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Nath Balakrishnan

AN INVESTMENT can be considered in the initial public offer of the Hyderabad-based Vivimed Labs. However, only those with a stomach for risk need to consider subscribing to the issue.

Background

Vivimed, which was originally involved in the manufacture of bulk drugs such as Ibuprofen, made the transition to being a player in the specialty chemicals space to counter the downturn in prices in the bulk drugs market.

Vivimed now makes specialty chemicals such as Triclosan, an anti-bacterial that finds wide application in dental care and deodorants; Avis, which offers sunscreen protection; CaGP, an ingredient that finds application in dental care; Chlorophenesin, an anti-fungal that serves as a preservative in cosmetics and foodstuffs; and NDGA, an anti-oxidant.

For the year-ended March 2005, Vivimed derived 54 per cent of its revenues from Triclosan; further, 23 per cent of the revenues for FY-05 was accounted for by sales to Hindustan Lever and its associates.

Apart from Hindustan Lever, Vivimed also has customers such as Marico and Anchor Healthcare in the domestic market; Unilever, Arnaud of France and Harmet International of the US are some of its customers on the export market.

The company has also developed a product for Hindustan Lever code-named A123, this product, according to the offer document, has received encouraging response from MNCs.

Object of the issue

Proceeds from the offer would be used to fund the expansion of the Triclosan manufacturing facility from 480 tonnes to 750 tonnes.

The company intends to set up in-house manufacturing facilities for products such as Avis, CaGP and COSVAT, which are now being outsourced; it also plans to manufacture A123 at this facility. The new factory would come up at Nalgonda in Andhra Pradesh.

Outlook

The risk element to our recommendation stems from Vivimed's dependence on a single product — Triclosan — to generate more than half its revenues. Though the reliance on this product has fallen from close to 80 per cent in FY-01, the current level of exposure to it is still high. However, we view the continuous decline in the contribution from Triclosan as a positive. There have also been some health concerns on the use of Triclosan in products such as toothpastes. Though no adverse pronouncements have yet been passed against its use, any news flow that suggests that it does indeed pose a health hazard will exacerbate the downside risk to this stock.

Given the bargaining power that a player such as Hindustan Lever would command and the multiplicity of supplier arrangements it would have in place, we do not expect this business to score high on the profitability metric.

sHowever, having a customer such as Hindustan Lever would serve as a good point of reference when courting other international customers.

Vivimed appears to have responded to this challenging environment by bringing about a change in its sales mix. Exports, as a percentage of sales, have risen from 43 per cent in FY-02 to 51.4 per cent in FY-05.

The higher level of exports has also rubbed-off on operating margins. From 17.3 per cent in FY-02, that number stood at 19.7 per cent for FY-05. In the commodity-type environment that Vivimed operates in, high profit margins are a positive.

Valuation and view

Though Vivimed's sustainable earnings have grown at a CAGR of 24 per cent over the past three years, we expect the earnings growth in FY-06 to slow on the back of rising depreciation (on account of capex) and interest costs (because of an increase in long-term loans to part-fund the expansion programme).

On the back of an estimated 10 per cent earnings growth, the stock will be available at 9.5 times its expected per share earnings (on the expanded equity) for this fiscal, based on the offer price of Rs 70.

At a return on shareholder funds of 23 per cent for FY-05 and a market cap-to-sales ratio (based on the offer price and FY-05 sales) of less than one, we believe that valuation levels are not too demanding.

However, given the extant profile of Vivimed's business and the attendant risks of investing in a small-cap stock, the offer appears suitable to investors who are not averse to risk.

Offer details

Vivimed is offering 25 lakh shares at Rs 70 each. Of this, 18.5 lakh shares are being offered to retail investors; the rest has been earmarked for employees and NRIs/FIIs.

The minimum application should be for 100 shares and thereafter in multiples of 100. The entire amount is payable on application. The offer opens on July 9 and closes on July 13. UTI Securities is the lead manager and Aarthi Consultants the registrar to the issue.

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