Ranbaxy: Dashed dollar dreams! - Views on News from Equitymaster

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Ranbaxy: Dashed dollar dreams!

Oct 21, 2005

Performance summary
Ranbaxy has announced its results for the third quarter and nine months ending September 2005. While the topline has declined on the back of continuing pricing pressure witnessed in the US generic markets, operating margins have been adversely impacted owing to a sharp surge in its R&D expenditure. These factors coupled with a rise in interest costs have severely dented the bottomline picture, which has declined by a huge 91% YoY.

Financial performance: A snapshot
(Rs m) 3QCY04 3QCY05 Change 9mCY04 9mCY05 Change
Net sales 13,614 12,830 -5.8% 40,076 38,947 -2.8%
Expenditure 10,489 12,518 19.3% 30,977 35,638 15.0%
Operating profit (EBDITA) 3,125 312 -90.0% 9,099 3,309 -63.6%
EBIDTA margin (%) 23.0% 2.4%   22.7% 8.5%  
Other income 66 48 -27.3% 396 164 -58.6%
Interest (net) 127 159 25.2% 360 467 29.7%
Depreciation 410 355 -13.4% 1,226 1,055 -13.9%
Profit before tax 2,654 (154) -105.8% 7,909 1,951 -75.3%
Tax 650 (341) -152.5% 2,035 37 -98.2%
Minority interest 3 3   9 9  
Profit after tax/(loss) 2,001 184 -90.8% 5,865 1,905 -67.5%
Net profit margin (%) 14.7% 1.4%   14.6% 4.9%  
No. of shares (m) 185.5 371.8   185.5 371.8  
Diluted earnings per share (Rs)*       21.0 6.8  
Price to earnings ratio (x)         56.9  
(* annualised)            

What is the company’s business?
Ranbaxy is the largest pharmaceutical company in India. Its annual sales crossed US$ 1 bn in the year 2004. The company manufactures and markets branded generic pharmaceuticals products and Active Pharmaceutical Ingredients (APIs). The continued focus on R&D has resulted in several approvals in developed markets and significant progress in New Drug Discovery Research. It invested 6% of revenues in R&D during CY04. Ranbaxy's continued focus on the US and European markets has helped it build deep product pipelines. The company has about 151 ANDA filings out of which 99 have been approved by the USFDA and 52 are awaiting approval. The company sells products in over 70 countries and has an expanding international portfolio of affiliates, joint ventures and alliances, ground operations in 44 countries and manufacturing operations in 7 countries.

What has driven performance in 3QCY05?
No respite in the US: The US market, which accounted for over 28% of Ranbaxy’s consolidated revenues in 9mCY05, reported a significant 25% YoY decline in 3QCY05 revenues. The geography continued to remain soft and witnessed intense competition resulting in severe price erosion. It must be noted that the number of products going off patent were very few during the nine months while the competition was large, affecting the pricing environment. This is most likely to continue throughout the year as well. The only silver lining in this dark cloud, however, was the fact that Ranbaxy’s total prescription growth in this region increased by 26% YoY during the quarter, beating the industry growth of 12%. The total cumulative product filings now stand at 154, with 43 pending approvals. This company’s product pipeline is the second largest in the US market, which indicates the potential growth prospect from this region in the form of new drug launches. However, CY06 is expected to be much better with a number of blockbuster drugs going off patent and consequently more product launches expected by Ranbaxy.

Going the European way: The European region (approx. 17% of total revenues) registered a marginal 5% YoY growth during the quarter. France led the business performance in Europe with sales of US$ 18 m, UK recorded sales of US$ 10 m and Germany clocking sales of US$ 9 m. The company’s operations in the Rest of Europe recorded sales of US$ 11 m.

One of the key events that took place in the European region was the ‘Lipitor’ judgment in the UK court. The court held Pfizer’s patent on the main patent of ‘Atorvastatin’ to be valid but ruled in favour of Ranbaxy on the other related patent. The company intends to gain a strong foothold in the European markets, which can be gauged by the fact it now has a presence in 21 of the 25 EU nations. Ranbaxy entered the Italian market during the quarter by establishing a subsidiary there and plans to launch generic products in the region from CY06.

Gaining market share in India: Ranbaxy garnered an increased share of the domestic market by occupying the second slot and dislodging Cipla from its position. This was on the back of the company’s continued focus on strengthening its chronic therapy portfolio. The share of this portfolio increased to 21% of domestic revenues (up from 19% in the corresponding period last year). Within this, the company’s CVD (cardiovascular plus diabetes) and Urology folio grew by 21% and 22% respectively as against 6% industry growth. The anti-infective NDDS products registered a growth of 7% as compared to the market growth of -1%.

Sharp contraction in margins: Operating margins registered a steep decline in 3QCY05, collapsing by almost 21% YoY. The major reason for the decline was due to a huge 71% YoY rise in R&D expenditure, which was attributed to the company's increased number of product filings worldwide (up 63% YoY). Increasing competition in the generics space has also led to lower realizations and consequently lower margins. Slower growth in sales and decline in the operating margins has been reflected in the bottomline which fell by a huge 91% YoY. The bottomline fall was further magnified owing to a 27% YoY fall in other income and a 25% YoY rise in interest expense.

Over the last few quarters: Ranbaxy has been facing rough weather over the last four quarters on account of intense price erosion witnessed in its key US market, which has resulted in the downslide in revenues. Despite this, the company has not curbed its R&D expenditure in line of its vision to become a discovery led company in light of the patent regime. However, the combination of these factors has led to a decline in bottomline over the past few quarters.

Over the last few quarters
(%) 1QCY04 2QCY04 3QCY04 4QCY04 1QCY05 2QCY05 3QCY05
Net sales growth 17.8% 10.1% 12.2% 18.6% -12.1% 5.0% -5.8%
Operating profit margin 23.7% 23.7% 23.0% 15.4% 10.8% 12.6% 2.4%
Net profit growth 9.8% -4.7% 7.1% -10.8% -62.9% -48.3% -90.8%

What to expect?
At the current price of Rs 389, the stock is trading at a price to earnings multiple of 10.5 times our estimated CY07 earnings. Going forward, considering the fact that Ranbaxy is a truly global company, the US and the European markets will be key growth drivers for the company. Increased focus on R&D will augur well for the company in the long run in the light of the product patent law with effect from January 1, 2005. With its global presence and strong R&D capabilities, Ranbaxy will look to garner a substantial pie of the generic market in the next 2 to 3 years when a large number of products go off patent.

While we anticipated a lacklustre CY05 with no growth in profits, the company has performed much below our expectations and we will be downgrading our numbers accordingly. We, however, expect a pick up in growth in CY06 and CY07 led by its generics business in the US, an increased product pipeline and its wide and expanding geographical reach. Despite the severe pricing pressure witnessed this year, the management remains steadfast on attaining US$ 2 bn revenues by CY07. We had recommended a ‘Hold’ on the stock in September 2005 with a three-year investment horizon. We maintain our view.

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