Brokers give buy rating to Nectar Life, target price Rs 380

Broking houses are bullish on Nectar Lifesciences . Prabhudas Lilladher has initiated coverage on the company with a buy rating. It has a target price of Rs 380.

A report by Prabhudas Lilladher says that, "Nectar Lifesciences is in transformation to a formulations and highend cephalosporin player in both the regulated and domestic markets from having been an API player in cephalosporins in nonregulated markets."

The report lists out several investment positives, these are below: -

"In cephalosporins, Nectar Lifesciences has been a key player. In the last three years, it has almost doubled revenues and profits, mainly due to operating in high-end (7 ACA-based) cephalosporins, (70% of revenue in FY05). This is in contrast with most of its peers, who were largely dependent on PenG-based products. We believe this is just the beginning, and Neclife's growth rates are likely to accelerate, following its planned capacity expansion."

"While Nectar Lifesciences has mainly been an API player in non-regulated markets, it is looking at moving up the value chain. And to forward integrate, it will be shifting to formulations for which it is setting up a plant in Baddi at a capex of Rs 300 million, to be commissioned in FY07. This facility is being built in accordance with US FDA standards to enable it to target the regulated markets also."

"Given that it continues with its contract manufacturing model for dosages, Neclife has adopted a pragmatic approach, as it believes that marketing is not its forte. Though margins in this model might not be as high as when handling its own marketing, this fits into Neclife's conservative model. Nectar will continue to follow the contract manufacturing model and does not intend to move into marketing on its own. Initially it is likely to start supplying dosages in non-regulated markets; then move into regulated markets, after obtaining the required US FDA approval."

"Though exports make up 25% of Neclife's revenue, they are all to non-regulated markets. However, given the better margins in regulated markets, the company will soon commence supplying to these markets, and is building its new facilities in line with international regulatory norms. Supply to these markets, however, is likely to start after 12-18 months, only when it obtains US FDA approval for its facility."

"In order to reduce dependence on antibiotics, Nectar Lifesciences is planning to manufacture APIs belonging to the CVS and anti-histamine segment. Some of the key drugs it plans to manufacture are simvastatin, atorvastatin, lisinopril, enalapril and fexofenadine."

"The company obtains 78% of its revenue from cephalosporins, of which 8% is dependent on PenG-based cephalosporins; the rest is through 7 ACA-based cephalosporins. Given that the latter command higher margins, Neclife is looking to increase its share from this segment. It now manufactures a variety of sterile cephalosporins (cefotaxime sodium, ceftriaxone sodium, cefazolin and cefipime). It will expand capacity for these and launch new products (cefepime, cefpirome and ceftibuten). In fact, following this expansion, we expect the share from 7 ACA-based cephalosporins to rise to 80% in FY07 (70% in FY05)."

"Though antibiotics as a class have been declining (mainly because of old products - penicillins and macrolides), cephalosporins are replacing SSPs as a line of treatment, given the better response and lower per day cost of therapy. We are thus confident of Nectarlifesciences' growth prospects despite its high dependence on one segment only, cephalosporins."

"Given that Indian companies have to pay 15% customs duty on imports of raw material (7 ACA) to manufacture cephalosporins, in FY03 Neclife set up a wholly owned subsidiary, Chempharma Pvt. Ltd., in Sri Lanka to benefit from the tax benefits of manufacturing there. Its plant is located in the exports-oriented zone in Sri Lanka. As a result, Chempharma is entitled to the following benefits:

• No customs duty on imports;
• Income tax exemption for five years from commencing operations (January 2004)

This has enabled Nectar to lower its raw material cost (as percent of sales) to 58.7% in FY05 (67% in the previous year). It expects a similar arrangement with Pakistan as well."

The report also mentioned some investment concerns, these are below: -

"Nectar Lifesciences currently gets its entire revenue from antibiotics, through SSPs and cephalosporins. Any slowdown in this segment could affect its growth rates. However, to reduce this dependence, it is looking at moving into the lifestyle segment"

"Though Pen G prices have bottomed out, any increase could squeeze Nectar's margins to some extent (despite its low 30% dependence on PenG-based antibiotics). Further, a rise in 7 ACA prices could also hit its margins."

"Nectar would be a late entrant in the regulated markets, as the commissioning of its plant would take 12-15 months. Further, given that patents for most of the cephalosporins are likely to expire in the next two-three years, Nectarlifesciences might not be able to make the most of this opportunity."

About the company's first quarter results review and its future earnings, the report says,

"Nectar's sales slid 5.9%, to Rs 543.6 million; its net profit, however, jumped 22.2%, to Rs 71.6 million. The decline in sales arose from the temporary shutdown of its crystalline Unit I at Derabassi for upgradation. Despite this slide in sales, EBITDA margins improved to 22.5% in Q1FY06 (17.1% a year earlier) because of improved gross margins (44% in Q1FY06, compared to 39% in Q1FY05). This vindicates the company's efforts to improve its product mix, and its concomitant improved margins."

"The 22.2% growth in net profit has thus been driven by the improved margins, despite reduction in other income and higher interest outgo. We expect the company to do better in the coming quarters."

"In the next two years we expect Nectar to record a CAGR of 25.2% in sales, 59% in profit and 37% in earnings. We expect its 25% rise in sales to be led by a 34% jump in 7 ACA based cephalosporins and its entry into dosages. We have, however, assumed a 41% slide in Pen-G-based antibiotics."

"We expect better EBITDA margins (from 18.2% in FY05 to 24.4% two years later) given the higher contribution from cephalosporins and the company's entry into dosages, which command higher margins than APIs."

"Given that Nectar has undertaken a capex of approximately Rs 900 million, we expect a rise in depreciation (from Rs 67 million in FY05 to Rs 90 million in FY06 and Rs 125 million in FY07)."

"We have assumed a fall in tax rate in FY07, given that Nectar has set up its dosages facility at Baddi, which is entitled to 100% tax exemption for the first five years."

"Based on better financial parameters, we expect Nectar's return ratios too to improve. We expect its RoE and RoCE to be a healthy 26.4% and 19.9% in FY07E respectively."

About the company's valuations, the report says, "In our universe of pharmaceutical stocks, Neclife is the least expensive. While we believe that the stock should trade at a discount to the sector, given that it is an API player and is not in the regulated markets, the valuation gap between Nectar and its peers cannot be justified."

"We expect a reduction in the valuation gap, based on the following:

• Nectar will be forward integrating by moving into formulations;
• It is expanding its facilities in accordance with US FDA norms to enable it
  to move into regulated markets."

"We therefore expect the company to record a 37% CAGR in earnings in the next two years. Our ideal PER target for Neclife is 10x FY07 estimates (based on a 50% discount to the sector). We have assumed a target PER of 10x FY07 estimates, given its high dependence on cephalosporins and presence in APIs, despite the strong growth momentum."

"The stock trades at a PER of 10.9x FY06 estimates and 7.0x those of FY07, which is the least expensive of the pharma stocks we cover. We initiate coverage of the stock, with a Buy rating, targeting a price of Rs 380 in the next 12-18 months."

About the company's itself, the report says,

"Incorporated in June 1995 as Surya Medicare Ltd., with financial collaboration from the Punjab State Industrial Development Corp. (PSIDC), its name was changed to Nectar Lifesciences in March 2004 after it bought out PSIDC. The company is engaged in producing oral and sterile bulk drugs in the antibiotic segment."

"Promoted by law graduate Sanjiv Goyal, who has more than 15 years in the pharmaceutical industry, Nectar Lifesciences (NecLife) had raised nearly Rs 929 million through the public issue, following which the promoters' holding had been reduced to 65.9% (earlier, 89.1%)."

"Nectar Lifesciences is one of the leading manufacturers in India of sterile SSP and cephalosporins, with 300 customers, chief being Ranbaxy, Cipla, Alembic and Alkem. 25% of its revenues arise from international markets (China, Korea, S. E. Asia, Italy, Africa and South America). Though Neclife does not operate in the US, it expects to soon enter there. The major part of its revenues, roughly 78%, come from cephalosporins, the rest through SSPs.

"Neclife has a manufacturing plant (installed capacity, 950 MT) at Derabassi (Unit I), which produces oral and sterile forms of SSPs and cephalosporins. Recent expansion plans include setting up a formulations plant at Baddi, HP, a sterile cephalosporin facility at Derabassi, an R&D centre and a Q.C centre."

"Within antibiotics, cephalosporins are the fastest growing category (a 15% CAGR in the last five years in India). Globally, cephalosporins, at $9.6 billion, constitute roughly 35% of the anti-infectives segment. They are used in treating a wide range of infections in the body, killing a certain kind of bacteria by attacking the bacteria cell wall. Cephalosporins are mainly derived from 7 ADCA, which in turn is derived from penicillin and 7 ACA. They are classified into four generations, with increasing activity against gram negative bacteria and decreasing gram positive activity."