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Vinati Organics: Should you be worried about recent performance? - Views on News from Equitymaster
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  • Oct 15, 2015 - Vinati Organics: Should you be worried about recent performance?

Vinati Organics: Should you be worried about recent performance?
Oct 15, 2015

The stock of Vinati Organics (VOL) has fallen by over 33% since we recommended it in The India Letter on 15th April 2015. Investors would recall that while we had recommended you to take partial (25%) exposure to the stock then, our Best Buy Price for the stock was almost 30% lower. Subsequently, we recommended you to increase your exposure to the stock to 50% in June 2015.

However, concerns over the recent quarterly performances of the company allowed the stock to correctly sharply and come close to the Best Buy Price much faster than we expected it to .

It may be noted that FY15 was not a bad financial year for the company at all. As per the full year results:

  • Net sales were up by 10% YoY.
  • Operating profits were up by 18% YoY.
  • Net profits (adjusted) were up by 25%.

But what seems to have become a concern is the performance in the quarters ended March and June 2015, wherein Vinati's revenues declined by 10% YoY and 22% YoY respectively. These are quite sharp corrections for a company that had been growing at a compounded pace of 31% and 26% over the past ten and five years respectively.

What is however interesting is that during these quarters, the company did well on the operating profit front. During the quarters ended March and June 2015, Vinati's operating margin (EBIDTA) was up by 10% YoY each. Margins expanded to 28.3% and 28.7% respectively as compared to the two year average figure of 22.5%.

Thanks to sharp dip in crude prices, lower input costs were the key reason for improved profitability. Input costs (as a percentage of sales) came in at 52% and 50% respectively as compared to the two year average of 61%. From what was told to us by the company's management earlier, Vinati revises its pricing contracts on a monthly basis with its customers, thereby allowing it to manage the risk of volatile input prices. As for the supplier side, most of the inputs are sourced from the Indian petchem majors on an import parity basis.

Therefore, it seems unlikely that this high margin trend will continue for long. A sharp decline in the price of crude and its derivatives in recent months, has led to this aberration in financial performance; which is why we believe that a few quarters from now, the base effect should kick in. After that Vinati's financial performance will be largely dependent on its volume growth - as long as there is not sharp movement in volatile prices thereafter.

We believe Vinati Organics will be in a position to maintain a high volume growth of about 15% to 20% comfortably over the next few years. This we believe is achievable due to its leadership position in IBB and ATBS, coupled with its focus of adding new products to its stable. The fact that the company is one of the highest quality and largest manufacturers of certain products in India and globally, coupled with it having strong technological processes in place are facets that will allow it to maintain its strong position in the market.

Nevertheless, given the pricing pressures, we have revised our projections at the revenue and operating profit levels marginally lower for next three years.

As per our new estimates, the stock of Vinati Organics, on a PEG basis, trades almost at par to Sensex PEG. We typically recommend investors to take full exposure to a stock when the PEG is at least at 25% discount to Sensex PEG.

However, in this case, despite assuming that Vinati's margins will normalize over time and volume growth will pick up, taking FY15 as the base year for PEG will not be correct. Hence one needs to look at the P/E multiple as well. Since Vinati is currently trading at an attractive P/E multiple of 12.2x our estimated FY19 earnings per share, we believe that the stock offers sufficient margin of safety.

For a strong business like this, passing through a bumpy road, we believe investors should make the most of the decline and increase their exposure to the stock at current levels. We thus recommend you to go ahead and increase your exposure to the stock by another 50% i.e. invest 100% of the sum you intend to invest in the stock. Having said that please ensure that your total exposure to the stock does not exceed 5% of your portfolio at any point of time.

It would be worth mentioning here that on 22nd September 2015, Vinati Organic's promoters bought 31,000 shares of the company through the open market route. The stock closed at Rs 471 on that day. As of today, the stock closed at Rs 428.

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