Analysts caution against betting on crude-dependent chemical stocks

Global and domestic equity markets alike have not been able to take a breather from a slew of headwinds that continue to rattle them three months into the calendar year 2022.

With Brent crude leaping to almost $140 per barrel on Sunday, the highest it has been since 2008 – up nearly 80 per cent thus far in calendar year 2022 (CY22), multiple sectors have started feeling the heat of the subsequent raw material inflation.

Among the impacted is the chemical sector, which had only recently begun gaining ground from Covid-19 induced increased logistics and freight charges and China-plant shutdowns.

The Russia-Ukraine crisis has sprung up worries for the sector yet again as analysts say margins of chemical companies will be impacted due to the rise in prices of crude oil, which is a key raw material for many players, with their performance to remain weak in the near term.

“High crude oil prices will likely lead to further input cost pressure for most chemical companies. Logistics were cooling off a bit resulting in some easing, however, the prevailing situation is likely to pressurize the supply chain again,” said brokerage B&K Securities in a recent note.

Within the space, companies with high dependency on crude based-derivatives will see a much larger impact and, therefore, investors must avoid these in particular, advises G Chokkalingam, founder, Equinomics Research.

“Lubricant companies, petrochemicals and commodity chemical makers are highly dependent on crude-based oil derivatives. So, companies like Savita Oil Tech, Gulf Oil, Philip Carbon, and Deepak Nitrite will be badly affected”, Chokkalingam said.

According to JM Financial, prices of a majority of chemicals have corrected sharply from their recent peak levels hit between September-November 2021. But recently, prices of some crude derivatives chemicals such as benzene, phenol, toluene, and xylene have again begun firming up due to a jump in crude oil.

Chemical majors such as Alkyl Amines, Atul, Deepak Nitrite, NOCIL and Vinati Organics are significantly dependent on crude derivatives, as per Motilal Oswal, with benzene, toluene, and acetic acid being their key raw materials. On a year-to-date (YTD) basis, the raw material prices for these companies have risen 17 per cent on an average from FY21, it said in a recent report.

“Even though recent correction in many chemical stocks have made valuations attractive from a long term perspective, the sector will not be able to deliver good performance at least for the next one to one-and a half years,” said AK Prabhakar, head of research at IDBI Capital.

Among those likely to be impacted the most with the surge in crude price, Deepak Nitrite, NOCIL, and Alkyl Amines have corrected 26 per cent, 21 per cent, and 15 per cent, respectively, year-to-date (YTD). In comparison, the Sensex benchmark has fallen 9 per cent, while the BSE mid-and small caps indices have shed 11 per cent and 13 per cent, respectively.

“One needs to be a long term investor in chemicals as presently high crude and raw material prices will result in inflationary pressures on all fronts impacting their margins. Next two-three quarters will be very difficult for the sector,” Prabhakar adds.

He prefers recently listed Ami Organics and Clean Science Technology from the space as these companies are engaged in creating niche products, which he believes, will act as import substitutes from China. He also likes SRF, Gujarat Alkalies and Chemicals, and Variant Organics, among others.

Meanwhile, Chokkalingam is positive on companies that do not majorly rely on crude-linked inputs, such as India Glycols, which he says, would actually benefit from high oil prices as it produces substitutes of oil derivatives through sugar molasses. Another preferred bet of his is specialty chemical player BASF, whose dependence on crude oil is relatively less.