Jubilant Life Sciences (erstwhile Jubilant Organosys) had started off fiscal 2011 by hiving off its APP (Agri & Performance Polymers) division which clearly indicated the management's intention to adopt a focused approach towards the PLSPS (Pharmaceuticals and Life Sciences Product Services) business. Fiscal 2012 started off with the repayment of the entire debt due on account of the FCCBs. The management has also clearly indicated that the present fiscal would be robust in terms of the financial performance of the company. But we have to remember that in spite of being the largest CRAMS (Custom Research and Manufacturing Services) company and despite having a presence across the CRAMS value chain, the company has underperformed last fiscal (FY11). What is hurting the company’s prospects?

What Went Wrong

Before you get into what went wrong, one must understand the business of the company. Jubilant is present into CRAMS right from preclinical trials to commercial production. All this is reported under the heads of PPES (Proprietary Products and Exclusive Synthesis), CMO (Contract Manufacturing) and Drug Discovery. The company also has a presence in API (Active Pharma Ingredients), Speciality Pharmaceuticals, Solid Dosage and Radiopharmaceuticals. Preclinical trials start after the drug discovery and then the drug goes for clinical trials in three phases; Phase I, II and III. Thereafter comes the commercial production which falls under CMO.

Delay in client orders, one-off business in H1N1 vaccine, and absence of milestones has led to the fall in the company’s services business. Product Services have reported a decline of 19% YoY (Rs 749 cr vs Rs 919 cr) in FY11. This was mainly due to a lower order flow from clients in CMO business despite the USD100 million contract manufacturing deal it signed for injectables and solid dosage formulations. There were reductions in forecast orders of key clients due to a delay in regulatory approvals of customers’ products.

The drug discovery business faced delays in initiating new integrating programs from key customers. The clinical trials business in the US has witnessed financial constraints affecting growth due to a market slowdown and a consolidation in the pharmaceutical sector which led to postponement of milestone payments from major clients. DDDS reported a 16% decline in FY11. Life Sciences products witnessed flat growth of 9% (Rs 2685 cr vs Rs 2467 cr) on a YoY basis for FY11. Business as a whole, remained flat during FY11, although the results cannot be compared as the company has demerged its APP business.[PAGE BREAK]
High Debt & Higher Tax

Jubilant raised USD 310 million in FCCBs in 2005 and 2006 to fund acquisitions and for capex. After the demerger of the APP division, FCCBs worth USD142 million (USD 202 million including YTM) in the books of Jubilant Life Sciences were fully redeemed in May 2011. As of date there are no outstanding FCCB’s in the books of the company. The company has borrowed rupee loans to the tune of Rs 900 cr for the purpose of the above repayment. After repayment of FCCBs, the debt on the books of the company will continue to be on the higher side at Rs 3250 cr. Earlier the YTM cost on the FCCBs used to be adjusted on the balance sheet rather than routing it through the P&L account, hence the overall interest cost appeared lower on the P&L account. However, after the redemption of the FCCBs, the debt on books will be interest bearing debt. Hence the overall interest cost for FY12 will almost double to Rs 200 cr, which may impact the company's profitability. The cost of debt on Rs 3250 cr will be 6.3% up from 5.3% earlier. For FY2011, the average tax rate was 5.6% due to exports and other R&D related benefits that the company enjoyed. In FY2012, the tax rate would be around 15%. This increase would mainly be on account of withdrawal of export benefits in FY2012. The total tax expenditure may go up to the range of Rs 30 to 40 cr as compared to Rs 14 cr in FY11.

Moving Ahead

The company has clearly defined four pillars that are going to be the growth drivers for the company viz. capacity enhancement, innovation led new launches, expansion of the geographic markets and vertical integration. The capex that the company has made so far will start bearing fruit commencing from FY12. The management has indicated that the DDDS and the CMO business which were reeling under the pressure are likely to witness a turnaround which will have a positive impact on the EBITDA margins. What will also help the company is an expansion into new geographies, with deeper penetration into higher growth markets of Europe, Japan, and other emerging markets. It is expected that sales from EU and Japan are likely to witness a 35% and emerging markets are likely to witness a 40% growth in FY12. In the EU region the growth is expected to come from the robust pipeline of products as it already has 25 filed dossiers of which 16 to 17 are already approved.

Jubilant has received two milestone payments from Endo Pharma and AstraZeneca in Q1FY12 amounts of which are unknown. Thanks to this, the EBITDA margins are likely to expand by 400-500 basis points in research services during FY12 to around 10%. It has received an approval to launch Aricept in the US market. It is expected that the operating leverage would lead to  improvement in gross margins as the product would be launched from its Roorkee plant, which was till now incurring fixed cost with no revenues. It is expected that Aricept will be launched in Q2FY12. The company has commenced trial batches for Vitamin B3 (Niacin/ Niacinamide) in Q1FY12. It is the largest producers of Betapicoline, which is the key raw material used for production of Niacin/Niacinamide. Cost advantage owing to scale, vertical integration in Betapicoline and tax incentives (the plant is set up in an SEZ in Gujarat) should help it to gain market share. Lonza which is the largest player in this segment does not have a vertical integration. The product pipeline of the company in the US is robust with 51 DMF’s filed  by it and 33 ANDA’s (15 approved) are likely to help the company’s fundamentals. Despite witnessing a flat growth, as a whole the US business has witnessed a 34% growth in 2011 and a same run rate is expected in FY12 too. Increase of Pyridine capacity by 20% and commissioning of Symtet by end of FY12 are the key positives to look forward.

Outlook & Valuation

As mentioned earlier the demerger of the APP business is a positive step. It will lead to improved RoCE for Jubilant as the APP business accounted for only 2% of its FY10 EBITDA but 6% of capital employed. However, the company is facing challenges in its key businesses, led by pricing pressure and delayed orders and execution. The management has indicated that they can reverse some of these headwinds faced in the last fiscal in the coming quarters. High debt and low RoCE in the range of 11 to 13% are overhangs. On the valuation front the stock discounts its FY11 earnings by 15.18 times and the EV/EBITDA stands at 10.45 times. There are many overhangs in the company that need to be looked after, but, the outlook that the company has shared gives an optimistic view. We had recommended this stock to our readers in October 2010. We suggest you hold on to the stock for the time being to witness better returns going forward once the plans that the company has undertaken materialize.