Why are FIIs piling into Granules India?

The Hyderabad-based mid-cap has seen a substantial jump in FII holding

Ever since ace investor Raamdeo Agrawal disclosed the names of probable 100-baggers in his 100X study in December last year, investors have been closely tracking them. One such stock, Granules India has been in the news lately as it has seen considerable FII interest. After falling from 4.04% in March, 2015 to 2.85% in June, 2015, FII stake has increased to 7.25% in September, 2015. During the same period, DIIs have also increased their stake from 0.07% to 1.02%.

This institutional optimism is also echoed by analysts tracking the stock. "We expect the company to continue its growth momentum on account of moving up the value chain towards high margin business, improved capacity utilisation & capitalising Auctus Pharma’s portfolio," says Rashmi Sancheti, analyst, KR Choksey.  More importantly, margins are expected to inch higher, says another analyst. "We expect the company's EBITDA margins to improve from 16.1% in FY15 to 19.0% by FY18E and keep improving from thereon due to a change in business mix," says Jehan Bhadha, who tracks the company at Motilal Oswal.

Granules generates close to 80% of its revenues from exports, supplying Paracetamol, Ibuprofen, Metformin and Guaifenesin to about 300 customers. Over the last ten years the company has grown its sales at 24.5% and earnings by 32% annually. Along with growth, margins have also improved from 11% in FY11 to 16% in FY15. While growth might moderate on a higher base, the expectation is that the strong growth will continue for the next few years. The management is consciously moving from active ingredients to formulations and wants to increase the share of formulation business from 30% to 50-60% of revenues over the next few years. Compared to the ingredient business which has 10-11% margin, in formulations, the margin can be as high as 25%.

To keep the growth momentum going, Granules acquired US-based Auctus in February 2014 for ₹102 crore. Through it, the company wants to exploit the high margins formulation market in the US. That apart, it has also set up an joint venture with CRAMS manufacturer Ajinomoto Omnichem. Through this JV, Omnichem will get access to low cost manufacturing as its facilities are fully utilised. "As products go off-patent, companies look for low cost manufacturing. Granules, which recently expanded its capacities and is operating at 60-65% utilisation can scale up with high margins," says Sancheti.

Analysts expect that contribution in the coming years from Auctus and Omnichem JV will reflect both on volume and profitability. For instance, Auctus, which is expected to contribute close to ₹150 crore in sales, is on course to hit operating breakeven in Q2FY16. This means higher cash flows and a higher return on capital, which is estimated to move up from 19% in FY15 to 21% in FY17. Excluding the JV and contribution of Auctus, the company has a return on capital of 26%. With most of its capex behind it, the increasing cash flow will help in reducing debt (currently at ₹481 crore) and further improve margins.