Tag: Mr. Krishna Chaitanya Chava

The growth story of Laurus Labs & it’s promoter

Let me start with a story of a fanatic who creates a 20 thousand Crore company from scratch. How does he do it? Where does he start?

The story begins at Andhra, which by the way has produced quite a few successful first generation entrepreneurs in the Pharma space. The ones I know of, are Dr. Reddy’s, Divi’s & Laurus. I don’t know if it is plain randomness or there was something in that environment that led to creation of multi billion dollar pharma companies by people starting from scratch. I speculate, one of the factors, may have been the way chemistry was taught in those colleges, was better than other places.

Or maybe it was about being in the right place at the right time with the right skills. Maybe, in an alternate universe, the same set of entrepreneurs may not have done as well as they have. Too many things needed to fall in place for this kind of, what some people may call, coincidence. Reminds me of the experiment which is widely known on the net, through the article about Justin Timberlake.

One of the key ideas in this article was that too many things need to fall in place, and more importantly, at the same time, for a knockout success story to happen. For example, imagine what would have happened if the exact same set of people were to start Infosys today. Would they be nearly as wildly successful as they have been? Or what if Bill Gates was born just 5 years later? Would we nearly have another giant monopoly like Microsoft or anything close? You get the point.

Will Laurus (20k Crs Market cap) follow the same trajectory as Dr. Reddy’s (75k Crs Market cap) & Divi’s (1 lac Crs Market cap)? In my biased view, chances are it will.

So after finishing his education, Dr. Chava,

  • Joins Ranbaxy as an R&D management trainee.
  • Moves to Veera Laboratories in 1995 and runs the R&D dept.
  • Moves to Vorin Labs which merges with Matrix Labs in 2001.
  • Becomes Chief Operating Officer of Matrix in 2004.
  • Starts Laurus Labs in 2005 due to differences with the chairman of Matrix.

How Matrix Labs strengthened it’s R&D – From Matrix Labs 2000 Annual Report

In 2000-2001, Matrix entered into drugs that treat the deadly AIDS disease. Here’s a snippet from Matrix’ 2001 annual report.

Matrix Labs 2003 Annual Report

Matrix Labs 2004 Annual Report

And here’s what happened at Matrix Labs during Dr. Chava’s tenure. Back then, this kind of growth might have been possible due to a mix of factors such as a growth in the overall industry + the management team driving the company’s focus on to the right products in the right markets, at the right time.

Now, let’s get into the current and future state of Laurus’ business.

In the past, growth was driven by sales of Antiviral APIs. This is the division that sells APIs for AIDS drugs, primarily in low and middle income countries through the Global Fund, PEPFAR and the WHO. A majority of ARV API sales growth came from 4 HIV/AIDS products – Tenofovir, Lamivudine, Efavirenz and Dolutegravir.

As per their latest concall, doubling sales in the HIV segment (APIs + Formulations) is going to be impossible. Having said that, they also mentioned, they should be able to deliver growth in their overall API business in FY22 as well. Based on whatever little info I could find, the largest player in ARVs seems to be Mylan (which acquired Matrix Labs in 2007), and has a 40% market share, in this space.

The other 2 therapies that management is bullish on, are Cardiovascular and Diabetes.

Some part of the growth was also driven Laurus’ Custom Synthesis, CDMO & Ingredients businesses. Custom Synthesis is the segment that has potential to do well over the next few years because the total sale from this division over the last 4 quarters is a minuscule 491 Crs.

Transforming into a full fledged Pharma player

Formulations / FDF showed up for the first time in 2020 Annual Report.

Q3 FY 2021 Concall – “See, if you look at the evolution from 80% to ARV APIs, in the five years we moved to 38% of ARV APIs. Similarly, our revenue dependency on ARV formulations currently is very high. But in the next five years, we will also diversify our revenues coming from non-ARV formulations significantly and the dependence on ARV will come down. Because there are no new formulations to be developed in the ARVs, we are almost done with developments. So, development focus is shifting from ARV to non-ARV. And also, we are adding very large capacity in Vizag and we have taken land for formulations expansion in Hyderabad as well. So if you want to look at where we will be in say, three, four years down the line, I am sure we will be discussing on non-ARV in five years from now. If you look at the calls one and a half year back, half of the times people were asking questions on Efavirenz. Now nobody asks questions on Efavirenz. Two years from now people will not ask questions on ARV APIs. And maybe another two years from then people will not ask about ARV formulations, people may talk about what is we are doing in our Laurus Bio?, what growth we have in Laurus Bio?, what other therapy areas we will be focusing?, what kind of delivery dosage forms we are doing?. So, company s in the transformation phase, so we need time and we are very confident to expand our portfolio beyond just ARV.“

The SMILE pattern

This is a pattern noted by the famous investor, Mr. Vijay Kedia. He believes multibagger companies exhibit the following characteristics – Small in size (at least it was small when I started investing in this co.), Medium in experience, Large in aspiration and Extra large in market potential. I am of the opinion that the company has all 4 ingredients and is likely to scale up to the next level, from here.

Regarding aspiration, here’s a person who starts with a salary of a few thousands, moves on to lead the R&D division of another co. and goes on to create a $2.5 billion business in less than 2 decades. If this is not aspiration, what is?

Disclaimer: I have stayed invested in Laurus Labs from lower levels. These are my views and are not to be construed as investment advice. As always, please do your own research before proceeding to buy/sell.

Barath Mukhi
26th-Feb-2021

Should you be worried about Pledged Shares & a lack of Free Cash Flows in Laurus Labs?

Firstly, I have been invested Laurus Labs since 600 odd levels and added more on the day this company declared Q1 FY2021 Results. Currently this co. forms a little over 10% of my portfolio.

Here’s how I thought about the company before investing.

Firstly, sales had been growing well.

I love straight lines, particularly the ones that are goin’ up and indicating there’s something nice cooking there.

Q1 FY2021 Revenue sources

Cumulative cash flows vs Cumulative profits are good.

Quarterly Sales were showing a nice uptrend. The co. had been on my radar since Mar 2020 because it had shown 2 quarters of growth in sales as well as Profits. In retrospect, I could have bought it a little earlier.

Anyway, the below increase in sales and profits should be seen in the context of the current Covid19 situation where every other business is struggling.

But see what was happening here, at Laurus.

5 quarters of increasing sales and profits in an environment where lockdowns and job losses are the norm, at least temporarily. Wow!

What got me worried though, was the trend in receivable days. Almost a third of the companies sales are being done on credit and not cash.

So, I came across a superb thought by another investor who said, receivables in the pharma sector usually don’t end up being bad debts and write offs because transactions between the seller and the buyer are usually over several years and customers are likely to be dependent on Laurus for future supplies. A data point to validate this would be the company’s sales growth. So there seems to be good demand for the company’s products and write offs seem unlikely.

High debt

Debt is 3 times cash flows generated by the co. If good times continue, then the co. may be able to pay off their debt in due time.

Debt to Equity at 0.6x. The cost of debt as per the company’s latest concall is 6.6% which provides some comfort because it is way lower than the Return on Equity of 15% delivered by the co. in FY 2020. And this ROE was delivered despite a significant amount spent on Capex.

Free Cash Flows – From the company’s FY2020 Annual Report

Changing Revenue Mix

Booming Generic Finished Dosage Forms Business (FDF)

In Q1 FY 2021 alone, the company’s Generic FDF division delivered sales of 351 Crs compared to 46 Crs in all of FY 2019 and just 6 Crs in all of FY 2018.

Growth expected to continue in FDF as per Q1 FY2021 Concall

Booming Contract Manufacturing / CDMO / CRAMS Business

Growth in CRAMS expected to continue as per Q1 FY2021 Concall

Pledged Shares

There are concerns that promoters have pledged shares and this combined with the fact that this co. is based out of Hyderabad (rings a bell, fellow investors?) seems to make a lethal combination. Doesn’t it?

So as per a recent disclosure the 3 promoters who have a cumulative 1 Cr shares pledged out of their total holding of 3 Cr shares, recently got 25 lac shares released from Axis Finance Ltd.

The below graph shows the 3 promoters still own a lot of unpledged shares in the company. Besides, promoters of fast growing manufacturing companies are often expected by lenders to pledge shares to ensure skin in the game. So the promoters pledged a third of their stake to do capex and grow the business, which is fine, in my view.

I bought the stock at a little below 20 times FY20 earnings. For a fast growing co. with a reasonable ROE of 15%, and with tailwinds due to global supply chain disruptions, this is an attractive valuation in my view.

Free Cash Flow vs Growth

Some investors recently raised a red flag about the company lacking free cash flows, on Twitter. This is the typical debate that occurs between a value investor and a growth investor.

Growth investors want the co. to keep reinvesting as long as there are good opportunities for high return on capital growth.

On the other hand some value investors look for companies with cash on their books. I counter that by saying that the markets reward companies that can reinvest all that money and keep the ROE above the critical threshold of say, 15%. Mr. Market doesn’t like companies keeping cash in the bank and I have a ton of such examples.

Promoters

Day to day affairs of the co. seem to be headed by Dr. Satyanarayana Chava. He started the co. in 2007 by investing Rs. 60 Crores of his own money.

Dr.Satyanarayana Chava, @Economist India Summit 2017

It is a phenomenal achievement to have reached 3000 Crs + Revenue in a span of 13 years. So, the gentleman certainly knows what he’s doing. In the past, he was the COO of Matrix Laboratories and has a few decades of experience in the Pharma industry. It always excites me to partner with first generation businessmen who’ve come up the ladder despite all the challenges they might have faced in their entrepreneurial journey.

Risks

  • Around 15 to 20 Crs out of Q1 FY2021 profit of 172 Crs came from Forex gains. So Forex gains contributed about 10-11% of last quarter’s PAT. This may or may not continue depending upon currency movements.
  • Increase in interest rates could lead to pressure on margins, if debt is not reduced.
  • If demand tapers off, then Capex cost may not translate into profits.
  • Who succeeds Dr. Chava in the future will decide the growth trajectory of this co. whenever the time comes from him to step down.

Disclosure – I and my clients have substantial positions in this company and my views are certainly biased. This blog is not to be construed as an investment advice. Please consult your investment advisor before investing.

Disclaimer: This is NOT investment buy/sell/hold advise. I am not SEBI registered. May change stance on above business anytime with new developments and/or new insights, and/or overall market conditions. May NOT be able to update periodically. Please do your own diligence and/or take professional advise, before investing.

Barath Mukhi

5th August 2020