Advanced Enzyme Technologies Ltd - Stock Valuation and Financial Performance

About the Company

Advanced Enzyme Technologies operates as a fully integrated enzyme manufacturing entity, with a significant emphasis on research and development (R&D), spanning various enzyme-related domains. While the company boasts the capability to produce enzymes from all four natural origins - plant, animal, bacterial, and fungal - its primary focus is on developing enzymes through microbial fermentation. As India's largest integrated enzyme manufacturer, Advanced Enzyme Technologies holds the second-highest market share in the country. The company boasts a diverse product portfolio, comprising over 400 proprietary products derived from 68 enzymes and probiotics.

Enzymes serve as biological catalysts, accelerating biochemical reactions within living organisms. They can be extracted from cells and applied to catalyze a broad spectrum of commercially significant processes. For instance, enzymes are crucial in the production of sweetening agents and the modification of antibiotics. They find utility in washing powders and diverse cleaning products, contributing to enhanced efficiency in removing stains and dirt. Additionally, enzymes play a pivotal role in analytical devices and assays utilized in clinical, forensic, and environmental applications, facilitating accurate detection and analysis.

The company has four business segments: (a) Human Healthcare and Nutrition, (b) Industrial bioprocessing, (c) Animal nutrition, (d) Specialised Manufacturing. Additionally, the company has a global presence and generates revenue from both Indian and international markets.

How has the company performed historically?

The past five years have presented significant challenges for the company. In FY23, there was a substantial increase in raw material prices, including soya, edible oil, and solvents like glycerine, phosphorus salts, and lithium, rising between 3-4 times. These price hikes were primarily driven by supply chain disruptions and escalated logistic costs, resulting in a decline in gross margins from 79% in FY22 to 76% in FY23. Moreover, fuel prices, including coal, surged by 2-3 times, further contributing to the escalation in manufacturing costs.

Overall, between FY19 and FY23, operating margins witnessed a notable decline of 15%, dropping from 44% in FY19 to 29% in FY23. These challenges underscore the significant impact of rising raw material and fuel prices on the company's profitability over the past five years.

The operating deleverage was combined with low sales growth of 6.5% between FY19 and FY23. These problems have been accompanied by the exit of one of the promoters, C.L. Rathi, who has now become the promoter of Advanced Vital Enzymes (Advenza), a direct competitor to Advanced Enzyme Technologies.

Understanding the Business

Human Health and Nutrition: This segment encompasses a diverse array of products, spanning anti-inflammatory, pro-digestion, and probiotic formulations, catering to a wide range of customers. These enzymes serve as active ingredients in pharmaceutical and nutraceutical formulations utilized by various clients. Key customers in this business vertical include Sanofi India, Cipla, Ipca Laboratories, Alkem Laboratories, and Emcure Pharmaceuticals.

The anti-inflammatory offering stands out as the largest revenue contributor, representing approximately 24% of sales in FY23. However, the segment's growth has experienced a modest annualized rate of 3% between FY19 and FY23, primarily attributable to a decline in revenue from the United States market.

Animal Nutrition: This segment comprises enzyme-based feed additives tailored for animal nutrition, offering essential nutrients that aid in digestion for animals. These additives promote cost-effective feed solutions, minimize animal waste, and contribute to environmental pollution mitigation. This segment has grown at an annualised rate of 10% between FY19 and FY23.

Industrial Bioprocessing: This segment involves harnessing living organisms and their components to innovate new products, offering a natural, secure, and effective approach to manufacturing. The company's industrial bioprocessing, a specialized branch of chemical engineering, concentrates on developing and producing a diverse range of products in sectors such as agriculture, polymers, and beyond. This segment has grown at an annualised rate of 12% between FY19 and FY23.

Specialised Manufacturing: This segment was introduced to the revenue stream in FY22 following the acquisition of SciTech Specialties (SSPL). This segment utilizes a unique technology known as effervescent technology to produce a variety of products for diverse industries, including health supplements, medicine, baking, cleaning solutions, and other specialized applications. Notably, these products dissolve rapidly and demonstrate effective performance.

What are the growth and margin prospects of the company?

Margins: The current margins have fallen due to an increase in raw material and power costs as previously mentioned. The raw material prices have softened over the last few quarters. Moreover, as the company undertakes new contracts, raw material costs are expected to be passed on to the customers. 

The increase in general costs as a percentage of revenue can be attributed to the lack of increase in revenue to offset such costs as a percentage. As revenue from the United States and human nutrition increases, the percentage of general costs should reduce, bringing the operating margins back to 40% plus levels as witnessed historically. This is attributable to a lag effect as costs are frontloaded.

Revenue Growth: 

While the growth over the last few years has been low primarily due to fall in revenue in the human nutrition business, this segment has begun recovering over the last few quarters. The growth is backed by new product launches, demand revival in end user markets, increased research & development along with acquisitions and strategic investments.

On a 9 month basis, the revenue grew by 16%. The human nutrition segment grew by 18% in 9MFY24 while bioprocessing and specialised manufacturing have grown at 17% and 30% respectively. While the animal nutrition segment has not grown on a 9 month basis, we believe that the business is strong and will continue to grow despite such fluctuations. This segment is currently the smallest and therefore, the reduction in revenue does not harm the overall growth prospects of the business unlike the earlier impact of revenue reduction in human nutrition witnessed in FY22 and FY23.

What is the competitive environment for Advanced Enzyme Technologies?

Threat of alternatives: The enzyme industry is benefitting from a shift in end consumer perceptions about the safety and use of biological inputs versus chemical inputs. As a result, players like Advanced Enzymes are increasingly replacing chemical inputs in the human and animal nutrition industry as well as pharmaceutical industry. This is one of the most important tailwinds, positioning the company positively with respect to substitutes. 

Threat of competition: While the company is the largest manufacturer in India, it competes in a global market where it is among the top 15. The largest player in the market is Novonesis, created through the merger of Novozymes and Chr Hansen. Novonesis, DSM-Firmenich, BASF and other large players account for more than 75% of the total market size. However, the larger players do not compete directly with Advanced Enzymes. This is due to: 

1. Niche products: Advanced enzymes manufactures niche products for particular clients, making the effective market quite small for such large players.
2. High gestation periods: The product approval cycle for enzymes is high due to the regulated nature of the business while research and development is an additional time consuming factor. Moreover, enzymes account for a small portion of overall costs, making switching based on pricing unlikely given the regulatory effort and risk involved.
3. Market differentiation: Novonesis is the global leader in industrial enzymes with ~50% market share, pharmaceuticals is not its key focus area and hence direct competition is limited. It is focused on industrial enzymes where Advanced Enzymes does not materially compete.

Good results, and margin recovery sequentially point towards a healthy future outlook. 

Good results, as guided by management earlier- growth is without compromising margins further.

At Par Result, US business to drive forward margins.