SRF Ltd. Q2 FY26: Strong Profit Rebound Masks Margin Pressure and Valuation Concerns

The chemical major's second-quarter performance reflects a tale of two narratives: a strong year-on-year recovery driven by improved realisations and operational efficiencies, set against sequential headwinds from lower volumes and margin compression. Net sales for Q2 FY26 stood at ₹3,640.19 crores, representing a 6.30% increase from ₹3,424.30 crores in Q2 FY25, but a 4.67% decline from the preceding quarter's ₹3,818.62 crores. This sequential revenue contraction, combined with a modest uptick in employee costs to ₹277.14 crores, underscores the challenges facing the company as it navigates a volatile demand environment across its key business segments.

The profit after tax margin for Q2 FY26 came in at 10.66%, an improvement from 5.88% in the year-ago quarter but below the 11.32% achieved in Q1 FY26. This sequential margin erosion reflects the pressure on operating leverage as fixed costs remain elevated amidst moderating revenue growth. Despite the headline profit surge, investors are increasingly focused on the company's ability to sustain margin expansion in an environment characterised by fluctuating raw material prices and competitive intensity in the specialty chemicals space.

Financial Performance: Recovery Momentum Faces Sequential Headwinds

The quarter-on-quarter revenue decline of 4.67% to ₹3,640.19 crores reflects softer demand conditions across certain product segments, particularly in the specialty chemicals portfolio. On a year-on-year basis, the 6.30% revenue growth demonstrates resilience, but falls short of the double-digit expansion witnessed in earlier periods. The operating profit before depreciation, interest, tax, and other income (PBDIT excluding OI) stood at ₹774.15 crores in Q2 FY26, translating to an operating margin of 21.27%. While this represents a substantial 556 basis points improvement from the 15.71% margin in Q2 FY25, it marks a 46 basis points sequential contraction from the 21.73% achieved in Q1 FY26.

The company's cost structure reveals a mixed picture. Employee costs rose marginally to ₹277.14 crores from ₹277.26 crores in the previous quarter, indicating stable workforce expenses. However, interest costs declined sequentially to ₹70.68 crores from ₹79.90 crores, reflecting improved debt management and potentially lower borrowing rates. Depreciation charges increased to ₹212.13 crores from ₹203.24 crores, consistent with the company's ongoing capital expenditure programme to expand manufacturing capacity across its chemical intermediates and specialty polymers divisions.

The tax expense for Q2 FY26 came in at ₹128.87 crores, representing an effective tax rate of 24.92%, in line with the previous quarter's 24.92% and below the 28.99% rate in Q2 FY25. This normalisation of the tax rate, following the anomalously low 4.76% rate in Mar'24, provides a clearer picture of the company's underlying profitability. The profit before tax of ₹517.05 crores reflects a 10.20% quarter-on-quarter decline from ₹575.82 crores, mirroring the sequential pressure on operating performance.

Operational Challenges: Capital Efficiency Under Scrutiny

A deeper examination of SRF's operational metrics reveals concerns about capital efficiency and return generation. The company's return on equity (ROE) for the latest quarter stands at 9.91%, significantly below the five-year average of 16.40%. This decline in ROE, despite the strong year-on-year profit growth, highlights the challenge of generating adequate returns on the expanded capital base. The return on capital employed (ROCE) of 11.95% similarly trails the five-year average of 17.30%, suggesting that recent capital investments have yet to deliver proportionate returns.

The balance sheet as of March 2025 shows shareholder funds of ₹12,626.20 crores, up from ₹11,479.02 crores in the previous year, reflecting retained earnings and reserve accumulation. Long-term debt stood at ₹1,981.33 crores, down from ₹2,251.14 crores, indicating a deleveraging trend. The debt-to-equity ratio of 0.35 remains comfortable, positioning the company well to weather cyclical downturns. However, with fixed assets ballooning to ₹13,470.81 crores from ₹12,964.98 crores, the pressure to generate improved asset turns and margins becomes increasingly critical.

The company's interest coverage ratio of 12.75 times (on average) provides adequate cushion for debt servicing, but the sequential increase in depreciation charges to ₹212.13 crores from ₹203.24 crores underscores the burden of maintaining and expanding the asset base. With a debt-to-EBITDA ratio averaging 1.61, SRF maintains a conservative leverage profile, but the declining ROE and ROCE metrics suggest that the incremental capital deployed in recent years has not yet translated into commensurate earnings growth.

Industry Context: Navigating Volatility in Specialty Chemicals

SRF operates in the diversified chemicals sector, a space characterised by cyclical demand patterns, raw material volatility, and intense competition from both domestic and international players. The company's primary business segments—technical textiles, chemicals, and packaging films—are exposed to varying degrees of end-market demand from industries such as automotive, agrochemicals, pharmaceuticals, and consumer goods. The global specialty chemicals industry has witnessed significant headwinds over the past year, including destocking by customers, pricing pressure from Chinese competition, and uncertainty around demand recovery in key export markets.

The year-on-year margin expansion from 15.71% to 21.27% in Q2 FY26 suggests that the worst of the pricing pressure may be behind the company, with improved realisations and better product mix contributing to the recovery. However, the sequential margin contraction from 21.73% to 21.27% indicates that the path to sustained margin improvement remains uneven. The company's ability to maintain pricing power whilst managing input cost volatility will be critical to defending margins in the quarters ahead.

SRF's diversified portfolio provides some insulation against sector-specific shocks, but also means that recovery across different business lines may occur at different paces. The technical textiles segment, which includes refrigerant gases and specialty chemicals, has historically been a margin-accretive business, whilst the packaging films segment faces more intense competition and pricing pressure. The company's strategic focus on value-added products and backward integration initiatives should support margin stability, but execution risks remain elevated given the uncertain demand outlook.

Peer Comparison: Valuation Premium Difficult to Justify

When benchmarked against peers in the diversified chemicals space, SRF's valuation appears stretched relative to its operational performance. The company trades at a price-to-earnings (TTM) multiple of 62.57x, significantly higher than Deepak Nitrite's 39.51x, and broadly in line with Pidilite Industries' 69.66x and Gujarat Fluorochemicals' 65.06x. However, SRF's return on equity of 9.91% lags well behind Pidilite's 21.47% and Deepak Nitrite's 12.94%, raising questions about the sustainability of the valuation premium.

SRF's price-to-book value (P/BV) ratio of 7.24x sits in the middle of the peer range, with Pidilite commanding a significantly higher 15.71x multiple on the back of its superior profitability and brand strength. Deepak Nitrite, despite its lower ROE, trades at a more modest 4.45x P/BV, reflecting investor caution around the cyclical nature of its business. SRF's dividend yield of 0.25% is amongst the lowest in the peer group, with the company retaining most earnings to fund capital expenditure and capacity expansion. The debt-to-equity ratio of 0.29x is comparable to peers, indicating a conservative balance sheet approach across the sector.

The key differentiator for SRF has historically been its diversified business model and leadership position in niche segments such as refrigerant gases and specialty chemicals. However, with ROE at sub-10% levels and sequential margin pressure emerging, the valuation premium appears increasingly difficult to justify. Investors are effectively paying a premium multiple for below-average returns, a disconnect that typically resolves either through earnings acceleration or multiple compression.

Valuation Analysis: Premium Pricing for Modest Returns

At the current market price of ₹3,020.55, SRF trades at a trailing twelve-month price-to-earnings ratio of 62.57x, a level that embeds significant expectations for future earnings growth. The company's PEG ratio of 3.80 suggests that the stock is expensive relative to its historical growth trajectory, with investors paying ₹3.80 for every unit of earnings growth. The enterprise value-to-EBITDA multiple of 31.65x further underscores the premium valuation, particularly when set against the backdrop of sequential margin compression and modest revenue growth.

The stock's 52-week range of ₹2,127.55 to ₹3,319.00 indicates significant volatility, with the current price approximately 9% below the recent high. The year-to-date return of 35.40% has substantially outpaced the Sensex's 8.50% gain, reflecting strong investor appetite for the chemical sector recovery theme. However, the one-year alpha of 29.86% over the Sensex comes at the cost of elevated volatility, with the stock exhibiting a beta of 1.20, indicating higher sensitivity to market movements than the broader index.

The company's enterprise value-to-sales ratio of 6.19x reflects the market's willingness to ascribe a significant premium to SRF's revenue base, likely driven by expectations of margin expansion and market share gains in high-value product segments. However, with the five-year sales CAGR at 16.57% and recent quarters showing sequential revenue declines, the sustainability of this premium is questionable. The dividend yield of 0.25% offers minimal income support, with the company prioritising capital allocation towards growth investments over shareholder distributions.

Shareholding Pattern: Institutional Confidence Remains Steady

The shareholding structure of SRF has remained remarkably stable over recent quarters, with promoter holding constant at 50.26% across the last five reporting periods. This unwavering promoter commitment provides a degree of governance comfort, particularly in a sector where management quality and execution capabilities are critical differentiators. The absence of any promoter pledging further reinforces the financial strength and confidence of the controlling shareholders.

Foreign institutional investor (FII) holdings declined marginally to 17.98% in September 2025 from 18.23% in the previous quarter, representing a reduction of 25 basis points. This modest trimming by FIIs could reflect profit-booking after the stock's strong year-to-date performance, or a tactical reallocation towards other opportunities within the chemicals space. The number of FII holders increased to 562 from 552, suggesting that whilst aggregate holdings declined, new investors entered the stock, indicating continued interest despite the valuation concerns.

Mutual fund holdings showed a positive trend, rising to 11.01% from 10.36% in the previous quarter, an increase of 65 basis points. This uptick in domestic institutional participation signals confidence in the company's medium-term prospects, even as the number of mutual fund schemes holding the stock declined to 35 from 38. The concentration of holdings amongst fewer schemes suggests that larger funds have been accumulating positions, potentially viewing the recent correction as an opportunity to build exposure to a quality chemical franchise.

Stock Performance: Volatility Accompanies Strong Returns

SRF's stock has delivered impressive absolute returns over the past year, gaining 36.63% compared to the Sensex's 6.77% advance, translating to an alpha of 29.86 percentage points. The year-to-date performance of 35.40% has significantly outpaced the broader market's 8.50% gain, reflecting strong investor enthusiasm for the chemical sector recovery narrative. However, this outperformance has come with elevated volatility, as evidenced by the stock's beta of 1.20 and recent price swings.

The shorter-term performance reveals a more nuanced picture. Over the past week, the stock declined 5.00% whilst the Sensex gained 0.49%, resulting in negative alpha of 5.49 percentage points. The three-month return of -0.44% compared to the Sensex's 4.07% gain highlights the recent underperformance, likely reflecting concerns about sequential margin compression and moderating growth momentum. The six-month return of 1.68% similarly lagged the broader market's 7.03% advance, suggesting that the stock's outperformance has been concentrated in the earlier part of the year.

The longer-term returns paint a more favourable picture, with the five-year return of 244.94% substantially outpacing the Sensex's 109.22% gain. This demonstrates the stock's ability to compound shareholder wealth over extended periods, driven by the company's successful capacity expansion, product diversification, and margin improvement initiatives. However, the three-year return of 20.79% lagging the Sensex's 41.87% gain indicates that the stock has faced headwinds during the recent period of sector-wide challenges in the chemicals industry.

Investment Thesis: Quality Company Facing Execution Challenges

SRF's investment proposition rests on several pillars: a diversified business model spanning technical textiles, chemicals, and packaging films; leadership positions in niche segments such as refrigerant gases; a conservative balance sheet with manageable debt levels; and a track record of operational excellence. The company's quality grade of "Good" reflects its strong fundamentals, including healthy institutional holdings of 37.55%, zero promoter pledging, and consistent profitability. The five-year sales CAGR of 16.57% and EBIT growth of 15.32% underscore the company's ability to grow revenues and earnings over the medium term.

However, the current financial trend, whilst positive for the last two consecutive quarters, masks underlying concerns about capital efficiency and return generation. The return on equity of 9.91% is well below the five-year average of 16.40%, indicating that the company is struggling to generate adequate returns on the expanded capital base. The return on capital employed of 11.95% similarly trails the historical average of 17.30%, raising questions about the effectiveness of recent capacity investments. These deteriorating return metrics, combined with sequential margin pressure and modest revenue growth, suggest that the company faces execution challenges in translating capital investments into improved profitability.

The valuation remains a significant headwind, with the stock trading at a "Very Expensive" P/E multiple of 62.57x and a PEG ratio of 3.80. This premium pricing appears difficult to justify given the sub-10% ROE and sequential margin compression. The technical trend has recently shifted to "Mildly Bullish" from "Bullish," reflecting the stock's underperformance over the past week and month. The combination of stretched valuations, deteriorating return metrics, and near-term execution challenges suggests that investors should approach the stock with caution at current levels.

Key Strengths & Risk Factors

Outlook: Key Monitoring Points for Investors

The trajectory for SRF over the coming quarters will depend critically on the company's ability to sustain margin expansion whilst improving capital efficiency. Investors should focus on several key indicators to assess whether the recent profit recovery represents a sustainable turnaround or merely a cyclical bounce. The sequential trends in operating margins, return on equity, and revenue growth will provide early signals about the company's operational momentum and competitive positioning.

The company's management commentary on demand trends, pricing environment, and capacity utilisation will be critical in shaping investor sentiment. Any guidance on improvement in return ratios or specific initiatives to enhance capital efficiency would be viewed positively by the market. Conversely, continued sequential margin pressure or acknowledgement of structural challenges in key business segments could trigger a valuation de-rating. The upcoming quarters will be decisive in determining whether SRF can justify its premium valuation through improved operational performance and earnings momentum.