Nicholas Piramal: Buy

Investors with a two-three year perspective can buy the stock of Nicholas Piramal India (NPIL). After cementing its position in the branded formulations business– its top10 brands and lifestyle products contribute over 50 per cent of formulations portfolio sales–NPIL forayed into the international market not through costly intellectual property rights (IPR) tussles but through partnerships with “Big Pharma”. These relationships have begun to bear fruit.

The custom manufacturing (CMG) business, grew 22 per cent to Rs 340 crore in Q2 FY-08. CMG revenues from Indian facilities, in particular, increased over three-fold to Rs 70 crore, as shipments for a supply contract with a big pharma company commenced.

A five-year formulations contract with a Fortune 500 company is set to commence from third quarter and another contract for anti-glaucoma active pharmaceutical ingredients is already underway with Allergan Inc. NPIL is set to clock peak sales of $30 million per year from both these contracts.

Numerous contracts to be executed in the next two years give NPIL admirable earnings visibility. At the current market price of Rs 301, Nicholas Piramal trades at 16 times its likely FY-09 per share earnings.
Custom manufacturing model

NPIL has, till date, invested Rs 900 crore to transform itself into a full-service custom manufacturing organisation. Its strong early stage capabilities provide a strong value proposition to shift active pharmaceutical ingredients (API) and dosage-form manufacturing to NPIL. Notably, its strategy to stay away from conflicting customer intellectual property rights (IPR) has enabled a comfortable equation with western innovator companies.

With the help of its global outsourcing strategy, NPIL sources cheap raw material from China and uses its US FDA-approved Indian facilities spread across Hyderabad, Pithampur, Digwal, among others, as manufacturing hubs. While raw material costs are a bit higher in India, conversion costs are significantly lower.

This helps NPIL post higher margins than its other facilities. Its US and UK units form the last end of the value chain helping with sales and distribution, apart from R&D expertise-led innovation at Avecia Pharma and Morpeth in the UK. Fixed costs are already covered and with Indian assets making a higher contribution to revenues, profitability is likely to improve.

There has also been a significant rise in NPIL’s global contract manufacturing and research business with molecules in pre-clinical and clinical trials (PDS) in the last six months. There are now 17 molecules in Phase-III compared to 12 in the second half of 2007. Sixty three molecules are in Phase-II as against just 44 six months ago. Encouraging data in some molecules will mean commercialisation that will give NPIL a boost. This is inline with the company’s strategy of trying to build a strong PDS pipeline, which would ultimately lead to contracts eventually on the Pharmaceutical Manufacturing Services.
Formulations and Pathlabs

Apart from its CMG business, strong foothold in the domestic formulations (finished dosages) market will see the company acquire momentum.

While the June quarter was a bad one for NPIL’s top selling cough syrup, Phensedyl, September has seen the situation normalise as the company has received enough quantities of Codeine — the most important ingredient for Phensedyl. Some recovery is expected in the rest of the year for the company’s best brand.

Nicholas has also continuously launched products (11 in the last three months) that could go in a long way in de-risking its portfolio. Products launched in the last two years have managed to garner 8 per cent of Q2 FY-08 formulations sales.

Revenues from its Pathlabs segment (Wellspring) grew 72 per cent to Rs 31 crore in the September quarter.

While the segment by itself has contributed just 3 per cent of sales in FY-07, the acquisition of Jankharia Imaging (Mumbai) has helped it deliver an all-encompassing range of high-end health imaging in Wellspring’s plans.
R&D demerger

NPIL recently announced the demerger of its Research and Development unit dealing with new drugs, with effect from April 1, 2007. Recognising that innovative research entails a higher risk profile than its core business nature, the division has been hived off. Shareholders will get one share of the research outfit for every 10 held in NPIL.

The new company will be listed by June-July 2008. With a strong pipeline of four products under clinical trials and nine additional ones undergoing pre-clinical tests, the new company’s R&D pipeline targets a potential market size of $48.5 billion.

The new company’s lead oncology molecule P-276 continues to do well in the clinic as extended phase I/II study carried out in Canada and India progress. If all goes well, the drug could be launched by 2011.