Cautious outlook for specialty chemical manufacturers

Multiple specialty chemical manufacturers are staring at weak prospects in the near term, led by weak global demand and destocking of inventory.

Declining chemical prices and increased competition from China post opening of the Chinese economy are putting pressure on their margins. The only solace for now comes from some decline in raw material prices. Nevertheless, there are multiple factors that led to a cautious near-term outlook for many companies even as analysts maintain a structurally positive view on the sector looking at long-term prospects.

Surya Patra, senior analyst at PhillipCapital Institutional Equity Research in a report, said the Indian specialty chemical industry is all set to face one of the worst quarters in Q1.

This is primarily driven by a broad based disruption in global chemical demand caused by visible economic slowdown in the advanced markets of Europe and the US, ongoing inventory rationalisation and enhanced competition from China.

The demand woes in the global arena, especially in developed markets such as Europe and US, is impacting exports of Indian manufacturers even though domestic demand continues to support the downside for volumes.

The increased supplies of chemicals from China post easing of covid-related measures has been a key concern for Indian manufacturers. The production in China caught pace while local demand failed to impress, leading to more export of chemicals out of China, especially after the Chinese new year.

The increased competition through higher Chinese exports and declining global prices of chemicals have further impacted the performance of the Indian manufacturers.

Many companies have resorted to provisioning for high-cost raw material inventories, too, as prices continued to decline further impacting earnings.

ICICI Securities estimated their specialty chemical coverage universe’s revenue to dip 7% y-o-y in Q1FY24 due to destocking and weak demand. Earnings before interest tax depreciation and amortization (Ebitda) is expected to decline 16.4% y-o-y on weaker spreads and operating deleveraging, they said.

The key decline in chemical costs remains a positive, however, analysts say that they may not be able to completely mitigate the impact of sharp dip in realisations.

The key input prices, energy cost, freight cost have certainly moderated sequentially in Q1 but those fail to protect the margin performance of the Indian chemical industry as the final product prices corrected faster. This was led by aggressive Chinese competition and the industry suffered negative operating leverage due to weak demand, said Patra.

Analysts expect the weakness to continue and not much respite may be expected soon. Rohit Nagraj, senior vice-president at Centrum Institutional broking, said global players’ commentary post Q1 calendar year 2023 results, indicated that the inventory destocking is at the fag end and expected to be over soon.

However, demand related challenges persist and recent commentaries from global chemical players suggest that demand recovery is now delayed to end-2023 or early 2024.

Nagraj said during H2 of FY23, chemical companies’ performance was affected due to lower export demand and believes that in Q1FY24 demand weakness has further exacerbated. Despite growth in the domestic market, significant weakness in exports is expected to take a toll on overall performance in Q1.

Not only does revenue performance remain a concern but deteriorating profitability is taking a toll on earnings, too, said analysts.

Moreover, the likelihood of this situation extending into Q2 and early Q3 makes the near-term earnings outlook bleak, said Patra

Amidst concerns, analysts, however, are recommending that investors make the right picks in the sector looking at structurally positive longer-term prospects. Those at JM Financial Institutional equities said the recent slowdown in the chemicals sector does not bring to an end India’s journey of becoming the next chemicals manufacturing hub.

“Although we agree that there is imminent risk of earnings downgrades, especially for non contracted businesses, we highlight that these corrections should be treated as buying opportunities,” analysts at JM Financial said.