| Summary of Contents STOCK UPDATE Sun Pharmaceutical Industries
Cluster: Ugly Duckling
Recommendation: Hold
Price target: Rs1,526
Current market price: Rs1,508
Vote against Taro could be a catalyst -
Taro Pharmaceuticals (Taro) held its annual general meeting (AGM) on December 31, 2009 to re-elect its existing board of directors and approve the indemnification proposals. However, Taro?s shareholders have rebuffed the company?s appeal and the majority (over 78%) of the shareholders has voted against the re-election of the existing directors and their nominees as well as the board?s indemnification proposals. Although the minority shareholders? decision has added credibility to Sun Pharmaceuticals (Sun)?s stand and brought the company an inch closer to the deal, yet financially the event has had no impact on the company. -
By the acquisition Sun intends to build on Taro's expertise in dermatology, paediatrics and over-the-counter products. Also, it plans to exploit the distribution strength of Taro in the USA, Canada, the UK and Israel. As per Taro?s 9MCY2009 results (un-audited) Taro seems to be in a comfortable position with $81 million of net cash balance and net debt/equity ratio below 1x. Further, given that Sun will be funding the acquisition by using idle cash on its balance sheet, we expect the deal to be investment accretive. -
Though we maintain our positive outlook on the company, we also feel that the stock would remain under pressure until the company obtains a clean chit from the US Food and Drug Administration (USFDA) which is unlikely in the near to medium term. The progress on Taro acquisition, a clean chit from the USFDA front and incremental acquisition opportunities would act as near-term triggers for the stock. At the current market price of Rs1,508, Sun is valued at 22.8x FY2010E and 21.8x its FY2011E fully diluted earnings. Given the near-term challenges, we maintain our Hold recommendation on the stock with a price target of Rs1,526 (22x its FY2011 earnings).
SECTOR UPDATE Automobiles On top gears
Automobile sales for the month of December 2009 backed by a continual strong demand environment and a low base of last year came in above expectation. Traditionally, automobile sales slow down in December, as new purchases are postponed till the start of the new year. Though the sales declined this December too when compared to November 2009 sales, the fall was not as sharp as seen in the previous years. We feel, the strong momentum in volume growth during the month was primarily on the back of buoyant consumer sentiment, lower interest rates and better liquidity, aptly aided by strong demand environment and success of new launches. And the same will also be reflected in the outstanding Q3FY2010 results of the automobile makers. On the low base of the last year, passenger car leader Maruti Suzuki India saw its December 2009 sales up by stellar 50.6% year on year (yoy). In the two-wheeler segment, Hero Honda Motor?s sales were up by strong 74% yoy and Bajaj Auto?s volumes were up by sterling 77.3% yoy.
SHAREKHAN SPECIAL Q3FY2010 Banking earnings preview Key points -
Languishing credit growth rules the quarter: The weakening trend in credit demand seen since Q4FY2009 continued in Q3FY2010 as well. As per the latest data by the Reserve Bank of India (RBI), the credit growth as on December 18, 2009 stood at 10.9% as against ~13% in Q2FY2010 and ~23% in the third quarter a year ago. While for most part of the quarter the credit growth languished in the range of 9-12%, the recent pick in December was largely due to an uptick in demand from the retail and infrastructure segment. While banks have moderated the deposit growth, the year-on-year (y-o-y) growth continues to be strong at ~18%, leading to an incremental credit-deposit (CD) ratio of a mere 43.2% as compared to ~78% a year ago. However, as mentioned earlier, we expect the credit demand to improve in Q4FY2010 due to improving macro economic fundamentals and a large amount of undrawn sanctions for which the disbursements are likely to take place in the coming quarters. Considering this environment, we believe that the net interest income (NII) growth for most of the public sector banks (PSBs) shall be muted due to the high base of Q3FY2009. On the other hand, a much healthier growth is expected for the private sector banks such as HDFC Bank and Axis Bank. -
NIM to improve sequentially: The net interest margin (NIM) of most of the banks under our coverage is likely to show a healthy improvement sequentially due to the anticipation of the fuller benefit of deposit repricing at lower rates in the previous and current quarters. However, the weaker deployment pace would keep the margin improvement contained. -
Treasury gains to come off sequentially: While banks had gained immensely in Q3FY2009 due to volatile yield movements and investment provision write-back, we are unlikely to again see the levels last seen in Q3FY2010. With the yields moving in the northward direction by ~40 basis points in this quarter due to speculations over the reversal of the interest rate cycle, most banks are likely to take a hit on their investment portfolio due to the marked-to-market (MTM) provisioning, thereby adversely affecting their bottom line. More importantly, we expect some of the banks to face MTM provisions on their bond books during the quarter. -
Asset quality contained: With a large part of the troubled assets restructured during the last two quarters, we do not expect any material deterioration in the asset quality of banks until Q4FY2010. In terms of restructuring, the increment for PSBs is likely to be minimal, if at all, while the private banks may continue to restructure some of the assets as guided by them. In line, the provisions during the quarter are likely to be stable sequentially on an absolute basis. Having said that, we do not rule out negative surprises on this front. -
Bottom line growth to moderate qoq: At the bottomline level, the stellar growth seen in the last two quarters is expected to come down during Q3FY2010 owing to a slowing credit offtake, relatively lesser treasury gains and potential MTM hits. -
For the quarter ended December 31, 2009, we expect Andhra Bank and IDBI to report relatively better numbers among public sector banks while HDFC Bank and Axis Bank are likely to report healthy bottom line growth among the private players under our coverage. Q3FY2010 Pharma earnings preview Key points -
Pharmaceutical companies under Sharekhan?s coverage are expected to report a cumulative 15.4% increase in their revenues for Q3FY2010. The revenues for the quarter will be primarily driven by strong domestic formulations (17.5% yoy) and steady growth in the export markets (11.4% yoy), as the inventory rationalisations have been completed in the domestic markets and signs of revival have been witnessed in the export markets. -
The rupee has appreciated by 2.9% against the dollar in Q3FY2010 (compared to flattish growth in Q2FY2010 and 5.6% appreciation in Q1FY2010). This is likely to impact the export revenues of major pharmaceutical companies, as they derive over 50% of their revenues from exports. With rupee appreciating, pharmaceutical companies such as Ipca Laboratories, Cadila Healthcare (Cadila) and Lupin will record marked to market (MTM) translational foreign exchange (forex) gains on outstanding foreign currency loans and hedges. Operationally, exporters will be adversely impacted by recording lower top line growth, but significant forward covers/options and forex loans will result in gains for some companies at the profit after tax (PAT) level. -
The operating profit margin (OPM) of the pharmaceutical companies under our coverage continue to moderate year on year (yoy), however, interestingly, the same are expected to improve over the quarter, revealing signs of easing cost and macro pressures (minimal impact of rupee appreciation on the margins). The OPM is expected to shrink by 239 basis points (23.4%) on a combined basis, as Sun Pharmaceutical Industries (Sun Pharma) and Glenmark Pharmaceuticals (Glenmark; due to absence of exclusivities/high base effect) see their margins contract in the quarter. Opto Circuits, Cadila and Lupin will see their margins expand on the back of increasing key approvals, easing raw material prices and lower other expenditure (due to various cost effective measures taken). Adoption of AS-11 would limit the impact of forex loss/gains on the Profit & Loss numbers of Piramal Healthcare (Piramal). -
With strong revenue growth and moderating operating performance, the reported net profit of pharmaceutical companies under our coverage is expected to grow by 14.8% yoy in the quarter. Companies like Glenmark and Opto Circuits, which reduced their debt significantly during the quarter, are expected to post lower interest expenses, aiding their bottom line. Easing of liquidity, improving business sentiments and re-stocking of inventories in trade channels in the emerging markets would lead to higher profits in most of the companies under our coverage. On the other hand, business erosion (due to waning of exclusivities and Caraco revenue loss) would limit the net profit growth of Sun Pharma. On excluding the forex impact, we believe the adjusted net profit of the companies under our coverage to show a flattish growth in the quarter (due to high forex losses in Q3FY2009). -
Despite the recent outperformance by pharmaceutical sector, we believe, there is still scope for substantial upside in pharmaceutical stocks (mid-cap pharmaceutical space in particular). With the US healthcare reform bill (currently being debated in the senate) and opening up of Japanese healthcare market, we believe that Indian generic companies are likely to exhibit a gradual improvement in their performance over the next two years. In terms of Q3FY2010 results we expect Cadila, Lupin, and Opto Circuits to deliver strong growth compared to their peers.
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