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* Despite the end of destocking, pricing pressure continues in the specialty chemical sector due to sluggish Chinese domestic consumption, with the China+1 strategy being a potential short-term solution. Company managements remain confident about longterm prospects, with capex on track and a gradual recovery expected in 2HFY25. However, pricing pressure is likely to persist through CY24.

* Our coverage universe saw a decline of 8%/18%/29% YoY in revenue/EBITDA/earnings in FY24, with EBITDAM down 240bp YoY. Although raw material prices and operating expenses declined YoY, it was not enough to arrest the decline in EBITDA amid severe pricing pressure. PI Industries was the only bright spot in FY24.

* We estimate a CAGR of 13%/17%/19% in revenue/EBITDA/earnings during FY24-26E, albeit on a lower base. EBITDAM is expected to expand by 160bp by FY26 vs. FY24. AACL, ATLP, NFIL, NOCIL and VO are expected to see the highest earnings growth of 25-40% during FY24-26E. We remain positive on PI, VO and GALSURF.

Cautiously optimistic outlook for the sector

* While destocking is over for most of the companies, pricing pressure persists in the sector as Chinese domestic consumption is not picking up as expected, with suppliers continuously looking for a market within the region, outside China. That said, the China+1 strategy could be one of the only saving graces in the near term for these chemical companies.

* Managements of various companies sounded confident about their long-term approach starting in FY25, with already announced capex on track to be completed within the guided timelines. For the first time in almost a year, some company managements have clearly stated that 1HFY25 is likely to be subdued, especially for companies with high exposure to agrochemicals, with a gradual recovery expected in 2HFY25.

* Throughout FY24, based on our channel checks and various interactions with companies, we reiterated that pricing pressure would continue in CY24 as well, and that any gradual recovery would happen only after 1HCY24 (read page 80 of our 4QFY24 preview). We expect pricing pressure to subside in the last quarter of CY24. There could be some earnings surprises as FY25 rolls on. Dismal FY24; PI remains the only bright spot

* Destocking, subdued demand and pricing pressure led to an earnings decline for the sector on an aggregate basis in FY24 and continuous downward revisions in estimates over the course of the four quarters by the Street. In FY24, our coverage universe saw a revenue decline of 8% YoY and even a bigger decline of 18%/29% YoY in EBITDA/ earnings, led by pricing pressure in the domestic and export markets. Aggregate gross margin expanded 70bp YoY, while EBITDAM declined 240bp YoY in FY24.

* There was some respite for chemical companies as raw material costs declined 9% YoY on an aggregate basis for our coverage universe after rising 46% YoY in FY22 and 23% YoY in FY23. Operating expenses were also down 3% YoY in FY24 after rising 36% YoY in FY22 and 25% YoY in FY23. However, this was not enough to arrest the decline in EBITDA as pricing pressure and volume decline weighed on the sector.

* Among our coverage companies, PI remained the only bright spot in FY24 in the sector (coverage of 12 companies), with a revenue/EBITDA/earnings growth of 18%/31%/37% YoY. We estimate a revenue/EBITDA/earnings CAGR of 13%/17%/ 19% during FY24-26E for our coverage universe, albeit on a lower base. EBITDAM is expected to expand 160bp by FY26 vs. FY24. We expect AACL, ATLP, NFIL, NOCIL and VO to report highest earnings growth to the tune of 25-40% during the same period.

Valuation and view

* PI Industries (PI): PI has levers in place to sustain near-term growth, led by: 1) consistent growth momentum in the CSM business; 2) product launches in the domestic market; and 3) the recent acquisition in the pharma API and CDMO segments. We expect a CAGR of 17%/18%/9% in revenue/EBITDA/adj. PAT over FY24-26. We reiterate our BUY rating on the stock with a TP of INR4,280.

* Vinati Organics (VO): Veeral Organics (VOL) has commissioned a couple of products (MEHQ and Guaiacol), while the rest are expected to be commissioned in 2HFY25. These products are going to be the growth drivers for the company going forward. VO is now the largest and only double-integrated manufacturer of AOs in India. We continue to believe that VO will do well in the long term. We reiterate our BUY rating on the stock with a TP of INR2,080.

* Galaxy Surfactants (GALSURF): We estimate a volume CAGR of 9% over FY24- 26, led by robust volumes in the domestic market and a volume recovery in specialty care products in the developed markets, which have already started growing. We reiterate our BUY rating on the stock with a TP of INR3,450.

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