CRISIL has upgraded its ratings on the bank facilities of Meghmani Organics Limited (MOL; part of the Meghmani Group) to 'CRISIL AA-/Stable/CRISIL A1+' from 'CRISIL A+/Positive/CRISIL A1'.
 
The upgrade follows the continued strong operating performance of the group marked by healthy contributions from agrochem, pigments and base chemicals segments.
 
The agrochem division in particular grew by a strong 30% in the first nine months of the current fiscal driven largely by the pickup in export demand. Both agrochem and pigments sustained healthy double-digit margins in the current fiscal owing to healthy operating efficiencies and favorable product mix. For the base chemicals division that is under MFL, revenues and margins have declined as expected earlier largely due to the drop in electro chemical unit (ECU) realizations, however cash generation remains healthy. The recently commissioned chloromethane sulphonate (CMS) capacity has scaled up to ~70% utilization by December 2019. Going forward, with the hydrogen peroxide and new caustic soda capacities expected to commission in March 2020 (albeit a delay of 2-3 months against previous estimates), accruals are expected to further improve next fiscal.
 
CRISIL also notes the announcement by MOL on January 29, 2020 wherein the company's board had approved the demerger of the businesses of standalone MOL (i.e) agrochem and pigments into a separate subsidiary, Meghmani Organochem Limited (MOCL); followed by amalgamation  of other Business of MOL ( Trading and Equity investment in MFL)  with its 57% subsidiary, Meghmani Finechem Limited (MFL; rated 'CRISIL A+/Rating Watch with Developing Implications (RWDI)') and subsequent listing of both MOCL and MFL as two separate entities. Eventually MOCL will be renamed as Meghmani Organics Limited.  
 
CRISIL currently consolidates the business and financial risk profiles of both MOL and its subsidiary to arrive at the ratings of MOL. CRISIL notes that the proposed demerger of the MOL and MFL will result in limited financial fungibility between the two entities. However, CRISIL notes that the critical operational synergies, common branding and common promoters between the two entities will remain post demerger also.
 
In event of a demerger, the credit risk profile of MOL on a standalone basis will continue to remain healthy supported by the relatively stable business risk profile of the pigments and agrochemicals divisions. The standalone financial risk profile of MOL is expected to remain strong over the medium term with debt/EBITDA sustaining at less than 1.5 times and interest cover of over 20 times. 
 
Group's capital expenditure (capex) is expected to be around Rs 1100 crore over fiscals 2020 to 2022 towards expansion of chlor-alkali, hydrogen peroxide and ECH units along with expansions in agrochemical business. CRISIL expects the group's consolidated revenue to sustain a healthy compound annual growth rate (CAGR) of 13-15% over the medium term with scaling up of new capacities. Improving product mix, growing synergies and continued strong backward integration in each business segment will support the group to maintain healthy operating margins at over 20% during this period leading to healthy cash accruals.
 
While this sizeable capex is partly debt-funded, financial risk profile will remain healthy marked by gearing of less than 0.9 times expected as on March 31, 2020. Capital structure should improve further over the medium term as benefits of capex accrue to the business. While the group has made progress on the large expansion plans, successful commercialization of remaining projects and ramp up of the new capacities will remain a key monitorable over the near to medium term.
 
The ratings continue to reflect the Meghmani group's established market position in the pigments and agrochemicals segments, and diversified revenue in terms of products and end-user industries. The ratings also factor in the significant cost advantage derived from integrated operations, and comfortable financial risk profile. These strengths are partially offset by large working capital requirement, exposure to risks inherent in the agrochemicals sector and cyclicality in the caustic soda segment. Besides group also remains exposed to risks arising from project implementation, stabilisation and ramp-up in sales during the initial stages.

For arriving at the ratings, CRISIL has combined the business and financial risk profiles of MOL and all its subsidiaries, together referred to as the Meghmani group, as all the entities are under a common management and have operational linkages and fungible cash flow.

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

Strengths
* Established market position in the pigments and agrochemical industries
The Meghmani group has an established market position in its principal business segments: pigments and agrochemicals. It is the largest producer of copper phthalocyanine (CPC) blue and is among the top 3 pigment blue players globally, and enjoys long-standing relationship with key customers. In agrochemicals also, the group is among the largest manufacturer of pesticides in India having presence across the value chain in both technical and formulations. The group has more than 30 brands of various pesticides formulations in India.
 
* Diversified revenue profile
The group has diversified revenue streams with an estimated 38% of its revenue came from agrochemicals, 29% from pigments, and 34% from basic chemicals in fiscal 2019. Revenue diversity is further augmented by presence in both domestic (47%) and international markets (53%). Besides, new products in base chemicals, agrochemicals and pigments will add to further diversity in revenue streams.
 
* Integrated operations, leading to cost advantages
The Meghmani group has integrated backwards into manufacturing CPC blue, resulting in considerable savings. In its agrochemicals business, the group has facilities for manufacturing cypermethric acid chloride, meta phenoxy benzaldehyde and meta phenoxy benzyl alcohol, which are key intermediates in crop-protection products, thus reducing reliance on import. In the base chemicals segment too, the group has announced projects for manufacturing value-added products such as hydrogen peroxide, methylene dichloride, ECH, chloroform and carbon tetra chloride from hydrogen and chlorine, which are by-products of existing manufacturing processes. CRISIL believes healthy integration of production facilities will stand the Meghmani group in good stead over the medium term, and profitability will remain healthy above 20%.
 
* Comfortable financial risk profile
The Meghmani group's financial risk profile is supported by adequate networth and gearing.
 
The group has planned a capex of around Rs 1100 Cr between fiscals 2020 and 2022, largely towards expansion of caustic soda capacity and new facility for chloromethane, hydrogen peroxide and ECH in MFL, besides setting up capacity for new products in the agrochemical division. Despite this part debt funded capex, the group's credit metrics are expected to remain adequate on the back of healthy margins, improving cash generation, and scheduled repayment of term debt. Gearing and net cash accruals to total debt estimated at 0.4 times as on March 31, 2020 and interest cover at 6 times for fiscal 2020.
 
Weaknesses
* Large working capital requirement
The Meghmani group has large working capital requirement as its key businesses are seasonal. A large proportion of agrochemical sales in the domestic market and pigment sales in the overseas market are made in the second and fourth quarters, respectively, of the fiscal. Although export partially offsets dependence on the seasonal domestic agrochemicals market, it exerts pressure on working capital management as the group has to provide credit of 3-4 months to overseas clients, resulting in large receivables. However lower working capital requirements in Chlor Alkali & its Derivatives business partly offsets high GCA in agrochemical and pigments division. Nevertheless, CRISIL believes the Meghmani group's working capital requirement will remain large because of the nature of its business.
 
* Susceptibility to cyclicality in the chlor alkali segment
The chlor alkali industry is intensely competitive and dominated by large players. The top seven players account for close to 50% of the market share. Furthermore, the industry is susceptible to governmental regulations and cyclicality. The profitability of the caustic soda manufacturing companies depends on the prevailing ECU prices. Caustic soda and chlorine prices are volatile. Cyclical downturns or adverse changes in the demand-supply balance may result in lower realisations for caustic soda manufacturers.
 
* Exposure to risks inherent in the agrochemicals sector
The demand for agrochemicals is driven by agricultural production, which depends on monsoon. A substantial area under cultivation in India is still not well irrigated, and depends on the monsoon to meet water requirement. Surplus or inadequate rainfall could affect the Meghmani group's domestic revenue and profitability. Furthermore, the agrochemicals industry is regulated by specific and separate registration processes in different countries. Changes in the export and import policy of these countries will affect Indian agrochemical exporters such as the Meghmani group. Ban on any key molecules will also be a monitorable.
 
* Exposure to risks related to project implementation and stabilisation
The group has four ongoing projects ' Capacity addition for CMS, Caustic Soda, Hydrogen peroxide (all three of which in subsidiary, MFL) and Agrochemicals; of which, one is in the early stage of implementation (Agrochemicals), two have made moderate progress (Caustic Soda and Hydrogen Peroxide) and one is recently commissioned (CMS). The company has also recently announced a new project (ECH) which is yet to be initiated and will come on stream over the medium term. This in turn exposes the group to project-related risks over the medium term such as the risk of time or cost overrun, stabilisation and ramp up in operations post completion. Significant delays in project implementation and stabilization can impact ability to generate cash flows and will remain a key rating sensitivity factor.

The group's liquidity is strong. It is supported by improving cash generation, expected at Rs 250-300 crore annually, which will suffice to service long term debt obligations of Rs 64 crore in fiscal 2020 and Rs 160-180 crore per annum in fiscals 2021 and 2022 and incremental working capital requirements. The group has also tied up long term loans for funding the incremental capex in the Chlor Alkali & its Derivatives business over fiscals 2020 to 2022. The group also has headroom in its fund based working capital limits which have been utilised at an average of 45% over the past nine months ended January 2020.

CRISIL believes that Meghmani group's business performance will remain healthy over the medium term marked by improving product mix, diversified revenue profile and healthy margins leading to strong cash accruals. Besides, financial risk profile is also expected to remain healthy driven by comfortable capital structure and healthy accretion to reserves, despite large on-going capex plans. MOL's credit profile will also remain stable post demerger due to healthy cash flows, and strong balance sheet on standalone basis as well.

Rating Sensitivity Factors
Upward Factors
*Sustenance of healthy performance marked by at least 10-12% revenue growth and operating margins sustaining at over 18-20%
*Further strengthening of credit metrics through prudent capex spends and working capital management 'debt/EBITDA of less than 1.5 times.

Downward Factors
*Significant moderation in operating performance - revenues declining by over 8-10% and operating margins deteriorating to less than 10-12% on a sustained basis
*Significant delay in commissioning and ramp up of new capacities or higher than expected debt availed for funding the capex leading to deterioration in credit metrics - debt/EBITDA deteriorating to over 3 times.

The Meghmani group was established in 1986, promoted by Mr Jayanti Patel, Mr Ashish Soparkar, Mr Natwarlal Patel, Mr Ramesh Patel, and Mr Anand Patel. The group manufactures green and blue pigment products, which are used to manufacture printing ink, plastic, paints, textiles, leather, and rubber. It also manufactures a wide variety of commonly used pesticides for crop and non-crop applications. The latter includes insect control in wood preservation and food grain storage. In July 2009, the group commissioned its caustic soda plant, which has capacity of 187,600 tonne per annum and is powered by a 60-megawatt captive power plant. MOL is listed on the Singapore Stock Exchange, National Stock Exchange of India Ltd, and BSE Limited.
 
In fiscal 2019, MOL gave an exit to the external investor ' International Finance Corporation (IFC) by buying back IFC's 25% stake in MFL for Rs 221.7 Cr. As part of this transaction, MOL infused funds in its fully owned subsidiary - Meghmani Agrochemicals Private Limited (MAPL) which in turn was used to buy IFC's stake. Subsequently, MOL merged MAPL with MFL. As part of the merger transaction, MFL redeemed the non-convertible compulsorily redeemable preference shares (NCRPS) of MAPL amounting to Rs 221.7 Cr using its internal cash accruals. MFL also issued optionally convertible redeemable preference shares (OCRPS) of Rs 210.9 Cr to MOL. These OCRPS are likely to be redeemed over the next 5-7 years post stabilization of MFL's cashflows.  
 
CRISIL also notes the announcement by MOL on January 29, 2020 concerning board approval for demerger of the Agrochem and Pigments businesses (along with the optionally convertible redeemable preference shares (OCRPS) issued to MFL) into a fully owned subsidiary Meghmani Organochem Limited (MOCL). Other Business of MOL (Trading and equity investment in MFL) will be amalgamated with its 57% subsidiary, MFL and the existing shareholders of MOL will be issued equity shares in both MOCL and MFL. Eventually MOCL will be renamed as Meghmani Organics Limited (MOL). Through this, the company aims to unlock shareholder value by demerging MOL (housing agrochem and pigments businesses) and MFL (housing the Chlor Alkali & its Derivatives business) into two separate listed entities. The company is now awaiting approval from the concerned authorities for the demerger.

For the first nine months of fiscal 2020, on a consolidated basis, MOL had revenues of about Rs 1671 crore and PAT of Rs 232 crore as compared to revenues of Rs 1530 crore and PAT of Rs 218 crore in the corresponding period of the previous fiscal.

Any other information: Not applicable