1. Sector Landscape

The Australian chemical industry holds 5,000 individual businesses, contributing over $38 billion to GDP in terms of industry value-added, according to Chemistry Australia. It is one of Australia’s most significant sectors in manufacturing, directly employing over 60,000 people, mostly falling in highly skilled jobs. Key applications for the chemical industry include the following –

• Key input for medical products
• Used in agricultural activities by way of fertilizers and high-yield seeds
• Usage in polymer membrane filters to disinfect water supplies
• Material innovation in adhesives, insulation, and sealants for efficient construction and transportation activities
• Used in new wind turbines, solar cells, and rechargeable batteries.

Favourable Momentum Captured in Chemical Industry

Chemical Industry from Commercial Standpoint: In FY20, the chemical industry’s total income manifested substantial gains by 8.39% YoY and aggregated to $35.97 billion. For the same period, Industry value added surged by 5.77% and clocked at $9.39 billion. After improved international demand and technological changes, the industry’s EBITDA edged up by 9.99% and registered $4.16 billion.

Figure 1: Total Income of Businesses in Basic Chemical and Chemical Product Manufacturing

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Manufacturing and Export Updates in the Sector: The basic chemicals and chemical products manufacturing clocked an output value of $117.3 billion in September 2021 quarter, up by 1.7% on a sequential basis. For October 2021, the chemical sector clocked an export value of $775 million, down by 5.4% on a sequential basis; however, it remains at elevated levels with 2.2% gains from the corresponding prior period.

Figure 2: Merchandise Export Value for Basic Chemical and Chemical Products Industry

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Update on AdBlue supplies and Healthcare Investments

Global Supply Pressures in AdBlue Industry: The international supply pressure has stemmed from numerous domestic usages in China, leading to global issues in securing urea, a key producing agent for AdBlue. Moreover, this is exacerbated by the natural gas shortage worldwide, the essential input for urea production. Current supplies of AdBlue stands at 15 million litres, equivalent to five weeks of business demand.

Promoting Food Security and Securing Life-saving Medicines: The Australian government is investing over $33 million to edge up Australia’s supply chain while backing local manufacturing sites for medical fluids. The grants shall improve Australia’s access to agricultural production chemicals and medicines. Successful companies under Round one funding will receive grants between $50k and $2 million across agricultural production chemicals and medicines.

Key Risks and Challenges

Although the government has dispensed remunerative support via Supply Chain Resilience Initiative (SCRI), the supply chain disruptions may stay intact in the short term. As part of COVID-19 relief measures, the retrenchment of government policies may pose a significant reversion of outperforming indicators. Higher input costs for Urea and AdBlue may discourage fertilizer usage in agricultural production. Increased domestic usage of urea in the Chinese market has resulted in the global scarcity of AdBlue. Shortage of Natural Gas has developed production challenges for agricultural production chemicals.

Figure 3: Key Drives V/S Key Constraints

Source: Analysis by Kalkine Group

Outlook

Modern Manufacturing Strategy: In support of recoveries and scale-up competition among Australian manufacturers, the Morrison Government rolled out the Modern Manufacturing Strategy to infuse $1.5 billion in new funding in the next four years.

Setup of AdBlue Taskforce: On 9 December 2021, an AdBlue Taskforce was set up to work on industry solutions to potential supply constraints in the future. Exploring options include bolstering local manufacturing capabilities, international supply options for refined urea, and technical options at the vehicle level.

Potential Improvement in Urea Supply Chain: The recent onset of global shortage from top exporters – Russia, Egypt, and China – may call for government support for improvements in the supply chain. Several shipments of refined urea are on their way to Australia, supporting two weeks of additional market supply.

Australia’s Supply Options for Urea Expected to Expand: Australia is seeking other international supply chains that are open and operating. The Australian government is manifesting a positive indication of exploring supply options in the medium term.

Rising Crop Production Supporting Chemical Demand: Gross value of crop production is estimated to clock $78 billion in FY22, an upward revision of $5.4 billion from the previous estimate, which may support pesticide and fertilizers in the chemical industry.

II. Investment theme and stocks under discussion (BAP, DGL, LCK, NUF)

After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/EBITDA’ multiple method and TTM valuation.

1. ASX: BAP (Bapcor Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$2.26 billion)

BAP is engaged in selling and distributing vehicle parts, accessories, automotive equipment, etc.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 15.69% on 16 December 2021. The company might trade at a slight premium to its peers, given favourable shifts in consumer demand from public to private transport. For valuation, a few peers like Supply Network Ltd (ASX: SNL), Apollo Tourism & Leisure Ltd (ASX: ATL), National Tyre & Wheel Ltd (ASX: NTD) have been considered. Given the solid interim results, prudent cash position, expansion strategies, current trading levels, and upside indicated by valuation, we give a “Buy” recommendation on the stock at the closing market price of $6.730, up by ~0.748%, as on 16 December 2021. In addition, the stock has delivered an annualised dividend yield of 2.99%.

 2. ASX: DGL (DGL Group Limited)

(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$775.87 million)

DGL is involved in the speciality chemicals industry that manufactures, stores, process, and transport chemicals and hazardous waste.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 17.34% on 16 December 2021. However, the stock might trade at a slight discount compared to its peers, given the lack of formal contracts with suppliers and a highly regulated environment. For valuation, peers such as Secos Group Ltd (ASX: SES), Clover Corporation Ltd (ASX: CLV), Scidev Ltd (ASX: SDV), and others are considered. Given the favourable cash position, high performance from chemical manufacturing and warehousing & distribution services, increased EBITDA level, and valuation, we give a “Speculative Buy” recommendation on the stock at the current market price of $2.850, as on 16 December 2021, at 01:16 PM (GMT+10), Sydney, Eastern Australia.

3. ASX: LCK (Leigh Creek Energy Limited)

(Recommendation: Speculative Buy, Mcap: A$148.24 million)

LCK is engaged in developing its Leigh Creek Urea Project (LCUP), involved in developing nitrogen-based fertilisers.

Technical Analysis:

On the daily chart, LCK stock price witnessed a breakout of the horizontal trendline resistance at AUD 0.165 level and sustaining above the breakout level. The momentum oscillator RSI (14-period) is at (~61.98 level), indicating bullish momentum in the stock. An important support level for the stock, is placed at AUD 0.15 while the key resistance level is placed at AUD 0.21.

Valuation

The stock of LCK gave a positive return of ~16.667% in the past year. The stock is currently trading lower than the 52-weeks’ average price level band of $0.100 - $0.310. On a TTM basis, the stock of LCK is trading at a price to book value multiple of 2.9x, lower than the industry average (Oil & Gas) of 3.4x, signalling undervaluation. Considering the current trading levels, valuation on a TTM basis, low estimations for operating costs at LCUP, improving fertiliser demand, low domestic competition, optimistic outlook, and associated key risks with the business, we give a “Speculative Buy” recommendation on the stock at the closing market price of $0.175, as of 16 December 2021.

4. ASX: NUF (Nufarm Limited)

(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$1.77 billion)

NUF is mainly engaged in the manufacturing and distribution of crop protection products.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 8.73% on 16 December 2021. However, the stock might trade at some discount compared to its peers, given high product development risks, regulatory headwinds, and high currency risk. For valuation, peers such as Orica Ltd (ASX: ORI), Incitec Pivot Ltd (ASX: IPL), Salt Lake Potash Ltd (ASX: SO4), and others are considered. Given the increased market share, favourable cash position, low financial leverage, significant operational efficiencies, top-line upside, and valuation, we give a “Hold” recommendation on the stock at the closing market price of $4.750, up by ~1.713% on 16 December 2021. In addition, the stock has delivered an annualised dividend yield of 0.85%.

Note: All the recommendations and the calculations are based on the closing price of 16 December 2021. The financial information has been retrieved from the respective company’s website and REFINITIV.  

Investment decisions should be made depending on the investors' appetite for upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the valuation has been achieved and is subject to the factors discussed above.

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