Laurus Labs Ltd - Stock Valuation and Financial Performance

Flat revenue as CDMO business is yet to ramp up. EBITDA and PAT remained subdued on account of high capital and operational expenditure linked to the CDMO business. Gross margins improved due to favorable product mix. 

Quarterly Call: Key Takeaways

1. CDMO: The Animal health facility is undergoing an early ramp-up phase and has begun commercial validations. The Crop Protection Ingredients Facility is expected to be completed by the end of FY25.
2. New Agreement Signed: New Long-term CMO agreement has been signed in the formulations segments with supplies commencing in FY27. Significant amount of this Capex will be funded by the customer. The formulations capacity will increase from 10 billion units to 13 billion units over the next 18 months.
3. CAPEX: The company incurred a capex of Rs. 125 Cr in Q1FY25. The Overall Capex for the next two years is estimated to be between Rs. 1800 and Rs. 2000 Crores, with majority earmarked for CDMO.
4. Guidance: Revenue and Profits will improve in H2FY25 as CDMO deliveries begin.

Please refer to the earlier Stock Pulse on Laurus Labs for more details about the company.

We are initiating a Buy Call on Laurus Labs for the following reasons:

Future Prospects:

1. ARV (FDF & API): The expectations of growth from the ARV business are low as it is a maturing market. More importantly, as this business is cost sensitive, has lower margins and depends on global fund contributions rather than free market practices, the business has highest opportunity cost compared to alternatives. There is very little, if at all, capital being invested into this business. The revenues are expected to be around Rs. 2,500 crores and pricing is expected to remain stable. The company won a 20% market share in the India NACO tender and will compete in the 2026 South Africa Tender.

2. FDF (non-ARV): Between FY22 and FY24, Rs. 600 crores have been invested in FDF manufacturing facilities to increase capacity by 4 bn units to 10 bn units from the existing 6 bn units. Of this 1 bn units are earmarked for Contract Manufacturing while 3 billion units are earmarked for non-ARV formulations, and none for ARV. The company has an option to increase capacity further by 5bn over time as demand materialises. This capacity is in the ramp up phase and utilisation has begun in the latter half of FY24.

3. API (non-ARV): Between FY22 and FY24, Rs. 1,050 crores have been invested in API manufacturing facilities to increase capacity by more than 3,000 KL in reactor volumes, from 4,200 KL in FY21 to 7,762 KL in FY24. This API capacity is fungible, and can, and will be used to fulfil the API requirements of the CDMO and CMO business. Such APIs would be more complex with 10-15 steps, leading to higher margins due to the scientific complexity.

4. CDMO: Rs. 650 crores have been earmarked exclusively for CDMO projects, making it the largest expansion project within the business (The Rs. 650 crores excludes the fungible API capacity that would be used for CDMO projects. CDMO including API makes this the largest project). The growth is expected to be visible FY25 onward through its multi-year Animal Health and Crop Protection contracts. While these projects are ongoing, there is no real contribution as these projects scale up post validation and qualification. The real contribution from these projects will be visible in FY26 and FY27.

The company witnessed a significant increase in RFPs (Requests for Proposals) in FY24 from leading pharmaceutical and biotech companies. The company entered a JV with KRKA (51%) which has an extensive pipeline in innovative generics of +170 pipeline products (CVS, CNS, GI, Diabetic). The total investment is expected to be 50 million euros (Rs. 450 crores) split as 51/49 between KRKA and Laurus Labs. This will increase Laurus Labs’ presence in the US market and furthermore showcases the company’s strong competitive positioning.

5. Bio: A new 2Mn Litre commercial scale facility will be operational with 700 KL in June 2026 (Phase 1) and the rest in the subsequent 12 months. This expansion marks an 8x growth over the current capacity of 240 KL across R1 and R2, which will be fully utilised in FY25. While such an expansion is large, it may take time to scale up and the costs associated with this expansion may be front ended. Nevertheless, a huge expansion upfront reduces the need for multiple small expansions that may be more costly and time consuming.

6. Deleveraging: The Company’s debt currently stands at about Rs. 2,600 crores; this debt is expected to reduce significantly over FY25 and FY26, which would lead to interest cost savings, lower debt to equity and stronger growth prospects.

7. Future Capex: The company is still in its expansion phase and is expected invest around Rs. 700 crores to expand its CDMO and Bio divisions in FY25.

Risks:

1. Lumpiness and Uncertainty: 

The pharmaceutical business is lumpy, especially in the case of Laurus Labs. The ARV business largely depends on tenders by governments and governmental aid allocations. Any change in government policies, political interests or fiscal policy could lead to volatility in the ARV segment.

The CDMO business is lumpy as well. This is due to the nature of contracts, which could either be short term or long term, with short term contracts causing volatility as seen in FY23. Moreover, the scale up of molecules from pre-clinical to Phase 1, 2, and 3 requires different levels of capacity requirements. As the progression of molecules is uncertain and is dependent on FDA approval, this business has a high level of uncertainty. Such uncertainty can be controlled by venturing into lower risk CDMO contracts across crop and animal health, but the human pharmaceutical business will be inherently lumpy. The lumpiness can be increased by interest rate risk as a large number of small clients depend on funding which varies with interest rates.

2. FDA Non-Compliance Risk:

This is by far the most important risk. Non-compliance with FDA standards can lead to Voluntary Action Initiated (VAI) and Official Action Initiated (OAI) based on Form 483 observations, with the latter being extremely serious. This could lead to import alerts and product recalls. However, innovators would not wait until matters reach high levels of seriousness and would halt business even at lower levels of observations. This is primarily due to the fact that at the innovation level, delays can be extremely expensive as each molecule can cost billions. Post approval, the patented molecules have a limited period patent protection that leads to high profits, and any delays can lead to significant loss in profitability. These are risks that innovators are extremely keen to avoid.

Overall, Laurus has one of the best compliance track records and holds all its facilities to higher standards than those required. In general, client audits are much more stringent than FDA audits due to the aforementioned risk. Since Laurus already works with 6 out of 10 of the world’s largest innovators, there are reasonable assurances about the company’s compliances. While small issues may arise, there is a low probability of a significant FDA risk.

Laurus Labs is an Indian pharmaceutical company specializing in active pharmaceutical ingredients (APIs), generic formulations, and custom synthesis. Founded in 2005 and headquartered in Hyderabad, the company is a key player in the global pharmaceutical industry, particularly in the areas of antiretroviral, oncology, cardiovascular, and anti-diabetic therapies. Laurus Labs operates multiple manufacturing facilities, all of which are approved by major regulatory agencies like the US FDA and WHO.

The company’s business is divided into four segments: (a) Active Pharmaceutical Ingredients, (b) Finished Dosage Form (FDF), (c) Contract Development & Manufacturing (CDMO), and (d) Biologics. The divisional segmentation is given below.

Source: Q4FY24 Investor Presentation

Financial Performance: Cause for Concern or Opportunity?

As the financials show, the company’s performance has deteriorated since 2021. The revenues have grown at 2% CAGR which is a remarkable underperformance. However, the remarkable underperformance is more evidently visible in the EBITDA and PAT, which have fallen at a 3 year rate of 20% and 45% respectively. The slight fall in gross profit is merely attributable to a change in the product mix and is not a significant cause for concern.

However, it is our opinion that the stressed financial situation represents a new phase of growth for the company. A large amount of expenses related to growth are currently expensed rather than capitalised which leads to an optically stressed income statement.

While the revenue has only grown at 2% annually since 2021, the various expenses have grown at a faster rate, highlighting that the decrease in profitability is growth related. Since 2021, depreciation, employee costs, and operating and manufacturing costs have increased by 15%, 20% and 21% on an annualised basis. The increase in depreciation is due to an increase in assets and the increase in employee costs, research & development, and operating & manufacturing costs are in order to utilise these assets. The increase in these expenses as a percentage of sales highlights that the additional capacities have not generated revenue due to the amount of time required for optimal capacity utilisation. As a result, the current financials show a significant operating deleverage which may soon reverse.

Segmental Breakdown:

The segmental breakup clearly shows a shift in the product mix over the last 5 years. The business is increasingly shifting towards FDF, CDMO and Biologics all of which have superior gross margins than the API business. The business is in the midst of transformation from an API manufacturer which is lower in the pharmaceutical value chain to a player higher in the value chain with formulations, contract development and manufacturing, and biologics.

Segmental Performance:

1. Active Pharmaceutical Ingredients: 

Active Pharmaceutical Ingredients (APIs) are the biologically active components in medications that produce the desired effects.

While API sales have fallen at an annualised rate of 1%, the fall in sales of Anti-Viral APIs (mainly HIV) is the major cause due to both its size and poor performance. In FY21, sales of Anti-Viral APIs were significantly higher due to a higher need for inventory arising out of the Covid-19 pandemic. The sales fell significantly in FY22 due to destocking and are now normalised at around Rs. 1500 crores. The API business has the lowest gross margins among all divisions at less than 50%, which reduces the impact of a decrease in sales on the gross profit. Conversely, a strong increase in anti-viral API sales can look like a decrease in gross margins. This segment acts as a cash cow to fund newer ventures that create more value.

During this period, sales on oncological and other APIs increased, with the oncology segment growing at an annualised rate of 19%, which suggests strong demand for the company’s oncological APIs, albeit small base.

2. Finished Dosage Form (FDF):

Finished Dosage Form (FDF) refers to a pharmaceutical product that has been processed and manufactured into its final form ready for consumer use. This includes all the processes from the raw active ingredients to the final product that patients take.

* Not reported but calculated based on assumptions

Since the complete scale up of the FDF division in FY21, there has been no overall growth. This is attributable to the fall in the ARV business, similar to that experienced by the API segment. The FDF Business is expected to have a 60%+ gross margin. Therefore, the fall in sales has had a higher impact on gross profit than sales. The current 6 billion unit capacity is used for Contract Manufacturing (20%), ARV (40%) and non-ARV (40%)

3. CDMO:

The CDMO business is one of the fastest growing business segments in the company. Over the last 3 years and 5 years, this division has grown at a CAGR of 21% and 25% respectively. More importantly, this growth has been achieved even after the loss of a huge one-time purchase order aided sales growth of 140% from Rs. 917 crores in FY22 to Rs. 2,167 in FY23. This business is expected to have a higher gross margin than the formulations business, making it extremely important from the perspective of value creation. Incremental money allocated to this business would yield higher returns over time.

4. Biologics:

*Only partial revenue considered due to the timing of acquisition. Revenues for FY20 and H1FY21 are Rs. 41 crores and Rs. 29 crores respectively.

Laurus Bio manufactures 100% Animal Origin Free products, growth factors, and cell-culture media supplements. The company’s products are used in industries such as stem cells and regenerative medicine, vaccines and biological drugs, cultured meat, and cell-culture media manufacturing.  In addition, Laurus Bio offers precision fermentation expertise as a CDMO service to novel protein companies and bio-manufacturers across healthcare, food, nutrition, personal care, and bio-based materials markets. The services span across the microbial precision fermentation value-chain from clone development, strain engineering, bio-process development, and scale-up to large-scale commercial manufacturing, supporting customers at every step of their journey. This business is expected to have the highest gross margin among all divisions.

Laurus Labs entered the biologics segment in 2021 through the acquisition of Richcore Lifesciences for Rs. 247 crores for a 72.55% stake (increased to 91.14% as on March 31, 2024). While the acquisition initially looked expensive, the rapid scale up since has proved the acquisition to be worthwhile. The company acquired the capabilities as it had the resources to commercialise such capabilities. This growth is primarily due to the increased utilisation of existing facilities, R1 and R2. Since the acquisition, Laurus Labs has expanded R1 from 10.75 KL to 15 KL, and R2 from 180 KL to 225 KL.

The future value hinges on decent performance from the ARV segment due to its high weightage, and the utilisation of current capacity which remains unseen in the revenues of the company.

Results are muted YoY but QoQ improvement is seen, the company signed first agro chem supply contract- yet to start commercial production. *CDMO- Contract development and manufacturing organization. 

About the company

Laurus Labs was incorporated in 2005 and is promoted by Dr C Satyanarayana, Chief Executive Officer (CEO) of the company.

Laurus Labs is Rs. 3,000 Cr pharmaceutical company into API, Formulations and customer manufacturing business (CDMO) and supplies to North America, Europe and Low Middle Income Countries (LMIC). Its peers are Granules India, Divis Labs, Shilpa Medicare and Aarti Drugs.

API and formulations have large part of sales coming from tender business which is a growing business but highly competitive and has pricing pressure.

Laurus Labs has the large market share in Anti- retroviral (ARV) (HIV/AIDS) and is at nascent stage in Oncology API manufacturing. API is an ingredient used to manufacture generic or innovative final drugs. The company is focusing on scaling up in other API segments like Anti Diabetic, Proton Pump Inhibitors & Central Nervous System.

Recent capacity additions have happened in Formulation business. It has scaled up from just 2% of overall sales in FY19 to 30% in FY20. Formulations business is a forward integration of existing API in Anti-retroviral generic formulations. Using inhouse API manufacturing gives the company advantage of lower pricing for generic drugs thereby limiting impact of pricing pressure, which a typical risk in generic formulations/tender business.

CDMO business is growing at a fast pace of 40% CAGR in last 4 years and contributes upto 14% of overall sales. Large innovators are looking out for outsourcing drugs research and manufacturing to low cost operators.

Financials

Laurus Labs’s sales growth is 16% CAGR in last 5 years while its operating profit has grown at 23% CAGR in the same time period.

Laurus Labs spends around 5-7% of sales on R&D for launching new drugs, API. The company has 6 manufacturing facilities with plan to add more capacity to existing facilities.

As the company was investing large sums into formulations and CDMO business, the company’s ROCE was subdued in last 2-3 years. With increase in capacity utilization ROCE, it is rising incrementally and expected to go north of 15% per annum.

The company has debt of Rs. 1,000 Cr and expected to come down over next 2 years backed by i) increase in sales and profits ii) declining in new investment releasing free cash flow for debt repayment.

Click here to view complete financials of Laurus Labs

Future Prospects

ARV API is a mature business growing at 4-5% CAGR but Laurus Labs is taking market share from other players due to lower cost of manufacturing.

Formulations is a new line of business for the company which is a natural extension of existing API manufacturing to produce final generic drugs too. Thanks to inhouse manufacturing it has competitively priced formulations to fight off competition. With introduction of new products it can grow its sales faster than average market growth of generics ~6% CAGR.

Laurus Labs is aggressively filing new drugs in North America and Europe. R&D of 5-7% of sales each year will help it file 10-12 new drugs every year in North American market.

With increase of Formulations share from 2% of sales in FY19 to 30% in FY20, we believe the company has the ability to file and scale up formulations business. The company is planning to double its formulations capacity in existing facilities which has lower investment and early payback period if scaled up in timely manner.

Custom Research (CRO) and Manufacturing (CMO) or (together called CDMO) business is gaining traction in India thanks to lower investment needs required in India and availability of low cost human resources. CRO and CMO is expected to grow at 11% CAGR and 8% CAGR respectively.

Two of our portfolio companies, Divis Labs and Syngene International also operate in CDMO segment; they are also experiencing good growth with rising enquiries.

Positive triggers

• Leadership in Anti Retroviral API and drugs.
• Opportunity to grow formulations in same therapy of API manufacturing lowering costs.
• Capacity addition in Formulations as well as CDMO
• Financial deleveraging leading to rise in equity value.

Risks

• Regulatory Compliance risk (USFDA)
• Negative cash flows due to regular capital investment
• Volatility in tender business.
• Pledged shares although it is declining with increase in share price & improving business prospects

Valuation

At current price of Rs. 128/share, TTM P/E ratio looks high ~26x due to i) higher depreciation without full capacity utilization ii) higher interest outgo for debt raised for expansion.

With our expectation of 15% CAGR growth in operating profit, Laurus Labs trades at 17x FY22 EPS assuming lower debt and hence lower interest costs.

We find Rs. 110-115/share is a good price to add Laurus Labs. We recommend to add Laurus Labs partially and accumulate more during market volatility.

We believe investing in Laurus labs is a long term opportunity so we can add during next 6 months as well.

While the future potential is large, the execution, competition and regulation can lead to lower than expected performance and hence disappointment. If we find such risks that outweigh future prospects, we will recommend to exit Laurus Labs even at a small loss. 

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