M-cap of 2 demerged entities could exceed Piramal's by 10-15%: Analysts

Piramal Enterprises’ (PEL’s) announcement of demerging its pharmaceuticals business and create two independent listed entities focused on financial services and pharma is expected to be positive for the company’s shareholders.

Analysts expect the combined market capitalisation of the listed entity to exceed the current market capitalisation of the company.

“Conglomerates always get a discounted valuation compared to companies with a focused line of business. Given this, PEL’s decision to demerge it into two independent companies is a positive move and will be value accretive in the long-term,” says Shailendra Kumar, chief investment officer at Narnolia Securities.

After the demerger, PEL will become a financial services company focused on lending to the real estate sector, while the pharma business will get consolidated under Piramal Pharma (PPL) and will be listed separately. All existing shareholders of Piramal Enterprises will get shares in PPL but there will be no cross holding between PEL and PPL.

The stock ended Thursday with a market cap of around Rs 69,000 crore and price of Rs 2,886 per share, after rising 1.6 per cent during the day, against a 0.8 per cent rise in the benchmark BSE Sensex. According to analysts, the demerged entities are expected to have a combined market capitalisation of around Rs 75,000-80,000 crore, nearly 10-15 per cent higher than PEL’s current market cap.

In financial year 2020-21 (FY21), the pharma division reported a profit before interest and taxes (PBIT) of Rs 1,241 crore on revenues of Rs 5,776 crore, and it accounted for 45 per cent of PEL’s consolidated revenues and 34 per cent of its consolidated PBIT. The rest came from its financial services division. (See the adjoining chart).

PEL pharma business is, however, more profitable with return on equity (RoE) of around 20 per cent and return on assets (RoA) of around 11.6 per cent in FY21. In comparison, the financial services division reported RoE of around 9.2 per cent and RoA of around 3.8 per cent. The calculation is based on the PEL’s consolidated segment finance as reported by Capitaline database.

The pharma business is also generated more steady revenue and profit growth, unlike financial services, which has been stagnant for three years with big volatility in quarterly earnings. Given this, analysts expect Piramal Pharma to get a premium valuation upon listing, in line with the valuation of the top pharma companies on the bourses.

Analysts say the demerger will make it easier for investors to value the two companies. “Financial services and pharma are as different as chalk and cheese and it has always been challenging for us to assign a fair value to PEL. The new corporate structure eliminates the pain point which is good from a shareholder’s perspective,” says G Chokkalingam, founder and managing director of Equinomics Research & Advisory Services.

Analysts say that while financial services firms are valued on the basis of their balance sheet size and book value, pharma companies are valued based on their revenues and profits.

The company has been one of the top performers on the bourses in recent months, but has lagged in the medium term. PEL’s share price has risen 102 per cent since the beginning of 2021, against a 25 per cent rally in the Sensex. PEL is, however, up just 34 per cent in the last three years, against 65 per cent rise in the index.

Analysts blame the poor longer-term show on the trouble at its non-banking finance business. The division took a big hit in FY20 due to a spike in bad loans. 

“PEL’s financial services loan book is concentrated towards the inherently risky real estate sector that accounts for nearly 80 per cent of its overall loan book as on March 31,” write analysts at ICRA Ratings on their rating update.