Bhagiradha Chemicals & Industries is one of India’s largest manufacturers of the best-selling insecticide, Chlorpyriphos. The company is reorienting its strategy and focusing on R&D to drive growth. It is foraying into contract manufacturing of high-value agrochemicals. We expect sales to grow at a CAGR of 22.50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E, resulting in EPS growing at a CAGR of 44.20% from Rs 17.5 in FY06 to Rs 36.4 in FY08E. We rate the stock an OUTPERFORMER with a 3 to 6-month price target of Rs 189.
Background
Bhagiradha Chemicals & Industries was incorporated in 1994 to manufacture Chlorpyriphos, a new generation insecticide at that time. Chlorpyriphos is an insecticide used on a wide variety of crops such as cotton, chilly, rice, sorghun, soyabean, sugarcane, groundnut, vegetables, ornamentals and flowers. It is used for commercially important plantation crops like citrus, mango and grapevive. Chlorpyriphos also finds application in the preservation of wood and timber.
The promoters, Koteswara Rao and D Sadasividu were previously working at Indian Institute of Chemical Technology (IICT), which has developed several innovative technologies for chemical products (including Chlorpyriphos). The initial capacity of the plant was 300 tonnes per annum (tpa) and this was expanded to 2,000 tpa as on March 2006. The company diversified into producing herbicides in 2004, and has been launching a new product every year. It also has a facility to make bulk formulations of Chlorpyriphos. Its current product portfolio comprises of two insecticides – Chlorpyriphos and Imidacloprid – and two herbicides (Triclopyr and Fluroxypyr).
Investment Rationale
Differentiated business model
Selling agrochemicals in regulated markets requires huge sums for generating the data package required for product registration. Alternatively, the data can be purchased from the original inventor. However, inventor companies demand hefty amounts, making the business unviable. Most Indian companies have thus focused on the domestic market and developing nations where it is easy and cheap to register their products. But the consequence has been too players competing in the same markets. Apart from drastic price erosions, there is also lack of stability in the business since customers can easily switch suppliers. Overcapacity in the agrochemical sector in China has further exacerbated the situation.
In order to overcome these hurdles, Bhagiradha is now reorienting its strategy and focusing on R&D to drive growth. The promoters of Bhagiradha are technocrats who have strong R&D experience. The company has a state-of-the-art R&D center at Hyderabad, which employs 30 scientists and its expenditure on R&D is on the rise with Rs 45 lakh being spent on R&D in FY06 (55% Y-o-Y growth).
Manufacturing pact with Dow AgroSciences
Bhagiradha recently signed a contract manufacturing agreement with Dow AgroSciences for the herbicide Fluroxypyr. Bhagiradha is to supply minimum 250 tonnes of Fluroxypyr per year for the next 4 years. Dow AgroSciences is the original inventor of Fluroxypyr and was its sole producer till now. The global demand for Fluroxypyr is about 1,500 tpa. It is a high-value product and is mainly used in the developed markets. This deal is an important milestone for Bhagiradha since Dow AgroSciences chose it as its partner despite the fact that the two are competitors in the Triclopyr and Chlorpyriphos market. It also vindicates Bhagiradha’s new business strategy of R&D-driven growth since many other Indian companies were also in the race to be the first to develop a generic version of this product.
With an increasing trend of MNCs to outsource molecules that have gone off patent, Bhagiradha will now be the preferred option for Dow AgroSciences in case it decides to outsource more of its Fluroxypyr requirement in the future.
For FY07E, Fluroxypyr volumes are expected to be 250 tonnes, translating into revenues of Rs 35 crore. We expect Dow AgroSciences to increase the quantity to 370 tonnes in FY08E, and revenues rising to Rs 50 crore. Bhagiradha’s bottom line is expected to get a significant boost since contribution level in this product is about 50%. The total investment in the Fluroxypyr plant was only Rs 8.5 crore.
Broad-based product portfolio
For the first 10 years since its inception, Bhagiradha was only manufacturing Chlorpyriphos. In 2004, it decided to diversify into other products to mitigate the risks associated with a one-product. It launched Triclopyr (a herbicide) in 2004, Imidacloprid (an insecticide) in 2005 and Fluroxypyr (herbicide) in 2006.
Revenues from new products now constitute 30% of its total sales. They expected to rise to 61 % by FY08E. Since these are high-margin products, its NPM has also increased to 11.5% in FY06 from 9.5% in FY05.
Product Profile
Chlorpyriphos: This insecticide was launched in 1994 in the Indian market. Initially many companies set up plants for this product based on a breakthrough technology developed by IICT. Chlorpyriphos volumes have grown exponentially since then but its price has crashed from more than Rs 500/kg in 1994 to current price of Rs 260/kg due to intense competition. This led to many smaller companies stopping production. Currently, there are only a few companies still left in the field. They include Bhagiradha, Excel industries, Dow AgroSciences, Gharda Chemicals and Mitsu. Considering the low-margins, Bhagiradha plans to maintain current capacity of 2,000 tpa and use it as a cash cow. It will funnel fresh investments into facilities for new high-value products only.
Financials:
The full benefits of the Fluroxypyr deal will be visible from the current year onwards with sales expected to grow by 50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E. However, net profit would soar by more than 100% from Rs 8.9 crore in FY06 to Rs 18.5 crore in FY08E. The shift towards high-value products will see NPM expand from 11.5% in FY06 to 15.9% in FY08E. RoCE, which was respectable 31.8% in FY06, is also set to reach impressive levels of 39.5% in FY08E. The free cash flow generated would be used to reduce debt through bullet repayments. Debt/Equity ratio is expected to fall from 1.1 in FY06 to 0.3 in FY08E, thus considerably de-leveraging the balance sheet.
Risks & Concerns
MNCs have an option to outsource products from their subsidiaries in developing nations. Syngenta has already done this by making its Indian arm a global sourcing base for the insecticide Thiamethoxam. Unless the patent holder considers Bhagiradha a serious threat, it may not be the preferred partner for its outsourcing deals.
Valuation
The company is currently trading at one of the lowest P/E ratios in the industry. We expect sales to grow at a CAGR of 22.50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E and EPS to grow at a CAGR of 44.20% from Rs 17.5 in FY06 to Rs 36.4 in FY08E. At the current price of Rs 157, the stock trades at 8.97x its FY06 EPS of Rs 17.5 and 4.31x its FY08E EPS of Rs 36.4. The stock is available at an EV/EBIDTA of 6.39x FY06 earnings and 3.10x FY08E earnings. We rate the stock an OUTPERFORMER with a price target of Rs 189 with a 3 to 6- month timeframe.
Technical Outlook
The stock has formed a good support at the Rs 120 levels and has been in an accumulation mode since then. Stochastic has turned positive and the RSI indicator also signals a BUY. It faces a minor resistance at Rs 160 levels. Volumes have been picking up recently.