SAC Capital has initiated “buy” on chemical solutions provider Megachem 5DS with a target price of 55 cents, highlighting the company’s sticky relationship with customers which allows for high order book visibility and studier margins.
In their report, analysts Nicole Lim Qiuni and Matthias Chan note that Megachem offers a one-stop integrated solution for its customers, leveraging on its capabilities in proprietary chemical products manufacturing, contract manufacturing and global distribution.
“Being appointed the sole distributor to multiple suppliers due to its strong presence in Asia further cements Megachem’s positioning as the company of choice. Its global just-in-time delivery offering — a venture requiring precision — calls for superior inventory management and logistic capabilities coupled with a strong IT management system,” the analysts add.
Once the lengthy and complex approval process for a customised product is cleared, customers are generally unwilling to hop to a different supplier. This is further augmented by the price inelasticity of specialty chemical products, Lim and Chan add. The fragmentation of the specialty chemical industry reinforces such staticity, allowing for meaningful passing of costs to customers.
This is witnessed during the pandemic years of FY2020 and FY2021, where Megachem’s gross profit margins remained stable at about 25% despite rapid hikes of raw material costs. Despite its lackluster performance in 1HFY2023, the analysts believe the weakness is short-term and should dissipate as the business cycle inflects.
Megachem also boasts well-diversified revenue streams. The analysts highlight Megachem’s broadly segmented FY2022 industry exposure, with the largest contributor only accounting for about a third of the aggregate. This reduces concentration risks, offering buoyancy in the event of a downturn in any particular industry.
For instance, its exposure to booming industries such as food and beverage as well as agriculture allows the company to record firm top-line performance against the backdrop of economic downturn during the pandemic years. This underscores the stability of Megachem’s business model, the analysts point out.
“This was in fact engineered as intended by management of the firm. In FY2018, its exposure to performance coatings and polymers stood at 42%, making up almost half of overall revenue. Sensing the potential risk of concentration, the team decided to scale up business in other segments, highlighting provident management,” they add.
Focusing on generating better profits, Megachem is currently moving towards higher margin industries, such as biotechnology. The analysts expect the company to continue in this direction, recording healthy and improving margins.
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Lim and Chan also point out Megachem’s low gearing and stable dividends, which reflect stable balance sheets. In its 1HFY2023, the company reported net gearing of 0.31x after a $6 million repayment of borrowings to alleviate the impact of higher financing costs. Borrowings up to a reasonable level of 0.5x would give the company additional headroom of about $23 million for further capital expenditure to finance future expansions, the analysts note.
“Current debt levels only stand at about $32.9 million. Interest coverage ratio has stood above 2.0x over the past 5 years, an indicator of sufficient cash flow to meet interest payments timely with no potential for default. Current ratio has been standing about 2.0x over the past five years, highlighting good coverage of liabilities and adequate short-term liquidity,” the analysts add.
As at 11.11am, shares in Megachem are trading flat at 49.5 cents.
