Indian Chemical Sector Thematic Report - Evolution to revolution! - HDFC Securities

Mr. Nilesh Ghuge & Mr. Harshad Katkar, Institutional Research Analyst, HDFC Securities

Our positive stance on our 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% over FY21-23E, (3) investment in Research & 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 business industry, the growth of the industry tends to mimic the growth of its end-user industry. We believe that companies supplying speciality chemicals to pharmaceutical and agrochemical industries are in a sweet spot due to (1) steady growth and (2) stringent regulations that create entry barriers for competitors. We maintain BUY on Alkyl Amines, Balaji Amines, and Galaxy Surfactants; ADD on Navin Fluorine (NFIL), while maintaining SELL on Vinati Organics. We are also initiating coverage on SRF and Aarti Industries (AIL) with a BUY recommendation.

Domestic availability of petrochemical intermediates to rise: Petrochemical intermediates are the building blocks for downstream speciality chemicals. India depends mainly on imports for petrochemical intermediates. Importing and storing low volumes of raw materials could make speciality chemicals manufacturers uncompetitive. Therefore, availability of petrochemical intermediates domestically is the crucial factor for growth. The increasing demand for petrochemical intermediates from speciality chemical manufacturers is resulting in the diversion of ethylene and propylene to produce petrochemical intermediates. Oil Marketing Companies (OMCs) and other petrochemical manufacturers have realised this opportunity and, to exploit it, have announced projects to manufacture petrochemical intermediates.

Accelerated Capex intensity will pay off: For FY18-20, the aggregate Capex spends of our speciality chemicals universe were 1.5x (INR 78bn) those during FY16-18. The companies had spent Capex for capacity augmentation and/or product development based on their end-user industries. Most (75%) of it was spent for revenue generation, and the remaining for backward integration. We expect growth momentum to continue with revenue, EBITDA and PAT CAGRs of 14/19/23% over FY21-23E owing to (1) increase in the share of value-added products, (2) rising backward integration, and (3) rising utilisations ushering benefits of operating leverage. The EBITDA margin is also expected to expand by ~190bps to 23%.

R&D capabilities to move up companies' positions in speciality chemicals value chain: The aggregate R&D spending by our speciality chemicals (ex-Vinati Organics) universe grew at an 18% CAGR over FY15-19 to INR 2bn. The investment in R&D capabilities has enabled them to secure the confidence of their customers and step up their position in the speciality chemicals manufacturing value chain to become 'custom chemical producers'. AIL and NFIL turn these R&D capabilities into contract manufacturing and research services. Further investment in R&D capabilities will enable speciality chemical manufacturers to step up their position in the value chain to become 'proprietary chemical producers', which will boost their margins.

Source : Equity Bulls

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