India's specialty chemicals industry (US$32bn) forms 4 per cent of the global pie and is expected to grow at 12 per cent CAGR over 2019-2025. According to Nirmal Bang, a brokerage firm, India’s Chemicals sector has disproportionately rewarded shareholders over multiple time horizons and consistently outperformed leading indices (both domestic and global). 

 

Nirmal Bang believes that this outperformance has been the function of revenue and earnings growth, margin expansion and multiple re-rating. Players who have been able to carve out a niche in complex chemistries, adopted environment friendly processes and established themselves at the global level stand to gain significantly over the next decade. “Considering India’s current salience in the global specialty chemicals space, there is huge headroom for growth going forward. We expect leading players in niche chemistries to deliver non-linear growth over the next decade and shareholders of these companies would be rewarded disproportionately. On ‘Plus One’, we believe that specialty chemicals players would benefit in a big way as they have R&D expertise, skilled manpower, global leadership in niche chemistry capacity etc.,” the report says. 

 

‘Plus One’ is imperative and not a buzzword in the brokerage firm’s view as reducing dependency on China is a structural shift, which is happening, especially after the environment crackdown in China. The US-China trade war and the Covid-19 pandemic would accelerate the pace of this shift as global supply chains would want to completely hedge themselves from supply disruptions. 

 

India is emerging as a more significant player in the global chemicals supply chain with its scalable low-cost manufacturing ecosystem, improving infrastructure and established VHS compliance framework. India offers low cost operations, availability of feedstock, skilled manpower, access to ports and strong IP protection etc. Going forward, the government’s initiatives on making India a manufacturing hub will benefit market leaders in niche chemistries and processes significantly in our view. The country is well positioned to expand its market share globally and there is a huge import substitution play as well.

 

Investment in operational excellence and new product development can create differentiation and strong long-term business visibility. There is a huge appetite for sourcing from India. The brokerage firm believes that the Chinese dominance in bulk chemicals will take more time to reduce but specialty chemicals has always been India’s forte and players having sizable capacity on global scale would be obvious choices for the majority of the multinational companies wanting to outsource/buy.

 

Although, overall Chinese costs are still lower, the gap is narrowing. Chinese labour cost is now double than India and environmental costs are similar. So, inherently, there is a cost advantage in India. While no one can accurately quantify the benefit from the ‘Plus One’ theme, Nirmal Bang expects select players in the chemicals industries ticking all the right boxes to witness non-linear growth over the next decade.

 

Nirmal Bang initiates coverage on SRF Ltd (SRF), Navin Fluorine International (NFIL), Aarti Industries (ARTO) and Vinati Organics (VO), which are established players in respective chemistries at a global level. All these companies are not dependent on China for raw materials. 

 

“We are structurally positive on all the 4 names, but from a 1-year standpoint we have an Accumulate rating on NFIL and VO as future growth has been largely priced in as per our opinion. SRF and ARTO are our top picks with ~25% and ~28% potential upside from CMP. Our report focusses more on specific companies as specialty chemicals is an ocean and each chemistry undergoes different dynamics with regards to the demand-supply, competitive intensity, raw material dependence etc.,” the report of Nirmal Bang reads. 

 

According to the Nirmal Bang, all of these companies have got re-rated over the last 1-2 years, however, the firm believes these multiples are sustainable as there has been a significant shift in the product mix towards high-value products and acceleration in capex intensity with greater visibility about future growth opportunities. 

 

“All these businesses have come a long way and have gained trust of the global majors over the last decade in our view. We believe that the next 10 years could be a dream run for these companies as India strengthens its position in the global chemicals’ universe. We believe that these companies will not be materially impacted by Covid-19 on account of higher salience towards pharmaceuticals and agrochemicals, which are doing well. So far there has been no major delay with regards to future capex plans or execution of long-term contracts. We expect SRF, NFIL and ARTO to nearly double their earnings over FY20-23E despite the challenging FY21,” the report states.