India's Offshore Advantage

to Last for 30 Years

The 2006 Global Sourcing Market Update, by research company Everest, claims fears that rapid wage inflation and skills shortages will quickly reduce India's offshore cost advantage are "greatly exaggerated".

The labour arbitrage advantage India has over the UK will last for at least another 30 years, while India will also retain its low-cost wage advantage over the US for at least another 18 years, according to the report.

Low-cost offshore locations such as India and the Philippines are aggressively making moves to minimise the impact of wage inflation by encouraging the expansion of the quality and size of the relevant workforces and by developing more low-cost offshore locations, the report says.

IT suppliers in India, for example, are lowering their costs by moving to 'tier two' cities--away from traditional high-tech centres such as Bangalore - and opening delivery centres in other countries.

Stephen Dunn, managing principal at Everest, said in the report: "Offshoring will retain a substantial labour arbitrage for the next 30 years between the UK and key low-cost destinations such as India and the Philippines. While current inflationary pressures exist, reports of 18 per cent salary growth in key destinations are overstated."

A separate study out this week also found that more than three-quarters of research and development facilities opened by western companies over the next three years will be located in China and India.

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Gwalior Chemical Industries

Gwalior Chemical Industries (GCIL) is one of the producers of niche chemical products in India, which find use in a variety of industries such as agrochemicals, pharmaceuticals, dyes, flavours and fragrances. The company is one of the largest producers in the world of chlorotoluenes and thionyl chloride. It has set up an integrated facility at Nagda in Madhya Pradesh and Ankleshwar in Gujarat to manufacture the first stage of products.

Catering to a widespread clientele of over 500 customers across nearly 40 countries, GCIL derives nearly 30% of its revenue from exports, which is expected to go up as it expand capacities. Similarly, the company derives nearly 40% revenue from the agrochemical industry, 14% from the flavors and fragrance industry, and 10% each from the pharmaceutical and dyes and paint industries. The clients of GCIL include Bilag Industries (a subsidiary of Bayer Crop Sciences AG), United Phosphorous, Grasim Industries, Gharda Chemicals, Gujarat Insecticides, Shasun Chemcials and Drugs, Dr. Reddy's Laboratories, Divi's Laboratories, Matrix Laboratories in India, while the international clients include Bayer AG (Germany), Clariant Gmbh (Germany), L.G Life Science Limited (Korea), Dooyang Industries Corporation Limited (Korea), Thor Specialties Limited (United Kingdom), A & F Limited (United Kingdom), Symrise AG (Germany), Pentagon Limited (United Kingdom), Kao Corporation (Spain) and Sika AG (Germany).

To go for forward integration and expand into the second stage of value-added downstream products, which will have better margin, GCIL has planned a capex programme of Rs. 90.10 crore, out of which it is raising Rs. 80 crore through its initial public offer (IPO). The company hopes to complete the expansion programme by December 2007 after which it will have 43% more capacity for its existing products such as benzyl chloride, benzal chloride, benzaldehyde, benzyl alcohol and thionyl chloride at 99,600 tonnes per annum besides a total of 6,000-tonne capacity for different new value- added products.

GCIL also plans to set up captive power plant at Nagda to fulfill its need for power as well as steam, which will lead to considerable savings in the cost of production. Being a specialty chemical manufacturer, the company has enjoyed pricing power and maintained its operating profit margin (OPM) around 20% in the past despite significant fluctuations in the raw material prices.

Strengths

1. No new plants are coming up in the west to manufacture chlorinated compounds, which is expected to boost the outsourcing opportunities for Indian players. GCIL is expected to benefit by supplying high quality molecules at competitive costs.
2. With the expansion into high margin products, pursuing forward integration, and setting up a captive power plant, OPM is expected to move up.
3. A de-risked business model with broad customer base.
4. Expected to benefit from in-house R&D team, which has helped to reengineer processes and cut costs.

Weaknesses

1. Since the pricing of the products is based on import parity, any reduction in customs duty will have an adverse impact on margin.
2. Important raw materials – toluene and chlorine – have witnessed wide fluctuations in pricing in the past and may continue fluctuating in the future.
3. Largely dependent on single suppliers for its key raw materials such as Reliance Industries for supply of toluene and Grasim Industries for chlorine at the Nagda facility.
4. Promoters Ashwin Kothari and Harisingh Shyamsukha had also promoted four listed companies: Aroni Chemical, Jacquart Chemical, Winro Commercial and Saraswati Commercial. Last year, Sebi had forced the promoters to make open offer for all these companies due to violation of guidelines related to inter-se transfers and acquisition of shares. All these companies are very thinly traded. Notably, GCIL has been trying to come out with an IPO for the past many months. But the issue got delayed. As a result, there is almost 15 to 18 months' delay in project implementation compared with the original schedule.

Valuation

GCIL has set a price band of Rs. 71 to Rs. 85 for its IPO to raise Rs. 80 crore, which translates into a PE of 11.9X to 13.2X EPS for FY 2006 and 10.5X to 11.6X annualised EPS for FY 2007 based on the results in the quarter ended June 2006. There is no listed company in India with a similar product profile. However, the company can be broadly classified as Specialty Chemicals-Large company. This group is presently trading at a PE of around 12 on the basis of trailing 12 months.

Gwalior Chemical Industries: Invest at cut-off

Investors with a medium-term perspective can consider subscribing to the initial public offering of Gwalior Chemical Industries. At the upper end of the band, fixed between Rs 71-85, the company is offering shares at 13 times its FY-06 earnings on an expanded equity base. Gwalior Chemical plans to sustain its aggressive growth by focusing on forward integration and overseas markets. A diversified client base and healthy demand from user industries are positive elements .

Gwalior Chemical's growth prospects primarily depend on the agro-chemicals, dyes and flavour and fragrance industries. It also caters to the pharmaceutical industry, which contributes about 10 per cent of its revenues. Benzaldehyde and thionyl chloride contribute the chunk of Gwalior Chemical's revenues. Benzyl alcohol, which generates 20 per cent of its revenues, contributed to a large part of Gwalior Chemical's 25 per cent revenue growth in FY-06.

Aided by a surge in revenues, Gwalior Chemical posted a 20 per cent growth in earnings for FY-06. The company has consistently maintained strong operating margins; however, this is susceptible to fluctuations as prices of toluene — a key feedstock — tends to move in tandem with prices of crude oil.

Gwalior Chemical's high debt-equity ratio is a cause for concern. Its long-term debt repayment schedule and interest coverage ratio, however, provide confidence.

Gwalior Chemical Industries plans to deploy a significant part of the proceeds in expansion and de-bottlenecking of its current product lines. It also proposes to utilise about Rs 16 crore for setting up facilities to manufacture benzyl esters and acid chlorides.

Details of the offer: Gwalior Chemical is offering shares worth Rs 80 crore within a price band of Rs 71-85. JM Morgan Stanley is the manager to the offer and Intime Spectrum the registrar. The offer opens on September 11 and closes on September 14.

HDFC & Suzlon

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