Investors should consider this niche play on animal healthcare value chain

Sequent Scientific Ltd.

Highlights:

– Pure animal healthcare play in both APIs and formulation space
– Manufactures 26 APIs with growing presence in the US and Japan
– Strongly positioned in formulations for injectables opportunity
– Adverse weather conditions in Europe and Brexit uncertainty a key near term watch
– Improving margin profile with favourable product/geography mix

The animal healthcare segment is one of the few niche plays in the pharmaceutical industry that is seeing a sustained improvement in growth prospects. Sequent Scientific (market cap: Rs 2,068 crore), the largest animal healthcare company, is well positioned to take advantage of this opportunity.

The animal healthcare market

The global animal healthcare industry with a market size of $42 billion is a subset of the pharma market ($1 trillion). However, growth in animal healthcare is accelerating. Sales grew at an annual average of 7.2 percent in the five years to 2019 compared to 6.6 percent during 2010-14.

Multiple drivers are responsible for this acceleration. There has been substantial increase in livestock production partly to meet the secular rise in human food consumption. Increasing demand for poultry and milk products are driving the demand for feed additives, vaccines and drugs. Demand for better food safety systems has risen. Further, changing urban lifestyles and rising per capita income levels are leading to increased pet ownership coupled with the ability to pay for pet healthcare.

Table: Animal healthcare segments

Source: Sequent Scientific

Sequent Scientific’s latest annual report said that the Indian animal healthcare market is estimated at Rs70 billion in 2019; livestock accounts for 55 percent share, poultry 40 percent and pet animals the remaining. As per its management, animal health in India has undergone significant changes over the last few years because of the adoption of innovative technologies used for prevention and cure of farm and companion animals.

Sequent’s business presence

Sequent makes both formulations and API (active pharmaceutical ingredients) with the latter contributing to one-third of sales. It started its operations as an API supplier for both animal health and human health in 2002. Later it started focusing on increasing its share of formulation business through acquisitions. After divesting its human API business in FY18, Sequent is now a pure play on animal health care through its Alivira Animal Health brand.

Business segments Q1 FY20

Source: Sequent Scientific

API – high growth trajectory to continue

Sequent has emerged as a partner of choice for APIs among top global animal health companies. The top 10 global animal healthcare customers account for 57 percent of its API sales. Sequent makes 26 APIs with an asset turnover ratio of more than 2x. In FY19, its API sales grew 38 percent. The management expects similar growth in the near term due to increasing reach and better capacity utilization. In the regulated markets, the company has successfully commercialized a second product in the US and entered the Japanese market with two product registrations.

Opportunity in formulations

The company makes 35 formulations. It derives half of its formulation sales from regulated markets. New registrations will drive Sequent’s growth now. Monetization of its injectable pipeline in the US and other markets would be crucial.

In the last fiscal year, the company scaled up capabilities with the addition of an injectable manufacturing facility in EU (Bremer Pharma). Recently, the company entered into the US which has a 40 percent global market share in the animal health formulations business. While pricing dynamics in the US are favorable compared to Europe, it poses an entry barrier in the form of high filing fees of $ 425,000. Due to this, the company is expected to grow gradually. The management has guided for commercialising injectables in the US from FY22.In addition, the following attributes add to the investment case for Sequent:

  • The company gets 10-15 percent of sales through third party distribution which provides a boost to margins as it leverages distribution reach and client relationship. Note that in the animal healthcare business, entities possessing last mile connectivity enjoy better margins.
  • Sequent has inducted new leadership for its thrust on injectables development. The new lead – Sirjiwan Singh – was earlier responsible for managing the injectable business in Europe for more than 15 years.
  • The company has a pipeline of 35 formulations which represent a market opportunity of $1 billion. Of this, 21 products are meant for the US market. One third of the pipeline products leverage from in-house strength of APIs. Moreover, it has 14 APIs in the pipeline.

Sequent acquired an EU GMP (Good manufacturing practice)-approved API facility at Mahad, Maharashtra which complements existing API facilities at Vizag (FDA approved) and Tarapur (API intermediates). Together with this, company operates from eight manufacturing facilities including four overseas factories.

Table: Manufacturing facilities

Source: Sequent Scientific

Risk

In the near term, the European formulation business could remain soft due to adverse weather conditions and the impact of Brexit uncertainty on supply chain. Further, the company has recently started operations in Italy and France which could take up to two years to breakeven. Additionally, the Turkey business has been impacted by regulatory changes to contain the misuse of antibiotics. While sales from Turkey business has recovered recently, it would remain a key watch in FY20.

Outlook

The management expects both the engines of growth – APIs and formulations – to contribute to earnings. The API business is expected to clock Rs 400 crore in FY20 implying around 25 percent growth, while the formulation business is guided to grow in mid-teens.

Further, the management expects improving geographical and product mix along with better pricing dynamics for APIs to translate to around 200 bps margin expansion in FY20. Further, the management has guided for Rs 2000 crore sales and 20 percent EBITDA margin in FY23.

To aid the growth outlook, company plans spend about Rs 30 crore in next two years dedicated towards existing API facility in Vizag and the injectables plant in Germany.

Table: Financial projections

Source: Moneycontrol Research

Table: Return profile and debt metrics

Source: Sequent Scientific

The Sequent stock has rebounded post strong results for Q1 FY20. It is trading at an EV/EBITDA (trailing) multiple of 16x,  broadly in line with the median multiple enjoyed by industry rivals. However, the multiple is only 10x when we consider FY21 estimated EBITDA leading us to believe that strong earnings growth drivers are yet to be priced in. With an improving return profile and a strong balance sheet, we advise investors with a long term horizon to accumulate the stock.

Table: Peer comparison


Source: Moneycontrol Research, Yahoo Finance

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