SRF is a chemical-based multi-business conglomerate and one of India’s leading fluorochemicals, technical textiles, and packaging film manufacturers. With decades of experience in handling fluorine chemistry (also called Lucifer’s chemical because of its highly volatile and flammable nature), SRF now gets almost 50% of its revenues from the chemicals division which is the most stable segment in terms of growth and margins. The management plans to double the company's asset base in the next 5 years providing growth visibility. A major part of the CAPEX plan is to further strengthen its presence in refrigerant gases, enter the fluoropolymer value chain, and explore higher complexity derivatives of fluorine. This chemistry expertise, higher margin products, execution track record, and efficient capital allocation practices, makes SRF Limited a compelling case to consider playing out the long-term growth story of Indian specialty chemicals.
Industry Structure and Company Positioning
Agrochemicals/Pharma Value chain
SRF primarily operates in the Intermediates space and to some extent in Active ingredients in the Agrochemicals space. Agrochemicals Value Chain and SRF position:
Key Starting Materials | Intermediates | Active Ingredients | Formulations | End Product |
Porters Five Force Analysis on the Industry and Company
Business Segments
Technical textiles (Stagnant): SRF makes nylon tyre cord fabric (NTCF), polyester yarn and belting fabrics under this segment. SRF is a domestic market leader in NTCF with over 40% market share. Historically, SRF has used cashflows from the TTB business to scale up the chemical division. TTB is a stagnant industry with growth in very low single digits. The capital employed in this segment has likewise remained stagnant over the last decade indicating prudent capital allocation policy.
Packaging Films business (Cyclical): The industry is characterized by steady growing demand but volatile supply with periods of new capacity coming on stream together leading to oversupply. Margins in this division have collapsed for the entire industry given excess supply coming on stream but SRF still remains the highest margin profile player in this category. This segment will continue to put downward 0pressure on earnings in FY24 but could lead to good entry points.
Chemical division (Growth Engine): Within this segment, SRF manufactures Refrigerant gases and Fluorine based chemicals (mostly intermediates for Agrochemical and Pharma companies). SRF has built local economies of scale in the chemical division. As the business model is fully integrated right from the key raw materials to the end products. SRF has laid out a capex plan of approx. Rs. 12,000 crores over the next 5 years in the chemical business. Asset base of Chemical business was close to Rs. 7200 crores as of March 31, 2022. Of this, 5,500 to 6000 crore capex will happen by FY24. The company is now planning to forward integrate into fluoropolymers.
Management
SRF is professionally run with promoters only take key strategic decisions. The management execution track record has been good and they seem to plan well ahead of the curve.
Management execution track record
A few Corporate Governance checks
Valuation
PE Method: SRF is trading at 34x P/E on TTM basis currently at Rs. 2535. I expect earnings to grow at 17-18% CAGR over the next 5 years led by the chemicals division. Expect revenues to grow at mid-double digits and some margin accretion with an increasing share of the chemicals business. On a PEG basis, (PE Multiple / Expected Growth in Earnings), it is roughly at 1.9-2x which is neither cheap nor overly expensive. I do expect PE multiples to sustain at higher levels than its 5- and 10-year averages given the business is now primarily driven by higher and steady margin chemicals division.
EV/EBITDA Method: As far as EV/EBITDA is concerned, SRF is trading at roughly 18-19 times FY23 Expected Core EBITDA (excluding other income), which again is slightly higher than the last 5-year average of 16x.
It’s peers – Gujarat Fluorochemicals trades at close to 25x EV/EBITDA and Navin Fluorine trades at 35x EV/EBITDA. However, both those peers derive 100% of their revenues from chemicals while SRF also carries with it, the commodity piece of technical textiles and packaging films. SOTP Valuation would make the most sense to capture that aspect.
DCF Valuation: Using the DCF Method, I value SRF at approximately Rs. 2,000 (Average of Base and Bull Case Scenario). Assumptions of operating income to grow at 15-18% CAGR, capex of close to Rs. 15,000 crores over the next 5 years. For the terminal value, used the constant growth model (using ROIC and sustainable growth rate calculations) and WACC at around 13%.
Attached is the rough Excel model for your ready reference:
Using an average of all three methods, overall, in terms of valuations, SRF seems to be trading around its fair value. As a disclosure, SRF is a part of my personal portfolio. I continue to hold the stock from lower levels and would look to add to my position only if there is any significant price correction. As far as the technical setup is concerned, the stock looks likely to continue to trade in a consolidation range.
Risk factors to the thesis
1. Slowdown in the global agrochemical industry with impact revenue growth significantly. Over 90% of chemical business is towards Agrochemicals.
2. Delay in capex plans of the chemicals division.
3. Correction in global prices of Refrigerant gases (Prices have been up 50% on average over last year due to demand-supply mismatch. The demand-supply mismatch is expected to continue in the coming years as well indicating that prices might remain steady at current levels).
Well, that's a wrap on the analysis for SRF as on April 30, 2023. Thanks for taking the time to read this. If you found this helpful, do subscribe and share. Happy investing!
Regards,
Shivam Jain
Disclosure: I’m not a SEBI Registered Investment Advisor. All content on this website is purely for educational purpose. Please consult your financial advisor before making any investment decision.
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