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Neuland Laboratories Limited - Transformation towards niche APIs?

Neuland Laboratories Ltd a 30 year old pharma company is a predominantly API manufacturer (85% ) with some presence in CRAMS (15%) derives 73% of its revenues from US, Europe & Japan.

Neuland claims to have to transformed itself from manufacturing commodity APIs towards having capability to develop complex molecules in niche segments – Opthalmic, Schizophrenia, anti-asthma, anti-fungal. -> This is verifiable easily. We will see in the subsequent sections.

Their top five products contribute to ~4% of the topline while top 5 customers contribute ~40% of the topline.

Active Pharma Ingredient (85%)
In API manufacturing, the competitiveness of a manufacturing company is determined by one of the following ways:

  1. Build massive scale, cost advantage in commoditized APIs – A new competitor won’t be able match you (or)
  2. Identify niche APIs which has complex chemistry so that competitors will find it difficult to imitate. -> How to verify this? Look at the molecule, find out the # of DMF filers for that molecule(may give a hint).

Neuland claims(or HAS IT?) to have graduated from #1 (above) towards building capabilities in developing niche complex APIs in segments like Opthalmics, Anti-asthma & Bronchodilator segments.

Here is the current list of Products from Neuland’s with the # of DMF filers:

To update - I am working on identifying the # of competitors for these molecules. Will update after I complete. All these molecules have more than 1 competitor.

Some observations:

  1. In about 15 molecules, Neuland is either the only player/ has only one another competitor. - This is quite significant because the generic company will have limited options when it looks at identifying a DMF partner. Lesser the available options, bargaining power of the API company increases.

  2. In antibiotics:
    a. Higher the generation the molecule is present in, higher the margin for the company. The company’s presence in 3rd and 4th Gen molecules indicates R&D capability of the company.(check the table below)
    b. In Antibiotics, Ciproflaxacin is a commoditized API. Neuland is moving away from this molecule. A few years back, 65% of their revenues were from this molecule vs 15% of their revenues from Ciproflaxacin now ->Aarti Drugs is the global leader here.

3.For commoditized APIs, Neuland’s claims to play the volume game. – this contradicts in case of Ciproflaxacin – Aarti has taken away significant market share in the last 3 years from Neuland.

4.Visibility of earnings : About 10-11 APIs for which DMFs have been filed, are expected to go off-patent in the next 3 years. Timeline column indicates the expiry date for the patented version of the molecule in US market.

Contract Manufacturing involves manufacturing APIs based on custom specifications of the customer.

  1. Their Contract Manufacturing segment has grown at a CAGR of ~70% in the last three years.
  2. They have non-exclusive agreement to manufacture custom products with leading Europe & US customers.
  3. Recently a large US customer has filed an NDA for the US market which is said to throw up an interesting opportunity – have to verify this claim

Pact with Mitsubishi Chemicals:
Neuland has entered into a pact with API Corporation (subsidiary of Mitsubishi chemicals ) to manufacture custom products for APIC.
APIC has invested 15 crores in their existing Pashamylaram facility to create the manufacturing infrastructure.
Neuland gets reimbursement of the operating expenses incurred at this facility – Don’t understand the revenue model here. Need to research more.

Neuland has developed some expertise on Peptide based products which are considered very complex in chemistry field.

The company definitely looks decent because of the following reasons:
a. it looks like it is trading at 12 PE based on FY17 earnings
b. # of molecules where they have limited competition.
c. Added Revenue visibility from APIC contract with Mitsubishi

But the following questions are key before one considers investment here. The management seems very transparent as they have disclosed most of what is required in every concall.

  • Imitability: The above pipeline of molecules going off-patent in the next few years looks interesting. But how difficult is it for a new API manufacturer to develop these molecules?
  • Debt: API manufacturing companies go down when they take the path of debt – Wanbury (global leader in Metformin), Parabolic(Cephalosporin), Indswift labs all failed because of financial distress and not because of lack of demand for their products.
    As of now their D/E ratio at ~1 looks decent for an API manufacturing company especially considering the future growth possibilities. What is their approach towards debt?
  • What is their revenue model with API Corporation?

I wanted to look at some pharma names outside our comfort zone - i.e. Torrent, Shilpa, Ajanta etc. That’s when I zeroed in on Neuland after researching other API manufacturers like Aarti, SMS, etc.

I am still researching on this idea. Will update this thread as and when I find out more.

Ravi S
Disclosure: I have no positions in Neuland as of today. I may initiate a position in the next few days in this company based on further analysis.



I know during ANDA filing the formulation maker has to identify the API source.
For the drugs that are coming off patent, Is there anyway to find out how many formulation makers are using Neuland as API source ?? I see that only as any hope to see topline growth.

One question is that why do formulation makers buy API from other when they can produce it themselves ?

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For formulation makers, APIs represent lower margin business many a times. (Occasionally there might be higher margin niche APIs).

Plus for a company focussing on formulations the effort to put up and run an api plant may not be worth the effort.

And putting up an API plant where the quantity of the stuff required for captive consumption is quite low may not make economic sense.

e.g for abilify, torrent used to source its API from someone else . (I think hetero).

whereas alembic is nearly vertically integrated for abilify.

So at the end of the day it depends on how strategically important it is for the company to manufacture its required APIs.

Coming to Neuland I had a look at the company and it does hold promise but how it delivers needs to be seen. Management has indicated some possibilities which can turn out to be interesting. But personally I would still prefer to keep it in my watchlist only.



Anyway to findout, from which API maker is the formulation maker sourcing ?

I have heard that during ANDA filing the formulation maker has to provide the API source.

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After reading some concall transcripts I noticed two critical things

1> EBITDA margin to improve to ~20% over the longer term
2> They have given a kind of guidance to grow at 25% CAGR for the next 3-4 yrs.

Taking these two into account I get close to 50% CAGR for PAT in my rough model. My understanding of their key strengths.

1> Regulatory compliance: they have huge expertise in handling regulatory issues so no US FDA shocker expected. They have more than 15 yrs expertise in dealing with US FDA without any adverse observations.
2> I believe their R&D capability is top notch. The promoter himself has spent considerable time as R&D head in an MNC pharma firm.
3> API pipeline is very strong and innovative. As mentioned above contract mfg. is also expected to grow strongly given their expertise in complex processes
4> Have not come across any other API manufacturer which is developing expertise in Peptides. These are complex molecules. Business potential looks good but don’t know much about this segment neither I have found any management comments.

Some cons:

Management is not yet shown any interest in developing formulations so margin kicker has to come from innovative APIs
Quarterly earnings have been lumpy and will remain so given their B2B focus
Their existing capacity utilisation suggests they need to invest in a new capacity by FY18 for which funds have not been finalised.

All in all a niche pharma company to watch out.

Disc: Have taken initial exposure and will watch closely


Some corporate governance issues!

In the FY15 annual report , there is a qualified opinion by auditors-

Auditors’ Observation: The Auditors have mentioned in
their respective Reports on Standalone Financial Statements
and Consolidated Financial Statements for the year ended
March 31, 2015 as under:
The Company recognized revenues from sale of goods
amounting to 290.53 lakhs based on management’s assessment of transfer of significant risks and rewards of ownership to the customers. However, in our opinion, such recognition does not meet the conditions enunciated under the Accounting Standard (AS) 9 on “Revenue Recognition” notified under the Companies (Accounting Standards) Rules, 2006. Had the Company followed the principles of AS 9, revenue from operations, profit before tax and tax expense for the year ended March 31, 2015 would have been lower by290.53 lakhs,
130.54 lakhs and44.37 lakhs respectively. Further, the trade
receivables, current liabilities and reserves and surplus as at
March 31, 2015 would have been lower by 290.53 lakhs,144.39 lakhs and 86.17 lakhs and the inventories as at that date would have been higher by59.97 lakhs.

Also - Possible conflict of interest / diversion of funds to related unlisted party - NPRPL ??

Analysis from senior members would be helpful…


Well, you should also copy management’s response on this remark by the auditor. I am not an expert on accounting so can’t make a firm comment on the same. Could you point out any instances to substantiate your claim about diversion of funds. What I found that NPRPL has provided 12cr unsecured loan to the listing entity at 0.0001%/yr for 5 yrs from 2012 onwards (FY15 AR, page 110) apart from helping secure loans from financial institutions. This makes me wonder why would promoters behave dishonestly.

Hope these family connections do not bring bad name for Neuland as they did with Aurobindo. I do not regret but my biggest miss was Auro. I never considered again after its name cropped up in Jagan’s scams.

Disc: Invested along with Strides and Granules in the pharma basket

In the FY14 Presentation the company had shown there will be 17 Products which will provide more than Rs.20Cr revenue but in the FY15 presentation they are showing only 8 products with more than Rs 20Cr revenue? Any reason for the same

Disc: Not invested but tracking

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Neuland labs comes up with good results.

Quarter Highlights:

  • Scaled up one additional API with strong revenue potential in the medium term

  • Robust business traction in Salmeterol and higher than anticipated sales for Levetiracetam

  • Received large value CMS supply order from an existing customer anticipating NDA filing next fiscal

Disc: Not invested but closely tracking

Good nos. along with the positive tone of press release. The most important update is acquisition of CMS assets from the JV partner.

“Neuland is in the process of entering into a modified agreement with APIC Corporation, Japan, to transfer the assets created for APIC to Neuland”. The mgmt. was mulling a low cost capacity expansion and had indicated reluctance in going for greenfield capacity. This will save capex/debt and takes care of capacity issues for at least 2 yrs.

The problem is that it is trading at 25x FY16 leaving little room for the near term. I expect them to deliver 26-27cr in FY16.

Dicsc: Invested and I don’t give any recco.

Any idea why suddenly stock is going up 10-12% yesterday and again 10% today?
Results are due on 20th May, so still couple of days to go, I searched on BSE site for any announcements, but could not find any.

Very average set of Q4 numbers from Neuland. Wondering what made the stock run so much ahead of results. Few positives from the concall.

  • Some deliveries spilled into Q1 so expect better results in Q1 but they also had indicated the same for Q4 result.
  • The most important thing is they have acquired plant from APIC in Feb. but refused to disclose details. Makes them sufficient in terms of capacity for the next 2 yrs. Future capacity growth to come from de-bottlenecking, brown field and even acquisitions as well. It could be a combination of all three. They will use internal accruals and debt to get this additional capacity.
  • With this they have two units of API plants and one testing unit USFDA approved. IMO, they are only one of those small companies to have all assets USFDA approved and 100% sales coming from regulated markets.
  • Q4 tax rate has one time VAT provisioning and would return to 30-34% tax rate going forward.
  • Debt will remain at current levels so leverage ratio will start looking better with growth.
  • maintain sales guidance of 20-25% CAGR and EBITDA margin of 20% over the medium to long term. (IMO, This could lead to very strong earnings growth in future). The only issue is this transition will be very unpredictable and may be non-linear at some point of time.
  • have improved reporting structure/disclosures and sales growth to come from Niche molecules and CMS. Both these businesses have similar margin profile. Global CMS market size is 35-40bn USD and the company can target the whole market theoretically.
  • CMS business is a long gestation one and takes upto 2 yrs for an original innovator to get the Neuland’s site approved as 2nd source so stickiness is very high. They plan to expand in US gradually.
  • ROCE has improved to 18%+, working capital is as per the industry standards and would remain so.

One can add if I have missed anything.

Disc: Invested and had added during recent correction

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Very good q1 results
Disc : Holding 2 percent of portfolio and accumulating on fall

The key takeaway is that sales has now started growing as per mgmt guidance of 20%+. EBITDA Margin contracted a bit but largely sales growth+ margin expansion (premium + operating leverage) story remains intact.

Disc: Invested

Working capital to sales ratio has increased significantly in last 4 years. Anyone aware of possible reasons for such increase and what is the outlook going forward?

This is because the nature of products they supply and ramp up of quite a few new molecules. Some complex molecules in their portfolio have mfg cycle of 3-4 months that leads to high WC, qoq volatility. Mgmt. guided that going forward WC will be 25-27% of annual sales.

Another good result by Neuland Lab. Sales up by 16%and PAT up by 65% yoy. Margin expansion continues as guided.

All private entities getting merged with listed entity resulting in 25% dilution. In return company will have Peptide division and a very profitable R&D enterprise of the promoters. Not an expert on M&A but looks fair to me.

Disc: Invested