The Hindu Business Line : SMS Pharma: Invest at cut-off

A valuation level that is not too demanding, reasonably good operating metrics and the growing potential in the contract manufacturing space make the offer worth exploring.

An investment may be considered in the initial public offering of Hyderabad-based bulk drug player SMS Pharma. The offer, Rs 360-380 band, will be valued at 12-13 times the expected consolidated per-share earnings for FY-08 on the expanded equity base, on the back of conservative growth estimates. This is reasonable, in our view, in the light of prospects in the contract manufacturing space and a fairly strong patent expiration pipeline over the next few years. Investments may be made at the cut-off price.

Background

SMS operates four manufacturing facilities, apart from a research and development centre, in and around Hyderabad. The primary purpose of the public offer is to fund the setting up of another facility at Vizianagaram in Andhra Pradesh, apart from meeting working capital expenses.

Investment rationale

As outsourcing becomes an integral part of the pharma landscape, outfits focused on a specific activity of the manufacturing chain (such as bulk drugs, as is the case with SMS) will be better placed to reap benefits. Given SMS' sphere of operation, we believe that the comfort level of the formulations players will be higher when they deal with players unlikely to morph into competitors. SMS already has leading names such as Ranbaxy, Dr Reddy's, Cadila, Sun and Torrent as its clients. We expect the business profile to improve further, as SMS pursues supply deals with players based abroad.

SMS is among the world's top producers of bulk Ranitidine (an anti-ulcerant), and revenues from this product accounted for almost half the revenues in H1FY07. While this exposes the company to pricing vagaries of this particular product, we believe that as the benefits of the new facility kick in and contributions from other products such as sumatriptan and gemcitibine scale up, the concentration risk will diminish considerably.

While cost competitiveness is at the very core of outsourcing, we note that in the SMS case, it is not at the expense of profitability. Margins, for example, in FY-05 and FY-06 have been in the high teens; for the half-year ended September 2006, margins breached the 20-per cent mark — a healthy number for an outfit with presence only in the bulk space.

Over the past five years, SMS also has a record of paying out a consistent dividend of 20 per cent — a feature conspicuous by its absence in the several pharma outfits that have hit the market in recent times.

Offer details

SMS intends raising about Rs 100 crore through the public issue, by offering about 26 lakh shares in the price band of Rs 360-380. UTI Securities and Aarthi Consultants are the book running lead manager and registrar to the issue respectively. The offer opens on February 5 and closes on February 8.

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