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Phillips Carbon Black Limited

Upcoming capacity to fuel growth

CMP Target Price Potential Upside

151 212 40%

BUY
BSE NSE Reuters Bloomberg Industry Market Cap (Rs. Mn) Equity (Rs. Mn) Face Value (Rs.) 52WkH/L Sensex Nifty 506590 PHILIPCARB PHIL.BO PHCB IN Inorganic Chemicals 5216 332.2 10 242.7/113.2 19386 5825

Investment Rationale:
Capacity Addition to fuel growth Backed by strong tyre demand, carbon black demand is expected to grow at CAGR 11-12% in next two years. To cash in this rising demand, Phillips Carbon Black(PCBL) is expanding its carbon black capacity at Mundra by 50,000 MTPA. We expect Companys revenues from carbon black business (India) to grow at CAGR 19% over FY2010-2013E. Power business to provide stability PCBL is expanding its power generating capacity by 18 MW by FY2013E, which would likely to increase revenue contribution to 5% and EBITDA contribution to 34% in FY2013E. This is likely to provide stability to companys earnings from cyclicality of carbon black business and help in de risking its business model to some extent. Vietnam Joint Venture to further escalate revenues PCBL is setting up first carbon black manufacturing unit in the country through Joint Venture (80% share) in two phases. The first phase of 55,000 MTPA and co-generation power plant of 12 MW is expected to be commissioned in 2HFY2013E. We expect Vietnam venture to contribute 5% and 4% to total revenues and EBITDA respectively in FY2013E. Improving balance sheet condition With strong operating cash flow (on account of capacity addition, increasing contribution from power business) and relatively less capex, company is likely to generate cumulative free cash flow of Rs.125 million over FY2011E-FY2013E period, which would help company to pursue growth opportunities without much dependence on debt. Similarly, we expect PCBLs debt to equity ratio to come down to 0.8x in FY2013E as compared to 1.7x in FY2010.

Shareholding Pattern

Indian (Promoter & group) Non Promoter (Institution) Non Promoter (Non Institution) Public & Others

NIFTY v/s PCBL Outlook & Valuation

PCBL, largest producer of Carbon black in India, is set to ride growth in carbon black demand with its capacity addition plans and dominant position in Carbon black industry. Moreover, the companys power business is expected to contribute significantly to its profitability and provide stability to the companys earnings. We initiate coverage on PCBL with a BUY rating and target price of Rs212 (based on EV/EBITDA exit multiple of 5.25x on 4 year perpetuity two-stage model), which implies around 40% upside from current levels.

(INR million)
FY2010A FY2011E FY2012E FY2013E

Net Revenue
12,325.74 16,577.59 19,432.40 21,860.00

y-o-y (%)
6.0% 34.5% 17.2% 12.5%

EBITDA
1,794.81 2,084.43 2,553.66 2,877.46

EBITDA (%)
14.6% 12.6% 13.1% 13.2%

Adj PAT
1,222.33 1,073.77 1,315.81 1,501.07

y-o-y (%)
-12.2% 22.5% 14.1%

EPS (FD)
36.80 32.32 39.61 43.55

ROE (%)
45% 25% 23% 21%

RoCE (%)
19% 17% 19% 19%

P/B (x)
1.32 0.96 0.79 0.67

Debt/Equity (x)
1.71 1.14 0.91 0.82

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About the company: Overview:

Phillips Carbon Black Limited (PCBL), part of the RPG Group, pioneered the carbon black industry in India. It is now the leading producer of carbon black in the country. The company is not only the largest exporter of Carbon Black from India but also one of the largest in Asia in its field. PCBL started production from December 1962 by the oil furnace technology. The company's present installed capacity is 360,000 MTPA (48% of total installed capacity in India as of FY2010). It currently has four manufacturing plants spread across India. Company is further expanding its capacity at Mundra by 50,000 MTPA. Location
Durgapur (W.B) Mundra (Gujarat) Palej (Gujarat) Cochin (Kerala) Total
Source: Company, AKS Research

Carbon Black (MTPA)

140,000 90,000 90,000 40,000 360,000

Today, Company is the largest and 8th largest producer of carbon black in India and world respectively. Company
Cabot Corp Evonik Columbian Chem Birla Group CSRC & Continental SID Richardson Tokai Carbon PCBL Omsktechuglerod Black Cat
Source: Company, AKS Research

Capacity(mn tn)
2.01 1.45 1.13 0.79 0.74 0.45 0.37 0.36 0.35 0.29

To take advantage of newly introduced Electricity Act of 2003, the company has set up 12 MW co-generation power plant at its Baroda plant using the off gas generated from production of carbon black. After meeting the internal demand for production of carbon black, the surplus power of around 7 MW - 7.5 MW was sold to the GEB Grid from end FY2005. Encouraged by the success of the Baroda co-generation power plant, company has subsequently set up co generation power plant at Mundra and Durgapur. With this companys total installed power capacity stands at 58 MW at the end of FY2010. Company further plans to expand its capacity at Mundra by 8 MW and Cochin by 10 MW, thus to have total capacity of 76 MW by FY2012E.

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Location
Durgapur (W.B) Mundra (Gujarat) Palej (Gujarat) Total

Power (MW)
30 16 12 58

Source: Company, AKS Research

Power segment has contributed 4% to companys net revenue in FY2010. While its EBIT contribution stands at 27% in FY2010.

Source: Company, AKS Research

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Investment Rational
Capacity Addition to fuel growth
Demand for tyre expected to increase at CAGR 11% The domestic tyre industry has grown by CAGR 10% over FY2005-FY2010 period led by strong automobile industry. The Automobile industry in India is one of the largest in the world and one of the fastest growing globally. It has produced 14 mn vehicles in FY2010 which has grown at 5 year CAGR of 11%.

Source: ATMA, AKS Research

Similar growth has witnessed by tyre industry. India produced 97 mn tyres in FY2010 which has grown at 5 year CAGR of 10%. Demand has further strengthened in FY2011. Tyre production has increased by 28% in 1HFY2011 as compared to 1HFY2010.

Source: ATMA, AKS Research

In FY2011, auto sector has witnessed very strong growth with auto sales registering 26.2% yoy volume growth. Growth in FY2011
29.6% 26.9% 25.8% 19.4% 26.2%

Category
Passenger Vehicles Commercial Vehicles Three Wheelers Two Wheelers Total Source: SIAM, AKS Research

Outlook for FY2012E

16%-18% 14%-16% 12%-14% 9%-11% 12%-15%

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Automobile industry is expected to continue its healthy growth on account of strong economic growth, rising income, favorable demographic profile and rising disposable income, easy credit availability. As per Society of Indian Automobile Manufacturers (SIAM), Auto industry is expected to grow by approximately 12-15% yo-y in FY2012E after taking into consideration higher interest rate scenario and rise in fuel costs. The rise in Auto demand would increase the demand for tyres from OEMs and the replacement market. The huge growth that has been witnessed in the last couple of years would translate into the replacement market for Tyre manufacturers during the next two years. Further, Indias growing importance as an automotive export hub for small cars is another key demand driver for tyres. Based on these expectations, almost all major tyre companies have either announced or undertaken major greenfield/brownfield expansion projects. According to ICRA, tyre companies in India are expected to invest around Rs 175bn in next 12 to 18 months to increase capacity by around 47%. This would translate into strong demand growth for carbon black in India in next few years. According to CRISIL estimates, The Indian tyre industry is expected to grow at a rate of around 11-12% over FY2011E and FY2012E. Similary carban black industry is expected to grow by 11-12% by FY12E. Volume growth to drive revenues To cash in rising demand for Carbon Black, company is increasing its capacity in past few years. It has commissioned 90,000 MTPA carbon black capacity in Q3FY2010. Further, the company is setting up Brownfield capacity of 50,000 MTPA at Mundra which is expected to come on stream by end Q1FY2012E. With stabilizing of capacity started in FY2010 and new capacity coming on stream in FY2012E, we expect volumes to increase by 18%, 11% and 10% in FY2011E, FY2012E and FY2013E respectively, registering CAGR growth of 13% over FY2010-FY2013E period.

Source: Company, AKS Research

Considering PCBLs dominant position in Industry and oligopoly nature of the industry, realization is expected to increase with rising CBFS cost. Accordingly we expect Companys revenues from carbon black business (India) to grow at CAGR 19% over FY2010-2013E. 5
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CAGR 19%

Source: Company, AKS Research

Power business to provide stability

The company has set up power plants at its existing facility in Durgapur, Mundra and palej with total installed capacity of 58 MW. After meeting its internal requirements, power is sold in open market. Further company is expanding its power capacity at Mundra and Cochin to reach total installed capacity of 76 MW by FY2012E. With additional volumes from new capacity, we expect revenues from Power business (India) to increase by 25% CAGR over FY2010-FY2013E period. Similarly we expect, power Businesss contribution to total revenue to increase to 5% in FY2013E from 4% in FY2010.

CAGR 25%

Source: Company, AKS Research

There is no raw material cost for generating power as it is produced from off-gas generated from carbon black production. On other hand, currently power is sold in the open market at Rs.2.5-3/per unit, which translates into higher EBITDA margin of 8588% for power segment. Additionally company plans to sell nearly half of its power through PPA from FY2012E, which would provide stability to realization from power business. With increasing contribution of power business total revenue, we expect EBITDA contribution to increase to 34% in FY2013E as compared to around 22% in FY2010.

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Source: AKS Research Increasing share of power business is likely to provide stability to companys earnings from cyclicality of carbon black business and help in de risking its business model to some extent.

Vietnam Joint Venture to further escalate revenues

Vietnam is the worlds 4th largest rubber producer and has become an attractive location for tyre manufacturers, but it does not have any carbon black manufacturing facility. Company estimates current carbon black demand of 100,000 MTPA in the country. To capitalize on this opportunity, PCBL is setting up first carbon black manufacturing unit in the country through Joint Venture (80% share) in two phases. The carbon black manufacturing capacity in the first phase will be 55,000 MTPA and co-generation power plant will be 12 MW which is expected to be commissioned in 2HFY2013E. The second phase of 60,000 MTPA plant and 6MW power plant is expected to be commissioned in FY2014E. We expect Vietnam venture to contribute 5% and 4% to total revenues and EBITDA respectively in FY2013E.

Improving balance sheet condition

The company is likely to generate steady cash flow in coming years due to capacity addition, increasing contribution from power business. These expected cash flows are sufficient to fund the companys capital expenditure and in addition likely to generate cumulative free cash flow of Rs.125 million over FY2011E-FY2013E period.

CAGR 85%

Source: AKS Research

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This would help company to pursue growth opportunities without much dependence on debt, which would further enhance value for the shareholders of the company. We expect PCBLs debt to equity ratio to come down to 0.8x in FY2013E as compared to 1.7x in FY2010.

Source: Company, AKS Research

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Key Concerns
Slowdown in tyre industry
Demand for carbon black industry is largely dependent on growth in the tyre industry. Hence, any slowdown in the tyre industry may lead to lower demand and in turn impact the companys earnings.

Rising Crude Oil prices

Carbon Black Feedstock (CBFS) is the main raw material used by the company which has to be imported. Being a derivative crude oil, its prices are directly linked to international crude oil price. Any sudden increase in oil prices could put pressure on operating margins of the company. To mitigate this risk, Company is considering setting up coal tar distillation plant. Carbon black oil(CBO) generated from this process can be used to produce Carbon black.

Delays in execution of upcoming capacities

PCBL is expanding its capacity in India and setting up new capacity in Vietnam. Any delays in timely execution of these capacities may affect the companys performance and our estimates.

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Peer Comparison
Trading at steep discount to global peers On EV/EBITDA basis, the company is trading at 30%-45% discount to its global peers.
Price FY2011E Phillips Carbon CSRC* Black Cat* Tokai* Cabot# 151 30 15 422 45 4.7 16.5 34.3 15.2 16.1 PE FY2012E 3.8 9.4 NA 13.1 14.4 FY2013E 3.5 NA NA 12.5 13.2 FY2011E 4.3 NA NA 5.0 7.3 EV/EBITDA FY2012E 3.3 NA NA 5.2 6.8 FY2013E 3.1 NA NA 4.5 6.3

*calendar year end, #Sep year end Source: Bloomberg, AKS Research

Recently Aditya Birla Group entered into a definitive agreement to acquire Columbian Chemicals Company (CCC) at an enterprise value of $875m. CCC has installed carbon black capacity of 1.1 MTPA which values the company at around EV of Rs35,800/ton, whereas PCBL is currently trading at EV of Rs24,700/ton (31% discount) based on FY2011E estimates.

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Outlook and Valuation

PCBL, largest producer of Carbon black in India, is set to ride growth in carbon black demand with its capacity addition plans and dominant position in Carbon black industry. Moreover, the companys power business is expected to contribute significantly to its profitability and provide stability to the companys earnings. We have valued the company based on EV/EBITDA exit multiple of 5.25x on 4 year perpetuity two-stage model. EV/EBIDTA exit Multiple ROIC (Accounting figure) WACC (based on dynamic VaR) Maintenance Capital (Incrimental) Tax Rate Long Term Growth Rate(g) n' (modelled Growth Period) Exit multiple for 'n' years Exit multiple for Terminal years EV/EBITDA (x) pre-tax & Mt. Cap. Adj. for Maintenance Cap. (1-20%) Adj. for Tax (1-28.3%) Target EV/EBITDA (x) Exit multiple EBITDA Forward EV Add: Cash Less: Debt Target EV No of Shares(mn) Target Price per share
Source: AKS Research

22.60% 13.50% 20.00% 28.30% 1.50% 4 2.80 4.74 7.54 0.95 1.34 5.25 Rs. Mn 2,084 10,951 2,040 5,953 7,038 33.22 212

We initiate coverage on PCBL with a BUY rating and target price of Rs212, which implies around 40% upside from current levels.
1 Year Forward PE Band 1 Year Forward EV/EBITDA Band

Source: AKS Research

Source: AKS Research

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Economic Returns PCBLs expected economic return of 24.6% is more than its cost of capital of 13.2% for FY2013E, which suggest company is able to create value for its shareholders.

Source: AKS Research

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Industry Overview
Carbon black is essentially an oil by-product used as reinforcing agent in rubber compounds. Carbon black is a general name for a variety of trade name products such as acetylene black, attrited black, channel black, flame black, furnace black, lamp black, and thermal black. Primary user industry for carbon black is tyre (65%) while rest is consumed by industrial rubber, inks. paints, belts & hoses.

Source: Company, AKS Research

Thus, carban black demand is largely driven by tyre demand which is in turn dependent upon automobile demand. According to ATMA, Carban black constitutes 11% of the raw material cost of tyre companies and forms 20-25% of volume of the tyre. Global Demand As per company estimates, total installed capacity of carbon black in the world was 12.7 mn MTPA in CY2009, while demand was around 9 mn MTPA during the same period. According to research by Freedonia, world carban black demand is expected to reach 11.6 mn MTPA by 2013(6.4% CAGR over 2009-2013E). Asia/Pacific region to post strongest gains in demand The Asia/Pacific region, excluding Japan, is expected to report the strongest growth in carbon black demand through 2013. Among these, China and India is likely to post healthy growth due to a continuing rapid expansion in their automobile and tyre industries that will be driven by robust economic growth in both nations. China and India saw the largest increases in new carbon black capacity among all countries of the world over the 2003 to 2008 period, and is expected to continue the same trend through 2013. Demand for carbon black in the developed parts of the world is expected to continue to post below-average gains through 2013. Carbon black capacity utilization rates dropped significantly in developed countries in 2008 due to economic slowdown. This situation was especially worst in the US, where capacity utilization rates fell below 70 percent, resulting in several carbon black plants being closed. Since then demand for carbon black in US and Japan, has started picking up in 2010, whereas demand in Europe may take a little longer to recover. North America and Western Europe, which combined produced 48% of the worlds carbon black in 1998, is expected to account for just 23% of global output in 2013. Conversely, the Asia/ Pacific region, which produced 36% of the worlds carbon black in 1998, is expected to account for a 57% share in 2013. 13

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Source: Freedonia, AKS Research

Domestic Demand The domestic tyre industry has grown by CAGR 10% over FY2005-FY2010 period led by robust automobile demand. Domestic demand for caran black was 605,000 MTPA in FY2010 as against 470,000 MTPA in FY2009(growth of 29%). (Mn Nos)
Tyre Production Automobile Production
Source: ATMA, AKS Research

FY2005
60.08 8.47

FY2006
66.03 9.74

FY2007
73.55 11.09

FY2008
81.10 10.85

FY2009
82.11 11.17

FY2010
97.14 14.05

CAGR
10% 11%

Automobile companies are developing smaller cars for the domestic as well as the overseas markets, which may see India emerge as an export hub for smaller cars, resulting in an exponential demand growth for tyres and carbon black after three to five years. Almost all major tyre companies have either announced or undertaken major greenfield/brownfield expansion projects which are expected to start commercial production during the next 12 to 18 months. Apart from this, strong industrial activity is expected to continue drive demand for industrial rubber, inks and paints. According to CRISIL estimates, The Indian tyre industry is expected to grow at a rate of around 11-12% over FY11E and FY12E driven by higher OEM (original equipment manufacturer) offtake and increase in replacement demand. Similary carban black industry is expected to grow by 11-12% by FY12E. Domestic Capacity As of FY2010, total installed capacity of carban black stands at around 750,000 MTPA. While, current installed capacity is around 700,000 MTPA(after closure of 50,000 MTPA capacity by Cabot in June 2010). Indian market is dominated by two players PCBL and Hi tech(division of Aditya Birla Nuvo) which controls around 84% of total installed capacity in India. As per capacity expansion planned by companies, total capacity is expected to grow at CAGR 8.4% by FY2012E.

Source: Company, AKS Research

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Financials
Income Statement (INR Million) 2010A 2011E 2012E

(INR Million)
2013E

Net Sales Other Income Total Income Total Expenditure Operating profit - Other Income EBITDA Interest Depreciation & Amortization Earnings Before Taxes Operating profit - other income & Dep Total Taxes Net Income After Taxes Minority Interest Share in associate Extraordinary Items Reported Net Income Reported EPS (INR) Adjusted EPS (INR) O/S Shares
Ratio Analysis

12,326 28 12,354 10,531 1,795 1,823 425 311 1,086 1,483 -79 1,007 (214.84) 1,222 36.80 30.33 33.2
2010A

16,578 94 16,672 14,493 2,084 2,178 451 338 1,389 1,746 -424 965 (108.40) 1,074 32.32 29.06 33.2
2011E

19,432 94 19,526 16,879 2,554 2,648 461 365 1,822 2,189 -507 1,316 1,316 39.61 39.61 33.2
2012E

21,860 94 21,954 18,983 2,877 2,971 493 390 2,088 2,488 -587 1,501 1,501 43.55 43.55 34.5
2013E

Balance Sheet ( INR Million) Cash Receivables Inventories Other Current Assets Loans and Advances Total Current Assets Gross Fixed Assets Less:Depriciation Net Fixed Assets CWIP Investments Misc. Expenses Total Assets Current Liabilities Provisions Current Liab & Provns Total Debt Equity Capital Reserves Deferred tax liability Minority Interest Total Liabilities and Equity Capital Employed
Cash Flow Statement (INR Million)

2010A 330 2,950 1,966 166 1,329 6,741 8,279 2,348 5,932 923 375 13,971 4,878 202 5,080 5,555 283 2,957 96 13,971 8,890
2010A

2011E 1,665 3,997 1,689 227 1,363 8,940 8,879 2,686 6,193 923 375 16,432 4,963 202 5,165 5,953 332 4,885 96 16,432 11,266
2011E

2012E 1,465 4,685 2,004 266 1,597 10,018 9,964 3,051 6,914 923 375 18,229 5,780 202 5,982 5,802 332 6,016 96 18,229 12,247
2012E

( INR Million) 2013E 1,970 5,210 2,301 299 1,797 11,578 11,563 3,441 8,123 923 375 20,999 6,501 202 6,703 6,377 345 7,478 96 20,999 14,296
2013E

Liquidity Ratios Current Ratio Quick Ratio Interest Coverage Ratio Activity ratios Asset Turnover Ratio Collection ratio Inventory Turnover Ratio Financing Ratio Debt/Equity Debt/Asset Performance Ratio Book Value per share EBITDA Per share EPS (Reported) EPS (Adjusted) EBITDA margin(%) PAT margin(%) P/E Return on Networth Return on Capital Employed Return on Assets P/BV Free Cash Flow Per Share Sales Per Share Growth Ratio Net Sales EPS 1.7 0.6 114.7 63.5 36.8 30.3 14.6% 8.2% 4.1 45% 19% 9% 1.3 (16.7) 371 6% 1.1 0.5 157.1 62.7 32.3 29.1 12.6% 5.8% 4.7 25% 17% 7% 1.0 1.0 499 34% -4% 0.9 0.5 191.1 76.9 39.6 39.6 13.1% 6.8% 3.8 23% 19% 7% 0.8 4.1 585 17% 36% 0.8 0.4 226.9 83.5 43.5 43.5 13.2% 6.9% 3.5 21% 19% 7% 0.7 (1.2) 634 12% 10% 1.5 4.2 6.3 1.9 4.1 9.8 2.0 4.1 9.7 1.9 4.2 9.5 1.3 0.9 3.5 1.7 1.4 3.9 1.7 1.3 4.8 1.7 1.4 5.0

Profit Before Tax Plus Depreciation Others Total Tax paid Changes in working capital Cash Flow from Operations Capital expenditure Proceeds from Asset Sales Chg in investments Others Cash Flow from investing FCF from Operations Proceeds from issue of Equity/Warrants Debt raised/(repaid) Others Dividend (incl. tax) paid Interest Expenses Cash Flow from Financing Net Cash Flow Beginning Cash Balance Ending Cash Balance

1,301 311 148 (245) (1,093) 423 (943) 4 0.1 (40) (978) (555) 1,311 (0) (496) 814 260 71 331

1,497 338 (202) (424) (780) 430 (600) 202 (398) 32 1,055 398 (151) 1,302 1,335 330 1,665

1,822 365 (94) (507) (460) 1,127 (1,085) 94 (991) 136 0 (151) (185) (335) (200) 1,665 1,465

2,088 390 (94) (587) (335) 1,462 (1,599) 94 (1,505) (43) 184 575 (211) 548 505 1,465 1,970

Source: Company data , AKS Research

Source: Company data , AKS Research

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Gaurav Oza Sr. Research Analyst Email:- gaurav.oza@akgroup.co.in Tel:- 91-22 67544783

Krupa Shah Associate Email:- krupa.shah@akgroup.co.in Tel:- 91-22 67544781

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