Prabhudas Lilladher on Ranbaxy

We recently met Mr. Malvinder Singh, CEO and Managing Director of Ranbaxy Laboratories (RLL) and came back with a positive note. RLL is likely to benefit from the three First-to-File (FTF) opportunities: de-merger of NCE, related R&D and cost control.

FTF opportunities RLL has 18 Para IV FTF opportunities with an innovator market size of over US$27bn (Rs1,080bn) over the next few years. The company has a robust product flow with assured visibility on FTF products from CY08 to CY10. It has plans to launch at least one potential FTF every year from CY08 to CY13. The company has settled the patent litigations with the three patented products namely: Imitrax, Valtrex and Flomax, with innovator companies and is confident of launching the generic version of these products over CY08 to CY10. RLL has not disclosed the terms of the settlement. These three products have market size of US$3.5bn (Rs140bn) at the innovator’s price. The launch of Nexium and Lipitor is subjected to the outcome of court cases and hence we have not factored them into our projections.

This indicates that the three FTF opportunities are likely to generate revenue of Rs852m, Rs8,431m and Rs1,7045m in CY08, CY09 and CY10 respectively. Considering PBT at 60% of sales and tax rate of 25%, this would result in net profit of Rs383m, Rs3,794m and Rs7,670m respectively during the same period. Moreover, RLL is likely to have an upside from generic version of Nexium (market size US$5.5bn) and generic Lipitor (market size US$8.0bn). The company has obtained tentative approval for generic Nexium and is waiting for the final approval. For generic Lipitor, RLL has won ‘995′ patent. The litigation for both these products are continuing in the US Courts and the management believes that they have a strong case.

Demerger of R&D RLL has announced the demerger of its NCE related R&D. This is likely to result in savings of over Rs1.0bn in CY08 and improve return ratios. RLL has currently eight NCE (one in phase II, two in phase I and five in pre-clinical) in the pipeline. The demerger would give an exit option for the shareholders, who do not wish to continue in the high-risk, high-return business. The shares of the demerged company are likely to be listed in June 2008. RLL has plans to rope a strategic investor in the R&D company. Under the demerger scheme, RLL shareholders will receive free of cost one share of FV of Rs1 each for every four shares of FV of Rs5 of RLL. The company is likely to declare the details of R&D pipeline shortly

Cost optimisation RLL has taken several measures to control cost. This is likely to improve its EBIDTA margin from 14.5% in CY07 to 19.9% in CY10. The improvement is likely to come from the reduction in material cost, R&D expenses and personnel costs. The company has achieved 3% improvement in working capital in CY07 and the same is likely to continue. The management has indicated that the litigation cost is likely to be maintained at the current level of around Rs2.0bn per annum.

 

Entry into new areas and markets RLL has plans to enter into new therapeutic areas to widen its product basket and higher coverage of doctors. RLL has improved its share in emerging market from 44% in CY05 to 54% in CY07. The emerging market business has higher margins and the same are sustainable. The promising markets are Romania (21% growth), Germany (69%), UK (36%), Italy (50%), Portugal (50%) and Spain (12%). RLL has received an approval to launch generic Amlodipine Besylate in Japan. It is the first company to receive such an approval.

Forex gains The company has consistently made gains from forex transactions in the past. It has not entered into cross currency or speculative forex transactions but has carried out only business related transactions in CY07. The net forex gain from FCCB and translation charges was Rs1,812m in CY07. It has US$440m FCCB, which is likely to be converted at Rs716.32 per share before March 2011.

Strong presence in the domestic market RLL derives around 20% of its revenue from the domestic market and has achieved 23% growth in CY07. The company has leadership in NDDS platform, which constitutes 9% of its domestic sales. RLL has 9 brands in top 100 and 18 brands in top 300 products. Its major OTC product Revital has sales of over Rs800m and is growing around 25% per annum.

Strategic alliances RLL has the following strategic alliances in the domestic market: Kreb’s Biochemicals (about 15% stake) for fermentation products, Jupiter Biosciences (about 15% stake) for peptides and Zenotech (45% stake) for biotech, oncology and injectibles.

Acquisition of Orchid Chemicals The management has said that they do not wish to comment on this issue. RLL is not likely to do any hostile takeovers.

Financials We expect RLL to report 22% CAGR in sales over next three years from CY07 CY10 due to strong growth in emerging markets and revenue from FTF opportunities. We expect its EBIDTA margin to improve from 14.5% in CY07 to 19.9% in CY10 due to expected reduction in material cost, personnel cost and R&D expenses. We expect RLL’s net profit before EO items to improve at CAGR of 41% over next three years. We expect RLL’s RoCE to improve from 10.6% in CY07 to 20.4% in CY10. However, its RoE is likely to decline from 25.7% in CY07 to 24.6% in CY10 due to FCCB conversion.

Valuation At the CMP of Rs444, the stock trades at 21.6x, 13.9x and 10.4x CY08E EPS of Rs20.5, CY09E EPS of Rs32.0 and CY10E EPS of Rs42.9 respectively (inclusive of FTF gains).On the basis of only core business EPS, the scrip is trading at 22.7x CY08, 19.8x CY09 and 19.0x CY10 earnings, without taking into consideration the upsides from generic Nexium and Lipitor. We expect RLL to be Outperformer with target price of Rs566 based on 20x earnings of base business (Rs468) and 5x earnings of FTF business(Rs98) in CY10.