Last week we revealed 10 businesses that we thought are good to invest and need further investigation to confirm whether they are worth to invest with. Marksans Pharma was one of them and it is today trading at cheaper valuations to what the consensus estimate it will earn profits in 2018.

Before investing in any business it is important to understand its business model and how does it earns or make money. Understanding Pharmaceutical business could be tricky if you are not from medicine background. We are not any close to medicine field but here is our understanding about this business.

Marksans Pharma manufactures medicines and sells them around the world. Not everyone can do this kind of business as it is highly regulated industry, especially in the western countries. They have to take license to sell their medicines in the respective countries. The issue of license depends on how you manufacture your medicine and you have to follow all the rules and regulations to do that.

Marksans Pharma operates in USA, UK and Australia, it also sells its products in the rest of the world, but majority of its business comes from these three countries which are highly regulated.

They have manufacturing unit in Goa which is approved by USFDA (USA Regulator) and MHRA (UK regulator). They also have manufacturing unit at south Port in UK and Farmingdale, New York, USA.

The business strategy of Marksans Pharma is to get into the manufacturing of soft gelatine capsules and enter in the US market where they estimate the total market of this product is around US$8 billion. The second line of investments is to manufacture medicines whose patents are expiring in 2015 – 2020. In other words manufacturing genetic medicine.

If you are confused about what is genetic medicines here then let me clarify. When pharmaceutical companies invent any medicines (new medicines) they acquire patent to manufacture exclusively that medicine. By average these patents give them exclusive rights to manufacture those medicine for 15 years, after that any pharmaceutical business can manufacture that medicine and sell them.

Marksans Pharma had identified that there are many patents of good medicines to expire in next 4 years.

To get into international market, the easiest and economical way was to acquire businesses in those countries they want to do business. They bought Time Cap Lab (TCL) in USA which is the 38 years old pharma business and also have USFDA approved manufacturing unit plus license of around 35 medicines to manufacture. The manufacturing unit is in Farmingdale, New York has capacity to manufacture 5 billion tablets and hard capsules. This acquisition had given them front end US presence and connects directly to its customer. Now as mentioned earlier, they are looking to manufacture soft gelatine capsules, as they are very popular and also the price erosion to make genetic medicine is only 50% -60% against 80% – 95% in tablets and normal capsules.

TCL contributes approximately 40% of total revenues of Marksans Pharma and is expected to grow as they are applying for more license (MOA) to manufacture medicine. They are already supplying generic Advil medicine in USA through tie ups with Walgreens, Walmart and CVS Health. The total market share of this medicine only is approximately US$250 million.

In UK they bought Bell, sons & company and Relonchem two businesses and in Australia Nova Pharmaceutical. In Europe they are looking to expand in other countries where they can sell soft gelatine capsules and market other medicines too.

The real money that this business will make is by manufacturing these soft gelatine capsules in India in Goa, where they have built world class manufacturing unit approved by USFDA and MHRA and have capacity to manufacture 6 billion capsules per anum.

They also expect the generic business market of about US$85 billion where they can bank upon.

The majority of growth, after understanding their business model looks it will come from the US markets. Looking at its 2016 financial results, they managed to grow their revenues by 13% but their Net profits have fallen down by 26%. This is because of jump in wages (employee benefit expenses) and other expenses.

As per our analysis they have also burnt lot of cash in 2016 and it will impact to its performance rating that we allocate. To justify this, we think they had done with capital expenditure for medium term.

We always advise to study annual reports and financial statements before investing. Our quality and performance grading is the barometer of how healthy is their balance sheet and its performance.

2016

2015 2014 2013 2012 2011 2010 2009 2008 2007
B2 (E) B1 C3 C4 C2 C4 C4 C3 C4

C3

 

Looking at the above table it looks that the business had not seen stability and just last year it qualified our investment grade (A1, A2 and B1). The quality of balance sheet had just improved recently from ‘C’ to ‘B’ grade.

It also had struggled to generate surplus cash flow. In last 10 years it was able to generate surplus cash after paying dividends and capital expenses was in 2015, 2014 and 2013. Due to capital expenses it might not be able report positive cash flow in 2016 financial year too.

Coming to its valuations, consensus analysts are expecting its 2017 earnings to be Rs 3.50 per share and for 2018 to be Rs 4.95. This is more than 40% earnings growth per anum for the next two year. These numbers are achievable if management can control its operating expenses and concentrate on profitability, as Rs 2.75 per share was reported EPS for the 2015 financial year.

Today, if we believe in the consensus reports than as per our calculations its intrinsic value comes Rs 37 per share for 2017 and Rs 63 for the 2018. It is trading today at the cheaper price to its expected 2018 earnings.

Investors can make good money by investing in it if they believe the management possess skills to deliver. Looking at the history of the management, they have not given stable results to believe in them, and our strict policy to invest in only quality grade business tells us to let go this opportunity at the moment until we see its first quarter 2017 results.

Aziz Dodhiya is the chief investment officer for the Valueoperations funds which operates in the Indian market as an FPI (Foreign Portfolio Investor). We do not offer any personal advice to buy or sell any stocks and the views that are shared by Aziz might not incline to your personal investment strategy and this is the reason we advise you to take professional advice before going ahead with our views.