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Systematix Research is also available on Bloomberg SSSL <Go>, Thomson & Reuters Systematix Shares & Stocks (I) Ltd. Investors are advised to refer through disclosures made at the end of the research report. Specialty API Industry Winners from global growth of Specialty Pharma Global pharmaceutical industry is witnessing phenomenal changes as specialty pharma is occupying the centre stage, while non-specialty segments are getting commoditised amid stiffer competition from extended innovations and generics. Specialty pharma encompasses drugs that are used to treat complex, chronic and often costly conditions such as in oncology, multiple sclerosis, rheumatoid arthritis, hepatitis-C, neurological disorders and HIV/AIDS. Though biological products constitute a vital part of specialty pharma, in this note, we focus on APIs (chemical entities) that are manufactured and delivered through a complex process. Our sector theme consists of the back-end business of specialty pharma such as manufacturing of drug intermediates and bulk drugs and contract research and manufacturing services (CRAMS). We are covering key dedicated Indian API and CRAMS players, who have steadily moved up the complexity profile, value chain or ramped up products and production capabilities over the past few years. They have also invested in R&D to offer services like drug discovery, custom synthesis, process development, or contract manufacturing to support innovators’ R&D projects and supply key materials. We analyse five API players to weigh their relative prospects in the high- value pharma segment and find Neuland Laboratories and Jubilant Life better placed under the captioned theme. Investment highlights Specialty pharma takes centre stage: Specialty pharma is getting maximum focus in the overall healthcare system -- be it innovations, manufacturing, distribution administration of drugs or healthcare planning by governments. Most of the new molecules being developed and drug delivery technologies are centered around these segments. The specialty pharma market is likely to post a CAGR of ~15% to reach $500bn by 2019, compared to 4-5% growth for the overall pharma market. For API players, the value transits to specialty segments: Given a high technological barrier and demand-supply mismatch, specialty segments normally command premium pricing for patented products and relatively lesser price erosion in generic segments. Given a number of patent expiries in the next couple of years, generic players present either in back-end or front-end will gain immensely. Thus, API players who have aligned their focus towards specialty segments stand to gain. Specialty-focused innovations to provide huge opportunities for CRAMS: As the global innovations centre around specialty segments (~4,000 of the ~7,000 new molecules under development belong to specialty segments), we believe the players having domain capabilities in drug discovery, expertise in complex chemistry and manufacturing set-up will get a stronger and high margin order book. Our universe of coverage: We initiate coverage on four mid-sized Indian players engaged in the business of bulk drugs, drug intermediates and CRAMS -- (a) Dishman Pharma, (b) Granules India, (c) Jubilant Life Science, (d) Suven Life Sciences and (e) Neuland Laboratories (under coverage; company update). Though a favourable change in business proposition has expanded their valuations, we believe the scope for further enhancements remains for most of them. Systematix Institutional Equities 6 January, 2016 Industry Healthcare Price: CNX Pharma v/s Sensex CMP TP Upside Reco. (Rs) (Rs) (%) Dishman Pharma. 350 415 18.5 Accumulate Granules India 148 166 12.1 Accumulate Jubilant Life 418 555 32.8 Buy Neuland Labs. 782 1,050 34.4 Buy Suven Life Scie. 263 293 11.3 Accumulate Source: Systematix Institutional Research Top picks Source: Systematix Institutional Research T. Ranvir Singh [email protected] +91 22 6704 8016 SECTOR REPORT

Transcript of Specialty API Industryintranet.systematixshares.com/Institutional/IPOMail/Specialty API... ·...

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Systematix Research is also available on Bloomberg SSSL <Go>, Thomson & Reuters Systematix Shares & Stocks (I) Ltd.

Investors are advised to refer through disclosures made at the end of the research report.

Specialty API Industry

Winners from global growth of Specialty Pharma

Global pharmaceutical industry is witnessing phenomenal changes as specialty pharma is occupying the centre stage, while non-specialty segments are getting commoditised amid stiffer competition from extended innovations and generics. Specialty pharma encompasses drugs that are used to treat complex, chronic and often costly conditions such as in oncology, multiple sclerosis, rheumatoid arthritis, hepatitis-C, neurological disorders and HIV/AIDS. Though biological products constitute a vital part of specialty pharma, in this note, we focus on APIs (chemical entities) that are manufactured and delivered through a complex process. Our sector theme consists of the back-end business of specialty pharma such as manufacturing of drug intermediates and bulk drugs and contract research and manufacturing services (CRAMS).

We are covering key dedicated Indian API and CRAMS players, who have steadily moved up the complexity profile, value chain or ramped up products and production capabilities over the past few years. They have also invested in R&D to offer services like drug discovery, custom synthesis, process development, or contract manufacturing to support innovators’ R&D projects and supply key materials. We analyse five API players to weigh their relative prospects in the high-value pharma segment and find Neuland Laboratories and Jubilant Life better placed under the captioned theme.

Investment highlights

Specialty pharma takes centre stage: Specialty pharma is getting maximum focus in the overall healthcare system -- be it innovations, manufacturing, distribution administration of drugs or healthcare planning by governments. Most of the new molecules being developed and drug delivery technologies are centered around these segments. The specialty pharma market is likely to post a CAGR of ~15% to reach $500bn by 2019, compared to 4-5% growth for the overall pharma market.

For API players, the value transits to specialty segments: Given a high technological barrier and demand-supply mismatch, specialty segments normally command premium pricing for patented products and relatively lesser price erosion in generic segments. Given a number of patent expiries in the next couple of years, generic players present either in back-end or front-end will gain immensely. Thus, API players who have aligned their focus towards specialty segments stand to gain.

Specialty-focused innovations to provide huge opportunities for CRAMS: As the global innovations centre around specialty segments (~4,000 of the ~7,000 new molecules under development belong to specialty segments), we believe the players having domain capabilities in drug discovery, expertise in complex chemistry and manufacturing set-up will get a stronger and high margin order book.

Our universe of coverage: We initiate coverage on four mid-sized Indian players engaged in the business of bulk drugs, drug intermediates and CRAMS -- (a) Dishman Pharma, (b) Granules India, (c) Jubilant Life Science, (d) Suven Life Sciences and (e) Neuland Laboratories (under coverage; company update). Though a favourable change in business proposition has expanded their valuations, we believe the scope for further enhancements remains for most of them.

Systematix

Institutional Equities

6 January, 2016

Industry Healthcare

Price: CNX Pharma v/s Sensex

CMP TP Upside Reco. (Rs) (Rs) (%)

Dishman Pharma. 350 415 18.5 Accumulate

Granules India 148 166 12.1 Accumulate

Jubilant Life 418 555 32.8 Buy

Neuland Labs. 782 1,050 34.4 Buy

Suven Life Scie. 263 293 11.3 Accumulate

Source: Systematix Institutional Research

Top picks

Source: Systematix Institutional Research

T. Ranvir Singh [email protected] +91 22 6704 8016

SECTOR REPORT

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Specialty API Industry

Table of Contents

Innovations in healthcare reaching the next level ................................................................................................................ 3

For generics, the value transits to specialty segments .......................................................................................................... 5

Specialty API players stand to gain ...................................................................................................................................... 7

CRAMS provides platform to enter specialty API segment .................................................................................................. 10

Our coverage universe ...................................................................................................................................................... 12

Dishman Pharmaceuticals ................................................................................................................................................. 16

Granules India. ................................................................................................................................................................. 30

Jubilant Life Sciences ......................................................................................................................................................... 44

Neuland Laboratories ........................................................................................................................................................ 62

Suven Life Sciences ........................................................................................................................................................... 78

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Global pharma

Innovations in healthcare reaching the next level

Innovations are the backbone of the healthcare industry and nature is always evolving. While the 20th century saw most innovations in anti-infective treatments, the prevailing era delivered many therapies for more complex diseases. While most of the diseases are either curable or manageable, few ailments like cancer, HIV/AIDS, diabetes, neurological disorders are segments to be effectively addressed. Thus, most innovations are directed at finding affordable and effective treatments for these diseases. These segments are often referred as Specialty Pharma, as patients with ailments need a specialist’s diagnosis. While most therapies continue to be based on chemical entities, alternate therapies based on biological, protein or peptide-based products and stem cell technologies are catching up fast among innovators, which will shape the healthcare industry’s future.

Chart 1: Past, Present and Future of pharmaceutical products

Source: Company, Systematix Institutional Research

Chart 2: Most innovations are focused on specialty pharma

Source: Company, Systematix Institutional Research

Of the ~7,000 molecules under development globally, ~4,000 belong to specialty segments like oncology, mental health, diabetes, HIV/AIDS

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Specialty API Industry

Global healthcare industry pegged to grow at 4-5% over next five years: As per IMS Health, the global pharmaceutical industry posted a CAGR of 5.4% during 2009-14 to reach $1,057bn in 2014. However, the industry is expected to see a slower rate of growth during 2014-19 (CAGR of 4.8%) to reach $1,336bn in 2019. Most of the growth will come from emerging markets of Asia, Africa and Australia (CAGR of 6.9-9.9%), followed by Latin America (CAGR of 4.8-7.8%). Regulated markets, which command over 70% of the global pharmaceutical market by value, will see a slow growth due to a series of patent expiries. Specialty segments, which contributed ~25% in 2014, are likely to contribute ~40% by 2019, registering a CAGR of ~15%.

Undeterred by competition, generic players to focus on specialty and innovations: As competition intensifies in the generic space, players are focusing more on technology and innovation-led products to create niches. Most of these innovations are focused on developing new processes and delivery systems to provide value-added products and maintain margins. Currently, most frontline players have developed capabilities to produce sterile products (injectibles, ophthalmic solutions), inhalers (technology intensive), combination drugs and extended release tablets or capsules, which aid them to withstand competition.

Chart 3: Patents expiry – generic opportunity pegged at ~$93bn in 2016-18

Source: Industry, Systematix Institutional Research

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Specialty API Industry

Specialty pharma

For generics, the value transits to specialty segments

Specialty refers to high cost and complex segments of pharma: Though specialty pharma is defined differently by sections of the industry, consensus emerges to refer drugs which are used to treat a variety of complex and chronic conditions including- but-not-limited to anemia, cancer, infertility, multiple sclerosis, HIV and hepatitis drugs. Certain sections of the industry categorise specialty drugs as meeting all the three ‘H’ -- high cost, high complexity, high touch. These segments are technology intensive and often include injectibles, inhalers, infusions, transdermals among others. A significant part of specialty drugs are biological (based on living organism), especially in oncology, rheumatoid arthritis and multiple sclerosis. However, we have limited our analysis to only back-end chemical entities that are used to produce complex formulations and CRAMS to aid R&D programs related to specialty projects.

Generics creating niche in specialty pharma: The global generic players created huge wealth during past decades on the back of few easy-to-replicate drugs (having blockbuster sales) losing patent protection and governments of big markets like the US, Europe and Japan taking a pro-generic stance in healthcare policies. As the competition intensifies, most generic segments have been commoditised and have seen huge value erosion, as it is no longer considered an innovation-led business. Thus, innovations remain a value driver even for generics. Thus, players across the generic value chain are focusing on specialty pharma to retain and expand profits.

As growth shifts to specialty, value will follow...

Backed by innovations and emerging new therapies, specialty segments are set to see a healthy growth, mainly in the developed markets. Emerging markets, which continue to be dominated by acute segments, though will follow suit in the course of transition.

Chart 4: Developed markets to see stronger growth in specialty Chart 5: Emerging markets to see a follow-up growth in specialty

Source: Industry, Systematix Institutional Research Source: Industry, Systematix Institutional Research

Generic penetration remains low in specialty pharma, hence a lucrative opportunity: Due to the high technological barriers, specialty pharma segments remain relatively less crowded. Most of the frontline generic players have invested a huge sum in R&D and facilities to produce complex and difficult-to-copy products.

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Chart 6: Generic opportunity of $57bn seen during 2016-18 in specialty pharma

Source: Industry, Systematix Institutional Research

Specialty segments provide attractive business across the pharma value chain: A high growth potential in specialty segments is set to provide opportunities across the pharma value chain encompassing chemical synthesis, process research, manufacturing of intermediates, bulk drugs and formulations.

Back-end business to follow suit in specialty segments: The strong prospects of growth in specialty pharma under patent and out-of-patent provide equally strong opportunities for back-end businesses like intermediates, bulk drugs and contract services for innovators (contract research and manufacturing [CRAMS]). In this report, we focus on players engaged in the back-end business in manufacturing and CRAMS.

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Bulk drug industry

Specialty API players stand to gain

The global bulk industry is very competitive as there are 2,000 firms with over 5,000 manufacturing facilities spread across the globe. The market size of bulk drugs and ingredients industry is pegged at $135bn, which is likely to reach $186bn by 2020, posting a CAGR of 6.5%.

In the US and EU, there are major API manufacturers focusing on specialty APIs, which share a major fraction of the global market. A significant number of API manufacturers are located around Asia, specifically in India and China. This has led to an increasing trend among pharmaceutical companies to outsource API manufacturing to such countries. Merck, AstraZeneca, GlaxoSmithKline, Teva Active Pharmaceutical Ingredients (TAPI), Dr. Reddy’s Laboratories, Aurobindo, Cipla, Sandoz, Sandoz-Lek-Biochemie, Ranbaxy, Matrix, Sun Pharma, BASF SE, Fabbrica Italiana Sintetici, GlaxoSmithKline, Pfizer CentreSource, Royal DSM and Zhejiang Hisun Pharmaceutical Co Ltd are the leading API manufacturers in the world.

Indian bulk drug industry is clearing multiple challenges

The Indian bulk drug industry has evolved as a result of backward integration by large players engaged in manufacturing different dosage forms of medicines (formulations) for their captive uses. However, as the market became competitive and portfolio of products started to widen, smaller and independent players, mostly having expertise in fine and specialty chemicals started diversifying into drug intermediates and bulk drugs manufacturing to meet the growing demand. However, a fierce competition in generic segments exerted pricing pressure on the backend business as well, leading to huge erosion in profitability of these players. Meanwhile China, which built huge capacities during 1980s and 1990s, started dumping its products in India, which worsened the situation. Presently, for a large number of essential medicines, India still significantly depends on API imports from China. Though India manufactures over 30% of the global generic drugs requirement, more than 80% of APIs needed to produce these medicines comes from China.

Most Chinese imports are concentrated on low-end products

On Dec 12, 2014, the Minister of Commerce and Industry informed the Indian Parliament that in the case of 12 essential drugs namely Paracetamol, Metformin, Ranitidine, Amoxicillin, Ciprofloxacin, Cefixime, Acetyl salicylic acid, Ascorbic acid, Ofloxacin, Ibuprofen, Metronidazole and Ampicillin, there is significant dependence on imports. Around 80-90% of the imports are from China and are based on economic considerations.

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Chart 7: Imports from China

Source: Company, Systematix Institutional Research

Hence, Indian bulk drug players shifted focus to specialty segments

Most Indian bulk drug players undertook a major shift in their business strategies during the past few years to enhance profitability and survive the competition from China. Such strategies include (a) focus on niche segments, where end products’ market has lesser competition, (b) focus on technology-intensive products, (c) enhancing capacities for economies of scale, (d) forward integration into formulations and (e) focus on R&D to develop new processes and undertake CRAMS.

Indian government in supportive stance, Katoch committee recommendations being mulled

The department of pharmaceuticals (DoP) had declared 2015 as the year of ‘Active Pharmaceutical Ingredient (API)’. Pursuing it, Union Minister of Chemicals &

Fertilizers Ananth Kumar assured the pharmaceutical industry (on Feb 25, 2015) that appropriate decisions will be taken soon to make India self-sufficient in bulk drugs (APIs) and reduce the dependence on Chinese imports. The department is actively considering the key recommendations by Katoch committee to boost the bulk drug industry. While the committee’s recommendations are focused to boost indigenous supplies of bulk drugs related to essential medicines (which are under price control in India), local players may get advantages from exports.

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Exhibit 8: Key recommendations of Katoch committee on bulk drugs

Establishment of Mega Parks for APIs with common facilities such as common Effluent

Treatment Plants (ETPs), Testing facilities, Captive Power Plants/assured power supply by

state systems, Common Utilities/Services such as storage, testing laboratories, IPR

management, designing, etc., maintained by a separate Special Purpose Vehicles (SPV)

A scheme for extending financial assistance to states to acquire land and also for setting up

common facilities

Revival of public sector units for starting the manufacturing of selected and very essential

critical drugs (e.g., penicillins, paracetamol etc.)

Financial investment from the Government for development of clusters which may be in

the form of a professionally managed dedicated equity fund for the promotion of

manufacture of APIs

Extending fiscal benefits to creation of the entire community cluster infrastructure and

individual unit infrastructure

Extension of fiscal and financial benefits to promote the bulk drugs sector

Promoting stronger industry-academia interaction

Synergizing R&D promotion efforts by various government agencies

Incentivizing scientists

Duty exemptions for capital goods imports

Source: Industry

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CRAMS

CRAMS provide platform to enter specialty API segment

The genesis of CRAMS business lies in the rising R&D costs and declining R&D productivities, which forced innovators to outsource part of their drug discovery and development process to low cost destinations like India and China. As per industry estimates, Indian CRAMS players are expected to register a strong growth of 18-20% CAGR to touch $18bn by 2018, from $7-8bn in 2013. As most innovations are focused on specialty segments, CRAMS opportunities are better in these segments. Indian CRAMS players have created a niche in specialty segments like oncology, CNS, cadiovascular among others.

CRAMS becomes a natural extension of bulk drugs business: Barring a few players who started and dedicated their operations as a key contract research and manufacturing service (CRAMS) since inception, most others engaged in the business of fine chemicals, drug intermediates and bulk drugs have diversified into CRAMS business to leverage their R&D capabilities and manufacturing infrastructure.

The diversification into CRAMS makes sense for bulk drug players for two key reasons: (a) it helps to recover the cost of R&D setup, which has to be established to make complex products, (b) while engaging in drug discovery, chemical synthesis and process development, a company is well prepared to provide the commercial supplies to innovators during the patented life of products and even after the products goes generic and (c) CRAMS generates better profit margins and hence helps a company to mitigate the weaker margin in bulk drugs segments.

Chart 9: Pharma value chain and CRAMS landscape

Source: Company, Systematix Institutional Research

Indian players provide services across the value chain -- from contract manufacturing of fine chemicals, intermediates, bulk drugs and formulations to contract research like drug discovery, process development among others

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Focus on specialty segments, late stage projects, customer diversifications are common strategies to grow in CRAMS

Most CRAMS players have evolved while serving a limited number of innovators (mostly MNCs) and working on a select number of projects undergoing different phases of drug discovery and developments. Typically, an innovator outsources the early part of a drug discovery and development activities to many players. Thus, very few get a chance to engage in supply to late stage projects, as the IP-related sensitivity increases and requirements of multi-location clinical trials make it unviable to depend on single outsourcing partners.

As the early phase projects, which include lead identification, drug discovery and custom synthesis require high R&D intensity but limited supplies of materials (only in grams), the profit is limited and revenue flow is not consistent. In such cases, CRAMS players focus to widen the customer base to get regular projects. However, late stage projects involve supplies of higher quantities of materials (likely at around few tonnes) and better chances of repeat orders from clients yield improved profits. CRAMS players serving late stage projects normally have a higher probability of getting supply agreements with innovators for intermediates and bulk drugs during the patented life of new chemical entities.

Thus, the key strategies for CRAMS players involve getting late stage projects, reduce the dependence on limited number of clients and projects and establish an expertise in key niche segments.

Chart 10: Presence of Indian players in CRAMS landscape

Source: Company, Systematix Institutional Research

Table 1: Key activities of Indian players in CRAMS business

Indian CRAMS players

Niches Key activities

Divi's Labs Cardiovascular, CNS, Hormones

One of the largest players in custom synthesis business, having over 25 years of presence

Dishman Pharma Oncology Multi-location CRAMS operations, one of the few players having Hi-Po facility

Granules India Miscellaneous Recently setup under a JV with Ajinomoto OmniChem

Jubilant Life Miscellaneous Mostly in contract manufacturing of Sterile injectibles

Neuland Labs Miscellaneous Custom manufacturing for on-patent and off-patent products

Suven Life Sciences CNS One of the key player in pure CRAMS having expertise in drug discovery, development and process development

Source: Company, Systematix Institutional Research

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Our coverage universe

We have chosen five mid-sized Indian companies engaged in the business of bulk drugs, drug intermediates and CRAMS namely (a) Dishman Pharma, (b) Granules India, (c) Jubilant Life Sciences, (d) Neuland Laboratories and (e) Suven Life Sciences.

Though these players faced multiple challenges during the past few years, they have unveiled a better business proposition to register healthy growth. Most of them started the business in specialty chemicals and drug intermediates, but have moved up the value chain to offer bulk drugs, advanced intermediates, contract research, contract manufacturing and formulations. These players have done sizable capex and restructured their business during the past few years to play on volume and focus on niche segments. Though a favourable change in their business proposition has expanded their valuations, we believe the scope for enhancements exists for most of them.

Table 2: A journey from chemical phase to bulk drugs and CRAMS…

Chemical Intermediates Bulk Drugs CRAMS Formulation Specialisation/ consolidation

Going forward

1980-1985 1986-90 1991-95 1996-00 2001-05 2006-2010 2011-15 2016-20

Dishman

Phase transfer catalysts

and quats

Chlorhexidine and

derivates

Bulk intermediates

Contract manufacturing

Acquisition of Corbogen Amcis,

setup of vitamin D business

Set up Hi-Po facility

Focus on value-added

CRAMS, generic APIs

Granules Paracetamol

API Multiple

APIs PFI

Expansion of PFI

facility

Expansion of Paracetamol API to

enter regulated markets; Forward

integration to formulation

Entry into CRAMS;

Expansion of PFI, API

(acquisition of Auctus)

Focus on formulation

through vertical

integration

Jubilant Vinyl Acetate

Monomer (VAM)

Poly vinyl acetate

emulsion; Vamicol,

an adhesive product

Pyridine & Picoline

Food polymer; Pyridine

derivates; acetyl

Enters API business through acquisition, starts

CRAMS

Contract Research, enters

Radiopharmaceuticals, Formulation

development, Rampup of other

business

Symtet developed through in-house R&D

Consolidation in each

segments, focus on generic

formulations

Neuland

Made first sale of

salbutamol sulphate/ albuterol

sulfate

Added few more

products

Received Certificate of Suitability for

Ranitidine

Nine products with Certificate of

Suitability; Exclusive peptide collaboration

with Genzyme Corporation

CRAMS through MAPIC

collaboration

Focus on niche APIs, rampup in

CRAMS

Suven Life

Fine Chemical

Intermediates

CRAMS

Drug Discovery Collaboration;

manufacture of APIs, CNS Drug Discovery Collaboration with Lilly; Certificate of

Suitability (CEP) for Tamsulosin

Hydrochloride

Focus on value-added projects in

CRAMS, NCE pipeline

focused on CNS segment

Own ANDA filings,

commercialisation of late

phase CRAMS projects,

monetising the NCE pipeline

Source: Company, Systematix Institutional Research

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Table 3: Brief profile of our coverage universe

Profile Key activities in specialty pharma

Dishman Pharma

Dishman is one of key players in CRAMS space and the key producer of vitamin D, phase transfer catalysts, drug intermediates and specialty chemicals. It has manufacturing facilities spread across India, Switzerland (Carbogen Amcis), the UK (Carbogen Amcis), the Netherlands and China. These include a high potency oncology facility, a vitamin-D facility and a disinfectant facility. Of late, the company has started to focus on generic APIs. In FY15, CRAMS contributed ~70% of revenue, while vitamin D ~15% and other business ~15%. The company posted a CAGR of ~12% during the past five years.

Presence in CRAMS with a focus on oncology, having hi-potency (class IV) manufacturing setup

Granules India

Granules India is a 30-year-old Hyderabad-based pharmaceutical company, with world-class manufacturing facilities for Active Pharmaceutical Ingredient (API), Pharmaceutical Formulation Intermediates (PFIs) and Finished Dosages (FD) serving customers in over 60 countries. In FY15, exports contributed 78% of its consolidated revenue, a significant portion (63%) of which came from regulated markets. While API business forms a major part of its business, the company has expanded its capacities in PFI and FD segments to move up the value chain and tap opportunity in the global generic market. The management has a revenue target of $1bn in the next seven years (implying 30% CAGR) and significant expansion in operating margins on the back of better scale and products mix.

Very low presence in specialty pharma; JV with Omni-Chem may bring new dimensions

Jubilant Life

Jubilant Life Sciences is an integrated global pharmaceutical and life sciences company engaged in the manufacturing and supply of APIs, Solid Dosages, Radiopharmaceuticals, Allergy Therapy Products and Life Science Ingredients. It also provides services in Contract Manufacturing of Sterile Injectables and Drug Discovery Solutions. It serves its customers globally with sales in over 100 countries and ground presence in India, North America, Europe and China. It has 7 world class manufacturing facilities in India and 3 in North America and a team of ~ 6,100 multicultural people across the globe.

Strong presence in Specialty Pharma through API as 60% of DMF filed belongs to specialty segments), finished dosages (near 40% FD portfolio from specialty pharma) and CMS for sterile products. Besides, it also has a presence in Radiopharma, which is a niche segment

Neuland Labs

Neuland is a 30-year-old Hyderabad-based player engaged in the manufacturing of wide range of bulk drugs, intermediates and custom manufacturing. The company has built a strong products pipeline and transformed itself from a low-end API manufacturer to high-end products, hence significantly changing its margin profile. Equipped with two state-of-the-art manufacturing facilities, a rich portfolio of over 75 products, over 586 regulatory filings and presence in 80 countries including Europe, the US and Japan, the company is well positioned to capitalise on the upsurge in generic pharmaceutical market.

Most of the new APIs under development and recently filed are from specialty segments

Suven Life

Suven Life Sciences designs, manufactures and supplies bulk drugs, intermediates, chemicals and is also engaged in CRAMS. Its business segments include manufacturing (CRAMS), which develops and produces bulk drugs and intermediates under contract manufacturing services; services (DDDSS), which consists of collaborative research projects (CRP), clinical trials and testing and analysis services, and research and development. The company offers products such as active pharmaceutical ingredients (APIs), including aripiprazole and calcium acetate, intermediates such as pyrimidines, carbohydrates and indoles among others.

Pure CRAMS with a focus on CNS (neuro-psychiatry) segments; of the 16 DMFs filed, six belong to specialty segments

Source: Company, Systematix Institutional Research

Chart 11: DMF filing trend

Source: Company, Systematix Institutional Research

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Chart 12: Revenue mix - well diversified business Chart 13: Revenue - expect healthy growth to continue

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 14: Profit to grow faster for key players Chart 15: RoE to improve on strong operating performance

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research; * excluding one-offs

* excluding one-off, # Turnaround in FY15

Chart 16: RoCE to jump on low capex and better margins Chart 17: Valuation - scope for re-rating remains

Source: Company, Systematix Institutional Research; * excluding one-offs Source: Company, Systematix Institutional Research

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COMPANIES SECTION

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Dishman Pharmaceuticals

Equipped for predictable growth

Dishman Pharmaceuticals and Chemicals (Dishman) provides contract research and manufacturing services (CRAMS) to global innovators and also manufactures and sells bulk drugs, vitamin-D and specialty chemicals. Post the huge capex to build a world-class high potency (Hi-Po) facility in India and a series of acquisitions during FY06-11, the company has taken measures to consolidate its position in CRAMS and Vitamin D business to ensure a stable revenue flow from key verticals. It has built a healthy order book in CRAMS, which is virtually full of current capacities, and thus the management’s focus is shifting to improve profitability. We expect a significant growth in earnings over the next couple of years (earnings CAGR of ~26% in FY15-18e versus ~9% in FY13-15), which will aid to generate sizable cash flows. We initiate coverage on Dishman Pharmaceuticals with an Accumulate rating and a target price of Rs415 (14x FY18e EPS).

Investment rationale

Widening customer base to de-risk CRAMS business: Dishman has built a sizable order book for CRAMS and is widening the customer base to reduce the dependence on few large innovators. It is focusing on small and mid-sized biopharma companies to de-risk the business and ensure predictable business flows. Historically, the company’s performance has been marred by inconsistency due to its dependence on a few large players and improper asset utilisation. Now, large innovators account for only 40% of its business, compared to 60-70% three to four years ago.

Post consolidation, focus is on specialty business; earnings to rise faster: Dishman witnessed a major consolidation in its manufacturing operations and integrated it into a CRAMS business model, which is mainly focused on oncology. The company is now equipped with a renovated vitamin D facility, higher degree of integration and more profitable CRAMS projects spanning across India, Switzerland, the UK, France and China. Hence, its EBITDA margin is likely to expand from 19.9% in FY15 to 24% in FY18e, though revenue may see a moderate growth (expecting revenue CAGR of 10% during FY15-18e).

Operating performance to shore up balance sheet: Dishman’s improving operating performance is set to ease the pressure on its balance sheet and perk up the return ratios. The company does not have major capex plans for the next couple of years and thus most of the internal accruals are likely to be utilised to retire debts. We expect the debt to recede from Rs8.7bn currently to Rs4.7bn by FY18e (debt-equity ratio to fall from 0.6x in FY15 to 0.3x in FY18e), while RoE will increase from 9.7% in FY15 to 13.7% in FY18e.

Consistent performance warrants re-rating: A more predictable business model, faster earnings growth and improving balance sheet are some of the key factors which will lead to the stock’s re-rating. The stock trades at 12x FY18e, which is 36% premium to its three-year historical average (8x). We assign a valuation multiple of 14x FY18e earnings to arrive at a target price of Rs415, with an Accumulate rating.

6 January, 2016

INITIATING COVERAGE

Sector: Pharma Rating: Accumulate

CMP: Rs350 Target Price: Rs415

Stock Info

Sensex/Nifty 25,580/7,785

Bloomberg DISH IN

Equity shares (mn) 80.7

52-wk High/Low Rs420/126

Face value Rs2

M-Cap Rs27bn/$0.4bn

3-m Avg volume $2.1mn

Financial Snapshot (Rs mn)

Y/E Mar FY15 FY16e FY17e

Net sales 15,752 17,020 18,960

EBITDA 3,138 3,829 4,399

PAT 1,199 1,487 1,926

EPS (Rs) 14.9 18.4 23.9

PE (x) 23.6 19.0 14.7

EV/EBITDA (x) 11.2 9.1 7.7

P/B (x) 2.3 2.1 1.9

RoE (%) 9.7 11.0 12.6

RoCE (%) 8.0 11.9 13.7

Dividend yield (%) 0.6 0.6 0.6

Shareholding pattern (%)

Sep ’15 Jun’15 Mar ’15

Promoter 61.4 61.4 61.4

–Pledged - - -

FII 13.9 14.5 14.7

DII 5.1 3.9 3.5

Others 19.6 20.2 20.4

Stock Performance (1-year)

T. Ranvir Singh [email protected] +91 22 6704 8016

Systematix

Institutional Equities

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FINANCIALS (CONSOLIDATED) Profit & Loss Statement

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Net revenue 13,853 15,752 17,020 18,960 20,903

YoY growth % 8.9 13.7 8.0 11.4 10.2

- Op. expenses 10,532 12,614 13,190 14,562 15,886

EBIDTA 3,321 3,138 3,829 4,399 5,017

EBIDTA margin (%) 24.0 19.9 22.5 23.2 24.0

- Interest expenses 921 897 756 646 525

- Depreciation 1,086 1,507 1,322 1,421 1,545

+ Other income 249 860 258 271 284

- Tax 471.3 394.4 522.4 676.7 840.1

Effective tax rate (%) 30.1 24.7 26.0 26.0 26.0

PAT 1,092 1,199 1,487 1,926 2,391

+/- Extraordinary items - - - - -

+/- Minority interest - 0.5 - - -

Reported PAT 1,093 1,199 1,487 1,926 2,391

Adj. FDEPS (Rs/share) 13.5 14.9 18.4 23.9 29.6

Adj. FDEPS growth (%) 8.9 9.7 24.0 29.5 24.2

Source: Company, Systematix Institutional Research

Balance Sheet

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Share capital 161.39 161.39 161.39 161.39 161.39

Reserve and Surplus 11,651 12,217 13,344 15,075 17,272

Net worth 11,813 12,379 13,505 15,237 17,433

Minority Interest - - - - -

Total Debt 7,185 7,370 6,870 5,870 4,770

Def. tax Laib(net) 677 629 660 693 728

Capital Employed 19,675 20,378 21,035 21,800 22,931

Net Fixed assets 15,840 15,828 15,710 16,089 16,793

Investments 249 381 249 249 249

- of which liquid

Net Working capital 3,233 3,807 4,647 5,179 5,599

Cash and bank balance 353 362 429 283 290

Capital deployed 19,675 20,378 21,035 21,800 22,931

Net debt 6,833 7,008 6,441 5,587 4,481

WC (days) 85 88 100 100 98

Book value (Rs/sh) 146.4 153.4 167.4 188.8 216.0

Source: Company, Systematix Institutional Research

Cash Flow

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

PAT 1,093 1,199 1,487 1,926 2,391

+ Non cash items 1,557 1,902 1,845 2,098 2,385

Cash profit 2,650 3,100 3,332 4,024 4,776

- Incr/(Decr) in WC (500) 574 840 533 420

Operating cash flow 3,149 2,526 2,492 3,491 4,357

- Capex 2,223 2,412 1,205 1,800 2,250

Free cash flow 926 114 1,287 1,691 2,107

- Dividend 113 194 194 194 194

- Tax 471 394 522 677 840

+ Equity raised - 0.5 (0.5) - -

+ Debt raised (811) 185 (500) (1,000) (1,100)

- Investments (28) 132 (132) - -

- Misc. items (585) (431) 134 (33) (35)

Net cash flow 143 9 67 (147) 7

+ Opening cash 210 353 362 429 283

Closing cash 353 362 429 283 290

Source: Company, Systematix Institutional Research

Ratios

YE: Mar FY14 FY15 FY16e FY17e FY18e

P/E (x) 25.8 23.6 19.0 14.7 11.8

P/CEPS (x) 13.0 10.4 10.1 8.4 7.2

P/B (x) 2.4 2.3 2.1 1.9 1.6

EV/EBITDA (x) 10.6 11.2 9.1 7.7 6.5

EV/Sales (x) 2.5 2.2 2.0 1.8 1.6

RoE (%) 9.3 9.7 11.0 12.6 13.7

RoCE (%) 11.4 8.0 11.9 13.7 15.1

Fixed Asset turnover (x) 0.8 0.7 0.7 0.7 0.7

Dividend yield (%) 0.4 0.6 0.6 0.6 0.6

Dividend payout (%) 8.9 13.5 10.9 8.4 6.8

Debtors (days) 21.8 50.8 30.0 31.0 32.0

Revenue growth (%) 8.9 13.7 8.0 11.4 10.2

EBITDA growth (%) 14.5 (5.5) 22.0 14.9 14.0

PAT growth (%) 8.9 9.7 24.0 29.5 24.2

EPS growth (%) 8.9 9.7 24.0 29.5 24.2

Net D/E ratio (x) 0.6 0.6 0.5 0.4 0.3

Source: Company, Systematix Institutional Research

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Charting the story

Chart 1: No major change in revenue mix Chart 2: Revenue growth to remain under 10-12% in each segment

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 3: EBITDA margin to expand by ~400bps over FY15-18e Chart 4: Low capex to help generate ~Rs5bn of FCF over FY16e-18e

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 5: Debt and debt-equity ratio to recede Chart 6: RoE and RoCE to perk up but remain below peers

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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Table 1: Business snapshot

Key business units Location Annual revenue

($ mn) - FY15 Key attributes Comments

Dishman-CRAMS India 38

Process development, process optimisation, manufacturing of late stage clinical and commercial supply

High margin business, having long term contracts with key global clients; the business de-grew at a CAGR of 2.3% during the past five years and generated an average EBITDA margin of 30%

Carbogen-Amcis Switzerland,

France, UK, India 138

Process research and development, API supply for clinical trials, niche scale in commercial manufacturing, high potency API supply. Mainly caters to specialty pharma segments

High margin business, with a high entry barrier. Sizeable client base across Europe and the US. Revenue grew at a CAGR of 11.2% during the past five years. This unit is one of the key growth drivers for the company. The average EBITDA margin continues to be in the low bracket of 15-17%

Dishman Specialty Chemicals

India, China, Saudi Arabia

39

Manufacturing of phase-transfer catalyst, intermediates and fine-chemicals for pharma and cosmetics use

Commoditised nature of business, having an average margin of 20%. However, a turnaround in China business (potential revenue $5mn in FY16) at an EBITDA margin of 25% will aid

Dishman Vitamins and Chemicals

Netherlands, India

37

Vitamin-D2 & D3, Vitamin-D analogues, cholesterol related products for Pharma, cosmetics use

Dishman is among the few global players in vitamin-D business, which is witnessing a high demand. The company recently reorganised this business to tap opportunities. Revenue grew at 16% in the past five years. It is likely to maintain the growth momentum at a sustainable EBITDA margin of 20-22%

Dishman Care India, Australia,

Saudi Arabia -

Disinfectants, anti-septic formulations

Commoditised nature of business, having an average margin of 15-18%. Does not contribute meaningfully

Dishman Generic-API India - Various APIs focused on the US market

Dishman is a new entrant in this business and is yet to see a meaningful revenue base

Source: Company, Systematix Institutional Research

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Progression to specialty CRAMS

Dishman Pharma started its operation in CRAMS by supplying starting materials for eprosartan mesylate (anti-hypertension drug) to US-based Solvay Pharmaceuticals BV. Later, it entered into a deal with AstraZeneca to supply starting materials for innovative anti-platelet drug Brilinta (ticagrelor). However, the company’s revenue saw a decline from Indian CRAMS operation after eprosratan went generic in 2003 and AstraZenaca’s Birlinta could not fetch the expected revenue for the innovator. Thus, Dishman’s large chunk of capacity went unutilised. However, Dishman has now positioned itself as an integrated CRAMS player by offering services of process development, process optimisation, manufacturing of late stage clinical and commercial supply that runs through pre-clinical to commercialisation stage. The company has got expertise in developing high-potency therapies like steroids, hormones, isotopes and cytotoxics - mostly related to oncology.

CRAMS business consolidated for better profit

During the past couple of years, the company consolidated its position by leveraging the multi-location facilities spanning across India, Europe and China. While European operations (through the wholly-owned subsidiary Carbogen Amcis) take care of early stage (pre-clinical, Phase I and II of clinical trials) process research, the Indian and Chinese facilities have been dedicated to the late stage (Phase III and commercial launch) services.

In FY15, Dishman consolidated its Chinese facilities under the CRAMS model -- bring intermediates from its China plant to India, convert them into active pharmaceutical ingredients (APIs) and sell both in the domestic and international markets. The company expects to derive significant cost advantage from this move.

Currently, Dishman’s CRAMS business is organised under two key verticals: (1) India CRAMS – which deals in late stage and commercial supplies of intermediates and bulk drugs (contributed 15% of consolidated revenue in FY15) and (2) Carbogen Amcis – undertakes operations in Switzerland, France, the UK, China and India’s Hi-Po facility (contributed 55% of consolidated revenue in FY15).

We estimate the company’s CRAMS business to post a revenue CAGR of 9% over FY15-18e. However, the profit from this business will grow much faster due to significant synergy coming from the integration.

Chart 7: Consolidated CRAMS model

Source: Company, Systematix Institutional Research

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Carbogen expands operations, shifts focus to profitability

Carbogen Amcis (wholly-owned subsidiary of Dishman) ramped up its operations during the past few years by widening the customer base and expanding reach to multi location operations. Currently, it undertakes operations from four sites in Switzerland, one site each in France and the UK, the Hi-Po facility in India and commercial manufacturing at China’s Shanghai facility. The multi-location facilities in Europe help to procure contracts from innovators based in nearby areas, while the late stage customers are catered to at low-cost locations like India and China.

While Carbogen has been operating at almost full capacity and the current order book indicates near full capacity utilisation in FY16, its focus is to improve profitability.

Carbogen’s EBITDA margin expanded during the past couple of years (except in FY15 when low margin projects were executed in first half of the fiscal). In 1HFY16, Dishman witnessed 350bps expansion in EBITDA margin to 18% from the Swiss operations of Carbogen. The management expects a revenue of CHF120mn (Rs8.3bn) from Carbogen in FY16.

In FY15, Dishman posted an EBITDA margin of 14% from CRAMS operation. We believe it will sustain 17-20% EBITDA margin from the Swiss operations during FY16-18e, though revenue will grow moderately at a CAGR of 9% during FY15-18e (assuming no major capex during the next couple of years).

Order book stagnant but focus on margins augurs well: Dishman’s total pipeline of orders was in excess of $150mn for FY16 in CRAMS (1HFY16 CRAMS revenue at $82mn) and new orders continue to flow. The company executed contracts worth $170mn in FY15 and thus the order book in FY16 may not see a change. The focus on more profitable contracts is set to boost earnings.

Currently, Dishman has over 150 projects at different stages of development. Of these, 100 CRAMS projects, 25 Generic APIs, ~25 NCE molecules are under laboratory/pilot scale, and commercial production IPR for some are given to customers on decided payments (Dishman owns the IPR for many projects). Of the total CRAMS projects, the company has 13 related to Phase III candidates and 20 projects related to Phase II.

Hi-Po facility will be a growth engine in next couple of years

Dishman is aiming to make the hi-potency business a critical element for growth. The Hi-Po facility (called Unit-9 at Bavla) is focused on high-margin, complex products serving the oncology therapeutic segment. The management plans to shift majority of the business initiated by Carbogen in Switzerland to its Hi-Po facility at Bavla in India for better cost synergies. Dishman’s two cells are operated at near full capacity utilisation (peak revenue level of $15-20mn) and thus it is evaluating options to operationalise the three additional cells to accommodate the increase in new projects. With these debottlenecking measures, the management expects a significant traction in Hi-Po business by FY17, and that may be a growth engine for the company.

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CRAMS’ focus to widen customer base to de-risk business

Dishman is focusing on widening the customer base, preferably small and mid-sized customers, which will aid the company to reduce the dependence on few large players. Currently, the top 10 customers contribute 40% of revenue, compared to 60-70% of revenue couple of years back.

Janssen deal showcases ability to convert services into manufacturing opportunity: Dishman recently bagged the licence agreement from Johnson Pharmaceutica NV, a Janssen Pharmaceutical company of the Johnson & Johnson group, to produce API for the drug Sirturo (bedaquiline), a medicine used in the treatment of Multi-Drug-Resistant Tuberculosis (MDR TB). In 2008, Janssen had contracted Dishman to conduct a full chemical synthesis of this API at its Bavla facility in Gujarat. Janssen subsequently registered Dishman as a manufacturer of API with the USFDA, the European Medicines Agency (EMA) and several other Asian regulatory authorities. The drug will open significant opportunities as Janssen launches it in the global markets.

Chinese facility turns profitable on integrated business approach

Dishman’s Chinese facility (at Shanghai) has been reeling under losses due to low-end products and low offtake during the past few years. However, FY15 witnessed a breakeven on the start of production, with four key projects under execution. The growth has mainly been driven by integrating operations with Carbogen, which site-transfers few projects to China for better cost advantages under the CRAMS model.

Dishman is clocking profit consistently and we can expect a stronger traction going forward. By FY16-end, the unit will be GMP-ready, thus presenting a strong opportunity for Carbogen to extend its capacity.

Vitamin D business witnessing stronger traction

The global vitamin D industry is witnessing an expansion in demand on the back of various analogues finding applications in a wider range of consumer products and drugs. As per industry estimates, the vitamin D market is likely to post a CAGR of 11% to reach $2.5bn by 2020. There are limited companies in this segment and thus provides opportunities for players like Dishman. Though the company’s vitamin D business witnessed multiple bumps in the recent past, it is now ready with an integrated business model of significant cost advantages.

The revenue from vitamin D business grew by 16.6% to Rs1.4bn in 1HFY16, while EBITDA margin expanded by 320bps to 29.2%.

Dishman Care adds new dimensions to CRAMS business

In FY15, Dishman operationalised the disinfectants business, Dishman Care, which will operate under the CRAMS model. This division will mainly undertake contract manufacturing for anti-microbial products based on Chlorhexidine Gluconate (CHG) and Octenidine Dihydrochloride (OCT). Though we do not expect significant profit from this venture in the near term, it may be a key growth driver in the long term.

API - natural extension of business, will add sheen to existing business

Dishman recently forayed into the generic API business, which is a natural extension of CRAMS and aids to utilise the spare capacities, with no additional capex. The process development for innovative products is a key advantage that is used to produce generic bulk drugs on expiry of exclusivity (patent protection). Dishman has 25 APIs in the pipeline and only few DMFs (five filed in the US) have been filed so far. The company will be able to garner sizeable revenue from generic API business, when the current pipeline fully unfolds. Dishman’s Bavla facilities have recently seen an USFDA scrutiny, which will pave the way for key products filing.

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Table 2: List of products filed with various authorities

Product Name Therapeutic Category Status

Bisacodyl Laxative US DMF / CEP

Bosentan monohydrate Antihypertensive ASMF

Bupivacaine Hydrochloride Anesthetic US DMF Available for Reference / CEP

Cetirizine Hydrochloride Antihistamine US DMF / CEP

Cinacalcet hydrochloride Endocrine and metabolic agent US DMF

Etofenamate Anti-inflammatory CEP

Fenofibrate Antihyperlipidemia Canadian DMF / CEP

Gemcitabine hydrochloride Antineoplastic US DMF

Glimepiride Antidiabetic US DMF/ CEP

Milnacipran Hydrochloride

(2)

Antidepressant ASMF

Omeprazole Antiulcer US DMF / CEP

Picosulphate Sodium Laxative US DMF Available for Reference / Canadian DMF / ASMF

Pralidoxime Chloride Cholinesterase reactivation US DMF / ASMF

Pralidoxime iodide Antidote ASMF

Quetiapine Hemifumarate Antipsychotic US DMF

Ropivacaine Hydrochloride (anhydrous)

Anesthetic US DMF

Ropivacaine Hydrochloride (monohydrate)

Anesthetic US DMF Available for Reference / CEP

Strontium Ranelate Osteoporosis treatment ASMF

Tramadol Hydrochloride Analgesic ASMF / CEP

Topiramate Anticonvulsant US DMF Available for Reference

Xipamide Diuretic ASMF

Source: Company, Systematix Institutional Research

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Financials

Expect revenue CAGR of 10% over FY15-18e

Dishman’s consolidated sales rose by 13.6% to Rs15.6bn in FY15 on the back of 17.4% growth in revenue from CRAMS to Rs10.9bn and 5.6% increase in revenue from marketable molecules to Rs4.71bn. In 1HFY16, the company reported a moderate 2.6% growth in revenue to Rs7.7bn, mainly due to a marginal decline in revenue from CRAMS, though vitamin D business saw a healthy growth.

Table 3: Quarterly revenue performance

Revenue breakup (Rs mn) 2QFY16 2QFY15 yoy % 1HFY16 1HFY15 yoy %

CRAMS 2,697 2,812 (4.1) 5,216 5,256 (0.8)

CRAMS-India 570 629 (9.4) 1,238 1,224 1.1

CRAMS – Carbogen Amcis 1,884 1,991 (5.4) 3,652 3,541 3.1

CRAMS – UK 243 192 26.4 325.7 378 (13.8)

CRAMS – Others - - - - 113 -

Marketable Molecules 1,040 1,112 (6.5) 2,521 2,283 10.4

Vitamin D 530.6 492 7.8 1405 1196 17.4

Others 509.4 620 (17.8) 1116 1087 2.7

Other operating income 75 68.1 10.1 80 80 0.6

Total 3,812 3,992 (4.5) 7,817 7,619 2.6

Source: Company, Systematix Institutional Research

Going forward, we expect the revenue growth will remain under single digit, as the company’s focus shifts to improve profitability from existing assets, without any major capex. We estimate a revenue growth of 9% in FY16e (management guided for 10% increase in revenue in FY16) and 10% revenue CAGR for FY15-18e.

Table 4: Revenue model

Revenue breakup (Rs mn) FY12 FY13 FY14 FY15 FY16e FY17e FY18e CAGR

(FY15-18e)

Dishman Crams 3,178 3,323 2,660 2,328 2,546 2,979 3,213 11.3

YoY% 4.6 (19.9) (12.5) 9.4 17 7.9 -

% of sales 28.3 26.2 19.4 14.9 15 15.7 15.4 -

Carbogen Amcis-Swiss 3,987 4,810 6,114 7,713 8,330 9,162 10,079 9.3

YoY% 20.7 27.1 26.2 8 10 10 -

% of sales 35.5 37.9 44.5 49.4 48.9 48.3 48.2 -

Carbogen Amcis-UK - - 502.9 853.5 800 900 1,000 5.4

YoY% - - - 69.7 (6.3) 12.5 11.1 -

% of sales - - 3.7 5.5 4.7 4.7 4.8 -

Total CRAMS 7,164 8,133 9,276 10,894 11,676 13,041 14,291 9.5

YoY% - 13.5 14.1 17.4 7.2 11.7 9.6 -

% of sales 63.9 64.2 67.6 69.8 68.6 68.8 68.4 -

Marketable Molecules 2,220 2,433 2,318 2,439 2,846 3,047 3,308 10.7

YoY% - 9.6 (4.7) 5.2 16.7 7.1 8.6 -

% of sales 19.8 19.2 16.9 15.6 16.7 16.1 15.8 -

Vitamin-D and Others 1,836 2,110 2,138 2,270 2,497 2,872 3,303 13.3

YoY% - 14.9 1.3 6.2 10 15 15 -

% of sales 16.4 16.6 15.6 14.6 14.7 15.1 15.8 -

Total Marketable Molecules 4,056 4,543 4,456 4,709 5,344 5,919 6,611 12

YoY% - 12 (1.9) 5.7 13.5 10.8 11.7 -

% of sales 36.1 35.8 32.4 30.2 31.4 31.2 31.6 -

Consolidated Revenue 11,220 12,676 13,732 15,604 17,020 18,960 20,903 10.2

Source: Company, Systematix Institutional Research

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EBITDA to see ~400bps expansion during FY15-18e

Dishman’s consolidated EBITDA margin stood at 19.9% in FY15, which rose to 24% in 1HFY16. The expansion in EBITDA margin is mainly attributed to (a) better projects’ execution at Carbogen, (b) synergy from integrated operations of vitamin D business and (c) turnaround in Chinese operations. With a clear focus to improve profitability, we believe EBITDA margin of 22-24% is sustainable during the next couple of years.

We estimate an EBITDA margin of 22.5% in FY16e (2HFY16 may see a decline in EBITDA margin from the high base achieved in 2HFY15), 23.2% in FY17e and 24% in FY18e.

Table 5: EBITDA breakup

EBITDA (Rs mn) FY14 FY15 FY16e FY17e FY18e

Dishman Crams 1,761 1,094 1,222 1,340 1,446

YoY% 2.1 (37.9) 11.7 9.7 7.9

EBIDTA margin % 66 47 48 45 45

Carbogen Amcis-Swiss 1,141 1,080 1,416 1,741 2,016

YoY% 46.0 (5.4) 31.1 22.9 15.8

EBIDTA margin % 19 14 17 19 20

Carbogen Amcis-UK 39 273 204 252 300

YoY% - 607.6 (25.3) 23.5 19.0

EBIDTA margin % 8 32 26 28 30

Total CRAMS 2,941 2,447 2,842 3,333 3,761

YoY% 17.3 (16.8) 16.1 17.3 12.8

EBIDTA margin % 32 22 24 26 26

Marketable Molecules 367 244 279 248 299

YoY% - (33.5) 14.4 (11.2) 20.8

EBIDTA margin % 16 10 10 8 9

Vitamin-D and Others 263 454 699 819 958

YoY% (32.7) 72.5 54.0 17.1 17.0

EBIDTA margin % 12 20 28 29 29

Total MM 630 698 978 1066 1257

YoY% 60.9 10.8 40.2 9.0 17.9

EBIDTA margin % 14 15 18 18 19

Total EBIDTA 3,571 3,145 3,820 4,400 5,018

YoY% 23.2 (11.9) 21.5 15.2 14.1

Source: Company, Systematix Institutional Research

Net profit to clock CAGR of ~26% over FY15-18e

The company reported a 9.7% increase in consolidated net profit to Rs1.2bn in FY15, which included Rs580mn towards recovery of insurance claims related to a delay in the delivery of products. Excluding the amount recovered from insurance, the adjusted net profit declined by 43% to Rs619mn.

In 1HFY16, Dishman reported 31% increase in net profit to Rs743mn. We estimate a net profit of 24% at Rs1.48bn in FY16e, 29.5% at Rs1.93bn in FY17e and 24% at Rs2.39bn in FY18e.

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Table 6: Quarterly performance

Consolidated (Rs mn) 2QFY16 2QFY15 yoy % 1HFY16 1HFY15 yoy %

Net sales 3,812 3,991 (4.5) 7,737 7,539 2.6

RM costs 903 1,188 (24.0) 1,726 2,233 (22.7)

Gross profit 2,909 2,803 3.78 6,011 5,306 13.3

Other op. exp. 1,994 1,925 3.56 4,132 3,754 10.1

EBIDTA 915 878 4.26 1879 1552 21.1

PBT 494 473 4.43 1,001 755 32.6

Tax 128.9 139.4 (7.50) 259 189 36.6

Reported PAT 365 334 9.41 743 572 29.8

Adjusted PAT 365 334 9.32 743 566 31.1

EPS 4.5 4.1 9.32 9.2 7.0 31.1

Gross margin % 76.3 70.2 609bps 77.7 70.4 731bps

EBIDTA % 24.0 22.0 202bps 24.3 20.6 370bps

Effective tax rate % 26.1 29.5 -337bps 25.8 25.1 76bps

Source: Company, Systematix Institutional Research

Free cash flows of ~Rs5bn in next three years; debt-equity ratio to decline to ~0.3x in FY18e

The company has done a massive capex during the last 10 years (Rs22bn capex during FY06-15) towards the acquisition of Carbogen (FY06), acquisition of Solvay Vitamins and Chemicals business based in the Netherlands (FY07), construction of Dishman Shanghai manufacturing facility (FY10) and creating a world-class Hipo facility at Bavla in India. While most of these facilities remain to be optimally utilised, the restructuring and consolidation during the last couple of years impacted Dishman’s return ratios. However, the management is now focused to optimise the assets through a better mix.

We do not expect major capex during the next couple of years, which will generate free cash flows of Rs5bn during FY16e-18e. The expected free cash flows may be compared to the current outstanding net debt of Rs7bn.

The company’s gross debt stood at Rs8.7bn as of September 2015-end, which included Rs6bn of foreign debts. We expect the net debt-equity ratio will decline from 0.57x in FY15 to ~0.28x in FY18e.

Chart 8: Low capex to help generate ~Rs5bn of FCF over FY16e-18e

Source: Company, Systematix Institutional Research

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Chart 9: Debt and debt-equity ratio to recede

Source: Company, Systematix Institutional Research

Return ratios remain low despite an improvement

The company’s RoE, which was reeling near 6% in FY12, has seen a gradual improvement during the past couple of years to reach ~10% in FY15; we expect it to reach 14% in FY18e. RoCE is likely to improve from 8% in FY15 to 15% in FY18e on the back of a reduction in debts. Nonetheless, Dishman’s return ratios remain low compared to peers.

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Valuation

Consistent performance to trigger re-rating

Historically, Dishman’s stock has shown a volatile performance mainly due to the inconsistent operating performance, successive expansion plans impacting RoE and currency volatility impacting its debt profile. Thus, the stock has been trading in a wide range of 3-17x during the last three years (one-year forward earnings basis). Currently, it is trading at 14.7x and 11.8x FY17e and FY18e earnings respectively.

We believe a consistent performance is key to the stock’s valuation. The company’s focus on de-risking its business by widening the customer base in CRAMS segments and renovated facilities for vitamin D will ensure consistency in performance and also aid to sustain a healthy profit margin.

We assign a valuation multiple of 14x to its FY18e earnings to arrive at a target price of Rs415.

Chart 10: P/E band Chart 11: P/BV band

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Risks and concerns: CRAMS business depends on the performance and success of innovators, which poses a huge risk. Also, a volatility in foreign exchange rate has the potential to materially impact Dishman’s performance.

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Background

Dishman was established in 1983 as a manufacturer of Quaternary compounds (quats) and later transformed into a full-fledged CRAMS partner for global pharma innovators. Currently, it has a global presence with manufacturing sites in Europe, India, China and Saudi Arabia, which are approved by recognised health authorities. Its operations are grouped under two major segments: (a) CRAMS and (b) Marketable Molecules. The company offers end-to-end services through its integrated business model which runs through process research and development to late stage clinical and commercial manufacturing. Its marketable molecule business deals in phase transfer catalysts, vitamin D, vitamin D analogues, cholesterol, laolin related products, antiseptic and disinfectant formulations for pharmaceutical, cosmetic and related markets. It recently forayed into high quality supply of generic APIs and intermediates for the pharmaceutical industry.

Chart 12: Well diversified business Chart 13: CRAMS remains key contributor of profits

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Table 7: Key management team

Name Designation Qualifications

Janmejay R Vyas Chairman & Managing Director BSc (Chemistry) & B Sc (Tech)

Deohooti J Vyas Whole-time Director B Sc (Chemistry)

Sanjay S Majmudar Director CA Bachelor Degree in Law & Company Secretary

Ashok C Gandhi Director UG in Commerce & Law (Advocate)

Arpit J Vyas Managing Director & CFO Degree in Chemical Engineering

Tushar Shah Company Secretary NA

Mark C Griffiths Additional Director NA

Subir Kumar Das Additional Director NA

Rajendra S Shah Additional Director NA

Source: Company, Systematix Institutional Research

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Granules India

Moving up the value chain

Granules India is a 30-year-old Hyderabad-based pharmaceutical company, with world-class manufacturing facilities for Active Pharmaceutical Ingredients (APIs), Pharmaceutical Formulation Intermediates (PFIs) and Finished Dosages (FDs) and serves customers in over 60 countries. While APIs form bulk of its business, Granules has expanded its presence in PFIs and FDs segments to move up the value chain, resulting in significant improvement in profit margin. The management has a revenue target of $1bn over the next seven years (implying 30% CAGR) and further expansion in operating margins on the back of optimisation of capacities and better products mix. We estimate revenue and profit CAGR of 17% and 30% respectively over FY15-18e. We believe the major uptick from FDs business will come in the next three to five years. We initiate coverage on Granules India with a Accumulate rating and a target price of Rs166 (implies 18x FY18e EPS).

Significant capacity additions to propel growth: Granules is undergoing major expansions across segments that will materially change the scale of business in the next couple of years. After expanding its FDs capacity by 3x to 18mn units and acquiring an API manufacturer (Auctus Pharma) in FY14, it is scaling up the 4,000mt capacity in PFIs to 18,400mt and 7,000mt of its Metformin business to 9,000mt. Besides, it is also setting up a new API facility at Vizag, which will be commissioned in the next 18 months. Having spent Rs5.2bn of capex during FY13-15, Granules has earmarked Rs4-4.5bn capex for FY16-18. Most of the capex will be met through internal accrual and promoters’ funding.

Forward integration to improve business profile: The company is aiming to forward integrate a significant portion of its business to improve profitability, apart from the capacity expansions. The contribution of FDs and PFIs is likely to increase from 32% and 24% in FY15 to ~40% and 29% respectively in FY18. The management’s target to achieve over 20% EBITDA margin in the next two to three years, from 16% in FY15, seems possible based on the products pipeline.

Products ramp-up: Granules’ products offerings have been widened with the acquisition of Auctus Pharma, which brought 12 new APIs for the company (end-use market size of $37bn). Further, Granules aims to develop four to five new APIs and file five to seven ANDAs every year with USFDA, which will significantly expand the products basket. Hence, we expect ~30 APIs and at least four to five ANDAs being commercialised in the next two to three years, which will significantly change the revenue base.

Initiate coverage with a Accumulate rating: The stock has seen successive re-rating during the past couple of years and is trading at 24.8x and 17.1x FY17e and FY18e earnings (versus the three-year average of 9x). Although we are optimistic on the company’s long-term growth prospects, we see limited scope to expand the valuation. We assign a valuation multiple of 18x FY18e earnings to arrive at a target price of Rs166, with an Accumulate rating.

Systematix

Institutional Equities

6 January, 2016

INITIATING COVERAGE

Sector: Pharma Rating: Accumulate

CMP: Rs148 Target Price: Rs166

Stock Info Sensex/Nifty 25,580/7,785

Bloomberg GRA IN

Equity shares (mn) 204.8

52-wk High/Low Rs164/75

Face value Rs1

M-Cap Rs30bn/$0.5bn

3-m Avg volume $1.6mn

Financial Snapshot (Rsmn)

Y/E Mar FY15 FY16e FY17e

Net sales 12,929 14,764 16,557

EBITDA 2,086 2,537 3,029

PAT 909 1,084 1,304

EPS (Rs) 4.4 5.3 6.4

PE (x) 33.3 28.0 23.2

EV/EBITDA (x) 16.3 12.9 11.3

P/B (x) 7.0 4.6 3.5

RoE (%) 21.1 16.4 15.2

RoCE (%) 17.1 16.4 16.4

Dividend yield (%) 0.3 0.3 0.3

Shareholding pattern (%)

Sep ’15 Jun’15 Mar ’15

Promoter 48.4 48.5 48.6

–Pledged - - -

FII 7.3 2.9 4.0

DII 1.0 0.2 0.1

Others 43.3 48.5 47.3

Stock Performance (1-year)

T. Ranvir Singh [email protected] +91 22 6704 8016

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FINANCIALS (CONSOLIDATED) Profit & Loss Statement

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Net revenue 10,959 12,929 14,764 16,557 19,702

YoY growth % 43.4 18.0 14.2 12.1 19.0

- Op. expenses 9,376 10,843 12,226 13,528 15,851

EBIDTA 1,583 2,086 2,537 3,029 3,851

EBIDTA margin (%) 14.4 16.1 17.2 18.3 19.5

- Interest expenses 204 323 339 325 287

- Depreciation 298 527 626 834 880

+ Other income 43 43 46 48 50

- Tax 371.3 370.5 533.8 613.6 847.6

Effective tax rate (%) 33.0 29.0 33.0 32.0 31.0

PAT 752 909 1,084 1,304 1,887

+/- Extraordinary items - - - - -

+/- Minority interest - - - - -

Reported PAT 752 909 1,084 1,304 1,887

Adj. FDEPS (Rs/share) 3.7 4.4 5.3 6.4 9.2

Adj. FDEPS growth (%) 131.0 20.8 19.2 20.3 44.7

Source: Company, Systematix Institutional Research

Balance Sheet

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Share capital 202.81 204.25 208.86 208.86 208.86

Reserve and Surplus 3,357 4,107 6,381 8,342 10,125

Net worth 3,560 4,312 6,590 8,550 10,334

Minority Interest - - - - -

Total Debt 4,102 4,331 4,539 4,349 3,849

Def. tax Laib(net) 303 493 500 500 500

Capital Employed 7,964 9,136 11,629 13,399 14,682

Net Fixed assets 6,070 6,786 7,239 9,355 9,025

Investments 1.9 1.9 2.0 2.1 2.2

- of which liquid

Net Working capital 1,474 1,695 2,377 3,501 4,835

Cash and bank balance 417 653 2,010 542 820

Capital deployed 7,964 9,136 11,629 13,399 14,682

Net debt 3,684 3,678 2,528 3,807 3,028

WC (days) 49 48 59 77 90

Book value (Rs/sh) 17.4 21.1 32.2 41.8 50.5

Source: Company, Systematix Institutional Research

Cash Flow

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

PAT 752 909 1,084 1,304 1,887

+ Non cash items 669 897 1,160 1,448 1,728

Cash profit 1,422 1,806 2,244 2,752 3,614

- Incr/(Decr) in WC 108 220 682 1,124 1,334

Operating cash flow 1,314 1,586 1,562 1,628 2,280

- Capex 2,822 1,273 1,080 2,950 550

Free cash flow (1,509) 313 482 (1,322) 1,730

- Dividend 47 47 47 47 47

- Tax 371 371 534 614 848

+ Equity raised 11.1 (8.4) 1,254.8 750.0 -

+ Debt raised 1,492 230 208 (190) (500)

- Investments (95) (6) - - -

- Misc. items (330) (113) 6 46 57

Net cash flow - 236 1,357 (1,469) 279

+ Opening cash 417 417 653 2,010 542

Closing cash 417 653 2,010 542 820

Source: Company, Systematix Institutional Research

Ratios

YE: Mar FY14 FY15 FY16e FY17e FY18e

P/E (x) 40.3 33.3 28.0 23.2 16.1

P/CEPS (x) 28.8 21.1 17.7 14.2 11.0

P/B (x) 8.5 7.0 4.6 3.5 2.9

EV/EBITDA (x) 21.5 16.3 12.9 11.3 8.7

EV/Sales (x) 3.1 2.6 2.2 2.1 1.7

RoE (%) 21.1 21.1 16.4 15.2 18.3

RoCE (%) 16.1 17.1 16.4 16.4 20.2

Fixed Asset turnover (x) 1.8 1.9 2.0 1.8 2.2

Dividend yield (%) 0.2 0.3 0.3 0.3 0.3

Dividend payout (%) 9.5 11.3 9.4 7.9 5.4

Debtors (days) 36.9 37.4 45.0 60.0 70.0

Revenue growth (%) 43.4 18.0 14.2 12.1 19.0

EBITDA growth (%) 86.2 31.8 21.6 19.4 27.2

PAT growth (%) 131.0 20.8 19.2 20.3 44.7

EPS growth (%) 131.0 20.8 19.2 20.3 44.7

Net D/E ratio (x) 1.0 0.9 0.4 0.4 0.3

Source: Company, Systematix Institutional Research

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Charting the story

Chart 1: Capacity expansions Chart 2: Forward integration

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 3: Geographical focus Chart 4: Margin profile

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 5: Cash flows to improve Chart 6: Return ratios to improve

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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Capacity expansions to transform business

Granules, which started the journey from producing paracetamol in 1984, has come a long way to produce multiples of APIs like Ibuprofen, Metformin, Guaifenesin and Methocarbamol. Besides, the acquisition of Auctus Pharma added 12 APIs and a significant pipeline of products are under development. Thus, the company has 18 APIs in its portfolio. While most of the APIs are being sold to clients across the globe, the management aims to captively use a major portion of APIs manufactured at various facilities.

Granules has significantly enhanced capacities in PFIs and FDs space during the past few years, which will lead to a significant change in its business profile. Capacity expansions are not only helping it scale up revenue but also the margin profile. These expansions, which will be followed by a wider products portfolio, are set to transform the company’s business into a more profitable entity.

Chart 7: Greenfield expansions at Vizag

Source: Company, Systematix Institutional Research

Chart 8: Focus on regulated markets to augur well Chart 9: Regulator market to contribute 67% of revenue in FY18e

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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APIs business to see wider portfolio and higher captive consumption

Currently, the external sales of APIs contribute 44% of Granules’ consolidated revenue, as a larger part of the production is captively consumed in PFIs and FDs businesses. The company is planning to increase metformin’s capacity by adding 7,000mt in the next two years to 9,000mt, which will help to reduce the dependence on outsourcing and also provide material for PFIs and FDs segments.

Chart 10: Capacity expansions in API

Source: Company, Systematix Institutional Research

Auctus Pharma brings diverse products base, to strengthen FDs business

Granules bought Auctus Pharma for Rs1.2bn in November 2013 to strengthen its APIs manufacturing base. Auctus has USFDA approved facilities at Vizag and an intermediate facility at Hyderabad. Auctus’ 12 APIs belong to diverse therapeutic fields like anti-hypertensive, anti-allergic, anti-infective and anti-fungal. Granules aims to captively consume the APIs produced by Auctus to make formulations. Auctus’ current products portfolio belongs to a $37bn FDs market world-wide. Auctus is likely to add three to four APIs every year and hence will help Granules to broad base its products portfolio.

Table 1: Auctus’ key products and respective market size

Global market size (US$bn) Global sales Volume (MT)

Valsartan 8.7 1,054

Clopidogrel 5.2 572

Pregabalin 4.8 342

Olmesartan 4.5 97

Pantoprazole 3.4 338

Losartan 3.2 662

Telmisartan 3.1 259

Cetrizine 1.0 58

Fluconazole 1.0 87

Rifaximin 0.8 85

Levocetrizine 0.6 15

Doxylamine 0.6 40

Source: Company, Systematix Institutional Research

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Commercialisation of Abacavir showcases capabilities

Granules recently commercialised Abacavir, an anti-retroviral drug, the API of which was developed in-house by the R&D team. This product is generating revenue of Rs40mn per quarter. The global market size of Abacavir is ~$1.5bn and is growing 15% on a yoy basis. In addition to Abacavir, the company is expecting to commercialise additional three to four APIs in the current fiscal year.

Revenue from APIs to reduce on increased captive use

The APIs business generated Rs5.7bn of revenue in FY15 (up 33%) on the back of the acquisition of Auctus, which contributed close to Rs1.15bn.

While the management has increased the capacity of various APIs (de-bottlenecking), a significant portion of the production is likely to be consumed captively and hence the revenue under this segment is likely to see a decline over a period of time.

Chart 11: Forward integration to increase asset turnover ratio

Source: Company, Systematix Institutional Research

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PFIs business has unique business proposition

Granules pioneered the concept of commercialising PFIs. The use of PFIs helps to reduce process timing, leading to significant reduction in capital expenditure and the number of suppliers. The company has PFIs manufacturing facilities at Jeedimetla and Gagillapur. Granules increased the PFIs capacity at Gagillapur by 4,000tpa, which has recently been commissioned. Post commissioning, the total capacity of PFIs increased to 18,400tpa. Apart from the economies of scale that the company will get from an enhanced capacity, it will also allow better flexibility to change the products mix and hence achieve better realisation.

We expect PFIs business to post CAGR of 25% over FY15-18e

The revenue from PFIs business posted a CAGR of 19% over FY11-15 to reach Rs3.1bn in FY15 and contributed 24% of the consolidated revenue in FY15. With the capacity expansions and growing demand for PFIs, we expect PFIs revenue to post a CAGR of 25% to reach Rs6bn in FY18e.

Chart 12: Revenue trend in PFI business

Source: Company, Systematix Institutional Research

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FDs business to lift long-term growth prospects

Granules ventured into the FDs business in FY09 with an initial capacity of 6bn tablets, which generated Rs375mn of revenue in FY10 and grew to Rs2bn in FY13. The company expanded its capacity by 3x to 18bn units in FY14, which scaled up the revenue to Rs3.5bn in FY14 and Rs4.1bn in FY15. Granules offers multiple FD forms, comprising tablets, caplets and press-fit capsules in bulk, blister packs and bottles. The company has a manufacturing facility at Gagillapur which has recently passed a USFDA inspection (in March 2015).

Regulated markets to be key focus for FDs business

Granules has planned to ramp up products in the regulated markets of the US and Europe to gain from the growing opportunities in generic markets. Currently, the company holds six ANDAs (related to two products -- Ibuprofen and Metformin) from USFDA, but it plans to ramp up the portfolio with 13 ANDA filings in FY16 and 14 ANDAs will be filed by FY17 (three already filed) through the newly set-up and wholly-owned subsidiary Granules Pharma Inc. Ibuprofen-based ANDAs will be commercialised in 3QFY16 under a partnership model.

The initial ones that will come up will be in the OTC segment, mostly cough and cold and analgesic segment, but gradually the focus will shift to hepatitis, anti-diabetic among others.

Granules has set up a wholly-owned subsidiary in the US to develop ANDAs. The products would be marketed in the US initially through partners but gradually will move on to set up a front-end presence. Although, we do not expect high margin generics from Granules in the early phases of products ramp-up, the company aims to develop complex and niche products over a period of time.

We expect revenue CAGR of 41% from FDs business over FY15-18e

We expect the FDs business to see a major boost after FY18, when most of the products filed during FY14-16 would start getting approvals. We estimate the revenue from FDs business to clock a CAGR of 41% over FY15-18e to reach Rs7.9bn in FY18e.

OmniChem JV to add sheen

The company set up a 50:50 JV with Ajinomoto OmniChem to focus on high-value, low-volume APIs and intermediates for the latter’s existing customers with a manufacturing facility at Vizag SEZ. This facility has recently completed the trial production and partially capitalised the project in January 2015. The JV plans to obtain all necessary regulatory approvals from the USFDA and other regulatory authorities by Mar 31, 2016. The JV is expected to be cash breakeven by FY16-end. We expect the JV to generate Rs1-1.5bn of revenue in the early phases of roll-out. We estimate a revenue of Rs330mn (Granules share) in FY16e, Rs500mn in FY17e and Rs600mn in FY18e from this venture.

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Financial performance

Granules reported revenue CAGR of 28% during the past five years (FY11-15), mainly driven by FDs business, which posted a revenue CAGR of 41%. PFIs business faced capacity constraints and hence grew slower at 19% during this period. The base APIs business grew by 21% during this period.

In FY15, Granules reported a consolidated revenue growth of 18% to Rs12.93bn, backed by consolidation of the newly-acquired Auctus Pharma, which contributed Rs1.15bn. Excluding the revenue from Auctus, the consolidated revenue rose by 7.5% in FY15.

Table 2: Revenue breakup

Rs mn FY11 FY13 FY14 FY15 FY16e FY17e FY18e

API 2,138 3,363 4,274 5,689 6,216 5,367 5,145

YoY % (9) 29 27 33 9 (14) (4)

% of sales 45 44 39 44 42 32 26

PFI 1,568 2,217 3,178 3,103 3,879 5,042 6,051

YoY % (17) 9 43 (2) 25 30 20

% of sales

FD 1,045 2,064 3,507 4,137 4,344 5,648 7,907

YoY % 179 9 70 18 5 30 40

% of sales

Granules Omnichem-CRAMS - - - - 325 500 600

YoY % 54 20

% of sales 2 3 3

Consolidated revenue 4,752 7,644 10,959 12,929 14,764 16,557 19,702

Source: Company, Systematix Institutional Research

APIs business grew by 33% to Rs5.69bn during FY15, including Auctus, and by 6% excluding Auctus. PFIs business declined 2% to Rs3.1bn during the year, while the business of FDs rose 18% to Rs4.14bn.

Going forward, we expect revenue CAGR of ~15% over FY15-18e on the back of capacity expansions in APIs, PFIs and new products launch in FDs segment.

Better product mix to help improve EBITDA margin

Granules has transformed from being a commoditised APIs player to a PFIs and FDs manufacturer. Typically, a vanilla API business generates an EBITDA margin of 10-13%, while PFIs business gets 15-20% of margin and FDs fetches more than 20% of the EBITDA margin.

The company significantly improved its margin profile over a period, as is seen from the EBITDA margin of 16.1% in FY15, compared to 11-12% a couple of years back.

Granules is focused on moving up the value chain to produce higher qualities of PFIs and FDs, which will help it improve the operating margins. Besides, the new APIs business brought by Auctus (part of it will be captively consumed), will aid the overall APIs business to post better operating margins.

We expect the contribution of APIs business to decline from 44% in FY15 to 26% in FY18e, while the contribution of PFIs will improve from 24% in FY15 to 31% in FY18e and FDs contribution will improve from 32% in FY15 to 40% in FY18e. However, the contribution of FDs will increase significantly in three to four years as the US-based subsidiary, which is engaged in developing formulations including complex ones, will start getting significant products approval.

The management targets to achieve 20% EBITDA margin in the next couple of years on better products offering.

However, we expect the EBITDA margin to improve to 17.2% in FY16e, 18.3% in FY17e and 19.5% in FY18e.

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Chart 13: EBIDTA margin to improve on forward integration

Source: Company, Systematix Institutional Research

Expect earnings CAGR of 33% over FY15-18e

Granules’ earnings posted a CAGR of 44% over FY11-15 on the back of an improvement in operating margins and healthy growth in revenue. In FY15, net profit grew by 21% to Rs909mn, despite a loss from the newly-acquired Auctus Pharma (though Auctus had turned around in 4QFY15). We believe the net profit will see a healthy growth (expect a CAGR of 28% over FY15-18e) on the back of an improvement in EBITDA margin of the base business and a turnaround in certain key subsidiaries and the newly-acquired Auctus.

Capex of Rs4-4.5bn in next two years to be managed through promoters funding

Granules has earmarked Rs4-4.5bn of capex, which will be spent on the Greenfield APIs facility at Vizag (Rs1.4bn), expansion of Guaifenesin facility (Rs700mn), products development expenses (Rs700mn) and US-based subsidiary (Rs800mn) and the remaining on maintenance.

Although, the company has sizable debts (Rs4.57bn), the capex is likely to be funded through internal accruals (it expects operating cash flow of Rs3bn in FY16-17) and promoters funding through the issue of warrants.

During 2QFY16, Granules issued warrants worth Rs2.13bn to the promoter group. So far, promoters have brought Rs800mn to the company and the remaining portion is likely to be infused when needed.

Expansions in equity and capex to affect RoE and RoCE

The company’s RoE has been ~21% during the past couple of years (FY14 and FY15). However, despite a better operating performance, we believe the RoE will decline due to expansions in equity (considering the conversion of warrants issued to promoters). An expansion of fixed assets base will impact RoCE in the next couple of years.

We expect a RoE and RoCE of 18.3% and 20.2% in FY18e, from 21% and 17% respectively in FY15.

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Chart 14: Significant improvement in return ratios

Source: Company, Systematix Institutional Research

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Valuation and view

Granules is in a transformation mode, which will provide sustainable growth over the long term. The massive expansions, vertical integration, products developments and venturing into CRAMS are some of the growth elements which will derisk the business and give a better pathway to generate wealth.

Re-rating scope remains intact: The stock has seen successive re-ratings during the past couple of years on the back of acquisitions and expansions. However, we believe the scope for further re-rating still exists. In our view, the next wave of growth, which will come from commercialisation of FDs in regulated markets, development of complex products and opportunity in CRAMS space (Omnichem JV) is yet to be fully factored. Although, return ratios may see headwinds in the short term, the solid growth platforms being created during the next couple of years will lead to the stock’s re-rating.

The stock trades at 23x FY17e and 16x FY18e EPS, compared to the three-year historical average of 9x (one-year forward earnings basis).

We assign a valuation multiple of 18x FY18e earnings to arrive at a target price of Rs166, with a Accumulate rating.

Chart 15: P/E band Chart 16: P/BV band

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Key risks and concerns

The delay in products approval, regulatory actions on facilities and fluctuation in currency are the key risks to our assumptions.

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Background

Incorporated in 1984, Hyderabad-based Granules India is a vertically integrated pharmaceutical manufacturer offering products across the pharma value chain -- APIs, PFIs and formulations and present in niche products. The company services more than 300 customers across 60 nations (exports are ~87% of revenue). It has three facilities in Hyderabad, India and a fourth one in Jingmen, China. A fifth plant is under construction at Vizag, India through the JV, Granules OmniChem. Granules has sales offices in India, the US, the UK, Colombia and China to service customers across 60 countries.

Table 3: Key management personnel

Name Designation Qualifications Brief profile

C Krishna Prasad Chairman & Managing Director

BSc

Krishna Prasad is the founder of Granules and has three decades of experience in the pharmaceutical industry. He is credited with pioneering and popularising the concept of Pharmaceutical Formulations Intermediates (PFIs) as a cost efficient product for global formulations manufacturers.

Harsha Chigurupati Executive Director BBA Harsha Chigurupati has been with Granules since 2005 and served as CMO from 2006-10. As the Executive Director, Chigurupati is responsible for the standalone operations of Granules India, including the P&L.

Uma Devi Chigurupati Executive Director Post Graduate in Soil Microbiology

Uma Devi has 29 years of experience in various fields. Uma and Krishna had co-founded Triton Laboratories Private Ltd in 1984, which was later amalgamated with Granules India.

Madhusudan Rao COO PG

Madhusudan Rao holds the designation of Chief Operating Officer and has over two decades of experience with global pharmaceutical companies. He previously served as COO of Global Generics at Orchid Pharmaceuticals where he was responsible for the entire operations of global generics and CRAMS businesses and had P&L responsibility.

VVS Murthy CFO NA

VVS Murthy has three decades of finance experience across various industries, including nearly two decades in pharmaceuticals. Murthy previously was the Group Chief Financial Officer at Dishman Pharmaceuticals which encompassed Indian operations and nine international operations. Prior to that, he was VP - Finance at Dr. Reddy's where he had extensive roles, including several international M&A transactions.

Stefan Lohle Chief Marketing Officer

NA

Stefan Lohle has over two decades of experience in the pharmaceutical industry. He has been associated with Granules since 2001 and previously was Head of Latin American Operations, where he primarily focused on PFIs business. He previously served at Kimberly Clark Corporation for new projects development.

Source: Company, Systematix Institutional Research

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Manufacturing facilities

Granules’ entire facilities are certified by leading regulatory agencies like the USFDA, MHRA, EDQM, Infarmed (EU), TPD Canada, KFDA, MCC, Russian Health Authorities, WHO GMP.

Table 4: Manufacturing facilities

Business units Facility Capacity Comments

API Bonthapally 14,400mta Successful completion of USFDA inspection at Bonthapally and Gagillapur facilities in FY15

Jeedimetla 2,000mta Being expanded to 9,000mtpa

Vizag NA New facility being set up with investments of Rs1.20-1.30bn, will take 18 months to get constructed

Jingmen – China (Granules Biocause - JV)

4,800mta

API intermediates Bonthapally NA

PFI Jeedimetla 14,400mta

Gagillapur Being expanded to 18,400mtpa

FD Gagillapur 18,000mn units

CRAMS Vizag (Granules Omnichem - JV) NA Inaugurated in February 2015, the facility still needs USFDA and EDQM approval. Till such time, Granules will supply intermediates to the JV partner Ajinomoto OmniChem

Source: Company, Systematix Institutional Research

Table 5: Key products

Drugs Market size ($mn) Product forms Therapy

Paracetamol

API, PFI, FD Analgesics

Ibuprofen

API, PFI, FD NSAID

Metformin HCl

API, PFI Anti-diabates

Guaifenesin

API, PFI, FD Coughs & cold

Methocarbamol

PFI Sedative

Abacavir

API HIV/AIDS

Valsartan 8,700 API Anti-hypertensive

Olmesartan 4,500 API Anti-hypertensive

Telmisartan 3,100 API Anti-hypertensive

Losartan 3,200 API Anti-hypertensive

Cetirizine 1,000 API Antihistamine

Levocitirizine 600 API Antihistamine

Clopidogrel 5,200 API Antiplatelet agnents

Rifaximin 800 API Antibiotic

Pregabalin 4,800 API Neuropathic pain,

epilepsy

Fluconazole NA API Fungal infections

Pantoprazole 3,400 API Acid Reflux

Doxylamine 600 API Antihistamine

Ciprofloxacin NA PFI Antibiotic

Naproxen Sodium NA FD Anti-inflamatory

Source: Company, Systematix Institutional Research

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Jubilant Life Sciences

Regaining lost ground

Jubilant Life Sciences is a Bhartia Group company and a leading player in pharma and specialty chemicals. The company offers a wide range of products and services, including specialty chemicals for pharma and crop science use, bulk drugs, finished dosages, radiopharmaceuticals, nutritional products, custom synthesis and allergy therapies among others. Post multiple challenges seen during the past few years, the company is witnessing a strong recovery in most business segments, as reflected in 1HFY16 performance -- reported 1,323bps expansion in EBITDA margin and net profit turnaround. The recovery in performance is mainly attributed to normalisation of CMO business, which was interrupted due to USFDA’s warning letters in FY13, focus on specialty pharma, forward integration in life science ingredients, products rampup in finished dosages and operational efficiencies. We initiate coverage on Jubilant Life with a Buy rating and a target price of Rs555(12x FY18e EPS).

Investment rationale

Reorganised, consolidated and rampup initiatives to aid to grow faster: During the last couple of years, the company has reorganised and consolidated its well diversified business for a dedicated focus. Apart from vertically integrating the low-end products like Pyridine, it has carved a niche in Specialty Pharma, nutrition business and branded formulation business, which will ensure sustainable growth and better profitability. We are optimistic on its innovative radiopharmaceutical product, Ruby-fill, which is on the verge of getting approvals in the US and rollout in Canada, and its solid dosages business in the regulated markets.

Recovery in CMO business to recoup growth and margins: Jubilant’s CMO business is witnessing a recovery from the glitches caused by USFDA’s warnings letters for its Spokane (USA) and Montreal (Canada) facilities. This business earns healthy margins for the company and thus its normalisation will help to recoup growth and profit margins.

Symtet prospects fade but alternative plans in place to offset damage: The company’s newly-commissioned Symtet business (forward integrated products of Pyridine used for agrochemicals) has been a key spoiler for the last two years, as it struggles to ramp up amid a low demand. Though we believe it is a key risk going forward, the management is likely to unveil alternative products, which would compete better than Symtet in financials terms.

Healthier balance sheet: A stronger operating performance (from a low base in FY15) will strengthen the balance sheet. We expect a free cash flow of ~Rs13.7bn in FY16-18e, which will reduce the debt/equity ratio from 1.8x in FY15 to 0.9x in FY18e. RoE is likely to improve to 18% in FY18e, from a negative return in FY15.

Valuation and view: The focus on niche segments like Specialty Pharma, recovery in CMO business and stronger traction in nutritional products are the key growth elements which warrant the stock’s re-rating. We initiate coverage on Jubilant, with a Buy rating and a target price of Rs555 (12x FY18e EPS).

Systematix

Institutional Equities

6 January, 2016

INITIATING COVERAGE

Sector: Pharma Rating: Buy

CMP: Rs422 Target Price: Rs555

Stock Info Sensex/Nifty 25,580/7,785

Bloomberg JOL IN

Equity shares (mn) 159.3

52-wk High/Low Rs455/138

Face value Rs1

M-Cap Rs67bn/$1.1bn

3-m Avg volume $0.9mn

Financial Snapshot (Rsmn)

Y/E Mar FY15 FY16e FY17e

Net sales 58,262 64,357 71,659

EBITDA 6,893 11,906 13,615

PAT 79 4,121 5,580

EPS (Rs) (0.6) 25.9 35.0

PE (x) (696) 16.3 12.0

EV/EBITDA (x) 12.4 15.8 9.0

P/B (x) 2.7 2.4 2.0

RoE (%) (0.4) 14.6 16.7

RoCE (%) 5.4 11.5 13.6

Dividend yield (%) 9.7 0.7 0.7

Shareholding pattern (%)

Sep ’15 Jun’15 Mar ’15

Promoter 54.0 54.0 54.0

–Pledged - - -

FII 17.6 16.9 21.8

DII 0.6 0.8 0.7

Others 27.9 28.3 23.5

Stock Performance (1-year)

T. Ranvir Singh [email protected] +91 22 6704 8016

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FINANCIALS (CONSOLIDATED) Profit & Loss Statement

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Net revenue 58,034 58,262 64,357 71,659 81,387

YoY growth % 12.3 0.4 10.5 11.3 13.6

- Op. expenses 49,042 51,370 52,451 58,044 65,517

EBIDTA 8,992 6,893 11,906 13,615 15,871

EBIDTA margin (%) 15.5 11.8 18.5 19.0 19.5

- Interest expenses 3,371 3,553 3,550 3,190 2,866

- Depreciation 2,812 2,880 3,085 3,225 3,405

+ Other income 191 425 152 99 99

- Tax 696.4 804.8 1,301.4 1,751.6 2,327.5

Effective tax rate (%) 23.2 91.0 24.0 24.0 24.0

PAT 2,303 79 4,121 5,547 7,370

+/- Extraordinary items (927) (481) 19 - -

+/- Minority interest 286 176 - - -

Reported PAT 1,090 (578) 4,141 5,547 7,370

Adjusted PAT 2,017 (97) 4,121 5,547 7,370

Adj. FDEPS (Rs/share) 12.7 (0.6) 25.9 34.8 46.3

Adj. FDEPS growth (%) (8.0) PL LP 34.6 32.9

Source: Company, Systematix Institutional Research

Balance Sheet

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Share capital 154.50 159.30 159.30 159.30 159.30

Reserve and Surplus 26,111 24,376 28,147 33,138 39,952

Net worth 26,265 24,535 28,307 33,297 40,112

Minority Interest 1,579 - 1,115 1,115 1,115

Total Debt 43,953 47,931 44,381 39,881 35,831

Def. tax Laib(net) 2,371 2,380 2,740 2,740 2,740

Capital Employed 74,168 74,847 76,543 77,034 79,798

Net Fixed assets 55,712 55,079 55,529 55,804 55,899

Investments 340 395 256 256 256

- of which liquid

Net Working capital 13,321 15,429 18,306 20,488 23,349

Cash and bank balance 4,795 3,943 2,452 486 294

Capital deployed 74,168 74,847 76,543 77,034 79,798

Net debt 39,158 43,988 41,929 39,396 35,537

WC (days) 84 97 104 104 105

Book value (Rs/sh) 164.9 154.0 177.7 209.0 251.8

Source: Company, Systematix Institutional Research

Cash Flow

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

PAT 1,090 (578) 4,141 5,547 7,370

+ Non cash items 3,508 3,684 4,386 4,976 5,732

Cash profit 4,598 3,107 8,527 10,523 13,103

- Incr/(Decr) in WC (70) 2,108 2,877 2,182 2,860

Operating cash flow 4,668 999 5,650 8,341 10,242

- Capex 4,960 1,557 3,534 3,500 3,500

Free cash flow (RHS) (292) (558) 2,116 4,841 6,742

- Dividend 545 575 558 556 556

- Tax 696 805 1,301 1,752 2,327

+ Equity raised (582.4) 582.4 - - -

+ Debt raised 1,501 3,978 (3,550) (4,500) (4,050)

- Investments 84 55 (139) - -

- Misc. items (1,933) 3,420 (1,664) - -

Net cash flow 1,235 (852) (1,491) (1,967) (191)

+ Opening cash 3,560 4,795 3,943 2,452 486

Closing cash 4,795 3,943 2,452 486 294

Source: Company, Systematix Institutional Research

Ratios

YE: Mar FY14 FY15 FY16e FY17e FY18e

P/E (x) 33.3 - 16.3 12.0 9.1

P/CEPS (x) 13.9 24.2 9.3 7.6 6.2

P/B (x) 2.6 2.7 2.4 2.0 1.7

EV/EBITDA (x) 11.3 12.4 15.8 9.0 7.5

EV/Sales (x) 1.8 1.9 1.7 1.5 1.3

RoE (%) 7.7 (0.4) 14.6 16.7 18.4

RoCE (%) 8.3 5.4 11.5 13.6 15.7

Fixed Asset turnover (x) 0.8 0.8 0.8 0.9 1.0

Dividend yield (%) 0.5 9.7 0.7 0.7 0.7

Dividend payout (%) 49.9 - 13.5 10.0 7.5

Debtors (days) 50.7 51.1 50.0 50.0 50.0

Revenue growth (%) 12.3 0.4 10.5 11.3 13.6

EBITDA growth (%) (38.5) (96.8) 2552.3 8.5 19.6

PAT growth (%) (8.0) PL LP 35.4 32.7

EPS growth (%) (8.0) PL LP 35.4 32.7

Net D/E ratio (x) (RHS) 1.5 1.8 1.5 1.2 0.9

Source: Company, Systematix Institutional Research; PL= Profit to Loss

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Charting the story

Chart 1: Revenue from LSI to moderate at ~8% CAGR over FY15-18e Chart 2: EBITDA margin to expand ~770bps over FY15-18e

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 3: Expect ~16% revenue CAGR from pharma during FY15-18e Chart 4: Expect Rs13.7bn FCF over FY15-18e on lower capex

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 5: Debt/equity ratio to decline 0.9x in FY18e Chart 6: Significant improvement in return ratios

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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Well diversified portfolio to de-risk business

Jubilant has vertically integrated most of its businesses and has a well-diversified yet niche products basket and services in its portfolio, which makes its business model unique. The company has meticulously transformed from fine and specialty chemicals to be a key player in pharmaceutical products, animal health and custom manufacturing (CMO). Currently, it offers a range of products running through fine chemicals, life science grade ingredients, intermediates, nutritional products, bulk drugs, finished dosages, radiopharmaceuticals, allergy therapies and research-based services like drug discovery and custom manufacturing. Jubilant has grouped these businesses under two major segments namely (a) Pharma -- includes the businesses of intermediates, bulk drugs, finished dosages, radiopharmaceuticals, allergy therapy, drug discovery, custom manufacturing for sterile products, branded formulation business and (b) Life Science Ingredients (LSI) -- focuses on Pyridine, Pyridine derivatives, nutritional products and life science chemicals. The company has dedicated CEOs for these two divisions, who independently draw the growth plans.

During the course of transformation, Jubilant restructured and consolidated its key businesses, to decouple the fast-growing segments, for a clear and dedicated focus.

Clearing the challenges

Jubilant faced multiple challenges during the past few years such as (a) sharp price erosion in its legacy product Pyridine (which contributed 23% of revenue in FY14 and 20% in FY15) due to competition and anti-dumping duty by China, (b) forward integration of Pyridine into Symtet was not stabilised and hence the losses, (c) CMO business impacted due to voluntary shutdown in the light of USFDA’s adverse observation and (d) currency volatility resulting in inflated debt obligation and other liabilities.

However, the company cleared most of the challenges and has an appropriate strategy to tackle the remaining going forward.

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Pharma - carving a niche in radiopharma, CMO and generics

Jubilant has carved its niche in the pharma space to focus on radiopharmaceuticals, allergy therapies, custom manufacturing (CMO), drug discovery and key generic products. Although the pharma business witnessed pressure during the past few years due to disruptions at its Spokane (US) and Montreal (Canada) facilities (USFDA’s warning letters), it saw healthy growth in other segments like generic (solid dosages) business and radiopharmaceuticals.

Ruby-fill to add sheen to radiopharma business, expects to launch in 1HFY17

Jubilant posted a revenue CAGR of 47% in radiopharmaceutical business during FY12-15. It develops, manufactures and markets radiopharmaceuticals used in nuclear medicine for the diagnosis, treatment and monitoring of various diseases. The company has a leadership position in North America for three key products: (a) I-131 (used as therapeutic and diagnostic for thyroid and cancer), (b) Methylene-Diphosphonate (MDP) for bone imaging and (c) Macro-Aggregated Albumin (MAA) for lung imaging, Diethylene Triamine Penta-acetic Acid (DTPA) for renal imaging. Besides, it has seven products under development through in-house R&D, including the most-promising Ruby-fill generator and elution system, which belongs to Nuclear Cardiology. Ruby-fill is under active review with the USFDA and partially approved in Canada. In Canada, the process requires the generator and elution system to be approved separately. The elution system is not yet approved for use in Canada. Ruby-fill is likely to be launched by 1QFY17 in the US.

We expect the radiopharmaceutical business to post a CAGR of ~25% over FY15-18e.

Products pipeline gets stronger in generic space

Currently, the company has 38 commercial APIs, including 24 in North America, 23 in Europe and 28 in ROW. Besides, it has 49 commercial Solid Dosage Formulations products, including 27 in North America, 29 in Europe and 27 in ROW. Jubilant has filed 71 ANDAs with USFDA, of which 32 are pending approvals. Most of the pending products pipeline will see commercial launches in the next two to three years. The company maintains its pace in products development and filings (seven to eight products every year), which will further strengthen its pipeline. Jubilant’s solid dosages business grew by ~17% during FY12-15 and we expect it to sustain the growth in generic solid dosages business.

CMO business to normalise in FY16-17, see sustained growth

As the USFDA issues recede at two of its overseas facilities catering to CMO and drug discovery, the business is on track for a fast revival. CMO business’ revenue declined by 37% in FY15 after the USFDA issue cropped up. We expect the business to normalise during FY16-17 and then witness sustained growth going forward. CMO is a high margin business and thus will aid to boost the profit margin as well.

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LSI to get an impetus from Nutrition business

Jubilant’s Life Science and Ingredients business (LSI) constitutes Pyridine, its derivatives and related chemistries which have application in pharmaceutical, agrochemical and other life science industries (sub-segmented under Advance Intermediates and Specialty Ingredients). Besides, this segment also constitutes nutritional products like Vitamin B3 (Niacinamide and Niacin) and Life Science Chemicals (organic intermediates including Acetic Anhydride, Ethyl Acetate, Monochloroacetic Acid and Sodium Monochloroacetate).

Pyridine continues to face pricing pressure; a favorable move on anti-dumping application may improve the scenario

Jubilant is one of the leading players in Pyridine and its derivatives. However, this business has been facing a severe pricing pressure due to competition from China. China imposed anti-dumping duties on Pyridine imports from India and Japan during November 2013, which affected the company’s prospects. Meanwhile, the low demand for agrochemicals, especially Paraquat globally, also impacted Jubilant’s prospects.

However, the Chinese Ministry of Finance and Commerce (MOFCOM) is reviewing Jubilant’s application to lift the anti-dumping duty and any favorable decision would give a fillip to its Pyridine business.

Due to the pricing pressure on stiff competition from China, the company has been focusing on producing Pyridine’s derivatives, by moving up the value chain, to derive better profits.

Symtet business seems to be fading, expect alternates to revive growth

The company ventured into the production of a Pyridine derivative, 2,3,5,6-Tetrachloropyridine, also known as Symtet, which is a precursor to manufacture Chlorpyrifos, one of the world’s largest, safest and low-cost insecticide. It set up a 24,000tpa capacity facility for Symtet and Chlorinated Pyridine derivatives of 5,000tpa in the Special Economic Zone, at Bharuch, Gujarat in 2011, which has the potential to generate peak revenue of Rs5bn. Symtet business was expected to derive better profits from the internally produced Pyridine.

However, after nearly three years of commercialisation, Jubilant is struggling to ramp up the business from Symtet, which remains at under 15% capacity utilisation. The management is not very optimistic on the early success of Symtet and thus is preparing to tap alternate opportunities in Pyridine derivatives. Symtet’s facilities can be modified by investing a small capex to produce other derivatives as well.

The revenue from advanced intermediates and specialty ingredients (Pyridine and derivatives) recorded a CAGR of 8% over FY12-15. However, as the pricing pressure is unlikely to ease in the near term and Symtet continues to see low offtake, we expect growth to be moderate (~2% CAGR over FY15-18e).

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Healthy growth in Nutrition business to continue

Jubilant’s Nutrition business mainly includes vitamin B3 (niacin) used for pharmacological, cosmetics and animal feed consumption and vitamin B4 (Choline Chloride), which is a vital feed additive for poultry. The company has integrated its operations to produce vitamins, and is witnessing a healthy growth in this business and expects to sustain it.

The revenue from Nutrition business posted a CAGR of 32% over FY12-15. We expect a sustainable growth of 15% (CAGR) over the next three years from this business.

Life Science Chemicals grew healthy, but pricing pressure may hamper growth: Life Science Chemicals segment basically deals in Acetyls, which are precursors to Advance Intermediates and Fine Chemicals used in a range of applications such as pharmaceuticals, aromatics, adhesives, food, packaging, beverages, crop protection chemicals, textiles and other solvents. The company posted a revenue CAGR of 15.5% over FY12-15 from this business. However, Acetyls are facing pricing pressure in the global market lately, which may hamper growth in this business. We expect 10% revenue CAGR from this business during FY15-18e.

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Financials

Pharma business declined in FY15: Jubilant reported flat yoy revenue of Rs58.3bn in FY15, a marginal decline of 2% in the Pharma business, while LSI segment inched up by 2.2% during the year. The decline in Pharma business is mainly attributed to the disruptions of business in Sterile Custom Manufacturing (CMO declined by 37% yoy and Drug Discovery Solutions business fell by 33% in FY15), which was voluntarily shut down in the light of warning letters issued by USFDA on its Spokane and Montreal facilities. However, the radiopharmaceutical business saw an impressive growth of 121% to Rs5.25bn in FY15. LSI segment continues to see pricing pressure in Pyridine and its derivatives and thus declined 11% in FY15, while Nutrition business and Life Science Chemicals reported a healthy yoy growth of 22.7% and 9.5% respectively in FY15.

1HFY16 performance shows strong recovery in Pharma business: The company reported a 22% revenue growth in Pharma business to Rs14.9bn in 1HFY16, though LSI business declined by 11.8% to Rs14.4bn during this period due to pricing pressure in Pyridine.

Estimate revenue CAGR of ~12% over FY15-18e: Going forward, we estimate Jubilant to report a revenue growth of 14% to Rs30.6bn in the Pharma business and 7% growth to Rs33.75bn in LSI segment during FY16e. We expect a consolidated revenue CAGR of 11.8% over FY15-18e, mainly driven by CMO business, radiopharmaceuticals and Indian branded business.

Table 1: Business model

Revenue breakup (Rs mn) FY12 FY13 FY14 FY15 FY16e FY17e FY18e CAGR

(FY15-18e)

Pharmaceuticals 21,764 26,630 27,260 26,820 30,610 35,220 41,965 16.1

YoY % 41 22 2 (2) 14 15 19 -

API 4,486 5,081 5,280 5,410 5,681 5,965 6,263 5.0

YoY % 33 13 4 2 5 5 5 -

Solid Dosages 5,366 8,315 8,760 8,510 9,701 11,157 13,388 16.3

YoY % 18 55 5 (3) 14 15 20 -

CMO (sterile injectable) 6,211 7,102 6,960 4,480 5,824 7,280 8,372 23.2

YoY % 17 14 (2) (36) 30 25 15 -

Radiopharmaceuticals 1,659 2,089 2,380 5,250 6,038 7,245 10,143 24.5

YoY % - 26 14 121 15 20 40 -

Allergy Therapy products 1,452 1,767 1,830 1,870 1,926 1,984 2,043 3.0

YoY % - 22 4 2 3 3 3 -

Drug discovery solutions 2,450 2,082 1,830 1,230 1,328 1,461 1,607 9.3

YoY % 16 (15) (12) (33) 8 10 10 -

India branded pharma and healthcare 140 194 220 70 112 129 148 28.4

YoY % 18 39 13 (68) 60 15 15 -

Life Science Ingredients 21,018 25,030 30,760 31,450 33,747 36,439 39,423 7.8

YoY % 11 19 23 2 7 8 8 -

Advanced Intermediates and Specialty Ingredients 9,312 11,211 13,280 11,790 12,026 12,266 12,512 2.0

YoY % (2) 20 18 (11) 2 2 2 -

Nutritional products 2,108 2,648 3,960 4,860 5,589 6,427 7,391 15.0

YoY % 10 26 50 23 15 15 15 -

Life Science Chemicals 9,598 11,171 13,520 14,800 16,132 17,745 19,520 9.7

Total 42,782 51,660 58,020 58,270 64,357 71,659 81,387 11.8

Source: Company, Systematix Institutional Research

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EBITDA to expand 770bps over FY16e-18e from a rock bottom in FY15

Jubilant’s EBITDA margin contracted by 280bps to 15.5% in FY14 and further declined by 370bps to 11.8% in FY15 due to the plunge in CMO business that contributes healthy margins. Besides, the margin also got impacted due to the non-absorption cost in Symtet and volume and margin reduction on the anti-dumping duty in China in Advanced Intermediates.

1HFY16 witnessed a sharp increase in margins: The company witnessed a strong recovery in Pharma business in 1HFY16, which led the EBITDA margin to expand by 1,322bps yoy to 22.2%. This was mainly driven by the Pharma business, which reported a healthy EBITDA margin of ~30%.

Table 2: Quarterly trend in revenue and margins

4QFY13 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16

Revenue 703 653 691 677 705 604 614 701 763 741 747

EBIDTA 164 149 175 151 132 36 69 140 200 225 215

Margin% 23 23 25 22 19 6 11 20 26 30 29

LSI

Revenue 691 706 744 767 858 869 757 744 774 718 717.9

EBIDTA 102 109 125 118 131 133 62 61 66 121 118

Margin% 15 15 17 15 15 15 8 8 9 17 16

Less: Corp expenses 28 15 24 14 13 13 (6) 10 13 13 9

Less: forex gains 98.4 117.9 155.3 3.7 4.2 10.5 26.0 6.1 5.6 3.6 3.4

Total 139.6 125.1 120.7 251.3 245.8 145.5 111.0 184.9 247.4 329.4 320.6

Source: Company, Systematix Institutional Research

Going forward, we expect the EBITDA margin to expand by 667bps to 18.5% in FY16e on the back of CMO business’ normalisation and strong traction in solid dosages. We estimate a further expansion of 50bps in the subsequent years on the back of forward integration in LSI segments and new products offering.

Chart 7: Consolidated EBITDA to see strong recovery of ~700bps over FY15-18e

Source: Company, Systematix Institutional Research

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Adj PAT to see strong turnaround in FY16; 34% CAGR over FY16e-18e

The company witnessed a net loss of Rs578mn in FY15, compared to a net profit of Rs1.09bn in FY14 and Rs1.53bn in FY13. However, it recorded a strong turnaround in 1HFY16 to achieve a net profit of Rs2.4bn (versus a net loss of Rs710mn in 1HFY15).

We estimate a net profit of Rs4.14bn in FY16e, which will grow by 35% to Rs5.55bn in FY17e and by 46% to Rs7.37bn in FY18e.

Improved operating performance to aid in debt reduction

Jubilant held a gross debt of Rs47bn as of September 2015-end, which constituted Rs27.4bn ($418mn) of overseas debt (overseas debt constituted 58% of gross debt), mainly on the books of subsidiaries.

Overseas debt included $87.5mn funding from the International Finance Corporation (IFC), of the $147.5mn committed.

During FY15, the company completed the consolidation of all pharmaceutical businesses under Jubilant Pharma, Singapore with effect from July 1, 2014. This was financed by a $147.5mn funding from IFC, which included $87.5mn of long-term loan, $60mn of zero coupon optionally convertible loan and a further loan of $52.5mn to be syndicated by IFC.

The company has reorganised its debt portfolio in such a way that free cash flows will take care of the scheduled loan repayments going forward. The repayment obligation is worked out at Rs3.2bn in FY16, Rs5.2bn in FY17 and Rs4bn in FY18. Jubilant has already prepaid all rupee loans scheduled over the next two years.

Table 3: Quarterly debts profile

Break-up of debts 4QFY15 1QFY16 2QFY16

Foreign Currency Loans ($ mn) - - -

Standalone 105 90 80

Subsidiaries 338 356 338

Total 443 446 418

Change % (from Q4FY15) - 0.7 (5.6)

Rupee Loans (Rs mn) -

Standalone 15,130 14,660 14210

Subsidiaries 5,090 4,850 5,520

Total 20,220 19,510 19,730

Change % (from Q4FY15) - (3.5) (2.4)

Gross Debt (Rs mn) 47,900 47,850 47,100

Cash & Equivalent (Rsmn) 3,940 3,940 3,740

Net Debt (Rsmn) 43,960 43,910 43,360

Change % (from Q4FY15) - (0.1) (1.4)

Source: Company, Systematix Institutional Research

Debt-equity ratio to plunge below 1x in FY18e: Though the high debt level will continue on the balance sheet over the next three years, the debt-equity ratio is set to decline on the back of stronger operating performance. This will lead to stronger free cash flows and aid in debt reduction. We estimate the debt-equity ratio to decline from 1.79x in FY15 to ~0.88x in FY18e.

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Chart 8: Expect significant decline in debt/equity, though debts remain at high level

Source: Company, Systematix Institutional Research

May raise funds via equity route: Jubilant got an enabling resolution to raise funds through the issue of equity/GDRs/ADRs/FCCBs or other equity related instruments up to $200mn (~Rs13bn), which may be considered as alternate plans to deleverage the balance sheet.

Expect Rs10.5bn capex during FY16e-18e versus operating cash flows of Rs13.7bn: The company spent a capex of Rs3.7bn, including Rs1bn for products development, in FY15. For 1HFY16, the capex stood at Rs1.67bn and the management has guided a capex of Rs4bn for FY16, including Rs1bn for products development. We estimate a capex of ~Rs3.5bn in FY17e and FY18e each.

Return ratios to improve: An improved operating performance is set to boost Jubilant’s return ratios. We expect the ROE to improve to 18.4% in FY18 from negative return in FY15. RoCE is likely to jump to 15.6% from a poor 5.4% in FY15.

Chart 9: Significant improvement in return ratios expected over FY16-18

Source: Company, Systematix Institutional Research

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Valuation and view

After facing multiple challenges during the past few years and consolidation of its business undertaken during FY15, we believe Jubilant is ready to ride the growth wave.

The company has increased its focus on value-added products in LSI segments through forward integration and specialty products (like radiopharma, niche solid dosages) and services (sterile CMO and drug discovery services) in pharma space. The key growth drivers in the short term would be USFDA approval for its radiopharma product, Ruby-fill, and approval of Ruby-fill elution system by the Canadian health authorities. Besides, the CMO business, which was affected due to USFDA’s warning letters, would see a revival and growth going forward. The company has built a strong products pipeline in the US, which will unfold in the next two to three years to drive the solid dosage business.

On the flip side, Jubilant’s investments in Symtet (Pyridine derivatives) have virtually been a flop as it is struggling to stabilise revenue and make it profitable. Though the company is preparing alternative plans to derive gains from Pyridine’s forward integration, it will take a year or two to make headway.

Jubilant has restructured its debts to ensure that the free cash flows would take care of the repayment obligation each year. If the company decides to go for an equity expansion (resolution passed to raise Rs13bn through equity), the debt level might see a significant reduction.

Overall, we maintain a positive stance on Jubilant and expect strong performance going forward.

Available at attractive valuation

The stock trades at 12x and 9x FY17e and FY18e earnings respectively, as compared to three-year average of 20x and five-year average of 17x. The focus on niche segments like Specialty Pharma, recovery in CMO business and stronger traction in Nutritional products are some of the growth elements which warrant the stock’s re-rating.

We assign a valuation multiple of 12x to its FY18e earnings to arrive at a target price of Rs555.

Chart 10: P/E band Chart 11: P/BV band

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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Risks and concerns

Key downside risks to our valuation assumptions are (a) delay in approvals of key products, including Ruby-fill, (b) delay in roll-out of alternate plans to mitigate the impact of Symtet, (c) volatility in prices of raw materials for its specialty chemical divisions and (d) volatility in foreign currency (as exports constitute 71% of consolidated revenue and overseas debt stands at $418mn).

Company background

Jubilant Life Sciences is a part of the Jubilant Bhartiya group, which deals in a wide spectrum of products and services, including Life Sciences, Agri Polymers, Food Services, Oil and Gas and Automobiles.

Chart 12: The Bhartiya Group

Source: Company, Systematix Institutional Research

Jubilant Life Sciences (erstwhile Jubilant Organosys Ltd) is a vertically integrated player and deals in the manufacture and supply of APIs, Solid Dosage Formulations, Radiopharmaceuticals, Allergy Therapy Products and Life Science Ingredients. It also provides services in Contract Manufacturing of Sterile Injectables and Drug Discovery Solutions. The company has categorised its well-diversified businesses into two major business segments -- Pharmaceuticals and Life Science Ingredients -- to streamline efficiencies and promote the ease of conducting business, which contributed 46% and 54% respectively in FY15. The company reorganised and consolidated all of its pharmaceutical business under Jubilant Pharma, Singapore with effect from July 1, 2014 and appointed separate CEOs for Pharma and LSI divisions to focus on growth in the respective segments. Jubilant also took a minority stake in Jubilant Cadista to consolidate the US generics business. The company recently forayed into the Indian branded formulation business to tap the high growth opportunities.

Jubilant has a presence across the globe either directly or through wholly-owned subsidiaries (48 subsidiaries). Exports contributed 71% of the consolidated revenue in FY15, of which 58% came from the regulated markets of the US, Canada, Europe and Japan.

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Chart 13: Products-wise revenue breakup (FY15) Chart 14: Geography-wise revenue breakup (FY15)

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Table 4: Key management team

Name Designation Qualifications

Shyam S Bhartiya Chairman & Managing Director BCom ICWA

Hari S Bhartiya Co-Chairman & Managing Director Chemical Engineering Graduate

Shyamsundar Bang Executive Director B Tech M Tech (Chemical Engg)

Shardul S Shroff Director Bachelors Degree in Commerce & LLB

S Sridhar Director NA

Sudha Pillai Director PG in Psychology (Gold medalist)

Ashok Misra Additional Director NA

Rajiv Shah Company Secretary NA

Source: Company, Systematix Institutional Research

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Annexure

Table 5: List of DMFs filed: Strong focus on specialty pharma and targeting key drugs facing a patent expiry in next five years

Drugs Ref. Brand Therapy Category Patent expiry

AZILSARTAN MEDOXOMIL POTASSIUM Edarbi Angiotensin II receptor antagonists Specialty 22-May-25

ZOPICLONE Lunesta Sedative non-specialty expired

LACOSAMIDE Vimpat Anti-epileptic Specialty 17-Mar-22

BOSENTAN MONOHYDRATE TRACLEER Blood pressure Specialty 20-Nov-15

ALISKIREN HEMIFUMARATE TEKTURNA Blood pressure Specialty 21-Jul-18

ESOMEPRAZOLE MAGNESIUM TRIHYDRATE Nexium GERD non-specialty expired

DEXLANSOPRAZOLE DEXILANT GERD non-specialty 15-Jun-20

ROSUVASTATIN CALCIUM AMORPHOUS CRESTOR Cholesterol control Specialty 4-Aug-20

GUANFACINE HYDROCHLORIDE INTUNIV Hypertension/ADHD Specilaty Expired

PALIPERIDONE PALMITATE INVEGA SUSTENNA Schizophrenia Specilaty 12-May-17

VORICONAZOLE Vfend antifungal Specilaty 24-May-16

TADALAFIL CIALIS erectile dysfunction Specialty 21-Nov-17

OLMESARTAN MEDOXOMIL BENICAR ARB Specialty 25-Apr-16

LINEZOLID ZYVOX antibiotic non-specialty expired

ESLICARBAZEPINE ACETATE APTIOM anticonvulsant Specialty

APREPITANT EMEND Chemotherapy Specialty 17-Apr-15

DARIFENACIN HYDROBROMIDE ENABLEX muscle spasms non-specialty 21-Aug-16

FEXOFENADINE HYDROCHLORIDE ALLEGRA antihistamine non-specialty expired

BUPROPION HYDROBROMIDE APLENZIN depressive disorder Specialty 27-Jun-26

LEVOCETIRIZINE DIHYDROCHLORIDE XYZAL antihistamine non-specialty expired

DEFERASIROX EXJADE oral iron chelator non-specialty 5-Apr-19

CINACALCET HYDROCHLORIDE SENSIPAR chronic kidney disease (CKD) Specialty 8-Mar-18

DULOXETINE HYDROCHLORIDE CYMBALTA depressive disorder Specialty expired

ROPIVACAINE HYDROCHLORIDE NAROPIN local anesthesia non-specialty Expired

ZIPRASIDONE HYDROCHLORIDE GEODON antipsychotic Specialty Expired

QUETIAPINE FUMARATE SEROQUEL XR depressive disorder Specialty 28-May-17

SOLIFENACIN SUCCINATE VESICARE muscle spasms non-specialty 19-Nov-18

RIVASTIGMINE TARTRATE Exelon Dementia Specialty Expired

CYCLOBENZAPRINE HYDROCHLORIDE AMRIX muscle spasm 26-Feb-25

REPAGLINIDE PRANDIN Diabetes Specialty Expired

FAMPRIDINE AMPYRA multiple sclerosis Specialty 30-Jul-18

VALACYCLOVIR HYDROCHLORIDE VALTREX antiviral non-specialty Expired

CLOPIDOGREL BISULFATE PLAVIX Blood thinner Specialty Expired

ENTACAPONE COMTAN/STALEVO Parkinson's disease Specialty 14-Sep-18

TELMISARTAN MICARDIS Blood pressure non-specialty 10-Jan-20

RIZATRIPTAN BENZOATE MAXALT migraine headaches non-specialty expired

LEVETIRACETAM KEPPRA antiepileptic Specialty expired

ZOLMITRIPTAN ZOMIG migraine non-specialty expired

LANSOPRAZOLE PREVACID GERD non-specialty expired

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PALIPERIDONE INVEGA SUSTENNA Schizophrenia Specialty 12-May-17

EPROSARTAN MESYLATE TEVETEN Blood pressure Non-specialty expired

ESCITALOPRAM OXALATE LEXAPRO depressive disorder Specialty expired

ALENDRONATE SODIUM FOSAMAX osteoporosis Specialty Expired

RABEPRAZOLE SODIUM ACIPHEX GERD Non-specialty Expired

PAROXETINE HYDROCHLORIDE PAXIL depressive disorder Specialty Expired

MECLIZINE HYDROCHLORIDE NA anti-nausea Non-specialty Expired

GALANTAMINE HYDROBROMIDE RAZADYNE Alzheimer's disease Specialty 6-Jun-17

PINAVERIUM BROMIDE NA gastrointestinal disorders Non-specialty Expired

ATORVASTATIN CALCIUM Lipitor Cholesterol regulator Non-specialty Expired

CANDESARTAN CILEXETIL ATACAND hypertension non-specialty Expired

LOSARTAN POTASSIUM hypertension non-specialty Expired

TERAZOSIN HYDROCHLORIDE hypertension non-specialty Expired

PANTOPRAZOLE SODIUM PROTONIX GERD non-specialty Expired

OLANZAPINE Zyprexa Antipsychoric Specialty Expired

OXCARBAZEPINE CO-PRECIPITATE Epilepsy Specialty Expired

CETIRIZINE DIHYDROCHLORIDE non-specialty Expired

ZOLEDRONIC ACID Zometa osteoporosis Specialty Expired

CITALOPRAM HYDROBROMIDE depression Specialty Expired

RISEDRONATE SODIUM osteoporosis Specialty Expired

BUPROPION HYDROCHLORIDE WELLBUTRIN Depression Specialty Expired

IRBESARTAN Hypertension Non-Specilaty Expired

ARIPIPRAZOLE Abilify antipsychotic Specialty Expired

ESCITALOPRAM OXALATE Lexapro antidepressant Specialty Expired

DONEPEZIL HYDROCHLORIDE ARICEPT Alzheimer's disease Specialty Expired

VALSARTAN Hypertension Non-Specilaty Expired

AZITHROMYCIN MONOHYDRATE Antibacterial Non-Specilaty Expired

TRAMADOL HYDROCHLORIDE ULTRAM Pain Non-Specilaty Expired

SIMVASTATIN ZOCOR Hypertension Non-Specilaty Expired

OXCARBAZEPINE TRILEPTAL epilepsy Specialty Expired

LAMOTRIGINE epilepsy Specialty Expired

CITALOPRAM HYDROBROMIDE Celexa Depression Specialty Expired

CARBAMAZEPINE epilepsy Specialty Expired

Source: Company, Systematix Institutional Research

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Table 6: Dosages form

Dosage Forms Reference

Product Originiator Therapeutic Class

Powder of suspension Zithromax Pfizer Anti-bacterial

FC Tablets Wellbutrin Sr Glaxosmithkline Anti-hypertensive

FC Tablets Atacand Astrazeneca Anti-hypertensive

XL Tablets Tegretol-Xr Novartis Anti-epileptic

FC Tablets Sensipar Amgen Anti-hypeparathyroidism

ER Tablets Enablex Warner Chilcott Llc Anti-spasmodic

SR Capsules - - NSAID

FC Tablets - - NSAID

Capsules Sporanox Janssen Pharms Anti-fungal

DR Capsules Prevacid Takeda Pharms Usa Proton Pump Inhibitor

FC Tablets Zyvoxid Pfizer Anti-bacterial

FC Tablets Singulair Merck Anti-asthma

FC Tablets Olmetec Daichii Sankyo Anti-hypertensive

FC Tablets Olmetec + Hctz Daichii Sankyo Anti-hypertensive

FC Tablets Aldactone Gd Searle Llc Diuretic

FC Tablets Micardis Hctz Boehringer Ingelheim Anti-hypertensive

FC Tablets Fosamax Merck Bone Resoprtion Inhibitor

FC Tablets Norvasc Pfizer Anti-hypertensive

FC Tablets Zithromax Pfizer Anti-bacterial

FC Tablets Zyrtec UCB Anti-allergic

Chewable Tablets Zyrtec UCB Anti-allergic

FC Tablets Atacand Hct AstraZeneca Anti-hypertensive

FC Tablets Aricept Pfizer Anti-alzheimer

FC Tablets Lexapro Forest Labs Anti-depressant

DR Tablets Nexium AstraZeneca Proton Pump Inhibitor

FC Tablets Aprovel Sanofi Aventis Anti-hypertensive

FC Tablets Co Aprovel Sanofi Aventis Anti-hypertensive

FC Tablets Lamictal GlaxoSmithKline Anti-epileptic

FC Tablets Keppra UCB Anti-epileptic

FC Tablets Tavanic Sanofi Aventis Anti-biotic

FC Tablets Levaquin Janssen Pharms Anti-hypertensive

FC Tablets Cozaar Comp MSD Anti-hypertensive

FC Tablets Cozaar MSD Anti-hypertensive

FC Tablets Namenda Forest Labs Anti-alzheimer

FC Tablets Zyprexa Eli Lily Anti-psychotic

Orodisoers-ible Tablets

Zyprexa Eli Lily Anti-psychotic

FC Tablets Trileptal Novartis Anti-epileptic

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GR Tablets Zuracale AstraZeneca Anti-ulcerant

FC Tablets - - Anti-emetic

FC Tablets Seroquel AstraZeneca Anti-psychotic

FC Tablets Paradin Novo Nordisk Bone Calcium Regulator

FC Tablets Actenol P & G Anti-oseteoporotic

Orodisoers-ible Tablets

Risperdal Janssen Anti-psychotic

FC Tablets Maxalt Merck Anti-migraine

FC Tablets Risperdal Janssen Anti-psychotic

Orodisoers-ible Tablets

Maxalt Mlt Merck Anti-migraine

FC Tablets Requip GlaxoSmithKline Anti-parkinson

FC Tablets Viagra Pfizer Erectile Dysfunction

FC Tablets Zocor Merck Lipid Lowering Agent

FC Tablets Vesicare Astellas Anti-spasmodic

FC Tablets Micardis Boehringer Ingelheim Anti- hypertensive

FC Tablets Valtrex GlaxoSmithKline Anti-viral

Capsules Diovan Novartis Anti-hypertensive

FC Tablets Diovan Novartis Anti-hypertensive

FC Tablets Diovan Novartis

FC Tablets Zomig AstraZeneca Anti-migraine

MD Tablets Zomig AstraZeneca Anti-migraine

Source: Company, Systematix Institutional Research

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Neuland Laboratories

A niche tranformation

Neuland Laboratories Ltd (Neuland) is a 30-year-old pharmaceutical company engaged in R&D, manufacturing and marketing of a wide range of bulk drugs, intermediates and custom synthesis of APIs (CMS). While catering to the generic and innovator customers in developed markets of the US, Europe and Japan (~88% of sales), Neuland has fast transformed its products basket into specialty pharma. Given its two state-of-the-art manufacturing facilities and R&D infrastructure, the company has developed a rich portfolio of over 75 products and has made over 652 regulatory filings, positioning itself among the most advanced API and CRAMS platforms in India. We expect revenue and profit CAGR of 23% and 64% over FY15-18e. We maintain our coverage on Neuland with a Buy rating and a target price of Rs1,050 (18x FY17e EPS).

Key investment rationale

Transformation from a low-end API player to complex and specialty products: Neuland has created a strong pipeline of differentiated products where competition is low. For example, of the 48 DMF filed with USFDA, 18 belong to niche therapy areas like bronchioliders (respiratory segment), ophthalmic and anti-psychotic segments. The company is the first and sole DMF holder of 9 products and the only competitor in case of six products. The end-product (finished dosages) market size for DMF filed in the US is pegged ~$22bn, while products under development relate to an end-product market size of $3.5bn.The company targets the contribution of complex products to increase to 20% in FY18, from 15% in FY15.

CMS and APIC JV to drive revenue faster: We expect the company to report a revenue CAGR of ~23% over FY15-18e on the back of ~21% revenue growth in custom manufacturing solutions (CMS) and contribution from the JV with APIC (subsidiary of Mitsubishi Chemicals, Japan), which has recently been rolled out. Neuland recently commissioned a new block to manufacture APIs in collaboration with APIC, based on a joint business agreement entered in 2013. This tie-up will pave the way for Neuland to establish a stronger foothold in Japan. We estimate a revenue contribution of Rs700mn and Rs900mn from this venture in FY17e and FY18e respectively.

Change in products mix to boost margin profile: A higher contribution from complex products, stronger traction in CMS business and contribution from APIC are set to boost Neuland’s margin profile. We expect the EBITDA margin to improve from 13.3% in FY15 to 17% n FY18e, which will help post an earnings CAGR of 64% over FY15-18e.

Pressure on balance sheet eases: Post the restructuring of business divisions in 2014 and a Rs250mn rights issue in FY15, the pressure on balance sheet has eased partially. We expect the D/E ratio to decline from 1.1x in FY15 to 0.57x in FY18e on the back of free cash flows of Rs900mn generated during this period. RoE is likely to improve from 14.6% in FY15 to 25.4% in FY18e.

Valuation and view: The stock trades at 13.5x FY17e EPS (three-year average being 11x). We believe the stock will see a gradual re-rating on the back of stronger products pipeline and improved return ratios. We assign a valuation multiple of 18x FY17e EPS to arrive at a target price of Rs1,050. We maintain our coverage on Neuland with a Buy rating.

Systematix Institutional Equities

6 January, 2016

COMPANY UPDATE

Sector: Pharma Rating: Buy

CMP: Rs781 Target Price: Rs1,050

Stock Info Sensex/Nifty 25,580/7,785

Bloomberg NLL IN

Equity shares (mn) 9.0

52-wk High/Low Rs924/310

Face value Rs10

M-Cap (Rsbn)/($ bn) Rs7.0bn/$0.1bn

3-m Avg volume $0.1mn

Financial Snapshot (Rsmn)

Y/E Mar FY15 FY16e FY17e

Net sales 4,647 5,671 6,953

EBITDA 619 907 1,182

PAT 158 344 522

EPS (Rs) 17.6 38.4 58.3

PE (x) 44.3 20.3 13.4

EV/EBITDA (x) 13.0 9.1 7.1

P/B (x) 4.4 3.6 2.9

RoE (%) 14.6 19.9 23.4

RoCE (%) 9.9 17.8 21.5

Dividend yield (%) 0.2 0.3 0.3

Shareholding pattern (%)

Sep’15 Jun ’15 Mar ’15

Promoter 51.7 51.7 51.7

–Pledged - - -

FII 1.7 1.5 1.5

DII 2.7 2.2 1.0

Others 43.9 44.6 45.7

Stock Performance (1-year)

T. Ranvir Singh [email protected] +91 22 6704 8016

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FINANCIALS (STANDALONE) Profit & Loss Statement

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Net revenues 4,657 4,647 5,671 6,953 8,607

YoY growth % 4.9 6.0 14.8 14.6 15.6

- Op. expenses 3,963 4,028 4,764 5,771 7,144

EBIDTA 694 619 907 1,182 1,463

EBIDTA margin (%) 14.9 13.3 16.0 17.0 17.0

- Interest expenses 236 273 284 284 284

- Depreciation 149 153 174 194 214

+ Other income 34 52 52 52 52

- Tax 75.6 87.0 158.2 234.6 315.4

Effective tax rate (%) 22.1 35.5 31.5 31.0 31.0

PAT 266 158 344 522 702

+/- Extraordinary items (1) - - - -

Reported PAT 266 158 344 522 702

Adj. FDEPS (Rs/share) 29.8 17.6 38.4 58.3 78.4

Adj. FDEPS growth (%) 95.9 (40.9) 118.0 51.7 34.5

Source: Company, Systematix Institutional Research

Balance Sheet

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Share capital 77.30 89.54 89.55 89.55 89.55

Reserve and Surplus 1,149 1,509 1,839 2,340 3,020

Net worth 1,226 1,598 1,929 2,429 3,110

Total Debt 1,735 1,790 1,858 1,858 1,858

Def. tax Laib(net) 103 122 122 122 122

Capital Employed 3,063 3,511 3,909 4,410 5,090

Net Fixed assets 1,654 1,645 1,753 1,909 2,055

Investments 76.4 76.7 76.7 76.7 76.7

- of which liquid

Net Working capital 1,330 1,724 1,960 2,325 2,789

Cash and bank balance 3 65 120 99 169

Capital deployed 3,063 3,511 3,909 4,410 5,090

Net debt 1,732 1,725 1,738 1,759 1,689

WC (days) 104 135 126 122 118

Book value (Rs/sh) 136.9 178.5 215.4 271.3 347.3

Source: Company, Systematix Institutional Research

Cash Flow

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

PAT 266 158 344 522 702

+ Non cash items 225 240 332 428 530

Cash profit 491 398 676 951 1,232

- Incr/(Decr) in WC 244 394 236 365 464

Operating cash flow 246 4 440 585 767

- Capex 70 120 281 350 360

Free cash flow 176 (116) 159 235 407

- Dividend 27 16 22 22 22

- Tax 76 87 158 235 315

+ Equity raised 1.0 241.2 7.8 - -

+ Debt raised (129) 55 68 - -

- Investments - - - - -

- Misc. items (55) 15 -

Net cash flow - 62 55 (21) 70

+ Opening cash 3 3 65 120 99

Closing cash 3 65 120 99 169

Source: Company, Systematix Institutional Research

Ratios

YE: Mar FY14 FY15 FY16e FY17e FY18e

P/E (x) 26.2 44.3 20.3 13.4 10.0

P/CEPS (x) 16.8 22.5 13.5 9.8 7.6

P/B (x) 5.7 4.4 3.6 2.9 2.3

EV/EBITDA (x) 10.7 13.0 9.1 7.1 5.7

EV/Sales (x) 1.7 1.9 1.5 1.3 1.0

RoE (%) 17.5 14.6 19.9 23.4 25.3

RoCE (%) 21.8 9.9 17.8 21.5 22.6

Fixed Asset turnover (x) 1.6 1.5 1.7 1.9 2.1

Dividend yield (%) 0.4 0.2 0.3 0.3 0.3

Dividend payout (%) 10.1 10.1 6.3 4.1 3.1

Debtors (days) 91.4 101.2 90.0 90.0 90.0

Revenue growth (%) 4.9 6.0 14.8 14.6 15.6

EBITDA growth (%) 19.3 (10.7) 46.6 30.3 23.8

PAT growth (%) 94.7 (40.6) 118.0 51.7 34.5

EPS growth (%) 95.9 (40.9) 118.0 51.7 34.5

Net D/E ratio (x) 1.4 1.1 0.9 0.7 0.5

Source: Company, Systematix Institutional Research

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Charting the story

Chart 1: Moving up the complexity profile (revenue contribution) Chart 2: Competitive landscape (quality of DMF filings)

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research; USFDA

Chart 3: Revenue growth to accelerate Chart 4: Better products mix to help improve margins

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 5: Improvement in debt/equity ratio Chart 6: Return ratios to improve

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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Neuland’s journey from vanilla to niche-and-complex products

Neuland has meticulously transformed from a commoditised API business to niche segments and focuses on complex products where the entry barrier is high. For example, the revenue from antibiotic API ciprofloxacin which used to contribute near 40% of the revenue four years ago, contributes close to 15-16% of the revenue now. While the low-end API (low margin products) still constitutes a significant portion of the revenue, the company chose to rampup volume in these segments with a focus on niche therapy and gradually moving to more complex APIs. Currently, ~70% of Neuland’s revenue is contributed by products which are high volume API (but margin not so high) and 15% from complex molecules, where the margin is high. The remaining 15% is contributed by custom synthesis business, which normally posts near 24-26% kind of the margin. Currently, top five products of the company contribute close to 4% of the revenue, while contribution of top five customers stands at 43% of revenue.

Chart 7: Moving up the value scale (revenue contribution)

Source: Company, Systematix Institutional Research

Advantages of being a niche and specialty API player

The merchant API industry is estimated at $43bn, which is likely to reach at $48bn by FY18, at a CAGR of 7%. India is among the top five API producers and accounts for 30% of the global production.

A pure API player like Neuland can expect huge opportunities due to:1)drugs increasingly coming out of patent and leading to a surge in demand from generic drugs and 2) most integrated players (formulators) have limited resource to produce multiple batches of different products(often in small-to-mid size quantities). Hence, players like Neuland, with a niche to focus on complex products, will see a strong demand and value in business.

Complex products will contribute 20% of revenue by FY18e

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Chart 8: Trend in global API market (merchant sales)

Source: Company, Systematix Institutional Research

A huge market opportunity for Neuland

Neuland has developed a strong products pipeline which relates to a $12bn finished dosages market size. The company timed its products development to target certain key products’ patent expiries in the next two to three years. We note that 35% of the total DMF filed in the US belongs to products which are yet to see a patent expiry, while 65% of DMF filed belongs to generic products. As much as 23% of DMF filed with the US will see a patent expiry during FY15-18.

Moreover, the company is increasingly focusing on the low-competition space as is evident from its DMF filings patterns in the US. Neuland is the sole DMF filer for 9 products and only one additional DMF filer for eight products.

The company is developing ~9-14 APIs on an annual basis and these are for the US and European markets. Thus, by FY20-21, significant launches can be expected in the US market.

Table 1: Products snapshot (FY15)

US DMF filed 48

Filings with Health Canada 25

EUDMF filings 400

CEPs Received for different products 19

Japanese DMF filed 5

Filings with KFDA Korea 11

ROW filings 144

Total 652

Source: Company, Systematix Institutional Research

Neuland aims to launch 8-10 products every year in the US market

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Chart 9: Competitive intensity of DMF filings Chart 10: Quality of US-DMF filings-based on IP profile

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 11: Market share profile of key products

Source: Company, Systematix Institutional Research

Key products to change profitability landscape

Neuland has built a strong products pipeline which will be unlocked over the next few years. We highlight select products which will play a significant role in the company’s financials over FY18-19:

(a) Salmeterol is a key element of anti-asthma drug Servent (market size $100mn) and Advair/Seretide (combination of salmeterol+fluticasoneproprionate; market size $5.5bn). The company launched this API in the smaller markets (Europe and RoW) and looks forward to launch it in the US. Recently, Mylan has launched the generic version of Advair in Europe and we expect one to two players to join the fray. The complexity of the formulation will limit competition in this segment.

(b) Entacapone is an anti-Parkinson drug (brand name Comtan; US market size ~$300mn) and available in the generic space. Neuland has launched it in Europe and is likely to launch in the US in FY16.

(c) Propofol is a key anesthetic drug (US market size ~$250mn), which is widely used during surgery. The product recently lost patent in the US. The company has launched propofol in the smaller markets of Europe and looks forward to launch it in the US by FY18-19.

(d) Levetiracetam (US market size $800mn) is an anti-epilepsy drug and is available in the generic space in the US and Europe but loses patent in the Japanese market in January 2018. Levetiracetam continues to be among the top revenue contributor for Neuland (among the top 10 products).

At least 9 products will have a market share of more than 40% by FY18e

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Table 2: Management's commentary on key products

API Reference brand US market size Management commentary

Salmeterol Serevent 100 Salmeterol is a complex launch and it may happen over several quarters in several regions

Propofol Diprivan 250 Propofol in the US will not be launched in FY16, but in other regions globally

Linezolid Zyvox 900 Linezolid is still under patent but in certain regions already started thelaunches

Palonosetron hydrochloride Aloxi 100 Not too excited about Palonosetron except for a little bit of sales in the Japanese market

Bosentan monohydrate Tracleer 1,200 May be launched in 2018 and 2019, it is not a big product in the US, but a major product in Europe, though approval pathway for Bosentan is not very clear

Entacapone Comtan 300 Launched in Europe; US launch may happen in FY16

Levetiracetam Keppra 800 Continues to be among top 10 products for the company

Ezetimibe Zetia/vytorin 2,400 Has been commercially launched in few markets

Pemetrexed disodium Alimta 1,750 Nothing happening as of now

Source: Company, Systematix Institutional Research

CMS business to see 21% CAGR over FY15-18e

The revenue from Custom Manufacturing Solutions (CMS) business clocked a CAGR of 73% over FY12-15 and contributed 15% of revenue in FY15. The CMS business involves manufacturing API to customer specifications, designing and developing manufacturing processes, process optimisation for competitiveness and filing of DMF/CMC for the API among others. Neuland has non-exclusive agreements to manufacture products with leading generic and innovator companies across Europe, the US and Japan. Recently, one of the CMS customers in the US filed an NDA for the US market, which opens an interesting opportunity for the company. We expect the CMS business revenue to post a CAGR of 21% over FY15-18e.

APIC pact to contribute to revenue, expect gradual ramp-up

As per the joint business agreement between Neuland and API Corporation, Japan (March6, 2013,) the company agreed to manufacture and supply various APIs and intermediates needed by APIC, for which it would carve out a dedicated area of manufacturing within the existing unit at Pashamylaram. APIC initially invested Rs150mn to create the manufacturing infrastructure. Neuland meanwhile commissioned a new block to manufacture APIs in collaboration with APIC in FY15. The company gets reimbursement of the operating expenses incurred on the facility and the same is shown under other operating income. The higher other operating incomes during the last three quarters reflect the scaled up operations at this site. APIC has initially identified two products to be rolled out in the current fiscal (only exhibit and validation batches), while more products may be on stream by FY18-19.

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Chart 12: Quarterly trend in other operating income

Source: Company, Systematix Institutional Research

Peptide-based products offer revenue potential

The protein and peptide therapeutics market is a multi-billion dollar play and involves a complex chemistry. Neulandhas developed niche capabilities that reflect technical expertise in the field of complex peptide. It manufactured a decapeptide and deuterated API during FY15. Globally, decapeptide is the first peptide-based drug for the treatment of vitiligo (skin disease which causes white patches). Although, most of the peptide-based drugs are currently in the development phase, the market space is likely to be less crowded.

Rs350mn capex to aid growth

The company has earmarked Rs350mn of capex for FY16 to back growth. Neuland’s current manufacturing capacity will fall short of demand by FY17. The company is looking forward to a mix of strategy to cope with the situation and that may involve capacity debottlenecking, outsourcing a part of manufacturing or inorganic expansions.

R&D backup

Neuland has spent Rs700mn on R&D (revenue expenses) during the last seven years to produce a portfolio of near 50 products and to execute various custom synthesis services. Annually, it spends ~2-2.5% of the revenue to develop 7-9 products.

Chart 13: Annual trend in R&D revenue expenditure

Source: Company, Systematix Institutional Research

The other operating income includes revenue from APIC in the form of reimbursement of operating expenses incurred by Neuland

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Financial performance

Renovation and multiple audits of key facilities affected FY15 revenue

Neuland’s revenue remained flat in FY15 at Rs4.65bn mainly as the renovation activity disrupted manufacturing during 3QFY15 and a string of audits undertaken by various regulatory agencies disturbed normal operations for a month. Besides, the joint business with APIC got moved out by about six months during the fiscal. However, processes got normalised from 4QFY15 onwards. In 1QFY16, the company’s revenue rose by 12.2% to Rs1.15bn.

Table 3: Expect revenue CAGR of 21% over FY15-18e

Business break up (Rs mn) FY14 FY15 FY16e FY17e FY18e

CMS 699 697 802 1,002 1,252

API 3,958 3,950 4,443 5,421 6,722

Japanese-APIC - - 390 570 900

Total 4,657 4,646 5,635 6,993 8,874

Revenue growth %

CMS 153 (0.2) 16 22 24

API (9) (0.2) 14 20 20

Japanese-APIC 46 58

Total 1.1 (0.2) 22.7 22.1 23.7

Source: Company, Systematix Institutional Research

The company reported a 18.6% YoY increase in revenue to Rs1.23bn in Q1FY16, while net profit jumped by 143% to Rs73mn due to 246bps expansion in EBITDA margins to 16.3%. The decline in profit was caused by high base effects.

Table 4: Quarterly performance

Quarterly (Standalone) 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16

Revenue 1,034 1,213 1,077 1,330 1,226 1,271

YoY% (15.3) 15.4 (18.1) 20.4 18.6 4.8

QoQ% (6.0) 16.6 (14.8) 21.2 (6.8) 3.9

Expenditure 891 1,059 943 1,135 1,026 1,087

EBIDTA 143 154 134 195 200 184

YoY% (30.4) 4.8 (30.6) 7.3 39.7 19.8

QoQ% (21.2) 7.4 (12.8) 45.5 2.6 (7.9)

EBIDTA margin% 13.9 12.7 12.4 14.7 16.3 14.5

PBT 48 75 36 86 113 93

PAT 30 51 19 57 73 62

YoY% (61.4) 50.1 (71.8) (33.8) 142.5 20.5

QoQ% (65.0) 71.0 (62.6) 195.6 28.4 (15.0)

PAT margin% 2.9 4.2 1.8 4.3 6.0 4.9

FDEPS 3.4 5.7 2.1 6.4 8.2 6.9

No. of shares (mn) 0.8 0.8 0.8 0.8 0.9 0.9

Source: Company, Systematix Institutional Research

We expect a healthy growth in revenue going forward on the back of better traction in CMS business, over 20 product launches during FY17-19 coupled with capacity expansions and Japanese APIC taking off. We estimate a revenue CAGR of 23% during FY15-18e on the back of 21% and 18% CAGR in CMS and API segment, while APIC will contribute Rs570mn and Rs900mn in FY17e and FY18e, respectively.

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EBITDA margin to expand on better products mix, expect 370bps expansion during FY15-18e

The company’s EBITDA margin was inconsistent during the past few years. It reported EBITDA margin of 13.3% in FY15, compared to 14.9% in FY14 and 12.6% in FY13. However, as Neuland is transiting to a more profitable products mix, we expect significant changes in the EBITDA profile. We expect EBITDA margin to expand by 270bps to 16% in FY16e and 100bps to 17% in FY17e. The management though targets to achieve 20% EBITDA margin on the back of a more profitable business and products mix.

PAT to see 64% CAGR over FY15-18e

The company reported a profit CAGR of 33% over FY11-15 on the back of expansion in margins and optimisation of facilities giving better operating leverage. In FY15, net profit declined by 41% to Rs158mn mainly due to the 160bps decline in EBITDA margin, higher interest costs and taxation. Interest cost rose by 16% during the year, while the effective tax rate spiked to 36% in FY15, compared to 22% in FY14.

Neuland falls under the full tax bracket, which led to an effective tax rate of 35.5% in FY15. However, the effective tax rate is likely to soften to 31-32% in FY16 on the back of R&D benefits. Going forward, we expect a net profit growth of 118%, 52% and 35% to Rs344mn, Rs522mn and Rs702mn during FY16e, FY17e and FY18e, respectively.

Capex of Rs1bn over FY16-18e to keep debt level steady till FY17

The company has considerably reduced its debt/equity ratio during the past five years on the back of increased profitability, limited capex (Rs400mn during FY11-15) and rights issue of equities. It raised Rs250mn from the rights issue last year to meet the capex program.

Chart 14: Trend in net debts

Source: Company, Systematix Institutional Research

Neuland may need to significantly expand capacity in FY17 and FY18 to back up the products launch plan. We expect Rs1bn capex for FY16e-18e, which will restrict the scope to reduce debts. Currently, it has debts of Rs1.8bn (as of June-15) and mostly denominated in INR. We expect the debt level to remain at this level during FY16-17, as most of the internal accruals will be ploughed back into the business. However, increasing profitability will reduce the debt-equity ratio from 1.12x in FY15 to 0.6x in FY18e.

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Chart 15: Trend in capex and free cash flow Chart 16: Significant improvement in return ratios

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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Valuation and view

The transformation process which started a couple of years back, will reflect in Neuland’s financial performance in the next couple of years when key drugs go off patent and open up attractive opportunities for the company. This will help Neuland differentiate itself among the local peers and command better valuation. The balance of portfolio among high value and high volume products will help it see a faster growth in earnings. Although, the requirements of capex in the next three years may restrict the scope to reduce debts, the debt/equity ratio will attain a comfortable position in FY18. The stock has seen successive re-rating over the past few years, albeit the scope for further re-rating exists.

Chart 17: P/E band

Source: Bloomberg, Systematix Institutional Research

Chart 18: P/B band

Source: Bloomberg, Systematix Institutional Research

Maintain Buy with a target price of Rs1,050: The stock trades at 13.4x FY17e EPS (three-year average being 11x). We believe the stock will see a gradual re-rating on the back of stronger products pipeline and improved return ratios. We assign a valuation multiple of 18x FY17e EPS to arrive at a target price of Rs1,050.

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Key risks

(a) Demand risk: The API business is dependent on the requirement of formulation players, which often causes inconsistency in offtake. Similar is the case for CMS business which keeps fluctuating due to demand variations. Thus, quarter-on-quarter performance may fluctuate and that will have an impact on the stock price.

(b) Quality compliance risk: The stringent quality norms prescribed by the key regulatory agencies lead to risks of recalls, production delays and ban of manufacturing activities. The company has recently undergone the USFDA inspections and came out clean with minor observations.

(c) Delay in products approvals: Delay in approvals of finished dosages may lead to a delay in offtake for API and may slow down projects’ execution under CMS business. On the other hand, an early genericisation of key drugs may provide an upside risk for the company.

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Company description

Neuland Laboratories is promoted by D R Rao, a PhD in organic chemistry with wide expertise in R&D. The 30-year-old Hyderabad-based company is engaged in manufacturing API and end-to-end solutions for the pharmaceutical industry for chemistry related services. The company is one of the few pure play API manufacturer, which has built a strong products basket of 75 plus products developed, 400+ regulatory filings and presence in over 80 countries. Exports contribute 75% of revenue (mainly regulated markets). Top 10 products of Neuland include Ciprofloxacin HCl, Mirtazapine, Ranitidine HCl, Enalapril Maleate, Ramipril, SotalolHCl, Olanzapine, Ipratropium Bromidet, Itraconazole and Salmeterol. The company has two USFDA and EDQM inspected manufacturing facilities (located at Bonthapally and Pashamylaram in Andhra Pradesh) and a 40,000sqft state-of-the-art R&D facility at Hyderabad. The R&D centers have 200 scientists with 31 PhDs. The R&D facility has the capability to develop 10-14 APIs annually and also execute 10-12 projects for process development.

Chart 19: Geographical breakup of revenue (FY15) Chart 20: Segment-wise breakup (FY15)

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 21: Strategic landscape

Source: Company, Systematix Institutional Research

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Table 5: Key management team

Name Designation Promoter /

Non Promoter Executive /

Non-Executive Qualifications

D R Rao Chairman & Managing

Director Promoter Executive

MSc PGD in Technology & PhD in Organic Chemistry

Humayun Dhanrajgir Independent Director NA Non-Executive B Tech MI CHEM (E)

P V Maiya Director NA Non-Executive MA(Econ) CAIIB

Will Mitchell Director NA Non-Executive PhD

Christopher M Cimarusti

Director NA Non-Executive PhD in Organic Chemistry

D Sucheth Rao Whole Time Director &

CEO Promoter Executive B Tech (Mech) & MBA in Corporate Finance

D Saharsh Rao Whole-time Director Promoter Executive Engineering Graduate Masters in MIS MBA

SaradaBhamidipati Company Secretary NA NA NA

Bharati Rao Additional Director NA NA NA

Nirmala Murthy Additional Director NA NA NA

Source: Company, Systematix Institutional Research

Table 6: Fund raising history

Date Amount (Rs mn) Route

Apr-12 101 Right issues

Dec-12 250 Inter-corporate deposits from group companies (NPRPL and

NHSPL)

Mar-13 361 Divestment of R&D assets to group companies

Feb-14 250 Right issues

Total 962

Source: Company, Systematix Institutional Research

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Annexure

Table 7: Details of DMF filings

Drug Brand name Innovator Patent expiry Therapy No. of DMF filers

Benzyl albuterol (intermediate) NA NA NA Precursor to salbutamol

Single player

Albuterol sulfate Proairhfa, ventolinhfa Teva/gsk 18-dec-17 Bronchodilator Cipla

Ranitidine Zantac Gsk/concordia Generic Antihistamine Multiple players

Ranitidine hydrochloride Zantac Gsk/concordia Generic Antihistamine Multiple players

Ciprofloxacin hydrochloride Cipro Bayer hlthcare Generic Antibacterial Multiple players

Sotalol hydrochloride Sorine Upsher smith/arbor pharms llc Generic Antiarrhythmic Heumann pharma gmbh

Ipratropium bromide Atroventhfa/duoneb Boehringeringelheim Generic Anticholinergic Single player

Ranitidine hydrochloride Zantac Gsk/concordia Generic Antihistamine Multipleplayers

Ofloxacin Ocuflox Allergan Generic Opthalmic/antibacterial Multipleplayers

Enalapril maleate Vasotec Valeant intl Generic Antihypertensive Multipleplayers

Itraconazole Onmel/sporanox Merz pharms/janssen pharms 12-may-17 Antifungal Glenmark

Mirtazapine Remeron Organonusainc Generic Antidepressant Multipleplayers

Albuterol Ventolin hfa Glaxo grp ltd 16-jan-18 Anti-asthma Cipla

Albuterol sulfate Ventolin hfa Glaxo grp ltd 16-jan-18 Anti-asthma Cipla

Ramipril Altace King pharms 30-aug-20 Antihypertensive Multipleplayers

Levofloxacin Levaquin Janssen pharms Generic Antibiotoc Multipleplayers

Levetiracetam Keppra Ucbinc Generic Anticonvulsant Multipleplayers

Ciprofloxacin Cipro Bayer hlthcare Generic Antibiotoc Multipleplayers

Moxifloxacin hydrochloride Avelox Bayer hlthcare 5-dec-16 Antibiotoc Multipleplayers

Levofloxacin Levaquin Janssen pharms Generic Antibiotoc Multipleplayers

Fluticasone propionate Dymista Meda pharms 29-aug-23 Allergic rhinitis Sun, Cipla

Olanzapine Zyprexa Lilly Generic Antipsychotic Multipleplayers

Ropinirole hydrochloride Requip Glaxosmithklinellc Generic Antiparkinsonian Multipleplayers

Escitalopram oxalate Lexapro Forest labs Generic Antidepressant Multipleplayers

Enalapril maleate Vasotec Valeant intl Generic Antihypertensive Multipleplayers

Palonosetron hydrochloride Aloxi Helsinnhlthcare 30-jul-24 Anti-nausea Multipleplayers

Donepezil hydrochloride Aricept Eisai inc Generic Anti-alzheimer Multipleplayers

Dorzolamide Trusopt Merck Generic Opthalmic Single player

Entacapone Comtan Orion pharma 14-sep-18 Anti-parkinsonian Multipleplayers

Tiotropium Spiriva Boehringeringelheim 24-sep-21 Chronic obstructive pulmonary

disease Single player

Ezetimibe Zetia/vytorin Msdintl Generic Antihyperlipidemic Multipleplayers

Aripiprazole Abilify Otsuka Generic Antipsychotic Multipleplayers

Salmeterol Advair hfa Glaxo grp ltd Generic Bronchodilator Multipleplayers

Voriconazole Vfend Pfizer 24-may-16 Antifungal Multipleplayers

Paricalcitol Zemplar Abbvie Generic Vitamin d compound Dishman

Mirtazapine Remeron Organonusainc Generic Antidepressant Multipleplayers

Linezolid Zyvox Pharmacia and upjohn Generic Antibacterial Multipleplayers

Ezetimibe Zetia/vytorin Msdintl Generic Cholesterol lowering agent Multipleplayers

Montelukast sodium Singulair Merck Generic Anti asthma/allergies Multipleplayers

Pemetrexed disodium Alimta Lilly 24-jul-16 Anti-cancer Multipleplayers

Deferasirox Exjade Novartis 5-apr-19 Chelating agent Multipleplayers

Brinzolamide Azopt Alcon pharms ltd Generic Opthalmic Single player

Bosentan Tracleer Actelion pharms ltd 20-nov-15 Antihypertensive Multipleplayers

Paliperidone Invegasustenna Janssen pharms 12-nov-17 Antipsychotic Multipleplayers

Dapiprazole NA NA Generic Opthalmic Single player

Ropinirole Requip Glaxosmithklinellc Generic Parkinson's disease/cns Multipleplayers

Brinzolamide Azopt Alcon pharms ltd Generic Opthalmic Single player

Propofol Diprivan Fresenius kabiusa 22-sep-15 Anesthetic Single player

Ethacrynic Edecrin Aton Generic Diuretic Cadila

Alcaftadine Lastacaft Allergan 5-oct-29 Antihistaminic Single player

Source: Company, Systematix Institutional Research

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Suven Life Sciences

Gaining from R&D

Suven Life Sciences is a niche pharmaceutical company providing contract research and manufacturing services (CRAMS) for drug discovery and development of molecules for innovators. With over 20 years of experience and research-intensive approach, the company is well positioned to tap the fast-growing opportunities in process research, custom synthesis and NCE development support services. Suven’s R&D program is focused on complex therapies like Alzheimer’s disease under CNS segment and currently it has seven molecules in the pipeline -- two of which are in the advanced stage of development, with significant out-licensing potential. We initiate coverage on Suven Life with a target price of Rs293 and an Accumulate rating.

Investment rationale

Profitable progression in CRAMS: The company has remarkably built the projects pipeline under CRAMS, most of which relate to new chemical entities (NCE) undergoing different phases of clinical trials. Of the 110 projects in hand currently, 52 belong to Phase II candidates and 57 projects relate to Phase I candidates. The company used to have only 30-40% of projects under Phase II a few years back. The progression in projects profile under CRAMS will ensure better and sustainable profits.

Encouraging progress in R&D pipeline: Of the seven NCEs under development, SUVN-502 has advanced to clinical Phase II trials (proof of concept study started in the US). SUVN-502 targets Alzheimer’s disease and has significant out-licensing potential for the company.

Foray into niche generics space to ensure predictable income: The company has ~16 DMFs filed with USFDA and it is an exclusive supplier for two of them -- Iron Sucrose Complex (for injection) and Sodium Ferric Gluconate (for injection). Besides, it has also filed six ANDAs with USFDA and continues to explore opportunities in niche generics, which will ensure predictable revenue flow for Suven.

FY17-18 to be eventful: The company may see vital developments during FY17-18: (a) repeat orders from three key intermediates for which it supplied pre-launch material in FY14 and FY15, (b) completion of Phase II clinical trials for SUVN-502 may open the out-licensing opportunity, (c) few of the ANDAs filed during the past years may see approvals by FY18 and (d) the newly setup Vizag facility will see a rampup.

Strong balance sheet limits financial risk: Suven has maintained a practice to plough back internal accruals for growth and innovations; though the recent fund-raising has been through a QIP. It maintains a debt-free balance sheet, which limits the financial risks. We estimate Rs3.8bn of free cash flows during FY16e-18e.

Valuation: We value the company in two parts -- (a) Rs240 (22x FY18e EPS for commercial operations, which primarily constitute CRAMS and Drug Discovery Services business and (b) Rs53 for potential value for its key R&D pipeline, SUVN-502, assuming out-licensing deals in FY18 -- to arrive at an SOTP-based target price of Rs293. We assign an Accumulate rating due to limited upside.

Systematix

Institutional Equities

6 January, 2016

INITIATING COVERAGE

Sector: Pharma Rating: Accumulate

CMP: Rs263 Target Price: Rs293

Stock Info Sensex/Nifty 25,580/7,785

Bloomberg SVLS IN

Equity shares (mn) 127.3

52-wk High/Low Rs338/192

Face value Rs1

M-Cap Rs34bn/$0.5bn

3-m Avg volume $0.7mn

Financial Snapshot (Rsmn)

Y/E Mar FY15 FY16e FY17e

Net sales 5,209 5,224 6,774

EBITDA 1,595 1,353 2,134

PAT 1,088 824 1,416

EPS (Rs) 8.5 6.5 11.1

PE (x) 30.8 40.6 23.6

EV/EBITDA (x) 19.9 23.7 14.6

P/B (x) 6.0 5.3 4.4

RoE (%) 19.4 13.1 18.7

RoCE (%) 21.4 15.7 23.0

Dividend yield (%) - - -

Shareholding pattern (%)

Sep ’15 Jun’15 Mar ’15

Promoter 59.6 59.4 59.4

–Pledged - - -

FII 2.0 1.8 1.6

DII 5.2 5.7 6.7

Others 33.2 33.1 32.2

Stock Performance (1-year)

T. Ranvir Singh [email protected] +91 22 6704 8016

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FINANCIALS (STANDALONE) Profit & Loss Statement

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Net revenue 5,103 5,209 5,224 6,774 8,045

YoY growth % 97.9 2.1 0.3 29.7 18.8

- Op. expenses 2,913 3,614 3,871 4,641 5,398

EBIDTA 2,191 1,595 1,353 2,134 2,646

EBIDTA margin (%) 42.9 30.6 25.9 31.5 32.9

- Interest expenses 105 47 88 61 35

- Depreciation 88 118 198 209 221

+ Other income 30 86 94 104 114

- Tax 585.8 428.0 336.7 550.7 701.3

Effective tax rate (%) 28.9 28.2 29.0 28.0 28.0

PAT 1,442 1,088 824 1,416 1,803

+/- Extraordinary items - - - - -

+/- Minority interest - - - - -

Reported PAT 1,442 1,088 824 1,416 1,803

Adjusted PAT 1,442 1,088 824 1,416 1,803

Adj. FDEPS (Rs/share) 12.3 8.5 6.5 11.1 14.2

Adj. FDEPS growth (%) 365.4 (30.8) (24.2) 71.8 27.4

Source: Company, Systematix Institutional Research; LP= Loss to profit; PL: Profit to Loss

Balance Sheet

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

Share capital 116.80 127.25 127.25 127.25 127.25

Reserve and Surplus 2,528 5,466 6,151 7,429 9,093

Net worth 2,644 5,593 6,279 7,556 9,221

Minority Interest - - - - -

Total Debt 906 1,085 835 585 335

Def. tax Liab (net) 276 227 227 227 227

Capital Employed 3,826 6,905 7,341 8,368 9,783

Net Fixed assets 1,921 2,790 3,521 3,562 3,591

Investments - - - - -

- of which liquid

Net Working capital 1,225 1,319 1,524 1,963 2,377

Cash and bank balance 680 2,797 2,296 2,842 3,814

Capital deployed 3,826 6,905 7,341 8,368 9,783

Net debt 225 (1,712) (1,461) (2,257) (3,479)

WC (days) 88 92 106 106 108

Book value (Rs/sh) 20.8 44.0 49.3 59.4 72.5

Source: Company, Systematix Institutional Research

Cash Flow

YE: Mar (Rs mn) FY14 FY15 FY16e FY17e FY18e

PAT 1,442 1,088 824 1,416 1,803

+ Non cash items 674 546 535 760 922

Cash profit 2,116 1,633 1,359 2,176 2,725

- Incr/(Decr) in WC 542 94 205 440 413

Operating cash flow 1,574 1,540 1,155 1,736 2,312

- Capex 378 1,173 930 250 250

Free cash flow 1,196 367 225 1,486 2,062

- Dividend 25 15 5 (5) (15)

- Tax 586 428 337 551 701

+ Equity raised - 2,000 - - -

+ Debt raised (265) 179 (250) (250) (250)

- Investments - - - - -

- Misc. items (142) (14) 134 144 154

Net cash flow 462 2,117 (501) 547 972

+ Opening cash 218 680 2,797 2,296 2,842

Closing cash 680 2,797 2,296 2,842 3,814

Source: Company, Systematix Institutional Research

Ratios

YE: Mar FY14 FY15 FY16e FY17e FY18e

P/E (x) 21.3 30.8 40.6 23.6 18.6

P/CEPS (x) 21.9 27.8 32.7 20.6 16.5

P/B (x) 12.7 6.0 5.3 4.4 3.6

EV/EBITDA (x) 15.4 19.9 23.7 14.6 11.3

EV/Sales (x) 6.6 6.1 6.1 4.6 3.7

RoE (%) 54.5 19.4 13.1 18.7 19.6

RoCE (%) 54.9 21.4 15.7 23.0 24.8

Fixed Asset turnover (x) 2.0 1.9 1.4 1.5 1.7

Dividend yield (%) 0.1 0.0 0.0 0.0 0.0

Dividend payout (%) 1.7 1.4 0.6 (0.4) (0.8)

Debtors (days) 46.8 28.1 45.0 45.0 45.0

Revenue growth (%) 97.9 2.1 0.3 29.7 18.8

EBITDA growth (%) 310.8 (27.2) (15.2) 57.7 24.0

PAT growth (%) 365.4 (24.6) (24.2) 71.8 27.4

EPS growth (%) 365.4 (30.8) (24.2) 71.8 27.4

Net D/E ratio (x) 0.1 (0.3) (0.2) (0.3) (0.4)

Source: Company, Systematix Institutional Research

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Charting the story

Chart 1: Projects under CRAMS progress to late phase Chart 2: Base revenue from CRAMS remains strong

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 3: Regulated market focused business Chart 4: Trend in EBITDA (base business)

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 5: Expect ~Rs3.8bn of free cash flows over FY16e-18e Chart 6: Return ratios to improve

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

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Niche R&D player, deals with high risk-and-return segments

Suven is one of the few players in the world with a presence in the high value Central Nervous System (CNS) research. Globally, the CNS market is the second-largest therapeutic category (15%) and is one of the fastest-growing segments. Currently, more than 200 compounds are under development in the CNS segment, though the segment is marred by high attrition during discovery and clinical development. However, it is equally rewarding on achieving success. The segment has also seen few out-licensing deals, which contains a risk for innovators like Suven.

Currently, the company has a promising NCE research pipeline of 13 molecules.

Table 1: R&D projects (key NCE pipeline)

Molecules Therapy Stage/status Comments

SUVN-502 Alzheimer’s and schizophrenia

Expected to enter Phase II trials (Proof of Concept)

A similar molecule by an European company addressing Alzheimer’s was out-licensed in July 2013

to a Japanese company for an upfront $150mn, milestone payments of over $600mn and royalty on

sales (when launched successfully)

SUVN-G3031 Alzheimer’s and schizophrenia

Initiated Phase I trials in November 2014 and is expected to be completed

in FY16 Phase II expected in 2016

SUVN-D4010 Alzheimer’s and schizophrenia

Phase I clinical trials are expected to start in 2015-16

Phase II expected in 2017

SUVN-911 Major depressive disorder (MDD)

In preparation for Phase I clinical trials Phase II expected in 2018

Source: Company, Systematix Institutional Research

Strong R&D team: Suven’s research team comprises of 30 PhDs and MSc degree holders. Over the last decade, the company has delivered 753 product patents for 27 inventions and 37 process patents for seven inventions.

Prudent P&L approach to write off R&D expenses: The company has followed a policy of writing off research and development expenses in the year of incurrence; it has never borrowed to invest in research and development spending. Thus, any income from the R&D pipeline will directly flow to earnings and increase the cash flow.

Chart 7: Trend in R&D expenses - written off in P&L

Source: Company, Systematix Institutional Research

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Suven’s lead molecule SUVN-502 may be a money spinner

The company’s lead molecule, SUVN-502, targeted at Alzheimer’s and Schizophrenia disease, has passed a vital milestone by successfully completing Phase I clinical trials and getting approval for Phase II (proof of concept) clinical trial in the US in September 2015 (537 patients in the US to be enrolled). Suven recently raised money through a Rs2bn QIP to fund this program and it aims to get a partner through out-licensing deals. The management targets to complete Phase II clinical trials for this molecule by FY17, which will open the avenue for a lucrative out-licensing deal.

SUVN-502 may be a money spinner for the company, given its potential and target market size. In a similar deal, an European company addressing Alzheimer’s was out-licensed in July 2013 to a Japanese company for an upfront payment of $150mn, milestone payments of over $600mn and royalty on sales (when launched successfully). This showcases Suven’s likely potential from this molecule.

Strong R&D base to sustain healthy CRAMS business

Suven is among the few players in India which has seen remarkable success through a pure CRAMS play. Since inception, the company has executed 727 projects, mainly related to process research, custom synthesis and NCE development support services for most top global innovators. It develops pharma intermediates and specialty chemicals for innovators under different stages of drug development process. A small portion of the revenue also comes from research services.

Suven has invested a sizable amount of internal accruals for its NCE-R&D pipeline and currently has a molecule in Phase II clinical trials, two in Phase I clinical trials and one at investigation stage. The company is mainly focused on products and process development, but is preparing for commercial manufacturing with a new facility being set up at Vizag.

Suven’s business model differs from players like Dishman Pharma, Divi’s Labs, Jubilant Life among others, who have commercial scale in the manufacturing setup and mostly undertake contract manufacturing at commercial scale, which is relatively a low margin segment.

Profitable progression in CRAMS business

Under a CRAMS landscape, projects related to Phase II and III normally give better profits due to higher quantity of supplies, compared to Phase I projects -- earns better margins but the supply in lower quantity (only in grams) restricts the overall profit.

Chart 8: Suven’s CRAMS landscape

Source: Company, Systematix Institutional Research

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Suven is witnessing strong growth in its base CRAMS business due to increased number of projects under execution.

Chart 9: High number of late-stage projects to ensure longer revenue flows

Source: Company, Systematix Institutional Research

Repeat orders from key intermediates to boost FY17-18 financials

The company generated over Rs2.2bn of revenue during FY14-15 from supply of key intermediates to a US-based client and two European clients for their innovative products passing through the pre-launch phase. Since these products are likely to be launched in FY17, Suven expects to get a repeat order for these intermediates for a longer period (during the patented life of products). Though innovators do not have binding supply agreements with Suven, the engagements during the drug discovery process give hope to the company to get sizable supply orders.

Suven posted a revenue CAGR of 41% from CRAMS during the past five years, which included the supply of three key intermediates for the pre-launch phase during FY14-15. We expect the revenue from CRAMS business to post a CAGR of 25% over FY16e-18e.

Chart 10: Expect ~24% revenue CAGR from base CRAMS business over FY15-18e

Source: Company, Systematix Institutional Research

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Vizag facility to get commercialised in FY16

The company has set up a multipurpose facility at Vizag with investments of Rs1.20bn to manufacture intermediates and APIs. The facility has six production blocks but only one will be in operation to start with. The repeat orders for commercial manufacturing of intermediates and API supplies will utilise the capacity at Vizag.

Healthy products pipeline in API and foray into finished dosages to perk up growth: Suven has near 16 DMFs filed with USFDA and is the exclusive supplier for two of them -- Iron Sucrose Complex (for injection) and Sodium Ferric Gluconate (for injection).

The company also supplies Malathion lotion to Taro Pharmaceutical from its formulation development centre under a royalty agreement. Suven has filed three ANDAs with USFDA, which will start to unfold from FY18.

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Financials

Expect revenue CAGR of ~15% over FY15-18e

The company generated a revenue of Rs5.2bn in FY15, which included Rs450mn revenue from one-off supplies of three intermediates. The limited period supply of these intermediates started in FY14 when it generated a revenue of Rs5.1bn, including Rs1.75bn as one-off. The one-off supplies of these intermediates related to products undergoing the last leg of drug development and readied for pre-launch formalities. The management hopes to get a repeat order from these products from FY17 onwards and thus growth is expected to accelerate from FY17.

We expect a revenue of Rs5.2bn in FY16e (yoy flat due to one-offs in FY15), Rs6.7bn in FY17e (30% yoy) and Rs8bn in FY18e (19% yoy).

Table 2: Revenue breakup (Rs mn)

FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e

CRAMS 1,268 1,917 2,276 4,934 5,002 4,976 6,476 7,687

YoY % 32 51 19 117 1 (0.5) 30 19

% of sales 84 94 88 97 96 95 96 96

-Base business 1,268 1,917 2,276 3,184 4,552 4,976 6,476 7,687

YoY % 32 51 19 40 43 9.3 30 19

-One off revenue - - - 1,750 450 - - -

DDDS 243 125 303 169 207 248 298 358

YoY % (27) (48) 142 (44) 23 35 15 15

% of sales 16 6 12 3 4 5 4 4

Others (7) (1) - - - - - -

Total 1,504 2,042 2,579 5,103 5,209 5,224 6,774 8,045

Source: Company, Systematix Institutional Research

EBITDA margin to sustain ~30% despite a rise in R&D spend

The company posted an EBITDA of Rs1.6bn, after spending Rs560mn on R&D. As a practice, it provides full R&D expenses incurred during the year to the profit and loss account, though benefits of these expenses are taken over a long period of time. EBITDA margin in FY15 stood at 30.6%, which partially rose due to a one-off income.

Going forward, we expect the EBITDA margin to improve as more projects are moving from Phase I to II under CRAMS business.

We estimate an EBITDA margin of 25.9% in FY16e, 31.5% in FY17e and 32.9% in FY18e, assuming the repeat orders from three intermediates will start flowing in FY17 and continue through FY18. The ramp-up at Vizag facility is likely to accelerate in FY18 thus easing the overhead costs.

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Chart 11: EBIDTA margin to remain strong despite higher R&D

Source: Company, Systematix Institutional Research

Net profit to see CAGR of ~18% over FY15-18e

Suven posted a profit CAGR of 80% over FY11-15, including one-off profits from supplies, and 55% excluding one-offs. Net profit stood at Rs1.09bn in FY15, which declined 25% yoy from a high base. On a like-to-like basis, we expect net profit to grow at 10% to Rs824mn in FY16e. Profit growth will peak in FY17e at 72% to Rs1.4bn, assuming repeat orders from the three intermediates flow in and Vizag facility is ramped up. We estimate a profit CAGR of 18.4% over FY15-18e.

Balance sheet remains strong, expect Rs3.8bn of free cash flows over FY16e-18e

The company has expanded its R&D initiatives and manufacturing operations mostly through internal accruals and thus maintains a debt-free status. It raised Rs2bn of equity in FY15 through the QIP route, mainly to fund the NCE programs, which have progressed to an advanced phase.

Suven spent Rs1.2bn to set up the Vizag facility, which is being capitalised in the current fiscal. Going forward, it will only have maintenance capex in the next couple of years (Rs200-300mn).

Chart 12: Low capex to ensure free cash flow of ~Rs3.8bn over FY16e-18e

Source: Company, Systematix Institutional Research

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The company generated a RoE of 19.4% in FY15, which included profits from one-off supplies. We estimate a base business RoE of 16% in FY15, which will improve to 17% in FY16e and 20% both in FY17e and FY18e.

Chart 13: Return ratios to improve on stronger operating performance

Source: Company, Systematix Institutional Research

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Valuation

The stock is trading at 41x, 24x and 19x FY16e, FY17e and FY18e earnings respectively.

We value the company in two parts -- (a) commercial operations, which primarily constitute CRAMS and Drug Discovery Services business and (b) potential value for its key R&D pipeline, SUVN-502, assuming out-licensing deals.

We estimate an EPS of Rs6.5, Rs11.1 and Rs14.2 from its commercial operations (base business) in FY16e, FY17e and FY18e respectively.

Derive SOTP value of Rs293

We assign a valuation multiple of 22x FY18e earnings to arrive at a price of Rs240 per share. We derive a value of Rs53 as an option value for its NCE candidate, SUVN-502, assuming an out-licensing deal fetches $150mn of milestone payments by FY17-end and $5mn yearly disbursement of R&D spends.

Table 3: SOTP valuation

Valuation Rs/share

Base business (22x FY18e EPS) 240

Value for SUVN-502 53

Total valuation 293

Source: Company, Systematix Institutional Research

Downside risks to our valuation assumption:

(a) Repeat orders from the supply of three intermediates may not come or be delayed – in such a case, we expect 15% and 19% downside risk to our base business valuation.

(b) SUVN-502 does not show expected advancement or the company fails to forge out-licensing deals – in such a scenario, valuation will be reduced by Rs30 per share.

Upside risks to valuation:

(a) New demand for pre-launch or post-launch quantities of innovative products (NCE): CRAMS business is prone to inconsistency and a positive or negative surprise. We have considered only three intermediates for which the management expects to get repeat orders in FY17 and FY18. However, Suven has many similar products under its CRAMS projects, which may lead to more deals.

(b) Out-licensing deals may fetch better upfront payments and milestone payments: we have factored $150mn potential milestone payments and $5mn of annual R&D reimbursement. However, the company may bargain for a better deal, including provision for royalties, supply of key intermediates and APIs for commercial launches.

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Chart 14: P/E band

Source: Company, Systematix Institutional Research

Chart 15: P/BV band

Source: Company, Systematix Institutional Research

The stock is trading at higher side of P/Book Value band at 4.5x FY17e (v/s three-year average of 3x)

The stock is trading marginally higher at 24x FY17e EPS versus three- year average of 23x (one-year forward earnings).

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Annexure

Company background

Suven Life Sciences was incorporated in March 1989 as a private limited company as Suven Pharmaceuticals (SPL) by Jasti Sudha Rani and Jasti Venkateswarlu, and was converted into a public limited company in January 1995. Currently, the company has four manufacturing facilities, which are approved by international regulatory agencies. Suven has focused on critical R&D and CRAMS to leverage on research capabilities. Currently, it spends close to 10-12% of revenue on R&D and has close to 380 employees in its R&D setup, of the 790 employees in the organisation. The company generates nearly 96% of revenue from CRAMS business and uses internal accruals to fund R&D projects and thus maintains a debt-free status.

Table 4: Manufacturing facilities

Facility Location Key operations

API and formulation Pashamylaram, Telangana, India

API Manufacturing; Biopharmaceutical Research (GLP); Formulation R&D

SUVEN R&D–Pilot Plant Jeedimetla, Telangana, India

Process Research; Discovery R&D, Analytical R&D

Intermediate Mfg. Facility

Suryapet, Andhra Pradesh, India

GMP complaint for manufacturing of intermediates

API and Intermediate facility

JNPC, Visakhapatnam, Andhra Pradesh

Source: Company, Systematix Institutional Research

Chart 16: Composition of human resources Chart 17: Major portion of HR devoted to drug discovery

Source: Company, Systematix Institutional Research Source: Company, Systematix Institutional Research

Chart 18: Geographical presence

Source: Company, Systematix Institutional Research

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Table 5: DMFs filed

List of DMF filed Therapy

Aripiprazole Antipsychotic

Calcium Acetate Multiple uses

Divalproex Sodium Antiseizure/Epilepsy

Entacapone Parkinson's disease

Fenoprofen Calcium Non-steroidal anti-inflammatory drug

Gabapentin Pain

Glycopyrrolate Used in surgery

Iron Sucrose Complex for Injection Multiple uses

Losartan Potassium Anti-hypertensive

Malathion Lotion (ANDA also available) Antiparasitc

Nitazoxanide Antiprotozoal

Pamabrom Diuretic

Sodium Ferric Gluconate for Injection Multiple uses

Tamsulosin HCL Enlarged prostate

Verapamil Hydrochoride Hypertension

Zolmitriptan Migraine Source: Company, Systematix Institutional Research; *company is exclusive supplier for these two products

Table 6: Quarterly results (Standalone)

(Rs mn) 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16

Revenue 1,087 1,514 1,194 1,308 1,415 1,398 1,288 1,107 1,010 1,168

YoY% 54.1 201.3 91.4 75.1 30.2 (7.6) 7.9 (15.4) (28.7) (16.5)

QoQ% 45.5 39.3 (21.1) 9.5 8.2 (1.2) (7.9) (14.1) (8.7) 15.6

Expenditure 657 800 645 834 871 1,047 829 880 760 860

EBIDTA 430 714 549 474 544 352 460 227 250 307

YoY% 109.3 108.3 93.0 99.3 (2.9) (46.7) (22.4) (43.4) (35.5) 4.6

QoQ% 117.6 19.2 (2.6) (21.1) 6.1 (34.6) 41.9 (42.5) 20.8 6.2

EBIDTA margin% 39.6 47.2 46.0 36.3 38.5 25.2 35.7 20.5 24.8 26.3

PBT 409 659 513 447 514 328 448 226 263 306

PAT 298 456 364 324 348 248 322 169 202 247

YoY% 274.0 601.8 369.6 275.3 16.8 (45.5) (11.6) (47.7) (41.8) (0.4)

QoQ% 69.9 53.1 (278.0) (56.5) (62.4) (501.3) (87.9) (771.3) 64.6 (10.0)

PAT margin% 27.4 30.1 30.5 24.8 24.6 17.8 25.0 15.3 20.0 21.2

EPS 2.3 3.6 2.9 2.5 2.7 2.0 2.5 1.3 1.6 1.9

No. of shares (mn) 127.3 127.3 127.3 127.3 127.3 127.3 127.3 127.3 127.3 127.3

Source: Company, Systematix Institutional Research

Table 7: Key management team

Name Designation Qualifications Experience

Venkateswarlu Jasti Chairman & CEO M Pharm M S(Indus Pharmacy) 40 Yrs

Sudha Rani Jasti Whole-time Director B Sc 33 Yrs

M R Naidu Director Doctorate in Science and Graduate

NA

K V Raghavan Director Fellow of the National Academy of Engineering

NA

D G Prasad Director CA 33 Yrs

K Hanumantha Rao Company Secretary NA NA

Syed E Hasnain Director Ph D & Post Doctoral Fellowship NA

M Gopalakrishna Director IAS(Retd) NA

Source: Company, Systematix Institutional Research

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Nikhil Khandelwal Managing Director +91-22-6704 8001 [email protected]

Equity Research

Analysts Industry Sectors Desk-Phone E-mail

Jaspreet Singh Arora - Head of Research Cement, Building Material, Construction +91-22-6704 8062 [email protected]

Rahul Jain IT, E-commerce +91-22-6704 8025 [email protected]

Priya Ranjan Auto & Auto Ancs +91-22-6704 8067 [email protected]

Salil Utagi Capital Goods, Engineering, Consumer Durables +91-22-6704 8064 [email protected]

T. Ranvir Singh Pharma, Healthcare, Agrochem +91-22-6704 8016 [email protected]

Ajit Agrawal BFSI +91-22-6704 8066 [email protected]

Ankit Gor Mid Caps +91-22-6704 8028 [email protected]

Divyata Dalal Cement, Building Material, Construction +91-22-6704 8059 [email protected]

Bibhishan Jagtap Auto & Auto Ancs +91-22-6704 8068 [email protected]

Rahul Khandelwal Mid Caps +91-22-6704 8003 [email protected]

Birendrakumar Singh Technical Research +91-22-6704 8024 [email protected]

Equity Sales & Trading

Name Desk-Phone E-mail

Pankaj Karde Head - Institutional Sales & Sales Trading +91-22-6704 8061 [email protected]

Jitendra Marchino, CFA Asia Sales +91-22-6704 8085 [email protected]

Dhanesh Padhya Sales +91-22-6704 8090 [email protected]

Dinesh Bajaj Sales +91-22-6704 8065 [email protected]

Jigar Kamdar Sales +91-22-6704 8060 [email protected]

Bhavik Shah Sales Trading +91-22-6704 8053 [email protected]

Vinod Bhuwad Sales Trading +91-22-6704 8051 [email protected]

Vahila Thoomu Assistant Manager +91-22-6704 8055 [email protected]

Sugandha Rane Support – Back office +91-22-6704 8056 [email protected]

Corporate Access

Shaheen Chamadia Manager +91-22-6704 8091 [email protected]

Production

Ramesh Nair Editor +91-22-6704 8071 [email protected]

Mrunali Pagdhare Production +91-22-6704 8057 [email protected]

Institutional Equities Team

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DISCLOSURES/ APPENDIX

I. ANALYST CERTIFICATION

I, T. Ranvir Singh, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report, (2) No part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report by Systematix Shares & Stocks (I) Limited or its Group/associates companies. (3) has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations.

Disclosure of Interest Statement Update

Analyst holding in the stock No

Served as an officer, director or employee No

II. ISSUER SPECIFIC REGULATORY DISCLOSURES, Unless specifically mentioned in Point No. 9 below:

1. The Research Analyst(s), Systematix Shares & Stocks(I) Limited (SSSIL), Associate of Analyst or his relative does not have any financial interest in the company(ies) covered in this report.

2. The Research Analyst, SSSIL or its associates or relatives of the Research Analyst affiliates collectively do not hold more than 1% of the securities of the company (ies) covered in this report as of the end of the month immediately preceding the distribution of the research report.

3. The Research Analyst, his associate, his relative and SSSIL do not have any other material conflict of interest at the time of publication of this research report.

4. The Research Analyst, SSSIL and its associates have not received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in this report, in the past twelve months.

5. The Research Analyst, SSSIL or its associates have not managed or co-managed in the previous twelve months, a private or public offering of securities for the company (ies) covered in this report.

6. SSSIL or its associates have not received compensation or other benefits from the company(ies) covered in this report or from any third party, in connection with the research report.

7. The Research Analyst has not served as an Officer, Director or employee of the company (ies) covered in the Research report.

8. The Research Analyst and SSSIL has not been engaged in market making activity for the company(ies) covered in the Research report.

9. Details SSSIL, Research Analyst and its associates pertaining to the companies covered in the Research report:

Sr. No.

Particulars Yes / No.

1 Whether compensation has been received from the company(ies) covered in the Research report in the past 12 months for investment banking transaction by SSSIL

No

2 Whether Research Analyst, SSSIL or its associates or relatives of the Research Analyst affiliates collectively hold more than 1% of the company(ies) covered in the Research report

No

3 Whether compensation has been received by SSSIL or its associates from the company(ies) covered in the Research report No

4

SSSIL or its affiliates have managed or co-managed in the previous twelve months a private or public offering of securities for the company(ies) covered in the Research report No

5 Research Analyst, his associate, SSSIL or its associates have received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in the Research report, in the last twelve month

No

10. There are no material disciplinary action that been taken by any regulatory authority impacting equity research analysis activities.

STOCK RATINGS

BUY (B): The stock's total return is expected to exceed 20% over the next 12 months. ACCUMULATE (A): The stock's total return is expected to be within 10-20% over the next 12 months. HOLD (H): The stock's total return is expected to be within 0-10% over the next 12 months. SELL (S): The stock's total return is expected to give negative returns over the next 12 months. NOT RATED (NR): The analyst has no recommendation on the stock under review.

INDUSTRY VIEWS

ATTRACTIVE (AT): Fundamentals/Valuations of the sector are expected to be attractive over the next 12-18 months. NEUTRAL (NL): Fundamentals/Valuations of the sector are expected to neither improve nor deteriorate over the next 12-18 months. CAUTIOUS (CS): Fundamentals/Valuations of the sector are expected to deteriorate over the next 12-18 months.

III. DISCLAIMER

The information and opinions contained herein have been compiled or arrived at, based upon information obtained in good faith from sources believed to be reliable. Such information has not been independently verified and no guaranty, representation of warranty, express or implied, is made as to its accuracy completeness or correctness.

This document is for information purposes only. This report is based on information that we consider reliable, but we do not represent that it is accurate or complete, and one should exercise due caution while acting on it. Descriptions of any company or companies or their securities mentioned herein are not complete and this document is not, and should not be construed as an offer or solicitation of an offer to buy or sell any securities or other financial instruments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. All opinions, projections and estimates constitute the judgment of the author as on the date of the report and these, plus any other information contained in the report, are subject to change without notice. Prices and availability of financial instruments also are subject to change without notice. This report is intended for distribution to institutional investors.

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This report is not directed to or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity that is a citizen or resident or located in any locality, state, country or other jurisdiction where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject to SSSIL or its affiliates to any registration or licensing requirement within such jurisdiction. If this report is inadvertently send or has reached any individual in such country, especially, USA, the same may be ignored and brought to the attention of the sender. Neither this document nor any copy of it may be taken or transmitted into the United State (to U.S.Persons), Canada, or Japan or distributed, directly or indirectly, in the United States or Canada or distributed or redistributed in Japan or to any resident thereof. Any unauthorized use, duplication, redistribution or disclosure of this report including, but not limited to, redistribution by electronic mail, posting of the report on a website or page, and/or providing to a third party a link, is prohibited by law and will result in prosecution. The information contained in the Report is intended solely for the recipient and may not be further distributed by the recipient to any third party.

SSSIL generally prohibits its analysts, persons reporting to analysts, and members of their households from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. Additionally, SSSIL generally prohibits its analysts and persons reporting to analysts from serving as an officer, director, or advisory board member of any companies that the analysts cover. Our salespeople, traders, and other professionals or affiliates may provide oral or written market commentary or trading strategies to our clients that reflect opinions that are contrary to the opinions expressed herein. Our proprietary trading and investing businesses may make investment decisions that are inconsistent with the recommendations expressed herein. The views expressed in this research report reflect the personal views of the analyst(s) about the subject securities or issues, and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by research analyst(s) in this report. The compensation of the analyst who prepared this document is determined exclusively by SSSIL however, compensation may relate to the revenues of the Systematix Group as a whole, of which investment banking, sales and trading are a part. Research analysts and sales persons of SSSIL may provide important inputs to its affiliated company(ies).

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SSSIL and its affiliates, officers, directors, and employees subject to the information given in the disclosures may: (a) from time to time, have long or short positions 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 earn brokerage or other compensation (financial interest) or act as a market maker in the financial instruments of the company (ies) discussed herein or act as advisor or lender / borrower to such company (ies) or have other potential material conflict of interest with respect to any recommendation and related information and opinions. The views expressed are those of the analyst and the Company may or may not subscribe to the views expressed therein.

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Systematix Shares & Stocks (I) Ltd. CIN : U65993MH1995PLC268414 BSE SEBI Reg. No.: INB/F011132736 (Member Code: 182) | NSE SEBI Reg. No.: INB/F/E231132730 (Member Code: 11327) | MCX-SX SEBI Reg. No.: INB/F261132733 (Member Code: 17560) | Depository Participant: IN-DP-CDSL-246-2004 (DP Id: 34600) | PMS : INP000002692 | AMFI : ARN - 64917|Research Analyst : INH200000840 Regd. office address: 2nd floor, J. K. Somani Bldg, British Hotel Lane, Fort, Mumbai - 400001 Corporate office address: A 603-606 , The Capital, BKC, Bandra (E), Mumbai, India - 400051