The chemical industry in India has been in focus on the back of developments taking place in China and customers increasingly sourcing their supplies from Indian manufacturers. Indian manufacturers having sensed these opportunities have set up capacities to cater to this demand. Indian listed companies have seen an increase in earnings and have given stellar returns to its investors in the last couple of years.
We take a deeper look at the Chemical Industry in this post. In the second part, we’ll do a focus post on one stock: Aarti Industries (Premium post).
Global Chemical Industry
The global chemical industry’s revenues in 2017 were $ 5,680 Billion, this is including pharmaceuticals. The compounded annual growth rate (CAGR) in the 2007-17 period was 5%.
The chemical industry can be broadly divided into five market segments : basic chemicals, agro chemicals, specialty chemicals, pharmaceuticals and consumer products. The global revenue breakup for 2016 and 2017 among these segments is shown below
As can be observed from the above chart, basic chemicals also known as bulk or commodity chemicals constitute major share of the revenues – $ 2,394 billion or 42%, this is followed by pharmaceuticals – $1,431 billion or 25% of revenues. Specialty chemicals sales were $ 967 billion and constituted 17% of revenues. In terms of growth basic chemicals and pharmaceuticals grew by 11% and 10% respectively over the previous year. We will explain the various segments later in the post.
Which are the regions/countries that contributed to these sales? Below is the region wise sales break up for 2017
China is the leader in the chemical industry. Chemical sales (ex pharmaceuticals) in China were EUR 1,293 billion or 37% of the global sales. It is expected that China will continue this momentum, the global chemical industry is expected to double from the current $ 3,470 billion to about $ 6,500 – 7,000 billion by 2030. China is expected to have 50% of this market.
There has been a structural change that has taken place in the global chemical industry. The chemical industry throughout most part of the 20th century was largely based in Europe, USA and Japan. It is since the 1970’s that capacities started getting created aggressively and shift started happening towards Asia – primarily China and Middle East.
Capacities
Below are capacities of major regions/countries in 2000 and 2017
As can be observed from the above chart, capacities in North America and Europe have been stagnant in between 2000 and 2017. China has seen massive capacity expansion during this period, capacities have grown the fastest at 12% CAGR from 118 Mn tonnes to 812 Mn tonnes. Capacities in India and Middle East have grown by 8% CAGR.
What are the reasons for this shift?
- Increase in cost of setting up plants and increase in wages, capacities in India and China today can be set up at 40-60% of that required in the West
- Stricter environmental norms leading to higher compliance costs
As a result of this most of the bulk chemicals capacities have moved out, though value added chemicals are still manufactured in these countries.
In 2016, 4 out of the top 10 largest chemical company’s were based in Asia or Middle East.
Will the next structural change be the move from China to India or the Indian chemical industry growing faster than that in China, while China still remains the leader?
There have been changes that are taking place in the Chinese chemical industry like stricter environmental norms and rise in labour costs. India stands to gain from this, we will look at this aspect in detail later in the post.
Value Chain
Chemical manufacturers, suppliers and users are spread across the world, in addition as the industry has grown so has the international trade. Exports (excluding intra EU exports) were $ 748 billion in 2017. EU is the largest exporting region – 20% of export value, followed by USA and China – 10% and 7% of total export value respectively.
Given the global reach of the industry it is very important to understand the value chain of the whole industry. The value chain extends from the feed stock (raw materials) to the chemical’s end application. Understanding the value chain will help us as investors to identify and better understand where does the company under research fit into the whole scheme of things.
Below is the chart showing the value chain of the chemical industry
Let us look at the value chain in detail below
Feedstock is the raw materials that goes into manufacturing chemicals. Fossil fuels (oil, gas and coal) are the feedstock to manufacture most chemical products, these are also the primary feedstocks for basic petrochemicals. Other reactants like water, oxygen, nitrogen and phosphoric acid are also used as feedstock. While fossil fuel act as primary feed stock in the manufacturing process, there is a shift seen towards use of bio based and renewable resources as feedstock.
Basic chemicals also known as commodity or bulk chemicals are the foundation raw materials to manufacture intermediates and speciality chemicals. Some of the characteristics of the bulk chemical industry are
- High volume low value business
- Highest share in sales and production of chemicals
- High capital cost, large scale production and high energy consumption required to run a bulk chemical business
- Mature industry – products, processes and production technologies haven’t changed in the last 50 years
- Emerging economies are more focussed on producing bulk chemicals than developed countries
- Large dominant firms versus speciality chemicals which is fragmented
The industry can be further classified into organic and inorganic chemicals. Inorganic chemicals is composed of reactants like soda ash, caustic soda, chlorine, industrial gases, titanium oxides. Nitrogen compounds make up largest share of the inorganic market. This segment is highly concentrated with few firms dominating this market.
The organic chemical market is largely made up of petrochemicals. 90% of the organic chemistry products are derived from 7 petrochemicals namely – benzene, toluene, xylene, ethylene, propylene, butadiene and methanol.
Bulk chemicals formed 42% of sales of chemicals in 2017. The break up of bulk chemical sales in 2016 and 2017 is shown below
Bulk petrochemicals and intermediates forms majority of the bulk chemical sales – 39%, this was followed by plastic resins – 31% and inorganic chemicals – 18%
Intermediate chemicals is forward integration from the bulk chemical process. Many companies in emerging countries which are known for producing bulk chemicals are moving up the value chain by entering the intermediate and speciality chemical space. Some of the products in this space are agro intermediates, pigments and dyes, pharma intermediates and petrochemical intermediates.
Specialty chemicals are value added chemicals, they are used towards specific end use applications. Some of the characteristics of this segment are
- Low volume high value business
- Fragmented – hundreds of sub segments and various producers distributed across the world
- B2B business – since they add value to the finished product
- Known for end use performance enhancing applications rather than composition, “What they do” rather than “What they are” , which is the case of basic chemicals
- Caters to several end user industries
- Financial metric to distinguish speciality chemical company from a bulk chemical company is to look at the operating margins. Speciality chemical company’s enjoy high operating margins
Finally these chemicals find end applications in various industries – packaging, food, electronic goods, water, automotive, construction, paints and coatings, textiles, pharmaceutical, pulp and paper etc.
Indian Specialty Chemicals
The Indian chemical industry was $ 163 billion in FY18, 3.5-4% of the global chemical industry. India is the 6th largest producer in the world followed by USA, China, Germany, Japan and Korea.
Break up of the domestic industry is shown below
Source: Aarti Annual Report
As it is in the global markets, bulk chemicals forms a major part of the domestic chemical industry. The industry serves large number of end application industries and covers more than 80,000 products. It is estimated that the industry employs about 2 million people. Per capita consumption of chemical products is estimated to be 1/10 of the world average, and this will act as one of the drivers for the growth in the industry. The overall domestic industry is expected to grow by 9% CAGR over the next 5 years. Growth is majorly expected to come from the speciality chemicals, petrochemical intermediates and import substitution segments.
The Indian specialty chemical market is estimated to be between $ 30-32 billion, constituting about 19-20% of the domestic chemical market. India’s share in the global specialty market is 3%.
Globally, the specialty chemical market is differentiated from the bulk chemical market by product R&D and innovation that the company and the industry does, however in India the specialty chemical market is more generalised.
The Indian specialty chemical industry can be classified into the below segments, though there are lot of specialty applications, the below segments constitute over 80% of the entire specialty chemical space. The balance includes segments like paper chemicals, printing inks, industrial and institutional cleaners and rubber chemicals.
- Agro Chemicals
- Flavours and Fragrances
- Dyes and Pigments
- Personal Care Active Ingredients
- Water Chemicals
- Construction Chemicals
- Surfactants
- Textile Chemicals
- Polymer Additives
The largest segments are agro chemicals, dyes and pigments, flavours and fragrances and surfactants having shares of 30%, 25% and 14% each of the specialty chemical market. While the fastest growing segments are water and construction chemicals, estimated to be growing at 15%. The overall industry is expected to grow at 12%, faster than the chemical industry.
Each of the above segments have different characteristics and have to be looked at in detail. For instance in the surfactants and dyes market scale is important and hence operational efficiency is a key success factor. On the other hand branding and distribution is the key in the agro chemical market.
Below figure shows the key success factors for some of the segments
Source: Specialty Chemical Report, Avendus Capital
Why is the specialty chemicals industry growing faster than the chemical industry and what are the drivers for this industry?
Growth in domestic consumption – specialty chemicals are found in products that we use or consume on day to day basis. For instance personal care chemicals are used in detergents, soaps and cosmetics that we use. Colorants are used in car paints and paints used in office and home segments. Water chemicals are used in water treatment etc. It is estimated that 70% of the specialty chemical demand is linked to consumer spending and the balance comes from the construction and infrastructure industry
Source: Indian Chemicals and Petrochemicals Industry, TSMG
Increase in exports is on the back of structural changes taking place in China and developed countries tightening environmental norms. Regulation that has maximum impact on Indian manufacturers is the REACH regulation (Registration, Evaluation, Authorisation and Restriction of chemicals) imposed by the EU. Significant proportion of agro chemicals, dyes and pigments and flavours and fragrances is exported
Many customers of specialty chemicals do not want to rely on one source of supply – China, especially after the enforcement of tighter environmental norms. India is the beneficiary of these developments. Lower production, labour costs and continuity in supplies are also helping in making this shift.
We follow this up with looking at Aarti Industries in detail in our next post.
References
Global Chemicals Outlook II, UN
Indian Chemical and Petrochemical Industry, TSMG
Specialty Chemicals in India, Avendus
Disclosure: The authors at Capitalmind may have positions in the stocks mentioned, please assume our bias exists. This is not a recommendation to buy or sell securities. This is purely information about the company mentioned.
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