Right Prescription

Considering Natco Pharma's size, restructured business model and positioning in the domestic and US markets, the stock is a value buy for investors

One-year beta: 0.9
Institutional holding (as of Mar''11): 13.7%
Current dividend yield: 0.7
Current P/E: 14.3
Current m-cap: 774 crore
Current market price: Rs 275

The Rs 460-crore, Hyderabad-based Natco Pharma is engaged in the manufacture of formulations, active pharmaceutical ingredients, or APIs, and contract research and manufacturing services. The company is a leading player in the profitable oncology therapeutic segment deriving two-third of its business from this segment.

Formulations business, contributing over 60% to the company''s total revenues, is likely to be the key growth lever for the company in the coming days. The company follows a policy of launching complex-to-manufacture niche products leading to minimal competition.

It has entered into exclusive manufacturing and supply agreements with leading pharma companies like Mylan, Watson, Dr Reddys Labs and Lupin.

Natco has strong pipeline of abbreviated new drug applications (ANDAs) in the US. With aggressive Para IV filings, the company is looking at making successful inroads in the US generic market.

The pharma firm also has a small but promising pipeline of new chemical entities developed through innovative research and development. Its NCE for pancreatic cancer has recently been awarded orphan drug status by the US FDA. When a drug is meant to cure rare diseases affecting less than 2,00,000 patients, it is designated as an orphan drug. The company thereby enjoys incentives like seven-year marketing exclusivity, tax credits and fast-track approval.

The drug maker is predominantly dependent on two markets ? India and the US ? for its business. It is, therefore, looking at tapping the South American market by setting up a unit in Brazil.

The company''s net sales have grown at a CAGR of 25% in the past four fiscals. Its net profit has risen at a CAGR of 19.5% during the same period. The company has been paying dividends since the past five years at an average payout of 10%. It intends to spend nearly 5% of its revenues in research and development.

While the company has been generating positive cash flows, it has been in an expansion mode since the past couple of years. It has strong finances with a comfortable debt equity ratio of 0.4. It earns stable operating profit margins at 16-17% (calculated on a trailing four quarter basis). The company has plans to raise funds of around Rs 100 crore through private placement route to build its product pipeline over the next three years. This may, however, result in to an equity dilution of close to 10%. Natco is looking at divesting its non-core low-margin pharmacy business in the US.

Growing competition in the domestic oncology segment is likely to threaten Natco''s first mover advantage and pricing. Natco''s API segment has been under pressure since the three years on account of significant price correction. The company''s future revenues are dependent on its partners. Any delay in seeking approvals by the partners will also impact its revenue and earnings visibility.

The company is trading at 14 times of its consolidated trailing 12-month earnings. At a market capitalisation of Rs 774 crore, it is valued at 1.6 times its total net sales of the past four quarters. Considering the size of the company, its restructured business model and its positioning in the domestic and US markets, the stock is a value buy for investors.

Kiran Kabtta Somvanshi