Meeta Shetty, CFA Pharmaceutical Sector …Pharmaceutical Sector SECTOR REPORT JANUARY 27, 2015...

Pharmaceutical Sector

SECTOR REPORTJANUARY 27, 2015

PRIVATE CLIENT RESEARCH

Meeta Shetty, [email protected]+91 22 6621 6309

We initiate coverage on the Indian Pharmaceutical (pharma) sector with anOverweight stance led by strong growth prospects and supporting macroparameters. Amongst our coverage universe, we like companies with resil-ient domestic formulations growth, differentiated therapy focus and inter-esting product pipelines (Para IVs + complex products) for US markets. Ourtop picks are Lupin, Cadila and Torrent Pharma.

Over the last 5-6 years Pharma stocks have been on a steady rise driven byimpressive growth, rock steady cash flows and increasing return ratios. Inspite of >3x rise in the BSE Healthcare Index over the last five years, weremain buoyant on the growth prospects of the Indian pharma companiesdriven by strong growth drivers (1) Growing domestic formulations mar-ket (2) Immense opportunity in US generics market (3) Niche product pipe-line of select companies (4) Opportunities in newer geographies like Ja-pan.

Domestic market (Indian Pharma Market)still of paramount importanceThe IPM (Indian Pharma Market) has witnessed a steady CAGR of 11% over2000-2013 driven by improving affordability, better health awareness, higherpenetration of healthcare facilities and worsening lifestyles. Going ahead too,IPM will remain the primary market for Indian pharma companies given (1) thestrong growth drivers, (2) higher profitability (average EBIDTA margins for do-mestic segment - large caps/midcaps - 25%/15-18%) of drugs sold in India and(3) resilient growth for established brands

Exports to remain the focus - Indian pharma companies entered into exportmarkets way back in 1990's with India's adoption of liberal economic policies.Pharma exports from India posted a CAGR of 25% over 1990-2013 and stoodat ~Rs 900 bn in 2013. Today every 3rd pill in the world is from India. As perPharmexcil (Pharmaceuticals Export Promotion Council of India), Indianpharma exports are expected to grow by nearly 20% CAGR to $41 billion by2020 from $14.7 billion in 2013, with US being the primary export market.

US - still a game changer - US pharma market has been a game changer formost of the large/mid cap pharma companies purely due to huge opportunitiesand higher profitability. At the market size of US$ 392bn US accounts for~40% of the world pharma market (US$980 bn). India has showcased its ca-pabilities on manufacturing and research over the last ~25 years. Today Indiancompanies account for 40% of the generic drugs in US (in volume terms). With~175 USFDA approved plants (second highest after US) and ~40% share intotal ANDA filings every year, Indian will continue to derive stupendous growthfrom the US pharma market.

In this report, we take a deep dive into the pharma sector from a global as wellIndian perspective. We look at the outlook and opportunities going ahead beforenarrowing down to our coverage companies.

Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been pre-pared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views,estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited.

Companies covered

Cadila Healthcare BUY

Cipla REDUCE

Dr Reddy Lab ACCUMULATE

Lupin BUY

Sun Pharma ACCUMULATE

Torrent Pharma BUY

xxx

RecommendationCompany Reco CMP TP MCap EPS (Rs) PE (x) RoE (%) EV/EBITDA (x)

(Rs) (Rs) (Rs mn) FY16E FY17E FY16E FY17E FY16E FY17E FY16E FY17E

Cadila Hc BUY 1647 1964 337,821 68.8 85.4 24.0 19.3 26.2 25.4 15.5 12.4

Cipla REDUCE 678 684 518,580 24.2 30.9 28.0 22.0 16.0 17.6 15.9 12.6

Dr Reddy’s ACCUMULATE 3349 3662 548,044 155.9 174.4 21.5 19.2 24.7 22.7 13.0 11.3

Lupin BUY 1490 1775 648,948 63.3 73.9 23.5 20.2 27.6 25.6 12.7 10.5

Sun ACCUMULATE 927 1026 1,739,808 35.3 39.8 26.2 23.3 25.5 22.7 16.7 14.5

Torrent BUY 1143 1385 196,272 54.6 69.2 20.9 16.5 27.6 25.6 13.9 11.3

Source: Kotak Securities - Private Client Research

Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2

SECTOR REPORT January 27, 2015

0

25

50

75

100

% Public Insurance% Other private insurance% Out of pocket

India's out of pocket expenditure on healthcare - 90%

Source : WHO, Kotak Private Research

GLOBAL PHARMA MARKET – OUTLOOK AHEAD

Pharmaceuticals market plays a vital role in an economy as well as ensuringwelfare of the citizens. The global pharma market stood at US$ 980 bn in 2013 (asper Statista 2014) and has grown at ~8% CAGR over 2001-13. US is the largestpharma market at ~US$392 bn or ~40% contribution followed by Europe (EUcountries) at ~US$ 265 bn or ~27% contribution and Japan at ~US$115 or 11.7%contribution. The Indian Pharma Market (IPM) stood at US$ 13.0 bn or at a mere1.3% contribution to the global pharma market. Though the IPM is ranked 12th

globally in value terms, it is the third largest in volume terms (due to lower pricingof drugs).

Indian Pharma Market (IPM) ranks 12th globally

Source: Industry, Kotak Securities - Private Client Research

Pharmerging markets to witnesses high CAGR

Top 13 markets Country 2013-17 CAGR

1 US 1–4%

2 Japan 2-5%

3 China 14-17%

4 Germany 1-4%

5 France (-2)–1%

6 Brazil 11-14%

7 Italy 0-3%

8 U.K. 1-4%

9 Canada 1-4%

1 0 Spain (-4)-(-1)%

1 1 Russia 8-11%

1 2 India 11-14%

1 3 South Korea 3-6%


Japan, US and EU countries to witnesses higher genericisation


392

11582

42 37 29 26 24 22 20 17 13 11

0

100

200

300

400US$ bn

Emerging markets constitutes~45% of the world population

but only 10% of the pharmasales



INDIAN PHARMACEUTICALS OVERVIEW

The pharmaceutical market for India constitutes domestic (IPM - Indian PharmaMarket) and exports markets. The IPM which stood at US$13.0bn in 2013, haswitnessed a steady CAGR ~11% over 2000-2013 driven by improving affordability,better health awareness, higher penetration of healthcare facilities and worseninglifestyles. The Indian pharma exports kick started when companies entered theglobal markets way back in 1990's (post India's adoption of liberal economicpolicies). Pharma exports from India posted a CAGR of 25% over 1990-2013 andstood at ~Rs 900 bn or US$ 14.7bn in 2013. Today every 3rd pill in the world ismanufactured in India. As per Pharmexcil (Pharmaceuticals Export PromotionCouncil of India), both the domestic as well exports are expected to grow at >16%CAGR from US$ 14.7/13.0bn to US$41/45bn over 2013-2020.

Domestic as well exports expected to post >16% CAGR

Source : Pharmaexil, Kotak Securities - Private Client Research

Indian pharma market has grown at 11% CAGR over 2000-2013


Indian Pharma exports have grown at 14% CAGR over FY09-13


USA is the largest export market for Indian companies

Rank Country FY13 US$ bn Gr % Cont %

1 USA 3.75 29.33 25.49

2 RUSSIA 0.57 57.28 3.89

3 UK 0.52 18.32 3.51

4 GERMANY 0.47 13.77 3.18

5 S. AFRICA 0.44 30.5 3.02

6 NIGERIA 0.34 24.59 2.34

7 BRAZIL 0.33 32.67 2.23

8 CANADA 0.28 23.8 1.93

9 KENYA 0.25 24.47 1.73

10 NETHERLANDS 0.25 22.69 1.71

11 VIETNAM 0.20 23.34 1.38

12 TURKEY 0.20 22.79 1.35

13 AUSTRALIA 0.19 22.77 1.28

14 SINGAPORE 0.19 25.15 1.28

15 GHANA 0.19 41.54 1.27


The IPM as well as exports provide immense opportunities for Indian companiesgiven the stellar growth expected over the next 6-7 years. In this report we wouldfocus mainly on two key markets for Indian companies – (1) Domestic and (2) theUS. We would take a deep dive in the current market dynamics, growth drivers andoverhangs of each market.

3.3 3.65 3.95 4.15 4.355.0

5.76.55

7.28.3

9.3

11.012.0

13

0

2

4

6

8

10

12

14

US$ bn

13.0

4514.7

41

0

20

40

60

80

100

2013 2020

US$ bn Domestic Exports

0

4

8

12

16

FY09 FY10 FY11 FY12 FY13

US$ bn

Domestic as well exports areexpected to grow at >16% CAGRfrom US$ 14.6/13.0bn to US$41/

45bn over 2013-2020



Domestic market (Indian Pharma Market) still ofparamount importanceThe IPM is largely a branded generic market wherein drugs are sold by brandnames, unlike in US and other developed markets, where drugs are sold by generic(chemical) name. The Indian market comprises of over 5000 pharma companies,22,000 stockist/distributors and over 600,000 retailers (chemist shops). IPM haswitnessed a steady CAGR 11% over 2000-2013 driven by improving affordability,better health awareness, higher penetration of healthcare facilities and worseninglifestyles.

IPM CAGR has improved in last 6 years

Source : Industry, Kotak Securities - Private Client Research

IPM – Skewed towards Acute therapies

The Indian market is largely an acute therapy market with ~70% contribution fromthat segment. Acute drugs are those medications which are prescribed by doctorsfor only 3-6 weeks. Large global markets comparatively are more chornic in naturewith ~60% contribution. Chronic drugs are medications which are taken for alonger period, for e.g. medication for diabetes, blood pressure, oncology andcholesterol. From the company's perspective, better share in chronic therapies leadto higher growth.

Domestic market – Therapeutic Break-up % ( Nov-2014)

% %

Anti-infectives 14.6 Vaccines 1.90

CVS 11.5 Ophthal 1.90

Gastro 10.5 Hormones 1.80

Pain 8.1 Blood related 1.10

Respiratory 8.0 Liver ailments 1.00

Vitamins 7.8 Anti-malaria 0.60

Anti-Diabetic 7.6 Stomatologicals 0.60

Derma 6.3 Sex stimulants/rejuvenators 0.50

Neuro/CNS 6.0 HIV 0.40

Gynaec 5.6 Others 4.2

Source : Industry, Kotak Private Research, bold indicates chronic therapies

0

2

4

6

8

10

12

14

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US$ bn

IPM has witnessed a steadyCAGR 11% over 2000-2013

driven by improving affordability,better health awareness, higher

penetration of healthcarefacilities and worsening lifestyles



IPM – competitive dynamicsThe Indian pharma market is very fragmented with top 10 players contributing~40% the market and top 25 companies accounting for ~70% of the market. Thelargest player as of 2014 is Abbott with 6.03% market share. The IPM in 1970'swas dominated by MNC's with hardly few Indian companies in top 25. However,when the Indian Patent Act changed from product patent to process patent, Indiancompanies emerged by manufacturing copycat drugs. By early 2000, there wereabout 20 Indian companies in top 25. In 2005, the Patent Act re-established productpatent, a patent law that was in line with the WTO mandate. Post the productpatent implementation no Indian companies could launch new (patented) productsand MNC's entered the Indian markets once again with their patented molecules/drugs. Moreover, after Abbott-Piramal and Ranbaxy-Daiichi takeover, top 3 out oftop 5 companies in IPM were MNC's. By 2015 (assuming Sun-Ranbaxy merger iscompleted) Sun will become the largest player in the market with ~8.5% marketshare and top 4 out of top 5 companies will be of Indian origin.

Top 10 companies hold ~40% of market share in the IPM as of Sep-2014

Source : AIOCD, Kotak Securities - Private Client Research

Sales force additions 2008 to 2014

Source : Industry, Company, Kotak Private Client Research, *Alembic Pharma 2010 data (2008unavailable)

The IPM growth over the years has been largely driven by volume growth (60%+contribution) whereas new launches have contributed ~30% of growth, while theremaining has been by price increases. The price sensitive nature of IPM as well ashigh competition have restricted price increase. Hence for companies to sustaingrowth and improve profitability, the focus on improving the productivity andlaunching niche products in the IPM is key. Companies have not only increased thefield force (or MRs - Medical Representatives) over the years but have also focusedon increasing the productivity per MR (MR productivity is measure as Rs mn earnedby per MR/per year).

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

(%)

Sun will become the largestplayer in the market with ~8.5%market share post Sun-Ranbaxy

merger

0

2000

4000

6000

80002014 2008

MRs

Volume growth, increasedpenetration have driven IPM

growth



Sun has the highest MR productivity per MR

Source : Industry, Company, Kotak Securities - Private Client Research

Sun leads its peers on the MR productivity due to its chronic focused portfolio aswell as branding capabilities. Having a chronic presence in itself does not lead tohigher MR productivity as is visible in lower MR productivity of Torrent (2.2x – 66%Chronic) and Unichem (~1.8x – 60% Chronic). Product basket/selection andbranding skills are the key drivers for attaining higher productivity.



IPM - Growth drivers

(1) Improving per capita spend to drive growth

India's spend on drugs is amongst the lowest compared to top 15 pharma markets.The per capita spend has been around US$60-64 pa (between 2010 and 2014) asper world bank. As the per capita income continues to grow (10.4% in FY13-14)led by good economic growth, disposable incomes are likely to go up and the percapita spend on drugs is set to increase. Although we do not expect spending toswell up to >US$100 pa immediately, but we foresee a steady 13-14% CAGR overthe next five years.

India’s per capita spend on drugs lower at US$61

Source : World bank

(2) Changing disease profile – to drive IPM

Though the IPM is currently an acute market, the shift towards chronic has beenswift. With changing lifestyles the occurrence of chronic ailments has increased overthe years. The chronic segment contributed ~23% in 2005 at ~US$ 1.15bn.Whereas as of 2013 the chronic market stood at US$ 3.9bn contributing ~30% tothe IPM, a CAGR of 16.5%. The chronic segment is expected to register 16-18%growth compared to single digit growth in the acute segment over the comingyears.

Chronic – Acute split in the IPM


Core focus of companies over the years has been to enhance the chronic productbasket as well increase penetration through recruiting field force. The most chronicfocused companies in the IPM include, Torrent Pharma, Sun, Lupin and Unichem(all more than 60% contribution from chronic).

77 76 76 75 74 73 72 71 70

23 24 24 25 26 27 28 29 30

0

25

50

75

100

2005 2006 2007 2008 2009 2010 2011 2012 2013

(%)

‐

2,000

4,000

6,000

8,000

10,000

US AU CN JP FR GR UK IT SP BR RU TU MX CH IN

US$/pa

Over 2012-17, the India's percapita pharma spend is expectedto increase at a CAGR of 13-14%



(3) Increasing insurance coverage

In India, unlike US/EU, the spending of drugs is largely out of pocket, which formaround 90% of payments. In the planning commission's draft twelve five-year plan,the vision laid out for India's healthcare sector is to establish a system of universalhealth coverage. This would be achieved primarily through more extensiveinsurance coverage, which would move up from 10% currently to 90%, partlythrough government hospitals or government payments.

India’s out of pocket expenditure on healthcare – 90%

Source : WHO, Kotak Securities - Private Client Research

(4) Higher penetration to drive growth

Around 2/3rd of India's population lives in rural areas, but rural markets contribute< 20% of the overall IPM sales. Moreover the split of hospitals and doctorsbetween rural and urban also remained highly skewed towards urban areas. Withgovernment's intention of universal health coverage, there is an immenseopportunity for expansion of the IPM.

India’s out of pocket expenditure on healthcare – 90%

Population Rural ( 72%) ‘842mn Urban (28%) ‘335mn

Hospital % 31 69

Hospital Beds % 20 80

Doctors % 26 74

Doctors / 100,000 people 22 160

Sources: Industry, Kotak Securities - Private Client Research

0

25

50

75

100

% Public Insurance % Other private insurance % Out of pocket

Around 2/3rd of India'spopulation lives in rural areas,but rural markets contribute <

20% of the overall IPM sales

In India, unlike US/EU, thespending of drugs is largely out

of pocket, which form around90% of payments



Overhangs of IPM - Drug price controlIn Nov-2012, the NPPA (National Pharmaceutical Pricing Authority) introduced thenew pricing policy for drugs which capped prices of 348 essential medicine (NLEM- National list of essential medicines) formulations at the arithmetic average of alldrugs in a particular segment with a minimum of one per cent market share. Since1974, the government had been fixing the prices of 74 bulk drugs on a cost-plusbasis. As a result of the regulator's switch from bulk to formulations, the prices ofvarious expensive branded drugs dropped significantly. It also increased the span ofdrugs under price control to 30% from around 17-18% earlier. Later in Aug-14,NPPA had included 109 incremental drugs under price control. This was laterwithdrawn in Sep-14, as the drugs were not in the NLEM. The government hasbeen hinting at capping the prices of drugs beyond the list of NLEM includinglifesaving drugs of cardiac, diabetes and HIV/AIDS ailments, hence we believe, thepricing control will remain the biggest overhang for companies with higher exposureto the IPM.

Domestic formulations as % of revenues

Source : Company, Kotak Securities - Private Client Research

DPCO revenues as % of Domestic revenues

Source : Company, Industy, Kotak Securities - Private Client Re-search; * Sun Pharma is <10%

Pricing control will remain thebiggest overhang for companieswith higher exposure to the IPM



US pharma market – India’s manufacturing and R&Dcapabilities well showcasedSince the introduction of the Hatch Waxman Act (which encourages genericmedicine consumption in the US) in 1984, the generics market has grown manifoldin the US. A staggering 84% of prescriptions written today are for generics, up from~20% in the 1980s. Today generics form ~15% of the US pharma market in valueterms at US$60bn. India has played a pivotal role in the US generic market overthe years and its share in prescriptions is on the rise (26% in FY14 from 17% inFY10). Moreover Indian companies account for nearly half of DMF (Drug MasterFiling) filings as well as ~40% of ANDA approvals every year. India has alsoshowcased its manufacturing capabilities with over ~175 USFDA approvedformulations facilities, the second largest after US.

India accounts for ~50% of DMF filings in US

Source : USFDA, Kotak Securities - Private Client Research

India has largest number of USFDA approved facilities after US

Source : Industry Kotak Securities - Private Client Research

India's share in ANDA approvals inching higher

Source : USFDA, Kotak Securities - Private Client Research

Indian companies account fornearly half of DMF (Drug MasterFiling) filings as well as ~40% of

ANDA approvals every year

0

0.1

0.2

0.3

0.4

0.5

0.6

0

250

500

750

1000

2005 2006 2007 2008 2009 2010 2011 2012 2013 1HCY14

Total DMFs (LHS) Indian (LHS) Indian % (RHS)



Growth Drivers

(1) Sheer Size

Indian formulations exports to the US accounted for ~US$4 bn, which is ~7% of theUS generic market. Moreover, of the top 10 generic players in the US market onlyone was Indian. Sun Pharma, with >US$1.6 bn revenues on the 9th position withTeva leading the list with ~US$10.0bn revenues.

Of India’s $14 bn global pharmaceutical exports, domestic drug makers depend onthe US market for ~ $4 bn in sales. Close to $3 billion of sales (excluding transferpricing) is garnered by larger players like Dr Reddy’s, Sun Pharma, Ranbaxy andLupin. Dozens of mid-sized drug makers such as Torrent Pharma, IPCA Laboratoriesand Alembic Pharma together account for the rest.

(2) Patent expiry

The last few years have been a boon for Indian generic players as they availedmajor upside from the patent expiry of blockbuster drugs. Indian majors (Sun, DrReddy’s, Lupin, Ranbaxy and Cadila) led by robust growth in the US revenueswitnessed ~40% YoY over the last three years. The coming 3-4 years are equallylucrative for Indian companies as US$44bn worth drugs go off patent in the USmarkets.

Revenues of patents expired / set to expire


India's share stands at mere 7% of US generics market


Size of US revenues of global generics vs. Top Indian companies


US$44 bn worth drugs go offpatent in the US markets

0

2,000

4,000

6,000

8,000 (US mn)

33256

460

US branded mkt ($ bn) US generic mkt ( $bn)

India's share ($ bn)

12.6 13.6 13.116.1

14.1

20.0

25.0

10.0

20.018.0

12.014.0

0

5

10

15

20

25

30US$ bn



(3) Healthy ANDA pipeline

The Indian generics players account for ~40% of the total ANDA approvals fromUSFDA. ANDA or Abbreviated New Drug Application is an application for a U.Sgeneric drug approval. Moreover, a deeper look at the individual pipeline of largerIndian generics highlights that most of the companies await approvals for more than50% of their ANDA pipeline. IPCA has ~80% of its pipeline awaiting approvals(delayed due to USFDA facility compliance issues). Lupin Alembic and Cadila awaitapprovals for ~50% of their ANDA filings.

(4) Increasing R&D spend

For most Indian companies, growth has so far been led by plain-vanilla generics andinteresting Para IV opportunities. Competition is rapidly intensifying in plain vanillasas well as para IV filings with more players from India as well as other emergingcountries targeting US generic market. Hence to sustain growth as well improveprofitability, few Indian companies have already increased spending on R&D. HigherR&D expense enables companies to file niche complex and difficult to makegenerics which acts as an entry barrier for competition. Select Indian pharma majorssuch as Sun Pharma, Dr Reddy's and Lupin are already ahead of the curve in thisrespect. Second rung players like Cadila, Alembic and Natco also have carved outniche opportunities for US markets.

Increasing R&D spend to focus on niche opportunities


Healthy ANDA pipeline


ALPM, CDH, LPC, CIPL & IPCA have >50% of pipeline awaits approval


0

100

200

300

400

500

600 (Nos)

ANDA filed

ANDA approved

0

3,000

6,000

9,000

12,000

15,000

0.00%

3.00%

6.00%

9.00%

12.00%

Alembic Cadila Cipla DrReddy's

IPCA Lupin SunPharma

Torrent

(Rs mn)

R&D FY14 ‐ Rs mn R&D expense as % rev

Higher R&D expense enablescompanies to file niche complex

and difficult to make genericswhich acts as an entry barrier for

competition

58% 62%

47%

33%

78%

48%

28% 32%

0%

25%

50%

75%

100%



Overhang for US generic market

Regulatory risk

Regulatory risk has cropped up as the biggest overhang for Indian generic players inrecent times. The US imports ~40% of formulations and ~80% of its APIrequirements. With stupendous increase in imports, the USFDA has increasedvigilance and focus on regulatory adherence of USFDA plants globally. Theproportion of Import alert, Warning letter and Form 483s has increased significantlyin last three years. As the largest number of USFDA approved plants outside US arein India, Indian companies have an inherent regulatory and compliance risk.

Higher Form 483s issued by USFDA

Source : USFDA, Industry

14 19 4145 43 33

162 129

300

0

100

200

300

400

2011 2012 2013

(Nos)

Import alert Warning letter Form 483s

Notable FDA actions on listed Indian companies

Companies Action Facility Date

Sun Pharma (Caraco) Warning letter Michigan, US Oct-08

Ranbaxy Warning Letter/Import Alert Paonta Sahib, Batamandi and Dewas - India Feb-09

Cipla From 483 issued Bangalore, India Apr-09

Lupin Warning Letter Manideep, Madhya Pradesh, India May-09

Claris Warning Letter/Import Alert Ahemdabad, India Nov-10

Claris Warning Letter/Import Alert New Jersey Nov-10

Aurobindo Pharma Warning Letter/Import Alert Hyderabad, India Feb-11

Cadila Hc Warning Letter Moraiya, Ahemdabad, India Jun-11

Dr Reddy’s Warning Letter/Import Alert Mexico Jun-11

Jubilant Warning Letter Canada Feb-13

Wockhardt Warning Letter/Import Alert Waluj, Maharashtra, India May-13

Aarti Drug Limited Warning letter Maharashtra, India Jul-13

Ranbaxy Warning Letter/Import Alert Mohali, Punjab, India Sep-13

Strides Warning Letter/Import Alert Banglore (Injectables), India Sep-13

Wockhardt Import Alert Chikalthana, Aurangabad, India Nov-13

Ranbaxy Import Alert Toansa, Punjab, India Jan-14

Sun Pharma Import Alert Kharkhadi, Gujurat, India Mar-14

Smruti Organics Warning letter Solapur, India Mar-14

Orchid Chem Form 483 issued Waluj, Maharashtra, India Apr-14

Natco Form 483 issued Telangana, India May-14

IPCA Labs Form 483 issued Ratlam, Madhya Pradesh, India Jul-14

Sun Pharma Form 483 issued Halol, Gujarat, India Sep-14

IPCA Labs Form 483 issued Indore, India Nov-14

Source : USFDA, Industry



Supply chain consolidation accentuating pricing pressures

In the US, the pharmacy supply chain comprises PBM’s (Pharma benefit managers),drug wholesale distributors and retail pharmacy/mail orders. PBM’s act as anintermediary between the payer and everyone else in the healthcare system. Theygenerally make money through service fees from large customer contracts forprocessing prescription claims, operating mail order pharmacies, and negotiatingprices with drug makers. The large PBM’s in US include CVS Caremark, CardinalHealth and AmerisourceBergen, whereas the key retail drugstore chains includeWalgreen, Alliance Boots, Rite Aid and Shoppers Drug Mart.

Since 2012, the US pharma market has seen rising number of collaborationsbetween PBM’s, wholesalers and retailers. Early in 2013, three large pharmacydistributors - Walgreen, Alliance Boots and Amerisource-Bergen - formed a 10-yearinternational alliance for deeper relationships with drug makers and get betterdiscounts. Later in Dec-13, the second-largest US wholesale distributor CardinalHeath formed an equal joint venture with another large player CVS Caremark. Andin Jan-14, another US pharmacy company McKesson agreed to acquire the EU’slargest distributor Celesio, further consolidating its position. Such consolidations inthe US pharmacy market has created a few dominant players with betterbargaining power which has accentuated pricing pressures for generic companies inan already competitive market. The prices of highly genericised drugs sawdecreased between 20-30% over last 18 months, however, there were also priceincreases in complex and low competitive drugs simultaneously. Hence we believe,moving up the value chain towards more complex and niche areas will alleviateconcerns due to channel consolidation.

US Pharmaceutical supply chain

Source: Industry; Kotak Securities - Private Client Research

Consumer

Payment Flow

Rebate Flow

Product Flow

RetailPharmacy/Mail

Orders

Drugmanufacturer

Health Insurer

PBM’sWholesaledistributor



Glossary180 day exclusivity – The period for which the first generic filer of an ANDA(which is under patent) is entitled for an exclusivity in which no other genericcompany can enter the market.

Acute drugs - Drugs which are precribed for less than three weeks

AG - Authorised generic, the innovator company appoints a generic company as anAG when the drug goes off patent and other generic competition enters markets

AIOCD - All India Organisation of Chemists and Druggists

ANDA or Abbreviated New Drug Application – Filing form at USFDA forlaunching generic drugs in the US market.

ANVISA - Is also known as National Health Surveillance Agency, it is the regulatorybody for healthcare of the Brazilian government

API or Active Pharmaceutical Ingredient – The chemical name of the drug, foreg. Paracetamol for Crocin

ARV - Anti Retro Viral, drugs used to treat HIV infections

Bio - Biosimilars

CCI - Competition Commission of India

CFC - Chlorofluorocarbon

Chronic drugs - Drugs which are prescribed for more than three weeks

CNS - Central nervous System

Combination inhalers - Combination of two medications into one inhaler.

Controlled Substances - Drugs controlled by DEA, US

CVS - Cardiovascular

DEA - The Drug Enforcement Administration (DEA) is an United States federal lawenforcement agency under the U.S. Department of Justice, tasked with combatingdrug smuggling and use within the United States.

Derma - Dermatology

Diagn - Diagnostics

DMF - Drug Master File, the submission form for supplying APIs in the US markets

DPC - Diagnostic Procedure Combination

DPCO - Drug Price Control Order

DPI - Dry powder Inhalers

EU - European Union

FHC - Female Health Care

Formulations – Any drug (Tablet, Capsule, Injection, Cream, Ointment, Patch ect.)which can be used by patients are called formulations

FTF or First to file – The generic company which files an ANDA for a drug whichis still under patent protection is known as FTF and is entitled for 180 day exclusivitypost the patent expiry.

Gastro - Gastrointestinal

Generics/ Generic drugs – Drugs that are copycats of the original patented drugs.These drugs are usually priced 90% lower than the original drugs as there is noR&D cost incurred by the generic manufacturers.

GI - Gastrointestinal



HFC - hydrofluorocarbon

HIV - Human Immunodeficiency Virus

ICS - Inhaled corticosteriod

ICS/LABA - Combination of ICS and LABA

Innovator companies – Companies that incur huge R&D expense on innovativedrugs. The usual cost incurred on any innovative drug is ~US$ 1.0bn.

IPM – Indian Pharma market

LABA - Long acting beta andrenoceptor agonist

LABA/LAMA - Long acting muscarinic antagonist

MDI - Metered Dose Inhalers

MHRA - Medicines and Healthcare Products Regulatory Agency, is an executiveagency of the Department of Health in the United Kingdom

MR - Medical Representatives, or field force of any pharma companies

NDA - New Drug Application, this is different from ANDA, as the company filing forNDA will have to do some trails on human body for the drug it has filed.

NLEM - National List of Essential Medicines

NPPA - National Pharmaceutical Pricing Authority (of India)

NSAIDs - Nonsteroidal anti-inflammatory drugs

OC - Oral Contraceptive

Opthal - Ophthalmology

OTC - Over the Counter

Pain - Pain Management

Para IV - When a generic player has challenged the patent, the drug is filed underPara IV of ANDA filings

PDMA - Pharmaceuticals Medical Devices Agency, Japanese Pharma regulator

PM - Pain Management

R&D - Research and Development expenses

Resp - Respiratory

SABA - Short acting beta agonist

TA - Therapeutic Area, diffirent classes of therapies

TGA - Therapeutic Goods Administration, is the regulatory body of the AustralianDepartment of Health

USFDA - United States Food and Drug Administration

Vit/Min/Nut - Vitamins/Minerals/Nutrients

WHO - World Health Organisation



COMPANIES



Cadila Healthcare Ltd

PRICE: RS.1647 RECOMMENDATION: BUYTARGET PRICE: RS.1964 FY17E P/E: 19.3X


Cadila Healthcare (CDH) is a well-placed most diversified companyamongst peers and has grown at a CAGR of ~20% in revenues as well asPAT over FY08-14. We like Cadila Hc (CDH) due to steady growth in domes-tic formulations, onset of US approvals after a long stagnation, few inter-esting opportunities for US markets over the next two years and the like-lihood of first mover advantage in the US$3.0bn Transdermals market (US).

Key Investment Rationale

Domestic formulations growth to revive - CDH's contract with Boheringerfor two products Dulcolax and Buscopan (revenues ~Rs 900mn) ended in Dec-13. Moreover, CDH also got impacted by (National List of Essential Medicines)NLEM to the tune of ~Rs750-800mn (highest amongst peers). Hence CDH'sdomestic segment growth has remained lumpy in recent past (FY14 - 6%growth). Continued focus on first time launches, price increases on NLEMproducts and new launches will revive growth in the segment going ahead.For the 1HFY15, CDH has posted growth of 8.3% in the segment. We expectCDH to post 13% CAGR over FY14-17E in the domestic formulations revenues.

US revenues to post a robust 25% CAGR over FY14-17E - CDH has built asizeable US franchise with US$356mn (FY14) from me-too generics and awaitsapproval for ~140 ANDAs (225+ ANDAs filed). Quality of filings has shiftedtowards complex products in the past 3-4 years; however monetization is yetto pick up materially due to lull in ANDA approvals run-rate in the last 2-3years. The US revenues posted growth of mere 12-13% in (US - ex Nesher)over FY12-13 (growth was largely due to currency depreciation). Going ahead,as the thick US pipeline fructifies along with incremental launches inInjectables and Transdermals space, we expect US revenues to post a robust26% CAGR over FY14-17E.

Margin revival - CDH's EBIDTA margins deep dived to a low of 14.9% in3QFY14 while closing the fiscal at 16.4% from a high of 22.8% in FY10. Thedip in margins was mainly due to sharp decline in (high margin) JV revenues.Going ahead, as the business model aligns, we expect CDH's margins to re-vive back gradually to earlier levels of ~23% driven by niche launches in theUS markets.

Outlook and valuation CDH is expected to deliver 16/31% CAGR in Rev/PAT over FY14-17E mainly

led by US revenues coupled with margin expansion due to niche launches inthe US markets. We are positive on CDH given (1) >50% of its US pipeline yetto be commercialised, (2) interesting targeted areas (Transdermals/Nasal/injectables) (3) improving free cash flows and (4) steady domestic formulationsfranchise. Initiate coverage with BUY rating, TP Rs 1964, 23x FY17E EPS of Rs85.4.

Risk and Concerns

Regulatory delays or compliance issues

USFDA approvals of niche products

Adverse currency movements


Price chart

Source: Bloomberg

Stock details

BSE code : 532321

NSE code : CADILAHC

Market cap (Rs mn) : 337821

Free float (%) : 30

52 wk Hi/Lo (Rs) : 1760/805.4

Avg daily volume : 87.7

Shares (o/s) (mn) : 204.74

Summary table(Rs mn) FY15E FY16E FY17E

Sales 83,056 95,564109,635.0Growth (%) 17.6 15.1 14.7EBITDA 16,143 21,402 25,955.2EBITDA margin (%) 19.0 21.8 23.1PBT 12,416 17,608 22,116.7Net profit 10,491 14,879 18,688.6EPS(Rs) 48.9 68.8 85.4Growth(%) 25.5 41.8 25.6CEPS(Rs) 63.9 85.2 103.7BVPS(Rs) 206.1 262.9 336.2DPS (Rs) 9.0 10.0 10.0ROE (%) 23.7 26.2 25.4ROCE (%) 20.0 24.1 25.8Net debt 17,724 10,372 736.5NW capital (Days) 72.1 72.2 72.2P/E (x) 33.7 24.0 19.3P/BV (x) 8.0 6.3 4.9EV/Sales (x) 4.3 3.6 3.1EV/EBITDA (x) 22.0 16.2 13.0

Source: Company,

Kotak Securities - Private Client Research

Shareholding pattern

Source: ACE Equity

Promoter75%

FII7%

MF/UTI4%

Bodies corporate

4%

Others10%



DOMESTIC FORMULATIONS - TO REVIVE BACK

CDH has been a prominent player in the domestic formulations market with strongleadership in the cardiac, gastro, women healthcare and respiratory segments. Ithas 4.03% (as per September 2014 AIOCD) market share in the IPM. During FY08-14, the domestic formulations segment registered 13% CAGR (organic as wellinorganic). CDH has done various acquisitions in the domestic market; it acquiredfour companies in the domestic formulations space, with the prominent ones beingGerman Remedies (FY02 net sales of Rs 2,260mn) and Biochem Ltd (FY11 net salesof Rs 2,640mn).

CDH is also the only player amongst peers with huge focus on the first timelaunches, CDH introduces 60-70 products every year in the domestic marketwherein 25-30% of products are first time launches. Of the total 75 productslaunched in FY14 19 were first-time launches.

CDH's domestic segment growth slowed down to 6% in FY14 due to two mainreason, (1) CDH's contract with Boheringer for two products Dulcolax and Buscopan(revenues ~Rs 900mn) ended by Dec-13. (2) CDH also got impacted by NLEM tothe tune of ~Rs750-800mn (highest amongst peers).

However, we believe, these events were an aberration and CDH is likely to revertback to its previous CAGR of 12-13%.

Cardiology is the largest franchise


Chronic portfolio set ot increase led by launches


Historical double digit growth comforting


Expect 13% CAGR over FY14-17E

Cadila has consistently posted double digit growth in lastseven years, except in FY14 largely due to price decreasein NLEM product. However, the price increase equivalentto CPI (consumer Price Index) available every year (DPCOallows companies to take price increase in NLEM productsin April every year) we believe, will allow CDH to postbetter growth from FY15E onwards. Moreover, continuedfocus on first time launches, improving productivity of MRsand new launches will further aid growth. We expect agradual revival in revenues, with 11% growth in FY15Efollowed by 14% growth in FY16E/17E. For the 1HFY15,CDH has posted growth of 8.3% in the segment. OverFY14-17E we expect CDH to post 13% CAGR in thedomestic formulations revenues.


0

5

10

15

20

25

0

10,000

20,000

30,000

40,000(Rs mn)

(%)Domestic Fomulations Growth

Chronic, 41.6%

Acute, 58.4%

CVS16.9%

CNS2.5%

Resp11.4%

Gyneac7.3%

GI14.5%

AI14.5%

Others11.7%

PM7.0%

Derma7.9%

Neutraceuticals2.8%

Biologicals3.5%



US FORMULATIONS - MORE TO COME

CDH entered the US market in FY06 and have been profitable from the very firstyear of its operations. CDH as of date has total ~225 ANDA's filed with 85approvals. It markets ~60 ANDAs in the US. While the company's product launcheshave been restricted to 'me-too' products this far, it has identified differentiatedgenerics/difficult-to-manufacture products as its next leg of growth in the US. CDHhas filed nasal products, transdermals, topicals and injectables in the US of whichfew injectables are already comercialised. Nasals and Transdermals will drive thenext leg of growth being low competition lucrative markets in the US due to itscomplexity. The market size for nasals and transdermal stood at $20bn and $3bnrespectively in December 2013.

CDH also acquired Nesher, a subsidiary of KV Pharma, in June 2011 for $60mn, andforayed into the $7bn controlled substance market. Controlled substance drugs aredrugs which use chemicals which are addictive in nature and hence monitored verystrictly by DEA (Drug Enforcement Administration) to keep a check on misuse ofthese drugs. Controlled substance drugs can only be manufactured in US and henceto build or acquire a facility in the US is the only way to enter this segment. Nesherhas not only helped CDH to enter a new business segment, but also opened a newavenue of limited competition opportunities with high entry barriers. We believeNesher will play a key role in the US growth over the next four years.

CDH awaits approvals for 140 ANDAs...

Source : Company, , Kotak Securities - Private Client Research

...which will lead to 26% CAGR in US revenues

Source : Company, , Kotak Securities - Private Client Research

Thick US pipeline to drive growth

Cadila's ANDA pipeline has mounted from ~130 to ~225 over the past two years;however, the US revenue growth has remained subdued at 15% CAGR over FY12-14 due to lack of approvals from the USFDA. Though CDH has witnessed growth(~30%) in the last 2/3 quarters, it was mainly driven by AG (Authorised Generics)launches (Tricor, Divalproex ER Triliprix and Zemplar). As Cadila's US approvals rollout we see US revenues providing immense opportunities.

Usually the timeline for ANDA approvals from USFDA in between 30 to 36 months.CDH started filing aggressively from FY13 onwards and hence the pick-up inapprovals is expected from FY16E onwards. So far in 1HFY15, CDH has witnessedimproved trajectory in US led by AG launches as well few ANDA launches from itspipe. Going ahead the outlook for US will get better as we model 10-15 launchesper year as well fructification of its niche pipeline (Injectables, transdermals, Nasalsand topical), we expect 26% CAGR over FY14-17E for the US revenues.

(Nos) (US$ mn) (%)

we model 10-15 launches peryear as well fructification of its

niche pipeline (Injectables,transdermals, Nasals and topical),we expect 26% CAGR over FY14-

17E for the US revenues



Key drug launches over next 2-3 years

Tentative launch Brand Generic name Brand Size - USD mn

FY15E Asacol® HD Mesalamine 750

FY15E Astelin Azelastine 144

FY16E Abilify Aripiprazole 4500

FY16E Pristiq Desvenlafaxine 441

Nov-19 Prevacid® SoluTab Lansoprazole ODT 400

FY16E/FY17E Exelon Rivastigmine transdermal PATCH 450

FY16E/FY17E Flector Diclofenac epolamine transdermal patch 170

FY16E/FY17E Catapres-TTS Clonidine transdermal patch 230

FY16E/FY17E Estradiol Estradiol transdermal patch 350

Unknown Lialda Mesalamine 500+

Source : Company, Industry, Kotak Securities - Private Client Research



Quarterly financial snapshot

(Rs mn) 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 YoY (%) QoQ (%)

Net Sales 17,254 18,603 19,163 20,204 20,635 19.6 2.1

Material Expenses 6,820 6,868 7,642 8,133 8,221 20.5 1.1

Employee Expenses 2,730 2,615 2,736 2,901 2,873 5.2 (1.0)

Other Operating Expenses 4,118 4,712 4,555 4,649 4,598 11.7 (1.1)

Research and Development expenses 1,288 1,234 1,033 1,057 1,179 (8.5) 11.5

Operating Profits 2,298 3,175 3,198 3,464 3,765 63.9 8.7

Other Operating Income 310 226 546 297 445 43.3 49.5

EBITDA 2,608 3,401 3,744 3,761 4,210 61.4 11.9

Interest Cost 316 293 271 181 173 (45.4) (4.5)

Depreciation 518 496 528 677 733 41.6 8.3

Other Income 122 128 131 104 146 19.5 40.3

PBT 1,897 2,740 3,076 3,007 3,451 81.9 14.7

Adj on Consolidation 82 92 72 69 101 22.7 45.6

Forex (loss) /gain 123 (345) (125) - -

Exceptional items (35) (131) (12) 2

Tax 101 408 348 524 571 465.1 8.9

RPAT 1,837 1,860 2,399 2,402 2,781 51.4 15.8

E/o (adj for tax) (105) 293 106 0 - (100.0) (100.0)

APAT 1,732 2,153 2,506 2,402 2,781 60.6 15.8

Source: Company, Kotak Securities - Private Client Research

Sales mix


Domestic business 7,997 7,651 8,136 8,708 8,835 10.5 1.5

- Formulations 6,263 5,883 6,247 6,749 6,808 8.7 0.9

- API 119 112 209 240 257 116.0 7.1

- Consumer products 1,039 1,034 1,073 1,075 1,101 6.0 2.4

- Animal Health 576 622 607 644 669 16.1 3.9

Exports 8,310 10,012 10,272 10,670 11,091 33.5 3.9

- USA 4,730 6,316 6,783 7,165 8,020 69.6 11.9

- EU 942 1,186 845 1,012 777 (17.5) (23.2)

- Brazil 654 639 597 544 647 (1.1) 18.9

- Japan 131 145 144 0 0

- Other EM 981 832 1,034 1,050 885 (9.8) (15.7)

- Animal Health 134 163 138 132 132 (1.5) 0.0

- API 738 731 731 767 630 (14.6) (17.9)

JV 1,068 1,012 1,111 1,189 1,136 6.4 (4.5)

Gross Revenues 17,375 18,675 19,519 20,567 21,062 21.2 2.4


Cadila Hc's (CDH) Q2FY15 results were a mixed bag, the domestic form growthremained tepid at mere 9% YoY whereas US revenues continued the trajectory at~70% growth YoY led by AG launches. Overall revenues were up ~20% at Rs20.6bn. Gross margins remained flat at ~60%, however EBITDAM expanded512bps led by improving efficiencies. PAT at Rs 2.8 bn was up 61% YoY.



OUTLOOK AND VALUATION

CDH's 21% revenue CAGR during FY08-14 was mainly driven by JV's (37% CAGR)and US formulations (42% CAGR), whereas Domestic revenues increased by 13%CAGR. Though CDH has one of the most diversified business model with variousrevenue segments, the margin contribution from segments was highly skewed untilFY13. The JV's which contributed a mere 6-7% to revenues were contributing~30% to profits. Hence, CDH's EBIDTA margins deep dived to a low of 14.9% in3QFY14 while closing the fiscal at 16.4% from a high of 22.8% in FY10. The dip inmargins was mainly due to sharp decline in (high margin) JV revenues.

CDH's JV with Hospira, under which, CDH was supplying docetaxel for the USmarkets grew multifold due to limited competition (and registered 61% CAGR overFY08-12), however, as the competition increased, the JV revenues dipped to a mere11% growth in FY13 and de-grew by 11% in FY14. Moreover, the Moraiya plantregulatory issues (In 2011 USFDA had sent a warning letter to CDH for its injectableunit in Moraiya plant. Since the oral dosage, injectable and nasal drug units were inthe same plant (Moraiya), the ANDA approvals were halted altogether, leading tooperating deleverage. Further NLEM impact and Boehringer contract expiry allaccentuated the margin pressures.

Going ahead, as the business model aligns, we expect CDH's margins to revertback gradually to earlier levels of ~23% driven by niche launches in the USmarkets. We expect CDH to deliver 16/31% CAGR in Rev/PAT over FY14-17Emainly led by US revenues coupled with margin expansion. We remain positive onCDH given (1) >50% of its US pipeline yet to be commercialised, (2) interestingtargeted areas (Transdermals / Nasal / injectables) (3) improving free cash flows and(4) steady domestic formulations franchise. The stock has been trading at anaverage one yr fwd P/E of 22x over the last five years. Strong outlook for US andmargin revival will keep the valuations close to its five years average. Initiatecoverage with Buy rating, TP Rs 1964, 23x FY17E EPS of Rs 85.4.

PE band - One year forward PE


0

5

10

15

20

25

30

35

Fwd PE 5 yrs A vg PE

Initiate coverage withBuy rating, TP Rs 1964,

23x FY17E EPS of Rs 85.4



FINANCIAL SUMMARY

Revenues to grow at ~16% CAGR


APAT to post an impressive ~31% CAGR


Margins to revive back


Increasing margins to aid return ratios


Working capital cycle has remained steady over last six years


Impressive cash flows to inflate cash in balance sheet




FY14 Revenue break up

Source: Company

RISK AND CONCERNS

Regulatory delays or compliance issues - US being the key driver, any delaysin product approvals or noncompliance issues from the regulatory authorities canimpact our earnings estimates significantly.

USFDA approvals of niche products – We expect CDH to revive back to 22-23% EBIDTA margins led by niche launches in the US markets, any delay onthe same, can impact our assumption materially.

Adverse currency movements - Cadila derives ~56% of its revenues from ex-ports. Any adverse currency movements may impact our earnings significantly.

COMPANY BACKGROUND

The group's origin can be traced to 1952 when it was founded by Late Mr.Ramanbhai B. Patel, a first-generation entrepreneur and one of the stalwarts of theIndian Pharmaceutical Industry. In 1995, the group restructured its operations andCadila Healthcare came into being under the aegis of the Zydus group. ZydusCadila (CDH), today, is spearheaded by Mr. Pankaj R. Patel, the Chairman andManaging Director of the group. CDH has come a long way from clocking revenuesof mere RS 2.0bn in FY96 to Rs 70.0bn in FY14, increasing at 21% CAGR over thelast 18 years. Acquisitions have played a key role in CDH's growth trajectory aidingits entry into new markets and segments and providing support to operations. On anaverage, CDH acquired two companies every year in the past (11 acquisitionsbetween FY06-12). Most of these acquisitions were on a smaller scale except forthe acquisitions done in FY12. CDH acquired three companies in FY12, Biochem,Bremer and Nesher. Biochem was amongst the top-40 pharma companies in Indiawith significant presence in anti-infectives. The other two acquisitions were outsideIndia, Bremer, a small German company, to get a base in Animal Health businessglobally and Nesher ( for $60mn) to get an entry in the restricted controlledsubstance area in US markets. Cadila as of today has five formulations and threeAPI units. Apart from them CDH also has one unit dedicated for biologics as well asthree units dedicated for JVs.



FINANCIALS: CADILA HEALTHCARE LTD

Profit and Loss Statement

(Rs mn) FY14 FY15E FY16E FY17E

Revenues 70,601 83,056 95,564 109,635

% Change YoY 14.7 17.6 15.1 14.7

EBITDA 11,795 16,143 21,402 25,955

% Change YoY 9.4 36.9 32.6 21.3

Other Income 507 633 704 774

Depreciation 2,012 3,068 3,368 3,758

EBIT 10,290 13,707 18,737 22,971

% change YoY 10.6 33.2 36.7 22.6

Interest cost 1,181 1,291 1,129 854

Forex gain/loss 485 - - -

Extraordinary items (171.5) 0 0 0

Profit before Tax 9,422 12,416 17,608 22,117

% change YoY 16.5 31.8 41.8 25.6

Tax 1,060 1,924 2,729 3,428

as % of PBT 11 16 16 16

Net Income 8,362 10,491 14,879 18,689

% change YoY 21.2 25.5 41.8 25.6

Shares outstanding (mn) 204.7 204.7 204.7 204.7

EPS (reported) (Rs) 39.2 48.9 68.8 85.4

CEPS (Rs.) 49.1 63.9 85.2 103.7

DPS (Rs) 8.0 9.0 10.0 10.0


Cash Flow Statement (Rs mn)


EBT 9,422 12,416 17,608 22,117

Depreciation 2,012 3,068 3,368 3,758

Change in working capital 3 (2,116) (2,490) (2,805)

Taxes Paid 1,060 1,924 2,729 3,428

Operating CF 10,378 11,444 15,757 19,642

Capex (4,553) (4,589) (5,090) (6,591)

Change in Investments (962) (743) (854) (983)

Dividends (1,966) (2,211) (2,457) (2,457)

CF from investments (7,481) (7,543) (8,401) (10,030)

Proceeds from issue of eq - - - -

Inc/(dec) in debt (2,174) (3,526) (2,943) (5,000)

Def tax credit/other adj. (1,072) (108) (4) 24

CF from financing (3,246) (3,634) (2,947) (4,976)

Opening cash 5,838 5,488 5,754 10,163

Closing cash 5,488 5,754 10,163 14,798


Balance sheet


Cash & cash equivalents 5,488 5,754 10,163 14,798

Accounts receivable 11,337 12,288 14,138 16,220

Inventories 13,675 15,929 18,327 21,026

Loan and Advances 2,707 2,842 2,984 3,134

Others 1,330 1,529 1,759 2,022

Current Assets 34,536 38,342 47,371 57,200

LT Investments/others 5,175 5,918 6,772 7,755

Net Fixed Assets 40,153 41,674 43,395 46,228

Total Assets 79,864 85,934 97,539 111,183

Payables 9,108 10,240 11,782 13,517

Others 5,650 5,942 6,531 7,184

Current liabilities 14,758 16,182 18,313 20,701

Provisions 761 837.1 920.81 1012.891

Net Debt (LT) 27,004 23,478 20,535 15,535

Equity 1,024 1,024 1,024 1,024

Reserves 33,366 41,175 52,795 67,819

Minority Interest 1,443 1,914 2,715 3,923

Other long term liabilities 548 426 426 468.6

Deferred tax assets/Liab 961 899 811 700

Total Liabilities 79,864 85,934 97,539 111,183

BVPS 168 206 263 336


Ratio Analysis

FY14 FY15E FY16E FY17E

EBITDA margin (%) 16.4 19.0 21.8 23.1

EBIT margin (%) 14.3 16.1 19.1 20.4

PAT margin (%) 11.2 11.8 14.4 15.5

Receivables (days) 58.6 54.0 54.0 54.0

Inventory (days) 70.7 70.0 70.0 70.0

Sundry creditors (days) 47.1 45.0 45.0 45.0

Sales/assets (x) 1.1 1.2 1.2 1.2

Interest coverage (x) 8.7 10.6 16.6 26.9

Debt/equity ratio (x) 0.8 0.6 0.4 0.2

ROE (%) 22.6 23.7 26.2 25.4

ROCE (%) 16.1 20.0 24.1 25.8

EV/ Sales (x) 5.1 4.3 3.6 3.1

EV/EBITDA (x) 30.4 22.0 16.2 13.0

Price to earnings (x) 42.0 33.7 24.0 19.3

Price to book value (x) 9.8 8.0 6.3 4.9

Price to Cash Earnings (x) 33.6 25.8 19.3 15.9




Cipla Ltd

PRICE: RS.678 RECOMMENDATION: REDUCETARGET PRICE: RS.684 FY17E P/E: 22.0X


Cipla's (CIPL)'s launch of much awaited combination inhalers has led tosharp move in the stock price (from ~Rs450 levels to ~Rs 630). The launchdoes open up high margin/sustainable revenue stream for CIPL, but webelieve most of it is priced in, hence we do not see any significant upsidefrom current levels. We expect CIPL to register 15/21% CAGR in rev/PATover FY14-17E led by robust 30%/20% CAGR in EU/US revenues led by highmargin inhaler revenues. CIPL currently trades at 24/19x (adj for NPV - Rs67) FY16E/17E earnings. We initiate coverage on Cipla with a REDUCE rat-ing, TP Rs 684, 20x FY17E EPS of Rs 30.9 plus NPV of Rs 67 (for inhalers).

Key Investment Rationale Growth revival to continue - Post underperforming the IPM in FY10-13,

Cipla improved its growth rates and has been registering mid-teens growth forthe past 8 quarters. Cipla's enhanced focus in areas like Oncology, Nephrologyand its existing strengths in the respiratory and CVS are the key drivers ofgrowth. We expect CIPL to continue the trajectory and post 14% CAGR in thedomestic formulations segment over FY14-17E led by new product launchesand enhanced focus on high growing therapy areas.

Inhaler launches - to drive sentiment - The global respiratory market sizestands at ~US$32bn of which the inhalers alone account for ~US$15bn mar-ket. Cipla has a strong franchise of generic respiratory inhaler products (bothMDI - Metered Dose Inhalers and DPI - Dry powder Inhalers) in domestic andfew emerging markets. However Cipla has not been able to monetize its prod-ucts substantially when it comes to advanced markets like EU and US. How-ever, recently Cipla has launched its much awaited combination inhaler, ge-neric MDI (Metered Dose Inhaler) Advair, in Germany (~US$ 35mn market)and Sweden (US$ 25mn mkt). Advair MDI is ~US$700mn opportunity in EUwith UK alone accounting for ~50%. We expect CIPL to be the first entrant inUK in 2015. Management has indicated having approvals in ten EU countries(exc UK) and would be launching over the coming quarters. Though theselaunches would be in FY15E, the benefit would be visible only from FY16Eonwards. We have modeled gAdvair MDI revenues of US$ 17/60/103mn forFY15E/16E/17E.

Increasing cost led to dip in return ratios - Cipla has seen its employeecost inflate 5x from FY09 to FY14 (from 5.5% of revenues to 15.7% of rev-enues). Moreover, the efforts to build the front end presence in the developedmarket led to increase in other expenses (from ~20% of revenues to 26% ofrevenues). Though the gross margins increased by 750bps over FY09-14, thesharp increase in expenses led to dip in NPM (adj NPM down 600bps) resultingin lower RoE/RoCE. We expect Cipla's return ratios to improve (RoE to improvefrom 14% to 18% over FY14-17E, RoCE to improve from 18.3% to 22.2%) ledby higher profitability.

Risks and Concerns

Delay in launching combination inhalers

Regulatory Risk

Steep price erosion in Domestic market


Price chart

Source: Bloomberg

Stock details

BSE code : 500087

NSE code : CIPLA

Market cap (Rs mn) : 502500

Free float (%) : 65

52 wk Hi/Lo (Rs) : 672/367

Avg daily volume (000's) : 592

Shares (o/s) (mn) : 804


Sales 109,862 129,791 151,204Growth (%) 12.1 18.1 16.5EBITDA 25,122 32,173 39,383EBITDA margin (%) 22.1 24.0 25.2PBT 20,158 27,375 34,652Net profit 14,177 19,477 24,806EPS (Rs) 17.6 24.2 30.9Growth (%) 2.1 37.4 27.4CEPS (Rs) 23.9 30.9 38.0BVPS (Rs) 140.3 161.6 189.6DPS (Rs) 2.0 2.5 2.5ROE (%) 13.1 16.0 17.6ROCE (%) 17.2 20.4 22.2Net debt 591 (7,817) (22,486)NW capital (Days) 130.1 134.2 137.4P/E (x) 38.5 28.0 22.0P/BV (x) 4.8 4.2 3.6EV/Sales (x) 5.0 4.1 3.5EV/EBITDA (x) 21.7 16.7 13.3

Source: Company,



Source: ACE Equity

Promoter37%

FII23%

MF/UTI4%

Bodies corporate

4%

Others32%



DOMESTIC FORMULATIONS - GETTING STEADIER

Cipla ranks third in the domestic market, with a 5.5% (as per September 2014AIOCD) market share and holds leadership position in key therapies such asrespiratory, anti-retroviral, urology and gynecology. Chronic therapy segments suchas respiratory / anti-asthma, cardiovascular, and anti-retroviral account for ~45% ofthe company's domestic revenue with Respiratory/ Anti-asthma segment aloneaccounting for ~31%. Cipla's leading brands Asthalin, Seroflo in the respiratory /anti-asthma segment feature among the top 10 brands of India.

Cipla's top 10 brands account for ~25% of its Domestic formulations segmentindicating lower brand concentration. And amongst that five brands belong to theAnti-Asthma segment. Its No1 brand Asthalin ranks fourteenth in the industry andreported growth of 11.7% CAGR over the past six years. Cipla's exposure to DPCOproducts stood at 28% in FY14.

Respiratory is the largest franchise


Well balance product basket


Domestic formulations growth to get steadier


Sales force productivity (Rs mn)

Source : Company, Industry, Kotak Securities - Private Client Re-search

0

5

10

15

20

25

30

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000 Domestic form (Mn ‐ LHS)

YoY (% ‐ RHS)

Respiratory31%

Anti Infective23%

Cardiac12%

Other11%

Gastro6%

HIV4%

Pain / Analgesic4%

Opthal3%

Derma3% CNS

3%

2.8

4.75.8

3.9

2.4

5.2

8.2

2.2

0

2

4

6

8

10 (Rs mn)



Expect to register 14% CAGR over FY14-17ECipla has seen changes in the management team along with aggressive focus onkey markets like domestic formulations. Cipla’s enhanced focus in areas likeOncology, Nephrology and its existing strengths in the respiratory and CVS are thekey drivers of growth. Led by these efforts, new product introductions have startedto contribute significantly in recent times. The share of new product introductionsincreased from 1.5% in 1QFY14 to 3.5% by end of FY14. We expect Cipla toimprove the growth trajectory led by new launches (Cipla introduces ~30 productsevery year) and aggressive focus. Moreover, the MR strength at 7,000 levels(highest in the industry) coupled with low MR productivity compared to peers givesCipla the muscle to drive growth in the domestic segment. Unlike CIPL’s lumpygrowth in the past, we expect the growth to be relatively steady at 14% CAGR overFY14-17E.

Inhaler market - different drug class

Class of drugs Details Use

ICS Inhaled corticosteroid Used to prevent

asthma attacks

SABA Short acting beta agonist To treat asthma

attacks

LABA Long acting beta Used to prevent

andrenoceptor agonist asthma attacks

ICS/LABA Combination of ICS and LABA Used to prevent

asthma attacks

Anti cholligenics Anticholinergic medicine Used to prevent

asthma attacks

Nasal steroids Nasal corticosteroids For controlling allergic

inflammation

LABA/LAMA Long acting muscarinic Used to treat COPD

antagonist


Inhaler market split across drugs (US$ bn)


ICS, 4.4

SABA, 3.2

LABA, 1

ICS/LABA, 11.7

Anti cholligenics, 4.2

Nasal steriods, 3.2

LABA/LAMA, 4

The largest brand in the inhalerspace (Advair) with worldwide

revenues of US$ 9bn including USrevenues of US$ 5bn, is the

largest opportunity for genericplayers

OVERVIEW OF INHALER MARKET

The global respiratory market today stands at US$32bn with Inhaler’s aloneaccounting for ~US$15bn. US (~36%) and EU (~16%) account for 52% of theglobal inhaler market. The inhaler market is predominantly dominated bycombination inhalers (ICS/LABA - with US$11.7bn sales) in EU as well as US. Theinhaler market is largely generic in both US and EU, but there haven’t been genericplayers in the markets due to complexity of molecule as well as device. As far asgeneric approvals are concerned, the regulatory pathway is established in EU butclarity in US still needs to emerge. However, over the next 2-3 years, the inhalermarket is likely to see major changes as generic players enter the market withbranded generic or generic-generic product. The largest brand in the inhaler space(Advair) with worldwide revenues of US$ 9bn including US revenues of US$ 5bn, isthe largest opportunity for generic players.



Europe - a near term opportunity

The inhaler market in EU stands at ~US$5.0bn of which Advair (Advair MDI -US$0.7bn and Advair DPI - US$ 1.7bn) alone account for ~US$2.4bn. In Sep-14,Cipla launched its much awaited combination inhaler, generic MDI Advair, inGermany (~US$ 35mn market) and Sweden (US$ 25mn mkt). Cipla's genericlaunch of combination inhaler has instilled confidence in company's capabilities inthe inhaler space. Moreover, CIPL has managed to launch the first eversubstitutable MDI combination inhaler showcasing its R&D capabilities.Management has indicated of having approvals in 10 EU countries, excluding UK.We believe CIPL's approval in UK is key catalyst given (1) the size of the MDIcombination inhaler mkt (US$400mn) (2) No significant competition expected for 2-3 years from launch. We expect CIPL to be the first entrant in UK in 2015. Thoughthese launches would be in FY15E, the benefit would be visible only from FY16Eonwards. We have modeled gAdvair MDI revenues of US$ 17/60/103mn for FY15E/16E/17E. We expect EU revenues to post an impressive CAGR of 39% over FY14-17E led by MDI inhaler launches. The DPI opportunity in EU we believe is still twoyears away, we have modelled DPI launch in EU from FY18E onwards. We expectSandoz and Teva to be close competitors In the EU, especially in the DPI market.

UK accounts for >50% of MDI market in EU


US – Inhalers, a long term opportunity - The combination inhalers in the USis more than US$7bn opportunity (largely Advair and Symbicort). Advair marketin US is largely a DPI market, the patent on molecule is expired but the deviceis still under patent. Though the opportunity size is huge, we believe the fructi-fication is still some time away (we have modelled FY19E launch). The patenton Advair Diskus (device) is expiring in August 2016, the company has not dis-closed any timeline for filing and launching of generic Advair DPI in the US.

400

50 40 40 40130

200

350240 250 200

450

0

200

400

600

800

UK France Spain Italy Germany Others

(US$ mn) MDI DPI

We have modeled gAdvair MDIrevenues of US$ 17/60/103mn

for FY15E/16E/17E

CIPL’s launch in UK will be keycatalyst as we do not expect

competition for 2-3 years fromlaunch



PEEK IN THE PAST

Advair – why there are no generics in the US

High regulatory hurdles and technical difficulties of device kept thegenerics at bay.

Advair was first approved for use by the FDA in August 2000, with patents cov-ering the active ingredients expiring in 2010. However the patent on its devicerun through 2016 and beyond.

Advair Diskus combines two drugs in a fine powder that’s inhaled through anintricate device. For generic companies to get the USFDA to approve an Advaircopy, they must prove to the agency that the generic version enters the body inthe exact same fashion as Advair does, and triggers the same response at thesame dose level

Few generic companies have the know-how to make complicated inhaleddrugs, but as the device still holds patent, making a closer to similar device is atough task due to the complexity of the device and high regulatory hurdles fromthe USFDA.

This has led to rival companies, post multiple attempts of making a substitutefor Advair, making a similar product with a different brand name.

What has changed now?

New FDA guideline

The USFDA very recently issued draft guidance on how drug makers should testany planned generic version of Advair, potentially smoothing the way for easierregulatory approval of generic versions once all relevant patents expire.

Advair was first approved for use by the FDA in August 2000, with patents cov-ering the active ingredients expiring in 2010, but rival drug makers have faced anumber of roadblocks in bringing generic versions of the drug to market, withno ANDAs for generic equivalents having yet been approved by the agency.

As such, in the draft guidance, the FDA lays out several recommended methodsfor testing generic fluticasone and salmeterol dry powder inhalers meant to testdrug particle distribution and the dose given with each use, suggesting drugmakers test their planned generics against a reference, presumably a brandedAdvair diskus.

How it helps Cipla?

Cipla has been working towards putting in place its inhaler product portfoliosince the last few years. Cipla has one of the strongest generic pipelines, thethird largest global capacity for inhalers along with advantages of strong chem-istry skills and low-cost production in the segment. These changes in the guide-lines gets Cipla a step closer for tapping the opportunity of combination inhalers(Advair) in the US.

Moreover, Cipla’s generic launch of combination inhalers has instilled confi-dence in company’s capabilities in the inhaler space. CIPL has also managed tolaunch the first ever substitutable MDI combination inhaler showcasing its R&Dcapabilities.



Inhalers - NPV

Mkt Size FY18E FY19E FY20E FY21E FY22E FY23E FY24E FY25E

EU - MDI 690 105 120 130 132 139 146 153 161

EU - DPI 1960 103 176 194 213 235 247 259 272

US - MDI 400 24 18 35 39 42 44 47

US - DPI 4500 180 203 270 297 312 327

Symbicort - EU 1200 108 119 131 144 158 174 183 192

Symbicort - US 1400 42 70 105 116 121 127

Others 4000 40 80 80 76 72 69 65 62

Total Inhlaer revenues $ mn 356 519 775 873 1017 1090 1137 1188

In Rs mn 20,625 30,112 44,932 48,013 55,962 59,935 60,280 62,948

EBIT 13,406 19,573 29,206 31,208 36,375 35,961 36,168 37,769

EBIT*(1-t) 10,725 15,658 23,365 24,967 29,100 28,769 28,934 30,215

Working Capital 3,300 4,667 6,291 8,162 10,353 13,186 15,070 20,143

Working Capital changes (1,198) (1,367) (1,623) (1,872) (2,191) (2,833) (1,884) (5,074)

Capex (5,000) (7,500) (7,500) (9,000) (9,000) (10,000) (10,000)

Free cash flows 9,527 9,291 14,242 15,595 17,909 16,936 17,050 15,142

PV - FY18E-FY25 46,258

PV - Terminal Value 7,710

Total Value 53,967

Value per share 67.2


Other growth drivers

US - generic ANDA pipeline - While the inhaler market opportunity in US isstill 3-4 years away, the near term growth in US revenues will be driven bylaunching products through partners (management has indicated of 18-20 inter-esting products). So far Cipla had a partnership model for marketing in US.However, the company has planned to have a front end in US in next 1-2 yearsand has been making efforts to get back products from partners. In FY14, Ciplareceived back ~40 products from partners. New launches (we have modelled 6-7 launches/per yr) and the products received back from partners will driver 20%CAGR in US over FY14-17E.

Medpro tender supplies to aid growth – Cipla's US$460mn buyout ofMedpro in SA (South Africa) (in FY13) is yet to make a mark on Cipla'sfinancials. The US$2.9bn SA pharma market is split between Innovator brands(46%), Generics (27%) and OTC (28%). Medpro is the second largest companyin the SA generic market. South Africa accounted for ~US$225 mn sales forCipla in FY2014 of which Medpro (acquisition) accounted for ~US$120mn (8months sales). Medpro accounted for ~7% of Cipla's revenues, however thecontribution to profits were negligible, due to lower profitability.

During acquisition, Medpro had US$60mn worth tender order for respiratorydrugs. Moreover, Cipla Medpro has won three tender in last one year, the mostrecent one was for Anti-retroviral drugs worth - US$182mn. With one of thehighest HIV infection rates in the world, the SA tender market for ARV drugs isone of the largest at US$470mn (2013). Consistent tender wins in SA, we be-lieve, will drive 25% CAGR over FY14-17E in SA revenue.

Increased focus on pipeline. CIPL has enhanced its focus on building a pipe-line with 200 products under development and targeted filings of 60 products inEU (in 2014-15). CIPL’s expertise in the inhalers and ARV space puts it ahead ofpeers however lack of aggressive focus has been a concern. With visible strate-gies now in place, enhanced R&D focus and technological expertise, CIPL couldwitness a strong trajectory over 3-4 year period.



Quarterly financial snapshotCipla’s (CIPL) 2QFY15 results were disappointing. Revenues were marginally lowerthan expected led by lower exports. However the huge miss on EBIDTA margins,adjusted for higher other operating income (Rs 1.37bn), down 490/170bps YoY/QoQ, led to a 17% YoY drop in PAT to Rs 2.98bn. Stellar growth in domesticformulations segment (at 20% YoY) cushioned the dismal performance of exportAPIs (down 33% YoY). However, no improvement in gross margins in spite of (1)lower API revenues (2) possibility of gBaraclude supplies to Teva (3) better revenuesfrom inhaler products; was surprising. Management cited the quarter as anaberration.

Quarterly financials snapshot


Net Sales 24,632 25,526 24,293 26,472 26,298 6.8 (0.7)

Material Expenses 9,466 9,991 10,035 10,252 10,159 7.3 (0.9)


Other Operating Expenses 6,391 7,116 6,788 6,730 7,194 12.6 6.9

Operating Profits 5,150 4,391 3,190 4,690 4,210 (18.3) (10.2)

Other Operating Income 492 282 902 728 1,375 179.4 88.8

EBITDA 5,642 4,673 4,093 5,418 5,584 (1.0) 3.1

Interest Cost 450 333 341 333 469 4.2 40.7

Depreciation 914 912 1,050 1,254 1,220 33.5 (2.7)

Other Income 356 124 775 154 233 (34.6) 51.4

PBT 4,634 3,552 3,477 3,985 4,128 (10.9) 3.6

Exceptional/forex items 400 400 - 250 (100.0) (100.0)

Tax 1,358 987 753 1,019 1,007 (25.8) (1.2)

Minority interest (96) (122) (117) (271) (134) 40.4 (50.4)

RPAT 3,581 2,843 2,607 2,945 2,987 (16.6) 1.4

E/o (adj for tax) (300) (300) (300) (188) - (100.0) (100.0)

APAT 3,281 2,543 2,307 2,757 2,987 (9.0) 8.3


MARGIN ANALYSIS

Margin Analysis 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 YoY (bps) QoQ (bps)

Material Expenses as % of Net Sales 38.4 39.1 41.3 38.7 38.6 20 (10)

Employee Expenses as % of Net Sales 14.7 15.8 17.6 18.1 18.0 329 (13)

Other Operating Expenses as % of Net Sales 25.9 27.9 27.9 25.4 27.4 141 193

Operating Margin (%) 20.9 17.2 13.1 17.7 16.0 (490) (171)

EBITDA Margin (%) 22.5 18.1 16.2 19.9 20.2 (228) 26

APAT Margin (%) 13.1 9.9 9.2 10.1 10.8 (226) 66

Tax Rate (%) 29.3 27.8 21.7 25.6 24.4 (490) (118)




OUTLOOK AND VALUATIONS

Cipla’s (CIPL)’s launch of much awaited combination inhalers has led to sharp movein the stock price (from ~Rs450 levels to ~Rs 630). The launch does open up highmargin/sustainable revenue stream for CIPL, but we believe most of it is priced in,hence we do not see any significant upside from current levels. We expect CIPL toregister 15/21% CAGR in rev/PAT over FY14-17E led by robust 30%/20% CAGR inEU/US revenues coupled with high margin inhaler revenues. We initiate coverageon Cipla with a REDUCE rating, TP Rs 684, 20x FY17E EPS of Rs 30.9 plus NPV ofRs 67 (for inhalers).

One yr fwd P/E


RISK AND CONCERNS

Delay in launching combination inhalers – Cipla’s growth as well profitabil-ity will be mainly driven by launch of combination inhalers in the developedmarkets, any delay will significantly impact the rev/PAT.

Regulatory Risk - Exports contribute ~60% of Cipla’s revenues. Any regulatoryrisk can be critical for the company.

Steep price erosions in Domestic or US markets – India has been witnessingfrequent price regulations from DPCO, any significant price erosions which im-pact Cipla’s large brands, will not only impact the profitability but also the valu-ations.



FINANCIAL SUMMARY

Revenues to grow at 15% CAGR over FY14-17E


APAT to post 21% CAGR over FY14-17E


Margins to improve led by inhaler launches


Return ratios's to improve as margins rise


Working capital cycle improved over last six years






COMPANY BACKGROUND

Cipla Limited incorporated in 1935 as ‘Chemical, Industrial and PharmaceuticalLaboratories’, today is the second largest pharma player in the IPM with marketshare of 5.2% (as of Nov 2014 - AIOCD). The company is not only renowneddomestically due to its large presence across therapies, but is also best-knownglobally for pioneering the manufacture of low-cost anti-AIDS drugs in developingcountries. In February 2001, Cipla stunned the HIV/AIDS and public healthcommunities by announcing it would make its triple cocktail of antiretroviral drugsavailable in developing countries for US $350/patient per year, a tiny fraction of theprice of US $12,500 prevailing internationally at the time. Cipla has beenendeavoring to provide medicines at competitive prices. Recently, Cipla slashedprices of Cancer medicines in the domestic market.

Cipla’s strategy beyond the domestic market was different not only from its ownsetup domestically, but also from peers. Cipla had consciously refrained from settingup its own direct presence in markets abroad and preferred to sell its productsthrough partnerships. This strategy of not having a front-end presence was beenperceived negatively by markets and seen as a prime reason for restricting Cipla’sentry into the export markets , especially the largest market of US. Given that Ciplawas among the first player way back in 1985 to receive USFDA approval for itsplant, as of date it lags all its peers on the revenue front from the US market.However, with change in senior management team, Cipla is aggressively pursuingto create front end presence in the developed markets of US and EU.

Revenue break-up – FY14

Source: Company

Key personnel change

In recent times Cipla has transformed in many ways from de-focusing from lowmargin segments to putting up front ends. But the biggest catalyst of change hasbeen hiring outside talents for senior positions. Cipla earlier has never beenaggressive, however hirings over the 2-3 years Cipla has had few key people joiningin as heads of various departments across HR, IT, Supply chain ect.

Table

Date Key Personnel Key role Previous role

Nov-12 Subhanu Saxena CEO, Cipla Hd Global Product strategy & Commer, Novartis

Aug-12 Raman Wattamwar Hd International Biz, LATAM Country Hd, Jamaica, Dr Reddy

Jul-12 Frank Peters Hd EU and Global Resp Biz Sr VP, Southern Europe, Teva

May-12 Arun Gupta CIO Cipla CTO Shoppers Stop

Jan-12 V. S. Mani CFO, Cipla VP, Wockhardt

Dec-11 Chandru Chawla International Biz, Corp Strategy & Devl Sr VP, International Operations

Jun-11 Sanjay Bhanushali International Biz Devl Sr Director, Dr Reddy’s




FINANCIALS: CIPLA LTD



Revenues 97,994 109,862 129,791 151,204

% Change YoY 20.7 12.1 18.1 16.5

EBITDA 21,982 25,122 32,173 39,383

% Change YoY -2.6 14.3 28.1 22.4

Other Income 2,003 1,410 1,840 2,172

Depreciation 3,726 5,012 5,387 5,762

EBIT 20,258 21,520 28,627 35,792

% change YoY (2.8) 6.2 33.0 25.0

Interest cost 1,457 1,363 1,252 1,140

Extraordinary items 0 0 0 0


% change YoY (8.3) 7.2 35.8 26.6

Tax 4,634 5,039 6,844 8,663

as % of PBT 25 25 25 25

Minority interest (283) (941) (1,054) (1,183)

Net Income 13,884 14,177 19,477 24,806

% change YoY (9.8) 2.1 37.4 27.4

Shares outstanding (mn) 804 804 804 804

EPS (reported) (Rs) 17.3 17.6 24.2 30.9

EPS (Adjsuted) (Rs) 16.9 17.4 24.2 30.9

CEPS (Rs.) 21.9 23.9 30.9 38.0

DPS (Rs) 2.0 2.0 2.5 2.5




EBT 18,800 20,158 27,375 34,652

Depreciation 3,726 5,012 5,387 5,762

Change in WC 14,872 (6,702) (9,895) (9,530)

Taxes Paid 4,634 5,039 6,844 8,663

Operating cash flow 32,765 13,428 16,024 22,221

Capex (33,232) (3,618) (4,500) (4,500)

Change in Investments 735 2,432 (623) (636)

Dividends (1,879) (1,868) (2,336) (2,336)


Proceeds from issue of eq - - - -

Inc/(dec) in debt 3,304 151 229 275

Def tax credit /other adj. (887) (237) (156) (81)

CF from financing 2,417 (86) 73 194

Opening cash 1,440 2,247 12,534 21,172

Closing cash 2,247 12,534 21,172 36,116


Balance sheet




Inventories 28,953 33,109 40,893 47,640


Others 3,466 2,466 3,141 3,905

Current Assets 57,009 75,133 96,649 123,864


Net Fixed Assets 44,452 43,058 42,170 40,908

Goodwill 24930.9 24930.9 24930.9 24930.9

Total Assets 134,528 148,826 170,077 196,666

Payables 9,795 12,040 14,224 16,570

Others 6,540 5,430 6,229 6,624


Provisions 1100.1 1210.11 1331.121 1464.2331

Debt (Total) 12,975 13,125 13,355 13,630

Equity 1,606 1,606 1,606 1,606

Reserves 98,898 111,206 128,347 150,818

Minority Interest 496 687 916 1,192

Deferred tax liabilities 3,119 3,522 4,069 4,762


BVPS 125 140 162 190


Ratio Analysis


EBITDA margin (%) 21.6 22.1 24.0 25.2

EBIT margin (%) 20.7 19.6 22.1 23.7

APAT margin (%) 13.7 12.4 14.5 15.9


Inventory (days) 107.8 110.0 115.0 115.0


Sales/assets (x) 0.8 0.8 0.9 0.9



ROE (%) 14.2 13.1 16.0 17.6

ROCE (%) 18.3 17.2 20.4 22.2

EV/ Sales (x) 5.7 5.0 4.1 3.5

EV/EBITDA (x) 25.3 21.7 16.7 13.3







Dr Reddy’s Laboratories Ltd

PRICE: RS.3349 RECOMMENDATION: ACCUMULATETARGET PRICE: RS.3662 FY17E P/E: 19.2X


Dr Reddy's (DRL's) stepped up R&D efforts are paying off with increasedlaunches in the complex injectable space. Moreover, DRL is targeting 30%of its revenues from non-orals by FY17E. Though we expect the transitionto be challenging, key products like Copaxone, Nexium IV and Aloxi willkeep the momentum strong in the interim. We initiate coverage on DRLwith an ACCUMULATE rating, with a TP of Rs 3,662, 21x FY17E EPS of Rs174.4.

Key Investment Rationale US - key driver - DRL's US revenues have grown at 16% CAGR over FY09-14

primarily led by oral solids. In FY14, DRL posted a steep 30% growth in USrevenues led by FTF/limited competition products like gVizada, gDacogen,gDepakote ER. DRL has increased its focus on the niche pipeline for US mar-kets and aims to achieve 30% of its revenues from non-orals by FY17E. DRLhas highlighted that non-oral solids currently accounts for ~50% of its filings inthe current year and 40% of total pending approvals. As of FY14, DRL hadtotal 209 ANDAs filed with 62 awaiting approval. We expect DRL to post 16%CAGR in US revenues over FY14-17E.

Copaxone - a game changer - Copaxone is the largest selling drug of Tevapharma with revenunes of US$ 2.5bn. It is currently a patented drug. Teva hashinted at generic competition by Sep-15. Natco (Mylan as marketing partner)and Momenta (Sandoz as marketing partner) will be the first two companiesto launch the drug followed by DRL. We expect DRL to launch Copaxone in1HFY16, however, the launch ahead of expectations will be a key trigger. Weexpect Copaxone to be a limited competition opportunity with only four ge-neric players in the market. Copaxone generic can add ~Rs 400crs or Rs 24.0to DRL's FY17E EPS.

High R&D expense can open up high margin avenues - DRL's spend onthe R&D is highest amongst peers at Rs 1.26 bn or US$ 200mn (up 2x fromFY12). R&D spend has increased from ~6% of revenues to ~11% since FY12.DRL expects the R&D spend to remain ~11-12% of revenues of which ~35%will be channelized towards biological/PP (proprietary product). We believe thiscan open up immense limited competition opportunities for DRL over the next5-7 years especially in biosimilars. However, given the uncertainty over approv-als for biosimilars in the US, the risk remains high.

Outlook and Valuations On the business model front, DRL lags its peers due to its higher dependence

on the US markets (42% contribution to revenues) for growth and limited pres-ence on the domestic formulations segment (12% contribution to revenues).However, the high spend on the R&D , products like Copaxone (potential toadd Rs 24.0 EPS in FY17E) and an aim to achieve 30% of US revenues fromnon-oral solids by FY17E instill confidence. Hence, we maintain our positivestance on the company. Going ahead, we expect DRL to post 12.6% CAGR inrevenues and 15% CAGR in profits over FY14-17E.

Risk and Concerns

Regulatory Risk Steep price erosions in Domestic or US markets Delay in incremental approvals from USFDA Currency fluctuation


Price chart

Source: Bloomberg

Stock details

BSE code : 500124

NSE code : DRREDDY

Market cap (Rs mn) : 539,964

Free float (%) : 75

52 wk Hi/Lo (Rs) : 3662/2250

Avg daily volume : 157

Shares (o/s) (mn) : 170.20


Sales 145,347 166,985 187,120Growth (%) 11.0 14.9 12.1EBITDA 35,483 40,964 45,692EBITDA margin (%) 24.0 23.9 23.8PBT 27,988 34,146 38,105Net profit 21,803 26,601 29,687EPS (Rs) 128.1 156.3 174.4Growth (%) 11.06 22.01 11.60CEPS (Rs) 178.7 206.9 231.2BVPS (Rs) 564.7 695.4 844.2DPS (Rs) 22.0 22.0 22.0ROE (%) 25.5 24.8 22.7ROCE (%) 20.9 21.5 20.9Net debt 15,669 7,083 (5,765)NW capital (Days) 96.8 97.8 99.0P/E (x) 26.1 21.4 19.2P/BV (x) 5.9 4.8 4.0EV/Sales (x) 3.9 3.4 2.9EV/EBITDA (x) 16.1 13.7 11.9

Source: Company,



Source: ACE Equity

Promoter26%

FII

38%

MF/UTI3%

Bodies corporate

5%

Others28%



DOMESTIC FORMULATIONS - GAINING GROUNDS

Dr Reddy's commands ~2.15% (as per September 2014 AIOCD) market share inthe IPM and is a prominent player in the Gastro, Anti-Diabetic and CVS segments.DRL dervies 70% of its domestic revenues from acute ailments unlike peers likeLupin and Sun Pharma, wherein the acute is <40% of domestic revenues. Acuteailments being more seasonal in nature leads to lumpy revenues. Moreover thecompetition in the acute segment also restricts growth as compared to chronicailments. Hence, DRL's CAGR in the Domestic formulations segment has been at13% over FY09-14. Moreover the growth has been lumpy with a mere single digitgrowth in few years; growth for FY14 stood at ~8%. With a field force of 4,000MR's, DRL has well managed its product portfolio across India. DRL's top 10products today contribute ~30% of the domestic formulations revenues. DRLlaunches >20 products every year in domestic markets, in FY14, however, DRLlaunched 11 products.


Source: Industry Kotak Securities - Private Client Research

Chronic portfolio set ot increase led by launches


Domestic formulations segment to post 18% CAGR


DRL is trying to revive the domestic formulations seg-ment through new launches in the chronic segmentcoupled with increased marketing efforts. DRL expectsto continue the momentum in the segment with adouble digit growth.

DRL posted ~14% growth in the 1HFY15 due to lowbase. Moreover, the first half of the fiscal are the bestquarters for Dr. Reddy's due to seasonality and higheracute product basket.

On a low base of FY14, we expect DRL to post 15%growth in FY15E. In FY16E/17E, we expect the growthto be close to IPM growth at ~12%. Over FY14-17E weexpect DRL to post a CAGR of 13%.

S

0

5

10

15

20

25

30

0

5000

10000

15000

20000

25000Domestic form rev (Rs mn ‐ LHS)

Growth (% ‐ RHS)

CVS17%

Anti Diabetic8%

Resp5%

Gastro23%Pain

management9%

Derma7%

Anti infective7%

Stomatology4%

Vit/Min/Nut4%

Others16%



US FORMULATIONS - TRAJECTORY TO TAPER OFF A BIT

DRL was the first Indian company to file/launch an ANDA in the US market wayback in 1997/2001. DRL also was the first Indian company to get 180 day exclusivitymarketing rights for a generic drug in US with launch of Fluoxetine 40mg capsuleson Aug 3 2001. Moreover, DRL registered revenues of ~US$ 500 mn from US wayback in 2006 (led by limited competition launches of Zocor and Prascar), whereasthe peers were still in process of entering the US markets.

US is the largest contributor to DRL's revenues, with revenues of US$900mn in FY14(expected to post US$ 1.0bn+ revenues in FY15E), and has grown at 16% CAGRover FY09-14. So far, the growth was primarily driven by oral solids, but withincreasing base, highly competitive oral solid drugs will not be sufficient to drivegrowth. Hence, DRL has stepped up R&D efforts over the last 1-2 years, which isvisible in increased launches in the complex injectable space. DRL aims to achieve30% of its revenues from non-orals by FY17E. DRL posted a steep 30% growth inFY14 in US revenues. Growth was primarily led by FTF/limited competition productslike gVizada, gDacogen, gDepakote ER. Though the outlook for FY15E US launchesseems weak, outlook for FY16E and beyond looks interesting as we build few nichegenerics, limited competition (Copazone, Gleevec) and NDA (undisclosed by themanagement) products in the US markets. DRL is set to file the first NDA in 4QFY15and expects the approval by 4QFY16. Moreover, DRL has highlighted that non-oralsolids account for ~50% of its filings in the current year and 40% of total pendingapprovals. This throws light on DRL's product pipeline which could significantlyimprove US growth and EBIDTA margins.

33% of the ANDAs filings await approvals


DRL has maintained steady ANDA filing run rate


DRL’s US revenue growth to slow down


Expect 16% CAGR over FY14-17

DRL has maintained a steady ANDA filing rate for US mar-

kets with ~219 ANDAs filed and has approval for 147

ANDAs. Of the 72 pending ANDAs, 45 are Para IVs and 11

are FTFs DRL's increasing focus on the niche pipeline for

US markets does raise expectations. However, concen-

trated growth drivers (US - Copaxone, Gleevec) compared

to its peers (Sun, Lupin have a wider products basket to

drive growth) is concerning. We expect DRL to post 16%

CAGR in US revenues over FY14-17E.


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DRL has highlighted that non-oralsolids account for ~50% of itsfilings in the current year and

40% of total pending approvals

(Nos)

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Cumulative filings

Cumulative approvals



Copaxone launch, ahead of expectations could be a game changer

We expect DRL to launch Copaxone in 1HFY16, however, Copaxone launch aheadof expectations will be a key trigger. Copaxone is the largest selling drug of Tevapharma with revenunes of US$ 2.5bn. We expect Copaxone to be a limitedcompetition opportunity with only three generic players in the market. Copaxonegeneric can add ~Rs 400crs or Rs 24 to DRL's FY17E EPS.


Tentative launch Brand Generic name Brand Size USD mn

FY15E/16E Nexium Esomeprazole 2300

FY16E Nameda Memantine hydrochloride 1520

FY16E Aloxi Palonosetron 450

FY16E Nexium IV Esomeprazole 250

FY16E Norvir Ritonavir 385


FY16E Diprivan Propofol 212

FY16E Abilify Aripiprazole 4500

FY16E Zyvox Linezolid 250

FY17E Gleevec Imatinib 2000




RUSSIA

DRL derives 15% of revenues from the Russian pharma market (higher than DRL'scontribution from India - Domestic formulations). DRL has grown the Russianbusiness at ~28% CAGR over FY09-14 (in rupee terms). Moreover, DRL has ahealthy mix of OTC/prescription drugs at 37%/43%. The OTC contribution hassignificantly increased from sub 18% in FY10 to 37% in FY14. Top two drugs, Niseand Omez, contribute ~50% of DRL's Russian revenues, whereas top 10 drugsconstitute 73% of revenues.

DRL's Russian revenues were down 13% in 2QFY15 led by sharp depreciation inRussian rouble and high base. With Russian currency dipping further, we expectFY15E Russian revenues to degrow by 3% and revive back at 10% growth/per yrFY16E onwards. Overall, we expect DRL to post 5% CAGR in Russian revenues overFY14-17E.

RUB has depreciated ~60% in last one year


Russia to post 5% CAGR over FY14-17E


PSAI segment set to revive


Expect 8% CAGR over FY14-17E

PSAI segment had grown at 13% CAGR over FY09-13.However, the segment posted 22% de growth in FY14, ledby lower launches, price compression and stocking patternchanges. To combat de growth and sustain profitability,management is implementing a structural change with aconscious cut down on low margin supplies and increase inthe range of products with the inclusion of complex prod-ucts for emerging markets. In 1HFY15, PSAI segmentposted negative 3% growth. We expect the revival to begradual, we model 8% CAGR in segment over FY14-17E.


PSAI - PHARMACEUTICAL SERVICES AND ACTIVE INGREDIENTS

This segment includes active pharmaceutical ingredients and intermediaries (API),contract research services and sale of APIs with the specific customer requirements.DRL is the only company amongst its generic focused peers to have asignificant presence in CRAMS (contract manufacturing and researchservices).

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COMPANY BACKGROUND

Headquartered in Hyderabad, Dr. Reddy’s Laboratories Limited (DRL) is a leadinggeneric pharmaceutical company. Dr Reddy’s started its operation in 1984 in theActive Pharmaceutical Ingredients (API) segment, with a single drug in 60 tonnefacility near Hyderabad. In 1986 it shipped its first consignment to West Germany.Today, Dr Reddy’s, is a global pharmaceutical company, with presence in more than100 countries. It has subsidiaries in the US, UK, Russia, Germany and Brazil; jointventures in China, South Africa and Australia; representative offices in 16 countriesand third-party distribution set ups in 21 countries It is also the first pharmaceuticalcompany in Asia, outside Japan, to be listed on the NYSE. DRL was also the firstcompany to launch an authorized generic version in the US market in 2008.

The Company’s principle areas of operations

(1) Global Generics (GC) (80% of sales) - This segment relates to branded formu-lations/generics. US accounts for ~50% of the segment and 42% of overall rev-enues. This is the largest contributor to revenues, wherein, DRL manufacturesgeneric medicines with business spread across India, Russia, US and Germany. Itis amongst the top ten players in India.

(2) Pharmaceutical Services and Active Ingredients (PSAI) (18% of sales) -Under this DRL offers over 100 molecules to customers across the world. APIsare its core strength, with DRL having a wide range of products. It entered intothe custom pharmaceutical services (CPS) in 2001 and acquired Roche's APImanufacturing unit Mexico in 2005to strengthen the segment. DRL also ac-quired the small molecule business of Dow Pharma at its Mirfield and Cam-bridge sites, UK in 2008, further strengthening its CPS business.

(3) Proprietary Products (PP): (2% of sales) - This segment involves the discoveryof new chemical entities for subsequent commercialization and out-licensing. Italso involves the Company's biosimilar business and differentiated formulation.DRL has launched biosimilars - Grafeel (Filgrastim), darbepoetin alfa andReditux(Rituximab) in India.

FY14 – Revenue break – up

Source: Company




On the business model front, DRL lags its peers due to its higher dependence on theUS markets (42% contribution to revenues) for growth and limited presence on thedomestic formulations segment (12% contribution to revenues). However, DRLspends the highest on the R&D compared to peers (Rs 1,260 crs in FY14) andhas planned to spend ~US$150mn/350mn on biological / proprietary products (PP)over the next 3/4 yrs. We believe this can open up immense limited competitionopportunities for DRL over the next 5-7 years, but the risk remains high. Moreover,products like Copaxone (US$ 2.5bn market) can potentially add Rs 400crs/Rs 24.0to DRL’s FY17E EPS. Hence we maintain our positive stance on the company.

DRL has posted 14% CAGR in revenues from FY09-14 mainly led by USformulations. Moreover, the sharp increase in EBIDTA margins from ~19% to 24%led to a whopping 51% CAGR in APAT over FY09-14. Going ahead we expect DRLto post comparatively muted CAGR of 12.6% in revenues, as we expect PSAI andRussia to post tepid growth. On margin front, in spite of high margin launches likeCopaxone (50% NPM) from FY16E onwards, we expect flat margins for DRL at~24% due to inflating R&D expense. Hence we expect DRL to post 15% CAGR inprofits over FY14-17E.

We initiate coverage on DRL with an ACCUMULATE rating, with a TP of Rs 3662,21x FY17E EPS of Rs 174.4.

One yr fwd P/E


0.0

10.0

20.0

30.0

40.0

Apr‐05 Apr‐06 Apr‐07 Apr‐08 Apr‐09 Apr‐10 Apr‐11 Apr‐12 Apr‐13 Apr‐14

We initiate coverage on DRLwith an Accumulate rating,

with a TP of Rs 3662, 21xFY17E EPS of Rs 174.4



FINANCIAL SUMMARY

Revenues to grow at ~13% CAGR


APAT to post ~15% CAGR


Margins to rise led by niche launches


Return ratios's to remain strong






0

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21

28

35

RoCE (%) RoE (%)



RISK AND CONCERN

Regulatory Risk - The US business contributes 42% of revenues. Any USFDAregulatory risk can be critical for the company.

Steep price erosions in Domestic or US markets – US has been witnessingprice erosion due to channel consolidation. We have assumed price erosions inour modelling, however, any steep price erosions can impact Rev/PAT signifi-cantly.

Delay in incremental approvals from USFDA – DRL’s approvals for nicheproducts like Copaxone and Gleevec will be a key catalyst for growth. Any de-lay in approvals can impact the Rev/PAT significantly.

Currency fluctuation – DRL is already witnessing growth concerns in Russia ledby currency depreciation. Further depreciation in key currencies can impact Rev/PAT significantly.



FINANCIALS: DR REDDYS LABORATORIES LTD



Revenues 130,895 145,347 166,985 187,120

% Change YoY 14.6 11.0 14.9 12.1

EBITDA 32,508 35,483 40,964 45,692

% Change YoY 24.2 24.0 23.9 23.8

Other Income 1,697 2,159 2,375 2,612

Depreciation 6,475 8,145 8,615 9,658

EBIT 27,730 29,497 34,724 38,646

% change YoY 19.6 6.4 17.7 11.3

Interest cost 1,267 1,034 578 541

Exceptional items 0 (475) 0 0


% change YoY 22.2 5.8 22.0 11.6

Tax 6,831 6,185 7,545 8,418

as % of PBT 25.8 22.1 22.1 22.1

Net Income 19,632 21,803 26,601 29,687

% change YoY 28.6 11.1 22.0 11.6


EPS (reported) (Rs) 115.3 128.1 156.3 174.4

CEPS (Rs.) 153.4 178.7 206.9 231.2

DPS (Rs) 20.0 22.0 22.0 22.0




EBT 26,463 27,988 34,146 38,105

Depreciation 6,475 8,145 8,615 9,658

Change in WC (18,112) (5,963) (9,202) (8,984)

Taxes Paid (6,831) (6,185) (7,545) (8,418)


Capex (13,112) (12,839) (12,903) (12,973)

Change in Investments (1,440) (573) (666) (738)

Dividends (3,955) (4,351) (4,351) (4,351)

CF from investmts (18,507) (17,763) (17,920) (18,062)

Proceeds from issue of eq 2 - - -

Inc/(dec) in debt 13,012 (3,295) (2,811) (2,500)

Deftax credit /other adj. 333 (240) 493 549

CF from financing 13,347 (3,535) (2,318) (1,951)

Opening cash 20,171 23,006 25,693 31,468

Closing cash 23,006 25,693 31,468 41,816


Balance sheet




Inventories 24,188 25,884 29,737 33,323


Others 11,821 14,937 18,064 21,204

Current Assets 103,257 114,440 133,739 157,105

Deferred tax assets 1,917 2,253 2,663 3,120

LT Investments 4 9 10 10

Net Fixed Assets 52,796 57,489 61,778 65,092

LT loan and advances 2,322 2,554 2,810 3,091

Total Assets 160,296 176,745 200,999 228,418

Payables 18,218 19,911 22,875 25,633

Others 7,627 7,686 8,175 8,703

Short term Provisions 8,157 8,938 9,806 10,555



Total Debt 44,657 41,362 38,551 36,051

Other long term liabilities 1,181 587 613 640

Long term provisions 563 581 639 703

Equity 851 851 851 851

Reserves 77,801 95,253 117,502 142,838


BVPS 462.12 564.65 695.38 844.24


Ratio Analysis


EBITDA margin (%) 24.2 24.0 23.9 23.8

EBIT margin (%) 21.2 20.3 20.8 20.7

PAT margin (%) 15.0 15.0 15.9 15.9


Inventory (days) 67.4 65.0 65.0 65.0


Sales/assets (x) 1.0 1.0 1.0 1.0



ROE (%) 27.6 25.5 24.8 22.7

ROCE (%) 21.8 20.9 21.5 20.9

EV/ Sales (x) 4.44 3.94 3.36 2.91

EV/EBITDA (x) 17.9 16.1 13.7 11.9







Lupin Ltd



Lupin Ltd is our preferred pick in the pharma space given its (1) robustproduct pipeline for the US, (2) attractive return ratios, (3) enhancing focuson the complex generics and (4) steady growth in domestic formulations.Management has set an inspirational target of USD 5bn sales to beachieved by FY19E (inorganic + organic), which translates into a CAGR of23% for FY14-19E. Management has also indicated its plan to achieve NPMof 20% by FY18E which translates into an impressive CAGR of 27% in PAT.The set target includes inorganic expansion, at organic level we expectLupin to post 17/21% CAGR in Rev/PAT over FY14-17E.


Domestic formulations rock steady - Lupin's strong product portfolio in thedomestic market has led to an impressive double digit growth for the last eightyears, barring FY14, wherein LPC posted a mere 4% growth led by NLEM anddiscontinuation of 2 products. However, with ~60% contribution from chronicsegment, we expect the segment to revive back and log 18% CAGR overFY14-17E.

US to deliver robust growth - Lupin has received 22 product approvals overlast one year against its earlier average of <10, its product basket has alsotilted towards lower competitive areas like OC's and Opthal. Lupin's gradualshift towards a specialty focused company and ~100 pending ANDAs will bethe key growth drivers. We expect US generics to register 21% CAGR whereasoverall US revenues (inc. branded segment) are expected to post 19% CAGRas we expect muted growth in the branded segment.

Japan to remain steady and gradual driver - Lupin is ahead of its peers inan otherwise difficult Japan market due to its timely acquisitions. We expectsubsidiary Kyowa to register 14% CAGR over FY14-17E. I'rom, LPC's secondsubsidiary focusing on hospital segment has been facing pressures due to loweroff-take in the contract manufacturing segment (~40% contribution to I'romrevenues). We expect I'rom to post 6% CAGR over FY14-17E. Overall, includ-ing both subsidiaries, we expect Japan revenues to post 12% CAGR over FY14-17E.

Valuations and view We expect Lupin to post a CAGR of 17%/22% in Rev/PAT over FY14-17E. Lu-

pin currently trades at 20x its FY17E EPS, which is around its 5 years averageP/E. Given the interesting product basket in US and the steady domestic for-mulations growth, we expect Lupin to trade at a higher multiple of 24x. InitiateBUY with a TP of Rs 1,775, 24x FY17E EPS of Rs 73.9.

Risk and Concerns

Delay in incremental approvals from USFDA

Expensive inorganic expansion

Steep price erosions in Domestic or US markets

Regulatory risk


One-year performance (Rel to Sensex)

Source: Bloomberg

Stock details

BSE code : 500257

NSE code : LUPIN


Free float (%) : 55

52 wk Hi/Lo (Rs) : 1500/855

Avg daily volume (OOO's) : 150

Shares (o/s) (mn) : 448.40


Sales 133,694 154,736 178,333Growth (%) 21.4 15.7 15.2EBITDA 38,927 46,798 54,852EBITDA margin (%) 28.7 29.7 30.2PBT 36,565 42,882 50,079Net profit 24,681 28,902 33,753EPS (Rs) 54.1 63.3 73.9Growth (%) 3203% 1710% 1678%CEPS (Rs) 64.2 74.8 86.7BVPS (Rs) 201.6 257.8 322.9DPS (Rs) 6.0 6.0 7.5ROE (%) 30.4 27.6 25.5ROCE (%) 36.2 33.7 31.7Net debt (11,854) (25,250) (43,030)NW capital (Days) 112.8 122.8 128.4P/E (x) 27.6 23.5 20.2P/BV (x) 7.4 5.8 4.6EV/Sales (x) 4.9 4.1 3.4EV/EBITDA (x) 16.7 13.5 11.1

Source: Company,



Source: ACE Equity

Promoter47%

FII32%

MF/UTI5%

Bodies corporate

2%

Others14%



DOMESTIC FORMULATIONS - REVIVING BACK

Lupin commands 3.35% (as per September 2014 AIOCD) market share in the IPMand is a prominent player in the CVS, anti-Asthma and anti-TB segments. Lupinonce known as an anti-TB company, with 50% contribution to its domestic revenuesin 2001, has come a long way since then. Today 63% of LPC’s domestic revenuesare from drugs targeting chronic ailments. Lupin’s strong product portfolio in thedomestic market has led to an impressive double digit growth for the last eightyears, baring FY14, wherein LPC posted a mere 4% growth led by NLEM (DPCOaccounts for 30% of Lupins domestic revenue) and discontinuation of 2 products.However, with 63% contribution from chronic segment, we expect the segment tolog 18% CAGR over FY14-17E.

With a field force of 4,800 MR's, LPC has well managed its product portfolio acrossIndia. LPC's strong brand building capability has not only built a strong domesticfranchise but has also led to well diversified portfolio. LPC's top 10 products todaycontribute a mere 20% of the domestic formulations revenues, the best acrossindustry.

Chronic therapies contribute 63% of domestic formulation revenues


Chronic focussed product basket




Growth reviving back

On an average Lupin launches 20-25 products per year.

Apart from product launches, Lupin also focusses on

launching products in India through marketing tie ups with

large MNC companies. Lupin’s deal with Eli Lilly to market

the latter’s diabetic drugs in India is amongst the latest

deals. Consistent product launches, strong marketing

strategies and tie-ups with MNC’s will drive robust growth

in the segment. We expect LPC to revive back to its earlier

growth levels and post 18% CAGR in the segment over

FY14-18E.


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FY06 FY08 FY10 FY12 FY14 FY16E

Domestic form rev (Rs mn ‐ LHS)

Growth (% ‐ RHS)

Acute36%

Chronic64%

CVS23%

CNS4%

Anti Ashtma10%

Anti Diabetic15%

Gyneac4%

Anti TB8%

Anti Infective15%

GI8%

Others13%



US FORMULATIONS - THE GROWTH ENGINE

Lupin entered the US generic formulations space in FY06 and was amongst the veryfew companies to break even in the very first year of operations. It increased itsrevenues at 47% CAGR in the past eight years from US$79mn to US$ 802mn.Lupin's US revenues are split into generic (~90% of sales) and branded (~10% ofsales) segments. Branded segment includes one major brand - Suprax (~US $ 80mnrevenues) and few newly acquired brands (with <US $5mn revenues each).

LPC's generic business has been the growth engine and will remain a key catalystover the coming years. Product selection and backward integration have beenLupin's key strengths in its US generic portfolio. Since 2009, Lupin has increased itspace of ANDA filings with consistent filing of 25-30 ANDA every year (vs. avg 10-12filings in past years). Moreover, the focus on niche therapeutic areas like oralcontraceptives (OC) and Opthal's also enhanced significantly, OC's (>30 filed)/Opthal (~10 filed). The shift in strategy not only lead to increased launches - 22launches in FY14 (vs. avg launches of 10-12 ANDA launches/per yr) but alsoimproved profitability due to niche launches (Lupin markets 13/1 OC's/Opthals as of1HFY15). LPC has also indicated towards entering lucrative areas like nasal sprays,complex Injectables, controlled substance and Dermatology for the US marketswhich will further enhance the profitability. Lupin filed 111 ANDAs in the last fouryears (highest among Indian peers) and currently has ~100 pending approvals ofwhich 21 are FTF, including 9 sole FTF's

LPC’s 50% of US filings await approval


Increased ANDA filings has led to higher approvals


LPC’s US revenues to grow at 19% CAGR


Generic revenues taking a large share


0

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50 79179 273

348441 494

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Lupin’s gradual shift towards a specialty focused company and ~100 pendingANDAs will be the key growth driver. We expect US generics to register 21% CAGRand overall US revenues (inc. branded segment) are expected to post 19% CAGRas we expect muted growth in the branded segment.



FY15E Namenda Memantine hydrochloride 1000

FY15E Detrol LA Tolterodine 300

FY15E/16E Renagel Sevelamer hydrochloride 200

FY15E/16E Renvela Sevelamer hydrochloride 350

FY15E/16E Apriso Mesalamine 50

FY15E/16E Nexium Esomeprazole 2700

FY16E Welchol Colesevelam hydrochloride 350


FY16E Glumetza Metformin hydrochloride extended release tablets 50

FY16E Loestrin® 24 Fe Norethindrone acetate and ethinyl estradiol tablets and

ferrous fumarate tablets 86

FY16E Coreg CR Carvedilol 250

FY17E OTC Lo Norgestimate and ethinyl estradiol 400

FY17E Prezista Darunavir 400

FY17E Nuvigil Armodafinil 300

FY17E Vimovo Naproxen and esomeprazole 60




Japan - a gradual moverLupin is the only Indian player with a significant presence in Japan’s generic pharmaspace. The company entered Japan with the acquisition of Kyowa in FY07. Kyowawas amongst the Top-10 generic companies with strengths in psychiatric andneurological drugs. Later in FY12, Lupin entered Japan’s specialty injectable spacewith the acquisition of I’rom. The ~US$115 bn Japanese pharmaceutical market isthe third largest in the world, but the generic penetration in Japan is the lowest at~5%. The generic penetration (by value) in Japan is expected to rise from ~5% in2013 to 9% in 2015 with US$9bn worth of products going off-patent in the next 3years. Apart from the revenue growth through launches, Lupin has also beenfocusing on enhancing its profitability in Japan by shifting its supplies to India.

Japan pharma regulator (PDMA) has gone for a blanked price cut (~12%) earlierthis year (CY14). However, LPC has been sailing through firmly (since FY08) amidstprice cuts (which happens every three years) and has managed to post healthygrowth of 14% CAGR over FY09-14 and expects to maintain the trajectory

We expect subsidiary Kyowa to register 14% CAGR over FY14-17E led by betterpenetration of generics in Japanese pharma market as well as new launches.However, I’rom, LPC’s second aubsidiary focusing on hospital segment has beenfacing pressures due to lower off-take in the contract manufacturing segment(~40% contribution to I’rom revenues), we expect I’rom to post 6% CAGR overFY14-17E. Overall, including both subsidiaries, we expect Japan revenues to post12% CAGR over FY14-17E.

Kyowa to lead growth

Source: Company

0

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8,000

12,000

16,000

20,000 Kyowa ‐ Japan (Rs mn) Irom ‐ Japan (Rs mn)



Quarterly financial snapshot

Quarterly performance


Net Revenues 26,315 29,830 30,516 32,840 31,168 18.4 (5.1)

Material Expenses 8,413 10,659 9,804 11,074 10,488 24.7 (5.3)

Employee Expenses 3,682 3,787 3,896 4,103 4,389 19.2 7.0

Other Operating Expenses 5,816 5,030 6,280 4,864 5,007 (13.9) 2.9

Research and Development expenses 2,172 2,710 2,456 2,439 2,848 31.1 16.8

Operating Profits 6,232 7,643 8,080 10,360 8,437 35.4 (18.6)

Other Operating Income 364 390 690 568 566 55.4 (0.4)

EBITDA 6,596 8,033 8,769 10,928 9,002 36.5 (17.6)

Interest Cost 49 42 122 26 21 (56.4) (18.1)

Depreciation 606 637 743 1,086 1,087 79.3 0.1

Other Income 100 69 52 289 255 156.4 (11.6)

Net forex gain/(loss) 714 (45) (830) 220 170 (76.2) (22.7)

PBT 6,755 7,379 7,127 10,325 8,320 23.2 (19.4)

Tax 2,582 2,542 2,327 4,029 1,926 (25.4) (52.2)

RPAT 4,173 4,837 4,800 6,296 6,394 53.2 1.6

Minority interest (111) (76) (100) (49) (94) (15.6) 91.2

Reported PAT 4,062 4,761 5,530 6,247 6,300 55.1 0.9

E/o (adj for tax) (441) 30 587 (134) (131) (70.4) (2.6)

APAT 3,621 4,791 6,117 6,113 6,170 70.4 0.9


Revenue mix

((Rs mn) 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 YoY (%) QoQ (%)

Formulations 23,942 26,857 27,601 29,915 27,985 16.9 (6.5)

- Domestic Formulations 6,635 6,504 5,763 7,615 7,990 20.4 4.9

- US formulations 10,349 13,567 14,699 16,055 12,716 22.9 (20.8)

- Japan formulations 3,098 3,720 3,218 3,415 3,459 11.7 1.3

- Europe formulations 741 661 795 690 876 18.2 27.0

- Other EM formulations 3,119 2,405 3,126 2,140 2,944 (5.6) 37.6

API 2,392 2,973 2,914 2,925 3,183 33.1 8.8

Revenues* 26,334 29,830 30,515 32,840 31,168 18.4 (5.1)

Source: Company, Kotak Securities - Private Client Research *FY14 revenues includes IP income of Rs 1,523

LPC's 2QFY15 US revenues were a blip compared to its robust performance in thepast. Though management cited competition and seasonality as reasons for lowerUS revenues, pick-up in the coming quarters will be closely watched. LPC expectsgrowth to revive led by 10-15 ANDA launches in 2HFY15. Margins too weredisappointing, especially post last quarter's commentary on improving efficiencies.However, management expects to close the fiscal with ~28-30% EBIDTA marginsand an increase of ~100bps every fiscal from thereon. On the positive side, LPC'sstrong domestic formulations growth (at 20%) for the second straight quarter iscommendable




Lupin logged robust 26% CAGR in net sales in the last eight years (FY06-14)increasing from Rs 17,503mn in FY06 to Rs 110,148 mn in FY14 primarily aided byshift in focus from API's to formulations and extending its geographical presenceoverseas and lesser dependence on domestic markets. Margins have also expandedfrom 16.5% in FY06 to 26.6% in FY14 despite the increase in R&D spend (from~6% of sales in FY06 to ~9% of sales in FY14) owing to better product mix andhigher efficiencies. Lupin has managed to maintain a healthy cash flow in spite of aCAGR of 23 % in gross block over FY08-14. Company has also improved its net D/E ratio from 0.7x in FY06 to a cash positive status in FY14.

Going ahead we expect Lupin to continue its trajectory primarily driven by USANDA launches, strong domestic franschise, steady growth in Japan and efforts totarget niche / low competition opportunities. We expect Lupin to post a CAGR of17%/22% in Rev/PAT over FY14-17E. We initiate coverage on Lupin with a positiveview on the stock. Lupin currently trades at 20x its FY17E EPS, which is around its5 years average P/E. Given the interesting product basket in US and the steadydomestic formulations growth, we expect Lupin to trade at a higher multiple of 24x.Initiate BUY with a TP of Rs 1,775, 24x FY17E EPS of Rs 73.9.

One year forward P/E band




FINANCIAL SUMMARY





Margins to improve led by improving efficiencies


Return ratio's to slide slightly due to lower asset turnovers




Net D/E to turn negative led by better cash flows


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RISK AND CONCERNS

Delay in incremental approvals from USFDA – LPC >50% (~100 ANDAs of190 ANDAs filed) pipeline awaits approval from USFDA and will be a key cata-lyst for growth. Any delay in approvals can impact the Rev/PAT significantly.

Expensive inorganic expansion – LPC has been indicating its intent for acqui-sitions in US/emerging/India markets. Any expensive valuations can impact thevaluations of company.

Steep price erosions in Domestic or US markets – US has been witnessingprice erosion due to channel consolidation. We have assumed price erosions inour modelling, however, any steep price erosions can impact Rev/PAT signifi-cantly.

Regulatory Risk - The US business contributes 44% of revenues. Any USFDAregulatory risk can be critical for the company.

COMPANY BACKGROUND

Lupin was founded by Desh Bandhu Gupta in 1968 and it became the first companyfrom India to manufacture anti-TB APIs. Even today Lupin is known as the world’slargest manufacturer of the anti-TB drugs. Lupin has come a long way from beingan anti-TB drugs manufacturer to a leading pharmaceutical company with notablemarket share in the cardiovascular, diabetology, asthma, pediatrics, CNS, GI, anti-Infectives and NSAIDs therapy segments. Lupin also exports a wide range ofgeneric, branded formulations and APIs to the developed as well as developingmarkets of the world. Lupin has distinguished itself as being a unique player with adifferent business model compared to peers. The key difference is the brandedformulation business in the US (10% of US revenues). It was also the first companyfrom India to enter the Japanese pharma market and as of date has significantpresence in oral dosages as well as injectables. The company currently has 12manufacturing plants, of which two are in Japan and ten in India.

FY14 Revenue breakup

Source: Company



FINANCIALS: LUPIN LTD



Revenues 110,866 133,694 154,736 178,333

% Change YoY 16.8 21.4 15.7 15.2

EBITDA 30,028 38,927 46,798 54,852

% Change YoY 32.3 29.6 20.2 17.2

Other Income 1,165 1,881 949 626

Depreciation 2,610 4,128 4,618 5,134

EBIT 28,583 36,680 43,128 50,344

% change YoY 45.4 28.3 17.6 16.7

Interest cost 267 115 246 265


% change YoY 47.1 29.1 17.3 16.8

Tax 9,622 11,884 13,979 16,326

as % of PBT 34.0 32.5 32.6 32.6

Net Income 18,694 24,681 28,902 33,753

% change YoY 39.5 32.0 17.1 16.8


EPS (reported) (Rs) 41.0 54.1 63.3 73.9

CEPS (Rs.) 47.5 64.2 74.8 86.7

DPS (Rs) 6.0 6.0 6.0 7.5




EBT 28,316 36,565 42,882 50,079

Depreciation 2,610 4,128 4,618 5,134

Change in WC (5,574) (9,537) (10,775) (10,678)

Taxes Paid (9,622) (11,884) (13,979) (16,326)


Capex (6,098) (5,429) (6,440) (6,784)

Change in Investments 140 (167) (175) (184)

Dividends (3,169) (3,169) (3,169) (3,962)



Inc/(dec) in debt (5,108) (803) 422 465

Def tax credit /other adj. 2,130 (91) 435 500

CF from financing (2,976) (894) 857 964

Opening cash 4,349 7,975 17,589 31,407

Closing cash 7,975 17,589 31,407 49,652


Balance sheet




Inventories 21,295 25,640 29,675 34,201


Others 4,077 9,308 14,563 19,843

Current Assets 61,005 85,159 113,210 146,797

Deferred tax assets 708 715 722 730


Net Fixed Assets 30,018 31,319 33,140 34,790

Goodwill 6,579 6,579 6,579 6,579


Total Assets 102,060 127,682 157,730 193,151

Payables 15,941 20,146 23,316 26,872

Others 1,872 1,627 1,782 1,952




Total Debt 6,537 5,735 6,157 6,622

Other long term liabilities 459 527 606 697

Long term provisions 1,325 982 1,081 1,189

Equity 897 897 897 897

Reserves 68,419 89,494 114,715 143,909

Minority interest 669 1,106 1,618 2,216


BVPS 154.58 201.58 257.83 322.94


Ratio Analysis


EBITDA margin (%) 26.6 28.7 29.7 30.2

EBIT margin (%) 25.8 27.4 27.9 28.2

PAT margin (%) 16.6 18.1 18.3 18.6


Inventory (days) 70.1 70.0 70.0 70.0


Sales/assets (x) 1.1 1.0 1.0 0.9



ROE (%) 30.3 30.4 27.6 25.5

ROCE (%) 35.4 36.2 33.7 31.7

EV/ Sales (x) 6.0 4.9 4.1 3.4

EV/EBITDA (x) 22.1 16.7 13.5 11.1







Sun Pharma

PRICE: RS.927 RECOMMENDATION: ACCUMULATETARGET PRICE: RS.1026 FY17E P/E: 23.2X


Sun Pharma is a class apart in the Indian pharma space given its nicheproduct portfolio, cash rich balance sheet, and most importantly its abilityto consistently manage superior performance. Moreover, the recently an-nounced intent to acquire Ranbaxy labs gives Sun an incremental opportu-nity to create value out of the regulatory issues and debt ridden company.We expect Sun to post 17% growth in revenues (ex-Ranbaxy) for FY14-17E,whereas adjusted profits are expected to grow at 16% CAGR post factor-ing margin dilution in Sun's high margin US products. However, the recentFDA issues on Halol plant will keep the stock under pressure in near term.We initiate coverage on Sun Pharma with a positive view and recommendACCUMULATE with a TP of Rs 1,026, 24x FY17E EPS and an NPV of Rs 70(for Tildrakizumab).

Key Investment Rationale Domestic formulations - riding high - Sun has registered resilient growth

year over year in the domestic formulations segment led by strong brandingand core focus on the chronic ailments. High sales force productivity, lowDPCO exposure, low product concentration and focus on in-licensing (Sun hasa marketing partnership with MSD (Merck) to co-market latter's diabetesdrugs in India) are key differentiators of Sun's domestic business. Going ahead,we expect the trajectory to continue, led by product launches, marketing tieups and better penetration. We expect Sun to post 17% CAGR in the segmentover FY14-17E.

US formulations - trajectory to continue - Sun's US revenues are split be-tween Sun (ex-Taro) and Taro (the acquired subsidiary). The outlook on bothsub segment remains buoyant. Gleevec and Nexium IV are the key launches tobe closely watched for Sun (ex - Taro), whereas sustained price increase andincremental launches in the derma space will drive Taro revenues and profit-ability. Overall we believe, US will remain the growth engine for Sun and ex-pect an 18% CAGR in US revenues over FY14-17E.

Rich pipe getting richer - In Sep-14, SUNP had announced the acquisition ofworldwide rights of Tildrakizumab, which is currently being evaluated in Phase-3 trials for treatment of Psoriasis, for an upfront payment of US$80mn. SUNPhas indicated at incurring an additional US$250mn on the molecule over aperiod of five years. The Psoriasis market in US is currently valued ~US$6.0bn.We incorporate an NPV of Rs 70 in our model for Tildrakizumab, with an ex-pected launch by FY20E and peak revenues of US$1.9bn

Outlook We expect Sun (ex-Ranbaxy) to post 17%/16% CAGR in revenues/APAT over

FY14-17E. Margins are expected to taper off by 270bps as we expect pricingpressure to build in Sun's key products. Regulatory issues at Halol plant (Halolcontributes ~40% to Sun's US revenues and ~25% to Sun's profits) will remainan overhang for the stock in near term. We initiate coverage on Sun Pharmawith a positive view and recommend ACCUMULATE with a TP of Rs 1,026,24x FY17E EPS and an NPV of Rs 70 (for Tildrakizumab).

Risk and Concerns Price erosions in Taro's products Delay in incremental approvals from USFDA Steep price erosions in Domestic or US markets Regulatory Risk


Price chart

Source: Bloomberg

Stock details

BSE code : 524715

NSE code : SUNPHARMA

Market cap (Rs mn) : 1712882.4

Free float (%) : 40.0

52 wk Hi/Lo (Rs) : 932/552.5




Sales 189,202 221,498 255,936Growth (%) 17.7 17.1 15.5EBITDA 81,806 93,678 103,691EBITDA margin (%) 43.2 42.3 40.5PBT 81,058 91,313 102,615Net profit 65,046 73,442 82,696EPS (Rs) 31.4 35.5 39.9Growth (%) 33.4 32.5 31.6CEPS (Rs) 34.3 38.6 43.3BVPS (Rs) 121.0 156.2 195.2DPS (Rs) 2.5 3.0 4.0ROE (%) 29.9 25.6 22.7ROCE (%) 34.8 30.4 27.3Net debt (94,026)(145,487) (203,536)NW capital (Days) 149.8 163.7 174.2P/E (x) 29.5 26.1 23.2P/BV (x) 7.7 5.9 4.7EV/Sales (x) 9.7 8.0 6.7EV/EBITDA (x) 22.3 18.9 16.6

Source: Company,



Source: ACE Equity

Promoter64%

FII23%

MF/UTI4%

Bodies

corporate3%

Others6%



DOMESTIC FORMULATIONS - RIDING HIGH

Sun commands 4.9% (as per September 2013 AIOCD) market share in the IPM andis a prominent player in the CVS, CNS and Anti-Diabetic segments. Sun is a chronicfocused company and these contribute 63% - to domestic revenues. Sun hasconsistently maintained the leadership position in 7 classes of specialists -psychiatrists, neurologists, cardiologists, ophthalmologists, orthopedicians,nephrologists, and gastroenterologists. Moreover, 50% of total 500 brands featureamong top-3 in their respective segments. Sun's brand building capabilities andproduct selection have been key for a stellar CAGR of ~18% over FY07-14.

Sun's field force productivity (Rs mn/per Medical representative - per yr) is thehighest in industry at Rs 8.2mn/per yr compared to industry average of Rs 3.0mn/peryr. Sun's DPCO exposure also stands lowest at <10% compared to IPM exposure of~30%. With a field force of 4,500 MR's, Sun has well managed its product portfolioacross India. Sun's top 10 products today contribute a mere 21.5% of the domesticformulations revenues, second best in the industry after Lupin.

CNS is the largest franchise


Product basket skewed towards chronic portfolio




Sales force productivity Rs mn/RM/Per yr


Sun has registered resilient growth year over year in the domestic formulationssegment led by strong branding and core focus on the chronic ailments. High salesforce productivity, low DPCO exposure, low product concentration and focus on in-licensing (Sun has a marketing partnership with MSD (Merck) to co-market latter'sdiabetes drugs in India) are key differentiators of Sun's domestic business. Goingahead we expect the trajectory to continue led by product launches (on an averageSun launches ~30 products in the domestic market), marketing tie ups and betterpenetration (gradual increase in MR). Moreover, the chronic therapies like CVS,CNS, and Anti Diabetic are expected to register 16-18% growth (IMS forecast). Weexpect Sun to post 17% CAGR in the segment over FY14-17E.

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CVS18%

Anti Diabetic12%

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Gastro14%

Gynaec.8%

PM5%

Ophthal5%

Others7%

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Acute39%



Post Sun-Ranbaxy merger, the combined entity will have revenues of ~Rs7,700crs from Domestic formulations and Sun Pharma will be the largest drugmaker in the country with a market share of ~9%. Due to concerns on high marketshare for certain products post the merger, the CCI has asked Sun as well asRanbaxy to sell 7 brands to ensure no monopoly. Out of the 7 products, 1 belongs toSun. The combined revenues of these drugs is ~Rs137crs, as per AIOCD. Theimpact of selling these brands will be non-material on the combined entity.



US FORMULATIONS (EX-TARO) - TRAJECTORY TO CONTINUE

Sun Pharma made its first foray into the US generics in 1997 with the acquisition ofCaraco Pharma. (Later in 2011 Sun made Caraco its wholly owned subsidiary). Sunhas made several acquisitions in the US (Intrexon JV, Caraco, Taro, URL, and DUSA)over the years which along with organic growth has led its US revenues to swellfrom US$ 0.8 mn in FY97 to US$ 1,620mn in FY14.

Sun today has capabilities in segments ranging from derma (through Taro), brandedspecialty (through Dusa), injectables, nasal, controlled-substances and complex oralsolid drugs which has led Sun to post highest profitability (EBIDTA margins of >40%)amongst peers.

Sun's growth in recent years (48% CAGR over FY11-14) has been driven by limitedcompetition opportunities (Doxil - US$300mn mkt and Doxycycline - US$150mnmkt) and FTFs (Prnadin - US$250mn mkt). Sustainability of these high marginrevenue streams has been a concern for Sun's (ex-Taro) US business. While we donot rule out competition in Prandin and Doxycycline, we do expect Doxil to remaina limited competition opportunity for Sun.

Doxil is a US$300mn market and contributed ~US$150mn (or 9%) (our estimates)to Sun's US revenues in FY14. Doxil is used mainly for the treatment of ovariancancer and is manufactured by J&J. J&J has been facing supply constraints since2011 due to regulatory issues at its Ben Venue Labs manufacturing plant (BenVenue is the manufacturing partner for J&J) which had led to shortage of the drug inUS markets. Sun is the only approved (approved in Feb-13) generic player for thiscomplex injectable drug. We do not foresee any significant competition on the drugfor the next 2-3 years and hence believe it will continue to remain of high marginopportunity for Sun.

27% of Sun's ANDAs await approval


Sun files 20-25 ANDAs per year


Expect Sun to post 18% CAGR over FY14-17E


Gleevec and Nexium IV - key launches in near termOver last 2-3 years Sun's (ex-Taro) US revenues haveshown impressive growth led by limited competition/FTFs.Though we do not rule out Sun's growth trajectory to taperoff a bit, we still remain optimistic and expect US segmentto remain a key catalyst for Sun. Growth will be driven bynew launches including few injectables, complex oralsolids and nasals, which will unfold in coming years.Gleevec and Nexium IV are the key launches to be closelywatched. These new launches will more than offset therevenue loss from Prandin and Doxycycline. Post factoringthe revenue loss from key drugs as well as incrementalrevenues from new launches we expect Sun to post 18%CAGR over FY14-17E.


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ANDA Filed ANDA Approved

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FY15 Nexium I.V Esomeprazole sodium I.V. 250

FY15E/16E YAZ Drospirenone & ethinyl estradiol 350

FY15E/16E Yasmin Drospirenone & ethinyl estradiol 300

FY15E/16E Reclast Zoledronic acid 350

FY16 Ortho Tri-Cyclen® Lo Norgestimate and ethinyl estradiol 425

FY16 Gleevec Imatinib 2000

FY16 Abilify Aripiprazole 4500

FY16 Precedex Dexmedetomidine hydrochloride injection 250

FY16E/FY17E Focalin XR dexmethylphenidate 400

FY17E Crestor Rosuvastatin calcium 5000

FY17E/FY18E Alimta Pemetrexed disodium 1000




TARO - MORE TO COME

Taro is the leader in the dermatology generic market in the US and was acquired bySun in 2010. Taro has not only added traction with 57% CAGR in revenue overFY11-14 but accounts for one-third of Sun's profits. Taro has benefited through aprice increase taken in the dermatology drugs. The Derma generic market in theUS is very concentrated with the top three players (Taro, Perrigo and Fougera)accounting for ~65% of the market. The Derma generic market in the US hastripled in the past five years from US$ 800mn to US$ 2,500mn. The growth in thederma generic market was largely driven by price increases. Taro's managementhas time and again cautioned that such price increase may not sustain, but Taro'sstupendous trajectory has been maintained year over year. With not many players inthe derma space, we expect the price increases to sustain for the next 1-2 years.Moreover Taro's ANDA filings run-rate has also picked up in the last three yearsand as of FY14, Taro has 27 ANDAs pending for approval. We expect Taro's ANDAsto fructify from FY16E onwards, which would drive the next leg of growth.

Taro has consistently improved the profitability


Taro's ANDA filing run-rate has picked up in last 3 years


Taro to post 15% CAGR over FY14-17E


Taro contribution to come down gradually in Sun's US revenues


Additionally, the dermatology market in the US is set to see multiple patent expiry'swhich will open up new avenues for Taro. Dermatology drugs worth US$700mn areset to expire between CY2015E-16E. With new avenues for growth through patentexpiry's and Taro's own ANDA pipeline set to fructify from FY16E, we expect Taroto post 15% CAGR over FY14-17E.

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WILL RANBAXY BE THE NEXT TARO?Sun pharma has propsed to acquire Ranbaxy in an all-stock transaction at a ratio of0.8x for each Ranbaxy share, thereby, valuing Ranbaxy at US$4.2bn. We see thedeal as a positive development for Sun due to the interesting FTFs set to unfold,presence in the OTC space (large brand like Absorica In the US) and mostimportantly the valuations at which it has acquired the company (2.2x CY13revenues).

Sun's history of acquisition has been the most promising amongst its Indian peersgiven the turnaround of Taro along with the handling of persistent FDA issues atCaraco's plant. Hence it gives immense comfort to us as far as this buyout isconcerned. Incrementally being an all-stock transaction it will not drain the balancesheet of Sun but only dilute its equity (by ~16%). Moreover, Ranbaxy has beenvalued at a mere 2.2x its CY13 sales (compared to ~5x revenues in Torrent- Elderdeal or a whopping 25x revenues in Actavis-Forest deal) and probably less than 1.0xits potential CY13 sales (had there been no issues from FDA). This points towards ahuge potential to create value for the shareholders of both Sun as well as Ranbaxyover the next 2/3 years. Additionally, Sun has made a mention of an incrementalEBIDTA of USD 250mn due to the operational synergies by the third year, postclosure of the deal.

Sun Pharma rev break up - FY17E (pre-acquisition)


Sun Pharma rev break up - FY17E (post acquisition)


Sun Pro-forma financials (FY17E)

Pre-acquisition Post-acquisition NotesRanbaxy Ranbaxy

P&L highlights

Revenues 255,936 395,950 We have assumed ~9% CAGR in revenues for RanbaxyEBIDTA 103,691 125,284 We have assumed EBIDTA margins of ~13% for Ranbaxy

in FY17EEBIDTA (%) 40.5 31.6PAT 82,696 95,244 We have assumed tax rate of ~30% for Ranbaxy and maintained

Sun's tax at 12%NPM (%) 32.3 24.1 Net profitmargins to dilute significantlyA EPS 39.9 39.5 We do not expect any significant EPS dilution in spite of

increase in share capitalBalance sheet highlightsShare capital 2,072 2,410 The total no. of shares outstadning will inflate from 2,071mn

to 2,410mnDebt 24,890 89,538 We have not assumed any debt repayment for Ranbaxy and

miantained debt at Rs ~140bnShareholding patternPromoter holding 63.7 54.7Daiichi Holding 0 8.9Public shareholding 36.4 36.4


Domestic form, 22%

US form, 52%

EU + CIS form, 8%

Africa form, 4%

RoW form, 10%

APIs, 4%




Over a 2+ year's horizon, we like Sun. However, the concerns over Halol plantissue, hiccups on Sun-Ranbaxy deal will keep the stock range bound over next 4-5months. We expect Sun (ex Ranbaxy) to post 17%16% CAGR in revenues/APATover FY14-17E. Margins are expected to taper off by 270bps as we expect pricingpressure to build in Sun's base US portfolio. Factoring for the concerns, werecommend Accumulate, with a TP of Rs 1026, 24x FY17E EPS and an NPV of Rs70 (for Tildrakizumab).

One yr fwd PE


RISK AND CONCERNS

Price erosions in Taro’s products – Taro’s growth so far has been primarilydriven by price increases. With increasing competition, Taro is prone to pricecompetition in the US derma space.

Delay in incremental approvals from USFDA – Product approvals fromUSFDA and will be a key catalyst for growth. Any delay in approvals can impactthe Rev/PAT significantly.

Steep price erosions in Domestic or US markets – US has been witnessingprice erosion due to channel consolidation. We have assumed price erosions inour model, however, any steep price erosions can impact Rev/PAT significantly.

Regulatory Risk - The US business contributes 60% of revenues. Any USFDAregulatory risk can be critical for the company. Sun is already facing issues atcertain plants (Halol and Kharkadi) wherein Halol plant issues will be closelywatched as it contributes ~40 per cent of US sales and ~25 per cent of consoli-dated profit of the company.

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QUARTERLY FINANCIALS SNAPSHOT


Net Sales 41,921 42,866 40,436 39,269 47,505 13.3 21.0




Research and Development expenses 2,108 2,898 2,936 2,437 2,919 38.5 19.8

Operating Profits 18,284 19,751 17,858 17,239 21,611 18.2 25.4

Other Operating Income 145 259 150 87 190 30.5 117.2

EBITDA 18,429 20,009 18,008 17,326 21,801 18.3 25.8

Interest Cost 117 67 39 66 244 108.9 270.8

Depreciation 1,005 1,050 1,061 1,280 1,672 66.4 30.6

Other Income 1,051 1,344 1,938 924 527 (49.9) (43.0)

PBT 18,358 20,236 18,846 16,904 20,412 11.2 20.8

Tax 2,760 2,438 1,199 2,119 1,942 (29.6) (8.3)

Minority interest (1,975) (2,487) (1,774) (880) (2,745) 39.0 212.0

RPAT 13,624 15,311 15,873 13,905 15,725 15.4 13.1

APAT 13,624 15,311 15,873 13,905 15,725 15.4 13.1


SALES MIX


Domestic formulations 9,490 9,472 9,465 9,923 11,520 21.4 16.1

Export formulations 30,804 31,996 29,307 28,148 34,480 11.9 22.5

- US formulations 25,880 26,789 24,861 23,234 29,118 12.5 25.3

- RoW formulations 4,924 5,207 4,446 4,913 5,362 8.9 9.1

Bulks 2,116 1,742 2,223 1,744 2,101 (0.7) 20.5

Others (20) 109 15 33 62 (406.4) 88.7

Revenues* 42,389 43,319 41,011 39,848 48,163 13.6 20.9

Source: Company, Kotak Securities - Private Client Research; * Gross revenues

In 2QFY15, Sun posted revenues of Rs 47.5bn, up 13% YoY. Higher other expenses(up 12%/47% YoY) reported by Sun over shadowed Taro's higher profitability. Sunposted EBIDTA margin of 45.7% (up 190/169bps YoY/QoQ) despite higher otherexpenses. PAT was at Rs 15.7bn, up 15.4% YoY. India formulations revenuesreported strong growth of 21% whereas US (ex-Taro) at ~US$ 255mn was up16.5% YoY (led by one time revenues of one/few products). Increased otherexpenses in 2QFY15 were largely related to Ranbaxy's integration and complianceissues and would be recurring for coming few quarters.



FINANCIAL SUMMARY

Revenues to grow at 17% CAGR


APAT to post 16% CAGR


Margins to taper off slightly


Return ratios's to dip as margins slide






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Net D/E (x ‐ RHS)



COMPANY BACKGROUND

Sun Pharma was established in 1983 with a portfolio of five products to treatpsychiatry ailments and a manufacturing facility in Vapi, Gujarat. Cardiologyproducts were introduced in 1987 followed by gastroenterology products in 1989.Today Sun is the largest chronic prescription company in India. Over the last 30years, Sun Pharma has become one of the most profitable pharmaceuticalsmanufacturers. Sun Pharma's growth has been dirven by both organic as wellinorganic expansion. In 1997, Sun Pharma acquired Caraco, a Detroit-basedmanufacturer of generics enabling its entry into the U.S generic market. Theacquisition of majority stake in Taro Pharmaceutical Industries Limited in 2010, notonly enhanced Sun's presence in the US generics markets but also paved way forpresence in niche therapy of dermatology. Sun's pillars for growth have been (1)Sustainable revenue streams (2) Cost leadership (3) Acquisitions which have yeildedhigher return on investments. As of date Sun has 26 manufacuturing facilities acrossfour continents and has ~75% of revenues from exports.

FY14 – Revenue break up

Source: Company

SUN’S ACQUISITION HISTORY – ACCESS TO NICHE MARKETS

Year Details of Acquisition/JVs Country Rationale

2013 Formation of Sun-Intrexon JV US JV for opthalmology drugs

2013 Acquired URL’s generic business US Expanded US product basket (107 products)

2012 Acquired DUSA Pharma, Inc. US Access to branded derma product

2011 Formation of Sun-MSD JV Emerging mkts Develop and commercialize technology based

combinations products

2010 Acquired Taro Pharmaceutical Industries Ltd. Israel Access to dermatology market in US

2008 Acquired Chattem Chemicals, Inc US Access to controlled substance market in US

1998 Brands from Natco India Respiratory brands

1997 Acquired Caraco US Access to US generics market

1997 Merged Tamil Nadu Dadha Pharmaceuticals Ltd India Access to gynecology and oncology brands

Source: Company



FINANCIALS: SUN PHARMA



Revenues 160,804 189,202 221,498 255,936

% Change YoY 42.3 17.7 17.1 15.5

EBITDA 70,017 81,806 93,678 103,691

% Change YoY 43.0 16.8 14.5 10.7

Other Income 5,522 5,428 4,311 6,100

Depreciation 4,092 5,907 6,407 6,907

EBIT 71,447 81,328 91,583 102,884

% change YoY 44.4 13.8 12.6 12.3

Interest cost 442 269 269 269

Extraordinary items (25,174) 0 0 0


% change YoY 28.5 42.8 41.2 40.1

Tax 7,022 9,727 10,958 12,314

as % of PBT 15 12 12 12

Minority interest (7,395) (6,285) (6,914) (7,605)

Reported PAT 31,415 65,046 73,442 82,696

% change YoY 18.9 33.4 32.5 31.6

APAT 52,813 65,046 73,442 82,696

% change YoY 47.8 23.2 12.9 12.6

Shares outstanding (mn) 2,071.2 2,071.2 2,071.2 2,071.2

EPS (reported) (Rs) 15.2 31.4 35.5 39.9

EPS (adjsuted) (Rs) 25.5 31.4 35.5 39.9

CEPS (Rs.) 17.1 34.3 38.6 43.3

DPS (Rs) 1.5 2.5 3.0 4.0




EBT 45,831 81,058 91,313 102,615

Depreciation 4,092 5,907 6,407 6,907

Change in WC (28,714) (25,431) (26,712) (28,815)

Taxes Paid 7,022 9,727 10,958 12,314


Capex (18,580) (8,842) (8,926) (9,018)

Change in Investments (1,560) (2,337) (2,472) (2,719)

Dividends (3,635) (6,058) (7,270) (9,693)


Proceeds from issue of eq 1,036 - - -

Inc/(dec) in debt 23,012 (719) - -

Def tax credit /other adj. 20,854 9,163 10,079 11,087

CF from financing 44,901 8,444 10,079 11,087

Opening cash 40,587 75,901 118,916 170,377

Closing cash 75,901 118,916 170,377 228,427


Balance sheet




Inventories 31,230 43,024 52,795 63,107


Others 45,283 54,343 65,415 78,701

Current Assets 186,864 262,319 345,954 440,824


Net Fixed Assets 58,242 61,177 63,696 65,808

Goodwill 18,346 18,346 18,346 18,346

Deferred tax assets 11867 13054 14359 15795

Total Assets 293,708 374,435 463,060 562,761

Payables 13,283 18,143 21,240 26,645

Others 21,491 23,641 26,005 28,605


Provisions 26016 28618 31480 34628

Debt (Total) 25,609 24,890 24,890 24,890

Equity 2,071 2,071 2,071 2,071

Reserves 183,178 248,451 321,537 402,145

Minority Interest 19,212 25,497 32,411 40,016


Def tax assets/Liabilities 2,757 3,032 3,336 3,669


BVPS 89 121 156 195


Ratio Analysis


EBITDA margin (%) 43.5 43.2 42.3 40.5

EBIT margin (%) 44.4 43.0 41.3 40.2

APAT margin (%) 32.8 34.4 33.2 32.3


Inventory (days) 70.9 83.0 87.0 90.0


Sales/assets (x) 0.7 0.6 0.6 0.5



ROE (%) 18.7 29.9 25.6 22.7

ROCE (%) 39.6 34.8 30.4 27.3

EV/ Sales (x) 11.6 9.7 8.0 6.7

EV/EBITDA (x) 26.7 22.3 18.9 16.6







Torrent Pharmaceuticals Ltd



Torrent Pharma (TRP) has been firing on all cylinders with strong momen-tum in the domestic segment (consistent double digit growth for the last10 quarters), 120% growth for the US segment in FY14 (driven by a limitedcompetition launch - Cymbalta) and recent AIOCD monthly data highlight-ing better traction in (acquired) Elder's brands. Enhanced focus on brandbuilding/ MR productivity improvement for Domestic segment, 8-10 prod-ucts launches in FY15E/16E/17E for US markets and better traction inElder's brands gives robust revenue visibility. Strong ROE/ROCE and Net D/E reverting back to sub 0.5x levels by FY17E adds to comfort. We valueTRP at 20x FY17E EPS and Initiate coverage with BUY rating, TP Rs 1385.


Domestic formulations getting steadier - TRP, in recent times, has in-creased focus on implementing strategies on improving productivity. This is alsoreflected in a steady double digit growth for the last ten quarters compared tolumpy growth in earlier years. Moreover, the brands acquired from Elder havestarted witnessing traction led by improved marketing strategies. We expectTorrent to continue to post double-digit CAGR of 15% (ex - Elder brands) anda 28% CAGR (inc Elder brands) over the FY14-17E.

US formulations to deliver steady growth - Torrent has doubled its US rev-enues (120% growth) in FY14 mainly led by one limited competition launch(gCymbalta). Going ahead, owing to high base, we expect the growth to taperoff a bit, however, consistent 8-10 launches per year and few limited competi-tion opportunities (gAbilify - FY16E) will keep the growth trajectory upwards.We expect the US segment to post CAGR of 17.4% over FY14-17E.

Brazil revenues to remain sluggish - Brazil contributes 13% to Torrents top-line and has been facing growth concerns for the past 2 years (FY13-FY14) dueto lack of product approvals. The sharp dip in currency over the past fewmonths have accentuated concerns. TRP has made plans to expand itsbranded generic portfolio (albeit depends on approvals) and is also focusing onaggressive launches in generic-generic segment. We believe recovery will bean uphill task, expect the segment to post a CAGR of 4% over FY14-17E.

Outlook and valuation Despite the concerns in Brazil, we remain positive on the stock owing to con-

sistent growth in domestic/US revenues, stable margins and improving balancesheet. We expect TRP to post 17%/20% CAGR in revenues/EBIDTA. Higherdepreciation (due to amortization of Elder's acquired brands) will restrictgrowth in profits, hence we expect a muted CAGR of 16% in PAT over FY14-17E. Initiate coverage with BUY rating, TP Rs 1385.

Risk and Concerns

Further acquisitions

Brazil Currency appreciation

Regulatory Risk


One-year performance (Rel to Sensex)

Source: Bloomberg

Stock details

BSE code : 500420

NSE code : TORNTPHARM


Free float (%) : 30

52 wk Hi/Lo (Rs) : 1205/464.1




Sales 49,493 56,547 64,838Growth (%) 22.6 14.3 14.7EBITDA 12,372 14,834 17,788EBITDA margin (%) 24.2 25.6 26.7PBT 10,066 11,994 15,217Net profit 7,750 9,235 11,717EPS (Rs) 45.8 54.6 69.2Growth (%) 16.2 19.2 26.9CEPS (Rs) 56.3 66.7 82.3BVPS (Rs) 146.5 187.0 239.9DPS (Rs) 10.0 12.0 14.0ROE (%) 30.4 27.6 25.6ROCE (%) 36.2 33.8 31.9Net debt 23,780 21,450 18,975NW capital (Days) 112.8 121.6 127.9P/E (x) 25.0 20.9 16.5P/BV (x) 7.8 6.1 4.8EV/Sales (x) 4.4 3.8 3.2EV/EBITDA (x) 17.4 14.4 11.7

Source: Company,



Source: ACE Equity

Promoter

72%

FII

13%

MF/UTI6%

Bodies corporate

1%

Others8%



DOMESTIC FORMULATIONS

Torrent commands 2.15% market share (as per September 2013 AIOCD). Itsdomestic formulations portfolio can be closely compared to Sun and Lupin due tohigher chronic contribution at ~60%. TRP's core strength in this segment is itsleadership in one of the fastest growing therapeutic areas. Torrent has been rankedamongst the top 3players in the CNS segment and CVS segment for the past 7years. But in spite of having a portfolio which is growing above market growth rate,Torrent had disappointed on the growth front between FY08-13 owing to lack ofaggressive marketing strategies. However, post the management change at themarketing level and enhanced focus on brand building TRP has managed to post ahealthy double digit growth over the past 10 quarters. Led by improved marketingstrategies, we expect the momentum to continue. TRP's domestic formulations (ex-Elder brands) are to register 15% CAGR over FY14-17E. TRP acquired Elder'sdomestic formulations portfolio last year (Dec-13) for Rs 2,000crs, paying ~5xrevenues. The acquisition gave TRP access to brands like Shelcal/Cymoral anddeeper access to high growth segments of women health care, nutraceutical andPain management. On the other hand, the acquisition led to higher debt (Net D/Erose to 0.9x from 0.3x) and steep decline in ROCE (from ~20% to 15%).



Skewed towards chronic therapies


Domestic formulations - Therapeutic area contribution


Elder's brands - new catalyst, expected to post 22% CAGR

The Elder brands taken by TRP had de-grown in last three

years from Rs 6.0bn to ~Rs4.0bn due to (1) lack of

aggressive marketing efforts, (2) MR attrition and (3) lower

focus on new launches, as Elder was struggling with huge

debt and repayment issues. However, with TRP's

management's enhanced focus, the brands are reviving

back as visible on the latest monthly figures (from AIOCD).

Hence, we expect TRP to grow the acquired brands at

22% over FY14-17E.


Improved marketing strategies, revival in Elder's brands and new product launcheswill drive the growth for the segment. Ovreall, we expect TRP to post a CAGR of28% (inc inorganic acquisition of Edler brands) over FY14-17E.

0

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10000

15000

20000

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30000TRP domestic form (Rs mn ‐ LHS)

Elder revenues (Rs mn ‐ LHS)

Growth (% ‐ RHS)

Chrocnic62%

Acute38%

Anti Infective8%

Cardiac36%

Other12%

Gastro18%

Anti diabetic8%

CNS18%



US FORMULATIONS

Torrent entered the US market in 2008; despite of being a late entrant in the USmarket Torrent has seen multiple fold revenue growth for the first four years andhas emerged as a largest supplier of Losartan and second largest for Citalopramand Zolpidem. Torrent currently has approvals for 44 products and tentativeapprovals for 6 ANDAs. While it awaits approvals for 21 ANDAs. TRP expects tolaunch 8-10 ANDAs every years and simultaneously enhance its filings. Most of theproducts which Torrent markets in the US market are in highly crowded segmentsand more of me too products. This had kept the company's per product revenuesrestricted at US $ 2.5mn compared to US$ 5.0mn of IPCA and Cadila. However,with the launch of gCymblata in FY14, TRP posted a whopping 120% growth dueto 180 day exclusivity. Our analysis highlights TRP clocked revenues of US$ 60mnfor gCymbalta in FY14. Although the revenues from exclusivities are short lived, weexpect TRP's trajectory to remain upwards in spite of high base led by 8-10launches and few limited competition opportunities like gAbilify.

ANDA filings trajectory improved from FY11


TRP awaits 30% of ANDAs to be approved


US revenues to post 17.4% CAGR over FY14-17E


US formulations to deliver steady growth

Torrent pharma is perceived as me too generic players dueto very genericised portfolio. Though Torrent has doubledits US revenues (120% growth) in FY14 but it was mainlyled by one limited competition launch (gCymbalta). Goingahead we expect the growth to taper off from high levelsof 100%+ owing to (1) high base and (2) lack of suchhuge limited competition products. However, consistent 8-10 launches per year and few limited competitionopportunities (gAbilify – FY16E) will keep the growthtrajectory upwards. We expect the US segment to postCAGR of 17.4% over FY14-17E.


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80ANDAs filed ANDAs approved

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FY11 FY12 FY13 FY14 FY15E FY16E FY17E

US revenues (Rs mn ‐ LHS) Growth (% ‐ RHS)

0%

25%

50%

75%

100%

0

150

300

450


% pending ANDAs



BRAZIL

Brazilian Pharmaceutical market is the largest market in Latin America and one ofthe biggest markets in emerging economies with a market size of ~US$ 25 billion.Brazil pharma market has been growing at a fast pace with ~15% CAGR over thelast six years. Torrent is the largest Indian player in the Brazilian market withpresence in branded generic segment. Torrent currently has a basket of 31approved products with another 25 products under approval. Though Torrent is thelargest Indian player in Brazilian pharma market, growth over the last two (FY13-FY14) has remained challenging for TRP due to lack of approvals from ANVISA (thepharma regulator of Brazil). Moreover, the pricing pressure due to presence ofstrong local generics, which are supported by government policies, are adding tothe woes. TRP has strategically planned to enter the generic-generic segment tocombat pricing pressures. However, we expect the challenges to remain owing tohalving of branded generic portfolio. (TRP marketed ~ 30 products in FY12 whichstood at 15 in FY14) and lack of clarity on approval timelines for branded generics.Low margin generic-generic segment may improve growth trajectory but will impactthe profitability of the company, being a low margin segment.

Brazil revenues to remain sluggish

Brazil contributes 13% to Torrent's top-line and has been facing growth concerns forthe past 2 years (FY13-FY14) due to lack of product approvals. The sharp dip incurrency over the past few months has accentuated concerns, Brazilian real/Rs iscurrently at Rs 23.76 from its earlier average of ~Rs 27.0. TRP has laid plans toexpand its branded generic portfolio (albeit depends on approvals) and is alsofocusing on aggressive launches in generic-generic segment. We believe recoverywill be an uphill task, expect the segment to post a CAGR of 4% over FY14-17E.

TRPs revenue growth in Brazilian Real and Rupee terms (%)

Source : Company, Industry, Kotak Securities - Private Client Re-search

Lack of approvals and currency concerns will restrict growth


0.0

10.0

20.0

30.0

40.0

50.0

FY08 FY09 FY10 FY11 FY12 FY13 FY14

Real terms Rupee terms

‐10.0

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40.0

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60.0

70.0

‐1000

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7000

Brazil rev (Rs mn ‐ LHS) Growth (% ‐ RHS)




Torrent has registered 20/30% CAGR in Rev/PAT from FY08-14 mainly driven by USrevenues (174% CAGR). Domestic revenues have grown at 12% CAGR over thesame period. EBIDTA margins have shown a sharp increase of ~900bps from 16%in FY08 to 24.8% in FY14, mainly led by better gross margins.

Going ahead, we expect Torrent Pharma to register 17% CAGR in revenues bysteady Domestic formulations (27.6% CAGR FY14-17E) and exports (CAGR of 13%over FY14-17E). EBIDTA margins are expected to increase by 190bps led byimproving efficiencies and better margins for Elder's acquired brands. However,higher depreciation (due to amortization of Elder's acquired brands) and thecommissioning of Dahej SEZ will restrict profitability, hence we expect a slightlylower CAGR of 16% in PAT over FY14-17E.

Torrent has witnessed a sharp P/E expansion from its last five years average of13.3x to ~23x at current levels. This expansion was led by improving margins,enhanced focus on domestic formulations as well robust growth in the USformulations revenues. We remain optimistic on Torrent Pharma from a 3-4 yearperspective given the expanding US pipeline, strengthening Domestic franchise andimproving financials. We value the stock at 20x FY17E EPS of Rs.69.2 and Initiatecoverage with BUY rating, TP Rs 1385.

Forward PE band

Source: Kotak Securities- Private Client Research

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Apr/06 Apr/07 Apr/08 Apr/09 Apr/10 Apr/11 Apr/12 Apr/13 Apr/14

Fwd PE AVERAGE 5 YR PE



FINANCIAL SUMMARY





Margins to improve led by better product mix


Return ratios's to dip marginally led by lower asset turnovers


Working capital cycle has expanded led by product mix change




0

9

18

27

36

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40,000

60,000

80,000


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3,000

6,000

9,000

12,000

15,000


0

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18

24

30

EBIDTAM (%) APATM (%)

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90

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150


‐0.30

0.00

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0.90

1.20

0

3,000

6,000

9,000

12,000


Net D/E (x ‐ RHS)



QUARTERLY FINANCIALS SNAPSHOT

Torrent Pharma’s (TRP) results were a mixed bag, Torrent’s US revenues were at~US$25mn, up 39% YoY but down 43% QoQ due to lower gCymbalta revenues.Torrent consolidated the (Elder’s) acquired portfolio from 2QFY15 resulting in 49%growth in the segment at Rs 4.4bn. Adj for the acquired portfolio (Rs 0.95bn rev)growth was at 17%. Overall revenues were at Rs 12bn, up 29% YoY, but EBIDTAmargins were lower at 22.4% due to sharp increase in other expenses. PAT washigher than expected at Rs 1.98bn, up 42% YoY led by higher other income.

Quarterly performance


Net Sales 9,360 9,900 12,070 10,920 12,030 28.5 10.2


Employee Expenses 1,820 1,790 2,080 1,840 2,240 23.1 21.7


Operating Profits 1,790 2,100 3,320 3,230 2,590 44.7 (19.8)

Other Operating Income 360 250 180 220 140 (61.1) (36.4)

EBITDA 2,150 2,350 3,500 3,450 2,730 27.0 (20.9)

Interest Cost 150 160 200 240 540 260.0 125.0

Depreciation 220 210 230 210 560 154.5 166.7

Other Income 100 100 100 150 720 620.0 380.0

Forex (loss) / Gain (360) (200) - 340 - (100.0) (100.0)

PBT 1,520 1,880 3,170 3,490 2,350 54.6 (32.7)

Tax 390 300 730 930 370 (5.1) (60.2)

RPAT 1,130 1,580 2,440 2,560 1,980 75.2 (22.7)

E/o (adj for tax) 268 168 - (249) - (100.0) (100.0)

APAT 1,398 1,748 2,440 2,311 1,980 41.7 (14.3)

Source: Company, HDFC sec Inst Research

Revenue MIX


Domestic formulations 2,970 2,960 2,560 3,520 4,420 48.8 25.6

Export formulaitons 5,730 6,380 8,822 7,330 6,725 17.4 (8.3)

- US formulations 1,146 1,480 4,002 2,690 1,670 45.8 (37.9)

- Brazil formulations 1,254 1,470 1,280 1,490 1,605 28.0 7.7

- Europe (inc Huenman) 2,347 2,480 2,510 2,300 2,480 5.7 7.8

- Row + Russia CIS 901 950 1,030 860 970 7.6 12.8

Contract manu 710 760 800 260 980 38.0 276.9

Revenues 9,360 9,900 12,070 10,998 12,030 28.5 9.4

Source: Company, HDFC sec Inst Research



COMPANY BACKGROUND

Torrent Pharma is the flagship company of the Torrent group, established in 1972,when Trinity Labs was renamed as Torrent Pharma. The company was started by MrU.N Mehta and was amongst the few companies to setup its own manufacturingfacilities in 1980's. Torrent's business segments can be split into Domestic (29%),Export (64%) and Contract manufacturing (8%) segments. It is a dominant player inthe therapeutic areas of cardiovascular (CV) and central nervous system (CNS) andhas achieved significant presence in gastro-intestinal, diabetology, anti-infective andpain management segments. It has three world-class manufacturing facilities atIndrad (Gujarat), Baddi (Himachal Pradesh) and Sikkim. The facilities are approvedby USFDA, WHO, MHRA, TGA and other global regulatory bodies. A new facility iscoming up at Dahej SEZ in western India, which will cater to the internationalmarkets. Torrent Pharma is the sole manufacturer of Insulin Formulations for NovoNordisk in India since the early '90s and has also set up a dedicated formulationand packaging facility for Insulin. Recently, Torrent Pharma acquired the brandeddomestic formulations business of Elder Pharmaceuticals in India and Nepal for Rs2004 crs. The acquisition comprises a portfolio of 30 brands including market-leading brands in the Women's Healthcare, Pain Management, Wound Care andNutraceuticals therapeutic segments.

Revenue break up – FY14


RISK AND CONCERNS

Futher acquisitions – TRP has recently acquired Elder’s domestic brands whichled sharp increase in the D/E rartio to 0.9x from 0.3x. Any further acquisitions(espceially large expensive acquisitions) will dilute the return ratios and mayimpact valuations.

Brazil Currency appreciation – Brazilian Real has dipped from Rs 27/BRZ to Rs23.76/BRZ. Any further steep depreication in the brazilian currency will impactTRP’s revenues as well profitability.

Regulatory Risk – TRP, like any other pharma company, remains prone toUSFDA regualtoy risk owing to frequent inspections (every 2 year usually).



FINANCIALS: TORRENT PHARMACEUTICALS LTD



Revenues 40,363 49,493 56,547 64,838

% Change YoY 32.2 22.6 14.3 14.7

EBITDA 10,357 12,372 14,834 17,788

% Change YoY 48.6 19.5 19.9 19.9

Other Income 381 1,250 1,375 1,513

Depreciation 870 1,781 2,052 2,213

EBIT 9,869 11,841 14,158 17,087

% change YoY 50.0 20.0 19.6 20.7

Interest cost 346 1,775 2,164 1,870

Forex (Gain/Loss) (1,048.7) - - -


% change YoY 45.7 18.8 19.2 26.9

Tax 1,801 2,315 2,759 3,500

as % of PBT 21.3 23.0 23.0 23.0

Minority interest (0.3) (0.3) (0.4) (0.5)

Net Income 6,673 7,750 9,235 11,717

% change YoY 54.2 16.2 19.2 26.9


EPS (reported) (Rs) 39.4 45.8 54.6 69.2

CEPS (Rs.) 44.6 56.3 66.7 82.3

DPS (Rs) 10.0 10.0 12.0 14.0




EBT 8,474 10,066 11,994 15,217

Depreciation 870 1,781 2,052 2,213

Change in WC (3,861) (3,134) (3,053) (4,643)

Taxes Paid (1,801) (2,315) (2,759) (3,500)


Capex (3,914) (24,710) (3,500) (3,997)

Change in Investments (1,380) (174) (383) (451)

Dividends (1,700) (1,692) (2,031) (2,369)



Inc/(dec) in debt 4,388 13,463 (2,000) (2,000)

Def tax credit /other adj. (76) 22 10 5

CF from financing 4,735 13,485 (1,990) (1,995)

Opening cash 6,270 7,694 1,000 1,331

Closing cash 7,694 1,000 1,331 1,805

B/S check 7,694 1,000 1,331 1,805


Balance sheet




Inventories 10,061 12,882 15,182 17,764

Loan and Advances 850 875 901 928

Others 4,446 4,649 5,877 9,458

Current Assets 34,045 32,966 39,558 48,607

Deferred tax assets 656 757 877 1,029


Net Fixed Assets 14,095 16,148 18,400 20,956

Goodwill - 20,875 20,072 19,300


Total Assets 50,698 72,722 81,146 92,430

Payables 14,291 16,272 18,901 22,205

Others 1,948 2,240 2,464 2,710



Deferred tax liabilities 475 484 494 504

Total Debt 11,318 24,780 22,780 20,780


Long term provisions 1,904 2,190 2,518 2,896

Equity 846 846 846 846

Reserves 18,178 23,948 30,807 39,751

Minority interest 4 4 5 5


BVPS 112.41 146.51 187.03 239.88


Ratio Analysis


EBITDA margin (%) 24.8 24.2 25.6 26.7

EBIT margin (%) 25.8 27.4 27.9 28.2

PAT margin (%) 16.6 18.1 18.3 18.6


Inventory (days) 70.1 70.0 70.0 70.0


Sales/assets (x) 1.1 1.0 1.0 0.9



ROE (%) 30.3 30.4 27.6 25.6

ROCE (%) 35.4 36.2 33.8 31.9

EV/ Sales (x) 4.8 4.4 3.8 3.2

EV/EBITDA (x) 18.8 17.4 14.4 11.7







Technical Research Team

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Amol [email protected]+91 20 6620 3350

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Rahul [email protected]+91 22 6621 6198

Malay [email protected]+91 22 6621 6350

Prashanth [email protected]+91 22 6621 6110

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DisclaimerKotak Securities Limited established in 1994, is a subsidiary of Kotak Mahindra Bank Limited. Kotak Securities is one of India's largest brokerage and distributionhouse.Kotak Securities Limited is a corporate trading and clearing member of Bombay Stock Exchange Limited (BSE), National Stock Exchange of India Limited (NSE), MCXStock Exchange Limited (MCX-SX), United Stock Exchange of India Limited (USEIL) and a dealer of the OTC Exchange of India (OTCEI). Our businesses include stockbroking, services rendered in connection with distribution of primary market issues and financial products like mutual funds and fixed deposits, depository servicesand Portfolio Management.Kotak Securities Limited is also a depository participant with National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited(CDSL).Kotak Securities Limited is also registered with Insurance Regulatory and Development Authority as Corporate Agent for Kotak Mahindra Old Mutual LifeInsurance Limited and is also a Mutual Fund Advisor registered with Association of Mutual Funds in India (AMFI). We are under the process of seeking registrationunder SEBI (Research Analyst) Regulations, 2014.We hereby declare that our activities were neither suspended nor we have defaulted with any stock exchange authority with whom we are registered in last fiveyears. However SEBI, Exchanges and Depositories have conducted the routine inspection and based on their observations have issued advise letters or levied minorpenalty on KSL for certain operational deviations. We have not been debarred from doing business by any Stock Exchange / SEBI or any other authorities; nor hasour certificate of registration been cancelled by SEBI at any point of time.We offer our research services to clients as well as our prospects.This document is not for public distribution and has been furnished to you solely for your information and must not be reproduced or redistributed to any otherperson. Persons into whose possession this document may come are required to observe these restrictions.This material is for the personal information of the authorized recipient, and we are not soliciting any action based upon it. This report is not to be construed asan offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It is for the general in-formation of clients of Kotak Securities Ltd. It does not constitute a personal recommendation or take into account the particular investment objectives, financialsituations, or needs of individual clients.We have reviewed the report, and in so far as it includes current or historical information, it is believed to be reliable though its accuracy or completeness cannotbe guaranteed. Neither Kotak Securities Limited, nor any person connected with it, accepts any liability arising from the use of this document. The recipients ofthis material should rely on their own investigations and take their own professional advice. Price and value of the investments referred to in this material maygo up or down. Past performance is not a guide for future performance. Certain transactions -including those involving futures, options and other derivatives aswell as non-investment grade securities - involve substantial risk and are not suitable for all investors. Reports based on technical analysis centers on studyingcharts of a stock's price movement and trading volume, as opposed to focusing on a company's fundamentals and as such, may not match with a report on acompany's fundamentals.Opinions expressed are our current opinions as of the date appearing on this material only. While we endeavor to update on a reasonable basis the informationdiscussed in this material, there may be regulatory, compliance or other reasons that prevent us from doing so. Prospective investors and others are cautioned thatany forward-looking statements are not predictions and may be subject to change without notice. Our proprietary trading and investment businesses may makeinvestment decisions that are inconsistent with the recommendations expressed herein.Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the PrivateClient Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of theInstitutional Equities Research Group of Kotak Securities Limited.We and our affiliates/associates, officers, directors, and employees, Research Analyst(including relatives) worldwide may: (a) from time to time, have long or shortpositions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earnbrokerage or other compensation or act as a market maker in the financial instruments of the subject company/company (ies) discussed herein or act as advisor orlender / borrower to such company (ies) or have other potential/material conflict of interest with respect to any recommendation and related information andopinions at the time of publication of Research Report or at the time of public appearance. Kotak Securities Limited (KSL) may have proprietary long/short positionin the above mentioned scrip(s) and therefore should be considered as interested. The views provided herein are general in nature and does not consider risk appetiteor investment objective of particular investor; readers are requested to take independent professional advice before investing. This should not be construed asinvitation or solicitation to do business with KSL. Kotak Securities Limited is also a Portfolio Manager. Portfolio Management Team (PMS) takes its investmentdecisions independent of the PCG research and accordingly PMS may have positions contrary to the PCG research recommendation.The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or com-panies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or viewsexpressed in this report.No part of this material may be duplicated in any form and/or redistributed without Kotak Securities' prior written consent.Details of Associates are available on our website ie www.kotak.comResearch Analyst has served as an officer, director or employee of Subject Companies: NoWe or our associates may have received compensation from the subject companies in the past 12 months. We or our associates may have managed or co-managedpublic offering of securities for the subject companies in the past 12 months. We or our associates may have received compensation for investment banking ormerchant banking or brokerage services from the subject companies in the past 12 months. We or our associates may have received any compensation for productsor services other than investment banking or merchant banking or brokerage services from the subject companies in the past 12 months. We or our associates havenot received any compensation or other benefits from the subject companies or third party in connection with the research report. Our associates may have financialinterest in the subject companies.Research Analyst or his/her relative's financial interest in the subject companies: NoKotak Securities Limited has financial interest in the subject companies: Cipla, Cadila HC, DRL, Lupin, Sun Pharma: Yes; Torrent Pharma: NoOur associates may have actual/beneficial ownership of 1% or more securities of the subject companies at the end of the month immediately preceding the dateof publication of Research Report.Research Analyst or his/her relatives has actual/beneficial ownership of 1% or more securities of the subject companies at the end of the month immediately pre-ceding the date of publication of Research Report: NoKotak Securities Limited has actual/beneficial ownership of 1% or more securities of the subject companies at the end of the month immediately preceding the dateof publication of Research Report: NoSubject Companies may have been client during twelve months preceding the date of distribution of the research report."A graph of daily closing prices of securities is available at www.nseindia.com and http://economictimes.indiatimes.com/markets/stocks/stock-quotes. (Choose acompany from the list on the browser and select the "three years" icon in the price chart)."Kotak Securities Limited. Registered Office: 27 BKC, C 27, G Block, Bandra Kurla Complex, Bandra (E), Mumbai 400051. CIN: U99999MH1994PLC134051, TelephoneNo.: +22 43360000, Fax No.: +22 67132430. Website: www.kotak.com. Correspondence Address: Infinity IT Park, Bldg. No 21, Opp. Film City Road, A K Vaidya Marg,Malad (East), Mumbai 400097. Telephone No: 42856825. SEBI Registration No: NSE INB/INF/INE 230808130, BSE INB 010808153/INF 011133230, OTCINB 200808136,MCXSX INE 260808130/INB 260808135/INF 260808135, AMFI ARN 0164 and PMS INP000000258. NSDL: IN-DP-NSDL-23-97. CDSL: IN-DP-CDSL-158-2001. Our researchshould not be considered as an advertisement or advice, professional or otherwise. The investor is requested to take into consideration all the risk factors includingtheir financial condition, suitability to risk return profile and the like and take professional advice before investing. Investments in securities are subject to marketrisk; please read the SEBI prescribed Combined Risk Disclosure Document prior to investing. Derivatives are a sophisticated investment device. The investor isrequested to take into consideration all the risk factors before actually trading in derivative contracts .Compliance Officer Details: Mr. Sandeep Chordia. Call: 022- 4285 6825, or Email: [email protected] case you require any clarification or have any concern, kindly write to us at below email ids: Level 1: For Trading related queries, contact our customer service at '[email protected]' and for demat account related queries contact us [email protected] or call us on:Online Customers - 30305757 (by using your city STD code as a prefix) or Toll free numbers18002099191 / 1800222299, Offline Customers - 18002099292Level 2: If you do not receive a satisfactory response at Level 1 within 3 working days, you may write to us at [email protected] or call us on 022-42858445 and if you feel you are still unheard, write to our customer service HOD at [email protected] or call us on 022-42858208.Level 3: If you still have not received a satisfactory response at Level 2 within 3 working days, you may contact our Compliance Officer (Name: Sandeep Chordia)at [email protected] or call on 91- (022) 4285 6825.Level 4: If you have not received a satisfactory response at Level 3 within 7 working days, you may also approach CEO (Mr. Kamlesh Rao) at [email protected] call on 91-(022) 6652 9160.

Meeta Shetty, CFA Pharmaceutical Sector …Pharmaceutical Sector SECTOR REPORT JANUARY 27, 2015...

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Transcript of Meeta Shetty, CFA Pharmaceutical Sector …Pharmaceutical Sector SECTOR REPORT JANUARY 27, 2015...