Corona blues for agrochemical players, input lines may choke

The current situation

So far, 170 deaths have been reported, with nearly 4,600 confirmed cases of infected individuals. China has imposed travel ban and taken quarantine measures that could impact local and global trade dynamics.

The virus is spreading rapidly and the painful impact is expected to intensify. Many major cities in China have been locked down to check the spread. This is leading to a shutdown of several businesses and production units.

The likely consequences of the flu are already being priced in by markets globally. Chinese equities have fallen by 5-6 percent from their January 20 highs. Oil has slumped by more than 10 percent in the past few days whereas gold is at its 6-year high.

The impact

China, the origin of the virus, is a major producer of many chemicals that find their application in agrochemicals, formulation chemicals, pharma, consumer durables, automobiles and the like.

India's agrochemical industry is heavily linked to and dependent on the Chinese imports for its raw material requirements.

The Hubei province, which is at the centre of the current epidemic, is a key manufacturing hub for chemicals. The nearby hubs of chemical manufacturing – Anhui, Jiangxi, Jiangsu and Zhejiang – are also major centres for herbicides, specialty chemicals, dyes, resins and agro intermediates.

With the lockdown of several cities and the mounting threat of closure of production units, there are rising concerns of interruption in supply of these chemicals. And if that happens, it may create a scarcity of many such chemicals and drive up their prices.

While many production units are now closed because of the Chinese New Year, the actual impact will be clear once the holiday season is over. Officially, the Chinese holiday is extended to February 2 nationally and February 9 for Shanghai.

Our view is any interruption in raw material supply could affect production costs and the process itself for Indian agrochemical players. Our interactions with the companies suggest that the existing raw material inventory would help them scrape through for nearly the next two months.

However, if the impact persists or aggravates, there could be acute input scarcity, leading to a surge in costs or even halt in production. In either of the cases, the consequences will not be healthy and could spill over to their overall performance in coming quarters.

In the recent past, the margins of many agrochemical companies came under severe strain due to supply disruptions from China. In 2018, stricter environment laws in China forced many production units to wind up.

India faced the ripple effect. The margins saw a sharp contraction in the following quarters before the authorities could get a grip on the situation with alternative sourcing.

While importers from China are likely to be adversely impacted, it might come as an opportunity for a few which are into manufacturing of technical grade chemicals as the demand of their product may rise.

So, any uptick in prices would benefit these producers. Plus, any shift in sourcing of specialty chemicals by developed markets from China to India would be another positive.

Our take

We believe that the current epidemic calls for caution. In the current scenario, intensive quarantines and travel bans will hit the Chinese economy hard. While the country is much better equipped to handle the crisis, the lockdowns will ripple through trade and travel.

The potential impact of these aggressive steps is likely to play out in many sectors, especially the commodity-linked ones like agrochemicals. This could spell more uncertain times for agrochemical and specialty chemical producers. The second-level impact would be more widespread across sectors and macro indicators.

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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here