Jubilant Organosys: Buy

Investors with a one-two year time-frame can consider taking exposure in the shares of mid-sized pharma company, Jubilant Organosys, an integrated contract research and manufacturing services (CRAMS) player.

From being a pure specialty chemicals company five years back, Jubilant has today emerged as a prominent player in pharma outsourcing with around 60 per cent revenues (Rs 1,159 crore) this fiscal coming from pharma and life-science products.

Industrial chemicals and performance polymers (IPP) account for the rest. The pharma/life sciences business has a higher margin profile and this indicates a conscious shift from a steady-growth to a high-margin segment.

At the current price of Rs 321, Jubilant trades at about 21 times its trailing 12-month earnings on current equity base and 24 times on a fully-diluted basis, which is at discount to focussed CRAMS players.

While the market has partially factored in the good performance of the company in the first half of FY-08 that saw 32 per cent revenue growth on consolidated basis, we feel the performance of newly acquired Hollister-Stier (Rs 110 crore) has the potential to add to earnings. The CRAMS segment looks good to contribute over 75 per cent to the pharma and life-science products business.

Successful integration with Hollister-Stier Laboratories leading to increasing traction on CRAMS side, long-term agreements in industrial polymers division ensuring stable earnings and foray into high-value areas such as bioinformatics, medicinal chemistry and clinical services, suggest a bright outlook on earnings.
New areas

Almost one-third revenues for Jubilant’s life-sciences business are from high-margin contract research and manufacturing done through Hollister, as well as custom synthesis. With the capacity expansion in the US-based Hollister happening on schedule, commercial operations should begin by March 2008. This has the potential to generate additional revenues, as capacity will more than double. Hollister was acquired in April.

The company’s custom synthesis segment is also growing well with about six products in the pre-clinical phase; 23 in phase I, 17 in phase II (failure rate is generally high) and 15 in phase III. Large number of products in the last segment ensures generation of good business as commercial production starts with receipt of regulatory approvals.

The company’s Drug Discovery & Development Services business also has emerged as an independent growth engine under life-sciences. Its subsidiary, Chemsys, offers medicinal chemistry services to drug discovery companies on molecule basis and works closely with another subsidiary, Biosys, in collaborative drug discovery research services areas.

The medicinal chemistry services business has seen revenue growth of 51 per cent year-on-year. Biosys, which serves clients such as Eli Lilly, deals with innovative informatics and structure-directed drug discovery solutions helping accelerate drug discovery.

The last segment of the drug discovery business is Clinsys, a full service clinical research organisation, providing a broad range of clinical research services which support Phase I-IV drug development.

This integrated approach helped Jubilant’s drug discovery and development business report Rs 80 crore as revenue for the first half of 2007-08. For the full year 2006-07, the same business reported Rs 65 crore. Jubilant targets revenues of Rs 175-200 crore for the full year.

With outsourced life-science products and services comprising 55 per cent of total revenues in the first half of FY-08, the future seems bright as pricing pressure and the urgent need to improve pipeline are forcing pharma, biotech and other life-science companies to increase outsourcing of products and services from low-cost locations such as India.
Legacy businesses

The industrial chemicals and performance polymers division has recorded a topline growth of 10.3 per cent and has shown decent profit growth during the September quarter.

Better margins, at 21 per cent, were realised in this segment mostly due to improved price realisation and favourable input cost environment. This factor is likely to remain in the company’s favour as prices of key inputs such as molasses and alcohol were lower in this quarter and are expected to remain soft in the future.

A global shift in capacity leading to increasing demand for this business in India, China and South-East Asian countries may benefit players such as Jubilant. Jubilant has recently raised its pyridines capacity by 24 per cent to 42,000 tonnes per annum.

While it does not plan to further increase capacity for the pyridines or industrial chemicals in the near term, de-bottlenecking existing capacity with minor investments is on the company’s radar.
Significant contracts

In September, Jubilant signed a new multi-million dollar long-term agreement with Syngenta for supply of pyridines, a basic organic chemical used in agrochemical, pharmaceutical and other industries. The contract starts from first quarter of 2008 and covers a period of five years, lending visibility to earnings.

Given the export component, rupee appreciation remains a concern. While negotiating higher contract prices may pose a challenge, funding of operations through dollar-denominated loans/FCCBs, provides a natural hedge against rupee appreciation.

On the bulk drugs front, the recent approval from USFDA for Oxcarbazepine to one of its customers has come as a big boost. Sales from the player (who has 180 days exclusivity) are expected to be reflected from the December quarter.

Oxcarbazepine is the active ingredient in Trileptal, used to treat epilepsy. In total, five clients are expected to procure the generic Trileptal from Jubilant. The drug had annual sales of $643 million in US.