Torrent's Unichem deal to add to its earnings after 3 years

For Unichem investors, larger gains will accrue if international business grows fast

Torrent Pharmaceuticals’ deal to acquire Unichem’s domestic and Nepal-based branded formulation business — 120 brands with revenues of Rs 842 crore — for Rs 3,600 crore, is a step in the right direction, but immediate gains on the earnings front are unlikely.

While factors such as slow growth of Unichem’s portfolio, investments and time required to prop up its growth, increase in leverage (to fund acquisition) and two-three years’ time frame for the deal to turn earnings-accretive may be disheartening, there are reasons to be positive.

The acquisition is Torrent’s fifth in India in the past four years, and it has a good track record of growing acquired portfolios — Elder Pharmaceuticals and Novartis India bear testimony. Elder’s brands, acquired in 2014, have grown annually by 23 per cent since then, driving Torrent’s overall growth. Unichem’s portfolio, which includes cardiology, central nervous system, gastrointestinal, anti-bacterial and over-the-counter drugs, will immediately boost Torrent’s India ranking to five and market share from 2.4 per cent to 3.4 per cent.

The timing of the acquisition is also important. Torrent’s India business (over 40 per cent of sales) grew by 22 per cent (Rs 607 crore) in the September quarter (Q2). But, its US business is still in the investment phase. In fact, its US and Brazil sales fell 20 per cent and 23 per cent year-on-year in Q2. Ranjit Kapadia at Centrum Broking said the Indian pharma market is growing in double digits compared to challenges on pricing in the US and hence the deal is positive. Interestingly, only 10-12 per cent of Torrent’s existing India business falls under price controls imposed by the drug regulator.

But, since Unichem’s portfolio has been growing at a slower pace (flat in the first half of FY18), further investments by Torrent will be required, and analysts said growth may not be fast. In this backdrop, the deal valuation at about 4.3x FY17 sales looks slightly stretched, Amay Chalke of HDFC Securities said.

However, the acquired portfolio, including the more profitable Unienzyme brand, enjoys operating profit margin of about 25 per cent (operating profit of Rs 210-220 crore), analysts estimated. With Torrent planning to fund 70-75 per cent of the acquisition cost through debt, its debt-equity ratio will rise from 0.58x in FY17, even as operating profit may prove enough to service interest costs. The acquisition will be cash-accretive by the first year Torrent said, and will add to its earnings by the third year. For Unichem, the deal looks more favourable, as it is selling its slow-growing businesses. Unichem plans to reward its shareholders, after providing for capital gains tax. Some of the residual sale proceeds will be required to grow its international business, and contract research and manufacturing, as Unichem increases investments on developing new chemical entities, biosimilars and complex generics. All this will be crucial in deciding the upside for its stock price.