Aarti Drugs Limited (524348) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to Aarti Drugs Limited Q2 FY '23 Earnings Conference Call. This conference call may contain forward-looking statements about the company, which are based on beliefs, opinions and expectations of the company as on date of this call. These statements are not the guarantees of future performance and involve risks 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.

Thank you very much. Good afternoon, everyone. On behalf of Aarti Drugs Limited, I extend a very warm welcome to everyone joining us today to discuss our financial results for the quarter ended September 30, 2022. On this call, we are joined by Mr. Harshit Savla, Joint Managing Director; Mr. Harit Shah, Whole Time Director of Aarti Drugs; and Mr. Vishwa Savla, Managing Director of Pinnacle Life Science Private Limited; and HJ, our Investor Relations adviser. I hope everyone had an opportunity to go through the financial results, press release and investor presentation, which have been uploaded on the stock exchange and on our company's website. In the quarter gone by, the pace of [indiscernible] construction activity for the Gujarat CapEx has picked up considerably towards the end of Q2 FY '23, which remain affected at the beginning due to monsoon season. The company is well on track to make this facility operational by the end of Q1 of FY '24. We are resolving few scale-up issues of Tarapur brownfield capacity installed in this year -- this financial year, and we expect this facility to start contributing to the top end from H2 FY '23 onwards. Apart from this, Tarapur API greenfield capacity is also expected to be completed by the end of FY '23. The total CapEx during H1 FY '23 stood at INR 77 crores and is expected to be in the range of INR 200 crores to INR 300 crores for the entire FY '23. Coming to CapEx for formulation segment. Expansion at Baddi plant is nearing completion. We are building an oral oncology manufacturing facility. The total planned CapEx including product development expenses is budgeted at INR 55 crores, out of which around INR 40 crores is done. We expect plant to commence commercial operations in March 2023. At full capacity, the plant can generate revenue of INR 200 crores. Products manufactured in this site will be majorly new age oncology drugs with patent expiry in coming few years. The business model for the unit will be a mix of contract manufacturing and own portfolio. Coming to our performance during the quarter. The company achieved a healthy top line growth in spite of geopolitical uncertainties, adverse currency movements across the group, macroeconomic volatility and sustained inflationary pressure on some operating costs such as power and fuel expenses. This growth was made predominantly by higher realizations in API and Specialty Chemicals segment. During Q2 FY '23, the company witnessed the highest ever realization in most of the API and Specialty Chemical products, along with softening of some input costs barring power and fuel cost. We expect further moderation in the input cost going forward, which can further aid the operating margins. The company's operating cost were marginally up during the quarter due to increased power and fuel cost and onetime earlier paid to the [indiscernible] labor contractors. Finance costs also inched up higher due to higher interest rates and increased working capital requirements due to higher inventory. With respect to our performance across our segments for the quarter, API segment, the largest segment of the company in terms of revenue contribution, grew 17% Y-o-Y. As stated earlier, the growth was mainly driven by an increase in selling price with an 11% volume both in export market and marginal volume growth in domestic market. We anticipate a healthy growth for this segment, along with a sustainable increased profitability on the back of operating leverage, ongoing CapEx, backward integration and falling raw material prices. Revenue from the Formulation segment stood up at INR 82.5 crores for the quarter, up 9% Y-o-Y. The Formulation segment's share of the total revenue for the quarter was around 12%. The Formulation segment's core focus area continued to remain export. During the quarter, exports contributed around 44% of the total revenue. Now coming to Specialty Chemicals, Intermediates and others. This segment continues to remain the fastest-growing segment of the company. The growth in this segment is mainly driven by capacity augmentation along with presence in niche product category of chloro-sulphonation, a few other contract manufacturing products. We expect the growth to remain in upward trajectory over the next few quarters for this segment. Turning to overall stand-alone performance for the quarter. Standalone revenues for Q2 FY '23, stood at INR 624.9 crores as against INR 511.6 crores, showing a growth of 22% on Y-o-Y basis. The stand-alone business contributed around 88% to the consolidated revenue for the market -- sorry, for the quarter. Approximately 62% of the revenues came from domestic market and approximately 38% from the export market for Q2 FY '23 for the stand-alone business. Domestic revenue grew approximately by 19%, while exports grew by around 28% year-on-year basis for Q2 FY '23. Within the API segment, the antibiotic therapeutic category contributed around 44%; antidiabetic, around 17%; antiprotozoal, around 16%; anti-inflammatory, around 10%; antifungal, around 8%; and the rest contributed around 5% to total APIs for Q2 FY '23. Going ahead, we remain confident of continuing our growth trajectory driven by capacity expansion through a combination of brownfield and greenfield CapEx in API and Formulation segments and sustained momentum in our Specialty Chemicals segment. The profitability and return ratios are also expected to include in tandem going to operating leverage and backward integration. The company will continue to explore various opportunities in terms of new therapy addition and geographic expansion. With this, we can now begin the question and answer session. Thank you.

[Operator Instructions] The first question is from the line of Rashmi Sancheti from Dolat Capital.

So my first question is that higher realization in the API and the Specialty Chemicals segment, and then we are also talking about moderation in the KSM. We are still seeing the quarter-on-quarter drop in the gross margins. So any specific reason behind that? Any kind of ForEx loss or any other reason for such a drop?

Yes, actually, for a few of the cases, the market has been very volatile from January till date. And the thing is based on these macro situations, we had piled up inventories also. So in some cases, we had purchased at a very high rate. If you see the ongoing negotiations on the raw material and selling prices for a few products, we can easily see 3% to 4% better margins. But then when it comes to taking the inventory loss on the accounting part, it is coming down. That is the main reason why still we are not able to show it in the [indiscernible].

Okay. And there is no ForEx loss element, right?

ForEx loss notion is around INR 2 crores, so not much.

Not much. Okay. And so earlier in last quarter, we said that from the second quarter onwards, we will be seeing improvement in the operating margin from the second quarter. But I think it was more or less similar to the first quarter only. And our first half EBITDA margin is around 10.8% now. In the second half, how do you see this operating margin and gross margin going forward? And for this full year, if you can give any direction or any guidance on it.

Okay. So one first, the September quarter versus June quarter, in the API segments the EBITDA margin improved from 10% to 11.2% though on consol level. As you correctly pointed out, it has remained same. We do -- Formulation segment has performed much better in the June quarter as compared to September quarter. That is why on the consol level, the EBITDA margin still came the same. However, the improvement in the stand-alone EBITDA margin was also attributed to more efficiency in the manufacturing expenses rather than the gross contribution. So the manufacturing expense, anyways, we feel we might incur a bit further too. But the main area for us is to include the gross contribution. And we think it will improve with the stability in the price movements. If the volatility goes away, the margins should improve considerably. And going forward, we at least expect around a couple of percent improvement going forward. And they will keep improved -- scenario becomes stable once all the inventory losses goes away, then the margin should improve. So at the end, we should try to, by the end in Q4, we should try to get EBITDA margins upwards of 15%.

Okay. Got it. That is helpful. And on your Formulation business, If I see that in this quarter also, we have done only 9% growth. Despite we have done majority of the exports in the formulation business. Still, it is not contributing big to the EBITDA. So any comments on that?

Yes. Vishwa, can you please answer this question? .

Last quarter, we had a much better EBITDA. So some of our high-value, high-margin exports, we were not able to execute in the current quarter towards -- the margins were low. However, we would be able to execute those orders in the coming 2 quarters. So on a year-on-year basis, we do expect the margins to recover and EBITDA margins to improve once we have to put our higher margin export.

Okay. And my last question is on metformin. If you could update on how the price is moving for the metformin in the export market as well as in the domestic market, whether the prices are going up or it is coming down. And also, if you can update on your additional capacity. Any new production from that additional capacity for metformin has started, what is the current total capacity installed now? And how much is the utilization rate?

I will answer your second question first. So last quarter, we have done very good sales for metformin. So our average capacity is around 1,150 to 1,200 tonnes per month. And we were able to achieve somewhere around 1,000 tonnes per month of sales, for the last quarter, that is. And regarding price movements, I will ask Harit bhai to answer that question.

So the price of major raw materials, DCBA, which is a major raw material for metformin has come down quarter-to-quarter. So at the peak of the beginning of the year, it was around $4,000 to $4,500. So now it has come down to less than $3,000. So we expect price to stabilize around these levels and then price of metformin will also stabilize. So these 2 quarters, the price keep on reducing and we had a lot of inventory unit loss because of that. But now things have stabilized, more or less.

[Operator Instructions] The next question is from the line of Ranvir Singh from Edelweiss.

One thing, you commented EBITDA margin of 15%. So this is the overall EBITDA margin you're talking about? Or only API part, you said? And secondly -- yes, you can continue, then we'll have another question.

Yes. On an overall basis, but also on the API side because almost stand-alone business is contributing around 88% to the total revenues. So more or less, it will go hand-in-hand.

Okay. Yes, fine. So in this quarter, whether we have any contribution from intermediate facility, any new projects we are working on.

I didn't understand your question.

That new products were supposed to -- intermediate facility was supposed to start contribution from both...

Correct. So that brownfield expansion, what we had done in Tarapur for Specialty Chemicals, we are still not able to fully ramp up the capacity since you can say almost 30 tonnes out of 400 tonnes, we are not cutting -- around 60 out of 400, we have achieved. But in November, we will be achieving output of 150 out of 400 tonnes per month. There are a few issues related to scale-up batches, but we know how to resolve that, just that we are waiting for a few equipment to come in, and then we'll be ramping up the production. And as far as the consumption norms are concerned, we feel that we will be surpassing our previous norms because earlier we used to do a batch manufacturing process, and now we will be doing continuous manufacturing for that particular product with different ROEs. So RMC will also be completed for that project.

So for FY '24 perspective, I think we expect a meaningful revenue coming from this.

So this full scale potential for this facility will be anywhere between INR 90 crores to INR 105 crores.

Okay, okay. And that should be achieved by?

So because it's Specialty Chemical and we have been dealing in this, we will try our best to ramp up as soon as possible. So by the end of next year, hopefully we should be occupying it by the end of next financial year. But how much time it will take, we also are not very clear on that, how much we will get for the next entire year.

Okay. And any update on the gliptins facility we are working on?

Yes. So there, we have taken commercial batches. We have started selling our product in the market so that the quality acceptance is there. And now we are working on the reduction of cost, and there are few intermediates also on which we are working. So we'll be handing out the process to a few of our exclusive job manufacturer for the [indiscernible]. And that will help us to reduce the cost and become ever more competitive. So though top line, it will start contributing. But bottom line, I should say it will take at least 2 quarters to start contributing meaningfully.

Okay, okay. Fine. And if in API, in overall perspective, your commentary said that inventory purchased earlier is still with you. So when that inventory is likely to exhaust? So in FY -- in Q4, you said that improvement will happen. So this is based on the new price negotiation you have started?

So if everything remains stable, by next quarter it should be over. I mean, by the next quarter mean Q3. So from Q3 onwards some improvements would start giving there.

The next question is from the line of Priya Harwani from Perpetuity Ventures.

So I just wanted to cross-check the number of CapEx mentioned in the commentary. So can you repeat that?

Yes. We said that around 77% (sic) [INR 77 crores] has been done for this year. And what we hope that it will go around INR 200 crores to INR 300 crores for this entire year because what has happened is we have ordered a lot of equipment for 2 of our greenfield projects. So when you order, typically, you give around 15% to 20% annually. But when the delivery will come in, at that time, the outflow will be higher. So we expect that second half CapEx are much higher than the first half of the FY '23.

[Operator Instructions] The next question is from the line of [ Pat Assani ] TK Advisers.

I have a couple of questions. First one would be how much revenue can we expect from the [indiscernible] CapEx for the entire FY 2023?

Yes. The thing is based on -- so you're asking how much is the total revenue potential of the existing capacity, right?

Yes.

So we haven't -- so based on the last quarter prices, we can do upwards of INR 3,000 turnover even for the stand-alone company itself. Yes, so around upwards of INR 3,000 crores for stand-alone company. And then we can add another INR 300 crores for Formulation. So that will be a full scale potential for existing capacities. But then there are more capacities which are coming up in Q4 and then Q1 of next financial year.

Okay, okay. Yes, that was helpful. Second, I wanted to ask that in the press release, you have mentioned about the increased requirement for working capital. So can you explain the reason for the same?

Yes. So the thing is our inventory has gone up, no doubt about that. So that is why we have reduced our -- we might reduce our production a little bit. But until September, we have gone -- we didn't reduce on the production, even though demand for few of the antibodies was a little less on the domestic market. On the export side, we are seeing good demand. But for the domestic market, the demand was a little subdued. And usually, monsoon season, the demand is good. So we kept on producing. So that is the reason why the inventory was piled up a little bit. And also because the macro factors where because of this war and others and everything, it was quite unclear. So we did not want to lose on production so that is why we kept on producing. But now going forward, I think by reducing some of the -- for some of the products, we might bring down the inventory and then the working capital will be freed up again.

[Operator Instructions] The next question is from the line of Rashmi Sancheti from Dolat Capital.

Just one question on gliptins, which we have started last year, last quarter, quarter 4. Where are we in terms of both teneligliptin and vildagliptin. And have you started any exports for the gliptins?

Harit bhai, would you like to answer this question?

So teneligliptin, we are more or less product is stable. Our cost efficiency has improved, and we are working on making it ourselves. So we are already going to get -- we are improving our market share in domestic market, and export for this product is not substantial. So -- but we are considering getting more and more Indian market by another 1 or 2 quarters. And about vildagliptin, we have just started export marketing and started submitting samples and valuation batches, et cetera. So most only another 2 quarters, vildagliptin we'll be able to export more volumes, yes.

Okay. And sir, if you all an update on the Specialty Chemical greenfield plant. Where are we currently? Are we on track to start the production at the end of FY '23?

For the greenfield plant of Specialty Chemicals, that is for backward integration, which we are building in Gujarat, the estimated start commissioning of the production -- commissioning of the equipment and the trials will be taken in the -- towards the end of first quarter of FY '24. That is the June quarter. And the Tarapur greenfield one we are expecting to start by March.

So Tarapur greenfield one, the chloro-sulphonation?

No. So there are 2 -- so there are 3. There are 2 greenfield projects which are going on. One is Specialty Chemicals at Gujarat, that's the greenfield. There is a second derma project, greenfield project which is going on in Tarapur. And the third was the brownfield expansion of Specialty Chemicals in Tarapur. It is already done.

All right. Okay. And the Specialty Chemical, the chloro-sulphonation one and the entire Specialty Chemical, that is in Gujarat, you're saying?

So the chloro -- there are little changes there. So the chloro-sulphonation one which we were planning to start at Gujarat, so it was a 10x scale up from our existing batch manufacturing project. So initially, what we had done -- we have done a brown-field expansion in Tarapur itself with 5x scale up, not the 10x, 5, 5x scale up. The ultimate plan is to shift the entire production to Gujarat. But the current Gujarat expansion which is going on, that is more on other intermediates, not the chloro-sulphonation.

But maybe after 1 year or something, this chloro-sulphonation which -- where you have started the brownfield will get shifted to ultimately to the Gujarat greenfield Specialty Chemical plant, right?

Yes. And that will be the second site. The current greenfield site which is going on, that is different. And this will be the additional greenfield site, which we'll be putting in Gujarat.

Understood. That would be the new lines basically.

[Operator Instructions] The next question is from the line of Priyanka Shah from [ Ativan ] Securities.

I have a couple of questions. Sir, can you bifurcate CapEx for API and Specialty Chemicals for FY '23 for INR 200 crores to INR 300 crores CapEx?

Okay. So on a broader scale, some of it, say, around INR 40 crores, INR 50 crores would be the brownfield and your maintenance-related CapEx. But the majority of it can be -- it is almost 50-50 at Tarapur greenfield and Gujarat greenfield projects.

Okay, sir. And what is the current capacity utilization for API and Specialty Chemicals?

So current would be somewhere in mid-70s only.

[Operator Instructions] The next question is from the line of Ranvir Singh from Edelweiss Wealth.

Just on CapEx side, you said -- in first half, how much CapEx we have spent and how much remains to be spent in second half of FY '23?

Yes. So the first half, we have done almost INR 77 crores. And by the end of the year, we expect it to remain between INR 200 crores to INR 300 crores. Now the reason we are in such a broad range is because it might just go in April. So that is -- I'm giving a range of INR 200 crores to INR 300 crores for the entire year .

For the entire year, okay. So of that INR 600 crores total CapEx, we are midway by -- half in FY '23.

Yes. So the 2 greenfield projects with almost INR 350 crores kind of CapEx, that will be completed by, you can say, June of 2023, June quarter of -- June month of 2023. Most of the in CapEx, which is like INR 350 crores to these 2 greenfield projects will be completed.

And remaining of the...

Yes. So yes, it will start in yes, correct, in FY '24.

By end of FY '24, yes. Okay. And there in intermediate backward integration side, right now because for the last few quarters we have been talking that we are working more on integration -- backward integration side. So any new development you could highlight that we have achieved in this first half of FY '23 on the integration front?

Yes. So that plant will be completed by around day or 2 in 2023. That is first quarter of next financial year. So after that, we will start utilizing the production from the intermediate facility.

And this is related to which product?

This will be broadly related to antidiabetic and other antiprotozoal.

Okay, okay. And projects are under the PLI scheme, so what is development there for DCBA?

No. So DCBA, we are not going ahead as of now. [indiscernible] because we are inputting that.

Okay. So that project has been canceled?

No. No, actually, DCBA project, we never announced. PLI scheme there was another project from antiprotozoal. That -- so we are doing it, but we are not going for PLI scheme, the reason being the CapEx which we had committed earlier, that got reduced substantially almost by 50%. And we approach government that whether it will be okay for them. But they say that we have to do the committed CapEx to be eligible to get that benefit. So we decided that rather than spending that much, we will spend less upfront and still increase at the capacity. But we are doing that tough project, but we are not going in -- we are giving up the PLI benefit because we are getting everything in CapEx.

Okay. And the API related to skin, the dermatology segment, I think that was an import substitute. So have you seen any competition there or pricing? Because we are a little delayed there.

So as of now, there is no substantial domestic competition for that. So the only competition will be from China.

The next question is from the line of Harsh from Marcellus.

With the chloro-sulphonation project moving to Tarapur, what exactly greenfield expansion are we doing in Gujarat facility?

Yes. So greenfield, that is we are doing a few special -- I mean, sort of intermediate, you can say, on specialty side. And it is also -- will serve as a backward integration for our other main products. Chloro-sulphonation, we'll be putting in the second site of Gujarat.

Okay. And for the current Gujarat facility, how much are we doing the CapEx?

So that will be roughly around INR 150 crores to INR 200 crores.

Okay, okay. And this facility is likely to commence production in Q1 FY '24?

Correct. By the end of that. By the end of that quarter.

[Operator Instructions] The next question is from the line of [ Niharika ] from Equitas Investments.

So I think you mentioned that volume growth has been flat in domestic market, and I think some 10% to 11% growth in export markets. So with all the API CapEx that is coming into picture, how are we planning to like ramp up? Like how are we -- where are we seeing the market for its export or domestic? Because I see the domestic is still flat.

Yes. So the CapEx also which we have planned, that is for additional products. So there will be the -- right now -- so basically, the market will be new for that. And for the current, you can say, 20%, 25% underutilized capacity for few of the existing API products. We have the visibility the domestic market will pick up. One is that. And secondly, there are a lot of small export geographies you can say. For each product, a bit of it is left out. And also, we are having a lot of European focus. So -- and to update on that, recently, recent limits in this week itself, 1 of the facilities of Tarapur, the E22 facility, we just had an EDQM inspection with the European authority. It was quite good. So the report will come out in a few days, and then probably do a press release on that as well. So European market, and there are a lot of other geographies where we can increase the sales.

Okay. And for the new greenfield Tarapur facility, are we also going for any U.S. FDA approval, the new facility which is coming? Are we also planning to go for...

The greenfield, no. But for the existing antidiabetic facility, which we will be expanding further in next year, there we are planning to get an U.S. FDA approval. And that is a dedicated plant. The current one was about multipurpose one.

Okay. And on the Gujarat greenfield, you said that it is majorly for backward integration. So it ideally would just reduce my operating cost and ARPU. Basically, this is 100% for captive consumption? Or are we also going to send it to outside parties as well?

It is both. It is a mix of both. So the thing is the entire CapEx plan, which we had, the INR 500 crores, INR 550 crores, the external revenue potential was somewhere between INR 1,500 crores to INR 1,600 crores. But -- sorry, the actual revenue potential from those, right, But the external revenue potential was only around INR 1,200 crores. So the race was the captive part.

Okay. So INR 1,200 crores -- so percentage-wise, some 60%, 70% would be captive and rest would be .

Okay. So if you are asking only of the Gujarat facility, what you say is correct.

Okay. Okay, sir. And my last question would be on inventory. So inventory still on a very higher side. And is it majorly the finished goods that is held up in our stock? Or is it also the raw material? Because I think raw material we were shedding off in last quarter as well. So this INR 500-odd crores inventory, does it constitute majorly of finished goods? Or...

Yes. So what has happened that in last quarter, our production was very high. In fact, we have a 10% volume growth in terms of production as well for the last quarter. So whatever raw material inventory pile-up was there, we have now -- by the end of last quarter, we have now converted it to finished goods. But now it will start scaling back.

But are you taking inventory loss on the finished goods that is in the stock? Or are we -- will we be able to make any margins on that? Because I think this by using the high price raw materials.

Yes. So as of now for the finished goods, there was no inventory loss. But because we follow that FIFO as well -- or raw material costing, so the higher value raw materials has been accounted in the September quarter. But as you correctly say, that this -- the newer stock will have a little less R&C because of the falling raw material prices. But then there will be some impact in December quarter as well because of...

The next question is from the line of [ Aditi Savant ] from ADM Advisors.

I have one question. The total expense in Formulation, can you please share how much is the developed markets and how much is for emerging markets?

Vishwa, can you please answer that?

Yes. As of now, majority of it is for emerging markets because in regulated markets, we are yet to receive our approval in registration in the last 2 years or 2.5 where we've been focusing on regulated markets. So most of our regulated market pricings are either in pipeline or under approval stage. So as of now, a majority of the revenue is coming from the emerging markets.

[Operator Instructions] The next question is from the line of Isha Savla from Arya Securities.

I just wanted to ask a few questions. So first of all, I would like to understand that we've witnessed highest ever prices for retail products So my question is, do we expect the realizations to fall as the input costs have started to come up?

Yes, it will happen slowly because -- that is true. Because most of the time, API prices follow the input prices. So because across the board, slowly, the raw material prices will start going down, the API prices will come off slowly.

Okay. What kind of time lag do you expect to have?

So it will depend on how much -- I mean, order book you have piled up, but typically 1 to 2 months, you can say.

Understood. And secondly, how much is the current differential between domestic and export API prices?

Okay. So again, product to product, it is different. But definitely, the export prices are high. In some cases, it is a lot higher than the domestic cases. But there also in exports also, it depends on which geographies we are selling. So the Indian subcontinent like Pakistan, Bangladesh and so on, there the prices will be very low or few emerging markets of Southeast Asia. But otherwise, in other geographies, the prices are much higher than domestic market. It's very difficult for me to quantify. I'm not able to quantify that.

Got it. the next question, I just wanted to check that are we planning to diversify Specialty Chemical business away from our chloro-sulphonation products with the ongoing CapEx?

Yes. So we are definitely doing more on the Specialty Chemical side. Other than chloro-sulphonation also we are expanding in other lines as well. We are also doing a few [indiscernible] manufacturing projects with bigger inventory in this field, and the Gujarat facility will also add new products in the Specialty Chemicals.

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

Sir, the first question is on the margins. Throughout the last 12, 15 months, not just Aarti, but all API companies have struggled with margin contraction. The reasons given out largely centered around high input prices and difficulty in passing the input prices on completely, also there were freight and utility price increases. Now iron prices are softening and you yourself indicated that in a couple of months, finished good prices will also sort of fall in line. So I mean, if that is the case, then what are your views for margin expansion? You're saying that you're probably going to exit the final quarter of this year at 15%. How will that happen if your output prices also fall in line with input?

Yes. . Actually, as I was explaining earlier, you correctly pointed out that utility prices have also gone up. And apart from gross conclusion, other major impact which API players are facing as compared to last financial year. especially for the first half that is, is because of the coal prices. So the prices have more than doubled. I mean, they have remained like that for the long period. We hope that to come down. And what has happened indirectly because of this very high coal prices, now the power rates have also gone up because of thermal power stations because they also rely on coal. So there, also because of that also manufacturing utility costs have gone up quite considerably for manufacturing companies, I would say. And as far as this gross contribution is concerned, as I was explaining, the negotiations which are happening, so if you take any particular month, the margins looks higher, but the problem is in the uncertain scenario of last 9 months, what has happened that we end up booking a lot of raw material at a higher price. And the sales order comes, you can say more or less, fade out every month. So sometimes there is a problem in terms of you might end up booking a high-priced raw material and then the prices start falling in. So once this volatility goes away, even then -- even if -- what we are trying to point out is that even if volatility goes away, the margin should expand once all the inventory losses are taken into account.

But are you saying that the expansion from 10% margin to a 15% margin, that's very significant.

Yes, yes. So API, already we're 11.2% right now. It would still mean another 400 basis point's improvement.

But is that all down to simply the lead in lag between are you holding out higher cost inventory and RM prices pushing down and therefore, we're looking inventory loss. Is that the only reason why your margins have sort of -- if I look at -- if I look at the longer-term trend for Aarti, the 4-, 5-year average margins would be on the 15% mark. And if I go back further into the past, probably still higher. I mean, if one keeps that sort of a perspective in mind, I understand short term, there is volatility and there are business cycles. But if it hits you so much and so badly...

Actually, there is one more factor regarding ammonia-related products. I think Harit bhai will be better able to explain you that.

Yes, yes. Overall, because of gas shortage, Russian-Ukraine war, the price of ammonia is almost 3x of 1 year back. And we don't see any correction in the immediate future because of supplies of gas from Russia. So fertilizer plants in -- across the Europe almost are affected. So they would rather put their energy into electricity than making fertilizers. So that's the theme. But otherwise, all other chemical prices are coming down. I say 1 or 2 stray cases, but overall situation looks good now.

And the same products are available at much cheaper rates in China. So the Chinese manufacturers which is our main competition in a lot of products, so they are having that price advantage in terms of raw material rates. And that is also one of the reasons for a few products are margin relating speed.

Okay. I would have thought normally that whatever you indicated on ammonia prices and utility you essentially just pass on the absolute cost increase, you don't get to retain the same percentage margin, right? If your costs have gone up by, let's say, on a base of 100 by 20, you pass on 20, you don't pass on the margin on that, right? So if that is the case then...

What you say is correct, absolutely correct in terms of short term because in short term, means within a year, [indiscernible] look only the, you can say, the value addition per kg. But in longer run, since -- when we close down the financial revenue, we see the returns. And then ultimately, for any business or any competitors as well, margins are very important. So that is the time when margin again started getting back to normal. Yes, what I'm trying to say is, suppose -- very roughly, suppose we're making INR 200 on a INR 2,000 product, then -- and INR 100 product, even INR 20 is okay for you. So basically, margins are important, what I'm trying to say. It's not -- so across -- otherwise, what will happen even for the INR 10,000 product, if your API start expecting only INR 200, then margins will go fall down. So ultimately, it will come back to margins in the longer run.

Okay, okay. But are you seeing your competitors sort of also not trying to break the market up for volumes? And therefore, your expectation that you need to...

Yes. It might happen because if suddenly demand goes down, I mean, everyone was expecting higher, we can say, demand. And everyone has produced a lot of quantity, and suddenly, the demand goes down. Everyone is loosing.

Our assessment is the inventory in the supply chain, I mean, I don't know how one gets a handle on that. We don't have any ways to do that. But would you believe that the inventory situation in the channel is normal, and therefore, such issues may not arise in your head.

So based on the feedback which we get from the market, I think the orders should start coming back. But Harit bhai can better...

Yes. Overall pharmaceutical demand was less in first 2 quarters and there were a lot of inventory. But now many things are back to normal, But we expect demand to go up people have started moving out and COVID-related issues are not -- no more there. So we expect demand to go back to normal before COVID levels, at least. Yes.

And -- I mean, if you look at the Chinese situation, there is a new Omicron variant and there's another set of rolling lockdowns happening in China again. You sort of are saying that things all stable going ahead, the scope for margin improvement. But it's -- these are the way they are in China, the supply chain will probably be disrupted once more. And there is already, as you indicated, a gas and ammonia disruption based out of Europe. So do you really see any stability in the supply chain coming in the next 2 quarters? Because I would have thought we are up for another wave of difficult Chinese supply chain.

So what you say is, see, we feel that if any additional negative impact comes out in terms of macro factors, then definitely the situation might remain same because that is the exact reason why the margins are lower even now. Last year -- last financial year also, the margins were quite low during the first half of the year. And then in December quarter, the margins had gone up to 14%, 15% in December '21. And then again, this war thing happened and again it got squeezed down. So the thing is if further negative factors happen, then definitely no one can know. But assuming that things will stabilize here on because we have seen some correction in the raw material prices also. So if we assume that things will stabilize, then definitely our margins will start expanding.

To what degree are you backbone integrated in your current sales? And post-Gujarat to what degree does that increase?

Yes. So after Gujarat, another, you can say, 10%, 12% of our finished sale will be further backward integrated, you can say. But other than that, for most of the products we are more backward integrated than our Indian counterparts in most of the cases. And that is the reason why we haven't hedged our Indian manufacturers. But definitely, even when it comes to Chinese manufacturers, we have captured a lot of their market share in Southeast Asian markets as well but only the few things about ammonia. And that has affected only the Indian players and not the Chinese players. So there, it is like out of our hands, though -- even though our efficiencies might be at par with them or even better. But then because of the raw material pricing disparity, they're having some advantages over there. But in that case, we are approaching government for antidumping duty because the Chinese manufacturers are getting undue advantage. So yes, let's see how things pan out. But we are quite confident that it should improve. I mean, how fast it could improve, we should see now.

I gathered one of your peers is backward integrating into DCBA. This is something that almost all the API manufacturers buy out of China. Do you -- I mean, if that is the case, do you see sort of this initiative on their behalf sort of causing market ripples and there will be a market share movement based out of their competencies which they get from backward integration?

Yes, definitely, it will help and even to start manufacturing DCBA, especially [indiscernible]. But it's quite a tricky product and the chemistry is quite hazardous. So let's see. Because a lot of people have tried that project in past as well, but haven't gone away.

But you do not consider it a positive?

We will. Obviously, we have to keep an eye on that because, otherwise, we might have to go in-house because we -- our sales will be having -- we are wanting to have almost 3,000 tonnes per month production of metformin. So it's quite a lot.

The next question is from the line of [ Niharika ] from Equitas Investments.

Just one another follow-up question. I just want to understand how are the long-term supply contract structure? And also like I want to understand long-term contracts from a buyer perspective as well as supplier perspective. Basically, is there any -- like is it fixed or any escalation on to the core?

Harit, would you like to answer this question?

Sorry, I didn't get the question.

I just want to understand how are our long-term supply contract structure and also how -- like as a buyer and as a supplier, how are the contracts [ structured ].

Normally, we have called volume contracts and prices due to volatile situation, we have decided to offer quarterly pricing only and quantities that take volumes of it. But -- and based on this quarterly ramping indication, we change our pricing for the next product for long-term contract.

And is it linked to any, say, particular commodities, say, ammonia?

Yes, yes, yes. So each product has a different. We are making 20 [ contracts ] -- more than 20. But 80% of volumes comes from [indiscernible]. On that each product has different raw materials in -- sorry, different raw materials.

So we are linking it to some raw material pricing and this [indiscernible] affect the volatility...

Correct, correct.

And also, sir, my second question is considering Aarti Drugs has like -- in few APIs, we are the largest players in like the domestic and some globally. So what kind of pricing power do we hold because still we are not able to pass it on fully. So why don't we have that kind of a pricing power because API is already a [ venture ] item. So why don't -- why haven't we...

No. the issue is the pricing are so volatile every month, the price valuation is as high as some products, is as high as the 10%. So how do we control that? But now things are better, and we expect -- if prices are stable, then we will definitely go back to our normal margins, yes.

I'm just trying to understand, if you are -- why aren't you able to like take the price hike? Because if there's some other competitors which is taking our share or because without API, even though like other than player cannot work. So then why cannot we have that kind of a pricing power. Is there some competition which you are seeing?

The thing is we are taking price hikes. So that is the reason why the September quarters selling prices are at maximum. But the thing is, are the price hikes, while taking the prices, it needs to be a gradual process because if we suddenly increase the price, generally formulator will get back, to try to look for other sources. And if someone else is having inventory during that period of low cost, then they will offer them. Then you might end up losing those orders in that particular quarter, too. But next quarter, again, both the competitors will come at a level playing field and then the prices will go. So these things happen on a temporary basis, but yes.

As there are no further questions from the participants, I now hand the conference over to Mr. Adhish Patil for closing comments. Over to you, sir.

Thank you, everyone, for joining us today on this earnings call. We appreciate your interest in Aarti Drugs Limited. If you have any further queries, please contact us or HJ, our Investor Relations. Thank you. .

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

Thank you.