Cipla: High valuations offer little upside

Monetisation of inhaler portfolio, domestic growth would be key

Cipla shed six per cent last week following cut in ratings and downgrades from research firms. With the exception of two stocks in the pharma, Bank of America Merrill Lynch (BofA-ML) and CLSA have taken a bearish view on the short-term prospects of the segment. Analysts say despite moderate earnings per share growth of 5-10 per cent over six months and similar expectations in the March quarter, pharma stocks have rallied 30 per cent over three months.

Among reasons for the bearish view are high valuations for the sector and for Cipla. The BSE Healthcare is up 32 per cent over six months and at the current valuations, the index trades at a 76 per cent premium to the Sensex, an all-time high. Cipla trades at 42 times its FY15 estimated earnings and 30 times its current year estimates, with only Lupin being more expensive among large caps. The Cipla stock outperformed the broader markets by a wide margin, gaining 75 per cent over the past year. While most analysts remain positive on the firm’s respiratory portfolio and upside from launches in different markets, the benefits will accrue only over the long term. BofA-ML analysts believe the near-term valuations leave limited upside and have downgraded the stock to ‘neutral’. The consensus Bloomberg estimates peg the one-year target price for the stock at Rs 707, up 1.5 per cent at Rs 711 on Monday.

The key near-term issues from the business perspective for the sector are on account of currency uncertainty in emerging markets, high base effect, a lack of any fresh US Food and Drug Administration and higher competition in some key products in the US market. The sector, according to analysts, has seen earnings downgrades for the first time in several quarters.

The March quarter expectations for Cipla, however, are mixed. While the firm is expected to see pressure on account of volatility and weakening of emerging market currencies versus the dollar, this is likely to be compensated by gains from the supply of antacid Nexium to Teva from February, 2015. Analysts expect revenues to grow upwards of 14 per cent, with the Nexium benefit boosting revenues by $26 million and earnings before interest, taxes, depreciation and amortisation by $22 million.

However, given the adverse cross-currency movement, which will have a six to seven per cent impact, ex-Nexium exports growth is expected to be a muted two per cent. Exports accounted for about 55 per cent of Cipla’s revenues in the December quarter. Cipla’s profitability in recent quarters has taken a hit, given the company’s strategic transformation efforts, including having its own front-end in key markets. Given the higher cost of setting up infrastructure and more filings, the operating profit margins, 27 per cent at the start of FY14, are  currently at 20 per cent.