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Pharmaceuticals
India I Equities
Sector Report
18 October 2010
Pharmaceuticals Overweight
India Pharma: Global healing Nifty/Sensex: 6063/20125
Macro Section
Sujan Hajra
+9122 6626 6720
sujanhajra@rathi.com
Sriram Rathi
+9122 6626 6737
sriramrathi@rathi.com
Sanjeev Chiniwar
+9122 6626 6716
sanjeevchiniwar@rathi.com
Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be
aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision. Disclosures and analyst certifications are located in Appendix 1.
Anand Rathi Research India Equities

Pharmaceuticals
India I Equities
Report
18 October 2010
Pharmaceuticals Overweight
India Pharma: Global healing Nifty/Sensex: 6063/20125
We initiate coverage on Indian Pharma with Overweight stance

on strong growth prospects for generics and supporting macro
Sriram Rathi
parameters. Our top picks are Aurobindo, Ranbaxy, Glenmark, +9122 6626 6737
Ipca, Jubilant and Dishman; we have a Sell on Cipla and Biocon. sriramrathi@rathi.com
 Supporting macro parameters. Growing per-capita income and high Sanjeev Chiniwar
elasticity of healthcare demand bode well for 15% FY10-14e CAGR in +9122 6626 6716
the domestic market. We expect exports CAGR of +20%, given largest sanjeevchiniwar@rathi.com
number of US FDA-approved plants outside the US, strong chemistry
skills, cost advantage and growth prospects.
 Generics manufacturers in sweet spot; domestic formulations
seeing traction. Patent expiries worth >US$200bn in CY10-15, focus
on generics and emerging innovator-generics partnerships provide Macro Section
significant opportunities for Indian players. Domestic formulations
would sustain 15% FY10-14e CAGR, driven by rising lifestyle diseases Sujan Hajra
and increasing reach to rural areas. +9122 6626 6720
sujanhajra@rathi.com
 M&As pick up speed. We believe the M&A trend is likely to
continue, given MNCs focus to enter India due to higher (mid teens)
long-term growth prospects, gaining access to US FDA-approved
capacities and product baskets, and leveraging the low-cost model.
 Premium valuations to sustain. BSE Healthcare has been trading
at an average of 40% premium (forward P/E) to the Sensex; at
present, the premium is down to 26%, which is unwarranted, given
18.8% PAT CAGR over FY10-13e and likelihood of more M&As.
 Risks. i) Currency fluctuation ii) pricing pressure for generics in
developed markets and iii) regulatory hurdles.
Sector valuation matrix BSE Healthcare vs Sensex

M-Cap EV/EBITDA RoCE
FY12e Rating Price Target (US$ m) P/E (x) (x) PBV (x) RoE (%) (%)
Aurobindo Buy 1,127 1,560 1,462 10.1 7.9 2.4 25.0 15.7
170
Biocon Sell 400 298 1,773 21.4 12.7 3.5 17.3 15.5 160
150 BSE
Cipla Sell 332 308 5,717 21.5 15.1 3.4 17.1 16.7 Healthcare
140
Dishman Buy 177 258 317 9.0 6.9 1.3 16.1 11.3 130
Dr Reddy's Labs Hold 1,589 1,636 5,961 20.1 12.6 4.8 25.9 22.1 120
110
Glenmark Buy 303 373 1,817 15.6 10.9 2.5 17.2 13.3
100 Sensex
Ipca Labs Buy 294 356 818 11.6 8.3 2.6 27.0 20.9 90
Aug-09
Oct-09
Dec-09
Feb-10
Apr-10
Jun-10
Aug-10
Oct-10
Jubilant Buy 314 411 1,108 10.8 8.0 1.9 17.7 10.2
Ranbaxy Buy 582 658 5,437 16.2 11.5 2.5 24.3 18.7
Sun Pharma Hold 2,038 2,053 9,380 23.0 22.0 4.0 18.7 18.2
Source: BSE, Company, Anand Rathi Research Source: Bloomberg
Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be
aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision. Disclosures and analyst certifications are located in Appendix 1.
Anand Rathi Research India Equities

18 October 2010 Pharmaceuticals – India Pharma: Global healing
Pharmaceuticals
India Pharma: Global healing
Investment Argument & Valuation ................................................................ 3

Supporting macro parameters........................................................................... 3
Generic manufacturers in sweet spot ................................................................ 3
M&As pick up speed.......................................................................................... 4
Premium valuations to sustain........................................................................... 4
Risks.................................................................................................................. 5
Recommendations ............................................................................................ 6
Pharma Sector: The Macro View .................................................................. 9
Healthcare spending in India............................................................................. 9
Global Pharma Industry and India ................................................................... 12
Outlook for the Indian Pharma industry ........................................................... 19
Generics companies in sweet spot ............................................................. 21
Generics to witness faster growth ................................................................... 21
Global pharma in transformation phase .......................................................... 21
Generics entail huge cost and operational advantage .................................... 22
Patent expiries – Major trigger......................................................................... 23
US – Immense opportunities for generics ....................................................... 24
Increasing generics penetration to drive growth.............................................. 25
Domestic formulations seeing traction ........................................................ 26
Strong growth to continue ............................................................................... 26
Growing eminence of chronic diseases........................................................... 26
Economic parameters ensure strong growth................................................... 28
M&As pick up speed ................................................................................... 29
Recent M&As setting new valuation parameters............................................. 29
Rationale for paying high prices ...................................................................... 30
Emerging novel growth trajectory – Licensing model ...................................... 30
More deals to follow ........................................................................................ 31
Company Section ....................................................................................... 33
Aurobindo ........................................................................................................ 34
Biocon ............................................................................................................. 49
Cipla ................................................................................................................ 62
Dishman .......................................................................................................... 78
Dr Reddy’s Labs.............................................................................................. 93
Glenmark Pharma ......................................................................................... 108
Ipca Labs....................................................................................................... 122
Jubilant .......................................................................................................... 137
Ranbaxy ........................................................................................................ 153
Sun Pharma .................................................................................................. 168
Annexure ...................................................................................................183
Anand Rathi Research 3

Investment Argument & Valuation

We initiate coverage on the Indian Pharma sector with an
Overweight stance on account of strong growth prospects for
generics manufacturers, supporting macro parameters, increasing
outsourcing by pharma multinational companies (MNCs) and 15%
CAGR over FY10-14e in the domestic market. Despite stock prices of
most pharma stocks having run up in the past 1-1.5 years, we remain
bullish on the sector mainly owing to strong growth prospects (18.8%
earnings CAGR over FY10-13e) and valuations still being at
reasonable levels. Our top picks in the sector are Aurobindo Pharma,
Ranbaxy Laboratories, Glenmark Pharma, Ipca Labs, Jubilant Life
Sciences (erstwhile Jubilant Organosys) and Dishman Pharma. While
we have a Hold on Dr Reddy’s Labs (DRL) and Sun Pharmaceutical
Industries (SPIL) with a positive bias, we have a Sell on Cipla and
Biocon.
Supporting macro parameters

Growing per-capita income and high elasticity of healthcare demand bode
well for 15% CAGR in domestic pharma demand. With the highest number
of US FDA-approved manufacturing facilities outside the US, chemistry
skills and low costs, the emerging political-economic situation offers a huge
opportunity for Indian pharma companies, especially in the US. We expect
exports earnings of Indian pharma companies to maintain CAGR of >20%
over the next five years.
Domestic sales and exports contribute equally to Indian pharma revenues.
India is the largest emerging market (EM) exporter of pharma products
with a diversified geographic spread and export basket, well tuned with
global demand. Generics’ falling margins in developed countries and
increased competition (from domestic companies as well as MNCs) in the
generics space are the key concerns.
Generic manufacturers in sweet spot

Indian companies are well-placed to capitalise on emerging opportunities in
the generics space, driven by patent expiries worth >US$200bn over CY10-
15, push by global governments for generic drugs, and emerging innovator-
generic partnerships (Pfizer-Aurobindo, GSK-DRL etc). We believe the
generics business would remain the key growth driver on the back of
India’s low-cost manufacturing advantage, well-established presence of
Indian pharma players across the globe, increasing generics penetration (in
regulated markets such as the US and Japan) and patent expiries. Further,
large innovators are now focusing on generics to maintain their growth
momentum and revenue share, which indicates strong future for the
generics market.
Domestic market witnessed 15% CAGR over CY05-09 and we expect the
trend to continue over CY09-14 led by lifestyle (chronic) diseases (+20%
CAGR), increasing reach to rural markets (grew 27% in ’09) through
increased field force and awareness, and continuous rise in private final
consumption expenditure (1.1% in FY1951 to 5.9% in FY08). The chronic
diseases segment would outpace industry growth rate because of changing
life style leading to diseases such as cardiovascular and diabetes. The Indian
formulations market grew a healthy 17.4% in ’09 to `401bn, mainly driven
by strong growth in the anti-diabetic, cardiac, gynaecology and anti-

infectives segments. Abbott, Cipla, GlaxoSmithKline Pharmaceuticals

(GSK), Ranbaxy Labs, DRL and SPIL are the key players in domestic
formulations and have a major presence in lifestyle-related diseases as well.
M&As pick up speed

The M&A trend has been ongoing in the Indian pharma space since the
Ranbaxy-Daiichi Sankyo deal, followed by Abbott acquiring Piramal
Healthcare’s domestic formulations business. We believe the trend is likely
to continue, given MNCs’ focus to enter India due to higher (mid teens)
and sustainable growth for the long term, gaining access to US FDA-
approved capacities and product baskets, and leveraging the low-cost model
in the territory. This has resulted in premium valuations for Indian pharma
companies.
The transactions include takeovers of whole companies or of particular
businesses, and tie ups for dossier licensing leading to product supply
contracts. The recent acquisition of Piramal Healthcare’s domestic
formulations business by Abbott has created a totally different benchmark
for valuations, as the deal concluded at more than 9x sales on trailing basis.
This indicates that MNCs have high interest levels in the fast-growing
Indian pharma market and are prepared to pay the high valuations. We
believe these deals would keep valuations of Indian pharma companies as
well as promoters’ aspiration levels high.
Premium valuations to sustain

The BSE Healthcare index has traded at an average of 40% premium (one-
year forward P/E) to the Sensex; at present, the premium is down to 26%.
We believe the discount is unwarranted, considering 18.8% earnings CAGR
over FY10-13e, possibility of positive earning surprises from para IV
opportunities and strong balance sheet position. We believe the premium
valuations commanded by Indian generic players would sustain going
forward. We estimate that the overall pharma sector (Anand Rathi
Universe) is currently trading at 22.1x FY11 and 19.7x FY12 earnings. We
believe large-cap generic companies such as SPIL, Cipla, DRL and Ranbaxy
would continue to trade at ~20x one-year forward earnings. Mid-cap
generics and CRAMS companies are expected to trade at 12-16x, depending
on their growth visibility and financial strength.
Fig 1 – One year forward P/E premium of BSE Healthcare over Sensex
(%)
200
150
100
Average 40% premium
50
-50
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Note: Companies in our coverage are on based on our estimates, on an adjusted basis
Source: Bloomberg, Anand Rathi Research

Fig 2 – Relative price performance: BSE Healthcare vs. Sensex

700
Sensex
600
500
400
300 BSE HC
200
100
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
BSE Healthcare has been underperforming the Sensex since FY07 that, we
believe, would get corrected. Our expectation of sustainability of premium
valuations is based on:
 strong growth visibility (18.8% earnings CAGR over FY10-13e),
 innovators and large global generics players would continue
outsourcing research and manufacturing due to cost pressure,
 patent expiries to provide one-time huge cash flows and earnings
surprises,
 push by governments worldwide for cheaper generics medicines as
healthcare costs escalate, may provide additional growth, and
 comfortable financial position and leverage.
Risks
 Currency fluctuation is a key risk for the Indian pharma industry as
~50% of the industry revenue is contributed by exports. However, a
few companies have a natural hedge to some extent as they import raw
materials and have debt in foreign currency (mainly US dollar) as well.
 Pricing pressure in regulated markets (US & EU) for generics remains a
key challenge as it has a direct impact on profitability.
 Regulatory hurdles have increased with US FDA becoming stricter,
given increase in the number of cases of warnings letters (such as
Ranbaxy, SPIL and Cipla). Further, delay in approval of products may
impact growth expectations as such delays would hinder launch of the
product.

Recommendations
Aurobindo Pharma (Buy, Target Price: `1,560)
We initiate coverage on Aurobindo Pharma with a Buy rating and target
price of `1,560 per share. We are positive on Aurobindo mainly owing to
our expectation of strong growth momentum, better visibility from supply
deals with MNCs, easing leverage, beginning of cash flow generation and
attractive valuations.
At CMP, the stock trades at 12.8x FY11e and 10.1x FY12e earnings. Current
valuations are at +50% discount to large-cap peers and 20% discount to its
past 5-year average (14.5x). We believe that the discount is unjustified,
considering strong growth visibility and improving balance sheet.
Biocon (Sell, Target Price: `298)
We initiate coverage on Biocon with a Sell rating and target price of `298.
We are negative on the stock due to muted growth outlook (11.4% revenue
CAGR over FY10-13e), stretched valuations (21.5x FY12e earnings) and
lack of short-to-medium term triggers. The stock is currently trading at
valuations similar to large-cap, high-quality stocks, which is unwarranted in
our view, considering muted revenue CAGR of only 11.4% over FY10-13e.
We value Biocon at `298 based on 16x FY12e earnings. At CMP, the stock
trades at 22.6x FY11e and 19.9x FY12e earnings. Current valuations look
stretched, given muted growth outlook and past 3-year average forward PE
of 17x. We have valued Biocon at 16x FY12e earnings, which is at 20%
discount to target valuation for large-caps SPIL, Cipla etc.
Cipla (Sell, Target Price: `308)
We initiate coverage on Cipla with a Sell rating and target price of `308 per
share. We are negative on the stock, given muted growth outlook (10.2%
revenue CAGR), deteriorating assets/turnover, declining return ratios and
stretched valuations. At CMP, the stock is already trading at ~21.4x FY12e
earnings that seem stretched considering the past three-year average
forward PE of 20x and muted growth outlook.
We value Cipla at `308 per share based on 20x FY12e earnings. At CMP,
the stock trades at 23.8x FY11e and 21.4x FY12e earnings and looks fairly
valued. We do not expect valuations to further improve from 20x FY12e
earnings due to muted growth outlook and historical past three years’
average forward PE of 20x.
Dishman Pharma (Buy, Target Price: `258)
We initiate coverage on Dishman Pharma with Buy and target price of
`258. We are positive on the stock given turnaround in Solvay contract and
operations at Carbogen Amcis (CA), addition of new contracts and
commissioning of new HIPO facility.
We value Dishman at `258 based on 10x FY12e CRAMS EBITDA and 4x
FY12e Marketable Molecules (MM) EBITDA. At CMP, the stock trades at
11.2x FY11e and 9x FY12e earnings and EV/EBITDA of 8.6x FY11e and
6.9x FY12e. Current valuations seem attractive, considering turnaround
story and past 3-year average forward P/E of 14x.

Dr Reddy’s Labs (Buy, Target Price: `1,636)

We initiate coverage on DRL with a Hold rating and target price of `1,636
per share. We are positive on DRL’s business model and growth prospects;
however, we are neutral on the stock, considering current fair valuations of
24.3x FY11e and 20.1x FY12e earnings.
We value DRL at `1,636, valuing base business at `1,577 based on 20x
FY12e base business earnings and `58 for para IV pipeline. The stock
trades at 24.3x FY11e and 20.1x FY12e earnings and looks fairly valued at
current levels, considering DRL’s historical average forward P/E of 18-19x.
Glenmark Pharma (Buy, Target Price: `373)
We initiate coverage on Glenmark Pharma with Buy and target price of
`373. We are positive on the stock, considering turnaround in the base
business, pipeline of key product launches, monetisation of new chemical
entity (NCE) pipeline and improving financials.
We value Glenmark at `373, valuing base business at `339 based on 18x
(10% discount to large-cap peers and considering the past 2-year average
forward PE of 19x) FY12e base business earnings and `24 for NPV of
exclusivity opportunities and GRC15300 (NCE). At CMP, the stock is
trading at 17.3x FY11e and 15.6x FY12e earnings. We believe that the
sensitivity to option value for NCE pipeline is the lowest ever and most of
the value is contributed by the base pharma business. Therefore, current
valuation provides upside for NCE value to investors, with minimal risk of
failure of NCE compounds.
Ipca Labs (Buy, Target Price: `356)
We initiate coverage on Ipca with Buy and target price of `356. We are
positive on the stock on our expectations of higher-than-industry growth in
domestic formulations, scale-up of exports formulations, upside from
Indore SEZ, strong return ratios and valuations at substantial discount
(50% to large-cap peers).
We value Ipca at `354 based on 14x FY12e earnings. At CMP, the stock
trades at 14.6x FY11e and 11.6x FY12e earnings. Current valuations are at
~50% discount to large-cap peers’ and, considering the company’s strong
and sustainable growth momentum; we believe that the discount is likely to
decline. We expect re-rating in Ipca’s valuations due to sustainable strong
growth, high professional management quality, minimal downside risk in
business and current valuations at ~50% discount to large-cap peers.
Jubilant Organosys (Buy, Target Price: `411)
We initiate coverage on Jubilant Life Sciences (erstwhile Jubilant
Organosys) with Buy and target price of `411. We are positive on the stock
owing to expectations of steady growth momentum, easing financial
leverage and value unlocking through demerger of the APP business.
We value Jubilant at `411 based on 10x FY12e PLSP EBITDA and 4x
FY12e APP EBITDA. At CMP, the stock trades at 11.8x FY11e and 10.8x
FY12e earnings and EV/EBITDA of 9.4x FY11e and 8x FY12e. At our
target price, the stock will trade at EV/EBITDA of 11.3x FY11e and 9.6x
FY12e EBITDA. Jubilant is predominantly a CRAMS player and CRAMS is
a capital-intensive industry where growth generally comes from capacity
addition. This leads to lower return ratios due to continuous incurrence of
capex; hence, CRAMS companies have low valuations. However, Jubilant’s

current valuations are lower than the past 3-year average forward PE of 14x
and EV/EBITDA of 11x.
Ranbaxy (Buy, Target Price: `658)
We initiate coverage on Ranbaxy Laboratories (Ranbaxy) with Buy and
target price of `658 per share. We believe Ranbaxy is well-placed to witness
turnaround in its base business and reap synergistic benefits of parent
Daiichi’s hybrid business model (Daiichi is an innovator company and
Ranbaxy is a successful generics company). Para IV opportunities (180-day
marketing exclusivity) would provide one-time upsides along with cash
inflows; also, cost-cutting strategies are expected to boost operating
efficiency.
We value Ranbaxy at `658 per share based on 20x CY12e base business
earnings and `140 per share for para IV pipeline. At CMP, the stock trades
at 17.1x CY10e and 16.2x CY11e earnings including the value of para IV
pipeline. Adjusting the expected value of `140 per share for para IV
pipeline in the CMP, the stock is trading at 24.9x CY11e and 17.1x CY12e
base business earnings. Resolution of US FDA issues would be a key upside
positive for the stock. Management has, for the first time, indicated that
there will be a comprehensive discussion with the US FDA in Q4CY10 and
the resolution may take ~6 months after that.
Sun Pharma (Hold, Target Price: `2,053)
We initiate coverage on SPIL with Hold and target price of `2,053. We are
Neutral on the stock mainly owing to high valuation of 24.9x FY11e and
23x FY12e earnings. However, we remain bullish on the business model,
growth momentum, high profitability and synergistic benefits from Taro
acquisition.
We value SPIL at `2,053 based on 22x FY12e earnings and `103 per share
for Taro integration. Our valuation for Taro is based on 15x CY10
annualised earnings (based on H1CY10 unaudited results). We assign 10%
higher multiple to SPIL vs. peers (20x) owing to strong management
quality, highest margins in the industry and possibility of upside from Taro.

Pharma Sector: The Macro View

Domestic sales and exports contribute equally to the revenues of
Indian pharma companies. Strong growth in per-capita income and
high income elasticity of healthcare demand bode well for 15% CAGR
in domestic pharma demand. India is the largest emerging market
(EM) exporter of pharma products, with a diversified geographic
spread and an export basket well-tuned with global demand. Given
the highest number of US FDA-approved manufacturing facilities
outside the US, chemistry skills and low costs, India Pharma is
primed to benefit from the emerging global opportunities, especially
in the US. We expect exports earnings of Indian pharma companies
to maintain CAGR of +20% over the next five years. The falling
margins for generics in the industrialised countries and increased
competition, including that from MNCs in the generics space are the
key concerns.
The pharma industry is one of the most export-oriented sectors in India.

For the ten companies included in the CNX Pharma index, the share of
Domestic sales and exports foreign exchange (forex) earnings in net sales jumped to 51.1% in FY10
contribute in equal measures to the from 31.5% in FY01. Interestingly, the proportion of forex expenditure as a
revenue of the Indian percentage of net sales hovered at ~20% over the same period and the ratio
pharmaceutical companies has, in fact, declined since FY05 (Fig 3). We undertook a similar exercise
with a broader sample of ~200 pharma companies, for which the results
were largely similar. Inclusion of Indian subsidies of MNCs and smaller
Indian companies in our sample, however, slightly reduces the export-
orientation of pharma companies operating in India. Yet, the main
inference remains largely the same – both domestic and international
demand contribute almost equally to the Indian pharma industry.
Fig 3 – Global and domestic demand contribute equally to Indian Pharma

(Forex earning & expen., % of net sales)
60
50
40
30
20
10
0
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Revenue earning in forex as % of net sales

Revenue expenditure in forex as % of net sales
Note: Data related to companies within the CNX Pharma index, which includes Biocon, Cipla, Divi's Lab., Dr Reddy's Labs,
GlaxoSmithkline Pharma, Glenmark Pharma., Lupin, Piramal Health, Ranbaxy Labs. and Sun Pharma. Inds
Source: Capital Line, Anand Rathi Research
Healthcare spending in India

Healthcare spending in India is The share of spending on medical and healthcare as a proportion of overall
growing well ahead of the growth in
personal final consumption expenditure in India has considerably increased
overall personal expenditure
over the years (Fig 4). Despite the decline post FY05, the share has more-
than-doubled since the early 1990s. The real growth in spending on medical
and healthcare has generally surpassed that for overall consumer spending
(Fig 5). Moreover, while the average income demand elasticity for overall

consumer spending is around one, that for medical and healthcare is higher
(Fig 6). This indicates that consumer spend on medical and healthcare is
rising faster than the increase in income.
Fig 4 – Share of healthcare in personal consumption expenditure in India

5.5
(Medical & healthcare in per. cons., %)

5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
FY52
FY57
FY62
FY67
FY72
FY77
FY82
FY87
FY92
FY97
FY02
FY07
Share of medical and healthcare in personal consumption
Source: Government of India, Anand Rathi Research
Fig 5 – Strong growth in healthcare and medical spending

14
(Growth in medical and Per. cons., %)
12
10
8
6
4
2
0
FY54
FY58
FY62
FY66
FY70
FY74
FY78
FY82
FY86
FY90
FY94
FY98
FY02
FY06
Personal consumption Medical and healthcare spending
Source: Government of India, Anand Rathi Research
Fig 6 – Spending on healthcare shows strong income elasticity

(Elasticity of medical etc. and per. cons.)
3.0
2.5
2.0
1.5
1.0
0.5
Per-capita healthcare spending is 0.0
low in India compared with most
FY54
FY58
FY62
FY66
FY70
FY74
FY78
FY82
FY86
FY90
FY94
FY98
FY02
FY06
emerging market peers; but, India’s

overall healthcare market is one of Personal consumption Medical and healthcare spending
the biggest in the world Source: Government of India Anand Rathi Research
Despite the strong growth in personal consumption on healthcare, such

spending in India remains one of the lowest among the big economies, on a
per-capita basis. The per-capita spend is not only significantly lower than
that of China, East Asian and South American EM economies; it is even
lower than smaller economies such as Sri Lanka, Thailand and Philippines.

Moreover, per-capita healthcare spend in India is growing slower than most

of the major EM economies’ (Fig 7). Yet, as a share of GDP, while spend
on healthcare in India is much below that in the industrialised countries or
EM economies from Latin America, it is comparable with the ratio in East
Asian countries and China (Fig 8). More importantly, because of the large
size of the Indian economy, healthcare market is in India is one of the
largest (Fig 9) as well as the fastest growing in the world.
Fig 7 – Low per-head spend on healthcare in India

8,000 32
(Heathcare spending per capita, US$)
(Growth in healthcare spending, %)

7,000 28
6,000 24
5,000 20
4,000 16
7,285
3,000 12
4,627
4,209
3,986
3,867
2,000 8
2,751
1,000 4
1,362
1,148
108
136
307
493
497
564
606
663
809
15
20
23
40
42
63
68
0 0
Nepal
Brazil
Philippines
UK
Germany
US
Bangladesh
Pakistan
India
Indonesia
China
Sri Lanka
Thailand
Malaysia
Russia
South Africa
Mexico
Argentina
Singapore
South Korea
Japan
Australia
France
World
Health expenditure per capita Growth in health expenditure per capita
Source: World Bank, Anand Rathi Research
Fig 8 – As a share of GDP, healthcare spend in India is in line with East Asia
(Change in heath. spending pa as % of GDP, bp)

16 32
(Heathcare spending as % of GDP)
14 24
12 16
10 8
15.7
8 0
6 11.0 -8
10.4
10.0
9.7
8.9
8.6
8.4
8.4
8.0
4 -16
6.3
5.9
5.4
5.1
4.4
4.3
4.2
4.1
3.9
3.7
2 -24
3.4
3.1
2.7
2.2
0 -32
Bangladesh
Sri Lanka
Singapore
South Africa
Argentina
Philippines
Nepal
Brazil
Germany
Indonesia
Thailand
India
Malaysia
Mexico
South Korea
Japan
Australia
World
France
UK
US
Pakistan
China
Russia
Health expenditure as % of GDP Change in heathcare spend as % of GDP


Fig 9 – India’s healthcare market one of the largest & fastest growing in the world
(US$ bn) ’04 ’05 ’06 ’07 ’08 ’09 %CAGR
('04-'09)
US 1,816 1,941 2,070 2,197 2,343 2,487 6.5
Germany 288 299 306 346 371 380 5.7
Japan 371 372 352 351 354 336 (1.9)
France 225 239 249 287 316 329 7.9
UK 176 188 207 236 266 284 10.1
China 87 100 115 143 167 191 16.9
Brazil 51 72 92 115 149 183 29.0
Russia 31 40 53 70 91 116 30.5
Australia 58 64 69 84 98 105 12.6
South Korea 38 48 57 66 78 88 18.0
Mexico 45 49 54 59 66 71 9.7
India 29 33 36 45 52 57 14.9
Argentina 15 19 22 26 33 38 20.6
South Africa 20 22 22 24 28 29 8.0
Thailand 6 6 8 9 11 12 15.6
Indonesia 6 6 7 9 11 10 12.0
Malaysia 6 6 7 8 9 9 10.9
Philippines 3 4 4 6 7 8 19.5
Singapore 4 4 4 5 6 6 10.0
Pakistan 3 3 3 4 4 4 10.8
Bangladesh 2 2 2 2 3 3 9.8
Sri Lanka 1 1 1 1 2 2 16.3
Nepal 0 0 1 1 1 1 7.5
Global Pharma Industry and India

Global pharma trade is dominated Structure of the global market
by industrialised countries, and Pharma exports accounted for over 3.4% of the global trade in ’09 – a sharp
medicaments in dosage account for jump from ~2.4% share maintained during ’02-08. World trade in pharma
60% of the world trade products is expanding much faster than in overall trade. In US dollar terms,
global trade saw CAGR of 9.1% during ’01-09 as against 17.2% for pharma
exports (Fig 10).
Fig 10 – Global pharma exports surging fast

30 3.6
20 3.3
10 3.0
0 2.7
-10 2.4
-20 2.1
-30 1.8
2002 2003 2004 2005 2006 2007 2008 2009
Share of pharma in the overall global exports (RHS)
Overall global export growth
Grobal pharma exports growth
Source: International Trade Centre (ITC), Anand Rathi Research
Industrialised countries dominate the global pharma exports space. All the
top-10 pharma product exporters are industrialised countries, which
account for ~80% of global trade (Fig 11). With 1.2% global share, India is
the largest pharma product-exporting EM economy and was ranked 15th

among the top exporters in ’09. Over the past decade, India has been able
to increase global market share by 30bps, stepping up three rungs since ’05.
With 0.8% share in global pharma exports, China is the only other EM
economy within the list of top-20 exporters.
Fig 11 – Overview of global pharma exports

’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
(Share in global pharma exports, %)
Germany 14.3 10.9 11.9 14.3 14.5 14.8 15.6 15.8 15.0
Belgium 7.6 14.3 13.6 13.3 13.4 13.0 13.2 12.2 12.2
Switzerland 9.3 8.6 8.8 8.8 9.0 9.5 9.5 10.1 9.9
US 10.7 8.8 8.8 8.7 8.7 8.8 8.5 8.6 9.8
France 10.3 9.6 9.5 8.9 8.8 8.3 8.1 8.1 8.0
UK 10.6 9.6 10.2 9.6 8.6 8.5 8.2 7.7 7.3
Netherlands 3.7 3.9 3.8 4.2 4.1 4.2 4.5 5.9 6.6
Ireland 6.2 9.1 7.7 7.9 6.6 5.8 5.5 5.7 6.4
Italy 5.4 5.4 5.0 4.5 4.7 4.5 4.2 3.8 3.6
Spain 1.7 2.2 2.2 2.0 2.5 2.5 2.7 2.7 2.5
Sweden 3.5 3.0 3.5 3.0 2.7 2.9 2.4 2.1 2.0
Denmark 2.6 2.3 2.4 2.2 2.2 2.0 2.0 1.9 1.8
Austria 1.6 1.8 1.7 1.5 1.7 1.8 1.7 1.7 1.8
Canada 1.2 1.0 1.3 1.3 1.4 1.6 1.8 1.5 1.5
India 0.9 0.9 0.9 0.9 0.9 1.0 1.1 1.3 1.2
Singapore 0.4 0.2 0.2 0.3 1.0 1.5 1.6 1.1 1.1
Israel 0.5 0.6 0.5 0.6 0.8 1.1 1.0 1.2 1.1
Japan 1.7 1.3 1.3 1.2 1.0 0.9 0.7 0.7 0.8
China 0.6 0.5 0.5 0.5 0.5 0.5 0.6 0.7 0.8
Australia 0.9 0.7 0.8 0.8 1.0 0.9 0.9 0.8 0.8
Others 6.2 5.3 5.3 5.5 5.9 5.9 6.2 6.5 5.9
(Size of global pharma exports; US$ bn)
117 148 181 224 249 287 341 385 399
Source: ITC, Anand Rathi Research
Like exports, industrialised countries dominate global imports of pharma

products. The concentration, however, is lower for imports than exports.
Top-10 importers account for about two-thirds of global pharma imports
(Fig 12). With ~US$1bn import of pharma products in ’09, India ranks
around the 50th among the importers of such products.

Fig 12 – Overview of the global pharma imports

’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
(Share in global pharma imports; %)
US 13.7 13.9 14.5 13.5 13.5 14.4 13.9 13.0 13.3
Germany 7.7 10.4 9.8 10.3 10.9 11.0 10.9 10.9 10.7
Belgium 6.3 12.8 12.7 13.2 13.0 11.4 11.2 10.4 9.8
Netherlands 3.6 3.5 3.2 3.8 3.9 4.0 4.3 5.7 6.5
France 6.2 5.4 5.6 5.6 5.4 5.4 5.5 5.5 5.9
UK 7.4 6.8 6.8 6.5 5.8 5.6 5.6 4.9 4.8
Italy 5.1 4.7 4.8 4.8 4.5 4.5 4.3 4.3 4.4
Switzerland 5.1 4.5 4.3 4.5 4.5 4.6 4.4 4.0 3.9
Spain 3.4 3.4 3.6 3.4 3.2 3.1 3.3 3.6 3.6
Japan 3.6 3.0 2.8 2.7 2.8 2.6 2.3 2.5 3.1
Canada 3.4 2.9 3.0 2.8 2.8 3.1 2.9 2.6 2.8
Russia 1.5 1.0 1.2 1.2 1.6 2.1 1.9 2.2 2.0
Australia 1.8 1.7 1.7 1.9 1.9 1.7 1.8 1.7 1.7
China 0.8 0.7 0.7 0.7 0.7 0.8 1.0 1.2 1.4
Austria 1.5 1.4 1.4 1.2 1.2 1.2 1.2 1.3 1.2
Greece 1.0 0.5 1.1 1.1 1.3 1.2 1.2 1.3 1.2
Poland 1.6 1.3 1.2 1.2 1.2 1.2 1.3 1.5 1.1
Brazil 1.3 1.0 0.8 0.8 0.8 0.9 1.0 1.1 1.1
Turkey 0.9 0.9 1.1 1.2 1.1 1.0 1.0 1.1 1.0
Sweden 1.2 1.2 1.1 1.0 1.0 1.1 1.0 1.0 1.0
Others 22.8 19.1 18.6 18.7 18.9 19.1 20.1 20.3 19.6
(Size of global pharma imports; US$ bn)
117 156 191 234 263 296 355 406 419
The trend of global pharma trade broadly indicates pre-eminence of the EU

(i.e., the EU-15 – Austria, Belgium, Denmark, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden
and UK). EU accounts for ~70% of global pharma exports and 52% of the
imports. Intra-EU trade alone accounts for ~40% of global pharma exports
as well as imports (Fig 13).
Fig 13 – Pre-eminence of the EU in global pharma trade

Importing country
Share in total exports/imports, %
EU US Japan Others Total
EU 39.9 9.0 1.2 19.0 69.1
US 5.1 0.4 3.1 8.6
Japan 0.2 0.4 0.2 0.8
Exporting country
Others 6.2 4.1 0.5 10.7 21.4
Total 53.7 14.1 2.6 32.9 100.0
Exporting country
EU US Japan Others Total
EU 38.4 7.3 0.4 6.0 52.0
US 9.2 0.4 4.0 13.7
Importing country Japan 1.5 0.5 0.5 2.5
Others 18.4 3.0 0.2 10.3 31.8
Total 66.9 8.3 0.8 20.7 100.0
Note: Calculations are based on average value during ’05-08. Inter alia there are some differences between export and import
values , because exports are based on free on board values while imports include cost, insurance and freight,
Fig 14 presents the broad product break-down of global pharma exports.

Medicaments in dosages alone account for 60% of global pharma exports;
and, along with antisera and other blood fractions, vaccines, hormones,
antibiotics and vitamins, they account for ~90% of global pharma trade.

Fig 14 – Overview of global pharma exports – As per product

’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
(Share in global exports, %)
Medicaments nes*, in dosage 61.5 64.8 65.0 65.9 65.3 66.0 65.2 63.5 62.1
Antisera and other blood fractions 6.0 5.9 7.1 7.9 7.9 8.5 10.4 11.3 11.6
Vaccines, human use 2.4 2.2 2.2 2.0 2.1 2.4 2.7 2.8 4.5
Hormones nes, in dosage 5.6 5.2 4.7 4.5 4.5 4.3 3.7 3.7 3.6
Antibiotics nes, in dosage 6.2 5.3 4.3 3.8 3.8 3.5 3.2 3.3 3.4
Insulin, in dosage 1.5 1.4 1.6 1.7 1.9 1.7 1.6 1.8 1.9
Adrenal cortex hormones, in dosage 1.0 1.0 1.0 1.3 1.6 1.5 1.4 1.3 1.4
Medicaments nes, formulated, in bulk 2.6 2.2 1.9 1.8 1.7 1.6 1.6 1.8 1.3
Vitamins and their derivatives, in dosage 1.6 1.3 1.4 1.2 1.2 1.1 1.1 1.1 0.9
Heparin & its salts; nes 0.5 0.5 0.5 0.6 0.8 0.7 0.7 0.7 0.9
Human blood etc; microbial prep nes 1.1 1.1 1.1 1.0 0.9 0.9 0.9 1.0 0.9
Contraceptive based on hormones 0.7 0.7 0.7 0.8 0.9 0.8 0.8 0.9 0.9
Penicillin etc, formulated, in bulk 1.4 1.4 1.4 1.2 1.1 1.0 1.0 1.0 0.8
Suture matls, etc 0.8 0.7 0.7 0.7 0.7 0.7 0.6 0.7 0.8
Others 7.0 6.3 6.2 5.6 5.6 5.4 5.1 5.2 4.9
(Total global exports of pharma products, US$ bn)
117 148 181 224 249 287 341 385 399
Source: ITC, Anand Rathi Research *nes = not elsewhere specified
India’s standing in global pharma trade

With 1.2% global export share, As aforementioned, among EM economies, India is the largest exporter of
India is the largest pharma exporter pharma products. Over the past decade, India’s pharma exports have largely
among EM economies and has grown in line with global import demand (Fig 15). The EU and US are India’s
geographic and product two largest destinations of pharma exports (Fig 16). Further, share of the two
diversification regions in India’s overall exports has increased during the past decade. Yet,
the combined share of pharma product exports still accounts for just above
one-thirds of total pharma exports by India. EM economies, particularly Asia
and Africa, are important destinations for India’s pharma exports.
Fig 15 – Share of pharma in India’s overall exports

35 1.6
(India's global share, %)
30 1.4
(Export growth, %)
25 1.2
20 1.0
15 0.8
10 0.6
5 0.4
0 0.2
-5 0.0
2002 2003 2004 2005 2006 2007 2008 2009
Overall exports - global share (RHS)
Pharmaceutical exports - global share (RHS)
Overall exports - growth
Pharmaceutical exports - growth

Fig 16 – Destination of India’s pharma exports

’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
(Share in India's total pharma exports, %)
US 12.8 17.9 14.9 16.4 11.4 15.6 22.3 19.4 23.3
EU 12.7 13.7 14.2 14.5 15.7 11.9 13.0 17.9 13.0
Russia 8.7 7.1 8.1 7.9 9.0 9.1 7.3 6.7 5.2
South Africa 1.3 1.3 1.9 1.9 2.0 2.3 2.9 3.8 3.8
Nigeria 7.0 5.1 4.8 4.8 4.5 4.1 3.5 3.6 3.3
Brazil 3.5 3.0 2.4 2.3 2.5 2.9 2.2 2.3 2.3
Ukraine 2.1 2.1 2.6 3.4 3.6 3.5 3.1 3.0 2.1
Viet Nam 3.2 2.5 2.2 2.1 2.2 2.1 2.0 1.6 1.9
Sri Lanka 2.7 2.9 2.8 2.4 2.7 2.5 2.0 1.8 1.8
Kenya 1.8 1.3 1.3 1.1 1.3 1.7 1.7 2.3 1.8
Ghana 1.0 1.0 0.9 1.0 1.1 1.2 1.5 1.2 1.6
Congo 1.0 1.3 1.0 1.1 0.9 1.1 0.9 1.0 1.4
Nepal 2.9 2.3 2.2 2.0 1.9 1.7 1.6 1.3 1.4
Uganda 1.0 1.0 1.1 0.9 0.9 1.1 1.1 1.1 1.3
Australia 0.8 0.5 0.6 0.6 1.0 0.8 0.8 0.8 1.3
Tanzania 0.6 0.6 0.6 0.6 0.9 1.0 0.9 1.1 1.2
Myanmar 1.0 0.9 0.9 1.0 1.0 1.1 1.1 1.0 1.1
Ethiopia 0.6 0.5 1.0 0.8 0.5 0.9 0.6 0.7 1.0
UAE 1.5 1.0 1.6 1.5 1.5 1.1 1.1 1.0 1.0
Afghanistan 0.1 0.3 1.4 1.0 1.2 1.3 1.0 1.1 1.0
Others 33.8 33.9 33.6 32.7 34.1 33.0 29.4 27.2 29.0
(India's total pharma exports, US$ m)
1,067 1,394 1,600 1,909 2,346 2,992 3,834 5,005 5,011
Some notable observations in share of pharma products exports from India

in total pharma imports by major trade partners are (Fig 17):
 While India’s share as the source of pharma imports by the EU and US
has seen some improvement, such shares remain modest, especially in
the EU.
 During the past decade, share of sourcing from India has either
increased sharply in some of the Asian and African EM economies
(e.g., South Africa, Sri Lanka, Kenya, Uganda, Congo, Tanzania and
Myanmar) or India’s high share has remained substantial in overall
pharma imports by Nigeria, Vietnam, Ghana and Nepal.
 While India’s share as the source of pharma imports has declined in
Russia, it is maintaining considerable market share in select countries
from the East European (Ukraine) and Latin American (Brazil)
countries.

Fig 17 – Share of sourcing from India in total pharma imports

’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
(Share of sourcing from India in total pharma imports of the trade partner, %)
US 0.9 1.2 0.9 1.0 0.8 1.1 1.7 1.8 2.1
EU 0.2 0.2 0.2 0.2 0.3 0.2 0.3 0.4 0.3
Russia 5.2 6.3 5.7 5.3 4.9 4.4 4.2 3.7 3.1
South Africa 2.2 3.1 3.9 3.7 4.1 5.1 7.4 12.2 12.0
Nigeria 72.0 46.3 61.1 .. .. 51.0 57.7 .. 58.8
Brazil 2.4 2.7 2.6 2.4 2.8 3.3 2.4 2.7 2.5
Ukraine 6.6 6.9 7.0 8.8 8.0 7.6 6.1 6.2 7.7
Viet Nam 10.0 9.6 8.5 8.9 9.5 10.4 9.8 8.7 10.6
Sri Lanka 35.3 43.0 47.2 45.3 51.7 52.5 49.4 50.1 52.9
Kenya 21.6 18.5 19.0 17.1 18.9 24.8 29.3 39.1 32.2
Ghana .. .. 33.8 36.9 47.1 .. 72.9 57.9 38.1
Congo 24.3 34.6 29.2 34.3 32.1 40.7 37.1 45.4 56.1
Nepal .. .. 87.6 83.4 .. .. .. .. 52.3
Uganda 22.1 30.3 24.5 21.0 26.2 26.4 23.5 22.4 31.5
Australia 0.4 0.3 0.3 0.2 0.5 0.5 0.5 0.6 0.9
Tanzania 13.3 23.4 19.6 21.0 18.7 34.3 21.6 40.0 55.9
Myanmar 19.2 23.0 24.7 26.6 26.9 33.5 32.7 33.7 32.5
Ethiopia 16.4 15.6 27.8 20.2 8.5 16.6 10.5 16.3 15.9
UAE 5.9 4.8 6.7 6.2 6.0 5.2 5.1 4.8 4.5
Afghanistan 8.5 12.6 38.0 .. .. .. .. .. ..
Others 0.9 1.1 1.1 1.0 1.1 1.2 1.1 1.2 1.2
India’s pharma export basket (Fig 18) compared with that globally (Fig 14)
shows a high level of synchronisation. Except antisera and other blood
fractions, which account for 11% of global pharma trade, India has
considerable presence in all major verticals of the global pharma markets.
For medicaments nes (not elsewhere specified) in dosage, which account
for 60% of global exports, India’s global share has increased from 0.7% in
’01 to 1.2% in ’09 (Fig 19). India also maintains considerable global market
shares and thereby high global rankings in antibiotic, hormone-based and
vitamin products (Fig 20). During the previous decade, growth in the value
of most exports from India surpassed corresponding global rates, resulting
in gain in India’s global market shares.
Fig 18 – Composition of India’s pharma exports

’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
Medicaments nes, in dosage 48.4 49.7 57.0 53.3 59.2 56.8 53.1 52.1 58.4
Antibiotics nes, in dosage 9.6 10.7 10.0 10.1 11.6 12.3 14.9 16.4 10.0
Hormones nes, formulated, in bulk 4.0 1.8 3.3 3.0 1.5 2.3 4.9 5.7 5.2
Vaccines, human use 4.9 4.7 4.3 3.5 2.8 5.2 3.5 1.3 5.2
Medicaments nes, formulated, in bulk 12.7 16.1 6.7 8.0 4.6 4.8 5.2 4.3 4.5
Vitamins and their derivatives, in 5.0 4.6 4.7 5.0 5.4 5.3 3.9 6.5 4.4
dosage
Penicillin etc, in dosage 8.1 5.5 5.7 5.8 6.5 5.5 5.4 5.2 4.0
Antibiotics nes, formulated, in bulk 0.6 1.4 2.6 4.7 2.2 3.0 2.4 3.0 2.0
Hormones nes, in dosage 1.7 1.5 0.8 0.9 1.1 0.8 0.9 0.7 0.9
Alkaloids, in dosage 1.2 0.7 0.7 0.7 0.9 0.6 1.0 0.9 0.8
Penicillin etc, formulated, in bulk 0.4 0.5 0.9 0.9 0.5 0.5 0.4 0.6 0.7
Insulin, in dosage 0.0 0.0 0.4 1.3 1.0 0.6 1.0 0.7 0.7
Contraceptive based on hormones 0.4 0.3 0.5 0.6 0.3 0.3 0.6 0.6 0.6
Dressings etc, nes 0.5 0.3 0.7 0.5 0.7 0.6 0.6 0.5 0.6
Others 2.5 2.1 1.8 1.7 1.8 1.5 2.2 1.6 2.0
Source: International Trade Centre (ITC) and Anand Rathi Research.

Fig 19 – India’s market share in major pharma products

’01 ’04 ’05 ’07 ’08 ’09 India' s exports Global exports
CAGR: ’01-09 CAGR: ’01-09
Medicaments nes, in dosage 0.7 0.7 0.9 0.9 1.1 1.2 24.2 16.8
Antibiotics nes, in dosage 1.4 2.2 2.8 5.3 6.5 3.7 21.9 8.0
Hormones nes, formulated, in bulk 26.2 8.3 5.5 17.1 28.9 26.5 25.3 25.1
Vaccines, human use 1.9 1.5 1.2 1.5 0.6 1.4 22.3 26.3
Medicaments nes, formulated, in bulk 4.4 3.7 2.6 3.5 3.2 4.2 6.5 7.2
Vitamins and their derivatives, in dosage 2.8 3.5 4.4 4.0 7.4 5.8 19.5 9.1
Penicillin etc, in dosage 5.1 4.2 5.3 5.7 6.7 6.1 11.1 8.7
Antibiotics nes, formulated, in bulk 1.7 14.3 6.8 10.3 15.2 6.7 40.5 18.1
Hormones nes, in dosage 0.3 0.2 0.2 0.3 0.3 0.3 12.0 10.5
Alkaloids, in dosage 0.8 0.5 0.7 1.3 1.2 1.4 15.9 8.4
Penicillin etc, formulated, in bulk 3.7 7.3 5.7 8.7 11.5 15.4 29.3 8.4
Insulin, in dosage 0.0 0.7 0.5 0.7 0.5 0.5 101.1 19.4
Contraceptive based on hormones 0.5 0.7 0.4 0.9 0.8 0.9 27.1 19.0
Dressings etc, nes 0.4 0.5 0.7 0.8 0.8 0.9 23.7 11.3
Others 0.2 0.1 0.1 0.1 0.1 0.1 18.2 21.2
Fig 20 – Global ranking of India, in terms of major pharma exports

50
(India's global rank in export)
45
40
36
34
29
28
30
23
22
20
20
17
17
17
15
15
15
14
13
13
10
10
10 10
9
9
7
7
6
5
3
2
2
2
Human blood etc;microbial prep nes

Insulin, formulated, in bulk
First-aid boxes and kits
Dental cements etc

Antibiotics nes, formulated, in bulk
Medicaments nes, formulated, in bulk

Alkaloids etc.,in bulk
Contraceptive based on hormones
Waste pharmaceuticals
Gel preparations
Dressings etc.,nes
Heparin etc.,nes
Blood-grouping reagents
Extracts of glands
Suture matls,etc.
Antisera and other blood fractions

Dressings etc.
Penicillins etc.,formulated,in bulk
Vitamins and their derivatives,in
Insulin, in dosage
Antibiotics nes, in dosage
Opacifyg prep,etc.
Hormones nes,formulatd
Medicaments nes, in dosage

Vaccines, human use
Hormones nes, in dosage
Vaccines, veterinary use

Adrenal cortex hormones, in dosage
Penicillins etc, in dosage
Alkaloids, in dosage
An interesting aspect of India’s pharma exports is the substantially lower

unit value relation in almost all categories compared with the global average
(Fig 21). To a large extent, this seems to reflect the high proportion of
generics as against patented drugs in India’s exports portfolio.
Consequently, India’s share in global pharma exports is much higher when
measured in terms of volume rather than value (Fig 22).
Fig 21 – Unit value realisation on pharma exports

(Per unit realisation, US$)
500
400
300
200
100
0
Dressings etc.
Opacifyg prep,etc.
Insulin, in dosage
Suture matls,etc.
Vaccines, human use

Glands and other organs, dried

Dressings etc.,nes
Vitamins and their derivatives,in dosage

Waste pharmaceuticals, nes
Gel preparations
Dental cements etc


Heparin etc.,nes

Extracts of glands
India World

Fig 22 – Global share of India pharma exports – Value versus volume

32
52
28
(Global share, %)
24
20
16
12
8
4
0
Opacifyg prep,etc.
Dressings etc.
Insulin, in dosage
Suture matls,etc.

Vaccines, human use

Glands and other organs, dried

Heparin etc.,nes

Gel preparations

Dressings etc.,nes
Dental cements etc

Vitamins and their derivatives,in dosage
Waste pharmaceuticals, nes

Extracts of glands

Quantity Value
Outlook for the Indian Pharma industry

For the Indian pharma industry, we With India witnessing considerable improvement in per-capita income
expect 15% CAGR of domestic growth over the past decade, outlook for the domestic healthcare industry
demand and 20% CAGR of looks promising. Our estimates suggest that the average income demand
exports elasticity for medical and healthcare since the mid 1990s is ~1.35.
Therefore, if India maintains a real growth of 8.5% and population grows
by 1.5%, the growth in medical and healthcare spending is likely to be
~9.5% in real terms and 15% in monetary terms per year, assuming 5.5%
average inflation.
As the biggest exporter of pharma products among EM economies, India is
currently poised to further increase global share. The presidential nod to the
healthcare reform law in the US in Mar ’10 has a special significance in this
context. The US currently accounts for over 40% of the global healthcare
spend, mainly on account of the high drug prices. The new law attempts to
provide healthcare coverage to 32m Americans who are currently excluded
from medical insurance coverage. In such a situation, the US would need
drastic reduction in the cost of medicines. This could be achieved inter alia
by increasing use of generic drugs. With the highest number of US FDA-
approved manufacturing facilities outside the US, chemistry skills and low
costs, India is likely to be the favoured option for US pharma companies
looking for sourcing generic drugs as well as partnerships. This offers
considerable opportunities for the Indian pharma companies who already
have 2% share of the overall US pharma imports.
With the healthcare market size of ~US$350bn and only US$13bn worth of
pharma product imports, Japan seems to be yet another promising market.
Japan’s pharma imports from India are currently less than US$10m. The
strict health regulations played a major role, keeping the Japanese pharma
markets sheltered from international competition. Moreover, the preference
of the Japanese population for patented drugs over generics has limited the
penetration of Indian exports into this market. The situation, however, is
changing. For the first time, a large number of drugs patented by Japanese
companies are going off patent. Rapid pace of population aging and
associated high healthcare expenditure is also increasing the popularity of
generics in Japan. Daiichi Sankyo is also likely to use Ranbaxy as a low-cost
production base to cater for the generics demand from Japan. These factors
are likely to boost exports prospects of pharma products to Japan.
Globally, spend on pharma products is witnessing a major rise across EM

economies as well as generics products. Given large pharma companies

producing generics products and the existing large exports base catering for
Asian and African countries, Indian pharma companies are poised to
increasingly leverage on both the opportunities.
Over the past decade, global trade in pharma products has increased by an
average annual rate of 17% while Indian pharma exports have increased
22%. While the rise in proportion of generics is likely to lead to deceleration
of growth in global pharma trade, India is likely to maintain strong growth
in pharma exports with highest number of US FDA-approved
manufacturing facilities outside the US, chemistry skills and low costs. We
expect India’s pharma exports to maintain 20% CAGR over the next five
years.
Despite several positive drivers for the Indian pharma companies, both on
the domestic and exports fronts, the outlook is not without challenges.
 In order to guard against sharp fall in revenue because of their major
drugs going off patent, many of the industrialised countries’ drug
manufacturers are introducing ‘branded’ generics for such off-patent
products. While prices of such generics are generally much lower than
during the period of patent protection, they are much higher than plain
vanilla generic versions offered by Indian manufacturers. Yet, brand
loyalty often poses significant challenge for Indian pharma players to
penetrate the market.
 The commoditisation of various generics drugs in major industrialised
countries due to intense competition often results in reduced profit
margins of Indian exports. Interestingly, despite accounting for over
40% of global healthcare spend, the US contributes ~20% of India’s
exports. In order to maintain margins, Indian pharma companies are
looking at other geographies, particularly emerging Asia and Africa.
 The growing global market for generics is attracting major pharma
companies of industrialised countries. Through M&As and alliances
with EM pharma companies, MNCs are attempting to build low-cost
production bases for exports and increase market shares in such EM
economies as well.
 Attracted by the fast-growing domestic demand for generic drugs, the
existing foreign pharma firms operating in India and many incumbents
have started targeting the generics market within EMs.

Generics companies in sweet spot

Indian companies are well-placed to capitalise on emerging
opportunities in the generics space, driven by patent expiries worth
>US$200bn over CY10-15, push by global governments for generic
drugs and emerging innovator-generics partnerships (Pfizer-
Aurobindo, GSK-DRL etc). We believe the generics business would
remain the key growth driver on the back of India’s low-cost
manufacturing advantage, well-established presence of Indian
pharma players across the globe, increasing generics penetration (in
regulated markets such as the US and Japan) and patent expiries.
Further, large innovators are now focusing on generics to maintain
their growth momentum and revenue share, which indicates strong
future for the generics market.
Generics to witness faster growth

The global generics pharma market grew ~12.6% in ’08 to ~US$106bn (Fig
23), which is ~14% of the overall pharma (patented and generics) market.
The growth was lower in ’08 due to the global economic slowdown, which
led to inventory rationalisation on account of credit crunch. Between ’04
and ’08, the generics pharma market registered 18.8% CAGR versus 6.5%
in the overall pharma sector. In the generics segment, the US is the largest
market and accounts for ~41% of the global generics market with ~18%
generics penetration in value terms, followed by the EU, Canada etc.
Further, Indian generics companies are witnessing high double-digit growth
rate.
Fig 23 – Regional share of global generics market (CY08)

Others
19%
Japan
USA
3%
41%
Spain
4%
Italy
4%
Canada
6%
UK
6% France
Germany
7% 10%
Source: Cygnus, Glenmark Pharma
Global pharma in transformation phase

The global pharma industry is undergoing a major change in terms of
increasing focus on generic products, consolidation, and in-licensing and
out-licensing deals. According to industry reports, the global generics
market is expected to continue witnessing +15% CAGR over the next five
years compared with 4-5% CAGR for the overall global pharma market.
Growth rate for the global pharma market is tapering down owing to patent
expiries and shift to low-cost generics from patented drugs, and is expected
to see <5% CAGR over CY08-13e to achieve US$975bn in ’13e (Fig 24).

Fig 24 – Global pharma market: Growth rate tapering

(US$ bn) (%)
1,200 12
1,000 10.2 10
4.5% CAGR
800 7.9 8
7.2
6.8
600 6.6 6
400 4.8 4
200 2
CY03
CY04
CY05
CY06
CY07
CY08
CY13e
US$ bn Growth (%)
Source IMS Health, Jubilant, Anand Rathi Research
North America is the largest pharma market accounting for ~41.4% market
share, mainly on account of big patented brands. The penetration of
generics drugs is still quite low, at less than 12%. The North American
market was valued at US$307.3bn in ’08. After the US, the EU and Japan
are the second- and third-largest markets respectively, also dominated by
big patented brands. The expiry of patents of several drugs is expected to
lead to a slowdown in these markets as the pipeline consisting of novel
molecules is not strong enough to offset the loss caused by expiries of
existing patents. On the other hand, EMs (especially India), which depend
mainly on branded generics, are expected to witness rapid growth.
Fig 25 – Geographical breakdown: World pharma market (CY08)

Africa Middle East Others
1% 1% 12%
Indian Sub-
continent
1%
CIS US
2% 42%
Latin America
6%
South East and

East Asia
6%
EU
29%
Source IMS Health, Glenmark Pharma
Generics entail huge cost and operational advantage

To build an innovative molecule and patent involves a cost of >US$1bn and
takes 7-12 years. On the other hand, it takes just 2-3 years to develop a
generics drug at a much lower cost. Further, developing a new molecule
involves considerably high risk and is rife with uncertainties as regards its
success. However, innovative drugs provide enhanced rewards in terms of
high profits and exclusive marketing rights during the patent period, where
generics witness intense competition and provide limited profit margins.
Generics drug manufacturers may sell generics products of innovative
molecules in EMs where patent does not hold (until those markets recognise
product patents). Generics drugs can only be sold in those developed markets
where the patent has expired or has been found invalid or unenforceable.

Fig 26 – Lifecycle: Branded vs. generics drugs
Source IMS Health, Cipla
Patent expiries – Major trigger

We believe patent expiries over the next 3-5 years would provide significant
opportunities for generics players – both for sustainable growth as well as
one-time opportunities. Patents of drugs worth >US$200bn would expire
over ’09-15 (Fig 27), indicating significant growth opportunity for generics
going forward. Generally, the expiry of a patent leads to intense
competition due to entry of generics players that, in turn, results in
significant price erosion (in some cases >90% in one year). Even so, patent
expiries entail strong growth opportunity for generics; hence, we expect
additional business worth +US$2bn every year for generics from patent
expiries for the next few years.
Indian generics players are well placed to capitalise on this opportunity with
ready regulatory filings, technical capabilities and sufficient capacity. In
addition to regular generics business post patent expiry, para IV filing with
first to file (FTF) status provide the generics player an opportunity to
market the product co-exclusively with the innovator for 180 days. During
this exclusivity period, the generics player gets more than even 50% market
share with lower price erosion (30-40%). Therefore, this period provides
huge one-time cash flows to the generics player from the expiring product
patent.
Fig 27 – Opportunity from patent expiries (at innovator prices)

(US$ bn)
250
204
200
150
121
100
50 28 28 27
0
CY10
CY11
CY12
CY13-CY15
Total (CY10-
CY15)
Source IMS Health, Glenmark Pharma

US – Immense opportunities for generics

The US remains the largest opportunity for generics players as the market
accounts for ~41% of the global generics business in value terms; also, a
pipeline of patent expiries would provide further impetus for generics. The
US generics market registered 15.2% CAGR over ’04-08 to US$39.3bn,
primarily driven by patent expiries and increased acceptance of generics by
medical professionals and healthcare companies. However, the growth rate
dipped to 5.6% in ’08 due to the global economic slowdown, leading to
inventory rationalisation by distributors and wholesalers. Generics
prescription in the US market is estimated to have increased, from 43% of
total prescriptions in ’02 to 72% in H1CY09, which indicates growing
demand for generic drugs.
Fig 28 – Consistent rise in share (volume terms) of generics in prescriptions in US

100%
28%
43% 39%
75% 51% 47%
57% 54%
50%
72%
57% 61%
25% 49% 53%
43% 46%
0%
CY02
CY03
CY04
CY05
CY06
CY07
H1CY09
Generics Branded
Source IMS Health, Teva, Glenmark Pharma
However, in value terms, generics account for only 18% of total sales in the
US, thereby implying that significant value lying in patented pipeline would
decline owing to patent expiries and shift towards low-price generics
products. The number of generics prescriptions has been growing
consistently, from 1.4bn in ’00 to 2.8bn in 1HCY09, implying 8% CAGR
over the same period.
Fig 29 – Consistent rise (8% CAGR) in generics prescriptions in the US

(bn)
3 2.8
2.6
2.5
2.3
2
2 1.8
1.7
1.6
1.5
1.4
0
CY00
CY01
CY02
CY03
CY04
CY05
CY06
CY07
CY08
H1CY09
Source IMS Health, Teva, Anand Rathi Research

Increasing generics penetration to drive growth

Generics penetration is set to increase in regulated markets on the back of
several global governments’ extensive efforts to promote generics due to
escalating healthcare costs, patent expiries in these markets and pressure on
global pharma majors to reduce the cost of medicines. Generics penetration
in regulated markets is quite low (below 20% in value terms) at present, but
is expected to grow to 20- 50% over next 3-4 years (Industry reports).
Significant opportunity would arise in the US, EU and Japan for generic
players.
Fig 30 – Generics penetration in regulated markets

(%)
25
20.8
20
16.3 16.2
15
11.7 12.2
10.4 11.2
8.8
“The proposed health care reform 10
legislation must and will get paid 5

for, while preserving what is best
about the current American health 0
care system.” – Barack Obama
US
EU
Japan
Canada
2007 2012e
Source IMS Health, Teva
US President Barack Obama has taken an innovative step towards

reforming the US healthcare system by hiking the Food and Drug
Administration’s (FDA) budget by 19% to strengthen inspections and
“…allowing the importation of safe increase the number of generics drugs in the US market. Increased generics
medicines from other developed penetration would lead to significant cost savings for individuals as well as
countries, increasing the use of the government. We believe the Obama government would keep the
generic drugs in public programs, growth window open for the generics industry, a move that would benefit
and taking on drug companies that Indian generics players.
block cheaper generic medicines
from the market...”
- Barack Obama

Domestic formulations seeing traction

Domestic market witnessed 15% CAGR over ’05-09 and we expect the
trend to continue over ’09-14 led by chronic diseases (+20% CAGR),
increasing reach to rural markets (grew 27% in ’09) through increased
field force and awareness, and continuous rise in private final
consumption expenditure (1.1% in FY1951 to 5.9% in FY08). The
chronic diseases segment would outpace industry growth rate
because of changing lifestyle, leading to diseases such as
cardiovascular and diabetes. The Indian formulations market grew a
healthy 17.4% in ’09 to `401bn. Segmental growth was driven
primarily by strong growth in the anti-diabetic, cardiac, gynaecology
and anti-infectives segments. Abbott, Cipla, GSK, Ranbaxy, DRL and
SPIL are the key players in domestic formulations and have a major
presence in lifestyle-related diseases as well.
Strong growth to continue

We expect the domestic formulations business to continue witnessing
strong growth (15% CAGR over the next five years), in line with the past
five-year CAGR. The Indian formulations market grew 9.9% in ’08, much
lower than the 15% CAGR recorded over CY05-09. The lower growth rate
was mainly on account of reduction in inventory at the retail level, due to
global slowdown that impacted 2-3 months of sales. However, the growth
momentum rebounded, with 17.4% growth in ’09, including the base effect.
Fig 31 – Growth momentum in domestic formulations

(`bn) (%)
900 20
800 17.7 17.4 18
700 16
14.6 15.1 15.2 14
600 13.4 14.0
13.9 12
500
9.9 10
400 9.0
8
300
6
200 4
100 2
0 0
2010e
2011e
2012e
2013e
2014e
2005
2006
2007
2008
2009
Rs bn growth (RHS)
Source: OPPI, Anand Rathi Research
Segmental growth was driven primarily by strong growth in the anti-

diabetic, cardiac, gynaecology and anti-infectives segments. The size of the
domestic pharma market was estimated at `401bn in Dec ’09, with anti-
infectives, cardiovascular and gastro intestinal being the leading categories.
Growing eminence of chronic diseases

Over the past few years, there has been an increase in lifestyle-related
diseases such as cardiac, anti-diabetic and gastro-intestinal. Further,
changing lifestyle has led to significant rise in diseases including high blood
pressure and elevated cholesterol levels. Globally, these ailments have also
been rising at a rapid pace and contributed ~20% to the top-10 therapy
segments. Diabetes, cardiovascular, asthma, obesity, few types of cancer etc
are considered as lifestyle diseases. The anti-diabetes market in India has

seen 25% CAGR over FY05-09, while the cardiac market saw 21% CAGR.
We expect the growth rate of +20% to continue.
Fig 32 – Chronic diseases
Chronic diseases
Diabetes Cardiovascular diseases Others
Type I Coronary heart Obesity
Type II Rheumatic heart Few cancers
Congenital heart Depression
Stroke Liver diseases

Source: Industry
Fig 33 – Factors with relative probability of contracting chronic diseases

Factors CVD Diabetes
Smoking High Less
Obesity High High
Sedentary lifestyle High High
Unhealthy diet High High
Stress High High
Alcohol consumption Less Less
High blood pressure Less Less
Source: Industry
Prevalence of chronic diseases in India is growing at an alarming rate due to

increasing sedentary lifestyle and unhealthy eating habits. Lifestyle diseases
offer sustainable sales and better operating margins compared with acute
segments. Apart from MNCs, Indian companies such as SPIL, Cadila
Healthcare, Lupin, Ipca Labs and Torrent Pharma derive a significant
portion of their sales from these segments.
The lifestyle pattern in India is undergoing a massive change, leading to
increased lifestyle-related issues such as obesity and stress that, in turn, lead
to cardiovascular diseases (CVDs) and diabetes. The anti-diabetic and
cardiovascular markets are expected to grow at a significantly higher rate
(+20%) than the average industry growth rate of ~15%. Further, drugs for
lifestyle diseases offer better price realisations compared with acute
segments. The margin enjoyed in lifestyle segments is 35-40% as against 15-
20% in acute segments.
Fig 34 – Typical cost structure

Acute Lifestyle
Cost of goods sold 65-70% 40-45%
S,G&A expenses 7-8% 10-12%
R&D 5-8% 5-8%
EBITDA 15-20% 35-40%
Source: Industry, Anand Rathi Research

Economic parameters ensure strong growth

India’s economic parameters strengthen our belief of a strong growth story
for the domestic pharma market. India is still far behind other developed
and emerging countries in terms of per capita healthcare expenditure,
proportion of population lacking access to essential medicines, and public
healthcare expenditure as a percentage of GDP. Further, India has
witnessed consistent increase in the proportion of private final
consumption expenditure (PFCE) on healthcare versus total PFCE, from
1.1% in FY1951 to 5.8% in FY08. This indicates the increasing awareness
and affordability among population.
Fig 35 – Continuous rise in proportion of PFCE on healthcare

(%)
6
0
FY1951
FY1961
FY1971
FY1981
FY1991
FY01
FY08
At constant prices At current prices
Source: Industry
About 65% of the population in India does not have access to essential
affordable medicines as against only 15% in China and 47% in Africa. This
is despite the fact that a stringent price control mechanism prevails in the
country and the government has been able to provide medicines in India at
a price which is cheaper than even in smaller economies such as Sri Lanka,
Pakistan and Bangladesh. However, rising income level of Indian
population and increasing healthcare awareness is likely to raise affordability
going forward.
Fig 36 – WHO: Percentage (population) lacking access to essential medicines

EU 14
West Pacific 14
China 15
America 22
SE Asia 26
East Mediterranean 29
Africa 47
India 65
All countries 30
0 10 20 30 40 50 60 70
Source: OPPI

M&As pick up speed

The M&A trend has been ongoing in the Indian pharma space since
the Ranbaxy-Daiichi deal, followed by Abbott acquiring Piramal
Healthcare’s domestic formulations business. We believe the trend is
likely to continue, given MNCs’ focus on India due to higher (mid
teens) and sustainable growth for long term, gaining access to US
FDA-approved capacities and product baskets, and leveraging the
low-cost model in the country. The transactions include takeovers of
whole companies or of particular businesses, and tie ups for dossier
licensing leading to product supply contracts. This has resulted in
premium valuations for Indian pharma companies.
Fig 37 – Recent M&A deals by Indian players with MNCs

Year Indian player MNC Nature of the deal Deal details
CY10 Aurobindo Astra-Zeneca Dossier licensing &
To develop and supply several solid dosage
supply contractsand sterile products (in anti-infectives, CVS
and CNS segments) for EMs
CY10 Piramal Abbott Sale of domestic Abbott acquired Piramal's domestic branded
Healthcare branded formulations formulations division along with 350 brands,
Baddi facility and ~5,200 sales force for
US$3.72bn
CY10 Strides Arcolab Pfizer Licensing and supply To supply 40 off-patent products mainly in
arrangement oncology injectables and would be
commercialised by Pfizer
CY09 Shantha Sanofi-Aventis Acquisition Acquired for ~US$820m and got access to
Biotech Shantha's vaccines pipeline and access to
EMs
CY09 Aurobindo Pfizer Dossier licensing & Formulations and injectables for the US,EU
supply contracts and ROW markets on exclusive and co-
exclusive basis
CY09 Biocon Mylan Development and To develop, manufacture, supply and
supply contacts commercialise many high-value generics
biologic compounds for global markets
CY09 Dr Reddy's GSK Pharma Supply contracts To develop and market +100 branded
Labs products on exclusive basis across an
extensive number of EMs, excluding India
CY08 Strides-Aspen GSK Pharma Upfront milestone To manufacture and supply branded generics
JV and supply contracts to GSK, which would be marketed in ~80
EMs
CY08 Daiichi Sankyo Ranbaxy Acquisition Daiichi acquired Ranbaxy and got access to
the latter’s diversified product portfolio and
vast geographical presence
Recent M&As setting new valuation parameters

The recent acquisition of Piramal Healthcare’s domestic formulations
business by Abbott has created a totally different benchmark for valuations.
The deal valued Piramal’s domestic brand formulations business at more
than 9x sales on a trailing basis, which is unprecedented in the Indian
pharma space. This indicates that MNCs have high interest levels in the
fast-growing Indian pharma market and are prepared to pay high valuations.
We believe that this is just the beginning, and the phase would continue for
sometime. We expect these deals to keep valuations of the Indian pharma
companies as well as the aspiration levels of the promoters high.

Rationale for paying high prices

MNCs are willing to pay high valuations owing to the evident growth
opportunity and better profitability, along with access to a low-cost
manufacturing model.
 India’s market size is expected to double over the next five years:
India’s pharma industry is one of the fastest-growing in the world, with
market size expected to double over the next five years. The industry
saw 15% CAGR over the past five years, which is expected to continue
in view of the huge population, increasing awareness for healthcare and
changing lifestyle.
 To gain influence in this market, MNCs need to growth
inorganically: To gain a leadership position, MNCs would have to
follow the inorganic path and acquire companies with a large existing
presence in the market.
 Expansion across therapeutic areas: Acquisitions would enable
MNCs to expand their presence across therapeutic areas and bridge the
gap with areas where they do not have presence.
 Average EBITDA margin in the market at 22-23%: Better
profitability in the Indian brand market is a major attraction for big
pharma players to reap benefits.
 Low-cost model: The low-cost manufacturing model in India is
another major attraction for MNCs, as it enables them to achieve the
same cost advantage possessed by Indian manufacturers of generics
drugs.
 India emerging as centre for MNC operations in the area:
Acquisitions in India enable MNCs to expand their presence in other
EMs, while making India a focal point for their operations
Emerging novel growth trajectory – Licensing model

Product licensing deals and supply contracts between innovators and
generics players have increased in the recent past, as seen in the case of the
Pfizer-Aurobindo and GSK-DRL deals. We believe deals such as these
would increase going forward, as they are beneficial for both players. The
tapering products pipeline of innovative drugs is forcing innovators to enter
into such deals with manufacturers of generic drugs to protect their top-
line. Such deals also reduce the timeline to build a generics products
pipeline with necessary approvals. Generics players get fixed profit margins
in a highly competitive and price-sensitive market and are also able to
leverage innovators’ strong marketing capability.
These deals generally include long-term supply contracts for generics
products in regulated and unregulated markets, and may or may not include
licensing fees (for providing the right to approved ANDAs and marketing).
Licensing fees typically cover past regulatory expenses and rewards for
ready access to products. We expect this business model to emerge as a new
growth driver for Indian and global players.

More deals to follow

We believe that the aforementioned licensing deals are just the beginning of
this evolving business model and expect more such deals going forward.
Further, most new deals would be signed for emerging countries (other
than developed nations such as the US and EU), as these are under
penetrated markets and are part of the branded generics market rather than
pure generics, which facilitates better profit margins. In our view, deals will
generate mainly on account of:
 Ready capacity with regulatory approvals
 Strong products pipeline across geographies with necessary approvals
 Presence across different therapies
 Cost efficiency
 Presence in branded generics as Rest of the World (RoW) would be the
key target
 Full vertical integration (APIs and formulations)
Pharma MNCs are mainly interested in expanding their presence in branded
generics in emerging countries as well as entering the generics market of the
US and EU. Such deals also provide cost benefits to MNCs as, without
such tie-ups, they are not able to compete with low-cost Indian
manufacturers. Further, such deals provide MNCs with ready access to
regulatory-approved plants and to already built-up product pipelines for
various geographies with necessary approvals. The strong marketing and
distribution network of MNCs allows them to save on these costs, as
against Indian players, and earn profits.
Fig 38 – Comparative strengths for potential M&As

Domestic formulations Product basket RoW presence Cost efficiency
Aurobindo • √√√ √ √√
Biocon •√ √√√ √√ √√√
Cipla • √√ √√√ √√ √√√
Dr Reddy's Labs • √√ √√√ √√√ √√
Glenmark •√ √√ √√ √√
Ipca Labs •√ √√ √√√ √√
Sun Pharma • √√ √√√ √ √√√
Source: Anand Rathi Research


Company section

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Aurobindo Pharma Rating: Buy

Target Price: `1,560
Still undervalued; initiate with Buy Share Price: `1,127
We initiate coverage on Aurobindo Pharma with Buy and target

price of `1,560. We are positive on Aurobindo mainly owing to Sriram Rathi
our expectation of strong growth momentum, rise in number of +9122 6626 6737
licensing deals, easing leverage and attractive valuations. sriramrathi@rathi.com
 Significant growth potential. Over 1,100 dossier filings globally, Sanjeev Chiniwar
126 ANDA approvals and ~50% unutilised formulations capacity +9122 6626 6716
provide significant growth potential. We expect Aurobindo to
report 17.5% revenue CAGR over FY10-13e (conservative basis).
 Dossier licensing and supply deals add visibility. Aurobindo’s
new business model involves foray into dossier licensing and supply Key data ARBP IN/ARBN.BO
contracts with MNCs such as Pfizer and Astra Zeneca that provide 52-week high/low `1,178/`735
Sensex/Nifty 20125/6063
upfront income (`1.5bn each over FY11, FY12, FY13) and add
3-m average volume US$6.4m
growth visibility via supply contracts (to contribute 19% of CAGR).
Market cap `66bn/US$1462m
 Easing financial leverage. Aurobindo’s D/E has reduced to Shares outstanding 58m
1.2x in FY10 from 1.8x in FY09 and is likely to further dip to 0.5x Free float 45.5%
in FY13e led by strong growth. We estimate net profit CAGR of Promoters 54.5%
17% (24.9% ex dossier licensing income) over FY10-13e. Foreign Institutions 22.5%
Domestic Institutions 11.7%
 Valuations. At CMP, the stock trades at 12.8x FY11e and 10.1x Public 11.4%
FY12e earnings. Current valuations are at +50% discount to large-cap
peers and 20% discount to its past 5-year average (14.5x). We believe
that the discount is unjustified, given strong growth visibility and
improving balance sheet. Delay or failure in execution of supply
contracts is the key downside risk as we expect 19% growth from
these contracts.
Key financials Relative price performance

Year-end 31 Mar FY09 FY10 FY11e FY12e FY13e
Sales (`m) 30,773 35,754 40,728 48,936 56,255
Net profit (`m) 2,947 4,838 5,148 6,499 7,745 200
EPS (`) 50.5 82.9 88.2 111.4 132.7 180 Aurobindo
Growth (%) 62.0 64.2 6.4 26.2 19.2 160
PE (x) 22.3 13.6 12.8 10.1 8.5 140
120
PBV (x) 4.9 3.4 2.7 2.4 1.9
100 Sensex
RoE (%) 24.9 31.5 24.1 25.0 24.9
80
RoCE (%) 10.9 13.9 13.5 15.7 17.2
Aug-09
Dec-09
Feb-10
Oct-09
Apr-10
Jun-10
Aug-10
Oct-10
Dividend yield (%) 0.4 0.4 0.5 0.7 0.8

Net gearing (%) 188.0 117.8 78.2 71.5 48.2
Source: Company, Anand Rathi Research Source: Bloomberg
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment
decision. Disclosures and analyst certifications are located in Appendix 1
Anand Rathi Research

India Equities
18 October 2010 Aurobindo Pharma - Still undervalued; initiate with Buy
Quick Glance – Financials and Valuations

Fig 1 – Income statement (`m) Fig 4 – PE Band
Net sales 30,773 35,754 40,728 48,936 56,255 (`m)
Sales growth (%) 25.8 16.2 13.9 20.2 15.0 2,000
- Op. expenses 25,599 27,523 31,917 38,099 43,650 20x
EBITDA 5,174 8,232 8,811 10,837 12,605 Valuations declined due to
1,600
EBITDA margins (%) 16.8 23.0 21.6 22.1 22.4 high leverage concern and
lower profitability 15x
- Interest 932 731 802 976 1,090
1,200
- Depreciation 1,276 1,493 1,685 1,984 2,155
+ Other income 261 442 277 247 321 10x
800
- Tax 280 1,889 1,452 1,625 1,936
PAT 2,947 4,838 5,148 6,499 7,745 5x
400
PAT growth (%) 62.0 64.2 6.4 26.2 19.2
Consolidated PAT 2,947 4,838 5,148 6,499 7,745
0
FDEPS (`/share) 50.5 82.9 88.2 111.4 132.7
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
CEPS (`/share) 65.2 97.7 105.5 131.0 152.8
DPS (`/share) 4.5 5.0 6.2 7.8 9.3
Source: Company, Anand Rathi Research Source: Bloomberg, Anand Rathi Research
Fig 2 – Balance sheet (`m) Fig 5 – EV/EBITDA Band

Share capital 269 279 292 292 292 (`m)
Reserves & surplus 12,144 18,012 24,153 27,196 34,306 170,000
Shareholders’ fund 12,413 18,291 24,445 27,488 34,598 16x
150,000
Debt 24,098 22,457 20,030 20,572 17,572
Minority interests 32 43 43 43 43 130,000
12x
Capital employed 36,543 40,792 44,518 48,102 52,213 110,000
90,000
Fixed assets 19,351 22,809 24,374 24,640 23,985 8x
70,000
Investments 3 3 3 3 3
Working capital 15,913 17,251 19,432 23,314 26,790 50,000
4x
Cash 1,277 728 710 146 1,436 30,000
Capital deployed 36,543 40,792 44,518 48,102 52,213
10,000
No. of shares (m) 53.8 55.7 58.4 58.4 58.4
Oct-06
Aug-07
Jan-08
Jun-08
Nov-08
Apr-09
Sep-09
May-06
Feb-10
Jul-10
Mar-07
Net Debt/Equity (%) 1.9 1.2 0.8 0.7 0.5

WC turn (days) 106.9 112.4 112.4 110.3 112.4
Fig 3 – Cash flow statement (`m) Fig 6 – Consistent rise in proportion of formulations
Consolidated PAT 1,040 5,805 5,148 6,294 7,487 (`bn (%)
+ Depreciation 1,276 1,493 1,685 1,984 2,155 40 65.9 70
Cash profit 2,316 7,298 6,834 8,278 9,642 62.8 65
35
- Incr/(Decr) in WC 4,017 1,338 2,181 3,479 3,375 57.6 60
30
Operating cash flow (1,701) 5,960 4,653 4,799 6,268 53.6
55
- Capex 5,774 4,678 3,250 2,250 1,500 25
46.1 50
Free cash flow (7,475) 1,282 1,403 2,549 4,768 20 37
30 45
- Dividend 283 324 422 515 613 39.4
15 23 40
+ Equity raised 0 0 0 0 0 19
+ Debt raised 4,860 (1,784) (2,427) 541 (3,000) 10 31.2 14 35
7 10
- Investments 36 143 0 0 0 5 30
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
- Misc. items (1,385) (421) (1,427) 2,924

Net cash flow (1,550) (549) (19) (349) 1,154
+ Opening cash 2,826 1,277 728 710 360 Formulations Revenue % of total revenue (RHS)
Closing cash 1,277 728 710 360 1,515
Source: Company, Anand Rathi Research Source: Company, Anand Rathi Research


We initiate coverage on Aurobindo Pharma with a Buy rating and
target price of `1,560 per share. We are positive on Aurobindo
mainly owing to our expectation of strong growth momentum,
better visibility from supply deals with MNCs, easing leverage,
beginning of cash flow generation and attractive valuations.
Significant growth potential

Aurobindo has successfully transformed itself from an API player into a
strong formulations player. More than 1,100 dossiers filing across the
globe, 126 ANDA approvals and ~50% unutilised formulations capacity
provide significant growth potential. We expect Aurobindo to register
17.5% revenue CAGR over FY10-13e on a conservative basis.
Aurobindo is well placed to ramp-up its formulations business at a fast
pace on the back of a strong pipeline of regulatory filings and approvals,
dossier licensing, new supply contracts with MNCs and huge unutilised
capacity. Aurobindo is one of the few generics companies that have +100
ANDA approvals and +1,100 registrations in other geographies.
Increasing proportion of formulations in total revenue has led to rise in
EBITDA margins. We estimate contribution of formulations to total
revenue (excluding dossier licensing) to increase to 65.9% in FY13e from
46.1% in FY09. APIs would grow at a steady pace, of 4.2% CAGR during
FY10-13e and their contribution to total revenue would decrease due to
lower growth.
Dossier licensing and supply deals add visibility

Aurobindo’s new business model involves foray into dossier licensing and
supply contracts with MNCs such as Pfizer and Astra Zeneca that provide
upfront income (`1.5bn each over FY11e, FY12e, FY13e) and add growth
visibility via supply contracts (to contribute 19% of total revenue CAGR over
FY10-13e). Also, the company has a few similar, albeit smaller, licensing
deals with European customers. Aurobindo signed its first big deal in Mar
’09 with Pfizer, with the deal size having expanded thereafter; we believe
Aurobindo has already received a +US$60m dossier licensing milestone
income from Pfizer as of date. The company entered into a new deal with
Astra Zeneca recently, for supplying branded generics for emerging
countries. Though smaller than Pfizer’s, the Astra Zeneca deal gives
growth visibility.
Easing financial leverage

Aurobindo’s debt-to-equity has reduced, from 1.8x in FY09 to 1.2x in
FY10; we expect it to further reduce to 0.5x in FY13e led by strong
revenue growth and profitability expansion (net profit margin likely to
improve to 13.8% in FY13e) from 12.6% in FY11e. We expect net profit
CAGR of 17% (24.9% excluding dossier licensing income) over FY10-
13e. EBITDA margin (ex dossier licensing income) has improved, from
12.8% in FY09 to 18.3% in FY10, and is further expected to improve to
20.3% in FY13e on the back of better revenue mix (higher formulations
sales) and increasing capacity utilisation.

Valuations
At CMP, the stock trades at 12.8x FY11e and 10.1x FY12e earnings.
Current valuations are at +50% discount to large-cap peers and 20%
discount to its past 5-year average (14.5x). We believe that the discount is
unjustified, considering strong growth visibility and improving balance
sheet.
We believe Aurobindo is still trading at attractive valuations, despite huge
re-rating from 3x one-year forward earnings to 12x one-year forward
earnings over the past 1.5 years. We initiate coverage with Buy and target
price of `1,560 per share, based on 14x FY12e earnings.
Fig 7 – One-year forward P/E

(`m)
2,000
20x
1,600 Valuations declined due to
high leverage concern and
lower profitability 15x
1,200
10x
800
400 5x
0
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Risks to our target price

 Any delay/failure in execution of supply contracts with MNCs may
impact growth momentum and valuations. We believe that 19% of
the revenue CAGR over FY10-13e would be driven by such supply
contracts
 Currency fluctuation, as +60% of revenue is contributed by exports
and the company has ~US$140m worth of FCCBs

Significant potential to ramp up

growth
Aurobindo has successfully transformed itself from an API player
into a strong formulations player. More than 1,100 dossiers filing
across the globe, 126 ANDA approvals and ~50% unutilised
formulations capacity provide significant growth potential. We
expect Aurobindo to register 17.5% revenue CAGR over FY10-13e on
a conservative basis. Aurobindo is well placed to rapidly ramp-up
its formulations business on the back of a strong pipeline of
regulatory filings and approvals, dossier licensing, new supply
contracts with MNCs and huge unutilised capacity. We estimate
contribution of formulations to total revenue (ex dossier licensing)
to increase to 65.9% in FY13e from 46.1% in FY09.
Formulations – Ripe for picking

We expect Aurobindo’s formulations business to grow rapidly on the back
of huge manufacturing capacity, strong pipeline of regulatory filings and
approvals, new supply contracts with MNCs and continuous launch of
new products. We estimate 25.7% revenue CAGR over FY10-13 to
`36.8bn from the formulations segment. Cumulative 173 ANDA filings,
including 126 (of which 29 are tentative approvals) already approved,
would drive significant revenue growth for Aurobindo. Further, dossier
licensing and supply contracts would also assist in maintaining the growth
momentum, as is evident from its contracts with Pfizer and Astra Zeneca.
We expect the proportion of formulations to total revenue (excluding
dossier licensing) to increase to 65.9% in FY13e from 46.1% in FY09.
Fig 8 – Continuous rise in formulations proportion to total revenue

(`bn) (%)
40 65.9 70
62.8 65
35
57.6 60
30
53.6
55
25
46.1 50
20 37
30 45
15 39.4
23 40
19
10 31.2 14 35
7 10
5 30
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
Formulations Revenue % of total revenue (RHS)
Source: Company, Anand Rathi Research.
Strong regulatory pipeline for formulations

Aurobindo has a strong regulatory pipeline of filings and we expect the
momentum of filings to continue. The company has made 173 ANDA
filings in the US, of which it has already received approvals for 126,
including 29 tentative approvals. Of the 97 final approvals, it has launched
~60 products in the US. We believe the company will regularly receive
approvals on the back of consistent filings and, thereby, continue to
launch new products that would drive revenue growth going forward.

The company has also registered >1,100 formulation dossiers for Europe
and other semi-regulated markets; this includes multiple registrations in
Europe for the same product. We expect product approvals for the
European market to increase rapidly, given that 819 filings have been
made (>262 over FY09-10 and >50 in Q1FY11). We expect the approval
and launch of products to follow the rapid pace at which regulatory filings
have been made and, thereby, drive revenue growth.
Fig 9 – Products pipeline

Formulations As on Mar As of Mar ’09 As of Mar ’10 During As of Jun ’10 Approvals
2008 Q1FY11
USFDA 128 147 169 4 173 120 (Final approval 90)
Europe* 502 664 764 55 819 50 (340 dossiers)
#
South Africa 107 174 238 6 244 39 (51 dossiers)
Total 737 985 1,171 65 1,236
Note: * Includes multiple registrations and # Includes duplicate and triplicate dossiers
Source: Company, Anand Rathi Research
Fig 10 – ANDA filings and approvals: Aurobindo versus peers

(nos.)
300
247
250
206
200 173 183
158
150 127 122
97 106 106
100 76 85 86 84
73 64 54 52 61
41 45
50
0
Sun Pharma
Aurobindo
DRL
Lupin
Cadila
Ranbaxy
Glenmark
Filings Final approvals Pending
US and Europe to drive major growth

Aurobindo would see majority of its growth from the US and European
markets on the back of a strong products pipeline, huge generics
opportunity in these markets, increasing customer base, dossier licensing
and supply contracts coupled with huge unutilised capacity. We expect
formulations revenue from the US and Europe to register 25.5% CAGR
to `18bn and 38.2% CAGR to `6.3bn over FY10-13e.
The company has built a strong products pipeline for these regulated
markets and has the capability to launch products in these markets
immediately post approvals, thanks to its huge capacity and in-house
availability of APIs. The company ventured into dossier licensing and
supply contracts of finished dosage products for the US and European
markets with Pfizer which would enhance its growth prospects. We
believe the company would be able to garner more such licensing and
supply contracts going forward.

Fig 11 – Growing revenue from US and EU formulations

(`bn)
20 18.0
18
16 14.8
14
11.5
12
10 9.1
8 6.3
5.6 5.4
6
3.7
4 1.9 2.4
2
0
FY11e
FY12e
FY13e
FY09
FY10
US Europe
Steady growth in APIs to continue

We expect the API segment to witness a steady 6% CAGR over FY10-13e
to `19.1bn, after building a strong API franchise, particularly in the semi
synthetic penicillin (SSP) and Cephalosporin (Ceph) segments. Lower
growth in APIs is mainly on account of higher focus on expanding the
formulations business and more APIs being used for captive
consumption. As regards formulations, the company has built large
capacities in API and currently operates at ~75% utilisation. Apart from
SSPs and Cephs, the company is also present in manufacturing of APIs
for ARV products. Increased focus on formulations and captive use of
APIs would result in lower API growth, in our view. However, we expect
steady growth in the segment to continue, given Aurobindo’s leadership in
some APIs and their increasing demand for exports.
Fig 12 – Segmental API revenue trend

(`bn)
9.0
7.9
8.0 7.5
7.1 7.1
7.0 6.8 6.8
6.5
6.1
6.0
5.0
4.1
4.0 3.7
3.4
3.1
3.0
FY10
FY11e
FY12e
FY13e
SSPs Cephs ARV and others
Aurobindo is a leading player in APIs and has a strong presence in SSPs,

CCPs and ARVs. It is #1 in terms of DMF filings by any Indian company
and is the second largest globally. The company has filed a total of 1,667
DMF filings globally, of which 148 pertain to the US market and the
remaining to Europe and emerging markets. In FY10 alone, Aurobindo
filed ~200 DMFs for APIs, which reflects its strength in API
manufacturing and ability to cater to global demand. However, we expect
the proportion of APIs to total revenue to decline going forward,
primarily due to higher growth in the formulations segment.

Fig 13 – Proportion of APIs to reduce on lower growth

(`bn) (%)
20 65
60.6
19 60
18 53.9
55
17
46.4 50
16
42.4 45
15
14 37.2 40
34.1
13 35
12 30
FY08
FY09
FY10
FY11e
FY12e
FY13e
Revenue % of total sales (RHS)
Aurobindo has set up seven state-of-the-art manufacturing facilities, and

has the necessary regulatory approvals for all. Six of these facilities are
situated in India near Hyderabad and one in China. We expect the
company to use part of its capacity for captive use to manufacture
formulations, which supports our view that the API segment would
witness steady growth going forward.

Dossier licensing deals add visibility

Aurobindo’s new business model involves foray into dossier
licensing and supply contracts with MNCs such as Pfizer and Astra
Zeneca that provide upfront income (`1.5bn each over FY11e,
FY12e, FY13e) and add growth visibility via supply contracts (to
contribute 19% of total revenue CAGR over FY10-13e). Also, the
company has a few similar, albeit smaller, licensing deals with
European customers. Aurobindo signed its first big deal in Mar ’09
with Pfizer, with the deal size having expanded thereafter; we
believe Aurobindo has already received a +US$60m dossier
licensing milestone income from Pfizer as of date. The company
entered into a new deal with Astra Zeneca recently, for supplying
branded generics for emerging countries. Though smaller
compared with Pfizer’s, the Astra Zeneca deal gives growth
visibility.
New growth driver

Aurobindo has another stream of business that includes sale of dossiers to
other companies (MNCs) and entering into long-term supply contracts
with them. This provides such MNCs with ready dossier to start business
and, concurrently, Aurobindo receives milestone income for the dossier
and regular supply contracts for the products. Aurobindo has entered into
such deals with Pfizer, Astra Zeneca and a few smaller European players.
Further, there is high scope to venture for more such crucial deals, given
the upfront cash inflow and future growth through long-term supply
contracts. The financial details of the Astra Zeneca deal have not been
disclosed, but we believe the company is likely to have received a small
quantum as upfront payment; the deal involves supplying branded
generics for emerging countries.
Pfizer deal – One of its kind…

Aurobindo entered into an agreement with Pfizer in Mar ’09 for dossier
licensing and long-term supply contracts. The agreement involved 44
finished dosage products and 12 injectables for few developed countries.
Pfizer expanded the deal size, in terms of number of products and
countries. Aurobindo received some upfront milestone payment from
Pfizer as well as further payment thereafter, based on certain milestones
such as commercialisation of products; it also received supply contracts
for these products. According to the supply contract, Aurobindo would
manufacture and supply the products to Pfizer after patent expiry. The
agreement stands for eight years and is renewable thereafter for seven
more years.
We believe that the company has already received >US$60m worth of
milestone income in addition to product supplies. Further, on achieving
other (aforementioned) milestones, as per the agreement, Aurobindo
would be eligible to receive further milestones of US$50m. The deal has
resulted in a turnaround for Aurobindo as it provided immediate cash
flows, which the company used for buying-back FCCBs at discount, hence
easing leverage and providing long-term growth visibility.

Fig 14 – Pfizer deal: Details

Solid oral products Sterile injectable products
USA 75 (co-exclusive) 11 (exclusive) + 1 (non exclusive)
France 34 (exclusive) + 13 (non exclusive) 12 (non exclusive)
Rest of EU 77 (non exclusive) 12 (non exclusive)
Aus/NZ 44 (non exclusive)
Canada 14 (non exclusive)
RoW 55 (non exclusive) 5 (non exclusive)
Source: Company
Aurobindo has already started supplying a few products to Pfizer for US

markets and some European countries. Revenue growth would increase
concurrently with rise in number of products and countries. Further,
increased capacity utilisation would assist in better profitability for the
company.
…followed by another big name, Astra Zeneca

Post its successful dossier licensing and supply contracts deal with Pfizer,
Aurobindo struck a deal with another big pharma player – Astra Zeneca –
in Sep ’10; this deal is smaller than that with Pfizer and includes ~30
products for 40 emerging countries. Financial terms of the deal have not
yet been disclosed. We believe that this deal gives Aurobindo long-term
growth visibility. It includes supplying branded generics products to Astra
Zeneca, which in turn will market in emerging markets such as Brazil and
Mexico. We believe it will take ~1.5 years for the commencement of
supply of products.
19% of growth expected from Pfizer deal

We expect 17.5% revenue CAGR (ex dossier licensing milestone income)
over FY10-13e and estimate that 19% of this growth would be driven by
the supply contracts with MNCs. We expect such deals to generate
revenue of US$95m, US$200m and US$260m in FY11e, FY12e and
FY13e respectively. We have not factored in estimates for supply to Astra
Zeneca due to lack of deal details. We believe that supply to Astra Zeneca
would start in FY13e and, hence, provide upside to our FY13e estimates.
Fig 15 – Contribution from supply contracts with Pfizer

(`m) (%)
9,000 16
14.4
8,000
14
7,000 12.3
12
6,000
5,000 10
4,000
8
3,000
6
2,000 4.4
1,000 4
FY11e
FY12e
FY13e
Revenue % of total revenue (RHS)

Financials
We expect Aurobindo to register 17.5% revenue (ex dossier licensing
income) CAGR over FY10-13e driven by a strong products pipeline
and supply contracts with MNCs. Adjusted net profit is expected to
witness 24.9% CAGR during the same period on the back of strong
revenue growth and EBITDA margin expansion to 20.3% from
18.5% over the same period. Including dossier licensing milestone
incomes, we expect 16.3% revenue and 17% net profit CAGR over
FY10-13e. D/E is expected to reduce to 0.5x in FY13e from 1.2x in
FY10 assuming redemption of FCCBs that are due in May ’11.
17.5% revenue CAGR over FY10-13e

We estimate consolidated revenue CAGR of 17.5% over FY10-13e to
`54.8bn mainly on the back of higher growth in formulations and steady
growth in APIs. The formulations segment is estimated to register robust
25.7% sales CAGR over FY10-13e on the back of strong growth
momentum in the US and European markets. API, on the other hand, is
estimated to post 6% revenue CAGR over the same period. The API
growth would be driven by a strong products pipeline, dossier licensing &
supply contracts and large unutilised capacity. The contribution of
formulations to total revenue would increase, while that of APIs would
decline on account of high growth in formulations and steady lower
growth in APIs. We have estimated income from dossier licensing at
`1.5bn each in FY11e, FY12e and FY13e on the back of deals with Pfizer,
Astra Zeneca and other MNCs.
Fig 16 – Revenue breakdown

(`m) FY10 FY11e FY12e FY13e
Formulations 18,521 23,059 30,417 36,800
% of sales 53.6 57.6 62.8 65.9
% yoy 31.4 24.5 31.9 21.0
USA 9,124 11,459 14,801 18,032
Europe 2,372 3,677 5,351 6,266
ARV 4,953 5,516 6,206 7,136
ROW 2,072 2,408 4,059 5,365
APIs 16,015 16,970 17,987 19,072
% of sales 46.4 42.4 37.2 34.1
% yoy (2.7) 6.0 6.0 6.0
SSPs 6,148 6,455 6,778 7,117
Cephs 6,792 7,132 7,488 7,863
ARVs & others 3,075 3,383 3,721 4,093
Total 34,536 40,029 48,404 55,872
Dossier Licensing 1,740 1,500 1,500 1,500
Total Revenue 36,276 41,529 49,904 57,372
Higher formulations to improve EBITDA margin

We expect the improving margin-expansion trend to continue and
estimate EBITDA margin to rise to 20.3% in FY13e from 18.5% in FY10.
The higher EBITDA margin would be led by rising contribution of
formulations to total revenue, from 53.6% in FY10 to 65.9% in FY13e.
EBITDA in absolute terms is estimated to register 21.1% CAGR to
`11.1bn over FY10-13e. We expect higher capacity utilisation going

forward, on the back of increasing generics business and supply contracts,

which would drive economies of scale. Further, formulations in general,
have higher margins compared with APIs; with Aurobindo now
expanding into the formulations business, it is likely to achieve higher
margins. Moreover, vertical integration, which aids in-house consumption
of APIs to manufacture formulations, also provides cost benefit.
Fig 17 – Margin uptrend

(%)
24
23.0
23 22.4
22.1
22 21.6
21
20.3
20 19.7
19 18.5 18.6
18
FY10
FY11e
FY12e
FY13e
Margin (excl dossier) Margin (incl dossier)
FCCBs – Not a major concern

We believe the outstanding FCCBs worth US$139.2m are not a major
concern for the company. The FCCBs will get redeemed as part of these is
convertible at `879 per share and others at `1,014 per share plus YTM of
~46%. Given its comfortable debt/EBITDA of 2.7x in FY10 and 1.9x in
FY12e, the company would not find it difficult to raise debt for redeem
the FCCBs. We expect the FCCBs to be redeemed through a combination
of internal accruals and debt.
Fig 18 – Outstanding FCCB: Details

Maturity Amount (US$m) Conversion price (`) Redemption Redemption amount
premium (%) (US$m)
May-11 33.0 879.0 47.0 48.5
May-11 106.2 1,014.1 46.3 155.4
Total 139.2 203.9
Fig 19 – Possible dilution in case of FCCB redemption

Maturity Amount (US$m) Conversion price (`) Issue of equity shares on Dilution (%)
conversion (m)
May-11 33.0 879.0 1.7 3.0
May-11 106.2 1,014.1 4.7 8.5
Total 139.2 6.4 11.5

Fig 20 – Income statement (`m)

Y/E 31 March FY09 FY10 FY11e FY12e FY13e
Revenues (formulations + API) 29,349 33,777 39,228 47,436 54,755
% growth 20.5 15.1 16.1 20.9 15.4
Dossier licensing income 1,424 1,977 1,500 1,500 1,500
Total revenue 30,773 35,754 40,728 48,936 56,255
Growth in revenues (%) 25.8 16.2 13.9 20.2 15.0
Raw materials 16,367 17,211 20,006 24,192 27,925
Personnel expenses 2,437 3,273 4,119 4,981 5,749
Selling and other expenses 6,795 7,039 7,791 8,926 9,976
EBITDA 5,174 8,232 8,811 10,837 12,605
EBITDA Margin (%) 17.6 24.4 22.5 22.8 23.0
Margin excl dossier licensing (%) 12.8 18.5 18.6 19.7 20.3
Depreciation 1,276 1,493 1,685 1,984 2,155
PBIT 3,898 6,739 7,126 8,853 10,450
Interest expenses 932 731 802 976 1,090
Other Income 261 442 277 247 321
Extra-ordinary income/ (expenses) (2,010) 1,095 - - -
PBT 1,216 7,544 6,601 8,124 9,681
Provision for tax 280 1,889 1,452 1,625 1,936
Effective tax rate 23.1 25.0 22.0 20.0 20.0
PAT 936 5,656 5,148 6,499 7,745
Minority Interest (1) (3) - - -
PAT after minority interest 936 5,659 5,148 6,499 7,745
Adjusted PAT 2,947 4,838 5,148 6,499 7,745
Growth in PAT (%) 62.0 64.2 6.4 26.2 19.2
PAT margin 10.0 14.3 13.1 13.7 14.1
Fig 21 – Balance sheet (`m)

Share Capital 269 279 292 292 292
Reserves 12,144 18,012 24,153 27,196 34,306
Shareholders' fund 12,413 18,291 24,445 27,488 34,598
Minority Interest 32 43 43 43 43
Debt 23,330 21,546 19,119 19,660 16,660
Deferred Tax Liability 769 912 912 912 912
Total Capital Employed 36,543 40,792 44,518 48,102 52,213
Gross Block 19,736 24,077 30,028 33,278 35,278
Accumulated depreciation 5,749 6,968 8,654 10,638 12,793
Net Block 13,988 17,109 21,374 22,640 22,485
Capital WIP 5,363 5,701 3,000 2,000 1,500
Total Fixed Assets 19,351 22,809 24,374 24,640 23,985
Inventories 8,776 11,025 11,368 13,569 15,547
Debtors 8,898 9,560 11,822 14,296 16,501
Cash and bank balances 1,277 728 710 146 1,436
Loans and Advances 3,939 3,746 3,956 4,777 5,509
Total current assets 22,890 25,059 27,855 32,788 38,992
Current liabilities and provisions 5,701 7,080 7,714 9,328 10,767
Net current assets 17,189 17,979 20,142 23,460 28,225
Total Assets 36,543 40,792 44,518 48,102 52,213

Fig 22 – Ratio @ `1,127

Return Ratios (%)
ROCE 10.9 13.9 13.5 15.7 17.2
ROIC 11.1 14.1 13.7 15.7 17.4
ROE 24.9 31.5 24.1 25.0 24.9
Turnover Ratios
Asset turnover ratio (x) 2.3 2.3 2.1 2.2 2.5
Working capital cycle (days) 107 112 112 110 112
Average collection period (days) 97 100 99 100 103
Average payment period (days) 109 119 115 110 112
Inventory holding (days) 119 131 128 119 122
Per share (`)
EPS 50.5 82.9 88.2 111.4 132.7
CEPS 65.2 97.7 105.5 131.0 152.8
Book Value 230.9 328.3 418.8 471.0 592.8
Solvency ratios
Debt/ Equity 1.9 1.2 0.8 0.7 0.5
Debt/EBITDA 4.5 2.6 2.2 1.8 1.3
Interest coverage 4.2 9.2 8.9 9.1 9.6
Valuation parameters (x)
P/E 22.3 22.3 13.6 12.8 10.1
P/BV 4.9 3.4 2.7 2.4 1.9
EV/ EBITDA 16.0 10.2 9.6 7.9 6.4
EV/ Sales 2.7 2.3 2.1 1.7 1.4
M-Cap/ Sales 2.0 1.8 1.6 1.3 1.2

Company Background & Management

Aurobindo Pharma forayed into the pharma space as an API
supplier focusing on antibiotics such as semi synthetic penicillin
(SSP) and cephalosporin (ceph), emerging a market leader in these
segments. Over the years, the company has successfully
transformed itself to a full-fledged formulations player. A higher
proportion of the company’s revenue is contributed by APIs at
present; but, the trend is likely to change, with formulations
becoming the more dominant contributor going forward.
Background
The company has slowly diversified into segments such as the
cardiovascular (CVS), central nervous system (CNS), gastrointestinal (GI)
and anti-infectives segments. Boasting of a strong presence in its core
business of bulk drugs, the company is now focusing on generic
formulations. Aurobindo has 14 state-of-the-art manufacturing facilities
across India, China, USA and Brazil. The company’s operations are
vertically integrated and formulations supported by in-house APIs.
Fig 23 – Shareholding pattern*

Public & Others
11%
FII
22% Promoters
55%
MF/Banks
12%
Source: BSE Note: *as of Sep 10’
Fig 24 – Key management personnel

Name Designation Background
PV Ramaprasad Chairman A postgraduate in Commerce; management experience in
Reddy various pharma companies before the incorporation of
Aurobindo Pharma in 1986; leads the strategic planning of
the Company and pilots implementation of joint ventures
K Nityananda Reddy Managing Director Mr Nityananda has a Master’s degree in Science (Organic
Chemistry) and is associated as the promoter with the
company since its incorporation; is versatile with the
manufacturing technology and supervises the overall affairs
of the company
M Madan Mohan Wholetime Director Has a Master's degree in Science (Organic Chemistry) and
Reddy held top managerial positions in leading pharma
companies; has experience in regulatory affairs of the
pharma industry. Before joining Aurobindo,, he was working
as the Managing Director of M/s Srichakra Remedies
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Biocon Rating: Sell

Target Price: `298
Lacking growth catalysts; initiate with Sell Share Price: `400
We initiate coverage on Biocon with Sell and target price of `298.

We are negative on the stock due to muted growth outlook Sriram Rathi
(11.4% revenue CAGR over FY10-13e), stretched valuations (21.5x +9122 6626 6737
FY12e earnings) and lack of short-to-medium term triggers. sriramrathi@rathi.com
 Lack of near-term catalysts. We do not see any major growth Sanjeev Chiniwar
+9122 6626 6716
drivers in the near-to-medium term. Launch of bio-generics in sanjeevchiniwar@rathi.com
regulated markets is expected only after FY12e and revenue
contribution to Biocon will increase gradually thereafter, thus
thereby presenting no immediate major upside.
Key data BIOS IN/BION.BO
 More than 50% revenue from low-margin businesses. Biocon 52-week high/low `417/`231
generates +50% of total revenue from low-margin businesses viz., Sensex/Nifty 20125/6063
statins and trading business of its subsidiary, AxiCorp. Such high 3-m average volume US$7.0m
contribution would act as a hurdle for margin expansion. Market cap `80bn/US$1773m
Shares outstanding 200m
 Muted growth outlook. We expect Biocon to witness only Free float 39.1%
11.4% revenue CAGR and 13.8% net profit CAGR over FY10- Promoters 60.9%
13e. We do not expect major improvement in EBITDA margin, Foreign Institutions 3.8%
which is likely to remain at 20-21%. Low growth would lead to Domestic Institutions 13.3%
Public 22.1%
RoE remaining flat at ~17% over FY11-13e vs. 17.9% in FY10.
 Valuation and risks. At CMP, the stock trades at 22.6x FY11e

and 19.9x FY12e earnings. Current valuations seem stretched,
given muted growth outlook and past 3-year average forward PE
of 17x. Upside risks: Outlicensing of oral insulin and supply
contracts for insulins/statins with MNCs.

YE 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 16,087 23,678 26,721 29,545 32,727
Net profit (`m) 2,403 2,932 3,271 3,727 4,327 180
EPS (`) 12.0 14.7 16.4 18.6 21.6 160
Biocon
Growth (%) 7.0 22.0 11.5 14.0 16.1 140
PE (x) 33.2 27.2 24.4 21.4 18.4 120
PBV (x) 5.3 4.5 4.0 3.5 3.0 100 Sensex
RoE (%) 16.0 17.9 17.4 17.3 17.6
80
RoCE (%) 13.2 13.8 14.4 15.5 16.2
Aug-09
Oct-09
Dec-09
Feb-10
Apr-10
Jun-10
Aug-10
Oct-10
Dividend yield (%) 0.8 0.9 0.8 0.9 1.1

Net gearing (%) 34.7 29.2 12.4 5.1 4.5

India Equities
18 Octber 2010 Biocon - Lacking growth catalysts; initiate with Sell

Net sales 16,087 23,678 26,721 29,545 32,727 (`)
Sales growth (%) 52.7 47.2 12.8 10.6 10.8 450
- Op. expenses 12,853 18,963 21,347 23,412 25,737 400
EBITDA 3,234 4,715 5,373 6,133 6,990 350 20x
EBITDA margins (%) 20.1 19.9 20.1 20.8 21.4
300
- Interest 177 169 126 47 21 16x
250
- Depreciation 1,103 1,401 1,572 1,705 1,838
200 12x
+ Other income 646 370 285 397 397
- Tax 118 487 594 956 1,106 150 8x
PAT 2,403 2,932 3,271 3,727 4,327 100
PAT growth (%) 7.0 22.0 11.5 14.0 16.1 50
0
FDEPS (`/share) 12.0 14.7 16.4 18.6 21.6
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
CEPS (`/share) 17.5 21.7 24.2 27.2 30.8
DPS (`/share) 3.0 3.5 3.3 3.7 4.3

Share capital 1,000 1,000 1,000 1,000 1,000 (`mn)
Debt 5,705 5,644 2,994 1,679 1,679 110,000
Minority interests 248 338 433 528 623
90,000 16x
Capital employed 21,061 23,561 23,511 25,146 28,556
70,000 12x
Fixed assets 13,836 14,134 13,813 13,358 12,770
Investments 3,676 4,306 4,306 4,306 4,306 50,000
8x
Working capital 3,430 3,721 3,826 4,257 4,743
Cash 118 1,399 1,567 3,226 6,737 30,000

10,000
No. of shares (m) 200.0 200.0 200.0 200.0 200.0
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Net Debt/Equity (%) 0.4 0.3 0.1 0.1 0.1
W C turn (days) 96.1 74.7 80.0 80.0 80.0
Fig 3 – Cash flow statement (`m) Fig 6 – Contribution of revenue from low-margin businesses
Consolidated PAT 1,011 3,070 3,366 3,822 4,422 (`m) (%)
+ Depreciation 1,103 1,401 1,572 1,705 1,838
18,000 63
Cash profit 2,114 4,471 4,938 5,527 6,260 59.1
- Incr/(Decr) in WC 1,185 291 104 432 486 16,000 59
57.4
Operating cash flow 928 4,181 4,833 5,095 5,774
14,000 55
- Capex 4,243 1,547 1,250 1,250 1,250 53.8
53.1
Free cash flow (3,315) 2,633 3,583 3,845 4,524 12,000 50.4 51
- Dividend 702 774 765 872 1,013
10,000 47
+ Equity raised 0 0 0 0 0
+ Debt raised 2,689 (103) (2,650) (1,315) 0 8,000 43
- Investments (1,071) 630 0 0 0
6,000 39
- Misc. items (278) (155) 0 0 0
Net cash flow 21 1,282 168 1,658 3,511 4,000 35
FY09
FY10
FY11e
FY12e
FY13e
+ Opening cash 96 118 1,399 1,567 3,226

Closing cash 118 1,399 1,567 3,226 6,737


We initiate coverage on Biocon with a Sell rating and target price of
`298. We are negative on the stock due to muted growth outlook
(11.4% revenue CAGR over FY10-13e), stretched valuations (21.5x
FY12e earnings) and lack of short-to-medium term triggers. The
stock is currently trading at valuations similar to large-cap, high-
quality stocks, which is unwarranted in our view, considering muted
revenue CAGR of only 11.4% over FY10-13e.
Lack of near-term catalysts

We do not see any major growth drivers in the near-to-medium term.
Launch of bio-generics in regulated markets is expected only after FY12e
and revenue contribution to Biocon will increase gradually thereafter, thus
presenting no immediate major upside. Finalisation of the approval process
for biogenerics in the EU will take 12-18 months; entry in the US will take
even longer.
Further, growth in contract research services is expected to witness a
subdued 13.2% FY10-13e CAGR to `4.1bn. The low growth, even on a
low base, is due to lack of innovation in the business model. As Biocon’s
research services business has become commoditised, the company plans
to implement a new strategy for better returns.
More than 50% revenue from low-margin businesses

Biocon generates +50% of total revenue from low-margin businesses viz.,
statins and trading business of its subsidiary, AxiCorp. Such high
contribution would act as a hurdle for margin expansion. Statins business
has become over-crowded with generic players, and prices have
significantly eroded (e.g., for simvastatin and pravastatin). Further, AxiCorp
is engaged in trading of pharma ingredients and formulations. AxiCorp’s
EBITDA margin is <5% owing to which Biocon’s overall EBITDA
margin has shrunk to ~20% at present from ~30% in FY08. We do not
expect any major margin expansion due to high revenue contribution from
such low-margin businesses.
Muted growth outlook

We expect Biocon to witness a mere 11.4% revenue CAGR and 13.8%
adjusted PAT CAGR over FY10-13e mainly due to high proportion of
revenue from the highly competitive statins and AxiCorp businesses. Also,
margin is expected to remain at 20-21%. We do not expect any major
trigger for profitability expansion in the near-to-medium term. Hence, RoE
and RoCE are expected to remain low at 14-17% during FY10-13e owing
to low profitability.
Valuations
We value Biocon at `298 based on 16x FY12e earnings. At CMP, the stock
trades at 22.6x FY11e and 19.9x FY12e earnings. Current valuations look
stretched, given muted growth outlook and past 3-year average forward PE
of 17x. We have valued Biocon at 16x FY12e earnings, which is at 20%
discount to target valuation for large-caps SPIL, Cipla etc.

Fig 7 – One-year forward PE

(`)
450
400
350 20x
300
16x
250
200 12x
150 8x
100
50
0
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Risk to our target price

 Out-licensing of oral insulin for regulated markets would provide
upside to our estimates
 Signing of any supply contract with MNCs for insulins or statins would
provide upside risk to our estimates

Lack of near-term catalysts

We do not see any major growth drivers in the near-to-medium term.
Launch of bio-generics in regulated markets is expected only after
FY12e and revenue contribution to Biocon will increase gradually
thereafter, hence presenting no immediate major upside. Finalisation
of the approval process for biogenerics in the EU will take 12-18
months; entry in the US will take even longer. Growth in contract
research services is also expected to remain subdued, at 13.2% CAGR
over FY10-13e to `4.1bn.
Bio-pharma business, key driver

The biopharma (excluding AxiCorp subsidiary) business segment remains
the key growth driver for Biocon. We expect the segment to register 16.6%
revenue CAGR over FY10-13e to `18.7bn, largely driven by insulins,
immunosuppressants and domestic branded formulations. Statins are
expected to witness muted 10% CAGR over the same period owing to stiff
competition and significant price erosion.
Fig 8 – Contribution of sub-segment to total bio-pharma revenues (`bn)

507 450 450 450
2,039 2,345 2,696 3,101
1,567 2,037 2,647 3,442
2,764 3,456 4,320 5,183
4,922 5,414 5,956 6,551

FY10
FY11e
FY12e
FY13e
Statins Insulin & Immunosuppressants

Domestic formulations APIs
Licensing income
Insulins and Immunosuppressants – Niche segments

We estimate insulins and immunosuppressants segments to witness 23.3%
CAGR over FY10-13e owing to their being niche and strong growth in the
industry which is on account of increasing acceptability of insulins in non-
regulated markets and supply of Tacrolimus to the US. Also, the company
would start supplying Sirolimus and Mycophenolate (MMF) to US markets
after their patent expiry as Biocon has already filed DMFs for the products.
At present, Biocon sells products mainly in the domestic and several non-
regulated exports markets.
Domestic branded formulations – At infancy
We expect domestic formulations business to see 30% CAGR over FY10-
13e driven by increased field staff, proprietary products and presence in
lifestyle diseases. Biocon’s current base is low in domestic branded
formulations, at `1.6bn in FY10e. Biocon is a relatively new player in the
business and has presence in selected lifestyle therapeutic areas such as
diabetology, nephrology, oncology and cardiovascular. Continuous launch
of new products in these areas would drive growth.

Statins to grow at steady pace, licensing income stagnant

Revenue from Biocon’s statins business is expected to witness 10% CAGR
over FY10-13e owing to increased volumes and launch of new products
post patent expiries. The growth is muted due to significant correction in
prices and stiff competition. We expect contribution from the business to
reduce, from ~42% of total bio-pharma revenues in FY10 to 36.8% in
FY13e because of higher growth in other businesses. The company gets
licensing income for providing marketing rights of some of its proprietary
products (such as BIOMAb-EGFR and Insugen) to other players in
different geographies. We expect the company to receive licensing income
of `450m each in FY11e, FY12e and FY13e.
Subdued research services growth in medium term

Growth in contract research services is expected to remain subdued, at
13.2% CAGR over FY10-13e to `4.1bn, even on a low base due to lack of
innovation. As Biocon’s research services business has become
commoditised, the company plans to implement a new strategy for better
returns. We expect contribution of research services business to total
revenues to rise to 12.8% in FY13e from 11.9% in FY10.
Syngene provides early stage discovery and process development to pharma
and biotechnology companies; and Clingene partners global pharma &
biotech companies in their clinical development programmes. Biocon has
signed research contracts with pharma MNCs such as Bristol-Myers Squibb
(BMS), Merck, GSK and Novartis.
Fig 9 – Contract research revenue trend

(`m) (%)
4,500 15
4,000
3,500 14
3,000
13
2,500
2,000 12.4
11.9 12
1,500 12.0
11.6
1,000 11
500
0 10
FY10
FY11e
FY12e
FY13e
Revenue Contribution (RHS)


More than 50% revenue from low-

margin businesses
Biocon generates +50% of total revenue from low-margin businesses
viz., statins and trading business of its subsidiary, AxiCorp. Such
high contribution would act as a hurdle for margin expansion. Statins
business has become over-crowded with generic players, and prices
have significantly eroded (for example, for simvastatin and
pravastatin). Further, AxiCorp is engaged in trading of pharma
ingredients and formulations. AxiCorp’s EBITDA margin is <5%,
owing to which Biocon’s overall EBITDA margin has shrunk to
~20% at present from ~30% in FY08. We do not expect any major
margin expansion due to high revenue contribution from such low-
margin businesses.
Fig 10 – Substantial portion of revenue from low-margin businesses

(`m) (%)
18,000 63
59.1
16,000 59
57.4
14,000 55
53.8
53.1
12,000 50.4 51
10,000 47
8,000 43
6,000 39
4,000 35
FY09
FY10
FY11e
FY12e
FY13e
AxiCorp – Strategic benefits in long term

Biocon acquired 70% stake in AxiCorp, Germany for €30m at beginning-
CY08. AxiCorp is a specialised marketing & distribution company involved
in ‘parallel distribution products’ (patented) and generics largely in
Germany. It witnessed sales of €75m during ’07 that almost doubled in
FY10 to ~€150m. Generics products are sold through its own brand –
axcount Generika AG – which contributed ~10% sales in ’07. The generic
products are marketed to pharmacies, retailers and insurers. Further,
Biocon has started supplying products to AOK tenders through axcount
which has led to high growth over the past two years.
The AxiCorp acquisition was a prudent step towards developing front-end
capabilities in Europe, especially when European markets are poised to
open for bio-similars; this strategic step would help Biocon launch bio-
similars on its own rather than via partnership or other alternatives.
Further, Biocon's first bio-similar (Insugen) approval would take over a
year in Europe.
Biocon’s restructuring AxiCorp’s sales force and business model led to
EBITDA margin expansion to 5.4% in FY10 from 1.3% in FY09.
However, its consolidated margins declined from ~30% in FY08 to ~20%
at present, after integration of AxiCorp financials. This was on account of
supply of Biocon’s products to AOK tenders. We believe that further

growth in AxiCorp’s sales and margin would be difficult as the subsidiary’s

main business is trading and it does not have manufacturing capability. We
expect `10bn annual revenue from AxiCorp over FY11-13e and EBITDA
margin to stabilise at 5.2%.
Fig 11 – AxiCorp: Revenue and margin trend

(`m) (%)
12,000 7
10,000 6
5.4
5.2 5.2 5.2
8,000 5
6,000 4
4,000 3
2,000 2
1.3
0 1
FY10
FY11e
FY12e
FY13e
9mFY09
Revenue EBITDA Margin (RHS)

Financials
We expect Biocon to witness only 11.4% revenue CAGR and 13.8%
adjusted PAT CAGR over FY10-13e mainly owing to high proportion
of revenue from the highly-competitive statins and AxiCorp
businesses. Also, EBITDA margin is expected to remain at 20-21%.
We do not expect any major trigger for profitability expansion in the
short-to-medium term. Hence, RoE and RoCE are likely to remain
lower, at 14-17% during FY10-13e, due to low profitability.
Muted growth outlook

We expect Biocon to register a mere 11.4% revenue CAGR to `32.7bn
over FY10-13e, mainly driven by the bio-pharma segment, which is
expected to witness 16.6% CAGR to `18.7bn. The research services
business would witness a muted 13.2% FY10-13e CAGR due to the
business model being more commoditised and lack of innovation. The
company plans investment in the segment for differentiation and
innovation in services that would drive growth going forward, albeit with
no immediate upside. We have factored in flat revenue from AxiCorp, of
`9.9bn annually over FY11-13e as it is a trading business.

`m FY10 FY11e FY12e FY13e
Bio Pharma 11,799 13,701 16,069 18,727
growth (%) 29.3 16.1 17.3 16.5
% of revenues 49.8 51.3 54.4 57.2
Research Services 2,807 3,088 3,544 4,068
growth (%) 17.2 10.0 14.8 14.8
% of revenues 11.9 11.6 12.0 12.4
Axicorp 9,072 9,932 9,932 9,932
growth (%) 93.2 9.5 - -
% of revenues 38.3 37.2 33.6 30.3
Total Revenues 23,678 26,721 29,545 32,727
Net profit to witness 13.8% CAGR

We expect Biocon to register 13.8% net profit CAGR over FY10-13e to
`4.3bn, driven by revenue growth and slight improvement in EBITDA
margin. In an optimistic scenario, we estimate 150bps improvement in
EBITDA margin over FY10-13e. EBITDA in absolute terms would see
14% CAGR. There is likely to be margin pressure on consolidated numbers
due to declining profitability of research services business and higher R&D
spend for development of novel molecules. Net profit margin is expected
to improve, from 12.4% in FY10 to 13.2% in FY13e.

Fig 13 – Net profit growth trend

(`m) (%)
4,500 25
4,000 22.0 22
3,500 19
3,000 16.1 16
14.0
2,500 13
11.5
2,000 10
FY10
FY11e
FY12e
FY13e
Net profit Growth (RHS)
Return ratios to remain lower

We expect return ratios to remain lower in the 14-17% range over FY10-
13e owing to low growth and profitability. We estimate RoE of 17.6% in
FY13e compared with 17.9% in FY10. RoCE would improve to 16.2% in
FY13e from 13.8% in FY10 on the back of repayment of debt from
internal accruals. We do not expect any major upside in return ratios in the
near-to-medium term owing to lack of growth triggers. Post integration of
AxiCorp in Biocon, consolidated RoE and RoCE dropped to 16% and
13.2% in FY09 from 21% and 18% in FY07 respectively.
Fig 14 – Return ratios

(%)
20
17.9
18
17.4 17.6
17.3
16
16.2
15.5
14 14.4
13.8
12
10
FY10
FY11e
FY12e
FY13e
RoE RoCE


Y/E March FY09 FY10 FY11e FY12e FY13e
Revenues 16,087 23,678 26,721 29,545 32,727
Growth (%) 52.7 47.2 12.8 10.6 10.8
Raw materials 8,384 13,460 15,672 17,025 18,549
EBITDA 3,234 4,715 5,373 6,133 6,990
EBITDA Margin (%) 20.1 19.9 20.1 20.8 21.4
Depreciation 1,103 1,401 1,572 1,705 1,838
PBIT 2,131 3,313 3,802 4,428 5,152
Interst expenses 177 169 126 47 21
Other non operating income 646 370 285 397 397
Extra-ordinary income/ (exp) (1,472) - - - -
PBT 1,128 3,515 3,960 4,778 5,528
Provision for tax 118 487 594 956 1,106
PAT 1,010 3,028 3,366 3,822 4,422
Adjusted PAT 2,403 2,932 3,271 3,727 4,327
Growth (%) 7.0 22.0 11.5 14.0 16.1
PAT margin (%) 14.9 12.4 12.2 12.6 13.2

Share Capital 1,000 1,000 1,000 1,000 1,000
Reserves 14,107 16,579 19,084 21,939 25,253
Debt 5,239 5,136 2,486 1,171 1,171
Gross Block 15,729 18,241 19,491 21,196 22,446
Net Block 12,116 13,379 13,057 13,058 12,470
Capital WIP 1,720 755 755 300 300
Investments 3,676 4,306 4,306 4,306 4,306
Inventories 3,192 3,716 4,294 4,664 5,082
Debtors 3,667 4,461 5,125 5,666 6,276
Cash and bank balances 118 1,399 1,567 3,226 6,737
Loans and Advances 947 1,344 1,007 1,177 1,368
Total Assets 21,061 23,561 23,511 25,147 28,556

Fig 17 – Ratio @ `400

Return Ratios (%)
ROCE 13.2 13.8 14.4 15.5 16.2
ROIC 13.3 14.3 15.3 17.2 19.9
ROE 16.0 17.9 17.4 17.3 17.6
Turnover Ratios
Per share (`)
Fully diluted EPS 12.0 14.7 16.4 18.6 21.6
CEPS 17.5 21.7 24.2 27.2 30.8
Book Value 75.5 87.9 100.4 114.7 131.3
Solvency ratios
Debt/ Equity 0.3 0.3 0.1 0.1 0.0
P/E 33.2 27.2 24.4 21.4 18.4
P/BV 5.3 4.5 4.0 3.5 3.0
EV/ EBITDA 26.3 17.7 15.0 12.7 10.6
EV/ Sales 5.3 3.5 3.0 2.6 2.3
M-Cap/ Sales 5.0 3.4 3.0 2.7 2.4


Biocon was established in 1978 as an enzyme manufacturing
company, primarily selling industrial and speciality-food enzymes. In
1998, the company entered the pharma segment with launch of statin
APIs and subsequently developed insulin, immunosuppressants and
various other products/formulations. Biocon has two business
divisions – Biopharma and Services.
Biopharma, which contributes ~88% of revenues (in FY10 including

AxiCorp), is involved in manufacturing and selling statins, insulin,
immunosuppressants and formulations; the services business, which
contributed ~12% in FY10, is associated with providing research services
to global pharma/biotech companies through Biocon's subsidiaries –
Syngene and Clinigene.

Public & Others
22%
FIIs
4%
Promoters
MF/Banks 61%
13%
Source: BSE Note: * as of Sep ’10

Person Designation Background
Kiran Mazumdar-Shaw Chairman and MD Ms. Shaw took Biocon from its inception in 1978 as an
industrial enzymes company to a fully integrated
Biopharma enterprise encompassing a well balanced
business portfolio of products and services with a research
focus on Diabetes, Oncology and Auto-immune disease.
John Shaw Vice Chairman John worked for over 30 years with Coats Viyella plc in
financial and General Management positions in Latin
America, Africa, and Europe. John plays an important role
in the Corporate Governance. He also plays a key role in
the financial and strategic development of the Group.
Dr Arun Chandavarkar Chief Operating Officer Dr. Chandavarkar completed his B Tech. in Chemical
Engineering from the IIT Mumbai and was awarded a Ph.D.
in BioChemical Engineering from the Massachusetts
Institute, USA. Under his leadership, Biocon established
expertise at large scale in diverse technology platforms
spanning microbial fermentation, cell culture, chemical
synthesis and purification.
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Cipla Rating: Sell

Target Price: `308
Valuations stretched, weak growth outook; initiate with Sell Share Price: `332
We initiate coverage on Cipla with a Sell rating and target price

of `308 per share. We are negative on the stock, given muted Sriram Rathi
growth outlook (10.2% revenue CAGR), deteriorating asset +9122 6626 6737
turnover, declining return ratios and stretched valuations (21.4x sriramrathi@rathi.com
FY12e). Sanjeev Chiniwar
+9122 6626 6716
 Expect muted growth. We expect Cipla to report only 10.2% sanjeevchiniwar@rathi.com
revenue CAGR over FY10-13e due to high base in domestic
formulations (5.38% market share), delay in commercialisation of
new capacity at Indore, peaking technical-knowhow fee income and
lack of near-term growth triggers. Key data CIPLA IN/CIPL.BO
 Inhalers – No immediate upside. We believe inhalers can be a huge 52-week high/low `364/`274
opportunity for Cipla, but only in FY13e or later. We do not expect any
major near-term upside as the first combination inhaler is expected in
FY13e. The company is working on nine products for European markets
that have cumulative innovator market size of ~US$3bn.
Free float 63.2%
 Declining return ratios and asset turnover. Asset turnover has Promoters 36.8%
been consistently falling, from3.5x in FY05 to 2.8x in FY10, and we Foreign Institutions 16.2%
expect it further fall to 2.5x in FY12e due to muted growth and 45% Domestic Institutions 17.5%
of inhalers capacity remaining unutilised. Also, we expect RoE to Public 29.6%
decline to 16.3% in FY13e from 24.5% in FY07.
 Valuation and risks. We value Cipla at `308/share based on 20x
FY12E earnings. At CMP, the stock trades at 23.8x FY11e and 21.4x
FY12e earnings, which look stretched considering muted growth and
past 3-year average forward PE of 20x. Any large products supply
deal with an MNC would provide upside risk to our estimates.

Sales (`m) 52,343 56,057 62,279 68,279 74,944
Net profit (`m) 9,721 10,565 11,140 12,384 13,686 140
EPS (`) 12.5 13.2 13.9 15.4 17.0 130 Cipla
Growth (%) 54.2 8.7 5.4 11.2 10.5 120
110
PE (x) 26.5 25.2 23.9 21.5 19.4 100 Sensex
PBV (x) 5.9 4.5 3.9 3.4 3.0 90
RoE (%) 24.0 20.6 17.6 17.1 16.6 80
70
RoCE (%) 20.1 18.6 17.1 16.7 16.2
Aug-09
Dec-09
Feb-10
Oct-09
Apr-10
Jun-10
Aug-10
Oct-10
Dividend yield (%) 0.6 0.6 0.8 0.9 1.0

Net gearing (%) 20.4 -0.9 -3.9 -8.1 -12.2

India Equities
18 October 2010 Cipla – Valuations stretched, weak growth outook; initiate with Sell

Net sales 52,343 56,057 62,279 68,279 74,944 (`)
Sales growth (%) 24 7 11 10 10 Valuations reaching
400 peak levels
- Op. expenses 40,089 42,312 47,316 51,616 56,354
EBITDA 12,254 13,745 14,963 16,663 18,591 350 24x
EBITDA margins (%) 23.4 24.5 24.0 24.4 24.8
- Interest 329 230 2 2 2 300 20x
- Depreciation 1,518 1,653 1,955 2,340 2,640 Cipla
250
+ Other income 881 1,076 919 1,159 1,159 16x
- Tax 1,245 2,435 2,785 3,096 3,421 200
PAT 9,721 10,565 11,140 12,384 13,686 12x
PAT growth (%) 54.2 8.7 5.4 11.2 10.5 150
Consolidated PAT 9,721 10,565 11,140 12,384 13,686 100
FDEPS (`/share) 12.5 13.2 13.9 15.4 17.0
Sep-07
Sep-08
Sep-09
Sep-10
Mar-07
Mar-08
Mar-09
Mar-10
CEPS (`/share) 10.3 13.8 13.9 15.4 17.0
DPS (`/share) 2.0 2.0 2.8 3.1 3.4

Share capital 1,555 1,606 1,606 1,606 1,606 (`m)
Debt 11,044 1,842 1,842 1,842 1,842 300,000
250,000 16x
200,000 Cipla
Fixed assets 23,588 26,954 31,000 33,660 36,020 12x
Investments 813 2,651 2,651 2,651 2,651 150,000
Working capital 29,620 30,770 33,143 36,404 40,033
Cash 530 608 2,722 6,288 10,781 100,000

50,000
No. of shares (m) 777.3 802.9 802.9 802.9 802.9
Sep-07
Sep-08
Sep-09
Sep-10
Mar-07
Mar-08
Mar-09
Mar-10
Net Debt/Equity (%) 0.2 0.0 0.0 0.0 0.0
W C turn (days) 168.0 167.6 159.6 166.5 167.1
Fig 3 – Cash flow statement (`m) Fig 6 – Consistent decline in assets-turnover ratio
Consolidated PAT 7,860 10,965 11,140 12,384 13,686 (`bn) (x)
+ Depreciation 1,518 1,653 1,955 2,340 2,640 50 4.3 4.5
Cash profit 9,378 12,617 13,095 14,724 16,326 4.2
45
- Incr/(Decr) in WC 5,448 1,150 2,374 3,260 3,629 40 4.0
Operating cash flow 3,930 11,468 10,721 11,463 12,696 35 3.5
- Capex 6,247 5,201 6,000 5,000 5,000 30 3.3 3.5
Free cash flow (2,317) 6,267 4,721 6,463 7,696 25
2.9 2.9
- Dividend 1,819 1,873 2,607 2,898 3,202 20 2.8 2.8 3.0
2.7
15 2.5 2.5
+ Equity raised 0 6,691 0 0 0
10 2.5
+ Debt raised 3,597 (9,352) 0 0 0
5
- Investments (122) 1,838 0 0 0 - 2.0
- Misc. items (150) (182) 0 0 0
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
Net cash flow (267) 78 2,114 3,565 4,494

+ Opening cash 797 530 608 2,722 6,288
Gross block Fixed asset/turnover (RHS)
Closing cash 530 608 2,722 6,288 10,781


We initiate coverage on Cipla with a Sell rating and target price of
`308 per share. We are negative on the stock, given muted growth
outlook (10.2% revenue CAGR), deteriorating assets/turnover,
declining return ratios and stretched valuations. At CMP, the stock is
already trading at ~21.4x FY12e earnings that seem stretched
considering the past three-year average forward PE of 20x and muted
growth outlook.
Expect muted growth

We expect Cipla to witness muted growth over the next couple of years
owing to high base in domestic formulations, delay in commercialisation of
new capacity, peaking technical know-how fee income and lack of near-
term growth triggers. We estimate that the company will register 10.2%
revenue CAGR to `74.9bn over FY10-13 and expect the growth to mainly
come from domestic and exports formulations.
The company has been following an organic growth strategy and achieved
high revenue base of `56.1bn. For further organic growth on such a high
base, Cipla would require continuing the huge capital expenditure for
increasing capacity. Cipla’s gross block has increased 7x over the past seven
years, while revenue has risen only 4x. We believe that revenue growth will
remain subdued over the next couple of years, within the 9-11% range.
Inhalers – No immediate upside

We believe that inhalers would offer a huge opportunity to Cipla, but only
in FY13e or later. We do not expect any major near-term upside as the first
combination inhaler is expected only in FY13e. In the long term, inhalers
hold a big promise for Cipla, given that it is working on nine products for
European markets that have total innovator market size of ~US$3bn. Cipla
has already received approval for some inhalers in a few EU countries,
albeit entailing much smaller opportunities. Launch of combination
inhalers (yet in the development stage) in the EU holds a sizeable revenue
opportunity as competition will be low due to presence of only a few
players in this segment. We believe Cipla is the second-largest company
globally, in terms of inhalers manufacturing capacity.
Declining return ratios and asset turnover

Cipla has witnessed consistent decline in its asset turnover and return
ratios. Net fixed-asset turnover has reduced, from 3.5x in FY05 to 2.8x in
FY10; we expect it to further reduce to 2.5x in FY12e due to low revenue
growth and 45% of inhalers capacity lying unutilised. Also, RoE and RoCE
are expected to decline, from 24.5% and 21.5% in FY07 to 16.3% and
15.9% respectively in FY13e owing to weaker growth prospects. We expect
Cipla to register 10.2% revenue CAGR to `74.9bn and 9% net profit
CAGR to `13.7bn over FY10-13e.

Valuations
We value Cipla at `308 per share based on 20x FY12e earnings. At CMP,
the stock trades at 23.8x FY11e and 21.4x FY12e earnings and looks fairly
valued. We do not expect valuations to further improve from 20x FY12e
earnings due to muted growth outlook and historical past three years’
average forward PE of 20x.
Fig 7 – One-year forward PE at peak

(`)
Valuations reaching
400 peak levels
350 24x
300 20x
250 Cipla
16x
200
12x
150
100
Sep-07
Sep-08
Sep-09
Sep-10
Mar-07
Mar-08
Mar-09
Mar-10

 Currency fluctuations could impact Cipla’s prospects and profitability
as exports constitute +50% of total revenue. Also, appreciation in the
rupee would impact the company’s financials, while depreciation will
have a positive affect.
 Signing of any large products supply deal with an MNC would provide
upside risk to our estimates.

Expect muted growth

We expect Cipla to report muted growth over the next couple of years
due to high base in domestic formulations, delay in
commercialisation of new capacity, peaking technical know-how fee
income and lack of near-term growth triggers. We estimate the
company to witness 10.2% revenue CAGR over FY10-13e to `74.9bn
and the growth to mainly come from domestic and export
formulations.
Conservative organic strategy

Cipla has been following an organic growth strategy and has not opted for
any large merger & acquisition (M&A) deal in its 70-year history. Such a
strategy has been fairly successful, resulting in the company achieving
`56.1bn revenue in FY10. However, we believe that the growth rate would
taper down going forward as revenue base has become substantially high
and Cipla’s business model does not indicate any major growth for the
medium term.
To achieve further organic growth on such a high base, the company will
need to continue with huge capex for increasing capacity. Cipla’s gross
block has increased 7x over past seven years, while rise in revenue has only
been 4x. We believe that revenue growth will remain subdued over the next
couple of years, in the range of 9-11%.
Fig 8 – Growth rate slowing down

(`m) (%)
90,000 32.0 35
30
70,000
24.2
25
19.7
50,000 18.4 20
17.2 15
30,000 11.1
9.6 9.8
7.1 10
10,000 5
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
Revenue Growth (RHS)

Maintaining leadership in domestic market

Cipla has maintained its leadership position in the domestic market (ranked
#1 in the domestic pharma space by ORG-IMS in FY10) with 5.38%
market share. It has built a broad products portfolio of branded
formulations. The company’s main brands rank among the top-selling
brands in their respective segments. We expect the company to register
10% revenue CAGR over FY10-13e to `33.4bn in the domestic pharma
business, driven by its ability of maintaining market share and continuous
enrichment of the products portfolio. The company registered 15.6%
revenue CAGR over FY05-09, higher than the industry average growth rate
of 12-14%. But, growth rate has started slowing down, with domestic
revenue growth of only 10.2% in FY10.

Cipla has presence across therapeutic segments such as anti-asthma, anti-

inflammatory, cardiac, anti-retroviral, anti-cancer, eye and ear preparations,
dermatology and anti-ulcerants. It is ranked #1 in India by ORG IMS in
respiratory care, anti-virals and urology with 52%, 50.8% and 18.2% market
share respectively in FY09. Cipla holds the leadership position in the anti-
asthma segment and caters to +70% of demand in India. In total, 20 of
Cipla’s brands are in the top-300 pharmas brands in India.
Fig 9 – Domestic formulations’ composition (FY10)

Others
28% Asthma
23%
Anti-allergic
2%
Anti-ulcerants
2%
Anti-biotics
Hormones 22%
3%
Anti-
inflammation ARVs CVS
Cold
4% 7%
preparations 5%
4%
Source: Company
Low risk, export-oriented model…

Cipla follows a low risk, export-oriented model for selling its products in
the US, Europe, Africa, Middle East and Australasia. It has de-risked its
business model by forming alliances and partnerships in international
markets. In developed markets, Cipla develops, manufactures and supplies
products while its partner is responsible for regulatory filings, legal matters
and marketing of products. Such an agreement is generally for 7-10 years
and renewable. Cipla does not have its own presence in international
markets and, hence, does not need to face regulatory litigations there.
‘Partnership’ is a low-risk low-returns model and provides low margins as
profit is shared with partners. Cipla has been able to consistently maintain
operating profit margin at 22-23% for the past five years. We believe that
though Cipla benefited from such a model, going forward, it is likely to
face increasing challenges from global consolidation in the industry. It has
started filing its own ANDAs with the US FDA to evade impact of
possible loss of partnerships. We expect 10.9% export revenue CAGR
(excluding technical-knowhow fee income) over FY10-13e to `39.5bn,
driven by 13% CAGR in formulations exports.

Fig 10 – Exports’ growth trend

(`m) (%)
40,000 35
35,000 30.5 30
30,000
25
25,000
20
20,000
13.0 15
15,000
9.8 10.0
10
10,000
5,000 5
5.2
0 0
FY09
FY10
FY11e
FY12e
FY13e
Formulations APIs Growth (RHS)
…but has shortcomings

The partnership model, however, also entails certain shortcomings as the
company has to share profit with partners. Further, the consolidation in the
industry may affect the company’s business going forward. However, Cipla
is rapidly increasing and strengthening its relationships and filing own
ANDAs to overcome the consolidation risk. The company has ~22
partners (including Teva, Watson, Eon Labs and Akorn) in the US for 135
projects. In the EU, the company has ~54 projects and ~25 partners. We
believe that its business model may face some risks going forward, as many
M&As are taking place globally in the pharma industry and MNCs are now
directly entering into dossier licensing and supply contracts with generics
companies.
Wide geographical presence

Cipla supplies products to both regulated and semi-regulated markets. It
has geographical presence across the US, Europe, Middle East, Africa and
Australasia. The company has +6,000 product registrations across the
globe. The company’s biggest market is Africa, which contributed ~34% to
total exports revenue in FY10. ANDA filings through partners are already
>100, with 57 product approvals. Of these approvals, the company has
commercialised 35 products as of date.

Inhalers – No immediate upside

We believe that inhalers can be a big opportunity for Cipla in the
long term as the company is working on nine products for European
markets that have cumulative innovator market size of ~US$3bn.
However, Cipla’s first combination inhaler is expected to be
launched only in FY13 or later. Although the company has already
received approval for two inhalers in some EU countries, these are
small opportunities. Launch of combination inhalers (in the
development stage) in EU would be sizeable opportunities as the
competition will be low (only few players).
No major near-term upside

We believe that launch of inhalers is a huge long-term opportunity for
Cipla, as the company has started filing products in EU countries and may
be able to gain from the early-mover advantage in a few products.
However, we do not foresee any major upside in the short-to-medium term
as the main combination products are expected to be launched only after
FY12, as indicated by management. Cipla is likely the world’s second-
largest inhaler manufacturer and the global market for inhalers is estimated
at +US$15bn. Based on the consistent increase in inhalers production
capacity, Cipla believes the segment has huge growth potential.
Cipla is developing nine HFA inhalers for the European markets and has
submitted registrations for six of them. It has already received approvals
for some inhaler products in Europe viz., Budesonide for Germany and
Portugal, Salbutamol MDI for Denmark and Portugal and Beclomethasone
for Portugal. We believe the inhalers segment would provide huge
opportunities for Cipla in the long term.
The company increased aerosol/inhalation devices capacity to ~96m in
FY10 from 44.6m in FY04. However, capacity utilisation for aerosol
inhalers has been consistently decreasing, from 89% in FY05 to 56% in
FY10, indicating that the company is not being able to utilise capacity due
to absence of regulatory approvals. We believe that the company is building
capacity in anticipation of strong business demand in the long term.
Fig 11 – Consistent increase in capacity and decrease in utilisation

('000) (%)
100,000 100
90,000 89.0
90
80,000 80.3
76.7 80
70,000
67.0 67.1 70
60,000 63.7
50,000 55.6 60
40,000 50
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Capacity Capacity Utilisation (RHS)

Cipla’s revenue from inhalers has witnessed 15.7% CAGR over FY04-10 to
`4.8bn, but contribution to total sales has decreased, from 10.1% in FY04
to 9% in FY10. Realisation per unit for inhalers increased to `80.4 in FY10
from `60.6 in FY04, which implies that the business is fairly demanding
and profitable; it also demonstrates Cipla’s focus on the higher-value
inhaler products as well as the segment’s potential.
Fig 12 – Steady rise in realisations

(`m) (`)
5,000 85
4,500 80.4
80
4,000
74.1 74.0
3,500 75
70.9
3,000 68.6 70
2,500
65
2,000 61.9
60.6
1,500 FY04 60
FY05
FY06
FY07
FY08
FY09
FY10
Sales Realisation per unit (RHS)

Declining returns and assets/turnover

Cipla has witnessed consistent decline in its assets-turnover ratio and
return ratios. Fixed assets/turnover has reduced, from 4.3x in FY03
to 2.8x in FY10 and we expect it to further decline to 2.5x in FY12e.
RoE and RoCE, too, are expected to reduce, from 24.5% and 21.5%
in FY07 to 16.3% and 15.9% in FY13e respectively on account of low
growth prospects. We believe that the huge additional capex is not
generating proportional additional growth for the company.
Deteriorating assets turnover ratio

Cipla has been consistently witnessing decline in the assets-turnover
(sales/net fixed assets) ratio over the past few years. We believe this is
mainly owing to the huge capital expenditure already incurred and expect
the trend to continue over the next couple of years due to planned capex of
`10-12bn. Fixed assets-turnover ratio has reduced, from 4.3x in FY03 to
2.8x in FY10 and we expect it to further decline to 2.5x in FY12e. In our
view, the company is not being able to generate equivalent revenue from its
assets base, as in the past, and capex for the inhalers business would start
generating sizeable business only after FY12, likely to grow at a gradual
pace thereon.
Cipla’s gross block + Capital WIP has increased almost 7x over the past
seven years, from `5.4bn in FY03 to `37.7bn in FY10. The huge capex has
been largely for supporting organic growth. However, revenue has
increased only 4x during the same period, from `14bn to `56bn. This
indicates that revenue generation is lower on new assets base and has,
thereby, led to decline in assets-turnover ratio. However, we have seen
significant capacity addition in aerosol inhalers, which is a high-margin
business segment and, therefore, benefits would accrue to the company
only in the long term.
Fig 13 – Fixed assets-to-turnover on the decline

(`bn) (x)
50 4.3 4.5
4.2
45
40 4.0
35 3.5
30 3.3 3.5
25
2.9 2.9
20 2.8 2.8 3.0
2.7
15 2.5 2.5
10 2.5
5
- 2.0
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
Gross block Fixed asset/turnover (RHS)


Return ratios under pressure

We expect Cipla’s return ratios (RoE and RoCE) to remain under pressure
for the next few years owing to muted growth outlook, declining assets-
turnover ratio and expectation of flat EBITDA margin. We estimate RoE
to reduce to 16.3% in FY13e from 20.6% in FY10, and RoCE to decline to
15.9% from 18.6% over the same period.
Fig 14 – Declining return ratios

(%)
Returns declined sharply due
30 to huge capex and lower
profitability
24.5 24.0
25
20.6
20 21.5 18.0
20.1 17.6 17.1 16.6
18.6
15 17.1 16.7
16.1 16.2
10
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
ROE ROCE

Financials
We expect Cipla to register 10.2% revenue CAGR over FY10-13e to
`74.9bn driven by steady growth in domestic branded formulations
and exports formulations. EBITDA margin is likely to be maintained
at 24-25% over the same period. We estimate 8.2% adjusted PAT
CAGR over FY10-13e to `13.4bn on the back of steady revenue
growth.

We expect the company to register 10.2% revenue CAGR over FY10-13e
to `74.9bn on the back of steady growth in the domestic market and
exports formulations. We forecast 13% revenue CAGR from exports
formulations to `33.5bn and 10% CAGR in domestic revenues to `33.4bn
over FY10-13e. The company’s significant capacity addition during the past
couple of years and huge planned capex coupled with industry growth
would be key growth drivers. The company’s main focus would be on the
formulation business, and APIs would witness only marginal growth as a
large portion is used for captive consumption in formulations
manufacturing. We assume flat technical-knowhow fee income of `1.5bn
each in FY11e, FY12e, and FY13e owing to lower visibility.

Domestic 25,113 27,625 30,387 33,426
% yoy (17.4) 10.0 10.0 10.0
% of total sales 44.4 43.9 44.1 44.2
Exports 28,989 32,758 35,957 39,541
% yoy (19.4) 13.0 9.8 10.0
% of total sales 51.3 52.1 52.2 52.3
Formulations 23,188 26,666 29,866 33,450
APIs 5,802 6,092 6,092 6,092
Technical know how and others 2,462 2,483 2,579 2,686
Total Sales 56,564 62,865 68,923 75,653
Less: Excise duty 522 586 645 709
Net Sales 56,057 62,279 68,279 74,944
EBITDA margin to remain stable

We expect the company to sustain stable EBITDA margin going forward.
In FY08, margin was impacted by the uneven product mix, higher raw
material expenses and rupee appreciation. We estimate EBITDA margin to
be 24-25% over the next three years. We believe that Cipla would ramp-up
its inhalation business in the long term as it has built substantial capacity in
the past couple of years and the business stream entails higher margins.
The ramp-up would enable Cipla to improve profitability in the long term.
However, we do not expect any major trigger for margin expansion in the
short term.

Fig 16 – Stable margins

(`m) (%)
21,000 24.8 24.9
19,000 24.8
17,000 24.7
24.5 24.6
15,000
24.4 24.5
13,000
24.4
11,000
24.3
9,000 24.2
7,000 24.0 24.1
5,000 24.0
FY10
FY11e
FY12e
FY13e
EBITDA Margin (RHS)
Adjusted PAT to grow lower

We expect the company to register 8.2% adjusted PAT CAGR over FY10-
13e to `13.4bn on the back of steady revenue growth and stable EBITDA
margin. Net profit growth is lower compared to revenue growth due to
expectation of lower other income and higher depreciation charge on
account of commissioning of new capacities. Further, minimum alternate
tax (MAT) rate has been increased (Cipla pays tax as per MAT). We expect
the effective tax rate to be 20% for Cipla.


Revenues 52,343 56,057 62,279 68,279 74,944
% growth 24.2 7.1 11.1 9.6 9.8
Raw materials 23,474 24,530 26,908 29,565 32,155
EBITDA 12,254 13,745 14,963 16,663 18,591
EBITDA Margin 23.4 24.5 24.0 24.4 24.8
Depreciation 1,518 1,653 1,955 2,340 2,640
PBIT 10,736 12,093 13,009 14,323 15,951
Interest expenses 329 230 2 2 2
Other income 881 1,076 919 1,159 1,159
Extra-ordinary income/ (expenses) (2,320) 311 - - -
PBT 8,968 13,250 13,925 15,480 17,107
Provision for tax 1,245 2,435 2,785 3,096 3,421
Effective tax rate 13.9 18.4 20.0 20.0 20.0
PAT 7,723 10,815 11,140 12,384 13,686
Adjusted PAT 9,721 10,565 11,140 12,384 13,686
Growth in PAT (%) 54.2 8.7 5.4 11.2 10.5
PAT margin 18.6 18.8 17.9 18.1 18.3

Share Capital 1,555 1,606 1,606 1,606 1,606
Reserves 41,953 57,535 66,068 75,554 86,038
Debt 9,402 51 51 51 51
Deferred Tax Liability 1,642 1,792 1,792 1,792 1,792
Gross Block 26,933 28,954 36,797 41,797 46,797
Net Block 19,925 20,112 26,000 28,660 31,020
Capital WIP 3,663 6,842 5,000 5,000 5,000
Investments 813 2,651 2,651 2,651 2,651
Inventories 13,983 15,126 17,063 18,706 20,533
Debtors 18,372 15,527 18,831 20,645 22,660
Cash and bank balances 530 608 2,722 6,288 10,781
Total Assets 54,551 60,983 69,516 79,002 89,486

Fig 19 – Ratio @ `332

Return Ratios (%)
ROCE 20.1 18.6 17.1 16.7 16.2
ROIC 20.2 18.5 17.3 17.3 17.7
ROE 24.0 20.6 17.6 17.1 16.6
Turnover Ratios
Per share (`)
CEPS 10.3 13.8 13.9 15.4 17.0
Book Value 56.0 73.7 84.3 96.1 109.2
Solvency ratios
Debt/ Equity 0.2 0.0 0.0 0.0 0.0
Interest coverage 32.6 52.7 NA NA NA
P/E 26.5 25.2 23.9 21.5 19.4
P/BV 5.9 4.5 3.9 3.4 3.0
EV/ EBITDA 21.7 18.7 17.0 15.1 13.3
EV/ Sales 5.1 4.6 4.1 3.7 3.3
M-Cap/ Sales 4.9 4.6 4.1 3.8 3.4


Cipla is one of India’s leading pharma companies, supplying generic
formulations and intermediates to domestic as well as international
markets. Its products are registered in more than 140 countries. Cipla
has strong export-oriented models for both regulated and semi-
regulated markets. It follows a low-risk business model through
partnerships in various geographies for the supply of APIs and
formulations.
Background
Cipla does not have a direct presence in international markets, unlike other
large pharma players. Its alliances with international pharma players help it
offer products across therapeutic categories in the US, Africa, Europe,
Middle East and Australasian markets. Apart from formulations and APIs,
Cipla generates fees by providing technological know-how services to its
international partners. It is the first company outside US and Europe to
supply CFC-free inhalers.

Public & Others Promoters
30% 37%
FIIs
16%
MF/Banks
17%

Person Designation Background and profile
YK Hamied Chairman and Managing A doctorate in chemistry and has done research work
Director under Lord Todd FCS, a Nobel Laureate. He plays a lead
role in strategy formulation and is actively involved in
research and development. He has vast and varied
experience in both Indian and international pharma
industry.
Amar Lulla Joint Managing Director Mr. Lulla is working with the company for more than 30
years and is a gold medallist from ICAI. He is responsible
for international business, manufacturing, technical
services, finance and administration.
S Radhakrishnan Chief Financial Officer Mr. Radhakrishnan is a Chartered Accountant and has a
total experience of over 25 years. He is also responsible
for information systems and co-ordinates domestic
outsourced marketing and logistic divisions.
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Dishman Pharma Rating: Buy

Target Price: `258
Turnaround in business; initiate with Buy Share Price: `177
We initiate coverage on Dishman Pharma with Buy and target price

of `258. We are positive on the stock given turnaround in Solvay Sriram Rathi
contract and operations at Carbogen Amcis (CA), addition of new +9122 6626 6737
contracts and commissioning of new high potency (HIPO) facility. sriramrathi@rathi.com
 Set to witness turnaround. Dishman is set to witness turnaround Sanjeev Chiniwar

after a dismal performance in the past five quarters on the back of : i) +9122 6626 6716
revival in Solvay contract for Eposartan Mesylate (supplies at normal
level of 120mtpa at present), ii) signing of an additional contract for
fenofibrate, iii) restructuring at CA subsidiary and iv) improving
outlook for outsourcing business. Key data DISH IN/DISH.BO
52-week high/low `275/`173
 Expansion in niche and high-end segment. With its HIPO
facility, Dishman would be substantially expanding presence in the
niche and high-end oncology API space. We expect the company to
Market cap `14.3bn/US$317m
generate US$4m & US$20m in FY11e & FY12e respectively from the
facility on the back of expected commercialisation in Q4FY11.
Free float 39.1%
Promoters 60.9%
 Expect robust H2FY11 and FY12. We believe Dishman is well-
Foreign Institutions 8.7%
positioned to deliver a strong performance with 16.7% top-line and
25.9% net profit CAGRs over FY10-13e. D/E would reduce to 0.6x
Public 17.9%
in FY13e from current 1x and RoCE would improve to 11.9% in
FY13e from 9% in FY10.
 Valuation and risks. Our target price is based on 10x FY12e

CRAMS EBITDA and 4x FY12e Marketable Molecules EBITDA.
The stock trades at 11.2x FY11e and 9x FY12e earnings and looks
attractive, given turnaround story and past 3-year average forward PE
of 14x. Risk: High dependence on Solvay (~15% of sales).

Sales (`m) 10,622 9,154 10,573 12,806 14,552
Net profit (`m) 1,603 949 1,276 1,586 1,893 150
EPS (`) 19.9 11.8 15.8 19.6 23.5 Dishman
140
Growth (%) 90.6 -40.8 34.5 24.2 19.4 130
PE (x) 8.9 15.0 11.2 9.0 7.5 120
PBV (x) 2.0 1.8 1.6 1.3 1.2 110
100 Sensex
RoE (%) 24.9 12.6 14.9 16.1 16.5
90
RoCE (%) 15.3 9.0 10.4 11.3 11.9
Aug-09
Dec-09
Feb-10
Oct-09
Apr-10
Jun-10
Aug-10
Oct-10
Dividend yield (%) 0.7 0.7 0.6 0.7 0.9

Net gearing (%) 101.3 97.1 83.4 71.9 61.7
Source: Company, Anand Rathi Research Source: Anand Rathi Research
may have a conflict of interest that could affect the objectivity of this report. Investo` should consider this report as only a single factor in making their investment

India Equities
18 October 2010 Dishman Pharma - Turnaround in business; initiate with Buy

Net sales 10,622 9,154 10,573 12,806 14,552
(`)
Sales growth (%) 32 -14 16 21 14 450
- Op. expenses 7,862 7,116 8,058 9,699 10,973
EBITDA 2,760 2,038 2,515 3,107 3,579
EBITDA margins (%) 26.0 22.3 23.8 24.3 24.6 350
18x
- Interest 494 480 497 497 497
- Depreciation 629 594 667 821 931 250 14x
+ Other income 83 106 68 76 76
- Tax 107 150 142 280 334 10x
PAT 1,603 949 1,276 1,586 1,893 150
PAT growth (%) 90.6 -40.8 34.5 24.2 19.4 6x
Consolidated PAT 1,603 949 1,276 1,586 1,893
50
FDEPS (`/share) 19.9 11.8 15.8 19.6 23.5
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
CEPS (`/share) 26.0 21.9 24.1 29.8 35.0
DPS (`/share) 1.2 1.2 1.0 1.3 1.5

Share capital 161 161 161 161 161
(`mn)
Shareholders’ fund 7,143 7,969 9,147 10,610 12,356
Debt 7,445 8,056 7,944 7,944 7,944 16x
45,000
35,000 12x
Fixed assets 10,008 12,004 12,837 13,516 14,085

25,000
Investments 14 14 14 14 14 8x
Working capital 4,115 3,552 3,882 4,684 5,313
15,000
Cash 452 455 358 339 887
5,000
No. of shares (m) 80.7 80.7 80.7 80.7 80.7
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Net Debt/Equity (%) 1.0 1.0 0.8 0.7 0.6
W C turn (days) 95.9 42.1 81.9 90.2 86.9
Fig 3 – Cash flow statement (`m) Fig 6 – Set for strong growth ahead
Consolidated PAT 1,679 1,035 1,276 1,586 1,893 (%)
+ Depreciation 629 594 667 821 931 100
90.6
Cash profit 2,308 1,629 1,943 2,406 2,823 80
- Incr/(Decr) in WC 371 (562) 329 803 629
60
Operating cash flow 1,937 2,192 1,614 1,603 2,194 34.5
40
- Capex 2,514 2,524 1,500 1,500 1,500 24.2
Free cash flow (576) (332) 114 103 694 20 19.4
- Dividend 113 113 99 122 146 0
+ Equity raised 0 0 0 0 0 -20
+ Debt raised 657 503 (112) 0 0
-40
- Investments 1 0 0 0 0 -40.8
-60
- Misc. items (114) 54 0 0 0
FY09
FY10
FY11e
FY12e
FY13e
Net cash flow 81 3 (97) (19) 548

+ Opening cash 371 452 455 358 339
Revenue growth PAT growth EBITDA margin
Closing cash 452 455 358 339 887
Source: Company, Anand Rathi Research Source: Comapny, Anand Rathi Research


We initiate coverage on Dishman Pharma with Buy and target price of
`258. We are positive on the stock given turnaround in Solvay contract
and operations at Carbogen Amcis (CA), addition of new contracts and
commissioning of new HIPO facility.
Set to witness turnaround

Dishman is set to witness a turnaround after a dismal performance in the past
five quarters on the back of : i) revival in Solvay contract for Eposartan
Mesylate (supplies at normal level of 120mtpa at present), ii) signing of an
additional contract for fenofibrate, iii) restructuring at CA subsidiary and
iv) improving outlook for outsourcing business.
Dishman has witnessed revenue decline in the past five consecutive quarters
mainly owing to: i) global economic recession, which led to inventory
rationalisation; and ii) temporary suspension of Solvay contract for nine
months due to restructuring of its manufacturing facilities at Solvay.
However, outsourcing demand is picking up as number of enquiries has risen
and supplies to Solvay have reached normal levels (~120mtpa). Therefore, we
expect Dishman to start reporting strong growth Q3FY11 onwards.
Fig 7 – Strong growth ahead

(%)
100
90.6
80
60
40 34.5
24.2
20 19.4
0
-20
-40
-40.8
-60
FY09
FY10
FY11e
FY12e
FY13e
Revenue growth PAT growth EBITDA margin

Expansion in niche and high-end segment

With the HIPO facility, Dishman would be substantially expanding its
presence in the niche and high-end oncology API space. We expect the
company to generate US$4m and US$20m in FY11e and FY12e respectively
from the facility. Also, the new facility is likely to start commercial production
from Q4FY11 as trial batches are ongoing. The HIPO facility is one of its
class and the largest facility for manufacturing niche oncology APIs in Asia.
We believe contribution from this segment would result in higher
consolidated EBITDA margin.
Expect robust H2FY11 and FY12

We believe that the company is well positioned to deliver strong performance
with 16.7% top-line and 25.9% net profit CAGRs over FY10-13e. D/E
would reduce to 0.6x in FY13e from current 1x and RoCE would improve to
11.9% in FY13e from 9% in FY10. Top-line CAGR would be driven by

revival in supplies to Solvay towards normal levels along with additional

contract for fenofibrate that could add ~`300m, commercialisation of HIPO
plant in Q4FY11 and high probability of signing new contracts as validation
batches are ongoing for potential contracts with new customers.
Valuations
We value Dishman at `258 based on 10x FY12e CRAMS EBITDA and 4x
FY12e Marketable Molecules (MM) EBITDA. At CMP, the stock trades at
11.2x FY11e and 9x FY12e earnings and EV/EBITDA of 8.6x FY11e and
6.9x FY12e. Current valuations seem attractive, considering turnaround story
and past 3-year average forward P/E of 14x.
Fig 8 – Target price calculation

`m FY12e EBITDA (x) EV
CRAMS 2,610 10 26,103
Marketable Molecules 497 4 1,988
Total EV 28,091
Less: Net debt/ (Cash) 7,288
Implied Market Capitalisation 20,803
Value per share (`) 258

(`)
450
350
18x
250 14x
10x
150
6x
50
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10

 High dependence on Solvay is the biggest risk as Solvay contributes
~15% to Dishman’s total revenue
 Timely execution of outsourcing contracts remains the key challenge and
any disappointment on this front would impact our estimates


Dishman is set to witness turnaround after a dismal performance in the
past five quarters on the back of : i) revival in Solvay contract for
Eposartan Mesylate (supplies at normal level of 120mtpa at present), ii)
signing of an additional contract for fenofibrate, iii) restructuring at CA
subsidiary and iv) improving outlook for outsourcing business.
Recovery post five quarters of disappointment

Dishman has witnessed five consecutive quarters of decline in revenue mainly
due to global economic recession that resulted in inventory rationalisation.
The decline was also owing to temporary suspension of Solvay contract for
nine months due to restructuring of manufacturing facilities at Solvay.
However, outsourcing demand is picking up as the number of enquiries has
risen and supplies to Solvay are also at normal levels (~120mtpa) now. Based
on this, we expect Dishman to start reporting strong growth Q3FY11
onwards.
Fig 10 – Recovery ahead

(`m) (%)
16,000 30
14,000 21.1
20
12,000 15.5 13.6
10
10,000
8,000 0
(3.5)
6,000
(11.3) -10
4,000 (13.7)
(13.9)
-20
2,000 (21.2)
0 -30
Q1FY10
Q2FY10
Q3FY10
Q4FY10
Q1FY11
FY11e
FY12e
FY13e

Revival in contract with Solvay

Dishman supplies Eposartan Mesylate API to Solvay for the latter’s patented
product and does contract research work for Solvay as well. Solvay
contributes ~15% of Dishman’s total revenue. However, there was a
temporary suspension of about nine months for the supply to Solvay as the
latter was getting integrated with Abbott and transferring all manufacturing
activities to one site from three sites earlier. This led to considerable impact
on Dishman’s revenue. However, the supplies are at normal level now and we
expect Dishman to supply ~120mtpa of Eposartan Mesylate to Solvay.
Further, Dishman has recently signed a new contract for supply of fenofibrate
to Solvay (Abbott), which can add ~`300m to the company’s FY11e top-line.
Currently, Dishman is doing the trial batches for the contract and commercial
supplies are expected to begin from Q3FY11. Post the merger of Abbott and
Solvay, Dishman has got the opportunity to leverage Solvay’s relationship to
attract orders from Abbott as well.

Carbogen Amcis to stabilise

Dishman acquired Carbogen Amcis (CA) in FY07 for US$74.5m (at ~6x
trailing EBITDA) that transformed its business model from a pure contract
manufacturing player to an integrated contract research and manufacturing
organisation. CA’s revenue grew 28% in FY09 and fell 18.2% in FY10. The
decline was due to setback in the contract research segment owing to lack of
new orders for the early-phase research projects. Over the past 1.5 years, we
have seen slowdown in the overall pharma outsourcing business on account
of global economic slowdown leading to inventory destocking, lower budgets
for R&D projects and credit crunch.
However, the environment for the pharma outsourcing business is improving,
as witnessed in the increased number of enquiries and signing of new
contracts by various companies. We believe that CA’s revenue has already hit
bottom, in terms of quarterly run rate for revenue in FY10, and expect the
business to stabilise this fiscal. We have assumed steady growth of 10% in
FY11e and FY12e for CA’s revenue.
Fig 11 – CA business stabilising

(`m) (%)
6,000 30
22.6
5,000 15.0 20
10.0
10
4,000 10.0
0
3,000 (10.2)
-10
2,000
(18.2) -20
(27.5) (22.4)
1,000 -30
(33.1)
0 -40
FY10
Q1FY10
Q2FY10
Q3FY10
Q4FY10
Q1FY11
FY11e
FY12e
FY13e
CRAMS to see 18.2% CAGR during FY10-13e

We estimate 18.2% revenue CAGR from CRAMS segment to `10.9bn over
FY10-13e. The growth will be driven by revival in Solvay contract, stabilising
CA business post restructuring, commercialisation of HIPO facility, pick up
in contracts with Astra Zeneca and addition of new contracts. CRAMS
revenue declined 14.7% in FY10 due to the aforementioned factors. Hence,
effect of low revenue base would also contribute to the strong 18.2% CAGR
in CRAMS business.

Fig 12 – CRAMS growth trend

(`m) (%)
12,000 30
11,000 22.6
16.7 20
10,000
15.4
9,000 10
8,000
7,000 0
6,000
-10
5,000 (14.7)
4,000 -20
FY10
FY11e
FY12e
FY13e
Fig 13 – CRAMS business model
CRAMS
Solvay Other MNCs Carbogen Amcis
 Supplying APIs  Contract  Acquired CA in

and intermediates manufacturing Aug ’06 for
and custom US$75m
 Catering to synthesis for
Solvay since ’01 GSK, Johnson &  Acquired a
and consistently Johnson, Astra manufacturing unit
getting new long- Zeneca, Merck and two R&D units
term contracts etc  Strategic fit, as
 Contributed  Continuous focus would strengthen
18.3% of on diversifying presence in contract
Dishman’s and strengthening research and big-
CRAMS’ revenue customer base value contracts
in FY08 Contributed 23%  Contributed 58.7%
 Does contract of CRAMS’ of CRAMS’ revenue
research on a revenue in FY08 in FY08
small scale
Steady growth in MM segment

We estimate 12.5% revenue CAGR from the Marketable Molecules (MM)
segment to `3.6bn driven by incremental revenue (`180m and `450m in
FY11e and FY12e respectively) from the China facility and 13.3% CAGR in
the Vitamin D business (Netherlands) during FY10-13e. However, base
Indian MM business is expected to remain flat over FY10-13e, in our view.
MM includes quats (quaternary compounds), specialty chemicals,
intermediates & APIs and vitamin D business of Solvay (recently acquired).
Quats are used as catalysts for transferring a reactant from one phase to
another. Dishman develops and produces niche quats that have specialised
applications and entail a high price; hence, they are not commodities by

nature. Such quats are applied as PTCs (chemical substances that improve
process time and yield of chemical reactions) and are also used in manufacture
of pharmas, dyes, agrochemicals, paints, perfumery aldehydes and flavours,
polymers, paper etc.
Dishman acquired Solvay’s fine chemicals, vitamin D & analogues businesses
in Oct ’07 and is classified under the MM segment. Further, the acquisition
would enable access to new customers for its pharma business. Dishman has
the unique advantage over competitors in quats production owing to its
dedicated facilities and long-term experience in establishing and improving
technology to manufacture quats at the lowest cost and the best quality.
Fig 14 – Contribution of MM on the decline

(`m) (%)
4,000 28
27.6
3,500 26.8
25.9 26
3,000
24.8
2,500
24
2,000
1,500 22
FY10
FY11e
FY12e
FY13e
Revenue Contribution to sales (RHS)

Expansion in niche segment

With the HIPO facility, Dishman would be substantially expanding its
presence in the niche and high-end oncology API space. We expect
Dishman to generate US$4m and US$20m in FY11e and FY12e
respectively from this facility. We believe the new facility would
commence commercial production from Q4FY11 as trial batches are
ongoing. The HIPO facility is one of its class and the largest facility for
manufacturing niche oncology APIs in Asia. We believe contribution
from the segment would result in higher consolidated EBITDA
margin.
Entering the niche oncology space

Dishman has set up a large HIPO API manufacturing facility for niche
oncology products at its export-oriented unit (EOU) at Bavla, Ahmedabad.
This development demonstrates the company’s unparalleled capability in the
scale-up, development and commercial manufacture of highly potent
compounds. The facility is being developed with full support from CA, a
Dishman group company and is one of the state-of-the-art in conceptual
design and technological standards.
With the commissioning of the new facility, Dishman has four facilities in this
segment, three in Switzerland (under CA) and one at Bavla. All the facilities
provide state-of-the-art containment services, operate to current Good
Manufacturing Practice (cGMP) and can produce material for preclinical
testing, clinical trials and commercial use. These facilities are designed based
on a containment concept utilising the ‘splitbutterfly valve’ and barrier
isolation technology as well as a strict zone concept with pressure cascades,
airlocks and access controls. This allows the safe handling of highly-potent
compounds of all categories including cytostatics/cytotoxics. Dishman offers
various services, from laboratory scale for process research and development
purposes to large-scale manufacturing on 1,600 litre scale including category
IV compounds (OEL < 1μg/m³), the highest category in the categorisation
system.
Fig 15 – Details of HIPO facility

Laboratories Kilo-scale Pilot plant Large-scale
Manufacturing Manufacturing Manufacturing
Facilities Facility Facility Facility
Switzerland Switzerland Switzerland Bavla, India

Up to 10L Up to 250L Up to 630L Up to 1,600L
Containment OEL<1 μg/m3 OEL<1 μg/m3 OEL<1 μg/m3 OEL<1 μg/m3
Toxicity Level Categories I to IV Categories I to IV Categories I to IV Categories I to IV
Highly potent APIs for clinical trials and commercial use

Source: Company Note: L = litre
The Bavla facility will complement the Bubendorf HIPO facility and enable
customers to work with CA from the early-stage route development to market
supply without volume limitations. The venture would enhance Dishman’s

existing operations with one of the largest, most extensive and flexible
custom-manufacturing HIPO facilities in the world. The new facility will cater
for both cytotoxic and non-cytotoxic highly active substances in dedicated
areas. The site specifications include:
 Bavla site will operate as CA category 3 (OEL <100 μg/m³) and category
4 (OEL <1 μg/m³) facilities
 Standalone facility with dedicated utilities
 4,300sq metres of operational floor space
 Designed to hold four segregated calls each with three reactors from 630
litre to 1,600 litre (glass-lined and hastelloy) and contained filter dryers
 Expansion option for cell with reactors up to 6,300 litre
 Contained development and analytical/quality control labs

Financials
We believe the company is well positioned to deliver strong
performance with 16.7% top-line and 25.9% net profit CAGRs over
FY10-13e. D/E would decline to 0.6x in FY13e from current 1x and
RoCE would improve to 11.9% in FY13e from 9% on the back of revival
in business and strong net profit growth.
Expect 16.7% top-line CAGR

We estimate Dishman to register 16.7% revenue CAGR over FY10-13 to
`14.6bn, driven by revival in supplies to Solvay for Eposartan Mesylate to
normal levels of 120mtpa along with additional contract for fenofibrate that
could add ~`300m in FY11e, commercialisation of HIPO plant in Q4FY11
and high probability of signing new contracts as validation batches are
ongoing for potential contracts with new customers.

`m FY10 FY11e FY12e FY13e
CRAMS 6,630 7,740 9,492 10,950
% of sales 72.4 73.2 74.1 75.2
% yoy (14.7) 16.7 22.6 15.4
Solvay and other MNCs 2,945 3,507 4,133 4,787
Carbogen Amcis 3,685 4,054 4,459 5,128
HIPO facility - 180 900 1,035
Marketable Molecules 2,524 2,832 3,314 3,602
% of sales 27.6 26.8 25.9 24.8
% yoy (11.4) 12.2 17.0 8.7
India 1,241 1,241 1,241 1,241
Vitamin D (Netherlands) 1,283 1,411 1,623 1,866
China - 180 450 495
Total Revenue 9,154 10,573 12,806 14,552
Margin improvement to lead higher profitability

We expect 230bps improvement in EBITDA margin, from 22.3% in FY10 to
24.5% in FY13e, led by revival in business operations and improvement in
margins of CA from current 16% to 20% post restructuring (reduced staff
strength due to sluggish business). Strong revenue growth and margin
improvement would result in net profit CAGR of 25.9% over FY10-13e to
`1.9bn. W expect net profit margin to improve to 13% in FY13e from 10.4%
in FY10.

Fig 17 – Margin and profit uptrend

(`m) (%)
2,000 26
24.3
24.6
1,600 24
23.8
22.3
1,200 22
800 20
FY10
FY11e
FY12e
FY13e
Net profit EBITDA margin (RHS)
Easing leverage and improving returns

We estimate Dishman’s D/E to reduce from 1x in FY10 to 0.6x in FY13e
driven by strong 25.9% net profit CAGR and no requirement for major capex
for the next two years. Further, RoCE is expected to improve to 11.9% in
FY12e from 9% in FY10 led by revival in business prospects and strong
profitability growth. Since CRAMS is a capital-intensive industry, return ratios
are generally lower.


Revenues 10,622 9,154 10,573 12,806 14,552
Growth in revenues (%) 32.3 (13.8) 15.5 21.1 13.6
Raw material expenses 3,242 2,768 3,202 3,860 4,360
EBITDA 2,760 2,038 2,515 3,107 3,579
EBITDA Margin 26.0 22.3 23.8 24.3 24.6
Depreciation 629 594 667 821 931
PBIT 2,131 1,444 1,847 2,287 2,648
Other income 83 106 68 76 76
Extra-ordinary income/ (expenses) (145) 256 - - -
PBT 1,575 1,325 1,418 1,865 2,227
Provision for tax 107 150 142 280 334
PAT 1,467 1,176 1,276 1,586 1,893
Adjusted PAT 1,603 949 1,276 1,586 1,893
Growth in PAT (%) 90.6 (40.8) 34.5 24.2 19.4
PAT margin 15.1 10.4 12.1 12.4 13.0

Share Capital 161 161 161 161 161
Reserves 6,981 7,808 8,985 10,448 12,195
Debt 7,110 7,627 7,627 7,627 7,627
FCCBs 127 112 - - -
Gross Block 9,733 10,910 13,985 16,485 17,985
Net Block 7,781 8,429 10,837 12,516 13,085
Capital WIP 2,227 3,574 2,000 1,000 1,000
Inventories 3,040 2,423 3,091 3,720 4,209
Debtors 1,494 1,131 1,738 2,105 2,392
Cash and bank balances 452 455 358 339 887
Total Assets 14,588 16,025 17,090 18,553 20,300

Fig 20 – Ratio @ `177

Return Ratios (%)
ROCE 15.3 9.0 10.4 11.3 11.9
ROIC 15.7 9.3 10.7 11.5 12.3
ROE 24.9 12.6 14.9 16.1 16.5
Turnover Ratios
Per share (`)
Basic EPS 19.9 11.8 15.8 19.6 23.5
CEPS 26.0 21.9 24.1 29.8 35.0
Book Value 88.5 98.8 113.3 131.5 153.1
Solvency ratios (x)
Debt/ Equity 1.0 1.0 0.8 0.7 0.6
Debt/EBITDA 2.6 3.8 3.0 2.5 2.1
P/E 8.9 15.0 11.2 9.0 7.5
P/BV 2.0 1.8 1.6 1.3 1.2
EV/ EBITDA 7.6 10.6 8.6 6.9 5.9
EV/ Sales 2.0 2.4 2.0 1.7 1.4
M-Cap/ Sales 1.3 1.6 1.4 1.1 1.0


Dishman commenced work on CRAMS in 1997 and has since re-
positioned itself, from being just an API and chemicals player towards
becoming a large and preferred contract manufacturing outsourcing
organisation in India within a short timespan, with its first major long-
term contract with Solvay.
Background
Dishman Pharma was incorporated in 1983 as a research-oriented
organisation with little commercial activity in the initial years. Later, it started
producing a range of Phase Transfer Catalysts and Quaternary Ammonium
and Phosphonium compounds in 1989 and earned the status of the ‘Quat
Company’. Gradually, Dishman increased its production capacity, from initial
10tpa to 1,500tpa. In 1995-96, Dishman extended its activities for the
development of various intermediates and APIs.

Public & Others
18%
FIIs
9%
Promoters
61%
MF/Banks
12%
Fig 22 – Shareholding pattern

Name Designation Background and profile
Rajnikant T Vyas Chairman Wide experience in the field of Finance and Management
and associated with fine knitting mills, a textile company
for 40 years. He is instrumental in the strategic decision-
making and growth of the Company.
Janmejay R Vyas Managing Director Holds a bachelor’s degree in Pharma & Fine Chemical
Technology. From 1974 to 1983, he acted as a
consultant to various pharma companies. In 1983, along
with others, he promoted the Company. He has been the
head of the research and development division for 20
years.
VVS Murthy Chief Financial Officer A Chartered Accountant with over 29 years post
qualification experience in various industries, viz.,
Engineering, Chemicals, Ceramics, Cement, Fertilizers
and Pharmaceuticals. Earlier, worked with Dr. Reddy's
Labs from 1995 to ’07.
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Dr Reddy’s Labs Rating: Hold

Prudent model, fairly valued; initiate with Hold Share Price: `1,589
We initiate coverage on Dr Reddy’s Laboratories (DRL) with

Hold rating and target price of `1,636 per share. We are positive Sriram Rathi
on DRL’s business model and growth prospects; however, we +9122 6626 6737
are neutral on the stock, considering current fair valuations. sriramrathi@rathi.com
 Strong traction in base business. We have a strong outlook on Sanjeev Chiniwar

+9122 6626 6716
DRL’s base generics business (14.7% CAGR over FY10-13e) on
the back of strengthened focus on niche products in the US (17%
CAGR), strategic expansion in emerging countries (GSK deal) and
new growth strategy for the Indian market (15.3% CAGR).
Key data DRRD IN/REDY.BO
 Para IV opportunities sustainable for the next 4-5 years. DRL 52-week high/low `1,645/`890
has built a sizeable para IV pipeline of 38 products, including 12 Sensex/Nifty 20125/6063
FTFs including Olanzapine, Fondaparinux and Lansoprazole. We 3-m average volume US$17.0m
value para IV opportunities at `82 per share. Market cap `268bn/US$5961m
 Improving profitability and margin. We estimate 27% PAT Free float 74.3%
CAGR over FY10-13e due to strong growth in base business, Promoters 25.7%
sustainable para IV opportunity and 170bps expansion in Foreign Institutions 28.5%
EBITDA margin. RoCE would improve to 21.5% in FY13e from Domestic Institutions 16.2%
13.6% at present. Public 29.6%
 Valuation and risks. The stock currently trades at fair valuations

of 24.3x FY11e and 20.1x FY12e earnings, which is higher than its
past 3-year average 18-19x forward PE. We value DRL at
`1,636/share, valuing base business at `1,577 based on 20x FY12e
base business earnings and `58/share for para IV pipeline. Risks:
Currency fluctuation and delay/failure in launching para IVs.

Sales (`m) 69,217 70,519 83,152 93,730 102,596
Net profit (`m) 5,456 7,181 11,049 13,312 14,724 210
Dr
EPS (`) 32.4 52.1 65.5 78.9 87.2 190 Reddy's
Growth (%) 24.5 31.6 53.9 20.5 10.6 170
150
PE (x) 49.0 30.5 24.3 20.1 18.2
130
PBV (x) 7.6 7.1 5.8 4.8 4.0
110
RoE (%) 13.6 19.7 26.3 25.9 23.7 90
Sensex
Aug-09
Oct-09
Dec-09
Feb-10
Apr-10
Jun-10
Aug-10
Oct-10
RoCE (%) 11.2 13.6 20.7 22.1 21.5

Dividend yield (%) 0.4 0.7 0.8 1.0 1.1
Net gearing (%) 56.7 39.3 25.6 15.7 8.6

India Equities
18 October 2010 Dr Reddy’s Labs - Prudent model, fairly valued; initiate with Hold

Net sales 69,217 70,519 83,152 93,730 102,596 (`)
Sales growth (%) 38 2 18 13 9 1,800
- Op. expenses 55,986 56,115 65,158 72,955 79,908 24x
1,600
EBITDA 13,231 14,404 17,995 20,775 22,687
1,400 20x
EBITDA margins (%) 19.1 20.4 21.6 22.2 22.1
- Interest 972 312 534 414 294 1,200
16x
- Depreciation 4,977 4,131 4,519 4,991 5,259 1,000
+ Other income 782 805 870 1,270 1,270 12x
800
- Tax 2,608 2,668 2,762 3,328 3,681
PAT 5,456 7,181 11,049 13,312 14,724 600
PAT growth (%) 24.5 31.6 53.9 20.5 10.6 400
200
FDEPS (`/share) 32.4 52.1 65.5 78.9 87.2
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
CEPS (`/share) 62.0 67.0 92.2 108.4 118.4
DPS (`/share) 6.3 11.3 13.1 15.8 17.4

Share capital 842 844 844 844 844
(`m)
Reserves & surplus 34,419 36,924 45,388 55,585 66,864 350,000 18x
Debt 20,514 14,910 11,910 8,910 5,910 300,000
Minority interests 0 0 0 0 0 14x
250,000
200,000
Fixed assets 33,566 31,144 31,125 29,509 27,625 10x
Investments 523 3,580 3,580 3,580 3,580 150,000

Working capital 16,063 11,354 15,792 17,866 19,610 6x
Cash 5,623 6,600 7,645 14,384 22,803 100,000
50,000
No. of shares (m) 168.2 168.8 168.8 168.8 168.8
Mar-07
Mar-08
Mar-09
Mar-10
Sep-07
Sep-08
Sep-09
Sep-10
Net Debt/Equity (%) 0.6 0.4 0.3 0.2 0.1
W C turn (days) 51.7 50.7 43.1 50.9 51.9
Fig 3 – Cash flow statement (`m) Fig 6 – Improving return ratios

+ Depreciation 4,977 4,131 4,519 4,991 5,259 30
Cash profit 10,204 11,669 15,569 18,303 19,983 25.7
- Incr/(Decr) in WC 4,681 (4,709) 4,438 2,074 1,744 25 25.1
Operating cash flow 5,523 16,378 11,130 16,229 18,239 23.2
21.4 21.0
- Capex 11,761 2,767 4,500 3,375 3,375 20 19.7 20.3
Free cash flow (6,238) 13,611 6,630 12,854 14,864
- Dividend 1,232 2,217 2,586 3,115 3,445 15
13.6 13.6
+ Equity raised 0 0 0 0 0 11.2
+ Debt raised 291 (5,136) (3,000) (3,000) (3,000) 10
- Investments (4,298) 3,057 0 0 0
- Misc. items (1,056) 2,224 0 0 0 5
FY09
FY10
FY11e
FY12e
FY13e
Net cash flow (1,824) 977 1,045 6,739 8,419

+ Opening cash 7,447 5,623 6,600 7,645 14,384
ROE ROCE
Closing cash 5,623 6,600 7,645 14,384 22,803


We initiate coverage on DRL with a Hold rating and target price of
`1,636 per share. We are positive on DRL’s business model and
growth prospects; however, we are neutral on the stock, considering
current fair valuations of 24.3x FY11e and 20.1x FY12e earnings.
Strong traction in base business

We have a strong outlook on DRL’s base business (excluding para IV
opportunities) on the back of strengthened focus on niche products in the
US generics market, strategic expansion in emerging countries (GSK deal),
and the company’s new growth strategy for the Indian market. We
estimate 14.7% revenue CAGR for the base business over FY10-13E to
`102.5bn, on a high base of `66bn in FY10.
Our calculation for base business factors in revenue from Fondaparinux
(Arixtra), Lotrel, Prevacid (Lansoprazole) and Tacrolimus (Prograf) that
have limited competition. betapharm (Germany) business is also expected
to stabilise from FY12e, after three disappointing years due to change in
the business environment and business model in the German market.
Russia & CIS remain the key emerging markets for DRL (12% of total
sales) as the company has established strong presence there. We expect
these markets to continue doing well with 16% CAGR over FY10-13e on
the back of continuous launch of new products, increasing market share
and growing pharma industry there.
Sustainable para IV opportunities

DRL has built a sizeable para IV pipeline of 38 products, of which 12 are
FTFs including Olanzapine, Fondaparinux and Rivastigmine. We see high
likelihood of the company monetising at least one opportunity each year
over the next 4-5 years. We value the para IV opportunities at `58 per
share.
For valuation purposes, we have considered NPVs of Allegra D24,
Desloratidine (Clarinex), and Zyprexa (Olanzapine). These products have
high probability of getting monetised either owing to the litigation already
having been settled or the company having got surety for final approval.
Improving profitability
We estimate 27% PAT CAGR over FY10-13e driven by strong growth in
base business, sustainable para IV opportunities and 170bps expansion in
EBITDA margin. The expansion would be led by increasing proportion of
niche as well as limited-competition products in total sales and stabilising
betapharm business. Better profitability would also result in improvement
in return ratios. We expect RoE and RoCE to improve, from 19.7% and
13.6% at present to 23.7% and 21.5% respectively in FY13e. D/E would
reduce to 0.1x in FY13e from 0.4x in FY10.
Valuations
We value DRL at `1,636, valuing base business at `1,577 based on 20x
FY12e base business earnings and `58 for para IV pipeline. The stock trades
at 24.3x FY11e and 20.1x FY12e earnings and looks fairly valued at current
levels, considering DRL’s historical average forward P/E of 18-19x.


` per share EPS/NPV (x) Value
Base business 78.9 20.0 1,577
Para IV 58
Allegra D24 8.6 5.0 43
Clarinex 1.5 1.0 2
Zyprexa 20mg 13.6 1.0 14
Total 1636

(`)
1,800
24x
1,600
1,400 20x
1,200
16x
1,000
12x
800
600
400
200
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10

 Significant currency fluctuation would impact our estimates as more
than 80% of revenue is contributed by exports
 Delay or failure in launching para IV products would impact our
estimates and valuations

Strong traction in base generics

We have a strong outlook for DRL’s base business (excluding para
IV opportunities) on the back of strengthened focus on niche
products in the US generics market, strategic expansion in emerging
countries (GSK deal), and the company’s new growth strategy for
the Indian market. We estimate 14.7% CAGR in base business
revenue (12% excluding limited competition products) over
FY10-13e to `102.6bn on a high base of `66bn in FY10.
Our calculation for base business factors-in revenue from Fondaparinux

(Arixtra), Lotrel, Prevacid (Lansoprazole) and Tacrolimus (Prograf) that
have limited competition. betapharm (Germany) business is also expected
to stabilise from FY12e, after three disappointing years due to change in
the business environment and business model in the German market.
Russia and CIS remain the key emerging markets for DRL (12% of total
sales) as the company has established strong presence there. We expect
these markets to continue doing well with 16% CAGR over FY10-13e on
the back of continuous launch of new products, increasing market share
and growing pharma industry there.
Fig 9 – Base generics business CAGR at 12% over FY10-13e

(`m) (%)
110,000 13.7 14
92733
95,000 13
83411
80,000 74981 12
65974
65,000 11.2 11.2 11
50,000 10
35,000 9
8.7
20,000 8
FY10
FY11e
FY12e
FY13e

US generics to grow consistently

We expect DRL to maintain growth momentum in its base US generics
business, driven by the continuous launch of new products, focus on
limited competition & niche products and raising market share in launched
products. We estimate 17% revenue CAGR from the base US generics
business to US$599m over FY10-13e. However, excluding revenue of
Imitrex (para IV with six-month exclusivity) worth US$58m in FY10, we
estimate 23.7% FY10-13e CAGR. Our estimates include revenue from
Omeprazole, Lotrel, Prevacid (Lansoprazole) and Prograf, and potential
revenue from Fondaparinux.
The company has filed 163 ANDAs to date (of which 70 are pending for
approval from the US FDA). The pending pipeline includes 38 para IV
filings and 12 FTFs. DRL is marketing ~55 generics in the US and has
garnered decent market share in 15 products. The company’s core strength
lies in solid oral dosage forms and it is now actively focusing on
injectables, cytotoxic, liquids etc. Further, 75% of its ANDA pipeline is
vertically integrated and, hence, we expect improved revenues and superior
gross margins from these products.

Fig 10 – Consistent growth in US generics

(US$m)
700
599
600 573
492
500
441
400 374
300
196
200 172
100
FY11e
FY12e
FY07
FY08
FY09
FY10
Fy13e
In addition to a strong products pipeline, the company has firmed up key

partnership pacts for product development, packaging and logistics that
would assist in faster launches. DRL has proved its ability to boost market
share in key products launched with para IV filings and other products as
well. We believe the company would maintain this positive trend in new
products too. Including para IV products, we expect a number of new
launches, considering that it has 71 ANDAs pending for approval. The
company has been able to garner ~50% market share in some key
products such as Sumatriptan, Ondensetron and Fexofenadine that were
launched in the past couple of years.
Fig 11 – DRL’s market share in key products in the US
Source: Company

Domestic formulations – Picking up momentum

We expect DRL’s domestic formulations business to regain growth
momentum after witnessing disappointment for six consecutive quarters
till Q1FY10 due to fewer product launches and change in operational
system to a replenishment-based system (driving retailers and chemists to
push DRL products and continue churning inventory). The growth rate
has already started picking up from Q3FY10 and we expect the
momentum to continue. We estimate 15.3% revenue CAGR in domestic
formulations to `15.6bn over FY10-13E on the back of improving
portfolio coverage, increasing market share and strong presence in the
dental, dermatology and oncology segments.
Further, the company has built strong brands in the Indian market (owns
seven brands of the top-300 in the industry) that would continue to
provide sustainable revenues. The recent change to the replenishment-
based system would lead to growth rate picking up after slowdown in the
past five quarters (particularly FY09). The company registered strong
18.4% revenue CAGR (vs. industry growth of 15%) in the domestic
market over FY05-10 to `10.2bn, reinforcing our view that DRL would
beat industry growth rate.
Fig 12 – Domestic formulations to continue on growth trajectory

(`bn)
18
15.3% CAGR 15.6
16
14 13.6
11.8
12
18.4% CAGR 10.2
10
8.1 8.5
8 7.0
6.0
6
4.4
4
2
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
DRL recently changed its domestic marketing strategy to a replenishment-

based system, where it will attempt to replace its products at the retailer
end faster by providing incentives to the latter to push faster sales of
products. The strategy has resulted in superior growth rate, as the
company has started recording double-digit growth from Q2FY10 vs.
single-digit growth over the past five quarters.

Fig 13 – Recovery in domestic growth

(`m) (%)
3,000 40
33.8 35
2,500
30
2,000 26.1 25
20
1,500
16.1 15
9.0 12.7
1,000 8.9 10
8.7
4.0 5
500
0
(1.3)
0 -5
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10
Q3FY10
Q4FY10
Q1FY11
GSK deal – Positive in long term

We view DRL’s pact with GlaxoSmithKline plc (GSK) to supply branded
products to emerging countries as a strategic move with long-term positive
implications. DRL announced a partnership with GSK in Jun ’09 to
develop and market select products across emerging markets outside India.
The deal enables the company to get strong exposure to emerging
countries without any investments. DRL would manufacture the products
and get a pre-determined revenue share to cover the manufacturing cost
and profit margin. Regulatory, logistics, marketing and selling expenses
would be borne by GSK. Though financial details have not been disclosed,
revenue in small quantum has started kicking in from FY11. We estimate
US$20m and US$30m revenue in FY12e and FY13e respectively. Full
impact of the deal is expected in FY13 as it would take about two years for
DRL to ramp up capacities.
Further, according to the terms of the agreement, GSK would gain access
to DRL’s rich and diverse portfolio and future pipeline of more than 100
branded pharmaceuticals in the fast-growing therapeutic segments such as
cardiovascular, diabetes, oncology, gastroenterology and pain management.
DRL would gain exposure in fast-growing emerging nations without
making any significant investments. The deal covers various emerging
countries such as Asia-Pacific (excluding India), the Middle East, Latin
America and Africa.
Biosimilars – Future growth driver

DRL is the first Indian company to develop a biosimilar in house and
launch a biosimilar monoclonal antibody called Reditux (biosimilars, or
follow-on proteins, are new versions of existing biopharmaceuticals whose
patents have expired. They are produced using the same core genetic
material and are approved on the basis that they are equal to the reference
product in terms of safety and efficacy). We expect this business to
account for sizeable revenue over the next 3-4 years. The company is
marketing three products in India and a few emerging countries, and earns
+`400m a year. There are four more products in the pipeline, with another
three in the late stages of development. All products have combined global
market size of >US$30bn. Two more products are expected to be
launched in FY11.

DRL customises its strategy for various emerging nations and developed
geographies to increase the biosimilars business. Also, the company is
aggressively looking for alliances for boosting the business in emerging
countries. However, it would take some time for the business to mature in
developed nations due to regulatory legislations.
Fig 14 – Biosimilars pipeline (development stage)
Source: Company

Sustainable para IV opportunities

DRL has built a sizeable para IV pipeline of 38 products, of which 12
are FTFs including Olanzapine, Fondaparinux, and Rivastigmine.
We see high likelihood of the company being able to monetise at
least one opportunity each year over the next 4-5 years. We value the
para IV opportunities at `58 per share. For valuation purposes, we
have considered NPVs of Allegra D24, Desloratidine (Clarinex) and
Zyprexa (Olanzapine). These products have high probability of
getting monetised either owing to the litigation already having been
settled or the company having got surety for final approval.
Fig 15 – Para IV pipeline

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15
Assured 180 days Ondansetron 2 2 1
exclusivity
Para IV settlement/ Sumatriptan 3 1
Go early
At risk launch Fexodfenadine
Summary Omeprazole mg OTC
judgement
Para IV possible 1 2 1 2 1
launches
Difficult/ limited Divalproex Fondaparinux
source possibility
We value DRL’s para IV pipeline at `58 per share, based on 5x annual

EPS from Allegra D24 (as DRL would continue to market for a period
longer than one year till patent expiry, without any major competition) and
1x NPV of Clarinex and Zyprexa 20mg. However, we have factored in
revenue from Omeprazole, Lotrel, Prevacid and Prograf in our base
business estimates because the company has already launched the products
which it would market, with limited competition. Further, we have
considered earnings of Fondaparinux (Arixtra) in base business valuations
as the product patent has already expired and no new player is expected in
the next three years. Although DRL has not yet received approval, we
expect it by Q4FY11.

Financials
We expect DRL to witness consolidated 13.3% revenue and 27% net
profit CAGRs over FY10-13e driven by strong growth in the base
business, sustainable para IV opportunities and 170bps expansion in
EBITDA margin. Also, better profitability would lead to
improvement in return ratios. We expect RoE and RoCE to improve
from 19.7% and 13.6% at present to 23.7% and 21.5% in FY13e
respectively. D/E would reduce, from 0.4x in FY10 to 0.1x in FY13e.
13.3% consolidated revenue CAGR over FY10-13e

We expect 13.3% consolidated revenue CAGR over FY10-13e to
`102.6bn on the back of the strong growth in base business, upsides from
para IV opportunities and incremental revenue from the DRL-GSK deal
for emerging markets. We estimate 14.7% revenue CAGR from its base
business, driven by strong growth in US generics and Indian formulations
businesses, coupled with steady growth (9.1% CAGR) in the pharma
services & active ingredients (PSAI) segment. Para IV opportunities would
provide additional growth during the period. We have factored in earnings
upsides from Omeprazole, Lansoprazole and Fondaparinux in our
estimates. Other para IVs aforementioned may provide further upside to
our estimates, if launched successfully.

(`m ) FY10 FY11e FY12e FY13e
Global Generics 48,605 57,017 64,834 70,766
% of total revenue 67.2 68.6 69.2 69.0
% YoY (2.4) 17.3 13.7 9.1
US (Including para IV) 16,817 22,124 25,775 26,977
India 10,158 11,783 13,551 15,583
Europe 9,643 9,018 9,469 9,942
Russia/ CIS 9,119 10,779 12,396 14,256
Others 2,868 3,312 3,643 4,008
PSAI 20,404 22,279 24,313 26,541
% of total revenue 28.2 26.8 25.9 25.9
% YoY 8.8 9.2 9.1 9.2
US 3,673 3,875 4,068 4,272
India 2,646 2,911 3,202 3,522
Europe 6,652 7,326 8,059 8,864
Others 7,433 8,168 8,984 9,883
Proprietary business 513 590 649 714
Others 2,756 3,267 3,934 4,575
Total 72,278 83,152 93,730 102,596
Better margins to boost earnings

We expect consolidated EBITDA margin to improve 170bps over FY10-
13e to 22.1% and base business margins to improve to 19.8% in FY13e
from 18.8% in FY10. The margin expansion would be driven by increasing
proportion of niche and limited competition products, optimisation of
S,G&A expenses, stabilising loss-making betapharm business and
recovering domestic brand formulations business. Better earnings and
lower amortisation cost (due to substantial write off in betapharm business
resulting in lower assets) would lead to net consolidated earnings CAGR
of 27% over FY10-13e to `14.7bn.

Fig 17 – Margin trend

(%)
25
21.6 22.2
22.1
20 20.4
15 13.3 14.2 14.4
10
10.2
FY10
FY11e
FY12e
FY13e
EBITDA margin Net profit margin

(`m) (%)
16,000 63
14,000 56
53.9
12,000 49
42
10,000
35
8,000 31.6
20.5 28
6,000
21
4,000 14
10.6
2,000 7
0 0
FY10
FY11e
FY12e
FY13e
We expect higher return ratios on the back of strong PAT growth,

improved margins and better & effective utilisation of assets. RoE is
estimated to grow to 23.7 % in FY13e from 13.6% in FY09 and RoCE to
21.5% in FY13e from 11.2% in FY09.
Fig 19 – Strong return ratios

(%)
30
26.3
25.9
25
23.7
22.1 21.5
20 19.7 20.7
15
13.6 13.6
11.2
10
5
FY09
FY10
FY11e
FY12e
FY13e
ROE ROCE


Revenues 69,217 70,519 83,152 93,730 102,596
Raw materials 23,223 23,297 29,354 33,335 35,860
EBITDA 13,231 14,404 17,995 20,775 22,687
EBITDA Margin 19.1 20.4 21.6 22.2 22.1
Depreciation 4,977 4,131 4,519 4,991 5,259
PBIT 8,254 10,273 13,475 15,784 17,429
Other non operating income 782 805 870 1,270 1,270
Extra-ordinary income/ (expenses) (14,628) (4,583.0) - - -
PBT (6,564) 6,183 13,812 16,641 18,405
Provision for tax 2,608 2,668 2,762 3,328 3,681
PAT (9,172) 3,515 11,049 13,312 14,724
Adjusted PAT 5,456 7,181 11,049 13,312 14,724
Growth in PAT (%) 24.5 31.6 53.9 20.5 10.6
PAT margin 7.9 10.2 13.3 14.2 14.4
Fig 21 – Balance sheet

Y/E Mar FY09 FY10 FY11e FY12e FY13e
Share Capital 842 844 844 844 844
Reserves 34,419 36,924 45,388 55,585 66,864
Debt 19,976 14,840 11,840 8,840 5,840
Gross Block 65,027 64,468 74,590 78,965 82,840
Net Block 29,270 23,522 29,125 28,509 27,125
Capital WIP 4,296 7,622 2,000 1,000 500
Investments 523 3,580 3,580 3,580 3,580
Inventories 13,250 13,394 15,014 16,923 18,524
Debtors 14,406 11,599 12,704 14,320 15,674
Cash and bank balances 5,623 6,600 7,645 14,384 22,803
Total Assets 55,775 52,678 58,142 65,339 73,618

Fig 22 – Ratio @ `1,589

Return Ratios (%)
ROCE 11.2 13.6 20.7 22.1 21.5
ROIC 12.6 15.3 23.8 26.9 29.4
ROE 13.6 19.7 26.3 25.9 23.7
Turnover Ratios
Per share (`)
EPS 32.4 52.1 65.5 78.9 87.2
CEPS 62.0 67.0 92.2 108.4 118.4
Book Value 209.4 223.7 273.9 334.3 401.1
Solvency ratios
Debt/ Equity 0.6 0.4 0.3 0.2 0.1
P/E 49.0 30.5 24.3 20.1 18.2
P/BV 7.6 7.1 5.8 4.8 4.0
EV/ EBITDA 21.3 19.2 15.1 12.6 11.1
EV/ Sales 4.1 3.9 3.3 2.8 2.4
M-Cap/ Sales 3.9 3.8 3.2 2.9 2.6


DRL is a leading Indian pharma company that focuses on value
addition in brand formulations and generics exports to regulated
markets. The company started operations as a bulk-drug
manufacturer in 1984 and subsequently moved up the value chain; it
now aims at becoming an innovator company.
DRL is targeting to increase its share of sales in generics from regulated

markets through pure generics and patent challenging. As part of its
inorganic growth strategy, it acquired betapharm in Germany and expects
to garner more such smaller deals going forward. The company has
presence across most regulated and emerging geographies and recently
entered into a strategic deal with GSK to expand its branded generics
business in emerging countries.
Promoters
Public & Others 26%
30%
MF/Banks
16%
FIIs
28%
Source: BSE Note: *as of Sep ’10

Dr K Anji Reddy Chairman He served in the state-owned Indian Drugs and
Pharmaceuticals from1969 to 1975, was Founder-
Managing Director of Uniloids Ltd from 1976 to 1980 and
Standard Organics Limited from 1980 to 1984, before
founding Dr. Reddy’s in 1984. Under his leadership, Dr.
Reddy’s has become a pioneer and a trendsetter in the
Indian Pharma industry.
GV Prasad Vice Chairman He has been Vice-Chairman and CEO of Dr. Reddy’s since
and CEO 2001, when Cheminor Drugs, the company of which he was
then Managing Director, merged with Dr Reddy’s. Prasad
nurtured new lines of business, helped to build a high-talent
organization, and was instrumental in introducing best-in-
class practices in corporate governance.
Satish Reddy MD and COO He graduated in Chemical Engineering and went on to
receive an M.S. in Medicinal Chemistry from Purdue
University, USA, in 1990. He joined Dr Reddy’s in 1993 as
Executive Director responsible for manufacturing and new
product development. Satish Reddy steers Dr Reddy’s
PSAI and Global Generics businesses, two of the
company’s core revenue generating streams.
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Glenmark Pharma Rating: Buy

Target Price: `373
Poised for turnaround; initiate with Buy Share Price: `303
We initiate coverage on Glenmark Pharma with Buy and target

price of `373. We are positive on the stock, given turnaround in Sriram Rathi
the base business, pipeline of key product launches, +9122 6626 6737
monetisation of new chemical entity (NCE) pipeline and sriramrathi@rathi.com
improving financials.
Sanjeev Chiniwar
 Set to witness turnaround. Glenmark is well poised to witness +9122 6626 6716
turnaround, post disappointing performance in FY09 and FY10. We sanjeevchiniwar@rathi.com
expect 17.1% revenue CAGR (ex NCE income) over FY10-13e
driven by recovery in the US (increasing ANDA approvals and
launch of Tarka) and Latin America (restructuring complete, returns
Key data GNP IN / GLEN.BO
to begin), and the growing Indian market.
52-week high/low `322/`210
 Monetising NCE pipeline. Glenmark is the only Indian company Sensex/Nifty 20125 / 6063
to have successfully monetised NCEs; its recent outlicensing of 3-m average volume US$6.0m
GRC15300 to Sanofi Aventis reinforces our confidence in its Market cap `82bn/US$1817m
monetising capability. We value GRC15300 at `14 per share, with Shares outstanding 270m
likely success in other compounds to provide upside. Free float 51.7%
Promoters 48.3%
 Improving financials. We expect Glenmark to register 17.1% Foreign Institutions 27.6%
revenue CAGR and 25.5% net profit CAGR over FY10-13e. This Domestic Institutions 7.6%
coupled with improvement in working capital cycle (194 days in Public 16.4%
FY13e from 218 days in FY10), would strengthen the balance sheet
and return ratios.
 Valuation and risks. We value Glenmark at `373, valuing base
business at `339 based on 18x (10% discount to large-cap peers and
considering the past 2-year average forward PE of 19x) FY12e
base business earnings and `24 for NPV of exclusivity

Sales (`m) 20,402 24,124 29,587 33,528 38,379
Net profit (`m) 1,794 3,242 4,718 5,228 6,415 140
EPS (`) 7.2 12.0 17.5 19.4 23.8 130 Sensex
Growth (%) -71.6 80.7 45.5 10.8 22.7 120
110
PE (x) 42.3 25.2 17.3 15.6 12.7
100
PBV (x) 4.8 3.5 3.0 2.5 2.1
90 Glenmark
RoE (%) 11.5 16.4 18.3 17.2 17.9
80
RoCE (%) 9.0 11.6 13.2 13.3 14.4
Oct-09
Dec-09
Aug-09
Feb-10
Apr-10
Jun-10
Aug-10
Oct-10
Dividend yield (%) 0.1 0.1 0.3 0.3 0.4

Net gearing (%) 131.0 79.4 56.6 45.1 33.0

India Equities
18 October 2010 Glenmark Pharma – Poised for turnaround; initiate with Buy

Net sales 20,402 24,124 29,587 33,528 38,379 (`)
Sales growth (%) 5 18 23 13 14 750
- Op. expenses 15,852 17,928 21,541 24,780 28,204 Glenmark
650
EBITDA 4,550 6,196 8,047 8,747 10,175
EBITDA margins (%) 22.3 25.7 27.2 26.1 26.5 550
- Interest 1,457 1,655 1,327 1,227 1,107
450 25x
- Depreciation 1,027 1,206 1,389 1,584 1,719
+ Other income 440 504 567 599 670 350 20x
- Tax 694 531 1,180 1,307 1,604 15x
250
PAT 1,812 3,308 4,718 5,228 6,415
PAT growth (%) -71.6 80.7 45.5 10.8 22.7 150 10x
50
FDEPS (`/share) 7.2 12.0 17.5 19.4 23.8
Mar-06
Jul-06
Nov-06
Mar-07
Jul-07
Nov-07
Mar-08
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
Jul-10
CEPS (`/share) 11.6 16.3 22.4 24.9 29.8
DPS (`/share) 0.4 0.4 0.9 1.0 1.2

Share capital 251 270 270 270 270 (`m)
Shareholders’ fund 15,982 23,552 27,994 32,917 38,956 Glenmark
Debt 21,513 19,404 16,550 15,550 13,550 16x
150,000
Capital employed 37,526 43,086 44,674 48,597 52,636 12x
100,000
Fixed assets 21,117 23,881 24,992 25,408 25,190 8x
Investments 181 181 181 181 181
50,000 4x
Working capital 15,513 17,954 19,266 21,995 24,628
Cash 715 1,070 235 1,012 2,638
Capital deployed 37,526 43,086 44,674 48,597 52,636 -
Mar-07
Jul-07
Nov-07
Mar-08
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
Jul-10
No. of shares (m) 250.5 269.8 269.8 269.8 269.8
Net Debt/Equity (%) 1.3 0.8 0.6 0.5 0.3
W C turn (days) 210.2 218.0 204.0 197.4 194.4
Fig 3 – Cash flow statement (`m) Fig 6 – Growth and margin trend
+Depreciation 1,027 1,206 1,389 1,584 1,719 90
Cash profit 2,953 4,448 6,107 6,812 8,134 80
80.7
- Incr/(Decr) in WC 3,775 2,441 1,312 2,729 2,633 70
Operating cash flow (823) 2,007 4,795 4,083 5,501 60
- Capex 9,227 3,923 2,500 2,000 1,500 50
Free cash flow (10,049) (1,916) 2,295 2,083 4,001 40 45.5
- Dividend 117 126 276 306 375 30
+ Equity raised 0 3,993 0 0 0 20 22.7
+ Debt raised 11,034 (2,250) (2,854) (1,000) (2,000) 10
- Investments (7) 0 0 0 0 10.8
0
FY11e
FY12e
FY13e
FY10
- Misc. items 1,725 (654) 0 0 0

Net cash flow (851) 355 (836) 777 1,626
+ Opening cash 1,565 715 1,070 235 1,012 Revenue growth PAT Growth EBITDA Margin
Closing cash 715 1,070 235 1,012 2,638


We initiate coverage on Glenmark Pharma with Buy and target price
of `373. We are positive on the stock, considering turnaround in the
base business, pipeline of key product launches, monetisation of new
chemical entity (NCE) pipeline and improving financials.

Glenmark is well poised to witness turnaround, post disappointing
performance in FY09 and FY10. We expect 17.1% revenue CAGR
(excluding NCE income) over FY10-13e driven by recovery in the US
(increasing ANDA approvals and launch of Tarka) and Latin America
(restructuring over, returns to begin), and the growing Indian market. The
recovery would mainly be driven by the company’s efforts in the past
couple of years, in terms of restructuring of business in a highly-impacted
Latin America, focus on higher number of quality product filings, field
force increase in India and 15 ANDA approvals in a single year (FY10).
FY09 and FY10 were impacted by global recession, increased working
capital cycle and absence of out-licensing deals for NCE molecules.
However, with the situation now having improved, Glenmark is well placed
to reap the benefits of its past efforts as well as the overall industry growth.
Further, the company has a pipeline of 11 para-IV opportunities and is
likely to enjoy sole exclusivity for four products. One of the products,
Tarka, has already been launched by the company; Glenmark is the only
generics player for the product. Such opportunities would assist in
maintaining growth momentum along with positive earnings surprises.
Monetising NCE pipeline

Glenmark is the only Indian company to have successfully monetised
NCEs through out-licensing deals with big innovators. Its recent
outlicensing of GRC15300 to Sanofi Aventis reinforces our confidence in
its monetising capability. Glenmark could not out-license any NCE in the
past two years – FY09 and FY10 – mainly due to the global economic
recession; hence, its valuations were impacted. Further, phase-II trials of
two earlier out-licensed NCEs were unsuccessful. However, Glenmark
recently entered into a new deal for GRC 15300 with Sanofi Aventis, which
reinforces our confidence in the company’s NCE pipeline. We value
GRC15300 at `14 per share based on the probability-adjusted discounted
cash flow (DCF) technique. Out-licensing of any new molecule (pipeline of
nine compounds) would provide upside to our valuations.
Improving financials
We expect Glenmark to register 17.1% revenue CAGR and 25.5% net
profit CAGR over FY10-13e. This coupled with improvement in working
capital cycle (194 days in FY13e from 218 days in FY10) would strengthen
the balance sheet and return ratios. D/E has already decreased, from 1.3x
in FY09 to 0.8x in FY10, and we expect it to further reduce to 0.3x in
FY13e on the back of strong net profit growth and improving working
capital cycle.

Valuations
We value Glenmark at `373, valuing base business at `339 based on 18x
(10% discount to large-cap peers and considering the past 2-year average
forward PE of 19x) FY12e base business earnings and `24 for NPV of
exclusivity opportunities and GRC15300 (NCE). At CMP, the stock is
trading at 17.3x FY11e and 15.6x FY12e earnings. We believe that the
sensitivity to option value for NCE pipeline is the lowest ever and most of
the value is contributed by the base pharma business. Therefore, current
valuation provides upside for NCE value to investors, with minimal risk of
failure of NCE compounds.

(`)
750
650 Glenmark
550
450 25x
350 20x
250 15x
150 10x
50
Nov-06
Nov-07
Nov-08
Nov-09
Mar-06
Jul-06
Mar-07
Jul-07
Mar-08
Jul-08
Mar-09
Jul-09
Mar-10
Jul-10

 Almost 75% of revenue is contributed by exports from various
geographies. Exchange fluctuation will directly impact company
financials and, hence, our estimates.
 Failure of GRC 15300 in clinical trials would impact valuations as our
target price includes value of the molecule at `14 per share.
 However, any new out-licensing deal will have upside risk to our
estimates.


Glenmark is well poised to witness turnaround, post disappointing
performance in FY09 and FY10. We expect 17.1% revenue CAGR
(excluding NCE income) over FY10-13e driven by recovery in the US
(increasing ANDA approvals and launch of Tarka) and Latin
America (restructuring over, returns to begin), and the growing
Indian market. The recovery would mainly be driven by the
company’s efforts in the past couple of years, in terms of
restructuring of business in a highly-impacted Latin America, focus
on higher number of quality product filings, increase in field force in
India and 15 ANDA approvals in a single year (FY10).
Worst is likely over

FY09 and FY10 were impacted by global recession, increased working
capital cycle and absence of out-licensing deals for NCE molecules.
However, with the situation having improved, Glenmark is well placed to
reap the benefits of its past efforts and overall industry growth. Further, the
company has a pipeline of 11 para-IV opportunities and is likely to enjoy
sole exclusivity for four products. One of the products, Tarka, has already
been launched by the company, and Glenmark is the only generic player for
the product. Such opportunities would assist in maintaining growth
momentum along with positive earnings surprises.
Reorganisation to play out

Glenmark announced re-organisation of its business in Nov ’07 by splitting
it into specialty/proprietary and generics businesses. The rationale behind
this innovative split was to enhance focus on different business segments
and align management skills. According to the reorganisation scheme,
Glenmark Pharmaceuticals (GPL) will be the holding company (which will
overlook the specialty business) and will hold 100% in Glenmark Generics
(GGL), which will overlook the generics business. We believe this to be a
positive step taken by the company as it would enable Glenmark to
strengthen its focus on different segments and move up the value chain in
the long term.
We expect benefits of this innovation to accrue henceforth, and base
business (excluding NCE income) to see 17.1% CAGR over FY10-13e to
`38.4bn. The growth will be driven across both the segments viz., specialty
and generics.

Fig 8 – Glenmark Pharma: Separate business aspects
Specialty Business Generics

(GPL) (GGL)
Branded generics and discovery Generic formulations and APIs

 Business research (NCE/NBE)
segments
Building brands, generate Launching formulations and APIs of

 Salient features prescriptions and to market novel drugs going off-patent which are price
drugs in long term sensitive
Proper therapy selection, IP Low cost manufacturing, product

 Strategy protection, new geographies and late selection, timing, IP challenges, newer
stage novel pipeline geographies & efficient marketing
To become global end to end To build up end to end integration,

 Vision Specialty Company and to launch two scale and capabilities for generic
proprietary drugs by 2015 formulations & APIs and niche
product portfolio
Specialty business to witness 17% CAGR

We expect Glenmark’s specialty formulations (branded generics) business
to witness 17% CAGR over FY10-13e to `22.7bn across various
geographies. Glenmark operates in India, Latin America (LatAm), Europe
and semi-regulated markets (SRMs), where India contributes +50% of
specialty revenues. We estimate Indian-brand formulations to see 15.3%
CAGR over FY10-13e on the back of recent expansion in field force,
continuous launch of new products and supportive industry scenario.
SRMs, another big contributor comprising 28% of total specialty revenue,
is expected to register 19.1% CAGR, driven by geographical expansion,
increasing number of products in different geographies and increased
demand for branded generics. Glenmark has been consistently expanding
its presence across SRMs such as Brazil, Mexico and Venezuela. The
company has recently ventured into Mexico, where the business is still in
the earliest stages of development. However, based on Glenmark’s track
record, we are confident that the company would be able to replicate its
growth momentum in these markets as well.
Fig 9 – Representative market evolution across GPL* markets
Source: Company, Anand Rathi Research *GP L- Glenmark Pharmaceuticals

Fig 10 – Revenue trend in specialty segment in different markets

(`m)
12,000
15.3% CAGR
10,000
8,000
19% CAGR
6,000
4,000 19% CAGR

18% CAGR
2,000
-
India Latam SRMs EU
FY10 FY11e FY12e FY13e
Generics to register 16% FY10-13e CAGR

We expect the company’s generic formulations (GGL) business to witness
16% CAGR over FY10-13e to `16.5bn. The US and EU markets would be
major growth drivers for the generics segment. US contributes ~70% of
total generics revenue and we expect this market to register 17.6% CAGR
over FY10-13e for Glenmark on the back of a large number of ANDA
approvals in the past 18 months, launch of Tarka in Q2FY11 (only generic
in the market) and launch of niche products. US would continue to be the
key focus area for Glenmark. EU is a fairly small contributor at present
(<5%) and is expected to witness 34% CAGR due to low base. APIs is
another major contributor to generics (~25% of total generics revenue) and
we expect it to witness muted 10% CAGR owing to the company focusing
on the growing formulations business.
Fig 11 – Revenue trend in different markets: Generics segment
(`m)
14,000
12,000 17.6% CAGR
10,000
8,000
6,000
4,000 9% CAGR
8% CAGR
2,000 34% CAGR
-
US EU Argentina APIs

Fig 12 – Glenmark: Generics business – Snapshot
Source: Company

Monetising NCE pipeline

Glenmark is the only Indian company to have successfully monetised
NCEs through out-licensing deals with big innovators. Its recent
outlicensing of GRC15300 to Sanofi Aventis reinforces our confidence
in its monetising capability. Glenmark could not out-license any
NCE in the past two years – FY09 and FY10 – mainly due to global
economic recession; hence, its valuations were impacted. Further,
phase-II trials of two earlier out-licensed NCEs were unsuccessful.
However, Glenmark recently entered into a new deal for GRC 15300
with Sanofi Aventis, which reinforces our confidence in the
company’s NCE pipeline. We value GRC15300 at `14 per share based
on the probability-adjusted DCF technique. Out-licensing of any new
molecule (pipeline of seven compounds) would provide upside to our
valuations.
Strong R&D pipeline

Glenmark has a strong R&D pipeline of seven molecules (five NCEe and
two new biological entities (NBEs) with two compounds in phase-3 and
two in phase-2. The R&D pipeline spreads across the asthma, pain, diabetes
and metabolic disorder therapeutic areas. The company faced a set-back in
two NCEs – GRC3886 (Oglemilast) that was out-licensed to Forest Labs
and GRC6211 that was out-licensed to Eli Lily – as they did not provide
satisfactory data and have been dropped. Further, GRC8200 (Melogliptin)
was earlier out-licensed to Merck and the deal was terminated due to
portfolio restructuring of the latter, whence it decided to exit diabetes.
Fig 13 – R&D pipeline

Compound Primary Indications Target Status
GRC 8200 Completed phase II-b studies and looking for
Diabetes (Type II) DPP IV
(Melogliptin) potential partners
GRC 4039 Respiratory and inflammatory
PDE IV Phase II trials to start soon
(Revamilast) disorders
Neuropathic pain,
GRC 10693
Osteoarthritis and other CB 2 Phase II trials to start soon
(tedalinab)
inflammatory pain
Phase I ongoing and out-licensed to Sanofi-
Osteoarthritic, Neuropathic and
GRC 15300 PDE IV Aventis for a total deal size of US$325m plus
other pain
royalty on commercial sales
Acute multiple sclerosis,
GBR 500 VLA2 Phase I trials ongoing in US
Inflammatory disorders
Acute stroke coronary
GBR 600 syndrome, Thrombosis undisclosed In the process of initiating phase I trials
disorders
In-licensed compound and progressing well
Crofelmer Acute infectious diarrhoea HIV
in phase III in US
Value GRC15300 at `14 per share

Glenmark recently out-licensed GRC15300 to Sanofi-Aventis with an
upfront income of US$20m. According to the terms of the agreement,
Sanofi will have exclusive marketing rights for North America, Europe and
Japan, subject to Glenmark’s rights to co-promote in North America and
five eastern EU regions. The total milestone payment could be US$325m,
including upfront payment of US$20m. We value the deal at `14 per share
for Glenmark, based on probability-adjusted DCF calculation and assuming
15% discount rate, commercial launch in FY17, peak sales of US$1bn in
FY24 and success probability of 25%.

Financials
We expect the company to register 17.1% revenue (excluding NCE
milestone income) CAGR and 25.5% net profit CAGR over FY10-13e.
Including NCE income, we expect revenue growth of 16.7% CAGR
over FY10-13e. This coupled with improvement in working capital
cycle (194 days in FY13e from 218 days in FY10) would strengthen the
balance sheet and return ratios. D/E has already decreased, from
1.3x in FY09 to 0.8x in FY10, and we expect it to further decline to
0.3x in FY13e on the back of strong net profit growth and improving
working capital cycle.
Expect 17.1% revenue CAGR

We expect Glenmark to report 17.1% revenue CAGR over FY10-13e to
`38.4bn. The growth would be driven across both, specialty and generics
segments. We estimate 17% CAGR for the specialty segment and 16%
CAGR for generics, mainly driven by recovery in the US (increasing
ANDA approvals and launch of Tarka) and Latin America (restructuring
over, returns to begin) and the growing Indian market.

Generics 10,580 12,276 14,464 16,452
% of sales 42.3 40.7 42.3 42.0
US 7,230 8,360 10,223 11,756
EU 299 552 621 714
Argentina (Oncology) 343 364 391 431
API 2,708 3,000 3,228 3,551
Speciality 14,194 17,002 19,748 22,710
% of sales 56.8 56.3 57.7 58.0
India 7,606 8,816 10,138 11,659
LatAm 1,361 1,642 1,927 2,216
SRM 3,864 4,840 5,681 6,533
Europe 1,363 1,705 2,001 2,302
NCE 232 895 - -
Total 25,006 30,173 34,212 39,163
Expect PAT CAGR of 25.5% during FY10-13e

We expect the company to register net profit CAGR of 25.5% over FY10-
13e to `6.4bn on the back of strong revenue growth, 150bps improvement
in EBITDA margin and declining interest cost, from `1.7bn in FY10 to
`1.1bn in FY11e. EBITDA margin improvement of 100bps will come from
launch of high-margin products in the US market, higher sales of branded
generics (17% CAGR) and decrease in R&D expenses as a proportion of
sales. Net profit margin would improve, from 13.4% in FY10 to 16.7% in
FY13e.

Fig 15 – Net profit and margin trend

(`m) (%)
7,000 17
16.7
6,000 15.9 16
15.6
5,000 15
4,000 14
13.4
3,000 13
2,000 12
FY10
FY11e
FY12e
FY13e
PAT NPM (RHS)
Improving working capital cycle

To reduce its working capital cycle, Glenmark has taken various steps such
as restructuring its LatAm business and strong focus on cash-rich domestic
brand business as against only focusing on top-line growth as earlier. We
expect Glenmark’s working capital cycle to reduce, from 218 days in FY10
to 194 days in FY13e, by reduction in both debtor and inventory days. This
will mainly be driven by: i) higher growth in Indian business, which has a
fairly low working capital cycle, and ii) launch of niche products in the US
market.

Fig 16 – Income statement

Year-end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e
Revenues 20,402 24,124 29,587 33,528 38,379
Raw materials 6,581 7,843 9,325 10,729 12,281
% of Sales 32.3 32.5 31.5 32.0 32.0
% of Sales 14.9 13.3 14.1 14.5 14.5
R&D expenses 883 773 1,150 1,238 1,350
% of Sales 4.3 3.2 3.9 3.7 3.5
% of Sales 26.2 25.3 23.3 23.7 23.5
EBITDA 4,550 6,196 8,047 8,747 10,175
EBITDA Margin 22.3 25.7 27.2 26.1 26.5
Depreciation 1,027 1,206 1,389 1,584 1,719
PBIT 3,523 4,989 6,658 7,163 8,456
Interst expenses 1,457 1,655 1,327 1,227 1,107
PBIT from operations 2,066 3,334 5,331 5,936 7,349
PBT before extra-ordinary items 2,506 3,839 5,898 6,535 8,019
Extra-ordinary income/ (expenses) 183 - - - -
PBT 2,689 3,839 5,898 6,535 8,019
Provision for tax 745 531 1,180 1,307 1,604
Effective tax rate 28 14 20 20 20
PAT 1,944 3,308 4,718 5,228 6,415
Adjusted PAT 1,794 3,242 4,718 5,228 6,415
Growth in PAT (%) (71.6) 80.7 45.5 10.8 22.7
PAT margin 8.8 13.4 15.9 15.6 16.7

Share Capital 251 270 270 270 270
Reserves 15,731 23,282 27,725 32,647 38,686
Debt 20,943 18,694 15,840 14,840 12,840
Gross Block 18,386 21,755 25,263 28,263 29,763

Net Block 15,662 17,873 19,992 21,408 21,190
Capital WIP 5,454 6,008 5,000 4,000 4,000
Investments 181 181 181 181 181
Inventories 6,302 7,085 7,377 8,486 9,659
Debtors 9,553 10,783 12,577 14,238 15,772
Cash and bank balances 715 1,070 235 1,012 2,638
Total Assets 37,526 43,086 44,674 48,597 52,636

Fig 18 – Ratio analysis

Cash flow from operating activities
Profit before tax 2,689 3,839 5,898 6,535 8,019
Depreciation 1,027 1,206 1,389 1,584 1,719
Interest expenses 1,457 1,655 1,327 1,227 1,107
Operating profit before working capital change 5,173 6,700 8,614 9,346 10,845
Working capital adjustment (3,775) (2,441) (1,312) (2,729) (2,633)
Gross cash generated from operations 1,397 4,259 7,301 6,617 8,212
Direct taxes paid (1,128) (394) (1,180) (1,307) (1,604)
Cash generated from operations 269 3,865 6,122 5,310 6,608
Cash flow from investing activities
Capex (9,227) (3,923) (2,500) (2,000) (1,500)
Investment 7 - - - -
Cash generated from investment activities (9,220) (3,923) (2,500) (2,000) (1,500)
Cash flow from financing activities
Proceeds from share capital and premium - 3,993 - - -
Borrowings/ (Repayments) 10,936 (1,768) (1,500) (1,000) (2,000)
Interest paid (1,457) (1,655) (1,327) (1,227) (1,107)
Dividend paid (117) (126) (276) (306) (375)
Cash generated from financing activities 9,361 444 (3,103) (2,533) (3,482)
Net cash increase/ (decrease) 411 385 519 777 1,626
Fig 19 – Ratio @ `303

Return Ratios (%)
ROCE 9.0 11.6 13.2 13.3 14.4
ROIC 7.9 10.6 12.1 12.2 13.6
ROE 11.5 16.4 18.3 17.2 17.9
Turnover Ratios
Per share (Rs)
CEPS 11.6 16.3 22.4 24.9 29.8
Book Value 62.9 86.2 102.5 120.5 142.6
Solvency ratios
Debt/ Equity 1.3 0.8 0.6 0.5 0.3
Debt/EBITDA 4.6 3.0 2.0 1.7 1.3
P/E 42.3 25.2 17.3 15.6 12.7
P/BV 4.8 3.5 3.0 2.5 2.1
EV/ EBITDA 20.7 15.8 12.1 10.9 9.0
EV/ Sales 4.6 4.1 3.3 2.9 2.4
M-Cap/ Sales 3.7 3.4 2.8 2.4 2.1


Glenmark Pharmaceuticals is a research-driven, fully integrated
pharma company, with presence across regulated (US and Europe),
semi-regulated (LatAm, CIS countries, Argentina etc) and domestic
markets. Glenmark is the leader in the dermatology segment in India
and has strong presence in the international market as well. Further,
the company has strong presence in other lifestyle diseases in both,
domestic as well exports markets. Glenmark has one of the best
discovery research (NCE) pipelines in the Indian pharma industry,
with five NCEs and two NBEs at various stages. Specialty business
is the highest contributor to the company’s overall top-line.
Background
Glenmark is the leader in the dermatology segment in India and has a
strong global presence as well. Further, the company has strong presence in
other lifestyle diseases in both, domestic and exports markets.
Public &
Others
16%
Promoters
48%
FIIs
28%
MF/Banks
8%

Name Designation Background
Gracias Saldanha Chairma & Non- Prior to setting up Glenmark, he worked with a
Executive Director number of MNC pharma companies from 1964 to
1977. He holds a Masters degree in Science and a
Diploma in Management Studies.
Glenn Saldanha MD & CEO He holds a Bachelor's degree in Pharmacy and an
MBA. He joined Glenmark in 1998 as Director and
took over as MD & CEO in 2001. He worked with Eli
Lily in global marketing team and later with PWC as
consultant.
RV Desai Director - Finanace & Mr. R.V.Desai is Director for Finance, & Legal. He
Legal started his career with Glenmark
Pharmaceuticals Limited in 1982 and was appointed
Director in 2002. He is graduate in Science and a
Chartered Accountant.
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Ipca Laboratories Rating: Buy

Target Price: `356
Strong growth, compelling valuations; initiate with Buy Share Price: `294
We initiate coverage on Ipca with Buy and target price of `356.

We are positive on the stock on our expectations of higher-than- Sriram Rathi
industry growth in domestic formulations, scale-up of exports +9122 6626 6737
formulations, upside from Indore SEZ, strong return ratios and sriramrathi@rathi.com
valuations at substantial discount (50% to large-cap peers). Sanjeev Chiniwar
 Domestic formulations to outperform industry. Ipca reported +9122 6626 6716
23% CAGR in domestic formulations over FY05-10, higher than
industry CAGR of 14-15%. Ipca would continue outperforming
the industry and see 17% CAGR over FY10-13e driven by thrust
on lifestyle diseases and launch of 18-20 new products each year. Key data IPCA IN/ IPCA.BO
 Exports formulations to scale up. With continued geographical 52-week high/low `327/`112
forays and additions to its product portfolio, Ipca is well poised to Sensex/Nifty 20125 / 6063
witness 24.2% FY10-13e CAGR in export formulations. Approval
for the Indore SEZ plant would help scale up formulations in the
US market and may provide upside of 5-10% to total revenue. Free float 53.8%
 Strong financials with upside triggers. We expect Ipca to Promoters 46.2%
report 16.7% revenue and 21.7% PAT CAGRs as well as strong Foreign Institutions 6.5%
RoE of ~26% and RoCE of ~20% over FY10-13e. Approval of Domestic Institutions 29%
Public 18.3%
the Indore SEZ plant and higher-than-expected supplies of
artemether-lumafantrine would provide upside to our estimates.
 Valuation and risks. We value Ipca at `356 based on 14x FY12e
earnings. At CMP, the stock trades at 14.6x FY11e and 11.6x FY12e
earnings. Risks: Currency fluctuation (as 52% of revenue is
contributed by exports.

Sales (`m) 12,926 15,666 18,750 22,031 24,891
Net profit (`m) 1,542 2,016 2,516 3,181 3,643 270
250 Ipca
EPS (`) 12.3 16.1 20.1 25.4 29.1 230
Growth (%) 13.6 30.8 24.8 26.5 14.5 210
190
PE (x) 23.9 18.3 14.6 11.6 10.1 170
PBV (x) 5.4 3.9 3.2 2.6 2.1 150
130 Sensex
RoE (%) 25.3 26.9 26.2 27.0 25.3 110
90
RoCE (%) 17.0 17.8 18.8 20.9 20.6
Aug-09
Oct-09
Dec-09
Apr-10
Jun-10
Aug-10
Oct-10
Feb-10
Dividend yield (%) 0.8 1.0 1.5 1.9 2.2

Net gearing (%) 72.9 52.6 33.5 25.3 20.9

India Equities
18 October 2010 Ipca Lab – Strong growth, compelling valuations; initiate with Buy

Net sales 12,926 15,666 18,750 22,031 24,891
(`)
Sales growth (%) 21 21 20 18 13 400
- Op. expenses 10,274 12,331 14,849 17,297 19,526 16x
350
EBITDA 2,653 3,335 3,901 4,735 5,364
EBITDA margins (%) 20.5 21.3 20.8 21.5 21.6 300
Ipca 12x
- Interest 378 329 243 205 198 250
- Depreciation 397 467 574 649 709
200
+ Other income 66 62 60 96 96 8x
- Tax 280 617 629 795 911 150
PAT 1,542 2,016 2,516 3,181 3,643 100 4x
PAT growth (%) 13.6 30.8 24.8 26.5 14.5
50
FDEPS (`/share) 12.3 16.1 20.1 25.4 29.1 0
Mar-06
Nov-06
Mar-07
Nov-07
Mar-08
Nov-08
Mar-09
Nov-09
Mar-10
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
CEPS (`/share) 15.5 19.8 24.7 30.6 34.7
DPS (`/share) 2.2 2.8 4.0 5.1 5.8

Share capital 250 251 251 251 251 (`)
Debt 5,251 5,338 4,338 4,089 4,089 45,000
Minority interests -4 -6 -6 -6 -6
Ipca
Capital employed 11,560 13,981 14,908 17,096 19,887 35,000 8x
Fixed assets 5,912 6,761 7,605 7,956 8,247 25,000

Investments 412 325 325 325 325
4x
Working capital 5,123 6,787 6,835 8,073 9,090 15,000
Cash 113 108 143 741 2,224
Capital deployed 11,560 13,981 14,908 17,096 19,887 5,000
No. of shares (m) 125.1 125.3 125.3 125.3 125.3
Mar-06
Jul-06
Mar-07
Jul-07
Mar-08
Jul-08
Mar-09
Jul-09
Mar-10
Jul-10
Nov-06
Nov-07
Nov-08
Nov-09
Net Debt/Equity (%) 72.9 52.6 33.5 25.3 20.9

W C turn (days) 135.5 148.6 129.6 130.5 130.1
Fig 3 – Cash flow statement (`m) Fig 6 – Ipca outperforms industry (India)
40
+ Depreciation 397 467 574 649 709
Cash profit 1,482 2,663 3,089 3,830 4,352 35
- Incr/(Decr) in WC 736 1,664 48 1,238 1,016 30
Operating cash flow 746 999 3,041 2,592 3,335 25
- Capex 869 1,261 1,417 1,000 1,000
20
Free cash flow (123) (261) 1,624 1,592 2,335
15
- Dividend 323 409 589 744 852
+ Equity raised 0 0 0 0 0 10
+ Debt raised 1,069 (54) (1,000) (249) 0 5
- Investments 316 (86) 0 0 0 0
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
- Misc. items 288 (633) 0 0 0

Net cash flow 19 (5) 35 598 1,483
+ Opening cash 94 113 108 143 741 Ipca Industry
Closing cash 113 108 143 741 2,224


We initiate coverage on Ipca with Buy and target price of `356. We
are positive on the stock on our expectations of higher-than-
industry growth in domestic formulations, scale-up of exports
formulations, upside from Indore SEZ, strong return ratios and
valuations at substantial discount (50% to large-cap peers).
Domestic formulations to outperform industry growth

Ipca registered 23% CAGR in domestic formulations over FY05-10,
substantially higher than industry CAGR of 14-15%. We expect Ipca to
continue outperforming the industry and register 17% CAGR over FY10-
13e driven by thrust on lifestyle diseases and launch of 18-20 products
each year. Ipca has already established a strong foothold in the domestic
market (leadership in malaria segment) with ~60% contribution from the
fast-growing chronic (lifestyle) diseases segment. Domestic formulations
contributed 39% of total revenue in FY10.
Fig 7 – Segmental contribution to domestic formulations (FY10)
Cough
Others
CNS & preparations
1%
Dermatology 4%
8% CVS & Diabetic
28%
Gastro-
Intestinal
7%
NSAIDs
26% Anti-malarials
17%
Anti-bacterials
9%
Source: Company
Exports formulations to scale up

With continued foray into new geographies and additions to its products
portfolio, Ipca is well positioned to witness 24.2% CAGR in exports
formulations over FY10-13e; it registered 24.5% CAGR over FY06-10. It
follows a conservative strategy of entering a new geography organically,
not being too aggressive in terms of acquisitions but building a strong
franchise instead and only then shifting focus to another geography. We
have included revenue from supplies of artemether-lumafantrine in
exports formulations.
Ipca’s strategy has been successful, as evident from the past growth
momentum and strong profitability. Europe, Africa and CIS are its major
international markets and the US is scaling up, with additional capacity at
the Silvassa plant. Approval for the Indore SEZ plant would help further
scale up formulations in the US market and may provide upside of 5-10%
to total revenue.

Strong financials with upside triggers

We expect Ipca to report 16.7% revenue and 21.8% PAT CAGRs over
FY10-13e, driven by 20.4% CAGR in formulations and 8.6% CAGR in
APIs. Ipca is likely to register strong return ratios, with RoE of ~26% and
RoCE of ~20% over FY10-13e owing to focused growth and a strong
profitability-oriented business strategy of growing organically as against
via M&As. Ipca has a comfortable D/E of 0.5x, which we expect to
decline to 0.2x in FY13e. Approval for the Indore SEZ plant and higher-
than-expected (US$30m in FY12e) supplies of artemether-lumafantrine
would provide upside to our estimates.
Valuations
We value Ipca at `354 based on 14x FY12e earnings. At CMP, the stock
trades at 14.6x FY11e and 11.6x FY12e earnings. Current valuations are at
~50% discount to large-cap peers’ and, considering the company’s strong
and sustainable growth momentum; we believe that the discount is likely
to decline. We expect re-rating in Ipca’s valuations due to sustainable
strong growth, high professional management quality, minimal downside
risk in business and current valuations at ~50% discount to large-cap
peers.
Ipca has historically traded at peak valuations of 12-13x one-year forward
earnings with current valuation at almost similar levels. Ipca trades at a
discount to sector valuations on account of:
 non-aggressiveness in entering large & highly-regulated US markets,
 higher proportion (~25%) of anti-malarials (low margins) in domestic
formulations,
 stake sale by a promoter and anticipated further stake sale, an
overhang on the stock,
 recognition of an API-focused company

(`)
400
16x
350
300
Ipca 12x
250
200
8x
150
100 4x
50
0
Mar-06
Jul-06
Nov-06
Mar-07
Jul-07
Nov-07
Mar-08
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
Jul-10
However, we expect the company’s valuations to re-rate, with IPCA

expected to register strong 16.7% and 22% revenue and net profit CAGRs
over FY10-13e. Return ratios, too, are estimated to be robust, at ~26%
RoE and 20% RoCE during the same period. We expect valuation re-rating
and, thus, ascribe a P/E of 14x to FY12e earnings on account of:

 Ipca ventured into US generics in Sep ’08 through its Silvassa facility
and is rapidly scaling up business. Further, the company has built a
facility at Indore SEZ to cater for the US market. Although Ipca
avoids the high-risk high-reward patent challenging stratagem, we
expect it to significantly benefit from pure generics, considering its
backward integration and proven cost efficiencies
 Proportion of anti-malarials has considerably fallen, from ~25%
earlier to 17-18%, and the company has built a strong franchise in the
chronic diseases segment, including cardiovascular, diabetes and pain
management that would sustain growth momentum in the domestic
market and ensure better margins.
 We do not perceive the 15% stake sale by one of the promoters (Mr
Chandurkar) in the past few years as negative for investors, given that
he has retired as Managing Director and is now +70 years old. He still
holds about 10% stake in the company.
 The company’s proportion of formulations, which has risen to 70%,
will likely increase to 76% in FY13e. Ipca is now more of a
formulations company like any front-line large-cap and holds
significant formulations brands in the domestic market and emerging
countries.

 Currency fluctuation, as +50% of revenue is contributed by
international markets
 Delay in launch of products may impact future growth rate
 Any negative issue regarding approval of new formulations plant at
the Indore SEZ would impact the company’s valuations

Domestic formulations to outperform

industry
Ipca reported 23% CAGR in domestic formulations over FY05-10,
substantially higher than industry CAGR of 14-15%. Ipca would
continue outperforming the industry and see 17% CAGR over FY10-
13e driven by thrust on lifestyle diseases and launch of 18-20
products each year. Ipca has already established strong foothold in
domestic market (leadership in anti-malaria and rheumatoid
arthritis segments) with about 60% contribution from the fast-
growing chronic diseases segment. Domestic formulations
contributed 39% of total revenue in FY10.
Fig 9 – Consistent outperformance by Ipca vs. industry growth; trend to continue

(%)
40
35
30
25
20
15
10
5
0
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
Ipca Industry
Source: Industry, Company, Anand Rathi Research
Thrust on chronic diseases segment, leadership in malaria and

rheumatoid arthritis
Though Ipca is the leader in the anti-malarial segment (non-chronic) with
>40% market share, it mainly focuses on lifestyle diseases such as pain
(NSAID) management, cardiovascular (CVS), anti-diabetic and gastro-
intestinal. The proportion of these segments in Ipca’s therapeutic
contribution is increasing. Proportion of the anti-malarial segment has
reduced, from ~25% in FY06 to 17% at present, and is likely to further
reduce due to higher growth in chronic diseases segments. Also, Ipca
holds the leadership position in the rheumatoid arthritis segment with
~50% market share. We expect the company to register a strong +25%
growth in anti-malarial segment in FY11e driven by substantial increase in
incidences of malaria in key parts of the country due to heavy rain. These
have resulted in huge demand for anti-malarial medicines from both the
public as well as the government.
Over the past few years, Ipca had been focussing on increasing its
presence in pain management, CVS, anti-diabetic etc via launching new
products and increasing field force to promote brands in the segments.
The company also created separate divisions for focussed strategy in these
chronic diseases categories. Its strategy has worked well and these
categories are witnessing high growth, resulting in increased contribution
to total domestic formulations revenue.

Fig 10 – Therapeutic contribution of domestic brand formulations

(%) FY07 FY08 FY09 FY10
CVS & anti-diabetic 27.0 28.0 29.0 28.0
Anti-malarials 22.0 17.0 17.0 17.0
Anti-bacterials 12.0 11.0 10.0 9.0
NSAIDs 20.0 23.0 24.0 26.0
Gastro-Intestinal 7.0 8.0 7.0 7.0
CNS & Dermatology 6.0 7.0 7.0 8.0
Cough preparations 4.0 3.0 4.0 4.0
Others 2.0 3.0 2.0 1.0
Field force additions, new divisions & products to drive growth

Ipca has sales (field) force of ~4,200 in India and plans to add 1,000
people over FY11-12 to increase penetration to new towns and villages.
The company covers ~250,000 of the total ~750,000 doctors in India. Of
the current ~4,200 sales force, Ipca has added 2,000 people in the past
three years. We believe that productivity of the additions would increase,
leading to higher revenue growth as well as profitability.
Further, Ipca recently created three new divisions, resulting in 11 divisions
at present. The rationale behind separate divisions for different
therapeutic areas is to have a focused and productive approach for each
category. The three new divisions are 3D (CVS), Nephro Sciences
(Nephrology) and Uro Sciences (Urology). We expect the company to
continue launching 18-20 new products each year to maintain the growth
momentum. Ipca witnessed 15% growth in FY10 from new products
launched in the past five years. We believe that such initiatives would
assist in supplementing the past growth momentum, of +20% CAGR.
Fig 11 – Growth from new products

Year of launch Revenue (`m) % Contribution
FY06 190 3
FY07 119 2
FY08 361 6
FY09 119 2
FY10 63 1
New products launched over FY06-10 852 15
Products launched before FY06 4,939 85
Total 5,791 100

Exports formulations to scale up

With increasing foray into new geographies and continuous
addition to its products portfolio, Ipca is well positioned to witness
24.2% CAGR in exports formulations over FY10-13e. Ipca registered
24.5% CAGR in international formulations over FY06-10. It follows a
conservative strategy of entering a new geography organically, not
being too aggressive in terms of acquisitions but building a strong
franchise instead and only then shifting focus to another geography.
As a result, it has registered growth momentum and strong
profitability. Its main international markets are Europe, Africa and
CIS; it is scaling up capacity at its Silvassa plant for catering to the
US demand. Approval for the Indore SEZ plant would help scale up
formulations in the US market and may provide upside of 5-10% to
total revenue.
Successful organic growth strategy

Ipca has been following a conservative organic growth strategy for
international markets vis-à-vis peers who follow the inorganic path. As a
result, the company registered 24.5% revenue CAGR over FY06-10 with
continuous margin improvement. Ipca enters a new geography, builds a
strong franchise (with meaningful revenue contribution through
increasing field force and introduction of new products) and only then
shifts focus to another geography.
Fig 12 – Geographical breakdown of exports formulations (FY10)
Asia
Australasia 4% US
2% 14%
CIS
13%
Africa
16%
Europe
51%
Source: Company
Ipca exports to +110 countries globally and has its own field force in 40
countries in the CIS, SouthEast Asia, the Middle East, Latin America and
Africa. However, in developed markets, Ipca has its own presence and tie
ups for marketing the products. We believe that the growth momentum is
likely to continue given low base and expect it to register 24.2% CAGR in
exports formulations driven by supplies of anti-malarial arthemeter-
lumafantrine and strong growth in the US, CIS, Africa, Europe etc.

Fig 13 – Strong growth momentum in exports formulations

(`m) Supply of arthemeter- (%)
11,000 lumafantrine to begin from 40
FY11 leading to robust growth
9,000 35
35.8
30.1 30
7,000
27.9 25
25.1 25.0
5,000
20
3,000 15
11.9 13.0
1,000 10
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
Source: Company. Anand Rathi Research
US business witnessing fast ramp-up

Ipca started generics formulations business in the US in FY09 and
registered `242m revenue the same year. In FY10, the business grew
174% to `664m, constituting 5% of total revenue compared with 2% in
FY09. Currently, Ipca supplies generics products to the US from its
Piparia (Silvassa) facility, which has recently increased capacity incurring
capex of `350-400m. We estimate CAGR of 32.8% (mainly owing of low
base) over FY10-13e in the US business, driven by additional capacity at
Silvassa.
The company has already set up a new plant at the Indore SEZ, which is
awaiting US FDA approval. Ipca has already started filing ANDAs from
the site. Post approval, the facility would help Ipca significantly ramp up
its US business. Management has indicated that the facility would
contribute peak sales of `3-3.5bn. Current revenue size of the US business
stood at `664m in FY10. We have not factored in any revenue from the
facility in our estimate; hence, approval and commercialisation at the
facility would provide upside to our estimates.
Arthemeter–lumafantrine to contribute incremental

7% revenue in FY11e
We expect Ipca to generate revenues of US$15m (3.9% of total revenue)
and US$30m (7% of revenue) in FY10E and FY11E respectively, from
the supply of Artemether - Lumefantrine (an anti-malarial drug with
market size of US$200-250m; supplied through tenders mainly to Africa).
Ipca recently received approval for the anti-malarial finished fixed dose
combination formulation – Artemether + Lumefantrine – under WHO's
Prequalification Programme (product is now listed in WHO’s pre-
qualification product list dated 15 Dec ’09). IPCA is the fourth company
(after Novartis, Cipla and Ajanta Pharma) to have acquired pre-
qualification for the product. However, it is the only company to
manufacture both the APIs (Artemether and Lumefantrine) required for
the finished dosage formulation and also possess WHO approval.
This product is supplied to tenders of various countries funded by global
health fund houses such as UNICEF. Currently, Novartis is the only
major supplier of the product, which it manufactures at a facility in China
but sources APIs from outside. We believe Ipca is better placed to win the

tenders, given its price advantage, as the finished dose formulation would
be backed by in-house APIs. This combination product enjoys 200-250m
treatments every year and average cost per treatment stands at US$1-1.3.
Total market size of the product is US$200-250m. We expect Ipca to
garner 5% and 15% market share in FY11E and FY12E respectively,
(assuming market size of US$200m), which in our view is fairly
achievable.

Financials
We expect Ipca to report 16.7% revenue and 21.8% PAT CAGRs over
FY10-13e, driven by 20.4% CAGR in formulations and 8.6% CAGR
in APIs. Ipca is likely to register strong return ratios, with RoE of
~26% and RoCE of ~20% over FY10-13e owing to focused growth
and a strong profitability-oriented business strategy of growing
organically as against via M&As. Ipca has a comfortable D/E of
0.5x, which we expect to decline to 0.2x in FY13e. Approval for the
Indore SEZ plant and higher-than-expected (US$30m in FY12e)
supplies of artemether-lumafantrine would provide upside to our
estimates.

We estimate revenue CAGR of 16.7% over FY10-13e to `24.9bn mainly
on the back of higher growth in formulations and steady growth in APIs.
The formulations segment is estimated to register robust 20.4% sales
CAGR over FY10-13e on account of strong growth momentum in India,
US and beginning of supplies of arthemeter-lumafantrine. API, on the
other hand, is estimated to post 8.6% revenue CAGR over the same
period. The growth would be driven by increased DMF filings (50 in the
US), strong long-term relationships with global MNCs and aggressive
pursuance for new MNC tie-ups for supply arrangements.

Formulations 10,870 13,698 16,555 18,952
% of sales 70.0 73.1 75.1 76.1
% growth 19.0 26.0 20.9 14.5
Domestic 5,978 7,055 8,254 9,574
Exports 4,892 6,643 8,302 9,378
APIs 4,586 4,982 5,406 5,868
% of sales 29.5 26.6 24.5 23.6
% growth 30.4 8.6 8.5 8.6
Domestic 1,416 1,487 1,561 1,640
Exports 3,169 3,495 3,844 4,229
Other operating income 70 70 70 70
Net Revenues 15,526 18,750 22,031 24,891
Net profit to be a strong 21.8% CAGR over FY10-13e

We expect Ipca to register 21.8% net profit CAGR over FY10-13e driven
by strong revenue growth, 30bps improvement in EBITDA margin and
declining interest cost in absolute terms (from `329m in FY10 to `198m
in FY13e). Net profit margin is expected to improve 170bps, from 12.9%
in FY10 to 14.6% in FY13e.


(`m) (%)
4,000 35
30.8
3,500 30
26.5
3,000 24.8
25
2,500
20
2,000
14.5
1,500 15
1,000 10
FY10
FY11e
FY12e
FY13e
Return ratios stabilising

We believe RoCE and RoE would stabilise at current levels and improve
gradually going forward. We expect RoCE to improve to 20.6% in FY13e
from 17.8% in FY10; RoE is expected to fall to 25.3% in FY13e from
26.9% in FY10 due to our assumption of lower leverage. We have
assumed debt repayment of `1.3bn over FY10-13e. In our view, falling
RoE is not concern as the net profit margin, assets-turnover ratio and
asset/net worth are likely to improve over the same period.
Fig 16 – Return ratios stabilising

(%)
29
26.9 27.0
27 26.2
25.3
25
23
21
20.9 20.6
19
18.8
17 17.8
15
FY10
FY11e
FY12e
FY13e
ROE ROCE


Revenues 12,926 15,666 18,750 22,031 24,891
Raw materials 5,073 6,456 7,752 9,004 10,176
EBITDA 2,653 3,335 3,901 4,735 5,364
EBITDA Margin 20.5 21.3 20.8 21.5 21.6
Depreciation 397 467 574 649 709
PBIT 2,256 2,868 3,327 4,086 4,656
Extra-ordinary income/ (expenses) (762) 63 - - -
PBT 1,183 2,663 3,145 3,977 4,554
Provision for tax 280 617 629 795 911
PAT 903 2,046 2,516 3,181 3,643
Profit & dividend from associates 57 18 - - -
Adjusted PAT 1,542 2,016 2,516 3,181 3,643
Growth in PAT (%) 13.6 30.8 24.8 26.5 14.5
PAT margin 11.9 12.9 13.4 14.4 14.6

Share Capital 250 251 251 251 251
Reserves 6,063 8,398 10,325 12,762 15,553
Minority Interest (4) (6) (6) (6) (6)
Debt 4,599 4,545 3,545 3,296 3,296
Gross Block 7,790 8,812 10,312 11,312 12,312
Net Block 5,768 6,379 7,305 7,656 7,947
Capital WIP 144 383 300 300 300
Investments 412 325 325 325 325
Inventories 3,062 3,802 4,272 4,976 5,617
Debtors 3,391 3,880 4,174 4,966 5,581
Cash and bank balances 113 108 143 741 2,224
Loans and Advances 832 1,201 1,130 1,328 1,500
Total Assets 11,560 13,981 14,908 17,096 19,887

Fig 19 – Ratio @ `294

Return Ratios (%)
ROCE 17.0 17.8 18.8 20.9 20.6
ROIC 17.1 17.8 18.9 21.4 21.9
ROE 25.3 26.9 26.2 27.0 25.3
Turnover Ratios
Per share (`)
CEPS 15.5 19.8 24.7 30.6 34.7
Book Value 50.5 69.1 84.4 103.9 126.2
Solvency ratios
Debt/ Equity 0.7 0.5 0.3 0.3 0.2
Debt/EBITDA 1.7 1.4 0.9 0.7 0.6
P/E 23.9 18.3 14.6 11.6 10.1
P/BV 5.4 3.9 3.2 2.6 2.1
EV/ EBITDA 15.6 12.4 10.3 8.3 7.1
EV/ Sales 3.2 2.6 2.1 1.8 1.5
M-Cap/ Sales 2.8 2.4 2.0 1.7 1.5


IPCA Labs is a fully integrated pharma company engaged in
manufacturing and marketing of brand & generics formulations,
APIs and intermediates. Most of its formulations products are
backed by APIs manufactured in house that assists in improving
overall operating efficiency.
The company has been assigned all-India rank of 27, as per ORG-IMS
(MAT Mar ’10). Ipca has strong presence in most therapeutic groups such
as cardiovascular, anti-diabetic, NSAID, anti-malarials and gastro-
intestinal in both domestic and international markets and is also dealing in
CNS, dermatology etc on a smaller scale. More than half its total revenues
are contributed by exports sales across Europe, Africa, US, Australia, CIS
etc.
Public & Others

18%
Promoters
FIIs 46%
7%
MF/Banks
29%
Source. BSE Note: *as of Sep ’10

RS Hugar Chairman A postgraduate in Econometrics; has an experience of 35
years in Banking & Finance; was Director of Institute of
Banking Personnel Selection, Chairman and Managing
Director of Corporation Bank and Global Trust Bank
Prem Chand Godha Managing Director He is a first-generation entrepreneur and Director on the
Board of the Company since 1975. Under his leadership, the
company has seen tremendous growth in all activity spheres;
he has brought Ipca to the forefront
AK Jain Finance Director He is a Science graduate and a Chartered Accountant. He
joined the Company as Chief Accountant in 1980 and has
grown steadily with the company. Mr Jain is in charge of
Finance, Accounts, Costing, Taxation, Distribution, Chemical
R&D and IT
Source. Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Jubilant Life Sciences Rating: Buy

Target Price: `411
CRAMS boost; initiate with Buy Share Price: `314

Organosys) with Buy and target price of `411. We are positive on Sriram Rathi
the stock owing to expectations of steady growth momentum, +9122 6626 6737
easing financial leverage and value unlocking through demerger sriramrathi@rathi.com
of agri & performance polymer (APP) business. Sanjeev Chiniwar
+9122 6626 6716
 Pharma life sciences (CRAMS) – Key growth driver. We sanjeevchiniwar@rathi.com
expect pharma & life sciences products (PLSP) segment
(contributes 88% of total revenue) to report 11.4% CAGR over
FY10-13e driven by increased capacity utilisation in custom
manufacturing operations (CMO), recent addition of new CRAMS Key data JOL IN/JOL.BO
contracts and +50% capacity addition in life sciences chemicals. 52-week high/low `395/`210
 Value unlocking via APP demerger. Demerger of APP 3-m average volume US$1.8m
business would result in better margin and return ratios as PLSP Market cap `50bn/US$1108m
has higher margins (21-22%) and returns than APP. We believe Shares outstanding 159m
this would lead to valuation re-rating for the company. Free float 52.7%
Promoters 47.3%
 Improving financials. We expect D/E to decline to 0.8x in Foreign Institutions 15.7%
FY13e from 2.8x in FY09 on the back of steady growth, recently Domestic Institutions 7.2%
Public 29.8%
concluded QIP and better profitability. Further, margins and
returns would improve post demerger of the APP business.
 Valuation and risks. We value Jubilant at `411 based on 10x

FY12e PLSP EBITDA and 4x FY12e APP EBITDA. At CMP,
the stock trades at 11.8x FY11e & 10.8x FY12e earnings. Risks:
Loss of any long-term contract would be major setback.

Sales (`m) 35,180 37,813 41,671 46,561 52,078
Net profit (`m) 3,268 3,733 4,213 4,603 5,279 200
EPS (`) 22.1 23.5 26.5 29.0 33.2 180
Jubilant
Growth (%) 0.8 14.2 12.9 9.2 14.7 160
PE (x) 14.2 13.4 11.8 10.8 9.4 140
PBV (x) 3.7 2.2 2.0 1.9 1.7 120
RoE (%) 25.9 21.2 17.6 17.7 19.0 100
Sensex
RoCE (%) 9.6 9.0 9.2 10.2 11.8 80
Feb-10
Oct-09
Apr-10
Jun-10
Dec-09
Aug-10
Oct-10
Dividend yield (%) 0.5 0.6 0.8 0.9 1.1

Net gearing (%) 275.8 114.8 99.2 95.6 83.0
Source: Company, Anand Rathi Research Source: Anand Rathi Research

India Equities
18 October 2010 Jubilant Life Sciences - CRAMS boost; initiate with Buy

Fig 1 – Income statement (`m) Fig 4 – One year forward PE
Net sales 35,180 37,813 41,671 46,561 52,078
(`)
Sales growth (%) 41 7 10 12 12 450
18x
- Op. expenses 29,457 29,926 33,656 37,157 41,519
400
EBITDA 5,723 7,887 8,015 9,403 10,559
EBITDA margins (%) 16.3 20.9 19.2 20.2 20.3 350 14x
- Interest 1,070 1,505 1,128 1,336 1,543 300
- Depreciation 1,632 1,986 2,169 2,377 2,481
250 10x
+ Other income 425 373 240 64 64
200
- Tax 267 959 744 1,151 1,320
PAT 3,268 3,733 4,213 4,603 5,279 150 6x
PAT growth (%) 0.8 14.2 12.9 9.2 14.7 100
50
FDEPS (`/share) 22.1 23.5 26.5 29.0 33.2
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
CEPS (`/share) 28.6 31.4 35.0 38.3 42.6
DPS (`/share) 1.5 2.0 2.7 2.9 3.3
Fig 2 – Balance sheet (`m) Fig 5 – One year forward EV/EBITDA

Share capital 148 159 159 159 159
(`m)
16x
Debt 39,932 33,652 29,808 28,332 26,352 125,000
Minority interests 320 324 324 324 324 105,000 12x

85,000
Fixed assets 42,481 42,995 44,826 45,949 45,467 8x

65,000
Investments 2,714 2,564 2,564 2,564 2,564
45,000
Working capital 3,915 5,077 5,423 6,047 6,762 4x
Cash 3,817 5,862 2,703 844 592 25,000
5,000
No. of shares (m) 147.6 158.8 158.8 158.8 158.8
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Net Debt/Equity (%) 275.8 114.8 99.2 95.6 83.0
W C turn (days) 59.9 49.2 49.3 56.9 56.8
Fig 3 – Cash flow statement (`m) Fig 6 – Past 12-month PE

(X)
+ Depreciation 1,632 1,986 2,169 2,377 2,481
20
Cash profit 4,204 6,569 6,383 6,980 7,761
- Incr/(Decr) in WC (1,569) 1,165 346 624 715
Operating cash flow 5,773 5,403 6,037 6,356 7,045
- Capex 21,708 2,500 4,000 3,500 2,000 16
Free cash flow (15,935) 2,903 2,037 2,856 5,045
- Dividend 257 261 372 493 539 One yr average 14.2x
+ Equity raised 0 3,871 0 0 0 12
+ Debt raised 17,697 (7,054) (4,703) (4,176) (4,680)
- Investments 2,257 (149) 0 0 0
- Misc. items 669 (2,436) 133 49 84
8
Net cash flow (1,421) 2,045 (3,171) (1,862) (257)
Oct-09
Nov-09
Dec-09
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
+ Opening cash 5,238 3,817 5,862 2,703 844

Closing cash 3,817 5,862 2,703 844 592


Organosys) with Buy and target price of `411. We are positive on the
stock owing to expectations of steady growth momentum, easing
financial leverage and value unlocking through demerger of the APP
business.
Pharma life sciences (CRAMS) – Key growth driver

We expect the pharma & life sciences (PLSP) segment (contributes 88%
of total revenue) to register 11.4% CAGR over FY10-13e driven by
increased capacity utilisation in CMOs (60% utilisation), recent addition of
new CRAMS contracts and +50% capacity addition in life sciences
chemicals. The company has recently signed two long-term contracts
worth US$33m and US$51m with two US-based life sciences companies.
This reinforces our belief of pick up in the company’s outsourcing
business post witnessing slowdown in the past two years.
The PLSP segment includes CRAMS, life sciences chemicals, specialty
pharmaceuticals, generics (dosage form) and nutritional ingredients.
CRAMS is the largest contributor, with 63% of sales and we expect the
segment to remain the major growth contributor with 11.6% CAGR over
FY10-13e. Jubilant’s long-term customer base includes 18 of the top-20
global pharma companies (such as GSK, Astra Zeneca, Merck, Eli Lilly
and Johnson & Johnson) that ensure sustainable growth opportunities.
Value unlocking through APP demerger

Demerger of the APP business would result in better margin and return
ratios for Jubilant as the PLSP segment has higher margins (21-22%) and
returns than APP. This would lead to valuation re-rating for the company.
The Board has already approved the demerger scheme for the APP
business, which will be listed separately on the stock exchanges as ‘Jubilant
Industries’ (JIL).
APP business includes agri products (single super phosphate and
agrochemicals) and performance polymers (food polymers, latex,
consumer products etc). The segment contributes ~12% of total revenue;
EBITDA margin stands at 8-10%. APP is more of a commoditised
business and has lower margins and returns compared with the PLSP
segment. We believe the APP (for which we estimate EV of `2.1bn)
demerger would lead to valuation re-rating of the PLSP business as
financials would look better for the standalone PLSP company.
Improving financials
We expect the company to register consolidated 11.4% revenue and 12.2%
net profit CAGRs over FY10-13e driven by steady growth in CRAMS and
life sciences chemicals on the back of increased capacity utilisation and
addition of new capacity in life sciences chemicals. We expect D/E to
reduce to 0.8x in FY13e from 2.8x in FY09 on account of steady growth,
recently concluded QIP and better profitability. Margins and returns
would also improve post demerger of the APP business.

Valuations
We value Jubilant at `411 based on 10x FY12e PLSP EBITDA and 4x
FY12e APP EBITDA. At CMP, the stock trades at 11.8x FY11e and 10.8x
FY12e earnings and EV/EBITDA of 9.4x FY11e and 8x FY12e. At our
target price, the stock will trade at EV/EBITDA of 11.3x FY11e and 9.6x
FY12e EBITDA. Jubilant is predominantly a CRAMS player and CRAMS
is a capital-intensive industry where growth generally comes from capacity
addition. This leads to lower return ratios due to continuous incurrence of
capex; hence, CRAMS companies have low valuations. However,
Jubilant’s current valuations are lower than the past 3-year average forward
PE of 14x and EV/EBITDA of 11x.

`m FY12e EBITDA EV/EBITDA (x) EV
PLSP 8,875 10.0 88,755
APP 528 4.0 2,112
Enterprise value (EV) 90,866
Less: Net debt 25,563
Market capitalistion 65,303
Value per share (`) 411
Fig 8 – One year forward EV/EBITDA

(`m)
145,000
16x
125,000
105,000 12x
85,000
8x
65,000
45,000
4x
25,000
5,000
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Fig 9 – One year forward PE

(`)
450
18x
400
350 14x
300
250 10x
200
150 6x
100
50
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10

Key risks
 Loss of any long-term big customer would be a major setback for the
company as growth momentum is generally based on repetitive and
new contracts from such customers
 Currency fluctuation remains a major risk as ~60% of revenue is
based on exports
 The pharma segment contributes 88% of total revenue and, hence,
regulatory risks persist in terms of manufacturing, quality assurance
and product approvals

PLSP – Key growth driver

We expect the PLSP segment (contributes 88% of total revenue) to
register 11.4% CAGR over FY10-13e driven by increased capacity
utilisation in CMOs (60% utilisation), recent addition of new
CRAMS contracts and +50% capacity addition in life sciences
chemicals. The company has recently signed two long-term
contracts worth US$33m and US$51m with two US-based life
sciences companies. This reinforces our belief of pick up in the
company’s outsourcing business post witnessing slowdown in the
past two years. Jubilant’s business model offers both synergistic as
well as vertical integration, from basic chemicals to high-value
derivatives and finished-dosage products.
Fig 10 – Synergistic and vertical integration
Source: Company
An overview
The PLSP segment includes CRAMS, life sciences chemicals, specialty
pharmaceuticals, generics (dosage form) and nutritional ingredients.
CRAMS is the largest contributor, with 63% of sales and we expect the
segment to remain the major growth contributor, with 11.6% CAGR over
FY10-13e. Jubilant’s long-term customer base includes 18 of the top-20
global pharma companies (such as GSK, Astra Zeneca, Merck, Eli Lilly
and Johnson & Johnson) that ensure sustainable growth opportunities.

Fig 11 – PLSP breakdown (FY10)

Nutritional
ingredients Healthcare
Specialty and 5.9% 0.2%
generics
11.4%
Life science
chemicals
19.1% CRAMS
63.4%
Source: Company
One-stop shop for CRAMS

Jubilant is the largest CRAMS company (in terms of revenue) in India that
provides end-to-end life science services across the total value chain (from
discovery research and development to full-scale manufacturing) to the
global pharmaceutical and life sciences industry, thereby being a preferred
outsourcing partner for global players. In the CRAMS space, the company
provides manufacturing and research services for proprietary products &
exclusive synthesis, APIs and CMOs of sterile and non-sterile products,
and drug discovery & development services (DDDS). Proprietary products
and custom synthesis constitutes ~45% of CRAMS business, implying
high margins.
Fig 12 – Presence across the CRAMS value chain
Source: Company
Jubilant is the largest producer of pyridines (an intermediate used by

pharma and agrochemical companies) and its derivatives globally, thereby
being a preferred partner for the intermediate. Further, the company is
increasing 20% capacity of pyridines and picolines, which would aid
growth going forward. The company has recently signed two new
contracts worth US$51m and US$33m with US-based companies,
indicating pick up in global outsourcing activities. The company is also in
the advanced discussions stage for 2-3 new contracts with large innovator
companies; the negotiations are expected to materialise in Q3FY11.

We expect the CRAMS segment to witness 11.6% revenue CAGR over

FY10-13e driven by pick up in outsourcing activities globally, continuous
addition of new long-term contracts, and increased capacity utilisation in
CMOs (current utilisation at only 60%). The company has a pipeline of
eight products in the proprietary products & exclusive synthesis segment,
with two being in phase-2 and five in phase-3; it also has a pipeline of 48
products in CMOs, with 12 in phase-2 and ten in phase-3. Successful
commercialisation of any of the products in phase-3 would imply a
significant opportunity for the company as likelihood of bagging large-
scale manufacturing contract will significantly increase.
Fig 13 – Recovering CRAMS growth
(`m) (%)
Lower growth due to
35,000 18
slowdown in CRAMS industry
in previous year leading to no
new major contracts 15
30,000
13.4 13.5
12.3 12
25,000
9
20,000 7.9
6
15,000 3
FY10
FY11e
FY12e
FY13e
CRAMS revenue Growth (RHS)
Pharmaceutical products – Specialty & generics

The pharma products segment consists of specialty pharmaceuticals
(comprising of radio-pharmaceuticals and allergenic extracts) and generic
dosage forms. Jubilant entered into specialty pharma through acquisition
of Draxis Healthcare in ’08. We estimate 12.8% CAGR over FY10-13e in
the pharma products segment driven by 11.3% CAGR in specialty pharma
and 15% CAGR in generics.
The growth in specialty pharma would mainly be driven by radio
pharmaceuticals. Specialty pharma develops, manufactures and markets
diagnostic imaging and therapeutic radio pharmaceutical products (nuclear
medicine imaging and therapeutic agents). Generics business growth
would be driven by 25 product filings, capacity expansion and a fairy low
base.

Fig 14 – Segmental revenue trend in pharmaceutical products

(`m)
3,500 3,187
3,000 2,846
2,541
2,500 2,310 2,312
2,010
2,000 1,748
1,520
1,500
1,000
500
FY10
FY11e
FY12e
FY13e
Specialty Pharma Generics
Life sciences chemicals and nutritional ingredients

We expect life sciences chemicals and nutritional ingredients to register
steady 12% and 5% CAGRs respectively over FY10-13e. Life sciences
chemicals division includes supply of products such as acetic anhydride
and ethyl acetate that are used as raw material in the life sciences industry.
The growth would mainly be driven by growing demand on the back of
strong growth in the life sciences industry and increase in capacity by
>50% in the next two years via plant modification and de-bottlenecking.
Jubilant is a leading supplier of nutritional ingredients for pharma, and
human and animal applications such as niacin, niacinamide and choline
chloride. We expect a steady 5% CAGR over FY10-13e driven new plants
being set up for niacinamide to generate high-value products.
Fig 15 – Revenue trend in life sciences chemicals & nutritional ingredients

(`m) (% of PLSP)
10,000 25
9,000
8,000 20
7,000
6,000 15
5,000
4,000 10
3,000
2,000 5
1,000
0 0
FY10
FY11e
FY12e
FY13e
Life science chemicals Nutritional ingredients

Life science chemicals (RHS) Nutritional ingredients (RHS)

Value unlocking through APP

demerger
Demerger of APP business would result in improved margin and
return ratios for Jubilant as the PLSP segment has higher margins
(21-22%) and return ratios compared with APP. We believe this
would lead to valuation re-rating for the company. The Board has
already approved the demerger scheme for the APP business, which
will be listed separately on the stock exchanges as ‘Jubilant
Industries’ (JIL). Standalone companies would enable management
to enhance focus on each business for better growth. We value APP
business at an EV of `2.3bn.
APP business – An overview

Agri products & performance polymer (APP) business includes agri
products (single super phosphate and agrochemicals) and performance
polymers (food polymers, latex, consumer products etc). The segment
contributes ~12% of total revenue and has EBITDA margin of 8-10%).
APP is more of a commoditised business and has lower margins and
returns compared with the PLSP segment.
Jubilant is among the top-3 manufacturers in India for single super
phosphates. The company markets agrochemicals for crop protection in
India. It is a leading manufacturer of performance polymers, including
food polymers (provides chewing gum base to global players), latex
(includes VP latex and SBR latex for application in tyre cord and conveyor
belt globally) etc. Consumer products include adhesives, sealants and
decorative products for furniture, footwear & allied industries. Application
polymers are used for manufacture of an extensive range of adhesives and
binders used for packaging, textiles and coatings.
Expect steady growth momentum

Though APP is more of a commodity business, growth fluctuates due to
high fluctuation in prices, which impacts profitability. Jubilant being a
leading player in single super phosphate, latex etc, we believe the company
would be able to witness steady revenue growth of 5% each and EBITDA
margin of 8% each in FY11e, FY12e and FY13e, considering past trend
and management guidance. However, margin would continue to fluctuate
with change in commodity prices.
We expect Jubilant to witness strong 20% growth in FY11e in the APP
segment mainly driven by full capacity utilisation of 420,000mtpa of single
super phosphate after change in fertiliser policy and 14,000mtpa of latex,
increase in distribution channel reach by 15% each in FY11e, FY12e and
FY13e for consumer products and contract for selling +50% of increased
production (120% capacity addition) of food polymers.

Fig 16 – APP revenue growth trend

(`m) (%)
7,000 30
20.0
20
6,000
10
5.0 5.0
5,000 0
-10
4,000
-20
(23.3)
3,000 -30
FY10
FY11e
FY12e
FY13e
APP revenue Growth (RHS)
Fig 17 – Demerger process timelines
Source: Company

Financials
We expect the company to register consolidated 11.3% revenue and
12.2% net profit CAGRs over FY10-13e driven by steady growth in
CRAMS and life sciences chemicals on the back of increased
capacity utilisation and addition of new capacity in life sciences
chemicals. We expect D/E to reduce to 0.8x in FY13e from 2.8x in
FY09 on account of steady growth, recently concluded QIP and
better profitability. Margins and returns would also improve post
demerger of APP business.
Expect 11.3% revenue CAGR over FY10-13e

We expect Jublant to witness consolidated revenue CAGR of 11.3% over
FY10-13e to `52.1bn driven by 11.4% CAGR PLSP business and 9.8%
CAGR in the APP segment. PLSP growth would be driven by increased
capacity utilisation in CMOs (60% utilisation at present), recent addition of
new CRAMS contracts (worth US$51m and US$33m) and +50% capacity
addition in life sciences chemicals. APP segment growth would be driven
by increased capacity utilisation in food polymers and single super
phosphate and increasing demand for agrochemicals.
Fig 18 – Revenue breakdown (`m)

PLSP 33,620 36,643 41,281 46,535
% YoY 13.1 9.0 12.7 12.7
% of sales 88.9 87.9 88.7 89.4
CRAMS 21,320 22,999 26,085 29,597
% YoY 12.3 7.9 13.4 13.5
% of PLSP 63.4 62.8 63.2 63.6
Prop products and excl synthesis 9,390 9,860 11,338 13,039
API 2,820 3,243 3,729 4,289
CMO 6,620 7,282 8,010 8,811
DDDS 2,490 2,615 3,007 3,458
Total pharma products 3,830 4,289 4,856 5,499
% YoY 25.2 12.0 13.2 13.2
% of PLSP 11.4 11.7 11.8 11.8
Specialty pharmas 2,310 2,541 2,846 3,187
Generics 1,520 1,748 2,010 2,312
Life Sciences Chemicals 6,420 7,190 8,053 9,020
% YoY 7.5 12.0 12.0 12.0
% of PLSP 19.1 19.6 19.5 19.4
Nutritional ingredients 1,970 2,069 2,172 2,281
% YoY - 5.0 5.0 5.0
% of PLSP 5.9 5.6 5.3 4.9
Healthcare 80 96 115 138
% YoY - 20.0 20.0 20.0
% of PLSP 0.2 0.3 0.3 0.3
APP 4,190 5,028 5,279 5,543
% YoY (23.3) 20.0 5.0 5.0
% of sales 11.1 12.1 11.3 10.6
Total 37,810 41,671 46,561 52,078

Fig 19 – Revenue growth momentum

(`m) (%)
60,000 15
50,000 11.8 12
11.7
10.2
40,000 9
7.5
30,000 6
FY10
FY11e
FY12e
FY13e
Net profit CAGR of 12.8% over FY10-13e

We expect Jubilant to register consolidated net profit CAGR of 12.8%
over FY10-13e to `5.3bn. The growth would be driven by steady revenue
growth and EBITDA margin of 19-21% over the same period. We expect
consolidated EBITDA margin to decline 170bps in FY11e due to impact
of high raw-material prices in H1FY11. However, we expect margins to
rebound to +20% levels from FY12e. Net profit margin in expected to
improve, from 9.9% in FY10 to 10.1% in FY13e.
Easing leverage
We expect D/E to reduce to 0.8x in FY13e from 2.8x in FY09 on the
back of steady growth, recently concluded QIP and better profitability.
D/E declined to 1.1x in FY10 led by fund raising through QIB worth
`3.9bn, which resulted in equity dilution of 7.7%. We believe this was
crucial as D/E stood at a high +2.5x before the QIB. We believe that
D/E would further ease to 0.8x in FY13e, assuming debt raising in FY12e
for redemption of FCCBs (due in May ’11) worth US$142m, which will
result in higher interest cost. Further, interest coverage ratio would
improve, from 3.9x in FY10 to 5.2x in FY13e and debt/EBITDA would
decline, from 4x in FY10 to 2.3x in FY13e.
Fig 20 – Solvency ratios

(%)
6
5.2 5.3 5.2
5
3.9
4
4.0 3.5
3 2.8
2.3
2
1.1 1.0
1 1.0
0.8
0
FY10
FY11e
FY12e
FY13e
Debt/Equity Debt/EBITDA Interest coverage



Revenues 35,180 37,813 41,671 46,561 52,078
Raw materials 15,614 17,091 19,506 21,331 23,801
EBITDA 5,723 7,887 8,015 9,403 10,559
EBITDA Margin 16.3 20.9 19.2 20.2 20.3
Depreciation 1,632 1,986 2,169 2,377 2,481
PBIT 4,090 5,901 5,845 7,026 8,078
Interst expenses 1,070 1,505 1,128 1,336 1,543
Extra-ordinary income/ (expenses) (479) (329) - - -
PBT 2,966 4,440 4,957 5,754 6,599
Provision for tax 267 959 744 1,151 1,320
PAT 2,699 3,481 4,213 4,603 5,279
Minority Interest (133) 5 - - -
PAT after minority interest 2,832 3,476 4,213 4,603 5,279
Adjusted PAT 3,268 3,733 4,213 4,603 5,279
Growth in PAT (%) 0.8 14.2 12.9 9.2 14.7
PAT margin 9.3 9.9 10.1 9.9 10.1

Share Capital 148 159 159 159 159
Reserves 12,528 22,364 25,225 26,589 28,551
Debt 29,040 23,117 21,487 26,407 24,427
FCCBs 9,741 8,610 6,396 - -
Deferred Tax Liability 1,151 1,924 1,924 1,924 1,924
Gross Block 46,483 51,514 56,514 60,514 62,514
Net Block 37,450 40,495 43,326 44,949 44,467
Capital WIP 5,031 2,500 1,500 1,000 1,000
Investments 2,714 2,564 2,564 2,564 2,564
Inventories 5,956 6,910 6,916 7,635 8,531
Debtors 5,044 5,186 5,708 6,378 7,134
Cash and bank balances 3,817 5,862 2,703 844 592
Misc Expenditure 3 - - - -
Total Assets 52,927 56,499 55,516 55,404 55,386

Fig 23 – Ratio @ `314

Return Ratios (%)
ROCE 9.6 9.0 9.2 10.2 11.8
ROIC 10.5 10.1 9.7 10.4 11.9
ROE 25.9 21.2 17.6 17.7 19.0
Turnover Ratios
Working capital cycle (days) 59.9 49.2 49.3 56.9 56.8
Average collection period (days) 48.3 49.4 47.7 47.4 47.4
Average payment period (days) 52.2 78.6 73.4 61.9 61.6
Inventory holding (days) 63.8 78.5 75.0 71.5 71.1
Per share (`)
EPS 22.1 23.5 26.5 29.0 33.2
CEPS 28.6 31.4 35.0 38.3 42.6
Book Value 85.9 141.8 159.8 168.4 180.8
Solvency ratios
Debt/ Equity 2.8 1.1 1.0 1.0 0.8
Debt/EBITDA 6.8 4.0 3.5 2.8 2.3
P/E 18.5 17.4 15.5 14.1 12.3
P/BV 4.8 2.9 2.6 2.4 2.3
EV/ EBITDA 16.7 11.5 11.3 9.6 8.4
EV/ Sales 2.7 2.4 2.2 1.9 1.7
M-Cap/ Sales 1.7 1.7 1.6 1.4 1.3


Jubilant is a fully integrated pharmaceutical player and offers a vast
range of products and services, from chemicals and drug discovery
to dosage forms. Its business model consists of Pharmaceutical &
Life Sciences products (PLSP), Industrial Products and
Performance Polymers. The services offered by the company are
related to research & development and manufacturing of key
building blocks and advance intermediates for the in-market
products and NCEs.
Public & Others

30%
Promoters
47%
FIIs
16%
MF/Banks
7%

Shyam S Bhartia Chairman & MD Mr Bhartia is a fellow member of ICWAI, Board
of Governors, IIT Kanpur and IIM Ahmedabad
and has a rich industrial experience in the
Pharma & Speciality Chemicals, Food, Oil and
Gas (Exploration & Production), Aerospace and
Information Technology sectors.
Hari S Bhartia Co-chairman & MD Mr Bhartia is a Chemical Engineer from IIT,
Delhi and has +20 years of experience in the
Pharma & Speciality Chemicals and
Biotechnology, Food, Oil and Gas, Aerospace,
IT sectors. He has led his business group into
strategic alliances and affiliations with leading
global corporations.
Mr Sankaraiah Excecutive Director - Mr Sankaraiah is a fellow member of the ICAI
Finance and has over 20 years of experience in the
industry. He has looked after Treasury
Management, Project Financing, Profit
Management, Forex Management, Investments,
Mergers & Acquisition, Taxation, Company
restructuring, Legal, Secretarial etc.
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Ranbaxy Laboratories Rating: Buy

Target Price: `658
Abundant opportunities; initiate with Buy Share Price: `582
We initiate coverage on Ranbaxy with a Buy rating and target

price of `658. Ranbaxy is well placed to witness turnaround in its
Sriram Rathi
base business, reap synergistic benefits of parent Daiichi +9122 6626 6737
Sankyo’s (Daiichi) hybrid business model and significant cash sriramrathi@rathi.com
flows from para IV opportunities.
Sanjeev Chiniwar
 Expect turnaround in base business. We expect Ranbaxy’s base +9122 6626 6716
business (ex para IVs) to turnaround (12.2% CAGR in CY09-12e) sanjeevchiniwar@rathi.com
led by stabilising US business (+US$250m annual revenue), strategic
focus on Indian business, commencement of Nexium supply to
Astra Zeneca and synergistic benefits from Daiichi integration. Key data RBXY IN / RANB.BO
 Para IVs to provide significant cash flows. Ranbaxy has some big 52-week high/low `613/`362
products (such as Lipitor, Caduet, Nexium, Aricept, Actos) with para Sensex/Nifty 20125 / 6063
IV filing for the next few years, which would provide significant one-
time cash profits. We value such opportunities at `140. Shares outstanding 420m
 Improving operating efficiency. We expect 1,040bps margin Free float 36.1%
expansion in base business over CY09-12e, driven by various cost- Promoters 63.9%
cutting measures and R&D savings of US$20mn post transfer of Foreign Institutions 8.3%
innovative R&D to Daiichi.
Public 16.2%
 Valuation and risks. We value Ranbaxy at `658 based on 20x
CY12e base business earnings and `140 for para IV pipeline.
Resolution of US FDA issue would provide upside to our
estimates. Risks: Failure to get approval for para IV products;
regulatory hurdles (such as delay in approval or US FDA warning).

YE 31 Dec CY08 CY09 CY10e CY11e CY12e
Sales (`m) 74,140 75,970 89,348 100,731 99,485
Net profit (`m) 2,909 4,016 14,274 15,068 10,873 230
EPS (`) 6.9 9.6 34.0 35.8 25.9 210
190 Ranbaxy
Growth (%) -45.4 38.1 255.4 5.6 -27.8
170
PE (x) 84.1 60.9 17.1 16.2 22.5
150
PBV (x) 2.0 3.9 3.0 2.5 2.2 130
RoE (%) 8.2 9.3 28.7 24.3 15.1 110
90 Sensex
RoCE (%) 5.7 5.6 18.2 18.7 13.8
Aug-09
Oct-09
Apr-10
Jun-10
Aug-10
Oct-10
Dec-09
Feb-10
Dividend yield (%) 0.0 0.0 2.0 1.8 1.3

Net gearing (%) 99.7 83.6 64.6 23.4 20.8

India Equities
18 October 2010 Ranbaxy Laboratories – Abundant opportunities; initiate with Buy

Fig 1 – Income statement (`m) Fig 4 – One year forward PE
Net sales 74,140 75,970 89,348 100,731 99,485
(`)
Sales growth (%) 6.2 2.5 17.6 12.7 (1.2) 700
- Op. expenses 68,302 68,846 71,412 79,613 84,236 Announcement of Daiichi taking
EBITDA 5,838 7,124 17,936 21,118 15,250 600 over Ranbaxy
Open offer
EBITDA margins (%) 7.9 9.4 20.1 21.0 15.3 closed and
500 USFDA 30x
- Interest 2,055 710 791 791 791 warning
- Depreciation 2,452 2,676 2,733 2,890 3,040 400 letters 25x
+ Other income 2,521 2,370 4,620 1,880 2,520 300 20x
- Tax -5,650 6,991 5,534 4,250 3,067 15x
PAT 2,909 4,016 14,274 15,068 10,873 200
PAT growth (%) -45.4 38.1 255.4 5.6 -27.8 100
-
FDEPS (`/share) 6.9 9.6 34.0 35.8 25.9
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Dec-05
Aug-06
Dec-06
Aug-07
Dec-07
Aug-08
Dec-08
Aug-09
Dec-09
Aug-10
CEPS (`/share) 12.8 15.9 40.5 42.7 33.1
DPS (`/share) 0.0 0.0 7.9 7.2 5.2
Fig 2 – Balance sheet (`m) Fig 5 – One year forward EV/EBITDA

Share capital 2,102 2,102 2,102 2,102 2,102 (`m)
Shareholders’ fund 42,962 43,434 56,150 67,692 76,021 Ranbaxy
Debt 250,000
30,619 31,550 31,550 11,074 11,074
200,000 20x
150,000
Fixed assets 49,607 51,136 49,903 48,513 46,974
Investments 5,432 5,407 5,407 5,407 5,407 100,000 10x
Working capital -4,739 6,558 5,662 8,774 10,537
50,000
Cash 23,956 12,416 27,261 16,605 24,710
Capital deployed 74,256 75,517 88,233 79,300 87,628 -
No. of shares (m) 420.4 420.4 420.4 420.4 420.4
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Net Debt/Equity (%) 99.7 83.6 64.6 23.4 20.8
W C turn (days) 115.3 118.0 117.6 111.6 112.2
Fig 3 – Cash flow statement (`m) Fig 6 – Base business margin recovering
Consolidated PAT 2,909 3,165 15,604 15,068 10,873 (`m) (%)
20,000 15.3 16
+ Depreciation 2,452 2,676 2,733 2,890 3,040
Cash profit 13.1 13.0
5,361 5,841 18,337 17,957 13,912
16,000
- Incr/(Decr) in WC (23,792) 11,296 (896) 3,112 1,763 12
Operating cash flow 29,153 (5,456) 19,232 14,845 12,149
12,000 7.9 8.0
- Capex 7,385 2,367 1,500 1,500 1,500 8
Free cash flow 21,768 (7,823) 17,732 13,345 10,649 8,000 4.9
- Dividend 0 0 3,885 3,526 2,544
+ Equity raised 4
0 0 0 0 0 4,000 1.7
+ Debt raised 1,433 (6,553) 0 (20,475) 0
- Investments 3,028 (25) 0 0 0 - 0
CY07
CY08
H1CY09
CY09
CY10e
CY11e
CY12e
- Misc. items 595 (2,811) (997)

Net cash flow 19,578 (11,541) 14,845 (10,656) 8,105
+ Opening cash 4,379 23,956 12,416 27,261 16,605 EBITDA OPM (RHS)
Closing cash 23,956 12,416 27,261 16,605 24,710 Source: Company, Anand Rathi Research


We initiate coverage on Ranbaxy Laboratories (Ranbaxy) with Buy and
target price of `658 per share. We believe Ranbaxy is well-placed to
witness turnaround in its base business and reap synergistic benefits of
parent Daiichi’s hybrid business model (Daiichi is an innovator
company and Ranbaxy is a successful generics company). Para IV
opportunities (180-day marketing exclusivity) would provide one-time
upsides along with cash inflows; also, cost-cutting strategies are
expected to boost operating efficiency.
Expect turnaround in base business

We expect Ranabxy’s base business (excluding para IVs) to turnaround on the
back of stabilising US business, expected resolution with US FDA, strategic
focus on Indian brand business, commencement of Nexium (API and
formulations) supply to Astra Zeneca and long-term synergistic benefits from
Daiichi integration. Resolution with the US FDA (earlier the better) for
manufacturing facilities would be a key positive for the company. However,
Ranbaxy has back-up plans, in case the resolution does not happen. US
business has started stabilising post six quarters of revenue decline due to US
FDA ban on the company’s Dewas and Paonta Sahib facilities. Further, the
company has taken certain strategic steps, which would strengthen growth in
India, EU and Africa going forward.
Fig 7 – Base business picking up growth momentum

(`bn)
105
6
90
6 13
75 12 11
5
5 10
60 9 10
9 25
45 9 21
13 13
30 18
15 16
14
15 25
16 18 21
-
CY09
CY10e
CY11e
CY12e
India North America EU (incl Nexium) Asia Pac Africa and Latam APIs
Para IV opportunities to provide significant cash flows

Ranbaxy has a few big products – such as Lipitor, Caduet, Nexium, Aricept,
Actos – in the para IV pipeline that would be launched over the next 4-5 years
and, hence, provide significant one-time cash profits. We value such
opportunities at `140 per share. The company has already proved its execution
capability through launch of Valtrex with 180-day exclusivity and garnering
+60% market share; also, it has monetised Flomax, although the product
could not be launched due to lack of US FDA approval. The company has
indicated that it has already taken the appropriate steps to monetise the para
IV opportunities. Based on its history, we believe that the company would be
able to generate huge cash flows from such opportunities over the next 4-5
years.

Improving operating efficiency

We expect 1,040bps margin expansion in base business over CY09-12e on the
back of turnaround in the base business, various cost-cutting measures across
global operations and R&D savings of US$20m post transfer of innovative
R&D to Daiichi. We expect EBITDA margin to improve to double-digit in
base business in CY11e vis-à-vis single-digit in the past two years. CY10
margin (ex para IV opportunities) is expected to be in single digit at 8% due to
expectation of higher consultancy charges on account of steps towards US
FDA resolution; however, we expect higher than 4.9% margin in CY09.
Further, the company has divested innovative R&D to Daiichi, which would
help Ranbaxy cut down annual R&D expenditure of up to ~US$20m. We
expect base business EBITDA margin to expand to 15.3% in CY12e from
4.9% in CY09.
Valuations
We value Ranbaxy at `658 per share based on 20x CY12e base business
earnings and `140 per share for para IV pipeline. At CMP, the stock trades at
17.1x CY10e and 16.2x CY11e earnings including the value of para IV
pipeline. Adjusting the expected value of `140 per share for para IV pipeline
in the CMP, the stock is trading at 24.9x CY11e and 17.1x CY12e base
business earnings. Resolution of US FDA issues would be a key upside
positive for the stock. Management has, for the first time, indicated that there
will be a comprehensive discussion with the US FDA in Q4CY10 and the
resolution may take ~6 months after that.

(`)
700
Announcement of Daiichi taking
600 over Ranbaxy
Open offer
closed and
500 USFDA 30x
warning
400 letters 25x
300 20x
15x
200
100
-
Dec-05
Apr-06
Aug-06
Dec-06
Apr-07
Aug-07
Dec-07
Apr-08
Aug-08
Dec-08
Apr-09
Aug-09
Dec-09
Apr-10
Aug-10

 Any problems in monetisation of para IV opportunities would impact our
target price
 Further issues with the US FDA will impact growth and earnings (as for
the Paonta Sahib and Dewas facilities, which had been issued warning
letters)

Expect turnaround in base business

We expect Ranabxy’s base business (excluding para IVs) to turnaround
on the back of stabilising US business, expected resolution with the US
FDA, strategic focus on Indian branded business, commencement of
Nexium (API and formulations) supply to Astra Zeneca and long-term
synergistic benefits from the Daiichi integration. Resolution with the US
FDA (the earlier the better) for manufacturing facilities would be a key
positive for the company. However, Ranbaxy has back-up plans, in case
the resolution does not happen. US business has started stabilising post
six quartes of revenue decline due to US FDA ban on the company’s
Dewas and Paonta Sahib facilities. Further, the company has taken
certain strategic steps, which would strengthen growth in India, EU and
Africa going forward.
Fig 9 – Reviving growth trajectory
Resolution of US FDA issues would be another key positive

from the business and financials perspective as well as
sentimentally. It seems that the company has already made
efforts to launch FTF products to save 180 days exclusivity in
case resolution does not take place
Nexium API and formulations supply to Astra Zeneca would

start in Q4CY10 and Q1CY11 respectively. We expect
consistent revenue flow (expect more than US$100m
annually) to occur till patent expiry in '14 and successful
launch of Nexium in '14 with 180 days exclusivity could add an
NPV of `25 per share.
Base business EPS

to inch up to `25.9
and successful
Revival in base Double-digit growth launch of Lipitor and
business and cost in base business and Caduet would
cutting measures continuous margin provide NPV of `68
(`) to expand base expansion would lead per share in addition
30 business EBITDA to increased EPS of to base business
margin to 8% `17.8. Aricept (para earnings
25 from 4.9% in IV) opportunity would
CY09, resulting in provide additional
Base business EPS
EPS of `8.4. upside of `18 to EPS

20 Valtrex, Flomax
and Aricept
15 opportunities to
result in total EPS Synergies from Daiichi could be substantial and may
provide significant upside to our estimates. The
of `34
10 financial impact could be in the form of higher
revenue growth and margin expansion through
premium products. Divestment of innovative R&D to
5 Daiichi would save annual expense of ~US$20m,
leading to margin expansion
0
CY10e CY11e CY12e

Negatives in US seem to have bottomed out

We believe that issues in Ranbaxy’s US business due to US FDA warning
letters for two of its manufacturing facilities have bottomed out. The revenue
trend (excluding para IV opportunities and limited competition products) is
stabilising at US$55-60m per quarter. North America is the biggest contributor
to the global pharma market as well as Ranbaxy. However, owing to regulatory
deviations and falsification of data by the company, the US FDA issued
warning letters to its Paonta Sahib and Dewas manufacturing facilities. The
products manufactured at these plants were banned and no new ANDA
approvals were granted. This substantially impacted the company’s US
business and dented its brand name. Revenue from the US declined 40% yoy
during CY09 to US$234m and 54% yoy in Q3CY09 to US$44m; we believe
that the decline has now bottomed out.
To stabilise its US business, Ranbaxy is taking various steps such as applying
to the US FDA for re-inspection of its Dewas facility, transferring
manufacturing for existing big products from the Paonta Sahib and Dewas
plants to other sites (such as Ohm in the US) and boosting capacities at other
sites. Further to this, the company has made timely launch of Valtrex, a para
IV product initially filed from the Dewas plant. We expect the US business to
witness 10% revenue growth each in CY10e, CY11e and CY12e.
Fig 10 – Stabilising US business

(US$m) Estimated
500 US$255m from
Valtrex
Estimated
400 US$100m
from Valtrex
300
386 388
200 311
257 283
234
100
CY07
CY08
CY09
CY10e
CY11e
CY12e
US FDA resolution would be key positive

Management has, for the first time, indicated that it would have a
comprehensive discussion with the US FDA about the warning letters issued
to its Paonta Sahib and Dewas facilities. Process for resolution of the issue
would be decided during the discussion, which may involve a one-time
penalty. However, uncertainty regarding potential resolution still persists,
though management seemed confident. We believe that a resolution with the
US FDA would be a key positive for the stock as the company would be able
to gradually gain the lost credibility and market share in regulated markets,
utilise capacity for regulated markets and use the facilities for para IVs which
have already been approved for the aforementioned sites.

Strategic focus to revive domestic formulations

Ranbaxy has taken various strategic steps towards reviving revenue growth in
the domestic formulations business after witnessing a decline in CY08 and low
growth of single digit in CY09. We expect Ranbaxy to report 15.3% CAGR in
domestic formulations over CY09-12e to `21.7bn. The company is ranked #3
(after Abbott and Cipla) in terms of market share (~5.1%) in domestic
formulations. Ranbaxy boasts of the highest productivity per person in the
domestic market as it has only 2,500 people in its field force (lowest among
top-3 domestic players) and has the third-highest market share.
Recently, the company increased sales force and hired another 1,500 people as
a part of the new project – Viraat. It has indicated that it has huge growth
plans, in line with industry trend. We believe the major growth drivers for the
company are likely to be:
 Increase in field force by another 1,500 in CY10 to 4,000 at present. This
should enable the company regain growth momentum on high base as
Ranbaxy has the highest productivity per person.
 In-licensing of brands from foreign partners and building market for such
products as witnessed in Revital (in-licensed brand). This would include
bringing Daiichi’s products to India.
 Focus on building own brands for new products to sustain revenue
momentum.
 To launch 40-50 new products each year to drive growth on high base of
+5% market share.
 Industry dynamics would support most established players to register
steady growth momentum as the overall sector is likely to record double-
digit growth rate (14-15%).
Fig 11 – Domestic formulations to regain growth momentum

(`m)
23,000
14.7% CAGR
21,738
20,000
18,740
17,000
16,155
14,000
13,932 14,171
12,958
11,000
8,000
5,000
CY07
CY08
CY09
CY10e
CY11e
CY12e

Huge synergies to accrue from Daiichi

We expect Ranbaxy to reap synergy benefits from Daiichi in terms of business
and geographic expansion, R&D activities and improved financials. Daiichi’s
acquisition of Ranbaxy has created a hybrid business model (Daiichi is an
innovator company and Ranbaxy a successful generic company with global
presence). Although, it is difficult to quantify the synergies at this stage,
Ranbaxy is expected to announce the same at an appropriate time, when it
would also disclose quantitative details. We believe the synergies can provide a
huge upside to revenue growth and margin as well as expansion in profitability.
Some possible synergy benefits are:
 Ranbaxy would find it easier to launch its generic products in the highly-
regulated Japanese market by leveraging Daiichi’s positioning. Japan is a
highly-regulated market with stiff entry barriers for generics. Japan is the
third-largest pharmaceutical market globally, with considerably low
(<10%) generics penetration. Ranbaxy could gain an edge over other
global generics players in garnering generics market share in Japan. The
company has already started focussing on the Japanese market and the
first generic from Daiichi-Ranbaxy in Japan may come in CY12e.
 Launch of Daiichi’s branded drugs in India like other pharma MNCs
(GSK, Pfizer, Novartis etc): This would enable the company to increase its
branded product portfolio and gain incremental market share. It would
also be able to charge premium price for these innovative products.
Ranbaxy has already launched a couple of products in India.
 Launch of Daiichi’s products in other emerging countries (Mexico, Russia,
CIS, Africa etc): This will enable Ranbaxy to gain more recognition and
increase revenue and earnings from these operations. Ranbaxy already has
presence in most of these markets; this would lead to timeliness of
launch. The company has already started such operations in Mexico,
Romania and Africa.
 Ranbaxy may get manufacturing contracts from Daiichi to produce
products. India is known to be a low-cost manufacturer with regulatory
strength and it is likely that Daiichi may outsource part manufacturing
activities to Ranbaxy like other innovators, to reduce costs; this would be a
business upside for Ranbaxy.
We believe that the aforementioned synergies could provide huge upside to
Ranbaxy in terms of growth and profitability, which would pan out over the
next few years. Some steps have already been taken by both companies to
drive synergies from this innovator-generic partnership (called a hybrid
business model). Ranbaxy has also divested innovative R&D division to
Daiichi that would result in annual savings of ~US$20m from R&D expenses,
thereby increasing margins. We believe that over the long term, such synergies
may create an additional valuation line for Ranbaxy.

Para IV opportunities to provide

significant cash flows
Ranbaxy has a few big products – such as Lipitor, Caduet, Nexium,
Aricept, Actos – in the para IV pipeline that would be launched over the
next 4-5 years and, hence, provide significant one-time cash profits. We
value such opportunities at `140 per share. The company has already
proved its execution capability through launch of Valtrex with 180-day
exclusivity and garnering +60% market share; also, it has monetised
Flomax, although the product could not be launched due to lack of US
FDA approval. The company has indicated that it has already taken
appropriate steps to monetise para IV opportunities. Based on its
history, we believe that the company would be able to generate huge
cash flows from such opportunities over the next 4-5 years.
Big para IV pipeline

Ranbaxy has a strong para IV pipeline with major big products such as Lipitor,
Nexium, Caduet, Actos and Aricept with first-to-file (FTF) status. Ranbaxy
launched Valtrex on 25 Nov ’09, even though the initial filing was from its
Dewas facility. This indicates that the company has been able to transfer the
manufacturing site to save the launch with 180-day exclusivity. We believe that
Ranbaxy would be able to make a timely launch of Aricept in Nov ’10 and
benefit from the 180-day marketing exclusivity. However, the para IV filings
for Lipitor, Caduet and Nexium were probably done from the Paonta Sahib
facility, which still remains blacklisted by the US FDA. The company seems
confident of saving these exclusivities by taking appropriate steps that would
provide substantial one-time income and cash flow.
Fig 12 – Ranbaxy’s para IV pipeline

Brand Innovator Molecule Launch period Remarks
Aricept Eisai Donepezil Nov-10 Received tentative approval
Actos Takeda Pioglitazone Aug-10 Settled with innovator
Valcyte Roche Valganciclovir Mar-15 Settled with innovator
Lipitor Pfizer Atorvastatin Nov-11 Out of court settlement
Caduet Pfizer Atorvastatin+Amlodipine Nov-11 Out of court settlement
Nexium AstraZeneca Esomeprazole May-14 Out of court settlement
Fig 13 – Computation of estimated revenue and PAT from para IV launches

US$m Aricept Actos Lipitor Caduet Nexium Valcyte
Brand sales 2,200 3,400 6,000 400 5,000 300
180 days' sales 1,100 1,700 3,000 200 2,500 150
Price erosion 40% 40% 35% 35% 40% 40%
Ranbaxy's market share 40% 40% 50% 50% 40% 25%
Ranbaxy's revenue 385 408 975 65 600 23
PBT margn 80% 80% 80% 80% 80% 80%
PBT 308 326 780 52 480 18
PAT 231 184 585 39 360 14
We expect significant cash flows and earnings to accrue from these

exclusivities over the next few years. Timely and successful launch of Lipitor,
Caduet and Nexium would provide substantial cash flows and one-time profits
to the company. We believe that this high profit trend would continue for the
next 4-5 years.

Fig 14 – Para IV NPV valuations

`per share NPV P/E (x) Value
Aricept 27.4 1.00 27
Actos 18.4 1.00 18
Lipitor 64.0 1.00 64
Caduet 4.2 1.00 4
Nexium 25.3 1.00 25
Valcyte 0.9 1.00 1
Total 140

Financials
We expect consolidated business growth to pick up from CY11e driven
by revival in base business, contribution from para IV opportunities and
commencement of supply of APIs and formulations for Nexium to Astra
Zeneca. Further, we expect substantial improvement in the base
business EBITDA margin, from 4.9% in CY09 to 15.3% in CY12e.
Expect 12.2% base business FY10-13e revenue CAGR

We expect Ranbaxy’s base business (ex para IV opportunities) revenue CAGR
of 12.2% over CY09-12e on the back of revival in base business, contribution
from para IV exclusivities and revenue from Nexium supply (API and
formulations) to Astra Zeneca. We expect growth rate to pick up from
Q3CY10. Excluding exclusivities and other operating income, we expect
revenue to grow 19.7% in CY11e and 13.7% in CY12e. We believe Ranbaxy
would earn revenue of US$150m in CY11e and US$200m in CY12e from the
Nexium supply to Astra Zeneca. Among para IVs, we have factored in
Valtrex, Flomax and Aricept in our financial estimates. We have considered
other para IVs separately for valuation purposes.

(`m) CY09 CY10e CY11e CY12e
Formulations 60,005 63,795 70,427 79,078
India 14,171 16,155 18,740 21,738
CIS 4,158 4,352 4,768 5,340
Rest of Asia Pacific 4,835 4,600 4,950 5,445
US 11,313 11,840 12,741 14,015
Canada 3,046 3,188 3,430 3,773
EU (excl Romania) 9,331 9,322 10,031 11,034
Romania 3,674 3,846 4,138 4,552
Africa 6,044 6,900 7,763 8,927
latin America 3,433 3,593 3,866 4,253
APIs 5,415 5,152 5,544 6,098
Global Consumer Healthcare 2,129 2,342 2,576 2,834
Para IV exclusivities 4,835 16,061 12,994 -
Others 2,676 2,321 9,565 11,911
Total 75,060 89,671 101,106 99,920
Margin recovery on business revival and cost rationalisation

We expect Ranbaxy to register substantial recovery in EBITDA margin from
CY11e, after hitting a low of 1.7% in H1CY09. We estimate EBITDA margin
to improve to 15.3% in CY12e. Margin recovery would be on the back of
revival in the base generics business and cost-cutting measures. The base
business is showing revival signs led by improving domestic formulations
growth, stabilising US business at current levels and steady growth in emerging
countries. Various cost-cutting measures such as the closure of non-profit
making manufacturing plants, reduction in excess staff across the globe and
cost rationalisation at the Paonta Sahib and Dewas facilities (being non-
operational for regulated markets). Further, synergy benefits with Daiichi
could further improve profitability. Recent divestment of innovative R&D to
Daiichi would save ~US$20m from R&D expenditure, thereby leading to
better margin.

Fig 16 – Base business margin recovering

(`m) (%)
20,000 15.3 16
13.1 13.0
16,000
12
12,000 7.9 8.0

8
8,000 4.9
4
4,000 1.7
- 0
CY07
CY08
H1CY09
CY09
CY10e
CY11e
CY12e
EBITDA OPM (RHS)
Revival in growth and margins to lead to multi-fold increase in PAT

We expect Ranbaxy’s base business’ adjusted PAT to increase multifold over
CY09-12e on the back of reviving growth outlook and substantial increase in
EBITDA margins. Base business PAT would increase to `10.8bn in CY12e
from `1.7bn in CY09. Also, net profit margin would increase to 10.9% in
CY12e from 2.1% in CY09. We expect incremental net profit of `9bn in
CY10e from Valtrex, Flomax and Aricept. We believe margins and profitability
would continue to improve going forward, driven by strong business outlook,
Daiichi’s initiatives to improve profitability and supporting industry dynamics.

(`m) (%)
12,000 10.9 12.0
10,000 10.0
8,000 7.6 7.4 8.0
6,000
6.0
4,000
3.9 3.9
2,000 4.0
2.1
- 2.0
CY07
CY08
CY09
CY10e
CY11e
CY12e
PAT NPM (RHS)


Year-end 31 Dec (`m) CY08 CY09 CY10e CY11e CY12e
Base business revenue 72,245 68,459 70,966 84,922 96,575
Growth (%) 8.7 (5.2) 3.7 19.7 13.7
Other operating income 1,895 2,676 2,321 2,815 2,911
Para IV exclusivity sales - 4,835 16,061 12,994 -
Total revenue 74,140 75,970 89,348 100,731 99,485
Growth (%) 6.2 2.5 17.6 12.7 (1.2)
Raw materials 31,831 32,080 33,111 38,916 39,596
EBITDA 5,838 7,124 17,936 21,118 15,250
EBITDA Margin (%) 7.9 9.4 20.1 21.0 15.3
EBITDA Margin excl para IVs (%) 7.9 4.9 8.0 13.0 15.3
Depreciation 2,452 2,676 2,733 2,890 3,040
PBIT 3,386 4,448 15,203 18,229 12,210
Interest expenses 2,055 710 791 791 791
Other non operating income 2,521 2,370 4,620 1,880 2,520
Extra-ordinary income/ (expenses) (18,558) 3,958 3,102 - -
PBT (14,706) 10,065 22,135 19,318 13,939
Provision for tax (5,650) 6,991 5,534 4,250 3,067
Minority Interest 84 109 - - -
PAT (9,141) 2,965 16,601 15,068 10,873
Adjusted PAT 2,909 4,016 14,274 15,068 10,873
Growth (%) (45.4) 38.1 255.4 5.6 (27.8)
PAT margin (%) 3.9 5.3 16.0 15.0 10.9

Year-end 31 Dec (`m) CY08 CY09 CY10e CY11e CY12e
Share Capital 3,858 3,861 2,104 2,104 2,104
Reserves 39,104 39,573 54,046 65,588 73,917
Debt 42,849 36,295 36,295 15,820 15,820
Deferred Tax Liability (12,229) (4,746) (4,746) (4,746) (4,746)
Gross Block 61,942 62,786 65,516 68,016 70,516
Net Block 44,900 44,905 44,903 44,513 43,974
Capital WIP 4,707 6,231 5,000 4,000 3,000
Investments 5,432 5,407 5,407 5,407 5,407
Inventories 19,643 18,407 19,565 21,812 23,078
Debtors 13,310 18,399 16,526 19,776 22,490
Total Assets 74,256 75,517 88,233 79,300 87,628

Fig 20 – Ratio @ `582

Year-end 31 Dec CY08 CY09 CY10e CY11e CY12e
Return Ratios (%)
ROCE 5.7 5.6 18.2 18.7 13.8
ROIC 6.0 6.9 21.6 23.8 15.9
ROE 8.2 9.3 28.7 24.3 15.1
Turnover Ratios
Per share (`)
EPS 6.9 9.6 34.0 35.8 25.9
EPS excl para IV opportunities 6.9 4.0 8.4 17.8 25.9
CEPS 12.8 15.9 40.5 42.7 33.1
Book Value 102.2 103.3 133.6 161.0 180.8
Solvency ratios
Debt/ Equity 1.0 0.8 0.6 0.2 0.2
Valuation paramete` (x)
P/E 84.1 60.9 17.1 16.2 22.5
P/BV 2.0 3.9 3.0 2.5 2.2
EV/ EBITDA 45.1 37.7 14.1 11.5 15.5
EV/ Sales 3.6 3.9 3.6 2.9 2.4
M-Cap/ Sales 3.4 3.6 3.4 2.9 2.5


Ranbaxy Laboratories is a leading Indian pharma company with a
strong exports and domestic business model. It is the third-largest
pharma company in terms of domestic market share. It has a global
footprint across 49 countries, world-class manufacturing facilities in ten
and serves customers in over 125.
In Jun ’08, Ranbaxy entered into an alliance with one of the largest Japanese
innovator companies, Daiichi Sankyo, to create an innovator and generic
pharmaceutical powerhouse. Accordingly, Daiichi took control of Ranbaxy by
acquiring 64% equity stake in the company. The combined entity now ranks
among the top-15 pharma companies worldwide. The transformational deal
will place Ranbaxy in a higher growth trajectory, help it emerge stronger in
terms of global reach and boost capabilities in drug development and
manufacturing.
Public & Others

16%
FIIs
8%
MF/Banks
12% Promoters
64%
Source: Anand Rathi Research. Note: *as of Sep ’10

Person Designation Background and profile
Dr Tsutomu Une Chairman and Non- Dr Une is a graduate and Ph.D. in Microbiology. Dr. Une
Executive director was inducted as Director of Daiichi Sankyo in September
2005 and has been Senior Executive Officer, Global
Corporate Strategy since April 2007. Dr. Tsutomu Une
was inducted as a Chairman of Ranbaxy in May 2009.
Atul Sobti CEO and MD He is a veteran with over three decades of global
experience in the Chemical and Pharmaceutical
industries. He has held senior functional and
management positions in several global pharmaceutical
companies like Max-Gb, Hindustan Ciba-Geigy, Bayer
India Limited and Dr. Reddy’s Laboratories Limited.
Omesh Sethi Chief Financial Officer Mr Sethi is a Chartered Accountant with over 25 years of
experience in the field of Finance & Accounts. Before
joining Ranbaxy in 1989, he was with Indo Asian
Fusegear (P) Limited. Besides heading the Finance
function, he also spearheads the Secretarial, Global
Taxation, Global Treasury & Insurance and Forex
operations.
Source: Company

Pharmaceuticals
India I Equities
Initiating Coverage
18 October 2010
Sun Pharmaceutical Industries Rating: Hold

Expensive, but holds further promise; initiate with Hold Share Price: `2,038
We initiate coverage on Sun Pharmaceutical Industries (SPIL)

with Hold and target price of `2,053. We are Neutral on the Sriram Rathi
stock mainly owing to high valuation of 24.9x FY11e and 23x +9122 6626 6737
FY12e earnings. However, we remain bullish on the business sriramrathi@rathi.com
model, growth momentum, high profitability and synergistic
Sanjeev Chiniwar
benefits from Taro acquisition. +9122 6626 6716
 Core business to deliver strong growth. We expect core sanjeevchiniwar@rathi.com
business to register a robust 20.9% CAGR over FY10-13e led by
higher-than-industry growth in the domestic market and
improving US business through third-party and own Key data SUNP IN / SUN.BO
manufacturing. 52-week high/low `2125/`1309
 Taro – Strategic fit. Taro acquisition brings into SPIL’s fold Sensex/Nifty 20125/6063
dermatology and paediatrics products. It also gives it access to
Europe and +100 ANDA approvals; the acquisition fits in line
with SPIL’s strategy of expanding in the US market. Free float 36.3%
 Healthy financials. The net cash of >`40bn would enable SPIL Promoters 63.7%
to target more strategic inorganic growth apart from Taro. SPIL Foreign Institutions 19.5%
Domestic Institutions 6%
enjoys the highest margins, of ~35%, in the Indian pharma space.
Public 10.8%
 Valuation and risks. We value SPIL at `2,053 based on 22x
FY12e earnings and `103/share for Taro integration. We assign
10% higher multiple to SPIL versus peers (20x) due to strong
management quality, highest margins and possibility of upside
from Taro. Risks: Currency fluctuation (as 52% revenue is
contributed by exports) and major negative deviation in accounts
of Taro post auditing.
Sales (`m) 41,833 40,075 45,305 52,019 59,891
Net profit (`m) 18,177 14,243 16,953 18,353 21,398 200
87.8 68.8 81.9 88.6 103.3 180 Sun
EPS (`) Pharma
21.1 -28.3 26.4 9.1 16.4 160
Growth (%)
140
PE (x) 23.2 29.6 24.9 23.0 19.7
120
PBV (x) 6.0 5.4 4.6 4.0 3.5
100 Sensex
RoE (%) 30.2 19.2 20.0 18.7 18.8
80
28.7 18.5 19.4 18.2 18.4
Aug-09
Jun-10
Aug-10
Dec-09
Feb-10
Oct-09
Apr-10
Oct-10
RoCE (%)
Dividend yield (%) 1.3 1.3 1.6 1.7 2.0
Net gearing (%) 2.5 2.2 1.9 1.6 1.4

India Equities
18 October 2010 Sun Pharmaceutical Industries – Expensive, but holds further promise; initiate with Hold

Net sales 41,833 40,075 45,305 52,019 59,891 (`)
Sales growth (%) 27 -4 13 15 15 2,100
24x
- Op. expenses 23,194 25,675 28,512 34,072 39,229
1,900
EBIDTA 18,640 14,400 16,793 17,947 20,662
EBITDA margins (%) 44.6 35.9 37.1 34.5 34.5 1,700 20x
Sun
- Interest 59 62 68 68 68 1,500
- Depreciation 1,233 1,533 1,699 1,869 2,007 16x
1,300
+ Other income 2,144 2,110 3,287 3,973 4,668
- Tax 1,100
712 679 1,282 1,399 1,628
PAT 18,780 13,470 17,032 18,584 21,627 900
PAT growth (%) 21.1 -28.3 26.4 9.1 16.4 700
500
FDEPS (`/share) 87.8 68.8 81.9 88.6 103.3
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Jun-10
Sep-10
CEPS (`/share) 91.4 74.1 90.1 97.6 113.0
DPS (`/share) 13.2 13.8 16.4 17.7 20.7

Share capital 1,036 1,036 1,036 1,036 1,036 (`m)
Shareholders’ fund 70,449 78,289 91,275 105,334 121,724 400,000
Debt 1,110 821 808 808 808 350,000 Sun 20x
Minority interests 1,970 1,932 2,010 2,241 2,471
300,000
Capital employed 73,530 81,042 94,093 108,383 125,003 16x
250,000
Fixed assets 19,450 20,836 21,137 21,268 21,261 200,000 12x
Investments 18,595 30,664 30,664 30,664 30,664
150,000
Working capital 18,795 23,469 23,433 27,326 31,461
Cash 16,690 6,073 18,860 29,125 41,617 100,000
Capital deployed 73,530 81,042 94,093 108,383 125,003 50,000
Jun-06
Jun-07
Jun-10
Sep-06
Dec-06
Mar-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Sep-10
No. of shares (m) 207.1 207.1 207.1 207.1 207.1
Net Debt/Equity (%) 2.5 2.2 1.9 1.6 1.4
W C turn (days) 153.2 167.9 173.1 162.1 162.8
Fig 3 – Cash flow statement (`m) Fig 6 – One year forward PBV
Consolidated PAT 18,299 13,042 17,032 18,584 21,627 2,500
5x
+ Depreciation 1,233 1,533 1,699 1,869 2,007
Cash profit 19,532 14,575 18,731 20,453 23,634 2,000
4x
- Incr/(Decr) in WC (1,818) 4,675 (36) 3,893 4,135
Sun
Operating cash flow 21,350 9,901 18,767 16,560 19,499 1,500
- Capex 7,925 2,548 2,000 2,000 2,000 3x
Free cash flow 13,426 7,352 16,767 14,560 17,499
1,000
- Dividend 3,215 3,321 3,967 4,295 5,007
+ Equity raised 0 0 0 0 0
+ Debt raised 353 (77) (13) 0 0 500
- Investments 12,030 12,069 0 0 0
- Misc. items (4,775) 2,502 0
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Net cash flow 3,308 (10,617) 12,787 10,265 12,492

+ Opening cash 13,382 16,690 6,073 18,860 29,125
Closing cash 16,690 6,073 18,860 29,125 41,617


We initiate coverage on SPIL with Hold and target price of `2,053.
We are Neutral on the stock mainly owing to high valuation of 24.9x
FY11e and 23x FY12e earnings. However, we remain bullish on the
business model, growth momentum, high profitability and synergistic
benefits from Taro acquisition.
Core business to deliver robust growth

We expect core business (ex para IVs) to register a robust 20.9% CAGR
over FY10-13e led by higher-than-industry growth in the domestic market
and improving US business through third-party and own manufacturing.
We expect SPIL to witness 21.5% CAGR in domestic branded formulations
(17.3% CAGR on like-to-like basis) driven by strengthening position in
chronic-diseases therapies and leveraging R&D capabilities to develop
technically complex products.
Further, we expect base exports formulations (ex para IV sales) to
strengthen at 21.5% FY10-13e CAGR led by continuous launch of new
products in the US from Indian facilities, low base of Caraco (impacted by
US FDA warning letter), transferring Caraco products to third-party sites so
as to market them in the US and strong growth in ROW markets.
Fig 7 – Segmental revenue contribution (FY10)

Export APIs
11%
Domestic
Formulations
45%
Export
formulations
41%
Domestic APIs
3%
Source: Company
Taro integration – Strategic fit

We view the Taro acquisition as a strategic fit to SPIL’s business and
strategy. After more than two years of legal tussle, SPIL has been able to
win the litigation with Taro promoters for acquisition and now holds
majority stake (48.7% with 65.8% voting rights) in Taro. We believe that the
integration of Taro would drive significant synergies for SPIL. It would
bring into SPIL’s fold dermatology and paediatrics products. It would also
give it access to Europe as well as +100 ANDA approvals; Taro also brings
with it manufacturing assets at a time when SPIL is facing regulatory
hurdles with the Caraco (76% subsidiary) facility. The acquisition is in line
with the company’s strategy of expanding in the US market as Taro
generates >90% revenue from the US. We value Taro stake at `103 per
share for SPIL shareholders and, considering the company’s past
acquisitions, we believe that SPIL would be able to increase returns for
shareholders.

Healthy financials
We expect SPIL to register consolidated revenue CAGR of 14.3% (20.9%
ex para IV) and net profit CAGR of 14.5% over FY10-13e. With net cash
of +`40bn in the books, we believe that SPIL would be able to target
further strategic inorganic growth, thereby increasing shareholders’ returns.
Also, SPIL enjoys highest margins of ~35% in the Indian pharma space (vs.
20-25% for other peers). RoE and RoCE would stand lower, at 18-20%
over FY11-13e due to sales of Pantaprazole and limited competition for
almost three years, which has inflated the base.
Valuations
We value SPIL at `2,053 based on 22x FY12e earnings and `103 per share
for Taro integration. Our valuation for Taro is based on 15x CY10
annualised earnings (based on H1CY10 unaudited results). We assign 10%
higher multiple to SPIL vs. peers (20x) owing to strong management
quality, highest margins in the industry and possibility of upside from Taro.

(`)
2,100
24x
1,900
1,700 20x
Sun
1,500
16x
1,300
1,100
900
700
500
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Jun-10
Sep-10

 Major deviation in accounts of Taro post auditing; Taro had been
providing unaudited accounts since ’07 and our valuation is based on
annualised earnings of the H1CY10 unaudited accounts.
 Currency fluctuation remains a key risk as ~52% of SPIL’s revenue
comes from exports.
 Regulatory hurdles such as warnings letters (Caraco has already been
issued one) and delay in product approvals for marketing.

Core business to deliver robust growth

We expect SPIL’s core business (ex para IVs) to register a robust
20.9% CAGR over FY10-13e led by higher-than-industry growth in the
domestic market and improving US business through third-party and
own manufacturing. We expect SPIL to witness 21.5% CAGR in
domestic branded formulations (17.3% CAGR on like-to-like basis)
driven by strengthening position in chronic diseases therapies and
leveraging R&D capabilities to develop technically-complex
products. Further, we expect base exports formulations (ex para IV
sales) to strengthen at 21.5% FY10-13e CAGR led by continuous
launch of new products in the US from Indian facilities, low base of
Caraco (impacted by US FDA warning letter), transferring Caraco
products to third-party sites so as to market them in the US and
strong growth in ROW markets
Well focussed domestic business strategy

SPIL has followed the expansion strategy for the domestic market in
chronic therapy areas such as cardiology, neuro-psychiatry, diabetology and
gastroenterology. We believe dedicated focus on chronic therapy areas and
strategy of building strong presence in these key therapies would drive
sustainable revenue growth. We expect the company to notch 20.8%
revenue CAGR over FY10-13e from the domestic market, driven by
continuous launch of new products, increased business from the
institutional segment and strong field force.
We expect 21.5% revenue CAGR from domestic formulations and 8.3%
CAGR from bulk drugs. However, domestic formulations would witness
like-to-like CAGR of 17.3% as the company booked `2bn spillover revenue
(pertaining to FY10 due to change in distribution system) in FY11. The
company recorded 23% revenue CAGR in domestic formulations (well
above industry growth of 15% CAGR) over FY04-10. We believe SPIL
would be able to outperform industry growth in the coming years as well,
driven by strong focus on chronic diseases segment that is growing much
faster than acute segments.
Fig 9 – Consistent growth in domestic (formulations and bulk) revenue

(`m) (%)
40000 35.0 40.0
31.9 35.0
35000 29.7
30.0
30000 21.8 23.4
25.0
17.6 20.0
25000 14.5 15.5
15.0
20000 10.0
15000 5.0
-
10000 (6.4)
(5.0)
5000 (10.0)
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY13e
Revenue Growth (%)
More than 50% of domestic revenue is contributed by chronic areas.

Neuro-psychiatry alone contributes ~28% to total domestic revenues while

diabetology and cardiology together contribute 30%. SPIL has more than
2,500 sales representatives who help it strengthen customer relationships.
The company’s ability to launch technically complex products by incurring
higher R&D expenses has resulted in high sustainable growth and better
margins.
Fig 10 – Domestic formulations therapeutic breakdown (FY10)
Oncology
Opthalmology 2% Others
Antiasthmatic & 4% 6%
Antiallergic Neuro-psychiatry
5% 27%
Musculo-skeleton
5%
Gynecology &
urology
7%
Gastroenterology Cardiology
14% 19%
Diabetology
11%
Source: Company
Enhancing presence in US market

SPIL’s main focus market is the US (the world’s largest pharma market) and
strengthened its presence through both organic and inorganic routes. The
company’s strategy of own regulatory filings, acquiring distressed assets and
focusing on complex and niche products has worked well. Penetration of
generic drugs has been increasing at a steady pace in the regulated US
market and size of the US generics market is estimated at +US$35bn. We
believe SPIL’s presence in niche therapeutic areas and complex filings
provide it an edge in terms of limited competition and strong growth. The
company has successfully displayed its ability to acquire distressed
companies and turn them around. Its first international acquisition was the
loss-making Detroit-based Caraco Pharma in 1987 which it successfully
turned around. Further, the company has also been acquiring manufacturing
assets at reasonable valuations, both in India and abroad, to cater to the US
market.
We believe the US market would remain a priority area and estimate 26.6%
revenue CAGR from it (excluding para IV opportunities) to `10bn over
FY10-13e. The high growth is the US market in mainly on account of low
base of Caraco in FY10, when it witnessed a decline of 34.5% (our estimate)
due to warning letter issued by the US FDA and, subsequently, products
from Caraco facility being banned. The company has been taking steps to
resolve this issue and concurrently transferring major products to third-
party sites to be able to start marketing them again.

Fig 11 – US formulations revenue trend

(`m) Includes revenue worth `7,143m,
16,000 14,818 `6,192m and `2,738m in FY09, FY10 and
FY11e respectively from para IV
14,000
12,000 11,218
10,049
10,000 8,937
8,501
8,000
6,000
4,000
2,000
FY09
FY10
FY11e
FY12e
FY13e
Foray into controlled substances

SPIL has forayed into controlled substances and already received approval
for a few products from the US FDA. Approval for these products indicates
the company’s credibility for regulatory purposes as very few companies
have received the nod to manufacture such products. Controlled substances
are narcotic products, which can also be misused for illegal purposes.
Governments issue orders to approved manufacturers from time to time for
specific quantity, depending on requirement. SPIL has already received US
FDA approvals for Hydrocodone and Roxicodone. We expect revenues
from this segment to be sizeable (10-15% of total revenue) over the next 3-
4 years. Profitability margins are also higher in these products as very few
companies can produce them. We believe this would be a new growth driver
and further boost expansion in the company’s profitability.
Strong regulatory pipeline to help maintain growth

SPIL has witnessed significant ramp-up in regulatory filings and launching
products after receiving requisite approvals. This has resulted in a strong
product basket and ANDA pipeline for the company. Till Jun ’10, SPIL and
Caraco together had 91 approved ANDAs and 120 pending for approval.
Further, the company has guided for 15-20 ANDA filings every year. We
believe this strong ANDA pipeline would help maintain growth momentum
in exports formulation. Further, Taro integration would provide an
additional +100 approved ANDAs, thereby enriching SPIL’s product
portfolio.

(Nos)
250
207 211
200 177
142
150
95 91
100 84
69
59 53
50 40
20 29
15
0
FY05
FY06
FY07
FY08
FY09
FY10
Q1FY11
Cumulative ANDAs filed Cumulative ANDAs approved

Source: Company

Successful record in acquisition

SPIL has a successful track record of acquiring loss-making or under-
performing companies and turning them around. The acquisitions include
companies, manufacturing assets and brands (products). We expect SPIL to
continue seeking more acquisitions which would drive future growth, given
that it has free cash of >`30bn. However, we have not factored in any
upside from possible acquisitions; but, we have factored in nominal income
on cash balance. The company has made 13 mergers and acquisitions since
1996, all of which were in line with its strategy of expanding presence in the
US market, gaining access to technology for manufacturing
complex/difficult-to-make products and at reasonable cost. Post
acquisitions, SPIL has been able to increase profitability via cost efficiency
and margin expansion.

CY Company Strategy and initiatives
1997 Tamil Nadu Dadha Entry into high-growth therapy areas like fertility, anticancer, anaesthesiology, gynaecology, pain management. Key benefits
Pharma included trusted brands, processes for difficult-to-make Oncology products such as Cisplatin and Carboplatin, and a field
force with existing relationships. The portfolio was totally revamped to bring new products to market, doctor coverage was
improved, and a swift increase in customer rankings was seen.
1999 Gujarat Lyka Organics Got manufacturing site for intermediates and APIs like Cephalexin and 7ADCA actives. Received regulatory certification for
intermediates and API manufacturing site for India and traditional markets.
’02-03 MJ Pharmaceuticals Plant with USFDA approval for Cephalexin capsules and UKMHRA approvals for oral dosage forms, was acquired for the
tremendous potential that the site offered for international markets. This plant has one of the best manufacturing sites for
insulin in India, and has one of Asia's largest sites for injectables and nasal sprays. Later upgraded it to offer capability
across dosage form lines (sterile dry powder injections, small volume injections, nasal sprays, tablets, capsules, soft gelatin
caps, aerosols, ophthalmics). This site was recently inspected and approved by the USFDA for injectables and nasal sprays.
1997-03 Caraco Pharma (US) Caraco was a manufacturer of generic pharmaceuticals with a US FDA approved 70,000 sq ft plant. In 1997, Sun Pharma
made structured a technology transfer agreement to bring new products to market and build sales. A similar agreement was
signed in 2002 on completion of the first agreement. Turned around Caraco operations at both sales and bottom-line levels.
For key products, Caraco sources API from Sun Pharma's plants and competes as an integrated manufacturer. Such
integration offers considerable time and cost advantages in the competitive US generics market.
1998 Brands from Natco In line with the company's strategy of reorienting brands so that they can offer the best value, a basket of brands in the
Pharma respiratory/chest therapy area as also brands in gastroenterology, orthopaedics, anti-infectives and paediatrics were
acquired. These brands were shifted into different divisions, doctor call-lists were reworked and new products added backed
by strong promotional programs.
1999 Milmet Labs Presence in ophthalmology with well-trusted brands like Viscomet (used in major eye surgeries) and Timolet (for glaucoma)
made it an attractive acquisition candidate. New products were brought in, several of which used complex delivery
technologies such as gel forming systems, the portfolio was revamped, and coverage improved with this high-growth
specialist group.
’00 Pradeep Drug Company WHO cGMP approved API manufacturing site for India and neighbouring markets and also for captive use in formulations.
Site upgraded for more APIs and subsequently received several regulatory certifications.
’04 Phlox Pharma An API manufacturing company with plant for Cephalosporins. This plant is approved for European markets for Cefuroxime
axetil amorphous. Filings for additional Cephalosporin-based actives are planned. Substantial capacity addition has been
completed and facilities meeting international regulatory requirements have been created for sterile and non-sterile
Cephalosporin formulations. This site recently received USFDA approval.
’04 Niche brands purchased Niche brands were bought from the San Diego, US, based Women's First Healthcare for less then $4 million. In 2001,
from Women's First WFHC had acquired the US rights for three products for a total of $25.7 million plus royalty payments. Considered this brand
Healthcare acquisition to be a first step towards branded generic space in the US at a reasonable cost.
’05 ICN, Hungary and a ICN Hungary is one of the few sites globally that is authorized to make controlled substance APIs. It also has facilities for
manufacturing plant in dosage form manufacture and a large research centre. Another facility in Ohio, US, for the manufacture of liquids, creams
Bryan, Ohio and ointments was also bought from Valeant, in order to file for interesting products in this area. Streamlining of operations,
filing for the developed markets and addressing developed market customers is some of the steps that have been put into
place as part of the turnaround.
’05 Able Labs (assets only) Dosage form manufacturing facilities with specifically designed areas to handle the manufacture of controlled substance
dosage forms were acquired for $23.15 million, from the US Bankruptcy Court of the District of New Jersey. This deal also
includes the rights to product dossiers that were being marketed by Able, iln line with the strategy of foraying in to controlled
substances business in regulated markets.
’08 Chattem Acquired 100% ownership of Chattem Chemicals, Inc., a narcotic raw material importer and manufacturer of controlled
substances with a facility in Tennessee, in line with the strategy of foraying in to controlled substances business in regulated
markets.
’10 Taro Pharma Taro has a strong franchise in dermatology and topical products, in addition to product baskets in cardiovascular,
neuropsychiatry and anti-inflammatory therapeutic categories. Taro US has more than 100 ANDA drug approvals in the U.S.
alone. Acquisition was announced for US$454mn, Sun has acquired 48.7% stake till date.

Taro integration – Strategic fit

We view the Taro acquisition as a strategic fit for SPIL’s business and
strategy. After more than two years of legal tussle, SPIL has been able
to win the litigation with Taro promoters for acquisition and now
holds majority stake (48.7% with 65.8% voting rights) in Taro. We
believe that the integration of Taro would drive significant synergies
for SPIL. It would bring into SPIL’s fold dermatology and paediatrics
products. It would also give it access to Europe as well as +100
ANDA approvals; Taro also brings with it manufacturing assets at a
time when SPIL is facing regulatory hurdles with the Caraco (76%
subsidiary) facility. The acquisition is in line with the company’s
strategy of expanding in the US market as Taro generates >90%
revenue from the US. We value Taro stake at `103 per share for SPIL
shareholders and, considering the company’s past acquisitions, we
believe that SPIL would be able to increase returns for shareholders.
Expect significant synergies

We expect Taro integration to bring significant synergies for SPIL in terms
of strengthening presence in the US market, entry into the EU, filling the
therapeutic gaps and top-line of >US$350m. Taro fits in line with SPIL’s
strategy of expanding presence in the US generics market as it generates
~90% revenue from the US market.
SPIL announced acquisition of Israeli drug-maker, Taro Pharma, in May ’07
for an all-cash deal of US$454m, valuing Taro’s equity at US$230m and debt
refinancing of US$224m. We view Taro integration as a strategic fit for
SPIL, considering Taro’s presence in the US, Canada and Israel with
expertise in the dermatology and paediatrics segments. At present, SPIL
does not have strong presence in Europe or in the dermatology segment.
With this integration, the company would be able to leverage on Taro’s
expertise in the dermatology segment, robust ANDA pipeline with +100
approvals, manufacturing assets and presence in Europe. As of date, SPIL
has acquired 48.7% stake in Taro and invested US$140m. Further, it has an
option to exercise warrants that would take SPIL’s stake to ~53.5%.
Turnaround in Taro after injection of funds by SPIL

After the announcement of SPIL’s acquisition and infusion of US$41m to
bail out Taro from a possible credit default, Taro has witnessed substantial
turnaround and became a profit-making company. Although, there has been
a significant decline in R&D expenses, Taro has a niche dermatology
product portfolio, strong presence in the US with +100 product approvals,
a large distribution reach in 30 countries and world-class manufacturing
facilities at Canada and Israel with necessary regulatory approvals. The
integration would directly fill the gap in SPIL’s business model and gain
presence in the dermatology segment and European market.
Taro invested capex of US$225m during FY03-06 and was suffering from
cash losses. It reported net loss of US$103m in ’06 and net profit of
US$35m in ’07. Post that, Taro had been reporting profit every year.
However, we do not have audited financial statements after ’07 and there is
a possibility of overstatement of numbers in accounts.

Fig 14 – Taro income statement

Year End December CY05 CY05 CY06* CY07 CY08 CY09 H1CY10
Net Sales 298 298 184 322 337 360 187
% yoy 14.0 - (38.2) 74.7 4.7 7.0 (48.0)
Cost of Sales 129 129 142 135 147 155 79
Gross Profit 169 169 42 186 189 206 108
% Gross Margin 56.8 56.8 22.9 57.9 56.3 57.0 57.7
Operating Expenses 154 154 133 128 134 139 71
SG&A Exp. 108 108 97 98 99 104 53
% Net Sales 36.3 36.3 52.6 30.4 29.3 28.8 28.3
R&D Exp. 46 46 36 30 36 35 18
% Net Sales 15.4 15.4 19.7 9.3 10.6 9.8 9.7
Operating Profit / - Loss 15 15 -91 59 55 66 37
% Operating Margin 5.1 5.1 -49.4 18.3 16.4 18.4 19.7
Financial Expenses 8 8 13 16 18 9 4
Other Income / - Loss -2 19 -8 1
PBT 7 7 -104 41 56 49 34
Income Tax 2 2 -2 6 12 5 4
% Effective Tax Rate 22.2 22.2 1.5 15.0 21.1 10.7 12.9
Net Income / - Loss 6 6 -103 35 44 44 29
% Net Margin 1.9 1.9 -55.8 10.7 13.2 12.2 15.7
Extra-Ordinary Items 38 0 0 0
Net Income / - Loss 6 6 -141 35 44 44 29
% Net Margin 1.9 1.9 -76.4 10.7 13.2 12.2 15.7
EPS 1.0 1.1 1.1 0.6
Source: Company
We value Taro stake at `103 per share

We value SPIL’s stake in Taro at `103 per share based on 15x annualised
CY10 earnings. However, we believe that the value can increase once full
integration happens, when most business synergies would accrue to SPIL
and provide further upside, given value accretion in past acquisitions. We
have not factored in financials of Taro in our estimates as audited accounts
are not available. Hence, risk persists in case there is significant deviation in
Taro’s audited financial statements.

Financials
We expect SPIL to register consolidated revenue CAGR of 14.3%
(20.9% ex para IV) and net profit CAGR of 14.5% over FY10-13e. With
net cash of +`40bn in the books, we believe that SPIL would be able
to target further strategic inorganic growth, thereby increasing
shareholders’ returns. Also, SPIL enjoys highest margins of ~35% in
the Indian pharma space (vs. 20-25% for other peers). RoE and RoCE
would stand lower, at 18-20% over FY11-13e due to sales of
Pantaprazole and limited competition for almost three years, which
has inflated the base.
Consolidated revenue CAGR of 14.3% over FY10-13e

We expect 14.3% CAGR in consolidated revenue over FY10-13e to
`59.9bn and 20.9% CAGR in base business revenue (ex para IVs). We
estimate `6.2bn and `2.7bn worth of revenues in FY10 and FY11e
respectively, from para IV and at-risk launches. However, these would not
be sustainable in future. We believe growth would be driven by domestic
formulations business and exports formulations. Bulk drugs are expected to
register a steady 9.7% CAGR over FY10-13e.

Domestic 19,334 25,079 29,503 34,088
% of total sales 47.4 55.4 56.7 56.9
% y-o-y (6.4) 29.7 17.6 15.5
Formulations 18,301 23,956 28,268 32,790
Bulk 1,021 1,123 1,235 1,297
Others 11 - - -
Exports 21,428 20,226 22,516 25,803
% of total sales 52.6 44.6 43.3 43.1
% y-o-y (7.2) (5.6) 11.3 14.6
Formulations 16,892 15,310 17,108 19,854
Bulk 4,470 4,917 5,408 5,949
Others 66 - - -
Total 40,761 45,305 52,019 59,891
EBITDA margin to remain strong

SPIL generates among the highest EBITDA margin in the industry despite
high R&D expenses, because of its presence in chronic therapies and
technically complex products, tight cost control, efficiency in input cost and
strong field force productivity. Products in chronic therapies and technically
complex products face limited price erosion as demand is high. We expect
the company to report EBITDA margin of >34% each in FY11e, FY12e.
FY13e. The company recorded a substantially high EBITDA margin
(+44%) in FY08 and FY09 due to para IV sales. If we exclude these
revenues, margin would be down to 36-37%. We expect 27.1% EBITDA
CAGR from core base business in absolute terms over FY10-13e to
`20.1bn.

Fig 16 – EBITDA margin trend

(`m) (%)
24000 38
37.1
20000 37
35.9
16000 36
12000 34.5 34.5 35
8000 34
4000 33
FY10
FY11e
FY12e
FY13e
EBITDA EBITDA margin (%)
High cash balance and net worth to keep returns lower

After delivering more than 40% net profit CAGR over the past 5-6 years on
the back of strong base business growth, para IV benefits and high cash
balance in the books, we expect SPIL’s return ratios (RoE and RoCE) to
decline to 18-20% levels from +30% in the past few years as the base net
worth has become higher and net profit growth would be lower. However,
due to high cash balance, we expect RoIC to be strong at ~30% over FY11-
13e.
Fig 17 – Return ratios

(%)
33 32.0
31 29.4 29.8
29 27.7
27
25
23
21 20.0
19.2 18.7 18.8
19
19.4
17 18.5 18.2 18.4
FY10
FY11e
FY12e
FY13e
ROE ROCE ROIC


Y/E March (`m) FY09 FY10 FY11e FY12e FY12e
Revenues 41,833 40,075 45,305 52,019 59,891
Growth in revenues (%) 27.0 (4.2) 13.1 14.8 15.1
Raw materials 8,556 10,211 11,560 13,525 15,572
R&D expenses 3,099 2,083 3,193 3,901 4,492
EBITDA 18,640 14,400 16,793 17,947 20,662
EBITDA Margin 44.6 35.9 37.1 34.5 34.5
Depreciation 1,233 1,533 1,699 1,869 2,007
PBIT 17,407 12,867 15,094 16,077 18,655
Other non operating income 2,144 2,110 3,287 3,973 4,668
Extra-ordinary income/ (expenses) - (767) - - -
PBT 19,492 14,148 18,314 19,983 23,255
Provision for tax 712 679 1,282 1,399 1,628
PAT 18,780 13,470 17,032 18,584 21,627
Minority Interest 603 (41) 78 231 230
PAT after minority interest 18,177 13,511 16,953 18,353 21,398
Adjusted PAT 18,177 14,243 16,953 18,353 21,398
Growth in PAT (%) 22.2 (21.6) 19.0 8.3 16.6
PAT margin 43.5 35.5 37.4 35.3 35.7

Y/E March (`m) FY09 FY10 FY11e FY12e FY12e
Share Capital 1,036 1,036 1,036 1,036 1,036
Reserves 69,414 77,254 90,240 104,298 120,689
Minority Interest 1,970 1,932 2,010 2,241 2,471
Debt 1,789 1,712 1,698 1,698 1,698
Deferred Tax Liability (679) (890) (890) (890) (890)
Gross Block 24,730 27,401 30,349 32,349 34,349
Net Block 17,879 19,388 20,637 20,768 20,761
Capital WIP 1,571 1,448 500 500 500
Investments 18,595 30,664 30,664 30,664 30,664
Inventories 9,757 10,739 12,108 14,469 16,659
Debtors 8,811 11,748 14,895 17,102 19,690
Total Assets 73,530 81,042 94,093 108,383 125,003

Fig 20 – Ratio @ `2,038

Return Ratios (%)
ROCE 28.7 18.5 19.4 18.2 18.4
ROIC 40.1 27.7 29.4 29.8 32.0
ROE 30.2 19.2 20.0 18.7 18.8
Turnover Ratios
Per share (`)
CEPS 91.4 74.1 90.1 97.6 113.0
Book Value 340.1 378.0 440.7 508.6 587.7
Solvency ratios
Debt/ Equity 0.0 0.0 0.0 0.0 0.0
P/E 23.2 29.6 24.9 23.0 19.7
P/BV 6.0 5.4 4.6 4.0 3.5
EV/ EBITDA 21.8 29.0 24.1 22.0 18.5
EV/ Sales 9.7 10.4 8.9 7.6 6.4
M-Cap/ Sales 10.1 10.5 9.3 8.1 7.0


SPIL is one of India’s leading pharma companies that manufactures
and supplies formulation and bulk drugs, both in the domestic and
international markets. The company has strong presence in key
therapy areas such as cardiology, psychiatry, neurology,
gastroenterology, diabetology and respiratory. SPIL has emerged as a
specialty pharma company with presence in regulated and semi-
regulated markets.
Enhancing market share and achieving leadership in different product

segments is a high priority for the company. India and the US are the
company’s key markets and contribute over 70% to total consolidated
revenue. SPIL’s main emphasis is on R&D activities, on which it spends 8-
9% of total revenue, thereby enabling manufacture of complex products
and generating higher profit margins.
Public & Others

11%
FIIs
20%
Promoters
MF/Banks 63%
6%

Name Position Profile
Dilip S Shanghvi Chairman and Mr Shanghvi is a graduate from Kolkata University and has extensive
Managing Director industrial experience in the pharma industry. He is actively involved
in international pharma markets and research and development
functions and is also the Chairman of our primary subsidiary, Caraco,
in Detroit, USA.
Sudhir V Valia Executive Director Mr Valia is a fellow Member of Institute of Chartered Accountants of
India and carries more than two decades of taxation and finance
experience. In addition to being on the Board of Directors of a
number of group companies, he is also on the Board of Directors of
Caraco.
Sailesh T Desai Executive Director Mr Desai is a science graduate from Kolkata University, with more
than 28 years of industrial experience, 18 of which have been in the
pharma industry. Mr. Desai has had comprehensive corporate affairs
experience, being involved in the turnaround at Milmet prior to Sun's
acquisition of it, as well as in the early stages of our company's
growth.
Source: Company

Key patent expiries

Annual Market size
Brand Molecule Innovator Category Year
(US$ m)
Aricept Donepezil Pfizer/Eisai Alzheimer's 3,000 2010
Cozaar Losartan Potassium Merck Hypertension 3,561 2010
Taxotere Docetaxel Sanofi-Aventis Cancer 3,037 2010
Differin Adapalene Galderma Acne 282 2010
Accolate Zafirlukast Astra Zeneca Asthma 44 2011
Femara Letrozole Novartis Infertility 384 2011
Actos (a) Pioglitazone Takeda Diabetes 3,193 2011
Lipitor Atorvastatin Pfizer Cholesterol 11,400 2011
Aprovel Irbesartan Sanofi/BMS Hypertension 1,724 2011
Plavix Clopidogrel Sanofi/BMS Anticoagulant 3,971 2011
Xalatan Latanoprost Pfizer Glaucoma 1,737 2011
Zyprexa Olanzapine Eli-Lily Antipsychotic 4,920 2011
Caduet Amlodipine+atorvastatin Pfizer Cholestrol 548 2011
Tazorac Tazarotene Allergan Acne 109 2011
Anzemet Dolasetron Sanofi-Aventis Anti-emetic, Cancer 11 2012
Levaquin Levofloxacin J&J Antibiotic 1,719 2012
Gabitril Tiagabine Cephalon Epilepsy 60 2012
Avapro Irbesartan Sanofi/BMS Hypertension 405 2012
Avalide Irbesartan/hydrochlorothiazide Sanofi/BMS Hypertension 351 2012
Seroquel Quetiapine Astra Zeneca Antipsychotic 3,236 2012
Avandia Rosiglitazone GlaxoSmithKline Diabetes 536 2012
Avandamet Rosiglitazone/metformin GlaxoSmithKline Diabetes 217 2012
Clarinex Desloratidine Schering Plough Allergic rhinitis 251 2012
Diovan/Diovan HCT (b) Valsartan/hydrochlorothiazide Novartis Hypertension 2,671 2012
Lexapro Escitalopram Forest/Lundback Antidepressant 2,554 2012
Singulair © Montelukast Merck Asthma 3,204 2012
Symbicort Budesonide/formoterol Astra Zeneca Asthma 2,294 2012
Zometa (d) Zoledronic Acid Novartis Cancer 1,469 2012
Lunesta Eszopiclone Sepracor Insomnia 845 2012
Lovenox Enoxaparin Sanofi-Aventis Thrombosys 1,107 2012
Geodon Ziprasidone Pfizer Bipolar disorder or Schizophrenia 875 2012
Detrol Tolterodine Pfizer Overactive bladder 43 2012
Viramune Nevirapine Boehringer Ingelheim HIV / AIDS 110 2012
Combivir Lamivudine/Zidovudine GlaxoSmithKline HIV / AIDS 312 2012
Lescol Fluvastatin Novartis Cholesterol 42 2012
Atacand/Atacand HCT Candesartan/Hydrochlorothiazide Astra Zeneca Heart failure / Hypertension 244 2012
Evista Raloxifene Eli-Lily Osteoporosis 534 2013
Zomig Zolmitriptan Astra Zeneca Migraine 224 2013
Fosamax Alendronate Merck Osteoporosis 240 2013
Eloxatin Oxaliplatin injection Sanofi-Aventis Cancer 6 2013
Aciphex Rebeprazole Eisai GERD 1,159 2013
Fuzeon Emfurvitide injection Genentech HIV / AIDS 43 2013
Cymbalta Duloxetin Eli-Lily Depression, MDD 2,294 2013
Asacol Mesalamine P&G Ulcerative colitis 494 2014
Avodart Dutasteride GlaxoSmithKline BPH 389 2014
Advicor Lovastatin/Niacin Kos Pharma Cholesterol 106 2014
Viracept Nelfinavir GlaxoSmithKline HIV / AIDS 71 2014
Namenda Memantine Forest Lab Alzheimer's 606 2014
Nexium Esomeprazole Merck Ulcer 5,080 2014
Celebrex Celecoxib Pfizer NSAID 1,634 2014
Actonel Risedronate Warner Chilcott Osteoporosis 805 2014
Company

Annual Market size

Brand Molecule Innovator Category Year
(US$ m)
Micardis Tlmisartan Boehringer Ingelheim Hypertension 163 2014
Temodar Temozolomide Schering Plough Brain tumor 224 2014
Maxalt Rizatriptan Merck Migraine 235 2014
Exelon Rivastigmine Novartis Alzheimer's 203 2014
Avelox Moxifloxacin Bayer / Schering Anti-bacterial 514 2014
Plough
Copaxone Glotiramer injection Teva Multiple Sclerosis 391 2014
Cipro Ciprofloxacin Bayer Anti-infective 46 2015
Lumigan Bimatoprost Allergan Intraocular pressure 253 2015
Sustiva Efavirenj BMS Rheumatoid Arthritis 192 2015
Renagel Sevelamer Genzyme Chronic Kidney Disease 394 2015
Welchol Colesevelam Daiichi Sankyo Reduce LDL-C 221 2015
Travatan Travoprost Alcon Intraocular pressure 120 2015
Patanol Olopatadine Alcon Allergic Conjunctivitis 256 2015
Crestor Rosuvastatin Astra Zeneca Cholesterol 3,100 2016
Relpax Eletriptan Pfizer Migraine 231 2017
Byetta Exenatide Eli-Lily Diabetes 627 2017
Zetia Ezetemibe Merck Cholesterol 1,232 2017
Vytorin Ezetemibe/simvastatin Merck Cholesterol 1,635 2017
Spiriva Tiotropium powder Boehringer Ingelheim COPD - Asthma 1,191 2018
Nasonex Mometasone Schering Plough Nasal allergy 1,045 2018
Lyrica (e) Pregabalin Pfizer Neurpathic pain 1,492 2019
Detrol (f) Tolterodine Pfizer Overactive bladder 729 2020
Crixivan (g) Indinavir Merck HIV / AIDS 12 2021
Viagra Sildenafil Citrate Pfizer Erectile Dysfunction 1892 2012
Zyvox Linezolid Pfizer Anti-bacterial 1141 2015
Chantix Varenicline Pfizer Aid to smoking cessation 700 2020
Cancidas Caspofungin Acetate Merck Anti-infective 617 2013
Integrilin Eptifibatide Merck Cardiovascular 46 2014
Emend Aprepitant Merck Cancer 313 2015
Follistim/Puregon Follitropin beta Merck WHC 97 2015
PegIntron Peginterferon alfa-2b Merck Anti-infective 149 2015
Zolinza Vorinostat Merck Cancer 17 2015
Invanz Ertapenem Merck Anti-infective 293 2016
Zostavax Zoster vaccine Merck Vaccine (Schingles) 277 2016
Noxafil Posaconazol Merck Antifungal 149 2019
RotaTeq Rotavirus vaccine Merck Vaccine 522 2019
Intron A Interferon alfa-2b Merck Cancer 38 2020
Januvia/Janumet Sitagliptin/Metformin HCl Merck Diabetes / Obesity 2580 2022
Isentress Raltegravir Merck Anti-infective 752 2023
Advair salmeterol xinafoate / fluticasone GlaxoSmithKline COPD - Asthma 7764 2010^
propionate
Gleevec Imatinib Novartis Cancer 3944 2015
Gemzar Gemcitabine Eli-Lily Cancer 1360 2010
Exforge amlodipine, valsartan Novartis Hypertension 671 2019
Tekturna/Rasilez aliskiren Novartis Hypertension 290 2018
Galvus vildagliptin Novartis Diabetes 181 2024
Source Industry, Company annual reports, Anand Rathi Research

Appendix 1
Analyst Certification
The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the
compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research
analyst(s) in this report.
The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi Research have received compensation based
upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking
revenues.
Anand Rathi Ratings Definitions
Analysts’ ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described
in the Ratings Table below.
Ratings Guide
Buy Hold Sell
Large Caps (>US$1bn) >20% 5-20% <5%
Mid/Small Caps (<US$1bn) >30% 10-30% <10%
Anand Rathi Research Ratings Distribution (as of 20 July 10)

Buy Hold Sell
Anand Rathi Research stock coverage (114) 66% 14% 20%
% who are investment banking clients 8% 0% 0%
Other Disclosures
This report has been issued by Anand Rathi Financial Services Limited (ARFSL), which is regulated by SEBI.
The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed
constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related
investments"). ARFSL and its affiliates may trade for their own accounts as market maker / jobber and/or arbitrageur in any securities of this issuer(s) or in related
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investment banking or other business from, any entity mentioned in this report. This research report is prepared for private circulation. It does not have regard to
the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial
advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that
statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's
price or value may rise or fall. Past performance is not necessarily a guide to future performance. Foreign currency rates of exchange may adversely affect the
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(HK) Limited., Unit 1211, Bank of America Tower, 12 Harcourt Road, Central, Hong Kong. Anand Rathi Financial Services (HK) Limited. is regulated by the Hong
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Pharmaceuticals

India Pharma: Global healing Nifty/Sensex: 6063/20125

Anand Rathi Research India Equities

India Pharma: Global healing Nifty/Sensex: 6063/20125

We initiate coverage on Indian Pharma with Overweight stance

Sector valuation matrix BSE Healthcare vs Sensex

Anand Rathi Research India Equities

Investment Argument & Valuation ................................................................ 3

Anand Rathi Research 3

Investment Argument & Valuation

Supporting macro parameters

Generic manufacturers in sweet spot

Anand Rathi Research 3

infectives segments. Abbott, Cipla, GlaxoSmithKline Pharmaceuticals

M&As pick up speed

Premium valuations to sustain

Anand Rathi Research 4

Fig 2 – Relative price performance: BSE Healthcare vs. Sensex

Anand Rathi Research 5

Anand Rathi Research 6

Dr Reddy’s Labs (Buy, Target Price: `1,636)

Anand Rathi Research 7

Anand Rathi Research 8

Pharma Sector: The Macro View

The pharma industry is one of the most export-oriented sectors in India.

Fig 3 – Global and domestic demand contribute equally to Indian Pharma

Revenue earning in forex as % of net sales

Healthcare spending in India

Anand Rathi Research 9

Fig 4 – Share of healthcare in personal consumption expenditure in India

(Medical & healthcare in per. cons., %)

Fig 5 – Strong growth in healthcare and medical spending

Fig 6 – Spending on healthcare shows strong income elasticity

emerging market peers; but, India’s

Despite the strong growth in personal consumption on healthcare, such

Anand Rathi Research 10

Moreover, per-capita healthcare spend in India is growing slower than most

Fig 7 – Low per-head spend on healthcare in India

(Heathcare spending per capita, US$)

(Growth in healthcare spending, %)

(Change in heath. spending pa as % of GDP, bp)

Health expenditure as % of GDP Change in heathcare spend as % of GDP

Anand Rathi Research 11

Global Pharma Industry and India

Fig 10 – Global pharma exports surging fast

Anand Rathi Research 12

Fig 11 – Overview of global pharma exports

Like exports, industrialised countries dominate global imports of pharma

Anand Rathi Research 13

Fig 12 – Overview of the global pharma imports

The trend of global pharma trade broadly indicates pre-eminence of the EU

Fig 13 – Pre-eminence of the EU in global pharma trade

Fig 14 presents the broad product break-down of global pharma exports.

Anand Rathi Research 14

Fig 14 – Overview of global pharma exports – As per product

India’s standing in global pharma trade

Fig 15 – Share of pharma in India’s overall exports

Anand Rathi Research 15

Fig 16 – Destination of India’s pharma exports

Some notable observations in share of pharma products exports from India

Anand Rathi Research 16

Fig 17 – Share of sourcing from India in total pharma imports