Speciality chemicals continue to report disappointing results, while investors seem exuberant about its prospects. From the September 2023 quarter, when revenue momentum started dipping, the average one-year forward PE has increased 40 per cent from 27 times to 37 times.

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Currently, the revenue decline for 9MFY24 stands at 10 per cent year-on-year on average amongst varied companies in base intermediates (Deepak Nitrite and Aarti Industries), contractual (Navin Fluorine) and advanced intermediates (SRF and Gujarat Fluorochem or GFCL). This is despite new capacities being commercialised in the period for most of the companies.

Expecting weak global economic growth in CY24-25, large order flows have either been delayed or lowered. The high cost of doing business (interest costs, shipping costs and conflict zones) is also pressuring the order flow to companies.

Accelerated sales prior to start of the Ukraine conflict and post-Covid recovery in 2022-23 is also acting as a high base of comparison for the companies.

China also increased its quantum of exports in weak demand, further pressuring prices. This has especially happened in base chemicals, refrigerant gases and also advanced intermediaries to an extent.

The dual impact of lower demand and lower prices has impacted profitability. The profit margins have declined by an average of 500 bps y-o-y in 9MFY24, despite a cool-off in input material costs.

Higher valuations

Against the Nifty-50 index growth of 28 per cent in the last one year, the stocks in consideration have returned an average of 6 per cent. In fact, excluding Navin Fluorine (facing management transition), the stocks have returned an average of 15 per cent in one year. Compared to the past five years’ average, the one-year forward PE, the stocks are trading at an average 33 per cent premium. This points to investors either extrapolating the last five-year performance or strong outlook in the stocks.

Mixed Outlook

However, what supports this expectation is the continuation of the capex and product expansion plans announced by companies. The large capex announcements, which drove the earlier re-rating, have only been delayed, lowered or restructured, but not scrapped. The next two fiscals can witness refrigerant gases expansion in SRF and Navin Florine, battery and energy storage facilities for GFCL and phenol downstream capacities of Deepak Nitrite.

The next few years could also witness some restructuring at the corporate level, which can provide arbitrage opportunities for investors as new units are monetised for growth.

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The current fiscal has been a speedbump and earnings growth is expected to resume from FY25 onwards. But the current valuation range of 30-40 times one-year forward earnings implies an earnings growth of at least 35 per cent CAGR over the next two years. The current consensus estimates are in the range of -15 to 15 per cent CAGR for the companies in FY23-25, marking a wide gap in expectations. Investors should brace for a period of flat returns till estimates catch up with valuations, or the next leg of growth drivers reflect in earnings.