Dishman Pharma

Contract Research and Manufacturing Services (CRAMS) is expected to grow faster than other sub-sectors in the pharmaceutical industry. This is due to the expected ramp up in revenues as global pharma majors look to cut costs through outsourcing and strong operating margins for players which usually work on a ‘cost-plus’ base.

Early players, which are at the last leg of their capex cycle and have put together acquisitions that stretch from early stage to late-stage commercialisation of medicines, may stand to reap greater benefits from this trend. Dishman Pharmaceuticals and Chemical, a leading CRAMS player catering exclusively to innovator companies, appears a good bet, in this context.

Initially constrained by small size, low capacities and a business skewed towards fine chemicals, the company today has manufacturing capabilities focussed on patented molecules, key medicine intermediates and special chemicals.

CRAMS accounted for 75 per cent of net sales in 2007-08. Acquisition of Carbogen Amcis has given it the much-needed strength to carry out full-fledged CRAMS, with the subsidiary now contributing more than half of CRAMS’ revenues.
Taking stock

Our earlier recommendation on Dishman was a ‘buy’ at Rs 275 in February. The stock has held its ground even as the broader markets have fallen by 33 per cent in the period that followed. The company’s annual results strengthen conviction in the company’s growth prospects. Dishman managed to register strong growth on both sales (39 per cent) and profit terms (32.5 per cent) against an appreciating rupee (around 8 per cent).

Quite a few new contracts are lined up for execution in the next 12-18 months even as Dishman is engaged in advanced talks with major MNC clients for new orders.

Post-commissioning, its new units are expected to generate over Rs 500 crore each year at optimum utilisation (expected in two-three years). On a consolidated basis, taking into account losses in some subsidiaries and a poor performance from the marketable molecules segment (19 per cent of sales), Dishman’s net profit margins came down to 15 per cent from 16 per cent last year.
Investment rationale

Higher realisations from CRAMS business (with new contracts), good client management history and rupee depreciation are set to play out well for Dishman, which draws 90 per cent of its sales from exports. At the current market price of Rs 286, the stock trades at around 14 times its estimated per share earnings for 2008-09. This is at a fair discount to sector leader Divi’s Labs. The valuation is comparable to Piramal Healthcare (formerly Nicholas Piramal), which is a much larger player (but less exposed to CRAMS).
Changing dynamics

Dishman’s client dependence has been de-risked further with Solvay accounting for less than 14 per cent, against 20 per cent in the December quarter. Cumulatively, top five clients now account for around 35 per cent of the business compared to more than 45 per cent even a year ago.

Dishman’s FY-08 EBITDA margin was muted at 19 per cent. Several extraordinary and one-off costs took their toll. Plus, the marketable molecules business was hampered with unexpected price hike in raw materials. Going forward, coupled with 5-10 per cent price increases (management expectations) for that business and absence of the non-recurring expenditure, Dishman’s core margins are expected to be back to 22 per cent levels.

CRAMS is also expected to profit from higher capacity utilisation. Profit margins will also be aided by the fact that most of Dishman’s subsidiaries are expected to break-even this year.
Way ahead

There are several opportunities and challenges for Dishman over the next two years. The company is looking at new areas such as manufacturing high potency (hipo) products. Unit 9, which is expected to be operational from March 2009, would cater to these typically high-cost and low-volume products such as anti-cancer drugs, steroids, hormonal drugs etc.

Indian CRAMS players are involved in initial stages of these ‘hipo’ products whereas Dishman (benefiting from Carbogen’s specialisation) will target class 3 and 4 substances.

Margins of Dishman’s Vitamin D business (4 per cent of turnover) are expected to normalise at 18 per cent over the next two years.

Business from marketable molecules segment is expected to remain under pressure for the next two quarters (the China unit starting soon may provide some relief). Dishman’s bulk drugs JV in Saudi Arabia is unlikely to pay off before 2010 and much will depend on the speed of execution.

Lastly, the company could book forex losses (as against forex gains in last one year) on its $100-million forex loans as the rupee begins to depreciate, affecting near-term earnings.