14 FEB 2018 Quarterly Update

NATCO PHARMA BUY

PHARMACEUTICALS Target Price: Rs 1,020

In-line PAT on strong margin; stronger Q4 guidance

Q3 sales were 16% below expectations on weak India business (down CMP : Rs 832
24% YoY on weak Hep-C sales) and lower-than-expected market share in Potential Upside : 23%
gCopaxone 40mg (14-15%). However, gross margin was strong at 88%
(up 18.6 pp YoY) and EBITDA margin healthy at 51% (up 12.6 pp YoY)
on higher profit share from key products gTamiflu, gCopaxone, gDoxil. MARKET DATA
FY18 PAT guidance of ~Rs 7 bn implies strong visibility on Q4 PAT of No. of Shares : 184mn
over Rs 3 bn (vs. Rs 2.2 bn in Q3) – which would be led by higher Free Float : 52%
gTamiflu sales (severe flu season) and improving traction in gCopaxone. Market Cap : Rs153bn
52-week High / Low : Rs1,080 / Rs671
We cut FY18-20 EPS by 6-8% to factor weak India business and revise Avg. Daily vol. (6mth) : 4,51,949 shares
SOTP to Rs 1,020 (20x FY20E EPS + Rs 131 for R&D pipeline) vs Bloomberg Code : NTCPH IB Equity
Rs 1,100 earlier. Maintain BUY on scale-up in sticky gCopaxone in FY19 Promoters Holding : 48%
and efficient utilization of cash (raised Rs 9.15 bn in Dec’17) given FII / DII : 25% / 5%

strong execution record.

♦ Revenue growth below expectation: Though revenue grew 32% QoQ on exclusive/semi-exclusive launches of
gCopaxone and gTamiflu (oral suspension), it declined 17% YoY on 24% YoY dip in domestic formulations sales to
Rs 1.65 bn, as HeP-C sales dropped 39% YoY to Rs 685 mn largely due to pricing pressure. Management believes
domestic Hep-C market has now flattened out, and expects growth to be driven by new product launches and
expansion through export markets (South East Asia). Domestic oncology (incl. C&D#) sales declined 4% YoY, but
Natco expects it to improve through new launches. Export formulations declined 19% YoY on high base of Q3FY17
(led by large stocking quantities of gTamiflu capsules). API sales grew 60% YoY on 125% YoY growth in exports
API on supplies of gTamiflu and gCopaxone
♦ Strong margin: We highlight 18.6 pp YoY (14.75 pp QoQ) improvement in gross margin and 12.6 pp YoY (22.4
pp QoQ) improvement in EBITDA margin. This was largely driven by profit share of Rs 2.54 bn in Q3FY18 – from
gCopaxone (40mg, 14-15% market share; 20 mg, 3.5% market share as per IQVIA), gDoxil, gTamiflu, gFosrenol.
Despite 30% YoY increase in staff expenses, EBITDA grew 10% YoY while PAT was 11% YoY on high gTamiflu
capsule base in Q3FY17 – both in line with our estimates

Financial summary (Consolidated) Key drivers

Y/E March FY17 FY18E FY19E FY20E
Gr owt h (% ) FY 1 8 E FY 1 9 E FY 2 0 E
Sales (Rs mn) 20,650 21,915 26,920 28,608
US (USD mn) 142 167 143
Adj PAT (Rs mn) 4,860 7,423 8,463 8,202
US growth (% ) 36 17 (15)
Con. EPS* (Rs) - 37.3 49.5 44.9
India (% ) (16) 22 19
EPS (Rs) 27.9 40.2 45.9 44.5 EBITDA margin (% ) 45.8 40.0 35.9
Change YOY (%) 213.2 44.4 14.0 (3.1)
P/E (x) 29.9 20.7 18.1 18.7
RoE (%) 33.0 30.5 23.5 18.9 Price performance
220
RoCE (%) 38.9 35.7 28.9 24.0 Sensex Natco Pharma
180
EV/E (x) 22.7 14.3 12.9 13.1
140
DPS (Rs) 3.0 4.0 4.0 4.0
100
Source: *Consensus broker estimates, Company, Axis Capital, CMP as on 08 Feb 2018
60
^OS – Oral suspension; #C&D – Cardio and Diabetology
Jan-17 Apr-17 Jul-17 Oct-17 Jan-18

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♦ gCopaxone scale-up ahead: Company expects stronger scale-up in the US in

Q4FY18/FY19 led by improving traction in gCopaxone 40mg (USD 2.9 bn
market – sole generic launched in Oct’17) and gCopaxone 20mg
(USD 700 mn market – 2nd generic). Company expects gCopaxone to remain a
sticky revenue driver despite launch by an additional generic competitor in
H1CY18 and another generic launch in H2CY18

♦ Entering the next league: Natco’s fundraise of Rs 9.15 bn in Dec’17 would

help expand its India and RoW market footprint (organically and
inorganically); thus, improving growth visibility from FY20 (also addressing the
decline in Hep-C business in India). It would also accelerate its complex
generics pipeline (with focus on chemistry, peptides & injectables) which would
drive growth after FY22/23 given 3-4 years of development and approval
timeframe

♦ Key conference call highlights: (1) R&D: Expects to file ~2 complex generics
annually, (2) Revlimid – Outstanding CRL, currently addressing the same.
Expects approval in CY18 (Natco was first filer and settled its litigation for
limited volume launch in 2022), (3) Capex: Guided for Rs 4-5 bn capex
annually. New oral solid facility in Vizag to be ready for exhibit batches in next
couple of months, (4) Dividend: Declared interim dividend of Rs 7 per share
and (5) Domestic Medical Representatives strength of 300; 80 for oncology,
120 for Hep-C, and 100 for Cardio and Diabetology

Exhibit 1: Strong margin performance…

(Rs mn) Q3'17 Q2'18 Q3'18 YoY (%) QoQ (%)
Revenues 6,790 4,267 5,622 (17) 32
Gross Profit 4,736 3,138 4,964 5 58
Gross Profit margin (%) 69.7 73.5 88.3 1855 bps 1475 bps
Staff 607 736 788 30 7
Staff as % of Sales 8.9 17.2 14.0 508 bps -323 bps
SGA 1,527 1,183 1,311 (14) 11
SGA as % of Sales 22.5 27.7 23.3 83 bps -441 bps
EBITDA 2,602 1,219 2,865 10 135
EBITDA margin (%) 38.3 28.6 51.0 1264 bps 2239 bps
Interest 46 42 43 (7) 2
Depreciation 137 160 172 26 8
Other Income 61 55 114 86 107
PBT 2,480 1,072 2,764 11 158
Tax 531 228 590 11 159
Tax rate 21.4 21.3 21.3 -8 bps 8 bps
Minority Interest (2) (4) (1) (58) (75)
Reported PAT 1,951 848 2,175 11 156
Source: Company

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Exhibit 2: …driven by high profit share

Rs mn Q3'17 Q2'18 Q3'18 YoY (%) QoQ (%)
Domestic formulations 2,189 2,135 1,658 (24) (22)
Oncology 883 973 848 (4) (13)
Hep-C 1,121 949 685 (39) (28)
B2B Business 184 213 125 (32) (41)
Export Formulations 3,581 1,268 2,890 (19) 128
Total Profit share 1,770 600 2,540
Total Formulation 5,770 3,403 4,548 (21) 34
Total API Sales 507 584 811 60 39
API Domestic 186 118 88 (53) (26)
API International 321 466 723 125 55
Total Revenue 6,848 4,322 5,622 (18) 30

Source: Company *Export Formulations includes US, Canada, Brazil

Exhibit 3: Natco has received a spate of approvals/launches in the US in recent quarters

Market Size No of
Date Approved Brand Name Generic Comments
(USD mn) Players
3.8.2016 Tamiflu Oseltamivir Phosphate 403 3 Natco launched the product in Dec'16
Capsules
24.11.2016 Entocort Budesonide Capsules 370 4 4 generic players
29.11.2016 Nuvugil Armodafinil Tablets 480 5 5 generic players
06.01.2017 Treanda Bendamustine 133 11 Natco will have shared FTF with 10 other players who
Hydrochloride have settled for launch in Nov'19
16.05.2017 Doxil Doxorubicin Hcl 196 1 Natco (partner Dr Reddy) have launched the product
23.06.2017 Vidaza Azacitidine for Injection 188 5 Natco (partner Breckenridge) have launched the product
31.08.2017 Fosrenol Lanthanum Carbonate 122 1 (AG) Natco (partner Lupin) received 1st generic approval and
have launched the product .
03.10.2017 Copaxone Glatiramer Acetate 20 mg 704 2 Natco (partner Mylan) have launched the product
03.10.2017 Copaxone Glatiramer Acetate 40 mg 2,840 1 Natco (partner Mylan) have launched the product at risk
31.10.2017 Tamiflu Oseltamivir Phosphate - 368 1 Natco (partner Alvogen) have launched the product
Oral Suspension
Source: Company, USFDA

Exhibit 4: US scale-up to continue to be driven by complex generics

Market size Expected USD mn
Brand name API (USD mn) launch date FY17 FY18 FY19 FY20
Copaxone 20 mg Glatiramer Acetate 700 Oct-17 - 4 16 13
Copaxone 40mg Glatiramer Acetate 2,840 Oct-17 - 43 77 60
Tamiflu Oseltamivir Phosphate 500 Dec-16 76 16 8 5
Tamiflu suspension Oseltamivir Phosphate 213 Nov-17 - 14 7 7
Doxil (liposome inj) Doxorubicin hydrochloride 196 May-17 - 19 14 10
Fosrenol Lanthanum Carbonate 120 Sep-17 - 9 5 2
Vidaza Azacitidine 203 H2FY18 - 6 9 6
Gleevec Imatinib Mesylate 2,000 FY19 - - 4 3
Tracleer Bosentan 368 FY19 - - 3 1
Others 5 10 4 15
New product revenue 81 120 146 123
Base US Revenue 24 22 21 20
Total US revenues 104 142 167 143
Source: Company, Axis Capital, ** built in incremental generic competition in gCopaxone in FY19

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PHARMACEUTICALS

Exhibit 5: We value Natco’s R&D pipeline at Rs 131 per share

Expected Sales* Revenue DCF
Products Therapy Para IV/FTF Other filers launch date Probability (USD mn) stream (Rs/ Sh)
Revlimid Oncology Sole FTF 4 (DRRD, CDH, CIPLA, Alvogen) Mar-22 100% 7,112 sustainable 125
Nexavar Oncology Sole FTF Teva Apr-20 100% 331 one-time 5
Others (6 Products) 1
Total option value 131
Source: Company, Axis Capital

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Financial summary (Consolidated)

Profit &loss (Rs mn) Cash flow (Rs mn)
Y/E March FY17 FY18E FY19E FY20E Y/E March FY17 FY18E FY19E FY20E
Net sales 20,650 21,915 26,920 28,608 Profit before tax 6,244 9,560 11,118 10,775
Other operating income - - - - Depreciation & Amortisation 544 657 778 892
Total operating income 20,650 21,915 26,920 28,608 Chg in working capital (2,528) (325) (1,913) (445)
Cost of goods sold (5,991) (3,835) (7,201) (8,296) Cash flow from operations 3,458 7,553 6,175 7,237
Gross profit 14,659 18,080 19,719 20,312 Capital expenditure (2,792) (3,500) (3,000) (3,000)
Gross margin (%) 71.0 82.5 73.3 71.0 Cash flow from investing (2,994) (4,250) (4,500) (6,000)
Total operating expenses (7,825) (8,050) (8,962) (10,043) Equity raised/ (repaid) - 9,150 - -
EBITDA 6,834 10,029 10,757 10,269 Debt raised/ (repaid) (142) 997 (1,125) (835)
EBITDA margin (%) 33.1 45.8 40.0 35.9 Dividend paid (1,409) (886) (886) (886)
Depreciation (544) (657) (778) (892) Cash flow from financing (1,709) 9,101 (2,115) (1,784)
EBIT 6,290 9,373 9,979 9,377 Net chg in cash (1,245) 12,404 (440) (546)
Net interest (185) (161) (104) (63)
Other income 139 348 1,244 1,460 Key ratios
Profit before tax 6,244 9,560 11,118 10,775 Y/E March FY17 FY18E FY19E FY20E
Total taxation (1,395) (2,151) (2,668) (2,586) OPERATIONAL

Tax rate (%) 22.3 22.5 24.0 24.0 FDEPS (Rs) 27.9 40.2 45.9 44.5
Profit after tax 4,849 7,409 8,450 8,189 CEPS (Rs) 31.0 43.8 50.1 49.3
Minorities 11 13 13 13 DPS (Rs) 3.0 4.0 4.0 4.0
Profit/ Loss associate co(s) - - - - Dividend payout ratio (%) 10.8 9.9 8.7 9.0
Adjusted net profit 4,860 7,423 8,463 8,202 GROWTH

Adj. PAT margin (%) 23.5 33.9 31.4 28.7 Net sales (%) 91.2 6.1 22.8 6.3

Net non-recurring items - - - - EBITDA (%) 157.3 46.8 7.3 (4.5)

Reported net profit 4,860 7,423 8,463 8,202 Adj net profit (%) 213.7 52.7 14.0 (3.1)
FDEPS (%) 213.2 44.4 14.0 (3.1)
Balance sheet (Rs mn) PERFORMANCE
Y/E March FY17 FY18E FY19E FY20E RoE (%) 33.0 30.5 23.5 18.9
Paid-up capital 349 369 369 369 RoCE (%) 38.9 35.7 28.9 24.0
Reserves & surplus 16,144 31,811 39,389 46,705 EFFICIENCY
Net worth 16,493 32,180 39,758 47,074 Asset turnover (x) 1.3 1.1 1.1 1.1
Borrowing 2,216 3,213 2,089 1,253 Sales/ total assets (x) 1.0 0.7 0.6 0.6
Other non-current liabilities 150 150 150 150 Working capital/ sales (x) 0.3 0.3 0.3 0.3
Total liabilities 18,900 35,571 42,010 48,478 Receivable days 84.0 84.0 84.0 84.0
Gross fixed assets 11,609 15,870 18,370 20,870 Inventory days 92.2 77.4 102.5 99.5
Less: Depreciation (3,279) (3,936) (4,714) (5,605) Payable days 69.4 51.6 71.3 72.4
Net fixed assets 8,330 11,934 13,656 15,264 FINANCIAL STABILITY
Add: Capital WIP 3,363 3,363 3,363 3,363 Total debt/ equity (x) 0.2 0.1 0.1 -
Total fixed assets 11,693 15,297 17,019 18,627 Net debt/ equity (x) 0.1 (0.4) (0.4) (0.4)
Total Investment 322 1,072 2,572 5,572 Current ratio (x) 2.6 6.6 5.2 5.1
Inventory 3,489 2,522 4,538 5,000 Interest cover (x) 34.0 58.3 95.6 149.7
Debtors 4,752 5,043 6,195 6,583 VALUATION
Cash & bank 358 12,349 13,654 15,068 PE (x) 29.9 20.7 18.1 18.7
Loans & advances 35 37 46 48 EV/ EBITDA (x) 22.7 14.3 12.9 13.1
Current liabilities 4,276 3,432 5,307 5,922 EV/ Net sales (x) 7.5 6.5 5.2 4.7
Net current assets 6,885 19,201 22,419 24,279 PB (x) 8.8 4.8 3.9 3.3
Other non-current assets - - - - Dividend yield (%) 0.4 0.5 0.5 0.5
Total assets 18,900 35,571 42,010 48,478 Free cash flow yield (%) - - - -
Source: Company, Axis Capital Source: Company, Axis Capital

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PHARMACEUTICALS

Disclosures:

The following Disclosures are being made in compliance with the SEBI Research Analyst Regulations 2014 (herein after referred to as the Regulations).

1. Axis Securities Ltd. (ASL) is a SEBI Registered Research Analyst having registration no. INH000000297. ASL, the Research Entity (RE) as defined in the
Regulations, is engaged in the business of providing Stock broking services, Depository participant services & distribution of various financial
products. ASL is a subsidiary company of Axis Bank Ltd. Axis Bank Ltd. is a listed public company and one of India’s largest private sector bank and
has its various subsidiaries engaged in businesses of Asset management, NBFC, Merchant Banking, Trusteeship, Venture Capital, Stock Broking, the
details in respect of which are available on www.axisbank.com.
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Research Team

Sr. No Name Designation E-mail

1 Suvarna Joshi Research Analyst suvarna.joshi@axissecurities.in
2 Hiren Trivedi Research Associate hiren.trivedi@axissecurities.in

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NATCO PHARMA
PHARMACEUTICALS

DEFINITION OF RATINGS
Ratings Expected absolute returns over 12-18 months
BUY More than 10%
HOLD Between 10% and -10%
SELL Less than -10%
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Axis Securities Limited, SEBI Single Reg. No.- NSE, BSE & MSEI – INZ000161633, ARN No. 64610, CDSL-IN-DP-CDSL-693-2013, SEBI-Research Analyst
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