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Research meet excerpts: Nicholas Piramal - Views on News from Equitymaster
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Research meet excerpts: Nicholas Piramal
Dec 1, 2004

In our recent meeting with Nicholas Piramal, we held discussions on the company's growth drivers and the impact post WTO patent regime. The following is a jist of that meeting.

Background
Nicholas Piramal India Ltd. is one of the leading Indian pharma companies with strong focus in the domestic market. It is the 4th largest company with 4.3% share of the domestic retail market with a large sales force covering 10 therapeutic segments of the pharma industry. The company has started focusing on the exports market too and the contribution of exports in total sales has increased to 11% from zero in two years time. With its differentiated exports strategy, the company is going to benefit from its cost competitiveness

Growth drivers
During our interaction, the management outlined three major drivers for the company over the next few years. These are:

Contract (Custom) manufacturing:  As per the Nicholas management, contract manufacturing has significant growth prospects going forward. The company has already entered into three long-term (5-8 years) agreements for contract manufacturing. Nicholas is in the process of creating a continuous pipeline for the same. Contract manufacturing business is dependent on the scale of operations; 'more is better' is the motto. Nicholas has entered into the business based on operating margins of around 25% and a payback of about 3-4 years (with respect to investment) for most of the contracts. While the profitability numbers, which Nicholas is working on are on the higher side if we compare to contract manufacturing business in other countries, the basic advantage India has is low capital and labour costs.

Another advantage with the contract manufacturing business is that it is highly scalable and flexible in operations. The contract payment to the company will be made in dollar terms, which means that it is susceptible to volatility in rupee-dollar exchange rate. The company is confident that the custom manufacturing business will be as large as the domestic formulations business (Rs 9.5 bn currently) in next 4-5 years.

In-licensed products:  Nicholas Piramal is well placed in the domestic industry with its strong sales force and ground presence. To leverage on this, the company's strategy is to in-license products from mid-sized global pharmaceutical companies which are not present in the India to market and distribute their products. In-licensing will make it the authorised agent of those drugs in India and in turn, Nicholas will either pay them a royalty or will work on profit sharing basis.

R&D activity:  Nicholas Piramal has established one of the largest R&D centres in the private sector. The R&D focus of the company is herbal, NCE (New Chemical entity) and NDDS (New drug delivery system). While investments in NDDS has lower gestation period, herbal and NCE will take a longer time to deliver results. On NCE front, the company is working on three major therapeutic segments viz. oncology, anti-inflammation and diabetes.

Scenario post new patent regime 2005
The company is of the view that there would be no significant change in the domestic market over the couple of years. Consolidation in the industry will take place in this period, but is unlikely to affecting the share of the major domestic pharma companies in the market. In the next few years, there would be change in the industry with innovative products from the MNC drug majors starting to take spaces in chemist shops.

However, the management is of the view that even a decade from now, the new patented products are likely to form only about 10% of the domestic market. This trend has also been witnessed in countries like Brazil and also to some extent Poland, which have migrated to the patent regime. The basic reason for the same is that the masses in the country will not be able to afford the drugs. India is a value conscious market and is likely to remain so, unless there is a paradigm shift in purchasing power. Nicholas is thus, well set to take up that challenge in the Indian market place with its strong presence on sales and marketing front.

Our view
The Nicholas Piramal stock has given a return of more than 100% in the last one year. The re-rating of stock was due to de-merging of its glass business as well as the new agreements on contract manufacturing front. At Rs 1,182, the stock is trading at P/E multiple of 19.5 times its FY05 expected earnings. For a company like Nicholas Piramal, we believe that this multiple is on the higher side of our valuation matrix from a longer-term perspective. This could however, change if there are new developments on contract manufacturing and in-licensing fronts.

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