Meghmani Organics’ disappointing performance; challenges faced by the chemical industry; and positive initiatives for future growth.
8 Dec. 2023
Recap
The stock performance of Meghmani Organics has been disappointing for investors in the past year. It experienced a loss of 32% in value, dropping from ₹111 to ₹75 per share. Over the last twelve months, sales decreased by 33%, and operating profit fell by a significant 91%. The most recent quarter (Q2FY24) was particularly disheartening, with sales declining by 41% and reporting losses at both the operating and net levels.
The stock was listed in August 2021 when its parent company was split into two companies: Meghmani Organics and Meghmani Finechem. We have been shareholders of the parent company since August 2019. After the split, we received shares in both Meghmani Organics and Meghmani Finechem. We sold all our shares of Meghmani Finechem in December 2021. The company later changed its name to ‘Epigral Ltd.’
Meghmani Organics (MOL) is a chemicals company with two business segments – pigments and agrochemicals. You can learn more about MOL and its long-term prospects in our Jan 2023 analysis. In that analysis, we said that:
the company is facing short-term challenges and the outlook for 2023 looks gloomy. However, despite all these, the stock has strong fundamentals, bright prospects, and cheap valuation – and finally concluded that the stock is a ‘promising stock.’
The stock then was trading at ₹99 per share.
In line with our analysis, we decided to keep our holdings and not engage in any buying or selling of MOL stock throughout the past year. Looking back, I consider this decision to be below average. It would have been better if we had reduced our positions since at least November 2022, after the Q2FY23 results.
Briefing
The challenges faced by MOL now and the subsequent drop in its earnings and stock price are not only happening to MOL, but to the entire chemical industry. The accumulation of expensive inventory due to oversupply in the market has impacted the revenue and profits of companies in the chemical industry.
MOL’s management contends that the industry is facing challenges such as price decreases, excess inventory, and weak global demand. However, the company has taken proactive steps to address these issues. They have implemented cost control measures, cleared out expensive inventory, improved the use of working capital, and made the cash conversion cycle more efficient. The management has also expressed confidence that most high-price inventory has been cleared. However, they have also stated that the subdued trend will continue for the next two quarters.
A big reason I’m hopeful about MOL is because there are many positive projects and advancements happening at the company. These could lead to high growth and profitability in the future, despite the recent struggle and challenges. Here are a few examples:
- The multipurpose plant set up at a CAPEX of ₹390 crores was commissioned in Q3FY23 and has commenced commercial production. The plant with an installed capacity of 5,000 MTPA is focused on producing high-value new-age insecticides. Moreover, the company has signed a 5-year agreement worth $100 million with a leading global agrochemical company.
- It has forayed into the crop nutrition segment by entering into a licensing agreement with the cooperative giant IFFCO to manufacture Nano Urea (liquid) fertilizer. The company is setting up a plant in Gujarat with an annual capacity of 5 crore bottles at a capex of ₹150 crores to manufacture nano urea fertilizer.
- Through the acquisition of Kilburn Chemicals in 2021, MOL forayed into the high margin Titanium Dioxide business which is used principally by the paints, coatings, and plastic industry. Currently, 73 percent of India’s titanium dioxide needs are met through imports. MOL is setting up a 33,000 MTPA plant at a cost of ₹600 crores in two phases. The first phase was commissioned in Q4FY23. The company expects to capture a 29 percent industry market share.
- Additionally, it is setting up a subsidiary in Brazil – the world’s largest agrochemical market.
Analysis
The strong financial position of MOL, with a healthy balance sheet and good cash flow, allows it to withstand the current challenging phase with minimal harm. Despite significant investments in recent years, the company maintains a low debt-equity ratio of 0.54. Notably, in the September 2023 quarter, the company efficiently managed its working capital, resulting in improved operating cash flow. Although MOL reported a loss before tax of -₹58.92 crores in H1FY24, it generated a positive operating cash flow of +₹149.24 crores. This was primarily due to a 25 percent decline in both inventories and trade receivables.
MOL derives 75 percent of its revenue from the agrochemical industry. For relative comparison, I selected four listed agrochemical companies – Dhanuka Agritech, Rallis India, Sumitomo Chemicals, and Bharat Rasayan.
The Gross Profit Margin (%) change over the past one year of the five players are noted below:
| Stock | TTM GPM (Q2FY24) | TTM GPM (Q2FY23) |
| Meghmani Organics | 36.4% | 41.4% |
| Dhanuka Agritech | 36.6% | 35.2% |
| Rallis India | 36.6% | 36.1% |
| Sumitomo Chemicals | 34.4% | 37.1% |
| Bharat Rasayan | 28.7% | 32.3% |
Similarly, the Operating Profit Margin (%) change over the past year of the five players is noted below:
| Stock | TTM OPM (Q2FY24) | TTM OPM (Q2FY23) |
| Meghmani Organics | 1.5% | 12.3% |
| Dhanuka Agritech | 16.6% | 15.7% |
| Rallis India | 4.9% | 7.1% |
| Sumitomo Chemicals | 13.7% | 18.7% |
| Bharat Rasayan | 9.0% | 15.7% |
As evident from the tables, except for Dhanuka, margins declined for all the companies, but MOL had the steepest fall.
The peer comparison has limitations. MOL mostly earns around 90 percent of its revenue from exports and mainly focuses on technical grade agrochemicals. On the other hand, Dhanuka Agritech, Rallis India, and Sumitomo Chemicals primarily deal with pesticide formulations and make a significant portion of their revenue from the domestic market.
Bharat Rasayan is a company that is similar to MOL in terms of its business. It mainly earns its income from exporting technical-grade pesticides and intermediates. However, Bharat Rasayan did not experience a decrease in profit margins as steep as MOL.
Insight
MOL’s stock price dropped by 32% in the last year. I should have noticed it and sold some of my shares when the company’s profitability was decreasing. Unfortunately, I didn’t do that. However, there’s no point in dwelling on the past. Instead, it’s more useful to focus on what actions I can take now.
The stock’s operating profit margin is 1.5% and return on equity is 1.4%. The price-earnings ratio might not be a reliable valuation metric now due to the low earnings. The price-to-book value is a better indicator. The current book value is ₹62.30 per share and the stock at the current market price of ₹77.20 is trading at a price-to-book value of 1.24. Considering the current earnings and profitability, the stock should ideally be valued at its book value.
My strategy for Meghmani Organics is to hold onto my current holdings. If the company’s earnings and profitability continue to decline in the future, I will start selling some of my shares. On the other hand, if the company’s financial performance improves, I will consider adding more shares to my position once its return on capital at least equals its cost of capital.
AMN CAPITAL 