Analysis – Dynemic Products

24 Oct. 23

Dynemic Products

Sector: Specialty Chemicals

CMP: ₹303 per share

Market Cap.: ₹354 crores

The stock of Dynemic Products has been in a bear phase for the past two years. The stock declined from a high of ₹650 per share in November 2021 to ₹303 per share now.

The period (last two years) also saw its earnings fall precipitously – operating profit fell from ₹35.60 crores in FY21 to just ₹4.65 crores in FY23. Dynemic Product’s business – specialty chemicals – is cyclical. For cyclical stocks, during favourable times, earnings, margins, and stock prices rise sharply. However, this period will be followed by challenging times – characterised by tepid demand and oversupply – when earnings, margins, and stock prices will exhibit a steep fall in value.

For Dynemic Products, the worst might be over, but it is too early to predict a recovery in business and earnings. The margins after bottoming out in the Dec 2022 quarter had made a gradual recovery over the next two quarters (March & June 2023 quarters). Despite that, the TTM OPM at 7.1 percent is a far cry from the peak of 20 percent in early 2021.

Our analysis shows that – despite earnings and margins suffering significantly over the last two years – Dynemic products’ competitive position held strong amid the difficult times: gross profit margins improved during the period. Dynemic products’ gross profit margin (%) – our straightforward method to measure a firm’s competitive position – improved from 44.2 percent in FY21 to 46.2 percent in FY23. In contrast, the operating profit margin (%) declined from 14.77 percent in FY21 to 3.28 percent in FY23 during the same period.

Dynemic Products’ ability to maintain its gross profit margins (%) during the difficult times is a commendable achievement, particularly when its major competitors saw a decline in their respective gross profit margins. Atul saw its gross profit margin decline from 53.3 percent in FY21 to 44.7 percent in FY23; Sudarshan Chemicals saw its gross profit margins decline from 42.5 percent in FY21 to 39.8 percent in FY23. Now, Dynemic Products with a gross profit margin of 46.2 percent has the highest gross profit margin among the lot: it has improved its relative competitive position over the last two years.

For Dynemic Products, sales grew at 19.74 percent annually between FY21 and FY23, and gross profit margins held steady during the period. Then what caused the precipitous fall in earnings during the period? The cost analysis sheds some light on this.

The cost analysis shows the earnings fall was principally contributed by three items: 1) finance cost, 2) depreciation, and 3) power cost. The company had executed a large capital expenditure (towards capacity expansion) during FY20-22, and 65 percent of this capex was financed through debt. The capex contributed to a large increase in depreciation cost, and the debt incurred to finance the capex led to a spike in finance costs over the last two years. The share of finance cost in net sales increased from 1.1 percent in FY21 to 5.6 percent in FY23. Similarly, the share of depreciation in net sales increased from 1.7 percent in FY21 to 5.8 percent in FY23.

Since the capex seems over by FY22, and as the company has started deleveraging its balance sheet FY23 onwards, the finance and depreciation costs would be less concerning going forward. However, the spike in power costs is a serious concern. The share of power & fuel costs in net sales increased from 6.7 percent in FY21 to 15.4 percent in FY23. Presently, Dynemic Products has the highest power cost among its competitors, which can seriously affect its competitive position. The share of power cost for competitors – Atul, Sudharshan Chemicals, and Heubach Colorants – was 12.5 percent, 6.9 percent, and 6.4 percent, respectively, for FY23. Since the Power & fuel cost is a fixed cost, once the full benefit of expansion unfolds, hopefully, it might normalise to a more competitive level.

After the results announcement, the management said “There’s a positive note that raw material costs have begun to stabilize, a shift that holds the potential to enhance our product margins. We expect the full benefit of our expansion program to unfold in FY24 and FY25. And fixed costs will not increase significantly compared to production volume, by which EBITDA margin will improve in FY24 and beyond.” We need to keep a close watch on how the company’s business performs in FY24 and FY25 for evidence of sustainable earnings recovery and cost rationalisation.

One criterion we look for in a quality stock is that its core operating profitability (RNOA) should at least match its required return. Due to the earnings fall of the last two years, Dynemic Products currently have a poor RNOA of 1.1 percent against its required return of 11.07 percent. Another criterion is that RNOA must be greater than the financial cost – here too, Dynemic falls short, with RNOA of 1.1 percent and financial cost (%) of 8.3 percent.

This is a very unfavourable position to be in. We should wait for the firm’s earnings to improve so that its RNOA at least matches its required return, and the RNOA exceeds the firm’s net finance cost by a large margin.

Another headwind for Dynemic Products is the equity dilution made in FY23 and FY24 as part of deleveraging its balance sheet. It paid back ₹22.92 crores worth of debt in FY23, but ₹15.42 crores were raised through a rights issue during the year resulting in an equity dilution of 3.2 percent. In FY24, further equity dilution (6.42 percent) resulted from a fresh issue of equity shares and warrants. In total, an equity dilution of around 10 percent occurred in FY23 and FY24. Usually, equity dilution negatively impacts stock prices by increasing the total shares outstanding and reducing the return on equity capital.

Strategy: Due to its strong competitive position, Dynemic Products warrants a place in any long-term investor’s watchlist. However, the depressed earnings and margins of the last two years, along with the equity dilution incurred to deleverage the balance sheet are serious concerns. The huge spike in and relatively high power & fuel costs is another concern. To consider this stock for one’s portfolio, I believe we need strong evidence of earnings recovery such that its Return on Net Operating Assets (RNOA) – measure of operating profitability – at least matches its required return. Until then, it is prudent to keep away from this stock.

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