Independent Equity Research PHARMACEUTICALS BSE Scrip Code: 532482 CMP Rs. 70.35 1 14 Feb 2012 Vertically intergrated and present across the pharma manufacturing value chain Granules India Limited (Granules) is a pharamaceutical manufacturing company which produces Active Pharmaceutical Ingredients (APIs), Formulation Intermediates (PFIs) and Finished Dosage (FDs) which offers its customers flexibility and choice. Granules is among the top global manufacturers of Paracetamol and Ibuprofen (APIs) and also manufactures single and multiple - active PFIs. The company also has its own Abbreviated New Drug Applications (ANDAs) and dossiers which enables MNC pharma companies to quickly enter the market instead of filing their own applications. Bright outlook due to buoyancy in pharma sector but New Drug pricing policy is a concern CARE Research believes buoyancy in Indian Pharma sector to remain intact but the industry may face pricing pressure from the new drug pricing policy, although the risk for Granules is majorly mitigated on account of high contribution of exports. Key concerns Exchange rate volatility Rising input costs Stiff competition from other Asian countries for manufacture of APIs High dependence on two products (Paracetamol and Ibuprofen) Valuations Granules is currently trading at trailing P/E and EV/EBITDA multiples of 7.2x and 4.9x, respectively. 1 www.careratings.com
CARE HISTORY AND BACKGROUND Background Granules was incorporated in 1984 and is Hyderabad based pharmaceutical company manufacturing Active Pharmaceutical Ingredients (APIs), Pharmaceutical Formulation Intermediates (PFIs) and Finished Dosage (FDs). Granules is among the top global manufacturers of Paracetamol and Ibuprofen (APIs) and also manufactures single and multiple-active PFIs. The company also has a dedicated FD plant with a capacity to produce 18 billion tablets per annum. In July 2011, Granules entered the contract manufacturing sector by signing a JV with Ajinomoto OmniChem forming Granules-OmniChem Private Limited. The new entity will initially focus on APIs and intermediates in the cardiovascular, central nervous system (CNS) and oncology therapeutic sectors for patented, brand name products. Operations Granules has manufacturing facilities at Bonthapally, Gagillapur and Jeedimetla (all on outskirts of Hyderabad) in India; and Jingmen and Hubei in China. The company has capacity of 15,200 MTPA for API, 8,400 MTPA for PFI and six billion tablets per annum for FD. The PFI facility in Gagillapur is the largest PFI facility in the world. The facilities have received approval from U.S.FDA, Infarmed, WHO GMP and Australian TGA amongst others. The company is carrying out capacity expansion at Galillapur FD facility from six to 18 billion tablets per annum, at Gaillapur PFI facility from 7,200 MTPA to 16,400 MTPA and is debottlenecking capacity at API facility at Jeedimetla. Industry Segments Source: Company www.careratings.com 2
Granules historically got majority of its revenues from the API segment. But gradually, with the expansion of PFI and FD segments the revenue mix is shifting towards them. Exports contributed about 83% of sales for Granules in FY11 compared to 80% in FY10. Granules: Industry Segments Source: Company and CARE Equity Research Granules: Operational Performance (In Rs crore) Product FY08 FY09 FY10 FY11 API 156.44 130.17 231.08 176.11 PFI 100.02 150.42 189.49 180.87 156.44 130.17 231.08 176.11 FD 256.45 289.27 462.16 475.98 Total sales Source: Company and CARE Equity Research 3 www.careratings.com
CARE Granules: Peer comparison (FY11) Units Granules Elder Pharma Dishman Pharma Strides Acrolab Net operating income Rs. Crores 478 968 1,060 1,761 EBITDA Rs. Crores 55 179 202 391 PAT Rs. Crores 22 64 81 141 Growth in net operating income % 2% 33.0% 13.0% 24.0% EBITDA Margin % 11.4% 18.5% 19.1% 22.2% PAT Margin % 4.5% 6.6% 7.7% 8.0% RoCE % 10.5% 4.2% 4.6% 4.0% RoE % 10.4% 10.5% 9.3% 9.1% Price/Earnings (P/E) Ratio times 7.2 10.6 5.9 16.0 Price/Book Value(P/BV) times 0.6 1.2 0.5 1.5 Enterprise Value (EV)/EBITDA times 4.9 7.3 6.5 10.0 Source: CapitalLine and CARE Equity Research www.careratings.com 4
CONSOLIDATED FINANCIAL PERFORMANCE AND ANALYSIS Top line remains almost flat in FY11 Revenue grew from Rs.460.75 crore to Rs.475.03 crore in FY11. Sales for the API division which contributed 37% of revenue in FY11 were flat due to higher requirement for captive consumption from tablets and due to a global Paracetamol inventory correction. The small growth in revenue was mainly fuelled by a 170% growth in PFI division. Slow growth in top line coupled with higher raw material prices hurts profitability margins The operating profit for the company decreased from Rs.23.95 crore in FY10 to Rs.21.72 crore in FY11. The EBITDA margins for the company decreased 190 basis points in FY11 on account of higher-than-proportionate increase in the raw material prices. Raw materials constitute about 62% of the total expense base. EPS shows de-growth of 9.7% in FY11 over FY10 Net profit for the company decreased by 9.3% in FY11 over FY10 on account of increase of raw material prices due to increase in crude oil prices and government regulations in China. Even the EPS decreased in tandem with the Net Profit and recorded decrease of about 9.7% in FY11 over FY10 after showing growth of about 279.6% in FY10 over FY09. Granules: Consolidated Financial Performance (FY07-11) (Rs. Crores) FY07 FY08 FY09 FY10 FY11 Net operating income 186 273 288 471 478 EBITDA 34 35 32 63 55 PAT 10 9 5 24 22 Fully Diluted EPS* (Rs.) 4.8 4.3 2.9 10.8 9.8 EBITDA margins 18.1% 12.7% 11.2% 13.3% 11.4% PAT margins 5.4% 3.3% 1.8% 5.1% 4.5% Source: Company and CARE Research 5 www.careratings.com
CARE EXPANISONS, NEW INITIATIVES AND CONCERNS Expansion plans and initiatives In July 2011, Granules entered the contract manufacturing sector by signing a JV with Ajinomoto OmniChem and decided to form Granules-OmniChem Private Limited, a 50:50 joint venture company. The new entity will deliver value through a unique contract manufacturing platform by leveraging Granules technological capabilities and efficient processes and OmniChem s extensive product portfolio and existing customers. A greenfield facility will be set up in the Pharmacity SEZ Zone in Vishakhapatnam. The construction of the facility is expected to begin in November 2011 and commercial production will commence in January 2013. As per the company, the JV will initially focus on APIs and intermediates in the cardiovascular, central nervous system (CNS) and oncology therapeutic sectors for patented, brand name products. The JV will also work on second-generation manufacturing processes and will develop new chemical entities in the future. The company is scaling up the FD facility in Gagillapur which will increase the capacity from 6 bn doses to 18 bn doses. The expansions are expected to be completed by March 2012. The company has added two more workshops at the PFI facility in Gagillapur Module C and D to enhance the capacity by 8,000 tpa and 1,200 tpa respectively. Module-D became operational in June 2011 and Module-C will be operational by March 2012. As per the management, Granules de-bottlenecked capacities through an operational excellence programme at the API facility in Jeedimetla which enhanced production capacity of Guaifenesin and Metformin with minimal investments. Granules is also building a new, state-of-the-art (fully-automated) warehouse at Gagillapur to support these expansions. The facility will be ready by mid-2012. Key concerns On account of high contribution of exports to the total revenue, the company is exposed to huge currency fluctuation risks. Rising input costs especially oil prices may further impact margins. As about 83% of revenue in FY11 came from export market, the company is in direct competition from other Asian countries for manufacture of APIs. Any failure of quality control tests can impact the future growth prospects. High dependence on a single product (Paracetamol and Ibuprofen); however the company has been de-risking by diversifying its product base and increasing contribution of FD s in the revenue mix. www.careratings.com 6
SECTOR OUTLOOK Sector outlook The global pharmaceutical market grew 4.1% in 2010 to reach US$856 bn. The market is expected to grow approximately 28% by 2015 to reach US$1.1 tn. Market growth will be driven by a continuing shift to generics and the rapid growth of pharmerging markets. In addition, drugs in the diabetic and oncology therapeutic sectors will grow more rapidly than other sectors. In order to take advantage of the market situation, pharmaceutical companies will need to strengthen production capabilities to meet demand and streamline their supply chain to meet the dynamics of each unique market. India s pharmaceutical market is one of the fastest-growing globally and is estimated to rise from US$10 bn in CY10 to US$17.5 bn in CY14 (14.5% CAGR). The Indian pharma market is now the third-largest in the world in terms of volume and 14 th largest in terms of value thereby accounting for around 10% of world s production by volume and 2% by value due to lower prices. The industry now produces about 500 bulk drugs (APIs) and almost entire range of formulations related to all major therapeutic groups requiring complex manufacturing technologies. This is supported by availability of strong scientific and technical manpower backed by pioneering work done in process development. Exports constituted around 42% of the industry s FY10 sales and have shown a robust growth of nearly 19% per annum over the five-year period ending FY10. Of the total exports, formulations represented approximately 60% while API accounted for the balance 40% in FY10. The share of exports to regulated markets of North America and Europe was 24% and 21% respectively in FY10 and the same has seen an increasing trend over the past few years. This can primarily be attributed to increasing genericization in the regulated markets and growing trend in outsourcing of pharmaceutical production by global pharma companies to low-cost destinations like India. Key segments of the Indian market include formulations, bulk drugs and contract research and manufacturing services. Geographically, the global pharmaceutical market can be classified into regulated markets and less-regulated markets depending upon the level of regulation pertaining to drug quality and patents. The industry is highly fragmented with around 20,000 odd players of which approximately 250 medium to large corporations control about 70% of the total domestic market. In addition there is severe price competition coupled with government price control in many drugs. The top-end of the market is dominated by the organized sector with key players which include domestic pharmaceutical companies and MNCs. The unorganized sector with large number of manufacturers faces intense competition and also deals with spurious drug manufacturers that hamper the overall credibility of the industry. While the growing share of generics in the developed markets and the opportunity from Contract Research and 7 www.careratings.com
CARE Manufacturing Services (CRAMS) have been the primary drivers for exports, changing demographics and growth in chronic therapies have been the major factors contributing to the domestic market growth. The domestic pharma market has grown steadily at a CAGR of around 8% in the past five years. In addition, the score on demand is boosted by the high inelasticity between cost and price in most drugs while penetration of pharmaceutical products in India remains low compared to global average. Also, there are no direct substitutes for pharma products and the industry remains immune against any economic cyclicality or interest rate fluctuations. The Indian pharma market is quite regulated when it comes to the formulation business for both the exports and domestic market. Indian manufacturers have to get their manufacturing units USFDA approved if they are exporting drugs to the US which is the world s largest pharmaceutical market. The Japanese and European markets also have their own stringent laws for exporters creating a huge entry barrier for new players. Moreover, branded drugs are protected by patent laws while generic drugs require the incumbent to have specialized process reengineering technique which is unique to each drug. Strong distribution network is another important parameter in the formulation business for the drugs to reach every hospital, medical practitioner and druggist in every part of the country. Certain generic drugs have brand name advantage (branded generics) while branded drugs have patent protection. The formulations market is quite fragmented and top 5 players control less than 20% of the market share. Competition is intense in the genericgeneric and Over-the-counter (OTC) business which have number of players with pressure on pricing. In the domestic market there is not much of an import threat in formulations but in the export market competition from major global generic players is intense. The Indian pharmaceutical industry is mainly regulated on patents, price and quality. Until 2004, the regulatory system in India focused only on process patents. Indian companies thrived during this phase by process reengineering products of global pharmaceutical players and launching them in India. Indian companies gained process chemistry skills, but de-emphasized on research & development for new drug discoveries. From January 2005, India adopted the WTO norms to follow the product patent regime. The Act allowed for only two types of generic drugs in the Indian market: off-patent generic drugs and generic versions of drugs patented before 1995. The Amendment grants new patent holders a 20-year monopoly starting on the date the patent was filed and no generic copies can be sold during the duration of the patent. Other regulations like the Drugs and Cosmetic Act regulate the import, manufacture, distribution and sale of drugs in India. The Drug Price Control Order (DPCO) fixes the ceiling price of some life-saving APIs and critical formulations. Currently, a number of bulk drugs and formulations are under the purview of price control. Currently, the government allows 100% FDI under the automatic route in drugs and pharma sector. www.careratings.com 8
CONSOLIDATED FINANCIAL SUMMARY Rs. Crores FY07 FY08 FY09 FY10 FY11 Income Statement Net operating income 186.0 272.6 288.1 470.8 478.3 EBITDA 33.7 34.5 32.1 62.8 54.6 Depreciation and amortisation 8.2 11.7 11.8 18.6 18.3 EBIT 25.5 24.8 22.4 46.9 38.8 Interest 12.2 13.0 15.7 17.6 12.6 PBT 11.0 12.6 7.0 37.6 26.8 Ordinary PAT (After minority interest) 10.1 9.1 5.1 24.0 21.7 PAT (After minority interest) 10.1 9.1 5.1 24.0 21.7 Fully Diluted Earnings Per Share* (Rs.) 4.8 4.3 2.9 10.8 9.8 Dividend, including tax 2.5 2.5 2.5 2.5 3.0 * Calculated based on ordinary PAT on Current Face Value of Rs. 10/- per share Balance sheet Net worth (incl. Minority Interest) 165.9 171.3 173.0 200.8 218.6 Debt 133.6 144.7 183.4 146.7 137.2 Deferred Liabilities / (Assets) 8.4 10.5 12.3 17.0 19.9 Capital Employed 308.0 326.5 368.6 364.6 375.7 Net Fixed Assets (incl. Capital WIP) 208.5 248.9 245.1 239.2 245.5 Investments 0.3 0.3 0.3 0.3 0.3 Loans and Advances 16.8 19.3 21.9 26.3 29.2 Inventory 29.6 52.9 59.5 68.6 75.1 Receivables 37.1 37.5 63.1 65.9 71.6 Cash and Cash Equivalents 36.4 10.9 12.8 13.5 12.0 Current Assets, Loans and Advances 119.9 120.5 157.4 174.3 187.9 Less: Current Liabilities and Provisions 20.7 43.2 34.2 49.3 58.0 Total Assets 308.0 326.5 368.6 364.6 375.7 Ratios Growth in Operating Income 46.5% 5.7% 63.4% 1.6% Growth in EBITDA 2.4% -6.8% 95.5% -13.0% Growth in PAT -9.8% -44.4% 371.5% -9.3% Growth in EPS -10.4% -33.7% 279.6% -9.7% EBITDA Margin 12.7% 11.2% 13.3% 11.4% PAT Margin 3.3% 1.8% 5.1% 4.5% RoCE 7.8% 6.4% 12.8% 10.5% RoE 5.4% 3.0% 12.8% 10.4% Debt-Equity (times) 0.8 1.1 0.7 0.6 Interest Coverage (times) 1.9 1.4 2.7 3.1 Current Ratio (times) 2.8 4.6 3.5 3.2 Inventory Days 71 75 53 57 Receivable Days 50 80 51 55 Price / Earnings (P/E) Ratio 16.4 24.7 6.5 7.2 Price / Book Value(P/BV) Ratio 0.8 0.8 0.7 0.6 Enterprise Value (EV)/EBITDA 7.7 8.3 4.2 4.9 Source: CapitalLine and CARE Equity Research 9 www.careratings.com
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