On eleventh of August 2016, Granules came out with the results for Q1 FY17. Let us try to look at the numbers for Q1 and evaluate the company’s performance for the first quarter. Before you continue further, I strongly recommend you to read the below link to get an overview of Granules India.

The below link provides the results analysis for Q4 FY16. Do skim through to get an overview of the results for the previous quarter.

Year-on-year performance

For Q1 FY17, Granules has reported the numbers in Ind AS standard. Ind AS is the new accounting standard. As per the standard the results for Q1 for Granules are as below:

YoY quarterly Results (As per Ind AS standard) Growth Q1 FY17 (Crores) Q1 FY16 (Crores)
Revenue 6.5% 343.7 322.6
EBITDA 11.71% 71.5 64
PAT 36.8% 39.0 28.5
EBIDTA Margin ( EBIDTA/Revenue) 1% 20.8% 19.8%
PAT Margin (PAT/Revenue) 2.51% 11.34% 8.83%

When I looked at the revenue numbers I was taken aback. 6.5% Y-o-Y growth was completely unexpected and I was mentally not prepared for these numbers. Moreover this was coming on top of a bad Q4 FY16 where the topline grew by 5%. I got a little nervous. I started to wonder if the growth is on track or the growth path is facing obstacles. Even the EBITDA numbers came in bad!  However when I looked at the PAT numbers the story was completely different. PAT seems to be much better. This was puzzling. How did the company manage to report huge PAT with limited revenue growth. A company can be efficient in managing the costs but the variation between the revenue growth and the PAT growth cannot be so divergent. That is when I realized that the numbers are based on the new Indian Accounting Standard (Ind AS). Ind AS mandates that the revenue from the subsidiaries should not be shown as a part of the overall revenue if the company does not have complete management control over the subsidiaries. In case of Granules, the company does not have a complete management control over Biocause and Omnichem JV. Hence they are forced to omit the revenue numbers for Biocause JV and Omnichem JV from their overall revenue numbers. But you are allowed to club the PAT from these JVs to your final PAT. No wonder we see a miniscule revenue growth and a huge PAT growth.

If we were to add back the revenue and EBITDA numbers of Biocause JV and the Omnichem JV (i.e. going back to the original IGAAP accounting), the numbers look as below:

YoY quarterly Results (As per the IGAAP standard) Growth Q1 FY17 (Crores) Q1 FY16 (Crores)
Revenue 20.4% 416.7 345.9
EBITDA 30.2% 83.2 63.9
PAT 36.8% 39.0 28.5
EBIDTA Margin ( EBIDTA/Revenue) 20% 18.4%
PAT Margin (PAT/Revenue) 11.34% 8.2%

So the revenue of 416.7 crores = 343.7 crores of non-Subsidiary income + 31 crores from Biocause + 41.9 crores from Omnichem JV. When we compare this number to the IGAAP number for Q1 FY16, the revenue growth is actually 20.4%. The EBITDA grew at 30.2% based on GAAP accounting. The PAT growth does not change between the Ind AS and GAAP accounting.

The revenue numbers of Ind AS mislead one to conclude that the revenue growth was mere 6.5%. One may ask that “Ind AS” would have taken care to remove Biocause and Omnichem numbers from Q1 FY16 as well so why doesn’t the revenue growth show 20% in Ind AS accounting? Well, we need to note that in Q1 FY16 there was no revenue from Omnichem JV as the sales from Omnichem JV started in August of 2016, hence the 41 crore that we see for Omnichem is a brand new sales numbers which get missed out in Ind AS accounting for “revenue”.  As stated above, when the PAT is calculated, Ind As allows the company to add the profits from Subsidiaries hence we notice the huge PAT jump.

The company believes that the revenue growth has not been as per expectation due to lower crude oil and raw material prices. Granules has a contract with its customers that if Granules’s cost price reduces then it is bound to reduce its selling price to its customer with a caveat that it is allowed to retain its margins. Hence the margins are healthy and improving but revenue growth is not as expected.

The table below shows the contribution of Formulations, PFI and API to the total sales. It is quite clear from the numbers that the company has been steadily moving towards being a finished goods manufacturer rather than a low margin API manufacturer. Heartening sign indeed.

Contributors Q1 FY17 Q1 FY16
Formulations 36% 29%
PFI 24% 30%
API 40% 41%

Business Contributors:

The table below shows the contribution of various generic molecules to the sales of Granules for Q1 Y-o-Y.  Paracetamol sales have dropped whereas Metformin and Ibuprofen sales have improved Y-o-Y. Hence, for Q1 FY17 collectively, Paracetamol, metformin and Ibuprofen contributed about 3/4th to the total revenue (76%). Over the years the contribution of these molecules has come down from 90% of the total revenue to 76%. As I was indicating in the Q4 FY16 analysis, this can be treated as a good news. It shows that the focus of the company is shifting towards high margin products.

Business Contributors Q1 FY17 Q1 FY16
Paracetamol 36% 42%
Metformin 29% 27%
Ibuprofen 11% 7%
Guaifenesin 6% 7%
Metocarbamol 3%
Others 14%

 Expenses:

The below number are for the Ind AS based accounting standard. I did not get the IGAAP based numbers for Q1, so I am using the IndAS numbers. Correspondingly the revenue numbers would also be used from Ind AS. The disadvantage of using Ind AS numbers is that we will not be able to capture the expenses from Omnichem JV and the biocause JV as the Ind As would have ignored them.

Expense Item Q1 FY17 (Crores) As a % of Revenue Q1 FY16 (Crores) As a % of Revenue
Raw Material 175.84 51.16% 185.39 57.46%
Employee Expense 33.90 9.8% 28.63 8.8%
Manufacturing Expense 22.68 6.5% 21.79 6.7%
R&D Expense 7.04 2% 4.25 1.3%
Other Expense 25.20 7.3% 20.44 6.3%

The expenses numbers were a pleasant surprise to me. Let me try to weave a story around these numbers to make sense of current numbers as well as the numbers for Q1 FY16.

  • The company has realized that it needs to “up its ante” and move from being a bulk generic drug manufacturer to a specialized drug manufacturer. So it has almost doubled its R&D expense from 4.25 crores to 7 crores.
  • If you are a bulk drug manufacturer then your employee quality can be mediocre. But once you start to manufacture specialized drugs you need employees with additional knowledge. Hence your employee expense as a percentage of sales goes up which is seen this quarter. The employee expense has gone up from 8.8% of sales to 9.8% of sales. Salary hikes are imminent in Q1. However, as a percentage of sales, the number should have remained constant. Increasing employee expense as a percentage of sales shows either an increase in headcount (for, hopefully, specialized staff) or higher wage hike for specific set of people.
  • As you start moving away from being a bulk drug manufacturer to a specialty drug manufacturer, you can earn more revenue by selling fewer drugs as you are at liberty to charge more (for example if you keep selling only paracetamol and you still want to earn more then you have to sell more of paracetamol. You are not really at liberty to increase the price else competition will outsell you). Hence if you are just a bulk drug manufacturer your raw material cost would be more. But we see that raw material cost has come down in Q1 FY17 compared to Q1 FY16. One of the reasons could be attributed to the fact that raw materials are cheaper and crude oil is cheaper, hence naturally the raw material costs are less. But then as a percentage of sale, the numbers have seen a significant drop from 57% to 51%. This also proves that there might be something more than just the fact that raw materials are cheaper. One possibility is that the company is manufacturing higher number of high-margin products.

Reduction of raw material cost has a direct impact on the profit margins as it forms a major chunk of expenses. No wonder the profit margins have jumped from 8.2% to 11.3%! A significant achievement in one year. I like to keep an eye on the profit margins. An improvement in profit margins, due to legitimate reasons, always excites me!

  • Manufacturing expense has stayed flat with increasing revenues which is again a good sign.

If my above assessment is true and if this path is sustainable then we are in for a pleasant journey in future.

Individual Products:

  • Ibuprofen Rx had sales of Rs. 17 crores in Q1 FY17
  • Abacavir had sales of Rs 4.5 crores in Q1 FY17
  • Zegerid OTC, which the company planned to sell in US, is on hold. Apparently there are many sellers of the product. Looks like Granules does not want to be a “me-too” player and is concerned about margins. Seems to be a calculated step but will result in loss of additional revenue that would have come, had the company went ahead and launched it.
  • OTC business (store brand OTC) as a whole is going slow, it should pick up in FY19 after the “big” customers in US are convinced that Granules can deliver sustained supplies.

Joint Venture and Subsidiary performance:

Actus (API division)

Actus had sales of 43 crores in Q1 FY17 compared to 37 crores in Q1 FY16. Actus saw a profit of 25 lakhs in Q1 FY17 compared to a loss of 4.1 crores in Q1 FY16. I get a feeling that Actus is more of an in-house API developer and enabler for filing ANDAs rather than being a contributor to the bottom-line of the company.

OmniChem JV

This year Omnichem should have a revenue of 180-200 crores at JV level (Granules will get 50% of this projected number). Out of this, the JV in Q1 FY17 has already seen a revenue of 80 crores. Q4 FY17 will again see a revenue of about 90 crores. This means that Q2 and Q3 are going to be lackluster (probably 10-15 crores per quarter). The sales numbers for Omnichem JV are not comparable to Q1 FY16 as there was no sales from Omnichem JV last year.

Biocause JV

Biocause saw sales of about 62 crores at JV level which translated to about 31 crores for Granules. A profit of about 6.2 crores was seen at JV level which translates to about 3.1 crores for Granules. In Q1 of FY16 Granules saw a profit of about 0.1 crores.  To me, the Biocause JV is a mere revenue generator. It does not contribute meaningfully to the profits. Things might change with the Ibuprofen Rx where the company might see higher margins that in-turn might add to the bottom-line.

Granules USA (GUSA) and Granules Pharma Inc (GPI)

This Quarter saw an interesting move by Granules. It bought 12.5% stake in early stage drug manufacturing company called USPharma for $4 million. This stake in US Pharma, gives Granules the first right of refusal on the products that USPharma manufactures. In return Granules shall market the products of USPharma in US. Believe me, when I heard this I was a little surprised. An Indian manufacturer shall be marketing products in US that are manufactured by a company which is a US based company (and to top it all, the company is named USPharma)! Krishna Prasad, the MD of Granules, went great lengths to explain the rationale for such a tie-up. Granules has setup an exhaustive marketing network in US that enables it to act as a marketing agent and be good at it. He believes that companies in US recognize this fact. Hence the trust in Granules to market the products in US. Moreover, Granules has about two and half decade of experience in US. Ahem ahem!

USPharma has 5 products in its kitty. Out of these five, four are USFDA approved and the first one will be in market by FY18. The four products that have got USFDA approval have been filed as para IV filings. So USPharma may get 180 days exclusive period on these four ANDAs. Granules may get a share of the sales revenue from these products as marketing revenue. By the way granules is paying an additional $1.5 million per ANDA (resulting in $6 million) for the four ANDAs that it has got access to. In all, Granules might end up paying $10 million (i.e. $6 million for the four ANDAs and $4 million for the 12.5% stake in the company).

By the way on the ANDAs front, Granules has filed two ANDAs in Q1 FY17. It plans to file six to eight ANDAs in FY17 which will come from both Indian arm as well as from the US arm.

Region Wise Sales

In Q4, the company saw 68% of its sales coming from regulated markets like the US, Canada and Europe. The rest came from unregulated/semi-regulated markets like India. Compared to Q1 FY16 there was an increase of 4% in sales from the regulated markets.

Region Wise Sale Q1 FY17  Q1 FY16
Regulated Market (US, Canada, Europe) 68% 64%
Unregulated Market (India, Latin America, ROW) 32% 36%

Loans:

In this quarter I did not hear the management talk about loans.

Debt-to-Equity:

The current debt-to-networth stands at: 0.5%. The company is not looking at using debt to fuel the growth but is not averse to take on debt considering the fact that the debt-to-net worth has just reached manageable state.

CAPEX Plans:

CAPEX (Fund) requirement for FY17 is now refined to Rs. 314 crores. This shall predominantly be used to increase the capacity of Metformin and Guaifensein. Additionally new API facility is planned in Vizag and a PFI facility is planned in Gagillapur.

Taxes:

The tax rate for Q1 FY17 was at 32.5%. As we noted in Q4 FY16 numbers (Click Here), the company wants to achieve the tax rate of 33% for FY17. In Q1 they seem to be on track with respect to their target to cap the taxes at around 33%. But then, there could be cyclical reasons for lower taxes. We need to keep a watch on the tax numbers for the upcoming quarters.

Other Titbits:

Capacity: The current capacity of Paracetamol is about 18,000 tons. Metformin capacity is about 2,000 tons. Guaifenesin capacity is about 1,200 tons and Methocarbamol capacity is about 360 tons. In future the Paracetamol capacity will be expanded by 5,000 tons. Metformin will see capacity expansion by about 7,000 tons and Guaifenesin is going to more than double i.e. the capacity is going to be expanded by 2,000 tons. The expansion is going to be complete by Q4 FY17 or latest by Q1 FY18.

ROE: The Company is planning to maintain an ROE of 21%.

Cash Flow: The Company may not be cash flow positive for the next three years. All the cash from operational activities is getting eaten up in CAPEX expansion. I saw substantial amount of cash going in Interest payment for short-term and long-term loans.

 

Summary:

The initial revenue numbers were indeed surprising. But then, on digging deeper I realized that the revenue numbers are not that bad. EBITDA growth based on IGAAP seem to be good. PAT at 36% is wonderful!

But the cherry on the cake lies somewhere else. The PAT margins that came in at 11.34% and the secondly the expenses numbers are encouraging. The raw material costs are down by a significant margin, manufacturing expenses are flat, R&D expenses have doubled. All these are good news!

Overall the numbers were satisfactory. If the company improves the profit margins by focusing on specialty drugs then the company shall see even higher profit growth backed by revenue growth. The damper was Krishna Prasad’s observation that the company will not be cash flow positive for at least three years.

Another important point to note is that Omnichem JV is going to have marginal revenue addition to Q2 and Q3 FY17. I am guessing about 7-10 crores of revenue per quarter resulting in about 1-2 crores of profit per quarter for Q2 and Q3 FY17. This may impact the overall revenue and profit numbers for both Q2 and Q3 of FY17.

I believe we are in for a phase of consolidation for the next two quarters. Brace yourself for a slow and steady ride in the short term. Beyond that, the CAPEX may eat away the cash flow from operations till probably FY18. So we might have a moderate and steady ride in FY18. Predicting beyond FY18 is mere speculation.

References:

[1] Granules India Q1 FY17 results press release and investor presentation.

[2] Granules India – Conference call – Q1 FY17

Disclaimer:

I am not a SEBI registered research analyst. The information provided above is my subjective view based on what I have read on different websites, annual reports, and quarterly reports of various companies which I assume to be accurate. The above information should not be treated as an offer/advise to purchase a specific stock/investment instrument. Since these are my subjective opinions, I could be wrong in my understanding or presentation of information. I do not claim that the above information is complete or can be relied upon as such. I cannot be held responsible for any loss or damage caused due to any inadvertent error in the above information. I will not be liable for investment decisions made by readers of this article based on the above information. I am not an investment advisor. I may or may not have position in the above company. Please consult your investment advisor for all your investment needs.