Where Will Laurus Labs Stock Be in 3 Years?

India is known as the 'Pharmacy of the world'.

The country truly deserves this title, considering how this industry evolved from being 'underdeveloped' to ranking third in the world in terms of pharma production by volume.

Today, India is the largest provider of generic drugs, accounting for 20% of the world's supply, and it supplies 60% of the world's vaccination demand.

The Indian pharmaceutical industry is expected to double in value by 2030. Thus, the demand for APIs, formulations, and contract manufacturing services will also go up.

Rising demand for medical products and services is the main driving force behind the sector.

The Indian government is also helping out with various schemes directed towards the industry, which include three PLI schemes as well as schemes for bulk drug parks and medical device parks.

The China+ megatrend is another factor driving growth.

In this fertile growth environment, Laurus Labs has emerged as a strong company in the industry.

In this editorial, we will examine the company to ascertain its future.

An Overview of the Company

Laurus Labs offers an integrated portfolio of custom synthesis, generic active pharmaceuticals ingredients (API) development, generic finished dosage forms (FDF), and biotechnology.

As a contract research and manufacturing services (CRAMS) partner, the company caters to the world's top generic and innovator pharma companies across North America, Europe, and Latin America. It counts 6 out of the top 10 innovator pharma companies as its customers.

It's products are sold in over 80 countries to more than 300 customers. The company derives more than 60% of its revenue from exports with Europe (27%) and North America (17%) contributing the largest share of exports.

The company has 12 manufacturing plants which collectively have a 10 billion (bn) drug products capacity and 240 kilo liters fermentation capacity. It also has 5 state of the art R&D labs in India employing over 1,100 scientists across various functions.

The revenue breakdown of the business in FY24 was as follows:

• Custom synthesis (CDMO): 18%
• Generics API: 51%
• Generics FDF: 28%
• Biotechnology: 3%

The generics API is its core business with the company specializing in anti-retrovirals (ARV). The company has established a name for itself as the world's leading third-party API supplier of ARV. It has built the largest HiPotent API capability in India.

A Look at the Financials

Between 2020-2024, Laurus Labs' revenue has grown at a CAGR of 17.2%, while net profit has increased at 12.4%.

The return on capital employed (RoCE) and return on equity (RoE) have averaged 21.9% and 22.9% over the last 5 years.

Capital expenditure reached approximately Rs 7 bn in the last financial year, with continued investment in CDMO and bio divisions planned at a similar level in FY25.

This is consistent with the management's strategy of investing in capacity development and R&D early in high growth areas, well before a contract is on the horizon. This is to ensure that the company is fully prepared to seize market opportunities as they present themselves.

However, this strategy results in high fixed costs which can be a big drag on the bottomline if sales growth does not come in as expected.

FY24 was a case in point. It was a bad year for the company. Revenue fell 16.6% year on year (YoY), operating profit fell 51.2% YoY, and net profit fell 78.9% YoY.

The operating margin and the net margin compressed significantly due to high costs. The operating margin fell to 15.4% in FY24 compared to 26.4% in FY23. The net margin fell to just 3.3% in FY24 compared to 13.2% in FY23.

The company's debt to equity ratio is manageable at 0.2. However, the operating cash flow fell 33% YoY to Rs 6.7 bn and the interest coverage ratio deteriorated to 2.3 in FY24, from 7.7 in FY23.

The RoE and RoCE also fell significantly to 4.1% and 8.6% respectively in FY24. This was largely due to the decline in the company's margins.

The dividend payout for FY24 25.6% of the net profit. The 5 year average dividend payout is 13%.

Outlook

The company is clearly in full investment mode across its entire portfolio and especially in R&D. The focus remains on scaling the high-potential, customer-centric CDMO business and enhancing its scientific capabilities.

Along with the ongoing expansion of CDMO/API capacities, it has commenced the US$ 40 m phase one construction of a new GMP-grade microbial fermentation commercial facility in Visakhapatnam.

Recently, the company commissioned a new research center. Also, two GMP plants for the emerging animal health business have started production, while two other units are in the buildup phase.

The company has also made a strategic investments in advanced technologies like gene therapy, cell therapy, precision fermentation, agrochemicals and animal health contract manufacturing.

Its associate company, ImmunoACT, has successfully launched NexCAR19 in India, a groundbreaking treatment for certain cancers. The company is constructing a second large GMP-integrated CAR-T facility to make this treatment more accessible and affordable.

The management's aim in FY25 is to improve the operating margin and increase the asset utilisation of the company. While the management anticipates some pricing pressure in parts of the company's API portfolio, they expect to offset these with volume increases and cost-improvement measures.

Conclusion

The company's management believes the investments being made are dedicated towards future growth and are designed to create long-term value for shareholders.

Also, the R&D investments, comprising 4.8% of sales in FY24, is directed towards enhancing the company's product pipeline.

However, this high investment strategy can cause impediments to short term profitability. The management could be proven right in the future as these investments bear fruit. In the meantime, the bottomline has taken a hit.

To be fair to the company, much of the margin pressure is due to insufficient revenue growth and not inefficient operations. The topline growth has been subdued due to pricing pressure in the core generic API business which is not in the management's control.

This the decision to invest early in new, high growth areas, which should have higher margins, is the right way to go. But until these businesses scale up, the company's financials will look unimpressive.

Investors in the stock and those looking to invest, should have clear expectations from the company regarding the revenue impact of all the R&D and the new capacities being created. Do your due diligence, have reasonable expectations for growth, and pay close attention to the stock's valuations.

Happy investing.

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