Credit Suisse:: What’s depressing Ranbaxy’s current margins?

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Ranbaxy--------------------------------------------------------------------- Maintain UNDERPERFORM
What’s depressing Ranbaxy’s current margins?


● We use the CY10 annual report disclosure to identify the geographies
that are depressing Ranbaxy’s margins. Except India and Romania,
Ranbaxy’s PBT margins are <=10% in each of the regions, with the
US, Europe and Russia making losses currently (Fig 1).
● French and Italian operations account for 30% of European sales,
but their combined loss makes Europe an overall loss-making region.
We expect the US operations to turn PBT positive in late CY11, as:
(1) professional charges for Dewas and Paonta reduce, (2) new
products are launched and (3) Dewas facility is cleared by the FDA.
● We view Ranbaxy’s new ESOP policy as more aggressive than
the previous three. The new scheme has exercise price as the
face value and the vesting period is reduced from five to three
years (Fig 2). The consensus sharecount does not include ESOP
dilution when 7.4 mn ESOPs are outstanding with exercise price
of 415; 3mn ESOPs would be issued under the new scheme.
● On the synergy front, RBXY started pilot manufacturing of APIs and
intermediates for innovative drugs for Daiichi. RBXY should act as
the front end for LatAm and ASEAN for Daiichi’s innovator products.

Figure 1: PBT margin split for CY10 based on annual report disclosure
Region  % of sales PBT margin Remarks
Europe  12% -2% France and Italy operations are loss making
Canada  4% 4% Margins impacted by price cut of 30-50%
Romania  6% 24% Strong sales growth of 19% in CY10
Asia Pacific  6% 10% Australian ops are loss making
CIS  7% -4% Russian ops are loss making
India  25% 17% Assumption: similar margins as peers
LatAm  5% 10% Except Brazil, most other ops are loss making
Africa  10% 10% Be-Tabs is loss making
API  7% 6% Assumption
USA  17% -12% Base business sales; reconciling margins
Total  6.1%
Source: Company data, Credit Suisse estimates
What’s depressing Ranbaxy’s current margins?
Ranbaxy’s base business EBITDA margin in CY10 was low at 7.5%.
With annual report disclosure now available at the subsidiary level, we
analyse PBT margins in each of the geographies (Figure 1) to identify
the loss-making and low-contributing regions. Except India and
Romania, Ranbaxy’s PBT margins are <=10% in each of the regions,
with the US, Europe and Russia making losses currently.
Within Europe, although the sales contribution from the French and
Italian operations is only 30% of European sales, the loss at these two
geographies makes Europe an overall loss-making region. We expect
the US operations to turn PBT positive in late CY11, as:
(1) professional charges for Dewas and Paonta facilities reduce,
(2) new products are launched and (3) Dewas facility is cleared by the
FDA (Paonta clearance by then would be a positive development).    
ESOPs: An aggressive new policy; would be dilutive  
Ranbaxy currently has 7.4 mn outstanding ESOPs with exercise price
ranging between 216 and 561 and weighted average price of 415. The
company is seeking shareholder approval for its 2011 ESOP scheme
for 3 mn additional ESOPs, which in our view is more aggressive than
the previous three schemes. The new scheme has low exercise price
(face value) and the vesting period is reduced from five years to three
years (Figure 2). Although this helps in employee retention, it would
be dilutive to the shareholders. The consensus sharecount suggests
that ESOPs dilution impact is not considered currently.
Figure 2: ESOP 2011 scheme is more aggressive and dilutive
Existing policies  New policy
Exercise price  26 weeks avg or closing price
before the committee meeting
Face value of the Equity shares
Vesting period  Over five years  Over three years
Source: Company data, Credit Suisse estimates
Synergy tracker between Ranbaxy and Daiichi
● Ranbaxy has started pilot manufacturing of some APIs and
intermediates for the innovative drugs, and shipped the same to
Daiichi. The collaboration should further expand in this area.
● Like India, Romania and South Africa, Ranbaxy should act as
front end for LatAm and ASEAN regions for Daiichi’s innovator
products.
● Daiichi Europe and Ranbaxy are working on possible cost synergy
opportunities in procurement.  
Other key takeaways
● Ranbaxy successfully cleared four inspections by the US FDA in
India, Europe and the US (Ohm’s lab). Additionally, EU inspection
at Dewas and Australian inspection at Paonta and Dewas were
successfully conducted.
● Out of the 12 ANDAs filed in CY10 with USFDA, Ranbaxy
believes it is eligible for FTF exclusivity on 3.
● Chronic portfolio now constitutes 24% of India sales and Novel
Drug Delivery System (NDDS) portfolio accounts for 6.6% of sales.
● During CY10, Ranbaxy launched 81 products in India, of which 24
were developed in-house, 53 were outsourced and 4 were inlicensed.