Orchid Chemicals - A Retrospective Analysis

Lot of mails and speculation has been offlate floating around Orchid Chemicals. The stock had its market cap wiping off by half in just two trading sessions.

Orchid had topped our recommendation List for quiet sometime now. We initiated a Buy at Rs. 222/- last year, after which it hit a high of Rs. 328/- almost near our recommendation target and then it has all the way crashed to current market price of Rs. 116/-. Let us take a retrospective analysis of what happened and what looks ahead of Orchid Chemical.

Most of you by this time know the reason for the steep fall, Bear Stearns which was acquired by JP Morgan offloaded its stake in Orchid Chemical to ease its liquidity crunch. Sudden liquidity in this stock was even more aggravated when the margin call on a particular portion of promoters stock got triggered of selling another 7.9% stake in the firm.

Question remains

1) Is it legal to increase the stake through borrowed funds on margin?

We do not see anything wrong in that. Looking at the brighter part the promoters had faith in growth of the firm and so increased stake in the company through the route of borrowing money.

2) What is the future of the company?

The company is fundamentally strong and will remain so with lot of USFDA filing waiting for approval. Secondly many of major drugs going off-patented in the years to come is expected to benefit Orchid.

3) What to look ahead and when is the recovery possible?

We need to watch for the upcoming shareholding pattern for more information and also the current quarter results. We need to look at share holding pattern to see if any other institution had sold its stake. If so the liquidity floating the market can make it a speculators den.

Let us just understand that this is a huge personal loss for the promoter K Raghavendra Roa and going by the success story of Orchid he is not a guy who will get visibly rattled. Yeah true it will take him sometime to recover out of this loss. K Raghavendra Roa has scripted the success story of Orchid Chemical for almost 14 years now and let us hope he will continue to do so.

At the current market price the stock is available at less than 6 times its FY08E fully diluted EPS of 22. Also Orchid market cap is around 0.56 times it expected FY08 sales.

Orchid Chemicals also has unutilised foreign currency convertible bonds (FCCBs) amounting to US$193mn. With the stipulated conversion price for these FCCBs now at a significant premium to the current stock price, it is highly unlikely that the holders will exercise the option. This may leave Orchid with a significant loan obligation to be serviced in 2012.

Indian Stock Market Outlook

For the last two weeks I have been getting ample of emails on the outlook of Indian markets. Due to busy schedule I will not be able to for sometime reply most of the emails. I would like to use this post in answering most common market and stock questions posted by our subscribers.

1) What is the outlook of Indian markets after a deep crash last week?. Can the markets go down even further?

Last week saw market swinging down by around 4000 points, thanks to the end of week recovery.

We had cautioned our investors on several occasion to take a conservative call on the markets Click Here and to book partial profits.

Despite the recent sharp correction, Indian equities have delivered relatively good performance over a three months period compared to it's Asian and Global peers.

The strong performance of Indian markets compared to the Asian peers can be attributed to the money inflow from Domestic Institutions of around USD 1.5 Billion as against the FII outflow of USD 3.5 billion dollars.

As such with the global economy outlook, the chances of US entering to recession (or slowdown, whaterver name it) has become high. With FED cutting interest rates by almost 125 basis points in a week shows the impact of damage the current credit crisis has caused to US Economy. Though the Indian economy has come to stand on strong domestic factors we cannot rule out the fact that a more pronounced correction in the US economy is likely to have a repercussion on Indian economy as well.

As per data on SEBI website FII's have pumped in around 17 billion USD dollars in 2007 alone. The net outflow in Jan' 08 stands around 3.5 billion US dollars. Any further impact on global slowdown can see FII's pull out more money from the markets. The probability of market touching the recent low at this stage looks very high. Investors are requested to watch the global trends and take a call before taking position in the markets.

2) The US Credit crisis at this stage seems to have come to a stand still. Is it safe to say at this time the correction in Indian markets have been bottomed out?

You are right in one way saying the credit crisis as reported by financial institutions have come to a standstill. But not to forget there are lot of loan defaulters in this subprime market, many of those have already filed bankurpcy. Secondly, the current credit crisis in housing market can also trigger defaults in the US Credit card market. Not to forget the US credit card market is around 950 Billion US Dollars of money in credit. At this stage it is very difficult to say if the Indian markets have bottomed out or not. But if you are a long term investor you need not worry about this short to medium term volatility.

3) Which stocks are looking good at this stage after the correction?

As we had recommended earlier Orchid Chemicals and Tata Steel looks good from 12 to 18 months horizon. Currently we have initiated coverage on SCI and ONGC (Recommendation Follows) with a 24 months horizon. Hotel Leelaventure looks strong with all the expansion turning EPS assertive in the coming years. Keep watching our blog for multibagger recommendation.

To conclude, there is a saying that anyone can make money in a bull market, Investors are one who ride the bear market. Our portfolio has delivered an average return of 19% as against the sensex negative return of -2% over the 4 months period (Since our blog Inception).

Orchid Chemicals - A Value Buy

Orchid is a globally recognized, integrated pharmaceutical company with core competencies in the development and manufacture of Active Pharmaceutical Ingredients (APIs) and Finished Dosage Forms as well as in drug discovery.

Orchid product range for the US market comprises 21 antibiotics and 20 non-antibiotic dosage forms, many of which are also aimed at European as well as other regulated and emerging markets.

Currently regulated markets like US, Europe and Japan contributes to around 77% revenue, while the less regulated market like Hongkong, China, India etc contributes to around 23%.

At the current market price of Rs. 222/- the stock trades at around 13 times it's 12 month diluted EPS of 17.08. Last two quarters the company saw a good spurt in their Operating Margin. The EBITDA margin improved significantly to around 35% during the quarter. This was made possible due to their new product Cefixime and Cefdinir. We expect the company to do EPS of around 21 in FY08. Based on it's FY08E EPS, Orchid has a target of around Rs. 340/- with a horizon of 12 to 15 months.

Betting On

In the antibiotics space Orchid expect to launch new products in the cephalosporins, betalactams and carbapenem spaces between 2007 and 2010 in US, EU and Japan. In the non-antibiotic space, Orchid is developing a robust pipeline of over 80 products covering diverse therapeutic segments.

Orchid is done with it's investment phase and hereon the investment is expected to get translated into revenues. Orchid has invested in and completed projects for expansion and diversification in the cephalosporin, betalactam and non-penicillin, non-cephalosporin (NPNC) or lifestyle drug spaces. Cephalosporin projects have already been translated into revenues; betalactam, carbapenem and NPNC projects will translate into revenues in this fiscal and beyond.

Orchid has also entered into the CRAMS (Custom Research and Manufacture Segment) with two agreements under execution

1) With Pfizer Inc. for animal healthcare products
2) With Biovitrum AB to undertake medicinal chemistry

Fundamentals

1) Cephalosporin and betalactam dosage form facilities would start generating remunerative generic business in Europe from the second half of 2007-08.

2) The Company intends to establish a marketing presence in Japan, the second largest pharmaceutical market in the world (estimated at around US$ 60 billion).

3) Entered into marketing alliances for antibiotics as well as non-antibiotics dosage forms with major pharmaceutical players in the US and Europe, strengthening its regulated market position.

Risks

1) Orchid further dilution of Equity can reduce the Earnings visibility.

2) Rupee appreciation against the dollar can impact the Operating Margins.

3) Cost control and taxes imposed by government can reduce the profitability of the firm.