This article provides a fundamental analysis of Kilitch Drugs (India) Ltd an Indian pharmaceutical company manufacturing all dosage forms i.e. solid, liquid and parenteral forms. Kilitch Drugs focuses on antibacterial parenteral formulations and sterile liquid formulations in small volumes. Kilitch Drugs also does contract manufacturing for national and multinational pharmaceutical companies.
In order to benefit the maximum from this article, an investor should focus more 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.
Kilitch Drugs (India) Ltd Research Report by Reader
Q: Dear Vijay. First of all, a big appreciation for sharing your stock selection & analysis articles. I came across them a few weeks back and learnt many things. I was looking for undervalued stocks in the pharma sector and came across Kilitch Drugs (India) Ltd.
I feel this is an undervalued stock on the below rationale:
- Market Cap is almost equal to cash holding of the company
- High promoter shareholding (>60%)
I feel the share price has been beaten down because of poor results for the last few quarters. Two years back they sold one of their divisions and paid a 300% dividend to shareholders. Their annual report says they are revamping and focusing on exports to African countries where they see huge potential.
I look at it, not as a very long-term investment but 1-2 years should give around 2-3x. What is your view on it?
Dr Vijay Malik’s Response
Thanks for your feedback and appreciation! I am happy that you found the articles useful. Analysis of financials of Kilitch Drugs (India) Ltd presents quite a few interesting observations.
Financial Analysis of Kilitch Drugs (India) Ltd:
Non-Utilization of Cash/Shareholder’s Funds Properly:
Kilitch Drugs (India) Ltd sold its Ponta Sahib plant to US firm Akorn in FY2012 for cash consideration of about INR 200 cr. However, it paid out dividends of only INR 33 cr. The use of the balance amount is not yet clear.
There is no increase in net fixed assets or capital work in progress (CWIP), therefore, it seems they are not spending it on building their manufacturing plants. Its cash balance has become INR 44 cr. only at FY2014 end, after about two years of concluding the sale to Akorn. The trend of cash flow from investing (CFI) indicates that Kilitch Drugs (India) might be getting money from Akorn in tranches. An investor needs to check the receipt of money and its usage by the company.
Operating Losses:
The company’s sales have dipped since the sale of the plant to Akorn, however, it does not entirely explain operating losses since the last two years. An investor needs to understand whether the remaining drug portfolio is an undesirable collection of products.
Similarly, net profits have taken a hit in line with operating losses.
Further advised reading: How to do Business Analysis of Pharmaceutical Companies
Operating Efficiency Analysis of Kilitch Drugs (India) Ltd:
Kilitch Drugs (India) is not performing well on the operating efficiency parameters. Inventory turnover and other parameters are not showing promising trends.
It seems Kilitch Drugs (India) is finding it difficult to recover its dues from customers. Its receivables days outstanding are increasing continuously and currently stand at whopping 258 days. It indicates that its customers are enjoying funds at the cost of Kilitch Drugs (India) & its shareholders. An investor needs to understand the reasons behind increasing receivables days.
Cumulative PAT vs. CFO analysis would not be very meaningful in the case of Kilitch Drugs (India) as the profits from the sale of the plant to Akorn would be shown in PAT but the cash would be shown in cash from investing & not as CFO. However, the CFO being negative is still significant as it indicates that the company’s cash is being stuck in working capital.
Erosion of Shareholder’s Wealth:
Over the last 10 years (2005-14), Kilitch Drugs (India) has withheld profits (retained earnings) of INR 89 cr. However, the increase in market capitalization during the same period is only INR 36 cr. This indicates that the company has not been able to generate wealth for its shareholders from the money it decided to withhold and not distribute as dividends. Effectively, shareholder wealth of INR 63 cr has been destroyed indicating INR 0.40 of wealth creation for every INR 1 of profits retained. This is not a desirable feature of any investment.
Margin of Safety in the market price of Kilitch Drugs (India) Ltd:
At the current price to earnings ratio (P/E ratio) of 35, Kilitch Drugs (India) Ltd offers no margin of safety to an investor. As per Benjamin Graham, an investor should strive for keeping a margin of safety while buying stocks.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, taking 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, 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, Kilitch Drugs (India) Ltd represents a story where a company sold its marque asset and has not yet recovered fully/utilized cash properly. Operating efficiency seems to be declining. Existing shareholders have reasons for being unhappy.
You mentioned that the company is revamping its operations and focusing on exports to African countries. However, the analysis of fixed assets and capital work in progress (CWIP) does not corroborate the management’s claim.
An investor must analyse the usage of cash received from the asset sales to Akorn before making up her mind about investing in Kilitch Drugs (India) Ltd.
I believe that in the current market there are many other good investment opportunities, even after considering that Kilitch Drugs (India) has cash reserves of almost equal to its current market capitalization. History has shown that companies do not take long before destroying cash reserves by resorting to “Diworsification”
You may read a case of repeated diversification attempts ending in “Diworsification” here: Analysis: Bodal Chemicals Ltd
I do not look at any company for a 1-2 years horizon. I agree with Warren Buffett when he says that an investor should look at stocks as investments for decades and never less than 5 years.
You may read more about my review of Warren Buffett’s teachings here:
“Warren Buffett’s 2014 Letter: A Complete Book for Investors”
These are my views about Kilitch Drugs (India) Ltd. You should do your own analysis before making any investment decision in Kilitch Drugs (India) Ltd.
You may use the framework described in the article on detailed analysis of a company to build upon the analysis done by you earlier:
How to Conduct Detailed Analysis of a Company
Hope it helps!
Regards,
P.S.
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Disclaimer
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.
