SOLARA ACTIVE PHARMA, A Pure API Player with vision for CRAMS

Brief Background

Arun Kumar, who is a common promoter for Strides Shasun and Sequent Scientific (both are listed in the market) decided to create a new company which would focus purely on APIs, as the APIs were low margin business and making it difficult to maintain margin, with this goal in mind he demerged the low margin API(Ibuprofen, Gabapentin, and Ranitidine, etc..) business of Strides Shasun and Human API business of Sequent Scientific to create SOLARA ACTIVE PHARMA, which would be a pure API company.

    In March 2017, the board of directors of Strides and Sequent approved the demerger, and in March 2018, the scheme got approved by NCLT and the company got listed on June 27, 2018.

    According to the deal, for every 6 shares held in Strides, 1 share of Solara was allotted and for every 25 shares held in Sequent, 1 share of Solara was allotted.

    Strides Shasun retained the formulation business and High Margin API business, and Sequent Scientific retained the Animal Health API business. There were more technical details of the demerger but let's not get into that.

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What's the current situation of SOLARA?

Today Solara is one of the world’s largest producers of APIs (ibuprofen, praziquantel, and gabapentin, etc..) and has a niche portfolio of products in therapeutic categories such as chronic kidney disease, anti-inflammatory drugs, and central nervous system and It has forayed into the CRAMS(Contract Research and Manufacturing Services) business.

 It has a team of 200+ scientists and two dedicated R&D centers in Bangalore and Chennai. The company has six API manufacturing facilities in Ambernath, Cuddalore, Mangalore, Mysore, Puducherry, and Visakhapatnam.

    At present Solara has 80+ commercial APIs and 25+ APIs under development across high-value product segments, predominantly in anthelmintic, anti-malarias, anti-infective, neuromuscular insomnia, and anti-psychotic hyperkalemia segments, among others. The company sells High-value commercial APIs and contract manufacturing services in over 75 countries.

Sales Geography

The majority of Solara's revenue comes from highly regulated markets such as the US, EU, JAPAN, and WHO.  The US, EU, and Japan combined contributed 68% of revenue in FY20. Additional revenue comes from South East Asia, Latam, etc..

   While major revenue exposure to a highly regulated market implies inherent regulatory risks but it also signifies the product quality the company offers. The regulated market also offers better margins and the company has been actively increasing revenue share from the regulated market and the same can be validated in YOY and QOQ revenue share change.

Subsidiaries

 Solara has 3 subsidiaries but as we can see the revenue contribution is not much(less than 6cr) from them at present so we will not discuss them.

Historical Performance

As we can see the revenue grew from FY18 to FY19 but had a decline in FY20 due to lockdown and one more interesting reason which we will cover in the updates section. Even after revenue decline, EBITDA grew 21% in FY20 YOY and EBITDA margin improved 420bps.
The company claims this improvement was because of operational efficiency and API price going up in the recent past. We know that Ibuprofen prices have gone up significantly and that is why IOLCP is doing exceptionally well, and that has positively impacted Solara too, but the company has not provided details of the contribution of operational efficiency and API prices in margin improvement.

  An interesting thing to note here is that the company significantly increased R&D spending in FY19 and FY20. As we know they started with low margin API business, they focused on operational efficiency and sales in regulated markets to improve margins of existing APIs, additional focus is on to launch high margin APIs through in-house research to improve margins further in the future.

    

It has significantly reduced debt as we can see the debt to equity has dropped from 1.5 to 0.8. Although the company generated good cash flow this reduction was on the backdrop of cash infusion by the TPG group and Promoters. The additional cash requirement was for setting up new plants for CRAMS business and the expansion of API capabilities. It is also looking for inorganic growth through acquisitions in the CRAMS space. CRAMS space in India is expected to do well, to know the details you can watch CRAMS and Syngene.

Q1FY21 Result

Q1 result was positive with topline increasing 6% YOY and 14% QOQ, bottom line PAT increased 60% YOY and 43% QOQ implying better margins and operational efficiency.

We can see EBITDA and EBITDA margin declined significantly in Q4 FY20 but is back on track in Q1FY21, a similar trend is observed in quarterly PAT and EPS growth.

Recent Relevant Updates

• Anti Acid drug Ranitidine hydrochloride when stored at room temperature or higher led to an increase in cancer-causing chemicals so their clients had to recall the drug. Solara didn't have an impact on the recall but they had to stop the production of Ranitidine, they could sell in other markets but the company decided to not do so as that might lead to compromise on the brand and they prefer to sell quality products in all markets. Ranitidine used to contribute 7% of revenue. The company wrote off the inventory for it by Q4FY20 so no further impact of it will be observed this year.
• CRAMS at present is only contributing 10% of revenue and it is actively looking for Inorganic acquisitions in CRAMS business
• Mr. Bharath Sesha came on board as the CEO of Solara last year and Jitesh Devendra the ex CEO has exited the firm to start his own CRAMS firm.
• Phase 1 of the new VIZAG facility for Ibuprofen and its derivatives has gone live and this increases Ibuprofen capacity from 4,800 TPA to 8,400 TPA. Phase 2 is being designed for multipurpose API capabilities and CRAMS business.
• It has 25+ products in the development pipeline spread over niche therapy segments, such as anthelmintic, anti-malarias, beta-blockers, muscle relaxants, novel oral anti-coagulants, anti-infective, and other niche segments and It has filed 150+ DMFs(Drug Master File) the world over.
• The company has given notice to SEBI to classify Promoters as public shareholders. This would imply that It will be managed professionally in the future and would have minimal to no promoter interventions.
• Regulated markets now represent ~76% of quarterly revenues in Q1FY21 and long term contracts now account for >50% of total revenues. The company focuses more on the long term contract over the benefit of short term prices.
• USFDA has classified one of their manufacturing site at Cuddalore as “Official Action Indicated” (OAI) and they are working to resolve this. This is a potential issue and signifies the regulatory risk associated with Pharma companies.

Valuations

Currently, it is trading at 1137 Rs with a Market Cap of 4,073.64cr.
PE 29.44
PB 4.06
Book Value 280.20 Rs
Looking at these metrics we can feel that it is at premium valuations but if the margin improvement can be maintained then it can very well go significantly up from here which to me seems more likely and unlike peers, they have been focusing on long-term contracts so this is sustainable over the peers.

Final Verdict

The company has done significantly well on operational efficiency which was the major reason it was created. CRAMS business expansion seems the right strategy coupled with the new high margin API launch with in-house Research for future growth and margins. Short term business support is well due to rises in prices of APIs but it is better placed to handle any fall as they have long term contracts. The company is good but not undervalued and can be accumulated for the long term. I feel even in the short term(6 months to 1 year) the company has a lot to offer from here but that remains to be seen and could be a bit risky owing to premium valuations. Any significant decline should be seen as an opportunity to buy. 

    The major risk here is regulatory which is relevant to all companies in the industry so prefer buying a basket of Pharma Companies over a single company. Premium valuations might hamper the short term returns. Only risky investors should invest in it for the short term returns.