Sharon Bio medicine stock with growth at reasonable price

Stock Opportunities
1

Analyzing a pharma company has never been my circle of competence. But I am giving it a try(I initially came across this pick from Peter lynch GARP list in wealth insight).

More importantly I am amazed with the consistency in analyzing upcoming pharma companies like Alembic and Ajanta by distinguished members like Hitesh, Donald, and Mahesh. Please share a comment and help me decide if this is a good opportunity to get in.

Consolidated basis

10 Year X-Ray

Jun'04

Jun'05

Jun'06

Jun'07

Jun'08

Jun'09

Jun'10

Jun'11

Jun'12

Jun'13

Return on Capital Employed

4.84%

11.64%

32.54%

23.11%

14.96%

8.78%

8.4%

9.93%

10.56%

10.45%

Growth Parameters

Growth Parameters Colour Code Guide

Net Sales (Rs. Cr.)

23.7

36.9

89.1

171

335

420

497

606

785

1,060

Y-o-Y Gr. Rt.

-

56%

141.5%

91.9%

95.7%

25.5%

18.3%

22.1%

29.5%

35%

Adjusted EPS (Rs.)

0.05

0.18

1.07

1.75

2.58

1.84

1.93

2.96

3.94

5.01

Y-o-Y Gr. Rt.

-

260%

494.4%

63.6%

47.4%

-28.7%

4.9%

53.4%

33.1%

27.2%

Book Value per Share (Rs.)

1.17

1.34

2.29

4.28

7.63

9.25

10.86

13.6

13.05

17.89

Adjusted Net Profit

0.5

1.8

10.7

17.9

27.2

19.4

20.3

31.3

41.6

52.9

Net Op. Cash Flow (Rs. Cr.)

0.5

-2.5

-5

-14.2

-40.5

-50.1

-28.1

-36

-53

-70.2

Debt to Cash Flow from Ops

7.08

-3.02

-3.3

-4.62

-5.3

-5.24

-12.19

-9.55

-9.58

-9.17

CAGR

9 yrs

5 yrs

3 yrs

1 yr

Net Sales

52.6%

25.9%

28.7%

35%

Adjusted EPS

66.9%

14.2%

37.4%

27.2%

Book Value per Share

35.4

18.6

18.1

37.1

Key Financial Parameter

Return on Equity (%)

4.17

13.94

47.92

40.66

37.44

19.95

17.76

19.45

21.27

24.2

Operating Profit Margin (%)

5.96

7.98

15.58

15.2

11.68

9.55

10.51

11.66

12.14

11.37

Net Profit Margin (%)

2.06

4.81

12.04

10.45

8.13

4.63

4.1

5.16

5.3

4.99

Debt to Equity

0.28

0.55

0.71

1.5

2.66

2.69

2.99

2.39

3.68

3.41

Working Capital Days

151

124

103

126

131

168

190

198

203

198

Cash Conversion Cycle

104

96

75

85

98

141

164

170

167

165

EPS: 5.01 RS

Proâs:

1) Consistent growth in Sales and Profit in last 10 years

2) Decent 3 year ROE average of 27.

3) It is pharmaceutical company engaged in manufacture of APIâs and pharma intermediates since 1995.

4) Relatively untracked with a market cap of 450 Crores. Only firstcall research is tracking this company. Find enclosed one of their reports for reference.

5) PE is 8.43.

6) It has recently spent 120Cr to expand its manufacturing capacities. Hopefully there wonât be any excess capital expenditure in future.

7) Management seems investor friendly. They have recently declared 1:5 split from 10Rs to 2Rs and bonus issue at the rate of 1:1.

8) The salary paid to top management seems conservative.

Conâs:

1) Highly leveraged. It has a Debt to Equity ratio of 3.41 and total debt is 641 crores.

2) The rough ratio between Interest payment and Net profit is 11:15.

3) The reason for this huge interest payment is due to FCCB bonds worth 16.5 million dollar raised for 5 years during 2007. In Dec 2012, the fccb bond was extended initially till Feb,2013 and after that again for 5 years.

4)Cash conversion cycle has increased to 165 from 85 5 years back.

If the company somehow is able to handle its debt by diluting equity then you get a good pharma company with consistent sales and profit growth at a very decent PE.

Investing in this company is all about figuring out if this company can successfully handle its debt overhang.

2

Here is url of one research report published by Firstcall Research

http://www.moneycontrol.com/mccode/news/article/article_pdf.php?autono=750600&num=0

3

High ROE with such a huge leverage (DE 3.41) is not an excellent figure as per me. See the ROCE figure, which is near 10%, which shows how poor this business is intrinsically.

Investing in such highly leveraged business is risky, and I would ask for way more margin of safety (in terms of pe) for investing in such business.

4

Subhash,

Thanks for getting back.

I do understand that ROCE currently is less about 10.

But we can say this may be due to increased capital expenditure of 120 cr for future projects. soeven thoughcapital expenditure was done, there was no return for the money spent during this time.The return from extra expenditure will be visible only in next 3 years. if you look at ROCE value till 2008, they are pretty decent.

The whole reason for looking at this stock now is that the revenue and profit may go up by 30% each year for next 3 years. Then if we assume that capital expenditure has stopped.

Then D/E after 3 years will be 1.7(decent enough number)

At that moment, if they do a equity dilution of lets say 10% , D/E value may get into normal rates.

For a company with this kind of return and Debt/equity ratio of 1.7, i would be willing to pay 10 to 11 PE after 3 years.

So in 3 years, i expect this company to double revenue and profits and in addition also expect itsPEto go up 30%.Taking into all these conditions, it seems like a above averageopportunityto look into.

Some of threats are:

1)May be they are not really able to ramp up revenue in 3 years

2)May be they need to do more capital expenditure to complete there project or their is a

delay in commissioning some of their projects.

5

No, ROCE for sharon has been around 10 for last 5yrs. So unlikely to be because of recent capex. That shows how poor it has been managed or its business fundamentals are.

When you have such high DE, projecting to future for next 3 yrs looks awesome only in excel sheet. In real life, high de stocks are the most unfaithful lot. In multitude of variables, that effect it, any adverse change in 2-3 variables, and your company will bleed to death like anything.

6

Even I looked at this stock 2-3 days back after reading capacity expansion announcement on BSE.

What put me off was **-ve CFO for each of last 5 years. **All profits generated is getting employed in WC.

Huge WC needs & capex needs makes this avoid according to me.

Any explanations?

7

India nivesh published a report today on the name

Bullish and projecting doubling of profit in next two years helped by operating leverage, change in product mix

They are waiting for UDFDA approval for one of their facility which was recently inspected by the FDA

8

More than debt I am worried about the cash flows

Not only the FCF but also the operating cash flow is negative indicating higher working capital and hence the pricing power of business

Positives are change in product mix and hence higher margins

A lot of capex made in last 5 years would become operational pending approval

India nivesh sounds bullish on earnings growth

Dirt cheap on p/e basis at 6 times 2015 profit and 4.3 times 2016

9

An interesting blog article on this stockhttp://rakesh-jhunjhunwala.in/index.php/2014/07/04/is-sharon-bio-medicine-going-to-be-a-multi-bagger-like-ajanta-pharma-alembic/

10

Hi Guys ,

Is there any opportunistic bet here ? Stock has tanked really big time,I don’t follow this at all. IS there some scandal or unethical promoter case or selling of pledges shares . or the fundamental are really terrible. I was just looking at screener,it doesn’t seem such a bad case. IS there a case of making 2x or 3 x in aquick time or it is a sinking boat, like satyam, kingfisher, Bhushans of the worlds and a complete avoid, No Not at all case.

Views are welcome !

11

)- Negative operating cash flow for each of the last 10 years(!)

)- High D/E

)- Pledged shares (percentage of pledged shares is not too much though)

aquick

12
13

Too much debt. Too little margin. Negative cash flow from operating activity. Inventory and sundry debtors are growing at alarming pace. In last many years, despite sale of thousands of crores, the company has not earned even a single penny from operating activity. I will give it a pass.

14

How does Sharon Bio Medicine at current level.
Also
The proposal for restructuring of the debts of Sharon Bio-Medicine Ltd
has been accepted by all its bankers, accordingly the Master
Restructuring Agreement has been executed by all the bankers.
Needed your valuable opinion.
Shall one should enter on this level.

Thanks
Inderjeet