Entero Healthcare Solutions is a pharmaceutical and healthcare products (medical devices and surgical consumables) distribution company supplying to pharmacies and hospitals. As of FY23, Entero supplies to 81,400 retail pharmacists and 3,400 hospitals and handles more than 64,500 SKU sourced from 1,900 pharma and healthcare companies. The distribution network covers 495 districts through its 74 warehouses as of FY23.

Established in 2018, the company has reported 36 per cent revenue CAGR in the last three years, to ₹3,300 crore in FY23, driven by organic and inorganic growth levers. But it is only in H1FY24 that the company reported its first profits since FY21 (the earliest reported period) at 0.6 per cent PAT margin. Even assuming a conservative 2-3 per cent PAT margins on the annualised H1FY24 operations (revenue of ₹1,895 crore), the stock may be valued at 48-72 times FY24 earnings.

Despite the structural factors supporting high growth, we recommend that investors wait till a track record of profitability, which is also proportional to the valuation, is established, before entering the stock. The IPO will raise ₹1,600 crore of which fresh issue is ₹1,000 crore.

Scope for high topline growth

The Indian pharmaceutical industry’s domestic arm will grow at a brisk 9-10 per cent in FY23-28, according to Crisil’s report in the RHP. Within the industry and specific to Entero, organic and inorganic growth levers further elevate the growth profile. Organic expansion accounted for two-thirds of the 36 per cent revenue CAGR in FY21-23, according to the company.

Entero generates high organic growth from improving wallet share, increasing geographic reach in existing markets and entering new markets. Entero’s SKU count has increased from 44,400 in FY21 to 64,000 now and retail pharmacists count doubled from 39,500 in FY21 to 81,400 now. Entero, established only in 2018, is in the nascent phase of growth and can experience high organic growth rates.

Industry consolidation provides the other lever for growth. The pharmaceutical distribution segment is highly fragmented, with 65,000 distributors handling 900,000 retail stores; organised distribution handles only 8-10 per cent of the volume, according to the RHP. With efficiency of inventory management, one-stop solution for retailers, digital experience, and high fill rates, organised distribution may improve its penetration, going forward.

Entero has acquired 34 distributors since its inception and the management expects to further heighten the pace with IPO funds. The synergy benefits for an unorganised player integrating into the organised fold provides a secure growth lever to Entero.

Margins yet to expand

After reporting average Gross/EBITDA/PAT margins of 8.1/1.4/-0.8 per cent in FY21-23, H1FY24 saw margin improvement to 8.9/2.9/0.6 per cent. Entero management highlighted three levers to improve margins —value added services and private label sales apart from procurement efficiencies. On the last lever, the scope may be limited, though, with COGS itself accounting for 90-92 per cent of sales in the distribution industry. Entero, on scaling up, can work on the current 6 per cent overhead costs to improve bottom lines.

Private labels (for surgical consumables, medical equipment and healthcare products) hitched onto Entero’s distribution network can generate 18-20 per cent gross margins. But scaling it to a sizeable portion of revenues is a tough task. Value added services include taking on a contract to promote a pharmaceutical portfolio, as done with Roche’s four nephrology products’ promotion in FY24. The management indicates that the 90-bps improvement in H1FY24 gross margins can be ascribed to this initiative and on further scaling can improve the margin profile.

Balance sheet as a driver

Growth aspirations will have a bearing on the balance sheet of Entero and the company has to manage growth efficiently to enhance shareholder value. Entero will turn cash-positive with IPO proceeds from 3.3 times net debt to EBITDA in H1FY24. The company intends to again leverage the post-IPO balance sheet for inorganic expansion, along with internal accruals. This may limit the margin gains from operational leverage, if Entero onboards debt similar to pre-IPO levels.

In the last three years, the company has raised ₹250 crore from convertible shares (no outstanding convertible shares now) and ₹267 crore from debt to finance its growth. But post the IPO, equity raise will be limited to restrict dilution and cost of debt should temper borrowing appetite. At already low EBITDA margins, a high net-debt would have a stronger impact on EBITDA margin pass-through to the bottom line.

On the other hand, the ₹1,000 crore fresh issue can nearly double its revenue base. This will be used for repayment of debt (₹142.5 crore), working capital funding (₹480 crore), inorganic initiatives and general corporate purposes (GCP). Except for GCP, the other three heads are geared towards acquisition as working capital accounts for roughly 70 per cent of acquisition costs, according to the company.

Assuming Entero stays course with its average 0.25 price to sales ratios for acquisitions, these fresh funds can add ₹4,000 crore revenues or double the FY24 revenue base. On the contrary, the IPO proposes 1.4 price to sales for Entero. Entero can glide on a high growth owing to industry growth, organic and inorganic opportunities. But the path to profitability will depend on operational leverage, value added and private label contribution and financial leverage post-IPO. As the company delivers clarity on margin glide path two-three quarters after listing, investors can look into the stock.