Suven Pharma ~ Demerged CRAMS Arm of Suven Life Sciences

Stock Opportunities Untested - but worth a good look
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First of all pharmaceutical business is not my forte, this analysis was done to continue my journey to learn a new industry

This is my first attempt to post in such an esteemed forum - it is very likley the analysis will have pit falls , please point out so that I can improve in future

About Company )- Suven Life Sciences, in the business of design, manufacture and supply of Bulk Actives, Drug Intermediates & Fine Chemicals, catering to the needs of global Life Science Industry.

**Business Segment **

1). CRAMS )- Contract Research And Manufacturing Services - This segment accounted for 95% of the Companyas top line in 2013-14; the business grew 20% CAGR over the 10 years leading to INR 514 crore turnover. This is a very high margin business, reason for company to have high ROCE, ROE

**2). New Chemical entity **- Cash guzzling unit of the company , 338 crore has been spent on drug discovery till 2014, the expected outflow in next 3-4 years is going be high as well as 1 molecule is entering phase 2 and three others in IND and phase 1. Important note no revenue realised till date

3.Formulations development )- Suven is also engaged in the development of formulations, an extension of its business model. The Company expects to develop and collaborate with a partner, out-license the product in exchange for royalties and revenues. The Company expects to focus on niche and small molecules (global sales about US$20 to 40 million), which are generally off the radar of most large pharmaceutical players. This is a superb annuity business from 2014 till 2028 their USFDA ANDA for Malathion lotion (Taro) is going to produce 2- 2.5 USD million ( ~ 11 INR Cr) annually. The management expects to file 3-4 ANDA with USFDA in next two years. This potentially can become USD $10 million (~45 INR Cr) annuity for future years

Management a My take management is extremely focussed and highly conservative (in terms of accounting), The CEO comes out openly on CNBC and says that investors get excited over filling of patents , they should not be as filing patents has no material impact to top/bottom line of the company. Guidance are conservative, they expense R&D instead of capitalising it. The Annual reports are quite informative on progress of the company. 2014 Annual report is a delight to read if anyone is interested to under the company in details. Management compensation is reasonable

Though I have to say the companyas website needs to be uplifted it is very outdated.

Possible risk a Mr Jasti is 65 and I donat see any succession planning put in place.

**Size of business opportunity **( Straight from Annual Report 2014)

Besides, the US$58 billion research spending by the top-50 global pharmaceutical companies represents a large market for companies like ours with annual revenues worth just H500 crore. Of the US$12 billion pre-clinical research market, only half a billion worth of projects are outsourced, a proportion that we feel will significantly increase. If anything, the pressure is on companies with established business models like ours to scale our presence and account for a larger share of the customeras wallet and widen our presence across a larger number of markets, therapeutic segments and customers.

Also read this 2011 ICRA report- http://1drv.ms/1r8CNZG,it highlights key drivers for CRAMS in pharmaceutical industry

  • Patents expiry

  • Falling R&D productivity

  • Focus on generics

  • Cost pressure

Quality of Earnings )- I have done last five years earnings quality analysis you can see details here - http://1drv.ms/1r8D1zV

They key thing that that has triggered my interest is companyas positive enterprising and defensive profits in 2014, a continuation in this box can create value for investors.

Valuation

Management has guided that CRAMS division will do sales of 450 Cr for FY15 (lower than FY14) and expects it to grow 20% annually for few years. Given managementas conservative guidance in past I tend to believe they can achieve it.

Letas transport ourselves in year 2024 (Wish I could do in reality) with my assumptions

CRAMS business had grown 20% for three years from FY15 on wards , 15% for next two years and 10% for next three years. We would end up with sales of INR 1643 crore in year 2024

NCE Segment a In spite for 1 molecule in phase 2 and several others in IND phase no commercial success for company till 2024, hence no revenues from this division. Highly unlikely a Read this from 2014 Annual report - It would be relevant to indicate that one of the partnerships (NCE molecule development) for a similar programme in July 2013 between two global pharma companies generated US$150 million upfront for the molecule developer (Like Suven) for the Phase 2 programme.

Formulations Development a The company was not able to file any new findings after initial two three years (Highly unlikely )as guided in annual report 2014 they have 4 ANDA USFDA filings. The annuity earnings are INR 44 crores

With INR 1687 Crore revenues and net profit margin of 18% ( in 2014 their margin was 28%) and management has indicated that CRAMS segment is a high margin business. The net profit would be around INR 304 crores . At 15 PE the market cap would be INR 4554 crore. This means if you buy company at current market cap of around ~INR 2000 crore. The CAGR profit is around 9.57% which is below par for a long term investor.

But as you would have seen expecting company to not to commercialize any R&D work for 18 years would be real surprise. If USD 30 million is added to bottom line for year 2024 this improves our CAGR return to 15% which is good and not great. Any continuation of growth CRAMS business , additional ANDA fillings and commercialization of molecules could mean huge upside for our returns

At CMP of INR 200 there is no steep margin of safety, the company has to deliver on promises to get block buster results for investors

Risks

  • As highlighted earlier senior management continuity beyond Mr. Jasti is not visible

  • If debt is taken to fund R&D in future it will be detrimental to investors return, the company has not done so in past

  • No revenue from NCE division will result in sub optimal returns for investors in long run

Positives

  • Conservative accounting they expense the entire R&D expense

  • No debt is taken for R&D

  • CRAMS business likely to be have consistent growth translating into revenue visibility and liquidity

P Value unlocking in NCE division can be a boon for investors, the management has done all right things till date. One successful commericial drug approval in next few years can change fortune of the company and it’s investors

Disclosure a Started an initial position will add more with thorough understanding of business

Original analysis posted at my weblog - http://wp.me/p4bScp-ai

Inviting view from fellow investors

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Hello Vivek,

Novice here, learning at a decent pace. That is probably the best annual report out of around 2 dozen reports I have read till now. Thanks for the analysis, I also started following your blog recently :slight_smile:

As for their NCEs, only SUVN 502 has cleared phase 1 trials. Still a long way to go for phase 2 and 3 and FDA approval, but stock should burst with each successive clearance.

If I may ask (have to put some time to read the whole report), why did the EBIDTA increase from 21% to 43% in a year? Also, from your CRAMS report, there is a mention of risk from China. The reasoning given that it won’t be very impactful is language and cultural barriers. But I wonder if it is underplayed, since I know most nutraceuticals are coming from China.

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My bad, SUVN 502 in phase 1b, expected to be in phase 2 soon.

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Hi

Malathion lotion is in first year of royalty payment and company expects to have 1-1.5 million $ as a payment from taro ,

Do you have any idea like how this is going to increase in coming years and how is royalty are done (% of sales or some thing else)

Apart from that this taro is seller only in US / Canada/Mexico , what about other country are they seeking for any other company to sell this product.

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On 22nd september, that is after 2 days, company is going for a fundraiser. Business standard has mentioned that for SUVEN-502 molecule of suven, company can look to raise upto Rs. 120 cr.

According to the company SUVEN 502 will be a game changer for it. They mention that the molecule has completed phase 1 of the trials in US. Phase 1 trials mean the drug has been found safe to use in a small group of subjects.

http://www.fda.gov/drugs/resourcesforyou/consumers/ucm143534.htm

As the link suggests, the phase 2 will be make or break for suven. The company is betting big here. If the molecule is found effective significantly, it will be addressing a $5 b of alzheimer market. As far as I know, there is still no highly effective drug for alzheimer. If SUVEN - 502 comes out better than or even as good as available drugs, Suven’s stock will shoot up.

My view is, a conservative company wouldn’t spend another 120cr if it was a losing cause. Their confidence in the SUVEN - 502 may indicate that they have decent chances of success. Of course, there is no assurity of USFDA approval, but I’ll be optimistic as long as company shows confidence.

Disclosure :- My views are certainly biased as I’m invested.

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Hello Sarthak - Thanks for your kind words , Managment in 2014 annual report has indiacted that EBITA increase was due to economies of scale and one time order to the tune of ~ 150 crore from an innovator. If you go by previous years annual reports the management team has indicated that they can increase scale without much capex that probably has increased EBITA margin.

On Competetive pressure from China - I think market is big enough for everyone to grow without dilution of margin

@ Vishal - My assumption of 2-2.5 mn USD annuity is based on managment communication, check out this link - http://www.youtube.com/watch?v=yAa5pEEH7Nw

@ Nikhil - If we go by management communication the success rate is about 21% from drug discovery to commericial release (AR 2014) , the comforting factor is strong pipe line. We have to wait and watch how this story unfolds

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I have myself wanted to initiate a thread on SLS since long.However,you have covered all points very well Vivek.Great work.

SUVN-502 is certainly the Joker In the Pack.What is more exciting,is the strong R&D capabilities,SLS has in the CNS segment.The stock had been at low valuations due to unpredictability of earnings,but the EPS went away too fast & the price HAD to catch up.I find a lot of comfort in the facts that: the company has consistently increased dividends since its listing…inspite of erratic PAT numbers,Mr. Jasti is very candid & a no-nonsense guy,the net investments of 330cr. cumulative…have come purely from internal accruals.

I feel SLS is a unique company…making almost industry leading EBITDA margins.So,the re-rating may continue.The run-up has been sharp though.Let’s see how the stock reacts to Q2 earnings.Its excellent for the long-term investor,payoffs could be huge.

Thanks for the initiation again.

Disc.: Invested since an year!

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Thanks for initiating this thread, Vivek.

Is there a reason why you have made the assumption that NPM will come down to 18% instead of the current 28%? Why would it not remain in that ballpark, or even inch up higher? Do you attribute it to increased size of the company, or the competition?

If one compares a similar company - Divi’s lab, one sees that there is a margin even now of about ~28%, even at a revenue higher than 2000 crores. And Suven’s intellectual property seems higher than DIVI’s so, one can expect a premium valuation as compared to Divi’s, which is today at around 30.

Disc: Invested

Regards,
Arun

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@ Arun - I was trying to balance and avoid error on higher side, the last five year’s average NPM is 12% . Also management has indicated that last year was an exceptional year for them and going forward they expect sustained growth but not spectacular growth, even the Q1 margin has come down to 24%. With other molecules entering IND and Phase 1 & 2 in next few years the R&D expenditure (Which is expensed on P/L) will be high, keeping all this mind I went with 18% NPM assumption.

Agree with you Sagar that SUVN - 502 is joker in pack, the management has shown tenacity in not milking the molecule in early stages, if they succeed with this one the results could be spectacular.

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A few more inputs on Drug Discovery process time lines and success rate of Drug Discovery.

Its an 6 - 8 years long process before market availability for the drug.Drug development - Wikipedia

Note success rates here in various stages: http://www.fdareview.org/approval_process.shtml

Cheers | Puneet

|Puneet

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@Vivek,

One of the very few pharma companies showing Research & development as expense. That is key attribute here. Agreed with @Arun thatSuven’s intellectual property seems higher than DIVI’s.

There are higher chance of triggering known (SUVN 502) + unknown in future but nobody can predict timing. Investors’ patience will be tested here.

DCF or Sum-of-parts valuation methods won’t work here.

Kunal
Disc : Invested small positions and building conviction to increase till 10% of PF

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Can anyone pls explain how come the growth trajectory of the company has just taken off… cash flows till FY13 was weak… even now CFO/EBITDA is 0.5… wht product it makes that the growth in topline flew straight into the PBT… and margins expanded sharply… hope nothing fishy here?

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This is an interesting find.

However, there are a few things that one needs to keep in mind regarding SLS.

1). 2014 was an exceptional year as they got large orders for three NCE’s. The rates for these quantities were R&D rates and hence SLS made a killing. The revenue last year on account of this was Rs175 crs and the PAT from this alone was close to Rs 85 crores. The management has confirmed that this will not be repeated this year.

2). To take SUVN 502 to Phase II trials will cost them $20 million(Rs 120 Crs) over the next two years. They also intend to take two more molecules to Phase I stage later this year. This will cost them another $4 million.(Rs 24 crores)

3). They have capex lined up for the Vizag plant and existing de-bottlenecking at Rs 100 crores in the next 12 -18 months.

4). This entails a spend of Rs 250 crs over the next two years which is a huge outlay. The management is looking to dilute equity to raise this money.

5). The management has guided that there are no takers for SUVN 502 till it crosses phase II trials. So the chances of striking a deal with a larger company in the near future is very remote.

The PAT for FY 15 would be 80-90 crs and for FY 16 it would be around Rs 110 crs.

Therefore at today’s market cap of Rs2200 crs, the FY 16 earnings are being discounted 20 times. This looks a little steep to me.

The management has been very open and have been guiding a de-growth in both the top and bottom line for the next two years.

The question really is ,that do the participants realise this or are they buying this stock in the general run up? Many of these participants will be disappointed when the Q2 results come out. There might be better entry points then. Q1 results were better than expected as there was a small spill over from the order from last year. This will not recur in Q2.

The real surprise in this stock could be if one of their molecules clicks. But that is a big if. The management expensing the R&D costs is very conservative but correct in my opinion. Had they been capitalizing this costs, then the bottom line would have looked much healthier and these numbers are not small. Around 50 - 60 crs per annum. This however tells us that there underlying CRAMS business is hugely profitable.

I think one should wait and watch what happens later this year before entering this stock.

Not invested.

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This is very crisp and clear explanation of the opportunity, Just one confirmation have they confirmed equity dilution for raising 120 Crores ?

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Yes the board has passed the resolution. However, the quantum or the shape this fund raising will take has not been stated.

I think that the funds raised would be in the vicinity of Rs 150 crs and would in all probability be a private placement or a QIP. Then, all of this will depend on the market conditions when they go to the market which should be in the next two quarters.

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Hello Mr Sharma,

I agree with most of the points here put forward by you.

On the point of valuations, I need to have an opinion from all the VP members. Shall we value Suven on the basis of its earnings only or shall we also consider the intellectual assets, this company owns, while valuing it?

During financial year 2013-14 itself Suven secured 76 product patents. Overall they have 676 product patents for their NCEs and 36 product patents. For the next few years, these NCEs are unlikely to help the bottomline. But shall we consider them while valuing the business or not?

A success in phase 2 for SUVEN 502 may bring the backing of big guys. In such a scenario, does the value of these NCEs increase?

A recent news release shows Suven has received two awards for their work last year.

Suven_Life_Sciences_Ltd_230914.pdf (64 KB)

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P Sharma,

You might be jumping the gun a bit there.SLS board has only passed a resolution ‘to raise funds’.There is no clarity on the WAY these funds will be raised.However,most likely,they may result in some dilution.

Regarding the PAT for FY15,the latest guidance is 90-100cr.(Ref.: Q1 Concall) This is typical of SLS.Even in FY14,they said 125cr. would be the upper end of PAT,but they ended up doing 144cr. …a good 15% higher.The other thing to note is,that the PAT from FY16 will be of a smoother quality…a high margin revenue stream,spread over 7-8 years.

The two most important points from stock markets perspective will be:

  1. Progress on SUVN-502 & profile of the investor who helps in meeting SLS’capital requirements.
  2. Sustainability of EBITDA margins.The company made 33-35% in Q1.This is an industry leading number(after Sun P.) & needs to be closely watched.

The management’s honesty is a very big positive & some premium for that too,maybe warranted(“governance premium”)

Disc.: Invested.Views maybe biased.

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Sagar,

I lot of what i have written is based on my interaction with the management. The fund raising will be via private placement or QIP and not debt.

I agree with you on the EBIDTA margins. However, how much of it is because of the underlying business and how much of it was based on the one off order remains be seen. As i said, Q2 numbers will tell the story.

I might be completely wrong here, but the PAT guided by the management for FY 15 and FY 16 is on the higher end in my opinion. This of course is based on the information in the public domain. There might be some one off orders that could boost the bottom line again.

I would like to wait and watch.

Regards

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What is the dilution percentage we are talking about ?

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Hi Vivek,

Am glad that there is a thread solely for Suven !

You mentioned about theone time order to the tune of ~ 150 crore in FY14. Agreed. But have you heard about the same kind of orders in the last quarter of FY15. Mr. Jasti had in his recent interview mentioned about the same.

Further FY16 is going to replicate FY14 is what Mr. Jasti said. What I believe is the management has been very very conservative in terms of their commitments and so fay they have delivered.

The Company initiated the construction of a 110 crore greenfield facility at Vizag dedicated to the CRAMS business in FY14. Revenue Generation for which will start from March 2015.

Finally not to forget major recent achievements:

Suven Life Sciences bags Pharmexcilâs âGold Patent Awardâ for NCEâs and “Outstanding Export Performance Award” for Contract Research and Manufacturing

Suven Life Sciences is selected as one of the “Best Under A Billion” companies by Forbes Asia 2014.

Disc : Entered @ 75 levels