Company Name – Laurus Labs Limited (Laurus Labs)
Current Share Price – INR 525 (July 28, 2022)
Market Cap – INR 28,225 cr
1. What is interesting about the stock?
I have no experience in the Pharma sector – I have avoided the space for a long time. Why? - I had a lot of doctors at home who studied till they were 35 and had a difficult time through their studies especially post-graduate - fat books, lack of sleep/stress! So, I realized early that it may not be of my liking as I can’t study for such a long time. I ended up doing engineering followed by MBA (yes! I know you guys have seen 3 idiots), I have worked in a lot of sectors – but still managed to avoid pharma. It's more of a phobia. Hence, if you don’t like the analysis - I will appreciate your feedback (good, bad, or ugly).
Ok, with the caveat out of the way. What’s the history of pharma in India and why did India develop into a generic pharma powerhouse of the world?
The earliest known compilation of medicinal substances in Indian traditional medicine dates to the 3rd or 4th century AD and has been attributed to Susruta (6th century BC) and Charaka (sometime between 100 BC and 150 AD). Susrata (surgeon) and Charaka (internal medicine) were medicinal doctors as well as pharmacists who had studied more than 1,000 herbs thoroughly (Ayurveda). Our history with pharma is quite old.
The Indian Government started to encourage the growth of drug manufacturing by Indian companies in the early 1960s, and with the Patents Act in 1970. With so much focus on PCM – Physics, Chemistry, and Maths, we created entrepreneurs with superior chemistry skills and access to low-cost labor. Entrepreneurship, big TAM (local population), and poor purchasing power became perfect ingredients for the launch of the pharma industry focused on low-cost generics.
Today, the Indian pharmaceutical market has characteristics that make it unique. First, branded generics dominate, making up 70-80% of the retail market. Second, local players have enjoyed a dominant position driven by formulation development capabilities and early investments. Third, price levels are low, driven by intense competition. While India ranks tenth globally in terms of value, it is ranked third in volumes (our corner medical shop lets the medicine flow without prescriptions!).
Laurus Labs is an India-based Pharma manufacturer. The Company was traditionally strong in Anti-retroviral API (an ingredient used in making drugs used to treat HIV patients) manufacturing but has since diversified into finished dosage (final drug or injectables) and, more recently, into Custom Synthesis or CDMO (full form - contract development and manufacturing company; an outsourcing company helping a big pharma company in development and manufacturing of medicines). CDMO allows big pharma companies to focus on drug discovery and marketing.
Key segment details of Laurus Labs are:
Anti-retroviral API – Antiretroviral (ARV) APIs accounted for 50% of company revenue in FY17 but only 41% of revenue in FY22. Laurus has been a global leader in Efavirenz production but has since diversified into other ARV API, such as Dolutegravir, Tenofovir, and Lamivudine (don’t worry – even I can’t make much out of the names!). Key other players in ARV API are Cipla and Aurobindo Pharma. Company is undertaking a capex of INR 900 cr to expand its API capacity.
Finished Dosage - Finished Dosage business accounts for 38% of Laurus revenues in FY22, having grown from a very small base in FY18. The business is built on backward integration of its API and consists of sales of ARV dosage forms to Low and Middle-Income countries. Laurus Labs plans to diversify into non-ARV formulations and expects the US and European markets to become a larger share of revenues in the future. The company is doubling its oral solids capacity to 10 billion units, given increasing demand. Laurus Labs has new contracts from European players for generic formulations, which provides further visibility into growth for this division.
CDMO – CDMO accounted for 19% of company revenue in FY22. The synthesis business has 50 ongoing projects and 4 commercial projects. There are over 100 R&D scientists working, and the company has 4 Big Pharma clients. In terms of capacity expansion, Laurus Labs commercialized unit 1 during 1QFY22. It created a subsidiary LSPL and is building manufacturing facilities, which will lend self-sufficiency to the CDMO business going forward. CDMO is driving revenue growth for the Company.
Key strengths of the Company are:
Promoters’ technical background has helped in the early identification of business opportunities
Strong R&D skills have led the Company to become a low-cost supplier of APIs. This skill has also enabled it to gain considerable share in the formulations business
Key weaknesses of the Company are:
Company derives most of its revenue from the ARV API segment. It continues to reduce its exposure to ARV APIs by adding newer business segments
Laurus Labs does not have much pricing power in products in which it has a significant market share
Weak financial performance in FY22 - revenue growth of 3% on a YoY basis
Very high inventory levels (~293 days) and payable days at 146 days
2. Key Historical Financials
Company had 3% revenue growth in FY22 and 20% in Q1FY23 on a YoY basis
EBITDA margin has contracted to 29% in FY22 and Q1FY23
The higher tax rate depressed the net profit growth rate to 4% in Q1FY23
Cash flow from operations to EBITDA ratio has improved to 64% but the cash conversion rate is still very poor
ROCE and ROE have come down to 26-28% in FY22 vs 40-45% in FY21
3. What is my view on company valuation?
Company had a big jump in revenue in FY21 but muted growth in FY22. EBITDA margin increase led to ~4x jump in profits but sustainability of such margins is still to be tested as they have come down from 32-33% to 28% in FY22. Company has a lot of competition in key segments – ARV API and Formulations (Government tenders for drugs in Low and Middle-Income countries) so having ROE/ROCE at 26/28% is unsustainable. I would expect the EBITDA margin to come down to a more sustainable level of ~24-25%.
Company trades at an EV/EBITDA (TTM) ratio of 20x and a P/E (TTM) ratio of 34x. The stock looks interesting in long term and should be evaluated further by investors at an entry price that is 25-30% lower than the current market price due to (1) reversion in EBITDA margins to a more sustainable level and (2) high working capital in the business.
4. What are the risks to the investment analysis?
Risks to the analysis are:
Promoter shareholding had come down from 28.8% in December 2020 to 27.5% in March 2021 – when the share price was around ~INR 365 which is ~30% lower than the current market price. Promoter selling stake is not a good sign
Warburg Pincus (PE fund) sold their stake in June 2020 when the share price was INR 100-110 (~20% of the current market price). PE investors have better access to information (board nominee, management meeting, a network of experts, etc) vs. retail investors so their exit at a lower price should be treated as a warning to study the Company closely before investing
About the Author
I have over 15 years of experience in venture capital, private equity, and investment banking in India and the Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the Middle East, to look after investments, M&A, and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB), and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.
I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).
I am an Insignificant Investor in the public market and co-founder of SocInvest.
I have no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI registered advisor. This article is purely for educational purposes and not to be construed as investment advice. Please consult your financial advisor before acting on it.
I have used publicly available information while writing this article.