Lasa Supergenerics Limited (NSE: LASA), an India-based microcap API manufacturer focusing on the veterinary market seems ready to benefit from the global move to reduce reliance on China for the supply of APIs, which are used in the production of medicines.
These favorable macro tailwinds will help put the spotlight on a company that is fast positioning itself as a supplier of choice for animal medicine manufacturers. Over the last 12-18 months, the company has overcome some of the legacy management and market issues dogging revenue growth and profitability, refined manufacturing process, and expanded product range.
The recent acquisition of Sequent Scientific (NSE: SEQUENT), another major supplier of veterinary APIs, by Carlyle Group (NASDAQ: CG) and Eastman Kodak Co. (NYSE: KODK) scoring loan by the U.S. government for manufacturing of generic APIs goes to show not just the importance of the API manufacturing for the global pharmaceutical industry but also the relative under-appreciation of stocks like Lasa Supergenerics.
Now that Lasa is cranking up the growth, both organic and inorganic, and margins starting to expand, the valuation gap with local and global peers is shining bright.
Please note that this is just an academic exercise to understand the company for our understanding and NOT an investment recommendation or advice. INR is Indian Rupee. Crore (Cr.), a commonly used metric in India, is equal to 10 million.
Why we bought the stock at these levels?
Yes, we do own the stock. Why?
At current levels, what caught our attention was the valuation gap, whether we look at the business on a standalone basis, relative to peers in the industry, or compared to valuation at which Carlyle acquired the majority stake in Sequent Scientific.
The stock is trading at 12 times price/ earnings and 1.25 times price/ sales, based on last quarter’s numbers annualized while revenues grew at 40% during the last quarter compared to the same period last year. In the meantime, NIFTY 50 is trading at PE of 32.
Relative to Indian pharmaceutical players
As the chart above shows, almost every pharma name in India is trading at 2-3 times the valuation, based on both the price to earnings as well as the price to sales.
Compared to what Carlyle paid to acquire Sequent Scientific
Early May of this year, Carlyle Group acquired a 74% outstanding share of Sequent Scientific, another major API manufacturer with a focus on the veterinary medicine market, for INR 1587 Cr. (approx.$214 Million), which at today’s share will value the deal at approximately INR 2523 Cr.
|Carlyle Sequent Deal (Amt. in INR Cr.)|
|For share ownership||74%|
|Current Mkt. Cap Sequent||3,600|
|26% yet to buy worth||936|
|Total cost to Carlyle||2,523|
|Results Sequent 2019||Valuation paid|
|Net profit||85||P/ Earnings||29.7|
At the same time, Street continues to ignore Lasa Supergenerics, which grew significantly faster than Sequent during the previous quarter.
|FY Q1 2021||Annualized||Growth Y/Y|
|Sales (INR Cr.)||55||219||40%|
|Earnings (INR Cr.)||5||21|
More importantly, when we assigned valuation multiples, at which Carlyle acquired Sequent, to Lasa, a valuation gap of 40-60% was evident, as the chart below shows.
|How Lasa stacks against Sequent valuation|
|Market Cap (INR Cr.)|
|Lasa valuation using P/Sales of Sequent||475|
|Lasa valuation using P/E of Sequent||638|
|Current Mkt. cap of Lasa||275|
Yes, there are some differences between the two businesses; scale for one given Sequent is almost 5 times the size in terms of revenue. But both companies share numerous growth catalysts.
Why global investors love the sector?
Favorable dynamics for animal medicine industry
The global animal health industry has been a favorite among global institutional investors. After consolidation and divestiture in the broader animal health space, including Elanco Animal Health Inc. (NYSE: ELAN) acquiring Bayer Animal Health business for $6.8 billion earlier this year, the animal medicine industry is consolidated with top 10 players commanding almost 68% market share globally and growing at a steady 4.5-5% every year. Almost 68% of the households own pets in the U.S.
For API manufacturers focusing on the veterinary market, the recent shift to move away from China by the global pharmaceutical industry is another major factor that should help India-based API manufacturers like Lasa, which are already exporting globally. For both Lasa and Sequent, exports constitute almost 50% of the total sales.
Currently, China controls almost 20% of the global API production and enjoys a 20% price advantage over India, but with recent price hikes by China, the said advantage may have eased a bit.
The price of crude oil going down
The lower price of oil is good for API manufacturer’s margins since petroleum-derived solvents constitute almost 50% of the materials used in the manufacture of APIs. Petrochemical products like Benzene, Acetylsalicylic acid, Phenol, and Cumene are key elements for various APIs and medicines.
With oil hovering around $40 per barrel, it seems good times for API manufacturers may last a while.
Can Lasa monetize the opportunity?
No doubt, API manufacturing is a low-margin business and over-time commoditization hit every player, but the company definitely has all the right ingredients for the current market.
The company is young but promising and hungry to make a mark. Even though the business has been in operation since 2011, Lasa Supergenerics was separated from the parent company and listed as an independent company in 2017.
As a vertically integrated manufacturer of veterinary APIs, the company participates through the entire animal and human healthcare value chain, i.e. from discovery-to-delivery, allowing better margins. Secondly, the company holds patents on all the products that it manufactures with average validity of almost 20 years, further helping its competitive positioning and margin profile.
Finally got rid of the historical baggage
The first two years as an independent company were tough. Revenues suffered because of a major product getting discontinued worldwide and margin suffered due to a significant jump in raw material prices, mainly led by an increase in global crude prices.
All this happened when currency movements were going against Indian exporters and the newly separated company had debt on its books, even though 1/3rd of that debt was from promoter carrying zero interest cost. To top it all, shareholders new to the company, since Lasa Supergenerics shares were allotted based on shareholding in the parent company, had little patience to understand the underlying dynamics of the business.
Most of those legacy issues are behind the company.
Coming of age: Improving trends and other growth catalysts
The company seems to be finally focused on expansion, both organically and by acquiring strategic relevant businesses, and early results of the move are encouraging.
Last quarter, revenues increased by 40% over the same period last year and 12% sequentially. Net profit increased by 108% sequentially and EBITDA margins came increased to more than 22%. Performance that stands tall in the complete pharmaceutical food chain.
This year, the company has successfully entered the market for hormone and steroid APIs for Human applications. Having already received FDA approval to manufacture Progesterone, a steroid hormone used in the treatment of Amenorrhea and infertility treatment for women, the company started manufacturing early this year. The total market for Progesterone is estimated at around $80 million and the hormone and steroid API market is estimated to be around $400 million.
Building upon its efforts to penetrate the market for APIs for Human application, Lasa also partnered with the Institute of Chemical Technology to start manufacturing Favipiravir, an antiviral drug that can effectively inhibit the RNA viruses like influenza and Ebola, besides a promising antidote for the treatment of Covid-19.
Highlighting the management’s confidence in future trends and the health of balance sheet that is almost free of debt, the company, earlier this year, announced acquiring Harishree Aromatics and Chemicals Limited, to boost its manufacturing capacity. Even though financial details weren’t announced, combined operation is expected to drive the usual benefits associated with scale and operational efficiencies.
DISCLOSURE: We are long the shares of both Lasa Supergenerics and Sequent Scientific covered in this note.. Before writing a note, we usually ask (via Twitter and Stocktwits) for things readers would like us to cover in the note, please do share your views for our next note. This is purely an academic exercise for our internal use and you should NOT invest based on this note.