Torrent Pharma - Aggressive M&A valuations to strain ROCE - Edelweiss

Torrent Pharmaceuticals (TRP) has acquired Elder Pharma's (Elder) India business (sales of INR4bn and 35% EBITDA margin) for INR20bn. The deal valued at 4.8x EV/sales and 14x EV/EBITDA, gives TRP a ready brand portfolio to aggressively entrench in new focus specialties of women care, pain management and nutraceuticals. While the acquired portfolio is complementary and synergistic, it is likely to result in earnings cut of 11% and 14% for FY14E and FY15E, respectively, add leverage of 1.2x from zero net debt and hit RoCEs of TRP. Ergo, we downgrade to 'HOLD' and believe TRP will have to harness strong execution capability to scale up the acquired portfolio to currently generated returns level.

Acquisition offers deep synergies and established brands

Elder's specialty portfolio offers multiple synergies to TRP such as addition of leading brands—Shelcal, Chymoral, Carnisure—strengthening its presence in gynecology, pain and vitamin segments. It also renders deeper access to tier II-IV markets with 1,100 market representatives and adds distribution network of 2,900 stockists to its existing base of 1,700, thereby enabling better penetration in North and West India. However, we believe it comes at a dearer value (5x sales) with projected payback of over 10 years and additional strain on balance sheet, limiting future expansion capacity.

Strong scale up potential, but earnings accretion could be delayed

Elder sales have declined sharply due to lack of product supplies in market. Thus, we perceive strong scale up potential with leveraging of key brands such as Shelcal to Torrent's existing portfolio. However, TRP will have to scale up EBITDA of the acquired business over 2x (INR3.0bn from INR1.5bn) to make it earnings accretive by FY15E.

Outlook and valuations: Execution critical; downgrade to 'HOLD'

TRP generates 45% RoCE, while the acquisition yields less than 10% RoCE. Thus, the company will have to scale up the acquired entity 4-5x to achieve similar level of returns. Moreover, execution risk is higher as it is a large buyout for TRP with no historical precedence. Hence, we do not expect significant upside from current level and downgrade to 'HOLD' with TP of INR508 valued at 14x 12m fwd (Sept -15E) EPS.

Source : Equity Bulls

Keywords