Specialty chemicals stocks maybe having a temporary reaction that could fizzle out

• Specialty chemicals stocks have been gaining for the last few weeks due to rising prices in the global markets.
• This run-up is a temporary seasonal effect and does not indicate long-term demand recovery, say experts.
• Without a meaningful demand recovery, rising crude prices can hurt the margins of chemical companies, fear market experts.

Specialty chemical stocks have been running up in the last few weeks, thanks to the rise in prices of basic chemicals in the international markets. However, this exuberance might be short-lived with many headwinds ahead that the sector has to weather through in spite of its long-term potential.

The rise in prices of chemicals is being interpreted by the market as demand recovery which does not seem to be the case, says a report by Kotak Institutional Equities.

“The firmness in prices appears to be related more to short-term and seasonal factors than to a structural improvement in demand-supply, which seems likely to remain challenged for the next few quarters,” the report adds.

Chemicals under pressure

Most specialty chemicals and chemicals stocks have been under pressure for the last one year — with dumping by China affecting their sales as well as margins.

“FY24 will be the year of consolidation with headwinds present as Chinese resurgence, inventory destocking, macro challenges and weak demand. In our view, companies with deep chemistry expertise, scale of products and financial discipline will be the winners,” says a report by IDBI Capital.

After being known as a breakout sector for many years, most specialty chemical stocks have been giving negative returns in the last one year. Even now, experts believe that the valuations in the sector are stretched.

“We note that any recovery is coming off a very depressed base, earnings estimates already factor in a recovery in the second half of FY24 and valuations are now even more stretched for most stocks. Besides, the outlook for end demand remains unclear for 2024 and the supply overhang from China continues to loom,” said Kotak.

In August, mutual funds have completely exited Deepak Nitrite and Balaji Amines; and selling was also seen in large cap as well as small cap companies like Pidilite Industries and Anupam Rasayan.

Source: BSE

A crude shock ahead

Crude oil prices have been hovering around $90 per barrel due to supply cuts taken by oil cartel OPEC as well as Russia. This has started a rally in the downstream chemical prices to cover the prices of basic raw materials that are linked to crude.

But rise in commodity prices in combination with a slow demand outlook is a dangerous combination for the sector – especially Indian chemical makers who are already fighting off Chinese competition.

“We are of the view that if demand does not recover meaningfully going ahead, chemical companies could see the darkest situation of low demand and higher cost which could further drag the margins,” said a research report by SMIFS.

Most Indian specialty companies have also been adding capacity in view of the long-term prospects which are robust. The Indian chemical industry is poised for growth and has potential to become a $1 trillion market by 2040 with a compounded annual growth rate of 8-10% over 2021-40, as per IDBI Capital.

“Despite global headwinds, India still remains on a strong footing in chemicals led by increasing interest of global companies to source from India to de-risk their supply chain, increasing share of speciality chemicals in overall product mix and robust capex aligned by chemical companies to capture future growth,” says SMIFS.

Moreover, the sector has significant entry barriers as players need to possess chemistry proficiency along with R&D as well as technical infrastructure. But, to be able to build for better growth, most specialty companies will have to fight off the medium-term headwinds.