Investor's Eye: Stock Idea - Cipla; Update - Bajaj Auto, V-Guard Industries; Sector Note - Basmati rice

 

Investor's Eye [May 16, 2013]  Sharekhan www.sharekhan.com     If you do not wish to receive this research report in future, please click here

Summary of Contents     STOCK IDEA Cipla Recommendation: Buy Price target: Rs490 Current market price: Rs411 On growth pill Key points  Shifting gear: Cipla has brought about a paradigm shift in its business strategy. To revive growth, it has (1) enhanced focus on technology intensive products in the inhalation and nasal spray segments; (2) established front-end presence in the key markets like the USA (a shift from the traditional partnership based model); (3) developed an appetite for inorganic expansions (the acquisition of Cipla Medpro); (4) decided to tap the first-to-file (FTF) opportunities through collaboration with major generic players in the regulated markets (eg it supplied active pharmaceutical ingredients [APIs] for generic Lexapro to Teva in FY2013); and (5) invested in future growth areas like biosimilars. Optimisation of facilities, acquisition and niche product launches are mid-term triggers: In addition to its aggressive strategy, Cipla's base business growth would be fast-tracked in the quarters ahead because of (1) the optimisation of the Indore formulation plant, which is expected to generate Rs600 crore in FY2013, (2) its focus on inhalation devices and difficult-to-make generics (we are especially looking at the opportunity emanating from inhalers like Dymista [an opportunity of $60-70 million of revenues in FY2014 and $15 million worth of milestone payments]; Seretide [brand size $2 billion]; and Symbicort [brand size $1.4 billion]); and (3) the acquisition of Cipla Medpro, which would be earnings accretive from the second year of the acquisition. Base business' margin to improve on better capacity utilisation and a favourable products mix: We expect the operating profit margin (OPM) of the company to improve from 20.2% in FY2012 to 25% in FY2013, taking into account the profit from the supply of generic Lexapro to Teva (a one-off opportunity). Excluding the one-off, the OPM is likely to improve to 21.5% in FY2013 and further expand to 22% in FY2014 and to 22.5% in FY2015, thanks to higher capacity utilisation at the Indore special economic zone (SEZ) facility and the supply of high-margin products in the international market. Acquisition to affect cash flows: We expect Cipla to generate over Rs3,000 crore of free cash during FY2013-15, thanks to its low-intensity capital expenditure (capex) programme and improved operating performance. However, the acquisition of Cipla Medpro (which cost Rs2,600 crore) is set to affect the cash flow in FY2014-15. We have not factored in the impact of the acquisition on our earnings model as the acquisition is pending regulatory clearances. Recommend Buy with a price target of Rs490: Currently, Cipla is trading at a 10% discount to its historical valuation (five-year average P/E on a one-year forward basis). When compared with peers, it is trading at a 27% discount to Sun Pharmaceutical Industries (Sun Pharma) and an 8% discount to Lupin. Our price target for Cipla is set at Rs490, which implies nearly 20x FY2015E earnings (over 15% discount to Sun Pharma's target multiple). Notably, we have not factored in the following: (a) the upside from the acquisition of Cipla Medpro and (b) the two FTF opportunities in the USA that are likely to be realised during FY2015. We recommend Buy on Cipla.   STOCK UPDATE Bajaj Auto Recommendation: Hold Price target: Rs2,111 Current market price: Rs1,808 Q4FY2013 results-First cut analysis  Result highlights Bajaj Auto's Q4FY2013 PAT ahead of estimate, operating performance surprises negatively Bajaj Auto Ltd (BAL)'s Q4FY2013 results were ahead of our estimate. However, on the operating front, the results were marginally below our estimate. An increase in the employee cost and the other expenses impacted profitability. The operating profit margin (OPM) at 17.6% was 60-basis-point lower than our estimate. However, the higher other income at Rs243.6 crore boosted the profit. Also, the tax rate at 25.9% was lower, which further helped the profit. Consequently, the profit after tax (PAT) at Rs765.8 crore was better than our estimate of Rs708 crore. Management outlook on business The domestic market volumes for May 2013 have been guided higher than that of May 2012. BAL plans to launch six Discover variants in FY2014 out of which four would be in the mass market category. BAL plans to improve the market share in the domestic motorcycle industry on the back of new launches. BAL would also revamp the entire three-wheeler portfolio in the next two to three months. The export realisation for FY2014 has been guided at higher levels due to the rupee's depreciation against the dollar, implying currency benefits. Valuation We have a Hold rating on the stock with a price target of Rs2,111. We would review the same after the conference call with BAL's management tomorrow.   V-Guard Industries Recommendation: Hold Price target: Rs508 Current market price: Rs488 Margin pressure building up; price target revised down to Rs508  Result highlights Lower margin dented profitability V-Guard Industries (V-Guard) Q4FY2013 results were significantly below our estimate on the bottom line front while they were in line with our estimate on the top line front on account of a lower margin. While the net sales grew by 36.5% year on year (YoY) and 8.5% quarter on quarter (QoQ) to Rs379 crore, the operating profit slipped by 39.6% YoY and 22.3% QoQ to Rs20 crore in Q4FY2013. The operating profit margin (OPM) contracted by 663 basis points YoY and 209 basis points QoQ to 5.3%. The steep decline in the OPM could be attributed to a hike in the raw material prices and a few one-off items, like write-down in inventory and scrapping of old spares. However, even after adjusting one-off items, the OPM remained under pressure during Q4FY2013. Consequently, the profit after tax (PAT) declined by 53% YoY and 42% QoQ to Rs9 crore in Q4FY2013. The net profit reported was 57% lower than our estimate. Fine-tuned estimates and reduced price target but retained Hold While we have retained our sales estimates for FY2014 and FY2015, we have revised downwards our OPM estimate from 9.4% to 8.5% for FY2014 and FY2015 respectively as we believe the margin pressure is building up. Effectively, we have reduced our earnings estimates by 12% for FY2014 and 9% for FY2015. Hence, we have reduced our price target by 6% to Rs508 but have retained Hold rating on the stock.   SECTOR NOTE Basmati rice Aroma is in the air  The demand for basmati rice has been consistently growing at a compounded annual growth rate (CAGR) of 20% driven by a robust growth in its exports as well as domestic consumption. A 5% lower output in 2012-13 has resulted in a demand-supply mismatch for the commodity, thereby pushing the prices higher by almost 50% in the last few months. With buoyancy in basmati rice prices over the past year, we believe manufacturers stand to gain as they improve their financial profiles. We expect the manufacturers to continue to scale up operations and improve profitability in the medium term, supported by a consistently rising demand. A leveraged capital structure, owing to the working-capital-intensive nature of the business, will however continue to strain the companies' balance sheets. We believe, players who judiciously fund their working capital requirements with a lower debt/equity mix and thus improve their cash flows and return ratios would outperform in the medium term. Basmati rice players will witness a quantum jump in profits in the current year on the back of the increasing basmati rice prices coupled with a lower purchase price for paddy that was procured in the last year. We have a positive view on KRBL, and Lakshmi Energy and Foods. We believe both the companies are attractively placed on the risk-reward spectrum and should witness a substantial improvement in their fortunes in the current year. Click here to read report: Investor's Eye     Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

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