Turning Point for India’s Chemical Sector
India’s chemicals sector has faced significant challenges over the past few years. Rising input prices, poor demand, limited pricing power, and destocking in international markets have led to the sector’s underperformance compared to the broader Nifty 50 Index since FY23. However, recent management commentary during the Q4 FY24 earnings season and high-frequency indicators released for FY25 suggest that the sector may be on the cusp of a turnaround.
Sector Struggles in Recent Years
The primary issue plaguing the chemicals sector has been declining demand, particularly in the international market of Europe, where the economic environment has remained weak. Additionally, cheap exports from China and increased exports from Europe, driven by weak domestic demand, have exacerbated oversupply in the sector. This has resulted in sharp destocking, slower purchases, and diminished pricing power for Indian chemical companies.
The weak demand environment has been a significant headwind. International markets, especially Europe, have seen economic softness, leading to reduced demand for chemicals. Simultaneously, the influx of cheap Chinese exports and increased exports from Europe have added to the oversupply problem. Consequently, companies have faced challenges such as sharp destocking, slower purchase cycles, and reduced pricing power.
Signs of Improvement in FY25
Despite these challenges, Q4 FY24 results indicated some positive trends. Notably, Q4 FY24 saw the highest-ever exports of chemicals (excluding petrochemicals) for Indian companies, despite lower chemical prices. This strong export momentum has continued into FY25. Furthermore, crude oil prices have mellowed so far in FY25, likely leading to lower input costs. Combined with higher pricing power in an improving demand scenario, this is expected to enhance margins for businesses in the chemicals sector.
The improvement in demand, however, varies across different segments of the chemicals sector. Commodity chemicals appear to be best positioned in the recovery cycle, followed by specialty chemicals, while the recovery in agrochemicals is expected to be slower. This is reflected in the capacity utilization rates: for commodity chemicals, it has increased from 62% in Q1 FY24 to 71% in Q4 FY24, whereas for other segments, it has remained stagnant at around 65% during the same period.
Stabilization and Future Prospects
The stabilization in demand has also led to a halt in the decline of chemical prices. For instance, the American Natural Soda Ash Corporation (ANSAC) recently announced an increase in export prices, providing relief to the oversupplied soda ash market. As businesses shift focus from capex to monetizing existing capacity, margins are expected to improve. With improving demand, a favorable product mix, new product launches, and increasing pricing power are anticipated to boost the sector further.
Despite the positive developments, demand has not yet returned to FY23 levels. Analyst estimates suggest that per-unit profitability is still around 20% below FY23 highs. Furthermore, competitive pressures remain high, and pricing strategies are uncertain. Consequently, management commentary during Q4 remained cautious, leading to steep earnings downgrades by analysts. In fact, the downgrades in the sector over the past 12 months have been the steepest in a decade.
Investor Takeaways
Despite these challenges, stocks in the chemicals sector have rallied in FY25. Some stocks, such as Aarti Industries, are already pricing in the most optimistic earnings growth scenarios, leaving little room for further upside. In other words, valuation comfort is lacking for some stocks in the sector.
The evidence of emerging green shoots in the sector is not yet concrete. Therefore, investors should closely monitor the evolving demand and pricing power dynamics. On the flip side, in a market scenario where most sectors have participated in a broad-market rally, the lagging sectors like chemicals may offer higher long-term returns on investment..
Investors should focus on businesses with strong long-term fundamentals that have not yet been adequately priced in. For example, Tata Chemicals is expected to be a primary beneficiary of rising soda ash prices due to higher demand from the solar panel industry, rising input costs, and the high cost of production in China. Similarly, Deepak Nitrite has remained an investor favorite. However, given the dynamic demand scenario in the sector, it is crucial for investors to stay vigilant and keep close tabs on the evolving market conditions to identify strong businesses promptly and capture superior returns on investment.
Conclusion
In conclusion, while India’s chemicals sector has faced significant headwinds in recent years, there are signs that FY25 could be a turning point. Improvements in demand, stabilization of prices, and a shift in business focus from capex to monetization of existing capacity all point to a potential recovery. However, investors should remain cautious and selective, closely monitoring the sector’s developments to make informed investment decisions.
Market this week
| 10th June 2024 (Open) | 14th June 2024 (Close) | %Change | |
| Nifty 50 | ₹ 23,319 | ₹ 23,466 | 0.6% |
| Sensex | ₹ 76,935 | ₹ 76,993 | 0.1% |
- The Indian market extended its winning streak for the second consecutive week, with benchmarks hitting fresh record highs in the week ending June 14.
- The rally was fueled by a moderate US and domestic inflation print, positive trends in global markets continued buying by Foreign Institutional Investors (FIIs), and an in-line outcome from the Federal Open Market Committee (FOMC) meeting.
- During the week, FIIs bought equities worth Rs 2,030.83 crore.
- Domestic Institutional Investors (DIIs) also participated in the buying spree, purchasing equities worth Rs 6,293.38 crore.
Weekly Leaderboard
| NSE Top Gainers | NSE Top Losers | ||||
| Stock | Change (%) | Stock | Change (%) | ||
| Shriram Finance | ▲ | 9.38 % | HUL | ▼ | (3.80) % |
| Ultratech Cements | ▲ | 7.45 % | Infosys | ▼ | (2.91) % |
| HDFC Life Insurance | ▲ | 6.29 % | Kotak Mahindra Bank | ▼ | (2.08) % |
| ONGC | ▲ | 5.76 % | TATA Consumer | ▼ | (2.04) % |
| Cipla | ▲ | 4.51 % | ITC | ▼ | (1.82) % |
Stocks that made the news this week:
- M&M briefly surpassed Tata Motors in market capitalization, becoming India’s second most valuable automobile company, according to Bloomberg data. On the day of Mahindra group’s Investor Day, M&M emerged as the top Sensex gainer. Year-to-date, Tata Motors shares have risen by 25%, while M&M shares have surged by 70%. During its Investor Day presentation, M&M announced plans to introduce six new SUVs and a total of 23 launches by 2030, including seven Born Electric vehicles by the end of the decade.
- Prestige Estates Projects surged over 6% to an all-time high of Rs 1,997 per share on June 14 after global brokerage firm CLSA reiterated its ‘buy’ rating and raised the target price to Rs 2,320, indicating a potential upside of over 16%. CLSA highlighted that Prestige Estates’ valuations are still discounted compared to peers and anticipates a continued re-rating, dismissing debt concerns. The firm noted that operational cash flow will significantly support the company’s capex and project pipeline growth.
- Vodafone Idea (VIL) surged by 1% to Rs 16.38 per share on June 14 after approving the issuance of shares worth up to Rs 2,458 crore on a preferential basis to Ericsson India, Nokia India, and Networks India. The telecom operator’s stock has climbed over 23% in the past three months, compared to a 5% rise in the benchmark Nifty 50 index. Earlier, Vodafone Idea had hit a 52-week high of Rs 18 per share on January 1, 2024.
