INVESTORS PLEASE LISTEN !: Q3FY2009 Pharma earnings preview: dated January 07, 2009

Wednesday, January 7, 2009

Q3FY2009 Pharma earnings preview: dated January 07, 2009

Q3FY2009 Pharma earnings preview

The pharmaceutical companies under our coverage are expected to report a 14.4% increase in their revenues for Q3FY2009. The expected growth of the pharmaceutical companies is lower than that seen in the previous quarters due to a general slowdown in the domestic market (the domestic market growth moderated to ~10.5% in Q3FY2009 as compared with ~12-14% in the preceding quarters) and the high-base of Q3FY2008 for companies such as Sun Pharmaceuticals (Sun Pharma) and Glenmark Pharmaceuticals (Glenmark). The Q3FY2008 revenues of these two companies were boosted by exclusivities and milestones respectively. With most companies having hedged a large part of their outstanding receivables at around the Rs41-42 level, the benefit of the weaker rupee would be only partial. Sun Pharma would be the biggest beneficiary of the weaker rupee, since it has not hedged aggressively at higher levels of the rupee, relying more on the natural hedge mechanism.

The operating profit margin (OPM) of companies under our coverage is expected to shrink by 400 basis points, largely driven by a reduction in the margin of Sun Pharma (the Q3FY2008 margin was at an all-time high due to the Oxcarbazepine, Pantoprazole and Ethyol exclusivities) and Glenmark (which had recorded a very high margin in Q3FY2008 due to the receipt of a milestone income). A low top line growth would also result in margin pressure for companies like Ranbaxy Laboratories (Ranbaxy; the US Food and Drug Administration [USFDA] ban to lead to decline in US business) and Orchid Chemicals and Pharmaceuticals (Orchids; due to the absence of any significant new launches). On the other hand, we expect companies like Lupin and Piramal Healthcare (Piramal) to witness healthy margin expansion due to strong traction in revenues. We expect in input cost to largely remain stable on account of the negating influences of the weaker rupee and the lower prices of active pharmaceutical ingredients (APIs) and intermediates (due to the resumption of supplies from China, after the Beijing Olympics 2008).

With a modest revenue growth and poor operating performance, the reported net profit of the companies under our coverage would decline by 23.7%. This would be on account of the marked-to-market (MTM) losses (owing to a ~3% depreciation in the Indian Rupee against the US Dollar) recorded by companies like Ranbaxy, Orchid, Cadila Healthcare (Cadila) and Ipca Laboratories (Ipca), which have outstanding foreign exchange (forex) liabilities. Higher interest and depreciation costs (due to acquisitions and/or expansion in capacities) would also affect the reported profits in the case of Lupin, Opto Circuits (Opto), Elder Pharmaceuticals (Elder) and Surya Pharmaceuticals (Surya). One-time incomes recorded in Q3FY2008 (in the case of Sun Pharma, Glenmark and Lupin) would also limit the net profit growth of these companies. Lupin's net profit growth would also be affected. On excluding the non-recurring income/expenses and the forex impact, we believe the adjusted net profit of the companies under our coverage would grow by ~30%.

Our top picks include Sun Pharma, Piramal, Opto and Torrent Pharmaceuticals (Torrent), which are expected to deliver strong top line and bottom line growth. On the other hand, companies like Ranbaxy, Ipca and Orchid could surprise negatively due to higher than anticipated forex losses.

The key risk to our estimates for Q3FY2009 is companies reporting MTM losses on hedging instruments or on foreign currency derivatives. We believe companies like Ranbaxy could have outstanding foreign currency hedges on which they could incur certain losses.