Thursday, 12 April 2012

Piramal Healthcare- Gazing Through Crystal ball- Part 2

In the Part-1 of this post, we reviewed three different businesses of PHL namely CRAMS, critical care and research division. As described in the earlier post, I have tried to be as conservative as possible while trying not to be projecting doomsday scenario at the same time. So let's do a small recap of revenue and investment projection for three businesses discussed in Part-1

Custom Research & Manufacturing: Assuming PHL is able to grow business at least as well as industry (historical data suggests that they have out performed industry), in 2016-17, one can expect revenue of INR 3500 crore with investment of roughly 1300 crores. 

Critical Care: One of the leading players having entire range of product portfolio and sales and distribution network, PHL shall be able to clock revenue of around  1500 crores with estimated investment of 1000 crores. 

Research Division: A business which is exposed to positive black swan. However, while counting for revenue, I have tried to derive expected value  based on actual receivable benefits in immediate future only (e.g. only upfront payment for out-licensing deal is considered, rest of the elements are not considered). Based on this, I arrive at revenue estimation of around 2100 crores with investment of 800 crores. 

So now moving on let's analyze rest of the three business namely OTC, NBFC and real estate private equity. 

OTC Business: PHL's OTC business comprises of 7 brands such as i-pill (emergency contraceptive pill), Lacto Calamine (skin care), Saridon (headache), Superactiv complete (nutrition supplement), itchmosol ( itching), Triactiv (nutrition suppliment) and Polycrol (acidity). Some of these products such as lacto calamine, Saridon and i-pill are household names. OTC business in India is expected to grow at 16-18% in next few years and will reach size of around USD 10 billion  from current size of roughly USD 2 billion. 


OTC business is driven by two things, building brands and distribution network. Both these activities will require substantial investment. Once the brands are well established and availability of the product is ensured, sales will be driven by "pull" rather than "push". In my opinion, PHL's portfolio of  brands can be categorized as follows 

Strong brands: LC, i-pill, Saridon and Superactiv 

Moderately strong brand : Polycrol 

Weak brand: Itchmosol and Triactiv  

So if we consider that PHL has 4 strong and 1 moderately strong brand out of 7 brands and financial capacity to make large investment in brand building and distribution network, it can grow at probably 25% CAGR in terms of revenue (OTC business is likely to grow at 16-18%). This will mean annual revenue of around 700 crores (taking 225 crores as base in FY 12). PHL has indicated investment of around 2500 crores in OTC considering inorganic growth. Even though, I have not considered inorganic growth in CAGR projections, to be on the conservative side, I will keep investment number at 2500 crore. 

NBFC Business: PHL has entered into NBFC business and started lending money. According to PHL, they would like to attain asset under management of around 6000 crores in next 5 years. As we do not have any benchmark in terms of past performance in this business for PHL, i would like to take management's guidance on its face value. Moreover, the target set by the management seems to be achievable compared to market potential of NBFC and niche area that they want to target such as real estate, education and hospitals. All these sector are currently not served by existing NBFC players (to the best of my knowledge)

In order to derive at revenue generation for NBFC, I have tried to look at other NBFCs such as IDFC and Shriram Transport to understand the ratio of revenue to AUM. In case of IDFC, 5 year average revenue/AUM is around 25% while that of STFC is around 14.5%. I will take lesser of the two and assume 15% revenue/AUM ratio which will mean revenue stream of around 1000 crores   from NBFC operations. Management has guided that investment required will be around 1000 crores. I will stick with management's number. 

Real Estate PE business:  Let me be candid here and admit that I do not know how to value (or predict revenue) for real estate PE firm. I believe that typical valuation of a PE firm is around 4-5% of Fund Value, however I do not know either the methodology or has grasp of the business to give any insight. Management has guided that they will invest roughly 1000 crores and manage funds of around 13,000 crores. So how should I value this business? After pondering over this, I decided to not put any revenue number and assume that by not valuing this business I am providing for "margin for error" in my estimates for other businesses. What I will do is, I will not count revenue from this business while will consider investment of 1000 crores in this business in the investment section. 

So at the end of the whole exercise, my conservative scenario, following are revenue and investment numbers. 

Revenue (in Crore): 3500 (CRAM) + 1500 (critical care) + 2100 crore(research) 
                            + 700 (OTC) + 1000 (NBFC) = 8800 Crores

Investment (in crore): 1300 (CRAMS) + 1000 (critical care) + 800 (research) + 
                               + 2500 (OTC) + 1000 (NBFC) + 1000 (real estate PE)
                              = 7,600 crores

PAT Estimates: 10 year average PAT for PHL's pharma business was 10.4%. However, in next 5 years, PHL is going to have tax shield of loss making research division which is going to bring down PHL's tax rate to 7-8%, less than average tax rate for last 10 years. Reduced tax burden shall translate into higher profit margin however, I am not accounting for that as I believe lower margin in initial years in OTC business may counter the upside.

For NBFC business, 5 year average net profit margin for STFC and IDFC is 18.7% and 25%  respectively. 

So I am assuming combined PAT as 10% of revenue (which in my opinion is fairly conservative). this will bring PAT to roughly 900 crores. 

Number of shares outstanding: 

After buyback, as on date, number of shares outstanding are 16.72 crores. 

PHL has total cash equivalent of 

Vodafone investment = 6600 crores (10% return on investment post tax which is much lower than management guidance)

Abbott Deal receivables: NPV of receivables is around 5000 crores 

Hence total cash available for deployment is roughly 11600 crores. Out of this, investment requirement will be around 7600 crores. 

This will leave 4000 crores of cash surplus plus free cash flows generated from 2012-2016. PHL may decide to partially retire debt out of this proceed. PHL management has clearly indicated their preference for buy back over dividend payout due to tax advantage. Hence, I see very high chances of second round of buy back by PHL. In my opinion PHL will buy back when the price of the stock is subdued. Hence let me assume PHL offers to buy back shares at Rs. 600 and allocates roughly 2000 crores for the same. This will mean extinguishing 3.33 crores shares. After second buy back, total shares outstanding around 13.39 crores. 

Thus, estimated EPS for PHL in 2017 will be PAT/outstanding shares = 900 crores/13.39 crores  = 67.2 

Valuation: Let me confess! This is the toughest part for me. I do not know how market will look at PHL five years down the line and what valuation it will assign to the company. The inference that I derive from my above analysis is: 
PHL's revenue will likely to have grown at CAGR 34% in 5 years and PAT (barring one time profit) at much higher rate. I think, if PHL is able to come near to expected numbers, considering valuations of peers (most of them have traded at 20-25 P/E), PHL's historical P/E (around 20-25) and clean balance sheet, P/E multiple of 15 seems reasonable. In my opinion, if PHL trades at P/E of 15, it will mean market is still circumspect about PHL's management ability or future growth prospect. However, I will  go with P/E of 15. 

If I apply P/E of 15 to EPS of 67, it will will give value of share around 1008. Thus from current price of 455, it will be return of CAGR 17%. 

To me, 17% is a base case, conservative and quantifiable estimate for return. In addition to this, Investor is exposed to following upsides. 

  • PHL is able to successfully complete phase-3 trials for its lead molecule P-276 which will open up a new vista for the company. If they are successfully able to commercialize this molecule, as intended by management, PHL will be in a different league altogether. 
  • PHL's molecules for Merck and Eli Lily moves forward in trials and if any one of them gets commercialized,  value of royalty, milestone payments and marketing rights will be substantial.
  • PHL is able to move some of the current molecule till phase-2 end. They will represent significant out-licensing value. (P1446 (likely to move to phase-2 in 3-6 months) and P2745 (phase-1 likely to be completed by end 2012)) 
  • As per management's guidance (management has track record of meeting their targets by and large) PHL is able to grow inorganically and achieve much higher growth rate than estimated in my analysis. 
  • PHL's margins improve due to increased income for R&D which is a high margin business. 
  • Last but not the least, market values PHL at least in line with their peers. 
On the downside following risks


  • It is not able to run NBFC business properly and is not able to achieve profitability as projected.
  • I have assumed complete loss of capital for PHL (i.e. investment of 1000 crores) 
In all if I am getting a chance to partner is a business where the management is flush with money, has excellent track record, top management is transparent, ethical and competent, I am able to see at least 17% compounded return in 5 years and exposed to large positive black swans, I would grab it with both the hands.


Update: PHL has received approval for BST-cargel in EU countries. It has also applied for approval in Canada and will approach authority in India post EU approval.

Disclosure: I have position in PHL. Views expressed in this post shall not be construed as investment advice. Readers must do their own due diligence before taking investment decision

2 comments:

  1. Hi

    What is your view abt Piramal Life?

    Karun Sandha

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    Replies
    1. Hi Karun,

      Frankly speaking, I have not gone through the details of piramal life. However from the conference call transcripts of piramal healthcare, I get a sense that management is not focused on growing piramal life as aggressively as piramal health. Moreover, piramal life has sole focus on developing medicines from natural extracts only while chemical entities research will be done in piramal healthcare. I see limited upside (from business perspective and not stock price perspective) in piramal life.

      Best Regards
      Dhwanil Desai

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