Sequent Scientific | Market Cap 6,250 Cr
CMP 252 | PE 38x FY22
Recommendation: Sell
Results: Sequent Scientific (Sequent) reported growth of 8% in Q1FY22 versus previous year. Operating profit declined 55% over same period due to lower growth and non-cash ESOP costs.
Key highlights:
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Formulations grew 15% and API de-grew by 4% year on year. Formulations business forms 67% of overall sales while API is 33%.
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Exports of formulations to Europe, Turkey and Latin America forms highest shares in total sales. The year on year change in sales to India, Turkey, Europe and Latin America was +171%, -13%, -1.5% and +52% respectively.
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Decline in API was primarily due to excess stocking of inventory as buffer done at customer end. (We are seeing the trend across the board in API).
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India business revenues more than doubled owing to strong performance around cattle and commercialization of Zoetis distribution arrangement.
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Operating margins were lower from higher reinvestment for future growth and ESOP costs. Part of it is one-off in nature. Adjusted for that operating margins were 2% lower than previous quarter.
Outlook: As per the management, the capacity expansion has been completed at Vizag & Mahad and this can maintain business growth momentum. The company has a long term arrangement with major animal health company for CDMO and product supplies– co investments at Vizag to be commercialized in 2023. It expects to focus on top-line growth and maintain high ROCE. It will focus on injectables and formulations business over API for future growth. Margins may not see expansion versus guided earlier.
There were concerns on notes to accounts about restating a part of sales of previous year albeit a small amount on absolute basis. We believe since it highlighted and addressed in conference call, it is not a problem. Usually the management who do not address/acknowledge if such thing has happened tends to raise a red flag. In this case, it has been addressed and corrected. With Carlyle group as promoter, we can assume there is reason to believe less of such malpractices.
MoneyWorks4me Opinion: We had recommended Sequent Scientific at ~120/share as it was expected to grow its sales at 12% CAGR over next 3 years while operating profit is expected to grow at 17% CAGR. Two primary reasons that are aiding its sales growth are i) low cost manufacturing from scale benefit in API and ii) innovator drugs going off patent in animal pharma will help Sequent to introduce generic formulations in regulated markets starting FY22. It is expected to continue delivering but in linear fashion versus what stock price indicates.
We had recommended 100% SELL On Sequent Scientific at 270/share as we intended to reduce exposure to small and mid-cap stocks. We had communicated in previous note “The stock has rallied fast, above our expected growth rate. ... We believe the opportunity size is large, but we can’t expect flawless execution and quarter after quarter blockbuster growth. Growth will be linear versus exponential.”
Sequent’s stock price correction might be a knee jerk reaction to results. Sequent stock price was factoring very high growth which was not the case post quarterly results. We have always written disclaimers for Booster Stocks.
For Booster stocks, even if the future potential is large; execution, competition and governance can lead to disappointment. If we find such risks outweigh future prospects, we will recommend an exit. We will continue to focus on consistency of portfolio returns versus individual stock return or timing exact buy and sell.
Our take is one cannot take similar stance on Booster stocks and Core Stocks. Core stocks can be held all through bad phase and still generate good return but it doesn’t hold true for Booster stocks as risks are relatively higher.
It has come to our notice that few of you did not sell Sequent Scientific on our advice. It is ok to not act on 2-3 of our calls. It wouldn’t make a big difference on overall portfolio return as long as rest of the actions are taken. Today if you wish to hold on small allocation in Sequent Scientific, you may with a caveat that it may or may not deliver very high returns from current price.
We often emphasize to focus on overall portfolio versus individual stocks. Batting for every stock to deliver is a tall ask. Let analysts keep track of individual stock, but as investor you must focus only on portfolio growth.
