In the year 2020, the Indian markets experienced a robust bull run, and among the shining stars of that period was the chemicals sector. Fueled by a resurgence in domestic demand and transformative changes in the global supply chain, this sector produced numerous multibagger stocks.
Companies like Tata Chemicals and Deepak Nitrite multiplied investors’ wealth by over 3X, while Balaji Amines compounded their wealth by over 5X.
Cut to the present, the overall market is once again turned bullish. But this time around, the chemicals industry is not part of the party. The benchmark Nifty 50 hit fresh new highs on July 20 and returned over 5% in the past month. Amid this hot rally, chemicals and retailing were the only sectors to generate negative monthly returns. In the past year, the chemicals sector gave dismal returns of close to 1.6%.
The Indian chemicals space is facing multiple challenges now. A decline in demand and higher Chinese supplies have created an uncertain landscape. Could this once-promising sector be facing a major roadblock in its growth?
Global markets face subdued demand
Global markets are facing a challenging demand environment, particularly in the US, Europe and Latin America. In the US, organic, inorganic, and agrochemical imports fell by 15% to $36 billion in the first five months of 2023. According to the U.S. Department of Commerce, imports of chemicals under the category of industrial supplies are also declining.
End-users in sectors like agrochemicals and advanced pharma ingredients are dealing with excess inventory at the dealer level, while reduced discretionary spending has led to lower demand from dyes and pigments, electric vehicles, electronics, and construction sectors.
Many foreign chemical makers like Evonik Industries, FMC, and Lanxess AG have guided a sluggish second quarter. A rather disturbing comment on the decline in volumes came from Matthias Zachert, CEO at Lanxess AG, “This feels like Lehman II.” This specialty chemicals maker is also being affected by the high energy costs in the EU.
Indian chemical exporters are also feeling the impact of this global slowdown. Organic and inorganic chemical exports from the country between January and May 2023 fell by nearly 10% YoY. India’s chemical exports had been rising with a healthy CAGR of 9.5% between FY14 and FY22. But the global slowdown has stalled this dream run.
The scenario in the home market is not very bright either. Demand for air conditioners was sub-par in April and May due to a weak summer season. This is likely to impact the offtake of refrigerant gasses as well. SRF, Gujarat Fluorochem and Navin Fluorine are major refrigerant manufacturers in India.
Chemical prices plummet due to dumping from China
China, known as the world’s largest chemical producer and consumer for more than a decade now, is facing a consumption slowdown despite its full reopening at the start of 2023. Given this, Chinese chemical companies are dumping their produce at dirt-cheap prices in foreign markets like India and Latin America.
The agrochemical industry is a major consumer of fluorine, benzene and phenol-based chemicals. Companies in this sector have been seeing higher Chinese supplies for generics since February. The oversupply has now worsened, causing prices of essential chemicals to fall sharply.
Fearing more correction in chemical prices, distributors are rapidly clearing their high-cost inventories, while fresh orders have decreased, directly affecting manufacturers' sales volumes.
Chemical companies to start FY24 on a weak note
According to ICICI Securities, specialty and commodity chemical makers may see a YoY fall in their Q1FY24 revenue due to weak realizations and volumes. Consensus estimates from analysts also indicate that companies like SRF, Deepak Nitrite and Gujarat Fluorochem may register a decline in their revenue and earnings.
While Tata Chemical may perform reasonably well, Navin Fluorine stands out. The company started manufacturing a new fluorine derivative for Honeywell in Q2FY23 and this has enhanced its overall revenue base. The business of fluorides and refrigerants has been a traditional mainstay of Navin Fluorine. But in the past decade, its main focus has been on expanding its specialty chemical, and contract development and manufacturing divisions.
Commenting on the pricing pressures in the specialty chemicals industry, Radhesh Welling, Managing Director at the company, said, “The company is not heavily impacted by pricing pressures as most of our business is contracted and we primarily work with innovators on new molecules.”
Chemical companies with a higher exposure to contract business are expected to do relatively better amid demand and pricing concerns, according to Axis Securities. This trend is also evident in the agrochemicals space, where PI Industries has outperformed other players.
Unpredictable weather, heat waves increase risk factor
Brokerages like Kotak Securities expect the prospects of the chemicals sector to remain subdued in H1FY24. Some independent analysts also see this challenging situation extending throughout FY24. Extreme weather conditions prevailing in India and the world only add fuel to the fire.
Wondering what’s the connection here? European countries and parts of the US are witnessing severe heat waves. Some Indian states are receiving higher than average rainfall, resulting in floods. Such events can hamper the farm sector. This also affects the industries dependent on agriculture, including fertilizers, agrochemicals, and specialty chemicals.
Analysts as a result, see lower growth for chemical majors in the next two years. Tata Chemicals’ top line may grow the slowest, while Navin Fluorine may sustain a robust performance.
Long-term prospects are still intact, fluorochemistry shows potential
Global consultancies and analysts stay optimistic about the Indian chemicals space despite this slowdown. Mckinsey sees the Indian chemicals market growing at a 9% CAGR to reach $305 billion in 2027 and an average of $925 billion by 2040. A recent report of EY expects the Indian speciality chemicals market to grow twice as fast as global markets in 2021-26.
Within specialty chemicals, Jefferies is particularly optimistic about fluorination chemistry. Indian players have more than doubled their revenues from the fluorochemicals business in the past two years. They have also outperformed their Chinese counterparts in the past five years.
These chemicals find applications in ACs, automobiles, cold storages, pharma, and agrochemicals. Fluoropolymers, a sub-segment of fluorination chemistry, are essential for manufacturing chips used in electronics and EVs.
Just about seven companies control 60% of the fluoropolymers supply. Among them, 3M plans to phase out the production of polyfluoroalkyl (PFAS), a key type, by 2025 due to health risks. But there is also no real alternative to it in the semiconductor industry. This creates a chance for Indian players to fill the gap and meet future demand.
Seeing this opportunity, SRF is commissioning a new fluoropolymers plant at Dahej in FY24, as a part of its medium-term capex plan. Meanwhile, Gujarat Fluorochem also seeks to invest Rs 1,000 crore in fluoropolymers and battery chemicals this year.
In the long run, the Indian chemicals industry has many factors, such as growing industrialization and low labour costs, making it an attractive manufacturing hub. Rapid urbanization and rising per-capita incomes also support domestic consumption.
But before the industry realizes its true potential, companies may have to sail through some rough waters. Investors may have to bide their time before betting on this sector again.
This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation