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China's decline in specialty chemicals business to benefit India
Mar. 30, 2016
Shares of Indian companies in the specialty chemicals business could be potential winners as the domestic industry could be beneficiaries of a potential decline in this business in China.
The Indian market is very small, barely 1-2% of the global market, which is growing at a rapid pace, said a report by Ambit Capital.
The global specialty chemicals market is likely to expand by 5.2% on a compounded basis from 2013-2018, and is estimated to jump to $761 billion by 2018 from $619 billion in 2014, said the report. "Business is shifting to India from China," said Dhiraj Sachdev, vice president, HSBC Asset Management.
"This is mainly on account of stringent effluent norms and increasing wage costs in China. India is only one -eighth, or one-tenth, the size of Chinese speciality chemicals market, which throws up a huge opportunity for Indian companies with the potential to scale up and grow on a sustained basis." Specialty chemicals are used to improve product quality in various industries such as electronics, paints, coatings, plastics, and automobiles. Though there's a consensus that the sector has huge potential, there are others who tell investors to be wary.
"There's a huge play in here, but you have to be very careful about where you are investing," said Hansal Thacker, director, Lalkar Group. "We are betting on ABS, which is a basic chemical used in consumer durables, toys, electrical circuits, interiors of cars — the applications are endless.
There's going to be a shift in consumption pattern and that will trigger the consumption of ABS." What makes the sector a good investment bet is that it's a very highly skilled segment, thus, providing a natural entry barrier. "Unlike the pharma sector, high-quality players in emerging markets which can deliver on innovators' quality and safety parameters are limited," said Ritesh Gupta, oil and gas, midcaps analyst and co-author of the Ambit Capital report whose top picks include PI Industries and SRF. "Facing compliance, cost, and capacity issues, global agrochemical innovators are looking to outsource their manufacturing processes to India. This creates an opportunity for Indian firms over the next 5-10 years." The report pegged PI Industries P/E at 20.3x estimated earnings for 2017-18 and SRF at a P/E of 15x estimated earnings for the same period. Shares of PI Industries have fallen 9% in the last month, while that of SRF have risen about 5% in the same period.
"Specialty chemical companies will prosper in India because of its chemistry, R&D skillset and economies of scales achieved by the country," said Manish Bhandari, CEO at Vallum Capital. "This is supported by a paradigm shift in Chinese markets towards urgency of reducing pollution and investing in labour cost across industries. "We have established ecosystem of basic chemicals, a key input of specialty and pharmaceutical industry." His preferred companies include PI Industries, SRF, Navin Flurochemicals, Godrej Industries and Balaji Amines. Some believe that valuations are rich while others feel they are justified.
According to the report, the specialty chemicals sector has been one of the best performing sub-sectors with most of the players delivering returns between 50% and 100% over the past year. This has made multiples increase from 5x one-year forward earnings to a band of 12-30x. It also said a 15-20x one-year forward earnings multiple is not expensive, because of the growth profile and high RoCEs that these companies provide. "Specialty chemicals don't sell a product, they sell a solution which means their margins will remain intact.
Don't be blinded only by valuation, address the opportunity as well," Thacker said. The fact that Indian players are being preferred for value propositions such as process capability, purity and IP protection rather than merely cost arbitrage is a reason to cheer, said analysts.
Source: The Economic Times
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