Ranbaxy Laboratories: Hold

Sharp run up in the price (30 per cent year-to-date), regulatory risks and high valuations may limit the upside in the stock of Ranbaxy Laboratories in the near term. Investors can continue to hold the stock for a 5-10 per cent return over a one-to-two year time frame. At the current price of Rs 531, the stock trades 19 times CY13 earnings, in line with the industry.

Investment to pay off

During the earlier part of the decade, the company shifted focus to export markets such as the US, Europe and other emerging markets. But over the last two years, Ranbaxy has renewed its focus in the domestic market to capitalise on the robust growth potential and superior profitability. Through its project ‘Viraat’, the company expanded into the semi-urban and rural markets. Ranbaxy doubled its field force from 2,500 medical representatives (MRs) in 2009 to 5,300 currently. India accounts for over a fifth of the company’s revenues.

However, the expansion initiatives are yet to pay off. Growth has been challenged by high attrition and intense competition in the acute therapies which account for three-forth of the company’s revenues. The average revenues per medical representative slipped from Rs 60 lakh in 2009 to Rs 36 lakh in 2011.

Higher employee and promotional costs have also dented the margins in the domestic market. Given the intense competition from multinationals and other Indian majors, ramp up in this market may be a gradual process. Regulatory intervention in pricing can further hurt revenues and profitability in the domestic market. In the September ended quarter, Ranbaxy’s India formulations revenues grew 11 per cent to Rs 583 crore (including Sri Lanka).

Ranbaxy’s over-the-counter business in India with flagship brands — Volini (pain management) and Revital (nutritional supplement) — witnessed healthy growth over the last few years. The revenues in this segment jumped 21 per cent in the September quarter to Rs 105 crore.

US not out of the woods

US accounts for almost a third of Ranbaxy’s revenues. In 2009, the company was charged by the US drug regulator Food and Drug Administrator (FDA) and the US Department of Justice (DoJ) for data falsification and irregularities at its two manufacturing facilities located at Poanta Sahib (Punjab) and Dewas (Madhya Pradesh).

Post regulatory issues with the FDA and DoJ, the sustainable revenues in this market dwindled from $400 million (Rs 2,160 crore) to $250 million (Rs 1,350 crore) over the last three years. Ranbaxy has appointed a consultant to advice on the necessary changes required to get both the facilities back on track. Also, as part of the negotiations, FDA banned the company from selling 29 products in the US. As a result of this, Ranbaxy’s base margins fell from mid-teens to high single-digits. In the September ended quarter, the revenues from the US market more than doubled from Rs 385 crore to Rs 840 crore, driven primarily by authorised generic (AG) launch of the anti-diabetic drug brand Actos, with a 28 per cent market share by end of September.

Though Ranbaxy has been successful in monetising most of its exclusive generic product opportunities for brands such as Lipitor, Aricept, Valtrex in the past; its application for generic cardiovascular drug Diovan is yet to be approved. Hence, uncertainty around the company’s ability to monetise its exclusive products filed from the above-mentioned facilities remains a risk.

Ranbaxy is likely to launch the patented acne drug, Absorica, jointly developed by Ranbaxy and Cipher Pharma in the US market by early 2013. This is an improved version of Ranbaxy’s erstwhile Sotret brand. The drug has a potential to garner peak revenues of $200 million (Rs 1,080 crore). But, given the availability of low-cost generic alternatives, revenue scale-up may take longer.

Higher penalty, a risk

In 2011, Ranbaxy provided $500 million (Rs 2,700 crore) for potential penalty it may have pay for resolving pending issues with FDA.

Increase in the quantum of penalty can risk the company’s earnings. Also, given that the plant and product re-approvals may take longer than expected, the margin improvement and operating leverage is likely to accrue only over a two-to-three year time frame.

In the light of the economic recession in the European market and consequential pricing pressure, growth in this geography has been under strain.

The weakening of the rupee against most other foreign currencies also had a bearing on Ranbaxy’s profitability. With derivatives worth $1.27 billion (Rs 6626 crore) outstanding, any adverse forex movement may further impact profits.

Under the hybrid business model, Ranbaxy and its Japanese promoter Daiichi Sankyo aim to leverage on each other’s marketing skills in specific geographies. As part of this, Ranbaxy currently sells Daiichi’s products in markets such as Italy and Singapore.

Similarly, Daiichi recently signed a pact with Ranbaxy to promote the latter’s products in Venezuela. The benefits from this will likely flow in over a three-to-five year time horizon.

In the September quarter, the company’s revenues grew 28 per cent to Rs 2691 crore on the back of generic launch of Actos in the US. This, in turn, helped Ranbaxy improve its margins by 7 percentage points to 16 per cent. Adjusted profits jumped 2.4 times to Rs 361 crore.