Prabhudas Lilladher has recommended a REDUCE rating for Deepak Nitrite Ltd (DN) with a target price of Rs 2,582, citing concerns over increasing competition from China, especially in the phenol and polycarbonate markets. The company is undertaking significant capacity expansions, but the rapid increase in phenol capacity in China and DN’s venture into the polycarbonate segment are expected to pressure margins. While DN is positioning itself for import substitution, the influx of cheaper imports from China is likely to pose a challenge. Prabhudas Lilladher forecasts an 8.7% CAGR in earnings per share (EPS) from FY24 to FY27, but the business's commodity nature limits upside potential.

Key Highlights and Market Outlook

Deepak Nitrite Expanding Phenol Capacity

Capacity Addition Plans: Deepak Nitrite is investing Rs 140 billion over the next 4-5 years, primarily in expanding its phenol production capacity. The company aims to increase phenol output to 700,000 metric tons per annum (tmtpa) through projects focused on forward integration into polycarbonate, methyl methacrylate (MMA), and poly methyl methacrylate (PMMA). These products serve applications in sectors like electronics, telecommunications, and automotive.

Margin Pressures Expected: Despite these aggressive expansion plans, the growing phenol capacity in China will likely pressure Deepak Nitrite’s margins. The company’s EBIT per kilogram for phenol has already declined from Rs 23/kg in FY22 to Rs 17/kg, and it is forecasted to stay in the Rs 16-17/kg range until FY27.

China’s Capacity Surge in Phenol and Polycarbonate

China’s Move Toward Self-Sufficiency in Phenol

Phenol Import Decline: China has been actively reducing its reliance on phenol imports, with its total imports falling by 51% from 650 tmtpa in CY20 to 320 tmtpa in CY23. This trend is expected to continue, with China set to add 4 million metric tons per annum of phenol-acetone capacity between CY24 and CY27. The global utilization rate of phenol, which stood at 88% in CY19, is expected to drop to 68% by CY26 due to these additions, putting further pressure on global phenol spreads.

Rising Competition in Polycarbonates and MMA

China’s capacity expansion in polycarbonates and MMA is equally concerning. By 2026, 60% of China’s phenol capacity will be integrated into Bisphenol A (BPA), and half of this will be converted into polycarbonates and epoxy resins. For example, Wanhua Chemical alone plans to increase its polycarbonate capacity by 20%, from 480 tmtpa to 600 tmtpa. These developments signal a flood of Chinese polycarbonate exports, which will pose significant competition to Deepak Nitrite’s entry into the polycarbonate market.

Financial Projections

Moderate Growth Ahead

Deepak Nitrite is expected to deliver EPS growth of 8.7% CAGR from FY24 to FY27. However, its commodity-based business model constrains upside potential. Below are key financial metrics for FY24 to FY27:

Sales: Expected to grow from Rs 76.8 billion in FY24 to Rs 97.7 billion in FY27, representing a 9.8% growth in FY27.
EBITDA: Expected to grow from Rs 11.2 billion in FY24 to Rs 15.8 billion in FY27, with margins improving from 14.6% in FY24 to 16.2% in FY27.
PAT: Expected to rise from Rs 8.1 billion in FY24 to Rs 9.8 billion in FY27, with a 2.1% growth in FY26 followed by 11.3% growth in FY27.

Polycarbonate Project: Margin Dilutive

Polycarbonate Investment Outlook

Project Return on Capital Employed (ROCE): Deepak Nitrite’s venture into polycarbonate production is expected to yield a ROCE of 10-11%, compared to the company's historical average ROCE of 23% during FY19-24. The company’s polycarbonate plant, with a planned production capacity of 100 tmtpa, is estimated to require a capital investment of $250 million and achieve peak revenue of $215 million, with an EBITDA margin of 13%.

This relatively low ROCE highlights the margin-dilutive nature of this project, particularly when compared to the company’s previous performance in its core businesses.

Risks to the Investment Thesis

China’s Growing Influence and Anti-Dumping Duty Uncertainty

Cheaper Imports from China: The anticipated influx of cheaper imports from China, particularly in phenol, polycarbonate, and MMA, represents a major challenge to Deepak Nitrite’s growth strategy. The company’s reliance on domestic demand and import substitution will be tested by competitive pricing from China.

Anti-Dumping Duty: A potential imposition of anti-dumping duties on certain chemicals, such as isopropyl alcohol (IPA), could provide some relief. Deepak Nitrite started producing IPA as an import substitute in 2018, but low-priced imports from China surged by 103% from FY22 to FY23, creating significant pricing pressure. If the Indian government imposes similar duties on other products, it could mitigate some risks, but this remains uncertain.

Valuation and Recommendation

Target Price of Rs 2,582

Prabhudas Lilladher has retained its REDUCE rating with a target price of Rs 2,582 for Deepak Nitrite. This valuation is based on a Price-to-Earnings (P/E) ratio of 36x FY27 EPS, reflecting the company’s moderate growth prospects and the competitive pressures from China. Key factors driving the valuation include:

Rising competition from China: The rapid expansion of phenol, polycarbonate, and MMA capacity in China is expected to depress global prices, pressuring Deepak Nitrite’s margins.
Low returns from polycarbonate investment: The company’s polycarbonate project is expected to generate lower-than-average returns, diluting overall margins.
Limited upside due to commodity exposure: The company’s exposure to commodity markets limits its ability to generate significant long-term upside.

Conclusion

While Deepak Nitrite is pursuing aggressive expansion plans in the phenol and polycarbonate markets, the competitive landscape—particularly from China—will likely result in margin pressure and moderate growth. With global supply rising faster than demand, and new capacity flooding the market, Deepak Nitrite’s prospects for meaningful margin improvement remain constrained. Investors are advised to REDUCE their holdings in the stock, with a target price of Rs 2,582.