BR Research met with Qureshi to learn more about the hydrogen peroxide sector of the chemical industry. Here are edited excerpts of the conversation.
BRR: Let's begin by talking a little about your company and this sector.
Imran Qureshi: Descon Oxychem Limited (DOL) was registered in 2004 as a private company and became a listed company in 2008. Commercial production started in 2009.
We have about 28 acres of land, and plant cost at that time was about $40 million. DOL has two plants; the first is the hydrogen plant for which the basic raw material is the natural gas methane. The process of converting methane to hydrogen is complicated with associated dangers such as fire load, thus we have to be especially careful about safety.
Once hydrogen is made, it is taken to the other plant which manufacturers peroxide. Hydrogen is oxidized to make hydrogen peroxide. Hydrogen peroxide's formula is H202. It is produced in liquid form in different concentrations such as 35 percent and 50 percent, depending on the requirements of the market.
DOL has its own grid. We buy electricity in bulk from WAPDA and ensure supply to our plant because electricity and gas are our two essentials. Any interruption in either results in big hits on production.
About 61 percent of the company holding is with the family and associated companies and 39 percent is by individual shareholders.
BRR: Can you tell us what the market for hydrogen is like?
IQ: In Pakistan, there are three suppliers of hydrogen peroxide which make up the market: DOL, Sitara Peroxide, and the third source is imports. Pakistan's market size is about 64,000 tons per annum of which we produce 33,000 tons, making our market share about 51 percent. Sitara produces about 22,000 tons and imports roughly 10,000 tons, thus Sitara's share of the market is 34 percent. Imports constitute 16 percent of the market.
Basically, this is an import substitution industry, similar to the other sectors within the chemical industry. Between the two Pakistani players, about $22 million are saved in imports through local production.
BRR: Which sectors are the biggest consumers of hydrogen peroxide?
IQ: Nearly 80 percent of this market is consumed by the textile industry for bleaching purposes, especially by the manufacturers of bed sheets, towels and other cotton-related sub-sectors. When cotton is processed to make fiber, it is first bleached with hydrogen peroxide to make it white. This ensures effective dyeing.
About 19 percent is used by the mining industry and the rest 1-2 percent is used by the food sector. Beverages manufacturers, particularly those that use tetra packs, use hydrogen peroxide as a disinfectant. It is also part of cosmetics as a whitening agent.
BRR: Regarding competition from imports, do you have any tariff protection or government support?
IQ: Firstly, government offers protection to all basic import substitution industries through 11 percent of custom duty. Then there is 2 percent of additional custom duty and recently 5 percent regulatory duty was imposed as well. So total protection offered to us is 18 percent.
Furthermore, there was also an anti-dumping duty on many suppliers that was imposed in 2012 and expired in 2017. Anti-dumping duty rates varied from 70 percent on some Chinese suppliers to 30 percent and 10 percent on others.
However, keeping in mind that we supply mainly to the textile sector which is export-oriented so they can benefit from DTRE (Duty and Tax Remission), thus they can still import without paying any tariffs. Not all textile manufacturers use DTRE because imports have their own challenges. This is a hazardous chemical and has storage issues which is why it is easier to buy from local players. But of course, we have to be careful about pricing when it comes to customers who use DTRE because they have other options.
BRR: Speaking of prices, if we compare your prices with international prices, where do you stand?
IQ: Our product is a commodity chemical. In commodity chemicals, such as soda ash and caustic soda, local prices are determined by global pricing. Though costing is an important consideration, at the end of the day, prices are determined by the rate at which imported hydrogen peroxide lands at our shores.
There have been periods, in the first six-seven years of operation, where this company was selling at a loss because international prices were low and dumping was taking place. Then anti-dumping duties were placed, we got tariff protection, and we were able to improve our prices.
BRR: And what determines international prices of hydrogen peroxide?
IQ: These prices move with oil and gas prices, especially since natural gas is an important raw material. Demand and supply situations also influence international prices.
Recently, we have been able to benefit from better prices because of two reasons. Firstly, there is a global demand-supply imbalance for hydrogen peroxide. Demand is outstripping supply as some plants have shut down for maintenance or environment issues. India, in particular has high demand.
Secondly, similar to all other import-substitution industries in Pakistan, we are benefiting from currency devaluation. Imports have become more expensive so our offerings appear competitive. My customers are mainly exporters so there products have become more competitive as well.
BRR: Does this mean that your margins are high currently?
IQ: Margins should be reasonable for any chemical supplier. We still have room to charge higher prices because we are cheaper than imports and there is a slight shortage in the market.
There have been times when hydrogen peroxide was selling at Rs 200 per kg in Jodia Bazaar, Karachi and we were selling at Rs 80 per kg. It was a short term spell with traders hoarding to exploit market conditions. Currently, DOL's price is Rs 105 per kg in Karachi whereas imported products sell at Rs 130-140 per kg.
So we have not taken the full advantage of spot international pricing and devaluation. We believe we should make decent margins but not exploit the situation.
BRR: Pakistan's textile sector has not done well in the last few years, how has that impacted your business?
IQ: There are different sectors within the textile industry. Home textiles sector, which includes towels and bedding, have been doing well in recent years so our business has not been adversely impacted. We are a cotton producing country, cotton is our strength, and home textiles are generally cotton-based.
BRR: Are there other markets that can be explored for further growth?
IQ: There is the food sector in which hydrogen peroxide is used as a disinfectant. Milk producers have been doing trials on their production lines. The risk there is that if the trial is not successful, we have to bear the costs for spoiled milk. So we are working on this segment, but compared to textiles, it is a small segment.
We have been very successful as disinfection for beverages that come in bottles. In the cosmetics sector, local manufacturers buy hydrogen peroxide for skin bleaching purposes.
We are trying to make inroads with MNCs in cosmetics industry.
BRR: Do you plan to expand your current capacity?
IQ: Keeping in view market demands and requirements, we have some expansion plans. We are going to expand our capacity by 25 percent, which will take our plant capacity to about 42,000 tons. This should come about in the first quarter 2020 as per calendar year. The cost of this is roughly Rs 1.1 billion.
BRR: So this will allow you to capture the market that is with imports currently. Do you know whether Sitara has any expansion plans?
IQ: They may expand but they have not announced their plans as yet, though it may be in the works. We also expect organic growth of 5-6 percent in the market.
BRR: We have talked about the demand side factors, let's talk about supply side. Are there ways from which DOL can become more cost efficient?
IQ: Manufacturing excellence is key because if we use our plant and equipment in an effective manner, if we sweat our assets, we can become more cost efficient. If our plant and equipment is not operating at an optimum level, we will not be able to manage costs.
Our plant's nameplate capacity was 28,000 tons per annum. Last year we were able to produce 33,000 tons. This 5,000 ton increase is through de-bottlenecking and maximizing output. We have to focus on this because we cannot control our key raw material - gas.
BRR: What is the contribution of gas in your cost of production and where are you supplied gas from?
IQ: The contribution of gas is around 30 percent. It used to be in the range of 20-22 percent but given RLNG and the price hike, its contribution has increased. The price difference is significant, from about Rs 700 per MMBTU previously to Rs 1,000 for mixed of which 60 percent is system gas and the rest is RLNG
Currently, we are supplied by SNGPL but in the north market it has been split into a combination of natural gas and LNG. Since gas is the raw material, increase in gas prices will strongly impact our margins.
BRR: How do you plan to manage this cost as it rises over time with the RLNG component increasing?
IQ: This cost has to be managed through manufacturing efficiencies. We have just initiated work on an energy conservation plan. Looking at all parameters, we are working towards decreasing cost and consumption. Price is internationally driven, gas prices are not in our control, so the way forward is through benchmarking our plant against international hydrogen peroxide plants.
BRR: What are your other components of cost of goods sold?
IQ: At 10 percent of CoGS, packaging is also a significant cost for us. We import our packaging raw material because it's a hazardous substance and it has to be made to certain specifications using high density polyethylene. About 90 to 95 percent of our sales are in imported cans.
If we sell in bulk, our consumers will benefit because their cost will decrease by 10 percent as well. If our current cost in Karachi is Rs 105 per kg, in bulk it can be reduced to Rs 95 per kg. This is what we are pushing our customers towards. Our focus is to convert the north market towards bulk purchases.
BRR: Let's talk about your debt structure, what is your debt to equity ratio?
IQ: We have paid off all our long-term debts so currently it is all equity with no long term debt. We are going for fresh financing of about Rs 1.1 billion for expansion in the next 18 months.
We have Rs 1.1 billion of preference share capital which we are planning to convert to inter-company loan. From this, it may appear that the company will go into debt for about Rs 2 billion but our debt equity ratio will be at 65:35 with debt at 65 percent and equity at 35 percent.
BRR: What are the biggest challenges that you face?
IQ: The biggest challenge that the industry faces is inconsistent energy supply. Things are better now but the industry went through a bad patch few years back. This crisis should not happen again. Government commitments such as refunds need to be upheld without long time lags and delays. Such situations create liquidity crunches.
Industry requires a level playing field. Dumping is a challenge which is often aggressively defended by vested interests. Commercial traders often look out for their interests and not of the interests of the industry as a whole.
On the customs sides, issues such as under invoicing and declaration need to be corrected. On the taxation side, through corporate tax, super tax, WPPF, WWF we end up paying 39 percent in taxes.
Addressing these issues require a huge amount of effort from domestic players. A lot of pressure is required to correct such malpractices to create a level playing field.