Cupid Ltd: Does this small-cap have large potential?

Key details: Price: 283, Mcap: 3.1bn

Given that this one is a small-cap, unheard and not so popular name on the street, I thought of listing its business profile at the top and will later highlights its key positive and risks. I came across this company after it made a debut on Forbes Asia’s Best under a Billion list this year and realised later that the company is well-researched on few blogs.  I list my perspective and key indicators to be monitored below.

Biz Profile

• Cupid Ltd. is engaged in the business of manufacturing rubber contraceptives and allied prophylactic products. It manufactures and markets varieties of male and female condoms. The Nashik-based company primarily supplies condoms to governments and NGOs for their AIDS prevention and family planning programs.
• It has a long-term agreement with the WHO/United Nations’ Population Fund (UNPA), supplies primarily to Africa where condom prevalence rate is low, and exports constitute ~80% of its sales.
  
  
• It is only second company in the world to get pre-qualification from WHO for the female condom.The Female Health Company (FHCO US) in Chicago is a key competitor for female condoms which makes FDA approved.the FC2 Female Condom.
• Company has capacity to produce upto 325 mn pieces of male condoms and upto 20 mn pieces of female condoms annually. Capacity utilization in FY16 was 64%.
• Note that female condoms are 10x the price of male condoms, and therefore despite having only 6% of capacity towards female condom, rev. contribution of female condoms is about equal that of male condoms in its top-line. 

• Promoter background: Omprakash Garg, who’s spent a good part of his life in Canada and the United States as a mining company manager, veered to gold jewelry distribution in the U.S. He took a stake in Cupid when it was founded by friends in 1993. But Garg now owns 49% of the company. He moved back to India in 2008 to run it full-time.

Key projections/ statistics

• Chairman says globally there is a huge demand for female condoms and it is expected to grow three times in the next five years (i.e 25% CAGR). Hence, Cupid is looking to double it's female condom capacity. 

• While the male condoms market would demonstrate a growth from annual 27 billion units to 42 billion units by 2020 (i.e 12% CAGR), and Cupid stake in global condoms is only  ~1% which goes to show the opportunity pool for Cupid.
• Indian sexual wellness market is touted to explode nearly nine-fold from ₹1,000 crore in 2014 to ₹8,700 crore by 2020 (i.e  43% CAGR). Successful entry into this market could mean huge untapped opportunity.

What attracts me about this company?

• Healthy financial profile...: Cupid has grown its revs. and EBITDA by 24% / 74% in the last four years as EBITDA margin expanded to 43% from 11% four years back. It's net profit has grown over 25x during the same period. Further, it's debt free status, and high return ratio (FY16: 44%) puts it in the best-in-class category.
  
• ... with huge growth potential: Global total revs from condoms, including the tenders and in the open market was about $27 billion and Cupid topline is at <$10mn... While this may not be true representative, but gives us an idea of growth potential. Cupid II product is under review by UNFPA (expected in Oct 2016), and has also launches recently water based lubricant jelly which can alone add 10% to revs.  

• While some could argue if recent growth achieved is sustainable, I would highlight that mgmt. expects 15%-20% growth for FY17E/18E, which will put it at Rs 800 mn topline company and mgmt. has guided 30-35% sustainable margin in the long-run. We note that margins in female condoms are 50%-60%, significantly higher than male condoms due to lesser competition. Assuming its guidance come true, company trades at 20x FY18E earnings, which I think is cheap if we were to look at slightly longer picture. 

Key moat in the biz

• Moat in the business is that it has cost advantage. Cost of producing a condom piece is 4 Rs for Cupid as compared to Rs 15 of it only competitor FHC, listed in US. Plus barriers to entry in the form of WHO/UNPF approval, which is difficult to get and time consuming.

Key risks/ negatives

• Majority of the revenue comes from B2B where it participates in the tenders and get long-term contracts awarded, that is its primary source of revenue (c.80%). The second one is the job work, third party contract manufacturing we do. The consumer business is minimal right now. Thus, visibility of its brand and thereby pricing power is less.
• Despite huge opportunity within its own biz, mgmt. is contemplating acquisition opportunities in baby/adult diapers, sanitary napkins, and hand sanitizers to utilise its cash on the B/S. I fail to understand that at one-hand mgmt. says the opportunity pool in condom market is huge, why does it want to venture into other categories where big players are already present. 

Conclusion

Cupid indeed has potential to barge into 100+crs topline club soon and if mgmt. executes well it can really make it big in domestic retail biz. and global wholesale biz. Valuations too are undemanding, and I would expect limited downside even if it falters slightly in between.