Surya Pharmaceuticals Ltd. (SURPHA) | ICICI Pick of the Week

Source: ICICI Bank ICICI Direct content.icicidirect.com

May 2009

By: Pankaj Pandey

Surya Pharmaceuticals, which is positioning itself as a low cost manufacturer of API and formulations, is set to be a key beneficiary of the emerging CRAMS opportunity. A change in revenue mix towards higher margin products coupled with commissioning of Jammu facility are the other key triggers for the stock.

Company background

Chandigarh-based Surya Pharmaceutical, Incorporated in 1992, manufactures and markets a range of active pharmaceutical ingredients (APIs), drug formulation and bulk intermediates that address various therapeutic segments. It is among the top five Indian players in betalactum and cephalosporin range of anti-infectives. It has four manufacturing units located in Himachal Pradesh, Punjab and Haryana and has increased its API capacity from 67 MTA in 1993 to 1263 MTA in 2004.

Investment Rationale & Expansion to drive growth

Surya Pharma has chalked out an ambitious Rs 90-crore expansion plan of setting up a facility in Jammu and upgrading its existing plants to the US Food and Drug Administration, (US FDA) standards. The new facility is expected to go on stream by June 2006 and will manufacture high-margin products such as statins, sterile cephalosporins & advanced intermediate and formulations. In addition, it would also help the company in servicing MNC companies through the contract-manufacturing route. This facility will be US FDA complaint and is expected to result in significant savings due to excise & income tax exemptions.

MRP-based excise regime to benefit Surya

The recent notification of the government to charge excise on maximum retail price (MRP) is expected to trigger a shift in the outsourcing business which is touted as a big opportunity for Indian companies in the years to come. Surya Pharma is expected to benefit immensely from this new regime as there could be a heavy flow of new orders from both MNCs and other domestic companies to take advantage of its units operating in duty exempted states like Himachal, J&K etc.

Contract manufacturing foray

The company has made impressive foray into contract research and manufacturing (CRAMS) space with order worth Rs 350 crore to be executed over the next few years. It is positioning itself as a low cost manufacturer and has bagged several contract manufacturing orders in the API and formulations stages. The company has recently signed a contract with a UK based pharma company for supplying off-patent API supplies worth Rs 220 crore spread over a period of 5 years starting FY07. We expect the company to notch up record profits in the coming years on the back of impressive order book which is likely to increase further with the commissioning of new facility in Jammu.

Improving revenue mix to expand margins

The company is changing its product-mix towards high margin products from current low margin, high volume products. The addition of sterile range of cephalosporin and other high margin products to its stable would enable the company lower its share of Semi-Synthetic Penicillin (SSP) from current 50% levels to 15-18% over the next 2-3 years. Besides, company’s cost of funds is expected to decline by about 275-300 basis points this financial due to renegotiation on rates and low cost funds from ECB which will result in significantly higher net profits.

Financials:
For the financial year ending March '05, Surya Pharma posted a marginal growth of 5.10% in revenues to Rs 170.33 crore, up from Rs 162.07 crore in the previous year. Operating margins improved substantially by 327 basis points to 17.26% in FY05 from 13.99% on the back of company’s focus on high margin products as compared to traditional penicillin G based antibiotics viz Ampicillin, Amoxicillin, Cloxacillin. The bottom-line of the company surged by 88.52% to Rs 11.50 crore as compared to Rs 6.1 crore in FY04 despite 28% & 19% jump in employee cost & depreciation, respectively.

Outlook

The commissioning of its Jammu facility & up-gradation of its existing four plants to the US Food and Drug Administration, US FDA, standards could results in company achieving a turnover of Rs 260 crore & Rs 432 crore by FY06 & FY07 respectively. Introduction of MRP based excise duty regime & commencement of production of a complex molecule (cephalosporin intermediate) is expected to improve Surya Pharma's margins by more than 300 basis points to 9.93% in FY07 from 6.72% in FY05. The bottomline of the company is set to grow exponentially to Rs 23.2 crore & Rs 42.3 crore in FY06 & FY07, respectively.

Technical analysis

Valuations

Surya Pharmaceuticals is expected to notch up significant profitability over the next 2-3 years on the back of impressive order book to the tune of Rs 350 crore and growing prowess in the CRAM space. The changing product-mix & benefits accruing from units operating in duty exempted states would become visible in the bottomline of the company. Surya currently trades attractively at 8.2x FY06E EPS of Rs 15.80 & 4.45x FY07E EPS of Rs 29.22 on expanded equity base. We believe investors can look for significant upside from current levels of Rs 129 to Rs 230 levels (upside of 78%) over the next 12 months.