HDFC Bank Investment Advisory Group

Chemical Industry May 7, 2018

Sector Update

Sector Overview
As per Department of Chemicals and Petrochemicals (DCPC), the Indian chemicals industry with
total sales of ~Euro77.3 bn in 2015 is the sixth largest producer of chemicals worldwide and the
fourth largest in Asia. India’s share of world chemicals market sales in 2015 marginally increased to
2.2% as compared to 2.1% in 2005. The chemical industry is a key component of Indian economy,
accounting for ~2% of the GDP. It is a well-diversified industry covering more than 80,000
commercial products. It includes basic chemicals and its products, petrochemicals, fertilizers,
pesticides, paints, varnishes, gases, soaps, perfumes and toiletry and pharmaceuticals. The
Chemicals & Chemical Products accounts for ~7.9% in overall Index of Industrial production (IlP)
which has been growing at a Compounded Annual Growth Rate (CAGR) of 2.9% YoY as
compared to overall index growing at 3.8% YoY during the same period. Over the last four years,
the growth in Chemical & Chemical Products had an inverse relationship with the growth in overall
IIP, mainly due to higher supply scenario in the global market resulting in subdued performance by
the sector. However, the relationship has been more or less positive throughout FY18 till Jan’18 as
Chinese government started focusing on production cut to control pollution level in the country and
imposition of anti-dumping duty by India in order to protect domestic industry which helped India’s
chemical sector to register positive growth in during Oct’17 to Jan’18 period. As per DCPC
secretary, Rajeev Kapoor, Indian chemical sector is growing at 8-10% annually and is
poised to reach USD 300 bn by 2025. (Source: Times of India, dated: November 28, 2017)
Inverse relationship in growth rate in Chemical products and in However, throughout FY18 they represented positive relationship
growth rate in IIP
5.0 10.0
8.0
4.0 6.0
(% change in YoY)

(% change in YoY

4.0
3.0
2.0
0.0
2.0
-2.0
1.0 -4.0
-6.0
0.0 -8.0
FY14 FY15 FY16 FY17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18

Chemicals & Chemical Products IIP Source: RBI, MOSPI Chemicals & Chemical Products IIP Source: RBI, MOSPI

Major Segment of Chemical Sector

The Chemical sector can be broadly classified into following segments such as bulk chemicals,
petrochemicals, agro-chemicals, specialty chemicals, colourant chemicals, biopharma, bio-agri,
and bio-industrial products.
 Bulk Chemicals: Bulk chemicals are group of chemicals that are made on a large scale
and act as inputs to downstream industries. Bulk chemical include basic organic chemicals
(methanol, acetic acid, formaldehyde, Phenol etc.) and basic inorganic chemicals (caustic
soda, Chlorine, Soda Ash etc.).
 Petrochemicals: Petrochemicals are derived from various chemical compounds, mainly
hydrocarbons which are derived from crude oil and natural gas. Major segments for
petrochemicals are basic petrochemicals and end-product petrochemicals. Based on
chemical structure, petrochemicals can be divided into 3 groups' olefins, aromatics and
synthesis gas. Examples of olefins include ethylene/propylene, which is used in industrial
production of chemicals, plastics & plastics products. Aromatics include benzene, which is
used in making dyes as well as in making synthetic detergents. Synthesis gas is used to
make ammonia and methanol, which are further utilized in making urea (fertilizer).
 Fertilizers: Fertilizers are materials - Organic or inorganic, natural or synthetic - that
provides for one or more nutrients required for plant growth. Fertilizers can broadly be
categorized into nitrogenous, phosphate, potassium and complex fertilizers. Application of
 fertilizers varies from region to region based on regional nutrient requirement, cost of
fertilizers and farmer preferences.
 Agrochemicals: Chemicals that are essentially meant for protecting agriculture crops
against insecticides and pesticides are covered under this sub-group. Agrochemicals
broadly cover Insecticides, Fungicides, Herbicides, Bio-pesticides, etc. They are applied on
seeds, soil, irrigation water and crops to prevent damage from pests, weeds and diseases.
 Specialty Chemicals: Specialty Chemicals are R&D intensive, high value and low volume
chemicals. These chemicals are derived from basic chemicals and are targeted towards
specific end-use application. It includes Polymer additives, Personal care ingredients,
Water treatment chemicals, Construction chemicals, Paints and coatings and Colorants
and others.
 Biotechnology: Biotechnology uses biological processes, organisms or systems to
develop products for improvement of human life. The biotechnology market consists of the
development, manufacturing and marketing of products based on advanced biotechnology
research.

Key factors influencing the sector

Shutdown of capacity in China driving the growth for Indian Chemical Companies
For many years, China had many liberal policies on both financial as well as environment front with
the motivation to grow faster and become one of major economies of the world. The slack
environment regulations and policies led to serious concerns on the pollution level in the country.
As a result, in past few years, Chinese government started focusing more on improving the health
of its citizen at the expenses of health of its economy (accepting the slower growth). Chinese
government implemented many stricter environment policies that include heavy penalties, forced
upgradation of plants for effective waste treatment, shutdown of many high polluting manufacturing
plants and/or shifting of plants to industrial zone situated away from human habitants. This has led
to sharp rise in cost of manufacturing in China and has taken away the key advantage of low cost
manufacturing from Chinese chemical manufacturing companies. The temporary and permanent
shutdown in China, one of largest chemical markets of world, has helped Indian chemical
companies to garner market share in the global market. As per an interaction with the
management of various chemical companies, the activities of upgradation of plants, shifting
to industrial cluster or resumption of these plants are likely to take another minimum 18-24
months. Moreover, these companies are unlikely to enjoy the similar cost advantage which
they used to enjoy in the past making it more advantageous for Indian companies which are
having superior quality products. This indicates that Indian companies are likely to continue
to reap benefits in near to medium term.
World Imports of All Chemicals by top 10 countries- 2016 World Exports of All Chemicals by top 10 countries- 2016
250000 250000

200000 200000
(Value in USD Mn)
(Value in USD Mn)

150000 150000

100000 100000

50000 50000

0 0

Source: Department of chemicals & Petrochemicals Source: Department of chemicals & Petrochemicals

Indian Chemical companies gaining traction in world markets

As per Chemical and Petrochemical Statistics at a Glance-2017 report by DCPC, India ranks 17th
in the world exports of chemicals (excluding pharmaceutical products) and ranks 7th in the world
imports of chemicals (excluding pharmaceutical products). However, India’s share of world
chemicals market sales in 2015 marginally increased to 2.2% as compared to 2.1% in 2005, its
overall chemical exports saw steady CAGR of Trend in exports of Chemicals and Chemical Products (including
14.4% over FY10-17 period. The contribution of 3000
Pharmaceutical Products and Fertilizers)
total Chemicals and Chemical Products
(including Pharmaceutical Products and 2500

Fertilizers) to India’s total exports grew to 15.0% 2000

in FY17 from 12.9% in FY10. India already has a

(Rs.in Bn)
1500
strong presence in the export market in the sub-
1000
segments of dyes, pharma and agro chemicals.
In addition, the exports of Pesticides have seen a 500

strong 17.5% CAGR in terms of quantity while it 0

registered 13.4% CAGR in terms of value during FY9 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
Source: Department of chemicals & Petrochemicals
the period of FY13-FY17. In the year FY17, Alkali
chemicals and Inorganic chemicals saw a strong growth both in terms of volume (44.5% YoY and
141.0% YoY, respectively) and in terms of value (35.5% YoY and 49.5% YoY, respectively). The
major contributor to total chemical export, Dyes and Pigments, is having a trade surplus for last five
consecutive years. The export performance of these sub segments indicates that India is
strengthening its position in global markets and is likely to continue to improve in near to
medium term due to its superior quality and cost competitiveness coupled with stringent
environment norms in China leading to supply curb in global markets.
Share of major Chemical exports (quantity) in FY17 Share of major Chemical exports (Value) in FY17
Alkali Chemicals
10% Dyes & Alkali Chemicals
Pigments 1%
Dyes & 43%
Pigments Inorganic
28% Chemicals
4%
Inorganic
Chemicals Organic
26% Chemicals
8%
Pesticides & Pesticides &
Insecticides Organic
Insecticides
23% Chemicals
44%
13%
Source: Department of chemicals & Petrochemicals Source: Department of chemicals & Petrochemicals

Improving capacity utilizations driving capex activity and attracting FDI inflows
As per Department of Industrial Policy & Promotion (DIPP), Chemicals (other than Fertilizers)
sector is contributing ~4% to the total foreign direct investment (FDI) in India. India had garnered
cumulative FDI to the tune of USD 13.8 bn during the period of Apr’00 to Jun’17 for the Chemical
sector. The government has taken various steps like allowing 100% FDI in Chemical sector,
removed licensing requirement except in the case of hazardous chemicals, etc. in order to increase
FDI inflow in to the sector. The sector has seen massive FDI inflow over the last four years, mainly
due to improvement in utilization levels in the industry, which has called for fresh investment
demand.
Robust FDI inflow in Chemicals (other than Fertilizer) Improvement in Capacity Utilization levels
(in USD mn) 90.0%
1800 80.0%
1600 70.0%
1400 60.0%
1200 50.0%
1000 40.0%
30.0%
800
20.0%
600 10.0%
400 0.0%
200 Inorganic Alkali Dyes & Pesticides Organic Total Major
Chemicals Chemicals Pigments (Tech.) Chemicals Chemicals
0
FY14 FY15 FY16 FY17 FY12 FY17
Source: Department of Industrial Policy & Promotion Source: Department of chemicals & Petrochemicals

The utilization of installed capacity improved in the range of 65-80% in major Chemicals like Dyes
& Pigments, Pesticides and Inorganic Chemicals between FY12 to FY17. This was mainly due to
improvement in global demand scenario for Indian chemical product post the supply constraint
witnessed in China. Moreover, domestic demand also started gaining traction as cheap imports got
impacted due to imposition of antidumping duty on various chemical products in order to protect
domestic industry. The utilization levels are likely to improve further going ahead on the back
of rising demand for basic as well as specialty chemicals in the wake of higher focus on
infrastructure projects (construction and coating chemicals), smart city projects, water
treatment solutions projects etc, that are expected drive the demand for chemical products
in India. Apart from FDI flows, Indian companies are also announcing their capex plans.
Himadri Speciality Chemical Ltd is planning to invest ~Rs.10 bn to expand its carbon black
business by setting up new carbon black lines at its existing integrated plant in Mahistikry, West
Bengal for producing specialty carbon black. Atul Ltd plans to invest around Rs.1.5-2.0 bn in FY19.
Sudarshan Chemicals is planning to invest ~Rs.10 bn over the next 5 years. Phillips Carbon Black
Ltd plans to expand its manufacturing capacity at an estimated cost of Rs.9.0 bn over the next two
years. Aarti Industries Ltd plans to invest USD 35-40 mn to set up a dedicated large-scale
manufacturing facility for the production of speciality chemical intermediate. The Board of Directors
of NOCIL approved an in-principle capex proposal of Rs.1.68 bn for expansion of its production
facilities for rubber chemicals at Dahej/Navi Mumbai. The capex announcements by various
chemical companies are indicating that they are upbeat on future demand in the sector.

High volatility in crude oil prices to influence the profitability in near term
Many chemicals, especially petrochemicals, are derived from chemical compounds, which are
derived from crude oil or from natural gas, predominately from crude oil. As per management
interactions with various Chemical companies, Crude oil is the major cost driver in the chemical
sector. Hence, volatility in crude oil prices has a direct and significant impact on the cost structures
of these chemicals. The prices of Brent crude oil in international markets had seen a sharp and
continuous decline during the period of FY12-16. This has resulted in sharp uptick in the operating
profitability margins for many chemical companies. While crude oil prices have started their
upward journey from FY17, they are still lower than their historical high levels, which is
likely to keep the margins stable in the near term with the help of operating efficiency due to
improvement in capacity utilization. However, any further sharp up move in the crude oil
prices may affect the operating margins and thereby overall profitability of the Chemical
companies.
Continuous decline in brent crude oil prices since FY12 ...though Sharp improvement in PBIDT margin for Dyes And
started reversing in FY17 but still at lower than historical highs Pigments manufacturing companies
140 20

120
15
100

80 10
60
5
40

20
0
0 Atul Bodal Kiri Indus. Sh.Pushkar Sudarshan Ultramarine
FY12 FY13 FY14 FY15 FY16 FY17 FY18 Chemicals Chem. Chem. Pig.
FY13 FY17
Note: Prices (USD/barrel) are as of 31 March of each year, Source: Bloomberg Source: Capitaline

Overall View: The Indian chemicals industry is the sixth largest producer of chemicals
worldwide and the fourth largest in Asia. As per DCPC secretary Rajeev Kapoor, Indian
chemical sector is growing at 8-10% annually and is poised to reach USD 300 bn by 2025.
This is mainly due to the benefits that the sector is likely to get from the government’s
increased focus on Make in India projects, infrastructure projects and initiative like Smart
Cities. Also with change in the Chinese environmental norms, the opportunity for Indian
chemical companies in the domestic (due to reduction in Chinese imports) as well as in
export markets looks compelling in the near to medium term. Revival in economic activities
in domestic market and pick up in the global growth also augurs well for growth of the
Chemical Sector companies. However, volatility in crude oil prices will be one of the key
monitorable for the sector in the near term. Within the Chemical space, we like Atul Ltd due
to its large and well-diversified portfolio, healthy balance sheet with strong return ratios.
Currently we have a Buy rating on the stock with the target price of Rs.3123 which is
20xFY20E (three years average PE multiple) EPS of Rs.156.2.
Atul Ltd. CMP: Rs.2811, Mkt Cap: Rs.83 bn
Background
Atul Ltd. (Atul) was originally promoted by Late Shri Kasturbhai Lalbhai in 1947 as Atul Products Ltd. as a step
towards backward integration of their cotton textile business. It has one of the biggest integrated chemical
complexes in Asia with well diversified portfolio of ~920 products and 460 formulations divided into Life
Science Chemicals and Performance & Other Chemicals catering to the requirement of wide range of
industries such as adhesives, agriculture, animal feed, automobile, composites, construction, cosmetic,
defense, footwear, fragrance, glass, home care, horticulture, hospitality, paint and coatings, paper, personal
care, soap and detergent, sports and leisure, textile, tire and wind energy. The company own 68 brands in
Crop Protection and Polymers business. It has manufacturing facilities located at Ankleshwar and Valsad in
Gujarat & Tarapur in Maharashtra. The Company has established subsidiary companies in the United States,
the United Kingdom, Germany, China and Brazil.

Key Details Shareholding Pattern (%) on 31 March 2018

52 week H/L(Rs) 3090/1958 Promoter 44.64
Book Value (Rs) YTD 739 Institutions 28.35
FV (Rs) 10.0 Public 27.01
PE (X) (TTM) 29.7 Total 100.00
Dividend Yield (%) 0.4
Valuations and Chart
PE (X) Daily closing price for last 3 years of Atul Ltd
3500
FY18 FY19E FY20E
3000
29.7 22.7 18.0 2500

2000

1500

1000

500
Jul-15

Jul-16

Jul-17
Mar-16

Mar-17

Mar-18
Nov-15

Nov-16

Nov-17
Sep-15

Sep-16

Sep-17
May-15

May-16

May-17

May-18
Jan-16

Jan-17

Jan-18
Source: Bloomberg

Earnings Summary (Consolidated)

Y/E Sales Growth EBITDA Margin PAT EPS Growth P/E Div.Yield
31-Mar Rs Mn (%) Rs Mn (%) Rs Mn (Rs) (%) (x) (%)
17A 28,339 9.2 5,095 18.0 3,234 108.9 17.9 25.8 0.4
18A 32,958 16.3 5,052 15.3 2,812 94.8 (13.0) 29.7 0.4
19E 36,898 12.0 6,125 16.6 3,673 123.8 30.6 22.7 0.4
20E 42,857 16.1 7,543 17.6 4,635 156.2 26.2 18.0 0.4

View: Atul continued to report improvement on EBIT growth sequentially during Q4FY18 along with
margin expansion for the first time past two years in Life Science Chemicals segment. Going ahead,
the management’s focus on expanding capacities of high margin segments, developing brand
business, introducing new products and formulations and expanding secondary sales is likely to
improve the earnings further and return ratios over the medium to long term. Moreover, the company
is well positioned to reap the benefits of recovery in the domestic and global markets with its
diversified product and customer profile. The government’s initiatives like Make in India for
manufacturing and Smart Cities augurs well for the company. Atul Ltd continues to maintain strong
balance sheet by becoming a debt free company on gross level basis in FY18. We have revised our
earnings estimate for FY19 and rolled over earnings to FY20. Hence, we have a Buy rating on the stock
with the revised target price of Rs.3123 which is 20xFY20E (three years average PE multiple) EPS of
Rs.156.2. Any changes in the price target/valuation would depend on performance improvement
across the segments, improvement in margin profile and general business momentum.
Please refer to disclaimer and disclosure on the last page.
 Rating Interpretation
Rating Expected to
Buy Appreciate more than 10% over a 12 to 15 month period
Hold Appreciate below 10% over a 12 to 15 month period
Under Review Rating under review
Exit Exited out of the Model Portfolio
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