Gujarat Fluorochemicals (GFL) is in a sweet spot with its presence in fluoropolymers, demand for which is increasing driven by the new-age verticals of battery, solar panel and green hydrogen. GFL is in the process of expanding its capacity in fluoropolymers, which provides visibility on growth during our forecast period (FY21-FY24E). The company is also expanding into other fluorine derivatives used in the new-age verticals, which expands the company’s addressable market and provides a vista of sustained growth.

GFL has laid out a bold capex plan of Rs25bn over the next three years. It is likely to see its earnings grow at 45.9% CAGR over FY21-FY24E (on low base though), and RoCE (post-tax) improve from 6.7% to 18% over the same period. Despite the strong earnings outlook, GFL is trading at a reasonable P/E multiple of 20x FY24 vs 42.1x for Navin Fluorine and 27.5x for SRF.

Fluoropolymers pose high entry barrier; GFL in a sweet spot

Generally, we like the fluorine play due to high entry barriers: 1) higher expertise required to manage the highly reactive chemistry of fluorine; 2) fluorine sink possible only through anhydrous hydrofluoric acid (AHF) or potassium fluoride (KF), which are difficult to load, store and transport, thus making backward integration preferable; 3) fluoropolymers use R-22 (for TFE monomer), which is a restricted product, and supplies of R-142B (for VDF monomer) are limited; 4) long gestation period in the fluoropolymer business (product development to customer approval takes several years). Demand for fluoropolymers such as PTFE, PVDF, FKM and FEP has increased due to their higher performance and increased use in new-age verticals such as battery, solar panel, green hydrogen, 5G, etc. GFL is the sole manufacturer of fluoropolymers in India and is among the very few players outside of China to have a large fluoropolymer portfolio. It is in a sweet spot in specialty fluoropolymers where the Chinese have limited global presence, and western and Japanese players are not adding meaningful capacity. GFL has not only built global scale production capacity, but has also established technical sales team (to drive application expertise) and supply chain (with local warehouses in the US and Europe).

Fluoropolymer revenues to grow at 32.9% CAGR over FY21-FY24E 

GFL achieved full capacity utilisation in PTFE in Q2FY22, and is planning to expand capacity by 25% in FY23 with a planned capex of Rs2.5bn. It already has enough capacity for R-22 and TFE; hence we expect higher asset turnover of 1.5-1.6x. New fluoropolymers segment has achieved only 65% capacity utilisation, and GFL expects it to hit full utilisation soon. Company is in the process of adding 57% capacity in new fluoropolymers including critical PVDF, FKM and micropowders. It is also introducing I-SAN, which finds application in flame retardants. This gives visibility on fluoropolymers’ revenue growth, while higher contribution from this portfolio should also aid margin expansion. GFL is also backward-integrating into R-142B, which should help scale PVDF in future.

Battery chemicals and other new-age verticals offer huge option value

The Chemours Company (spin-off of DuPont, ‘godfather’ of fluoropolymers) has increased its revenue growth guidance for fluoropolymers to higher than global GDP growth rate with the likelihood of accelerating it over the next few years. It has also raised its margin guidance to early twenties (earlier: mid-teens) for 2022. This is on back of rising demand from new-age verticals. We believe the same trend should also benefit GFL, which has a large basket of fluoropolymers. Further, GFL is planning to enter into battery chemicals [e.g. electrolyte salts (lithium hexafluorophosphate, LiPF6), electrolyte solutions, additives], and is planning a plant to manufacture PVDF sheets which are used in solar panels. This would increase the company’s addressable market in new-age verticals. Besides, GFL is working on photon exchange membranes (PEMs) for production of green hydrogen. New-age verticals carry an option value – and successful execution can create huge value for stakeholders, in our view.

Bold capex plans provide strong earnings visibility

GFL has unveiled large capex plans envisaging investment of Rs25bn over FY22E-FY24E. This is on the existing gross block of Rs32bn. Incremental capex will be used entirely in fluoropolymers, fluorospecialties and new-age verticals including backward integration of a few crucial products. Of this, Rs10bn will go in fluoropolymers where the company has already established its market leadership. New-age verticals will see investment of Rs8bn. It also plans to incur Rs2.5bn capex on fluorospecialties. The remaining capex will be used to build infrastructure including buying fresh land for future growth, captive wind power etc. We have reasonable confidence on revenue generation from fluoropolymers and fluorospecialties in the near term, but we would wait to see ramp-up in new-age verticals.

Risk of related-party transactions to recede

GFL has >Rs20bn exposure to group company INOX Wind in terms of advances totalling Rs9bn and bank guarantees for Rs12bn. Company expects to execute wind power project of 20-25MW in FY22 with the remaining ~100MW power plant build-up depends on government policy / regulations. We expect clarity on usage of the advances to INOX Wind by Jun’22. If the power project plans don’t materialise, GFL would expect unspent money to be refunded. Further, it has guided for related-party bank guarantees to be revoked by end-FY23.

Earnings trajectory remains strong; valuations reasonable

GFL’s revenues are expected to grow at 21.6% CAGR over FY21-FY24E driven by higher growth in fluoropolymers (32.9%) and fluorospecialties (23.8%). Its EBITDA is estimated to grow at a healthy CAGR of 39.5% to Rs18.3bn in the same period, and net profit at 45.9% CAGR to Rs11.3bn. Company is working on reducing working capital to 100 days from 164 in FY21, which, along with utilisation of advances, should help significantly boost FCF. We expect GFL to have very little net debt at end of the forecast period, and RoCE (post-tax) to expand to 18% in FY24E from 6.7% in FY21.