Execution risks could mar prospects

While its existing pharma business is likely to perform well, the company’s move into financial services and the drug discovery space could put pressure on margins in the medium term.

Investors gave the thumbs down to the restructuring at Piramal Healthcare, knocking the stock down 9 per cent since the start of the week. Among the key reasons for shareholder disappointment is the company’s decision last week to set up two financial services subsidiaries for lending to infrastructure and other sectors. The company, which has registered good growth in its core pharma operations, is also integrating its new drug discovery business back into Piramal Healthcare from group company Piramal Lifesciences. This move is likely to put margins under pressure as well as bring in debt on Piramal’s book.

While the company’s core pharma business is expected to deliver good performance, analysts are split on the options the company had for deployment of additional cash received from the sale of the domestic formulations and diagnostic businesses and have set target prices ranging between Rs 345 and Rs 450. Even as the stock, post the recent correction, is going cheap at 0.5 times the book value, analysts believe only investors with an appetite for risk and long-term horizon (2-3 years) could consider the stock.
 

ROBUST GROWTH
In Rs  crore	Q4, FY11	% chg	FY11	FY12E
Sales	559	38.4	1670	2342
Operating profit*	45	23.2	380	491
OPM (%)*	8.1	-100 bps	22.8	21.0
Other income	130	21.1	335	–
Adjusted net profit **	115	1584.0	156	404
E: Estimates         % change is year-on-year for continuing businesses *Ebitda estimates for FY12 ** Adjusted net profit is excluding one-off items FY11 and FY12 figures are for continuing businesses Source: Company, Bloomberg, Analyst estimates

RISKY VENTURES
Post the sale of its drug formulations business to Abbott of US and diagnostics operations to Religare, the company is left with pharma services, critical care and over the counter (OTC) drugs. However, these businesses require little cash to grow and the company cannot enter the formulations space due to the non-compete agreement it signed with Abbott. It is in this context that the company has chosen to diversify and restructure its business.

However, although analysts say the company’s track record and management quality are impeccable, they believe the moves to diversify into financial services and purchase the pharma proprietary drug business are high-risk propositions.

They believe the company could have a tough time in the infra lending space, given that specialists such as IDFC are struggling to cope with macro headwinds. Sharekhan believes the integration of the drug discovery business will bring an additional debt of Rs 500 crore, which is a negative.

Given that a large part of the 24 molecules are in the initial stages, integration of this business is likely to result in higher expenditure, thereby impacting the company’s operating margins which are likely to be subdued in FY12, feel analysts.

VALUE AT RISK?
	Rs crore
Payments recd/due*	11,416
Less: Buyback	2,508
Less: Dividend payout	202
Net cash retained	8,707
Cash per share (Rs)	518
Reinvestment discount  (50%) (Rs)	259
Residual business (Rs)	99
Value per share (Rs)	358
* Includes Abbott, Religare deals Source: Sharekhan

Given the diversification and risk profile, Sharekhan has increased its reinvestment discount from 20 per cent to 50 per cent for the cash on the company’s books. It has downgraded the stock from ‘hold’ to ‘reduce’ and revised its price target downwards.

CASH UTILISATION
While the company has already rewarded shareholders by announcing a buyback and declaring a special dividend, the head of a leading brokerage says minority shareholders have not been able to participate fully in the Abbott deal. However, the management believes if there are no more opportunities for acquisitions and investments in various businesses, the company may look at returning a part of the cash to shareholders. While the company has not gone overboard in its expansion and has limited its investments to Rs 1,000 crore in the infra lending space as of now, how the remaining cash is utilised over the next 18 months could decide the direction of the stock, believes an analyst.

CORE BUSINESS GROWTH PICKS UP
Meanwhile, the company’s March quarter results were strong, with sales and operating profit growing handsomely. While the company had reported a loss at the operating level in the September and December quarters due to higher fixed overheads, it reported a profit of Rs 45.3 crore in the latest quarter.

The company expects revenues from the current businesses of pharma services, critical care and over the counter (OTC) drugs to grow about 25 per cent annually over the next three years. Pharma services, which had been lagging behind due to inventory issues, has come back on track in the last two quarters. Further, on the back of the acquisition and expansion of its OTC brand portfolio and new launches in Europe and the US in the critical care segment, analysts believe the company is likely to meet its revenue targets.