Analysis: IOL Chemicals and Pharmaceuticals Ltd

The current section of the “Analysis” series covers IOL Chemicals and Pharmaceuticals Ltd, an associate of the Trident Group, India. The company primarily manufactures two products, Ibuprofen and Ethyl Acetate. In addition, the company also deals in active pharmaceutical ingredients (API) and other chemicals.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

IOL Chemicals and Pharmaceuticals Ltd Research Report by Reader

Hello Sir,

Hope you are doing well.

I have tried to analyse the fundamentals of IOL Chemicals and Pharmaceuticals Ltd based on the learnings and the knowledge I gained from reading your articles and through your workshop in Pune.

I would request you to give your valuable inputs on the same.

Thank you so much.

Regards,

Kalyani Wadnere

Financial analysis of IOL Chemicals and Pharmaceuticals Ltd:

• Sales growth: 20%
• Profitability: 19% in 2020 and 14% in 2019. Previous years NPM was not impressive in the range of 1 to 3% and made a loss in 2015 and 2016. The profitability in the last two years increased due to demand in its main product of ibuprofen and an increase in price for the same, diversification of product. Will this sustain going forward and will the company earn profitability at the same margins?
• Tax payout: Tax rate has been fluctuating over the years. In 2019, they paid 30% and in 2020, it is 46%, which is much higher than the prevailing tax rate. Are they paying previous years’ tax?
• Interest coverage: 26.48
• Debt to Equity ratio: 0.07
• Current ratio: 2.38
• Cash flow from operating activities: CFO: CFO had been positive expect in 2015. Overall Net Cash Flow is positive.
• Cumulative PAT vs. CFO for last 10 years: cPAT = ₹178 cr, cCFO = ₹657 cr. CFO is much higher than the Net Profit. How can CFO be so high? Does it mean that their other source of income is higher than their core business?

Valuation analysis of IOL Chemicals and Pharmaceuticals Ltd:

• P/E ratio: 12.26
• P/E to Growth ratio (PEG ratio): 0.09
• Earnings Yield (EY): 12.78
• P/B ratio: 5.45
• Price to Sales ratio (P/S ratio): 2.34
• Dividend Yield (DY): 0.40%

Business and industry analysis of IOL Chemicals and Pharmaceuticals Ltd:

• Comparison with industry peers: NPM is higher than peers at 14% and OPM at 30%. 5 years Sales Growth at 25%
• Increase in production capacity and sales volume: Annual Report 19 page no.7: Expansion schemes: During the year the Company has enhanced installed capacity of Metformin from 3,000 TPA to 4,000 TPA with a capex of ₹2.71 crores. The Company has also successfully set up unit V to manufacture Clopidogrel Bisulphate & Fenofibrate with a capacity of 180 MT per annum with capex of ₹19.26 crore. The Company has further enhanced existing manufacturing facilities of Ibuprofen from 10,000 TPA to 12,000 TPA and Iso Butyl Benzene from 9,000 TPA to 12,000 TPA in May 2019 with capex of ₹12.10 crore. All capex was funded through internal accruals.
• Conversion of sales growth into profits: Increasing sales and increasing price of Ibuprofen both led to an increase in profits for the last 2 years
• Conversion of profits into cash: cCFO is much higher than the cPAT. cPAT = ₹178 cr, cCFO = ₹657 cr. Why CFO is so high than NP?

Management analysis of IOL Chemicals and Pharmaceuticals Ltd:

• Background check of promoters & directors: Did not find any news related to fraud, scam etc.
• Management succession plans: Promoter Varinder Gupta’s son Vikas Gupta joined the company as Executive Director since 2016.
• Salary of promoters vs. net profits: From the year 12 to 14 and in 2017 the salary drawn was higher 10%, 30%, 15% and 28% of Net Profit where the company was not earning good profits. The promoter’s remuneration is only salary based. There was an increase in salary from 0.45 to 0.89 in 2016 when the company was making a loss.
• A consistent increase in dividend payments: No dividend. The company utilised the earnings for expansion and capacity increase.
• Promoter shareholding: 43.69%
• Promoter buying the shares: Promoter holding has increased last year from 41.89 to 43.69
• FII shareholding: 6.47

Other business parameters of IOL Chemicals and Pharmaceuticals Ltd:

• Product diversification: Pure Play
• The company is supplying to different countries and has to adhere to their rules and regulations like FDA norms.

Credit rating history of IOL Chemicals and Pharmaceuticals Ltd:

Credit Rating History: Revised from A- to A for Long term Bank Facilities

Other points:

The company showed significant improvement in Revenue and Net Profit in 2018 and 2019 due to the selling price of Ibuprofen has increased from Rs 660 in Oct-16 to Rs 1170 in Sep-19 an increase of 77%. The massive increase in the operating profit margins from 9% in 2016 to 24% in 2019 has been due to a significant increase in the selling prices of its two main products – Ibuprofen and Ethyl Acetate which comprise (90%) of the revenues

Can we expect the same growth going forward?

Regards,

Kalyani Wadnere

Dr Vijay Malik’s Response

Hi Kalyani,

Thanks for sharing the analysis of IOL Chemicals and Pharmaceuticals Ltd with us! We appreciate the time & effort put in by you in the analysis.

Let us analyse the financial performance of the company over the last 10 years.

Financial and Business Analysis of IOL Chemicals and Pharmaceuticals Ltd:

While analyzing the financials of IOL Chemicals and Pharmaceuticals Ltd, an investor notices that over the last 10 years, the sales of the company have increased at a growth rate of about 20% from ₹387 cr in FY2011 to ₹1,894 cr in FY2020. Further, the company reported a slight decline in sales to ₹1,862 cr in the 12 months ending June 2020 (i.e. from July 2019-June 2020).

However, when an investor analyses the trend of sales growth in detail, then she notices that the journey of the company has not been smooth. The sales of the company grew consistently from FY2011-FY2014. However, in FY2015, IOL Chemicals and Pharmaceuticals Ltd witnessed a sharp decline in sales from ₹564 cr in FY2014 to ₹385 cr in FY2015, a decline of more than 30%. Thereafter, the sales of the company increased year on year to ₹1,894 cr by FY2020.

When an investor looks at the profit margins, then she notices that the operating profit margins (OPM) of the company used to be between 15-18% during FY2011-FY2014. However, during FY2015, the OPM declined sharply to 3%. In FY2016 as well, IOL Chemicals and Pharmaceuticals Ltd reported a single-digit OPM of 9%. Thereafter, the OPM has increased consistently to 30% in FY2020. The OPM increased further to 31% in the 12 months ending June 2020 (i.e. from July 2019-June 2020).

Therefore, an investor would notice that the business of the company seemed to be doing well until FY2014. In FY2015 and FY2016, the business of the company witnessed a decline and as a result, it reported a decline in sales in FY2015 and single-digit OPM in FY2015 and FY2016. Moreover, when an investor analyses the net profit margin (NPM) of IOL Chemicals and Pharmaceuticals Ltd during FY2015 and FY2016, then she notices that the company reported net losses during these years. In FY2015, the company reported a net loss of ₹67 cr and in FY2016; it reported a net loss of ₹40 cr.

As a result, an investor would notice that to understand the business characteristics of IOL Chemicals and Pharmaceuticals Ltd, an investor needs to understand its business performance during FY2015 and FY2016 to find out the reasons for losses. Once an investor understands the reasons for losses in FY2015-FY2016, then she may have a view about the possibility of reoccurrence of such losses in the future.

Further advised reading: How to do Business Analysis of Pharmaceutical Companies

While reading the FY2015 annual report, an investor notices that the company faced an increase in its raw material costs, which it could not pass on to its customers. As a result, it reported losses during the year. The company commented that it suffered from subdued sentiment in the overall economy.

FY2015 annual report, page 25:

During the year, loss before tax of the Company was ₹75.44 crore against Profit before tax of ₹5.08 crore in the previous year. This decrease is mainly due to mis-match in input and output prices in chemical business and company was not able to pass on the increase price of raw materials to its customers because of subdued sentiments in overall economy.

In the FY2016 annual report, IOL Chemicals and Pharmaceuticals Ltd highlighted to the shareholders that it reported losses as it could not pass on the increase in raw material costs to its customers.

FY2016 annual report, page 9:

Reasons of loss or inadequate profits: The Company has inadequate profits due to mis-match in input and output prices in chemical business and company was not able to pass on the increase price of raw materials to its customers because of subdued sentiments in overall economy.

Once again, in FY2017, when IOL Chemicals and Pharmaceuticals Ltd did not have sufficient profits to justify the remuneration to its promoters/senior management, then it told its shareholders that the inadequate profits are because it could not pass on the increased cost of raw materials to its customers.

FY2017 annual report, page 7:

Reasons of inadequate profits: The Company has inadequate profits due to mis-match in input and output prices in chemical business and Company was not able to pass on the increase price of raw materials to its customers because of subdued sentiments in overall economy.

The company highlighted that the major threat faced by the company is the intense competition in the generic pharmaceutical markets.

FY2018 annual report, page 20:

Threats:

• Cut throat competition in generic market.

From the above disclosures, an investor may appreciate two things. First, the business performance of IOL Chemicals and Pharmaceuticals Ltd is dependent on the overall sentiment of the economy and second, the company does not have a high negotiating power over its customers and it is not able to pass on the increase in its raw material costs to its customers.

While looking at both the above-mentioned factors, an investor would note that the economy might go into a downturn in the future as well. In addition, the poor negotiating power of the company over its customers can affect the company in the future as well.

Read: How to do Business & Industry Analysis of a Company

An investor notices that until FY2017, IOL Chemicals and Pharmaceuticals Ltd mentioned in its annual reports that it was not able to pass on the increase in the prices of its raw materials to its customers. However, since FY2018, the OPM of the company started rising and it increased from 12% in FY2018 to 30% in FY2020 and further to 31% in the 12 months ending June 2020 (i.e. from July 2019-June 2020).

When an investor attempts to analyse the sharp improvement of the business performance of IOL Chemicals and Pharmaceuticals Ltd in both sales and profitability after FY2017, then she gets to know that from FY2017 onwards, the company witnessed an increase in the sales realizations of its products and a decline in the cost of its raw material.

The credit rating agency, CARE Ltd, highlighted it in its report for IOL Chemicals and Pharmaceuticals Ltd in February 2017.

Further, the company was able to increase its sales realisation while there has been reduction in cost of its major raw materials viz. Acetic Acid, Toluene, Propylene Gas, Iso-Propyl Alcohol (crude derivatives) and alcohol.

The company depends on two key chemicals, Ibuprofen and Ethyl Acetate, for about 80-90% of its sales. Upon analysis, an investor notices that all of a sudden the prices of both the key products manufactured by the company witnessed a price increase.

The following charts sourced from the Screener website, contain the export prices of Ibuprofen and Ethyl Acetate over the last 5 years.

From the above charts, an investor notices that during FY2018, the prices of both the key products of IOL Chemicals and Pharmaceuticals Ltd witnessed a sudden increase.

The credit rating agency, CARE also highlighted this aspect of improvement in the business performance of the company in its credit rating report for IOL Chemicals and Pharmaceuticals Ltd in December 2018.

Improvement in operational performance: The total income of IOL grew to Rs. 986.32 crore during FY18 (refers to the period April 1 to March 31) (PY: Rs. 713.75 crore) driven by increase in sales quantity and higher sales realizations. Its net profit margin also increased to 2.81% in FY18 (PY: 0.65%). The company has shown further improvement during H1FY19 (refers to the period April 1 to September 30) and reported a total operating income of Rs. 794.10 crore as against Rs. 453.13 crore in H1FY18 on account of expansion in manufacturing capacity of Ibuprofen amid supply constraints and PAT margin of 6.65%. (PY: 1.64%).

From the above information, an investor would notice that around 2018, IOL Chemicals and Pharmaceuticals Ltd had increased its manufacturing capacity and around the same time, there was a supply constraint in the market.

While reading annual reports, an investor notices that apart from steadily increasing the manufacturing capacity of Ibuprofen, IOL Chemicals and Pharmaceuticals Ltd had also converted its multipurpose chemical production plant into the exclusive Ibuprofen production plant.

FY2017 annual report, page 11:

The Company has converted its existing multiple purpose plant into a dedicated ibuprofen manufacturing facility during the current year, resulting in increase of ibuprofen manufacturing from 6200 TPA to 7200 TPA on its conversion.

In addition, when IOL Chemicals and Pharmaceuticals Ltd increased its production capacity of Ibuprofen, then the largest producer of Ibuprofen in the world, BASF had to shut down its plant.

• BASF shuts ibuprofen production at U.S. plant due to technical problem: Reuters, June 27, 2018

Therefore, from the above discussion, an investor would appreciate that after FY2017, apart from a decline in the prices of the raw material, multiple other factors worked simultaneously in the favour of IOL Chemicals and Pharmaceuticals Ltd:

• The company had increased the manufacturing capacity of its key product Ibuprofen.
• During the same time, BASF had to shut the production of its Ibuprofen plant
• As a result, the prices of Ibuprofen increased sharply resulting in an increase in sales volume as well as revenue for IOL Chemicals and Pharmaceuticals Ltd.

In addition, during 2020, the lockdown imposed by China in the country to control Coronavirus also added to supply constraints in the Ibuprofen market.

• Top Ibuprofen Maker Rallies as China Lockdown Disrupts Supply: Bloomberg, Feb. 25, 2020

The said disruption in China came at a time when the world witnessed an increased demand for drugs to reduce fever, like paracetamol and Ibuprofen.

Further, since May 2020, there has been an increase in stress in India-China relations due to territorial disputes. As a result, the Indian govt has planned to reduce its dependence on China for different sectors including Pharmaceuticals.

In Pharmaceuticals, India is highly dependent on China for its requirements of active pharmaceutical ingredients (API). As the current trend in India is to achieve self-sufficiency in API production, as a result, almost all the companies involved in API production are expecting improved business performance.

Therefore, an investor would notice that after FY2017, multiple factors have worked in the favour of IOL Chemicals and Pharmaceuticals Ltd that has led to a significant improvement in its business performance. Otherwise, in the past, there have been many instances where the company reached the bankruptcy stage and its lenders had to restructure its debt as it failed to repay money to the lenders.

The most recent instance of restructuring of the debt of IOL Chemicals and Pharmaceuticals Ltd by its lenders took place in FY2015.

FY2015 annual report, page 10:

Debt Restructuring: The Joint Lender Forum (JLF) has sanctioned the comprehensive restructuring of all debts of the Company with cut-off date as 01 September 2014. The restructuring of facilities included restructuring of repayment schedule, interest funding, reduction in interest rates, sanction of working capital term loans.

As per the above disclosure, an investor notes that during FY2015, the company reached a stage where it could not repay its lenders and the lenders had to restructure its complete debt with the deferment of repayments, reduction of interest rates and sanctioning of new loans. Such a restructuring indicates that the company was under a debt trap and its business could no longer repay its debt.

The signs of stress in IOL Chemicals and Pharmaceuticals Ltd.’s financial position indicating that the company’s business model is not able to sustain the levels of debt had started appearing in FY2012 when it defaulted in repayments to Punjab National Bank (PNB).

FY2012 annual report, page 35:

The Company has defaulted in repayment of loans and interest in respect of the following: (Particulars as at 31 March 2012): Term loans from banks: Punjab National Bank

• Principal (Jan – March 2012): 3,14,42,000
• Interest (Feb 2012): 1,63,02,423
• Total: 4,77,44,423

From the above disclosure, an investor notices that during January-March 2012, IOL Chemicals and Pharmaceuticals Ltd had reached a financial position where it could not repay dues of about ₹4.77 cr to Punjab National Bank

When an investor analyses the history of IOL Chemicals and Pharmaceuticals Ltd, then she notices that in the past, loans of the company were restructured by IDBI three times during 2003 and 2004. Then, IOL Chemicals and Pharmaceuticals Ltd was known as Industrial Organics Limited. (The company changed its name in FY2007 as per the EGM, Dec. 2, 2006).

The draft red herring prospectus (DRHP) filed by the company for the follow-on public offer (FPO) in March 2006, contains the details of its restructuring with IDBI. (Click here to download the DRHP)

DRHP, March 2006, page (x):

Certain Loans of our Company were rescheduled in past: We had obtained term loans from IDBI amounting to Rs. 1070 Lacs, Rs. 220 Lacs and Rs. 108 Lacs, vide Loan Agreements dated February 03, 1998, June 18, 1998 and February 22, 2000. IDBI restructured the term loans for three times vide letter dated March 31, 2003, August 08, 2003 and April 15, 2004

Therefore, an investor would notice that historically, the business model of IOL Chemicals and Pharmaceuticals Ltd has been weak where the company has reached a situation of bankruptcy many times. Its loans were restructured by lenders in FY2003, FY2004 and FY2015. In between as well, the company defaulted to its lenders e.g. with PNB in FY2012.

Therefore, an investor would notice that the history of IOL Chemicals and Pharmaceuticals Ltd for the last two decades until FY2017 has indicated that its business model is weak where the company does not have a high negotiating power over its customers. As a result, the company has faced periods where its raw material prices increased but it could not pass on the same to its customers.

FY2015 and FY2016 are not the only periods in which the company reported losses. Previously, during FY2000, FY2001 and FY2002 as well, the company had reported a series of losses.

DRHP March 2006, page (3):

Profit/(Loss) after tax (₹ lac/0.1 million):

• Year ended December 31, 2000: (114.68)
• Year ended March 31, 2001: (1044.24)
• Year ended March 31, 2002: (614.14)

Therefore, the investor would appreciate that the company has faced challenges in passing on the increase in raw material costs to its customers. As a result, the company reported losses and defaulted to its lenders.

Further advised reading: How to do Business Analysis of Chemical Companies

As discussed above, since FY2018, multiple factors have worked in favour of the company like the decline in the supply of Ibuprofen due to closure of BASF facility, Coronavirus related restrictions in China and thereafter, strain in India-China relations.

It remains to be seen whether the current good times of the company would sustain going ahead. This is because, previously, in 2016, many Indian chemical manufacturers experienced good times when the supply from China declined due to strict environmental norms implemented by China in the country.

At that time, the share prices of almost all the Indian chemical manufacturers increased significantly. However, soon, the supply caught up with the demand and the good times for the Indian chemical manufacturers ended.

Therefore, in the case of IOL Chemicals and Pharmaceuticals Ltd, an investor needs to notice that the price of one of its key products Ethyl Acetate has started to decline from last year.

Moreover, for Ibuprofen, an investor needs to keep a track of the additional supply coming up either in India or overseas. Any increase in the supply of Ibuprofen, either from India, China, the US or any other country would tend to reduce the prices of Ibuprofen.

The world’s largest manufacturer of Ibuprofen, BASF, has already disclosed its plans to increase the manufacturing capacity for Ibuprofen.

• BASF plans significant investment in ibuprofen capacities in Germany and North America: BASF, June 28, 2017

As per a report published by HDFC Securities, the BASF plant has started production of Ibuprofen. (Source: Growth for Indian chemical companies looks sluggish in Q1 FY21 says HDFC Securities, July 23, 2020)

BASF resumed production of Ibuprofen

Therefore, in the case of IOL Chemicals and Pharmaceuticals Ltd, an investor needs to keep a close watch on the developments related to the supply situation of Ibuprofen to ascertain whether the current good times can sustain going ahead. In addition, it remains to be seen whether the current euphoria surrounding all the API manufacturers in India ultimately benefits all the existing API manufacturers or only a few selected players would corner all the business opportunities.

While looking at the tax payout ratio of IOL Chemicals and Pharmaceuticals Ltd., an investor notices that the tax payout ratio of the company before FY2018 has been at a significant variation than the standard corporate tax rate prevalent in India.

One of the major reasons for the same is that IOL Chemicals and Pharmaceuticals Ltd has been a minimum alternate tax (MAT) paying company, where the applicable rate was in the range of 20%.

FY2018 annual report, page 51:

Tax rate applicable to the company 21.3416% (FY2018) | 20.3889% (FY2017)

In addition, the company earns a significant portion of its revenues by exports, which have tax incentives. Because of MAT and the tax incentives, the tax payout ratio of IOL Chemicals and Pharmaceuticals Ltd has been different from the standard tax payout ratio applicable to corporates in India.

For any further clarifications on the tax payout ratio, investors may contact the company directly.

Further advised reading: How to do Financial Analysis of a Company

Operating Efficiency Analysis of IOL Chemicals and Pharmaceuticals Ltd:

a) Net fixed asset turnover (NFAT):

When an investor analyses the net fixed asset turnover (NFAT) of IOL Chemicals and Pharmaceuticals Ltd in the past years (FY2011-20), then she notices that the NFAT of the company has been in the range of 1-1.50 until FY2017 when the current phase of improved business performance of the company started. After FY2017, the NFAT has increased in line with the business performance from 1.84 in FY2017 to 4.30 in FY2020.

The increase in NFAT is due to higher capacity utilization of the manufacturing capacities by the company in recent times as witnessed by an increase in sales volumes by the company.

The credit rating agency, CARE highlighted in its report for IOL Chemicals and Pharmaceuticals Ltd in July 2020 that the company has sold higher sales volumes.

During FY20, the company registered a growth of around 12% in total operating income to Rs.1909.41 cr (PY: Rs.1695.05 cr), driven by increase in sales volumes from 83,545 MTPA in FY19 to 1,12,640 MTPA in FY20 and higher sales realization.

Better utilization of its manufacturing capacity during recent years has led to an increase in the NFAT of the company.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio of IOL Chemicals and Pharmaceuticals Ltd:

While analysing the inventory turnover ratio (ITR) of the company, an investor notices that the ITR of IOL Chemicals and Pharmaceuticals Ltd has followed the business performance of the company. During the initial part of the last decade until FY2015 when it reported losses and its debt was restructured, the company reported a decline in its ITR from 4.1 in FY2012 to 1.9 in FY2015. Thereafter, as the business performance of IOL Chemicals and Pharmaceuticals Ltd improved, its ITR also improved to 10.1 in FY2020.

An increase in ITR indicates that the company has been able to use its inventory efficiently.

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of IOL Chemicals and Pharmaceuticals Ltd:

While analysing the receivables days of the company, an investor notices that over the years, the receivables days of IOL Chemicals and Pharmaceuticals Ltd have increased from 20 days in FY2012 to 51 days in FY2017. This coincided with the phase when the business performance of the company was declining and it reported net losses in FY2015 and FY2016.

It seems that during this period, the customers of the company delayed their payments significantly, which led to the liquidity crunch for the company. As a result, the company had to restructure its debt with its lenders.

Further Advised Reading: Receivable Days: A Complete Guide

Nevertheless, since FY2017, the business performance of the company has improved significantly. In addition, the deteriorating trend of its receivables paused and the company reported a decline in its receivables days from 51 days in FY2017 to 46 days in FY2020.

While comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of IOL Chemicals and Pharmaceuticals Ltd for FY2011-20, an investor notices that the company has been able to convert its profits into cash flow from operations (CFO).

Over FY2011-20, IOL Chemicals and Pharmaceuticals Ltd reported a total cumulative net profit after tax (cPAT) of ₹540 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹1,128 cr.

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than the PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Learning from the article on CFO will indicate to an investor that the cCFO of IOL Chemicals and Pharmaceuticals Ltd is significantly higher than the cPAT due to the following factors:

• Interest expense of ₹523 cr (a non-operating expense) over FY2011-FY2020, which is deducted while calculating PAT but is added back while calculating CFO.
• Depreciation expense of ₹298 cr (a non-cash expense) over FY2011-FY2020, which is deducted while calculating PAT but is added back while calculating CFO.

Primarily due to the interest expense and the depreciation, the cCFO of the company is about ₹590 cr higher than its cPAT (1128 – 540 = 588).

The Margin of Safety in the Business of IOL Chemicals and Pharmaceuticals Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While analysing the SSGR of IOL Chemicals and Pharmaceuticals Ltd, an investor would notice that initially, when the company was facing a tough phase in its business until FY2017, then it reported lower NFAT, and low net profit margins (NPM). However, from FY2018 onwards, the company improved its business performance significantly and its NFAT, as well as NPM, improved significantly.

While studying the formula for the calculation of SSGR, an investor would understand that the SSGR directly depends on the net fixed asset turnover (NFAT) and NPM of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• SSGR = Self Sustainable Growth Rate in %
• Dep = Depreciation rate as a % of net fixed assets
• NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
• NPM = Net profit margin as % of sales
• DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

Therefore, an investor would notice that IOL Chemicals and Pharmaceuticals Ltd had a very low (negative) SSGR initially. However, in recent times, the SSGR of the company has increased to 35%. (Please also note that while calculating SSGR, we use a 3-year average of each parameter. Therefore, the impact of any improvement and deterioration of the performance parameters comes with a lag).

During the initial periods of low SSGR, an investor notices that the company had to rely on external resources like debt and equity dilution to meet its growth requirements. In fact, the company raised so much debt that it reached a stage of bankruptcy and its debt had to be restructured.

Nevertheless, in recent years of high SSGR, the company has generated a lot of surplus cash and as a result, it has repaid almost all the debt that it has raised in the past.

As per the announcement done by IOL Chemicals and Pharmaceuticals Ltd to BSE on March 21, 2020, it has prepaid all its long-term debt. (Click here)

b) Free Cash Flow (FCF) Analysis of IOL Chemicals and Pharmaceuticals Ltd:

While looking at the cash flow performance of IOL Chemicals and Pharmaceuticals Ltd, an investor notices that during FY2011-2020, it generated cash flow from operations of ₹1,128 cr. However, during the same period, it did a capital expenditure of about ₹354 cr. Therefore, during this period (FY2011-2020), IOL Chemicals and Pharmaceuticals Ltd had a free cash flow (FCF) of ₹774 cr (=1,128 – 354).

However, the presence of this FCF over the 10-year should not confound an investor about the tough times the company faced during the first half of this decade leading to its near bankruptcy and restructuring of its debt.

The following table shows the straining financial position of IOL Chemicals and Pharmaceuticals Ltd during FY2011-FY2015, which led to the debt restructuring of the company in FY2015.

When an investor analyses the cash flow dynamics of the business of IOL Chemicals and Pharmaceuticals Ltd during FY2011-FY2015 shown in the above table, then she gets to know that during this period, the company reported

• CFO of ₹163 cr. Out of which, it had to pay:
• Capital expenditure (capex) of ₹173 cr and
• Interest expense of ₹257 cr

As a result, the company had a net cash shortfall of ₹267 cr.

An investor would appreciate that the company could get money to meet this shortfall either by way of incremental debt or its shareholders need to infuse equity in the company. IOL Chemicals and Pharmaceuticals Ltd resort to both methods.

During FY2011-2015, its debt increased from ₹337 cr to ₹400 cr indicating a net inflow of ₹63 cr. An increase in debt by only ₹63 cr against a cash flow shortfall of ₹267 cr clearly indicates that the lenders of the company refused to give any further cash flow support to the company and its promoters. Instead, they forced the promoters to arrange the remaining funds of about ₹204 cr (= 267 – 63) on their own.

As a result, the promoters brought in money by way of equity infusion through different methods of warrants, preference shares, convertible bonds, preferential allotment of shares etc. However, during FY2011-2015, the promoters could bring in only ₹109 cr against a shortfall of ₹204 cr. (An investor may find a detailed history of equity dilution by the company later in this article).

Therefore, it does not come as a surprise to the investor that the company could not meet its debt repayment obligations and it had to seek a restructuring of its debt.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are the main pillars of assessing the margin of safety in the business model of any company: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

An investor should remember that FY2015 was not the only time when the company ran out of funds to meet its debt obligations. The company had to seek a restructuring of its debt from lenders in the past in FY2003 and FY2004 as well.

In light of the same, we advise investors to be cautious while analysing the business prospects of IOL Chemicals and Pharmaceuticals Ltd in light of the recent improvement in the business performance of the company. Investors should double-check their assumptions about the supply and demand expectations of the company’s products before they make any investment decision. Only after convincing themselves thoroughly with their expectations from the business environment, they should take the final investment decision. This is because, if an investor looks at the historical performance of IOL Chemicals and Pharmaceuticals Ltd throughout the last couple of decades, then it comes out that the company almost never made sufficient cash flow from its operations to meet its capex and other funding requirements. In the past, the company had to rely on additional debt as well as equity to meet its cash flow requirements.

Currently, the company has generated a lot of cash from its improved business performance and as a result, it has prepaid all of its long term debt. It remains to be seen whether the current tailwinds faced by the company are sustained in the future.

Investors must be cautious about short-term spikes in the business performance of companies. This is because, in recent history, there have been many instances where at the time of short-term good performance of companies, investors assumed that the good times would last forever. As a result, investors purchased the shares of such companies at a very high valuation. However, shortly thereafter, the good times ended and the business performance, as well as the share price of the companies, declined.

Apart from the typical case of Indian chemical manufacturers in the 2016 spike due to the Chinese implementation of tough environmental norms discussed earlier, an investor should focus on two more cases of short-term performance spikes.

The first case appeared for the manufacturers of Graphite Electrodes that supplies electrodes to steel manufacturers for use in the electric arc furnace. An overview of the performance of one of graphite electrodes manufacturers, HEG Ltd, over the recent past will provide good insights to the investor about the role industry phases play in such industries.

If an investor analyses the quarterly business performance of HEG Ltd from March 2017 quarter to December 2019 quarter, then she can appreciate how the uptrend of the industry influenced the performance of the company. (The data in the below table is in ₹ crores/10 million).

In the above data, an investor will notice that during March 2017, and June 2017 quarters, HEG Ltd used to report quarterly sales of ₹200-250 cr and hardly any net profit. In March 2017 quarter, it reported a profit of only ₹1 cr and in the June 2017 quarter, it reported a net loss of (₹7 cr).

From September 2017 quarter, the uptrend in the industry started and the sales, as well as the profit of the company, started increasing rapidly. The industry cycle reached the peak in September 2018 quarter when HEG Ltd reported sales of ₹1,794 cr in the September 2018 quarter as compared to ₹200-250 cr in the March-June 2017 quarters. Similarly, HEG Ltd reported net profit after tax (PAT) of ₹889 cr in the September 2018 quarter as compared to ₹1 cr profit or (₹7 cr) loss in March-June 2017 quarters.

HEG Ltd witnessed its net profit margin (NPM) rise to 50% at the peak of the industry cycle in September 2018 quarter as compared to losses in June 2017 quarter.

However, thereafter, the industry cycle turned and the down-cycle started. As a result, the business performance of HEG Ltd started declining. In the December 2019 quarter, HEG Ltd has reported sales of ₹394 cr, down from the high of about ₹1,800 cr quarterly sales at the peak of the cycle. The sales in December 2019 quarter are more in line with what the sales of HEG Ltd used to be before the up-cycle in the graphite electrode industry started in September 2017. Similarly, in December 2019, HEG Ltd reported net profits of ₹6 cr with an NPM of 2%, down from the quarterly net profit of ₹889 cr with the NPM of 50% at the peak of the industry cycle in September 2018.

If an investor analyses the history of cyclical industries over a long period, then she will notice that in these industries, the periods of good business performance always lead to periods of subdued performance and vice-versa. This has been the case for centuries and it may remain the same in the future as well.

However, it seems that in the case of HEG Ltd, many investors assumed that the good times would continue forever and the share price of the company reach very high levels of valuation.

In the case of HEG Ltd, when the industry up-cycle started in September 2017 and reached the peak in September 2018, the stock market took the share price of HEG Ltd from the levels of ₹150/- in early 2017 to an all-time high of ₹4,950/- in October 2018 at the peak of up-cycle. However, once the down-cycle of the graphite electrode industry started and the business performance of the company started declining, its share price has also come down to about ₹450/- in March 2020. HEG Ltd’s share price closed at ₹913.15 on June 12, 2020.

An investor may read our complete analysis of HEG Ltd in the following article: Analysis: HEG Ltd

Another such case in recent history where investors increased the share price of a company to very high levels of valuation is Rain Industries Ltd.

While reading our analysis of Rain Industries Ltd, an investor would notice that in 2017, the company faced the up-cycle phase of the industry when its sales, as well as profit margins, increased at a sharp pace. The aluminium demand, as well as prices, were increasing. Many inefficient aluminium plants, which were earlier closed due to unviability at low prices, were again started by the aluminium manufacturers. As a result, the demand for calcined pet coke (CPC) and coal tar pitch (CTP) increased. The company also acknowledged this momentum of industry upcycle of 2017 to its shareholders in its annual report.

2018 annual report of Rain Industries Ltd, page 10:

We began 2018 by continuing to ride a wave of momentum that began in mid-2017, as global aluminium production and demand for our calcination and distillation products steadily increased, leading to corresponding improvements in selling prices and margins. The global economy also continued to strengthen, especially in the US, where import tariffs and rising prices for aluminium and steel motivated US manufacturers to restart mothballed facilities and increase capacity utilisations.

However, starting in 2018, the industry cycle turned and the industry entered a down cycle. The sales and the profit margins of the company started declining.

2019 annual report of Rain Industries Ltd, page 10:

….many of the challenges that impacted our businesses in late 2018 persisted, in particular: continued softness in the Chinese economy; reduced automotive sales in China, Europe, the UK and Japan, which impacted demand for raw materials that we produce for aluminium, automobile tyres and adhesives; and disruption to our calcination business due to India’s restrictions on petroleum coke imports, resulting in high-cost inventories in a declining market that reduced profit margins.

The down cycle of the aluminium industry that started in 2018 is continuing in 2020.

If the investor notices the share price movement of Rain Industries Ltd over these industry phases of upcycle in 2017 and then the resultant down cycle, then she notices that the share price movement is similar to HEG Ltd discussed above.

An investor may read our complete analysis of Rain Industries Ltd in the following article: Analysis: Rain Industries Ltd

We have highlighted the examples of performance of chemical companies during 2016 and the examples of HEG Ltd and Rain Industries Ltd so that investors may note that they need to be very cautious while projecting periods of recent good performance in future.

It may be a case that the recent good performance of any company is due to some tailwinds like a short-term demand-supply mismatch, which may get corrected in the near future. In such a case, if an investor assumes that the periods of high business growth and high-profit margins would continue forever and as a result, pays a very high valuation for the stocks of the company, then she may face a negative surprise when the situation reverses. Investors have seen such negative surprises in the case of HEG Ltd and Rain Industries Ltd in the recent past.

Advised reading: What I learnt from brief analysis of 2,800 Companies

Going ahead, investors need to be highly cautious while projecting the recent good performance of any company in the future and giving it a high level of valuation, which has historically shown an average level of performance.

Additional aspects of IOL Chemicals and Pharmaceuticals Ltd:

On analysing IOL Chemicals and Pharmaceuticals Ltd and after reading its publicly available information like past annual reports from FY2010, corporate announcements since September 2003, DRHP of 2006 and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

1) Management Succession of IOL Chemicals and Pharmaceuticals Ltd:

The company was established in 1986 by Mr. Varinder Gupta and Mr. Rajinder Gupta. Mr. Varinder Gupta is currently, the managing director of the company. Mr. Rajinder Gupta is the chairman of Trident Ltd, a leading textile company.

Credit rating report for the company by CARE Ltd in July 2020:

IOL was incorporated as a public limited company in September 29, 1986 by Mr. Varinder Gupta and Mr. Rajinder Gupta (promoter of Trident Limited) to setup acetic acid manufacturing facility.

As per the public sources, Mr. Varinder Gupta and Mr. Rajinder Gupta are brothers. The following article in a Hindi newspaper, Jagran, about a fire incidence in IOL Chemicals and Pharmaceuticals Ltd in July 2012 highlights the relationship between Mr. Varinder Gupta and Mr. Rajinder Gupta (Click here).

गौरतलब है कि उक्त उद्योग ट्राइडेंट ग्रुप उद्योग के स्वामी राजिंदर गुप्ता के सगे भाई वरिंदर गुप्ता का है।

The above citation mentions that the company (IOL Chemicals and Pharmaceuticals Ltd) belongs to Varinder Gupta who is a brother of Mr. Rajinder Gupta, the owner of Trident group.

In the past, as per a family settlement, Mr. Varinder Gupta took over the stake of Mr. Rajinder Gupta in the company.

2006 DRHP, page (x):

Our Company was originally incorporated by Mr. Rajinder Gupta together with PSIDC. Pursuant to a family settlement, Mr. Varinder Gupta and MPL acquired the entire shareholding of Nominees of Mr. Rajinder Gupta through interse transfer.

As per the details mentioned in a SEBI order against Mr. Varinder Gupta & M/s Mayadevi Polycot Ltd (MPL) dated March 31, 2004 (click here), the said transfer took place on June 08, 2002.

The acquirers have acquired 49,88,800 equity shares representing 61.97% of the share capital of the target company on June 08, 2002.

Since then, Mr. Varinder Gupta is in charge of the operations of IOL Chemicals and Pharmaceuticals Ltd (previously named Industrial Organics Limited).

In 2013, Mr. Vikas Gupta, son of Mr. Varinder Gupta, joined the company. He, first, worked as Deputy Manager (Strategic Management) from July 20, 2013, and then from May 29, 2015, he was appointed to the board of directors as an executive director.

FY2015 annual report, page 6 and 9:

Mr Vikas Gupta was appointed as Additional and Executive Director on the Board w.e.f. 29 May 2015 for a term of five years.

Mr Vikas Gupta, aged 23 years, BSc. (Hons.) in Business Management from Kings College London. He has an international exposure in the field of Business Management…He was working as Deputy Manager (Strategic Management) since 20 July 2013 in the Company.

Relationship with other directors: Son of Mr Varinder Gupta, Managing Director

Therefore, an investor would notice that currently, Mr. Varinder Gupta (age 57 years), managing director and his son, Mr. Vikas Gupta (age 28 years), executive directors are in charge of the company.

The presence of two generations of the promoter family at the same time in the management of the company indicates that the company has put in place a management succession plan. The new generation of the promoter family is being groomed in business while the senior member of the promoter family is still playing an active part in the day-to-day activities.

The presence of a well thought out management succession plan is essential in the case of promoter run businesses as it provides for a smooth transition of leadership over the generations and provides continuity in the business operations of any company.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

2) A prolonged history of business continuously demanding money from equity shareholders:

In the above discussion on the free cash flow (FCF), an investor notices that during FY2011-FY2015, IOL Chemicals and Pharmaceuticals Ltd had to raise a lot of money from its equity shareholders including promoters.

However, when an investor analyses the history of the company, then she notices that the company had to raise money continuously from equity shareholders in the past as well.

BSE announcement dated March 24, 2004: The Company raised ₹5 cr in preference shares from Abhishek Industries Ltd. These preference shares were later transferred to Trident Ltd and converted into equity shares in 2014.

Industrial Organics Ltd has informed BSE that the Board has approved the allotment of 50,00,000 7% Non cumulative Redeemable Preference shares of Rs. 10/- each to Abhishek Industries Ltd totaling to Rs. 50 million in its meeting held on March 20, 2004.

BSE announcement dated Sept 21, 2005: In the EGM, the company approved raising ₹13.5 cr by rights issue and ₹11.6 cr by warrants.

Industrial Organics Ltd has informed BSE that members at the Extra Ordinary General Meeting (EGM) of the Company held on September 20, 2005, inter alia, have approved the following matters :

• Issue of 32,20,000 equity shares of Rs 10/- each for cash at premium of Rs 32/- per equity share aggregating to Rs 135.240 million to the existing shareholders of the Company in the ratio of two equity share for every five equity shares held by them on the Record Date as may be fixed by the Board of Directors.
• Issue of 20,00,000 warrants carrying an option to the holders of such warrants to subscribe to one equity share of Rs 10/- each after three months but within 18 months from the date of allotment of warrants at Rs 58/- per share on preferential basis.

BSE announcement dated January 9, 2006: In the EGM dated January 7, 2006; the shareholders approved raising ₹30 cr from a further issue of shares and ₹7.7 cr by warrants.

Industrial Organics Ltd has informed BSE that the members at the Extra Ordinary General Meeting (EGM) of the Company held on January 07, 2006, inter alia, have passed the following resolutions:

• Issue of further Equity Shares of Rs 10/- each for cash so however that the total amount raised through such securities should not exceed Rs 300 million.
• Issue of 14,00,000 warrants, carrying an option to the holder of such warrants to subscribe to one equity share of Rs 10/- each within 18 months from the date of allotment of the warrants at Rs 55/- per share on preferential basis, to Sundram Commercials Ltd (4,70,000 Warrants), Sunlight Commercial & Trading Ltd (4,60,000 Warrants) and Shiva Enterprises Ltd (4,70,000 warrants).

BSE announcement dated April 11, 2007: approved raising ₹10.92 cr by issuing 26,00,000 shares at ₹42 each.

IOL Chemicals & Pharmaceuticals Ltd has informed BSE that subject to the approval of shareholders the Board of Directors of the Company at its meeting held on April 07, 2007 has approved the issue up to 15,00,000 Equity Shares to the promoter and other promoters group entities as defined under the SEBI guidelines and up to 11,00,000 Equity Shares to M/s. Chamunda Traders Pvt Ltd, a non promoter entity on preferential basis at the rate of Rs 42 per share (face value of Rs 10 and premium of Rs 32 per share) or the price to be determined as per SEBI guidelines.

BSE announcement dated July 23, 2007: approved raising ₹23.94 cr by issuing 57,00,000 warrants at ₹42 each

IOL Chemicals & Pharmaceuticals Ltd has informed BSE that the members at the Extra Ordinary General Meeting (EGM) of the Company held on July 23, 2007, inter alia, approved the following:

Issue of 57,00,000 warrants, carrying an option to the holder of such warrants to subscribe to one equity share of Rs 10/- for every warrant held, within 18 months from the date of allotment of the warrants at a price of Rs 42/- per share to the following persons on the Preferential basis.

BSE announcement dated Oct 22, 2007: approved raising ₹9.97 cr by issuing 13,30,000 shares on a preferential basis, ₹13.99 cr by issuing fully convertible debentures and ₹17.25 cr by issuing warrants at ₹75 each.

IOL Chemicals & Pharmaceuticals Ltd has informed BSE that the members at the Extra Ordinary General Meeting (EGM) of the Company held on October 22, 2007, inter alia, have approved the following:

• upto 13,30,000 (Thirteen Lac Thirty Thousand) Equity Shares of face value of Rs 10/- each at a premium of Rs 65/ per share aggregating to Rs 9,97,50,000 (Rupees nine crore ninety seven lac fifty thousand only) to M/s. Indiastar (Mauritius) Ltd, Non-promoter of the Company.
• Upto 13,99,998 (Thirteen Lac Ninety Nine Thousand Nine Hundred Ninety Eight) unsecured 10% fully convertible debentures (FCDs) of Rs 100 each aggregating to Rs 13,99,99,800 ( Rupees Thirteen Crores Ninety Nine Lac Nine Thousand Eight Hundreds only) at an interest rate of 10% p.a. payable monthly convertible in one or more tranches within a period of 18 months from the date of allotment into equity shares of face value of Rs 10 each at a premium of Rs 65 per share to Indiastar (Mauritius) Ltd, Non-promoter of the Company.
• Upto 23,00,000 (twenty three lacs) warrants, carrying an option to the holder of such warrants to subscribe to one equity share of Rs 10/- at premium of Rs 65/- per share for every warrant held, within 18 months from the date of allotment of the warrants, to the following persons, on preferential basis in accordance with the applicable law:

BSE announcement dated September 20, 2008: approved raising ₹100 cr by QIP and $25 million in an international issue of securities.

IOL Chemicals & Pharmaceuticals Ltd has informed BSE that the members at the 21st Annual General Meeting (AGM) of the Company held on September 20, 2008, inter alia, have accorded to the following:

• Approval to the Issue of Securities to Qualified Institutional Buyers (QIBs) in accordance with the provision of Chapter XIII A of SEBI (QIB Guidelines, 2000 for an amount not exceeding Rs 100 Crores (Rupees One Hundred Crores).
• Approval to the raising of resources through issue of Securities in the international market upto US Dollars 25 (Twenty Five) millions.

BSE announcement dated January 11, 2010: approved raising ₹8.4 cr by the preferential issue of shares and ₹16.8 cr by way of warrants.

IOL Chemicals & Pharmaceuticals Ltd has informed BSE that the members at the Extra Ordinary General Meeting (EGM) of the Company held on January 09, 2010, have approved the following matters by way of passing the ordinary / special resolutions unanimously:

• Issue of 15,00,000 (Fifteen lac) equity shares of face value of Rs. 10/- each at a premium of Rs. 46/- per share aggregating to Rs. 8,40,00,000 (Rupees eight crore forty lac only) to NM Merchantiles Ltd., Promoters / Promoters Companies.
• Issue of 30,00,000 (Thirty lac) warrants, carrying the option to the holders of such warrants to subscribe to one equity share of face value of Rs. 10/- at premium of Rs. 46/- per share for every warrant held, within a period of 18 months from the date of allotment of the warrants, to the following Promoters/ Promoters Companies, on preferential basis in accordance with the applicable laws.

FY2010 annual report, page 2: approved raising ₹11.7 cr by issuing warrants at ₹78 each.

approval of the Company be and is hereby accorded to the Board to issue, offer and allot 15,00,000 (Fifteen lac) warrants, carrying the option to the holders of such warrants to subscribe to one equity share of face value of Rs 10/- at premium of Rs 68/- per share for every warrant held, within a period of 18 months from the date of allotment of the warrants, to G Consultants and Fabricators Limited, Non-Promoter on preferential basis in accordance with the applicable laws.

Further advised reading: Understanding the Annual Report of a Company

FY2014-FY2015: the company raised ₹9.38 cr by issuing 33,50,000 shares on a preferential basis at ₹28 per share, ₹30.8 cr by issuing 1,10,00,000 warrants at ₹28 each and ₹15.01 cr by issuing 1,50,10,000 preference shares at ₹10 each.

FY2014 annual report, page 8:

22,00,000 equity share of face value of ₹ 10/- each at premium of ₹ 18/-each on preferential basis on 21 June 2014 to non-promoters;

11,50,000 equity share of face value of ₹ 10/- each at premium of ₹ 18/- each on preferential basis on 4 July 2014 to non promoters;

In addition of above, the Company has allotted 1,10,00,000 warrants with option to subscribe to a equity share of face value of ₹ 10/- at the premium of ₹ 18/- for each warrant, within period of 18 month from the date of allotment on preferential basis to non-promoters on 04 July 2014.

FY2014 annual report, page 34:

The Company has allotted 1,50,10,000, 1% non cumulative redeemable preference shares of ₹10/- each to the promoter/promoter group companies. These preference shares shall be redeemable at par on expiry of 10 years from the date of allotment i.e. 5 November 2013.

While reading about the company, an investor notices that all these preference shares, foreign currency convertibles bonds, fully convertible debentures etc. were converted by IOL Chemicals and Pharmaceuticals Ltd into equity shares of the company at different times.

In addition, due to the weak financial position of the company, the lenders of the company forced the equity shareholders (promoters) to give unsecured loans to the company with a condition that these unsecured loans cannot be repaid until the time, the Bank’s loans are outstanding.

FY2012 annual report, page 35:

Loan from related parties is as per stipulation of banks. These loans are interest free and not repayable during the currency of the credit facilities availed from these banks.

FY2017 annual report, page 42:

Unsecured interest free loan from related party has been brought in pursuance to the stipulation imposed by lending banks and are repayable after the repayment of loans so obtained from banks.

Therefore, an investor would appreciate that in addition to the above-mentioned equity dilutions in the form of preferential allotment of shares, warrants, fully converted debentures, FCCBs, rights issues etc. the business model of the company required more money. The lenders were not ready to give this money to the company and as a result, they forced the promoters to bring in more capital in the form of unsecured loans.

While reading the history of the company, the investor notices that IOL Chemicals and Pharmaceuticals Ltd converted a part of these unsecured loans into equity shares & warrants of the company.

FY2014 annual report, page 33:

The Company has issued 26,64,000 equity shares of face value of ₹10/- each at a premium of ₹ 68/- per share aggregating to ₹ 20,77,92,000 on 5 November 2013 to Promoter Group entities on conversion of unsecured loan, brought in by them.

FY2019 annual report, page 7:

During the year the Company has issued 25,00,000 (Twenty five lakh) warrants at a price on ₹205/- (Rupees two hundred five) per warrant on preferential basis to Towels Enterprises Limited, a promoter company on partially conversion of unsecured loan into warrants with an option to subscribe to an equity share of face value of ₹10/- (Rupees ten) at a price of ₹ 205/- (Rupees two hundred five) per equity share

Therefore, when an investor analyses the history of the company since 2003, then she notices that the business of the company has been highly cash consuming. The company has to continuously feed the business with additional cash by way of raising additional debt from lenders and raising additional equity from shareholders.

The credit rating agency, CARE Ltd highlighted the highly capital-intensive nature of the business of IOL Chemicals and Pharmaceuticals Ltd in its report for the company in February 2017.

However, given the capital intensive nature of operations, the overall gearing tends to remain high.

Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

It seems that throughout its existence, the company has faced industry tailwinds only since FY2018 onwards when the supply of its key products declined and the product prices increased. As a result, IOL Chemicals and Pharmaceuticals Ltd could make a lot of surplus cash that it used to pre-pay its long-term debt. Otherwise, the history of the company from 2003 to 2017 does not show strong fundamental signs in its business.

Therefore, an investor should be very cautious while determining whether the current good times for the business would be sustainable in the future.

3) Promoters exercising the warrants when the market price was higher and letting them expire when the market price was low:

While analysing the issuance and exercise of different incidences of allocation of warrants by IOL Chemicals and Pharmaceuticals Ltd, an investor comes across instances, where the promoters did not exercise their warrants and let them expire.

FY2012 annual report, page 33:

The allottees of 15,00,000 warrants expressed their unwillingness to convert these warrants to equity shares. The Company, in accordance with SEBI guidelines for preferential issue, forfeited ₹ 210 lacs, the amount paid by the allottees for these warrants

When an investor studies more about these warrants, then she notices that these warrants were issued on January 16, 2010, at an exercise price of ₹56 per share. However, shortly after the allotment of the warrants, the share price of the company started declining. By March 2012, the share price of the company had declined to ₹25/-.

An investor would appreciate that it does not make any economic sense for the promoters to buy shares from the company by exercising the warrants at ₹56/- when the market price is only ₹25/-. As a result, the promoters expressed their unwillingness to exercise the warrants to the company.

Because of the refusal of the promoters to exercise 15,00,000 warrants priced at ₹56/-, in FY2012 the company could not receive the 75% of the money due on the exercise of warrants i.e. ₹6.3 cr. (= 15,00,000 * 56 * 75%).

An investor would remember that in FY2012, IOL Chemicals and Pharmaceuticals Ltd defaulted to Punjab National Bank (PNB) for its dues of about ₹4.77 cr.

FY2012 annual report, page 35:

The Company has defaulted in repayment of loans and interest in respect of the following: (Particulars as at 31 March 2012): Term loans from banks: Punjab National Bank

• Principal (Jan – March 2012): 3,14,42,000
• Interest (Feb 2012): 1,63,02,423
• Total: 4,77,44,423

It was not the first instance when the promoters of IOL Chemicals and Pharmaceuticals Ltd declined to exercise the warrants allotted to them. Previously, in FY2009 as well, when the share price of the company declined sharply, then the promoters chose not to exercise the warrants and let them expire.

FY2010 annual report, page 33:

Other income in year ended March 31, 2009

• Equity Warrants forfeited ₹96,42,000

The following chart shows the share price movement of IOL Chemicals and Pharmaceuticals Ltd from January 2008 to March 2009.

Therefore, an investor would appreciate that when promoters attempt to structure infusion of their contribution by way of warrants, then they would give the entire money to the company only when the promoters make a profit by way of buying the shares at a cheaper price from the company than the prevailing share price in the market. If the price in the market is lower, then the promoters hesitate to exercise the warrants even if the company is in severe liquidity stress and may default to the lenders.

This incidence proved the concerns of the minority investors about preferential allotment of warrants to promoters that promoters use warrants to benefit themselves ahead of minority shareholders.

In the past, promoters used to pay only 10% of the money upfront while subscribing to the warrants. SEBI realized that 10% upfront payment of 10% for warrants was very low to generate commitment from promoters to infuse money in the company by compulsorily exercising to them. As a result, in February 2009, SEBI increased the upfront payment for warrants allotment from 10% to 25%.

The key reason that led SEBI to increase the upfront payment for warrants was that the promoters used warrants to enrich themselves when the stock markets rose while their loss was limited to only 10% if the markets fell. (Source)

There were complaints that promoters allotted warrants to themselves and select investors at a pre-determined price, but didn’t buy them when the due date came if the prevailing stock prices were lower than the decided price. If the prices were higher, they would convert those warrants and at least make a paper profit, and in some cases encash the gains.

It is to discourage promoters from trading profits. Warrants are seen as an instrument that gives an advantage to promoters above retail investors, who have all other rights equal to company founders.

When the markets melted during 2008 and early 2009, promoters of many companies such as Hindalco Industries, Tata Power, GE Shipping and Pantaloon Retail did not convert those warrants, regulatory filings show.

After similar complaints, in February 2009, the regulator had raised the up-front margin to be paid by warrant subscribers to 25% from 10% since the payment lost was insignificant compared with the losses one would have made if forced to buy.

This also goes with our belief that the warrants are if at all, 25% beneficial to the company and 75% beneficial to the promoters.

Common logic says that no one holding stock warrants would exercise them to get shares at a price, which is higher than the price at which he/she can get shares from the market.

More so, if the promoters intend to infuse money into the company, then they should simply get all the shares at the current market price and give the entire money to the company upfront so that the company may use it for the purpose for which it needs money.

The entire gimmick of paying 25% at the time of allotment of stock warrants and then keeping the option to pay 75% at the time of exercise, which the promoters would decide based on whether at the date of exercise, the promoters are making money or not, seems like a facade to us.

If the promoters pay 25% now and let the stock warrants expire due to the market price being consistently lower than the exercise price in future, then it effectively means that the promoters did not have the true intention of infusing 100% of the money.

The above instance of the promoters of IOL Chemicals and Pharmaceuticals Ltd declining to subscribe to the warrants and infuse ₹6.3 cr in the company in FY2012 when the company ended up defaulting to PNB for ₹4.77 cr shows that the fund requirements of the company might be secondary for the promoters.

To learn more about the behaviour of the promoters where they refused to infuse money in the company by declining to exercise the warrants when the market price of the shares of the company declined, an investor may read the examples of ADF Foods Ltd.

Analysis: ADF Foods Ltd

The promoters of ADF Foods Ltd also refused to exercise the warrants when the stock price fell and subsequently, to recover the subscription money forfeited by them, they immediately subscribed to new warrants at a much lower price.

It is a generally seen behaviour that the promoters prefer to use warrants when they anticipate gaining from the upward movement in the share price of the company. When the share price moves up, then they exercise the warrants and when the share price goes down, then they let the warrants lapse.

An investor would notice that in the recent year, the business performance of IOL Chemicals and Pharmaceuticals Ltd improved significantly from FY2018 onwards and the company started making a lot of surplus cash. As a result, the company prepaid most of its debt.

At this time of improving business performance, the promoters thought it appropriate that instead of accepting repayment of their unsecured loans from the company, they should convert them into warrants so that they may benefit from the potential upward movement of the share price of the company.

FY2019 annual report, page 7:

During the year the Company has issued 25,00,000 (Twenty five lakh) warrants at a price on ₹205/- (Rupees two hundred five) per warrant on preferential basis to Towels Enterprises Limited, a promoter company on partially conversion of unsecured loan into warrants with an option to subscribe to an equity share of face value of ₹10/- (Rupees ten) at a price of ₹ 205/- (Rupees two hundred five) per equity share

Further reading: Stock Warrants to Promoters: How to Analyse

4) The merger of a bankrupt promoter entity with IOL Chemicals and Pharmaceuticals Ltd:

During FY2012, IOL Chemicals and Pharmaceuticals Ltd merged a promoter entity, G Drugs and Pharmaceuticals Limited (GDPL) with itself. The company allotted 434,500 equity shares to the promoters as consideration for GDPL.

The merger of GDPL along with the consideration of 434,500 shares to the promoters was approved in the AGM dated September 24, 2011 (Saturday). The closing price of the shares of IOL Chemicals and Pharmaceuticals Ltd on BSE on Friday, September 23, 2011 (Friday) was ₹29.55. Therefore, the net consideration paid by the company to the promoters for GDPL was ₹1.28 cr.

In lieu of this payment of 434,500 shares of IOL Chemicals and Pharmaceuticals Ltd to the promoters, the company took over all the liabilities and assets of GDPL. However, when an investor looks at the financial position of GDPL, then she notices that it is a bankrupt company with a negative net worth indicating that liabilities of the company are more than its assets.

FY2011 annual report, page 5-6:

The net worth of GDPL was fully eroded based on its audited Balance Sheet (ABS) as on 31 March 2003. Hence, pursuant to Section 15 (1) Sick Industrial Companies (Special provisions) Act, 1985 (for short, SICA), it made a reference to the Hon’ble Board for Industrial and Financial Reconstruction (BIFR) for determination of measures for its rehabilitation.

IOLCP, which is a profit making company, is in better position to invest / arrange the funds required to revive GDPL.

All assets and liabilities of GDPL shall vest in IOLCP with effect from the merger appointed date but will be operative from the effective date

As per the balance sheet of GDPL disclosed by IOL Chemicals and Pharmaceuticals Ltd in its FY2012 annual report, page 45, GDPL had the following financial status:

• Assets of ₹2.67 cr including plant & machinery, receivables, cash etc.
• Liabilities of ₹6.15 cr including loans and current liabilities.

An investor also notes that GDPL had accumulated losses of ₹12.67 cr over the years.

It indicates that the company had a negative net worth of ₹3.48 (=2.67 – 6.15) cr for which IOL Chemicals and Pharmaceuticals Ltd paid a value of ₹1.28 cr in the form of 434,500 shares to the promoters.

An investor may do deeper due diligence to assess the fair value of GDPL and for any further information or clarification, she may contact the company directly.

Further advised reading: Why management analysis is the most important in stock investing?

5) Purchase and sales from related parties by IOL Chemicals and Pharmaceuticals Ltd:

An investor notices that in recent years, the company is making a large amount of sales and purchases of goods and services from the promoter group entities.

FY2020: BSE announcement dated June 12, 2020, about related party transactions:

• Sale of goods to Vivachem Intermediates Pvt Ltd: ₹142.0 cr
• Purchase of goods from:
• From NCVI Enterprises Limited: ₹84.44 cr
• From Vivachem Intermediates Pvt Ltd: ₹210.00 cr

FY2019 annual report, page 61:

• Purchase of goods from Towels Enterprises Ltd: ₹116.03 cr
• Advances against purchases of goods to Vivachem Intermediates Pvt. Ltd.: ₹20.00 cr

FY2018 annual report, page 59:

• Purchase of goods from related parties: ₹44.75 cr

FY2017 annual report, page 51:

• Purchase and receiving of services from related parties: ₹52.27 cr

FY2016 annual report, page 51:

• Purchase and receiving of services from related parties: ₹17.43 cr

An investor would notice that any transaction between the company and its promoter entities has the potential of shifting the economic benefits from the minority shareholder to the promoters. If the promoter entity sells a good to the company at a price higher than the prevailing market price or the promoter entity buys a good from the company at a price lower than the prevailing market price, then if effectively means that the promoter entity is benefiting at the cost of minority shareholders of the company.

Therefore, investors need to be very cautious while analysing the transactions between the company and the promoters. These may have instances of conflict of interest.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

The Margin of Safety in the market price of IOL Chemicals and Pharmaceuticals Ltd:

Currently (August 30, 2020), IOL Chemicals and Pharmaceuticals Ltd is available at a price to earnings (PE) ratio of about 12.26 based on earnings of twelve months ended June 2020 (i.e. July 2019-June 2020). The PE ratio of 12.26 offers a small margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, taking into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

• 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
• How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
• Hidden Risk of Investing in High P/E Stocks

Analysis Summary

Overall, IOL Chemicals and Pharmaceuticals Ltd seems a company that has a very capital-intensive business model. The company had to continuously raise capital money from lenders and from equity shareholders to meet the requirements of the business. Moreover, the products of the company are such that it has not been able to enjoy a lot of pricing power over its customers. As a result, in the past, the company could not pass on the increase in raw material costs to its customers and reported net losses. Recently, the company had losses in FY2015 and FY2016. Moreover, in the past, the company reported losses in FY2000, FY2001 and FY2002.

The poor cash generation ability of the company has historically created a lot of challenges for the company. The company had to rely on lenders and equity shareholders to continuously support it with additional funds. However, when the lenders hesitated to give more loans to the company, then at times, the equity shareholders (promoters) could not infuse the required capital in the company. As a result, the company has reached the bankruptcy stage twice in the past.

Recently, in FY2015, all the loans of the company were restructured by the lenders with an extension of repayment tenure, lowering of interest rate and additional loans to revive the company. Previously, IDBI has restructured its loans in FY2003 and FY2004. In addition, in FY2012, the company had defaulted to Punjab National Bank (PNB) for its repayments.

Such incidences of loan defaults indicate that the business model of IOL Chemicals and Pharmaceuticals Ltd is tough and without a lot of fundamental strength.

However, in the recent period, since FY2018, the company has seen a turnover of its fortunes. The company has witnessed its sales increase at a sharp pace with significant improvement in its profit margins. As a result, the company has generated a lot of surplus cash and prepaid all its long-term debt.

An analysis of the business environment indicates that the recent good performance of IOL Chemicals and Pharmaceuticals Ltd is linked to the significant price rise of its key products Ibuprofen and Ethyl Acetate. Ibuprofen has seen reduced supply due to, first, the closure of the plant of BASF, the largest manufacturer of the world and second, lockdown restrictions in China due to the Coronavirus pandemic. Moreover, the coronavirus pandemic has increased the demand for the drugs used to lower fever e.g. Ibuprofen.

In addition, the recent stress in India-China relations due to territorial disputes has also pushed the outlook of active pharmaceutical ingredient (API) manufacturers. This is because India imports a lot of API from China and now, India wishes to be self-reliant in API production.

In the light of these industry tailwinds, it remains to be seen whether the shortage of Ibuprofen in the market lasts for long. The prices of Ethyl Acetate have already started declining since last year. As per market news, the plant of BASF, which was shut down in 2018 has started production and in addition, BASF has plans to increase Ibuprofen production by expanding manufacturing capacity. In addition, it remains to be seen whether the current euphoria around API manufacturing translates into a ground-level business opportunity for all the companies or only a handful of players corner all the business.

An investor needs to be very cautious while projecting the recent good performance of IOL Chemicals and Pharmaceuticals Ltd in future because there have been many instances in the past where the short periods of good performance did not last long and the investors who bought the stocks at high levels of valuation burned their fingers. Cases of chemical manufacturers in 2016 in the light of tough environmental regulation in China, graphite electrode manufacturers in 2018 and CPC & CTP producers in the light of upcycle in the aluminium market come to mind when an investor notices the euphoria around API manufacturers in the current markets.

As a result, an investor needs to be careful in her approach to assess the future prospects of IOL Chemicals and Pharmaceuticals Ltd. Historical analysis indicates that the business model of the company lacks a lot of fundamental strength. The equity shareholders (promoter and non-promoter associates) had to continuously infuse capital in the company by way of preferential issue of shares, warrants, preference shares, convertible debentures, foreign currency convertible bonds, unsecured loans etc. An analysis of the corporate announcements by the company from 2003 indicates that almost every year, the company had to implement a capital-raising program.

In the long history of the company, the recent period since FY2018 looks like an aberration when it is generating surplus cash and has repaid its long-term debt. Now, whether these good times sustain for a long time to generate sustained wealth for shareholders or the business performance reverts to its historical average levels with intermittent losses is to be seen.

Going ahead, an investor needs to be very cautious about the changing landscape of the supply situation of Ibuprofen, the main product of IOL Chemicals and Pharmaceuticals Ltd. In addition, the investor needs to keep a close watch on the related party transactions of the company where it buys and sells goods & services from the promoter group entities. This is because; these transactions have the potential of shifting the economic benefits from the minority shareholders to the promoters.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on IOL Chemicals and Pharmaceuticals Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

• Subscribe to Dr Vijay Malik’s Recommended Stocks: Click here
• Mumbai “Peaceful Investing” Workshop, July 27, 2025: Register here
• To learn stock investing through videos, you may subscribe to the Peaceful Investing – Workshop Videos
• 25% savings on buying our Stock Analysis Excel Template and all ebooks together: Analysis Package: Excel Template + All eBooks (25% savings)
• To download our customized Stock Analysis Excel Template for analysing companies: Stock Analysis Excel
• Learn about our stock analysis approach in the e-book: “Peaceful Investing – A Simple Guide to Hassle-free Stock Investing”
• To learn how to do business analysis of companies: e-book: Business Analysis Guide
• To pre-register/express interest in a “Peaceful Investing” workshop in your city: Click here

Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.