Detailed Rationale

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

 

Operating income grew by 18.1% to Rs 2,201 crore for fiscal 2022, aided by the domestic and export business, which recorded year-on-year (y-o-y) growth of 27% and 9% respectively. Growth in domestic business was supported by growth in plastic and coatings segments. In comparison to fiscal 2022, operations in the first half of fiscal 2021 were impacted by disruptions caused by the Covid-19 pandemic.

 

Operating margin contracted by nearly 290 basis points to 12.6% in fiscal 2022, on account of high cost of raw material, energy and logistics. Rise in coal prices and freight rates led to a spike in energy prices and logistics cost, thereby driving up manufacturing overhead. For the first half of fiscal 2023, turnover rose by almost 11% year-on-year to Rs 1,003 crore, driven by nearly 16% growth in the first quarter, aided by price revisions even as volume remained muted. In the second quarter, turnover was impacted by drop in volume on account of geopolitical risks leading to high inflation in the US and Europe, and other major economies, and China’s zero Covid policy, resulting in demand pull-back in overseas markets. Even in the domestic market, plastic manufacturers deferred their buying decisions, due to significant drop in polymer prices, in anticipation of further correction. As a result, operating margin contracted to 7.5% and 8.1% in the first and second quarters of fiscal 2023, respectively, on account of under-recovery of fixed cost with volume contraction and high energy cost.

 

Demand is likely to revive in the later part of third quarter of fiscal 2023, primarily in the domestic market, with stabilization of raw material prices, especially benzene, crude, toluene and Linear Low Density Polyethylene. In contrast, demand in overseas markets remains subdued. Revenue for fiscal 2023 is expected to remain flat but will revive thereafter, driven by capacity expansion in the pigment business and new launches. Operating margin is likely to be lower in fiscal 2023, vis-a-vis fiscal 2022, but will still be higher than levels reported for the first quarter of fiscal 2023 (7.8%), aided by various cost rationalization measures undertaken to offset the impact of the rise in prices of coal and other raw materials. Recovery in operating performance over the next couple of quarters shall remain a key rating monitorable.

 

Financial risk profile should be comfortable with interest cover and net cash accrual to adjusted net debt (NCA/AD) ratios projected around 5 times and 15%, respectively, in fiscal 2023. The total outside liabilities to tangible networth (TOL/TNW) and gearing ratios are likely to remain around 2.0 times and 1.2 times, respectively, as on March 31, 2023, considering the large capital expenditure (capex) of Rs 750 crore incurred over the last three and half years, and mainly funded via debt (75%).

 

The ratings reflect the extensive experience of the promoters in the pigment industry and the established market position of Sudarshan. The ratings also factor in the diversified product range and end-user industry profile, strong distribution network, marquee clientele, and comfortable financial risk profile of the Company. These strengths are partially offset by the industry based large working capital requirements and risks related to volatility in commodity prices and those related to ramp-up of capacities with regards to large capex incurred.

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. All these companies are collectively referred to as the 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 the support committed by the group and its track record demonstrated earlier. 

 

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 in the pigment industry

Sudarshan is the largest pigment manufacturer in India, with a market share of 35%, and as per company estimates, is the third largest pigment manufacturer in the world with an overall market share of about 3%. The products are used in various 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. It has a strong distribution network comprising more than 60 channel partners and subsidiaries in USA, Netherlands, China, Mexico and Japan, for distribution of pigments worldwide. Exports accounted for 45% of revenue in fiscal 2022, as against 49% in fiscal 2021. The company is likely to see its global market position strengthen further, aided by ongoing consolidation in the industry. Growth should also be supported by new product launches and benefits from the large capex incurred over the last three years, along with revival in demand.

 

Comfortable financial risk profile

Capital structure is comfortable with adjusted networth, gearing and total outside liabilities to tangible networth (TOL/TNW) ratio of Rs 786 crore, 1.04 time and 1.9 times, respectively, as on March 31, 2022. Adjusted gearing and TOL/TNW are likely to increase to around 1.20 times and 2.0 times, respectively, as on March 31, 2023, as the company has raised debt to fund the large ongoing capex. However, given the expected revival in demand, commercialization of capex, and strong market share, both, adjusted gearing and TOL/TNW are expected to improve to below 0.8 times and 1.8 times, respectively, over the medium term. Interest coverage ratio should also be adequate around 5 times in fiscal 2023.

 

Weaknesses:

Large working capital requirement and exposure to volatility in commodity prices 

Gross current assets (net of cash) stood at 188 days as on March 31, 2022, vis-à-vis 168 days a year before, as inventory rose to 112 days from 98 days over the same period, following a build-up and price inflation. Inventory requirement remains high as the company has multiple stock keeping units for pigments (over 400) and several distribution centers both in India and abroad. Working capital has been managed well by matching the receivables with payables over the last few years, thereby reducing dependence on debt. However, as cash accrual was utilized to partly fund the ongoing capex in the last fiscal, reliance on working capital borrowing has increased. With ramp up in revenue and overall operating performance expected to improve at gradual pace over the medium term, due to the ongoing macro headwinds and relatively high manufacturing cost, working capital borrowing is likely to remain high.

 

Sudarshan 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. Nonetheless, margins are still susceptible to risks related to sudden and continues volatility in raw material prices.

 

Susceptibility to risks related to the large capex

The company has incurred total capex of nearly Rs 750 crore over fiscals 2020 to 2023, towards multiple projects, capacity expansion and launch of new products. However, due to demand headwinds on account of geopolitical pressure leading to high inflation, tightening of monetary policy, and volatility of raw material prices, revenue ramp up from capex investment is expected to be slower-than-expected. However, the strong market position of the company in India and abroad, and steady revival in demand likely in the last quarter of fiscal 2023, coupled with industry related tailwinds in the global market, should help the company reap benefits on its recent capex. Overall ramping up of capacities will remain a key monitorable in the medium term.

Liquidity: Strong

Expected cash accrual of Rs.130 – Rs.190 crore over fiscal 2023 and 2024, coupled with cash and cash equivalents of around Rs. 36 crore as on September 30, 2022, should suffice to cover the debt obligation of around Rs 145 crore and Rs. 160 crore, respectively. Debt availed by the company during current fiscal should also offer some buffer to liquidity. Bank limit utilization averaged around 70% over the 12 months through October 2022. Backed by its strong market position, the company has been able to raise funds via commercial paper issuances at competitive rates during the last six months, which indicates financial flexibility.

About the Company

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

 

During the six months ended September 30, 2022, on a consolidated basis, the company posted net profit of Rs 12 crore (Rs 49 crore for the corresponding period of previous fiscal) on net sales of Rs 1,082 crore (Rs 972 crore).

Any other information: Not applicable