Slack in chemicals, lower packaging margins to dent SRF's earnings growth

The shares of specialty chemical company SRF were down 8.5 per cent in trade on Friday, after brokerages downgraded the stock, citing expensive valuations. While most analysts have revised their earnings estimates upwards for the company by five per cent for FY22, they believe the risk reward remains unfavourable after the recent rally. After a 16 per cent gain since the start of April the stock is trading at just under 23 times its FY23 earnings estimates. Even on an enterprise value to operating profit basis, valuations at 18 times are at a 50 per cent premium to five-year averages.

Analysts at Motilal Oswal Research expect earnings momentum to slow to 21 per cent annual growth over FY21-23 due to margin contraction in the packaging segment and lower growth momentum in specialty chemicals, weighed down by a high base. The lower growth comes after robust performance in the last three years which saw the company’s annual net profit jump 42 per cent with stock returns mirroring earnings growth with a gain of 43 per cent.

While the stock was downgraded due to valuations, the March quarter performance was better than expected on most counts. SRF reported a revenue growth of 40 per cent and operating profit margin expansion of 340 basis points, led by the specialty chemicals and technical textiles segments.

Strong demand from overseas markets and higher volumes of key products from European clients led to the growth in specialty chemicals. While the segment grew over 42 per cent in FY21, the company has forecast a 10-15 per cent growth in FY22 due to the high base. SRF has a capex programme of over Rs 1,600 crore in FY22 with 70 per cent of the spends going into the chemicals segment.

The packaging business too saw strong revenue growth due to additional capacities in Hungary and Thailand and higher sales of value-added products. Margins on a sequential basis, however, have declined by 420 basis points and will weigh on consolidated earnings over the next year.

Given the valuation worries, investors should await further correction before considering the stock.