It has the tangible and intangible capabilities to grow its business
We initiate coverage of Strides with a Buy rating and TP of Rs 1,500. The management track record in capital allocation and execution gives us comfort on its unique business model. We believe backward integration and product mix will lead to 320 bps margin improvement in the next three years. US and Africa are the key revenue growth drivers. Organic EPS CAGR of 32% for FY16E-18e and sharp ROE improvement should see the stock re-rate from current levels. Strides is trading at 16x FY17 P/E (price to earnings ratio), a 25% discount to the sector and 20% to mid-cap peers. Given the 23% FY18 EPS growth and improving fundamentals (RoE of 25% and net debt to equity of 0.8 by FY18), we expect the gap to narrow. We initiate at Buy with a TP of Rs 1,500, FY17E P/E of 20x, in line with mid/small cap peers. Risks: approval delays and currency.
Unique strategy across markets: Strides has a unique business model in all its key markets compared with its Indian peers. In the US, Strides is working towards being a niche player with portfolio of small off-patent products and is not focused on large Para IV challenges. In Africa, it is building a strong branded presence outside South Africa with integrated and local manufacturing. In Australia, it is now a top-three generic player with front-end presence.
Focus on asset utilisation: We believe following significant inorganic growth over the past two years, the management is now focusing on integration of businesses. It plans to backward integrate its US and Institutional business using Shasun’s API facility and also bring Australia production in-house. It now has sufficient tangible (production) and intangible (R&D) capabilities to execute its strategy and grow the business. We expect US revenues to grow at 35% CAGR over FY15-18, driven by new product launches and market share gains, and Africa business to grow at 24% CAGR over FY15-18, led by branded business and benefits from local manufacturing assets. As a result, we expect margins to improve 320bps by FY18. Strides is building a global integrated business with front-end presence in the US, Africa and Australia. We expect reported EPS to grow at a CAGR of 62% over FY15-18,driven by both organic and inorganic drivers. We expect organic EPS CAGR of 32% over FY16-18. The company has a unique business model in all its key markets: (i) branded presence in Africa, (ii) portfolio of small molecules in the US and (iii) a large product portfolio in Australia. We believe that inorganic expansion is largely complete and going forward the focus will be on growing the US and Africa businesses through new launches and market share gains, and improving margins through backward integration of key products. The stock is trading at 16x FY17 PE, at a 25% discount to the sector.
Strong earnings growth ahead: We expect Strides’ reported EPS to grow at FY15-18 CAGR of 62%, return ratios to improve to 25% and net debt to equity to decline to 0.8x by FY18, from 1.6x currently. While part of the growth is due to low base and M&A, we expect organic growth CAGR post FY16 to be 32% over the next two years. We expect revenue to grow to $800m by FY18, led by M&A and organic growth in the US and Africa. We expect US revenue to grow 36% CAGR over FY15-18, led by doubling of product portfolio and market share gains in the current portfolio. We expect Africa to grow 24% CAGR over FY15-18, driven by branded business and gains from local manufacturing. We expect reported margins to see 320 bps improvement to c22% by FY18, driven by improved mix in the US, Africa and CRAMS business, and backward integration of Institutional and Australian businesses.
Shasun — a booster for base business: In September 2014, Strides announced its merger with Shasun. The merger is a gamechanger for Strides business, making it a vertically integrated global pharma player. The merger provided Strides with three key assets: (i) an API backend which it currently lacks for its products, (ii) strong R&D team with complementary therapeutic focus and (iii) heavily under-utilised infrastructure. The acquisition provides additional drivers for its US and institutional businesses. The management focus post the completion will be on better utilisation of Shasun’s capabilities.