July 7, 2017

Caplin Point Laboratories Research Report

www.drvijaymalik.com has a dedicated section for investment & stock specific queries of readers: “Ask Your Queries”. Over time, readers have asked queries about multiple stocks in this section. Answers to these queries have been done post preliminary analysis of the stocks under consideration. Such analysis has been found helpful by readers.

“Analysis” series is an attempt to summarize & share with all the readers, the key questions and their answers, which have featured on “Ask Your Queries” section. The primary aim of this new feature is to share the knowledge with all the readers of the website.

The current section of this series, “Q&A” covers Caplin Point Laboratories Limited, an Indian pharmaceutical generics player focusing on Latin America, Sub-Saharan Africa markets.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets


Reader’s Query


Hello Sir

We have tried to do some analysis on Caplin Point Laboratories Limited as per the guideline discussed in your site. Please find attached our analysis report of Caplin Point Laboratories Limited. In some of the sections, we have some queries, which are already shared in the report. Please give your feedback on the complete report. Also, let us know the analysis points that we might have missed in this case.

Regards

Kunal & Aditya

Caplin Point Laboratories Limited


Business Overview

Caplin Point Laboratories Limited is a manufacturer & seller of generic drugs. It is mainly doing business in Latin America region and in Africa. These are unregulated/semi-regulated market. Recently it tries to enter into the regulated market like Europe, Brazil & USA.

Caplin Point Laboratories Limited was established in 1990 & listed in 1994 following its IPO which was oversubscribed 117 times. At present it has 4 production units:
  • CP I: Suthukeny, Puducherry
  • CP II (R&D): Gummidipoondi, Chennai
  • CP III: Baddi, Himachal Pradesh (Argus Plant)
  • CP IV (manufacturing and R&D): Gummidipoondi, Chennai [EU-GMP and ANVISA approved]

Till 2011, Caplin Point Laboratories Limited was running its business as a single company. But in FY2011, It created a subsidiary named Argus Salud Pharma LLP which is running its Himachal Pradesh unit. For this reason, we have used standalone data from 2007 to 2010 & consolidated data from 2011 to 2016 to analyze Caplin Point.

Also Caplin Point Laboratories Limited has changed its financial year from March 2016. For FY2016 data, we have used summation of 4 quarters data from April 2015 to March 2016 instead of 9months data filed by the company

Before going into deep analysis let’s check the overall numbers and performance of last 10 years as per our checklist.


Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Top-line Growth & Profitability

Other than 2009, 2010 Caplin Point Laboratories Limited is growing its business (top line) at around 30% rate. Along with this growth, Caplin Point Laboratories Limited has also increased its Operating Profit Margin & PAT margin (or NPM) at a steady rate. From 2012 to 2017, OPM has increased from 10% to 31% and PAT margin has increased from 7% to 23%. Since Caplin Point Laboratories Limited is a debt free company, its NPM runs closely with OPM.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Consistent increase in margin shows the domination of the company over its customers. From this analysis, we can say that Caplin Point Laboratories Limited is running a really profitable business which is good for the shareholders.

Tax Payout

Caplin Point Laboratories Limited is paying around 23% tax on its income which less than the normal industry standard. However, from the balance sheet of Argus, we have come to know that Himachal plant enjoys tax exemption for 10 years.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Cash Flow

Cash Flow is one of the key parameters to analyze a business. If the business model does not generate enough cash, then the company needs to borrow money from somewhere else to run the existing business and do the expansion.

Caplin Point Laboratories Limited is generating enough cash from its business. Over the last 10 years, its cumulative PAT is ₹161.6 Cr and cumulative CFO is ₹242.17 Cr, which satisfies our criteria cCFO >> cPAT. 

From 2007 to 2016, Caplin has generated a Free Cash Flow of ₹77.9 Cr which is 32% of its cCFO. FCF is the excess cash company has from its operation after fulfilling its CAPEX requirement.  In the case of Caplin Point Laboratories Limited, it is able to generate excess cash, which is getting accumulated in its balance sheet. This cash can be used for any future expansion which is why Caplin Point Laboratories Limited has not taken any debt or equity dilution in recent past to do CAPEX.


Let’s see how Caplin Point Laboratories Limited has created this positive cash flow. Caplin has reduced its receivable days from 70 to 20 in last 10 years.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

On the other hand, Caplin Point Laboratories Limited has maintained Inventory Turnover ratio within 15 to 20 and a payable turnover of around 3.25. These three things created a surplus working capital for the company.

Management has also highlighted this working capital strength of the business model. In the Annual Report of FY15, in the financial model section (page13), management has pointed out that Caplin Point Laboratories Limited has a 100 days payable and 8 days receivable cycle which helps it to create a negative working capital.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

However, in recent time there is a little bit of increase in the receivable days which is seen 2014 onwards just when CP IV unit started commercial production. It could be a possibility that with the help of CP IV unit Caplin is entering into the large regulated market with more competition and to get a competitive edge over its peers, Caplin might have increased the credit period. The investor must get this clarified by the management.


Self-Sustainable Growth Rate (SSGR)

Self-Sustainable Growth Ratio shows company’s growth potential without diluting equity or taking any debt. Caplin Point Laboratories Limited has an SSGR of 27%. But its top line growth (30%) is a little bit higher than SSGR although Caplin has not taken any debt or equity dilution. This has been possible due to an increase in business efficiency.


As mentioned in Cash Flow section, Caplin Point Laboratories Limited has reduced receivable days which has released the money got stuck in working capital thus creating a higher Sales growth. However, in the long run, it will not be sustainable. So, it can be assumed that eventually, Caplin Point’s topline growth will come below SSGR.

SSGR and free cash flow (FCF) are two of the main pillars of assessing the margin of safety in the business model of any company. As seen by the analysis of self-sustainable growth rate (SSGR) and the free cash flow (FCF), Caplin Point Laboratories Limited has shown that it has a margin of safety in the business model.

Fixed Asset Turnover

Basically, Caplin Point Laboratories Limited runs an asset-light business model and most of its products are outsourced. It also implies that Caplin Point Laboratories Limited doesn’t need much cash for CAPEX to expand the business growth which why it is able to generate continuous FCF.

However since 2012, Caplin Point Laboratories Limited decided to build its own US FDA compliant unit. It started doing CAPEX for this with its internal cash reserves. This CAPEX got completed in 2014 and CPIV unit started production from 27th March 2014. This addition of CPIV unit increased Caplin Point Laboratories Limited’s Fixed Asset and we saw a decline in its Asset Turnover ratio in 2014.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

At present, there is no CWIP in Caplin Point Laboratories Limited’s Balance Sheet, which indicates that its major CAPEX is over. But still, NFAT is at the lower level. It shows that CP IV unit is yet to be utilized at optimum capacity. The reason could be that this plant is mainly for the regulated market and Caplin Point Laboratories Limited is still in process to get all US FDA clearance.

As conveyed by management in the Q4-FY17 press release, it has filed 2 ANDAs and 7 more are in pipeline which will be filed by Q3FY18. So, we need to wait for at least FY19 result to see any progress in NFAT number.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets


Management Analysis

Mr. C. C. Paarthipan is the chairman & promoter of Caplin Point Laboratories Limited. He does not take any salary from the company. Vivek Sidharth, son of Mr. Paarthipan, is the 2nd generation entrepreneur and is already involved with Caplin Point Laboratories Limited. So there is a proper management succession plan.


Increasing Promoter holding

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

The above table shows there is a consistent increase in promoter holding for last 5-6 years. It shows management’s faith in the business in the long run.

Management Salary

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Directors’ salary is way below the maximum threshold which is 5% of PAT. Even total management salary including key management personnel (KMP) is 1.35%.

Subsidiary

Regarding Argus Salud Pharma LLP

Caplin Point Laboratories Limited created its first subsidiary Argus Salud Pharma LLP in 2011. Argus runs its CPIII unit (Himachal Pradesh). As of March 2016, Caplin owns 99.9% stake and May India Pvt. Ltd, a company owned by promoter family, owns 0.1% stake. Argus cannot be a wholly owned subsidiary because as per LLP Act there have to be at least two partners. Although it is a subsidiary, Caplin Point Laboratories Limited is adding profit share from Argus in its standalone sales figure.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Query1: Why was Argus formed as LLP instead of the company? What are the advantages in such case? Why is Caplin Point Laboratories Limited adding Argus profit in standalone numbers?

Related Party transaction with Argus

Caplin Point Laboratories Limited is heavily involved in related party transactions with Argus. Although Caplin is reporting this transaction as ‘On arm’s length basis’, we are not sure how to analyze such transactions.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Query2: Please help us to understand the merit/demerit of these related party transactions.

Regarding newly formed subsidiary Caplin Point Far East Ltd.

As mentioned in Q4FY17 result, Caplin Point Laboratories Limited has invested in two new subsidiaries in FY17. Out of them, Caplin Point Far East Ltd has started its operation this year. The other subsidiary (Colombia based) is yet to commence its operation.

As per the auditor report in FY17, Caplin Point Far East Ltd. has a total asset of ₹41.88Cr. It has generated revenue of ₹48.5 Cr and PAT ₹25.18 Cr.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

If we compare standalone & consolidated balance sheet of FY17, we can approximately predict the asset break up of Caplin Point Far East Ltd.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

As shown in above table, there was only a little difference between standalone and consolidated data in 2016. However, this has increased in 2017 to around ₹41Cr which is the same amount of asset owned by Caplin Point Far East Ltd. Moreover, on further analysis, it has come out that, ₹30 Cr asset is in the form of receivable and ₹ 16Cr as Cash. This also explains that subsidiary company doesn’t have any fixed asset (plant & machinery) and only working as a sales & marketing arm of the parent company.

It is clear that out of ₹48Cr revenue, ₹30Cr is on credit. The receivable is 62% of sales which is quite on the higher side. This behavior of the subsidiary is against the basic strength of the Caplin business model which is running at 8 receivable days.  

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

We can observe that there is a sudden difference in revenue from September 2016. It can be assumed that subsidiary started business from Sep-16. That’s why we need to use 3 quarters to calculate receivable days.
  • Revenue generated by subsidiary = 13.71 + 14.14 + 24.28 = 52.13Cr
  • Which is quite same as reported revenue (48.5Cr) of the subsidiary.
  • Receivable days = 270/(48.5/30) = 168 days

This receivable days is nowhere near to the Caplin Point Laboratories Limited’s benchmark receivable days of 8.

Query3: What should an investor interpret from these high receivable days?

Query4: Caplin Point Far East Limited was established on 13 May 2014. But Caplin Point Laboratories Limited declared it as subsidiary only in 2017. Moreover, there is no filing regarding this incorporation in BSE/NSE. Isn’t it compulsory to notify this information to the stock exchange in such case?

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Source: https://www.hkgbusiness.com/en/company/Caplin-Point-Far-East-Limited

Future outlook

As conveyed by management through its Annual Report 2016, Caplin Point Laboratories Limited has achieved its target in Latin America/Africa region and the future target is regulated market through its CP IV unit.
Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

(Chairman’s message to shareholder in AR2016)

However, there is a growing apprehension among analysts and shareholders about whether Caplin Point Laboratories Limited is capable of competing with large players in the regulated market. Mr. Paarthipan has addressed this concern in AR16 and was confident on Caplin Point Laboratories Limited’s success in the regulated market as well based on arguments like there are very few players in US market for injectable and Caplin Point Laboratories Limited has an alliance with Europe giant Fresenius Kabi.

Even Chairman has already agreed that US business will not be cash rich rather it will be a cash intensive business. At the same time, he has assured that this investment will come from internal accruals (generated from FCF) and no equity dilution will happen. Going forward investor needs to monitor whether Caplin Point Laboratories Limited is funding through debt or equity dilution.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Query 5: What are other things an investor can monitor to judge whether Caplin Point Laboratories Limited is on the right track for its new venture? 



Author’s Response


Hi Kunal & Aditya,

Thanks for sharing the analysis of Caplin Point Laboratories Limited with us! We appreciate the hard work put in by you in the analysis. The effort put in by you in the analysis is clearly visible in terms of assessment of the company, its subsidiaries and the usage of various public documents to derive understanding about the company’s business situation in India and abroad. Your report of Caplin Point Laboratories Limited would prove helpful to any investor trying to study this company.

We appreciate that you have analysed the standalone financials of the company until the time it did not have any subsidiary (June 2010) and have analysed consolidated financials post that. We agree that while analysing any company, the investor should always look at the company as a whole and focus on financials which represent the business picture of the entire group.

We also appreciate that you have analysed the 12-month numbers preceding March 2016 (i.e. from April 2015 to March 2016) as looking at 12 monthly numbers helps in better understanding of the trend of the company’s performance over a long period of time.

However, in the case of this adjustment, the quarter of June 2015 gets double counted, first, in the period July 2014 to June 2015 and then again during the period April 2015 to March 2016. Therefore, while doing an analysis of the data of performance over 10 years i.e. from FY2007-16, it is advised that one adjusts for this double counting of June 2015 quarter data.

Let us analyse the performance of Caplin Point Laboratories Limited over last 10 years.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Caplin Point Laboratories Limited has been growing its sales since last 10 years (FY2007-17) at a brisk pace of about 20-25% year on year, which has increased to about 30% year on year in the last 5-7 years. The sales revenue grow by about 9 times from ₹44 cr. in FY2007 to ₹405 cr. in FY2017.

The company has realized this growth by way of creating additional capacity in the form of its own manufacturing plants as well as increasing higher outsourcing of manufacturing of a lot of products to China. (Annual Report FY2016, page 21):

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets
 Going ahead, Caplin Point Laboratories Limited seems to be looking for using the capacity in the 4th unit (CP-IV) near Chennai and the outsourcing channel from China to generate the supply needed future growth. Usage of outsourcing would help it bypass the capacity constraints if any.

While analysing the growth of the company in the last decade, an investor would notice that Caplin Point Laboratories Limited has achieved the growth rate of 25-30% year on year with significant improvement in its profitability margins. The operating profitability margin (OPM) has improved from 4% in FY2010 to 32% in FY2017. This is a very good performance by the company.

This performance starkly stands out when we compare the OPM of Caplin Point Laboratories Limited with some of the other Indian small pharmaceutical players having FY2017 annual sales of less than ₹1,000 cr. viz: Lincoln Pharmaceuticals Limited (₹360 cr), Anuh Pharma Limited (₹206 cr), Bliss GVS Pharma Limited (₹799 cr) and Venus Remedies Limited (₹418 cr).

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets


An investor would notice that the OPM for Caplin Point Laboratories Limited has defied the industry trend over the years. For most of the other peers, identified above, OPM has either remained stagnant, improved marginally or declined over the years. However, the OPM for Caplin Point Laboratories Limited has increased sharply from FY2010 to FY2017.

Such standout improvement in the operating margins of any company indicates that the improvement in OPM is not a result of only the industry tailwinds e.g. fall in raw material prices e.g. crude derivatives. Such comparative outperformance results from company specific factors, which need to be analysed further.

In the annual report for FY2016, page 24, the management of Caplin Point Laboratories Limited has outlined the key reasons for the margins improvement:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets


The company has communicated that the increase in margins is on the account of multiple factors including:
  1. The improved supply chain, logistics and distribution, which involved selling the products directly to retailers,
  2. Change in product mix to include more of high margin products and
  3. The decline in raw material costs, which are in turn linked to the price of crude oil.

An investor would notice that out of the three reasons for improvement in the margins highlighted by the management, improving supply chain & distribution and product mix are the company specific factors, which indicate that the management of Caplin Point Laboratories Limited has been able to add value to the business by way of timely decisions and outperform its peers.

As Caplin Point Laboratories Limited is an almost debt-free company, therefore, the net profit margin (NPM) has followed the trend of its operating profitability margins due to the absence of the impact of interest expense. Otherwise, for debt-laden companies, interest expenses eat up the improvements in OPM and do not allow the benefits of business to reach the equity shareholders.

NPM of Caplin Point Laboratories Limited has improved from 2% in FY2008 to 24% in FY2017.

The tax payout ratio of Caplin Point Laboratories Limited has been consistently below the standard corporate tax rate. One of the reasons for the same, as rightly pointed out by you, is the tax benefits available to the company’s manufacturing unit (CP-III) at Baddi, Himachal Pradesh. Caplin Point Laboratories Limited has disclosed the same in its FY2016 annual report, page: 100:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

However, it is important to note that Caplin Point Laboratories Limited has decided to shut down this manufacturing unit (CP-III) as the company plans to continue manufacture these products from Pondicherry unit and by way of outsourcing. FY2016 annual report, page 15:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

One of the reasons for this decision might be the upcoming end of the tax exemptions for this unit, which might lead to increase in tax payout ratios going ahead. An investor may take further clarity from the company about the various tax exemptions, which Caplin Point Laboratories Limited is enjoying currently and the time period for which these exemptions would be available.


Operating efficiency performance:

While assessing Caplin Point Laboratories Limited an investor would note that the company has stressed on outsourcing the manufacturing of a lot of its products. As a result, the share of the sale of outsourced products has increased from 25% of sales in FY2011 to 60% of sales in FY2016. FY2016 Annual Report, page 17:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Moreover, the management has also stressed its focus on being an asset-light business. FY2016 Annual Report, page 9:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Looking at the above parameters, an investor would assume that Caplin Point Laboratories Limited would have a net fixed asset turnover (NFAT) level, which would be high both on absolute levels as well as on comparative levels than the peers.


However, an investor notices that the NFAT level of Caplin Point Laboratories Limited has been declining over the years. NFAT has declined from 4.14 in FY2008 to 2.34 in FY2015. There has been a significant decline in NFAT after reaching the level of 4.22 in FY2013. As rightly pointed out by you, the key reason for the decline in NFAT of Caplin Point Laboratories Limited seems to be commissioning of CP-IV unit in Tamil Nadu in FY2014.

The increasing utilization levels of CP-IV over recent years have seen the NFAT improve from the lows of 2.34 in FY2015 to 2.74 in FY2017.

Moreover, when an investor compares the NFAT level of Caplin Point Laboratories Limited with the above-mentioned peers to check the comparative asset-light nature of the business, then she notices that the performance of Caplin Point Laboratories Limited is nothing remarkable:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

The investor would note that the peers of Caplin Point Laboratories Limited have better NFAT ratio and thereby more advantageous asset-light business model. Caplin Point Laboratories Limited has NFAT, which is much lower than the NFAT of some of its peers. Therefore, it does not look like that Caplin Point Laboratories Limited is doing something out of the box by doing outsourcing of its product manufacturing, which other peers are not doing.

The above graph indicates that Anuh Pharma Limited has a significantly higher NFAT when compared to any of the other compared companies.


In fact, an investor would notice that outsourcing of manufacturing of products is fairly common in the pharmaceutical industry as the key players prefer to focus mainly on marketing and distribution.

However, disregarding the comparative standing of Caplin Point Laboratories Limited, an investor would appreciate that the management of the company has been able to steer the company by way of a mix of in-house manufacturing and outsourcing that it has been able to achieve remarkable sales growth of about 30% over the years without leveraging its balance sheet. We will discuss it more in the later part of this article.

Caplin Point Laboratories Limited has managed to reduce its receivables days from the high of 69 days in FY2008 to 18 days in FY2017. This is a significant improvement in the credit terms being offered by the company to its customers and subsequent collection practices. The company has managed to achieve a level of receivables days being 1 day in FY2014.

Such reduction in the receivables days is a good performance by Caplin Point Laboratories Limited when we compare the performance of the company with the above-mentioned peers:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

An investor would notice in the above comparative chart that the receivables days of Caplin Point Laboratories Limited has defied the industry trend where receivables days of most other peers over FY2008-16 have either increased or stayed within the same range. However, Caplin Point Laboratories Limited has witnessed a significant reduction in its receivables days.

This observation gains further significance in the light that the key markets serviced by Caplin Point Laboratories Limited are Latin American, Sub-Sahara African etc., which are known to face a lot of issues in relation to law and order. So on the face of it, it would seem that it would be extremely hard for any company to enforce contracts and collect the money from these geographies.

However, as mentioned by the company in its communication to stakeholders, the difficult law and order situation in these countries has ensured that many companies hesitate to serve these markets. This, in turn, reduces the options available to the customers in these countries to source pharmaceutical products. As a result, the customers in these countries are willing to accept the strict payment terms offered by those companies who wish to supply to these markets.

No wonder that Caplin Point Laboratories Limited has been able to sell its products in these markets on advance payment basis. The company has acknowledged in its FY2016 annual report (page 24) that the dealers pay it in advance for their orders and in fact, the ability to get advance payments has helped the company to stay debt free.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Moreover, while analysing the balance sheet, the investor would notice that at March 31, 2016, Caplin Point Laboratories Limited had received an advance of about ₹57 cr. from its customers for which it needed to supply products. 

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

Caplin Point Laboratories Limited seems to have used the weak law and order situation of its markets in its favour by gaining the trust of its customers and making them pay in advance for the goods.

The inventory levels also seem to be managed efficiently by Caplin Point Laboratories Limited as the inventory turnover ratio (ITR) has improved from 8.6 in FY2009 to 19.7 in FY2017.

It seems that as a result of efficient working capital management by Caplin Point Laboratories Limited, it has been able to fund its entire working capital needs of inventory and receivables from its trade payables.

At March 31, 2017, Caplin Point Laboratories Limited had an inventory of ₹22 cr. and trade receivables of ₹33 cr. This working capital requirement of ₹55 cr. (22+33) has been sufficiently funded by the outstanding trade payables of ₹78 cr. at March 31, 2017. Effectively, the suppliers are funding a lot of business operations of Caplin Point Laboratories Limited.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

An investor should not forget the significant amount of advances that Caplin Point Laboratories Limited receives from its customers, which in the above table is part of “other current liabilities” of ₹33 cr.

Therefore, an investor would notice that Caplin Point Laboratories Limited has been able to manage its working capital well to generate funds and use it for other aspects of the business.


Self-Sustainable Growth Rate (SSGR):

The investor would notice that Caplin Point Laboratories Limited has an SSGR of about 26-28% over the years whereas it has been growing its sales revenue at a growth rate of about 30% in the recent years.


Upon reading the SSGR article, an investor would appreciate that if a company attempts to grow at a sales growth rate, which is higher than the SSGR, which it can afford from its internal sources, then will have to rely on the fund infusion from outside in terms of debt or equity.

However, as rightly pointed out by you, in case a company is able to efficiently manage its working capital and in turn have a higher cash flow from operations (CFO) than its PAT, then the excess CFO helps to fund its business expansion attempts over and above the SSGR levels. In such cases, the companies are able to grow at a rate higher than SSGR and still stay debt-free.

An investor would notice that during FY2007-16, Caplin Point Laboratories Limited had a total net profit of ₹149 cr. and during the same period, it had reported a total cash flow from operations (CFO) of ₹242 cr. The higher CFO levels than PAT have helped Caplin Point Laboratories Limited to fund its growth of 30% year on year from its internal resources, which is more than its SSGR (26-28%) and stay almost debt free over the years.


This assessment gets substantiated when the investor analyses the free cash flow position of Caplin Point Laboratories Limited.

Over FY2007-16, Caplin Point Laboratories Limited has witnessed its sales increase from ₹44 cr. in FY2007 to ₹309 cr. in FY2016 (12 months). For achieving this sales growth the company has done an additional capital expenditure (capex) of ₹162 cr. However, Caplin Point Laboratories Limited has generated a cash flow from operations (CFO) of ₹242 cr. over FY2007-16 leading to a surplus of ₹80 cr. as free cash flow (FCF) to its shareholders. SSGR and FCF are two of the main pillars of assessing the margin of safety in the business model of any company.


Caplin Point Laboratories Limited seems to have utilized the resulting free cash flow (FCF) to consistently pay dividends to the equity shareholders since FY2010. Since then Caplin Point Laboratories Limited has paid a total dividend (excluding dividend distribution tax) of about ₹33 cr. to its equity shareholders.

While studying about Caplin Point Laboratories Limited, an investor comes across certain other aspects, which are important for analysis and subsequent final investment decision by investors:

1) Innovative and risk taking promoters/management:

In the annual report, the promoter chairman has disclosed the manner in which the company took the risk and decided to establish business operations in a war-ridden country, Angola.

The promoters decided to open a restaurant offering Indian cuisine to get business networks to establish their pharmaceutical business in the country. The food was offered free on the first day to gain the visibility and the idea worked. FY2016 annual report, page 21:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

However, running the business was not easy. In fact, staying in the country itself was not free of risks. The chairman shares an incident where he was robbed at the gunpoint in Angola. FY2016 annual report, page 21:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets


Such events and incidences indicate that the promoters of Caplin Point Laboratories Limited are able to think out of the box and are willing to take a lot of risks to put their vision into action.

2) Management succession planning:

As rightly highlighted by you, the son of the founder promoter, Mr. Vivek Siddarth, who has completed his education from Harvard Business School in 2016 (LinkedIn), has joined the company as chief operating officer.

The presence of the next generation of promoter’s family in the company management offers a visibility of smooth management succession in the company.


3) No salary being taken by founder promoter:

As per the disclosures by Caplin Point Laboratories Limited, its founder promoter, Mr. C C Paarthipan, who is currently the chairman of the company is not taking any salary/remuneration from the company. Annual report FY2016, page 58:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

As per our experience of analysing multiple companies, the analysis of many of such companies is present on our website (click here), it is not a common occurrence that the founder promoter, who helped the business of the company take shape is not taking any salary/remuneration from the company.

4) Nominal salary to the son of the founder promoter:

The related party section of FY2016 annual report of Caplin Point Laboratories Limited, page 99 indicates that the son of the founder promoter, Mr. Vivek Siddharth is being paid a salary of about ₹1.50 lac per month. (₹18 lac in 12 months in FY2015 and ₹13 lac in 9 months in FY2016).

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets


This salary level is equal to average starting salary levels for corporate jobs for tier A business schools in India. It is to be noted that Mr. Vivek Siddharth has completed his education from Harvard Business School (LinkedIn) and might get a job at a remuneration higher than ₹1.50 lac per month in other corporates.

Moreover, this is in stark contrast to some other corporates where the salaries to relatives of founder promoters do not seem to be in line with the value being added by them to the company.

The case of Ruchira Papers Limited is an apt example for such case where 8 relative of the promoters with vastly different experience levels (8 years to 23 years), different educational qualifications and age (29 years to 69 years) were being paid exactly same remuneration by the company (₹36.2 lac each in FY2016 and ₹29.3 lac each in FY2015).



No remuneration to the founder-promoter-chairman and nominal salary to the son of founder promoter is the key reason that the remuneration of key management personnel (KMP) is low for Caplin Point Laboratories Limited when compared to other corporates.

5) Avenues of future growth:

As per the company disclosures to stock exchanges, Caplin Point Laboratories Limited has received the approval from USFDA in May 2017. The ability to supply products in a new market offers the opportunity to achieve further growth in future.

6) Most of the products of the company are for short term treatment durations:

As per the product segment mix provided by the company in its FY2016 annual report, page 17, Caplin Point Laboratories Limited has only 5% of its sales from long-term treatment segments like cardiovascular drugs.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

The above chart shows that 95% of the products being sold by the company are antibiotics, painkillers, skin ointments and anti-ulcer drugs. These pharmaceutical products have a shorter duration treatment cycle of 5-20 days and therefore require continuous selling efforts by the manufacturer/distributors where new sales have to be generated by consistently being in visibility to the doctors prescribing these medications to new patients.

This is unlike the drugs used in the treatment of chronic illnesses like hypertension where many times, patients have to take drug throughout their remaining life and they usually stick to one brand of medicine.

The product mix of Caplin Point Laboratories Limited might require it to continuously keep investing in marketing and distribution.

7) An error in the annual report FY2016:
The FY2016 annual report of Caplin Point Laboratories Limited has an error in the shareholding details section, page 42:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

The shareholding of public institutions has increased from 1.82% at July 1, 2015, to 4.88% at March 31, 2016, which is an increase of 2.66%. However, the company seems to have erroneously mentioned the change as a decrease of 0.01% in the annual report.


8) The impact of trade payables, current liabilities & provisions in the calculation of CFO:

In the consolidated cash flow statement in the annual report for FY2016, page 108, Caplin Point Laboratories Limited has disclosed an impact of the increase of about ₹20.5 cr in the CFO on account of trade payables, current liabilities & provisions:

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets

However, when we look at the consolidated balance sheet of Caplin Point Laboratories Limited for FY2016 (page 106), then we are not able to decipher this change of ₹20.5 cr from the current liabilities section of the balance sheet or from the related notes to the financial statements.

Analysis Equity Research report of Caplin Point Laboratories Limited, an Indian pharmaceutical generics player, Latin America, Sub-Saharan Africa markets


It is advised that an investor may contact the company and get clarification about the details of the impact of current liabilities calculation in the CFO estimation.

Let us now address the specific queries raised by you as part of your analysis:

1) So, it can be assumed that eventually, Caplin Point Laboratories Limited’s topline growth will come below SSGR.

As mentioned earlier in the article, a company might be able to grow at a rate higher than its self-sustainable growth rate (SSGR) in case it is able to keep it working capital management efficient and continues to report a CFO, which is higher than the net profit (PAT).

Moreover, if a company needs to grow more than its SSGR, then it would have to infuse outside funds into its business operations e.g. additional debt or equity dilution.


As, currently, Caplin Point Laboratories Limited is a nearly debt-free company, it can easily raise some debt to fund its growth plans. Therefore, we might be very conservative in concluding that the looking at its SSGR, the company would necessarily have to slow down its growth rate.

The growth rate of Caplin Point Laboratories Limited may slow down in future. However, it might be due to increasing size of the company, lack of attractive business opportunities or future weak management decisions. It would be difficult to comment on future growth rate by looking solely at SSGR in the current situation of the company.

2) Why was Argus formed as LLP instead of a company? What are the advantages in such case?

There are many articles present on the internet, which delve deeper into the pros and cons of establishing a business entity in the form of limited liability partnership (LLP) or a company. Delving upon all these aspects is beyond the scope of this website. You may refer to those articles and take the opinion of any legal counsel to get further insights into the LLP vs Company question.

On the face of it, the biggest benefits of LLP over the company are fewer compliance requirements and non-applicability of minimum alternate tax (MAT) and dividend distribution tax (DDT) on LLPs. (However, as pointed out by Santosh Gogave, in the comments to this article below, LLPs are subject to Alternate Minimum Tax (AMT), which is applicable at a rate of 18.5%).

3) Why is Caplin Point Laboratories Limited adding Argus profit in standalone numbers?

The share of profits from the subsidiaries and investments is added in the standalone financials just like the dividend income/interest income from other investments.

In consolidated financials, entire revenue and profit are added in the profit and loss statement of the holding company. Therefore, the separate entry of profit share from subsidiary is removed in consolidated financials.

4) Please help us to understand the merit/demerit of these related party transactions.

In the case of Caplin Point Laboratories Limited and Argus Salud Pharma LLP, at the current levels, the related party transactions need to be looked after considering following aspects:
  • Argus Salud Pharma LLP is nearly 100% owned by Caplin Point Laboratories Limited. Therefore, any economic benefit occurring to Argus Salud Pharma LLP would eventually flow back to the shareholders of Caplin Point Laboratories Limited. The concern of investors should increase if the counterparty involved in such transactions has a significant third party/promoters stake. This is because then a significant share of economic benefits passed by the holding company to the subsidiary would be claimed by the third party.
  • The size of transactions (₹2 cr - ₹7 cr) is small when compared to the overall size of Caplin Point Laboratories Limited of about ₹400 cr. of sales. 


About the Hong Kong subsidiary: Caplin Point Far East Limited

First of all, we appreciate the hard work along with the time put in by you in assessing the business position of Caplin Point Laboratories Limited and its subsidiaries by deriving the conclusions from the comparison of the reported standalone and consolidated financials. Let’s now deal with the specific queries asked by you:

5) What should an investor interpret from these high receivable days?

We believe that an investor should wait for the annual report for the company for FY2017 to assess the days for which these receivables are due for receipt. The conclusion for an investor would change whether these receivables in the Hong Kong subsidiary are due for less than or for more than 6 months.

An investor would appreciate that reported financial position would be the same even if these receivables are due for 1 day meaning that if the company would have supplied the goods on March 31, 2017, and the money is due on April 1, 2017, even then the reported financial position would be the same as present in the March 2017 results.

Moreover, an investor would appreciate that the company is able to sell goods on advance payment basis to customers in Latin America and Sub-Saharan Africa because of perceived low credit quality and other law & order/security position of these countries, which makes the customers agree for advance payment if they wish to receive the goods. The lack of competition/options for customers to purchase goods in these markets also acts in favour of Caplin Point Laboratories Limited.

However, the situation in the Hong Kong market would be entirely different. In Hong Kong & China overall, the customers would be spoilt for choices among the suppliers. Investors would appreciate that Caplin Point Laboratories Limited itself sources a lot of its products from China. 

Therefore, it is reasonable that Caplin Point Laboratories Limited might not be able to force the advance payment terms on the customers in Hong Kong. However, whether the receivables are outstanding for 168 days as calculated by you or less than that can only be assessed on a rough basis by waiting for the annual report for FY2017 or directly asking the company/management about it.

6) Caplin Point Far East Limited was established on 13 May 2014. But Caplin Point Laboratories Limited declared it as subsidiary only in 2017. Moreover, there is no filing regarding this incorporation in BSE/NSE. Isn’t it compulsory to notify this information to the stock exchange in such case?

You are right that the company details at HKGBusiness website (click here) shows that Caplin Point Far East Limited was incorporated on May 13, 2014. Moreover, the company has not taken any explicit approval from shareholders that it is going ahead and establishing subsidiaries in overseas locations as per FY2014, FY2015 or FY2016 AGM notices.

Our experience has been that the companies usually take shareholders’ approvals when they establish subsidiaries overseas. However, we are not certain whether the companies are expected to follow the same guidelines when they are subscribing to shares of/making investments in any existing company in overseas location to make it a subsidiary. 

Therefore, if the current situation involved a scenario where the Hong Kong subsidiary Caplin Point Far East Limited was established in 2014 by promoters or any other acquaintance, then the company might not have made any disclosure as the company did not have any stake in Hong Kong subsidiary. And now when the company has made the Hong Kong entity a subsidiary by making investments, then it has made the disclosure.

However, all these are conjectures/guesses. An investor should take clarity from the management/company about the incorporation of the subsidiaries and the reasons/guidelines under which it did not make the disclosure or is it that it made any separate disclosure to the stock exchanges and did not include the details in the annual reports of FY2014, FY2015 and FY2016.

7) What are other things an investor can monitor to judge whether Caplin Point Laboratories Limited is on the right track for its new venture?

Monitoring is an ongoing process, where an investor needs to monitor whether the venture has taken off within expected timelines, the amount of sales being generated, the kind of margins being produced and the impact of new sales on both asset and inventory turnover ratios as well as working capital etc. She should also assess whether the new venture is leading to free cash generation for the company or eating up cash continuously.


Currently, Caplin Point Laboratories Limited is available at a price to earnings (P/E) ratio of about 54 (based on FY2017 consolidated earnings), which does not offer any margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.




Overall, Caplin Point Laboratories Limited seems to be a company run by an innovative and risk-taking management, which has depicted out of the box thinking to establish and grow the business. The company has been able to grow its sales at a decent pace of about 30% year on year in recent past with improving profitability. The company has managed to fund its growth requirements from its own resources and therefore has managed to stay almost debt-free on its growth path.

Caplin Point Laboratories Limited has taken the risk of focusing on business on supposedly risky countries (Latin America and Sub-Saharan Africa) and has used it to its advantage by benefiting from lower competition and better credit terms with customers. The company has been able to get an advance from its customers and a credit period from its suppliers, thereby, enjoying a negative working capital position.

The management has disclosed conservative remunerative practices with the founder-promoter-chairman not taking any remuneration from the company and the son of the promoter taking a nominal salary for his contributions to the company. Management succession planning seems to be in place for Caplin Point Laboratories Limited.

There are certain aspects related to the annual report and the business, which an investor may get clarified from the company. These aspects relate to the disclosures related to the establishment of overseas subsidiaries, the impact of current liabilities on the cash flow from operations etc.

An investor should monitor the execution of the future growth plans of the company by way of using the opportunity to supply to US and other markets.


These are our views about Caplin Point Laboratories Limited. However, you should do your own analysis before taking any investment related decision about Caplin Point Laboratories Limited.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy - A Step by Step Process of Finding Multibagger Stocks

Hope it helps!

Regards,

Dr Vijay Malik

P.S:
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  • The financial table in the above analysis has been prepared by using my customized stock analysis excel template which is now compatible with screener.in. This customized Excel template is now available for download as a premium feature. For further details and download: Click Here
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  • I have used the financial data provided by screener.in and the annual reports of the companies mentioned above while conducting analysis for this article.



DISCLAIMER


Registration Status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:

Currently, I do not own stocks of the companies mentioned above in my portfolio.