Piramal Healthcare: Concerns limit upside

While pharma business does well, stock likely to underperform, as the Street is sceptical on foray into financial services & strategic investments.

The Piramal Healthcare stock has been an under-performer over the past year, losing 22 per cent as the Street was disappointed with the diversification into non-pharma segments and strategic investments. It recent deal to invest nearly Rs 2,900 crore in Vodafone Essar, to yield returns of 17-20 per cent, also hasn’t helped much in changing the sentiment.

While the core business of contract manufacturing and research (CRAMS), which contributes over half its consolidated revenues, has done well, the market is clearly concerned about the company’s non-core, as well as strategic, investments. Although the investments and diversifications could yield returns over the long term, at Rs 373.75 the stock from a valuations perspective appears attractive, given that it is quoting at half its book value --it has cash equivalents of about Rs 400 per share on its books.
 

STRONG CORE GROWTH
in Rs crore	Q1FY12	% chg
CRAMS **	290.0	39.9
Critical Care	91.0	-15.8
OTC & Optha.	55.7	47.8
Financial Serv.	71.0	195.7
Others	4.0	66.4
NET SALES	512.0	34.8
OP. PROFIT	154.0	287.0
NET PROFIT	89.2	–
P/E* (x)	17.8	–
% change is year-on-year Consolidated numbers for continuing businesses * annualised EPS;  ** Pharma Solutions Source: Company

HIT BY UNCERTAINTY
One key reason for the stock’s under-performance has been the lack of clarity as well as confidence from the investor point of view about the prudent use of surplus cash and the period it takes for the investments to bear fruit. Some analysts are miffed since the company did not distribute majority of the cash generated from the sale of two businesses and is diversifying into non-core areas, and are recommending an exit from the stock.

Says investment advisor S P Tulsian, “Instead of diversifying into real estate (through a real estate investment trust) and now in a telecom venture, the company should have distributed the cash received (from sale of its domestic formulations and diagnostics businesses in 2010) in the form of dividend to shareholders and let them decide what they wanted to do with the money.”

Adding: “There is a confusion as to what the company is focused now on—whether it is a financial, realty or pharma play.” Despite the investments in other businesses, Ajay Piramal, chairman, Piramal Healthcare, says he is committed to the pharma space. The company would be investing Rs 7,000 crore over the next five years in drug discovery, CRAMS, critical care and the over-the-counter drug businesses. The company has also spelt out its target of being in the top three positions in these businesses and is likely to grow by a combination of organic and inorganic routes.

STRATEGIC INVESTMENTS
While the Street has not taken kindly to the investments in diversified business, some analysts say it is the best course of action in the circumstances. Says Sarabjit Kour Nangra, vice-president, research, at Angel Broking, “The pharma business cannot absorb so much cash and as long as the company is investing in businesses which delivers high returns and are value-accretive, it will benefit shareholders.” Analysts point to the company’s recent acquisition of a 5.5 per cent stake in Vodafone Essar for Rs 2,856 crore, where the management had indicated returns in the region of 17-20 per cent within two years. The deal is an attractive one for Piramal, believe telecom analysts, given that the valuations at enterprise value (EV)/Ebitda of 10.4 are in line with market leader Bharti Airtel.

While Piramal has done a great job in acquiring Indian subsidiaries of multi-national companies and growing these, the past is hardly an indicator of how he’d perform in the future, given that the investments are in non-core (pharma) assets, says Tulsian. However, analysts such as Nangra believe the stock is attractively valued and investors with a long-term outlook (three to four years) can look at accumulating it.

BUSINESS GROWTH
The company turned out a good performance in the June quarter, with revenues growing 35 per cent year-on-year. A positive for the company is its performance in the CRAMS space, which grew 40 per cent. Key players in the CRAMS businesses were struggling due to inventory rationalisation but the business has recovered and order books have improved over the past two quarters. The company aims to achieve an organic growth of 20-25 per cent for each of the businesses it is in. However, going ahead, the performance will be viewed not just from the pharma business perspective but also from the financial services space, which includes its realty, infrastructure and corporate lending segments. Until it delivers good performance in these new areas, its return on equity (which has dipped to below six per cent in 2010-11 from 24-26 per cent during FY08 and FY10) is unlikely to move up meaningfully, thereby preventing a re-rating of its stock.