A case study in capital allocation

In this post, we evaluate the capital allocation dynamics of a specialty chemicals company.



In this post, we discussed the ways in which the firm can allocate capital. The firm can either invest organically or it can pursue acquisitions to enhance capabilities. However, tailwinds in the form of capacity reduction in China owing to the pollution-related clampdown by the government and China plus one strategy have opened up the organic growth opportunities for Indian chemical players. One such example is Balaji Amines, a classic case of sector opportunity (in terms of import substitution) meeting prudent cash deployment by the management over a long period.


Before we dive into Balaji Amines’ capital allocation strategy, let’s look at the key numbers for the period FY12-22. The company generated INR 1,179 Cr. of cash from operations during this period. Out of the cash generated, the company re-deployed INR 879 Cr. in Capex leaving the free cash flow of INR 300 Cr. during the period. The company paid dividends of INR 77 Cr. to shareholders and raised negligible capital through debt or equity during the period.

Particulars

Amount (INR Cr.)

Cash flow from operations

1,179

Capex

879

Dividends

77

Incremental bank borrowings

11

Incremental equity capital

NIL

It is clear from the above figures that the management has broadly focused on redeploying the cash flow back into the business and less on distributing it to the shareholders. In light of this, let's put the capital allocation strategy of Balaji Amines into perspective.


Organic capacity addition and moving up the value chain


In India, Balaji Amines is one of the two manufacturers of aliphatic amines including methylamines and ethylamines. During FY12-22, the company has steadily increased the capacity of amines in line with increasing demand from the end-user industries. Further, the company has diversified its product basket with amine derivatives and other specialty chemicals. Total installed capacity increased from 108,000 MTPA in FY12 to 231,000 MTPA in FY22. Out of 123,000 MTPA capacity addition during the period, 46,500 MTPA pertain to amines and 76,500 MTPA include amine derivatives and other specialty chemicals. As a part of the ongoing greenfield expansion plan, the company has proposed an additional 40,000 MTPA capacity for amines and 75,500 MTPA for other specialty chemicals. This additional 115,500 MTPA capacity will be fully operational by FY24/25.

An important thing to note here is how the company has moved up the value chain by adding specialty chemical products that were primarily being imported into the country. The company is now the only player in India to manufacture Dimethylformamide (DMF), N-Methy-Pyrrolidone (NMP), and Gamma-Butyrolactone (GBL). With these specialty products, the company has increased its end market size significantly from USD 4.6 bn for only aliphatic amines. The below table outlines the products added during FY12-22 and their estimated global market size.

Low dividend pay-out and productive R&D


Balaji Amines has been growth-focused in the last decade with most of the cash flow reinvested in the business. The company paid only INR 77 Cr. of dividends against net profits of INR 1,216 Cr, during FY12-22. This roughly translates to an aggregate dividend payout of 6% which is understandable given the growth stage of the company and better opportunities for value creation in the existing business. It’s important to note however that the above addition of value-added products was supported by the company’s focus on R&D which was geared towards improvement in the manufacturing process of existing products as well as piloting new products/catalysts that helped the company move up the value chain. Balaji Amines’ R&D spend at INR 0.5-1Cr. has been rather low for its size but can be considered effective given product additions during the period.

Small capital allocation towards non-core activities


The management’s approach towards outside capital has been rather conservative as the company has not added significant bank borrowings or raised equity from the market. Major Capex projects undertaken during FY12-22 have been funded largely out of internal cash accruals. However, it’s important to note that not all Capex has been incurred towards the core business of amines and specialty chemicals. The company has also incurred INR 104 Cr. towards building a five-star hotel ‘Balaji Sarovar’ in Solapur. The company commenced its Hotel Division in 2014 but on a net level, it has been a loss-making proposition till now (INR 66 Cr. total net loss). Nevertheless, the impact of sub-optimal output from this venture remains low on an overall basis given strong momentum in the chemical business.


The compounding effect of a consistent strategy


Steady capacity addition for existing products and diversifying the product basket with specialty products have worked well for Balaji Amines. The company has registered c.18% CAGR in revenues during FY12-22 with EBITDA margins expanding from 17-18% to 26-27%. Most importantly, the returns profile has improved dramatically with ROIC increasing from 10-11% to 27-28%. Steadily increasing ROIC suggests that every incremental investment has been more productive with bringing in either economies of scale or a higher value-adding proposition. It’s a classic case of reinvestments in the business coupled with higher incremental returns. Needless to say that the stock has created an extraordinary value for shareholders over the last decade.

Note: Above case study is for educational purposes only and should not be construed as investment advice. We are not SEBI registered investment advisors.