From an ICICI direct report on Lupin in Nov 2016, when the company relaunched this drug.
Methergine (methylergonovine maleate) Oral tablets 0.2 mg are used for the prevention and management of postpartum haemorrhage (PPH). Methergine is the only FDA-approved oral uterotonic and is a preferred oral agent in management of PPH
Also see http://www.lupin.com/lupin-bolsters-us-brands-portfolio-with-methergine-oral-tablets.php
An article in 2016 mentioned Lupin’s branded Methergine could be an $80-100 m annualised opportunity for Lupin in the US market.
In FY17 it achieved a $55-60 million annual rate (link)
They still have 2 weeks in hand & technically it shouldn’t be a concern as regulator allows 60 days from end of FY, although early results are considered good by investor community
The presentation says, one of the reason for lower margins is Geographic distribution of sales. Does this mean that they are selling more in low margin regions, and less in high margin regions?
Granules has expanded capacity in FY18. For Metformin capacity, it would require approval from US FDA/EU before they can sell them to developed countries. They are hoping that the approval shall come in sometimes in Q2/Q3 FY18 (based on my understanding of earlier con call). Until these facilities are approved, Granules will sell these API in other counties, which are not that profitable.
Management has made it clear in earlier calls, so the market is aware of the situation. I have not heard latest con call, so not sure what they said. Would appreciate if someone can post highlights of the Q4 con call.
There are multiple reasons for the fall in margins in Q4 FY18.
Sale in unregulated markets and unfavorable product mix: Since the company did not have the US FDA approvals in Q4, 38% of the sales were in unregulated markets. These, of course, carry lower margins and hence dragged profitability lower. Given that a few approvals have come in Q1 FY19 and they have launched new products, they expect the situation to improve over the course of the year.
High raw material prices: This was the biggest reason for the sharp fall in profits, and it has two sub-components to it. Firstly, the rise in crude oil prices, which has a direct impact on gross margins. The company was unable to pass this on immediately since revision in pricing with clients sets-in with a lag of a quarter. Given that prices have gone up in Q1 also, I would expect this pressure to continue in the current quarter as well since price pass-through (if any) for the current quarter would only happen in Q2. The second reason is the shut down in Chinese capacity for Acetic Acid (a key RM component for Granules) due to environmental concerns. The squeeze in supply here meant that Acetic Acid prices have gone up by 100% in a very short time as only a handful of vendors are left. The management said that they are looking for new vendors to de-risk and also that prices have started to cool-off a bit. In my view, vendor diversification takes time and China issues don’t seem to be abating – read here and here. We have seen how Chinese shutdowns have impacted prices of other commodities in the last two to three years, so I wouldn’t expect this situation to sort itself in a hurry.
Accounting change for R&D expenses: The company is moving from capitalization of R&D expenses on the balance sheet to accounting for them on the P&L, based on the progress of the development of the molecules. This also had a negative impact. This practice will continue in the future as well so expect to see optically higher R&D costs. Overall, this a good accounting practice to follow as it means that all the profits on the P&L will be real and not paper profits. Other small and transparent players like Suven also do this and I view it as good for investor transparency.
Regulatory costs: Granules had multiple inspections in FY18 and the higher costs for those and their resolution also brought the profit down.
As per the management, there was a spill-over impact of the fire incident in Q3 on Q4 as well.
Overall, the management was fairly cautious in terms of their ability to deal with external cost pressures, especially those emanating from higher RM prices due to a combination of rising crude and China squeeze. They are aiming to achieve ~19% EBITDA margins in FY19 on the back of new launches in regulated markets, passing-on of costs to customers, and easing of other cost pressures. But at the same time, they admitted that if the China situation doesn’t improve and crude keeps going up, then their ability to pass on costs to customers will be constrained and we could end-up looking at mid-teen EBITDA margins.
Also, expect the promoter pledging to go-up in the current year (FY19).
Downside from current levels looks minimal though this is probably a 2 year story rather than a short term play, management explanations of the reasons for fall in profitability look reasonable. In retrospect the management seems to have taken on too many things at one go, give their size there was limited margin of error which has hit them in 2017-18. As they have (thankfully) clarified that there will be no more expansions till returns on current investments are stabilised one should see some improvement in a couple of quarters.
Will debt levels remains same if the margin are at 11% and 15%. I mean lower margin means lower cash from operations and hence negative free cash generation, given that they have some expansion plan
There was inventory write off of 12 cr in Q4. If we deduct this one off from expenses then operating profit would have been 55 cr i.e. 10.9% EBITA margin. Down from 20 to 21% average. This is a big drop mainly because of two issues 1) Rising crude oil 2) Increse in raw material because of shortage
Crude oil has gone up this qtr also and I don’t know whehter increase in raw material is temportary of will stay here for while.
Management has guided for 19% margin but if both the above issues persists then should we project revenue based on 10.9% or somewhere around 15 to 16%?
I have tried to project the net profit based on 4 different margin assumptions
FY20 Projections (in Cr INR)
Worst case
Mix Case
Best Case
Best Best
Revenue in Cr.
2350
2350
2350
2600
EBITA margin
11%
15%
19%
20%
Operating profit
259
353
447
520
Other income
15
15
15
15
Depreciation
95
95
95
95
Inerest cost
45
45
45
45
Project before tax
134
228
322
395
Profit assuming Tax rate @35%
87
148
209
257
Profit from associates
20
23
27
30
Total Profit
107
171
236
287
P/E assumption
13
14
16
17
Project market cap Cr
1388
2392
3776
4875
Current Market cap
1872
1872
1872
1872
Upside
-26%
28%
102%
160%
Your thoughts/comments please? Management has clarified that they can pass on the increase in raw material with one quarter lag so I think they can still maintain 15 to 16% margin in current kind of scenario?
Management has guided for current tax which is 35% but in previous years it is 31 to 32%. Which one we should consider? Report from Centrum has considered 31%
As per Management no capex in future. But yes debt might go up if cash from operations dips
Other income - mostly interest from deposit.
I have not done any projections myself, will not comment on the exact numbers. Turnover assumptions look good, I would broadly go with a 16% EBITDA scenario (though management is indicating higher), cost is getting passed on with a lag as you have rightly said. If after than they can’t do 15-16% they should not be in business! Also historically they have done around 20%.
But I am more positive on higher share from associates, the Omnichem thing should probably show traction in some time.
What asset accretion assumptions have you taken for the depreciation calculations? Other than balance work on oncology unit etc and routine capex there should not be much more asset additions. Interest I would go with 35-40 cr, on back of envelope calculations (assuming broadly same level of debt, small uptick in interest rates). Also tax should probably be around 31-32% rather than 35%.
My TP would be somewhere in the 120-140 range but I will add this is a company where you have to keep a close watch. I am expecting they will implement the recent expansions well but balance sheet is over-extended and is something doesn’t go as per plan there can be a downward spiral. But at current price I would say most risks are pretty well factored. PE of 14 on this low earnings base with most of the capex done, looks good to me.
I think we all shud put our heads together in this wonderful exercise you initiated. I don’t rely so much on broker reports.
I think your revenue projections is on the higher side. My estimate is about 1900 crores. Secondly, interest cost at 59 crores. Thirdly, I’m looking at EV which to me gives a worst case price of 55 with a pe of 10. My approach is the downside risk.
Revenue: The revenue projection of 2350 cr I assumed is for FY20 and not FY19.
Last qtr revenue was 503 cr. They shipped the big order in the first week of Apr which was on hold because of dealy from customer. With additoinal capacity from Paracetomol, Metmorphin, + revenue from 3 to 4 product commercialization ( Methergine annual revenue US $70 million - 430 cr with only Lupin and Granules) + 25% CAGR revenue from Omni JV + revenue from Onocology block in late FY20 + higher pricing of finish goods because of higher crude oil should help to clock the revenue of 2350 cr in FY20. I think 1900 cr is too conservative. Infact few brokerage were estimating revenue at 2800 in FY20.
Depreciation:
Oncology block with capext of 200 to 250 cr will be operational by end of FY19.
So 100 cr in FY19 and 20 Cr in FY20 = 120 Cr depreciation
Motilal has projected 135 cr deprecian while KR choksey has projected 75 to 80 cr. Huge difference
Tax rate
Current tax rate for FY18 is 35% which as per Management would remain same. We can assume 33 to 34% as some R&D, they get tax rebate
Interest expense:
Borrowing gone up from approximately 600 cr to 950 cr in FY18 (59% up). Interst expense were almost same 32 to 33 cr. Management has clarifed that they won’t need additional debt. In fact it will go down by 50 to 100 cr in FY120. So assuming that interest expense would be 60% than last year (33 cr) = 53 cr approximately
On revenue front I think Granules can suprise us . Does anyone know the revenue potential at the optimum capacity?
@pumba22 - i think you are right on the tax side, though I will point that tax rate is only higher this year, previous years it has been 31-32% only. My impression was one of the write-offs is not tax deductible so it has increased but it is better we be conservative.
Depreciation also we can go with those numbers, so pretty much what we need to track is revenue CAGR, EBITDA & share of associates. Personally feel the approx 15% revenue CAGR what you have taken is a good assumption, with all the capex coming that is bare minimum one would look at. If it is higher well and good, we are not equity analysts to give flowery forecasts. Even with very conservative assumptions you are looking at a 30% upside without PE expansion, which is neat.
