SOIC Business Updates|Neuland,Solara,Pi Industries & Navin Fluorine
Hi investors. Welcome to SOIC. So, in today’s SOIC business update session, we will discuss about Solara active, Navin Fluorine, Pi industries and Neuland labs.
We are going to come with a detailed video of Solara active and Neuland labs soon on the channel. Along with this it is very important to discuss the changes in quarterly results and moreover, the trend running in business because quarterly results are nothing but small steps in the journey of a company. There are small steps in the journey of a company, right. So, just before starting I will just give a standard disclaimer that we are not SEBI registered advisors and nothing in this video should be taken as an investment advice. We do own some of the stocks mentioned over here.
So, before starting link to our last video, I will just present a mental model here. So, the name of the mental model is variant perception, right. So, variant perception means that if today you are buying a business then as a fundamental investor or as a value investor what you are doing is that you are seeing the change which will come after 2 to 3 years in the business through the lens of variant perception. What all things are included in variant perception? Like we discussed in last video about future ROC and ROIC the 1st thing is margin expansion, right.
Why margin expansion happens? Because margin expansion is linked to product mix change. We will see in Neuland labs case that their CMS business percentage is increasing means contract manufacturing business unit is increasing. If we will talk about Solara then even there the CRAMS business has started. Moreover, in Navin the higher value-added business in last 10 years is already become a very big portion of the business and moreover, the same thing can be seen in PI industries because in PI industries when the custom synthesis was started in 2008 from then till now the business have reached the sales to 65 to 70 percent currently. So, again product mix change has been done in all these businesses. In Solara and Neuland product mix change can happen which makes both these industries very interesting.
One over here is deleveraging like we saw this time in sequent scientific case that they have reduced their debt similarly when interest cost reduces and debt reduces then automatically the ROE starts growing because the net income increases. So, deleveraging also seems very interesting. There are corporate actions like we can see in Jubilant life sciences, we can also see in Suven pharmaceuticals and fair chemicals that corporate action creates a lot of wealth if you can get in at the right time of demerger. So, corporate actions are also very interesting which is due to demerger. So, personally we were invested in Seven pharma for last 7 to 8 months now.
So, again demerger mental model has played out very beautifully for us. So, these mental models are actually pattern which you can apply on your own investing and at the end of the day you need to make a portfolio of 15 to 20 stocks. If you apply this patter and make the portfolio then sooner or later wealth creation happens, right.
One more is operating leverage like we saw earlier in Laurus labs case, right. We may see it in Neuland labs case when unit decommercialize, today they don’t even have 30% utilization of it. When the utilization reaches to 75, 80 or 85 percent then again that will be really interesting.
Neuland labs management says that we do a capex at 75 to 80 percent but even if it reaches 75% then you get an idea that if fixed cost is fixed and incremental revenue keep on coming from unit 3 then again ROC expansion will happen, margin expansion will happen and moreover, this is a key criteria for wealth creation, right. One more is management change. Management change has played out actually in SL propack and TATA consumer. Management change is an interesting mental model. Management change has played out in Bajaj consumer. So again, not easy to catch but still if you can catch this at early stage then management change becomes a very interesting mental model.
We feel that in Sequent case, carlite coming on board is a great thing due to management change maybe they can be more aggressive in terms of pursuing new business so management change is a good thing sometimes if you can get the direction of the business at early stage. Then there is industry cycle, right. You can watch Balkrishna industries that what is the industry cycle of an ideal industry then cost reduction is a very big variant perception where companies do a backward integration. IT companies during Covid-19 have reduced the cost a lot since work from home is started and backward integration is a very interesting mental model for cost reduction.
Then come your capex, right. So, all these mental models actually linked with guessing where the perk is going to be. You will get to know from where the future earnings and future ROC will come through these variant perceptions. Every value investing which do in the end through these key variables you can think about the key metrics of the business.
If I talk about IT business than there is a key metrics that how many deals they won, how much attrition they have, are they large cap IT company or mid cap IT company, in which verticals are they dealing, are they in 5G vertical or banking and financials vertical, right. So, there are different metrics in every industry. Like if we talk about retail then there are different metrics, per sq ft how much sales they are getting in industry, what is the type of retailer, whether it is a value retailer, whether they serve multi brand outlet like if we talk about shopper stop then they are in multi brand outlet. So, every industry has different metrics. If we talk about CRAMS then they have same metrics that how strong is the pipeline and at the end, more or less its like a manufacturing business. So due to this it becomes easier to guess future returns.
So, with this I think we will straight away dive into Solara active. So, coming to Solara active so we use a filter while screening the stocks. There is a filter like if we see Tijori finance screener than we have a filter that we look for companies which have improving operating margins or improving ROCE and moreover, if some company’s earnings growth is really great than it matches our filter. Similarly, Solara is a company which matches our filter from last 6 to 7 quarters and what happened in Solara active is the sales growth was 24% in this quarter and PAT level growth was more than 50%, I guess.
I think EBITDA growth was more than 30 to 40 percent. So, what is happening in Solara active? A demerger happened between Solara active and Sequent few years back, I think in 2017, 2018 or 2019. Solara active is actually focusing on human APIs means active pharmaceutical ingredient.
You get a key starting material when we produce medicines then comes intermediates and then comes API then comes formulation. All the companies which we have discussed on our channel have worked more on intermediates. We have also discussed about Laurus labs which works in APIs and we will also discuss about Solara active because what is happening in Solara active that ROCE is on an improving trajectory, right. So, ROCE from 6 to 7 percent have reached to 18% today and margins are also on improving trajectory. Let’s discuss that what different is happening in the business and let’s comment on their results.
Along with that let’s apply SOIC business risk of management break up. Let’s see what is happening in the business in Solara active. Solara active business is on a long-term basis. What is the meaning of long-term basis? Competitor of Solara active like IOCL chemical both produce API by the name of Ibuprofen.
So, what is Solara active doing? Solara active actually works on long term contracts due to which their pricing is very stabilize in APIs. So, for Ibuprofen they have very long-term contracts. Their 70 to 75 percent business comes from long-term contract. API pricing has been stabled this time. Many people say that API is a commodity but in our opinion all APIs companies are not commoditized. Some API companies like if we talk about chemical businesses, RP industries, PI industries and Deepak nitrite so they are those companies where after 3 to 4 years you will be able to see the gross margin above 60%.
Solara active might be a company where gross margin will be 60 to 62 percent after 3 to 4 years, right. So, Solara current margin is between 53 to 55 percent. Solara wants to maintain this gross margin.
If we minus gross margin with COGS which is cost of goods sold or if you minus it with cost of raw material then you get a gross margin. So, if in any business there is an expansion in gross margin of 55 to 60 percent then you realize that industries dynamics are changing or they are entering such products where they get pricing power. So, something similar is happening in Solara’s case.
In FY22 if we look at their capex then the capex will be 150-200 crores and their asset turn in this capex is close to 2 times so they may get 400 crore sales here but some capex out of this will be for maintenance. Before this let’s discuss what is their business direction. This year the capex will be close to 180-200 crores. So, annualized ROCE is already 18.3% means EBIT/capital employed, we do operate employed/capital employed that has already reached to 18.3% but this is on an improving trajectory. The speed on which it is improving then it may reach in 2 to 3 years based on their business targets.
Because what they are doing is that they are launching many new types of products. Let’s see what they are doing in new products. So, always before launching API, you need to launch DMF. If you are launching an API in regulated markets like US so if you launch DMF there then by reading their DMF we get to know that many APIs are being introduced where there is less competition.
Moreover, their new products have more complex chemistry means they are difficult to produce and have higher margin. In this quarter, 9 to 10 percent of business they have received from new products. Every year their target is that 10 to 12 percent revenue should always come through new products. Moreover, they have done experiment with 3 to 4 technology platforms and CRAMS is already 10% of this business.
So, they are also entering into contract research and manufacturing services. Just to move ahead, I will show you one thing that they are introducing greenfield project in Vizag, right. So, 1st part of the project is already commercial. So, 1st part of the project they have added 36000 tones capacity of Ibuprofen, right. Currently, the capacity is operating at 1/3rd utilization rates and expect it to reach optimum utilization in next 3 to 6 months.
So again, operating leverage level will be introduced because the capacity is operating at less than 30%. Operating leverage level will be introduced and phase 1 of Vizag has already been completed. They announced greenfield capex in Vizag whose phase 1 is completed. Phase 2 of the Vizag facility will be commenced in H1FY22. Phase 2 will commence in first 6 months of FY22 and what they are doing here which is very interesting is that they will add a multi-product plant. If we see in API businesses or CRAMS businesses then multi-product plant means that you make many products in small volumes.
Why they do this? So that they have a lot of catalogue of the products. Suppose customers are ordering many products but as nobody buys one product in high volume so you can set up a multi-product plant. Today, in DMCC also multiproduct plant is set up. Due to this DMCC is interesting because through multiproduct plant you reach to dedicated plant. 1st multiproduct plant is set up than dedicated plant is set up. Multiproduct plant is a very good indication towards where the business is headed.
Let’s see what they said along with our thesis that they are seeing huge traction of customers asking us to make few products. It means customers are asking them to make few products and these products have favorable margins as compared to the corporate margins. Today, if their EBITDA margin is between 20 to 25 percent then there may be more margin in these products. Multiproduct plants provide you great indication that in which direction the business is going, right. So, I think we should discuss the small risks they have in this. Also, let’s discuss about the business updates once.
Just to show you that in which direction business is going so their gross margin in Q1FY19 Or Q2FY19 we have mapped out. So, just look at the improvements that have been happening in the gross margins, right. So, gross margins have already gone up to nearly 56%.
On the basis of track Solara has arrived if their contract research and manufacturing services get successful where they want to do acquisition then again gross margins can actually go above 60% because in CRAMS business minimum gross margins are somewhere close to 75 to 80 percent which makes it very interesting because new line of business is entering where margins are high. So, more or less this was the discussion of Solara. Just a second. Their EBITA margins are also improving here. So, EBITDA margins are improving, I think in Q4FY20 Covid-19 was there due to which we are unable to see but EBITDA margins are also in an improving trajectory.
They have launched a new product here which we will discuss in our detailed video but the key risk is that today they have a plant in Cuddalore where they received an official action indicated warning letter from US FDA. Again, they have institutionalized the data and process and called US FDA again for inspection and if it turns into a warning letter than this can be a risk in the short term as well. We will discuss the reasons of it in our detailed video that why the Solara active plant received OAI. 2nd thing is that Vizag plant serves semi-regulated markets so inspection and audits are yet to be done here and if any failure will be seen in inspection and audits than again the story of ROCE margins will be derail since last 1 to 2 years.
Last thing is pricing of key APIs. If they are unable to maintain the pricing power than this can be a very big risk in Solara Active business today. So, I think these were the key insights from the result of Solara active and this is the business which we are actively tracking and we will bring the detailed video for this. I think with this we will go to PI industries.
Just before talking about PI industries we have a detailed intensive course, if someone wants to learn how to find out the business updates, how to read con calls, what are the tools of research and what is the business valuation framework of SOIC and how we find SOIC businesses where ROCE is on an improving trajectory then you can check our course which is mentioned in the description below. Along with this we are going to do a webinar on platform businesses and platform businesses webinar will be done at the end of this month. For SOIC students, platform business webinar is a part of the course and if anyone wants to check the course than you can check it out in the description below. With this we will move to business updates of PI industries where something interesting is going on at this time. Now, coming to the business analysis and business updates of PI industries then a very key development has happened and again in next 2 to 3 quarters a very interesting thing can happen. So, what happened in PI industries is that close to 2000 crore is on their balance sheet because they did QIP and today PI industries is at that stage of its journey where PI industries have to diversify into pharmaceutical CRAMS.
Now, they do agrochemicals CRAMS. Why they will have to diversify into pharma CRAMS? Because market of agrochemicals CRAMS is 5 to 6 billion dollars and we feel that PI industries agrochemicals custom synthesis manufacturing business will reach close to 5000 to 6000 crores. So, I think so it must reach 3000 to 3500 crores by the end of this year. Again, seems very interesting to see where the business is going. If we look at the results here than the revenue, top line has grown by 37% because they have an order book of 11,400 at this time so as the order book is executed and they built the plants too and done capex in advance so sale number and profit number growth of 2 to 3 years is very expected.
PI industries will definitely grow more than 20% in next 2 to 3 years. If we see the net profit than it has reached from 121 crores to 195 crores so there is a growth of 61% in net profit and there is a growth of 41% in EBITDA. Why? Because operating leverage lever play out here and moreover, again its just very interesting because when operating leverage play out then you can see here that gross margin have done a lot of improvement but there is more improvement in EBITDA margin as compared to gross margin. Because you get EBITDA when all expenses are subtracted, when all fixed cost is subtracted, right.
Due to this reason, there is more improvement in EBITDA margin because of operating leverage playing out so from their con calls or business updates we have received a key take away which I think is very interesting. What PI industries have done? In last 2 to 3 years, they have done high utilization of technology. What is happening by using technology? The plant output has increased by 20% means the work which you were doing at 85 to 90 percent utilization and the output which they were producing because of technology initiatives PI industries have taken same work can be achieved at 65-70 percent utilization. So, this just shows you that what is very interesting about the business, right. Great managements always try to improve the business due to which their ROCE is effectively going to increase because their asset turns earlier was between 1.8x to 2x which have now reached to 2.5x.
So, now they have 2000 crore fixed asset out of which 1 plant will add by the end of this year and 2 more plants will be added. So, effectively again these fixed assets are enough to take the sales between 4500 to 6000 crores. According to us in next 2 to 3 years, 20% profit growth CAGR is possible because of the order book and the initiative they are taking but ROCE expansion can be done on the basis of the approval of their assets turn. Again, what is the risk in PI today? That how will their acquisition perform. The management have done ISAGO acquisition very well and working on efficiency technology so we think that we will rarely see a management like this in India, right. This is the company that we have been knowing from last 20 to 24 months now so PI industries is a very interesting business, right.
So, with this I think I will come to Navin Fluorine and after Navin Fluorine we will discuss about Neuland labs. So, Navin Fluorine is a very interesting business today and many people asks us about Navin Fluorine so I will show you their results once that what interesting is happening here. Just give me a moment, right. So, in Navin Fluorine what is happening in business today is that the high value-added business in Navin Fluorine means there is a lot of growth in CRAMS business and specialty chemical business. We can see in first 9 months in CRAMS business it has grown by 71% whereas specialty chemical business has grown to 16%.
The high value business has grown to 33%. Navin’s story is a story of product mix change. If today we take an example of Britannia industry then margins of Britannia from 2014 till now have improved a lot because they introduced high value products. Similarly, in Navin Fluorine business the CRAMS business is growing at a very fast space and moreover, very less people have the business which Navin has. I think so there are not many producers in Asia who does fluorine-based CRAMS. Even in west there are very less producers so this is only one player from India which is CGMP for fluorine chemistry in CRAMS and which is purely supplying patented molecules of intermediates and advanced intermediates.
So, in India there are not many companies like Navin Fluorine in CRAMS which makes it very interesting, right. So, this is what is happening in Navin Fluorine’s case and let’s take an update of the result once. So, over here again their operating margins again have gone up by 28% in the first nine months and EBIT margins have gone up by 200 bps. Just to show you here EBIT margins have gone up by 200 bps. EBITDA margins have improved up by 260 bps that is 2.6%.
Moreover, FY23 will be such a year in Navin’s history where you can see profit growth of 50 to 60 percent because their major projects will be commercialized. What is interesting in Navin today is that we feel that the capex amount will be more in its CGMP4, in CGMP1 they did small capex and they did more capex in CGMP2 than CGMP1 then they did more capex in CGMP3 which is their CRAMS business compared to CGMP2 so we feel that they will do more capex in CGMP4 compared to CGMP3. There is a non-linear growth in CRAMS business. I think all the SOIC students watching this video must tell us that is Navin in bucket 1, bucket 2, bucket 3, bucket 4 or bucket 5. You must also tell us that at what speed their CRAMS business going, how much they are growing year on year. Even though at this time valuation wise Navin seems optically expensive but FY222 and FY24 will be 2 years in Navin’s history where earnings growth will be really fast.
FY23 is the year where you will be able to see 50 to 60 percent growth and in FY24 you will be able to see similar type of growth. Again, it is very interestingly poised because ROCE is very high and earnings growth is very high. So, let me know in the comment section it is a part of which bucket, right. So, this was Navin’s business analysis but in FY22 more or less their legacy business will also make a comeback and in their specialty chemical business 20% growth is expected but in FY23 their chemical capital will be commercialized whereas their high-performance product capex will also be commercialized. We think that they will let us know the capex of CGMP4 some or the other day.
Their con call details are mentioned in the presentation itself and presentation link is mentioned in the description below. So, I think with this we will come to the last business we will be discussing today which is Neuland laboratories. We will do detailed business analysis of Neuland labs maybe in next week or next to next week. We will do a video on both Neuland labs and Solara active. But what happens in Neuland labs case that Neuland labs is actually a very interesting API manufacturer, right. So, their operating margin in 2017 was close to 18% which fall down drastically in 2018 and 2019.
Now, one of the reasons for the fall was that there were 2 to 3 problems which occurred in their business. The biggest problem in the business was of capacity mismatch. They got capacity of some other product and they got order of some other product. Their capacities were not fungible. Fungible means where you can create different products in one capacity. So, their capacity was not fungible in a way where only few types of products can be manufactured.
To improve their business now they have made all capacities fungible. 2nd reason was that their dependence of raw materials on China was close to 60 to 65 percent. Whoever attended the chemical webinar and who have seen our chemical sector analysis then they know that chemical shut down is going on in China from last 2 to 3 years due to which Neuland labs were also impacted a lot because due to key starting material and intermediate their price increased a lot, right. Their prices became very volatile due to which their margin collapsed immediately. In investing there is a very big mental module named as reversion to mean, back to average. We think that management have been very proactive so they made their plants fungible so that they can produce any products there and they have also acquired a facility named as unit 3 and even here the capacity is fungible.
Management at this time have done backward integration to reduce dependence on China. Their dependence has reduced from 60 to 65 percent to 30% and it will go below 10% in future. Their derisking the business now, right.
Moreover, they have peptide ATI technology means they have a technical know how of peptide so we will discuss about in detailed video that what is peptide. Something very interesting is happening. If we see back to average and if we look at their operating margin than they are going back to mean, means they are again going from 18 to 19 percent.
Many people are missing out one interesting thing here that in unit 3 there is a capital employed of 180-200 crore and current utilization of capacity in unit 3 is below 30%. So, a massive element of operating leverage is built in business today. If unit 3 capitalization reaches 70 to 80 percent, I think it will reach up to 70% then management will announce capacity expansion than their margins can grow more.
We think that their EBITDA margins can easily reach to 23 to 25 percent but again that depends on some factors which we will talk in detail in the video but this business looks very interesting to us. Moreover, if we look at their result than in result also, we have seen healthy expansion. If we look at product pipelines so if we talk about CRAMS then you are basically increasing the size of opportunity in CRAMS. You are expanding the optionality again and again. So, in Neuland lab’s case the pipeline of products has expanded from 42 products to close to 76 products.
The expansion has become slow in last 1 year from 74 to 76 products only but management says that they are getting more quality projects. They are not going for projects just for the sake of quantity but they are quality projects where they feel the molecules can scale up, they go behind those projects. In Neuland lab’s case it was very clear on regulatory part then it is a very interesting business today. Today, the main triggers which you need to track is that how much is the capacity utilization of unit 3.
2nd key trigger you need to track is how much margin expansion is been done as the capacity utilization increases in unit 3. 3rd key trigger you need to track is how much the gross margin is increasing. When 2 type of leverage play out in business then that business becomes an unstoppable force. 1st leverage is that when gross margin expansion starts, 2nd leverage is when operating leverage kicks in, when both leverage kicks in together then at that time I think the most amount of wealth creation happens.
In many businesses we have seen this happening that gross margin expands because of product mix change and operating leverage kick in because capacity utilization increases. So, Neuland labs is actually somewhere in that phase right now that if this happens then stock look very interesting and we will be doing detailed analysis of this very soon on the channel. Let’s check why we feel that gross margin expansion is possible and I have already told you the trigger of operating leverage that unit 3 capacity utilization increases. So, their CMS business which is contract manufacturing services business is actually going up as a percentage of the entire business for gross margin. So, I think their CMS business have reached close to 37%. So, again if 1 or 2 molecules get successful in case of Neuland labs for whom they are doing contract manufacturing service then gross margin expansion will play out like anything.
Due to which operating leverage will play out like anything. This is why Neuland labs is something which we are personally tracking very closely at SOIC. Again, this is not a stock recommendation so we will do the detailed analysis of this in next 1 or 2 weeks. I think with this we will conclude today’s session but I think along with this session what we want to teach SOIC students and other investors that if we talk about business then actually there are key triggers in business. If you are fundamental investor than you have to formulate thesis. If you go behind every running train then you won’t be able to get any train in our view.
So, if you are doing fundamental investing or value investing than you need to know these triggers 1 or 2 year before the market. So, with this I will conclude and do let us know in the comment section because we will do a Q&A video soon so you can ask all the questions you have. I think we have already shot the video so we will also upload that in next 2 to 3 days. Thank you for joining us.
Hope to see you in the next session.
2021-02-08 09:33
