Mangalam Drugs & Organics – valuation comfort for this small cap

While the margin improvement stood out in Q2 FY18, it has to be seen in the context of the absence of excise duty in the cost head.

The products

The company principally manufactures anti-malarial API like Arthemether, Lumefrantine, Artesunate, Amodiaquine Hydrochloride, Dihydroartemisinin, Piperaquine phosphate, Chloroquine Phosphate, Hydroxychloroquine Sulphate and Pyronaridine tetraphosphate. It has also forayed into anti retroviral API’s and has received approval and is manufacturing Tenofovir Disoproxyl Fumarate.

What are its niches?

Globally accredited facility - The company manufactures APIs and intermediates from its WHO-GMP certified plants in Vapi. It has also signed a pact with the prestigious Bill Clinton Foundation under their Fight Malaria Program for supply of anti-malarial bulk drugs worldwide.

Capacity in place - The company has expanded capacity by around 900 tonnes/year and demand for its products supported by World Health Organisation’s (WHO) thrust on malaria and HIV/AIDS treatment should translate into higher revenue in the coming years despite competitive intensity in the segments.

Product diversification strategy -The company has been consistently filing DMFs (drug master file). After establishing itself in malaria, the company aims to become an established player in Anti-AIDS APIs too and finally eye that lucrative WHO Anti-AIDS funding and that should certainly give a major fillip to future earnings.

Financials showing traction - In the past three years, while the revenue has grown at a CAGR (compounded annual growth rate) of 37 percent, operating profit has shown a growth of 70 percent and the company has turned itself from a loss making entity to a path of healthy profitability.

While there is still some leverage on the books, the debt-to-equity ratio has fallen from 2.4x to 0.7x. It is important to note that the company has improved its interest coverage ratio from 0.98x couple of years back to close to 4x now. The double-digit EBIDTA margin should impart further health to the balance sheet.

Raw material price volatility – while the company’s EBITDA margins are impacted to the extent of price volatility in artemisinin - the core raw material for its products, it can pass on raw material price fluctuations to its clients, although the same is effected with a time lag.

Anti-malarial APIs account for close to 90 percent of the company’s revenue and the company has high customer concentration with top two clients Ajanta Pharma and Cipla contributing significantly to the total revenue. The company is exposed to the risk arising from a drop in anti-malarial API demand or a drop in demand from its clients. However, a successful diversification to other therapeutic categories should mitigate the risk.

Undemanding valuation – For a company on a turnaround journey where the return ratios have started looking up meaningfully, the undemanding valuation at 9X FY19 projected earnings should be looked at seriously by investors with a slightly higher appetite for risk.