Will China Plus One Position India as a Specialty Chemicals Hub?

Unless you’ve been living under a rock for the past couple of months, you would have come across the term – China Plus One. But before we move on to the implications and how it benefits India, you need to understand why this shift is happening.

The China of the future is going to be very different from the China that is today. The country has chosen to pivot from capitalism to socialism. For almost three decades, many western companies made significant investments in China, lured by its affordable labour and production expenses. However, its cost advantage has decreased in the last decade, and mounting geopolitical tension between China and the West has caused companies to seek alternatives.

A couple of years back, Taiwan and Vietnam were touted as the biggest beneficiaries of the China Plus One strategy. India was next in line, but it only started to show some serious progress after 2021 as the Modi government came out with lucrative incentives through the Product Linked Incentive (PLI) scheme.

Now, the stage is set for India.

There are many sectors that benefit from the China Plus One shift. However, one sector possibly offers a great opportunity, given the current risk-reward market equation. The sector is none other than the Indian Specialty Chemicals Sector. Stocks from the sector have corrected over 40%, thereby offering enough margin of safety for those who are looking to buy the dip. Check out this screener for more such stocks.

Let us have a closer look on what’s happening in Indian specialty chemicals. Here are some aspects of the sector…

Chemicals vs Specialty Chemicals

This is a question that has many confused. Yet people can’t make out the actual difference between the two. Specialty chemicals are high-value, low-volume chemicals that are used in a wide range of applications. They often provide specific performance-enhancing properties or unique characteristics that cannot be achieved with commodity chemicals.

The specialty chemical sector encompasses a broad range of sub-sectors, including agrochemicals, flavours and fragrances, surfactants, and polymers. For commodity chemicals, there is little differentiation between products, and the main goal is to maintain high volumes while keeping production costs low. However, for specialty chemical producers, the situation is different. Instead of focusing on volume, they prioritise knowledge and processes to meet the specific needs of their clients. This also makes their business less cyclical in nature.

And so the specialty chemical sector is poised to play a critical role in addressing some of the world's most pressing challenges. From climate change to public health crises, many of today's most complex issues require innovative solutions that can only be achieved through cutting-edge chemistry. For instance, specialty chemicals can help reduce greenhouse gas emissions, improve energy efficiency, and develop life-saving pharmaceuticals.

The Opportunity

The below table shows the performance of top chemical and specialty chemical companies over the past one year:

Source: BSE. % change as on 25/04/2023

As you can see, even the good quality stocks from the sector are taken to the cleaners. However, the fluctuation of a stock's value should not be the sole basis for determining whether it is a good buy. You need to go beyond this basic understanding and look for specific triggers and the company’s earnings growth.

In the post-Covid recovery, the chemical industry experienced a sharp increase in prices. Chemical stocks rallied as a result, and a lot of narratives were thrown around as to why these stocks could continue to move up. However, investors failed to take note of the froth in valuations and assumed that these inflated earnings would continue forever.

The party had to end eventually, and it did. The assumptions made by investors were proven wrong, resulting in a sharp correction in most of the chemical stocks. This was in the past. What about now?

In the first nine months of 2023, chemical companies were under pressure owing to **input costs **and supply chain disruptions. Going forward, costs are expected to stabilise. The management of specialty chemical firm Aarti Industries was quoted saying, “In the nine-month period of the current fiscal there was a decrease in demand across some end-user categories. While demand for products in the textiles end-use industry continue to be affected, we expect demand to recover by the first half of next fiscal year,”

No doubt management commentaries will be upbeat, but the companies now have massive capacities to back their statements.

In the past two years, many specialty chemicals companies have expanded their capacity. In the coming years, these companies could see a sharp re-rating as earnings are set to get a boost with capacity addition.

According to industry estimates, India's chemical industry is expected to reach $304 billion by 2025, registering an annual growth rate of over 15%. Massive investments are expected into the sector as it directly contributes to the country’s GDP. So, the overall sentiment remains positive for now. Coming to the companies, one should look out for companies that are leaders in niche segments. Also note that while the concept of expanding beyond China is possible, it is a gradual procedure and will take some time before companies actually start leveraging China plus one opportunity. So it can pay to keep a long-term investing approach in mind if you decide to invest in the specialty chemical sector. Click here to invest in a basket of stocks that will participate in the megatrends that have and will emerge over the next decade.

Speaking of trending sectors, pharma has been in the spotlight lately and the 4th largest Indian pharmaceutical company (by domestic sales) recently concluded their IPO offering. Check out our conversation with the company’s Vice Chairman & Managing Director ⤵ Kotak Chatroom

Happy Investing!

Sources: Kotak Securities, IBKR, Aarti Industries Annual Report, BSE