Rising From The Ashes: Chemical Sector’s Phoenix Moment

The Indian chemical sector, long overshadowed by market challenges, is now staging an impressive comeback. Against the odds, this phoenix-like rise has been bolstered by expectations of government interventions, improved margins, and a renewed focus on operational efficiency. As investors who took a contrarian approach reap rewards, Mandar Wagh uncovers the key drivers behind the industry's remarkable comeback and the challenges that still remain 

Recent developments have significantly boosted metal stocks, particularly those of steel manufacturers, as the government’s imposition of anti-dumping duties on select Chinese steel imports has offered substantial relief to domestic producers. Another industry that has been struggling in past few quarters due to higher imports of products available at significantly lower prices than domestic products is the chemicals industry. 

However, investors who adopted a contrarian approach towards chemical stocks have been handsomely rewarded, as these stocks have delivered impressive returns year-to-date. This raises an important question: What are the underlying factors driving the current optimism in the Indian chemical industry? In this analysis, we delve into the current state of the industry, assess the financial performance of its leading players, explore the key growth drivers, and identify the challenges that lie ahead. 

Overview of Chemical Industry

The Indian chemical industry plays a pivotal role in the nation's economy, spanning vital segments such as bulk chemicals, agrochemicals, petrochemicals, polymers, fertilizers, and specialty chemicals. As the sixth-largest chemical producer globally and third in Asia, the industry contributes around 7 per cent to India’s GDP. India also ranks as the world’s fourthlargest producer of agrochemicals and is the third-largest consumer of polymers, behind only the United States, Japan, and China, underscoring its influence in the global markets. 

Excluding pharmaceutical products, India is the eleventhlargest exporter of chemicals, accounting for approximately 15 per cent of the world’s total dyestuff and dye intermediate production, making it a leading global supplier in this category. The industry is highly diversified, producing over 80,000 commercial products and employing more than 2 million people. Its proximity to the Middle East, a key supplier of raw materials for petrochemicals, allows India to benefit from economies of scale, enhancing its competitive edge in the global chemical market. 

The Indian chemicals market, valued at USD 220 billion in 2023, is projected to reach USD 383 billion by 2030, driven by an anticipated CAGR of 8.2 per cent from 2023 to 2030. Specialty chemicals, in particular, are expected to expand at a CAGR of 12 per cent from 2020 to 2025, fuelled by innovations and rising demand across diverse applications. Recognised by the government as a key contributor to India's economic growth, the sector allows 100 per cent foreign direct investment (FDI), with exceptions for certain hazardous chemicals. 

The China Dumping Dilemma

The chemicals industry, which had been resilient amid the global economic downturn caused by the corona virus pandemic, experienced a significant boost due to an unexpected surge in global pharmaceutical demand. This surge was driven by the critical role of chemicals in drug production. The industry’s optimistic outlook was further reinforced by the 'China Plus One' strategy, where companies began diversifying their operations away from China to mitigate risks. 

With China facing challenges from new, stringent environmental regulations targeting pollution from its chemical and pharmaceutical industries and mounting pressure from US and European investors to reduce dependence on Chinese sources, India found a unique opportunity to expand its market share. Leveraging its technical expertise and cost-efficient manufacturing capabilities, India positioned itself as a competitive alternative on the global stage. 

However, China's aggressive dumping strategy—selling chemicals at prices below market value—posed a serious challenge for Indian manufacturers. This strategy not only intensified local competition but also made it difficult for Indian companies to compete both domestically and internationally. Domestic chemical companies, already grappling with volatile raw material costs, were compelled to lower product prices to stay competitive. However, this strategy led to a substantial erosion in profit margins. 

Rising from the Ashes: Chemical Industry’s Q1FY25 Comeback

In assessing the financial performance of the top 20 BSE-listed chemical companies by market capitalisation, the overall results showed a significant improvement compared to the previous quarters. Our research on the chemical industry in December 2023 revealed negative year-on-year and sequential growth in both revenue and net profit, reflecting concerns over demand and profitability margins, exacerbated by China's dumping strategies. However, in Q1FY25, the Indian chemical industry (represented by the top 20 companies) recorded an impressive 74 per cent sequential growth in net profit. Tata Chemicals emerged as a turnaround success, rebounding from a significant loss of ₹829 crore in the January-March quarter to post a gain of ₹121 crore in the June quarter. Tata Chemicals' robust Q1FY25 performance was driven by stable demand in key segments like flat, container and solar glass, especially in China and India. 

Improved operational efficiency, including commissioning new soda ash capacity at Mithapur, supported output growth. Marginal price improvements for exports, particularly from the US, and higher volumes in Kenya also contributed to better revenues. Cost management efforts further boosted margins, leading to a notable rise in EBITDA. Leading companies such as Pidilite Industries, Solar Industries India and Godrej Industries were also key contributors to this recovery 

The operating profit also recovered, showing a 14 per cent sequential growth. Although aggregate revenue growth was marginal, it remained in the positive territory. While industry leaders struggled to boost revenue and combat competition from Chinese products, relatively smaller players like Aarti Industries, Himadri Speciality Chemical and Deepak Nitrite achieved robust double-digit year-on-year revenue growth. Pidilite Industries delivered a strong 17 per cent sequential revenue growth. 

The demand remained resilient across its key product segments, including adhesives and construction chemicals, despite external challenges like the heatwave. Strong growth in retail and project segments, along with continued cost optimisation efforts, further enhanced profitability. A key contributor was the company's improved margins, supported by price increases implemented in prior quarters and lower raw material costs, particularly for VAM (Vinyl Acetate Monomer), a significant input. 

From Dips to Peaks: Revival of Chemical Stocks 




 

Financial Performance of the Top 20 Chemical Companies by Market Capitalization

Click here to download Financial Performance of the Top 20 Chemical Companies by Market Capitalization

The Indian markets have traded within a narrow range ahead of the Lok Sabha election results, posting modest gains of 3-4 per cent since the beginning of the year. However, the benchmarks BSE Sensex and Nifty 50 quickly rebounded as political stability persisted, with the current government retaining power, which helped renew investor confidence. The indices, with around 15 per cent gains year-to-date, have recently been consistently hitting new record highs on the bourses. 

The rally was further supported by signals from the US Federal Reserve of a potential interest rate cut, along with strong macroeconomic indicators from major global economies. The strong performance of Indian companies in the June quarter was another key growth driver, with over 60 per cent of the companies reporting positive profit growth. Leading this success were sectors such as banking, financial services, automotive and pharmaceuticals. 

While most industries benefited from the rally driven by optimistic investor sentiment, the chemical sector also attracted considerable investor attention, delivering substantial returns. Many chemical stocks, which had been down around 20-25 per cent from their 52-week highs, saw a notable recovery. These stocks entered a strong uptrend, driven by enhanced profitability margins and expectations of a robust revenue recovery in the coming quarters. 

Analysing the stock price movements of the top 10 chemical companies by market capitalisation, the majority displayed positive momentum across multiple timeframes. Notably, Solar Industries India and Godrej Industries more than doubled investors' wealth over the past year. Additionally, several Small-Cap dark horses have outperformed, multiplying investors' wealth by up to six times within just a year! 

Charting a Course Through Challenges

The Indian chemical industry, while poised for significant growth, faces several critical challenges that could impact its trajectory. We have already addressed the major challenge posed by China’s dumping strategy and its impact on the performance of domestic manufacturers. One another major hurdle is the stringent environmental regulations and increasing focus on sustainability. Compliance with these regulations often necessitates significant investment in cleaner technologies and processes, which can lead to higher operational costs and potential delays in scaling up production. 

Another significant challenge is the dependency on imported raw materials. The industry relies heavily on imports, particularly for specialty chemicals, which exposes it to fluctuations in global supply chains and price volatility. Any disruption in the supply of these raw materials can lead to increased costs and affect production schedules, impacting overall profitability. Infrastructure limitations also pose a challenge. Despite ongoing improvements, inadequate infrastructure in areas like transportation, logistics and industrial facilities can hinder efficient operations and expansion. 

Additionally, technological advancements in the industry require continuous investment in research and development. While there is significant potential for innovation, smaller players may struggle to keep pace with technological changes due to financial constraints.



This can affect their ability to compete with larger, more resource-rich companies. Global competition is another concern, with many countries aggressively pursuing market share in the chemicals sector. Indian companies must continuously enhance their product offerings and operational efficiencies to maintain a competitive edge in a crowded global market. Addressing these challenges effectively will be crucial for the industry’s sustained growth and success. 

The Next Chapter for India’s Chemical Industry

The Indian chemicals industry is poised for substantial growth, driven by key factors and emerging opportunities, with a major acceleration expected once China’s dumping policy, a significant challenge, comes to an end. One of the major growth drivers is the rising demand from end-user industries such as agriculture, pharmaceuticals, textiles, automotive and construction. As the world looks for alternatives to China for chemical sourcing, India is increasingly becoming a preferred destination due to its cost competitiveness and skilled workforce. 

The government's Production Linked Incentive (PLI) scheme and initiatives like ‘Make in India’ are further boosting investments in the sector, encouraging domestic manufacturing and capacity expansion. India's large domestic market and increasing urbanisation are creating strong demand for commodity chemicals, while its strength in the production of specialty chemicals is positioning the country as a global leader. Specialty chemicals, particularly in sectors like agriculture, personal care, paints, adhesives and water treatment, offer higher margins and lower price volatility, making this segment a lucrative opportunity for Indian players. 

The push for sustainability and green chemistry presents additional opportunities, as global demand for eco-friendly chemicals continues to rise. Innovations in biodegradable and energy-efficient products are opening new market segments. 

The Indian government’s focus on reducing import dependence through anti-dumping duties on Chinese products is also helping local manufacturers gain a competitive edge. Moreover, significant investments in research and development and technological upgrades, along with improvements in infrastructure, are strengthening India's global presence. With increasing exports, favourable regulatory changes, and strategic partnerships, the Indian chemicals industry is well-positioned for long-term growth. 

Conclusion
In our December 2023 report on the Indian chemicals industry, we highlighted a contrarian approach that has largely played out. Despite initial profitability challenges, chemical companies have overcome margin issues, and renewed investor confidence has driven notable buying in chemical stocks, resulting in a significant rebound from previously discounted prices. Leading chemical firms have delivered impressive double-digit returns year-to-date. However, the sustainability of this rally depends on several factors: the government's approach to anti-dumping duties on Chinese imports, the duration of China's dumping strategy, and the ability of Indian manufacturers to manage demand fluctuations and pricing pressures. 

Despite improving profitability, many leading players continue to face unstable demand due to intense competition and China's dumping strategy. Industry experts, however, remain optimistic, projecting a strong demand recovery for Indian players in the latter half of FY25, alongside a substantial reduction in China's surplus inventory. Therefore, while investing in chemical companies remains promising, it is advisable for investors with a high-risk tolerance and a longterm perspective to consider such investments at this time. 

The financial landscape in India is dominated by both traditional banks and non-banking financial companies (NBFCs). Their performance, as illustrated below, varies due to their operational structures, business models, and segment exposure. Understanding these differences is crucial for investors aiming to fine-tune their portfolios. Let’s understand the returns performance and the underlying factors that shape these entities’ financial dynamics. 

Returns Performance: Banks versus NBFCs

The data for YTD (year-to-date) returns and one-year returns shows a clear divergence between the performance of banks and NBFCs. Nifty 50 has yielded a solid 15.20 per cent YTD return and 25.28 per cent over one year, indicating a strong broad market performance. Bank Nifty lags behind with 6.34 per cent YTD and 12.60 per cent one-year returns. This is largely due to the underperformance of HDFC Bank and Kotak Bank which have significant weightage in the index. 

Banks

Among the major banks, ICICI Bank stands out with a stellar 23.80 per cent YTD and 26.48 per cent one-year returns, well above the industry average. Axis Bank has also delivered moderate gains, posting 8.16 per cent YTD and 18.95 per cent over the year. On the other hand, HDFC Bank and Kotak Mahindra Bank have struggled. HDFC Bank’s deposit costs increased due to tight liquidity conditions and Kotak Bank faced regulatory action from the Reserve Bank of India (RBI). 

NBFCs

Shriram Finance leads the NBFCs pack with a whopping 59.18 per cent YTD and 66.64 per cent one-year returns, far outpacing the top-performing banks. Muthoot Finance and Manappuram Finance have also demonstrated strong performances primarily due to the rally in gold prices which drive the demand for gold loans. An interim ban posed by the RBI on IIFL Finance for gold loans has also helped these companies. Cholamandalam Investment has similarly outperformed the banks with 23.01 per cent YTD and 27.27 per cent over one year. However, Bajaj Finance showed a muted performance with -0.70 per cent YTD and -1.94 per cent over the year. 

Understanding the Key Differentiators: Banks versus NBFCs

1. Raw Material for Banks and NBFCs
The primary raw material for both banks and NBFCs is capital, which they deploy in the form of loans and credit. However, the source of capital for these institutions differs significantly. Banks primarily source their capital through CASA (current account and savings account) deposits, which are relatively cheaper sources of funds. They also rely on term deposits and borrow from the market when necessary. NBFCs, on the other hand, do not have access to CASA deposits. They rely on wholesale borrowings from banks and financial markets, as well as issuing debt instruments like debentures and commercial papers. 

2. Raw Material Prices: The Deciding Factors
The price of capital for both banks and NBFCs is largely influenced by the existing monetary policy and market conditions. For banks, the cost of funds is primarily determined by the repo rate set by the RBI, as it impacts the interest rates on deposits and borrowing. For NBFCs, since they depend on the wholesale market, the cost of capital is tied to bond yields and the prevailing interest rate environment. Credit ratings also play a crucial role. NBFCs with better ratings can secure funds at lower costs. 

3. Banks’ CASA Advantage and NBFCs’ Dependence on Wholesale Deposits
One of the key advantages banks hold over NBFCs is their CASA base. CASA deposits are a low-cost source of funds, which allows banks to maintain lower interest rates on loans while preserving profitability. The larger the share of CASA in a bank’s deposit base, the lower its overall cost of funds. Conversely, NBFCs rely heavily on wholesale deposits and market borrowings, which are typically more expensive. This dependence on external funding sources exposes NBFCs to fluctuations in market interest rates, often resulting in higher borrowing costs, which can impact their lending rates and profitability. 

4. Impact of Interest Rates on Credit Growth
Interest rates have a profound impact on the demand for credit. When the interest rates are low, borrowing becomes more affordable, encouraging businesses and consumers to take out loans for investment or consumption, thereby stimulating credit growth. On the flip side, when the interest rates are high, the cost of borrowing rises, reducing the demand for loans. This can lead to slower credit growth as individuals and companies defer or reduce borrowing. 

5. High Interest Rates: Effect on Credit Growth
In an environment of high interest rates, both banks and NBFCs face challenges. Borrowers may find it expensive to service debt, resulting in a reduced demand for loans, especially for discretionary purposes like personal loans or vehicle financing. Lenders may witness a slowdown in loan disbursements, particularly in sectors that are interest-sensitive, such as real estate and consumer durables. NBFCs, given their higher cost of capital, might find it even more challenging to maintain margins, as they cannot pass on the entire cost increase to customers without impacting the demand. 

6. Falling Interest Rates: NIM Compression and Credit Growth Offset
When interest rates begin to fall, banks and NBFCs face net interest margin (NIM) compression. This happens because loan rates typically adjust downwards faster than the cost of deposits or borrowing. As a result, the spread between lending rates and the cost of funds narrows, reducing profitability. However, falling rates can also lead to a boost in credit growth. 

The increased demand for loans, driven by lower borrowing costs, can offset the margin compression by expanding the loan book, thereby maintaining profitability. Banks with a strong CASA base are better positioned to handle NIM compression because their cost of funds is relatively low. NBFCs, reliant on market borrowings, may feel the pinch more acutely, but rapid loan growth can still offset the margin pressure. 

7. Floating Interest Rates: Impact on Loans
In a floating interest rate regime, the interest rate on loans adjusts in line with changes in the benchmark rate, such as the repo rate or the MCLR (marginal cost of lending rate) for banks. 

For borrowers, floating rates mean that their loan repayments will fluctuate with changes in interest rates. During periods of rising rates, borrowers could face higher monthly payments, increasing the risk of defaults in some cases. Banks benefit from the ability to quickly reprice loans, maintaining profitability. NBFCs, however, may face higher costs to refinance their borrowings, especially if they are locked into fixed-rate loans while borrowing costs increase. 

Conclusion
Interest rates have reached their peak, and rate cuts are somewhere near the horizon. The RBI is expected to cut repo rates in October, December or Q4, following the Federal Reserve rate cuts. In this environment, fixed-rate lenders like NBFCs and small finance banks typically perform better. 

Since their lending rates are fixed, a reduction in borrowing rates leads to an expansion in their net interest margins. For this reason, NBFCs should do better. Meanwhile, larger private banks, with a higher proportion of repo-linked loans, will see an immediate impact once the repo rates are reduced.