Detailed Rationale

CRISIL Ratings has removed its ratings on the bank facilities of Solara Active Pharma Sciences Limited (Solara) from 'Rating Watch with Developing Implications' and has downgraded the ratings to ‘CRISIL BBB+/CRISIL A2’ from ‘CRISIL A-/CRISIL A2+’ while assigned a ‘Negative’ outlook to the long term rating.

 

Previously, CRISIL Ratings had placed its rating on the bank facilities of Solara Active Pharma Sciences Limited (Solara) on watch on 17th February, 2022 basis the significant deterioration in Solara’s revenue and profit levels for the third quarter of fiscal 2022, as per the announcement of the quarterly results on 9th February 2022. The turnover for the quarter ended December 2021 declined to Rs.100 crore from Rs.401 crore for the previous quarter on account of a one-time impact due to change in the business strategy from a distributorship sale model to a direct customer sale model and significant sale returns. Consequently, Solara reported an operating loss of Rs.94 crore and a net loss of Rs.140 crore for the quarter ended December 2021

 

The rating downgrade reflects continuation of stress in the business risk profile marked by operating margin of less than 4% in the fourth quarter of fiscal 2022. Although, it has improved from the third quarter of fiscal 2022, the operating margin remains much lower than its previous levels. The operating margins were in the range of 17.89% to 24.69% in the previous four quarters ended September 2021. Decline in operating margin has also eroded net worth from Rs.1148 crore as on 31st March, 2021 to less than Rs.1100 crore as on 31st March, 2022. Further, with NCA falling below Rs.45 crore in FY22, repayment obligations of more than Rs.90 crore were largely met through cash and bank balances. Risk related to deteriorating NCA cushion, which is exposed to improvement in operating performance, will remain key monitorable going forward.

 

Solara took a sale return of Rs.130 crore from distributors in the unregulated markets as part of its one-time business strategy reset, during third quarter of FY22. This along with continuation of modest sales led to significant increase in fourth quarter inventory and working capital borrowings resulting in gearing of around 0.93 times as on 31st March, 2022; the ratio was 0.53 times a year ago. Increased debt and declined profitability have also impacted debt protection metrics marked by interest coverage of less than 1.4 times for FY22. CRISIL Ratings has put the ratings outlook on ‘Negative’ to factor in these key monitorable over the medium term. Further, with the commencement of operations in the first phase of Vishakhapatnam unit, inventory management and scaling up will remain key rating sensitivity factors to be monitored in the next few quarters.

 

The ratings continue to reflect Solara's established market position in its key APIs, such as Ibuprofen and Praziquantel, and strong relationships with its customers and suppliers. The ratings also factor in the company's above average financial risk profile. These strengths are partially offset by susceptibility of operations to regulatory changes, large working capital requirement, and exposure to risks related to implementation of capex and stabilisation and ramp up of the second phase of the project at Visakhapatnam

Analytical Approach

For arriving at the rating CRISIL Ratings has consolidated the business and financial risk profiles of Solara and its subsidiaries Chemsynth Labarotories Private Limited, Sequent Penems Private Limited and Shasun USA INC.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation

Key Rating Drivers & Detailed Description

Strengths:

• Established market position in key APIs, along with strong customer and supplier relationships

Solara has a strong portfolio of APIs in key therapeutic segments, with expertise in anthelmintic, anti-malaria, anti-infective and non-steroidal anti-inflammatory segments. Furthermore, it has been increasing its focus on the non-steroidal anti-inflammatory segment by adding capacity, and working on other therapeutic segments. Solara has a diversified customer basis, with more exposure to regulated markets. Its longstanding presence in the industry has helped Solara build strong relationships with customers and suppliers.

 

• Above average financial risk profile

Solara’s financial risk profile is above average marked by a comfortable capital structure, albeit constrained by expected weakening of its debt protection metrics. The gearing continues to remain moderate at less than 1 times as on 31st March, 2022, as the net worth remains healthy at Rs.1082 crore as on 31st March, 2022, despite decline from Rs.1148 crore as on 31st March, 2021. Debt protection metrics is estimated to have weakened in fiscal 2022 due to decline in operating profitability. Interest coverage for fiscal 2022 is below 1.4 time and is expected to improve gradually over the medium term with moderation of operating profitability. However financial risk profile is supported by a comfortable gearing and unencumbered cash and cash equivalents supporting liquidity.

 

Weaknesses:

• Exposure to risks related to implementation, stabilisation and ramp up of the second phase of the project at Visakhapatnam

Solara is undertaking a greenfield project at Visakhapatnam at a cost of around Rs 250 crore, to be funded through debt and equity infusion. The first phase of the project is has commenced operations from the third quarter of fiscal 2021 and the second phase is in progress and is expected to commence operations from the second/third quarter of fiscal 2023. Any time or cost overrun in the project will impact the financial risk profile adversely.

 

• Exposure to risks relating to strict regulations

Most of the products manufactured by Solara face challenges of increased inspections and regulatory actions by authorities, such as the US Food and Drug Administration (US FDA). Additionally, production of a few products involves waste discharge, which needs to be treated in effluent treatment plants (ETPs). Thus, Solara needs to invest continuously to upgrade ETPs and bring efficiency in the process to reduce waste discharge.

 

• Large working capital requirements

Working capital requirements are high as reflected in high receivables and inventory of around 144 days and 176 days respectively as on 31st March, 2022. The working capital requirements are expected to gradually improve on account of increase in sales expected from first quarter of fiscal 2023. CRISIL Ratings expects the working capital requirements to gradually improve over the medium term with improvement in turnover. Correction in working capital requirements that shall aid in liquidity shall be a key monitorable.

Liquidity: Adequate

Solara’s liquidity is expected to remain strong over the medium term. Though cash accrual for fiscal 2022 is expected to be inadequate to meet repayment obligations due to the unanticipated losses, unencumbered cash and cash equivalents of close to Rs.46 crore as on March 31, 2022, provided cushion to liquidity to meet repayment obligations of close to Rs.20 crore in the fourth quarter of the year. With expected improvement in revenues and profitability, the cash accrual is expected to improve and be adequate for meeting repayment obligations; however shall remain a key monitorable. Further the fund based working capital limits have been utilized at close to 90 percent over the 12month ended December 2021. Improvement in cash accrual aided by improvement in operating profitability shall remain a key monitorable.

Outlook: Negative

CRISIL Ratings believes Solara will continue to benefit over the medium term from management's extensive experience. However, the business risk of the company will continue to remain a key monitorable.

Rating Sensitivity Factors

Upward Factors:

• Strong revenue growth to levels prior to Q3 of fiscal 2022 along with improvement in operating profitability to more than 20 percent.
• Efficient working capital management

 

Downward Factors:

• Revenue fall or delays in stabilization of new facilities or decline in profitablity resulting in cash accrual of less than Rs.120 crore
• Further deterioration in working capital cycle or large debt funded capex

About the Company

Established in October 2017, Solara was formed through the demerger of the API business of Strides Shasun Ltd (currently named Strides Pharma Sciences Ltd). Solara acquired the human API business from Sequent Scientific Ltd during the same time, and hence, is a pure play API company. The company is listed on the Bombay Stock Exchange and the National Stock Exchange.

Any other information: Not applicable