Fund Call. Looking for a good long-term buy in the agriculture sector? Dhanuka Agritech fits the bill

Investors wanting to bet on the progress in Indian agriculture and improved farm incomes over the next five years can buy the stock of Dhanuka Agritech, which is into manufacture of crop protection chemicals (herbicides, fungicides and insecticides) and plant growth nutrients.

The Budget 2020 has come up with a few long-term positives for the farm sector (including creation of new warehouses and an allocation for setting farmer-producer companies) that can improve the income of farmers and thereby demand for crop protection chemicals.

While the first half of 2019-20 was not good for Dhanuka Agritech (sales growth of 4 per cent to ₹621 crore and PAT growth of 5 per cent to ₹74.7 crore) on lacklustre demand due to delayed onset of monsoon (farmers preferred short-duration crops), the second half holds promise. The company is expected to report strong sales growth in the December 2019 quarter following an uptick in sales in the rabi season. With the high-cost inventory used up, there’ll be further savings in input cut, which should help profit.

The stock of Dhanuka Agritech has seen a sharp rally in the past one month from ₹290 levels, and the valuations are a tad expensive now.

At the current market price of ₹506 per share, the stock discounts its estimated earnings for 2019-20 by 20 times. Coromandel International, a larger player in the agri-input space, is also trading at 20 times.

However, Rallis India (revenue of ₹1,671 crore), similar in size, is trading at 22 times the expected earnings for 2019-20.

Long-term investors can buy the stock at current levels.

Business

Dhanuka Agritech has a diversified portfolio in crop protection. In the September quarter, 50 per cent of revenue was from insecticides, 23 per cent from herbicides and the balance from fungicides and other products.

Revenues have grown at a compounded annual rate of 6 per cent between 2014-15 and 2018-19. PAT growth though was at a lower 1.4 per cent — due to an increase in the cost of raw materials. The operating profit margin was about 17.5 per cent in 2014-15 and it improved to 21.2 per cent in 2016-17, but declined to 16.62 per cent in 2018-19. An increase in raw material costs was due to shortage of inputs in the market on shutdown of many units in China. The increase in costs could not be passed on to end-consumers completely and the company suffered margin erosion.

That said, penetration into new geographies and new products launches have ensured that revenue growth doesn’t falter. In April last year, the company launched three new products — CHEMPA, a herbicide which controls broad leaf weeds and grassy weeds in paddy; APPLY, an insecticide to control brown planthopper, and LARGO that controls pests of cotton crops.

All these three products have found good acceptance in the market. In November, a new insecticide for use by paddy and vegetable farmers was launched. This product is being sold at a price that is premium to conventional insecticides in the market, and can help improve profit margin.

Dhanuka’s revenue growth will continue to be driven by new product launches in the next one year as conventional products — mainly pesticides for paddy crop — are seeing a lower demand. Further, the company’s growing distribution reach should also help. The firm currently has a network of more than 8,000 distributors and dealers selling to over 75,000 retailers across India.

Raw material prices

The cost of key imported raw materials such as metribuzin, lamda, and bifenthrin used by manufacturers of pesticides increased significantly in November-December 2017. This was due to a large supply shortage in the market after many factories were shut down in China following the change in pollution control norms. Profit margins of many agri-input players in India thus saw a sharp erosion. Even as the price of these inputs started to correct from May 2018, many players including Dhanuka Agritech, had stocks of high-cost inputs and hence could not benefit from the price correction.

However, things are looking up. Dhanuka has exhausted much of the high-cost inventory it had. So, the company could see some respite on margin in the second half of 2019-20. That said, prices of some other inputs are rising now, which will limit the upside in margins.

Over the last two quarters, the company has controlled its other expenses, including selling costs which will give a breather here on.

All the new products launched by the company have also been priced higher , which can help boost margin in the coming quarters.

The operating profit margin for the half year 2019-20 was 15 per cent against 15.3 per cent in the same period last year.

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