India’s chemical industry will continue on growth path, says JM Financial

Speciality chemicals constitute 22 percent of the total chemicals and petro-chemicals market in India. The speciality chemical industry grew from around USD 18 billion in 2014 to USD 32 billion in 2019 and is expected to be worth USD 64 billion by 2025 at a CAGR of 12.4 percent, says a report by JM Financial Research.

India’s share in the global speciality chemicals market increased from 3 percent in 2015 to 4 percent in 2019. This is expected to reach 5.5 percent by 2025.

Recent Trends

The pandemic shook the chemical industry just as it did other sectors, and in H1FY22, the majority of companies witnessed a slump in their operating margins. Gross margins contracted and operating costs jumped significantly.

Gross margins were impacted as raw material prices soared because producers in China had to cut production due to energy crises (power shutdowns due to a shortage of coal) and unavailability of major raw materials due to supply chain constraints.

Operating costs were impacted by higher freight costs due to a shortage of containers and higher power and fuel costs due to a significant jump in coal and gas prices.

However, chemical producers are optimistic about the future as demand remains robust.

Things are beginning to look up

Most players have implemented price hikes to cushion their margins. “Several Indian chemical players have indicated that their customers have accepted the price hikes needed to offset the higher input cost. Hence, we believe that major Indian players should be able to pass on the complete price increases over the next 1-2 quarters,” said the JM Financial report.

Prices of a majority of basic chemicals have reached record highs, which are unlikely to sustain. In fact, some correction is beginning to be seen in the prices of some of the chemicals, which augurs well for the industry. “Any further meaningful correction in raw material prices would mean that Indian chemical players could have windfall gains as the price cuts could also happen with a lag just like the price hikes,” said the report.

Prices of caustic soda have started to decline and have come down to about USD 600/MT this month from over USD 800/MT in October. Soda Ash prices from China have declined to just over USD 400/MT from USD 600/MT in October. Similar declines have also been witnessed in prices of other important raw materials such as acetic acid, benzene, phenol, vinyl acetate, etc.

The supply chain situation is also beginning to improve gradually with better container availability, which should result in lower freight costs. “Hence, in our view, operating margins of Indian chemicals players should improve in H2FY22 due to likely rise in gross margins and moderation in operation costs,” said the brokerage.

Alternative to China

There have been reports in the global press that the United States will slap investment and export sanctions against more Chinese companies, including biotechnology, health care and tech firms. Chances of more companies getting added to the banned list are high but it remains to be seen if any chemicals companies will be on the list.

Regardless, this can result in a shift in the focus of multinationals, which may want a reliable alternative to China to avoid further disruptions in supply. Indian chemical companies are well positioned to benefit from such a shift and garner a major chunk of the pie.

“We believe this is likely to benefit Indian specialty chemicals players, especially players such as Navin Fluorine, who supply certain intermediates to Wuxi biologics (a Chinese company potentially facing blacklisting) to make certain end-products,” added the JM Financial report.

Emphasis on capacity addition, process improvement and development
Companies are investing in capacity addition for backward integration as well as research & development to develop high-margin products and reduce dependence on imports.

“A revival in domestic demand and robust exports will spur a 50% YoY increase in the capex of specialty chemicals manufacturers in FY22 to Rs 6,000-6,200 crore (USD 815-842 million),” said a CRISIL report.

Indian chemical producers such as Clean Science have done process innovation while companies such as Deepak Nitrite, Navin Fluorine, Galaxy Surfactants and Fine Organics have filed several patents to improve their processes, said JM Financial.

These measures put the Indian players in a good position to give their Chinese counterparts stiff competition.

“India’s specialty chemicals industry is a decadal growth opportunity and it is still not too late to participate in the value creation process,” the JM Financial report concluded.

Stocks to look out for

The brokerage has a “buy” recommendation for Deepak Ntirite Ltd with a target price of Rs 2,800 as it believes that despite the inherent cost advantages for its upcoming phenol derivative products and strong entry barriers, it is currently trading at a significant discount to its peers.

JM Financial has also put a “buy” rating on Navin Fluorine International Ltd and PI Industries Ltd with targets of Rs 4,400 and Rs 3,675, respectively, as “they provide long term earnings visibility”.

Brokerage firm Edelweiss has placed its bets on emerging players such as Balaji Amines Ltd, Neogen Chemicals Ltd and Rossari Biotech Ltd.