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Value play
Torrent Pharma is poised to benefit from growth in domestic as well
branded export markets. We expect recent investments in domestic
market to push up growth rates to 18.7% cagr over FY10-13 while key
export markets, Brazil and the US see margin expansion. We expect net
profits to grow at 22.1% cagr over FY10-13 and cash flows to surge in
FY12-13. We expect the stock to rerate and initiate coverage with a BUY
and a target price of Rs761 per share.
Domestic formulations: High exposure to lifestyle diseases
High exposure (60%+) to lifestyle related therapy segments offers Torrent an
inherent growth advantage over peers within the domestic market that
contributes 40% of its total revenues. While the company’s domestic growth
at 16.7% cagr over the last five years has not been among the best, we
expect pick up considering a recent expansion of field force and incorporate
18.7% cagr over FY10-13CL.
Improving export basket
Continued margin expansion in Torrent’s key export markets (Brazil and the
US) is likely to contribute to earnings growth over the coming years. The
company is expanding in to profitable branded generic markets in LatAm and
Asia like Mexico and Thailand. Apart from this, the company has also entered
in to formulation supply agreements with AstraZeneca and another multinational pharmaceutical firm for branded emerging markets both of which are
likely to ramp up over the next 2-3 years. We expect 17.7% cagr in export
revenues over FY10-13CL.
Strong cash generation
We expect Torrent Pharma’s investments in domestic and export markets to
pay off over the coming years and result in strong cash flows that will enable
the company to fund its capex internally while reducing net debt position.
Torrent has a comfortable balance sheet with very low net gearing and one of
the highest return ratios in the pharmaceutical sector.
Attractive valuations, initiate with a BUY
With substantial investments in domestic and other branded markets, we
expect profits to grow 22.1% and see strong cash flows in FY12-13. With
valuations at substantial discount to larger pharmaceutical names and
reasonably strong core earnings growth, we expect Torrent Pharma to rerate
from current levels. We initiate coverage on the company with a BUY and a
target price of Rs761 per share that is based on 16x one year forward EPS.
Domestic formulations: High exposure to lifestyle diseases
Torrent Pharma derives 40% of total revenues from domestic formulations
segment which in turn has substantial exposure to lifestyle related therapy
segments (chronic therapies). While the company’s domestic growth at
16.7% cagr over the last five years has not been among the best, it continues
to comfortably outperform the market average growth of c. 14% cagr. We
expect the domestic growth rate to pick up considering a major expansion of
field force undertaken by the company recently.
Domestic growth to strengthen
We expect Torrent’s domestic growth rate to continue to pick up from a lower
growth in FY08-09 as a result of planned new product introductions, reversion
to old and effective marketing structure and enhanced marketing efforts.
Considering that the company has high exposure to lifestyle related
segments, it has inherent advantage as these therapy segments are growing
faster than the market average growth rate of 14%.
Comparatively, Torrent’s domestic formulations revenues have grown at a
lower pace than other large listed Indian pharmaceutical companies like Sun
Pharma, Dr Reddy’s, Lupin, and IPCA. FY08-09 growth was impacted due to
change in divisions from 8 to 11 where in the product specific coverage was
increased but doctor coverage got reduced. This has been reversed in FY10
and hence we saw a pick up in growth that is expected to sustain and in fact
likely to increase as a result of additional sale force.
High exposure to profitable lifestyle therapy segments
Indian market is witnessing gradual transition from acute diseases to lifestyle
diseases and chronic therapies like cardiology, neurology, psychiatry and
diabetes. Torrent Pharma is one of the best placed among Indian
pharmaceutical companies with a high exposure to these segments. With
current demographic profile and growth prospects of the economy, Indian
pharmaceutical market would see continuing trend of transition towards
chronic therapies resulting in market growth rate also inching up
Cardiovascular, neurology and anti-diabetes therapy segments comprise
60%+ of total domestic revenues. Torrent’s domestic business registered a
growth of 16% YoY in FY10 primarily driven by anti-diabetic and anti–infective
segments. Top ten brands contributed to c. 40% of the domestic formulation
revenues with seven of the top brands belonging to chronic therapy areas.
Top twenty products comprise upwards of 50% of the domestic formulation
revenues for Torrent Pharma. Some of the key brands like Dilzem, Nikoran,
and Alprax are more than 5% of domestic formulation revenues. Only 10% of
domestic revenues come from products under Drug Price Control Order
(DPCO) that is one of the lowest in the pharmaceutical industry.
Spurt in marketing efforts
As is the case with most Indian pharmaceutical companies, Torrent has
ramped up its sales force over the last two years after having the same
number for FY06-09. It has slightly over 3,450 sales representatives now.
The company’s growth suffered over FY08 and FY09 primarily due to
reorganization in marketing divisions that resulted in lower effectiveness. The
company has reverted to the old structure and has along side added three
more divisions to cater to lifestyle related therapy segments. This has started
yielding results in FY10 and is expected to pay over the coming years. The
company has enhanced geographical focus to tier-II and lower cities. It is also
making entry in to newer therapy segments like gynaecology and
dermatology where it has no presence.
Contract manufacturing for Novo Nordisk
Torrent has a long standing tie up with Novo Nordisk to manufacture human
insulin. Torrent’s revenues from the segment have grown at 17% cagr over
FY07-10 on back of growing domestic demand for insulin. Last fiscal, the
company has commissioned a human insulin manufacturing facility at Indrad
with a capacity to produce 26m vials per annum. We incorporate a
conservative 11% cagr growth in this business over FY10-13CL.
Improving export basket
Torrent Pharma has established presence in a number of export markets like
Brazil, Germany, US and Russia via organic and inorganic route. The focus
markets for the company are Brazil and the US. It intends to expand in to
profitable branded generic markets in LatAm like Mexico.
Apart from this, the company has also entered in to formulation supply
agreements with AstraZeneca and another multi-national pharmaceutical firm
for branded emerging markets both of which are likely to ramp up over the
next 2-3 years.
Largest Indian pharmaceutical company in Brazil
Torrent Pharma has a reasonable presence in Brazil, one of the biggest
pharmaceutical markets among the emerging economies with US$12bn in
value (i.e. larger than Indian market) and growing at 15% cagr over the last
five years. However, MNC penetration is much higher than India with MNCs
having half of Brazilian market share by value.
Among all Indian pharmaceutical companies, Torrent Pharma has the largest
presence in Brazilian market covering a market of US$1bn and has a market
share of 7% in the covered market. In FY10, Torrent grew 17% YoY (local
currency growth of 9%) to reach Rs3bn+ in revenues in Brazil. It has 43
products under approval and 5 products are expected to be approved by
second half of the coming year. Another 40 products are in pipeline primarily
belonging to chronic therapy segments.
Re-strategising in Russia
Within Russia, Torrent’s focus has been the DLO program run by government.
Considering that the government has been scaling down DLO program,
Torrent has decided to rethink its action plan in Russian market. Apart from
the scale down of DLO, the payments from government have seen
considerable delays (up to 1 year). Hence, Torrent intends to now start afresh
in Russia and is in process of developing fresh relationships with key
distributors to launch products in that market.
Scale down of Russia’s
DLO program hurting
Torrent in Russia
Heumann pain easing
Torrent Pharma has not been the most successful of companies in the export
markets. The company entered in to German generic market in FY06 with
acquisition of Heumann (for less than US$20m) and have suffered during last
4-5 years due to market dynamics changing from branded generic to generic
generic resulting in substantial pricing decline each year. As a result,
revenues from German market have not grown over the last four years
despite strong volume increases and profits too have eluded. The
management has been able to restructure the operations and reduce costs
dramatically to just break even at Heumann by FY10. Sales force in Heumann
has been reduced from 130 odd to just 15 now and a lot of manufacturing (c.
45%) has moved to India.
Considering that Heumann’s entire business is now derived from tenders in
Germany, we expect margins to remain stable or decline marginally as pricing
comes under pressure with incremental market moving to tender based
system. Heumann has won tenders from insurance firms like AOK and is
looking to participate in more over the coming years. We incorporate a 5%
cagr over the coming years with steady margins.
US business to do well
Torrent Pharma was one of the last among Indian pharma companies to enter
the US generics business. From a small beginning in FY08, the company has
filed nearly 50 ANDAs cumulatively and has reached Rs909m in FY10
revenues. In FY10, it received 2 ANDA approvals and 3 tentative approvals
and plans to launch 4 to 5 products every year. The company’s portfolio of
lifestyle related therapy areas would not be as great a help in the US as in
some of the branded emerging markets. Notwithstanding an exponential
growth rate over next 2-3 years, we expect Torrent to remain a fringe player
in the US generics for coming 2-3 years before it is able to develop a pipeline
of some niche filings.
Taping in to new markets
The management intends to enter/expand in to some of lucrative branded
generic markets in LatAm, Africa and Asia. The foremost among these is
Mexico, a US$9bn market, where the company has introduced 6 products in
the neurology area that it intends to follow up with cardiovascular and anti
diabetic segments over the next 2-3 years as it develops a better
understanding of the market. It has around 35 sales representatives currently
and plans to increase it to 200 by FY14.
Apart from Mexico, the management intends to establish footprint in South
Asian markets like Thailand, Vietnam and Indonesia. In FY10, the company
incorporated a subsidiary in Thailand, the second largest pharmaceutical
market in South East Asia with a market size of US$2bn, growing at 16%
cagr. The growth rate is expected to accelerate as a result of universal
insurance coverage policy implemented by the Thai Government. Torrent
intends to roll out a portfolio of 45 molecules in cardiovascular, neurology and
anti-diabetic segments for launch in the market.
Formulation supplies to MNCs to take off over coming two years
Over the last two years, Torrent Pharma has entered into formulation supply
agreements with two multi-national pharmaceutical companies. While one of
the names has not been disclosed, the second agreement with Astra Zeneca
to supply 18 products for sale in nine branded generic markets was signed in
March 2010. Both the deals involve milestone payments as well as revenues
from supplies for Torrent Pharma. We expect these deals to contribute FY12
onwards though material contribution can be expected in a couple of years.
Strong cash flows and pick up in earnings momentum
We expect Torrent Pharma’s investments in domestic and export markets to
pay off over the coming years. We see domestic growth strengthening further
within 2-3 quarters. Considering a high exposure to chronic therapy
segments, we would expect Torrent’s domestic growth to be upwards of 18%
cagr. We incorporate 20% for FY12 and FY13 as expanded sales force delivers
and moderate growth thereafter. Growth in export markets especially where
the company has recently entered like Mexico might not deliver returns in the
initial two years. We do expect margin expansion in Brazil and the US market.
Overall we expect revenue growth of 17.4% cagr over FY10-13CL with key
markets namely India, Brazil and the US contributing substantially to the
revenue growth. Domestic formulation, the largest segment for Torrent, is
clearly on an uptrend and should deliver margin benefits. We also expect an
improved performance from Brazil and the US generics business.
Torrent’s Sikkim facility is about to commission in 4QFY11 or 1QFY12 for the
domestic market. There would be some margin impact in the short term as
the company bears the cost of operating the facility while revenues ramp up
gradually. However, at the same time, it would see benefit from some of the
recent investments in expanding the sales force.
In export segment, the company expects benefit increasing profitability in
Brazil and expects profitable dossier supplies to the EU market to continue.
Further milestone payments can be expected from the recently signed deals
with MNCs.
However, currency movement (US$, Brazilian real) could impact margins. The
company has completely hedged its FY11 net forex receivables and c. 20% of
FY12 net forex receivables.
Torrent has a comfortable balance sheet with very low net gearing (less than
10%). It has one of the best managed working capital requirements. With
strong cash flows over recent years, it has been able to fund its capex
internally while reducing net debt position. While the company has a strong
capital expenditure plan largely to cater to export markets, we expect it will
remain cash flow positive and in fact deliver strong cash flows over FY12-13.
The company’s return ratios are one of the highest in the pharmaceutical
industry though we might see some compression in RoEs due to accumulation
of cash on the balance sheet.
Attractive valuations, Initiate with BUY
Torrent Pharma has delivered a strong earnings growth (35% cagr) over last
three years on back of substantial margin improvement and reasonable
revenue growth. We expect the company to deliver 17.4% cagr in revenue
growth over FY10-13CL, however see profit growth of 22.1% cagr over the
same period as costs are likely to grow slower than revenues. Considering
recent addition in manufacturing facilities, we see strong cash flows as well in
FY12-13.
With valuations at substantial discount to larger pharmaceutical names and
reasonably strong core earnings growth, we expect Torrent Pharma to rerate
from current levels. We initiate coverage on the company with a BUY and a
target price of Rs761 per share that is based on 16x one year forward EPS.
Key risks to investment thesis
Rupee appreciation would impact margins to some extent
Torrent Pharma derives nearly 60% of its total revenues from exports. Thus
an appreciating rupee would impact margins. Apart from natural hedge due to
raw material imports and employee costs in international markets, it hedges
net receivable position for the immediate year and then c. 20% for the
following year. 1% appreciation of rupee would negatively impact Torrent’s
Ebitda by 1.25%. Apart from US$ exposure, the company has exposure to
Brazilian Real and has been benefiting from rupee’s relative weakening
against that currency.
Regulatory risks across markets
Pharmaceutical regulatory landscape has seen a lot of noises over the last
two years. We have seen some reform/control measures recently being
adopted in a couple of geographies (US, Germany, Russia, Brazil) and similar
measures (drug price controls, tender based sourcing) could be adopted other
regions as well and result in risk for companies in that country. Torrent’s
higher exposure to Brazil that remains a branded generic market has been
beneficial. However, any negative newsflow on regulatory side there could
impact earnings and the stock performance.
Concerns on domestic growth due to a product patent regime
There have been concerns on long term outlook for domestic market growth
due to adoption of product patent regime in 2005. However, domestic players
have been developing and launching new combinations and formulations of
the products existing in the market. Pharmaceutical companies also have
options of new generic launches from the basket of pre 1995 products and
post 1995 products that have not been patented or patent has not been
granted.
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