HEALTHCARE - A mamoth among moles !

The healthcare sector consists of all businesses involved in the provision and coordination of medical and related goods and services. With such huge base it packs together a number of companies from API players to generic drug makers to hospitals. Here an overview of the sector is provided using numbers, facts and estimated growth rates.

Drug Segment

Global-1.3tn$ @ CAGR 4.5% 2025E

-Formulation-85% i.e. $1.1tn and rest 15% API and bulk drugs-$200bn

-US=$500bn

US Pharma Chain

Fastest growing therapies :

The domestic formulations business of pharmaceutical companies in India are pure cash cow businesses. This bucket has the highest ROCE, lowest working capital requirement & least capital intensive, generating ~11% of Revenue as free cash over the last 10 years. Given that the Indian Pharmaceutical market is a Branded generic market, the brands of companies are essentially their greatest competitive advantage. This is reflected in the fact that the top 25 pharma companies account for more than 2/3rd of the market. There are less than 200 medicine brands in India having more than 100cr of sales & these brands account for 1/3^rd of the market. 

Domestic formulations vs FMCG 

The characteristics of domestic focused companies are very similar to HUL – large part of CFO converting to free cash (capex only ~20% of 10Y Cum. CFO), high return ratios (>50% 10Yr Average) & low working capital requirement (~10% of Revenue).

Players like Aristo Pharma, Mankind, Macleods, USV which are among the Top 20 companies in the domestic market exhibit similar characteristics – cash cows (high FCF to Revenue), less capital intensive (low capex as % of CFO & working capital days) & high ROCE businesses. With best in the industry fundamentals, the domestic focused companies rightfully command the highest valuation at an aggregate ~28x trailing EV/EBITDA

ELEPHANT IN THE ROOM – DIVIS Lab: Trading at ~40x EV/EBITDA – Highest the industry. Just to put the rich valuation of Divi’s in Context
Divi’s FY21 Topline ≈ Aurobindo’s FY21 PBT while Divi’s Market cap is more than ~3x of Aurobindo.

Pure Play API Lowest cost producer in the world for 3 dominant molecules. Despite being in a capital-intensive space having invested more than Rs. 5000cr in capex, with ~50% of revenue being consumed in working capital, almost half of Divi’s cash flow from operations have translated into free cash ≈11% of revenue; equivalent to branded domestic business – paying ~75% of the free cash as dividends, That’s close to ~35% of cash flow from operations being paid out as dividends on an average historically. (50% for CAPEX,35% Dividends +15% on books as reserve cash)

Spectrum

At one extreme end, Aurobindo has built a scale in Generics (less prominent in Specialty) with the highest no. of ANDA filings, approvals & launches – this kind of a model has its own challenges as one needs to run faster than their competitors & be the lowest cost producer. Market is unwilling to reward it with higher valuation multiples given the price erosion that ensues with cut-throat competition & the regulatory risks associated with such markets. Any adverse regulatory outcomes in any of the facilities takes operating costs up & margins dip in the near term.  However, over a decade, while such businesses might not be consistent, they generate similar cash flow from operations, albeit with lower free cash. 

While cash from operations are similar, free cash is much lower. But it is noteworthy that Aurobindo has generated >50% of its 10yr cumulative free cash in the last two years.

MARKET GIVES UNCERTAINITY A SIGNIFICANT DISCOUNT

Source - Perpetuity

API 

Active Pharmaceutical Ingredient (API) is the biologically active component of a drug product (tablet, capsule, cream, injectable) that produces the intended effects. APIs find application in high quality drugs that treat diseases pertaining to oncology, cardiology, CNS and neurology, orthopaedic, pulmonology, gastroenterology, nephrology, ophthalmology, and endocrinology. APIs can potentially create a more sustainable healthcare system by introducing more innovative products.

Eg—Granules Paracetamol (PAP from China) and Solara in regulated markets, therefore boast margins(Not very deep moats)

Whereas—IOLCP and Aarti Drugs—Semi and unregulated—Aspire to be in regulated

CDMO

A contract development and manufacturing company (CDMO) is a company within the pharmaceutical industry that provides drug development and manufacturing services. Pharmaceutical companies partner with CDMOs as a way to outsource drug development and drug manufacturing. 

Full-service CDMOs can take on every aspect of drug development and manufacturing, and they also work with clients looking to outsource certain components of their process. It all depends on what each client needs.

WHAT’S THE DIFFERENCE BETWEEN CDMO AND CMO?

The difference between a contract development and manufacturing company (CDMO) and a contract manufacturing company (CMO) is development. CMOs are companies that take a pre-formulated drug and manufacture it, while CDMOs are companies that do both the development and manufacturing of a drug.

Many pharmaceutical companies are drawn to the consistency and timeliness that’s provided by working with a CDMO versus a CMO. 

US $75bn-@7-8% CAGR growth(scale up molecule and production) and 

CRO-  US $44bn@8% CAGR and Double by 2025(phase 3 and other research work)

Types of CDMO

1.      Specialty CDMOs-Niche know hows-Eg Suven in Central Nervous system CRAMS

2.      Capacity Consolidators—Acquire/merge—Eg Piramal and shasun

3.      Vertically integrated---CRO and CDMO both by same.

Syngene Model- From grams to kilograms to tonnes 

Low Cost service clubbed with high quality regulatory compliance.

Syngene -High switching Costs and Forward integration via Greenfield capex and Long term contracts 

Operating Leverage : Scientists-475 in 2006 and Revenue 200Cr              

 vis a vis in 2021 : 2000Cr sales and 4250 Scientists

Extended strategic collaboration with Bristol Myers Squibb until 2030 (Sticky long term contracts i.e. some certainty in cash flows)

30%+EBITDA margins and 5400+ Employees (10% growth)

P/S=15x Revenue -2180 Cr                                         

CFO to EBITDA-90% (highest)

Concall Snippets

-biologics drugs ranging from anti-cancer to hormonal disorder therapies and many others

-the margins are likely to get moderated during the year but expected to stay around 30%

-750/900Cr Capex

Of the total CAPEX for the year $10 million pertains to the commercial API manufacturing facility, $20 million was invested in discovery services, $10 million in the biologics manufacturing facility and the balance $25 million in dedicated centers, development services and common assets.

-animal health, chemicals industrials polymers any of those others where we've got small footprints, but they occasionally want the sophisticated science we do-10% of our revenues come from that.

-Mangalore API plant-five years and more, it will return an asset turnover of one, but typically the return generation period for an investment like that extends over 15, 20 years.

"21-22, the fundamentals of the global biopharma industry remains strong. There is good momentum of new chemical entity and new biological entity approvals by the regulators, underpinned by a strong pipeline of drugs under early stage discovery and development. The continuing drive to reduce cost of drug discovery and the increased productivity is expected to increase outsourcing further with significant interest in the integrated drug discovery and development model. On the manufacturing side, growing demand for biologics, the capital-intensive nature of the business and the complexity involved in pharmaceutical manufacturing is further driving demand for outsourcing. We believe Syngene is well-positioned to capture many of these market opportunities to increase R&D scientists by another 20% in a phased manner on top of the 20% expansion that happened by the fourth quarter."

Some other case studies for research purpose may include-

1) Laurus Labs—ARV APis, Generic APIs, Formulations(Cardio and Diabetes)-Forward integration from APIs  and CRAMS in 4 segments-Generic ARV APIs(economies of scale work) + Finished dose formulation(forward integrated)+ CDMO + Laurus Bio(animal free biotech)

Moving from ARV API(cash cow) to oncology ,anti diabetes, Proton pump inhibitor and CNS APIs as growth engines

2) Divi’s mix of simple and complex API’s and continued capex (now in Contrasted API (niche 6-7bn$ market)—Q4FY21 and Q1FY2022 Growth come in

I will try to give in detail description about these companies in some other blog. Reading as many companies concall, investor presentation, and annual reports will help in expanding the circle of competence.