Fire in BASF’s German chemical plant, China resorting to factory shutdowns in a move to regulate environmental laws, and floods in the US have caused several supply-side disruptions for flavors and fragrances (F&F) players like S H Kelkar (SHKL).
Fire in BASF’s German chemical plant, China resorting to factory shutdowns in a move to regulate environmental laws, and floods in the US have caused several supply-side disruptions for flavors and fragrances (F&F) players like S H Kelkar (SHKL), with sourcing of raw materials like orange oil, citral and Isoprenol being severely affected. BASF alone accounts for 20-25% of SHKL’s RM requirements. While SHKL maintains a large stock of inventory, severe supply constraints could exert pressure on margins over the next 2-3 quarters. We, however, believe that margin compression will be partly offset by the shifting of production from the Netherlands facility to Vapi (likely to be completed by July/August 2018). We cut our FY19 EBIDTA estimate by 7% and PAT estimate by 8%. SHKL acquired a 51% stake (for EUR12m) in Creative Flavors and Fragrances SpA (CFF), an Italian F&F player headquartered in Milan, Italy with significant presence in fine fragrances and fabric care. CFF acquisition will help SHKL to bridge the gaps in its existing portfolio. CFF acquisition will provide a gamut of premium Italian products that SHKL intends to introduce in emerging markets like India, Indonesia and Middle East. In Italy, the company will use CFF as a front-ended platform to sell fabric care products based on SHKL-developed encapsulation technology. There has been continued focus on new launches and widening of portfolio in the FMCG space to tap new segments and categories. This will continue benefiting SHKL, which has a 23% market share in fragrances and 3-4% market share in flavors. Changing consumer preferences necessitate strong R&D capabilities to develop new F&F formulations. SHKL continues to reinvest any expansion in margins beyond 20% into R&D activities in order to drive revenues further. We maintain our revenue estimates, led by a rebound in FMCG demand and available cross-selling opportunities post CFF acquisition. However, we cut EBIDTA estimates for FY19 owing to raw material supply disruptions post Germany-BASF blast, Florida storms and Chinese plant shutdowns in 2HFY17. We value the stock at 26x FY20E consol. earnings of `12.2/share and reiterate our Buy rating with a revised price target of `318/share.