Hi Donald,
When I discovered JB chem it was a Graham’s classical net-net bargain hence a deep value stock. In my opinion it still remains a deep value stock. So from my perspective, as you very rightly put, It is a highly mispriced stock. At current valuation, there is big gap between the price and private value of business (value that promoters would seek if they were to sell the business to a private investor). As per my understanding, key attribute one has to look for such businesses is whether company’s business is good enough not to burn cash to bring down its intrinsic value to reduce the gap! As long as one ensures that, there is a good chance of high returns from such situations.
Before going into specifics of the JB, i would like to reiterate here that, in my opinion, JB is a decent business available at dirt cheap price. But it is a average business and not great business and hence after the gap between value/price closes, I personally would like to book profit and exit unless thecompany, in mean time, has transformed the business whereby one sees good chances of intrinsic value increasing at decent rate for a long period of time .
Coming to specifics about JB , following are my observations/analysis of JB business.
**Sale of Russia CIS business: **JB waswell entrenched into Russia-CIS market since they hand entered this market at very early stage, built strong brand and distribution network. Doktor-Mom and Rinza were primary revenue earners in OTC market. Profit marginswerethe best amongst all of JB’sbusiness segments due tostrong brand equity created by Doktor Mom and Rinza. Rx business was relatively smaller. However,Russia-CIS operationswere working capital intensive as 180 receivable days were considered normal! Considering this large requirement for working capital andhigher cost in spreading distribution network and sales/advertisement/promotion activities in the marketmade sense for JB especiallyfor the deal that theygot from J &J. Based on this primer, key fall out of sale of Russia-CIS business is,
)- Working capital requirement for the company will go down substantially leading into higher asset turnover and lower financing cost
)- Company has inked a exclusive supply contract with J&J to supply OTC products for 5 years which meant that topline impact from Russia-CIS sale will be somewhat mitigated.
)- Operating and net profit margins will come down due to relatively higher sales contribution from lower margin (doemstic formulation) business verticals.
)- Company has started a strong relationship with a MNC pharma (J&J) for supply of product which can be built upon in future for other contract manufacturing opportunities.
So post sale of Russia-CIS business, management has panned outmulti pronged strategy
)- Focus on Domestic formulation business-management expects 15% CAGR in the domestic formulationsbusiness which isrealistic and achievablegiven their revived focus on domestic business, new product developments, development of new theraputic areas (gynecology/dental) and increased field force. However, it is also equally important to realize that JB has grown only modestly in the past decade inspite of support of relatively strong brands. In my opinion,slower growth was due to conservative approach by management to grow thisperticular business.
In future,as management hasindicated, theefforts will bear fruit slowly as prescription generation is a slow process and buy in from medical fraternity/hospitals can not be achieved overnight. Hence, one must be willing to give at least 1-1.5 years after onecompany starts putting infocused efforts (which they did since last 9 months as indicated by management). Another thing to bear in mind is that new division (gynecology/dental)means higher operating/sales/promotion expenses upfront before realization starts to come from new division. So, in all for FY 13, the margins may be under pressure due to this and company may achieve modest growth in topline in this division.
)- Contract Manufacturing: JB has number of manufacturing facilities spread across locations which are approved by various regulatory agencies such as USFDA/MHRA, EU-GMP, South African and australian agencies for various types of products. JB has started contract manufacturing for J&J for supplying OTC products to Russia-CIS market. Hence, given their understanding of various forms of dosage manufacturing, they can surely tap this market. However, as I see it, this market is becoming increasingly competitive but there is enough space for new players considering increasing off patent drugs.
)- Niche Branded formulation exports: This again is a lucrative market and JB has grown in this area and can capitalize in the markets/geographies it has already entered more swiftly than any other opportunities.
)- Growing in US Generics Market: In my opinion, JB has been slow on this front and it will take some time for them to reach a stage where every year 8-10 ANDA can be filed every year (as indicated by management, which seems over optimistic to me)and based on that new products launched in US market.
In all, I see JB business doing reasonably well (12-15% growth) in near future and there after it will dependuponhow management’s effort on various fronts pan out. So, I do not see any risk of intrinsic value eroding from this point at least.In my opinion,it is low risk bet with potential returns of 80-100% from this level ( NWC + investments- Debt = 635 crores while market cap is 638 croreswhich means fixed assets + business is available for free).
for ROE/ROCE, I feel that in the past, JB’s ROE/ROCE performance wasdriven byNPM as itmaintained high profit margin therange of 15% (+/-2%)while asset turns were around 1.15-1.3 which is on the lower side for a pharma company.However post Russia-CISbusiness sale, asset turns will increase due to lower working capital requirements which will partly offset the impact of lower net profit margins on retun ratios. So, i still feel, that JB will be able to post decent return ratios in next few years.
Best Regards
Dhwanil Desai
