Cipla: High valuations offer little upside

Cipla has shed about 6% towards the end of last week after cut in ratings and downgrades from research firms. With the exception of a couple of stocks in the pharma space, research firms (Bank of America Merrill Lynch (BoAML), CLSA) have taken a bearish view on the short-term prospects of the sector. Analysts say despite moderate EPS growth (of 5-10%) over the past six months and similar expectations in the March quarter of 2015, the stocks in the sector have rallied 30% over the last three months.

Among the reasons for the bearish view are high valuations for the sector and for Cipla. The BSE Healthcare sector is up 32% over the last six months and at current valuations the index trades at 76% premium to the Sensex, which is at an all-time high. Cipla, for example, trades at 42 times its FY15 estimated earnings and 30 times its current year estimates with only Lupin being more expensive in the large cap space.

The Cipla stock outperformed the broader markets by a wide margin gaining 75% over the last one year. While most analysts remain positive on the company's respiratory portfolio and upside from launches in different markets, the benefits will accrue only over the long term. BoAML analysts believe that the near-term valuations leave limited upside and thus have downgraded the stock to 'neutral'. Consensus Bloomberg estimates peg the one-year target price at Rs 707 for the stock, which was up 1.5% at Rs 711 on Monday.

The key near-term issues from the business perspective for the sector are on account of currency uncertainty in emerging markets, high base effect, lack of any fresh USFDA and higher competition in some key products in the US market. The sector, according to analysts, has seen earnings downgrades for the first time in several quarters. March 2015 quarter expectations for Cipla, however, are mixed. While the company is expected to see pressure on account of volatility and weakening of emerging market currencies versus the dollar, this is likely to be compensated by gains from the supply of antacid Nexium to Teva from February, 2015.

Analysts expect revenues to grow by upwards of 14% with Nexium benefit boosting revenues by $26 million and Ebidta by $22 million. However, given the adverse cross-currency movement which will have a 6-7% impact, ex-Nexium exports growth is expected to be a muted two%. Exports accounted for about 55% of Cipla's revenues in the December 2014 quarter.

Cipla's profitability in recent quarters has taken a hit given the company's strategic transformation efforts including having its own front-end in key markets. Given the higher cost of setting up its infrastructure and more filings, the operating profit margins which were at 27% at the start of FY14 are at about 20% currently.