Orchid Chemicals & Pharmaceuticals Cluster: Emerging Star Recommendation: Buy Price target: Rs300 Current market price: Rs251
Price target revised to Rs300
Result highlights
Orchid Chemicals' (Orchid) Q4FY2008 and FY2008 results are a mixed bag: While the revenue growth was above our estimate, strong margin pressure along with higher than anticipated interest burden and foreign exchange (forex) translation losses dragged down the profitability of the company during Q4FY2008.
The US generic market continued to power Orchid's growth, with revenues growing by 55.9% to Rs379.2 crore in Q4FY2008 and by 35.7% to Rs1,238.9 crore in FY2008. The growth was driven by the consolidation of the market share in niche product opportunities like Cefepime injections, Cefdinir tablets, and Cefoxitin and Cefazolin injections.
Orchid's operating profit margin (OPM) shrank by 730 basis points to 20.3% in Q4FY2008 and by 290 basis points to 27.8% in FY2008. The margin shrank largely due to one-time product development expenses incurred by the company and a huge inventory build up due to the impending launch of Tazobactum-Piperacillin (Tazo-Pip) in the USA. The declining margin restricted the operating profit growth to 14.6% at Rs77.1 crore in Q4FY2008 and to 23.2% at Rs344.8 crore in FY2008. Going forward, we expect the material cost to moderate as the inventory position corrects itself once the product is launched in the market.
Orchid's reported net profit fell by 34.7% to Rs15.8 crore in Q4FY2008, due to the poor operating performance and a Rs7.8-crore (pre-tax) translation loss. For FY2008, the reported net profit grew by an appreciable 91% to Rs184.5 crore. On excluding the net impact of the forex translation, the adjusted net profit of the company grew by 79.4% to Rs27.6 crore in Q4FY2008 and by 65.3% to Rs143.3 crore in FY2008. The adjusted profits reported by the company during Q4FY2008 and FY2008 are below our expectations.
Despite repeated assurances from the management, Orchid's debt level remains high at $220 million (excluding the foreign currency convertible bonds [FCCBs]) as reflected in the increase in the interest cost in Q4FY2008. Further, the capital expenditure (capex) cycle does not seem to be over yet, with the company planning capex of ~Rs150 crore in FY2009 and of Rs150-175 crore in FY2010. We expect the company's debt level to remain high over the next one to two years.
Orchid has strong growth drivers over the next two years. We expect the competitive scenario in the Cephalosporin segment to intensify whereas the launch of Tazo-Pip and other non-antibiotic products will fuel growth in FY2009. The opening up of the Carbapenem generic market from FY2010 onwards will maintain the growth.
In order to factor in the higher revenue base of FY2008, the delayed launch of Tazo-Pip both in the USA and Europe, the pressure on the margins due to the rising crude oil prices (which would increase the company's power & fuel costs) and the higher than anticipated debt and capex, we are revising our FY2009 estimates for Orchid. We are upgrading our FY2009 revenue estimate by 2.4% to Rs1,492.7 crore to reflect the higher revenue base in FY2008 but we are downgrading our profit estimate by 30%, accounting for the lower OPM and higher interest burden in FY2009. We now expect Orchid to deliver a pre-exceptional profit of Rs157.7 crore, which would translate into fully diluted earnings of Rs16.3 per share in FY2009.
We are also introducing our FY2010 numbers in this report. We expect Orchid's revenues to grow by 17.6% in FY2010 to Rs1,756.0 crore, on the back of a full-year impact of the Tazo-Pip launch as well as the incremental contributions from the Carbapenem opportunity. We expect profits of Rs207.6 crore in FY2010 which should yield fully diluted earnings of Rs21.5 per share.
The management has stated its intention of reducing its debt level further in the coming years, though we are yet to see the effect of the same on the company's financials. Despite the strong growth drivers and a robust business model, we believe the above-mentioned concerns will remain as an overhang on the stock, until the company's financials clearly reflect the management's intentions of reducing the debt further. In view of these concerns, we are reducing our target price/earnings multiple for Orchid to 14x and rolling over our valuations to FY2010E earnings. We maintain our Buy recommendation on the stock with a revised price target of Rs300.
MUTUAL GAINS
Sharekhan's top equity fund picks
We have identified the best equity-oriented schemes available in the market today based on the following 3 parameters: the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).
The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.
FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager's ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager.
