IPOs - Nectar Lifesciences

I know I was supposed to post my thoughts on IPO analysis but today’s the opening day for the Nectar Lifesciences IPO and the company looks like a good buy so thought I'd take a rain-check on preaching for today...

The Business

Nectar Lifesciences is a pharma company engaged primarily in API (Active Pharmaceutical Ingredient, the chemicals that actually have medicinal value in any tablet, syrup or powder we consume) manufacturing. It focuses on manufacturing Cephalosporin and Semi-Synthetic Penicillin (SSP), both of which are anti-bacterials and has manufacturing facilities in India as well as Sri Lanka.

It currently supplies to several Indian pharma firms including Ranbaxy, Aristo Pharma, Alkem, Ind Chemie and Biochem.

What Makes the Issue Interesting?

Reasonable Growth Prospects

• SSPs seem to be in a de-growth phase and demand seems to be slackening. However, the accelerating growth of Cephalosporins more than makes up for it. Bulk drugs (APIs) have shown a growth of almost 20% year on year for the past decade. One of the objects of the issue is to increase production capacity to take advantage of rapid growth in this segment and Nectar Lifesciences is well-placed to grow in line with this trend.
• Cephalosporins are the fastest-growing category in the Indian anti-infective segment, with a CAGR Of over 15%. Globally, too, they figure in the top 10 drug classes. Nectar Lifesciences manufactures 10 out of 15 types of Cephalosporins used in India
• There’s been limited impact of the new patent regime on the company’s business, primarily due to their focus on off-patent drugs

Sound Objectives for Deploying IPO Proceeds

The IPO proceeds are being routed to high-growth and business-critical areas, namely:

• Setting up a formulation plant, which will enable the company to forward-integrate into manufacture of capsules, tablets etc. and move up the value chain from being a supplier of bulk drugs
• Increasing production capacity of Cephalosporins to take advantage of high growth in this segment. Current capacity utilization is around 90%
• Improved R&D and quality control facilities. The quality control facilities will help the company obtain US FDA approval, which will significantly improve the company’s business prospects, especially in regulated markets like the US and Europe
• Movement into non-antibiotic segment for greater breadth in the company’s product portfolio

Sound Financials

• Sales and profits have increased at a compounded rate of 15% and 38% respectively from 2000 to 2005
• RONW has been steadily increasing from 21% in 2000 to 31% in 2005
• Profit margin has grown from 4 % in 2000 to about 10 % today
• Debt-equity ratio has fallen marginally from 1.54 in 2000 to 1.34 today, though total debt has increased (not very worrying for a growth business, especially since interest payments are still quite low compared to revenues and operating profits)
• EBITDA / EV (a good measure for capital intensive and growth businesses) is at about 9.6%, which implies that an investor in the operations of the business could expect an ROI of about 10%

Low Single-Client Exposure

The company exports to about 40 countries and its top 5 customers account for only about 17% of its revenues.

External Validation of Business Model

The company has a venture capital fund (Swisstec) among its shareholders.

High Promoter Holding

Post-issue, the promoter holding will stand at about 65%, which will ensure that the promoters have sufficient ‘skin in the game’ to ensure good governance and management.

Some Areas of Concern

Pricing Pressures

APIs are an ingredient in branded drugs and hence are susceptible to pricing pressures and price volatility. Further, the company’s main focus is on the Indian market, where leading pharma players have not been doing as well as in the past and drug prices are being brought under regulatory control. If big-name players find their margins being squeezed, they will almost certainly look at re-negotiating contracts with their suppliers

Size

Pharma, by and large, seems to be the kind of industry where scale is an important factor. Bigger companies can spend more on marketing, distribution and R&D than smaller ones, thereby making it that much more difficult for the smaller players to survive. Companies like Nectar Lifesciences need to find a niche or fall by the way-side.

Export Slow-Down

Exports as a percentage of sales has actually been falling (primarily due to lack of demand for SSPs) whereas it is rising for most Indian pharma companies

Tax Penalty

A tax –related penalty of Rs. 2 million looks likely to be imposed. It won’t have a major impact on profits, but will probably depress the share price for a while. Lawsuits and related payouts are always dampeners on stock prices

Few Big-Name Clients

The company does not seem to have any really large Indian clients except Ranbaxy, even though most of the drug majors market medicines that require Cephalosporin.

Competition

It is in direct competition with Aurobindo Pharma, Lupin and Orchid Chemicals, all of which are well-established players in the market.

Price Attractiveness

One thing I did not like in the prospectus was the use of pre-IPO numbers in calculating EPS and PE. This gives a pretty distorted picture of the price attractiveness. I’ve used post-issue share numbers below.

Post-issue, the number of shares outstanding will be approximately 14.9 million. This implies that the ’05 EPS post-issue will be about Rs. 15 per share. The book value (BV) will be about Rs 48.38.

The shares have been priced in the range of Rs 200 – 240, which yields a PE range of 13.3 - 16 and a P/BV range of 4.1 – 5.0. To give some perspective, its peers are valued in a PE range of 22-45 and P/BV range of 2.0-4.7.

For a company that’s been growing profits at about 38% compounded over the past 5 years this seems quite attractive, especially given the company’s growth plans and strategy. It would be worth buying even at the top end of the band.