NatWest Securities is upbeat on the pharmaceutical sector. Over the next two years, the FII expects the sector to post an EPS growth of over 20 per cent. In its review of three pharmaceutical companies -- Ranbaxy, Cipla and Dr Reddy's -- NatWest Securities has recommended accumulation at current levels.

Ranbaxy Laboratories

Ranbaxy's aggressive thrust on branded products has resulted in a strong 34 per cent year-on-year growth in overall formulation sales in the first-half of 1997-98. New products and drug delivery systems coupled with the existing strong brands have spurred a 29 per cent year-on-year growth in domestic formulations. Sales of the company's branded generics in the UK and other non-regulated markets grew by 29 per cent year-on-year.

The domestic bulk drug business grew by 47 per cent year-on-year in the first-half. Bulk drug exports fell by 8 per cent in value terms in spite of a 10 per cent rise mainly because of a 23 per cent fall in prices. Ranbaxy's allied business including animal health, fine chemicals and diagnostics grew by 9 per year-on-year. Sales from overseas joint ventures, accounted for 17 per cent of the total sales in the first-half of 1997-98 compared with 11 per cent in the corresponding period last year.

Meanwhile, Ranbaxy has tightened its working capital requirement by negotiating better terms with trade -- Rs 50 crore has been released as a result during the first-half of 1997-98 (the year-end target is Rs 70-80 crore). The company plans to contain its capital expenditure to Rs 67 crore in fiscal 1997-98, of which Rs 33 crore has already been been spent. The focus on branded products is improving margins and helping maintain a tight rein on waorking capital and capital spending.

We believe the return on capital employed (ROCE) will rise by 1.7 per cent in fiscal 1997-98. Ranbaxy has also targeted an annual improvement of ROCE of 1.3 per cent from fiscal 1999.

Cipla Limited

The two-and-a-half month trade ban on Cipla products in Maharashtra (following some differences on the terms of trade between the company and its stockists) in July-Sept 1997 as well as the slack in the company's antibiotic and anti-bacterial product sales, we believe will result in a slowdown in the domestic sales growth. Although the trade ban has been lifted and both product groups have begun to show better growth we believe it will be difficult for Cipla's sales to exceed Rs 520 crore in fiscal 1997-98. We expect an overall sales growth of 13.6 per cent in the current financial year. Despite the slowdown in domestic sales, Cipla will maintain its operating margin in the current fiscal owing to a strong 27 per cent year-on-year growth in exports. Besides, the company will also benefit from the fall in the prices of bulk drugs (ciprofloxacin and amoxycillin prices have fallen by 40 and 25 per cent, respectively). Moreover, Cipla has also managed to cut its interest cost by 54 per cent by bringing down its total debt by 80 per cent.

Anti-asthma products account for 17 per cent of Cipla's domestic sales and the company controls 40 per cent of the market for these products. Given the growing incidence of asthma cases in India, we expect this market to grow by 20 per cent year-on-year in fiscal 1998. Cipla's strength is the wide range of drug delivery systems it has put and continues to put on the market.

Even after cutting Cipla's two-year EPS compounded annual growth rate, it is still strong at 30.5 per cent. The stock trades at a 16 percent premium to the pharmaceutical sector (domestic companies), based on FY 99 earnings, although it FY 97-99 EPS CAGR is 30 per cent higher than the sector's 23.5 per cent. We are looking at a 12 per cent outperformance over the next 12 months. With the company, continuing to launch new products regularly and increasing its thrust on high-margin exports, the stock's rating should improve.

Dr Reddy's Laboratories

The strong first-half sales growth of 39 per cent year-on-year follows a solid growth in all its core-focus business segments -- 47 per cent in the domestic formulation business, 53 per cent in bulk exports and 165 per cent in formulation exports. The strategic shift at Dr Reddy's Laboratories from bulk drugs towards value-addition and brand building is beginning to deliver good results. We once again stress that formulation sales -- domestic and exports -- will be the key driver to Dr Reddy's growth over the next two years.

Dr Reddy's restructuring of its CIS operations, by routing sales through its joint ventures in Russia, has yielded positive results. Its cash flows have improved, as collection have gone up and, hence, working capital requirement has eased. Consequently, Dr Reddy's interest costs (in the first-half) have dropped by 4.5 per cent year-on-year. We estimate that interest cost for the full year will fall by 16 per cent. The first-half depreciation charge has risen by 48 per cent year-on-year, with Dr Reddy's formulation plant going on stream during the second-half of 1997-98. We estimate the depreciation charge for the full year to rise by 34 per cent. The stock has outperformed the market by 16 per cent in the last eight weeks, but as Dr Reddy's forecast of EPS growth of 38.6 per cent over the next two years is much higher than the 23.5 pwer cent EPS growth we expect to see in the pharmaceutical sector, we believe the outperformance will continue. We, therefore, maintain our "buy" recommendation.

(The report was written before the political impasse began and, hence, does not factor in the current market sentiment)

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