Have you invested in Indian specialty chemicals yet?
Industry analysis of the rapidly rising specialty chemicals sector in India
The ongoing pandemic has drew the retail investor's attention to the sectors of pharmaceuticals and chemicals. Despite the stellar rallies of major chemical companies on D-street, are these so-called growth stocks actually worth investing in?
Let's find out!
Specialty - what's the difference?
There are many types of chemicals used for a ton of purposes. We, however, are talking about specialty chemicals.
Being about 22% of the total chemicals manufactured in India, these are single or complex chemical compositions that are sold on the basis of their functions and performance, not structure. They have super specific uses and are low - volume, high margin products sold to niche segments. This makes these high quality chemicals patent protected, thus giving the producer the ability to make good margins based on the factor of differentiability.
The most common of them in India are agrochemicals (its sales led by insecticides) and dyes. There are colorants, construction chemicals, flavours, paintings, and personal care ingredients among others.
Since they have 1-2 specific uses, they require heavy investments on research and development, and studies prove that Indian companies spend less than 2% of their revenues on this.
Boasting a global market share of ~15%, this booming sector is valued at $711.0 billion in 2019, and is projected to reach $953.9 billion by 2027. Earlier, the majority of the manufacturing used to take place in Europe and North America. But advantages of cheap wages and easily installable factories of Asian markets, making of these niche chemicals moved base to China, making the country a hub for the segment.
China's Plus Points
China boasted of cheap credit, cheap labour and affordably easy access to raw materials. The loose laws relating to carbon emissions and high corruption enabled companies to manufacture these specialty chemicals on a large scale and export them at competitive prices.
Given it is the highest populated country in the world and its fastly growing economy has a fair share of toxic factories, uncontrolled pollution levels shot up alarmingly. A documentary film, "Under the Dome" by one of the Chinese journalists was also responsible for creating havoc and pressured authorities to shut down these waste producing factories. Soon, whiplash from international treaties hit the well-doing sector and forced the government to shut down enterprises that did not follow regulations on carbon emissions and environment protection policies.
The irresponsibility on part of China resulted in trade conflicts with other countries which inadvertently shifted the focus to India as an emerging manufacturer for specialty chemicals.
India is the best option for chemical buyers after China, owing to cheap labour, even cheaper than China!
Specialty chemicals in India are likely to clock a CAGR of 12.4% over the next few years, reaching $64 billion by calendar year 2025, according to reports. Agrochemicals and dyes pose the greatest growth potential.
18-23% of revenue growth in FY22 is expected by small and medium enterprises, contributing US$ 300 billion to India’s GDP by 2025.
Companies in India witnessed interest from new and buzzing investors in November 2020 from Japan, Korea and Thailand, seeking to diversify supply chains. Some of the shining companies receiving funding were JB Chemicals and Pharmaceuticals Ltd., SeQuent Scientific Ltd. and Grasim Industries. Pidilite Industries also made some strategic changes to their portfolio.
Hurdles to watch out for
Though the picture may look pretty, there are enough hurdles.
There needs to be effective regulation for safety and proper maintenance.
Also, environmental concerns like limited carbon emissions and safety processes need to be taken care of, the non compliance of which resulted in disasters like the Bhopal Gas tragedy. Adhering to global compliance norms would be another entry barrier for new companies to enter the field.
Indian companies also lack innovation and spend not even 2% of their revenues on research aspects.
Taking on China won't be easy unless billions of investments are sanctioned.
Good Future prospects
Indian industry has not earned business only because China lost it. Our fast growing economy has skilled labour compared to China, and economies of scale enables production in huge quantities.
The "young population", as they call it, are gradually shifting from rural to middle class which is also responsible for rapidly growing consumption that leads to growth for chemical led industries.
The NaMo government propagating the "make in India '' mission has triggered what could be the rise of the Indian specialty chemical manufacturing industry.
The union budget of 21-22 has allocated 233.14 crores to the department of chemicals and petrochemicals.
Plans to implement production-linked incentive schemes for the agrochemical sector, extending support through fiscal incentives, such as tax breaks and special incentives will help uplift MSMEs in enhancing their production capacity.
Besides, the government also allows 100% FDI under the automatic route and has reduced basic customs duty on several imported products.
Producing specialized plastic products has been incentivized too through setting up of "Plastic Parks" to facilitate technology development.
Approach to investing
Finally the part that would concern you the most.
Here's how you can look to invest in this industry.
One way to go about it is looking for potential market leaders. Focus on a company that produces a chemical having a specific function. Navin Fluorine does this focusing on only fluorine chemistry. This promises their potential to be a dominant player in that specified segment.
Another way to look at it is from the point of view of secondary industries. Companies that produce specialty chemicals like agrochemicals and dyes for evergreen industries like the food industry and pharmaceuticals are always a go-to option.
You can also catch on to trends of secondary industries that are dependent on certain specialty chemicals. For instance certain surfactants and chemical synthetics are in demand when the general consumption rate of the population that needs personal care is growing.
Top stocks in this industry are Aarti Industries, Vinati Organics, Deepak Nitrite and SRF Ltd.
In a nutshell, India cannot be dependent on China's weaknesses and true growth of the industry lies in bringing about structural changes in the working of supply system of the industry, dedicated investments and focus on building manufacturing hubs backed by innovation.