Analysis

_{November 15, 2023}

Sector: Pharmaceuticals

CMP: ₹603 per share

Market Cap.: ₹1,207 crores

Briefing

Lincoln Pharma reported revenue, operating profit, and net profit growth of 11 percent, 8 percent, and 15 percent, respectively, for the quarter ended 30 Sept. 2023 (Q2FY24). A disproportionate rise in other expenses adversely impacted operating profit for the quarter, however, this was more than compensated by a higher other income that led to better net profit growth.

The management appears to be optimistic about the company’s prospects. “We expect better growth in Q3 and Q4 of the financial year, driven by new product launches in both the domestic and export markets, as well as improvements in operational efficiency and higher-margin products. With the robust growth initiatives, product and geographical expansion, and operational efficiency, we expect to achieve revenue of ₹ 750 crores in FY26,” said Mr. Mahendra Patel, Managing Director of Lincoln Pharma, in a press release post-result. Moreover, after the successful completion of the expansion, commercial production started at the Cephalosporin plant at Mehsana, Gujarat. The plant is expected to contribute sales of ₹150 crores in three years.

The company has a global presence in 60 countries – principally from Africa, Central America, and Southeast Asia. In FY23, it received 57.40 percent of its annual revenue through exports; the share of exports in revenue was 25.50 percent a decade ago. It intends to gradually expand its presence to 90 countries over the next 2 – 3 years. It has already obtained product registrations in East & West Africa, Southeast Asia, and Latin America. Additionally, the drug approvals from the European Union and Australia, which it received in recent years, are expected to enhance its credibility and presence in global markets.

Moreover, it is strategically developing its portfolio in the lifestyle and chronic segments, with a special focus on women’s healthcare and dermatology, which is expected to complement its existing strong presence in the acute segment. The company is also considering establishing a USFDA facility in Gujarat to expand its global footprint further and capitalise on export opportunities.

The stock sustained its high gross profit margins – a key indicator of competitive position – during the quarter. The stock’s return on equity (RoE) – the key measure of profitability from shareholders’ perspective – improved marginally during the quarter: it gained 0.1 percent quarter-on-quarter (QoQ) and 0.4 percent year-on-year (YoY).

However, RoE, measured exempt of other income, declined marginally for the quarter. This indicates that ‘other income’ drove Lincoln Pharma’s profitability this quarter. The ‘other income’ for Lincoln Pharma principally comprises interest income, capital gain on investments, and foreign exchange gains. Only growth and profitability that are sustainable do add value to a stock, and only growth and profitability that arise from a firm’s operating activity are sustainable: considering which, Lincoln Pharma’s Q2F24 performance appears muted.

However, the market’s reaction to the results wasn’t that muted, rather it seems elevated. The stock is up 22 percent two weeks after the results and has gained 70 percent in 2023. Despite the gains, the stock’s current valuation – price-earnings multiple of 14.94 and price-to-book value of 2.21 – looks attractive. Our estimated fair value for the stock is ₹701.50 per share, and at this price, it will have a price-earnings multiple of 17.38 and a price-to-book value of 2.57.

Insight

Perhaps, the most remarkable thing about Lincoln Pharma would be the sizeable insider buying. The promoters hiked their stake in the company by 1.86 percent from the previous quarter. The promoters’ shareholding currently stands at 50.53 percent. The promoters have increased their shareholding from 32.41 percent to 50.53 percent over the last three-and-a-half years. Buoyantly, foreign institutional investors have been increasing their shareholding in Lincoln Pharmaceuticals too. In Q2FY24 alone, the FII stake rose from 1.74 percent to 2.59 percent. Their shareholding increased from zero to 2.59 percent over the last two-and-a-half years.

However, the stock is not devoid of risk. The two most conspicuous risk factor is a significantly high working capital on its books and a poor dividend payment history. The trade receivables of ₹173.10 crores as of 30 Sept. 2023 is equivalent to 32.18 percent of annual sales. Also, the net working capital (inventories + trade receivables – trade payables) equals 30 percent of annual sales. These figures are perturbing. Moreover, the dividend payment had remained stagnant – at ₹1.50 per share – over the last six years, despite the doubling of net profit over the same period.

We have been bullish on the stock since early 2021 when the stock was trading at ₹235 per share, and we are still bullish. Since the stock price has spiked significantly in recent weeks, it would be prudent to buy the stock until the price reverts to its 50-day or 100-day moving averages.