Indian chemicals companies are likely to face challenges for the next couple of quarters due to weak global demand and inventory destocking by customers following a slow revival of China's economy.
Earnings for most domestic companies exposed to cyclical end-uses were under severe pressure during the fourth quarter of the last fiscal, particularly those involved in the production of commodity chemicals due to falling prices.
Domestic players have made huge amounts of capex in building the industry as an alternative to China. However, softer demand for a prolonged period may not only delay the full realisation of these capex initiatives but also keep their margins under pressure, analysts believe.
Maulik Patel, Chairman and Managing Director of Meghmani Finechem in a previous interview with Moneycontrol had predicted a bounceback in demand only by the second half of the current fiscal.
Kotak analysts expressed a pessimistic outlook for the next couple of quarters due to the prevailing challenges. They see inventory destocking by customers and weak demand from certain end-uses persisting throughout most of the first half of the current fiscal.
Analysts at Motilal Oswal Financial Services said that volumes are likely to remain subdued for chemicals players in the near term. Market participants are also worried that margins may also continue to remain depressed if demand revival doesn't happen.
The global scenario
The global chemicals sector is going through a downturn in demand, brought about by inventory destocking and a slower-than-expected revival of China's economy.
The demand scenario for the sector looks bleak enough for German specialty chemical maker Lanxess AG to slash its second quarter and annual core profit forecast earlier in the month. The specialty chemical maker also warned of the weakening demand as it highlighted that the drop in sales volumes was worse than that seen during the 2008 global recession.
But what is driving the demand down?
As China reopened its economy post the Covid-induced lockdowns, customers heavily raked up their inventories in anticipation of a rise in demand. However, things fell flat as the rebound in the world's second-largest economy has not been as fast as anticipated. This has led to the destocking of inventories, pushing demand lower.
A recent private survey showed that China's stimulus last year to support economic revival post the reopening is not working, resulting in a slower-than-expected growth rebound.
Impact on India
Despite being caught in the global demand slowdown, domestic chemicals were in a better place as compared to their European peers due to several factors including snatching the market share from Europe-based companies and moving up in the value chain thanks to the China+1 sentiment.
While European firms cut production in FY23, Indian players went big on capital expenditures, which helped them grab a higher market share by filling the supply void. Clients looking at alternatives to China for sourcing chemicals also worked in India's favour.
Regardless of the strides made by Indian chemicals companies in grabbing a higher market share, these firms cannot remain unaffected by the prolonged weakness in global demand.
Long-term prospects bright
Despite the near-term concerns, most brokerages remain bullish on the long-term view for the chemicals sector. Centrum Broking anticipates inventory destocking to end by the current quarter and sees a revival in demand from the second half of the current fiscal. "Once demand revives, Indian chemicals exports are likely to be benefited from normal demand growth coupled with some growth from inventory restocking. With spare capacities at hand, Indian companies are well-placed to take up any sudden surge in demand," the brokerage said in a report.
"Despite near-term challenges, we remain optimistic on the growth prospects of the chemicals sector in the medium-to-long term," the Centrum report said.
Expressing similar optimism, broking firm Jefferies highlighted that domestic chemicals players have directed the majority of their capex into higher value complex chemistry and backward integration into key feedstock.
Motilal Oswal expects the chemical companies in its coverage to post a cumulative EBITDA (Earnings before interest, taxes, depreciation, and amortisation) of Rs 13,010 crore driven by their aggressive capex plans over the next couple of years.
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