Company Analysis - Oriental Carbon and Chemicals Limited

Disclaimer: This report is prepared purely for academic purposes with data taken from available sources like company annual reports, company website, credit reports, research reports, screener.com etc.

This report intends to:

1. Analyse the various financial metrics of the company

2. Attempts to study the industry that the company operates in and analyses whether the company has any distinctive competitive advantages

3. Gather information from various Annual Reports, Investor Presentation reports and Credit reports to understand the company strategy

This report is NOT:

1. An analyst report with future projections or target prices

2. A recommendation on the stock to “Buy” or “Not Buy” – since the company is listed

Please don’t make any investment decision based on this report.

Introduction

Oriental Carbon and Chemicals Ltd (OCCL) is a company manufacturing insoluble sulphur and sulphuric acid. Insoluble sulphur is a necessary compound to be used as a vulcanisation agent in manufacturing tyres. This essentially means that tyre companies are there major customers.

The company operates in an oligopolistic market. OCCL is the sole listed domestic player in the country manufacturing insoluble sulphur as of now.

Why choose OCCL for this analysis?

There are many large companies in India which, if looked closely, exhibit monopoly/leadership traits. Few examples are Colgate with 50%+ market share in oral care, Asian Paints with 50%+ market share in decorative paints, Maruti Suzuki with 50%+ market share in passenger cars, ITC with 75%+ market share in cigarettes. These companies are said to have a strong ‘moat’. Conceptualized and named by Warren Buffett, an economic moat is a distinct advantage a company has over its competitors, which allows it to protect its market share and profitability.

Could there be listed companies in small cap and mid cap sectors having strong moats – may be even exhibiting monopoly traits?

Prima facie, following points strike immediately when it comes to OCCL:

1. They are the only listed domestic player supplying insoluble sulphur

2. They have 60% market share in India (source : company website – https://www.occlindia.com/)

3. They have global market share of 10%

These factors prompted us to study this company further. Let’s get into some details.

The investor presentation in Quarter 3, FY 2020-21 revealed the following:

1. Entry Barriers – The company has high entry barriers with regards to customer approvals, technology and capital intensiveness.

2. Niche Products – The company possesses a niche product portfolio of Insoluble Sulphur, Sulphuric acids and Olems offered in various grades to satisfy diverse compounding requirements majorly for tyre industry

3. Customer Base – The company has a customer base of 40+ clients spread across 21 countries

4. Capacity Expansion – Continuous Expansion of capacities of Insoluble Sulphur have taken place from 3,000 MT in 1994 to 34,000 MT currently

These are interesting facets which drives us to delve deeper. So here we go:

An Analysis of the Past

Sales and Operating Profit

Let’s explore the growth in Sales and how the company has fared in maintaining the operating profit for the past ten years.

(Source of financials: screener.com)

OCCL has been able to grow sales at an almost consistent basis on a CAGR of 9% from 2011 to 2020. (We have to note that FY 2019-20 figures also reflects the partial Covid and lock down impact, without which sales could have been higher).

The operating margin was in the range of 26% to 30% throughout almost all the years. This is a good margin and the consistency endorses the moat factor we discussed previously. It also reflects its ability to pass on the price increase in raw materials to its customers. We would need to analyse the business in depth to understand this further.

The growth of sales have come from consistent capacity expansions done by the company.

The major milestones of the company as found on the Annual Report 2019-20:

About the product

Since it was mentioned in the investor presentation that the company had a niche product portfolio, we looked into further details about the product. The following details were found in the Annual Report 2019-20:

Insoluble Sulphur: It is an amorphous form of sulphur in polymeric form in contrast to natural sulphur which is crystalline and monomeric in nature. The product is rendered insoluble in all known solvents and rubber compounds. It does not take part in cross-linking reaction like natural sulphur as long as it is in polymeric form.

(Source: Annual Report 2019-20)

Manufacturing Capacity and Future Expansion Plans

OCCL has a manufacturing capacity of 34,000 tonne of insoluble sulphur and 46,000 tonne of sulphuric acid; with the former forming ~93% of sales with exports constituting ~60% of sales.

In the past, OCCL had successfully commissioned 11,000 tonne of insoluble surplus and has already attained the optimum utilisation levels. Sensing steady demand prospects, OCCL has formulated and is currently executing a new capex plan.

They intend to install 11,000 tonne of insoluble sulphur (two lines of 5,500 tonne each) at Dharuhera (Haryana) coupled with 42,000 tonne of sulphuric acid plant at a total outlay of Rs 216 crore at a targeted IRR of ~20%. OCCL expect first phase i.e. 5,500 tonne to commissioning by FY21 end.

(Source : ICICI Direct Research Report)

The Insoluble Sulphur Industry

The global demand for Insoluble sulphur was estimated at 300,000 MTPA as per latest Notch report. The demand for quality Insoluble Sulphur should be around 250,000 MTPA. Demand in India was expected to be around 18,000 MTPA. The industry consists of three major players who manufactures internationally acceptable insoluble sulphur – one being OCCL. One of the companies is a global multinational, having multi location plants, and that player dominates the international insoluble sulphur market. However, OCCL’s geographical footprint is wide and encompasses all continents.

Sulphuric Acid and Oleum

Sulphuric Acid is used in the production of phosphate fertilizers, detergents and lead batteries. It is used as a catalyst and dehydrating agent in petrochemical process and organic chemical manufacturing. India is one of the largest consumers of Sulphuric Acid globally and accounts for 4% of demand and produces around 5% of all Sulphuric Acid consumed.

(Source : Annual Report 2019-20)

Net profit

(Source of financials: screener.com)

OCCL has been able to grow its Net Profit from Rs 37Crores in 2011 to Rs 72 Crores in 2020 at a CAGR of 7.4%.

The net profit margin decreased from 24% in 2011 to 12% in 2013; thereafter increasing to 21% in 2020. From 2015 to 2020 the net profit margin has been quite steady in the range of 18% to 21%. The company being able to keep up both operating profit margins and net profit margins in both favourable and tough years is a good sign. This shows the company’s ability to pass on the price increase in raw materials to its customers and its operational efficiency.

Interest Coverage

The interest coverage ratio measures how many times a company can cover its current interest payment with its available earnings. The ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by the company’s interest expenses for the same period. A higher ratio means that the company would not be overburdened with debt issues during low business cycles or tough economic circumstances like the recent Covid-19 uncertainty.

With this background, let us check the debt and interest coverage of OCCL:

(Source of financials: screener.com)

Throughout the years from 2011 to 2020, OCCL has been able to maintain a high interest coverage ratio, meaning its debt burden was low compared to its earnings. This also means that the capacity expansions that had taken place could have been amply supported by internal accruals. Hence, OCCL is able to expand its capacity without relying highly on external sources of funds.

Operational Performance

Let us look at the split of expenses in the company.

(Source of financials: screener.com)

Raw material cost contributes the maximum percentage of expenses. As a percentage of sales, this is around 28% and more or less consistent throughout the years. This again reflects the fact that OCCL is able to pass the rise in cost of raw materials on to its customers. The niche portfolio of products could be the helping factor here, as although the customers of OCCL are large tyre companies which in normal course would have better bargaining power, but in this case the suppliers of insoluble sulphur are limited and hence OCCL is able to preserve its margins.

Employee cost has risen over the years. From 10% of sales in 2011, it is 14% of sales in 2020. OCCL has been able to reduce the power and fuel expenses which hovered around 16% in 2013 and 2014 to 11% in 2019 and 10% in 2020. Over the years, the company has been able to keep its expenses in check as can be seen from the table.

Next, we can look at how efficiently the company is putting its assets to use and its inventory management.

Net Fixed Asset Turnover ratio compares sales from income statement and net fixed assets from balance sheet to measure the company’s ability to generate sales from its fixed asset investments comprising property, plant and equipment.

Inventory Turnover ratio measures the number of times inventory is sold or consumed in a given time. Higher the inventory turn over the better, as it means there are more inventory turns happening in that period.

(Source of financials: screener.com)

Inventory turnover has been in the range of 7 to 10 throughout the years from 2011 to 2020. This reflects good working capital management by the company.

Net Fixed Asset Turnover (NFAT) however was 2.3 in 2011 and it reduced to 1.5 in 2012. Again in 2016, NFAT from 1.5 fell to 1.1 in 2019. We need to analyse further to find the reasons why. The Capex done by the company could not be converted effectively into sales from 2017 to 2020.

Cash Flows

(Source of financials: screener.com)

OCCL in the last nine years, has generated a cumulative net profit of Rs 460 Cr. The cumulative Cash from Operating Activity (CFO) over the same period has been Rs 627 Cr. This means the company has been able to convert its profits into cash, which is positive.

To increase its sales from Rs 218 Cr in 2012 to Rs 340 Cr in 2020, OCCL had to invest a cumulative Capex of Rs 372 Crore. The CFO over the same period was Rs 627 Crore, meaning that the company was able to generate a Free Cash Flow of Rs 255 Crores. Company could have used this FCF to pay dividends which amounted to a total of Rs 78 Crores over the last nine years; and also to fund its Capex requirements.

The years 2016, 2017 and 2018 had relatively high Capex of Rs 46Cr, Rs 101Cr and Rs 56Cr respectively. The company also had a negative FCF in the year 2017. We had previously seen in our NFAT ratio calculation that NFAT was lower in years 2019, 2020. It could mean that these investments done in 2016, 2017 and 2018 are still to generate the desired sales.

The Capex in PPE can be seen in the respective Annual Reports:

In Director’s Report of Annual Report 2016-17, it is mentioned about the growth in sales which was contributed mainly due to the commissioning of the new line at Mundra SEZ.

In Annual Report 2015-16, it can be seen that Rs 827 lakhs have been invested in Plant and Equipment. Similarly, in Annual Report 2016-17, and amount of Rs 6,829 lakhs have been invested in buildings and Rs 6,204 lakhs have been invested into adding new Plant and Equipment. As seen in our cash flow statements, this shows continuous investments in Capex by the company, a large part of it going into PPE.

(Source : Annual Report 2016-17)

In the Director’s Report of Annual Report 2016-17, the on-going capacity expansion is mentioned and its expected commissioning in second quarter of 2018-19 is also stated.

Return Ratios

Though many return ratios can be analysed, we shall focus on Return on Capital Employed (ROCE) and Return on Equity (ROE). ROCE can help to understand how well a company is generating profits from its capital as it is put to use. ROCE = EBIT/Capital Employed.

ROE is considered a measure of the profitability of a company with respect to stockholders’ equity. ROE = Net Income/Shareholders’ Equity.

(Source of financials : screener.com)

The Return on Equity was above 20% in years 2014, 2015 and 2016, but thereafter reduced to 18% in 2019 and 16% in 2020. This prompts us to check the PAT growth trends which are as:

The PAT growth in recent years seems to have slowed down. This could be a reason on RoE falling. The DuPont Analysis which we shall do later would give a clearer picture on why the RoE is declining.

ROCE was 24% in 2012. It was able to maintain an average of 20% almost throughout the last nine years. In 2020, the ROCE fell to 15%. We had also seen that the company has been doing continuous expansions and the falling NFAT. The new assets are yet to produce the desired levels of output, which could also be a reason of the low RoCE in 2020.

DuPont Analysis

DuPont analysis helps us to look further into detail of Return on equity. There are three major financial metrics that drive return on equity (ROE): operating efficiency, asset use efficiency and financial leverage.

This can be explained as:

(Source of financials : screener.com)

As can be seen from DuPont Analysis table, Net Profit Margin was maintained at healthy levels by OCCL. From 14% in 2012, the company managed to raise it to a consistent level of close to 20% throughout the years of 2016(20%), 2017(18%), 2018(18%), 2019(19%) and 2020 (21%).

Hence, we are able to see that RoE has fallen mainly due to decline in asset turnover and equity multiplier. The capex done and inability to bring about proportionate realizations has caused the erosion in asset turnover from 0.7 in 2012 to 0.5 in 2020 and equity multiplier from 2.0 in 2012 to 1.5 in 2020.

Other notable points of the company

The credit report by ICRA dated July 20, 2020 mentions the following details (in italics), worth knowing about OCCL:

“The ratings factor in the long and established track record of OCCL in the business of producing Insoluble sulphur, dominant position in the domestic market and favourable position as a second supplier to all major tyre manufacturer in global markets and healthy financial risk profile characterised by large un-encumbered cash balances, adequate albeit significantly lower cash accruals in the current fiscal and low debt repayments in the near to medium term.”

ICRA acknowledges the long established track record of the company. Also, it notes the healthy financial risk profile and the positive signs of significant cash balances.

“OCCL has around 60% market share in the domestic insoluble sulphur market and ~10% market share globally. While it has dominant position in the domestic market, it has been able to position itself as the preferred / second preferred supplier to most of the global tyre makers.”

The dominant position of the company is mentioned here. We had mentioned this as one of the reasons for selecting OCCL for analysis – as it is as established leader in a not-so-talked segment.

“ICRA also takes note of the capacity expansion underway at OCCL to expand the IS capacity by 11,000 MTPA and Sulphuric acid capacity by 42,000 MTPA at a total capital outlay of Rs. 216 crore at its Dharuhera facility of which the first phase of IS capacity expansion by 5500 MTPA along with Sulphuric acid capacity at an outlay of Rs 156 crore is underway.”

We have already seen that the company is into continuous capacity expansions. The details of the recent expansion plans are mentioned here.

“OCCL is the sole manufacturer of IS in the domestic market. OCCL continues to retain its leadership position in the domestic market with nearly 55%-60% of the market share and around 10% market share in the global market.”

Again the “sole manufacturer in domestic market” is a tag worth taking note of.

“Insoluble sulphur is used as an input for manufacturing of tyres and with rising radialisation the consumption of insoluble sulphur is expected to rise. Notwithstanding the current weakness in demand due to the Covid-19 pandemic, the long-term demand growth of the domestic tyre market is expected to remain around 7-9%. With healthy growth rate for the tyre segment going forward, the demand outlook for IS is expected to remain healthy in the long term.”

ICRA also gives bright prospects for the company in the long term, as the main customer segment (tyres) is expected to have a healthy growth rate going forward.

Probable challenges for OCCL

1. If near term outlook for tyre industry is weak, it could pose realisation challenges for the company

2. Majority of its revenue comes from a single product – Insoluble Sulpur. Also, the company relies mainly on one sector – Automobile. This concentration poses a risk as the OCCL also has to move with the cyclicality associated with the automotive sector.

3. Capacity Expansion / Project Execution – We have already seen that new assets may not provide immediate desired results. There are also risks associated with timely project executions.

4. Regulations : Environment, Health and safety standards could continuously evolve and the company has to keep abreast with the same.

5. Forex movements : A significant share of revenues come through exports, thus exposing the company towards the risk associated with foreign exchange fluctuations.

Conclusion

Oriental Carbon and Chemicals Ltd (OCCL) is a small cap company with a market capitalization below Rs 1000 Crores as of now. The company possesses “economic moat” as can be seen from its stable and healthy operating margins and its ability to pass on the increase in raw material price to its customers.

It is also the sole domestic player manufacturing insoluble sulphur, catering to tyre industries, giving it a distinct and strong positioning in the industry evident from its domestic market share of ~60% and global market share of 10%. The management is continuously expanding the production capacity as can be seen from the Capex happening across the years. Also from a capacity of 11,712 MTPA for insoluble sulphur in 2009-10, OCCL in 2019-20 has a manufacturing capacity of 34,000 MTPA, reflecting the capacity additions done.

Company also has healthy cash flows, as it was seen all the profits were converted to operating cash flows in the past ten years. The company has also consistently paid dividends over the past ten years and also funded for expansions from internal accruals, keeping debt in control, which was again endorsed by ICRA reports.

The cyclicality of automobile industry is a factor that effects OCCL’s performance along with forex fluctuations. As a result, Capex done may not yield sales as anticipated. Environment concerns is also a factor which the company needs to look out for, considering the industry it operates in.

About the Author

Dileepraj R is the CEO and Managing Partner of MintMelon Business Consulting LLP.

Regular Grades : Insoluble Sulphur oil treated grades are insoluble in elastomers, they are completely non-blooming and are ideal vulcanizing agent for unsaturated elastomers.

High Stability Grades: Insoluble Sulphur possesses a high level of thermal stability and provides optimum resistance to Sulphur reversion in soluble form even at elevated temperatures. The product facilitates enhanced bloom protection.

Special grades: Insoluble Sulphur special grades are customized around specific requirements. These grades have been progressively enhanced, customized further in line with demanding downstream requirements.