Uncle Iroh is my favorite character in the animation series The Last Airbender

Uncle Iroh is known for his words of wisdom as he freely advises most of the other characters throughout the series, including his nephew Prince Zuko.

Zuko is preparing to battle General Zhao in an Agni Kai, a battle that will define their future, A Night before the battle Zuko asks for advice from Uncle Iroh to win this crucial battle.

Iroh’s reply was

Although his musings of wisdom are given within the constraints of the animated fantasy, most of his wisdom can be applied to one’s life and some in investing too.

Aarti Drugs Limited was established in the year 1984 and is part of Aarti Group of Industries, The Company is engaged in the manufacturing of

• Active Pharmaceutical Ingredients (APIs)
• Pharma Intermediates and Specialty Chemicals and
• wholly-owned subsidiary- Pinnacle Life Science Private Limited focussing on formulations

For a company of its size (sub INR 5000 cr sales), it seems to punch above its weight targeting specific APIs / compounds and then gaining world dominance

 

And API is a tough business to be in

ADL has been continuously striving to keep its costs to minimum possible to aggressively compete with Chinese competitors.

Annual report 2015

How then such a small company competes in this space?

1. Economies of scale due to its large production capacities in Anti Diarrhea, Anti Inflammatory, Anti Fungal, and Anti Biotic segments.
2. Vertically integrated manufacturing for captive consumption allowing to slowly improve margins

Their business strategy is two-fold

• Improve operational efficiency by building scale and consolidate market position in key compounds
• Move up the value chain by moving into higher-margin formulation business

This is the exact template that many smart promoters have followed. For ADL around INR 75 to 100 cr CAPEX is being done every year to fuel growth for coming 5 years considering higher gestation period in API business, We learned from Mr. Jasti of Suven Pharmaceuticals that pharmaceuticals companies are best in three-year blocks due to long gestation projects and significant regulatory procedures involved post drug synthesis.

Some of the results of their business strategy are visible with PBT margins almost doubling in the last 10 years

While a third part of them experience erection see this cialis online issues. Mint, orange, strawberry, vanilla, chocolate, cheap cialis online apple etc are some of the most liked flavors of kamagra jelly. Many experts have encouraged that this viagra prices particular pill may be used against pulmonary hypertension as much as possible. Men get this benefit because buy canadian viagra of the low dosage strength of this pill – 2.5mg and 5mg – making it suitable for prescription for them.

In fact, the quarterly sales and profit momentum is even better

Are these margins sustainable?

No, the current quarter margins are very good because of the disruption with Chinese suppliers. The management indicated that they expect margins to normalize

In a broader context overall, the whole space (APIs) has been lifted by

• Government attention – A PLI scheme that intends to boost domestic manufacturing of identified KSMs, Drug Intermediates, and APIs by attracting large investments in the sector and thereby reduce India’s import dependence in critical APIs
• COVID forcing global companies to focus on securing non-china supply chains
• Indian companies are getting competitive with respect to Chinese manufacturers, as Chinese environmental rules are becoming stringent like that of India
• Global players prefer Indian manufacturers to Chinese due to better documentation and quality

Positive factors working in favor of ADL

• A lot of Chinese companies are looking at partnering with Indian API companies to jointly set up plants for global production
• Formulations business is growing very well and expected to do well with new filings
• US FDA restrictions could be in lifted, so they can start exporting to US
• India’s COVID situation improving could help in lifting domestic volumes
• Government Chinese anti-dumping duties would help
• Pedigree and Awesome Parentage – Aarti Group

Million dollar question
So how does one deal with a fast 5 bagger?

We will follow Uncle Iroh’s wise words and go back to basics. We know that current profitability is not sustainable let’s use a crystal ball to take a glimpse into future

FY 21 – Sales – Optimistic estimates – INR 2800 Crore

FY 21 – Profit – Optimistic estimates – INR 300 Crore

at 20 times the company would be valued at INR 6000 crore (20 X is reasonable for 15% grower earning sub 20% ROCE)

Personally I am not as optimistic as Mr. Market as history tells me the market can bid up a rosy picture. ADL’s market cap increased by 5X in 2015 as well

In the scorecard, we will be taking 1/3 position off the table and starting a new small tracking position in a different interesting company

 

Premium readers, please go to the scorecard > India Transaction Tab for new company info. I will share more fundamental info on it later. Closing price on Monday 10th Aug will be assumed as cost basis

 

Let me know your thoughts on ADL or APIs