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CDMO stands for contract development and manufacturing organisation

The CDMO industry started out decades ago as a niche service, offering additional manufacturing capacity or specialty services to pharmaceutical companies. The rise of the CDMOs was fuelled by failure stories in the pharmaceutical industry. In the past, pharmaceutical companies often installed dedicated manufacturing capacities for innovative drugs in development, only to see them fail during phase III of clinical research trials. Thus, the additional manufacturing capacity for the specific drugs was no longer needed. To reduce the risk of expensive over-capacities, the demand for outsourced manufacturing has been rising continually.

Source

In this post we will look at some players through charts to get a sense of whats happening in industry

While Divis Lab is the big daddy as far as market cap is considered, Jubilant and PI are emerging as contribution from their CDMO business is increasing to their overall enterprise revenues

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And the second chart will probably partially answer on why Mr market is gung-ho about Divis, the sales momentum has been strong with sales growing 4.5X over a decade. Syngene and PI Industries have also a shown a stellar sales momentum by increasing their sales by 7X over last decade. Overall every company has done reasonably well growing between 2-4 times

When it comes to operating efficiency , Suven Pharma is out of Syallbus having operating margins over 45% . Syngene and Divis are cut above the rest. PI industries is consistently improving its operating margin while Hikal and Neuland are under some pressure for last few years. Laurus Labs is consistent ranker in this measure

So what is causing pressure on Neuland and Hikal’s operating margins is it raw material costs?

No while Hikal has maintained its material cost as percentage of sales, Neuland has improved it significantly in last one decade . Another clear insight from this chart would be Suven and Syngene are research heavy while others are balanced or manufacturing heavy. This is also partially revealed when you look at next chart

The employee cost charges makes it very clear that Syngene is research heavy and spending almost ~30% of its revenues on employees (scientists primarily). Neuland’s subdued margins can be explained now – they are heavily investing in building team. Laurus labs have also increased their spending on building capabilities

 

Having looked at present,Now we will shift our focus to future or at-least try to 🙂 All CDMOs have grown big in size the below chart on their fixed assets depicts this

What is not visible from above is who is the most aggressive? The next chart clearly answers that question

Neuland and Syngene have been ramping their capacities significantly increasing them by 5X and 4X in last 5 years , PI Industries is close follower increasing their net block 3.5X overall as a group their net block has gone by 2.72 times

How are these players are funding their capex ?

All except Neuland have used internal accruals to fund their capex plans. I like businesses which can self fund their growth. However growth is one side of story what as investors  we should look for is profitable growth

This is where things get interesting

Looking as their ROCE one could say that operations are becoming cumbersome and additional capital / capacity are not yielding same returns . PI Industries and Divis are not near their 40%+ ROCE even Syngene, Neuland and Laurus have dropped their ROCEs . So have these business become lousy?

short answer NO

The answer is in below chart

Almost every company is sweating their fixed assets at a lower capacity than their 2015 self , e.g. if Neuland is able to repeat its feat in 2015 then the current sales can increase by 4X without adding Re1 to fixed assets. This is nature of industry –   CDMOs play crucial roles in providing additional capacities to mitigate the risk of supply shortages.

For me this is one of most important variable to keep track if you are invested in this sector

Bonus Chart if you stayed with me till end

Syngene’s obscene cash conversion cycle dwarfs everyone else

Players among above that worth considering are available in scorecard