The stock of agrochemicals maker Dhanuka Agritech Ltd is showing no signs of exhaustion. After rising 61% in 2013, it has gained more than 80% so far this year. Steady growth and superior return ratios explain the climb. Notwithstanding the vagaries facing the agriculture sector, Dhanuka Agritech has managed to grow its business in a robust manner. Sales and profits more than doubled over the last five years.

The company manufactures agrochemical formulations and focuses on distribution. It does not have a presence in the capital-intensive active ingredients business. To access technology and molecules, it depends on tie-ups with innovator firms and it has technical collaborations with three US and four Japanese companies. International firms who want exposure to India, but have no distribution network, tend to tie up with companies like Dhanuka Agritech.

The tie-ups give Dhanuka Agritech access to high-margin specialty products. It helps the company use its assets better and register superior return ratios. “DAL (Dhanuka Agritech) is present only in formulations manufacturing and this exclusive focus helps it enhance sales with least investments in assets. Further, it aids clock higher asset turnover ratio versus competitors, which assures superior RoE/RoCE (return on equity/return on capital employed),” Edelweiss Securities Ltd said in a note. Last fiscal year, products sold under tie-ups with international firms contributed around 47% to the company’s revenue, the broking firm said.

Dhanuka Agritech continues to pursue a similar strategy. Aided by tie-ups, it is planning to launch six new products, Sharekhan Ltd said in a note. Add to this the five new products the company has launched in the previous fiscal year and Emkay Global Financial Services Ltd expects the positive growth momentum to continue at least in the medium term.

All this is fine, but the pertinent question is will the stock continue to do well? Most broking firms are enthused by Dhanuka Agritech’s strong balance sheet and free cash flows. If the company continues to deliver high return ratios, many of them expect the stock to close the valuation gap with its peers. “We believe that sustained RoCE at 30% plus and strong balance sheet with free cash flows will reduce the valuation gap between Dhanuka (currently trading at 12 times fiscal year 2016, or FY16) and other leading industry players (15-18 times FY16),” Emkay said while revising its earnings estimates upwards by 12% for the current fiscal year.

Overall, Dhanuka Agritech has had a dream run in the past 18 months. While analysts expect the company to do well, continuation of the stock outperformance will depend on the success of new products and sustainability of high return ratios.

(As published in Mint on Mon, 16 June 2014)