Torrent Pharma

While FY08 was under pressure due to losses registered by its German arm, Torrent Pharma is showing signs of recovering to a profitable FY10
GIVEN its performance and growth potential, Torrent Pharma is a relatively under-valued stock in the Indian pharma space. However, the stock has out-performed the broader indices in the past 12 months. While the Sensex declined by over 40% last year, the stock is trading around the same level.

The company has been on a growth path in the past two fiscals. While the losses registered by the German subsidiary adversely impacted its overall growth in FY08, the company is showing signs of a recovery and is likely to bounce back by FY10.

Business:

Incorporated in 1972, the Ahmedabad-based Torrent Pharma is engaged in the production of drug formulations and contract manufacturing. The domestic branded formulations, exports and contract manufacturing contribute 44%, 45% and 11% to the company’s total revenues respectively. The company has a strong presence in the high-value chronic therapies of cardio vascular, gastrointestinal, central nervous system (CNS) and anti-diabetes. The company’s top 10 brands constituted 41% of its total domestic formulation sales in FY’08 as against 44% in the previous year.

Torrent’s major international operations are situated in Brazil, Europe, Russia and the former Soviet republics in Eastern Europe and Central Asia. It has nine wholly owned subsidiaries in various regulated and semi-regulated markets abroad. The pharma company’s other revenue source is contract manufacturing, which largely comprises of sourcing, manufacturing and supplying insulin formulations under a third-party brand name.

Torrent is steadily ramping up its product development activity. Research and development (R&D) expenditure account for 7% of its revenues, with a 70:30 spend ratio towards product development and discovery research. The company has a healthy product pipeline for the US and European markets on expiry of the patents. It also undertakes new drug discovery research and currently has seven new chemical entities (NCE) in diabetes and related ailments.

Growth Strategy:

The domestic formulations business and operations in the semi-regulated markets of Brazil, Russia and countries in Eastern Europe and Central Asia are the growth drivers for the company. These markets are witnessing a double-digit volume growth. The company is bullish on its international generic business. Many of its international operations have achieved critical size, leading to revenue traction.

Torrent’s domestic business also benefits from the tax-free status enjoyed by its manufacturing operations. Its units, located at Baddi and Sikkim, enjoy tax exemption for 5 and 10 years respectively. This enables it to compete effectively in a pricesensitive market.

Financials:

The company’s net sales rose at a compound annual growth rate (CAGR) of 28.7% over the past five years to Rs 1355 crore in FY08. The net profits have grown at a CAGR of 25% to Rs 134.6 crore in FY08. At an average dividend payout of 25% over the past three years, the company’s dividend payouts have grown at a CAGR of 12% over the past five years, half than the corresponding profit growth. The company has positive operating cash flows and a debt equity ratio lower than one.

The company’s sales growth in FY08 was weighed down by de-growth in its German subsidiary Heumann in wake of severe price erosions and a volume shift to unexplored segments. The company expects to shift 70-80% of Heumann’s manufacturing to India. The subsidiary is thereby expected to break even in FY10.

The past twelve months have reflected the recovery in the company’s operations and profitability. The position is likely to improve going forward. Recent measures such as realignment of field operations, cost-cutting, and shifting of manufacturing from Germany to India are expected to beef up the profit margins.

Valuations:

Torrent has outperformed the Sensex and is currently valued at little over its annual turnover. It witnessed a stable 22% return on capital employed (ROCE) over the past two years. It is an under-valued stock among similar-sized peers and holds promise for investors looking for value in the mid-cap space.