Morgan Stanley’s latest report on chemical stocks reflects cautious sentiment, foreseeing ongoing challenges for the sector in the near term. It believes that the chemicals sector is still not out of the woods and advises remaining on the sidelines until an earnings upgrade cycle occurs. The brokerage also expressed a preference for commodity chemicals amidst the current market conditions.
It issued several ratings downgrades on chemical stocks. The brokerage downgraded Tata Chemicals, Aarti Industries, and SRF due to their weak growth outlook. SRF and Aarti Industries saw their ratings lowered from ‘overweight’ to ‘equal-weight’, while Tata Chemicals was downgraded to ‘underweight’.
“Fiscal 2025 should see India chemicals revert back to growth, after a tough reset from F23 highs. Easing destocking intensity, stabilization in price declines, pockets of restocking, increased competitive pressures and monetisation were key messages out of earnings. Recovery acceleration is still pegged for the second half of the next fiscal, especially for agrochemicals. We remain cautious on specialty chemicals and prefer refiners, gas utilities, and select commodity chemicals,” said the brokerage.
Against this backdrop, investments totaling approximately US$0.5 billion are set to be monetized during F25-26. MS anticipates that increased volumes, driven by improved operating rates and capacity expansions, will largely drive incremental EBITDA growth by F27. Despite remaining partially derisked, renewed demand across various end markets suggests potential for higher volumes. Currently, implied EBITDA per ton remains about 20% below the levels seen in F22-23. Potential for upside surprises lies in favorable changes in product mix, new product launches, and improved pricing dynamics, contingent upon robust demand and supply chain adjustments, which are crucial for an earnings upgrade cycle, noted the brokerage.
What’s Priced In? As per the brokerage, year-to-date, the sector has lagged behind the NIFTY by approximately 10-12 percentage points. Despite recent earnings reductions after the fourth quarter of FY24, current multiples do not indicate cheap valuations and already reflect expectations of significant normalization and sequential earnings improvement in the short term. Caution is advised, with a selective approach recommended, it advised.
Downgrades and price target changes
Morgan Stanley attributed the downgrade of Aarti Industries to its substantial price increase since early November, nearly doubling during that period. Despite the downgrade, the brokerage raised its price target for Aarti Industries by over 6 percent to ₹613, suggesting a 9 percent downside from its CMP. The stock has jumped 20 percent in the last 1 year and over 10 percent just in June so far.
Meanwhile, Morgan Stanley reduced the price target for SRF by more than 17 percent to ₹2,115, citing uncertainties regarding recovery, competitive pressures, and prolonged challenges in its packaging business. The revised target also indicates a potential downside of 12 percent from the previous closing price. In June so far the stock has risen almost 9 percent while in the last 1 year, it has been up 1.5 percent.
Furthermore, the brokerage cited the oversupplied soda ash market as the primary reason for downgrading Tata Chemicals. The firm also reduced its price target for the stock by approximately 7 percent to ₹843. This target represents an over 24 percent decline from its previous closing price according to Morgan Stanley. The stock has added over 15 percent in the last 1 year and 7 percent in June so far.
In addition to these downgrades, Morgan Stanley also lowered its price target for Navin Fluorine to ₹2,633 while retaining its ‘underweight’ recommendation on the stock. Meanwhile, for PI industries, the brokerage has kept an underweight call but raised its target to ₹3,350 from ₹3,245.
Outlook
As the sector consolidates and anticipates a return to growth in F25, the brokerage has factored in these uncertainties into our earnings estimates, price targets, and ratings. While growth prospects leading into F27 appear promising, they are accompanied by inherent risks. Its revised forecasts and growth projections primarily hinge on (i) Volume expansion through new capacities, expansions, and debottlenecking initiatives, contributing to over 80% of incremental earnings growth; (ii) Operational efficiencies as monetization accelerates throughout FY25-26, accounting for the remaining delta. Pricing dynamics or margin improvements driven by demand trends or supply chain constraints are not significant drivers in its base case scenario.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.
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Published: 15 Jun 2024, 01:25 PM IST