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Mgmt meeting KTAs; recovery underway, U/G to ADD

We met Sequent Scientific to better assess the recovery trajectory in animal health across API and formulation segments. Company appears upbeat on API business as price erosion run its course; efforts also underway to ensure increased sourcing from the same customer. In formulations, Turkey appears stable after price hikes and company is expecting growth after a period of macro-led disruption. Domestic business was impacted by stoppage of Zoetis product distribution and whose resumption should add to ex-Zoetis growth. Overall, we reckon pressure on revenue (due to demand shortfall and portfolio rationalization) and margin has likely ended though we await signs of traction in API and scale up in formulations. Believe worst may have ended even as it may be too early for signs for earnings upgrades. We roll over to FY26 estimate and upgrade to ADD from Neutral with revised TP Rs145, based on a trimmed multiple of ~30x (earlier 35x) as we base target on a normalized year of earnings.

API business – in recovery mode after a 4-year long drawdown

API business is in the revival mode after a 4-year long drawdown in which revenue has shrunk ~20% from their normalized peak in FY20 (and even more from one-off levels seen in pandemic). We reckon most of the decline has been on account of price compression. To recap, API sales to regulated markets of US & Europe account for 67% of revenues while rest is to emerging markets. Company has made efforts to embed itself in supplying more products to each regulated market customer as also adding new customers and products; albeit the former – increased API supplies to same customer – has likely more room to grow followed by new launches. API business which performed well in Q4 FY24 is still lumpy in nature and even though price erosion has stabilized, inflection point could be still some time away in clocking quarterly Rs1bn in sales.

Formulations – manufacturing rationalization, Turkey demand key

Sequent’s export formulation business has gone through disruption from 1) demand slowdown in key markets like Europe and 2) currency volatility in Turkey. Europe recovered in FY24 on the back of pivot towards higher margin/growth products in Spain along with increase in distribution business in Benelux countries. Company expects Europe business to clock moderate growth (given the mature nature of underlying market) on FY24 base. Turkey business has been severely impacted by currency and hyperinflation in the past few years. As the macro normalizes (stable currency in last few months), company believes Turkey is poised to grow especially on back of two price hikes implemented in FY24. Manufacturing footprint has been rationalized with shutdown of German and Tarapur (API/intermediates) facilities that should contribute to cost savings.

India – resumption of Zoetis product distribution to lift growth

India business at 8% of revenue was affected by non-availability of Zoetis product for distribution. We understand Zoetis would likely resume the distribution arrangement soon which should bolster the domestic business. Separately, company has ramped up MR force in India that would support scale up of ex-Zoetis business that has been clocking healthy mid-teens growth.

Growth to be a key driver of margin between FY24-26

Gross margin has recovered largely on back of lower input costs and some benefit from product rationalization as Sequent exited low end commodity businesses in Europe. It has also run a cost optimization program in API which has resulted in improved EBIDTA. Overall, we reckon the benefit from cost rationalization and procurement savings have played out and further margin improvement would be an outcome of expected better revenue growth over next 2 years

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