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High volume drives growth; margins hit by RM inflation/higher opex

* Dhanuka’s 21% YoY revenue growth in Q3 was fuelled by ~18% higher volumes and pricing. However, operating margins contracted by 160bps YoY owing to RM cost inflation, delays in the pass-through of price inflation in some generics and higher opex due to elevated freight costs. Furthermore, lower other income on a YoY basis affected the bottom-line, which grew by 6% YoY to Rs425mn.

* Dhanuka received three 9 (3) product registrations from CIBRC during Dec’21-Jan’22, which are expected to be launched in Q1FY23. All three products are jointly developed in partnership with Japanese innovators. Management expects to garner revenues of ~Rs500mn over the next 2-3 years from these three new products.

* Management expects Feb-Mar’22 to remain good for the Rabi season, and thus remains upbeat about achieving double-digit growth in Q4, implying revenue growth in FY22, albeit at a slower pace. However, margin pressure in FY22 is expected to impact EBITDA and the bottom-line, which are likely to decline on a YoY basis. Dhanuka’s greenfield project is progressing well and is expected to be commissioned by FY23-end. This will help the company to tap the export opportunities while derisking its current 100% domestic-oriented business. We maintain Buy with an unchanged Mar’23E TP of Rs1,000, based on a two-stage growth model.

* What we liked? 1) Strong Q3 revenue growth driven by volumes amid challenging market conditions; 2) Q3 growth driven by newly launched products ONEKIL and Tornado in previous quarter; 3) CIBRC approval for three 9 (3) product registrations developed for horticulture crops, Maize, cotton, and chilly; 4) healthy new product launch pipeline with the target to launch eight new products in the next two years

* What we didn’t like? 1) Delays in the pass-through of cost increases in generic products and inability to fully pass on the cost increases in some cases; 2) increase in YoY working capital days from 102 days to 108 days

* Healthy product launch pipeline, Dahej greenfield project on track: With recent CIBRC registrations, Dhanuka’s product launch pipeline is healthy for FY23. With new product launches in 2020-21, management indicated that the Innovation Turnover Index (ITI) will improve in the coming quarters. ITI remained suppressed in 9MFY21 at 10%. Barring monsoon vagaries, Dhanuka maintains its guidance of double-digit growth for FY23. The Dahej greenfield project is on track and is expected to be commissioned by FY23-end and should start contributing from FY24 onwards.

* Valuation and Outlook: We believe Dhanuka’s healthy new product pipeline will help it keep up growth momentum in the domestic market, while the Dahej greenfield capex would help the company to tap the export opportunities in the wake of the China+1 strategy by global MNCs. We maintain Buy. Our Mar’23E TP of Rs1,000 implies an FY24E P/E at 19x. Key assumptions: 1) 10.75% cost of equity, 2) 10% PAT CAGR in FY25-35E, and 3) terminal growth rate of 5% starting in FY35E.

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