Cipla

CIPLA, the second-most valuable pharmaceutical company in India, is showing signs of stress on its financials. Its free cash flow – or the cash it generates after providing the money required to maintain and expand its asset base – is getting deeper and deeper into the negative territory.

The company recently announced its intention to raise Rs 1,500 crore by selling securities in the domestic and international markets, to meet its capital expenditure requirements. With no noteworthy returns generated on the investments it made in the last four years, Cipla will become a riskier bet for investors unless it sets its books right and starts generating positive free cash flows.

Deteriorating Financials:

The company has been on a capital expenditure spree since the last five years. It invested Rs 1,854 crore in fixed assets between FY04 and FY08. Against this, it has generated cashflows of Rs 1,443 crore from its operations during the same period. The surplus has been financed through net longterm borrowings to the tune of Rs 386 crore. An excess of investment over cash generation has resulted in negative free cash flows. The net cash flow from operating and investing activities has been negative and getting worse from Rs 112 crore in FY06 to Rs 151 crore in FY07 to Rs 307 crore in FY08.

Unlike its industry peers like Sun Pharmaceutical Industries and GlaxoSmithKline Pharmaceuticals, Cipla has negligible cash and investments of Rs 174 crore (as on March 31, 2008 as per the latest available data). Sun Pharma’s cash and investments stood at Rs 1,995 crore (on March 31, 2008) and Glaxosmithkline Pharma’s at Rs 1,686 crore (on December 31, 2008). Despite its precarious cash position and aggressive capex, Cipla has been generous in distributing dividends to its shareholders. At an average payout of 24%, the company has disbursed dividend of nearly Rs 466 crore in three fiscals years ending FY08. With a 39% promoter shareholding in the company, the dividends rewarded to the promoters have been to the tune of Rs 186 crore over the same three-year period.

Impressive Performance:

Cipla posted a 73% increase in its net profits for the quarter ended June 2009, while its sales rose 13%. It will, however, face severe cash flow issues in case of a poor show in the coming quarters. The company has seen its stock prices rise 43% since the start of this year although it could not match the 57% jump achieved by the Sensex.

In a recent filing to stock exchanges, Cipla said it plans to mop up Rs 1,500 crore through issue of various instruments including warrants, debentures, institutional placement, foreign currency bonds or global depository receipts.

The company, which is quite under-leveraged, may benefit more from raising funds through debt than issuing additional shares. For a company with a debt-equity ratio of 0.1, an additional debt of Rs 1,500 crore would increase the ratio to 0.5. Given its current market capitalisation, tapping equity market for Rs 1,500 crore will reduce Cipla’s earnings per share (EPS) by around 10%. The EPS currently stands at Rs 11.2. This will depress the share price even if the market cap doesn’t decline.

Poor Defence Technique:

Despite having a very small pool of cash in hand, Cipla has been aggressive on its capital expenditure. This is quite unlike the common strategy in a defensive sector like pharma. To justify its current valuations, Cipla must improve its cash-flow and maintain a continuous streak of outstanding performance over the forthcoming quarters. Investors, on their part, can book their profits on the stock, before any dilution in EPS or before the company’s cash flow problems start getting reflected in its stock price.