Detailed Rationale

CRISIL Ratings has reaffirmed its rating on the long-term bank facilities of Meghmani Finechem Limited (MFL) at 'CRISIL AA-/Stable'.

 

Company recorded year on year revenue growth of ~87% for fiscal 2022 at Rs. 1554 crores (FY21: 830 crores). The growth was driven by a sharp increase in realizations (more than 50% in Chlor Alkali segment) and healthy utilization levels across product segments (Chlor Alkali - 86%, CMS-103% and H2O2-78%). Healthy growth momentum continued in H1 2023 with revenues growing ~73% year on year to ~Rs. 1088 crores (H1FY22: 630) with continued healthy realizations and capacity utilization levels (Chlor Alkali - 89%, CMS-105% and H2O2-96%). The share of revenue from Chlor Alkali segment stood at ~75% for both fiscal 2022 and H1 2023 driven by higher realizations. The capacity expansion undertaken in Chlorine downstream segments is expected to strengthen MFL's business risk profile over the medium term with increased product diversification and higher share of revenues coming from Chlorinated Polyvinyl Chloride (CPVC) & Epichlorohydrin (ECH) thereby mitigating the volatility in margins brought about by the purely commoditized nature of caustic soda. Share of caustic soda in total revenues has been steadily coming down from ~85% in fiscal 2019 to 75% during the first half of fiscal 2023 and is further expected to come down to ~50-55% over the next 2-3 years. Contribution from these downstream chlorine and hydrogen products along with healthy utilization rates in existing facilities are expected to drive healthy revenue growth over the medium term.

 

Operating margins for fiscal 2022 stood at 33% driven by higher realizations especially in the Chlor Alkali segment. Despite moderation in gross margins, strong efficiencies arising from integrated nature of operations and lower power costs due to captive power plant resulted in better fixed cost absorption and better margins as compared to fiscal 2021. Continuing on a similar trend, the operating margins for H1 2023 stood at ~34% and are expected to stay in the range of 26-30% over the medium term owing to ramp up of additional Chlor Alkali capacity and new product (CPVC and ECH) capacities.

 

MFL's has a strong financial risk profile driven by strong capital structure and healthy debt protection metrics. The company's financial risk profile has been on an improving trend despite capex being undertaken due to strong operating performance of existing as well as newly commissioned facilities. MFL's networth stood at ~Rs. 1124 crores with gearing at healthy 0.66 times as on September 30th 2022. Despite ongoing capex, debt protection metrics such as interest cover stood at 14.6 times as on September 30th 2022. Furthermore, these metrics are expected to improve over the medium term with progressive debt repayments and accruals being used to meet incremental capex and working capital requirements. Improvement in debt metrics, will nevertheless, remain sensitive to any cost overruns, which may necessitate additional debt funding.

 

MFL has demonstrated a strong track record in execution of complex projects like Chloromethanes and Hydrogen Peroxide over the last 2 fiscals. It has also commissioned additional Chlor Alkali capacity of 106KTPA in Q2FY23, 30,000 ton per annum CPVC plant in Q2FY23 and 50,000 ton per annum ECH plant in Q1FY23. Company is also in process to implement a Chlorotoluene plant by next fiscal. The company has also purchased land worth ~150 crores in Dahej for future expansion. The land purchase has been fully funded by internal accruals. Over the medium term, the company is expected to incur capex of approximately ~Rs. 250-300 crores per annum which will be funded by a prudent mix of increased internal accruals and incremental debt.

 

The rating continues to reflect MFL's healthy business risk profile supported by steady revenue growth, healthy operating margin and good demand prospects. The rating also factors its adequate and improving financial risk profile. These strengths are partially offset by the company's high revenue dependence on the intensely competitive chlor alkali industry, exposure to regulatory risks, moderate vulnerability of operating margin to fluctuations in caustic soda prices and also exposure to project implementation risks, though lower than earlier.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has considered the standalone business and financial risk profile of MFL.

 

CRISIL Ratings has also treated the RPS of Rs 199 crores as equity on account of high equity like nature of the instrument and understanding that redemption is not expected over the medium term.

Key Rating Drivers & Detailed Description

Strengths:

Steady revenue growth, healthy operating margin and good demand prospects: Revenue visibility over the medium term will be driven by steady demand for Caustic Soda, Hydrogen Peroxide and CMS and quick ramp up of upcoming facilities for ECH and CPVC. The company has maintained a comfortable operating margin of over 30% (despite certain volatility), owing to its integrated nature of operations and low-cost production model. Most of MFL's chlorine and hydrogen derivative products like CMS, ECH and CPVC are aimed at import substitution as domestic capacities are low and there is a demand supply mismatch in these products. This is expected to continue over the medium term as well aiding MFL's revenue growth and diversification from base chemicals like caustic soda.

 

Adequate and improving financial risk profile: MFL had availed debt for funding past capex which has resulted in gearing increasing to ~1.20 time as of March 31, 2022 from 0.14 times as of March 31, 2018. Capex spending is expected to continue over the next two fiscals, but reliance on debt will be lower due to strong accruals. The ECH and CPVC plants are expected to ramp up by fourth quarter of fiscal 2023. As the benefits of new projects and capacities accrue into business, capital structure and debt protection metrics should improve over the medium term. Besides, ongoing capex is also modular in nature, and can be postponed, in the event of sharp deterioration in demand or any external exigencies.

 

Weakness:

High though moderating dependence on the intensely competitive chlor alkali industry: The chlor alkali industry is intensely competitive and dominated by large players such as Gujarat Alkalis and Chemicals Ltd, DCM Shriram Ltd, Grasim Industries Ltd, and Reliance Industries Ltd (rated 'CRISIL AAA/Stable/CRISIL A1+'). The top 7 players together hold 40-50% of the market share. While MFL has been growing at a healthy pace and new products will add to revenue visibility further, scale of operations remains moderate compared to peers. Besides, currently around 75% of its revenues are derived from the chlor-alkali segment, especially caustic soda, which is commoditized in nature, and prone to business cycles. Nevertheless, with addition of new downstream products, dependence on caustic soda revenues will gradually decline over the medium term.

 

Vulnerability to fluctuations in caustic soda prices and regulatory risk: Profitability of caustic manufacturing companies depends on the prevailing ECU prices. Cyclical downturns or adverse variability in demand-supply balance, may drag down realisations for caustic soda players. The government of India imposed an anti-dumping duty on caustic soda imports from South Korea and China. Hence, prices could come under pressure in the event of increased imports from China, and removal of anti-dumping duty, thus impacting profitability of domestic players including MFL. The company's operating margin has ranged from 30-40% in the past six years, reflective of the aforesaid factors.

 

With MFL diversifying into downstream chlorine derivative products like CMS, ECH and CPVC, contribution from caustic soda is expected to reduce in the future which will help in stabilizing operating profitability and accruals

Liquidity: Strong

MFL's liquidity is strong. Cash generation was Rs. 339 crore in fiscal 2022, and over Rs. 240 crores in first half of fiscal 2023. Expected accruals of over Rs.450 crore per annum  will suffice to meet annual repayment obligations of about Rs. 140-180 crores over the medium term. CRISIL Ratings also draws comfort from the headroom available in its fund based working capital limits of Rs 400 crore which have been moderately utilized at less than 45% on average over the past 6 months ended September 2022.

Outlook: Stable

CRISIL Ratings believes the MFL's business risk profile will continue to benefit from the diversity in revenues from downstream derivative products and from healthy operating efficiency over the medium term. While debt levels are likely to peak in fiscal 2023, healthy cash accruals and progressive debt repayment, will help buttress impact of debt addition for ongoing projects, enabling improvement in debt metrics over the medium term.

Rating Sensitivity Factors

Upward factors:

• Improvement in operating performance driven by swift ramp up of new capacities, supporting double digit revenue growth and sustenance of healthy operating margins
• Continued improvement in financial profile and debt metrics; for instance, debt/EBITDA remaining at less than 1.2-1.4 times

 

Downward factors:

• Significant moderation in operating performance with sustained deterioration in operating margins impacting cash generation
• Significant delay in commissioning of new capacities or higher than expected debt availed for funding the capex leading to deterioration in credit metrics - debt/EBITDA of over 2.5-2.7 times on a sustained basis. 

About the Company

MFL, part of the Ahmedabad-based Meghmani group, was incorporated in September 2007 as a subsidiary of Meghmani Organics Ltd (MOL), to establish a captive source of caustic soda and chlorine derivatives. Pursuant to NCLT approval for demerger, MFL was listed on the stock exchanges with the promoters currently holding 72.6% of the equity stake with balance being held by public.

 

MFL started operations from July 2009 with an installed capacity for manufacturing 119,000 tons per annum (tpa) of caustic soda; the capacity was enhanced to 187,600 tpa (caustic soda 166,600 tpa and caustic potash 21,000 tpa) subsequently to 294,000 tpa as of June 30, 2020, and 400,000 tpa as of 30th September 2022. A 96-megawatt captive power plant (increased from original 60 MW) was added at Dahej, Gujarat. The capacity of the power plant will be increased to 132 MW by Q4FY23.

Key Financial Indicators

Particulars*	Unit	2022	2021
Revenue	Rs crore	1554	830
Profit After Tax (PAT)	Rs crore	253	101
PAT Margin	%	16.3	12.1
Adjusted Debt/Adjusted networth	Times	0.86	0.83
Interest Coverage	Times	11.60	9.05

*CRISIL Ratings adjusted

Any other information: Not applicable