The Hindu Business Line : Lupin: Buy

A focus on chronic therapy areas in the domestic market, coupled with the completion of major investments for developed market initiatives, is likely to show up in Lupin's bottomline.

DR KAMAL K. SHARMA, Managing Director, Lupin Ltd. — Shashi Ashiwal

Exposure can be considered in the Lupin stock, which now trades at about Rs 540. We have been positive about Lupin's prospects for a while now; though the stock has gained close to 60 per cent since our earlier `buy' recommendation, we believe there is still scope for upside.

Given that the stock has recovered ground smartly since the market crash in May, we would recommend that investors buy into the stock in small lots. Any fall in price linked to the overall market weakness can be used as an opportunity to step up exposure. As in the case of mid-caps that have seen a stellar run over the past couple of years, we expect modest gains from Lupin over the long term . Investors can also consider booking profits as and when their returns target is achieved.

Financial performance

For the quarter-ended June 2006, Lupin's performance was driven by an across-the-board strong showing across regions and products (both formulations and active pharmaceutical ingredients — API). The only area that set the performance back was API exports to developed markets on account of a drop in the offtake of a couple of products.

A look at the headline numbers suggests a sharp drop in margins, which have fallen in excess of 500 basis points to 12.1 per cent compared to the year-ago period. However, it must be noted that two items of a one-off nature — pertaining to a patent litigation (Ramipril) and an accounting adjustment under the head of staff costs — have been reckoned as part of operating costs. Adjusting for these items, the fall in operating margins would have been in the region of 100-plus basis points.

Investment rationale

FY-05 was not particularly good for Lupin, as the investments it had made for the foray into developed markets did not yield commensurate returns. That anomaly was rectified in FY-06 and the trend is set to continue this fiscal too.

With most of the investments out of the way, we believe that Lupin is set to reap the benefits of its initiatives.

For Lupin a key focus area is the domestic market, accounting for about 60 per cent of revenues (quarter-ended June 2006). The company has also made the transition from being predominantly a player in such mature categories as cephalosporins and anti-TB segment to chronic therapy areas such as cardio-vasculars and anti-asthma. The foray into the latter was aimed at leveraging the strong franchise that Lupin's anti-TB portfolio commands with chest physicians. The results are also beginning to show, with Lupin's domestic formulations business posting 30 per cent growth. Also, realisations tend to be better in the chronic therapy area.

Lupin's American market initiatives continue to make steady progress. Though it suffered a setback on the Ramipril litigation, it continues to target niches: Ceftriaxone and Suprax being recent examples. The key product to watch out for would be Cefdinir, the patent for which expires next May. With Lupin having received approval, and competition likely to be limited, it should serve as a window to a profitable opportunity.

We also note that Lupin's product mix now is skewed more towards formulations than bulk products. For instance, the FY-05 revenue composition stood at 55:45 in favour of bulk, but the mix reversed in FY-06. Though Lupin is a strong player in the API space, we believe that a tilt towards formulations is a positive, as pricing tends to be more stable. API prices tend to be volatile and that can lead to fluctuating earnings.

To reduce the dependence on any particular geography, Lupin has entered into supply agreements for its anti-TB range to address markets in Africa and South-East Asia. Last year, it also entered into a strategic relationship with DSM — a key competitor — for cephalosporins.

Recently, it acquired a stake in a Belgium-based company, Dafra, which gives it access to anti-malarial products. This is a prudent approach to scale up, as opposed to a big-bang acquisition that may be expensive and pose integration challenges.

In the drug development arena, Lupin has a few molecules — a couple of which are to treat psoriasis and another for migraine — in different stages of development.

It recently received approval to start Phase-II trials on its anti-psoriasis molecule. Out-licensing of such molecules is likely to bolster the revenue stream, though we have not incorporated such numbers into our forecasts.

Valuation and view

On a fully diluted basis, the Lupin stock trades at 21 times the expected per share earnings (assuming full conversion of the $100-million FCCB issue put through last year), in line with other mid-cap pharma stocks whose prospects we are confident about. We reiterate that we do not expect the stock to post runaway gains and recommend investors to temper return expectations. Maintain Buy.

Key risks to our recommendation include significant expansion in the number of drugs under price control; a delay in getting regulatory approval for products to be launched in developed markets; and lack of opportunities to deploy funds raised through the foreign currency convertible bonds (FCCB) route productively, which may pull down return metrics.

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