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Wednesday, May 21, 2008

Chemicals industry offers excellent investment opportunities

After the meltdown earlier this year, the stock market has been range-bound for the past three months. While most sectors have been struggling on the bourses, an unglamorous industry has suddenly come to the forefront by demonstrating its ability to weather the storm.

We are referring to the chemicals industry, since January ’08 the ET Chemicals index fared reasonably well. Last year, the ET Chemicals index may have underperformed thebroader benchmark ET100 index, but after the recent meltdown, it has made a stronger recovery compared to ET100.

In the past three months, the ET Chemicals index gave returns above 6%, while the ET100 fell 3%. Despite the strong performance, the valuations of the chemicals industry continue to remain reasonable, which offeRs scope for investment in this sector.

While the average price-toearnings (P/E) multiple of the ET100 index stands at 18.7, that of the ET Chemicals index is 12.4, which is below its five-year average P/E of 13.1. This is not surprising if one looks at the industry’s financial performance over the past few quarters.

The aggregate performance of the chemicals industry in the September ’07 and December ’07 quarters was better compared to the rest of India Inc. The industry’s growth rates in sales and operating profits have been rising at a time when other sectors are facing a slowdown. The chemicals sector is expected to turn in a similar performance for the March ’08 quarter as well.

A detailed analysis of 35 chemical companies that have published results for the March ’08 quarter reveals a robust revenue growth. Aggregate revenues rose 21% to Rs 2,514 crore. Additionally, the industry has not just safeguarded its operating margins but has, in fact, slightly improved margins over the past six quarters to 16.8%.

This resulted in a 30.3% jump in operating profit at Rs 421.8 crore. However, the operating performance has been weighed down by rising depreciation costs and tax provisions. In particular, companies such as Sterling Biotech, Gujarat Alkalies and Navin Fluorine have reported a jump in their depreciation provisions, as well as deferred tax liabilities in the current quarter, influencing the overall numbers.

The chemicals industry provides the basic building blocks for almost all other manufacturing industries such as textiles, pharmaceuticals, pesticides, packaging, metals and mining. With the manufacturing sector growing rapidly in India, the favourable effects on the domestic chemicals industry are already visible. The demand for basic chemicals is rising sharply, thereby enabling manufacturers to improve their margins.

existing players are implementing greenfield and brownfield expansions, as well as debottlenecking projects. According to CMIE data, at the end of the March ’08 quarter, the chemicals industry had projects under implementation worth Rs 2,38,000 crore, with another Rs 2,43,000 crore in proposed investments.

A year ago, proposed investments stood at half that number. All of this augurs well for investors seeking opportunities in the chemicals industry. Depending on their risk appetite, investors can choose from two alternative approaches to identify the best investment bets in this industry.

A wide number of companies in this sector such as Foseco India, Clariant Chemicals, BASF, Kanoria Chemicals, Chemfab Alkalis and Pondy Oxides have been paying dividends on a consistent basis with healthy dividend yields. While their dividend yield will give assured returns on the investments, investors can also look forward to growth in earnings per share (EPS), thanks to the improved outlook for the industry.

Investors can also put their money in companies that are expanding capacities to boost their future profits. Companies such as Tata Chemicals, Sterling Biotech, Kanoria Chemicals, IOL Chemicals, Gwalior Chemicals, Himadri Chemicals and Hikal, among others, have expansion projects under implementation currently.

Thanks to the current improved outlook, the chemicals sector is likely to put up an excellent show, both in financial numbers, as well as on the bourses, offering excellent investment opportunities.

The recent inflation numbers have revealed the ability of the chemicals industry to increase prices and safeguard margins. The wholesale price index (WPI) of organic and inorganic chemicals was ruling nearly 7.5% higher during the first half of the March ’08 quarter, when the overall WPI index was up 4.5%.

The prices of a number of chemicals such as acetic acid, ethylene glycol, soda ash, caustic soda, carbon-black are ruling at multi-year high levels. Changes in the international markets have also helped boost the outlook for India’s chemicals industry. China, India’s main competitor in the global chemicals industry, removed the incentives in the form of rebate of value-added tax (VAT) offered on several chemical products exported from China in mid ’07.

Similarly, it tightened up the environmental norms for effluent treatment, which affected the cost efficiency of Chinese produceRs. This has effectively eased the pressure off the Indian chemicals industry, particularly the dyestuff industry. The industry’s buoyant outlook is now beginning to reflect on the investment front.

A number of expansion projects have been lined up in the domestic chemicals sector and variousexisting players are implementing greenfield and brownfield expansions, as well as debottlenecking projects. According to CMIE data, at the end of the March ’08 quarter, the chemicals industry had projects under implementation worth Rs 2,38,000 crore, with another Rs 2,43,000 crore in proposed investments.

A year ago, proposed investments stood at half that number. All of this augurs well for investors seeking opportunities in the chemicals industry. Depending on their risk appetite, investors can choose from two alternative approaches to identify the best investment bets in this industry.

A wide number of companies in this sector such as Foseco India, Clariant Chemicals, BASF, Kanoria Chemicals, Chemfab Alkalis and Pondy Oxides have been paying dividends on a consistent basis with healthy dividend yields. While their dividend yield will give assured returns on the investments, investors can also look forward to growth in earnings per share (EPS), thanks to the improved outlook for the industry.

Investors can also put their money in companies that are expanding capacities to boost their future profits. Companies such as Tata Chemicals, Sterling Biotech, Kanoria Chemicals, IOL Chemicals, Gwalior Chemicals, Himadri Chemicals and Hikal, among others, have expansion projects under implementation currently.

Thanks to the current improved outlook, the chemicals sector is likely to put up an excellent show, both in financial numbers, as well as on the bourses, offering excellent investment opportunities.

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