Hester Biosciences Ltd Management Discussions.

ECONOMIC ENVIRONMENT GLOBAL

The year in review

The global economy grew by 3.6% in 2018 (Source: IMF), weighed down by weak financial market sentiments, continued trade tensions between the US and China, macroeconomic issues in Argentina and Turkey, and volatile crude prices. The US was an outlier among advanced economies, recording an acceleration to 2.9% from 2.2% in 2017, as the US dollar strengthened, unemployment stayed at the natural rate, and inflation remained low. The Eurozone slowed to 1.8% from 2.4% in 2017, largely due to sluggish domestic demand, while China grew by 6.6% versus 6.9% a year earlier.

Highlights of the key markets of the Company

• Nepal grew by 6.3% on the back of healthy momentum in the industrial and services sectors, and the governments continued reforms.

• Africa grew by 3.5% (Source: African Development Bank) owing to strong performance of East African countries— Ethiopia, Kenya, Rwanda and Tanzania—aided by government reforms to attract more investments.

• Indonesias economic growth of 5.2% was driven by a pick-up in domestic consumption.

Outlook

While downside risks to global economic expansion remain, persistently low inflation in major economies may prompt the central banks to adopt a more accommodative policy stance. This dovish strategy could stimulate the global economy in the second half of 2019 and trigger capital inflows into emerging and developing economies, especially China and India. China may also increase the size of its economic stimulus to cushion the impact of trade tariffs and boost domestic consumption.

INDIA

The year in review

India, the worlds sixth largest economy, remained the fastest growing major economy in FY19. An uptick in private sector investment, strong gross capital formation and improved exports boosted GDP, aided by double-digit growth in private consumption and steady construction activity aided this growth. Consumer confidence improved in the second half of FY19, inching up for two straight quarters.

Retail inflation, measured by the Consumer Price Index (CPI), and wholesale inflation, measured by the Wholesale Price Index (WPI), remained in low single digits for the most part of FY19. The Reserve Bank of India (RBI) reverted to its ‘neutral stance from ‘calibrated tightening (briefly adopted between October and December 2018). The apex bank announced a 25-basis-point cut in the repo rate in its last policy review meeting of FY19 to fast-track growth and improve system liquidity. The government adopted prudent policy measures to contain fiscal deficit in a narrow band.

The Indian rupee (Rs) remained tepid for most part of the year and hit a low of 74.48 against the US dollar (USD) due to higher oil prices, improving US yields, weak domestic fundamentals and outflows from domestic markets.

Key macro growth enablers

• Favourable demographics are likely to propel the Indian consumption story

• A stable and reform focussed policy framework will drive business and investment

• Government focus on improving disease control and providing financial support to new farms

• Growing demand for poultry protein

Outlook

Indias economy is likely to grow at over 7.2% in FY20, driven by wide-ranging reforms undertaken by the government such as Goods and Services Tax (GST), Housing for All by 2022, Ease of Foreign Direct Investment (FDI) norms, among others. These reforms will help drive consumption and investment in the country.

Another reason for this stable growth is the countrys low-exposure to a slowdown in global manufacturing trade growth vis-a-vis other major Asian economies and emerging markets.

INDUSTRY INSIGHT

Global animal healthcare industry

The size of the global animal healthcare market was estimated at $27 billion in 2017 and is forecast to grow at a CAGR of 4% between 2018 and 2024 (Source: Global Market Insights). The rising prevalence of different communicable diseases in animals and the subsequent increase in the cases of zoonotic diseases in humans have boosted demand for animal vaccines globally.

Outlook

The global veterinary vaccines market is driven by the vulnerability of animals to fatal and chronic diseases and the rapidly changing patterns of diseases among animals. Veterinary vaccines have also reduced the amount of drug treatments to control established diseases and, in many instances, have prevented long-term suffering and death.

Structural trends such as rising awareness on animal health, early disease detection and the increased use of preventive medicines are likely to act as key catalysts for demand for veterinary vaccines in the coming years.

Improving demand for animal protein, including milk, meat, eggs and fish, and growing expenditure on healthcare of companion animals are expected to boost the global veterinary vaccines market.

Indian animal healthcare industry

The Indian animal health industry has played a major role in safeguarding the animal husbandry interests of the nation.

The size of the Indian animal healthcare industry is estimated to almost double from Rs39,200 million in 2016 to Rs75,000 million in 2020. During this period, dairy healthcare products are expected to record a 12-15% CAGR while poultry could grow at 8-10%. The companion animal and other segments are expected to record a CAGR of 18-20% and 8-10%, respectively, during this period. This high growth could be attributed to a robust livestock sector which has been buoyed by strong domestic consumption and technology intervention, coupled with the emerging risk of diseases of economic and zoonotic significance.

Outlook

Animal husbandry in India has undergone significant changes over the years, thanks to the adoption of innovative technologies used for the prevention and cure of farm and companion animals. There has been a paradigm shift in the business approach of animal health companies—from therapeutics to preventive and productivity enhancement to overall healthcare of animals now. The animal health industry has evolved and propelled animal husbandry to new heights, catapulting India at the top of milk and egg production.

REVIEW OF THE BUSINESS

Business overview

Hester Biosciences Limited (Hester) is the second largest poultry vaccine manufacturer and one of the leading animal healthcare companies in India. Incorporated in 1987, the Company has come a long way from being a small proprietary trading business. Today, Hester is one of the leading animal healthcare manufacturers globally. Its manufacturing facility in Ahmedabad is Asias largest single-location animal biological manufacturing unit. The Company also has another state-of- the-art facility in Nepal and is setting up another plant in Tanzania to capture the immense potential of the Africa market. Hester has an installed manufacturing capacity of 4.8 billion doses in India and 1.24 billion doses in Nepal, and its products cover the entire spectrum of vaccines, health products and diagnostics. The Companys service offerings include sero-profiling for poultry flocks and mastitis control programmes for cattle. It operates through four verticals—Poultry Vaccines, Animal Vaccines, Poultry Health Products and Animal Health Products. Hesters product portfolio includes over 50 vaccines and 35 health products. The Companys cutting-edge research and development capabilities distinguish Hester from the rest, and lends it a sustainable competitive edge. Hester is a WHO GMP (Good Manufacturing Practices), GLP (Good Laboratory Practices), ISO 9001:2015, ISO 14001:2015 and OHSAS 18001:2007 certified Company. The Companys R&D department is recognised and approved by the DSIR (Department of Scientific & Industrial Research).

Competitive positioning SWOT analysis: Hester Biosciences

Strengths Weakness Opportunities Threats
a) Only company in the world which can offer both strains of PPR vaccine—Indian (Sungri/96) and Global (Nigerian 75/1) a) Over-dependence on the poultry segment a) Ramping up the large animal health business a) High competitive intensity
b) Strong prospects in the markets of Nepal and Africa b) Any increase in regulatory restrictions in the Companys key markets
b) Strong in-house R&D capabilities c) Develop new generation vaccines through its R&D capabilities
c) Dominant position in Indias animal healthcare market d) Favourable government policies to drive higher penetration of animal healthcare products in India
d) Wide range of product offerings with 50+ vaccines and 35+ health products
e) World class infrastructure
f) Access to changing technologies
g) Low employee attrition
h) Strong distribution network in India
i) Strong financials

Performance Review

• Revenue grew 27% to Rs1,711.87 million driven by all-round growth in all the markets.

• Continued to de-risk its business by growing the animal healthcare business to 21% of total revenue from 13% a year ago.

• Domestic business clocked 31% revenue growth to Rs1,565.27 million.

• Exports grew by 9% to Rs138.26 million.

• EBITDA margin witnessed a robust expansion of 291 basis points to 40% during the year.

• Profit after tax grew by 44% to Rs438.52 million owing to doubling of revenues from animal healthcare segment, good growth in poultry revenues and higher cost efficiencies.

• The Debt Equity Ratios (in times) is 0.21 in FY19 whereas the same was 0.29 in FY18, the reason for decrease in ratio by 27% mainly due to decrease in total borrowings by 43.25 million in FY19 as compared to FY18 and increase in shareholders fund by 333.59 million in FY19 as compared to FY18.

• The Return on Net worth (%) is 24% in FY19 whereas the same was 21% in FY18, the reason for increase in ratio by 17% mainly due to increase in Net profit by 132.94 million in FY19 as compared to FY18 and increase in Net worth by 333.59 million in FY19 as compared to FY18.

• In Nepal, the Company has 11 number of vaccine licenses and expects 11 number of vaccine licenses in the future. These vaccines will be available for domestic sale.

• In Africa, 6 vaccines have been approved.

• Announced an additional final dividend of Rs7 per equity share, taking total dividend for the financial year to Rs11.

Outlook

Hester will continue to diversify its business to achieve a healthy balance of poultry healthcare and animal healthcare segments. While the momentum is likely to continue in domestic markets, the Company will continue to ramp up its presence in select locations within Africa and Asia.

Hester is moving swiftly to register in more countries in these continents. The Company is expanding its distribution network in select African countries via its subsidiaries.

This network will distribute products from the Companys India, Nepal and Tanzania plants and will drive growth in the international business in the coming years.

RISK IDENTIFICATION AND MITIGATION STRATEGIES

Refer to pages 26-27 of this report.

INTERNAL CONTROL SYSTEMS AND ADEQUACY

The Company has clearly laid down policies, guidelines and procedures keeping in mind the nature, size and complexity of its business operations. The Company maintains a proper and adequate system of internal controls, which provide for automatic checks and balances. The Companys resilience and focus is driven to a large extent by its strong internal control systems for financial reporting. The Company follows strict procedures to ensure high accuracy in recording and providing reliable financial and operational information, meeting statutory compliances. The Companys internal team and Audit Committee closely oversee business operations. These responsibilities include the design, implementation and maintenance of adequate internal financial controls to ensure an orderly and efficient conduct of its business.

The committees also ensure adherence to the Companys policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information. Any deviations are promptly reported to the management. Various risk mitigation measures are then devised to bring risk exposure levels in line with risk appetite. Timely and adequate measures are undertaken to ensure undisrupted functioning of the business.

HUMAN RESOURCES

Human Resources play a critical role in driving Hesters strategies and growth. The Company endeavours to become the best place to work for its employees and to provide them with a nurturing environment that is essential for their growth. Hester has implemented comprehensive and well-structured HR policies to ensure employee growth both at personal and professional levels. The Companys talent pool comprises a diverse set of experienced and skilled people who play key roles in enhancing business efficiency, devising strategies, setting up systems and evolving business as per industry requirements. The Company provides a safe, conducive and productive work environment to its people. Hesters strong organisational culture also enables it to attract talented resources. The Company conducts regular training programmes for employees to ensure skill upgradation and personnel development. High employee retention levels is a key outcome of these initiatives. Overall, the Company provides a nurturing work environment to a diverse set of workforce including 461, 42 and 6 number of people with Indian, Nepali and African nationalities.