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Last Updated : Jul 01, 2016 01:03 PM IST | Source: CNBC-TV18

Here are a few investment ideas from Rahul Arora

In an interview to CNBC-TV18, Rahul Arora of Nirmal Bang Institutional Equities shared his readings and outlook on specific stocks and sector.

In an interview to CNBC-TV18, Rahul Arora of Nirmal Bang Institutional Equities shared his readings and outlook on specific stocks and sector.

Below is the verbatim transcript of Rahul Arora's interview to Ekta Batra & Prashant Nair on CNBC-TV18.

Ekta: I was looking at your list of stocks, and the one that caught my fancy was Dr Reddys Laboratories. You like it? What is your theory on it?

A: We initiated on the stock about a month back. The stock has done pretty well in the last one month. It is a pretty big call that we are taking on Dr Reddys. We think that between here and 2022, the US business could grow by 3-4 times, which would imply tripling of profits between now and then. Essentially, USD 16 billion worth of complex generics off patent by FY20 for Dr Reddys. And given its specialisation in complex generics and the filings that they have, we think that this could stand to benefit quite dramatically. The big call that we are taking here is that their proprietary business which is currently about 2 percent of their revenues would probably scale up to about 15-16 percent. And generate very big cash flows to them. So, currently it is about USD 100-150 million.

We are taking a call that it will probably scale up to about USD 1 billion plus in the next 3-4 years. They have a block buster drug and I hope I remember this correctly, I think it is XP23829 which is psoriasis treating drug and that is supposed to be one of the big blockbusters for them, something like probably what Natco Pharma was talking about with respect to Copaxone a few years back. So, it is a great buy. We think it is a multi-year compounding story and it should be had in the portfolio. One of the best in the pharmaceutical space.

Ekta: What about those US Food and Drug Administration (FDA) issues, three plants, warnings letter, yes remediation is getting completed, but is that not a worry for you?

A: I think Srikakulam is where their basic issue is on the plant. It is predominantly an active pharmaceutical ingredient (API) facility and I do not think it is going to be too much trouble for them to transfer, but if you want to buy a quality business, you will buy it at times when things are going wrong for them. There is no point in buying Dr Reddys after the US FDA letter comes through in positive for them. The stock will probably be up 15-20 percent then. So, our interactions with the management suggest that they are probably shifting out a lot of their API facilities to other plants any which ways and this is a great time to be accumulating this stock. So, I was worried when it came through, but a lot of that has already been mitigated to a large extent, I would think.

Prashant: If you juxtapose your logic and the price target, 14 percent upside, is it a near-term target? You were virtually talking about some big numbers.

A: Unfortunately, the street does not allow us to start pricing in FY19-FY20. We will be dissected.

Prashant: This is pricing in FY17?

A: No, we are valuing the company in FY18 on a one year forward basis, but it is not going to be a stock that is going to be a stock that is going to run away in a hurry in the next one year or so. It is probably going to be a reasonable accumulation phase, but there is going to be a huge delta that comes through beyond FY18. In pharmaceutical, you have got to play a very large option value because so many of these Abbreviated New Drug Applications (ANDA) come through, and generally, ANDAs can be anywhere between USD 3 million to about USD 15 million. If one of these become a USD 15 million opportunity, the stock is up 25-30 percent.

Prashant: On that note, Aurobindo Pharma. They have been getting approvals right, left and centre all the way from the middle of 2015. The point is the stock somehow just does not catching on and not doing well. Many mainstream brokers have started covering the stock as well. But is there an issue here because we know the approvals are coming in.

A: If you look at the last four years, the profits have grown 10x for Aurobindo Pharma and the market cap is up about 12x. So I am not too perturbed by the fact that the stock has corrected about 15-20 percent. I know one of the very large institutional holders has been selling the stock. But as you yourself very correctly pointed out, they have got about 150 ANDAs that they have filed. If you take on average about USD 3 million per ANDA, that is about USD 450 million of option value. They are predominantly focusing on the US formulation of business. The antiretroviral business which was in double digits in now down to just about 8-9 percent of their revenues. And the US formulation business is up to about 45 percent. Our call is that the US business will compound at 18-20 percent in FY17 and FY18 with enough triggers to keep them going beyond that.

The company should generate about Rs 2,500 crore of free cash flow. One of the biggest problems with Aurobindo has been its leverage in the pharmaceutical space. So, we think that the debt equity which is currently at about 0.6-0.7 will probably come down to about 0.2 by FY18 and that will probably drive some amount of rerating. So, the correction is welcome, it has been a dream stock, one of the best in the industry. And it has surprised everyone with the rate of approvals. So, that keeps our confidence going.

Ekta: The other space that you are looking at interestingly is the deal between UltraTech Cement and Jaypee Infratech and in case that does not go through, that would be a positive.

A: So, we are very positive on the cement space as a whole if you remember about a few months back, I had given a slightly contrarian call, when most of the street was a sell, but there are two ways to look at this deal. One is if it goes through, it definitely going to be return ratio dilutive for UltraTech. There is no question about that in the short to medium-term. And the question is how will the market choose to price that. UltraTech is essentially is a 65 million tonne player. Jaypee Associates would probably bring on another 20 million tonnes and that is at about 130 it is being perceived as a reasonable acquisition. But the benefits may not outweigh the costs in the near-term, because UltraTech is not a major player in central India. This gives them a huge holding in central India.

So for the moment if you are looking at UltraTech for the short-term, if you have just FY18 in mind, this deal not going through will perhaps be a positive. The stock will probably edge up to about Rs 4,000 or thereabouts. But I like playing structural stories and beyond. So, keeping in mind like a 3-5 year view, it is a good deal to happen. But immediately, it will relieve some of the pressure that could emerge on some of the financials.

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First Published on Jul 1, 2016 12:18 pm
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