Analyzing Deemerger Strategy for OCCL

Sep 22, 2024

Notes on Deemerger Strategy and OCCL Analysis

Introduction

  • Speaker: Dhruv Bajaj, SmartSync Services
  • Topic: Deemerger as an investment strategy
  • Premise: Deemers generate superior alpha historically.

Case Study: Oriental Carbon and Chemicals Limited (OCCL)

  • Overview of OCCL:
    • Presently facing low stock performance (negligible returns over the last 10 years).
    • Market leader with high entry barriers.
    • Current margins at a 10-year low.

John Templeton Quote

  • "The time of maximum pessimism is the best time to buy."
  • Focus on underperforming companies in a favorable market.

Business Segments

  • OCCL has two segments:
    1. Chemicals Business: Produces insoluble sulfur (used in radial tires).
    2. Investment Business: Holds significant stake in Duncan Engineering and investments in various AIFs and startups.

Demerger Announcement

  • Demerger planned to separate chemical business (OCCL) from the investment segment.
  • Date of record for the demerger: July 1st.

Industry Overview

  • Insoluble Sulfur:
    • Key in rubber industry as a vulcanizing accelerator.
    • Demand driven by radial tire consumption.
    • OCCL holds 55-60% market share in India and 10% globally.
  • Market Dynamics:
    • Recent price downward trend due to increased supply from China.
    • Exports affected by geopolitical issues (e.g., Red Sea Crisis).

Competitive Advantage

  • Cost Competitiveness:
    • Lower raw material costs and strategic location for exports (Mundra SEZ).
    • Economies of scale due to long-standing operations.
  • High Entry Barriers:
    • Significant capital investment for R&D and approval from tire manufacturers.

Financial Performance

  • 88% revenue from insoluble sulfur; 12% from sulfuric acid.
  • Historical revenues and margins below median (25% median margins).
  • Capital allocation strategy focuses on maintaining ROCE and shareholder wealth.

Risks and Challenges

  • China's Market Influence: Increased capacity and dumping affecting pricing.
  • Low Growth Business: Limited growth prospects due to mature market.
  • Volatility in Raw Material Prices: Affects margins due to high working capital intensity.

Valuation Perspective

  • Current market capitalization around 700 crores.
  • Expected enterprise value of the chemical segment around 600 crores post-demerger.
  • Cash flow yield estimated at 15%, with low price-to-cash flow ratio (6x).

Key Triggers for Future Success

  • Improvement in operating margins towards 25% could lead to higher valuations.
  • Successful anti-dumping investigation can enhance domestic margin prospects.
  • Radial tire adoption trend supports long-term sustainability in cash flows.

Conclusion

  • Despite current challenges, OCCL's valuation makes it an interesting case study.
  • Need to monitor key drivers and potential catalysts for investment decisions.
  • Encouragement for further discussion on the findings.