Cupid Limited Valuation: David Vs. Goliath

Cupid limited is a manufacturer of Male and Female Condoms, mostly for the global B2G Condoms market. The company also produces Lubricant Jelly, Hand Sanitizer and related health and hygiene products. COVID19 is most likely to pose serious challenges for the company, with Donor Funding re-routed to fight the pandemic. What are the long term prospects for the seemingly small, Nashik-based Condom Manufacturer and what does it all tell us about its Value?

Disclaimer

Before going further, let me inform you that I hold a stake in Cupid Limited in my stock portfolio. So far, I have avoided writing about the companies I own, because I felt like I will be biased. But following persuasion by several investors, I have decided to try out writing a Valuation post on Cupid Limited. If this goes well and I feel certain that I have not brought my own biases into the post, I might write about some other companies I won as well.

However, I may change my mind about any and every company I own or track based on future happenings and new information available. Cloning my holdings without doing adequate homework yourself is not a smart move. Remember, conviction is your rock in investing. Do not expect it from someone else.

The Company

Cupid Limited is a manufacturer of Male Condoms and Female Condoms, mostly for sale in countries like Africa, Brazil, Venezuela and to a small extent, in India too. They also manufacture and market health and hygiene products like Lubricant Jelly, Hair Removal Cream, Sanity Wipes and Hand Sanitizer.

Incorporated in 1995 as "Cupid Rubbers Limited", the company has come a long way from being a small-time domestic condom manufacturer to a high-quality exporter of Male and Female Condoms with a ton of Awards and support behind them.

The first thing you will notice when you look at the Financial Statements of Cupid Limited is that its fortunes shifted for the better starting from 2010-11. That's because they pivoted from local condom manufacturing to high-value export condom manufacturing since that year. You can see a short summary of the story below:

(Source: https://www.cupidlimited.com/wp-content/uploads/2017/04/Cupid_Investor_Presentation.pdf)

The following video may also give you a fair idea about the growth trajectory of the company so far:

Currently, Cupid Limited can produce 560 Millions Male Condoms and 52 Million Female Condoms. But the capacity is fungible. That is, if the company gets 100% orders for Female Condoms in a given year (Highly unlikely, but still), they can configure the factory to produce 200 Million pieces of Female Condoms instead.

Male Condoms have a Realization of Rs. 2 and Female Condoms close to Rs. 21. The Margins for Male Condoms are 15-20%, whereas for Female Condoms it is a high 40-50%.

The Management

The Board of Directors of Cupid Limited consist of 4 key people:

1. Mr. Omprakash Garg (Chairman and Managing Director)

2. Mr. J. L. Sharma (Independent Director)

3. Mrs. Veena Garg (Non Executive Director), wife of Mr. Garg

4. Mr. Pradeep Kumar Jain (Independent Director)

You can read / research about the other employees, but I would say Mr. Omprakash Garg is the most important driving force behind the company. His story is one of perseverance and grit.

Many people who don't follow the company don't know this - but Mr. Garg is partially blind. He often uses the help of his wife, Mrs. Veena Garg, to get around. But he has not let this shortfall limit him. He has catapulted Cupid from being a small, 1-2 Crore Revenue, mostly loss-making company into one with a nearly 200 Crores of Revenue with excellent Operating Margins, Returns and Shareholder Value Creation all over the course of a two decades. The numbers speak for themselves, especially the transition over the last half a decade.

Also, if I do say so myself, he is very humble and always clarifies most doubts the shareholder have regarding the company. Read at least the 2019-20 Concall Transcripts of the company in order to verify this yourself.

Managerial Remuneration

It is always good to check whether the management is getting Salary & Benefits as prescribed by the Regulatory Authorities.

(Source: Cupid Limited Annual Report)

It looks like Cupid's Managerial Remuneration is within Regulatory Limits. Although it should be noted that almost 90% of the Managerial Remuneration every year goes to Mr. Garg. Cupid Limited is truly a one-man show.

Production in a COVID19 World

Cupid Limited has shared a video on their YouTube channel on how they are resuming production in a COVID19 world:

I know this isn't much. But at least we know that the management is taking all steps possible to ensure a safe and healthy working place during this pandemic.

Accolades

Further, here are some accolades received by Cupid Limited under the leadership of Mr. Garg:

Forbes Magazine - Asia's Best Under a Billion (2016)

Cupid was featured in Forbes Magazine's "Asia - Best Under a Billion" list. They also had an article written about them for this achievement. You can read it here.

Capexil Special Export Award (2019, for Years 2015-16 and 2016-17)

(Source: https://www.cupidlimited.com/latest-news/capexil-special-export-award-for-cupid-limited/)

India's Growth Champions 2020

Cupid Limited was featured at in ET's "India's Growth Champions 2020" list. You can read more about it here.

(Source: https://www.statista.com/page/indias-growth-champions-2020)

The Industry

The Global B2G Condoms Market / Global Public Market

The Global B2G Condoms industry is fairly straight-forward. The orders come largely from 3 sources:

1. World Health Organization (WHO) / United Nations Population Fund (UNFPA)

2. Donor Funding (NGOs and other non-profit organizations)

3. Governments (Ex: Africa, Brazil, India)

The orders are tender-based. So, demand mostly comes in spurts. The market size is about Rs. 300 Crores (Inclusive of both Male and Female Condoms). Male Condoms command about a 10-15% Margin, while Female Condoms command a 40-50% Margin. The market is growing at a rate of about 18%, considering both Cupid's and FC2's growth tracjectory.

But here's the interesting thing about the Female Condom: Cupid Limited is one of the only 2 companies in the world qualified to produce Female Condoms. This is because of an entry barrier for the Female Condoms business.

Entry Barrier (Female Condoms)

In order for a company to get into the Female Condom manufacturing business, they need to do the following:

1. An investment of Rs. 25-30 Crores for producing good quality Female Condoms.

2. A gestation period of 5 years in which the design and quality of the Female Condoms will be tested by the World Health Organization (Meaning, there will be no Revenues for those 5 years, despite the Rs. 25-30 Crores of investment)

3. A Pre-qualification issued by WHO after the 5-year gestation, which can be revoked at any time if they feel that the quality of the Female Condoms being produced are not up to the mark (See the info about the Chinese player below).

You can read this document, Female Condom; Generic Specification, Prequalification and Guidelines for Procurement (2012), published by the WHO for more details.

The U.S. Prescription Market

On September 21, 2018, the FDA issued a final order reclassifying female condoms from Class III to Class II medical devices, renaming them “single-use internal condoms” and requiring new devices in this category to submit a 510(k) premarket notification and comply with various “special controls.” Special controls are a battery of product clinical testing which includes, but is not limited to, determining product effectiveness against pregnancy and against infection transmission, and product tolerability. While FC2 is the only currently available female condom approved for marketing by the FDA in the U.S., this reclassification by the FDA may reduce the barriers for other types of female condoms to enter the U.S. market.

Cupid Limited has already applied to enter the U.S. Prescription market, which is another Rs. 100 Crores in size and growing at a decent pace. The order was supposed to come by 2021, but COVID19 may have temporarily delayed this.

The Competition

The Global B2G Condoms market contains 4 main players:

1. Cupid Limited (https://www.cupidlimited.com/)

2. FC2 (https://fc2.us.com/)

3. HLL (http://www.lifecarehll.com/)

4. PATH (https://www.path.org/)

Out of these, Cupid and FC2 (A division of Veru, a pharmaceutical company in the United States) alone hold nearly 95% of the market between themselves with an almost equal share. HLL is a Government of India enterprises, but a very small player (In this market). There also used to be a small Chinese player called PATH, but they lost their WHO pre-qualification in 2019 and no longer compete in this market.

Interestingly, FC2 is also the one of the major competitors in the U.S. Prescription market, which Cupid is trying to enter. So, a head-to-head with FC2 alone will be sufficient as far as Competitive Analysis is concerned. Better yet, we can hear it straight from the horse's mouth. Here are select quotes from Veru's last year's 10-K filing:

"Cupid received part of the last two South African tenders. Increasing competition in FC2’s markets has, and will likely continue to, put pressure on pricing for FC2 and may also adversely affect sales of FC2."

"If other female condoms enter the U.S. market, we may face increased competition in the U.S., which may put downward pressure on pricing for FC2 and adversely affect sales of FC2 in the U.S."

"We have experienced increasing competition in the global public health sector, and competitors received part of the last three South African tenders and the latest Brazilian tender. Increasing competition in FC2’s markets has put pressure on pricing for FC2 and adversely affected sales of FC2, and some customers, particularly in the global public health sector, may prioritize price over other features where FC2 may have an advantage."

"Over time, due to increased competition or other factors, we may experience price erosion in the U.S. market. Negative pressure on our price levels for U.S. sales may have a material adverse effect on our net revenues and gross margin in the U.S. market."

Suffice it to say, Cupid is a formidable competitor to FC2.

Other Businesses (Cupid Limited)

Domestic B2C / B2B Business

A prominent question many people have is: "Why doesn't Cupid do B2C in India?" They do Contract Manufacturing for Indian B2C Condom players from time to time, some Wholesale marketing of Condoms in India and even online retailing on sites like Amazon. But all this put together will not even cover 5% of Revenues for the company. Is this bad? Read on.

The wrong presumption people have is that all sorts of B2C businesses are great in India. This is wrong. The B2C condom market in India is riddled with competition from 15-20 players for a market size of Rs. 1,500 Crores. Apart from the top dogs like Mankind, Skore, HLL Lifecare, TTK etc., the rest of them have sporadic Revenues and Profits. Even for the ones mentioned above, it's not all rosy. Take the case of Skore, for example. They make about Rs. 15 Crores in Profits. But even they regularly spend Rs. 8-9 Crores on Advertisement Expenditure. So, they must constantly reinvest close to 50% of their Net Profits into Ads just to keep the treadmill running. It's not worth the effort to try and capture this market.

Sanity Products Business

In addition to this, Cupid has a line of hygiene products like Lubricant Jelly, Sanity Wipes, Hair Removal Cream and Hand Sanitizer. But these are very small streams of Revenue (<2%). Hence, I will not be covering these in this post, at least extensively.

Marketing Campaigns

Since Cupid is mostly into B2G, there is not a lot of need for marketing / sales promotion. But Cupid has done some marketing campaigns over the years, which I am sharing here purely from an information standpoint.

Digital Marketing

Cupid has Facebook and Twitter pages where they do Digital Marketing.

Expo (NIMA Index 2018)

(Source: https://www.cupidlimited.com/blog/cupid-limited-at-nima-index-2018-at-mumbai/)

Expo (Africa)

Awareness Campaign (ICASA 2013 - COMDOMIZE!)

Cupid Island

One of the more interesting campaigns was done by Cupid Limited recently. In July 2020, Cupid inaugurated 'Cupid Island' at City Center Mall Square in Nashik. It has a statue of a couple with Umbrella in rain surrounded by a beautiful garden and a statue of Cupid (The Roman God of Love). This island also has a population clock which shows the current population of India. It also shows the current date, time and the current temperature.

You can find similar campaign material from Cupid by simple Google searches. You can also follow the News & Articles page on Cupid's website for regular updates.

The Numbers

I have entered the following numbers from Cupid Limited's 2019-20 Q4 Quarterly Results release.

Note: Debt

You may notice that the company has a Liquid Cash balance of close to Rs. 60 Crores. But in the recent quarters, they have taken up a Bank Loan of Rs. 31 Crores. What is the need for this?

Cupid very recently supplied to the Brazilian government for the first time. The African government, which is their regular client, has been quick in terms of payments. But it looks like the Brazilian government has demanded a 90-day period for paying for a consignment worth Rs. 31 Crores. So naturally, a Receivables of Rs. 31 Crores has been created.

(Source: https://www.cupidlimited.com/wp-content/uploads/2019/11/Q2FY20_Concall_Transcript.pdf)

Instead of taking it on their existing Book (Using up the Liquid Cash), the management decided to take a loan to act as the Working Capital for this consignment. So, they took out a Bank loan against their Fixed Deposit for a similar amount. In the company's history, Bad Debts have not been very prominent (Ironically, a couple of Bad Debts, although very small in amount, have been written off due to mix up with the Government of India):

(Source: https://www.cupidlimited.com/wp-content/uploads/2020/01/Q3FY20_Concall_Transcript.pdf)

Rest assured, Mr. Garg has promised that the loan will be repaid once the Receivables situation is resolved.

(Source: https://www.cupidlimited.com/wp-content/uploads/2020/01/Q3FY20_Concall_Transcript.pdf)

Unfortunately, there is no concall scheduled to discuss the Q4 results (Because of COVID19). So, there is no status update on this specific Receivables item. We can still see the loan existing on the company's books, however.

Note: Risk-free Rate

I entered the Risk-free Rate based on Government of India's 10-year Bond Yield as seen below:

(Source: http://www.worldgovernmentbonds.com/country/india/)

Note: Beta and Indexed Returns

Also, I tried calculating the Beta and Indexed Returns (NIFTY 50 Returns) using data from Yahoo! Finance.

(Download Cupid Limited - Beta and Standard Deviation)

But it looks like NIFTY 50 Returns even since the last 10 years is too low (~6%). This would put Cupid's Cost of Capital at roughly ~7%, which is obviously too low. I will be using a workaround for this, which I will explain later in this post.

The Capital Conversions

Cupid does not have any R&D or Stock Options/Warrants. It does have a lease obligation of Rs. 17 Crores, which I have included.

The Assumptions

The following are the assumptions I am going to make for my Valuation of Cupid Limited:

Note: Sales Growth

This may get a little confusing, so I request you to pay close attention.

There are two parts to this assumption:

1. COVID19 Impact (Only for 2021): Most of Cupid's Revenues comes from Donor Funding and WHO. Since both of these would have been re-routed to fight COVID19, I expect a washout 2021. I have assumed that Cupid will be able to run only at a Capacity Utilization level of 50%, as opposed to the current, 99% level of utilization.

2. Post COVID19 (2021-2030): Post COVID19, I expect the Global B2G (Public) Condoms business to grow at its regular rate of 15% on average. However, I expect an important catalyst in Cupid entering the U.S. Female Condoms Prescriptions market, where FC2 is the sole competitor now. I expect them to take up 50% of the market over a decade (This is a very conservative assumption, because Cupid has the cost advantage - producing in India and selling in the U.S.)

I used Excel Solver to arrive at the growth rates to match these assumptions. The growth rate looks very high because it is on a smaller base of ~Rs. 80 Crores, not on the current base of ~Rs. 160 Crores. If you actually work it out from the current base, the CAGR over 10 year turns out to be ~16% or so, which seems like a reasonable assumption to me. This is way below the Sustainable Growth Rate of Cupid, which is up there at 21% or so. Hence, we are good.

Note: Operating Margins

This is just an extension of my assumptions for Sales Growth above.

When Cupid captures the U.S. Prescription market, the Product Mix will turn favorable towards Female Condoms, which will increase the blended Margins of the company eventually.

During the Terminal period, I have assumed that the Margins will reduce to 75% of the peak Margins. I know this isn't exactly logical - but we have only 2 players in this market and both of them are in early stages of growth. We don't have any references for what a matured Margin profile looks like.

Note: Tax Rate

Corporate Tax Rate in India has been cut to 25%. 

Note: Capital Turnover

This is not a capital intensive business. So I have more or less used the long term average as my pivot.

Note: Reinvestment Rate

Since I manually adjusted the Sales for the first year alone, I adjusted the Reinvestment amount to also match a 'regular' level of Reinvestment. The rest of it is calculated automatically by the model.

Note: Return on Capital

Return on Capital will converge towards the Cost of Capital over the long term. Actually in the Terminal Year, it is nearly equal to the Cost of Capital - which assures us that this valuation is conservative. Return on Capital always converges to the Cost of Capital over the long term, unless and until there is a considerable change at the business level (Business Model change, Strategy change, Pivoting and so on).

Note: Depreciation

Depreciation as a percentage of Sales will converge towards the long-term average of 3.94%.

Note: Opportunity Cost

I have used 15% as my Cost of Capital, which is the 99th Percentile Cost of Capital for Indian companies according to Prof. Aswath Damodaran's Useful Data Sets. You will find this fairly reasonable when I explain the Risks in the company later on in this post.

The Diagnostics

The Diagnostics section does not show any red flags (Logical errors in the assumptions).

The Cashflows

According to my assumptions, this is how Cupid's business will evolve over the long term (Sales is in the Secondary Axis):

Now we can look at the implied value of Cupid Limited based on these assumptions.

The Value

Moment of truth.

I think Cupid Limited is fairly valued at Rs. 220, which is more or less equivalent to the CMP of the company. So to me, it was not a surprise when the stock fell to Rs. 125 during the March crash and quickly recovered by ~66% to get to the CMP.

(Source: https://www.screener.in/company/CUPID/)

But that is not all. We still need to look at some of the Risks surrounding the company.

The Sensitivity of Value

The Sensitivity of Value tool shows the different Valuations of the company based on differing assumptions of Growth and Cost of Capital during the Terminal period.

To put it shortly, you are more likely to make good returns if you purchase the stock between the Pessimistic Value and the Probable Value. You are less likely to make good returns as you move past the Probable Value and towards the Optimistic Value.

The Risks

In this section, we will talk about the potential risks in the company. For some of them, we will also attempt to convert the risks into a number impacting the final Value.

Succession Risk

The biggest risk I see for Cupid Limited is the succession. Mr. Garg is getting old. The company has been searching for a new CEO for more than 3 years and there is still no suitable candidate. Mr. Garg is looking for someone with a Sales background, so they can help out the company with B2C prospects. Furthermore, it seems like some CEO candidates demanded an office in Mumbai. Mr. Garg felt it was unnecessary, when the plant is in Nashik. So the search for the CEO trudges on, which leads us to the next point.

Takeover Risk

I wouldn't really call this a 'Risk'. This is more of a possible endgame for the company. If there is no suitable CEO even when Mr. Garg is too old to work efficiently, there is a good possibility of a sell out to a larger player like Mankind or Skore. Mankind is even looking to enter the U.S. market themselves, so they may find Cupid a good fit. The actual 'Risk' is that existing shareholders either have to take whatever valuation the acquirer provides them (or) stay put with an unlisted company (After takeover).

Capital Misallocation

This is a legitimate Corporate Governance issue. In the past, the company has 'invested' in a couple of unrelated Real Estate companies and written off the entire amount later. The amounts themselves are small in nature and there hasn't been a repeat in the recent few years. But I highly suggest you read the blog post written by Dr. Vijay Malik for better understanding.

Receivables Risk

I talked about the Brazil Government Receivables issue above. Cupid Limited has also had some run-ins with the Government of India before, and had to write off a consignment. Being in a tender-based business, especially with large customers like entire Governments, Working Capital bogging down the Growth of the business is a small Risk.

Regulatory Risk

As mentioned above, WHO currently holds the power to cancel Cupid's 'license' to produce Female Condoms. When they enter the U.S. prescription market, they will be liable for further scrutiny by the FDA. These regulators can make or break the fate of Cupid Limited. Although to be logical, Cupid has been a good supplier to many WHO-supported countries. Over the years, they have developed a good rapport. So, this Risk may not really come to pass. But it is good to keep an eye on it anyway.

Competitive Risk

It is fairly difficult to get into this market and compete (See 'Entry Barriers' section above). But any new dominant entrant into the market will eat away at the Margins of Cupid Limited.

The Monte Carlo Simulation

I am going to 'simulate' some of the assumptions I have made above based on the Risks we discussed. I have tried to show exactly what I am trying to simulate in a tabular format:

So once I run a 1,000 simulations, this is the output I get:

In case you are not familiar with a Normal Curve, we can reinterpret this diagram is easier terms:

I personally like a Probability of Undervaluation of 90-95% for most companies. But that is because I am a conservative investor by nature. If you are different and have a varied Risk Aversion compared to me, you will have to pick a Probability of Undervaluation for yourself. This will define how much you are willing to pay to own Cupid Limited (If you are willing to own it at all).

The Model

In case my assumptions do no seem logical to you, feel free to download the model below and make your own changes. In fact, I encourage you to do the same. We can also have a conversation in the comments section below to discuss differing views.

(Download Numbers and Narratives - Cupid Limited)

Warning: I have manually edited the model for valuing Cupid. So if you are going to use this Excel sheet to value something else, it will not work properly. If you are looking to download just the model for your personal use, please go here. You can ideally delete everything within the yellow boxes and keep it as a template for future use.

I've hidden several sheets in the Cupid Valuation Excel to avoid clutter. Unhide them as you wish.

David Vs. Goliath

Cupid Limited coming up from being a small-timer to getting a WHO pre-qualification to going toe-to-toe with a U.S. Pharma company (Veru Inc - Parent of FC2) reminded me of the biblical fight between David and Goliath.

(Image Source)

Will David (Cupid) successfully rise up to the challenge and defeat Goliath (Veru) in his home ground (U.S.)? Only time will tell.