Detailed Rationale

CRISIL Ratings has reaffirmed its 'CRISIL A1+' rating on the commercial paper programme of Sudarshan Chemical Industries Limited (Sudarshan).

 

Operating revenue for fiscal 2022 is expected to show marginal growth despite the lockdowns imposed during the second wave of Covid-19 impacting domestic revenue in the first quarter, supported by recovery in domestic demand from the second quarter. Exports registered a 9% year-on-year growth in the first half of fiscal 2022 due to subdued demand and logistic issues due to lack of containers. Turnover is expected to see moderate growth over fiscals 2023 and 2024 due to additional revenue potential from expansion in capacity for the pigment business, increasing market share with new launches in the current fiscal and healthy export demand.

 

Profitability expected in the current fiscal, will be lower than that in the previous fiscal due to continuous and sharp input cost increases, creating a lag in passing on the increase in raw material prices to customer, logistics cost escalation and increase in manufacturing costs due to high coal prices. Operating margin and return on capital employed are expected to improve fiscal 2023 onwards backed by greater contribution from higher margin specialty segment, launch of new products with higher margin, cost optimisation measures adopted by the company and ramp up of new capacities.

 

Financial risk profile is expected to remain strong with interest cover and net cash accrual to adjusted debt (NCA/AD) ratios of 10-12 times and 25%-35%, respectively, in fiscal 2022. Capital expenditure (capex) should be funded prudently through internal accrual - expected at a healthy Rs 190-230 crore each in fiscals 2022 and 2023 - and external debt. The total outside liabilities to tangible networth ratio and gearing is expected to remain below 1.8 times and 1.2 times in the medium term.

 

The ratings reflect a healthy business risk profile - marked by Sudarshan’s established market position in the pigments industry, wide product range, diversified end-user industries and strong distribution network with marquee clientele - moderate operating efficiency, comfortable financial risk profile and the extensive industry experience of the promoters. These strengths are partially offset by the large working capital requirements and risks related to volatility in commodity prices as well as to large capex over the medium term.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of Sudarshan and its subsidiaries, Sudarshan Europe B.V., Sudarshan North America, Inc., Sudarshan Shanghai Trading Company Ltd, Sudarshan Mexico S de R.L.de CV and Sudarshan Japan K.K.. This is because all the companies are collectively referred to as Sudarshan group and have significant managerial, operational, and financial linkages. CRISIL Ratings has also consolidated the business and financial risk profiles of RIECO Industries Ltd and Sudarshan CSR Foundation as both are wholly owned subsidiaries of Sudarshan and because of commitment of support from the group and past demonstrated track record. 

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths
* Healthy market position

Sudarshan is the largest pigment manufacturer in India with a 35% market share and as per company estimates, is the third largest pigment manufacturer in the world with an overall market share of about 3%. The company’s products are used in diverse end-user industries such as decorative and automotive coatings, plastics, inks and cosmetics. The company, with a product base comparable to global leaders, aims to add more products to its portfolio. The company has strong distribution network consisting of 60+ channel partners and subsidiaries in USA, Netherlands, China, Mexico and Japan for distribution of pigments world-wide. Exports comprised 51% of sales in fiscal 2021 as against 49% in fiscal 2020. The global market position of Sudarshan is expected to improve further over the medium term given the ongoing consolidation in the industry. The growth is also expected to be supported by new product launches as well as planned capacity expansion by fiscal 2022 end.

 

 * Healthy operating efficiency

Operating margin has improved from around 11.0% in 2015 to 15.5% in fiscal 2021, driven by the increasing contribution of higher margin specialty pigments, benefits of operating leverage as well as focus on pigments business demonstrated by divestment of other businesses. Operating margin decreased to 11.8% in the first half of fiscal 2022 from 15.4% in the same period during last fiscal impacted by lag in passing on the increase in raw material prices to customer, rising logistic and  coal costs. The margins are expected to improve from current levels in the medium term.

 

The divestment of non-core businesses over fiscals 2019 and 2020 has improved the operating efficiency of Sudarshan, as pigments is a relatively higher margin/higher return on capital employed (RoCE) business. RoCE is expected to marginally improve in the medium term. The company’s planned capacity expansion is mainly into high margin specialty segments with increasing operating leverage, the profitability margin of Sudarshan is expected to remain strong. 

 

* Strong financial risk profile

Sudarshan’s capital structure is comfortable with adjusted networth, gearing and total outside liabilities to tangible networth (TOL/TNW) ratio of around Rs 700 crore, 0.88 time and 1.8 times, respectively, as on March 31, 2021. Cash accrual expected at Rs 190-230 crore per annum over the medium term is sufficient as against yearly repayment obligations of Rs 120-140 crore. The debt protection metrics remained comfortable with interest coverage and net cash accrual to total debt ratios of 14.6 times and 37%, respectively, in fiscal 2021.

 

The company is  currently executing ongoing capex worth Rs 400 crore, to be funded by debt and internal accrual. Net debt levels are expected to remain at Rs 750-800 crore over the medium term. Despite the capex being undertaken, capital structure is likely to remain healthy with gearing remaining below 0.95 time owing to healthy cash accrual that is being reinvested in the company. TOL/TNW, expected to remain below 1.8 times in the medium term, should improve thereafter.

 

Weaknesses

* Large working capital requirements as well as risks related to volatility in commodity prices

Gross current assets were sizeable at 196 days as on March 31, 2021 driven by inventory and debtors of around 90 days each. The inventory requirements are high as there are multiple stock keeping units of pigments (over 400) as well as several distribution centres of the company both in India and abroad. The company has been able to manage the working capital requirements well by matching its receivable days with payable days over the last few years, which reduces the dependence on large working capital borrowings. With strong ramp up expected in revenue over the medium term, working capital requirements are likely to increase.

 

The company imports around 35% of its overall raw material requirement, mainly from China, where environmental-led restrictions have caused prices to rise. While Sudarshan revises the pricing of its sale contracts every quarter, the timing difference in passing on the volatility may impact the margins for a particular period. The company’s revenue from specialty pigments has been increasing leading to growing ability to pass on input cost hikes. Nonetheless, margins are still susceptible to risks related to volatility in raw material prices.

* Risks related to large capex over the medium term

The company is carrying out the overall capex of Rs 750 crore for expansion of existing capacities and new products of which capex of Rs 293 crore has already been undertaken in fiscal 2020 and 2021 and balance is under execution. Although the capex is in similar product segments, ensuring they are completed within budgeted time and costs will be critical. The entire capex consists of multiple projects, which are also modular in nature providing significant financial flexibility to the company to manage the same. The funding risk is lower as the company has already tied-up a low-cost foreign currency loan for the same. Also, while the offtake risk is relatively low due to the strong market position of the company and the expansion will be mainly to increase the wallet share of existing customers, overall ramping up of capacities as planned, will remain a key monitorable.

Liquidity: Strong

Cash accrual, expected at Rs 190-230 crore each in fiscals 2022 and 2023 should comfortably cover repayment obligation of Rs 120 crore and Rs 140 crore, respectively, and the surplus will support liquidity. Current ratio was moderate at 1.2 times as on March 31, 2021.

Rating Sensitivity Factors

Downward Factors:

• Operating performance worsens, leading to lower-than-expected cash accrual
• Debt protection metrics weaken, because of substantial working capital requirement, higher-than-expected debt-funded capex, or acquisition expenditure leading to gearing increasing to 1.2-1.5 times or debt/earnings before interest, depreciation, tax and amortisation ratio increasing to above 2.5 times on a sustained basis

About the Company

Sudarshan is a globally renowned pigment player, largest in India, manufacturing a wide range of organic and inorganic pigments and mica-based effect pigments. The company was established in 1952 and remained domestic focused till 2006. The company entered into a joint venture with Dainippon Ink Corporation (DIC) in 1990 which lasted till 2006 after which Sudarshan went global, establishing its footprint in North America and Europe. The company has two manufacturing facilities in Roha and Mahad.

 

During the six months ended September 30, 2021, the company posted net profit of Rs 48.9 crore (Rs 48.5 crore for the corresponding period of previous fiscal) on net sales of Rs 972 crore (Rs 781 crore).

Any other information: Not applicable