COVID-19 is indeed a nightmare come true. Just before the COVID fever caught up in India, I was on my journey to complete the Netflix Original drama- Stranger Things (honestly I slightly repent spending much time on this one). Suddenly life started appearing as if I am a part of the Stranger Things plot. Hallucinations increased and once I saw myself befriending the monster! I am sure you have your own thriller dramas to relate to COVID!
Coming to the point, India ranks quite low on personal hygiene standards. Since the onset of this virus, the Government has been encouraging people to wash their hands frequently. We are fortunate to have witnessed a decent rainfall in the year 2019. A billion hands to be washed with inadequate rainfall, scary thought! Anyway, that is a discussion for another day where I would like to talk in-depth about the second-order effects of COVID.
COVID is going to change our lives in many ways. Some positive and some negative. Many of these changes will be permanent in nature and some of these changes will actually be improvements. For example, washing hands more frequently. I am sure there is no harm in washing hands more frequently even after COVID vaccine is developed. Who knows, when our beloved neighbor will export another COVID cousin!
For some reason, I feel that this will become a habit for at least a small portion of a billion Indians, who are currently on the verge of obsessive-compulsive disorder for hygiene (I am sure clinical psychologists are going to witness a surge in demand post-COVID). So, yes! Companies making suitable products are going to benefit from this structural change in habits. But, where to scout for value in this sector? The fast-moving sector is known for its high valuations. I hereby present one opportunity which I feel can serve as a proxy to invest in the fast-moving hygiene products sector.
Galaxy surfactants is a chemicals manufacturing company with headquarters in Mumbai. The company manufactures various grades and categories of surfactants. Surfactants are chemical compounds used to bring two or more different material phases together, for example dirt & water in surface cleaning, air & water in foaming, organic chemical & water in medicine, and oil & water to form emulsions. Phenoxyethanol is a major product that the company manufactures. It has a 15% market share in the global phenoxyethanol market. Notable customers that the company serves include Unilever, Reckitt Benckiser, P&G, L’oreal, Himalaya, Colgate Palmolive, Cavinkare. The company has subsidiaries in New Hampshire, USA and Suez, Egypt. 35% of the revenues are derived from specialty care portfolio and 65% from performance surfactants.
About the industry
The global surfactants industry is a competitive space where few big names like O-BASF, Kao Corporation, DuPont Chemicals, Air products & chemicals, Croda International, Huntsman Corporation hold a big market share. Despite being a commodity space, there is good scope for players to create their niche by way of specialty products. Surfactants are of various types namely anionic, cationic, nonionic and amphoteric. Choosing a particular type of surfactant is a matter of end-use which includes crop care, personal care, health care, industrial & institutional cleaning, and other industrial uses. The cationic variety of surfactants is mainly used in textile processing. The global surfactants industry is presently valued at 11bn USD and is expected to grow at 5% CAGR over the next 6 years.
The industry is widely divided into synthetic and green surfactants. The difference between these two is the type of feedstock used for making the end product. In case of synthetic surfactants, the feedstock used is oil, gas & chemicals. Whereas the renewable/ green surfactants are produced from feedstocks derived from plant oils, mainly coconut and palm kernel oils. The difference between the two varieties of surfactants is mainly in the form of raw material availability and hence pricing. The biodegradability of green surfactants is higher than the synthetic varieties and hence it gives an edge over the synthetic ones. Just like almost every other product, synthetic surfactants sell higher volumes due to the above-mentioned reasons. However, this preference is changing with many countries tightening their pollution regulations. This shift from synthetic to green surfactants will require many companies to change their processes and Galaxy is no exception. I am still evaluating the impact that this structural change will have on the company in the mid to long term.
Surfactants is an important raw material of almost everything required for cleansing. Right from soaps to detergents to industrial cleansing solutions. By definition, surfactant is something which helps two or more material phases come together. This explains how important these products really are. Another beauty of this product category is that it is a part of fast-moving items. Hindustan Unilever, a giant in it's category, is perhaps where it is today partially because of the predictable nature of demand for its products. A simple thought here is if the end-user industry has predictable demand, won’t the raw materials be required accordingly? Most likely, it will be the case! Alongwith cleaning solutions, surfactants are also widely used in healthcare, cropcare and other industrial uses. In the world of agriculture, surfactants help the pesticides, herbicides & fungicides to gel well with the crops/ soil. This wide usage of surfactants gives the industry a benefit of diversification of the client base. Moreover, the product category is almost irreplaceable.
Galaxy surfactants is an important partner to many companies whose end products are fast moving. Although the surfactants industry is pretty commoditized, there is a high degree of expertise needed to run the show successfully. The business is sensitive to input cost pressures for its key raw material- fatty acids. Competent management is much desired to manage this key risk.
The company’s manufacturing facilities are strategically positioned in 3 geographies: India, Egypt & USA. The plant in New Hampshire, USA serves the North American region. Egypt serves Africa, the Middle East & Turkey. Majority of surfactant volumes come from Asia Pacific and the company has a presence in major high growth areas.
“Having a technically-sound management is a big positive in a commoditized market having volatile input costs and end product prices. A strong management is generally better placed to play the premiumization theme.”
Broadly, the company’s products are divided into performance surfactants and specialty products. The key to succeeding in the former is increasing volumes, whereas the key to succeeding in the latter is higher EBITDA margins. The management is optimistic about premiumization in the surfactant industry. That naturally means the share of specialty products in revenues is expected to rise and thereby increasing EBITDA margins. Currently, the share of performance to specialty products is 35:65 for the global business. This number for the Indian market is 25:75.
To sum up, strong management, strategic placement of manufacturing facilities close to high growth areas & premiumization of the product mix calls for detailed study about the company. In short, it can be said that this investment is a pseudo-consumption investment in the B2B space.
Fatty acids form close to 50% of the input cost for the company. Approximately 20% of the input cost comprises crude derivatives namely ethylene oxide, phenol, linear alkyl benzene.
Cumulative operating cashflows from 2012 to 2019 stand at Rs. 969 crores. Cumulative PAT during the same period adds up to Rs. 756 crores. The ratio of CFO to PAT stands at 78%. Increase in receivables for the company over a period of the last 7 years stands at 47%. The company has not been able to convert all its profits into cash flows. Although the deficit is not very high, the credit policy of the company needs a closer look.
Free cashflows to the company during the same period from 2012 to 2019 stood at Rs. 450 crores. Percentage of free cashflows to total cash from operations stands at 46.51%. The company has expanded its business substantially over this period, hence the ratio is justified.
Indebtedness & solvency
Long term borrowings for the company are Rs. 88 crores & short term borrowing stood at Rs. 163 crores as on 31st march 2019. Borrowing numbers are slightly elated as a %age of equity (D/E = 0.34). The interest coverage ratio is a comfortable number. The management has given an acceptable reason for an increase in the D/E ratio. They are awaiting some refunds post which the debt will be cleared.
Receivable days for the company have increased from 39 to 55 from 2011 to 2019. During the same period, payable days and inventory days increased respectively from 34 and 48 to 41 and 46. Clearly, there is inventory buildup and also pressure on receivables. However, the increase in receivable days is partly offset by the increase in payable days. This needs a more careful look.
From 2012 to 2019, the company has paid total dividends of Rs. 141 crores against a cumulative net profit of Rs. 756 crores during the same period. The average dividend payout during the period stood at 19.17%.
Management & board
4 out of 12 board members are independent directors. Mr. Unnathan Shekhar is the Promoter & Managing Director of the board. He is professionally qualified with a Bachelor’s degree in Chemical Engineering from the University Department of Chemical Technology, Mumbai and a post graduate diploma in management from IIM-C. Mr. Shekhar Warriar is the chairman of the board. He joined Galaxy in the year 2007. He has more than 30 years of experience with Unilever in various capacities. The board also has participation from some notable names like Ms. Nandita Gurjar. Overall, the board quality is good, with the exception of a lesser than the desired number of independent directors.
What stands out
Potential premiumization of a commodity product, stable demand from end-user industries, diversified customer base, and a strong management.
The 7 year CAGR in sales, EBIT and PAT is 5.4%, 4.7%, 10.7% respectively.
EV: EBITDA - 13.66
Price: Earnings per share - 21.33
Price:Book - 4.61
Quick DCF valuation
10 year CAGR growht: 10%
Terminal growth: 4%
Cost of capital: 12%
5 year avg FCFF: Rs. 84 crores
Year 1 FCFF for DCF: Rs. 84 crores
Fair value by DCF: Rs. 3267 crores
Current mcap: Rs. 4794 crores
Volatile input costs.
For valuations to be justified, a 12-15% growth needs to be factored in for free cashflows. 15% growth over the next 10 years is quite high and expecting this kind of consistent volume growth can be challenging. This means the management has to deliver on its conviction of EBITDA expansion using the premiumization theme. If this conviction doesn’t come true, valuations are surely expensive. It is better to invest in a staggered manner and very closely track EBITDA margins. Only an expansion in EBITDA can justify the current valuations.
The manufacturing facility in Egypt is all fine till such time there is relative political stability in the country. As per world bank data, the political stability in Egypt stood at -1.16 in 2018 (-2.5 is the worst and +2.5 is the best). The average from 1996 to 2018 stands at -0.9.
Increasing operations in politically instable nations could invite forex risk for the company. This needs a closer look.
Other salient information
Research & development expenditure stood at 1.06% of revenue as on March 2019.
The company has earned 49 patents since 2002 and 37 patent applications are pending.
The company has done major capex addition at Jhagadia in Gujarat. The capacity at various location now is: Jhagadia (79500 MT), Taloja(15900), Tarapur(32880), USA(600 MT)
Deloitte Haskins & Sells LLP is the statutory auditor for the company.
The company doesn’t have a substantial forex risk as the net position at a given time is close to neutral.
Disclaimer: We currently do not hold any position in Galaxy Surfactants. However, I am waiting for a correction in the prices. The 10% growth rate factored in the above calculations is on the higher end in my opinion. I am working on factoring the right discount rate for the company taking into consideration its operations in Egypt(cost of equity in Egypt is high owing to the higher risk premiums). Please treat this article as study material and consult your advisor before making any investment decision. You may contact us in case you need a more detailed study of this company.