Businessline - IPCA Labs

Investors can take exposure to the stock of Ipca Laboratories, a Mumbai-based player in both the bulk drugs and formulations space. At the current price of about Rs 440, the stock trades at 11-12 times its expected per-share earnings for FY-07. In the light of the likely growth prospects over the next couple of years, we believe that the valuation is attractive vis-à-vis its peers and provides scope for further upside. The stock has also moved up sharply in the recent past and, hence, investors can buy into the stock with modest return expectations.

Company profile

Ipca derives about 65 per cent of its revenues from the formulations business; bulk drugs chip in with the rest. Exports-to-domestic market composition stand at 55:45. In the bulk arena, Ipca is among the largest manufactures of drugs in the anti-hypertensive and -malarial areas. The domestic formulations business accounts for as much as 40 per cent of the overall revenues.

Earnings snapshot

The topline continues to exhibit strong growth trends with sales up by 25 per cent and 16 per cent on a quarterly and half-yearly basis respectively (compared to the year-ago period). Margins too are on the rise; at 23.7 per cent for the latest quarter; operating margins are up by more than 500 basis points compared to the year-ago period. For the quarter, earnings have doubled to Rs 35.4 crore; earnings growth for the half year is slightly below 40 per cent

After a lacklustre performance in FY-06, when Ipca's exports were strained largely because of pricing pressure in its key UK market, the overall business now appears back on track, if the first half of the year is any indication. The company's domestic business appears to be the principal driver behind the sharp margin improvement and earnings delivery for the latest quarter. With a clutch of launches addressing chronic therapy areas, this business posted an impressive growth of close to 40 per cent in FY-06. With the sales force being organised into divisions for specific therapy focus, sales growth is expected to be brisk, backed by product launches.

Ipca has also commenced production from its new Dehradun facility since May. The plant entails tax benefits, that should lead to a moderation of tax outgo and prop up earnings.

On the exports front, Ipca follows a differentiated tack by targeting branded generic markets such as CIS countries and Africa. Most Indian companies have targeted the huge generic opportunity opening up in the US; this has also exposed them to a highly competitive pricing environment that provides for wafer-thin margins.

On the contrary, the branded generics business should result in better margins and we expect to see meaningful growth in Ipca's key markets; the UK market is facing pricing erosion, but Ipca is addressing the issue through product launches. With a rising contribution from other markets, the importance of the UK market would diminish, which would be a positive if the pricing environment there continues to remain challenging.

The focus on markets for branded generics has not meant that Ipca has decided not to address the US market either. Though a product launch there could still be a couple of years away, we expect to Ipca to be competitive, as its abbreviated new drug applications would be backed by its own active ingredients, given the integrated nature of its business.

In the interim, Ipca has also sewn up an agreement with Ranbaxy for the US market; generics manufactured by Ipca will be marketed by the latter. This arrangement would give Ipca the advantage of a presence in a key geography without the associated front-end costs.

Valuation and view

With prospects encouraging, a valuation of 11-12 times forward earnings appears reasonable. Also, a market cap-to-sales ratio of 1.25 (reckoned on expected FY-07 sales of Rs 900 crore and current market price) offers scope for expansion, in our view, as the revenue profile improves further in favour of formulations. The principal risk to our recommendation would be if the proposed new pharma policy seeks to bring under its ambit a much wider scope of drugs.