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Wockhardt - Hale And Hearty

Not too long ago, Wockhardt was floundering in a vortex of debt and losses. In a remarkable reversal supported by a debt restructuring initiative and a consistent focus on R&D, the company now presents a value proposition for investors, says Shrikant Akolkar.



Companies with a high debt on their balance sheet will always be avoided by investors, especially in times when the interest rate scenario is not favourable. Needless to say, the stocks of companies that have been referred to the debt restructuring cell would be the last ones on investors’ minds. From the investment perspective, such companies are obviously a big NO as they find it very difficult to return to profits. Of course, there is one factor that cannot be ignored before you jump to any conclusion – the management’s willpower to stand up to odds and perform better. Generally speaking though, the cases where companies have actually managed to come out of such a mess are rare.

From huge forex losses to debt restructuring and a dirty balance sheet, pharma company Wockhardt has been through what can best be described as a hellish situation over the past five years. The company, though, has been among the rare cases, emerging victorious from these trying circumstances. All this strengthens our conviction in this company, which we believe is having a dream run on the bourses and helping investors create wealth. The bullish phase of the stock may have already begun some time ago (up 329 per cent on a YTD basis), but we believe that the counter has a whole lot of steam yet before it reaches its peak.

Background

This 45-year old company is among the first few Indian companies to have started business in the developed US market, and has always proactively engaged with the changes in the international pharma markets. Wockhardt is also the first company in Asia and outside of the US to have developed its own version of Recombinant Insulin. It is further developing insulin analogues at its research facilities. It has also been actively seizing the correct opportunities to acquire companies to grow inorganically, particularly in the European region.

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The Business

Wockhardt is principally an export-oriented pharma company with a focus mainly on the US and Europe. Over the past five years, its revenues from the US have grown at a five-year CAGR of 63 per cent. The US contributed to 10 per cent of its total revenues in 2006, which has now increased to 41 per cent. The company was marketing 10 products there in 2006, and this number has gone up to 71 as of now. The company has a good pipeline of ANDA-approved products and also has a potential 10 first to file products (FTFs), which are expected to bring in huge revenues in the future.

The domestic business has grown at 11 per cent during the same period. This is below the market growth rate in India, but we expect it to revive as it has launched several products over the last few years.

Its French revenues have been lower than what they used to be before the patent expiry of ART 50. However, the company is preparing to launch another patented product ARTflexo and a few generic products in France, which will boost its business there. In the UK, Wockhardt is the largest Indian pharma company. It has recently won a large tender for the supply of insulin from the Department Of Health (DoH) there. In Ireland, the company is witnessing positive sales growth despite a sluggish economic environment. The company is set to launch about 20 products in the UK and Ireland, which will improve its performance. It has also launched Atorvastatin in a few countries, which will help it put in good numbers going forward.

In the rest of the world (ROW) market too, it has seen a CAGR of 11 per cent over the past five years. Last year, the company posted a healthy growth of 36 per cent in the ROW market, indicating that the growth momentum will sustain.

Over the past 10 years, the company’s topline saw a CAGR of 21 per cent and its operating profits grew at 30 per cent. The net profit, though, has registered 14 per cent growth in the period, including two years of losses.

Despite all this, how did the company report losses? Here are the answers.

Debt-Funded Acquisitions

In order to grab the opportunities available in the regulated markets (USA and Europe), Wockhardt acquired several companies between 1998 and 2007. Thanks to these acquisitions, its revenues rose from Rs 200 crore in 2001 to Rs 3500 crore in 2008.

Though the revenues went up, its sound balance sheet was stressed due to the debt build-up of Rs 4200 crore by 2008. The debt-to-equity ratio, which was nearly negligible at 0.14x in 2002, surged to 4.1x in 2008. This debt pileup mainly included foreign currency convertible bonds (FCCBs) worth USD 108 million, external commercial borrowings (ECBs) worth USD 250 million by its Swiss subsidiary and another set of ECBs worth Euro 158 million by its French and Irish subsidiaries.

This high leverage took a heavy toll on the company’s profits, as interest payments rose sharply. This is evident from its interest coverage ratio, which declined from a highly comfortable level of 30x in 2005 to a mere 5x in 2007. This further declined to 2x in 2008. Business in all these years remained quite normal. Sales were growing; operating profit margins were intact at 23-24 per cent. However, the net profit tumbled to the extent that the company reported a loss of Rs 160 crore in 2008 and repeated the same feat in FY10, when its losses stood at Rs 1000 crore. What went wrong?

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Loss On Derivatives

Due to the financial crisis of 2008, major currencies such as the euro, GBP and even the rupee depreciated significantly against the US dollar. This global meltdown impacted Wockhardt’s foreign exchange hedged positions, and the company incurred a forex loss of Rs 580 crore.

What further worsened matters were the company’s treasury positions. S R Batliboi & Company, its auditors at that time, reported in the annual report that Wockhardt had stopped margin payments on certain derivative contracts, due to which its banks had terminated the derivatives contracts and claimed Rs 489 crore from the company. Wockhardt disputed the same. It did not make any provision for these losses in its financial statements, which turned out to be a liability in the following year. The issue was resolved in FY12 after it converted the liabilities on derivatives into preference shares.

As losses zoomed, the company faced a severe liquidity crunch. This impacted its ability to repay FCCBs (USD 108.50 million), and the company was also certain of a default on the term loans that were due in 2009. Foreseeing this, it eventually approached the Corporate Debt Restructuring Cell (CDR Cell) through ICICI Bank in 2008. This debt restructuring scheme proved to be very vital for its survival and future prospects.

The Turnaround

Wockhardt’s restructuring plan was approved by the CDR Cell in July 2009. Under the scheme, the company was granted a concessional interest rate of 10 per cent, of which eight per cent was payable on a monthly basis and two per cent was converted into preference share capital. This brought down its interest costs substantially. The company also received priority loans to meet its urgent capital needs.

The CDR Cell asked the promoters to bring more contributions into the company and to sell the noncore assets between 2009 and 2015 to strengthen its financial position. Its FCCBs and ECBs were also restructured. Wockhardt was not allowed to execute any derivative contract without the approval of the cell. These concessions and the liquidity infusion transformed a debt-ridden Wockhardt into a profitable company by FY11.

Under the scheme, the company divested its non-core businesses, which included its animal health business (Rs 170 crore) and its nutrition business (Rs 1280 crore). The nutrition business comprised two domestic brands, Protinex and Farex, bought from Dumex in 2006. The business was originally sold to Abbott, but the deal was called off later under pressure from its FCCB holders. After clearance from the court, the nutrition business was sold to Danone in July 2012. Both these divestments brought in a lot more cash (Rs 1297 crore) than required as per the CDR (Rs 790 crore).

The CDR Cell also covered the disputed FCCBs of the company. Of its bondholders, State Bank of India chose to take up preference shares, while the other bondholders filed a winding up petition against the company. The court has directed the company to repay the FCCB holders in multiple instalments ending August 2012, by which time all its FCCB obligations will be cleared.

Besides the above, its USD 250 million loan in Europe has also been restructured, extending the repayment schedule to 2015. The 88 million Euro loan of its French subsidiary has been restructured to be repaid over the next 10 years. On the back of the reduction in revenues of its French subsidiary, Wockhardt has reduced its staff and also has shifted some operations to India to rationalise it.

As proposed in the CDR plan, the promoters pumped in Rs 80 crore in the company. Overall, Wockhardt has repaid loans worth Rs 850 crore in cash over the last three years. Its debt currently stands at Rs 3400 crore, which will further reduce as the company intends to use its cash (Rs 900 crore) and the money received from divestment of the nutrition business to repay some part of the loans. Its current debt-to-equity ratio is under 1x, well below the 5.5x level which it crossed in FY10. The decline in the ratio has also been due to a surge in its total share capital.

This laudable turnaround would not have been possible without good business operations and winning products.

Huge R&D Investments

Despite reporting losses in 2008 and FY10*, Wockhardt has been consistent in its R&D investments. The fruits of this are seen in its strong product pipeline. The company has a total of 1570 patents filed, of which 158 have been approved. It has a potential 10 FTFs and 19 inlicensed products in India. Besides, it also has a few products undergoing clinical trials. Its potential drug WCK 771 is expected to meet with success as it has been developed to counter the resistant Staphylococcus aureus infection. We believe that the R&D investments will provide Wockhardt with an opportunity to take its business higher.

Road To Recovery


     FY 2008
  • Debt-funded acquisitions in the previous years take its D/E ratio up to 4.1x
  • Incurs losses due to exchange rate volatility
  • Also sees losses on derivatives
  • Due to the liquidity crunch, the company enters CDR

   FY 2010
  • Losses rise to Rs 1000 crore, D/E soars to 5.5x
  • Fails to repay FCCBs, bondholders move the court
  • Receives concessional interest rates, converts liabilities into preference shares
  • Promoters bring more contribution, liquidity enhances

    FY 2011
  • FCCB and EU loans restructured
  • Key businesses divested, market share in India improves
  • Makes profits of Rs 90 crore, starts paying bondholders
  • Debt-to-equity comes down to 3.42x

    FY 2012
  • Divestment of nutrition business to Danone (Rs 1280 crore)
  • Profitability improves by 62 per cent
  • The US business starts performing
  • Clinical trials enter next phase

    FY 2013
  • Guidance of 30 per cent growth and 36 per cent
  • EBITDA margins
  • First quarter sees 95 per cent rise in net profits
  • Debt-to-equity below 1x

Valuations

On the valuations front, the scrip is trading at an EV/EBITDA of 10x. As we expect higher growth and significant debt reduction in the current fiscal, the scrip looks undervalued at its FY13 EV/EBITDA of about 7x. The scrip has surged by over 329 per cent on a YTD basis, and we envision a further 30 per cent rise from here on. Given its remarkable turnaround and the strong results that it has posted, we advise investors to enter the counter.

Note:

  • Wockhardt’s promoters have pledged 73 per cent of their shares.
  • The company’s shares have recently been transferred to the ‘T’ group.

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