Valuation concerns weigh on SRF

Slow growth of chemicals segment, lower packaging margin may impact earnings

The stock of specialty chemicals company SRF was down 8.5 per cent in trade on Friday after brokerages downgraded it, citing expensive valuations. While most analysts have revised their earnings estimates upwards for the company by 5 per cent for FY22, they believe the riskreward remains unfavourable after the recent rally.

After a 16 per cent gain since the start of April, the stock is trading just under 23x its FY23 earnings estimates. Even on an enterprise value to operating profit basis, the valuation at 18x is at a 50 per cent premium to the five-year average.

Analysts at Motilal Oswal Research expect earnings momentum to slow down to 21 per cent annual growth over FY21-23 due to margin contraction in the packaging segment and lower growth momentum in specialty chemicals, weighed down by a high base. Slower growth comes after a robust performance in the last three years which saw the company’s annual net profit jump 42 per cent, with stock returns mirroring earnings growth with a gain of 43 per cent.

While the stock witnessed downgrades due to its valuation, the March quarter performance was better than expected on most counts. SRF reported revenue growth of 40 per cent and the operating profit margin expansion of 340 basis points, led by the specialty chemicals and technical textiles segments.

Strong demand from overseas markets and higher volumes of key products from European clients led to the growth in specialty chemicals. While the segment grew over 42 per cent in FY21, the company has guided for 10-15 per cent growth in FY22 due to the high base. SRF has a capital expenditure programme of over ~1,600 crore in FY22 with 70 per cent of the spends going into the chemicals segment.

Packaging business, too, saw strong revenue growth due to additional capacities in Hungary and Thailand, and higher sales of valueadded products. The margin on a sequential basis however has seen a decline of 420 basis points and will weigh on consolidated earnings over the next year.

Given the valuation worries, investors should await further correction before considering the stock.