VIEWPOINT - Ranbaxy Laboratories - Sharekhan

Consent decree comes at huge cost for Ranbaxy; we prefer Sun Pharma

Consent decree will open the door for resumption of exports to USA: Ranbaxy Laboratories (Ranbaxy) has signed a consent decree with the US Food and Drug Administration (USFDA) under which it has committed to further strengthen procedures and policies to ensure data integrity and to comply with current good manufacturing practices. The consent decree which is subject to approval by the United States District Court for the District of Maryland, seems to be a part of the comprehensive resolution for Ranbaxy which will open the door for exports to USA. If the decree is approved by court, it may lead to USFDA allowing the resumption of supplies from two of its India based plants, which were banned by the USFDA in 2008. Ranbaxy's management has indicated that details of consent decree, relating to time-line of implementations and other details would be set and disclosed in the next few weeks (after an approval of the court).

Huge provisioning to impact short term finances: Ranbaxy also announced its intentions to make a provision of $500 million in connection with the investigation by the US Department of Justice (DOJ), which the company believes will be sufficient to resolve all potential civil and criminal liability. Such provisioning may be considered as preparation to pay heavy penalty either one-time or deferred over a period of time, which may be charged as per court's order. The company's management indicated that it has enough resources to meet the obligation. In a related incident, Ranbaxy's parent company Daiichi Sankyo has subjected its employees to pay cuts and reduced the profit target for CY2012.

Unfavorable cost-benefit balances: We believe a $500 million provision will appear in Ranbaxy's balance sheet of CY2011 while the profit and loss account would be debited to the extent of actual penalty/fees paid in a particular period of time (expect over CY2012-2013). Although, the actual cost-benefit analysis in absolute terms would be difficult in absence of information relating to actual cash outflows in connection with comprehensive resolution, finances of the company would definitely be strained in the short to medium term.

On the other hand, going by product pipeline so far declared by Ranbaxy, we don't find any big products pending launch or approvals (the company's two settlement launches-Actos and Nexium are expected to face huge generic competition), which might cover the amount of provisioning to its full extent.

We prefer Sun Pharma over Ranbaxy: The resolution will be helpful for Ranbaxy to ramp up exports to USA. The Mohali plants which got approval of USFDA recently, would also help to generate incremental revenue stream for the company. However, it will take at least three-four years to see full benefits of additional revenues from USA.

In contrast, we find Sun Pharmaceutical Industries (Sun Pharma) well placed in the global generic markets. It has a strong products pipeline pending approvals (including few difficult to make products having less competition), among front line Indian pharmaceutical companies. Moreover, Sun Pharma is a debt free company, which also insulates it from high-cost-debts regime and currency volatility. Ranbaxy, which currently has over $900 million of gross debt, will be relatively in a disadvantageous position amidst an unfavorable macro environment.

We have a Buy rating on Sun Pharma with a target price of Rs575 (23x FY2013E earning per share [EPS]).

Source : Equity Bulls

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