Jubilant Organosys

Investors with a long-term perspective can consider investing in the stock of Jubilant Organosys, among thelargest custom research and manufacturing services company in the country. Besides improving trends in global pharma outsourcing, Jubilant's presence across the pharmaceutical value chain, likely expansion in capacities and a strong order pipeline underscore our optimism.

At the current market price of Rs 328, the stock trades at a reasonable valuation of about 11 times its likely FY11 per share earnings. This is at a discount to pure play CRAMs players, mainly due to its high debt burden and presence in non-core businesses of agri products and performance polymers.

However, with Jubilant planning to demerge its Agri and Performance Polymer (APP) business into a separate listed company and taking steps to address its debt burden, it may only be a matter of time before valuations catch up.

Business segments

The company's business can be broadly divided under two segments — Pharmaceutical Life Sciences Products and Services (PLSPS) segment, which makes up more than 80 per cent of its revenue pie and the APP segment that accounts for the rest.

With the APP segment now slated to be demerged, it is the PLSPS business that holds the key to future growth. This segment is further divided into CRAMS (50 per cent of revenues), pharmaceutical products (9 per cent), life sciences chemicals (17 per cent), and nutrition ingredients (5 per cent). Jubilant also has nascent presence in healthcare – hospitals.

Multi-pronged growth

CRAMs, which makes up more than half of the company's revenues and has grown at a compounded rate of over 45 per cent in the last five years, is likely to remain Jubilant's main growth driver in future too. Its stronghold in the manufacture of pyridines and its derivatives (used as solvents and intermediaries in many pharmaceutical applications) — makes up more than half of CRAMS revenues — is likely to sustain, led largely by capacity expansion.

The company is planning to increase Pyridine and Picolines capacities by over 20 per cent in the next few months. The management has indicated improving demand and is negotiating for more than three new contracts with large innovator companies. Confirmation of orders could therefore be potential triggers. Besides that, it has signed contracts worth $77 million for this year and has a pipeline of 11 products (three in Phase II and eight in Phase III).

Improving trends in global pharma outsourcing also augur well for Jubilant given its niche in sterile injectables space. It has a strong customer base — services six of the world's top ten pharma companies — and has a capacity of over 180 million vials (including that of Draxis and Hollister).

With capacity utilisation at about 65 per cent, there is scope for the company to take on more orders. The management has indicated at improving prospects in this business too. The company recently signed four new contracts for the division in the December 2009 quarter; these orders are expected to drive the segment's revenue growth this fiscal. Overall, the division has an order pipeline worth $102 million (almost equal to the segment's FY09 revenues).

Jubilant also has plans to invest in its manufacturing facility of APIs. It expects the new capacities to be operational by the second quarter of current fiscal. It is also planning to commission a high-potency API facility (for oncology) by January 2011. While procuring orders will hold the key, the hipo facility is likely to enjoy higher margins. That said, considering Jubilant's healthy regulatory track record — it has so far filed 37 DMFs in USA, 19 in Canada and 17 in Europe — procuring orders may not be very challenging. Besides, its focus on therapeutic segments — CVS, CNS, Gastro-intestinal, and anti-infectives — and global leadership in Carbamazepine, Oxcarba-mazepine, and Lamotrigines also lend confidence. It plans to file 8-10 DMFs every year.

Its presence in Drug Discovery & Development Services business holds the potential to emerge as an independent growth engine. Operating with three subsidiaries — Chemsys, Biosys, and Clinsys — the division operates as a full service research organisation. The division has signed contracts worth $43 million for FY11 so far.

Potential triggers

These apart, Jubilant has a string of potential revenue drivers lined up. For one, the likely launch of Sestamibi (pharmaceutical agent used in nuclear medicine imaging).

The US FDA had approved the product a year ago, but owing to shortage of nuclear isotopes, its sales did not take off as expected. The management, however, expects better availability of nuclear isotopes from this quarter onwards. Jubilant has a distribution tie-up with GE Heathcare in the US and Guerbet for Europe.

As of December 31, 2009 the company had a net debt of Rs 2,866 crore on its books (consolidated). This amounts to interest coverage of about 4.8 times. In an effort to address its high leverage, Jubilant recently raised $85 million (about Rs 380 crore) through QIPs at Rs 344.5 per share.

While this would result in an equity dilution of about 8 per cent, it may not affect profits as much given the interest cost savings it is expected to make (a portion of debt enjoys a high average rate of 9.7 per cent). The management expects its improving cash flows to help meet its debt obligations. Note that the company had exercised the option of AS 11 and to that extent, restatement of foreign currency borrowings including FCCBs were taken to its balance sheet.

Demerger of APP business

The demerger of its APP business, which is expected to be completed by the third quarter of this fiscal, would also help reduce the volatility in earnings. While there will be a one-time impact on the revenues, it wouldn't be much as performance polymers and fertilisers business contributes to just about 10 per cent and 4 per cent of Jubilant's total sales and net profits.

Besides, shares of the new company would be issued to the existing shareholders of Jubilant Organosys; the de-merged entity will have a mirror-shareholding pattern to that of Jubilant. The bulk of the debt (about 96 per cent) however will remain with Jubilant Organosys.

via BL