Edelweiss research on Unichem Laboratories

Unichem Laboratories (UL IN, INR 535, Not Rated)

We recently met the management of Unichem Laboratories (Unichem). Key highlights of the discussion are summarised below:

n  Potential new contracts to buoy steady business

Unichem’s medium-term growth strategy remains intact, with reasonable traction in domestic formulations (72% of FY10 sales) and scale up in the US business.  The company’s current negotiation for additional CRAMs contracts could materialise by Q4FY11, contributing 20% to potential FY10 revenues. FY11 revenue growth will be led by domestic branded formulation growth (15% Y-o-Y), with muted outlook for Niche subsidiary (10% of revenues) and single-digit growth in other external sales.

n  Healthy EBITDA margin impacted by losses in subsidiaries

Unichem’s standalone EBITDA margins of 26% are healthy and higher than most peers, reflecting the profitability of domestic franchise. This is, however, offset by losses in international subsidiaries, which has negatively impacted FY10 margins by 300-400bps. In the near term, margins could be adversely affected by increased costs from field force ramp up and commercialisation of new facilities. The impact will, however, be capped to some extent by marginal gains in subsidiaries. Newer contracts could likely have lower margins than company average.

n  Strength of balance sheet a key positive

Unichem is a zero debt company and has positive free cash flows. Moreover, it expects to fund its estimated ~INR 1.5 bn capex over FY11-13 through internal accruals only. The zero leverage strategy offers stability to operations, and positive operating cash flows give headroom for expansion. The company has ROCE of 26% and ROE of 24% in FY10.

n  Outlook and valuations: Strong fundamentals; ‘Not Rated’

At current CMP of INR 535, the stock is trading at 16x FY10 and 11x FY12E EPS (based on consensus EPS estimate of INR 48 per share).