Poly Medicure Management Q&A: July 2011

Management Q&A

1. POLY MEDICURE HAS HAD A NICE RUN OVER THE LAST DECADE. SALES AND PROFITS HAVE GROWN AT OVER 25% CAGR. THAT’S A DECENT ACHIEVEMENT. CONGRATULATIONS!

What are the future plans? Where does the company see itself in the next few years? We have recently heard the company talking of a 300-400 Cr turnover goal – by 2013. That’s like a 30-50% plus CAGR for next 2 years. Kindly explain the reasons behind this optimism/aggression.

We have been able to grow at a 25% CAGR over the long term as noted by you. We have had a few significant successes in the last year – getting USFDA approval for our Faridabad facility, introducing Safety IV Cannulae product- these developments are likely to help us leverage new contracts and increase order flows. We should be able to register a 30% CAGR comfortably for next 2 years.

2.     SAFETY DEVICES MARKET IS REPUTED TO BE A $1BN CURRENT MARKET. A 5% MARKET SHARE IS WHAT IS BEING AIMED AT BY POLY MEDICURE IN THE NEXT 2-3 YEARS, OR $50MN FROM SAFETY DEVICES ALONE.

You have successfully defended patent infringement suits by B. Braun (Safety IV Cannulae products) in the recent past –both in Indian & German courts. What is the current status? Does this make Poly Medicure only the second player in the world after Braun to manufacture this product for developed markets? How many players and how is the competition in this segment. How has the company seized the opportunity in Safety IV Cannulae devices? Any major wins in outsourced contracts?

Yes we were successful in defending the patent infringement suits by B. Braun. So far there has been no further developments, and we have been shipping this product as planned. Globally there are 5-6 players. B. Braun is the market leader and holds 50-60% market share.
We are ramping up production capacities and will be able to start shipping this product in bulk by Q3/Q4 FY12.

3.     USFDA APPROVAL RECEIVED FOR FARIDABAD PLANT IN DEC 2010

Kindly explain the significance of this development for Poly Medicure’s plans for the developed markets. How has the company benefited from this in FY11? Will FY12 see the company extracting the most of this opportunity.

As you are aware USFDA approval was received in Dec 2010. This is a significant development coupled with our Safety IV Cannulae product development. In the US Market, safety feature is a must. We have started exports to US in small numbers in FY12, the full benefit of this will be available to us in FY13.
For the US market we are introducing a number of safety products including Safety IV Cannulae, Safety Catheters, Safety Blood Collection Holders, among others.

4.     PRODUCT SEGMENTS. SAFETY DEVICES, BLOOD BAGS, OTHERS

Kindly give us an idea of the revenue contribution & margins from major product segments. Which segments are expected to drive growth in next 2-3 years, where is the company’s focus and why?

IV Cannulae contributes ~45% of Sales today. IV Sets, Blood Bags, Catheters, Blood Transfusion Sets contribute another 20-25% Sales. Balance 30% comes from a variety of other small products. Margin contributions vary in the range of 18-25%.
All segments are growing strongly. Safety devices should see a spurt in the next 2 years as contribution from this segment is expected to go up from 7-8% to 15%.

5.     BLOOD BAGS SEGMENT.

Recently we saw an announcement by the company on a contract for supply of single Blood Bags for total consideration of INR 12.93 Cr from Ministry of Health & Family Welfare. Please share the significance of this order, does it open up this segment for major growth for Poly Medicure?

Blood Bags segment has been a steady growing segment for us in the last few years. Yes this is a major order from National Aids Control organisation (NACO), and the single largest order so far in this segment. Sales for this segment so driven by Govt. Tender supplies or to Hospitals which is License based.

6.     CUSTOMER SEGMENTS –TOP CUSTOMERS & REPEAT BUSINESS

Who are your top Customers? How much do your top 5 customers contribute in revenues? Does any customer contribute more than 10% of Sales?

International OEMs are some of the top customers. Top 5 customers contribute 30-35% of our Revenues. Sales are evenly distributed and no single customer accounts for more than 10% of Sales.

7.     EXPORT MARKETS. SALES & MARKETING. OUTSOURCED MANUFACTURING FOR OEMS.

Exports contributed some 58% of Sales in FY10. Kindly explain your sales & marketing set-up for developed markets. What contribution is expected from outsourced manufacturing contracts? Are margin contributions likely to be much higher in outsourced contracts for Safety IV Cannualae. What is the split between Europe and US markets currently, and what is the picture for next 2-3 years?

In most countries medical kits supplies are a Tender driven business. In overseas markets we go through distributors. 50% of the supplies are for OEMs and 50% under Poly Medicure brand. There isn’t much difference in margins.
Europe accounts for ~45% of exports. US market supplies have started in a small way which should go up significantly in the next 2 years.

How about the domestic market? Is your sales process any different here?

As mentioned before, this is mostly a Tender driven business in India. Roughly 60% of our domestic sales comes from Tenders, which is addressed by our direct sales force. The sales force also addresses major hospitals in Metros. About 15% of additional sales come from Direct Sales and the rest comes through distributors.

8.     PRODUCT PRICING. SAFETY IV CANNULAE

Kindly give us a sense of product pricing on IV Cannulae vs Safety IV Cannulae and the margin contributions.

Well a IV Cannulae from Poly medicure typically sells for Rs 5 or 5.5 and a Safety IV Cannulae we can sell at Rs.17, though the addition raw material cost is hardly 50 paisa to a rupee. B. Braun sells the Safety IV Cannulae at Rs. 45-50. (They can provide finer guage of needles for kids & babies). Internationally too, the prices are in the same range.

9.     MARGINS & PROFITABILTY. SUSTAINABILITY

After a dismal FY08 and FY09, Poly Medicure registered an Operating margin of over 22% and Net Margin of over 12% in FY10. This was sustained, infact marginally improved in FY11. Return on Equity (28%) and Return on Capital Employed (25%) are back to robust levels for the last 2 years. How sustainable are these going forward? Are margins and profitability on an upward trend consider significance of new product segment and volumes coming from there?

Margins shopuld show an uptrend considering volume increases and other cost-cutting measures undertaken by us including waste recycling. 30% growth in earnings is a given.

10.  FOREX DERIVATIVES CONTRACTS – FY08 AND FY09 SAW THE COMPANY TAKING A HIT ON ACCOUNT OF DERIVATIVE CONTRACTS ENTERED INTO BY THE COMPANY TO HEDGE THE RISK OF CHANGES IN FOREIGN CURRENCY EXCHANGE RATE ON FUTURE EXPORT SALES AGAINST EXISTING LONG TERM CONTRACTS.

Outstanding as at March 31, 2010 for hedging currency related risk aggregate to Rs. 118.54 Cr (Previous year Rs. 197.73 Cr). What is the current position on this front? How much of a risk does this currently pose? When will these contracts finally be over?

There are 3 outstanding contracts, out of which one will expire in Sep 2012, and another 2 will restart from Oct 2012, but for only a year. We continue to hedge these using simple 1 year forwards. Having learnt our lessons, we monitor these movements very strictly. We don’t think there is any major risk from these.

11.  CAPITAL EXPENDITURE. TO GROW SALES, POLY MEDICURE NEEDS TO CONTINUALLY INVEST IN CAPACITY EXPANSION. WE HAVE HEARD OF INVESTMENTS OF RS.100 CRS IN CAPACITY EXPANSION.

What is the current capacity? How much was the capital expenditure incurred in FY11 and what is the expected ramp up in the next 2-3 years?

25 Cr has been invested in FY11 towards new building and machinery. Another 25-30 Cr is being invested in FY2012 towards increasing automation. Balance 40 Cr is looked to be invested in the Jaipur SEZ at an appropriate time.

12.  DEBT POSITION. FUNDING

FY11 debt stood at 40 Crs. What is the current debt position? How much additional debt is likely to be taken to fund current capacity expansions?

Debt levels including working capital will remain at similar levels in FY12.

13. EUROPE AS A MARKET. EURO AS A CURRENCY. RISKS

How much of company’s sales comes from Europe. And is this booked in Euros or US$? Given the serious economic environment in Europe currently and the attendant risks both on the market and the currency, what is the sense that you are getting from your customers, and what has been the impact, if any? What steps are being taken to mitigate these risks?

As mentioned before 45% of Exports are from Europe. Roughly 15% of such sales are booked in Euros, and the balance is all booked in US$.
Our existing customers in Europe are large players and we have a long relationship with them. We haven’t got any sense of slowdown in business from them, so far. Yes, Euro as a currency has been fluctuating a lot. We hedge our Euro Sales on simple 1 year forward contracts.
Any new players we are booking sales on 100% advance basis.

14.  MANUFACTURING FACILITIES BEYOND INDIA. THE COMPANY HAS BEEN TRYING TO SET UP A MANUFACTURING FACILITY IN SOUTH AMERICA FOR SOME TIME NOW. ANNOUNCEMENTS HAVE BEEN MADE A FEW TIMES, BUT NOTHING HAS FRUCTIFIED SO FAR.

Besides manufacturing facilities in India, you already have a manufacturing facility in Egypt and another in China. There seems to be a focus in the company for locating manufacturing close to important markets, but the contribution has been negligible so far? How has been the experience managing these facilities and what has been the progress? When will these contribute significantly to topline and bottomline?

The Egypt JV is a different type of project where we provide consultancy, machinery and some of our products on a 10% markup/commission basis. So that’s an entirely different project.
The Chinese facility is expected to break even in FY12. But more importantly it has been a great source of RM sourcing for us -from China, and neighbouring regions. The savings on the sourcing side has been ~20%.

Why is the South American presence so important? Is it for the Brazil market or catering to US market?

Well we have been looking to acquire a manufacturing facility in these markets. Brazil can be a very important market to gain access to. If we get some manufacturing facility in Europe at a reasonable price, we are open to that too.

15. OVERSEAS ACQUISITION.WE HAVE BEEN HEARING OF AN ACQUISITION IN TEH RANGE OF $20-30 MN FROM TIME TO TIME.

What is the focus here? Is it to acquire a manufacturing facility or a sales & marketing set-up in developed markets?

Nothing has materialised so far. We are keen on acquiring a manufacturing facility close to developed markets where we can draw synergies form our production facilities, at the same time get increased market access for our products.

16. COMPETITION. PLEASE TELL US MORE ON THE COMPETITION YOU FACE FROM BITH DOMESTIC AND MNC PLAYERS IN THIS MEDICAL KITS & ACCESSORIES BUSINESS.

Hindustan Syringes are the biggest players in our niche, but only 10% of our product lines co-incide, as they concentrate mostly on syringes, which we do not manufacture. Then there is Eastern Medikit who compete directly with us on the whole product range, but they have poor financials. Besides them there is the Romsons group which has 6 brothers operating different facilities. Effectively we are the 2nd largest player in this segment.

MNC presence is small. There is a MNC player Bechtel Dickinson who have set up an ultra-modern plant in Manesar, Haryana. The plant set-up cost is 3x ours of comparable capacity. They cannot compete head-on with us and restrict themselves to the high-value niche segment.

17. RAW MATERIALS. RISKS

Raw Material is ~40% of Sales. With a rising crude prices scenario, raw material prices must be a cause for strain. Kindly explain how the company manages raw material price volatility risks.

As you mentioned raw materials is some 40% of Sales, and so far we have been able to manage the volatility without significant impact.

18. TAX BENEFIT WITHDRAWALS. IMPACT ON MARGINS.

Effective tax rate for the company in FY10 and FY11 was under 10%. Now with the withdrawls in the benefits, what is the likely tax rate for FY12, and how significant will be the impact on net margins and growth? Any impact on Jaipur SEZ plans also because of the SEZ Tax exemptions being withdrawn too?

Yes, there will be significant impact on account of this. We are hopeful of minimising the impact through higher depreciation in our accounting and the margin expansion that is likley to accrue form the new products.

19. SHAREHOLDING PATTERN

Company has 48% in promoter holdings and then about 37% by persons holding more than 1% (few bodies have been holding since several years). Please throw some light on the shareholding pattern. Are some of these parties part of promoter group?

Most of these are people known to the Promoter group – not part of the promoter group. These people are long term shareholders. When our share price was in the RS 10-15 range, they have not exited and now that they know the company is on an inflection point, they are unlikely to exit their holdings.

20.  MAJOR OPPORTUNITIES & CHALLENGES

Where does Poly Medicure see itself in the next 5 years? What is the size of the opportunity in its niche? Can we see Poly Medicure reach 1000 Cr Sales, by when? What are the major challenges before the company and where are the big opportunities?

Well we are on course to register a 25%-30% growth for the next few years. The significant developments in FY11 should see us win major contracts from OEM suppliers and increase our presence in developed markets like the US. So this growth itself should take us to 600 Cr in the next 5 years. Any Acquisition that we do is likely to add to that and help us in reaching the Rs 1000 Cr mark.
The main challenges are in scaling up to meet the growth in demand. Funding is not an issue, but Labour orientation and skills training is a major challenge. We are also trying to increase automation in our factories to help on this front.

Disclosure(s)

Ayush Mittal: More than 5% of Portfolio in the Company; Holding for more than 2 years;
Donald Francis: No Holdings in the Company; ;
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