US$ 500 million provisions to eat into Ranbaxy's profits

Indian pharma major, Ranbaxy, has set aside US$ 500 million (Rs 2500-2600 cr) after it signed a consent of decree with the USFDA (U.S. Food and Drugs Administration). The provision of US$ 500 million is huge compared to analysts' expectation of US$ 250-300 (Rs 1300-1500 cr).

In 2008, the USFDA banned the import of more than 30 products manufactured by Ranbaxy. This setback came when the regulating body found significant deviations from the US Good Manufacturing Practices in Ranbaxy’s manufacturing facilities at Dewas (Madhya Pradesh) and Paonta Sahib (Himachal Pradesh).*

Ranbaxy has posted disappointing results in the recent quarters, and one need to see how the company is going to pay this penalty. According to the half yearly results announced in Jun 2011, its total debt (Rs 2800 cr) is almost equal to the provision amount, while the cash and bank balances (Rs 1634 cr) are far less than the provision amount. In fact, the net yearly profits for 2010 (Rs 1736 cr) also remained lower than the provision.

In the recent results for the 9 months ended Sep 2011, the company posted a 4% fall in its total sales to Rs 6233 cr over  the corresponding period last year. Its EBITDA margins also decreased from 27% to 11% on a YoY basis. The sales in India remained strong with 15% growth, but the exports income decreased by 8%. We believe that this is a concern, given the fact that the provision amount exceeds the company's current cash position.

Ranbaxy has recently launched a generic version of anti-cholesterol drug, Lipitor, in the US market. According to IMS Health, the company has gained 3% market share with this product in the first 2 weeks itself, which sounds quite encouraging. As we mentioned in a previous article, it expects to make approximately US$ 300-400 million (Rs 1500-2000 cr) in earnings in the first 6 months. The earnings estimates however, are quite lower compared to the penalty provision, which we believe is a huge blow for the company.

Daiichi-Sankyo, the holding company of Ranbaxy, has cut its executives' pay by 5%-30% for the next 6 months. They have also lowered the profit outlook by 48%, indicating the impact of the penalty on their revenues as well. The deal is still awaiting the court's approval. Assuming that the ban on the 30 products is lifted, it will still take a year to sell these products in the market. In the worst case scenario, if the company is required to re-file for approval for these products, it will need to wait for about 3 years to get approval.

Besides, there is no clarity on the exact amount and timeline of the penalty to be paid to the USFDA. With a significant impact on its earnings, we believe that Ranbaxy is not a good scrip to invest into in the current volatile market, where sentiments are changing quickly.

*(Source: USFDA website)