Firm strides

GUEST COLUMN/ TORCH-LIGHT

We back Strides Arcolab as a potential multi-bagger from the mid-cap pharma space. I visited the company's headquarters in Bangalore recently and, following a meeting with its top officials, left convinced that we have been backing the right stock.

Strides Arcolab has realigned its market focus with an entry into the regulated markets - US, UK, Japan, Europe, Australia, New Zealand and South Africa - in partnership with pharma majors. The company's profits were affected in the past due to adverse forex movements in Brazil, its key market. So it undertook a series of crisis-management measures, enhancing its performance subsequently.

The company has signed a pact with Sorm Co, Japan, for the supply of generics, over-the-counter (OTC) and nutraceutical products. As per the pact, Strides will be Sorm's 'priority global manufacturer' for OTC and nutraceutical products.

In the first phase, Strides will supply 16 OTC and prescription (Rx) products. It will also undertake developmental work on 34 additional products. Strides has already received contracts for four products worth Rs 250 million.

The two companies have also agreed to form a joint venture (JV) in Japan to get a lead in the emerging opportunity for generic drugs in the country where Strides will be the exclusive supplier to the JV.

The company also intends to emerge as a cephalosporin pharmaceutical major for the regulated markets. It has signed a pact with Ribbon SRL of Italy for a 50:50 venture to manufacture and market cephalosporin formulations for the regulated markets.

The JV will leverage the high chemistry skill sets of Ribbon, using Ribbon's multiple Certificate of Suitability (CoS) and European Drug Master Files (EDMF)-approved actives.

Strides has also signed an agreement with Aspen Pharmacare, Africa's largest generics manufacturer. Aspen is a major supplier of branded pharmaceutical and healthcare products to South Africa and select international markets and has subsidiaries in UK and Australia.

Its co-operation with Strides extends to anti-retrovirals (ARVs) not already manufactured by Aspen and to the sharing of quality systems and product development expertise.

For the fiscal ended September 2003, Strides' sales were Rs 266 crore, net profit was Rs 6.3 crore and earning per share was Rs 1. Whereas the financials for the last two years capture the turnaround story, they do not indicate the immense potential that the company holds out for the next couple of years.

Like many other mid-cap pharma stocks, the share price of Strides, too, has been volatile, having risen from Rs 85 to around Rs 250, before falling back to around Rs 110 and then rebounding to the current price of around Rs 190. However, those who back Strides as a growth stock - as we do - would have stayed invested, anticipating opportunities that lie ahead.

Meanwhile, amid the excitement in the secondary market, SAL Steel (SSL) entered the primary market on November 1, 2004, with a book-built public issue of 4.2 crore equity shares of Rs 10 each. The price was fixed at the higher end of the Rs 12-14 band.

The stock was listed at Rs 20, yielding a gain in excess of 40 per cent. That there was some profit-booking thereafter (that brought its price down to the Rs 17.50 level) suggests that the greed factor is not yet as unbridled as it can be.

The company planned to set up a sponge iron plant, ferro-alloys unit, rolling mill unit and captive power plant in Gujarat, using the issue proceeds. State Bank of India estimated the cost of the project at Rs 203.3 crore. The debt-equity ratio stands at 1.3:1. The first phase of the project is expected to commence towards the end of this month.

The company was set up as a backward integration initiative by its parent, Shah Alloys group. Hence its major customer is its parent. This would not only link SSL's fortunes to that of its parent, but minimise its ability to drive margins. Furthermore, there might be product overlaps that could lead to a conflict of interest.

It is a fact that there is an over-supply situation in the steel sector worldwide due to high capacity addition in South-East Asia and recessionary trends witnessed by steel-consuming sectors.

Cheaper availability of gas could have an unfavourable impact on SSL whose sponge-iron plant will be coal-based. The promoters' contribution to the project stands at a healthy Rs 46.4 crore which enhances the credibility of their commitment.

Another plus is the parent company's post-public issue record. It surpassed the projections it had made, notwithstanding a poor start.

Given SSl is yet to commence commercial production, there are no financials that merit comment. While it is unlikely to set off post-listing fireworks at the bourses, there might be investors who queue up for the long haul that lies ahead with a capital intensive project such as this. That alone can explain the spectacular listing of the company with a long gestation period project.

(The author heads Lotus Knowlwealth, Mumbai, and can be contacted at ceolotus@hotmail.com. Disclosure: He has an outstanding interest in Strides Arcolab.)