Premium valuations for specialty chemicals to sustain on multiple tailwinds

Near-term upsides however are limited given the spurt in stock prices

Investor interest in specialty chemical companies continues to be strong given the stellar listing gains for Clean Science and Technology and the subscription for Tatva Chintan Pharma Chem. Clean Science, which develops eco-friendly technologies and operates in performance chemicals and pharmaceutical intermediates, is up 78 per cent on debut. Tatva Chintan, another specialty chemical company, has seen a 14 times oversubscription for its initial primary offering which closes on Tuesday.

Among the larger listed players, Deepak Nitrite has been a major outperformer, nearly doubling in value over the last six months. Even over a three year period while most large specialty chemicals companies have generated returns over 200 per cent, Deepak Nitrite has been an outlier enriching investor wealth by a whopping 782 per cent. The Nifty 50 on the other hand trails behind over this period with returns of 43 per cent.

Gains over the last year for most of the specialty chemical companies have come on the back of the China+1 strategy adopted by global multinationals. Says Yogesh Patil, senior research analyst at Reliance Securities, “Post Covid-19, several downstream MNCs that used to import bulk of their chemical requirements from China are now contemplating to supplement this supply from elsewhere to reduce dependence on China. This has been a positive trigger for Indian specialty chemical industry.”

In addition to the export opportunity, strong domestic consumption, low cost labour compared to China, lower regulatory costs, strong intellectual property protection and government policies (import substitution) are the other factors which benefit Indian companies. Innovation led by progress on the research and development front and new product launches could add to incremental growth for the sector.

These triggers are expected to help the sector grow at over 12.4 per cent over CY20-25 to hit $64 billion. The growth is on a higher base of $32 billion; the domestic specialty sector  has grown 11.7 per cent which is double the global growth rate over CY15-20, according to analysts at Motilal Oswal Financial Services.

While sales are expected to rise as India accounts for under 5 per cent of global specialty chemicals market but is registering double the global growth rates, valuations are now in the premium zone. B&K Securities had pegged a three-year target of Rs 1,600 for Clean Science and Technology valuing the company at 35 times its FY25 earnings estimates. Given the surge on day one of listing, the targets have already been reached. Most brokerages believe that valuations are in the premium zone with most specialty companies trading at 30-40 times FY23 earnings.

Siddhartha Khemka, head-retail research, broking & distribution, Motilal Oswal Financial Services, says that the higher valuations are based on the promise of consistent growth going ahead. Most of the companies getting listed are operating in niche segments, have global leadership and a consistent track record of growth and profits.

Given that the street is paying for growth, valuations are unlikely to correct in the near term. Ashish Chaturmohta, Director, Research at Sanctum Wealth Management believes that these companies will trade at higher valuation as growth is visible for the next 8-10 years. His top picks are Navin Fluorine, Aarti Industries, PI Industries and SRF. Patil of Reliance Securities is also bullish about the long term prospects of Aarti Industries as the company recently revised their growth guidance upwards and expects margins to improve from FY23.

While the long-term growth trajectory appears robust and there are multiple tailwinds, given the sharp rise in stock prices, the sector has priced itself to perfection ignoring risks such as supply disruptions/manufacturing delays. Near-term upsides are therefore capped. Investors should await meaningful correction before considering these stocks.