Forward integration and formulation business to drive growth and profitability for Laurus Labs
Laurus Lab (LAURUS) is a young, R&D led Pharma Company. LAURUS is one of the leading API manufacturers for ARV (Antiretrovirals) and Hep-C (Hepatitis C). Company has leveraged chemistry skills towards synthesis services and manufacture specialty ingredients. It is also forward integrating to formulations for regulated markets. LAURUS is targeting 30 ANDA filings (six filed till date) over the next 2-3 years and accordingly expanding capacity from 1b units/year to 5b units/year. It is also forward integrating in ARVs for further improvement in profitability.
This midcap pharma company has superior operating margins in API segment. Company has been enjoying 18-20% EBITDA margin in its business which is currently dominated by API segment. This is on the back of highly cost efficient processes implemented by the company. The company is in the process of transforming itself from pure API play to formulator by forward integration and building product pipeline for regulated as well as emerging markets.
Addition of new molecules to help drive ARV API sales:
LAURUS commenced commercial operations in the ARV API segment in 2009 and now it contributed 64% (Rs.12.2b) of sales in FY17. Company has significant market share in this API segment mainly due to its cost efficiency. The key molecules that LAURUS sells in this segment are Efavirenz, Tenofovir, Disoproxil, Fumarate, and Emitracitabine. LAURUS has been enjoying almost 50% market share in supplying Efavirenz API since 2013. Growth in the ARV API segment is expected to be led by stable EFV sales, introduction of Lamivudine/Dolutegravir and other combinations.
Moving towards formulations in ARV products:
LAURUS is leveraging its API skills and forward integrating to supply finished dosages, which would enable LAURUS to expand margins. With the formulations facility in place and one dossier filed with the WHO, LAURUS plans to supply to LMIC countries through the tender process. Also, LAURUS has entered into an agreement with Dr.Reddy’s Laboratories for developing and marketing of several ARV formulations on profit and cost sharing basis. Also, LAURUS intends to tap opportunities arising from the expiry of key ARV products in the US market over the next 2-3 years.
Company has invested INR 2B in building formulations facility at Vishakapatnam and expanded capacity from 1b tablets per year to 5b tablets per year. The additional capital investment for this project would be about INR1b over two years.
Volume growth to drive Hep C API business
LAURUS’ Hep C business largely involves manufacturing and selling Hepatitis C APIs comprising of Sofosbuvir, Ledipasvir, Daclatasvir and Velpatasvir to Natco Pharma. The deal with Natco Pharma gives LAURUS two revenue streams: (1) sale of API to Natco Pharma, and (2) share of profit from Natco Pharma on sale of formulations. Also, LAURUS has to share profits with Natco Pharma if it sells API to third parties.
LAURUS started this business in FY15 with a turnover of INR231m; in FY17, sales from this segment were INR2.5b. Being early to market, sales were led by significant ramp-up in volume offtake. These sales are largely in India. Though volume growth remains strong, the growth in LAURUS’ revenue from this segment is likely to moderate, primarily due to declining prices. Prices have been declining due to increased competition.
New molecules to drive growth in Oncology API segment
The key API molecules sold by LAURUS in this segment are Imatinib Mesylate and Gemcitabine HCL. Currently, Imatinib Mesylate is largely sold in the domestic market, while Gemcitabine HCL is exported. LAURUS’ Oncology API revenue grew at a CAGR of 14% over FY14-16, largely led by pick-up in Gemcitabine volumes. Gemcitabine is a higher value product than Imatinib. Going forward, growth would be led by launch of new molecules, capacity expansion and increased traction from existing molecules. LAURUS intends to launch a couple of products every year for the next 2-3 years.
Synthesis/Ingredient business – another growth trigger
LAURUS leverages its strong chemistry skills to provide contract development and manufacturing services to pharmaceutical companies. It provides analytical and research services, clinical research supplies, and commercial-scale contract manufacturing services. Its focus has been to supply key starting materials and intermediates for NCEs. The quantum of revenue would increase, as the molecule moves to commercial manufacturing stage.
LAURUS has entered into a toll manufacturing and supply agreement with an Aspen group entity, under which it would manufacture and supply certain hormonal intermediates to the entity. It has built unit-5 and a dedicated block in unit-1 for this task. The investment of about EUR26m in unit 5 was funded by Aspen. Unit-1 is already commercialized and unit-5 became operational from November 2016. The validation batches are progressing and commercialization would be in 1QFY19. We expect LAURUS to maintain strong momentum in this segment on the back of NCE molecules moving to higher clinical phase and higher capacity utilization of unit-5.
Formulations business to pick up from current financial year:
LAURUS has developed and filed 42 DMFs and eight ANDAs till date with USFDA. It intends to file 8-10 ANDAs annually, taking its cumulative filings to 30 in the next three years. Specifically, it has tentative approval for g-Viread. Given that facility compliance is in place and all USFDA queries have been resolved, final approval would kick-start revenue from the US market. In addition, LAURUS would incur total capex of INR3b (INR2b spent till date) to facilitate manufacturing. Also, it is in the process of filing products to participate in global tenders for ARV formulations. It is targeting ARVs, antidiabetic, cardiovascular and proton pump inhibitors as therapy categories for the formulations segment. We expect strong growth in LAURUS’ formulations business over the next 2-3 years.
LAURUS’ facilities have been inspected multiple times in the last 8 years. The company has cleared these inspections with minimal observations – Unit 1 and Unit 3 had two observations in Form 483 issued in August 2017. Recently, it received EIR for the inspection conducted at Unit 2 in May 2017. This implies minimal regulatory hurdles for LAURUS in the medium term.
LAURUS remains on track to file 30 ANDAs on cumulative basis over next 2-3 years. Accordingly, LAURUS has increased its R&D spent from INR0.4b to INR1.2b in FY17. Annual R&D spent is expected to be about INR1.2-1.4b over next 2-3 years to support product development for regulated market, development of products in synthesis business and newer molecules in oncology segment.
Growth in revenue and profitability to be strong over the next three years:
Over FY14-17, LAURUS has delivered 18% CAGR in revenue to INR19b and 25% CAGR in PAT to INR1.9b. The strong growth has been on the back of new API launches/ healthy growth in base API business and meaningful addition in ingredients and synthesis business over the past two years. On overall basis, we expect LAURUS’ revenue to grow at a CAGR of 18% over FY17- 20, led by incremental sales from the formulations segment, better traction from the Aspen contract, and restoration of momentum in API segments.
Gross margin has expanded 1000bp over FY14-17, led by increased share of higher margin synthesis and Hep-C businesses. Accordingly, EBITDA margin increased by 314bp over FY14-17. Going forward, we expect EBITDA margin to increase by 200bp over FY17-20 due to addition of formulations business and continued traction in synthesis business.
Finance cost has reduced in 1HFY18 due to ratings upgrade, which has resulted in lowering of cost of borrowing. We expect further reduction in interest cost going forward. With considerable capex cycle starting in FY14, the return ratios lowered during FY14-17 compared to FY11-14 period. As considerable capex now behind, we expect return ratios to improve FY19 onwards on the back of better capacity utilization as well as improvement in profitability. Currently the company is trading at 17x on expected FY19E earnings. With the multiple levers in place to drive growth and profitability we expect the stock to perform well over the medium term.