Neuland Labs Business Analysis| Reaching Critical Mass
Hi investors. Welcome to SOIC. So, in today’s business analysis, we will discuss about Neuland labs. But before discussing about Neuland labs, I want to discuss a very interesting theme with you. What is the name of this theme?
Basically, we have observed one thing in mid and small cap businesses from many years that there is a very interesting theme in interesting mid and small cap businesses by the name of moving from commodity business to a value-added player. In many mid and small cap businesses or interesting businesses, this theme has played out that initially they used to sell a commodity then slowly they started selling value-added products. It has a very simple reason. If since many years you are doing this and
selling commodity then what happens is that slowly you become perfect in it and you slowly start finding different ways of business. Here, if we discuss about Garware fiber technical then from 2012 to 2013 this company was a commodity company. But after 2012 to 2013, this company started adding value added products. They came in such rocks or fishing nets which was value added and very less people used to produce it. If we see Garware margins from 2014 to 2020 then their margins are increasing. So, what does this mean?
You were such products in your shop which had less margin but as you moved to value-added, the product price increased and your margin as a shopkeeper also increased. Similarly, it happened in Garware technical. One more business which I can think of where an interesting thing played out is Navin Fluorine. So, Navin Fluorine was also a commodity chemical company from 2010 to 2011, right. But what they did after 2011 that they had feed stock of the chemical commodities for upstream, along with it they also entered into downstream derivatives. In last 10 years, I think Navin Fluorine is one of the best performers because if anyone is able to understand mid and small cap businesses strategy in advance then I think there can be lot of fruitful returns.
Similar thing happened in Navin. In Deepak Nitrite also similar thing happened. Deepak Nitrite used to basic chemical business which was majorly a commodity business. But they moved from basic chemicals to fine and specialty business. So, fine and specialty business is the one where the volume is less but margin is high and realization is also high. So, similarly if we will see the basic chemical business of Deepak Nitrite then there is 20 to 22 percent EBIT margin which is very high for a bulk chemical. But their fine and specialty business which have many products from their feed stock, there the margin is between 40 to 44 percent which is very high. Similarly, in Deepak Nitrite phenol and acetone
plant is set up. Phenol and acetone is your commodity chemicals. But the downstream which will be produced by phenol and acetone will be a value addition there and there the margins can increase from 1.5 to 2 percent for which they have set up a subsidiary by the name of Deepak clean tech where their downstream value-added intermediates will be created. So, this is a very interesting trend. If we catch this transformation in any company then I think the small cap ends up becoming a mid-cap. If we catch the transformation in mid cap then mid cap ends up becoming a large cap. So, this is the transformation which we should find in each business story. One such story of Neuland labs, I am going
to discuss with you. In their valuation first time we will discuss the base case, bull case and bear case with you. Let’s start with the business history of Neuland labs. Neuland labs was found in 1984 by Dr. D R Rao.
When we were reading the story of Dr. D R Rao and when we read the annual report of 2010 then we got to know a very interesting thing that from where the Neuland labs name was originated. So, Julius Arthur Neuland was a PHD from University id Notre Dame and Dr. D R Rao was from the same university. Dr. D R Rao read the story of Julius Arthur Neuland that he spent his life in devotion
of organic chemistry and he also became the founding father of synthetic rubber. Dr. D R Rao was so motivated with his story that as a mark of tribute, he named his company as Neuland labs. So, this was the story behind the name and
if we see their first API was a respiratory API. Neuland labs is a company of active pharmaceuticals. Before going ahead, let’s discuss about its value chain. So, what happens in pharma is that it starts with key starting material. When we talk about a medicine then KSM comes which is a key starting material, then comes intermediates, then comes APIs.
What are APIs? The salt of medicine means the active pharma ingredient which is the main salt in medicine which actually performs the work of medicine is called as API. After the comes the formulation. Formulation can be of any type. We eat capsules, it can be in the form of injections or in the form of oral solid. So, Neuland is today a pure API company.
So, their first API was launched in 1980 which was for a respiratory disease. It was launched for breathing problems. That API is still in use, after I think 35 years of history, even today it is in use. So, this was the history of this business.
His two sons, Suchit and Harsh also joined the business between 2003 to 2007. There is an interesting blog of Harsh on the website of Neuland, you can read it if you want to know in depth about API industry. So, here if we see their various different DMFs (drug master fillings) of Neuland labs all over the world then we get to know that 57 DMFs is filled with US FDA. In USA, they have DMFs. DMFs is actually the filling of API which used to give them a right in a way to launch the API later. They have 30 fillings in Canada and in total
they have some 900 fillings. This company also have some 50 to 60 patents too. So, this was the business history of Neuland labs and evolution till date. Here, the interesting thing is that what are the 3 segments of their business. So, 1st segment in the business is known as prime APIs. 2nd segment of their business is specialty APIs. 3rd segment of their business is CMS business
which is kind of a CRAMS business. Prime APIs and Specialty APIs are called as GDS by them. GDS is generic drug substance and another business is of CRAMS. So, let’s discuss here that prime APIs business is active pharmaceutical business where the volume is high but realization is less, selling price is less. If we look at prime APIs then these products are less differentiated and here the EBITDA margin is between 10 to 12 percentage. One way to compete here is that you should have economies of scale or you are producing at high volume so that your cost of goods sold should reduce.
In a way, prime APIs are bit commoditized means we can say it is in commodity category. From 1984 foundation to 2012, actually Neuland labs was a commoditized company who used to sell prime APIs. It is important to know this point because if we will see their historic numbers then we won’t be able to see anything in numbers but historic numbers are not actually a correct guide. As Warren Buffet always say that if you will look at the back mirror of your car, you will be able to see clearly that what happened behind. But investor earns money on front wind sheet because you need to judge the future, right. To judge future, we have their 2 businesses, it is very important to discuss specialty APIs and CMS business. I think from 2012 the specialty business R&D
effort was started very intensively and we can call specialty API business as complex API. Complex chemistry skill is required to produce these APIs, so these are niche APIs and here the volume is less but the realization is very high. There is also multi-step chemistry here. It is not easy to produce. There is hydrogenation use and Kirill chemistry use. So, we have read many chemical companies across. We have also done webinar on chemical. So, here we saw that actual API companies or complex API companies are actually a type of chemical businesses because here chemical synthesis is involved a lot. So, what is an interesting thing about niche
API business? As the realization here is more, the margin in this business is also more than the prime API. If we see here, the supply sector in generic APIs and discuss about a formulator. Suppose you are a formulator and you have 20 to 30 generic APIs company out of which you can choose and buy API. As you have 30 to 40 supply options so you will pick the one which will be cheapest or convenient. So, the manufacturer of generic API company does not have a lot of pricing power, right.
So, we can call this as prime API business. Whereas, let’s discuss another type. If you are a formulator and you are selling a medicine at very high cost, right and there are only 3 or 4 API suppliers then you are not price conscious, right. You are more quality conscious. So, here the API companies get pricing power. Similarly, their specialty business is this type of business and prime API business is this type of business. Their 3rd type of business is of CMS.
CMS business is custom manufacturing services. This is like CRAMS business. If you want to understand CRAMS business then you can watch our Syngene video where we have discussed about complete industry and we have also written Syngene blog where we have discussed in depth. CRAMS business in a way is outsource manufacturing hub for innovator. The ones who produce medicine or do R&D of the medicines, you provide outsource manufacturing to them.
There is a non-linear element in this business. We saw in Navin Fluorine case that if we see only the stock chart of Navin Fluorine then it is like a 70 bagger in last 8 to 9 years because there are non-linear elements in this business. Devi’s laboratories have more than a 300 bagger because there is non-linear element of business. PI industries has been close to 500 baggers because there is a non-linear element in the business.
Even if 1 molecule gets hit and come to you then it becomes non-linear. 30 – 45 percent growth. We call it as a hockey stick. So, this is their CMS business and this business is very sticky.
Once the technology is transferred to you, once you have worked with innovator then here usually it is very difficult to change. This is a high entry barrier business which most of the companies are doing and I think in India you will see many companies in next 1 to 2 decades who will enter Nifty and do custom synthesis manufacturing. Devi’s laboratories have already entered and there are chances for other companies to enter. If we see margin wise then the least margin is in prime APIs then there is a lot of margin in niche APIs, majority of the margin is in CMS business. But some niche business has margin similar to the margin in CMS business. If anyone wants to learn how to analyze the industry structure with different sectors or if anyone wants to learn how to get deep insight of annual reports or conference call and today an interesting concept is that many people forget accounting checks in bull market but accounting checks are sanity and rest is not sanity in the case of bull markets. So different forensic accounting checks and
Indian and International case studies in forensic accounting is basics of accounting. If you want to learn the language of business and wants to learn portfolio allocation of SOIC then all these things we do in our intensive SOIC course. In this course, there are more than 100 to 150 case studies and our own story is already covered in this case study. If anyone wants to learn all this then the link is given in the description below. So, coming back to Neuland labs. So, here let’s discuss about first business segment which is prime APIs so here as we can check in the business mix. So, if we see in 2013 – 2014 then prime
business of this business was 70 to 71 percent, right. What all products are included in prime APIs? I will tell you that in prime APIs they have products like ciprofloxacin, levacetam and labetalol. In these products the DMF fillers means their competitors are more and number of API suppliers are also more. If we look at realization here, means what is the price on and average then here their realization is always less. Just to give you an example, if we talk about the 1st one here then here their realization is 80 to 90 rupees per kg which is very low, right.
But what is there in this business? In this business the scale should be high and volume should be high. But there are typical commodity characteristics in this business. So, this was their legacy business and in 2012 if you read annual report then here, we understand that why is it important to read annual reports. Because in between 2012 to 2016, transformation was going on in this business. So, here I will do a discussion with you about
2015 – 2016 annual report. So, here if we see their 2015 annual report then here, they said one thing that their annual report is also done in Q&A type. Here, there is a perceived lack of growth in Neuland’s topline as well as margins over last 3 to 4 years. How do you explain that and how should an investor see the future with Neuland? So, here Suchit Rao said that at macro level it seems that 2012 to 2016 stagnation happened but here a layer is there which shows the reality of business. In 2012, we used to sell 1220-ton API with average realization of 53 dollars per kg but if you look at numbers in 2016, we are very close to 600 tons of API at 118 dollars per kg, right.
Which means that realization per kg is up by over 120%. It means that there was hardly any realization in the API we used to sell earlier but slowly business nix change is happening due to which in 2016, average realization increased by 120%. So, this was their prime API business and going forward there won’t be much growth in this business, there will be single digit growth. So, now let’s come to their niche API business
and look at their products that actually there is high realization in their products. So, if we discuss their products in niche API business, there is a product by the name of salmeterol and this is used for asthma and in respiratory therapy. If we see the dollar per kg of this API then it is close to 65,000 dollars per kg, again huge realizations, right. If we talk about propofol then propofol is also an API and here there are only 3 generic players. DMF fillers are also 10, I think these are 2018 numbers but API price is 20,000 dollars per kg. If we take one more example here of API then
there is an API by the name of entacapone API so again this is for central nervous system therapy and here if we check then their API price is 220 dollar per kg. But here interesting part is that this is complex to produce, we will discuss about it that how it is complex. Let’s first take an example of entacapone. The problem in making entacapone API is that many steps are involved in traditional method.
It is time consuming and yield is also less. The result you are getting is very less. Due to which undesirable residue is happening and the solvent means the raw material used to produce this is very expensive. But through process innovation what Neuland labs have done is that their patented method delivers 90% yield which is more than the traditional method. It is very cost effective, it is not corrosive and it re-agent free. Also, there is no requirement of monitoring the temperature condition in it. It is not necessary to keep in cold temperature and don’t need to monitor the temperature. Lastly, if we discuss about this API then
there are no impurities as compared to traditional method. So, this is again a niche API, complex API and all of the complex API name we have mentioned in the presentation, you can check all of them. If we discuss about process innovation that actually why there are complex APIs then let’s discuss about propofol. Many people will feel that they haven’t
heard the name of propofol but actually many people must have heard. Propofol was a medicine which led to Michael Jackson’s demise basically. Michael Jackson had overdose of propofol in 2010 – 2011.
What are the challenges in propofol? There cannot be even a little deviation during manufacturing. If even slight deviation happens then it will not work properly in human body and actually there can be adverse reaction. What all challenges took place in propofol? Why we are trying to understand this? We need to go behind the reasons that what is the underlined reason of niche APIs, why is it tuff to manufacture and why there are less players. 2nd reason is that many Chinese capacities have closed because not even a little impurity can be tolerated. If we see more in propofol then there were
1 or 2 companies who faced legal problems in propofol manufacturing. So, again it is a complicated process because of the complicated formulation. It is expensive, difficult and length process. The way of Neuland labs to manufacture propofol
is innovative and they started manufacturing propofol in 2012. They got US FDA means to launch it in US permission in 2013. Again, they got the certificate of suitability which demonstrates their compliance because within 9 months of finding they got it, which generally takes on and average 18 months. Here, an interesting thing which is going on due to covid is demand of propofol is increased and propofol prices have also increased. We have 2018 data so latest data is not available with us but I think propofol prices must have increased because of temporary shortages. So, this was propofol and its niche APIs capabilities. Let’s come to the most interesting business
that is custom manufacturing service business. So, value chain of custom manufacturing service business looks something like this. 1st there is a drug discovery phase then there is phase 1 where there are few patients then there are more patients and in 3rd phase there are maximum number of patients, then comes development and finally comes commercialization. But all of this cruck is for the custom manufacturing provider. So, what do we name this business? We call this business basically from grams to Kilos to tons to multi tons, right. The non-linear growth of Navin fluorine came as there were grams earlier then grams order converted to kilos, then from kilos it converted into tons and from tons it got converted into multi-tons, right.
So, similarly if we see the needs of API then usually in drug discovery the synthetic scale is in milligrams. Then in phase 1 there are less kgs and it happens in phase 2 also. Then when the product is launched, it passes the tons and here the interesting thing is that if we read Solara call then Solara is way behind than Neuland in custom manufacturing service or CRAMS because Solara has to do acquisition. Solara says in their con call that they want to focus in Lej Tej project. Why this company focus in Lej Tej project? The reason is that if the drug gets late mean if it is in phase 3 of clinical trials or if it comes in commercialization then your probability of success increases a lot.
Because many times molecules get spoiled between phase 1 and phase 2 and they are sent out from the pipeline. So, Neuland labs is focusing more on phase 3 and commercialization and they are acting like a 2nd source of supplier. Let’s understand the economics of this business again.
There is an innovator and innovator did a lot of efforts by doing R&D and launched a drug but with one drug he has associated only 1 crams player. But when US FDA audit was done on this CRAMS player, a problem occurred. So, what will happen? Innovator becomes handicapped because he was taking it from only 1 player. Due to this reason, innovator always classify
2 CRAMS player for 1 single drug. So, 2nd CRAMS player who is getting classified, Neuland is getting many opportunities there. Here, what is the interesting thing? Again, if we read 2020 annual report and I can’t stress this enough that for retail investors like you and me, annual report is actually like the bible. If we want to know any company, then we must read the annual report. So, what hidden insights we get from annual report? In Q&A basically, they say that we are targeting on low-risk projects with the probability of high returns since they are close to commercialization. As we just discussed with you. Here, during the year they received 4 to 5 projects which will get commercialized by the clients in next 12 to 36 months and this includes 3 APIs which are in late stage of development and are likely to get commercialized in next 12 to 18 months.
Again, it is very interesting because close to commercialization stage, you are getting API. When it commercializes, it doesn’t take much time to become tons from kilos if the end market response goes well. Their CRAMS business is basically in 3 geographies. 1 is in North America, 2nd is in Japan and 3rd is in Europe. What type of clients are they focusing in
North America? Basically, they are focusing on venture pact companies and bio-tech. Nowadays, what is happening in USA? Small companies are entering who don’t own their own manufacturing units but they focus more on drug discovery, right. So, basically these are known as virtual companies. For them the Neuland lab is very useful, right. 2nd in Japan, they are working with all top pharmaceutical companies. They are working a lot with mid-size innovator in Europe means mid-size pharmaceutical companies. What is one more interesting thing in their business? If we see their pipeline then we get an interesting thing in pipeline that total number of projects in Q3FY18 were 42.
After 1 year in Q3FY19 it was 54, then after 1 year it was 74 and then again after 1 year it was 76. At commercial stage, there are some 15 projects, in development there are some 18 projects. Our commercial and development is very relevant because probability of revenue increases a lot. One more interesting thing here is as we can see, we discussed about what is critical mass? Slowly, critical mass is attained in this business because the growth in this business is very rapid, right. So, here it is very interesting but year on
year growth in project was not that high, one reason of it can be pandemic. Due to pandemic, scientists are unable to go to their lab most of the times and there can be a problem in funding too. So, their lead stage projects seem very interesting as there won’t be any funding problem in them because these are close to commercialization. So, this is their CRAMS business and in CRAMS business again over the internet you can actually find that their one of the end customers is known by the name of Teva pharmaceuticals who have a formulation named Austedo. So, what is Austedo? Basically, Austedo is a orphan drug. What are orphan drugs? Orphan drugs is a disease which can be rarely seen in humans, 1 out of 1000 can get this disease. This disease treatment for them is not so
common. Their treatment actually is very expensive. So, these are called orphan drugs and as we can see here, 12% growth can be seen in orphan drugs. So, Austedo which is an orphan drug of Teva pharmaceuticals, its API is supplied by Neuland labs, right.
If we actually see the growth of Austedo, why is it important to see the growth? If my end user is growing then I will also grow with him. So, Austedo sales is growing at a very fast grip, right. Its sales in Q32017 was 6 million which in Q32020 is 168 million. So, actually Teva pharmaceutical is guiding that our sales can be of 2 million dollars here and this product has also been launched in China right now.
So as when the geographical expansion will be done and if they get more approvals, I think it is difficult for them to get approval in Europe. But if they get approval from there then this could be very interesting in nature because for this API, their realization will be very high and margin will be very high. So, in CRAMS business as we have seen in many companies, I think the gross margin can be between 50 to 85 percent because Austedo is an orphan drug where the pricing of treatment is very high. So, their gross margin can be very high. So, again this could be a key trigger. So, they have CRAMS business and if we see product mix change in business then let’s see how it’s going. As we can see, in 2014 some 71% business was commodity business in prime API, 18% was of niche APIs and 11% was of CMS means only 29% was value added.
In 2019, 25% was CMS business, 26% was in niche API business and in 2017, 49% was commodity. But in 2018 and 2019, some problems came in the business which I will discuss with you now. But if we see in Q3FY20 – 21 which is recent quarter, you can beautifully see the product mix change here that how the prime API business is 43% and 37% is CMS business and 18% is your niche API business. That means 50 to 55 percent business is coming from value added products. One more interesting thing to notice here is that in last 3 to 4 years if you see employee cost then employee cost as a percentage of sales has reached from 16% to 18% which is on higher side because here many scientists have been hired. I think close to 250 to 300 scientists in a year pass.
So, again EBITDA margin expansion was less at that time because a lot of hiring was done and there are few more reasons behind it which we will understand now. So, Warren Buffet says again and again that, “A business should be seen as an evolving movie and not a static picture. One business is like a movie. There is a beginning, climax, villain of the movie, hero of the movie and conclusion of the movie. So, it is not a static picture.
What is static picture? You saw the financials and said this business is bad and you moved it away. So, it is not a static picture. Money is made only when you become the part of the movie and actually you can get the movie, right. You can understand the evolution of movie properly. So, similarly when we discuss about movie, what we discuss that what was the history of business, how did business started, who is the entrepreneur, how is the management, how are the products and if value addition is done from commodity then what will happen in end? Actually, the hero which was very small in beginning will become very big and get an important role in the end. Who is the villain of movie? Anti-thesis pointers. Villain is basically like the risk of the
business. Warren Buffet quotation actually mean this. So, here if we look at the stock chart of Neuland labs then we get to know here as in long term stock charts, there is an interesting thing that most of the times they tell you the truth of the business. You can see from 2006 to 2012 that the stock was basically a deadline, basically flat line stock because here it was a commoditized business and here there was no ROCE etc. But if we see from 2014 to 2018 then actually
the stock started going up. Reason being because value added mix was increasing and market was catching on the narrative. From 2018 to 2020 there came a decline. Here, 3 black swan events occurred. I will discuss those 3 black swan events with you because to understand the risks of the business, you have to understand those black swan events. So, what was interesting here? If we see their EBITDA margin than from 2004 to 2012-2013, the EBITDA margin was 10 – 12 percent and slowly this EBITDA margin started increasing. If we view this business as a movie then here we can see that in quarter 1 there is 16 to 17 percent EBITDA margin but from Q3FY18, if we see Q3FY19 or Q1FY20 then 3 black swan events happened. It is very important to know which were the
3 black swan events if you want to understand Neuland labs business. So, first was disruption for Chinese supply, right. So, from China actually at that time, they used to import 60% raw material which was a lot due to which their supply disrupted. As soon as the shut down took place in China of pollution then it impacted a lot on their raw material. At same time, FY18 to FY20 PI industries and Laurus labs said the same thing. There was a product of Laurus labs by the name of gemcitabine.
Gemcitabine was their oncology product in which a lot of disruption arrived because their key starting material and intermediate used to come from China and they were unable to get it. So, they did backward integration inhouse and PI industries 30% raw material was imported from China. They also started doing backward integration and along with that they found more sources in India out of 30 percent, 8 to 9 percent raw material comes from China. So, again all the industry got disrupted. Similarly, they had 60% so disruption was more and 2nd reason was that prime API business were not able to pass on price in commodity business. This is the truth due to which their EBITDA
margin decreased a lot. So, this was 1st black swan event. Other 2 black swan events had non fungible capacities. So, many investors felt that operating leverage will play out but to successfully play out the operating leverage, business operations should be very smooth because capacity was non fungible. In one reactor, only 1 API can be created. 2 APIs of different type cannot be created. What else happened? The product order which they were expecting, they didn’t receive that order so there was a mismatch in their capacity. So, to correct it, what corrective actions they took due to which business was going towards robustness? Anti-fragile didn’t happened but business happened to be robust.
After 1 or 2 years, anti-fragile will happen, let’s see what actions they take. So, 1st steps of robustness were that they started taking 60% from China which was less than 10% in this year. They did backward integration and they also found alternated vendors for the raw materials coming below 10%. 2nd key step was that they made their capacities fungible. Now, on any reactor, any API can be produced. Here, many people will get an interesting
insight that if you think about operating leverage then operating leverage is a concept where business required smoothness and as much as the loss time is less that much it is better. So, what happens through fungible capacity? What is a hidden insight? It is easier to get operating leverage. So, in this business, margin will be or can surprise on upside next 2 to 3 years. We will discuss, how. They have acquired unit 3 also. In 2017 – 2018 they did an acquisition of almost close to 130 to 133 crores and in this actually they have 3 plants, unit 1, unit 2 and unit 3.
So, unit 3 is bigger than other 2 plants. So, what is there in unit 3? From unit 3, their backward integration has happened and unit 3 is larger in size. So, they are shifting some prime APIs in unit 3 because they are larger in size so it can give greater economies of scale. But still, I do not expect drastic margin improvements in prime APIs. But what is one more hidden insight of unit 3? If you have many orders coming of custom manufacturing service and if you don’t have the capacity then the innovator will not give you the order.
He gives you order after looking at the capacity. So, again hidden insight and now, there will be brown field capex in unit 3 which is more return accretive. So, now their asset turn has reached 2.3 to 2.4 times but once unit 3 is fully operational so again from there it can be interesting. In last quarter it has become fully operational.
What are other hidden insights? We will see those in thesis pointers. This is how the business is becoming more and more robust. Now, we will come to thesis pointers, anti-thesis pointers and in between we will also discuss the valuation. So, what is the 1st thesis pointer in business? So, 1st thesis pointer is operating leverage. 2nd thesis pointer is that nonlinear growth can come. 3rd thesis pointer is gross margin expansion
and EBIT expansion both can come. So, let’s discuss how it can be done. So, we saw in Laurus labs case that 40 to 50 percent gross block in 2019 wasn’t generating even single rupee revenue, right. Similarly, today in Neuland labs case, there is a capital employed of 600 to 650 crores out of which 180 to 190 crores is not earning anything at this time. Almost 33 to 35 percent capital employed is not earning anything so again once it starts earning, as the revenue starts coming, operating leverage starts generating, ROCE expansion also starts. 2nd interesting thing is that as the product mix change is happening, their gross margin is improving. If we discuss about revenue to mean then in 2018, their 1 quarter was such where gross margin was 50 to 55 percent.
I think throughout the year, the margins were between 50 to 55 percent. So, again there is mean reversion in this business, gross margin is moving towards 55%, right. As operating leverage had come so EBIT margin will also expand. So, here what will happen? Basically 2 powerful sources of expansion will combine.
One is product mix change which is a powerful source and 2nd is operating leverage and whenever these two works together, most of the time good things happen, right. In sequent also this happened, Laurus also same thing happened and even in this business it will happen. If we talk about other thesis pointers then non-linear growth can arrive. If Austedo sales rises or more products get
commercialized in CMS business then again there can be a non-linear growth element in this business. If we see more thesis pointers then in unit 3, brown field capex is happening and here one more interesting thing is that recently they gave a contract to contract manufacturing organization for steralimbize. What is steralimbize? Basically, which are in the form of injectables.
You yourself inhouse injectables so it is risky because to inhouse injectables, a lot of compliance and regulation issue is there. So, they have very smartly outsourced it which I think is very nice decision. So, again additional capacity is created. Here, if we see the anti-thesis pointers of the business at the same time then some of the anti-thesis pointers are that to judge the product mix change quarter to quarter becomes difficult. The margins of prime API is less, right. Here, one part of the business is till commodity. Then there is customer and product concentration risk in this business and here there is regulated risk too as it is in regulated industry.
We will also discuss about fragilities and optionality’s. But here if we look at their facility then in their history of last 20 to 27 years, have cleared all USA FDA audits successfully without any adverse objections. So, again it is a very big thing. So, again regulated track record wise, company looks very clean and due to this they are able to pass qualitative filter because if nothing is bad in your product then that means you are doing a good thing.
If you are unethical in product then in a way that chain is connected to the top management. So, again very interesting. If we look at the valuation of this business today then 1st thing we build here is base case, bear case and bull case. So, we build a case which can be average. Then we can build bear case which can be bad.
Then we can build bull case which is the best. So, their sale in base case can be 1800 crore and their EBITDA margin in last quarter was 19% so now as operating leverage and many more things will play out, it can reach 20 to 22 percent. Product mix will be 65% value added and commodity will be 30 to 40 percent. Here, EBITA is 360 crores and if we give 15 to 16 multiples then the market can be of 6000 crores in next 5 years. Which is currently 2500 crore approx.
This is your base case, if we talk about the worst situation of bear case, it says that sale will be around 1600 crore So, if we buy TTM number in 900 crores it has almost reached 1000 crore. So, in bear case we are super conservative. EBITDA margin goes upto 18 to 20 percent, which is as good as today. And product mix is also the same. When EBITDA goes around 300 to 320 crores,
so 15 times multiple is received. So, in 4 to 5 years, the market cap is around 4500 crores. So, it’s not double but around 70%-80% high. So again, become risky as its 12-13 percent returns in bear case. What the Bull case of the company says that the vision of management is to grow the sales by 15 to 20 percent. So the sale would be around 2000 crores after 5 years, right. But in bull case scenario what we can think or happen is that 70-75 percent of business will come from value added product.
Like from CMS business and niche business. Here the margin will expand to 25-27 percent due to which their EBITDA will be around 500-540 crores. If they get the EBITDA in multiple of 20 times in bull case then their market cap would go around 10,000 crores. So, we think actually again, this is not a stock advise and we are not a SEBI registered advisor. Our purpose is to educate how in valuation how you can build scenarios.
As a disclosure we are already biased in the company and there is some kind of probability what the base case and bull case can happen. Again, nothing is a recommendation from our side. For SOIC intensive students have to look at what is going to happen in the bucket frame work. So, in bucket frame work, companies are coming from bucket 5 to bucket 3. And if bull’s span out, then the companies are going from bucket 3 to bucket 1. We have uploaded a video for SOIC intensive students in SOIC continues dashboard about how the ROCE expansion can be done and for its breakup.
We have included the cash flow analysis and breakdown of conversation between sherlock and Watson in the monthly newsletter in SOIC intensive course. So, thank you for joining us. This was the case study on Neuland labs. Let me know in comment section what you feel, base case will span out or bear case will span out or bull case will span out. Thank you for joining us. Our next video will be on Walmart V/S Dmart on valuations. Thank you.
2021-04-07 02:52
