Indian Equity Market Stock Picks: SSKI Stock Ideas

Price target: Rs910
Market cap: Rs2,992 cr
52 week high/low: Rs1,225/516
NSE volume: 1.4 lakh
(No of shares)
BSE code: 500378
NSE code: JINDALSAW
Sharekhan code: JINDALSAW
Free float: 2.9 cr
(No of shares)

Shareholding pattern

Price performance
(%)	1m	3m	6m	12m
Absolute	-6.9	-25.1	-47.7	-6.0
Relative to Sensex	2.5	-24.5	-31.1	-14.1

The Government of India has scrapped the export levy on pipes and tubes, which was imposed last month. The move, taken last month in an endeavour to cool down inflation, took the industry by storm. As the bulk of the order book of pipe makers comprises of export orders, the move would have led to a significant margin erosion for the industry and would have also reduced the competitiveness of domestic players vis-à-vis other international players. The market too reflected this concern, as the stocks of the pipe making companies corrected by almost 10-15% over the last one month, as the entire sector witnessed a considerable de-rating. We believe the withdrawal of the export levy would act as a significant booster for the sector and the sector should go back tracking the fundamentals as the concerns relating to government intervention are done away with.

Impact to be felt in this quarter''s numbers; marginally downgrade our numbers
Jindal Saw Ltd''s (JSL) order book currently stands at $1.09 billion. Out of this, $775 million is for submerged arc welded (SAW) pipes, $165 million for ductile iron (DI) pipes and $60 million for seamless pipes. Export contributes about 65% (almost $650 million) to the total order book. The earnings of the company are likely to be affected to the extent of the sales booked in the previous one month only, and hence we are marginally reducing our CY2008E estimates by 2.3% to Rs61.6. We maintain our CY2008E earnings estimate at Rs90.5.

Outlook and valuations
We believe that the core business of JSL would continue to do well on the back of buoyant demand outlook. As mentioned in our previous update, the margins of the DI pipes division might be impacted due to the rising coking coal prices. However, the capacity expansion and the commencement of the captive power plant should help mitigate the adverse impact to a certain extent.

At the current level, the stock is trading at 6.3x its CY2009E earnings and is available at an enterprise value (EV)/ earnings before interest, depreciation, tax and amortisation (EBIDTA) of 3.2x. We maintain our Buy recommendation with a price target of Rs910.

Valuation table
Particulars	FY2004	FY2005	FY2006	FY2007E (15 mths)	CY2008E	CY2009E
Net sales (Rs cr)	1,082.1	2,313.6	3,855.7	6,787.8	4,315.8	5,503.2
Net profit (Rs cr)	57.1	99.1	169.1	280.3	345.4	507.5
EPS (annualised)	10.2	17.7	30.1	40.0	61.6	90.5
% yoy growth		73.6	70.6	32.6	54.0	46.9
PER	56.4	32.5	19.0	11.5	9.3	6.3
P/B	8.1	3.8	3.2	1.6	1.2	1.0
EV/EBIDTA	27.8	14.9	10.0	5.3	4.7	3.2
ROCE (%)	16.1	17.8	18.9	22.2	17.1	21.3
RONW (%)	14.3	11.7	16.6	11.3	12.6	16.1

Price target: Under review
Market cap: Rs22,317 cr
52 week high/low: Rs660/297
NSE volume: 92 lakh
(No of shares)
BSE code: 500359
NSE code: RANBAXY
Sharekhan code: RANBAXY
Free float: 24.3 cr
(No of shares)

Key points

Ranbaxy Laboratories (Ranbaxy) has reached an out-of-court settlement with Pfizer, Inc (Pfizer) on Lipitor. Lipitor is the world's best selling drug, with global sales of $12.7 billion annually. Ranbaxy and Pfizer have been fighting on Lipitor since six years in 12-15 markets across the world.
As per the agreement, Ranbaxy can launch generic Lipitor and generic Caduet in the USA with a 180-day marketing exclusivity in November 2011 and on varying dates prior to the patent expiry in seven other markets including Canada, Australia, Belgium, Germany, Sweden, Italy and the Netherlands.
All the pending lawsuits between Ranbaxy and Pfizer relating to Lipitor in these selected markets have been dismissed. In addition, the pending patent litigation between Ranbaxy and Pfizer on Caduet will be dismissed in the USA.
The agreement provides visibility and clarity to Ranbaxy's impeding launch of generic Lipitor in the USA and provides it with an early entry in other world markets. The termination of all pending litigation related to Lipitor would also benefit Ranbaxy in terms of reduced litigation costs.
We believe Ranbaxy will be able to garner collective revenues and profits of ~$1.5 billion and $880 million respectively from the launch of Lipitor in various markets at pre-determined dates and from the launch of Caduet in the USA. This would translate into an incremental upside of Rs25-30 per share from Ranbaxy (after excluding the earlier NPV of Rs35 per share for Lipitor, which has already been discounted in the stock price).

Shareholding pattern

Price performance
(%)	1m	3m	6m	12m
Absolute	15.3	33.7	44.5	58.5
Relative to Sensex	27.7	25.7	76.5	41.8

In the most comprehensive settlement ever done between a global innovator pharmaceutical company and a generic player, Ranbaxy has entered into an out-of-court settlement with the world's largest pharmaceutical company Pfizer on its blockbuster drug Lipitor. Ranbaxy and Pfizer have been entangled in a legal battle over the validity and potential infringement of Pfizer's numerous patents on Lipitor, which would determine the timing of the launch of a generic version of Lipitor in various world markets. The settlement outlines Ranbaxy's timing of launch of generic Lipitor in various US and non-US markets and also terminates all the litigation between the two companies on the various patents covering Lipitor in these markets. Additionally, the settlement also covers two other products on which Ranbaxy and Pfizer have been fighting: Caduet and Accupril.

Background
Lipitor is the world's best selling cholesterol-lowering drug with annual revenues of $12.7 billion in 2007. Of this, the USA is the largest market, accounting for annual sales of $8.5 billion. Atorvastatin is the generic version of Lipitor and is covered by various patents on the basic compound, the enantiomer, the manufacturing process and the crystalline form of Atorvastatin. The various patents are due to expire in 2010, 2011, 2016 and 2017. Caduet is Pfizer's fixed dose combination drug with Amlodipine Besylate and Atorvastatin and is used to treat hypertension as well as high cholesterol. Caduet generated around $568 million in worldwide sales for Pfizer in 2007, of which ~$400 million came from the USA. The patent for Caduet is due to expire in August 2018 in the USA.

Pfizer and Ranbaxy have been fighting on Lipitor since 2002 in 12-15 world markets. Since Ranbaxy is the first to file a Para IV abbreviated new drug application for generic Lipitor, it is entitled to receive a 180-day period of marketing exclusively for Lipitor in the USA, as per the Hatch-Waxman Act.

Details on Lipitor & Caduet
	Market size ($mn)	Patent expiry	Date of launch
Lipitor
USA	8500	March 2010, Nov 2011, July 2016, Jan 2017	11-Nov
Canada	800	July 2010, July 2016	10-May
Australia	500	12-Jun	12-Feb
Others	200	-	2012
Europe	1000	Nov 2011/May 2012	Sep 2011/Mar-12
Caduet- USA	400	18-Aug	11-Nov

Features of the deal

Pfizer has granted Ranbaxy a license to sell the generic version of Lipitor and Caduet with a 180-day marketing exclusivity in the USA from November 30, 2011.
Pfizer has appointed Ranbaxy as the authorised generic player for Lipitor in Canada. As per the agreement, Ranbaxy can launch its generic version of Lipitor in Canada two months prior to the expiration of the patent covering Lipitor in Canada.
Pfizer has also granted Ranbaxy a license to start selling the generic version of Lipitor on varying dates in six additional markets including Australia, Belgium, the Netherlands, Italy, Sweden and Germany.

Ranbaxy can launch its generic version of Lipitor 105 days before the patent expiry in Australia.
Ranbaxy can launch its generic version of Lipitor two months prior to patent expiry in the various western European markets covered in the settlement.

Pfizer and Ranbaxy have resolved their disputes relating to patent infringement in Malaysia, Peru, Vietnam and Brunei.
The lawsuits between Pfizer and Ranbaxy regarding Lipitor and Caduet will be dismissed in the specified countries, and Ranbaxy will no longer contest the validity of Pfizer's patents in the specified countries, including the USA, according to the agreement.
The settlement also resolves all patent litigation with Ranbaxy relating to Accupril in the USA and Viagra in Ecuador.
The patent infringement litigation between Pfizer and Ranbaxy relating to Lipitor will continue in five other European countries—Finland, Spain, Portugal, Denmark and Romania.
The agreement is subject to approval by the Federal Trade Commission (FTC).

Benefits to Ranbaxy
Though the agreement has advanced Ranbaxy's launch of Lipitor in the USA by 18 months, it has brought with it a large amount of certainty and clarity by eliminating the complex patent challenge lawsuits that Ranbaxy and Pfizer have been engaged in since the past six years. Ranbaxy would now be able to launch the product with absolute certainty, pending approval by the FTC, with a 180-day marketing exclusivity in the USA on November 30, 2011. In addition, the agreement has also provided Ranbaxy with another exclusivity opportunity for Caduet in 2011, much ahead of its patent expiry in 2018. Further, the termination of all pending lawsuits related to Lipitor in the various markets would result in a substantial reduction in Ranbaxy's litigation costs in the future.

Financial implications
We have analysed three scenarios for determining the incremental upside from this settlement. Following is the description of the three scenarios:

Base case: Pfizer appoints an authorised generic player only in the USA, allowing Ranbaxy to capture only 50% of the US market and 55% of the non-US markets.

Bull case: Pfizer does not appoint an authorised generic player in any country, enabling Ranbaxy to capture ~60% of the US market and 55% of the non-US markets.

Bear case: Pfizer appoints an authorised generic player in the USA, all the European markets and in Australia, enabling Ranbaxy to capture only 40% of the US market and 40-50% of the non-US markets.

Following are our revenue and profit estimates for Ranbaxy in the three scenarios. After accounting for the Rs35 per share for the earlier launch of Lipitor in March 2010, which has already been discounted in the stock price, we believe the incremental upside from the deal would be Rs11 per share in the worst case and Rs42 per share in the best case. We believe our base case assumption of an authorised generic player only in the US market is the most probable scenario, given the fact that the USA is the largest market for Lipitor. Hence, we believe that the settlement could lead to an incremental upside in the range of Rs25-30 per share for Ranbaxy.

Financial analysis of the settlement
Particulars	Bear case	Base case	Bull case
Revenues ($mn)	1203	1504	2001
Profits ($mn)	702	879	1179
NPV per share	46	58	77
Lipitor value (already discounted in price) (Rs/share)	35	35	35
Incremental upsides from deal (Rs/share)	11	25	42

Outlook
We view this agreement as a win-win agreement from a financial and strategic perspective for both Pfizer and Ranbaxy. The settlement agreement not only provides increasing visibility and certainty to Ranbaxy's impending launch of Lipitor but also benefits consumers by providing with a generic alternative to Lipitor earlier than the patent expiry of the innovator brand. Finally, the agreement highlights Ranbaxy's ability to monetise and extract value from its Para IV patent challenge cases.

Company details

Price target: Rs180
Market cap: Rs1,540 cr
52 week high/low: Rs162/84
NSE volume: 3.2 lakh
(No of shares)
BSE code: 532628
NSE code: 3IINFOTECH
Sharekhan code: 3IINFOTECH
Free float: 8.0 cr
(No of shares)

Key points

3i Infotech has announced three acquisitions since April 2008, namely Regulus Group LLC (Regulus), M/S Locuz Enterprise Solution (Locuz) and M/S FinEng Solutions Pvt Ltd (FSL).
Post these acquisitions, we expect 3i Infotech''s top line to grow significantly in FY2009. However, the operating profit margin (OPM) and the net profit margin are expected to decline primarily due to revenue contribution from Regulus, which had a lower OPM of 13% in CY2007 and due to higher interest expenses associated with Regulus debt financing.
We have revised upwards our FY2009 earnings estimate by 7.2% and FY2010 earnings estimate by 12.7%. At the current market price, the stock is trading at an attractive valuation of 8.2x FY2009 earnings estimate and 6.7x FY2010 earnings estimate. We maintain our Buy recommendation on the stock with price target of Rs180 (10x FY2010 earnings estimate).

Shareholding pattern

Price performance
(%)	1m	3m	6m	12m
Absolute	-7.0	30.4	-14.9	-22.4
Relative to Sensex	3.0	22.6	3.9	-30.6

Regulus acquisition—EPS accretive
3i Infotech has recently announced that it has completed the acquisition of Regulus, a leading document processing service provider in the USA, which handles more than 2.1 billion paper and electronic transactions annually. 3i Infotech acquired Regulus for US$80 million with an additional consideration of US$20 million based on an earn-out linked to performance. Regulus generated revenues of US$148 million and earnings before interest, depreciation, tax, and amortisation (EBITDA) of US$20 million in CY2007. We have already highlighted the financial details in the last update on May 02, 2008. Apart from expanding 3i Infotech’s operation in the processing services, this acquisition will also complement products of J&B Software. Regulus provides processing services to BFSI (Banking, finance, services and insurance) clients, while J&B Software is a product company for BFSI vertical. Hence the acquisition will enable the company to provide enhanced services to the BFSI vertical in the USA market. Beside this, 3i Infotech is also targeting $25 million revenues from India over the next two-three year period.

Locuz acquisition—26% stake
3i Infotech also took a 26% stake in the Hyderabad-based Locuz for a consideration of Rs6.9 crore. The company also has the option to acquire the remaining stake in Locuz over the next four years. Locuz primarily operates in the infrastructure management services business and has annual revenues of Rs80 crore with an EBITDA margin of 10%.

FSL acquisition—51% stake
3i Infotech has also announced recently that it has acquired a 51% stake in FSL with a commitment to acquire the remaining stake in two tranches over a period of time. FSL owns certain proprietary software providing various business solutions in mutual fund, wealth management and credit risk space. Since, the financial details are not available, we have not considered this acquisition in our earnings estimates.

Financial performance—Post acquisitions
We expect 3i Infotech earnings to grow significantly after these acquisitions (Regulus and Locuz). The earnings estimates however do not include the earnings estimate of FSL acquisition, since the financial details for the same is not available. 3i Infotech’s revenues are expected to grow 87.5% yoy to Rs2,260.3 crore in FY2009 primarily due to Regulus acquisition. However, we expect 3i Infotech''s OPM to decline by ~230 basis points to 20.5% from our previous estimates of 22.8%, as Regulus'' OPM (13.5% in CY2007) is lower than that of 3i Infotech''s OPM (24.5% in FY2008). We also expect the company''s net income to grow 40.9% year on year to Rs248.8 crore in FY2009. The growth in the net income is lower than the top line growth post these acquisitions, primarily due to lower OPM and higher interest expenses associated with Regulus'' acquisition debt financing.

Financial performance				Rs (cr)
Particulars	Excluding these acquisitions		Including these acquisitions
Particulars	FY09E	FY10E	FY09E	FY10E
Sales	1,720.3	2,142.0	2,260.3	2,934.0
% y-o-y growth	42.7	24.5	87.5	29.8
Operating profit	392.4	460.7	462.6	563.6
OPM (%)	22.8	21.5	20.5	19.2
Net profit	223.8	260.3	248.8	304.2
NPM (%)	13.0	12.2	11.0	10.4
% y-o-y growth	26.7	16.3	40.9	22.3

Valuation
We have revised upwards our FY2009 earnings estimate by 7.2% and FY2010 earnings estimate by 12.7%. At the current market price, the stock is trading at an attractive valuation of 8.2x FY2009 earnings estimate and 6.7x FY2010 earnings estimate. We maintain our Buy recommendation on the stock with price target of Rs180 (at 10x FY2010 earning estimates).

Key financials
Particulars	FY2006	FY2007	FY2008	FY2009E	FY2010E
Net sales (Rs cr)	417.8	655.3	1205.3	2260.3	2934.0
Adj net profit (Rs cr)	50.2	98.0	169.4	248.8	304.2
Share in issue (cr)	10.6	14.1	17.2	17.2	17.2
EPS (Rs)	4.7	6.9	9.8	14.5	17.7
% yoy growth	37.4	46.6	41.9	46.9	22.3
PER (x)	24.9	17.0	12.0	8.2	6.7
Book value (Rs)	34.7	53.9	82.2	116.8	131.2
P/BV (x)	3.4	2.2	1.4	1.0	0.9
EV/Ebidta (x)	9.5	8.4	6.0	5.1	4.3
Dividend yield (%)	1.1	1.5	1.1	1.5	1.5
RoCE (%)	9.4	11.4	12.1	14.0	14.9
RoNW (%)	9.8	13.7	13.0	11.9	12.3

The author doesn''t hold any investment in any of the companies mentioned in the article

Company details

Price target: Rs30
Market cap: Rs157 cr
52 week high/low: Rs55/16
NSE volume: 2.5 lakh
(No of shares)
BSE code: 526650
NSE code: TFCILTD
Sharekhan code: TFCI
Free float: 3.9 cr
(No of shares)

Result highlights

The net interest income of Tourism Finance Corporation of India (TFCI) declined by 27.0% year on year (yoy) to Rs11.2 crore in Q4FY2008. This was mainly due to a 15.6% drop in the interest income and an 11.0% increase in the interest expenses of the company.
Notably, the operating expenses of TFCI declined sharply by 30.3% yoy during the quarter. The decline was primarily due to a higher base in the year-ago quarter on account of an extraordinary payment of Rs1.0 crore made towards the arrears of employee expenses.
In addition to the decline in the operating expenses, there was a write-back of provisions (for bad and doubtful debt) of Rs10.0 crore, as the same was no longer required. The significant write-back was the primary reason why the bottom line improved.
Lower operating expenses and write-back of provisions boosted the operating profit for the quarter. The operating profit increased by 45.4% to Rs19.9 crore. Hence, the net profit for Q4FY2008 also increased by a strong 60.2% to Rs15.3 crore.
At the end of the fiscal, the sanctions made by the company stood at Rs333.8 crore, up 36.0%. The disbursals also registered an increase of 50.0% to Rs180.36 crore. However, the high growth in the disbursals could not translate into growth of the loan book due to higher repayment of loans.
The loans increased by 6.0% to Rs372.7 crore, breaking the previous five years'' trend of declining growth.
The gross non-performing assets (NPAs) stood at Rs61.0 crore on an asset base of over Rs500 crore (advances and investments combined). However, the company has maintained the net NPA level at 0% by fully providing for the gross NPAs.
During the quarter, TFCI raised Rs63.8 crore through the preferential allotment of 1.32 crore equity shares of Rs10 each for cash at a price of Rs48 per share (including a Rs38.0 premium). The capital raising was aimed at enabling the company to finance its future growth.
At the current market price of Rs19.5, the stock trades at 8.2x its FY2009E adjusted earnings per share (EPS) of Rs2.4 and 0.6x its FY2009E book value of Rs34.9. At the existing valuations, the stock still has substantial upside potential and hence we are upgrading it to a Buy with a revised price target of Rs30.

Shareholding pattern

Price performance
(%)	1m	3m	6m	12m
Absolute	-25.0	-12.1	-48.5	20.9
Relative to Sensex	-16.9	-17.4	-37.1	8.1

Result table							Rs (cr)
Particulars	Q4FY08	Q4FY07	% yoy	% qoq	FY08	FY07	% yoy
Interest earned	18.6	22.0	-15.6	30.6	58.2	63.2	-7.9
Interest expended	7.3	6.6	11.0	-9.3	31.8	34.3	-7.4
NII	11.2	15.4	-27.0	83.5	26.5	28.9	-8.5
Other income	0.2	0.5	-53.3	-4.5	1.1	0.8	46.2
Net total income	11.4	15.8	-27.8	80.4	27.6	29.7	-7.1
Operating expenses	1.5	2.1	-30.3	16.9	4.8	4.8	-0.4
Operating profit	10.0	13.7	-27.4	95.9	22.8	24.9	-8.4
Depreciation	0.2	0.2	0.0	0.0	0.6	0.6	-3.3
Provisions and contingencies	-10.0	0.0	-	-	-7.5	0.0	-
Profit before tax	19.8	13.6	45.9	301.2	29.7	24.3	22.3
Tax	4.5	4.0	12.0	197.4	8.0	10.0	-20.1
Profit after tax	15.3	9.6	60.2	346.9	21.7	14.3	52.2
Adj net profit	7.6	9.6	-20.9	123.4	16.3	14.3	14.0

Margins remain under pressure
Though the advances saw a 6% growth in FY2008, breaking the trend of declining advances in the past five years, the yield on the advances continued its declining trend. Also, the company saw a sharp increase in the cost of funds, causing the spreads to contract significantly. We believe that with a higher growth in sanctions and disbursals, the company should be able to maintain the spreads.

Turnaround in loan growth
In FY2008, the company saw a robust growth in the sanctions and disbursals. It closed the year with a 36% growth in the sanctions and a 50% growth in the disbursals. However, the high growth in the disbursals could not translate into growth of the loan book due to higher repayment of loans. Although the growth is marginal, yet it is a strong positive for the company, looking at the continual decline in its loan book in the past four to five years. As the company is now adequately capitalised, it expects to maintain this high growth trend in the sanctions and disbursals.

Loan growth

Provision write-back boosts bottom line
In Q4FY2008, the company wrote back a provision of Rs10.0 crore created on account of bad and doubtful debts, as the same was no longer required. This provision write-back was on the back of an improvement in the asset quality of the company and it led to a 60.2% growth in the profit after tax (PAT) in the quarter. On a full year basis, the net provision write-back stood at Rs7.5 crore.

FY2008 PAT up by 52%
On a full year basis, the net interest income declined by 8.5% yoy to Rs26.5 crore. This was mainly on account of a decline in the interest income and a reduction in the spreads. The net profit of the company increased by 52.2% to Rs21.7 crore due to lower operating expenses and a provision write-back of Rs7.5 crore.

Asset quality improves further
In FY2008, the company maintained its zero NPA status. Though the NPAs at the gross level stood at Rs61 crore, but we believe the same was mainly due to the nature of the industry that TFCI caters to. Also, looking at the recoveries it has done in the past, we believe it would be able to manage these NPAs well. The company has also fully provided for these NPAs.

Successful capital raising
TFCI raised Rs63.8 crore through a preferential allotment of 1.32 crore equity shares of face value Rs10 each at a price of Rs48 per share. The allotment was done at over 50% premium to the stock''s prevailing market price and thus boosted the capital base. This exercise should augment TFCI''s capacity to fund projects that have higher capital requirement. The company is now at a comfortable capital adequacy level of 53%.

Likely delay in QIP
The TFCI board had earlier approved the placement of 1.92 crore equity shares at a minimum price of Rs48.0 per share (including a Rs38.0 premium per share) with a view to raising up to Rs125.0 crore. However, the company will have to delay its capital raising plans through the qualified institutional placement (QIP) route, considering the current market conditions. The likely delay in the QIP can hamper the company''s future growth.

Delay in private equity foray
TFCI plans to enter into the private equity space with a $100-million fund, which would cater to tourism projects in smaller towns and rural areas. The fund would be first of its kind in the industry. Initially, the fund launch was scheduled in mid 2008; however due to unfavorable market conditions the company has delayed the launch of the fund. The eventual launch of the fund will open up a new avenue of fee income for the company and augur well for the stability of the company''s bottom line.

Dividend yield high at ~5%
The company recommended a dividend of 10% for FY2008, double the 5% dividend announced for the previous fiscal. Earlier, the Reserve Bank of India due to its high NPA levels had barred TFCI from recommending dividend for two years. However, this ban was lifted in FY2007 as the company''s net NPAs were reduced to nil by then. At the current market price and dividend per share, the stock provides a dividend yield of 5%, thereby offering a healthy margin of safety for the investor.

Attractive valuations
The stock has corrected by over 60% from its previous peak of Rs55.5 and has under-performed the benchmark index, the Sensex. It is currently trading at a significant discount to its FY2008 book value of Rs32.9. Looking at the future growth prospects of both the company and the industry, we believe the stock is undervalued and is available at very attractive valuations.

Trend in shareholding pattern

FII, promoter holdings on rise
Notably, in the past one year, the holdings of the promoter and foreign institutional investors (FIIs) in the stock have gone up substantially. Though the increase in the promoter holding is mainly due to the preferential allotment, the increase in the FII holding indicates the rising interest of various institutions in the stock.

Post-allotment shareholding pattern (%)
	Pre-allotment	Post-allotment
IFCI	21.58	26.50
State Bank of India	7.42	9.19
LIC of India	6.21	7.70
Bank of India	3.79	4.70
United India Insurance Co	1.41	1.75
The Oriental Insurance Co	1.06	1.29
	41.47	51.11
FIIs, institutions and others	58.53	48.89
TOTAL	100.00	100.00

Industry outlook remains bullish
According to a survey conducted by the tourism ministry on 50 major tourism centres and major metro cities in India, the growth in the number of tourist visitors in India as well as the demand for hotel rooms will grow at a very high rate in the years to come. The analysis was done based on two scenarios:

Scenario I—the current growth rate: Under this scenario, it is assumed that the industry will maintain its current growth rate; the demand for rooms is expected to grow at a compounded annual growth rate (CAGR) of 19.2% during the period 2006 to 2010 and at a CAGR of 18.9% during the period 2010 to 2015.

Demand for rooms - Scenario I

Scenario II—targeted growth rate: The tourism ministry targets 15 million foreign visitors by 2010 and 25 million foreign visitors in 2015. Under this scenario, it is assumed that these growth targets will be achieved and hence the demand for rooms is expected to grow at a CAGR of 27.7% during the period 2006 to 2010 and at a CAGR of 11.2% during the period 2010 to 2015.

Demand for rooms - Scenario II

Regardless of the growth scenarios, the significant capacity addition happening in the hotel industry offers major funding opportunities. This supply crunch is well evident from the skyrocketing room rentals, rising occupancy levels and the capacity addition plans undertaken by various companies. Hence we believe that with improved fundamentals, better NPA management and expanded capital base, TFCI is rightly poised to make the most of this emerging opportunity in the hotel and tourism industry.

Valuation
We are lowering our growth estimates for TFCI, based on the fact that the company raised Rs63.8 crore against our estimate of Rs125.0 crore. Although the company has got an approval to raise additional funds through the QIP route, we believe the company would be unable to use this option considering the existing market conditions. At the current market price of Rs19.5, the stock trades at 8.5x its FY2009E adjusted EPS of Rs2.4 and 0.6x its FY2009E book value of Rs34.9. At these valuations, the stock still has substantial upside potential and hence we are upgrading it to a Buy with a revised price target of Rs30.

Valuation table
Paticulars	FY06	FY07	FY08	FY09E	FY10E
Adj net profit (Rs cr)	11.9	14.3	16.3	18.6	21.7
Shares in issue (cr)	6.7	6.7	8.1	8.1	8.1
EPS (Rs)	1.8	2.1	2.0	2.3	2.7
EPS growth (%)	-17.0	21.0	-5.0	14.0	17.0
Dividend yield (%)	0.0	3.5	5.0	5.1	5.1
PE (x)	11.4	9.4	9.9	8.5	7.2
BV (Rs/share)	27.4	28.2	32.9	34.9	37.4
P/BV (x)	0.7	0.7	0.6	0.6	0.5
Ad BV (Rs/share)	25.2	28.2	32.9	34.9	37.4
P/ABV (x)	0.8	0.7	0.6	0.6	0.5
RONW (%)	6.6	7.6	6.6	6.8	7.4

The author doesn''t hold any investment in any of the companies mentioned in the article.

Company details

Price target: Rs300
Market cap: Rs1,651 cr
52 week high/low: Rs343/106
NSE volume: 11.4 lakh
(No of shares)
BSE code: 524372
NSE code: ORCHIDCHEM
Sharekhan code: ORCHID
Free float: 5.0 cr
(No of shares)

Result highlights

Orchid Chemicals'' (Orchid) Q4FY2008 and FY2008 results are a mixed bag: While the revenue growth was above our estimate, strong margin pressure along with higher than anticipated interest burden and foreign exchange (forex) translation losses dragged down the profitability of the company during Q4FY2008.
The US generic market continued to power Orchid''s growth, with revenues growing by 55.9% to Rs379.2 crore in Q4FY2008 and by 35.7% to Rs1,238.9 crore in FY2008. The growth was driven by the consolidation of the market share in niche product opportunities like Cefepime injections, Cefdinir tablets, and Cefoxitin and Cefazolin injections.
Orchid''s operating profit margin (OPM) shrank by 730 basis points to 20.3% in Q4FY2008 and by 290 basis points to 27.8% in FY2008. The margin shrank largely due to one-time product development expenses incurred by the company and a huge inventory build up due to the impending launch of Tazobactum-Piperacillin (Tazo-Pip) in the USA. The declining margin restricted the operating profit growth to 14.6% at Rs77.1 crore in Q4FY2008 and to 23.2% at Rs344.8 crore in FY2008. Going forward, we expect the material cost to moderae as the inventory position corretcts itself once the product is launched in the market.
Orchid''s reported net profit fell by 34.7% to Rs15.8 crore in Q4FY2008, due to the poor operating performance and a Rs7.8-crore (pre-tax) translation loss. For FY2008, the reported net profit grew by an appreciable 91% to Rs184.5 crore. On excluding the net impact of the forex translation, the adjusted net profit of the company grew by 79.4% to Rs27.6 crore in Q4FY2008 and by 65.3% to Rs143.3 crore in FY2008. The adjusted profits reported by the company during Q4FY2008 and FY2008 are below our expectations.
Despite repeated assurances from the management, Orchid''s debt level remains high at $220 million (excluding the foreign currency convertible bonds [FCCBs]) as reflected in the increase in the interest cost in Q4FY2008. Further, the capital expenditure (capex) cycle does not seem to be over yet, with the company planning capex of ~Rs150 crore in FY2009 and of Rs150-175 crore in FY2010. We expect the company''s debt level to remain high over the next one to two years.
Orchid has strong growth drivers over the next two years. We expect the competitive scenario in the Cephalosporin segment to intensify whereas the launch of Tazo-Pip and other non-antibiotic products will fuel growth in FY2009. The opening up of the Carbapenem generic market from FY2010 onwards will maintain the growth.
In order to factor in the higher revenue base of FY2008, the delayed launch of Tazo-Pip both in the USA and Europe, the pressure on the margins due to the rising crude oil prices (which would increase the company''s power & fuel costs) and the higher than anticipated debt and capex, we are revising our FY2009 estimates for Orchid. We are upgrading our FY2009 revenue estimates by 2.4% to Rs1,492.7 crore to reflect the higher revenue base in FY2008 but we are downgrading our profit estimate by 30%, accounting for the lower OPM and higher interest burden in FY2009. We now expect Orchid to deliver a pre-exceptional profit of Rs157.7 crore, which would translate into fully diluted earnings of Rs16.3 per share in FY2009.
We are also introducing our FY2010 numbers in this report. We expect Orchid''s revenues to grow by 17.6% in FY2010 to Rs1,756.0 crore, on the back of a full-year impact of the Tazo-Pip launch as well as the incremental contributions from the Carbapenem opportunity. We expect profits of Rs207.6 crore in FY2010 which should yield fully diluted earnings of Rs21.5 per share.
The management has stated its intention of reducing its debt level further in the coming years, though we are yet to see the effect of the same on the company''s financials. Despite the strong growth drivers and a robust business model, we believe the above-mentioned concerns will remain as an overhang on the stock, until the company''s financials clearly reflect the management''s intentions of reducing the debt further. In view of these concerns, we are reducing our target price/earnings multiple for Orchid to 14x and rolling over our valuations to FY2010E earnings. We maintain our Buy recommendation on the stock with a revised price target of Rs300.

Shareholding pattern

Price performance
(%)	1m	3m	6m	12m
Absolute	-5.4	20.2	-3.6	1.1
Relative to Sensex	6.9	22.6	24.8	-7.9

Result table (stand-alone)						Rs (cr)
Particulars	Q4FY2008	Q4FY2007	% yoy	FY2008	FY2007	% yoy
Net sales	379.2	243.2	55.9	1238.9	912.9	35.7
Expenditure	302.1	176.0	71.7	894.1	633.1	41.2
Operating profit	77.1	67.2	14.6	344.8	279.9	23.2
Other income	0.3	0.3	13.8	1.2	1.6	-20.4
EBIDTA	77.4	67.5	14.6	346.1	281.4	23.0
Interest	24.3	24.2	0.1	81.1	98.3	-17.5
Depreciation	28.8	22.7	26.9	97.7	82.5	18.4
PBT	24.4	20.6	18.1	167.3	100.7	66.2
Taxes	0.7	5.3	-86.1	24.0	14.0	71.9
Adjusted PAT	27.6	15.4	79.4	143.3	86.7	65.3
Extraordinary items	-11.7	8.9	-231.9	41.3	9.9	315.2
Reported PAT	15.8	24.3	-34.7	184.5	96.6	91.0
EPS (Rs)	3.6	2.3	53.6	21.8	13.2	65.2
OPM (%)	20.3	27.6	-730 bps	27.8	30.7	-290 bps
EBITBA margin (%)	20.4	27.8	-740 bps	27.9	30.8	-290 bps
Net profit margin (%)	7.3	6.3	-10 bps	11.6	9.5	+210 bps

Niche opportunities in the USA drives growth
The US generic market continued to power Orchid''s growth, with revenues of the US business growing by 55.9% to Rs379.2 crore in Q4FY2008 and by 35.7% to Rs1,238.9 crore in FY2008. The revenues reported by the company are above our estimates. Orchid''s US business crossed the $100 million mark in FY2008, accounting for over 30% of its sales. The growth was driven by the consolidation of the market share in niche product opportunities like Cefepime injections, Cefdinir tablets, and Cefoxitin and Cefazolin injections. Orchid continues to be the sole generic player in the Cefepime market and the dominant player in the Cefoxitin and Cefazolin segments. The ongoing flu season in the USA also resulted in an increase in the offtake of Orchid''s products during Q4FY2008. Orchid''s products fall predominantly in the antibiotic category and this boosted the overall volumes and sales.

Rising costs exert pressure on margins
Orchid''s OPM shrank by 730 basis points to 20.3% in Q4FY2008 and by 290 basis points to 27.8% in FY2008, largely due to a substantial spike in its material cost during Q4FY2008. The material cost jumped by 1,410 basis points during Q4FY2008, partly due to a Rs23.6-crore spend on the development of four products for the US generic market. The company has not been reimbursed for the same by its marketing partner yet. The reimbursement is expected upon the finalisation of the marketing partner over the next few months.

However, even on excluding the additional product development costs, the material cost would be higher when compared with that in the previous quarters, due to a large inventory build up for the impending launch of Tazo-Pip in the US and European markets. The inventory build up is expected to correct itself over the next two quarters upon launch of the product in the market. We expect the raw material costs to moderate in the coming quarters as the inventory position reverses and the product development costs are reimbursed.

The declining margins restricted the operating profit growth to 14.6% at Rs77.1 crore in Q4FY2008 and to 23.2% at Rs344.8 crore in FY2008.

Rising material cost exerts pressure on margins

Forex loss drags down net profit; below estimates
Orchid''s reported net profit fell by 34.7% to Rs15.8 crore in Q4FY2008, due to the poor operating performance and a Rs7.8-crore (pre-tax) translation loss recorded on the outstanding FCCB loans because of the depreciation in the rupee against the US Dollar. For FY2008, the reported net profit grew by an appreciable 91% to Rs184.5 crore. On excluding the net impact of the adjustment of a forex translation loss of Rs11.7 crore (post-tax) in Q4FY2008 and a forex gain of ~Rs41 crore in FY2008, the adjusted net profit of the company grew by 79.4% to Rs27.6 crore in Q4FY2008 and by 65.3% to Rs143.3 crore in FY2008. The adjusted profit reported by the company for Q4FY2008 and FY2008 are below our expectations.

Interest cost spikes in Q4FY2008
Remaining flat on a year-on-year basis, Orchid''s interest cost showed a sudden sequential spike in Q4FY2008 from the Rs18-19 crore level in the first three quarters of FY2008 to the FY2007 levels of Rs24-25 crore. This was due to an increase in the company''s short-term working capital loans taken during Q4FY2008; the company expects to repay these loans in Q1FY2009.

Competition in niche Cephalosporin products to increase
Orchid saw a stellar growth in its US generic business during FY2008. The growth was achieved on the back of niche product opportunities like Cefoxitin, Cefazolin, Cefepime and Cefdinir. The company has been able to garner supernormal market shares in each of these products, due to the presence of limited competition and the distribution strength of its marketing partners. The company expects the competitive scenario in Cefoxitin and Cefazolin to remain benign atleast for the next 3-4 quarters. On the other hand, the competition in Cefepime (where Orchid is currently the only generic player and holds a market share of 65%) is expectd to intensify with the entry of 2-3 more players in Q3FY2009. Based on our estimates, we believe that Cephalosporins will account for only 74% of the formulation sales from the advanced markets in FY2009 (as compared with ~100% in FY2008); the share would fall even further in FY2010 to around 57%.

Orchid''s market share in key Cephalosporins during FY2008

Product	Market share (%)	No of generic competitors
Ceftriaxone	20	12
Cefoxitin	70	1
Cefazolin	80	7
Cefepime	65	0
Cefdinir	15	4

Future growth drivers
Orchid has traditionally been a manufacturer of oral and sterile Cephalosporins. However, the company has a reasonably robust pipeline of niche non-Cephalosporin-based products, viz Penicillin injectibles, penems and non-Penicillin, non-Cephalosporin (NPNC) products, which would contribute to growth going forward. Orchid has largely completed the investment required for Penicillin injectibles, penems and NPNC products, and we expect growth to be driven by these segments in FY2009 and beyond.

Non-antibiotic products in FY2009: Orchid has diversified into the non-antibiotic segment and identified a product basket of over 80 products across therapeutic segments. The company has also formed marketing alliances for 20 NPNC products in the USA and Europe with three prominent players: Actavis, Stada (Dava) and Par Pharma. These 20 products represent a combined market opportunity of over $17 billion in the USA and of over $3 billion in Europe. Orchid has already filed 16 abbreviated new drug applications (ANDAs) in this space with the US Food and Drug Administration (FDA) and three marketing authorisations in Europe. We expect the product approvals to trickle through in FY2009, enabling Orchid to launch at least seven to eight products. We expect the non-antibiotic products to generate $15.5 million in FY2009 and $30.9 million in FY2010.

Orchid''s key non-antibiotic product opportunities

Generic name	Innovator	Brand name	Market size ($m)
Amlodipine	Pfizer	Norvasc	2700
Sumatriptan Succinate	Glaxo	Imitrex	890
Carvedilol	SmithKline Beecham	Coreg	1140
Levetiracetam	UCB	Keppra	705
Alandronate	Merck	Fosamax	1941
Divalproex	Abbott	Depakote	770
Phenytoin	Pfizer	Dilantin	170
Granisetron HCL	Roche	Kytril	120

Injectable Penicillins—Tazo-Pip in USA and Europe: With four niche opportunities already under its fold, Orchid is waiting to capitalise on yet another niche product opportunity of Tazo-Pip injections in both the USA and Europe. Tazo-Pip is the generic version of Zosyn, for which Wyeth holds the patent in the regulated markets. Orchid had filed the drug master file (DMF) for this product in July 2005 and had tied up with Apotex for distribution in the US market. Subsequently, Wyeth discontinued its original formulation and launched a new version with fresh patents. In response, the generic players, viz APP, Sandoz and Orchid, filed a citizen''s petition in February 2007 claiming that Wyeth is trying to unfairly extend the patent life. The generic companies have claimed that a drug can be withdrawn from the market only for safety or efficacy reasons, and that Zosyn is a safe and effective drug that Wyeth had marketed for 13 years, and hence cannot be withdrawn and replaced with a new drug. Even though the FDA is yet to rule on the pending citizen''s petition, with the compound patent having expired in February 2007 in the US and most major non-US markets in July 2007, we believe that a generic launch of Zosyn is imminent in the USA, Canada and the European Union. Further, in a recent filing made with the Securities and Exchange Commission (SEC), Wyeth has also indicated a likely risk of genericisation of Tazo-Pip anytime now in the USA.

We expect Orchid to launch Tazo-Pip in the USA sometime in August/September 2008 and in Europe in July/August 2008. With an addresseable market of $220 million in the USA and that of $228 million in Europe, along with a limited competitive scenario comprising two to three players (Orchid, Sandoz and APP), the Tazo-Pip launch in the USA and Europe is expected to collectively generate approximately $22.4 million in FY2009 and $36.8 million in FY2010.

FY2010 onwards—Carbapenems, another niche opportunity: Carbapenems are a class of betalactum antibiotics, having a vast spectrum of antibacterial activity and requiring dedicated facilities for manufacturing. Orchid is one of the two players from India (the other being Ranbaxy Laboratories [Ranbaxy]), which has invested significantly in setting up these specialised and dedicated facilities for Carbapenems. A host of Carbapenem products are slated to go off patent in the next two to three years, thereby opening up a huge opportunity for players like Orchid. Further, these opportunities will have limited competition, thus limiting the price erosion and enhancing the market share potential. Orchid has tied up with Mayne Pharma (now Hospira) for the marketing of these products in the USA. Assuming a launch in Q4FY2009 in both the USA and Europe, we expect Orchid to get revenues of ~$15.4 million from two Carbapenem products in FY2010.

High capex and debt levels continue to persist
Despite the management''s repeated assurances of reducing the company''s debt, Orchid''s debt level at the end of FY2008 remained high at $220 million (excluding the outstanding FCCBs), up from ~$175 million at the end of FY2007.

Further, the management of Orchid has repeatedly reiterated the fact that the company''s capex cycle is largely over and all cash flows would be used to further reduce the debt levels in the coming years. However, after spending money in excess of Rs200 crore on capex in FY2008, the company intends to further spend ~Rs150 crore in FY2009 (on setting up additional capacities for carbapenems) and another Rs150-175 crore in FY2010 on capital investments.

On account of an already high debt level and further plans of large capital investments, our concerns related to Orchid''s high debt levels persist. We expect the company''s debt level to remain high over the next one to two years.

Forex translation loss expected in Q1FY2009
We expect Orchid to report a significant translation loss on the outstanding FCCBs to the tune of ~Rs58-59 crore (pre-tax) in Q1FY2009 due to the ~7-8% depreciation in the Indian Rupee against the US Dollar during Q1FY2009.

Filing spree continues
Orchid maintained its pace of regulatory filings in Q4FY2008. The company''s cumulative filings stand at 47 DMFs and 47 ANDAs till date in the USA. Of the ANDAs filed, 28 filings are in the Cephalosporin segment, 16 in the non-antibiotic segment and three in the betalactum segments. Further, the company has also made one additional Para IV filing with first-to-file (FTF) status during the quarter, taking the total tally of Para IV filings to five. These five filings are for products in the non-antibiotic space, with a combined market potential of $1.8 billion currently. The market for these products is estimated to grow to $2.3-2.4 billion by the time Orchid actually launches the products in the market.

Orchid has also ramped up its filings in Europe. During the quarter, Orchid increased its cumulative marketing authorisation filing count in Europe to 19. The company now has 15 dossier filings in the Cephalosporin segment, three in the non-antibiotic space and one in the Betalactum segment.

Further, the management has indicated that it plans to take its total filing count in the USA and Europe from 70 at the end of FY2008 to 100 at the end of FY2009 by having a filing run rate of two ANDAs per month. We expect strong revenue flow for the company as and when the filing pipeline gets approved and commercialised.

Para IV filings add sheen to US pipeline
Over the past few quarters, Orchid has become an aggressive participant in the Para IV patent challenge space. Till date, Orchid has made five Para IV filings, addressing a combined market potential of $1.5 billion. Favourable outcome on any of these patent challenge litigations could result in Orchid getting the 180-day exclusivity for the products, leading to significant upside from 2010 onwards. The company intends to continue making more such filings in order to build its Para IV pipeline.

Orchid''s Para IV FTF opportunities

Generic name	Innovator	Brand name	Market size ($ mn)
Desloratadine IR	Schering Plough	Clarinex	377
Desloratadine ODT	Schering Plough	Clarinex	14
Ibandronate Sodium	Roche	Boniva	400
Memantine	Forest Laboratories	Namenda	610

Alliance with Ranbaxy to present new business opportunities
Orchid has recently entered into a strategic business alliance with India''s largest pharmaceutical company, Ranbaxy, for multiple geographies and therapies for both active pharmaceutical ingredients (APIs) and formulations. What this means for Orchid essentially is that it would leverage Ranbaxy''s strong front-end presence in multiple emerging markets including India to enhance its own presence in these markets. Further, Orchid would also be a source of APIs for Ranbaxy, which would increase its contract manufacturing opportunities. While the exact quantum of the new business for Orchid is difficult to determine until the specific products and markets this alliance would cater to are known, we view this as a positive development for Orchid.

Revising FY2009 estimates, introducing FY2010 numbers
In order to factor in the higher revenue base of FY2008, the delayed launch of Tazo-Pip both in the USA and Europe, the pressure on the margins due to the rising crude oil prices (which would increase the company''s power & fuel costs) and the higher than anticipated debt and capex, we are revising our FY2009 estimates for Orchid. We are upgrading our FY2009 revenue estimates by 2.4% to Rs1,492.7 crore to reflect the higher revenue base in FY2008 but we are downgrading our profit estimate by 30%, accounting for the lower OPM and higher interest burden in FY2009. We now expect Orchid to deliver a pre-exceptional profit of Rs157.7 crore, which would translate into fully diluted earnings of Rs16.3 per share in FY2009.

We are also introducing our FY2010 numbers in this report. We expect Orchid''s revenues to grow by 17.6% in FY2010 to Rs1,756.0 crore, on the back of a full-year impact of the Tazo-Pip launch as well as the incremental contributions from the Carbapenem opportunity. We expect profits of Rs207.6 crore in FY2010 which should yield fully diluted earnings of Rs21.5 per share.

Valuation and view
Orchid''s performance in Q4FY2008 and FY2008 has been mixed: The top line growth driven by niche product opportunities has surpassed our expectations whereas the strong margin pressure due to sharp escalations in the raw material cost and the higher than expected interest burden has dragged down profitability. We remain positive on Orchid''s business model, which is focused on niche opportunities and has strong growth drivers. We are concerned about the high debt levels despite further equity dilution that occurred in the beginning of FY2008 to reduce debt. We are also worried about the never-ending capex despite the company''s stance of having completed its major investments.

The management has stated its intention of reducing its debt level further in the coming years, though we are yet to see the effect of the same on the company''s financials. Despite the strong growth drivers and a robust business model, we believe the above-mentioned concerns will remain as an overhang on the stock, until the company''s financials clearly reflect the management''s intentions of reducing the debt further. In view of these concerns, we are reducing our target price/earnings multiple for Orchid to 14x and rolling over our valuations to FY2010E earnings. We maintain our Buy recommendation on the stock with a revised price target of Rs300.

Valuation table (standalone)					Rs (cr)
Paticulars	FY06	FY07	FY08	FY09E	FY10E
Operating income	873.5	912.9	1238.9	1492.7	1756.0
Net profit	82.9	86.7	143.3	157.7	207.6
Shares in issue (cr)	9.7	9.7	9.7	9.7	9.7
EPS (Rs)	8.6	9.0	14.8	16.3	21.5
PER (x)	29.2	27.9	16.9	15.3	11.7
EV/Ebidta (x)	3.9	5.4	4.6	1.8	1.6
BV (Rs/share)	81.3	51.9	67.6	175.6	193.6
P/BV (x)	3.1	4.8	3.7	1.4	1.3
Mcap/sales	2.8	2.7	2.0	1.6	1.4
RoCE (%)	9.4	8.9	10.2	11.0	12.3
RoNW (%)	10.6	17.3	22.0	9.3	11.1

The author doesn''t hold any investment in any of the companies mentioned in the article.

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