India Pharma Sector - Sector Update

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Edel Pulse: Pharmaceuticals

Edelweiss Securities Limited 1

Executive Summary The domestic branded generics market, a critical cog in the growth wheel for most Indian

companies, is currently in spate. Unlike the apprehension of market participants about the

sustainability of growth, our survey findings indicate that growth is not only sustainable but

will move into the next orbit of 18-20% viz-a-viz current growth of 14-15%. Higher growth

in domestic market will not only improve growth prospects of pharma companies (c30-50%

to revenue), but will also improve overall profitability (margins are relatively higher).

Further, as is the norm, when all companies are in expansion mode, only a handful will

potentially emerge as winners. Hence, to understand these changing dynamics, we

commissioned an extensive and unique study across 27 cities in 11 states (all four zones—

North, South, East, and West), covering more than 100 distributors, representing notably 45-

50% of the total pharma market. These distributors, with more than 10-15 years of presence

in the market, ideally connect suppliers on one hand and consumers on the other.

We covered all tiers of geographies in each zone including metros, tier-I to IV cities. We

travelled across the length and breadth of the country to gain incisive insights into

the future of the domestic pharma market, performance of various Indian

companies, strategies adopted and ground level challenges impacting growth. We

have tied our observations to industry data from AIOCD to overcome individual distributor’s

bias over companies. We further highlight that views of distributors are restricted to their

coverage companies, which differ, but collectively represent 80% of the total market.

Key questions addressed from the survey include:

• What is the potential growth in domestic market and key drivers of this growth?

• How sustainable is the current market growth over next three-four years?

• Which therapeutic areas are growing faster?

• What are the key strategies adopted by various companies?

• What are the key changes in the activity level of MNCs?

We conclude that, Sun Pharma and Lupin are ranked by 94% and 74% of coverage

distributors, respectively, as preferred players in the large–cap space, while IPCA and Torrent

Pharma are ranked by 86% and 70% of coverage distributors, respectively, as leading

players in the mid-cap space. Interestingly, Sanofi-Aventis, among MNCs, is ahead of peers

and is aggressively making its mark in tier III and IV cities. We also identified emerging new

players such as Mankind, Eris, and Macleods, which are gaining strong traction in various

markets.

Combining the takeaways from our distributors survey and the prospects of Indian companies

in emerging markets and US, we expect Lupin, Dr. Reddy’s, Cadila and Torrent Pharma to do

well over the next 12-18 months. We are positive on Sun Pharma, however, current

valuations do not leave much upside for investors.

Overall, through this report, we have attempted to identify trends, drivers, and challenges

faced in the ever-changing market scenario and effectiveness of current strategies adopted

by various companies.



2 Edelweiss Securities Limited


Contents At a Glance ................................................................................................................ 3

Ear to the ground: Verdict is Out ................................................................................... 4

Domestic Formulations: On a high ................................................................................. 7

Chronic Leads; Cosmetology New Avenue ...................................................................... 9

Metro, tier-I key markets; Semi urban and rural areas are new growth pockets ................ 13

Aggressive MNC expansion Poses High Risk .................................................................. 17

Differentiating ‘ Class from Mass’ ................................................................................ 20

Future Growth Drivers ............................................................................................... 29

Valuations: Rich, But Not Stretched ............................................................................. 31

Key Risks ................................................................................................................. 34

Appendix – I – Growth drivers: Pull and Push factors ..................................................... 37

Appendix – II – Survey Methodology ........................................................................... 43

Distributor Survey - Questionnaire ........................................................................ 45

Companies

Cadila Healthcare ................................................................................................ 53

Cipla .................................................................................................................. 71

Dr. Reddy’s Laboratories ...................................................................................... 79

Lupin ................................................................................................................. 89

Ranbaxy Laboratories .......................................................................................... 99

Sun Pharmaceuticals ......................................................................................... 119

Torrent Pharmaceuticals .................................................................................... 129

I S I E m e r g i n g M a r k e t s P D F i n - s d m c p l 0 1 f r o m 1 2 4 . 1 2 4 . 2 5 5 . 5 o n 2 0 1 1 - 1 1 - 0 9 0 1 : 1 9 : 4 5 E S T . D o w n l o a d P D F .

D o w n l o a d e d b y i n - s d m c p l 0 1 f r o m 1 2 4 . 1 2 4 . 2 5 5 . 5 a t 2 0 1 1 - 1 1 - 0 9 0 1 : 1 9 : 4 5 E S T . I S I E m e r g i n g M a r k e t s . U n a u t h o r i z e d D i s t r i b u t i o n P r o h i b i t e d .



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54.3

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FY09

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120.0

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28.6

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15.8

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67,6

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17.8

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FY09

38,5

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66

12.7

40.0

49.0

18.7

17.6

23.5

32.4

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24.9

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48,3

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9,7

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15.4

25.5

29.0

29.9

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19.2

23.8

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Ear to the Ground: Verdict is Out India is projected to be the third-largest pharma market (after the US and China) in terms of incremental growth. It is also evident that the sub-continent, with the highest population and robust economic growth, offers attractive return to pharma companies due to its cost-effective manufacturing capabilities and branded generics nature of the market. Historically, the non-regulated structure of market has enabled Indian companies to build strong market share, however, with changing market dynamics, companies have to adopt new strategic approach to grow and compete. Therefore, to gain a deeper understanding of this transformation, we set out to survey various markets, encompassing all zones and tiers. We selected a sample of 27 cities, ideally representing a mix of all geographies within India, and after meeting more than 100 distributors across cities, we gained the following insights:

Growth momentum to sustain and move into next orbit Indian pharma market is likely to sustain current growth momentum (14-15% versus historical run-rate of 10-12% over FY00-10) and a large number of distributors anticipate growth trajectory to move to the next level of 18-20%. This could potentially add USD 3 bn of incremental sales over the next four to five years. This strong growth is inclusive of metros, tier I and II cities and smaller or tier III and IV towns. However, one-third of this incremental growth will come from tier III-IV towns and rural markets, which constitute 20% of the total market, and are currently growing at 25-30%, higher than metros and tier-I cities. This is largely led by increase in income levels, higher penetration of healthcare, and increase in health awareness among masses. Cipla, with a strong portfolio in the acute and respiratory segment, is depicting strong growth in tier II-IV markets, while Cadila, Lupin, Sanofi-Aventis and IPCA are also aggressively expanding in these regions.

Chronic therapies leading growth; cosmetology new growth avenue

Chronic therapies including cardiac, diabetics and neuro-psychiatry, constitute 28% of the total market and are growing at 18-19% versus the current industry growth of 15% (MAT March 2011). Most distributors have observed that anti-diabetics is emerging as a high-growth segment, followed by cardiac and CNS. Further, rising discretionary spending and focus on personal care is driving growth in the cosmetology segment. This segment’s growth potential is large, given lower penetration, and it entails higher margins due to better pricing of products. Other super specialties such as oncology, pediatrics and nephrology are also picking up in selective markets.

The competition in chronic therapies is increasing rapidly, leading to higher investments by players to retain market share. Consequently, specialty focused promotion is emerging as a strong and effective approach to build brand loyalty. As per our survey, most companies have carved new divisions for key specialties, while others have created dedicated field force or special tasks force (STFs) to promote high-value brands within segments. Most distributors view this as highly effective strategy to enhance market share and also results in higher field force productivity. Sun Pharma has pioneered the specialty focus model, resulting in higher market share in the chronic segment.

Expansion by MNCs could intensify competition for Indian counterparts

Multinational pharma companies have become aggressive and have initiated meaningful investments in the domestic market. These investments, although at nascent stage, will eventually set the base for the next leg of growth. Most leading players have set bold aspirations for their Indian businesses and are adopting a more localised business model, including pan-India penetration, branded generics launches, and well-spread out distribution network. While recent branded generics launches are priced economically, our survey indicates that sales have not ramped up in most markets for these products.





Moreover, in-licensing of off-patented/patented molecules could incrementally drive higher revenues in the medium term. We believe that with aggressive expansion plans and deep pockets, MNCs could potentially emerge as strong competitors, compelling Indian companies to hike investments, while price wars could potentially hurt their profitability in the long term.

Higher attrition in field force poses risk to current growth

The cost of hiring competent field force is soaring and retention is posing a key challenge. Most markets are seeing more than 30% field force attrition. We have identified four key reasons behind high attrition: (a) increase in demand for medical representatives to increase doctor focus, coverage and number of divisions; (b) limited supply of talent pool with companies competing for high quality people; (c) setting up challenging field force targets with a mandate to aggressively capture market share; and (d) shift to other sectors like IT and financial services which offer higher incentives and growth. We perceive higher attrition as a potential risk for companies following the old incentive structure and inefficient policies to retain field force, which could dent their growth and profitability in the near term. Cadila, Cipla, IPCA and GSK are few players facing higher attrition, while Sun Pharma, Lupin and Torrent have been ranked by most distributors as companies possessing highly effective and stable field force.

Decline in success rate of new product introductions

Most large and mid-size companies, to actively expand coverage across molecules or therapies, are aggressively launching new products. New product introductions contribute 4-5% of overall market growth. However, as per our survey, 70-80% of these products are failures. Most of these failures are in established segments, where more than 10-15 players currently exist. Also, there is a growing resistance among retailers and distributors to provide shelf space for new products before prescription generation. Hence, we observe companies that are more proactive and launch products ahead of the market are more successful in building brands, which potentially contributes to higher business growth. Most distributors suggest that new launches by Sun Pharma, Sanofi-Aventis and Lupin have pent-up demand in the first week of launch. Also, companies with differentiated R&D pipeline like Sun Pharma and Dr. Reddy’s clearly have an edge over others.

Differentiating ‘class from mass’: End driver of survey

Through our distributor survey we tried to differentiate highly effective companies from others (‘class from mass’) on the basis of parameters such as: (a) portfolio concentration (chronic versus acute); (b) growth relative to the market; (c) field force stability and productivity; (d) field force penetration; (e) success of new product launches; and (f) ability to build brands. The survey questionnaire was designed to gauge top 30 companies (as per market share) on the basis of these key parameters. We conclude that, Sun Pharma and Lupin are ranked by 94% and 74% of coverage distributors, respectively, as preferred players in the large–cap space, while IPCA and Torrent are ranked by 86% and 70% of coverage distributors, respectively, as leading players in the mid-cap space. MNCs are adopting a more localised approach to build market presence and are building infrastructure for the next leg of growth. Interestingly Sanofi-Aventis, among MNC pharma, is ahead of peers and is aggressively coming up in tier III–IV cities. Moreover, we also identified some key emerging small-mid size players, such as Macleods, Aristo, Eris and Mankind, who are scaling up and capturing incrementally higher market share.





Fig. 1: Competitive scorecard

Source: Edelweiss research

Table 1: Top picks - Lupin and Torrent Pharma offer highest upside (INR)


Note: * PE multiple for Dr Reddy’s, Sun Pharma. and Ranbaxy is based on CMP adjusted for NPV of one-off exclusivity sales

Company NameDomestic growth CAGR (5yr)

Portfolio concentration

Brand building ability

Success of new product launches

Field force stability

Field force productivity

Reach (Medical reps)

Large Cap

Sun Pharma

Dr Reddy's

Cipla

Lupin

Cadila

Mid-cap

Torrent Pharma

IPCA

Glenmark

MNC

Ranbaxy

Sanofi-Aventis

GSK India

Pfizer India

Scale: Best ………………………………………………………………………………………………Least 5 1

CMP TP NPV of Reco Upside

one-offs (%) FY11E FY12E FY13E

Cadila 844 960 BUY 14 26.7 20.8 16.7

Cipla 321 350 HOLD 9 25.9 21.1 17.3

Dr. Reddy's 1,656 1,950 94 BUY 18 25.0 20.5 17.7

Lupin 412 500 BUY 21 21.6 19.1 15.6

Ranbaxy 468 432 94 HOLD (8) 44.0 27.5 22.2

Sun pharma 446 477 10 HOLD 7 33.7 24.3 20.5

Torrent Pharma 591 760 BUY 29 16.8 13.9 10.9

P/E (x)Company





Domestic Formulations: On A High

The Indian pharmaceutical market (IPM) has historically posted 10% CAGR over FY01-09. However, in the past two years market growth has been on a high trajectory at 15-16% indicating significant expansion in overall market base. To understand the trends and drivers of this growth, we commissioned an extensive survey of 100 distributors covering 27 cities in 11 states (all four zones—North, West, South, and East), representing notably 45-50% of the total pharma market.

Chart 1: IPM growth has been robust over past two years

Source: CRISIL, Edelweiss research

……Growth not only sustainable, but likely to move in higher orbit

Most distributors (95%) believe that the growth is not only strong, but will sustain over the medium term. Over 60% respondents are of the view that growth is likely to sustain at an average 13-15%, while a relatively good number of distributors (27%) believe that it can be higher than the current average.

Chart 2: Majority of distributors believe growth is sustainable


10.0

8.0

5.0

7.0

4.5

14.914.2

15.0

10.4

17.8

15.0

0.0

4.0

8.0

12.0

16.0

20.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (MAT

March)

(%)

<13%8%

13-15%65%

>15%27%

Average sustainable growth

Not sustainable

5%

Sustainable95%

Sustainability of growth

Sustainability of growth is not an issue





We believe, apart from strong macro economic growth and changing socio economic profile, aggressive strategies adopted by pharma companies are also adding momentum. We, thus, broadly classify growth drivers as pull factors and push factors (Chart 3 shows the major drivers of growth as per distributors). Among pull factors, increase in health awareness and higher prevalence of lifestyle-related disease is resulting in higher demand for pharmaceuticals. Further, among push factors, field force expansion to cover larger masses, focus on building brands, aggressive product introductions, and specialty-focused promotion have been identified as major growth drivers. We have analysed each of these factors in detail (Appendix A) and our study indicates that these macro factors will continue to drive higher growth over the next decade.

Chart 3: Factors driving growth in the market


Healthcare infrastructu

re / Govt expenditure

11%

Changing lifestyle

30%

Health awareness

30%

Higher income level /

Affordability4%

Health insurance

9%

Population and aeging

16%

Pull factors Push factors

New product launches

23%

Field force expansion

32%Brand

building13%

Specialty promotion

17%

Price increases

9%

New divisions

6%





Chronic Leads; Cosmetology New Avenue The chronic segment (also termed as life-style-related ailments), comprising three specialty areas—cardiovascular, anti-diabetics and neuro-psychiatry—account for ~28% of the total market and is growing at a faster clip of 18-19%, well above the average industry growth of 16% (Table 2). Among these specialties, cardiovascular is the largest therapy constituting 15% of total pharma market, while anti-diabetics, though relatively smaller in size (6% contribution), is emerging as the fastest growing segment (chart 4). This is further substantiated by our survey which shows that among various therapies, highest growth is viewed in anti-diabetics, followed by cardiac and neuro-psychiatry segments. Table 2: Chronic segment has out performed overall market growth (%)

Source: AIOCD, Edelweiss research

Chart 4: Anti-diabetics is fastest growing segment Chart 5: Therapies depicting higher growth (survey)

Source: AIOCD, Edelweiss research Source: Edelweiss research

While rising urbanisation and sedentary lifestyles are driving higher growth in lifestyle diseases (Chart 6), the overall base of the market is also expanding. Increase in health awareness and proliferation of various single specialty and multispecialty hospitals has led to early diagnosis of chronic disease among people. As shown in chart 7, growth in the chronic segment is led by higher prescription growth, rather than pricing, which implies higher penetration of the market. Hence, companies focused on chronic segment are likely to post higher and sustainable growth than overall market, in the long term.

FY09 FY10 Mar-11 % of total

Chronic 19.1 19.2 17.4 27.9

Acute 14.9 14.9 14.1 72.1

Overall market growth 16.1 16.2 15.0 100.0

0.0

6.0

12.0

18.0

24.0

30.0

Anti-

Dia

betics

Card

io

vasc

ula

r

Neuro

-Psy

chia

try

Onco

logy

Gro

wth

-(%

)

MAT Mar-10 MAT Mar-11

6% 7%15%% of total market

1%

Base of chronic segment is expanding

0.0

20.0

40.0

60.0

80.0

100.0

Anti-

Infe

ctiv

es

Resp

irato

ry

Card

iac

CN

S

Anti-D

iabete

s

Cosm

eto

logy

Onco

logy

(% o

f dis

trib

uto

rs)





Chart 6: Population with lifestyle disease will double Chart 7: Growth driven by higher prescriptions

Source: McKinsey, Edelweiss research Source: AIOCD, Edelweiss research

Cosmetology, oncology and nephrology: New growth avenues within chronic

As per our survey, the super specialty segment could be the next growth driver within chronic, given lower penetration, soaring affordability and insurance penetration. The rise in discretionary spending and focus on personal care is driving growth of the cosmetology segment and players like Dr. Reddy’s, Ranbaxy, and Glenmark are gaining from this trend. Super specialty therapies such as oncology, urology, vaccines, and nephrology are also depicting higher prevalence, specifically in metros and tier-I cities. These therapies, although have niche presence, are growing double the industry growth rate due to higher number of standalone specialty centers for early diagnosis and treatments. Moreover, newer introductions in these therapeutic areas will also expand the market as was the case with DPP IV categories in diabetes where despite premium pricing of Januvia (Sitagliptin; 4-5x to the current treatment), the product has been a huge success. More active competition in chronic segments is resulting in higher investments

Strong growth in chronic therapies has led to higher competition with most companies expanding portfolios to enter the lucrative market. For instance, Ranbaxy, Cipla and IPCA, which are traditionally focused on the acute segment, are now actively building their chronic portfolio, by aggressively launching new products to fill therapeutic gaps. Moreover, while the market is becoming more competitive, its overall scope has expanded with higher number of doctors. Most of the existing and new players have enhanced investments in terms of field force expansion and new divisions to: (a) increase focus on specialists and super specialists; (b) expand reach to the uncovered doctor population; and (c) ramp-up sales of new products. We mention two cases of companies, with higher focus on chronic segment (Torrent and Sun Pharma), to understand their strategic approach to gain market share in a highly competitive market.

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oro

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Dia

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Ast

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a

Obesi

ty

Cance

r

(% o

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tion)

2005 2015E

0%

20%

40%

60%

80%

100%

Anti -diabetics

CVS CNS IPM

Volume Price New products





Chart 8: Case 1 – Torrent Pharma has doubled field force and added sub-divisions and further subdivided existing divisions to increase focus on each specialty

Source: Company, Edelweiss research

As shown in Case 1, focus on brand building is becoming vital for existing players, hence, specialty promotion is emerging as the new and widely adopted strategy across markets wherein companies, like Torrent, are adopting micro-focused approach to build brand loyalty with doctors. Most companies are carving new divisions with dedicated field force to focus on individual specialties like anti-diabetics, CVS, CNS, dermatology, etc. and even individual products or brands in a few cases (e.g., Sanofi Aventis). This helps field force to focus on few products, leading to better promotion among doctors and higher market share. Sun Pharma (case 2) has been successful in building strong brand franchise through therapy-focused marketing. The company has mapped three to four divisions within each of the key therapies to focus on multiple product segments with dedicated field force (refer Fig. 2). This strategy offers more depth in marketing, with multiple medical representatives covering a single specialist, leading to higher prescription share and mind share. Sun Pharma’s multi-focused marketing has rendered it the highest field force productivity among peers (INR 8.9 mn versus industry average of INR 3.7 mn). Almost all distributors believe that specialty focus improves brand positioning and creates high impact on growth.

530

935

254

285 386

577

0

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800

1,200

1,600

2,000

FY09 FY11

(No o

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)

Cardiovascular Anti-diabetics CNS

1,170

1,797

49%

76%

12%

Specialty focused marketing is gaining ground

Divisions

FY09 FY10 FY11

CVS / Anti-diabetics

Psycan, Delta and Azuca

Psycan, Delta, Psycan CND and Azuca

CVS

Psycan, Delta, Psycan CND

Anti-Diabetics

Azuca

CNSAxon, Mind & Neuron

Therapies

CNSAxon, Mind & Neuron

Axon, Mind & Neuron

Therapies

Divisions





Fig. 2: Case 2 - Sun Pharma has build strong franchise by creating higher specialty focus


Cardiovascular

Cardiology,Diabetology

InterventionalCardiology

ARIAN AZURA AVIORLife sciences

AZURACriticare

CNS(Psychiatry, Neurology)

SYNERGY SYMBIOSIS SIRIUS

Gynecology

Fertility, Urology

GastroenterologyOrthopedics

SPECTRA INCALife Sciences

INCA Life Sciences

SUN SOLARES

Therapy Divisions / Sub divisions

Opthalmology AVESTA MILMET

Oncology

Rheumatology,Dermatology

SUN Oncology

ORTUS

RADIANT





Metro, tier-I key markets; Semi urban and rural areas are new growth pockets We believe metros and tier-I markets will remain key drivers of industry growth, while the base of semi-urban and rural markets will expand driven by higher affordability and improved access to better healthcare. We have tried to analyse through our survey the changing dynamics of various tiers or classes of geographies within the industry. We can divide, based on the population parameter, the IPM into two major categories: (a) metros and tier–I cities (population ranging from 500,000 to 1 mn and above); and (b) semi urban and rural markets (population ranging from 5000 to < 500,000). Metros and tier-I cities account for 60% of the total market, while semi-urban (tier II-IV) and rural markets account for the balance 40%. The table, below, highlights cities covered through the survey and growth in various tiers of the market, as perceived by distributors.

Table 3: Tier-I, III and IV cities are registering higher growth above industry average


We highlight that metros are growing at an average rate of 13-15%, in line with the industry. Acute therapy still constitute ~60-65% of volumes, while the share of chronic therapies is increasing, which is driving higher number of specialty set ups. As a result, companies are expanding field force in these markets to target larger doctor population. Most distributors guide that growth in metros will sustain for the foreseeable future led by four key factors: (i) urbanisation (due to migration of people from lower tiers) resulting in higher population; (ii) rapid changes in lifestyle, leading to faulty eating habits, key driver of chronic disease; (iii) higher growth of middle income levels group driving affordability; and (iv) increase in diagnosis and treatment levels. Increase in health awareness is also resulting in higher self medication, which is driving most companies to switch leading brands from prescription to OTC (e.g., Pfizer is expanding its brand franchise by promoting Gelusil syrup as an OTC product). This strategy enables companies to get higher growth and return from established brands with lower investments. Moreover, companies like IPCA and Cadila are entering into nutraceuticals segment driven by higher demand for additional supplements to cope with rising stress levels. IPCA has introduced Nutralite to venture into the nutraceutical segment.

City Tier Overall share

of market (%)Population Cities covered through survey

No of retail chemists

Average Growth (%)

Metro 30% >1 mn Hyderabad, Chennai, Mumbai, Ahmedabad, Delhi, Kolkata

4,000 to 20,000 13-15%

Tier-I 30% 500,000 to <1 mn

Pune, Surat, Secunderabad 2,000 to 5,000 >15%

Tier-II Gurgaon, Bhubaneshwar,Baroda, Cuttak, Howrah

1,000 to 3,000

Tier III Karimnagar, Warangal,Nashik, Noida

1,000 to 2,000

Tier IV

Rural/Micro Towns

20%300,000 to 500,000

>15%

20% up to 300,000Vapi, Satara, Sangli, Abhore, Kolhapur, Miraj, Behrampur, Sikar, Chomu etc.

250 to 700 25-30%





Growth in tier-I cities higher than metros

We view, on the basis of our survey, higher growth in tier-I markets (at 15-20%) than metros, largely due to increasing base of chronic disease (diabetes and CNS) growing at a faster rate compared to metros and increasing penetration of better healthcare facilities such as higher secondary care and single specialty care hospitals. Semi-urban and rural markets: New growth pockets

Semi-urban markets, comprising various tier II-IV cities, are potentially high growth markets, growing in the range of 15-30%, higher than average industry growth. Affordability is the biggest growth driver, led by higher disposable incomes, which has led to significant increase in pharmaceutical spending. Further, these markets are highly underpenetrated (70-75% of population comprising 40% of total market by value) which will enable it to sustain high double digit growth over the next four-five years. We believe this strong growth has positive implications for top tier pharma companies, majority of which have embryonic presence in these markets. However, the dynamics are different form metros (Table 4) entailing companies to tailor their marketing strategies to individual markets.

Table 4: Dynamics of semi-urban and rural markets vary from metros and tier-I markets


We detail out three key strategies adopted by companies to penetrate tier III and IV markets. First, most companies are appointing local staff or setting up a local headquarter to cater to these markets, which was earlier addressed by field force from tier I and II towns in close proximity. As per distributors, local field force is essential to promote products effectively to local GPs and CPs which leads to higher volume growth. Second, existing

Semi-urban & Rural markets

Metros & Tier -I towns Comments

Therapeutic mix

Acute therapies account for 80-90% of total consumption in semi urban areas

Anit-infectives, gastro-intestinal and respiratory are high growth therapies, while chornic therapies are catching up with higher growth in towns with more urbanization

Doctor population

Nature of doctor population is largely GPs and CPs (90-95% of total), while specialists presence is limited to fewer class-II/III towns which are seeing higher urbanization and expansion of therapies like respiratory, neuro-psychiatry and diabetics

Local competition Very high Not much impact

Poliferation of local players giving stiff competition to Top tier pharma companies

Local playes have better relations with doctors, low pricing strategy and incentivise retailers with better schemes

Distribution set-up

Hub and spoke (Hub is the Tier-III/IV town

which catrers to near by micro towns)

Multi-layeredWide spread and organized

Lack of distribution set-up leading to higher cost of distribution. (Sanofi Aventis does taxis tours using own vehicles into micro interiors)

Field force Lack of quality in field force More skillful with better product knowledge and

understanding of the market

Penetration and local presence is lower in tier-III/IV cities

Chronic (10-20%)

Chronic (35-40%)

GPs (MBBS), RMPs (90-95%)

Specialists (5-10%) GPs and CPs (50%)

Specialists (50%)

Local field force presence is critical to gain market share in semi-urban and rural markets





players are expanding their coverage (field force is doubled in most regions) to address larger pool of doctors and micro interiors, which were earlier not covered. For instance, to increase penetration, Sanofi Aventis is doing taxi tours in micro interiors which have no transport. Last, companies are organising more CMEs (medical education programmes by inviting senior physicians for local doctors) as well as healthcare awareness camps which are helping them reach targeted customers more effectively. Hence, by improving accessibility in under-penetrated markets, companies are creating higher demand for pharmaceuticals. We believe companies like Cipla, Cadila, IPCA, Ranbaxy, and Sanofi Aventis, which are adopting a more localized approach, are well positioned to take advantage of growing demand. Table 4, above, further depicts that the disease profile of tier III-IV cities is highly concentrated on the acute segment. We believe companies in order to penetrate and build base in tier III–IV markets, will have to initially tailor their product portfolios to the acute segment, while selectively positioning in the chronic segment. As per our analysis, chronic segments like respiratory (anti-asthma), cardiac, and diabetes are also picking up in selective markets which gives opportunities for growth to companies like Sun pharma, Torrent, and USV, who have selectively focused on neuropsychiatry, cardiac and anti-diabetic segments, respectively, in these markets. Chart 9: Players becoming more active or expanding coverage in tier III-IV areas


As per our survey, larger players such as Cipla, Cadila, and Ranbaxy, with strong concentration in the acute segment, are doing well in semi-urban and rural areas, while players such as Lupin and IPCA are also expanding coverage and seeing positive traction from these regions (Chart 10). Moreover, MNCs (GSK, Pfizer and Sanofi Aventis) are also expanding field force, strengthening distribution networks, and launching economically priced branded generics products (such as Rabeprazole by Pfizer). We highlight that these products have initially not posted higher traction and will take longer gestation periods before building market share.

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Companies primarily focus on acute segment in tier III-IV and rural markets





Chart 10: Relative performance in semi-urban and rural markets (Survey)


Interestingly, Mankind and Macleods are prominently gaining market share, giving stiff competition to other players in these markets. While most companies have been traditionally focused on metros and tier-I towns, companies like Mankind and Macleods have expanded penetration in smaller markets, thereby establishing strong hold in terms of prescription share of doctors. However, the positioning is different than other peers and hence do not directly compete with similar doctor population. To illustrate our point further, Mankind strategy differentiates on two points: (a) lower prices; and (b) deeper penetration in doctors with a larger coverage list. Moreover, they have relatively better promotional strategies for retailers wherein the company offers schemes with higher incentives than other players. Finally, Mankind’s field force largely comprises people with non-science backgrounds and attrition is low due to higher incentive structure. We believe higher stability or lower attrition is critical to build market share in these markets. Chart 11: Field force stability of players in rural market (Survey)


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0% 20% 40% 60% 80% 100%

IPCA

Cipla

Cadila

Ranbaxy

Lupin

Mankind

Pfizer

(% distributors)

Better field force Poor field force

Mankind, Macleods have strong foothold in semi-urban and rural markets





Aggressive MNC Expansion Poses High Risk MNC pharma companies are aggressively expanding with meaningful investments in the domestic market. These investments, although at a nascent stage, will set up base for the next leg of growth. Most leading MNC companies have set bold aspirations for their Indian businesses and are adopting a more localised business model including pan-India penetration, well spread out competent field force, strong distribution network and branded generic presence. 65% of total distributors believe that MNCs are becoming aggressive in terms of launching new products, therapies, and competitive pricing of products. MNCs such as Aventis, MSD, and Abbott are transforming existing policies and aggressively building channel relations with distributors. For instance, Sanofi Aventis has directly interacted with all distributors across India (video conference call) to elucidate their business and future strategies. Moreover, senior management and area heads from MNCs are directly meeting key distributors to strengthen coverage.

Chart 12: Strategies adopted by MNCs


Chart 13: Most distributors perceive aggressive expansion by MNCs


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New product launches (incl

branded generics)

Field force expasnion

Brand promotion Building channel relations

(% o

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uto

rs)

Not much change in activity

35%

Higher activity level65%





Distinct shift in strategy by launching branded generics products

MNCs are overhauling domestic portfolios by aggressively investing into branded generics, rebuilding the old/established brands through the OTC route and expanding into new therapies like CVS, CNS and Oncology. Table 5 shows, recent braded generic launches by some MNCs (GSK and Pfizer) and respective pricing of products versus Indian players.

Table 5: MNCs are adopting aggressive pricing strategy in branded generics


This, table, depicts that MNCs have entered into the branded generics segment with extremely competitive prices versus Indian companies. However, sales from these brands have not picked up due to lack of strategic bandwidth in promoting branded generics. Most distributors believe that branded generics launches by MNCs will take longer to build traction as there are cultural barriers which companies face while marketing a non-parent product. Moreover, in licensing of off- patented/patented drugs from parent pipeline (over next two-three years) are sought as key business drivers. For example, MSD has strong pipeline of in licensed molecules which are gaining traction in the market. Field force expansion to enhance penetration

MNCs are rapidly expanding field force as part of their strategy to expand geographical reach into tier I and II cities. For instance, Pfizer has increased its field force from 1,100 reps in CY09 to 2,300 by CY2010 and further plans to add field force in CY11-12. Similarly, GSK has increased its field force from 2,000 in CY08 to 2,800 in CY10 (growth of 40%). Sanofi Aventis has also expanded its field force to 1,800 reps from 1,100 in CY08. These investments will reap benefits over the next three to four years, in our view.

MNC Molecules Therapy Brand name Pricing

(INR) Company Brand name Pricing (INR)

Glaxo Atorvastatin CVS43

(10 tablets)

Ranbaxy

Intas

Dr Reddy's

Cipla

Pfizer RabeprazoleGastro-

intestinalAbove 5

24 (7 tablets)

Intas

Cipla

Dr Reddy's

Indian Competitive brands

180(10 tablets)

125(10 tablets)

110(10 tablets)

157(10 tablets)

55(15 tablets)

64(15 tablets)

70(10 tablets)





Chart 14: Field force expansion by key MNC players


Sanofi-Aventis is preferred play in MNC space

Sanofi Aventis is emerging as the most aggressive player, among MNCs, with an all inclusive strategy for growth. The company has positioned itself into the high growth chronic segment (50% of its total portfolio) with strong market share in anti-diabetics. Among the top 10 brands, six are in the chronic segment. Further, Aventis has active coverage across markets and is increasing reach into various tier II-IV markets. The company has adopted dual strategies for each class of market. For instance, its focus in metros and tier-I markets is to aggressively build brands and has employed a specialty task force (STF) for each of its brands. Lantus, Cardace and Allegra are few of the strong brands build by Sanofi despite stiff competition. For tier II to IV markets, the company is building upon its acute franchise by expanding reach and access through project Prayas (which underlines its strategy to reach micro interiors) and by launching line extensions of established brands such as combiflam cream.

Chart 15: Relative performance of MNCs (Survey)


0

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GSK Pfizer Aventis

(No. of re

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188%

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Sanofi

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Abbott

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am

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r

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Ranbaxy

Growing above market Growing below market In line

Sanofi-Aventis is leading the MNC pack

MNCs have doubled field force to expand geographical reach





Differentiating ‘Class from Mass’ A strong and growing domestic market has opened floodgates of opportunities for Indian as well as MNC players, who are targeting these with multi-pronged approach. While some companies have been frontrunners in identifying future opportunities, others have lost momentum. To differentiate the former from the latter, we have contemplated various parameters which could be critical for growth. Further, we believe that historical execution is a realistic measure to differentiate players, but it may not be indicative of future growth and performance. Hence, these five key parameters (or critical success factors) could gauge the strength of a company’s domestic business and act as an effective tool to differentiate good from the bad (or winners from losers). These include: a) Portfolio concentration or business mix (acute versus chronic)

b) Ability to build brands

c) Success of new product launches

d) Field force penetration or coverage

e) Field force stability and productivity On the basis of above mentioned parameters and through our analysis from the survey, we have identified few highly effective companies which have strong execution and are growing ahead of market. Sun and Lupin emerge as favored plays in large cap; Torrent/IPCA score in mid cap

Sun pharma and Lupin were ranked by most distributors as outperformers among large caps, while Torrent and IPCA scored in mid caps. Among MNCs, Aventis scored over other players such as GSK and Pfizer. Players such as Cipla, Ranbaxy and Cadila are facing some pressures in terms of growth and stability but are likely to turnaround, in our view. Sun pharma has emerged as the undisputed choice among distributors primarily because of its ability to identify therapeutic gap areas and launch products ahead of competition, resulting in better mind share and market share. Second, the company has focus on medical colleges and has innovatively built its doctors franchise by engaging them at an early stage. Lupin scores over peers due to its focus on key opinion leaders (KOLs). The company has actively build a wider portfolio by entering into newer therapeutic areas and is growing ahead of peers in chronic segments such as CVS, CNS, and respiratory. Moreover, its aggressive and highly effective field force helps it sustain growth in a highly competitive market. Cipla, despite deep penetration and high field force productivity, has seen slow growth in domestic market. This is largely due to instability in the field force which has further impacted its ability to build big brands. However, we believe that Cipla can surprise the market positively due to its higher focus on tier II and IV markets, where the company has started witnessing high growth traction, and addressing of structural issues with reference to its mature and generic-generic portfolio in domestic market. Other companies like Cadila, Dr. Reddy’s, and Ranbaxy are also gearing up which is evident from the fact that they have ramped up their field force by 22%, 94%, and 72%, respectively, over the past two years. In the mid-cap space, Torrent is ahead of comparable peers on account of higher focus on the chronic segment, better field force stability, and ability to build brands. However, it lags in terms of launching new products. Moreover, IPCA is also gaining strong momentum in all

We judge strength of domestic business of each player on the basis of five key parameters





markets and has increased divisions (12 from earlier seven) to expand into newer therapies and tier II to IV towns. We highlight that Torrent and IPCA have expanded field force aggressively (by 64% and 58%, respectively) which has impacted their field force productivity (Fig. 3). In the MNC space, Sanofi-Aventis has a clear advantage over other MNCs because of high focus on the chronic segment, strong brand building abilities, competent sales force, and aggressive approach in metros as well as tier II to IV towns.

Fig. 3: Competitive score card


The competitive score card, above, measures each company on the basis of its strength in each of the parameters, which is key end driver of our survey. We now illustrate our findings through discussion of each of these key parameters and substantiate our preferred plays over others.

Company NameDomestic growth CAGR (5yr)

Portfolio concentration

Brand building ability

Success of new product launches

Field force stability

Field force productivity

Reach (Medical reps)

Large Cap

Sun Pharma

Dr Reddy's

Cipla

Lupin

Cadila

Mid-cap

Torrent Pharma

IPCA

Glenmark

MNC

Ranbaxy

Sanofi-Aventis

GSK India

Pfizer India

Scale: Best ………………………………………………………………………………………Least 5 1





Portfolio concentration or business mix We prefer Sun Pharma, Lupin, and Torrent as they have higher concentration in chronic therapies, which contribute 45-60% of their total sales (Chart 16). The presence in the chronic segment has historically offered these players higher growth than industry. Further, chronic therapies provide better realization than acute, thereby rendering higher gross margins (80-90% versus 70% in acute segments). Companies which are largely focused on the acute segment such as Ranbaxy, Dr. Reddy’s, Cipla, and IPCA, are posting higher growth in micro markets. The acute segment continues to have larger share of IPM (~72% of total market) and has posted better growth in the past two years due to increased penetration of companies in tier II-IV towns and rural areas. Among MNCs, portfolio concentration is more skewed towards acute except Sanofi-Aventis which has build strong presence in the chronic segment, where we see growth picking up over the past six months. Chart 16: Players with strong focus on chronic segment to outperform market


We believe, within the chronic segment, companies with higher market share and ability to build successful brands will grow ahead of peers. As seen in charts 17-19, Sun Pharma has leading market share in most specialty segments, while Lupin has posted higher growth among peers. We highlight that the cardiovascular segment has become extremely competitive with older molecules facing pricing pressures. Cadila and Torrent have relatively underperformed in CVS due to pricing pressures in older molecules and lack of new product launches. As per our survey, Cadila is facing higher attrition among peers, leading to loss of market share in few divisions.

0.0 20.0 40.0 60.0 80.0 100.0

GlaxoPfizer

GlenmarkRanbaxy

IPCACadila

Dr Reddy'sCiplaLupin

Sanofi …Sun Pharma

Torrent

(%)Chronic Acute

Sun, Lupin and Torrent have high focus on chronic segment





Chart 17: Key players in anti-diabetics market

Chart 18: Key players in cardiovascular market

Chart 19: Key players in neuro-psychiatry market


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(%)

(%)


Industrygrowth

We prefer players with higher market share and growth within chronic segment





Ability to build brands: A key differentiator As new product launches dwindle, building big brands has assumed much greater importance and is rather necessary to improve profitability. To instill a culture and mindset of building large brands, companies need to focus on several aspects. First, for large brands, company’s require active life cycle management, while for scaling up medium sized brands they need to broaden coverage across doctors and geographies and finally for relatively new brands the focus should be to create credibility and generate prescriptions among KOLs (key opinion leaders). We recognize brand building as future growth driver and have identified companies with better track records in building brands. Our survey highlights that among domestic companies, Sun pharma leads the pack, followed by Lupin with 68% and 59% of distributors, respectively, gauging strong brand building capability. Among MNCs, respondents believe Sanofi-Aventis has better brand building ability. Similarly, in mid caps, Torrent, IPCA and Glenmark have better brand building ability compared to peers. Chart 20: 68% respondents believe Sun Pharma has better brand building ability


The table 6, below, further shows that the incremental growth in top 10 brands of most players is higher or in line with the overall growth of respective domestic business, except for Dr Reddy’s where growth is largely driven by new products. Sun pharma has shown highest growth in top 10 brands which further supports our preference.

0

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30

45

60

75

Sun

Pharm

a

Lupin

Aventis

Mankin

d

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US

V

IPC

A

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nm

ark

Inta

s

Torr

ent

GS

K

Abbott

Pir

am

al

Dr

Reddy

Cip

la

Pfize

r

Ranbaxy

(% c

overa

ge d

istr

iibuto

rs)





Table 6: Top 10 brands are growing in line or higher than overall domestic growth


Success of new product launches Most large and mid-size companies, to actively expand coverage across molecules or therapies, are launching new products. However, as per our survey 70-80% of these products have been failures; most of these failures have been in established segments, where more than 10-15 players currently exist. Hence, we observe companies which are more proactive and launch products ahead of the market are more successful in building brands, which potentially contribute to higher growth of the business. The chart, below, indicates that companies like Sun Pharma and Lupin are equally successful in building new products, as Top 10 brands contribution to growth is relatively lower than the peers. However, companies like Ranbaxy and Glenmark still have high dependency on Top 10 brands. Ranbaxy’s Top 10 brands are driving ~50% of its incremental growth, primarily due to slower pace of new launches over the past two three years. Similarly, MNCs dependency on top 10 brands is relatively high due to fewer product launches compared to Indian peers.

Chart 21: Lower contribution from Top 10 brands indicates higher traction from new launches

Indian peers MNC peers


Top 10 brandsOverall

domestic Relative

performance

Glenmark 36.9 27.6 22.4 5

Ranbaxy 36.6 15.7 9.1 7

Torrent 30.4 24.0 22.1 2

Cipla 27.9 25.0 20.6 4

Cadila 28.3 17.9 14.9 3

Sun Pharma 19.6 32.5 22.9 10

GSK 38.7 12.4 13.2 -1

Sanofi Aventis 55.1 20.0 21.2 -1

IPCA 34.7 22.0 24.4 -2

Lupin 21.0 21.6 24.3 -3

Pfizer 63.9 21.0 23.7 -3

Dr Reddy's 39.9 8.2 11.5 -3

Top - 10 brands Cont. to sales

(%)

Growth (MAT Mar 2011) (%)

Cipla

Dr Reddy's

Glenmark

IPCA

Lupin

Sun Pharma

Torrent Cadila

10

18

26

34

42

50

10 20 30 40 50

(Top 1

0 b

rands

c ontr

ibution

to

gro

wth

)

Top 10 brands contribution to total domestic sales (%)

Relative outperformance of Top 10 brands reflects higher focus on brand building by most players

Sanofi Aventis

Pfizer

GSK

Ranbaxy

30

37

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Chart 22: Companies most aggressive in launching new products


Most distributors view higher traction from new launches by Sun Pharma , Sanofi Aventis and Lupin. Sun Pharma’s ability to identify therapeutic gap area and launch products ahead of the market are key differentiating factors behind its success. Also differentiated R&D pipeline of Sun Pharma and Dr Reddy’s clearly give them an edge over others. Dr. Reddy’s growth contribution from new products (78%) is highest among peers and higher than industry (40%).

Higher field force penetration or coverage Many pharma companies, including MNCs, have enhanced their field force over the past two years to expand their reach and penetration in existing as well as tier-II to IV markets. We believe there is a huge scope for higher coverage as modern medicine till date reaches only 35% of the population. India has approximately 8, 00,000 doctors, but most companies cover only 1,50,000-2,00,000 as these are the leading prescription generators. However, success of few pharma companies such as Mankind and Macleods has challenged the traditional model of top down approach and many companies (both Indian as well as MNCs) have expanded their reach to gain the incremental pie of growing opportunities.

Chart 23: Field force penetration has increased over past four years


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Higher field force penetration to optimise reach to pharmacists, doctors and hospitals





As viewed in Chart 23, Cipla, IPCA, and Cadila have the largest field force, while Sun Pharma has not expanded its field force due to its restricted focus on Metro’s and tier I towns. Ranbaxy’s field force expansion, through its ‘Project Virat’, from 2,500 reps to 4,200 reps, over the past six months, has been the largest. Further, Glenmark lags its peers in terms of penetration, but expects to expand field force by 15-20% per annum over the next two years.

Field force stability critical for sustainable growth Field force stability is critical to maintain higher productivity and growth, while instability results in disruption of sales. Although retention has always been a challenge for the industry, off late, the attrition rate has zoomed owing to aggressive hiring. We believe, companies with strong and effective field force management have higher probability of sustaining market share and growth. Historically, MNCs were associated with better field force stability because of higher pay scale. However, as per the survey, Lupin, Sanofi-Aventis and Sun pharma have been ranked as companies possessing highly effective and stable field force compared to its large cap and MNC peers. Cipla has the highest attrition followed by Ranbaxy, while field force stability of Dr. Reddy’s and Cadila is above average. In the mid-cap space, Torrent and Glenmark have more stability than IPCA, Unichem, and FDC. In the unlisted space, Mankind has a stable field force because of its highly effective incentive policy. Chart 24: Companies with highly stable and effective field force (Survey)


Field force productivity is of paramount importance Companies with higher field force stability and higher concentration in chronic segment has better productivity. Although, aggressive field force expansion has impacted per man productivity of many companies in the short term, we view these investments as positive as they lend long-term growth visibility. Analysing the long-term trend, we observe that Sun pharma, Cipla, and Lupin have higher productivity. Among MNCs, the field forces of Aventis and GSK are highly productive because of strong brand equity and concentration in a few therapies and geographies. Among mid caps, productivity of Torrent and IPCA has been impacted due to aggressive expansion in field force over the past two years. We highlight that it takes three to four years for new medical representatives to achieve company level productivity.

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Higher field force productivity yields higher margins





Chart 25: Recent expansion in field force has impacted productivity


Historical execution in domestic market Historical revenue growth reflects the effectiveness of strategies and strong execution capabilities of management. We highlight that companies which have scored well on all parameters, as discussed above, have also delivered strong revenue growth (over past five years). Chart 26 indicates that Lupin and IPCA have posted 24% CAGR over FY05-10, while Sun Pharma and Torrent have also registered strong growth of 22% and 20%, respectively. Chart 26: Companies with strong historical growth scored well in our survey


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Future Growth Drivers As the domestic pharma market grows in size and diversity, there are several opportunities that will scale up to their full potential. Some of these include biologics and vaccines, consumer healthcare, patented products and hospital segment, which are at an early stage of lifecycle, but are likely to scale up with upgradation of therapies, increased penetration of multi-specialty hospitals and changes in patients preference. According to industry sources, these opportunities will collectively grow to USD 25 bn by 2020 from the current USD 5 bn. Rising acceptability of new therapies

As the domestic pharma market grows in size and diversity, we believe the acceptability of modern medicine (including biologics and vaccines) and new therapies will increase due to aggressive market creation by players and greater propensity of self medication. Investment in enhancing patient awareness and education will impact diagnosis and treatment levels. In addition patients will show greater propensity to self medicate. The consumer healthcare segment has the potential to grow at over 14% annually, provided players make large OTC brands easily available to consumers, differentiate their products, and establish an emotional connection with patients. Finally, the acceptance of biologics and vaccines will rise. The biologics market is expected to reach USD 3 bn by 2020 from the current USD 300 mn. Launch of patented products

Although patented products’ contribution to the domestic market is negligible (USD 200 mn; <1% of total market) and there have been very few launches since 2005 in India, the recent successes of Januvia and Galvus indicates that patented products can drive tremendous growth in a few therapeutic areas, provided they are priced adequately. Rising affordability and increased healthcare insurance penetration will be the primary growth drivers for the patented products segment. The overall contribution of patented products is likely to remain below 5% (USD 1.7 bn by 2020), however, revenue will be concentrated to few brands and hence would be attractive for MNC players who proactively launch and build brands. Hospital segment to gain importance

The hospital segment is one of the fast growing segments and has been a key growth driver for the domestic industry. While the retail segment is mainstay of the pharma market (contributes 85-90% of overall sales), the hospital segment is gaining importance driven by dramatic rise in infrastructure and advent of corporate hospitals. In the developed world, hospitals account for more than 25% of the pharmaceutical market, while in India they account for less than 10%, but are increasing at rapid pace. Over time, the proportion of pharmaceutical sales to hospitals is likely to increase with strong capacity addition (37% increase in FY10) in the healthcare segment. The hospital market contribution to domestic market to likely to grow from USD 1.7 bn to USD 14 bn by 2020 (22% CAGR; 26% market share). We highlight that our survey indicates strong focus by MNCs in hospital segment.

Acceptance of biologics and vaccines will increase





Chart 27: Hospital market to post 22% CAGR

Source: Mckinsey, Edelweiss research

0

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13 26





Valuations: Rich, But Not Stretched

Earning CAGR of 23% likely over FY10-13E We expect our pharma universe to post 17% revenue CAGR over FY11-13E, driven by 25% and 21% growth in Sun Pharma and Cadila, respectively. The drivers of this growth are multiple, in our view, including strong traction in the domestic market, USD 135 bn worth opportunity from patent cliff in the US market, and double digit growth in various emerging markets. We expect operating margins to expand by 220 bps to 21.8% over FY11-13E, led by outperformance from Ranbaxy (400 bps expansion) and Sun Pharma (300 bps margin expansion) during the same period. We expect strong revenue growth and operating margin expansion to drive 23% earning CAGR over FY11-13E.

Table 7: Earnings growth momentum across coverage universe (INR bn)


Note: * Financials (ex-ROCE) represent base business (Ex one-off from Para IV)

**Financials for Sun pharma includes Taro but excludes one-off from Para-IV

Pharma Index’s relative performance to broad market has moderated The BSE Healthcare Index has underperformed the broad market (Sensex) over the past four months, after a strong outperformance over the past three years. This is further evident from the fact that the relative premium to the broader market, which had expanded towards the beginning of the year (43-45% relative to market), has corrected more than 14-15% from its peak since January 2011. We believe this is largely because: (a) sector valuation multiples (one year forward) have expanded from their five year historical average of 19x to 23x; and (b) the sector is fairly owned across institutional investors who have been booking profits. However, post correction, over the past four months, the sector is trading near to its five year average multiple (18-19x).

Company FY11 FY13E CAGR FY11 FY13E CAGR FY11 FY13E FY11 FY13E CAGR FY11 FY13E CAGR (%)

(%) (%) (%)

Cadila 45.0 65.9 21.1 9.9 15.0 23.4 21.9 22.8 6.5 10.3 26.5 31.6 50.5 26.5

Cipla 62.5 82.8 15.1 13.6 19.3 19.3 21.7 23.3 10.0 14.9 22.1 12.4 18.5 22.1

Dr Reddy's* 72.7 97.5 15.8 15.3 21.2 17.7 21.0 21.7 10.5 14.9 19.0 62.4 88.4 19.0

Lupin 56.7 75.3 15.2 11.6 16.1 17.9 20.5 21.4 8.5 11.8 17.9 19.1 26.5 17.9

Ranbaxy* 72.3 90.3 11.8 6.1 11.3 36.0 8.5 12.5 3.6 7.1 40.8 8.5 16.9 40.8

Sun Pharma** 50.6 78.6 24.6 15.2 24.5 27.0 30.0 31.2 13.4 20.7 24.3 12.9 21.2 28.1

Torrent Pharma 22.6 32.1 19.3 4.4 6.7 23.0 19.5 20.8 3.0 4.6 24.6 35.1 54.5 24.6

Total 382.4 522.6 16.9 76.0 114.1 22.5 19.9 21.8 55.4 84.3 23.4 182.0 276.5 23.3

Revenue EBIDTA EBIDTA Margins (%) PAT EPS





Chart 28: Healthcare Index performance viz-à-viz Sensex


Valuations rich, but not stretched; prefer stock-specific approach Although valuations of the pharma sector have moved up, they are not in stretched territory. While we remain positive on the sector (as fundamentals remain strong), we prefer to be more stock specific. Moreover, variations in stock performance within the sector also highlight the importance of company-focused approach.

Chart 29: Relative performance within sector (to Sensex)


Premium valuations to sustain

Our universe currently trades at 22x FY12E and 18.5x FY13E EPS. Current sector valuations are closer to their five year average PE. Historically, the pharma universe has traded at a 10-15% premium to the broader market on account of consistent earnings growth, healthy balance sheet, and defensive nature of the market. Currently, the Pharma Index is trading at 24-25% premium to the Sensex (past one year average premium is 25-26%), slightly higher than the long-term average premium of 10-15%. We expect premium valuations to sustain with emergence of the innovator-generic partnership model, strong earnings growth (23% earning CAGR), robust financial ratios (Universe RoCE of 28% and low leverage of 0.2 x) and higher positive free cash flow.

(9)

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1 yr AblsoluteISIEmergingMarketsPDF in-sdmcpl01 from 124.124.255.5 on 2011-11-09 01:19:45 EST. DownloadPDF.




Chart 30: Pharma relative premium/discount to Sensex


Lupin and Cadila likely to catch up peers’ multiple We expect our large-cap universe to continue to trade at 19x one year forward PE (in-line with five-year average). However, Lupin and Cadila, which have historically traded at five year mean multiple of 13-14 (mid-cap valuations), are seeing visible narrowing down of the multiple gap with large peers as these companies have gradually moved into the big league and we expect this gap (still trading at 10-15% discount to comparable peers) to further narrow. Top picks

We conclude, on the basis of our distributor survey, that Sun Pharma, Lupin, Cipla, and Torrent have a strong franchise in the domestic market and robust growth outlook. However, after considering incremental upsides from international markets, company-specific issues and current valuations, we expect Lupin, Dr Reddy’s, Cadila, and Torrent to be outperformers over the next 12-18 months.

Table 8: Peer valuations matrix

Note: * PE multiple for Dr Reddy’s, Sun Pharma. and Ranbaxy is based on CMP adjusted for NPV of one-off exclusivity sales


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Pharma Sensex Relative premium

Pharma index has traded at 45% premium

CMP Reco

INR FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E

Sun Pharma* 446 HOLD 12.9 17.9 21.2 28.1 33.7 24.4 20.5 8.4 7.8 6.3 28.7 20.2 16.7

Cipla 321 HOLD 12.4 15.2 18.5 22.1 25.9 21.1 17.3 4.0 3.5 3.0 18.8 15.7 12.9

Ranbaxy* 468 HOLD 8.5 13.6 16.9 40.8 44.0 27.5 22.2 2.3 2.0 1.7 27.5 19.9 14.0

Cadila 844 BUY 31.6 40.6 50.5 26.5 26.7 20.8 16.7 4.0 3.2 2.6 18.2 14.3 11.4

Dr. Reddy's* 1,656 BUY 62.4 76.4 88.4 19.0 25.0 20.5 17.7 3.7 2.8 2.4 17.3 14.1 11.4

Lupin 412 BUY 19.1 21.6 26.5 17.9 21.6 19.1 15.6 3.2 2.7 2.3 15.4 12.3 10.5Large Caps 29.5 22.2 18.3 4.3 3.7 3.0 21.0 16.1 12.8

Glenmark 300 NC 15.2 18.6 22.9 22.9 19.8 16.2 13.1 3.2 2.8 2.3 11.8 10.7 8.8

Torrent pharma 592 BUY 35.1 42.6 54.5 24.6 16.8 13.9 10.9 2.2 1.8 1.5 11.6 9.4 7.3

IPCA 310 NC 17.2 22.0 29.0 29.9 18.1 14.1 10.7 2.2 1.8 1.5 11.1 8.9 7.3

Aurobindo 195 BUY 19.7 22.5 27.8 18.7 9.9 8.7 7.0 1.8 1.5 1.2 7.5 6.8 5.5

Unichem 191 NC 13.1 15.2 19.8 23.0 14.6 12.5 9.7 2.0 1.7 1.3 9.6 8.2 6.3Mid-cap 15.8 13.1 10.3 2.3 1.9 1.6 10.3 8.8 7.1

EV/EBITDA (x)EPS (INR) P/E (x)CAGR

(FY11-13) (%)

EV/Sales (x)





Key Risks

High field force attrition could dent growth and profitability A well spread out and competent field force (with good communication skills and product knowledge) is critical for establishing and sustaining market share in a fiercely competitive market like India. Players like Sun pharma, Lupin and most MNCs have pioneered various models to establish quality field force. This entails rigorous investment in hiring, training, and retaining people, which creates upfront costs recovered over two-three years. For example, it takes one year for a company to recover upfront costs (or sunk costs) for each new medical representative and it takes another two-three years for a medical representative to reach company level productivity. Moreover, it takes six-eight months for a new sales representative to establish relations with physicians and practitioners. Hence, loss of a trained field person not only results in loss of sales, but also loss of initial investment. As per the survey, most companies are facing high attrition across tiers or geographies which could potentially risk growth in near term. Almost ~ 75-80% of distributors confirmed 15-30% (and above) field force attrition across markets surveyed (see chart 31).

Chart 31: Higher attrition rates across the board


We have identified three key reasons behind higher attrition: (a) increase in demand for medical representatives and limited supply of talent pool with companies competing for high quality people; (b) setting up challenging field force targets with mandate to aggressively capture market share; and (c) shift to other sectors like IT and financial services for better incentives and growth. Sun pharma, Lupin, and Torrent have been ranked by distributors as companies possessing highly effective and stable field force, while Cadila, IPCA, GSK, and Cipla are companies facing higher attrition.

<10%

10-15%

15-30%

>30%





Chart 32: Companies with poor field force stability


Rise in fixed costs and higher competition to impact domestic margins

While attrition is posing potential risk to growth, increase in cost of hiring is likely to impact profitability. Most companies are hiring non-science graduates for ramping up field force which could result in high training expenses. Moreover, to retain the field force, companies such as Unichem, IPCA, and Torrent, among others, are revising inventive structures, resulting in higher employee costs. Other factors such as expansion into Tier-II to Tier IV towns as well as increase in competition from MNCs and new players will also exert pressure on margins. Rural penetration requires higher investment

Managing penetration in smaller markets offers several challenges to companies such as higher distribution costs due to poor infrastructure, increase in working capital led by high inventories to initially fill channel and longer credit period. As per the survey, average credit period in smaller towns is between one to two months versus less than fifteen days in metros and tier-I cities. Moreover, it takes longer to break even investments due to lower productivity of medical representatives. The payback period ranges from one and half to two years versus less than one year for urban markets. Apart from higher cost of investment, attrition, lack of talent pool, malpractices and higher competition from local players are other challenges for companies to grow and expand in these markets. Emerging competition from MNCs and new players could lead to price war

The domestic market is being targeted by both MNCs and Indian companies. This is further brought out by our survey where most distributors are seeing aggressive expansion by MNCs. As seen in chart 33, these high investments have started to yield traction for MNC players like Aventis, AstraZeneca, and MSD. Further, new players such as Macleods, Mankind, Aristo etc. are rapidly expanding market share, giving stiff competition to Indian counterparts. We believe this emerging competition could lead to higher investments by existing players, while price wars could potentially hurt their profitability in the near term.

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Chart 33: MNC growth has improved over past few months


Table 9: Emerging competition from new players


Decline in success rate of new product introductions

New product introductions contribute 4-5% of overall market growth. Most large and mid-size companies, to actively expand coverage across molecules or therapies, are aggressively launching new products. However, as per our survey, 70-80% of these products are failures. Most of these failures are in established segments, where more than 10-15 players currently exist. Also, there is a growing resistance among retailers and distributors to provide shelf space for new products before prescription generation. Hence, we observe companies that are more proactive and launch products ahead of the market are more successful in building brands, which potentially contributes to higher business growth. Most distributors suggest that new launches by Sun Pharma, Sanofi-Aventis and Lupin have pent-up demand in the first week of launch. Also, companies with differentiated R&D pipeline like Sun Pharma and Dr. Reddy’s clearly have an edge over others.

Potential expansion of controlled pricing list to impact profitability

Domestic drug prices are lowest in the world, however, time and again the government has deliberated expansion of the drugs list under pricing control. Currently, 74 drugs (15% of total market) are under controlled pricing and government is contemplating to expand this list to include up to 356 drugs which could cover potentially 50-60% of the total market. Most of the existing products under price control are anti-infective, pain killers and vitamins, among others, which primarily belong to the acute therapy segment. However, the proposal, if implemented, will extend the list to include some basic anti-diabetics and cardiovascular/other specialty class drugs, which are increasing prevalence and affecting the masses.

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2010 2011 2010 2011 2010 2011

Mankind 2.87 3.21 7 7 22.5 28.7

Alkem 2.82 2.96 8 9 16.3 21.0

Macleods 1.69 1.98 17 15 35.8 34.4

Eris Life Sciences 0.24 0.40 75 58 146.0 93.4

Market share (%) Growth Y-o-Y (%)Rank





Appendix- I

India will emerge third largest country in terms of incremental growth

Chart 1: USD 55 bn industry by 2020

Source: McKinsey, Edelweiss research

Chart 2: India will emerge third largest in terms of incremental growth


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Industry sources project Indian pharma market to be worth USD 55 bn by 2020 (14.5% CAGR). Interestingly, this makes the domestic market the third largest, next to US and China, in terms of incremental growth.





Key driver of growth in pharma industry (PULL factors)

Aging population and increased prevalence of chronic diseases:

Chart 3: Aging population Chart 4: Increased prevalence of chronic diseases

Source: Industry, Edelweiss research

Rising income level and increased awareness:

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• 46% of distributors believe that large and aging population coupled with increase in prevalence of chronic diseases is key drivers of pharma growth.

• Also, increased prevalence of chronic diseases will sustain higher growth in domestic market (currently growing at 18-20% vs. 15% of industry) due to longevity of prescription generation.

• India is also home to the largest pediatric and geriatric population, which is an attractive market in healthcare segment (consumes 66% higher drugs).

• Increased awareness and rising per capita income have emerged (34% of the respondents) as second key growth drivers for pharma growth, as per our survey.

• The per capita pharma spend in India significantly lags other emerging markets.

• Healthcare spending has high beta on income. Rising income will drive 73 mn people into middle or upper income segment, leading to higher affordability and as income grows, percentage spend on healthcare rises as well.

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3.8 0.2ISIEmergingMarketsPDF in-sdmcpl01 from 124.124.255.5 on 2011-11-09 01:19:45 EST. DownloadPDF.




Chart 5: India has low /capita inc. (USD) Affordability drives growth Health spend has high beta on income


Growing healthcare infrastructure, higher access and increase in government spending are other macro drivers

Chart 6: Growing healthcare infra. Rapid insurance penetration High spending on healthcare by Govt.


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• USD 200 bn projected investment for creating and upgrading the healthcare infrastructure which will add growth momentum to the pharma industry. This spend will be largely through private sector.

• Healthcare insurance posted 25% CAGR over CY05-10 and currently over 300mn people are covered by various healthcare policies. This is likely to go up to 655 mn people by 2020.

• Higher government spending on healthcare e.g. ‘Arogya Raksha Yojana (micro health insurance plan)’ has increased health spend in Tier IV and other micro areas. Total government expenditure has increased by a healthy 18% CAGR over CY06-09.

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Key driver of growth in pharma industry (PUSH factors)

Chart 7: Various strategies adopted by Indian companies (Survey)


Expanding reach to drive penetration-driven growth story

Chart 6:

Chart 8: Pace of field force expansion


Field force expansion

35%


25%

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High79%

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7%

• Most pharma companies have ramped up their sales force over the past two-three years in order to extend their marketing efforts to Tier II and rural markets.

• 79% of distributors believe that pace of field force expansion by both Indian as well as MNC pharma companies is very aggressive.

• 35% of distributors believe that field force expansion is one of the key strategies adopted by pharma companies to accelerate growth.





Penetration in rural markets

Chart 9: Rural markets have outperformed average domestic growth in the past



Table 1: Value contribution from new products (>INR 100mn) has increased multi fold

Source: IMS, Edelweiss research

0

1,200

2,400

3,600

4,800

6,000

Urban market

(US

D b

n)

2005 2007

CAGR 13%

2007 2008 2009 2010

Domestic market (INR bn) 288 329 366 438

No. of new introduction (NI) 4,810 4,285 4,365 4,562

Value of NI (INR bn) 22 22 24 27

Value/ NI (INR mn) 6.0 7.7 8.4 9.6

Contribution to domestic market (%) 7.5 6.6 6.7 6.2

No. of NIs above INR 100 mn 10 10 15 20

Contribution of NIs above INR 100 mn to total NI value (%) 6.2 7.5 12.3 16.1

Value of largest NIs (INR mn) 233 309 521 814

• 25% of the respondents believe that new product introduction is another key strategy adopted by pharma companies to step up the growth trajectory.

• 4-5% of the industry growth has been driven by new launches in the past. However, going forward, the pace of new launches will moderate and focus will be on building brands.

• The average value per new launch has increased consistently despite lesser products being launched. This could be due to brand building efforts by companies.

• Metro and tier-I towns will continue to remain significant growth drivers because of growing urbanization, while rural and tier II markets are gaining importance because of high income growth and penetration.

• Rural markets have grown higher (25% CAGR) than the industry owing to better penetration and increase in affordability.

• We expect this growth momentum to sustain, taking its share from 20% of total market in 2010 to 25% in 2020.

0

300

600

900

1,200

1,500

Rural market

(US

D b

n)

2005 2007

CAGR 25%





Focus on building brands

Focus on specialty promotion Chart 8:

• 21% of our distributors believe that focus on brand building is a key strategy adopted by various pharma companies.

• Understanding the need of building brands, companies have already started focusing on specialty promotions as well as multi-brand marketing strategies.

• Not only the number of new introductions above INR 100 mn has doubled over the past 4 years, but their value contribution has also increased multifold.

• Mass therapies continue to remain largest segment (contributes 67% to the market), while specialty and super specialty therapies have grown higher than the market.

• Increased awareness (higher rate of diagnosis) and affordability are key growth drivers of specialty therapies.

• Pharma companies are carving out separate marketing divisions to monetise growth opportunities in chronic segments.





Appendix- II

Survey Methodology

Objective of the survey

We conducted an extensive field study by interviewing distributors/stockists, area managers, and medical representatives across various geographies within India, to gain comprehensive perspective of the domestic market. This exercise had four primary objectives: A) To understand growth in various regions and its sustainability: The first

objective was to review current growth in various regions across the country (including metros, tier-I, II, III, and IV towns) and its sustainability over the next three to four years. This objective was set to address a key question: Whether the high growth of 14-15% in the domestic market is a near term phenomenon or a structural change which will sustain over the next three to four years? This further puts a check on current higher estimates of domestic growth build for various large cap/mid-cap domestic-focused players.

B) To understand drivers of this growth: The second objective was to understand from perspective of distributors the impact of various factors such as rising income, health awareness, changing lifestyles, affordability, insurance penetration, etc. on current domestic growth. We classified these as ‘Pull Factors’. We also tried to identify the activity level of various companies (including MNCs) in terms of new launches, field force expansion, new divisions, specialty focus, among others, and its impact on current growth. We classify these as ‘Push Factors’. We, further, tried to get distributors’ perspective on new business models adopted by pharma companies.

C) To understand growth within segments: The third objective was to understand growth within various therapeutic areas, shifting focus of market to new therapies and evolving competition in these segments. Our focus was to identify therapies growing ahead of the market and companies with niche strong traction in these therapies.

D) To gauge performance of key focus companies: The ultimate aim of our survey was to identify, as per distributors’ preference, companies (among Top 30 players) that have a strong domestic franchise in terms of growth relative to the market, ability to build brands, success of new product launches and higher field force stability. We tried to dwell into the reasons behind outperformance/ underperformance of these companies in terms of their marketing focus, therapeutic focus, operational strategies, and supply-chain models.

Further, we also gained insights on the structure of the domestic market and key risks to its current growth. Methodology

We designed a questionnaire which covers the aforesaid objectives in a structured manner for all markets. However, a few questions were customized for tier-III/IV markets, where our objective was to identify trends which are driving higher focus of pharma companies in these areas. We tried to understand the characteristics of these markets, marketing strategies adopted by companies, and challenges faced by new players.





We split the domestic market into four zones (North, West, East, and South) and carefully selected cities in each zone which represent an ideal mix of large market (metros , tier I), mid-size market (tier II) and smaller markets (tier III and IV) within each zone. We targeted primarily large and mid size distributors in each of these cities to get a broader perspective on the market. Our distributor sample has larger retail network (at least 70-80% of retail chemists coverage within the region), distributorship of at least 20 companies and annual turnover in the INR 50 mn to INR 750 mn range. This ensured that the survey findings reflect a larger coverage list of companies, which helps minimize errors. We also interacted with a few unlisted players, medical representatives, area managers, and regional heads, with 10-15 years of experience in respective regions, who shared their perspectives on the market. This helped us dwell into operational models of companies, commercial approach adopted, and current strategic perspective. Why distributors?

Distributors also called ‘stockists’, are a key link between manufacturers and consumers. The domestic drug distribution system is multi-layered where stockists form the first layer and represent primary sales. They distribute products, based on secondary sales demand, to various retail chemists, hospitals, medical professionals, and other consumers. They are also an important link, as they handle inventory in the supply chain. There is a sub-layer of second level distributors called ‘sub-stockists’ which caters to a smaller area within a region. The sub-stockists help to expand reach to retailers which are not catered to by wholesale distributors. We highlight that distributors are more a organized section of the channel with better understanding of players in the market and hence, in our view, have a finger on the pulse of market. Fig. 1: Domestic distribution channel

Source: KPMG

Manufacturers

C&F agents/Super stockists

Stokists (65,000)

Sub-stockist

Chemists 5,50,000 NGO/OthersMedical

professionalsGovt

tendershospitals

(>15,000)

78-83% 1-2%2-3%4-5% 13%

Consumers





DISTRIBUTOR SURVEY - Questionnaire • Name of the distributor :

• No of companies covered :

• List of all companies covered :

• No. of chemists under coverage :

• Total chemists in the area or city :

• Monthly turnover (INR mn) :

• Visiting card :





END MARKET DEMAND What is the average growth rate (please tick below)? What in your view is sustainable growth?

Range Respective coverage region Overall market

<13%

13-15%

>15% (please mention)

Which factors are driving this growth? (Please rank the factors below in each column in increasing order of your preference -1 means highest preference, 2,3 etc.)

Pull Strategy (demand driven) Push Strategy (company driven)

- Increase no. of healthcare facilities - Rapid product introductions

- Changing lifestyles - Increase in field force

- Increasing health awareness - Focus on brand building

- Government expenditure - Focus on specialty promotion

- Health insurance - Price increases

- Increase in life expectancy - Others

Which are the fast-growing companies in your region and which companies are losing market share? (Please tick relevant column below)

Gaining market share Losing market share

Cipla

Sun Pharma

Ranbaxy

Dr Reddy’s

Torrent Pharma

Cadila

Lupin

IPCA

Abbott Piramal

Unichem

Alkem

Intas Pharma

FDC

USV

Glenmark

GSK Pharma

Pfizer

Sanofi – Aventis

Others (Please specify)

Which are the upcoming local players in the region? Are local players increasing activity in your region of coverage?





THERAPEUTIC AREAS Which therapeutic areas are growing at a rapid pace? Where do you see active competition among these fast growing TA?

TA Rank in terms of growth (highest ranked 1 followed by 2, 3 etc.)

Active competition (please tick)

Acute

Anti-infectives

Respiratory

Pain management

Gastrointestinal

Chronic

Cardiac

CNS

Anti-Diabetes

Gynecology

Dermatology

PRICING

Are companies taking price increases (Y/N)?

What is the magnitude of price increases?

o <5%

o 5-10%

o >10% (please mention)

What percentage of products depicting price changes (frequency)?

o <15%

o 15-30%

o 30-50%


Which therapeutic areas do you see price increases and pricing pressures (please tick relevant column)?

TA Price increases Pricing pressures

Anti-infectives

Respiratory

Pain management

Gastrointestinal

Cardiac

CNS

Anti-Diabetes

Gynecology

Dermatology

Others (please mention)





STRATEGIC FOCUS

Which of these is the key strategic focus of Indian companies in recent past?

o New product introduction

o Brand building (key promotional strategies)

o Field force expansion

o New divisions

o Others

Do you see change in activity level of MNC players?

o Increase in product introductions

o Increase in field force

o Building channel relations (frequency of visits)

FIELD FORCE EXPANSION

At what pace are companies increasing field force in the region?

o Normal

o Higher

o Not much change in field force

Has this resulted in higher sales (Y/N)?

What are your observations on field force attrition in your region?

o Less than 10%

o 10-15%

o 15-30%


Which companies have more stable and effective field force?

(Please rank companies with higher stability 1, followed by 2, 3…)

Cipla Abbott Piramal

Sun Pharma Mankind

Ranbaxy Alkem

Dr Reddy’s Intas Pharma

Torrent Pharma FDC

Cadila USV

Lupin GSK Pharma

Glenmark Pfizer

Unichem Others

IPCA

Dos u think ‘specialty focused’ field force bring in better results (Y/N)?





NEW PRODUCT INTRODUCTIONs Which companies are very aggressive in launching new products/brands in the market?

Cipla Unichem

Sun Pharma Alkem

Ranbaxy Intas Pharma

Dr Reddy’s FDC

Torrent Pharma USV

Cadila GSK Pharma

Lupin Pfizer

Abbott Piramal Sanofi – Aventis

Glenmark Others (Please specify)

IPCA

Which of these companies have been successful in building new brands?

Cipla Unichem

Sun Pharma Alkem


Dr Reddy’s FDC

Torrent Pharma USV

Cadila GSK Pharma

Lupin Pfizer

Abbott Piramal Sanofi – Aventis

Glenmark Others (Please specify)

IPCA

Which therapeutic areas you see highest product introduction?

Therapeutic area

Anti-infectives CNS

Respiratory Anti-Diabetes

Pain management Gynecology

Gastrointestinal Dermatology

Cardiac Others (please mention)

Do u see lack of brand shelf space as a concern for new products?





TIER-II /IV CITIES Which are the key areas where you see increase in activity level by companies?

- Rapidly introducing new products

- Increase in field force

- Increase in brand building

- Specialty promotion

- Increase in Number of divisions

Which companies are becoming more active or expanding coverage (in terms of new products, new therapies) or recently started coverage in your area?

Cipla Unichem

Sun Pharma Alkem


Dr Reddy’s FDC

Torrent Pharma USV

Cadila GSK Pharma

Lupin Pfizer

IPCA Sanofi – Aventis

Abbott Piramal

Others (Please specify)

What in your view are the key challenges these companies (mentioned above) could face?

o Lack of trained pool of field force

o Higher attrition

o Higher investment in training

o Distribution challenges (unorganized)

o Receivables loss

o Capturing market share from local players

o Pricing of products





SUPPLY CHAIN What are average inventory days (please tick)? Do you see increase in channel inventory (Y/N)?

o <7 days

o 7-15 days

o 15-30 days

o >1 month (please mention no of days)

What is the credit period given by companies?

o <15 days

o 15-30 days

o >1 month (please mention no of days)

What is the magnitude of change in the period (substantial or no change)? KEY RISKS / CONCERNS

What are the key risks that you feel could impact current growth momentum in the industry?

o Short term (regulatory and other)

o Long term (regulatory and other) OTHERS In your view which companies should potentially do well and why? Which others companies, excluding your existing list, would you like to add?





THIS PAGE IS INTENTIONALLY LEFT BLANK ISIEmergingMarketsPDF in-sdmcpl01 from 124.124.255.5 on 2011-11-09 01:19:45 EST. DownloadPDF.




Domestic formulations turnaround: A boon Cadila Healthcare’s (CDH) renewed focus on the chronic segment and expansion

in field force over the past two years (22%) has improved its revenue traction in

the domestic market. Revenues have grown a robust 17% Y-o-Y (9mFY11), in

line with the industry, viz-a-viz relative underperformance over FY07-10 (11.6%

CAGR). CDH is through with restructuring phase and is set to grow in tandem

with industry. This growth will be more inclusive with strong traction from tier-

II/IV markets, as depicted through our distributor survey. Further, recent tie-up

with Bayer Schering (Bayer) secures its future product pipeline.

US generics gearing for more profitable growth CDH has build USD 200 mn solid franchise (80% CAGR in FY06-11) in US on the

back of higher focus on quality and services. Its recent filings focus on niche or

limited competition products (including Para IVs), encompass USD 160-180 bn

innovator market, which supports next leg of growth. CDH has three Para IVs

opportunities in its pipeline, which offer decent upsides over next two-three years,

in our view. These products also offer higher margin than current plain-vanilla

generic portfolio. We expect CDH’s US sales to post 22% CAGR over FY11-13E.

Higher return on investment through JVs/partnerships CDH has been exceptionally successful in establishing highly profitable JVs with

global pharma majors. With modest investment of USD 13 mn, it has attained

cumulative profits of USD 100 mn and USD 13 mn from Nycomed and Hospira

JVs (18 mths), respectively. We expect sales from the Hospira JV to ramp-up to

INR 3.5-4.0 bn at peak capacity utilisation by FY13E, with PAT contribution of

INR 875 mn to INR 1 bn (CDH’s share). The incremental earnings from Hospira

JV will offset lower earnings from Nycomed, with genericisation of Pantoprazole.

Outlook and valuations: Strong execution; initiating coverage with ‘BUY’ CDH’s one-year forward P/E has expanded from 9x to 17x, driven by consistent

outperformance and strong execution across markets. However, it still trades at

10% discount to larger peers. We note that CDH’s medium-term earnings growth

(29% CAGR over FY10-13E) is best among peers and its long-term vision to

attain USD 3 bn supports downside risks to valuation. We, thus, value the stock

at 19x FY13E EPS (TP INR 960) and expect gap to narrow down with larger

peers. We initiate coverage on CDH with ‘BUY/Sector Outperformer’.

India Equity Research | Pharmaceuticals Initiating Coverage

CADILA HEALTHCARE

Looking for next leap of growth

April 25, 2011

Reuters: COKI.BO Bloomberg: CDH IN

EDELWEISS 4D RATINGS

Absolute Rating BUY

Rating Relative to Sector Outperformer

Risk Rating Relative to Sector Medium

Sector Relative to Market Equalweight

Note: Please refer last page of the report for rating explanation

MARKET DATA

CMP : INR 844

52-week range (INR) : 941 / 542

Share in issue (mn) : 204.7

M cap (INR bn/USD mn) : 172.7 / 3,891.5

Avg. Daily Vol. BSE/NSE (‘000): 110.4

SHARE HOLDING PATTERN (%)

Promoters* : 74.8

MFs, FIs & Banks : 13.3

FIIs : 5.4

Others : 6.5

* Promoters pledged shares (% of share in issue)

: Nil

PRICE PERFORMANCE (%)

Stock Nifty EW Pharma

Index

1 month 13.6 8.9 5.5

3 months 1.2 2.5 (7.0)

12 months 48.4 11.9 18.0

Manoj Garg

+91 22 6623 3302

[email protected]

Peril Ali

+91 22 6620 3032

[email protected]

Edelweiss Research is also available on www.edelresearch.com,, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

Financials

Year to March FY10 FY11E FY12E FY13E

Revenues (INR mn) 36,580 44,991 54,932 65,929

Rev growth (%) 25.0 23.0 22.1 20.0

EBITDA (INR mn) 7,798 9,856 12,289 15,001

Adj. net profit (INR mn) 4,808 6,462 8,319 10,345

Shares outstanding (mn) 204.7 204.7 204.7 204.7

Adj. Diluted EPS (INR) 23.5 31.6 40.6 50.5

EPS growth (%) 51.0 34.4 28.7 24.4

P/E (x) 35.9 26.7 20.8 16.7

EV/EBITDA (x) 23.3 18.2 14.3 11.4

ROAE (%) 34.2 33.3 32.6 31.2





Investment Rationale

Domestic formulations ramp-up to contribute to higher growth and profitability We expect domestic branded formulations to post 15% CAGR over FY10-13E, in line with average industry growth, viz-a-viz relative under performance during FY07-10 (growth of 11% versus average industry growth of 15-16%). Domestic growth suffered since the company was re-organising various business units and had defocused on the generics business (CAGR of 1% over FY07-10).

Table 1: Domestic formulations to ramp-up over FY10-13E, in line with industry (INR mn)


While re-structuring of the domestic business is now complete, the management has renewed its focus on higher-growth chronic therapies such as cardiovascular (CVS), respiratory, neuro-psychiatry (CNS) and rheumatology, which, coupled with expansion in field force (from 3,400 reps. in FY07 to 4,500 in FY11), has resulted in relatively higher growth over the past nine months (Chart 1). We believe that the company is now set to attain industry level growth over FY13E. Chart 1: Revival in domestic growth momentum


As shown in the chart 1, 9mFY11 growth performance in the domestic business has been in line with the industry. We highlight that this outperformance is largely from CVS, respiratory, gastro-intestinal and gynecology segments, where the company has build a formidable franchise. These segments contribute ~59% to its overall revenues and are growing higher than the industry, which underpins CDH’s strong franchise in these segments. Moreover, the company’s growth will be all inclusive of metros and tier-II-IV towns, where it has inducted ~350 people under special rural task force. This is also evident from the results of our survey, which indicates that all coverage distributors in tier-II and tier-IV towns see strong growth traction for CDH.

FY07 FY10 CAGR (%) FY11E FY12E FY13E CAGR (%)

Domestic formlations 10,602 14,458 10.9 16,511 19,001 21,899 14.8

Branded generics 9,790 13,625 11.6 15,587 17,974 20,760 15.1

Generic-generics 812 833 0.9 925 1,026 1,139 11.0

4.8

13.2 11.8

8.6

13.2

9.9

17.1

8.4

17.3 18.6

16.6

0.0

5.0

10.0

15.0

20.0

25.0

Q1'0

9

Q2'0

9

Q3'0

9

Q4'0

9

Q1'1

0

Q2'1

0

Q3'1

0

Q4'1

0

Q1'1

1

Q2'1

1

Q3'1

1

(Gro

wth

%)

Domestic business growing in line with industry





Chart 2: Domestic business geared up for higher growth


Tie-up with Bayer improves future product pipeline for domestic market

CDH has formed a 50:50 JV with Bayer Schering (Bayer), Germany, where both partners will shift some of their existing products to the JV. Bayer will further add future potential off-patented/patented drugs that will be supplied through CDH’s distribution network. The JV is likely to commence operation from H2 FY12. While the company has not disclosed the detailed functioning of the JV, its focus is likely to be largely on CVS, diabetes, women’s healthcare, oncology and diagnostic segments. We view this development as win-win for both partners. Through this JV, CDH can access Bayer’s strong domestic portfolio for diabetes (where CDH currently does not have much presence) and also its future pipeline (Bayer’s key late stage pipelines are in oncology, CVS and CNS). Bayer, on the other hand, could capitalise on CDH’s strong distribution and reach.

US generics gearing up for profitable and robust growth Despite being a late entrant and with plain vanilla generic portfolio, CDH has been able to build up USD 200 mn franchise (80% CAGR growth) in US generics, driven by higher focus on quality and customer services. Owing to relatively higher focus on services, the company currently enjoys a strong relationship with customers and has been bestowed the status of “preferred supplier”. This enables it to retain higher market share in most products. Out of 39 products currently marketed in the US, company enjoys more than 20% market share in 15 products and has average market share of 14% across products.

0.0

1.2

2.4

3.6

4.8

6.0

1,500

2,200

2,900

3,600

4,300

5,000

FY06 FY07 FY08 FY09 FY10 FY11 (YTD)

Sale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)

Field force Productivity





Chart 3: CDH has established solid base in US generics market


As shown in Chart 3, CDH’s US generics business has ramped-up from modest revenue of INR 500 mn from five products in FY06, to INR 9.3 bn revenue by FY11E (39 products). Gearing for the next leg of growth

CDH’s long-term strategy largely focuses on niche and limited competition products. The company has ramped up its ANDA filing in niche segments, including Para IVs and has a pending pipeline of 59 ANDAs with 12-15 new filings each year. These filings consist of differentiated and difficult-to-formulate products, including those in the respiratory segment (seven ANDAs filed; market opportunity of USD 20 bn) and injectibles (15 filed; market opportunity of USD 17 bn). Moreover, the company is also focused on different delivery systems such as transdermal patches and has planned to file seven ANDAs (USD 3 bn opportunity) over the next 3-4 months. Other segments where CDH has increased its focus are: oncology (USD 55 bn opportunity), bio-similars (USD 40 bn opportunity) and vaccines (USD 22 bn opportunity). Collectively, these initiatives target USD 160-180 bn market and could be long-term growth drivers. Over the near term, we expect CDH to launch 10-12 products each year, driving 22-25% growth over FY13E. Moreover, we expect CDH to also monetise its Para IV/limited competition products opportunities such as Astelin (USD 100 mn opportunity), Prevacid-ODT (limited competition product with sales of USD 400 mn with expiry in September 2012) and Lialda (USD 291 mn opportunity; FTF; expiry in October 2012) over the next two years. While we have build INR 276 mn and INR 473 mn of sales from Astelin in our FY12 and FY13 estimates, respectively (expect CDH to launch the product in Q2FY12), we currently do not factor any upside from Prevacid ODT and Lialda due to lack of clarity. However, successful launch of these could provide decent upsides to our FY13 estimates.

0

40

80

120

160

200

0

2,000

4,000

6,000

8,000

10,000

FY06 FY07 FY08 FY09 FY10 FY11

(%)

(US

D m

n)

Revenue Growth

Built-up franchise of USD 200 mn over six years in US

Niche pipeline will drive next leg of growth in US





Table 2: US generics to benefit from Para IV pipeline


Unlocking value through alliances CDH is one of the few Indian companies to have formed most successful and profitable JVs with global pharma majors. The company formed its first JV with Altana (later on acquired by Nycomed) to supply two key intermediates of Pantaprazole (Altana was the innovator) for its global supply. The company has initially invested USD 2 mn in the JV in 1997, and has made over USD 100 mn profit over the past nine years (JV started supplying Pantaprazole intermediates from 2003). However, going forward, owing to patent expiry and generic launch of Pantoprazole, we expect lower revenue and profits from JV. This is despite the fact that the JV has added 14 incremental APIs, supplies for which are likely to start from H2FY12. These APIs include all genericised products and, hence, will have lower margins, in our view. CDH entered into a second JV with Mayne (later on acquired by Hospira) in 2005 to manufacture and supply six oncology products for global markets, with an initial investment of USD 11 mn (CDH’s contribution to total USD 22 mn investment). Supplies to Hospira have started from Q1FY10 and in less than two years (18 months), CDH has recouped its initial investment and made a profit of INR 602 mn (USD 13 mn), while the JV is yet to reach its full potential. Hospira JV to ramp-up with supplies of Taxotere and Gemzar in US

We expect Hospira JV’s revenue to ramp-up after it starts supplying generic Taxotere and generic Gemzar to JV partner in the US (Q4FY11 onwards). YTD, the JV was supplying three products to Hospira for the EU markets (9mFY11 revenue of INR 818 mn), with relatively smaller batches of generic Taxotere in the US. However, with recent launch of Taxotere in the US (launched in March 2011, with Hospira as the only generic player in the USD 1.2 bn innovator market), we expect significant revenue growth over the next few quarters. We highlight that Hospira is the largest generic player in EU for Taxotere, and we expect it to garner a large market share even in the US, since the product is similar to originator (single vial injection) unlike other players such as Sun Pharma, Sandoz, and Apotex that have a two-vial product. Overall, we expect the JV to reach peak level by FY13 with potential sales of INR 3.5-4.0 bn (CDH’s share) and 25-30% sustainable PAT margins. We estimate INR 875 mn to INR 1 bn recurring PAT per annum from the JV for CDH.

Brand Generic name InnovatorUS Revenue

(USD mn)Patent expiry

Cadila's potential launch

Para IV Remarks

Astelin Azelastine Meda 100 May'2011 May'2011 N Apotex and Cobalt have already launched the products through settlement with innovator; Cadila will be third company

Prevacid-ODT

Lanzoprazole Takeda 400 Expired Oct'2012 Y Teva (FTF) and Sandoz (AG) have launched; Limited competition

Lialda Mesalamine Shire 291 June'2020 Nov'2012 Y

Created most successful and profitable JV





Chart 4: Hospira JV to be on firm footing over FY11-13E


We believe that incremental earnings from Hospira JV will offset lower profitability of Nycomed JV and will be highly accretive to CDH’s overall earnings.

Chart 5: Hospira earnings to offset decline in Nycomed JV profits


Strategic alliance with Abbott to add growth momentum in emerging markets

CDH has signed a strategic deal with Abbott to supply 24 products in 15 key emerging markets with an option to add another 40 products. CDH has already received initial milestone of USD 10 mn from Abbott for the deal and product supply is likely to commence 2HFY12 onwards. Full impact of revenue from this deal will be visible in the next 2-3 years, as we believe that combined portfolio has potential to contribute USD 50-60 mn revenues for CDH. Moreover, we see this deal as strategically important to CDH as it will enable the company to tap the emerging market opportunities without any substantial investments in front-end sales and marketing infrastructure. We expect CDH to start generating revenue FY12E onwards with initial launch of 8-10 products, which could attain critical mass in the third year of its operations (USD 50-60 mn).

0

800

1,600

2,400

3,200

4,000

FY10 FY11 FY12E FY13E

(IN

R m

n)

Revenue PAT

0

180

360

540

720

900

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

(IN

R m

n)

Nycomed - PAT Hospira -PAT

Strategic alliance with Abbott will add USD 50-60 mn revenue





Bold vision to attain USD 3 bn in FY16 from USD 1 bn in FY11 After attaining a billion-dollar revenue target in FY11E, CDH has set a milestone of USD 3 bn revenue by 2016 (25% CAGR over FY11-16). Although management has not shared details of its five-year strategic plan, the past track record and management commitment to execute guidance gives some surety of achieving the set target. We believe the growth will be multipronged, encompassing all segments including US, India, Brazil and partnerships. We try to summarize key growth drivers with focus on achieving the said objective. First, the company’s investment in niche segments for US generics such as transdermal patch, oncology, vaccines and pulmonary products, which have a market potential of over USD 160-180 bn, will be highly accretive over next three to four years. Few of these products are already off-patent and others still under patent. The company is also developing new drug delivery system for some of these products to file them under 505 (b) 2 routes to enjoy exclusivity. The second driver is CDH’s focus on new drug discovery research, to become a global research-driven company in the long term. The company has been increasing its R&D expenditure over the years and currently has 12 molecules (including two from partners) in the pipeline addressing the therapeutic areas of metabolic disorders (diabetes, obesity and dyslipidemia) and inflammation.

Chart 6: CDH aims to become a research-driven company by 2020

Source: Company

As shown in chart 6 above, 12 NCE molecules are in various stages of development, with over 425 scientists dedicated for new molecular entity research at Zydus Research Centre. Six of these programs are currently in human clinical trials in India and three NCEs have already got IND approval from USFDA. The company has also entered into strategic alliances with Eli Lilly and Co. (CVS drug), Prolong Pharmaceuticals of USA and Karo Bio of Sweden to undertake joint drug discovery and development programs. Commercialisation of molecules will take time; nevertheless, successful launch of any molecule could be instrumental to the company attaining its vision.

P ro ject T arget Indicat io n D rug Lead P reclinical IN D P hase I P hase II P hase II N D A

disco very o pt imisat io n develo pment

ZYH1PPAR alpha:

gammaDyslipidemia

ZY11M ulti-model

Pain

ZY01CB-1

antagonistObesity,Diabetes

ZYH2PPAR alpha:

gammaDiabetes

ZYH7PPARalpha

Dystipldemie

ZYT1TR betaagonist

Dystipldemie

ZYD1GLP-1

agonistDiabetes

GLP-1agonist

Diabetes

ZYOG1 Undisclosed Diabetes

UndisclosedAtheroscterotic

Plaque

Collaborative program

Selective GRagonist

Inflammation

Collaborative program

Undisclosed CVS

With Karo Bio

With EII Lilly

Cadila is aiming to become USD 3 bn company by 2016

Out of 12 NCEs, six are in human clinical trial stage





Chart 7: R&D investments to increase as pipeline achieves higher milestones


During FY10, expenditure on R&D was INR 2.1 bn (6% of total sales). Management has indicated that it does not plan to de-merge its R&D entity, while monetising its R&D assets are likely to take some time (18-24 months). However, we strongly feel that in the long run, unlocking its R&D assets can provide significant upside. The company has a stated objective to look for out-licensing partners only once it establishes the proof of concept (post Phase II trial). We currently do not forecast any out-licensing income or upside from NCE research owing to lack of visibility.

0

280

560

840

1,120

1,400

FY06 FY07 FY08 FY09 FY10

(IN

R m

n)

NCE Research Generic Markets API & Others





Valuation

Valuations: Re-rating driven by strong execution; initiating coverage with ‘BUY’ CDH has re-rated from 9x to 17x one-year forward P/E on the back of consistent outperformance and strong execution across markets. It has consistently delivered market expectations, which strengthen our confidence in its ability to meet future guidance. Although we believe that a large part of multiple re-rating is already behind us, the stock currently trades at 10% discount to large peers. CHD strong earnings growth visibility of 29% CAGR over FY10-13E (highest among peers), high return on capital (RoCE and RoE of over 30%) and healthy balance sheet, could potentially result in narrowing of gap with peers. Chart 8: Historical valuation trend—one year forward P/E


Moreover, valuations based on earnings before NCE R&D are highly attractive (Table 3). CDH has been directing ~30-35% of its R&D expenditure on NCE, for which, it currently does not accrue to its value.

Table 3: Valuations excluding investments on NCE are attractive (INR mn)


We, thus, initiate our coverage on CDH with a ‘BUY/ Sector Outperformer’ recommendation/rating. We set a target price of INR 960, valuing the company at 19x March FY13E EPS of INR 50.4, the average one year forward multiple for large cap peers.

5x

10x

15x

20x

0

240

480

720

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Apr-

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R)

FY08 FY09 FY10 FY11E FY12E FY13E

Basic R&D 516 465 598 670 818 1,001

% of total R&D 38.6 29.7 36.0 30.0 30.0 30.0

PBT (reported) 3,232 3,611 6,039 8,432 10,350 13,176

PBT (pre R&D) 3,748 4,076 6,637 9,102 11,168 14,177

PAT (pre R&D) 3,037 3,324 5,823 7,736 9,382 11,625

Eps (reported) 12.9 15.6 23.5 31.6 40.6 50.4

EPS (pre R&D) 14.8 16.2 28.4 37.8 45.8 56.8

PE (EPS rep) 65.5 54.3 36.0 26.8 20.8 16.8

PE (EPS pre R&D) 57.0 52.0 29.7 22.4 18.4 14.9

Ex NCE R&D valuations become more attractive





Key Risks

Re-structuring in domestic formulation impacted historical performance Despite being the fifth largest player in the domestic market (with market share of 3.7%), CDH has struggled to keep pace with the market growth during FY07-10 (grew 11% versus industry growth of 14%) due to internal restructuring initiatives. The company consolidated its marketing divisions by merging non-profitable smaller divisions and optimised field force by removing 350 low productive sales force in 2006-07. Chart 9: Historical execution poses risk to growth outlook


The underperformance can be further illustrated with its growth in top 10 brands (~28% of total domestic sales), which has lagged industry (Table 4). The top two brands: ATEN (Atenolol; 4.5% of domestic revenue) and DERIPHYLIN (Theophylin; 3.4% of domestic revenue) have pulled down performance of the domestic formulation business. Further, growth in unbranded generics has remain muted (8-9% of domestic formulation business and 1% CAGR over FY07-10) negatively impacting overall growth.

Table 4: Top 10 brand performance


While most of the restructuring is over, with domestic formulations reverting back to industry level growth (9m FY11), CDH has resumed its plans of increasing depth and

0.0

6.0

12.0

18.0

24.0

30.0

Lupin Sun Pharma

Dr Reddy's Cipla Ranbaxy Industry Cadila

(%)

Brands Therapy % of totalMarket share

Growth rate

Contrbution to growth

ATEN Chronic 4.5 56.0 12 3.7

DERIPHYLLIN Chronic 3.4 90.4 4 1.0

ATORVA Chronic 3.2 10.3 17 3.5

FALCIGO Acute 3.1 54.2 (5) (1.2)

PANTODAC Acute 2.9 16.2 15 2.9

OCID Acute 2.8 26.5 8 1.6

MIFEGEST KIT Acute 2.3 18.9 2,866 16.8

PRIMOLUT N Acute 2.1 46.7 7 1.1

DEXONA Acute 2.0 42.8 21 2.8

AMLODAC Chronic 1.9 15.0 6 0.9

Total 28.3 33.1





width of coverage. However, given its historical underperformance, we remain cautious and build a normal industry level growth scenario for FY12 and FY13. We highlight that incremental upsides from higher field force productivity (post expansion) and profitable product pipeline (from Bayer JV) could be an upside risk to the overall company’s growth and earnings estimates.

Delay in ANDA approval from US FDA US generics constitute 18% of total sales and have incrementally higher contribution to overall growth of business. The approval time at USFDA has increased dramatically over the past one-two years due to manpower issues in the agency. As per USFDA, the current backlog of pending ANDAs is more than 2,000, with an average waiting period of ~26 months (from 12-14 months earlier). CDH ANDA pipeline with 59 pending approvals and 15-16 annual filings under development, underlines strong growth visibility, however, any delay in approvals could hurt growth in FY12-13E.

Lower scale-up from Hospira JV

We expect the Hospira JV to scale from INR 817 mn in 9mFY11 to INR 3.4 bn in FY13E on the back of expected ramp-up in supplies to the US market for generic Taxotere and generic Gemzar. Lower offtake by Hospira for these products could impact our revenue and earnings estimates for the JV.

Currency appreciation could hit profitability

CDH’s international markets constitute 54% of total sales. Hence, volatility in currency (INR USD and INR EUR) could hit its profitability.





Company Description CDH, founded in 1952 and headed by second generation entrepreneur Pankaj R Patel, is the sixth largest company in Indian pharma market with 3.9% market share. The domestic franchise, with widespread field force (4,500) and pan-India presence, constitute 35-40% of total sales. The chronic segment accounts for 26% of total domestic business with largest contribution from cardio vascular therapy (CVS), where CDH has leading market share (6.1%) after Sun Pharma and Ranbaxy. Apart from prescription products, CDH has built a formidable presence in nutraceuticals through its listed entity Zydus Wellness (owns 72% of total share holding). CDH has successfully build its international operations, with presence in branded generics emerging markets of Brazil, Asia-Pac and Africa and plain generics regulated markets of US, EU and Japan, which together account for 39% of CDH’s total business. Moreover, management’s strategic focus on building strong partnerships in the US through Hospira and Nycomed JVs has been significantly accretive to business over the past five years.

Chart 10: Revenue mix Chart 11: Export formulations mix


Chart 12: Current shareholding pattern

Source: NSE

India formulations

37%

India consumer

8%

Export formulations

39%

APIs8%

JVs5%

Others3%

Promoters75%

FIIs5%

Institutions and FIs

13%

Retail and others

7%

US generics

53%

Europe (France/Spain)21%

Japan3%

Brazil12%

Other emerging markets

11%





Domestic Formulation Snapshot Growth versus industry (%)

Therapeutic growth versus industry (MAT) (%) Top 10 brand performance (%)

Therapy wise break-up Field force expansion and productivity

Growth composition (MAT Mar-11) Relative performance to peers (MAT Mar-11)


Incl bonus Excl bonus Incl bonus Excl bonus

Company growth 26.5 20.7 16.6 14.6 11.6

Industry growth 13.8 13.1 15.0 14.3 14.4

Relative performance

Mar 2011 (Month) MAT (Mar-11) CAGR (5yr)

Therapeutic area% of total

Market share

Cadila growth

IndustryGrowth


Cardiovasculars 20 6.0 14.2 16.5 19.3

Gastrointestinal 17 6.2 16.0 14.1 17.9

Respiratory 10 4.8 19.5 14.5 11.5

Gyneacology 10 11.2 31.1 21.9 19.9

Anti-infectives 11 1.6 0.0 13.4 0.0

Pain t

7 3.9 16.1 13.8 6.1

Neurologicals 3 2.6 12.8 14.1 3.8

Dermatology 3 1.8 52.0 14.4 5.8

Anti diabetic 1 0.8 10.9 21.0 0.8

35.4 Chronic contribution to growth

Cardiovasculars

20%

CNS3%

Respiratory10%

Dermatology3%

Gyneacology 10%

Anti-infectives

11%

Gastrointestinal

17%

Pain mgmt.7%

Biologicals4%

Nutraceuticals

2%

Diagnostics2%

Others11% Chronic

33%

7 6

2 3

8 6

0.0

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7.2

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(%)

Volume Price New product introductions

15%17%

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FY06 FY07 FY08 FY09 FY10 FY11 (YTD)

Sale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)


CAGR (3%)

Brands Therapy% of total

Market share

Growth rate


ATEN Chronic 4.5 56.0 12 3.7

DERIPHYLLIN Chronic 3.4 90.4 4 1.0

ATORVA Chronic 3.2 10.3 17 3.5

FALCIGO Acute 3.1 54.2 (5) (1.2)

PANTODAC Acute 2.9 16.2 15 2.9

OCID Acute 2.8 26.5 8 1.6

MIFEGEST KIT Acute 2.3 18.9 2,866 16.8

PRIMOLUT N Acute 2.1 46.7 7 1.1

DEXONA Acute 2.0 42.8 21 2.8

AMLODAC Chronic 1.9 15.0 6 0.9

Total 28.3 33.1

0

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14

21

28

35

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14

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Financial Outlook

29% earnings CAGR led by strong revenue growth and operating performance We expect CDH to pose 22% CAGR over FY10-13E, driven by (a) 59% CAGR in Hospira JV, (b) 28% CAGR from US business, and (c) 15% CAGR in the domestic formulation business. Over the past five years, CDH’s EBIDTA margins (ex-other operating income) has improved from 16.7% to 19.5% in FY10, driven by operating leverage and improved product mix. We expect EBIDTA margins to continue to expand further over FY11-13E (110 bps expansion) to 21.3% on the back of sustain improvement in product mix and higher scale of operations in the US. Overall, robust sales growth coupled with strong operating performance will lead to 29% earnings growth over FY10-13E. Moreover, strong operating performance will also lead to its ROCE catapulting from 26% in FY10 to 38% in FY13E.

Table 5: Revenue break-up (INR mn)


Table 6: EBTIDA margins to expand over FY13 (%)


FY10 FY11E % Y-o-Y FY12E FY13E CAGR

(FY10-13E)

Domestic formulation 14,458 16,511 14.2 18,943 21,802 14.7

Consumer/OTC 2,675 3,478 30.0 4,277 5,176 24.6

Animal health 1,191 1,274 7.0 1,351 1,432 6.3

Export formulation 13,179 17,573 33.3 21,694 26,062 25.5

US generics 6,715 9,401 40.0 11,665 14,051 27.9

Europe (France/Spain) 2,740 3,699 35.0 4,624 5,549 26.5

Japan 316 474 50.0 711 995 46.6

Brazil 1,818 2,091 15.0 2,404 2,765 15.0

Other emerging markets 1,590 1,908 20.0 2,290 2,702 19.3

JVs 1,597 2,168 35.8 3,897 5,846 54.1

Nycomed 758 568 (25.0) 597 686 (3.3)

Hospira 839 1,600 90.7 2,400 3,360 58.8

Abbott alliance 900 1,800

API 3,043 3,561 17.0 4,266 5,050 18.4

Domestic 321 289 (10.0) 275 261 (6.7)

Others 2,721 3,271 20.2 3,991 4,789 20.7

Total gross sales 36,142 44,564 23.3 54,427 65,367 21.8

FY09 FY10 FY11E FY12E FY13E

COGS 33.4 33.0 32.6 32.6 32.8

R&D 5.5 4.6 5.1 5.1 5.2

Employee costs 10.9 11.0 10.7 10.5 10.5

Other fixed costs 31.4 31.9 31.3 30.9 30.2

EBITDA (excl other op income) 18.9 19.5 20.3 20.9 21.4

EBITDA 20.7 21.3 21.9 22.4 22.7





Chart 13: ROCE likely to expand from 26% in FY10 to 38% n FY13E


26

31

34

38

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8.0

16.0

24.0

32.0

40.0

FY10 FY11E FY12E FY13E

(%)





Financial Statements

Income statement (INR Mn)

Year to March FY09 FY10 FY11E FY12E FY13E

Income from operations 29,275 36,580 44,991 54,932 65,929

Net revenues 28,624 35,741 44,090 53,937 64,831

Other operating income 651 839 901 995 1,098

Total operating expenses 23,217 28,782 35,135 42,643 50,928

Materials cost 9,566 11,784 14,383 17,607 21,238

Employee cost 3,109 3,930 4,716 5,659 6,791

R&D cost 1,564 1,660 2,234 2,731 3,341

Selling, admin and general exp. 7,322 9,172 11,067 13,484 15,884

Other expenses 1,656 2,236 2,736 3,161 3,674

EBITDA 6,058 7,798 9,856 12,289 15,001

Depreciation and amortisation 1,118 1,339 1,312 1,490 1,656

EBIT 4,940 6,459 8,544 10,798 13,345

Net interest expense/(income) 1,205 821 705 544 289

Other income 116 158 142 115 153

Profit before tax (excl extraord.) 3,851 5,796 7,981 10,369 13,209

Provision for tax 666 741 1,265 1,659 2,378

Core profit 3,185 5,055 6,716 8,710 10,831

Extraordinary items (241) 243 451 - -

Reported profit after tax 2,944 5,298 7,167 8,710 10,831

Minority interest & others 1 247 322 391 487

Adjusted Profit after minority int. 3,184 4,808 6,462 8,319 10,345Equity shares outstanding (mn) 205 205 205 205 205

EPS (INR) basic 15.55 23.49 31.24 40.64 50.54

Diluted shares (mn) 205 205 205 205 205

EPS (INR) adjusted 15.6 23.5 31.6 40.6 50.5

CEPS (INR) 21.0 30.0 37.6 47.9 58.6

Dividend per share (INR) 4.5 5.0 5.0 6.5 8.0

Dividend payout (%) 28.9 21.3 15.8 16.0 15.8

Common size metrics- as % of net revenues


Cost of revenues 32.7 32.2 32.0 32.1 32.2

Employee cost 10.6 10.7 10.5 10.3 10.3

Selling, admin and general exp. 25.0 25.1 24.6 24.5 24.1

R & D cost 5.3 4.5 5.0 5.0 5.1

Total operating expenses 79.3 78.7 78.1 77.6 77.2

Depreciation and Amortisation 3.8 3.7 2.9 2.7 2.5

Interest expenditure 4.1 2.2 1.6 1.0 0.4

EBITDA margins 20.7 21.3 21.9 22.4 22.8

Net profit margins 11.1 14.1 15.2 16.1 16.7

Growth metrics (%)


Revenues 26.1 25.0 23.0 22.1 20.0

EBITDA 32.7 28.7 26.4 24.7 22.1

Net profit 18.5 58.7 32.9 29.7 24.4

PBT 16.7 50.5 37.7 29.9 27.4

Adj. EPS 20.5 51.0 34.4 28.7 24.4





Balance sheet (INR Mn)

As on 31st March FY09 FY10 FY11E FY12E FY13E

Equity capital 682 682 1,024 1,024 1,024

Reserves & surplus 11,670 15,603 21,250 28,012 36,440

Total shareholders Funds 12,352 16,285 22,274 29,036 37,464

Borrowings 12,673 10,905 7,905 4,905 1,905

Deferred tax liability (net) 1,316 1,141 1,141 1,141 1,141

Minority interest 228 392 714 1,105 1,592

Sources of funds 26,569 28,723 32,034 36,187 42,102

Gross block 22,870 25,578 29,328 33,078 36,571

Depreciation 7,571 8,733 10,046 11,536 13,192

Net block 15,299 16,845 19,282 21,542 23,378

Capital WIP 1,889 2,482 2,482 2,482 2,482

Investments 249 207 750 1,250 1,750

Inventories 6,012 7,504 8,799 10,760 12,925

Sundry debtors 4,549 4,668 5,753 7,035 8,451

Cash and bank balances 2,517 2,507 1,700 1,467 3,281

Loans and advances 2,533 3,070 3,249 3,973 4,772

Total current assets 15,611 17,749 19,502 23,234 29,430

Sundry creditors 5,256 6,146 7,446 9,104 10,937

Other current liabilities 474 564 812 993 1,193

Provisions 1,186 1,951 1,825 2,325 2,909

Total current liabilities and provisions 6,916 8,661 10,083 12,422 15,039

Net current assets 8,695 9,088 9,419 10,812 14,390

Miscellaneous expenditure 438 102 102 102 102

Uses of funds 26,569 28,723 32,034 36,187 42,102

Book value per share ( INR) 58 79 108 141 183

Free cash flow (INR Mn)


Net profit 3,184 4,808 6,462 8,319 10,345

Depreciation 1,118 1,339 1,312 1,490 1,656

Others (2,020) (499) (1,570) (2,862) (3,042)

Gross cash flow 2,282 5,648 6,204 6,947 8,958

Less: Changes in WC 932 403 1,138 1,627 1,764

Operating cash flow 3,214 6,051 7,341 8,574 10,723

Less: Capex (4,305) (3,478) (3,749) (3,750) (3,493)

Free cash flow (1,091) 2,573 3,592 4,824 7,230

Cash flow metrices



Financing cash flow 3,083 (2,886) (3,856) (4,557) (4,916)

Investing cash flow (4,300) (3,436) (4,292) (4,250) (3,993)

Net cash flow 1,997 (271) (807) (233) 1,814

Capex (4,305) (3,478) (3,749) (3,750) (3,493)

Dividends paid (1,483) (408) (462) (1,302) (1,302)





Profitability and liquidity ratios


ROAE (%) 28.3 34.2 33.3 32.6 31.2

ROACE (%) 22.9 25.9 30.7 34.3 37.8

Inventory days 202 206 204 200 201

Debtors days 50 45 42 42 42

Payable days 167 174 170 169 170

Cash conversion cycles 85 78 76 73 73

Current ratio 2.3 2.0 1.9 1.9 2.0

Debt/ EBITDA 2.1 1.4 0.8 0.4 0.1

Debt/equity 1.0 0.7 0.4 0.2 0.1

Adjusted debt/Equity 1.0 0.7 0.4 0.2 0.1

Operating ratios (x)


Total asset turnover 1.2 1.3 1.5 1.6 1.7

Fixed asset turnover 2.1 2.2 2.4 2.6 2.9

Equity turnover 2.5 2.5 2.3 2.1 1.9

Du pont analysis


NP margin 11.1 13.5 14.5 15.4 16.0

Total assets turnover 1.2 1.3 1.5 1.6 1.7

Leverage multiplier 2.1 2.0 1.6 1.3 1.2

ROAE 28.3 34.2 33.3 32.6 31.2

Valuation parameters


Adjusted EPS (INR) 15.6 23.5 31.6 40.6 50.5

EPS YoY growth (%) 20.5 51.0 34.4 28.7 24.4

CEPS (INR) 21.0 30.0 37.6 47.9 58.6

Diluted PE (x) 54.3 35.9 26.7 20.8 16.7

Price/BV(x) 14.5 10.7 7.8 6.0 4.6

EV/Sales (x) 6.2 5.0 4.0 3.2 2.6

EV/EBITDA (x) 30.2 23.3 18.2 14.3 11.4

Dividend yield (%) 0.5 0.6 0.6 0.8 0.9





Domestic growth can surprise positively Cipla has broadly underperformed the domestic market (13% CAGR versus

industry growth of 14-15%) over the past three years due to decline in its mature

(~20% of domestic) and generic portfolio (20% of total domestic sales declined by

10-15%), while its focus portfolio was growing ahead of the market (19-20%

growth). We believe the company’s domestic market growth can surprise positively

due to higher traction from tier II-IV towns, where it has a strong foothold (as per

our survey), while its strategy to address decline in mature and generic-generic

portfolio can give higher upside from a low base.

Emerging markets lead exports; regulated markets to gain traction Emerging markets so far have been the key growth drivers for Cipla’s exports; the

contribution has jumped from 46% in FY07 to 54% in FY10 (24% CAGR), driven

by Africa, Middle East, and Australia. We expect regulated markets’ contribution to

soar with ramp-up in supply contracts as the company will benefit from the patent

expiry in US and EU where it is one of the early filers of DMF/ANDA, through

partners, for some blockbuster drugs. We estimate 17% CAGR for ROW markets.

Combination inhalers in EU: Key driver of future growth After initial regulatory hurdles in EU, the company has launched single ingredient

inhalers in a few EU markets. Cipla has also launched the Seroflo combination

inhaler (gAdvair) in Russia and South Africa, which instills confidence in its ability

to monetise opportunities in regulated (initially in EU) and ROW markets going

forward. The combined addressable market (single and combination products) in

ROW/EU is USD 2.3 bn/USD 6 bn. We expect Cipla to get early approvals for ROW

markets, while launch of combination inhalers in EU will be a long term driver.

Outlook and valuations: Positive growth catalyst; upgrade to ‘HOLD’ We expect Cipla’s revenue (ex-tech income) to post 15% CAGR over FY10-13E,

driven by growth in India and formulation exports. We believe, with higher growth

in the domestic formulation business and lower base effect of licensing income,

EBIDTA margin is likely to expand 160 bps over FY10-13E. We value the company

at 19x FY13E, in line with the industry and set a 12 months price target of INR 350

per share. Hence, we upgrade our recommendation on the stock from ‘REDUCE’ to

‘HOLD’. We rate the stock ‘Sector Performer’ on relative returns basis.

India Equity Research | Pharmaceuticals Company Update

CIPLA

Turning around

April 25, 2011

Reuters: CIPL.BO Bloomberg: CIPLA IN


Absolute Rating HOLD

Rating Relative to Sector Performer

Risk Rating Relative to Sector Medium



MARKET DATA

CMP : INR 321

52-week range (INR) : 380 / 286


M cap (INR bn/USD mn) : 257.7 / 5,801.2

Avg. Daily Vol. BSE/NSE (‘000): 1,625.9


Promoters* : 36.8


FIIs : 15.4

Others : 29.1


: NIL



Index

1 month 9.9 8.9 5.5

3 months (8.3) 2.5 (7.0)

12 months (1.3) 11.9 18.0

Manoj Garg

+91 22 6623 3302

[email protected]

Peril Ali

+91 22 6620 3032

[email protected]


Financials


Revenues (INR mn) 56,057 62,465 71,260 82,819

Rev growth (%) 7.1 11.4 14.1 16.2

EBITDA (INR mn) 13,795 13,569 16,128 19,311

Adj Net profit (INR mn) 10,050 9,967 12,195 14,867


EPS (INR) 12.5 12.4 15.2 18.5

EPS growth (%) 3.6 (0.8) 22.4 21.9

P/E (x) 25.6 25.9 21.1 17.3

EV/EBITDA (x) 18.5 18.6 15.5 12.7

ROE (%) 19.6 15.9 17.2 18.4





Table 1: Financial snapshot (INR mn)


Chart 1: Historical valuation trend – One year forward PE


FY10 FY11E % Y-o-Y FY12E % Y-o-Y FY13E % Y-o-Y

Net sales 56,057 62,465 11.4 71,260 14.1 82,819 16.2

- Domestic formulations 25,113 28,536 13.6 32,816 15.0 38,067 16.0

- Export formulations 23,188 26,202 13.0 30,132 15.0 35,707 18.5

- Export bulk 5,802 6,324 9.0 6,893 9.0 7,582 10.0

- Technology fee income 1,538 770 (49.9) 700 (9.1) 600 (14.3)

Gross profit 31,527 34,855 10.6 39,692 13.9 46,130 16.2

Gross margins (%) 56.2 55.8 55.7 55.7

EBITDA 13,795 13,569 (1.6) 16,128 18.9 19,311 19.7

EBITDA margin (%) 24.6 21.7 22.6 23.3

EBITDA margin (Ex milestone) 22.5 20.7 21.9 22.8

PBT 12,311 11,965 (2.8) 14,692 22.8 17,912 21.9

Tax 2,435 1,998 (17.9) 2,498 25.0 3,045 21.9

Tax rate (%) 19.8 16.7 17.0 17.0

Reported PAT 10,826 9,967 (7.9) 12,195 22.4 14,867 21.9

Adjusted PAT 10,050 9,967 (0.8) 12,195 22.4 14,867 21.9

Adjusted EPS 12.5 12.4 (0.8) 15.2 22.4 18.5 21.9

12x

16x

20x

25x

0

100

200

300

400

500

Apr-

06

Oct

-06

Apr-

07

Oct

-07

Apr-

08

Oct

-08

Apr-

09

Oct

-09

Apr-

10

Oct

-10

Apr-

11

(IN

R)





Company Description Owned and managed by Dr. Y.K. Hamied, a second generation entrepreneur, Cipla is India’s third largest company by domestic sales. The company’s revenues (excluding tech fees) and profits have posted 17% and 13% CAGR over FY06-10 to INR 65 bn and INR 12 bn in FY10, respectively. Domestic formulations contributed 47% to total FY10 revenues (excluding tech fees) and posted 14% CAGR over FY06-10. With a market share of ~5%, Cipla is the third largest player in the domestic market, with leadership positions in ARTs, respiratory and urology. The company’s export sales (excluding tech fees) posted 22% CAGR over FY06-10 to INR 28 bn in FY10. Africa, with 34% share, is the largest contributor to exports, followed by the Americas (26%) and Europe (17%).

Chart 2: Revenue mix Chart 3: Export formulation mix


Chart 4: Shareholding pattern

Source: NSE

Domestic formulations

47%

ROW43%

APIs10%

Promoters 37%

MF & inst 19%

FII's15%

Retail & others 29%

Africa42%

Australia12%

EU14%

North/South America

21%

MEA11%





Domestic Formulations Snapshot Growth versus industry (%)






Company growth 10.3 8.8 18.8 16.4 14.5

Industry growth 13.8 13.1 15.0 14.3 14.4




Market share

Cipla growth

IndustryGrowth


Respiratory 28 19.2 19.9 14.5 29.1

Anti-infectives 25 7.1 16.1 13.4 22.1

Gyneacology 13 14.6 29.2 21.9 18.1

CVS 12 4.6 14.5 16.5 9.6

Gastro-intestinal 8 3.7 14.1 14.1 6.1

Pain mgmt. 2 2.1 11.0 13.8 1.5

CNS 2 1.8 26.7 14.1 3.1

Dermatology 2 1.9 18.3 14.4 1.6

Anti - diabetics 1 0.6 18.7 21.0 0.6


Respiratory28%

CVS12%

CNS2% Anti -

diabetics0%

Dermatology

1.6%

Gyneacology13%

Gastro-intestinal

8%

Anti-Infectives & pain mgmt.

28%

Others7%

Chronic 43%

12

6

1

3

6

6

0.0

4.0

8.0

12.0

16.0

20.0

Cipla Industry

(%)


19%

15%

4.5

4.8

5.1

5.4

5.7

6.0

1,500

2,300

3,100

3,900

4,700

5,500

FY06

FY07

FY08

FY09

FY10

FY11E S

ale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)


CAGR 2.2%


Market share

Growth rate


SEROFLO Chronic 3.8 62.4 18.4 3.7

ASTHALIN Chronic 3.2 88.7 19.1 3.3

MTP KIT Acute 3.1 34.8 246.0 14.0

NOVAMOX Acute 3.1 32.0 9.7 1.7

FORACORT Chronic 2.9 54.2 34.8 4.8

AEROCORT Chronic 2.8 100.0 15.1 2.3

MT PILL Acute 2.8 40.0 (4.4) (0.8)

CIPLOX Acute 2.3 23.2 14.1 1.8

BUDECORT Chronic 2.1 70.6 15.4 1.8

AMLOPRES AT Chronic 1.8 18.6 5.2 0.6

Total 27.9 33.1

0

7

14

21

28

35

Cip

la

GS

K

Ranbaxy

Sun

Pharm

a

Cadila

Lupin

Pfize

r

Dr

Reddy's

Sale

s (I

NR

bn)

Industrygrowth





Key Risks

Higher field force attrition poses risk to domestic growth Cipla has one of the highest attrition among the comparable peers in the domestic

market. Instability is one of the major reasons for subpar performance in the domestic market.

Contingent NPPA liability NPPA (National Pharmaceutical pricing Authority) has served notice to Cipla demanding

INR 12.3 bn (including interest) penalty for overcharging on certain products which comes under Drug Price Control Order (DPCO). Cipla has challenged the NPPA assertions and the matter is currently under sub-judice in the Supreme Court. We highlight that Cipla has not made any provisions for such a contingency and any adverse ruling can have one time material impact on its profitability. Moreover, Supreme Court in its recent verdict has asked Glaxo India to pay principal amount of outstanding dues to NPPA, over the dispute on pricing of DPCO controlled drug, which could be used as precedent for future litigations and thus increases risk for Cipla.

Large contracts could boost exports Large contracts, especially in ART and to some extent in the swine flu segment, could

have a disproportionate impact on Cipla’s revenues. These contracts are based on funding programmes that are difficult to predict.

Strong growth in export formulation sales Strong, unanticipated growth in export contracts, especially as only 37 products out of a

product basket of 118 products have been launched in the US. Inhaler opportunity in Europe could be significant but is contingent on long-pending approvals.






Income statement (INR mn)



Gross revenues 50,216 54,117 61,062 69,842 81,356

Less: Excise 610 522 571 651 750

Net revenues 49,606 53,595 60,491 69,191 80,607

Other operating income 2,737 2,462 1,973 2,070 2,213


Materials cost 23,474 24,530 27,609 31,568 36,689

Employee cost 2,714 3,191 4,476 4,843 5,804

R&D cost 2,355 2,507 2,722 3,114 3,627

Selling, admin and general expenses 11,389 12,034 14,088 15,607 17,389

EBITDA 12,411 13,795 13,569 16,128 19,311


EBIT 10,893 12,125 11,168 13,435 16,399

Interest expense/(income) 378 99 3 3 3

Other income (1,546) 285 800 1,260 1,515

Profit before tax 8,968 12,311 11,965 14,692 17,912

Provision for tax 1,258 2,435 1,998 2,498 3,045

Core profit 9,705 10,050 9,967 12,195 14,867

Extraordinary items - 950 - - -

Reported Profit after minority interest 7,710 10,826 9,967 12,195 14,867

Adjusted PAT after minority interest 9,705 10,050 9,967 12,195 14,867

Equity shares outstanding (mn) 777 803 803 803 803

EPS (INR) basic 12.49 12.52 12.41 15.19 18.52


Adjusted EPS (INR) fully diluted 12.09 12.52 12.41 15.19 18.52

CEPS (INR) 14.4 14.6 15.4 18.5 22.1


Dividend payout (%) 16.0 16.0 22.5 22.5 22.5



Cost of revenues 44.8 43.8 44.2 44.3 44.3

Selling, admin and general expenses 21.8 21.5 22.6 21.9 21.0

R & D cost 4.5 4.5 4.4 4.4 4.4

Other expenses 21.8 21.5 22.6 21.9 21.0


Depreciation and amortisation 2.9 3.0 3.8 3.8 3.5


EBITDA margins 23.7 24.6 21.7 22.6 23.3


Growth metrics (%)


Revenues 23.7 7.1 11.4 14.1 16.2

EBITDA 45.5 11.2 (1.6) 18.9 19.7

Net profit 50.4 3.6 (0.8) 22.4 21.9

PBT 7.0 37.3 (2.8) 22.8 21.9

EPS 50.4 3.6 (0.8) 22.4 21.9





Balance sheet (INR mn)


Equity capital 1,555 1,606 1,606 1,606 1,606


Common shareholders equity 43,478 59,106 66,449 75,433 86,386

Total Shareholders Funds 43,478 59,106 66,449 75,433 86,386

Borrowings 9,402 51 51 51 51


Sources of funds 54,522 60,948 68,291 77,275 88,228

Gross block 26,933 28,973 39,630 43,230 46,347

Depreciation 7,008 8,861 11,262 13,955 16,866

Net block 19,925 20,112 28,368 29,275 29,481

Capital work in progress 3,663 6,842 - - -

Investments 801 2,464 2,464 2,464 2,464

Inventories 13,983 15,126 17,114 19,523 22,690

Sundry debtors 18,529 15,666 17,114 19,523 22,690

Cash and bank balances 534 621 2,785 4,759 9,495


Other current assets 235 578 665 765 879


Current liabilities 10,129 9,980 10,153 9,668 10,816

Provisions 3,917 2,164 2,915 3,501 4,205



Uses of funds 54,522 60,948 68,291 77,275 88,228


Free cash flow (INR mn)


Net profit 7,710 10,826 9,967 12,195 14,867

Depreciation 1,518 1,671 2,401 2,693 2,911

Others 150 150 - - -

Gross cash flow 9,378 12,647 12,368 14,888 17,778

Less: Changes in WC (5,828) (1,310) (3,765) (6,103) (6,011)


Less: Capex (6,161) (5,037) (3,815) (3,600) (3,117)

Free cash flow (2,611) 6,300 4,788 5,184 8,650

Cash flow metrices





Net cash flow (263) 69 2,164 1,974 4,736

Capex (6,161) (5,037) (3,815) (3,600) (3,117)

Dividends paid (1,819) (1,873) (2,624) (3,210) (3,914)







ROAE (%) 24.0 19.6 15.9 17.2 18.4

ROACE (%) 22.4 21.6 18.0 19.1 20.4

Inventory days 195.8 216.6 213.1 211.8 210.0

Debtors days 119.9 116.4 98.9 96.6 95.6

Payable days 146.5 149.6 133.1 114.6 101.9

Cash conversion cycles 169.3 183.4 178.9 193.8 203.7

Current ratio 3 4 4 4 5

Debt/ EBITDA 0.8 0.0 0.0 0.0 0.0

Debt/equity 0.2 0.0 0.0 0.0 0.0






Equity turnover 1.22 1.04 0.96 0.98 1.00

Du pont analysis


NP margin (%) 19.6 18.8 16.5 17.6 18.4



ROAE (%) 23.95 19.59 15.88 17.19 18.37



Adjusted diluted EPS (INR) 12.1 12.5 12.4 15.2 18.5

EPS YoY growth (%) 50.4 3.6 (0.8) 22.4 21.9

CEPS (INR) 14.4 14.6 15.4 18.5 22.1

Diluted PE (x) 26.6 25.6 25.9 21.1 17.3

Price/BV(x) 5.7 4.4 3.9 3.4 3.0

EV/Sales (x) 4.9 4.5 4.0 3.5 3.0

EV/EBITDA (x) 20.8 18.5 18.6 15.5 12.7

Dividend yield (%) 0.6 0.6 0.9 1.1 1.3





April 25, 2011

Reuters : REDY.BO Bloomberg : DRRD IN

Absolute Rating BUY

Rating Relative to Sector Outperformer Risk Rating Relative to Sector High

Sector Relative to Market Equalweight Note: Please refer last page of the report for rating explanation MARKET DATA CMP : 1,656

52-week range (INR) : 1,855 / 1,160


M cap (INR bn/USD mn) :279.7 / 6,314.2

Avg. Daily Vol. BSE/NSE (‘000) : 448.5 SHARE HOLDING PATTERN (%)

Promoters* : 25.7


FIIs : 27.2

Others : 34.0

* Promoters pledged shares : 1.2 (% of share in issue) PRICE PERFORMANCE (%)

Stock Nifty EW Pharma Index

1 month 12.2 8.9 5.5

3 months 0.6 2.5 (7.0)

12 months 45.1 11.9 18.0

Domestic formulation: Gaining priority We expect Dr. Reddys Laboratories’ (DRRD) domestic market to grow at 17%

over FY10-13E led by strategic initiatives such as field force expansion (750

additions in existing markets and 1,600 contractual field force for rural markets)

and increase in new launches. Its differentiated product pipeline such as bio-

similars (Reditux and Cresp) and novel formulations like Fentanyl patches, have

also been successful. Our survey indicates that the company’s supply chain

initiatives, which had impacted growth in FY09, are now contributing to better

performance and incrementally higher returns as inventory in channel has dipped

to 7-8 days versus 15-21 days (best among peers).

US pipeline of limited competition products DRRD has the most interesting pipeline of limited competition and Para IV

products (34 Para IV, 18 have FTF status), however execution of the same is

critical to attain the goal of USD 1bn revenue from current base of USD 350 mn

(FY10) in the US. We expect US to post 27% CAGR over FY10-13E led by ramp-up

in sales from existing products such as Omeprazole OTC, Prevacid and Tacrolimus

and new product launches such as Fondaperinux, Finestride, Olanzapine,

Ziprasidon and Rivastigmin.

GSK alliance to aid growth momentum in emerging markets DRRD has exited a few non-core ROW markets in FY10 and forged an alliance with

GSK to capture the growing opportunity in the branded generic space in emerging

markets. The company has already started supplying products to GSK for five-six

markets including Brazil and Mexico; however, full impact on revenue will be

visible in the next two-three years.

Outlook and valuations: Execution critical for growth; upgrade to ’BUY’ We remain positive on strong growth visibility in branded generics, improved

traction in limited competition products and potential upside from the GSK deal.

We maintain our core earnings estimate of INR 76 and INR 88 for FY12 and FY13,

respectively. Our SOTP-based fair value at INR 1,950, values base business at

21x FY13E core EPS (10% premium to sector multiple due to strong pipeline in

US) and assigns INR 94 per share as NPV of Para IVs. Hence, we upgrade our

recommendation to ‘BUY/Sector Outperformer’ from ‘HOLD/Sector

Outperformer’. Execution in US is a key risk.

Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

Manoj Garg

+91 22 6623 3302

[email protected]

Peril Ali

+91 22 6620 3032

[email protected]


DR. REDDY’S LABORATORIES

More steam left


Financials


Revenues (INR mn) 70,519 74,508 93,814 104,148

Rev growth (%) 2.5 5.7 25.9 11.0

EBITDA (INR mn) 15,970 16,546 24,485 25,012

Adj. Net profit (INR mn) 8,376 11,351 17,128 17,413


Adj. EPS (INR) 49.6 67.2 101.4 103.1

EPS growth (%) 10.3 35.5 50.9 1.7

P/E (x) 33.4 24.6 16.3 16.1

EV/EBITDA (x) 17.8 16.7 10.8 10.1

ROE (%) 26.3 27.0 31.4 25.1







Chart 1: Historical valuation trend – One year forward P/E


Table 2: SOTP based valuation (INR)

` Source: Edelweiss research


Net sales 70,519 74,508 5.7 93,814 25.9 104,148 11.0

- India formulations 10,158 11,864 16.8 13,900 17.2 16,336 17.5

- Betapharm 7,298 5,564 (23.8) 5,767 3.7 5,796 0.5

- US formulations 16,817 18,070 7.5 30,497 68.8 32,351 6.1

- Russia 7,200 8,652 20.2 10,154 17.4 11,987 18.1

- PSAI 20,404 19,287 (5.5) 20,093 4.2 21,688 7.9

Gross profit 47,831 50,568 5.7 64,189 26.9 70,534 9.9

Gross margins (%) 67.8 67.9 68.4 67.7

EBITDA 15,970 16,546 3.6 24,485 48.0 25,012 2.2

EBITDA margin (%) 22.6 22.2 26.1 24.0

EBITDA margin (ex-milestones) 20.4 19.9 24.2 22.1

PBT 12,259 12,754 4.0 20,391 59.9 20,979 2.9

Tax 2,668 1,333 3,263 144.7 3,566 9.3 Tax rate (%) 21.8 10.5 16.0 17.0Reported PAT 3,515 10,789 206.9 17,128 58.8 17,413 1.7

Recurring PAT 6,777 10,539 55.5 12,901 22.4 14,926 15.7

Recurring EPS 40.1 62.4 76.4 88.4

6x

10x

14x

18x

0

400

800

1,200

1,600

2,000

Apr-

06

Oct

-06

Apr-

07

Oct

-07

Apr-

08

Oct

-08

Apr-

09

Oct

-09

Apr-

10

Oct

-10

Apr-

11

(IN

R)

SOTP

Base business EPS March-13 88

Target P/E 21

Value of base business (INR per share) 1,856

NPV per share for one-off sales 94

Total target price 1,950





Table 3: Niche product pipeline (including Para IV filings) for US market


Brand Name Molecule Innovator TypeMarket size (USD mn)

Generic players Data of Launch

Arixtra Fondaparinux GSK 270 1 Awaiting approval

Zyprexa Olanzapine-20mg Eli Lilly Para IV 800 1 April'11

Avandia Rosiglitazone GSK Para IV 600 2 June'11

Allegra-D-24 (OTC) Fexofenadine Sanofi Aventis 200 1 Aug'11

Plavix Clopidogrel BMS 3,300 4-5 players Nov'11/ May'12

Boniva Ibandronate Roche Para IV 500 Multiple players Mar'12

Geodon Ziprasidone Pfizer Para IV 1,200 4 Mar'12

Clarinex-D-12/24 Desloratidine Scherring Para IV 172 2 Mar'12

Exelon Rivastigmine Novartis 225 3 Aug'12

Propecia Finestride Merck Para IV 100 1 Dec'12

Micardis Telmisartan Boehringer Para IV 140 1 Jan'14

Lunesta Eszopiclone Sepracor Para IV 761 4 May'14

Actonel Residronate Roche 700 Many June'14

Avelox Moxifloxacin Bayer Para IV 400 2 Aug'14

Namenda Memantine Forest Labs Para IV 1,300 Multiple players Jan'15





Company Description

Promoted by Dr. K Anji Reddy, a first generation entrepreneur, DRRD is a professionally managed company with revenue of USD 1.6 bn in FY10 (30% CAGR between FY06 and FY10). Operating in 40 plus countries, international operations’ revenue contribution has increased to 82% currently from 40% in FY00, with US/Russia operations contributing c.32% of FY10 sales. The company has set itself an internal target of USD 3 bn revenue and ROCE of 25% by FY13. The company’s key strength has been its vertical integration through its Pharmaceutical Services & Active Ingredients (PSAI) operations and 16 manufacturing bases (10 USDFDA approved) which enable it to have one of the best gross margin ratios in the Indian pharmaceutical industry. This is actively supported by an extensive R&D programme, which spans CRAMs to drug discovery. It also has one of the deepest pipelines of bio-similars amongst leading global generic companies, addressing global brand sales of USD 30 bn. Chart 2: Revenue mix



Source: NSE


15%

ROW17%

US24%

EU3%

Germany (Betapharm)

10%

Biotech2%

APIs29%

Promoters 26%

MF & inst 13%

FII's27%

Retail & others 34%





Domestic Snapshot

Growth versus industry (%)






Company growth 13.5 13.5 10.6 10.5 18.4

Industry growth 13.8 13.1 15.0 14.3 14.4




Market share

Dr Reddy's

IndustryGrowth


Gastro 24 4.5 12.5 14.1 28.3

CV 21 3.6 10.1 16.5 20.1

Pain mgmt. 12 4.1 (0.7) 13.8 (0.8)

Anti-infectives 10 1.0 9.9 13.4 9.0

Anti - diabetics 6 2.3 17.0 21.0 9.2

Respiratory 5 1.5 23.1 14.5 10.8

Dermatology 5 2.4 30.5 14.4 13.4

Gyneacology 4 0.1 7.7 21.9 3.2

CNS 1 0.4 7.4 14.1 0.9


CV21%

CNS1%Anti -

diabetics6%

Respiratory5%

Dermatology5%Gastro

24%

Pain mgmt.13%

Anti-infectives

10%

Gyneacology4%

Others11%

Chronic 34%

(0)

6 3

3 8

6

(4.0)

0.0

4.0

8.0

12.0

16.0

Dr Reddy's Industry

(%)


10.6%

15%


Market share

Growth rate


OMEZ Acute 9.9 53.1 9.8 9.3

NISE Acute 6.9 48.3 (7.5) (5.8)

STAMLO Chronic 4.7 20.6 4.4 2.1

OMEZ D Acute 3.2 26.2 11.6 3.5

STAMLO BETA Chronic 3.2 12.9 3.6 1.1

ATOCOR Chronic 2.9 5.2 7.2 2.0

RAZO Acute 2.8 13.7 8.2 2.2

MINTOP Acute 2.2 48.9 16.8 3.3

CLAMP Acute 2.2 2.9 24.5 4.4

ECONORM Acute 2.1 10.3 28.4 4.8

Total 39.9 26.8

3.5

3.9

4.3

4.7

5.1

5.5

0

600

1,200

1,800

2,400

3,000

FY06 FY07 FY08 FY09 FY10 FY11E

Sale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)


CAGR 3.7%

0

7

14

21

28

35

Cip

la

GS

K

Ranbaxy

Sun

Pharm

a

Cadila

Lupin

Pfize

r

Dr

Reddy's

Sale

s (I

NR

bn)

Industrygrowth





Key Risks

Domestic growth driven by new products than prescription generation DRRD’s domestic performance has been a laggard because of lack of strategic focus. In most therapeutic segments, company’s performance is below the industry level growth. Moreover, growth is mainly led by new introductions and price increase which indicates that new prescription growth is very poor. However, as domestic market is expected to report robust growth, management has also changed its priority towards Indian market.

Rupee appreciation Rapid rupee appreciation could impact our sales estimate, especially on international revenues which are currently based on a currency estimate of USD/INR of INR 46.

Regulatory issues Regulatory issues including product approval delays, unfavorable litigation outcomes, and potential future adverse inspections from USFDA are structural negatives for DRRD.









Gross revenues 68,326 68,833 72,909 92,103 102,322

Less: Excise 809 316 583 667 770

Net revenues 67,517 68,517 72,327 91,436 101,552

Other operating income 1,313 2,002 2,181 2,379 2,595


Materials cost 23,223 22,688 23,940 29,625 33,614

Employee cost 9,920 10,948 12,700 14,605 16,503

R&D cost 4,093 3,731 4,520 6,035 7,109


EBITDA 14,749 15,970 16,546 24,485 25,012


EBIT 9,772 11,839 11,981 19,499 19,605

Interest expense 972 312 247 284 124

Other income 783 732 1,020 1,175 1,497


Provision for tax 2,608 2,668 1,333 3,263 3,566

Core Profit 6,975 9,591 11,421 17,128 17,413

Extraordinary items 16,147 6,077 632 0 0

Profit after tax (9,172) 3,515 10,789 17,128 17,413Reported profit after minority interest (9,172) 3,515 10,789 17,128 17,413Adjusted PAT after minority interest 7,571 8,376 11,351 17,128 17,413


Adjusted EPS (INR) (Dil) 44.9 49.6 67.2 101.4 103.1


Recurring EPS (INR) fully diluted 25.5 40.1 62.4 76.4 88.4

CEPS (INR) 71.0 81.2 94.6 130.9 135.1


Dividend payout (%) 13.9 22.7 11.9 9.9 14.6



Cost of revenues 33.7 32.2 32.1 31.6 32.3


R & D cost 5.9 5.3 6.1 6.4 6.8




EBITDA margins 21.4 22.6 22.2 26.1 24.0


Growth metrics (%)


Revenues (241.3) 2.5 5.7 25.9 11.0

EBITDA (116.4) 8.3 3.6 48.0 2.2

Net profit (107.4) 37.5 19.1 50.0 1.7

PBT (110.2) 27.9 4.0 59.9 2.9

EPS 124.3 10.3 35.5 50.9 1.7







Equity capital 842 845 845 845 845

ESOPS & others 628 573 573 573 573



Total shareholders funds 35,261 37,768 46,976 62,128 76,576

Borrowings 19,976 14,840 9,840 4,340 1,840

Deferred tax liability (net) 539 70 70 70 70

Sources of funds 55,775 52,678 56,886 66,538 78,486

Net block 16,318 17,376 20,807 22,924 24,724

Capital work in progress 4,296 7,622 4,246 4,567 4,891

Intangible assets & goodwill 12,952 6,146 4,470 2,719 915

Investments 523 3,580 3,580 3,580 3,580

Inventories 13,250 13,394 14,046 17,629 19,721

Sundry debtors 14,406 11,599 12,296 15,544 17,264





Provisions 1,994 3,502 2,172 3,174 4,282



Uses of funds 55,775 52,678 56,886 66,538 78,486


Free cash flow


Net profit (9,172) 3,515 10,789 17,128 17,413

Add: Non cash charge

Depreciation 4,977 4,131 4,565 4,986 5,407

Others - - (0) 0 (0)

Gross cash flow (4,195) 7,646 15,354 22,114 22,820

Less:Changes in WC (4,681) 4,709 (2,695) (3,173) (1,298)

Operating cash flow (8,876) 12,355 12,659 18,941 21,521

Less: Capex (11,761) (2,767) (5,500) (5,000) (5,000)

Free cash flow (20,638) 9,588 7,159 13,941 16,521

Cash flow metrices


Operating cash flow (8,876) 12,355 12,659 18,941 21,521

Financing cash flow (512) (6,611) (6,581) (7,476) (5,464)

Investing cash flow 7,564 (4,766) (2,943) (5,674) (5,727)

Net cash flow (1,824) 978 3,134 5,791 10,330

Capex (11,761) (2,767) (5,500) (5,000) (5,000)

Dividends paid (1,232) (2,217) (1,581) (1,976) (2,964)

Share issuance / (buyback) 172 226 - - -







ROAE (%) 17.4 26.3 27.0 31.4 25.1

ROACE (%) 19.3 20.4 23.4 33.5 28.4

Inventory days 191 214 209 195 203


Payable days 200 256 258 238 247


Current ratio 2.3 1.9 2.2 2.3 2.6

Debt/ EBITDA 1.4 0.9 0.6 0.2 0.1

Debt/equity 0.6 0.4 0.2 0.1 0.0







Du Pont Analysis


NP margin 10.3 14.0 15.8 18.7 17.1



ROAE 17.4 26.3 27.0 31.4 25.1



Adj. Diluted EPS (INR) 44.9 49.6 67.2 101.4 103.1

EPS YoY growth (%) 124.3 10.3 35.5 50.9 1.7

CEPS (INR) 71.0 81.2 94.6 130.9 135.1

Diluted PE (x) 36.8 33.4 24.6 16.3 16.1

Price/BV(x) 7.9 7.4 6.0 4.5 3.7

EV/Sales (x) 4.3 4.0 3.7 2.8 2.4

EV/EBITDA (x) 19.8 17.8 16.7 10.8 10.1

Dividend yield (%) 0.4 0.7 0.5 0.6 0.9









Domestic formulations growth to outpace industry Lupin Pharma’s (LPC) domestic growth has consistently outpaced the broad

market and peers over the past five years—domestic growth has been a sturdy

24% (CAGR) over FY05-10. This is further evident through our extensive

distributor survey, which validates LPC’s strong domestic franchise led by wider

therapy coverage (chronic 41% of total sales), strong traction from new

launches, and effective field force. We expect the company’s growth momentum

to sustain in the domestic market and estimate 18% CAGR over FY11-13E.

Higher API sourcing from India to boost Japan margins LPC has guided to 15-16% growth driven by 8-10 products launches in FY12E.

We believe Japan’s contribution to margins will be far higher as the company

expects to source more products from India (out of the 8-10 product launches,

four-five will be sourced from India). Management expects margins from Japan

to expand 600 bps to 24-25% over FY13-14E.

Strong ANDA pipeline in US imparts strong growth visibility LPC’s solid base in US generics (USD 350 mn) with a large pending pipeline of 90

products (50-60 ANDA approvals expected in next 2-3 years) including niche

segments such as OC, ophthalmology as well as Para IV (13 FTFs with four being

exclusive), imparts long-term growth visibility. However, there could be some

pressures in the near term, largely due to genericization of Lotrel and delay in

launches of OCs (2-3 launches by end FY12).

Execution slippage in US branded formulations poses key risk US branded formulations faces key challenge of possible genericization of Antara

and Suprax, although management is confident of mitigating these risks through

effective product life cycle management. Further, with no visible product pipeline

and expected delay in launch of Allernaze (FY13E), we expect a moderate 11%

CAGR in US branded formulations over FY11-13E.

Outlook and valuations: Strong execution play; maintain ‘BUY’ We remain positive on LPC due to its strong execution track record, established

franchise in domestic market, and earnings growth visibility, imparting strong

upsides from current valuations. It is our preferred pick in the large cap space.

We re-iterate ‘BUY/Sector outperformer’ rating with TP of INR 500.


LUPIN PHARMA

Growth evident; strong outlook

April 25, 2011

Reuters: LUPN.BO Bloomberg: LPC IN


Absolute Rating BUY


Risk Rating Relative to Sector Low



MARKET DATA

CMP : INR 412

52-week range (INR) : 519 / 324


M cap (INR bn/USD mn) : 183.2 / 4,137.3



Promoters* : 47.0


FIIs : 22.0

Others : 11.0


: NIL



Index

1 month 6.3 8.9 5.5

3 months (10.3) 2.5 (7.0)

12 months 25.6 11.9 18.0

Manoj Garg

+91 22 6623 3302

[email protected]

Peril Ali

+91 22 6620 3032

[email protected]

Financials


Revenues (INR mn) 48,359 56,693 64,939 75,280

Rev growth (%) 25.5 17.2 14.5 15.9

EBITDA (INR mn) 9,728 11,594 13,710 16,121



Adj. EPS (INR) diluted 15.4 19.1 21.6 26.5

EPS growth (%) 21.0 23.8 13.4 22.6

P/E (x) 26.8 21.6 19.1 15.6

EV/EBITDA (x) 19.8 15.8 12.9 10.5

ROE (%) 34.3 28.0 24.4 23.9










Net sales 48,359 56,693 17.2 64,939 14.5 75,280 15.9

- Domestic Formulations 13,498 15,928 18.0 18,795 18.0 22,178 18.0

- US (generics) 10,783 13,710 27.1 15,245 11.2 18,480 21.2

- US (branded) 6,033 5,690 (5.7) 6,594 15.9 6,868 4.2

- Europe 1,396 1,954 40.0 2,541 30.0 3,176 25.0

- Japan 5,341 6,089 14.0 7,002 15.0 8,052 15.0

- API 8,106 8,798 8.5 9,551 8.6 10,368 8.6

Gross profit 28,665 33,725 17.7 38,653 14.6 44,921 16.2

Gross margins (%) 59.3 59.5 59.5 59.7

EBITDA 9,728 11,594 19.2 13,710 18.3 16,121 17.6

EBITDA margin (%) 20.1 20.5 21.1 21.4

PBT 8,357 9,884 18.3 12,331 24.8 15,119 22.6

Tax 1,360 1,186 (12.8) 2,466 107.9 3,024 22.6

Tax rate (%) 16.3 12.0 20.0 20.0

Reported PAT 6,816 8,472 24.3 9,608 13.4 11,781 22.6

Adjusted PAT 6,841 8,472 23.8 9,608 13.4 11,781 22.6

Adjusted EPS 15.4 19.1 23.8 21.6 13.4 26.5 22.6

7x

12x

16x

22x

0

100

200

300

400

500

600

Apr-

06

Oct

-06

Apr-

07

Oct

-07

Apr-

08

Oct

-08

Apr-

09

Oct

-09

Apr-

10

Oct

-10

Apr-

11

(IN

R)





Table 2: Niche product pipeline over FY11-15E


Brand Name Molecule InnovatorMarket size (USD mn)

Generic Players

Data of Launch

Type

Fortamet Metformin Depomed 70 1 June'11 Para-IV

Effexor-XR Venlafaxine ER Pfizer (Wyeth) 800 5 July'11

Tricor Fenofibrate Abbott 1,500 4

Renagel Sevelamer Genzyme 600 2 Sep'11 Para-IV

Solodyn Minocycline 500 Multiple players

Nov'11 Para-IV

Geodon Ziprasidone Pfizer 1,200 4 Mar'12 Para-IV

Fosrenol Lanthum Shire 130 2 Apr'12 Para-IV

Glumetza Metformin Depomed 45 1 May'12 Para-IV

Combivir Lamivudine and Zidovudine GSK 360 2 May'12

Cipro OD Ciprofloxacin Bayer 150 4 June'12 Para-IV

Clarinex-D-12/24 Desloratidine Scherring 172 2 July'12 Para-IV

Femcon FEEstradiol and Norethindrone

Warner Chillcot 65 3 Jan'13

YazEthinyl Estradiol and Drospirenone

Bayer 772 Jan'13

Cymbalta Duloxitine Eli Lilly 2,500 Multiple players

June'13 Para-IV

Oracea Doxycycline Galderma 240 June'13

Niacin Niaspan Abbott 330 3 Sep'13 Para-IV

Lyrica Pregabalin Pfizer 1,596 Multiple players

Oct'13 Para-IV

Lunesta Eszopiclone Sepracor 761 4 May'14 Para-IV

Ultram Tramedol 200 2 May'14

Loestrin 24 Norethindrone and Ethinyl Warner Chillcot 357 2 Julu'14

Namenda Memantine Forest Labs 1,300 Multiple players

Jan'15 Para-IV

Welchol Daiichi Sankyo 30 3 2015 Para-IV





Company Description Promoted by Dr. Desh Bandhu Gupta, a first generation entrepreneur, LPC is India’s fifth largest company by domestic sales. The company’s revenue and profit (ex-IP related revenues) have posted 29% and 40% CAGR over FY06-10 to INR 49 bn and INR 6.8 bn in FY10, respectively. Its domestic formulations contributed 28% to total FY10 revenues and posted 22% CAGR over FY06-10 to INR 13.3 bn in FY10. With a market share of ~2.8%, LPC is the tenth largest player in the domestic market with six products in the top 300 pharma brands in India. The company’s export sales posted 39% CAGR during FY06-10, growing to INR 32 bn in FY10. US formulations contributed 35%, with Japan and Europe formulations contributing 14% to FY10 sales. Chart 2: Revenue mix (%)



Source: NSE


33%

US40%

Europe6%

Japan13%

ROW8%

Promoters 47%

MF & inst 19%

FII's23%

Retail & others 11%





Domestic Formulations Snapshot Growth versus industry (%)



Growth composition (MAT Mar 2011) Relative performance to peers (MAT Mar 2011)



Company growth 24.9 24.2 25.4 24.9 24.1

Industry growth 13.8 13.1 15.0 14.3 14.4




Market share

Lupin growth

Industry growth


Anti infectives (incl TB)

34 4.6 15.4 13.4 20.4

CVS 22 4.3 35.2 16.5 31.1

Respiratory 12 4.3 21.4 14.5 10.2

Gastrointestinal 7 1.7 23.8 14.1 6.5

Anti-diabetics 7 3.8 36.6 21.0 9.8

CNS 5 2.2 30.6 14.1 6.1


CVS21%

Anti-diabetics

6%

CNS5%

Respiratory9%

Anti TB11%

Antibiotoics18%

Gastrointestinal6%

Nsaids2%

Others10%

Generics12%

Chronic 41%

11 6

2

3

12

6

0.0

6.0

12.0

18.0

24.0

30.0

Lupin Industry

(%)


25%

15%

1.0

1.9

2.8

3.7

4.6

5.5

1,500

1,900

2,300

2,700

3,100

3,500

FY06

FY07

FY08

FY09

FY10

FY11E

Sale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)


CAGR 4.1%


Market share

Growth rate


TONACT Chronic 3.8 9.6 27.7 4.1

RAMISTAR Chronic 2.1 16.5 20.4 1.8

GLUCONORM G Chronic 2.1 7.2 45.6 3.2

R-CINEX Acute 2.0 52.6 19.7 1.6

BUDAMATE Chronic 2.0 19.4 30.9 2.3

LUPENOX Chronic 2.0 13.9 12.9 1.1

L CIN Acute 1.8 13.6 11.9 0.9

ESIFLO Chronic 1.8 15.4 23.7 1.7

TAZAR Acute 1.7 10.2 23.3 1.6

RABLET Acute 1.7 11.6 25.6 1.7

Total 21.0 20.1

0

7

14

21

28

35

Cip

la

GS

K

Ranbaxy

Sun

Pharm

a

Cadila

Lupin

Pfize

r

Dr

Reddy's

Sale

s (I

NR

bn)

Industrygrowth





Key Risks

Lack of new approvals; delay in approvals The pace of new product approvals has moderated since FY10. Despite such low success rate, LPC has managed to deliver robust growth in 9mFY11. While LPC has a healthy pipeline of ANDAs pending, a delay in approvals could hurt US generics sales in FY12.

Slowdown in domestic formulation market Domestic market contributed 34% to total sales and has a higher impact on overall profits. Moreover, Anti-infective and anti TB still contributes 33% of overall domestic sales and these segments are growing at lesser pace than the overall growth of the industry and the company. We have estimated domestic formulation CAGR of 18% over FY11-13. Slowdown in the domestic market could have a disproportionate impact on profits.

Price reductions in Kyowa As per LPC, Kyowa is expected to grow at 15-16% over FY12-13E despite a mandated price cut of 15-16% in LPC’s current portfolio in Japan. We highlight that Kyowa contributes 11% to total revenue and any shortfall in sales could impact our earning estimates.






Income statement (INR Mn)



Net revenues 37,761 47,405 55,747 63,956 74,227

Other operating income 762 954 946 983 1,053

Materials cost 16,043 19,694 22,968 26,286 30,359

Employee cost 4,871 5,872 6,968 7,995 9,130

R&D cost 2,228 3,438 3,958 4,477 5,196



EBITDA 7,541 9,728 11,594 13,710 16,121

Depreciation and amortisation 880 1,239 1,698 1,854 1,817

EBIT 6,661 8,489 9,896 11,856 14,303

Interest expense/(income) 499 385 337 255 270

Other income (incl. forex gain/(loss)) 192 282 325 730 1,086


Provision for tax 983 1,360 1,186 2,466 3,024

Core profit 5,372 7,026 8,698 9,865 12,095

Extraordinary items (295) (29) - - -

Profit after tax 5,666 7,055 8,698 9,865 12,095


Reported profit after minority interest 5,604 6,875 8,472 9,608 11,781

Adjusted PAT after Minority interest 5,266 6,841 8,472 9,608 11,781


EPS (INR) basic 12.8 15.4 19.1 21.6 26.5


Adjusted EPS (INR) diluted 12.7 15.4 19.1 21.6 26.5

CEPS (INR) 14.9 18.2 22.9 25.8 30.6


Dividend payout (%) 20.1 18.6 20.6 20.6 20.6



Cost of revenues 41.6 40.7 40.5 40.5 40.3

Employee cost 12.6 12.1 12.3 12.3 12.1


R & D cost 5.8 7.1 7.0 6.9 6.9


Depreciation and Amortisation 2.3 2.6 3.0 2.9 2.4


EBITDA margins 19.6 20.1 20.5 21.1 21.4


Growth metrics (%)


Revenues 40.6 25.5 17.2 14.5 15.9

EBITDA 49.5 29.0 19.2 18.3 17.6

Net profit 26.6 30.8 23.8 13.4 22.6

PBT 14.3 32.0 17.9 24.8 22.6

Adjusted EPS 17.6 21.0 23.8 13.4 22.6







Equity capital 828 889 889 889 889



Total Shareholders Funds 14,248 25,678 34,869 44,014 54,493

Borrowings 12,233 11,399 8,899 7,399 5,399


Minority interest 143 255 481 738 1,052

Sources of funds 27,788 38,767 45,684 53,585 62,379

Gross block 18,200 22,937 25,937 29,437 32,937

Depreciation 6,188 7,072 8,770 10,624 12,441

Net block 12,012 15,865 17,167 18,813 20,496

Capital work in progress 2,240 3,579 964 964 964

Intangible assets & Goodwill 3,174 3,197 3,197 3,197 3,197

Investments 216 264 1,176 1,176 1,176

Inventories 9,572 9,715 14,104 16,181 18,779

Sundry debtors 9,180 11,266 15,163 17,396 20,190

Cash and bank balances 778 2,015 8,636 13,275 18,553




Provisions 1,827 2,243 1,344 2,067 3,162



Uses of funds 27,788 38,767 45,684 53,585 62,379


Free cash flow


Net profit 5,372 7,026 8,698 9,865 12,095

Depreciation 880 1,239 1,698 1,854 1,817

Others (188) 221 - - -

Gross cash flow 6,064 8,486 10,396 11,719 13,913

Less:Changes in WC 860 (4,478) (697) (1,616) (1,833)


Less: Capex (4,007) (6,431) (385) (3,500) (3,500)

Free cash flow 2,917 (2,422) 9,313 6,603 8,580

Cash flow metrices



Financing cash flow (3,360) 3,780 (1,781) (1,963) (3,302)


Net cash flow (1,902) 1,285 6,620 4,640 5,278

Capex (4,007) (6,431) (385) (3,500) (3,500)

Dividends paid (1,235) (1,483) (408) (463) (1,302)







ROAE (%) 39.3 34.3 28.0 24.4 23.9

ROACE (%) 24.9 25.7 23.8 24.5 25.2

Inventory days 199 179 189 210 210


Payable days 186 185 214 258 258


Current ratio 1.8 2.3 2.2 2.3 2.4

Debt/ EBITDA 1.6 1.2 0.8 0.5 0.3

Debt/equity 0.9 0.4 0.3 0.2 0.1






Equity turnover 2.79 2.37 1.84 1.62 1.51

Du pont analysis


NP margin 14.1 14.4 15.2 15.0 15.9



ROAE 39.3 34.3 28.0 24.4 23.9



Adj. diluted EPS (INR) 12.7 15.4 19.1 21.6 26.5

EPS YoY growth (%) 17.6 21.0 23.8 13.4 22.6

CEPS (INR) 14.9 18.2 22.9 25.8 30.6

Diluted PE (x) 32.4 26.8 21.6 19.1 15.6

Price/BV(x) 12.0 7.1 5.3 4.2 3.4

EV/Sales (x) 4.7 4.0 3.2 2.7 2.3

EV/EBITDA (x) 24.1 19.8 15.8 12.9 10.5

Dividend yield (%) 0.6 0.7 1.0 1.1 1.3









Emerging markets to drive growth; positive traction from Project Virat Ranbaxy Laboratories’ (RBXY) CY11 revenue guidance of USD 1.87 bn implies

base business growth of 14%, largely driven by emerging markets (EM) such as

Africa, Latam, India, CIS, and Romania. During CY10, organic growth in EM has

been robust at 12%. We believe growth from these regions will be key growth

driver over the medium term. This is further evident from Daiichi Sankyo’s mid-

term business plan, where EMs (ex-Japan) are projected to post 23% CAGR,

largely driven by RBXY. India is the key component of this growth strategy and

is seeing positive traction over the past three months after launch of Project

Virat, a significant positive. We expect EM to post 15% CAGR over CY10-12E.

Lipitor launch: Key trigger for stock

Lipitor (USD 5.3 bn opportunity in US) is an exciting PIV opportunity for RBXY.

The company’s success in monetising other Para IVs cannot be extrapolated for

Lipitor; however, successful launch could have a large bearing on valuations. We

believe there is uncertainty around Lipitor launch during the exclusivity period,

given the current import ban and AIP at Ponta Sahib (Lipitor ANDA is filed from

the facility). However, we have build base case scenario for Lipitor

(relinquishes Lipitor exclusivity) with an NPV of INR21 per share. Successful

launch of Lipitor in Nov’2011 can has incremental option value of INR48/ share.

We estimate INR 74 per share upside from positive FDA-DOJ resolution Positive resolution of the FDA-DOJ issue could be another positive trigger and

enable RBXY to cover lost ground in the US. We believe recovery in the US base

business sales, post resolution, is likely to be gradual and more accretive to

earnings than sales, as assets have been underutilized and fixed costs have

soared due to higher legal and consultation costs. We estimate incremental EPS

of INR4.6 per share (option value of INR 74) on back of positive resolution.

Outlook and valuations: Fairly valued; initiating coverage with ‘HOLD’ Current valuations, in our view, already factor in potential upsides in the base

business. However, positive resolution of the FDA-DOJ issue and/or clarity on

Lipitor launch could be potential triggers for the stock. We initiate coverage with

‘HOLD/Sector Performer’ recommendation/rating with SOTP-based value of

INR 432 per share, valuing the base business at INR 338 per share (20X one

year forward PE). NPV of Para IV is INR 94 per share. Our estimates on core

earnings fully reflect the benefits of revival in its base business operations.

India Equity Research | Pharmaceuticals Initiating Coverage

RANBAXY LABORATORIES

Running ahead of reality

April 25, 2011

Reuters: RANB.BO Bloomberg: RBXY IN


Absolute Rating HOLD

Rating Relative to Sector Performer

Risk Rating Relative to Sector High



MARKET DATA

CMP : INR 468

52-week range (INR) : 624 / 364


M cap (INR bn/USD mn) : 197.3 / 4,444.6



Promoters* : 63.8


FIIs : 7.5

Others : 16.7

* Promoters pledged shares (% of share in issue) : NIL



Index

1 month (0.6) 8.9 5.5

3 months (17.2) 2.5 (7.0)

12 months 5.1 11.9 18.0

Manoj Garg

+91 22 6623 3302

[email protected]

Peril Ali

+91 22 6620 3032

[email protected]


FinancialsYear to December CY09 CY10 CY11E CY12E

Revenues (INR mn) 74,529 87,106 102,450 111,900

Rev growth (%) 0.4 16.9 17.6 9.2

EBITDA (INR mn) 6,106 16,802 22,600 22,500

Adjusted net profit (INR mn) 3,586 12,929 14,989 14,548



EPS growth (%) 60.5 260.6 15.9 (2.9)

P/E (x) 55.0 15.2 13.1 13.5

EV/EBITDA (x) 35.3 12.1 9.0 8.6

ROAE (%) 9.0 28.1 27.1 20.4





Investment Rationale

CY11 guidance underlines emerging markets as future growth drivers RBXY’s CY11 revenue guidance of USD 1.87 bn (including Aricept, but excluding other Para IVs) implies base business growth of 14% in CY11E. The growth guidance holds significance as it underlines importance of EMs as future growth drivers. During CY10, the company’s base business posted strong organic growth of 12% Y-o-Y, driven by 23% growth in Africa, 17% each in CIS and Latam, and 13% in the domestic formulation business. Further, US generics also grew 35% Y-o-Y, largely driven by strong sales (post exclusivity) from generic Valtrex.

Chart 1: Base business growth guidance of 14% in CY11


RBXY has identified seven priority markets—India, Brazil, Mexico, South Africa, Nigeria, CIS, and Romania—within EMs, which are currently contributing over USD 100 mn each and will continue to drive strong organic growth, in our view. India is the key component of the company’s EM strategy as it is committed to be No. 1 (in terms of market share) through both organic as well as inorganic initiatives. Similarly, in other EMs, the focus will be to grow profitably by leveraging Daiichi- Sankyo’s pipeline. Daiichi-Sankyo, in its mid-term business plan, has guided to 23% CAGR from EMs over FY10-13 where RBXY will be used as a front-end vehicle. Table 1: Key growth drivers within emerging markets (USD mn)


1,400

1,500

1,600

1,700

1,800

1,900

CY10 CY11

(US

D m

n)

Base Para IV

CY09 CY10 % chg CY11 CY12CAGR (CY10-

12E)

India 337 384 13.8 438 504 14.6

Africa 125 154 23.2 223 246 26.3

CIS 86 101 17.4 116 132 14.5

LatAM 71 83 16.9 95 108 14.2

Asia 120 100 (16.7) 112 124 11.5

Romania 76 80 5.3 90 100 12.0

Total 815 902 10.6 1074 1214 16.1

Total base business 1,400 1,545 10.3 1,755 2,009 14.1

% of overall base revenue 58.2 58.4 61.2 60.4

Ranbaxy expect base business growth of 14% in CY11E





Table 2: Daiichi’s guidance implies 23% growth in EM through RBXY (Yen bn)


Note: * ASCA is term used for emerging markets outside US, EU and Japan

Project Virat: Positive traction over past three months

RBXY’s domestic business has been a laggard in the past despite strong franchise in CVS, anti-infective, and dermatology segments. The company posted a 6.7% CAGR over CY05-10 vis-à-vis industry’s average 14.4% growth. Chart 2: Domestic growth has lagged industry


Chart 3: RBXY- Domestic business is largely concentrated on acute segment


FY10 FY13E Growth (%)

Net sales 960.0 1150.0 6.2

Japan 470.4 494.5 1.7

US 220.8 310.5 12.0

EU 115.2 149.5 9.1

ASCA* 86.4 161.0 23.1

Others 67.2 34.5 (19.9)

Ranbaxy 148 270 22.2

0.0

4.0

8.0

12.0

16.0

20.0

CY07 CY08 CY09 CY100

3,200

6,400

9,600

12,800

16,000

(%)

(IN

R m

n)

India sales (excl consumer) Ranbaxy growth IPM growth

CVS15%

CNS6%Anti-diabetics

3%Respiratory

4%

Dermatology9%

Anti infective35%

Gastro-intestinal

6%

Pain mgmt.9%

Urology4%

Others9% Chronic

28%

Historically domestic business has underperformed





In most therapeutic areas, except CVS, RBXY has lost market share (Table 3) which is evident from the fact that growth in most therapies has been lower than industry. Table 3: Most therapies lagging industry growth (%)


Daiichi-Sankyo’s post acquisition strategy lays strong focus on growth from the domestic market. Consequently, RBXY management has renewed its strategic focus with significant investments over CY11 to regain leading market share in India. Management has undertaken several initiatives under Project Viraat such as increasing reach (field force has been expanded from 2,500 to 4,300), portfolio optimization, new launches (60 till date), hospital focus as well as shifting of the operational team from Delhi to Mumbai. While the company is a leader in metros and tier-1 markets with more than 6.5% share, the focus is to expand reach to tier II and IV towns to capitalize on the penetration-driven growth opportunity. Though it is early to estimate the impact of Project Viraat, growth over the past three months (as seen in monthly growth trend) is a positive indicator, with initial signs of turnaround in the domestic market. Over the past three months, RBXY has outpaced the industry growth and grew by 26-28% in Dec-Feb 2011 (chart 4). Moreover, as per our distributor survey, feedback is positive, especially from tier II and IV towns, which shows off late quicker pick up of RBXY’s products. We expect its domestic business to post 15% CAGR over CY10-12E. Chart 4: Monthly trend growth implies strong growth


Therapeutic area % of totalMarket share

Ranbaxy growth

Industrygrowth


Anti infective 35 8.1 6.8 13.4 21.7

CVS 16 4.9 20.2 16.5 25.5

Pain mgmt. 9 6.5 18.5 13.8 13.9

Dermatology 9 8.1 12.1 14.4 9.1


CNS 6 3.6 5.0 14.1 2.6

Respiratory 4 2.1 6.5 14.5 2.2

Urology 4 12.3 25.9 16.8 7.3 Anti-diabetics 3 2.3 9.2 21.0 2.4


0.0

6.0

12.0

18.0

24.0

30.0

Apr-

10

May-1

0

Jun-1

0

Jul-

10

Aug-1

0

Sep-1

0

Oct

-10

Nov-1

0

Dec-

10

Jan-1

1

Feb-1

1

Mar-

11

(% Y

-o-Y

)

IPM Ranbaxy

Over last three months growth in domestic market has picked up





Multiple margin expansion drivers in base business Over the past seven quarters, operating margins of RBXY’s base business have seen a marked improvement. Although in lower teens, they have improved from 3% in Q2CY09 to 8.5% in Q4CY10. We expect them to improve from 8.4% in CY10 to 12.5% in CY12E driven by: (a) increased contribution from high margin geographies such as India, Africa, CIS, and Latam; (b) savings from divestment of NCE research; and (c) operational leverage by consolidating non-profitable businesses and cost optimisation. Chart 5: Base business margins improving


RBXY is consolidating its position in EU by lowering the cost base. The company has also closed its London marketing office as well as scaled down operations in many non-profitable countries. Similarly, it has also divested its stake in China, Vietnam, and Japan as part of the re-structuring exercise. It has further realigned its R&D strategy by transferring NDDR (New Drug Discovery Research) unit to Daiichi-Sankyo, saving USD 20-25 mn annually. Moreover, synergies with Daiichi-Sankyo for launching its patented products in India and other EMs coupled with its recent initiatives on developing more profitable field force franchises will further aid margin expansion.

Table 4: Daiichi’s product launch in emerging markets


FDA resolution: Lever for margin expansion

It has been more than 31 months since the US FDA issued an import ban on 30 drugs from Ranbaxy because of CGMP compliance failures at two of its manufacturing facilities,

11.0

13.3

0.1

3.0

5.7 5.5

9.6 8.8

9.8

8.0 8.5

10.5

12.5

0.0

2.8

5.6

8.4

11.2

14.0

CY08

Q408

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

CY10

CY11E

CY12E

(%)

Date Market TA Generic Brand

Apr'09 India CVS Olmesartan Olvance

Jun'09 India CVS Prasugrel Prastia

Sep'09 Romania Osteoporosis Raloxifene Evista

Aug'10 Romania Antibacterial Levofloxacin Tavanic

Oct'09 Mexico Portfolio of Daiichi products

Mar'11 Singapore Antibacterial Levofloxacin Cravit

Jan'12 South Africa Antibacterial Levofloxacin TavanicDec'09 Kenya, Mozambique, Nigeria, Tanzania,

Uganda, and ZambiaCVS Olmesartan Olvance

Base business margins have moved up from 3% in Q2 CY09 to 8% in Q4 CY10





Dewas and Paonta Sahib (under AIP). Post this ban, the revenue of the company declined from USD 106 mn per quarter to USD 44 mn per quarter in Q4CY09. Although base business revenue of US has picked up, off late, led by higher market share of Valtrex post exclusivity, however, company is still incurring higher manufacturing and legal costs in US. Positive resolution of the FDA-DOJ issue will enable RBXY to optimise costs in the US generics business, wherein the company is currently manufacturing products out of the US Ohm facility (at higher cost than India), while on other, it is also incurring higher legal and consulting fees (USD 68 mn in CY09) to resolve the FDA issue. We believe post resolution of import alert on Dewas and Ponta Sahib, utilisation of these assets will be higher, resulting in positive operating leverage.

Successful monetisation of rich Para IV pipeline

RBXY has probably one of the most lucrative Para IV pipelines among domestic peers with 13 Para IV products addressing USD 23 bn opportunity (including 10 FTFs worth USD 18 bn). Despite a FDA issue in CY09, RBXY has been able to monetise all Para IV opportunities. It has generated USD 565 mn revenue and USD 305 mn PAT from the FTFs in CY09-10, which reflects the company’s ability to monetise its highly lucrative Para IV pipeline.

Table 5: Value accretion from earlier Para IV monetization (USD mn)


Note: Estimated revenue of USD 100 mn in CY11

Table 6: Future Para IV pipeline addresses USD 18 bn innovator market (USD mn)


Among the future Para IV pipeline, Lipitor is the most exciting PIV opportunity. It is a blockbuster drug with US sales of USD 5.3 bn and RBXY is entitled to FTF exclusivity on the product. Though the company’s success with all other Para IVs, post FDA import ban, cannot be extrapolated to Lipitor launch, timely launch during the exclusivity period (November 2011) could have a large bearing on valuations. We believe there is uncertainty on RBXY’s ability to launch Lipitor by November 2011, given its current

Revenue PAT NPV (INR)

Imitrex 20 10 1

Valtrex 360 200 22

Flomax 50 35 4

Aricept* 135 60 7

Total 565 305 34

ProductLaunch date

market size

No. of generic players

CY11E CY12E CY13E CY14E

Aricept Nov'10 2,300 2 99

Caduet Nov'11 300 1 18 35

Lipitor Nov'11 5,300 2 250

Provigil Apr'12 1,000 4 50

Oxycontin Apr'12 380 46

Actos Aug'12 3,100 3 124

Diovan Sep'12 2,492 2 150 75

Valcyte Mar'13 270 1 54 36

Rapamune Jan'14 211 2 19

Nexium FTF May'2014 2,675 1 321

Total Para IV 366 255 204 451

NPV of Para-IV pipeline is INR 94 per share





import ban. Unlike earlier Para IVs, Lipitor application has been filed out of the Ponta Sahib facility which is under serious allegation of fraudulent data and currently AIP (Application Integrity Policy). Although media reports suggest that validity assessment at the Ponta Sahib facility has already begun, which is a step closure to the final inspection of the facility to revoke the AIP, the timeline of the same cannot be ascertained. Moreover, Mylan’s suit against USFDA seeks clarity on approval status of RBXY’s ANDA for Lipitor and has further raised doubts in investors’ minds. However, the FDA has filed an opposition to Mylan’s preliminary injunction and requested the court dismiss the same. FDA has further stated that its determination of RBXY's eligibility for exclusivity will necessarily be intensely fact-driven, entailing, among other things, an evaluation of whether the data in the company’s atorvastatin application is unreliable. FDA is currently engaged in ongoing and confidential discussions with RBXY to resolve issues identified in the AIP letter. Scenarios on launch of Lipitor and its impact on earnings

Given the uncertainty over the launch, various scenarios can play out which is further clouded by the pre-MMA nature of the ANDA challenge, legal complexities, and heightened political focus, where several US senators have weighed in on the importance of getting generics to market in a timely fashion. We have highlighted each of the scenarios and their sensitivity to RBXY’s earnings.

A. RBXY secures ANDA approval and launches by November 2011

In this scenario we have assumed RBXY securing approval for ANDA (either by revoking of AIP at Ponta Sahib or site transfer) and subsequent launch on November 30, 2011, with 180 days’ exclusivity along with Watson (authorised generic). We further incorporate dynamics during exclusivity and post exclusivity. Pfizer has recently introduced co-pay card system which allows 33% discount over the current market price for a month’s supply. This will enable the company to retain market share and dampen pricing for generic Lipitor, thereby lower revenue for RBXY and Watson during exclusivity. The scenario assumes limited competition post 180 days’ exclusivity (4-5 additional players), which implies that price erosion will not be at commodity levels, resulting in meaningful sales post exclusivity. We expect Teva and Mylan to launch by May 2012, while the 30 months’ stay on Dr Reddy’s and Kudco expires on April 12 and they may launch the product at risk. In either case, we believe competition should not exceed beyond six-seven players until end CY12, which will help early entrants post decent sales. Overall, we have build NPV of INR 32 per share during exclusivity and INR 37 per share as recurring earnings post exclusivity from Lipitor for RBXY, in this scenario.

B. RBXY parks exclusivity

RBXY’s ANDA has pre-MMA (Medicare Modernization Act) status, wherein exclusivity can only be triggered until the company launches the product. In this case, it is technically possible that RBXY may park exclusivity till it resolves the outstanding FDA issue. In other words, no other generic company will be able to launch pending completion of RBXY’s exclusivity. This could be positive for Pfizer and Watson, where only one generic can be in the market for possibly more than six months.





While technically there is no limit on how long RBXY could park its exclusivity, we see a number of swing factors such as: (i) RBXY will do this only in case it is sure that its ANDA is approvable and FDA issues could be resolved in the near term; (ii) we believe FDA will prefer multiple generics to come in to the market for such a large product and hence could grant approval to other generic players; and (iii) Teva and Mylan can settle with RBXY to launch during the exclusivity period

C. RBXY relinquishes its exclusivity

If RBXY believes there is little chance of its ANDA being approved, it could potentially monetise the opportunity by relinquishing its exclusivity and strike a deal with Teva and/or Mylan for a potential payment or royalty as they get to launch their generic versions six months earlier. This is the base case scenario which we have assumed in our estimates as we believe that in any case, Ranbaxy must have protected their downside risk and time and again they have assured about the monetization of this opportunity. In the past, RBXY has used this option to monetise Flomax exclusivity by striking a deal with the innovator. In this case, though RBXY will be able to monetize the upside from 180 days’ exclusivity, it will lose recurring earnings from Lipitor post exclusivity. We estimate NPV of INR 21 per share if this scenario unfolds.

D. RBXY licenses its exclusivity

RBXY can potentially out license its product to another approvable generic manufacturer as the USFDA allows the first filer to waive its 180-days’ exclusivity. But, in order to do so with a pre-MMA application it must first start the exclusivity clock by gaining approval and shipping the product. We see a low probability of this scenario and do not believe the company will select it. Moreover, in this case, though the impact will depend on the economics of the agreement, the value accretion to RBXY will definitely be lower relative to expectations of an outright launch.

FDA rejects RBXY’s ANDA

It is possible that USFDA could eliminate RBXY’s exclusivity and allow other approvable generic manufacturers to enter the market, a route pursued by Mylan. In this scenario, RBXY will not only lose out on NPV of INR 32 per share on Lipitor, but also the recurring earning of INR 1.9 per share post exclusivity.

We have assumed relinquishing of exclusivity as a base case scenario for arriving at our TP





Table 7: Various scenario analysis and impact


Positive FDA-DOJ resolution: A potential trigger…… RBXY management has been seeking a composite resolution of the FDA-DOJ issue. Few media reports lately have suggested that the validity assessment of the Ponta Sahib facility has begun, which could be the penultimate step in the process of revoking the AIP. While management is confident of resolving the FDA-DOJ issue, its timeline cannot be ascertained. A resolution will definitely be positive for RBXY and enable it to cover lost ground in the US market. Post FDA ban and import alert, RBXY’s US business sales plummeted from USD 106 mn in Q2CY08 to USD 44 mn in Q4CY09 (ex one-offs; current run rate is USD65-70mn USD). We believe post resolution, recovery in the US business will be gradual and is likely to be more accretive to earnings than revenue. RBXY is currently manufacturing products out of the Ohm facility in the US where manufacturing cost is higher than in India, and on other hand the company has incurred high fixed costs on consultants and legal resources to resolve the FDA-DOJ issue. Moreover, positive resolution of the issue will also bring clarity on the monetization of its FTF pipeline along with other niche opportunities such as Penems (potential USD 50-60 mn revenue in the first year of launch). RBXY is the second generic company (Orchid Pharma was first) to file ANDAs for both Imipenem (base patent expired in September 2009 in US; no generic approval) and Meropenem (base patent will expire in September 2010 in US). Penems require dedicated manufacturing facilities and are, therefore, expected to be limited competition products. Overall, there are just five players who have filed DMFs for both these products, making it a lucrative opportunity for RBXY.

ScenariosRBXY launches 30 Nov'11

RBXY parks exclusivity

RBXY relinquishes exclusivity (base case)

RBXY licenses exclusivity

FDA rejects RBXY's ANDA

No. of players 3 players market (RBXY, WPI,PFE)

2 players market (WPI and PFE)

4 players (WPI,PFE, MYLAN and Teva

3 players market (Teva or Mylan along with WPI and PFE)

4 players (WPI,PFE, MYLAN and Teva)

Assumptions 50% discount; 35% MS

RBXY manages approval after six months from FDA, i.e, May'12

RBXY strikes a deal with Teva and Mylan for upfront Royalty (USD 250 mn)

RBXY license its product to others generic company for potential upfront payment; assuming USD250mn

RBXY will not be able to launch Lipitor for next 26-30 months

NPV during exclusivity (INR) 32 0 21 21 0

Recurring earnings post exclusivity

INR 1.85 in CY12; EPS cont. (10%)

Assuming co will launch after six months; EPS contribution- INR1.85

RBXY will not be able to launch the product

RBXY will have small market share post exclusivity

RBXY will not be able to launch the product

Overall NPV contribution of Lipitor - including recurring eanings post exclusivity (INR)

69 37 21 21 0

Fair value of base business (ex Lipitor) (INR)

338 338 338 338 338

NPV of Para IV (ex Lipitor) (INR)

73 73 73 73 73

Target price (INR) 480 448 432 432 411

% impact to our target price

11.1 3.7 0.0 (4.9)





Currently, Hospira (through Orchid ANDA) and Sandoz are marketing Meropenem in the US. Despite Imipenem base patent expiry in September 2009, no generic has been approved in the US so far (most likely RBXY has FTF status on Imipenem). We believe post resolution of the Dewas issue and approval for Penems, RBXY will be able to launch these products in the market. We are of the view that Carbapenem launch can add USD 50-60 mn revenue for RBXY within the first year of launch.

Table 8: Potential earning accretion on positive resolution of FDA-DOJ issue


……… extent of penalties remains a hangover

Given the extent of inquiry by DOJ, it seems a near certainty that RBXY will be asked to pay financial penalties to settle the ongoing FDA issue. However, quantum of the penalty cannot be estimated. The number of financial settlements, off-late, has increased, with the FDA tightening its regulatory standards. Few of the recent settlements involving large players are Glaxo (USD 750 mn), Schering Plough (USD 500 mn) and Genzyme (USD 175 mn) in the branded space, while RBXY could be the first major settlement in the generic counterpart. We estimate the penalty to range from USD 200-400 mn (impact of INR 20-40 per share). We believe the penalty could be a short-term negative for the stock; however, complete resolution of the FDA issue is a long-term positive for the company.

Cost savings on FDA-DOJ resolution (INR mn) RemarksLegal and processing charges 1,034 Legal and professional charges have increased

from 2.8% of revenue in CY07 to 4.3% in CY09

Saving in manufacturing cost and export benefits 116 Assuming 50 bps expansion in EBIDTA due to saving in manufacturing cost and 1% of export benefits on incremental exports

Total savings 1,150

Total savings net of tax 840

Incremental EPS 2

CY11 CY12 RemarksBase business EPS 13.6 16.9 Current estimates including Lipitor launch

Incremental EPS from Penem's 2.7 Assuming positive FDA resolution and timely approval of penem's in US (one full year impact in CY12)

Incremental EPS from savings 2.0

Total base business EPS 21.5

Total incremental EPS 4.7

incremental delta on FDA resolution 28.0%

Incremental value per share (20x incremental EPS)

94

Less: Penality 20 Assuming one time penalty of USD200mn; few media reports also indicated USD400mn penalty

Option value of FDA resolution 74





Table 9: Recent financial settlements with FDA


Japan: Long-term growth driver

Japan generics market offers significant potential for all players, as generics currently contribute only 15% of the total prescription and 7% to total value of the overall Japanese pharma market (much lower than the US where the penetration is as high as 76%). Mounting healthcare costs has forced the Japanese government to undertake various initiatives to encourage generic usage and the government is committed to increase the penetration to 30% by 2013-14. In order to tap this opportunity, Daiichi-Sankyo has already floated Daiichi-Sankyo Espha, a subsidiary, which will market generic drugs as well as Daiichi-Sankyo products in Japan. RBXY will benefit by supplying the products to Daiichi-Sankyo. However, it will take three-four years for it to make a meaningful contribution to RBXY sales.

Date Company Facility FDA issue Settlement with the FDA Remarks

26-10-10 Glaxo Cidra, Pureto Rico

Manufacturing violations

GSK has been asked to pay USD750mn

Equivalent to the revenue of 4 products under question

24-05-10 Genzyme Allston (US) Manufacturing violations

Genzyme agreed to pay USD175mn under consent decree

Equivalent to 18.5% of the revenue Genzyme received from selling these products

18-05-02 Schering - Plough

NJ and Pureto Rico

Violations of manufacturing standards

Schering signed a consent decree and paid a fine of USD500mn





Valuation

Positive FDA resolution or clarity on Lipitor launch critical to stock performance Post 12% correction in the stock price in the past three months, key question on investors’ minds is, what to do with the stock? Though we do agree that post the sharp correction the stock is currently trading at fair value, the upside from here primarily depends upon a lot of variables such as clarity on Lipitor launch, extent of penalty FDA will impose and composite resolution of the FDA-DOJ issue. Though we believe RBXY’s base business has already bottomed out and we are positive on the company’s long-term prospects, current valuations have factored in most of the improvement in the base business. We believe outcome of the FDA-DOJ issue and clarity on Lipitor launch could be potential triggers for the stock. We continue to maintain our cautious outlook on the company. Chart 6: Historical valuation trend—One year forward P/E


We have arrived at a target price of INR 432 per share

We have valued the company on its CY12E base business earnings on account of it fully reflecting the benefits of revival in the base business, strong earnings traction in domestic and other emerging markets and operating performance. We have valued its base business at INR 338 per share (20x CY12E base EPS of INR 16.9). The NPV of our Para IV pipeline is INR 94 per share. We have arrived at a price target of INR 432. We initiate coverage on RBXY with ‘HOLD/Sector Performer’ recommendation/rating. Table 10: SOTP base value (INR)


8x

16x

24x

32x

0

160

320

480

640

800

Apr-

06

Oct

-06

Apr-

07

Oct

-07

Apr-

08

Oct

-08

Apr-

09

Oct

-09

Apr-

10

Oct

-10

Apr-

11

(IN

R)

SOTP

Base business EPS Dec-12 16.9

Target P/E 20.0

Value of base business (INR per share) 338


Total target price 432





Key Risks

Slower recovery in base business profitability We have assumed 400 bps expansion in operating margins over the next two years in the base business driven by change in product mix and cost optimization. Slower-than-expected recovery in base business margins can impact our earnings estimate.

Inability to monetise Lipitor exclusivity

Despite the ongoing FDA issue, we have built option value of INR 69 per share from Lipitor launch in the US. This is because the company in the past was able to monetise all other Para IV opportunities. Inability to monetise the same can negatively impact valuations.

Higher-than-expected penalty for FDA resolution

We have assumed USD 200 mn as financial penalty by FDA-DOJ to settle the ongoing issue. Higher-than-expected penalty could lead to downside to our target price.

Significant delay in FDA resolution

A potential resolution of the FDA issue is not part of our estimates currently. However, a significant delay of beyond six-eight months can cap the option value of INR 74 per share. Moreover, it can also impact the base business in the US.





Company Description RBXY, incorporated in 1961, is India’s largest pharma company with presence in domestic, emerging, and regulated markets. The company has strong presence in the domestic market and ranks No. 2 as per IMS. Over the years it has build a well diversified model with presence in various international markets (including LATAM, Europe, Russia, Africa, Asia, US and Canada) which renders sustainable growth to overall business. Also, the company, historically, has been successful in developing a strong FTF/exclusivity product pipeline (launched products such as Sumatriptan, Valacyclovir, Oxcarbazepine and Aricept in US over past two years) and despite an overhang from AIP imposed by USFDA in 2008, has been successful in monetising these opportunities. In 2008, the second generation promoters sold their stake to Daiichi Sankyo, which now owns ~64% in the company.

Chart 7: Revenue mix


Chart 8: Current shareholding pattern

Source: NSE

India18%

US & Canada35%

Europe, CIS, Africa28%

Asia Pacific5%

Latin America5%

API6%

Consumer Healthcare

3%

Promoters 64%

MF & inst 12%

FII's7%

Retail & others 17%











Company growth 24.8 23.5 9.1 9.1 6.8

Industry growth 13.8 13.1 15.0 14.3 14.4




Market share

Ranbaxy

growth

Industrygrowth


Anti infective 35 8.1 6.8 13.4 21.7

CVS 16 4.9 20.2 16.5 25.5

Pain mgmt. 9 6.5 18.5 13.8 13.9

Dermatology 9 8.1 12.1 14.4 9.1


CNS 6 3.6 5.0 14.1 2.6

Respiratory 4 2.1 6.5 14.5 2.2

Urology 4 12.3 25.9 16.8 7.3

Anti-diabetics 3 2.3 9.2 21.0 2.4


CVS15%

CNS6%

Anti-diabetics

3%Respiratory

4%

Dermatology9%

Anti infective

35%

Gastro-intestinal

6%

Pain mgmt.9%

Urology4%

Others9% Chronic

28%

4 6

2

3 6

6

0.0

4.0

8.0

12.0

16.0

Ranbaxy Industry

(%)


11%

15%


Market share

Growth rate


REVITAL Acute 5.7 87 17 8.2

STORVAS Chronic 5.5 22 17 7.8

MOX Acute 4.7 41 (1) (0.6)

VOLINI Acute 4.6 49 49 14.8

CIFRAN Acute 4.0 34 (3) (1.2)

ZANOCIN Acute 2.6 20 8 1.9

CEPODEM Acute 2.6 13 25 5.0

SPORIDEX Acute 2.5 27 1 0.1

ROSUVAS Chronic 2.3 37 55 7.9

CILANEM Acute 2.1 40 48 6.6

Total 36.6 50.5

0

2

3

5

7

9

1,500

2,100

2,700

3,300

3,900

4,500

CY06 CY07 CY08 CY09 CY10 CY11E

Sale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)


CAGR (5%)

0

7

14

21

28

0

7

14

21

28

35

Cip

la

GS

K

Ranbaxy

Sun P

harm

a

Cadila

Lupin

Pfize

r

Dr

Reddy's

Sale

s (I

NR

bn) Industry

growth





Financial Outlook

41% earnings CAGR in base business We expect 6% earnings CAGR over CY10-12E driven by 41% CAGR in base business earnings and monetization of FTF opportunity (INR 22.6bn of PAT over CY10-12E). We expect base business revenue to post 12% CAGR on back of growth in (a) Africa (25% CAGR); (b) CIS (13.5%); (c) India (14%); and (d) US base business (8%). We expect base business operating margins to expand by 400bps to 12.5% in CY12E driven by higher contribution from branded generic and USD 25 mn savings on account of NCE research. We expect base business EPS to grow from INRI 8.5n CY10 to INR 16.9 in CY12E, driven by recovery in the base business and strong operating performance.

Table 11: Differentiating base and Para IV (INR mn)


CY10 CY11E CY12E CAGR (%)

US 27,456 34,445 36,097 14.7

Base 12,624 12,782 14,748 8.1

Para IV 13,957 16,932 11,457 (9.4)

Nexium supply 875 4,731 9,892 236.3

Canada 2,791 3,020 3,321 9.1

Europe (Ex Romania) 8,786 9,442 9,986 6.6

Romania 3,661 4,032 4,516 11.1

Africa 7,047 10,049 11,053 25.2

CIS 4,622 5,227 5,958 13.5

India 17,557 19,706 22,832 14.0

Lat AM 3,798 4,294 4,867 13.2

Asia 4,576 5,040 5,594 10.6

API 5,217 5,387 5,656 4.1

Total revenue 85,510 100,641 109,881 13.4

Para IV 13,957 16,932 11,457 (9.4)

Base 70,679 78,977 88,532 11.9

EBIDTA 16,802 22,600 22,499 15.7

Base 6,108 8,472 11,291 36.0

Para IV 10,475 12,699 8,020 (12.5)

Nexium supply 220 1,429 3,187 280.8

PAT 12,929 14,989 14,548 6.1

Base 3,583 5,735 7,104 40.8

Para IV 9,182 8,254 5,213 (24.7)

Nexium supply 165 1,000 2,231 267.9

EPS 30.7 35.6 34.6 6.1

Base 8.5 13.6 16.9 40.8

Para IV 21.8 19.6 12.4 (24.7)

Nexium supply 0.4 2.4 5.3 267.9







Year to December CY08 CY09 CY10 CY11E CY12E


Net revenues 72,414 73,294 85,355 100,387 109,587

Licensing income 237 688 799 799 799

Other operating income 1,562 547 951 1,265 1,514


Materials cost 27,704 31,657 30,978 36,240 41,039

Employee cost 9,670 14,175 15,060 18,070 20,164

R&D cost 4,314 4,875 4,577 4,519 4,745


Other expenses 10,982 8,431 8,111 8,340 9,205

EBITDA 5,001 6,106 16,802 22,600 22,500


EBIT 2,176 3,430 13,405 19,493 19,153

Net interest expense/(income) 2,055 710 614 1,832 1,614

Other income 2,706 2,402 2,795 2,514 2,653

Profit before tax (excl extraordinaries) 2,827 5,123 15,586 20,175 20,191

Provision for tax 0 1,102 1,447 3,637 5,452

Core profit 2,827 4,020 14,139 16,538 14,740

Extraordinary items (17,827) 4,976 5,415 (5,628) 0


Reported profit after minority interest (15,163) 8,854 19,369 10,769 14,548



EPS (INR) basic (36.1) 21.1 46.0 25.6 34.6

Diluted shares (mn) 420.4 420.4 421.0 421.0 421.0

EPS (INR) adjusted 5.3 8.5 30.7 35.6 34.6

CEPS (INR) 13.1 15.6 41.2 46.3 42.5


Dividend payout (%) 0.0 0.0 6.5 10.0 10.0



Cost of revenues 37.3 42.5 35.6 35.4 36.7

Employee cost 13.0 19.0 17.3 17.6 18.0


R & D cost 5.8 6.5 5.3 4.4 4.2




EBITDA margins 6.7 8.2 19.3 22.1 20.1


Growth metrics (%)


Revenues 9.4 0.4 16.9 17.6 9.2

EBITDA (45.3) 22.1 175.2 34.5 (0.4)

Net profit (68.3) 42.2 251.7 17.0 (10.9)

PBT (71.7) 81.2 204.3 29.4 0.1

Adj. EPS (59.6) 60.5 260.6 15.9 (2.9)






As on 31st December FY09E CY09 CY10 CY11E CY12E

Equity capital 2,102 2,102 2,105 2,105 2,105

Share warrants/appliaction money 1,757 1,759 66 66 66



Borrowings 43,114 36,295 43,348 26,176 20,176

Deferred tax liability (net) (12,229) (4,746) (227) (227) (227)

Minority interest 675 533 647 789 981

Sources of funds 74,522 75,517 99,815 91,801 98,840

Gross block 61,942 62,785 67,050 72,837 78,500

Depreciation 17,042 17,880 21,571 23,768 26,856

Net block 44,900 44,906 45,479 49,069 51,644

Capital work in progress 4,707 6,231 3,818 3,663 3,583

Total fixed assets 49,607 51,137 49,296 52,732 55,227

Investments 5,432 5,407 4,985 4,985 4,985

Inventories 19,643 18,407 21,926 25,558 27,886

Sundry debtors 13,310 18,400 16,053 18,873 20,602





Other current liabilities 31,536 18,117 12,888 15,717 17,097

Provisions 7,720 8,602 9,534 6,024 7,313



Uses of funds 74,522 75,518 99,815 91,801 98,840


Free cash flow (INR mn)


Net profit (15,163) 8,854 19,369 10,769 14,548

Depreciation 2,825 2,676 3,397 3,107 3,348

Others 51,026 (38,597) (50,780) (45,377) (34,412)

Gross cash flow 38,688 (27,067) (28,014) (31,502) (16,517)

Less: Changes in WC (23,526) 11,031 6,332 6,269 (266)

Operating cash flow 15,161 (16,036) (21,682) (25,233) (16,783)

Less: Capex (6,813) (4,206) (1,557) (6,542) (5,843)

Free cash flow 8,349 (20,242) (23,239) (31,775) (22,626)

Cash flow metrices


Operating cash flow 15,161 (16,036) (21,682) (25,233) (16,783)

Financing cash flow 16,391 (6,350) 19,599 (8,156) 6,847


Net cash flow 9,607 (25,465) (13,881) (49,477) (30,730)

Capex (6,813) (4,206) (1,557) (6,542) (5,843)

Dividends paid (43,065) (43,537) (56,180) (65,218) (78,096)







ROAE (%) 7.5 9.0 28.1 27.1 20.4

ROACE (%) 4.0 6.7 22.4 29.1 26.2

Inventory days 234 216 234 236 234


Payable days 109 128 194 201 202


Current ratio 1.4 1.5 2.1 1.8 1.8

Debt/ EBITDA 8.6 5.9 2.6 1.2 0.9

Debt/equity 1.0 0.8 0.8 0.4 0.3







Du Pont Analysis


NP margin 3.7 5.3 16.3 16.3 13.3



ROAE 7.5 9.0 28.1 27.1 20.4



Adjusted EPS (INR) 5.3 8.5 30.7 35.6 34.6

EPS YoY growth (%) (59.6) 60.5 260.6 15.9 (2.9)

CEPS (INR) 13.1 15.6 41.2 46.3 42.5

Diluted PE (x) 88.2 55.0 15.2 13.1 13.5

Price/BV(x) 4.6 4.5 3.5 3.0 2.5

EV/Sales (x) 2.8 2.9 2.3 2.0 1.7

EV/EBITDA (x) 42.2 35.3 12.1 9.0 8.6

Dividend yield (%) 0.0 0.0 0.4 0.8 0.7





THIS PAGE IS INTENTIONALLY LEFT BLANK





Differentiated strategy in domestic market to render higher growth Sun Pharma (SUNP), with its unique ability to identify therapeutic gap areas and

launch products ahead of market, dominates the Indian chronic therapy segment

(62% of domestic sales). The company also tops our survey results and has

emerged an undisputed choice among distributors. SUNP has innovatively built its

doctors franchise by engaging them at an early stage, which enables it to retain

market share. It is now focused on building a wider product portfolio in other

therapies (such as respiratory) and plans to launch 15 products per annum. Recent

tie-up with Merck for differentiated products is likely to further augment the

company’s product pipeline for domestic market, in our view. We expect the

domestic business to grow at 20% CAGR over FY10-13E, higher than peers.

Margin upsides from core business We expect Taro’s operating margin (27%) to remain under pressure due to lack of

new products in its R&D pipeline, pricing pressure on existing base of business and

integration risk. We expect SUNP’s core EBITDA margins (including Taro) to improve

by 120 bps over FY12-13E, led by higher contribution from domestic and emerging

markets and expected ramp-up from Caraco in H2 FY12.

Current pipeline offers upsides to US generics business SUNP currently has a large pipeline of 149 pending approvals (including 28

pending Taro and 29 pending Caraco), which will support sustainable growth in

US generics over the next three-four years. We expect the US base business

(ex-taro) to post 15% CAGR over FY11-13E, while special products (Taxotere,

Gemzar, Stalevo) would contribute USD 145-150 mn of sales.

ROW markets to depict strong growth trajectory The company expects ROW to post strong double-digit growth over the next 3-4

years and is, therefore, raising its localised therapeutic focus. Moreover, the

current tie-up with Merck adds visibility for higher growth from these markets.

Outlook and valuations: Strong levers for growth; maintain ‘HOLD’ We are positive on SUNP over the long term due to its strong franchise in

domestic market and growth potential in the US. However, current valuations

fully discount base business growth and incremental upsides from exclusivity-

driven revenues in the US. We maintain ‘HOLD/Sector Outperformer’

recommendation/rating on the stock.


SUN PHARMACEUTICALS

Undisputed leader

April 25, 2011

Reuters: SUN.BO Bloomberg: SUNP IN


Absolute Rating Hold


Risk Rating Relative to Sector Low



MARKET DATA

CMP : INR 446

52-week range (INR) : 511 / 303

Share in issue (mn) : 1,035.6

M cap (INR bn/USD mn) : 461.9 / 10,402.5



Promoters* : 63.7


FIIs : 19.0

Others : 10.6


: 0.4



Index

1 month 2.6 8.9 5.5

3 months (8.7) 2.5 (7.0)

12 months 24.7 11.9 18.0

Manoj Garg

+91 22 6623 3302

[email protected]

Peril Ali

+91 22 6620 3032

[email protected]


Financials


Revenues (INR mn) 40,075 49,440 52,113 62,218

Rev growth (%) (4.2) 23.4 5.4 19.4

Operating profit (INR mn) 13,633 18,068 18,213 21,854


Shares outstanding (mn) 1,035.6 1,035.6 1,035.6 1,035.6

EPS (INR) 12.7 16.0 16.5 20.0

EPS growth (%) (27.4) 25.4 3.4 20.8

P/E (x) 35.0 27.9 27.0 22.3

EV/EBITDA (x) 31.5 23.1 22.3 18.0





Table 1: Financial Snapshot (INR mn)


Table 2: Revenue mix (Consolidated, including Taro) (INR mn)




FY10

SUNP Taro Consol SUNP Taro Consol SUNP Taro Consol

Revenue 38,086 49,440 8,830 58,269 52,113 18,554 70,667 62,218 19,481 81,699

Growth (%) 29.8 53.0 5.4 21.3 19.4 15.6

EBITDA 13,633 18,068 2,440 20,507 18,213 4,657 22,871 21,854 4,982 26,835

EBITDA margin (%) 35.8 36.5 27.6 35.2 34.9 25.1 32.4 35.1 25.6 32.8

EBITDA margin (ex-one off) % 26.3 30.5 27.6 30.0 32.5 25.1 30.5 33.0 25.6 31.2

PBT 13,815 18,250 1,715 19,964 18,669 3,381 22,050 22,550 3,658 26,208

Adj PAT 13,194 16,551 1,272 17,391 17,113 2,536 18,787 20,671 2,744 22,481

Margin (%) 34.6 33.5 14.4 29.8 32.8 13.7 26.6 33.2 14.1 27.5

EPS 12.7 16.0 1.2 16.8 16.5 2.4 18.1 20.0 2.6 21.7

- Core EPS 8.8 12.1 1.2 12.9 16.3 2.4 17.9 19.5 2.6 21.2

- Special products (one-off) 4.0 3.9 3.9 0.3 0.3 0.5 0.5

FY11E FY12E FY13E

Year to March FY10 FY11E % change FY12E % change FY13E % change

Total formulations 34,246 52,460 53.2 64,290 22.6 74,717 16.2

Domestic formulations 18,301 22,831 24.7 27,000 18.3 31,866 18.0

International formulations 15,945 29,629 85.8 37,290 25.9 42,851 14.9

- of which Caraco (USD mn) 22 25 12.2 40 60.0 80 100.0

- of which Taro (USD mn) 192 412 114.8 433 5.0

Total bulk 5,491 5,727 4.3 6,288 9.8 6,893 9.6

Domestic bulk 1,021 1,123 10.0 1,224 9.0 1,322 8.0

International bulk 4,470 4,604 3.0 5,064 10.0 5,571 10.0

Others 78 82 6.1 89 7.6 90 1.5

Total sales 39,815 58,269 46.4 70,667 21.3 81,699 15.6

5x

12x

19x

26x

0

120

240

360

480

600

Apr-

06

Oct

-06

Apr-

07

Oct

-07

Apr-

08

Oct

-08

Apr-

09

Oct

-09

Apr-

10

Oct

-10

Apr-

11

(IN

R)





Table 3: SOTP based value (INR)


Table 4: Niche product pipeline (including Para IV filings) for US market


SOTP

Base business EPS Mar-13 21.2

Target P/E 22.0

Value of base business (INR per share) 467


Total target price 477

Brand Name Molecule InnovatorMarket

Size (USD mn)

Launch dateNo. of

generic players

Type

Taxotere Docetaxel Sanofi Aventis 1100 Any time 3

Cardizem CD DILTIAZEM Biovail 70 Waiting approval 1

Gemzar Gemcitabine Eli Lilly 600 May'11 6

Gabitril Tiagabine Cephalon 60 Sep'11/ April'12 1 Para IV

Prandin Repaglinide Novo Nordisk 250 March'12 1 Para IV

StalevoCarvidopa/Levadopa/Entacapone

Orion 120 April'12 1 Para IV

Lyrica Pregabalin Pfizer 1596 July'12 8 Para IV

Eloxatin oxaliplatin Sanofi Aventis 1000 Aug'12 4

Comtan Entacapone Orion 90 April'13 2

Cymbalta Duloxitine Eli Lilly 2896 June'13 10 Para IV

Lunesta Eszopiclone Sepracor 760 May'14 Multiple Para IV

Strattera Atmoxitine HCL Eli Lilly 500 Not confirmed 10 Para IV

Gleevec Imatinib Novartis 1000 July'15 1 Para IV

Namenda Memantine Forest 1300 Jan'15 Multiple Para IV





Company Description Promoted by Mr. Dilip S Shanghvi, a first generation entrepreneur, SUNP is India’s fourth largest pharmaceutical company. It is also one of the fastest growing Indian pharmaceutical companies with revenue and profit growth of 26% CAGR and 30% CAGR over FY05/10, respectively. It also has one of the highest margins amongst its domestic peers. SUNP has significant presence in the domestic formulation and the US generic market. Indian domestic formulations sales, at INR 18 bn in FY10, constitute almost 45% of sales. With over 3,000 medical reps, SUNP has a market share of 3.7% and is a top five player in the Indian domestic market. It has been consistently ranked #1 across leading therapeutic categories like psychiatry, neurology and CVs. Taro’s acquisition in the US generics space augments its ANDA pipeline with products differentiated in dermatology and pediatrics therapies.

Chart 2: Revenue mix (%)

Excluding Taro Including Taro



Source: NSE

Domestic formulatio

ns46%

ROW markets (ex-US)

13%

US generics

29%

APIs12%

Promoters 64%MF & inst

7%

FII's19%

Retail & others 10%

Domestic formulatio

ns32%

ROW markets (ex-US)

14%

US generics

44%

APIs10%











Company growth 24.7 25.2 21.3 21.3 21.9

Industry growth 13.8 13.1 15.0 14.3 14.4




Market share

Sungrowth

IndustryContrbution

to growth

Neuro-psychiatry 27 16.4 19.5 14.1 25.5

Cardiology 19 6.2 19.6 16.5 19.5

Gastroentrology 14 4.9 23.2 14.1 14.1

Diabetology 11 6.8 26.9 21.0 11.0

Gyneacology 7 6.8 19.1 21.9 7.1

Pain 5 3.3 36.8 13.8 7.6

Respiratory 5 2.3 12.6 14.5 2.7


Cardiology19%

Diabetology11%

Neuro-psychiatry

27%

Gastroentrology14%

Gyneacology

7%

Pain mgmt.5%

Opthalmology4%

Others8%

Respiratory5%

Chronic 62%

12 6

2

3

7

6

0.0

5.0

10.0

15.0

20.0

25.0

Sun Pharma Industry

(%)


21%

15%

0

2

4

6

8

10

1,500

1,750

2,000

2,250

2,500

2,750

FY06

FY07

FY08

FY09

FY10

FY11E

Sale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)


CAGR 12.7%

0

7

14

21

28

35

Cip

la

GS

K

Ranbaxy

Sun

Pharm

a

Cadila

Lupin

Pfize

r

Dr

Reddy's

Sale

s (I

NR

bn)

Industrygrowth


Market share

Growth rate


PANTOCID Acute 3.1 19.2 17.7 2.7

SUSTEN Acute 2.5 26.1 14.0 1.8

GLUCORED Chronic 2.4 59.7 9.2 1.1

AZTOR Chronic 2.4 8.6 16.8 1.9

GEMER Chronic 2.0 9.9 28.7 2.5

PANTOCID DSR Acute 1.6 14.7 22.0 1.7

OXETOL Chronic 1.5 36.3 23.2 1.6

CLOPILET Chronic 1.4 20.6 16.7 1.1

ENCORATE CHRONO

Chronic 1.4 57.7 9.6 0.7

STROCIT Chronic 1.4 22.7 6.9 0.5

Total 19.6 15.6 ISIEmergingMarketsPDF in-sdmcpl01 from 124.124.255.5 on 2011-11-09 01:19:45 EST. DownloadPDF.




Key Risks

Excessive dependence on metro/tier-I markets SUNP’s domestic focus in chronic therapy is largely restricted to metros and tier–I markets and specialists/super specialists doctors. Hence, rising competition in these markets/segments, for chronic therapies, can be a potential risk to company’s domestic growth.

Rupee appreciation Rapid rupee appreciation could impact our sales estimate, especially on international revenues which are currently based on a currency estimate of USD/INR of INR 46 and INR 45 for FY12E and FY13E, respectively.

Regulatory issues Regulatory issues, including product approval delays, unfavourable litigation outcomes and potential future adverse inspections from USFDA, are structural negatives for SUNP.





Financial Statements (Ex-Taro)




Net revenues 41,833 38,086 49,440 52,113 62,218

Other operating income 0 1,988 0 0 0


Materials cost 8,556 10,977 14,585 14,435 17,608

Employee cost 3,401 4,008 4,729 5,439 6,146

R&D cost 3,099 2,083 3,584 3,856 4,666


Other expenses 2,860 3,230 3,458 4,032 4,718

Operating income 18,640 13,633 18,068 18,213 21,854


EBIT 17,407 12,100 16,477 16,497 20,012

Interest expense/(income) (1,217) (1,138) (1,338) (1,676) (2,042)

Other income 868 576 435 497 497


Provision for tax 712 679 1,186 1,027 1,240

Core profit 18,780 13,136 17,063 17,642 21,310

Extraordinary items 0 334 0 0 0

Profit after tax 18,780 13,470 17,063 17,642 21,310

Minority interest & others 603 (41) 512 529 639

Profit after minority interest 18,177 13,511 16,551 17,113 20,671


Equity shares outstanding (mn) 1,036 1,036 1,036 1,036 1,036

EPS (INR) adjusted 17.6 12.7 16.0 16.5 20.0

Diluted shares (mn) 1,036 1,036 1,036 1,036 1,036

Recurring EPS (INR) fully diluted 12.9 8.8 12.1 16.3 19.5

CEPS (INR) 1.2 14.2 17.5 18.2 21.7


Dividend payout (%) 17.7 25.2 18.1 18.1 18.1



Cost of revenues 20.5 27.4 29.5 27.7 28.3


R & D cost 7.4 5.2 7.3 7.4 7.5

Other expenses 6.8 8.1 7.0 7.7 7.6



Interest expenditure (2.9) (2.8) (2.7) (3.2) (3.3)

EBITDA margins 44.6 34.0 36.5 34.9 35.1


Growth metrics (%)


Revenues 27.1 (4.2) 23.4 5.4 19.4

EBITDA 20.2 (26.9) 32.5 0.8 20.0

Net profit 21.1 (30.1) 29.9 3.4 20.8

PBT 21.9 (29.1) 32.1 2.3 20.8

EPS (10.3) (31.9) 38.0 34.3 19.8






As on 31st March FY09E FY10 FY11E FY12E FY13E

Equity capital 1,036 1,036 1,036 1,036 1,036




Secured loans 227 479 479 479 479

Unsecured loans 1,562 1,233 733 733 733

Borrowings 1,789 1,712 1,212 1,212 1,212

Deferred tax liability (net) (679) (890) (890) (890) (890)

Minority interest 1,970 1,932 2,444 2,973 3,612

Sources of funds 73,530 81,042 94,611 109,157 126,727

Gross block 21,476 23,340 25,340 27,340 29,340

Depreciation 6,851 8,013 9,603 11,320 13,162

Net block 14,625 15,328 15,737 16,021 16,178

Capital work in progress 1,571 1,448 500 500 500

Intangible assets & goodwill 3,253 4,060 4,060 4,060 4,060

Investments 18,595 30,664 30,664 30,664 30,664

Inventories 9,757 10,739 11,865 12,507 14,372

Sundry debtors 8,811 11,748 14,832 15,634 17,732





Provisions 4,550 4,886 5,259 5,496 6,572



Uses of funds 73,530 81,042 94,611 109,157 126,727


Free cash flow


Net profit 18,177 13,511 16,551 17,113 20,671

Depreciation 1,233 1,533 1,591 1,716 1,842

Others 122 (469) 512 529 639

Gross cash flow 19,532 14,575 18,654 19,359 23,152

Less:Changes in WC 1,818 (4,675) (2,785) (1,900) (3,855)


Less: Capex (7,914) (2,920) (1,052) (2,000) (2,000)

Free cash flow 13,437 6,981 14,818 15,458 17,297

Cash flow metrices





Net cash flow 3,308 (10,618) 11,323 12,362 13,557

Capex (7,914) (2,920) (1,052) (2,000) (2,000)

Dividends paid (3,215) (3,321) (2,995) (3,096) (3,740)







ROAE (%) 30.2 17.7 19.5 17.3 18.1

ROACE (%) 48.6 29.3 36.3 34.6 39.4

Inventory days 373 341 283 308 279

Debtors days 100 94 98 107 98

Payable days 109 89 85 101 90


Current ratio 5.9 4.9 5.7 7.2 7.7

Debt/ EBITDA 0.1 0.1 0.1 0.1 0.1






Du pont analysis


NP margin 43.5 34.6 33.5 32.8 33.2



ROAE 30.2 17.7 19.5 17.3 18.1



Diluted EPS (INR) 17.6 12.7 16.0 16.5 20.0

EPS YoY growth (%) 22.2 (27.4) 25.4 3.4 20.8

CEPS (INR) 1.2 14.2 17.5 18.2 21.7

Diluted PE (x) 25.4 35.0 27.9 27.0 22.3

Price/BV(x) 6.6 5.9 5.0 4.4 3.8

EV/Sales (x) 10.3 10.7 8.4 7.8 6.3

EV/EBITDA (x) 23.1 31.5 23.1 22.3 18.0

Dividend yield (%) 0.7 0.7 0.6 0.7 0.8









Strong domestic formulations growth over FY11-13 Torrent Pharma’s (TRP) domestic focus on the high growth chronic segment

(62% of domestic sales), with leading market share in CVS and CNS, imparts

higher growth than the industry. Moreover, with strong focus on brand building

and higher field force stability, the company is gaining strong traction in metros

and tier I cities, as per our survey. We expect its domestic business to post 18%

CAGR over FY11-13E after registering 16-17% growth in FY10-11, led by growth

in covered market and ramp-up of new divisions.

Field force expansion, new launches to boost margin from H2 FY12 The company has been in consolidation phase with significant investments over

the past 12-14 months, which has impacted its operating performance. EBITDA

margins declined 170 bps from 21.5% in FY10 to 19.8% in 9m FY11, while

earnings growth has been mute. We expect margin pressure to continue in

H1FY12 with commissioning of the Sikkim facility; however, margins are likely to

recover from H2FY11 as domestic field force ramp up and new launches in

Brazil/Mexico start attaining critical mass. We expect EBITDA margins to improve

100-120 bps over FY13E.

27% earnings CAGR over FY11-13E likely

We expect TRP’s earnings to post 27% CAGR over FY11-13E on back of

improvement in operating margins and robust revenue growth, as investments

start gaining traction. We estimate 19% revenue CAGR over FY11-13 driven by:

(a) strong growth in domestic business; (b) scaling up of Mexico; (c) new

product launches in Brazil and Europe; and (d) ramp-up in US generics (USD 60

mn in FY13E from USD 30 mn in FY11E). Moreover, TRP’s strategic tie ups (AZN)

for emerging markets will add further momentum to earnings.

Outlook and valuations: Positive upsides; maintain ’BUY’

TRP has set itself a goal of expanding into higher value branded generics

markets of India, Brazil, Mexico, and other emerging markets. Moreover, the

company has been consistently ramping up filings to establish a strong base in

US and Europe. We believe these investments should start gaining traction,

thereby contributing higher to overall growth and profits. We reiterate

‘BUY/Sector Outperformer’ recommendation/rating. Torrent offers higher

upside in our coverage universe.


TORRENT PHARMACEUTICALS

Strong play on branded generics

April 25, 2011

Reuters: TORP.BO Bloomberg: TRP IN


Absolute Rating BUY


Risk Rating Relative to Sector High



MARKET DATA

CMP : INR 591

52-week range (INR) : 640 / 490


M cap (INR bn/USD mn) : 50.0 / 1,127.4

Avg. Daily Vol. BSE/NSE (‘000): 76.9


Promoters* : 71.5


FIIs : 3.6

Others : 12.2


: NIL



Index

1 month 12.4 8.9 5.5

3 months 0.5 2.5 (7.0)

12 months 14.2 11.9 18.0

Manoj Garg

+91 22 6623 3302

[email protected]

Peril Ali

+91 22 6620 3032

[email protected]


Financials


Revenues (INR mn) 19,040 22,586 26,616 32,142

Rev growth (%) 16.8 18.6 17.8 20.8

EBITDA (INR mn) 4,087 4,414 5,323 6,679

Adjusted net profit (INR mn) 2,687 2,973 3,608 4,614



EPS growth (%) 24.8 10.6 21.3 27.9

P/E (x) 18.6 16.8 13.9 10.8

EV/EBITDA (x) 12.2 11.3 9.2 7.1

ROAE (%) 36.3 31.3 29.7 29.9







Chart 1: Historical Valuation trend – One year forward P/E



Net sales 19,040 22,586 18.6 26,616 17.8 32,142 20.8

- Domestic formulations 7,254 8,465 16.7 10,019 18.4 12,023 20.0

- Brazil/Mexico 3,006 3,645 21.2 4,414 21.1 5,250 18.9

- Heumann 2,547 2,928 15.0 3,074 5.0 3,228 5.0

- US 909 1,343 47.8 2,025 50.8 2,813 38.9

- EU 1,163 1,314 13.0 1,551 18.0 1,830 18.0

Gross profit 13,315 15,630 17.4 18,631 19.2 22,499 20.8

Gross margins (%) 69.9 69.2 70.0 70.0

EBITDA 4,087 4,414 8.0 5,323 20.6 6,679 25.5

EBITDA margin (%) 21.5 19.5 20.0 20.8

EBITDA margin (ex-milestone) 18.4 16.3 17.8 18.9

PBT 3,652 3,847 5.3 4,625 20.2 5,915 27.9

Tax 1,160 873 (24.7) 1,018 16.5 1,301 27.9

Tax rate (%) 31.8 22.7 22.0 22.0

Reported PAT 2,312 2,973 28.6 3,608 21.3 4,614 27.9

Adjusted PAT 2,687 2,973 10.6 3,608 21.3 4,614 27.9

Adjusted EPS 31.8 35.1 10.6 42.6 21.3 54.5 27.9

5x

8x

11x

14x

0

160

320

480

640

800

Apr-

06

Oct

-06

Apr-

07

Oct

-07

Apr-

08

Oct

-08

Apr-

09

Oct

-09

Apr-

10

Oct

-10

Apr-

11

(IN

R)





Company Description TRP, founded in 1959, is headed by Mr. Samir Mehta, a second generation entrepreneur. The company is a leading player in the branded generics space in India and Brazil. Domestic formulations is the largest segment contributing 39% to FY11 sales. It is the second largest domestic player in the chronic segment (CNS, CV, and anti-diabetic) which contributes 62% to its portfolio. The company’s branded generics business in Brazil is the second largest segment and contributed 16% to total sales in FY10 and is one of the largest operations by an Indian company in this crucial market. Apart from branded generics, the company is also present in regulated markets of US/Europe. It is also involved in the contract manufacturing business with Novo Nordisk for supplying insulin. Chart 2: Revenue mix



Source: NSE


39%

Brazil17%

Russia2%

EU6%

Germany (Heumann)

14%

ROW6%

US6%

CRAMS10%

Promoters 71%

MF & inst 13%

FII's4%

Retail & others 12%





Domestic Formulations Snapshot Growth versus Industry (%)

Therapeutic growth versus Industry (MAT) (%) Top 10 brand performance (%)

Therapy wise break-up Field force expansion and productivity trend




Company growth 13.9 13.2 21.4 20.8 20.1

Industry growth 13.8 13.1 15.0 14.3 14.4




Market share

Torrent Growth

IndustryGrowth


CV 35.0 3.5 12.6 16.5 20.5

CNS 20.0 4.4 17.0 14.1 16.9

Gastrointestinal 19.0 2.6 44.9 14.1 22.0

Anti-infectives 11.0 1.1 14.4 13.4 25.5

Anti-diabetics 7.0 1.5 23.3 21.0 4.0

Pain mgmt. 4.0 0.8 21.4 13.8 3.5

Chronic contribution to growth 41.4

CVS35%

CNS20%

Others4%

Gastrointestinal19%

Anti-infectives

11%

Pain mgmt.

4%

Anti-diabetics

7%

Chronic 62%

15

6

0.4

3

6

6

0.0

5.0

10.0

15.0

20.0

25.0

Torrent pharma Industry

(%)


0.0

0.5

1.0

1.5

2.0

2.5

1,500

2,000

2,500

3,000

3,500

4,000

FY06 FY07 FY08 FY09 FY10 FY11E

Sale

s per

rep

(IN

R m

n)

(No o

f m

edic

al r

eps)


CAGR 10.8%


Market share

Growth rate


ALPRAX Chronic 4.3 25.8 15.3 3.3

TOPCEF Acute 4.1 4.7 66.3 9.2

DILZEM Chronic 3.8 45.4 13.0 2.5

NIKORAN Chronic 3.7 45.7 10.4 2.0

DOMSTAL Acute 3.7 63.5 20.8 3.6

DROXYL Acute 2.5 15.1 8.9 1.2

NEBICARD Chronic 2.4 33.2 16.1 1.9

AZULIX-MF Chronic 2.0 3.7 29.4 2.6

NEXPRO RD Acute 2.0 34.1 49.5 3.8

NEXPRO Acute 1.9 22.9 32.8 2.7

Total 30.4 32.6

0

6

12

18

24

30

0

7

14

21

28

35

Cip

la

Sun

Pharm

a

Cadila

Lupin

Inta

s

Dr

Reddy's

IPC

A

Torr

ent

Pharm

a

Sale

s (

INR

bn) Industry

growth





Key Risks

Slippages in domestic business could hurt revenue growth TRP’s track record in the domestic business has been uneven. Continued execution issues in semi-urban and rural markets could slowdown the business and have a disproportionate impact on overall company growth and margins.

Forex impact from adverse currency movement Over the past quarter, USD and INR have been appreciating against EUR due to concerns over deficits in Greece, Portugal, and Spain. TRP has fully hedged its exposure in Europe; however, adverse currency movements could lead to translation losses. We have not included the forex impact in our estimates.

Delay in product launches in Brazil Our revenue assumptions for Brazil market estimate ~60 product launches in the next three-five years, which is aggressive. Any slippage on product introductions could negatively impact sales growth in this critical market.

Capacity constraints TRP has been envisaging capacity constraints due to significant ramp-up in various geographies and entry in new markets. The company has planned capital investments of INR 10 bn over the next three-five years. Any delay in commissioning of facilities could have a disproportionate impact on growth in various markets and could have long-term implications on licensing contracts.









Gross revenues 16,169 18,673 22,158 26,443 32,056

Less: Excise 304 344 443 529 641

Net revenues 15,865 18,329 21,715 25,914 31,415

Other operating income 441 710 871 702 727


Materials cost 5,357 5,725 6,957 7,985 9,643

Employee cost 2,565 3,162 3,873 4,454 5,077

R&D cost 1,119 1,202 1,355 1,677 2,089


EBITDA 2,999 4,087 4,414 5,323 6,679

Depreciation and amortisation 423 481 610 709 840

EBIT 2,577 3,606 3,804 4,614 5,840

Net Interest expense/(income) 94 165 128 89 25

Other income (473) 211 170 100 100

Profit before tax (excl extraordinaries) 2,010 3,652 3,847 4,625 5,915

Provision for tax 78 1,160 873 1,018 1,301

Core profit 2,154 2,687 2,973 3,608 4,614

Extraordinary items (88) (180) 0 0 0

Reported profit after minority interest 1,844 2,312 2,973 3,608 4,614



EPS (INR) basic 25.5 31.8 35.1 42.6 54.5

Diluted shares (mn) 84.6 84.6 84.6 84.6 84.6

EPS (INR) adjusted 25.5 31.8 35.1 42.6 54.5

CEPS (INR) 30.5 37.4 42.3 51.0 64.4


Dividend payout (%) 15.7 18.9 17.1 17.1 17.1



Cost of revenues 32.9 30.1 30.8 30.0 30.0

Employee cost 15.7 16.6 17.1 16.7 15.8


R & D cost 6.9 6.3 6.0 6.3 6.5




EBITDA margins 18.4 21.5 19.5 20.0 20.8


Growth metrics (%)


Revenues 20.4 16.8 18.6 17.8 20.8

EBITDA 43.5 36.3 8.0 20.6 25.5

Net profit 63.1 24.8 10.6 21.3 27.9

PBT 34.8 81.7 5.3 20.2 27.9

Adj. EPS 63.1 24.8 10.6 21.3 27.9







Equity capital 423 423 423 423 423



Borrowings 4,826 5,224 4,824 3,724 3,224

Deferred tax liability (net) 584 499 499 499 499

Sources of funds 11,919 14,033 16,011 17,798 20,989

Gross block 7,740 9,228 11,228 13,228 15,728

Depreciation 2,094 2,718 3,328 4,037 4,876

Net block 5,647 6,510 7,900 9,191 10,851

Investments 1,395 1,412 1,412 1,412 1,412

Inventories 2,645 3,236 3,992 4,718 5,795

Sundry debtors 2,666 2,982 3,421 4,044 4,829



Other current assets 344 368 405 405 405



Other current liabilities 609 434 477 525 578

Provisions 913 1,280 1,280 1,280 1,280



Uses of funds 11,919 14,033 16,011 17,798 20,989


Free cash flow - (INR mn)


Net profit 1,844 2,312 2,973 3,608 4,614

Add : Non cash charge

Depreciation 423 481 610 709 840

Others 211 (74)

Gross cash flow 2,478 2,719 3,583 4,317 5,453

Less: Changes in WC 101 349 (886) (520) (911)


Less: Capex (705) (1,108) (2,000) (2,000) (2,500)

Free cash flow 1,874 1,961 697 1,797 2,042

Cash flow metrices



Financing cash flow (182) 1,047 (995) (1,822) (1,423)

Investing cash flow (396) (1,125) (2,000) (2,000) (2,500)

Net cash flow 2,001 2,991 (298) (24) 619

Capex (705) (1,108) (2,000) (2,000) (2,500)

Dividends paid (332) (592) (595) (722) (923)







ROAE (%) 37.1 36.3 31.3 29.7 29.9

ROACE (%) 32.6 42.5 38.5 38.7 41.4

Inventory days 55.5 56.4 70.0 70.0 72.0

Debtors days 53.5 54.1 60.0 60.0 60.0

Payable days 85.9 94.8 90.0 90.0 90.0

Cash conversion cycles 23.0 15.7 40.0 40.0 42.0

Current ratio 2.0 2.1 2.1 2.1 2.1

Debt/ EBITDA 1.6 1.3 1.1 0.7 0.5

Debt/equity 0.7 0.6 0.5 0.3 0.2






Equity turnover 2.73 2.47 2.29 2.14 2.04

Du Pont Analysis


NP margin 13.6 14.7 13.7 13.9 14.7



ROAE 37.12 36.27 31.30 29.74 29.92



Adjusted EPS (INR) 25.5 31.8 35.1 42.6 54.5

EPS YoY growth (%) 63.1 24.8 10.6 21.3 27.9

CEPS (INR) 30.5 37.4 42.3 51.0 64.4

Diluted PE (x) 23.2 18.6 16.8 13.9 10.8

Price/BV(x) 7.7 6.0 4.7 3.7 2.9

EV/Sales (x) 3.1 2.6 2.2 1.8 1.5

EV/EBITDA (x) 17.1 12.2 11.3 9.2 7.1

Dividend yield (%) 0.7 1.0 1.0 1.2 1.6





Cadila Healthcare Cipla

Dr. Reddy’s Laboratories Lupin

Ranbaxy Laboratories Sun Pharmaceuticals

Torrent Pharmaceuticals

400

525

650

775

900

Apr-

10

May-1

0Ju

n-1

0Ju

l-10

Aug-1

0S

ep-1

0O

ct-1

0

Nov-1

0D

ec-

10

Jan-1

1Fe

b-1

1M

ar-

11

Apr-

11

(IN

R)

HoldHoldHold

Hold

500

875

1,250

1,625

2,000

Apr-

10

May-1

0Ju

n-1

0Ju

l-10

Aug-1

0S

ep-1

0O

ct-1

0N

ov-1

0D

ec-

10

Jan-1

1Fe

b-1

1M

ar-

11

Apr-

11

(IN

R)

150

270

390

510

630

May-1

0Ju

n-1

0Ju

l-10

Aug-1

0

Sep-1

0O

ct-1

0

Nov-1

0D

ec-

10

Jan-1

1

Feb-1

1M

ar-

11

Apr-

11

(IN

R)

BuyBuy

Buy

Buy

300

400

500

600

700

Apr-

10

May-1

0Ju

n-1

0Ju

l-10

Aug-1

0S

ep-1

0O

ct-1

0N

ov-1

0D

ec-

10

Jan-1

1Fe

b-1

1M

ar-

11

Apr-

11

(IN

R)

Redc

Redc

Redc

Redc

Redc

200

250

300

350

400

Apr-

10

May-1

0Ju

n-1

0Ju

l-10

Aug-1

0S

ep-1

0O

ct-1

0N

ov-1

0D

ec-

10

Jan-1

1Fe

b-1

1M

ar-

11

Apr-

11

(IN

R)

BuyBuy

Buy

Buy

Buy

100

200

300

400

500

Apr-

10

May-1

0Ju

n-1

0Ju

l-10

Aug-1

0S

ep-1

0O

ct-1

0N

ov-1

0D

ec-

10

Jan-1

1Fe

b-1

1M

ar-

11

Apr-

11

(IN

R)

HoldHold

Hold

Hold

Hold

Hold

Hold

Hold

200

275

350

425

500

Apr-

10

May-1

0Ju

n-1

0Ju

l-10

Aug-1

0S

ep-1

0O

ct-1

0N

ov-1

0D

ec-

10

Jan-1

1Fe

b-1

1M

ar-

11

Apr-

11

(IN

R)





NOTES:





Company Absolute

reco

Relative

reco

Relative

risk

Company Absolute

reco

Relative

reco

Relative

Risk

Apollo Hospitals Enterprise BUY None None Aurobindo Pharma BUY SO H

Cipla REDUCE SU L Dr.Reddys Laboratories HOLD SO M

Lupin BUY SO M Piramal Healthcare UNDER

REVIEW

SU H

Sun Pharmaceuticals Industries HOLD SP L Torrent Pharmaceuticals BUY SO H

RATING & INTERPRETATION

ABSOLUTE RATING

Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria

Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe within the sector

RELATIVE RISK RATING

Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING

Ratings Criteria

Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return





Edelweiss Research is also available on www.edelresearch.com ,Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021, Board: (91-22) 2286 4400, Email: [email protected]

Vikas Khemani Head Institutional Equities [email protected] +91 22 2286 4206

Nischal Maheshwari Head Research [email protected] +91 22 6623 3411

Coverage group(s) of stocks by primary analyst(s): Pharmaceuticals Apollo Hospitals Enterprise, Aurobindo Pharma, Cipla, Dr.Reddys Laboratories, Lupin, Piramal Healthcare, Sun Pharmaceuticals Industries, Torrent Pharmaceuticals

EW indices Recent Research

11-Apr-11 Sun JV with Merck: A 450 Hold Pharma win win deal;

Event Update

01-Apr-11 Pharma Steady growth and margins; strong visibility for next fiscal; Quarterly Preview

23-Mar-11 Lupin Near- term challenges; long-term growth intact; 415 Buy

Visit Note

08-Mar-11 UPL Positive move to tap 136 Buy largest Latin American market; Event Update

Date Company Title Price (INR) Recos

This document has been prepared by Edelweiss Securities Limited (Edelweiss). Edelweiss, its holding company and associate companies are a full service, integrated investment banking, portfolio management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities. This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable, but we do not represent that it is accurate or complete and it should not be relied on as such. Edelweiss or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his own advisors to determine the merits and risks of such investment. The investment discussed or views expressed may not be suitable for all investors. We and our affiliates, group companies, officers, directors, and employees may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as advisor or lender/borrower to such company (ies) or have other potential conflict of interest with respect to any recommendation and related information and opinions. This information is strictly confidential and is being furnished to you solely for your information. This information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject Edelweiss and affiliates/ group companies to any registration or licensing requirements within such jurisdiction. The distribution of this document in certain jurisdictions may be restricted by law, and persons in whose possession this document comes, should inform themselves about and observe, any such restrictions. The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. Edelweiss reserves the right to make modifications and alterations to this statement as may be required from time to time. However, Edelweiss is under no obligation to update or keep the information current. Nevertheless, Edelweiss is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Neither Edelweiss nor any of its affiliates, group companies, directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance is not necessarily a guide to future performance. The disclosures of interest statements incorporated in this document are provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. Edelweiss Securities Limited generally prohibits its analysts, persons reporting to analysts and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report.

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Access the entire repository of Edelweiss Research on www.edelresearch.com

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe

Rating Distribution* 118 51 17 189

* 3 stocks under review

Market Cap (INR) 111 61 17

> 50bn Between 10bn and 50 bn < 10bn

Buy Hold Reduce Total

Rating Interpretation

Buy appreciate more than 15% over a 12-month period

Hold appreciate up to 15% over a 12-month period

Reduce depreciate more than 5% over a 12-month period

Rating Expected to

800

950

1,100

1,250

1,400

20-Apr-10 20-Oct-10 20-Apr-11

EW Pharma Index Nifty



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