CARE PMS opines that Indian chemical companies have been witnessing 20-25% earnings growth in the last three years due to improved pricing, benign crude and positive sentiment on China+1 theme.

This enabled industry to generate operating cash flow (OCF) of Rs 1,856 crore with capex at Rs 900 crore over FY16-21; the industry is gearing for capex of Rs 460 crore over the next two years. Increasing capex will burden gross block turnover (1.4x in FY21 vs 1.8x in FY18) and rising input costs will hurt margins (OPM 17% in FY21 vs 14% in FY18), a latest research report by Care Portfolio Managers (CARE PMs) states. ICN carries here the brief of the report.

The Indian chemicals story is no more a generic broad-based one as we are cautious on project execution challenges, delay in RM price pass-on and China+1 not playing out meaningfully due to limited petrochem infra.

According to the report, in the midst of capex cycle, demand environment needs to be strong in FY16-21, industry revenues grew 8% with capex of Rs 900 crore (top 5/10 account for 29%/37%). Investments were made in downstream (for growth) and backward integrated (to reduce RM volatility). Capex was largely funded internally as industry had strong cash conversion (OCF/EBITDA: 90%) and simultaneously expanded margins.

Basic chemical segment’s share to remain dominant

Basic chemicals formed 79% of industry revenue in FY21 vs 84% in FY16. Its share is expected to remain high with improving domestic demand and import substitution. Even China’s basic chemical segment contributes ~80% to overall industry revenues. In the last five years, basic chemical companies improved EBITDA margin to 17% in FY21 from 11% in FY16 along with balance sheet improvement. With scale, faster execution and nimble-footed management, basic chemicals can also be a profitable segment. Deepak Nitrite, Aarti and Atul will continue to gain traction given wide product baskets, higher exposure to domestic industry, vertical integration and scale.

CSM to remain major theme for a decade

(1) As China continues to move up the economic-development ladder and expand in industries like semiconductors and electronics and (2) Europe (25% share in US$200bn global CSM industry) and China (15%) become environment conscious, global demand for conventional agrichem/pharma molecules will be incrementally met by countries like India. India (10% share) is rightly placed as it offers (1) stable political environment with transparent policies/practices (very relevant in present times), (2) legacy of IP protection (thanks to PI & Divis), (3) R&D culture with technology transfer capabilities and (4) adherence to QSHE standards. With strong base of working with global innovators, SRF, PI, Navin Fluorine have an edge to scale operations.

India’s chemicals industry is on a strong footing supported by improving domestic as well as export demand. India has 4% share of the global chemicals industry (4% share of specialty as well) and even a marginal shift of sourcing from China (~37% share of global market) will significantly boost growth of the industry. The specialty segment will be the primary beneficiary as the domestic manufacturers forward integrate into downstream high value intermediates.

According to the report, the industry will continue to invest in capacities as it offers best growth (15-20%) and Indian manufacturers move towards downstream products/chemistries. The increased capital investments will be supported by stable working capital, low leverage on balance sheet and strong cash conversion (OCF/EBITDA averaged 90% over FY16-21).

The report forecasts that margin and gross block turnover will remain volatile near term due to volatile operating environment but in the long term investments will strengthen the operating framework of the industry as nearly 45% of incremental capex will come from top 12 listed companies which are entering into new chemistries, pharmaceuticals CSM, solvents, high performance products, antioxidants and MCA.