Citi: Dishman Pharmaceuticals -Carbogen Drives Material Disappointment

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Dishman Pharmaceuticals & Chemicals 
(DISH.BO) 
Alert: Carbogen Drives Material Disappointment 
Dishman’s 3Q results were very disappointing, with the company reporting a loss
(adjusted for forex) at the net level. Apart from the tough environment for CRAMS,
execution at Carbogen Amcis (CA) has been very poor & has accentuated the
problems. While Dishman is now taking corrective action (including a revamp of
the CA top management), we do not expect any major recovery in the near term.

 Marginal revenue growth — Top-line growth (+4% YoY, +9% QoQ) was marginal,
driven by Carbogen Amcis (+19% YoY) & Marketable Molecules (+20% YoY). India
CRAMS sales however declined on a YoY basis (-16%, high base effect) but grew
c8% QoQ.
 Big miss on margins — EBITDA margins dipped sharply (by 1093bps YoY,
1132bps QoQ) on higher RM/Sales (+903bps YoY, +962 bps QoQ) and fixed
overheads – primarily in the Carbogen Amcis business. This along with higher
interest cost (+56% YoY) led to a net loss (adjusted for forex gains) of Rs40m.
 CA hurts CRAMS profitability — CRAMS sales dipped 2% YoY & EBIT margins
declined 1331bps YoY. Despite good growth, CA dragged down profitability,
clocking a negative EBITDA margin (pre forex) of -3.8%. This was primarily due to
higher material cost, cancellation of one research project, several very low-margin
orders & adverse currency movement. The dip in Indian CRAMS sales (-16% YoY)
was due to a high base (re-initiation of Eprosartan supplies in 3QFY10) – QoQ
growth was healthy at c8%.
 MM biz revenues grow but margins lower — Revenue (+20% YoY) growth was
driven by the Vitamins biz (+30% YoY). EBIT margin however declined c888bps
YoY due to adverse product mix (leading to higher RM/sales) in vitamins &
currency fluctuations.
 Conference call key takeaways — 1) Received intimation from one of its EU
partners that it is currently the sole approved supplier for an intermediate for a
product (launched in EU, RoW; awaiting approval in US); 2) Supplies from the
China HiPo unit / Unit-IX (at Bavla) & the disinfectant facility should begin in
1HFY12; 3) Has initiated a major restructuring process at Carbogen to improve
profitability, focusing on profitability rather than topline – full benefits to be visible
only in FY13; 4) Fenofibrate supplies delayed to FY12 (earlier FY11); 5) Guidance
lowered for FY11: no significant top-line growth, should see decline in profitability.
Dishman Pharmaceuticals & Chemicals (DISH.BO; Rs116.90; 1M)


Dishman Pharmaceuticals & Chemicals
Valuation
Given that pharma is a growth sector, we use P/E as our primary method to value
the base business of every company. At the same time, since many pharma
companies have some unique opportunities that could play out, we ascribe
separate values for these. For Dishman, we use a target P/E multiple of 13x, which
is at a 25% discount to our target multiple for Piramal Healthcare, which is the
leader in the innovator CRAMS segment. We believe that a discount is justified
given Dishman's relatively smaller size and pipeline, higher leverage, inferior
return ratios and lower market cap/liquidity. In its limited trading history of less than
5 years, Dishman has traded in a band of 6-26x 1-year forward earnings. Our
target P/E of 13x is towards the lower end of this band. At 13x June 11E EPS we
value Dishman at Rs265.
Risks
Our risk rating for Dishman is Medium Risk, as against the High Risk reflected in
our quantitative risk-rating system, which tracks 260-day historical share price
volatility. The lower risk rating is to account for the recovery in the CRAMS space
as destocking by customers comes to an end and the overall improvement in
macro conditions. Regulatory risks - Delays in the execution of various contracts
due to delays in regulatory approvals or any adverse outcome at the customer end
could impact Dishman's revenues and profitability, especially given that Dishman
has to build the facilities upfront. Generally, the time lag between entering into a
contract and commencement of revenues is around 2-3 years. Lumpy business -
CRAMS revenues tend to be lumpy across quarters and hence the quarterly
performance of the company might be volatile. These risks could impede the stock
from achieving our price target.