61720395

India – Pharma

2Q2010Dr India

Aiming high in the US generics market

India - Pharma

bino@iif lcap.com

Dr Bino Pathiparampil [email protected] (91 22) 4646 4648 Ankit Jain [email protected] (91 22) 4646 4675

Contents

Executive summary .................................................................. 1

Structural growth in base business ............................................ 2

Special products drive near-term growth .................................... 7

The right strategy, relevant competencies ................................. 11

Appendix .............................................................................. 20

Companies

Biocon .................................................................................. 25

Cipla Ltd ............................................................................... 29

Dr Reddy’s Laboratories .......................................................... 33

GlaxoSmithKline Pharma ........................................................ 37

Glenmark Pharma Ltd ............................................................. 41

Lupin Ltd .............................................................................. 45

Opto Circuits ......................................................................... 49

Ranbaxy Laboratories ............................................................. 53

Sun Pharma .......................................................................... 57

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Sensex vs BSE Healthcare

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Executive summary

Underlying business to get stronger: The base business of Indian players in the US will continue to be strong, notwithstanding concerns on competition, price erosion, FDA quality control, and a longer FDA approval process. The imperative to reduce healthcare costs will ensure that adoption of generics in the US market continues to increase. Indian players still account for less than 9% of the market, and we expect significant market share gains organically as well as inorganically.

Special products provide further upside: Over CY10-14, Ranbaxy, Sun Pharma and Dr Reddy’s could generate revenues of US$1.6bn, US$230m and US$202m, respectively, from market exclusivities in the US related to already-disclosed patent challenges. The patent cliff involves a US$96bn market at innovator prices, and we expect more upsides from undisclosed opportunities. Early indicators of these upsides are Sun Pharma’s strong growth guidance for FY11, and Dr Reddy’s revenue target of US$3bn for FY13.

The right focus and competencies: The US contributes a third of the topline of the top five Indian generics firms by revenue. These firms’ US revenue has registered 28% CAGR over FY06-10 vs overall topline growth of 18% annually. Indian players already possess best-in-industry competencies in product development, regulation, manufacturing and patent litigation. We see further improvement in the product basket and distribution reach. Biosimilars could be a support for long-term growth.

Valuation matrix FY11ii FY11ii base business

CMP (Rs)

Mkt cap (US$ m)

Reco

Target price (Rs)

Rev (Rs m)

EBITDA (Rs m)

EPS (Rs) P/E Rev

(Rs m)EBITDA

(Rs m) EPS (Rs)

Adj* P/E

FY10-12ii base

EPS growthBiocon 304 1,304 ADD 342 27,286 5,380 18.3 16.6 27,286 5,380 15.3 18.1 17.9%Cipla 338 5,828 REDUCE 328 62,031 15,877 14.1 24.0 62,031 15,877 13.5 24.9 13.6%Dr Reddy’s 1,422 5,154 BUY 1,803 78,293 18,358 66.3 21.4 77,051 17,364 63.3 21.7 44.6%Glaxo 2,078 3,779 ADD 2,232 21,668 7,497 67.6 30.7 21,668 7,497 56.8 32.7 14%Glenmark 262 1,521 SELL 252 29,034 8,086 16.7 15.7 29,034 8,086 15.8 16.4 31.4%Lupin Ltd 1,879 3,591 REDUCE 1,807 58,430 11,658 89.4 21.0 58,430 11,658 88.5 21.1 17.7%Opto Circuits 230 902 BUY 293 13,065 4,311 18.9 12.2 13,065 4,311 16.9 13.2 29.2%Ranbaxy 436 3,939 SELL 411 89,715 17,506 30.5 14.3 76,519 5,930 2.2 164.4 NASun Pharma 1,702 7,526 BUY 2,111 43,239 14,270 68.6 24.8 40,443 12,294 46.5 31.3 46.0%Source: IIFL Research. Priced as at close of business on 15 June 2010. *Adjusted for non-recurring income and value thereof.

We expect 20%-plus revenue CAGR coupled with significant margin expansion for Indian generics players in the US over the next five years. This phase of growth would be driven by: 1)

share of the US generics market from the current 9% by revenue; 2) large product-specific opportunities from US$96bn worth of patent expiries; 3) unique opportunities with low competition for extended periods; and 4) strong competencies that will help them capitalise on these. We estimate upsides from disclosed patent challenge exclusivities in the US at about US$2.5bn over the next five years. Undisclosed opportunities and unique products could throw up more positive surprises, supporting Indian pharmas’ premium valuations. An expanding product basket and wider distribution reach would accelerate market share gains in the base business as well. Our top picks are Dr Reddy’s Labs and Sun Pharma.

structural factors that favour an increase in Indian pharmas’

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Structural growth in base business

Large homogenous market helps faster penetration The US generic market represents an immense growth opportunity for Indian generics players with world-class expertise, but modest resources compared to their Western big-pharma counterparts. They

other pharmaceutical market in the world. The US market also offers large scope for scaling up operations, as the country accounts for more than 40% of the US$80bn global generics market. Although emerging markets’ growth will likely outpace that of the US market in the medium to long term, these markets are fragmented, with each country having its own separate regulatory framework, distribution network and legal structure. In contrast, the US is one large market that offers the following advantages that can significantly benefit Indian players:

• approval from a single agency can open up a large US$35bn market;

• as the market is dominated by ‘generic generics’, it is easier to penetrate than the branded-generic markets in the emerging world;

• there is no need of large upfront investments in sales and marketing infrastructure—an efficient chain of distributors already exists; and

• the gestation period is shorter, as there is no need to build relationships with physicians.

Figure 1: The US accounts for 40% of the global generics market

Global generics market (US$ bn)

Europe, 27

US, 35

Others, 18

Total market size(2008)-US$80bn

Source: Teva, IMS, IIFL research

Cost saving ensures continued ‘genericisation’ Reduction in healthcare costs is an imperative throughout the developed world, not least the US. The US was one of the first countries to promote reduction in prescription-drug costs through adoption of generics. This has already taken generics’ share of volumes to over 60%. That said, there is still considerable room for growth from: 1) further increase in generics’ share of the pharma market; and 2) extension of healthcare coverage to hitherto uncovered Americans as part of healthcare reforms. At present, about 15% of the US population has no medical insurance and thus has virtually no access to formal healthcare services. When the healthcare reform brings them under some form of coverage, 47m

Indian players can significantly benefit from

the US market, which accounts for over 40% of

the US$80bn global generics market

can penetrate the US generics market faster and easier than any

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Americans will be added to the potential consumers of healthcare. Most of them would be covered under low-end policies—an ideal market for generics.

Savings from use of generics are too large to be ignored by policymakers—according to data from the Generic Pharmaceutical Association (GPhA), generic drugs saved the American healthcare system more than US$734 billion over 1999-2008, with ~US$121 billion in savings in 2008 alone. Healthcare costs have already crossed 16% of GDP in the US; if this growth continues unchecked, they will reach 20% by 2017, according to the Centre for Medicare and Medicaid Studies. Expenditure on prescription drugs is one of the fastest-growing components of healthcare costs, and hence is a prime target for cost reduction. Figure 2: US generics penetration will continue to improve

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US Generic penetration by value US Generic penetration by prescription volume

Source: Teva Figure 3: Rising healthcare costs continue to spur increases in generics’ penetration

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Expenditure on prescription drugs is a prime target for healthcare cost reduction

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Figure 4: Prescription-drug cost is growing faster than overall healthcare costs

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Source: Centre for Medicare & Medicaid services Figure 5: Large savings from use of generics in US cannot be ignored

Annual savings from use of generics

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Small base to help high growth for Indian players Notwithstanding rapid growth over the past decade, Indian players are still small in the US generics market. Only Lupin and Dr Reddy’s Labs have market shares of over 2% in the market; all Indian companies together have only 9% share of the market. The main reason for Indian companies’ low market share, in our view, is that they were small players who entered late in the US market—they made a major entry almost a decade after market leaders like Teva, Sandoz, Mylan and Watson. By the time Indian companies developed the necessary competencies to effectively compete in the market, the leading global players had already built large product portfolios and wide distribution networks. There was also significant consolidation in the market, which has so far largely evaded the Indian players. Indian companies had neither the size to acquire other firms, nor significant presence in the US market to make them attractive targets. This is changing—a relatively small base, together with competencies that can match any of the leading players, can help Indian players maintain their high growth rates in the US market in the long term. Furthermore, Indian companies have become significant enough in the market to start active participation in the consolidation process, though big-ticket acquisitions are some time away. Gains from exploiting the patent cliff over the next 4-5 years will add to this structural growth momentum, in our view.

Indian companies have low market share, in our view, as they were late entrants

in the US market…

... but they have significant scope for growth

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Figure 6: Indian players have substantial scope for growth in the US

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Source: Dr Reddy’s Labs, IIFL Research

Figure 7: Indian companies yet to gain breadth of product offering

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The ramp-up is fast and visible Indian companies are ramping up quickly in the US market—in a decade, we expect to see at least a couple of them among the top five generics players in the US. They are choosing higher-value and niche products to break through to US distributors and from there on, gain more share in commoditised products. At the same time, they are also expanding their product basket so that they can compete effectively with the market leaders in the race for large–scale purchases by nationwide distributors. According to data from Pharmabiz, Indian companies accounted for 408 of the 1,394 ANDAs approved by the US FDA over the last three years. In 2009 alone, Indian companies accounted for 132 of the 419 ANDA approvals by US FDA. This represents a share of roughly 30% in ANDA approvals—compared to Indian companies’ current combined revenue share of the total market at 7-9%. The large number of ANDAs pending approval with US FDA for Indian companies also indicates that they are well-positioned to capture a significant share of the pie.

Indian players are among the most prolific ANDA

filers in the US

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Figure 8: Indian companies hold a large share of FDA generic filings

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Sun Pharma Lupin Dr Reddy's Ranbaxy Cipla Glenmark

Pending ANDA approvals (nos)

Source: Company reports, IIFL Research

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Special products drive near-term growth Adding to the structural growth story of Indian generic players in the US market is the “patent cliff”—the overwhelmingly huge number of patented drugs going off-patent between 2010 and 2014, compared to other periods. This throws open a large part of the market to generics companies, apart from the generation of several one-off opportunities of market exclusivity for some companies in select drugs. Drugs with about US$96bn in cumulative annual sales, accounting for almost 40% of the total US pharma market in 2009, will go off-patent over the next five years. Assuming average price erosion of 60% and average 5-month market exclusivity for first-to-file players, the market size of one-off opportunities itself works out to about US$19bn. Indian generics players have cornered about US$2.5bn, or about 16% of this market. This is a significant improvement over Indian companies’ current overall share of less than 9% in the US generics market. Further, beyond the period of market exclusivity for selected players, the market will open up for the gamut of generics companies. Competition will intensify and prices will collapse. Even if we assume 90% price erosion, the market for these new generics would be worth annual sales of some US$10bn—an addition of 29% to the current market of US$35bn annually. Considering the 16% share in the exclusivities upside and the 30%-plus share in current ANDA approvals, we believe Indian players will corner a much larger share of the market for new generics (compared to their current share of 9%). Thus, we expect Indian players to expand their overall market share significantly over the next 4-5 years.

An overwhelmingly huge number of patented drugs

are going off-patent between 2010 and 2014

Indian players will corner a much larger share of the market for new generics

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Figure 9: Major drugs facing new generic competition in the US over 2010-15

Generic name Brand name Therapy area Innovator company

US sales (2009)

(US$ m)First Para IV filer

Expected generic entry

dateDonepezil Aricept Alzheimer's disease Pfizer/Eisai 1,886 Teva 2010

Enoxaparin Lovenox Thrombosis, pulmonary embolism Sanofi Aventis 2,264 Amphastar Pharma 2010

Venlafaxine Effexor XR Depression Pfizer 1,899 Teva 2010

Levofloxacin Levaquin Quinilone antibiotic Johnson & Johnson 1,745 Mylan 2010

Docetaxel Taxotere Oncology Sanofi Aventis 1,235 Hospira 2010

Atorvastatin Lipitor Cholesterol Pfizer 5,650 Ranbaxy 2011Clopidogrel Plavix Anti-platelet Sanofi Aventis 4,000 Apotex 2011Montelukast Singulair Asthma/COPD Merck 3,750 Teva 2011Pioglitazone Actos Diabetes Takeda 3,000 Mylan 2011Quetiapine Seroquel Schizophrenia Astra Zeneca 3,400 Teva 2011Olanzapine Zyprexa Schizophrenia Eli Lilly 3,000 Ivax 2011

Losartan Diovan Hypertension Novartis 1,860 Ranbaxy 2012Escitalopram Lexapro Depression Forest 2,750 Ivax 2012Ziprasidone Geodon Schizophrenia Pfizer 1,160 Lupin 2012Modafinil Provigil Narcolepsy Cephalon 925 Teva, Mylan, Barr, Ranbaxy 2012Sildenafil Viagra Erectile Dysfunction Pfizer 1,000 Teva 2012

Oxycodone ER OxyContin Pain Purdue 2,900 Endo (10, 20, 40 mg); Teva (80 mg) 2013

Duloxetine Cymbalta Fibromyalgia, depression Eli Lilly 2,850 Impax, Actavis, Sandoz, Wockhardt,

Cobalt, Lupin, Aurobindo, Sun, Anchen 2013

Memantine Namenda Alzheimer's disease Forest 1,100Barr, Cobalt, Lupin, Orchid, Teva, Upsher-Smith , Wockhardt, Dr. Reddy's, Mylan, Amneal ,Genpharm

2013

Aripiprazole Abilify Schizophrenia Otsuka and BMS 1,556 Teva, Sandoz, Barr,

Apotex, Synthon 2014

Tiotropium Spiriva COPD Boehringer and Pfizer 1,003 NA 2014

Celecoxib Celebrex Osteoarthritis Pfizer 880 Teva 2014

Imatinib Gleevec Oncology Novartis 1,088 Sun Pharma 2015Ezetimibe Zetia Cholesterol Merck 1,500 Glenmark 2015Source: Company reports, IIFL Research

Figure 10: Key product exclusivities for Ranbaxy in the US market

Generic name Brand Innovator Therapy area Innovator

market size (US$ m)

Probable launch date

Donepezil Aricept Eisai / Pfizer Alzheimer's 1,886 2010Atorvastatin Lipitor Pfizer Anti-Cholesterol 5,650 2011

Valganciclovir Valcyte Roche Antiviral, CMV retinitis, prophylaxis in immunosuppressed patients 240 2011

Pioglitazone Actos Takeda Diabetes 3,000 2012Valsartan Diovan Novartis Cardiovascular 1,860 2012Modafinil Provigil Cephalon Narcolepsy 925 2012Sirolimus Rapamune Wyeth- now Pfizer Transplant-rejection 201 2013Esomeprazole magnesium Nexium AstraZeneca Gastric ulcer 1,850 2014Source: Company reports, IIFL Research

Figure 11: Key product exclusivities for Dr Reddy’s Labs in the US market


market size (US$ m)


Rosiglitazone Avandia GSK Diabetes 520 2012Rivastigmine Exelon Novartis Alzheimers 180 2012desloratadine + pseudoephedrine Clarinex D24 Merck Allergy 22 2012

desloratadine + pseudoephedrine Clarinex D12 Merck Allergy 15 2012

Desloratadine Clarinex reditabs Merck Allergy 8 2012Finasteride Propecia Merck Hair loss 150 2013Source: Company reports, IIFL Research

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Figure 12: Key product exclusivities for Sun Pharma in the US market


market size(US$ m)


Carbidopa, leveodopa and entacapone Stalevo Orion/Novartis Parkinson's 217 2010

Tiagabine Gabitril Cephalon anticonvulsant 51 2011Atomoxetine Strattera Lilly ADHD 446 2012Rivastigmine Exelon Novartis Alzheimers 150 2012Memantine Namenda Forest Alzheimers 1,100 2015Imatinib Gleevev Novartis oncology 1,088 2015

Pregabalin Lyrica Pfizer neuralgia, neuropathy, anxiety disorder 1,600 2018


Figure 13: Key product exclusivities for Lupin in the US market


market size(US$ m)


Metformin ER Fortamet ER Andrx (Watson) diabetes 50 2011Ciprofloxacin oral suspension Cipro DS Bayer anti-infective 30 2011

Ethinyl estradiol/levonorgestrel Loseasonique Teva/Barr OCP 5 2012

Memantine Namenda Forest Lab Alzheimers 1100 2015Metformin HCL Glumetza Depomed diabetes 35 2016

Pregabalin Lyrica Pfizer neuralgia, neuropathy, anxiety disorder 1600 2018

Lanthanum Fosrenol Shire kidney disease 86 2018Source: Company reports, IIFL Research

Figure 14: Key product exclusivities for Glenmark in the US market


market size(US$ m)


Trandolapril + Verapamil Tarka Abbott cardiovascular 64 2014

Ezetimibe Zetia MRK/SGP cholesterol 1,500 2016Source: Company reports, IIFL Research

Unique products offer large value in small opportunities Indian pharma companies have adopted a new strategy for the US market over the past couple of years, identifying products in which competition remains low for extended periods. This is a shift from their earlier model, which concentrated only on large products that get commoditised soon. These unique products usually have three features in common: ● they address niche segments of the market, where a larger

player may not be interested in investing resources; ● they are relatively small-revenue products (usually US$25m-

100m annual revenue) that do not attract significant competition; and

● the technological barriers to entry are higher, making these products inaccessible to low-end players competing on price.

We view this as an important strategic shift to a higher stage in the value chain—identifying such gaps in the market and investing on them in a timely manner calls for superior competencies like market foresight, advance planning, acquiring necessary technological capabilities, additional regulatory experience and product portfolio management. These competencies are typically attributes of innovator companies.

Indian players have adopted a new strategy of

targeting unique opportunities with limited

competition in the marketplace

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The types of unique opportunities vary significantly across products and companies—there is no set pattern. This makes it an even more commendable achievement—Indian players have employed early at-risk launches, niche product filings with few or no competitors, differentiated delivery systems, marketing of branded products and development of technologically challenging products to gain unique low-competitive environments in the market. We list some of these products that are already contributing revenues and some that are likely to contribute in future.

Figure 15: Unique products demonstrate the move up the value chain Company Product Key feature

Prilosec OTC Private-label supply of OTC drug; in market long before patent expiry; low competition for up to two years

generic Arixtra Technologically challenging product; patents expired, but hardly any other generic filer; still growing market; low competition for 2-3 years

Allegra D24 Potential at-risk launch, no other known generic filers, up to three years of low competition Dr Reddy's

Clarinex D12/24/Reditabs Technologically challenging extended-release formulations of desloratadine—small in market size, but Dr Reddy's has settled with innovator for first generic launch and will have an extended period of high profitability.

Suprax Has been selling as branded generic for four years, under a brand name acquired from Wyeth. No other generics approved till now.

Aerochamber Inhalation device product acquired from Forest Labs, sold through physician sales force

Antara Patented product, bought from Oscient, being sold through a physician-focussed sales force Lupin

Allernaze Patented new product, expected to be launched soon and sold through prescriptions

generic Protonix Launched at risk in February 2008; had been driving Sun Pharma’s US revenues for almost two years before discontinuation in May 2010.

Sun Pharma Generic Effexor XR

Sun developed a tablet form of Wyeth's Effexor XR capsules; this could have been a long-term opportunity if it had succeeded in getting timely FDA approval. But it got entangled in a citizen's petition to FDA and has not got approval till date.

Glenmark Vanos Competition in dermatology products is normally low, and this therapeutic area is generally considered niche. Glenmark does not have the first-to-file exclusivity for this product, but could be the second entrant, and achieve significant share and maintain it for an extended period.


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The right strategy, relevant competencies Strong focus on the US market paying off The US generics business is a major source of revenues for all large Indian pharma players, except Glaxo Pharma and Piramal Healthcare, who sell formulations only in the domestic market. It is particularly important for Dr Reddy’s Labs and Sun Pharma, which derived 24% and 28%, respectively, of their FY10 revenues from the US. With more product acquisitions and launches in the US, the market has increasingly become important for Lupin, which has built a strong branded-product business there. We expect the US’s contribution to Lupin’s revenue to increase from 34% in FY10 to 38% in FY11. Ranbaxy has historically been the largest Indian player in the US market, with more than US$400m revenue in CY08, but has been hit by manufacturing quality issues at several of its facilities. Figure 16: US formulations is a major revenue contributor

US formulations as a % of total revenues -FY10/CY09

33.9%

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Lupin Glenmark Sun Pharma Ranbaxy Dr Reddy's Cipla


Indian companies’ focus on the US has paid off handsomely: over the last four years, most companies’ revenues from that market have grown faster than their overall revenues. We expect this trend to continue for the next 4-5 years as well. Figure 17: US revenues have grown faster than the rest of the business*

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Total revenues CAGR (4 year) US revenues CAGR (4 year)

* Revenue addition from major acquisitions excluded from the data Source: Company reports, IIFL Research

Indian pharma companies’ revenues from the US

market have grown faster than their overall revenues

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Fast catching up on market share drivers The US market is dominated by ‘generic generics’—drugs are more commoditised than in a ‘branded–generic’ market. In such commoditised markets, there are various classes of customers that wield considerable bargaining power—such as insurance companies, governments and patients themselves. Thus, prices are the most important factor in driving sales. That said, price is not the only factor—players’ market shares are also sensitive to perception of quality, reliability of supply to distributors, distribution reach, size of product basket and relationships with customers (mainly distributors). These attributes take time to develop, which explains the lag between Indian players and the large players in the US generics market. We believe that Indian players are well on course and will increasingly improve their score on all parameters over the next few years. Inorganic opportunities may also play a significant role. The right competencies in place; distribution and product basket have to expand Over the past decade, Indian companies have made significant progress in acquiring and developing the competencies needed to operate in the highly-competitive and rigorously regulated US market. Indian firms can now match most of their larger global peers in product development, regulatory experience, legal expertise and quality manufacturing at competitive cost. But they have quite a way to go before they can match their larger rivals in sales and distribution. We expect this gap to be bridged over the next five years through a mix of organic and inorganic routes. Sun Pharma’s ongoing effort to acquire Taro Pharma in the US is a classic example of how Indian companies can ramp up their sales and distribution reach to match their larger competitors. Figure 18: Indian companies have developed significant competencies for the US market over the last decade Competencies for success in US generics market

Where Indian players are

Product development skills Indian players have good chemistry and formulation skills, but have some way to go before they can match the largest global competitors.

Regulatory experience Large Indian pharma players have accumulated significant regulatory experience over the past decade and can match any competitor globally in this respect.

Legal experience Indian companies have mastered the legal aspects related to patents and have emerged as major challengers to IP rights of big innovator pharma companies.

Market reach Indian companies have considerable scope for improvement in this area—their larger rivals such as Teva and Sandoz have much wider sales networks and deeper customer relationships. We expect Indian player to bridge this gap through organic as well as inorganic routes.


Manufacturing issues are transient; no long-term concerns A number of Indian pharma players were recently pulled up by the US FDA on manufacturing and product-quality-related issues. In our view, however, this issue has been overdone: a look at US FDA’s record shows that such quality-related notifications are quite common, and have been served on several global players from time to time. The list of companies that have received warning letters from the FDA include some of the leading global innovator pharma companies, among them Wyeth, Merck and Abbott. Among the large

Indian players match other global players in generic

product development skills and regulatory and legal

experience; market reach is improving and product

basket expanding

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generic players in the US market, Teva, Sandoz and Apotex have received warnings from the FDA.

Figure 19: FDA warning letters to Indian companies – last five years Company Date Facility US FDA’s charges against the company

Ranbaxy Dec-10 Ohm Laboratories, NY, USA Improper investigation into a failed batch; failure to comply with the written procedure to test stability and determine expiry dates; inadequate quality control systems and checks; questionable entries by quality dept regarding checks; failure to report to FDA complaints on products in the market

Lupin Ltd May-09 Mandideep, Bhopal, India Improper maintenance of records; inadequate aseptic training to staff; inadequate response on quality systems and record-keeping; inadequate investigation of sanitation issues in the facility; inadequate investigation of failed batches

Dabur Oncology plc Apr-09 Bordon, UK Inadequate precaution against microbial contamination; inadequate investigation of contamination; poor maintenance and calibration of equipments and utensils; lax acceptance criteria in quality control checks; improper record-keeping

Caraco Pharmaceuticals

Oct-08 Detroit, Michigan, USA Inadequate review of products by quality control unit; inadequate investigation into discrepancies in product; contamination of products with other drug chemicals; release of products against standard operating procedure; change in operating procedure without adequate checks; improper record maintenance; poor maintenance of equipment; up to three repeat violations of 2005, 2006 and 2008 observations

Ranbaxy Sep-08 Dewas, India Poor separation of penicillin and non-penicillin products; inadequate systems to monitor contamination by beta-lactam products; poor production and quality control, record-keeping: inadequate investigations into deviations; poor organisational structure, procedures, resources and activities of the quality control unit; poor aseptic precautions

Ranbaxy Sep-08 Paonta Sahib, India Inaccurate records of equipment-cleaning; persons recorded to have supervised equipment-cleaning were absent on the day when it was carried out; potential contamination of products

Ranbaxy Jun-06 Paonta Sahib, India Improper record maintenance; practice of discarding / disregarding data; inadequate stability-testing programme; improper documentation of quality sampling; erroneous process of quality sampling; inadequate laboratory resources at the quality control unit; unexplained different markings on the same product

Source: USFDA, IIFL Research

Figure 20: FDA warning letters to non-Indian companies – last five years Company Date Facility US FDA’s charges against the company

Apotex Inc. Mar-10 Toronto, Canada Lack of adequate processes and quality systems at the corporation level - issues at multiple plants; manufacture of formulations from API that was found to be contaminated; repackaging and assigning new batch numbers to products that failed quality tests; returning defective material back to inventory; re-releasing failed material without sufficient corrective action; inadequate investigation of discrepancies; improper equipment cleaning and maintenance system; foreign materials in tablets; non-reporting of key quality findings regarding released drugs to FDA in a timely manner

Baxter Biosciences Jan-10 Lessines, Belgium Inadequate investigation of a glitch in the production process of a particular drug; non-conformation to written protocols; failure to inform USFDA about change in production process

Hospira Inc Aug-09 Morgan Hill, California Insufficient action regarding faulty power codes used in infusion pumps

Abbott Molecular Aug-09 Des Plaines, Illinois In-vitro diagnostics: inadequate procedures for quality checks; use of failed and quarantined material for quality tests; Continuation of production and distribution despite knowing of a circuit flaw in the product; inadequate procedures for corrective actions

Apotex Inc Jun-09 Etobicoke, Ontario, Canada Improper investigation into failed batches; non-reporting of key quality findings regarding released drugs to FDA on a timely manner

Taro Pharmaceuticals, Inc

Feb-09 Brampton, Ontario, Canada, inadequate stability testing programme; inadequate investigation of discrepancies in the product; release of products by quality control unit without adequate checks

Sandoz Aug-08 Wilson, North Carolina Failure to establish and follow written procedures for production and quality control; inadequate investigation of discrepancies; inadequate record-keeping

14

India - Pharma

bino@iif lcap.com

Company Date Facility Issues

Merck & Company, Inc.

Apr-08 West Point, Pennsylvania, USA

Inadequate investigation of discrepancies; inadequate systems to handle product related complaints; failure to establish and follow written procedures for production and quality control; lack of proper process for inspection and calibration of equipments; failure to quarantine products that were associated with faulty equipments; improper storage systems

Abbott Laboratories, Inc.

Mar-07 Irving, Texas, USA Diagnostics: inadequate quality control systems; failure to identify defects and correct them in the manufacturing process

Wyeth Pharmaceuticals Company

May-06 Guayama Inadequate investigation of discrepancies; failure in cleaning and maintenance of packing equipment; non-reporting of key quality findings regarding released drugs to USFDA in a timely manner

Merck & Company, Inc.

Jul-05 Riverside, PA, US Change in production process without intimating USFDA


Consolidation will help Indian players There is already a wave of consolidation underway in the US generics market, and we expect the large Indian players to emerge beneficiaries of the process. Between 1997 and 2007, market share of the top four companies has increased from 35% to 61%. Teva, the market leader, has done 15 acquisitions in the last 13 years. We expect this consolidation process to continue, as a broad product basket and wider customer reach can enhance capabilities in intelligently bundling products. Cross-subsidising and cross-selling of products are key strategies to gain market share in the highly-competitive US market.

We expect Indian companies to benefit from the ongoing wave of consolidation, be they buyers or sellers. In our view, they are more likely to be buyers than sellers, as they have focused promoters, global business ambitions, strong balance sheets and the requisite competencies for the US market. Our view is supported by Sun Pharma’s acquisition of Caraco and continuing efforts to gain control of Taro Pharma and Lupin’s acquisition of brands.

That said, Indian players are becoming potential acquisition targets of large innovator companies or larger generics companies keen to consolidate their position. In any case, shareholders of Indian companies that are strong in the US stand to benefit. In other words, we believe that the Indian players will be part of the consolidation process and will benefit from it, rather than being sidelined and pushed behind by the larger players.

Indian companies will be part of the consolidation

process rather than being sidelined by larger players

15

India - Pharma

bino@iif lcap.com

Figure 21: Consolidation continues in the US market

8%

8%

65% 7%

12%

Sandoz10%

Watson11%

Teva21%Others

30%

Mallinck-rodt5%

Mylan13%

Ivax0%

Apoth-econ0%

Barr6%

Actavis4%

2008 1997

US generic market share (prescription volume)

Source: Teva

Biosimilars—adding to the competencies Biologic drug development capabilities of Indian companies add to their long-term growth outlook in the US market, which is increasingly moving to biologic drugs. Historically, pharmaceuticals have been dominated by small-molecule drugs that are essentially simple chemicals of non-organic (not from living sources) origin. However, the advent of biologics—first as hormonal drugs and later, advanced monoclonal antibodies—changed the pharmaceutical business in many ways. These products raised the technological bar in the industry, commanded high premium pricing and altered manufacturing costs. Biologics are much more complex molecules, with up to 50,000 atoms per molecule, and have to be manufactured from living sources (bacteria, cell cultures, etc). They are typically administered parenterally. Figure 22: Biologics are much more complex molecules

Small-molecule drug Small biologic Large biologic

Aspirin 21 atoms

hGH ~3,000 atoms

lgG Antibody

~ 25,000 atoms

Source: Genentech The molecules’ complexity also adds to the intensity of the R&D process. Often, only a small area of a molecule is therapeutically relevant and the rest just functions as a substrate that carries the active part. Often, the effects of every part of a molecule are not completely understood, causing surprise effects from minor variations in the structure of the molecule. This means that investments in research and production facilities for biologics are significantly higher than those required for small molecules.

Biologics are advanced, very expensive drugs

16

India - Pharma

bino@iif lcap.com

Figure 23: Biologics are more technology-intensive and costly Small molecule drugs Biologics

Typically molecules of 20-100 atoms Small biologic molecules of 200-3,000 atoms and large biologic molecules of 5,000-50,000 atoms

Produced by chemical manufacturing processes Produced through biological processes such as recombinant-DNA technology

Low cost of mass production High cost of manufacturing on a large scale

Low complexity of the molecule; typically, only the number and type of atoms matter

Complex; alignment and 3-dimensional orientation matters, as does the number and type of atoms and their sequence in the molecule

Usually low level of specific targeting leading to wide range of effects in the body

Highly targeted therapies, towards the exact diseased part or pathogenic process in the body

Low immunogenicity and hence chance of fatal reactions in the body

High immunogenicity leading to increased chance of fatal immunologic reactions


Biologics form an increasingly important part of the global therapeutics market. Fierce Biotech, a consultancy, estimates global biologics sales in 2007 at US$75bn, more than 10% of the global prescription drug market of US$712bn in the same year. Amgen and Genentech together commanded 42% of the biologics market in 2007. The share of biologics in the pharmaceutical market is increasing rapidly; sales of biologics grew 12.5% in 2007, twice as fast as the total pharmaceutical market. According to IMS Health, the number of biologics with annual sales greater than a billion dollars has risen from 44 in 2000 to 105 in 2006, doubling their share of the growing blockbuster pharmaceutical market to 20%. With more of the global pharma giants chasing biologics pipelines, we believe that the biologics market’s growth is likely to accelerate over the next ten years. Schering Plough’s acquisition of Organon Biosciences, Astra Zeneca’s purchase of MedImmune and Merck KGaA’s acquisition of Serono were the major ones among scores of deals over the last couple of years in which the traditional small-molecule pharma companies picked up biologics companies. Figure 24: Dominant players in the biologics market

Abbott4%

Merck KGaA4%

Others19%

J&J8%

Genentech / Roche21%

Amgen21%

Sanofi Aventis4%

Wyeth3%

Schering Plough

3%

Novo Nordisk8%

Eli Lilly5%

Source: Fierce Biotech

Biologics account for more than 10% of prescription-

drug spends

17

India - Pharma

bino@iif lcap.com

Figure 25: Top-selling innovator biologic products Brand Compound Company 2007 Global Sales

(US$ m)Mabthera / Rituxan Rituximab Roche / Genentech 4,753Neupogen / Neulasta Filgastrim Amgen 4,277Herceptin Trastuzumab Roche 4,181Aranesp Darbepoietin alfa Amgen 3,614Avastin Bevacizumab Roche / Genentech 3,538Remicade Infliximab J&J 3,300Enbrel Etanercept Amgen 3,230Procrit / Eprex Epoietin alfa J&J 2,900Epogen Epoietin alfa Amgen 2,489Avonex Epoietin alfa Biogen Idec 1,900Neorecormon/Epogin Epoietin beta Roche 1,804Erbitux Cetuximab Imclone/BMS/Merck Serono 1,300Source: Company reports, IIFL Research

The biosimilars opportunity The evolution of the biologics markets is likely to present a significant opportunity for generics companies with biologics capabilities. However, the exact size of the opportunity and timelines still remain vague, given the technological and regulatory risks involved. Biosimilars may not present an explosive growth opportunity for generics companies in the near term, but we expect the segment to evolve into a high-growth multi-billion-dollar market in 5-10 years. From then on, rapid penetration of the global pharmaceutical market by novel biologics and gradual expiry of their patents will help the biosimilars market sustain its high growth rates for well over a decade. Given the significantly higher technological complexity and capital requirement compared to small-molecule generics, and longer learning curves, companies who gear themselves up in advance will emerge as major players. Global generics leaders have already marked their entry through biosimilar approvals and launches in Europe. Indian companies are fast catching up with emerging market launches and development work for regulated markets. Institution of the US regulatory mechanism for biosimilars would be a near-term fillip for the market.

Figure 26: Market dynamics to be different for small-molecule generics and biosimilars Small-molecule generics Biosimilars / follow-on biologics (FOB)

Low technological and clinical entry barrier for generic competition High technological and clinical entry barrier for generic competition

Automatic interchangeability and substitutability can be assumed Interchangeability and substitutability have to be proved through costly clinical trials

Large price discount (up to 95%) to the innovator, as the cost and technology risk of getting the generic to market are significantly lower

Smaller price discounts to the innovator drug (25-35%), as the cost and technology risk are high

Only limited clinical trials (only bio-availability / bio-equivalence to the reference drug) required for regulatory approval

More extensive clinical trials needed to prove safety and efficacy, as the biologics produced from different organic lines can vary significantly in structure

Proper regulatory frame work in place in most developed markets for generic approval

Only Europe has so far put together an approval process. US is still in the process of legislation.


Biosimilars to evolve into multi-billion-dollar market

in 5-10 years

18

India - Pharma

bino@iif lcap.com

Figure 27: Biosimilar market will evolve as a large high-growth market in 5-10 years

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2000 2005 2010 2015 2020 2025 2030 2035 2040

First biosimilar approval in EU

US starts approving

Follow on rltuxan & herceptin achieve block buster status

More biosimilars get launched in oncology, immunology and other areas

Biosimilars market sales (US$ m)


Figure 28: Biosimilar approvals in Europe Biosimilar brand Company Reference product Innovator brand Innovator company Approval/positive

opinion date Omnitrope Sandoz Somatropin (Growth Hormone) Genotropin Pfizer April 2006 Valtropin** Biopartners Somatropin (Growth Hormone) Humatrope Eli Lilly April 2006 Binocrit Sandoz Epoetin alpha (Erythropoietin) Eprex/Erypro Janssen-Cilag August 2007 Epoetin alpha Hexal Hexal Epoetin alpha (Erythropoietin) Eprex/Erypro Janssen-Cilag August 2007 Abseamed Medice Epoetin alpha (Erythropoietin) Eprex/Erypro Janssen-Cilag August 2007 Retacrit** Hospira Epoetin alpha (Erythropoietin) Eprex/Erypro Janssen-Cilag December 2007 Silapo Stada Epoetin alpha (Erythropoietin) Eprex/Erypro Janssen-Cilag December 2007 Ratiogastrim* Ratiopharm Filgrastim (G-CSF) Neupogen Amgen February 2008 Biogastrim* CT Arzneimittel Filgrastim (G-CSF) Neupogen Amgen February 2008 Tevagastrim* Teva Generics Filgrastim (G-CSF) Neupogen Amgen February 2008 *Positive opinion received from the advisory boards, approval expected. **Not currently marketed Source: IIFL Research

Moving ahead with the biosimilar opportunity Several generics companies are already aware of the significant potential of the biosimilar market and have made early investments. The leading ones are Sandoz, Hexal and Arzneimittel, which have already garnered approvals from EMEA. They are closely followed by Teva, Ratiopharm and Stada, which are likely to get approvals near term. A host of companies, including several Indian ones, are not far behind. Most of them have already secured marketing authorisations for biosimilars in the semi-regulated markets, a launchpad for the developed markets. Indian companies have mostly concentrated on insulin, erythropoietin, filgrastim and interferons. An exception is Dr Reddy’s Labs, which is concentrating on high-molecular-weight cell-culture-based products like monoclonal antibodies. It has already launched in India, the first generic version globally, of the multi-billion-dollar Rituxan for rheumatoid arthritis and lymphoma. However, it will have to wait several years before an advance into the regulated markets because of regulatory and patent issues. Currently, there are five biologics with patents expired, that can be developed for the regulated markets—Erythropoietin, Growth Hormone, Filgrastim, Insulin and Interferon. The most prominent biologics that are still under patent protection include the insulin analogs and monoclonal antibodies used in oncology and immunology. As these products lose patent protection over the

Some generics companies have obtained biosimilar

approvals in Europe

19

India - Pharma

bino@iif lcap.com

years, the market for biosimilars is likely to see rapid growth. Generic penetration could be much faster in these product segments due to higher costs involved.

Figure 29: Leading players in biosimilars Company Approved / launched in EU Approved/launched in semi-

regulated markets In pipeline

Barr Pharma (now part of Teva) Erythropoietin Filgrastim Insulin human Growth Hormone

Biocon In early stages of working towards filing for insulin in EU

Insulin Erythropoietin Filgrastim Streptokinase Nimotuzumab (similar to Erbitux)

Insulin analogs human Growth Hormone Reteplase

Biopartners Growth Hormone Interferon Erythropoietin

Cipla (in partnership with Avesthagen)

Biosimilars in immunology & oncology

CT Arzneimittel Filgrastim has received positive opinion

Dr Reddy's Labs Filgrastim Rituximab

Interferon alpha Undisclosed monoclonal antibodies

Hexal Erythropoietin Hospira Erythropoietin Intas Biopharma Filgrastim is in final clinical study

for filing Filgrastim PEG-Filgrastim Erythropoietin Interferon alfa

Monoclonal antibodies

Medice Erythropoietin Prolong Pharmaceuticals PEG-Erythropoietin

Other PEG-proteins Ranbaxy (in partnership with Zenotech Labs)

Filgrastim Molgramostim

Interleukin-2

Ratiopharm Filgrastim has received positive opinion

Sandoz (part of Novartis) Growth Hormone Erythropoietin

Growth Hormone Erythropoietin

Filgrastim other undisclosed products

Shantha Biotech Interferon alpha Erythropoietin

Monoclonal antibodies Pegylated proteins

Stada Erythropoietin Filgrastim Teva Filgrastim has received positive

opinion Filgrastim Growth Hormone Interferon alpha

Insulin? Erythropoietin Interleukins

Wockhardt Erythropoietin Insulin

Interferon Filgrastim Insulin glargine


20

India - Pharma

bino@iif lcap.com

Appendix

Figure 30: Business model matrix – Indian pharma space

Company M Cap (US$ m)

Domestic generics

Developed market

generics

Emerging market

generics CRAMS Biosimilars Drug

discovery Vaccines Medical devices

Sun Pharma 8,045

Cipla 6,109

Dr Reddy's Lab 4,784

Ranbaxy 4,408

GlaxoSmithKline Pharma 3,271

Lupin Ltd 3,223

Cadila Healthcare 2,494

Piramal Healthcare 1,958

Divi's Lab 1,935

Glenmark Pharma 1,504

Biocon 1,302

Aurobindo Pharma 1,182

Jubilant Organosys 1,130

Torrent Pharma 982

Aventis 927

Opto Circuits 898

Ipca Laboratories 755

Pfizer 626

Sterling Biotech 597

AstraZeneca 480

Sun Pharma Advanced Research Co 441

Novartis 402

Dishman Pharma 383

Unichem Labs 353


21

India - Pharma

bino@iif lcap.com

Figure 31: Business model matrix – Indian pharma space

Company M Cap (US$m)

Domestic generics

Developed market

generics

Emerging market

generics CRAMS Biosimilars Drug

discovery Vaccines Medical devices

Wockhardt Ltd 342

Solvay 324

Panacea Biotech 320

Strides Arcolab 309

Plethico Pharma 286

Abbott 277

Orchid Chemicals 248

Merck 232

Nectar Lifesciences 185

Elder Pharma 151

Alembic 149

JB Chemicals 138

Indoco Remedies 105

Parenteral Drugs 92

Ankur Drugs 86

Zenotech Labs 86

Natco Pharma 84

Suven Life Sciences 83

Piramal Life Sciences 77

Shasun Chemicals 55

Venus Remedies 49

Ajanta Pharma 48

Marksans Pharma 40

Ind-Swift Labs 40

SMS Pharma 36

Wanbury Ltd 24


Figure 32: Several segments contribute meaningfully to the topline

FY10 revenue break up

010,00020,00030,00040,00050,00060,00070,00080,000

Ranbaxy Dr Reddy's Cipla Lupin SunPharma

Glenmark Glaxo

US formulations Non US/Intl formulations Domestic formulationsAPIs/CRAMS Others

(Rs m)


22

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23

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Companies

24

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This page is intentionally left blank

25

India - Pharma

CMP Rs 304

Target 12m Rs342 (13%)

Market cap (US$ m) 1304

Bloomberg BIOS IN

Sector Pharmaceuticals 16 June 2010 52Wk High/Low (Rs) 311/185 Diluted o/s shares (m) 200 Daily volume (US$ m) 4 Dividend yield FY11ii (%) 0.5 Free float (%) 39.1 Shareholding pattern (%) Promoters 60.9 FIIs 3.9 DIIs 13.2 Others 22.0

Price performance (%) 1M 3M 1Y

Biocon 6.4 12.1 47.8 Rel. to Sensex 4.0 10.7 30.7 Jubilant Organ 1.1 1.9 106.5 Divis Lab 10.0 22.5 36.0 Orchid Chem 8.7 -2.9 27.0

Stock movement

01,0002,0003,0004,0005,000

Jun-

09Ju

l-09

Aug-

09Se

p-09

Oct

-09

Nov

-09

Dec

-09

Jan-

10Fe

b-10

Mar

-10

Apr

-10

May

-10

Jun-

10

050100150200250300350

Volume (LHS)Price (RHS)

(Rs)Shares (000')

Biopharma shows improvement in growth

02,000

4,0006,000

8,00010,000

12,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

0%

5%10%

15%20%

25%30%

Biopharmaceuticals (LHS)Grow th rate (RHS)

(Rs m)

Source: Company, IIFL Research

Dr Bino Pathiparampil bino@i i f lcap.com (91 22) 4646 4648

Ankit Jain ankit.jain@i i f lcap.com (91 22) 4646 4675 www.iiflcap.com

Growth picking up

Biocon is set for robust growth over the near-medium term, with growth in the legacy biopharmaceuticals business picking up and the Axicorp subsidiary in Germany benefitting from the AOK contracts. Growth in the biopharma business is driven by new immunosuppressant products in the US and increasing contribution from the fast-growing domestic formulations business. Furthermore, licensing fees picked up in FY10 after a year’s slump, and we expect growth to sustain. We continue to be optimistic on Biocon’s pipeline for the large biosimilars opportunity in regulated markets. ADD. New products, domestic formulations add momentum to legacy portfolio: Biocon’s new products have started delivering robust growth in the legacy biopharmaceuticals API business. Growth is mainly driven by the new immunosuppressant products—mycophenolate mofetil (MMF) and tacrolimus. The relatively new domestic formulations business is also increasing its share of overall revenue growth—this business now accounts for more than 10% of the company’s revenues (excluding Axicorp). The newly launched glargine insulin product should boost growth further. Axicorp benefitting from turmoil in the German market: Biocon’s German acquisition, Axicorp, has been a beneficiary of the turmoil in the German generics market. As the incumbent players suffered major revenue losses on account of the market’s shift towards a tender-based system, Axicorp, which was not a major player in the generics space, won a contract to supply metformin for AOK, a large German insurance company. As a result, Axicorp’s performance has beaten our expectations. The company has made its intent clear to go with more bids in subsequent floating of tenders by AOK or other insurance companies. Reasonable valuation; biosimilars could present upsides: Biocon is trading at 18x FY11ii core earnings, at 10-20% discount to frontline pharma stocks. Our price target of Rs342 is 18x FY12ii core earnings plus cash per share. We have not included any separate value for the large biosimilars opportunity in regulated markets; any positive developments there could provide significant upsides.

Financial summary Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenues (Rs m) 16,087 23,678 27,286 30,739 34,651EBITDA Margins (%) 20.8 20.2 19.7 20.0 20.4

Pre-Exceptional PAT (Rs m) 931 2,933 3,665 4,187 5,008Reported PAT (Rs m) 931 2,933 3,665 4,187 5,008Reported EPS (Rs) 4.7 14.7 18.3 20.9 25.0Growth (%) 215.0 25.0 14.2 19.6PER (x) 65.3 20.7 16.6 14.5 12.1ROE (%) 6.2 16.7 17.9 17.3 17.3Debt/Equity (x) 0.3 0.3 0.2 0.0 0.0EV/EBITDA (x) 18.7 12.7 11.6 9.6 7.8Price/Book (x) 4.0 3.5 3.0 2.5 2.1Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Biocon ADD

bino@iif lcap.com

26

Biocon Ltd - ADD

bino@iif lcap.com

Company snapshot Biocon was launched in 1978 in Bangalore, as a manufacturer of industrial enzymes. Over the past decade, it shifted its focus to biopharmaceuticals; for several years, it was a leading global supplier of statins (cholesterol drug) API. The company focuses on technology-intensive products and processes in pharmaceuticals. It also has a strong contract-research business, including a long-term relationship with BMS. The company has successfully developed several biosimilar products, among them recombinant insulin, glargine insulin and GCSF. These products have been launched in semi-regulated markets, and clinical development is underway in regulated markets. Biocon has also developed a strong domestic pharma business with an emphasis on lifestyle diseases. Management Name Designation Remarks / management description

Kiran Mazumdar Shaw

Chairman and Managing Director

Founded the company in 1978. Has a graduate honours degree in zoology. Has spearheaded the company’s evolution from an industrial enzymes company to a fully-integrated biopharmaceuticals enterprise. Has been voted by Nature Biotechnology as ‘The Most Influential in Bio-business’ person outside Europe and USA.

Dr Arun Chandavarkar

Chief Operating Officer

Alumnus of IIT Mumbai and MIT, Boston. Joined the company in 1990. Covers all aspects of Biocon’s business, with a specific emphasis on strategic management.

Revenue break-up between domestic and international –FY10

Contract research

12%

Biopharma48%

Licensing fees2%

Axicorp38%

Shareholding pattern

DIIs13%

Others22%

Promoters61%

FIIs4%

Growth prospects improving

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

FY06A FY07A FY08A FY09A FY10A FY11ii FY12ii FY13ii0%

10%

20%

30%

40%

50%

60%

Total operating revenue (LHS) Grow th rate (RHS)(Rs m)


Strong revenue growth in FY09-10 was driven mainly

by an acquisition

27

Biocon Ltd - ADD

bino@iif lcap.com

Biopharma – growth accelerating Licensing fees picked up in FY10 – likely to sustain

0

2,000

4,000

6,000

8,000

10,000

12,000

FY06A FY07A FY08A FY09A FY10A0%

5%

10%

15%

20%

25%

30%Biopharmaceuticals (LHS) Grow th rate (RHS)

(Rs m)

0

100

200

300

400

500

600

FY07A FY08A FY09A FY10A

Licensing fees(Rs m)

Source: Company reports, IIFL Research Source: Company reports, IIFL Research

Contract research – on a secular growth path Axicorp revenues pick up on AOK tender supply in Germany

0

1,000

2,000

3,000

4,000

5,000

FY06

A

FY07

A

FY08

A

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FY10

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FY11

ii

FY12

ii

FY13

ii

Contract research revenues(Rs m)

0

500

1,000

1,500

2,000

2,500

3,000

2Q 3Q 4Q 1Q 2Q 3Q 4Q

FY09A FY10A

Axicorp revenues(Rs m)


EBITDA margins to remain steady Improving working-capital cycle

0%

5%

10%

15%

20%

25%

30%

35%

FY06

A

FY07

A

FY08

A

FY09

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FY11

ii

FY12

ii

FY13

ii

EBITDA margin EBITDA margin ex license fees & Axicorp

0%

5%

10%

15%

20%

25%

30%


Net w orking capital as a % of revenues


28

Biocon Ltd - ADD

bino@iif lcap.com

Financial summary

Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenue 16,087 23,678 27,286 30,739 34,651EBITDA 3,346 4,774 5,380 6,159 7,061EBIT 2,243 3,373 3,902 4,625 5,530Treasury income -938 311 723 575 585Interest expense 177 169 154 94 7Profit before tax 1,128 3,515 4,470 5,106 6,108Taxes 118 487 715 817 977Minorities and other 79 96 89 102 122Net profit 931 2,933 3,665 4,187 5,008

Cashflow summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiProfit before tax 1,044 3,515 4,470 5,106 6,108Depr. & amortization 1,103 1,401 1,478 1,535 1,531Tax paid 169 445 715 817 977Working capital ∆ -1,282 -290 -3,585 -844 -949Other operating items 256 -142 -568 -482 -578Operating cashflow 951 4,038 1,080 4,498 5,134Capital expenditure -3,649 -1,020 -2,500 -1,500 -1,500Free cash flow -2,698 3,018 -1,420 2,998 3,634Investments 211 256 0 0 0Debt financing/disposal 2,111 -103 -2,008 -2,880 48Dividends paid -585 -702 -819 -351 -351Other items -432 142 568 482 578Net change in cash -1,393 2,611 -3,679 249 3,909

Balance-sheet summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiCash & equivalents 3,403 5,314 1,635 1,884 5,793Sundry debtors 3,667 4,461 6,276 7,070 7,970Inventories - trade 3,192 3,716 5,457 6,148 6,930Other current assets 947 1,343 1,637 1,844 2,079Fixed assets 12,205 12,439 13,461 13,426 13,395Intangible assets 1,631 1,695 1,695 1,695 1,695Other term assets 391 391 391 391 391Total assets 25,436 29,359 30,552 32,458 38,253Sundry creditors 4,375 5,799 6,064 6,912 7,880Long-term debt/CBs 5,239 5,136 3,128 248 296Other long-term liabs 466 508 508 508 508Minorities/other equity 248 338 427 530 652Net worth 15,107 17,578 20,424 24,260 28,918Total liabs & equity 25,436 29,359 30,552 32,458 38,253

Ratio analysis Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenue growth (%) 52.7 47.2 15.2 12.7 12.7Op Ebitda growth (%) 12.1 42.7 12.7 14.5 14.6Op Ebit growth (%) 9.6 50.4 15.7 18.5 19.6Op Ebitda margin (%) 20.8 20.2 19.7 20.0 20.4Op Ebit margin (%) 13.9 14.2 14.3 15.0 16.0Net profit margin (%) 5.8 12.4 13.4 13.6 14.5Dividend payout (%) 64.4 23.9 8.2 7.2 6.0Tax rate (%) 10.5 13.9 16.0 16.0 16.0Net debt/equity (%) 12.2 -1.0 7.3 -6.7 -19.0Net debt/op Ebitda (x) 0.5 0.0 0.3 -0.3 -0.8Return on equity (%) 6.2 16.7 17.9 17.3 17.3ROCE (%) 10.8 14.5 16.2 18.5 18.6Return on assets (%) 3.7 10.0 12.0 12.9 13.1Source: Company, IIFL Research

Business prospects looking up with better

pricing in statins, strong growth in domestic

business and AOK tender business in Germany

Major capex planned in FY11 would mean a dip in

free cashflow

Strong balance sheet with cash

Strong growth in FY09-10 was due to acquisition in

Germany; organic growth accelerating in FY10-11ii

29

India - Pharma

CMP Rs 338

Target 12m Rs328 (-3%)


Bloomberg CIPLA IN



Cipla 7.9 7.5 32.5 Rel. to Sensex 5.5 6.1 15.4 Ranbaxy -4.7 -6.3 51.4 Dr Reddy's 10.1 18.4 101.6 Sun Pharma 6.9 4.8 33.1

Stock movement

02,0004,0006,0008,000

10,000

Jun-

09Ju

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09Se

p-09

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-09

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-09

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-09

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10Fe

b-10

Mar

-10

Apr

-10

May

-10

Jun-

10

0

100

200

300

400


(Rs)Shares (000')

Growth takes a beating

0

20,000

40,000

60,000

80,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii 0%

10%

20%

30%

40%

Total operating revenue (LHS)Grow th rate (RHS)

(Rs m)




High price for low growth Cipla has a robust stable of businesses that includes its domestic branded-formulations business, which leads the market with over 5% share by revenue. In exports, Cipla has a partnership-based model, and the company has an emphasis on emerging markets rather than developed ones. Thus, a pick-up in overall sales from one or two new products with high potential is rather unlikely. Sales of CFC-free inhalers in Europe and high-value APIs in the US market remain potential opportunities, but we would prefer to wait for more visibility before factoring them into our estimates. We estimate an earnings CAGR of 13% over FY10-13ii—a rate of growth which, in our view, does not justify the large cash-burn and high P/E of 24x FY11ii. REDUCE.

Revenue growth to trail that of peers: We estimate Cipla’s revenue growth at 10% annualised over FY10-12—significantly slower than the ~20% CAGR in organic businesses that we expect from its peers. There is increased competition in the domestic market, especially in the respiratory segment, which has long been Cipla’s stronghold. In Africa, prices of HIV drugs—another key market for Cipla—have fallen significantly. A sizeable deal with a Western pharma major to sell generics in emerging markets is likely, but we do not expect a rapid ramp–up following such a deal.

High capex not yielding results: Cipla has spent about Rs27bn over FY06-10 on capacity expansion and other enhancements. However, these investments show no signs of paying off, going by the company’s 8-10% revenue growth guidance, despite the new Sikkim facility ramping up and the Indore facility coming online. Staff cost has been growing faster than revenues for the last three years—which means EBITDA margins would have fallen, were it not for the rupee’s depreciation. There is little visibility of operating leverage setting in when the Indore facility is fully operational.

Valuations are still rich: Despite lacklustre growth and large cash burn, Cipla’s trading at 25x FY11ii core earnings—at a premium to Dr Reddy’s Labs and Lupin. We see little room for appreciation from this level, unless new and unexpected growth drivers show up. We retain REDUCE, with a price target of Rs328 (21x FY12ii core earnings). Any significant rupee depreciation or a major partnership deal with a big MNC pharma company could pose risks to our call.

Financial summary Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenues (Rs m) 52,570 56,300 62,031 68,656 75,999EBITDA Margins (%) 23.9 24.9 25.6 25.9 26.3Pre-Exceptional PAT (Rs m) 7,608 9,870 11,313 12,956 14,669Reported PAT (Rs m) 7,608 10,820 11,313 12,956 14,669EPS (Rs) 9.8 12.3 14.1 16.1 18.3Growth (%) 8.5 25.6 14.6 14.5 13.2PER (x) 34.5 27.5 24.0 20.9 18.5ROE (%) 17.5 18.3 16.6 16.5 16.2Debt/Equity (x) 0.2 0.0 0.0 0.0 0.0EV/EBITDA (x) 21.6 19.4 17.0 15.0 13.1Price/Book (x) 6.0 4.6 4.0 3.4 3.0Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Cipla Ltd REDUCE

bino@iif lcap.com

30

Cipla Ltd – REDUCE

bino@iif lcap.com

Company snapshot

Cipla, established in 1935, is one of the largest and oldest pharmaceutical companies in India. It has maintained its revenue market share at ~5% for several years. The company is the largest maker of anti-asthma drugs in the country, controlling more than 70% of the inhaler market. Cipla is the world’s third largest manufacturer of inhalers, and it continues to invest heavily in inhaler facilities. It is also the world’s largest producer of anti-retroviral drugs used in the treatment of AIDS. Exports account for 50% of the company’s turnover. Africa and the US are its key export markets. Cipla has a partnership-based business model for its export market. It does not maintain its own front-end, but supplies bulk and finished dosages to its partners, who then market these products in their respective countries.

Management Name Designation Remarks / management description

Dr Yusuf Hamied

Chairman and Managing Director

Doctorate in chemistry from Cambridge, he joined Cipla in 1960 as an officer in charge of research and development. Has been awarded the Padma Bhushan by the Government of India in 2005.

Mr Amar Lulla Joint Managing Director and Executive Director

Chartered accountant by training, he manages the overall operations of the company; has been instrumental in driving the company’s growth.

Revenue break-up between domestic and international (FY10)

Export APIs10%

Export formulations

41%

Technology fees3%

Domestic formulations

44%

Others2%


DIIs17%

Others30%

Promoters36%

FIIs17%

Growth takes a beating

0

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20,000

30,000

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70,000

80,000


5%

10%

15%

20%

25%

30%

35%Total operating revenue (LHS) Grow th rate (RHS)(Rs m)


31


bino@iif lcap.com

Moderating growth in formulations exports API exports has been a laggard in growth

04,0008,000

12,00016,00020,00024,00028,00032,00036,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii 0%5%10%15%20%25%30%35%40%45%

Exports - formulations (LHS) Grow th rate (RHS)

(Rs m)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii -20%

0%

20%

40%

60%

80%Exports - APIs (LHS) Grow th rate (RHS)

(Rs m)


Domestic formulations business has been growing slower than the overall market

Volatile technology and licensing fees

0

5,00010,000

15,00020,000

25,000

30,00035,000

40,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii 0%

5%

10%

15%

20%

25%Domestic fomulations (LHS) Grow th rate (RHS)

(Rs m)

0

300

600

900

1,200

1,500

1,800

2,100

2,400

FY06A FY07A FY08A FY09A FY10A

Technology/Consulting fees(Rs m)


Margin very sensitive to rupee rate Large capex over the years – free cashflow remains

negative

0%

5%

10%

15%

20%

25%

30%

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

EBITDA margin

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000


Capital expenditure(Rs m)


32


bino@iif lcap.com

Financial summary Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenue 52,570 56,300 62,031 68,656 75,999EBITDA 12,538 13,996 15,877 17,815 19,976EBIT 10,832 12,109 13,579 15,202 17,076Interest income -1,640 482 600 600 600Interest expense 340 237 37 2 2Exceptional items 0 950 0 0 0Profit before tax 8,853 13,305 14,142 15,801 17,674Taxes 1,245 2,485 2,828 2,844 3,005Net profit 7,608 10,820 11,313 12,956 14,669 Cashflow summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiProfit before tax 8,968 13,305 14,142 15,801 17,674Depr. & amortization 1,706 1,888 2,298 2,613 2,901Tax paid 648 2,485 2,828 2,844 3,005Working capital ∆ -7,112 -3,684 -3,524 -3,991 -4,428Other operating items 817 -1,196 -563 -598 -598Operating cashflow 3,732 7,828 9,525 10,980 12,544Capital expenditure -6,998 -5,050 -6,000 -6,000 -6,000Free cash flow -3,266 2,778 3,525 4,980 6,544Equity raised 0 6,692 0 0 0Investments 839 0 0 0 0Debt financing/disposal 3,948 -8,783 -592 0 0Dividends paid -1,819 -1,819 -2,255 -2,442 -2,630Other items -100 246 563 598 598Net change in cash -397 -885 1,241 3,136 4,512 Balance-sheet summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiCash & equivalents 1,334 449 1,690 4,826 9,338Sundry debtors 18,529 20,268 22,331 24,716 27,360Inventories - trade 13,983 15,201 16,748 18,537 20,520Other current assets 11,133 12,621 13,881 15,339 16,954Fixed assets 23,588 27,700 31,402 34,789 37,889Total assets 68,568 76,239 86,054 98,208 112,061Sundry creditors 14,046 14,806 16,154 17,794 19,608Long-term debt/CBs 9,402 620 28 28 28Other long-term liabs 1,642 1,641 1,641 1,641 1,641Net worth 43,478 59,172 68,230 78,744 90,783Total liabs & equity 68,568 76,239 86,054 98,208 112,061 Ratio analysis Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenue growth (%) 24.9 7.1 10.2 10.7 10.7Op Ebitda growth (%) 47.6 11.6 13.4 12.2 12.1Op Ebit growth (%) 50.7 11.8 12.1 12.0 12.3Op Ebitda margin (%) 23.9 24.9 25.6 25.9 26.3Op Ebit margin (%) 20.6 21.5 21.9 22.1 22.5Net profit margin (%) 14.5 17.5 18.2 18.9 19.3Dividend payout (%) 20.4 17.8 18.5 17.4 15.3Tax rate (%) 14.1 18.7 20.0 18.0 17.0Net debt/equity (%) 18.6 0.3 -2.4 -6.1 -10.3Net debt/op Ebitda (x) 0.6 0.0 -0.1 -0.3 -0.5Return on equity (%) 17.5 18.3 16.6 16.5 16.2ROCE (%) 19.9 19.7 19.4 18.9 18.5Return on assets (%) 11.1 12.9 13.1 13.2 13.1Source: Company, IIFL Research

Significant slowdown in business growth despite

large capex

Free cashflow has been negative for several years

owing to large capex—expect a pick-up ahead

Equity financing in FY10 used to pay off debt

Growth rates take a deep dip—high growth in FY09,

mostly from rupee depreciation

33

India - Pharma

CMP Rs 1422

Target 12m Rs1803 (27%)


Bloomberg DRRD IN

Sector Pharmaceuticals

16 June 2010 52Wk High/Low (Rs) 1517/670 Diluted o/s shares (m) 169 Daily volume (US$ m) 15 Dividend yield FY11ii (%) 0.4 Free float (%) 74.2 Shareholding pattern (%) Promoters 25.8 FIIs 27.3 DIIs 18.0 Others 28.9


Dr Reddy's 10.1 18.4 101.6 Rel. to Sensex 7.6 17.0 84.5 Ranbaxy -4.7 -6.3 51.4 Sun Pharma 6.9 4.8 33.1 Cipla 7.9 7.5 32.5

Stock movement

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1,0001,5002,0002,5003,000

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500

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(Rs)Shares (000')

Unique products and cost control will lead to operating margin expansion

0%

5%

10%

15%

20%

25%

FY08

A

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A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Operating margin

Source: Company. IIFL Research



Thoroughbred Dr Reddy’s offers the best earnings growth visibility and potential for further upsides in the Indian pharma space, in our view. Its US generics business, will be boosted by market-share gains in generic Prilosec OTC and more potential high-value launches. Generic fondaparinux, if approved and launched, could provide up to 10% upside to our estimates. The emerging-market business is gaining strength, with increased growth in the domestic market, continued strength in the Russian market, and the budding partnership with GSK. The pharma-services business will benefit significantly from the large number of drugs going off-patent in the US over the next 2-3 years. Superior technological capabilities, well-qualified professional management and good corporate governance practices add to our confidence. We retain BUY with a target price of Rs1803.

US—the main growth driver: Dr Reddy’s growth in the US continues unabated: revenues rose by over 40% in FY09, and a further 18% in FY10, despite a product recall in September 2009. We expect 25-30% growth to sustain over the next 2-3 years. Generic fondaparinux, another low-competition product, if approved, could provide Rs5-6 upside to our earnings projections on an annualised basis and could be a growing long-term opportunity.

Rightly positioned for the emerging markets: After two years of modest performance, the company’s growth in the domestic market is picking up pace on the back of new product introductions and a streamlined distribution system. The Russian business is continuing its strong growth, despite a slowdown in the overall market. The recent partnership with GSK for emerging markets should prove to be another major contributor to growth in the coming years—our projections from these markets may prove to be too conservative.

No major concerns; strong growth ahead: Dr Reddy’s continues to face headwinds in the German business, but that has become less significant for the company. The company has successfully managed debtors in Russia through the financial crisis. We estimate 35-40% organic FY10-13ii CAGR in core earnings. Dr Reddy’s stock is trading at 22x FY11ii core earnings. Our price target of Rs1,803 is 21x FY12ii core earnings plus cash and other values per share.

Financial summary Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenues (Rs m) 69,441 70,277 78,293 92,197 110,822EBITDA Margins (%) 23.4 20.8 23.4 24.9 27.5Pre-Exceptional PAT (Rs m) 9,824 10,167 11,276 14,986 21,664Reported PAT (Rs m) -5,168 1,068 11,276 14,986 21,664EPS (Rs) -30.5 6.3 66.3 88.0 126.9Growth (%) NA NA 32.7 44.3PER (x) -46.6 226.0 21.4 16.2 11.2ROE (%) -12.3 2.6 22.1 23.2 25.5Debt/Equity (x) 0.5 0.2 0.2 0.1 0.1EV/EBITDA (x) 15.7 16.8 13.2 10.2 7.2Price/Book (x) 5.7 5.8 4.7 3.7 2.9Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Dr Reddy’s Laboratories BUY

bino@iif lcap.com

34

Dr Reddy’s Laboratories – BUY

bino@iif lcap.com

Company snapshot The Hyderabad-based Dr Reddy’s Laboratories was founded by Dr K Anji Reddy as a bulk-drugs player. Incorporated in 1984 with an initial capital outlay of Rs2.5m, it rapidly moved up the value chain to become a major generics company with global operations. It is India’s second-largest pharmaceutical company in revenues. Its product portfolio spans a wide range of therapeutic categories, including ulcer medicines, antibiotics, pain relievers, antidepressants and cardiovascular drugs. The company also has significant capabilities in the biological-therapeutics space and has already launched three biosimilar products in India. It markets its products in more than 100 countries, but the main markets are the US, Europe, India and Russia. The company employs over 10,000 personnel of over 40 nationalities. Management Name Designation Remarks / management description

Dr K Anji Reddy Chairman

Founded the company in 1984; has been a pioneer and trendsetter in the Indian pharma Industry. Currently, serving member of Prime Minister’s Council on Trade & Industry. Has been a recipient of several awards and honours.

G V Prasad Vice Chairman and CEO

Widely credited as the architect of DRL’s successful global generics strategy; an Illinois Institute of Technology and Purdue University alumnus; leads the core team at DRL.

Satish Reddy MD and COO Looks after the company’s pharma services and global generic business; has played an instrumental role in the company’s transition up the pharma value chain.


Intl formulations

31%US

formulations24%

APIs/CRAMS

29%


14%

Others2%


FIIs27%

Promoters26%

Others29%

DIIs18%

Company target of US$3bn in FY13 makes upgrades to our estimates possible

0

20,000

40,000

60,000

80,000

100,000

120,000

FY05A FY06A FY07A FY08A FY09A FY10A FY11ii FY12ii FY13ii-50%

0%

50%

100%

150%

200%Total operating revenue (LHS) Grow th (RHS)(Rs m)


35


bino@iif lcap.com

US generics business is the most important growth driver Betapharm revenues likely to decline, but the company’s share in DRL’s overall revenues is now much less important

0

5,000

10,000

15,000

20,000

25,000

30,000

FY08A FY09A FY10A FY11ii FY12ii FY13ii

US base business revenues US - exclusivities(Rs m)

0

2,000

4,000

6,000

8,000

10,000

12,000

FY07A FY08A FY09A FY10A FY11ii FY12ii FY13ii

Betapharm revenues(Rs m)


Russia business beats all market concerns Company back on the growth track in the domestic

business

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

FY05

A

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Russia business revenues(Rs m)

0

3,000

6,000

9,000

12,000

15,000

18,000

21,000FY

05A

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Domestic formulations revenues(Rs m)


CRAMS business will benefit from patent expiries in the US Unique products and cost control will drive EBIT margin

expansion

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

FY05

A

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Pharma Services & API(Rs m)

0%

5%

10%

15%

20%

25%


EBIT margin


36


bino@iif lcap.com

Financial summary

Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenue 69,441 70,277 78,293 92,197 110,822EBITDA 16,226 14,597 18,358 22,967 30,524EBIT 12,412 10,538 13,824 18,245 25,685Interest income -405 1,354 635 847 1,744Interest expense 1,034 788 383 383 383Exceptional items -14,992 -9,099 0 0 0Profit before tax -4,019 2,005 14,077 18,709 27,046Taxes 1,173 985 2,815 3,742 5,409Minorities and other -24 -48 -14 -19 -27Net profit -5,168 1,068 11,276 14,986 21,664 Cashflow summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiNet profit -5,168 1,068 11,276 14,984 21,636Depr. & amortization 3,814 4,059 4,534 4,722 4,839Tax paid 1,619 0 0 0 0Working capital ∆ -8,267 3,963 -4,473 -3,502 -5,137Other operating items 15,745 8,037 -253 -464 -1,361Operating cashflow 4,505 17,127 11,084 15,740 19,977Capital expenditure -8,224 -4,200 -7,000 -6,000 -6,000Free cash flow -3,719 12,927 4,084 9,740 13,977Equity raised 5 0 0 0 0Investments -155 -1,900 0 0 0Debt financing/disposal -662 -10,132 0 0 0Dividends paid -738 -1,232 -2,221 -1,236 -1,239Net change in cash -5,269 -337 1,862 8,504 12,738 Balance-sheet summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiCash & equivalents 6,126 6,355 8,470 17,438 31,537Sundry debtors 14,592 11,947 13,310 15,673 18,829Inventories - trade 13,226 13,353 17,225 20,282 24,367Other current assets 5,066 4,977 5,539 6,511 7,811Fixed assets 20,882 22,502 25,442 27,089 28,538Intangible assets 22,179 13,997 13,524 13,154 12,866Other term assets 1,721 1,721 1,721 1,721 1,721Total assets 83,792 74,852 85,229 101,868 125,669Short-term debt 9,569 9,569 9,569 9,569 9,569Sundry creditors 5,987 6,691 7,092 8,134 9,362Other current liabs 10,997 11,649 12,571 14,420 16,596Long-term debt/CBs 10,132 0 0 0 0Other long-term liabs 5,062 5,062 5,062 5,062 5,062Net worth 42,045 41,881 50,935 64,683 85,081Total liabs & equity 83,792 74,852 85,229 101,868 125,669 Ratio analysis Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenue growth (%) 38.9 1.2 11.4 17.8 20.1Op Ebitda growth (%) 92.5 -10.0 25.8 25.1 32.8Op Ebit growth (%) 146.3 -15.1 31.2 32.0 40.6Op Ebitda margin (%) 23.4 20.8 23.4 24.9 27.5Op Ebit margin (%) 17.9 15.0 17.7 19.8 23.2Net profit margin (%) 14.1 14.5 14.4 16.3 19.5Dividend payout (%) -20.4 177.8 9.4 7.1 4.9Tax rate (%) -29.2 49.1 20.0 20.0 20.0Net debt/equity (%) 32.3 7.7 2.2 -12.2 -25.8Net debt/op Ebitda (x) 0.8 0.2 0.1 -0.3 -0.7Return on equity (%) -12.3 2.6 22.1 23.2 25.4ROCE (%) 18.6 18.6 21.1 23.0 25.7Return on assets (%) 11.7 13.6 13.2 14.7 17.2Source: Company data, IIFL Research

Our projections are short of the company’s FY13

target of US$3bn topline; upside surprise possible

Net loss in FY09 due to write-off of intangibles

related to Betapharm acquisition

Good operating cash flows would make the company

robust and resilient to adverse market conditions

Strong unlevered balance sheet will open up

opportunities for inorganic growth

EBITDA margins to improve significantly as

new low-competition products are introduced

37

India - Pharma

CMP Rs 2078



Bloomberg GLXO IN

Sector Pharmaceuticals 16 June 2010 52Wk High/Low (Rs) 2271/1150 Diluted o/s shares (m) 85 Daily volume (US$ m) 2 Dividend yield CY10ii (%) 1.6 Free float (%) 49.3 Shareholding pattern (%) Promoters 50.7 FIIs 15.0 DIIs 17.0 Others 17.3


GlaxoSK Pharma -2.9 22.4 65.0 Rel. to Sensex -5.4 20.9 47.9 Ranbaxy -4.7 -6.3 51.4 Cipla 7.9 7.5 32.5 Pfizer 4.9 21.7 32.8

Stock movement

050

100150200250300

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05001,0001,5002,0002,500


(Rs)Shares (000')

Robust free cashflow

0

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The domestic story

GlaxoSmithKline Pharma’s strong brand franchise in the high-growth Indian market makes it a compelling play. Add to it the large free cashflow generation, strong debt-free balance sheet and operations with negative net working capital—the result is a company with ROIC of over 800% in a market that is in a long-term secular growth phase. It offers modest growth compared to generics players, but its growth is more steady, predictable and profitable. Recent acceleration in the domestic market and better-than-expected pick-up in newly launched products such as Tykerb and Rotarix could deliver positive surprises—growth rates could pick up from historical rates of 10-12% to 14-16%. About US$400m cash on books provides potential upside through acquisitions. ADD. Focus on domestic pharma: Glaxo is a pure play on the high-growth domestic pharma market. As such, it is one of the best-positioned players in India to benefit from the industry’s acceleration in growth to 15%, from 11% in the previous few years. Introduction of new patented products from the parent (GSK Plc) or other innovator companies and consolidation in the domestic market could further accelerate Glaxo’s growth over the next few years.

Well-positioned to participate in industry consolidation: The domestic pharma industry is highly fragmented, with over 20,000 companies, and the market leader having a share of just about 5% by revenue. The advent of the patent regime, increasing regulatory hurdles and growth pressures for big pharma in the developed markets have triggered a round of M&A activity in the industry. GSK, with ~US$400m cash in hand and its ability to price products at significant premium is well positioned to benefit from M&A. Premium valuations to sustain: Glaxo’s strong brand franchise offers several benefits, among them: 1) a stable business; 2) ~25% premium pricing; and 3) negative working capital. Thus, Glaxo can be viewed as a highly visible stream of future cash flows. Together with potential inorganic upsides, these factors will help sustain the stock’s high valuation, in our view. Glaxo shares trade at 32.7x CY10ii core earnings; our price target of Rs2,232 is 30x CY11ii core earnings plus cash per share.

Financial summary Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiRevenues (Rs m) 16,604 18,708 21,668 24,918 28,406EBITDA Margin (%) 34.8 35.0 34.6 34.7 34.7Pre-Exceptional PAT (Rs m) 4,484 5,049 5,728 6,600 7,562Reported PAT (Rs m) 5,766 5,123 5,728 6,600 7,562EPS (Rs) 52.9 59.6 67.6 77.9 89.3Growth (%) - 12.6 13.5 15.2 14.6PER (x) 39.3 34.9 30.7 26.7 23.3ROE (%) 36.6 28.7 27.7 27.6 27.4Debt/Equity (x) 0.0 0.0 0.0 0.0 0.0EV/EBITDA (x) 27.6 24.0 20.6 17.4 14.8Price/Book (x) 11.2 9.9 8.5 7.4 6.4Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

GlaxoSmithKline Pharma ADD

bino@iif lcap.com

38

GlaxoSmithKline Pharma – ADD

Company snapshot GlaxoSmithKline Pharmaceuticals, established in 1924 in India, is one of the oldest and largest pharmaceuticals companies in India. Over the last four years, it has divested its fine-chemicals and animal-health businesses, and shut most of its manufacturing facilities; most of its new products are outsourced. Its product portfolio has historically been heavy on anti-infectives, vaccines and acute therapies, but of late it has started concentrating on diabetes, oncology and cardiovascular diseases. The company employs over 3,500 sales representatives in India, among the largest sales forces in the Indian pharma industry. The UK-based GSK Plc owns 51% of the company and sells products developed by it through Glaxo India. Management Name Designation Remarks / management description

Dr H B Joshipura Chairman

On the board of the company. Previously worked with Johnson & Johnson. Is in charge of the company’s overall operations.

M B Kapadia Senior Executive Director

In charge of finance, legal & corporate affairs, corporate communications and administration.

Revenue break-up between domestic and international (CY10)

APIs / CRAMS

4%


91%

Others5%


DIIs17%

Others17%

Promoters51%

FIIs15%

Revenue growth has picked up sharply in recent years

0

4,000

8,000

12,000

16,000

20,000

24,000

28,000

32,000

CY05A CY06A CY07A CY08A CY09A CY10ii CY11ii CY12ii0%

2%4%

6%8%

10%12%

14%16%



bino@iif lcap.com

39


Industry-leading margins Robust free cashflow

28%

29%

30%

31%

32%

33%

34%

35%

36%

CY06A CY07A CY08A CY09A CY10ii CY11ii CY12ii

EBITDA margin

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000


Free cashflow(Rs m)


Works on negative working capital Domestic formulations will remain the growth driver

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

CY05A CY06A CY07A CY08A CY09A

Net w orking capital as % of total revenues

0

5,000

10,000

15,000

20,000

25,000

30,000


IodexExports - external contract manufacturingTotal domestic pharma

(Rs m)


High-potential product launches over 2007-09 should continue to drive growth Product Year of launch Therapeutic area Zemetril 250 mg 2007-08 Antibiotic, Anti-infective Arixtra 2.5mg/0.5 ml 2007-08 Anticoagulant Inflapen Tablets 2007-08 Anti-inflammatory Benitec -40 2007-08 Cardiology Augmentin DDS 2007-08 Antibiotic Tykerb 2007-08 Breast cancer Carzec Tablets 2007-08 Cardiology Esblanem 1g 2009 Injectable anti-biotic Dermocalm Lotion 2009 Dermatology Cervarix 2009 Cervical cancer vaccine Rotarix 2009 Gastro-enteritis vaccine Infanrix 2009 Pediatric Source: Company, IIFL Research

bino@iif lcap.com

40


Financial summary

Income statement summary (Rs m) Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiRevenue 16,604 18,708 21,668 24,918 28,406EBITDA 5,777 6,546 7,497 8,647 9,857EBIT 5,614 6,383 7,301 8,440 9,640Interest income 1,186 1,202 1,390 1,560 1,817Exceptional items 1,282 74 0 0 0Profit before tax 8,081 7,659 8,691 9,999 11,457Taxes 2,315 2,536 2,962 3,400 3,895Net profit 5,766 5,123 5,728 6,600 7,562

Cashflow summary (Rs m) Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiProfit before tax 7,010 7,612 8,691 9,999 11,457Depr. & amortization 163 164 196 207 217Tax paid 2,464 1,854 2,962 3,400 3,895Working capital ∆ -326 205 413 422 467Other operating items -1,083 -1,011 -1,390 -1,560 -1,817Operating cashflow 3,300 5,115 4,948 5,669 6,429Capital expenditure -242 -358 -250 -250 -250Free cash flow 3,059 4,757 4,698 5,419 6,179Investments 1,469 138 0 0 0Debt financing/disposal -2 -2 0 0 0Dividends paid -3,549 -3,943 -2,942 -3,351 -3,861Other items 870 1,011 1,390 1,560 1,817Net change in cash 1,848 1,961 3,145 3,627 4,135

Balance-sheet summary (Rs m) Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiCash & equivalents 16,863 18,824 21,968 25,596 29,731Sundry debtors 579 537 650 748 852Inventories - trade 2,330 2,573 3,033 3,488 3,977Other current assets 2,041 1,377 1,907 2,193 2,500Fixed assets 1,004 1,142 1,196 1,239 1,271Total assets 22,816 24,453 28,755 33,263 38,331Sundry creditors 7,302 6,987 8,502 9,763 11,129Long-term debt/CBs 57 54 54 54 54Other long-term liabs -298 -449 -449 -449 -449Net worth 15,755 17,861 20,647 23,896 27,596Total liabs & equity 22,816 24,453 28,755 33,263 38,331

Ratio analysis Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiRevenue growth (%) 5.3 12.7 15.8 15.0 14.0Op Ebitda growth (%) 7.5 13.3 14.5 15.3 14.0Op Ebit growth (%) 7.7 13.7 14.4 15.6 14.2Op Ebitda margin (%) 34.8 35.0 34.6 34.7 34.7Op Ebit margin (%) 33.8 34.1 33.7 33.9 33.9Net profit margin (%) 27.0 27.0 26.4 26.5 26.6Dividend payout (%) 58.8 49.6 50.0 50.0 50.0Tax rate (%) 28.7 33.1 34.1 34.0 34.0Net debt/equity (%) -106.7 -105.1 -106.1 -106.9 -107.5Net debt/op Ebitda (x) -2.9 -2.9 0.0 0.0 0.0Return on equity (%) 36.6 28.7 27.7 27.6 27.4ROCE (%) 36.2 36.5 36.1 35.9 35.4Return on assets (%) 19.7 20.6 19.9 19.8 19.7Source: Company, IIFL Research

Strong performance mirrors the pick-up in the domestic pharma market

Very strong free cash flow

Debt-free balance sheet with

~US$400m cash

Growth picked up from CY09 onwards

High return ratios—they would have

been higher, but for high cash in hand

bino@iif lcap.com

41

India - Pharma

CMP Rs 262



Bloomberg GNP IN



Glenmark -5.3 9.9 19.4 Rel. to Sensex -7.7 8.5 2.3 Ranbaxy -4.7 -6.3 51.4 Dr Reddys 10.1 18.4 101.6 Sun Pharma 6.9 4.8 33.1

Stock movement

0

5,000

10,000

15,000

Jun-

09Ju

l-09

Aug-

09Se

p-09

Oct

-09

Nov

-09

Dec

-09

Jan-

10Fe

b-10

Mar

-10

Apr

-10

May

-10

Jun-

10

050100150200250300350


(Rs)Shares (000')

Moderating growth rates

0

10000

20000

30000

40000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii 0%

20%

40%

60%

80%


(Rs m)




Yet to excite Glenmark has recovered significantly from a severe cash crunch and its impact on business, but our original concerns about significant capitalisation of expenses still remain—the company continues to burn cash. This, combined with the withdrawal of its plan to float an IPO for its generics subsidiary, could limit upside on the stock. Business growth in most geographies remains lacklustre, except in the domestic market, where the company has so far maintained steady annual growth of ~20%. NCE licensing revenues have started flowing in with the outlicensing of a pain molecule to Sanofi, but the profitability of that business remains unclear. Although the stock is trading at a 20–30% discount to peers, we remain cautious and await more balance-sheet details to assess the company’s future potential. SELL.

Balance sheet remains weak: Notwithstanding a strong reported performance for FY10, our concerns regarding significant capitalisation of expenses still persist. Despite an EBITDA of Rs1.8bn in 4QFY10, Glenmark’s net debt climbed to Rs17.5bn from Rs15.8bn immediately after the Rs4bn QIP in 3QFY10. The increase in intangibles and CWIP was higher than the company’s EBITDA in FY09, as brand-related intangibles went up by Rs3.1bn and CWIP, which includes capitalised R&D, went up by Rs2.1bn. We await more details on the balance sheet as at end-FY10.

Mixed business performance: Glenmark’s business performance remains mixed. In the US, its revenues declined in FY10, and we don’t expect any significant growth in FY11. The domestic business remains robust, with revenue growth of ~20% in FY10. The company’s performance in other markets continues to be volatile, and there is no clarity on the profitability of the NCE business. Revenues from the Latin American business declined in FY10, while those from other semi-regulated markets grew by more than 60%, though on a small base.

Valuation remains low, but not necessarily attractive: Glenmark is trading at 16.3x FY11ii core earnings, at a 20-40% discount to peers. We believe that the discount is justified, given the lack of clarity on capitalised expenses. Our price target of Rs252 is 13x FY12ii core earnings, which include US$20m as NCE licensing income.

Financial summary Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenues (Rs m) 21,162 24,848 29,034 33,260 37,870EBITDA Margins (%) 22.9 26.1 27.9 28.1 27.8Pre-Exceptional PAT (Rs m) 3,086 3,310 4,567 5,679 6,566Reported PAT (Rs m) 1,917 3,310 4,567 5,679 6,566EPS (Rs) 7.5 12.1 16.7 20.7 23.9Growth (%) -52.1 60.5 37.7 24.1 15.4PER (x) 34.7 21.6 15.7 12.7 11.0ROE (%) 12.0 14.2 16.5 17.1 16.5Debt/Equity (x) 1.3 0.8 0.6 0.5 0.4EV/EBITDA (x) 17.9 13.7 10.9 9.4 8.2Price/Book (x) 4.2 3.1 2.6 2.2 1.8Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Glenmark Pharma Ltd SELL

bino@iif lcap.com

42

Glenmark Pharma – SELL

bino@iif lcap.com

Company snapshot Glenmark, which was originally engaged almost exclusively in the domestic generics market, has over the last decade expanded its operations into the US generics market and other semi-regulated markets. The company also has developed a drug-discovery division, which develops early-stage molecules for further out-licensing to larger partners. After a series of failed drug-discovery partnerships, the company has recently outlicensed a molecule to Sanofi Aventis. Glenmark has twelve manufacturing facilities in four countries, and has five R&D centres. It recently carved out part of its business into a subsidiary, Glenmark Generics Limited, to market generic generics, mainly in the US. Plans to take this subsidiary public have been shelved for the time being. Management Name Designation Remarks / management description

Glenn Saldanha

Managing Director & CEO

Joined the company in 1998. Oversees the entire operations of the organisation. A pharmacy graduate and a MBA from Stern, he has worked with Eli Lilly and PWC in the US before joining Glenmark. He has transformed the company from a branded-generics player to a research-driven innovation-led company.

A S Mohanty Director – Formulations

Joined the company in January, 1984. Responsible for the strategic growth of the company’s branded formulations business across the world.


Intl formulations

29%

US formulations

29%

APIs / CRAMS

11%


30%

Others1%


DIIs8%

Others17%

Promoters48%

FIIs27%

Moderating growth rates

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000


10%

20%

30%

40%

50%

60%

70%



43


bino@iif lcap.com

Growth in the US business remains modest API revenues have picked up from the FY09 slump

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000


Total US revenues(Rs m)

0

500

1,000

1,500

2,000

2,500

3,000


API revenues(Rs m)


Latin America remains volatile; other semi-regulated markets show strength

Domestic business continues to be strong

0

5001,000

1,500

2,0002,500

3,000

3,5004,000

4,500


Latin America (ex Argentina) Semi regulated markets(Rs m)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Domestic formulations(Rs m)


Licensing income from NCEs remains volatile Major cash-burn is a concern

0

500

1,000

1,500

2,000

2,500

3,000

FY05A FY06A FY07A FY08A FY09A FY10A

R&D license fee/ milestones(Rs m)

(10,000)

(8,000)

(6,000)

(4,000)

(2,000)

0


Free cashflow(Rs m)


44


bino@iif lcap.com

Financial summary

Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenue 21,162 24,848 29,034 33,260 37,870EBITDA 4,847 6,486 8,086 9,338 10,514EBIT 3,820 5,280 6,654 7,764 8,790Interest income 1,443 200 240 280 300Interest expense 1,405 1,640 1,416 1,438 1,415Exceptional items -1,170 0 0 0 0Profit before tax 2,689 3,839 5,478 6,606 7,675Taxes 754 529 912 928 1,109Minorities and other 18 0 0 0 0Net profit 1,917 3,310 4,567 5,679 6,566

Cashflow summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiProfit before tax 2,689 3,839 5,478 6,606 7,675Depr. & amortization 1,027 1,206 1,432 1,574 1,724Tax paid 1,395 529 912 928 1,109Working capital ∆ -3,877 -3,272 -2,057 -2,963 -3,418Other operating items 1,715 1,441 1,176 1,158 1,115Operating cashflow 159 2,685 5,117 5,447 5,987Capital expenditure -9,562 -2,400 -3,000 -3,500 -3,500Free cash flow -9,403 285 2,117 1,947 2,487Equity raised 351 4,133 0 0 0Investments 6 0 0 0 0Debt financing/disposal 9,839 -2,450 -1,573 -275 -1,151Dividends paid 0 -126 -127 -127 -127Other items -1,389 -1,441 -1,176 -1,158 -1,115Net change in cash -596 401 -759 387 94

Balance-sheet summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiCash & equivalents 896 1,297 538 925 1,019Sundry debtors 9,553 10,831 12,933 14,771 16,891Inventories - trade 6,302 7,877 8,153 9,312 10,649Other current assets 4,221 5,292 5,623 6,422 7,344Fixed assets 21,117 22,310 23,879 25,805 27,581Total assets 42,089 47,608 51,125 57,234 63,484Sundry creditors 4,563 5,215 5,865 6,698 7,660Long-term debt/CBs 20,944 18,494 16,920 16,645 15,494Other long-term liabs 569 569 569 569 569Minorities/other equity 32 32 32 32 32Net worth 15,982 23,298 27,738 33,290 39,729Total liabs & equity 42,089 47,607 51,125 57,234 63,484

Ratio analysis Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenue growth (%) 6.8 17.4 16.8 14.6 13.9Op Ebitda growth (%) -39.8 33.8 24.7 15.5 12.6Op Ebit growth (%) -47.9 38.2 26.0 16.7 13.2Op Ebitda margin (%) 22.9 26.1 27.9 28.1 27.8Op Ebit margin (%) 18.1 21.2 22.9 23.3 23.2Net profit margin (%) 14.6 13.3 15.7 17.1 17.3Dividend payout (%) 5.2 3.3 2.4 1.9 1.7Tax rate (%) 28.0 13.8 16.6 14.0 14.5Net debt/equity (%) 125.4 73.8 61.0 50.0 39.0Net debt/op Ebitda (x) 4.1 2.7 2.1 1.8 1.5Return on equity (%) 12.0 14.2 16.5 17.1 16.5ROCE (%) 10.2 12.5 14.7 15.4 15.8Return on assets (%) 7.3 7.0 8.9 9.9 10.3Source: Company, IIFL Research

Growth rates have moderated significantly

from historical rates

Assuming there is no significant capitalisation, we expect free cashflow

to improve from FY11 onwards

Growth rates have picked up in FY10 over a low

base; we expect them to moderate in the years

ahead

Debt remains high, despite equity funding of

Rs4.1bn in FY10

45

India - Pharma

CMP Rs 1879

Target 12m Rs1807 (-4%)


Bloomberg LPC IN



Lupin 4.6 17.5 118.5 Rel. to Sensex 2.1 16.1 101.5 Ranbaxy -4.7 -6.3 51.4 Dr Reddy's 10.1 18.4 101.6 Sun Pharma 6.9 4.8 33.1

Stock movement

0

500

1,000

1,500

2,000

Jun-

09Ju

l-09

Aug-

09Se

p-09

Oct

-09

Nov

-09

Dec

-09

Jan-

10Fe

b-10

Mar

-10

Apr

-10

May

-10

Jun-

10

0

500

1,000

1,500

2,000


(Rs)Shares (000')

The US business has been a key growth driver so far

0

2,000

4,000

6,000

8,000

10,000

12,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

US - branded bus inessUS - generic generic

(Rs m)


Dr Bino Pathiparampil b ino@i i f lcap.com (91 22) 4646 4648


Take a breather

Lupin has created a unique business model of its own by establishing a strong branded-generics franchise in the US, acquiring well-chosen products there, and making value-accretive acquisitions in other markets. Its US revenues have grown 10.5x in the last four years, aided by the low base and comparatively large product acquisitions. The domestic business has also done well, consistently clocking 20%-plus revenue growth in the last five years. While we continue to believe in the management and its strategy, we are increasingly concerned about the steep growth expectations on the street. We believe it is now time to move to the sidelines and wait for further clarity on the company’s near-term growth potential. REDUCE.

Expectations look stretched: While Lupin has demonstrated strong capabilities in building a branded-drug business in the US, the company’s lacklustre organic growth over the last few quarters suggest that consensus growth expectations are stretched. Lupin’s consolidated revenue growth over the last few years had a substantial contribution from acquisitions: against the reported consolidated revenue growth of 34% in FY08, 40% in FY09 and 26% in FY10, its standalone growth rates in these years were 27%, 19% and 16%, respectively. Nevertheless, organic growth in the domestic business continues to be strong, at above 20%.

Some risks in sight: Rapid expansion of the company’s sales force in the US, to promote Antara to general practitioners, could raise some margin pressure in the near term. The Suprax brand, which contributes almost 30% of Lupin’s US revenues from branded drugs, could face competition from generics in 2HFY11. The consequent fall in revenues could be too large to be offset by Allernaze (to be launched in August 2010) and other in-house products. On the other hand, any acquisition of larger products in the US could take a toll on return ratios.

Valuations—little room for re-rating: Lupin is trading at 21x FY11ii core earnings, in line with Dr Reddy’s. Any further returns from the stock would have to be driven by earnings growth. Our price target of Rs1,807 is 18x FY12ii core earnings, plus other value per share. Generic competition to Suprax and a slower-than-expected pick-up in new products are downside risks, while value-accretive acquisitions could provide upside risk to our projections.

Financial summary Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenues (Rs m) 38,666 48,708 58,430 67,806 80,058EBITDA Margins (%) 20.0 20.2 20.0 20.0 21.1Pre-Exceptional PAT (Rs m) 5,338 6,816 8,047 9,406 12,053Reported PAT (Rs m) 5,015 6,816 8,047 9,406 12,053EPS (Rs) 55.9 75.9 89.4 104.4 133.7Growth (%) 35.8 17.9 16.8 28.0PER (x) 33.6 24.8 21.0 18.0 14.1ROE (%) 35.2 29.5 27.0 25.0 25.0Debt/Equity (x) 0.9 0.5 0.4 0.2 0.1EV/EBITDA (x) 23.3 18.1 15.2 12.9 10.1Price/Book (x) 11.8 7.3 5.7 4.5 3.5Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Lupin Limited REDUCE

bino@iif lcap.com

46

Lupin Ltd – REDUCE

bino@iif lcap.com

Company snapshot Established in 1968 as an API manufacturer, Mumbai-based Lupin has grown to become a fully-integrated pharmaceutical company. It has products in many major therapeutic areas: cardiovascular, diabetes, respiratory, paediatrics, neurology, gastro-intestinal, anti-infectives and painkillers. The company is one of the world’s largest players in anti-tuberculosis drugs and cephalosporins. Its products reach over 70 countries and it has direct marketing presence in several geographies, including the US, Europe and Japan. Management Name Designation Remarks / management description Dr Desh Bandhu Gupta Chairman Founded the company in 1968. Has an honorary Doctor

of Science with a master’s degree in chemistry.

Dr Kamal K Sharma Managing Director

Alumnus of IIT Kanpur, JBIMS, IIT Mumbai and Harvard University, he has more than three decades’ experience in the pharmaceuticals and chemical industries.

Nilesh Gupta Group President & Executive Director

A chemical engineer and Wharton alumnus, he is in charge of all research, including drug discovery, process and formulation research, and IP group. He also oversees the supply chain, regulatory, quality and project functions.

Vinita Gupta Director Pharmacy graduate and Kellogg alumnus. Has been instrumental in the company’s entry into the advanced markets of the USA and Europe.

Ramesh Swaminathan

President- Finance & Planning

Chartered accountant and London Business School alumnus, he functions as the CFO. Has worked with Standard Chartered Bank and Henkel.


Intl formulations

20%

US formulations

34%

APIs / CRAMS

16%


27%

Others3%


FIIs17%

Promoters47%

Others12%

DIIs24%

Growth rate may moderate if acquisitions don’t come through

0

20,000

40,000

60,000

80,000


10%

20%

30%

40%

50%

Total operating revenue (LHS) Grow th rate (RHS)(Rs m)

Source: Company reports, IIFL

47


bino@iif lcap.com

The US business has been a key growth driver so far Domestic formulations business continues to grow at 20%+

0

2,000

4,000

6,000

8,000

10,000

12,000


US - branded business US - generic generic(Rs m)

0

5,000

10,000

15,000

20,000

25,000

FY05

A

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii



API revenues have picked up after the slump in FY09 Expect EBITDA margin to remain stable

01,000

2,0003,0004,000

5,0006,0007,000

8,0009,000

FY05A FY06A FY07A FY08A FY09A FY10A

Total API revenues(Rs m)

15%

16%

17%

18%

19%

20%

21%

22%

FY07A FY08A FY09A FY10A FY11ii FY12ii FY13ii

EBITDA Margin


Acquisitions kept free cashflow low; set to improve ahead Acquisitions have contributed significantly to reported

growth figures

(4,000)

(2,000)

0

2,000

4,000

6,000

8,000


Total Free cash f low(Rs m)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

FY07

FY08

FY09

FY10

Novodigm extra contribution (acquired2QFY08)South-Africa extra contribution(acquired 3QFY09)Kyow a Japan - extra contribution(acquired 3QFY08)Hormosan Germany - extracontribution (acquired in 2QFY09)Aerochamber extra contributionestimate (acquired 2Q09)Lotrel contribution (not acquired, butone-off in 4QFY10)Antara contribution estimate(acquireded 3QFY10)Organic grow th


48


bino@iif lcap.com

Financial summary Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenue 38,666 48,708 58,430 67,806 80,058EBITDA 7,715 9,839 11,658 13,529 16,871EBIT 6,835 8,600 10,064 11,655 14,741Interest income 46 142 105 132 144Interest expense 499 385 463 441 346Exceptional items -322 0 0 0 0Profit before tax 6,060 8,357 9,707 11,346 14,539Taxes 983 1,360 1,553 1,815 2,326Minorities and other 62 180 107 125 160Net profit 5,015 6,816 8,047 9,406 12,053

Cashflow summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiNet profit 6,060 8,357 9,707 11,346 13,366Depr. & amortization 880 1,239 1,594 1,873 2,130Tax paid 1,068 1,360 1,553 1,815 2,139Working capital ∆ -1,739 -2,265 -2,260 -2,229 -2,585Other operating items 562 243 358 309 202Operating cashflow 4,695 6,213 7,845 9,484 10,974Capital expenditure -4,953 -6,167 -5,000 -5,000 -5,000Free cash flow -258 46 2,845 4,484 5,974Equity raised 54 0 0 0 0Investments -88 0 0 0 0Debt financing/disposal -246 2,701 -551 -2,366 -3,469Dividends paid -983 -1,211 -1,404 -1,562 -1,564Other items -458 -243 -358 -309 -202Net change in cash -1,978 1,294 533 247 739

Balance-sheet summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiCash & equivalents 811 2,104 2,637 2,884 3,624Sundry debtors 10,349 12,664 15,192 17,629 20,456Inventories – trade 9,572 12,177 14,607 16,951 19,670Other current assets 2,780 3,507 4,207 4,882 5,665Fixed assets 14,252 19,180 22,586 25,712 28,582Intangible assets 3,174 3,174 3,174 3,174 3,174Other term assets 406 406 406 406 406Total assets 41,342 53,211 62,808 71,638 81,576Sundry creditors 11,504 14,887 18,285 21,512 25,255Other current liabs 1,827 1,827 1,827 1,827 1,827Long-term debt/CBs 12,233 11,645 11,095 8,729 5,260Other long-term liabs 1,387 1,387 1,387 1,387 1,387Minorities/other equity 143 323 430 554 702Net worth 14,248 23,142 29,785 37,629 47,145Total liabs & equity 41,342 53,211 62,808 71,638 81,576

Ratio analysis Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenue growth (%) 34.7 26.0 20.0 16.0 18.1Op Ebitda growth (%) 28.5 27.5 18.5 16.0 24.7Op Ebit growth (%) 27.6 25.8 17.0 15.8 26.5Op Ebitda margin (%) 20.0 20.2 20.0 20.0 21.1Op Ebit margin (%) 17.7 17.7 17.2 17.2 18.4Net profit margin (%) 13.8 14.0 13.8 13.9 15.1Dividend payout (%) 20.6 17.6 16.6 14.2 11.1Tax rate (%) 16.2 16.3 16.0 16.0 16.0Net debt/equity (%) 80.2 41.2 28.4 15.5 2.8Net debt/op Ebitda (x) 1.5 1.0 0.7 0.4 0.1Return on equity (%) 35.2 29.5 27.0 25.0 25.0ROCE (%) 24.5 23.8 23.8 24.4 26.9Return on assets (%) 12.9 12.8 12.8 13.1 14.6Source: Company, IIFL Research

Frequent acquisitions have historically kept free

cashflow subdued

Strong balance sheet with low debt—can support

more acquisitions

Expect margins to remain stable

Growth significantly aided by several acquisitions

Strong revenue growth, both organically and through acquisitions

49

India - Pharma

CMP Rs 230



Bloomberg OPTC IN



Opto Circuits Ltd 0.7 3.3 43.1 Rel. to Sensex -1.7 1.8 26.1 Ranbaxy -4.7 -6.3 51.4 Dr Reddy's 10.1 18.4 101.6 Biocon 6.4 12.1 47.8

Stock movement

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(Rs)Shares (000')

The growth story

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Finger on the pulse After a few quarters of a lull, Opto Circuits is set for another stage of rapid growth. The company’s invasive and Criticare businesses registered a surge in revenues in 4QFY10, growing 28% YoY and 30% YoY, respectively. Opto’s revenues grew 50% annually over FY05-10, but in our view, it has barely scratched the surface of the huge opportunity in the global medical-devices market. Opto has single-digit market share in most of the markets in which it operates, and has demonstrated its ability to gain share rapidly, both organically and through acquisitions. We project 26% earnings CAGR over FY10-13ii. We retain BUY with a target price of Rs293 (14x FY12ii core EPS).

World-wide reach enables growth through market share gains: Opto has developed a strong global distribution reach in the medical-devices business. Yet, its share in most markets is still in single digits, and we see significant room for growth. Distribution reach is also key to the company’s inorganic growth strategy: Opto acquires product companies and accelerates sales growth by ramping up penetration of various geographies. Its legacy business of selling sensors for pulse oximeters to original equipment manufacturers (OEMs) and distributors continues to grow by gaining share. Its OEM customers include Philips, GE Healthcare and Nonin. The acquisition of Eurocor widened its product basket in the high-entry-barrier interventional cardiology market, and sales in this segment ramped up rapidly through Opto’s distribution chain. Acquisition of Criticare added more products to its non-invasive portfolio.

Enhancing the product portfolio: Eurocor, Opto’s subsidiary in the interventional coronary devices business, recently launched a cobalt chromium drug-coated stent. These stents are stronger and more radio-opaque, providing several benefits over the traditional stainless-steel stents. This launch has added considerable growth momentum to Opto’s invasives business. The Criticare subsidiary in the US has launched a gas bench, whose sales have been picking up, adding to the growth in non-invasive portfolio.

Valuations continue to be attractive: Opto is trading at 13x FY11ii core earnings. This, we believe, is an attractive valuation for a company whose earnings we expect to grow at 26% annually over FY10-13ii. Our price target of Rs293 is 14x FY12ii core earnings.

Financial summary Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenues (Rs m) 8,185 10,776 13,065 15,511 18,112EBITDA Margins (%) 31.2 33.7 33.0 33.0 33.0Pre-Exceptional PAT (Rs m) 2,087 2,601 3,548 4,196 4,965Reported PAT (Rs m) 2,087 2,601 3,548 4,196 4,965EPS (Rs) 12.9 13.8 18.9 22.3 26.4Growth (%) 7.1 36.4 18.3 18.3PER (x) 17.8 16.6 12.2 10.3 8.7ROE (%) 40.4 23.5 25.7 25.1 24.4Debt/Equity (x) 1.0 0.2 0.1 0.1 0.0EV/EBITDA (x) 16.3 12.1 10.1 8.4 7.0Price/Book (x) 7.2 3.9 3.1 2.6 2.1Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Opto Circuits BUY

bino@iif lcap.com

50

Opto Circuits – BUY

bino@iif lcap.com

Company snapshot Originally started in 1982 as a supplier of hardware parts to the computer industry, Opto soon shifted its focus to medical devices. Original products were mainly OEM supplies of sensors to large medical-device players of the West. At present, the company’s non-invasive product portfolio includes digital thermometers, pulse oximeters, fluid warmers, patient monitoring systems and medical sensors. The company has manufacturing units in Bangalore and Vizag. In 2006, it entered the invasive vascular-intervention segment through the acquisition of Eurocor in Germany. Another acquisition—Criticare in the US in 2008—enhanced its non-invasive-products portfolio. The company has a wide customer base spanning the USA, Europe, Middle East, Far East and South Africa. Management Name Designation Remarks / management description

Vinod Ramnani Chairman and Managing Director

Mechanical engineer by training, oversees the entire operations of Opto; very hands-on management style.

Thomas Dietiker Promoter Director

A Swiss-born American citizen and co-promoter of Opto. An electronics engineer by training; has extensive experience in business development, products and wide range of related electronic assemblies.

Jayesh Patel Promoter Director Engineer by training, has been instrumental in product design and conception of a multitude of opto-electronic products for the company.

Revenues by business segment (FY10)

Criticare17%

Mediaid + Opto

international55%

Domestic healthcare -

AMDL3%

Invasive / Eurocor

23%

Domestic IT-AMDL

2%


FIIs35%

Promoters27%

Others35%

DIIs3%

The growth story

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bino@iif lcap.com

Legacy non-invasives business continues to grow Criticare – revenue growth has gained momentum

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Legacy non-invasive business(Rs m)

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Eurocor is getting back on the growth track EBITDA margin stays steady, despite acquisition of low-

margin Criticare business

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26%

28%

30%

32%

34%

36%FY

06A

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Working-capital situation is improving Tax rate likely to rise as tax exemption for EOU expires

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52


bino@iif lcap.com

Financial summary

Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenue 8,185 10,776 13,065 15,511 18,112EBITDA 2,555 3,637 4,311 5,119 5,977EBIT 2,417 3,359 4,040 4,765 5,548Interest income 288 -76 98 72 81Interest expense 537 382 303 251 202Profit before tax 2,168 2,901 3,836 4,586 5,426Taxes 75 299 268 367 434Minorities and other 6 1 19 23 27Net profit 2,087 2,601 3,548 4,196 4,965

Cashflow summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiProfit before tax 2,203 2,901 3,836 4,586 5,426Depr. & amortization 138 197 271 353 429Tax paid 75 299 268 367 434Working capital ∆ -1,953 -1,513 -1,366 -1,517 -1,612Other operating items 840 458 205 179 122Operating cashflow 1,153 1,744 2,677 3,235 3,931Capital expenditure -3,941 -940 -1,300 -1,300 -1,300Free cash flow -2,788 804 1,377 1,935 2,631Equity raised 175 4,079 0 0 0Investments -400 0 0 0 0Debt financing/disposal 4,367 -3,359 -348 -323 -1,144Dividends paid -755 -755 -856 -1,284 -1,284Other items -516 -458 -205 -179 -122Net change in cash 83 311 -32 149 81

Balance-sheet summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiCash & equivalents 916 1,227 1,195 1,344 1,425Sundry debtors 4,060 4,428 5,357 6,360 7,426Inventories - trade 2,305 2,952 3,528 4,188 4,890Other current assets 2,565 3,772 4,573 5,429 6,339Fixed assets 2,167 2,910 3,939 4,886 5,757Intangible assets 2,374 2,374 2,374 2,374 2,374Other term assets 3 3 3 3 3Total assets 14,391 17,667 20,968 24,584 28,214Sundry creditors 3,709 4,418 5,357 6,360 7,426Long-term debt/CBs 5,379 2,020 1,672 1,350 206Other long-term liabs 3 3 3 3 3Minorities/other equity 134 135 154 177 204Net worth 5,166 11,090 13,782 16,694 20,375Total liabs & equity 14,391 17,667 20,968 24,584 28,214

Ratio analysis Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenue growth (%) 74.9 31.7 21.2 18.7 16.8Op Ebitda growth (%) 88.9 42.3 18.6 18.7 16.8Op Ebit growth (%) 87.4 39.0 20.3 17.9 16.4Op Ebitda margin (%) 31.2 33.7 33.0 33.0 33.0Op Ebit margin (%) 29.5 31.2 30.9 30.7 30.6Net profit margin (%) 25.5 24.1 27.2 27.1 27.4Dividend payout (%) 30.9 28.1 30.9 26.2 22.1Tax rate (%) 3.5 10.3 7.0 8.0 8.0Net debt/equity (%) 86.4 7.2 12.1 8.1 1.0Net debt/op Ebitda (x) 1.7 0.2 0.4 0.3 0.0Return on equity (%) 40.4 23.5 25.7 25.1 24.4ROCE (%) 22.9 25.6 26.1 26.4 27.0Return on assets (%) 14.5 14.7 16.9 17.1 17.6Source: Company, IIFL Research

Strong revenue growth continues

Operating cashflow is strong; negative free

cashflow in FY09 due to Criticare acquisition

Proceeds of equity issue in FY10 used to repay part

of debt issue

Potential upsides to our growth rate projections

53

India - Pharma

CMP Rs 436



Bloomberg RBXY IN

Sector Pharmaceuticals 16 June 2010 52Wk High/Low (Rs) 538/236 Diluted o/s shares (m) 421 Daily volume (US$ m) 11 Dividend yield CY10ii (%) 1.2 Free float (%) 36.1 Shareholding pattern (%) Promoters 63.9 FIIs 7.6 DIIs 11.6 Others 16.9


Ranbaxy -4.7 -6.3 51.4 Rel. to Sensex -7.2 -7.8 34.3 Sun Pharma 6.9 4.8 33.1 Dr Reddy's 10.1 18.4 101.6 Cipla 7.9 7.5 32.5

Stock movement

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0100200300400500600


(Rs)Shares (000')

Base business margins remain subdued

0%

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EBITDA margin excl exclusivity




Running ahead of reality Ranbaxy’s large first-to-file exclusivity opportunities in the US market that started kicking in from CY09 have driven a strong rally in the stock. While the exclusivity earnings momentum may keep the stock buoyant, we believe the upside is limited, as gaps between exclusivity revenue streams will bring upsides due to investors’ focus on the lacklustre performance in the base business and the unsustainability of the exclusivity. With new management in place and the manufacturing quality situation and general operational matters improving, we do expect steady improvement in the base business; however, these factors, in our view, are already priced in. We retain SELL.

Shaping base business is not easy: According to Ranbaxy’s guidance, its base business—excluding one-off exclusivity upsides in the US—will continue to make operating losses in CY10. A clean chit from the US FDA on manufacturing plants would bolster revenue growth rates in CY11 and CY12, but EBITDA margins are unlikely to better historical levels of 12-13%. Meanwhile, the growth outlook in most markets is bleak; one exception is Africa, but this market is yet to deliver stable growth that can reflect on the company’s overall topline. We continue to expect steady improvement in overall operations, but consider the stock price to have run ahead of time. The Japan generics opportunity and other synergies with Daiichi Sankyo will take several years to play out, in our view.

Resolution of US FDA issues will take time; risk of losing exclusivity opportunities: Of the two Ranbaxy plants implicated in the US FDA quality issues, we expect Dewas to get clearance within the next 3-4 months. However, the AIP (application integrity policy) applied on the Paonta Sahib facility is more critical and could take 1-2 years to be completely resolved. The company will have to take up each of the ANDAs filed from the facility and determine the extent of remedial measures required in each case. This could even risk the loss of one or more of the large exclusivity opportunities in its bag.

Valuation remains very expensive: Ranbaxy is trading at 30x CY12ii core earnings, adjusted for the value of exclusivities and non-recurring earnings per share. Our CY12 numbers assume near-complete resolution of US FDA issues. Our price target of Rs411 is 22x CY12ii core earnings plus the value of one-off exclusivities.

Financial summary Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiRevenues (Rs m) 74,214 75,970 89,715 105,540 137,125EBITDA Margins (%) 7.7 8.1 19.5 21.6 27.7Pre-Exceptional PAT (Rs m) -9,512 2,027 13,053 15,218 26,982Reported PAT (Rs m) -9,512 2,965 13,053 15,218 26,982EPS (Rs) -22.6 4.7 30.5 35.5 62.8Growth (%) -121.0 543.1 16.4 77.1PER (x) -19.3 92.0 14.3 12.3 6.9ROE (%) -22.1 6.8 23.1 22.0 29.6Debt/Equity (x) 1.0 0.8 1.0 0.4 0.3EV/EBITDA (x) 35.4 34.0 12.1 9.2 5.4Price/Book (x) 4.3 4.3 3.3 2.7 2.1Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Ranbaxy Laboratories SELL

bino@iif lcap.com

54

Ranbaxy – SELL

bino@iif lcap.com

Company snapshot

Ranbaxy is India’s leading pharma company, with a global footprint in 46 countries. It is one of the largest players in the domestic market, with a share of ~5% by revenue, and has products across most therapeutic areas. In 2008, Daiichi Sankyo, a leading Japanese innovator pharma company, acquired majority stake in Ranbaxy. Ranbaxy has manufacturing facilities in seven countries and employs over 12,000 people of 50 nationalities. It is one of the most successful companies to gain from the system of 180-day exclusivity for first generic player in any particular drug in the US market, under the Hatch-Waxman Act; it has exclusivity rights to Lipitor generic, a US$7bn drug at innovator prices. However, it has been plagued by manufacturing quality issues at its plants that have weighed on its US sales for the last two years.


Dr Tsutomu Une

Chairman, Non Executive & Non Independent Director

A graduate from Hokkaido University and a PhD in Microbiology, he was inducted on the board of Ranbaxy in Dec, 2008. He has been with Daiichi for close to four decades holding many important managerial positions.

Atul Sobti CEO & Managing Director

An alumnus of IIM-A and St Stephens College, he worked with Xerox and Hero Honda prior to joining Ranbaxy in Oct, 2005. He is responsible for the global business operations encompassing pharma, consumer healthcare, API, manufacturing and R&D.

Omesh Sethi President & CFO

A chartered accountant by profession, he joined the company in 1989.He head the Finance function, Secretarial, Global Taxation, Treasury, Insurance and Forex operations.

Revenue break-up between domestic and international (CY09)

Others4%


19%

APIs/CRAMS7%

US formulations

26%

Intl formulations

44%


DIIs12%

Others17%

Promoters63%

FIIs8%

US FDA clearance of manufacturing facilities will spur growth

020,00040,00060,00080,000

100,000120,000140,000160,000

CY06A CY07A CY08A CY09A CY10ii CY11ii CY12ii0%

5%

10%

15%

20%

25%

30%



55

Ranbaxy – SELL

bino@iif lcap.com

Expect a pick-up in the domestic business Expect OTC business to continue robust growth

0

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Global consumer healthcare(Rs m)


CIS business declined in CY09 Asia-Pacific revenues will decline in CY10 as some

businesses are being wound up

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US revenues to pick up as manufacturing issues get sorted out

Base business margins remain subdued

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56

Ranbaxy – SELL

bino@iif lcap.com

Financial summary

Income statement summary (Rs m) Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiRevenue 74,214 75,970 89,715 105,540 137,125EBITDA 5,731 6,187 17,506 22,831 38,018EBIT 2,906 3,510 14,437 19,657 34,731Interest income -15,852 6,360 5,491 800 800Interest expense 2,055 710 395 902 855Exceptional items 0 938 0 0 0Profit before tax -15,000 10,098 18,937 19,555 34,676Taxes -5,651 6,991 5,803 4,107 7,282Minorities and other 163 142 80 231 412Net profit -9,512 2,965 13,053 15,218 26,982

Cashflow summary (Rs m) Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiProfit before tax -15,000 10,098 18,937 19,555 34,676Depr. & amortization 2,825 2,676 3,068 3,174 3,287Tax paid 1,360 2,426 5,803 4,107 7,282Working capital ∆ -3,235 -939 -4,435 -5,346 -12,264Other operating items 14,373 -12,239 -9,096 102 55Operating cashflow -2,397 -2,831 2,671 13,379 18,472Capital expenditure -7,224 -4,382 -4,600 -4,800 -5,000Free cash flow -9,621 -7,213 -1,929 8,579 13,472Equity raised 36,146 13 0 0 0Investments 647 6,237 -4,000 -4,000 -4,000Debt financing/disposal -4,497 -4,460 20,259 -28,056 -5,315Dividends paid -2,620 0 0 -2,463 -4,932Other items -1,686 -770 5,096 -102 -55Net change in cash 18,369 -6,192 19,426 -26,041 -830

Balance-sheet summary (Rs m) Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiCash & equivalents 23,956 12,416 31,842 5,801 4,970Sundry debtors 13,310 18,399 19,737 23,219 30,167Inventories - trade 19,643 18,407 21,531 25,330 32,910Other current assets 10,012 10,863 11,667 13,407 16,882Fixed assets 49,607 51,136 52,667 54,293 56,006Other term assets -21,329 -11,262 -3,262 738 4,738Total assets 95,200 99,959 134,182 122,787 145,674Sundry creditors 20,678 24,443 25,273 28,948 34,688Long-term debt/CBs 43,114 36,295 56,554 28,499 23,184Other long-term liabs -12,229 -4,746 -4,746 -4,746 -4,746Minorities/other equity 675 533 613 844 1,256Net worth 42,962 43,434 56,487 69,242 91,292Total liabs & equity 95,200 99,959 134,182 122,787 145,674

Ratio analysis Y/e 31 Dec CY08A CY09A CY10ii CY11ii CY12iiRevenue growth (%) 9.4 2.4 18.1 17.6 29.9Op Ebitda growth (%) -19.7 8.0 183.0 30.4 66.5Op Ebit growth (%) -41.3 20.8 311.3 36.2 76.7Op Ebitda margin (%) 7.7 8.1 19.5 21.6 27.7Op Ebit margin (%) 3.9 4.6 16.1 18.6 25.3Net profit margin (%) -12.8 2.7 14.5 14.4 19.7Dividend payout (%) 0.0 0.0 16.1 27.7 15.6Tax rate (%) 37.7 69.2 30.6 21.0 21.0Net debt/equity (%) 44.6 55.0 100.1 41.2 25.4Net debt/op Ebitda (x) 3.3 3.9 3.2 1.2 0.6Return on equity (%) -22.1 6.8 23.1 22.0 29.6ROCE (%) 3.9 4.7 13.3 21.1 31.7Return on assets (%) -10.0 2.0 9.7 12.4 18.5Source: Company, IIFL Research

Expect margins to show major improvement,

mainly due to one-off exclusivity-related upside

US FDA clearance of facilities could lead to a

pick-up in business

Expect free cashflow to remain negative in CY10

Balance sheet continues to be levered; large

liabilities related to forex derivatives compound the

problem

57

India - Pharma

CMP Rs 1702

Target 12m Rs2111 (24%)


Bloomberg SUNP IN

Sector Pharmaceuticals 16 June 2010 52Wk High/Low (Rs) 1853/1050 Diluted o/s shares (m) 206 Daily volume (US$ m) 9 Dividend yield FY11ii (%) 0.8 Free float (%) 36.3 Shareholding pattern (%) Promoters 63.7 FII 20.2 DIIs 5.5 Others 10.6


Sun Pharma 6.9 4.8 33.1 Rel. to Sensex 4.4 3.4 16.0 Ranbaxy -4.7 -6.3 51.4 Dr Reddy's 10.1 18.4 101.6 Cipla 7.9 7.5 32.5

Stock movement

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Market leader in margins

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Sun Pharma Dr Reddy'sGlenmark CiplaRanbaxy

Source: Company reports, IIFL research


Ankit Jain ankit.jain@i i f lcap.com (91 22) 4646 4675

www.iiflcap.com

Undisputed leadership Sun Pharma will retain its premium valuation, in our view, by virtue of superior margins, better ROE, strong balance sheet and cash flows, high promoter shareholding, and the increasing involvement of professional management. Sun has a strategic focus on the US market and has 123 ANDAs pending approval—the largest such portfolio among Indian players. Revenues from the domestic and other emerging markets are set to grow more than 20% in FY11. The strong 18-20% growth guidance for FY11 and signs of a quick resolution of quality issues at Caraco facilities in the US make us confident about the continuing growth momentum in the company’s businesses. We retain BUY with a target price of Rs2,111.

Strong guidance despite loss of Protonix revenue: Sun Pharma’s guidance of 18-20% topline growth and maintenance of profitability for FY11 is a major surprise on the upside, considering the large base of FY10 that included generic Protonix in US (~US$140m in FY10). Following an adverse jury opinion in the patent litigation, Sun has discontinued selling the product from May 2010. Our projections are still 8-9% below company guidance, but we see potential for earnings upgrades, as we get more visibility on growth during the course of the year.

Optimism on Caraco: For the first time since the US FDA action at Caraco’s facilities in Detroit, Sun Pharma’s management has expressed optimism on resolution of the quality issues well ahead of end-FY11. This deadline is at the near end of the time frame we had expected, and will contribute to growth and margin recovery. We expect revenues from the products shifted to other facilities to start flowing in as early as 1HFY11.

Potential earnings upgrades; premium valuations to stay: Sun Pharma trades at 31x FY11ii core earnings, adjusted for cash and one-off upsides. This is a 20-30% premium to peers, but with the loss of Protonix revenues and impact of manufacturing halt at Caraco already priced in, we see no downside to Sun Pharma’s premium valuation. Our price target of Rs2,111 is 28x FY12ii core earnings plus cash and other values per share. Improvement in visibility about achieving the guidance and positive developments on the Taro acquisition front could provide further upside.

Financial summary Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenues (Rs m) 42,723 39,938 43,239 52,496 61,451EBITDA Margins (%) 43.6 33.3 33.0 34.6 35.7Pre-Exceptional PAT (Rs m) 18,177 14,275 14,218 18,177 22,264Reported PAT (Rs m) 18,177 13,511 14,218 18,177 22,264EPS (Rs) 87.8 65.2 68.6 87.8 107.5Growth (%) -25.7 5.2 27.8 22.5PER (x) 19.4 26.1 24.8 19.4 15.8ROE (%) 25.8 16.8 15.5 17.1 17.8Debt/Equity (x) 0.0 0.0 0.0 0.0 0.0EV/EBITDA (x) 17.5 23.7 21.5 16.3 12.8Price/Book (x) 5.0 4.4 3.9 3.3 2.8Source: Company, IIFL Research. Price as at close of business on 15 June 2010.

Sun Pharma BUY

bino@iif lcap.com

58

Sun Pharma – BUY

bino@iif lcap.com

Company snapshot

Founded by Dilip Shanghvi in Kolkata in 1983, with just five psychiatry products and a 10-member team, Sun Pharma has grown to become the largest Indian pharma company by market capitalisation. In the domestic market, the company concentrates on high-growth lifestyle therapeutic segments such as CVS, CNS, GI and pain management. Sun Pharma has a strategy to enter the high-barrier niche segments in India and the international markets. Sun entered the US generics market through the acquisition of Caraco in 2002. Over the past few years, the company has built a 123-strong pipeline of ANDA filings. Currently, the company is trying to acquire Taro Pharma in the US. Sun has 17 manufacturing plants across three continents, 8,000 employees, two world-class research centres, and leadership brands selling in markets worldwide.


Dilip Shanghvi Chairman and Managing Director

Founded the company in 1982. Has extensive industrial experience in the pharmaceutical industry and is actively involved in international pharmaceutical markets and R&D functions of the company.

Sudhir Valia Executive Director Fellow member of Institute of Chartered Accountants of India. Joined Sun in 1994 and has more than two decades of taxation and finance experience.

Kal Sundaram Chief Executive Officer

Former GSK India MD; joined Sun from April this year, has been inducted on the board as an additional director and will look after the worldwide operations of the company.


Intl formulations

(12%)

US formulations

(27%)

APIs/CRAMS(14%)Domestic

formulations(44%)

Others(3%)


FIIs(4%)

Promoters(61%)

Others(22%)

DIIs(13%)

Strong growth momentum to continue; FY10 numbers adversely affected by high exclusivity base of FY09 and Caraco facility shutdown in the US

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

FY04A FY05A FY06A FY07A FY08A FY09A FY10A FY11ii FY12ii FY13ii-10%0%10%20%30%40%50%60%70%

Total operating revenue (LHS) Grow th rate (RHS)(Rs m) (%)


59

Sun Pharma – BUY

bino@iif lcap.com

Secular growth in the domestic market Revenues from Caraco products set to rebound as manufacturing quality issues get sorted out

0

7,000

14,000

21,000

28,000

35,000

FY04

A

FY05

A

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii -10%

0%

10%

20%

30%

40%

50%Domestic formulations revenue (LHS) Grow th rate (%)

(Rs m)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Caraco - ow n products(Rs m)


Secular growth in the US base business, with additional benefits from product exclusivities

Emerging market business growing fast as well

0

2,000

4,000

6,000

8,000

10,000


Sun's revenue excluding Caraco US exclusivities revenue

(Rs m)

0

2,000

4,000

6,000

8,000

10,000FY

06A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Non-US international formulations(Rs m)


Industry-leading EBITDA margins Strong cashflow generation

0%

10%

20%

30%

40%

50%

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

ii

Sun Pharma Dr Reddy's GlenmarkCipla Ranbaxy

(4,000)

0

4,000

8,000

12,000

16,000

FY06

A

FY07

A

FY08

A

FY09

A

FY10

A

FY11

ii

FY12

ii

FY13

iiFree cashflow(Rs m)


60

Sun Pharma – BUY

bino@iif lcap.com

Financial summary Income statement summary (Rs m) Y/e 31 Mar FY09A FY10A FY11ii FY12ii FY13iiRevenue 42,723 39,938 43,239 52,496 61,451EBITDA 18,639 13,302 14,270 18,155 21,962EBIT 17,406 11,769 12,691 16,514 20,245Interest income 2,229 3,143 2,907 3,603 4,364Interest expense 143 0 143 143 143Exceptional items 0 -764 0 0 0Profit before tax 19,492 14,148 15,455 19,974 24,466Taxes 712 679 927 1,198 1,468Minorities and other 603 -41 309 599 734Net profit 18,177 13,511 14,218 18,177 22,264

Cashflow summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiProfit before tax 19,492 14,148 15,455 19,974 24,466Depr. & amortization 1,233 1,533 1,579 1,641 1,717Tax paid 1,690 679 927 1,198 1,468Working capital ∆ 31 226 -1,495 -4,544 -4,411Other operating items 2,585 -3,143 -2,764 -3,460 -4,221Operating cashflow 21,651 12,086 11,848 12,413 16,083Capital expenditure -6,556 -1,700 -2,000 -2,400 -2,400Free cash flow 15,095 10,386 9,848 10,013 13,683Investments -205 0 0 0 0Debt financing/disposal 351 0 0 0 0Dividends paid -2,422 -3,332 -3,332 -3,332 -3,332Other items 857 3,143 2,764 3,460 4,221Net change in cash 13,675 10,197 9,280 10,141 14,572

Balance-sheet summary (Rs m) Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiCash & equivalents 28,566 38,763 48,043 58,184 72,756Sundry debtors 8,811 9,984 10,810 13,124 15,363Inventories - trade 9,757 9,186 9,945 12,074 14,134Other current assets 7,425 7,389 7,999 9,712 11,368Fixed assets 16,196 16,363 16,784 17,543 18,226Intangible assets 3,253 3,253 3,253 3,253 3,253Investments 6,719 6,719 6,719 6,719 6,719Total assets 80,728 91,658 103,554 120,609 141,819Sundry creditors 7,198 7,991 8,691 10,302 11,847Long-term debt/CBs 1,789 1,789 1,789 1,789 1,789Other long-term liabs -679 -679 -679 -679 -679Minorities/other equity 1,970 1,929 2,238 2,838 3,572Net worth 70,449 80,628 91,514 106,359 125,291Total liabs & equity 80,728 91,658 103,554 120,609 141,819

Ratio analysis Y/e 31 Mar FY09A FY10ii FY11ii FY12ii FY13iiRevenue growth (%) 27.3 -6.5 8.3 21.4 17.1Op Ebitda growth (%) 20.2 -28.6 7.3 27.2 21.0Op Ebit growth (%) 19.7 -32.4 7.8 30.1 22.6Op Ebitda margin (%) 43.6 33.3 33.0 34.6 35.7Op Ebit margin (%) 40.7 29.5 29.4 31.5 32.9Net profit margin (%) 42.5 35.7 32.9 34.6 36.2Dividend payout (%) 15.7 21.1 20.0 15.7 12.8Tax rate (%) 3.7 4.8 6.0 6.0 6.0Net debt/equity (%) -47.5 -54.2 2.0 1.7 1.4Net debt/op Ebitda (x) -1.8 -3.3 0.1 0.1 0.1Return on equity (%) 25.8 16.8 15.5 17.1 17.8ROCE (%) 24.3 14.4 13.7 15.4 16.0Return on assets (%) 22.5 15.6 13.7 15.1 15.7Source: Company, IIFL Research

Our projections are 8-9% below management

guidance; there is potential for upgrades

Robust free cashflow will aid growth through acquisitions

About US$800m cash in hand; more acquisitions

possible even after completion of Taro deal

Consistently high margins, with occasional

upside from product exclusivities in the US;

base margins will improve further as Caraco facilities

re-start production

India - Pharma

bino@iif lcap.com

Key to our recommendation structure BUY - Absolute - Stock expected to give a positive return of over 20% over a 1-year horizon. SELL - Absolute - Stock expected to fall by more than 10% over a 1-year horizon. In addition, Add and Reduce recommendations are based on expected returns relative to a hurdle rate. Investment horizon for Add and Reduce recommendations is up to a year. We assume the current hurdle rate at 10%, this being the average return on a debt instrument available for investment. Add - Stock expected to give a return of 0-10% over the hurdle rate, ie a positive return of 10%+. Reduce - Stock expected to return less than the hurdle rate, ie return of less than 10%. Published in 2010. © India Infoline Ltd 2010 This report is for the personal information of the authorised recipient and is not for public distribution. This should not be reproduced or redistributed to any other person or in any form. This report is for the general information of the clients of IIFL, a division of India Infoline, and should not be construed as an offer or solicitation of an offer to buy/sell any securities. MICA (P) 024/11/2009. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, so far as it relates to current and historical information, but do not guarantee its accuracy or completeness. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. India Infoline or any persons connected with it do not accept any liability arising from the use of this document. The recipients of this material should rely on their own judgment and take their own professional advice before acting on this information. India Infoline or any of its connected persons including its directors or subsidiaries or associates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained, views and opinions expressed in this publication. India Infoline and/or its affiliate companies may deal in the securities mentioned herein as a broker or for any other transaction as a Market Maker, Investment Advisor, etc. to the issuer company or its connected persons. India Infoline generally prohibits its analysts from having financial interest in the securities of any of the companies that the analysts cover. In addition, the company prohibits analysts from conducting F&O transactions or holding any shares for a period of less than 30 days.

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