Ranbaxy Labs - Upgrade to Hold on better clarity - Centrum

We upgrade Ranbaxy Labs (RLL) to Hold from Sell as the company has completed the settlement with Department of Justice, US (DOJ). The stock may get re-rated on positive news from Dewas and Paonta Sahib facilities currently under US FDA scanner. However, it is likely to suffer in the domestic market after NPPP implementation. We have reduced EPS estimates for CY13 and CY14 by 50% and 18% respectively due to the sharp fall in margins. We have also revised the target price to Rs377 from Rs400 (based on 20x CY14 EPS of Rs18.8).

Revenue declines: RLL's revenues declined by 18%YoY to Rs26.83bn from Rs32.59bn due to the absence of FTF opportunities in the US. Domestic sales during the quarter were affected by the three-week strike by traders in Maharashtra leading to lower off-take. Moreover, chemists maintained lower stocks due to the expected decline in prices for drugs going under price control as per NPPP.

Sharp drop in margin: RLL's EBIDTA margin dropped by 600bps to 9.8% from 15.8% mainly due to the increase in material cost and other expenses. Material cost grew by 290bps to 34.7% from 31.8% of revenues due to the absence of high margin FTF opportunities in the US. Personnel cost increased by 420bps to 19.1% from 14.9% due to annual increments. Other expenses declined by 100bps to 36.4% from 37.4% of revenues.

Upgrade to Hold from Sell: Due to the settlement with DoJ and payment of $500mn (Rs30.0bn) we expect better clarity on the US business. We expect the US FDA re-inspection of Dewas and Paonta Sahib facility soon. The company will then be able to capitalise FTF opportunities of Diovan, Valcite and Nexium in the US market.

Risks & Valuations: The stock may get re-rated upwards if the company's products gain volumes and it raises prices by 10% on products outside price control. It also faces risks from other regulatory agencies over its manufacturing facilities. At the CMP of Rs398 the stock trades at 35.7x CY13E EPS of Rs11.1 and 21.1x CY14E EPS of Rs18.8. We have changed our rating to Hold from Sell due to more clarity on regulatory approvals from US FDA and DoJ. We prefer Sun Pharma over RLL in the Pharma space. We have revised our target price to Rs 377 from Rs400 due to the expected drop in EBIDTA margin and net profit in CY13 and CY14. Our target price is based on 20x CY14E EPS of Rs18.8 with a downside of 5.3% over the CMP.

Source : Equity Bulls

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