“People who narrowly specialise can get terribly good at occupying some little niche. Just as animals flourish in niches, similarly, people who specialise in the business world — and get very good because they specialise — frequently find good economics that they wouldn’t get any other way.”
– Charlie Munger
Businesses operating in a niche market with good economics make very good investments. Identifying such niche businesses can be very rewarding for investors. One such company is Alkyl Amines Chemical (AACL), which is into manufacturing and marketing of aliphatic amines, the industry which has typical characteristics of a profitable niche business.
Globally, it has been observed that the alkyl amine industry is oligopolistic with two-three producers catering to the majority of demand in a region. Eastman and BASF are the largest players globally with the top six companies controlling around 50% of the global capacities. As with many chemicals, China is the largest consumer and producer of aliphatic amines accounting for almost 60% of the global production. In India, AACL and Balaji Amines enjoy a combined share of more than 90% with balance being fulfilled by Rashtriya Chemicals & Fertilizers,and imports.
There are multiple entry barriers because of which the industry is very concentrated. The process of producing aliphatic amines is a complex one and the know-how of the process is closely guarded with a few producers. A new entrant will have to make a significant investment in research and development (R&D) to develop a meaningful product offering. Further, setting up amines facility is a capital-intensive undertaking with fixed asset turns hovering in the range of 1.5-2x. Being a chemical set-up, environmental clearances are also difficult to come by as governments, across the globe, are working on curbing pollution.
According to industry reports, the size of aliphatic amines industry globally is $4.1 billion, which is hardly a fraction of the overall chemical industry. Indian market for amines is estimated to be around #30 billion. The absolute size of the industry is so small that it is unattractive for any player to enter the market afresh. Hence, the few big fishes rule the roost in a small pond.
Besides, transporting amines (especially commodities such as methyl amines) is a difficult job as they are hazardous in nature. Specialised vehicles are required for movement of these chemicals which restricts the distances over which they can be transported. As a result, consumers prefer to source locally. Only 5% of the Indian demand for methyl amines is catered to by imports. On the flip side, even Indian players are not able to export these products. However, the export opportunities arise from derivatives, which is largely dominated by China.
Among the two Indian players, we like AACL given its management pedigree, capital allocation as well as stability in gross margins.
AACL was promoted by Yogesh Kothari in 1979. He is chemical engineer from ICT, Mumbai and post graduate in chemical engineering as well as management science from the University of Massachusetts. He is aided by Kirat Patel (executive director), who is B.Tech, mechanical engineering from IIT, Mumbai, and MMS (Finance) from the Jamnalal Bajaj Institute of Management, Mumbai, and has been working with the company since the inception. The pedigree runs through the family with Suneet Kothari (executive director) and son of Yogesh, earning his spurs as a chemical engineer and biochemistry graduate from the Cornell University, US and MBA from the INSEAD, France. Suneet has been associated with the company since the past 15 years and has been instrumental in developing the derivative and specialty chemical side of the business.
Ever since the commissioning its ethyl amines plant in 1982 in Patalganga, AACL has had a singular focus on the core business, that is, manufacturing and marketing of amines and related chemicals. This is in stark contrast with Balaji Amines, which has diversified into hospitality with a five-star hotel in Solapur as well as into the compact fluorescent lamps business. AACL has reinvested most of the capital in expansion of its capacities and building capabilities solely in amine related chemicals. Today, the company has 12 plants with capacity of more than one lakh MT capacity across three manufacturing sites — Patalganga, Kurkumbh and Dahej, a recent addition.
The Dahej unit is in the Petroleum, Chemicals and Petrochemical Investment Region (PCPIR), one of the four PCPIRs declared by the ministry of chemicals and fertilisers in 2007 and is expected to be one of the largest chemical manufacturing hubs in the world. With suppliers as well as consumers in the vicinity, logistics cost (4-5% of sales) and working capital investments are expected to reduce meaningfully. Proximity to ports can also help AACL to improve its exports (20% of revenues in FY18) of specialty chemicals from Dahej. AACL has incurred #1.5 billion capex in Dahej. Further, it will invest #1 billion each year for the next three years in capacity addition. This should help company take a substantial leap from its current position. Importantly, R&D has been one of the focus areas of AACL with the team directly reporting to the CMD. With 50 highly qualified professionals based in Pune, AACL spends around 1% of its sales on R&D every year. Consequently, it has developed a portfolio of around 100 products compared with 25 of Balaji. This focus on product as well as quality has helped AACL earn a strong reputation in the market, giving it the ability to pass on price fluctuations to its customers. This can be seen from the stickiness in gross margins which have been in a tight range of 48-51%, despite volatility in raw material prices.
Over the past 15 years, the company’s sales have grown at 21% CAGR, while profit after tax has compounded at 35%. While AACL has been able to maintain its gross margins, there is a marked improvement in operating margins as well as other profitability metrics. Besides, the company has an uninterrupted dividend track record for the past 15 years.
Pharmaceutical and agrochemicals are major consumers of aliphatic amines, representing almost 70% of the total consumption. Remaining production is almost equally consumed by water treatment, dyes, foundries and specialty chemicals. The disruption in the Chinese chemical market owing to pollution-related crackdown over the past few years has triggered substantial growth of chemical industries in the country. These tailwinds are expected to continue for years to come and AACL will be a big beneficiary. At 25x trailing 12-month multiple and earnings growing at 35% CAGR, the stock should be able to generate substantial return for its shareholders.
The stock is part of Equirus Long Horizon Fund Strategy