What's So Special about the Specialty Chemical Business?

Everything you hear, see, smell, taste, and touch involves chemistry and chemicals.

The Indian chemical Industry comprises upstream commodity products, intermediaries, and specialty products. Analysts divide this sector into two segments - bulk chemicals and specialty chemicals.

Bulk chemicals are building blocks. The production of these chemicals usually requires large investments in plant and machinery and technology. Investment and pricing in this segment is driven by the demand-supply scenario. This segment is typically cyclical. The bulk of chemicals produced in India are for either upstream products or intermediates with a variety of manufacturing applications. This includes fertilizers, pharmaceuticals, textiles and plastics, agrochemicals, paints, and dyes.

Specialty chemicals are high-value, low-volume chemicals recognised for their performance-enhancing, end-use applications. Specialty chemical companies focus on chemistry or technology and invest a large amount of their revenues towards R&D.

These companies produce products derived from chemical processes such as chlorination, sulphonation, nitration, ethoxilation, hydrogenation, condensation, etc. Thus, it is imperative to identify a company with expertise in chemistry and a unique product profile.

What's so special about Indian specialty chemical companies?

As multinationals scout for a reliable alternative to China, India's specialty chemical space is garnering increased interest.

China's health-conscious emerging middle class is forcing the government to fight pollution. Due to this, regulations in the chemical industry have tightened in the recent past. The Chinese government has made it mandatory for chemical plants to operate from chemical parks. Since approximately just 45% of the country's chemical industry is currently based out of such parks, major plant shutdowns or relocations are expected over the next couple of years.

With the implementation of strict environmental policies in 2015, the Chinese chemical industry has already seen 1,000 plant shutdowns. This has also resulted in ~15% YoY decline in chemical exports in CY15. This scenario is likely to continue for a couple more years as the Chinese industry goes green.

Since Chinese specialty chemical exports are still ~10 times larger than the Indian industry, a visible slowdown in China could multiply the size of the Indian specialty industry over the next couple of years.

Not to mention China faces other issues such as rising costs (including labour), overcapacity of many products, and the complex and fragmented nature of their industry.

How to tell a specialty chemical company from a generic one?

It is a common trend in the chemical industry to add the word 'specialty' to get a premium valuation. Nowadays, every chemical company claims to be a specialty chemical company.

However, it is important to note that companies that only focus on products cannot truly be called a 'specialty chemical company'. For this, the company has to focus on chemistry or technology and produce various products that are vital inputs for the end user industry. The key is how much of proportion of contribution to such companies comes from these unique businesses and how much comes from commodity chemicals.

Though there is a structural shift from China to India, the selection of a company with the right product profile will be the key to the best returns in this space in the coming years.