Torrent's Unichem Deal to Add to Earnings only After 2-3 Years

For Unichem investors, immediate rewards may come in the form of dividend or buyback, but larger gains will accrue if international business grows fast

Torrent Pharmaceuticals’ deal to acquire Unichem’s domestic and Nepal-based branded formulation businesses is a step in the right direction, but immediate gains on the earnings front are unlikely.

Torrent is acquiring over 120 brands — which contributed to Unichem’s India and Nepal revenues of Rs 842 core in FY17 — for Rs 3,600 crore, a deal it expects to complete by end of 2017. 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 timeframe 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 last four years, and the company has a good track-record of growing acquired portfolios. 

In the past, Torrent has acquired select brands of Elder Pharmaceuticals and Novartis India as well as manufacturing facilities from Zygpharma and Glochem. The Elder brands acquired in 2014, for instance, have clocked a compounded annual growth rate (CAGR) of 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 (OTC) drugs, will immediately boost Torrent’s India pharma ranking to number five as market share (in terms of sales) will increase from 2.4 per cent to 3.4 per cent (see table for category-wise market share gains). 

Besides, Torrent will also get Unichem’s Sikkim plant along with 3,000 field-force and 2,100 stockists. Though some rationalisation of manpower is not ruled out, their combined network can be used to drive sales of Torrent’s overall portfolio.

The timing of acquisition is also important. Torrent’s India business accounts for over 40 per cent of its sales and grew by 22 per cent (to Rs 607 crore) in the quarter ended September 2017. 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 to Rs 255 crore and Rs 120 crore respectively in September quarter. Ranjit Kapadia at Centrum Broking says that Indian pharma market is still growing in double-digits compared to challenges on pricing in the US and hence the Unichem deal is positive. Interestingly, only 10-12 per cent of Torrent’s existing India business falls under price controls imposed by drug regulator.

However, Unichem’s portfolio has been growing at a slower pace. Further investments and efforts by Torrent will be required, and analysts believe that growth may not be as fast as has been the case with business acquired from Elder. Growth of products acquired from Elder, however, was also helped by price hikes.

Amay Chalke of HDFC Securities feels the valuation of acquired business (from Unichem) at about 4.3x FY17 sales looks slightly stretched as he is not confident of it growing at a 15 per cent per annum rate initially. It was flat in first half FY18 as compared to 11 per cent growth in FY17.

The acquired portfolio, excluding the more profitable Unienzyme brand, however, enjoys operating profit margin of about 22 per cent, estimate analysts. 

Including Unienzyme, the margin would be about 25 per cent (operating profit of Rs 210-220 crore on Rs 840 crore of sales). With Torrent planning to fund 70-75 per cent of the acquisition cost of Rs 3,600 crore through debt, it will lead to a rise in its debt-equity ratio from 0.58 times in FY17 unless it raises some fresh equity. But, the acquisition will be cash accretive by first year says Torrent, and will add to its earnings by third year. Clearly, there are challenges as well as opportunities for Torrent.

For Unichem, the deal looks more favourable as it is selling its slow-growing businesses. Being a slump sale, Unichem has indicated that it will be rewarding investors (possibly through special dividend), but the entire proceeds are unlikely to be distributed. 

Unichem will need to pay capital gains tax on the profit on sale of the business, as well as dividend distribution tax if it decides in favour of paying dividend. Further, since the business being sold to Torrent accounts for 60 per cent of its topline, the residual sale proceeds will be utilised to grow its international business, active pharma ingredients (APIs; an input) and contract research and manufacturing as the company increases investments on developing new chemical entities (NCEs), biosimilars and complex generics. 

All this will be crucial in deciding upside for the stock prices.

Torrent: How the numbers stack up

In Rs crore	FY15	FY16	FY17
Net sales	4,653	6,687	5,857
% change y-o-y	11.2	43.7	-12.4
PBIDT	1,306	2,765	1,601
% change y-o-y	31.9	111.8	-42.1
PAT	751	1,733	934
% change y-o-y	13.1	130.8	-46.1
Debt-Equity (x)	1.10	0.67	0.58

PBIDT: profit before interest, depreciation and tax

Source Capitaline

Compiled by BS Research Bureau

Adding market share in key segments

Segment	Current market share (%)	Post deal market share (%)
Cardiology	5.60%	8.60%
Central Nervous System	6.40%	8.40%
Gastro-intestinal	3.10%	3.90%

Table indicates the market share of Torrent, currently and post Unichem deal

Source: Company

Reference - http://www.business-standard.com/article/companies/torrent-s-unichem-deal-to-add-to-earnings-only-after-2-3-years-117110600177_1.html