Balaji Amines Versus Alkyl Amines Chemicals: A Case of Valuation Arbitrage in Speciality Chemicals? 

Dear Viewers

The chemical and specialty chemical stocks in the last one year have been on a downtrend.

Increase in the raw material prices, rising fuel and freight costs, demand moderation especially in export markets due to geopolitical issues, and inventory build-ups are some of the reasons weighing over the specialty chemical stocks.

However, in my view, these are short term disruptions.

The chemical industry in India is one of the biggest beneficiaries of China plus one factor, and its long-term story, especially for niche market leaders, remains intact.

Since the scope of chemical industry is vast and cannot be covered in a single video, for today's video, I'm going on a niche segment in specialty chemical industry of aliphatic amines, and on two key domestic players, i.e, Balaji Amines and Alkyl Amines, in this segment.

Let's first under what Aliphatic Amines are.

Without going into technical details, aliphatic amines and their derivatives are used as find applications as solvents, and in pesticides and animal feed additives.

In terms of end applications, 61% of aliphatic amines and derivatives get consumed in pharma segment and 26% in the agrochemical. These products also find applications in paints, water chemicals, rubber chemicals and so on.

What is special about aliphatic amines is that it is an oligopolistic industry, that is, there are only a few producers catering to a specific region. One of the key reasons is hazardous nature of products and the need for safe handling with proper protocols and controls.

End users also prefer to work with local two to three credible suppliers for these reasons, that can offer quality and timely supplies. Scalability and low-cost production.

The entry barriers are high as it is a capital-intensive industry, with fixed asset turnover ratio of 1.5 to 2 times, expensive transportation costs, high technical expertise and approvals required.

Key raw materials are ammonia, methanol and denatured ethyl alcohol and are mainly crude derivatives.

The size of global aliphatic industry is at US$ 5 bn or Rs 400 bn and is expected to grow at a compound annual growth rate of 5% -7%. Again, this is not a big enough market for new players to enter, especially when there are already well settled vertically, and horizontally integrated players present.

China is the largest producer and consumer of aliphatic amines, accounting for 60% of global production.

In terms of export potential, Europe is the biggest market with 45%-55% share, followed by the US and Japan.

The key risks for aliphatic amine industry players include volatility in prices of raw materials and end products, slowdown in the end industries, especially pharma and agrochemicals, and competitive pressure.

Coming to the two most prominent domestic players in aliphatic amines industry ...

Balaji Amines is the largest maker of aliphatic amines in India, and derives 25.5% of revenue from it, while the remaining share comes from specialty chemicals and amine derivatives. The end industries include pharma, agrochem, refineries, water treatment chemicals, rubber, electronics, dye stuff and paints, animal feed, photographic chemicals, and leather processing chemicals.

Around 15% of revenues come from export markets.

The company has been in existence since 1988. As such, the management team comes with strong experience. Balaji Amines has 55% stake in Balaji Specialty Chemicals which is based in Solapur, Maharashtra, and started production in FY20. Balaji Specialty Chemicals is planning to raise Rs 2.5 bn through IPO, along with an offer for sale by the promoters and selling shareholders. At peak utilisation, the revenue of Balaji Specialty Chemicals is expected at upto Rs 500 crore, which is 22% of the Balaji Amines' revenue in FY22.

Balaji Amines has completed Phase 1 of Capex and plans to invest Rs 3 to 3.5 bn more by FY25. With the proposed investments, the installed capacity is expected to increase from 231,000 MT to 346,000 MT, i.e by 50%.

The company has set up capacities and is now the sole manufacturer of Di-methyl Carbonate (DMC) and Propylene Carbonate (PC) in India. These products were earlier imported in the country, and find use in pharma industry, in production of polycarbonate, which is a high strength polymer, and in Lithium batteries. As such, the company could be a big beneficiary of the rise of EVs.

The company boasts of a strong forward and backward integration in the business.

BAL in the past had entered some unrelated businesses such as hotel (in 2013) and CFL lamps, that are more of a legacy business and are not the focus areas for the management. The investment in hotel was Rs 1.1 bn. The company has tied up with Sarovar group for management of this hotel on management fees plus revenue share model.

Coming to the guidance, the management expects revenue of Rs 40 bn by FY25-FY26, versus Rs 23 bn in FY22. The EBITDA margin guidance is at 24% to 26%, versus 27.5% in FY22. The stock is trading at a TTM PE of 18 times, versus a 5-year median PE of 19 times.

Let's now take a look at Alkyl Amines.

On the slide, I have placed it next to Balaji Amines for an easy comparison.

The company was set up in 1979 and is present in the same segments as Balaji Amines, catering to similar industries.

With regards to expansion, the company is investing Rs 4 bn to increase the capacity of aliphatic amines and expects it to be added in the second half of this year.

Both Alkyl Amines and Balaji Amines have witnessed correction over last year, due to dull domestic performance in the pharma segment, along with volatile raw material prices due to crude price vagaries, high energy or fuel prices, inflationary pressures, crisis in Europe due to geopolitical situation and supply issues with China amid Covid. For Alkyl Amines, the exports account for 17% of the revenue.

Alkyl Amines will be adding new products to cater to pharma and agrochem. These products will be substitutes for imports. The management's focus is on products where competition is limited to maximum one or two players, and it aims to be one of the top three in the new products it enters. These new products are expected to add Rs 6 to Rs 8 bn to the topline over next three to four years. This compares to Rs 15.4 bn of revenue base in FY22.

In its latest earnings call, the management of Aliphatic Amines has reiterated a long term CAGR growth target of 10%-15% for its volumes. However, this growth guidance for volumes can not be translated into revenues because there is another factor of price realisations that is difficult to predict. Do note that of 25% growth in the topline for Alkyl Amines in FY22, almost 70% was due to price.

I have found the management of Alkyl Amines a bit guarded on disclosing too much information. They avoid sharing new product details and volume details. While this is not a negative, as the intention could be to avoid competition, it makes the business a little less transparent for potential investors.

While the slide is self-explanatory, I would like to highlight a few points.

Alkyl Amines has a much lower and tighter working capital cycle, at almost 0 days for FY22, as compared to Balaji Amines where the working capital cycle is 59 days. A lower working capital cycle is better for the business, as such Alkyl ranks better on this metric. The difference is high primarily because Alkyl Amines has higher payable days, that is time it takes to payback its vendors for the sales it makes. Alkyl Amines dividend payout is also much better than Balaji Amines.

While Balaji has done better on parameters like return on equity and return on capital employed for FY22, on a 5-year average basis, Alkyl Amines has offered better returns.

And there are some more points to note which are not captured in financials. The R&D expense for FY22 for Alkyl Amines is much higher than Balaji Amines. Alkyl Amines total R&D expense in FY22 stood at Rs 5.8 crores. This compared to Rs 56 lacs of expense on R&D by Balaji Amines.

The remuneration of Directors in Balaji Amines stands at 11% of net profit, lower than 14% for Alkyl Amines.

Alkyl Amines has 71.98% promoter stake as compared to 53.71% promoter stake in Balaji Amines.

But then, in last one year, Alkyl Amines stock has seen promoters selling the stock in the open markets. On the other hand, the stock of Balaji Amines has witnessed insider buying in the current year.

But the most interesting difference point to highlight is the valuation gap between the two. Alkyl Amines trades at a current PE or price to earnings multiple of 53 times, at a significant premium to its 5-year median PE of 23 times. Balaji Amines is available at a much lower PE OF 18 times, close to a 5-year median PE of 19 times. On a 5-year median basis, Alkyl has traded at premium to Balaji. Alkyl Amines has traded at long term PE of 23 times versus 19 times PE for Balaji. But in the last 2 years, the gap has widened significantly.

Without implying a Buy or Sell view on any of these two stocks, in my view the premium valuation that Alkyl Amines is commanding over Balaji Amines is not justified. Whether you agree or disagree with me, let me know in the comment section.

With this, I have come to the end of the video.

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