Specialty chemicals companies to ride high on China+1, EU production slump

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Specialty chemicals companies in India are set for strong growth, thanks to the growing desire among global players to shift dependence from China and a production slump in the European Union (EU).

Tightening environmental restrictions, the high cost of energy, and decelerating demand have seen the production of specialty chemicals in the EU consistently decrease. According to global research and broking firm Jefferies, repeated disruptions in plant operations in China as a result of the government's policy to discourage industries that consume high amounts of energy and emit large quantities of pollutants, along with COVID-induced lockdowns, have accelerated the trend of buyers diversifying their sourcing.

These two factors have significantly boosted demand for Indian players, who rose to the occasion and filled the demand-supply void. Besides, the new investments worth Rs 9,100 crore made by companies in the sector will drive sustainable growth in revenue in the coming years as demand rises.

Even though Indian specialty chemicals companies have witnessed higher demand due to the China+1 sentiment, industry experts believe that infrastructural constraints compared to China are a major letdown for the sector. To mitigate the lack of infrastructure that’s hampering the growth of domestic specialty chemicals players, companies pumped money towards capital expenditure.

The majority of this capex went into developing higher-value complex chemistry, and backward integration into key feedstock, noted Jefferies. "These investments helped the contribution of specialty chemicals in revenues rise from 55 percent in FY17 to 63 percent in FY23, helping drive a 211-basis-point (bps) expansion in EBITDA margin to 24 percent over the same period," the Jefferies report stated.

The broking firm anticipates earnings before interest, taxes, depreciation, and amortisation (EBITDA) margin expansion to continue in the near future. "Improving profitability, judicious fund-raising, and prudent capital allocation have led to improved balance sheet health with net debt to equity at multi-year low, implying adequate room to invest in this compounding opportunity," the brokerage believes.

Investment ideas

Within the specialty chemicals space, Jefferies is most bullish on Navin Fluorine. Rising revenue contribution from specialty chemicals and industry-leading growth with a 35 percent earnings per stock (EPS) CAGR (compounded annual growth rate) over FY23-25, are reasons attributed by Jefferies for its upbeat view.

The broking firm also likes SRF's top-notch execution and entry into new specialty verticals, which it believes positions the company strongly for multi-year compounded growth. However, even with a forecast for 13 percent EPS CAGR over FY23-25E for SRF, Jefferies says it will wait for a pullback of the life-time high chemicals margins to turn more constructive on the company.

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