The Hindu Business Line : Ranbaxy Laboratories: Hold

Investors can retain their holdings in the Ranbaxy stock, which trades at about Rs 400. At this price, the stock would command a valuation multiple of 21 times its expected per-share earnings for Calendar Year-07 (on a fully diluted basis). We note that Ranbaxy's operational numbers are improving gradually as the benefits of the restructuring efforts are paying off. At this juncture, investors can wait for sustainability in these numbers over the next couple of quarters before considering an entry into the stock.

Operational highlights

Sales growth at 27 per cent has been strong. Ranbaxy has been working on its cost structure since the beginning of this calendar and the improvement has begun to show up in the numbers. Operating margins, at close to 18 per cent for the quarter, have improved compared to the previous quarter (we look at numbers on a sequential basis, as Y-o-Y comparisons are not very meaningful). Reckoned as a percentage of sales, cost of goods sold moderated, even as selling and general administrative expenditure remained flat. R&D expenses have risen on a sequential basis, but that can be explained by more filings undertaken by the company in the latest quarter.

The bottomline would have been better but for the loss on account of forex forward cover and an exceptional expenditure relating to settlement of a manufacturing arrangement. While the loss on account of the former was Rs 40 crore, the latter resulted in a one-time outgo of Rs 22.6 crore. Adjusted for this one-off item, Ranbaxy reported Rs 162 crore as earnings for the quarter.

Business performance

The US, India and CIS continue to account for a sizeable share of sales. Revenues from the key US market were up by 25 per cent compared to the year-ago period, but that has been driven largely by the exclusivity that Ranbaxy has been enjoying since late June on the 80mg dosage form of simvastatin.

Exclusive of the simvastatin effect, the numbers would point to a continuing pressure in the pricing environment in the US.

We expect growth to cool off in the next quarter in the run-up to the ending of exclusivity; Ranbaxy may launch the other dosage forms (on which Teva was the sole generic player) once the exclusivity period ends.

The ANDA pipeline is expected to be bolstered with another 9-10 filings expected in the ensuing quarter. We also note that Ranbaxy has exclusivity on a small-size product (sales of about Rs 110 crore) to be launched this quarter.

Both the Indian and the CIS markets turned in a strong performance. While sales in India were up 14 per cent, that in the CIS region trebled, with the Terapia acquisition kicking in.

In our view, these markets are likely to be more lucrative to Ranbaxy from a margin standpoint, compared to the US and other markets in Europe. A skew in the sales composition towards these geographies would be a significant positive, in our view. We expect the momentum in the Indian market to sustain on the back of product launches and in-licensing tie-ups. We also expect the strength in the Romanian market to sustain.

Other key markets in which Ranbaxy operates either saw a marginal growth (Europe) or a drop (as with South Africa and China). Good growth was seen in Brazil, though on a small base.

Key stock triggers

In the past, the US Food and Drug Administration had raised objection to Ranbaxy's facility at Paonta Sahib; Ranbaxy is in the process of addressing it.

While an early resolution of the issue and approval could act as a near-term catalyst, a protracted delay maybe an overhang on the stock. This, in our view, would be the principal trigger to watch out for.

Ranbaxy has consistently sought out inorganic growth opportunities and an acquisition in a key geography could lend the stock some pop. If the acquisition, as the management intends, focuses on technology or a niche in a key geography, we believe it would be a key positive.

We would also keep a close watch on the amortisation charges pertaining to the Terapia acquisition, a picture of which would emerge in the year-end numbers.

Valuation and view

It may be argued that scope for further reduction in costs exists, but we believe that most of the benefits of cost restructuring have already accrued to Ranbaxy; improvements are likely be incremental.

Improving pricing trends in the US market and an alteration in revenue composition may change our view on the stock.

With the issue to USFDA plant approval pending resolution, we prefer to be circumspect at the moment. At 21 times the expected CY-07 earnings, investors can retain their holdings.

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