Shilpa Medicare: Preferred vehicle to ride the Oncology bandwagon

Let's discuss today about the stock I am most bullish on at current levels for the year ahead - Shilpa Medicare. 

Shilpa has been one of the many brilliant discoveries of Ayush Mittal (of Dalal-Street fame) who have been tracking this since July '09 and already sitting pretty on a five bagger. Well done Ayush :)

Before we get started on this, would ask readers to go through the following links on the pharma sector at EquityMaster and ValuePickr (use the follow up reads too). 

Pharma as you know is a very complex sector and we have seen many debacles in the past one year. Sun Pharma's patent settlement with Pfizer, USFDA ban on Wockhardt and Ranbaxy are some of the major debacles which cost their shareholders heavily. Thus one must be aware of the risks before assuming this to be a "safe" or "defensive" sector.

Within the Pharma space, Oncology or Cancer drugs are showing the fastest growth.Sites one report, 

"...Oncology products have grown at more than double the rate of global pharmaceuticals, with a CAGR of 8.39% during 2004–’08.  Reasons for the robust growth of the oncology market are :

    • Increased use of targeted therapeutics, including more patients accessing modern
       targeted therapies in emerging markets 
    • Premium pricing for targeted brands as compared to cytotoxic therapies 
       and antihormonal therapies 
    • Longer treatment duration for patients due to longer survival and adjuvant treatment 
    • Earlier detection of disease with the availability of new screening procedures....."

Another ET report suggests similar potential for Indian Oncology market, 

"Chemotherapy, biologics, targeted therapy, hormonal therapy, and supportive care are the different types of available cancer treatment in India. Among this chemotherapy recorded the highest market value of approximately Rs 700 crore in 2012. Oncology market in India is forecasted to grow to Rs 3,831 crore by 2017," a study by Frost & Sullivan said."

Within the Oncology space, Shilpa offers one of the best bets in terms of seasoned capabilities and smaller market cap to ride this opportunity better as an investor. Starting from very humble beginnings in 1987 the company has shaped up well with strong R&D laden pipeline of 30+ products in the Oncology space. 

Oncology portfolio

Shilpa currently boasts of 25+ products strong present Oncology portfolio along with regulatory approvals across the world (and many pending). There are also 15+ oncology APIs under development. The key difference with other similar generic capabilities is the complexity involved in these. This space thus has much lower competition and hence higher margins. Also because of limited competition the post patent price erosion here is much lesser, hence provides opportunity of margins for both API manufacturers and generic marketers.

AntiRetroVirals

There is an alarming increase in patients of HIV/AIDs belonging to underdeveloped economies. In June 2013, Shilpa has signed an agreement with The United Nations-backed Medicines Patent Pool (MPP) and Gilead Sciences to increase access to medicines for HIV/AIDS treatment.

As part of this agreement, Shilpa will now be able to produce five key HIV medicines i.e. Tenofovir, Emtricitabine, Cobicistat, Elvitegravir and a combination of the four, known as "the Quad" for sale in over 100 countries, depending on the medicine. Post technology transfer Shilpa will be able to produce these at an even lower cost.

Formulation Foray

Backed by strong R&D capabilities from its centers at Raichur and Vizag the company is forward integrating to own formulations. The state of the art formulations unit at Pharma Park Jadcherla (SEZ) in AP will cater to Shilpa's own formulations also along with contract research and bulk API production for other partners. 

Company currently has API units at Raichur (Unit I and 100% Export oriented Unit II, while Unit III is coming up). It has formulation units at Jadcherla while one coming up besides the API units at Raichur

Key Subsidiaries

The subsidiaries form an important part of the Shilpa. Here's a brief snapshot of the subsidiaries.

Subsidiary	Details
1. Raichem Lifesciences (P) Limited (RLSPL) (Merged with parent in FY13)	Incorporated as the marketing unit for their formulation foray (in Oral, Injectibles and Lyophilised segments), it became a 100% subsidiary in FY13.  The SEZ at Jedcharla was conceived under Raichem Lifesciences. The subsidiary was involved in marketing activity since FY10. It incurred overall losses (59.27 lacs in FY11, 59.14 lacs in FY12) which was spending on establishing the marketing network. Finally with the completion of Jedcharla SEZ, it was merged to parent in FY13 w.e.f. 01-04-2011. The commercial operations after the initial stabilization period (trial runs, dossiers being sent for final regulatory approvals etc.) is expected to commence from Q3FY14 onwards.
2. Raichem Medicare Pvt limited	Raichem Medicare(P) Ltd. was incorporated in FY09 considering the good demand for Shilpa's Custom Synthesis products and capacity constraints in the existing production facilities. A 50:50 JV was formed with the "Industria Chimica Emiliana S.r.l, Italy" and "Prodotti Chini Alimetari S.p.A, Italy". During FY11, with further investment of Rs.164.98 lacs in Raichem Medicare Private Limited (RMPL) it became a subsidiary of the company. The proposed Unit III at Raichur, Karnataka is coming up adjacent to Shilpa's main plant in Raichur with total outlay of 40 crores. It earned a profit of Rs 23 lacs in FY13 from surplus funds. Civil construction has started and company also place orders for major equipment and machineries. It will be operational by FY 14 end-FY15.
3. Loba Feinchemie, Austria	Shipa acquired Loba Feinchemie, Austria through Zatortia holdings in 2007. Up to 2013 they invested total 23.29 crores as equity. The company turned cash positive in FY10 and profitable in FY12.   Year    FY 09 FY 10 FY 11 FY 12 FY 13 Sales 31.16 29.72 31.24 36.53 40.25 PBT -8.77 -2.29 -0.47 1.99 1.72 Loba Feinchemie, Austria has APIs, Laboratory Chemicals & Customs Synthesis manufacturing facilities and the strong marketing network in European countries. The marketing network (with their forthcoming formulations foray) and access to regulated markets was primary reason for this acquisition rather than immediate profitability.
3A. Zatortia holdings ( Holding company of Loba)
4. Nu Therapeutics Private Limited (NTPL)	Shilpa acquired 25.08% of equity stake in Nu Therapeutics Private Limited (FY09) a formulation developing company with an option to acquire up to 50.1% of equity shares as a strategic investment.It acquired further stake in FY11 to 67% ( Total equity outlay of 7.7 Cr as on FY 13 ). Nu therapeutics possess novel oral fast dissolving thin strip technology. It commenced production in FY12 and earned cash profit. FY 13 Revenues and profits were 2.5 Cr and 3.06 lac respectively. While expansion plan has been chalked out with land acquired, machines installed, it is awaiting for the approval of Government for its new products. This technology might be future growth driver for Shilpa.

Financials

Here's a look at the last 5 years financials, as seen from below, profits has been almost stagnant over the past 5 years, while revenues have grown 45%. Company has maintained consistent dividend payout over the past. 

Figures in Rs Cr	FY 09	FY 10	FY 11	FY 12	FY13
Sales Turnover	169	270	296	324	378
Other Income	1	2	5	9	5
Stock Adjustments	0	13	-9	18	-3
Total Income	170	285	292	351	380
( - ) Raw Materials	94	150	154	202	212
( - ) Excise Duty	2	5	6	6	7
( - ) Power & Fuel Cost	5	6	7	9	11
( - ) Other Manufacturing Expenses	2	4	4	10	11
( - ) Employee Cost	24	28	33	34	43
( - ) Selling and Administration Expenses	7	11	9	13	19
( - ) Miscellaneous Expenses	12	-1	-1	7	4
Profit before Interest, Depreciation & Tax	23	82	80	70	75
( - ) Interest & Financial Charges	6	6	3	2	2
Profit before Depreciation & Tax	17	76	77	68	72
( - ) Depreciation	9	13	13	14	15
Profit Before Tax	8	64	64	53	57
( - ) Tax	9	21	15	12	10
Profit After Tax	-1	43	49	41	47
Equity Dividend (%)	25	35	40	45	65
Earning Per Share (Rs.)	0.0	19.3	20.4	16.7	19.1
Book Value	27	46	91	113	131

Looking at the common size metric, the company enjoys fairly handsome operating margins while the other costs would come down significantly with enhanced operations and further margin improvement from their formulations foray.

	Common Size Metric
Figures in Rs Cr	FY 09	FY 10	FY 11	FY 12	FY13
Sales Turnover	99%	95%	101%	92%	100%
Other Income	1%	1%	2%	3%	1%
Stock Adjustments	0%	5%	-3%	5%	-1%
Total Income	100%	100%	100%	100%	100%
( - ) Raw Materials	55%	52%	53%	58%	56%
( - ) Excise Duty	1%	2%	2%	2%	2%
( - ) Power & Fuel Cost	3%	2%	2%	3%	3%
( - ) Other Manufacturing Expenses	1%	1%	2%	3%	3%
( - ) Employee Cost	14%	10%	11%	10%	11%
( - ) Selling and Administration Expenses	4%	4%	3%	4%	5%
( - ) Miscellaneous Expenses	7%	0%	0%	2%	1%
Profit before Interest, Depreciation & Tax	14%	29%	27%	20%	20%
( - ) Interest & Financial Charges	4%	2%	1%	1%	1%
Profit before Depreciation & Tax	10%	27%	26%	19%	19%
( - ) Depreciation	6%	4%	4%	4%	4%
Profit Before Tax	5%	22%	22%	15%	15%
( - ) Tax	5%	7%	5%	3%	3%
Profit After Tax	-1%	15%	17%	12%	12%

R&D Spends 

It is highly critical for the company to maintain quality R&D spend in terms of research as well as regulatory filings. The company has in fact improved R&D spend significantly over the last 5 years.

Figures in Rs Cr	FY 09	FY 10	FY 11	FY 12	FY 13
Sales(Net of Excise)	166	265	290	318	371
PAT	-1	43	50	42	47
R&D Spend	0.5	2.2	1.9	19.3	21.7
R&D Capex	0.1	0.3	0.3	10.6	5.5
As %age of PAT	0.0%	5.2%	3.9%	46.4%	45.7%
As %age of Sales	0.3%	0.8%	0.7%	6.1%	5.8%

Forex Woes

Shilpa's quarterly numbers are often plagued by huge forex losses, but over a larger period there's hardly any significant dent to profits. Hence any short term aberrations from forex woes might provide additional entry points to long term investors here. As we see from below Forex adjusted NPM is hardly 1% above the reported average NPM.

Figures in Rs Cr	FY 09	FY 10	FY 11	FY 12	FY 13
Forex Loss/(Gain)	10	4	(4)	3	(1)
As %age of PAT	-988%	10%	-8%	7%	-2%
Forex Adjusted PAT	9	47	46	44	46
Reported NPM	-1%	16%	17%	13%	13%
Forex Adjusted NPM	6%	18%	16%	14%	13%

Robust Balance Sheet

Now comes the most interesting part. Since till now Shilpa was more of a API and CRAMs play there is high correlation between completed capex resulting into high sales over the immediate future. With Jadcherla SEZ gearing up for commercial production and foray into higher margin formulations investors might be in for exciting times.

Line Item	Mar-09	Mar-10	Mar-11	Mar-12	Mar-13	Sep-13
Change in Net Block (Y/Y)	64%	2%	-1%	14%	8%	58%*
Change in Sales (Y/Y)	74%	59%	10%	10%	17%	34%*

* compared to FY13E on Mar-31

However, one major concern for a company of Shilpa's size undergoing this major capex (100Cr+ , over 50% of the then net block) is working capital management and debt servicing. 

But the Sep-30, 2013 balance sheet is a delight on both counts. The company has managed working capital beautifully, and D/E has in fact come down in the last 6 months. Also the operating cash flows over the past 6 years have always been robust. 

	Mar-08	Mar-09	Mar-10	Mar-11	Mar-12	Mar-13	Sep-13
Sales	95.81	166.43	264.91	290.29	318.18	371.32	249.59
Working Capital	39.04	21.17	24.95	124.87	34.69	84.43	67.00
Wcap as %Sales	41%	13%	9%	43%	11%	23%	27%
Op Cash Flow	6.93	29.74	53.52	42.61	56.73	43.50
as %age of PAT	61%	NA	126%	87%	138%	92%
Total debt	88.28	112.43	77.27	57.39	46.32	115.53	83.78
Net Block	87.85	144.51	147.55	146.25	166.61	180.67	286.01
Debt/Equity	1.00	0.78	0.52	0.39	0.28	0.64	0.29

Projections: Future growth ahead. 

Equipped with the above here's a take on the earnings ahead. Here are the key assumptions for the proposed model to project future earnings.

Assumptions:
Operating Margin	Move toward FY11 levels post full cap-ex to OPM of 25-27%
Depreciation	Considered over full Net Block as on Mar-13, Sep-13. Should reduce from FY15 onwards
Interest	Charged considering higher outgo and debt outstanding Mar-13, Sep-13
Tax	Considered at 25% for rest of FY14, 30% for FY15

Future Earnings

Period	FY13	FY14E	FY15E
Total Income	383.43	546.54	759.80
EBIT	59.26	108.33	171.03
Net Profit	47.46	80.16	117.57
% Net margin	12.4%	14.7%	15.5%
Projected EPS	19.37	21.78	31.95
Reported EPS		20.10

As discussed above, the Forex losses can swing quarterly numbers but won't materially impact the overall PAT. The reported EPS here thus deviates from Projected EPS because of recent forex loss of 9.58 Cr (in Q2FY14). 

Based on a trailing P/E assumption of 18x-20x for Shilpa we arrive at the June -2015 price target of Rs 570 - 640 levels. On a 18 months time frame this is 62-73% CAGR opportunity based on current market price of Rs 280. 

Views invited. 

Disclosure: Invested.