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Sales and margin recovery in sight

During 1HFY22, many chemical companies’ i) export sales were impacted by unavailability of containers as well as raw materials, and ii) gross margins contracted due to steep rise in input costs. In 3QFY22E, many chemical companies are likely to see robust sales growth on account of a) execution of some of the orders in 3Q due to easing of supply chain constraints; and b) price hikes of end-products. Gross margins (in most cases) should also improve QoQ as most companies would pass on the high input costs. In our chemicals coverage universe, a majority of the companies are likely to post robust sequential sales growth except UPL, PI, Tatva Chintan, and Fine organics while Galaxy Surfactants’ sequential sales growth is likely to be muted.

As highlighted in our sector note, India Speciality Chemicals — Shaking Up The Status Quo, India’s specialty chemicals industry is a decadal growth opportunity and it is still not too late to participate in the value creation process. We prefer: a) Deepak Nitrite (A chemical giant in the making) due to its strong entry barriers owing to its phenol capacity, and b) CRAMS/CSM players Navin Fluorine and PI Industries as they provide long-term earnings visibility.

* Higher ref gas prices and specialty chemicals sales to drive substantial EBITDA growth for SRF and Navin Fluorine: SRF’s 3QFY22 EBITDA is likely to jump 17%/40% QoQ/YoY mainly on account of a) 7%/42% QoQ/YoY sales growth driven by higher ref gas prices and specialty chemicals sales, and b) sequential rise in EBITDA margin to 25.1% (vs. 23.0%/25.4% in 2QFY22/3QFY21) driven by both higher gross margin and positive operating leverage. Navin fluorine’s EBITDA is likely to grow 21%/23% QoQ/YoY led by i) 11%/22% QoQ/YoY sales growth owing to jump in specialty chemicals revenue and higher ref gas prices and ii) higher EBITDA margin at 27.9% (vs. 25.8%/27.8% in 2QFY22/3QFY21).

* Deepak’s EBITDA to rise 11%/28% QoQ/YoY: During 3QFY22, phenol-acetone realisations rose 4% QoQ. This along with price increases in basic intermediates and performance products is likely to drive 5%/43% QoQ/YoY sales growth for Deepak Nitrite. Further, EBITDA margin is likely to improve sequentially to 24.3% (vs. 23.0%/27.1% in 2QFY22/3QFY21) driven by margin improvements across segments.

* Seasonally weak quarter for PI and UPL: UPL’s 3QFY22 revenue is likely to see -4%/11% QoQ/YoY growth as likely strong growth in North America (up 62%/15% QoQ YoY), ROW (up 19%/7% QoQ/YoY) and Europe (up 1%/20% QoQ/YoY) revenues is to be offset by QoQ decline in Latin America (still up 10% YoY) and India (still up 4% YoY) revenues. Further, a sharp sequential jump in EBITDA margin is likely to limit EBITDA decline to 4%/11% QoQ/YoY. For PI, CSM revenue is likely to moderate 4% QoQ (still up 6% YoY) while India revenue is likely to fall 17% QoQ (still up 15% YoY). As a result, its 3QFY22 revenue is likely to grow -4%/8% QoQ/YoY. However, EBITDA is likely to rise 3%/9% QoQ/YoY on account of improvement in EBITDA margin to 24.6% (vs. 22.8%/24.4% in 2QFY22/3QFY21).

* Fine Organics and Tatva Chintan EBITDA to decline sequentially: We estimate Fine’s 3QFY22 sales to fall by 8% on account of lower volume offtake of both plastic and food additives. This coupled with likely 17bps QoQ moderation in EBITDA margin despite 39bps QoQ improvement would lead to 9% sequential decline in EBITDA. For Tatva, we estimate 3% QoQ decline in sales on account of lower SDA sales led by chip shortages, which is likely to be partly offset by higher PTC and PASC sales. Since SDA is a high margin business, its EBITDA is likely to decline 18% sequentially.

* Anupam Rasayan and India Pesticides to benefit from ramp-up of additional capacities: We estimate Anupam and India pesticides’ 3QFY22 sales to grow 14% and 5% sequentially on the back of ramp-up of additional capacities. Further, despite 29bps/39bps QoQ decline in EBITDA margin for Anupam/IPL, EBITDA is likely to grow 13%/4% QoQ.

* Clean Science to see strong sales growth; Galaxy’s EBITDA on a path to recovery: We estimate Clean’s revenue to grow 12% QoQ driven by both higher volume and price hikes. However, gross margin is likely to be under pressure in the quarter due to increase in prices of phenol and other key raw materials. This is likely to result in 39bps QoQ dip in EBITDA margin. Hence, EBITDA is likely to rise 11% QoQ. For Galaxy, we have assumed a modest ~1% QoQ growth in sales and a significant jump in its per-tonne EBITDA margin at INR 16,659 per tonne (vs. INR 12,050 per tonne in 2QFY22). This is likely to result in sharp 44% QoQ jump in EBITDA (still down 15% YoY).

* Prefer Deepak > Navin Fluorine > PI Industries: Deepak Nitrite (BUY, TP: INR 2,800) is our top pick in the sector as we believe that despite its inherent cost advantages for its upcoming phenol derivative products and strong entry barriers, it is currently trading at a significant discount to its peers. We also prefer CRAMS/CSM players Navin Fluorine (BUY, TP: INR 4,440) and PI Industries (BUY: TP: INR 3,675) as they provide long-term earnings visibility.

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