Cipla: Is the upswing justified? - Views on News from Equitymaster

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Cipla: Is the upswing justified?

Sep 5, 2003

Domestic pharma major, Cipla has seen a sharp rise in its stock price in the past one month. The stock price has gone up from Rs 806 on 1st Aug '03 to Rs 994 on 3rd Sep '03. Infact the stock had almost breached its 52-week high level during this period. But is this upsurge in price driven by fundamentals or is this just another speculative run that will end in the stock prices crashing as quickly as they gained. Let us find out!Stock price of a company rises when there is a perceived improvement in fundamentals of a company. An improvement in the financial performance which is depicted by the latest results and/or better prospects of the company (which is inferred from the press releases given by the company about their future plans and approvals/contracts that the company has received), can lead to improvement in investor sentiment and trigger a rise in the company's stock price. So what is the reason for an improvement in sentiment towards Cipla?

First, let us take a look at the latest declared financial results of the company.

Slow progress…
1QFY031QFY04ChangeFY03
Net Sales4,0304,54212.7%15,724
Operating profits8238746.2%3,164
Operating profits margin (%)20.419.220.1
Profit after tax60667210.8%2,475
Net profit margin (%)15.014.8 15.7
No of shares6060 60
Diluted earnings per share*40.444.8 41.3
P/E ratio 22.3

As can be seen from the above table, Cipla has not shown any significant improvement in its financial performance. Although there was a rise in topline and bottomline in 1QFY04 as compared to 1QFY03, operating as well as profit margins of the company have come under pressure. (Detailed review of the 1QFY04 performance) The margins are even lower than what the company recorded in FY03. This is despite the fact that FY03 was not a good year for the domestic pharma industry due to sluggish demand and the VAT fiasco that had severely affected the performance of the company in 4QFY03. Thus, an improvement in the financial performance of the company does not seem to be the likely reason for the sharp rise in the stock prices.

Another possible reason could be a positive press release given by the company regarding a new contract or an approval that the company could have received. However, Cipla's management as a policy provides very little information regarding their future plans. Infact, there has been no news of the R&D progress made by the company for a long time now. Moreover, Cipla has also refrained from giving any time frame within which it expects to receive the requisite approval for the selling CFC-free inhalers in Europe. Hence, this again could not be the reason for an improvement in the market sentiment.

So is the surge in stock price justified?

Cipla is a fundamentally strong company. The company has a strong presence in the domestic market, which is witnessing a steady revival in demand. The expected reduction in DPCO cover is another positive for the company. Even on the exports front, the company has steadily increased its exposure. In FY03, exports accounted for almost 40% of its net sales. Further, Cipla, with its expertise in AIDS drugs, is likely to be the biggest beneficiary if the draft WTO agreement is accepted by all members. Moreover, Cipla has entered into a number of strategic alliances with leading generics companies in the USA and Europe for the supply of bulk drugs. These initiatives and the impending approval of its CFC-free inhalers are expected to be the key export drivers going forward.

However, with product patents being implemented in India post 2005, Cipla's performance in the domestic market could be adversely affected. The uncertainty regarding the implementation of DPCO 2002 could further affect the performance of the company.

At Rs 999, Cipla is trading at a P/E of 22x its 1QFY04 annualised earnings. Although a revival in domestic demand in view of company's strong presence and focus on exports augment well for the company, it does not justify such a sharp rise in price. The recent price upswing appears to be more speculation driven rather than being fundamentally driven. Investors are hence advised to exercise caution and not get carried away by market ‘khabars'. They should stick to the fundamentals of the company while taking any decision. Investing in stocks at 4,000+ levels is not an unwise decision as long as it is made in fundamentally strong companies with good business models. Stock picking needs to be research based and not on an adhoc basis.

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