Putting up some notes I made regarding Neuland. These are based on reading latest AR, last 3 concalls and also Q1FY21 investor presentation.
General Summary
Business
Neuland Laboratories is a company undergoing transformation from being a bulk API manufacturer to switching towards more value-added products: specialty (low volume high complexity) generics API manufacturing as well as CRAMS [custom synthesis for innovator molecules] (they are involved in all the 5 stages of a molecule’s life-cycle: Stage 1,2,3 of clinical trials, Development Phase and Commercial Phase). They intend to improve margin on the bulk-API (they call it Prime API) side by cutting costs by improving operations. They also intend to manufacture complex chemistries such as peptides. Some of these will enhance their specialty API business.
The highest growth business for the company is the CRAMS business. It grew by 100% last year. CRAMS contributes 20-25% of business for Neuland right now. Eventually Neuland wants it to contribute 33% of revenues. They want to grow the company at 15-20% per annum maintaining EBITDA margins of 20%. Neuland margins dipped a bit in 2018-19 due to less fungible capacity at their unit 1 and unit 2 (there were too many orders for unit 1 and not enough for unit 2 and this led to a sub-optimal utilization of the factories, including the CRAMS side of the business which suffered. However management seems to have learned their lesson and as far as I can tell, they do claim that plant capacities are more fungible now. In 2021, Unit 3 capacities are coming online. This is a 50% Capacity addition over and above unit 1 and 2. As per management guidance of 15-20% growth, this is definitely going to be enough for 2 years and they only need to do maintenance capex now. Company has had an immaculate USFDA track record over 20 years because they think about compliance actively and work towards ensuring plant compliance.
Management
Management is quite conservative. Several times, the analysts have tried to get the management to commit to high growth rates overall, but management has continually guided conservatively for a 15-20% growth rate. Analysts have requested management to guide for revenue addition due to new capex. Management has chosen to not provide that and instead expertly added that new capacities at the new unit are similar to other 2 existing units. Analysts tried to get the management to commit to CRAMS business growth. Management has not given any growth commitments and has constantly guided for lumpy, volatile order book execution (both QoQ and YoY). Instead of harping too much on Anti-china sentiment, management has been very prudent/cautious about it. They have talked about multi-sourcing, ensuring continuity of supply chain and business operations. Management continued to deploy capital even during slowdown to take advantage of the opportunity which has been presented by the pandemic. Management learns lessons from failures and improves capital allocation decisions. For example: derisking the supply chain post the Levetiracetam China issue (got stocked out which caused severe financial stress). Management does not blindly follow backward integration, they understand the concept of value addition and strategic backward integration.
Valuation
Many valuation measures exist. Due a 1-time tax hit in Q4-2020 (write down of deferred tax assets), the tax rate for Q4 was 154% instead of 25% and hence eps was -7. If we assume normalized earnings (25% tax rate), the TTM P/E ratio of the company is around 26-27. This is high, but for a company with a stable and growing CRAMS business (a sub-industry which has great tailwinds), this is by no means terrible or severely over-valued.
Clientele
Company gets most of its revenues from the USA and then from Japan and Europe. It has all sized biotech companies as clients from japan and mostly mid and small sized biotech companies from the USA. Teva is one of the famous clients for Neuland.
Products
Probably the most famous product is API for ciprofloxacin. Recently the company has started manufacturing peptide chemistry which is considered to be complex.
Major molecules manufactured:
Specialty APIs: Peptides (Linaclotide, Liraglutide, and Semaglutide), Sterile APIs,
Prime APIs: Levetiracetam, Mirtazapine and Labetalol
Proof Based hierarchy of knowledge
On CMS (CRAMS)
[Q1FY21 concall]: Company started showing split of revenue for commercialized molecules versus those under development (experimenting stage). The QoQ results show high volatility. We should look at CRAMS numbers in an annualized manner [proof]. The product portfolio has a diverse mix in terms of market size of opportunities. Molecules that give 5cr a year stable commercial revenue versus those which give 50-60 cr. There can be a few blockbuster ones which give 100cr+ of revenue but this diversity will always be there [proof]
[Q1FY21 investor presentation] CMS Revenue has been growing steadily since last 9 quarters. It grew from 92cr (FY19) to 189 cr (FY20). [proof]
On GDS
[Q1FY21 concall]: Prime growth driven by Mirtazapine and Labetalol. Many products contributed well in the specialty segment. [proof]. One of the complex (specialty) product manufacturing that the company is undertaking is Sterile APIs (page 5). One molecule is already commercialized [proof]. Strategy: Prime API business segment strategy is to add new customers to increase Neuland’s market share across the global market. Specialty API segment, focus is on technology, patents, supplying sterile API, complex APIs, don’t expect too much competition [proof]. 3 peptides (Linaclotide, Liraglutide, and Semaglutide) are under development and management expects to file DMF in 2 years [proof, proof2]. The primary RM for the peptides are amino acids. Company buys them from Companies in Japan, China and India. Complex ones are made in-house (backward integration) [proof].
On general Financials
[Q1FY21 concall]: EBITDA margins are recovering. Achieved EBITDA margins of 17% in Q1 [proof]. Margins achieved are sustainable (modulo unseen one-offs) [proof]. Company guides towards 20% EBITDA margins in the medium term on the back of improving product mix, cost optimization for Prime APIs, operating leverage [proof]. Capacity Utilization of 70-75% today [proof]. ROCE was very low in 2018/19. Expect it to improve to 16%+ in coming years. As new capacities are utilized [proof]. Company will fund maintenance capex through internal accruals. For new capacity expansion company looks for a payback period of 36-48 months (25-33% returns) [proof]. For very specialized projects, Neuland would ask customers for an advance so they don’t need to fund the capex entirely by themselves [proof].
On products-mix
[Q1FY21 concall]: Management is actively working to move the portfolio mix towards value added segments [Proof].
On Business Growth
[Q1FY21 concall]: Growth in Q1-FY21 was driven by all business verticals: Prime, Specialty, CMS [proof]. Growth has been a bit lumpy the last 5 years, specially due to a smaller base of company and also high margin businesses. Much broader base now. Company guides for 20% growth as a target in the next 3-5 years going forward [proof]. Management is expecting a lot of projects to get commercialized in the next 2 years in the CMS front. Going forward, the numbers in this quarter will function as a good base, and the growth will come on top of this [proof]. Pharma companies looking to de-risk supply chain. The resurgence of European API players is not detrimental for neuland or indian API players Neuland competes on chemistry and technical competence not cost of labor or capital [proof].
On FDA Compliance
[Q1FY21 concall]: Company has an immaculate USFDA compliance record due to a culture of putting compliance and safety as #1 priority. Have a healthy level of paranoia [proof].
On the China issues
[Q1FY21 concall]: Neither prices of inputs or outputs of the company have been affected by China disruption. The supply of raw materials has been disrupted a bit. [Proof]. Been hearing from customers about increased focus on India due to China issues, but haven’t seen any impact on Neuland business yet [proof]. In one of the financial years, due to China issues, the company got stocked out on Levetiracetam causing huge financial impact. Company learned its lessons, made strategic moves towards derisking the supply chain (local suppliers + backward integration for critical CMS inputs in Unit 3). Reduced China dependence for RM from 50% 4 years ago to 20-25% now. Plan to bring it down to < 15% in next 1-2 years [proof].
PS: This proof based evidence gathering is a very laborious process. I went through Q1FY21 a few times to gather the proof based statements. Plan to do that for earlier concalls and other artifacts too at some point in the future.