Lactose India - Unique Play on Lactulose & Contract Manufacturer for MNCs


(Nirav8) #1

LACTOSE INDIA (CMP Rs 46.6, Mkt Cap Rs 39 cr)
Lactose India (founded in 1991) is one of the leading producer of lactose in India with 40% market share. Clients include large pharma companies like Abott, Astra Zeneca, Wyeth, Bayer, Cadila, etc. Company has recently started focusing on Finished Pharma Formulations and API. What has been the potential game changer for the company is its agreement with Kerry (since Sep 2011) and its putting up of Lactulose plant of 2400MT/Annum.

Investment Highlights
1) Significant Capacity expansion undertaken since FY11. Benefits of the same expected over next couple of years.

2) Kerry agreement in FY 12 has likely changed course for the company with significant capex undertaken post that. Fixed assets have grown from Rs 15cr in FY12 to Rs 63cr in FY15.

Understanding Kerry Transaction
Kerry Transaction
Kerry Advance explained as Note 33 in AR FY12
During the year, based on certain commercial negotiations, the Company has received from Kerry Ingredients Private Limited a sum of 7,67,72,000 for expansion of production capacity and others measures for strengthening of business and 3,36,81,113 as an advance against goods to be supplied by the Company. The final terms & conditions of these transactions are still under negotiation. Till then the said amounts have been reflected as “other long term liabilities” and “advance from customers” respectively in the financial statements.
My comment – Rs 11.04 cr received from Kerry. Rs 7.67cr shown as other long term liabilities and Rs 3.36cr as advance against goods supplied. Asset side as Cash.

Kerry Transaction as explained in Note 33 in AR FY 13
a) During the F.Y 2011-12, the Company had received from Kerry Ingredients India Private Limited (Kerry) a sum of Rs. 767.72 lacs for expansion of production capacity and others measures for strengthening of business and the same had been reflected as Liabilities in the financial statements for the year ended 31st March 2012 in absence of any agreement with Kerry.
b) During the current year, the Company has executed a Manufacturing Agreement with Kerry on 11th January, 2013 and as per the terms of the agreement the said sum Rs. 767.72 has been received as follows:
i. Rs. 190 Lacs has been received for the purchase of Company’s customers for such products. The said sum will be accounted for as Income in the year when the Company’s customers will be transferred to Kerry.
ii. Rs. 577.72 Lacs has been received as Advance Manufacturing Consideration by the Company on having agreed to upgrade its plant and produce up to 10000 metric tons 200 Mesh Lactose per year exclusively for Kerry. This Consideration shall be apportioned over a period of 10 years from the commencement date which is the date on which the Company commences the production of the upgraded manufacturing facility as agreed in the Manufacturing Agreement.
Accordingly, the said sum of Rs. 767.72 Lacs has been reflected as current / long term liability as the case may in the in the Financial Statements for the year ended 31st March 2013.
My comment – Rs 5.77cr used for capex and could be reflected in P&L once plant commissions.

AR FY 14 Details of Kerry Transaction
Note 30
Note: The Company had during the earlier years received an amount of Rs. 1,90,00,000 from Kerry Ingredients Private Limited (KIIPL) for transfer of Company’s customers as per the manufacturing agreement executed on 11th January, 2013. During the Current year in terms of Manufacturing Agreement, the Comapny has transferred its entire customers to KIIPL and accordingly the amount received has been recognized as income under exceptional item.
My comment –
Rs 1.9cr have been recognized in income after transferring customers.
Rs 5.77cr and Rs 3.36cr yet to show in P&L. Rs 5.77cr used for capex and Rs 3.36cr against future supply of goods.

AR FY15 (Kerry and Sanofi)
Note 37 :
a) During the FY 2013-14, the Company had commenced production of its upgraded manufacturing facility to manufacture up to 10000 metric tons 200 Mesh Lactose per year exclusively for Kerry Ingredients India Private Limited (KIIPL) and accordingly as per the manufacturing agreement with KIIPL , has recognised during the year income of 57,77,200 (P.Y. 33,70,033/-) on proportionate basis out of total Advance Manufacturing Consideration amounting to 5,77,72,000 and the balance of 57,77,200/ - (P.Y. 57,77,200/- is disclosed under the head “Other Current liability” and 4,28,47,561/-(P.Y. ` 4,86,24,767/-) is disclosed under the head “Other Long term liability”.

b) During the year, Company has received an advance amounting to 2,60,00,000/- from Sanofi India Limited for procurement of machinery, equipment and carrying out civil work for structural modification of manufacturing facility exclusively meant for Sanofi India Limited through an agreement dated 10th April, 2014 and addendum thereto dated 1st January, 2015.As per said agreement, advance payment is to be adjusted by way of monthly deductions by Sanofi India Limited equivalent to 20% of the Conversion and Packaging charges billed to Sanofi India Limited by Lactose (India) Limited from F.Y 2015-2016.Accordingly, out of advance of 2,60,00,000/-, 36,00,000/- is disclosed under the head “Other Current liability” and 2,24,00,000/- is disclosed under the head “Other Long term liability” on estimated basis.
My Comment –
Lactose India has ramped up production of Lactose from 3500MT to 11000MT (exclusively meant for Kerry). This assures demand clarity. According to management, Kerry wants to further enhance lactose sourcing but Lactose India wants to stabilize current capacity before adding more.
Sanofi agreement is on similar lines to Kerry. Thus, Lactose India is becoming more of contract manufacturer for MNCs with asset light model.

3) Promoter has issued warrants at Rs 12.5/share in FY14 and at Rs 27.5/share recently in August 2015. Promoter stake has increased from 28%(since Kerry transaction) to 38% and will potentially increase to 46% (post conversion of recent warrants)

  1. Capacity expansion has been largely funded through debt (Long term + Short term). Debt has increased from Rs 5cr in FY12 to Rs 32cr in FY15. The reason for highlighting this point is when bank funds capacity of company with market cap of Rs 12-15cr to the tune of Rs 25cr, there has to be very good clarity on demand.

5) Company’s margins have shown very good improvement (steadily) over past few quarters from 15% in Q4 FY14 to 29% in Q1 FY16.

6) Company has put up 2400MT/annum Lactulose plant which should add to numbers in FY17. This can add to Sales to the tune of Rs 55-60cr. (Capex for Lactulose has be Rs 30cr).

Financial Tables
Balance Sheet (Rs mn)

  1. Sharp increase in FA from Rs 15cr in FY12 to Rs 63cr (benefit likely to come over FY17 & FY18.

Profit & Loss

P&L Quarterly


EBIDTA margins have smartly improved from 15% in Q4 FY14 to 29% in Q1 FY16. Largely due to asset light model and contract work undertaken by the company.

Cash Flows

Lactose has enjoyed good operating cash flows over last 3 years.

Company has undertaken massive capex and has spent close to Rs 55cr on fixed assets over last 3 years.

Investment Summary in Brief
With very big capex and demand largely tied up, financial performance can sharply improve over next couple of years.

Due to asset light model EBIDTA margins have sharply improved. Existing business can do sales of Rs 45-50cr and Lactulose can add another Rs 55-60cr. Based on 20-25% EBIDTA , Lactose India can do EBIDTA of Rs 20-25cr in FY17/FY18 (depending on ramping up of capacity). ROE and ROCE will be quite high over coming years.

Company’s Website - www.lactoseindialimited.com (contains useful information)

Disclosure - Invested.


(mahesh112) #2

Hi,

The ROE seems very low, Please suggest:

Return on Equity:

10 YEARS: 1.84%
5 YEARS: 1.98%
3 YEARS: -0.84%
TTM: 3.25%

Source: Screener.in

Thanks
Mahesh


(Nirav8) #3

Hi Mahesh,
As mentioned, game changer for the company is Kerry agreement & Lactulose (capacity 2400MT/annum).
Impact of Kerry agreement will be partially in FY16 and fully in FY17. Similarly Lactulose plant will come on stream in FY16 and will be ramped up in FY17 and FY18.

Lactulose accounts for 55-60% of capex incurred (Rs 30cr). Next 2 years (FY17 & FY18) will see impact of capex incurred over past 3 years (FA - on stream increased from Rs 28cr in FY14 to Rs62cr in FY15…hence impact will come now). Also, capex of Rs 10cr has been done through client funding (Kerry and Sanofi) which will help higher return ratios.

ROE & ROCE will be high when numbers will come over next 2 years. Just to give sense…last 4 quarters EBIDTA has been Rs 6.7cr (this without any significant benefit of capex). EBIDTA can jump to Rs 16cr and Rs 25cr in FY17 & FY18 respectively.

My sense is Lactose India can do EBIT of close Rs 12cr & Rs 21cr respectively in FY17 and FY18 while PAT could be near Rs 7.5cr and Rs 13cr in same period.

These are my estimates Mahesh based on Capex done and limited interaction with management (in AGM).


#4

Highlights and concerns:

  1. Lactose started as contract manufacturer for Kerry in 2011 where the capacity was increase 10,000 tonnes which is mostly taken away by Kerry.
    o Charges are on cost plus basis
    o Utilization as of now is c. 6,000+ tonnes
    o Probably next year utilization level will increase to 100%

View: Strong visibility, but concerns around customer concentration. It is understood that Kerry wants Lactose to set up additional capacities for lactose. Management is currently focussing on Lactulose, which will enable them to reduce concentration on Kerry.

  1. Second division: Pharma (Formulation) – Does contract manufacturing for players like Sanofi. These products are premium products where 80% products are export and 20% used locally.
    o Oectan (100% manufactured by Lactose) – Sanofi has shut down their operations in Turkey and now they source from Lactose India. Oectan is INR 100crores for Sanofi with INR 40crores or profit.
    o Though there is concentration risk, but it is less likely that Sanofi will cut short its contract with Lactose to the the approval process / formalities for assigning new capacities for manufacturing

  2. Lactulose – Claims to be the largest in India post commissioning of new plant
    o Raw material is Lactose, so in-house lactose acts as supply for Lactulose plant
    o Expect to clock INR 60- 70 crores of turnover in next 2 years

View: Company has incurred capex through creditor funding / long term loan. equity requirement was brought in by sponsors.

Queries:

  1. Management’s ability to market new product - Lactulose; this is different as compared to its tradiitonal client driven product segments including lactose and formulations.

  2. Ability to service debt in case of delay in take-off of new project

Disclosure - hold small quanitites


(Nirav8) #5

Thanks that’s quite helpful.


(Aniket Nikumb) #6

Hi folks,

Thanks for bringing this up here. Very educational & interesting. Had a couple of questions:

1. What exactly is the product and how are these margins justified?
The current financials (FY15) with 57% GM and 22% EBITDA sounds quite high. Even if one discounts the operating leverage, I couldn’t understand such high GM levels. Prabhat Dairy manufactures some specialised milk-based ingredients for a global pharma client that does into their formulations. Even Prabhat earns 15%-odd margins here, and significantly lower for their other B2B clients.

2. Wallet Share, Bargaining Power
From a rough reading of your post, I understood that Kerry and Sanofi are effectively loaning money out to Lactose to set up capacity. Why would they do that and let Lactose earn high RoCEs? What wallet share does Lactose have among other suppliers for the same product in Kerry and Sanofi?

3. Promoter and Management
Contracts into these companies require significant sales effort and track record. It’s unique to see a small-ish company achieve this break. Would love to get some background around the promoter and his ability to gain in-roads into these companies.

Best,
A


(Raj Panda) #7

And very curiously , Kerry had announced in an notice to Ireland exchange in 2011, that they have acquired Lactose India

and same was also reported in an Irish newspaper http://www.irishexaminer.com/business/kfqlojsncwau/

And again same was reported in 2011 AR of Kerry,

but Lactose India finds no mention in 2012 AR of Kerry http://www.kerrygroup.com/docs/reports/2012/Kerry_Group_2012_Annual_Report.pdf .

So officially it’s part of Kerry group now :smiley:

The business prospects appears good, but given this kind of mis-information, I doubt if promoter can be trusted ?


(Raj Panda) #8

Another research report which went on to analyse the impact of the Lactose India acquisition on Kerry.


(Nirav8) #9

Hi Aniket,
Thanks for appreciating the effort.

  1. Margins have improved for 2 reasons -
    a) Proportion of conversion sales have increased, if you observe sales have come down while EBIDTA has increased.
    For eg FY 13 had sales of Rs 46cr & EBIDTA at Rs 3cr while, FY15 had sales of Rs 24cr and EBIDTA of Rs 5cr.
    b) Increase in lactose capacity exclusively for Kerry (from 3500tons to 11000tons).

    As of now Lactose India numbers include lactose exclusively done for Kerry and small work for sanofi (pls refer Mitin’s reply above). Bigger kicker will be higher utlisation of kerry capacity and Lactulose (which will happen over next 2 years). Many companies outsource smaller ingredient or component work to specialists take for Eg AIA engineering…what AIA does (grinding balls) constitutes small ( in terms of cost) for mining and cement companies but AIA enjoys very good margins with almost monopoly. AIA cost is small and sticky for mining & cement companies. Lactose India with high market share and long history could have been chosen by kerry for similar reasons. Rs 10cr for Kerry would be too small, while they get supplies from Lactose India (Pls refer to Kerry transaction to understand)

  2. Yes you are right contracts into these companies would require significant sales effort and track record. Lactose does have a track record and Kerry approached them for capacity expansion. According to management many of their clients insisted Lactose India to manufacture Lactulose (Lactulose is 3rd derivation from Lactose after processing…pls google further to understand the same). Thus Lactulose capacity has been put up after such requests/demand from clients.
    Pls go through their site www.lactoseindialimited.com…it contains good info.
    Hope that helps.
    Thanks.


(JatinK) #10

Was covered by Value-picks blog also -

Promoters have also been reducing stake over last few quarters. Why?


(Raj Panda) #11

0.17% reduction over a quarter can be ignored i guess. Could be for personal reason? :smile:


(JatinK) #12

Consistent reduction (though minor) every quarter.


(Raj Panda) #13

You are right, roughly 46382 shares sold by promoters during this period, for maybe for a consideration of about ~15 lacs at average price of 25 ?
Both promoters draw about 55 lac per annum salary from company. So not sure, what prompted them to sell shares when prospects look so bright for the company. I think it’s not a deal breaker

Total no. of shares belonging to promoter.
Jun’14 - 3250792
Sep’14 - 3236792
Dec’14 - 3234910
Mar’15 - 3218700
Jun’15 - 3204410


(Raj Panda) #14

Hi @Nirav8,

The allotment of 1260000 @27.50 is to non-promoters “Gyaneshwar Multitrade Private Limited”, right ?
At least that’s what companies share holding pattern seem to suggest. Would you know what could be rationale to allot shares to non-promoters with only 25% of 3.46 cr. payable at time of allotment and rest at time of conversion (within 18 months) ?
This dilution doesn’t seem to have helped the promoters anyways (cash or increase in promoter holding), unless Gyaneshwar is also part of promoter group and company is giving wrong shareholding pattern.


(Nirav8) #15

Hi Raj,

Gyaneshwar is a part of promoter group…it doesn’t come across that way directly :-). Gyaneshwar is indirectly linked to promoters. Search for potentially related companies through tofler. Follow this chain - Lactose India - Omega Colors Pvt Ltd - Cellseed Enterprises Pvt Ltd - Gyaneshwar Multi trade Pvt Ltd.
Hope this helps.
Thanks


(Raj Panda) #16

Fantastic results from Lactose India.

YoY P &L
Revenue up 116%
Expenses up 50%
EBITDA up 710%
PAT up from 2.94 lac to 182.33 lacs
EPS up from 0.03 to 2.18

Balance sheet
Long term debt down 3 cr.
Working capital from 313.08 lac to 304.03 lac

Showing good signs of improvement.


(Nirav8) #17

Very nice results indeed.
Thanks Raj for updating. This looks like stock for long innings :wink:


(Parth S) #18

Their GP Margins have gone from 65% in 2014 to 95% this quarter, do you guys have any idea why?


(Samir) #19

My sense is that Kerry has only acquired one part of the biz. Reference to the Davy report shared by Raj. …only the pharma lactose biz… Page 2 of the report. Operative word being Only. Therefore, Lactose India cannot be said to be part of Kerry Group.

My limited submission

Samir


(thanveer) #20

Lactose seems an Interesting story. Company growth is almost certain. But the question is when and how it will reflect to the stock price. I think promoters intended to keep the price down and increase their holding to the maximum. that is why they did not disclose Kerry acquisition of the company. As well promoters selling few shares in every quarter hence public get a fear about it meantime they are increasing their holdings through preferential shares and allotting shares to non promotors (As Nirav said companies indirectly related to promoters). Now it seems apart from Kerry Sanofi also invested in Lactose. I cannot able to read the scenario going to happen in lactose. If someone can please explain the possibilities going to happen here