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Sunday, October 29, 2000













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Specialty chemicals -- The price-product-competition chemistry

A. Srikanth

ALTHOUGH specialty chemical companies have historically traded at substantial premia compared to their commodity chemical counterparts, the trend appears to have reversed recently.

While the P/E multiples of specialty chemical companies declined, that of commodity chemical firms appreciated; the gap between the P/E multiples of both the sets closing. The valuation premium once attributable to the specialty chemical companies being a high-margin-low-cyclical business appears to be disappearing.

For example, the P/E multiple of Clariant India declined from 25 times in early 1999 to 8 times now as the share prices fell steeply compared to the decline in the earnings per share (EPS). ICI's P/E multiple declined from 16 times in early 1999 to 5 times now, and that of Ciba Specialties' from 16 times to 6. So also of Colour-Chem, Nalco Chemicals, Pidilite Industries, Sudarshan Chemicals, BASF and Bayer India and a number of other specialty chemical companies.


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However, the P/E multiple of Reliance Industries, the largest commodity chemical company, rose from 6 times in early 1999 to around 13 times now. While IPCL managed to hold on to its multiples despite the uncertainties over its disinvestment.

The impact is more severe in the international market, where the P/E multiple gaps between specialty and commodity chemical companies narrowed significantly in the last two years. Though the pace of mergers and acquisitions (M&As) did not slow, the valuation multiples, which the buyers are willing to pay, declined significantly from 8-12 times two years ago to 6-7.5 times now. The current multiples are down to the extent of attracting a lot of financial buyers into the specialty chemical industry.

Fundamentals take a hit

The reason for the decline in P/E multiples is that for most specialty chemical firms, the growth rate in both revenues and earnings declined significantly in 1999-2000. For fiscal 2000, Clariant India posted a 1.80 per cent decline in net profits on a meagre 7.50 per cent increase in turnover. The company's textile and leather dyes business suffered because of the increased competition from China and Indonesia. Exports grew a mere 2.70 per cent compared to the 16.25 per cent jump in 1998-99.


Similarly, though ICI India's turnover rose 16 per cent (on a comparable basis after disposing of its explosives business), its post-tax earnings net of non-recurring income dipped 3.75 per cent. The margins of the company's rubber chemicals business, accounting for 12 per cent of the total turnover, dipped.


Colour-Chem's net profits declined 27.40 per cent as the fine chemicals sales declined 15 per cent and the margins of the pigments and additives and leather chemicals business came under pressure.

However, both Ciba Specialty Chemicals and Nalco Chemicals bucked the trend by posting significant increases in sales and earnings. For Ciba Specialty Chemicals, the sluggish growth in the domestic business was compensated by the 156 per cent growth in exports. Consequently, the company's P/E multiple did not decline to the same extent as it did for other companies. However, despite the good performance, the P/E multiple of Nalco Chemicals declined significantly.

Most specialty chemical companies were hit by the lower offtake and increased competition from imports and dumping. At the same time, the margins came under pressure due to higher raw material costs. Consequently, their operating profit margins declined as they found it difficult to pass on the higher costs.

Market bias

The narrowing of the P/E multiple between commodity and specialty chemical companies is due to the upward and downward bias of the market. On the one hand, the revenues and earnings of specialty chemical companies suffered due to the lower offtake and pressure on margins. On the other, the commodity chemical companies, which reached their troughs earlier, have started recovering. And the market is known to exaggerate both. It exaggerated the higher earnings expectations of the commodity chemical companies and the lower earnings expectations of the specialty chemical companies. The price reaction to this exaggeration was dramatic, resulting in lower P/E multiples for the specialty chemical companies and higher P/E multiple for the commodity chemical ones.

Higher crude prices had a knock-on effect and increased downstream commodity chemical prices. This coincided with the revival in demand in the Asian markets. So, to the extent the commodity chemical producers were able to pass on the price increases to the customers, their margins saw an improvement. But a stage has already been reached where it may not be possible to pass on further increases in prices.

Is this reversal in trend permanent? What are the prospects for the industry's various segments? How will this change the relative market positions and the investment prospects of the companies? Without doubt, it is highly unlikely this situation will persist for long. The inherent strengths in the specialty chemical business should bring about a revival. Also, the higher raw material prices are not sustainable. And, as the industry restructures further, the pace of consolidation should take the companies closer to their critical mass. That would make companies more competitive and flexible.

Markets and relative positions

The Indian specialty chemical industry is worth Rs 12,000 crore, with the organised sector accounting for 21 per cent and the unorganised sector the rest. In number terms, the unorganised sector accounts for 1,950 firms of the total of around 2000. In terms of profitability, however, innovation, global reach, customer orientation, product range, marketing power and R&D base, the organised sector reigns supreme.

Though there are more than 50 major categories of specialty chemicals, most companies in India operate in textile dyes and chemicals, leather dyes and chemicals, paper chemicals, rubber chemicals, masterbatches, pigments, additives, electronic chemicals, fine chemicals, cellulose esters and polymerasates, water treatment chemicals and adhesives.


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Textile chemicals: Textile chemicals is one of the biggest product segments. The market is fragmented, the organised sector accounting for 72 per cent. However, it is also a very profitable segment. Clariant India controls 10 per cent of the overall domestic market and 40 per cent of the organised sector. Of the various types, dyeing and printing accounts for the maximum share of 13 per cent of the total demand for textile chemicals, followed by pre-treatment (11 per cent), finishing (10 per cent) and optical brightening agents (9 per cent).

The major players, Ciba Specialties, Colour-Chem and ICI India, have a significant presence in textile chemicals and managed to post impressive growth rates over the last three years. Though there is huge potential, profitability depends on product innovation. While the average demand growth over the medium-term is estimated at 14-15 per cent, sizing chemicals, flame-retardants, water-repellents, spin-finishes, anti-microbials, wrinkle-resistant finishes and fabric softeners are expected to post higher growth.

Textile dyes: The global textile dyestuffs market is going through a major restructuring. And this is impacting the prospects of the Indian industry. The industry is trying hard to combat increasing commoditisation and competition from China. The domestic dyestuff business suffered last year as the textile industry posted a very low growth rate of around 1.50 per cent, with polyester recording negative growth. Exports were affected due to the increased competition from China and lower demand from Europe.

For the third largest dyestuff manufacturer (both globally and in the domestic market), Clariant India's export growth was limited to 2.70 per cent (16.25 per cent) and the share of the domestic business to the total turnover declined by 1 per cent to 13 per cent. To a large extent, Ciba Specialties was shielded from the external influences as the company operated its dyes and pigments business through two joint ventures (though these will merge in this fiscal). Having sold its dyestuff business to DyStar India, Colour-Chem too was safe. The situation has eased slightly, but it is still a major cause for concern. The overall market is expected to grow 13 per cent in the medium term.

Leather dyes and chemicals: Of the total demand from the leather industry, while dyestuffs account for around 40 per cent, various categories of leather chemicals account for the rest. With leather dyes accounting for 19 per cent of the total revenues (leather chemicals -3 per cent), Clariant India controls nearly 40 per cent of the market. However, in leather chemicals (both wet-end and finishing), both Colour-Chem and BASF have much larger market shares.

Both the leather dyes and chemicals businesses are under pressure. The dyes business suffered as leather exports were affected by competition from China and Indonesia. The chemicals business suffered because of demand stagnation in Tamil Nadu and West Bengal. Though the situation improved, the prospects for the medium term appear sluggish.

Pigments: Colour-Chem is the market leader in pigments, which accounts for nearly 35 per cent of the total turnover. Nearly a third of this is from exports. The company exchanged its masterbatches business with Clariant India for the pigments and additives business. While the printing inks industry accounts for nearly 50 per cent of the total demand for pigments, paints and coatings account for 20 per cent, followed by plastics (10 per cent), textile printing (5 per cent), pigmented fibres (3 per cent), paper (2 per cent) and others (10 per cent). Though markets abroad are fast shifting from inorganic to organic pigments, Asian markets have been slow to react.

Pigments experienced intense competition this fiscal both in the domestic and export markets, leading to further reductions in prices and eroded margins. While the domestic offtake remained stagnant, demand from the US and Europe increased substantially.

Additives: Though Colour-Chem is stream-lining its additives business, Ciba Specialties is the market leader in additives, especially plastic additives. With the revival of the Asian economies, demand volumes and pricing are expected to grow 5 per cent annually over the next five years. Within additives, while modifiers (including plasticisers, impact modifiers, blowing agents and coupling agents) account for 70 per cent of the total market, property extenders (including flame-retardants, heat stabilisers, anti-oxidants, light stabilisers and antistatic agents) account for another 23 per cent. Processing agents, including lubricants and mold release agents, account for the balance demand.

Environmental and health issues, new technologies, demand for metallocene-based polyolefins and competition among materials influence the demand-mix for plastic additives. The demand for additives is also affected by substitution between commodity plastics. Additives used in polyolefins (HDPE, LDPE and so on) would grow faster than those used in PVC, such as plasticisers. While coupling agents and light stabilisers are expected to grow 6-7 per cent until 2003, plasticisers and biocides are expected to post slower growth rates of around 3 per cent. All other segments, including anti-blocking agents, anti-oxidants, anti-static agents, flame-retardants and heat-stabilisers, are expected to post a growth rate of around 4-5 per cent.

In fiscal 2000, Ciba Specialties' domestic additives sales improved 33 per cent, and exports by 61 per cent. However, prices declined due to severe competition. The company's new phenolic anti-oxidants plant at Goa was commissioned during February. With good reception for this import substitution product, the company expects to boost this year's domestic sales.

Fine chemicals: Colour-Chem is one of the biggest players in fine chemicals (primarily agrochemicals), which accounts for nearly 40 per cent of the company's turnover. The prospects for agro fine chemicals took a beating last year as the offtake of intermediates for the manufacture monocrotophos technical declined significantly. On the one hand, the multinational pesticide suppliers shifted their focus away from monocrotophos. On the other, excessive production capacity in pesticides led to fierce competition, and consequently greater price pressure. At the same time, the ban on the manufacture of phosphamidon affected the offtake of related fine chemicals. With Colour-Chem being the leading fine chemical supplier for both monocrotophos and phosphamidon, sales declined 15 per cent in fiscal 2000.

Though the company has shifted its focus from fine chemicals to life sciences, it may take some time before this stabilises. Despite the support from BTP (latest global fine chemical acquisition by parent, Clariant International), the fine chemicals business of Colour-Chem would be under pressure at least during fiscal 2001.

Other segments: The market for masterbatches, paper chemicals, electronic chemicals, though small is witnessing high growth rates, and consequently emerging a big opportunity. Clariant, Ciba Specialties and Colour-Chem, being the major players, would be the biggest beneficiaries. The adhesives market is now the sole domain of Pidilite Industries. Though Colour-Chem is trying to establish its presence in this market, it is facing stiff resistance. Ciba Specialties recently exited from this segment by selling its global business to Morgan Grenfell. With that, the company's Petro-Araldite JV is on the blocks.

In the same way, the water treatment specialty chemicals business is the sole domain of Nalco Chemicals, which controls nearly 65 per cent of the Rs 300-crore market. Part of the Suez Lyonnaise group of France, Nalco Chemicals concentrates on raw water, effluents and process treatment chemicals. While the recent acquisition of Aqua Chemicals (now Nalco ACS) and Aquazur India would boost its ingredients and services business, the tie-up with Degremond India, Tractabel of Belgium and Lyonnaise of France would enhance the water-treatment equipment business.

The market for surfactants, personal care chemicals, and industrial catalysts also holds much potential for growth. ICI India is the market leader in surfactants and personal care (through the acquisition of Uniquema from Hindustan Lever Plc), catalysts (through Synetix), polyurethanes, nitrocellulose and rubber chemicals.


The demand prospects for the various segments of the specialty chemical industry is thus influenced by a multitude of factors, both domestic and international. Consequently, the investment prospects could also vary accordingly. On an overall scale, both Ciba Specialties and Nalco Chemicals holds reasonable upside potential for the medium term. Clariant India, Colour-Chem and ICI India would continue to face bearish pressure. Shareholders can postpone fresh investments for a while.


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