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We hosted investors for a visit to JB Chemicals' Daman lozenges facility to better understand the outlook for lozenges business and factors that can drive growth. Key takeaways include 1) Geographical expansion with same customer, tech transfer for customer owned product and owned product push are three main levers of growth 2) Companies want to do quick marketing and not earlier practice of filing of own dossiers which is leading to quicker but durable demand 3) Overall 50% by volume is JB Chem IP (owned developed products) and rest is customer who has brought in the tech transfer or products 4) Growth of top 5 customers has doubled in volumes with 70% share of top 5 customers 5) Switching takes at least 2-3 years which explains lack of client churn since inception 6) Many of the products currently sold in India would not be feasible in JB Chemicals facility given the multiple regulatory approvals garnered by the facility. 7) Return on capital invested would never be commensurate with scale achievable in the near term and it is always a long term business. Key learning was while lozenges business does not have manufacturing complexity, primary barrier is the relationship built with customers over 2 decades and would be difficult to disrupt. Overall, JB Chem should report margin impact in Q4 due to payment for acquired ophthalmology portfolio even as rebound in acute season is eyed from Q1 FY25. Since there is no change to growth expectation but recent correction has bought stock in to a semblance of comfort zone, raise our rating to ADD from Reduce with largely unchanged TP Rs1,720, based on 30x FY26 EPS.  

3 ways to grow – geographical, tech transfer and owned development

 Lozenges business presents several different ways to drive growth. Addition of geographical region is the quickest way to expand lozenges business and JB has been adding territories for some of the largest global consumer oriented companies. Tech transfer involves sharing of product and composition know how from the customer to be further built on by JB. Pushing owned developed IP and products is the third and probably the toughest way to grow as customer conversion takes a long time. About ~50% share by volume is linked to products where JB has the IP leading to better pricing. Pertinent to note is even if the product belongs to JB, it does not share identical composition with other customers to avoid conflict with existing partner.  

Relatively simple manufacturing: long standing relationships act as barrier to entry

Our lozenges visit shows manufacturing complexity is unlikely to be a key barrier to building CMO business; moreover, reckon JB may not have cumulatively invested more than Rs1.2-1.3bn (excluding the recently purchased land adjacent to current unit), which leaves strength of relationships build over 2 decades as the key differentiator. Indeed, in building a lozenges business, even in the medium term say 3-5 years, the volume offtake does not justify putting up the capacity. Only over a long period of time, does the value of front loading capacity appears to be value additive. As a corollary, JB has never lost a client since inception, an indication of the customer stickiness.   

Recent correction brings valuation within comfort zone; raise rating to ADD

Expect CMO business to be subdued in FY24 followed by a rebound next fiscal. We incorporate Rs1.25bn payment to Novartis for marketing and distribution in Q4 as JB Chem begins to market the acquired ophthalmic portfolio. JB has largely put in growth and margin performance along expected line which in turn implies the estimated FY25 EPS (~Rs47 in Q1 FY24 to Rs46.7 in Q3 FY24 for FY25) has not undergone any material change. Continue to value JB Chem at ~30x but recent correction brings the stock into some semblance of comfort zone, and we retain largely unchanged TP Rs1,720 based on 30x FY26 EPS.  

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