Chemical stocks may underperform; brokerages stay cautious

Since their highs in September, chemical stocks have underperformed the benchmarks and broader indices over the past month with larger players witnessing a 9-22 per cent fall during this period.

Expectations of weak September quarter results amid high inventory, demand woes and weak realisations have led to the underperformance.

The rally in chemical prices over the last month and a half has, however, boosted sentiment for companies in the sector.

Brokerages, however, have a mixed outlook on the sustainability of the pricing improvement and are by and large cautious on the sector.

They either recommend players higher up the value chain or contract manufacturers to investors.

Jason Soans and Aayush Rathi of IDBI Capital say that certain chemical prices are exhibiting smart recovery in prices owing to demand recovery, abating of intensity in dumping by Chinese players (owing to unsustainability of such low prices), rise in crude prices and hopes of strong stimulus measures in the Chinese economy.

The analysts expect commodity chemicals to witness improvement in pricing levels owing to decent domestic demand and abatement of Chinese dumping.

Companies, according to the brokerage, with long term contracts which have price variation clauses embedded in them will fare better owing to better revenue visibility and margin protection.

It expects companies who are higher up the specialty chemicals value chain (SRF, Navin Fluorine) to benefit immensely from a longer term perspective.

Prabhudas Lilladher Research highlights that even as base chemical prices are moderating (excluding crude oil), the demand environment continues to be weak, particularly in discretionary end user industries.

Companies with exposure to industries such as refrigerants and fluoropolymers to see pricing pressure on account of demand slowdown, says Swarnendu Bhushan of the brokerage.

While chemical prices have seen some recovery, brokerages believe caution is warranted.

Analysts led by Ranjit Cirumalla of IIFL Research cite channel checks which indicate muted demand persisting for most of the chemicals in domestic and export markets.

The lower aggression by the Chinese suppliers could be a function of limiting losses while any curbs going into the winter season to reduce pollution would be an additional supply constraint.

However, the brokerage believes there is no meaningful recovery in the demand so far, and therefore the current momentum is unlikely to hold steady.

On the back of a weak quarter (Q2FY24) Kotak Research highlights the risk of earnings downgrades.

Q2 would be a weak quarter for most chemical companies due to continued destocking by customers, demand weakness across certain important end-use industries, and price erosion amid intense competition from Chinese suppliers, says the brokerage.

Companies at risk of maximum downgrades to FY2024 earnings estimates are Aarti Industries, Atul, Navin Fluorine, SRF and UPL.

Say analysts led by Abhijit Akella of the brokerage, “The asking rate for earnings in 2HFY24 is likely to be almost impossibly high following two consecutive quarters of weak earnings in 1HFY24.

"But these are not all: other companies that are at risk — albeit to a lesser extent — are Deepak Nitrite, Tata Chemicals and Vinati Organics, unless their earnings pick up meaningfully in 2HFY24.”

Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.

Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.