Graphic: Mint
Graphic: Mint

China output curbs, rupee fall put specialty chemicals on a better footing

Apart from vendor consolidation due to production curbs in China, the recovery in the global agrochemicals market is another opportunity

The steep correction in the equity markets notwithstanding, shares of specialty chemical producers, Aarti Industries Ltd and SRF Ltd, continue to hold above the year-ago levels. Aarti Industries is up 42% over the past year compared with a 2% fall in the BSE 500 index. SRF is up about 5%. Shares of specialty chemicals firm Vinati Organics Ltd also held up rather well—up 25% from a year ago.

The outperformance reflects the improving business environment. Sanjeev Hota, associate vice president (research) at Sharekhan Ltd, says Indian companies are gaining market share after China’s imposition of stricter environmental rules curbed supplies, triggering vendor diversification.

According to Edelweiss Securities Ltd, the tighter environmental rules have raised production costs in China, leading to cost competitiveness and increasing outsourcing opportunities for Indian manufacturers. “Though there are no sufficient data points to substantiate this, management commentaries, industry articles, etc., corroborate our view," analysts at Edelweiss said in a note.

While the sharp rupee depreciation should aid the domestic industry’s export competitiveness, Hota of Sharekhan warns that all companies will not benefit uniformly from vendor reorganization. Companies such as Aarti Industries, which have greater exposure to the export business, are seen to be better placed. Compared to SRF, Aarti Industries also derives a large portion of its revenues from the chemicals business—85% compared to 32% at SRF.

Apart from vendor consolidation due to production curbs in China, the recovery in the global agrochemicals market is another opportunity. After years of stagnation, the global agrochemicals market is on the path to recovery. “Things have started perking up during the latter part of FY18. Initial signs of the slowdown cycle bottoming out are apparent—global commodity prices are strengthening, agrochemical exports from China have dipped and the INR has weakened. Moreover, inventory levels are low," add analysts at Edelweiss.

The management commentaries too have been alluding to recovery in the global agrochemicals market. After releasing its first-quarter results, SRF said it expects the specialty chemicals business to rebound in the second half of the fiscal year, tracking the recovery in global agrochemicals.

These developments have helped the stocks. But as an analyst at a wealth management firm says, the key now is upside potential. As Aarti Industries announced large order wins, the stock has seen strong gains. It now trades at 16 times FY20 earnings compared to SRF’s 14 times.

“While Aarti Industries is reflecting all the positives, SRF is discounting all the negatives," adds the analyst, referring to delayed recovery in global agrochemicals demand.

A difference of a percentage point or two in valuation may not be a major deterrent for investors. What matters more is business and earnings momentum. On these yardsticks, Aarti Industries is on the forefront, winning two large orders and diversifying into new value chains. While SRF’s positive commentary should translate into earnings in the coming quarters, continued business gains (order wins) by Aarti Industries will strengthen investor confidence in the stock.