Granules India: BUY. Growing strong

The stock of small cap drug maker Granules India has more than doubled (2.5 times) since our buy recommendation in May 2014. This was thanks to the company’s strong performance helped by improving product mix (higher contribution from better margin formulations) and measures taken to prune costs.

Despite the sharp rally, the stock which has been re-rated in the last two years, is available at less than 12 times its estimated 2015-16 earnings. This implies an over 50 per cent discount to the BSE Healthcare Index.

Being a small cap stock, investors with a three-to-five year investment horizon can take measured exposure to the stock, given the strong growth potential over the medium term.

Granules is at an inflexion point and is expected to sustain healthy growth in excess of 20 per cent both on the revenue and profit front over the medium term. There are a few factors in the company’s favour.

First, capacity expansions should spur growth in revenue and profit. The company has set up an additional formulation intermediates block at Gagillapur (Telangana) with an annual capacity of 4,000 tonnes. The new block is expected to become operational by early next fiscal. Also, the company is expanding its Vizag facility which was acquired from Auctus Pharma in November 2013. This should help the company sustain healthy growth over the next two years.

Second, Granules’ Gagillapur facility was successfully inspected by the US FDA recently. This assumes significance given the company’s plans to expand its presence in the US. Granules expects the contribution from the US market to increase next year from the current 30 per cent (as a proportion of its standalone sales). Given the healthy margins in this geography, higher sales from the US should rev up profitability. Also, changing business mix in favour of higher margin formulation intermediates and finished dosage formulations should boost Granules’ profitability. The contribution from high-margin finished dosage formulations has increased steadily over the past few years — from 24 per cent in 2009-10 to 32 per cent in the nine months ended December 2014. In the recent December quarter, finished dosage formulations contributed 42 per cent of standalone sales; this is higher than the 39 per cent contribution during the same period last year.

Third, the company’s joint venture with the Belgian specialty chemicals player, Ajinomoto Omnichem, to supply high-value active pharma ingredients has commenced trial production. After approvals from regulatory agencies such as the US FDA, the joint venture will start commercial supplies. This should contribute to Granules’ revenues and profit. Finally, the company’s acquisition, Auctus Pharma, which was in the red at the time of the buy (November 2013), is expected to turn profitable in the current quarter.

Auctus’ product portfolio of 12 drugs, which includes blood thinner drug Clopidogrel, will boost Granules’ revenue and reduce concentration risk. Risks include delay in commissioning the new block at Gagillapur. Also, delay in FDA approval for the company’s joint venture with Omnichem may slow down the growth pace. Auctus’ return to profit will also be critical.

For the nine month period ended December 2014, Granules’ revenue grew 26 per cent to ₹896 crore, compared with the same period last year. Operating profit margin improved by 1.9 percentage points to 17.3 per cent. Net profit grew 21 per cent to Rs 67 crore during this period.

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