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Monday, October 6, 2008

IPCA Laboratories - Defensive Small Cap Investment Pick

Beta: 0.16
Institutional Holding: 33.6%
Dividend Yield: 1.4%
P/E: 10.5
M-Cap: Rs 1,365.6 cr
CMP: Rs 544.30

BUSINESS:
The Rs 1,090-crore Ipca is one of the oldest home-grown pharma companies. It lost out on growth to other players who emerged in 1980s, taking advantage of the process patent regime. Ipca’s growth prospects were also adversely affected by frequent changes in ownership and management control. This turmoil is now over and a stable management is in place. In fact, the company has grown steadily over the past five years. Ipca is engaged manufactures formulations, APIs and intermediates. Its formulations business comprising generic and branded formulations accounts for nearly 70% of its total revenues, while APIs contribute the balance. The company maintains a 50:50 revenue mix between its domestic and international businesses, which is likely to change to 45:55 in favour of the latter in two years.

Ipca manufactures its own intermediates and chemicals that go into the production of API and branded formulations. By following this integrated strategy, it aims to be among the lowest cost producer of drugs in the world. The company is the largest and the lowest cost manufacturer of 8-10 APIs globally.

GROWTH STRATEGY:
Ipca is a market leader in the anti-malarial therapeutic category in India, enjoying 45% market share. Antimalarial drugs accounted for 40% of its revenues around a decade ago, but now they contribute only 17%. This is due to a diversified product mix that includes therapeutic areas like cardio-vascular, diabetes, non-steroidal anti-inflammatory drugs and anti-bacterials. Till a few years ago, over half its portfolio comprised drugs which were under price control, but that proportion has now fallen to 13-14%. The company also plans to foray into oncology — another attractive therapeutic area.

In ’05, Ipca entered into an agreement with Ranbaxy Labs for manufacturing drugs to be sold by the latter in the US. It has signed two more such agreements with companies in the US and Canada. The branded formulations business (spread across India, CIS, Asia, Africa and Latin America) is set to be its biggest growth driver. Ipca expects its domestic formulations business to grow by 20% and the international segment to grow 40% this year.

FINANCIALS:
The company’s consolidated net sales have witnessed a CAGR of 17.6% since ’03 to reach Rs 1,091.4 crore in FY08, while net profit posted a CAGR of over 16.8% to Rs 136 crore. This growth has mainly been organic. The past two quarters have seen a drop in profits (and hence margins) due to (extraordinary) translational losses on foreign currency loans. Ipca is in the process of commercialising its new facilities. The expanded facilities are likely to result in tax benefits and increase the company’s capacity to meet new demand. The company has commenced its formulations business in the US and expects an additional business worth $5 million (Rs 22.5 crore) this year. Ipca incurred a capex of Rs 140 crore in FY08 to increase existing capacities in India. It has a planned capex of Rs 80 crore and Rs 100 crore for FY09 and FY10, respectively. Ipca is a dividend-paying company with an average dividend payout of 20% of profits. It is likely to maintain this payout ratio in the near future.

VALUATIONS:
The company’s consolidated EPS is Rs 51. It commands a fair valuation compared to similarsized peers. It is likely to log a growth of 18-20% to achieve a turnover of Rs 1,287.8 crore in FY09. Considering its estimated earnings for FY09 and excluding the effect of extraordinary translational losses on forex loans, Ipca is currently trading at an attractive forward P/E of 8, against the current consolidated P/E of 10.5.
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