A clear winner of the 2021 IPO rush is Ami Organics. The stock has doubled since its IPO and has held its highs quite well compared to others. The stock is well positioned in the chemicals sector, with a differentiated presence and visible growth drivers.
We were positive about the stock when it went public. We remain positive about the company’s prospects, with its high valuation (42x FY24 earnings) strengthening its prospects for successful execution. Given the balanced risk-reward ratio, existing investors can continue to hold the stock. New investors don’t have to come in now.
Differentiated
The current challenges for the specialty chemicals sector are related to high inventory levels in distribution channels and deflationary pricing due to Chinese dumping. As a supplier of advanced pharmaceutical intermediaries (AI), Ami Organics is protected from excessive Chinese competition or dumping.
The Company’s sales are driven by long-term contracts with innovators/generic formulation manufacturers whose demand visibility is less volatile than purely commercially available chemicals. The two factors of long-term contracts and pharmaceutical end market should protect the company from short-term challenges. In the last quarter, when the sector reported an 8 to 10 percent year-on-year decline in sales, Ami Organics reported 9 percent year-on-year sales growth.
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However, this growth is well below the growth rates expected by investors for Ami Organics, which are in the high range of 18 to 20 percent. A decline in the cost of chemical raw materials (impact on sales prices) and sluggish demand in the pharmaceutical sector were cited as reasons for the lower growth in Q1FY24. The first quarter is also the slow season for the company.
However, Ami Organics’ high growth expectations are actually underlined by other growth drivers.
Growth accelerator
In FY23, 85 percent of revenue came from Pharma AI and the rest from specialty chemicals business. The Pharmaceutical segment provides intermediaries for antipsychotic, anticoagulant or anticancer molecules from stage n-6 to n-1 (where n is the final formulation). As the company expands in therapy and customers, the base business will grow. The company is also adding two new businesses that are expected to be significant – electrolyte additives (EA) and a longer-term contract with Fermion, an international API contractor.
Electrolyte additives or EA for lithium-ion and other battery applications require precise formulation. Ami Organics has made great progress in this area, securing six customer approvals by FY23 and expects strong commercial order in the next few quarters. The scope and size of the end market is expected to be a long-term growth driver for the company. `
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The Fermion contract is a multi-year, high-value interim contract for an innovative molecule that is in the commercialization phase. The company has allocated a large chunk of new capital expenditure (₹200 crore in FY23-24) for this project, which will have a dedicated facility. The capital expenditure for EA will be in addition to this budget. As the final formulation is registered in regulated and other markets, Ami’s scope will expand and become a visible revenue driver over the next six to seven years. The company has also indicated opportunities to increase its portfolio share of the product through additional intermediate products. Ami Organics will be the exclusive supplier of the intermediate and expects to generate significant revenue in FY25.
Specialty chemicals
The segment accounts for 15 percent of revenue, which rose sharply with the acquisition of two facilities from Gujarat Organics in 2021. With streamlining operations, optimizing capacity and converting processes to flow chemistry from batch process, which will be completed in Q1FY24, Ami reported 25 percent YoY growth in the quarter. The segment’s EBITDA margins of 11 percent are below the consolidated range of 21 percent and are expected to increase as scale and efficiency improve. The company is expanding the segment to include additional products.
Valuation and margins
Ami Organics is a contract manufacturing operator (CMO) that does not have a high level of development (CDMO). This is reflected in peak EBITDA margins of 23 percent in the pharma AI segment in the fourth quarter of fiscal 2023. Still, Ami’s niche and growth portfolio has received a 42x earnings valuation. For comparison, Divi’s, the leading provider of high-quality CDMO deals with innovators with established scale, is trading at a forward EPS of 51 and an expected EBITDA margin of 32 to 35 percent.
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In the specialty space, Navin Flourine, also with CDMO designation in specialty chemicals and a longer operating history, was trading at 40x (27 percent expected EBITDA margins) prior to the recent management issues, despite the company’s foray into the fluorination space, currently on is most sought after.
We recommend investors to hold Ami Organics stock as earnings growth from new verticals, growth of existing businesses and expansion of the specialty chemicals segment can help bridge any decline in earnings multiple over the next two years.
Why
Multiple contraction options
Visible growth drivers can stabilize the valuation
The implementation phase is expected to last two years
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