Investors brush aside tariff, margin concerns for SRF; stock rebounds

The stock has been under pressure on concerns related to the demand, its ability to sustain margins, and increased competitive pressures due to policy decisions

After a 10 per cent fall over the last few trading sessions, the stock of India’s largest specialty chemicals maker by market capitalisation, SRF, recovered on Friday gaining 5 per cent and then going up by over a per cent after the twin market sessions of Monday and Tuesday to end at Rs 2198.75 apiece. The stock has been under pressure on concerns related to demand, its ability to sustain margins and increased competitive pressures due to policy decisions.

Surya Patra of PhillipCapital India Research highlights three uncertain macro developments which will make the near-term outlook of the global chemical industry (and by extension, SRF) volatile. These include the possibility of a recession which will hit demand, global chemicals giant BASF shutting down its largest fully integrated plant in Germany on account of gas unavailability and US government’s intention to lift tariffs on some China supplies which were imposed during the Trump administration.

While a recession would have a significant impact, the plant shutdown at BASF would have a limited immediate one, believes the brokerage. About 4 per cent of earnings are at risk due to supply of certain specialty chemicals from BASF. However, it throws up a potential mid-to long-term supply opportunity of downstream products instead of intermediates currently for companies such as SRF.

Brokerages have also brushed aside concerns of additional competition due to the lifting of tariffs on Chinese exports of refrigerant gases. The US government had imposed a 285 per cent duty on import of hydrofluorocarbon (HFC) gases from China back in 2018. HFCs are used in refrigeration, air conditioning and in fire extinguishing systems among others.

Investors are concerned that lifting of tariffs would result in pressure on pricing and thus impact margins for SRF. The company’s exposure to the US refrigerant market is limited to 6 per cent overall sales and would thus have a limited impact on the bottomline. Further, while the imposition of tariffs led to higher refrigerant prices it was more due to supply disruption in China rather than the American action.

Krishan Parwani of JM Financial Research says it is highly unlikely that the US will reverse the tariff hike as refrigerant gases make up only 1-2 per cent of final equipment costs and will not lead to price inflation. Further, no additional capacities can be put up in China for HFCs starting January 2022 which means future incremental HFCs demand will have to be met by incremental supplies from India and several Middle-Eastern countries. However, if the US indeed lifts tariffs, downward revision of earnings before interest and taxes is expected to be 6 per cent and 9 per cent respectively, for FY23 and FY24.

While there are worries of phasing out of HFCs given their impact on global warming and multiple global pacts have been signed for the same, brokerages believe that demand trend will continue to remain strong over the next few years. Among the reasons cited by JM Financial for HFC demand staying strong till at least CY30 is the European Union’s support for heat pumps to replace oil and gas for space heating, replacement of older generation fluorine-based gases in developing countries and global shift towards interim low global warming potential HFCs.

In addition to the US tariff decision, the near-term trigger would be the June quarter results. SRF’s revenues are expected to grow by 31 per cent year-on-year (YoY) to Rs 3,500 crore while its operating profit is expected to rise by 46 per cent YoY to Rs 980 crore. ICICI Securities expects SRF’s chemical business segment profit to gain from steady growth in fluoro-specialty (on agro-chemicals cycle), strong price increase in refrigerant gas (HFC) and anti-dumping duty on HFC imports in India.

At the current price the stock is trading at 26.5 times its FY24 earnings estimates and investors can consider it on dips.