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Ranbaxy key contributor to Daichii Sankyo’s MTP, says Nomura Equity Research

The MTP suggests Ranbaxy would move beyond just plain vanilla generics and pursue differentiated generic opportunities and branded segments like dermatology in the US. The MTP suggests Ranbaxy pursuing inorganic growth options in key markets

 
The US FDA (Food and Drug Administration) issues at pharmaceutical major Ranbaxy had significant impact, as Daichii Sankyo (DS) failed to achieve the projected revenue target for 2012. Ex the impact of forex movement, the FDA issues at Ranbaxy have contributed to 60% of the slippage in the target, as per company. In the mid-term plan (MTP), Ranbaxy is expected to be a material contributor to DS’s growth and profitability improvement targets. Ranbaxy’s contribution to revenues is expected to rise from 18.6% currently to 27.7% in 2017. As per the MTP, most markets in which Ranbaxy currently operates are expected to record strong growth, significantly higher than our current expectations. These are the observations by Nomura Equity Research in its Quick Note.
 
Nomura believes there is greater focus on cost and profitability improvement, as they form one of the three strategic pillars of DS’s MTP. The three core strategies for the MTP are: a) enhance innovation portfolio and overcome the challenge of patent expiration of key products like Olmesartan, b) greater push in emerging markets (EMs) and generics, and c) establish a low-cost operating framework. Corporate restructuring is done to bring in flexibility and cost efficiency.
 
Nomura Equity Research points out that there is greater clarity in the front- and back-end roles of Ranbaxy. The MTP suggests Ranbaxy would move beyond just plain vanilla generics and pursue differentiated generic opportunities and branded segments like dermatology in the US. Biosimilar opportunities in regulated market are most likely pursued by DS. The MTP suggests Ranbaxy pursuing inorganic growth options in key markets.
 
The revenue growth expectations in the MTP are ahead of Nomura’s expectations and will be challenging, but focus in profitability is in line with its expectations. Margin improvement from a low base shall be the key driver of earnings for Ranbaxy. On core earnings (ex exclusivity), the stock is trading at EV/EBITDA of 12.4x CY14F ests, which is higher than its peer group, which is trading at 10.6x. “We believe the stock can trade at a premium multiple, if there is greater clarity on improvement in the base business. The EBITDA margin in CY14F is 13.8%, which is still suppressed compared with the industry average of ~20%. Therefore, scope for improvement and growth, beyond our explicit forecast period, remains,” the report stated.
 
Ranbaxy’s revenue contribution to DS will rise to more than a quarter by 2017, as per MTP
 
The plan details as shared by DS suggest that Ranbaxy’s revenue contribution shall increase during the MTP period. Though Ranbaxy hasn’t shared any revenue guidance, DS expects Ranbaxy to contribute $4 billion in revenues by 2017, which is 27.7% of the DS’s estimated revenues in 2017, as per MTP. Currently, Ranbaxy’s contribution to DS rev is 18.8%. If one were to exclude the exclusivity-related revenues, Ranbaxy’s revenue contribution to DS is only 15%. Ranbaxy is expected to grow faster than rest of the DS business as patents of key products like Olmesartan expire.
 
Ranbaxy’s revenues of $4 billion in 2017 implies a CAGR of 11.6% over 2012-2017. Excluding the exclusivity-related upsides in 2012, implied CAGR is 18% over 2012-2017. The growth rate is ahead of current expectations. This is also significantly higher than Ranbaxy’s 2013 base business revenue guidance of 10%.
 
In India, DS expects Ranbaxy to deliver revenue CAGR of 16% over 2012-2017. This compares with last five year CAGR of 9%. In India besides retaining dominance in acute therapies, Ranbaxy will focus on chronic segments, OTC, and biosimilars. The growth expectations are aggressive, particularly given the proposed price control in India. Nomura expects the impact on Ranbaxy will be greater than the average market impact given the premium pricing enjoyed by the company in certain products proposed under new pricing policy.
 
In emerging markets like Africa and Eastern Europe, which are largely represented by Ranbaxy, revenue CAGR over 2012-17 is estimated at 23% and 20%, respectively. The growth plan envisages acquisitions.
 
In the US, besides plain vanilla generics, Ranbaxy would pursue high value-added opportunities in differentiated products and areas like dermatology. Further Ranbaxy shall be marketing authorized generics of DS products post patent expiry. Patents of two key products—Benicar ($1.5 billion) and Welchol ($500 million)—expire in 2016 and 2014, respectively.
 
Daichii Sankyo to pursue to aggressively implement low-cost operating framework
 
Cost control and improving profitability is a key management agenda. Operating margin is estimated to rise to 15.7% from 10.1% in 2012. The cumulative cost-savings target during the mid-term plan is 30 billion yen or higher. Overall at the DS level, SG&A as percentage of sales is estimated to come down by 900 basis points (bps) over 2012-17. The management commentary suggests that Ranbaxy will be a key contributor to improving profitability. For Ranbaxy there are additional costs related to consent decree. The consent decree may take around four years to resolve. Outside of the costs related to the consent decree there are other cost elements in which efficiency can be brought in, as per management. 
 
DS intends to bring in changes in the corporate structure and ensure flexibility and faster decision making. As part of the process, human resource allocation will be optimized. Corporate restructuring and greater alignment between Ranbaxy’s senior management team and DS will present a platform for faster decision making going ahead.
 
At the back end, cost reduction will be driven by Ranbaxy. Ranbaxy will be the undertaking production process of Olmesartan and Edoxaban. DS and Ranbaxy shall collaborate in purchasing, procurement and logistics, thereby realizing synergy in global supply chain.
 

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