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May 29, 2013, 03.43 PM IST | Source: CNBC-TV18

Positive on Ranbaxy; Sun Pharma to come off highs: Nomura

Dr Reddy’s Laboratory and Lupin are top picks of Nomura India's Saion Mukherjee. He expects Sun Pharma to come off from current highs and see operational improvement in Ranbaxy.

Despite Sun Pharma posting a good set of numbers in the fourth quarter, Saion Mukherjee of Nomura India remains cautious on the stock which may see some moderation going ahead due to high valuations.  Ranbaxy , which was hammered on the bourses last week, has also remained on Mukherjee's radar owing to its possible improvement in operations. He also warns investors that the company may face the brunt of drug price control, which is currently being considered by the government .

“Ranbaxy would be one of the companies which will be relatively more impacted given the premium pricing they command on some of the products which will come under price control,” he told CNBC-TV18 in an interview.

Leading pharmaceutical stocks have been going through turmoil recently due to US food and drug administration related issues. Last week BSE pharma index lost Rs 16,822 crore in market cap, with Ranbaxy, Glenmark and Wockhardt together losing Rs 10,280 crore.

Last week, Wockhardt shares had plunged nearly 38 percent on reports that US FDA had banned import of drugs from the company’s Aurangabad unit. Ranbaxy also suffered after it admitted guilty to felony charges related to drug safety and agreed to pay USD 500 million in civil and criminal fines under a settlement with the US Department of Justice.

Mukherjee is, however, bullish on Dr Reddy's Laboratory and Lupin among pharmaceutical counters.

Below is the verbatim transcript of his interview

Q: For Sun Pharma it has been a heady concoction of very good revenue guidance that they have for the next year, solid earnings performance this time around. We had that bonus issue as well. In terms of a recommendation on the stock and a stock price how much more of an upside do you see?

A: Sun Pharma came out with numbers which were more or less in line with our expectations, if you adjust for some provision on litigation. Sun Pharma has benefited a lot in the last one year from product specific opportunities. As you are aware they have taken significant price hikes at Taro. Doxycycline is another opportunity where they have been able to take price hikes and also Doxil approval where they are the only approved product manufacturer in the market. All this has benefited as far as bottom-line is concerned. But the key going forward would be how sustainable are these upsides. The management has been guiding for some moderation in these upsides and that is also reflected in the guidance. If you look at the revenue growth guidance of 18-20 percent, despite the full year impact of acquisition at URL and Dusa, we believe that there would be some moderation going forward. Currently the stock is trading at around 25 times FY14 estimates which are ahead of the peer group. So lots of these expectations are around sustaining price hike and on possible acquisition given the strong balance sheet, which is already factored into the price. Therefore we have a neutral rating and we see limited upsides from the current levels.

Q: Would you have a call on Ranbaxy considering all of the bad news which has plagued the stock? Do you expect its domestic business to get significantly affected because of the recent news from South Mumbai hospitals etc.?

A: We have upgraded Ranbaxy a few months back when it was at Rs 380 levels. We think that they are now putting in systems and processes which will help them to address the necessary FDA requirements. We still remain hopeful that on a very low base their Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) margins are quite suppressed in single digits. They should be able to improve on that. Incrementally we should see a gradual improvement in operational performance. As far as the domestic business is concerned there are some news items related to product quality, some requirements or local FDA wanting to see what the US Food and Drugs Administration (USFDA) has said etc. But I do believe that they have a strong franchise in India and they should be in a position to deliver growth more or less in line with the market. The only headwind there we see is in terms of price control that is going to be in place. Ranbaxy would be one of the companies which will be relatively more impacted given the premium pricing they command on some of the products which will come under price control.

Q: Generally when companies like these are plagued with some sort of controversy or the other specifically in the pharma business where people's health is involved we do see the stock under pressure for quite a while. Do you fear that despite no problems coming in on the P&L because of these issues that are constantly being raised on Ranbaxy the noose has been tightened around their neck; the stock could remain under pressure for a while?

A: That happens. We have seen that in the past. Whenever there is a FDA issue, quality issue etc. it does impact P&L to some extent, but it also leads to a meaningful derating in the stock and that is possible. We have to look at it objectively and see whether they can come out of it over time and that becomes a long-term investment opportunity.

Q: Do you have a view on Wockhardt?

A: We do not cover Wockhardt. The stock has been under pressure primarily on the FDA issue. That again highlights what we were talking about earlier that such news flow can have short-term impact which could be quite significant on the stock.

Q: What is your top pick in the pharma space? If you had to recommend one stock to buy right now what would it be?

A: On the large cap space the run up in the stock has been significant. So we are very selective there. Our pick from the large cap space is Lupin and Dr Reddys. In both these companies we could see material earnings upgrade and that should allow the stock to continue to trade at the current PE multiples. So these are the two names that we like in the large cap pharma space.

Q: In your historical analysis in terms of companies that have had USFDA problems do you see them to recover in terms of a stock price performance to the earlier highs that they were trading at or do you see that there is a structural derating that takes place in a couple of these pharmaceutical stocks, for example like Ranbaxy, Wockhardt or an Aurobindo?

A: I think many Indian companies have faced issues in the past. We had issue with Caraco a few years back, but Sun Pharma happened to be one of the best performing pharma stock. Similarly, Lupin had a warning letter. The stock was under pressure for sometime, but they recovered. So it is not a case of a permanent derating. In a way this process helps because it strengthens the internal processes of the companies and that is something which is beneficial in the long-term.

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