This article provides an in-depth fundamental analysis of SMS Pharmaceuticals Ltd, an Indian active pharmaceutical ingredient (API) manufacturer.
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.
SMS Pharmaceuticals Ltd Research Report by Reader
Q: Hello Vijay Sir. Would like to know your views on SMS Pharmaceuticals Ltd, a Hyderabad based API manufacturer. Promoters’ holding is around 65 % shares. The company sold one of its units in FY 13 and used this fund for clearing debt, company expansion and for buying back shares.
SMS Pharmaceuticals Ltd is showing good revenue and profit growth from Sept 13 with improving Profit Margins. At Current P/E 11, the company looks cheaper compared to other API manufacturers. Debt to Equity is 0.75.
In the last 10 years, SMS Pharmaceuticals Ltd skipped dividends only in FY 12. The company is consistently paying tax.
Thanks
Dr Vijay Malik’s Response
Thanks for writing to me!
Financial Analysis of SMS Pharmaceuticals Ltd:
SMS Pharmaceuticals Ltd was languishing in its sales growth for 6 years from FY2008 to FY2013. There was almost no sales growth during this period. However, since FY2013, it has increased its pace of growth substantially. It seems mainly because of the addition of new manufacturing units.
Further advised reading: How to do Business Analysis of Pharmaceutical Companies
The fixed asset turnover ratio of the company has more than doubled from 1.0 in FY2012 to 2.1 in FY2014. Such kinds of sudden improvements in operating efficiency are not common and the investor should analyse it in further detail.
Profitability margins (both OPM & NPM) of the company have been fluctuating wildly, which is common for commodity product companies. Such companies do not have much pricing power with buyers and therefore are not able to pass on the rising raw material costs to buyers. SMS Pharmaceuticals Ltd reported operating losses in FY2013. An investor should analyse the reasons for operating losses during this year.
Operating Efficiency Analysis of SMS Pharmaceuticals Ltd:
SMS Pharmaceuticals Ltd seems to have been improving its operating efficiency on all parameters whether it is receivables days or inventory turnover ratio.
The company is continuously adding new projects, which is evident from consistent capital work in progress (CWIP) levels and increasing net fixed assets. However, the company is relying more on debt for funding its capital expansion. Debt levels, which declined a bit in FY2013 because of the sale of the Vizag unit to Mylan Laboratories, have again started to rise in FY2014.
Increasing debt levels are a persistent problem with companies operating in capital-intensive businesses with very low asset turnover. Increasing debt levels always put any company into a difficult scenario with the potential to impact profitability and heightened risk of bankruptcy.
Overall, SMS Pharmaceuticals Ltd looks like a company, which has suddenly found some magical formula that has revamped its business with high sales growth and improved operating efficiency. A company that was not able to increase its sales for the last 6 years is suddenly witnessing all the things going right for it. An investor should be cautious and analyse the change in the company in detail before making any investment decision about the company.
SMS Pharmaceuticals Ltd is operating in a capital-intensive business with a very low asset turnover. In order to grow its business, SMS Pharmaceuticals Ltd would always be required to raise debt to fund capacity expansion and then sell its assets to reduce debt when it rises to significant levels. In future, an investor should be prepared to see periods of low profitability due to high-interest costs before the company reduces debt by either asset sales or equity dilution.
Margin of Safety in the market price of SMS Pharmaceuticals Ltd:
SMS Pharmaceuticals Ltd is currently available at a P/E ratio of about 15, which does not offer any margin of safety 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, 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
These are my views about SMS Pharmaceuticals Ltd. However, you should do your own analysis before making any investment-related decision about the company.
You may use the following steps to analyse the company: “How to do 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.
