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The spin-off of Dabur's pharma business into a separate company appears well-structured to deliver value to shareholders. But investing in the stock now, in the hope of a bumper profit on the listing, may be risky. The stock already appears to have priced in much of the valuation gains from the demerger, says Aarati Krishnan.

The company's FMCG brands may deliver higher growth than its peers.

AFTER creeping up steadily in the period from May to September 2003, the Dabur India stock has begun to gallop in recent times; amassing a gain of 43 per cent in barely a fortnight, to trade at Rs 86.

The stock appears to be attracting enhanced trading interest on the eve of the proposed de-merger of Dabur India's pharma business into a separate entity. Though announced last year, this move has only now got the legal go-ahead and the record date is expected to be announced shortly. The pharma company is expected make its debut on the bourses in February 2004.

The de-merger augurs well both for Dabur India — the parent company — and the pharma business, which will now be housed under the new company. But the recent surge in Dabur India's stock price appears to have already captured much of the potential improvement in valuations arising from the de-merger. It may, therefore, be prudent to avoid fresh exposures in the stock at this juncture.

Shape of businesses

The de-merger of Dabur's pharma business from its core FMCG operations appears well-structured to deliver an improvement in valuations for both businesses. Post-demerger, Dabur India will be left with a portfolio consisting of personal care products, health supplements and digestives and ayurvedic specialties.

This business registered a compounded annual sales growth of around 12 per cent over the past three years, with net sales of Rs 1,048.5 crore and net profit of Rs 72 crore in 2002-03. This translates into a per share earnings of Rs 2.5 (face value of Re 1) on the post de-merger equity base of Rs.28.6 crore.

The pharma business, on the other hand, has more than doubled its net sales over the past three years. This division reported a net profit of Rs 13.1 crore on a net sales of Rs 184 crore in 2002-03. Based on the share exchange ratio for the de-merger , the pharma business is likely to start out with an equity base of Rs 14.3 crore. Based on its 2002-03 earnings, this would mean a per share earnings of around Re 1.

The company's pharma brands have a fairly strong domestic presence, with a 20 per cent share of the market for oncology products. The company also holds a range of product registrations through which it proposes to push exports to over 20 countries.

Valuations captured

Based on the shape of the de-merged companies, the recent surge in stock price appears to have already captured the bulk of valuation gains likely from this de-merger. Take the FMCG business. Stocks of frontline MNCs in the FMCG business presently command price earnings multiples (PEMs) of between 22-25 times their trailing earnings, while the PEMs of their Indian counterparts are pegged lower, between 10 and 15 times.

As Dabur India has consistently managed a higher growth rate in sales and profits than many of its FMCG peers, it may command a liberal PEM even as a stand-alone FMCG company.

Assuming that Dabur India commands a PEM of around 25 times its 2002-03 earnings, this would suggest a price of around Rs 63 for Dabur India's FMCG business, post-demerger.

Given that it is still in a nascent stage, the pharma business will have to be valued mainly for its potential. Frontline Indian pharma companies command PEMs of between 20 and 25 times their trailing earnings. Assuming Dabur Pharma manages a PEM of 22-25 times, based on its potential, it may be valued in the Rs 22-25 range.

If the actual valuations for these two entities settle at the levels computed above, every share held by a shareholder in the present Dabur India would be worth around Rs 76, post-demerger, after factoring in the value of additional shares acquired through the demerger.

This suggests that the recent surge in stock price has already captured much of the gains possible from the demerger. This makes it risky for investors to enter the stock at this juncture, in the hope of a bumper profit on the listing of the pharma business.

Potential still

However, investors in Dabur India, especially those with a long investment horizon, may hold on to the stock, and wait for the demerger to take effect, due to two factors. Both the FMCG and pharma businesses of Dabur India appear well-poised to deliver healthy earnings growth over the long term.

Dabur India's strong brands in the health and personal care segments — two fast-growing segments of the FMCG market — may help it post growth rates which are ahead of its peers, while its cost cutting efforts may expand profit margins in the FMCG business.

With the pharma business spun off into a separate company, the FMCG business will also be left with a larger cash chest, with which it can step up its dividend distributions.

Though at a nascent stage, the pharma business too appears to carry promise. With over 250 product registrations in the overseas markets and a renewed focus on original research to unearth new molecules and drug delivery systems, Dabur Pharma does appears to be quite high on potential.

Secondly, in its present mood, the market appears to be quite willing to accord fancy valuations to mid-cap pharma stocks. The past couple of months have seen a sharp surge in market fancy for pharma stocks, especially those with a strong export presence.

Therefore, the timing of the demerger may add some flavour to a deal that is already well-structured to deliver value to Dabur India's shareholders.

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