See moderate to good quarter for pharma: Nimish Mehta

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The earnings season is just round the corner and this week we discuss brokerage estimates for each sector. Nimish Mehta of Edelweiss Securities  discusses the numbers and the companies that are worth a watch in the pharma sector.

Excerpts from CNBC - TV18's exclusive interview with Nimish Mehta:

Q: What would be the key surprises or the key downsides you would watch out for this quarter from the pharmaceutical pack and which would be the key outperformers and the key laggards from this entire earnings season?

A: In terms of surprises, I don't think there will be any, barring the fact that some companies will continue to demonstrate good earnings growth on the domestic formulations side. Otherwise, the quarter would largely be in line with expectations and I expect the quarter to give a moderate to a good profitability growth.

A lot of growth from CRAMs company will actually come from integration of acquisitions that have happened earlier, and there would be an unusual one-time growth that may come in for Dr Reddy as they launch the 180-day exclusivity product Zofran on Ondansetron.

Q: You touched upon domestic formulation and you seem unusually bullish about Cipla's domestic formulation business. Could you walk us through the rationale of that? Which would be your three biggest bets going into this earnings season in terms of EPS growth for this particular quarter?

A: Cipla has been one of my top picks and we believe that the domestic formulation business for Cipla will do very well in the last quarter, which means that its Q3 was not good and that is mainly an aberration because they had seen some issues related to VAT getting introduced in Tamil Nadu.

However, because of the rural market for domestic formulation you are seeing a very robust increase and Cipla is present in a big way in those markets not just by physical presence, but they have a relevant brand in anti-infectives which is why we believe Cipla can be a good pick at this point of time.

In terms of our estimate for the quarter, many CRAM companies actually lead the EPS growth and that is mainly because of acquisition-led growth that is coming through just because the companies which they have acquired were not there in the last year earnings. For Nicholas Piramal we can see something like 300% growth. Dishman Pharma can be more than 100% kind of growth. Dr Reddy as I just told you, has a 180-day exclusivity product, which is being launched will see an EPS of about Rs 9 for this quarter versus a Rs 1.5 loss in the previous quarter. Cipla may see some modest growth of about 10% in this quarter.

Q: A quick word on Aurobindo . What are you expecting it to deliver this particular quarter, because there has been much talk on it being one of the front-runners for Merck's generic business?

A: The quarter for Aurobindo is going to be a good one; in fact it is going to be in line with what their numbers were in last quarter that is Q3. We are expecting about 70% increase in EPS for that company for the quarter. In terms of their acquiring Merck business, we haven't had a word from the management but it seems that it makes a lot of sense for Aurobindo to get into the race - not because they are not actually looking at investing into the company; it seems more or less like a Cipla kind of a model where private equity guys will fund the company and Aurobindo, which has a lot of excess capacity can manufacture all the products for Merck generics.

Aurobindo is one of the largest companies with a lot of excess capacity and that too spread over almost kind of generic technologies right from injectibles to suspensions to orals to liquids to tablets; everything makes a lot of sense for them to actually grab this company. Obviously valuations will have their own way but as I said they do not seem to be investing into the company directly.

Q: Going forward is there something that you are particularly watching out for from the kind of guidance that Ranbaxy and Dr Reddy may give out for FY08?

A: The FY08 guidance from Ranbaxy is already out; we are already into the first quarter of the new financial year because their financial year is calendar year. Dr Reddy per se doesn't give any guidance but it seems that FY08 will be a lot lower than FY07 because FY07 had a lot of exclusivity or one time income in growth coming from products, which will not recur in the next year, so on and so forth. Overall, we see that most of the companies in a way - asset wise or directly - are agreeing to the fact that the US generics market has become an extremely competitive market and find it difficult to grow there.

So unless you have exclusivity kind of products or you have acquisitions, it becomes very challenging for them to grow after a particular level; so that is what we expect for both these companies. In fact for both these companies, we expect the Western European market not to deliver good growth numbers.

We are already seeing some pressure for Dr Reddy on Betapharm and Ranbaxy has expressed the same concern about the Western European markets. I am coming back to the domestic formulation part and it seems that to some extent, the branded formulation business will be driving the growth of these two companies. Broadly speaking the guidance that the companies are not sharing, especially Dr Reddy but seems to be muted if we were to take on an organic basis excluding all the one times into FY07.

Any disclosures

I don't own any of the stocks, which I just spoke.