Before we start off, I would like to inform that this would be my last post for the calendar year 2016. This year has been an amazing ride for the equities. I have had a great time watching the companies grow their earnings in spite of all the challenges thrust upon them which are/were beyond their control.
Towards the end of October, the Q2 FY17 results for Granules were announced. Let us take a look at the results. But before we delve further into the results, I suggest you look at the following links in case you have not gone through them. They can form a basis for the results for Q2.

Financial Analysis
The Q2 FY17 numbers for Granules are given below. The numbers are as per IndAS standard

YoY quarterly Results   Growth Q2 FY17 (crores) Q2 FY16 (Crores)
Revenue 3% 363.80  352.90
EBITDA 12% 78 69.6
PAT 26%  40.82 32.27
EBITDA Margin 21.44% 19.72%
PAT Margin 11.22% 9.17%

Revenue growth has been disappointing. Krishna Prasad touched on this aspect. There are two main reasons for the revenue stagnation:

  • Capacity constraints: API manufacturing plants seem to have hit maximum utilization. This should get resolved with the capacity expansion planned in future. Capacity expansion is planned for Paracetamol, Metformin and Guaifensein. With close to 80% utilization of the API facility, no wonder the company is not able to meet up the demands.
  • The price of para-aminophenol (PAP) which is used in manufacturing Paracetamol has gone down by 15-20%. Hence Paracetamol selling price has also come down. However Granules has agreements with its customers to maintain its profit margins. So its profit margin remain intact, but revenue growth will be less. No wonder the Revenue growth is 3% and PAT grew at 26%
    Currently the contribution of new molecules (i.e. molecules other than the 5 base molecules) to the overall revenue is not very significant. In the next three years these should make up 30-40% of the revenue. This is a good to hear. This means the company is serious about improving the topline and bottomline by moving away from its comfort zone of bulk drugs.
    Another revenue and PAT enhancer would be the Formulation sales. Currently formulations forms 37% of revenue. The intent of the company is to take it to about 65% of the revenue in the long term. The EBITDA margins for API is around 10% whereas the EBITDA margins of formulations is close to 20%. So a shift to formulations from 37% of total sales to 65% of total sales with double the profit margins is indeed a happy prospect isn’t it?

The numbers as per GAAP standards are as below:

YoY quarterly Results Growth Q2 FY17 (Crores) Q2 FY16 (Crores)
Revenue 3.4% 378.5  366
EBITDA 19.2% 83.5 70
PAT 31.6% 40.82  31
EBITDA Margin 22% 19.1%
PAT Margin 10.78% 8.4%

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 moving towards being a finished goods (i.e. formulations) manufacturer rather than a low margin API manufacturer. Heartening sign indeed.

Contributors Q2 FY17 Q2 FY16 EBITDA Margins
Formulations 37% 30% 20%
PFI 26% 28% 20%
API 37% 42% 10%

The table below shows the contribution of various generic molecules to the sales of Granules for Q1 Y-o-Y. Paracetamol contribution to the overall revenue have dropped whereas Metformin and Ibuprofen share has improved Y-o-Y.

Business Contributors Q2 FY17 Q2 FY16
Paracetamol 33% 37%
Metformin 30% 25%
Ibuprofen 13% 10%
Guaifenesin 5% 6%
Metocarbamol 3% 4%

Expenses:

The table below shows the comparison of year-on-year expenses for Q2.

Expense Item Q2 FY17 (Crores) As a % of Revenue Q2 FY16 (Crores) As a % of Revenue
Raw Material 169.16 46.49% 205.81 58.31%
Employee Expense 33.97 9.33% 28.51 8.07%
Manufacturing Expense 25.59 7.03% 21.58 6.1%
R&D Expense 6.50 1.7% 3.00 0.8%
Other Expense 24.03 6.6% 21.96 6.22%

Except for the sudden drop in raw material price all other items seem to be in-line. The drop in raw material cost as well as its share as a percentage of revenue was a surprise to me. MD has accepted that the raw material costs have come down. But then the revenue did not come down at the same rate. Which effectively means that the company was able to defend its profit margins. This is one of the most import signs of a company with a moat. If it is able to sustain its profit margins with lowering input costs then it means it has some command over its customers. It shows that customers of granules value the quality of the product that granules provides them and they see no reason to go to a lower cost supplier. I am glad to see this.

Actus (API division)
Actus saw sales of 47 crores (compared to 43 crore in Q2 FY16). The unit saw profit of 30 lakhs. By the way, Actus is predominantly being used for captive consumption, hence tracking its profits may not make much sense.

OmniChem JV
At the JV level the sales are at Rs 8.2 crores (Granules share out of this would be 4.1 crores). As noted in Q1 FY, for Q1 the sales numbers were 80 crores. This huge drop in sales was expected and the management had forewarned about this in Q1. In fact Q3 would also have miniscule sales. Q4 should see sales of more than 80 crores (possibly 90 crores).
Since the APIs (intermediates) being developed in Omnichem are complex, they have a cycle time of 6 months. The first wave of sales were seen in Q1. The next wave of sales would be seen six months from Q1 which is Q4. However as the number of APIs manufactured by the JV increases, this cyclicality would get corrected and the JV should see uniform sales in the future FYs.
For FY18 many new intermediates might be manufactured. Moreover the company is expecting approval from USFDA in the next FY. So the JV might see API manufacturing to begin next year. Krishna prasad seems pretty optimistic about the JV.
At the end of Q2, the capacity utilization for the Omnichem JV plant stands at about 60%.

Biocause JV
Biocause JV recorded sales of 65.8 crores with a profit at the JV level of 8.8 crores (Granules share would be 4.4 crores). For the first time I am seeing profits of this scale in the Biocause JV. There was hardly any profit from the Biocause JV.
An interesting point about Biocause came out this quarter. Granules has an exclusivity agreement with Biocause for Ibuprofein. However it does not stop each of the companies to start a new manufacturing plant for Ibuprofein. Granules in not interested in a new plant for Ibuprofein due to other priorities. This effectively means that Granules does not anticipate higher margins in Ibuprofein. However I am hoping that if the Ibuprofein Rx business picks up in US then there should be a higher demand for the finished product.

Granules USA (GUSA) and Granules Pharma Inc (GPI)
Store brand OTC sales in US is growing at a gradual rate. For FY17 the estimated sales is between $2 to $2.5 million. This is pretty small considering the scope of growth. Store brand OTC is a game of patience. Granules has to gain customers confidence for it to get bigger orders. This will take time. The company has spent about 133 crores ($20 million) on the Virginia facility till now. This year the company may spend about 112 crores more. The Virginia facility may file two products this year and in FY18 the facility might see 5-6 filings. Management seems very optimistic of the plans for the Virginia facility for FY20. They believe that some very interesting products shall be commercialized from this facility by FY20. This is good news and I would be eager to get more information on this.

Region Wise Sales:
The table below shows region wise sales. The sales have got further skewed towards the regulated markets.

Region Wise Sale Q2 FY17 Q2 FY16
Regulated Market (US, Canada, Europe) 63% 53%
Unregulated Market (India, Latin America, ROW)  37% 47%

CAPEX:
CAPEX (Fund) requirement for FY17 stays at Rs. 314 crores. This shall predominantly be used to increase the capacity of Paracetamol, Metformin and Guaifensein. Additionally new API facility is planned in Vizag and a PFI facility is planned in Gagillapur. Some of it will also go to Virginia Plant.
There shall be additional CAPEX requirement in FY18. By Q3 (or at the max Q4), the company would have identified the amount of CAPEX for FY18. The CAPEX needs shall be met with internal accruals and possibly by new debt or issuance of equity. The CAPEX shall be used for a Greenfield (New) API manufacturing plant in Vizag as well as for the Granules Pharmaceuticals Inc. in Virginia. The Store brand OTC segment does not need any CAPEX this FY.
Most of the CAPEX is to improve capacity of API and PFI. FD capacity utilization currently stands at 50-55%. Hence FD capacity enhancement is not needed in the near term.

Loans:
As of Q2 FY17, Granules has long term loans at 212 crores. The Working capital loans are at 405 crores.

Individual Products:

  • Ibuprofen Rx had a sale of Rs 14.3 crores. In previous quarter (i.e. Q1 FY17) the sales were Rs. 17 crores.
  • Abacavir has a sale of Rs. 3.5 crores. In previous quarter (i.e Q1 FY17) the sales were Rs 4.5 crores.
  • Multiple sclerosis drug sales have not yet started.
  • Out of the four molecules of USPharma, one of them is planned to be commercialized by end of FY18 or early FY19. All the four products might see launches at different times during FY19. USPharma is additionally developing two more molecules.
  • Paracetamol sales growth has more or less stagnated. The growth that is currently happening is predominantly NOT organic growth. It is due to snatching of sales volume from competitors. I don’t see Paracetamol bringing in huge growth in future. It will eventually be more of a revenue stabilizer. Granules has a global market share of 20% for paracetamol.

Titbits:

  • Capacity: The new capacity being built for Metformin (the entire 7000 tons of additional capacity) and Guaifenesin should be ready by Feb 2017. Paracetamol capacity expansion would be completed by around May 2017
  • Promoters have been pledging their shares. Krishna Prasad clarified that the pledging is purely to fund the additional share purchases done by the promoters.
  • The company is setting up a UK subsidiary. This is being setup only to cater to a specific customer and that too as a warehouse. No manufacturing or sales is planned form this Subsidiary.

Summary

  • The revenue growth was very tepid. The major contributor to that was the drop in raw material cost which brings down the sale price of the product resulting in lower revenue.
  • But the positive side is the decent growth in the PAT numbers. This was due to the fact that in spite of decrease in raw material cost the company was able to maintain its profit margins. Which is an excellent sign of a strong company.
  • Omnichem JV saw megre sales which was expected for this quarter and will continue in Q3 as well.
  • I notice the management mumbling about taking on debt or selling equity in FY18. And here I sit on my seat turning from one side to the other with an unease. The company already has debt with the Deb-to-equity standing at 0.6. Raising money via equity is always a sour point for an existing share holder. This is the side effect of being a bulk drug manufacturer. CAPEX is a constant requirement.
  • Granules is a long term story that should start to unfold in FY19 or FY20. With a current market cap of 2500 crores and all the positive triggers this seems to be an exciting journey.

References:
[1] Granules India Limited Q2 FY17 results
[2] Granules India Limited Q2 FY17 conference call

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.