Should you bet on Piramal Pharma's lofty growth guidance?

Piramal Pharma, the priciest mid-cap pharma stock in the current market, is turning heads on Dalal Street with its recent growth guidance. The company said it will double its revenue and triple its EBITDA (earnings before interest, tax, depreciation and amortisation) to nearly Rs 16,000 crore and Rs 3,600 crore, respectively, by FY30— a growth of 12 and 20 per cent per annum, respectively, in the next six years.

Investors concur with the management's confidence. The stock has more than doubled over the last year. Its market cap has leapt to Rs 30,000 crore, despite a meagre profit of Rs 28 crore for 12 months ending June 2024 (due to higher than usual tax liability). The result is an astronomical P/E ratio of 1,082 as of September 30, 2024. It is natural to wonder if the exuberance is truly justified. We examine that in the story. But first, let's understand the underlying growth strategy the company is betting on:

The game plan

The company plans to double down on its contract manufacturing or CDMO vertical, its biggest revenue generator at 58 per cent. It earns almost half of the CDMO revenue from experimental work, which involves research to development to preclinical trials. This reflects its expertise in new product development. The focus is, thus, narrowed on developing specialised products, especially for its biopharma clients, which generate high-margin business.

Apart from CDMO, the company is aggressively expanding its other vertical—off-patent generic products—in the US and Europe. The last vertical is the consumer healthcare segment. Piramal is working to increase the distribution network and brand visibility of its consumer products.

The challenges

But there are many hurdles, and achieving its growth plans may not be as easy:

• Tedious process: New drug development is time-consuming and is subject to strict regulations. It requires domain expertise and significant capital investment. Although biopharma companies are growing rapidly, very few manage to launch products commercially. This is because the chances of success completely depend on clinical trials and commercial feasibility. These factors generally result in very long gestation periods. Profit realisation is thus often a distant dream.
  
• Increased leverage: The company's large scale is a result of aggressive inorganic growth over the years. It has made 15 acquisitions in the last 10 years (including the period prior to the demerger). The management is set to pursue the inorganic growth strategy. But this does not bode well for the company, which already has a debt of over Rs 4,000 crore on its books. High working capital requirements also add to the strain and its cash conversion cycle is poor at around 180 days.

Valuations are too hot

Even if Piramal manages to triple its EBITDA over the next six years, its current valuations are barely justifiable. We did a small exercise that demonstrates this:

Replacing its profit before tax of Rs 241 crore (for 12 months ending June 2024) with earnings, its current P/E ratio works out to be 125 times. Assuming that the company manages to triple its profit before tax to Rs 723 crore by FY30, the forward P/E based on this figure works out to be 42 times. This is still higher than current P/E multiples of giants like Cipla (31 times) and Dr Reddy's (20 times).

So, even when the earnings prospects are bright for Piramal, the stock rally leaves little margin of safety. Given that the regulatory risks could easily play a spoilsport, it may not be wise to pay top dollar for the red hot stock.

Disclaimer: This is not a stock recommendation. Please do your own research before making an investment decision.

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