How will the next opportunity unfold in Speciality Chemicals

Ajay Garg & Munish Aggarwal

Speciality chemicals has been one of the few sector that have bucked the Covid-19 slowdown and most companies in this space are now poised to deliver growth in FY21. A changing geopolitical scenario will continue to drive growth over the next decade.

“There are decades when nothing happens, and there are weeks where decades happen,” Lenin once said famously. A similar story appears to be unfolding in the Indian speciality chemicals sector, which has gone through its journey of ‘a dull decade’ before the ‘hyper-active weeks’ started unfolding and changed the complexion of the industry forever.

The decades
Indian speciality chemicals is actually one of the oldest sectors, which has evolved from being a supplier of natural extracts (dyes like Indigo and flavour extracts from spices) to become a diverse industry catering to global markets and commanding ~5% market share in the $600 billion global speciality chemicals market.

While the sector has grown at 10% for the past decade, the industry in India was overshadowed by China, which sprinted to capture 35% of the global market in production and 25% of the global market in consumption.

India is currently sixth largest manufacturer of chemicals and has consistently been the one of the leading global producers in segments like dyes and pigments, polymers and agrochemicals.

While Indian companies have been leaders in several segments and have been part of the supply chain of most global customers, for investors the focus was on China and its rapid buildup in chemicals as well as speciality chemicals, which made it integral to global supply chains.

The Weeks
Over the last five years, there has been a gradual shift in the underlying business, driven gradually by China further tightening environmental compliance norms and purchase managers feeling uncomfortable with extremely high dependence on a single source. In recent months, escalating trade tensions between the US and China became a rallying cry for users to look elsewhere, as China became increasingly belligerent with important economies such as the US, Japan, Australia and India.

US sanctions on select companies and the expected impact of end-user industries convinced companies to reduce dependence on China and move towards a ‘China+1’ sourcing strategy.

India with its large domestic consumption market, trained work force and a government focused on improving ease of business should be a significant beneficiary of this shift.

Over the past few years, the Indian speciality chemicals sector has been on the priority list of most investors, both local and global, and it was getting reflected in the significant re-rating and improved fund-flow seen into the sector

Exhibit A – P/E Ratios for leading speciality chemical companies over last 10 years

ET CONTRIBUTORS

ET CONTRIBUTORS

The size of the Indian speciality chemicals sector is expected to double from $30 billion to $60 billion over the next five years. Our analysis shows the industry will require over $10 billion to fund the incremental capex and working capital requirements through a combination of external debt and equity. The fund requirement may be even higher as companies look for backward integration and have set up units at scale significantly larger than what they have done in the past.

We are witnessing significant investor interest in the sector as reflected in recent IPOs and buyout transactions. While we believe capital allocation is reflecting a shift in underlying fundamentals, the trend is expected to continue for some time. Availability of growth capital and flexibility to raise capital to consummate synergistic acquisitions will emerge as key determinants of how the leader board looks like over the next five years.

(Ajay Garg is Founder MD, and Munish Aggarwal, head- chemicals and industrials vertical, at Equirus Capital. Views are their own.)