Ranbaxy Laboratories: Hold

Recommendation: Hold

Sanjiv Shankaran

LAST year, Ranbaxy justified the faith the equity market reposed in the company by concluding a landmark deal for a a novel drug delivery system.

The deal coincided with the stock peaking to Rs. 1,250. Since then, the stock has fallen sharply to now trade at Rs. 660. With pharmaceutical stocks stabilising after taking a beating, a look at Ranbaxy's operations may be in order.

In the wake of a decline in profit margins over the last couple of years, investors can wait for a while before taking fresh exposures. However, shareholders may hold on to their exposure as the downside risks from current levels are low considering the company's potential.

Diversified revenue stream

A striking feature of Ranbaxy's operations is that, in absolute terms, it has one of the most diversified revenue streams in the pharmaceutical industry. The company is also one of the biggest generic pharmaceutical companies, in terms of revenue.

About 47 per cent of the company's sales in 1999 came from exports to all continents -- both the regulated markets and the ones with loose regulation. Ranbaxy also has a stake in overseas manufacturing facilities through a network of alliances and investments.

The diversified revenue comes from formulations (drugs in a ready-to-consume form such as tablets) and bulk drugs (the chemical ingredient for formulations), and this lowers the risk level.

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Overwhelming domestic impact

The diversified revenue stream, however, does not allow Ranbaxy to escape the environment that prevails in the domestic pharmaceutical market. Even for a global generic company, domestic operations are critical.

The market is characterised by a slowdown in growth in 1999 and an increasing presence of unbranded generics. These are formulations sold simply under their chemical name at a significant discount to the existing branded products. So significant has their influence been over the last couple of years that top-rung companies have also introduced unbranded formulations. The trend has had an adverse impact on the realisations.

Ranbaxy's critical therapeutic segment is anti-infectives, which is also the most competitive in the market. The company has introduced new products with higher margins in other therapeutic segments, but the heavy turnover from the anti-infective segment means the company's fortunes will largely depend on the segment.

The dependence on anti-infectives is not just confined to India; it true of other markets too. The weak trend in Penicillin-based drugs in the world last year impacted the company negatively in 1999.

Non-paying overseas investments

Ranbaxy spent a considerable amount of resources in getting its overseas operations off the ground, but till date, the returns have not come. In 1999, for instance, the company's loss from its consolidated overseas operations increased.

Of the overseas operations, the company's presence in the American market has probably drawn the most attention. In view of the potential size of the US generic market with the expiry of patents in quite a few blockbuster drugs over the next few years, the performance there is critical.

While a few Indian companies have either tapped or are getting into the supply of bulk drugs in the US market, Ranbaxy is one of the few domestic companies that has received approval for the more lucrative formulation product.

A few days ago, Ranbaxy and Wockhardt got the approval to market the cardiovascular formulation Enalapril Maleate. Ranbaxy had earlier got approvals for other formulations too.

The potential of the US market has a had a volatile effect on the pharmaceutical stocks. While the market size is large and may increase in the light of the growing importance of generic drugs to check healthcare costs, the initial rosy projections may be misplaced.

Available evidence indicates that the price of drugs that lose patent can fall rapidly as more and more players jump in. Also, the original patent-holder uses the complex patent guidelines as an entry barrier by contriving to extend the life of the patent. Consequently, generic companies have to wait longer to recover developmental costs.

R&D, the key

In this environment, Ranbaxy's R&D expertise will play a key role. The company's proven R&D skills show that it has a competitive edge in replicating and lowering the cost of products that will become generic soon. In addition, by making about 600 filings annually in over 50 countries, the company has built a base which can handle tricky regulation.

R&D has also helped Ranbaxy augment its earnings directly through the drug delivery deal with Bayer last year. The company has also brought two new chemical entities up to the clinical trials stage. The overall R&D strength will have a significant bearing when the equity market values the company.

Ranbaxy has brought together diverse ingredients that can make for a successful global generic pharmaceutical company. But, given the lacklustre performance over the last two years and the gestation period for its overseas investments, investors may wait and watch than buy into the stock at this point in time.