KamayaKya’s stock picking philosophy, Case Study: Gufic Bioscience Ltd.

Our research team at KamayaKya looks at the following factors when pitching a stock idea:

1. Skin in the game, no cheap equity dilution and clear succession planning: a high promoter shareholding of 50% and above is preferred. The promoter stands to lose more if things go wrong. This shows the conviction of a business owner. We have seen that no clear succession plan can cause an overhang in the company due to a key man risk, there should be competent candidates in such a case.
2. Manageable debt: Debt to Equity below 1.25. Net debt free companies can tackle tough operating environments and survive a crisis. Weak balance sheets tend to go bust in such times.
3. Moated/niche products and services which can create barriers to entry: Now imagine a smallcap company starts an oil refinery similar to that of Reliance. They would have pricing power nowhere close to that of Reliance due to the sheer scale, brand power and economies of scale. Not saying the company won’t be profitable, but will it create value? Doubtful. We look for companies with some sort of USP or moat where there are certain capabilities with very few players in the market. This allows pricing power, higher operating margins and creates barriers for new entrants, which expands market share in their segment. Due to this, a switching cost for a customer can also be very high which would increase the customer’s stickiness or retention.
4. Optionality value: Companies which have received patent approvals, tied up with a JV partner to start a new and novel revenue stream which can change the trajectory of the company going forward.
5. Technocrat promoter/ impressive new management changes: The person who is in charge of the business must be equipped to handle all nuances of the business and should be adequately qualified with in-depth knowledge of his industry. New KMP hires are kept a watch on as they can make crucial changes in the running of the business. An honest, hardworking management can make or break the business. That’s why our team interacts with the management prior to recommendations in order to gauge their quality and energy.
6. Promoter should be communicative and not be in a hurry to create value: We have noticed companies who often take analyst calls and dish out fancy presentations using the hottest buzz words the market enjoys hearing when the going is good and then disappear during periods of declining sales and profitability. A solid promoter can face the music. We appreciate companies who communicate in such times and are conservative in their guidances. Undercommitting and overdelivering is ideal. We compare past guidances to actual performance to judge management quality and track record.
7. Capital allocation: Companies with ROCE’s and ROE’s of 15% + are considered sensible allocators and these are one of the parameters we use for screening. Smallcap companies paying out excessive dividends instead of investing in further growing the business is not value accretive according to us. We would prefer higher dividend yields in mature large caps.
8. Reducing working capital cycles: Faster debtor collections, improved terms with suppliers and quicker inventory turnover help in improving cash conversion cycles and in turn improve the ROCE’s of the business.
9. Sales and Earnings growth triggers: Revenue growth of a business on a 5 year CAGR basis should be higher than the GDP growth in the same time period: If the company is unable to do so, something’s not going right! Capacity expansion (additions to gross block with high asset turns) coming onstream when the demand is strong, debt reduction, operating leverage (margin expansion) due to economies of scale and higher margin or value added products, favourable government policies, schemes (eg: PLI, anti dumping duty etc) are some earnings growth triggers.
10. Dealer network/ channel expansion and other qualitative aspects: Companies rapidly expanding their distribution base helps increase awareness of the product which can grow their sales and increase mindshare for the consumers. We also track the social media, Google analytics, Glassdoor employee reviews of the companies we recommend to see their digital initiatives, hiring plans and morale of employees.
11. Corporate Governance and Forensic Checks: Multiple factors such as independence of the board, related party transactions, litigations, contingent liabilities, frequent company name changes, non compliances, promoter pledge etc are analysed. The quantum and materiality of it is more important to interpret. We also look at frequent auditor changes and KMP resignations. While analysing financials, we study the EBITDA to OCF conversion, debtors as % of sales, KMP remuneration as a % of PAT, lavish purchases by promoters and provisioning.
12. Terminal Value and reasonable entry valuation: Will this business exist in the long run or will it turn obsolete? We look for businesses which have longevity and will not lose relevance in the coming future. When we buy a stock, we see the earnings growth CAGR and the stock price CAGR over time periods to understand how much valuation re-rating has already been done. We do not like entering when most of the re-rating has already been captured. We buy stocks where the TAM (opportunity size) is huge and available at a reasonable price with growth triggers where there is scope for the multiple to expand. A bonus would be that the stock is not identified by institutions, while allows cheaper entry prices due to being a hidden gem.

Case Study

Now let’s take each of the above points into consideration and apply it to Gufic Bioscience Ltd as a case study. We have recommended this stock to our subscribers at Rs 212 in Dec 2022. CMP is Rs 321 and is still part of our BUY recommendations. Our team is personally invested in the stock with a high allocation.

1. 72.5% promoter holding where 3.32% shareholder equity was diluted and placed to Motilal Oswal at Rs 300 to raise Rs 100 cr. for debt reduction. Market price at the time was Rs 273, so it was diluted at a premium.

While there is a key man risk in Mr Pranav Choksi (son of Mr Jayesh Choksi), Gufic’s team is filled with highly experienced employees which mitigates this risk.

2. Declining debt to equity ratio from 1.27 (2016) to 0.9 (Mar’2023), this will further reduce once the 100 cr raised for debt repayment will reflect in Mar’24 balance sheet.

3. The company is moated with differentiated products, better scale and continuous launch of new products through innovation. It is a pioneer in Lyophilisation and is one of the largest manufacturers of Lyophilised Injections in India with a wide range of products in various therapy areas. In lyophilisation, the economies of scale and the pipeline are its USP, where GBL offers a lot of products for the first time in India and they offer some new drug delivery systems which may occasionally be a pioneering achievement on a global scale. The company is also venturing into futuristic therapy areas like — Biologicals (which is the core competency of the management) and Immuno-Oncology. The entry barriers for anyone to get into the biological are tougher since it is more complex. Gufic is the first Indian company to make Botulinum Toxin from scratch and the Indian market has a potential to reach ₹2,000–3,000 Cr from the current size of ₹150 Cr. GBL has taken Botulinum Toxin range of products beyond the aesthetic dermatology where company has the first mover advantage with launch of Zarbot, targeting Cerebral Palsy, Migraine and Over Active Bladder. Gufic spends about 10% of its turnover on R&D.

4. Gufic has received multiple patent approvals which shows their consistency and strength in R&D over the years. They have also tied up with many partners for niche therapies such as cancer immunology, botox etc.

5. Gufic’s young CEO, Mr Pranav Choksi is a technocrat.He completed his Bachelor in Pharmacy from the Institute of Chemical Technology, University of Mumbai (ICT/UDCT) and Masters in Biotechnology from The John Hopkins University, USA and has also done specialization in Autologous Cancer Vaccines from US.

6. Concall has been done every quarter since Jun’21 quarter. Mr Choksi is conservative with his guidance. In his AGM speech, he spoke for close to an hour regarding the company’s future plans. We enjoy listening to passionate promoters.

7. and 8. Consistent improvement in working capital and ROCE. March 2023 worsened as Gufic was setting up business channels with hospitals which stretched receivables, inventory and operating cash flow. On being questioned about this, the management guided for reversal in FY25.

9. Gufic 5 year sales growth has been 18% and their capex coming onstream in Q1FY25 should contribute to growth as capacity utilisation picks up leading to operating leverage. We expect their EBITDA margin to range between 21–22% in the next 3–4 years.

10. Gufic’s Critical Care brands have penetrated over 1500 hospitals and are recognized as the preferred choice by the medical fraternity.

11. Governance checks:

Quantum of related party transactions was not significant to be red flagged.

Data snippet which was part of our initiating coverage report in Dec’22

12. We entered Gufic at 25x TTM PE and 16x EV/EBITDA. Due to the future growth prospects, we continue to accumulate the stock at current levels for a long investment horizon as the valuations are not out of whack but they are not cheap by any means.

Looking at the above 5 year stock price CAGR data, there has been re-rating from its median valuations in the last 1 year but still not to the extent of the 5 year earnings growth.

If you enjoyed reading, do check www.kamayakya.com and kamayakya.smallcase.com

Author:

Mr. Nitya Shah, co-founder and Director of Research at KamayaKya Wealth Management Pvt. Ltd. (nitya@kamayakya.com)

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