Sector Update: Chemicals

Chemicals industry in India is highly diversified, covering more than 80,000 commercial products. It is broadly classified into Bulk chemicals, Specialty chemicals, Agrochemicals, Petrochemicals, Polymers and Fertilizers. India is a strong global dye supplier, accounting for approximately 16% of the world’s production of dyestuff and dye intermediates. Indian ranks 14th in export and 8th in the import of chemicals (Excluding Pharmaceuticals products) globally. As per IBEF, India is the sixth-largest producer of chemicals globally and the third-largest producer in Asia in terms of output. The country ranks third globally in the production of agrochemicals.

Currently, Indian chemical industry operations are severely disrupted due to coronavirus (covid19) pandemic. Manpower shortages and logistical constraints are likely to exist at least for 2-3 months. Demand pressures will also probably pull down FY21 earnings. However, in longer-term, there are definite opportunities, given a desire among multinationals to shift sourcing away from China. But, India’s gains may be limited, owing to the country’s poor infrastructure, high corruption levels, restrictive labour laws and environmental activism.

The covid-19 perspective can be divided into two horizons the short-term (i.e. the next couple of months until Jun-2020) and the medium-to-longer term (Jul-2020 to Mar-2021).

Short-Term Challenges

Manufacturing in major cities are more severely impacted

 Major manufacturing cities such as Mumbai, Pune and Vadodara are all classified as red zone areas, leading to relatively more severe disruption. Migrant workers are finding it difficult to rejoin workplaces in these cities. In contrast, smaller towns that have a high concentration of chemical units are witnessing relatively more limited impact on operations as it has been possible to transport workers from nearby towns. Thus, the shutdown or limited access to manufacturing units in red zones will impact the production activity of the chemical companies.

Manpower availability is the biggest constraint

Government restrictions currently cap headcount at 30-40% of normal levels, except in the case of manufacturing units catering to the pharma/food sectors (agrochemicals are not exempt: industry experts indicate that headcount here is capped at 40% of normal) and a shortage of skilled personnel and contract labour (often migrants) is the key constraint on production.

Logistic bottlenecks

Logistics is another key hurdle, with ports operating at 25-30% of normal levels and tankers in short supply for effluent discharge. As per the market experts, transport costs have spiked by up to 40%. However, companies are focused primarily on resuming production; profitability concerns have taken a back seat.

Medium and Long-term challenges

Cash Flow Management

Cash flow management is a major issue, as either collections from customers may take longer or, in some cases, suppliers are demanding advance payment. Companies do have orders in hand for a couple of months but production constraints are forcing them to prioritize manufacturing of key products. While, customer enquiries are ongoing, but customers are not committing on price. Meanwhile, Chinese producers have resumed production and are cutting prices, leading to further uncertainty around pricing. Given all these pressures, revenues and profits are likely to be impacted in FY21.

Industry is likely to rationalise headcount

Some companies have started using reduced manpower and this trend is expected to continue, potentially backed by greater automation. Even after capacity utilization ramps up, there will be a need to practice social distancing in the workplace, demanding for headcount reductions.

Definite opportunities in the medium to long term:

There are definite chances that the global chemical industry begins to shift its sourcing away from China, but a key question is the speed at which Indian companies can respond. Larger Indian companies are relatively better-placed to capitalise on the opportunity as smaller ones may not have the resources. However, India’s gains may be limited, owing to the country’s poor infrastructure, high corruption levels, restrictive labour laws and environmental activism.  Similarly, India’s long lockdown is likely to hurt the country’s prospects of gaining market share and damaged the country’s credibility as a reliable supplier.

Facts and figures: China is too large to completely bypass

The global chemical industry is worth ~US$4 trillion, of which China holds 38% share, while India is only at US$160bn. Similarly, in the specialty chemicals industry, China is several-fold larger than India. Certain basic chemicals required for downstream applications are still not produced in India and are imported, e.g. methanol, styrene, and acetic acid. Hence, the world will continue to buy from China for at least the next few years.

Conclusion and Recommendations

Opportunities are emerging for Indian chemical companies. However, we also believe that given the likely deep economic recession ahead, the industry faces a weak near-term demand outlook. Given the likely pressure on earnings, valuations seem too high for most leading companies. We would be cautious on richly-valued names and would instead favour those with relatively attractive valuations, such as Deepak Nitrite (DNL) and Tata Chemicals.  DNL and Tata Chemicals are trading at 15.0x, 6.6x FY21EPS respectively.

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