The current section of the “Analysis” series covers Marksans Pharma Ltd, an Indian drug manufacturer selling generic drugs primarily in the developed markets of the USA, UK, Europe and Australia. The company has production facilities in Goa, India as well as in the UK and USA.
“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.
To benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.
Marksans Pharma Ltd Research Report by Reader
Dear Dr Vijay Malik,
Please find my analysis of Marksans Pharma Ltd, a mid-cap pharma company. I request you to provide your views and comments.
Financial analysis of Marksans Pharma Ltd:
The company’s sales have grown from 305 cr FY2010-11 to 1134 cr FY 2019-20 with a CAGR of 15.7%
The company’s net profit has grown from (222) cr FY2010-11 to 117cr FY 2019-20
The present tax rate is 22.8%, which looks a little lower than the standard.
Current P/E ratio = 14.4
EPS = 4.2 Rs, which is less than cash flow per share 5.12 Rs. Therefore, it looks like all the profits are encashed.
Dividend yield=0.17% looks low value
Debtor days = 78.3 (Improved from 118.5 in 2011)
Inventory Turnover =4.7
The company has a healthy interest coverage ratio of 18.97.
The company’s PEG ratio is 0.27.
The company has a healthy liquidity position with a current ratio of 2.69.
Borrowings have been reduced year on year and at present; it is a debt-free company
Cash from operating activity increased from (65) FY2010-11 to 201 cr FY 2019-20
Free cash flow activity increased from (228) FY2010-11 to 150 cr FY 2019-20
Business Analysis of Marksans Pharma Ltd:
Manufacturing facilities: Goa, India; Southport, UK; Farmingdale, USA
48.25% promoters’ shareholding and no pledging
Cumulative PAT < Cumulative CFO this shows all the profits are converted into cash.
Credit Rating Reports for Marksans Pharma Ltd:
India Ratings and Research (Ind-Ra) has revised Marksans Pharma Limited’s Outlook to Positive from Stable while affirming its Long-Term Issuer Rating at ‘IND A-’.
Marksans Pharma Ltd has built a steady franchise in the regulated market space of the UK and US (over 80% revenues), with a front-end presence through subsidiaries.
The company has improved leverage ratio, which is 0.01X in 9MFY20
The company does not require any capex for new facilities until 21.
The company has a modest business risk profile due to its portfolio in the OTC segment and Soft get products in the US and UK which are expected to low pricing challenges.
The company has relationships with diversified retailers in regulated geographies. Recently it got approvals from USFDA. The company’s front-end presence in key markets gives product approval opportunities optimally.
However, it is vulnerable to raw material price risks, given the lack of backward integration.
Management Analysis of Marksans Pharma Ltd:
1150 employees globally
500+ registered products
2462 cr Mcap at present
Remuneration of directors and Key Managerial Persons around 3.12 cr and other key managerial persons around 1.48 cr, which looks ok since it is in 2-4% of PAT (172cr)
Total revenue contribution of different geographies:
- UK= 45% ( 23.5 % YOY growth)
- US= 38.5% ( 6.1 % YOY growth)
- Australia= 12.4% ( 17.5 % YOY growth)
- Rest of the world= 4.2%
Opportunities and challenges of Indian pharma industry:
Government-sponsored health coverage programs
Growing focus on chronic diseases
Opportunities in newer product classes such as biosimilars, gene therapy, and speciality drugs
Exploring the underpenetrated markets
Leveraging the patent cliff
Public health sector to offer meaningful opportunities
India still lacks universal healthcare access
Lack of a stable pricing and policy environment
Dependence on external markets for intermediates and active pharmaceutical ingredients (APIs)
Excessive dependence on one geography.
Dr Vijay Malik’s Response
Thanks for sharing the analysis of Marksans Pharma Ltd with us! We appreciate the time & effort put in by you in the analysis.
While analysing the history of Marksans Pharma Ltd., an investor notices that throughout the last 10-years (FY2011-2020), the company has had a few subsidiaries in foreign locations. As per the FY2020 annual report, pages 160, the company has 10 subsidiaries (4 subsidiaries and 6 step-down subsidiaries) in its corporate structure. As a result, throughout the last 10 years (FY2011-2020), Marksans Pharma Ltd has reported both standalone as well as consolidated financials.
We believe that while analysing any company, an investor should always look at the company as a whole and focus on the financials, which represent the business picture of the entire group. Consolidated financials of any company, whenever they are present, provide such a picture.
Further advised reading: Standalone vs Consolidated Financials: A Complete Guide
Therefore, in the analysis of Marksans Pharma Ltd, we have used consolidated financials in the assessment.
With this background, let us analyse the financial performance of the company.
Financial and Business Analysis of Marksans Pharma Ltd:
While analyzing the financials of Marksans Pharma Ltd, an investor notices that the sales of the company have grown at a pace of about 15% year on year from ₹305 cr in FY2011 to ₹1,134 cr in FY2020. Further, during the 12-months ending December 2020 (i.e. January 2020-December 2020), the sales of the company have increased to ₹1,381 cr.
However, an investor would notice that the journey of the growth of the company over the last 10 years has not been smooth. The company has witnessed alternating periods of good and poor performance.
In the initial years, the company reported sharp losses. In FY2011, Marksans Pharma Ltd reported an operating loss of ₹73 cr and a net loss of ₹223 cr. In FY2012, the operating loss increased to ₹100 cr and the net loss was ₹179 cr.
Thereafter, the performance of Marksans Pharma Ltd started improving and in FY2015, the company reported sales of ₹797 cr and an operating profit margin (OPM) of 23% and a net profit margin of 14%. However, then, Marksans Pharma Ltd saw its performance decline. By FY2017, the sales of the company have declined to ₹767 cr, OPM to 6% and NPM to 1%.
From FY2018 onwards, the performance of Marksans Pharma Ltd is again on an improving trend. By 12-months ending December 2020 (i.e. January 2020-December 2020), the sales have improved to ₹1,381 cr, OPM to 23% and NPM to 15%.
To understand the reasons behind such fluctuating performance of Marksans Pharma Ltd and to assess whether the company can repeatedly face the decline in its sales in FY2017, and the losses in FY2011-FY2012 and the sharp reduction in its profit margins as seen in FY2016-FY2017, an investor needs to understand the business model of the company. Once an investor understands the reasons behind the subdued performance for Marksans Pharma Ltd during these periods, then she may make an insightful judgment about the future performance of Marksans Pharma Ltd.
Advised reading: How to do Business Analysis of a Company
While reading about Marksans Pharma Ltd and learning its business decisions, an investor learns the following key strategic directions taken by the company. Let us first learn about these strategic business decisions; thereafter, we will study how these decisions affected the business performance of the company over the years.
A) Reliance on acquisitions to achieve growth:
An investor notices that Marksans Pharma Ltd has a history of using acquisitions as a means of growth. It was originally established in 2001 as Glenmark Laboratories Ltd, a wholly-owned subsidiary of Glenmark Pharmaceuticals Ltd. Mr Mark Saldanha acquired it from Glenmark Pharmaceuticals Ltd.
In 2005, it acquired & merged with TASC Pharmaceuticals Ltd. (Source: Glenmark Labs, Tasc Pharma to merge: Business Standard)
Thereafter, the company acquired many companies in foreign countries:
- In 2005, in Australia, it acquired Nova Pharmaceuticals Australasia Pty Ltd.
- In 2008, in the UK, it acquired Bell, Sons & Co. (Druggists) Ltd and Relonchem Ltd.
- Thereafter in 2015, in the USA, it acquired Time Cap Labs.
B) Reliance on external money to fund acquisitions:
An investor notices that the company relies on external money like debt or equity dilution instead of its internal accruals (business profits) to fund its acquisitions.
In FY2006, Marksans Pharma Ltd had raised debt in the form of foreign currency convertible bonds (FCCB) for $50 million (₹225 cr) to fund the acquisitions done in the last decade. (Oct. 2014 corporate presentation, page 6).
In 2015, the company relied on an equity dilution of about $21 million (about ₹131 cr) to fund the acquisition of Time Cap Labs. (FY2015 annual report, page 10).
C) Shift from contract manufacturing to selling its own brands of medicines:
While analysing the evolution of Marksans Pharma Ltd over the years, an investor notices that the company has changed its product mix from almost entirely contract manufacturing in the previous decade to almost branded-medicines seller with negligible contract manufacturing in 2020.
This shift has been gradual. As per the FY2014 annual report, page 6, CRAMS (contract research and manufacturing) used to constitute 100% of the revenues of Marksans Pharma Ltd in 2009. However, by FY2014, the share of CRAMS had declined to 20% of sales.
CRAMS accounted for almost 100 percent of our revenues in 2009, this has now been moderated to 20 percent of overall revenues. Correspondingly, IP-centric revenues have increased to 80 percent of overall revenues today
Moreover, as per the February 2021 conference call, page 15, Marksans Pharma Ltd had negligible revenues from contract manufacturing.
Mark Saldanha: …we have evolved from the CRAMS business we do not have much of it and might be less than a percent… We just maintain it but otherwise per se I would not say we are into CRAMS business model anymore.
D) Heavy reliance on developed countries/highly-regulated markets for business:
While reading about the progress of the business of Marksans Pharma Ltd over the years, an investor notices that the company has always relied on regulated pharmaceutical markets of developed countries for its revenue.
In FY2014, Marksans Pharma Ltd had almost 90% of revenues from regulated-developed markets. As per the FY2014 annual report, pages 15-17, during the year, Marksans Pharma Ltd had about 62% sales from UK/Europe, about 15% sales from the USA and about 13% from Australia.
After 6 years, in FY2020, the share of regulated-developed markets in the sales of Marksans Pharma Ltd increased to 96%. As per the FY2020 annual report, page 9, the company had 45% sales from UK/Europe, about 38% from the USA and 12% from Australia in FY2020.
Therefore, an investor would notice that over the years, the revenue profile of Marksans Pharma Ltd has shifted more towards regulated-developed markets, even though, the share of UK/Europe has come down and the share of USA has gone up.
E) Large exposure to foreign exchange fluctuations:
From the above discussion, an investor would notice that Marksans Pharma Ltd earns a large proportion of its revenues from overseas markets. Therefore, the financial performance of Marksans Pharma Ltd is dependent on the foreign exchange fluctuations of the Indian Rupee to currencies like US Dollars, British Pound, Euros and Australian Dollars.
Any large movement in the value of these currencies to the Indian Rupee may have a significant impact on the financial results of Marksans Pharma Ltd.
Therefore, while analysing the business of Marksans Pharma Ltd in detail, the investor gets to know about the major strategic aspects of its business strategy like relying on acquisitions for growth, funding those acquisitions from additional resources like debt or equity dilution, shifting from contract manufacturing to selling own-branded medicines, relying on regulated-developed markets for business and thereby exposure to foreign exchange fluctuations.
Advised reading: How to Analyse New Companies in Unknown Industries?
All these business aspects have their own advantages as well as disadvantages. Let us now see how these strategic decisions influenced the business of Marksans Pharma Ltd over the years and led to fluctuating performance in terms of sales growth and profit margins over the years.
1) Debt funded acquisitions proved a risky decision:
Marksans Pharma Ltd raised a debt of $50 million (₹225 cr) by way of foreign currency convertible bonds (FCCBs) in FY2006 and used this money to purchase companies in overseas locations.
Investors would remember that during FY2004-2007, many Indian companies raised money by way of FCCBs. The Indian economy was growing at a fast pace during this period and the stock market was rising day-by-day. As a result, many promoters thought that their stock price would keep on increasing and at the date of maturity, the FCCBs would be converted into equity. As a result, the promoters thought that their companies would never have to repay the debt raised by FCCBs.
However, as luck would have it, in 2008, the global financial meltdown hit the world and with that businesses as well as stock markets crashed. As a result, the companies that had done acquisitions with money borrowed through FCCBs faced a double-whammy. On one hand, the companies’ own businesses, as well as their acquired companies, were not doing well and on the other hand due to declining stock prices, at the date of maturity of FCCBs, their stock prices were below the conversion price. As a result, when the maturity date of FCCBs arrived, then the holder of FCCBs asked for cash redemption instead of converting them into equity shares.
Now, many companies faced the tough situation of repaying FCCB holders with cash when their own businesses were suffering. No wonder that many companies failed and shut down, became bankrupt, underwent debt restructuring.
Marksans Pharma Ltd faced a similar situation when the FCCBs raised by it in FY2006, came up for repayment in FY2011.
By FY2011, Marksans Pharma Ltd.’s business was suffering. The companies acquired by it were not doing well. FY2010 annual report, page 10:
The principal activity of Relonchem Limited is the wholesale distribution of pharmaceutical products. During the year sales decreased from £13939962 to £7677380 and the loss before taxation was £1170399 as compared to profit of £515995 in the previous year.
FY2012 annual report, page 33:
The Company, in the year 2008, acquired two UK based companies Bell, Sons and Co (Druggists) Limited and Relonchem Limited through its 100% subsidiary, Marksans Pharma (UK) Limited. The company has made an investment of ₹68.78 Crores to part finance above acquisitions. However, Relonchem Limited has been incurring losses and Bell, Sons and Co (Druggists) Limited has failed to meet the expectations.
At the same time, its active pharmaceutical ingredients (API) business was making huge losses. Marksans Pharma Ltd had to sell its API business in FY2011 at a huge loss.
FY2011 annual report, page 6:
Due to severe pricing pressure, foreign exchange fluctuations and rising raw material prices, Active Pharmaceutical Ingredient (API) division of your company located at Kurkumbh, Pune was not performing well… Consequently, the Company has sold the API business to Kores (India) Limited in July 2010 on a slump sale basis, resulting into loss of Rs. 8663.88 Lacs.
An investor would appreciate that when the own business, as well as the acquired businesses, are not doing well and the company is asked to repay hundreds of crores of rupees to FCCB holders, then there are going to be many challenges. It seems that originally, the company might have expected that it would never have to repay FCCBs, as these would be converted into equity shares. However, when the luck went against Marksans Pharma Ltd and the FCCB holders asked for their money, then it did not have it.
No wonder that Marksans Pharma Ltd defaulted on its obligations to FCCB holders.
FY2011 annual report, page 6:
FCCBs have not been redeemed on the due date due to financial constraints. The Management was in constant discussion with the bondholders for restructuring of the FCCBs and were offered various options. However, the negotiation has not yielded any result as on the date of this report.
This was despite the company selling its API division as well as its Mumbai office to repay the lenders.
FY2011 annual report, page 14:
Secured loans has reduced to Rs. 11175.68 Lacs in 2010-11 from Rs. 17593.67 Lacs in 2009-10 i.e. a decrease by 36.48% due to repayment of bank term loans out of the proceeds from sale of API business and Mumbai office premise.
The next year, in FY2012, the investor gets to know that the company has also defaulted on the loan taken by it in British Pounds when she reads in the FY2012 annual report, page 49, that one instalment of GBP 300,000 is due for payment and is unpaid on the balance sheet date of March 31, 2012.
Term loan includes loan of £ 5.05 million taken by subsidiary Companies, which is secured by corporate guarantee provided by the parent company Marksans Pharma Ltd, and a pledge of shares in Marksans Holding Limited & Relonchem Limited. One installment of Term loan of GBP 300000 is due for payment.
The losses in the business activities, losses in the sale of API business, losses on the impairment of assets and its investments and the adverse foreign exchange currency movements, all of them together pulled Marksans Pharma Ltd into deep losses in FY2011.
FY2011 annual report, page 6:
The year under review has registered a net loss of Rs. 21778.91 Lacs as compared to net profit Rs. 28.98 Lacs in the previous year. This is mainly due to loss on the sale of API Business of Rs. 8663.88 Lacs, provision of redemption premium of FCCBs of Rs. 9017.33 Lacs and provision of foreign exchange loss on FCCBs of Rs. 2363.45 Lacs.
The loss in one year (FY2011) was sufficient to wipe out the entire net worth of the company and it had to register with the Board of Industrial and Financial Reconstruction (BIFR) as a sick company.
FY2011 annual report, page 6:
the Net Worth of the Company as on 31 st March, 2011 has been completely eroded. Therefore, the Directors have formed an opinion that the Company has become a Sick Industrial Company within the meaning of Section 3(1)(o) of the Sick Industrial Companies (Special Provisions) Act, 1985 and it is mandatory under the provisions of the said Act to make a reference to the Board for Industrial and Financial Reconstruction…
Therefore, an investor would appreciate that the strategy of growing by acquisitions using debt is risky and it worked against Marksans Pharma Ltd in FY2011-FY2012 when the company reported substantial losses leading to a default in meeting its repayment obligations, which is effectively a state of bankruptcy.
Advised reading: How to identify if Management is Misallocating Capital
2) Highly regulated-developed pharmaceutical markets demand very high operating standards:
An investor notices that Marksans Pharma Ltd had relied on the highly regulated markets of developed countries for its business. These countries demand very high operational standards from the companies supplying drugs to their markets. As a result, there are times when companies fail to meet those standards and are barred from selling to these countries. In such a situation, companies lose significant business and have to spend a lot of time and money to rectify their deficiencies.
This is a big risk for any pharmaceutical company focusing on developed countries. In the past, many large companies including the likes of Ranbaxy Laboratories Limited, Wockhardt Ltd, Sun Pharmaceutical Industries Limited etc. have witnessed the certifications of their plants revoked due to non-compliance to the required standards.
Marksans Pharma Ltd faced such a situation in FY2016 when the UK drug regulator (MHRA) disapproved both its Goa plant as well as the UK plant of its subsidiary, Relonchem Ltd.
In May 2015, UK MHRA revoked the good manufacturing practices (GMP) certificate of Relonchem as it was certifying suspect batches of drugs as OK. (U.K. regulators find issues with Indian-owned API distributor Relonchem, May 5, 2015):
U.K. regulators have revoked the license of an Indian-owned API distributor after finding a host of problems at its operations in Cheshire. But the Medicines and Healthcare Regulatory Agency (MHRA) says that Relonchem will be allowed to import some “critical” meds under strict oversight if it is found to be the key supplier.
Relonchem is owned by Indian API maker Marksans Pharma, which bought the marketer in 2008 for 100 crore rupees ($15 million)…They said the company was not carefully certifying batches, giving the OK to batches that were suspect.
In January 2016, the Goa plant of Marksans Pharma Ltd failed the inspection by UK MHRA (Marksans Pharma plunges 18% after Goa plant fails UK MHRA inspection: January 13, 2016):
Shares of Marksans Pharma plunged 18 per cent after the company’s Goa plant failed to clear an inspection by the UK drug regulator, media reports said. The company got a notice of deficiency from UK MHRA, as per sources related to the matter.
The drug regulator is said to have found violations in goods manufacturing practices (GMP) norms in the Goa plant.
Due to the revoking of certificates of the UK as well as Goa plants, Marksans Pharma Ltd suffered a significant loss of business from the UK, which was its largest market. As a result, the company faced a decline in its sales in FY2017 as well as a sharp decline in its profit margins. The OPM of the company declined to 6% in FY2017 from 23% in FY2015 and the NPM declined to 1% in FY2017 from 14% in FY2015.
The credit rating agency, India Ratings, highlighted this impact on the business of Marksans Pharma Ltd in its report for the company in December 2016:
The decline in financial performance followed the issue of a Restrictive GMP Certificate by The UK Medicines and Healthcare products Regulatory Agency (MHRA) against the company’s Goa plant in March 2016, and was aggravated by pricing pressures in UK market, which led to a moderation in volume off-take.
Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors
An investor would appreciate the extent of high costs to keep up with the regulatory standards of developed markets when she notices that the subsidiaries of Marksans Pharma Ltd had to pay about ₹17 cr to keep themselves updated on UK MHRA guidelines. (GBP 2.12 million @ ₹82/GBP in FY2017).
FY2017 annual report, page 125:
The two step down subsidiaries have incurred one off Pharmacovigilance and Regulatory Cost of GBP 2.12 Mn during the FY 2016-17 to keep themselves abreast of latest UK MHRA guidelines.
An investor would appreciate that any company that relies upon only a handful of plants to supply drugs to developed markets will always continue to face this risk of failing inspections and thereby losing a significant amount of sales until it passes the inspection again.
An investor may note that such risk of losing business if the regulatory guidelines are not met, is not limited only to the developed markets. Every country whether developed or developing attempts to maintain strict compliance with its laws related to the pharmaceutical industry.
In FY2015, Vietnam cancelled the operating license of Marksans Pharma Ltd for 6 months when the company violated some of the laws for the production of its drugs.
March 2015 placement document for the QIP, page 46:
For instance, the Ministry of Health, Drug Administration of Vietnam (“Ministry”) vide its order dated August 8, 2014 (“Order”) had imposed certain administrative sanctions against our Company for violation of certain laws relating to the manufacture of Ferromark Injection and Markime 50 DS (“Products”). The Ministry has had imposed a penalty 130 million Vietnamese dong (equivalent to US$6,125) and suspended the operating license of our Company for six months effective from August 8, 2014.
Therefore, an investor would note that the highly regulated nature of the pharmaceutical industry and additionally, the focus of Marksans Pharma Ltd on developed markets exposes it to a higher regulatory risk, which has affected its business in the past.
3) Shift from contract manufacturing to branded drugs improved profit margins:
An investor would remember from the above discussion that over the years, Marksans Pharma Ltd has shifted from an about 100% contract manufacturing (CRAMS) business in FY2009 to nearly 0% CRAMS and 100% intellectual property (IP) led branded drugs business in 2020.
Previously, when the company used to manufacture drugs for others, then it used to retain only a part of the overall profit from raw material to the final price paid by the consumer. However, when the company started marketing its own drugs, since then, it could capture a higher share of the overall profit.
While explaining the acquisition of Time Cap Labs, the company mentioned this increase in the share of the value as one of the reasons. FY2015 annual report, page 15:
In its current structure, MPL supplies formulations in bulk while its US partners package and market the final formulations. MPL estimates that it books 50-60 percent of the final value realisation in the current structure. As the Company evolves from a partnered to a front-end sales approach (post the acquisition of Time Cap Labs), it should be able to capture a significant proportion of this growing segment over the next few quarters.
The company focused on selling directly to the distribution channel instead of other generic players so that it could retain a higher share of the profit margin/value created in the business.
FY2015 annual report, page 17:
At the time of acquisition, ~90 percent of Relonchem’s sales were derived from supplying to global generic players with limited direct distributor access. Over the years, MPL has changed the model, wherein ~90 percent of Relonchem’s revenues are now supplied directly to the distribution channel, leading to significantly higher value retention.
In February 2021 conference call, the company highlighted the shift in its business from contract manufacturing to independent sales as the key reason for the increase in profit margins in the USA business in recent years.
February 2021 conference call, page 5:
Mark Saldanha: During those days, our business model was pretty much supplying bulk to the US market, and it was then repacked by importers and distributed on their labels. We had never had a front end, so obviously while our products evolved in the US market many people were not aware of us because we did not have an identity at that time. In late 2015, middle to late 2015 we acquired Time-Cap Labs in US and obviously we pursued our belief and our business model of going direct to the consumer or to the source of sales and that is where we started integrating the Time-Cap and basically creation of our own labels and creation of our identity and then moving into the retail market as well as tapping on clients, so if one has to look at how we have evolved definitely we have evolved from you could say from CRAMS strategy to an independent strategy…
Therefore, an investor would appreciate that the changing product mix for Marksans Pharma Ltd from contract manufacturing to selling own-branded drugs has resulted in an increase in profit margins over the years.
The CFO of the company, Mr Jitendra Sharma, mentioned it as one of the reasons for improving profitability in the February 2021 conference call (page 3):
Jitendra Sharma: The improvement in EBITDA margin is due to variety of factors; increase in revenue coupled with operational efficiencies and improving product mix are some of the key factors.
Therefore, from the above discussion, an investor learns about different strategic business decisions taken by Marksans Pharma Ltd regarding growing by acquisitions using debt funds, shifting from contract manufacturing to selling own-branded drugs, and reliance on developed markets and exposing itself to heavy regulations and foreign exchange risk.
The investor learns that Marksans Pharma Ltd faced losses in FY2011-FY2012 due to poor performance of its own business as well as acquired businesses and the demand of repayment by FCCB holders. As it recovered from the bankruptcy, thereafter, in FY2016, UK and Goa plants of Marksans Pharma Ltd failed the inspections by the drug regulator of UK, MHRA. As a result, its business to the UK suffered, which was its largest market. Therefore, the company saw a decline in its sales as well as a sharp reduction in its profit margins over FY2016-FY2017.
After FY2017, the sales, as well as profit margins of Marksans Pharma Ltd, have improved. However, before an investor extrapolates the recent increase in profit margins of the company in future, she needs to understand that Marksans Pharma Ltd operates in a highly competitive and regulated industry where many large players compete fiercely for the market share and in the field of generics (an area where Marksans Pharma Ltd operates), many times, the competition is only based on price.
The large existing players in the pharmaceutical industry resort to various methods to hit competition like severe price reductions, litigations and lawsuits etc. In addition, governments around the world want to keep strict control over drug prices and thereby affecting the profit margins of pharmaceutical companies.
Marksans Pharma Ltd has highlighted these issues in its various annual reports.
FY2013 annual report, page 9:
Competition from MNCs: To stunt the growth of generic companies, the Big Pharma companies are posing a threat to generic manufacturers through litigations. They are also increasingly launching authorized generics. In order to compete with the low prices, MNCs are also pricing drugs competitively.
Multiple players (new and old) rushing towards the US generics market along with the regulatory changes proposed by the government has resulted in pricing pressure leading to severe price erosion compared with the brand price.
Price erosion in certain blockbuster drugs has been as high as 95 percent.
FY2016 annual report, page 12:
The margins of Relonchem, which offers high-end prescription drugs, came under pressure owing to increased competition.
FY2016 annual report, page 24-25:
Standalone turnover of the Company decreased…mainly due to price erosion on account of higher competition, channel consolidation and government action on pricing/reimbursement in UK and other European countries.
FY2016 annual report, page 30:
The year witnessed degrowth in Europe formulation business on account of pricing pressure.
FY2017 annual report, page 11:
The US pharma market went through a consolidation at the wholesaler-level (the top four wholesalers controlled >80% of the market) that exerted a pricing pressure on the pharma sector
Therefore, an investor would appreciate that the pharmaceutical industry, especially the generic players face significant challenges from their MNC competitors, govt. regulations, distribution channels etc., which puts significant pressure on prices and profit margins. These factors have led to a decline in the profit margins of Marksans Pharma Ltd in the past. These factors are not going to go away in the future and an investor should keep this in her mind while she extrapolates the current profit margins of the company in the future.
To get an idea about the challenges that may appear for Marksans Pharma Ltd, an investor may notice that in FY2021 on two occasions, the company had to recall its drug Metformin from the market due to the presence of harmful contaminants (NOMA).
- As per the corporate announcement to BSE on June 8, 2020, the company recalled one batch of Metformin Extended Release Tablets USP 500 mg (11,279 bottles)
- Thereafter, as per the corporate announcement to BSE on Oct. 3, 2020, the company recalled another 76 lots of Metformin.
Such drug recalls can have serious implications on the business of pharmaceutical companies if they affect the products that constitute a major amount of sales for the company, have contaminants that are very harmful to patients and reveal a lack of proper manufacturing processes that lead to contamination of drugs.
Therefore, going ahead, an investor should keep a close watch on the developments related to the product quality of Marksans Pharma Ltd related to drug recalls, regulatory inspections etc. so that she may get to know about any adverse developments related to the company.
While looking at the tax payout ratio of Marksans Pharma Ltd., an investor notices that in most of the last 10 years (FY2011-2020), the tax payout ratio of the company has been lower than the standard corporate tax rate prevalent in India.
An investor would notice that Marksans Pharma Ltd earns almost its entire revenues from exports. Its plant in Goa is a 100% export oriented unit (EOU).
FY2020 annual report, page 48:
your Company is a 100% export oriented unit and therefore, it is exempted from audit of its cost accounting records.
An investor would appreciate that in India, exporting companies get various tax incentives from the govt. As a result, the lower tax payout ratio of Marksans Pharma Ltd seems to be due to its exports oriented business.
Further advised reading: How to do Financial Analysis of a Company
Operating Efficiency Analysis of Marksans Pharma Ltd:
a) Net fixed asset turnover (NFAT) of Marksans Pharma Ltd:
When an investor analyses the net fixed asset turnover (NFAT) of Marksans Pharma Ltd in the past years (FY2011-20), then she notices that the NFAT of the company has improved from 1.6 in FY2012 to 4.0 in FY2020. An increase in the NFAT over FY2012-2020 indicates that the company is able to use its assets more efficiently over the years.
When an investor analyses the year-on-year trend of NFAT, then she notices that in FY2011-FY2012, Marksans Pharma Ltd had an unusually low NFAT because its own business, as well as the business of acquisitions, was not doing good. Since the FY2012, the business of its UK and Australian subsidiaries improved, which is visible in the increasing sales, profit margins as well as NFAT during FY2013-FY2015. The NFAT of Marksans Pharma Ltd increased from 1.6 in FY2012 to 5.1 in FY2015.
In FY2016, Marksans Pharma Ltd acquired Time Cap Labs in the USA. It is usual for a company to take some time to integrate and fully utilize any new acquisition. In the case of Marksans Pharma Ltd, the management has indicated that it usually takes it 3 to 5 years to optimally utilize an acquisition.
February 2021 conference call, page 9:
Mark Saldanha: …some of our acquisitions have taken nearly five years to actually see returns because of various reasons and some have given returns within three years or three year to four years. So, I think it is to be realistic that one should look at a horizon of minimum three years to five years if we ever go down the road of an acquisition
Therefore, in the case of the acquisition of Time Cap Labs in FY2016, the NFAT of Marksans Pharma Ltd declined from 5.1 in FY2015 to 2.9 in FY2017. However, since then, as the company is able to improve the utilization of Time Cap Labs and as a result, the NFAT of the company has consistently improved to 4.0 in FY2020.
Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors
b) Inventory turnover ratio of Marksans Pharma Ltd:
While analysing the efficiency of inventory utilization by Marksans Pharma Ltd, an investor notices that over the last 10 years, the inventory turnover ratio (ITR) of the company has declined 5.1 in FY2012 to 4.2 in FY2020. The ITR reached a high of 7.0 in FY2014 and has been on a decline since then.
A decline in the inventory turnover ratio indicates that the efficiency of utilization of inventory by the company is coming down over the years. It means that the company is using comparatively more inventory to run its business.
While analysing the financial performance and the strategic business decisions taken by the company, an investor notices that the shift in the business model of the company from a primarily contract manufacturer to an independent company selling own-branded goods has played a role in the requirement of a higher level of inventory for the company as now, it needs to keep more inventory in the supply chain.
In addition, over the years, Marksans Pharma Ltd has shifted the production of many products that were earlier produced by the plants of its subsidiaries in the UK and USA, to its Goa plant in India. As a result, it now manufactures products in India and then sends them to its overseas markets, which requires a higher amount of inventory than when its plants in the UK and USA used to manufacture those drugs.
In February 2021 conference call, the CFO of the company, Mr Jitendra Sharma explained the increased requirement of inventory in the business model of Marksans Pharma Ltd.
February 2021 conference call, page 7:
Jitendra Sharma: …because of the front-end distribution model we need to keep higher level of inventory, we need to service our customers, they keep being honest to us and we need to ensure that we deliver in time and there are no delays or defaults in our service levels. So, we need to ensure that we have sufficient level of inventory at our front ends. In terms of manufacturing also, we manufacture a large part in India, we export to our subsidiaries, so our overall working capital cycle is a bit longer
Going ahead, an investor should monitor the inventory turnover ratio of Marksans Pharma Ltd to check whether the company is able to improve its inventory utilization.
Further advised reading: Inventory Turnover Ratio: A Complete Guide
c) Analysis of receivables days of Marksans Pharma Ltd:
While analysing the receivables position of the company, an investor notices that Marksans Pharma Ltd has improved its receivables days from 109 days in FY2012 to 68 days in FY2020. This improvement in the receivables position has been nearly consistent except in FY2017 when the receivables days increased sharply to 111 days from 82 days in FY2016.
The primary reason for the increase in receivables days of Marksans Pharma Ltd in FY2017 seems to be the acquisition of Time Cap Labs where after the acquisition, the company needed to give a higher credit period to its customers to retain the existing business/gain new business.
FY2017 annual report, page 28:
Receivables increased to ₹15479.85 Lakh in 2016-17 from ₹13341.49 Lakh in 2015-16 due to offering of higher credit period to customers in USA
However, Marksans Pharma Ltd could bring its receivables position under control and has improved its receivables days to 68 days in FY2020 from 111 days in FY2017.
Further advised reading: Receivable Days: A Complete Guide
When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Marksans Pharma Ltd for FY2011-20 then she notices that the company has collected all the profits as cash flow from operating activities.
Over FY2011-20, Marksans Pharma Ltd reported a total cumulative net profit after tax (cPAT) of ₹139 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹463 cr.
It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than the PAT.
Further advised reading: Understanding Cash Flow from Operations (CFO)
Learning from the article on CFO will indicate to an investor that the cCFO of Marksans Pharma Ltd is higher than the cPAT due to the following factors:
- Depreciation expense of ₹226 cr (a non-cash expense) over FY2011-FY2020, which is deducted while calculating PAT but is added back while calculating CFO.
- Interest expense of ₹193 cr (a non-operating expense) over FY2011-FY2020, which is deducted while calculating PAT but is added back while calculating CFO.
Overall, the above factors led to a CFO, which is more than the PAT of the company by about ₹324 cr.
The Margin of Safety in the Business of Marksans Pharma Ltd:
a) Self-Sustainable Growth Rate (SSGR):
Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it can convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.
Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.
An investor may calculate the SSGR using the following formula:
SSGR = NFAT * NPM * (1-DPR) – Dep
- SSGR = Self Sustainable Growth Rate in %
- Dep = Depreciation rate as a % of net fixed assets
- NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
- NPM = Net profit margin as % of sales
- DPR = Dividend paid as % of net profit after tax
(For systematic algebraic calculation of SSGR formula: Click Here)
While analysing the SSGR of Marksans Pharma Ltd, an investor would notice that the SSGR of the company has been very volatile from -37% to 35% and to the levels of 2% in other years. This is primarily due to the very volatile profit margins and NFAT of the company over the years. The NPM of Marksans Pharma Ltd has varied from -73% to 14% to 1% over the years and similarly, the NFAT of the company has varied from 1.6 to 5.2 over the years. Such large fluctuations in these parameters of Marksans Pharma Ltd, which characterizes an unstable/volatile business model, have led to significant variations in the SSGR year-on-year.
Nevertheless, an investor would remember from the above discussion that Marksans Pharma Ltd has relied on additional funds like debt (FCCBs) and equity (QIP) to fund its acquisitions. This indicates that the company has grown more than what its business profits could support. Because of stretching itself beyond what its business model could support, the company landed up in a situation in FY2011 when the FCCB holders asked for their money and Marksans Pharma Ltd was caught completely unprepared for repayments and it defaulted.
Ultimately, the price of the decisions to stretch the resources beyond what its business model could support was paid by the FCCB holders who had to forego about 70% of their invested money (principal) as discussed below. Please note that this is without considering any return i.e. redemption premium.
The following order by the England and Wales High Court (Commercial Court) dated June 8, 2015 (click here) in the dispute between Marksans Pharma Ltd and one of the FCCB holders, Peter Beck and Partners (PBP) offers good insights into the loss taken by the investors on their investments in FCCBs issued by Marksans Pharma Ltd.
As per the order:
- On 17 July 2009, Marksans bought $6 million worth of the bonds back from the market for 24.63% of their nominal value.
- On 14 April 2010, a holder of a single bond (with a nominal value of US$1,000) converted its holding into equity.
- On 22 November 2011, Marksans bought $6million worth of the bonds back from the market for 20% of their nominal value.
- Between Oct 1, 2012, and Feb 19, 2013, Marksans bought $9.871 million worth of bonds from Yalegrove for 34.36% of nominal value.
- On Feb 22, 2013, Marksans agreed to buy $26.19 million worth of bonds from PBP for 34.36% of nominal value.
- On June 30, 2014, Marksans bought $1.149 million worth of bonds for 30% of the nominal value.
- Owners for 61 bonds ($61,000 nominal value) remain untraced.
The weighted average of the purchase value of all the bonds bought by Marksans Pharma Ltd comes to about 31% of nominal value indicating that the FCCB holders lost about 69% of their original investment (principal value).
Marksans Pharma Ltd intimated the shareholders about the amount of redemption premium in its FY2011 annual report, page 6:
The FCCBs have become due for redemption in November 2010. The redemption premium of USD 19.89 Mn. (Rs. 9017.33 Lacs) has become payable along with the principal amount of USD 43,999,000 (Rs. 19949.85 Lacs) (total due USD 63.89 Mn or Rs. 28967.18 Lacs). However, the FCCBs have not been redeemed on the due date due to financial constraints.
It indicates that FCCBs of principal value $43.999 million had a redemption premium of $19.89 million i.e. 45% of the principal value (19.89 / 43.999 = 45.20%). The redemption premium corresponds to the return promised by Marksans Pharma Ltd to the FCCB holders on maturity.
If an investor factors in the redemption premium in her calculations, then the money received by the FCCB holders, which was 31% of principal value, now comes to about 21% of principal + redemption premium value ($63.89 million or ₹289.67 cr). It indicates that the FCCB holders had to lose about 80% of the money due to them at redemption, which is about ₹227 cr (= ₹289.67 cr * 79%).
Therefore, an investor would note that the FCCB holders had to pay a price of about ₹227 cr due to aggressive debt-funded acquisitions done by Marksans Pharma Ltd.
b) Free Cash Flow (FCF) Analysis of Marksans Pharma Ltd:
While looking at the cash flow performance of Marksans Pharma Ltd, an investor notices that during FY2011-2020, it generated cash flow from operations of ₹463 cr. However, during the same period, it did a capital expenditure of about ₹230 cr.
Therefore, during this period (FY2011-2020), Marksans Pharma Ltd had a free cash flow (FCF) of ₹233 cr (=463 – 230).
In addition, during this period, the company had a non-operating loss (negative other income) of ₹36 cr and an interest expense of ₹193 cr. As a result, the company had a net free cash flow of ₹4 cr (= 233 – 36 – 193). Please note that the capitalized interest is already factored in as a part of capex deducted earlier.
In such a situation, an investor may think that if over FY2011-2020, Marksans Pharma Ltd reported a net free cash flow of only ₹4 cr, then how it could repay a debt of ₹116 cr over the same period. The total debt of Marksans Pharma Ltd reduced from ₹135 cr in FY2011 to ₹ 19 cr in FY2020.
From the above discussion, an investor would remember that in FY2016, Marksans Pharma Ltd funded its acquisition of Time Cap Labs by way of a qualified institutional placement (QIP) of about $21 million (about ₹147 cr @ ₹70/USD). This additional cash inflow provides an investor with the missing source in the overall cash flow position of the company over FY2011-2020.
An investor would appreciate that the cash flow position of Marksans Pharma Ltd would be much worse if the FCCB holders had not agreed to take a loss of about ₹227 cr on their investment and the company had to pay their full dues.
Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing
Additional aspects of Marksans Pharma Ltd:
On analysing Marksans Pharma Ltd and after reading its publicly available past annual reports since FY2009 and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.
1) Management Succession of Marksans Pharma Ltd:
When an investor reads about the promoter family of Marksans Pharma Ltd, then she notices that the promoter Mark Saldanha is a part of the family owning Glenmark Pharmaceuticals group. Glenmark was established by his father Gracias Saldanha.
Mr Gracias Saldanha named the company Glenmark after the names of his two sons, Glenn Saldanha and Mark Saldanha (Glenn + Mark) (Source: Rediff). Glenn Saldanha is currently the Chairman and Managing Director of Glenmark Pharmaceuticals Ltd and Mark Saldanha looks after Marksans Pharma Ltd.
In Marksans Pharma Ltd, two members of the promoter family are a part of the board of directors, Mr Mark Saldanha (age 48 years) and his wife, Ms Sandra Saldanha (age 49 years) (FY2020 annual report, page 81). However, apart from them, the annual reports do not mention whether anyone else from the younger generation is a part of the company or not.
An investor may contact the company directly to know about the next generation of the promoters of Marksans Pharma Ltd and what plans the company and the promoters have for succession planning.
Further advised reading: How to do Management Analysis of Companies?
2) Curious case of impairment of investments in the subsidiaries by Marksans Pharma Ltd:
While analysing the performance of the subsidiaries of the company, an investor notices that by FY2012, the performance of its subsidiaries has been much lower than the expectations and the company made huge losses in FY2011 and FY2012.
In FY2012, Marksans Pharma Ltd recognized that the investments done by it in its subsidiaries have failed to generate any value for the shareholders and as a result, it wrote-off/impaired a significant amount of its investments in the subsidiaries.
As per Marksans Pharma Ltd, it had made investments of ₹68.78 cr in the UK subsidiaries in 2008. However, in FY2012, the company reassessed the value of its investments in these subsidiaries by doing financial projections and comparing their value with peer companies. After this exercise, Marksans Pharma Ltd confirmed that the value of these subsidiaries has declined significantly. The company reduced the value of these subsidiaries by 68% from ₹68.78 cr and recognized a loss of ₹46.86 cr.
FY2012 annual report, page 33:
The Company, in the year 2008, acquired two UK based companies Bell, Sons and Co (Druggists) Limited and Relonchem Limited through its 100% subsidiary, Marksans Pharma (UK) Limited. The company has made an investment of ₹ 68.78 Crores to part finance above acquisitions. However, Relonchem Limited has been incurring losses and Bell, Sons and Co (Druggists) Limited has failed to meet the expectations. Therefore, the Management has carried out an analysis of the value of investment in subsidiaries. The analysis is based on financial projections and market valuation of the peer companies operating in the similar area of operation. This analysis indicated a diminution in the realisable value of investment in the subsidiaries. Accordingly, the carrying value of the investment in subsidiaries has been reduced in the Balance Sheet as on 31 March, 2012 and the amount of the diminution of ₹ 4686 Lacs has been charged to the Statement of Profit and Loss for the year ended 31 March, 2012
The losses incurred by Marksans Pharma Ltd in FY2011 and FY2012 helped the company to report itself to the Board of Industrial and Financial Reconstruction (BIFR) in FY2012.
FY2012 annual report, page 3:
As reported in our last reports, the Net Worth of the Company as on 31 st March, 2011 had been completely eroded. Therefore, as required under the provisions of the Sick Industrial Companies (Special Provisions) Act, 1985, we have made a reference to the Board for Industrial and Financial Reconstruction for determining measures that will be adopted with respect to the Company.
Advised reading: How to identify if Management is Misallocating Capital
Once a company makes a reference to the BIFR, it effectively files for bankruptcy and thereafter, the creditors/lenders have to sit down and negotiate with the company for a settlement. Lenders do not have much power left to recover their money.
The statement by one of the FCCB holders Mr Bernd H gel of Peter Beck and Partners (PBP) in the England and Wales High Court (Commercial Court) about his fears of Marksans Pharma Ltd staying in BIFR would tie-up his hands in getting his money clearly indicates the fear that investors/lenders/creditors have about BIFR. The order of the England and Wales High Court (Commercial Court) dated June 8, 2015 (click here) in the dispute between Marksans Pharma Ltd and Peter Beck and Partners (PBP) contains this statement:
As Mr H gel accepted, he was in a “corner“. As he further accepted, it was “basically correct” that he was in that corner “[R]egardless of whether there were other bonds in the market or not”. Either he sold all his bonds to Marksans or he sold none. If he sold none then there was a very real risk that Marksans would remain in BIFR and PBP would get nothing for the very large holding it had. This was a prospect which “frightened” him. As he said in evidence, “I was really frightened. I have never seen such a mechanism because there is full protection against creditors. Promoters can do what they want. I was really, really worried ..frightened“.
The above part of the High Court order clearly brings out the fears that the lenders have of BIFR as the FCCB holder felt the real risk that he might lose his entire investment.
As per the above order, Marksans Pharma Ltd was declared a sick company by BIFR on January 17, 2013. After being labelled a sick company in January 2013, Marksans Pharma Ltd entered into settlement agreements with the majority of FCCB holders in February 2013.
Thereafter, at the end of FY2013, Marksans Pharma Ltd reinstated the diminution of value of its investments in its subsidiaries by exactly the same amount by which it had reduced it in the previous year.
FY2013 annual report, page 37:
However, during the period under review, the aforesaid two subsidiaries have shown improvement in performances. The management foresee further improvement in both the subsidiary’s performance in the years to come. Therefore, the management has revisited the investment valuation at 31 676,163,898 as on 31.03.2013. Accordingly, the Company has written back the amount of diminution in the value of investment of ₹4,686 Lacs directly in Balance Sheet for the year ended 31.03.2013.
An investor notices that Marksans Pharma Ltd reduced the valuation of its investments in its subsidiaries in FY2012 by about 68% when it did the financial projections and compared the valuations with peer companies. In the next year, FY2013, the company reinstated the entire reduction in value by increasing it to more than 3x (i.e. from 32% to 100%).
An investor also notices that in FY2013, after Marksans Pharma Ltd entered into the settlement agreements with the FCCB holders, then it wrote back the total amount that it was supposed to pay if there was no default and thereafter, provided for only the settlement amount which was about 80% lower than the principal amount + redemption premium.
FY2013 annual report, page 3:
Your company has signed settlement agreement with few bondholders for settlement of principal value of USD 36,789,000 worth of Bonds. Under the settlement agreement, the settlement amount is payable over a period of 12 months from the date of signing the respective settlement agreements. Accordingly, the Company has written back the entire amount of USD 36,789,000 Bonds along with redemption premium of USD 16,628,628 (aggregating to USD 53,417,628) and provided for new liability based on the settlement payout in terms of the Settlement Agreements in the books of accounts for the year ended 31 March, 2013.
Therefore, an investor would appreciate that the settlement by the company with the bondholders increased the net worth by say $100 (principal + redemption premium) due to write-back and then reduced it by about $21, the amount of settlement money to be paid to FCCBs. Therefore, the settlement with the FCCB holders at about an 80% haircut had the impact of increasing the net worth of Marksans Pharma Ltd significantly and it came out of BIFR immediately.
FY2013 annual report, page 3:
Due to settlement of a substantial amount of FCCBs and improved financial performance of your company, the Net Worth of your company has turned positive as at 31 March, 2013. Therefore, your company has been de-registered from the purview of SICA and is no longer under BIFR.
Looking at the overall situation comprehensively, an investor may appreciate that it is the steep loss taken by the FCCB holders that had contributed to the increasing net worth of Marksans Pharma Ltd and thereby its coming out of BIFR.
3) Overstating of profits and non-provisions for the foreign exchange losses on FCCBs by Marksans Pharma Ltd:
While reading the past annual reports of Marksans Pharma Ltd, an investor notices that the auditor of the company repeatedly highlighted in its reports that the profits of the company were overstated significantly as it did not provide for the foreign exchange losses on the FCCBs in its reported financials, even though as per the Companies Act, it should have done so.
The auditor highlighted in the FY2009 annual report, page 29 that the profits of the company are overstated by ₹53.35 cr in FY2009.
No Provision have been made during the year for Rs.5335 lacs towards Foreign Exchange Difference account in case of Foreign Currency Convertible Bond. The Management is of the opinion the determination and Crystallisation of Liabilities is dependent upon the outcome of uncertain future events or actions not wholly within the control of the Company and therefore, the same has been considered as ‘Contingent Liability’ as on 31.3.2009 and to that extent profit for the year ended 31.3.2009 is overstated.
The auditor again highlighted the same in the FY2010 annual report, page 27 that the profits of the company are overstated by ₹21.64 cr in FY2010.
As required by Accounting Standard 11 “the effect of changes in the foreign exchange rates” during the year the company has restated its assets & liabilities at the closing exchange rate prevailing at the Balance Sheet date except towards Foreign Exchange Difference of Rs.2164.80 Lakh in case of Foreign Currency Convertible Bond, the Management is of the opinion the determination and Crystallization of Liabilities is dependent upon the outcome of uncertain future events or actions not wholly within the control of the Company and therefore the same has been considered as ‘Contingent Liability’ as on 31.3.2010 and Due to this profit for the year ended 31.3.2010 is overstated.
Advised reading: How Companies Inflate their Profits
Therefore, an investor would appreciate that Marksans Pharma Ltd overstated its profits by ₹53.35 cr in FY2009 and by ₹21.64 cr in FY2010 as it refused to provide for the foreign exchange losses on FCCBs, even though the auditor of the company highlighted it in its reports.
The next year, FY2011, the FCCB holders did not convert them into equity shares and therefore, the FCCBs became due for payment in November 2010. At this time, Marksans Pharma Ltd did not have money for paying off the FCCB holders.
Now, in FY2011, the company decided to provide for the foreign exchange losses on FCCBs to the extent of ₹23.63 cr.
FY2011 annual report, page 6:
The year under review has registered a net loss of Rs. 21778.91 Lacs as compared to net profit Rs. 28.98 Lacs in the previous year. This is mainly due to loss on the sale of API Business of Rs. 8663.88 Lacs, provision of redemption premium of FCCBs of Rs. 9017.33 Lacs and provision of foreign exchange loss on FCCBs of Rs. 2363.45 Lacs.
The said provision contributed to the very large losses of the company in FY2011, which wiped out its net worth completely, it referred itself to BIFR, and thereafter, it could enter into a settlement with the majority of FCCB holders.
FY2011 annual report, page 6:
the Net Worth of the Company as on 31 st March, 2011 has been completely eroded. Therefore, the Directors have formed an opinion that the Company has become a Sick Industrial Company within the meaning of Section 3(1)(o) of the Sick Industrial Companies (Special Provisions) Act, 1985 and it is mandatory under the provisions of the said Act to make a reference to the Board for Industrial and Financial Reconstruction
4) Intangible assets are a black box:
While reading the FY2012 annual report of Marksans Pharma Ltd, an investor notices that the company impaired its intangible assets by almost 80% when it reduced their value from ₹137.08 cr in FY2011 to ₹27.70 cr in FY2012, a decline of about ₹110 cr.
FY2012 annual report, page 10:
During the year 2011-12, the Company’s Intangible Assets has reduced to ₹ 2770.13 Lacs in 2011-12 from ₹ 13708.90 Lacs in 2010-11 on account of impairment.
The company explained on page 32 of the FY2012 annual report that the intangible assets constitute the expenses incurred by it on activities like product developments, filing of ANDAs, license for CRAMS etc. The company said that now, it has reassessed their value and decreased it to the recoverable amount.
The expenses incurred on development of process/product and compliance with regulatory procedures of US FDA and other global health authorities in filing of Abbreviated New Drug Application (ANDA), Market Authorisation/Site Variation Licenses for CRAMS and MHRA procedure for Market Authorisation/Site Variation Licenses are capitalised and identified as intangible assets
the carrying value of the Intangible Assets have been reduced to their recoverable amount in the Balance Sheet as on 31 March 2012…The recoverable amount is as per the binding out licensing/distribution agreements for the respective products.
Impairment of intangible assets by 80% means that the actual value of these intangible assets was 80% lower than what they were stated in the balance sheet in the previous years. Such a sharp deterioration in the intangible assets that the company claimed to have created by spending on critical activities like product developments, filing of ANDAs, license for CRAMS etc. creates a doubt in the minds of the investor about how she should perceive any financial data presented to her.
In addition, while analysing the FY2010 annual report, page 7-8, an investor notices that in FY2010, the company has created intangible assets of about ₹23 cr:
Company continues to benefit from the extensive Research and Development (R&D) activity carried on. During the year, your company has incurred major expenses of R & D nature for new products development and ANDA / Dossiers filing for regulated and emerging markets, has capitalized as intangible assets, the total amount capitalized during the year as intangible assets is Rs. 2288.17 Lacs.
In FY2011, any shareholder of Marksans Pharma Ltd would have got the shock that almost all those investments by Marksans Pharma Ltd that she believed to be an investment for future growth were in fact wasteful expenditure where the actual value was only 20% of what was spent.
An investor may believe that the money spent by the company in FY2010 (₹23 cr) would be very cautious spending that would not go down in value within one year. Therefore, if an investor assumes that ₹23 cr of intangible value created in FY2010 would retain its value, then she faces a situation where the intangible assets created by the company before FY2010 have lost their almost entire value. This is because, in FY2011, the company impaired its intangible assets from ₹137.08 cr in FY2011 to ₹27.70 cr in FY2012. Therefore, after factoring in the ₹23 cr spent in FY2010, an investor notices that ₹114 cr (= 137 – 23) spent as intangible assets before FY2010 are now valued at only ₹4 cr (= 27 – 23).
The investor realizes that the intangible assets are a black box where a shareholder can never be certain what the assets are truly worth. What is mentioned as ₹100 in one year can become ₹20 in the next.
FY2011 was the year in which the FCCBs became due for repayment and Marksans Pharma Ltd defaulted, it reported its largest loss in history and its entire net worth was wiped out. Thereafter, the company referred itself to BIFR, got itself declared a sick company and then entered into a settlement with the FCCB holders.
An investor realizes that the intangible assets are a black box in the financial statements again in FY2019 when she reads in the FY2019 annual report, page 141 that during the year, it has disposed off the goodwill of about ₹27 cr. However, she is not able to find any supporting information in the annual report that may help her understand this disposal of goodwill for a significant amount of ₹27 cr.
An investor may contact the company directly for seeking more clarification on such aspects where the annual reports do not provide sufficient information to make an informed judgment.
Advised reading: Understanding the Annual Report of a Company
5) Delays in completing the R&D centre in Navi-Mumbai:
While reading the FY2016 annual report of Marksans Pharma Ltd, an investor gets to know that the company is making a new R&D centre in Navi Mumbai that it plans to complete by Dec 2016.
FY2016 annual report, page 13:
Company is investing in a new R&D centre in Navi Mumbai that should be up and running by 2016-end.
However, it seems that the centre got delayed for about 2 years, as the company could intimate its completion to the shareholders in the FY2018 annual report.
FY2018 annual report, page 9:
our state-of-the-art R&D centre in Navi Mumbai focusing on formulations and novel drug delivery systems addressing the regulated markets became functional under a strong team.
An investor would appreciate that completion of projects within time and cost estimates is one of the essential aspects of strong competence for any company’s management.
Going ahead, an investor should keep a close track of the progress of any project announced by the company so that she can get to know of any delays and resultant time and cost overruns.
6) Plans for the manufacturing plant at Nagpur by Marksans Pharma Ltd:
While analysing the publicly available information about the company at various govt. portals, an investor gets to know that in the 59th meeting of the approval committee of the MIHAN SEZ, Nagpur on June 5, 2015, the govt. had approved the application of Marksans Pharma Ltd for allotment of a plot of about 10 acres of land. (Source: page 5-14 of minutes of the meeting). The approval letter mentions that the land allotment is for 99 years.
While reading the annual reports of the company, an investor does not get to know about the status of any such manufacturing project initiated by Marksans Pharma Ltd in Nagpur.
An investor may contact the company directly to understand the status of allotment of the said land in Nagpur and whether it has started constructing any plant on the same and other related details.
7) No spending on CSR by Marksans Pharma Ltd for many years:
While reading the annual reports of the company, an investor notices that Marksans Pharma Ltd did not spend money on CSR despite reporting profits.
In FY2017, the company was required to spend ₹66 lac on CSR; however, it did not spend any money on CSR despite profits of about ₹9 cr.
FY2017 annual report, page 40:
During the financial year 2016-17, the Company has not spent any amount towards CSR. The Company understands its responsibilities towards the Society, Community, environment and committed to spend sensibly after identifying right avenue for the purpose.
In FY2018, the company was required to spend ₹1.33 cr on CSR; however, it did not spend any money on CSR despite profits of about ₹33 cr. The company said that one of the reasons it could not spend money on CSR is that it had to spend money on the expansion of its operations (business growth) and the new R&D centre.
FY2018 annual report, page 37:
During the year 2017-18, the Company has not spent any amount towards CSR…However even after meeting number of NGOs, the Committee could not identify any suitable NGOs for the purpose
Company had undertaken to scale-up its domestic operation and set-up a state-of-the-art R&D Centre. These two projects would require extensive cash outflow. In view of the aforesaid, the CSR Committee decided to defer the CSR expenditure.
However, when an investor analyses the cash flow position of the company for FY2018, then she notices that in FY2018, the company had cash flow from operations (CFO) of ₹50 cr out of which it spent about ₹39 cr on capital expenditure and had a free cash flow of about ₹11 cr. Because of the free cash flow generation by the company in FY2018, its cash & investments increased from ₹25 cr in FY2017 to ₹40 cr in FY2018.
Even in the next year, FY2019, the company did not spend any money on CSR even though it was required to spend ₹80 lac on CSR. This was despite profits of about ₹76 cr reported by the company in FY2019. The company said that it could not find any suitable projects for spending CSR money.
FY2019 annual report, page 37:
During the year 2018-19, the Company has not spent any amount towards CSR…However, the Company could not identify right avenues for the purpose. The Company is continuing its efforts in identifying right activities as per its CSR Policy to achieve CSR objectives.
Finally, it was in FY2020 that the company spent some part of its obligation under CSR when it spent about ₹24 lac out of its obligation of ₹56 lac to be spent during the year. (FY2020 annual report, page 51).
8) Marksans Pharma GmbH, a subsidiary company of Marksans Pharma Ltd:
While reading the FY2019 annual report, an investor comes to know that Marksans Pharma Ltd has recognized the money spent to form a subsidiary in Germany named Marksans Pharma GmbH as a loss. The investor gets to know that this German subsidiary company was formed by Marksans Pharma Ltd in FY2015.
FY2019 annual report, page 94:
The Company has Subsidiary namely Marksans Pharma GmbH which was formed in the financial year 2014-2015. The amount repatriated for its formation had been charged off to Statement of Profit & Loss as Subsidiary is dormant, since its incorporation.
When an investor searches the annual reports for FY2015, FY2016, FY2017 and FY2018, then she is not able to find any mention of either the formation or the existence of Marksans Pharma GmbH as a subsidiary of the company. For example in the list of subsidiaries in the FY2018 annual report, page 150, the following companies are mentioned, which does not include the name of Marksans Pharma GmbH:
List of Related Parties: Subsidiary:
- Marksans Pharma (UK) Limited
- Marksans Holdings Limited
- Bell, Sons and Co. (Druggists) Limited
- Relonchem Limited
- Marksans Pharma Inc.
- Time-Cap Laboratories Inc.
- Custom Coatings Inc.
- Marksans Realty LLC
- Nova Pharmaceuticals Australasia Pty Ltd
An investor may contact the company directly to understand the reasons why Marksans Pharma GmbH was not mentioned as a subsidiary in the annual reports from FY2015 to FY2018.
9) Investment in Yalegrove Limited by Marksans Pharma Ltd:
The order of the England and Wales High Court (Commercial Court) dated June 8, 2015 (click here) in the dispute between Marksans Pharma Ltd and Peter Beck and Partners (PBP) makes for interesting reading for any investor to understand how the participants of the financial system operate to negotiate terms in their favour, the lies that help their commercial terms, concealing identities, bring sham entities as fronts etc. We would advise every investor to go through the entire order in detail. It would be a good learning exercise for every investor.
While reading the order, an investor gets to know that one of the investors in the FCCB was ICICI. ICICI did not want to sell the bonds to any Indian company or Marksans Pharma Ltd. Therefore, Marksans Pharma Ltd brought into the picture a company named Yalegrove Limited, which as per the order of the High Court, was an associate of Mankind Pharma Ltd and received the money from Marksans Pharma Ltd to buy the bonds from ICICI.
The order mentions that Marksans Pharma Ltd concealed the real identity of the buyer of FCCBs from ICICI and it was embarrassed when these dealings got disclosed in the court proceedings.
While reading the said order of the High Court (click here), an investor may focus on the following sections:
i) Yalegrove Limited that acquired bonds from ICICI was an associate company of Marksans Pharma Ltd and was funded by it to acquire the bonds:
(4) On 1 October 2012, Marksans signed a Memorandum of Understanding with Yalegrove Limited under which it was agreed that Marksans would buy all of their bonds (which had a nominal value of US$9.871 million) back from them on mutually agreeable terms…In fact Yalegrove was an associated company of Marksans and Marksans had funded its purchase of the bonds from ICICI.
ii) ICICI did not want to sell bonds (FCCBs) to an Indian company or to Marksans Pharma Ltd and the company concealed the identity of the real buyer from ICICI:
12. PBP submitted that the Yalegrove transaction was relevant to the credibility of Mr Sharma and Mr Saldanha (but not Mr Parekh). First, it submitted that the transaction involved the misleading of ICICI by Marksans as to the true identity to the purchaser and evidenced a willingness to use underhand tactics if necessary to acquire the bonds. Secondly, it submitted that Marksans was embarrassed by the transaction and had sought to conceal the truth in relation to Yalegrove’s acquisition of bonds from ICICI.
13. I accept that the evidence supports a desire by Marksans to conceal that it was ultimately behind the purchase. ICICI had stated that it did not want to sell its bonds to an Indian company or to Marksans. I also accept that Marksans was coy about this in its disclosure (which involved redactions) and its evidence.
Nevertheless, the order mentions that the judge did not find any illegality in these transactions.
When an investor reads the annual report for the years when all these purchase transactions took place, then she notices that none of the annual reports of Marksans Pharma Ltd contained any reference of Yalegrove Ltd either as an associate company or that it had advanced money to Yalegrove Ltd for purchasing bonds (FCCBs) from the bondholders like ICICI. An investor may contact the company directly if she wants any clarifications in this regard.
The Margin of Safety in the market price of Marksans Pharma Ltd:
Currently (March 9, 2021), Marksans Pharma Ltd is available at a price to earnings (PE) ratio of about 10.9 based on consolidated earnings for 12-months ending December 2020 (i.e. January 2020-December 2020). The PE ratio of 10.9 offers some margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, which takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Overall, Marksans Pharma Ltd is a company that is has grown its sales at a rate of 15% year on year for the last 10 years. However, the company faced many difficulties during this journey. It reported record losses during FY2011-FY2012. It defaulted on its redemption obligations to the foreign currency convertible bonds (FCCBs). Its net worth was wiped out; it became bankrupt and a sick company under BIFR. It could negotiate a settlement with FCCB holders and get them to accept a heavy loss on their investment and as a result, it could come out of the crisis.
The company improved its business performance over FY2013-FY2015; however, in FY2016, the company was hit by regulatory challenges when its plants in the UK as well as in India failed the regulatory inspection. As a result, its sales declined in FY2017 as well as its profit margins dropped significantly over FY2016-FY2017. Since FY2018, the company has again improved its business and its sales as well as profit margins have improved.
Over the years, the company has relied on outside resources like debt (including FCCBs) and equity (QIP) to fund its growth aspiration by acquiring companies in foreign locations. The FCCB holders paid a price by suffering heavy losses when the company could not integrate and optimally use its acquired companies in the last decade. Nevertheless, the decision of the company like shifting from a contract manufacturer to selling own-branded drugs has helped the company to improve its business significantly, as it is able to capture a higher proportion of the profit margin in the business.
The shift in the business of the company to selling own-branded drugs has led to an increased requirement of working capital in the form of a higher requirement of inventory as well as, at times, giving a higher credit period to the customers to generate sales.
Marksans Pharma Ltd operates in a highly competitive and regulated business where existing large MNC players use every trick to stop the success of generic drug manufacturers. The tricks include attempts to prolong patent periods to litigations against generic players to aggressive price-based competition. In addition, the govt. authorities attempt to control the prices of key drugs to keep the cost of healthcare under check. All these factors have influenced generic players including Marksans Pharma Ltd and have affected its profit margins in the past. An investor should keep in her mind that these factors are not going to go away and instead are going to become stronger with time. Therefore, she should be cautious when she extrapolates current profit margins in the future.
In the past, there have been instances where auditors of Marksans Pharma Ltd highlighted that the company overstated its profits by not providing for large losses on its FCCBs due to foreign exchange fluctuations. At one instance, the company reduced the value of its investments in the subsidiaries by 68% in one year stating poor performance, financial projections and comparison with the valuation of peer companies. However, the very next year, it increased the value of the same investments to more than 3 times stating that now their performance has improved.
The intangible assets of Marksans Pharma Ltd are a black box for the investors. On one occasion, the company diminished their value by about 80% stating that their realizable value is much lower than what it had spent on them. On another occasion, it disposed of the goodwill of about ₹23 cr without providing any supporting explanation in the annual report.
In one instance, the company formed a subsidiary in Germany. However, it did not mention the same in the annual reports for 4 years until the time it wrote-off the money used to create that subsidiary in FY2019. In another instance, during the hearing of litigation between the company and an FCCB holder, it comes out that the company had funded an associate company to buy FCCBs from existing holders. However, in the annual reports, an investor is not able to find any mention of that associate company or any explanation to the shareholders about the money given by the company to that associate company.
All these instances make it difficult for an investor to confidently interpret and make long-term decisions on the financial data provided by the company. We believe that an investor should approach the company for any aspect that she believes that she needs more information and clarification to make an informed opinion about the company.
Going ahead, an investor should carefully monitor developments related to the regulatory compliances by the company, its profit margins, any debt-funded large acquisition, auditor’s comments about any deviation from the statutory guidelines, timely completion of capital expenditure etc. so that she may stay updated with the important developments related to the company.
Further advised reading: How to Monitor Stocks in your Portfolio
These are our views on Marksans Pharma Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.
You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”
I hope it helps!
Dr Vijay Malik
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Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.