'We will reduce interest costs'

SMART TALK

K Raghavendra Rao

From a bulk drugs player in the cephalosporin antibiotics, the country's 11th largest pharma company, Orchid Chemical and Pharmaceuticals is evolving into a formulations major eyeing the generic opportunity in regulated markets.

With the help of equity infusion from Schroders and International Finance Corporation and a GDR-cum-FCCB issue of $75 million a year ago, the company has been able to put in place infrastructure which will help it tackle product launches in the US market till 2010-11.

The man at the helm, K Raghavendra Rao talks to Ram Prasad Sahu about the products, markets and timing of launches and how he would like to tackle the high debt which has reduced its net margins to single digits.

The stock at Rs 198 currently trades at 14 times its trailing twelve months earnings and, considering the growth ahead, is attractively valued.

Why is there a focus on antibiotics vis-a-vis other therapeutic segments?

Antibiotics in terms of value, variety and consumption is as much in use in the US as it is in China. Be it hospital-related infections or microbial resistance to drugs, new versions are required which are responsible for higher antibiotic demand.

By the very nature of being able to manufacture this product for the world market, assets that are required to be created in this field to make these antibiotics, especially injectibles and the process/technology that is used in making them will act as an entry barrier. A dedicated facility, specialised skill sets, process knowledge and investment is not everybody's cup of tea.

How will growth pan out in cephalosporins?

Going forward, our plan for cephalosporins is to make them in dosage forms and sell them in regulated markets and be counted in the first wave of launches of those molecules when the products come off patents. Growth will come in three ways.

First, a full year impact of already launched molecules because every molecule is not launched on day one of the financial year. Second, a partial year impact of new products that are going to be launched as soon as the products go off-patent. Third, expansion beyond the Americas into EU, South Africa, New Zealand, Australia and Japan.

What about other therapeutic segments?

The first introduction will be in this calendar year in the form of a penicillin injectible products""tazobactam and piperacillin""which will go off patent in February 2007.

Between 2008-10, some of the carbapenems are going off patent and for these the manufacturing facilities is already in place.

In the non-antibiotics space, we have chosen cardiovascular, central nervous system, osteoporosis and diabetes. Within this we chose formulations that have a lower chance of getting cannibalised. Seven products in these segments offer a non-infringing Para IV FTF opportunity for us.

Price erosion is a concern. What are the pricing arrangements with US players?

In antibiotics, and especially injectibles, price competitiveness compared to other oral products (tablets, capsules) is pretty much in favour of the manufacturers. The price erosion is not more than 70-80 per cent of the innovator's price which leaves 20-30 per cent--a big number-- for the generic companies.

In some products (cefoxitin injectible where Orchid and APP are the only two generic players in the world), we are selling at 70 per cent of the innovator's price. Similar is the case with cefazolin, where BMS and Novartis are marginal players and our our market share is 85 per cent.

In distribution, we are working with generic companies to fill the gaps in their product offerings. They in turn approach large distributors who control the hospital chain and distribution networks. Of the revenues generated, about 60-65 per cent is for us and about 35-40 per cent is for them on an average.

These agreements could be based on value, number of units or market share. This is a model which is paying handsome dividends to the company and we would like to continue with it.

What about less regulated markets?

We are into Russia, Latin America and China and these three are our major focus areas. We have our offices in these countries and a factory in China. The reasons for choosing these countries is that the consumption is high and the manufacturing base is low.

For example, demand outstrips supply for antibiotics within China. Out of the three markets, South America offers the highest margins while China the lowest.

What part will acquisitions play in your growth strategy?

We want to grow from the present level of $240 million to $1 billion in the next five years.

If you divide the pie into three business segments, one third will come from the cephalosporins space, one third from other antibiotics such as penicillin injectibles and carbapenems, while the balance will come from the non-antibiotic segments we have entered into recently in areas such as CVS and CNS with products that are difficult to manufacture.

We will continue to follow the partnership model of distribution. For all the three, the back end which has been created will be sufficient to take us through to 2010-11 to cater to the demand from the supply angle.

In terms of marketing, however, we need to acquire a company, especially in Europe which can take care of registration, quality control and distribution needs. We want to replicate this in Japan and other markets where a joint venture and a local presence is required. For the 41 molecules we have now, the arrangements are in place.

For newer molecules, we would need this distribution network.

What are you going to do about your net margins which are at 7 per cent?

The only way to tackle this is to reduce the interest charges. We can pay the debt raised from the cash flow being generated in the coming quarters and years and in an EPS accretive manner raise money to repay debt.

The saving in interest cost will be more than offset by the increase in share capital. We have approval to raise $200 million and we are waiting for the right time to issue the zero coupon convertible bonds.

By March 2008, we should be able to get to a better position on the net profit margin (NPM) front. At the net level anything between 15 to 20 per cent will be considered healthy.

As far as the OPM is concerned (the company did 27 per cent for the September quarter), the margin is a weighted average of two components. In less regulated markets, the operating margins are between 20-22 per cent (NPM of 5 per cent) constituting 50 per cent of our revenues.

In regulated markets, which accounts for 40 per cent of revenues, the OPM is between 35 to 40 per cent (NPM 15 per cent) depending on products and markets.

With more growth expected from the regulated markets the margins will inch up closer to 30 per cent. Every six months it will be possible to improve the OPM by a percentage point because our business from regulated markets is growing every year. By 2010, 80 per cent of our business will come from regulated markets.

Any new molecules in the pipeline?

There are two molecules in the diabetes, inflammatory and oncology segments---one of them is in pre-clinical stage and the other is in phase two, and we expect one of these in the next year to result into something meaningful. Then we will be known as an innovator company.