ValuePickr Forum

Solara Active Pharma Sciences - Work in progress!

The company is on track to expand its API and CRAMS presence over the next three years. Long-lasting contracts in high-volume APIs will provide a solid base while high-value low-volume APIs and scale-up in the CRAMS business will drive both top-line growth and profitability. A 15% CAGR in top-line and 20% CAGR in EBITDA looks achievable. The recent fundraising of Rs 4.6bn will be utilized in developing capabilities in both these segments.

 Fundraise of Rs 4.6bn: In Feb-2019, Solara announced a fundraise of Rs 4.6bn through warrants given to promoters and PE investor TPG. The company has already received 25% of total commitment while the remaining fund is likely to come in FY20E. A large portion of this fund will be used to acquire capabilities in CRAMS and in setting up a Rs 2bn Greenfield API plant in Vizag. The co has already started working on the plant with an initial investment of Rs 700mn. The revenue generation is likely to start in 2HFY21. Residual funds will be used to pare down debt.

 CRAMS to improve business mix: As of now, Solara has only 5% of its revenue coming in from CRAMS orders. The management is looking to scale up its presence in CRAMS. It already has two R&D units in India while it is building its leadership team in the US. The potential acquisition in the US is likely to be in the form of kilo lab facilities having certain technological capabilities. Since the margins in the CRAMS segment are upwards of 30%, the management is targeting 20%+ EBITDA margin for Solara over the next few years.

 Clean regulatory slate: The company has 4 API and one intermediate unit in India. It has not faced any enforcement action from the USFDA for its plants so far. The recently inspected Ambernath and Cuddalore plants received zero 483s. Puducherry and Mangalore plants were inspected in 2017 and 2016 respectively, both the inspections were clear.

 New product filings remain high: Solara filed 9 DMFs in FY19 and is likely to file 10 more in FY20. The focus on new product launches remains high. Some of the interesting DMF filings include Posaconazole, Patiromer, and Pregabalin. The company is committed to spending Rs 500-600mn on R&D per year.

 View & valuations: With 16/21/30% Sales/EBITDA/EPS CAGR and improved Adj. Net Debt/Equity ratio of 0.8x (v/s 1.4x in FY18), we believe the stock is trading at attractive valuations of 16/10x on FY20/21E P/E. However, the developing Ranitidine story related to NDMA impurities could be an overhang in the near term. If Solara successfully clears the impurity hurdles, it could turn out to be a big bonanza; else, sizable Ranitidine sales could be at risk. HDFC Sec (sept 2019) assigned a fair value of Rs 655 (15x FY21E EPS).

Disc: Invested since 3 months, 10% of PF.

HDFC Sec report:

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There is very good written article about this company on Capital mind by guest author @mehrotra_saket

Hope this will add value to the thread.

Regards,
Ramesh

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I spotted this company first at ValuePickr, mentioned in discussions of some well-informed, esteemed investors. The overall investment thesis seems good, about a few months ago, when looking at the Pharma sector as a whole seemed ready for a break-out after half-decade of going nowhere.

The pedigree was good or some what mixed on second thoughts, and the product profile looked promising due to China disruptions and an agenda seemed to be developing of more intermediates and API production moving to India. Hopefully the growth plays out as planned.

Q4 FY2020 investor presentation looks quite informative, though I do not understand how 2 week disruption could have such great effect to lower the PAT.

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Hi Vikas,

At this moment i am not asking anything about company specific questions.

But about API industry as a whole. What is your reading about the industry getting shifted from China to elsewhere in the world. Especially to India. I have been asking this in various forums, and answers were mixed so far.

Regards,
Ramesh

Hi Ramesh,

China’s story going to change slowly but surely, at least most sourcers are going to be looking at an alternative as well. India as Pharma and Chem manufacturing hub has an established edge over other locations, some how here our human capital of well-educated, english speakers works well for products requiring more compliances and value-addition. Definitely pharma and allied are going to see a big upturn, also there is good govt support announced for the same.

Not necessary that the trade-war will be announced with a bugle and fanfare. Much of the dealing will be in the backrooms and under the table. Not in public statements or clear-cut discriminatory laws but the emphasis of trading will move out to other locations with a nod and a whisper. India has a big obvious advantage, esp. APIs to be great part of this re-location of supply chains.

regards,
Vikas

PS: APIs, intermediates, fit in well with the atma-nirbhar theme as well. India might be a big, recognized pharma player but it lacks the depth of in-house sourcing in the value-chain, losing out to China in the past decade or so.

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Carlyle group being an investor in the above mentioned company. I don’t think this group is in particular known to be having ethical behaviour. Rather questionable investments and activity. Is this a red flag here?

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While there have been deals involving Carlyle of the group(?) related companies, such as Sequent buy-out, I do not see them as holding any stake here:
https://trendlyne.com/equity/share-holding/94298/SOLARA/latest/solara-active-pharma-sciences-ltd/

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Concerns:

  1. Tax rate is zero. How long can they sustain this even with fresh govt incentives for their product family?

In the conference call, the management mentioned that they have 2 years of Tax asset which they will use. My major concern is ICD to a group company which has BBB rating and ICRA has expressed concerns over liquidity condition of the firm. I won’t touch this company for investment unless ICD issues go away. We have seen in Britannia that once an owner gets used it, they don’t stop.

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Introduction

SAPS was formed in the year 2018 by carving out the Active Pharmaceutical Ingredients (API) business of Strides Pharma and Sequent Scientific. Within 6 months of the carve out taking place, the company went public and listed at a price of 239. It reached a low of 154 on 13th July, ’18 only to hit an all time high of 737 is less than two years, a 6x jump in the price.

But before delving deeper into this small-cap stock having a market capitalisation of ~Rs. 1,273 cr. on 22nd May, ’20 let’s take a step back and have a look at Strides, Sequent and the man behind the show, Mr. Arun Kumar.

Deals, deals and more deals

Strides Pharma was earlier named as Strides Shasun (after the USD 200 Mn acquisition of Shasun) which was earlier named as Strides Arcolab. The API carve-out of SAPS is not something new. In 2010, Strides carved out Agila Specialities – their injectables business and ended up selling it to Mylan Inc. for USD 1.65 Bn in 2013-14. I specifically remember this deal since I was holding shares of the erstwhile ‘Strides Arcolab’ and was happy to receive a dividend of Rs. 625 per share in FY14.

Sequent Scientific, is India’s largest animal health company. Their key markets are spread across Europe, Turkey and a host of other countries globally. As early as 8th May, 2020 – the US based Private Equity firm Carlyle group has agreed to acquire a 74% stake in Sequent Scientific for USD 210 Mn (Rs. 1,587 cr.)

See a pattern here?

Fortune India had called Arun Kumar as Indian pharma’s maverick thinker[1]. As early as 2019, The Ken did a piece on Arun Kumar labelling him as ‘India’s best kept management secret’.

“His ability to seal a new deal sooner than the ink on the previous one has dried, makes him an unusual wealth generation machine[2].” – The Ken was quoted stating this in their introduction.

Coming to SAPS

SAPS was provided to existing shareholders of Strides (1 for every 6) and Sequent (1 for every 25) when the existing businesses were restructured to make SAPS a pure play company on API.

The pharmaceutical business is fairly complex. Broadly, one can split the business offering into formulations and API. Formulations involves preparing new drugs to address specific diseases or illnesses whereas API as the name suggests, manufacture the raw materials or develop specialized molecules that act as an input for formulations.

In India, most of the API production is captively consumed and most big pharma companies have an integrated offering of API and formulations.

Amongst the key players in API production in India – Dr. Reddy’s, Lupin and Aurobindo Pharma are key players. Since these companies are also focussed in manufacturing of bulk drugs, their focus on developing niche molecules that are complex in nature takes a backseat. Complex approvals can become a challenge and non-availability of high volumes makes them keep their resources allocated to existing portfolio.

SAPS has created a niche position for itself by being a pure play on the API space. Shortages led by shutdown of plants in China or paucity of raw materials gives them the right time to capitalize on the opportunity.

SAPS presently has 5 FDA approved manufacturing facilities & 2 R&D centres in India. It has successfully completed 25 USFDA audits.

Regulatory Compliance and DMF Filings

In their latest investor presentation, they have given a granular level detail of all their manufacturing facilities and a timeline of all the audits that have been conducted by the global regulators. ​

Another interesting aspect about API companies is filing of DMF’s i.e. Drug Master File which is a detailed document submitted to the US FDA containing chemistry, manufacturing and controls of a drug component. API manufacturers with a large number of DMFs are often considered more reliable in terms of quality, regulatory standing, and ability to meet Current Good Manufacturing Process (cGMP) requirements.

As on 31st March, 2020, there are a total of 33,152 DMF’s filed with the FDA[3] by 7,573 pharma companies from across the Globe. This translates to roughly 4 DMF’s per company.

But there’s something interesting about this number. The top 100 companies file close to 92 DMFs on an average, the next 400, 22 and the next 800, 7.

SAPS has 84 DMF’s making it amongst the 98.9th percentile! (A 21x of the global average)

The Indian pharma pack has been clearly dominating the FDA filings. In the top 100, there are close to 30+ Indian companies with around 3,535 DMFs. Dr. Reddy’s is leading this pack (Global Rank 4) with 291 filings. In terms of pure API play, Solara is ahead of a few semi-API plays like Neuland Laboratories, Divis Labs, Laurus Labs and Cadila Healthcare.

Global Presence

As per their Annual Report, SAPS has presence in close to 75+ countries. Split between India and the rest of the world is 46:54 with Mexico, US, Japan and USA being their top 4 markets (collectively 23% of total sales and 43% of global sales).

After the new environmental regulations had kicked in in China, there were multiple stringent requirements put in to both local manufacturing and global sourcing of imports. One of them was the requirement to have a Zero Liquid Discharge (ZLD) on the plants. SAPS is ZLD compliant and has also listed that as a key strength in their Annual Report to dominate the Chinese market.

Global Risks & Opportunities

China is a major supplier of API and critical active salts to the global pharmaceutical supply chain. The current crisis has opened up a big void which the Indian pharma companies are rushing to fill in.

On 3rd March, 2020, the Government of India placed export restrictions on 26 API and formulations to which 200+ firms applied to DGFT seeking licenses to ship restricted API. The export restrictions can lead to cancellation of other orders for pharma companies which cannot be captively used for the domestic market. Thus, having a diverse product mix and long standing relationships with existing customers can play as a key strength here.

While India contributes ~20% to the world generic pharma supply chain, for inputs they are dependent on China for ~67% of chemical components (API imports are ~USD 2.5 Bn from China annually).

Of the export mix for Indian pharma, North America leads the pack (30%) followed by Europe and Africa (~16% each).

On 1st April, 2020, the FDA announced an immediate withdrawal of all drugs containing Ranitidine on some studies that found a contaminant.

Ranitidine forms 7% of the overall revenues for SAPS (as per a release put out on 2nd April, 2020 by the company) and is amongst the top 10 API for them. This immediately led to a correction in the stock price but the company did not foresee any significant impact with this ban.

TPG Capital & Other Global Investors

TPG Capital, a US based global Private Equity behemoth with ~USD 103 of Assets Under Management announced an infusion of ~Rs. 200 cr. in SAPS in February. ’19 at Rs. 500/share through warrants. SAPS made a preferential issue of an equal amount to it’s existing promoters at Rs. 400/share. The share price at the time of announcement was in the range of Rs. 370-380 and remained fairly flat for a few months.

As on 31st March, 2020 – The Management & Leadership team has a decent ‘skin in the game’. The promoters own 42% of the company and Mr. Jitesh Devendra, the Managing Director owns 1.12%.

SAPS has a set of diverse global and local investors – right from a healthcare focussed Swiss firm, to a US based hedge fund and the makers of Threptin biscuits in India.

Financials & looking ahead

SAPS has been achieving a healthy growth, improving it’s EBITDA margin along with it’s bottom-line. It’s superior product mix and achieving efficiencies in manufacturing is effectively translated in it’s Statement of Profit & Loss.

The first full year of operations was in the year 2018. SAPS was in a healthy runway to achieve a higher revenue but got impacted due to Covid-19 shutdown in Q4 leading to a short dip in Revenues. Despite that, Revenue has shown a CAGR of 159%.

EBITDA has grown at a CAGR of 203% alongside margin expansion from 12 to 20%. Similar growth has been seen in the bottom-line – both in value and margins.

On the Financial position, SAPS has been infusing equity and also paring it’s debt levels. As on FY19, the debt is ~28% of the Liability side. The company was incurring capex for a new capacity in Vizag and can take care of additional demand anticipated.

With the world moving towards getting their priority on Healthcare back and multiple future developments happening in the pharma space, we can see more breakthroughs coming in this space. All this will fuel the requirement of APIs and other complex molecules which SAPS has a clear focus on.

With the backing of Mr. Kumar, well known for his ability to execute deals along with a bouquet of global investors present in the stock, it will surely be interesting to see how SAPS comes out in the future. At a time when globally pharma companies are filing anywhere between 7-12 DMFs, Solara has 84. The company, as per their annual report has claimed to file 140+ DMFs upto 2019. As per their latest investor presentation released along with their full year earnings, the company has maintained strong guidance for FY21 despite the Covid – 19 situation and ban on Ranitidine.

If things go as planned, SAPS could well be a David walking towards being the Goliath.

I saw someone share a link to the article published earlier, that will give you the complete picture.

Thanks for reading.

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Hi @saketmehrotra

Thanks for responding in this newly started thread.

Your article in Capitalmind was really insightful and very informative. So is the reason i had shared in this forum for wider audiences.

I would like to ask you below questions.

1.According to you what are the top 3 risks for this company in next 10 years?
2. During your detailed analysis what are other minor/major disconfirming eveidences found?
3. Do you think sooner or later the promoter will run out of luck in creating the value? Earlier Sun founder was also having serial successes only to be stopped by Ranbaxy.

Regards,
Ramesh

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Solara is one of my larger holdings.
ICD issue was one off and will not happen again.
Pledges will be removed once the promoter receives the sequent money.
At the current cmp the valuation is extremely good for this api company. The market is sensing something happening in this group and before long I expect a re rating for this stock.
I am also betting on Arun Kumar to work his magic here and eventually sell solara.

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I would like to think that almost all businesses have a ‘Follow the Leader’ effect. Any strategic move by an industry leader or a biggie tends to be copied by the smaller players. The prudent, conservative and transparent management style at industry leader Infosys spawned a host of similar companies giving us investors a flock of golden geese to invest in. While in pharma formulations business, Dr Reddy started overseas acquisitions which led all pharma companies to copy the move leading to several failed acquisitions and misallocation of capital. In API business, Divis Lab is the big daddy that has been following a fairly conservative, sticking to its knitting type of business model and showing remarkable success in the strategy. Solara can easily follow the leader here and stick to the same strategy to generate good results and hopefully it will do that.

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Hi All,

They have got “Official Action needed” from USFDA for Cuddalore Site.But company clarified no impact on business continuity plan.Anyone having more idea what actually this means?

Thanks,
Deb

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From google I understand that the currently OK’ed products can continue to be made at the plant with OAI, but new/applied-for products can have their approval delayed/cancelled. Apparently, Solara thinks they can either deal with this OAI before any delays are caused to their plans to launch new products from that plant, or there are no significant new products in the pipeline from this plant etc.

Disc: holding.

Corporate Governance issues flagged by Aditya Khemka of DSP fund -

Does it raise questions on Sequent Scientific as well as it comes from the same promoter group.

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Sequent will see a promoter change with Carlyle acquiring 74% thereby addressing these concerns.

@preposturous … does the conversation between hariharan and Aditya continue forward? Does hariharan reply to Aditya in the next part of the transcript? Please do post /share the link if you have the rest of the transcript please. I am currently invested in solara and I usually make immediate exits whenever corporate governance issue prop up in small caps since it usually indicates the beginning of the end. I want to make sure before I do make an exit though. Cheers

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It is an older earnings call transcript -->

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Are you sure it’s this one? I’ve gone through it a couple of times now and I can’t find that section you highlighted . There is a question from aditya regards a 55 crore investment but nothing on intercorporate deposits.

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