– Focus on APIs, instead of intermediates, has helped in improving margin profile
– More than 50 percent sales are from exports to regulated markets of the US and Europe
– Zero debt company with improving working capital cycle
Looking at the list of corporates that have posted extraordinary results in the quarter gone by, we spotted this microcap pharma stock. Tyche Industries limited (Market cap: Rs 67 crore) is an Andhra Pradesh-based pharma company involved mainly in the production of API (active pharmaceutical ingredients) and API intermediates.
With about 52 percent of sales comprising of exports to the regulated markets of Europe and the USA, the company has the relevant expertise to manufacture and commercially sell APIs related to the anti-arthritic, anti-retroviral and nervous system therapeutic areas.
The company merits attention for its clean balance sheet, strong free cash flows and attractive valuation. The company’s business model change in 2014 has helped it increase margins.
Interesting chequered history
The company was incorporated as Siris Soft, a software company in 1998, dealing in ERP (Enterprise resource planning) products. It got listed in 2000 and planned to expand into the US. Recall that this was the time when entrepreneurs were trying to ride the boom in IT and IT enabled services. The period is known as the dotcom bubble and when the bubble burst, lots of businesses went bust.
Siris Soft too was hit by the popping of the bubble and chose to diversify into the manufacturing of chemicals related to the pharma industry. In 2004, it changed its name to Tyche Industries and in 2005, it started the commercial production of Glucosamine HCL, which is used for the treatment of osteoarthritis, rheumatoid arthritis and glaucoma.
Current portfolio of about 12 APIs
Currently, the company manufactures 12 APIs and 24 API intermediates with therapeutic areas ranging from anti-arthritic, anti-retroviral, CNS and prostatic hypertrophy. An analysis of raw materials used by the company suggest that Glucosamine based products constitute a significant part of the turnover which are mainly exported to Europe and the USA. We estimate it be ~20 percent of sales. Glucosamine is manufactured using chitin from the shells of seas creatures such as shellfish, shrimp, lobsters, crabs and prawns. The company relies on the supply of cooked prawn shells which is treated with caustic soda for the production of Glucosamine. Apart from Glucosamine based APIs, the company also make Glucosamine based nutraceuticals.
Although Glucosamine based products have low margins, it provides stable cash flows for the business.
Table: Select list of APIs & intermediates
Change in business model
The company changed its business model from the year 2014 onwards. It decided to focus on the relatively high margin API business instead of making API Intermediates. This was aided by EU-GMP (Good manufacturing practice) approval for a few of the APIs manufactured by the company. Further, the company planned to prepare for USFDA approval, which it obtained by 2016. As of now, the company has EU-GMP approval for 11 APIs. It also has US DMF (Drug Master File) approval for Anti Emetic API – Palonosetron HCL and Antidepressant – Phenelzine Sulfate. Palonosetron HCL is used to prevent nausea and vomiting caused by cancer drug treatment (chemotherapy).
Due to this change in the business model, the company’s sales contracted from the highs of FY14, although it stabilized from FY18 onwards. Operating margins have significantly improved from the vicinity of 10 percent to the range of 18-24 percent.
Chart: Sales and margin trajectory
ource: Tyche Industries, Moneycontrol Research
Raw material mainly sourced domestically
Given the difficulty in sourcing the key raw material for the pharma value chain from overseas due to the anti-pollution clampdown in China, it comes as a relief for the company that imported raw materials constitute only about 8 percent of total raw material cost.
Idle infrastructure for expansion
The company reportedly has 24 acres of land of which only 8 acres are utilized for manufacturing. This leaves scope for further expansion. It has 6 production blocks with a total reactor capacity of 156 KL. Four blocks are utilized for API and API intermediates
Strong balance sheet and improved working capital cycle
Since 2017, Tyche Industries is a zero debt company. Further, its working capital cycle has improved over the years. Debtors days—-the average number of days its customers are taking to pay their bills– which were around 107 days in FY16 have reduced to 69 in FY19.
Key risk factors
The business approach of the company’s management is quite conservative which can be seen from the way the balance sheet has been managed. Though the company has the requisite technical expertise, it has avoided any aggressive growth plan. This could be an opportunity for investors, as Tyche Industries may be flying under the radar of analysts looking for small cap companies in a high growth phase. This managerial approach may have to do with their earlier experience with different businesses. While the promoters of Tyche industries had an unpleasant experience with the software business, the promoter family’s other IT business–Siris Labs— also had to be closed down due to the piling up of massive debt. Indeed, Siris Labs, incorporated in 1966, once posted sales of Rs 500 crore in 1995. But its high debt of Rs 300 crore was one reason the company could not sustain the business and had to shut down.
It’s also worth noting the company had, back in 2009, failed to comply with SEBI rules. At that time, the promoter group acquired a stake in the company but failed to disclose the change within the stipulated 7 days of the acquisition.
To be sure, the promoters’ track record has been far from spotless. That is probably why its trading multiples are abysmally low (Trailing P/B = 1.1 times, EV/EBITDA FY21 estimates = 2.8 times ). It’s also true that this is a micro-cap stock and such stocks are prone to bouts of volatility and are often illiquid. Nevertheless, the clean balance sheet, improving margin profile and strong cash flow could provide an opportunity to investors willing to take the risk.
Chart: Free cash flow
Source: Tyche Industries, Moneycontrol Research
In the last four years there has been cumulative free cash flow of Rs 35 crore. Excluding the cash inflow of Rs 6.6 crore on account of fixed assets sold in FY16, the cumulative cash flow for the last four years has been 82 percent of the enterprise value of the stock. Further, given the cash in books (Rs 29 crore), the company seems well positioned to invest in R&D and in regulatory filings for new molecules which can help propel faster earnings growth.
Chart: Financial projections
Source: Tyche Industries, Moneycontrol Research