Pitched as $300-billion market, chemical stocks are on the roll again

Chemical sector stocks are back in favour on the back of their “superior” growth prospects after a recent disruption that led to a moderation in their valuations.

In mid-December, doubts had emerged for the first time about a sector that had been a return-generating machine for the past few years. The chemical sector, a go-to bet for most investors, was suddenly the subject of a brutal drawdown.

Rising input costs, rich valuations, and scepticism over whether product price increases could be sustained had combined to unleash concerns that led the shares of companies such as Camlin Fine Science, Balaji Amines and Chemplast Sanmar to drop 30-50 percent from their record highs.

Prior to this selling spree, the sector had generated annualised returns of 17 percent in 2016-19, outperforming the 5 percent growth in the Indian market and 6 percent by global equities in the same period.

Over the past two weeks, though, investors are returning to these shares, likely following the moderation in the valuations of the sector. As many as 58 of the 78 listed chemical sector stocks have seen positive returns in the past two weeks, with Jubilant Industries, India Glycols and Valiant Organics, among others, having climbed 20-30 percent.

While the concerns over margins were legitimate, given the sustained rally in global input prices over the past half a year, the extreme reaction of investors allowed for many of these previously expensive stocks to enter the ‘value’ zone, analysts said.

Secular growth

According to Yes Securities, the short-term challenges are unlikely to cloud the industry’s long-term secular growth.

“Growing domestic consumer base, increase in disposable incomes, changes in lifestyle and supportive government policies are likely to propel the industry into a phase of superior growth, whereby the industry is expected to reach $300 billion (in size) by FY25,” the brokerage firm said in a recent note.

Surya Patra of Phillips Capital said in a note last week that chemical stocks under his coverage are set to deliver strong earnings growth in the December quarter “against the fear of margin squeeze caused by elevated input prices.”

Phillips Capital expects specialty chemical companies to deliver 38 percent year-on-year growth in earnings in the December quarter, aided by a 43 percent on-year rise in sales.

However, raw material costs and freight charges are unlikely to ease because of supply-chain shortages caused by the emergence of the Omicron variant of the coronavirus. Global container freight rates resumed rising in January after plateauing in November-December, media reports showed.

Nirmal Bang Equities said chemical producers will get relief from high raw material prices on their gross margins as the expected tightness in the global chemical market in the coming months would result in higher product prices.

Looking beyond the short-term cost challenges, Yes Securities recommended that investors focus on the tailwinds on the demand front. The retreat of Chinese chemical companies from the global stage caused by their government’s heavy-handed clean-up of the environment, global chemical giants diversifying their supply chains and burgeoning demand at home provides a recipe for years of strong earnings growth for the sector.

“That said, in our view, the key to ‘sustained’ and ‘superior’ value creation would be contingent upon a chemical company’s ability to consistently and continually scale up its operations, efficiently control its operations and capex allocation and develop expertise in existing and newer chemistries,” Yes Securities said.

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