Is the risk reward in Cipla still favourable?

Joshi: Clearly post the results it was an encouraging set of news flow which came in for Cipla, the kind of announcements that one saw with drugs in Germany followed by the drugs in Hungary and Slovakia. That is a positive set of news for Cipla and the kind of addressable market that Cipla is looking at with CFC-free inhalers is close to USD 3 billion. So it is a huge market potential for a company like Cipla which has successfully demonstrated the substitutable compounded inhaler generic growth that one can derive from developed markets as well.

But having said that the sustainability in terms of earnings when it comes specifically to the export market they have grown at a rate of 10 percent in the last quarter. The domestic volumes have grown 17 percent. So to sustain this kind of growth will take some time. Though all these news flows has been extremely positive for the company our take is that the valuations are something which is kind of bothering impact for Cipla from an FY16 perspective cyclically.

If you are looking at the top line growth our estimates were close to 16 odd percent for Cipla over the next two years of close to Rs 13,100 odd crore and clearly the kind of earnings per Share (EPS) growth that Cipla has demonstrated with the stock price running up has more or less discounted our valuations.

So apart from valuations the stock is poised for good growth going forward but valuations is the only weak link possibly the weak link in Cipla’s performance going forward. At around 22-23 times our take is that fresh investments can possibly wait for declines or discount.

Senthil: Would you agree, hold and not a buy on Cipla?

Baliga: Yes, at this point of time after the sort of move which we saw in the last three to four weeks it would be a hold because the upside which I see from here is possibly Rs 680 where it discounts the FY16 by about 27-28 times. It really gets fully priced at those levels. So possibly for the next Rs 40-50 sort of move one could look at buying at this point in time but I won’t say it is a investment buy right now although I missed it out when it was in the region of about Rs 500-530. But then at these levels I will not buy fresh on investment.

Sonia: A lot of people actually did not anticipate so much good news for the company in the last couple of months, especially in the inhaler division etc.

Baliga: Because if you see the last three to four years there has been no good news from Cipla, a major underperformer all through and even in this rally where you had all the other pharma stocks moving this was the last to move.

Sonia: You did mention that the growth is looking very strong but it is only the valuation hurdle that prevents you from advising a fresh buy on Cipla, but given the fact that it has the launch of the combination inhalers space has instilled a lot of confidence in the company’s growth potential from hereon do you think that the valuations could get rerated further. It has already rerated from 18 to about 22 times, now some EPS estimates stand at 25 for FY16 that would mean it is trading at 25 times forward. Do you think that it could deserve more purely because of the new verticals that are opening up?

Joshi: As I was saying the addressable market is pretty huge. It is a USD 3 billion market if you assume the European and the US markets and combine that together. So there is a huge amount of potential for Cipla to actually deliver and perform and they have already demonstrated that in a few key EU regions that we have just seen. However if you look at the other performance the South African operations are going to play a little bit of truant onto their margins because they are not only taking out the entire marketing expenses but the front end is totally going to be managed by Cipla.

So the dip in margins are possibly going to happen from the South African business and the results will be something to be keenly watched out for. So the results for Q2-Q3 if they throw up a sustained improvement in margins you might warrant the case for rerating but at least at the current juncture our take is that valuations are rich for the company. So we would still wait before we rerate the counter at this current juncture.

Sonia: At what point do you think Cipla will be good to go for the longer term. As in how many quarters of sustained performance would you want to see?

Baliga: At least two to three quarters if not more. But then again in case we see a poor performance in the next one or two quarters and in case see a correction, say, to levels of about Rs 555-560 at those levels it would become a buy.

Sonia: To give it the benefit of doubt Cipla is also one of the few pharma companies who is not embroiled in this whole US FDA issue. It hasn’t had too many inspections etc. So in that context do you think it is the cleanest shirt in the laundry?

Baliga: Comparatively cleaner company in the sector, but at the same time like I said in the last two or four years there was nothing too positive happening in the company to make it a buy at those levels except for whatever we heard in the last couple of weeks. So we need to really look at their performance going ahead and ensure that it is consistent before it actually becomes a buy even at higher levels.