Cadila Healthcare Limited (CADHEA) - ICICI...

January 25, 2011

ICICIdirect.com | Equity Research

Initiating Coverage

ICICI Securities Limited

Multiple growth drivers… Cadila Healthcare Ltd (CHL) is one of the leading Indian pharma players with a strong presence in both domestic and export markets. CHL’s revenues have grown at a CAGR of ~26% between FY06 and FY10 to | 3687 crore driven by higher exports (~47% CAGR) fuelled by M&As and numerous product launches. Having ~3.7% market share in domestic formulations, CHL is an established player in the domestic market as well. With strong traction from exports triggered by a growing presence in developed and emerging markets together with a well complemented domestic portfolio tilted towards chronic therapies and ever growing consumers business, we expect CHL’s revenues and profits to grow at a CAGR of ~19% and ~25%, respectively, between FY10 and FY13E to | 6267 crore and | 1006 crore, respectively. We are initiating coverage on the stock with an ADD rating.

Strong presence in domestic formulations, traction from consumer business

The company is the fifth-largest player in the domestic formulations market with ~3.7% market share. It owns a strong product portfolio (16 brands among top 300 domestic pharma brands) with a chronic bias. With aggressive product launches (~119 products addition between April 2009-December 2010) and focus on semi-urban and rural areas, we expect CHL to further consolidate its position in the domestic market with estimated CAGR of 17% between FY10 and FY13E to | 2321 crore. CHL is also well placed in the fast growing consumer wellness business through three broad product offerings that enjoy good growth and brand loyalty.

International business – sustained growth anticipated

International business continues to remain the main growth driver for CHL. The company has a strong presence in the US generic market (~20% share in 12 products) followed by France, Brazil and Japan. We expect exports to grow at ~22% CAGR between FY10-13E to | 3164 crore. International business will be supported by incremental sales flowing from Abbott deal (in FY13) and new launches from the two JVs.

Valuations At | 834, the stock is trading at 21.1x FY12E EPS of | 39.6 and 17.0x FY13E EPS of | 49.2. CHL’s business model is time tested with a sound mix of domestic and international portfolios. It has consistently exceeded its own targets and also rewarded shareholders with two bonus issues in the last five years. The JVs and deals with leading MNCs have further vindicated the capabilities of the company. We have valued CHL at | 885, i.e. 18x FY13E EPS of | 49.2. Exhibit 1: Key Financials

(| Crore) FY08 FY09 FY10 FY11E FY12E FY13ETotal Revenues 2,323 2,928 3,687 4,421 5,274 6,267EBITDA 458 606 809 982 1,206 1,451Adjusted Net Profit 263 323 509 639 809 1,006PE (x) 59.7 52.9 33.5 26.7 21.1 17.0Target PE (x) 63.3 56.1 35.6 28.3 22.4 18.0EV/EBITDA (x) 38.9 29.9 22.1 18.0 14.4 11.8P/BV (x) 14.8 13.8 10.5 7.8 6.0 4.6RoNW (x) 27.2 26.4 37.0 37.0 34.0 32.5RoCE (%) 22.4 22.4 25.8 28.7 30.9 31.9

Source: Company, ICICIdirect.com Research

Cadila Healthcare Limited (CADHEA) | 834

Rating Matrix Rating : Add

Target : | 885

Target Period : 12 months

Potential Upside : 6%

YoY Growth (%)

FY09 FY10 FY11E FY12E FY13ETotal Revenue 26.0 25.9 19.9 19.3 18.8EBITDA 32.2 33.5 21.4 22.8 20.4Net Profit 22.7 57.7 25.5 26.7 24.3

Current & Target Multiple (x) FY09 FY10 FY11E FY12E FY13E

PE 52.9 33.5 26.7 21.1 17.0EV/ EBITDA 29.9 22.1 18.0 14.4 11.8P/BV 13.8 10.5 7.8 6.0 4.6Target P/E 56.1 35.6 28.3 22.4 18.0Target EV/ EBITDA 31.6 23.4 19.1 15.2 12.5Target P/BV 14.7 11.1 8.3 6.4 4.9

Stock Metrics

Bloomberg Code CDH:IN

Reuters Code CADI.BO

Face Value (Rs) 5

Promoters Holding 74.8Market Cap (Rs cr) 17,06852 week H/L 864/413Sensex 19,151Average volumes 76,181 Price movement

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CHL Nifty - RHS

Comparable return matrix (%)

Company 1 Month 3 Month 6 Month 1 Year

Cadila Healthcare 8.7 19.3 32.6 95.7

Lupin 2.2 4.0 22.4 62.9

Dr Reddy's -2.1 2.2 17.6 47.1

Sun Pharma 13.2 14.5 41.3 65.5 Analyst’s name

Siddhant Khandekar [email protected]

Krishna Kiran Konduri [email protected]



Company Background Headquartered in Ahmedabad, Gujarat, the company was established as Cadila Laboratories in 1952. After a family split, the group was restructured to form Cadila Healthcare Ltd (CHL) in 1995. It got listed on the stock exchange in 2000. CHL manufactures and markets a wide range of products, including formulations, active pharmaceutical ingredients (API), intermediates, biologicals, animal healthcare products and consumer wellness products. The domestic business constitutes ~52% of gross sales (9MFY11). Major components are branded & generic formulations (~40% of gross sales), consumer products (~8%), animal health and others (~3%) and APIs (~1%). CHL is the fifth largest player in the Indian formulation market with ~3.7% market share, according to IMS ORG. CHL also has a presence in the fast growing domestic consumer wellness segment through its publicly-listed subsidiary, Zydus Wellness Ltd (ZWL). CHL holds a 72% stake in Zydus Wellness. Sales from ZWL contributed ~8% to gross sales in 9MFY11.

CHL operates in both the developed markets of the US, EU and Japan as well as the emerging markets (EMs) of Latin America, Asia-Pacific, Africa and the Middle East. The company’s foray into the international markets has primarily been through the inorganic route providing it access to brands and distribution channels. International revenues constituted 48% of gross sales in 9MFY11 (as against 25% in FY06). Formulation sales to advanced markets (US, EU and Japan) accounted for ~28% of gross sales in 9MFY11.

CHL has entered into long-term strategic alliances with global players like Hospira, Nycomed and Abbott Laboratories. While it struck JVs with Nycomed (1998) and Hospira (2009), recently it entered into an agreement with Abbott to out-license 24 branded generics to market in 15 key emerging markets from FY13 onwards. In 9MFY11, alliances constituted ~4% of gross sales. CHL owns eight formulation manufacturing facilities (two USFDA approved), five API and intermediates manufacturing facilities (three USFDA approved) and three R&D centres.

Exhibit 2: Sales have grown at a CAGR of 26% between FY06-10

1,4811,855

2,323

2,928

3,687

0

1,000

2,000

3,000

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FY06 FY07 FY08 FY09 FY10

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Exhibit 3: International segment accounted for 49% of sales in FY10

68 59 52 46 41 40

47

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20 28 34 40 44 45

4 4 3 3 4 4

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FY06 FY07 FY08 FY09 FY10 9MFY11

(%)

Domestic Formulations* Zydus Wellness Animal Health Business

Export Formulations* Alliances

Source: Company, ICICIdirect.com Research, *Includes sales of APIs

Share holding pattern (Q3FY11)

Shareholder Holding (%)

Promoters 74.8

Institutional Investors 18.7

Other Investors 1.4

General Public 6.6

Promoter & Institutional holding trend (%)

74.8 74.8 74.8 74.8 74.8

11.6 11.5 11.4 12.6 18.7

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Promoters FIIs & MFs



Exhibit 4: Inorganic growth strategy followed by CHL to expand global presence Year Country Company Name Stake (%) Drivers for Acquisition

FY10 South Africa Simayla Pharmaceuticals 100.0 Entry in the South African generics market

FY09 Italy Etna Biotech 100.0 Strengthen R&D initiatives in vaccines segment

FY09 Spain Laboratorios Combix 100.0 Entry in the Spanish generics market

FY08 BrazilQuimica e Farmaceutica Nikkho do Brasil Ltda.

100.0Entry in the Brazilian generic market, expand existing product portfolio and coverage

FY08 India Sarabhai Zydus Animal Health Ltd. 100.0 Expansion of animal healthcare business

FY08 Japan Nippon Universal Pharmaceutical Ltd. 100.0Stregthen position in Japanese generic market, access to ready manufacturing and marketing base, distribution network

FY07 India Liva Healthcare 97.5 Establish presence in the Indian dermatology market


Exhibit 5: CHL has a strong global footprint, focus on EMs

United States:• Zydus Pharmaceuticals (USA) Inc. markets formulation generics

France:• Established presence in France through Zydus France SAS

• Offers wide product portfolio

Italy:Carrying out biotech research through Etna Biotech S.R.L

Brazil:• Entered generics market through Zydus Brasil Healthcare Ltda.

• Acquisition of Quimica e Farmaceutica Nikkho do Brasil Ltda. in 2007 for branded generics

South Africa:• Entered South African generic market with the acquisition of Simayla Pharmaceuticals in 2008

Spain:• Entered Spanish generic market with the acquisition of Laboratorios Combix in 2008

Japan:• Launched Zydus Pharma Inc. in 2006

• Commenced operations with acquisition of Nippon Universal Pharmaceutical Ltd. in 2007

Emerging Markets:• Top Indian pharma company in Uganda and Sudan

• Amongst top 3 Indian pharma companies in Sri Lanka and Myanmar

Russia:• Operates though Zydus IntRus Limited• Main business involves providing logistic services and distributing pharma products in Russia




Business Overview (9MFY11)

Cadila Healthcare (100%)

Domestic (51.5%) International (44.6%) Alliances (3.9%)

Formulations (39.8%)

API s (0.7%)

Consumer Wellness (7.7%)

Animal Healthcare (3.3%)

Formulation (37.2%)

APIs (7.4%)

Hospira JV (2.5%)

Nycomed JV (1.4%)

Abbott Deal

US (20.5%)

Europe (6.3%)

Japan (0.9%)

Latin America (5.2%)

Other Emerging Markets (4.4%)



Investment Rationale We expect healthy sales growth driven by both international and domestic businesses. On the international front, new product launches in the US, Latin America and emerging markets are expected to drive growth. We estimate sales from the international market to grow at a CAGR of ~21% between FY10 and FY13E to | 2785 crore. In the domestic market, we expect the domestic formulation business to grow at a CAGR of ~17% between FY10 and FY13E to | 2321 crore. The JV with Hospira and supply agreement with Abbott will also support sales growth. Also noteworthy will be the expected growth from Zydus Wellness where we expect 21% CAGR between FY10 and FY13E to | 477 crore. Overall, we estimate total gross sales will grow at a CAGR of ~19% between FY10 and FY13E. Exhibit 6: Sales break-up

1136 12

70 1484 16

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Domestic International Alliances


Growing domestic formulation business

New launches to drive growth CHL is one of the leading players in the domestic respiratory, cardiovascular (CVS), gastrointestinal (GI) and female healthcare segments. It is the fifth-largest domestic player with ~3.7% market share, as per IMS ORG. Total 16 of its brands feature among India’s top-300 pharma brands in FY10. Sales from domestic formulations contributed ~ 40% of gross sales in 9MFY11. Sales from the domestic formulation market grew at a CAGR of only 10% between FY06 and FY09 due to muted sales growth of key brands. To counter this, CHL launched nearly 119 products including 36 first launches in the last 21 months (April 2009-December 2010). This led to favourable results that were visible from ~18% YoY growth in the first nine months of the current fiscal. With a slew of new launches and focus on chronic therapies, we expect CHL’s domestic formulation sales to grow at a CAGR of ~17% to | 2321 crore between FY10 and FY13E.

CHL’s domestic formulation sales are projected to grow at a CAGR of 17% in FY10-13E to | 2321 crore driven by the company’s stable market position, product launches and focus on the chronic segment



Focus on chronic segment provides sales visibility…

CHL’s product portfolio is tilted towards chronic segment (57% of domestic formulations revenues in FY10). With longer treatment periods associated with chronic diseases (vis-à-vis acute diseases), this focus, we believe, will drive the overall formulations growth. In recent years, CHL has strengthened its position in this segment through the creation of the specialty divisions and ramp up in the field force. Some major initiatives include:

− Formation of Zydus Cardiva in FY10, which focuses on urban markets with a range of anti-hypertensive and aspirin combinations. The division has a sales force of 300 personnel.

− The size of the respiratory sales force was increased by 100 personnel in FY10 to better exploit the potential of anti-asthma inhalation therapy management in mass markets.

Exhibit 7: Domestic formulations to grow at a CAGR of 17% between FY10-13E

979 1,0601,176

1,2891,446

1,696

1,989

2,321

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(| c

rore

) Source: Company, ICICIdirect.com Research

Exhibit 8: CHL has 3.7% market share in the domestic formulation market

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Exhibit 9: …but has grown slower than overall industry & peers in FY06-10

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Numerous initiatives were taken by the company to expand its presence in the chronic segment



New product launches cater across therapeutic areas

In FY10, the company launched over 60 new products and line extensions of which 17 were first-in-India products. New products accounted for ~2.5% of the revenue growth of the domestic formulation segment in FY10. This exercise continued in FY11 as well with the company launching 59 products in India (19 first-in-India products) in the first nine months. CHL is now planning to launch 35 new products (excluding line extensions) every year.

Expansion of product portfolio through in-licensing agreements…

CHL’s product portfolio (and competitive positioning) is improved by its in-licensing agreements with global pharmaceutical players i.e. Bayer Schering Pharma (BSP), Boehringer Ingelheim, Nycomed, Baxter and Genzyme Inc for manufacturing and marketing their patented products.

…and expansion of geographic coverage through large sales force and doctors’ coverage

To increase its domestic market share, CHL is focusing on expanding its penetration, especially in semi-urban and rural areas. We believe the semi-urban and rural areas present attractive opportunities for pharma companies given the relatively low penetration of allopathic medication. With a sales force of ~4500 medical representatives (MRs) at its disposal, CHL is well poised to tap many of these uncovered areas. CHL plans to increase its doctor coverage to 2,00,000 doctors in the next six to nine months from the current coverage of ~1,25,000.

Exhibit 10: Focus on chronic segment provides sales visibility

Acute 27%

Biologicals 4%

Chronic 57%

Others 12%


Exhibit 11: ~50% of branded formulation sales in FY10 accounted by CVS, GI and respiratory therapies (key chronic segments)

Respiratory 11%

Neurologicals and Pain Mgmt

10%

Gastro Intestinals 16%

Female Healthcare11%

Cardiovasculars 21%

Anti-infectives 11%

Others*20%

Source: Company, ICICIdirect.com Research, *Includes sale of neutraceuticals, dermatology, diagnostics, biological products

Exhibit 12: Average run rate of 60 new products and line extensions launched in FY08-10

FY08 FY09 FY10 9MFY11

New Products 35 25 30 59*

Line Extensions 25 30 30 NA

First-in-India 10 15 17 19

Source: Company, ICICIdirect.com Research; *includes line extensions

The management plans to expand doctor coverage to 2,00,000 doctors in the next six to nine months



Potential from vaccine & Biosimilars sales

Until FY10, CHL had a limited presence in the vaccines business with two vaccines under its portfolio: anti-rabies and anti–typhoid vaccine. In June 2010, CHL launched India’s first indigenously manufactured vaccine for Pandemic Influenza A (H1N1) - Vaxiflu-S. With built-in annual production capacity of 5-6 million doses of Vaxiflu-S, the company plans to sell ~2 million doses in the next two or three years.

Although there are a few companies that are expected to launch H1N1 vaccine (Serum Institute, Pune is likely to launch nasal formulation in late FY11), we believe CHL will continue to enjoy a first-mover advantage. Currently, CHL is developing 10-12 vaccines. We expect CHL to launch a couple of vaccines in the domestic market in the next two or three years.

Around 4% of domestic formulation sales came from biosimilars in FY10. Till date, CHL has launched two products in the domestic market while two more are in the commercial stage.

CHL was the first Indian company to indigenously manufacture H1N1 vaccine - Vaxiflu-S.



Established international presence

Robust growth expected for international business

CHL has a presence in the US, EU, Japan, Latin America, Asia-Pacific, Africa and the Middle East. With formulation exports growing at a CAGR of ~61% between FY06 and FY10 (36% of gross sales in FY10), the international business has been a key growth driver for CHL. Growth has been driven by increasing market share in developed markets, entry in new markets, strategic acquisitions and numerous product launches. We expect CHL to continue to focus on its generic portfolio to expand market share abroad. We expect formulation exports to grow at a CAGR of~ 22% to | 2391 crore between FY10 and FY13E (39% share in gross sales in FY13E).

US to continue to remain key international market for CHL…

Impressive performance despite being a late entrant

Although CHL’s foray into the US market in FY05 was late, its performance in this market has been impressive. With 39 products launches in the US till date, CHL is among the top-20 generic companies in the US. Among these launches, CHL enjoys over ~20% market share in at least 12 products. On a lower base, sales in the US region have grown at a CAGR of ~91% between FY06 and FY10 to | 672 crore.

Having filed 118 abbreviated new drug applications (ANDAs) till date, CHL’s generic product pipeline in the US is strong. However, due to its ‘internal return’ criteria, CHL has gone slow on product launches despite already having 59 ANDA approvals. In 9MFY11, the company launched eight new products (FY11 target is 9-10) and filed for 11 ANDAs. Going forward, the company’s target will be 12-15 ANDA filings and seven to eight product launches every year in the US. We project CHL’s US sales will grow at a CAGR of ~28% to | 1397 crore between FY10 and 13E.

International formulation sales will grow strongly in FY10-13E (CAGR of 22% to | 2391 crore) driven by product launches in regulated and semi-regulated markets

Exhibit 13: International sales projected to grow at a CAGR of ~22% between FY10-13E driven by robust product pipeline

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Exhibit 14: US to remain dominant contributor of international revenues in FY10-13E

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US EU Japan Brazil EMs


Expansion of market share in existing products and product launches driving growth in the US

Exhibit 15: CHL has a strong product pipeline in the US FY08 FY09 FY10 9MFY11

ANDA filed 78 92 106 118

ANDA approvals 39 42 54 59

Products launched 16 25 29 39




Drugs worth US$ 90 billion losing patent between 2011 and 2016 The US by far will remain the most important market for Indian companies thanks to the sheer size of the market and the generic opportunities on account of the impending patent cliff. Between 2011 and 2016, drugs worth ~US$110 billion will lose marketing exclusivity worldwide. Of this, ~US$90 billion is in the US alone. Although price erosion and increase in competition will be a matter of concern, we believe Indian players, on account of vertically integrated model and proven capabilities and capacities, are best placed to fathom the price erosions among others. With close to 120 USFDA approved facilities (second only to US), Indian generic payers will be the major beneficiaries of the so-called impending patent cliff. We believe Indian generic players have already smelled the opportunity and we could see the expediting of ANDA filings in spite of delays for getting approvals from the USFDA. From big players like Ranbaxy and Sun to smaller players like Natco, all are preparing themselves for this opportunity. We are also seeing increasing first to file challenges by leading generic players over and above the normal Para IV filing, which will lead to growing out of court settlements given the high success ratio of Indian players (~70%). Exhibit 17: Impending Patent cliff

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Exhibit 16: US sales expected to grow at ~28% CAGR between FY10-13E

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EU market to support international business growth

Sales from the EU region accounted for ~6% of gross sales in 9MFY11. In the EU, the company operates in France (generic market size of €2.5 billion) and Spain (generic market size of €713 million). On a lower base, sales from the EU regions have grown at a CAGR of ~45% between FY06 and FY10. Till date, CHL has filed 102 new product applications, received approval for 42 products and launched 19 products.

Growing French business due to launch of new generic products…

CHL has a presence in the French generic market through its subsidiary Zydus France SAS. It is one of the top 10 generic companies in the French generic market and holds 2.7% market share. The overall French generic market has been valued at €2.5 billion in 2009, growing at ~15% per annum. This healthy growth is due to patent expiration of many blockbuster drugs like Pantoprazole, Clopidogrel, etc. In FY10, CHL launched 14 new molecules including eight day one launches.

Expansion in Spanish market

CHL entered the Spanish market in FY08 with the acquisition of Loboratorios Combix. The total Spanish generic market is valued at ~€713 million. Till date, CHL has launched 30 products in this market. Additionally, the company has filed for 22 new product dossiers in FY10, providing attractive growth opportunities. We believe CHL will ramp up the product filings and product launches, going forward, to tap this less penetrated market. We project that CHL’s EU sales will grow at a CAGR of ~10% to | 363 crore between FY10 and FY13E.

Large opportunities beckon in Japanese generic market

With a size of nearly US$80 billion, Japan is the second-largest pharma market globally. With the country’s rapidly aging population and spiralling healthcare costs, substantial opportunities exist for generic drug manufacturers. Currently, the Japanese generic market is worth US$3.5 billion (penetration still low).

In FY07, CHL acquired Nippon Universal Pharma Ltd (NUP) to foray into this high potential market. NUP has a manufacturing facility approved by the Japanese regulatory authority. The company plans to launch in-house products in Japan over the next five years. Right now, CHL is following a strategy of in-licensing of products and acquisition of brands. With 25 in-licensed products and one in-house product already launched in Japan (four added in FY10) and firm expansion plans, we believe CHL is well placed to capture incremental opportunities in Japan. We project sales in the Japanese market to grow at a CAGR of ~21% between FY10 and FY13E, albeit on a smaller base.

Exhibit 18: EU sales projected to grow at 10% CAGR in FY10-13E

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The Japanese market will provide good opportunities



Brazil expected to remain CHL’s single largest market outside developed markets

In Brazil, CHL operates in both branded and unbranded segments (total market size of US$15 billion). So far, the company has filed for 60 dossiers for branded and generic products and has a portfolio of 25 branded and 14 generic products. With the strong growth prospects in the Brazilian market and plans to launch 8-10 products annually, we project CHL’s sales in Brazil to grow at a CAGR of~20% to | 316 crore between FY10 and FY13E.

Other EMs, primarily South Africa, to add to revenues

CHL has a presence in over 20 other emerging pharma markets like Sri Lanka, Myanmar, Uganda, Taiwan, Philippines and South Africa. As a leading player in some of these markets, CHL has enjoyed strong growth in revenues at a CAGR of ~17% to | 159 crore between FY06 and FY10. (4.4% share in gross sales).

In FY10, as the company dedicated its manufacturing facility at Moraiya to developed markets, supplies to EMs declined ~9%. With the establishment of a dedicated manufacturing facility in Goa to address requirements of EMs (expected to commence operations in FY12), we believe supply constraints will not be a major issue, going forward. So far, it has filed 68 products with SA MCC (South African Agency) and received approval for 28 products and launched 20 products. With a strong focus on the South African pharmaceutical market (Africa’s largest and only regulated market), CHL made Simayla Pharmaceuticals a wholly-owned subsidiary in FY10 (70% stake acquired in FY09). Leveraging Simayla’s marketing capabilities, CHL will develop a strong product pipeline from India to capture the demand for generic drugs in South Africa. We expect sales from emerging markets to grow at a CAGR of ~18% to | 259 crore between FY10 and FY13E.

Supply-side constraints no longer expected to remain an issue with the new plant in Goa dedicated for EMs

Exhibit 19: New product launches and growing generic market to drive CHL’s sales growth in Brazil (CAGR 20% between FY10-13E)

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Exhibit 20: EMs unlikely to be plagued with capacity constraints driving EM sales at 18% CAGR in FY10-13E

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Mixed growth tractions from the JVs

Zydus Hospira JV – Provides an entry into high-margin oncology injectable segment

In FY09, Zydus Hospira, a 50:50 JV between CHL and the US-based Hospira, Inc. commenced commercial operations (supplying oncology injectables in Europe). Through the JV, CHL plans to manufacture six oncology products in its Cytotoxic facility in Ahmedabad. Out of the six products, the JV has already begun supply of three products to Hospira to be marketed in the EU. With the USFDA and Health Canada approving the oncology products facility in FY10, the JV also commenced initial shipments to the US market during Q3FY11. Additionally, the management has indicated plans to launch the remaining products in FY12E. This will result in full capacity utilisation of the manufacturing facility by FY12E.

We believe this foray into the oncology space through the JV augurs well due to following reasons:

− A substantially large opportunity exists due to the huge size of the global oncology injectables market (US$21 billion in 2009 as per IMS Health)

− With oncology drugs worth US$9 billion expected to lose patent protection by 2015, the scale of opportunity becomes even larger

− Limited competition exists due to the high entry barriers and stringent regulatory requirements for oncology products

On a small base, we expect sales from this JV (CHL’s share) to grow at a CAGR of ~37% to | 218 crore between FY10 and FY13E.

Nycomed JV – Growth to revive following expansion of scope

CHL has formed a JV with Swiss pharma major, Nycomed in 1999 to manufacture active ingredients for API Pantoprazole, which is an anti-ulcerants sold under the brand name Protonix by Pfizer. However, the JV began losing its market strength following the genericisation of the drug. Even after some restriction for generic version from June 30, 2010, the drug will lose exclusivity in the current year. Consequently, CHL’s share in the JV’ sales dipped by 24% in FY10 to | 76 crore (as against almost ~50% rise in FY09).

Although the growing competition in the Pantoprazole market provides a grim outlook, recent developments indicate hopes for revival.

− The scope of the JV expanded to supply intermediates for 14 additional APIs (including Pantoprazole) for both generic and patented drugs. Of this, the JV will supply eight APIs while the balance six APIs will be supplied by CHL

− Nycomed is shifting its entire API production to India

o Commercial production of three APIs (Pantoprazole, Urapidil and Lornoxicam) will begin by Q4FY11

o There are plans to expand the portfolio by adding another 11 APIs by Q1FY12

We expect sales from APIs to pick up slowly. We expect CHL’s share in the Nycomed JV sales to de-grow at a CAGR of ~6% between FY10 and FY13E.

The JV with Hospira allows CHL to exploit the large opportunities in the high-margin oncology injectable market

Revenues from the expanded JV expected to start flowing in from Q1FY12E onwards



Abbott alliance – Opens attractive opportunities in EMs

In Q1FY11, CHL entered into a strategic alliance with global pharma company Abbott Laboratories. As a part of this alliance, CHL will manufacture 24 branded generic drugs under the Abbott brand name, which the latter will sell in 15 EMs where it has a strong presence (including Brazil, Russia, Turkey, etc). Abbott has the option to increase the scope of the agreement to 40 drugs. This alliance presents attractive growth opportunities for CHL given the potential for growth in the EMs. In Q1FY11, as part of the agreement, CHL received licensing fee of | 47 crore from Abbott. We expect sales to start from this deal in FY13.

Exhibit 21: JVs with international players show mixed results

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30

40

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11

( | c

rore

)

Nycomed JV Hospira JV




Presence in consumer wellness segment through Zydus Wellness

Well positioned in this high growth segment

Through its listed subsidiary, Zydus Wellness Ltd (72% holding), CHL has a presence in the fast-growing Indian consumer wellness market. With increasing focus of Indian consumers towards health and wellness, rising income levels and greater product awareness, the Indian consumer healthcare market holds good potential for growth. CHL owns good distribution network with a team of ~500 sales personnel. CHL’s product portfolio includes the following products-

− Sugar Free: With ~80% market share, Sugar Free is India’s largest selling sugar substitute. The product has witnessed robust sales growth (~25% CAGR between FY07 and FY10) driven by the increased health consciousness and good ad campaign.

− EverYuth: Enjoys leadership position in the domestic peel-offs (~90% market share), scrubs (~65%) and face wash (~14%) categories with sales growing at ~35% CAGR between FY07 and FY10. In FY10, a new product ‘Menz’ was launched, creating a new category (skin cream for men).

− Nutralite: India’s largest selling margarine butter (sales growing at ~25% CAGR in FY07-10).

In-house production to improve competitive positioning

CHL has recently set up a manufacturing facility in Sikkim for ‘Sugar Free’ and ‘EverYuth’ (currently being outsourced). We expect this to make CHL better placed to meet the growing market demand and improve its competitive positioning. CHL is planning sales of | 500 crore by FY13E from the consumer wellness segment. We believe the company is on track to achieve the target given the robust demand for the company’s products and strong brand loyalty. We expect the sales of the segment to grow at a CAGR of ~21% to | 477 crore between FY10 and FY13E.

Strong market position and brand equity enjoyed by CHL in the consumer wellness segment.

Exhibit 22: Robust sales growth in FY07-10 of three products sold by CHL in consumer wellness segment

50 67 78 1072931

5069

4356

67

92

0

75

150

225

300

FY07 FY08 FY09 FY10

( | c

rore

)

Sugar Free EverYuth NutraLite


Exhibit 23: Sales to grow at CAGR of ~21% between FY10-FY13E

65122

154195

268

337

405

477

0

125

250

375

500


( | c

rore

)




R&D activities undertaken across segments Majority of R&D focused on generic drug development…

During FY06-10, CHL’s R&D spend (percentage of sales) has been in the range of 5-6%. With ~950 member strong R&D team, the company undertakes R&D activities in generics formulations (ANDAs), new molecular entities (NMEs), novel drug delivery systems (NDDS) and biologics. CHL has a pipeline of 15 biosimilars, which are officially-approved subsequent versions of innovator biopharmaceutical products. The research pipeline is in various stages of development. Apart from Biosimilars, it is also developing two novel products. In FY10, CHL commissioned a manufacturing facility near Ahmedabad, which is catering to the global biosimilars business.

NME pipeline still in initial development phase

According to the company, CHL’s long-term aim is to launch novel discovery products from its new molecular entity (NME) pipeline. At present, the company has 12 molecules in various stages of development in its NME portfolio (focused on dyslipidemia, diabetes, obesity and inflammation). Of these, only one molecule (ZYH1 – dyslipidemia) is in the Phase-III development stage while one more molecule (ZYI1 – pain) is in Phase-II development stage. Given the current scenario, we believe CHL has a long way to go to really monetise the R&D pipeline.

Exhibit 24: R&D expenditure break-up in FY10 (| Crore)

APIs & Others, 26.8

Generics, 120.9

NMEs & Drug Discovery, 59.8


Exhibit 25: while 42% of 950-member R&D team focus on generics

NMEs & Drug Discovery

37%

Generics42%

APIs & Others21%


Exhibit 26: Large portion of NME pipeline in initial stages of R&D NMEs Indication R&D Stage

ZYH1 Dyslipidemia Phase III

ZYI1 Pain management Phase II

ZY01 Obesity, Diabetes Phase I

ZYH7 Dyslipidemia Phase I

ZYH2 Diabetes Phase I

ZYT1 Dyslipidemia Phase I

ZYD1 Diabetes Pre-clinical

ZYOG1 Diabetes; Atherosclerotic Plaque Pre-clinical

Collaborative Program (Karo Bio) Inflammation Discovery

Collaborative Program (Eli Lilly) CVS Discovery




Assumptions – Revenues

We expect international revenues to continue to grow faster than domestic revenues between FY10 and FY13E (~22% CAGR vs. ~17% CAGR for domestic revenues). Growth of international revenues will be driven by higher revenues from regulated markets (US, France and Japan) and semi-regulated markets. This will lead to share of international revenues rising to ~51% by FY13E (vs. 48% in FY10). Additionally, we have built ~17% CAGR of domestic formulations revenues in FY10-13E.

Exhibit 27: Assumptions – Segment-wise gross sales

(|crore) FY08 FY09 FY10 FY11E FY12E FY13ECAGR (FY10-

13E)

Domestic formulations 1,176 1,289 1,446 1,696 1,989 2,321 17.1

YoY (%) 11.0 9.6 12.2 17.3 17.2 16.7

API and Intermediates 51 43 32 30 31 32 -0.2

YoY (%) 34.2 -16.0 -25.4 -4.6 2.0 2.0

Consumer wellness 154 195 268 337 405 477 21.3

YoY (%) 26.1 26.5 37.4 26.0 20.0 18.0

Animal health business 103 117 127 144 158 171 10.3

YoY (%) 107.0 14.2 8.5 12.8 10.0 8.0

Total Domestic 1,489 1,644 1,872 2,208 2,582 3,000 17.0

YoY (%) 17.3 10.4 13.9 17.9 17.0 16.2

Export formulations 642 968 1,318 1,660 2,021 2,391 22.0

YoY (%) 70.2 50.8 36.2 25.9 21.8 18.4

API and Intermediates 162 206 264 325 358 393 14.2

YoY (%) 12.0 27.3 28.2 23.0 10.0 10.0

Alliances 67 100 160 177 227 380 33.5

YoY (%) -20.2 49.6 59.9 11.0 28.3 67.0

Total International 875 1,274 1,742 2,162 2,606 3,164 22.0

YoY (%) 44.6 45.5 36.8 24.1 20.5 21.4




Risks and concerns Lower revenues from regulatory non-compliance

Regulated markets (US, France and Japan) accounted for ~27% of CHL’s gross sales in 9MFY11. With high share of generic revenues for CHL in regulated markets, non-compliance with regulatory guidelines is a major risk faced by the company. In the last three years, the USFDA has issued warnings to some Indian companies (Ranbaxy, Sun Pharma, Lupin, Claris, etc) w.r.t. compliance issues in their manufacturing facilities.

Delays in approvals could result in lower revenues

CHL’s growth was primarily driven by its new product launches in different geographies. Hence, the company is largely dependent on approvals from various regulatory agencies (USFDA, EMA, ANVISA, etc) to meet its growth targets. Any unanticipated delays in approvals could result in lower-than-expected revenues for CHL.

Appreciation of rupee may result in lower earnings

The international segment accounted for ~48% of the company’s gross sales in 9MFY11. With the strong focus on the international segment, we expect its contribution to further rise. Significant appreciation of the rupee vis-à-vis the US dollar and euro can put pressure on margins.

Loss of revenue due to attrition in sales force

Pharma Industry faces high attrition levels among the Medical Representatives (MRs) which could disrupt the smooth functioning of the company’s sales practices, leading to a loss of customers and sales and also increase in the cost of recruitment and training.



Financials Revenues to grow at a CAGR of 19% in FY10-13E With the robust growth expected from exports, we project that CHL’s total revenues will grow at a CAGR of ~19% to | 6267 crore between FY10 and FY13E. Consequently, we project the share of international sales in gross sales will increase to 52% in FY13E (vs. 48% in FY10). Topline growth will be supported by steady growth of domestic formulation sales (CAGR ~17% between FY10 and FY13E) driven by new product launches, focus on chronic products and higher penetration.

EBITDA margins likely to expand in FY11E-13E… We expect the company’s EBITDA margins to expand from 22.6% in FY10 to 23.9% in FY13E, driven by incremental product launches and optimal use of APIs. We project EBITDA will grow at a CAGR of 22% to | 1451 crore between FY10 and FY13E.

Exhibit 28: Total revenue projected to grow at 19% CAGR in FY10-13E

1,4811,855

2,3232,928

3,6874,421

5,274

6,267

0

1,500

3,000

4,500

6,000

7,500


( | c

rore

)


Exhibit 29: EBITDA margins expected to expand slightly

19.621.2

20.221.2

22.6 22.823.6 23.9

0

300

600

900

1,200

1,500


( | c

rore

)

14.0

18.0

22.0

26.0

(%)

EBITDA EBITDA margin (RHS)




Higher return ratios to sustain With improved profitability and incremental asset-turnover ratio, we estimate CHL will continue to generate high return ratios between FY10 and FY13E. RoCE is projected to increase ~610 bps in FY10-13E to 31.9%.

Exhibit 30: RoCE expected to improve to 31.9% in FY13E

19.524.0 22.4 22.4

25.828.7

30.9 31.923.6

30.927.2 26.4

37.0 37.034.0 32.5

10

19

28

36

45


(%)

RoCE RoNW




Valuations At | 834, the stock is trading at 21.1x FY12E EPS of | 39.6 and 17.0x FY13E EPS of | 49.2. Being pedigreed, the company’s business model is time tested with a sound mix of domestic and international portfolios. It has consistently exceeded its own targets and also rewarded shareholders with two bonus issues in the last five years. The JVs and deals with leading MNCs have further vindicated the capabilities of the company. We expect the valuation gap between top 4 pharma players and CHL to come down from ~20-25% to ~10% on account of incremental product offerings in multiple markets and strong balance sheet. Consequently, we have valued CHL at | 885, i.e. 18x FY13E EPS of | 49.2.

We have valued CHL at | 885 per share at a FY13E P/E of 18x

Exhibit 31: P/E band chart

0

225

450

675

900

Mar

-04

Sep-

04

Mar

-05

Sep-

05

Mar

-06

Sep-

06

Mar

-07

Sep-

07

Mar

-08

Sep-

08

Mar

-09

Sep-

09

Mar

-10

Sep-

10

(|)

Price 14.9x 21.0x 8.8x


Exhibit 32: EV/EBITDA band chart

0

4,000

8,000

12,000

16,000

20,000

Mar

-04

Sep-

04

Mar

-05

Sep-

05

Mar

-06

Sep-

06

Mar

-07

Sep-

07

Mar

-08

Sep-

08

Mar

-09

Sep-

09

Mar

-10

Sep-

10

(| c

rore

)

EV 10.1x 14.1x 6.0x


Exhibit 33: Peer valuation (FY12) M Cap (| cr) EV/Sales EV/E P/BV Base PE RoCE RoNW

Cadila Healthcare 17,068 3.4 14.4 6.0 21.1 30.9 34.0

Lupin 20,596 3.0 14.9 7.0 18.8 25.4 25.8

Dr Reddy's 28,098 3.0 13.0 4.5 22.1 25.7 17.5

Sun Pharma 50,361 6.8 19.5 4.6 24.8 18.9 18.5




Exhibit 34: Profit & loss account | Crore FY08 FY09 FY10 FY11E FY12E FY13ETotal Revenues 2,323 2,928 3,687 4,421 5,274 6,267Growth (%) 25.2 26.0 25.9 19.9 19.3 18.8Op. Expenditure 1,865 2,322 2,878 3,439 4,068 4,816EBITDA 458 606 809 982 1,206 1,451Growth (%) 21.2 32.2 33.5 21.4 22.8 20.4Depreciation 97 112 134 128 142 162EBIT 361 494 675 854 1,063 1,289Interest 52 98 81 80 84 70Other Income 21 -2 15 7 23 27Extraordinary Item -7 -24 -5 47 0 0PBT 323 370 604 828 1,002 1,246Growth (%) 18.1 14.3 63.3 37.0 21.1 24.3Tax 61 67 74 123 150 187Rep. PAT before MI 262 303 530 704 852 1,059Minority Interest (MI) 5 0 25 26 43 53Rep. PAT after MI 258 303 505 679 809 1,006Adjustments -7 -24 -5 47 0 0Adj. Net Profit 263 323 509 639 809 1,006Growth (%) 12.6 22.7 57.7 25.5 26.7 24.3


Exhibit 35: Balance sheet | Crore FY08 FY09 FY10 FY11E FY12E FY13EEquity Capital 63 68 68 102 102 102Reserves & Surplus 999 1,167 1,560 2,073 2,741 3,571Shareholder's Fund 1,062 1,235 1,629 2,175 2,843 3,673Secured Loans 633 1,036 944 904 784 704Unsecured Loans 205 232 146 146 34 34Minority Interest 19 23 39 66 108 161Deferred Tax Liability 123 132 114 114 114 114Source of Funds 2,043 2,657 2,872 3,405 3,883 4,686Gross Block 1,164 1,314 1,568 1,872 2,222 2,597Less: Acc. Depreciation 335 389 465 552 654 777Net Block 829 926 1,103 1,320 1,568 1,820Capital WIP 140 189 248 294 319 244Net Fixed Assets 969 1,115 1,351 1,615 1,887 2,065Intangible Assets 432 604 582 542 503 463Investments 25 25 21 21 21 21Cash 93 252 251 410 567 735Trade Receivables 356 455 467 558 662 943Loans & Advances 201 253 307 346 409 486Inventory 473 601 750 725 773 1,019Total Current Asset 1,122 1,561 1,775 2,039 2,410 3,183Current Liab. & Prov. 505 692 866 807 933 1,041Net Current Asset 617 870 909 1,232 1,477 2,142FCMTDA* 0 44 10 -3 -3 -3Application of Funds 2,043 2,657 2,872 3,405 3,883 4,687

* Foreign currency Monetary items translation difference account Source: Company, ICICIdirect.com Research



Exhibit 36: Cash flow statement | Crore FY08 FY09 FY10 FY11E FY12E FY13ENet Profit before Tax 323 370 604 828 1,002 1,246Other Non Cash Exp 0 0 0 0 0 0Depreciation 97 112 134 128 142 162Direct Tax Paid 52 58 92 123 150 187Other Non Cash Inc 2 4 4 15 23 27Other Items 44 37 102 94 84 70CF before change in WC 410 457 744 910 1,055 1,264Inc./Dec. In WC -181 -93 -40 -164 -88 -497CF from Operations 229 364 704 747 967 767Pur. of Fix Assets -577 -424 -330 -350 -375 -300Pur. of Inv 1 1 4 0 0 0CF from Investing -566 -403 -310 -335 -352 -273Inc./(Dec.) in Debt 384 430 -177 -40 -232 -80Inc./(Dec.) in Sh.cap 0 -208 0 0 0 0Others -125 -177 -205 -213 -225 -246CF from Financing 259 45 -381 -253 -458 -326Cash generated during year -71 29 17 159 157 169Opening Cash Balance 99 93 252 251 410 567Closing Cash Balance 93 252 251 410 567 735

Y-o-Y Growth (%) FY08 FY09 FY10 FY11E FY12E FY13ETotal Revenues 25.2 26.0 25.9 19.9 19.3 18.8EBITDA 21.2 32.2 33.5 21.4 22.8 20.4Adj. Net Profit 12.6 22.7 57.7 25.5 26.7 24.3Cash EPS 10.2 7.4 60.2 25.1 19.3 22.8Net Worth 22.7 16.3 31.8 33.6 30.7 29.2


Exhibit 37: Key ratios

(%)FY08 FY09 FY10 FY11E FY12E FY13E

Raw Material 34.9 33.4 33.0 31.7 32.4 32.4Employee Expenditure 12.1 12.2 12.1 12.3 12.2 12.4Effective Tax Rate 19.0 18.0 12.3 14.9 15.0 15.0

Profitability Ratios (%)EBITDA Margin 20.2 21.2 22.6 22.8 23.6 23.9PAT Margin 11.6 10.6 14.8 16.3 16.6 17.4

Per Share Data (Rs)Revenue per share 123.3 143.1 180.2 216.0 257.7 306.2Book Value 56.4 60.4 79.6 106.3 138.9 179.5Cash per share 4.9 12.3 12.3 20.0 27.7 35.9EPS 14.0 15.8 24.9 31.2 39.6 49.2Cash EPS 19.1 20.5 32.8 41.0 49.0 60.1DPS 3.0 3.0 5.0 5.4 5.7 7.1




Exhibit 38: Key ratios

(%)Return Ratios FY08 FY09 FY10 FY11E FY12E FY13ERoNW 27.2 26.4 37.0 37.0 34.0 32.5ROCE 22.4 22.4 25.8 28.7 30.9 31.9ROIC 9.7 8.9 14.0 16.9 18.2 18.8Financial Health Ratio Operating CF (Rs Cr) 229 364 704 747 967 767FCF (Rs Cr) -361 22 364 345 592 467Cap. Emp. (Rs Cr) 1,900 2,503 2,719 3,225 3,661 4,411Debt to Equity (x) 0.8 1.0 0.7 0.5 0.3 0.2Debt to Cap. Emp. (x) 0.4 0.5 0.4 0.3 0.2 0.2Interest Coverage (x) 6.9 5.1 8.3 10.6 12.7 18.4Debt to EBITDA (x) 1.8 2.1 1.3 1.1 0.7 0.5DuPont Ratio Analysis PAT/PBT 81.0 82.0 87.7 85.1 85.0 85.0PBT/EBIT 89.5 74.9 89.5 96.9 94.3 96.7EBIT/Net Sales 15.9 17.3 18.9 19.8 20.8 21.2Net Sales/Total Asset 1.3 1.2 1.3 1.37 1.40 1.42Total Asset/NW 1.9 2.2 1.8 1.6 1.4 1.3

(x times)Working Capital FY08 FY09 FY10 FY11E FY12E FY13EWorking Cap./Revenues (%) 26.6 29.7 24.7 27.9 28.0 34.2Inventory turnover 69.5 68.5 69.0 62.4 53.4 53.8Debtor turnover 51.1 51.7 47.1 43.4 43.5 48.1Creditor turnover 60.3 56.7 58.2 54.9 53.2 51.8Current Ratio 2.2 2.3 2.0 2.5 2.6 3.1

(| crore)FCF Calculation FY08 FY09 FY10 FY11E FY12E FY13EEBITDA 458 606 809 982 1,206 1,451Less: Tax 61 67 74 123 150 187NOPLAT 397 539 735 859 1,055 1,264Capex -577 -424 -330 -350 -375 -300Change in working cap. -181 -93 -40 -164 -88 -497FCF -361 22 364 345 592 467

(x times)Valuation FY08 FY09 FY10 FY11E FY12E FY13EPE (x) 59.7 52.9 33.5 26.7 21.1 17.0EV/EBITDA (x) 38.9 29.9 22.1 18.0 14.4 11.8EV/Sales (x) 7.7 6.2 4.9 4.0 3.3 2.7Dividend Yield (%) 0.4 0.4 0.6 0.6 0.7 0.9Price/BV (x) 14.8 13.8 10.5 7.8 6.0 4.6




RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Add, Reduce and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: 20% or more; Buy: Between 10% and 20%; Add: Up to 10%; Reduce: Up to -10% Sell: -10% or more;

Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 7th Floor, Akruti Centre Point, MIDC Main Road, Marol Naka, Andheri (East) Mumbai – 400 093

[email protected]

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