Chemical sector in a sweet spot, says HDFC Securities; 5 stocks that can give double-digit returns

The chemical industry contributes significantly to India's export-import trade in terms of value. Its speciality chemicals segment has a lot of space to grow.

As per HDFC Securities, the global speciality market grew from $577 billion in FY12 to $745 billion in FY17 at a CAGR of 5 percent.

"It is expected to grow to $1,000 billion by FY22E at a CAGR of 6 percent. China and North America dominate the global speciality market, with about 50 percent market share while India's share is merely 3 percent. This shows that the speciality chemicals market in India is at a lower level as compared to the US and China, creating significant scope for growth," said HDFC Securities.

The brokerage said its positive stance on speciality chemicals universe is premised on:

(1) domestic availability of raw materials, (2) accelerated capital expenditure (Capex) to build product development capabilities and backward integration resulting in EBITDA and PAT CAGR of 19/23 percent over FY21-23E, (3) investment in research and development (R&D), which would allow these companies to step up their position in the speciality chemicals manufacturing value chain to become 'proprietary chemical producers', and (4) import substitution along with export opportunity.

Being a B2B industry, the segment’s tends to mimic the growth of end-user industry, HDFC Securities added.

Stocks to buy:

Aarti Industries (AIL) | Buy | LTP: Rs 1,050 | Target price: Rs 1,320 | Upside: 26%

HDFC Securities expects AIL's PAT to grow at a 29 percent CAGR over FY21-23E, led by a 14 percent CAGR in revenue.

The brokerage expects the RoCE to dip in FY21E to 8 percent due to significant Capex and the adverse impact of the pandemic on the business but it is expected to recover to 10 percent in FY23E.

"The constant focus on R&D will enable the company to remain competitive and expand its customer base. The toluene segment in India is mainly untapped and catered to through imports; AIL will benefit in the long-term by entering this segment," HDFC Securities said.

SRF | Buy | LTP: Rs 4,210 | Target price: Rs 5,120 | Upside: 22%

HDFC Securities expects SRF's PAT to grow at a 23 percent CAGR over FY21-23E, led by an 11 percent CAGR in revenue.

Revenue growth is expected to be driven primarily by a 17 percent revenue CAGR in the chemicals segment and a 7 percent revenue CAGR in the packaging film segment, while technical textiles revenue is expected to grow by a mere 2 percent.

"We expect the RoCE to dip to 8.5 percent in FY21E, owing to significant capex spend, but it could recover to 10.5 percent by FY23E. Capacity expansion and the plan to launch three-four new products every year will sustain growth momentum," said the brokerage.

Robust demand for BOPET and ramp-up in capacity utilisation of the recently-commissioned plants should drive earnings growth for packaging business, it added.

Alkyl Amines | Buy | LTP: Rs 3,350 | Target price: Rs 4,010 | Upside: 20%

As per HDFC Securities, over FY11-20, the company's earnings per share have grown by a 33 percent CAGR to Rs 88 per share, driven by growth in both volume and realisation.

The stock, which rallied 2.7 times until August from its March 2020 lows, is now trading at an all-time high.

The stock has been re-rated based on its customer and product mix as well as the current product realisations and margins.

HDFC Securities' expectation of a stock outperformance is premised on (1) unabated growth in demand from its pharmaceutical and agrochemical customers that form about 70 percent of the company's revenue mix, (2) rising domestic market share in methylamines, (3) impending capacity expansion for (high-margin) acetonitrile, (4) production linked incentive scheme that provides the right tailwinds for long-term volume growth, (5) strong return ratios (RoE/RoIC of 30/34 percent in FY22E and 28/37 percent in FY23E), and (6) OCF and FCF yield of 4.9/3.1 percent in FY22E and 3.1/4.4 percent in FY23E.

Balaji Amines (BLA) | Buy | LTP: Rs 870 | Target price: Rs 980 | Upside: 13%

HDFC Securities expects the stock to outperform based on (1) unabated growth in demand from its pharmaceutical and agrochemical customers that formed nearly 77 percent of BLA's Q1FY21 revenue mix, leading to an EPS CAGR of 25 percent over FY20-23E to Rs 59 per share (2) ramp up in BSCL's production, (3) production linked incentive scheme that provides the right tailwinds for longterm volume growth, (4) rising return ratios (RoIC should improve to 23/27/29 percent in FY21/22/23E from 21 percent in FY20), and (5) improving OCF and FCF yield of 5.7/2 percent in FY22E and 7.6/4.4 percent in FY23E.

Galaxy Surfactants | Buy | LTP: Rs 1,800 | Target price: Rs 2,070 | Upside: 15%

Over FY18-20, GSL's EPS has grown by 46 percent to Rs 65 per share compared to a mere 2.6 percent CAGR rise in its share price from February 2018 to August 2020, the brokerage said.

This is post considering the 73 percent stock rally from its March 20 lows until August.

"Our expectation of a stock outperformance is premised on (1) stickiness of business as 55 percent of the revenue mix comes from MNCs, (2) EPS growth of 22 percent over FY20-22E, led by 18 percent growth in volume to 265kT and 9 percent growth in per-thousand ton EBITDA to Rs 18, (3) stable EBITDA margins at more than 12 percent since fluctuations in raw material costs (RMC) are easily passed on to customers, (4) strong return ratios (RoE/RoIC of 22/18 percent in FY22E), and (5) dividend and FCF yield of 1.9/0.8 percent in FY22E," said HDFC Securities.

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