Stock Analysis - Torrent Pharmaceuticals

Business Overview:  

Torrent Pharmaceuticals is a Pharma company having presence in Indian and global markets.  It manufactures both branded and unbranded generics and has a small exposure to contract manufacturing.  It sells branded generics in India and sells both branded and unbranded generics in overseas markets.  As of 2013, domestic revenues contribute about 32% of total revenues and international revenue contribution is around 57%. Contract manufacturing and other form the rest of the revenue.

Their product key segments are Cardio Vascular (36%) followed by , CNS and Gastro Intestinal (18%) segments.  Other major areas include Anti Infective(9%) and Anti Diabetic (8%)

Torrent is now 17^th by turnover and has around 5 brands of top 300.  5 years back they were 16^th by turnover and had around 6 of top 300 brands.  They are present in Brazil, Germany and US.  Entry in US market was late but this market is growing to be a significant one for them.  They have presence in Europe and other emerging countries as well.

While the domestic operations are very profitable, the overseas operation performance has been lackluster and the profit always fluctuates.  They seem to always have good revenue growth overseas but the profitability is always inconsistent suggesting margin pressures.  They are expanding their footprint into global markets and are investing aggressively into many countries.

             Financials:

Company has employed debt at reasonable levels and has debt to equity ratio of 0.35 as of Mar 13.   On consolidated basis, company employs around 819 cr on Net Block and around 150 cr of net working capital to generate a revenue of 3211 cr which is pretty good.  It generates operating profit of 692 Cr from this capital deployed on core business and this looks impressive.  Company always has been generating good amount of free cash flow on regular basis except for last year when the free cash flow was negative because of high inventories and receivables.  Company has been investing aggressively into global businesses but they are not consistent in terms of profitability.  Consolidated profits has always been lower than stand alone profits showing that they are making losses in their overseas operations.  Despite all these, the return ratios and metrics are pretty impressive for the company.  It has an average ROE of around 30% and given the capital retention ratio one can expect a growth of around 16%.  Companies return on reinvested capital has been very impressive with a 5 year average of around 31%.

Investment Rationale:

Company has the potential to grow for some time at around 15%  due to various reasons ranging from expansion in global markets and domestic markets to the amount of products they have in pipeline given the numbers of products that are going off patent until 2016.   Company has been spending consistently on R&D to keep its product portfolio growing. 

Company is available at a reasonable valuation of around 15 time EV/EBIT(average)   basis.  Assuming a growth of 15% for 5 years and terminal growth of 4% afterwards and a discount of 12%, this stock has a fair value of Rs 562 and at current price of Rs 459, it provides a margin of safety of around 18%.  On PE basis it had valuation range between 7 times and 17 times and currently it is available at the high PE range of around 16.  

Any buy at a price with around 25% margin of safety would be great.  As of now I will wait for the price to decline to 425 or below for accumulation.

            Risks:

Currency risks due to exposure to global currencies may impact the profitability of the company as global revenues are almost nearing 60% of the total revenues.

Global operations may make big losses and may not turn out to be profitable as the company expects due to competition from other players.

Margins may contract in the global markets due to competition and changes in government policies.

Working capital requirements may increase in some countries due to long time for payment.

Product launches could be delayed due to longer approval cycles.

Drug price control revised by the government last year may bring in more products of the company under max price ceiling and that may affect margins in domestic market.

Quality issues could result in product return which could affect the profitability.

            Exit Criteria:

Company does not grow on average at 15% as per assumption and likelihood of future growth in this range is very bleak.

Balance sheet structure gets weaker with increased debt exposing the company to leverage risks

Prolonged decrease in the free cash making ability of the business

Company price grows more than the intrinsic value and priced over value by 25%

Return on reinvested capital falls below the bond rate.