The stock of active ingredients and drug formulations maker Granules India has rallied almost 46 per cent from our last buy call given in March 2019, thanks to its favourable product mix and healthy show in the US market.

The company’s large capex spend over the past three years has started to pay off.

Granules India has improved its R&D capabilities, which is now aiding revenue growth.

In the nine months ended 2019-20, Granules’ consolidated revenue grew by 20 per cent (year-on-year) at ₹1,999 crore and net profit was up by 41 per cent at ₹243 crore. The company’s operating margin stood at 22 per cent during the period.

The growth prospects of the company over the medium-to-long run remain healthy, thanks to changing the product mix in favour of the high-margin formulations business, optimal utilisation of increased capacities and scaling up of US generics operations.

The commercialisation of multi-product API (active pharmaceutical ingredient) and oncology facility is likely to open new avenues for revenue generation for the company. With stabilisation of raw material prices, regulatory approvals in place and NDA (new drug application) approvals, the company’s growth momentum is expected to continue in the subsequent quarters.

At the current price of ₹175, the stock trades at about 10.5 times its estimated FY2020-21 per-share earnings; its mid-cap peers Jubilant Life Sciences and JB Chemicals trade at 9 and 15 times their respective FY2020-21 per-share earnings. Investors with a long-term time horizon can accumulate the stock.

Robust business model

Granules India is one of the leading manufacturers of molecules such as Ibuprofen, Paracetamol, Metformin, Methocarbamol, Guaifenesin and three newly launched molecules — Losartan, Cetirizine and Fexofenadine. The company manufactures and sells these molecules in all formats — APIs, PFIs (pharmaceutical formulation intermediates) and FDs (finished dosages business).

About 80 per cent of the FY19 revenue came from these core products.

While North America is the key market for the company — accounting for about 53 per cent of the revenue in the third quarter of 2019-20 — Europe (20 per cent), India (14 per cent) and Latin America (8 per cent) are also significant contributors.

Over the past few years, the company revised its strategy and increased focus on high-margin products. It has shifted its product portfolio split of PFI, API and FD from 32:37:31 in 2012-13 to 16:30:54 in the third quarter of 2019-20. This has benefited the company as its finished dosages business registered a healthy growth of 47 per cent in FY 2019.

In the coming years, the management plans to take the share of finished dosage business to 75 per cent of the total revenues. This will lead to better margins.

Granules’ US generics business, which has contributed 20 per cent of the revenue, continued to grow at a faster pace than the rest of its businesses. The recently launched Ritalin has captured 65 per cent of the market in the US. It has another 39 cumulative ANDAs (abbreviated NDAs) of which 19 are pending approval from the USFDA. The company has guided for 7-8 launches in the US via own fillings in FY21 including Fortamet and Glumetza.

Strong capex spend

Over the past few years, the company has implemented an aggressive expansion programme with an outlay of around ₹1,250 crore for capacity enhancement, improving R&D capabilities, plant upgrade and building an oncology API block. This has enabled the launch of new products, higher sales growth and improved margins.

But, higher capex spending has resulted in piling up of more debt and elevated promoter’s pledge.

However, limited capex requirements over the next few years and healthy free cashflow will likely enable debt reduction significantly.

The company has decided to sell its China-based JVs OmniChem and Biocause. The divestment is likely to generate around ₹200 crore cash (net of taxes).

Further, the company has announced a share buyback plan of nearly ₹250 crore. This could help bring down the promoter’s pledge, according to the management.