Rakesh Jhunjhunwala’s New Multibagger Stock Pick: Orchid Chemicals

Rakesh Jhunjhunwala is normally very reticent about his stock picks. Despite persistent coaxing, he keeps a tight lip and doesn’t let in on what stocks he is buying or is bullish on. So, it came as a big surprise that in November 2010, he openly declared that his latest stock pick was Orchid Chemicals & Pharmaceuticals and that he was bullish on its prospects.

Rakesh Jhunjhunwala said this on CNBC-TV18 about Orchid Chemicals:

“Q: What were you betting on there at Orchid?

A: Let us not get into too much of details. I don’t want to discuss it. But I think it will do well. It has made large investments; those investments will now come to fruition. A large part of the investments have been made in areas where others cannot enter in. So there is some kind of a surety to the future prospects. That is one thing. The second is that they deleveraged substantially by selling to Hospira and they have a good deal with hospitals where they can supply the APIs. So it is an area where people cannot enter easily. It has made large investments and it will bear fruit. As usual you have to be a patient investor.”

Rakesh Jhunjhunwala has hinted that there are two things about Orchid Chemicals that has caught his attention. The first is that Orchid Chemicals has made “large investments in areas where others cannot enter“. This gives Orchid Chemicals some sort of a “moat”. The second is that Orchid Chemicals has a “good deal with hospitals” and there is a “surety to the future prospects“.

Rakesh Jhunjhunwala has obviously seen something in Orchid Chemicals that is not immediately obvious to the lay investor.

Rakesh Jhunjhunwala‘s last pharma stock pick was Lupin and that stock has delivered such incredible multibagger returns that our heart begins to beat faster just thinking about it! Even Bilcare, his other pharma stock pick has done very well (see Bilcare: Rakesh Jhunjhunwala’s Stock Pick & Bilcare: Q2 FY 2011 Results Sparkle).

So, does Orchid Chemicals have a chance of becoming another multibagger pick?

Rakesh Jhunjhunwala presently holds 17,50,000 shares of Orchid Chemicals (2.48% of its equity) while Rekha Jhunjhunwala holds 7,50,000 (1.06% of its equity) as of December 2010. It is believed that he bought these shares in October 2010 for the price of about Rs. 245 or thereabouts. His total holding of 25,00,000 shares is worth about Rs. 60 crores or so.

As of March 2009, Orchid Chemicals was heavily indebted with a debt of around Rs 2,600 crore against a net worth of Rs 670 crore. Orchid Chemicals‘ interest cost was about Rs. 150 crores per annum. In order to resolve this impossible situation, in FY 2009-10, Orchid Chemicals sold its generic injectable formulations business for around US$400 million to Hospira, a generics injectable major. The agreement covered the sale of assets, products, product pipeline and team to manage the transferred assets.

The deal size of around Rs 1,800 crore generated about Rs 1,500 crore in cash and was used to repay around Rs 1,400 crore of debt.

Orchid Chemicals was severely criticized for this move on the ground that its main growth engine was sold away.

Orchid Chemicals now has eight facilities which manufacture APIs for injections and orals, oral antibiotic formulations and non-penicillin, non-cephalosporin (NPNC) formulation products. Orchid Chemicals has two API sites (in India) and one in China (through JV), one oral generic formulations facility for advanced markets, two formulations facilities for emerging markets. Orchid Chemicals also has R&D and drug discovery facilities with global regulatory approvals.

Orchid Chemicals has an exclusive ten-year API supply contract for molecules transferred to Hospira. This will assure Orchid Chemicals of a high API capacity utilisation.

Orchid Chemicals has also entered into an agreement to acquire US-based generics marketing company Karalex Pharma LLC, in an all-cash deal to establish its front-end presence in generic sales and marketing. Karalex Pharma is a generics pharmaceutical marketing company focused on marketing and sales services to US classes of trade for developers and manufacturers of generic pharmaceuticals.

Orchid Chemicals‘ strategy seems to be working in the Q2 & Q3 FY 2011 results are an indication. In Q2 FY 2011, Orchid Chemicals net profit was Rs 24 crores versus a loss of Rs 13.2 crores for the same period last year. Its net sales were up at Rs 382 crores versus Rs 305 crores in the same period last year. The topline grew by more than 21% from the preceding year’s Rs 314 crores (including the injectible doses business was later hived off to Hospira) to about Rs 382 crores in the current quarter. The EBITDA in Q2 FY 2011 was about Rs 82 crores, which is also approximately 22% of sales.

Orchid Chemicals‘ reported good results for Q3 FY 2011 as well. The sales rose to Rs. 478 crores, up 32% on a YOY basis while the net profit came in at Rs. 48.78 crores as against a loss of Rs. 22 crores in Q3 FY 2010.

Orchid Chemicals‘ MD K Raghavendra Rao was quoted as saying that Q3 FY 2011 had exceeded all internal expectations and that the chief contributors of the growth were attributable to Tazo Pip and Penems which gave significant boost to earnings. Hospira contributed 22% to nine-month revenues.

K Raghavendra Rao also said that he expects Orchid Chemicals to end FY11 with margins of 24%. With regard to FY 2012, he said that Orchid Chemicals had a chance of seeing strong double digit growth.

Orchid Chemicals still has a lot of debt on its books (about 2.71:1) though K Raghavendra Rao said Orchid Chemicals was actively working to improve the debt-equity ratio in FY12.

Orchid Chemicals‘ valuations are not cheap. In FY 2010, Orchid Chemicals made a diluted EPS of Rs. 37.31 and on that basis the CMP of Rs. 275 is discounted 7.37 times. However, this is misleading because FY 2010 included the figures for the Injectibles division. In the nine month ended December 2010, Orchid Chemicals made a diluted EPS of Rs. 11.52. By simple extrapolation, the EPS for FY 2011 should be in the region of Rs. 15 – 16 which will give a PE ratio of 18 on the basis of the CMP of Rs. 275. This is not cheap compared to the TTM EPS of Orchid Chemicals‘ peers like Lupin (TTM PE 20), Divi’s Lab (TTM PE 21), Torrent Pharma (TTM PE 16) etc.

Rakesh Jhunjhunwala gets his multi-baggers because he is able to spot them early. He does not make his purchases on the basis of the historical PE valuations but on the basis of the scale that the stock can achieve in the near future. So what may appear expensive today may turn out to be cheap tommorow if one factors in the plans that the company has in place. He is obviously banking on Orchid Chemicals to scale itself rapidly. Whether Orchid Chemicals will become another Lupin and Rakesh Jhunjhunwala‘s multibagger, only time will tell. Till then, we are happy to go on the ride!