Hikal - Pharma & Agrochem

Posting below only key Investment Arguments in Favour & Against Hikal but members are advised to refer entire research note via scribd link attached to assess the company in a proper way.

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Key Investment Arguments In Favour of Hikal Ltd. :

  • Baba Kalyani (Bharat Forge fame) group company who, alongwith Hiremath family owns 73.52 % equity in the company.

  • Highly competent and distinguished management team as well as Board of Advisors - most of whom are PhDs and distinguished personalities in their respective field - including ex-CEO of Aventis, Mr. Kannan Unni, ex-Head of Bayer, Dr. Wolfgang Walter, Padma Shri Prof. Goverdhan Mehta, etc.

  • Exclusive supplier-relationship with Syngenta (for Thiabendazole), Bayer (for Fenamidone) and BASF (for Initium)

  • World’s Largest Producer of Gabapentin molecule enjoying 45 % of world marketshare

  • Strong IPR-building focus which is evident from 6 Process Patents already under company’s portfolio in addition to 4 Process Patents filed for approval

  • Batch Quantities of AI Initium and API Venlafaxine supplied in FY12 received approval )- commercial production of which to commence from Q4FY13

  • Panoli Plant received USFDA approval in September’2012 which is expected to provide significant boost to non-Gabapentin business starting FY14

  • Exceptional focus on high margin products which is evident from last 10 years’ average EBITDA margins at 27.64% )- one of the best in the industry.

  • Company has made heavy upfront investment in building assets and forging strong relationships with global innovators over last decade - fruits of which likely to accrue from FY14 onwards as heavy CAPEX phase got concluded in FY11 and commercial production of major molecules to commence from Q4FY13

  • Consolidated Tangible Net **Fixed Asset base at **INR

714.87__** cr.** (including CWP of 75 cr.) )- higher than current market-cap of INR 697 cr. - a Rare thing for such a high caliber company

  • Asset Utilisation to significantly improve starting Q4FY13 as delivery of signed contracts begin

  • PAT to get significant boost going forward as all forward covers and derivative contracts meant for hedging (80% of revenue comes from exports) expire in October’2012 post which PAT margin will improve considerably

  • Valuations compelling at 0.99 x FY12 Net Fixed Asset base; 1 x FY12 Sales; 8.7 x FY12 EPS (without forex loss) and 15.1 x FY12 EPS (with forex loss); 1.52 x FY12 Book Value

  • If we extrapolate further, company trading at MCAP/FY14e EBITDA ratio of just 2.5 and MCAP/FY14e Sales of 0.68 with FY14e Price/B.V. of just 1.16 which signifies gross undervaluation for a company like Hikal which is on the verge of entering growth phase starting FY14.

Key Investment Arguments Against Hikal Ltd. :

  • **Product & Client Concentration. **Company’s 76% revenue comes from just 3 molecules, viz., API Gabapentin and AIs Thiabendazole and Fenamidone wherein AIs are supplied to largely single client.

However, this product and client concentration risk gets largely nullified by Hikal’s dominant world leadership status in Gabapentin business (45 % world marketshare) and proprietary nature of molecules (AIs) to respective clients (Syngenta and Bayer) wherein Hikal is the exclusive supplier.

  • High Debt. As at FY12, debt on books of Hikal is to the tune of ~INR 550 crores. It is worthwhile to note here the reasons of such high debt on books :

(a) API, AI and CRAMS business model requires significant upfront investment for building assets and winning trust of global innovators so as to win preferred or exclusive supplier- relationship with them. Time-frame involved for upfront investments is normally 8-10 years post which there is significant improvement in asset utilisation. [ For Detailed Explanation of Business Model Refer Page 7-8 of this Research Note ]

(b) Hikal has spent last decade doing upfront investment for future growth which is evident from large Net Fixed Tangible Asset base at INR 714.87 cr. (including CWP of 75 cr.) – 500 crores of which were spent in last 5 years. Since asset utilisation is low in initial phase and company went for debt-funded capex, its debt has increased proportionately.

© Company acquired Marsing & Co. in 2004 that didn’t materialise as expected which resulted in one time write-off of the acquisition in FY10.

(d) Since 80% of company’s sales are from exports, it took forward covers and derivative contracts for hedging 30% of its future exports because of which there were significant forex losses booked in P&L as INR depreciated sharply. These contracts expire in October’2012 post which management expects significant improvement in PAT.

Owing to reasons stated above, debt as at FY12 stands at ~550 crores. However, since CAPEX phase is already concluded in FY11 and no substantial CAPEX is planned till FY15, there is unlikely to be much addition in debt going forward. Also, since forward covers and derivative contracts expire in October’2012, pressure on profitability will significantly ease up starting Q4FY13.

With current EBITDA at 180 cr.+ and FY14e EBITDA at 250 cr.+ in addition to low equity base of just 16.4 crores (1.64 crore shares) with 73.52% promoter holding, servicing debt should not be a problem for Hikal.

  • Low Liquidity in Company’s stock because of 73.52 % promoters’ shareholding and another 13.02 % held by International Finance Corporation and Reliance Capital (acquired in 2008 & 2006 respectively at INR 464 and INR 360). Hence, effective free public float is just 13.46 %.

Posted above only key Investment Arguments in Favour & Against Hikal but members are advised to refer entire research note via scribd link attached to assess the company in a proper way.

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http://www.scribd.com/doc/109449715/

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