Aarti Drugs Limited (524348) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Aarti Drugs Limited Q1 FY '23 Earnings Conference Call. This conference call may contain forward-looking statements about the company, which are based on the beliefs, opinions and expectations of the company as on the date of this call. These statements are not of the guarantees of future performance and involve risk and uncertainties that are difficult to predict. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Adhish Patil, CFO at Aarti Drugs Limited. Thank you, and over to you, sir.

Good morning, everyone, and thank you for joining us today to discuss our financial results for the quarter ended June 30, 2022. The company's performance Q1 FY '23 was impacted due to the challenging business environment in terms of constant depreciation in the domestic currency, leading to provision of notional ForEx losses, lockdowns in China affecting purchase decisions in uncertain scenario, fever of recession in key geographies, driven by ongoing geopolitical conflict and continuous upward momentum in crude, coal and other raw material input costs. I will now quickly take you to segment-wise performance, and then I will dwell more into impact of rising throughput costs, the overall demand scenario and the company's strategy to counter the ongoing difficulties. First, we'll take up stand-alone business performance. Standalone revenues for Q1 FY '23 stood at INR 551.4 crores as against INR 507.4 crores, a growth of 9% year-on-year. Standalone business contributed approximately 86% to the consolidated revenue. Approximately 64% of the standalone revenues came from the domestic market, while the remaining 36% came from the exports market for Q1 FY '23. Domestic revenue grew approximately by 3%, while exports grew by around 23% year-on-year. Within the API segment, the antibiotic therapeutic category contributed around 46%, antidiabetic around 13%, and antiprotozoal around 19%, anti-inflammatory around 10%, antifungal around 9% and the rest contributed around 4% to total API sales. For the quarter, revenue from operations for specialty chemicals and intermediates stood at INR 56.8 crores, which grew 21% on a year-on-year basis. Now we will discuss Formulation segment performance. For the quarter, revenue for formulation stood at INR 85 crores as against INR 86.5 crores year-on-year basis. Formulation segment contributed approximately 14% of the consolidated revenue for the quarter. Approximately 50% of the revenue came from exports during the quarter. Exports continues to be the key focus area for Formulation segment. And so far, we are able to achieve the targets. Now coming to the consolidated results. As mentioned, earlier, the company reported a revenue growth of 7%, which was mainly driven by higher realizations in antibiotics, antidiabetics, antiprotozoal and specialty chemicals. Demand in API business witnessed lower than anticipated traction as the offtake by the customers remained lower on the account of inventory recalibration at the customer's level due to high API prices. Margins and profitability continue to remain affected as sustained inflationary pressure impacted raw material costs, crude, power and coal cost, coupled with sharp depreciation in the currency. This impact is likely to extend to some part of Q2 FY '23 as well. Just to give you some perspective, there is an impact of approximately INR 4 crores due to ForEx movements and INR 8 crores due to rate -- only rate increase in power and coal costs. The company has undertaken multiple price hikes since the beginning of FY '23. And as a result, the company witnessed the highest ever realizations for most of its products in Q1 FY '23 when compared to previous 4 quarters. Domestic demand for the antibiotic therapeutic category was slightly weaker for Q1 FY '23. In the wake of series of sharp price hikes across almost all our products, the demand was subdued for the quarter, for the same reason. The company expects normalized margin levels once the input price volatility stabilizes, which is expected from second half of FY '23 onwards. We are already witnessing softening in some of the raw materials and some other input costs, although they are still much higher than long-term averages. Debt-to-equity ratio has marginally reduced to 0.51 by the end of Q1 FY '23 in spite of carrying heavier inventories. Thus, there is scope to further improve on net operating working capital. Now coming to the company's ongoing CapEx. The company incurred a CapEx of INR 35 crores during the quarter and planning to invest around INR 250 crores to INR 350 crores for the entire FY '23. The civil construction activity for Gujarat CapEx remains well on track. However, heavy monsoons have slowed down the pace temporarily. Tarapur specialty chemicals brownfield capacity for which we had taken scale-up batches in the last quarter has now been ramped up and the optimization process is on at the plant level. The company expects a meaningful contribution from this facility from second half of FY '23 onwards. For Tarapur greenfield API facility, boiler and zero liquid discharge treatment plants have been operationalized from May 2022 and commissioning of the main plant is expected by the end of FY '23. We firmly believe that most of the headwinds are transient in nature rather than structural, and hopefully, it will improve soon. Our company remains confident of overcoming the challenges and remain optimistic on the opportunities for all the segments in the upcoming years, driven by the ongoing project CapEx, downfield expansion and higher utilization of existing capacities. With this, we can now begin the question-and-answer session.

[Operator Instructions] The first question is from the line of Rupesh Tatiya from IntelSense Capital.

Hello, sir, can you hear me?

Yes. I can hear you.

Sir, my first question is -- yes, my first question is in specialty chemicals, sir, what is the CapEx amount we have spent and what is the revenue potential?

So approximately you can say half of the budget, what we have planned in that INR 500 crore CapEx plan is -- will be going for Specialty. And typically, overall, on an overall basis, the asset turn is up somewhere around INR 2 to 2.5 crore.

So I think currently, we are doing commercial sampling batches, right? How much is that CapEx? This INR 250 crores is the medium-term...

Hello, can you repeat the question?

Sir, this INR 250 crore you're saying for specialty chemical, this is already spent or this is a medium-term plan?

No, no. That is the ongoing CapEx, which is happening in terms of greenfield projects. So it will take around a year to finish, approximately.

Yes. But currently, we are doing some sampling batches, right, in specialty chemicals?

Yes, yes. That is the brownfield expansion that we have carried out in the Tarapur facility.

How much is the amount, sir, for that one?

So that is a brownfield, so approximate -- we don't give out the CapEx number, but then it is much lower. But very roughly around INR 90 crores to INR 100 crores revenue potential, is what we expect from the specialty at a full scale level.

Okay. Okay. And specialty chemicals has a better gross margin EBITDA margin. Is that a fair understanding, sir?

Yes. Yes. That is true.

Okay. Okay. Okay. Then my second question, sir, is I was going through your annual report. You have done 39,000 metric tonne production and our capacity is 49,000 metric tonne roughly in FY '22. What can we expect by FY '23 exit for these production and capacities?

Production numbers, definitely, some brownfield expansions will add up sooner. And yes, if our target date for the greenfield expansion of Tarapur facility completes, then this number will be much higher. Right now -- since because we have not disclosed the product names and the capacity for the greenfield projects that is why we cannot answer it right now. But then it's an import substitute product and the capacities will be quite huge, quite huge. By the end of FY '23.

So it'll be achieved, sir, 80,000 above from currently roughly 49,000, 50,000, would it be at least INR 80,000 and above, sir, ballpark? Hello?

I think, yes, it would be more than 80,000 [indiscernible] 2, 3 projects comes into commercial production.

Okay. Okay. Sir, my another observation, sir, from annual report was your R&D expenses were only INR 7 crores, although the detail on R&D projects was quite extensive. What we see in other API companies is selling the R&D spend is like 3%, 4% of the revenue. So why this number is so low? Or is there some different way in which we are doing accounting and other companies are doing accounting? Because on a INR 2,500 crore revenue, INR 7 crore number looks really low.

Adhish, he is offline, is he? Operator?

Ladies and gentlemen, Mr. Adhish, can you hear us? Ladies and gentlemen, the management line is disconnected. Please stay on hold, we'll quickly get him back. All right? Thank you. Ladies and gentlemen, the management line is reconnected. Please go ahead, sir.

Yes. Hello, sir. Do you want me to repeat my question?

Yes, please. The last -- yes, please, please.

Sir, my question is I was going through annual report. The R&D spend number was INR 7 crore -- for a revenue base of INR 2,500 crore roughly, the R&D spend number of INR 7 crores looks really low. When we look at other API companies, the R&D spend is in the range of 3% to 4% roughly. So is there some accounting difference, we are accounting it differently, the other companies are accounting it differently? That is my question.

Probably, to some extent, that can be the case. Because what happens is sometimes we have to take trial basis at the plant scale also. So which is a part of R&D, but then we expense it out. And we don't consider -- means, label it as R&D. So probably, that is why it is looking low. And mainly our R&D is into process development and process improvement of the existing products. So that is why I think the number is looks low.

Okay. Okay. And then my final question, sir, is in metformin, we were, I think, roughly around 1,100 tonnes per month capacity. What is the current capacity as of quarter 1 exit? Can you just give me the number?

As of now, we have reached 1,200 tonnes per month. That can be achieved.

And this is supposed to go to 2,000 tonnes per month by then?

Yes. So it might take a year -- means around 12 to 18 months' time to achieve that number probably.

Okay. And what is the capacity utilization right now of metformin?

Yes, last year, we consumed [ up to ] roughly, you can say 2/3 means, somewhere in mid-60s or something like that.

The next question is from the line of Aejas Lakhani from Unifi Capital.

In the press release, you mentioned that we've had the highest ever realizations for several API products in Q1 FY '23. But despite the fact that the EBITDA margin has been the lowest over the last 3 years. So does that mean the cost pressures were far higher than the realization? And could you comment -- so some of it, you have already mentioned that some cost pressures are easing out, but what about the realization? Would realization sustain at current levels?

Yes. So the thing is the reason for taking all these price hikes was because the input cost had escalated quite sharply in the beginning of this calendar year for multiple reasons, which I highlighted. And then we started taking price hikes, but there is always a lag in taking price hikes, because of which definitely the margins -- gross margins were squeezed in last quarter. But what we could see, the pending orders are even higher than what realizations we achieved in June quarter. So probably that will help in the beginning of this Q2. And now that the -- a little bit easing is there in some areas, not everywhere, in some areas, hopefully, the situation should improve quickly. And the thing is, this time, for EBITDA margins, there had been pressure on 2 sides. One was gross contribution margin, and other was even at the manufacturing overhead side because of this coal and there was a lot of rate variance and increase in the manufacturing cost, which also needs to be taken care, ideally, by the further enhancement in the gross contribution.

Okay. And so is it fair to assume this is -- I mean, this is sort of a bottom that we have hit and some now on EBITDA margins can only improve?

Yes. Yes. We definitely feel so.

Okay. And in terms of volumes, would you take a call of -- I mean, were you seeing some prices so that your volumes are back on track? Or we would want to have the current prices and then work with new partners to increase the volumes?

Yes. So it was really challenging. So the pass on the margins or to maintain the margin and to pass on the increased input cost, we had to take very sharp price hikes. And when that thing happens, -- so quickly, definitely, there is a hit on demand side because if the -- at the customer side, if the inventories are not at critically low levels, they will refrain from making a purchase decision. So that impact, definitely, we have seen in -- majorly in the domestic market. So hopefully, right now, see, we don't want to make any variable losses. But as far as we are not making any variable losses for incremental production, I think we should go for it. It's more than margins, we should try to focus on the absolute EBITDA number, in shorter term that is.

Got it. Just 1 more question. Patil, Aejas here. Sir, I wanted to ask you that you mentioned the inventory recalibration and the demand which was subdued. So can you speak a little bit about customer and inventory levels today? Is that normalized? And should we start to see volume upticks in second quarter or there's still inventory left at their end?

I think our Director, Mr. Harit Shah would be better able to answer this question.

I think there is still -- in many of the products, we see demand picking up again. But still, it is not as the -- like pre-COVID on levels like about 2 years back. And what has happened also is that during COVID period, there was growth rate was very high, and I -- we have all [indiscernible] budgeted high growth rate for this quarter also. So the inventory was very high at the beginning of the year because last quarter, they produced more of finished formulations. And that is what -- and all the stocks level that distributor and superstore stockings levels were very high. But we expect now this quarter -- means, we started seeing some improvement from July, yes.

Got it. And sir, for all the increase in cost, is the present price hike adequate to maintain our levels of gross margins? Or is the price hike still needed?

Now the raw material price has started softening. Basically, all basic chemical prices went up like caustic flake, sulfuric, all sulfur based chemistry due to crude oil solvent prices, they have started correcting now due to overall degrowth in textile, in pharma last quarter. So that -- so we feel this quarter, there should be definitely improvement in the gross margin, yes.

Got it. And sir, what is the debt today? Because we are expecting to take some incremental debt in the current year for the INR 250 crores to INR 350 crores of CapEx, right?

Yes. So as of today, the total debt figure on a consolidated basis is around INR 541 crores, out of which around INR 187 crores is long term and rest is short term for working capital.

Got it. And sir, this number is likely to go up by about, say, INR 150 crores during the course of the year. Is that understanding correct?

Yes, probably. It should. But then with the increase -- so what we were expecting at the peak debt-to-equity can go around 0.7-or-something, 0.7, 0.75, 0.78 and then again, from there, it should start coming down with each quarter because of the additional profits.

Sir, could you quantify that in -- as a number of the debt instead of the 0.7? Is the number at peak, 700?

Right now -- okay, debt number you mean? Debt number -- yes, so we were -- by the end of it, say, around 50% means, roughly, it is very rough calculation, around 50% of our this thing will be funded through term debt. And at the same side, there will be some repayments also, around INR 30 crore per annum -- INR 30 crore to INR 40 crore per annum every year. So that -- so around say -- yes, you can say around 150 something like that.

Yes, INR 130 crores incremental from here, so INR 545 crores is what we are at. So we should peak out at 700 and then start to taper down, right. Okay. Got it, sir.

The next question is from the line of Bobby Jayaraman from Falcon.

What is the -- a bit concerning about your business model is that you don't have any control over your EBITDA margin. The kind of reasons you're giving on INR depreciation and the cost inflation and all that. That's going to happen in some form or the other all the time, right? That's out of your control. But it seems that when you raise prices, you lose demand. So given this, how are you planning for so much capital expenditure, when you don't know what your level of profit is going to be because you don't have control of your margins?

Yes. So the thing is one thing is for sure because we have been doing this business in the last 30 years, what we've realized is that the kind of product profile we have and the kind of efficiencies we have our competitors and the level of backward integration, 15% to 16% EBITDA margin is fairly easy. I mean it is not something very optimistic. So definitely, this, you can say, scenario, it's transitory in nature and it won't sustain for long. So we know that it will revert back. But with this, if we stop doing CapEx, that will definitely impact our growth in third and fourth year. And as far as this INR depreciation I was talking about, because it has happened suddenly in 1 quarter, we had to provide notional ForEx losses for the -- for our open imports but against that, our export orders, which we have already taken for 2.5 to 3 months, they will be going at a much higher price in the June quarter. So part of that will be offsetted in the September -- sorry, in the September quarter. And another thing what had happened is that power had gone up -- power rates are going to be the month of April, and you get all those numbers and bills and everything by mid-May or May. So there was some level of rate variation in the power cost more than approximately around INR 1.5 crores, and then there was almost INR 6.5 crores of variations in the rates of coal. So what happens is that many of the times, when you negotiate contracts in shorter term, it is always done based on what are the input costs, but the main key intermediates and accordingly, what should be the selling prices. But then slowly, when this kind of coal prices becomes a new norm, then definitely, those gross contributions needs to be revised in the newer negotiations. So that will come -- that also will come back on track. Apart from that, around -- we foresee that around -- approximately around INR 2 crores means, INR 2.5 crores, means around 0.5% of the EBITDA margin we can recur by a reduction in some cost. Since last quarter, we had some exceptional one-time maintenance as well as USFDA remediation costs, which also we have booked in last quarter. So that will also be not there from the next quarter. So what we feel is that 15% to 16% EBITDA margin we should recover. It is just a matter of time. Means, once the volatility stops in macro factors, then it should be back on track.

What about the competition from China? Is it back to peak competition?

Yes, the competition from China -- okay, so the most -- I mean the stiffest competition from China was in the decade of 2001 to 2010. After that, from 2011 to 2020, what we had seen that we had become very competitive against China. Means, I'm talking even before pre-COVID levels. And then towards the end of 2020 decades, the Chinese government had started implementing very strictly all the pollution norms and everything, so their OpEx has also gone up. Sometimes, sometimes, there might be a few cases where a particular raw material or a commodity is available cheaper in China, so they might get a benefit of that in few products, what we have seen. But apart from that, from the efficiency point of view and the overall cost point of view, and the process and the technology point of view, we are very much competent with China. And it's in the top 10 products -- top 14 products what we manufacture, in that -- in around 4 or 5 products, we are even larger than Chinese capacity.

Right. But in terms of pricing, because if you go back to the earlier era, right, 2001 to 2010, your margins were only at 10%.

Got it. Got it. And then we improved in the next decade.

Right. You only started getting to 15%, 16% after 2013. So given that there's been this major reset after COVID, what gives you the conviction that things won't go back to the old days? I know the pollution and all that, I take that point, but the Chinese can always...

Even if it goes back to the old days, that is what we feel it will be around 15% to 16% pre-COVID. Means, in the COVID actually, the margins had gone up even beyond 20%.

Right. And the reason is because you think the Chinese have higher cost that they won't get into a pricing competition? Is that the reason? Or...

Yes, basically, that has been the trend.

Right. But -- and you made a statement in your press release that when you increase the API prices, there was some demand disruption. So what are these dealers waiting for, lower API prices? Because at some point, they do have to stock up, right? These are medicines and I mean, it's not discretionary.

Yes. Very, very true. And that is the reason why we were at least able to achieve some bit of sale at a very high prices. So for the players where they had a little bit higher inventories, they must have refrained, but the players where the inventory was critically low, they had to make that purchase at a higher price, is what we have observed.

So if input prices don't come down, assuming they're at the same levels, which is a very probable scenario, your margins will only be around this 11%, 12% level. Is that right?

No. No. If it gets stabilized at this price -- this levels, then slowly [indiscernible] if they remain high for a year, like this, it should again move upwards, it should start going up. Because ultimately, all the businesses, they look at return in longer term. So if a particular company is not able to make decent enough returns in this business, especially API manufacturing is a oriented business, then people start exiting. The competitors start exiting. That is what we have seen in the past.

So you're saying if inputs stabilize at a higher level, the formulation guys would have no alternative but to purchase at higher prices?

Yes. And what will happen, as of today, there are certain pricing caps on the finished formulations at the retailer level. So even those will be revised by the government, if such cost pressures persist for a long time.

All right. So if the margins aren't at 15%, 16%, then your ROICs don't make sense. Is that correct? The CapEx that you're undergoing, the INR 600 crores, it's not going to be commercially viable if you don't get that level of margin, correct?

No, look, what we do internally, we check whether the IRRs of the project is beyond 18% or more for the project, for the new products that we are launching. And if they are, then we do. And whatever products we have selected as of now, they make a lot of sense as of now. The only thing is, see, when we launch a particular product, obviously, initially, say, for depending upon product to product, 3 to 6 months growth in optimizing the process, whatever results we have achieved at the plant or -- sorry, at the lab or the pilot level, it takes some time to achieve the similar kind of results at a very big commercial batch level. So that much time goes. But then ultimately, we are very confident to achieve good return on investments for the newer product.

Next question is from the line of Anchal Kansal from Green Portfolio Private Limited.

Am I audible?

Yes, yes. You are audible.

Sir, in previous con-call, you said that you have backed out from CLI scheme as you were able to complete the project in INR 20 crores, not meeting the government's CapEx requirement of INR 80. But in recent investor presentation, CLI scheme is still mentioned. Sir, I wanted to know if these both are linked...

No, sorry. No, the thing is actually I think that is missed out, overlooked. We'll correct that. Thank you for pointing out.

Okay. No worry, sir. Sir, as you know, we have heard a lot about anti-China. In some industries in past is already on ground. How is it impacting the chemical sector? And I wanted to know how dependent are the China on raw materials for financial year 2022 -- sorry, 2023?

Okay. So the thing is -- yes. So right now, still, approximately our imports is like -- imports and indigenous purchases like 50-50. And as I said, that around 15% to 18% of the raw materials are available only in China. Rest can be procured from rest of the world. So that risk is always there. So we have developed technologies, but right now, we are not going ahead with the CapEx of those -- that particular backward integration. The newer projects, what we are launching a few import substitutes also what we are launching, for that -- for raw material of those, we are not -- we won't be dependent on China. So overall, on an aggregate basis, our dependency should come down ideally with respect to China.

Okay. Sir, can you tell me the capacity utilization on an average, give or take? And your revenue has decreased 11% quarter-on-quarter, how about volume in the same period?

Yes. So our volume has also decreased, right? This particular -- in exports, the volume has grown, but in the domestic market, the volume has gone down. And the main reason was very high prices, which we were trying to pitch in the antibiotic category. There, we saw a lot of volume degrowth for the first quarter because of the very high price escalations.

And sir, are we underutilizing the capacity?

Yes. We are. We are. We're expecting...

Sir, if the volumes are not rising and we have spare capacity, so what is the point of doing capital expenditures?

So see, so volumes, what we have now, the spare capacity is what we have, are for particular products. And we typically 80% to 90% of our revenue comes from dedicated plant. And it is not -- it is [indiscernible] in nature, it's for 1 quarter. It is not that the overall market of that product has gone down albeit older, it should come back, that volume should come back. And plus there is a lot of scope in further increase of market share as well. So that scope is also there.

Sir, 1 more question. Sir, EBITDA and PAT margins can be seen declining due to high other expenses. So can you please shed some light on the other expenses that you have incurred? Does this include onetime maintenance and USFDA reinspection cost that you just mentioned?

Yes. So other expenses will, means, that will also include all our manufacturing expenses. I think the 1 format which you're looking at. So right? Am I right? That includes manufacturing, right? There is no separate manufacturing expense in that. You are looking at the -- what we published in the SEBI, right?

Yes, yes. What you published in the report. Yes.

Yes, I saw that. So that includes all the manufacturing expenses. One of the most important variation what we are seeing is in coal around INR 6.5 crore and around INR 1.5 crore in power. That is only because of the rate variation year-on-year. I mean even if you keep the consumption same just because the increase in the rates of coal and increase in the rates of power kWh unit, that much cost have gone up. And rest and other -- some other would be, means, increments in the employee -- means EB expenses and then selling and distribution freight has gone up because of the increase in the crude since February. And there are a few expenses, onetime expenses as well related to the USFDA remediation and a few other expenses, which were in 1 time in some very old plants we had done some maintenance, which we expensed so...

Next question is from the line of Chirag Dagli from DSP Mutual Fund.

Sir, what is the volume growth in Q1?

So there is no volume growth -- yes, so there is no volume growth in Q1. Only the exports has in some very small lowered, means 2%, 3% kind of a volume growth. But mainly all the growth is because of the rates what we have charged in Q1. And basically, that -- it was like either that or you achieve the volume growth and keep the rates low. So those are the only 2 options.

Understood. Understood. So volumes were flat for the quarter?

So -- but we expect it to grow because it cannot remain flat for a longer period because then the inventories will go down.

Sure. Sure. I understand. What percentage of your revenue is long-term contracts versus spot business or is it mostly spot?

I will give you a brief summary, and then I will ask Harit bhai to answer that question. But in domestic market, what happens, you can say, very roughly I'm saying, 70% to 80% would be more of a short term, I mean, within 1 month or 1, 1.5 months delivery. But in exports, deliveries are around, means, the pending orders are around 2.7 to 3 months, typically. And also, a few of the customers, they like to do longer-term contracts as well in terms of supply of quantity that ranges anywhere between 6 to 12 months. That also is there. It is mainly observed in the case of bigger MNCs. They like to do longer-term contract.

But 80% of the domestic business, which is 2/3 of the business is 1 month kind of delivery. So mostly spot kind of market?

For domestic.

Understood. Understood. Okay. Other thing was, sir, on this specialty chemical CapEx, you indicated INR 250-odd crores, roughly, you are likely to have INR 600-odd crores kind of sales from this business. Question is how do you sell these? Who are the customers? Are these the same customers that you have for pharma? What is the customer set? How are you doing market seeding, et cetera?

For the spec chem?

Yes.

For specialty chemicals. Harit bhai, would you like to answer that question?

Yes. Actually, most of the customer would be chemical companies or intimate company and these pharmaceutical companies. And we are already selling some products to them. So marketing would not be -- they won't be a new customer, but some products, there will be a new customer specifically for specialty chemical products. But normally, we are in touch with them for our other group company also are selling some products to them. So a question of new customer won't be arise, more or less same customers would be there.

You don't see a challenge basically in...

No, no. We don't see any challenge yet. So 1 product which we are planning to do is import subsidiary product. They will be -- they are mostly they are imported from China. So we will be replacing that with indigenous product, yes.

Understood, sir. And sir, in terms of new product launches that you've done in the last 2, 3 years on the API side, how has traction been there? Are we suboptimal there? If you can just give some color of what part of our business today comes from new products launched in the last 2, 3 years. And what is the kind of traction that we are expecting?

So mainly the new product launches were more on the spec chem side where we have seen more traction in last couple of years. The APIs which we have launched recently, that is yet to receive traction. Since right now, I would say it is -- you can say almost breakeven or that kind of a thing because scale-up batches are going on. So right now, we haven't received any profit from those products, you can safely assume that.

So how many are these? What is the potential there?

The market is big, means, it can go INR 400 crores to INR 500 crores overall market potential for these products. But then obviously, we haven't put those high capacities yet. We have only put the capacities for around, say, INR 80 crores to INR 100 crores kind of a turnover. And once we get traction in that, and -- so after that, we'll be in fact going for a maybe newer plant with much higher capacity. Once we get success with that level.

So that INR 80 crores to INR 100 crore potential has also not been reached, sir?

No, no, no. So we are far from that. So we are still in the process of optimizing the intermediates and doing more backward integration, getting some tolling done for some intermediates, so that we can reduce the cost, and then we will go full fledge on those orders.

Understood. And how many products are these -- how many APIs are these?

So mainly newer, means, gliptins we have 2. In spec chem, again, 1 or 2 products. But obviously, there are derivatives of chloro-sulphonation chemistry only. Also in chloro-sulphonation, a lot of our earlier products which we used to [ manufacture ], we had a long list of chloro-sulphonation products, but many of them were like they are there, but meaningfully, it was not there. So we are hoping to increase the market of that. So it will be like as good as a new product in terms of increase in the scale-up. So there also, we are focusing more.

No, but that is on the specialty chemicals, right, sir?

Correct. Correct.

No, I'm saying on the API side there are 2 gliptins that you talked about, what else?

Correct. And there are a few antifungal products which we are -- means, we have done piloting of that. But as of now, they are not contributing anything on the bottom line.

Next question is from the line of Gagan Thareja from ASK Investment Managers.

Hello? Am I audible?

Yes.

Sir, my first question is on the tax rate. Why is the tax rate for the quarter higher compared to 1Q of last year, year-on-year and I think even sequentially?

I think that is more to do with the deferred tax. Otherwise, it remains same because we have gone for that 22-point-something plus taxation. So we have opted for that.

Full year, what should be the tax rate for you then?

Ideally, around 25% is what we expect.

Okay. Okay. And what has been the reason for the formulation sales not growing in this quarter? We've actually dropped 2% year-on-year.

Yes. So though the formulation sales did not grow, but then the profitability was very, very good. I think Vishwa is on the call, so he will answer your question.

Yes, yes, yes. So basically, last quarter -- last year same quarter and sales were higher because of some -- more of domestic tender execution, especially some of the COVID-related products were also in higher sales at that time. However, it has been a constant focus to shift from the domestic to more value-added sales. And due to that, although there is not a high growth -- there is not a growth in revenues, but there's a substantial growth in profitability.

Okay. But how should we then think of formulation sales from a full year perspective for FY '23 and going ahead, both in terms of growth and in terms of margins?

In current financial year, our focus is to grow more in profitability and grow export sales. So our sales expectations for the remaining quarters are more or less in line with our current quarter sales. But at the same time, we have a CapEx project going on which is in the final stages and due to be completed in the next 1 quarter and which will start adding revenues from the next financial year. So that block will -- or the new block will start to add up capacity for us and start contributing revenues from next financial year.

How much capacity will that effectively add for you?

Basically, it's a new line. Right now, we are into general oral solids. This is a dedicated facility for oncology. So in terms of the number of units, it will be lower since it's more of a high-value product, but our item at expectation in the next -- once it starts in the next -- in about 1.5 to 2 years is to reach revenues of about INR 200 crores to INR 250 crores from the new facility.

So INR 200 crores to INR 250 crores additional sales from the new onco line.

Yes. At the full potential, we can reach, yes.

And it will take 2 to 2.5 years for you to do that?

Correct. Correct. Right.

And when you say your margins have improved in formulations, if you could give us some idea of how much they have improved year-on-year for you?

Yes. So in this quarter, we've achieved a profit before tax of about INR 12 crores. And in terms of margins, it's about at about 14% to 15%. And we expect to kind of -- yes.

I will answer that. The margins -- means, the EBITDA margins year-on-year has grown from 6.7% to now 15% in EBITDA in this particular quarter. And the PBT margins have also gone up from around 5.8% to around 14%, 1 4, you may tell. So this is mainly on the account of higher export sales, as Vishwa said that we are focusing more on profitability now and the export sales than the -- earlier we used to do a lot of toll manufacturing sales, which has much lower profitability.

Okay. So you've discontinued with toll manufacturing and you actually emphasized more on export sales. So if you could give us some idea of the sales mix, this quarter, how much was exports as a proportion of total formulation sales versus last year? And also for toll manufacturing, how much was it as a proportion of formulation sales compared to last year?

Last year, we have made -- yes, Vishwa.

Yes, yes. So we've not discontinued the contract manufacturing or toll manufacturing sales, it's just that we are slowly trying to reduce that in favor of higher capacity utilization for exports. So current quarter would be roughly about 50% of our revenues would be from exports. And also, there are slightly higher about 5%, 7% growth in direct exports as well.

Okay. And then with the onco line, would margins have potential to grow further still because of it being maybe a higher realization product versus the plain vanilla white?

Yes, we would expect it to have higher margins. And since that would be more concentrated on regulated markets. However, as currently the scenario in regulated markets is also -- there is a lot of margin pressure -- so while we would expect it to be better, but there is also significant competition in oncology in those markets.

Okay. And the next question is around the capacity expansion that you're planning, what's the fixed cost associated with the new facilities, greenfield and brownfield that will come up? And what will be the breakeven utilization for you in these CapExes?

See, you're asking about the formulation facility [indiscernible].

Not formulation. I mean I'm looking at your capital investment plans in aggregate, the Tarapur facility and Gujarat facility, as and when they come on stream, what's the additional fixed cost and at what utilization do you breakeven?

Yes, typically, the addition of fixed cost once the facility is to use, then it will start coming into our financials. More or less, whatever we have right now in terms of percentages. More or less, it won't be impacted much, frankly speaking, with the addition of Tarapur. It will be more or less in line in terms of percentage to sales. So that impact won't be that high.

Right. And what would be the breakeven point for -- in terms of utilization for these capacities?

Probably, we feel that within 1 year's time, we should be able to breakeven, means, the utilization will go up. And on month-to-month basis would be profitable.

Okay. So you're saying at 1 year's time post-commissioning, you can see these capacities sort of contributing to profit?

[indiscernible].

Okay. And you mentioned that the stringency of the Chinese government regulations on environment standards has increased, I would then infer that a certain amount of input cost inflation coming from China is actually sustainable in nature and has nothing to do with the geopolitics or the COVID or the supply chain issues. It would simply be higher because the operating cost for your suppliers based out of China would have actually gone up. If you could, therefore, sort of delineate as to how much cost inflation is coming from this sector and therefore, is there to stay for the future? And how much can sort of soften because of the transitory impact of some of these issues related to COVID and supply chain and so on?

Yes. Harit bhai, would you like to answer this on the raw material side?

What has happened in China over the years that chemical sector, government is giving low priority now due to environmental issue and many industrial parks, which were in near the cities have been asked to move to remote places and plus environmental laws have become more stringent. So -- and plus, in addition to that, the labor cost also in China is very high compared to -- vis-à-vis to India now. So overall scenario, if you are efficiently producing any product, we can always compete China. That is our philosophy. We see that we can always compete China basically.

Sir, my question is that your procurement cost of the inputs coming from China, not your competency versus the Chinese suppliers. I'm saying since you rely very heavily on Chinese vendors to -- for your inputs -- and some of those input costs would have gone up simply because the operating costs of our vendors based out of China would have gone up on a sustainable and permanent basis, which you therefore need to pass on to protect your margin, right? Some of the other input cost inflation is related to a sharp up move due to supply chain disruption caused by COVID and some coming from the sharp gas price movements and so on. So I'm simply trying to pass the -- or separate out the impact between these 2 elements because 1 is sustainable going ahead and 1 is sort of something that can normalize and therefore, trying to understand how much of the input cost inflation is actually now permanently set in the base? And how much can go away?

It depends on the product to product, it differs, basically, but 15% pre-COVID level, the costs have gone up, that will be sustainable for future. That is the permanent cost gone up, basically. Because many small producers have stopped producing in China. So there are lot less producers for particular products, so, yes.

And have you seen the prices of intermediates and key starting materials soften over the last month or 2 for you?

Not from China, but domestically, yes, some due to higher power cost, this commodity price, some chemical, basic chemicals like nitric acid, ammonia, caustic soda, et cetera, which is very common and used in all our APIs and chemicals, has started softening now, yes, basically.

No, no, bulk chemicals, I understand have softened. I'm sort of looking more for...

Yes. Intermediates price also a little bit softening, yes, yes.

Okay. So final question from my side. I mean you -- in the products that you supply, you've said that you -- you've not been able to pass on the input price increase, having tried to do so, you've lost out on volumes. I mean, if that is the case, I'm simply trying to understand is the supply or the capacity for supply for these products in the market, really in excess of the demand and therefore, even a very large and very cost competitive supplier like you has not been able to pass on...

Partly true. But what has also happened is last quarter, our sales were very high. And all formulation companies started believing that this whatever growth was there in the last 2 years will sustain. So their formulation, all distributor level, everything, their forecast was very high and they produced more in last quarter, basically. So now more of destocking is happening and they're happening in this quarter, basically. So that was the major -- it is not one...

It's [indiscernible] sustainable sales.

Yes.

It was basically a lot of channel inventory being replayed.

Yes. I will answer that question. See, what happened is we are able to pass on increased prices. And that is why at least you can say more than 90% of the customers have procured at that high level, maybe 10% or some customers have refrained from purchasing at that higher level, probably because they might be the ones to have the better inventories in the last quarter. So they were able to refrain that rather postponed that purchasing decision. But if it persists for a longer period, then even they will have to start buying at such high levels. So more or less, this impact is more in short-term nature than long-term.

My dilemma is that for the last so many quarters, it has been difficult, not only for you but for the entire sort of API industry to pass on the input inflation in comments rate measured in output prices to formulation companies. This can happen only in the case where alternate supplies are available to formulation companies at lower prices. Otherwise, I fail to understand why this has been the case even intermediate suppliers have managed to protect margin better than API supplier. So I'm simply trying to understand what has been the underlying reason for this? You are at least in 3 or 4 molecules, you are the largest supplier globally, let alone in India, and even then it has been very hard for you to pass input inflation in full measure or anywhere close to full measure. So what else explains that?

See, what I can make out of it is only 1 thing that last entire 1 year, the last 5 quarters, prices have gone up to a large extent. If we take current quarter selling prices with respect to, you can say, last quarter's purchase prices, then the margins will look fantastic. But right now, it is not looking because again, the escalation had happened at the input prices, means, in the month of February till April, so there's a little [indiscernible].

I get that. But is it also a case that in the products that you supply at least for the domestic market, most of them are under price control, and therefore, the formulation companies give you pushback and is input inflation being passed on because they themselves can pass it on because they are under DC rule.

Definitely. Definitely, that happens. And they get escalations every year so -- based on inflation. So if this kind of scenario persists, then definitely there will be more escalations in the final prices. And then...

Deputy Rao has given a 10% -- this year has been given a 10.7% sort of a...

Correct. But they work on last 12 months data. So there is -- they also have a lot of lag in terms of -- and obviously, they will also have to be conservative in increasing prices. So if it persists like this, then definitely they will have to look into it.

Due to time constraints, we have reached the end of question-and-answer session. I would now like to hand the conference over to Mr. Adhish Patil for closing comments. Thank you.

Thank you, everyone, for joining us on the call and having a good discussion. We look forward to interacting with you again with a bit of good set of numbers in the next quarter. Please reach out to us by our IR consultant, AGA or directly to us, if you have any further queries. We can now close the call. Thank you.

Thank you. On behalf of Aarti Drugs Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.