Bulls have taken investors on the horns of dilemma—stock prices are skyrocketing and so as valuations, in the absence of earnings growth.
Valuations won’t offer you comfort at present but that doesn’t mean all expensive stocks will make bad investments. This only means you have to be extremely selective about them and shouldn’t lose focus on the big picture.
For instance, some chemical companies are trading at rich valuations but if you completely avoid them, you might miss some great investment opportunities.
These are interesting times for Indian chemical manufacturers. On the one hand, MNCs are reimagining their supply chains on the back of the outbreak of coronavirus, while on the other, India’s been promoting domestic manufacturing.
The Indian chemical industry has a 3.4% market share in the global chemical industry and is expected to grow at a compounded annualised growth rate of 9.2% by 2025. According to a McKinsey report, India runs a deficit of USD 15 billion on chemicals trade. In other words, the Indian chemical industry is likely to see three major growth trends playing out in the foreseeable future—growth of the domestic market due to favourable demographics, import substitution and export augmentation.
But the chemical industry is diverse in nature. Some companies engage only in the manufacturing and trading of bulk chemicals, which are bought and sold as commodities. While others address specific purposes/functions and are thus called specialty chemicals. Specialty chemicals has become a buzzword nowadays, however, it’s imperative not to label the entire space as attractive.
Therefore, depending on the chemistry and the product basket, a company will quote valuations. Needless to say, specialty chemical companies would command premium valuations vis-à-vis bulk chemical manufacturing companies since they become a partner in the growth of their clients. That said, not all specialty companies will get similar valuations.
Going by the market movement, we spotted two stocks that appeared strong on monthly charts.
Fine Organics is a Mumbai headquartered company specialized in manufacturing environment-friendly oleo-chemical-based additives. Fine Organics went public in 2018.
Its diversified product portfolio of over 400 specialty additives finds applications in various industries such as FMCG, automotive, plastics, rubber, packaging and pharmaceuticals, to name a few. It ranks amongst the top 6 players in the food additives industry and amongst the top 5 players in the plastics additives space globally. The company derives nearly 56% of its revenues through exports.
Fine Organics has an installed capacity of 1,01,300 Tonnes Per Annum (TPA) of which 32,000 TPA was added in FY20. It has 2 capex projects in the pipeline which will further enhance its production capacity by 20% over the next 2 years.
The company supplies specialty chemicals additives to the food industry which help improve the shelf life of food items such as breads, cookies, chocolates and ice-creams. Fine organics derives almost 1/3rd of its revenues from the food segment. The new capacities that came upstream in FY20 will help it grow revenues from the plastics division. Both these segments are expected to grow steadily in the foreseeable future.
Fine Organics has another niche capability. Apart from strong product Research & Development (R&D) capabilities, the company has a dedicated team to address the engineering R&D function. In simple words, it means, the company not only delivers new products but it also develops machinery required to manufacture them in-house. Fine Organics launches 5-6 new products every year.
On the monthly chart, Fine Organics closed above its 10-Month and 20-Month moving average in July. The uptrend has become more pronounced in early August. Besides moving averages, other technical parameters such as RSI, Stochastics, and MACD look extremely strong.
Over the last 5 quarters, the top line growth has remained flat but the bottom line has grown at 14% on an average. It’s noteworthy that, the company’s PAT margins have improved from 9.1% in FY15 to 16.2% in FY20.
Fine Organics enjoys a high Return on Equity (RoE) of 26.6% on a Trailing Twelve Month (TTM) basis and has a cash surplus after adjusting for debt. The stock trades at a PE of 45.4 which is not cheap.
Gujarat-based Atul is one of the oldest integrated chemical companies. It serves nearly 4,000 customers in 90 countries with a diverse portfolio of 900 products and 400 formulations. It reports revenues in two segments—Life Science Chemicals, and Performance and Other Chemicals.
The Life Sciences Chemicals segment, which comprises three sub-categories—crop protection, pharmaceuticals and intermediates and aromatics-I—contributes approximately 31% to the top line. The Performance and Other Chemicals segment which consists of four sub categories—Aromatics - II, Bulk Chemicals and Intermediates, Colors and Polymers—accounts for 69% of the revenue.
In FY20, Atul reported the top line of Rs 4,093 crore and the bottom line of Rs 671 crore. As stated in the company’s annual report for FY20, with new capacities coming upstream, achieving the revenue of Rs 5,400 at 90% utilization is a near-term objective of Atul. On TTM basis, Atul generates an ROE of 21%--which is attractive for a multi-product-multi-market integrated chemical company. Negligible debt offers comfort. The PE multiple of 24 suggests that the stock isn’t cheap but isn’t expensive either.
After sliding sharply in March 2020, the stock has witnessed a steady rise. In July, it experienced a strong buying interest on the bourses, which is evident from a formation of large green candle.
The strong uptrend is getting carried forward even in August with the stock firmly trading above its 10-Month and 30-Month moving averages. Other technical indicators such as RSI, Stochastics, and MACD appear strong too.
If you observed carefully, Fine Organics and Atul have a strong presence in all three growth themes for the chemical sector discussed earlier—expansion of the domestic market, import substitution and export augmentation. Given their track-record, research-oriented approach and complexity involved in operations, Fine Organics and Atul are likely to remain investors’ favourites. That said, you must keep an eye on monthly charts and quarterly numbers.
Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.
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We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflicts of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.