Let me do this through a case study on Hester Biosciences, an Indian Animal Healthcare company.
We should first start with the industry – how it is now, and how it could look like in the future. Then, we will look at the company specifics.
How does the industry look like?
The animal healthcare industry can be segmented into three key product segments:
- Vaccines – live, inactivated, recombinant
- Health products – drugs, food supplements, disinfectants
The animals can be segmented into two:
- Poultry (chicken and other domesticated birds)
- Large animals (cow, goat, pigs, dogs etc.)
Global market size: US$ 32 billion in 2014, and expected to reach US$ 43 billion by 2020 – a CAGR of 5.1%.
Hester derives most of its revenues from India. So, let’s see how big is the Indian market:
Indian market: US$ 1 billion in 2014, and expected to reach US$ 2.4 billion by 2020 – a CAGR of 15.2%. That’s about 13% of global demand growth.
Drivers of revenue growth
Emerging economies are driving the demand growth due to:
- Increasing demand for meat, milk and eggs -> higher demand for vaccines, drugs and feed additives. Production animals and livestock account for 65% of healthcare demand. The increasing consumption is primarily due to lifestyle change, rather than population growth.
- Increasing pet adoption -> higher vaccine demand. Pet healthcare account for 35% of revenues.
On meat and egg consumption, there is always a question – “Aren’t Indians mostly vegetarian?” The answer is “no”. Look at the below chart on state-wise composition of vegetarians and non-vegetarians:
Source: Huffington Post, Govt of India
Now, let’s see how much is the per capita consumption of meat, egg and milk. This is how we will try to understand the market potential of client industry.
Eggs: On average, and Indian consume 54 eggs – compared to the US average of 251 (in 2013) and global average of 179 (in 2014) – showing a potential for 5x growth. India is the second largest egg producer in the world after China, producing approximately 78.5 bn tonnes in 2015.
Meat: On meat consumption, Indians consume 3.5 kgs. per capita – just a fraction of the global average of 43 kgs. The country ranks fourth in broiler production with an annual output of 3.8 mn tonnes of broiler meat (2016 est: 4.2 mn tonnes). Look at the below figure – Indians consume much less meat vs. BRICS peers:
Source: Meat Atlas
There is another fact visible in the above chart – Indians consume more of poultry than large animals. The reason is due to religion – Hindus are 80% of India’s population and don’t consume beef, Muslims are 14% and do not consume pig meat. Hence, the demographics favor poultry, for meat consumption.
Milk: On milk consumption, India seems to be in line with world average – 322 grams per day (2014-15) vs. global average of 294 gms (in 2013). Here, we can’t expect too much of quantity growth on the client side – it will be mostly adoption modern healthcare practices that will drive this segment. India has the largest cattle population in the world., accounting for 31% (301.6 million units) of the world cattle population in May 2016.
So, this sets the context – the market opportunity is quite big.
Now, let’s look at the company specifics:
Here, we are checking for the operating track record of the company in question.
- 1983: Started out as a proprietary concern, to distributor of poultry medicines and feed additives
- 1987-90: Incorporate as a company and entered into exclusive marketing agreements with Ghen Corporation (Japan) for its range of poultry feed additives, and with Maine Biological Laboratories (USA) for its range of poultry vaccine.
- 1993: Enters into technical and financial collaboration agreement with Maine Bio, to manufacture poultry vaccines in India.
- 1994: IPO, and allotted shares to Maine Bio in lieu of technical and financial collaboration agreements
- 1997: commenced the marketing of locally produced poultry vaccines.
- 2000: Reports profit for the first time, though nominal.
- 2003: Terminates the financial and technical collaboration with Maine Bio.
- 2007: Expands manufacturing capacity four fold.
- 2012: Launched poultry and large animal health products divisions.
- 2013-till date: Receives WHO-GMP certification; Establishes Nepal manufacturing facility; plans to launch diagnostics division in 2016.
Notice here that the company was focused purely on animal healthcare business – unlike its competitor Venky’s, which is into many activities. Solid focus.
Here, we are trying to understand the company’s standing in the industry, the specifics on its revenues and how it undertakes manufacturing and distribution.
- Hester has a 28-30% share of India’s poultry vaccine market – second to Venky’s with 40% share.
- Nearly 87 per cent of the company’s revenues are derived from the poultry vaccines segment. This segment grew at a CAGR of 20 per cent over FY 2011 to FY 2015 and the Company expects the segment to grow at a CAGR of 16 per cent over FY 2015-18.
- Current product basket – 45 (live and inactivated) vaccines in the poultry segment, 2
live and inactivated vaccines in the large animal vaccines segment along with numerous other healthcare products and diagnostic services like seromonitoring for poultry and mastitis prevention programmes for cattle.
- 90% revenues are from India, and rest from exports.
- Proportion of revenues derived from the products launched in the last three years was 6.3% in 2015-16. The company explicitly providing this data shows the management focus on new product development.
- Focus areas are vaccines and health products for poultry and large animals.
- Two manufacturing plants – one in India and another in Nepal (for vaccines not allowed in India; commenced trial production and expected to become operational in Sep’16). Non-vaccine product manufacturing is outsourced.
- Distribution chains – Pan-India network ; exports to 18 countries. In vaccines business, storing them at low temperatures is very important. Cold storage facilities are the backbone of vaccine distribution chain. Vaccines manufactured need to be stored between 4-8°C and in some instances at -196°C (using liquid nitrogen). Hester has its own cold chain network and mobile equipped vans to take care of this. This is a major competitive advantage.
- Patents -It is not clear whether Hester holds patents for the vaccines. This is a clear negative.
- CEO & MD: Mr. Rajiv Gandhi – who founded the company more than 30 years back, and holds 10% stake – Positive sign, as owner-operator companies tend to outperform others.
- CEO drew a remuneration of INR 8.9 mn in FY16 – 3% of EBITDA.
- Promoter group holds 54.1% – as on March 31, 2016.
We need to have an idea as to how the company plans to grow.
- Expected to foray into diagnostics kits, new-generation recombinant vaccines, monitoring of animal diseases.
- Recombinant vaccines are expected to have higher margins considering the advantages – over live or inactivated vaccines – such as safety, efficacy and ease of administration.
- Plans to increase the share of exports (mostly to Africa), to diversify. Current share of exports is 10%.
- Plans to create an international marketing and distribution network with a focus on Africa.
- Plans to build manufacturing facility in Africa, in the long term.
Competition and Competitive advantage: Moat factor
We cannot analyse a company in isolation. There is competition – everything is relative. To succeed, it is not enough to do things well, but it needs to be done better than competition.
- Key competitor is Venky’s which has 40% share of Indian poultry vaccines market. Venky’s is diversified into poultry supply and retail chains, apart from animal healthcare. Venky’s management can be viewed as weak, given the fact that it went on to buy football club Blackburn Rovers which is loss-making and debt-ridden now – a bad way to spend shareholder money. Hester’s management is more stronger with CEO of more than 30 years’ experience in the field, and is focused only on the animal healthcare business. Good management, and focused operations.
- High technology and regulatory hurdles leads to high entry barrier – Biotech is not a business where anyone can enter. Dealing with micro-organisms means the need to have high technological capability and experience, which is the biggest entry barrier in this business. Hester does not emphasize patents in its annual reports or corporate PPT. This has led me to believe that it is not the patent, but the manufacturing process that is Hester’s core strength.
- Cold storage chain – In vaccines business, storing them at low temperatures is very important. Cold storage facilities are the backbone of vaccine distribution chain. Vaccines manufactured need to be stored between 4-8°C and in some instances at minus 196°C (using liquid nitrogen). Hester has its own cold chain network and mobile equipped vans to take care of this. This is a major competitive advantage.
- Long operating track record – Hester has been manufacturing poultry vaccines since 1997.
- Low cost vs. global players – Operations are based out of India and Nepal, enabling Hester to offer lower rates for FAO contracts, than global peers.
Profitability, Cash Flows, Balance sheet strength
- Sales growth of 19% CAGR over past 5 years; Gross margins down by 5ppts to 80.6% during the period.
- EBITDA grew @10% 5-year CAGR – as margins fell from 43.2% in FY11 to 28.6% in FY16.
- PAT growth @ 20% 5-year CAGR – margin of 18.5%, mostly unchanged over the period.
- RoE at 20% in FY16 (5-year average of 15%); RoCE at 16% in FY16 (5-year average of 17%).
- Consistently cash flow positive at operating level (5-year avg: CFO was 126% as % of PATMI). Due to high capex (5-year avg: 22% of revenues), the company was only marginally free cash flow (FCF) positive in FY16.
- High demand for incremental working capital @ 6% of revenues over past 5 years. Cash conversion cycle has come down from 283 days in FY11 to 195 days – still high despite management’s efforts.
- R&D division spending was 5% of revenues in FY15-16.
- Debt-equity ratio is only 0.5 despite the high capital intensity of the business – meaning that the company is able to generate internal funds to finance growth (Capex + WC).
Risks and challenges
- Slowdown in poultry market in India, as happened in FY16 – this is a very possible risk.
- Inability of Hester to obtain product registrations in key African markets – this could be viewed as a remote risk, as African markets are mostly unregulated or semi-regulated, and Hester has extensive experience in the field.
- Hester needs to scale up the cold storage network in both India and Africa. Hence capex intensity might continue at current rates of ¬20%, leading to strain on FCF.
- The management need to work intensely on bringing down the cash conversion cycle which is currently over 6 months.
- DCF (Notice that the company we discussed here was hardly FCF positive. Expect similar capex and WC intensity for the next 5 years or so.)
- The market potential is quite big, and has a long runway.
- Choose companies with long operating track record, strong R&D capability and cold storage chain.
- The company discussed here (Hester) has strong fundamentals, huge market opportunity and strong management. Take the call to buy / sell based on current market prices.
Note: This post is for educational purposes to understand the sector, and not a stock recommendation.
Note: This post is part of “How to analyse” series. I will continue to update the post, as I learn new stuff about the industry. Please let me know if I missed anything.
Image source: Pixabay