Markets
Is the worst seemingly behind for Indian chemical players?
Summary
The chemical sector appears to be at the bottom of the cycle, indicating potential recovery ahead, but said it is challenging to predict whether this will take 3 months or 6.With the worst seemingly behind for the chemical sector now, market participants believe fresh opportunities could emerge in this space in the coming months. As a matter of fact, several chemical stocks are still 10-33% away from hitting their 52-week high, which is indicative of the potential upside.
"The chemical sector appears to be at the bottom of the cycle, indicating potential recovery ahead," said Resham Jain, fund manager at DSP Mutual Fund. "However, it's challenging to predict whether this will take 3 months or 6."
Indian chemical companies anticipate that the worst has passed, foreseeing an uptick in demand from current levels, particularly as the second half of FY25 looks robust, said some analysts.
Vinati Organics, Clean Science, Sudarshan Chemicals, Privi Specialty, Neogen Chemicals, SRF and Navin Fluorine witnessed a strong volume- recovery, they noted.
“They (global peers) too are experiencing early signs of demand recovery but are cautions regarding near-term performances considering volatile macros and the geopolitical environment, de-stocking and inflationary trends," said Bhawana Israni, Research Analyst, Anand Rathi Institutional Equities. She believes that growth of global peers may come in low single digits in 2024.
Analysts believe that the recovery has begun, albeit gradually, with demand improving across various sectors and a pick-up in channel restocking alongside better realizations.
Talking about realizations ahead, during May, crude slumped 8-10% month on month while chemical prices remain mixed.
“China Soda Ash prices rose 8% month-on-month (MoM) while caustic soda/TDI/acrylonitrile prices fell 2%/4%/3% MoM. Crude decline led to decline in petchem, building blocks, and monomer prices however polymer prices remained resilient," according to a 4 June report by Centrum Broking.
In the March quarter, margin pressure persisted mainly because of weak realizations, higher freight costs (the Red Sea issue) and input-price volatility.
However, Israni believes that “The average Ebitda (earnings before interest, tax, depreciation and amortization) margin after the March quarter is 18% as compared to 22-25% in 2023", suggesting some improvement from this level with volume driven recovery.
She also highlighted that between FY20 and FY24, 26 specialty and commodity chemical companies invested around Rs483 billion on capital expenditure (capex) and acquisitions. These companies are expected to spend an additional Rs395 billion over FY24-26 on import substitution opportunities, expanding their CRAMS (contract research and manufacturing services) portfolios, and shifting further towards value-added derivatives.
A report by UBS Securities dated 14 May said, “Indian chemicals companies scaled up their capex by 4 times in FY16-23 to leverage specific opportunities in speciality chemicals, and ongoing supply chain diversification and companies' increased capacity and capability may drive structural growth".
That said, the foreign brokerage firm noted that Indian companies have ramped up capex to seize sectoral opportunities, supply intermediates for various end products, and secure large-scale contracts from global majors. UBS Securities believes Indian companies are positioned favourably in the overall chemicals space.
“India's chemicals sector is relatively small (around 4% export share globally) and could potentially increase share in the global market on drivers such as supply chain diversification and lower research and manufacturing costs," the report read.
Additionally, the risk of Chinese supplies remains a key concern, as China's capacity could affect prices, noted a Nuvama Institutional Equities report dated 31 May. “However, most managements believe prices across products have bottomed out, demand recovery and Chinese supply remains a key concern".
So, another challenge the Indian chemical sector is facing is the influx of Chinese product dumping. While this issue remains unresolved, customers are actively seeking to diversify away from China, a trend that is undoubtedly benefiting Indian chemical players.
All said, the longer-than-expected recovery resulted in a sharp earnings cut over the last 2-3 quarters. After Q4, future earnings have not seen major cuts except for a few such as Tatva Chintan, Anupam Rasayan, Archean Chemicals and Aether Industries, analysts have pointed out.
However, the current price-to-earnings ratio is notably above the five-year average for most chemical stocks. Bloomberg data reveals that currently SRF and Deepak Nitrite are trading at 50.97 and 38.33 times earnings, well above their five-year average PEs of 33.74 and 28.64, respectively. Meanwhile, Tata Chemicals stands out with a current PE of 96.06 times compared to its five-year average of 23.
"Valuations in the chemicals space are still expensive," said Swarnendu Bhushan, co-head of Institutional Equities, Prabhudas Lilladher. He believes demand recovery will take another six months or longer, especially in companies exposed to agrochem, hence investors may wait for better times.
Even Gagan Dixit, senior VP - Equity Research at Elara Capital, said, “Overall, valuations are still not cheap". Even so, he believes it is a good time to invest in this space, as revenue recovery will be driven by recovery in chemical prices, improving demand, normalized global demand, and favourable crude prices.
Dixit anticipates the government support going ahead to focus on developing petrochemical hubs in India.
Moreover, market speculation suggests potential duty reductions, which would bolster Indian chemical players in achieving import substitution.
