Kotak Institutional Equities Cautious on Chemical Sector, Downgrades Deepak Nitrite and Vinati Organics

Kotak Institutional Equities analysts have expressed caution regarding the recent surge in specialty chemical stocks, suggesting that the optimism may be premature. They believe that the factors driving this surge are more short-term and seasonal, rather than indicative of any structural changes in the sector.

In response to their concerns, the analysts have downgraded two prominent stocks, Deepak Nitrite and Vinati Organics, giving them a ‘reduce’ and ‘sell’ rating, respectively.

In their latest report titled “One swallow does not make a summer,” the analysts emphasized their wariness of the sector, citing “stretched valuations” as a significant reason for their caution. They also highlighted their reservations about a robust recovery in end-demand, given the ongoing uncertainty in key global regions. Additionally, the analysts expressed concerns about Chinese oversupply, which could continue to put pressure on industry realizations for an extended period.

The rally in Indian chemical stocks, according to the analysts, may have been fueled by the rising prices of basic chemicals in China. Market participants interpreted this as a sign of recovering demand. In August 2023, prices of 28 out of 32 chemicals tracked by ICIS in China experienced an upswing. ICIS’ index, which monitors the price changes of petrochemicals in China, increased by approximately 15% from its June 2023 lows by the end of August.

However, the Kotak analysts believe that these price increases in China are likely due to seasonal and temporary factors, including production turnarounds, increased demand ahead of the upcoming ‘Golden’ season in September-October, stimulus measures announced by the Chinese government, and restocking by customers to replenish depleted inventory levels. They also raised doubts about the effectiveness of China’s stimulus measures in reviving the construction sector. Additionally, they noted the possibility of China adding substantial new production capacities in the coming quarters, which could further strain the chemicals market.

Apart from price fluctuations, the rally in Indian chemical stocks has been supported by claims from certain companies that demand improved quarter-over-quarter in 2QFY24. However, the Kotak analysts pointed out that this recovery is starting from a low base, earnings estimates already incorporate a 2HFY24 recovery, and valuations for most stocks have become even more stretched. They underscored the uncertainty surrounding end-demand in CY2024 and the persistent supply overhang from China as ongoing challenges for the sector.

In summary, Kotak Institutional Equities remains cautious about the chemical sector and has downgraded Deepak Nitrite and Vinati Organics due to stretched valuations and uncertainties in the industry’s future outlook.