Fine Organics: A play on the regulated and high margin segments of oleochemicals

Oleochemicals — chemicals derived from plant origins — have gained usage in varied consumer-facing businesses over the years. We look at two listed companies in this market, operating in niche segments, where entry barriers are high and the end-use demand is strong, and decode which ones investors should be looking at.

While the global market size of oleochemicals, estimated at $25.9 billion, is a tiny subset of the $4.5 trillion global market for chemicals, it is expected to grow in double-digits in the medium term. A key driving force is need for environmental friendly alternatives to petrochemicals. Further, research has helped in expanding applications across industries.

Source: Fine Organics, Moneycontrol Research

In the early part of the value chain, the technology to make base oleochemicals is easily available which makes these products more commoditised. But the green derived additives from base oleochemicals is a specialised process with few players having the technical know-how.

Over years, these oleochemicals have become essential to industries such as coatings, surfactants, plasticisers, lubricant additives, cosmetics, soaps, detergents, textiles, plastics and organic pesticides.

Regulation is another reason why there are few companies in this industry, apart from access to intellectual property and process technology. The approval process is lengthy, taking three-to-five years and involves an expensive customer product approval process. Since these additives have a direct impact on human life and the environment, it necessitates stringent regulatory requirements (FDA, FSA, REACH).

There are a few players who have gained global scale in the sub-segments of oleochemicals that they are operating in. Here are two companies we are looking at: Fine Organics (CMP: Rs 1,334, market capitalistaion: Rs 4,089 crore) and Galaxy Surfactants (CMP: Rs 1,038, m-cap: Rs 3,679 crore).

Galaxy Surfactants makes surfactants that are used by the makers of personal care and household cleaning products. The applications in these segments constitute about 55 percent of the global surfactants industry. The company caters to most known names in the FMCG sector such as Unilever, Colgate, P&G, Dabur, Reckitt Benckiser, and L’Oreal.

About three-fourth of Fine Organics’s revenue comes from plastic additives which are used to improve various functional and processing properties for the plastic, packaging and petrochemical industries. The rest comes from food additives (emulsifiers, preservatives) and other end-user markets such as personal care and feed nutrition. Some of the large global companies in FMCG and plastic processing are its clients.

Both players are aiming to strengthen their positions globally. Galaxy Surfactants has a large capacity catering to surfactants and is running at near 60 percent utilisation. It plans to increase it by around 20 percent by next quarter through a brownfield expansion at a cost of Rs 100 crore. Fine Organics aims at nearly doubling capacity in almost one-and-a-half year with a focus on food additives, cosmetics additives, feed nutrition and bakery pre-mixes.

Compared to MNCs such as BASF, their production capacities still appear small but their strength lies in niche sub-segments. While Fine Organics is one of the world’s top six companies making plastic additives and specialty food emulsifier sub-segments, Galaxy holds around 15 percent market share in phenoxyethanol -– a key preservative in the personal care industry.

Raw materials are derived from a range of vegetable oils where supply-demand is affected by overlapping applications such as biofuels. In case of Fine Organics, about 70 percent of its requirement is sourced domestically, while raw materials derived from palm and palm kernel oil are imported.

In case of Galaxy, feedstock is derived from palm oil, palm kernel oil and coconut oil. Of this, lauryl alcohol, which is derived from palm kernel, requires special mention as it is imported from southeast Asia. Overall, this makes prices of palm oil and changes in import duties the key variables to monitor for this segment.

Exposure to high growth end-markets, regulated business and technical know-how keep us constructive on the oleochemicals sector. We believe that stock selection in this segment should be governed by pricing power and earnings growth aspects.

In case of Galaxy, we take account of company’s dominant market share in surfactants industry but are equally wary of increasing competitive intensity as local players -- AR Surfactants and Khurana Oleo Chemicals -- emerge. While Galaxy’s stock has corrected by 33 percent from the 52 week high, valuation still appears elevated given the slowdown in Middle East/Turkey region (around 35-40 percent of sales) and limited pricing power. Hence, investors can wait for better entry levels.

For Fine Organics, though the valuation multiple appears high, we believe it reflects its exposure to higher margin segments of oleochemicals businesses. Expansion plans suggests more than 25 percent earnings CAGR (compounded annual growth rate) in the medium term. A stronger balance sheet makes it an accumulation candidate in our opinion.

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