by Aakash Athawasya
“We got lucky and unlucky because of the pandemic,” said Maulik Mehta, the CEO of Deepak Nitrite during the Q3 earnings call. Mehta was discussing the commodity chemicals company’s performance in Q1, but these words may continue to be true.
Deepak Nitrite is one of the success stories of 2020. It took over the vacuum created by the Chinese chemical supply running dry and diversified across product segments to take advantage of the growing need for certain chemical products in India. But unlike most companies attempting to diversify, Deepak Nitrite didn’t burn through its cash doing it. The company’s top line, bottom line, and balance sheet were better for it. But now with these extraordinary demand drivers gone, will the phenomenal growth rate continue?
Phenolics’ phenomenal growth
On a standalone basis, Deepak Nitrite manufactures three products - basic chemicals, fine and specialty chemicals, and performance products. Basic chemicals like sodium nitrite and nitro toluene are supplied to the rubber products industry. Specialty chemicals like cumidines and xylidines are used in agrochemicals and pharmaceuticals. Performance products refer mainly to whitening agents used in textiles and paper products. These three segments contributed 40% of Deepak Nitrite’s Q3FY21 revenue.
The lion’s share of 60% of Q3 revenue came from its wholly-owned subsidiary - Deepak Phenolics, which primarily produces phenol and its byproduct acetone. These chemicals are used in the automotive, FMCG, and industrial packaging industries.
In 2018, 80% of India’s phenol was imported from Southeast Asian countries like Thailand and South Korea, and China. Deepak Nitrite wanted to pivot to domestic phenol manufacturing as an import substitute for the Indian market. This is why, in November 2018, Deepak Nitrite set up the largest phenolics plant in the country at its facility in Dahej, Gujarat. This was funded through a capital expenditure (capex) of Rs 1,400 crore entirely through debt financing.
During the launch of the phenolics plant, Deepak Mehta, the Chairman, and Managing Director of Deepak Nitrite set a turnover target of $1 billion (~Rs 7,400 crore) within a four-year period. In his words, this was an “ambitious and challenging target.”
In Q4FY19 (the first full quarter of phenolics production) Deepak Phenolics contributed Rs 910 crore in revenue, 40% of the company’s total revenue. In the quarter ended December 2020, Deepak Phenolics’ revenue was Rs 726 crore, 60% of total revenue for the quarter. Since setting up the plant, Deepak Phenolics has recorded revenues of Rs 4,500 crore, 61% of Deepak Mehta’s ambitious target. It is a year away from achieving Mehta’s four year target.
Deepak Phenolics’ contribution to the overall revenue has been increasing.
Capacity and margin expansion
Deepak Phenolics began phenol and acetone production in November 2018 at the Dahej plant. By July 2019, the capacity utilization reached 80%. At the end of FY20, the plant was operating at 100% capacity, till the pandemic stopped all economic activity.
In Q1FY21, several industrial companies opted to coordinate their plants’ maintenance shutdown with the national lockdown. Deepak Phenolics did the same. This allowed the phenolics subsidiary to increase capacity in future quarters. And they did.
For the quarter ended December 2020, the phenolics plant operated at 115% capacity. Maulik Mehta, during the Q3 earnings call, said that there is “more gas in the tank” referring to a possible additional capacity expansion. He said that the 115% capacity mark will be a baseline going forward. This means that phenolics, which accounts for nearly two-thirds of Deepak Nitrite’s revenues, will ramp up its production capacity soon.
This efficient use of the phenolic capacity has boosted the margins of Deepak Phenolics.
Growth capex and stable cash
Even with the strong operating margins, and capacity utilisation already above 100%, Deepak Nitrite is pushing the envelope, forecasting even more revenue growth.
One of the chemicals Deepak Phenolics produces is isopropyl alcohol (IPA). IPA is a key chemical intermediate in the production of hand sanitizers. Due to the pandemic and prioritization of hygiene and sanitation, several FMCG companies began manufacturing sanitizers. In order to cater to this demand, in April 2020, Deepak Nitrite commissioned an investment of Rs 200 crore to set up a dedicated IPA plant at its Dahej site with a capacity of 30,000 metric tonnes (MT).
In 2021, the demand for hygiene products still remains. Hence, Deepak Nitrite is expanding its IPA production capacity as well. This will be part of a brownfield expansion and will be commissioned by March - April 2021. With the supply of Deepak Nitrite’s IPA increasing and the demand for hand sanitizers sustaining, this could provide another boost to its phenolics revenue going forward.
For the six months ended September 2020, Deepak Nitrite had Rs 428 crore in free cash flow and Rs 82 crore as cash in hand. This is after accounting for the Rs 200 crore for the IPA plant commissioning. With this stable cash position, it plans on further increasing its capacity. For FY22, The management earmarked a total capex of Rs 700 crore divided between Rs 400 crore for Deepak Nitrite, and Rs 300 crore for Deepak Phenolics.
In addition to these expansion plans, Deepak Nitrite also has a new subsidiary that hasn’t started production yet. In October 2020, it set-up Deepak Clean Tech, to manufacture chemical intermediates. This was at a time when the specialty chemicals industry was shifting its focus to the pharmaceutical sector. In September 2020, Maulik Mehta said, “We are evaluating other chemical intermediates for the pharma segment.”
However, in the Q3 earnings call, he said that Deepak Clean Tech has not started production yet. Mehta mentioned that the company is waiting for “steel prices to moderate.” Providing no other details on the subsidiary or the products it will manufacture, he said, “This [Deepak Clean Tech] is also one of the key channels through which we are able to improve our profitability.” A board announcement on Deepak Clean Tech is expected in the next two months.
While in Q1 production was curtailed due to the lockdown and the maintenance shutdown, Deepak Nitrite’s net profits and profit margins have been increasing.
Consolidated debt declines
A key worry for Deepak Nitrite’s investors was the rising debt of the company. However, the company is using its increasing cash flows to steadily reduce debt. This is also helped by the strong operational performance of the company. Since this debt is under Deepak Phenolics, it shows up on Deepak Nitrite’s consolidated books, and on a standalone basis at least, the company is net debt-free.
For the six months ended September 2020, Deepak Nitrite’s total borrowings were Rs 34.7 crore, a decrease of 96% on a YoY basis, and 86% since the beginning of FY21. Its debt has been steadily decreasing. At the end of the December 2020 quarter, Deepak Phenolics’ total debt to equity ratio stood at 0.78 times, while Deepak Nitrite’s total debt to equity ratio was 0.28 times.
Strong demand and robust operations to drive phenomenal growth
Chemical companies were initially helped by the Chinese government’s crackdown on pollution-causing industries in 2017. This led to the closure of several chemical plants in China. As India was dependent on several chemicals from China, especially phenolics, Deepak Nitrite plugged the short-supply by setting up Deepak Phenolics. This move into phenolics was further helped by the Indian government’s potential move to hike import duties on Chinese products in Q1FY21. These two factors gave an initial demand impetus to Deepak Nitrite as its customers wanted to de-risk away from China. The company used this impetus and made its phenolics division a priority.
From 40% of total revenues when it began phenol and acetone production, to 60% at the end of Q3, Deepak Nitrite’s pivot towards phenolics is evident. Given the phenolics division’s strong revenue growth and robust margins between 45-48%, the chemicals company is putting its weight behind it. With capacity already above 100%, capex, and brownfield expansions in store, this division is only going to grow. This growth will be to cater to the increasing demand for phenolics products.
On the other hand, its standalone chemicals business does have a sleeping giant. The performance product division is yet to witness a demand resurgence from the paper, oil, and textile industry. Because of the muted demand in FY21, due to these sectors still reopening, its share in the total revenue has dropped to 7% in Q3FY21, from 15% in the same period a year ago. The management expects this segment to revive only in early FY22.
With this outlook in place, its current cash and debt position are also strong. Since FY19, free cash flows are positive and growing. This allowed the company to spend on capex and decrease debt. This is why Deepak Nitrite’s stock has jumped by 250% since March 2020 outpacing the rest of the chemicals industry. And by the looks of it, its phenomenal growth will continue.