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Weakness in the Chemicals business hampers performance

Operating performance below estimates

* SRF posted weak performance in 2QFY25, with a material decline in operating profitability (EBIT down 22% YoY), due to the continuous weakness in the Chemicals business (EBIT dipped 29% YoY). The Technical Textiles business also witnessed subdued performance (EBIT down 5% YoY), which was offset by a relatively healthier performance in the Packaging Film business (EBIT grew 7% YoY).

* The overall macro scenario remains uncertain for the Chemicals business (74% EBIT mix in FY24); however, the management is expecting some recovery in 3Q which is likely to further accelerate in 4QFY25, led by a healthy order book in specialty chemicals and ramp-up of export/domestic volumes in the Fluorochemicals business.

* Factoring in the weak macro scenario and uncertain near-term outlook in the Chemicals business, we cut our FY25/FY26 EBITDA estimates by 13%/7%. We value the stock on an SoTP basis to arrive at our TP of INR2,080. Reiterate Neutral. Operating deleverage and pricing pressure hurt margin

* SRF reported an overall revenue of INR34.2b (est. of INR35.8b) in 2QFY25, up ~8% YoY. EBITDA margins contracted 390bp YoY to 16.4% (est. of 18.2%). EBITDA stood at INR5.6b (est. of INR6.5b), down 13% YoY. Adj. PAT declined 30% YoY to INR2.2b (est. of INR3.1b).

* Chemicals’ revenue (40%/59% of total sales/EBIT in 2QFY25) declined 5% YoY to INR13.6b, while EBIT declined 29% YoY to INR2.5b. EBIT margin contracted 630bp YoY to 18.1%. The Specialty Chemicals business experienced traction on certain new products, while volumes of some key products witnessed a lower offtake. The Fluorochemicals business witnessed volume growth in the domestic market.

Margins were under pressure due to a decline in export realizations.

* Packaging Film’s revenue (41%/20% of total sales/EBIT in 2QFY25) grew 27% YoY to INR14.2b, while EBIT grew 7% YoY to INR828m. Margin contracted 110bp YoY to 5.8%. The BOPET Film business witnessed improved margin in India, while the Thailand business continued to be affected by the Chinese dumping.

* Technical Textiles’ revenue (16%/17% of total sales/EBIT in 2QFY25) grew 6% YoY to INR5.3b. EBIT declined 5% YoY to INR713m. EBIT margin contracted 150bp YoY to 13.3%. The business performed well owing to the higher sales volume of its flagship Nylon Tyre Cord Fabric (NTCF) and healthy demand for its Polyester Yarn segment. However, the Belting Fabrics segment witnessed low demand and margins, impacting the overall performance.

* For 1HFY25, revenue grew 6% YoY to INR68.9b while EBITDA/adj. PAT declined 13%/30% YoY to INR11.8b/INR5b. Based on our estimates, the implied revenue/EBITDA growth for 2HFY25 is 17%/14% YoY, led by a recovery in the Chemicals business.

Highlights from the management commentary

* The Chemicals business is facing headwinds but is likely to witness a revival in 2HFY25. The company is not witnessing demand contraction for any product, but inventory rationalization is leading to lower offtakes. The management has not provided any growth guidance due to the current volatile macro scenario.

* Packaging business: The BOPET Film segment witnessed healthy domestic performance, while the Thailand business was hampered due to stiff Chinese competition and logistics issues. The company is expecting recovery in 2HFY25, led by the proposed imposition of anti-dumping duty by the US on Chinese imports.

* Capex: SRF has incurred a cash capex of ~INR6.5b in 1HFY25. It expects to incur a total capex of ~INR16-18b in FY25. This is much lower than the initial expectation, but the company will announce capex as and when the situation improves.

Valuation and view

* The Chemicals business (Fluorochemicals and specialty chemicals) is expected to witness some recovery in 2HFY25, led by a strong order book in the specialty business and ramp-up of export volumes coupled with gradual growth in PTFE within the Fluorochemicals business. The packaging business is likely to remain under pressure in the medium term, while the Technical Textiles business is likely to continue the current growth momentum.

* Factoring in the weak macro scenario and uncertain near-term outlook in the chemicals business, we cut our FY25/FY26 EBITDA estimates by 13%/7%. We value the stock on an SoTP-basis to arrive at our TP of INR2,080. Reiterate Neutral.

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