Natco Pharma Ltd

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About the Company

Natco Pharma Limited was incorporated in Hyderabad in the year 1981 with an initial investment of only INR 33 Lacs. With a modest beginning of operations as a single unit with 20 employees, Natco today has seven manufacturing facilities spread across India with dedicated modern research laboratories, capabilities in New Drug Development, etc. Natco family currently consists of around 5000 employees, they are a vertically integrated and R&D focused enterprise, engaged in developing, manufacturing and marketing finished dosage formulations (FDF) and active pharmaceutical ingredients (APIs) and intermediates.

The Company focuses on niche therapeutic areas and complex products, which gives it a unique positioning in the market, spread over 40 countries. It sells FDF products in the US, India, Europe, and the Rest of the World (RoW); with substantial clientele in Canada and Brazil as well. It holds a leading market share in the domestic oncology segment.

Q2FY21 Updates

Financial Results & Highlights

Detailed Results

1. Consolidated revenues were up with 60% YoY growth. Profit has risen 73% YoY in Q2.
2. The segment revenue split is as follows:
   1. APIs: Rs 199.7 Cr
   2. Domestic Formulations: Rs 108.3 Cr
   3. Export Formulations: Rs 482 Cr
   4. Other Operating Income: Rs 10.7 Cr
   5. Other Income: Rs 27.2 Cr
3. The company announced a second interim dividend of Rs 3 per share for Q2FY21.

Investor Conference Call Highlights

1. Other expenses have risen due to one-time employee increment which was deferred from Q1 due to COVID-19. There were also some costs related to setting up ramps of about 3, 4 products.
2. The management insists that the Canada Remlivid settlement has been over.
3. In oncology, the company is seeing only 70% to 75% of the sale potential being realized because of lower hospitalization in cancer treatment. This is because a lot of patients are deferring treatment of cancer because of COVID fears. This is the reason behind the weakness in domestic revenues.
4. The company won some very good tenders in agrochemical supply. The company has launched Tamiflu for the first time in Brazil. And it is also getting good government orders from Canada. In the USA, the profit share from Alvogen will be recognized in Q3 & Q4.
5. Generally, Q1, Q2 tend to have lower margins because there’s a lot of stocking, and Q3, Q4 is when the actual revenue gets realized.
6. The company has started off with a modest portfolio for Agrochemicals but it does have a few blockbuster ideas in this space.
7. Natco is trying to get an all-India coverage and by end of this year, it should have enough reps to launch in all the major agro states in the country.
8. Despite the revival of oncology in small cities, the sales of this segment remain subdued as most of the sale happens in Delhi, Mumbai, Chennai, Hyderabad, and Bangalore.
9. The rise in export profits has not been as high as the rise in export revenues as the company is directly recognizing setup costs as expenses and is not looking to capitalize them.
10. The management remains confident of reaching the guided target of 20-25% PAT growth for FY21.
11. The big factor for growth in 2022 will be Revlimid approval and launch.
12. The company has cash and cash equivalents of Rs 1065 Cr and a total debt of Rs 431 Cr.
13. The company has 5 REMS products which are Lenalidomide & pomalidomide in Canada and pomalidomide & Bosentan in the USA. The fifth product is yet to be announced.
14. Total Capex spends so far this year was Rs 140 Cr.
15. The pricing pressure on the oncology space has largely been resolved and the only issue here is the lack of growth.
16. A lot of the onetime costs have been done already and the company can now come back to historical gross margins going forward.
17. The company has gotten approval for generic Pomalyst and the market opportunity here is a little less than $1 billion. Natco is one of the only 2 companies with approval for this drug currently.
18. Apixaban is selling well for Natco. Only Natco and Pfizer have brands for this drug in India currently.
19. The sales opportunity from the new agrochemical product which is pending approval is Rs 2000 Cr.
20. The company is waiting for manufacturing licenses after which it will start expensing the operational costs for the Agchem business.
21. The management believes that the opportunity from Tamiflu is better in Brazil & Canada than in the USA for Natco. The retail opportunity is not strong and thus the company is relying on govt tenders for this product.
22. The management has stated that there is always aggressive competition in India in oncology but in India, the declines are not as steep as the USA due to the branded generic nature of the products.
23. The management has admitted that Lotus Pharma has indeed gotten approval for Revlimid earlier than Natco but this is not expected to have any financial impact.
24. The company has not seen any decline in market share and demand for Copaxone from the launch of a competing oral drug in the same therapeutic space.
25. The litigation on CCP is pending in Delhi High Court.

Analyst’s View

Natco Pharma is a vertically integrated and R&D focussed pharma company with a specialization in FDFs and APIs. The revenues for Q2 has been very good especially from the export market. In the last few years, they have made some progress on expanding newer geographies, however, there is still a lot of work to be done on that front. In the domestic market, they are highly dependent on the oncology market. Demand for this sector has stayed muted as the hospitalization rate for cancer patients has remained subdued. The management expects the demand to come back slowly. The company is doing well from Tamiflu supply to Brazil and Canada through govt tenders and is also expecting big things from the emerging Agrochem segment. In the long run, meaningful expansion in newer geographies around the world and adding new segments in the domestic market is going to be the points to track about the company. Despite the challenges, Natco pharma appears to be a good stock to watch out for due to the management’s focus on R&D and execution of long term plans for the company.

Q1FY21 Updates

Financial Results & Highlights

Detailed Results

1. 1. Consolidated revenues were up with 13.5% YoY growth. Profit has fallen 14.7% YoY in Q1.
   2. The company faced margin pressure in both domestic and export formulations businesses.
   3. The company has guided for >25% YoY profit growth in FY21.
   4. The segment revenue split is as follows:
      1. APIs: Rs 143.92 Cr
      2. Domestic Formulations: Rs 125.62 Cr
      3. Export Formulations: Rs 274.23 Cr
      4. Other Operating Income: Rs 18.35 Cr
      5. Other Income: Rs 19.95 Cr
   5. The company announced an interim dividend of Rs 1.25 per share for Q1FY21.

Investor Conference Call Highlights

1. The company saw challenges in the domestic oncology business primarily due to lower hospitalization due to the COVID situation.
2. The company saw good demand in June which included pent-up demand from April and May. Most of the company’s domestic portfolio in oncology driven as it is the most profitable segment for the company. This product segment was affected not only by lower hospitalizations but also by the fact that the company’s scale here is driven by metros like Mumbai, Delhi, Hyderabad, Bangalore, Chennai. Chandigarh and Kolkata, all of which have been the worst hit place in India by COVID-19. The management expects things to normalize in 2-3 months and sales to come back then.
3. The management is confident of getting FDA approval for Remlivid by December.
4. Broadly the company’s USA business is driven by 3-4 products. They are Copaxane, Doxil, and Lanthanum Carbonate. In Copaxane, Natco and Sandoz are the main competitors. In Doxil, the main competitor is Sun Pharma. Natco is the only generic maker of Lanthanum Carbonate in the USA.
5. The company has 2 main pandemic products which are Oseltamivir and chloroquine. These products saw good sales but have lower margins resulting in an overall drop in margins for the company.
6. The management has stated that the margins are driven solely by sales mix and it should revert back to previous levels as sales mix normalizes.
7. The company is waiting on approval from the insecticide board for Coragen and it is also expecting an outcome on litigation on the same product. The company has no new filings in place for agrochemicals.
8. The company has made a filing for a drug called trabectedin in partnership with Sun Pharma. This product has annual sales of almost $ 100 million and the company was the first 2 players to file an ANDA for it.
9. The management has admitted that its R&D efficiency has dropped due to COVID-19.
10. The profit guidance of 25% in FY21 does not include any earnings from Sorafenib. Everolimus and Lapatinib. This guidance is based solely on the order book according to the management.
11. The management expects the oncology business to be running at 75-80% of pre-COVID levels.
12. In terms of launches, the management is confident of delivering 10-12 launches each year. It has already done 5 launches in the year so far.
13. The company’s previous guidance of achieving the target PAT of Rs 1400 Cr in FY22 is heavily dependent on the product Remlivid.
14. The company’s new markets in Canada and Brazil are doing reasonably well. Non-USA earnings are at almost 10-15% of total earnings. The management is looking to increase this to 15-20%. It is also aiming to increase the share of India from the current 20-22% to 30-35% going forward.
15. The management has stated that the US is seeing the strengthening of high market share brands and people who are dropping out of tail brands.
16. The company will continue to stick to its focus areas of niche products and try to do a multi-market approach to get the best out of its R&D.
17. The management has refrained from commenting on the incoming flu season as there are too many uncertainties at hand.
18. The company has 2 manufacturing sites in the USA and India for Oseltamivir. So the company has no worries if any sort of Make in America compulsion arises for the drug.
19. The company has around 3 niche and 6 commodity products in the generic agribusiness segment. The market size for the 3 niche products is expected to be around Rs 2000 Cr. The company is expected to the first to make generics for these 3 niche products.
20. The management expects agrichemicals business to contribute to 10-15% of India business in the next 3 years.
21. The domestic revenue split is:
    1. Oncology: Rs 78 Cr
    2. Non-oncology: Rs 25 Cr
    3. 3^rd party formulations: Rs 22 Cr
22. The management is not too concerned about the competition in the oncology business segment as the company has an established brand image and a good launch pipeline in this segment.
23. The management does not expect any significant price erosion in oncology products.
24. The management remains confident of completing the filing process with the CIB for its agrochemical filings in the next 6 months. This is because the management has stated that the filing process takes 12-18 months and the company filed for it in August or September last year.
25. The management remains confident of good performance in Canada due to the conclusion of the settlement of Remlivid and the fact that Remlivid has big demand in Canada.
26. The company is looking to make concentrated, high-value bets to expand its portfolio, add new geographies, and adding new segments of cardio and diabetes.

Analyst’s View

Natco Pharma is a vertically integrated and R&D focussed pharma company with a specialization in FDFs and APIs. Their revenues and margins have taken a hit due to pressure in both the domestic and the export market. In the export market, their dependency on the USA is still high. In the last few years, they have made some progress on expanding newer geographies, however, there is still a lot of work to be done on that front. In the domestic market, they are highly dependent on the oncology market. As the lockdown was in force, the demand for their products also fell. The management expects the demand to come back soon. However, in the long run, meaningful expansion in newer geographies around the world and adding new segments in the domestic market is going to be the points to track about the company. Despite the challenges, Natco pharma appears to be a good stock to watch out for due to the management’s focus on R&D and execution of long term plans for the company.

Notes on Annual Report (FY18-19)

Business Divisions

Natco Pharma Limited is a vertically integrated and R&D focused pharmaceutical company engaged in developing, manufacturing and marketing of finished dosage formulations (“FDF”) and active pharmaceutical ingredients (“APIs”). Their focus is primarily on niche therapeutic areas and complex products. They market and distribute their products in over 40 countries. They sell their FDF products in the United States, India, Europe and the rest of the world (“RoW”).

• Over the years, meticulously built businesses across different molecules, multiple therapy segments and global markets, through strategic alliances and manufacturing capabilities.
• Steadily increased its presence from an oncology-focused product portfolio to multiple therapy segments.
• After the initial high-impact foray into oncology in 2003, through Imatinib, they have made their mark in the gastro hepatology segment through the launch of Hep C. They have further capitalized through well-recognized product launches of Glatiramer Acetate, Liposomal Doxorubicin and Oseltamivir in the US.
• A few years ago, they made a conscious decision to diversify their exposure into other non-US markets to minimize the impact from economic and geographic risks.
• Taken a unique global portfolio approach towards their products by filing for approvals across different markets.
• Selective investments in crop health sciences, by building on their existing resources and skill sets in both chemistry and manufacturing.

Filings and Patents Detail

Snapshot of Business Performance

Macro Trends in Pharma

1. In USA, generic face pricing pressure, specialty drugs command higher value. The interesting opportunities in the US market will be restricted to niche products and complex generics.
2. With an estimated spending of $31.8 billon, the Brazilian healthcare market is the world’s seventh largest. The Brazilian government’s largest spending is on healthcare and 80% of the pharmaceutical market is being driven by federal and local tenders. To contain its healthcare costs, the Brazilian government is moving towards generics.
3. The Government of India with its grand scheme of Ayushman Bharat-Pradhan Mantri Jan Aarogya Yojana (AB-PMJAY) targets over 50 crore beneficiaries. This is seen as the ‘world’s largest healthcare programme’.
4. Pharmaceutical spending in China reached $137 billion in 2018, making it the world’s second largest pharma market. China could be a significant opportunity for Indian players.

Message from the Management

1. NATCO’s investments in emerging markets are bearing fruit and they are growing their footprints in Canada, Brazil and South East Asia.
2. In FY19, the market dynamics in the US and India were largely unfavorable, and there were several macro pressures on the business.
3. Some of their key products in the US have seen strong competitive pressures while in India, they have seen market size reduction in the Hepatitis C portfolio.
4. A few years ago, they perceived risks surrounding their business, especially the onset of strong headwinds in the US market and had taken firm steps to increase their pace of development in the emerging markets, especially India, Brazil and Canada.
5. The result of the geographical diversification is that the non-US market’s revenue stood at INR 1173 Cr for FY 2018-19.
6. NATCO is focusing on filing of oncology products for markets in China and has begun exploratory work for expansion into Africa.
7. For the year, the R&D spend stood at INR 198 Cr or 9% of the total revenue.
8. INR 443 Cr was spent on creating new capacities.
9. Company is also investing to further establish its presence in Australia, Singapore, China and South East Asian countries. Businesses in these market will propel growth in the future for them.
10. To leverage their skills in organic chemistry they have forayed into the crop health sciences space as well. They are looking to address the unmet needs in Integrated Pest Management (IPM).
11. During FY19, the company announced a buyback and purchased about 30 lakh shares worth INR 186 Cr. The market value of the company was under sharp discount (of more than 30 %) from their All Time High price. The buyback reflects promoters’ faith in NATCO’s long-term prospects, and a move to improve the return on equity for shareholders.
12. In FY19, three interim dividends announced amounting to INR 138 Cr including dividend distribution tax of INR 24 Cr and it results in a pay-out of 20.72% of standalone profit after tax.

Business updates by Geography

Points from Management Discussions Analysis

1. The global spending on medicines reached $1.2 trillion in 2018 and is expected to exceed $1.5 trillion by 2023; growing at a compounded annual growth rate (CAGR) of 3–6% over the next five years (Source: IQVIA: The Global Use of Medicine in 2019 and Outlook to 2023).
2. The US pharma spending registered $484.9 billion in 2018 on the back of new product updates and brand pricing. Most drug makers limited their annual price hike to 6% for branded products due to criticism of price hikes by manufacturers on established products.
3. Spending on medication in pharmerging markets recorded a robust 9.3% CAGR in 2014-18 to register $285.9 billion. Factors such as governments’ efforts to make healthcare products accessible to multiple geographies and consumers’ ability to afford better healthcare products on the back of higher disposable income bolstered overall spending. Pharmerging markets are expected to grow at CAGR 5–8% over the next five years.
4. Within the pharmerging markets, China, Brazil and India have the greatest medicine spending.
5. Pharma spending in India stood at $20.4 billion for 2018 and is expected to grow at a CAGR 8-11% in the next five years to touch $28-32 billion, making India one of the top 10 pharma markets by 2020.
6. Domestic Active Pharmaceutical Ingredient (API), consumption is expected to reach US $18.8 billion by FY 2021-22.
7. In FY 2017-18, India exported pharma products worth $17.27 billion and by 2020, the industry estimates the exports to grow by 30% to reach $20 billion.
8. In FY 2018-19, NATCO’s revenue from operations on a consolidated basis amounted to INR 2224.7 Cr, recording a 26.9% CAGR over the last 3 years. Profit after tax stood at INR 644.4 Cr, representing a CAGR of 60.1% over the last 3 years.
9. The EBITDA for the year was INR925 Cr, representing an EBITDA margin of 41.6%.
10. The Company declared three interim dividends for the FY 2018-19. Collectively, all the three dividends stand to 17.18% of standalone profit (excluding divided distribution tax).
11. During the year ended 31st March 2019, the Company bought back 2015656 equity shares with Face Value of INR 2 each for an aggregate purchase value of INR 132.9 Cr, excluding transaction costs. This means the effective rate at which the company bought back its stock was around 660.

Exhibits

Analyst’s View

NATCO Pharma is one of the long standing pharma companies in India with a good track record over the years. It has been a long term wealth creator for its shareholders. Unlike most pharma companies which are dependent mainly on US market, NATCO has diversified into other geographies like Canada, Brazil, China and many other to de-risk their dependency on the US markets. Robust pipeline of products, strong research capability, high free cash flows and reasonable valuations make this large pharma company worth looking as an investment option.

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