Friday, October 23, 2009


Steady outlook; receding FDA risk; raise sector TPs; RBX off C-List

Stable long-term outlook; Receding FDA risk; raise TPs
Our fundamentally stable outlook for the sector has over the last year been overshadowed by FDA risks around mainstream companies. However, recent developments (with Cipla, Sun) demonstrate that FDA issues can be resolved, allowing the focus to shift back to a longer term view for the sector (despite near-term pain). We continue to believe that the sector will grow at mid-teen rates, sustain its operating margins at 18%-19% and generate consistent cash returns over FY10E-12E. Hence, we raise our Director’s Cut based (evaluates cash returns calculated by EV/GCI vs CROCI/WACC) multiple for the sector to 1.30x (1.04x prev.) and increase our target prices by 17%-45%.

Ranbaxy off Conviction list, retain Sell; 39% potential downside
We remove Ranbaxy from the Conviction Sell list but maintain our Sell rating on expensive valuations, trading at 108% premium to peers on FY11 P/E. The stock has underperformed the sector by 32% since the FDA import alert in Sep 2008. Despite a positive move by Ranbaxy inviting FDA to reinspect Dewas, we have limited visibility into progress of the key issue of Paonta Sahib resolution. Owing to the rupee’s appreciation trend, we expect hedging losses to be fully reversed and revise our EPS estimates from Rs (14.72) to Rs2.78 for CY2009E and by 37% and 6% for CY2010E and 11E respectively.

Best Buy idea
Our top picks in the sector continue to be Dr Reddy’s Labs (REDY.BO; TP – Rs1060), Cadila (CADI.BO; TP – Rs646) and Piramal (PIRA.BO, TP – Rs443) yielding potential upside of 10%, 27% and 18% respectively.

Best Sell idea
We maintain our Sell rating on Ranbaxy; we also maintain Sell ratings for Sun (SUN.BO; TP – Rs1099), Cipla (CIPL.BO; TP – Rs201) and Biocon (TP – Rs224), yielding potential downside of 21%, 33% and 15% respectively. We expect the next quarterly results to provide greater clarity on FDA impact on US sales for Sell rated stocks Ranbaxy and Sun.

Translational risk of currency volatility, especially strengthening rupee and still existing overhang of FDA.

To see the full report: PHARMACEUTICAL SECTOR