There was a very nice management interaction where they talked in length about evolution in their business. I have captured the notes below.
07.03.2023 (Smart Sync interview)
Capsule business
- 95% of revenues come from gelatin capsule
- All competitors have expanded capacity in capsules, current capacity is excess of demand which should get absorbed in next 2-3 years
- Global peers: Capsugel (Lonza; largest co), Qualicaps (Mitsubishi; second largest co), ACG (largest Indian co)
- India: 60-70bn capsule demand, 8-10bn is HPMC capsule
- Had introduced HPMC capsule in 2002 (5-years earlier than competitors). But their size was very small to gain a lot of market. Also, in 1999 India had introduced a green dot on capsules (which causes demand for HPMC capsules) which was later withdrawn in 2004 and this effected the HPMC capsule market demand
- Demand for HPMC capsule comes largely from nutraceutical market. For e.g. in US 75% of nutraceutical market is HPMC capsule
- New capacity is coming in vegetarian capsule (HPMC capsule), product mix should change from gelatin to higher realization HPMC capsule (15-17% contribution from HPMC capsule in next 3 years). With this, EBITDA margin can increase to 23-25% from current 19-20%. They have installed a 5bn capsule machine (higher capacity than other machines), where they have MOU that they will be exclusive users of the machine if they keep buying from them (not clear for how long)
- Raw material for HPMC capsule is imported (RM chain: pine wood / cotton → wood pulp → cellulose → chemically treated to make HPMC)
- One of their peers strategy is to give filling machines on lease to get more business
- Indian unlisted peer is doing higher margins: very old and entrenched player and has the first mover advantage and are the only suppliers in certain regulated markets. Natural capsules’ latest expansion gives them better machinery
- Its very hard to get into other customer accounts for existing filings as the filing is already done with the current capsule supplier and cost of capsule is miniscule. Unless there is a big supply hiccup, there is no need to change the capsule supplier
- Export: 25% of capsule revenues (blended realization is 108-110 per 1000 capsule). Export realizations are higher by 15-17%
- Supplies to Pfizer in India, currently discussing with their Mexican operations
- In 2015-18 cycle, they had a lot of exposure to Nigeria (direct + indirect supplies; 60% of total exports) which got impacted thereby impacting Natural Capsules. Didn’t supply to government, only private buyers
- Strategy to deal with this was to diversify and go after volume based clients in domestic market and sell on just-in-time inventory model (operating leverage cuts both ways?). Even during covid when International market demand was higher, they focused on high volume domestic customers
- Receivable in pharma were always higher, during covid this reduced to 60 days. It is going back to 90-120 days
- Their strategy historically (until 2018) has been to buy used machines to ensure higher asset turns
- R&D spends will increase from 2-2.5% of sales to 3-4%
API business
- Capex: 130 cr. (expect 1x asset turns in FY24 and 2x on full utilization)
- Steroid API: Customers like Lupin and Cipla are looking for alternate suppliers due to Chinese supply chain problems which is opening opportunities. Natural Capsules will do fully integrated manufacturing (starting from raw material phytosterols which is available in India and exported to China). It’s a sandwich process (fermentation then chemical synthesis then fermentation and 3-4 synthesis steps) making a long chain. It takes time to crack these processes and this gives them leeway to get regulatory approvals and establish customer relationships before competition comes in. Have brought in a separate team with experience in commercialization of fermentation based APIs from China
- Fermentation is done on batch mode
- API margins: 10-12% in domestic market, 15-18% for customers who are exporting formulations in US but buying intermediates from China, 15% in ROW, regulated market like US and Japan (25-27%)
- First product will be Hydrocortisone (don’t have PLI approval, but huge demand in domestic market) followed by Prednisolone (1 step fermentation ahead in chain of Hydrocortisone). After that, they will introduce Betamethasone followed by Dexamethasone
- Commercialization has been a bit delayed (validation batch from March to April-May). Can potentially contribute 1x fixed asset turns in first year of operations (140 cr.)
- Starting out with importing intermediates from China and will then backward integrate
https://www.youtube.com/embed/9sUelbNfJ0A
Disclosure: Not invested (no transactions in last-30 days)
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