10-year Financials Overview

Profit and Loss Statement: 

  • Stable growth & strong return ratios
  • Margins volatile ( A function of the US business: Price erosion and increased competition in legacy products; 1st ANDA filed in FY07)
  • Consistently paying dividend

Balance Sheet:

  • Equity Dilution? Only once
    • Aug 2020: 8047210 shares have been allotted at a premium of Rs.930 shares to QIBs pursuant to Qualified Institutional Placement: Raised 750cr.
  • Continuously investing into the business: Gross block+ CWIP up 4x in the last 4 years.
  • Funding? Initially, debt-funded & then paid it back through QIP & Operating Cashflows.
    • Has consistently kept the debt under control.

Cashflow statement:

  • High Working capital requirements: Cash conversion is okayish.
  • Ramped up capex investments in the past 4 years.

Basic Details about the business:

  • Headquartered in Vadodara, India 
  • The controlling company is Alembic Limited (owns 28.4%)
    • Alembic Pharmaceuticals was demerged from Alembic Limited on 1st April 2010: Pure Pharmaceutical company (Promoter has other businesses like Real Estate developer, fine chemicals, Power in Alembic ltd.)
  • Cumulatively, promoters hold 69.5% (as of Q1FY22) of the company | No ESOP scheme
  • Organizational structure: complex (with multiple subsidiaries of foreign subsidiaries)

  • Business Model: Formulations & API sales across the world (particularly in India & USA)

Annual Report notes of the last 11 years:

Tells us how the business has progressed over the years & judge the past decisions taken by the management.

Given our learnings from the above, we wrote a SWOT analysis.

Strengths

  • Partnered with leading research outfits to intensify their R&D (Rationalized approach)
    • The result: ~25% of their research programs are carried out in collaboration with partners.
  • The originator of the 1st innovator product to be developed in India & now approved by USFDA: Formed a Joint Venture (JV) with Rhizen in 2012.
    • Adds optionality, as they can both manufacture + gain from royalty payments.
  • New plants F2, F3 & F4 with specialty products to come online by FY22.
  • Strong API capabilities with cumulative DMF fillings of 117: In house consumption+ Outside(15-20% of rev)
    • It’s tough to be backwardly integrated in the USA market: Get API, Get Compliance of API, Get Formulation, Get Compliance of Formulation; Then, Supply chain efficiency.
    • Among the top 5 Indian Pharma companies (Alembic, Ajanta, Sun pharma, Natco, Torrent) who have consistently shown over 70% gross margins in the industry.
    • Currently, 80% of Alembic’s portfolio in the USA is backwardly integrated: will go down in the future.
    • Alembic has good capabilities in oncology APIs, so growth in onco will come from both APIs + formulations. However, Alembic is not backward integrated into dermatology, ophthalmology & injectables.
  • Strong R&D strength: Continually spends 12-15% of sales in it+ more than 1200 R&D personnel ( Has consistently ramped up the personnel with increased investments)
    • 200+ products in R&D pipeline: Will start yielding dividends by FY23 & gradually ramp up.
    • With respect to the fillings & approval timelines; this story will peak in the next 5-7 years.
  • ROCE is currently subdued due to 3K+ crs spent on newer projects.
  • USA launches are in line with industry standards: $2-3m per ANDA launched
  • Follows a rather conservative accounting treatment in many aspects including R&D – 100% expensed through the P&L (ex Aleor & Rhizen)

Weaknesses

  • Lack of focus in the branded Indian markets is visible: Market share down from 1.8% to 1.4% & only 2 among the Top 300 brands from 5, a decade ago.
    • 19% of the product portfolio in NLEM
    • Over Diversified across therapies with a lack of clear leadership.
    • MR productivity is also one of the weakest. (Alembic’s 30 lakh per year per MR vs 50-60 lakhs for the industry)
Not a leader in any therapeutic.

  • Formed a JV to enter China, FDA approves Oncology oral solid facility: Misallocation of capital given most of the other big pharma continues to lose money in these stories.
    • If China makes most of the APIs, why would it not make the formulations for itself rather than paying a top premium to Indian formulation players?
  • Promoters’ salary has always had an upper band of 10-12% of profits (includes 3-4% of profits as commissions) | A red flag.
    • Dividends are also quite on the higher side (250-300crs) for a company that is not making any free cash flows.

  • Had to wind down Algeria business & book a loss, as the huge opportunity size story failed: Capital misallocation.
  • 50-60% of the Business (USA) is a treadmill business: where they only make money when there is a PARA-IV opportunity (Abilify in 2016) or a Shortage (sartans from 2018-2020).
    • Continuous investments into this commodity business while ignoring other branded generics markets.

Opportunity:

  • US formulations business is $128B (as of FY21) & growing at 7-8% vs India which is $15B: Indian Pharma cos. will grow faster due to manufacturing cost advantage.
    • Has mentioned that the USA Quarterly run rate could reach $100-125m by FY25, currently at $50-60m.
  • IPM will grow to 3-4x by 2030.
  • Regions ex US+India (Europe, Canada, South Africa, and Australia) have started picking up; the momentum is trackable.
  • API capacity doubled in last 2 years: China+ 1 beneficiary.
    • Moreover, the company is investing in new capacities.

Risks

  • Increasing competitive intensity; previously in FTF & FTM companies were only 5, now it’s 15+ (Smaller profit pools due to price erosion)
    • 25-30% EBITDA margins in the USA might only sustain for companies that are ahead of the curve: differentiated strategy.
    • Currently, the exceptional sartan opportunity has lost its shine.
  • Inventory levels in the US are at an ATH (Q1FY22); how these go down over time will be a key indicator for more normalized pricing pressure
  • USFDA black swan risk: either through adverse action or lack of visits. (Record with USFDA is among the best)
    • Compliances have become increasingly stringent and regulatory standards determine every single operational aspect – from product quality to systemic accuracy and data integrity (including softer aspects). Regulatory audits can take place at any time as opposed to the earlier practice of them being planned months in advance. 
    • We still need to see how good their sterile capabilities are (in terms of compliance), given injectables are a key growth driver for them. Karkhadi plant getting approval or adverse action is a key trackable.

US FDA finds quality control, equipment issues at Alembic Pharma unit:  From Alembic Pharma: “None of the observations are related to data integrity and are procedural in nature”

  • China & Eastern European countries (with similar cost structures as India) are coming up with formulation plants; need to understand how this incremental competition pans out.
  • India’s drug price control regime is inconsistent in its implementation. The National List of Essential Medicines (NLEM) has drugs whose prices are decided by the government but without any industry representation.
    • More of Alembic’s portfolio included in NLEM will be a big risk to it’s India’s P&L.
  • Patriarch or chairman has a shady past; Chirayu Amin (cricket lovers will also know him as the interim chairman of the Indian Premier League in 2010, following the unceremonious exit of Lalit Modi as well as a former BCCI vice president)
    • In the Real Estate business, run by sibling’s youngest brother, Udit: owns over 100 acres of land in the city and is gradually developing portions of it into premium residential projects. Any developments here should be noticed.

Finally, Our Outlook:

Markets hate unpredictability. The generics space is proving to be highly unpredictable with booms due to the timing of ANDAs for when patents end and busts when competition inevitably comes in.

What happened in Q1FY22 was a zero dip in volumes but a dip of 38% in revenues due to price competition. This has led to previous guidance of FY22 EPS of 50 going out for a toss (given just a quarter before); Even the management has pointed out the extreme uncertainty that they face in the USA currently. (Long term bullish though)

Additionally, Management admits that hitting the first $ 500 million revenues (currently at $250-300m) in the US is not as hard as growing from thereon. They don’t want to get into biologics and biosimilars due to heavy upfront investments. They will evaluate future growth opportunities only after stabilizing according to the current capex, so if no sustainable future vision is provided; will remain at most a cyclical bet.

FY22 is when the costs of running the plants start: nearly 450crs & any operating leverage would only play out once the injectables plant is approved & the Launch of the new portfolio begins (FY24 at the very least as approvals after fillings take 2-3 years.)

Valuation: At the current EV/EBITDA of 11 & EV/ sales of 3; the valuations might look reasonable, however, given the non-quantifiable risks mentioned above & lack of any durable moats in the business, one should be cautious until the USFDA situation clears & check how the market share ramps up (in line with the competitive scenario) when molecules are launched.

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