Investment has played out differently from how I had anticipated initially. Bought at it’s absolute peak of Rs. 680 and have averaged down since then. With that the company has reached my largest investment by buying cost.
The reason I ended up buying at the peak was –
- I could not see the fall in ARV business that was showing up due to channel stocking and only focussed on the USD 1 Bn target which the managment was giving
- And again repeated the same by not anticipating the impact of one time contract in CDMO and extrapolated the revenue with the managment guidance of USD 1 bn
- When both of these normalised, huge operating deleverage started to show up because of un-utilised new and old capex
Investment thesis while adding Laurus Labs to the portfolio..
In FY21, the company experienced significant growth, supported by its gross block expansion from Rs 1100 Cr to Rs 3000 Cr over five years. Leading to a revenue increase from Rs 2832 Cr to Rs 4814 Cr, with a 22% CAGR between FY16 and FY21, while achieving a ROCE of 41%. They evolved from an API to a pharmaceutical company.
Future guidance also sounded very promising with a sales target of USD 1 Bn by FY23, and the capex plans indicated that the transformational growth would continue.
Taking a hindsight view - mistake made while forming thesis..
Invested at peak ROCE and peak margins, no margin of safety left as excessive optimism was already priced in. My thesis relied on future capex driving growth, but I failed to anticipate that the capex incurred before becoming operational would impact the ROCE negatively.. Additionally, the custom synthesis PO was lumpy in nature (they were reaching 30 % contribution from synthesis business much more earlier then guided) and that was leading to peak EBITDA margins of 32%.
Why have I continued buying?..
Since FY21 they have worked towards metamorphosing into a Lifescience company..
- Richcore acquisition was a stepping stone into capturing the biotechnology opportunity. Their current focus would be in large scale r-protein fermentation focusing in food industry.
- Within custom synthesis added Crop sciences and Animal pharma clients, and developing a dedicated block for the same.
- Collaboration with Immunoact and IIT Kanpur for cutting edge technologies in cell (like Car T) and gene therapy.
As the haze in revenue have cleared out (post ARV de-growth stabilising and the one time gain from custom synthesis purchase order normalising), operating deleverage is coming through. FY24E revenue is largely similar to FY21, with profitability fallen to 20% of FY 21 earnings; as a lot of operational inefficiencies are currently present with the gross block doubling and team strength having increased by 35%.
Expected result of this transformation
The effect of Laurus transformation was best described by Mr Sajal Kapoor in his recent webinar on ‘Anti Fragile Businesses’. Currently optimisation of FY22-24 capex is underway, which would result into better asset turns, probably surpassing the previous high of 1.4x. This would come as they shift from simple to more complex molecules along with higher gross margin CDMO business, and as the capex shifts from greenfield to mix of greenfield and brownfield.
Keeping in mind managment’s missed guidance of USD 1 Bn and debt in the business as negatives, key reasons for staying invested and believing for a turn around –
- Proper utilisation of capex and resources, brings in a possibility of high operating leverage showing up
- The shift from an ARV company towards life sciences, brings in a lot of optionallities in the business
- Managment’s past execution track record has been good
- It is nearing a point where reversion to mean should be expected
Investment is currently at 9% by buying allocation and 3.5% of total portfolio value @ an average price of Rs. 508