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Posted on 18-Jan-2019 Comments  0

Sun Pharma

How it got into the current mess and how can it get out of it?

The stock of Sun Pharma has been under pressure for a very long time. In fact, if you look at the returns of the stock from 2015 onwards, the stock has lost nearly 75% in value. That is hardly normal for a company that dominates the Indian pharma industry and has been synonymous with the growth of the generics business in India.

How the crisis at Sun started?

The crisis at Sun Pharma began with the genuine business related problems in the pharma industry. There was a subtle shift happening and Indian pharma companies were, perhaps, a little too slow to react. Firstly, the global pharma margins were dipping and the premium pricing that Indian generics enjoyed in the US market was never going to sustain. Secondly, tough competition was emerging. For a long time, Indian pharma companies thrived on reverse engineering. They would wait for the patents to expire and then launch generic versions of the same drug. With companies from Israel, Turkey and East Europe developing capabilities to deliver drugs even cheaper, that advantage was diminishing. Finally, at some point pharma pricing became a big political issue in the US. The idea of Indian pharma companies selling generic versions at a premium in the US did not go down well. The result was a slew of FDI investigations, bans and Form 483 strictures which created the first big fundamental challenge for pharma!
Ranbaxy started the rot

When Sun Pharma acquired Ranbaxy in 2008 from Dai-Ichi, it was already touted as an expensive acquisition. Subsequent events like the US FDA strictures and rising competition made the costs steeper for Sun Pharma. At some point, Sun Pharma and its promoters felt the need to churn money faster due to the down cycle in the pharma industry. It is perhaps here that most of the problems for Sun Pharma began. They had already acquired Sun Pharma at steep valuations and inherited most of the problems of the Singh brothers. Secondly, they had real problems integrating Ranbaxy into Sun due to the massive culture gap.

Decoding the Aditya link

Recent whistleblower complaints have revealed a murky nexus between Sun Pharma, its promoters, Aditya Medisales and real estate companies. As per the complaint, funds had been diverted from Sun Pharma into realty companies owned by the promoter’s relatives via Aditya Medisales. There were also allegations that money had been illegally laundered by the promoter group imposing a huge cost on the company. Dilip Shanghavi had built the company single-handled in the last 35 years. It is time for him to come clean and ensure that his own image and the shareholders of Sun Pharma do not face any further value erosion!

Fiscal Targets

As Union Budget approaches, the big casualty could be fiscal deficit

Fiscal deficit shows the extent to which the government cannot fund the budget through internal sources. That has to be bridged by borrowing and it is a key barometer of the overall health of the economy. As the NDA government prepares to present its last budget before the 2019 elections, the big focus will be on the fiscal deficit and how much it deviates from the fiscal targets.

FRBM; where is the discipline

When P Chidambaram was the finance minister, he had introduced the FRBM Act which called for announcing and respecting fiscal deficit targets each year. The previous UPA government also slipped on fiscal targets towards the end of its tenure and the current government is also likely to do the same. The original target for fiscal deficit for the full year was targeted at 3.3% of GDP. That target has already been hit by the end of October itself. Disinvestment revenues are likely to fall short by nearly Rs.20,000 crore. That is likely to push fiscal deficit closer to the 3.5% mark. Then there is the big disappointment that is expected on the GST front. According to early estimates, GST for the year is expected to fall short by at least Rs.1 trillion. While there has been some growth visible on direct tax collections it is going to be grossly insufficient to cover this shortfall. We have not even looked at spending. Merely the shortfall in revenues could take fiscal deficit closer to 4% of GDP.

Rescuing farmers

The government has by now realized that MSP announcements and farm loan waivers are not really improving the lot of farmers. That is because MSP is hard to implement and farm loan waivers typically benefit landed farmers only. One option could be the Telangana model which does a direct cash transfer of Rs.4000 per acre per season to the farmers. This has been extremely useful in alleviating the condition of the farmers. Jharkhand and Odisha are adopting this model and the centre too may follow suit. This direct transfer alone is likely to cost nearly $10 billion and the overall farm rescue package is likely to be closer to $35 billion. It may be announced in the Union Budget and could put severe pressure on the government finances.

Off balance sheet items

A lot of government debt is hidden in the books of the Food Corporation and NHAI. Estimates show that this off balance sheet deficit has already gone up from 0.4% to 2.3% in the last 5 years. That more than neutralizes the fall in the fiscal deficit. Rating agencies always look at the total deficit including off balance sheet items and this will not go down well with the rating agencies. Watch out for fiscal deficit numbers and the commentary. That could be the big macro parameter that the government will have to contend with in 2019.

Turning dovish

Will the RBI even consider a 50 bps rate cut and CRR cut?

One of the highlights of the previous week was the CII representation to the RBI governor, Shaktikanta Das. The representative body of Indian industry has called on the RBI to aggressively cut the repo rates by 50 bps and also the Cash reserve ratio (CRR) by 50 bps. According to the CII, such a move would have the dual effect of making funds cheaper in India and also ensure abundant liquidity in the market. Why this request and is it feasible?

Inflation and growth

Broadly, there were three reasons for the CII request to the RBI governor. Firstly CPI inflation for the month of December touched an 18-month low of 2.19% even as the WPI inflation fell closer to 4.4%. Low inflation is normally the biggest trigger for a cut in repo rates. Secondly, the RBI had hiked the repo rates in 2 tranches of 25 bps each in June and October. This move to cut the repo rates would, at least, bring down the cost of funds and keep the real interest rates at reasonable level. There is also an IIP angle to this. The Index of industrial production (IIP) was principally reflective of weak growth in the economy overall since IIP is the largest component of GDP growth. Thirdly, CII also wants to ensure that apart from cost of funding, the problem of value depreciation on bond holdings of banks, NBFCs and mutual funds is also under control. CRR will provide the much needed liquidity.

Why CRR cut is unlikely?

The cash reserve ratio (CRR) reflects the deposits that the commercial banks maintain with the RBI. These are non-remunerative assets for the banks and more for statutory requirements of safety and integrity of the banking system. The government is already aggressively spending ahead of the elections. In fact, the farm package alone is expected to be close to $35 billion. In addition, China has already announced an $85 billion package to prop up growth and that is also likely to spur liquidity across world markets. A sharp CRR cut will lead to a spurt of liquidity in the banking system. The RBI would be wary of triggering higher inflation through such sudden liquidity infusion measures.

Calibrated rate cuts

The RBI may probably look to shift to a neutral to dovish stance in the February policy and probably consider a rate cut in the subsequent policy. The RBI would still be very cautious about a 50% rate cut as it would not only stoke inflation but also lead to a weakening of the Indian rupee. That is something that the RBI would want to avoid, looking at its stagnating forex reserve chest. RBI would also be hard pressed to ensuring that rate cuts do not take advantage of the spread that Indian bonds are enjoying today. That will make the RBI a lot more cautious on rate cuts!



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