Assets worth much more than what Wockhardt’s balance sheet reflected saved the day for the pharmaceutical major

Stakeholders in Wockhardt have got in the past 11 months what they could not get in the previous 12 years, with their wealth multiplying seven times from a low of Rs 261 in January, to a high of Rs 1,830 on November 16. This makes Wockhardt, one of the best-performing stocks of the year in the large-cap segment.

What made this happen even after the company was forced to sell its assets, renegotiate loans settlements with bankers to ensure that that they could carry on with the surviving business, and pursue a major clean-up?

In an ordinary situation, the Street would have punished both the scrip and the promoters; and the stock price would have languished in the doldrums for decades.

Instead, the way the Wockhardt’s scrip has behaved, points to the complex web of reasons and logic behind pricing of any stock. Stock prices merely do not reflect potential earnings, but also the Street’s confidence in the management’s ability to emerge out of extremely tough circumstances, as has been the case with Wockhardt. There is no dearth of investors backing a promoter with honest intentions and the ability to turnaround a company, both in terms of buying the stock and rescheduling loans and advances.

Going back to history, Wockhardt landed in a mess when it embarked upon a massive expansion and acquisitions drive. In hindsight, one can suggest that the timing of these acquisitions, during 2006-2007, was wrong because valuations of all asset classes then were inflated, with high liquidity chasing scarce assets across the globe.

Wockhardt too paid high prices for acquiring European pharmaceuticals companies Pinewood and Negma. In doing so, it bet that the high acquisition prices would be compensated by growth, which Wockhardt would be able to achieve in the euro zone – the company’s focus area then. Had Wockhardt succeeded at executing that strategy, its incremental expansion in the EU markets would have come at a much lower cost.

Often, Indian promoters acquire foreign companies presuming that they would be able to drive margins higher by cutting costs. They assume that net margins can be enhanced by a few hundred basis points, sharply raising bottomlines, even when sales remain constant. This, they believe would improve the valuation of the parent company.

It seems that Wockhardt too gambled on the same premises when it took over Pinewood and Negma that sported Ebitda margins between 18 per cent and 20 per cent — rather low against the benchmark for Indian companies.

The acquisitions increased Wockhardt’s debt, exposing the company to far bigger and complex derivative transactions than its balance sheet or export income would justify. It was trying to hedge against exports, as the rupee emerged stronger by the day.

The global financial crisis could have not come at a worse time for the company. Besides the high debt, its huge exposure to complex currency derivatives became a major cause of concern. The cross-currency correlation between various currencies and the US dollar that had existed for more than five decades saw volatile changes, rendering hedging by the company and its bankers useless.

Wockhardt was not alone. A number of other Indian companies too suffered currency speculation losses. However, what made Wockhardt stand aside from its troubled peers was the value of its assets and brands that were worth much more than what its balance sheet reflected. It managed to sell those assets, including its nutritional business, and once again focused on its core competencies. The company also shifted focus from the EU to the US, where it managed good growth, ensuring a steady cash flow, leaving it with some breathing space to negotiate with its debtors.

As the year runs out, Wockhardt has emerged as a lean and efficient company. Should it continue to perform the way it has over the past few quarters, it is likely to increase its asset base once more, over the next few years.

For shareholders, Wockhardt has emerged as the surprise bet of the year, with individual and institutional investors who bought the stock at the start of the year, waiting to reap a golden harvest. However, the fact remains that not many investors bought the stock when the company embarked on its painful cleaning up operation. Mostly foreign institutional investors (FIIs) had increased their stake in the company ahead of the sharp run-up in the stock price and also during the phase when it outperformed the broader and sectoral indices.

A change in the shareholding pattern reflects that FIIs had more faith in the restructuring story than domestic institutional investors (DIIs). DII stake in the company fell to 3.66 per cent on September 31 from 6.68 per cent a year ago. In contrast, FIIs had increased their stake to 6.76 per cent by September 31 from a mere 1.44 per cent a year ago.

After a stupendous year, it is time for the stock to take a breather; a large part of the good news is already built into the stock price. Though the scrip is likely to continue to outperform, that pace should slow down now. Expect a normal return from the stock in the coming years, as some of the extraordinary margins that company was able to enjoy till now are likely to come under pressure. Stay with the company, but don’t expect to become a millionaire just by owning this one stock.

(Rajiv Nagpal is the director of independent brokerage Elan Equity Services and the consulting editor of Financial Chronicle)


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