Oriental Aromatics Ltd Q2 FY2023 Concall Summary

Key Takeaways

• Margins collapsed, guidance slashed: EBITDA margin fell to 6.61% from 7.06% QoQ, and management revised near-term margin guidance down to 8–10% from a historical 15–16% target, citing a complete disruption of the prior steady state.
• Chinese pricing assault blindsided the industry: In a single quarter, global buyers shelved China Plus One considerations and pivoted entirely to price, exploiting aggressive Chinese pricing and a 12–14% currency advantage; the company was caught with high-cost inventory just as demand softened.
• Demand volumes hold up, but pricing power is gone: RFQs for H1 calendar 2023 show no volume shrinkage versus H1 2022, and management expects plants to run at optimal capacity, yet customer expectations for price reductions have increased many fold.
• Two large CAPEX projects are on the way, not yet earning: The hydrogenation facility at Baroda and the Mahad greenfield site represent a new chemistry and a new manufacturing hub, but full sales contribution will not materialize until FY 2024–2025, while net debt is expected to peak around ₹300 crores in the next 12 months.
• What to watch next quarter: Whether the delayed specialty aroma ingredient shipments actually clear by end-2022 as customers committed, whether input cost easing proves sustainable, and whether the fragrance division’s gradual price pass-through to customers begins to recover gross margins.

The Margin Shock & Revised Guidance

• Steady state shattered: The 15–16% long-term margin target was based on a steady state that held from 2015 to 2019; that environment has been completely disrupted by raw material volatility, currency instability, and aggressive Chinese pricing, forcing a near-term reset to 8–10%.
• Gross margin fell sharply: Dropped to 28.9% from 32.4% QoQ, driven by consumption of high-cost alpha pinene inventory; competitive pressure in camphor makes immediate recovery difficult, so specialty ingredients and the F&F division must carry the improvement.
• Margin pressure is across the board: All companies entered the quarter with elevated inventory, consumed it at high cost, then faced demand softness from global overstocking; the sudden buyer pivot to price discussions compressed margins everywhere, not just in camphor.
• Product diversity as a hedge: The fragrance and flavors side saw increased sales and production; management noted that if the company were concentrated only on camphor, the impact would have been far worse.
• Guidance will be revisited: Management will revisit margin guidance once stability returns in raw materials and currency over a few quarters; the current 8–10% is a deliberate under-commitment.

Parag Satoskar: "I think it's better to kind of under commit, because what we are seeing is we are seeing complete disruption of a steady state situation which we always talk about and the envisaged margins of between 15% to 16% were in that steady state which was pretty constant from 2015 till around 2019."

Chinese Competition & Pricing Pressure

• Buyers flipped in one quarter: In Q1, nobody talked about price reduction; suddenly, buyers started talking only about price, putting China Plus One considerations aside because Chinese manufacturers are offering aggressive pricing backed by local feedstock and a 12–14% currency devaluation advantage.
• Customer expectations transformed: The expectation for price reductions has increased many fold, and the company faces this pressure while still working through high-cost inventory and trying to pass through its own input cost increases to customers.
• Camphor under specific pressure: The competitive landscape in camphor has changed, and the company is holding prices in the local market only to the extent necessary to ensure profitability; immediate margin improvement there is unlikely.
• Pricing strategies vary by region: The company does not apply uniform global pricing; the US, LATAM, and India each have different pricing strategies and margin expectations, providing some flexibility in managing competitive pressure.

Parag Satoskar: "Now people suddenly in one quarter started only talking about price, the whole concept of China Plus One etc etc. now is actually put in the drawer by the buyer because he is getting some fancy pricing from Chinese."

Demand: Volumes Resilient, Pricing Weak

• RFQ volumes hold steady: Requests for quotations from all global customers for H1 calendar 2023 show quantities in line with H1 2022; no shrinkage in demand observed despite recession fears.
• Non-discretionary end-use provides floor: Specialty aroma ingredients go into functional perfumes for FMCG products like soaps, detergents, and shampoos, which are non-discretionary; demand is expected to follow the CAGR growth of these FMCG categories globally.
• Fragrance division showing health: Production grew 9% QoQ and sales volume increased 8% QoQ, indicating healthy underlying demand even as pricing discussions intensify.
• Delayed shipments created artificial softness: Specialty aroma ingredients sales volume dipped 13% QoQ because some global customers requested delivery delays, causing finished goods inventory to pile up at plants; those shipments have now begun moving, and customers committed to pick up all contracted material by end of 2022.
• Camphor and terpene chemicals production dipped: Production volume reduced 4% QoQ primarily due to a six-day preventive maintenance shutdown at the Bareilly plant in July 2022, not demand weakness.

Parag Satoskar: "We feel that... there will be sufficient demand to ensure that all the plans that we have are running at optimal capacity."

CAPEX Pipeline: Building Capacity Before Earnings

• Hydrogenation facility at Baroda: A completely new chemistry for the company; commissioning planned by end of H1 calendar 2023, with spot sales for customer approvals in H2 calendar 2023 and global contract bidding in H1 calendar 2024; the first full financial year of sales will be FY 2024–2025.
• Mahad greenfield site: First phase commissioning with the utility block targeted for end of Q3 calendar 2023, a nominal three-month delay over earlier guidance due to long lead times for certain utility items; plant and product validation will take 300–500 days thereafter, with full sales incorporation expected in calendar 2024–2025.
• Bareilly expansion completed: Production validated for increased volumes of certain terpene chemicals, but elevated inventory levels will persist until new customer approvals are obtained globally; a sales plan is in progress.
• CAPEX postponement saved costs: A brief postponement in Q1 FY23 due to unreasonable input cost increases saved 7–8% in project costs in some cases; prices have since stabilized at higher levels, and execution has refocused on commissioning timelines.
• Net debt peak ahead: Expected to reach around ₹300 crores in the next 12 months as CAPEX spending continues before new assets begin generating revenue.
• Return expectations maintained: Management remains confident of achieving 12–15% return on invested capital, recovering investments within five to six years even at conservative margin levels.
• Hydrogenation competitive positioning: The basket of products envisaged from the hydrogenation plant, combined with the existing product basket, is something very few companies globally will be able to offer on a long-term sustainable basis.

Parag Satoskar: "The basket of products that we envisage to make at that plant along with the existing basket of products is something which probably very few companies in the world will be in a position to offer on a long term sustainable way, so that's our game."

Working Capital & Cash Flow Strain

• Free cash flow turned negative: Minus ₹28.40 crores in H1, driven by higher working capital requirements and additional investments in ongoing projects versus FY22.
• Inventory pileup from two sources: Inability to pass through price increases to customers in the fragrance division and delayed shipments in the specialty aroma ingredients division both contributed to inventory build-up; trade receivables rose ₹16.7 crores and inventory rose ₹19.2 crores versus FY22.
• Operating cash flow decreased: Higher cash investment in working capital and project investments drove the decline.
• Manufacturing costs rose: A ₹1.6 crores increase mainly due to a ₹1 crore power cost increase; tight cost control on operating expenses partially offset this, lowering other expenses by ₹3.73 crores QoQ.
• Rupee weakening added pressure: The weakening of the Indian rupee against the US dollar increased input costs of imported raw materials, further impacting profitability of local sales, especially in camphor and the F&F division.

Strategic Bets: De-risking & Diversification

• CST as a procurement hedge: The company is committed to developing a sustainable and efficient process for refining CST, viewing it as a de-risking tool for the current GTO procurement strategy; it provides some level of de-risking and a marginal cost advantage, not a transformational one.
• Bulk commodity ingredients from alpha pinene: The company is actively looking at bulk commodity ingredients like dihydromyrcenol and materials similar to Iso E Super, leveraging its alpha pinene feedstock position.
• Camphor and terpene chemicals contribution protected: Incremental capacity increases are planned through process engineering at Bareilly with minimal investment, so the contribution from these segments will not drop significantly even as new products ramp up.
• Fragrance pass-through plan in motion: For old projects, a plan has been created to gradually pass input cost increases to customers over the next three quarters; new projects already factor in the higher input costs.

Dharmil Bodani: "We look at our CST strategy as a de-risking tool for our current GTO procurement strategy. We will stick to our understanding that having a CST refinery at best gives us some level of de-risking and a marginal cost advantage."

Guidance & Commitments

Key Metrics