Slowing Farm Segment Orderbook Is A Risk For India Chemicals, Says Morgan Stanley

A slowing order book growth in agrochemicals amid rising investments is a risk for India's chemicals sector, according to Morgan Stanley.

"Risks to orderbook growth, particularly within agrochemicals, coming at a time when incumbents are prepping for the next capex cycle and new players entering the space have translated into around 20% multiple compression since the second half of 2022," the brokerage said in its investor note dated Feb. 28.

Still, a broad-based downturn is unlikely, according to the brokerage.

The brokerage pointed out that amid potential risks of concentration and rising competition, the companies are boosting efforts to diversify from the agrochemicals segment.

Morgan Stanley named a few projects, such as SRF Ltd.'s new fluoropolymer investment, PI Industries Ltd.'s expansion of its non-agrochemical portfolio, and Navin Fluorine International Ltd.'s focus on high-performance products and accelerating contract manufacturing expansion.

The balance sheets are robust, and stocks will likely start to discount these projects as investors look past the risks of an agrochemical slowdown and evaluate the execution over fiscal 2023–2024, according to the brokerage.

With supply chain bottlenecks normalising coupled with the rapid cooling down of commodity and energy costs, the risks of destocking, falling customer offtake, and high inventories in certain pockets remain, the brokerage added.

However, Morgan Stanley expects improvement from the second half of fiscal 2024, as expected from early fiscal 2024 earlier.

It noted that the companies sounded more cautious looking into the second half of fiscal 2023, despite "very strong" near-term visibility.

Morgan Stanley's top picks in the sector are Tata Chemicals Ltd., SRF Ltd., and Navin Fluorine International Ltd.

The brokerage said that Tata Chemicals sees multiple margin tailwinds as contracts of calendar year 2023 for its U.S segment start kicking in from the fourth quarter of fiscal 2023.

This, as per the brokerage, also likely offsets the lower margins that the company is reporting in the U.K. and Kenya. The chemical company's margins will also benefit from lower gas prices and healthy demand, it added.

SRF and Navin Fluorine will see new project ramp-ups every quarter and also have relatively limited exposure to domestic sluggishness, according to Morgan Stanley.

Morgan Stanley noted that exports have outpaced domestic revenues in the year-to-date period.

Higher volumes from new capacities and recently won contracts, a sustainable margin uptick aided by a better product mix and robust contract pricing, and better efficiencies were key, according to the brokerage.

"We view this as sustainable, with exports taking more revenue share as companies hasten downstream investments to meet the growing pipeline of overseas enquiries."

Adding that the capex profile year-to-date suggests a "more aggressive outlay," Morgan Stanley estimated that the capital expenditure for over 20 chemical companies in the first nine months of fiscal 2023 is about 95% of the spending seen in fiscal 2022.

The increasing capex is necessitated either by rising capacity constraints to meet existing demand or strong traction in new customer wins, according to the borkerage.

The sector is on track for a 25–30% year-over-year jump for the full fiscal year, it added. "This is in line with our expectation that the sector is poised for a 50% jump in intensity for fiscal 2024 and beyond."