Near-term worry to be acid test for speciality chemical companies

The October-December quarter (third quarter, or Q3) performance of chemical companies is likely to be muted. Some of the issues which weighed on the financials of key players last year, such as supply-side disruptions, concern about raw material availability, and higher power and freight costs, are expected to continue in the near term. Within the chemicals space, brokerages expect companies catering to the discretionary segments to be more impacted than others.

Companies exposed to discretionary applications, such as dyes and pigments, automotive, flavours and fragrances, and polymers, will face several headwinds in the near term, observe analysts, led by Ranjit Cirumalla, at IIFL Securities.

There could be some slippages in the commissioning and ramp-up of new capacities, considering the aforesaid worries. The analysts, however, believe that agrichemical- and pharmaceutical-based value chains will remain resilient. The risk/reward is favourable for bulk chemicals and value stocks like Deepak Fertilisers and Petrochemicals and Chemplast Sanmar. It has downgraded its rating to ‘reduce’ for Navin Fluorine International and Aarti Industries, given the risk to earnings and slippages in capital expenditure (capex) execution.

For speciality chemical players, continued correction in crude oil prices, a sharp decline in freight rates, elevated energy cost, and simultaneous demand moderation could lead to muted earnings performance in Q3. The underperformance in Q3, according to Surya Patra of PhillipCapital Research, comes after the segment delivered consistent healthy earnings growth over many quarters.

The brokerage expects companies under its coverage to deliver a 6 per cent decline in overall earnings (and flat sequentially) on the back of flat revenue and margin compression of 110 basis points during the quarter. Although input costs are down, that might not bring relief to companies in Q3, given elevated energy (coal) costs, high-cost inventories or container contracts.

Moreover, volatile crude prices in Q3 deferred the input price adjustment/correction, leading to pressure on margins, says Patra.

IIFL Research, too, believes that pressures have not abated, notwithstanding moderation in power and freight costs as companies have not been able to completely pass on the incremental costs. They expect a reduction in freight charges to benefit exporters, helping them buffer the impact on profitability.

Among stocks under its coverage, Vinati Organics is uniquely positioned to deliver strong earnings with improved margins over the year-ago period, led by higher demand for its products, says PhillipCapital.

Kotak Institutional Equities believes that Q3 for speciality chemicals will be a mixed bag, with weak earnings from most players in the crop protection space. The brokerage, however, says there are specific growth drivers for firms like PI Industries, Clean Science & Technology, Vinati Organics, and Navin Fluorine International. Amid weakening macros and valuations above its comfort zone, it advises investors to maintain a watch for better entry points into the stocks.

While there are near-term headwinds, some brokerages remain optimistic about the prospects of the sector. Despite global headwinds, India remains on firm ground in chemicals, led by increasing interest of global companies to source from India to derisk their supply chain, increasing the share of speciality chemicals in the overall product mix, and robust capex plans of chemical companies to capture future growth, says SMIFS Research.

With China relaxing its Covid curbs, demand is expected to remain vigorous, although Chinese New Year, which starts on January 2 and ends on February 5, can be a short-term demand dampener, believe Aditya Khetan and Awanish Chandra of the brokerage. Their top bets are National Organic Chemical Industries, Bodal Chemicals, Phillips Carbon Black, and Supreme Petrochem.