Australia’s Chemicals Sector – A Gunpowder for Growth in Priority Sectors

I.Sector Landscape and Outlook

Figure 1. Top 12 Stocks by Market Capitalization in Australian Chemical Sector Outperformed S&P/ASX 200 Index by 5.74% over the Past 3-months* 

Data Source: Refinitiv, Thomson Reuters, ASX; Price Comparison from *26^th August 2020 – 26^th November 2020

Analysis by Kalkine: QTD Average price performance of Top 12 Australian Chemical Stocks by Market Capitalization as on 26^th November 2020 as per GICS Industry Classification including ORI, NUF, ANO, CLV, IPL, SO4, FGR, SDV, HFR, ZNO, KLL, CXL

The Australian Chemicals Industry is one of the largest manufacturing sectors in the country with a significant contribution to GDP through supply of essential inputs to a wide range of sectors, including mining, food processing, construction, pharmaceuticals, etc. Players in the industry entail suppliers of fertilizers, pesticides and other crop protection chemicals, composites in construction and fittings, water disinfectants, health supplements such as fish oil, infant nutrition formula, and chemicals used in mining such as ammonium nitrate and nitric acid. The sector also plays a key role in creating numerous employment opportunities as most of the industry’s output is served as input to other industries, hence, creating a multiplier effect for jobs. Growing importance of mining in the economy, increased activity in the construction sector, government financial support for infrastructure, and advancements in agriculture are expected to boost the demand for the chemicals sector, in the time ahead.

Growth Drivers 

Importance of Commercial Explosives in Mining: Commercial explosives are an essential component in the supply chain of the mining industry. Potassium, ammonium nitrate, aluminium, and magnesium, are some of the chemicals/ explosives used in mining to extract ore and discover orebodies. Given the contribution of mining in Australia’s economic growth, the sector is expected to have a strong demand for chemicals. Notably, capital expenditure in mining has increased significantly over the last decade. Mining investment is likely to increase over the coming quarters as several large projects are constructed. Investment in iron ore projects has been made more attractive by ongoing high prices and exports.

Figure 2. Mining and Non-Mining Capital Expenditure

Source: RBA, ABS 

Figure 3. Resource Exports (Seasonally Adjusted)

Source: RBA, ABS 

Modern Manufacturing Strategy: The Government is investing $1.5 billion to support Australia’s economic recovery, delivering high value jobs and improve the competitiveness of the manufacturing sector. Being the third largest manufacturing sector in Australia, the chemicals sector will benefit from the new strategy by improving conditions for manufacturing and supporting economic recovery.

Figure 4. Modern Manufacturing Strategy in a Nutshell

Data Source: Federal Budget 2020-21, Chart Created by Kalkine Group

Rising Demand for Personal Care Products: The chemicals sector plays an important role in the manufacturing of skin/personal care products which continue to witness increased demand as consumers look for new and advanced products to fulfill their personal care needs. The outbreak of coronavirus led to hoarding of these products by customers. The March 2020 quarter saw household expenditure on these products rise by 17.7% indicating their essential nature. In the June 2020 quarter, expenditure on these products increased by 1.7%. Going forward, as restrictions ease and household spending improves, spending patterns indicate that a larger proportion of household income may go in purchasing these items.

Figure 5. Insights into Household Expenditure (Supermarket Scanner Data)

Data Source: ABS, Chart Created by Kalkine Group

Relevance of Crop Protection Products: Synthetic crop protection products, as well as natural chemicals and minerals are essential for adequate and reliable food supply. Crop protection products ensure the availability of high-quality, affordable food and fibre in Australia and are believed to have increased Australian crop yields by about 40% as well as increasing the value of food production by $13 billion each year. The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) expects crop production to increase strongly in 2020/21, which, in turn, will increase the demand for crop protection products.

Figure 6. Farm Production Volumes

Source: RBA, Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES)

Key Risks 

Figure 7. Key Risks in the Chemical Sector

Source: Kalkine Group 

High Reliance on Imports: Australia’s share of output to global market is very small for chemical products. The economy is a net importer for materials in commodity and industrial chemicals. The sector imports bulk of raw materials from China and other markets. Raw material prices remained elevated due to logistics and supply constraints on the backdrop of COVID-19. Geopolitical risk is high as trade to China could be interrupted if ongoing trade wars extends.

High Reliance on Natural Gas for Feedstock: The chemical industry is heavily relied upon natural gas for feedstock. Transition to renewable energy is yet to show rapid progression. The government mulls to invest in natural gas for feedstock. Global economies believe renewable energy is the cost-efficient and carbon friendly. This could potentially reduce the competitive cost advantage of Australian chemical manufacturers.

Increased regulation: The industry is exposed to increased regulatory oversight on matters like reducing carbon emission and waste recycling, etc.

Risk of Hazards: The chemicals industry is exposed to the risk of hazards at manufacturing sites, which may lead to delays in production and risks to employee safety.

Exposure to Sensitive Industries: Agriculture, mining and construction industry are the downstream users of chemical. These industries are largely influenced by economic swings, commodity prices, and cyclical/ seasonal factors.  The market for chemical products in agriculture industry is dependent on hot, dry weather conditions affecting crop yield. Volatile crude oil and gold price affects the output and margin of mining sector. 

Outlook: Growth in mining, construction, and infrastructure investment are currently supporting the demand for chemicals in Australia. Improving business and household sentiments are a sign that gradual easing of restrictions is promoting economic recovery, which will lead to an uptick in manufacturing. As households begin to use their accumulated savings to fulfil their previously unmet needs due to conservative spending, businesses across food, beverages, personal care, and other household items will witness an increase in demand and support the chemicals sector. Similarly, construction of roads and railways, increased resource exports, rise in farm production, etc., are also expected to drive growth in the demand for chemicals.

II.Investment theme and stocks under discussion (ORI, CLV, ANO and 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 ‘EV/Sales’ method.

1. ASX: ORI (Orica Limited)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 7.01 Billion)

Orica Limited (ASX: ORI) is engaged in the manufacturing and distribution of commercial blasting systems including technical services and solutions, mining and tunnelling support system.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~32.40% on 26 November 2020 closing price. For the said purposes, we have taken the overall industry mean. At the same price, the stock of ORI was offering a dividend yield of ~1.90%.

2. ASX: CLV (Clover Corporation Limited)

(Recommendation: Speculative Buy, Potential Upside: Low Double Digit, Mcap: A$ 304.34 Million)

Clover Corporation Limited (ASX: CLV) is engaged in the refining and sale of natural oils, the production of encapsulated powders and the research and product development of functional food and infant nutrition ingredients.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~26.47% on 26 November 2020 closing price. For the said purposes, we have taken peers such as Zoono Group Ltd (ASX: ZNO), Scidev Ltd (ASX: SDV), Alexium International Group Ltd (ASX: AJX), etc. At the same price, the stock of CLV was offering a dividend yield of ~2.32%.

3. ASX: ANO (Advance Nanotek Limited)

(Recommendation: Speculative Buy, Potential Upside: Low Double Digit, Mcap: A$ 269.44 Million)

Valuation

4. ASX: NUF (Nufarm Limited)

(Recommendation: Hold, Potential Upside: Low Double Digit, Mcap: A$ 1.60 Billion)

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~17.82% on 26 November 2020 closing price. For the said purposes, we have taken peers such as Orica Ltd (ASX: ORI), Alexium International Group Ltd (ASX: AJX), Carbonxt Group Ltd (ASX: CG1), etc.

Note: All the recommendations and the calculations are based on the closing price of 26 November 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

Disclaimer

Kalkine New Zealand Limited is authorised to provide class advice only. The information on this site does not take into account any of your investment objectives, financial situation or needs. Before you make a decision about whether to acquire a financial product, you should obtain the Product Disclosure Statement from the product issuer. You should consider the appropriateness of advice taking into account your own objectives, financial situation and needs and seek independent financial advice before making any financial decisions.