Healthy fundamentals and attractive valuations helped mid-sized pharma major Torrent Pharma’s stock outperform the BSE Healthcare Index over the last seven months.
The stock has gained over 28 per cent since the last buy recommendation in March, compared to a 20 per cent rise in the healthcare index. But it may be challenging for the stock to sustain performance in the near future for three reasons. Pricing pressure in Brazil will temper Torrent’s margins.
Similarly, in the domestic market, while growth may continue, margins are likely to moderate on account of price cuts under the new drug pricing policy. Also, given its aggressive expansion plans to double formulations capacity, the company’s return ratios may moderate in the medium term. Though Torrent is among the cheaper stocks in the mid-cap pharma space trading 13.4 times its 2014-15 earnings (28 per cent discount to BSE Healthcare Index), downside risk due to margin pressure may limit the upside in the medium term. Investors can consider booking profits in the stock.
BRAZILIAN WOES CONTINUE
Next to India, Brazil is an important market for Torrent, given the strong margins and revenue contribution of over 16 per cent. But performance in this geography has been volatile in the last few quarters. For instance, strike by employees of Brazilian regulatory agency ANVISA delayed approvals, thereby impacting performance in the September 2012 quarter.
Similarly, the Brazilian government’s reimbursement programme added to the company’s hardships. Key molecules such as the cardiovascular drug Losartan being part of the reimbursement programme were distributed to patients for free, hurting Torrent’s growth. In addition, intensifying competition and increasing generic penetration led to an almost 50 per cent cut in prices of key drugs such as the anti-depressant venlafaxine.
The pricing pressure is evident from the Brazilian subsidiary’s performance in 2012-13. Revenues in local currency (Brazilian real) grew 8.7 per cent last fiscal. But pricing pressure in key products ate into the company’s profits in 2012-13 leading to a loss of real 2.47 million, compared to a profit of 8.46 million in 2011-12.
The depreciation of the real against the rupee only heightened worries for Torrent. In rupee terms, the loss from the Brazilian operations widened to Rs 9.23 crore in 2012-13, compared to profit of Rs 26.3 crore (almost 10 per cent of consolidated profits) a year ago.
To sustain growth in a challenging environment, the company now intends a foray into the low-margin, unbranded generic business.
The launches are expected to commence in the current quarter. While this may help revenue growth, it will dilute Torrent’s margins. The company’s plans to increase field force in the Brazilian market will add to the margin pressure.
LOWER MARGINS IN INDIA
India is the single largest market for Torrent, accounting for nearly a third of its consolidated revenues. Growth in the home market has improved from high single digit levels in 2011-12 to early teens in 2012-13. Despite this, Torrent’s field force productivity continues to lag peers such as Sun Pharma, Lupin and Cipla. The average revenue per representative is less than Rs 30 lakh, compared to over Rs 40 lakh for Cipla and Lupin.
While the management is confident of maintaining the double-digit growth, the margins in the Indian market may be impacted by price cuts mandated by the new drug pricing policy.
The 1.2 percentage point decline in gross margins to 68.9 per cent in the June quarter compared to a year ago is indicative of the pricing pressure faced in key markets — Brazil and India.
UNFAVOURABLE MIX
Torrent has been witnessing strong growth in regulated markets — US and Europe. Growth in the US has been led by product launches and ramp-up from a low base. While revenues in this geography grew in excess of 30 per cent in US dollar terms, net margins slipped from 2 per cent to 1.8 per cent possibly due to intensifying competition.
Higher revenues from government tenders for Heumann, its German subsidiary, helped the company’s growth in the European market. A favourable currency movement also aided growth.
The growth in low-margin, developed markets may mitigate the revenue slowdown in Brazil. But higher contribution from the low-margin US and European markets may drag consolidated margins.
INVESTMENT MODE
Torrent enjoys healthy return ratios with return on capital employed (ROCE) of almost 30 per cent. However, the company is pursuing aggressive expansion plans.
It has earmarked Rs 11,000 crore for doubling its formulation capacity at Dahej SEZ over the next four years. As the revenue growth from this facility will take time to materialise, the return ratios may taper down in the interim.
Torrent’s revenues stood at Rs 972 crore in the June quarter, around 27 per cent higher than a year ago. Pricing pressure and unfavourable geography mix led to a 0.9 percentage point decline in operating margin to 22.7 per cent for the quarter, compared with the same period last year.
However, lower interest and tax outgo helped the 46 per cent jump in net profit to Rs 149 crore.
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