Pharmaceutical Company Financial Analysis

The assignment delves into a comprehensive analysis of several pharmaceutical companies' financial performance. It utilizes key ratios such as Price-to-Earnings (PE) ratio, Price-to-Book (PB) ratio, and Enterprise Value to EBITDA (EV/EBITDA) to compare and contrast the firms. Specific examples like Dr. Reddy's Lab, Sun Pharma, Lupin, Cipla, and Piramal Enterprises are used for illustration. The analysis also explores Net Asset Value (NAV) as a valuation metric.

CORPORATE FINANCE

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Business description...............................................................................................................1
Value to shareholders in recent history..................................................................................2
Industry overview and competitive position..........................................................................2
Investment summary..............................................................................................................3
Valuation including explanation of assumptions...................................................................3
Investment risks......................................................................................................................5
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7
APPENDIX......................................................................................................................................9

INDEX OF TABLES
Table 1: EVA analysis.....................................................................................................................9
Table 2: TSR analysis......................................................................................................................9
Table 3: Calculation of terminal value............................................................................................9
Table 4: Calculation of enterprise value........................................................................................10
Table 5: Calculation of intrinsic value of share.............................................................................10
Table 6: Ratio analysis...................................................................................................................10
Table 7: Comparison of firms on the basis of PE ratio..................................................................11
Table 8: Comparison of the firms on the basis of PB ratio...........................................................11
Table 9: Calculation of intrinsic value on the basis of EV/EBITDA method...............................12
Table 10: Computation of NPV.....................................................................................................12

INTRODUCTION
Sun pharma is the India largest pharmaceutical company and in order to understand
concept of equity valuation, mentioned firm is taken in the report. In the report, EVA and TSR
analysis is done and their results are explained in detail. Along with this, valuation methods like
DCF, PE, PB, EV/EBITDA and net present value is also mentioned in the report. Out of these
methods best technique is identified for the share price valuation. Apart from this, assumptions
are used for conducting analysis in the report are also mentioned. At the end of the report,
investment risks are pointed out and global and domestic economic environment are considered.
Business description
Sun pharma is a leading pharmaceutical company of India and it is the world fifth largest
generic medicine manufacturer across the globe. Currently, it is operating in several nations and
supplying active pharmaceutical ingredients (API) to many large pharmaceutical corporations all
over the world. Its inception is focused on research & development, developing API and generic
medicine and launching medicines in major therapeutic areas. It also brings large strategic
change in its distribution strategy by following front end model in largest pharmaceutical market
in the world that is USA. Due to this reason, it rapidly grows its business in the mentioned
geographic region. Time to time it is also entering into strategic partnership with the leading
pharmaceutical firms that are headquartered in the USA, UK and Japan. This is the big reason
behind fast growth of the mentioned firm (Chaudhuri, 2005). Currently, it is producing
medicines related to various therapeutic areas like Oncology, respiratory and neurology etc.
Recently, it acquires Ranbaxy which was also giant firm of India. Due to some mistakes in its
operations, USFDA took strict action against the firm. After that, Ranbaxy was continuously
facing a lot of problems. In such a situation, Sun pharma decided to acquire Ranbaxy by
following a merger process. Regarding this, firm has completed all legal formalities and in FY
2015 it completely acquired a giant firm. After acquisition, firm distribution network got
increased and its product portfolio also enhanced (Kamath, 2008). After acquisition of Ranbaxy,
firm became number one company in the generic dermatology space and many projects of
Ranbaxy are in pipeline. Hence, it can be said that in future time period, firm will grow at a rapid
pace across the globe.
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Value to shareholders in recent history
Shareholder value is the sum of positive and negative impact of all strategic decisions on
the return that they earn on the invested amount. Making wise investment and good return on
investment are the major components of shareholder value. Sun pharma is a large pharmaceutical
company in India and across the globe. Since its inception it pays due attention on increasing its
business at a rapid rate. With the passage of time it also changes its strategy. Since FY 2011, it
gives good return to the shareholders. From FY 2011 to 2015 return percentage is 68.32%, which
is very huge in nature. Firm gives this return in the situation when economic health of the nations
was not well and people lose their confidence on the firm earning capability (Kale, and Little,
2007). During this period, Sun Pharma undertook and completed many projects that were related
to the development of the innovative medicines. It also carries out research projects in
collaboration with other well known pharmaceutical firms. Its main objective was to increase
presence in USA and Europe and in this regard it adopted front end model for distributing its
product. This model to large extent reduces firm dependency on other pharmaceutical firms to
distribute its product in the international market. This helps Sun pharma in running its business
smoothly and in proper manner. Continue approval of generic medicines from USFDA and
increase in demand for the company API in preparation of medicines by foreign companies in
international market increases confidence of investors in the company (Chittoor and et.al, 2009).
This is evident from the higher return percentage. Hence, it can be said that Sun pharma gives
good value to the shareholders.
Industry overview and competitive position
India pharmaceutical industry is one of the largest in the world. In mentioned industry,
there are many large companies like Cipla and Dr Datson etc. Indian companies have good
presence across the globe especially in USA. Preparation of generic medicines is one of the
unique selling prepositions of this industry. In USA, there is high demand for generic medicines
because medical operation cost is already high in the mentioned nation. Moreover, price of
newly developed medicines is already high in USA. Due to this reason, people mostly prefer to
consume generic medicines so as to reduce their treatment cost to some extent (Greene. 2007). In
USA, 80-85% prescriptions are based on generic drugs. Hence, in future also demand for generic
medicines will increase in the world’s largest pharmaceutical market. Other major USP or unique
selling proposition of Indian pharmaceutical industry is API or active pharmaceutical ingredient.
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It is a component of the tablet which plays a most important role in treatment of the patient who
is suffering from the specific disease. India is at second rank in API production after China
across the globe. There is a growing demand for API in the world. This is because cost of
preparing medicines API is very high in the large pharmaceutical markets like USA and Europe.
Due to this reason, companies that are headquartered in these continents are importing API from
countries like India and China. Indian companies are supplying API to companies like
Glaxosmitkline. This indicates that cost of API is small and quality of same supplied by the
Indian companies is of excellent quality (Chittoor and Ray, 2007). Thus, it can be said that
Indian pharmaceutical industry is highly competitive and companies operating in this industry
are giving stiff competition to the companies of USA and Europe etc.
Investment summary
In order to make investment in any company it is necessary to understand the same. By
creating a broad understanding it can be determined whether investment will be profitable or
unprofitable. In this report, Sun pharma is taken for valuation of equity. On the basis of valuation
of equity it can be determined that whether firm share is valued at its fair price in the stock
exchange. In this regard, techniques like discounted cash flow method and EV/EBITDA
technique is used in the report. But every time for earning profit an investor cannot entirely rely
of valuation of the company shares (Bhaumik, Driffield and Pal, 2010). With the change in time
shares gives profit or loss to an investor. If investment on 100 shares of the company is made
then it will be valued at 48,465 in the FY 2011. In FY 2015, the value of these 100 shares was
81,575. This clearly indicates that investment gives huge profit to the investor and even market
fluctuate sharply and investor gets a higher return on the invested amount.
Valuation including explanation of assumptions
In the report, valuation of the company shares is done by using several techniques. These
techniques are PE, PB, EV/EBITDA, DCF and net present value method. The results of these
techniques are explained below. PE ratio- This ratio indicates that firm share price is overvalued or undervalued in the
stock exchange. If firm PE ratio is below industry PE ratio then it is assumed that firm
share is undervalued and recommendation for investment is made (Hodder, Hopkins and
Wahlen, 2006). On other hand, if vice verse happen then it is assumed that share price is
overvalued and recommendation for investment is not made in this case by the
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investment experts. PE ratio of the Sun pharma is below and on this basis it can be said
that firm shares valuation is proper. If we compare Sun pharma with other companies on
the basis of this ratio then it can be said that firm share is positively valued and at low PE
ratio. Thus, there is a high probability of growth in the firm share value in future. Hence,
it will be profitable to make investment in the company equity share. PB ratio- In this technique, valuation is done by comparing share value with the book
value of per share. By comparing with the same ratio of the other firms operating in the
industry it can be accessed whether firm shares are overvalued or undervalued (Roehling
and et.al, 2005). On comparison of value of ratio of Sun pharma with other companies it
can be seen that shares are overvalued so, on the basis of this technique it can be said that
investors must abstain from making investment in the firm. EV/EBITDA- In this ratio, enterprise value is calculated and divided by the EBITDA in
order to identify fair value the shares (EV/EBITDA ratio. 2016). By doing calculation, it
is identified that real value of the company share is 2332. Current share price is below
these values and this reflects that share price is undervalued and there is very high
probability of increase in the share price. DCF or discounted cash flow technique- In this method, share price is calculated by
using discounted cash flows. By using forecasting methodology, firm revenue is
projected and cost of the firm to earn that revenue is also computed (Fernández, 2007).
On the basis of this technique, fair value of per share is 1170. This is nearby the company
share price to some extent. Hence, it can be said that this technique is producing good
results. Net present value- In this method it is identified whether firm is earning profit on capital
expenditures (Net present value. 2013). For this, CAPEX for each year is computed and
future investment value if forecasted. NPV is positive and this reflects that firm is earning
good return on investment. Due to this reason, it can be said that investment in the firm
will be profitable for the investor.
Which technique is best?
PE ratio is best for the firm in comparison to other techniques. This is because market
players only understand pricing patterns and other large investor investing behavior. They have
deep knowledge of PE ratio. People do not understand DCF technique EV/EBITDA valuation
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techniques for making investment decisions. PE ratio concept is also related to the price pattern
or technical analysis. Concept of PE ratio is simple and by comparing firm’s earning to shares
price is easily identified that company shares are fairly priced or not. This technique fairly valued
share price in comparison to other complicated techniques. DCF technique requires preparation
of assumptions and they may prove wrong in the future. Due to these reasons PE ratio is
considered better than other techniques.
Assumptions
 In order to compute cost of equity, market returns are assumed by considering specific
time period of economic condition of India and relevant stock exchange performances.
 Tax rate is assumed constant at 15%.
 In past years, cost as a percentage of revenue does no change sharply. So, cost as a
percentage of revenue is taken same from FY 2016-2020 with reference to earlier year
cost percentages. Every year, revenue growth rate is increasing and on the basis of acquisition of Ranbaxy
in FY 2015 it is assumed that revenue will grow at a rapid rate. On the basis of hope of
approval from USFDA on several generic medicines whose production is in pipeline it is
assumed that revenue will increase at a rapid rate.
EVA and TSR analysis
Economic value added technique shows that Sun pharma EVA is above the average
EVA. Hence, it can be said that firm is giving elegant performance on this front. On other hand
TSR technique is also used in the report and it is identified that in last five years Sun pharma
shares gives return above the minimum return that investors must earn on the investment. Hence,
it can be said that investors earn good return on the Sun pharma shares.
Investment risks
Following are the investment risks.
 If market becomes bearish then share price of Sun pharma will also fall. Hence,
investment needs to be made with full caution.
 Frequent change in currency and interest rates in negative direction may lead to fall in
share price (Yang and Blyth, 2007).
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 Downturn in China will negatively affect the global economy and pressure on economic
data of India can be observed. Thus, if this happens then share price of Sun pharma may
fall in future.
CONCLUSION
On the basis of above discussion it is concluded that there are many techniques of
valuation. But investor cannot use all techniques in order to make its investment decisions.
Hence, investors must abstain from using complicated methods for equity valuation. In DCF
techniques, assumptions are made and these may prove incorrect in the future. Hence, if
investment decisions are taken on the basis of this technique then investor may bear loss on the
investment. Hence, it is concluded that investors must use simple methods for equity valuation.
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REFERENCES
Books & journals
Bhaumik, S.K., Driffield, N. and Pal, S., 2010. Does ownership structure of emerging-market
firms affect their outward FDI? The case of the Indian automotive and
pharmaceutical sectors. Journal of International Business Studies. 41(3). pp.437-450.
Chaudhuri, S., 2005. The WTO and India's pharmaceuticals industry: Patent protection, TRIPS,
and developing countries. New Delhi: Oxford University Press.
Chittoor, R. and Ray, S., 2007. Internationalization paths of Indian pharmaceutical firms—A
strategic group analysis. Journal of International Management. 13(3). pp.338-355.
Chittoor, R., et.al., 2009. Third-world copycats to emerging multinationals: Institutional changes
and organizational transformation in the Indian pharmaceutical industry. Organization
Science, 20(1). pp.187-205.
Fernández, P., 2007. Valuing companies by cash flow discounting: ten methods and nine
theories. Managerial Finance, 33(11), pp.853-876.
Greene, W., 2007. The emergence of India's pharmaceutical industry and implications for the
US generic drug market. US International Trade Commission, Office of Economics.
Hodder, L.D., Hopkins, P.E. and Wahlen, J.M., 2006. Risk-relevance of fair-value income
measures for commercial banks. The Accounting Review, 81(2), pp.337-375.
Kale, D. and Little, S., 2007. From imitation to innovation: The evolution of R&D capabilities
and learning processes in the Indian pharmaceutical industry. Technology Analysis &
Strategic Management. 19(5). pp.589-609.
Kamath, G., 2008. Intellectual capital and corporate performance in Indian pharmaceutical
industry. Journal of Intellectual Capital. 9(4). pp.684-704.
Roehling, M.V., et.al., 2005. The future of HR management: Research needs and directions.
Human Resource Management, 44(2), pp.207-216.
Yang, M. and Blyth, W., 2007. Modeling investment risks and uncertainties with real options
approach. International Energy Agency.
Online
EV/EBITDA ratio, 2016. [Online]. Available through: <
http://www.readyratios.com/reference/market/ev_ebitda_ratio.html>. [Accessed on 6th
January 2016].
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Net present value, 2013. [Online], Available through: <
http://accountingexplained.com/managerial/capital-budgeting/npv>. [Accessed on 6th
January 2016].
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APPENDIX
EVA analysis
Table 1: EVA analysis
2010 2011 2012 2013 2014
Capital 178674.9 144741.8 169674 251841.1 1781607
WACC 4.91% 17.22% 0.76% 0.92% 1.11%
Net operating profit after tax 8986 19074 29739 34758 38809
Capital*WACC 8766 24919 1283 2323 19768
EVA analysis 220 -5845 28456 32435 19041
Average 14861
Current value 19040
TSR analysis
Table 2: TSR analysis
Beta 0.51
RFR 7.82%
R(M) 65.00%
Required rate of return 37.27%
Actual return 68.32%
DCF
Table 3: Calculation of terminal value
Terminal Value
Sum of PV of FCF for explicit forecast 73,59,590
WACC 3.89%
Long term growth in Revenues 320%
Present Value of terminal value (3,73,186)
Terminal Value as % of Total Value -5%
Table 4: Calculation of enterprise value
Equity Value
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Enterprise Value 69,86,404
- Debt 18,952
+ Cash 4,164
Net Debt 23,116
Equity Value 70,09,520
Table 5: Calculation of intrinsic value of share
Intrinsic Value
Equity Value 70,09,520
Diluted Shares 5,990
Intrinsic Value 1170
Ratio analysis
Table 6: Ratio analysis
Ratio analysis
Net profit -14741
Shares issued 5990
EPS -2.46
Current market price 794
EPS -2.46
P/E ratio 0.1
Price 794
Book value 227164
Book value per share 38
P/B ratio 20.937
Enterprise value 4770848
EBITDA 724995
EV/EBITDA 6.58
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Table 7: Comparison of firms on the basis of PE ratio
Comparison of PE ratio of firms
Companies PE ratio
Dr Datson -11
Fulford -5
Fdc 9
Neuland lab 33
Sun pharma 0.1
Industry PE ratio
Industry ratio 60
Table 8: Comparison of the firms on the basis of PB ratio
Comparison of PB ratio of firms
Companies PB ratio
Piramal enter 1.1
Dr Reddy lab 5.9
Divis lab 7.9
Ipca lab 5.6
Cipla 4.1
Sun pharma 20.9
Lupin 10.7
Valuation by EV/EBITDA
Table 9: Calculation of intrinsic value on the basis of EV/EBITDA method
EV/EBITDA Exit
Multiple PV of Terminal Value (EV/EBITDA) Intrinsic value
WACC
PV of
FCF 2.00%
3.9% 73,86,702 6559179.94210 2332
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