Chemicals still strong after poor Q2 results

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In the second quarter of FY 2023-24 profits of Nifty-50 companies grew at the rate of 28% while broking house Motilal Oswal expected  a 21 % growth. The results of companies in the Auto, Banking Financial Services & Insurance, and Cement sectors have been the best. However, if we talk about other sectors, results of healthcare and metal sector companies have also been positive, results of consumer and IT sectors were as per estimates.

But are there sectors where the results have not been favourable? If yes, then which are those sectors and what is the outlook for those  sectors? And should one consider buying shares in that sector now?

During the September quarter, most companies in the chemical sector came up with disappointing results. This means that the results are worse than market expectations… so let’s understand the quarterly performance of companies in this sector.

Due to destocking by consumers and a decrease in prices, the results of chemical sector companies were expected to be weak. Concerns about weak demand from companies using chemicals and the impact of increasing competition from China on volumes were already factored by the market.

Additionally, concerns about increased expenses, interest, and depreciation costs were there, putting pressure on companies’ profits.

Because over the past year, with most companies expanding their capacity, there was an anticipation of rising interest and depreciation costs.

There were also concerns about pressure on margins because the increase in crude prices was expected to make raw materials more expensive..

Due to weak demand, there was an expectation of limited pass-through of the increased costs. In this scenario, pressure on the profits of most companies was natural. Profits of Gujarat Fluoro’s profit declined by more than 85% year-on-year.

However, in the a weak quarter, there was also a glimpse of growth in the profits of selected companies. Sudarshan Chemical’s results were particularly outstanding, benefiting from a reduction in pigment production in western countries.

According to Santosh Meena, Head of Research at Swastika InvestMart, due to slowdown in China and competition, there is pressure on results.There is an opportunity for value buying in selected chemical shares, but it is not sustained. The market is expecting clarity in 1-2 quarters.

Now the question is, even if the results of most chemical companies are not good, is the outlook for these companies in the coming quarters expected to be the same?

For companies in this sector, the US and Europe are the largest export markets, where challenges still persist.

Brokers are cautious about the chemical sector due to the fear of a global slowdown amid concerns about a downturn. However, management of these companies expect that in H2FY24, demand and results will improve.

This is because the Chinese economy and consumption are recovering from lower levels.

Although there are questions about its sustainability, one portion of the market is also feels that there are no signs of improvement in demand so far in the second half of 2023.

This is because competition from China continues to put upward pressure on commodity chemical prices. Any improvement in margins should be seen from H2FY24, meaning the second half of this fiscal year.

As far as demand is concerned, the situation is mixed. On one hand, there is robust demand in the pharmaceutical sector because of a decline in API prices and the end of the downturn in the US.

On the other hand, demand from the agrochemical sector is still weak due to high inventory levels.

As for valuations, chemical companies have factored in the positives, and most of the shares are trading around fair valuations.

Santosh Meena believes that the long-term outlook for this sector is still strong, with pressure seen only in the short term due to global slowdown and competition from China…

So the big question is should one invest in companies in this sector, or stay away?

Among the many listed companies in this sector, how should one choose good ones?

According to Santosh Meena, from a perspective of 2-3 years, gradual buying can be initiated in SRF, Deepak Nitrite, Tata Chem, Coromandel Intl, PI Industries where there is a possibility of an average return of around 20%. It is crucial for a significant uptrend to see recovery in results. Before investing in any chemical share, it is important to check which product the company deals in, and how is the supply from China along with global demand for that product.

So, overall, the results of most chemical companies are reportedly poor according to market expectations but the management commentary of companies has been positive, anticipating recovery after 1-2 quarters.

In such a scenario, investors with a long-term perspective of 2-3 years can gradually start buying in selected chemical companies.

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