Piramal Healthcare: Hold

Shareholders with a long-term perspective can hold on to the stock of Piramal Healthcare given the company’s strengthening presence across both domestic formulations and CRAMS (custom research and manufacturing services).

The company’s established relationships with global pharma majors may help Piramal rake in steady revenues even as it restructures its strategies to better weather the current economic downturn. At current market price of Rs 187, the stock trades at about 7 times its likely FY10 per share earnings. However, even as the stock’s valuations appear reasonable vis-À-vis the growth potential it holds, the likely lag in turning its recent acquisitions to profitability and a high debt and interest burden may cap the upside potential in the near-term.

The company’s recent acquisition of Minrad, however, bears watching even as other acquisitions (Avecia and Morpeth) are yet to make meaningful contribution to the bottom line.
long-term gain

Over the next few years, custom research and manufacturing services are expected to be much in demand as the global pharma majors look to reduce costs. The recent deals in the pharma space and the fact that global pharma majors are actively seeking partners for CRAMS (especially so for drugs that are likely to go off patent over the next couple of years) validate this. While the competition in this space is quite high given the many players involved, Piramal appears to be in a position of strength, with manufacturing capabilities in place and long-standing relationships with many of the global pharma players. However, even as the long-term growth for CRAMS and Piramal’s own prospects appear promising, there may be a few short-term hiccups. For the quarter ended December 08, the company reported a tepid CRAMS sales growth (4 per cent).

This was attributable mainly to the de-stocking of inventories by some of the large pharmaceuticals (which, in turn, was driven by the tightening credit environment) and the decline in orders from smaller biotech companies due to drying up of their funding.

However, the company expects this to last only over the next couple of quarters, as long as the inventory rationalisation process is on. Based on its client interactions, the company predicts robust demand. The company has, therefore, scaled down its FY09 Indian CRAMS estimates to Rs 370 crore from the targeted Rs 400 crore.
global model

To reduce costs further, the company has decided to move its CRAMS business from its foreign assets into India. While the company’s previous acquisitions — both Avecia and Morpeth — have not yet delivered outstanding profitability, the decision to move contracts to India may help broaden the client-sourcing base for the company.

Tough economic conditions are said to be prompting more customers to shift production from European facilities into India, given the cost advantages. While such moves may reduce the company’s topline to that extent, they may still prove earnings accretive, given the likely higher profit margins.

Further, Piramal is also increasing its focus on early phase contracts rather than pursuing large-sized commercial manufacturing contracts. This changed focus, though unlikely to result in immediate gains, may stand in it good stead over the long run by helping it increase its pipeline for commercial manufacturing contracts.
Financials

Piramal reported a 15 per cent growth in revenues during December 2008 quarter, driven primarily by the domestic formulations business, which grew by 22 per cent. Revenues from the custom manufacturing business, however, were sedate. Operating margins improved by 3.5 percentage points to 19.2 per cent. However, the company reported 18 per cent decline in profits for the quarter on account of forex losses of over Rs 35 crore (as against a gain of Rs 7.5 crore in the corresponding quarter last year). If not for the forex losses (or gains), the company’s profits would have grown by about 46 per cent. Also, the company currently has sufficient debt on its books (debt equity at 1.1), which the management has said would be brought down considerably by next year.
Domestic formulations

The company’s presence in domestic formulations also holds significant long-term potential. Helped by a large field force, strong brands and a robust new product pipeline, the company has managed to shore up its share in the market to 4.3 per cent this year from 3.7 per cent in November 2007. For 9MFY09, Piramal’s Healthcare Solutions segment reported a revenue growth of over 22 per cent even though the domestic formulations market grew by only about 10 per cent.

The company’s top 10 brands contributed about 25 per cent of its sales in the third quarter, while the new products made up for over 6 per cent. While the company may not enjoy high pricing power in a few of its products, a large field force may help it maintain its volume share.
Minrad acquisition

Given that the company is not new to acquisitions, having carried out many in the past few years, its recent acquisition of Minrad International Inc, though a tad costly, appears to hold significant long-term potential. Being a leading inhalation anaesthetic products company, this product portfolio complements Piramal’s and in the long run may help strengthen its presence in the Global Critical Care (GCC) segment. Piramal will pay about $40 million for Minrad, which is making loss at an operational level and did about $23 million of sales for 9MCY08.