Aarti Industries Ltd Management Discussions

1. Economic Overview

Global

The global economy defied expectations in 2023, achieving a GDP growth rate of about 3%, a full percentage point above earlier forecasts. This resilience is particularly remarkable considering the challenging backdrop - the most aggressive central bank interest rate hikes in four decades, significant stress in the banking sector, a period of tight financial conditions, inflationary pressures across various economies, inventory corrections, geo political issues due to ongoing conflicts in Ukraine and Israel, and supply chain challenges. Crucial factors underpinning the robust global economic performance included:

• A thriving labour market that boosted consumer purchasing power

• The anticipated shift towards a service-led economy

• Moderated impact of tighter monetary policy, due to robust household and corporate financial positions

• Targeted fiscal measures in select economies World economy is experiencing a cautious recovery in 2024.

While inflationary pressures have eased somewhat and recessions in major economies seem less likely, growth remains moderated due to factors like persistent geopolitical tensions and ongoing disruptions to global trade. The labour market, however, shows some resilience with low unemployment rates, offering a glimmer of hope for endured consumer spending and economic activity. Consumer price inflation in most Advanced Economies (AEs) has moderated - while, banking sector risks also appear subdued. Global growth has increased, with the global composite Purchasing Managers Index (PMI) remaining in the expansionary zone since February 2023.

India

Indias economic growth engine has demonstrated remarkable resilience in the face of strong global headwinds. This robust performance can be attributed to supportive policy & regulatory framework and gradual reinvigoration of the private sector. India has emerged as the fastest-growing major economy in the world in FY24 by clocking an impressive growth rate of about 8.2% despite several pressures in the global market. This was fueled by the manufacturing sector, which rebounded sharply from a contraction in the previous year. This revival, coupled with increased Government infrastructure spending and robust domestic demand, steered the overall economic expansion. While the growth momentum is expected to moderate slightly in the coming year, Indias strong performance in FY24 positions it well for continued economic progress. With its solid democratic framework and continued focus on building strong partnerships, India is well-positioned to be among the top three economic powers within the next decade or so. The current environment of global uncertainty has only amplified Indias appeal as a stable and attractive destination for investment, solidifying its path towards sustainable economic growth.

For FY25, Indias economy is poised for a solid 7% growth, as predicted by the RBI. Strong agricultural output, resilient services, and ongoing manufacturing profitability will steer activity. Rising household consumption and a surge in fixed investments driven by private spending, healthy financials, and Government infrastructure push will bolster domestic demand. Positive global trade and deeper supply chain integration will further boost the economy. However, geopolitical tensions, market volatility, and potential trade disruptions remain potential risks.

2. Industry Overview

Global Chemicals

The chemical industry is a cornerstone of the global economy, transforming base materials into essential products for everyday life. It encompasses through a wide variety of chemicals, broadly classified into bulk (commodities), specialty, and others. These chemicals serve as building blocks for numerous applications, prominent ones include petrochemicals, agrochemicals, pharmaceuticals, life-sciences, and specialty applications in dyes, pigments, polymers, adhesives and coatings among others. Sustainability is a growing focus, with global giants striving for cleaner production processes and developing eco-friendly products. Technological advancements are also driving innovation, with areas like bio-based chemicals gaining significant traction.

The global chemicals market has experienced significant growth in recent years. It is projected to increase at a Compound Annual Growth Rate (CAGR) above global GDP growth. This growth is anticipated to be driven mainly by stringent environmental regulations, shifting consumer preferences towards renewable and bio-based materials, geopolitical factors, and an increased focus on health and safety.

Unlike bulk chemicals used in large quantities, specialty chemicals are high-performance, value-added products. They play a crucial role in various industries, enhancing the properties and functionalities of final goods. While pharma and agrochemicals are key end-markets of global speciality chemicals, this market is driven by multiple factors. Expansion of end-use industries is a leading driver as each industry relies on specialty chemicals for specific purposes, like improving durability or enhancing the performance. Moreover, growing demand for sustainable solutions is pushing the development of eco-friendly specialty chemicals, creating new opportunities within the market.

The past year has been challenging for the global chemical industry elevated interest rates, inflationary pressures resulting into destocking cycle, supply disruptions, and geopolitical tensions. Since the onset of the Russia-Ukraine conflict, the European chemical industry has faced significant challenges and lost competitiveness in global markets. Elevated energy and feedstock costs have led to reduced export and import volumes throughout CY23. This highlights the mounting pressure on the European chemical sector amid intense global competition, weakened demand, and low-capacity utilization. In this context, European players are losing market share to Indian and Chinese companies in several value chains.

Asia: The Chemical Powerhouse of the World

Asia holds a substantial position in the global chemicals market, representing about 60% of the market share. Within this, China is a dominant force, driving the recent increases in Asias exports and consumption of chemicals. Other Southeast Asian countries, with its fast-growing economies and large population base, are also emerging as significant players. This region offers a dynamic market for specialty and commodity chemicals, attracting investments and contributing to the overall growth of the Asian chemical industry.

Looking ahead, Asias chemical consumption is anticipated to rise at the fastest pace globally. This is due to factors like continued economic development, urbanization, and increasing demand for consumer goods and industrial products. While this presents vast opportunities, it also necessitates addressing challenges related to sustainability and environmental impact.

From Local to Global Force: Indias Specialty Chemicals Take Centre Stage

The Indian chemical industry is witnessing a remarkable transformation. From a USD 186 billion market in 2020 (around 4% of the global share), its projected to reach a staggering USD 330 billion by 2025. This growth is fueled by a booming specialty chemicals sector, expected to climb at a stellar 11 % CAGR, reaching USD 148 billion by 2025. Notably, this will contribute nearly half (47%) of the total Indian chemical market value.

Driving this surge is a rise in demand from diverse end-user industries like food, automobiles, construction, textiles, and cosmetics. Indias rapid industrialization and robust domestic demand further propel this growth, putting it on track to outperform established players like China and Japan. This shift in the global landscape is stimulated by a strategic move in speciality chemicals manufacturing - a migration from Europe and North America to Asia, perfectly positioned to cater to the burgeoning needs of emerging markets.

While current per capita consumption of specialty chemicals increasing steadily, the future looks bright. A booming population, rising disposable income, and rapid urbanization are creating a massive potential for growth in this sector. Powering this potential is a surge in domestic demand from end-user industries. Indian manufacturers are also expanding production capacity and investing heavily in R&D to develop innovative and sustainable specialty chemicals. The Government is playing a key role too, with initiatives like the Production-Linked Incentive (PLI) scheme across various end applications, PCPIR zones, and dedicated chemical promotion programs. These efforts, coupled with the ambitious 2034 vision for the chemical sector, are creating a fertile ground for the Indian specialty chemicals industry to take centre stage on the global stage.

Indian speciality chemical companies started escalating their CAPEX plans due to robust demand visibility in the next few years, shifting from China to India, and diversifying their supply chain base. Some of the large Indian speciality chemicals announced CAPEX plans to expand production capacities and fulfil demand.

Rising Star: How India is Capitalising on the Shift in Specialty Chemicals

Chinas environmental crackdown (post-2015) forced shutting down of several manufacturing facilities within the country. Rising labor costs, COVID-19 disruptions, and a changing geopolitical landscape further fueled the desire for alternatives. This gave rise to the China+1 strategy, prompting manufacturers to diversify their sourcing beyond China.

This shift presented a golden opportunity for Asia. Countries like India, with their well-established manufacturing capabilities, skilled workforce at competitive wages, and strong export infrastructure, emerged as attractive options. India, in particular, has become a preferred partner for global manufacturers due to its ability to offer cost-effective production, strong engineering talent, and a readily available, affordable labor pool.

The war in Ukraine has thrown Europes chemical industry into disarray. Blackouts, factory closures, and crippled supply chains are forcing companies to rethink their production bases. Energy-intensive industries like chemicals are particularly hard-hit by soaring energy prices, creating a perfect storm for relocation. This turmoil presents a golden opportunity for India. With its comparatively low energy and labor costs, India offers a compelling alternative. The Governments focus on infrastructure development further sweetens the deal for European companies seeking a more stable and cost-effective environment. This confluence of factors is making India a prime destination for European speciality chemical companies seeking to escape the turbulence in their home continent.

Susceptible to global economic headwinds

Indian chemical companies are deeply entwined with the global economic landscape. This is especially true in the agrochemical sector, where many companies export finished products or supply key ingredients for them. This tight link to global demand means that both prices and profit margins fluctuate with international market shifts. However, India has been making strategic moves to weather these fluctuations. By diversifying the global supply chain, boosting manufacturing capabilities, and leveraging Government initiatives, the industry has gained significant traction in recent years. This has led to a surge in capital investment, positioning India as a strong player on the global stage. While global demand remains a factor, Indias proactive approach is creating a more stable foundation for future growth.

The Road Ahead: Charting a Sustainable Future

The Indian Speciality chemical industry is poised for a bright future, with the potential to become a major player in both demand and supply on the global stage.

Indias booming economy and growing middle class position provides a foundation for strong domestic demand. India also represents as a potential powerhouse for the global chemical industry, offering manufacturers lower capital and operating costs. However, challenges like limited domestic raw materials, slow regulatory approvals, and a skilled R&D talent gap remain. These factors influence which chemical sub-segments are most attractive for India, requiring a focus on cost-competitive areas to solidify its position as a future leader in the global chemical landscape.

3. Company Overview

Established in 1984, pioneer by first-generation technocrats in India, Aarti Industries Limited (AIL) has globally emerged as one of the most competitive, highly integrated and diversified speciality chemical company. It carefully combines process chemistry expertise with its world class engineering capabilities to scale up its manufacturing powerhouses for optimal asset utilization.

Over the years, AIL has demonstrated significant growth and development, achieving operational excellence.

Based in India, the Company serves both domestic and global markets and offering over 100 products to more than 700 domestic and over 400 international customers, exporting to over 60 countries, including major markets like the USA, Europe, Asia and Rest of the world. Its presence also spans across various chemistries, utilizing base raw materials such as benzene, toluene, nitric acid, chlorine, methanol, aniline, Sulphur, etc.

As a leader in the Indian market, AIL has -diversified into several product value chains and innovative chemistries. Its integrated operations across product chains have enabled it to effectively utilize co-products and generate value-added products, reinforcing its position as a leading player in the speciality chemicals industry.

Internationally, AIL ranks among the top 4 for 75% of its portfolio, earning its reputation as the "Partner of Choice” for numerous major global and domestic customers. It is a leading global player, ranking in the top 3 for chlorination and nitration and in the top 2 for hydrogenation.

The Companys speciality chemical intermediates are integral to various industries, including Pharmaceuticals, Agrochemicals, Aromatics, Dyes and Pigments, Energy, Home and personal care (FMCG), polymers, printing inks, and rubber chemicals among others.

AIL has built a strong foundation through an integrated and diverse business model, driven by a relentless focus on R&D and advanced chemistry capabilities, including ammonolysis, chlorination, diazotisation, Halex (fluorination), hydrogenation, nitration, etc. AIL boasts its two state-of-the-art R&D centres across Maharashtra and Gujarat, covering ~40,000 sq. ft. with an ultramodern synthesis laboratory. Its R&D team, comprising over 250 engineers and scientists, including 19 PhDs, works on several high-potential projects. Currently, AIL has more than 40 products in its R&D pipeline at various stages of development, with many being introduced in India for the first time.

AIL operates 16 manufacturing facilities, including 11 Zero Discharge Units that emphasizes its principles of reduce-reuse-recycle. The Companys dedication to safety, health, and equipment quality is evident in its adherence to global standards across all facilities. As a signatory of esteemed initiatives such as "Responsible Care”, "Together for Sustainability”,” CDP - Driving Sustainable Economies”, and "Eco Vadis”, AIL underscores its commitment to enhancing overall performance, bolstering customer confidence and adding shareholder value.

Financial Performance

Throughout FY24, the chemicals sector faced a challenging landscape with sluggish global demand, oversupply situation in China, supply disruptions due to geopolitical tensions and widespread inventory corrections. Combined with a slowdown in key markets, these factors impacted AILs performance trajectory for the year.

To counter these pressures, AIL implemented strategic initiatives to enhance its market position, optimise its product mix, and drive operational excellence. Despite challenges in certain end use categories like agrochemicals and pharmaceuticals, the Companys robust and diversified product portfolio, and unmatched expertise in high-end chemistries provided a buffer against adverse conditions.

Amid these headwinds, demand and pricing trends in segments such as dyes, pigments, polymers, and select speciality applications recovered noticeably. Yet, concerns around softening global demand and ongoing inventory destocking lingered. Geopolitical tensions, disrupted logistics, escalating freight costs and extending transit times possessed new challenges.

In light of this, the Company reported revenues of Rs.7,012 Crore in FY24, compared to Rs.7,283 Crore in FY23. Exports were Rs.3,644 Crore in FY24, compared to Rs.3,517 Crore in FY23. Exports as a percentage of sales increased over the year to ~52% from ~48% in FY23. The Company has robust pricing mechanisms in place to mitigate the impact of inflationary cost pressures by passing them on to the customers, thus protecting absolute profitability. During the year, AILs profitability was supported by the contribution of value-added products with high growth and better margins. EBITDA inclusive of other income was Rs.984 Crore for FY24 as compared to Rs.1,089 Crore in the previous year. Depreciation increased with the commencement of new capacities. Interest costs were higher due to a mark-to-market/revaluation impact on unhedged long-term loans and increasing interest rates. The Company benefited from higher tax depreciation, resulting in lower tax liability and the accrual of deferred tax assets. Profit After Tax in FY24 was Rs.416 Crore, compared to Rs.545 Crore in FY23. Earnings Per Share were Rs.11.49 in FY24 compared to Rs.15.04 in FY23. For the financial year ended March 31, 2024, the Board of Directors recommended a dividend of Rs.1 per Equity Share of Face Value of Rs.5 each.

AILs skillful maneuvering through a difficult year showcases its resilience and adaptability. The Companys focus on market growth and operational efficiency lays a strong groundwork for future success, positioning itself to seize opportunities as the market rebounds.

Update on Key Projects and CAPEX Initiatives

Despite a challenging FY24, AIL secured two important long-term supply contracts. This achievement is a tribute to our teams hard work and strengthens our integrated product value chain. These contracts solidify our commitment to building long-lasting relationships that translate into future growth opportunities.

In December 2023, the Company secured a contract with a Global Agrochemicals major for a niche agrochemical intermediate, projecting a revenue potential exceeding Rs.3,000 Crore over nine years starting from FY24. This intermediate serves as a crucial input for a widely used herbicide with a sizable and steadily growing global market. The product has been supplied to the customer for the past few years.

AIL secured a 4-year contract in January 2024 worth over Rs.6,000 Crore with a multinational conglomerate for a niche speciality chemical. This contract, spanning from CY24 to CY27, involves a product in the Companys existing portfolio, which has been supplied to the customer for a few years with consistent annual volume increases. Volumes are expected to double in CY24 as compared to CY23, driven by strong demand from evolving new applications over the past 4-5 years. For both these contracts, no additional Capex was required.

Aside from the previously mentioned contracts, AIL has entered into several other long-term agreements in recent years.

The first contract, terminated in FY23, was intended to procure a key herbicide. Manufacturing activities at the associated plant are ongoing albeit at lower utilization levels. The Company is conducting a strategic evaluation of potential new avenues product lines for implementation over the next few years in order to optimize the utilization rates. Operations for the second contract were stabilized in FY23, with the facility continuing to meet the terms of the agreement. The facility related to the third contract commenced operations in FY23 and the scale-up in operations is underway in accordance with the contract terms.

Further as a strategic collaboration with Renew Power, AIL also commercialized a 13 MW renewable power generation unit, underscoring its commitment to sustainability by addressing power needs through cost-effective and renewable sources.

The year saw the successful commercialization of NCB Expansion, Phase 1 of the Acid Unit revamp at Vapi (Gujarat). Additionally, substantial progress was made in key projects, including the NT expansion at Jhagadia and ethylation expansion at DahejSEZ with capital expenditure of about Rs.200 Crore. Phase 2 of the Acid Unit expansion, and the debottlenecking and enhancement of Speciality Chemical units are underway.

The greenfield initiatives at Zone IV in Jhagadia (Gujarat), spanning ~95 acres and encompassing the MPP, the pilot plant, and Chloro Toluene project, has been advancing as planned. The Chloro Toluene project is slated in a phase wise manner starting by FY26. The Zone IV plant is intended to cater majorly to agrochemicals and pharma applications, producing niche, high value-added products, with robust EBITDA margins of ~25-30%. These also open up niche opportunities in custom manufacturing for AIL.

The total Capex for the financial year was over Rs.1,358 Crore. The Company has earmarked an estimated Rs.1,500-1,800 Crore as Capex for FY25. This strategic investment aims to develop innovative chemical value chains and launch high-potential products, with the goal of expanding market reach and effectively meeting the growing demands of key customers.

Joint venture with UPL

UPL Limited (UPL) and Aarti Industries Limited (AIL) entered into a 50-50 joint venture (JV) in May 2024 to manufacture and market specialty chemicals. The JV will supply downstream derivatives of amines, which have diverse applications in the agro-chemical and paint industries. Commercial supplies are expected to commence by Q1 FY27, with peak revenue potential of Rs.400-500 Crs anticipated 2-3 years post-commercialization, likely in FY30. The total investment in the project is Rs.300 Crs, with each partner contributing Rs.150 Crs over a two-year period.

This partnership builds on the existing two-decade- long relationship between AIL and UPL, combining their strengths and resources. Both companies will provide key raw materials for manufacturing the desired chemicals. This JV demonstrates Indias capability to collaborate and create world-class chemical manufacturing assets.

4. Business Outlook

AIL, a leading player in the Indian specialty chemical industry, is building on its decades of expertise and research prowess to drive future growth and solidify its position as a global leader. The Company recognizes the emerging opportunities in new chemical value chains and is expanding its capabilities by adding new chemistries such as photo chlorination and oxidation. Additionally, AIL is broadening its existing value chain to enhance its product offerings and maintain a competitive edge.

In a move to fortify its market dominance, AIL is actively pursuing several strategic initiatives. This includes strengthening existing partnerships, forging new alliances with key players, and exploring opportunities in contract manufacturing and CDMO (Contract Development and Manufacturing Organizations). By expanding its network and expertise through these collaborations, the company aims to further cement its position within the industry.

Despite a challenging FY24 riddled with sluggish global demand, slower exports, inventory adjustments, and logistical nightmares due to geopolitical crises, the Company forecasts a robust rebound in demand for the coming year. Encouragingly, discretionary applications like dyes, pigments, specialty polymers, energy and additives are already showing signs of demand revival, while non-discretionary portfolio including agrochemicals and pharma are expected to see gradual improvement in demand starting second half of FY25. While the increase in peer capacities in china along with demand contraction had led to margin pressures, we expect the same to gradually normalize in coming years. Building on this momentum, the Company projects a healthy EBIDTA growth for FY25 and beyond. Operating leverage and increased volumes are expected to further fuel this growth trajectory.

AIL remains committed to its long-term goals by leveraging best-in-class manufacturing processes, continuous process enhancements, strong focus on R&D and a firm dedication to innovation. The Company is investing in R&D for products in emerging sectors, with a growing emphasis on sustainable and green solutions, battery chemicals, electronics chemicals, new-age materials and high-end polymers. By focusing on R&D-led product offerings and maximizing returns from existing value chains, AIL is poised to capitalize on long-term favorable industry trends. This strategy will create a stronger value proposition for all stakeholders, ensuring sustained growth and success in the evolving chemical industry landscape.

1. Key Risks and Mitigation

1. Regulatory Risk: Widespread geographical presence leads to exposure to different prevailing rules and regulations. Non-compliance to any new policies or changes in existing policies may impact normal business functions.

Mitigation: The Company follows the highest Environment, Health, and Safety (EHS) standards. Dedicated team is responsible for tracking adherence to all applicable laws and statutes. AIL has developed its own SOPs and a best-in-class compliance framework to this end.

2. Innovation Risk: R&D is crucial for sustainable growth in the speciality chemicals market. The Company has to remain ahead of competition with innovation and focused R&D.

Mitigation: AILs two state-of-the-art R&D centres, with a strong team of PhDs and 250+ scientists, ensure a high level of innovation. The Company is a well-known knowledge-driven organisation, with product innovation as its USP. It has earned several awards for innovation in chemical engineering. AIL strives to strengthen its technical skill set around niche applications. Strong customer connect enables us to develop specialized products with unique features.

3. Forex Risk: Due to its widespread business operations in over 60 countries, Aarti Industries Limited is exposed to several currencies. Fluctuations in Fore x may thus impact earnings.

Mitigation: The Company has ~52% export earnings, of which most is in USD. Lower exposure to multiple currencies reduces cross currency fluctuations. It enters hedging contracts of maturities ranging from 3 months to 3 years to help insulate any untoward movement in Forex.

4. Raw Material Risk: All manufacturing organisations face the inherent risk of unavailability/limited availability of key raw material(s). In addition, fluctuation in costs may impact earnings.

Mitigation: AILs long-standing vendor relationships enable it to maintain uninterrupted flow of raw materials at competitive prices. It is also fully integrated for key products, thereby limiting the impact of raw material supply shortage. To insulate itself from the impact of price fluctuation, the Company signs cost-plus pricing contracts for various speciality chemicals, which helps it to protect margins in rising input costs scenarios.

2. Internal Controls, Systems and Adequacy

AIL has designed well-structured internal control systems comprising detailed policies, guidelines and procedures commensurate with the nature, size and complexity of the industry in which it operates. The comprehensive system ensures automatic checks and balances and robust financial reporting. Adhering to all applicable statutory compliances, AIL follows stringent procedures, enabling us to achieve high accuracy in recording and providing reliable financial and operational information. All business operations are monitored by the internal team and Audit Committee, ensuring smooth business functioning by designing, implementing and maintaining adequate internal financial controls. The Company is responsible for safeguarding assets, prevention and timely detection of frauds and errors, accuracy and completeness of the accounting records, and timely preparation of reliable financial information. Any deviation from normal is reported to the management. Prompt action is ensured to run business as usual and keep these exposures at manageable levels. Internal control framework ensures business continuity.

3. Cautionary Statement

AIL may, from time to time, make additional written and oral forward-looking statements, including statements contained in the Companys filings with BSE and NSE, and the reports to shareholders. The Company does not undertake to update any forward-looking statements that may be made from time to time by or on behalf of the Company. The Company does not accept any liability whatsoever for any loss, howsoever, arising from any use or reliance on this Annual Report or its contents or otherwise arising in connection therewith.