Natural Capsules – Pharma play with solid fundamentals

Couple of interesting things happening here. Elevator pitch pointers,

• Capacity augmentation by ~80% within FY’22.
• Sharp jump in Operating margins (from 10% in FY’18 to 21% last fiscal).
• Promoter holding increased by 4%+
• Significant capex 150 Crs.+. Getting into low domestic competition fermentation APIs with eligible for sizable PLI subsidy.

I think key broad monitorable on the legacy capsule side of business are:

• Competitive intensity – possibility of supply glut considering the kind of huge capex in last 4/5 years by each of the key players and few players accelerating the capacity even more aggressively going ahead.
• Margin profile has improved in recent years. However historically for them and even across rest of the players in the industry has been in the range of 6% – 10% of Net margins. How much of margin improvement they are able to drive with change in product mix (high proportion of HPMC) and significantly improved production yield (using high productivity machines) will be important.

Have tried to map the competitive landscape for the legacy Capsule (Gelatine/EHGC) and HPMC/Vegan) business

• Global empty capsule market size – ~1000 Bn/Year
• China empty capsules market ~450 bn/year (45%)
• India empty capsule market size – ~220bn/Year (22%)

Lonza:

• Must have capacity ~220 bn capsules/year. (mostly equal to all Indian manufacturers put together)
• In 2020, announced an investment of 93M USD To expand its overall production capacity of capsules within Capsugel® portfolio by 30 billion capsules annually. The investment allowed them a 15% increase in capsule production capacity. (link).
• This investment was to be be made over two fiscal years, 2020 and 2021, across eight global Lonza manufacturing sites including the one Lonza site in Haryana India
• This announcement came in quick heels of previous announced capacity expansion in 2019 where they had increased the capacity by 10 bn/year.

ACG Capsules ( link):

Must be within top 5 globally and number one in India. The group has a capsule manufacturing capacity of around 115 billion units per annum. spread across six plants located in India (4), Croatia (1) and Brazil (1)

• The group’s diversified customer portfolio consists of marque clients such as Cadila Healthcare Ltd, Aurobindo Pharma Ltd, Alkem Laboratories Ltd, Sanofi S.A, among others.
• PAT Margin is 10.6% for FY20 and 14.9% for FY19.
• Unencumbered cash and bank balance stood at Rs 99 crore as on March 31, 2020. Cash accrual, expected at Rs 450 crore each in fiscals 2022 and 2023.
• Revenue of ~1550 Crs and PAT margin of 10.60%.
• Debtor days of 120 days (very high as compared to rest of the India players)
• Significant capacity ramp-up: 83 bn capsules/year in 2017 to 115 bn capsules/year.
• Further, doing a capex of 600 Crs to double the capacity. Mostly into fast growing HPMC capsules.

Natural Capsules:

Is engaged in manufacturing of Hard Gelatine Capsule Shells and Hard Cellulose Shells to be supplied to various pharma companies in India as well as abroad (primarily un-regulated markets). The company has two manufacturing units; one in Bangalore and one in Pondicherry

• Impressive 70% revenue growth. Revenue of 135 Crs against 80 Crs for last fiscal. ~20% revenue from Exports for FY’22.
• EBIDTA of 18%. PAT margin of 10%
• Good discipline visible in cash cycle. Cash cycle of 170 days in FY20 to -6 days in FY22.
• Had a combined capacity of 13.3 billion capsules per annum as on March 31, 2022. Which has been rapidly increased to 18 bn within 3 quarter of the fiscal FY’23. Further projection to take total capacity to 22 bn by financial year end at a capex of 38 Crs.
• Significant capacity augmentation made possible by tech breakthrough in machine line optimization (from 1 million capsules per day to 5 MCPD).

Sunil Healthcare:

BSE Listed player (Link) with <50 Crs market cap (for context Natural capsules has MCap of 365 Crs.). SHL is mainly engaged in the manufacturing of Empty Hard Gelatin Capsule (EHGC) shells and Hydroxypropyl Methylcellulose (HPMC) at its sole unit at Alwar, Rajasthan.

[Trivia: The company was earlier also engaged in the trading (including merchant trading) of agro based commodities since 2013, under brand ‘Sunloc foods’. However, the same has been discontinued in FY20]

• Revenue of 116 Crs for FY22 as against 90 Crs for previous year. Net margin 6% (was reporting net loss for previous 3 years). Cash cycle has improved this year and both debtor and creditor days have reduced significantly.
• Had capacity of 13 bn in FY18 has been increased to 15 bn by FY22.
• Company is planning to increase proportion of HPMC capsules in revenue from operation which is likely to further improve profitability going forward.

Medicaps:

Again a BSE listed player with market cap of <50 Crs. (link). The company is in the manufacturing of the Hard Gelatine Capsules and is equipped to produce 7.5 billion pieces of empty hard gelatine capsules per year.

• Presently, the company has discontinued its pharma business operation and has entered into real estate business.

[Trivia, they had invested a small amount in share of Natural Capsules. What to make out when competitor trust you with his money?]

Gelcap:

Gelcaps, a partnership firm, is entirely owned by the promoter family of Aurobindo Pharma Ltd,
Gelcaps has an installed capacity of 3.51 billion capsules that will go up to 5.07 billion capsules with the ongoing enhancement.

• Gelcaps is expected to register strong revenue growth over the medium term, as it has now become the majority supplier of gelatin capsules to Aurobindo Pharma.
• The firm also booked a strong EBITDA margin of 29.7% (FY20: 27.1%; FY19: 4.23%) during 11MFY21. The margins are likely to remain strong at around 30% over the medium term as Gelcaps sells capsules to Aurobindo Pharma, which are then sold to regulated markets and thus command high margins.
• Revenue of Rs 44 crs in FY20 as against 290 crs in FY19. PAT margin were around 6%. Interest cost must be diluting net margin considering high debt that they have got from promoter group.
• They will have biggest customer concentration risk out of all the players, should any regulatory issues hit Aurobindo.

To conclude, each of the industry players have worked swiftly to a) capture the covid induced demand, b)shift/preference towards HPMC in nutraceuticals and c) void being crated by capacity of ~7.5 bn going away due to MediCap discontinuing operations. However, going ahead, the situation can be challenging:

1. On export side, Lonza is augmenting capacity by decent 30%, mostly into high growth HPMC.

2. Likewise, in domestic, ACG is aspiring to double its capacity. They are deeply entrenched player with E2E offerings (film and foil packaging, tableting, granulation, encapsulation, packaging machines and all).

3. Finally, Aurobindo’s business may gradually move captive (GelCap) at least for any of the new product launches/dossier submission.

Disc: No Position
Tarun