Neutral on Unichem Laboratories - Reliance Securities

Results in line, continued pressure on domestic formulations

Key highlights of the result

- Exports help build 12.7% top-line growth: Unichem reported a 12.7% growth to Rs219.8cr during 3QFY2012, (vs. our estimate of Rs221.6cr) led by an astounding 84.1% yoy growth in export formulations (albeit on a low base), aided by order commencement from Ghaziabad facility as well as due to rupee depreciation. However, the domestic market continued to drag due to the ongoing shift in its distribution channel (down by 6.1% yoy).

- Operating margin remains stable sequentially: The Company recorded a 14bp increase in the operating margins sequentially marking stability in the business at 15.5%. However, the margins contracted by 370bp and declined from 19.2% to 15.5% on a yoy basis on the back of lower domestic sales and inflationary pressures. Adjusted PAT declined 9% yoy to Rs23.2cr, (against our estimate of Rs22.2cr) impacted by higher operating expenses. The Company reported a forex gain of Rs1.2cr during the quarter.

- Management Commentary: (a) Domestic formulations are expected to resume normalcy by 2HFY2013 (b) Order commencement from Ghaziabad facility in Nov, 2011 boosted CRAMS growth (c) Company has filed 2 ANDA in US in 3QFY2012, taking the cumulative filings to 23 ANDA with 11 approvals (d) Niche Generics continued to report losses at the bottom-line and the breakeven is still some time away.

Outlook and Valuation

The 3QFY2012 results are in line with our estimates, boosted by the new CRAMS orders on the export formulations front. However, the domestic business continued to be under pressure. We remain positive about the initiatives that Unichem has introduced in the domestic business, which is the core revenue and profit centre of the company. While, the core strengths of the business remain intact, the challenges pose a threat in the near term. Inventory rationalization and increasing cost pressure (increased promotion spend and commissioning of new plants) may continue to impact margins and profitability in the near term.

A strong domestic franchise along with strong balance sheet makes Unichem an attractive prospect for tie-ups and/or buyout by MNCs to gain access to Indian markets as well as capitalize on efficient manufacturing for sourcing key product globally. Despite the management's denial of any such deal, we believe that newsflow of such nature could support the stock price.

We expect an improved performance from the company from 2HFY2013 onwards as the domestic business will start recovering. The full impact of CRAMS would also be visible from next year once the manufacturing facilities start operations at the optimal level. Hence, though we believe that the near term hurdles have been priced in, we would re-visit our stance later and maintain our Neutral rating on the stock. At the CMP of Rs143 the stock is trading at 11.7x FY2013E EPS.

Risks to the view

- Slippage in the domestic growth, besides restricting expansion in valuations could aggravate margin pressure

- Slowdown in the ramp up of new distribution model could also pose its own set of challenges.

Source : Equity Bulls

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