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Sanjiv Shankaran

Wockhardt has created the ingredients to genetically engineer its way ahead. Sanjiv Shankaran takes a look at the potential of biotechnology to be the company's engine of growth.

A BIG pharmaceutical company, marketing a variety of commonplace drugs is the last place one should expect to find successful research and development (R&D) in biotechnology. Conventional wisdom suggests that nimble, small companies are more likely to dabble successfully in biotechnology. In India, conventional wisdom has been turned on its head, because a big pharmaceutical company, Wockhardt, has quietly emerged as a successful biotechnology player. Today, Wockhardt is arguably the best-placed Indian company to exploit the rich potential of biotechnology.

Genetically-engineered profit

The biotechnology exercise started off as a 50:50 joint venture with an overseas company, Rhein Biotech GmbH. The joint venture company, Wockhardt Rhein Biopharm, has developed two products: Biovac-B, a Hepatitis-B vaccine, and Epox, a genetically- engineered human Erythropoietin. Last year, there were changes in the joint venture structure and Wockhardt bought out Rhein Biotech. However, the erstwhile partners continue to have a relationship limited to technology transfer and royalties.

The biotech business contributed about 10 per cent of Wockhardt's domestic sales in the financial year 2001 (January-December), a significant growth over the 4 per cent contribution to domestic sales in 2000. The sharp growth in the contribution holds promise for Wockhardt's profitability because the returns are high in the business.

The returns from biotechnology could be higher in the near future because Wockhardt is working towards launching in 2003 human insulin for diabetics and interferon alpha 2b for people battling cancer. Once Wockhardt gets both the products into the market, it should have the largest range of biotech products.

The other domestic companies in the field are smaller, and seem to restrict themselves to one or two products. Of its competitors, the privately-owned Shanta Biotech, is likely to be the most significant competitor. It successfully launched Hepatitis-B vaccine a couple of years ago, and is in the race to manufacture and market human insulin.

At the moment, Wockhardt is well-placed to make the most of the market potential for biotechnology products. Human insulin, in particular, could yield a rich harvest for Indian firms once export opportunities open up. The returns from the growth in biotechnology revenue to a company such as Wockhardt, that draws about 61 per cent of its operating revenue from a highly competitive domestic formulations market, can be significant.

Exports: The other growth steroid

The financial year 2001 was a good one for Wockhardt. The company's profitability increased sharply, boosted in part by a 41 per cent year-on-year growth in exports. Exports spell good news for the company. Intense competition keeps a tight check on realisations, and exports seem the best way to escape price-driven competition.

Wockhardt's export business has been traditionally dominated by bulk drugs (chemical ingredients that go into making formulations). Vitamin B12, Dextromethorphan (antidote for cough) and Dextropropoxyphene (analgesic) are key bulk exports. An indication of the success that Wockhardt has had with bulk exports can be gauged from the increase in production capacity for the bulk drugs, especially Vitamin B12.

A key determinant of the good export performance in 2001 was the increased composition of formulations in export turnover. Generally, export of formulations yields a far higher return than what can be obtained in the domestic market. The growth in the proportion of formulations to 32 per cent of exports in 2001 from the preceding year's 24 per cent is likely to have had an impact on the profit. More of the same may be in store because Wockhardt has indicated that it aims to focus on formulation exports, and if the proportion of formulations in exports grows, the pay-off can be significant.

Relatively speaking, Wockhardt has done little in the US generic market for formulations. The hassles associated with the distribution system in the US appear to have put it off. On Wockhardt's future plans after the announcement of 2001 results, the top management indicated that the company has not given up on the US generic market. Wockhardt seems to have set its sight on generic products that present a technological entry barrier to other producers. As of now, few details are available and trying to forecast the impact of the US generic plans may be premature.

Domestic formulations: Relatively anaemic

Domestic formulations are the key to Wockhardt's performance. Biotech and exports hold the key to higher profitability, but the domestic formulations business can partially offset the growth in other divisions. About 61 per cent of Wockhardt's operating revenue comes from branded formulations. Wockhardt is gradually increasing the contribution of cardiovascular drugs, nervous system-related medicines and vaccines in its product basket. These have grown faster than the huge antibiotic segment. Once the composition of the product basket tilts towards cardiovascular drugs and vaccines, Wockhardt may be partially insulated from the marked slowdown in growth in antibiotic segment.

Financials

Wockhardt's financial statement in 2001 was marked by a sharp growth in profitability and an increase in return on net worth. The growth in biotechnology and export divisions had a marked impact on operations. The operating profit margin rose to 20.3 per cent from 17 per cent the preceding year.

The return on net worth increased to 32.3 per cent from the previous year's level of 29.7 per cent.

Wockhardt's high return on net worth has come about in a year in which the company reduced the capital deployed in the business, the capital deployed came down by about 10 per cent to Rs 381 crore.

About 83 per cent of the capital in the business belongs to equity shareholders.

The relatively low level of debt suggests that capital expenditure in the near future is likely to come through debt, and equity dilution is unlikely.

Investment outlook

Wockhardt's share trades around Rs 570 now, up by about 71 per cent since last July. The price-earnings ratio (PER) is about 21. The company is an attractive investment at the current level for the following reason:

The company's profitability is likely to increase in the near future on the heels of the growing significance of its biotech and export businesses.

While the growth in profitability in the near future may not be as impressive as the previous financial year, there is a strong possibility that it will continue to improve.

Wockhardt's domestic formulation business did not show any noteworthy growth last year, but the change in the composition of the product basket towards fast growing segments and the calibration in the marketing arm may result in gain.

Wockhardt has filed a new molecule with the regulatory authority for clinical trials.

At the moment, it may be too early to reach a concensus about the prospects, but a bit of progress made in clinical trials holds the potential for a sharp increase in share price. Progress here may also have a positive spin-off on the valuation of the company.

Therefore, investors may consider a long-term investment in Wockhardt, a top-rung pharmaceutical company that is likely to record a marked increase in valuation over the next two years.

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