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Edel Pulse: Pharmaceuticals

Executive Summary

The domestic branded generics market, a critical cog in the growth wheel for most Indian
companies, is currently in spate. Unlike the apprehension of market participants about the
sustainability of growth, our survey findings indicate that growth is not only sustainable but
will move into the next orbit of 18-20% viz-a-viz current growth of 14-15%. Higher growth
in domestic market will not only improve growth prospects of pharma companies (c30-50%
to revenue), but will also improve overall profitability (margins are relatively higher).

Further, as is the norm, when all companies are in expansion mode, only a handful will
potentially emerge as winners. Hence, to understand these changing dynamics, we
commissioned an extensive and unique study across 27 cities in 11 states (all four zones—
North, South, East, and West), covering more than 100 distributors, representing notably 45-
50% of the total pharma market. These distributors, with more than 10-15 years of presence
in the market, ideally connect suppliers on one hand and consumers on the other.

We covered all tiers of geographies in each zone including metros, tier-I to IV cities. We
travelled across the length and breadth of the country to gain incisive insights into
the future of the domestic pharma market, performance of various Indian
companies, strategies adopted and ground level challenges impacting growth. We
have tied our observations to industry data from AIOCD to overcome individual distributor’s
bias over companies. We further highlight that views of distributors are restricted to their
coverage companies, which differ, but collectively represent 80% of the total market.

Key questions addressed from the survey include:

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

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

• Which therapeutic areas are growing faster?

• What are the key strategies adopted by various companies?

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

We conclude that, Sun Pharma and Lupin are ranked by 94% and 74% of coverage
distributors, respectively, as preferred players in the large–cap space, while IPCA and Torrent
Pharma are ranked by 86% and 70% of coverage distributors, respectively, as leading
players in the mid-cap space. Interestingly, Sanofi-Aventis, among MNCs, is ahead of peers
and is aggressively making its mark in tier III and IV cities. We also identified emerging new
players such as Mankind, Eris, and Macleods, which are gaining strong traction in various
markets.

Combining the takeaways from our distributors survey and the prospects of Indian companies
in emerging markets and US, we expect Lupin, Dr. Reddy’s, Cadila and Torrent Pharma to do
well over the next 12-18 months. We are positive on Sun Pharma, however, current
valuations do not leave much upside for investors.

Overall, through this report, we have attempted to identify trends, drivers, and challenges
faced in the ever-changing market scenario and effectiveness of current strategies adopted
by various companies.

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Edel Pulse: Pharmaceuticals

Contents

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

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

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

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

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

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

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

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

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

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

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

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

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

Companies

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

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

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

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

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

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

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

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AT A GLANCE
Financials (INR mn) Growth (%) Valuations
CMP (Ex- EV / EBITDA
CMP Shares O/S Mkt cap EPS ROCE
Company NPV) Rating Revenue EBITDA Net profit Revenue EBITDA Net profit EPS EBITDA P/E (x) P/B (x) margins
(INR)*** (mn ) (INR mn) (INR) (%)
(INR) (x) (%)

Cadila Healthcare 844 844 204.7 172,767 Buy FY09 29,275 6,058 3,184 15.6 26.0 33.0 20.5 20.5 30.2 54.3 9.2 22.9 20.7
FY10 36,580 7,798 4,808 23.5 25.0 28.7 51.0 51.0 23.2 35.9 6.9 25.9 21.3
FY11E 44,991 9,856 6,462 31.6 23.0 26.4 34.4 34.4 18.2 26.7 7.5 30.7 21.9
FY12E 54,932 12,289 8,319 40.6 22.1 24.7 28.7 28.7 14.3 20.8 5.7 34.3 22.4
FY13E 65,929 15,001 10,345 50.5 20.0 22.1 24.4 24.4 11.4 16.7 4.4 37.8 22.8

Cipla 321 321 802.9 257,731 Hold FY09 52,343 12,411 9,705 12.1 23.7 45.5 50.4 50.4 21.5 26.6 5.7 22.4 23.7
FY10 56,057 13,795 10,050 12.5 7.1 11.2 3.6 3.6 18.6 25.6 4.4 21.6 24.6
FY11E 62,465 13,569 9,967 12.4 11.4 (1.6) (0.8) (0.8) 18.8 25.9 3.9 18.0 21.7
FY12E 71,260 16,128 12,195 15.2 14.1 18.9 22.4 22.4 15.7 21.1 3.4 19.1 22.6
FY13E 82,819 19,311 14,867 18.5 16.2 19.7 21.9 21.9 12.9 17.3 3.0 20.4 23.3

Dr Reddy's* 1656 1,562 168.9 279,726 Buy FY09 61,642 9,718 4,300 25.5 35.0 44.0 120.0 120.0 28.6 61.2 7.9 19.3 15.8
FY10 67,624 13,510 6,777 40.1 9.7 39.0 57.6 57.1 20.1 38.9 7.4 20.4 20.0
FY11E 72,724 15,297 10,539 62.4 7.5 13.2 55.5 55.5 17.3 25.0 6.0 23.4 21.0
FY12E 84,371 17,982 12,901 76.4 16.0 17.6 22.4 22.4 14.1 20.5 4.5 33.5 21.3
FY13E 97,459 21,186 14,926 88.4 15.5 17.8 15.7 15.7 11.4 17.7 3.7 28.4 21.7

Lupin Pharma 412 412 444.7 183,216 Buy FY09 38,523 7,541 5,266 12.7 40.0 49.0 18.7 17.6 23.5 32.4 12.0 24.9 19.6
FY10 48,359 9,728 6,841 15.4 25.5 29.0 29.9 21.0 19.2 26.8 7.1 25.7 20.1
FY11E 56,693 11,594 8,472 19.1 17.2 19.2 23.8 23.8 15.4 21.6 5.3 23.8 20.5
FY12E 64,939 13,710 9,608 21.6 14.5 18.3 13.4 13.4 12.3 19.1 4.2 24.5 21.1
FY13E 75,280 16,121 11,781 26.5 15.9 17.6 22.6 22.6 10.5 15.6 3.4 25.2 21.4

Ranbaxy* 468 374 421.0 197,047 Hold CY08 73,610 7,873 1,891 4.5 8.0 18.0 16.0 16.0 22.4 83.3 4.6 4.0 10.7
CY09 68,725 1,801 788 1.9 (6.6) (77.1) (58.4) (58.4) 100.5 200.0 4.5 6.7 2.6
CY10 72,273 6,108 3,583 8.5 5.2 239.1 354.9 354.9 27.5 44.0 3.5 22.4 8.5
CY11E 80,682 8,472 5,735 13.6 11.6 38.7 60.1 60.1 19.9 27.5 3.0 29.1 10.5
CY12E 90,331 11,291 7,104 16.9 12.0 33.3 23.9 23.9 14.0 22.2 2.5 26.2 12.5

Sun Pharma** 446 436 1,035.6 461,878 Hold FY09 35,141 12,190 13,340 12.9 31.0 31.0 30.0 30.0 35.8 33.8 6.4 29.6 34.7
FY10 32,546 8,545 9,084 8.8 (7.4) (29.9) (31.9) (31.9) 52.3 49.7 5.8 16.5 26.3
FY11E 50,623 15,186 13,377 12.9 55.5 77.7 47.3 47.2 28.7 33.7 4.9 27.2 30.0
FY12E 68,656 20,941 17,576 17.9 35.6 37.9 31.4 38.3 20.2 24.4 4.3 31.0 30.5
FY13E 78,642 24,504 20,658 21.2 14.5 17.0 17.5 18.7 16.7 20.5 3.7 34.3 31.2

Torrent Pharma 591 591 84.6 50,009 Buy FY09 16,307 2,999 2,154 25.5 20.4 43.5 63.1 63.1 17.5 23.2 7.7 32.6 18.4
FY10 19,040 4,087 2,687 31.8 16.8 36.3 24.8 24.8 12.6 18.6 6.0 42.5 21.5
FY11E 22,586 4,414 2,973 35.1 18.6 8.0 10.6 10.6 11.6 16.8 4.7 38.5 19.5
FY12E 26,616 5,323 3,608 42.6 17.8 20.6 21.3 21.3 9.4 13.9 3.7 38.7 20.0
FY13E 32,142 6,679 4,614 54.5 20.8 25.5 27.9 27.9 7.3 10.8 2.9 41.4 20.8
Note: * Financials (ex-ROCE) represent base business (Ex one-off from para IV)
**Financials for Sun pharma includes Taro but excludes one-off from Para-IV

*** CMP as on 21st April 2011

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Edel Pulse: Pharmaceuticals

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Edel Pulse: Pharmaceuticals

Ear to the Ground: Verdict is Out

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

„ Growth momentum to sustain and move into next orbit


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

„ Chronic therapies leading growth; cosmetology new growth avenue


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

The competition in chronic therapies is increasing rapidly, leading to higher investments


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

„ Expansion by MNCs could intensify competition for Indian counterparts


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

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Edel Pulse: Pharmaceuticals

Moreover, in-licensing of off-patented/patented molecules could incrementally drive


higher revenues in the medium term. We believe that with aggressive expansion plans
and deep pockets, MNCs could potentially emerge as strong competitors, compelling
Indian companies to hike investments, while price wars could potentially hurt their
profitability in the long term.

„ Higher attrition in field force poses risk to current growth


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

„ Decline in success rate of new product introductions


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

„ Differentiating ‘class from mass’: End driver of survey


Through our distributor survey we tried to differentiate highly effective companies from
others (‘class from mass’) on the basis of parameters such as: (a) portfolio concentration
(chronic versus acute); (b) growth relative to the market; (c) field force stability and
productivity; (d) field force penetration; (e) success of new product launches; and (f)
ability to build brands. The survey questionnaire was designed to gauge top 30
companies (as per market share) on the basis of these key parameters.

We conclude that, Sun Pharma and Lupin are ranked by 94% and 74% of coverage
distributors, respectively, as preferred players in the large–cap space, while IPCA and
Torrent are ranked by 86% and 70% of coverage distributors, respectively, as leading
players in the mid-cap space. MNCs are adopting a more localised approach to build
market presence and are building infrastructure for the next leg of growth. Interestingly
Sanofi-Aventis, among MNC pharma, is ahead of peers and is aggressively coming up in
tier III–IV cities. Moreover, we also identified some key emerging small-mid size players,
such as Macleods, Aristo, Eris and Mankind, who are scaling up and capturing
incrementally higher market share.

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Edel Pulse: Pharmaceuticals

Fig. 1: Competitive scorecard


Domestic growth Success of
Portfolio Brand Field force Field force Reach
Company Name CAGR new product
concentration building ability stability productivity (Medical reps)
(5yr) launches

Large Cap

Sun Pharma

Dr Reddy's

Cipla

Lupin

Cadila

Mid-cap

Torrent Pharma

IPCA

Glenmark
MNC

Ranbaxy

Sanofi-Aventis

GSK India

Pfizer India

Scale: Best ………………………………………………………………………………………………Least


5 1

Source: Edelweiss research

Table 1: Top picks - Lupin and Torrent Pharma offer highest upside (INR)
CMP TP NPV of Reco Upside P/E (x)
Company
one-offs (%) FY11E FY12E FY13E
Cadila 844 960 BUY 14 26.7 20.8 16.7
Cipla 321 350 HOLD 9 25.9 21.1 17.3
Dr. Reddy's 1,656 1,950 94 BUY 18 25.0 20.5 17.7
Lupin 412 500 BUY 21 21.6 19.1 15.6
Ranbaxy 468 432 94 HOLD (8) 44.0 27.5 22.2
Sun pharma 446 477 10 HOLD 7 33.7 24.3 20.5
Torrent Pharma 591 760 BUY 29 16.8 13.9 10.9
Source: Edelweiss research
Note: * PE multiple for Dr Reddy’s, Sun Pharma. and Ranbaxy is based on CMP adjusted for NPV of one-off exclusivity sales

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Edel Pulse: Pharmaceuticals

Domestic Formulations: On A High


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

Chart 1: IPM growth has been robust over past two years
20.0
17.8

16.0 14.9 15.0 15.0


14.2
Sustainability of growth is
not an issue 12.0
10.0 10.4
(%)

8.0
8.0 7.0
5.0 4.5
4.0

0.0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
(MAT
March)

Source: CRISIL, Edelweiss research

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


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

Chart 2: Majority of distributors believe growth is sustainable


Average sustainable growth Sustainability of growth

Not
<13% sustainable
8% 5%
>15%
27%

Sustainable
95%
13-15%
65%

Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

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

Chart 3: Factors driving growth in the market


Pull factors Push factors
Population Healthcare New
and aeging infrastructu divisions New
16% re / Govt 6%
Price product
expenditure
increases launches
Health 11%
9% 23%
insurance
9% Specialty
promotion
17%

Higher Changing
income lifestyle
level / 30%
Field force
Affordability Brand expansion
4% building 32%
Health
awareness 13%
30%

Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Chronic Leads; Cosmetology New Avenue

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

Table 2: Chronic segment has out performed overall market growth (%)
FY09 FY10 Mar-11 % of total
Chronic 19.1 19.2 17.4 27.9
Acute 14.9 14.9 14.1 72.1
Overall market growth 16.1 16.2 15.0 100.0

Source: AIOCD, Edelweiss research

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

% of total 6% 15% 7% 1% 100.0


market
80.0
30.0
(% of distributors)

24.0 60.0
Growth- (%)

18.0
40.0
12.0
20.0
6.0

0.0 0.0
vascular

Psychiatry

Oncology
Diabetics

Respiratory

Cosmetology
Infectives

Anti-Diabetes
Cardiac

Oncology
CNS
Cardio

Neuro-
Anti-

Anti-

MAT Mar-10 MAT Mar-11


Source: AIOCD, Edelweiss research Source: Edelweiss research

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

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Edel Pulse: Pharmaceuticals

Chart 6: Population with lifestyle disease will double Chart 7: Growth driven by higher prescriptions
6.0 100%

4.8
(% of population)

80%

3.6
60%

2.4
40%
1.2
20%
0.0
Coronary

Diabetes

Asthma

Obesity

Cancer
disease

0%
heart

Anti - CVS CNS IPM


diabetics
2005 2015E Volume Price New products
Source: McKinsey, Edelweiss research Source: AIOCD, Edelweiss research

Cosmetology, oncology and nephrology: New growth avenues within chronic


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

More active competition in chronic segments is resulting in higher investments


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

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Edel Pulse: Pharmaceuticals

Chart 8: Case 1 – Torrent Pharma has doubled field force and added sub-divisions and further subdivided existing
divisions to increase focus on each specialty
2,000 Divisions Divisions
1,797
Therapies FY09 FY10 Therapies FY11
1,600
577 Psycan,
Psycan,
1,170 Psycan, Delta,
49%
(No of reps.)

CVS / Anti- Delta,


1,200 Delta and Psycan CVS
diabetics Psycan
285 Azuca CND and
386 CND
12% Azuca
800
254 Anti-
76% Azuca
935 Axon, Axon, Diabetics
400 CNS Mind & Mind &
530 Neuron Neuron Axon, Mind
CNS
& Neuron
0
FY09 FY11

Cardiovascular Anti-diabetics CNS


Source: Company, Edelweiss research

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

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Edel Pulse: Pharmaceuticals

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

Therapy Divisions / Sub divisions

Cardiology, ARIAN AZURA AVIOR


Diabetology Life sciences
Cardiovascular
Interventional AZURA
Cardiology Criticare

CNS
SYNERGY SYMBIOSIS SIRIUS
(Psychiatry, Neurology)

SPECTRA INCA
Gynecology
Life Sciences
INCA
Fertility, Urology
Life Sciences

Gastroenterology
SUN SOLARES
Orthopedics

Opthalmology AVESTA MILMET

Oncology SUN Oncology

Rheumatology, ORTUS
Dermatology
RADIANT
Source: Company, Edelweiss research

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Edel Pulse: Pharmaceuticals

Metro, tier-I key markets; Semi urban and rural


areas are new growth pockets

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

Table 3: Tier-I, III and IV cities are registering higher growth above industry average
Overall share No of retail Average
City Tier Population Cities covered through survey
of market (%) chemists Growth (%)
Metro 30% >1 mn Hyderabad, Chennai, Mumbai, 4,000 to 20,000 13-15%
Ahmedabad, Delhi, Kolkata
Tier-I 30% 500,000 to <1 Pune, Surat, Secunderabad 2,000 to 5,000 >15%
mn
Tier-II Gurgaon, Bhubaneshwar,Baroda, 1,000 to 3,000
300,000 to Cuttak, Howrah
20% >15%
Tier III 500,000 Karimnagar, Warangal, 1,000 to 2,000
Nashik, Noida
Tier IV
Vapi, Satara, Sangli, Abhore,
20% up to 300,000 Kolhapur, Miraj, Behrampur, Sikar, 250 to 700 25-30%
Rural/Micro Chomu etc.
Towns
Source: Edelweiss research

We highlight that metros are growing at an average rate of 13-15%, in line with the industry.
Acute therapy still constitute ~60-65% of volumes, while the share of chronic therapies is
increasing, which is driving higher number of specialty set ups. As a result, companies are
expanding field force in these markets to target larger doctor population. Most distributors
guide that growth in metros will sustain for the foreseeable future led by four key factors: (i)
urbanisation (due to migration of people from lower tiers) resulting in higher population; (ii)
rapid changes in lifestyle, leading to faulty eating habits, key driver of chronic disease; (iii)
higher growth of middle income levels group driving affordability; and (iv) increase in
diagnosis and treatment levels.

Increase in health awareness is also resulting in higher self medication, which is driving most
companies to switch leading brands from prescription to OTC (e.g., Pfizer is expanding its
brand franchise by promoting Gelusil syrup as an OTC product). This strategy enables
companies to get higher growth and return from established brands with lower investments.
Moreover, companies like IPCA and Cadila are entering into nutraceuticals segment driven by
higher demand for additional supplements to cope with rising stress levels. IPCA has
introduced Nutralite to venture into the nutraceutical segment.

Edelweiss Securities Limited 13


Edel Pulse: Pharmaceuticals

Growth in tier-I cities higher than metros


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

Semi-urban and rural markets: New growth pockets


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

Table 4: Dynamics of semi-urban and rural markets vary from metros and tier-I markets
Semi-urban & Rural
Metros & Tier -I towns Comments
markets
Chronic Chronic Acute therapies account for 80-90% of total
(10-20%) (35-40%) consumption in semi urban areas

Anit-infectives, gastro-intestinal and respiratory


Therapeutic mix
are high growth therapies, while chornic
therapies are catching up with higher growth in
towns with more urbanization

Specialists (5-10%)
GPs and CPs
(50%) Nature of doctor population is largely GPs and
CPs (90-95% of total), while specialists
presence is limited to fewer class-II/III towns
Doctor population
which are seeing higher urbanization and
expansion of therapies like respiratory, neuro-
GPs (MBBS), RMPs Specialists (50%) psychiatry and diabetics
(90-95%)

Poliferation of local players giving stiff


competition to Top tier pharma companies

Local competition Very high Not much impact Local playes have better relations with doctors,
low pricing strategy and incentivise retailers
with better schemes

Hub and spoke


Multi-layered Lack of distribution set-up leading to higher cost
(Hub is the Tier-III/IV town
Distribution set-up Wide spread and organized of distribution. (Sanofi Aventis does taxis tours
which catrers to near by
using own vehicles into micro interiors)
micro towns)

More skillful with better


Penetration and local presence is lower in tier-
Field force Lack of quality in field force product knowledge and
III/IV cities
understanding of the market

Source: Edelweiss research

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

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Edel Pulse: Pharmaceuticals

players are expanding their coverage (field force is doubled in most regions) to address
larger pool of doctors and micro interiors, which were earlier not covered. For instance, to
increase penetration, Sanofi Aventis is doing taxi tours in micro interiors which have no
transport. Last, companies are organising more CMEs (medical education programmes by
inviting senior physicians for local doctors) as well as healthcare awareness camps which are
helping them reach targeted customers more effectively. Hence, by improving accessibility in
under-penetrated markets, companies are creating higher demand for pharmaceuticals. We
believe companies like Cipla, Cadila, IPCA, Ranbaxy, and Sanofi Aventis, which are adopting
a more localized approach, are well positioned to take advantage of growing demand.

Table 4, above, further depicts that the disease profile of tier III-IV cities is highly
Companies primarily focus concentrated on the acute segment. We believe companies in order to penetrate and build
on acute segment in tier base in tier III–IV markets, will have to initially tailor their product portfolios to the acute
III-IV and rural markets segment, while selectively positioning in the chronic segment. As per our analysis, chronic
segments like respiratory (anti-asthma), cardiac, and diabetes are also picking up in selective
markets which gives opportunities for growth to companies like Sun pharma, Torrent, and
USV, who have selectively focused on neuropsychiatry, cardiac and anti-diabetic segments,
respectively, in these markets.

Chart 9: Players becoming more active or expanding coverage in tier III-IV areas
75.0

60.0
(% of distributors)

45.0

30.0

15.0

0.0

Torrent
Glenmark
Ranbaxy

Aventis

Pfizer
Reddy's
IPCA

Lupin
Cipla

Cadila

Sanofi

GSK
Dr

Source: Edelweiss research

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

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Edel Pulse: Pharmaceuticals

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


100.0

80.0

60.0

(%)
40.0

20.0

0.0

Dr Reddy's

Glenmark
Ranbaxy

Torrent
Mankind

Macleods
Cadila

Aventis
Pfizer
IPCA
Lupin
Cipla

Sanofi

GSK
Gaining market share Losing market share
Source: Edelweiss research

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

Chart 11: Field force stability of players in rural market (Survey)


Pfizer

Mankind

Lupin

Ranbaxy

Cadila

Cipla

IPCA

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


(% distributors)

Better field force Poor field force


Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Aggressive MNC Expansion Poses High Risk

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

Chart 12: Strategies adopted by MNCs


100.0

80.0
(% of distributors)

60.0

40.0

20.0

0.0
New product Field force Brand promotion Building channel
launches (incl expasnion relations
branded generics)

Source: Edelweiss research

Chart 13: Most distributors perceive aggressive expansion by MNCs

Not much
change in
activity
35%

Higher activity
level
65%

Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Distinct shift in strategy by launching branded generics products


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

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

MNC Molecules Therapy Brand name Pricing Indian Competitive brands

(INR) Company Brand name Pricing (INR)

Ranbaxy
180
(10 tablets)

Intas 125
(10 tablets)
43
Glaxo Atorvastatin CVS
(10 tablets) 110
Dr Reddy's (10 tablets)

157
Cipla (10 tablets)

Intas 55
(15 tablets)

Gastro- 24 64
Pfizer Rabeprazole Above 5 Cipla
intestinal (7 tablets) (15 tablets)

70
Dr Reddy's (10 tablets)

Source: Edelweiss research

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

Field force expansion to enhance penetration


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

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Chart 14: Field force expansion by key MNC players

3,500
43%
2,800
188%
MNCs have doubled field

(No. of reps.)
force to expand 64%
2,100
geographical reach

1,400

700

0
GSK Pfizer Aventis
2008 2010

Source: Edelweiss research

Sanofi-Aventis is preferred play in MNC space


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

Chart 15: Relative performance of MNCs (Survey)


100%

80%
Sanofi-Aventis is leading
the MNC pack 60%

40%

20%

0%
Ranbaxy
Aventis

Piramal

Pfizer
Abbott
Sanofi

GSK

Growing above market Growing below market In line


Source: Edelweiss research

Edelweiss Securities Limited 19


Edel Pulse: Pharmaceuticals

Differentiating ‘Class from Mass’

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

a) Portfolio concentration or business mix (acute versus chronic)

b) Ability to build brands

c) Success of new product launches

d) Field force penetration or coverage

e) Field force stability and productivity

On the basis of above mentioned parameters and through our analysis from the survey, we
have identified few highly effective companies which have strong execution and are growing
ahead of market.

Sun and Lupin emerge as favored plays in large cap; Torrent/IPCA score in mid cap
Sun pharma and Lupin were ranked by most distributors as outperformers among large caps,
We judge strength of
while Torrent and IPCA scored in mid caps. Among MNCs, Aventis scored over other players
domestic business of each
such as GSK and Pfizer. Players such as Cipla, Ranbaxy and Cadila are facing some pressures
player on the basis of five
in terms of growth and stability but are likely to turnaround, in our view.
key parameters

Sun pharma has emerged as the undisputed choice among distributors primarily because of
its ability to identify therapeutic gap areas and launch products ahead of competition,
resulting in better mind share and market share. Second, the company has focus on medical
colleges and has innovatively built its doctors franchise by engaging them at an early stage.

Lupin scores over peers due to its focus on key opinion leaders (KOLs). The company has
actively build a wider portfolio by entering into newer therapeutic areas and is growing ahead
of peers in chronic segments such as CVS, CNS, and respiratory. Moreover, its aggressive
and highly effective field force helps it sustain growth in a highly competitive market.

Cipla, despite deep penetration and high field force productivity, has seen slow growth in
domestic market. This is largely due to instability in the field force which has further
impacted its ability to build big brands. However, we believe that Cipla can surprise the
market positively due to its higher focus on tier II and IV markets, where the company has
started witnessing high growth traction, and addressing of structural issues with reference to
its mature and generic-generic portfolio in domestic market.

Other companies like Cadila, Dr. Reddy’s, and Ranbaxy are also gearing up which is
evident from the fact that they have ramped up their field force by 22%, 94%, and 72%,
respectively, over the past two years.

In the mid-cap space, Torrent is ahead of comparable peers on account of higher focus on
the chronic segment, better field force stability, and ability to build brands. However, it lags
in terms of launching new products. Moreover, IPCA is also gaining strong momentum in all

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Edel Pulse: Pharmaceuticals

markets and has increased divisions (12 from earlier seven) to expand into newer therapies
and tier II to IV towns. We highlight that Torrent and IPCA have expanded field force
aggressively (by 64% and 58%, respectively) which has impacted their field force
productivity (Fig. 3).

In the MNC space, Sanofi-Aventis has a clear advantage over other MNCs because of high
focus on the chronic segment, strong brand building abilities, competent sales force, and
aggressive approach in metros as well as tier II to IV towns.

Fig. 3: Competitive score card


Domestic Brand Success of
Portfolio Field force Field force Reach
C ompany Name growth C AGR building new product
concentration stability productivity (Medical reps)
(5yr) ability launches

Large Cap

Sun Pharma

Dr Reddy's

C ipla

Lupin

C adila

Mid-cap

Torrent Pharma

IPC A

Glenmark
MNC

Ranbaxy

Sanofi-Aventis

GSK India

Pfizer India

Scale: Best ………………………………………………………………………………………Least


5 1

Source: Edelweiss research

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

Edelweiss Securities Limited 21


Edel Pulse: Pharmaceuticals

„ Portfolio concentration or business mix


We prefer Sun Pharma, Lupin, and Torrent as they have higher concentration in chronic
therapies, which contribute 45-60% of their total sales (Chart 16). The presence in the
chronic segment has historically offered these players higher growth than industry. Further,
chronic therapies provide better realization than acute, thereby rendering higher gross
margins (80-90% versus 70% in acute segments).

Companies which are largely focused on the acute segment such as Ranbaxy, Dr. Reddy’s,
Cipla, and IPCA, are posting higher growth in micro markets. The acute segment continues to
have larger share of IPM (~72% of total market) and has posted better growth in the past
two years due to increased penetration of companies in tier II-IV towns and rural areas.
Among MNCs, portfolio concentration is more skewed towards acute except Sanofi-Aventis
which has build strong presence in the chronic segment, where we see growth picking up
over the past six months.

Chart 16: Players with strong focus on chronic segment to outperform market
Torrent
Sun Pharma
Sanofi…
Lupin
Cipla
Dr Reddy's
Sun, Lupin and Torrent
Cadila
have high focus on
IPCA
chronic segment
Ranbaxy
Glenmark
Pfizer
Glaxo

0.0 20.0 40.0 60.0 80.0 100.0

Chronic (%) Acute


Source: Edelweiss research

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

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Edel Pulse: Pharmaceuticals

Chart 17: Key players in anti-diabetics market


40.0 12.0
36
32.0 29 29 9.6

22
24.0 20 7.2
Industry

(%)

(%)
16 growth
16.0 17 4.8

8.0 2.4

0.0 0.0

Pharma

Aventis

Piramal

Lupin
Sanofi-
USV

MSD

Torrent
Sun
Market share (RHS) Growth (LHS)

Chart 18: Key players in cardiovascular market


40.0 6.5
35

32.0 5.2
We prefer players with
higher market share and Industry
24.0 19 3.9
growth within chronic 19 growth
(%)

(%)
16
segment 14 14
16.0 12 2.6

8.0 1.3

0.0 0.0
Ranbaxy
Cadila
Pharma

Pharma
Intas

Torrent
Lupin

Cipla
Sun

Market share (RHS) Growth (LHS)

Chart 19: Key players in neuro-psychiatry market


30.0 27 17.5
24
24.0 14.0
19
18
15
18.0 10.5
14 Industry
(%)

(%)

13 growth
12.0 10 7.0

6.0 3.5

0.0 0.0
Torrent
Pharma

Aventis
Piramal

Abbott

Lupin
Sanofi-
GSK
Intas
Sun

Market share (RHS) Growth (LHS)


Source: Edelweiss research

Edelweiss Securities Limited 23


Edel Pulse: Pharmaceuticals

„ Ability to build brands: A key differentiator


As new product launches dwindle, building big brands has assumed much greater importance
and is rather necessary to improve profitability. To instill a culture and mindset of building
large brands, companies need to focus on several aspects. First, for large brands, company’s
require active life cycle management, while for scaling up medium sized brands they need to
broaden coverage across doctors and geographies and finally for relatively new brands the
focus should be to create credibility and generate prescriptions among KOLs (key opinion
leaders).

We recognize brand building as future growth driver and have identified companies with
better track records in building brands. Our survey highlights that among domestic
companies, Sun pharma leads the pack, followed by Lupin with 68% and 59% of distributors,
respectively, gauging strong brand building capability. Among MNCs, respondents believe
Sanofi-Aventis has better brand building ability. Similarly, in mid caps, Torrent, IPCA and
Glenmark have better brand building ability compared to peers.

Chart 20: 68% respondents believe Sun Pharma has better brand building ability
75
(% coverage distriibutors)

60

45

30

15

Ranbaxy
Piramal
Torrent
Glenmark

Dr Reddy
Mankind

Cadila
Pharma

Aventis

Intas

Pfizer
IPCA
Lupin

Cipla
USV

Abbott
GSK
Sun

Source: Edelweiss research

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

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Edel Pulse: Pharmaceuticals

Table 6: Top 10 brands are growing in line or higher than overall domestic growth
Growth (MAT Mar 2011) (%)
Top - 10 brands
Cont. to sales Overall Relative
Relative outperformance of (%) Top 10 brands domestic performance
Top 10 brands reflects
higher focus on brand Glenmark 36.9 27.6 22.4 5
building by most players Ranbaxy 36.6 15.7 9.1 7
Torrent 30.4 24.0 22.1 2
Cipla 27.9 25.0 20.6 4
Cadila 28.3 17.9 14.9 3
Sun Pharma 19.6 32.5 22.9 10
GSK 38.7 12.4 13.2 -1
Sanofi Aventis 55.1 20.0 21.2 -1
IPCA 34.7 22.0 24.4 -2
Lupin 21.0 21.6 24.3 -3
Pfizer 63.9 21.0 23.7 -3
Dr Reddy's 39.9 8.2 11.5 -3
Source: AIOCD, Edelweiss research

„ Success of new product launches


Most large and mid-size companies, to actively expand coverage across molecules or
therapies, are launching new products. However, as per our survey 70-80% of these products
have been failures; most of these failures have been in established segments, where more
than 10-15 players currently exist. Hence, we observe companies which are more proactive
and launch products ahead of the market are more successful in building brands, which
potentially contribute to higher growth of the business.

The chart, below, indicates that companies like Sun Pharma and Lupin are equally successful
in building new products, as Top 10 brands contribution to growth is relatively lower than the
peers. However, companies like Ranbaxy and Glenmark still have high dependency on Top 10
brands. Ranbaxy’s Top 10 brands are driving ~50% of its incremental growth, primarily due
to slower pace of new launches over the past two three years. Similarly, MNCs dependency
on top 10 brands is relatively high due to fewer product launches compared to Indian peers.

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

Indian peers MNC peers


50 65
(Top 10 brands c ontribution to

(Top 10 brands c ontribution to

Glenmark
42 58 Pfizer
Cipla
Sanofi
34 51 Aventis
Ranbaxy
growth)

growth)

Cadila Torrent
IPCA
Dr
26 44
Reddy's
Lupin
18 37 GSK
Sun
Pharma
10 30

10 20 30 40 50 10 30 50 70 90
Top 10 brands contribution to total domestic Top 10 brands contribution to total domestic
sales (%) sales (%)
Source: AIOCD, Edelweiss research

Edelweiss Securities Limited 25


Edel Pulse: Pharmaceuticals

Chart 22: Companies most aggressive in launching new products


65.0

52.0

(% of distributors)
39.0

26.0

13.0

0.0

Ranbaxy
Torrent

Glenmark
Mankind
Pharma

Intas
Pfizer

IPCA
Lupin
Cipla
Sun

Source: Edelweiss research

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

„ Higher field force penetration or coverage


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

Chart 23: Field force penetration has increased over past four years
5,500
CAGR (FY08-11)

Higher field force 4,400 13%


19%
penetration to optimise 23%
25%
(Field force)

reach to pharmacists, 3,300


doctors and hospitals 20% 18% 19% 5%

2,200 9%

1,100

0
Glenmark
Ranbaxy

Reddy's

Torrent
Cadila

Pharma
IPCA

Lupin
Cipla

Sun
Dr.

FY08 FY11 (YTD)

Source: Edelweiss research

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

„ Field force stability critical for sustainable growth


Field force stability is critical to maintain higher productivity and growth, while instability
results in disruption of sales. Although retention has always been a challenge for the
industry, off late, the attrition rate has zoomed owing to aggressive hiring. We believe,
companies with strong and effective field force management have higher probability of
sustaining market share and growth.

Historically, MNCs were associated with better field force stability because of higher pay
scale. However, as per the survey, Lupin, Sanofi-Aventis and Sun pharma have been ranked
as companies possessing highly effective and stable field force compared to its large cap and
MNC peers. Cipla has the highest attrition followed by Ranbaxy, while field force stability of
Dr. Reddy’s and Cadila is above average. In the mid-cap space, Torrent and Glenmark have
more stability than IPCA, Unichem, and FDC. In the unlisted space, Mankind has a stable field
force because of its highly effective incentive policy.

Chart 24: Companies with highly stable and effective field force (Survey)
100%

80%

60%

40%

20%

0%
Dr Reddy's
Glenmark

Ranbaxy
Sun Pharma

Torrent

Unichem
Mankind
Sanofi Aventis

Abbott Piramal

Cadila
Pfizer

FDC
IPCA
Lupin

Cipla
USV

GSK

Satble field force Average Poor field force stability


Source: Edelweiss research

„ Field force productivity is of paramount importance


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

Edelweiss Securities Limited 27


Edel Pulse: Pharmaceuticals

Chart 25: Recent expansion in field force has impacted productivity


12.0

Field force productivity (INR mn)


9.6
Sun

7.2
GSK

Ranbaxy Cipla
4.8 Aventis Lupin
Glenmark
DRRD Cadila
2.4 Torrent
IPCA

0.0
1,000 2,000 3,000 4,000 5,000 6,000

Field force (no of reps)


Source: Edelweiss research

„ Historical execution in domestic market


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

Chart 26: Companies with strong historical growth scored well in our survey
30.0
24.1 23.7
24.0 21.9
20.1 19.9
18.4
Growth (%)

18.0
14.5
11.6
12.0 10.0 9.3
7.2 6.8
6.0

0.0
Dr Reddy's
Glenmark

Ranbaxy
Sun Pharma

Pharma

Cadila

GSK
Aventis
Torrent

Pfizer
IPCA
Lupin

Sanofi
Cipla

Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Future Growth Drivers


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

Rising acceptability of new therapies


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

Launch of patented products


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

Hospital segment to gain importance


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

Edelweiss Securities Limited 29


Edel Pulse: Pharmaceuticals

Chart 27: Hospital market to post 22% CAGR


15

12

(%)
6

0
2009 2020E

Market 13 26
Share (%)
Public Private

Source: Mckinsey, Edelweiss research

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Edel Pulse: Pharmaceuticals

Valuations: Rich, But Not Stretched


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

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


Revenue EBIDTA EBIDTA Margins (%) PAT EPS
Company FY11 FY13E CAGR FY11 FY13E CAGR FY11 FY13E FY11 FY13E CAGR FY11 FY13E CAGR (%)
(%) (%) (%)
Cadila 45.0 65.9 21.1 9.9 15.0 23.4 21.9 22.8 6.5 10.3 26.5 31.6 50.5 26.5
Cipla 62.5 82.8 15.1 13.6 19.3 19.3 21.7 23.3 10.0 14.9 22.1 12.4 18.5 22.1
Dr Reddy's* 72.7 97.5 15.8 15.3 21.2 17.7 21.0 21.7 10.5 14.9 19.0 62.4 88.4 19.0
Lupin 56.7 75.3 15.2 11.6 16.1 17.9 20.5 21.4 8.5 11.8 17.9 19.1 26.5 17.9
Ranbaxy* 72.3 90.3 11.8 6.1 11.3 36.0 8.5 12.5 3.6 7.1 40.8 8.5 16.9 40.8
Sun Pharma** 50.6 78.6 24.6 15.2 24.5 27.0 30.0 31.2 13.4 20.7 24.3 12.9 21.2 28.1
Torrent Pharma 22.6 32.1 19.3 4.4 6.7 23.0 19.5 20.8 3.0 4.6 24.6 35.1 54.5 24.6
Total 382.4 522.6 16.9 76.0 114.1 22.5 19.9 21.8 55.4 84.3 23.4 182.0 276.5 23.3

Source: Edelweiss research


Note: * Financials (ex-ROCE) represent base business (Ex one-off from Para IV)
**Financials for Sun pharma includes Taro but excludes one-off from Para-IV

„ Pharma Index’s relative performance to broad market has moderated


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

Edelweiss Securities Limited 31


Edel Pulse: Pharmaceuticals

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


105.0

68 71
70.0
47 47
34
Recent 35.0 22
18

(%)
16
underperformance led
by correction from 0.0
peak multiples
(9) (5)
(35.0)
(32)
(51)
(70.0)
YTD CY10 CY09 CY08 CY07 CY06
BSE HC Sensex
Source: Edelweiss research

„ Valuations rich, but not stretched; prefer stock-specific approach


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

Chart 29: Relative performance within sector (to Sensex)


1 yr Relative 1 yr Ablsolute
Pfizer 12 Pfizer 25
GSK (2) GSK 10
Torrent Pharma 2 Torrent Pharma 14
IPCA 5 IPCA 18
Cadila 42 Cadila 54
Lupin 13 Lupin 25
Glenmark (1) Glenmark 11
Ranbaxy (8) Ranbaxy 4
Sun pharma 16 Sun pharma 28
Dr Reddy's 30 Dr Reddy's 42
Cipla (16) Cipla (4)

(20) 0 20 40 60 (20) 0 20 40 60
(%) (%)
Source: Edelweiss research

„ Premium valuations to sustain


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

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Edel Pulse: Pharmaceuticals

Chart 30: Pharma relative premium/discount to Sensex

(Relative premium to sensex)


400 1.8
Pharma index has traded
at 45% premium
320 1.4

(Index)
240 1.1

160 0.7

80 0.4

0 0.0

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10
Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Pharma Sensex Relative premium

Source: Edelweiss research

„ Lupin and Cadila likely to catch up peers’ multiple


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

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

Table 8: Peer valuations matrix


CAGR
CMP Reco EPS (INR) (FY11-13) P/E (x) EV/Sales (x) EV/EBITDA (x)
INR FY11E FY12E FY13E (%) FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E
Sun Pharma* 446 HOLD 12.9 17.9 21.2 28.1 33.7 24.4 20.5 8.4 7.8 6.3 28.7 20.2 16.7
Cipla 321 HOLD 12.4 15.2 18.5 22.1 25.9 21.1 17.3 4.0 3.5 3.0 18.8 15.7 12.9
Ranbaxy* 468 HOLD 8.5 13.6 16.9 40.8 44.0 27.5 22.2 2.3 2.0 1.7 27.5 19.9 14.0
Cadila 844 BUY 31.6 40.6 50.5 26.5 26.7 20.8 16.7 4.0 3.2 2.6 18.2 14.3 11.4
Dr. Reddy's* 1,656 BUY 62.4 76.4 88.4 19.0 25.0 20.5 17.7 3.7 2.8 2.4 17.3 14.1 11.4
Lupin 412 BUY 19.1 21.6 26.5 17.9 21.6 19.1 15.6 3.2 2.7 2.3 15.4 12.3 10.5
Large Caps 29.5 22.2 18.3 4.3 3.7 3.0 21.0 16.1 12.8
Glenmark 300 NC 15.2 18.6 22.9 22.9 19.8 16.2 13.1 3.2 2.8 2.3 11.8 10.7 8.8
Torrent pharma 592 BUY 35.1 42.6 54.5 24.6 16.8 13.9 10.9 2.2 1.8 1.5 11.6 9.4 7.3
IPCA 310 NC 17.2 22.0 29.0 29.9 18.1 14.1 10.7 2.2 1.8 1.5 11.1 8.9 7.3
Aurobindo 195 BUY 19.7 22.5 27.8 18.7 9.9 8.7 7.0 1.8 1.5 1.2 7.5 6.8 5.5
Unichem 191 NC 13.1 15.2 19.8 23.0 14.6 12.5 9.7 2.0 1.7 1.3 9.6 8.2 6.3
Mid-cap 15.8 13.1 10.3 2.3 1.9 1.6 10.3 8.8 7.1
Note: * PE multiple for Dr Reddy’s, Sun Pharma. and Ranbaxy is based on CMP adjusted for NPV of one-off exclusivity sales
Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Key Risks

„ High field force attrition could dent growth and profitability


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

Chart 31: Higher attrition rates across the board

<10%

10-15%

>30%

15-30%

Source: Edelweiss research

We have identified three key reasons behind higher attrition: (a) increase in demand for
medical representatives and limited supply of talent pool with companies competing for
high quality people; (b) setting up challenging field force targets with mandate to
aggressively capture market share; and (c) shift to other sectors like IT and financial
services for better incentives and growth.

Sun pharma, Lupin, and Torrent have been ranked by distributors as companies
possessing highly effective and stable field force, while Cadila, IPCA, GSK, and Cipla are
companies facing higher attrition.

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Edel Pulse: Pharmaceuticals

Chart 32: Companies with poor field force stability


100.0

80.0

(% of distributors)
60.0

40.0

20.0

0.0

Ranbaxy

Reddy's

IPCA
Unichem
Cipla

Cadila
FDC

Dr
Source: Edelweiss research

„ Rise in fixed costs and higher competition to impact domestic margins


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

Rural penetration requires higher investment


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

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

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Edel Pulse: Pharmaceuticals

Chart 33: MNC growth has improved over past few months
35.0

28.0

(% Y-o-Y)
21.0

14.0

7.0

0.0
Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11
Aventis Pfizer GSK
Source: AIOCD, Edelweiss research

Table 9: Emerging competition from new players


Market share (%) Rank Growth Y-o-Y (%)
2010 2011 2010 2011 2010 2011
Mankind 2.87 3.21 7 7 22.5 28.7
Alkem 2.82 2.96 8 9 16.3 21.0
Macleods 1.69 1.98 17 15 35.8 34.4
Eris Life Sciences 0.24 0.40 75 58 146.0 93.4
Source: AIOCD, Edelweiss research

„ Decline in success rate of new product introductions


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

„ Potential expansion of controlled pricing list to impact profitability


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

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Edel Pulse: Pharmaceuticals

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

Chart 1: USD 55 bn industry by 2020

80
CAGR ~17% 70
70

60 CAGR ~14.5% 55

50
CAGR
40 ~10%
35

30

20 12.6
10

0
2009 Pessimistic case Base case Aggressive case
(2020) (2020) (2020)

Source: McKinsey, Edelweiss research

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

1 US 1 US US 9%

2 Japan 2 Japan
China 11%
3 France 3 France

4 Germany 4 Germany India 13%

5 Italy 5 China
France 4%
6 UK 6 UK

7 Spain 7 Italy Japan 2%

8 China 8 Spain
UK 5%
9 Canada 9 Canada

10 Mexico 10 India Canada 7%

11 Brazil 11 Brazil
8%
Brazil
12 South Korea 12 Mexico
13 13 South 2%
Turkey Germany
Korea
14 India 14 Turkey

Source: McKinsey, Edelweiss research

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Edel Pulse: Pharmaceuticals

Key driver of growth in pharma industry (PULL factors)

Aging population and increased prevalence of chronic diseases:

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

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

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

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

100 75

60
80
45

30
60
(%)

15
40 0
CHD Diabetes Asthma Obesity Cancer
20 Prevalence of disease areas (%)

0
2000 2005 2010 2015 2020 2025 2030 5.0 3.8 2.8 2.8 0.2

0-14 15-59 60+ years 65+ years


2005 2010 2020

Source: Industry, Edelweiss research

Rising income level and increased awareness:

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

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

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

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Edel Pulse: Pharmaceuticals

Chart 5: India has low /capita inc. (USD) Affordability drives growth Health spend has high beta on income
100% 30.0
Brazil 690
80% 24.0

Russia 613
60% 18.0

(%)
Thailand 40% 12.0
346

20% 6.0
China 148
0%
0.0
FY06 FY10 FY20
India 50 (P) 1960 1970 1980 1990 2000 2010

Deprived Consuming Elite Health Food

Source: Industry, Edelweiss research

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

• 20% of distributors believe that rapid penetration of insurance and growing healthcare infrastructure is another factor
driving higher growth in pharma spending.

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

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

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

Chart 6: Growing healthcare infra. Rapid insurance penetration High spending on healthcare by Govt.
50 Growth 12.5
40
CAGR 18%
2
30 10.0
20 22
(USD bn)

10 7.5
8
0
5.0
Large Pvt.
Govt. hospital

Corp. chains
hospitals

Med. Pvt.
hospitals

hospitals

14
Mini

2010 2020
3 2.5
State insurance
RSBY
Growth rate (%)
ESIC
0.0
3 7 5 9 16 Pvt insurance
Govt. employee insurance 2006 2007 2008 2009
2009 2020
Source: Industry, Edelweiss research

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Edel Pulse: Pharmaceuticals

Key driver of growth in pharma industry (PUSH factors)

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


Pricing
4%
New divisions
15%
Field force
expansion
35%

Brand
building
21%

New product
launches
25%
Source: Edelweiss research

Expanding reach to drive penetration-driven growth story

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

• 79% of distributors believe that pace of field force expansion by both Indian as well as MNC pharma companies is
very aggressive. Chart 6:
• 35% of distributors believe that field force expansion is one of the key strategies adopted by pharma companies to
accelerate growth.

Chart 8: Pace of field force expansion

No change in
field force
7%

Normal
14%

High
79%

Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Penetration in rural markets

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

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

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

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

6,000 1,500
CAGR 13% CAGR 25%
4,800 1,200
(USD bn)

(USD bn)
3,600 900

2,400 600

1,200 300

0
0
Rural market
Urban market
2005 2007 2005 2007
Source: McKinsey, Edelweiss research
New product launches

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

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

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

Table 1: Value contribution from new products (>INR 100mn) has increased multi fold
2007 2008 2009 2010
Domestic market (INR bn) 288 329 366 438
No. of new introduction (NI) 4,810 4,285 4,365 4,562
Value of NI (INR bn) 22 22 24 27
Value/ NI (INR mn) 6.0 7.7 8.4 9.6
Contribution to domestic market (%) 7.5 6.6 6.7 6.2
No. of NIs above INR 100 mn 10 10 15 20
Contribution of NIs above INR 100 mn to total NI value (%) 6.2 7.5 12.3 16.1
Value of largest NIs (INR mn) 233 309 521 814
Source: IMS, Edelweiss research

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Edel Pulse: Pharmaceuticals

Focus on building brands

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

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

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

Focus on specialty promotion

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

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

• Pharma companies are carving out separate marketing divisions to monetise growth opportunities in chronic
segments. Chart 8:

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Edel Pulse: Pharmaceuticals

Appendix- II

„ Survey Methodology
Objective of the survey
We conducted an extensive field study by interviewing distributors/stockists, area
managers, and medical representatives across various geographies within India, to gain
comprehensive perspective of the domestic market. This exercise had four primary
objectives:

A) To understand growth in various regions and its sustainability: The first


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

B) To understand drivers of this growth: The second objective was to understand


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

C) To understand growth within segments: The third objective was to understand


growth within various therapeutic areas, shifting focus of market to new therapies
and evolving competition in these segments. Our focus was to identify therapies
growing ahead of the market and companies with niche strong traction in these
therapies.

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

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

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

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Edel Pulse: Pharmaceuticals

We split the domestic market into four zones (North, West, East, and South) and
carefully selected cities in each zone which represent an ideal mix of large market
(metros , tier I), mid-size market (tier II) and smaller markets (tier III and IV) within
each zone. We targeted primarily large and mid size distributors in each of these cities to
get a broader perspective on the market. Our distributor sample has larger retail network
(at least 70-80% of retail chemists coverage within the region), distributorship of at least
20 companies and annual turnover in the INR 50 mn to INR 750 mn range. This ensured
that the survey findings reflect a larger coverage list of companies, which helps minimize
errors.

We also interacted with a few unlisted players, medical representatives, area managers,
and regional heads, with 10-15 years of experience in respective regions, who shared
their perspectives on the market. This helped us dwell into operational models of
companies, commercial approach adopted, and current strategic perspective.

Why distributors?
Distributors also called ‘stockists’, are a key link between manufacturers and consumers.
The domestic drug distribution system is multi-layered where stockists form the first
layer and represent primary sales. They distribute products, based on secondary sales
demand, to various retail chemists, hospitals, medical professionals, and other
consumers. They are also an important link, as they handle inventory in the supply
chain. There is a sub-layer of second level distributors called ‘sub-stockists’ which caters
to a smaller area within a region. The sub-stockists help to expand reach to retailers
which are not catered to by wholesale distributors.

We highlight that distributors are more a organized section of the channel with better
understanding of players in the market and hence, in our view, have a finger on the
pulse of market.

Fig. 1: Domestic distribution channel


Manufacturers

C&F agents/Super stockists

Stokists (65,000)

Sub-stockist

Govt Medical Chemists hospitals


NGO/Others
tenders professionals 5,50,000 (>15,000)

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

Consumers

Source: KPMG

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Edel Pulse: Pharmaceuticals

DISTRIBUTOR SURVEY - Questionnaire

• Name of the distributor :

• No of companies covered :

• List of all companies covered :

• No. of chemists under coverage :

• Total chemists in the area or city :

• Monthly turnover (INR mn) :

• Visiting card :

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Edel Pulse: Pharmaceuticals

END MARKET DEMAND

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

Range Respective coverage region Overall market


<13%
13-15%
>15%
(please mention)

Which factors are driving this growth?


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

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

- Increase no. of healthcare facilities - Rapid product introductions


- Changing lifestyles - Increase in field force
- Increasing health awareness - Focus on brand building
- Government expenditure - Focus on specialty promotion
- Health insurance - Price increases
- Increase in life expectancy - Others

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

Gaining market share Losing market share


Cipla
Sun Pharma
Ranbaxy
Dr Reddy’s
Torrent Pharma
Cadila
Lupin
IPCA
Abbott Piramal
Unichem
Alkem
Intas Pharma
FDC
USV
Glenmark
GSK Pharma
Pfizer
Sanofi – Aventis
Others (Please specify)

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

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Edel Pulse: Pharmaceuticals

THERAPEUTIC AREAS

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

TA Rank in terms of growth (highest Active competition (please tick)


ranked 1 followed by 2, 3 etc.)
Acute
Anti-infectives
Respiratory
Pain management
Gastrointestinal
Chronic
Cardiac
CNS
Anti-Diabetes
Gynecology
Dermatology

PRICING

Are companies taking price increases (Y/N)?

What is the magnitude of price increases?

o <5%

o 5-10%

o >10% (please mention)

What percentage of products depicting price changes (frequency)?

o <15%

o 15-30%

o 30-50%

o >50% (please mention)

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

TA Price increases Pricing pressures


Anti-infectives
Respiratory
Pain management
Gastrointestinal
Cardiac
CNS
Anti-Diabetes
Gynecology
Dermatology
Others (please mention)

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Edel Pulse: Pharmaceuticals

STRATEGIC FOCUS

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

o New product introduction


o Brand building (key promotional strategies)
o Field force expansion
o New divisions
o Others

Do you see change in activity level of MNC players?


o Increase in product introductions
o Increase in field force
o Building channel relations (frequency of visits)

FIELD FORCE EXPANSION

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


o Normal
o Higher
o Not much change in field force

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

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


o Less than 10%
o 10-15%
o 15-30%
o >30% (please mention)

Which companies have more stable and effective field force?

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


Cipla Abbott Piramal
Sun Pharma Mankind
Ranbaxy Alkem
Dr Reddy’s Intas Pharma
Torrent Pharma FDC
Cadila USV
Lupin GSK Pharma
Glenmark Pfizer
Unichem Others
IPCA

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

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Edel Pulse: Pharmaceuticals

NEW PRODUCT INTRODUCTIONs

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

Cipla Unichem
Sun Pharma Alkem
Ranbaxy Intas Pharma
Dr Reddy’s FDC
Torrent Pharma USV
Cadila GSK Pharma
Lupin Pfizer
Abbott Piramal Sanofi – Aventis
Glenmark Others (Please specify)
IPCA

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

Cipla Unichem
Sun Pharma Alkem
Ranbaxy Intas Pharma
Dr Reddy’s FDC
Torrent Pharma USV
Cadila GSK Pharma
Lupin Pfizer
Abbott Piramal Sanofi – Aventis
Glenmark Others (Please specify)
IPCA

Which therapeutic areas you see highest product introduction?

Therapeutic area
Anti-infectives CNS
Respiratory Anti-Diabetes
Pain management Gynecology
Gastrointestinal Dermatology
Cardiac Others (please mention)

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

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Edel Pulse: Pharmaceuticals

TIER-II /IV CITIES

Which are the key areas where you see increase in activity level by companies?

- Rapidly introducing new products


- Increase in field force
- Increase in brand building
- Specialty promotion
- Increase in Number of divisions

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

Cipla Unichem
Sun Pharma Alkem
Ranbaxy Intas Pharma
Dr Reddy’s FDC
Torrent Pharma USV
Cadila GSK Pharma
Lupin Pfizer
IPCA Sanofi – Aventis
Abbott Piramal
Others (Please specify)

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

o Lack of trained pool of field force

o Higher attrition

o Higher investment in training

o Distribution challenges (unorganized)

o Receivables loss

o Capturing market share from local players

o Pricing of products

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SUPPLY CHAIN

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

o <7 days

o 7-15 days

o 15-30 days

o >1 month (please mention no of days)

What is the credit period given by companies?

o <15 days

o 15-30 days

o >1 month (please mention no of days)

What is the magnitude of change in the period (substantial or no change)?

KEY RISKS / CONCERNS

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

o Short term (regulatory and other)

o Long term (regulatory and other)

OTHERS

In your view which companies should potentially do well and why?

Which others companies, excluding your existing list, would you like to add?

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THIS PAGE IS INTENTIONALLY LEFT BLANK

52 Edelweiss Securities Limited


India Equity Research | Pharmaceuticals Initiating Coverage
Edel Pulse: Pharmaceuticals
CADILA HEALTHCARE
Looking for next leap of growth

„ Domestic formulations turnaround: A boon


April 25, 2011
Cadila Healthcare’s (CDH) renewed focus on the chronic segment and expansion
in field force over the past two years (22%) has improved its revenue traction in
Reuters: COKI.BO Bloomberg: CDH IN
the domestic market. Revenues have grown a robust 17% Y-o-Y (9mFY11), in
line with the industry, viz-a-viz relative underperformance over FY07-10 (11.6%
EDELWEISS 4D RATINGS
CAGR). CDH is through with restructuring phase and is set to grow in tandem
Absolute Rating BUY
with industry. This growth will be more inclusive with strong traction from tier-
Rating Relative to Sector Outperformer
II/IV markets, as depicted through our distributor survey. Further, recent tie-up
Risk Rating Relative to Sector Medium
with Bayer Schering (Bayer) secures its future product pipeline.
Sector Relative to Market Equalweight

Note:
„ US generics gearing for more profitable growth Please refer last page of the report for rating explanation

CDH has build USD 200 mn solid franchise (80% CAGR in FY06-11) in US on the
back of higher focus on quality and services. Its recent filings focus on niche or MARKET DATA
limited competition products (including Para IVs), encompass USD 160-180 bn CMP INR 844
:
innovator market, which supports next leg of growth. CDH has three Para IVs 52-week range (INR) 941 / 542
:
opportunities in its pipeline, which offer decent upsides over next two-three years, Share in issue (mn) 204.7
:
in our view. These products also offer higher margin than current plain-vanilla M cap (INR bn/USD mn) 172.7 / 3,891.5
:
generic portfolio. We expect CDH’s US sales to post 22% CAGR over FY11-13E. Avg. Daily Vol. BSE/NSE (‘000) : 110.4

SHARE HOLDING PATTERN (%)


„ Higher return on investment through JVs/partnerships
Promoters* : 74.8
CDH has been exceptionally successful in establishing highly profitable JVs with
MFs, FIs & Banks : 13.3
global pharma majors. With modest investment of USD 13 mn, it has attained
cumulative profits of USD 100 mn and USD 13 mn from Nycomed and Hospira FIIs : 5.4

JVs (18 mths), respectively. We expect sales from the Hospira JV to ramp-up to Others : 6.5

INR 3.5-4.0 bn at peak capacity utilisation by FY13E, with PAT contribution of * Promoters pledged shares
: Nil
(% of share in issue)
INR 875 mn to INR 1 bn (CDH’s share). The incremental earnings from Hospira
PRICE PERFORMANCE (%)
JV will offset lower earnings from Nycomed, with genericisation of Pantoprazole.
Stock Nifty EW Pharma
Index

„ Outlook and valuations: Strong execution; initiating coverage with ‘BUY’ 1 month 13.6 8.9 5.5

CDH’s one-year forward P/E has expanded from 9x to 17x, driven by consistent 3 months 1.2 2.5 (7.0)

outperformance and strong execution across markets. However, it still trades at 12 months 48.4 11.9 18.0
10% discount to larger peers. We note that CDH’s medium-term earnings growth
(29% CAGR over FY10-13E) is best among peers and its long-term vision to
attain USD 3 bn supports downside risks to valuation. We, thus, value the stock
at 19x FY13E EPS (TP INR 960) and expect gap to narrow down with larger
peers. We initiate coverage on CDH with ‘BUY/Sector Outperformer’.
Financials
Year to March FY10 FY11E FY12E FY13E
Revenues (INR mn) 36,580 44,991 54,932 65,929
Rev growth (%) 25.0 23.0 22.1 20.0
EBITDA (INR mn) 7,798 9,856 12,289 15,001 Manoj Garg
Adj. net profit (INR mn) 4,808 6,462 8,319 10,345 +91 22 6623 3302
Shares outstanding (mn) 204.7 204.7 204.7 204.7 manoj.garg@edelcap.com
Adj. Diluted EPS (INR) 23.5 31.6 40.6 50.5
EPS growth (%) 51.0 34.4 28.7 24.4 Peril Ali
P/E (x) 35.9 26.7 20.8 16.7 +91 22 6620 3032
EV/EBITDA (x) 23.3 18.2 14.3 11.4 perin.ali@edelcap.com
ROAE (%) 34.2 33.3 32.6 31.2

Edelweiss Research is also available on www.edelresearch.com,, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities
EdelweissLimited 53
Securities Limited
Edel Pulse: Pharmaceuticals

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

Table 1: Domestic formulations to ramp-up over FY10-13E, in line with industry (INR mn)
FY07 FY10 CAGR (%) FY11E FY12E FY13E CAGR (%)
Domestic formlations 10,602 14,458 10.9 16,511 19,001 21,899 14.8
Branded generics 9,790 13,625 11.6 15,587 17,974 20,760 15.1
Generic-generics 812 833 0.9 925 1,026 1,139 11.0
Source: Company, Edelweiss research

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

Chart 1: Revival in domestic growth momentum


25.0
Domestic business growing in
line with industry
20.0 18.6
17.1 17.3 16.6
(Growth %)

15.0 13.2 13.2


11.8
9.9
10.0 8.6 8.4

4.8
5.0

0.0
Q1'09

Q2'09

Q3'09

Q4'09

Q1'10

Q2'10

Q3'10

Q4'10

Q1'11

Q2'11

Q3'11

Source: Company, Edelweiss research

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

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Edel Pulse: Pharmaceuticals

Chart 2: Domestic business geared up for higher growth


5,000 6.0

Sales per rep (INR mn)


4,300 4.8

(No of medical reps)


3,600 3.6

2,900 2.4

2,200 1.2

1,500 0.0
FY06 FY07 FY08 FY09 FY10 FY11
(YTD)
Field force Productivity
Source: Company, Edelweiss research

Tie-up with Bayer improves future product pipeline for domestic market
CDH has formed a 50:50 JV with Bayer Schering (Bayer), Germany, where both partners
will shift some of their existing products to the JV. Bayer will further add future potential
off-patented/patented drugs that will be supplied through CDH’s distribution network.
The JV is likely to commence operation from H2 FY12. While the company has not
disclosed the detailed functioning of the JV, its focus is likely to be largely on CVS,
diabetes, women’s healthcare, oncology and diagnostic segments.

We view this development as win-win for both partners. Through this JV, CDH can access
Bayer’s strong domestic portfolio for diabetes (where CDH currently does not have much
presence) and also its future pipeline (Bayer’s key late stage pipelines are in oncology,
CVS and CNS). Bayer, on the other hand, could capitalise on CDH’s strong distribution
and reach.

„ US generics gearing up for profitable and robust growth


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

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Edel Pulse: Pharmaceuticals

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


10,000 200

8,000 160

(USD mn)
6,000 120
Built-up franchise of USD 200

(%)
mn over six years in US

4,000 80

2,000 40

0 0
FY06 FY07 FY08 FY09 FY10 FY11
Revenue Growth
Source: Company, Edelweiss research

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

Gearing for the next leg of growth


CDH’s long-term strategy largely focuses on niche and limited competition products. The
company has ramped up its ANDA filing in niche segments, including Para IVs and has a
pending pipeline of 59 ANDAs with 12-15 new filings each year. These filings consist of
differentiated and difficult-to-formulate products, including those in the respiratory
Niche pipeline will drive next segment (seven ANDAs filed; market opportunity of USD 20 bn) and injectibles (15 filed;
leg of growth in US market opportunity of USD 17 bn). Moreover, the company is also focused on different
delivery systems such as transdermal patches and has planned to file seven ANDAs (USD
3 bn opportunity) over the next 3-4 months. Other segments where CDH has increased
its focus are: oncology (USD 55 bn opportunity), bio-similars (USD 40 bn opportunity)
and vaccines (USD 22 bn opportunity). Collectively, these initiatives target USD 160-180
bn market and could be long-term growth drivers.

Over the near term, we expect CDH to launch 10-12 products each year, driving 22-25%
growth over FY13E. Moreover, we expect CDH to also monetise its Para IV/limited
competition products opportunities such as Astelin (USD 100 mn opportunity), Prevacid-
ODT (limited competition product with sales of USD 400 mn with expiry in September
2012) and Lialda (USD 291 mn opportunity; FTF; expiry in October 2012) over the next
two years. While we have build INR 276 mn and INR 473 mn of sales from Astelin in our
FY12 and FY13 estimates, respectively (expect CDH to launch the product in Q2FY12),
we currently do not factor any upside from Prevacid ODT and Lialda due to lack of
clarity. However, successful launch of these could provide decent upsides to our FY13
estimates.

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Edel Pulse: Pharmaceuticals

Table 2: US generics to benefit from Para IV pipeline


US Revenue Patent Cadila's
Brand Generic name Innovator Para IV Remarks
(USD mn) expiry potential launch
Astelin Azelastine Meda 100 May'2011 May'2011 N Apotex and Cobalt have already
launched the products through
settlement with innovator; Cadila
will be third company

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

Lialda Mesalamine Shire 291 June'2020 Nov'2012 Y

Source: Company, Edelweiss research

„ Unlocking value through alliances


CDH is one of the few Indian companies to have formed most successful and profitable
JVs with global pharma majors. The company formed its first JV with Altana (later on
Created most successful and acquired by Nycomed) to supply two key intermediates of Pantaprazole (Altana was the
profitable JV innovator) for its global supply. The company has initially invested USD 2 mn in the JV in
1997, and has made over USD 100 mn profit over the past nine years (JV started
supplying Pantaprazole intermediates from 2003). However, going forward, owing to
patent expiry and generic launch of Pantoprazole, we expect lower revenue and profits
from JV. This is despite the fact that the JV has added 14 incremental APIs, supplies for
which are likely to start from H2FY12. These APIs include all genericised products and,
hence, will have lower margins, in our view.

CDH entered into a second JV with Mayne (later on acquired by Hospira) in 2005 to
manufacture and supply six oncology products for global markets, with an initial
investment of USD 11 mn (CDH’s contribution to total USD 22 mn investment). Supplies
to Hospira have started from Q1FY10 and in less than two years (18 months), CDH has
recouped its initial investment and made a profit of INR 602 mn (USD 13 mn), while the
JV is yet to reach its full potential.

Hospira JV to ramp-up with supplies of Taxotere and Gemzar in US


We expect Hospira JV’s revenue to ramp-up after it starts supplying generic Taxotere
and generic Gemzar to JV partner in the US (Q4FY11 onwards). YTD, the JV was
supplying three products to Hospira for the EU markets (9mFY11 revenue of INR 818
mn), with relatively smaller batches of generic Taxotere in the US. However, with recent
launch of Taxotere in the US (launched in March 2011, with Hospira as the only generic
player in the USD 1.2 bn innovator market), we expect significant revenue growth over
the next few quarters. We highlight that Hospira is the largest generic player in EU for
Taxotere, and we expect it to garner a large market share even in the US, since the
product is similar to originator (single vial injection) unlike other players such as Sun
Pharma, Sandoz, and Apotex that have a two-vial product.

Overall, we expect the JV to reach peak level by FY13 with potential sales of INR 3.5-4.0
bn (CDH’s share) and 25-30% sustainable PAT margins. We estimate INR 875 mn to INR
1 bn recurring PAT per annum from the JV for CDH.

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Edel Pulse: Pharmaceuticals

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


4,000

3,200

2,400

(INR mn)
1,600

800

0
FY10 FY11 FY12E FY13E
Revenue PAT
Source: Company, Edelweiss research
We believe that incremental earnings from Hospira JV will offset lower profitability of
Nycomed JV and will be highly accretive to CDH’s overall earnings.

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


900

720

540
(INR mn)

360

180

0
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11
Nycomed - PAT Hospira -PAT
Source: Company, Edelweiss research

„ Strategic alliance with Abbott to add growth momentum in emerging markets


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

58 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

„ Bold vision to attain USD 3 bn in FY16 from USD 1 bn in FY11


After attaining a billion-dollar revenue target in FY11E, CDH has set a milestone of USD 3
bn revenue by 2016 (25% CAGR over FY11-16). Although management has not shared
Cadila is aiming to become
details of its five-year strategic plan, the past track record and management
USD 3 bn company by 2016
commitment to execute guidance gives some surety of achieving the set target. We
believe the growth will be multipronged, encompassing all segments including US, India,
Brazil and partnerships.

We try to summarize key growth drivers with focus on achieving the said objective.
First, the company’s investment in niche segments for US generics such as transdermal
patch, oncology, vaccines and pulmonary products, which have a market potential of
over USD 160-180 bn, will be highly accretive over next three to four years. Few of
these products are already off-patent and others still under patent. The company is also
developing new drug delivery system for some of these products to file them under 505
(b) 2 routes to enjoy exclusivity. The second driver is CDH’s focus on new drug
discovery research, to become a global research-driven company in the long term. The
company has been increasing its R&D expenditure over the years and currently has 12
molecules (including two from partners) in the pipeline addressing the therapeutic areas
of metabolic disorders (diabetes, obesity and dyslipidemia) and inflammation.

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


P ro je c t T a rge t Indic a t io n D rug Le a d P re c linic a l IN D P ha s e I P ha s e II P ha s e II NDA

dis c o v e ry o pt im is a t io n de v e lo pm e nt
P P A R alpha:
ZYH1 Dyslipidemia
gamma
M ulti-
ZY11 P ain
mo del
CB -1 Obesity,
ZY01
antago nist Diabetes
P P A R alpha:
ZYH2 Diabetes
gamma
PPAR
ZYH7 Dystipldemie
alpha
TR beta
ZYT1 Dystipldemie
ago nist
GLP -1
ZYD1 Diabetes
ago nist
GLP -1
Diabetes
ago nist

ZYOG1 Undisclo sed Diabetes

A thero sctero tic


Undisclo sed
P laque
Co llabo rative Selective GR
Inflammatio n With Karo Bio
pro gram ago nist
Co llabo rative
Undisclo sed CVS With EII Lilly
pro gram
Source: Company

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

Edelweiss Securities Limited 59


Edel Pulse: Pharmaceuticals

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


1,400

1,120

(INR mn)
840

560

280

0
FY06 FY07 FY08 FY09 FY10
NCE Research Generic Markets API & Others
Source: Company, Edelweiss research

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

60 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Valuation

„ Valuations: Re-rating driven by strong execution; initiating coverage with ‘BUY’


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

Chart 8: Historical valuation trend—one year forward P/E


1,200

20x
960

15x
720
(INR)

10x
480

240 5x

0
Oct-06

Oct-07

Oct-08

Oct-09

Oct-10
Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Source: Edelweiss research

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

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


FY08 FY09 FY10 FY11E FY12E FY13E
Basic R&D 516 465 598 670 818 1,001
% of total R&D 38.6 29.7 36.0 30.0 30.0 30.0

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


Ex NCE R&D valuations PBT (pre R&D) 3,748 4,076 6,637 9,102 11,168 14,177
become more attractive PAT (pre R&D) 3,037 3,324 5,823 7,736 9,382 11,625
Eps (reported) 12.9 15.6 23.5 31.6 40.6 50.4
EPS (pre R&D) 14.8 16.2 28.4 37.8 45.8 56.8

PE (EPS rep) 65.5 54.3 36.0 26.8 20.8 16.8


PE (EPS pre R&D) 57.0 52.0 29.7 22.4 18.4 14.9
Source: Edelweiss research

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

Edelweiss Securities Limited 61


Edel Pulse: Pharmaceuticals

Key Risks

„ Re-structuring in domestic formulation impacted historical performance


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

Chart 9: Historical execution poses risk to growth outlook


30.0

24.0

18.0
(%)

12.0

6.0

0.0
Lupin Sun Dr Reddy's Cipla Ranbaxy Industry Cadila
Pharma

Source: Company, Edelweiss research

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

Table 4: Top 10 brand performance


Market Growth Contrbution to
Brands Therapy % of total
share rate growth
ATEN Chronic 4.5 56.0 12 3.7
DERIPHYLLIN Chronic 3.4 90.4 4 1.0
ATORVA Chronic 3.2 10.3 17 3.5
FALCIGO Acute 3.1 54.2 (5) (1.2)
PANTODAC Acute 2.9 16.2 15 2.9
OCID Acute 2.8 26.5 8 1.6
MIFEGEST KIT Acute 2.3 18.9 2,866 16.8
PRIMOLUT N Acute 2.1 46.7 7 1.1
DEXONA Acute 2.0 42.8 21 2.8
AMLODAC Chronic 1.9 15.0 6 0.9
Total 28.3 33.1
Source: Company, Edelweiss research

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

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Edel Pulse: Pharmaceuticals

width of coverage. However, given its historical underperformance, we remain cautious


and build a normal industry level growth scenario for FY12 and FY13. We highlight that
incremental upsides from higher field force productivity (post expansion) and profitable
product pipeline (from Bayer JV) could be an upside risk to the overall company’s growth
and earnings estimates.

„ Delay in ANDA approval from US FDA


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

„ Lower scale-up from Hospira JV


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

„ Currency appreciation could hit profitability


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

Edelweiss Securities Limited 63


Edel Pulse: Pharmaceuticals

Company Description

CDH, founded in 1952 and headed by second generation entrepreneur Pankaj R Patel, is the
sixth largest company in Indian pharma market with 3.9% market share. The domestic
franchise, with widespread field force (4,500) and pan-India presence, constitute 35-40% of
total sales. The chronic segment accounts for 26% of total domestic business with largest
contribution from cardio vascular therapy (CVS), where CDH has leading market share
(6.1%) after Sun Pharma and Ranbaxy. Apart from prescription products, CDH has built a
formidable presence in nutraceuticals through its listed entity Zydus Wellness (owns 72% of
total share holding).

CDH has successfully build its international operations, with presence in branded generics
emerging markets of Brazil, Asia-Pac and Africa and plain generics regulated markets of US,
EU and Japan, which together account for 39% of CDH’s total business. Moreover,
management’s strategic focus on building strong partnerships in the US through Hospira and
Nycomed JVs has been significantly accretive to business over the past five years.

Chart 10: Revenue mix Chart 11: Export formulations mix


Other
JVs Others emerging
5% 3% markets
APIs 11%
8%
India Brazil
formulations 12%
37%

Japan US
3% generics
53%

Export Europe
formulations (France/
India Spain)
39%
consumer 21%
8%

Source: Company, Edelweiss research

Chart 12: Current shareholding pattern


Retail and
others
Institutions and 7%
FIs
13%

FIIs
5%

Promoters
75%

Source: NSE

64 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Domestic Formulation Snapshot


Growth versus industry (%)
Mar 2011 (Month) MAT (Mar-11)
CAGR (5yr)
Incl bonus Excl bonus Incl bonus Excl bonus
Company growth 26.5 20.7 16.6 14.6 11.6
Industry growth 13.8 13.1 15.0 14.3 14.4
Relative performance

Therapeutic growth versus industry (MAT) (%) Top 10 brand performance (%)
% of Market Cadila Industry Contrbution % of Market Growth Contrbution
Therapeutic area Brands Therapy
total share growth Growth to growth total share rate to growth
Cardiovasculars 20 6.0 14.2 16.5 19.3 ATEN Chronic 4.5 56.0 12 3.7

Gastrointestinal 17 6.2 16.0 14.1 17.9 DERIPHYLLIN Chronic 3.4 90.4 4 1.0
ATORVA Chronic 3.2 10.3 17 3.5
Respiratory 10 4.8 19.5 14.5 11.5
FALCIGO Acute 3.1 54.2 (5) (1.2)
Gyneacology 10 11.2 31.1 21.9 19.9
PANTODAC Acute 2.9 16.2 15 2.9
Anti-infectives 11 1.6 0.0 13.4 0.0
OCID Acute 2.8 26.5 8 1.6
Pain 7 3.9 16.1 13.8 6.1
t MIFEGEST KIT Acute 2.3 18.9 2,866 16.8
Neurologicals 3 2.6 12.8 14.1 3.8
PRIMOLUT N Acute 2.1 46.7 7 1.1
Dermatology 3 1.8 52.0 14.4 5.8
DEXONA Acute 2.0 42.8 21 2.8
Anti diabetic 1 0.8 10.9 21.0 0.8 AMLODAC Chronic 1.9 15.0 6 0.9
Chronic contribution to growth 35.4 Total 28.3 33.1

Therapy wise break-up Field force expansion and productivity


5,000 6.0
Diagnostics Others Cardiovascul Chronic
Nutraceutica 11%
2% ars 33% CAGR (3%)

Sales per rep (INR mn)


ls 4,300 4.8
(No of medical reps)

2% 20%
Biologicals 3,600 3.6
CNS
4%
3%
2,900 2.4
Pain mgmt. Respiratory
7% 2,200 1.2
10%
Dermatology 1,500 0.0
Gastrointesti 3%
nal Anti- FY06 FY07 FY08 FY09 FY10 FY11
17% infectives Gyneacology (YTD)
11% 10% Field force Productivity

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


18.0 17% 35 35
(Industry growth)

15% 28 28
14.4
Sales (INR bn)

8 21 21
6
10.8 14 14
(%)

2 3 7 7
7.2
0 0
3.6 7 6
Ranbaxy

Sun pharma

Mankind
Cadila
GSK

Pfizer
Lupin
Cipla

Dr Reddy's
Piramal

0.0
Cadila Industry
Volume Price New product introductions
Source: AIOCD, Edelweiss research

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Edel Pulse: Pharmaceuticals

Financial Outlook

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

Overall, robust sales growth coupled with strong operating performance will lead to 29%
earnings growth over FY10-13E. Moreover, strong operating performance will also lead
to its ROCE catapulting from 26% in FY10 to 38% in FY13E.

Table 5: Revenue break-up (INR mn)


CAGR
FY10 FY11E % Y-o-Y FY12E FY13E
(FY10-13E)
Domestic formulation 14,458 16,511 14.2 18,943 21,802 14.7
Consumer/OTC 2,675 3,478 30.0 4,277 5,176 24.6
Animal health 1,191 1,274 7.0 1,351 1,432 6.3
Export formulation 13,179 17,573 33.3 21,694 26,062 25.5
US generics 6,715 9,401 40.0 11,665 14,051 27.9
Europe (France/Spain) 2,740 3,699 35.0 4,624 5,549 26.5
Japan 316 474 50.0 711 995 46.6
Brazil 1,818 2,091 15.0 2,404 2,765 15.0
Other emerging markets 1,590 1,908 20.0 2,290 2,702 19.3
JVs 1,597 2,168 35.8 3,897 5,846 54.1
Nycomed 758 568 (25.0) 597 686 (3.3)
Hospira 839 1,600 90.7 2,400 3,360 58.8
Abbott alliance 900 1,800
API 3,043 3,561 17.0 4,266 5,050 18.4
Domestic 321 289 (10.0) 275 261 (6.7)
Others 2,721 3,271 20.2 3,991 4,789 20.7
Total gross sales 36,142 44,564 23.3 54,427 65,367 21.8
Source: Edelweiss research

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


FY09 FY10 FY11E FY12E FY13E
C OGS 33.4 33.0 32.6 32.6 32.8
R&D 5.5 4.6 5.1 5.1 5.2
Employee costs 10.9 11.0 10.7 10.5 10.5
Other fixed costs 31.4 31.9 31.3 30.9 30.2
EBITDA (excl other op income) 18.9 19.5 20.3 20.9 21.4
EBITDA 20.7 21.3 21.9 22.4 22.7
Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Chart 13: ROCE likely to expand from 26% in FY10 to 38% n FY13E
40.0 38
34

32.0 31

26

24.0

(%)
16.0

8.0

0.0
FY10 FY11E FY12E FY13E

Source: Edelweiss research

Edelweiss Securities Limited 67


Edel Pulse: Pharmaceuticals

Financial Statements

Income statement (INR Mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Income from operations 29,275 36,580 44,991 54,932 65,929
Net revenues 28,624 35,741 44,090 53,937 64,831
Other operating income 651 839 901 995 1,098
Total operating expenses 23,217 28,782 35,135 42,643 50,928
Materials cost 9,566 11,784 14,383 17,607 21,238
Employee cost 3,109 3,930 4,716 5,659 6,791
R&D cost 1,564 1,660 2,234 2,731 3,341
Selling, admin and general exp. 7,322 9,172 11,067 13,484 15,884
Other expenses 1,656 2,236 2,736 3,161 3,674
EBITDA 6,058 7,798 9,856 12,289 15,001
Depreciation and amortisation 1,118 1,339 1,312 1,490 1,656
EBIT 4,940 6,459 8,544 10,798 13,345
Net interest expense/(income) 1,205 821 705 544 289
Other income 116 158 142 115 153
Profit before tax (excl extraord.) 3,851 5,796 7,981 10,369 13,209
Provision for tax 666 741 1,265 1,659 2,378
Core profit 3,185 5,055 6,716 8,710 10,831
Extraordinary items (241) 243 451 - -
Reported profit after tax 2,944 5,298 7,167 8,710 10,831
Minority interest & others 1 247 322 391 487
Adjusted Profit after minority int. 3,184 4,808 6,462 8,319 10,345
Equity shares outstanding (mn) 205 205 205 205 205
EPS (INR) basic 15.55 23.49 31.24 40.64 50.54
Diluted shares (mn) 205 205 205 205 205
EPS (INR) adjusted 15.6 23.5 31.6 40.6 50.5
CEPS (INR) 21.0 30.0 37.6 47.9 58.6
Dividend per share (INR) 4.5 5.0 5.0 6.5 8.0
Dividend payout (%) 28.9 21.3 15.8 16.0 15.8

Common size metrics- as % of net revenues


Year to March FY09 FY10 FY11E FY12E FY13E
Cost of revenues 32.7 32.2 32.0 32.1 32.2
Employee cost 10.6 10.7 10.5 10.3 10.3
Selling, admin and general exp. 25.0 25.1 24.6 24.5 24.1
R & D cost 5.3 4.5 5.0 5.0 5.1
Total operating expenses 79.3 78.7 78.1 77.6 77.2
Depreciation and Amortisation 3.8 3.7 2.9 2.7 2.5
Interest expenditure 4.1 2.2 1.6 1.0 0.4
EBITDA margins 20.7 21.3 21.9 22.4 22.8
Net profit margins 11.1 14.1 15.2 16.1 16.7

Growth metrics (%)


Year to March FY09 FY10 FY11E FY12E FY13E
Revenues 26.1 25.0 23.0 22.1 20.0
EBITDA 32.7 28.7 26.4 24.7 22.1
Net profit 18.5 58.7 32.9 29.7 24.4
PBT 16.7 50.5 37.7 29.9 27.4
Adj. EPS 20.5 51.0 34.4 28.7 24.4

68 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Balance sheet (INR Mn)


As on 31st March FY09 FY10 FY11E FY12E FY13E
Equity capital 682 682 1,024 1,024 1,024
Reserves & surplus 11,670 15,603 21,250 28,012 36,440
Total shareholders Funds 12,352 16,285 22,274 29,036 37,464
Borrowings 12,673 10,905 7,905 4,905 1,905
Deferred tax liability (net) 1,316 1,141 1,141 1,141 1,141
Minority interest 228 392 714 1,105 1,592
Sources of funds 26,569 28,723 32,034 36,187 42,102
Gross block 22,870 25,578 29,328 33,078 36,571
Depreciation 7,571 8,733 10,046 11,536 13,192
Net block 15,299 16,845 19,282 21,542 23,378
Capital WIP 1,889 2,482 2,482 2,482 2,482
Investments 249 207 750 1,250 1,750
Inventories 6,012 7,504 8,799 10,760 12,925
Sundry debtors 4,549 4,668 5,753 7,035 8,451
Cash and bank balances 2,517 2,507 1,700 1,467 3,281
Loans and advances 2,533 3,070 3,249 3,973 4,772
Total current assets 15,611 17,749 19,502 23,234 29,430
Sundry creditors 5,256 6,146 7,446 9,104 10,937
Other current liabilities 474 564 812 993 1,193
Provisions 1,186 1,951 1,825 2,325 2,909
Total current liabilities and provisions 6,916 8,661 10,083 12,422 15,039
Net current assets 8,695 9,088 9,419 10,812 14,390
Miscellaneous expenditure 438 102 102 102 102
Uses of funds 26,569 28,723 32,034 36,187 42,102
Book value per share ( INR) 58 79 108 141 183

Free cash flow (INR Mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Net profit 3,184 4,808 6,462 8,319 10,345
Depreciation 1,118 1,339 1,312 1,490 1,656
Others (2,020) (499) (1,570) (2,862) (3,042)
Gross cash flow 2,282 5,648 6,204 6,947 8,958
Less: Changes in WC 932 403 1,138 1,627 1,764
Operating cash flow 3,214 6,051 7,341 8,574 10,723
Less: Capex (4,305) (3,478) (3,749) (3,750) (3,493)
Free cash flow (1,091) 2,573 3,592 4,824 7,230

Cash flow metrices


Year to March FY09 FY10 FY11E FY12E FY13E
Operating cash flow 3,214 6,051 7,341 8,574 10,723
Financing cash flow 3,083 (2,886) (3,856) (4,557) (4,916)
Investing cash flow (4,300) (3,436) (4,292) (4,250) (3,993)
Net cash flow 1,997 (271) (807) (233) 1,814
Capex (4,305) (3,478) (3,749) (3,750) (3,493)
Dividends paid (1,483) (408) (462) (1,302) (1,302)

Edelweiss Securities Limited 69


Edel Pulse: Pharmaceuticals

Profitability and liquidity ratios


Year to March FY09 FY10 FY11E FY12E FY13E
ROAE (%) 28.3 34.2 33.3 32.6 31.2
ROACE (%) 22.9 25.9 30.7 34.3 37.8
Inventory days 202 206 204 200 201
Debtors days 50 45 42 42 42
Payable days 167 174 170 169 170
Cash conversion cycles 85 78 76 73 73
Current ratio 2.3 2.0 1.9 1.9 2.0
Debt/ EBITDA 2.1 1.4 0.8 0.4 0.1
Debt/equity 1.0 0.7 0.4 0.2 0.1
Adjusted debt/Equity 1.0 0.7 0.4 0.2 0.1

Operating ratios (x)


Year to March FY09 FY10 FY11E FY12E FY13E
Total asset turnover 1.2 1.3 1.5 1.6 1.7
Fixed asset turnover 2.1 2.2 2.4 2.6 2.9
Equity turnover 2.5 2.5 2.3 2.1 1.9

Du pont analysis
Year to March FY09 FY10 FY11E FY12E FY13E
NP margin 11.1 13.5 14.5 15.4 16.0
Total assets turnover 1.2 1.3 1.5 1.6 1.7
Leverage multiplier 2.1 2.0 1.6 1.3 1.2
ROAE 28.3 34.2 33.3 32.6 31.2

Valuation parameters
Year to March FY09 FY10 FY11E FY12E FY13E
Adjusted EPS (INR) 15.6 23.5 31.6 40.6 50.5
EPS YoY growth (%) 20.5 51.0 34.4 28.7 24.4
CEPS (INR) 21.0 30.0 37.6 47.9 58.6
Diluted PE (x) 54.3 35.9 26.7 20.8 16.7
Price/BV(x) 14.5 10.7 7.8 6.0 4.6
EV/Sales (x) 6.2 5.0 4.0 3.2 2.6
EV/EBITDA (x) 30.2 23.3 18.2 14.3 11.4
Dividend yield (%) 0.5 0.6 0.6 0.8 0.9

70 Edelweiss Securities Limited


India Equity Research | Pharmaceuticals Company Update
Edel Pulse: Pharmaceuticals

CIPLA
Turning around

„ Domestic growth can surprise positively April 25, 2011

Cipla has broadly underperformed the domestic market (13% CAGR versus
Reuters: CIPL.BO Bloomberg: CIPLA IN
industry growth of 14-15%) over the past three years due to decline in its mature
(~20% of domestic) and generic portfolio (20% of total domestic sales declined by
EDELWEISS 4D RATINGS
10-15%), while its focus portfolio was growing ahead of the market (19-20%
Absolute Rating HOLD
growth). We believe the company’s domestic market growth can surprise positively
Rating Relative to Sector Performer
due to higher traction from tier II-IV towns, where it has a strong foothold (as per
Risk Rating Relative to Sector Medium
our survey), while its strategy to address decline in mature and generic-generic
Sector Relative to Market Equalweight
portfolio can give higher upside from a low base.
Note:
Please refer last page of the report for rating explanation

„ Emerging markets lead exports; regulated markets to gain traction


Emerging markets so far have been the key growth drivers for Cipla’s exports; the MARKET DATA
contribution has jumped from 46% in FY07 to 54% in FY10 (24% CAGR), driven CMP : INR 321

by Africa, Middle East, and Australia. We expect regulated markets’ contribution to 52-week range (INR) : 380 / 286

soar with ramp-up in supply contracts as the company will benefit from the patent Share in issue (mn) : 802.9

expiry in US and EU where it is one of the early filers of DMF/ANDA, through M cap (INR bn/USD mn) 257.7 / 5,801.2
:
partners, for some blockbuster drugs. We estimate 17% CAGR for ROW markets. Avg. Daily Vol. BSE/NSE (‘000): 1,625.9

SHARE HOLDING PATTERN (%)


„ Combination inhalers in EU: Key driver of future growth
Promoters* : 36.8
After initial regulatory hurdles in EU, the company has launched single ingredient
MFs, FIs & Banks : 18.7
inhalers in a few EU markets. Cipla has also launched the Seroflo combination
FIIs : 15.4
inhaler (gAdvair) in Russia and South Africa, which instills confidence in its ability
to monetise opportunities in regulated (initially in EU) and ROW markets going Others : 29.1

forward. The combined addressable market (single and combination products) in * Promoters pledged shares
: NIL
(% of share in issue)
ROW/EU is USD 2.3 bn/USD 6 bn. We expect Cipla to get early approvals for ROW
PRICE PERFORMANCE (%)
markets, while launch of combination inhalers in EU will be a long term driver.
Stock Nifty EW Pharma
Index

„ Outlook and valuations: Positive growth catalyst; upgrade to ‘HOLD’ 1 month 9.9 8.9 5.5

We expect Cipla’s revenue (ex-tech income) to post 15% CAGR over FY10-13E, 3 months (8.3) 2.5 (7.0)

driven by growth in India and formulation exports. We believe, with higher growth 12 months (1.3) 11.9 18.0
in the domestic formulation business and lower base effect of licensing income,
EBIDTA margin is likely to expand 160 bps over FY10-13E. We value the company
at 19x FY13E, in line with the industry and set a 12 months price target of INR 350
per share. Hence, we upgrade our recommendation on the stock from ‘REDUCE’ to
‘HOLD’. We rate the stock ‘Sector Performer’ on relative returns basis.
Financials
Year to March FY10 FY11E FY12E FY13E
Revenues (INR mn) 56,057 62,465 71,260 82,819
Rev growth (%) 7.1 11.4 14.1 16.2
Manoj Garg
EBITDA (INR mn) 13,795 13,569 16,128 19,311
Adj Net profit (INR mn) 10,050 9,967 12,195 14,867 +91 22 6623 3302

Shares outstanding (mn) 802.9 802.9 802.9 802.9 manoj.garg@edelcap.com

EPS (INR) 12.5 12.4 15.2 18.5


Peril Ali
EPS growth (%) 3.6 (0.8) 22.4 21.9
+91 22 6620 3032
P/E (x) 25.6 25.9 21.1 17.3
perin.ali@edelcap.com
EV/EBITDA (x) 18.5 18.6 15.5 12.7
ROE (%) 19.6 15.9 17.2 18.4

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Edelweiss Securities Securities Limited
71
Edel Pulse: Pharmaceuticals

Table 1: Financial snapshot (INR mn)


FY10 FY11E % Y-o-Y FY12E % Y-o-Y FY13E % Y-o-Y
Net sales 56,057 62,465 11.4 71,260 14.1 82,819 16.2
- Domestic formulations 25,113 28,536 13.6 32,816 15.0 38,067 16.0
- Export formulations 23,188 26,202 13.0 30,132 15.0 35,707 18.5
- Export bulk 5,802 6,324 9.0 6,893 9.0 7,582 10.0
- Technology fee income 1,538 770 (49.9) 700 (9.1) 600 (14.3)
Gross profit 31,527 34,855 10.6 39,692 13.9 46,130 16.2
Gross margins (%) 56.2 55.8 55.7 55.7
EBITDA 13,795 13,569 (1.6) 16,128 18.9 19,311 19.7
EBITDA margin (%) 24.6 21.7 22.6 23.3
EBITDA margin (Ex milestone) 22.5 20.7 21.9 22.8
PBT 12,311 11,965 (2.8) 14,692 22.8 17,912 21.9
Tax 2,435 1,998 (17.9) 2,498 25.0 3,045 21.9
Tax rate (%) 19.8 16.7 17.0 17.0
Reported PAT 10,826 9,967 (7.9) 12,195 22.4 14,867 21.9
Adjusted PAT 10,050 9,967 (0.8) 12,195 22.4 14,867 21.9
Adjusted EPS 12.5 12.4 (0.8) 15.2 22.4 18.5 21.9
Source: Edelweiss research

Chart 1: Historical valuation trend – One year forward PE


500 25x

400 20x

300 16x
(INR)

12x
200

100

0
Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Source: Edelweiss research

72 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Company Description

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

Chart 2: Revenue mix Chart 3: Export formulation mix


MEA
11%
APIs
10%

North/South Africa
America 42%
Domestic 21%
formulations
47%

ROW
43%

EU
14%
Australia
12%
Source: Edelweiss research

Chart 4: Shareholding pattern

Retail & others


29%
Promoters
37%

FII's
15%
MF & inst
19%
Source: NSE

Edelweiss Securities Limited 73


Edel Pulse: Pharmaceuticals

Domestic Formulations Snapshot

Growth versus industry (%)


Mar 2011 (Month) MAT (Mar-11)
CAGR (5yr)
Incl bonus Excl bonus Incl bonus Excl bonus
Company growth 10.3 8.8 18.8 16.4 14.5
Industry growth 13.8 13.1 15.0 14.3 14.4
Relative performance

Therapeutic growth versus industry (MAT) (%) Top 10 brand performance (%)
% of Market Cipla Industry Contrbution % of Market Growth Contrbution
Therapeutic area Brands Therapy
total share growth Growth to growth total share rate to growth
Respiratory 28 19.2 19.9 14.5 29.1 SEROFLO Chronic 3.8 62.4 18.4 3.7
Anti-infectives 25 7.1 16.1 13.4 22.1 ASTHALIN Chronic 3.2 88.7 19.1 3.3
Gyneacology 13 14.6 29.2 21.9 18.1 MTP KIT Acute 3.1 34.8 246.0 14.0

CVS 12 4.6 14.5 16.5 9.6 NOVAMOX Acute 3.1 32.0 9.7 1.7
FORACORT Chronic 2.9 54.2 34.8 4.8
Gastro-intestinal 8 3.7 14.1 14.1 6.1
AEROCORT Chronic 2.8 100.0 15.1 2.3
Pain mgmt. 2 2.1 11.0 13.8 1.5
MT PILL Acute 2.8 40.0 (4.4) (0.8)
CNS 2 1.8 26.7 14.1 3.1
CIPLOX Acute 2.3 23.2 14.1 1.8
Dermatology 2 1.9 18.3 14.4 1.6
BUDECORT Chronic 2.1 70.6 15.4 1.8
Anti - diabetics 1 0.6 18.7 21.0 0.6 AMLOPRES AT Chronic 1.8 18.6 5.2 0.6
Chronic contribution to growth 42.4 Total 27.9 33.1

Therapy wise break-up Field force expansion and productivity


Others
5,500 6.0
7% CAGR 2.2%

Sales per rep (INR mn)


Respiratory
(No of medical reps)

Anti- 28% 4,700 5.7


Infectives &
pain mgmt. 3,900 5.4
28%
3,100 5.1
CVS Chronic 2,300 4.8
12% 43%
Gastro- CNS 1,500 4.5
intestinal 2%
Anti -
FY11E
FY06

FY07

FY08

FY09

FY10

8% Gyneacology Dermatolog
13% y diabetics
1.6% 0%
Field force Productivity

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


20.0 19% 35

15% 28
16.0 6
Sales (INR bn)

21
12.0 1 6 Industry
(%)

14 growth
8.0 3 7
12
4.0 0
6
Ranbaxy

Cadila
Pharma
GSK

Pfizer
Lupin
Cipla

Reddy's

0.0
Sun

Dr

Cipla Industry
Volume Price New product introductions
Source: AIOCD, Edelweiss research

74 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Key Risks

„ Higher field force attrition poses risk to domestic growth


Cipla has one of the highest attrition among the comparable peers in the domestic
market. Instability is one of the major reasons for subpar performance in the domestic
market.

„ Contingent NPPA liability


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

„ Large contracts could boost exports


Large contracts, especially in ART and to some extent in the swine flu segment, could
have a disproportionate impact on Cipla’s revenues. These contracts are based on
funding programmes that are difficult to predict.

„ Strong growth in export formulation sales


Strong, unanticipated growth in export contracts, especially as only 37 products out of a
product basket of 118 products have been launched in the US. Inhaler opportunity in
Europe could be significant but is contingent on long-pending approvals.

Edelweiss Securities Limited 75


Edel Pulse: Pharmaceuticals

Financial Statements

Income statement (INR mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Income from operations 52,343 56,057 62,465 71,260 82,819
Gross revenues 50,216 54,117 61,062 69,842 81,356
Less: Excise 610 522 571 651 750
Net revenues 49,606 53,595 60,491 69,191 80,607
Other operating income 2,737 2,462 1,973 2,070 2,213
Total operating expenses 39,932 42,262 48,895 55,133 63,509
Materials cost 23,474 24,530 27,609 31,568 36,689
Employee cost 2,714 3,191 4,476 4,843 5,804
R&D cost 2,355 2,507 2,722 3,114 3,627
Selling, admin and general expenses 11,389 12,034 14,088 15,607 17,389
EBITDA 12,411 13,795 13,569 16,128 19,311
Depreciation and amortisation 1,518 1,671 2,401 2,693 2,911
EBIT 10,893 12,125 11,168 13,435 16,399
Interest expense/(income) 378 99 3 3 3
Other income (1,546) 285 800 1,260 1,515
Profit before tax 8,968 12,311 11,965 14,692 17,912
Provision for tax 1,258 2,435 1,998 2,498 3,045
Core profit 9,705 10,050 9,967 12,195 14,867
Extraordinary items - 950 - - -
Reported Profit after minority interest 7,710 10,826 9,967 12,195 14,867
Adjusted PAT after minority interest 9,705 10,050 9,967 12,195 14,867
Equity shares outstanding (mn) 777 803 803 803 803
EPS (INR) basic 12.49 12.52 12.41 15.19 18.52
Diluted shares (mn) 803 803 803 803 803
Adjusted EPS (INR) fully diluted 12.09 12.52 12.41 15.19 18.52
CEPS (INR) 14.4 14.6 15.4 18.5 22.1
Dividend per share (INR) 1.9 2.0 2.8 3.4 4.2
Dividend payout (%) 16.0 16.0 22.5 22.5 22.5

Common size metrics- as % of net revenues


Year to March FY09 FY10 FY11E FY12E FY13E
Cost of revenues 44.8 43.8 44.2 44.3 44.3
Selling, admin and general expenses 21.8 21.5 22.6 21.9 21.0
R & D cost 4.5 4.5 4.4 4.4 4.4
Other expenses 21.8 21.5 22.6 21.9 21.0
Total operating expenses 76.3 75.4 78.3 77.4 76.7
Depreciation and amortisation 2.9 3.0 3.8 3.8 3.5
Interest expenditure 0.7 0.2 0.0 0.0 0.0
EBITDA margins 23.7 24.6 21.7 22.6 23.3
Net profit margins 19.6 18.8 16.5 17.6 18.4

Growth metrics (%)


Year to March FY09 FY10 FY11E FY12E FY13E
Revenues 23.7 7.1 11.4 14.1 16.2
EBITDA 45.5 11.2 (1.6) 18.9 19.7
Net profit 50.4 3.6 (0.8) 22.4 21.9
PBT 7.0 37.3 (2.8) 22.8 21.9
EPS 50.4 3.6 (0.8) 22.4 21.9

76 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Balance sheet (INR mn)


As on 31st March FY09 FY10 FY11E FY12E FY13E
Equity capital 1,555 1,606 1,606 1,606 1,606
Reserves & surplus 41,923 57,500 64,843 73,827 84,780
Common shareholders equity 43,478 59,106 66,449 75,433 86,386
Total Shareholders Funds 43,478 59,106 66,449 75,433 86,386
Borrowings 9,402 51 51 51 51
Deferred tax liability (net) 1,642 1,792 1,792 1,792 1,792
Sources of funds 54,522 60,948 68,291 77,275 88,228
Gross block 26,933 28,973 39,630 43,230 46,347
Depreciation 7,008 8,861 11,262 13,955 16,866
Net block 19,925 20,112 28,368 29,275 29,481
Capital work in progress 3,663 6,842 - - -
Investments 801 2,464 2,464 2,464 2,464
Inventories 13,983 15,126 17,114 19,523 22,690
Sundry debtors 18,529 15,666 17,114 19,523 22,690
Cash and bank balances 534 621 2,785 4,759 9,495
Loans and advances 10,899 11,682 12,850 14,135 15,549
Other current assets 235 578 665 765 879
Total current assets 44,179 43,673 50,527 58,706 71,304
Current liabilities 10,129 9,980 10,153 9,668 10,816
Provisions 3,917 2,164 2,915 3,501 4,205
Total current liabilities and provisions 14,046 12,143 13,068 13,170 15,021
Net current assets 30,133 31,530 37,459 45,536 56,284
Uses of funds 54,522 60,948 68,291 77,275 88,228
Book value per share ( INR) 56 74 83 94 108

Free cash flow (INR mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Net profit 7,710 10,826 9,967 12,195 14,867
Depreciation 1,518 1,671 2,401 2,693 2,911
Others 150 150 - - -
Gross cash flow 9,378 12,647 12,368 14,888 17,778
Less: Changes in WC (5,828) (1,310) (3,765) (6,103) (6,011)
Operating cash flow 3,550 11,337 8,603 8,784 11,767
Less: Capex (6,161) (5,037) (3,815) (3,600) (3,117)
Free cash flow (2,611) 6,300 4,788 5,184 8,650

Cash flow metrices


Year to March FY09 FY10 FY11E FY12E FY13E
Operating cash flow 3,550 11,337 8,603 8,784 11,767
Financing cash flow 2,214 (4,568) (2,624) (3,210) (3,914)
Investing cash flow (6,027) (6,700) (3,815) (3,600) (3,117)
Net cash flow (263) 69 2,164 1,974 4,736
Capex (6,161) (5,037) (3,815) (3,600) (3,117)
Dividends paid (1,819) (1,873) (2,624) (3,210) (3,914)

Edelweiss Securities Limited 77


Edel Pulse: Pharmaceuticals

Profitability and liquidity ratios


Year to March FY09 FY10 FY11E FY12E FY13E
ROAE (%) 24.0 19.6 15.9 17.2 18.4
ROACE (%) 22.4 21.6 18.0 19.1 20.4
Inventory days 195.8 216.6 213.1 211.8 210.0
Debtors days 119.9 116.4 98.9 96.6 95.6
Payable days 146.5 149.6 133.1 114.6 101.9
Cash conversion cycles 169.3 183.4 178.9 193.8 203.7
Current ratio 3 4 4 4 5
Debt/ EBITDA 0.8 0.0 0.0 0.0 0.0
Debt/equity 0.2 0.0 0.0 0.0 0.0
Adjusted debt/Equity 0.2 0.0 0.0 0.0 0.0

Operating ratios (x)


Year to March FY09 FY10 FY11E FY12E FY13E
Total asset turnover 1.00 0.93 0.94 0.95 0.97
Fixed asset turnover 2.72 2.68 2.50 2.40 2.74
Equity turnover 1.22 1.04 0.96 0.98 1.00

Du pont analysis
Year to March FY09 FY10 FY11E FY12E FY13E
NP margin (%) 19.6 18.8 16.5 17.6 18.4
Total assets turnover 1.00 0.93 0.94 0.95 0.97
Leverage multiplier 1.22 1.13 1.03 1.03 1.02
ROAE (%) 23.95 19.59 15.88 17.19 18.37

Valuation parameters
Year to March FY09 FY10 FY11E FY12E FY13E
Adjusted diluted EPS (INR) 12.1 12.5 12.4 15.2 18.5
EPS YoY growth (%) 50.4 3.6 (0.8) 22.4 21.9
CEPS (INR) 14.4 14.6 15.4 18.5 22.1
Diluted PE (x) 26.6 25.6 25.9 21.1 17.3
Price/BV(x) 5.7 4.4 3.9 3.4 3.0
EV/Sales (x) 4.9 4.5 4.0 3.5 3.0
EV/EBITDA (x) 20.8 18.5 18.6 15.5 12.7
Dividend yield (%) 0.6 0.6 0.9 1.1 1.3

78 Edelweiss Securities Limited


India Equity Research | Pharmaceuticals Company Update
Edel Pulse: Pharmaceuticals
DR. REDDY’S LABORATORIES
More steam left

„ Domestic formulation: Gaining priority April 25, 2011


We expect Dr. Reddys Laboratories’ (DRRD) domestic market to grow at 17%
over FY10-13E led by strategic initiatives such as field force expansion (750
Reuters : REDY.BO Bloomberg : DRRD IN
additions in existing markets and 1,600 contractual field force for rural markets)
and increase in new launches. Its differentiated product pipeline such as bio-
EDELWEISS 4D RATINGS
similars (Reditux and Cresp) and novel formulations like Fentanyl patches, have
also been successful. Our survey indicates that the company’s supply chain Absolute Rating BUY

initiatives, which had impacted growth in FY09, are now contributing to better Rating Relative to Sector Outperformer

performance and incrementally higher returns as inventory in channel has dipped Risk Rating Relative to Sector High

to 7-8 days versus 15-21 days (best among peers). Sector Relative to Market Equalweight

Note:
Please refer last page of the report for rating explanation
„ US pipeline of limited competition products
DRRD has the most interesting pipeline of limited competition and Para IV
products (34 Para IV, 18 have FTF status), however execution of the same is
MARKET DATA
critical to attain the goal of USD 1bn revenue from current base of USD 350 mn
CMP : 1,656
(FY10) in the US. We expect US to post 27% CAGR over FY10-13E led by ramp-up
52-week range (INR) : 1,855 / 1,160
in sales from existing products such as Omeprazole OTC, Prevacid and Tacrolimus Share in issue (mn) : 168.9
and new product launches such as Fondaperinux, Finestride, Olanzapine, M cap (INR bn/USD mn) :279.7 / 6,314.2
Ziprasidon and Rivastigmin. Avg. Daily Vol. BSE/NSE (‘000) : 448.5

„ GSK alliance to aid growth momentum in emerging markets


SHARE HOLDING PATTERN (%)
DRRD has exited a few non-core ROW markets in FY10 and forged an alliance with
Promoters* : 25.7
GSK to capture the growing opportunity in the branded generic space in emerging
MFs, FIs & Banks : 13.1
markets. The company has already started supplying products to GSK for five-six FIIs : 27.2
markets including Brazil and Mexico; however, full impact on revenue will be Others : 34.0
visible in the next two-three years. * Promoters pledged shares : 1.2
(% of share in issue)

„ Outlook and valuations: Execution critical for growth; upgrade to ’BUY’


We remain positive on strong growth visibility in branded generics, improved PRICE PERFORMANCE (%)
traction in limited competition products and potential upside from the GSK deal. Stock Nifty EW Pharma
Index
We maintain our core earnings estimate of INR 76 and INR 88 for FY12 and FY13,
1 month 12.2 8.9 5.5
respectively. Our SOTP-based fair value at INR 1,950, values base business at
3 months 0.6 2.5 (7.0)
21x FY13E core EPS (10% premium to sector multiple due to strong pipeline in
12 months 45.1 11.9 18.0
US) and assigns INR 94 per share as NPV of Para IVs. Hence, we upgrade our
recommendation to ‘BUY/Sector Outperformer’ from ‘HOLD/Sector
Outperformer’. Execution in US is a key risk.
Financials
Year to March FY10 FY11E FY12E FY13E
Revenues (INR mn) 70,519 74,508 93,814 104,148
Rev growth (%) 2.5 5.7 25.9 11.0
EBITDA (INR mn) 15,970 16,546 24,485 25,012 Manoj Garg
Adj. Net profit (INR mn) 8,376 11,351 17,128 17,413
+91 22 6623 3302
Shares outstanding (mn) 168.9 168.9 168.9 168.9
manoj.garg@edelcap.com
Adj. EPS (INR) 49.6 67.2 101.4 103.1
EPS growth (%) 10.3 35.5 50.9 1.7 Peril Ali
P/E (x) 33.4 24.6 16.3 16.1 +91 22 6620 3032
EV/EBITDA (x) 17.8 16.7 10.8 10.1 perin.ali@edelcap.com
ROE (%) 26.3 27.0 31.4 25.1

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EdelweissLimited 79
Securities Limited
Edel Pulse: Pharmaceuticals

Table 1: Financial snapshot (INR mn)


FY10 FY11E % Y-o-Y FY12E % Y-o-Y FY13E % Y-o-Y
Net sales 70,519 74,508 5.7 93,814 25.9 104,148 11.0
- India formulations 10,158 11,864 16.8 13,900 17.2 16,336 17.5
- Betapharm 7,298 5,564 (23.8) 5,767 3.7 5,796 0.5
- US formulations 16,817 18,070 7.5 30,497 68.8 32,351 6.1
- Russia 7,200 8,652 20.2 10,154 17.4 11,987 18.1
- PSAI 20,404 19,287 (5.5) 20,093 4.2 21,688 7.9
Gross profit 47,831 50,568 5.7 64,189 26.9 70,534 9.9
Gross margins (%) 67.8 67.9 68.4 67.7
EBITDA 15,970 16,546 3.6 24,485 48.0 25,012 2.2
EBITDA margin (%) 22.6 22.2 26.1 24.0
EBITDA margin (ex-milestones) 20.4 19.9 24.2 22.1
PBT 12,259 12,754 4.0 20,391 59.9 20,979 2.9
Tax 2,668 1,333 3,263 144.7 3,566 9.3
Tax rate (%) 21.8 10.5 16.0 17.0
Reported PAT 3,515 10,789 206.9 17,128 58.8 17,413 1.7
Recurring PAT 6,777 10,539 55.5 12,901 22.4 14,926 15.7
Recurring EPS 40.1 62.4 76.4 88.4
Source: Edelweiss research

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


2,000
18x

1,600 14x

1,200
(INR)

10x

800
6x

400

0
Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Source: Edelweiss research

Table 2: SOTP based valuation (INR)


SOTP
Base business EPS March-13 88
Target P/E 21
Value of base business (INR per share) 1,856
NPV per share for one-off sales 94
Total target price 1,950
` Source: Edelweiss research

80 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

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


Market size
Brand Name Molecule Innovator Type Generic players Data of Launch
(USD mn)
Arixtra Fondaparinux GSK 270 1 Awaiting approval
Zyprexa Olanzapine-20mg Eli Lilly Para IV 800 1 April'11
Avandia Rosiglitazone GSK Para IV 600 2 June'11
Allegra-D-24 (OTC) Fexofenadine Sanofi Aventis 200 1 Aug'11
Plavix Clopidogrel BMS 3,300 4-5 players Nov'11/ May'12
Boniva Ibandronate Roche Para IV 500 Multiple players Mar'12
Geodon Ziprasidone Pfizer Para IV 1,200 4 Mar'12
Clarinex-D-12/24 Desloratidine Scherring Para IV 172 2 Mar'12
Exelon Rivastigmine Novartis 225 3 Aug'12
Propecia Finestride Merck Para IV 100 1 Dec'12
Micardis Telmisartan Boehringer Para IV 140 1 Jan'14
Lunesta Eszopiclone Sepracor Para IV 761 4 May'14
Actonel Residronate Roche 700 Many June'14
Avelox Moxifloxacin Bayer Para IV 400 2 Aug'14
Namenda Memantine Forest Labs Para IV 1,300 Multiple players Jan'15
Source: Edelweiss research

Edelweiss Securities Limited 81


Edel Pulse: Pharmaceuticals

Company Description

Promoted by Dr. K Anji Reddy, a first generation entrepreneur, DRRD is a professionally


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

Chart 2: Revenue mix


Domestic
formulations
15%
APIs
29%

ROW
17%

Biotech
2%

Germany
(Betapharm)
10% EU US
3% 24%

Source: Edelweiss research

Chart 3: Shareholding pattern

Promoters
26%
Retail & others
34%

MF & inst
13%

FII's
27%
Source: NSE

82 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Domestic Snapshot
Growth versus industry (%)
Mar 2011 (Month) MAT (Mar-11)
CAGR (5yr)
Incl bonus Excl bonus Incl bonus Excl bonus
Company growth 13.5 13.5 10.6 10.5 18.4
Industry growth 13.8 13.1 15.0 14.3 14.4
Relative performance

Therapeutic growth versus industry (MAT) (%) Top 10 brand performance (%)
% of Market Dr Industry Contrbution
Therapeutic area % of Market Growth Contrbution
total share Reddy's Growth to growth Brands Therapy
total share rate to growth
Gastro 24 4.5 12.5 14.1 28.3
OMEZ Acute 9.9 53.1 9.8 9.3
CV 21 3.6 10.1 16.5 20.1
NISE Acute 6.9 48.3 (7.5) (5.8)
Pain mgmt. 12 4.1 (0.7) 13.8 (0.8) STAMLO Chronic 4.7 20.6 4.4 2.1
Anti-infectives 10 1.0 9.9 13.4 9.0 OMEZ D Acute 3.2 26.2 11.6 3.5
Anti - diabetics 6 2.3 17.0 21.0 9.2 STAMLO BETA Chronic 3.2 12.9 3.6 1.1

Respiratory 5 1.5 23.1 14.5 10.8 ATOCOR Chronic 2.9 5.2 7.2 2.0
RAZO Acute 2.8 13.7 8.2 2.2
Dermatology 5 2.4 30.5 14.4 13.4
MINTOP Acute 2.2 48.9 16.8 3.3
Gyneacology 4 0.1 7.7 21.9 3.2
CLAMP Acute 2.2 2.9 24.5 4.4
CNS 1 0.4 7.4 14.1 0.9
ECONORM Acute 2.1 10.3 28.4 4.8
Chronic contribution to growth 40.9
Total 39.9 26.8

Therapy wise break-up Field force expansion and productivity


3,000 5.5
CV

Sales per rep (INR mn)


Gyneacology Others
(No of medical reps)

21% CAGR 3.7%


4% 11% 2,400 5.1
CNS
Anti- 1% 1,800 4.7
infectives
Anti -
10% Chronic 1,200 4.3
diabetics
6% 34%
Pain mgmt. Respiratory 600 3.9
13% 5%
0 3.5
Dermatology
Gastro FY06 FY07 FY08 FY09 FY10 FY11E
5%
24%
Field force Productivity

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


15% 35
16.0

10.6% 28
12.0 6
Sales (INR bn)

21
8.0 Industry
3 14 growth
8
(%)

4.0 7
6
3 0
0.0 (0)
Ranbaxy

Pharma

Pfizer
Lupin
Cipla

Cadila
GSK

Reddy's
Sun

Dr Reddy's Industry
Dr

(4.0)
Volume Price New product introductions
Source: AIOCD, Edelweiss research

Edelweiss Securities Limited 83


Edel Pulse: Pharmaceuticals

Key Risks

„ Domestic growth driven by new products than prescription generation


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

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

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

84 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Financial Statements

Income statement (INR mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Income from operations 68,830 70,519 74,508 93,814 104,148
Gross revenues 68,326 68,833 72,909 92,103 102,322
Less: Excise 809 316 583 667 770
Net revenues 67,517 68,517 72,327 91,436 101,552
Other operating income 1,313 2,002 2,181 2,379 2,595
Total operating expenses 54,081 54,549 57,962 69,329 79,136
Materials cost 23,223 22,688 23,940 29,625 33,614
Employee cost 9,920 10,948 12,700 14,605 16,503
R&D cost 4,093 3,731 4,520 6,035 7,109
Selling, admin and general expenses 16,845 17,182 16,802 19,064 21,910
EBITDA 14,749 15,970 16,546 24,485 25,012
Depreciation and amortisation 4,977 4,131 4,565 4,986 5,407
EBIT 9,772 11,839 11,981 19,499 19,605
Interest expense 972 312 247 284 124
Other income 783 732 1,020 1,175 1,497
Profit before tax 9,583 12,259 12,754 20,391 20,979
Provision for tax 2,608 2,668 1,333 3,263 3,566
Core Profit 6,975 9,591 11,421 17,128 17,413
Extraordinary items 16,147 6,077 632 0 0
Profit after tax (9,172) 3,515 10,789 17,128 17,413
Reported profit after minority interest (9,172) 3,515 10,789 17,128 17,413
Adjusted PAT after minority interest 7,571 8,376 11,351 17,128 17,413
Equity shares outstanding (mn) 168 169 169 169 169
Adjusted EPS (INR) (Dil) 44.9 49.6 67.2 101.4 103.1
Diluted shares (mn) 168 169 169 169 169
Recurring EPS (INR) fully diluted 25.5 40.1 62.4 76.4 88.4
CEPS (INR) 71.0 81.2 94.6 130.9 135.1
Dividend per share (INR) 6.3 11.2 8.0 10.0 15.0
Dividend payout (%) 13.9 22.7 11.9 9.9 14.6

Common size metrics- as % of net revenues


Year to March FY09 FY10 FY11E FY12E FY13E
Cost of revenues 33.7 32.2 32.1 31.6 32.3
Selling, admin and general expenses 24.5 24.4 22.5 20.3 21.0
R & D cost 5.9 5.3 6.1 6.4 6.8
Total operating expenses 78.6 77.4 77.8 73.9 76.0
Depreciation and amortisation 7.2 5.9 6.1 5.3 5.2
Interest expenditure 1.4 0.4 0.3 0.3 0.1
EBITDA margins 21.4 22.6 22.2 26.1 24.0
Net profit margins 10.3 14.0 15.8 18.7 17.1

Growth metrics (%)


Year to March FY09 FY10 FY11E FY12E FY13E
Revenues (241.3) 2.5 5.7 25.9 11.0
EBITDA (116.4) 8.3 3.6 48.0 2.2
Net profit (107.4) 37.5 19.1 50.0 1.7
PBT (110.2) 27.9 4.0 59.9 2.9
EPS 124.3 10.3 35.5 50.9 1.7

Edelweiss Securities Limited 85


Edel Pulse: Pharmaceuticals

Balance sheet (INR mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Equity capital 842 845 845 845 845
ESOPS & others 628 573 573 573 573
Reserves & surplus 33,791 36,351 45,558 60,710 75,158
Common shareholders equity 35,261 37,768 46,976 62,128 76,576
Total shareholders funds 35,261 37,768 46,976 62,128 76,576
Borrowings 19,976 14,840 9,840 4,340 1,840
Deferred tax liability (net) 539 70 70 70 70
Sources of funds 55,775 52,678 56,886 66,538 78,486
Net block 16,318 17,376 20,807 22,924 24,724
Capital work in progress 4,296 7,622 4,246 4,567 4,891
Intangible assets & goodwill 12,952 6,146 4,470 2,719 915
Investments 523 3,580 3,580 3,580 3,580
Inventories 13,250 13,394 14,046 17,629 19,721
Sundry debtors 14,406 11,599 12,296 15,544 17,264
Cash and bank balances 5,623 6,600 9,734 15,525 25,855
Loans and advances 5,519 6,609 6,943 8,778 9,749
Total current assets 38,798 38,202 43,019 57,476 72,589
Current liabilities 15,118 16,746 17,064 21,554 23,932
Provisions 1,994 3,502 2,172 3,174 4,282
Total current liabilities and provisions 17,112 20,248 19,235 24,729 28,214
Net current assets 21,686 17,954 23,784 32,748 44,376
Uses of funds 55,775 52,678 56,886 66,538 78,486
Book value per share ( INR) 209 224 278 368 453

Free cash flow


Year to March FY09 FY10 FY11E FY12E FY13E
Net profit (9,172) 3,515 10,789 17,128 17,413
Add: Non cash charge
Depreciation 4,977 4,131 4,565 4,986 5,407
Others - - (0) 0 (0)
Gross cash flow (4,195) 7,646 15,354 22,114 22,820
Less:Changes in WC (4,681) 4,709 (2,695) (3,173) (1,298)
Operating cash flow (8,876) 12,355 12,659 18,941 21,521
Less: Capex (11,761) (2,767) (5,500) (5,000) (5,000)
Free cash flow (20,638) 9,588 7,159 13,941 16,521

Cash flow metrices


Year to March FY09 FY10 FY11E FY12E FY13E
Operating cash flow (8,876) 12,355 12,659 18,941 21,521
Financing cash flow (512) (6,611) (6,581) (7,476) (5,464)
Investing cash flow 7,564 (4,766) (2,943) (5,674) (5,727)
Net cash flow (1,824) 978 3,134 5,791 10,330
Capex (11,761) (2,767) (5,500) (5,000) (5,000)
Dividends paid (1,232) (2,217) (1,581) (1,976) (2,964)
Share issuance / (buyback) 172 226 - - -

86 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Profitability and liquidity ratios


Year to March FY09 FY10 FY11E FY12E FY13E
ROAE (%) 17.4 26.3 27.0 31.4 25.1
ROACE (%) 19.3 20.4 23.4 33.5 28.4
Inventory days 191 214 209 195 203
Debtors days 57 69 60 56 59
Payable days 200 256 258 238 247
Cash conversion cycles 47 27 12 13 15
Current ratio 2.3 1.9 2.2 2.3 2.6
Debt/ EBITDA 1.4 0.9 0.6 0.2 0.1
Debt/equity 0.6 0.4 0.2 0.1 0.0
Adjusted debt/Equity 0.6 0.4 0.2 0.1 0.0

Operating ratios (x)


Year to March FY09 FY10 FY11E FY12E FY13E
Total asset turnover 1.1 1.3 1.3 1.5 1.4
Fixed asset turnover 4.7 4.1 3.8 4.2 4.3
Equity turnover 1.7 1.9 1.7 1.7 1.5

Du Pont Analysis
Year to March FY09 FY10 FY11E FY12E FY13E
NP margin 10.3 14.0 15.8 18.7 17.1
Total assets turnover 1.1 1.3 1.3 1.5 1.4
Leverage multiplier 1.5 1.5 1.3 1.1 1.0
ROAE 17.4 26.3 27.0 31.4 25.1

Valuation parameters
Year to March FY09 FY10 FY11E FY12E FY13E
Adj. Diluted EPS (INR) 44.9 49.6 67.2 101.4 103.1
EPS YoY growth (%) 124.3 10.3 35.5 50.9 1.7
CEPS (INR) 71.0 81.2 94.6 130.9 135.1
Diluted PE (x) 36.8 33.4 24.6 16.3 16.1
Price/BV(x) 7.9 7.4 6.0 4.5 3.7
EV/Sales (x) 4.3 4.0 3.7 2.8 2.4
EV/EBITDA (x) 19.8 17.8 16.7 10.8 10.1
Dividend yield (%) 0.4 0.7 0.5 0.6 0.9

Edelweiss Securities Limited 87


Edel Pulse: Pharmaceuticals

THIS PAGE IS INTENTIONALLY LEFT BLANK

88 Edelweiss Securities Limited


India Equity Research | Pharmaceuticals Company Update
Edel Pulse: Pharmaceuticals

LUPIN PHARMA
Growth evident; strong outlook

„ Domestic formulations growth to outpace industry April 25, 2011


Lupin Pharma’s (LPC) domestic growth has consistently outpaced the broad
market and peers over the past five years—domestic growth has been a sturdy Reuters: LUPN.BO Bloomberg: LPC IN

24% (CAGR) over FY05-10. This is further evident through our extensive
distributor survey, which validates LPC’s strong domestic franchise led by wider EDELWEISS 4D RATINGS
therapy coverage (chronic 41% of total sales), strong traction from new Absolute Rating BUY

launches, and effective field force. We expect the company’s growth momentum Rating Relative to Sector Outperformer

to sustain in the domestic market and estimate 18% CAGR over FY11-13E. Risk Rating Relative to Sector Low

Sector Relative to Market Equalweight


„ Higher API sourcing from India to boost Japan margins Note:
Please refer last page of the report for rating explanation
LPC has guided to 15-16% growth driven by 8-10 products launches in FY12E.
We believe Japan’s contribution to margins will be far higher as the company
expects to source more products from India (out of the 8-10 product launches, MARKET DATA
four-five will be sourced from India). Management expects margins from Japan CMP : INR 412

to expand 600 bps to 24-25% over FY13-14E. 52-week range (INR) : 519 / 324

Share in issue (mn) 444.7


:
„ Strong ANDA pipeline in US imparts strong growth visibility M cap (INR bn/USD mn) : 183.2 / 4,137.3

LPC’s solid base in US generics (USD 350 mn) with a large pending pipeline of 90 Avg. Daily Vol. BSE/NSE (‘000) : 1,107.9

products (50-60 ANDA approvals expected in next 2-3 years) including niche
SHARE HOLDING PATTERN (%)
segments such as OC, ophthalmology as well as Para IV (13 FTFs with four being
exclusive), imparts long-term growth visibility. However, there could be some Promoters* : 47.0

pressures in the near term, largely due to genericization of Lotrel and delay in MFs, FIs & Banks : 20.1

launches of OCs (2-3 launches by end FY12). FIIs : 22.0

Others : 11.0
„ Execution slippage in US branded formulations poses key risk * Promoters pledged shares
: NIL
(% of share in issue)
US branded formulations faces key challenge of possible genericization of Antara
and Suprax, although management is confident of mitigating these risks through PRICE PERFORMANCE (%)

effective product life cycle management. Further, with no visible product pipeline Stock Nifty EW Pharma
Index
and expected delay in launch of Allernaze (FY13E), we expect a moderate 11%
1 month 6.3 8.9 5.5
CAGR in US branded formulations over FY11-13E.
3 months (10.3) 2.5 (7.0)

12 months 25.6 11.9 18.0


„ Outlook and valuations: Strong execution play; maintain ‘BUY’
We remain positive on LPC due to its strong execution track record, established
franchise in domestic market, and earnings growth visibility, imparting strong
upsides from current valuations. It is our preferred pick in the large cap space.
We re-iterate ‘BUY/Sector outperformer’ rating with TP of INR 500.
Financials
Year to March FY10 FY11E FY12E FY13E
Revenues (INR mn) 48,359 56,693 64,939 75,280
Rev growth (%) 25.5 17.2 14.5 15.9
EBITDA (INR mn) 9,728 11,594 13,710 16,121
Manoj Garg
Adj. Net profit (INR mn) 6,841 8,472 9,608 11,781
+91 22 6623 3302
Shares outstanding (mn) 444.7 444.7 444.7 444.7
manoj.garg@edelcap.com
Adj. EPS (INR) diluted 15.4 19.1 21.6 26.5
EPS growth (%) 21.0 23.8 13.4 22.6 Peril Ali
P/E (x) 26.8 21.6 19.1 15.6 +91 22 6620 3032
EV/EBITDA (x) 19.8 15.8 12.9 10.5
perin.ali@edelcap.com
ROE (%) 34.3 28.0 24.4 23.9

Edelweiss Securities Limited 89


Edel Pulse: Pharmaceuticals

Table 1: Financial snapshot (INR mn)


FY10 FY11E % Y-o-Y FY12E % Y-o-Y FY13E % Y-o-Y
Net sales 48,359 56,693 17.2 64,939 14.5 75,280 15.9
- Domestic Formulations 13,498 15,928 18.0 18,795 18.0 22,178 18.0
- US (generics) 10,783 13,710 27.1 15,245 11.2 18,480 21.2
- US (branded) 6,033 5,690 (5.7) 6,594 15.9 6,868 4.2
- Europe 1,396 1,954 40.0 2,541 30.0 3,176 25.0
- Japan 5,341 6,089 14.0 7,002 15.0 8,052 15.0
- API 8,106 8,798 8.5 9,551 8.6 10,368 8.6
Gross profit 28,665 33,725 17.7 38,653 14.6 44,921 16.2
Gross margins (%) 59.3 59.5 59.5 59.7
EBITDA 9,728 11,594 19.2 13,710 18.3 16,121 17.6
EBITDA margin (%) 20.1 20.5 21.1 21.4
PBT 8,357 9,884 18.3 12,331 24.8 15,119 22.6
Tax 1,360 1,186 (12.8) 2,466 107.9 3,024 22.6
Tax rate (%) 16.3 12.0 20.0 20.0
Reported PAT 6,816 8,472 24.3 9,608 13.4 11,781 22.6
Adjusted PAT 6,841 8,472 23.8 9,608 13.4 11,781 22.6
Adjusted EPS 15.4 19.1 23.8 21.6 13.4 26.5 22.6
Source: Edelweiss research

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


600 22x

500
16x

400
12x
(INR)

300

200 7x

100

0
Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Source: Edelweiss research

90 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Table 2: Niche product pipeline over FY11-15E


Market size Generic Data of
Brand Name Molecule Innovator Type
(USD mn) Players Launch

Fortamet Metformin Depomed 70 1 June'11 Para-IV


Effexor-XR Venlafaxine ER Pfizer (Wyeth) 800 5 July'11
Tricor Fenofibrate Abbott 1,500 4
Renagel Sevelamer Genzyme 600 2 Sep'11 Para-IV
Multiple
Solodyn Minocycline 500 Nov'11 Para-IV
players
Geodon Ziprasidone Pfizer 1,200 4 Mar'12 Para-IV
Fosrenol Lanthum Shire 130 2 Apr'12 Para-IV
Glumetza Metformin Depomed 45 1 May'12 Para-IV
Combivir Lamivudine and Zidovudine GSK 360 2 May'12
Cipro OD Ciprofloxacin Bayer 150 4 June'12 Para-IV
Clarinex-D-12/24 Desloratidine Scherring 172 2 July'12 Para-IV
Estradiol and
Femcon FE Warner Chillcot 65 3 Jan'13
Norethindrone

Ethinyl Estradiol and


Yaz Bayer 772 Jan'13
Drospirenone

Multiple
Cymbalta Duloxitine Eli Lilly 2,500 June'13 Para-IV
players
Oracea Doxycycline Galderma 240 June'13
Niacin Niaspan Abbott 330 3 Sep'13 Para-IV
Multiple
Lyrica Pregabalin Pfizer 1,596 Oct'13 Para-IV
players
Lunesta Eszopiclone Sepracor 761 4 May'14 Para-IV
Ultram Tramedol 200 2 May'14
Loestrin 24 Norethindrone and Ethinyl Warner Chillcot 357 2 Julu'14
Multiple
Namenda Memantine Forest Labs 1,300 Jan'15 Para-IV
players
Welchol Daiichi Sankyo 30 3 2015 Para-IV

Source: Edelweiss research

Edelweiss Securities Limited 91


Edel Pulse: Pharmaceuticals

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

Chart 2: Revenue mix (%)


ROW
8%
Japan
Domestic
13%
formulations
33%

Europe
6%

US
40%

Source: Edelweiss research

Chart 3: Shareholding pattern


Retail & others
11%

FII's
Promoters
23%
47%

MF & inst
19%

Source: NSE

92 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Domestic Formulations Snapshot


Growth versus industry (%)
Mar 2011 (Month) MAT (Mar-11)
CAGR (5yr)
Incl bonus Excl bonus Incl bonus Excl bonus
Company growth 24.9 24.2 25.4 24.9 24.1
Industry growth 13.8 13.1 15.0 14.3 14.4
Relative performance

Therapeutic growth versus industry (MAT) (%) Top 10 brand performance (%)
% of Market Lupin Industry Contrbution % of Market Growth Contrbution
Therapeutic area Brands Therapy
total share growth growth to growth total share rate to growth
Anti infectives
34 4.6 15.4 13.4 20.4 TONACT Chronic 3.8 9.6 27.7 4.1
(incl TB)
RAMISTAR Chronic 2.1 16.5 20.4 1.8
CVS 22 4.3 35.2 16.5 31.1
GLUCONORM G Chronic 2.1 7.2 45.6 3.2
Respiratory 12 4.3 21.4 14.5 10.2
R-CINEX Acute 2.0 52.6 19.7 1.6
Gastrointestinal 7 1.7 23.8 14.1 6.5
BUDAMATE Chronic 2.0 19.4 30.9 2.3
Anti-diabetics 7 3.8 36.6 21.0 9.8
LUPENOX Chronic 2.0 13.9 12.9 1.1
CNS 5 2.2 30.6 14.1 6.1 L CIN Acute 1.8 13.6 11.9 0.9
Chronic contribution to growth 57.1 ESIFLO Chronic 1.8 15.4 23.7 1.7
TAZAR Acute 1.7 10.2 23.3 1.6
RABLET Acute 1.7 11.6 25.6 1.7
Total 21.0 20.1

Therapy wise break-up Field force expansion and productivity


Generics 3,500 5.5

Sales per rep (INR mn)


CVS CAGR 4.1%
(No of medical reps)

12%
21% 3,100 4.6
Others Chronic
10% 41% 2,700 3.7
Anti-
Nsaids diabetics
2,300 2.8
2% 6%
Gastrointes 1,900 1.9
CNS
tinal
5%
6% 1,500 1.0
Respiratory FY11E
FY06

FY07

FY08

FY09

FY10

Antibiotoics 9%
18% Anti TB
11%
Field force Productivity

Growth composition (MAT Mar 2011) Relative performance to peers (MAT Mar 2011)
30.0 35
25%
24.0 28
Sales (INR bn)

12 21 Industry
18.0 15%
(%)

growth
14
12.0 2 6
7
3
6.0 11 0
6
Ranbaxy

Pharma

Pfizer
Lupin
Cipla

Cadila
GSK

Reddy's

0.0
Sun

Dr

Lupin Industry
Volume Price New product introductions
Source: AIOCD, Edelweiss research

Edelweiss Securities Limited 93


Edel Pulse: Pharmaceuticals

Key Risks

„ Lack of new approvals; delay in approvals


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

„ Slowdown in domestic formulation market


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

„ Price reductions in Kyowa


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

94 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Financial Statements
Income statement (INR Mn)
Year to March FY09 FY10 FY11E FY12E FY13E
Income from operations 38,523 48,359 56,693 64,939 75,280
Net revenues 37,761 47,405 55,747 63,956 74,227
Other operating income 762 954 946 983 1,053
Materials cost 16,043 19,694 22,968 26,286 30,359
Employee cost 4,871 5,872 6,968 7,995 9,130
R&D cost 2,228 3,438 3,958 4,477 5,196
Selling, admin and general expenses 7,839 9,627 11,205 12,471 14,474
Total operating expenses 30,981 38,631 45,099 51,229 59,159
EBITDA 7,541 9,728 11,594 13,710 16,121
Depreciation and amortisation 880 1,239 1,698 1,854 1,817
EBIT 6,661 8,489 9,896 11,856 14,303
Interest expense/(income) 499 385 337 255 270
Other income (incl. forex gain/(loss)) 192 282 325 730 1,086
Profit before tax 6,355 8,386 9,884 12,331 15,119
Provision for tax 983 1,360 1,186 2,466 3,024
Core profit 5,372 7,026 8,698 9,865 12,095
Extraordinary items (295) (29) - - -
Profit after tax 5,666 7,055 8,698 9,865 12,095
Minority interest & others 62 180 226 256 314
Reported profit after minority interest 5,604 6,875 8,472 9,608 11,781
Adjusted PAT after Minority interest 5,266 6,841 8,472 9,608 11,781
Equity shares outstanding (mn) 414 445 445 445 445
EPS (INR) basic 12.8 15.4 19.1 21.6 26.5
Diluted shares (mn) 414 445 445 445 445
Adjusted EPS (INR) diluted 12.7 15.4 19.1 21.6 26.5
CEPS (INR) 14.9 18.2 22.9 25.8 30.6
Dividend per share (INR) 2.6 2.9 3.9 4.4 5.5
Dividend payout (%) 20.1 18.6 20.6 20.6 20.6

Common size metrics- as % of net revenues


Year to March FY09 FY10 FY11E FY12E FY13E
Cost of revenues 41.6 40.7 40.5 40.5 40.3
Employee cost 12.6 12.1 12.3 12.3 12.1
Selling, admin and general expenses 20.4 19.9 19.8 19.2 19.2
R & D cost 5.8 7.1 7.0 6.9 6.9
Total operating expenses 80.4 79.9 79.5 78.9 78.6
Depreciation and Amortisation 2.3 2.6 3.0 2.9 2.4
Interest expenditure 1.3 0.8 0.6 0.4 0.4
EBITDA margins 19.6 20.1 20.5 21.1 21.4
Net profit margins 14.2 14.8 15.6 15.4 16.3

Growth metrics (%)


Year to March FY09 FY10 FY11E FY12E FY13E
Revenues 40.6 25.5 17.2 14.5 15.9
EBITDA 49.5 29.0 19.2 18.3 17.6
Net profit 26.6 30.8 23.8 13.4 22.6
PBT 14.3 32.0 17.9 24.8 22.6
Adjusted EPS 17.6 21.0 23.8 13.4 22.6

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Edel Pulse: Pharmaceuticals

Balance sheet (INR Mn)


As on 31st March FY09 FY10 FY11E FY12E FY13E
Equity capital 828 889 889 889 889
Reserves & surplus 13,420 24,789 33,980 43,125 53,604
Common shareholders equity 14,248 25,678 34,869 44,014 54,493
Total Shareholders Funds 14,248 25,678 34,869 44,014 54,493
Borrowings 12,233 11,399 8,899 7,399 5,399
Deferred tax liability (net) 1,164 1,435 1,435 1,435 1,435
Minority interest 143 255 481 738 1,052
Sources of funds 27,788 38,767 45,684 53,585 62,379
Gross block 18,200 22,937 25,937 29,437 32,937
Depreciation 6,188 7,072 8,770 10,624 12,441
Net block 12,012 15,865 17,167 18,813 20,496
Capital work in progress 2,240 3,579 964 964 964
Intangible assets & Goodwill 3,174 3,197 3,197 3,197 3,197
Investments 216 264 1,176 1,176 1,176
Inventories 9,572 9,715 14,104 16,181 18,779
Sundry debtors 9,180 11,266 15,163 17,396 20,190
Cash and bank balances 778 2,015 8,636 13,275 18,553
Loans and advances 2,780 4,759 3,902 4,477 5,196
Total current assets 22,309 27,755 41,805 51,329 62,718
Current liabilities 10,335 9,649 17,281 19,826 23,010
Provisions 1,827 2,243 1,344 2,067 3,162
Total current liabilities and provisions 12,162 11,893 18,625 21,894 26,172
Net current assets 10,147 15,862 23,180 29,435 36,546
Uses of funds 27,788 38,767 45,684 53,585 62,379
Book value per share ( INR) 34 58 78 99 123

Free cash flow


Year to March FY09 FY10 FY11E FY12E FY13E
Net profit 5,372 7,026 8,698 9,865 12,095
Depreciation 880 1,239 1,698 1,854 1,817
Others (188) 221 - - -
Gross cash flow 6,064 8,486 10,396 11,719 13,913
Less:Changes in WC 860 (4,478) (697) (1,616) (1,833)
Operating cash flow 6,923 4,009 9,698 10,103 12,080
Less: Capex (4,007) (6,431) (385) (3,500) (3,500)
Free cash flow 2,917 (2,422) 9,313 6,603 8,580

Cash flow metrices


Year to March FY09 FY10 FY11E FY12E FY13E
Operating cash flow 6,923 4,009 9,698 10,103 12,080
Financing cash flow (3,360) 3,780 (1,781) (1,963) (3,302)
Investing cash flow (5,465) (6,503) (1,297) (3,500) (3,500)
Net cash flow (1,902) 1,285 6,620 4,640 5,278
Capex (4,007) (6,431) (385) (3,500) (3,500)
Dividends paid (1,235) (1,483) (408) (463) (1,302)

96 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Profitability and liquidity ratios


Year to March FY09 FY10 FY11E FY12E FY13E
ROAE (%) 39.3 34.3 28.0 24.4 23.9
ROACE (%) 24.9 25.7 23.8 24.5 25.2
Inventory days 199 179 189 210 210
Debtors days 79 77 85 92 91
Payable days 186 185 214 258 258
Cash conversion cycles 91 71 60 44 44
Current ratio 1.8 2.3 2.2 2.3 2.4
Debt/ EBITDA 1.6 1.2 0.8 0.5 0.3
Debt/equity 0.9 0.4 0.3 0.2 0.1
Adjusted debt/Equity 0.9 0.4 0.3 0.2 0.1

Operating ratios (x)


Year to March FY09 FY10 FY11E FY12E FY13E
Total asset turnover 1.40 1.42 1.32 1.29 1.28
Fixed asset turnover 3.41 3.40 3.38 3.56 3.78
Equity turnover 2.79 2.37 1.84 1.62 1.51

Du pont analysis
Year to March FY09 FY10 FY11E FY12E FY13E
NP margin 14.1 14.4 15.2 15.0 15.9
Total assets turnover 1.4 1.4 1.3 1.3 1.3
Leverage multiplier 2.0 1.7 1.4 1.3 1.2
ROAE 39.3 34.3 28.0 24.4 23.9

Valuation parameters
Year to March FY09 FY10 FY11E FY12E FY13E
Adj. diluted EPS (INR) 12.7 15.4 19.1 21.6 26.5
EPS YoY growth (%) 17.6 21.0 23.8 13.4 22.6
CEPS (INR) 14.9 18.2 22.9 25.8 30.6
Diluted PE (x) 32.4 26.8 21.6 19.1 15.6
Price/BV(x) 12.0 7.1 5.3 4.2 3.4
EV/Sales (x) 4.7 4.0 3.2 2.7 2.3
EV/EBITDA (x) 24.1 19.8 15.8 12.9 10.5
Dividend yield (%) 0.6 0.7 1.0 1.1 1.3

Edelweiss Securities Limited 97


Edel Pulse: Pharmaceuticals

THIS PAGE IS INTENTIONALLY LEFT BLANK

98 Edelweiss Securities Limited


India Equity Research | Pharmaceuticals Initiating Coverage
Edel Pulse: Pharmaceuticals
RANBAXY LABORATORIES
Running ahead of reality

„ Emerging markets to drive growth; positive traction from Project Virat


April 25, 2011
Ranbaxy Laboratories’ (RBXY) CY11 revenue guidance of USD 1.87 bn implies
base business growth of 14%, largely driven by emerging markets (EM) such as
Reuters: RANB.BO Bloomberg: RBXY IN
Africa, Latam, India, CIS, and Romania. During CY10, organic growth in EM has
been robust at 12%. We believe growth from these regions will be key growth
EDELWEISS 4D RATINGS
driver over the medium term. This is further evident from Daiichi Sankyo’s mid-
Absolute Rating HOLD
term business plan, where EMs (ex-Japan) are projected to post 23% CAGR,
Rating Relative to Sector Performer
largely driven by RBXY. India is the key component of this growth strategy and
Risk Rating Relative to Sector High
is seeing positive traction over the past three months after launch of Project
Sector Relative to Market Equalweight
Virat, a significant positive. We expect EM to post 15% CAGR over CY10-12E.
Note:
Please refer last page of the report for rating explanation

„ Lipitor launch: Key trigger for stock


Lipitor (USD 5.3 bn opportunity in US) is an exciting PIV opportunity for RBXY.
MARKET DATA
The company’s success in monetising other Para IVs cannot be extrapolated for
CMP INR 468
:
Lipitor; however, successful launch could have a large bearing on valuations. We
52-week range (INR) 624 / 364
:
believe there is uncertainty around Lipitor launch during the exclusivity period,
Share in issue (mn) 421.3
:
given the current import ban and AIP at Ponta Sahib (Lipitor ANDA is filed from
M cap (INR bn/USD mn) 197.3 / 4,444.6
:
the facility). However, we have build base case scenario for Lipitor
Avg. Daily Vol. BSE/NSE (‘000) : 1,109.4
(relinquishes Lipitor exclusivity) with an NPV of INR21 per share. Successful
launch of Lipitor in Nov’2011 can has incremental option value of INR48/ share. SHARE HOLDING PATTERN (%)

Promoters* : 63.8
„ We estimate INR 74 per share upside from positive FDA-DOJ resolution MFs, FIs & Banks : 12.0
Positive resolution of the FDA-DOJ issue could be another positive trigger and
FIIs : 7.5
enable RBXY to cover lost ground in the US. We believe recovery in the US base
Others : 16.7
business sales, post resolution, is likely to be gradual and more accretive to
* Promoters pledged shares
: NIL
earnings than sales, as assets have been underutilized and fixed costs have (% of share in issue)

soared due to higher legal and consultation costs. We estimate incremental EPS PRICE PERFORMANCE (%)
of INR4.6 per share (option value of INR 74) on back of positive resolution. Stock Nifty EW Pharma
Index

„ Outlook and valuations: Fairly valued; initiating coverage with ‘HOLD’ 1 month (0.6) 8.9 5.5

Current valuations, in our view, already factor in potential upsides in the base 3 months (17.2) 2.5 (7.0)

business. However, positive resolution of the FDA-DOJ issue and/or clarity on 12 months 5.1 11.9 18.0
Lipitor launch could be potential triggers for the stock. We initiate coverage with
‘HOLD/Sector Performer’ recommendation/rating with SOTP-based value of
INR 432 per share, valuing the base business at INR 338 per share (20X one
year forward PE). NPV of Para IV is INR 94 per share. Our estimates on core
earnings fully reflect the benefits of revival in its base business operations.

Financials
Year to December CY09 CY10 CY11E CY12E
Revenues (INR mn) 74,529 87,106 102,450 111,900
Rev growth (%) 0.4 16.9 17.6 9.2
EBITDA (INR mn) 6,106 16,802 22,600 22,500 Manoj Garg
Adjusted net profit (INR mn) 3,586 12,929 14,989 14,548 +91 22 6623 3302
Shares outstanding (mn) 420.4 421.0 421.0 421.0 manoj.garg@edelcap.com
Adj. Diluted EPS (INR) 8.5 30.7 35.6 34.6
EPS growth (%) 60.5 260.6 15.9 (2.9) Peril Ali
P/E (x) 55.0 15.2 13.1 13.5 +91 22 6620 3032
EV/EBITDA (x) 35.3 12.1 9.0 8.6 perin.ali@edelcap.com
ROAE (%) 9.0 28.1 27.1 20.4

Edelweiss Research is also available on www.edelresearch.com,, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities
EdelweissLimited
Securities99
Limited
Edel Pulse: Pharmaceuticals

Investment Rationale

„ CY11 guidance underlines emerging markets as future growth drivers


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

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


1,900

1,800

Ranbaxy expect base


(USD mn)

1,700
business growth of 14% in
CY11E
1,600

1,500

1,400
CY10 CY11
Base Para IV
Source: Edelweiss research

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

Table 1: Key growth drivers within emerging markets (USD mn)


CAGR (CY10-
CY09 CY10 % chg CY11 CY12
12E)
India 337 384 13.8 438 504 14.6
Africa 125 154 23.2 223 246 26.3
CIS 86 101 17.4 116 132 14.5
LatAM 71 83 16.9 95 108 14.2
Asia 120 100 (16.7) 112 124 11.5
Romania 76 80 5.3 90 100 12.0
Total 815 902 10.6 1074 1214 16.1
Total base business 1,400 1,545 10.3 1,755 2,009 14.1
% of overall base revenue 58.2 58.4 61.2 60.4
Source: Edelweiss research

100 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Table 2: Daiichi’s guidance implies 23% growth in EM through RBXY (Yen bn)
FY10 FY13E Growth (%)
Net sales 960.0 1150.0 6.2
Japan 470.4 494.5 1.7
US 220.8 310.5 12.0
EU 115.2 149.5 9.1
ASCA* 86.4 161.0 23.1
Others 67.2 34.5 (19.9)
Ranbaxy 148 270 22.2
Source: Company, Edelweiss research
Note: * ASCA is term used for emerging markets outside US, EU and Japan

„ Project Virat: Positive traction over past three months


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

Chart 2: Domestic growth has lagged industry


16,000 20.0
Historically domestic
business has
underperformed
12,800 16.0

9,600 12.0
(INR mn)

(%)
6,400 8.0

3,200 4.0

0 0.0
CY07 CY08 CY09 CY10
India sales (excl consumer) Ranbaxy growth IPM growth
Source: Company, Edelweiss research

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

Others
CVS
Urology 9% 15% Chronic
4% 28%

Pain mgmt. CNS


9% 6%
Anti-diabetics
Gastro- 3%
intestinal Respiratory
6% 4%

Dermatology
9%

Anti infective
35%
Source: AIOCD, Edelweiss research

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Edel Pulse: Pharmaceuticals

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

Table 3: Most therapies lagging industry growth (%)


Market Ranbaxy Industry Contrbution
Therapeutic area % of total
share growth growth to growth

Anti infective 35 8.1 6.8 13.4 21.7


CVS 16 4.9 20.2 16.5 25.5
Pain mgmt. 9 6.5 18.5 13.8 13.9
Dermatology 9 8.1 12.1 14.4 9.1
Gastro-intestinal 6 2.5 1.1 14.1 0.7
CNS 6 3.6 5.0 14.1 2.6
Respiratory 4 2.1 6.5 14.5 2.2
Urology 4 12.3 25.9 16.8 7.3
Anti-diabetics 3 2.3 9.2 21.0 2.4
Chronic contribution to growth 32.7
Source: AIOCD, Edelweiss research

Daiichi-Sankyo’s post acquisition strategy lays strong focus on growth from the domestic
market. Consequently, RBXY management has renewed its strategic focus with
significant investments over CY11 to regain leading market share in India. Management
has undertaken several initiatives under Project Viraat such as increasing reach (field
force has been expanded from 2,500 to 4,300), portfolio optimization, new launches (60
till date), hospital focus as well as shifting of the operational team from Delhi to Mumbai.
While the company is a leader in metros and tier-1 markets with more than 6.5% share,
the focus is to expand reach to tier II and IV towns to capitalize on the penetration-
driven growth opportunity.

Though it is early to estimate the impact of Project Viraat, growth over the past three
months (as seen in monthly growth trend) is a positive indicator, with initial signs of
turnaround in the domestic market. Over the past three months, RBXY has outpaced the
industry growth and grew by 26-28% in Dec-Feb 2011 (chart 4). Moreover, as per our
distributor survey, feedback is positive, especially from tier II and IV towns, which shows
off late quicker pick up of RBXY’s products. We expect its domestic business to post 15%
CAGR over CY10-12E.

Chart 4: Monthly trend growth implies strong growth


30.0

24.0
Over last three months
(% Y-o-Y)

growth in domestic market 18.0


has picked up

12.0

6.0

0.0
May-10

Jan-11

Mar-11
Oct-10

Dec-10
Sep-10
Apr-10

Jun-10

Jul-10

Aug-10

Nov-10

Feb-11

IPM Ranbaxy
Source: AIOCD, Edelweiss research

102 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

„ Multiple margin expansion drivers in base business


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

Chart 5: Base business margins improving


14.0 13.3
12.5
11.0
11.2 10.5
9.6 9.8
Base business margins
8.8 8.5
have moved up from 3% 8.0
in Q2 CY09 to 8% in Q4 8.4
(%)

CY10
5.7 5.5
5.6

3.0
2.8

0.1
0.0

CY11E

CY12E
Q408

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410
CY08

CY10
Source: Edelweiss research

RBXY is consolidating its position in EU by lowering the cost base. The company has also
closed its London marketing office as well as scaled down operations in many non-
profitable countries. Similarly, it has also divested its stake in China, Vietnam, and Japan
as part of the re-structuring exercise. It has further realigned its R&D strategy by
transferring NDDR (New Drug Discovery Research) unit to Daiichi-Sankyo, saving USD
20-25 mn annually.

Moreover, synergies with Daiichi-Sankyo for launching its patented products in India and
other EMs coupled with its recent initiatives on developing more profitable field force
franchises will further aid margin expansion.

Table 4: Daiichi’s product launch in emerging markets


Date Market TA Generic Brand
Apr'09 India CVS Olmesartan Olvance
Jun'09 India CVS Prasugrel Prastia
Sep'09 Romania Osteoporosis Raloxifene Evista
Aug'10 Romania Antibacterial Levofloxacin Tavanic
Oct'09 Mexico Portfolio of Daiichi products
Mar'11 Singapore Antibacterial Levofloxacin Cravit
Jan'12 South Africa Antibacterial Levofloxacin Tavanic
Dec'09 Kenya, Mozambique, Nigeria, Tanzania, CVS Olmesartan Olvance
Uganda, and Zambia
Source: Company, Edelweiss research

FDA resolution: Lever for margin expansion


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

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Edel Pulse: Pharmaceuticals

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

„ Successful monetisation of rich Para IV pipeline


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

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


Revenue PAT NPV (INR)
Imitrex 20 10 1
Valtrex 360 200 22
Flomax 50 35 4
Aricept* 135 60 7
Total 565 305 34
Source: Edelweiss research
Note: Estimated revenue of USD 100 mn in CY11

Table 6: Future Para IV pipeline addresses USD 18 bn innovator market (USD mn)
No. of
Launch market
Product generic CY11E CY12E CY13E CY14E
date size
players
Aricept Nov'10 2,300 2 99
Caduet Nov'11 300 1 18 35
Lipitor Nov'11 5,300 2 250
NPV of Para-IV pipeline is Provigil Apr'12 1,000 4 50
INR 94 per share
Oxycontin Apr'12 380 46
Actos Aug'12 3,100 3 124
Diovan Sep'12 2,492 2 150 75
Valcyte Mar'13 270 1 54 36
Rapamune Jan'14 211 2 19
Nexium FTF May'2014 2,675 1 321
Total Para IV 366 255 204 451
Source: Edelweiss research

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

104 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

import ban. Unlike earlier Para IVs, Lipitor application has been filed out of the Ponta
Sahib facility which is under serious allegation of fraudulent data and currently AIP
(Application Integrity Policy).

Although media reports suggest that validity assessment at the Ponta Sahib facility has
already begun, which is a step closure to the final inspection of the facility to revoke the
AIP, the timeline of the same cannot be ascertained. Moreover, Mylan’s suit against
USFDA seeks clarity on approval status of RBXY’s ANDA for Lipitor and has further raised
doubts in investors’ minds.

However, the FDA has filed an opposition to Mylan’s preliminary injunction and requested
the court dismiss the same. FDA has further stated that its determination of RBXY's
eligibility for exclusivity will necessarily be intensely fact-driven, entailing, among other
things, an evaluation of whether the data in the company’s atorvastatin application is
unreliable. FDA is currently engaged in ongoing and confidential discussions with RBXY to
resolve issues identified in the AIP letter.

Scenarios on launch of Lipitor and its impact on earnings


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

A. RBXY secures ANDA approval and launches by November 2011


In this scenario we have assumed RBXY securing approval for ANDA (either by revoking
of AIP at Ponta Sahib or site transfer) and subsequent launch on November 30, 2011,
with 180 days’ exclusivity along with Watson (authorised generic). We further
incorporate dynamics during exclusivity and post exclusivity.

Pfizer has recently introduced co-pay card system which allows 33% discount over the
current market price for a month’s supply. This will enable the company to retain market
share and dampen pricing for generic Lipitor, thereby lower revenue for RBXY and
Watson during exclusivity.

The scenario assumes limited competition post 180 days’ exclusivity (4-5 additional
players), which implies that price erosion will not be at commodity levels, resulting in
meaningful sales post exclusivity. We expect Teva and Mylan to launch by May 2012,
while the 30 months’ stay on Dr Reddy’s and Kudco expires on April 12 and they may
launch the product at risk. In either case, we believe competition should not exceed
beyond six-seven players until end CY12, which will help early entrants post decent
sales.

Overall, we have build NPV of INR 32 per share during exclusivity and INR 37 per share
as recurring earnings post exclusivity from Lipitor for RBXY, in this scenario.

B. RBXY parks exclusivity


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

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Edel Pulse: Pharmaceuticals

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

C. RBXY relinquishes its exclusivity


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

D. RBXY licenses its exclusivity


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

FDA rejects RBXY’s ANDA


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

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Edel Pulse: Pharmaceuticals

Table 7: Various scenario analysis and impact


RBXY relinquishes
RBXY launches 30 RBXY parks RBXY licenses FDA rejects RBXY's
Scenarios exclusivity
Nov'11 exclusivity exclusivity ANDA
(base case)
No. of players 3 players market 2 players market 4 players (WPI,PFE, 3 players market 4 players
(RBXY, WPI,PFE) (WPI and PFE) MYLAN and Teva (Teva or Mylan (WPI,PFE, MYLAN
along with WPI and and Teva)
PFE)
Assumptions 50% discount; RBXY manages RBXY strikes a deal RBXY license its RBXY will not be
35% MS approval after six with Teva and Mylan for product to others able to launch
months from FDA, upfront Royalty (USD generic company Lipitor for next 26-
i.e, May'12 250 mn) for potential 30 months
upfront payment;
assuming
USD250mn

NPV during exclusivity (INR) 32 0 21 21 0


Recurring earnings post INR 1.85 in CY12; Assuming co will RBXY will not be able to RBXY will have RBXY will not be
exclusivity EPS cont. (10%) launch after six launch the product small market share able to launch the
months; EPS post exclusivity product
contribution-
INR1.85
Overall NPV contribution 69 37 21 21 0
of Lipitor - including recurring
eanings post exclusivity (INR)

Fair value of base business (ex 338 338 338 338 338
Lipitor) (INR)

NPV of Para IV 73 73 73 73 73
(ex Lipitor) (INR)
Target price (INR) 480 448 432 432 411
% impact to our 11.1 3.7 0.0 (4.9)
target price
Source: Edelweiss research

„ Positive FDA-DOJ resolution: A potential trigger……


RBXY management has been seeking a composite resolution of the FDA-DOJ issue. Few
media reports lately have suggested that the validity assessment of the Ponta Sahib
facility has begun, which could be the penultimate step in the process of revoking the
AIP. While management is confident of resolving the FDA-DOJ issue, its timeline cannot
be ascertained. A resolution will definitely be positive for RBXY and enable it to cover lost
ground in the US market.

Post FDA ban and import alert, RBXY’s US business sales plummeted from USD 106 mn
in Q2CY08 to USD 44 mn in Q4CY09 (ex one-offs; current run rate is USD65-70mn
USD). We believe post resolution, recovery in the US business will be gradual and is
likely to be more accretive to earnings than revenue. RBXY is currently manufacturing
products out of the Ohm facility in the US where manufacturing cost is higher than in
India, and on other hand the company has incurred high fixed costs on consultants and
legal resources to resolve the FDA-DOJ issue.

Moreover, positive resolution of the issue will also bring clarity on the monetization of its
FTF pipeline along with other niche opportunities such as Penems (potential USD 50-60
mn revenue in the first year of launch). RBXY is the second generic company (Orchid
Pharma was first) to file ANDAs for both Imipenem (base patent expired in September
2009 in US; no generic approval) and Meropenem (base patent will expire in September
2010 in US). Penems require dedicated manufacturing facilities and are, therefore,
expected to be limited competition products. Overall, there are just five players who
have filed DMFs for both these products, making it a lucrative opportunity for RBXY.

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Edel Pulse: Pharmaceuticals

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

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


Cost savings on FDA-DOJ resolution (INR mn) Remarks
Legal and processing charges 1,034 Legal and professional charges have increased
from 2.8% of revenue in CY07 to 4.3% in CY09

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

Total savings 1,150


Total savings net of tax 840
Incremental EPS 2

CY11 CY12 Remarks


Base business EPS 13.6 16.9 Current estimates including Lipitor launch
Incremental EPS from Penem's 2.7 Assuming positive FDA resolution and timely
approval of penem's in US (one full year impact
in CY12)
Incremental EPS from savings 2.0
Total base business EPS 21.5
Total incremental EPS 4.7
incremental delta on FDA resolution 28.0%
Incremental value per share (20x incremental 94
EPS)
Less: Penality 20 Assuming one time penalty of USD200mn; few
media reports also indicated USD400mn penalty

Option value of FDA resolution 74

Source: Edelweiss research

……… extent of penalties remains a hangover


Given the extent of inquiry by DOJ, it seems a near certainty that RBXY will be asked to
pay financial penalties to settle the ongoing FDA issue. However, quantum of the penalty
cannot be estimated. The number of financial settlements, off-late, has increased, with
the FDA tightening its regulatory standards. Few of the recent settlements involving
large players are Glaxo (USD 750 mn), Schering Plough (USD 500 mn) and Genzyme
(USD 175 mn) in the branded space, while RBXY could be the first major settlement in
the generic counterpart.

We estimate the penalty to range from USD 200-400 mn (impact of INR 20-40 per
share). We believe the penalty could be a short-term negative for the stock; however,
complete resolution of the FDA issue is a long-term positive for the company.

108 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Table 9: Recent financial settlements with FDA


Date Company Facility FDA issue Settlement with the FDA Remarks
26-10-10 Glaxo Cidra, Pureto Manufacturing GSK has been asked to pay Equivalent to the revenue
Rico violations USD750mn of 4 products under
question

24-05-10 Genzyme Allston (US) Manufacturing Genzyme agreed to pay Equivalent to 18.5% of the
violations USD175mn under consent revenue Genzyme received
decree from selling these products

18-05-02 Schering - NJ and Pureto Violations of Schering signed a consent


Plough Rico manufacturing decree and paid a fine of
standards USD500mn
Source: Edelweiss research

„ Japan: Long-term growth driver


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

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Edel Pulse: Pharmaceuticals

Valuation

„ Positive FDA resolution or clarity on Lipitor launch critical to stock performance


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

Chart 6: Historical valuation trend—One year forward P/E


800

640
32x

480
24x
(INR)

320 16x

160 8x

0
Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Oct-06

Oct-07

Oct-08

Oct-09

Oct-10
Source: Edelweiss research

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


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

Table 10: SOTP base value (INR)


SOTP
Base business EPS Dec-12 16.9
Target P/E 20.0
Value of base business (INR per share) 338
NPV per share for one-off sales 94
Total target price 432
Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

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

„ Inability to monetise Lipitor exclusivity


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

„ Higher-than-expected penalty for FDA resolution


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

„ Significant delay in FDA resolution


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

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Edel Pulse: Pharmaceuticals

Company Description

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

Chart 7: Revenue mix

Latin America API Consumer


5% 6% Healthcare
3%
India
Asia Pacific 18%
5%

Europe, CIS,
Africa
28%
US & Canada
35%

Source: Company, Edelweiss research

Chart 8: Current shareholding pattern

Retail & others


17%

FII's
7%

MF & inst
12% Promoters
64%

Source: NSE

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Edel Pulse: Pharmaceuticals

Domestic Formulation Snapshot

Growth versus industry (%)


Mar 2011 (Month) MAT (Mar-11)
CAGR (5yr)
Incl bonus Excl bonus Incl bonus Excl bonus
Company growth 24.8 23.5 9.1 9.1 6.8
Industry growth 13.8 13.1 15.0 14.3 14.4
Relative performance

Therapeutic growth versus industry (MAT) (%) Top 10 brand performance (%)
Ranbax % of Market Growth Contrbution
% of Market Industry Contrbution Brands Therapy
Therapeutic area y total share rate to growth
total share growth to growth
growth
REVITAL Acute 5.7 87 17 8.2
Anti infective 35 8.1 6.8 13.4 21.7
STORVAS Chronic 5.5 22 17 7.8
CVS 16 4.9 20.2 16.5 25.5
MOX Acute 4.7 41 (1) (0.6)
Pain mgmt. 9 6.5 18.5 13.8 13.9 VOLINI Acute 4.6 49 49 14.8
Dermatology 9 8.1 12.1 14.4 9.1 CIFRAN Acute 4.0 34 (3) (1.2)
Gastro-intestinal 6 2.5 1.1 14.1 0.7 ZANOCIN Acute 2.6 20 8 1.9
CNS 6 3.6 5.0 14.1 2.6 CEPODEM Acute 2.6 13 25 5.0

Respiratory 4 2.1 6.5 14.5 2.2 SPORIDEX Acute 2.5 27 1 0.1


Urology 4 12.3 25.9 16.8 7.3 ROSUVAS Chronic 2.3 37 55 7.9
Anti-diabetics 3 2.3 9.2 21.0 2.4 CILANEM Acute 2.1 40 48 6.6

Chronic contribution to growth 32.7 Total 36.6 50.5

Therapy wise break-up Field force expansion and productivity


4,500 9
Others CVS CAGR (5%)
Urology
(No of medical reps)

9% 15% Chronic
3,900 7

Sales per rep (INR mn)


4%
CNS 28%
Pain mgmt. 6% 3,300 5
Anti-
9%
diabetics
3% 2,700 3
Gastro- Respiratory
4% 2,100 2
intestinal
6% Dermatology
9% 1,500 0
Anti CY06 CY07 CY08 CY09 CY10 CY11E
infective
35% Field force Productivity

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

16.0 15% 35 28
28 Industry21
Sales (INR bn)

11%
12.0 6 21 growth
14
14
(%)

8.0 6 7
3 7
0 0
2
4.0
Sun Pharma
Ranbaxy

Pfizer
Lupin
Cipla

Cadila
GSK

6
Dr Reddy's

4
0.0
Ranbaxy Industry
Volume Price New product introductions
Source: AIOCD, Edelweiss research

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Edel Pulse: Pharmaceuticals

Financial Outlook

„ 41% earnings CAGR in base business


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

Table 11: Differentiating base and Para IV (INR mn)


CY10 CY11E CY12E CAGR (%)
US 27,456 34,445 36,097 14.7
Base 12,624 12,782 14,748 8.1
Para IV 13,957 16,932 11,457 (9.4)
Nexium supply 875 4,731 9,892 236.3
Canada 2,791 3,020 3,321 9.1
Europe (Ex Romania) 8,786 9,442 9,986 6.6
Romania 3,661 4,032 4,516 11.1
Africa 7,047 10,049 11,053 25.2
CIS 4,622 5,227 5,958 13.5
India 17,557 19,706 22,832 14.0
Lat AM 3,798 4,294 4,867 13.2
Asia 4,576 5,040 5,594 10.6
API 5,217 5,387 5,656 4.1
Total revenue 85,510 100,641 109,881 13.4
Para IV 13,957 16,932 11,457 (9.4)
Base 70,679 78,977 88,532 11.9
EBIDTA 16,802 22,600 22,499 15.7
Base 6,108 8,472 11,291 36.0
Para IV 10,475 12,699 8,020 (12.5)
Nexium supply 220 1,429 3,187 280.8
PAT 12,929 14,989 14,548 6.1
Base 3,583 5,735 7,104 40.8
Para IV 9,182 8,254 5,213 (24.7)
Nexium supply 165 1,000 2,231 267.9
EPS 30.7 35.6 34.6 6.1
Base 8.5 13.6 16.9 40.8
Para IV 21.8 19.6 12.4 (24.7)
Nexium supply 0.4 2.4 5.3 267.9
Source: Edelweiss research

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Edel Pulse: Pharmaceuticals

Financial Statements
Income statement (INR mn)
Year to December CY08 CY09 CY10 CY11E CY12E
Income from operations 74,214 74,529 87,106 102,450 111,900
Net revenues 72,414 73,294 85,355 100,387 109,587
Licensing income 237 688 799 799 799
Other operating income 1,562 547 951 1,265 1,514
Total operating expenses 69,213 68,423 70,303 79,850 89,400
Materials cost 27,704 31,657 30,978 36,240 41,039
Employee cost 9,670 14,175 15,060 18,070 20,164
R&D cost 4,314 4,875 4,577 4,519 4,745
Selling, admin and general expenses 16,543 9,285 11,577 12,682 14,246
Other expenses 10,982 8,431 8,111 8,340 9,205
EBITDA 5,001 6,106 16,802 22,600 22,500
Depreciation and amortisation 2,825 2,676 3,397 3,107 3,348
EBIT 2,176 3,430 13,405 19,493 19,153
Net interest expense/(income) 2,055 710 614 1,832 1,614
Other income 2,706 2,402 2,795 2,514 2,653
Profit before tax (excl extraordinaries) 2,827 5,123 15,586 20,175 20,191
Provision for tax 0 1,102 1,447 3,637 5,452
Core profit 2,827 4,020 14,139 16,538 14,740
Extraordinary items (17,827) 4,976 5,415 (5,628) 0
Minority interest & others 163 142 185 142 192
Reported profit after minority interest (15,163) 8,854 19,369 10,769 14,548
Adjusted PAT after minority interest 2,234 3,586 12,929 14,989 14,548
Equity shares outstanding (mn) 420 420 421 421 421
EPS (INR) basic (36.1) 21.1 46.0 25.6 34.6
Diluted shares (mn) 420.4 420.4 421.0 421.0 421.0
EPS (INR) adjusted 5.3 8.5 30.7 35.6 34.6
CEPS (INR) 13.1 15.6 41.2 46.3 42.5
Dividend per share (INR) 0.0 0.0 2.0 3.6 3.5
Dividend payout (%) 0.0 0.0 6.5 10.0 10.0

Common size metrics- as % of net revenues


Year to December CY08 CY09 CY10 CY11E CY12E
Cost of revenues 37.3 42.5 35.6 35.4 36.7
Employee cost 13.0 19.0 17.3 17.6 18.0
Selling, admin and general expenses 22.3 12.5 13.3 12.4 12.7
R & D cost 5.8 6.5 5.3 4.4 4.2
Total operating expenses 93.3 91.8 80.7 77.9 79.9
Depreciation and amortisation 3.8 3.6 3.9 3.0 3.0
Interest expenditure 2.8 1.0 0.7 1.8 1.4
EBITDA margins 6.7 8.2 19.3 22.1 20.1
Net profit margins 3.9 5.5 16.6 16.5 13.5

Growth metrics (%)


Year to December CY08 CY09 CY10 CY11E CY12E
Revenues 9.4 0.4 16.9 17.6 9.2
EBITDA (45.3) 22.1 175.2 34.5 (0.4)
Net profit (68.3) 42.2 251.7 17.0 (10.9)
PBT (71.7) 81.2 204.3 29.4 0.1
Adj. EPS (59.6) 60.5 260.6 15.9 (2.9)

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Edel Pulse: Pharmaceuticals

Balance sheet (INR Mn)


As on 31st December FY09E CY09 CY10 CY11E CY12E
Equity capital 2,102 2,102 2,105 2,105 2,105
Share warrants/appliaction money 1,757 1,759 66 66 66
Reserves & surplus 39,104 39,573 53,876 62,892 75,740
Total shareholders funds 42,962 43,434 56,047 65,064 77,911
Borrowings 43,114 36,295 43,348 26,176 20,176
Deferred tax liability (net) (12,229) (4,746) (227) (227) (227)
Minority interest 675 533 647 789 981
Sources of funds 74,522 75,517 99,815 91,801 98,840
Gross block 61,942 62,785 67,050 72,837 78,500
Depreciation 17,042 17,880 21,571 23,768 26,856
Net block 44,900 44,906 45,479 49,069 51,644
Capital work in progress 4,707 6,231 3,818 3,663 3,583
Total fixed assets 49,607 51,137 49,296 52,732 55,227
Investments 5,432 5,407 4,985 4,985 4,985
Inventories 19,643 18,407 21,926 25,558 27,886
Sundry debtors 13,310 18,400 16,053 18,873 20,602
Cash and bank balances 23,956 12,416 32,644 14,926 19,735
Loans and advances 10,012 10,863 16,309 18,025 19,313
Total current assets 66,922 60,086 86,932 77,382 87,536
Sundry creditors 8,183 14,394 18,977 21,556 24,498
Other current liabilities 31,536 18,117 12,888 15,717 17,097
Provisions 7,720 8,602 9,534 6,024 7,313
Total current liabilities and provisions 47,438 41,112 41,398 43,297 48,908
Net current assets 19,484 18,974 45,534 34,084 38,628
Uses of funds 74,522 75,518 99,815 91,801 98,840
Book value per share ( INR) 102 103 133 155 185

Free cash flow (INR mn)


Year to December CY08 CY09 CY10 CY11E CY12E
Net profit (15,163) 8,854 19,369 10,769 14,548
Depreciation 2,825 2,676 3,397 3,107 3,348
Others 51,026 (38,597) (50,780) (45,377) (34,412)
Gross cash flow 38,688 (27,067) (28,014) (31,502) (16,517)
Less: Changes in WC (23,526) 11,031 6,332 6,269 (266)
Operating cash flow 15,161 (16,036) (21,682) (25,233) (16,783)
Less: Capex (6,813) (4,206) (1,557) (6,542) (5,843)
Free cash flow 8,349 (20,242) (23,239) (31,775) (22,626)

Cash flow metrices


Year to December CY08 CY09 CY10 CY11E CY12E
Operating cash flow 15,161 (16,036) (21,682) (25,233) (16,783)
Financing cash flow 16,391 (6,350) 19,599 (8,156) 6,847
Investing cash flow (21,945) (3,079) (11,798) (16,089) (20,794)
Net cash flow 9,607 (25,465) (13,881) (49,477) (30,730)
Capex (6,813) (4,206) (1,557) (6,542) (5,843)
Dividends paid (43,065) (43,537) (56,180) (65,218) (78,096)

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Edel Pulse: Pharmaceuticals

Profitability and liquidity ratios


Year to December CY08 CY09 CY10 CY11E CY12E
ROAE (%) 7.5 9.0 28.1 27.1 20.4
ROACE (%) 4.0 6.7 22.4 29.1 26.2
Inventory days 234 216 234 236 234
Debtors days 68 77 71 61 63
Payable days 109 128 194 201 202
Cash conversion cycles 194 165 112 96 96
Current ratio 1.4 1.5 2.1 1.8 1.8
Debt/ EBITDA 8.6 5.9 2.6 1.2 0.9
Debt/equity 1.0 0.8 0.8 0.4 0.3
Adjusted debt/Equity 1.0 0.8 0.8 0.4 0.3

Operating ratios (x)


Year to December CY08 CY09 CY10 CY11E CY12E
Total asset turnover 1.0 1.0 1.0 1.0 1.1
Fixed asset turnover 1.7 1.6 1.9 2.1 2.2
Equity turnover 2.0 1.7 1.7 1.7 1.5

Du Pont Analysis
Year to December CY08 CY09 CY10 CY11E CY12E
NP margin 3.7 5.3 16.3 16.3 13.3
Total assets turnover 1.0 1.0 1.0 1.0 1.1
Leverage multiplier 2.1 1.7 1.8 1.6 1.3
ROAE 7.5 9.0 28.1 27.1 20.4

Valuation parameters
Year to December CY08 CY09 CY10 CY11E CY12E
Adjusted EPS (INR) 5.3 8.5 30.7 35.6 34.6
EPS YoY growth (%) (59.6) 60.5 260.6 15.9 (2.9)
CEPS (INR) 13.1 15.6 41.2 46.3 42.5
Diluted PE (x) 88.2 55.0 15.2 13.1 13.5
Price/BV(x) 4.6 4.5 3.5 3.0 2.5
EV/Sales (x) 2.8 2.9 2.3 2.0 1.7
EV/EBITDA (x) 42.2 35.3 12.1 9.0 8.6
Dividend yield (%) 0.0 0.0 0.4 0.8 0.7

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THIS PAGE IS INTENTIONALLY LEFT BLANK

118 Edelweiss Securities Limited


India Equity Research | Pharmaceuticals Company Update
Edel Pulse: Pharmaceuticals
SUN PHARMACEUTICALS
Undisputed leader

„ Differentiated strategy in domestic market to render higher growth April 25, 2011
Sun Pharma (SUNP), with its unique ability to identify therapeutic gap areas and
launch products ahead of market, dominates the Indian chronic therapy segment Reuters: SUN.BO Bloomberg: SUNP IN

(62% of domestic sales). The company also tops our survey results and has
emerged an undisputed choice among distributors. SUNP has innovatively built its EDELWEISS 4D RATINGS

doctors franchise by engaging them at an early stage, which enables it to retain Absolute Rating Hold

market share. It is now focused on building a wider product portfolio in other Rating Relative to Sector Outperformer

therapies (such as respiratory) and plans to launch 15 products per annum. Recent Risk Rating Relative to Sector Low
tie-up with Merck for differentiated products is likely to further augment the Sector Relative to Market Equalweight
company’s product pipeline for domestic market, in our view. We expect the Note:
Please refer last page of the report for rating explanation
domestic business to grow at 20% CAGR over FY10-13E, higher than peers.
MARKET DATA
„ Margin upsides from core business CMP : INR 446

We expect Taro’s operating margin (27%) to remain under pressure due to lack of 52-week range (INR) : 511 / 303

new products in its R&D pipeline, pricing pressure on existing base of business and Share in issue (mn) : 1,035.6

integration risk. We expect SUNP’s core EBITDA margins (including Taro) to improve M cap (INR bn/USD mn) : 461.9 / 10,402.5
by 120 bps over FY12-13E, led by higher contribution from domestic and emerging Avg. Daily Vol. BSE/NSE (‘000) : 1,087.0

markets and expected ramp-up from Caraco in H2 FY12.


SHARE HOLDING PATTERN (%)

Promoters* : 63.7
„ Current pipeline offers upsides to US generics business
MFs, FIs & Banks : 6.7
SUNP currently has a large pipeline of 149 pending approvals (including 28
FIIs : 19.0
pending Taro and 29 pending Caraco), which will support sustainable growth in
US generics over the next three-four years. We expect the US base business Others : 10.6

(ex-taro) to post 15% CAGR over FY11-13E, while special products (Taxotere, * Promoters pledged shares
: 0.4
(% of share in issue)
Gemzar, Stalevo) would contribute USD 145-150 mn of sales.
PRICE PERFORMANCE (%)

Stock Nifty EW Pharma


„ ROW markets to depict strong growth trajectory Index

The company expects ROW to post strong double-digit growth over the next 3-4 1 month 2.6 8.9 5.5

years and is, therefore, raising its localised therapeutic focus. Moreover, the 3 months (8.7) 2.5 (7.0)

current tie-up with Merck adds visibility for higher growth from these markets.
12 months 24.7 11.9 18.0

„ Outlook and valuations: Strong levers for growth; maintain ‘HOLD’


We are positive on SUNP over the long term due to its strong franchise in
domestic market and growth potential in the US. However, current valuations
fully discount base business growth and incremental upsides from exclusivity-
driven revenues in the US. We maintain ‘HOLD/Sector Outperformer’
recommendation/rating on the stock.
Financials
Year to March FY10 FY11E FY12E FY13E
Revenues (INR mn) 40,075 49,440 52,113 62,218
Rev growth (%) (4.2) 23.4 5.4 19.4 Manoj Garg

Operating profit (INR mn) 13,633 18,068 18,213 21,854 +91 22 6623 3302

Adj. Net profit (INR mn) 13,194 16,551 17,113 20,671 manoj.garg@edelcap.com

Shares outstanding (mn) 1,035.6 1,035.6 1,035.6 1,035.6


Peril Ali
EPS (INR) 12.7 16.0 16.5 20.0
+91 22 6620 3032
EPS growth (%) (27.4) 25.4 3.4 20.8
perin.ali@edelcap.com
P/E (x) 35.0 27.9 27.0 22.3
EV/EBITDA (x) 31.5 23.1 22.3 18.0

Edelweiss Research is also available on www.edelresearch.com,, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss
Edelweiss Securities Securities119
Limited Limited
Edel Pulse: Pharmaceuticals

Table 1: Financial Snapshot (INR mn)


FY10 FY11E FY12E FY13E
SUNP Taro C onsol SUNP Taro C onsol SUNP Taro C onsol
Revenue 38,086 49,440 8,830 58,269 52,113 18,554 70,667 62,218 19,481 81,699
Growth (%) 29.8 53.0 5.4 21.3 19.4 15.6
EBITDA 13,633 18,068 2,440 20,507 18,213 4,657 22,871 21,854 4,982 26,835
EBITDA margin (%) 35.8 36.5 27.6 35.2 34.9 25.1 32.4 35.1 25.6 32.8
EBITDA margin (ex-one off) % 26.3 30.5 27.6 30.0 32.5 25.1 30.5 33.0 25.6 31.2
PBT 13,815 18,250 1,715 19,964 18,669 3,381 22,050 22,550 3,658 26,208
Adj PAT 13,194 16,551 1,272 17,391 17,113 2,536 18,787 20,671 2,744 22,481
Margin (%) 34.6 33.5 14.4 29.8 32.8 13.7 26.6 33.2 14.1 27.5
EPS 12.7 16.0 1.2 16.8 16.5 2.4 18.1 20.0 2.6 21.7
- C ore EPS 8.8 12.1 1.2 12.9 16.3 2.4 17.9 19.5 2.6 21.2
- Special products (one-off) 4.0 3.9 3.9 0.3 0.3 0.5 0.5
Source: Edelweiss research

Table 2: Revenue mix (Consolidated, including Taro) (INR mn)


Year to March FY10 FY11E % change FY12E % change FY13E % change
Total formulations 34,246 52,460 53.2 64,290 22.6 74,717 16.2
Domestic formulations 18,301 22,831 24.7 27,000 18.3 31,866 18.0
International formulations 15,945 29,629 85.8 37,290 25.9 42,851 14.9
- of which C araco (USD mn) 22 25 12.2 40 60.0 80 100.0
- of which Taro (USD mn) 192 412 114.8 433 5.0
Total bulk 5,491 5,727 4.3 6,288 9.8 6,893 9.6
Domestic bulk 1,021 1,123 10.0 1,224 9.0 1,322 8.0
International bulk 4,470 4,604 3.0 5,064 10.0 5,571 10.0
Others 78 82 6.1 89 7.6 90 1.5
Total sales 39,815 58,269 46.4 70,667 21.3 81,699 15.6
Source: Edelweiss research

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


600 26x

480
19x

360
(INR)

12x
240

120 5x

0
Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Source: Edelweiss research

120 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Table 3: SOTP based value (INR)


SOTP
Base business EPS Mar-13 21.2
Target P/E 22.0
Value of base business (INR per share) 467
NPV per share for one-off sales 10
Total target price 477
Source: Edelweiss research

Table 4: Niche product pipeline (including Para IV filings) for US market


Market No. of
Brand Name Molecule Innovator Size Launch date generic Type
(USD mn) players
Taxotere Docetaxel Sanofi Aventis 1100 Any time 3
C ardizem C D DILTIAZEM Biovail 70 Waiting approval 1
Gemzar Gemcitabine Eli Lilly 600 May'11 6
Gabitril Tiagabine C ephalon 60 Sep'11/ April'12 1 Para IV
Prandin Repaglinide Novo Nordisk 250 March'12 1 Para IV
C arvidopa/Levadopa/
Stalevo Orion 120 April'12 1 Para IV
Entacapone
Lyrica Pregabalin Pfizer 1596 July'12 8 Para IV
Eloxatin oxaliplatin Sanofi Aventis 1000 Aug'12 4
C omtan Entacapone Orion 90 April'13 2
C ymbalta Duloxitine Eli Lilly 2896 June'13 10 Para IV
Lunesta Eszopiclone Sepracor 760 May'14 Multiple Para IV
Strattera Atmoxitine HC L Eli Lilly 500 Not confirmed 10 Para IV
Gleevec Imatinib Novartis 1000 July'15 1 Para IV
Namenda Memantine Forest 1300 Jan'15 Multiple Para IV
Source: Edelweiss research

Edelweiss Securities Limited 121


Edel Pulse: Pharmaceuticals

Company Description

Promoted by Mr. Dilip S Shanghvi, a first generation entrepreneur, SUNP is India’s fourth
largest pharmaceutical company. It is also one of the fastest growing Indian pharmaceutical
companies with revenue and profit growth of 26% CAGR and 30% CAGR over FY05/10,
respectively. It also has one of the highest margins amongst its domestic peers. SUNP has
significant presence in the domestic formulation and the US generic market. Indian domestic
formulations sales, at INR 18 bn in FY10, constitute almost 45% of sales. With over 3,000
medical reps, SUNP has a market share of 3.7% and is a top five player in the Indian
domestic market. It has been consistently ranked #1 across leading therapeutic categories
like psychiatry, neurology and CVs. Taro’s acquisition in the US generics space augments its
ANDA pipeline with products differentiated in dermatology and pediatrics therapies.

Chart 2: Revenue mix (%)

Excluding Taro Including Taro


APIs APIs
12% 10%
Domestic
formulatio
ns
32%
Domestic
formulatio
US ns
generics 46%
29%
US
generics
44%
ROW
ROW markets
markets (ex-US)
(ex-US) 14%
13%
Source: Edelweiss research

Chart 3: Shareholding pattern

Retail & others


10%

FII's
19%

Promoters
MF & inst
64%
7%

Source: NSE

122 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Domestic Formulation Snapshot

Growth versus industry (%)


Mar 2011 (Month) MAT (Mar-11)
CAGR (5yr)
Incl bonus Excl bonus Incl bonus Excl bonus
Company growth 24.7 25.2 21.3 21.3 21.9
Industry growth 13.8 13.1 15.0 14.3 14.4
Relative performance

Therapeutic growth versus industry (MAT) (%) Top 10 brand performance (%)
% of Market Sun Contrbution
Therapeutic area Industry % of Market Growth Contrbution
total share growth to growth Brands Therapy
total share rate to growth
Neuro-psychiatry 27 16.4 19.5 14.1 25.5
Cardiology 19 6.2 19.6 16.5 19.5 PANTOCID Acute 3.1 19.2 17.7 2.7

Gastroentrology 14 4.9 23.2 14.1 14.1 SUSTEN Acute 2.5 26.1 14.0 1.8
GLUCORED Chronic 2.4 59.7 9.2 1.1
Diabetology 11 6.8 26.9 21.0 11.0
AZTOR Chronic 2.4 8.6 16.8 1.9
Gyneacology 7 6.8 19.1 21.9 7.1
GEMER Chronic 2.0 9.9 28.7 2.5
Pain 5 3.3 36.8 13.8 7.6
Respiratory 5 2.3 12.6 14.5 2.7 PANTOCID DSR Acute 1.6 14.7 22.0 1.7

Chronic contribution to growth 58.7 OXETOL Chronic 1.5 36.3 23.2 1.6
CLOPILET Chronic 1.4 20.6 16.7 1.1
ENCORATE
Chronic 1.4 57.7 9.6 0.7
CHRONO
STROCIT Chronic 1.4 22.7 6.9 0.5
Total 19.6 15.6

Therapy wise break-up Field force expansion and productivity


Others Respiratory 2,750 10
Opthalmolo CAGR 12.7%
(No of medical reps)

8% 5%
gy

Sales per rep (INR mn)


Cardiology 2,500 8
4% 19%
Pain mgmt. 2,250 6
5% Chronic
Diabetology 2,000 4
Gyneacolog 11% 62%
y 1,750 2
7%
1,500 0
Gastroentro Neuro-
FY06

FY07

FY08

FY09

FY10

FY11E

logy psychiatry
14% 27%
Field force Productivity

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


25.0 35
21%
20.0 28
Sales (INR bn)

7 15% 21 Industry
15.0 growth
(%)

2 6 14
10.0
3 7
5.0 12
6 0
Ranbaxy

Pharma

Pfizer
Lupin
Cipla

Cadila
GSK

0.0
Reddy's
Sun

Dr

Sun Pharma Industry


Volume Price New product introductions
Source: AIOCD, Edelweiss research

Edelweiss Securities Limited 123


Edel Pulse: Pharmaceuticals

Key Risks

„ Excessive dependence on metro/tier-I markets


SUNP’s domestic focus in chronic therapy is largely restricted to metros and tier–I
markets and specialists/super specialists doctors. Hence, rising competition in these
markets/segments, for chronic therapies, can be a potential risk to company’s domestic
growth.

„ Rupee appreciation
Rapid rupee appreciation could impact our sales estimate, especially on international
revenues which are currently based on a currency estimate of USD/INR of INR 46 and
INR 45 for FY12E and FY13E, respectively.

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

124 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Financial Statements (Ex-Taro)


Income statement (INR mn)
Year to March FY09 FY10 FY11E FY12E FY13E
Income from operations 41,833 40,075 49,440 52,113 62,218
Net revenues 41,833 38,086 49,440 52,113 62,218
Other operating income 0 1,988 0 0 0
Total operating expenses 23,194 26,441 31,372 33,900 40,364
Materials cost 8,556 10,977 14,585 14,435 17,608
Employee cost 3,401 4,008 4,729 5,439 6,146
R&D cost 3,099 2,083 3,584 3,856 4,666
Selling, admin and general expenses 5,278 6,143 5,015 6,138 7,226
Other expenses 2,860 3,230 3,458 4,032 4,718
Operating income 18,640 13,633 18,068 18,213 21,854
Depreciation and amortisation 1,233 1,533 1,591 1,716 1,842
EBIT 17,407 12,100 16,477 16,497 20,012
Interest expense/(income) (1,217) (1,138) (1,338) (1,676) (2,042)
Other income 868 576 435 497 497
Profit before tax 19,492 13,815 18,250 18,669 22,550
Provision for tax 712 679 1,186 1,027 1,240
Core profit 18,780 13,136 17,063 17,642 21,310
Extraordinary items 0 334 0 0 0
Profit after tax 18,780 13,470 17,063 17,642 21,310
Minority interest & others 603 (41) 512 529 639
Profit after minority interest 18,177 13,511 16,551 17,113 20,671
Adjusted PAT after minority interest 18,177 13,194 16,551 17,113 20,671
Equity shares outstanding (mn) 1,036 1,036 1,036 1,036 1,036
EPS (INR) adjusted 17.6 12.7 16.0 16.5 20.0
Diluted shares (mn) 1,036 1,036 1,036 1,036 1,036
Recurring EPS (INR) fully diluted 12.9 8.8 12.1 16.3 19.5
CEPS (INR) 1.2 14.2 17.5 18.2 21.7
Dividend per share (INR) 3.1 3.2 2.9 3.0 3.6
Dividend payout (%) 17.7 25.2 18.1 18.1 18.1

Common size metrics- as % of net revenues


Year to March FY09 FY10 FY11E FY12E FY13E
Cost of revenues 20.5 27.4 29.5 27.7 28.3
Selling, admin and general expenses 12.6 15.3 10.1 11.8 11.6
R & D cost 7.4 5.2 7.3 7.4 7.5
Other expenses 6.8 8.1 7.0 7.7 7.6
Total operating expenses 55.4 66.0 63.5 65.1 64.9
Depreciation and amortisation 2.9 3.8 3.2 3.3 3.0
Interest expenditure (2.9) (2.8) (2.7) (3.2) (3.3)
EBITDA margins 44.6 34.0 36.5 34.9 35.1
Net profit margins 44.9 34.5 34.5 33.9 34.3

Growth metrics (%)


Year to March FY09 FY10 FY11E FY12E FY13E
Revenues 27.1 (4.2) 23.4 5.4 19.4
EBITDA 20.2 (26.9) 32.5 0.8 20.0
Net profit 21.1 (30.1) 29.9 3.4 20.8
PBT 21.9 (29.1) 32.1 2.3 20.8
EPS (10.3) (31.9) 38.0 34.3 19.8

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Edel Pulse: Pharmaceuticals

Balance sheet (INR mn)


As on 31st March FY09E FY10 FY11E FY12E FY13E
Equity capital 1,036 1,036 1,036 1,036 1,036
Reserves & surplus 69,414 77,254 90,810 104,827 121,758
Common shareholders equity 70,449 78,289 91,846 105,863 122,793
Total shareholders funds 70,449 78,289 91,846 105,863 122,793
Secured loans 227 479 479 479 479
Unsecured loans 1,562 1,233 733 733 733
Borrowings 1,789 1,712 1,212 1,212 1,212
Deferred tax liability (net) (679) (890) (890) (890) (890)
Minority interest 1,970 1,932 2,444 2,973 3,612
Sources of funds 73,530 81,042 94,611 109,157 126,727
Gross block 21,476 23,340 25,340 27,340 29,340
Depreciation 6,851 8,013 9,603 11,320 13,162
Net block 14,625 15,328 15,737 16,021 16,178
Capital work in progress 1,571 1,448 500 500 500
Intangible assets & goodwill 3,253 4,060 4,060 4,060 4,060
Investments 18,595 30,664 30,664 30,664 30,664
Inventories 9,757 10,739 11,865 12,507 14,372
Sundry debtors 8,811 11,748 14,832 15,634 17,732
Cash and bank balances 16,690 6,073 17,396 29,758 43,315
Loans and advances 7,425 8,562 8,899 9,406 11,230
Total current assets 42,683 37,121 52,992 67,306 86,650
Current liabilities 2,648 2,693 4,084 3,898 4,754
Provisions 4,550 4,886 5,259 5,496 6,572
Total current liabilities and provisions 7,198 7,579 9,343 9,393 11,326
Net current assets 35,485 29,542 43,650 57,912 75,324
Uses of funds 73,530 81,042 94,611 109,157 126,727
Book value per share ( INR) 68 76 89 102 119

Free cash flow


Year to March FY09 FY10 FY11E FY12E FY13E
Net profit 18,177 13,511 16,551 17,113 20,671
Depreciation 1,233 1,533 1,591 1,716 1,842
Others 122 (469) 512 529 639
Gross cash flow 19,532 14,575 18,654 19,359 23,152
Less:Changes in WC 1,818 (4,675) (2,785) (1,900) (3,855)
Operating cash flow 21,350 9,901 15,870 17,458 19,297
Less: Capex (7,914) (2,920) (1,052) (2,000) (2,000)
Free cash flow 13,437 6,981 14,818 15,458 17,297

Cash flow metrices


Year to March FY09 FY10 FY11E FY12E FY13E
Operating cash flow 21,350 9,901 15,870 17,458 19,297
Financing cash flow 1,902 (5,529) (3,495) (3,096) (3,740)
Investing cash flow (19,944) (14,989) (1,052) (2,000) (2,000)
Net cash flow 3,308 (10,618) 11,323 12,362 13,557
Capex (7,914) (2,920) (1,052) (2,000) (2,000)
Dividends paid (3,215) (3,321) (2,995) (3,096) (3,740)

126 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Profitability and liquidity ratios


Year to March FY09 FY10 FY11E FY12E FY13E
ROAE (%) 30.2 17.7 19.5 17.3 18.1
ROACE (%) 48.6 29.3 36.3 34.6 39.4
Inventory days 373 341 283 308 279
Debtors days 100 94 98 107 98
Payable days 109 89 85 101 90
Cash conversion cycles 364 346 296 314 287
Current ratio 5.9 4.9 5.7 7.2 7.7
Debt/ EBITDA 0.1 0.1 0.1 0.1 0.1

Operating ratios (x)


Year to March FY09 FY10 FY11E FY12E FY13E
Total asset turnover 0.7 0.5 0.6 0.5 0.5
Fixed asset turnover 3.3 2.5 3.2 3.3 3.9
Equity turnover 0.7 0.5 0.6 0.5 0.5

Du pont analysis
Year to March FY09 FY10 FY11E FY12E FY13E
NP margin 43.5 34.6 33.5 32.8 33.2
Total assets turnover 0.7 0.5 0.6 0.5 0.5
Leverage multiplier 1.1 1.0 1.0 1.0 1.0
ROAE 30.2 17.7 19.5 17.3 18.1

Valuation parameters
Year to March FY09 FY10 FY11E FY12E FY13E
Diluted EPS (INR) 17.6 12.7 16.0 16.5 20.0
EPS YoY growth (%) 22.2 (27.4) 25.4 3.4 20.8
CEPS (INR) 1.2 14.2 17.5 18.2 21.7
Diluted PE (x) 25.4 35.0 27.9 27.0 22.3
Price/BV(x) 6.6 5.9 5.0 4.4 3.8
EV/Sales (x) 10.3 10.7 8.4 7.8 6.3
EV/EBITDA (x) 23.1 31.5 23.1 22.3 18.0
Dividend yield (%) 0.7 0.7 0.6 0.7 0.8

Edelweiss Securities Limited 127


Edel Pulse: Pharmaceuticals

THIS PAGE IS INTENTIONALLY LEFT BLANK

128 Edelweiss Securities Limited


India Equity Research | Pharmaceuticals Company Update Edel Pulse: Pharmaceuticals

TORRENT PHARMACEUTICALS
Strong play on branded generics

„ Strong domestic formulations growth over FY11-13


April 25, 2011
Torrent Pharma’s (TRP) domestic focus on the high growth chronic segment
(62% of domestic sales), with leading market share in CVS and CNS, imparts
Reuters: TORP.BO Bloomberg: TRP IN
higher growth than the industry. Moreover, with strong focus on brand building
and higher field force stability, the company is gaining strong traction in metros
EDELWEISS 4D RATINGS
and tier I cities, as per our survey. We expect its domestic business to post 18%
Absolute Rating BUY
CAGR over FY11-13E after registering 16-17% growth in FY10-11, led by growth
Rating Relative to Sector Outperformer
in covered market and ramp-up of new divisions.
Risk Rating Relative to Sector High

Sector Relative to Market Equalweight


„ Field force expansion, new launches to boost margin from H2 FY12
Note:
The company has been in consolidation phase with significant investments over Please refer last page of the report for rating explanation

the past 12-14 months, which has impacted its operating performance. EBITDA
margins declined 170 bps from 21.5% in FY10 to 19.8% in 9m FY11, while
MARKET DATA
earnings growth has been mute. We expect margin pressure to continue in
CMP INR 591
:
H1FY12 with commissioning of the Sikkim facility; however, margins are likely to
52-week range (INR) 640 / 490
:
recover from H2FY11 as domestic field force ramp up and new launches in
Share in issue (mn) 84.6
:
Brazil/Mexico start attaining critical mass. We expect EBITDA margins to improve
M cap (INR bn/USD mn) 50.0 / 1,127.4
:
100-120 bps over FY13E.
Avg. Daily Vol. BSE/NSE (‘000): 76.9

„ 27% earnings CAGR over FY11-13E likely


SHARE HOLDING PATTERN (%)
We expect TRP’s earnings to post 27% CAGR over FY11-13E on back of
improvement in operating margins and robust revenue growth, as investments Promoters* : 71.5

start gaining traction. We estimate 19% revenue CAGR over FY11-13 driven by: MFs, FIs & Banks : 12.8

(a) strong growth in domestic business; (b) scaling up of Mexico; (c) new FIIs : 3.6

product launches in Brazil and Europe; and (d) ramp-up in US generics (USD 60 Others : 12.2
mn in FY13E from USD 30 mn in FY11E). Moreover, TRP’s strategic tie ups (AZN) * Promoters pledged shares
: NIL
(% of share in issue)
for emerging markets will add further momentum to earnings.

PRICE PERFORMANCE (%)


„ Outlook and valuations: Positive upsides; maintain ’BUY’ Stock Nifty EW Pharma
TRP has set itself a goal of expanding into higher value branded generics Index

markets of India, Brazil, Mexico, and other emerging markets. Moreover, the 1 month 12.4 8.9 5.5

company has been consistently ramping up filings to establish a strong base in 3 months 0.5 2.5 (7.0)

US and Europe. We believe these investments should start gaining traction, 12 months 14.2 11.9 18.0
thereby contributing higher to overall growth and profits. We reiterate
‘BUY/Sector Outperformer’ recommendation/rating. Torrent offers higher
upside in our coverage universe.

Financials
Year to March FY10 FY11E FY12E FY13E
Revenues (INR mn) 19,040 22,586 26,616 32,142
Rev growth (%) 16.8 18.6 17.8 20.8
EBITDA (INR mn) 4,087 4,414 5,323 6,679
Manoj Garg
Adjusted net profit (INR mn) 2,687 2,973 3,608 4,614
+91 22 6623 3302
Shares outstanding (mn) 84.6 84.6 84.6 84.6
manoj.garg@edelcap.com
Adj. Diluted EPS (INR) 31.8 35.1 42.6 54.5
EPS growth (%) 24.8 10.6 21.3 27.9
Peril Ali
P/E (x) 18.6 16.8 13.9 10.8
+91 22 6620 3032
EV/EBITDA (x) 12.2 11.3 9.2 7.1
perin.ali@edelcap.com
ROAE (%) 36.3 31.3 29.7 29.9

Edelweiss Research is also available on www.edelresearch.com,, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. EdelweissLimited
Edelweiss Securities Securities129
Limited
Edel Pulse: Pharmaceuticals

Table 1: Financial snapshot (INR mn)


FY10 FY11E % Y-o-Y FY12E % Y-o-Y FY13E % Y-o-Y
Net sales 19,040 22,586 18.6 26,616 17.8 32,142 20.8
- Domestic formulations 7,254 8,465 16.7 10,019 18.4 12,023 20.0
- Brazil/Mexico 3,006 3,645 21.2 4,414 21.1 5,250 18.9
- Heumann 2,547 2,928 15.0 3,074 5.0 3,228 5.0
- US 909 1,343 47.8 2,025 50.8 2,813 38.9
- EU 1,163 1,314 13.0 1,551 18.0 1,830 18.0
Gross profit 13,315 15,630 17.4 18,631 19.2 22,499 20.8
Gross margins (%) 69.9 69.2 70.0 70.0
EBITDA 4,087 4,414 8.0 5,323 20.6 6,679 25.5
EBITDA margin (%) 21.5 19.5 20.0 20.8
EBITDA margin (ex-milestone) 18.4 16.3 17.8 18.9
PBT 3,652 3,847 5.3 4,625 20.2 5,915 27.9
Tax 1,160 873 (24.7) 1,018 16.5 1,301 27.9
Tax rate (%) 31.8 22.7 22.0 22.0
Reported PAT 2,312 2,973 28.6 3,608 21.3 4,614 27.9
Adjusted PAT 2,687 2,973 10.6 3,608 21.3 4,614 27.9
Adjusted EPS 31.8 35.1 10.6 42.6 21.3 54.5 27.9
Source: Edelweiss research

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


800 14x

640 11x

480
8x
(INR)

320
5x

160

0
Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11
Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Source: Edelweiss research

130 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Company Description

TRP, founded in 1959, is headed by Mr. Samir Mehta, a second generation entrepreneur. The
company is a leading player in the branded generics space in India and Brazil. Domestic
formulations is the largest segment contributing 39% to FY11 sales. It is the second largest
domestic player in the chronic segment (CNS, CV, and anti-diabetic) which contributes 62%
to its portfolio. The company’s branded generics business in Brazil is the second largest
segment and contributed 16% to total sales in FY10 and is one of the largest operations by
an Indian company in this crucial market. Apart from branded generics, the company is also
present in regulated markets of US/Europe. It is also involved in the contract manufacturing
business with Novo Nordisk for supplying insulin.

Chart 2: Revenue mix


CRAMS
10%
US
6%
Domestic
ROW formulations
6% 39%

Germany
(Heumann)
14%

EU
6%
Russia Brazil
2% 17%

Source: Edelweiss research

Chart 3: Shareholding pattern

Retail & others


12%
FII's
4%

MF & inst
13%

Promoters
71%

Source: NSE

Edelweiss Securities Limited 131


Edel Pulse: Pharmaceuticals

Domestic Formulations Snapshot


Growth versus Industry (%)
Mar 2011 (Month) MAT (Mar-11)
CAGR (5yr)
Incl bonus Excl bonus Incl bonus Excl bonus
Company growth 13.9 13.2 21.4 20.8 20.1
Industry growth 13.8 13.1 15.0 14.3 14.4
Relative performance

Therapeutic growth versus Industry (MAT) (%) Top 10 brand performance (%)
% of Market Torrent Industry Contrbution % of Market Growth Contrbution
Therapeutic area Brands Therapy
total share Growth Growth to growth total share rate to growth

CV 35.0 3.5 12.6 16.5 20.5 ALPRAX Chronic 4.3 25.8 15.3 3.3

CNS 20.0 4.4 17.0 14.1 16.9 TOPCEF Acute 4.1 4.7 66.3 9.2
DILZEM Chronic 3.8 45.4 13.0 2.5
Gastrointestinal 19.0 2.6 44.9 14.1 22.0
NIKORAN Chronic 3.7 45.7 10.4 2.0
Anti-infectives 11.0 1.1 14.4 13.4 25.5
DOMSTAL Acute 3.7 63.5 20.8 3.6
Anti-diabetics 7.0 1.5 23.3 21.0 4.0
DROXYL Acute 2.5 15.1 8.9 1.2
Pain mgmt. 4.0 0.8 21.4 13.8 3.5
NEBICARD Chronic 2.4 33.2 16.1 1.9
Chronic contribution to growth 41.4
AZULIX-MF Chronic 2.0 3.7 29.4 2.6
NEXPRO RD Acute 2.0 34.1 49.5 3.8
NEXPRO Acute 1.9 22.9 32.8 2.7
Total 30.4 32.6

Therapy wise break-up Field force expansion and productivity trend


Pain Anti- 4,000 2.5
CAGR 10.8%
mgmt. diabetics
4% 7% 3,500 2.0

Sales per rep (INR mn)


(No of medical reps)

Anti- CVS
3,000 1.5
infectives 35%
Chronic
11% 62% 2,500 1.0

Gastrointe 2,000 0.5


stinal
19% 1,500 0.0

Others FY06 FY07 FY08 FY09 FY10 FY11E


CNS
4% 20% Field force Productivity

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


25.0 35 30

20.0 28 24
6 Industry
Sales (INR bn)

21 18
15.0 0.4 growth
(%)

6 14 12
10.0
15 3 7 6
5.0 0 0
6
Reddy's
Cadila
Pharma

Pharma
Intas

Torrent
IPCA
Lupin
Cipla

0.0
Sun

Dr

Torrent pharma Industry


Volume Price New product introductions
Source: AIOCD, Edelweiss research

132 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Key Risks

„ Slippages in domestic business could hurt revenue growth


TRP’s track record in the domestic business has been uneven. Continued execution
issues in semi-urban and rural markets could slowdown the business and have a
disproportionate impact on overall company growth and margins.

„ Forex impact from adverse currency movement


Over the past quarter, USD and INR have been appreciating against EUR due to concerns
over deficits in Greece, Portugal, and Spain. TRP has fully hedged its exposure in Europe;
however, adverse currency movements could lead to translation losses. We have not
included the forex impact in our estimates.

„ Delay in product launches in Brazil


Our revenue assumptions for Brazil market estimate ~60 product launches in the next
three-five years, which is aggressive. Any slippage on product introductions could
negatively impact sales growth in this critical market.

„ Capacity constraints
TRP has been envisaging capacity constraints due to significant ramp-up in various
geographies and entry in new markets. The company has planned capital investments of
INR 10 bn over the next three-five years. Any delay in commissioning of facilities could
have a disproportionate impact on growth in various markets and could have long-term
implications on licensing contracts.

Edelweiss Securities Limited 133


Edel Pulse: Pharmaceuticals

Financial Statements

Income statement (INR mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Income from operations 16,307 19,040 22,586 26,616 32,142
Gross revenues 16,169 18,673 22,158 26,443 32,056
Less: Excise 304 344 443 529 641
Net revenues 15,865 18,329 21,715 25,914 31,415
Other operating income 441 710 871 702 727
Total operating expenses 13,307 14,953 18,172 21,292 25,463
Materials cost 5,357 5,725 6,957 7,985 9,643
Employee cost 2,565 3,162 3,873 4,454 5,077
R&D cost 1,119 1,202 1,355 1,677 2,089
Selling, admin and general expenses 4,266 4,864 5,987 7,177 8,653
EBITDA 2,999 4,087 4,414 5,323 6,679
Depreciation and amortisation 423 481 610 709 840
EBIT 2,577 3,606 3,804 4,614 5,840
Net Interest expense/(income) 94 165 128 89 25
Other income (473) 211 170 100 100
Profit before tax (excl extraordinaries) 2,010 3,652 3,847 4,625 5,915
Provision for tax 78 1,160 873 1,018 1,301
Core profit 2,154 2,687 2,973 3,608 4,614
Extraordinary items (88) (180) 0 0 0
Reported profit after minority interest 1,844 2,312 2,973 3,608 4,614
Adjusted PAT after minority interest 2,154 2,687 2,973 3,608 4,614
Equity shares outstanding (mn) 85 85 85 85 85
EPS (INR) basic 25.5 31.8 35.1 42.6 54.5
Diluted shares (mn) 84.6 84.6 84.6 84.6 84.6
EPS (INR) adjusted 25.5 31.8 35.1 42.6 54.5
CEPS (INR) 30.5 37.4 42.3 51.0 64.4
Dividend per share (INR) 4.0 6.0 6.0 7.3 9.3
Dividend payout (%) 15.7 18.9 17.1 17.1 17.1

Common size metrics- as % of net revenues


Year to March FY09 FY10 FY11E FY12E FY13E
Cost of revenues 32.9 30.1 30.8 30.0 30.0
Employee cost 15.7 16.6 17.1 16.7 15.8
Selling, admin and general expenses 26.2 25.5 26.5 27.0 26.9
R & D cost 6.9 6.3 6.0 6.3 6.5
Total operating expenses 81.6 78.5 80.5 80.0 79.2
Depreciation and amortisation 2.6 2.5 2.7 2.7 2.6
Interest expenditure 0.6 0.9 0.6 0.3 0.1
EBITDA margins 18.4 21.5 19.5 20.0 20.8
Net profit margins 13.6 14.7 13.7 13.9 14.7

Growth metrics (%)


Year to March FY09 FY10 FY11E FY12E FY13E
Revenues 20.4 16.8 18.6 17.8 20.8
EBITDA 43.5 36.3 8.0 20.6 25.5
Net profit 63.1 24.8 10.6 21.3 27.9
PBT 34.8 81.7 5.3 20.2 27.9
Adj. EPS 63.1 24.8 10.6 21.3 27.9

134 Edelweiss Securities Limited


Edel Pulse: Pharmaceuticals

Balance sheet (INR Mn)


As on 31st March FY09 FY10 FY11E FY12E FY13E
Equity capital 423 423 423 423 423
Reserves & surplus 6,086 7,887 10,265 13,152 16,843
Total shareholders funds 6,509 8,310 10,688 13,575 17,266
Borrowings 4,826 5,224 4,824 3,724 3,224
Deferred tax liability (net) 584 499 499 499 499
Sources of funds 11,919 14,033 16,011 17,798 20,989
Gross block 7,740 9,228 11,228 13,228 15,728
Depreciation 2,094 2,718 3,328 4,037 4,876
Net block 5,647 6,510 7,900 9,191 10,851
Investments 1,395 1,412 1,412 1,412 1,412
Inventories 2,645 3,236 3,992 4,718 5,795
Sundry debtors 2,666 2,982 3,421 4,044 4,829
Cash and bank balances 2,300 3,883 3,585 3,561 4,180
Loans and advances 1,578 1,138 1,138 1,138 1,138
Other current assets 344 368 405 405 405
Total current assets 9,534 11,607 12,541 13,866 16,348
Sundry creditors 3,134 3,782 4,084 4,865 5,764
Other current liabilities 609 434 477 525 578
Provisions 913 1,280 1,280 1,280 1,280
Total current liabilities and provisions 4,656 5,496 5,841 6,671 7,622
Net current assets 4,877 6,111 6,700 7,195 8,726
Uses of funds 11,919 14,033 16,011 17,798 20,989
Book value per share ( INR) 77 98 126 160 204

Free cash flow - (INR mn)


Year to March FY09 FY10 FY11E FY12E FY13E
Net profit 1,844 2,312 2,973 3,608 4,614
Add : Non cash charge
Depreciation 423 481 610 709 840
Others 211 (74)
Gross cash flow 2,478 2,719 3,583 4,317 5,453
Less: Changes in WC 101 349 (886) (520) (911)
Operating cash flow 2,579 3,069 2,697 3,797 4,542
Less: Capex (705) (1,108) (2,000) (2,000) (2,500)
Free cash flow 1,874 1,961 697 1,797 2,042

Cash flow metrices


Year to March FY09 FY10 FY11E FY12E FY13E
Operating cash flow 2,579 3,069 2,697 3,797 4,542
Financing cash flow (182) 1,047 (995) (1,822) (1,423)
Investing cash flow (396) (1,125) (2,000) (2,000) (2,500)
Net cash flow 2,001 2,991 (298) (24) 619
Capex (705) (1,108) (2,000) (2,000) (2,500)
Dividends paid (332) (592) (595) (722) (923)

Edelweiss Securities Limited 135


Edel Pulse: Pharmaceuticals

Profitability and liquidity ratios


Year to March FY09 FY10 FY11E FY12E FY13E
ROAE (%) 37.1 36.3 31.3 29.7 29.9
ROACE (%) 32.6 42.5 38.5 38.7 41.4
Inventory days 55.5 56.4 70.0 70.0 72.0
Debtors days 53.5 54.1 60.0 60.0 60.0
Payable days 85.9 94.8 90.0 90.0 90.0
Cash conversion cycles 23.0 15.7 40.0 40.0 42.0
Current ratio 2.0 2.1 2.1 2.1 2.1
Debt/ EBITDA 1.6 1.3 1.1 0.7 0.5
Debt/equity 0.7 0.6 0.5 0.3 0.2
Adjusted debt/Equity 0.7 0.6 0.5 0.3 0.2

Operating ratios (x)


Year to March FY09 FY10 FY11E FY12E FY13E
Total asset turnover 1.49 1.41 1.45 1.53 1.62
Fixed asset turnover 2.84 3.02 3.01 3.03 3.13
Equity turnover 2.73 2.47 2.29 2.14 2.04

Du Pont Analysis
Year to March FY09 FY10 FY11E FY12E FY13E
NP margin 13.6 14.7 13.7 13.9 14.7
Total assets turnover 1.49 1.41 1.45 1.53 1.62
Leverage multiplier 1.83 1.75 1.58 1.39 1.26
ROAE 37.12 36.27 31.30 29.74 29.92

Valuation parameters
Year to March FY09 FY10 FY11E FY12E FY13E
Adjusted EPS (INR) 25.5 31.8 35.1 42.6 54.5
EPS YoY growth (%) 63.1 24.8 10.6 21.3 27.9
CEPS (INR) 30.5 37.4 42.3 51.0 64.4
Diluted PE (x) 23.2 18.6 16.8 13.9 10.8
Price/BV(x) 7.7 6.0 4.7 3.7 2.9
EV/Sales (x) 3.1 2.6 2.2 1.8 1.5
EV/EBITDA (x) 17.1 12.2 11.3 9.2 7.1
Dividend yield (%) 0.7 1.0 1.0 1.2 1.6

136 Edelweiss Securities Limited


(INR) (INR) (INR) (INR)

300
400
500
600
700
400
525
650
775
900

150
270
390
510
630
Apr-10

500
875
1,250
1,625
2,000
May-10 Apr-10
May-10 Jun-10 Apr-10 May-10

Buy
Jun-10 May-10 Jun-10
Jul-10

Hold
Jul-10 Jun-10
Cadila Healthcare

Aug-10 Jul-10
Aug-10 Jul-10

Buy
Sep-10 Aug-10

Ranbaxy Laboratories
Sep-10 Aug-10

Hold
Oct-10 Sep-10
Oct-10 Sep-10

Torrent Pharmaceuticals
Dr. Reddy’s Laboratories
Nov-10 Oct-10 Oct-10
Nov-10

Hold
Dec-10 Nov-10

Buy
Dec-10 Nov-10
Jan-11 Jan-11 Dec-10 Dec-10
Feb-11 Feb-11 Jan-11 Jan-11

Buy
Mar-11 Mar-11 Feb-11 Feb-11

Hold
Apr-11 Mar-11 Mar-11
Apr-11
Apr-11 Apr-11

(INR) (INR) (INR)


Cipla

Lupin

100
200
300
400
500

200
275
350
425
500
200
250
300
350
400

Apr-10 Apr-10 Apr-10


May-10 May-10 May-10
Jun-10 Jun-10 Jun-10

Hold
Buy

Jul-10 Jul-10 Jul-10


Aug-10
Redc

Aug-10 Aug-10
Sun Pharmaceuticals

Hold Hold
Buy

Sep-10 Sep-10 Sep-10


Redc

Hold
Oct-10 Oct-10 Oct-10
Redc

Nov-10 Nov-10 Nov-10


Hold
Redc

Buy

Dec-10 Dec-10 Dec-10


Hold

Jan-11 Jan-11 Jan-11


Redc

Feb-11 Feb-11 Feb-11


Mar-11 Mar-11 Mar-11
Buy

Hold

Apr-11 Apr-11 Apr-11

Edelweiss Securities Limited


Buy

Hold
Edel Pulse: Pharmaceuticals

137
Edel Pulse: Pharmaceuticals

NOTES:

138 Edelweiss Securities Limited


RATING & INTERPRETATION Edel Pulse: Pharmaceuticals

Company Absolute Relative Relative Company Absolute Relative Relative


reco reco risk reco reco Risk
Apollo Hospitals Enterprise BUY None None Aurobindo Pharma BUY SO H
Cipla REDUCE SU L Dr.Reddys Laboratories HOLD SO M
Lupin BUY SO M Piramal Healthcare UNDER SU H
REVIEW
Sun Pharmaceuticals Industries HOLD SP L Torrent Pharmaceuticals BUY SO H

ABSOLUTE RATING
Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING


Ratings Criteria
Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe
within the sector

RELATIVE RISK RATING


Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING
Ratings Criteria
Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return

Edelweiss Securities Limited 139


Edel Pulse: Pharmaceuticals

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021,
Board: (91-22) 2286 4400, Email: research@edelcap.com

Vikas Khemani Head Institutional Equities vikas.khemani@edelcap.com +91 22 2286 4206

Nischal Maheshwari Head Research nischal.maheshwari@edelcap.com +91 22 6623 3411

Coverage group(s) of stocks by primary analyst(s): Pharmaceuticals


Apollo Hospitals Enterprise, Aurobindo Pharma, Cipla, Dr.Reddys Laboratories, Lupin, Piramal Healthcare, Sun Pharmaceuticals Industries,
Torrent Pharmaceuticals

EW indices Recent Research


1,400
Date Company Title Price (INR) Recos

1,250 11-Apr-11 Sun JV with Merck: A 450 Hold


Pharma win win deal;
1,100 Event Update
01-Apr-11 Pharma Steady growth and margins; strong
visibility for next fiscal; Quarterly Preview
950
23-Mar-11 Lupin Near- term challenges;
long-term growth intact; 415 Buy
800 Visit Note
20-Apr-10 20-Oct-10 20-Apr-11 08-Mar-11 UPL Positive move to tap 136 Buy
largest Latin American
EW Pharma Index Nifty
market; Event Update

Distribution of Ratings / Market Cap


Rating Interpretation
Edelweiss Research Coverage Universe
Buy Hold Reduce Total Rating Expected to

Buy appreciate more than 15% over a 12-month period


Rating Distribution* 118 51 17 189
* 3 stocks under review Hold appreciate up to 15% over a 12-month period
> 50bn Between 10bn and 50 bn < 10bn
Reduce depreciate more than 5% over a 12-month period
Market Cap (INR) 111 61 17

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