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Scaling up new levers to accelerate growth

Expanding the base business as well

* Laurus Labs (LAURUS)’s Annual Report Analysis indicates a sharp improvement in ROE, led by a strong head-start in Finished dosage forms (FDF), improving operating profit, and a reduced interest rate.

* Since its journey from ARV API to a fully integrated pharmaceutical company over FY06–21, LAURUS is on the path to strengthening its capabilities/capacity in Contract Development and Manufacturing Operations (CDMO) – the Synthesis as well as Biotechnology space.

* Accordingly, LAURUS is investing INR15–17b in building R&D centers and greenfield/brownfield expansions for a meaningful commercial benefit from FY23.

* We raise our EPS by 3%/6% for FY22/FY23, factoring in improved business scope in the ARV – Synthesis segment. We raise the PE multiple to 24x (from 18x earlier) as LAURUS fortifies its skillsets across the clinical phase towards (a) commercial manufacturing in the CDMO segment (Synthesis), (b) gaining traction in the Biotech space, and (c) total integration as well as pipeline buildup in the ARV/Non-ARV space. Accordingly, we arrive at TP of INR800 on a 12M forward earnings basis and reiterate BUY on the stock.

Multiple levers drive ROE expansion in FY21

The DuPont Analysis indicates that a superior product mix, better capacity utilization, and a lower interest/tax burden led to a sharp jump in the ROE trajectory in FY21. The doubling of FDF sales and strong recovery in ARV API sales (up 79% YoY) / Synthesis sales (up 67% YoY) led to operating margin expansion (1230bp YoY). Supported by a lower interest burden, this resulted in ROE rising to historically high levels of 45% in FY21.

Healthy revival in FCF…

Being in the growth phase of the business cycle, LAURUS has reported considerable capex (cumulative capex of INR18.5b over the past five years); FCF was in the negative territory up to FY19. With the commercialization benefit accrued on FDF capacity, LAURUS has been able to show positive FCF for FY20/FY21.

…but capex program to curb FCF

About 50%/25%/25% of INR15–17b would be spent towards the API / Custom Synthesis / Formulations segment over the next two years. The debottlenecking benefit would start accruing in FY22 and brownfield formulation expansion of 4b tablets per annum would be partly operational in FY22 / fully operational in FY23. LAURUS is refurbishing its newly acquired unit for the Synthesis segment, scheduled to be operational in FY22. It is also building a new R&D center, expected to be operational by FY23. LAURUS is also investing in a greenfield FDF capacity and expects to have Phase 1 operational by FY24. It has also acquired new land to construct an API facility, which would be operational by FY24. We expect these growth capital investments to keep FCF at lower levels.

Valuation and view

We expect a 29% earnings CAGR over FY21–23, led by a 32%/42%/42% sales CAGR in the FDF / Synthesis / Other API segment.

LAURUS has built its Custom Synthesis business steadfastly over the past decade on the firm foundation of its chemistry skills. With the groundwork having already been laid out, new project additions are expected to increase at a faster rate than seen before. This is evident from the fact that while it took around a decade to reach 40 projects in Custom Synthesis up to FY20, it added 10 new projects in FY21, implying a 25% increase in active projects YoY. Furthermore, a dedicated R&D center and two greenfield manufacturing facilities could cater to the larger commercial-scale requirements of clients. This would enable multi-fold growth in revenues at betterthan-company levels as well as in Formulations business margins.

The number of biologics products introduced in regulated markets at the industry level is growing at a faster rate than seen in the past. LAURUS aims to cater to increased demand in the Biologics CDMO segment through its integrated offering. It can leverage its ongoing relationships with innovators to build this segment at a much faster rate than seen in the Custom Synthesis segment through cross-selling. Being a high entry barrier segment, Biologics offers better margins and revenue potential than small molecule projects. The higher ticket sizes of projects in this segment would also ensure a faster ramp-up in this segment. We expect Laurus Bio to further augment its research support capabilities in Biologics to be able to provide end-to-end integrated services in the Biologics CDMO segment.

Considering enhanced growth prospects in CDMO (Synthetics/Biologics) and NonARV FDF/API, consistent compliance, and lower financial leverage, we revise the PE multiple to 24x (from 18x earlier). Accordingly, we revise our TP to INR800 on a 12M forward earnings basis. Reiterate BUY

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