Stock Idea – IPCA Laboratories

This one is a long post, I apologize in advance if you doze off while reading it, if you do manage to reach the end, feedback would be highly appreciated: p

About:

  1. Incorporated in 1949 and currently employees ~11,000 employees
  2. Integrated pharmaceutical company; currently having around 80 APIs and 350 formulations ( branded and generics )in its product portfolio
  3. Market leader in anti-malarial and Rheumatoid Arthritis with over 30% market share
  4. Formulations business is 76% of revenue and the remaining is API
  5. Share of exports is over 60%
  6. Has more than 12 manufacturing locations

Key Market Indicators:

Key Financials & Analysis:

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  1. Net worth ( Book Value ) measures the intrinsic and inherent value of stockholder’s equity, for IPCA labs, it has grown at an amazing 25% CAGR over the past 5 years, not only that, it has maintained an Return on equity (ROE) at an average of 24% over that period, this clearly states the superior fundamentals of the business and the efficient capital allocation skills of its management, maintaining a decent return on incremental capital employed by owners is one of the most challenging tasks for any company, IPCA labs seems to be doing a good job
  2. Company has delivered excellent growth over the past 5 years with Sales and PAT growing at 20.05% and 38.15% respectively
  3. Very less leverage which is a very good sign, when you look at that in conjunction with very little equity dilution, high growth and very good ROE, you realize the fantastic cash flow generating ability of the business and the superior capital allocation skills of the management
  4. The management is paying out only around 17% ( Avg 5 yrs ) of PAT as dividend and yet maintaining excellent ROE indicating that management is aggressively pursuing growth but not at the cost of profitability
  5. Fixed asset turns are impressive at an average of 1.97, the interesting thing is that over the past 5 years, this ratio has grown, indicating efficient use of assets by the company
  6. The business is consistently Free cash flow positive over the past 10 years
  7. Debtor receivable days have consistently come down and payable days have gone up indicating that the company is collecting cash faster and making payments later, further shows management efficiency
  8. Company is aggressively incurring capex aggressively to expand capacities, ~60% of PBT and ~10% of sales is incurred as capex

Reasons to buy:

  1. On fundamental grounds this is a company with superior fundamentals
  2. Company growing at +20% with little dilution or debt, this shows how large and deep the market potential is
  3. Management is decent and an efficient allocator of capital as evident from above analysis
  4. Aggressively investing in building capacities
  5. Recently one of its plants was inspected by US-FDA and it was shut down voluntarily by the company as a result of which the stock fell down by 13% ( this is where things get most interesting )
  6. The contribution of revenues from the US markets is ~10%, FY 2014 revenue was 3,296 cr ( Net ), let’s assume that 330 cr revenue from the USA is wiped off indefinitely
  7. PAT margin of 12% should mean an impact of ~40 cr on the bottom line
  8. So for FY 2015 let’s consider PAT to be 430 cr and assume there is no growth in any other segments either ( which by the way is unlikely as management has given guidance of 12% )
  9. So under these assumptions at 12% cost of capital, the current market price is assuming growth of ~12% for the next 10 years and 3% for the distant future
  10. The question is can the company do better? In our opinion it can and this is a very lucrative opportunity to buy this company
  11. The US-FDA issue is short term in nature as the management is committed to resolving it within 6-8 months time
  12. The company hopes to quickly regain lost market share as it would be difficult for competition to match its scale so quickly
  13. There is no penalty clauses with customers in case of discontinuation of supplies
  14. IPCA has been automating most of its production processes and management is confident that once it is complete, most of the issues raised by FDA will be resolved

Risks and Concerns:

  1. If the US-FDA issue isn’t resolved in time, it could further impact profitability and delay new launches
  2. Post resolving this issue the company could find it difficult to regain market share
  3. If there is a general slowdown in the industry
  4. Increased competition could impact margins

Conclusion:

  1. In our opinion this is an opportunity to buy a company with superior fundamentals at a discount
  2. It is a long term idea and would require patience for the returns to unfold, we think CAGR of 15-18% is comfortably possible over the next 3-5 years

Disclaimer : This is not a buy/sell recommendation, it is purely meant for discussion and knowledge purposes, please do your own homework

Sources: Company AR, presentation, Ace equity and third party research

Stock Idea – South Indian Bank

About:

  • Incorporated in 1929, South Indian Bank (SIB) is a mid-sized bank in the private sector space
  • It operates a network of ~800 branches and ~1000 ATMs
  • Predominantly present in Southern India ( Kerala )
  • It has scaled to a business of 83,894 cr in FY 2014 at a CAGR of 25% over a 5 years period

Loan Portfolio:

  • 22% of the loans are RETAIL LOANS out of which majority are against gold
  • Around 50% of loans are in the CORPORATE segment
  • 28% of the loans are in the SME & AGRICULTURE space
  • It has quite a conservative approach, if you observe they have negligible exposure directly to sensitive sectors like real estate and almost all of them are in the housing mortgage space

Key Financials: 

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Reasons to buy:

  1. Management is managing risk quite well, Net NPAs<1% are really good, especially considering the recent slowdown and a very difficult macroeconomic scenario, bank is not sacrificing quality for growth
  2. In spite of that the bank seems to be growing and expanding quite well at a healthy CAGR of ~20% and expanding rapidly by adding new branches to have a pan India presence
  3. Profitability of the bank is very good, ROE is averaging at 18% over a 5 year period and NIM average is healthy too at ~2.5%
  4. It is well capitalized and its CAR stands at a comfortable 12.5%
  5. Another thing I like about SIB is that it hasn’t diluted too much equity in the past, this is one very critical element which we often overlook
  6. Management is quite transparent and clean, in addition to that the remuneration for the top brass is reasonable
  7. Its a professionally run bank, with no promoter holding
  8. It has decided to focus more towards the Retail, SME and Agriculture segments which has a high growth potential
  9. Other Income growing at ~18% CAGR will add a healthy fee based stable income to the bank’s bottom line and reduce earnings volatility
  10. Valuations are very attractive, for a bank growing @20% CAGR and having ROE @18% is quoting at a P/BV of 1.19
  11. Dividend yield of around 2.5% is quite good
  12. Mohnish Pabrai who is an investor I really admire for his style and Investment philosophy has recently invested in this idea

Risks and Concerns:

  1. The nature of the banking business is by itself quite risky, SIB however through its conservative approach is managing that risk quite well
  2. CASA ratio of the bank is quite low in comparison to some of its peers, this is very crucial to reduce its cost of funding, the bank is aware of this and taking adequate steps to increase the same
  3. Its Cost/Income is also on the higher side which the company should take steps to reduce
  4. If the macroeconomic scenario should not improve and remain sluggish it could impact its growth and profitability
  5. SIB has a high exposure to gold loans, which the company is taking steps to reduce

Conclusion:

  • Overall I think this idea should do pretty well over 3-5 years and compound at a decent 15% CAGR
  • True there are some risks and concerns, which is why we always look for margin of safety which is adequate in this case

DISCLAIMER: I am not in any way making any recommendation to buy/sell through this post, please do your own analysis and homework

 

Sources: Company AR, presentations, ACE EQUITY, third party reports