The company has managed the supreme feat of selling almost its entire output of pharma intermediates in the West and making a financial success of it.
The large outlay on R&D
The chairman and CEO of the Andhra Pradesh based company, Mr Venkat Jasti, is more than modest in his communiqué to the shareholders. He says 'drug discovery and development is a long drawn process and it takes 10-12 years to have a successful molecule. Suven has been in drug discovery for the past eight years and have not yet achieved any success or a milestone. The company is involved in research in the toughest area, the Central Nervous System (CNS) disorders... success in this area is a rarity and failure is the norm. The CNS disorders market is one of the fastest growing markets in the industry, and Alzheimer's disease affect millions of people the world over. There is no cure yet for Alzheimer's disease'. The question that arises is that if success is a rarity in this area, why then is the company committing such large sums and chasing a mirage perhaps? The company has charged R&D expenditure of Rs 330 m to revenue expenses during the year against a charge of Rs 311 m previously. It is not known the amount of R&D expenditure which has been capitalised. But the gross value of the capitalised R&D assets stands at Rs 539 m. This figure has to be seen in conjunction to the total gross block of Rs 2 bn.
One point in the company's favour is the detailed reporting of the figures that go to make up the P&L account and the balance sheet. So one gets a better take on what this company is all about. The company states that it is primarily in the business of manufacturing and selling bulk drugs, intermediates, and fine chemicals. It also earns revenues from the sale of pharma related services. It has yet to get any moneys from the efforts expended in generating new drug molecules. The company makes do with two production facilities in Andhra Pradesh, and two research centres in Hyderabad.
The revenue streams
Revenues consist of accruals from sale of 'manufactured products' and 'services'. The sale of manufactured products accounted for almost 94% of the gross revenues of Rs 2 bn in 2011-12. The balance revenues accrued from the sales of services. Again, in the manufacturing segment it is the sale of 'intermediates' which brings home the bacon by far, with the sales income of 'bulk drugs' accounting for almost the entire balance lilliput receipts. There does not appear to be any revenues realised separately from the sale of fine chemicals. The revenues realised from the sale of services is a mixed bag of items, and includes contract technical services, clinical trials services, process development charges, and collaborative research projects. In 2011-12 it earned revenues of Rs 125 m from this effort which was sharply lower than the Rs 243 m that it received in the preceding year. This head of account does not look like a steady stream and their individual contributions could vary substantially from year to year. For example in 2010-11, it earned income of Rs 110 m from an item called Collaborative Research project. In the latter year there was no income from this item.
But the point is that this income stream would appear to contribute quite some bit to the pre-tax profit. Have a look at the statistics. In 2010-11 the pre-tax profit amounted to Rs 32.5 m and the figure for 2011-12 was Rs 91.4 m. Now juxtapose these figures with the income from services given in the earlier paragraph (before deducting related expenses). Even if one were to take the net operating profit figures of Rs 53 m against Rs 106 m previously from this line of activity, it forms a vital component to the bottom-line. The income from services in effect heralded in the black ink at the pre-tax level, in a manner of speaking. One may also add here that separately 'other income' contributed Rs 19 m (Rs 12.5 m) to the cash inflow kitty. However, the latter receipt includes a generous dose of forex gains in either year - the latter can go the wrong way in another year.
The revenue expenses
The company generated a sharp increase of 35.7% in its revenue streams during the year. This increase could have been partly occasioned by the benefits flowing from the merger of its sibling Suven Nishtaa Pharma Pvt Ltd with the parent during the year. (This company was apparently a loss making unit). The company on its part claims that the merger enables better utilisation of resources and capital in achieving economies of scale. Some of the major revenue expense items rose at a faster percentage clip even though the pre-tax profit jumped 182%. The consumption cost of 'material inputs' - the largest item of expenditure -- rose 38% to Rs 814 m, while 'other expenses' rose 103% to Rs 227 m. (This head of expense includes two items amounting to Rs 97 m against NIL previously, being the loss on forward contracts, and the loss on marked to market, on forward contracts, and which is directly linked to the export effort. If the company gets it right the next time around it could figure in the income side of the equation).
But the company did exercise some control over two other major expense heads. Manufacturing costs, and employee expenses, were contained with the former rising 28% and the latter by 6%. And, research and development expenditure, over which it has absolute control, was allowed to grow only by a mere 6%. As stated earlier this expenditure has yet to bear fruit. And this outflow currently weighs heavily on margins, and also on the amount of debt that it is forced to carry as a result. But, as is quite evident there are other dicey tricks also involved when booking R&D expenses, as we shall see further on in this copy.
Dependence on offshore revenues
The other very pertinent aspect of this company is that the vast bulk of the manufactured sales are affected offshore. Or to look at it from a different angle, only 5% of such sales were made in India, against a much larger percentile of 9.6% previously. Clearly, the company's focus in generating revenues is 'outside of India'. The largest target market is Europe which took in over 57% of all sales against 45% previously. This is followed by the USA with close to 31% against 30% previously. A category titled 'Others' brought in the balance moolah.
Creditably enough, inspite of the company's avowed focus on foreign markets to earn its succour, the manufacturing operations turn in a judicious margin at the end of the day. It achieved an operating profit margin of 34% on manufacturing sales against a lower 28% previously. The company has not touched on the reasons for the increase in margins in the directors' report. But at the same time the 'income from services' head of account rolled in a margin of over 42% against 44% previously. This is one of the few companies - pharma or otherwise - that I have analysed, which is actually turning a profit, and a delectable one at that, from export sales. This company should serve as a beacon to other Indian corporates which are rushing in pell mell into the export effort and having very little to show for it.
Deft working capital management
Keeping pace with the margin generation is the deft working capital management. The gross current assets at year end including cash and bank balances was only marginally higher than the current liabilities. Equally importantly, the trade receivables were brought down sharply as compared to the level pertaining in the preceding year and are now on par with the trade payables. And the level of inventories was kept at a steady 23% of the gross sales for the year. The only question mark is on its ability to generate manufactured sales on its sizeable gross block. On a year-end gross block of Rs 1.5 bn the company rustled up gross manufactured revenues of Rs 1.9 bn. This would not appear to be a very healthy usage of its manufacturing facilities. Besides, the borrowings at year end were quite some bit higher at Rs 778 m against Rs 658 m. This would appear an anomaly at first sight given that it generated substantially more cash from operations of Rs 335 m in 2011-12 as compared to Rs 52 m previously. However, more on this cash flow aspect later on in the copy.
Just as remarkable as the export sales margins are, so is the accounting for tax provision. This again is the first company I have seen where the post tax profits are greater than the pre-tax profits, and after provision for tax for the year. The higher post tax profits are a fallout of the adjustments made for deferred tax and for MAT credit entitlement. Thus on a pre-tax profit of Rs 91 m, and after a tax provision of Rs 17 m, thanks to such credits the company posted a post tax profit of Rs 144 m. It was almost a ditto makeover in the preceding year too. If in reality life was only as elementary as this! Importantly, unabsorbed losses at year end -and which is a part of deferred tax assets amounts in all to Rs 418 m. This probably refers to the unabsorbed losses for taxation purposes.
The nominal asset factor
Assets such as unabsorbed losses are described as nominal assets - which exist in theory. This company has a plethora of such assets in a manner of speaking. Besides deferred tax assets of Rs 418 m it has a bogey of them under such heads of account as Value Added Tax (VAT) credits receivable, Central Value Added Tax (CENVAT) credit receivable, service tax receivable, Minimum Alternate Tax (MAT) credit entitlement etc amounting in all to Rs 186 m.
Besides the nominal assets that it boasts of, there is also the bizarre cash flow statement that the company has anted up. How it balanced its books on the cash flow front is not immediately known. The company generated Rs 355 m of cash generated from operations, compared to a considerably lower Rs 52 m previously. But at this point the data becomes foggy. The 'cash flow from investing activities' does not appear to project the correct status. The investment portfolio has actually become considerably lighter from the sale of securities during the year and hence it should be shown as an inflow of cash of Rs 159 m rather than as an outflow of cash. So the net position here should be an outflow of Rs 107 m rather than an outflow of Rs 317 m that the company has declared.
The cash flow does not add up
By the time you migrate to the 'cash flow from financing activities' it appears to get a little muddier. The company says that the net borrowings have risen by Rs 114 m during the year. From the data that is available, the net borrowings including short term debt maturing in the next 12 months has actually risen by Rs 321 m. This would again alter the final figure of the cash flow from financing activities. It is not known how the company has come up with the figures that it has.
It is very difficult to take a call on this company especially since it is almost completely in the export business. It has a meagre paid up capital of Rs 116 m with a face value of Re 1 each. The promoters control a non assailable 63.5 % of the paid up equity. It is listed for trading both on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The share price on the NSE vacillated from a high of Rs 25.8 to a low of Rs 11.1 in the last accounting year, indicating a considerable movement in the share price. The company even boasts of over 40,000 stakeholders. Obviously there are also those who see quite some value in this share.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.