External
environment favourable for Indian chemical businesses, but beware of
complacency
The improved financial performance of Indian chemical companies
for the last few quarters have raised both interest and expectations from the
investor community like never before. There is a belief in some of them at
least that the chemical industry here could be a considerable wealth generator
in the years to come, both due to internal and external factors. This author
was recently involved in a discussion with more than 50 analysts that track the
sector and came out of the room pleasantly surprised at the interest shown this
time around; a couple of years ago a similar interaction attracted just a
handful!
Key economic enabler
There are several good reasons to be optimistic of the growth
prospects of the broad Indian chemical industry. An important one is the
criticality of the industry, especially as a key enabler of modern living. Life
without chemicals and the chemical industry is inconceivable today, though this
is mostly unrecognised by modern society. The role of the chemical industry in
supplying inputs that lead to the creation of textiles, pharmaceuticals,
colorants, agrochemicals, paints, fertilisers etc. is critical and will stay
that way well into the future. For sure the chemical industry will evolve – in
the technologies it employs, the raw materials it transforms and the scale
& size in which all of this is done. But it will be around long after
several of the start-ups that hog the headlines today have vanished.
But the criticality of the industry is not enough to ensure the
prosperity of Indian chemical companies. Even in the challenging years since
the turn of the century, the Indian market for chemicals posted increases
year-after-year, albeit at varying rates. Two aspects are noteworthy. One is
that much of the growth in demand in the last decade has been met by increase
in imports, as the domestic industry has largely been unable to leverage this
opportunity for varying reasons. Another critical aspect has been the intense
pressure on margins for much of the period and for most of the industry. Aside
of brief periods of prosperity, most chemical companies here have been
challenged on profitability and this has, to a considerable extent, happened
due developments in China.
The irrational ramp up in China
In many fine and speciality chemical businesses, global capacity
and output has increasingly come to be dominated by China. The country has
accounted for most of the incremental capacity built up since the turn of the
century, and the pace of this growth has far exceeded that of demand. A natural
consequence of this reckless investment binge has been on operating rates – not
just in China, but also in most other parts of the world, given the global
nature of the industry. The over-capacity varies from segment to segment, but
where substantial they have wrecked havoc for producers, especially those
offering undifferentiated products sold to specifications.
Indian producers too did not escape the consequences and were
forced to either lower prices to match the landed costs of Chinese imports, or,
worse, shut shop. Supply chains in consuming industries such as pharmaceuticals
and agrochemicals exploited the situation and turned en masse to imports of
cheap chemicals from China to keep their raw materials pipeline well stocked.
Purchase manners spent more time shopping in Shanghai than in Gujarat or
Hyderabad, and were rewarded for having saved a buck or two for their
companies.
Tightening the environmental screws
For several industry watchers (including this author) this was
an unsustainable situation that had to give. And it did about a year ago when
the Chinese government announced that it was tightening the screws on
environmental compliance, partly in response to growing public anger against
reckless practices by small chemical producers. This came alongside a
reprioritisation of growth targets, and a clear indication from the top of the
political heap that growth will henceforth need to come in a more sustainable
manner and from services and industries targeted as being critical to China’s
transition to a prosperous, middle-income country. What have followed in the
period since have been large-scale closures, leading to disruptions in several
supply chains. This is forcing Indian companies to revaluate their purchasing
strategies and look once again at local supply options for intermediates for
agrochemicals and pharmaceuticals, to name a few. Several large pharmaceutical
companies are also now looking for full integration to key raw materials needed
for making active pharmaceutical ingredients (APIs). Just a year ago they were
pitching one Chinese supplier against another in a bid to get the lowest price
input.
Global chemical companies are also revaluating their supply
options, and seeking to hedge their exposure in China. It is only logical that
they will turn to India as an option. Several small- and mid-sized chemical
companies in India that this author recently spoke to, report a spate of
enquiries from western companies for fine chemicals that they exclusively
procured from China till not too long ago. This is a strategic shift that will
stay and have a positive impact on the industry here.
Proactive approach needed
Indian fine and speciality chemical companies stand to benefit
from a more rational investment and pricing approach producers in China will be
forced to take. The costs of environmental compliance – which can be
substantial – will henceforth need to be factored into product pricing. Closure
of some capacity will bring a semblance of balance between demand and supply –
at least for some chemicals – which could afford opportunities for better
margins for producers elsewhere, including in India.
The uptick in the financial performance of Indian chemical
companies is due all of the above reasons, but making it last will require a
more proactive approach than seen hitherto. Ramping up manufacturing
capabilities quickly to leverage the window of opportunity will be a challenge,
given the slow pace of regulatory approvals and land acquisition challenges
that investors in new projects or brownfield expansions typically face.
Overseas buyers, in particular, are looking for concrete evidence of
manufacturing capability (steel on the ground, customer references etc.) before
committing business orders, not well-meaning promises of future investments. As
a few recent examples of sizeable supply contracts between Indian vendors and
MNCs show, those Indian companies that have ready manufacturing infrastructure,
technology development capability and the requisite permissions, will reap
rewards.
There are issues related to feedstock availability and the lack
of streamlined logistics that make for inefficient manufacturing that will need
to be overcome. In a typical manufacturing scenario here, raw materials and
finished goods typically need to be carted considerable distances for
processing and sales, respectively – all adding to costs. One way around this
is collaborations between companies, but government assistance in getting the
infrastructure right is even more important.
Technology-led growth
There is a need to invest in technology, as this is the only way
to ensure sustained competitiveness, even when the going gets tough. There is
ample evidence to show that in the few instances wherein Indian chemical
companies have sizeable global market share, it is their technological edge
that has provided them with the wherewithal to compete with the best in the
world. Where internal capabilities at technology development are lacking, it
can be supplemented by partnerships with research laboratories and academic
institutions. This is sorely missing in India, in sharp contrast to China.
The introduction of the Goods and Services Tax has rationalised
costs to some extent by avoiding the cascading effect of taxation that has
escalated manufacturing costs in the past. There are some issues to be ironed
out on this front, especially the rules related to the ease of compliance, but
the tax reform is a welcome measure that should aid local manufacturing.
No place for complacency
Indian entrepreneurs must realise that the external environment
is now as conducive to supporting their growth as it can ever be. But it should
not take this situation for granted and expect that the opportunity is theirs
to take. Companies that have been edged out of the business elsewhere in the
world, and particularly in China, will also be gearing themselves up to compete
in an evolved marketplace. Some of them will be back in business, and ready to
take on the world.
Ravi Raghavan
Chwkly 7Aug18
No comments:
Post a Comment