Sun Pharma: Potent stuff

The acquisition of Israel-based generics player Taro is priced at $454 million, or about 1.5 times its CY05 revenues

The Sun Pharma stock gained 5 per cent on Monday, aided by a strong financial performance and the announcement of the Taro Pharmaceutical acquisition. The acquisition of Israel-based generics player Taro is priced at $454 million, or about 1.5 times its CY05 revenues.

Analysts estimate Taro's CY06 revenues slightly lower, but even at 1.6 times revenues, they say that this deal would be among the cheapest acquisitions globally in the past few years, and pretty much in line with Sun's strategy of buying distressed assets. Ranbaxy's betapharm buy came at 2.92 times revenues and Matrix's Docpharma purchase was at 2.3 times sales.

Taro's performance has deteriorated over the past few years and the stock price has declined from about $30 two years ago to $6.1. Taro's reporting of its financials for 2005 was delayed to March 2007 and it had to restate previous year's figures too due to inventory errors.

Its selling, general and administrative expenses were 36 per cent of revenues in CY05, because of its foray in OTC formulations in the US, which do not seem to have yielded results. Taro is expected to have made substantial losses in CY06.

But there are many positives. Taro has a strong presence in the stringent US dermatology market, which will help Sun Pharma.

Besides, Taro also has presence in cardiovascular, neuropsychiatric and anti-inflammatory segments. Eighty-five per cent of Taro's CY05 sales came from the US. Taro has 170 scientists, which will help Sun apply for more products.

Thus, the Taro acquisition should be good for Sun's shareholders. In March 2007, Sun had hived off its R&D business into a separate company. In its quarterly results for Q4 FY07, Sun Pharma reported a 34 per cent y-o-y revenue growth and 70 per cent operating profit growth.

Operating margin improved by 610 basis points to 28.4 per cent, as raw material costs as a percentage of sales declined 470 basis points. Without factoring the Taro acquisition, Sun Pharma trades at 23 times estimated FY08 earnings, and should be an outperformer.

SAIL: Awesome

Sail reported an improved performance in the March 2007 quarter helped by its focus on higher value products and improved product prices on a y-o-y basis. In addition, the company benefited from lower input costs.

As a result, the company's operating profit grew a whopping 102.6 per cent y-o-y to Rs 3,023.6 crore in Q4 FY07, while its net sales grew 15.65 per cent to Rs 10,385 crore.

Its operating profit margin also improved an impressive 1,250 basis points y-o-y to 29.11 per cent in the last quarter. The stock surged 4.3 per cent to Rs 145 on Monday. Other players like Tata Steel's operating margin also improved 640 basis points y-o-y to 38.2 per cent in the last quarter.

Sail sold 3.5 million tonne of steel in Q4 FY07 as compared to 3.97 million tonnes a year earlier. However, the company boosted sales of higher value products like rails and TMT bars in the last quarter.

Realisations were estimated at Rs 29,671 per tonne in the March 2007 quarter as compared to Rs 22,618 per tonne a year earlier. In addition, Sail benefited from its adjusted raw material costs as a percentage of net sales that declined 1,450 basis points y-o-y to 35.3 per cent in the last quarter.

Going forward, the company's growth is expected to be powered by strong demand condition for steel products. The stock trades at a reasonable 8 times estimated FY08 earnings.

Tata Motors: Muted

Despite a 20 per cent y-o-y increase in standalone revenues to Rs 8,267 crore, Tata Motors' operating margins for the March quarter dropped 130 basis points to 11.7 per cent.

That indicates the lack of operating leverage and the continuing pressure from higher input costs which were up 230 basis points y-o-y to 70.8 per cent.

Had it not been for a one-time gain on investments and currency, Tata Motors' earnings growth too would have been far more muted than has been reported. Not surprisingly, the stock fell over 2 per cent in Monday's trading.

Looking ahead, volume growth, which has been reasonably good at 16 per cent y-o-y in Q4 could taper off to around 10-12 per cent in the next couple of years, given the deteriorating economics of freight operators. Also, the ban on overloading of vehicles has not been as strictly implemented in some regions as was expected.

However, if the company is able to sell a better product mix as it did in the March quarter, the sales momentum should not drop significantly. Tata Motors has Rs 12,000 crore of capital expenditure lined up over the next four years""Rs 4,000 crore for maintenance and capacity expansion and Rs 8,000 crore for new products.

That will mean higher interest outflows even though three-fourths of this will be funded through internal accruals. That together with lower volume growth will put pressure on earnings.

At the current price of Rs 724, the stock trades at 14 times FY08 estimated earnings and while not expensive, is not justified given the subdued earnings growth expected in the next few years.

With contributions from Amriteshwar Mathur and Shobhana Subramanian