I get really interested in stocks whenever there are customer advances. And when I saw 30% of current turnover in advances, it really got my attention. The numbers are there for everybody to see on Screener. I personally think this one is undervalued and have bought some quantity yesterday and today.
A few comments before I delve deeper into the analysis.
a) Not any and all pharma related stocks will command a premium PE (PE>15). Have a look at Medi-caps for example. So painting all pharma stocks with a broad brush would lead to erroneous analysis.
b) Yes, it was extremely under-valued say 4-6 months back. But at that point of time, I would not have invested since I would be speculating with the information that was available back then. Hindsight bias always strikes when a trade goes right. But now, with revised information and AR getting published very recently (maybe 15 days back), we now know that 30% of turnover is already advanced by customers and their plans and outlook for the future. With this new information, I saw it as undervalued at these levels and have invested in it. Of course, there is a possibility that the trade is wrong, but as long as I have convinced myself with available information and not shooting in the dark, I am ok to lose money.
c) The biggest gains are made, in my opinion, when businesses are on the cusp of growth and also come under the funds radar. This business is no doubt on the cusp of growth but fund recognition might take time since it is still a 100 cr turnover business. But 2-3 years down the line, if and when the hit the 300 cr mark, and if they continue with this performance, funds will jump in and that’s when you;ll see the highest gains. Not immediately.
Anyhow, enough of global stuff. So, as I said, I got interested in the stock due to customer advances, read through all available ARs and framed a list of questions. I contacted the best pharma analyst I know, Ayush and asked him these questions. I present the Q&A here. Caplin’s corporate office is in Chennai. So, if anyone here is from Chennai, please do make an effort to have an appointment with the management. I am sure if enough Valuepickrs see undervaluation here, we’ll not be short of an intelligent questionnaire. Chennai-folks, please raise a hand if you are interested.
Q&A with Ayush follows (K is Kiran, A is Ayush below):
K: Business model of Caplin â Who are their customers? Aid agencies in Africa and South/Central America (AR 2009)? Why are they paying so much in advance? In 2009 annual report, Caplin clearly states that they insist on upfront payment. How does this work â in your experience, have you seen any other business like this?
A: Due to this being a small cap, there is not much information out there. My hypothesis is some big pharma co. is backing these folks and putting them in touch with various customers and agencies. This is most likely a B2B kind of thing and not B2C. The business value chain is not very clear even though I have been tracking this co. for a while now.
K: They keep talking of unique business model/unique marketing strategy in almost all ARs â any insights here?
A: Nope. An interview with management would help a great deal here. In my experience, they respond to any shareholder very promptly.
K: There doesnât seem to be any seasonality in the business. Even if you take out the forex gains in Sep quarter, year on year EPS jump is close to 70% which is extremely healthy.Expected EPS? I see it as 10-11 if a similar performance and margin basis continues and without forex gains. With such growth and even at 10 PE, we are looking at 50% appreciation.
A: Yep, even my guess is around the same level given no black swan event. I don’t know the how and why of forex losses last year and gains this year though. So unless we meet the management, we wouldn’t know at what levels have they hedged their exports.
K: This seems to be a clear traded goods, contract manufacturing play. Am I right in that? Why canât anybody do it? And why are net margins close to 10% in a commodity play?
A: Net margins are close to 8% and not 10%. See, the entire play here is they are moving up the value chain. From tablets and ointments currently, they are setting up an injectibles plant which have higher margins. Let’s say I assume the big pharma company helps them get through the US/UK FDA approvals quickly, and even the big pharma company squeezes these guys’ margins to the current level, the volume explosion from the current level itself should move them to the next orbit. Look, for a 100 cr turnover business, setting up a plant worth Rs. 25 cr would not have been a shot in the dark. They already might have a big customer or two lined up (maybe the big pharma co. backing them itself provides the demand and advances)
K: This new plant that they talk about â finish by Dec 2012 and commercial production by mid-2013. Shouldnât the authorities in US/UK give permission? And if their major customers till now are aid agencies, then how are they even penetrating this market and who are the customers buying this stuff? Doesnât the approvals time extend to a year or two?
A: If aid agencies are their customers, then I am not really sure how they would get the approvals so quickly. US FDA takes 1-2 years, but UK is pretty ok. This in turn, leads me to the hypothesis that some big pharma co. is backing them and hence the approvals would come in quickly, else they would not set up a 25cr plant just like that.
K: Argus Salud Pharma â in 2011 AR, they say this HP plant has handsomely added to the topline and bottomline. However, look at the current AR, and the consolidated is actually slightly less than standalone. Now, given that this is the only subsidiary, isnât the conclusion that Argus is just about breaking even?
A: Yep, this seems to be the only disconnect between the talk and walk of management. We should ask the management this question though.
K: Any cashflow â earnings mismatch you found?
A: Not as far as I could see. Taxes are being paid, dividends are being paid, fixed assets are growing, there is no inventory problem, there is no debtor problem, the balance sheet is in terrific shape.
So, that was the end of our Q&A. If anybody here has any contacts in the pharma industry in Chennai, that’d be great and we can have a meet/call with the management.
What do you guys think of this story?