AGM Note: Fredun Pharma an interesting smallcap to watch out for
The company’s inventory has increased from Rs 18 crore to Rs 40 crore.
(Kolkata’s Arun Mukherjee, who dropped out of college to turn a full-time investor at an early age, and Soumya Malani, a London School of Economics alumnus, have come to be known as smallcap aficionados within India’s investor community. They would show up at most AGMs, visit the remotest factories of a company and go chasing end-users to understand their experience with a product in their passionate hunt for good smallcaps. Arun and Soumya share their experiences with such companies from the ground in this space every now and then.)
Fredun Pharma has come a long way by growing at a CAGR of 30-40 per cent and recorded sales of Rs 98 crore in FY19. The company aims to grow at 25-30 per cent in next 2-3 years, and the management seems to understand the balance between scalability and sustainability.
The company started operations way back in the 1990s as a contract manufacturer for big pharma companies. Currently, contract manufacturing is only 2% of its total turnover. Anti-diabetic ingredients contribute 25% of its total sales, anti-cardiac 18%, NSAID 24% and others 33%.
The company has expanded production capacity by 530% in last few years. It has been systematically investing in its productive infrastructure by installing additional granulation departments, high-speed tableting and blister packing machines. The current capacity utilisation is at 50% and it is projected to go up to 80% by mid-2020.
The company’s product portfolio has expanded from around 63 products in 2007 to 427 in 2019. It is registering its products in various countries and over 200 products are due for registration over next 18-24 months. It hopes to get a cosmetic licence for manufacturing-related stuff soon and plans to launch a generic medicine line.
Anti-diabetic products contribute nearly 25% of its revenues. The number of Indians with diabetes is projected to reach 73.5 million in 2025. Direct and indirect costs of treating such patients are currently estimated at $420 per person per year. If these costs remain the same as they are now, India’s total bill for diabetes treatment would be $30 billion by 2025.
The company is targeting Rs 120 crore sales of in FY20 and Rs 150 crore in FY21. The focus over the next 2-3 years will be on marketing/registering products. The company has the right mix of value and volume-based products.
It is targeting Africa and considers it a huge potential market that can deliver good future growth. Sri Lanka is another market, which the company believes can be huge. It has registered some products for the high potential Russian market too.
The company’s net margins are likely to go up from 3% to 8% in next 2-3 years. It is in talks with banks and investors for working capital required to scale up. It could either be in the form of equity or debt.
The company expects to do a business of around Rs 60 crore only from ointments and pellets in next 2-3 years. Most product developments are in final stages. The current order book in hand is Rs 45 crore.
The company’s inventory has increased from Rs 18 crore to Rs 40 crore and it is likely to remain high since it has been buying in bulk (for 4-6 quarters) to get discounts, which leads to savings. Operating leverage will come into play once it crosses Rs 170-180 crore in sales.
The company has no concern regarding Africa client payments or bad debtors. It deals with parties that are largest or second largest in their respective countries. The total debtors of only Rs 13 crore on Rs 98 crore sales is a testimony of that.
The company has enough capacity to deliver Rs 230 crore sales and doesn’t need to expand it over the next two-three years. It will, however, require some machine and plant upgradation cost.
The promoters recently pledged 4% holding as collateral for secured loans. The company, however, has no plan to pledge more shares. There is no risk of the lender dumping existing pledged shares in the market. The company is aiming to reduce debt and become an almost debt-free company by 2020.
Keeping in view the company’s growth, the board of directors recommended a final dividend of Rs 0.65 per equity share of face value Rs 10/- each for the financial year ended March 31, 2019.
Our Take: The note comes from Ayush Gupta, one of our go-to guys for AGM coverages. Ayush is a serious smallcap investor and making a mark already. The management of Fredun Pharma has a good habit of putting out conservative guidance and overdelivering by a good margin. The first quarter profit looked pretty deflated. Instead of capitalising its R&D expenses, the company showed them as expenses and took a hit on P&L. We feel it would have been better to create a subsidiary to do research & development- related activities. It would have led to showcasing the true standalone numbers and given them the chance to raise funds in the subsidiary, which wouldn’t have led to dilution the parent company’s equity.
In next three years, we expect the company to hit a top-line of Rs 200 crore along with 8-9% net margins. Altogether, an interesting smallcap with a lot of potential to watch out for.
DISCLAIMER - The writers are partners of SA Investment Advisers, a Sebi-registered investment advisory firm. They along with their family members may have position in the company discussed above.