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Changing tide

Alembic Pharma

Initiating Coverage | 12 March 2014Sector: Healthcare

Alok Dalal ([email protected]);+91 22 3982 5584

Hardick Bora ([email protected]);+91 22 3982 5423

Alembic Pharma

12 March 2014 2

Prices as on 11 March 2014

Alembic Pharma: Changing tide

Page No.

Summary ............................................................................................................ 3

About Alembic Pharma ..................................................................................... 4

New management investing in right places ................................................. 5-8

Ingredients in place; focus on execution .................................................... 9-15

Improving business profile; re-rating candidate ..................................... 16-18

Key risks to investment arguments ................................................................ 19

Financials and valuation ........................................................................... 20-21

Investors are advised to refer through disclosures made at the end of the Research Report.

Note: The pharmaceutical undertaking of Alembic Ltd was transferred to Alembic Pharmaceuticals

Ltd from 1 April 2010. Hence, financials before FY11 include operations of Alembic Ltd.

Alembic Pharma

12 March 2014 3

Changing tide Stepping into next phase of high growth

Started as a tincture and alcohol maker in 1907, Alembic Pharma Ltd (ALPM) is one of

the oldest pharmaceutical companies in India. For a major part of the last decade, ALPM

lagged the strong industry growth due to high dependence on the slow growing acute

therapies in India, insignificant presence in international markets, dilution of

management’s time between varied businesses and high leverage. However, we see the

tides changing for ALPM as the new management is investing in right geographies and

markets to build a sustainable business model. We initiate coverage with a Buy rating

and see potential upside of 40%.

Getting more organized under new management Since mid 2007, the day-to-day operations of the company have been taken over by the next generation of entrepreneurs who have incorporated structural changes in the organization. They have strengthened their field force in India, increased ANDA filings in US, ironed out inefficiencies in the organization and hired personnel in important areas of R&D and marketing. These changes have led to reduction in cash conversion cycle by 50 days, near-zero net-debt/equity position and improvement in operational performance witnessed over the last 8 quarters. We believe ALPM has a focused management team in place and has stepped into its next phase of high growth. Ingredients in place; large room for growth ALPM has filed 60 ANDAs with majority of them backed by own DMFs, providing greater cost control compared to some of its larger peers. The company is awaiting approval for more than half of its ANDA filings. We note that ALPM has 45% of its ANDA filings with Para IV certification, which is significantly more than most of its peers. We believe US generics could grow more than 5x to USD125m by FY16E. In India, ALPM has increased its presence in the fast-growing specialty therapies which contribute 45% to its business. We believe these structural changes would enable ALPM to grow its revenue by 21% CAGR over FY14E-16E. Improving business profile; re- rating candidate The business mix at ALPM is likely to improve further, with higher contribution from US generics and specialty therapies in India, while low-margin APIs and acute therapies may continue to face slowdown. We expected transition to result in 280bp EBITDA margin expansion and 35% earnings CAGR over FY14E-16E. With majority of the capex behind them and high free cash generation visibility, we expect ALPM to be net-debt free by FY16E. Return ratios are expected to remain above 40%. Our EPS estimates for FY15E/16E are 10%/14% above Bloomberg consensus estimate. With improving business profile and strong earnings growth, we believe ALPM is a potential re-rating candidate. Initiate coverage with a Buy and target price of INR350 (15x FY16E EPS).

Initiating Coverage | Sector: Healthcare

Alembic Pharma CMP: INR251 TP: INR350 Buy

BSE Sensex S&P CNX

21,826 6,512

Stock Info

Bloomberg ALPM IN

Equity Shares (m) 188.5

52-Week Range (INR) 310/94

1, 6, 12 Rel. Per (%) 2/68/120 M.Cap. (INR b)

48.6

M.Cap. (USD b) 0.8

Financial Snapshot (INR Billion)

Y/E March 2014E 2015E 2016E Sales 18.9 22.8 27.7

EBITDA 3.6 4.7 6.1

NP 2.4 3.3 4.3

EPS (INR) 12.5 17.3 23.0

EPS Gr. (%) 42.5 38.3 33.1

BV/Share (INR) 34.5 44.7 58.4

RoE (%) 40.8 43.6 44.6

RoCE (%) 43.5 47.8 51.2

P/E (x) 20.1 14.5 10.9

P/BV (x) 7.3 5.6 4.3

Shareholding pattern (%)

As on Dec-13 Sep-13 Dec-12

Promoter 74.1 74.1 74.1

Dom. Inst 1.5 1.4 0.6

Foreign 9.0 8.5 7.6

Others 15.4 16.0 17.7

Stock Performance (1-year)

Alembic Pharma

12 March 2014 4

About Alembic Pharma Started in 1907, Alembic Pharma (ALPM) is one of the oldest pharmaceutical companies of

Indian origin in the domestic formulations market. The company was first established as a

tincture and alcohol manufacturer and made its way into modern medicine in 1940. Today

ALPM is being run by its fourth generation of entrepreneurs, is the 25th largest

formulations player in India and has sales presence in more than 75 countries.

Predominant domestic player; expanding into international markets ALPM has historically been a focused domestic formulation player along with presence in API segments. Its marquee products like Glycodin, Azithral, Althrocin are household brands in India. Over the years, the company has gradually increased its presence in the export formulations markets like US, EU and CIS. Today, ALPM has sales presence in more than 75 countries

Exhibit 1: From a predominant domestic formulations player…

Source: Company, MOSL

Exhibit 2: …to a global generic company


Strong management team at the helm Mr. Pranav Amin (39 years) Mr. Pranav Amin is the elder son of ALPM’s Chairman; Mr. Chirayu Amin. He is working as Director, International Operations of the Company for last five years. Pranav holds a Bachelors degree of Science in Economics/Industrial Management from the Carnegie Mellon University in Pittsburgh, USA. He also pursued his M.B.A in International Management from Thunderbird, The American Graduate School of International Management. Mr. Shaunak Amin (36 years) Mr. Shaunak Amin is the younger son of Mr. Chirayu Amin. He is the President, Formulations of the company and is heading the Branded Formulations Division of the company since 2009. Shaunak has graduated from University of Massachusetts, USA with Economics as his specials. He has varied work experience with renowned MNCs including Merrill Lynch and HSBC.

Oldest pharmaceutical companies of Indian origin;

more than 100 years old

Alembic Pharma

12 March 2014 5

New management investing in right places A focused company stepping into its next phase of growth

Since mid 2007, the day-to-day operations of the company have been taken over by

the next generation of entrepreneurs who have incorporated structural changes in the

organization.

Today ALPM has strengthened their field force in India, increased its ANDA filings in

US, ironed out inefficiencies in the organization and hired personnel in important

areas of R&D and marketing.

Result is significant reduction in cash conversion cycle, near-zero net-debt/equity

position and improved operational performance witnessed over the last 8 quarters.

We believe ALPM has a focused management team in place and has stepped into its

next phase of high growth.

Management moves to 4th generation of entrepreneurs Despite its long-standing establishment, ALPM had failed to grow in line with peers like Cipla, Dr. Reddy’s, Sun Pharma, Lupin and its market share in Indian pharma market is lower than today’s mid-sized players like Torrent, IPCA Labs, Emcure, Intas and Wockhardt to name a few. This was partly due to dilution of promoter group’s interests across varied businesses like glassware, specialty chemicals and real estate. Since 2007, the next generation of entrepreneurs, Mr. Pranav Amin and Mr. Shaunak Amin have taken over the day-to-day operations of the company. In a bid to increase the focus on the pharmaceutical business, they decided to carve Alembic Pharma out of the Alembic group. Since then, the management has spent all the time, effort and resources needed to transform ALPM into a dominant generic player. The strong improvement in operational performance over the last few quarters, we believe, is but an undertone of this transformation.

Exhibit 3: Recent uptick in sales growth led by improving sales mix…


Exhibit 4: … has led to improving profitability


Streamlining processes to create a leaner, steadier organization In our discussions with the new management, we could not miss the increased importance laid on streamlining processes in each department within the organization to increase efficiency. Some of the major changes outlined were: Restricting repeat sales to defaulting debtors

Next generation of entrepreneurs have taken

over day-to-day operations

Carved out pharma business from Alembic

group in 2010 for greater focus

Alembic Pharma

12 March 2014 6

Advancement in billing processes Optimizing the inventory managed at stockiest level Hired younger staff; average age reduced to 27 years from 40 years earlier Promoting people from within the organization to higher ranks The benefit of these changes can be seen in the company over the last 5 years. There has been a consistent reduction in cash conversion cycle from 109 days in FY08 to 57 days in 1HFY14. The debt has been gradually repaid off, net-debt/equity down to 0.2x in 1HFY14 from 1.1x in FY08. The management indicated that attrition rate has lowered from its high of 45% to 20% today. There has been a steady growth in domestic formulations business due to improved field force productivity, in a year which was impacted by the new pricing policy.

Exhibit 5: Tight control on working capital


Exhibit 6: Lowering debt burden


Diversifying into other specialty therapies into India In India, Alembic has been known among doctor community as a leader in Macrolides (a class of antibiotics) segment. Some of its marquee offering in the area include Azithral, Althrocin and Roxid which contribute approx 25% to overall sales. Their cough syrup Glycodin has a significant brand recall. However, given the intense competition in these therapies, the slow growing nature of acute therapies and paucity of new launches, ALPM’s market share has been lower than other midcap companies. In the three years ending FY13, the new management has been able to revive the growth in this division by launching 80 products over this period. These products today account for 15% of domestic formulations sales. More importantly, Alembic has increased its focus on seven specialty therapies which will be the next growth drivers for the domestic formulations business. These therapies enjoy higher profitability compared to ALPM’s legacy business and majority of product launches have been in these areas. The company plans to maintain the current pace of product introductions, which is likely to drive above-industry growth rate along with improving profitability.

Visible improvement in organization under the new

management

Identified seven specialty therapies in India to drive

growth and profitability

Alembic Pharma

12 March 2014 7

Exhibit 7: Increasing presence into fast-growing specialties (% of domestic formulations)

Source: Company, MOSL, * Specialty formulations include CVS, Diabetology, Ophthalmology, Gastro

and Gynecology

Expanding into US; world’s largest free-priced generic market With a view to capitalize on the free-priced US generic market, ALPM started filing for ANDAs in FY07. Over a period of six years, the company has filed for 60 ANDAs with the USFDA. Despite being a late entrant, we see two strengths in ALPM’s US strategy. Firstly, unlike many of its mid-sized peers, ALPM has targeted formulations that it can support by its own APIs. If one takes into account the approved ANDAs that are backward integrated (i.e., supported by own DMFs), then the company comes ahead of peers like Torrent Pharma, Glenmark and Cadila Healthcare. We have observed that backward integrated launches in US are becoming increasingly important as the competition has intensified with entry of the fourth wave of Indian generics. Also, the company has filed 29 para IVs of the 60 ANDAs filed so far. As a proportion of his total filings, ALPM’s para IV filings are ahead than peers like Cadila Healthcare, Glenmark, Torrent Pharma and IPCA Labs. These low competition opportunities are likely to provide some bargaining power over the distribution channel in US despite being a late entrant. The management indicated that its strategy is to file for products that could typically be monetized in the next 3-4 years. As such, they plan to launch 8-10 products every year for the next three years. We expect their US business to scale up 5x to USD125m by FY16E.

Exhibit 8: Significant scale-up in ANDA filings…

Source: Company, MOSL, *Till December 2013

Exhibit 8: …supported by its own DMF pipeline

Source: Company, MOSL, * Till December 2013

Sharp ramp-up in ANDA filings over the last 6 years

60 ANDAs filed so far, of which 29 are para IV

Alembic Pharma

12 March 2014 8

Better utilization of resources; return oriented approach The positive changes brought in by the new management have started showing its impact in the financial performance. Despite deriving 65% of its sales from domestic formulations, the company has been able to grow its business consistently over the past 4 quarters, while the industry has been facing slowdown due to the new pricing policy. At the same time, there has been steady improvement in EBITDA margins over the past 7 quarters led by an improving business mix. We note the company has been generating healthy free cash flow and gradually reducing its debt burden. We believe these changes in the business are but an undercurrent of the transformation taking place at ALPM.

Exhibit 9: Steady free cash-flow generation


Exhibit 10: Reduced net-debt/equity


Exhibit 11: Above industry-average return ratios (%)

2 6

28

38 37

39

7 8 20

29 32

40

FY09 FY10 FY11 FY12 FY13 1HFY14

RoE RoCE


Alembic Pharma

12 March 2014 9

Ingredients in place; focus on execution Investments have just started yielding results; large room for growth ahead

ALPM’s is ahead of most of its peers in ANDA filings in terms of (1) backward

integration and (2) paragraph IV certification.

With more than half of its filings awaiting approval, we expect US generics could grow

by more than 5x to USD125m by FY16E.

Contribution from fast-growing specialty therapies in India has increased to 45%.

These therapies are likely to drive above industry growth in domestic formulations

segment for ALPM.

Hence, we expect the current growth momentum to continue and forecast 21%

revenue CAGR over FY14E-16E.

Expanding into US; world’s largest free-priced generic market The new management has targeted the free-priced US generic market (worth USD95b in 2012) as one of the important growth drivers for the company. Starting in FY07, the company has filed 60 ANDAs with the US FDA till date, of which 27 have been approved and 18 have been launched. Although the products are commercialized through marketing partners, ALPM intends to establish its own front-end in US by the end of FY15E. Despite being a late entrant, we believe that ALPM has laid the right foundation to achieve USD125m in sales by FY16E; 5x growth over FY13.

Exhibit 12: Fast expanding ANDA pipeline (Nos)

Source: Company, MOSL, USFDA, *Till December 2013

Backward integrated ANDA filings to provide cost control While analyzing ALPM’s DMF filings vis-à-vis it’s approved ANDAs, we realized that more than 80% of its ANDAs are backward integrated, i.e., are supported by its own DMFs. This is higher than most of its similar-sized as well as larger competitors. The US generic market is seeing intensifying competition with increasing number of players entering the market. We have observed that companies with less backward integration capabilities have exited certain products due to excessive price erosion. On the other hand, many companies are able to corner majority market share in mature products due to strong vertical integration.

More than 80% of ANDA filings are supported by

own DMFs

Alembic Pharma

12 March 2014 10

Leading other mid-sized players in para IV filings

Close to 50% of its ANDA filings have a paragraph IV certification, which is high compared to most of the similar sized peers like Torrent, IPCA, Unichem Labs as well as larger competitors like Glenmark and Cadila Healthcare. We are of the opinion that this will equip the company’s portfolio and offer it relatively stronger bargaining power over distributors, given its late entry in the US. Moreover, the approved ANDAs outline the company’s strategy to file backward integrated products. We see ALPM establishing a solid foundation for becoming a meaningful player in US generics market.

Exhibit 13: Comparison of backward integrated filings

Source: Company, MOSL, USFDA

Exhibit 14: Comparison of Para IV filings (%)

Source: Company, MOSL, USFDA

Established R&D capabilities ALPM received approval for its first 505 (b) (2) filing on Desvenlafaxine in March 2013, within a period of 10 months from its date of filing. Desvenlafaxine is an anti-depressant prescribed for clinical depression. The volume uptick has been slower than anticipated due to the time taken to shift prescriptions in case of CNS therapies. However, the FDA approval itself stands testimony to ALPM’s established R&D capabilities, despite its current size. The management has indicated that it will be working on a few more 505 (b) (2) filings along with certain other complex generics. Our estimates do not factor any upside from ramp-up in Desvenlafaxine sales. Potential to scale up to USD125m by FY16E US generics segment contributed ~9% of total sales in FY13, or approximately USD25m. This was generated through commercialization of 15 ANDAs of the total 60 filed as of FY13. With more than 55% of its ANDAs still awaiting commercialization, the management is confident of launching 8-10 products in the US every year over the next 3-4 years. Moreover, the company plans to file 10-12 ANDAs per year over the same period. We expect ALPM’s US generic segment to garner USD125m in sales and make up for 27% of FY16E total sales.

Greater cost control and para IV launches to drive

profitable growth

US generics likely to grow 5x over FY13-16E

Alembic Pharma

12 March 2014 11

Exhibit 15: US generics sales to reach USD125m by FY16E


About 55% of ANDA pipeline still waiting to be commercialized Given the apparent strategy to file backward integrated ANDAs, we analyzed ALPM’s DMF filings to better understand their product pipeline and present below our findings. We have classified the probable future opportunities into four categories, based on their likelihood of getting launched in the next three years:

I. Products whose last patent will expire over the next three years; highest probability of commercialization.

II. Products with no patent protection and probably awaiting ANDA approval; relatively high likelihood of launch.

III. Products whose substance patents have expired. These probably could be para IV filings but whose launch is more certain then category 4 below.

IV. Products whose substance patent expires in next three years. Probable para IV filings whose launch is dependent on litigation outcomes. There is no clarity over their launch timeline.

Some of the key launches expected over the forecast period include gAtacand, gNamenda, gCelebrex, gSular and gTracleer (refer Exhibit 16 below). Our analysis of ALPM’s DMF filings revealed that there are many products whose patents have already expired and could be awaiting ANDA approval (refer Exhibit 17 below). Further, our analysis does not even include those ANDAs that the company may have filed through third party DMFs. Hence, we are reasonably confident that the company can achieve its target of 8-10 launches per year for the next three years.

Vast pipeline lends growth visibility in US; 8-10

launches per year achievable

Alembic Pharma

12 March 2014 12

Exhibit 16: I. Product opportunities with patent expiring in next three years

DMF Filed on Molecule Brand Innovator Sales

(USD m) Patent expiration Competition Likely

launch in

31-Mar-08 Candesartan Cilexetil Atacand AstraZeneca 120

EPE: Jan 9, 2014 LPE: Feb 24, 2015

Sandoz launched first generic version in May 2013. Apotex also received approval on 10 Jan 2014. Likely launch after Feb 2015 patent expiry. FY15

7-Oct-11 Nisoldipine Sular Shinogi 103 LPE: Nov 30, 2014

Mylan was FTF and recd approval in Jan 2011. Likely launch after patent expiry in Nov 2014 FY15

11-Sep-09 Memantine HCL Namenda Forest Labs 1500 LPE: Apr 11, 2015 Multiple players FY16

30-Nov-10 Celecoxib Celebrex Gd Searle 1770 EPE: May 30, 2014* LPE: Dec 2, 2015

Teva is FTF; lost in court. '068 patent has been invalidated. Expect generic entry in May 2014. More than 15 DMFs FY16

30-Jun-11 Bosentan Tracleer Actelion Pharma - LPE: Nov 20, 2015

No ANDA approved. No para IV as well. More than 10 DMF filers FY16

6-Apr-11 Iloperidone Fanapt Novartis 20 LPE: Nov 15, 2016* NCE: May 6, 2014

FTF was filed in May 2013. No clarity on filer. Only 5 players including ALPM had DMF at the time. FY17

27-Jun-12 Darifenacin Hydrobromide Enablex

Warner Chilcott 270

EPE: Mar 13, 2015* LPE: Aug 21, 2016

Anchen has TA. Teva and Watson have lost case. FY17

6-Apr-11 Topiramate Topamax Janssen - LPE: Apr 13, 2016 Multiple players already. Market was USD2.4b before generics. FY17

Source: USFDA, MOSL research; EPE: Earliest Patent’s Expiration; LPE: Last Patent’s Expiration; * Is a Substance patent

Exhibit 17: II. Product opportunities with no patent protection


(USD m) Patent expiration Competition

22-Jun-04 Cilostazol Pletal Otsuka - None 8 players have approval. Market of USD178m when generics entered.

26-Nov-07 Levetiracetam Keppra UCB - NPP: Jun 16, 2015 Many players. Market size was USD1b before generics

29-Mar-08 Metoprolol Succinate Toprol Xl AstraZeneca - None

Few players. WPL also left due to import alert. Market was USD1.1b when DRRD entered in Sep 2012.

20-Feb-09 Pentosan Polysulfate Elmiron Janssen - None

No ANDA approved. No para IV as well. 6 DMF filers; none of them meaningful players.

27-Mar-09 Erythromycin NA NA - None Many players. Pre 1982 product.

9-Mar-11 Warfarin Sodium Coumadin BMS - None Many players. Pre 1982 product.

9-Mar-11 Mexiletine HCL Mexitil Boehringer Ingelheim - None

Innovatory and another Generic (Sandoz) discontinued. Only Teva is the approved player.

29-Mar-11 Warfarin Sodium Coumadin BMS - None Many players. Pre 1982 product.

5-Apr-11 Rabeprazole Sodium Aciphex Takeda 830 None DRRD, LPC, MYL, TRP, TEVA have launched.

11-Oct-11 Felodipine Plendil AstraZeneca - None 9 players have approval. Market size was USD66m when Wockhardt entered in Aug 2012.

20-Dec-11 Zolmitriptan Zomig AstraZeneca - None 3 players have approval. Market size was USD153m when Mylan entered in May 2013.

Source: USFDA, MOSL research; NPP: New Patient Population

Alembic Pharma

12 March 2014 13

Exhibit 18: III. Product opportunities with no substance patent protection



21-Nov-06 Clarithromycin Biaxin Abbott - LPE: Apr 11, 2017 EPE: Jul 15, 2017

9 players already have approval. Market size was USD500+ before generics

7-Feb-07 Telmisartan Micardis/ HCT

Boehringer Ingelheim

274/ 235

EPE: Jan 7, 2014 LPE: Jan 10, 2020

Watson recd FA on 8 Jan 2014 and is FTF. GNP and ALPM have TA. May launch on 181 day

25-Jun-07 Alendronate Sodium Fosamax Merck -

LPE: Nov 17, 2014 LPE: Jan 17, 2019

Many Players already present. Market size was USD1.9b before generics.

26-Sep-08 Bupropion HCL Wellbutrin/ SR/XR GSK 500 LPE: Oct 30, 2018 About 10 players

30-Nov-09 Quetiapine Fumarate

Seroquel/ XR AstraZeneca 1200 LPE: Nov 28, 2017

Many players in IR. For XR, 2017 patent was upheld in court. Accord and Handa are FTF. 5 more para IVs.

9-Apr-10 Duloxetine HCL Cymbalta Eli Lilly 3300 EPE: Jan 18, 2015 LPE: Mar 10, 2020

12 para IV filers. More than 8 settled. Only 5 launched. No clarity on ALPM's position.

14-Oct-10 Fenofibric Acid Fibricor Mutual Pharma - LPE: Aug 20, 2027 No ANDA approved. No para IV as well. Only 3 DMF filers

25-Feb-11 Olmesartan Medoxomil

Benicar/ HCT Daiichi Sankyo

700/ 600

EPE: Oct 25, 2016 LPE: May 19, 2022

Mylan lost in court. Mylan and Sandoz (not for HCT) have TA. No clarity on ALPM's position

Source: USFDA, MOSL research

Exhibit 19: IV. Product opportunities with substance patent expiring in next three years



31-Mar-09 Tadalafil Cialis/ Adcirca Eli Lilly 800

EPE: Jul 11, 2016 LPE: Nov 19, 2020*

FTF were filed on Nov 2007 and Oct 2008. Filer not known. Only Teva, Mylan, DRRD, Orchid had DMFs at that time. 10 more DMFs today.

18-Nov-09 Aripiprazole Abilify Otsuka 5190 EPE: Apr 20, 2015* LPE: Dec 16, 2024

7 para IV players. Court upheld Apr 2015 patent. No clarity on ALPM's position

25-Mar-11 Linezolid Zyvox Pharmacia Upjohn 430

EPE: May 18, 2015* LPE: Jul 29, 2021*

GNP, NYL, TVA have TA. TVA is para IV for tabs or inj.

7-Sep-12 Lacosamide Vimpat UCB 338 EPE: Aug 5, 2014* LPE: Mar 17, 2022*#

Multiple para IV filers. UCB has sued 13 companies including ALPM.

26-Mar-13 Dronedarone HCL Multaq Sanofi Aventis -

EPE: Jul 26, 2016* LPE: Jun 30, 2031 NCE: Jul 1, 2014

FTF was filed in July 2013. Identity of filer not known. 15 DMF filers.

Source: USFDA, MOSL research; EPE: Earliest Patent’s Expiration; LPE: Last Patent’s Expiration; * Is a Substance patent; # Re-issue patent

Alembic Pharma

12 March 2014 14

Entry into specialty segments to drive above-industry growth ALPM’s growth in domestic formulations has been restricted due to its overdependence on slow growing acute therapies. The company has identified and expanded into certain specialty segments like Respiratory, CVS, Diabetology, Ophthalmic, Gastro, and Gynecology. These will not only drive above-industry growth, but also improve the profitability of the business along with adding more stability to it. Overdependence on slow growing acute therapies in India The major reason for ALPM’s slowdown has been its overdependence on Macrolides (a class of antibiotics) and other acute therapies. Legacy brands Glycodin, Azithral, Althrocin, Roxid and Wikoryl which constitute about 30% of ALPM’s domestic formulations sales (as per AIOCD), has grown mere 6% CAGR over last 4 year, while the overall segment grew at 12%. This implies a 15%+ growth in the balance portfolio over the same period.

Exhibit 20: Chronic v/s acute (% of domestic formulations)

Source: Company, MOSL, AIOCD

Exhibit 21: Specialty therapies (% of domestic formulations)

Source: Company, MOSL, AIOCD

Expansion into specialty segments The high growth in the balance portfolio has been driven by new product introductions in therapies like Ophthalmology, Cardiology, Diabetology, Gastroenterology, Gynecology, Nephrology and Orthopedic. Prescriptions in these segments are written by specialists, who usually do not switch brands. Hence, established brands in these therapies generate sustainable revenues and command a premium in the market. Further, these specialty therapies are witnessing growth faster than the overall market due to increasing diagnosis and penetration.

Exhibit 22: 49% contribution from anti-infectives …


Exhibit 23: …reduced to 33% as specialty contribution grows


Respiratory, CVS, Diabetology, Ophthalmic,

Gastro, and Gynecology indentified as key specialty

therapies to drive growth as well as profitability

Alembic Pharma

12 March 2014 15

Overall domestic formulations to grow faster than industry Driven by increasing contribution from specialty segments, we expect ALPM’s domestic formulations business to grow by 15% over the next two years, which is higher than our expectation of industry growth rate of 12-14%. Exhibit 24: Domestic formulations to grow faster than the industry


International branded formulations at investment stage ALPM has been investing to build product portfolios in South East Africa and CIS markets. However, given the slow approval process and gestation period required to gain scale in these markets, we believe the branded formulations business may take another 2-3 years before meaningfully contributing to ALPM’s overall business. At the same time, growth in these markets may remain high due to the small base effect. APIs to slow down due to increasing captive consumption We expect the API sales to continue its downward trend due to increasing captive consumption. Given the backward integrated manufacturing approach taken by the company, this trend is likely to continue until such time as ALPM expands current API capacities.

Exhibit 25:Investment phase for Intl branded formulations


Exhibit 26: Slowdown in APIs to continue


Alembic Pharma

12 March 2014 16

Improving business profile; re-rating candidate Likely to be net-debt free by FY16E

Business mix at ALPM likely to improve further, with higher contribution from US

generics and specialty therapies in India.

This is likely to result in 280bp EBITDA margin expansion and 35% earnings CAGR over

FY14E-16E.

With majority of the capex behind them and high free cash generation visibility, we

expect ALPM to be net-debt free by FY16E.

An improving business profile and strong earnings growth makes ALPM a potential re-

rating candidate. Initiate coverage with a Buy and target price of INR350 (15x FY16E

EPS), 40% upside.

Improving business mix likely to result in increasing profitability We expect contribution from US generics market and specialties therapies in India to increase from 37% in FY13 to 64% in FY16E. At the same time, low-margin APIs and acute therapies may continue to face slowdown over this period. This is likely to result in an overall revenue growth of 21% CAGR over FY14E-16E in our view.

ALPM is also planning to establish its own front-end in the US market (by end FY15E), which may also aid increase in profitability. Hence, we expect the improving business mix to drive a 280bp EBITDA margin expansion over FY14E-16E. This in turn is likely to result in 35% earnings CAGR over the same period. Our EPS estimates for FY15E/16E are 10%/14% above Bloomberg consensus estimates.

Exhibit 27: We expect improving business mix (%)…


Exhibit 28: … sales growth of 21% CAGR over FY14E-16E…


Exhibit 29: EBITDA margin likely to expand by 280bp…


Exhibit 30: …resulting in 35% earnings CAGR over FY14E-16E


US generics and specialties areas in India likely to make

up 64% of sales in FY16E

Our EPS estimates for FY15E/16E are 10%/14%

above consensus.

Alembic Pharma

12 March 2014 17

Strengthening balance sheet Owing to the structural changes brought in by the new management, ALPM has been able to halve its cash conversion cycle over the last 5 years. The healthy cash flow generation has aided in significantly lowering the net-debt position over the same period. As major of the company’s capex is behind them, we expect it to attain a net-debt free position by FY16E. At the same time, return ratios are expected to sustain above 40% over the foreseeable future.

Exhibit 31: Management has only guided for maintenance capex


Exhibit 32: steady free cash-flow generation


Exhibit 33: Reduced net-debt/equity (X)


Exhibit 34: Return ratios to remain above industry average levels (%)


Free cash-flows expected to increase given limited capex

needs; could be net-debt free by FY16E

Alembic Pharma

12 March 2014 18

Potential re-rating candidate; Initiate with BUY We believe that ALPM’s business profile has undergone a sea change at multiple parameters as discussed above. However, the re-rating undergone over the past 12 months does not adequately reflect this improvement.

Exhibit 35: One year forward P/E chart

Source: Bloomberg, MOSL

Exhibit 36: One year forward P/B chart

Source: Bloomberg, MOSL

With increased earnings growth visibility and strengthening balance sheet, we ascribe a PE multiple of 15x, which is still a 25% discount to the sector average considering its relatively smaller scale. We see further room for re-rating once the company becomes net-debt free and achieves sizeable scale in US generics and Indian formulations market.

Exhibit 37: Valuation: Peer comparison

Company P/E (X) EV/EBITDA (X) EV/Sales (X) RoE (%) EPS CAGR (%)

FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E FY14E-16E Alembic Pharma 14.5 10.9 10.2 7.7 2.1 1.7 43.6 44.6 35.7 IPCA Labs 17.4 14.1 11.8 9.7 2.9 2.4 29.4 28.8 30.6 Torrent Pharma 17.5 14.4 11.5 9.3 2.4 2.0 26.8 27.3 10.3 Unichem Labs* 12.6 11.1 8.0 7.1 1.5 1.3 18.2 18.5 20.4 Indoco Remedies* 16.4 11.9 9.7 7.3 1.6 1.3 16.4 19.0 43.2 Natco Pharma* 18.4 19.0 12.6 13.2 3.2 3.2 19.9 18.6 21.8

Source: MOSL Research, *Bloomberg

Based on our EPS estimates, stock is trading at 14.5x FY15E EPS and 10.9x FY16E EPS. We initiate coverage on ALPM with a Buy recommendation and a target price of INR350 (15x FY16E EPS).

Considerable improvement in business profile; still

trading at significant discount to sector average

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Key risks to our investment arguments Regulatory enforcement actions Any enforcement action by the USFDA on any of its facilities could lead to a significant downgrade in our estimates, as strong growth US generics is one of the important investment arguments. The management indicated that its formulations and API plants at Baroda were inspected about 12 months ago. Corporate governance related issues Alembic Group has interests in varied businesses like real estate, specialty chemicals and glassware. Although the extent of inter-corporate transactions has reduced since the ALPM de-merger from Alembic Ltd in 2009, there were loans worth INR1.48b given to its associates during FY13. The management has indicated that the group companies have already repaid this amount and it stood ‘NIL’ at the end of FY13. The company has also stressed that it would refrain from any such activities in the future. While these are surely positive signs, any such transaction in the future will impair investor confidence, leading to a potential de-rating in the stock. Delay in obtaining ANDA approvals Management expects 8-10 product launches every year for the next three years. Prolonged delay in obtaining ANDA approval from USFDA can lead to lower than expected growth in US generics. This could lead to downgrade in our estimates. Field force attrition With an aim to increase its presence in specialties therapies in Indian formulations market, ALPM has built a strong field force of 3,000 medical representatives. We have noticed that attrition of trained personnel has impacted other chronic focused companies like Unichem, IPCA Labs and Torrent Pharma. While the management indicated that attrition rate has been brought down to 25% (from its high of 45%), an unexpected increase in attrition can hinder ALPM’s marketing strategy in India and impact our growth as well as profitability assumptions.

Alembic Pharma

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Financials and valuation Income statement (INR Million) Y/E March 2011 2012 2013 2014E 2015E 2016E Net Sales 12,021 14,654 15,204 18,914 22,768 27,707 Change (%) 18 22 4 24 20 22 EBITDA 1,602 2,194 2,520 3,624 4,667 6,096 EBITDA Margin (%) 13.3 15.0 16.6 19.2 20.5 22.0 Depreciation 296 337 350 400 465 553 EBIT 1,307 1,858 2,170 3,224 4,202 5,542 Interest 276 376 240 159 141 123 Other Income 38 128 133 50 114 139 Extraordinary items 0 0 0 0 0 0 PBT 1,068 1,610 2,063 3,115 4,175 5,558 Tax 215 309 411 760 918 1,223 Tax Rate (%) 20.1 19.2 19.9 24.4 22.0 22.0 Min. Int. & Assoc. Share 0 0 0 0 0 0 Reported PAT 854 1,301 1,653 2,355 3,256 4,335 Adjusted PAT 854 1,301 1,653 2,355 3,256 4,335 Change (%) 313 52 27 42 38 33 Margins (%) 7 9 11 12 14 16

Balance sheet (INR Million) Y/E March 2011 2012 2013 2014E 2015E 2016E Share Capital 377 377 377 377 377 377 Reserves 2,590 3,573 4,652 6,125 8,058 10,629 Net Worth 2,967 3,950 5,029 6,502 8,435 11,006 Debt 3,279 3,527 1,868 1,668 1,468 1,268 Deferred Tax 54 95 139 191 191 191 Total Capital Employed 6,300 7,572 7,036 8,360 10,094 12,464 Gross Fixed Assets 4,335 4,629 5,725 6,525 7,725 9,225 Less: Acc Depreciation 1,616 1,951 2,283 2,683 3,148 3,701 Net Fixed Assets 2,720 2,678 3,442 3,842 4,577 5,523 Capital WIP 265 582 323 323 323 323 Investments 33 33 33 33 33 33 Current Assets 5,419 7,226 6,680 8,190 10,178 12,820 Inventory 2,192 2,587 2,668 2,829 3,302 3,991 Debtors 2,020 1,993 2,329 2,897 3,487 4,244 Cash & Bank 63 471 161 571 1,109 1,811 Loans & Adv, Others 1,144 2,174 1,522 1,894 2,280 2,774 Curr Liabs & Provns 2,136 2,947 3,442 4,028 5,017 6,235 Curr. Liabilities 1,873 2,590 2,819 3,066 3,598 4,354 Provisions 264 357 623 962 1,420 1,881 Net Current Assets 3,283 4,279 3,239 4,163 5,161 6,585 Total Assets 6,300 7,572 7,036 8,360 10,094 12,464

E: MOSL Estimates

Alembic Pharma

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Financials and valuation Ratios Y/E March 2011 2012 2013 2014E 2015E 2016E Basic (INR) EPS 4.5 6.9 8.8 12.5 17.3 23.0 Cash EPS 6.1 8.7 10.6 14.6 19.7 25.9 Book Value 15.7 21.0 26.7 34.5 44.7 58.4 DPS 1.0 1.4 2.5 4.0 6.0 8.0 Payout (incl. Div. Tax.) 25.7 23.6 33.4 37.5 40.6 40.7 Valuation(x) P/E 55.4 36.4 28.6 20.1 14.5 10.9 Cash P/E 41.1 28.9 23.6 17.2 12.7 9.7 Price / Book Value 15.9 12.0 9.4 7.3 5.6 4.3 EV/Sales 4.2 3.4 3.2 2.6 2.1 1.7 EV/EBITDA 31.5 23.0 19.5 13.4 10.2 7.7 Dividend Yield (%) 0.4 0.6 1.0 1.6 2.4 3.2 Profitability Ratios (%) RoE 27.9 37.6 36.8 40.8 43.6 44.6 RoCE 19.9 28.9 32.0 43.5 47.8 51.2 Turnover Ratios (%) Asset Turnover (x) 1.9 1.9 2.2 2.3 2.3 2.2 Debtors (No. of Days) 60.9 49.5 55.6 55.7 55.7 55.7 Inventory (No. of Days) 66.6 64.4 64.1 54.6 52.9 52.6 Creditors (No. of Days) 48.5 61.3 69.1 60.7 59.9 60.6 Leverage Ratios (%) Net Debt/Equity (x) 1.1 0.9 0.4 0.3 0.2 0.1

Cash flow statement (INR Million) Y/E March 2011 2012 2013 2014E 2015E 2016E OP/(Loss) before Tax 1,068 1,610 2,064 3,115 4,175 5,558 Depreciation 296 337 350 400 465 553 Others 0 0 0 0 0 0 Interest 239 262 146 109 27 -15 Direct Taxes Paid 178 327 387 709 918 1,223 (Inc)/Dec in Wkg Cap -488 -616 439 -515 -460 -723 CF from Op. Activity 950 1,418 2,648 2,401 3,289 4,150 (Inc)/Dec in FA & CWIP -624 -612 -854 -800 -1,200 -1,500 (Pur)/Sale of Invt 0 0 0 0 0 0 Others 55 48 184 50 114 139 CF from Inv. Activity -568 -564 -670 -750 -1,086 -1,361 Inc/(Dec) in Net Worth 0 0 0 0 0 0 Inc / (Dec) in Debt -305 143 -1,696 -200 -200 -200 Interest Paid -164 -372 -288 -159 -141 -123 Divd Paid (incl Tax) 0 -216 -304 -882 -1,323 -1,764 CF from Fin. Activity -470 -446 -2,288 -1,241 -1,664 -2,087 Inc/(Dec) in Cash -88 408 -310 409 539 701 Add: Opening Balance 151 63 471 161 571 1,109 Closing Balance 63 471 161 571 1,109 1,811

E: MOSL Estimates

Alembic Pharma

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Disclosure of Interest Statement ALEMBIC PHARMA 1. Analyst ownership of the stock No 2. Group/Directors ownership of the stock No 3. Broking relationship with company covered No 4. Investment Banking relationship with company covered No

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