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Anand Rathi Share and Stock Brokers Limited (hereinafter “ARSSBL”) is a full-service brokerage and equities-research firm and the views expressed therein are solely of ARSSBL and not of the companies which have been covered in the Research Report. This report is intended for the sole use of the Recipient. Disclosures and analyst certifications are present in the Appendix. Anand Rathi Research India Equities

India I Equities

Key financials (YE Mar) FY19 FY20 FY21e FY22e FY23e

Sales (Rsm) 15,930 17,082 17,583 20,099 23,929

Net profit (Rsm) 1,351 1,445 1,068 1,336 1,816

EPS (Rs) 12.6 18.9 15.4 19.3 26.2

PE (x) 36.2 24.2 29.6 23.7 17.4

EV / EBITDA (x) 17.2 14.8 14.4 12.0 9.3

P/BV (x) 5.6 5.3 4.7 4.1 3.5

RoE (%) 17.3 22.4 16.7 18.5 21.8

RoCE (%) 10.1 13.4 9.6 10.4 13.9

Dividend yield (%) 1.3 1.3 1.0 1.3 1.7

Net debt / equity (x) 0.6 0.8 0.9 0.8 0.6

Source: Company, Anand Rathi Research

Nav Bhardwaj Research Analyst

Bhawana Israni Research Associate

Chemicals

Initiating Coverage `

Rating: Buy Target Price: Rs585 Share Price: Rs457

Relative price performance

Source: Bloomberg

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Key data SCHI IN / SDCH.BO52-week high / low Rs538 / 286Sensex / Nifty 38105 / 11222

3-m average volume $2.4m

Market cap Rs32bn / $435m

Shares outstanding 69m

Shareholding pattern (%) Jun’20 Mar’20 Dec’19

Promoters 42.7 42.7 52.3 - of which, Pledged - - -Free Float 57.3 57.3 47.7 - Foreign Institutions 8.3 8.2 8.3 - Domestic Institutions 3.2 3.6 1.6 - Public 45.8 45.5 37.7

30 September 2020

Sudarshan Chemicals

Capex fuelled growth story; Buy

One of the largest pigment manufacturers in its home market (with a 35% market share) and the fourth-largest globally, Sudarshan’s strong brand equity, leading position, regular capacity additions and focus on high-margin products have been its key strengths. We believe that the exit of global players (BASF, Clariant), coming capex (Rs8bn over FY20-23), product launches and focus on the global market will be its future growth drivers. We initiate coverage on Sudarshan Chemicals with a Buy at a TP of Rs585 (22.3x FY23e EPS). The auto-sector slowdown and ban on single-use plastic would trim its short-term performance.

Leading position. Beginning with manufacturing a few inorganic pigments, Sudarshan has now become the largest manufacturer of pigments in India. In the last seven decades, it has added a range of products, comprising not only organic and inorganic pigments but also HPP, “effect” and high-margin pigments. It manufactures and markets more than 400 products.

Well-timed capex as global players quitting. Sudarshan invested Rs5.5bn over FY17-20 (with plans to invest Rs3.5bn in FY21) to achieve its target of Rs10bn capex in a few years. Global pigment manufacturers (BASF, Clariant) are quitting by end-2020 due to keen competition from India and China. We believe that the capex would help the company strengthen its market position and expand its geographic reach.

Covid-19, a short-term challenge. Q1 was severely affected due to the lockdown. Domestic market demand recovered to 70-80% in July and expected to improve at pre-Covid levels in coming months. The company expects full recovery in demand from H2 both domestically and globally.

Valuation. We initiate coverage on the company, with a TP of Rs585 valuing the stock at 22.3x FY23e EPS and 11.6x FY23 EV/EBITDA. Risks: RM price fluctuation; forex movements.

30 September 2020 Sudarshan Chemicals – Capex fuelled growth story; Buy

Anand Rathi Research 2

Quick Glance – Financials and ValuationsFig 1 – Income statement (Rsm) Year-end: Mar FY19 FY20 FY21e FY22e FY23e

Net revenues 15,930 17,082 17,583 20,099 23,929 Growth (%) 19.8 7.2 2.9 14.3 19.1

Direct costs 9,422 9,762 10,286 11,657 13,639

SG&A 4,468 4,857 4,659 5,326 6,341EBITDA 2,040 2,463 2,637 3,115 3,948 EBITDA margins (%) 12.8 14.4 15.0 15.5 16.5- Depreciation 656 735 1,011 1,125 1,167Other income 70 47 53 60 72Interest expenses 170 142 195 195 330PBT 2,007 1,804 1,484 1,855 2,522 Effective tax rate (%) 33.9 19.6 28.0 28.0 28.0+ Associates / (minorities) Net income 1,351 1,445 1,068 1,336 1,816Adjusted income 873 1,307 1,068 1,336 1,816WANS 69 69 69 69 69FDEPS (Rs / sh) 12.6 18.9 15.4 19.3 26.2 FDEPS growth (%) 3.0 49.7 -18.3 25.1 35.9 Gross margins (%) 40.9 42.9 41.5 42.0 43.0

Fig 3 – Cash-flow statement (Rsm) Year-end: Mar FY19 FY20 FY21e FY22e FY23e

PBT adj. OI and Interest 2,107 1,900 1,626 1,990 2,781 + Non-cash items 656 735 1,011 1,125 1,167Oper. prof. before WC 2,763 2,635 2,637 3,115 3,948 - Incr. / (decr.) in WC 723 (379) (273) 659 813 Others incl. taxes 638 403 415 520 706 Operating cash-flow 1,402 2,611 2,495 1,937 2,429 - Capex (tang. + intang.) 736 2,597 3,500 1,000 1,000 Free cash-flow 667 14 (1,005) 937 1,429 Acquisitions - Div. (incl. buyback& taxes) 500 500 320 401 545 + Equity raised - - - - - + Debt raised (638) 1,335 1,500 - (1,000) - Fin investments (5) 9 - - - - Misc. (CFI + CFF) (406) 766 142 135 259 Net cash-flow (61) 75 32 401 (375)Source: Company, Anand Rathi Research

Fig 5 – Price movement

Source: Bloomberg

Fig 2 – Balance sheet (Rsm) Year-end: Mar FY19 FY20 FY21e FY22e FY23e

Share capital 138 138 138 138 138Net worth 5,677 6,008 6,756 7,691 8,962Debt 3,671 5,006 6,506 6,506 5,506Minority interest - - - - -DTL / (Assets) 546 446 446 446 446Capital employed 9,894 11,460 13,708 14,643 14,914Net tangible assets 4,542 6,011 7,579 8,454 8,287Net intangible assets 107 192 192 192 192Goodwill - 68 68 68 68CWIP (tang. & intang.) 240 480 1,400 400 400Investments (strategic) 0 9 9 9 9Investments (financial) - - - - -Current assets (ex cash) 8,613 9,325 9,178 10,492 12,251Cash 81 156 188 589 215Current liabilities 3,690 4,781 4,907 5,562 6,508Working capital 4,923 4,544 4,271 4,930 5,743Capital deployed 9,894 11,460 13,708 14,643 14,914Contingent liabilities 165 200 - - -

Fig 4 – Ratio analysis Year-end: Mar FY19 FY20 FY21e FY22e FY23e

P/E (x) 36.2 24.2 29.6 23.6 17.4EV / EBITDA (x) 17.2 14.8 14.4 12.0 9.3EV / Sales (x) 2.2 2.1 2.2 1.9 1.5P/B (x) 5.6 5.3 4.7 4.1 3.5RoE (%) 17.3 22.4 16.7 18.5 21.8RoCE (%) - after tax 10.1 13.4 9.6 10.4 13.9RoIC 10.2 13.5 9.7 10.7 14.3DPS (Rs / sh) 6.0 6.0 4.6 5.8 7.9Dividend yield (%) 1.3 1.3 1.0 1.3 1.7Dividend payout (%) - incl. DDT 30.7 28.7 30.0 30.0 30.0Net debt / equity (x) 0.6 0.8 0.9 0.8 0.6Receivables (days) 79 78 77 77 73Inventory (days) 119 154 144 145 147Payables (days) 94 139 136 136 136CFO : PAT % 160.6 199.7 233.5 145.0 133.7Source: Company, Anand Rathi Research

Fig 6 – Revenue split

Source: Company

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Fourth-largest globally Incorporated in 1952, Sudarshan established itself as largest pigment producer in India (a 35% market share) and the fourth-largest producer in the world. At the beginning it manufactured only inorganic pigments. Over almost seven decades, it expanded its product basket to organic, inorganic and “effect” pigments, which cover classical azo pigments, specialised azo pigments, high-performance pigments, pearlescent pigments, pthalos and pigment dispersions.

It soon went global with operations in more than 85 countries, and sales offices in India, the Netherlands, the USA and China. It has more than 170 channel partners globally to serve its international market.

Fig 7 – Sudarshan in a Snapshot


It has two state-of-the-art manufacturing plants, at Roha and Mahad, and an R&D centre at Pune (all three in Maharashtra).

Fig 8 – Manufacturing plants

Source: Company, Anand Rathi research

Sudarshan Chemicals

35% market share in domestic pigment industry

2,000+ Global

Workforce with 60 Channel

Partners

4,000 Product Basket

2 Manufacturing

facilities

Presence + 85 countries

Wide product range Organic/

inorganic / effect pigments

4th Largest player

in the global market

Incepted in 1973

Products manufactured Azos Blue and green HPPs

Effect Pigments Agro Chemicals Inorganic

Products manufactured Effect pigments

High performance pigments Blue & green pigments

Commissioned in 1994 with 100tpm capacity

Sudarshan's Manufacturing

FacilitiesMahad Facility

(Mahad) Roha Facility

(Mumbai)



Fig 9 – Sudarshan’s Product portfolio Particulars Organic Pigments Inorganic Pigments Effect pigments

Nature Colored materials made carbon chains with pigment properties

Chemical compounds not based on carbon

Consisting of metallic flakes acts as miniature mirrors

Sourcing From natural and synthetic sources

Metallic compounds and salts such as chromates, metallic oxides,

sulphates etc.

Produced from silver, titanium, and platinum and can be

natural and synthetics

Type Azo, Phthalocyanine, Alizarin, Arylide and

others

Titanium Dioxide, Iron Oxide, Carbon Black

Mica flake

Application

Printing Ink, paints, plastics, rubber, optoelectronics,

cosmetics

Building & construction, automotive, packaging, paper &

printing, textiles, and others

Automotive Industry, coatings, paintings and personal care

industry

Properties

Good chemical resistance, light

fastness, chemical stability, bright & strong

colors

Heat Stability, chemical inertness, durability and weather resistance

Transparent, durable and chemical resistance

Key players- Globally

BASF SE, Heubach GmbH (Germany)

Clariant (Switzerland) Trust Chem Co.,

Changzhou Longyu pigments chemicals

(China) Ferro Corporation(US)

DIC corporation, Toyocolor co.,

Dainichiseika color & chemicals Mfg. co.

(Japan)

Venator (UK) The Chemours Company, Tronox Ltd, Kronos Worldwide, Inc., Ferro Corporation, Alabama Pigments Company, Cabot Corporation,

DyStar , INEOS Pigments (US) LANXESS, Heubach GmbH, Carl

Schlenk AG, ECKART GmbH (Germany)

Cathay Industries, Lomon Billions, Jiangsu Yuxing Industry & Trade

Co., Ltd. (China) Clariant (Switzerland)

Dominion Colour Corporation (Canada)

BASF SE, Clariant AG, Huntsman Corp., Altana AG,

Merck KGaA, DIC Corporation, Sensient Industrial Colours, Geotech International B.V.,

Kolortek Co., Ltd

Key players- Domestic

VOXCO Pigments and Chemicals Pvt Ltd,

Meghmani organics, Asahi Songwon

Tata pigments, VOXCO Pigments and Chemicals Pvt Ltd

-

Expected CAGR over five years

3 - 5% 3 - 5% 3 - 5%

Source: Anand Rathi research

Aiming at becoming the third-largest

The first plant manufactured only a few inorganic pigments. Over the years, the product basket was expanded, manufacturing capabilities were enhanced, geographic reach was widened. Today, Sudarshan is the fourth-largest globally and the largest in its home country, with a commanding 35% market share.

Now, it is aiming at becoming the third-largest in the industry. For this, it is working on a few strategies such as

Adding business lines with advanced technologies

Deep market penetration in paints, plastics, cosmetics and certain segments of printing inks, globally

Innovation to add more products to its basket



Capex to fuel growth To become the third -largest globally in pigments, in Sep’16, it announced that it would invest ~Rs10bn in the next five years. From FY12 to FY16 it incurred capex of Rs3.7bn; over FY17-19, Rs2.9bn and Rs2.6bn for FY20. The company has guided to invest Rs3.5bn in FY21 on different projects while capex execution in FY21 is expected to be delayed by six months due to outbreak of Covid-19.

Major capex would be to

Enhance and expand capacities at Roha and Mahad

Product launches

Backward integration to raw materials

Management says that capex would be in phases, chiefly to add products and lines. It aims to launch 20-25 products globally, and is adding lines for 2-3 products. The expected asset-turn would be 2–2.5x at peak utilisation with a payback of 4-5 years.

Fig 10 – Expected to incur Rs8.0bn capex over FY20-23


Restructuring by global manufacturers benefits Sudarshan

After two global leaders (BASF and Clariant) announced their exit from the business by end-2020, the global pigment industry is restructuring.

The German chemicals giant (BASF) announced it was selling its low-margin pigment division. It has a wide range of products, comprising “effect” and colour pigments.

According to BASF, the global pigments market is growing slower and is faced with challenges in sourcing raw materials and in trade conflicts in two key markets, China and the US. Further, competition with Asian manufacturers is intensifying, making it difficult for global manufacturers to compete and gain market share.

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Fig 11 – Pigment market structure Global producers Organic Inorganic Specialties

Clariant

BASF

DIC

Heubach

Ferro

Venator (excl. Huntsman)

Lanxess

Altana (Eckart)

Sudarshan (India)

Meghmani Organics (India)

Changzhou North American Chemical Group (China)

The Lily Group (Hangzhou Baihe Chemical) (China)

Source: Anand Rathi Research, Company

Total pigment exports (organic, inorganic, emulsions) from India grew 9.5% over FY10-18 from 68,600 tonnes in FY 10 to 142,500 tonnes in FY18.

Fig 12 – Rising exports from India

Source: Chemical and petrochemical statics, Anand Rathi Research

We believe that the exit of both these would help Sudarshan capture a greater market share internationally and expand its customer base in the ~$10bn global pigment market. BASF and Clariant are well-established in organic pigments. Sudarshan, though, has only 2% of the global revenue in organic pigments. Its continuous focus on high-margin specialty pigments, launches and fresh capacities would strengthen its position.

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Total Pigment export Growth (RHS)



Product development To cater to the global market and secure a better position, the company plans to launch ~20-25 products yearly. In FY19, it added 25 products largely for cosmetics. These are now in the sampling stage and are expected to start contributing revenue in coming quarters as lead times are longer.

Earlier, the company was expecting to launch one yellow high-performance pigment (it is only the second in the world to launch this), used in coatings and the plastics industries in FY20 which is now expected to be commissioned in FY21 due to lockdown and Covid-19. Its market size is estimated at ~Rs2.5bn.

Further, it intends to commercialise one high-performance organic pigment and one large molecule in FY21.

We believe that these products would help to future growth as the products are high-value, high-margin, and the market is in a nascent stage with only a few manufacturers.

Management says that revenue from the recently launched products is rising. In FY18, the new products brought Rs114m to revenue.

Divestment from other businesses to focus only on pigments

Aiming to become the third-largest globally, the company divested several businesses in FY18-19. Its strategy now would be to focus only on pigments.

Fig 13 – Sudarshan’s divestments

Segment / business Type of agreement To whom Effective

date Transaction Value Rsbn

Prescient Color (wholly-owned subsidiary)

Sale purchase Americhem. USA 1st Jun’18 1.17

Agro formulations brand business Business transfer 20th Sep’18

Industrial mixing solutions On a going-concern basis GMM Pfaudler 26th Apr’19 0.3


Further, it is continually seeking to divest its holdings in its wholly-owned subsidiary, RIECO Industries, on a going-concern basis. The latter is engaged in size-reduction equipment, and pneumatic conveyance and air-pollution-control systems.

Entry barriers despite being commodity products

Earlier, the pigment industry was commoditised in nature due to lack of product differentiation. Blue, green and azo are commodity pigments. Today, it has been transformed into a specialised industry due to changing customer needs for specialty and high-performance pigments. Now, every product is customised.

This requires strong R&D capabilities, technical knowhow, long gestation periods (6-24 months) and good customer relations. All these factors become high entry barriers. The approval time for pigment sales varies according to products, and the company is well placed in this regard.



Fig 14 – Pigment approval times and Sudarshan’s positioning

Segment Coatings Plastics Inks Cosmetics

Approval time Automotive: 1 to 5 yrs Decorative: 6 months

to a year

3 to 6 months 1 month 1 to 2 years

Pigment type High performance General purpose and high-performance

pigments

Effect pigments

Position Market leaders in many regions

Proven record with significant growth

Future strategy Coatings are a prominent focus

Key focus segments –automotive, decorative

Focus on niche applications: liquid inks

to build competency


Being the market leader with almost seven decades’ experience, Sudarshan is well-established and has a competitive edge over others.

Fig 15 – High entry barriers

Source: Company

Focus on global markets

To expand its geographic operations and cater to the international market, the company has subsidiaries, sales offices and branches internationally. It now exports to more than 85 countries (exports bring ~50% to revenue). It has sales and trading offices in the USA, Europe, China, Mexico and Brazil. Its percentage of export revenue has climbed from 34% in FY11 to 48% in FY20. Its major sales are to Europe, followed by Asia Pacific market and North America.

Long approval process & customized

products

R&D capabilities

Customer relation

Technical knowhow

Entry Barriers



The global market for pigments is ~$10bn and the company’s focus area of exports lies in the vast opportunities there. Sudarshan’s overseas offices report improved performances and have entered a consolidation phase. This would play a crucial role in positioning the company as dominant in global pigments.

Fig 18 – Subsidiaries Name Nature Holding % Revenue (Rsm) % of revenue

Sudarshan North America Inc., USA Step- down 100 772 5

Sudarshan Europe BV, The Netherlands Subsidiary 100 2,360 14

Sudarshan (Shanghai) Trading Company Subsidiary 100 132 1

Sudarshan Mexico S de R.L. De CV Step- down 100 317 2

RIECO Industries Ltd Subsidiary 100 1,196 7


Diversified product range

Sudarshan worked on strategy to diversify its product range. The company has been expanding its brands. With this, it has built a robust product portfolio which boosts the performance of end-application products.

Fig 19 – Brief details of brands Brand Name Category Type Application

Sudaperm High-performance / premium range Plastics and coatings

Sudafast Medium performance / consistent high quality Organic Coloration

Sudacolor Quality, value and easy-use pigments Organic Coatings

Sudadur Extensive range Inorganic For durable colour

Sudafine Complimentary range of high pigment Decorative paints, other applications

Sudatex Concentrated water-based dispersions Dispersion Textiles

Sumica Pearlescent pigments HPP & effect Plastics, coatings, inks.

Sumicos Pearlescent pigments HPP & effect Colour, cosmetics


Fig 16 – Domestic and export revenue split

Source: Company

Fig 17 – Exports break-up


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23%

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Export Domestic

Europe35%

South America7%

Asia Pacific15%

North America11%

Rest of World32%



Fig 20 – Key brands


Fig 21 – Market positioning of brands

Source: Company

We believe that product expansion and the diversification to high-margin products would help the company cater to the growing international market in the near future. The coming capacities would help address additional demand and enhance penetration in global markets.

Strong R&D capability, with focus on innovation

R&D is the backbone of the segment, driven by meeting specific customer needs when manufacturing a particular product. The R&D thrust is on improving production processes, enhancing the quality of products and creating new additives and downstream products.

The strong technical capabilities at its R&D centre at Pune have been enhanced with more than 100 scientists and technical staff, who seek greater efficiencies, competencies, product development and innovations. The three labs are NABL-accredited and DSIR-approved. The company invests 1–1.5% of revenue annually on its R&D centre.

Brands offered by Sudarshan

Sudaperm (High

performance) Sudafast (Medium

performance pigments)

Sudacolor (Quality, value and easy-use

pigments)

Sudadur (Pigments for durable color)

Sudafine (Easy-to-use

stir-in pigments)

Sudatex (Pigments

dispersions for textiles)

Sumica (Pearlescent

pigments)

Sumicos (Pearlescent

pigments)



Fig 22 – ~1–1.5% of revenue on R&D

Source: Company

Raw material

Major raw materials used are CPC blue

Litharge and lead

Naphthols

3.3 di chloro benzidine di hydro chloride

5-amino, 6-methyl benzimidazolone

Di methyl succinylo succinate

Beta naphthols

Bon acid

Titanium oxy chloride

Uncalcined / calcined mica

Sodium bi chromate

Pricing mechanism and sourcing contracts

The company procures raw materials from India and internationally, chiefly China. Management says it works on a pass-through model with quarters’ lag effect. The delay in pass-through impacts the gross margins. To obtain raw materials from China (more than a third of its requirements are sourced from there), a wholly-owned subsidiary has been established in that country.

In the last two years, sourcing of raw material has been hit by the shutting of some factories in China. This has led to a rise in raw-material prices and a demand-supply gap. Currently the company is well stocked.

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Fig 23 – Gross margins and EBITDA margin to improve


Management says prices of key raw materials stabilised in the last quarter. Further, for a better position in the global market and to reduce dependence, the company plans to backward integrate its processes for sourcing raw materials. This would help expand the gross margins.

Rupee-rate depreciation against the dollar, beneficial in the short term

The company is net positive of foreign currency exposure. The Indian Rupee depreciated to Rs74 in Sep’20 against the USD as compared to Rs70 in Sep’19. Any further depreciation will contribute positively to its earnings.

Fig 24 – Positive foreign currency exposure

Source: Company

COVID-19 and lockdown impact

Sudarshan chemicals derive half their revenue from exports. While the country exports to 85+ countries, substantial part of the exports (mid teen’s percentage) comes from the Netherlands. USA, UAE and Turkey have major clients for the company. As per our channel checks, velocity of sales might be impacted due to clogged logistics channels.

What happened in Q4 and Q1

The company’s plants were closed during the lockdown. The Roha plant resumed operating from 5th Apr’20 and is now at normal levels while the Mahad plant started operations from 11th Apr’20 and is operating at lower levels due to shortage of labour and social distancing.

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In last week of June, the company’ operations and productions were closed due to Covid-19 cases. The company lost production for 15 days in July also. It expect to make it up in Q2 itself

Per management, it lost Rs1.25bn revenue in Q4 and Rs450m in last week of Jun’20 due to production loss.

Sudashan sources ~25% of raw material from China and considering the present geo-political situation, the company maintains higher RM stocks than in the past.

Management said that, for some products, it has another supply option; for other products, though, it completely depends on China and is looking for other options to de-risk supplies.

In Q1, demand from international market was strong. Export demand increased due to lower exports from China, where utilization was lower. The company is doing well in the US and Europe.

Going forward

The company guided that due to lower capacity utilization in domestic industry on account of outbreak of covid-19 would impact the industry performance in H1. It is expected that industry performance would recover from H2 and achieve pre Covid level utilization.

The company is expanding its product range by considering the fact that shifting of sourcing from China to India would help it better serve customers

The company is receiving new orders and enquiries from the clients. It expects a strong performance from the next quarter.

What are pigments?

Pigments are chemicals that add colour to a material. Being water- and oil-insoluble, these natural and synthetic products alter light reflected and absorbed by an object or material, thus producing a perceivable colour.

They are used to colour any object, coating or blending them with the product ingredients. Based on chemical properties, pigments can be put into two categories: organic and inorganic.

Fig 25 – Pigments

Source: Anand Rathi Research

Classification

Organic pigments are based on carbon chains and carbon rings. They may also contain metallic (inorganic) elements that help stabilise the properties of the organic component.

Pigments

Organic Inorganic Effect

Phthalos

AZO

HPP

Dispersions

Cadmiums

Chromes Mica base for industrial and

cosmetics

Iron Oxides



Inorganic pigments are chemical compounds not based on carbon. They are usually metallic salts precipitated from solutions.

Effect pigments are mica-based and coated with oxides to provide glow and shimmer.

Pigments – Global market

In the ~$10bn global pigment market, organic pigments are the largest (~$5bn) followed by inorganic pigments ($3bn) and “effect” pigments ($0.6bn). On application and end-user basis, coatings and plastics industries are the largest pigment consumers.

Fig 26 – Global market size of the pigments segment

Source: Company

Expected future growth of industry

Supported by end-user industries, chiefly coatings and plastics, the organic pigment market is expected to grow at a softer 3% in the next 1-2 years.

The inorganic pigments market is estimated at $3bn globally, and is expected to clock a ~3–3.5% CAGR in the next 1-2 years, widely used in paints and coatings, plastics and construction materials, all of which would drive growth.

The “effect” pigment segment is expected to register a 3% CAGR over next two years. Such pigments are increasingly used in coatings for automotives, plastics and cosmetics since consumer preferences are moving toward product differentiation and enhancing appearances. Automotives are the largest end-application as customers seek high performance and visual appeal.

Growth in the mid-term would be impacted chiefly by the slowdown in the auto industry globally as well as at home, the ongoing US-China trade war and regulations and norms regarding the use of plastic.

The Indian pigment sub-segment

The Indian pigment market has been transformed from export-dependent to export-driven. It is expected to touch Rs2.95bn by 2026.

Pigment-user industries

Paints and coatings are the dominant users of pigments globally, followed by plastics, printing inks, construction and others. Sudarshan is uniquely set to offer a comprehensive range, from general-purpose grades to high-performance and “effect” pigments.

Organic$5bn

Inorganic$3bn

Effect$0.6bn



Fig 27 – End-user industries’ shares

Source: Company

Expected growth drivers of end-user industries

Paints & Coatings: Demand for paints and coatings is expected to be dominated by the automotive industry. Industrial OEMs use industrial coatings in the production processes. Further, changes in customers’ taste from traditional to glossy are expected to boost demand for paints and coatings.

Some challenges would remain as the global and domestic auto industries are still faced with headwinds, expected to continue for awhile. A pick-up in auto demand is expected in the short to mid-term. Management says the impact of the domestic auto slowdown was not material as the company’s exposure to auto manufacturers is mainly in the exports market.

Plastics / Masterbatches: Developing countries’ mounting rising demand for packaging is primarily driving demand for pigments for plastics which in turn drive the demand for masterbatchs and pigments.

Demand for pigments for plastics is expected to grow because of

Increasing need for aesthetics in packaging

Rising industrialisation in emerging economies and

Huge demand for high-performance pigments

On the other hand, the ban on single-use plastics in the home market would curb demand for pigments for plastics. The management said that such pigments were struck by the government ban on single-use plastics. Management says that, if the ban continues, some (though not a large) impact would be seen on the performance, as the use of colour pigments is not very large in this segment.

Inks: Printing inks is the largest application for organic pigments. Key industries driving demand are

Plastic packaging of food & beverages

Consumer goods

Print media

Besides, stringent government regulations about the use of organic pigments in food-contact materials would further drive demand.

Coatings & Paints50%

Plastics30%

Inks15%

Cosmetics5%



Cosmetics: Pigments for cosmetics have been segmented according to application:

Facial make-up

Eye make-up

Lip products

Nail products

Hair-colour products

Special-effect and special-purpose products

Mounting demand for root make-up products such as foundations and face powders is expected to drive cosmetics pigments in facial make-up. Further, an aging population, rise of e-commerce as a distribution channel and better living standards are expected to drive growth in cosmetic pigments.

The Indian pigment sub-segment

In India, pigments clocked a 4.7% CAGR over 2012-17. Strong demand from end-user industries, the better position in the global market, cost competiveness, focus on high-performance pigments and working to environmental norms would be key triggers to the industry’s growth in India, expected to register 6.9% over 2017-22.



Financials Sudarshan Chemicals’ capacity expansion is in sync with rising demand at end-user industries, offering assurance of decent revenue in the next three years.

A 17% revenue CAGR over FY21-23

We expect Sudarshan to deliver a 17% revenue CAGR over FY21-23 (to ~Rs24bn), against 13% over FY18-20 and 9% over FY13-20. This would be driven by the rising proportion of high-margin products, huge capex, launching of three large products and expanding geographical reach. Management says utilisation currently is ~80-85%. The coming capacities and new product lines would contribute to revenue growth.

Fig 28 – Revenue to clock a 17% CAGR over FY21-23


EBITDA margin to hold

The company has, in the past, continually improved its EBITDA margin, from 8.9% in FY13 to ~14.4% in FY20. In Q1FY21, too, it expanded to 15.0%, driven by the passing on of raw-material costs, cost optimisation, the rising proportion of high-margin products and swelling gross margins. We believe that margin would expand to ~16.5% over FY20-23 driven by high-margin products launched, better cost control and the rising percentage of high-performance pigments in revenue.

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Fig 30 – EBITDA-to-gross-block


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Sudarshan’s EBITDA-to-gross-block ratio improved continually, from 25% in FY11 to 28% in FY20. We expect it would be hold within the range of 24-28% over FY21-23, as the company is investing heavily on assets (Rs8bn over FY20-23). The gross block is expected to double to Rs14bn in FY23 from Rs6.4bn in FY19.

PAT would grow at 30% CAGR over FY21-23

We expect a 30% net profit CAGR over FY21-23 against 24% over FY18-20 and 25% over FY13-20 on account of healthy revenue growth, an expanding operating margin and lower tax expenses, though partial funding of capex through debt and higher depreciation expenses would eat into profitability.

Fig 31 – PAT to clock 30% CAGR over FY21-23


Return ratios

We expect a mean reversal in the return ratios to the past average as the company is investing substantially in capex over the next three years. From 22.4% in FY20, a 16.7% RoE is expected in FY21, 18.5% in FY22 and 21.8% in FY23. The RoCE is expected to rise ~380bps over FY19-23 to ~13.9%, from 10.1% in FY19.

Fig 32 – Return ratios


Capex funded by debt and cash flows

The ~Rs5.5bn capex over FY21-23 for different projects would be funded from internal accruals and debt. In FY20, debt rose by ~Rs1.3bn. Due to the capex, we expect negative FCF in FY21, and a positive ~Rs2.4bn FCF over FY22-FY23.

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Despite the large, ~Rs5.5bn, capex, the company’s net-debt-to-equity ratio would hold within a similar range of ~0.8x over FY20-23, against 0.6x in FY19. Its debt-equity ratio has improved from 1.5x in FY13 to 0.6x in FY19 due to greater profits and better leveraging while it rose to 0.8x in FY20 due to capex.

Cash-conversion cycle

In the last few years, the company has shifted focus on working-capital management, mainly on inventory and the payables cycle. This resulted in the cash-conversion cycle shortening from ~179 days in FY13 to 96 in FY18, 105 in FY19 and 92 days in FY20. It lengthened in FY19, chiefly due to fewer payable days. We expect the 80-85 cash-conversion cycle to be maintained over FY21-23.

Fig 33 – Capex / FCF / OCF


Fig 34 – Debt and D/E


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Fig 36 – Working-capital days


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Valuations To arrive at the true value of Sudarshan Chemicals, we use the DCF method. The 10% WACC used has been arrived at as follows

Fig 37 – WACC Equity (FY20) (Rsm) 6,008

Cost of equity (%) 11.0

Debt (FY20) (Rsm) 5,006

Cost of debt (%) 8.0

Weighted average cost of capital (%) 9.6


To arrive at future cash-flows, a 5% terminal growth rate has been assumed.

Fig 38 – Present value of FCFF (Rs m) FY21e FY22e FY23e FY24e FY25e FY26e FY27e FY28e FY29e FY30e FY31e

EBIT 1,679 2,051 2,426 2,870 3,395 4,016 4,751 5,621 6,649 7,866 9,305

EBIT (1-t) 1,209 1,476 1,747 2,066 2,444 2,892 3,421 4,047 4,787 5,664 6,700

Depreciation 1,011 1,125 1,193 1,265 1,342 1,423 1,509 1,600 1,697 1,799 1,908

WC changes 273 (659) (779) (922) (1,091) (1,290) (1,527) (1,806) (2,137) (2,527) (2,990)

Capex (3,500) (1,000) (800) (848) (900) (954) (1,012) (1,073) (1,138) (1,206) (1,279)

FCFF (1,007) 943 1,360 1,561 1,796 2,070 2,391 2,768 3,210 3,729 4,339

PV of FCFF (919) 784 1,032 1,080 1,133 1,192 1,256 1,326 1,402 1,486 1,577


DCF-based valuation

Fig 39 – Target price (Rs m) PV 11,351

Terminal value 34,014

Debt (5,006)

Cash 156

Total value 40,515

No. of shares 69

Target price (Rs) 585


To fund the guided-to capex, debt would rise. We have arrived at a target price of Rs585. At this, the stock is valued at a PE multiple of 30.3x FY22e and 22.3x FY23e. This gives the company a PEG of ~0.7x FY23e. On an EV/EBITDA, it is valued at 14.9x FY22e and 11.6x FY23e.



Peer valuations

Fig 41 – Peer comparison (Rs bn) Revenue EBITDA PAT Revenue growth (%) EBITDA margins (%)

Company FY20 FY21e FY22e FY23e FY20 FY21e FY22e FY23e FY20 FY21e FY22e FY23e FY20 FY21e FY22e FY23e FY20 FY21e FY22e FY23e

Galaxy 26.0 26.1 30.2 33.6 3.7 3.5 4.1 4.7 2.3 2.0 2.4 2.9 (6.0) 0.6 15.6 11.4 14.2 13.5 13.5 14.0

Aarti Industries 41.9 46.5 55.4 68.4 9.8 10.0 12.5 15.0 5.4 5.2 6.7 8.4 0.4 11.0 19.3 23.3 23.3 21.5 22.5 22.0

Atul 40.9 44.1 52.1 59.1 9.0 9.7 11.5 12.7 6.7 6.6 7.7 8.5 1.4 7.6 18.3 13.5 22.0 22.0 22.0 21.5

Fine Organics 10.4 11.3 13.5 16.0 2.4 2.4 3.0 3.7 1.6 1.7 2.2 2.7 (2.1) 8.5 19.9 18.7 23.2 21.0 22.0 23.0

Vinati 10.3 12.3 17.6 23.3 4.1 4.5 6.3 8.3 3.3 3.4 4.8 6.4 (8.8) 19.7 43.1 31.8 40.2 36.6 35.6 35.6

Navin Fluorine 10.6 11.7 14.7 18.7 2.6 3.0 3.9 5.0 1.7 2.2 2.7 3.9 6.6 10.1 25.7 26.9 24.8 26.0 26.5 27.0

SRF* 72.1 78.1 92.5 109.8 14.5 14.5 14.5 14.5 10.2 6.6 9.5 12.1 1.5 8.3 18.4 18.8 20.2 19.9 20.6 20.3

Deepak Nitrite* 42.3 36.5 42.6 50.1 10.3 8.6 10.1 11.4 6.1 5.2 6.5 7.6 56.7 (13.8) 16.8 17.7 24.3 23.5 23.8 22.8

Sudarshan 17.1 17.1 17.1 17.1 2.5 2.6 3.1 3.9 1.3 1.1 1.4 1.8 7.2 2.9 14.3 19.1 14.4 15.0 15.5 16.5

Source: Company, Anand Rathi Research, *Bloomberg Consensus

Fig 42 – One year forward PE band chart


Fig 43 – One year forward EV/EBITDA band chart


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Fig 40 – Peer comparison M Cap EV P/E (x) EV/EBITDA(x) EV/Sales (x)

Company (Rs bn) (Rs bn) FY20 FY21e FY22e FY23e FY20 FY21e FY22e FY23e FY20 FY21e FY22e FY23e

Galaxy 64.9 68.2 28.2 32.2 26.7 22.7 18.5 19.3 16.5 14.0 2.6 2.6 2.2 2.0

Aarti Industries 178.1 196.6 33.2 34.4 26.5 21.3 20.1 20.3 16.1 13.3 4.7 4.4 3.6 2.9

Atul 178.9 179.6 26.8 26.9 23.4 21.1 19.2 17.8 15.0 12.9 4.2 3.9 3.3 2.8

Fine Organics 83.3 82.4 50.6 49.9 38.0 30.3 34.3 34.8 27.4 21.7 7.9 7.3 6.0 5.0

Vinati 138.6 138.1 41.5 40.8 28.8 21.7 32.8 29.8 21.1 15.6 13.2 10.9 7.5 5.6

Navin Fluorine 101.7 98.0 25.0 45.4 38.1 26.1 37.1 33.0 25.9 19.9 9.2 8.6 6.9 5.4

SRF* 239.7 279.8 23.5 37.1 25.7 20.2 19.1 17.9 14.4 12.0 3.9 3.6 3.0 2.4

Deepak Nitrite* 114.4 125.2 18.7 22.0 17.5 15.0 12.2 14.1 11.5 9.6 3.0 3.3 2.7 2.2

Sudarshan 31.6 36.5 24.2 29.6 23.7 17.4 14.8 14.4 12.0 9.3 2.1 2.2 1.9 1.5

Average 30.2 35.4 27.6 21.8 23.1 22.4 17.8 14.3 5.6 5.2 4.1 3.3

Source: Company, Anand Rathi Research, *Bloomberg Consensus



Risks

Fluctuations in raw-material prices. The company’s largest expense (58% of revenue) is raw-material cost. Any rise in such costs due to disruption in China would slash margins and profitability.

Foreign currency fluctuation. ~50% of revenue is generated from exports denominated predominantly in US dollar and euro. Fluctuations in the value of the rupee against such foreign currencies, to the extent not hedged, would result in gains or losses.

Delay in capex implementation. The earnings estimated in FY 23 encompass the utilisation of the new capitalised gross block. Delay in capex implementation will further delay the earnings growth.

Protracted global slowdown, leading to a continual deceleration in key consumer sectors.



Company Background & Management Almost seven decades’ experience

Incorporated in 1952, Sudarshan Chemicals, of the Rathi Group of companies, established itself as one of the largest producers of organic and inorganic pigments globally, with a 35% domestic market.

Fig 44 – Key milestones

Source: Company

Phase I

1951-1988 Business

Establishment

1951: Established as Sudarshan Chemical Industries Pvt Ltd

1952: Started its first manufacturing facility in Swargate, Pune

1961: Began manufacturing of organic pigments

1967: Started exporting globally

1968: Built a new plant in Pune

1973: Established manufacturing facility at Roha

Phase II 1989-2006

Focus on technology

1989: Collaboration with world leader, DIC, Japan

1993: Became the first Indian chemical company to receive ISO 9001 certificate

1994: Commenced manufacturing plant Mahad for Pthalos and Effect pigments

1999: Introduced SAP across all its functions

Phase III 2006-2018

Converting as Global company

2006: Established a state-ofthe- art technology R&D centre at Sutarwadi

2007: Established subsidiarySudarshan Europe BV

2009: Expanded itsfootprints in the USA, incorporation ofSudarshan NorthAmerica

2010: Received Swordof Honour from the British SafetyCouncil

2017: Started co-gen plant

2018: Established SudarshanMexico and invested in renewable source of energy such as windmill, solar energy

Phase IV 2019 onwards

To be third largest company

2019: Sudarshan established laboratory in Germany

Fig 45 – Technically qualified management team Name Designation Description

Pradeep R. Rathi Chairman Master’s of Science in chemical engineering from MIT, USA and M.B.A. from Columbia University, USA. Heis associated with the company for more than three decades.

Rajesh Rathi MD B.E. Mechanical engineer from MIT, Pune; B.Sc. Chemical engineer from Ohio State University, USA and an MBA from Pittsburgh University, USA. He has been associated with the company for more than two decades.

Ashish Vij Whole time Director

BE (Chemical) UDCT, from Punjab University. He is a certified six sigma black belt and lean practitionerfrom Uniworld, USA and Breakthrough management group India. He has also completed strategyintervention programme from the strategy academy of Mr. Ranjan Das (Strategy Prof. of IIMC) Mr. Vij has been associated with the Company for more than fifteen years.

Tushar Ramesh Shah Executive Director, CEO Bachelor’s in Science from Bombay University. Associated with the company since 1989

Bimal Mukesh Shah Executive Director, VP

(Projects)

Bachelor’s in Science, Purdue University. Master’s in Management from Boston College. Joined a promotergroup entity in 2009. Has been involved with projects encompassing vision & strategy development,operational excellence, business transformation and technology & knowledge transfer initiatives

Kaushik Dwarkadas Shah Independent Director B.Com, Bombay University; CA, CS. Work experience in managing the business of pharmaceutical operations

Mahesh Pansukhlal Sarda Independent Director B.Com. Bombay University; LLB Saurashtra University, CA

Parthasarathi Thiruvengadam

Independent Director Bachelor’s in Chemical Engineering from IIT, Madras; post-graduate diploma in industrial engineering from The Training Institute for Productivity & Industrial Engineering. Fellow of The Institute of Cost Accountants ofIndia. Work experience in management consulting

Pratima Umarji Independent Director LLB from Bombay University. Panel member “Lok Adalat” set up by the Bombay High Court

Source: Company

Appendix Analyst Certification The views expressed in this Research Report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. The research analysts are bound by stringent internal regulations and also legal and statutory requirements of the Securities and Exchange Board of India (hereinafter “SEBI”) and the analysts’ compensation are completely delinked from all the other companies and/or entities of Anand Rathi, and have no bearing whatsoever on any recommendation that they have given in the Research Report. Anand Rathi Ratings Definitions

Analysts’ ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described in the Ratings Table below:

Ratings Guide (12 months) Buy Hold Sell Large Caps (>US$1bn) >15% 5-15% <5% Mid/Small Caps (<US$1bn) >25% 5-25% <5% Research Disclaimer and Disclosure inter-alia as required under Securities and Exchange Board of India (Research Analysts) Regulations, 2014

Anand Rathi Share and Stock Brokers Ltd. (hereinafter refer as ARSSBL) (Research Entity) is a subsidiary of Anand Rathi Financial Services Ltd. ARSSBL is a corporate trading and clearing member of Bombay Stock Exchange Ltd, National Stock Exchange of India Ltd. (NSEIL), Multi Stock Exchange of India Ltd (MCX-SX) and also depository participant with National Securities Depository Ltd (NSDL) and Central Depository Services Ltd. ARSSBL is engaged in the business of Stock Broking, Depository Participant and Mutual Fund distributor.

The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors and firm revenues.

General Disclaimer: This Research Report (hereinafter called “Report”) is meant solely for use by the recipient and is not for circulation. This Report does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The recommendations, if any, made herein are expression of views and/or opinions and should not be deemed or construed to be neither advice for the purpose of purchase or sale of any security, derivatives or any other security through ARSSBL nor any solicitation or offering of any investment /trading opportunity on behalf of the issuer(s) of the respective security (ies) referred to herein. These information / opinions / views are not meant to serve as a professional investment guide for the readers. No action is solicited based upon the information provided herein. Recipients of this Report should rely on information/data arising out of their own investigations. Readers are advised to seek independent professional advice and arrive at an informed trading/investment decision before executing any trades or making any investments. This Report has been prepared on the basis of publicly available information, internally developed data and other sources believed by ARSSBL to be reliable. ARSSBL or its directors, employees, affiliates or representatives do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information / opinions / views. While due care has been taken to ensure that the disclosures and opinions given are fair and reasonable, none of the directors, employees, affiliates or representatives of ARSSBL shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way whatsoever from the information / opinions / views contained in this Report. The price and value of the investments referred to in this Report and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not a guide for future performance. ARSSBL does not provide tax advice to its clients, and all investors are strongly advised to consult with their tax advisers regarding taxation aspects of any potential investment.

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Statements on ownership and material conflicts of interest, compensation - ARSSBL and Associates

Answers to the Best of the knowledge and belief of ARSSBL/ its Associates/ Research Analyst who is preparing this report

Research analyst or research entity or his associate or his relative has any financial interest in the subject company and the nature of such financial interest. No

ARSSBL/its Associates/ Research Analyst/ his Relative have actual/beneficial ownership of one per cent or more securities of the subject company, at the end of the month immediately preceding the date of publication of the research report?

No

ARSSBL/its Associates/ Research Analyst/ his Relative have actual/beneficial ownership of one per cent or more securities of the subject company No

ARSSBL/its Associates/ Research Analyst/ his Relative have any other material conflict of interest at the time of publication of the research report? No

ARSSBL/its Associates/ Research Analyst/ his Relative have received any compensation from the subject company in the past twelve months No

ARSSBL/its Associates/ Research Analyst/ his Relative have managed or co-managed public offering of securities for the subject company in the past twelve months

No

ARSSBL/its Associates/ Research Analyst/ his Relative have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months

No

ARSSBL/its Associates/ Research Analyst/ his Relative have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months

No

ARSSBL/its Associates/ Research Analyst/ his Relative have received any compensation or other benefits from the subject company or third party in connection with the research report

No

ARSSBL/its Associates/ Research Analyst/ his Relative have served as an officer, director or employee of the subject company. No

Other Disclosures pertaining to distribution of research in the United States of America

This research report is a product of ARSSBL, which is the employer of the research analyst(s) who has prepared the research report. The research analyst(s) preparing the research report is/are resident outside the United States (U.S.) and are not associated persons of any U.S. regulated broker-dealer and therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

This report is intended for distribution by ARSSBL only to "Major Institutional Investors" as defined by Rule 15a-6(b)(4) of the U.S. Securities and Exchange Act, 1934 (the Exchange Act) and interpretations thereof by U.S. Securities and Exchange Commission (SEC) in reliance on Rule 15a 6(a)(2). If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not the Major Institutional Investor.

In reliance on the exemption from registration provided by Rule 15a-6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain business withMajor Institutional Investors, ARSSBL has entered into an agreement with a U.S. registered broker-dealer, Cabrera Capital Markets. ("Cabrera"). Transactions in securities discussed in this research report should be effected through Cabrera or another U.S. registered broker dealer.

1. ARSSBL or its Affiliates may or may not have been beneficial owners of the securities mentioned in this report.

2. ARSSBL or its affiliates may have or not managed or co-managed a public offering of the securities mentioned in the report in the past 12 months.

3. ARSSBL or its affiliates may have or not received compensation for investment banking services from the issuer of these securities in the past 12 months and do not expect to receive compensation for investment banking services from the issuer of these securities within the next three months.

4. However, one or more of ARSSBL or its Affiliates may, from time to time, have a long or short position in any of the securities mentioned herein and may buy or sell those securities or options thereon, either on their own account or on behalf of their clients.

5. As of the publication of this report, ARSSBL does not make a market in the subject securities.

6. ARSSBL or its Affiliates may or may not, to the extent permitted by law, act upon or use the above material or the conclusions stated above, or the research or analysis on which they are based before the material is published to recipients and from time to time, provide investment banking, investment management or other services for orsolicit to seek to obtain investment banking, or other securities business from, any entity referred to in this report.

© 2019. This report is strictly confidential and is being furnished to you solely for your information. All material presented in this report, unless specifically indicated otherwise, is under copyright to ARSSBL. None of the material, its content, or any copy of such material or content, may be altered in any way, transmitted, copied or reproduced (in whole or in part) or redistributed in any form to any other party, without the prior express written permission of ARSSBL. All trademarks, service marks and logos used in this report are trademarks or service marks or registered trademarks or service marks of ARSSBL or its affiliates, unless specifically mentioned otherwise.

Additional information on recommended securities/instruments is available on request.

ARSSBL registered address: Express Zone, A Wing, 9th Floor, Western Express Highway, Diagonally Opposite Oberoi Mall, Malad (E), Mumbai – 400097. Tel No: +91 22 6281 7000 | Fax No: +91 22 4001 3770 | CIN: U67120MH1991PLC064106.

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