Ideas for Profit | Steep correction in this agri stock could usher in gains

Post-correction, the stock is now trading at an FY19 estimated price-to-earnings of 14 times

Ruchi Agrawal
Moneycontrol Research

Dhanuka Agritech’s (DHAG) stock looks attractive after a 39 percent correction from its 52-week high (August 2018), given that its growth story remains intact. The company is well-positioned for margin improvement with the clearing up of high-cost inventory and a healthy line-up of new products.

About the company
DHAG manufactures insecticides, pesticides, fungicides, and herbicides. More than half of its sales comprise specialty molecules. The company has a pan-India presence, with marketing offices in all major Indian states and a network of more than 8,000 distributors. It has technical tie-ups with three US and four Japanese companies. It has three manufacturing units located in Gurugram (Haryana), Sanand (Gujarat), and Udhampur (J&K).

Healthy operating performance
Barring FY19, the company has maintained a healthy operating performance in the past few years. Financials in FY19 were impacted due to raw material cost pressure and below-normal monsoons. Overall performance, in the long run, has been healthy. The company has maintained a decent margin profile, with an operating margin of around 19 percent and a net margin of around 13 percent. Return on capital (RoC) has been around 20 percent in the past few years.

Clearing up of high-cost inventory
Owing to steep fluctuations in raw material prices, the company stocked up at the beginning of 2018. Towards the middle of the year, product prices started correcting, but the company was stuck with high-cost inventory, which impacted margin. Most of this inventory is now cleared, making us believe that the margin is positioned to improve.

Insulated portfolio and regional mix
Over half of the company’s portfolio comprises specialty molecule manufacturing, which is somewhat insulated from the weather’s vagaries. The region-wise revenue break-up stands around 35 percent, 16 percent, 14 percent, and 35 percent from the north, east, west, and southern regions, respectively. This makes it less exposed to one particular state and provides stability to growth.

New products to drive growth
The company launched 11 products in FY18 and around five products in FY19. Of these, almost 9-10 products have yet to gain traction. Acceleration in sales of these products would drive the topline in the coming quarters.

Debt-free balance sheet
The company has steadily paid off its debt and has a debt-free balance sheet. This leaves scope for both organic and inorganic expansion.

Key risks

Chinese raw material supply situation
Imported raw material constitutes 25 percent of the total inputs. Around 33 percent of this is due to imports from China. The company was impacted by high raw material prices owing to the closure of factories in China, which may continue. However, the management feels that the situation is stabilizing now. Its total raw material requirements from China are relatively low compared to those of its agrochemical peers. Also, the company has raised prices of generic products, which should cushion the margin.

The risk from lower monsoon
The agrochemical business and demand for the company’s products are highly linked to the quantum of rainfall, thereby exposing the company to the vagaries of nature.

Dependency on global innovators for technical sourcing
DHAG depends on global innovators to supply technical/active ingredients for its key products. Any supply disruption here could adversely impact its earnings.

Valuations
Given its healthy track record, we remain optimistic about DHAG’s long-term prospects. We see the business as a strong and growing one that generates a decent return.

The stock has corrected 32 percent over the last one year. After the correction, the stock is trading at an FY19 estimated price-to-earnings of 14 times. With the growth story remaining intact, the stock appears attractive.

We expect consistency in earnings as the company has a healthy product mix, with more than half of its sales accruing from specialty molecules, strong pick-up in recently launched products, low penetration of herbicides and fungicides in India, and a favorable macro and policy environment for agriculture companies.