Aarti Industries: Multi-year contracts makes it a partner of choice for global majors; accumulate

Aarti Industries has announced another multi-year contract with a leading global chemical major for supply of a specialty chemical intermediate. The supply contract is worth Rs 900 crore, spread over 10 years, starting Q4 FY21. Interestingly, the product under focus is not part of the company’s existing portfolio and the process has been jointly developed over the last four years. The management said that end use of the product is a new growth initiative from the client. Currently, supply quantities from the contract is limited as it is used to seed the market and increase the potential market size of the product.

Also read: Strong domestic demand, China factor aids earnings outlook

To implement this deal, Aarti Industries has to do an upfront capex of $15 million (Rs 108 crore) for setting up a dedicated plant in Gujarat. This multi-year foray adds to company’s product portfolio and supply contract and implies average annual revenue accretion of Rs 90 crore per year (around 2.5 percent of FY18 sales).

Interestingly, multi-year contracts with the global chemical majors are now a norm and Aarti Industries has emerged as a partner of choice for sourcing chemical intermediates. In the last one-year, the company has bagged multi-year contracts from a global agrichemical company (valued at Rs 4,000 crore) and a chemical conglomerate (Rs 10,000 crore). In the contract with a global agrichemical company, the company would supply agrochemical intermediate for 10 years, starting H2 FY20. In the later contract, the company would provide chemical intermediate for a period of 20 years starting Q1 FY21.

These cumulative multi-year contracts imply that on an average the company’s revenue would increase by 26 percent on FY18's base.

The new supply contract deal re-emphasises the trend of easternisation of chemical manufacturing. Over the years, there has been a shift in chemical manufacturing from developed countries to Asia due to reasons of cost efficiencies, environment and availability of technical know-how. Within Asia, India has emerged as a preferred destination, partially aided by China’s supply-side reforms. However, as far as Aarti Industries is concerned, the company has apparently moved up the value chain and now participates in the optimisation and execution of niche chemistry processes.

On the company outlook, we continue to expect double-digit volume growth for specialty chemicals in the near term, aided by capacity expansion and higher domestic demand. The pharmaceutical segment should continue to benefit from higher product pricing due to ongoing disruption in the Chinese active pharmaceutical ingredient (API) market.

We believe the stock of Aarti Industries, after the recent correction, is now trading at reasonable multiples (21/17 times FY20 and FY21 estimated earnings, respectively), factoring in an estimated EBITDA CAGR (FY18-21) of about 24 percent.

Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here