Four specialty chemical stocks to buy: Sector valuations rich but Kotak Sec finds these opportunities

Valuations of domestic specialty chemical stocks are rich. (Image: REUTERS)

India’s specialty chemicals sector is expected to enjoy massive tailwinds helped by macro drivers such as the China+1 strategy, which has made domestic brokerage and research firm Kotak Securities initiate coverage of the sector despite rich valuations. “We expect India’s chemicals sector to get bigger and gain market share in global chemicals over the next decade. Global chemicals is a large market currently dominated by China and expected to grow at 5-6% CAGR,” Kotak Securities said in a note. The brokerage firm has initiated coverage of 7 stocks in the sector, and has named four stocks as their top picks.

Industry outlook

The China+1 strategy, import substitution, growing costs within China, and currency benefits are seen as some of the reasons that could help the sector grow. Analysts believe domestic specialty chemical companies have opportunities emerging for them from ageing US/EU/Japan capacities, improving returns on capital as China’s green manufacturing mandate makes it more expensive, and faster innovation cycles. Government support programs such as the PLI scheme are seen as additional enablers. 

Valuations too rich but earnings growth might sustain

The specialty chemicals sector has galloped higher since the middle of 2020 and has seen a massive re-rating. “ Investors need to be selective and look at companies that are preparing to make the most of the favourable macros. Indian companies would have to build multi-product offerings, drive M&As and build organization capabilities,” Kotak Securities said. The brokerage firm has picked Aarti Industries, Vinati Organics, PI Industries, and SRF as their top picks from the sector. 

Stocks to buy

Aarti Industries – Buy
Fair value – Rs 1,080

Kotak Securities has initiated the coverage of Aarti Industries with a buy rating and conviction in its strong growth trajectory aided by the large opportunity arising from import substitution and supply chain diversification by global majors. “We find the business scalable, led by aggressive investments on capacity and capability (R&D, talent) and favourable macro factors. We see limited upside for our near-term growth estimates, but the company can surprise in the longer term, given its aggressive investments in new growth engines,” the report added. Currently, the stock is trading at Rs 935 per share, implying an upside potential of 15%.

Vinati Organics – Buy
Fair value – Rs 2,200

The stock has 56% so far this year but analysts believe the rally could continue further. The company has global leadership in products like ATBS and IBB and its focus on greener chemistries, which differentiates it from peers, Kotak Securities highlighted. The fair value pinned on the stock implies 40X Sept 2023E EPS, however, the brokerage firm believes the premium valuations are justified given its high RoICs (~25%) driving healthy FCF, strong ESG compliance, well-defined succession planning with stable management team, and proven track record of building global leadership across products. Analysts see 15% upside.

SRF – Add
Fair value – Rs 12,000

Kotak Securities believes that SRF’s strength lies in its ability to incubate new businesses at a global scale through R&D-led superior product grades and cost efficiencies. “SRF is well-placed to leverage the growing applications of fluorine in existing (organic intermediates, refrigerants) and future opportunities (fluoropolymers, batter electrolytes) led by its strong R&D, business development and integrated manufacturing infrastructure at Dahej,” they added. The fair value estimated by Kotak Securities implies an upside potential of 7%.

PI Industries – Add
Fair value – Rs 3,500

Analysts expect a sharp rise in PI Industries’ revenue going ahead. This is expected to come from the existing R&D pipeline in the pharma business, Ind-Swift labs’ own plans to launch new APIs such as Lisdex, Ibrutinib, etc. and introduce existing API Fexofenadine into newer markets, cross-selling to its client base in Europe and Japan who are large pharma companies apart from being agri players, and better asset utilization and improvement in quality/product yields supporting margin expansion. The fair value of Rs 3,500 translated to an upside potential of 11% from the current market price.