Caplin Point Laboratories

Posting the investor ppt here as it hasn’t been discussed since the results.

Slide 6 has details of upcoming capex: maintenance (200cr), Oncology (130cr) and backward integration (100cr). They are planning to manufacture 70% of their APIs inhouse, in an attempt to backward integrate and reduce margin compression in generic generic businesses. Have also mentioned that they are evaluating an inorganic opportunity here which may close by March 2022, so we may hear an announcement soon if this route is taken. On slide 14 they mention that they have already completed R&D for 22 APIs to be used for backward integration in US and Emerging markets.

Also noticed their their R&D spends have gone down to 45cr 9M FY 22 after peaking in FY20 at 85cr. This is interesting, given that they are looking to get into newer areas like oncology, and also file for more ANDAs in regulated markets. So this reduction in R&D spends is very counter-intuitive.

Disclosure: Invested from lower levels and evaluating whether to add more in the present correction.

Full portfolio Vineet Jain portfolio

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Had a quick check with their IR company - he’s still very much invested. Pared it down slightly to less than 1% and their group owns close to 2.1% in total.

Caplin came out with the decent set of numbers for Q4. Below is a summary. Company holding up the gross margins is a big positive and sign of a resilience in the business.

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I could not find any problem yet in their numbers. Seems things are improving. They are progressing well in their operations, but capex has increased a little bit.

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Caplin has been moving on its stated path in a measured way. The things are broadly on track (expansion, delivery of numbers, working capital, cash flows, US entry and R&D etc).
I attended the concall. Some key points were (from memory)

  • Reiterated the earlier growth view - 20% growth in LATAM regions and expanding presence in Mexico/Chile - 2 major tender markets + Private markets
  • US injectable business can be breakeven in FY23, after expensing all the R&D in this year. Order book of 160 Cr+ for the US business. Looking for potential partnership with distribution company in the US. Target of $100mn business by FY26.
  • Looking to buy an API facility in next 2-3 months - Per earlier discussions, this would be pilot facility for making niche API for internal consumption (which are hard to get by from outside)
  • Capex plans broadly on track - Bag line to be commissioned this quarter and final capex to come by mid 2023. So over the next 12-18 months, lot of capex will come onstream for them. They have one of the most comprehensive Injectable portfolio (Vials, Lyophilized Bags, PFS) along with Opthalmics and Oncology. This combination is not available with many companies , especially of Caplin’s size.
  • R&D expenses at 60-65 Cr as last year
  • Planning to enter Russia, given the spate of US/EU companies who are leaving Russia, leaving a vacuum. It could become interesting if Russia relaxes the regulations to counter any shortages
  • USFDA inspection may happen in this quarter/next for Caplin Steriles
  • Ashish Kacholia was on the call asking questions
  • They have not faced any difficulties in getting the formulations from China till now. There might be some impact in this quarter but Chinese may pull it off once the Lockdowns are eased

I had a chat with one of my industry friends who has good confidence in Caplin capabilities for US market - injectable product development etc. So the injectable business is legit and they are doing good work.

Overall, I feel that management is rooted to the ground, smart, opportunistic and able to execute the big projects ( We will see more about execution over the next 2 years).
However if everything works well for them and they pull the capex, R&D etc, then this sure would be an exciting company with potential to double or more by FY25.

Risk:

  • Execution risk for all big projects, getting the customers etc
  • FDA risk (though seems low right now but cannot say for sure)
  • Financial numbers - I am no expert in understanding the legitimacy of the financial numbers. Earlier several queries were raised on Caplin’s business model as well as their numbers coming in. Based on my limited understanding and reading, I believe that numbers are legit, management is honest and working to improve the organization. They have taken steps to address the concerns on receivables etc. However smarter investors may have a different view.

Regards,

Nikhil

Disc: Invested and adding.

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Hi

In the latest quarter filling they had mentioned that they had exited the JV in China. I have written to the company but no response regarding wether this would impact their China sales? Or why this decision was taken?

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Caplin is not selling products in china. They do purchase good quantity of products from china and directly export them to LATAM, africa. This JV created only for the purpose of procuring materials, not manufacturing. This is kind of trading company. Investments are done in 2018 with only 1.82 crore for 39% shareholding. And this investment never materialised and they did not draw any meaningful business from this JV. So this JV is liquidated. and in Q4 results noted that
The Company's Associate entity in China namely Hainan Jointown Caplinpoint Pharmaceutical Company Limited has been liquidated and the amount invested by the Company In this joint venture has been received in full in April 2022

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Sorry yes what I meant is the exports from China. If the exports were done through the JV then will this be affected?

Exports are not through this JV. These are handled through hongkong subsidiary. This JV does not make any meaningful business. Just go through the profit details of this JV in annual report for FY19,20,21. contribution from this JV is next to zero.

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Q1 FY23 RESULTS AND CONCALL NOTES:

  • US Operating revenue grows 61% YoY to Rs. 41 Cr.

  • Geographical breakup of sales: LATAM & Africa – 88 %, US - 12%

  • Caplin Steriles completed the development of 2 complex emulsion injectable products with a target to file them during the current financial year. On track to complete 3 more complex products in the next 3-4 months.

  • Company finalizes plans to start a Warehouse in Chile, with specific focus on Private Market and specialized generics in Tenders . The Company already has 75 products approved in Chile.

  • Company sets up a new marketing team for Vietnam and Cambodia with first order for Cambodia already received.

  • CRO: Company’s CRO wing AMARIS CLINICAL receives approval from ISP Chile, in addition to US FDA EIR. Around 9 products shortlisted for conducting BE studies for Chile, for Caplin. First product approval received (for partner ANDA) through studies completed from AMARIS CLINICAL.

  • API Facility – Company plans for greenfield API facility at Thervoy SIPCOT site acquired in 2020. Project to have 2 dedicated blocks, for Oncology and General Category APIs.

  • First two complex emulsion injectables developed from CSL will be filed within FY23, with Biostudies completed at AMARIS CLINICAL for one of the products.

  • Company has earmarked Mexico and Chile as the next immediate avenues for growth in LatAm . Company has 1 product approved in Mexico, with 6 more approvals expected in the next few quarters. Company currently has 66 product registrations in Chile.

  • Targeting Tier II-III customers in US (Just like the Latin America business model)

  • Launching Own Label products by Year-end in the US (3 products)

  • Caplin Steriles to turn Net breakeven this year.

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The company is executing and planning quite well for it to achieve long term compounding

EXPANSION / NEW MARKETS in established Business
US BUSINESS growth (With larger capacities and product registrations )
BACKWARD AND FORWARD INTEGRATION (API’s KSM manufacturing, Front end presence in the US)
CRO/CMO

All this while generating great cash flows, funding everything with internal accruals, maintaining high and sustainable margins, high returns on capital.

DISCLOSURE: INVESTED

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Caplin’s aim is “The top line of FY 2021-22 will be the bottom line of
FY 2027-28”. Top line for Fy22 was Rs. 1,300Cr.

Assuming the company achieves the above, and assuming a P/E of 20, the market cap could cross Rs 25,000Cr. Thats over 4x from current levels.

Most companies in Pharma sector which have healthy return ratios, are debt free, healthy free cash flow generation trade at higher valuation. Caplin has a potential to give 4-5 times returns in the next 6-7 years. Thats an interesting opportunity.

What am I missing?

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Upto recent past, the company has grown in the less penetrated LatAm countries. Now they are spending money into USA, where all companies are facing price erosion

what’s the big deal in giving 4 to 5 times in 5 yrs when the company has given more than 100X in 10 yrs ( actually 5 yrs. But didn’t do anything in next 5 yrs). It took the route of risky markets of Latam where very few had dared to enter. It was highly successful in entering and entrenching themselves. 10% to 15 % growth in existing market should be easy. They are also entering new Latam mats like chile , mexico, brazil…and I think they just need to replicate their success in these new countries of a similar market.

USA seems to be a risky one. They claim to be addressing the bottom of the pyramid and so are not competing with other players in USA. Only time will tell.

They have been good executioners and that is what makes me confident that they will continue to create wealth though at a much slower pace. But that slow pace should be much higher than the market pace.

Disclosure: Invested since a long time.

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Chile, Peru, Colombia, Brazil, Paraguay, Mexico are the other countries where Caplin will be expanding. Mexico and Chile to be focus in 2022.

Brazil and Mexico are “crowded” by other Indian pharma cos.

Sharing an interesting article I came across.

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Caplin Point FY22 Annual report highlights

FY 16 topline has become FY22 Bottom line. FY16 Topline 243 FY 22 Bottom-line - 308Cr

Operations target:
To backward integrate to KSM for 70% of US Products by FY24 to reduce costs.
Caplin Steriles has completed Pre mixed bags line, Filing will start in the US by Q4 FY23.

Capex
Invested over 355Cr in the last 5Years.
Will invest 500-560Cr Moving forward
300Cr in Expansion and maintenance
130Cr Oncology
100r API

Total R&D Spend(Capex+Opex) Stood at 20% of FY22 PAT.
Branded Generic Revenue share increased from 5% to 25% over FY12 and FY22.
African revenue doubled over 4years and focused mainly on branded generic products in Africa.

Asset light model where 55% of production is outsourced.

LATAM business:
In line to open its own distribution in Chile.
Filed 13 registrations in Mexico and 2 approved
44 Filed in Peru and approved 29
75 Registration in Chile and further 20 More in pipeline.

Have opened 33 retail chains and plan to take in to 50 by 2022 and in 2023 plan to launch a franchise model.
Online B2B Platform has grown 30%(trying to get exact numbers).

Caplin Steriles
75% is Own Products and 25% is CMO(contract manufacturing) for large players
API for caplin steriles will be organic and will come up in 18 Months.( previously they were planning to acquire API Plant in Vizag)
Expanding Caplin steriles 3 new lines, out of this 2 will be under a new unit and said new unit will have
provision to accommodate 4 more lines depending upon the demand in future.

Receivable Days and Inventory days
As company has entered tender business mostly government contracts thus having a longer receivable days and company has ventured into aggressive growth the where credit has to be given in terms of sales (previously an advance will be collected from customers and product will be supplied now this has changed) both of these factors were the reason the negative working capital has been changed.

Inventory days
The company has acquired and in process of acquiring its channel partners thus resulting in increasing the inventory days. Previously consignments in transit were considered as goods sold to channel partners thus reducing the inventory, since the company has acquired the channel partners only when the actual sales happen the inventory will be reduced.

However the company has maintained its inventory days significantly well below its peers and maintaining the receivable days/debtor days with its peers

Guidelines
20% Growth
30%+ Margins.
FY 22 topline will be FY 28 bottom Line - FY22 Topline 1300 CR
Will be under TOP 30 Indian Pharma Companies.

The Guideline is quite ambitious, the countries in which the companies operate currently have a combined population size of Tamil Nadu and they are entering Brazil and Mexico which have very large markets and expanding to other countries like Chile and Peru. Thus giving a revenue opportunity and entering regulated markets US & Canada etc.
Strategic partners: Eight road and F-Prime(A fund whose primary focus is Healthcare and technology) into Steriles gives more conviction.

2026 Guidance- LATAM Business revenue will double(LATAM & Africa revenue 1170 IN FY22) and Steriles will be 100 Million dollar (800CR REVENUE) Currently 130Cr. - Interview by COO Will double our topline in next 5 years: Caplin Point - YouTube

Disclosure: Invested

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The journey of this company (CAPLIN Point, henceforth referred to as CAPLIN) has been very different from most of its Indian peers. The company’s major business (90% of sales) is selling formulations in frontier markets of Latin America which are collectively referred to as Central America. The region includes small countries such as Guatemala, Nicaragua, Ecuador, El Salvador, Honduras, and the Dominican Republic. Collectively, this region has a population about the population of the state of Tamil Nadu (~65mn people). The first-generation promoter and founder, CC Paarthipan, started his journey in these markets after realizing that they were underserved with hardly any presence of large, organized pharma companies. These markets were serviced by large importers and distributors who imported from other countries and sold locally at higher prices, constraining access. This also led to a high element of counterfeit and poor-quality drugs being sold.
CAPLIN slowly built this business by supplying quality and essential medicines (90% of what they supplied in the early years were on the WHO list) and at the lowest possible prices (build volumes at low margins initially). The business model was to first aggregate and asses the demand for the key therapies and products in these markets. Basis this, CAPLIN worked with suppliers in China and India to get these products manufactured for them at scale. These were then sold down to exclusive appointed distributors in these markets who in turn supplied to the last mile pharmacy network and hospitals. Most of these drugs/formulations were long off-patent generics and thus could be easily procured from suppliers in China and India. Besides, these frontier markets had low regulatory requirements for drug approvals.
CAPLIN today is a dominant supplier in these markets in terms of market share with superior scale economics and market access. Over time, they have also built direct coverage of pharmacies (akin to FMCG companies building direct retail reach) which fetches better margins and real-time feed on market demand dynamics. CAPLIN’s distributors pay upfront cash for its supplies while CAPLIN can take some time before it pays off its suppliers. This makes this business light on working capital. Given CAPLIN outsources a substantial part of manufacturing and procures formulations directly, the business is asset light as well. This results in high 60%+ ROCEs with very high free cash flow generation. This operation thus resembles a sales, marketing, and distribution set up than a traditional pharma-based manufacturing one. Over time, the share of branded generics has increased to one-fourth of the overall pie fetching higher margins for CAPLIN.
Over the last few years, CAPLIN has started participating in large government tender-based projects from larger Latin American countries such as Mexico, Chile, and Peru. This leg of the business comes with somewhat lower margins and a reasonably large receivables cycle but is a large opportunity as there are few large competitors in these markets. The tender business today is about 15% of sales for CAPLIN and has thus far not seen any bad debts with hardly any visible impact on the overall margin profile of CAPLIN. Receivable days spiked up to 90 in FY19 but have remained steady with no further deterioration. In my estimate, tender business ROCEs are 20-25% which while lower than those generated by the base B2C business (working capital free), is still a good way to deploy surplus cash. The tender business potentially paves way for building a B2C formulations franchise in some of the new larger markets of South America. These include countries such as Chile, Peru, Mexico, etc. where CAPLIN is still to make a meaningful dent.

Prima facie, one would imagine that CAPLIN’s target market would be small and with lower margins given most of these countries are lower income with volatile economic environments. CAPLIN’s numbers tell an entirely different story. Starting with sales of Rs125cr in FY13, it has compounded sales at 29% since then and quite consistently. Even as the base has become larger, growth has sustained at good levels – last five-year sales CAGR of 25%. This is easily the top tier of the pharma universe not just in India but perhaps globally. Granted, their sales base is still much smaller (US$170mn) versus the larger peers (Cipla: US$2.75bn). But note that they have substantially outperformed most of their mid-cap and small-cap peers too.

Prima facie, one would imagine that CAPLIN’s target market would be small and with lower margins given most of these countries are lower income with volatile economic environments. CAPLIN’s numbers tell an entirely different story. Starting with sales of Rs125cr in FY13, it has compounded sales at 29% since then and quite consistently. Even as the base has become larger, growth has sustained at good levels – last five-year sales CAGR of 25%. This is easily the top tier of the pharma universe not just in India but perhaps globally. Granted, their sales base is still much smaller (US$170mn) versus the larger peers (Cipla: US$2.75bn). But note that they have substantially outperformed most of their mid-cap and small-cap peers too.

The base Latin American business we discussed above throws out a lot of cash. For context, for every incremental US$100 in sales, the business generates US$20 worth of free net cash even post taking care of all investments for growth. This calculation also includes the small tender-based business with its higher working capital requirement. Given this high cash generation, CAPLIN mgmt. could either return cash to shareholders or look for new investment avenues to grow the company.
They decided on the latter and have chosen to invest heavily in high-margin areas with limited competition such as sterile injectables, oncology, and ophthalmology. Admittedly, this was a strange pivot as this meant getting into an entirely different business with limited overlap with their Latin America business (except arguably the management grit). These products are primarily intended for regulated markets (the US being the key market) and need US FDA-approved manufacturing facilities in place. Moreover, the regulated markets need approved ANDAs and those need a large R&D operation able to build a pipeline in place. Sterile injectables as a space have lower competition and shortages in end markets partly because it is a hard one to crack with complicated manufacturing and a stringent approval process. Yet CAPLIN has taken this bet and one needs to wait to see in what measure this pays off. Notably, CAPLIN has refused to participate in the commoditized oral dosage formulations which is going through extreme competition and pricing pressure last few years.
Over the last five years, CAPLIN has invested a cumulative of Rs350cr as capex in this business and another Rs350cr as R&D spends (capex plus opex). They now have 5 R&D facilities and a team of 340 people versus virtually no R&D presence ten years ago. The next three years are likely to see another Rs450cr in capex. The capex is further picking up with a rising number of ANDA approvals by the US FDA and a rich 55-plus ANDA pipeline. This past and future capex have been spent on areas such as 1) sterile injectables manufacturing capacity expansion 2) ophthalmology and oncology OSD and injectables 3) API manufacturing capability for 70% of the final formulations (crucial to winning business in the US in the current era). 4) substantial investment in R&D infrastructure.

Their execution so far has been impressive. This became evident as I read through the last several years of annual reports. They invested in their first sterile manufacturing line in 2014 and gradually got approvals from regulated markets such as Europe and Brazil. In 2016, they also go the coveted US FDA approval which is very hard to get in the sterile injectables category.
In 2019, Fidelity invested Rs218cr in this sterile injectables business for a 25% stake at a valuation of ~Rs900cr. Note that this was even before revenues had started to trickle in for the US business. This shows Fidelity’s confidence in the space of sterile injectables and the management capabilities of CAPLIN.

Their US FDA regulatory inspection track record has been clean with minor observations if at all. To be able to pull this off in a complex space like sterile injectables is creditable. Parallelly, the company has been able to build a product pipeline with currently 18 product approvals in place. Out of these, 15 products are already commercialized reflected in the current quarterly revenue run-rate of Rs45cr and an order book of Rs175cr (as of June 22). The company has a pipeline of 55 ANDAs under work with a potential market opportunity of US$4.9bn versus the current US$670 market opportunity basis their current approvals.

The key point here is that skeptical as people may have been on this drastic new business entry by CAPLIN, early results seem impressive to say the least. Most importantly, this has been done while keeping the overall balance sheet healthy and not jeopardizing the overall profitability of the company.

Forecasting business prospects for this company comes down to taking a medium to long-term view of the two disparate businesses - Latin America and the newly incubated regulated markets business.
First, the Latin American business seems to be holding up well and grew by 20% CAGR basis even through COVID (FY20-22) with resilient margins. The opportunity set remains large as thus far, CAPLIN was present in the central American smaller countries but is now making headway into the larger markets such as Brazil, Mexico, Chile, and Peru. Some of these larger markets have a similar market structure to the smaller markets so Caplin can leverage on its prior experience. However, these are also semi-regulated and need approvals or bio-equivalence studies before launches. To address this, Caplin is using its recently scaled-up R&D infrastructure and knowledge base. The company has started a CRO with an investment of Rs30cr to conduct clinical trials for these markets. The CRO can be used for its use as well as do outsourced work in the future. It will be reasonable to expect CAPLIN to grow its Latin American business at a 17-18% CAGR for the foreseeable future. This is not a maturing cash cow but one which itself has a decent growth runway.
The second, and the most crucial piece is the regulated markets business which did Rs125cr (45% growth) or 10% of overall company sales in FY22. This should like to grow another 45% in FY23 (1QFY23 sales grew 60% YoY) and CAPLIN management reckons this should be a US$100mn business by FY26 (in my base case I have assumed US$55mn). This can go wrong, and plans do not always work out, but this is a management with a solid execution track record. For example, in FY16, they said that by FY22, their FY16 top line with become the bottom line of FY22 and that did happen. This is despite general fortunes in the pharma sector taking a nosedive. Their current guidance is that they will generate a cash surplus of Rs1000-1500cr by FY27. The US business achieved breakeven in FY22 excluding R&D spends (completely expensed and nothing is capitalized) and should turn green at the EBITDA level in FY23. The one variable to watch out for is pricing pressures in oral formulations spilling into other areas like sterile injectables.

The stock is trading at 16x TTM earnings which are in line with their 5/10-year averages. However, the stock was at nearly 50x between 2015 and 2017. While earnings have grown 6-7x since FY15, the PE multiple of derated 65% led to a 3x higher stock price change since then. However, the 3x move us upfronted with stock being broadly flat last five years although it is up 2x versus pre-COVID levels.

The likely reason for the de-rating is the entire pharma sector going out of favor due to the worsening US generics business. Pharma sector valuations have corrected 35% since 2015. Even though Caplin did not suffer from a poor US generics business, it seems a case of a small-cap stock suffering due to it being a part of the same pharma basket.

Basis FY24, the stock trades at 13x and this seems very reasonable to me with a high margin of safety given their growth prospects and consistent execution. I expect Caplin should grow sales and earnings at a 20% CAGR over FY22-25. Assuming an undemanding 15x exit multiple on FY26 estimated earnings, potential IRRs can be ~25%. My hunch is that exit multiples will likely be much higher if 1) the pharma cycle and valuations will turn/ mean revert at some point and 2) the market will take cognizance of the consistent progress by the company. If we assume a 20x exit multiple, IRRs can be more rewarding at 30-35%.

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I’m not able to understand at all even with such good ROE and growth rates, no institution talks about Caplin at all. Why is that?

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Could this be because of the dominant geo they are operating on?

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