Piramal Healthcare : D/G to Neutral; TP Rs480 ::Goldman Sachs

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Removed from Asia Pacific Buy List
Piramal Healthcare (PIRA.BO)
Limited visibility on future cash utilization; D/G to Neutral; TP Rs480
What happened
We downgrade Piramal Healthcare to Neutral from Buy, due to reduced
visibility on cash utilization post its recent share buy-back announcement.
Management stated it has not finalized its cash utilization plans. Hence, we
increase the discount applied to the cash from 10% to 20%, while noting that
management’s track record in integrating past acquisitions has been solid. Since
we added Piramal to our Buy List on June 10, 2009, the stock has risen 72.4% vs.
29.5% rise in the Sensex. We revise our FY11E-FY13E EPS by -1%/+16%/+25%,
to incorporate the completed sale of Pathlabs and the share buy-back proposal.
Current view
We see continued uncertainty on full deployment of cash, following the
announcement of the buy-back proposal on October 22 (up to 20% equity at
Rs600/sh; Promoters to tender equal number of shares). Management
commentary on seeking acquisitions beyond healthcare implies uncertainty on
cash returns and the multiples it could command. While share price could rise
around the buy-back period, we believe there is reduced potential for complete
utilization of cash in the near-term, and thus limited upside in the shares.
Residual business in flux: We believe the current business (post Abbott deal
and Pathlabs divestiture) consisting of CRAMS, Critical care and OTC segments
is in a state of flux as management has been focused on closure of the Abbott
deal in the past few months. We expect EBIT margins to shrink in FY2011E in
this transitionary period and recover to normalized levels going forward.
Valuation: Our revised 12-month SOTP-based target price of Rs480 (from
Rs576), implies 1% upside. We apply a 20% discount (up from 10%) to the cash
available post the buy-back (Rs438/sh), due to reduced visibility on utilization,
leading to a value of Rs350/sh. For the residual business, we use a multiple of
12X on FY12E EPS of Rs10.9 to arrive at a value of Rs130. Risks: Large scale
acquisition outside the healthcare sector, inability to drive operating margin
improvements in contract manufacturing business.