Piramal Pharma Rights issue: Negatives priced in

Piramal Pharma demerged in October 2022 and has recently announced a rights issue, despite tepid stock gains post-demerger. Last year, the pharma business of Piramal demerged from the combined business in Piramal Enterprises, which includes NBFC operations. On paper, the proposition has its merits as the CDMO/consumer brands business growth could be unlocked by disengaging from a diametrically opposite NBFC business. But with the volatile environment in pharma research outsourcing, 9MFY23 results were weak. The stock followed suit as the share prices have declined by 65 per cent since listing.

At such a juncture, the company announced rights issue to existing shareholders of upto ₹1,050 crore. The proceeds from the rights issue will be used to repay a debt of ₹778 crores (15 per cent of outstanding net debt as of December 2022) according to the draft letter of offering filed on March 28.

Equity dilution amidst weak operating environment

Using (high-cost) equity to repay (low-cost) debt may prove to be returns dilutive to shareholders. Especially considering that the company is using internal accruals to fund capacity expansion to the tune of $100 million or ₹820 crore so far in 9MFY23.

The current operating performance of the company is also not encouraging. The company reported revenue growth of 11 per cent YoY in 9MFY23 driven by CDMO business (56 per cent of revenue and 12 per cent YoY growth), complex hospital generics business (32 per cent contribution and 9 per cent YoY growth) and Indian consumer healthcare business (13 per cent contribution and 19 per cent YoY growth).

Also read: Access to capital, regulatory reforms key to boost innovation in pharma industry: CEOs

But more importantly, EBITDA margins declined from 17 per cent in 9MFY22 to 10 per cent in 9MFY23. The company reported under utilisation of capacities as clients delayed decision-making in an uncertain macroeconomic environment. The increased headcount and operating expenses added negatively to operating leverage further impacting performance in a period with higher marketing expenses, input material cost, and negative forex impact.

Following suit

That said, the Piramal Pharma stock price may have discounted most of the negatives making the current rights issue a sweetener to stockholders. The leader in research outsourcing - Divi’s - also reported weak operating environment in the same period. The expected improvement in performance supported our recent accumulate call on the stock of Divi’s Laboratories. Hence, Piramal Pharma too may follow suit.

The CDMO division and India Consumer business are positioned well currently. The CDMO business is spread across verticals (High Potent API, Complex OSDs, Injectables, Peptides, Antibody Drug Conjugates, Biologics and Vaccines) serving large pharma and generics. It has 46 per cent of revenues from molecules on the commercialisation threshold (Phase-III). Any turnaround in the current low utilisation of capacity (set-up or WIP) can improve the operating performance. The Indian consumer brands have reported a 19 per cent YoY growth in 9MFY23 on a high base as branding and marketing bear fruit. As the secular shift in research outsourcing unfolds along with the mentioned commercial opportunities in CDMO and Indian brands, the company can make a turnaround.

The company is yet to announce the record date and the discount in the rights issue which could happen by Q2FY24. Following the board announcement on February 8, 2023, the stock corrected by 10 per cent, which takes care of the potential dilution from rights issue. Shareholders who factored in the negative operating environment since demerging should hold on to the announcement and the discounted rights issue before taking a call on the stock.

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