Initiating Coverage - Neogen Chemicals - ICICI Direct

Commencing operations in 1991, Neogen Chemicals manufactures specialty organic bromine-based chemical compounds as well as specialty inorganic lithium-based chemicals compounds. The company's products find application in pharmaceutical intermediates, agrochemical intermediates, engineering fluids, polymers additives, water treatment chemicals to name a few. Neogen has two segments viz. (i) organic chemicals, (ii) inorganic chemicals of which organic chemical constitute ~80% of overall revenue while the rest comes from inorganic chemicals. Going ahead, with the recent increase in the organic chemical capacity at Dahej, the company is poised to witness compounded growth over the medium to long run. The upcoming capacity would largely cater to the Custom Synthesis (CRAMS) opportunity given that two of the customers have expressed long term interest. Since the company is more focused on the advanced bromine intermediates market, hence, such a custom synthesis opportunity is expected to arise in the years to come. Thus, we expect another capacity expansion in Dahej to take place post FY23/FY24E (it has already taken EC approval for around 18000 MT of organic chemicals at Dahej of which only 25% would get commissioned in the next two years).

New capacity to drive incremental growth for organic chemical

Both phase 1, 2 expansion at Dahej would expand organic chemical capacity by 3x with a capex of Rs. 130 crore. This would translate into incremental revenue of Rs. 350-375 crore at peak utilisation against overall revenues of Rs. 306 crore currently. We expect the Dahej facility to largely cater to the custom synthesis opportunity with the Vadodara plant catering to advanced intermediates market. Given both these segments have better gross margins compared to the base business, increase in the share of these segments is likely to expand group gross margins and, thereby, OPM and return ratios.

WC cycle to improve, going forward, and thereby FCF

Since Neogen is working on many organic molecules and size of the same is materially lower, it has to keep large WIP inventory to curb manufacturing cycle time. Going forward, with an increase in custom synthesis deliveries and garnering large custom synthesis contracts as witnessed recently, the company can keep dedicated glass lined reactors. Thus, WIP inventories can be restricted significantly. Further, higher bromine consumptions could lead to more bargaining power for Neogen, which can lift payable cycle. This would improve cash conversion cycle and thereby FCF.

Valuation and outlook

We value the company at 38x FY23E PER (~1.25x on two year forward PEG) and arrive at a target price of Rs. 1040. We initiate coverage on Neogen Chemicals with a BUY recommendation on the stock.

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Source : Equity Bulls

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