The outlook suggests a gradual recovery ahead, with Q3FY24 poised to demonstrate subdued performance amidst prevailing market challenges.
Indian Chemical Stocks Struggle to Meet Market Momentum
In the past year, the performance of Indian chemical stocks has lagged behind the broader market, failing to keep up with the Nifty 50 index, which experienced a nearly 20% surge. While prominent chemical companies such as SRF observed a minor upturn of around 7%, UPL Ltd and Navin Fluorine International Ltd endured declines of about 27% and 15% respectively. This stands in stark contrast to their remarkable showing in 2022, with stock gains ranging from 30% to 120%.
Factors Influencing Underperformance
The lackluster performance can be attributed to a combination of weak export demand and surging input costs, which have exerted pressure on quarterly earnings. Companies heavily reliant on exports, like UPL, SRF, and Navin Flourine, are grappling with the repercussions, given that export revenues accounted for 82%, 51%, and 66% of their total revenues in FY23 respectively.
Challenges for the Fiscal Year 2023-24
The first half of fiscal year 2023-24 bore the brunt of feeble exports, and the outlook for the December quarter (Q3FY24) remains subdued. Typically, Q3 is a seasonally lackluster period, owing to the holiday season in Europe and the US.
Projections and Expectations
Centrum Broking anticipates UPL to post a year-on-year decline in sales and EBITDA, while SRF is expected to follow suit with both year-on-year and sequential drops in sales, impacted by sluggish exports. Navin Flourine is also projected to register a year-on-year dip in revenue and EBITDA, although sequential growth is expected. (EBITDA refers to earnings before interest, tax, depreciation, and amortization.)
Promising Signs of Export Recovery
Nevertheless, there are indications of a potential export resurgence. European chemical production experienced a marginal rise of 0.5% in the third quarter of the calendar year 2023 (Q3CY23), marking the first positive movement in six quarters, despite enduring a significant 10.6% year-on-year decline in the initial nine months of CY23.
Signs of Recovery in Global Chemical Industry
The global chemicals industry faced a multitude of challenges in 2023, including a European recession, US inflation, and slow demand recovery from China. However, there are now signs of easing. The American Chemistry Council forecasts a modest 1.5% rise in US chemical production in 2024 after a 1% decline in 2023, with global output expected to grow by 2.9% year-on-year. The destocking that began in Q3CY22 has largely concluded, but restocking is yet to commence.
Challenges for Specialty Chemical Stocks
Specialty chemical stocks, such as Navin Flourine and SRF, may continue to face pressure due to the phasing out of certain refrigerant gases in the US, which could impact revenues from exports. Additionally, recent attacks on commercial carriers in the Red Sea have led to higher freight rates and insurance costs, along with extended voyage times impacting supply chains and profitability.
Gradual Recovery and Q3FY24 Outlook
While a recovery seems imminent, it is expected to be gradual, with Q3FY24 likely to show muted performance. UPL, in its Q2FY24 earnings call, acknowledged the challenging phase in the global agrochemicals industry, marked by significant price drops and distributor destocking in key regions like Brazil, North America, and Europe.
Potential Rebound for Indian Chemical Stocks
Despite these short-term challenges, Indian chemical stocks may be preparing for a rebound. Early indicators of a global recovery in the chemical sector hint at a potential revival for Indian companies, with Centrum Broking predicting a sharp upturn in FY25E followed by normalization in FY26E. While the immediate future looks subdued, long-term investors might find attractive opportunities in these currently undervalued stocks, with their price-to-earnings multiples now in the range of 12-44 times, compared to 21-77 times in January 2022.
