demonstrating how the supply side is gearing up now. All the manufacturing is gearing up.

So can we expect the September run rate to continue, sir, going forward now into 3Q? So like October onwards, will the revenue -- monthly revenue run rate be at the same level?

I think, like I mentioned that we do expect a good run. Having said that, like I mentioned, there were 2, 3 concerns which we had is domestic, obviously, there is a slowdown after Diwali. However, we feel that there will be -- given that it's just not filling up the supply chain and there's real good demand, which is kind of coming up, right, people start painting their houses, construction is picking up, et cetera, that we expect good movement there. And the second caveat, where we felt is that in several countries, the second wave of COVID was coming up. We are not sure how this affects the economies of those countries and exports, right? From that perspective, those are the only areas. Otherwise, we do expect a good run.

Understood. That's helpful, sir. And my last question is just on the CapEx for the previous year, the INR 225 crores that Mr. Natu mentioned was executed last year. Have we seen any revenue contribution coming in from that CapEx already so far this year? And was some element of that part of the September numbers that we've shown?

Yes. So obviously, part of -- other than the new product, the others were all growth driven volume reasons and those have started coming in.

Sir, any sense of like how much of the INR 225 crores is already utilized and how much is left to be utilized? I mean, just a rough ballpark number in percentage terms? Is it more than half, less than half?

I don't have those numbers top of my head right now. And -- yes. Okay.

The next question is from the line of [indiscernible] Shah from [indiscernible] Financials.

Sir, can you just give us some sense on the earlier asked questions on the CapEx. You said this is predominantly growth. So if you can help us explain that would be efficacy of the new CapEx be equivalent or more to the already done balance sheet efficiency that you seem to be showing? So a, could you please answer that? #2, possibly, if you can also help us understand in terms of demand, given the situation that we are in and possibly small advantage that we have as an alternate to China, is there some advantage that we will possibly get in terms of being more kind of dependable supplier in all the 3 categories either organic or inorganic or the pigments, the effect pigments? So if you can help us understand that. And lastly, on the balance sheet, you are -- you seem to be spending something on the -- something called intangible asset. If you can just explain what that line item is?

Okay. So I think -- on the perspective of our standard growth, I mean, let me talk about that first. There are great tailwinds in the way. So the 2 major players are about to sell their business. And China, certain uncertainties, there's definitely an opportunity for an Indian player whether we can take up a leadership position and how does it kind of grow, right? And that's been our story to kind of sell ourselves as a reliable alternative, reliable leader in the industry, right? So that's been our liability, right?

True. But is there any specific segment where we are seeing this more attenuated in the sense that is this more...

It's very difficult to kind of pan out know. It will take some time to see how it really works out in the sense, really, our customers from a perspective of -- our China perspective, really willing to look at alternatives, given that the China government has come up with 13% export rebate, whereas India has withdrawn given the 2% rebate, which we used to get, right? So the competitiveness is also very important in this aspect. It's not just this. So I think there are several factors which would kind of pan out and we'll see how the result comes out. There was a time when even India, we could not supply a couple of months, whereas other countries during that time, could kind of supply that. So I think it's the entire story, how we come out now and how we come across. But that's how -- there is a -- we still feel there's a great opportunity and it will play out. It should play out in our favor. More and more, there are dialogues between key accounts, talking about India sourcing strategy, right, which never expected for decades. So that's the area of test. The entire CapEx, which is planned is, obviously, our CapEx is standing towards the growth CapEx, which is talking about also product mix change, which should kind of help improve our balance sheet. Having said this, I think the challenges of COVID have been multiple, right? Entire working capital, inventory levels, et cetera, have -- were tremendously increased. Our CapExs -- our CapEx has got delayed a lot. So from a balance sheet perspective, both these items have not helped. We do expect that given that, it's like all this will get -- will shuttle in. In the next 6 months, we should be able to now drive our growth CapEx, and we should be able to kind of much better results in the coming years.

So in other words, this CapEx that when it finally comes into place, will give you more superior turnover and related margins than the existing CapEx that is there. Is that a fair assessment?

Yes, absolutely. I mean, if you see over years, our EBITDA margins have improved, right? And a lot to do with how we change our product mix and also held on to pricing. Yes.

And if you can just explain what that intangible is on the balance sheet, intangible assets? And...

So this is regarding the intangible asset capitalization. So we implemented [indiscernible] our project, and this capitalization is towards that project.

Sorry, could you repeat that? You were...?

We implemented [indiscernible] projects in the first quarter, and this capitalization is towards this project implementation.

The next question is from the line of Madhav Marda from Fidelity Investments.

My question was just on the export opportunity. How is India faring in terms of competitiveness? Or how is Sudarshan more specifically in terms of competition versus players in China? You mentioned a 13% export a bit as well today. When -- from when it is applicable? And is that like likely to impact us going ahead in terms of volumes?

I think, this has been applicable, if I remember, it's from April, April itself. I don't know about the exact date, but it's been some time, which is in the lower end of the product this does affect us. But in the more premium products, high-performance pigment products, this doesn't affect us as much.

Understood. And in general, if you were to look at Sudarshan Chemical cost structure, versus any of our global competition, are we like more competitive? Or is that like some more years of journey before we sort of reach that? How should we think about it broadly? Because the 12% like if we have to keep getting market share and become a global soft player eventually, just wanted to see or understand how that journey plays out for us?

I think, we have -- there are certain product range, which we have gained a better cost position. However, obviously, to offset a 13% export benefit is -- it's again, not a level playing field. And in certain areas, we do get a little bit concerned there. However, our whole core on certain molecules when we talk about cost leadership and we complete some of our backward integration projects, those will be kind of -- those will be quite useful in kind of improving our cost base for them.