Syngene International Ltd (SYNGENE) Q3 FY23 Earnings Concall Transcript

Syngene International Ltd (NSE: SYNGENE) Q3 FY23 Earnings Concall dated Jan. 24, 2023

Corporate Participants:

Avantika Mishra — Associate – EY

Jonathan Hunt — Managing Director and Chief Executive Officer

Sibaji Biswas — Chief Financial Officer

Analysts:

Tarang Agrawal — Old Bridge Capital Management Pvt. Ltd. — Analyst

Surya Patra — PhillipCapital (India) Pvt Ltd — Analyst

Presentation:

Operator

Ladies and gentlemen, good day and welcome to Syngene International Third Quarter Ended December 2023 Financial Results Conference Call. As a reminder, all participant lines will be in the listen-only mode and there will be an opportunity for you to ask questions after the presentation concludes. [Operator Instructions] Please note that this conference is being recorded.

I now hand the conference over to Ms. Avantika Mishra from EY. Thank you, and over to you, ma’am.

Avantika Mishra — Associate – EY

Thank you, Rujitha and good afternoon, everyone. Thank you for joining us on this call to discuss Syngene’s Q3 FY ’23 financial and business performance.

From the management side, we have Mr. Jonathan Hunt, MD and Chief Executive Officer; Mr. Sibaji Biswas, Chief Financial Officer; and Dr. Mahesh Bhalgat, Chief Operating Officer.

Post opening remarks from the management, we will open the line for Q&A and we’ll be happy to answer any questions you may have.

Before we begin, I would like to caution that comments made during this conference call today will contain certain forward-looking statements and must be viewed in relation to the risk pertaining to the business. The Safe Harbor clause indicated in the investor presentation also applies to this conference call.

The replay of this call will be available for the next few days and the transcript will be subsequently made available.

With this, I now hand over the call to Mr. Jonathan Hunt. Thank you, and over to you, sir.

Jonathan Hunt — Managing Director and Chief Executive Officer

Thank you, and good afternoon to everybody. Thank you for joining us on the call today to discuss Syngene’s performance in the third quarter. I’ll start by commenting on the headline numbers and then move on to some key operational and strategic highlights for the quarter. Sibaji will provide a more detailed insight into the financials in his remarks.

I’m pleased to report that we continue to see good demand in our main client markets of the US and Europe, which combined with strong execution and good forward planning helped us deliver solid revenue growth in the third quarter. In addition, I think we had a busy quarter working with regulators. During the quarter, we received regulatory approval for our commercial biologics operations from the USFDA, from European Union’s EMA, and the UK’s MHRA. Pleased to have these audits behind us, but more importantly, we’re delighted to see that our commitments of high operating standards was endorsed.

All four divisions performed well during the quarter. Revenue from operations grew by 23% to INR786 crores over the corresponding quarter last year. Operating EBITDA was up around 14% to INR231 crore. Profit after tax was up 5% over the corresponding quarter last year to INR110 crore. On the back of robust first half of the year, performance during the third quarter was steady and we continue to make progress on our strategic priorities.

I think overall, we’re well-positioned to deliver our guidance for the full year. So turning now to each of the operating divisions, starting with Discovery Services, which grew steadily through the quarter. Our second campus in Hyderabad continued to expand and now in place and increased the important role in our discovery chemistry operations. In the last nine months, the number of scientists has increased to around 800 and we expect the completion of an additional 24,000 square foot of lab space and a new compound management facility in the current quarter. This gives us further space to grow as well as enhancing our capabilities.

Growth in Development Services was driven predominantly by repeat orders from existing clients, as well as an increase in the number of collaborations with emerging biopharma companies. During the quarter, we continued to invest in new infrastructure and capability development. For example, we completed the construction of a state-of-the-art, sterile fill-finish facility for small-scale clinical manufacturing. Facility successfully completed the CDSCO joint inspection and we expect to start GMP production this quarter. This facility offers us the ability to offer end-to-end solutions in drug product development and manufacturing for clinical supplies about small and large molecules.

Turning now to manufacturing services. Overall, we made good progress on our strategic milestones for the quarter. As I mentioned, we successfully completed the USFDA, EMA and MHRA regulatory audits for our commercial scale biologics manufacturing facility. So cGMP certifications from the regulators aided to good place, we’re on track to manufacture drug substance at commercial scale and make progress on the biologics growth strategy.

So to summarize before I hand over to Sibaji, overall, the demand environment remains broadly positive. To capture these opportunities, we continue to invest in digitization, capability building and additional infrastructure development. All divisions have shown steady growth over the past nine months and we expect to complete the fourth quarter. The positive outcomes during the course of the three major regulatory and it’s in a very positive step forward in enabling our commercial scale biologics strategy. So overall I think we’re confident that we’re on track to deliver our annual revenue growth of guidance of high-teens.

So with that let me hand over to Sibaji to provide more details on the financials.

Sibaji Biswas — Chief Financial Officer

Thank you, Jonathan, and a very good afternoon to you all. Let me start with the revenue performance then take you through margins, profitability and capex investments for the Company and end with thoughts on the outlook for the full year FY ’23, which is in line with the upgraded guidance given at the end of the first quarter. I’ll cover the third quarter performance in the beginning and then we will briefly touch on the nine months performance.

Like the previous two quarters, you will hear me referring to underlying performance in parts of my comments. Just to be clear, this is performance excluding the impact of remdesivir manufacturing, we recorded high sales of remdesivir during the past financial year, most of it in the first quarter. However, we did continue remdesivir sales last year till the end of the third quarter. As no remdesivir sales have been recorded in the first nine months of this financial year, we think it is helpful to exclude remdesivir from both periods to illustrate strength underlying performance of the business.

As you’ve heard from Jonathan, the reported revenue from operations for the third quarter grew by 23% versus the same quarter last year. Underlying revenue growth, that is excluding remdesivir was stronger at around 28%. This performance come on back of a very strong first half where we had an underlying growth of around 13%. Growth was primarily driven by continued good performance from the Discovery Services division and strong performance from manufacturing division driven by biologics. Development Services also grew well, but the growth was relatively modest due to spillover of execution to quarter four.

Overall, reported EBITDA for the quarter was up 15% year-on-year to INR248 crores compared to INR216 crores for the same period last year. The reported EBITDA margin for the quarter was at 30.9% versus 33.1% last year. EBITDA from operations that is excluding other income came in at INR231 crores, compared to INR203 crores in the same quarter last year, up by around 14%. The operating EBITDA margin which is without other income was 29.4% for the quarter compared to 31.7% last year.

To understand the operating leverage equation, it is important to look at the P&L restated at the hedge rate, which form the basis of our guidance at the beginning of the year. Our reported hedge rate is based on average values of the forward and option contracts for the period and builds in the structural long-term rupee depreciation versus the US dollar. The forward rate which is generally higher than the spot rate provides partial cover for the Indian inflation which shows up in the expense lines. The hedge rate revenue growth was at high-teens this quarter. However, EBITDA growth for the quarter was 15%. The EBITDA growth was a bit lower than the revenue growth, primarily due to achieved in fixed cost manufacturing, which currently has lower margins because of lower scale and capacity utilization. In addition, there are inflationary pressures on other operating expenses, which I’ll explain further.

During the quarter, staff cost increased by 12% year-on-year. The increase is in line with the increase in headcount and reflects salary increases and change in mix of the employee base. Other OpEx has seen a 33% increase versus the third quarter last year. This is primarily due to cost inflation as well as a step-up in business travel, sales promotion and other overhead. It is important to note that as we came out of the pandemic at the beginning of this year, we deliberately chose to invest in business and sales promotion activities including travel, which also drove-up costs.

Maintenance expenses increased as a reflection of the new facilities built over the last few years. Other operating investments, including the expansion of the commercial team and acceleration of digitization and automation project across the business also led to higher costs on a year-on-year basis. These are some of investments for the future and we should see benefits from these investments over the long run.

Other direct costs which primarily include power and electricity costs increased 7% year-on-year. And this now constitutes 3.4% of the revenue from operations for the quarter compared to 3.8% for the corresponding period in the prior year. In the current environment, we are seeing benefit of our investments in renewable energy, which is not only derisking the cost of energy supply, but also helping us make good progress on our environmental commitments by reducing carbon emissions. Despite an increase in total energy consumption, due to the expansion of our facilities, an increase in power and fuel tariffs, these investments provide us a mechanism to mitigate cost increases.

Revenue for the quarter was hedged at INR79 to the US dollar. Our margin guidance for the topline was given at the hedged exchange rate, while the average realized rate was upward of INR81 per US dollar. The depreciation of the rupee versus the US dollar strengthened our topline without commensurate benefit on the bottom line because we booked hedge losses as a part of our operating expenses. In summary, the operating margin adjusted for the revenue at the hedge rate was 30% compared to 30.8% last year. Hedge losses during the quarter was INR16 crores, reflecting the difference between average spot rate during the quarter to the hedge rate. This is compared to hedge gain of INR20 crores in the same quarter last year. Other income for the period increased from INR13 crores to INR17 crores, an increase of 34% on back of increasing yields on investment and fixed forex.

Depreciation and amortization for the period was at INR95 crores compared to INR79 crores in the same period last year. This increase of 21% on a year-on-year basis is mainly owing to the new investments that we made in the last 12 months. Finance cost increased from INR9.4 crores to INR13.7 crores as we recognize the interest component on newly leased assets following lease accounting as per accounting standard IAS under 16. This is in addition to rising interest rate on borrowings. Even though a large part of our loan is covered through interest rate swaps, a steep increase in the interest rate on the unhedged portion of the loans led to higher interest cost.

Profit before tax increased by 9% year-on-year [Indecipherable] growth of PBT compared to EBITDA is on account of high interest rate and increased depreciation. The effective tax rate for the quarter was around 21.5% compared to 19% during the same period last year. You will remember that we expect that there will be a gradual increase in the tax rate, as some of our units move out of SEZ tax benefit period and an increasing share of business is coming from locations not enjoying its benefits. While the effective tax rate is going up, we have a MAT credit of INR160 crores, which will be utilized over the next few years and this will enable us to maintain a cash outflow for income tax at the minimum alternate tax level. Profit after tax stood at INR110 crores as compared to INR104 crores last year, a growth of around 5%.

Nine months FY ’23 performance, moving to that. Revenue from operations grew by 19% including the impact of remdesivir in the base year. Underlying revenue growth for nine months was at 30%. Material costs increased by 6% year-on-year. However, adjusted for the remdesivir impact in the last year, material cost growth was around 26% year-on-year, reflecting the change in mix of revenues towards development and manufacturing businesses.

Staff cost increased by 13% YTD in line with the headcount growth. Other direct costs increased by 32%, mainly driven by inflationary pressures on utility and other costs while other expenses grew by 37% primarily due to resumption of activities post-pandemic and other operating investments explained earlier.

The reported EBITDA margin for nine months was at 29.7%, against 31% last year. EBITDA margin from operations were around 28.2% against 29.6% last year for the same period.

Capex for the nine months of the year was around $50 million and an almost equal amount has been committed and projects are under execution.

Now moving to the guidance for the year. Based on the nine months’ results and the overall trajectory of the business, I am happy to reconfirm the guidance for the full year of high-teens revenue growth and an EBITDA margin of around 30%. Next point that I will make is very important. Please note that this guidance was made and continues to be at the hedge rate of INR79 per US dollar. Given the rupee versus US dollar depreciation we have seen, you need to adjust the topline growth and the margins accordingly. PAT growth for the full year continues to be expected in the single digits. Looking forward, we expect operating leverage within the business to improve from next year onwards and that should improve the overall PAT outlook into coming years. But I’ll say more about that, once we have completed the year at the full year results.

With this I complete my commentary and will hand back to the moderator for questions. Thank you.

Questions and Answers:

Operator

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] The first question is from the line of Tarang Agrawal from Old Bridge Capital. Please go ahead.

Tarang Agrawal — Old Bridge Capital Management Pvt. Ltd. — Analyst

Hi, everyone. Good afternoon and thank you for your time. Three questions from my side. One, Jonathan, are you witnessing any slowdown in preclinical or Phase I clinical projects, especially from your emerging biopharma customers? That’s one.

The second, if you could just give us some sense on what percentage of your molecules currently under Phase II and Phase III would be with emerging bio customers and what percentage would be perhaps with the big pharma?

The third question is, in the quarter gone by, did any of your customers receive any NC approvals, which is likely to be commercialized in the near future? Thanks.

Jonathan Hunt — Managing Director and Chief Executive Officer

Thanks for the questions. Albeit, you stand a bit anxious by the nature of the question. So with the first question, the answer is no, which is probably the most direct. It’s I think given you are not really seeing a slowdown or makes. I’m assuming this question. Do feel free to come back and comment, is [Indecipherable] trying to interpret US fundraising and the environment for US biotech in terms of IPOs and fundraising. To some extent, and I think I commented this on previous quarters, those that have already well-funded are very keen to try and stretch that money if they got a year’s funding, they’d love to turn it into two years funding pathway. One of the ways they can do that is making sure that they’re spending it smartly and wisely and companies like Syngene offer them very good value for money. So I think that sort of offsets a bit. I’m not seeing any discernible mix. Of course, it all depends on US from this point. If you go back to 18 months, two years ago, we were at an all-time peak for fundraising in the US starts of biotech environment, driven to some extent by two factors that are unusual in tempo. One is 10 years quantitative easing and incredibly low cost of capital and cost of fundraising and another one was an awful lot of work that is driven in related to the pandemic. So it depends on what you’re comparing to. If you compare it to a once in a decade high, but I think funding levels have come down, but I’m not seeing anything discernible.

To answer the other two questions, we already have a comment. I mean, we actually don’t — I don’t track our projects by Phase I, Phase II, Phase III or percentage. So it’s not a number I can really report. But I think you can get an essence from our commentary and from my answering of the question. The demand in the market I think it’s reasonably healthy we have seen across Discovery Services, development, and manufacturing reasonable demand environment for us in the US and Europe to our main markets. It’s much more around execution and being commercially competitive and think of the drivers of our growth.

Does that help?

Tarang Agrawal — Old Bridge Capital Management Pvt. Ltd. — Analyst

It does. And to my last question, I mean, on if your clients getting a NC approval in the quarter gone by?

Jonathan Hunt — Managing Director and Chief Executive Officer

But I’m not sure what can you do with that information [Indecipherable] answer it. This is one of our manufacturing business.

Tarang Agrawal — Old Bridge Capital Management Pvt. Ltd. — Analyst

Okay. Sure. And if I can squeeze in one more. Sibaji, typically I mean, if I look at FY ’22 over ’21, the rupee-dollar exchange rate was rather flat, and we saw that your reaping in forex gains. And in ’23 over ’22, we are witnessing extreme depreciation of rupee against dollars, where we are essentially seeing some kind of forex losses. So what it says is effectively, I mean, at an average rupee depreciates by about 5%. So that’s typically what your forward hedge rate would be. And if in any given year, the depreciation is more acute, then we’ll probably see a forex loss and if the depreciation is perhaps a little lower, then that will translate into a forex gain. Would that be the right way to look at it?

Sibaji Biswas — Chief Financial Officer

Yeah, you are right, Tarang. That’s how it is. The point to note over here is that either way EBITDA or the PAT does not get impacted. So if we actually have a rupee depreciation and the rupee and the spot rate is above the hedge rate, we do get a bit of buoyancy on the topline, but then we have hedge losses. So at the profit level at EBITDA level, they net-off. It only optically impacts the margin because if our inflated topline and the same absolute EBITDA the margins [Technical Issues] and that’s why my guidance — the guidance was given of high-teens 30% margin at the hedge rate trading at 81 at this point. You may have a slightly better topline, but the margins will be lower. So though the adjustments have been better in the moment, but we continue to look at business what exactly addition we get and hedge rate built in the structure rupee depreciation that’s part and parcel of our operating model.

Tarang Agrawal — Old Bridge Capital Management Pvt. Ltd. — Analyst

Okay, thank you. That’s it from me.

Sibaji Biswas — Chief Financial Officer

Thank you.

Operator

Thank you. [Operator Instructions] The next question is from the line of Surya Patra from PhillipCapital. Please go-ahead.

Surya Patra — PhillipCapital (India) Pvt Ltd — Analyst

Yeah. Hello?

Operator

Please go ahead, sir. Your line is open.

Surya Patra — PhillipCapital (India) Pvt Ltd — Analyst

Yeah. Hi, sir. Just first question on the fill-finish unit that you have indicated about. So what is the scale size and of the fill-finish facility and if you can also share the size of investment in that. That is the first question. And maybe if you can clarify whether this is part of the Mangalore site or it is part of the Bangalore site.

Jonathan Hunt — Managing Director and Chief Executive Officer

It’s in the Bangalore site and I don’t think we’re going to dimension it. I think the advice I’d give you is its clinical scale, its small enough, it’s not a line item in an analyst model is that sort of capture the asking sort of the question.

Surya Patra — PhillipCapital (India) Pvt Ltd — Analyst

Yeah, a bit. And just here trying to understand the scale size, because is it just a kind of this facility is capable of doing some kind of development that support service or it is also capable of offering commercialized manufacturing service?

Jonathan Hunt — Managing Director and Chief Executive Officer

Clinical scale. That is the reason for describing clinical scale to support Phase I, Phase II type clinical trials and therefore the volumes are relatively small. So I think that answers the essence of the question. It’s not commercial scale fill-finish.

Surya Patra — PhillipCapital (India) Pvt Ltd — Analyst

Yeah. Got it, sir. So my second question is Sibaji sir, if you can just update about the cumulative capex for Mangalore site as of now and what is the cumulative capex in the biologic assets so far. That would be helpful.

Sibaji Biswas — Chief Financial Officer

Yeah. So the capex in Mangalore site hasn’t really increased much from the last quarter. If you recall, I mentioned it’s around $85 million that we have invested over there [Technical Issues] depending on what exchange rate intake, so that remains broadly at the same level. In case of biologics, cumulatively, in the beginning of the year, we invested $55 million. Again [Technical Issues] exchange rate and we have started a program of another $30 million of execution that’s still not in books, because the program is underway. And you can expect to see that facility and the capex coming into the books for the next few quarters, but the [Technical Issues].

Surya Patra — PhillipCapital (India) Pvt Ltd — Analyst

Sure, sir. Yeah. Thank you.

Operator

Thank you. Ladies and gentlemen, that was the last question for today. I now hand the conference over to Ms. Avantika Mishra from EY for closing comments.

Avantika Mishra — Associate – EY

Thank you, everyone, for joining today’s call. I hope we have answered your questions. If you have any further queries, please do get in touch with our team and we will be happy to get back to you. Have a good day and thank you once again.

Operator

[Operator Closing Remarks]