Weekly Wrap - May 2 2010
Sunday, May 02, 2010
Investors with a long-term perspective can consider taking exposure to the stock of Cadila Healthcare.
The company's strong product pipeline, expected contributions from its Hospira joint venture and a strengthening presence in the high-margin domestic consumer markets (through its listed subsidiary Zydus Wellness) point towards healthy growth potential over the long term.
Cadila's improving focus on the domestic pharmaceutical market through product launches, in-licensing arrangements, and a special focus on rural markets also promise further growth in the domestic market.
At current market price of Rs 564, the stock trades at an expected FY-11 price earnings multiple of about 19 times. This appears reasonable given its long-term growth potential.
Possible triggers from its R&D pipeline and the commercial launch of H1N1 drug can also provide further upside to the stock price. Investors may, however, consider a phased accumulation of the stock.
For the coming year, the management has given a guidance of $1 billion revenues. It expects growth to be driven by international revenues, largely helped by its presence in the US. Given the company's robust regulatory pipeline of 106 abbreviated new drug application (ANDA) filings and 90 drug master files (DMFs), and its focus on filing for niche, difficult-to-make products, a ramp up in US generic revenues may not be difficult to achieve. Cadila plans to file 12-15 ANDAs annually for the US market each year. For the year ended March 2010, it received 12 ANDA approvals, taking the total to 54.
New product launches and improvement in the market share of existing products would help push US revenues; introduction of generic version of Flomax providing significant revenue opportunity. Overall, Cadila's export formulations business reported a 45 per cent revenue growth last year. Domestic revenues, which grew by over 12 per cent in FY10, are expected to expand by 15 per cent in the coming year.
Cadila's joint venture with Nycomed, which supplies final active ingredient for Pantoprazole drug, is expected to see a fall in revenues in the next couple of years (as the drug is set to lose patent by February 2011 in the US).
However, the extent of fall in revenues may not be drastic since the company will soon start the supply of 14 new Active Pharmaceutical Ingredients (APIs).
The recent US court ruling upholding the patent on Pantoprazole drug too may provide a short-term reprieve, given the possibility of a fall in sales from Teva and Sun Pharmaceuticals.
The ramp up in production by its joint venture with Hospira will also provide further long-term thrust.
Shareholders with a two-three-year investment horizon can retain their exposure to the stock of GlaxoSmithKline Pharma (GSK Pharma). A strong first quarter performance, planned launches from the company's product pipeline and the parent GSK plc's strong focus on growth from emerging markets underscore our optimism.
These apart, a strong balance sheet, significant cash on hand (about Rs 1,672 crore as on December 2009) and a total exposure to the domestic market add to its appeal. However, despite the many positives, the stock's present valuations appear a tad expensive.
At the current market price of Rs 1,905, the stock trades at 29 times and 25 times it’s likely CY-10 and CY-11 per share earnings. Sure enough, the company has always commanded premium valuations, but the present ones seem stiff and may leave little room for upside in the near-term.
Shareholders nevertheless can continue holding the stock given its strong long-term fundamentals; fresh exposure can be considered, should there be a significant fall in price linked to broad market weakness.
What drives growth
GSK Pharma has always commanded premium valuations, thanks to its MNC tag, clean balance sheet and a market positioning that affords it better vantage to benefit from the product patent regime.
While these arguments still hold good, what has added sheen to its investment appeal is a slew of high-growth potential product launches. Ratarix, the rota-viral diarrhoea vaccine; Tykerb, the breast cancer drug, and Cervarix, the first vaccine with a potential to prevent select strains of cervical cancer, are some of its recent launches that, over the years, hold potential to become big revenue spinners.
Over the past year, some of the company's main product launches include Benitec A, Dermocalm, Ventrolin CFC free inhaler, and Esblanem.
Products launches hold the key to future growth is apparent from the company's performance in the just-ended March quarter too. It scaled 18 per cent revenue growth, largely helped by product launches. It launched Mycamine, an antibiotic in-licensed from Japan-based Astellas, and strengthened its portfolio in the dermatology segment (estimated to be Rs 2,000 crore market).
Dermatology segment revenues were helped by its parent's acquisition of the US-based dermatology company, Stiefel Laboratories, globally.
While GSK had a presence in the domestic derma market, its coverage was limited to 60 per cent. This has now improved to 90 per cent with the global acquisition of Stiefel Laboratories Inc.
For the coming year, the company has lined up several products for launch including vaccines, Infanrix-Hexa (a six-component vaccine) and pneumococcal vaccine Synflorix; notably regulatory filings with the Drug Controller General of India have been completed for the two vaccines.
It also plans to launch three products (two are patented) in the oncology segment and has indicated that the patented products would be priced differently in the local market.
It has also indicated at the launch of some branded generic products.
While new product launches are likely to drive its growth, note that it may take a couple of years for the upside from such launches to assume critical mass.
Improving market reach
With most pharma companies (both local and MNCs) increasing their domestic focus, it will be the market reach and product portfolios of companies that will become key growth differentiators.
While GSK Pharma scores well on the product front, it will have to improve on its field force if it were to capture a larger share of the domestic market.
Notably, the company has added 200 people to its field force last year, and plans to continue adding to its field strength each year in the coming years.
Though this helps, it still stands pale when compared with some domestic pharma companies that boast of larger field force.
However, the company has done well to position itself, as preferred in-licensing partner for pharma companies, which want to widen their presence in the domestic market, as also for those looking to establish their footprint in the fast-growing Indian pharma market.
GSK’s access to molecules from its parent's stable too promises growth in the medium term.
For the coming year, the management has guided for a sales growth of over 12-13 per cent (in line with industry growth), with a focus on prescription-led growth.
This appears achievable given the company's product pipeline and strengthening field force.
For the quarter-ended March 2010, the company managed a broad-based sales growth of over 18 per cent, spread across all therapeutic segments, particularly vaccines and dermatology. It also improved its operating margins helped by its focus on power brands.
Decreasing dependence on drugs under the ambit of price control also helped; coverage of price-controlled products reduced to 27 per cent this quarter, compared with 29 per cent last year. Operating margins improved by over 100 basis points to 37.6 per cent.
Investors with a penchant for risk can consider the initial public offer of infrastructure developer, Jaypee Infratech, a subsidiary of the listed Jaiprakash Associates. A unique combination of infrastructure and real-estate development, with each segment driving the other's prospects, is the company's key advantage.
The company is in an advanced stage of expressway construction that is likely to be commissioned two years ahead of schedule. This combined with the availability of low-cost land for real-estate development (with a good part in Noida) provide earnings visibility to Jaypee Infratech. Revenues and earnings could be lumpy until 2011, after which the expressway would start earning toll revenues. Income from real-estate development would be the key contributor to revenues until such time.
The primary risk to this recommendation is that both the business segments are working-capital intensive and, until such time, the expressway is complete, liquidity could be tight. Inability to fully monetise the land bank would also mute growth.
The offer price band is Rs 102-117. Retail investors would get a 5 per cent discount on the offer price. Post- discount, the company's share is likely to trade at 24-27 times its annualised per share earnings for FY-10 on an expanded capital base on listing.
This is at par with infrastructure industry average. On a price-to-book basis, the valuation comes to 3.7-4.2 times; at a marginal discount to IRB Infrastructure Developers, which has a larger portfolio of roads in operation. On an enterprise value to earnings before interest, depreciation, taxation and amortisation (EBITDA) basis, Jaypee Infratech appears to be valued closer to real estate players rather than infrastructure. Given that revenues from real estate are likely to be higher than income from toll, the valuation appears justified.
The company and offer
Jaypee Infratech was launched as a special purpose vehicle in 2007 to implement a single road concession agreement — Yamuna Expressway — that connects Noida to Agra through a 165-km single expressway, built in Uttar Pradesh. The concession would allow Jaypee Infratech to operate and collect tolls for a period of 36 years. This comes with about 6,175 acres of land (translating in to 530 million sq ft of area) for real-estate development for a lease period of 90 years. The land can be developed or sold at the discretion of Jaypee.
The company proposes to raise about Rs 1,650 core through fresh issue of shares, while the parent company, Jaiprakash Associates, would receive about Rs 700 crore through an offer for sale. The offer proceeds would be utilised predominantly to fund the expressway.
Jaypee Infratech has timed its capital market foray after two key risk factors have been addressed. One, the entire Rs 6,000 crore debt, of the Rs 9740 crore of project cost has been tied up. The remaining funding has been done through promoter contribution and cash flow from real-estate activity. The current offer proceeds would go towards funding only 15 per cent of the project cost. Two, the company is in possession of 96 per cent of the land required for the expressway and expects to complete the project by 2011, two years ahead of the 2013 target. Three, Jaiprakash Associates, the parent, with wide experience in execution of large projects, is the contractor.
Besides, 70 per cent of the land proposed for real estate has also been handed over to the company.
Due to the above factors, Jaypee Infratech enjoys several advantages: The company would enjoy cost-efficiencies, given Jaiprakash Associates' captive cement production and ownership of stone aggregates. The company is unlikely to be leveraged further as the projects have tied up full funding. The company has stated that it would keep the real-estate development self-financed, as it can sell land to monetise it, apart from developing the same.
Towards this end, Jaypee has already booked profits for the year ending FY-09 and nine months ending December 2009 by selling residential and commercial plots. It has also initiated development of 24 million sq ft of five residential and one commercial project, 88 per cent of which has been sold and advance received, although none has reached the revenue-booking stage. Jaypee's biggest advantage in this project is the lucrative land bank that has been leased to it. At the anticipated cost of Rs 2,619 crore (besides an insignificant annual lease), the land cost works out to Rs 25 lakh per acre. It has also stated that the cost of a small portion of the land sold in Noida was Rs 50 lakh per acre a couple of years ago.
Weighed against about Rs 5 crore per acre incurred by a few other large players in Noida in recent times, Jaypee's deal could be termed a steal. This edge would allow Jaypee to price its projects aggressively, especially in Noida. The company did launch its initial phase of residential projects at a list price of Rs 2100 per sq. ft, drastically lower than competitors' rates. For the nine months ended December, Jaypee's sales were Rs 525 crore and net profits Rs 399 crore, the high margins arising solely on account of selling plots. The 76 per cent net profit margin is unlikely to sustain once the company's development costs and revenue are brought into the books.
A good part of the revenue for the nine-month ended December came from associate companies for hotel and certain other developments in the township. Going forward, as revenue from residential projects are brought into books, income from associates may dwindle as a proportion of the total revenue. With 88 per cent pre-sales and the entire current development to be completed by 2013, the existing projects could well manage their working capital from advances; even as toll revenues are expected to kick in from 2012.
Real-estate development may turn out to be the key driver of revenues and improve prospects for the expressway. After all, the existence of crucial infrastructure such as road, power (hydro power to be developed by associate company) and water in integrated townships are the key attractions for buyers of property in Tier-II and Tier-III areas.
Toll revenues on the road project would be subject to the UP Government's toll regulations, which currently allow about Rs 1.9/km as against Rs 1.4/km for the Mumbai-Pune Expressway. Jaypee may have to start at modest toll rates to attract traffic. The expressway has the advantage of operating within a single State, thus reducing hassles of inter-state movement for commercial traffic. Tourist destinations such as Mathura (along the expressway) and Agra candrive traffic volume.
An international airport and extension of Delhi Metro are other factors that could drive traffic. Nevertheless, the expressway cannot at this point look forward to volumes similar to the industrialised Mumbai-Pune route.
Lack of volumes may, however, be compensated by real-estate activity. It is perhaps for this reason that the government has chosen to bundle this expressway project with such massive tracts of land for real-estate development.
The offer closes on May 4.
Investors with a long-term horizon can subscribe to the initial public offering from the hydro power generation company, Satluj Jal Vidyut Nigam (SJVN).
Despite sound earnings prospects, the offer appears inexpensively priced compared with peers. At Rs 24.7 (the retail offer price at the upper-end of the price band), the offer values the stock at a price-earnings multiple of about 10 on estimated earnings for this fiscal. The price-to-estimated book value is 1.25 times. This is at a discount to NHPC's valuation of 1.53 times.
This despite SJVN having a superior return on equity (estimated at 15.5 per cent for 2009-10) than NHPC (8.3 per cent). The company also scores due to low leverage and better net profit margins than its listed peer. Earnings potential may also receive a boost from the revised CERC norms, which are yet to take effect. The dividends paid out in 2008-09 would result in a 3.13 per cent yield for the stock.
SJVN operates the 1500 MW Nathpa Jakhri Hydro Power Station project, a run-of-the river project on the Sutlej River in Himachal Pradesh. The company plans to increase this capacity to 5,500 MW over the next 10 years.
During FY-10, this project generated 7017 million units of power as against the annual design energy generation of 6,612 million units. The plant availability was 102 per cent wll above its normative plant availability factor.
The regulated tariff regime for SJVN results in pass through of interest rate fluctuations, hydrology risk, operations and maintenance and depreciation. Therefore, the company's earnings will continue to rise as long as it expands its power output and maintains higher plant availability.
CERC's new norms for power projects which promise higher return on equity are yet to be applied to SJVN, and this holds potential to boost profits. SJVN stands to benefit to greater extent than NHPC from these new norms, due to its higher equity component.
The Nathpa Jakhri project calculates its annual fixed charge, the key component in calculating tariffs, at a debt equity of 1:1 compared to 70:30 followed by NHPC. Higher efficiency and plant availability also place the company in a good position to earn higher incentives. However, the earnings growth over the next three years may remain muted, given that limited capacity additions are planned in this period.
The first of the additions — the 412 MW Rampur project — is expected to come up in 2013 and will add 27.5 per cent to the existing capacity. This project may entitle the company to carbon credits, which it can later trade to augment revenues.
The Rampur project is a cascade project for Nathpa Jakhri, which would mean that the water would be already de-silted, lowering the silt costs for the company. While hydro projects have several advantages, being a renewable energy source with nil fuel costs, the primary challenge lies in executing the projects. Delays and associated cost overruns are normal. Even in SJVN's case, the 412 MW Rampur project was to have been commissioned in the Eleventh Plan, but is now expected to suffer a delay of one-and-a- half years, due to the slow progress of the head-race tunnel.
SJVN also has seven other projects that are set to be commissioned between 2016-20. This includes the 775 MW Luhri in Himachal Pradesh; the 900 MW Arun III project in Nepal and the 1,500 MW Tipaimukh project in Manipur (a JV in which SJVN will have a 26 per cent stake).
All projects except Arun III are regulated-tariff-based and have no short-term power opportunities. However, given the seven-eight year gestation period between the initiation of the project and actual implementation, hydro projects may entail a high opportunity capital cost with the probability of overruns.
That more than 60 per cent of the projects are to come up over a decade, may put pressure on SJVN's returns. Another risk the company may face is that of regulated tariffs being reset after five years.
The requirement that the company supply free power (12 per cent of capacity) to the state in which it is setting up the project, is also a drag on returns. While it hasn't signed power purchase agreements for 4,000 MW of the planned projects, given the high demand-supply gap and lower regulated tariffs, the output is likely to find ready takers.
Comfortable on funding
The total funds required for 2,500 MW of additional projects is more than Rs 13,000 crore. But the fact that their commissioning will be spread out over a period of a few years means that it would be easier to fund the projects.
Currently SJVN holds Rs 1,487 crore as cash . This coupled with internal resources should be adequate to take care of funding, at a normative debt:equity of 70:30. It is expected to invest excess of Rs 4,100 crore as part of equity, of which it has already incurred Rs 940 crore.
Internal accruals are strong. SJVN usually sees higher generation during the May- September period as the snow melts. The sales and net profit grew at an annual rate of 5 per cent and 6.5 per cent respectively during the period 2004-09. For the nine months ended December ‘09, net profits were Rs 775 crore, higher than that for FY-09 (Rs 759 crore), with net margin improving to 51 per cent.
The proceeds from this issue for the government is expected to be a maximum of Rs 1054 crore at the price band of Rs 23-26.
Take a good old equity fund stripped of the 2.25 per cent charged to investors, add a insurance component and layer it with five or six charges with esoteric titles such as premium allocation charges, policy administration charges, mortality charge and you have the hybrid product that is called a Unit Linked Insurance Plan.
ULIPs marketed by insurance companies are quite a hit with investors planning for almost anything – ranging from their child's education to pensions. Yet in recent times the plans have been in the eye of a storm. One of accusations against ULIPs is the bevy of charges they levy on investors.
Here's a rundown of the charges you can expect if you buy an Unit Linked Insurance Plan. Understand them before you take the plunge.
Premium allocation charges – This is the biggest expense component for investors buying ULIPs. It tends to range between 10 per cent and 100 per cent of the premium amount invested for the first year.
Premium allocation charges may be spread out in differing proportions for different ULIPs.
Some insurers levy a high charge upfront and taper it down from the second year. Others have a uniform charge across several years. This charge usually ceases in the fifth year of holding with any premium top-up seeing a two per cent deduction.
The controversial and sizable agent commission, which the Insurance Regulatory and Development Authority (IRDA) has recently asked insurance companies to disclose, usually comes out of the Premium Allocation Charge.
PAC is deducted from the sum you invest before buying units in your account.
Policy administration charge – A sizable component of the fee paid by investors, this charge is levied throughout the tenure of holding the policy and in many cases begins to increase annually from the third or fifth year.
This charge occurs in a percentage of premium and fixed rate forms. The magnitude of the charge per annum ranges from 3 per cent to 8 per cent of the premium paid. This charge is usually deducted from your holdings, by reducing the unit balance to your credit.
The investor really needs to watch for this number, as it is often displayed on a monthly basis on brochures. When you annualise it, a small but sizable bite is taken out of your capital and returns.
Fund management charge – In addition to charging you for allocating and administering your funds, insurers charge between 0.95 per cent and 1.35 per cent of your fund value (the prevailing worth of your portfolio) for managing it.
Mortality charge – Mortality charge is what the insurer charges you for providing the insurance cover that is bundled into a ULIP. This amount is charged per thousand rupees of sum assured – what the insurance company pays your kin in the event of your death.
Mortality charges usually rise with age with additional amounts sometimes being charged for unhealthy lifestyle choices such as for smoking.
The amount could range from Rs 150 a year for a lakh of sum assured for a 20-year-old to Rs 700 a lakh for a 50-year-old. The charge varies between individuals and is determined by actuaries.
Surrender charges – Surrender charges are usually applied only if you choose to exit your ULIP prematurely, or discontinue premium payments ahead of term.
This component could potentially turn your Unit Linked Insurance Plan into an expensive, if not a loss-making, affair.
The magnitude varies from 10-40 per cent of first year policy premium for exiting within the initial two to five years.
This charge again varies with schemes and insurers.
Other possible charges – Switching between plans, partially withdrawing premiums, reinstating a lapsed policy are other investor actions that could entail charges. While they may pale in comparison to the aforementioned charges, being aware of such fees prepares the holder for an eventuality.
For example, a rider premium charge, which is an additional charge not found in all policies, could enable the holder to amend the terms of the policy in the event of serious illness or disability.
While the charges on ULIPs may appear daunting, remember that all charges have to fit into the cap imposed by the IRDA.
With effect from January, the Insurance Regulatory and Development Authority has moved to cap the expenses related to holding ULIPs for 10 years at 3 per cent per annum and beyond that at 2.25 per cent per annum.
The mortality premium and rider premium are excluded from this cap.
However, these caps apply only to investors who stay put with the fund for a decade. A shorter holding period may yield below-par returns, by virtue of the expenses loaded on the investors in Unit Linked Insurance Plans during the early years.