28th Sep 2017 INDIAN SPECIALTY CHEMICALS GROWTH CATALYSTS USA Indian Specialty Chemicals 28 September 2017 Table of Contents Contents Page No. Indian Specialty Chemicals Specialty Chemicals – Distilling the common into the special 4 Unveiling the key catalysts behind specialty chemicals 5 Where does India’s specialty chemicals industry stand? 6 Confluence of identified drivers suggests high growth potential 8 Specialty chemicals – An aggregate of distinct segments 20 Agrochemicals 23 Navin Fluorine (Buy, TP INR 700) 29 PI Industries (Hold, TP INR 750) 32 SRF (Buy, TP INR 1670) 35 UPL (Buy, TP INR 950) 38 Colourants 41 Aarti Industries (Not Rated) 51 Aksharchem India (Not Rated) 53 Asahi Songwon (Not Rated) 55 Atul Limited (Not Rated) 57 Clariant Chemicals (Not Rated) 59 Meghmani Organics Ltd. (Not Rated) 61 Sudarshan Chemicals (Not Rated) 63 Surfactants 65 Sunshield Chemicals (Not Rated) 74 Ultramarine & Pigments (Not Rated) 76 Water Treatment Chemicals 79 Ion Exchange (Not Rated) 86 Appendix Specialty chemicals – A special segment within chemicals 88 Specialty chemicals – Transitions, worth looking at 89 Oleochemicals – Driving consumers toward GREENER products 96 JM Financial Institutional Securities Limited Page 2 28 September 2017 India | Specialty Chemicals | Sector Report Indian Specialty Chemicals Growth Catalysts Over the years, growth drivers in the chemicals industry (including specialty chemicals) have shifted and evolved. The US was the original home to innovation and production of Mehul Thanawala chemicals and specialty chemicals. The industry then gradually transitioned to Europe, [email protected] | Tel: (91 22) 66303063 followed by developing countries such as China. In this report, we focus on specialty Alok Ranjan chemicals and analyse these transitions and identify their drivers, ultimately aiming to [email protected] | (+91 22) 6630 3073 understand whether India can be the next global growth leader. We believe the drivers for Pramod Krishna [email protected] | Tel: (91 22) 61781074 specialty chemicals are: (1) domestic availability of raw material at competitive prices, (2) strong demand growth in consumer industries and a domestic industry that supports ‘premiumisation’ of products, (3) competitive manufacturing costs, (4) investment in R&D and (5) an ecosystem that supports the industry and innovation. Our analysis indicates that India has all these drivers required to ‘Make in India’ and become the top destination for specialty chemicals. Additionally, in this report, we analyse four specialty chemicals sub-segments and identify why they make an attractive investment proposition. We believe agrochemicals, colourants, surfactants and water treatment chemicals are the most attractive segments as they are characterised by high growth potential, high product differentiation and low-to- medium penetration levels. Having analysed this industry in detail, we believe companies with high focus on R&D, with a diversified product profile and increasing share of revenue from high-value products will be the most attractive in the long term. The specialty chemicals industry needs certain drivers to grow: Some of the drivers we have highlighted may be generic and applicable to any industry, but drivers such as investment in R&D are more relevant to specialty chemicals. In this report, we empirically validate these drivers based on how the US, Europe and later China used these growth drivers to become leaders in the specialty chemicals industry. India has all the drivers to focus on specialty chemicals: India has a strong base of technically skilled manpower (over 2.5 million students graduated in 2016 Science, Technology, Engineering and Maths - STEM). Just as STEM graduates were the base for growth in India’s IT and Pharma sectors, they can also help boost the specialty chemicals industry. India also has a well-developed chemicals industry, which is the 6th largest producer of chemicals globally. This not only provides raw materials at competitive prices, but also the expertise needed to store and handle chemicals. Finally, the Indian government has also focussed on the specialty chemicals industry under its ‘Make in India’ programme. India’s global competitiveness improving: Globally, at various points in time, various regions have emerged as industry leaders. China has led the chemicals industry over the past two decades, but over the past five years, its labour costs increased from c.2% of sales to c.5%, while Indian companies’ labour costs have been stable at 6-7%. This has improved India’s competitiveness. We analyse these and other factors in the report to substantiate that Indian companies are now competitive. The specialty chemicals industry has several segments: Specialty chemicals are used to add value to an end product, and therefore, the industry operates on a B2B premise. Accordingly, specialty chemicals can be classified based on their use into agrochemicals, construction chemicals, paints & coatings, personal care, polymer additives, textile chemicals and water treatment chemicals. They can also be classified based on application into segments such as colourants, flavours & fragrances and surfactants. We analyse these sub-segments in this report and identify those that are attractive from an investment perspective. Some of these segments (such as textile chemicals) do not have many listed players and some (like flavours & fragrances and paints & coatings) are more JM Financial Research is also available on: FMCG plays than chemicals. We exclude these and analyse the growth drivers and Bloomberg - JMFR <GO>, potential for the remaining segments. Thomson Publisher & Reuters S&P Capital IQ and FactSet Major companies: Finally, in this report, we provide a brief overview of some of the companies operating in the specialty chemicals industry. These are Navin Fluorine Please see Appendix I at the end of this International Limited (Buy rating; Sep’18 TP: INR 700), PI Industries Limited (Hold rating; report for Important Disclosures and Sep’18 TP: INR 750), SRF Limited (Buy rating; Sep’18 TP: INR 1670), UPL (Buy rating; Disclaimers and Research Analyst Sep’18 TP: INR 950), and others. Certification. JM Financial Institutional Securities Limited Indian Specialty Chemicals 28 September 2017 1. Specialty Chemicals – Distilling the common into the special The chemicals industry can be classified based on various parameters such as value addition Basic chemicals are high-volume (basic/specialty), end-use (water treatment/construction/agrochemicals), process and low-value chemicals. Specialty (batch/continuous), etc. If we focus on value addition, the chemicals industry can be chemicals are low-volume and classified into two broad segments - basic and specialty. high-value chemicals Basic chemicals are generally high-volume and low-value products that are sold to other industries for further processing. Typically, basic chemicals are more likely to be manufactured in continuous process plants and there is no major product differentiation among several manufacturers. Sales of basic chemicals are primarily driven by price. On the other hand, specialty chemicals are low-volume and high-value products sold on the basis of their quality or utility, rather than composition. Thus, they may be used primarily as additives or to provide a specific attribute to the end product. Specialty chemicals are more likely to be prepared and processed in batches. The focus is on value addition to the end- product and the properties or technical specifications of the chemical. Specialty chemicals are an important group, but classifying a particular chemical as ‘basic’ or ‘specialty’ has been somewhat contentious. Often, terms such as specialty chemicals, fine chemicals, and performance chemicals are used interchangeably and can cause confusion. Therefore, Kline and Company prepared a simple matrix to explain the classification. Exhibit 1. Specialty chemicals - differentiation matrix Fine chemicals Specialty chemicals Specialty chemicals cost more per kg and have a high differentiation Price ($/Kg) index Commodities Pseudo-commodities Source: Kline and Company, Inc., JM Financial Differentiation Index Another useful way to look at chemicals is based on the value chain (Exhibit 2). Exhibit 2. Chemical industry value chain Parameters Basic chemicals Differentiated commodities Specialty chemicals Chemistry Production of molecule Development of molecule Modification of molecule Specialty chemicals are Focus Economy of scale Operations Customer/market characterised by low capital Structure Centralised Somewhat decentralised Decentralised intensity and high product technology Process & product Product & application Technology Process technology technology know-how Capital Intensity High Moderate Low Source: Kline & Company, Inc., JM Financial Appendix 1 analyses the basic and specialty chemical companies in more details. In this report, we focus on specialty chemicals. Since specialty chemicals are mainly used to add value to the finished product, they are primarily sold on a B2B basis. Specialty chemicals can be further divided into various sub-segments on the basis of end-use and application. In this report, we have classified specialty chemicals into ten sub-segments. These sub-segments are 1) Agrochemicals, 2) Colourants, 3) Construction chemicals, 4) Flavours & Fragrances, 5) Paints & Coatings, 6) Personal care, 7) Polymer additives, 8) Surfactants, 9) Textile chemicals and 10) Water treatment chemicals. Of these,