Sharekhan Stock Broking firm is bullish on Nicholas Piramal and has maintained buy rating on the stock with target price of Rs 326.

Sharekhan research report on Nicholas Piramal

Key points 

Nicholas Piramal India Ltd (NPIL) has announced the demerger of its new chemical entity (NCE) research into a separate company called Nicholas Piramal Research Company (NPRC). The proposed demerger would be effective from April 1, 2007 and the new company will be listed on the bourses by June 2008. 

With a focus on the therapeutic segments of oncology, diabetes, inflammation and infectious diseases, NPIL has a pipeline of 13 molecules, including one molecule in-licensed from Eli Lilly for clinical development. Of the 13 molecules, nine molecules (including the one in-licensed from Eli Lilly) are in pre-clinical development stage, whereas the remaining four molecules are in Phase II clinical trials. Further, four more molecules are scheduled to enter the clinics by the end of FY2008, which would make NPIL one of the largest clinical development pipelines among the Indian players. 

As a part of the demerger plan, NPIL will initially invest Rs4.55 crore as equity capital in the new company (NPRC). It will also transfer Rs90 crore worth of fixed assets (as per book value) and Rs95 crore of cash to the new company. In consideration, NPIL will issue one new share of face value Rs10 each in the new company to all its shareholders for every ten shares of face value Rs2 each held in NPIL (ie in the ratio of 1:10). 

With the proposed demerger, the managament has revised its guidance for FY2008. Even though the top line growth guidance has been maintained at 25%, the operating profit margin (OPM) is expected to expand to 17.7% (as against the earlier guidance of 15.5%) on the back of a Rs70 crore savings in the research and development (R&D) expenses. The capital expenditure (capex) is also expected to come down to Rs150 crore versus the earlier guidance of Rs210 crore. As a result, the earnings per share (EPS) is expected to improve by Rs3 to Rs17.0 (as compared with the earlier guidance of Rs14).

We have attempted to value NPRC in line with Sun Pharma Advanced Research Company (SPARC, which is the demerged innovative R&D unit of Sun Pharmaceuticals). SPARC is currently trading at an estimated 5.7x its planned R&D spend of around USD70 million (Rs287 crore) over the next three years. On assigning a similar multiple to NPRC's projected discovery R&D spend of Rs310 crore, we arrive at a value of Rs1,755.2 crore for NPRC. This translates into a per share value of Rs688.3 (2.545 crore shares of face value Rs10 each). However, for NPIL, whose shares have a face value of Rs2 each, this would imply a per share value of Rs137.6.

With the demerger of the R&D division, the earnings of the company are expected to improve by Rs3 per share (as per management guidance), implying a price appreciation of Rs54 (if we assign a multiple of 18x to the incremental EPS). We will be revising our estimates for NPIL in order to incorporate the impact of the proposed demerger at a later date. At the current market price of Rs288, the stock is trading at 21.5x its estimated FY2008E earnings and at 17.7x its estimated FY2009E earnings. We maintain our Buy recommendation on the stock with a price target of Rs326. NPIL has announced the demerger of its NCE research into a separate company called NPRC. The proposed demerger would be effective from April 1, 2007 and will be listed on the bourses by June 2008.

Capex:

The demerger will reduce the company's capex to Rs150 crore as against the earlier guidance of Rs210 crore. EPS: The savings in the R&D spend, along with the reduction in the depreciation expense (due to asset transfer and reduced capex) will cause the EPS of the company to increase by Rs3 per share to Rs17 ( as against the earlier guidance of Rs14).

Valuation of the demerged entity

We have attempted to value NPRC in line with SPARC, which is the demerged innovative R&D unit of Sun Pharmaceuticals. SPARC is currently trading at an estimated 5.7x its planned R&D spend of around USD70 million (Rs287 crore) over the next three years. On assigning a similar multiple to NPRC's projected discovery R&D spend of Rs310 crore (Rs70 crore in FY2008, Rs100 crore in FY2009 and Rs140 crore in FY2010), we arrive at a value of Rs1,755.2 crore for NPRC. This translates into a per share value of Rs688.3 (2.545 crore shares of face value Rs10 each). However for NPIL, whose shares have a face value of Rs2 each, this would imply a per share value of Rs137.6. At the current market price of Rs288, the stock is trading at 21.5x its estimated FY2008E earnings and at 17.7x its estimated FY2009E earnings. We maintain our Buy recommendation on the stock with a price target of Rs 326.