Stock pick from the chemicals sector

Omkar Specialty Chemicals (OSCL) had tapped the markets in January 2011 to garner funds for its capacity expansion plans and for its working capital requirements. After it tanked heavily on the listing date, the counter is currently available at a 39 per cent discount to its issue price of Rs 98 a share.

At the time of analysing its offer, DSIJ had recommended avoiding the IPO, citing expensive valuations as a major concern. Now, at a PE multiple of 7.7x and with its annualised EPS of Rs 7.92, the counter looks attractively priced.

Our confidence stems from OSCL’s constantly improving financial performance. The company reported a five quarter CQGR of 16 per cent and 17 per cent in its topline and bottomline. Moreover, with the capacity expansion expected to go onstream over the coming financial year, we expect OSCL to carry on with its robust performance, and the share prices to go up and create wealth for its shareholders.

OSCL manufactures organic and inorganic intermediates, ranging from derivatives of molybdenum, selenium and iodine to tartaric acid. Its products find major application in the pharmaceuticals industry, which contributes to around 75 per cent of the total revenues. The chemicals, glass, cosmetics and cattle and poultry feeds industries make up the rest of its revenues.

Coming to the investment rationale, OSCL’s proposed capacity expansion  plans seem to be well on track, as the company has already added capacities of  1950 MTPA against the envisaged capacity addition of 3650 MTPA. It has also recently acquired Urdhwa Chemicals based in Ratnagiri, Maharashtra that has  an installed capacity of 2800 MTPA, which is expected to commence operations from May 2012 onwards. Going forward, the management is eyeing a robust topline growth for FY13, as the remaining capacities go live and the revenues from its new acquisition start pouring in.

With the Indian pharma industry expected to witness a strong traction over the coming years and the user industry (bulk drugs) pegged to grow at a five-year CAGR of 21 per cent (according to CRISIL Research), OSCL would ride the wave ahead smoothly, powered by its diverse portfolio of 105 products, the robust capacity expansion and strong clientele comprising industry leaders like Cipla, Dr Reddy’s, Ranbaxy and others.

The only pitfall is its high dependence on imports for raw material, which constitutes 40-50 per cent of its raw material costs. However, despite the high input costs and the sharp rupee depreciation prevailing over the past year, the company has not only managed to maintain its margins but has also reduced its raw material to sales ratio by 700 bps to 68 per cent in the December 2011 quarter. This signifies that it has constantly been able to pass on the costs to its customers, without hampering the demand for its products.

The company has posted a whopping growth of 66 per cent in its topline to Rs 125.94 crore in the nine month period ended December 2011. Despite the 93 per cent rise in interest costs to Rs 6.22 crore, the bottomline grew by 63 per cent to Rs 11.67 crore during the same period. Moreover, with an interest cover ratio of 3.5x, the company looks comfortable with respect to covering its interest costs.

In conclusion, at a CMP of Rs 59.05 which discounts its FY13E EPS of Rs 13.7 at PE of 4.3x, we recommend a 'buy' on the counter with a price target of Rs 91.