Analysis Overview – Sunil Healthcare, a producer of empty hard gelatine capsules, is already a multibagger with 241% returns in the last 12 months. This article discusses why Sunil Healthcare still has immense growth and stock upside potential in the coming years.
Company Overview – Sunil Healthcare is the second largest producer of empty hard gelatine capsules in India with current capacity to manufacture 10 billion capsules on an annual basis. Sunil healthcare also has strong global presence with exports to over 30 countries and with approximately 50% of the revenue coming from exports. The image below provides the diversified range of capsule offering by Sunil Healthcare with HPMC capsules being the latest launch.
Key Stock Upside Triggers
Brownfield Capacity Expansion – As of 4Q15, Sunil Healthcare had total manufacturing capacity for 7.7 billion capsules. However, after capacity expansion that was completed in 3Q16, the total manufacturing capacity has expanded to 10.0 billion. With the impact of capacity expansion likely to be seen in full for FY17, I expect positive momentum for the stock to sustain on improving revenue and EBITDA numbers.
Increased Capacity Utilization And Economies Of Scale – For 3Q16, Sunil Healthcare reported revenue on INR25.0 Crore on capacity utilization of 80%. Going forward, as capacity utilization increased, I expect the company to generate revenue in the range of INR25 to INR30 Crore (quarterly basis) at current capacity. It is important to mention here that in a generic industry of capsules manufacturing, capacity provides competitive advantage and EBITDA margin support. My point is backed by the fact that Sunil Healthcare reported EBITDA margin of 17.3% for 3Q16 as compared to 14.2% for 3Q15. I expect steady increase in EBITDA margin in the coming quarters driven by higher capacity and economies of scale.
The Certifications Asset – In the healthcare industry, quality is of paramount importance and for Sunil Healthcare, global certifications are a big asset. The company’s quality control is evident from the fact that it derives nearly 50% revenue from exports. The chart below gives the regulatory certifications and raw material certification the company possesses. With strong focus on quality, I expect the company’s client list to continue expanding.
Quality Clients – Sunil Healthcare has a list of quality clients, which again underscores the company’s quality product offering and strict standards. Some of the company’s clients include reputed names like Pfizer, GSK, Wyeth, Abbott, Intas, Cadila, Dabur, Himalya and Medopharm. With rapid expansion in the pharmaceutical industry globally and with a bright growth outlook for the names mentioned above, Sunil Healthcare is likely to witness robust business growth from existing clients and continued client addition. To put things into perspective, the global capsule industry is likely to grow at a CAGR of 7% globally for 2014-19. During the same period, the Asia-Pacific capsule industry is likely to grow at a CAGR of 125-13%.
Financial Analysis – Besides the points discussed, Sunil Healthcare has strong fundamentals and the company’s key financial metrics are listed in the table below.
I see the following key conclusions from the analysis –
1) The company’s revenue growth was relatively muted. However, with capacity expansion in 3Q16, revenue growth is likely to be strong (y-o-y) in the coming quarters. For 3Q16, revenue growth was 25% as compared to 3Q15 and EBITDA growth was 52% for the same comparable period.
2) The company’s EBITDA margin has been robust for 9M16 and I expect EBITDA margin improvement to sustain through economies of scale and potentially higher capacity utilization in the coming quarters.
3) The company’s debt has increased to fund capacity expansion and for working capital, but the EBITDA interest coverage remains healthy and debt servicing is not a concern. With Sunil Healthcare on a growth trajectory, investors can expect debt to increase. I must mention here that the company’s free cash flow has been negative in the last three years, but that’s not a concern since expansion will trigger OCF growth.
Risk Factors – While there are several positives, I see the following risks associated with investment in the stock.
1) Sunil Healthcare is in a generic product business and increased competition can impact EBITDA margin. The company is looking to mitigate this risk through economies of scale and strict control on quality standards.
2) The company’s current expansion is completed and can potentially give Sunil Healthcare quarterly revenue in the range of INR25 to INR30 Crore. However, the company needs to embark on further expansion if growth has to sustain beyond the next 3-4 quarters.
3) The stock has surged by 241% and it is entirely likely that the stock corrects on profit booking before any further upside. Investors can use any potential correction to gradually accumulate the stock. I am against a big exposure to the stock at current levels.
Valuation – For 3Q16, Sunil Healthcare reported EPS of INR1.45 per share. Considering the same capacity utilization in the coming quarters (base case scenario), the annualized EPS is likely to be INR5.8 after capacity expansion.
At current stock price of INR116, the stock is therefore trading at a PE of 20 times 12-month forward earnings. Considering the fact that the company’s PAT growth for 9M16 is 49% as compared to 9M15, valuations are not expensive. However, profit booking after a big rally can make the stock even more attractive.
Conclusion – Sunil Healthcare is worth considering for the next few years with a focused management likely to deliver returns for shareholders. The company is in a growth trajectory and I expect further Brownfield or Greenfield expansion in the coming years with strong growth in the pharmaceuticals industry.