Speciality Chemicals: The Back-Benchers, Moving Ahead

The reason I call speciality chemical companies the back-benchers is that while they are present in every classroom (read every brokerage picks list), they miss out on being on the front row (not quite finding mention as the top stocks on an overall basis). Is that changing, and does it deserve to change? I thought of running a check on five-year stock returns to test whether these stocks pass muster or not. The result? They do, with flying colours!

This is just a small sample of stocks, but indicative enough of how good the returns have been for the sector. I tried to poke holes into the whole speciality chemical juggernaut and met the head of an unlisted company, to get a sense from someone who has no interest in increasing market capitalisation.

Maybe I could get some red flags from him, I thought. The businessman, on the condition of anonymity, said he believed that the stage is set for the sector to grow at a compounded annual growth rate (CAGR) of 15-20 percent for the next five years at least, and then some more. This is no mean feat, and this came from a promoter who is extremely conservative.

Picture this... There is a speciality chemical manufacturing company, which manufactures a food additive chemical used in bread making, to make bread light and fluffy. That company said that a vada pav maker from interior Maharashtra traveled all the way to Mumbai to thank them. The reason? Ever since the vada pav maker started using their chemical in the pav (bread) that he made himself, it has become less heavy, and people who would usually have one vada pav, now have two. Yes, you too could be eating chemical-induced bread, but that is not to say that it's harmful.

That is what is fuelling these growth assumptions. Food additives, dye intermediates, textiles, you name it – and you have some dominant Indian names there. These companies have strong capacities and are undertaking big capital expenditure to enhance them, and are not seeing return ratios declining over the long term yet.

Ambit Capital, in a recent note, brought out some key observations from the industry players. Companies apparently believe that faster regulatory approvals have reduced the lead time for capacity creation.

Their key takeaways:

• The focus of Indian promoters is changing from cost savings to meeting global quality norms.
• The cost difference between India and China has reduced substantially (except feedstock).
• Indian companies seem to excel at frugality, having managed to meaningfully reduce raw material as well as capital costs.

According to the Ambit report, experts believe the future could be bright for players that transform by building a global presence, hiring the right talent, focusing on quality, safety, health, and environment; and becoming a solutions providers rather than low-cost vendors. PI Industries Ltd., SRF Ltd., Vinati Organics Ltd., and Aarti Industries Ltd. are stocks that Ambit likes from an investment perspective.

Niraj Shah is Markets Editor at BloombergQuint.