Specialty chemical firms pare capex as margins come under pressure

India's specialty chemical manufacturers are expected to moderate capital expenditure to around Rs 16,500 crore this financial year as weak exports, elevated raw material costs and pricing pressure weigh on profitability, according to a Crisil Ratings report released on Thursday.

The ratings agency expects operating margins to contract by 150-200 basis points even as domestic demand keeps the industry on a moderate growth path. Crisil expects the sector's revenue to grow around 6% this fiscal, down from about 8% in each of the previous two years.

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While domestic demand across sectors such as agrochemicals, dyes and pigments, and flavours and fragrances is expected to remain firm, subdued exports driven by supply disruptions and cautious procurement by overseas buyers will limit overall growth. Trade flows are likely to normalise over the next couple of quarters if the easing of tensions in West Asia is sustained.

"Supported by diversified end-user segments, domestic demand will remain the key growth driver this fiscal and support 7-8% growth in industry revenue. Though exports will stay muted amid global disruptions, trade flows should normalise over the next couple of quarters if the recent easing of the West Asia conflict holds," said Anuj Sethi, Senior Director, Crisil Ratings. He added that China's reduction in export incentives for select products could lend some support to pricing, although continued dumping would cap any meaningful gains.

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The pressure on profitability is expected to be more pronounced because exports, which account for roughly one-third of industry revenue, typically generate better margins than domestic sales. At the same time, companies have a limited ability to pass on rising crude-linked raw material costs in overseas markets. As a result, Crisil expects the industry's operating margin to decline to 14-14.5% this fiscal from around 16% last year.

The impact, however, will vary across manufacturers depending on their raw material mix and pricing power. Companies dependent on ethylene and propylene are likely to face greater pressure because of their higher exposure to crude prices, while manufacturers using benzene, toluene and xylene (BTX)-based inputs could fare relatively better on the back of value-added products. Producers focused on fluorine-based chemistries are expected to remain relatively resilient because of their niche positioning and stronger ability to pass on costs.

"Crude-linked inputs, accounting for nearly one-third of raw material cost, will continue to weigh on profitability, though the recent softening in crude and chemical input prices should limit the decline in operating margin to 150-200 bps this fiscal," said Poonam Upadhyay, Director, Crisil Ratings. "Chinese competition will constrain pricing flexibility, and supply chains may take a couple of quarters to normalise. Benefits will flow through gradually."

While recent customs duty exemptions on select petrochemical inputs may provide some relief, Crisil said they are unlikely to materially offset broader input cost volatility. Against this backdrop, companies are recalibrating capital spending, with investments expected to remain focused on backward integration, import substitution and niche chemistries. Most manufacturers are likely to fund these investments through internal accruals, although lower earnings and higher working capital requirements could put pressure on balance sheets.

The ratings agency expects debt-to-EBITDA to increase to around 2.2 times this fiscal from 1.9 times last year, while interest coverage is likely to decline to about 6 times from 7.5 times, reflecting the impact of weaker profitability and higher working capital needs.

Crisil said the pace of recovery in export demand, easing of Chinese pricing pressure, movement in feedstock costs, and companies' ability to restore margins through selective price increases will remain the key factors determining the sector's performance over the coming quarters.