We recommended that investors buy the stock of Gujarat Fluorochem (GFCL) in December 2022, then trading at 24 times one-year forward earnings (FY24). The stock has since delivered 28 per cent returns and is now trading at even higher forward earnings of 40 times FY25 expected EPS.
The company is facing headwinds in its three sectors owing to competitive pressures. These pressures may resolve but refrigerant gases division may remain subdued. Even as expansion into new-age solutions is still a possibility, high growth expectations and higher multiples baked into the price should be an opportune time for investors to book profits from the stock.
Clarity on demand pick-up in new expansion, regulatory acceptance and overall business outlook in Europe is needed to take a re-look at the stock.
GFCL reports three segments: Bulk chemicals (16 per cent of H1FY24 revenues), Fluorochemicals (Refrigerant gases and specialty chemicals - 25 per cent) and Fluoropolymers (59 per cent). The three segments reported a significant decline in Q2FY24 when revenues declined 37/52/27 per cent YoY respectively and consolidated EBITDA margins contracted by 19 percentage points to 17 per cent.
The common reason for the three segments’ decline relates to destocking from clients and excess Chinese supplies. Companies/clients overstocked supplies last year owing to supply chain volatilities. As the built-up inventory is rationalised, demand for chemicals will be weaker for a few more quarters for all related companies, not only for GFCL. The rapid rise in interest rates is also impacting the cost of inventory holding, further pressuring demand.
With Chinese demand not expanding as expected, its domestic capacity of chemicals is also finding its way to European markets, impacting price realisations as well. GFCL is facing volume decline from destocking and price decline from Chinese competition in recent quarters. It being cyclical in nature, it can be expected to reverse as destocking may wane and inventory build-up resumes and based on Chinese economic growth, excess supplies may be curtailed in next few quarters.
GFCL also faces company-specific issues. Refrigerant gases were to be phased out of production in US markets gradually. This generated a strong demand in 2023 before the phase-out. The segment (fluorochemicals) reported a 158 per cent YoY growth in FY23 on strong demand and higher pricing. As the demand normalises after stocking and from other markets, the segment will remain subdued, going forward as well. The company had planned a large capex for R32 refrigerant gas, which is on hold till demand resumption is on the outlook.
Europe, which is the main market for fluoropolymers, is toying with a ban on polyfluoroalkyl substances or PFAS, unless essential in nature. GFCL maintains that the long-chain compounds manufactured by it are not subjected to the regulation. Also, as end-use is into semiconductors, EV and batteries and not in food grade products, the scope of regulation may be limited. Legacy manufacturers in Europe are also cutting down on production in Europe, which is again driving heightened stocking by clients and pushing demand for GFCL’s fluoropolymers down. But this should be a short-term pressure.
Though in the midst of a challenging environment, GFCL has a strong suite of products in development, which find applications in new-age solutions. Several polymers for semiconductors, solar films, battery chemicals and energy storage have been developed and are in lab analysis stage with manufacturing capacity readied or at the commercialisation stage.
For PVDF (Polyvinylidene fluoride) for electric vehicle battery, client approvals are underway and capacity is to be commercialised. Full-scale revenues should be expected by FY26 on a capacity of ₹800 crore and two times asset turnover. Similarly, applications for PTFE (Polytetrafluoroethylene), PFA (Perfluoroalkoxy alkanes) and FKM (Fluoroelastomers) are also under way, which can open new lines of revenue source in next two years. With their being high grade polymers with low levels of impurity and undergoing client approvals, entry barrier will be high for competition to step in when renewables and green energy solutions come into focus.
Financials and valuation
Consensus estimates are factoring in the current negatives and also a sharp recovery. The FY24 estimates are baking in 22/55 per cent decline in FY24 for revenue and earnings (22/62 per cent YoY decline reported by H2FY24). Owing to commercialisation of new facilities and cyclical recovery in base business, the FY25 estimates are at 27/67 per cent YoY growth in revenue and earnings.
Not only is a sharp recovery expected, but the market is also valuing such growth at 40 times earnings in FY25. This leaves little room for error; risks from severe regulatory rulings, execution risks in new facilities, failure of China to absorb its chemical production and global growth outlook are not priced into the risks. With the recent rally of 28 per cent in last six months, investors can book profits from the stock.