Valuation hurdle weighs on stocks of specialty chemical companies

Top companies in the space have risen sharply over the last year

Stocks of specialty chemical companies have been among the biggest gainers on the bourses over the last year, outperforming the broader market. The top five specialty companies by market capitalisation have gained over 50 per cent since June last year, compared to 12 per cent that the Sensex has generated. 

There have been multiple reasons for the strong showing by these companies. In addition to the crackdown on Chinese chemical manufacturers, the triggers include trade disputes and anti-dumping duty by the US on Chinese imports, domestic demand from user industries as well as export opportunities to the developed markets. From a small base, the sector has grown double digits over the past decade. Analysts expect the double-digit growth rate for the $35-billion sector to continue over the next few years. 

While companies have been expanding their capacity to tap demand over the last couple of years, analysts expect the capital expenditure (capex) in the 2018-19 to 2021 period to nearly double to about Rs 6,200 crore. Among the companies doubling their capex over the next few years is Aarti Industries, which is the country’s largest specialty chemicals player.

Similarly, SRF, which is a diversified chemicals player, is also expected to benefit from expansion and pickup in global agrochemicals and fluorochemicals. 

While growth prospects remain robust, analysts believe that valuations have turned expensive. Analysts at Edelweiss Research believe that valuations already factor in the optimism and potential growth drivers. In addition to the hazardous manufacturing process, they cite regulatory risks like further tightening of pollution norms and compliance in India. These might increase capital spending, thereby impacting margins. Any slowdown in underlying sectors such as fast-moving consumer goods could also affect sales of chemical companies.  

The top companies are trading at over 25x their one-year forward price-to-earnings estimate, which is at a 20 per cent-plus premium to the industry average. Given the sharp run-up, brokerages recommend adding players such as SRF, Aarti Industries, and PI Industries on dips.