Are chemical stocks a good buy at this juncture?

The story of China+1 strategy that put India’s chemicals sector in the limelight dates back to pre-pandemic times.

It received further tailwinds as pandemic-related supply-chain disruptions shook global giants.  

We have written about chemical companies on numerous occasions over the last 12-14 months. We thought it’s a good time to do a follow-up story,

2 specialty chemical companies buzzing on the bourses

Solar Industries: Warming up for an explosive growth?

Tatva Chintan Pharma Chem: Meditating growth

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Asahi Songwon Colors: Dhai Akshar paint ke

Mangalam Organics: can it do sabka mangal?

But the time for story-telling is over; tracking performance is crucial now.  

We thought it’s a good time to do a follow-up story, given that stock prices in the chemicals sector have shot up, and valuations on many counters now look a bit overstretched.

Has the entire growth story of chemical companies in India played out?

The answer is no.

Highlights of Q2 performance

The market response to Q2FY22 earnings of the sector has been mixed.

We have observed that markets have been merciless to companies enjoying lofty valuations if they even slightly defaulted on performance, especially margins.

Higher input costs and freight costs dented the margin performance of Atul. Its EBITDA margins dropped 800bps (basis points) on Y-o-Y (Year-on-Year) and 600bps Quarter-on-Quarter (Q-o-Q). A basis point is 1/100th of a per cent.

The Life Sciences division of Atul recorded a flat top line while Performance and Other Chemicals segment clocked 23% top line growth Q-o-Q.

Pharmaceuticals revenue dragged the performance of the Life Sciences division despite it launching three new APIs (Active Pharmaceutical Ingredients). The demand scenario for the pharmaceuticals business remained weak.

The company successfully completed the expansion projects of Sulphur Black Dyes, Para Cresol and Para Cresidine. It expects to achieve the full utilization of these capacities over the next 1-2 years.

Mirroring the industry trend, even Tata Chemicals on a consolidated basis reported an EBITDA margin contraction of 300bps Q-o-Q.

Rising soda ash volumes remained an encouraging sign though.

The company expects Q3 soda ash and salt volumes to be lower in the US and India due to an annual shutdown conducted in October. Nonetheless, the management has guided for normalcy returning on the margin front in Q3FY22. 

Soda ash prices have jumped to an all-time high in November 2021 in the international market. The prices have shot up 60% between September and November—from ~2300 CNY/T to ~3,700 CNY/T, according to trading economics.

Interestingly, Tata Chemicals revises export contract prices of North America operations on a quarterly basis.

And barring 15%-20% contracts in India where the reset happens annually, other domestic contracts see price revisions on a quarterly basis.

Tata Chemicals expects the first tranche of soda ash, bicarb and salt capacity expansion to come on-stream in FY23. This would be revenue accretive.  Green economy initiatives, such as EVs and renewable energy, are likely to brighten the demand scenario for Tata Chemicals.

The company has managed to re-price its debt in the US which is expected to result in savings of Rs 50 crore of interest cost annually.

Solar Industries reported a reduction of 300bps in its EBITDA margins Q-o-Q. However, it is sitting on a healthy order book of Rs 2,842 crore. Of this, a little over 50% is from Coal India.

Explosive volumes grew 16% Y-o-Y in Q2FY22. The raw material prices have gone up 63% Y-o-Y in H1FY22 while the employee cost too has witnessed a steep rise of 27%.

Revenue contribution of exports improved from 38% in Q1FY22 to 46% in Q2FY22.

Solar Industries has chalked out a capex plan of Rs 315 crore for the current financial year of which it has already deployed Rs 137 crore. 

The company has revised its growth guidance upwards—from 30% to 40% for FY22.

Food for thought

The range of products and industries affected by massive price escalations seem to be unprecedented this time.

 Imagine, an explosive manufacturer is reporting raw material price inflation which is building up in coal prices. As a result, the cost of production for soda ash manufacturers is shooting up as well.

Despite this, companies appear confident of volumes growth and future business prospects.

Does that mean immense liquidity will still be required to finance infrastructure growth and renewable energy targets? And will monetary and fiscal policy makers in the US find themselves in a catch-22 situation?

Massive disruptions in supply of raw materials and fluctuation in prices has placed the informal sector in a tight spot.

Companies such as Asahi Songwon have been optimistic that the formal sector players have a good chance to improve their market share going forward.

The company’s recent diversification into Azo Pigments through its Joint Venture with Tennants Textile Colours Limited (TTC) is expected to boost its future prospects. TTC will offtake/absorb 20% of the quantity manufactured.

In phase-I, the joint venture has set up a capacity of 2,400 TPA which can be enhanced to 4,800 TPA within 6 months at a capex of ~Rs 40 crore.

The management has guided that once the 40% capacity utilization is reached for the new facility, it will undertake the brownfield expansion.  Going by the management commentary, such capacity utilization might be reached by March 2022.

Connecting the dots

Stock prices have been reacting sharply to Q2FY22 results of chemical companies. Clearly, they will have to report higher volume growths and margin improvements to justify valuations.

Moderately valued big chemical companies supplying to sunrise industries might remain on investors’ radars if they can ride out the current phase of supply-side bottlenecks and unprecedented inflation.

Small companies which are expanding and adding environment-friendly value-added products might look interesting too, provided managements of these companies ‘walk the talk’.

In the past era, water changed colour several times in a day in India’s chemical belt in Gujarat—thanks to polluting chemical companies.

If Indian manufacturers want to grow their market share globally in future, they must embrace environment-friendly practices as the foundation of whatever they do. 

Likewise, stock price performance of chemical companies may change colour several times going forward.

Indian investors should now learn to deal with extreme volatility to be able to make money in stocks.

Markets have already ceded low-hanging fruits. They might make investors work hard now.

But as they say, adversity often opens doors to opportunity.

You may also like to read: Is value the new mantra for portfolio growth?

 

Disclaimer: The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock.

Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities.

We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances. Asset allocation becomes extremely relevant.

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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