Religare's outlook for pharma challenging; sees 6.3% Q2 sales growth

MUMBAI: The outlook for pharmaceutical sector remains challenging, says Religare Securities. The generics business of most companies has become commoditised and hence they have limited pricing power.

The depreciating dollar coupled with high raw material costs from China will keep margins under pressure. Research and development, marketing & sales costs are unlikely to soften at least in the short to medium term, feels Religare. The brokerage favours companies with differentiated business models, like Sun Pharma and Glenmark.

Religare expects the consolidation phase in the global generic space to continue, and Indian companies to remain active in this consolidation. This could lead to fund raising/dilution to finance pricey deals.

The brokerage does not expect companies with FCCBs/ECBs to have significant mark-to-market forex gains in the July-September quarter on account of rupee appreciation, vis-à-vis the first quarter.

Religare expects companies under its coverage to report negative sales growth of 6.3 per cent at Rs 4,490 crore during Jul-Sep, mainly on account of lower revenues of Dr Reddy’s Laboratories and GlaxoSmithKline Pharmaceutical.

Earnings before interest, tax, depreciation and amortisation for Jul-Sep is seen declining by 16.5 per cent to Rs 920 crore compared with Rs 1,100 crore in the year-ago quarter and margin to contract by 251 basis points to 20.5 per cent against 23.0 per cent same quarter previous year, especially on account of the depreciating dollar.

Adjusted profit after tax is seen contracting 15.5 per cent to Rs740 crore. Excluding Dr Reddy’s, all other companies will have lower adjusted net profit growth than EBITDA growth.

SUN PHARMACEUTICAL INDUSTRIIES

Religare’s top pick is Sun Pharma with a target price of Rs1,265 against the current market price of Rs 958.

Sun Pharma has a better product and revenue mix compared to peers. It has over 50 per cent exposure to the high margin, low risk domestic market.

The demerger of the high risk innovative R&D into a separate entity has unlocked value and lowered the risk for the existing entity, feels Religare.

The stock is trading at a price to earning ratio of 20.9 times 2007-08 estimates and 17.3 times 2008-09 estimated earnings.

AUROBINDO PHARMA

Religare recommends “reduce” on Aurobindo with a current price of Rs 595 and target price of Rs 678.

Aurobindo is largely a bulk drug company; its move into formulations is positive, but its formulations are also largely generics. Its margin expansion in the future will be muted because of the need to create a front end for its generics business. Earnings growth in 2007-08 is mainly driven by the rise in Pen-G prices, which is not sustainable. Its lower margin Anti Retroviral business and a depreciating dollar are other negatives.

Aurobindo will remain an EVA negative company over the next two years. The stock is trading at a price to earning ratio of 14.9 times 2007-08 estimate and 13.9 times 2008-09 estimated earnings.

BIOCON

Religare recommends “reduce” on Biocon with a current price of Rs 462 and target price of Rs 512.

Biocon’s profitability will be strained as the company continues to be in an investment phase, the brokerage says.

The current product basket is small with 35 per cent exposure to the commoditized stating business, which will be a drag on performance. Big ticket product opportunities and out-licensing triggers are at least 12 months away. The stock is trading at a price to earning of 20.8 times 2007-08 estimates and 16.8 times 2008-09 estimated earnings. At these valuations, the price fully captures the research story.