Granules India: On the mend

The stock of active ingredients and drug formulations maker Granules India has corrected significantly in the past six months — it had fallen about 50 per cent from its January 2018 high. The company’s docile earnings growth in the third and fourth quarters of 2017-18, mainly as a result of increase in raw material prices, had impacted investors’ sentiment.

However, the stock has bounced back from its lows as the company’s profitability has improved. The company has delivered a stable set of numbers in the first quarter of FY2019, thanks to higher sales in its active pharmaceutical ingredients (API) and formulations businesses, and easing raw material prices.

Over the medium to long term, the company’s changing product mix in favour of the high-margin formulations business, expansion in its API segment and ramp-up in the US should translate into good growth in the coming quarters. The company’s large capex spend to expand its capacities and R&D capabilities should provide the next leg of growth in revenue.

At the current price of ₹102, the stock trades at about 11 times its estimated 2019-20 earnings, which is at a steep discount to its three-year average of 20 times. Considering the company’s healthy growth prospects, investors with a long-term perspective can buy the stock.

Granules recorded modest revenue growth during the third and fourth quarters of 2017-18, mainly on three counts. One, increase in raw material prices due to supply shortage in China, an industrial accident at a key supplier plant, and higher oil prices adversely impacted gross margins of the company. The inability to pass on such higher raw material cost to clients affected the gross margins. Two, delay in pick-up in the contract manufacturing order from clients, especially from the OmniChem joint venture, led to erosion in earnings growth. Finally, higher incremental paracetamol sales as APIs in the domestic market led to lower selling prices. Despite these headwinds, the consolidated revenue grew (y-o-y) 14 and 39 per cent, respectively, during the periods.

Recovery in business

The company has reported healthy numbers in the first quarter of the 2018-19 as most of the concerns have been addressed. The company passed a portion of the hike in raw material prices to customers, and tied up with a fresh supplier to diversify supply-side risks. These steps resulted in higher sales growth in API and formulations businesses in the period. In the first quarter of 2018-19, the consolidated revenue and net profit rose y-o-y 20 and 41 per cent to ₹453 crore and ₹52 crore, respectively.

Gross margins should improve in the subsequent quarters as raw material price is getting stabilised and a part of price hikes is being passed on. A new supplier for raw materials should also ensure a consistent flow of production going ahead.

Partnering Hikma, the company launched the Methergine generic drug in the US in June 2018 and captured over 50 per cent of the US market share. Though it has contributed to only one month in this quarter, the company has received a milestone payment of ₹13 crore from Hikma under a profit-sharing agreement for selling the drug. The gain from the drug looks promising for the company as it is expected to add 15-20 per cent to its earnings for FY2019. Methergine generic is a fairly complex and limited-competition product (Lupin is the only other player in the US currently). The company will benefit from high entry barriers.

Good prospects

Granules India enjoys leadership position in its core business of manufacturing Paracetamol, Metformin, Ibuprofen and Guaifenesin. It supplies APIs and PFIs (pharmaceutical formulation intermediates) to global clients on contracts. Its formulation business comprises both direct market sale and contract manufacturing. While North America is the key market for the company — accounting for about 42 per cent of the revenue in the first quarter of 2018-19 — Europe (19 per cent), India (25 per cent) and Latin America (8 per cent) are also significant contributors.

Over the years, Granules India has changed its business mix from low- to high-margin products. The company has shifted its product portfolio from PFI and API (61 per cent and 39 per cent, respectively) in 2007-08 to PFI, API and FD (Finished Dosage) (20 per cent, 40 per cent and 40 per cent) in 2017-18. While this led to a reduction in revenue in the initial period, there has been a sharp improvement in the company’s margins. With the expansion in formulations, the business mix is expected to change further and aid margin growth. The company, while strengthening its base API business, is also focussing on enhancing the formulations portfolio.

Growing US business

The company is focussing on strategic portfolio selection in the US, primarily limited-competition products. The company has filed 21 ANDAs (Abbreviated New Drug Applications), of which nine have been approved. The US business is likely to see a healthy growth on the ramp-up of newly launched Methergine, Methocarbamol and two OTCs (Cetirizine and Fexofenadine). Two more products are likely to get launched the next month, which may fetch considerable revenues in the next couple of years.

The company is one of a few to be minimally impacted by the pricing pressure in the US market, given its complex products portfolio.

The company has guided for ₹40-crore profit from the two joint ventures — OmniChem and Biocause — in FY19.

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