Chemical sector on the cusp of a turnaround with improving pricing environment, says Ambit Asset Management

Ambit Asset Management highlights that several companies are currently trading at attractive valuations, with some of its portfolio stocks like Rossari, PI Industries, and Alkyl Amines offering forward FCF yields exceeding 2%–3%.

A Ksheerasagar
First Published10 Jul 2024, 03:23 PM IST
Chemical sector on the cusp of a turnaround with improving pricing environment, says Ambit Asset Management.
Chemical sector on the cusp of a turnaround with improving pricing environment, says Ambit Asset Management.(Bloomberg)

Over the past few years, the Indian chemical sector has witnessed a significant de-rating, driven by channel destocking among global players, escalating feedstock costs, diminished pricing power due to destocking effects, and rising freight expenses owing to global supply chain imbalances.

Consequently, the sector's valuation multiple has declined to 39x the forward one-year PE, marking an 18% decrease from peak multiples, with forward PE ratios reflecting subdued earnings.

However, insights from domestic brokerage firm Ambit Asset Management, gleaned through interactions with industry players and channel partners, suggest that the chemical sector is poised for a turnaround. This optimism is buoyed by an improving pricing environment, which, if sustained, could replicate the robust double-digit growth witnessed by companies during FY17–22.

Also Read: TCS Q1 result tomorrow: June quarter likely to be softer; margin may remain under pressure

Ambit highlights that several companies are currently trading at attractive valuations, with some of its portfolio stocks like Rossari, PI Industries, and Alkyl Amines offering forward FCF yields exceeding 2%–3%.

The brokerage identifies key drivers for the anticipated pricing improvement, including reduced channel inventories, significant deflation in raw material costs leading to improved spreads from 2HFY25 onwards, and early indicators of a rebound in global demand.

Golden period

Between FY17–22, chemical companies experienced a golden period marked by record EBITDA margins, robust revenue growth, and strong cash flow generation. Across sub-sectors such as agrochemicals, specialty chemicals, amines, and glass-lined reactors, companies witnessed outstanding performance.

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For instance, companies like SRF and PI Industries in agrochemicals, and Aarti Industries, Deepak Nitrite, Navin Fluorine, and Vinati Organics in intermediates and specialty chemicals, along with Alkyl Amines Chemicals and Balaji Amines, reported impressive average and median 5-year earnings at a CAGR of 31% and 29%, respectively, during this period, said Ambit.

Post-COVID distress for the sector

Following the COVID-19 pandemic, the brokerage said the chemical sector underwent significant de-rating, with valuation multiples correcting by approximately 18% to 39x the forward one-year PE, compared to the bull period's multiple of 46x.

The sharp correction in EBITDA margins and ROCE during this period was a key factor contributing to the downturn. Analysts revised their estimates downward across companies due to higher depreciation and interest costs, leading to year-on-year profit declines.

Also Read: Fineotex Chemical share price: Nirmal Bang sees 25% upside in long-term

Time is ripe for a re-look at the chemical sector

The brokerage highlighted that the chemical sector is poised for a turnaround, underscoring the following key factors including improvements in pricing.

Better Monsoon and Good Sowing: After challenging years, the Indian Meteorological Department predicts above-average rainfall in 2024, estimated at 106% of the long-term average. Ambit noted that the weakening El Nino is expected to transition to a neutral phase by the onset of the monsoon, with La Nina conditions potentially developing later. This bodes well for domestic ag-chem players, suggesting a strong sector recovery.

Also Read: Monsoon & Share Market: What do above-normal rains mean for the economy? How should investors play the monsoon theme?

Improving Spreads: The brokerage has observed that spreads and prices are gradually returning to historic levels, signifying a return to normalcy. Phenol-acetone spreads have increased over the past few months, although they are still below historic lows. Additionally, generic ag-chem pricing has seen a sharp rebound recently.

Underutilised Gross Block Addition: Ambit points out that robust capex from FY20–24, coupled with low demand, has led to low utilization for most companies. This implies that capex over the next four years is likely to remain muted. However, with ample capacities already in place, future capex as a percentage of OCF will decrease significantly.

As operating profits increase due to better demand, pricing, and operating leverage, the sector is poised for exponential growth.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions

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First Published:10 Jul 2024, 03:23 PM IST
HomeMarketsStock MarketsChemical sector on the cusp of a turnaround with improving pricing environment, says Ambit Asset Management

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