Hi Investors! Welcome to SOIC! For the 1st time, we're going to review the Clean Science & Tech. Before we begin the review, I'd like to tell you something I've often observed something interesting "We see but we do not observe." Sherlock Holmes often said this This means, 20 yrs ago during the 2000s (2003), it was easy to use quantitative screens in investing. If a long-term investor who's a value investor, tried to invest would only use quantitative screens, would have to ask for companies' facts & financials to see which companies have low debt, high ROCE & would decide to buy that company.
Truth be told, nowadays, this wouldn't be applicable A company's decreased P/E would have a reason, the company's perception isn't good in the market that the company would get good earnings If a company's P/E is high there's a reason behind this, the company's perception maybe good. There can be a justification for this, so we concentrate on the earnings. The trend 20 yrs ago is now over. Not a lot of people are comfortable with this change. I have observed some things, I won't be taking any names of course, the quantitative analysis is now a thing of the past.
Today's fundamentalist investor is only interested in numbers one who can't imagine the future, you are actually toast now. No one can help you in investing because you're driving while looking into the rear-view Actual returns are gained when we view through the windshield watch towards the road, The older method of reading the numbers can be seen in the rearview This method of investing, in our view, if you want to gain substantial returns This type of investing is toast. The world has changed so much, the markets are becoming more efficient The second order thinking, that has to be really concrete With this, we can begin the Clean Science & Technology IPO review. We'll make this analysis very simple for you to understand we'll do this in a Q&A format I'll ask 4-5 Questions, & I'll also learn along with you. The 1st question, before we begin is Which characteristics make a Chemical Company successful? You must know about the China +1 trend that's been going on since 2013-14 this is now being well known in the market Looking at the company's P/E ratios , everyone knows the trend that China +1 Trend is going on Q1. Which characteristics make a Chemical Company successful?
Why are some chemicals massive wealth generators? Why do some companies have cyclical natures? One of the best reasons for making a chemical company successful is the Strategy of Integration Ranjeet, who is our student, asked us a question about Integration I will answer your question in the SOIC's podcast this Sunday for our members: SOIC Key Business Terms to clarify these terms Focus on how this Integration Strategy works in a chemical company? Let's 1st discuss, Navine Fluorine Looking at its Value Chain what you'll understand it is, let's suppose a chemical "HF' which can create different chemicals, Suppose HF can create Fluorobenzene Fluorobenzene can make 4-Fluorobromobenzene 4-Fluorophenol, & Fluoroanisole Similarly, HF can create other things as well. Don't complicate this. Basically this means is that, with 1 chemical's reaction in the 2nd step, you can create more chemicals, you can continue this to step 3, 4, & 5 1st step for ensuring the successful Integration Strategy of a chemical For purpose of disclosure, we've owned Navine Fluorine for some time now We believe that within the Indian Fluorine Chemical & Fluorine Industry Gujarat Fluorochemicals Limited (GFL) doesn't have the value strength SRF has some good strengths, I don't think there's a company like Navine Fluorine because of their expertise. Navine Fluorine has been working in the fluorine chemistry for 50 yrs It's a dominant player in fluorine chemistry Secondly, Vinati Organics is the world marker leader in 2 products They outperformed their competitors from the market.
1. ATBS 2. Isobutyl Benzene What is the Integration Strategy for these chemicals? I'm Vertically, Backward, & Forward Integrated. All 3 types of integrations are done. Looking at Vinati Organics' Value Chain, we find something very interesting Key Starting Material & 1st stage in the Value Chain HP MTBE & MTBE Chemical which are used to make Isobultylene (IB) which makes PTBT PTBBA & Butylated Phenols There's no need to get too confused here, they're taking one raw material to make other chemicals.
This is an Integrated Strategy For e.g., ACN creates TBA ATBS/ns ATBS TBS further creates Polymers PTBT, PTBBA, & Butylated Phenols these are used in sunscreens & cosmeceuticals This is the company's Integrated Strategy from the beginning this is why Vinati Organics is one of the only companies with Operating Margin more than 35% Now, it's probably Clean Science & Technology whose Operating Margin can come to 55-56% of EBITDA Similarity, Deepak Nitrite's Fine & Speciality Division I'll take an e.g., of a Vertical Integration There's Vertical, Backward, & Forward Integration. Discussing the example, I'll discuss a single Value Chain.
I don't want to complicate this for you. Considering the Fine & Speciality Division From Ammonia they make a chemical called NOx From NOx they make Sodium Nitrite from Sodium Nitrite they make MAHCL They're already a market leader in Sodium Nitrite, but it's a bulk chemical. Sodium Nitrite, you actually have to think of this strategy, this is a feedstock, this acts as a raw material to create MAHCL which again is a Fine & Speciality Chemical. A student had frequently asked us about Deepak Nitrite there's a Bulk Chemical division & Fine & Speciality Chemical division so why don't they close the Bulk Chemical division It's interesting to understand if they close down the Bulk Chemical division, there will be no feedstock for Fine & Speciality Chemicals The Strategy is actually of Integration. Bulk Chemical will serve as a downstream into making Fine & Speciality Chemical. This is the Strategy.
That's why I repeatedly say, We see but don't observe. Observation is important for every chemical company or for any successful company It can be Chemical, HDFC Bank, Kotak Bank, IEX, there's a competitive behind this If you understand the reason number crunching can be done by almost everyone, there's no speciality in it. Let's talk about Clean Science &Technology The company was incorporated in 2003, their board consists of M.D. Ashok Boob, Executive Director is SIddharth Sikchi, The company's board is strong 1/3 of directors are independent directors, Pradeep Rathi, director of Sudarshan Chemicals Sudarshan Chemicals is a strong chemicals company Within Pigments, they are dominant market leaders If a director of Sudarshan Chemicals has a place on the board this serves as a strength of the board We applied similar pattern recognition in Alkyl Amines, where in comparison of BKT & Alkyl Amines' board consisted of strong contenders. A Padmarshree Prof. G.D. Yadav, is part of the board he's a director at Aarti Industries Limited & Meghmani Organics Limited Interestingly, the board members' quality is good.
Let's discuss an interesting trend here, before getting into their products. Let's ask ourselves again, 1. Which characteristics make a chemical company successful? Let's ask ourselves: Which Chemicals does Clean Science & Technology operate in? What's special about them? Which products use them? Which products are they market leaders of? Why are they market leaders? What does market leadership mean? If their margins are the industry's best margins, what the reason behind it? This is the Second-Order Thinking, you must apply this if you want to be a good investor. otherwise investing wouldn't be easy for you, or wouldn't be quite simple for you. 1st reason to where they're applied the most The company's Key Material is Performance Products, are chemicals that make a product perform. these are critical application products.
As we'd seen in Deepak Nitrite's video, OBA (Optical Brightening Agents) & DASDA are Performance Products without OBA & DASDA (diamino stilbene disulfonic acid) Surfexel or any other detergent, won't be effective Similarly, Performance Products mean that without their usage, the end usage of the products can't occur Slight failure in quality, will fail the application of the end product Similarly, Vinati Organic's product ATBS, is a Performance Product Sanjoy Bhattacharya repeatedly says, Hats off to his foresight, his foresight 8-9 yrs ago was commendable, He'd said this 8-8 yrs ago about India's Contract Manufacturing will be immensely successful. He even mentioned that, "Lower Volume & Higher Value" at a low volume & higher value of contract manufacturing Whoever is able to provide supplies at low volume or in small batches, will take away the Pricing Power, because the end Customer isn't affected by pricing. Similar is the case with this company, a Mental Model can be applied here.
Let's ask ourselves which products it can operate in? Looking at this company's products, MEHQ, BHA, Guaiacol, Anisole, 4-MAP, DCC, & L-Ascorbyl For MEHQ, the company is a world market leader, it's also a market leader in India It's also a market leader in the world & India in BHA. For Guaiacol, it's 3rd world market leader. There's a reason behind this. In India it's the 2nd market leader for Guaiacol. In Anisole, it's the market leader in the world & in India.
In 4-Map, t's also a market leader in the world and India. In DCC, it's the market leader in the world & India. What do these products mean? MEHQ is a Critical Application Performance Product that's used in several things 1. Used in dermatology for skincare. 2. Intermediate in the pharmaceutical industry. intermediate in APIs or other application as intermediate it's also used in Agro-Chemicals it's used in the Ink Industry & Monomers & Polymers The industry is growing at 5.8% CAGR, it's also the no.1 player in the world The competitors are Solvay & Camlin Another product: Guaiacol It's one of the world market leader—3rd in the world & 2nd in India There's a reason behind this.
The Guaiacol they make is pharma Grade The Guaiacol made by Camlin is used for Vanillin production. Vanillin is used to make synthetic vanilla When we're consuming vanilla ice-cream or cake, if we want to naturally extract it, it meets only 2% of the world's demand that's why we produce synthetic vanilla Camlin Life sciences makes Guaiacol because it's used to produce Vanillin it's a captive production While this company produces pharma Grade Guaiacol It's realisation is substantially more than Camlin LifeSciences Someone had asked why their margins are higher than Camlin? Camlin isn't targeting this section that much, Their Guaiacol's major usage is in Cough Syrups There's a product in Glycodin, I'm not going to name it because you might get confused. That's where its used. It's a Critical Application Product 2. BHA
It's an integration Strategy We'll discuss what makes this company special? BHA is also a Performance Product From 2 products: BHA & MEHQ, they get 70% of the sales BHA is used as an Animal Feed Additive It's used as Animal Feed Additive It's also used in Food Packaging The industry size is small of $ 95 million growing at 3% When they began to manufacture the product in 2013-14 their sales were only $2 million Today, they get $15 million sales from BHA This means 7x in 6 yrs, I've grown my sales. There must be some reason. We see but do not observe. Consider the reason, we'll discuss it later. 3. 4-MAP contributes 4% of their sales these include sunscreens, UV blockers.
4-MAP product is also used in cosmetics. When they'd begun to make their products, there was a lot of competition from China However, they've taken the market share from China just imagine that they've taken the market share from China This is not because of Anti-Dumping Duty or anything else. This is a different company. When I read about the companies, I can easily find out how different the companies are because there's a dictionary of companies being created in my mind Where does this differentiation come from? They're exporting to China at present, 33-35% of their sales for past 3 yrs, are due to exports to China For a chemical company to export to China, is something substantial You may ask, Ishmohit, you've told us all of this, now tell us about the company's margins & the reasons behind these margins.
Since we want to understand the business we're not here to provide you with superficial knowledge, we want to give you in-depth insights Let's understand the company's Margins EBITDA Margin is ~55% Profit After Tax Margin is ~39% in the last 3-4 yrs their Revenues have grown by 14-15% EBITDA has grown at 39-40% Profit After Tax ahas grown to ~38=39% ROCE is ~73% because if there's cash of Rs. 2.5 cr. on the balance sheet when we subtract it to calculate the ROCE, we get ~73% ROCE, ROE is also ~40% seems suppressed because this company's a Cash Flow Machine remember this term Why? Why it's easy for people to state this? There are 2 reasons: 1. Exchange in Revenue The Performance Products in the last 3 yrs, which were MEHQ & BHA these are higher margin products the sales has increased & Performance Products sales are ~71% from ~64-65% that revenue mix has changed This is a higher margin product What's interesting is, their strategy As we'd seen with Vinit, everything starts from IB (Isobutylene) & Navine Fluorine, there's a Key Starting Material In 2018, their Key Starting Material was Anisole—let's understand this They used to initially source it from outside In 2018, they began manufacturing it in-house While they produced it in-house, let's assume they were using the technology Liquid Phase Technology They were using a liquid tech to produce Anisole due to which they weren't getting good margins In 2019 they became the 1st company to make Anisole through Vaporisation when they began to produce Anisole through Vaporisation their margins began to expand In 2020, they tripled their capacity to produce Anisole Why did it triple? because of Backward Integration i.e., actively consuming its own raw materials & not exporting it from outside. I have my destiny in my own hands, this is what this means When they tripled their capacity in 2020, we can now observe an Abnormal Margin Expansion I believe these Margins will be sustainable because this is integrated from the Key Starting Material Many miss out by superficially understanding the Integration Strategy of Chemical Companies We believe that it's our responsibility to create content that's in-depth & not superficial Even though we may make 1-2 videos a week, we can promise the content will be in-depth We strive to give you true knowledge & not superficial number crunching. Their Strategy in the Value Chain, Clean Science's Unique Manufacturing Process Anisole is being used every where It is their Key Starting Material.
They're using Phenol—44% of raw material cost— to produce Anisole through Vaporisation From Anisole they're making MEHQ, this is where you'll understand what Integration is From MEHQ, they make BHA Anisole—> MEHQ —> BHA This is a complete Integration. That's why I'm the lowest cost Manufacturer of BHA in the world I'm also one of the lowest cost Manufacturer of MEHQ in the world because I'm integrated with Aninsole—the Key Starting Material—to other things This was an e.g. of what we look for when we analyse a chemical company. We've also included, if someone's interested: The Conventional Manufacturing Process & the differences this is where you'll get to know it. I think this company is very differentiated You may want a P2P Comparative Analysis & its Valuations Valuations becomes important when we talk about IPOs Firstly, the P2P Analysis: Interestingly, I could find 2-3 competitors in the industry 1. Deepak Nitrite's Fine & Speciality Chemicals Division Deepak Nitrite is partly a Bulk Chemical player & partly a Specialised player As a disclosure, & not an investment advice, we own Deepak Nitrite A disadvantage is that 50-60% consists of Bulk Chemical business 40-50% is Fine & Speciality business. In Fine & Speciality division, Deepak Nitrite has EBITDA Margin of ~40-44% Navine Fluorine, we believe is one of the best listed companies in India for Fluorine The Operating Margin is ~25-26% Vinati's EBITDA is ~35-37% because their strategy is similar to Clean Science's Clean Science & Technology's EBOTDA Margins are ~55-56% which is absolutely mind boggling.
It's no.1 in metrics 2nd comparison of ROCE: Deepak Nitrite's Fine & Speciality Chemical is ~40 % Navine's ROCE is ~22% Vinati's ROCE fell to ~25% because their product mix is going to dilute, butylphenol is a lower margin product Clean Science & Technology's ROCE is industry leading at ~73% Again, it's the best company in industry metrics. P/E Ratio of Sales Vinati is at ~78 Navine is ~76.5 Deepak Nitrite is ~34 Clean Science & Tech~48 which is interesting to observe I can't only compare it with Deepak Nitrite. Comparing this company to Vinati Organics which in my opinion is the closest peer to this company. I do believe that at the time of its IPO, this company its Market Capitalisation will be ~Rs. 96 cr.
on which they're earning Rs. 190-200 cr. profit which is why their P/E ratio is 48 times However, the ROCE is 73 times & their capacity if going to expand This will be the best listed company, in my opinion, in terms of Return Ratios. At present the Industry's Valuations are over heating I think the IPO is coming at reasonable Valuations, I wouldn't say that these valuations are expensive. I'll say that these valuations are reasonable for a company with high ROCE & can keep growing at these points Interesting question would be about the Sources of Risk. Also, what's the Capacity Expansion? The Gross Fixed Asset Turnover is ~2.75x If I invest Rs. 100 cr. in the assets, I can make Rs. 2.75 profit in sales
there's an addition of Rs. 20 cr. on Fixed Assets Rs. 20 cr. is in CWIP If the sales is currently Rs. 500 cr. this can increase up to Rs. 700-750-800 cr. Current Capacities & Utilisation is ~71% whereas, in a chemical company, it can go up to 84-85% Sources of Risk include their total capacity is 29,900 metric tonnes per annum They're expanding their capacity & bringing about unit 3 expansion They've also applied the unit 4 EC 1st source of risk, because there will be an IPO The sector is hot. In my view, this is not a recommendation, when it gets listed, the market participants will be able to gauge it's true business worth I think the Valuations will balloon This is just my opinion, this could be a plausible occurrence, this is NOT a recommendation 2: Delay in Environmental Clearance of Unit 4 Many companies have to wait for the EC. 3: Niche Products the products are niche, & the market size is already small even after Return Rations, this is still a niche company with Rs. 500 cr. of sales
Even though the future looks bright, even after being so niche, if it expands to more products, like Vinati, there will be dilution in Return Ratios It's difficult to imagine how good this can be for the business, because there isn't much margin in Butylphenol This is another thing to look out for. 4. Copying their Technical-Know How because this isn't patented This isn't a source of risk, because you'll be surprised to know that Vinati Organic's patent of 80BS went away several yrs ago Yet, Vinati Organics remains a dominant company because they've create economies of scale within those products No one else is able to create a similarly large manufacturing plant like you (Vinati) until there's no overnight technological advancement, I don't think it'll be easy to break a company's Economies of Scale These are our reasons about the company. To be honest with you, we haven't appleid for the IPO, because we think the over-subscription will be too much.
We don' think we'll win any lottery IPO system is based on lottery, it is an offer for sale, the promoters are selling their stakes their holdings will go from 95% to 78% This IPO might be over-subscribed The probability of getting lots seems low. Thank you for joining us! Do tell us in the comments section whether you were able to easily understand Clean Science & Techology's business. Do join us on Sunday for our analysis of the Hidden IT company poised for > 20% growth Thank you for joining us! I hope to see in the next business analysis of SOIC!
2021-07-08