This article provides an in-depth fundamental analysis of Torrent Pharmaceuticals Limited (Torrent Pharma), an Indian pharmaceutical company focused on lifestyle-related drug segments like Cardiovascular (CVS) and Central Nervous System (CNS).
In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.
Torrent Pharma Research Report by Reader
Reader’s Query:
Hello Vijay,
Here is my analysis for Torrent Pharma:
- The company is an API (active pharmaceutical ingredient) and formulations player.
- The stock is available at reasonable valuations (trailing PE around 12).
- It has huge growth potential in both API and formulations business where it has presence.
- It is spread across the globe with US as key growth driver for future.
- It has recently spent ₹650 cr on Dahej plant.
- Latest results show that it is facing challenges in Brazil (around 15% revenue).
- It recently got bumper sales (one off kind, which will taper over a period of time) from generic drugs Abilify, Nexium, Detrol in US.
Management Quality of Torrent Pharma:
- No equity dilution and
- Regular dividend and
- 20% sales CAGR (10 yrs.) along with
- Positive operating cash flow gives credence to management quality.
Opportunity:
- Use synergies from Elder Pharmaceuticals Limited and Zyg Pharma Private Limited
- Huge presence across US, Europe, India and rest of the world. Demand is soaring in US and Germany.
- Plans to do 10-15 ANDA (abbreviated new drug application) filing for generics in US every year
- Dahej plant to take care of current and future demand.
- Torrent Pharma is currently running at full capacity for regulated markets (pre-Dahej era)
- No more significant capex requirement for future demand
- Improving sales productivity
Risks:
i) Debt:
- Though Torrent Pharma can continue to grow at 20%+ rates given it has almost doubled its production capacity through Dahej and leverage synergies/strategic fitment from Elder Pharmaceuticals Limited and Zyg Pharma Private Limited acquisitions, I see that debt of Torrent Pharma is very high, which is close to ₹2000 cr (as per last conference call) due to Elder pharma acquisition.
- However, from the US, I see there will be a windfall gain of close to ₹1200 cr in this year due to the 3 generics sales there. So net debt is ₹800 Cr. (D/E close to 0.3, which is not bad).
- High ROCE, coupled with high NPM should address high debt to some extent in future.
- However I feel that Torrent Pharma seriously needs to address receivables and inventory part to free up capital.
- Currently receivables and inventory is about 57% of their sales while Industry average is around 35% average. There is a scope for improvement (but why at such a high level)
- Debtor days (receivables days) have reduced to 3 months in last quarter against industry average of 2 month. It was 4 months in the last annual report.
ii) High Receivables:
- Another issue is rising receivables.
- Huge capex spike is also there last year, due to Elder Pharmaceuticals Limited acquisition and capex spend in Dahej. Otherwise capex had been ok in the past.
- Net fixed asset turnover (NFAT) has reduced recently, showing deteriorating operating efficiency but it could be due to these acquisitions. I don’t know if it is the right assumption.
- Delay in ANDA approvals would have impact on debt and cash flow.
Valuation analysis of Torrent Pharma:
- Trailing PE of 11 looks reasonable and close to fair value (graham’s intrinsic value of ₹1138 with 20% growth assumption which is their 10 yrs sales CAGR).
What is your view on this analysis?
Does Torrent Pharma look well set to reap the rewards of their new plant and demand in the next few years and so do the investors?
Regards,
Rahul Khandelwal
Dr Vijay Malik’s Response
Hi Rahul,
I appreciate the hard work that you have put in the analysis of Torrent Pharma. It is a very kind gesture to share the analysis with the author and readers of this website. I thank you on behalf of all the readers of www.drvijaymalik.com for the time & effort put in by you. Let us analyse the past consolidated financial performance of Torrent Pharma.
Financial Analysis of Torrent Pharma:
Torrent Pharma has been growing its sales at an excellent pace of about 20% year on year over the last 10 years (2006-15). The last 4 quarters (Jan-Dec 2015) have witnessed an increase in sales of about 35% over FY2015, which seems primarily on account of the acquisitions done by Torrent Pharma in the last 2 years.
A look at the profitability trend of Torrent Pharma would indicate that both the operating profitability margin (OPM) and net profit margin (NPM) have witnessed fluctuations during the last 10 years (FY2006-15). The profitability margins were increasing since FY2006 and peaked in FY2010 when the margins started declining and then bottomed out in FY2012. Since FY2013, the profitability margins have been improving.
Fluctuating margins are a characteristic of its primary generics business, which faces competitive pressures that limit its ability to pass on the entire increase in raw material costs to its end customers. However, throughout the last 10 years, the operating profit margins (OPM) and net profit margins (NPM) have been consistently at healthy levels in excess of 14-16% and 10% respectively.
Further advised reading: How to do Business Analysis of Pharmaceutical Companies
In FY2015, Torrent Pharma reported a non-operating income of ₹286 cr, which is primarily on account of net foreign exchange gains of ₹253 cr. (page 133 of FY2015 annual report):
The forex gains of ₹253 cr, which is about 27% of profit before tax of ₹940 cr. in FY2015, indicates that the reported net profit margin of 16% in FY2015 might not be a true representation of operating profits. Excluding the impact of this forex gain, (assuming the company’s tax payout ratio of 20%), the net profits would have been lower by ₹202 cr. (253*0.80) and net profits would have been ₹550 cr. instead of reported net profit of ₹751 cr. The PAT margin would have been 11.8% instead of the reported PAT margin of 16%.
Also Read: How to do Financial Analysis of a Company
Over the years, the tax payout ratio of Torrent Pharma has been fluctuating from 20-25%, which is less than the standard corporate tax rate in India. The primary reason seems to be the tax incentives that manufacturing units of Torrent Pharma get due to their location in Sikkim and Himachal Pradesh.
Torrent Pharma is coming up with a new capacity in Dahej, Gujarat in a special economic zone (SEZ), which would have tax rebates for the next many years. It implies that Torrent Pharma would be able to keep its tax payout ratio less than the standard corporate tax rate for the next few years.
Operating Efficiency Analysis of Torrent Pharma:
Net fixed asset turnover (NFAT) of Torrent Pharma reflects that it was able to improve its asset efficiency over the years from 3.03 in FY2007 to 4.94 in FY2014 when it witnessed a decline to 2.51 in FY2015. The decline in NFAT of Torrent Pharma in FY2015 seems on account of the acquisition of Elder Pharmaceuticals Limited in June 2014.
You have rightly pointed out that the efficiency of working capital management of Torrent Pharma has declined over the year. The inventory turnover ratio of Torrent Pharma has declined from 6 in FY2010 to 4 in FY2015. Similarly, the receivables days (debtor days) have increased from 53 days in FY2011 to 106 days in FY2015, which indicates that the company is not able to collect its money from its customers in time.
An investor may think that the sudden rise in receivables days from 78 days in FY2014 to 106 days in FY2015 can be due to the acquisition of Elder Pharmaceuticals Limited by the company in FY2015. However, even otherwise, an analyst would notice that the receivables days had been deteriorating from 53 days in FY2011 to 78 days in FY2014, which clearly indicates that there are certain issues plaguing the cash management of Torrent Pharma.
Also Read: 5 Simple Steps to Analyse Operating Performance of Companies
The above analysis of receivables is based on the consolidated financials of Torrent Pharma, however, if an investor studies the comparative receivables position of the company at both consolidated and standalone levels, then further insights can be gained in the company’s actions.
As per the FY2015 annual report (page 97), the breakup of trade receivables of Torrent Pharma at standalone level reflect that there are ₹222 cr of receivables outstanding for more than 6 months from the date they become collectable:
However, when an investor notices the receivables position of Torrent Pharma in the consolidated financials (page 132 of FY2015 annual report), which cancels the impact of receivables due from group companies, then it comes out that the receivables due for more than 6 months are only ₹16 cr:
It indicates that the majority of receivables owed to the standalone entity of Torrent Pharma for more than 6 months are from its own subsidiaries, on account of sales of products from the Indian unit of Torrent Pharma to its subsidiaries.
When an investor studies the related party transactions on page 109 of the FY2015 annual report of the company, then she comes to know that these receivables are due primarily from the USA, Brazil and Romania subsidiaries. (An investor can find the details of the country of operations of the entities in this table from the website of Torrent Pharma):
The above observations would highlight to the investor that the subsidiaries of Torrent Pharma in the USA, Brazil and Romania are not remitting money to the Indian unit, despite collecting them from their end customers in respective geographies.
An investor should try to understand the reasons why Torrent Pharma is keeping the money parked in overseas locations, while it needs the money in India to meet its liabilities.
On account of non-receipt of money from its overseas subsidiaries, Torrent Pharma has to raise incremental debt over and above what it required for funding its acquisition of Elder Pharmaceuticals Limited, which could have been avoided to that extent (about ₹200 cr. which is due for collection for more than 6 months from overseas subsidiaries). We would discuss more on the debt requirements of Torrent Pharma later in the article.
The receivables data at the standalone level shown above shows that the receivables that are more than 6 months have undergone a substantial increase from ₹126 cr. in FY2014 to ₹222 cr. in FY2015.
An investor should keep on monitoring the receivables position of Torrent Pharma closely to see whether everything is in order.
Read: How to Monitor Stocks in Your Portfolio
Margin of Safety in the Business of Torrent Pharma:
i) Self-Sustainable Growth Rate (SSGR):
(As mentioned in the article on Self-Sustainable Growth Rate, SSGR does not factor in working capital changes. However, we can estimate whether funds are being tied up in working capital by comparing cPAT with cCFO. Torrent Pharma, has had PAT for the last 10 years (FY2006-15) of ₹3,096 cr. whereas the CFO over a similar period is ₹3,325 cr.)
Also Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company
Analysis of SSGR indicates that if Torrent Pharma can manage its working capital management and operating efficiency properly, then it can grow continuously at about 25-30% growth rate without creating an additional debt burden on the balance sheet.
As Torrent Pharma has been growing at a rate of 20% over the years up to FY2014, before it acquired Elder Pharmaceuticals Limited in FY2015 (June 2014), it was able to manage its growth without effectively leveraging its balance sheet. The entire increase in debt of about ₹900 cr from FY2006 to FY2014 is visible as an increase in the cash balance & investments of about ₹900 cr over the same period.
However, it seems counter-intuitive that a company would carry a high cash balance and simultaneously have high debt on its balance sheet. Even at a conservative rate of about 10% as the cost of debt (base rate of most of the banks until recent interest rate reductions), the debt of about ₹1,000 cr. entails an interest cost of ₹100 cr per annum, which is an outflow that could have been avoided, if the company manages its cash positions efficiently.
An investor should keep a close watch on the cash levels of any company along with the debt levels. If there is a constant increase in disclosed cash balance and simultaneous increase in debt levels, then it should increase the caution level of the investor. An investor would appreciate that the debt has its costs and therefore, raising debt only to keep it with banks is not a good strategy as it is counterproductive for the company and shareholders.
Sometimes, incidences in the past have proven it that such cash balances might be questionable. Therefore, an investor should remain cautious and keep a close watch to monitor future developments on this front.
Read: How to Monitor Stocks in Your Portfolio
ii) Free Cash Flow Analysis of Torrent Pharma:
SSGR being higher than the sales growth rate means that Torrent Pharma could easily manage the growth without external resources. It gets substantiated when the investor notices the free cash flow (FCF) position of Torrent Pharma from FY2006 to FY2014. During the 9 year period of FY2006-14, the company reported an FCF of ₹1,017 cr. (CFO of ₹2,514 cr. and capex of ₹1,498 cr).
The company could leverage its free cash flow generating ability and venture to grow its business by making acquisitions of Elder Pharmaceuticals Limited in FY2015 and Zyg Pharma Private Limited in FY2016. The company funded these acquisitions partly by debt and as a result, Torrent Pharma has witnessed its debt levels increase to ₹2,740 cr in FY2015.
An investor needs to keep track of whether Torrent Pharma is able to continue generating the free cash flow in future as well, once it integrates the newly acquired companies in its ambit. Managing acquisitions is a tough proposition and instances in the past contain cases where acquisitions have not worked well for acquirers. Therefore, an investor needs to keep a close watch on the business performance of Torrent Pharma in future to assess whether the acquisition would prove cash gain or cash drain for the company.
Torrent Pharma has been a consistent dividend-paying company and has been paying out about 25% of its earnings to its shareholders. Over the last 10 years (FY2006-15), Torrent Pharma has cumulatively paid about ₹855 cr in dividends to shareholders (excluding dividend distribution tax, DDT). If we add DDT of about 15% on the dividend paid, then the amount of payments come to ₹983 cr.
One observation constantly keeps coming to an investor’s mind why would a company keep on paying dividends, while it is continuously raising more and more debt over the years. This needs further probing by the investor before she takes any final investment decision about Torrent Pharma.
Investors should be cautious of investing in companies, which have continuously increasing debt levels, as high debt has the potential of increasing the risk of bankruptcy and reduced profitability under tough business conditions.
An investor should read the analysis of two other companies: Ahmednagar Forgings Limited and Amtek India Limited, to understand the impact low fixed asset turnover can have on the debt levels of companies. You may read their analysis here:
- Also Read: Analysis: Ahmednagar Forgings Limited
- Also Read: Analysis: Amtek India Limited
Margin of Safety in the market price of Torrent Pharma:
Torrent Pharma is currently available at a P/E ratio of about 14 (March 6, 2016) based on consolidated earnings.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, taking into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Analysis Summary
Overall, Torrent Pharma seems to be a company, which has achieved a good pace of business growth over the years along with healthy profitability. The company has been generating free cash flow over the years, however, it has shown the concerning trend of rising cash & investments along with rising debt levels. An investor needs to do further analysis (to the extent of forensic analysis) before committing large amounts of money to it.
An investor should also analyse the increasing amount of delays in realizing receivables from its overseas subsidiaries, to monitor whether everything is in order or whether the company has any specific logical plan of utilizing the cash being retained in overseas subsidiaries.
Torrent Pharma has embarked upon business expansion by acquiring Elder Pharmaceuticals Limited and Zyg Pharma Private Limited, which are partly debt-funded. It has led to further leverage on its balance sheet. As discussed above, an investor needs to keep a track of the cash-generating ability of a newly acquired business to assess whether these decisions prove cash positive or negative for the company.
Also Read: How to Monitor Stocks in your Portfolio
These are my views about Torrent Pharma. However, any investor should do her own analysis before making any investment-related decision about Torrent Pharma.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Hope it helps!
Regards,
P.S.
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Disclaimer
Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.
