india indian pharmaceuticals initiation of coverage - · pdf filedeutsche bank markets...

Deutsche Bank Markets Research

Asia

India

Health Care

Industry

Indian Pharmaceuticals

Date

2 December 2015

Initiation of Coverage

Acquisition upside outweighs regulatory fears Acquisition-led growth; regulatory risks to drive near-term sentiment

________________________________________________________________________________________________________________

Deutsche Bank AG/Hong Kong

Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015.

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]

Key Changes

Company Target Price Rating

SUN.NS – to 880.00(INR) NR to Buy

CIPL.NS – to 722.00(INR) NR to Buy

CADI.NS – to 422.00(INR) NR to Hold

GLEN.NS – to 1,133.00(INR) NR to Buy

TORP.NS – to 1,672.00(INR) NR to Buy

REDY.NS – to 2,748.00(INR) NR to Sell

LUPN.NS – to 2,165.00(INR) NR to Buy

Source: Deutsche Bank

Top picks

Sun Pharma (SUN.NS),INR729.25 Buy

Lupin (LUPN.NS),INR1,811.55 Buy

Dr. Reddy's (REDY.NS),INR3,210.90 Sell


Companies Featured

Sun Pharma (SUN.NS),INR729.25 Buy

Lupin (LUPN.NS),INR1,811.55 Buy

Cipla (CIPL.NS),INR648.55 Buy

Glenmark (GLEN.NS),INR983.45 Buy

Torrent (TORP.NS),INR1,468.65 Buy

Cadila Healthcare (CADI.NS),INR401.05 Hold

Dr. Reddy's (REDY.NS),INR3,210.90 Sell


Product launches in US markets and synergies from recent acquisitions are set to drive sector earnings at a CAGR of 24% in FY15-18E, following a CAGR of 18% over the past three years. Indian pharmaceutical companies will continue to use their under-leveraged balance sheets to pursue inorganic growth by acquiring assets in both the Indian and US markets. While regulatory risks will remain a sector overhang, the risk-reward profile appears favourable, with current valuations discounting recent moves by the FDA (S&P BSE Healthcare underperformed BSE Sensex by c.10% in last 3M).

Initiating with Buy on Sun, Lupin, Cipla, Glenmark, Torrent; Sell on Dr. Reddy’s We initiate coverage with a Buy rating on Sun (PER of 22x, lower than historical multiple mainly on account of impending FDA issues), Lupin (PER of 23x, to factor in higher growth trajectory), Cipla (PER of 21x, discount to Sun and Lupin to factor in continuing front-end investments), Glenmark (PER of 21x, at c.5-10% discount Sun and Lupin) and Torrent Pharma (PER of 20x, at c.5-15% discount to Sun and Lupin); a Sell rating on Dr. Reddy’s (PER of 18x to factor in USFDA warning letter on three of its plants); and a Hold rating on Cadila (PER of 18x to factor in delays in approvals for Moraiya plant). All our target prices are based on PER (x) assigned to our FY18 recurring earnings forecast plus relevant one-offs on a cash basis.

Regulatory risks appear highest for Dr. Reddy’s While Dr. Reddy’s (US sales 44%) has received a warning letter for two of its bulk drugs and one oncology formulation plant, Sun and Cadila have seen a slower pace of approvals in FY16 due to observations issued for their USFDA formulation plants in India (Halol and Moraiya). US sales, which represent the highest proportion (c.30%-45%) of sales for Indian pharma companies, will likely see sluggish growth rates as the ANDA approvals for Dr. Reddy’s, Sun and Cadila could be delayed, leading to downside risk to consensus earnings for these companies. We see low risk to our earnings forecasts for Sun as we do not factor in new approvals for Halol until 4QFY17.

Low leverage and low dividend payouts expected to drive acquisitions We expect Indian companies to capitalise on their low leverage by seeking inorganic growth opportunities, mainly in regulated markets like the US, to add to and diversify their existing portfolios, while also acquiring front-end businesses in emerging markets. Sun, Lupin, Dr. Reddy’s and Cipla look set to take the lead in seeking acquisitions globally. Consequently, we expect Sun, Lupin and Cipla to deliver the highest earnings growth in the sector. With organic growth capped for Dr. Reddy’s, due to existing US FDA regulatory issues, it could be aggressive in seeking acquisitions globally. We believe acquiring assets at reasonable multiples will remain a challenge and payback periods may get stretched if integration synergies are delayed.

Demographics to drive IPM, product launches to fuel US generic sales We forecast a c.12-15% CAGR in the Indian pharma market over the next five years and anticipate key product launches such as generic Gleevec (Sun), generic Glumetza (Lupin), generic Zetia (Glenmark) and generic Asacol HD (Cadila).

2 December 2015

Health Care



Table Of Contents

Executive summary ............................................................. 3

Acquisitions have been mainly in India and US .................. 6

USFDA risks – allaying investor concerns ........................... 9

Research costs have been rising, approvals lagging ........ 11

IPM – positive outlook ....................................................... 13

Valuation and risks ............................................................ 15

Glossary ............................................................................. 27

Company Section .............................................................. 28

Sun Pharma ....................................................................... 29

Lupin .................................................................................. 40

Dr. Reddy's ........................................................................ 49

Cipla ................................................................................... 60

Cadila Healthcare .............................................................. 70

Glenmark ........................................................................... 80

Torrent ............................................................................... 89

2 December 2015

Health Care



Executive summary

Acquisition-led growth supported by balance sheet strength USFDA actions are NOT generic regulatory sector risk Regulatory risks for Dr. Reddy’s are higher than for Sun and Cadila

Acquisition-led growth to emerge as key sector theme

A confluence of factors, ranging from strong balance sheets following several

years of robust cash flow generation to confidence in successfully integrating

acquisitions, is set to drive an even faster pace of M&A activity in the sector.

As M&A continues, the recent acquisition multiples could set the benchmark

for secondary market valuations. US sales contribute c.30-50% of sales for

most large Indian companies; others with lower US exposure are adding to

their presence in this market by acquiring assets (Cipla – Invagen and Exelan).

While non-US markets like Japan, Latam and the EU are large, every company

has a different strategy in these markets, as they continue to pose challenges

in relation to entry, regulation and currency volatility.

Regulatory challenges notwithstanding, we estimate that current business

operations should drive an EPS CAGR of 24% for the sector for FY15-18E. The

big outperformance should be from Sun (26.3% EPS CAGR in FY15-18E) and

Lupin. We see downside risk to the consensus earnings of Dr. Reddy’s, which

faces headwinds in the US. Acquisitions by Indian pharma companies (with a

few exceptions) have a payback period of 5-7 years under modest growth

assumptions (Sun – Taro, Torrent – Elder, see Figure 8).

USFDA actions are NOT generic regulatory sector risk

Following recent US FDA actions on Indian pharma manufacturing units,

investors fear a generic regulatory risk for the sector. Our detailed table (see

glossary on page 28) should allay investor fears: not all 483 observation letters

turn into warning letters, and not all warning letters turn into import alerts.

Also, on most occasions, further USFDA actions have been initiated within a

year of the issuance of 483 observations and warning letters.

Regulatory risks for Dr. Reddy’s are higher than for Sun and Cadila

In November 2015, the USFDA issued warning letters for three of Dr. Reddy's

Indian manufacturing sites. The US contributes 44% of Dr. Reddy’s sales and

we believe that delays in the resolution of the issues at these plants will have

an impact on new approvals, putting pressure on consensus sales and

earnings. Currently, the status of Sun's USFDA plant at Halol in Gujarat is

Official Action Initiated; this plant has not seen any ANDA approvals for about

a year. Sun transferred generic Gleevec from its Halol plant to another facility

outside India. We see low risk to our earnings forecasts for Sun Pharma, as we

do not factor in new approvals for Halol until 3QFY17. Sun and Cadila received

483 observations at the above plants in September 2014.

2 December 2015

Health Care



Valuation based on PER, risks mainly relate to market growth

We have used PER as our principal valuation matrix for the sector. The critical

parameter is our assessment of each company’s ability to enhance growth in

key markets (US and India). We also consider the potential for growth beyond

FY’18 that will be derived from acquisitions made in the past 1-2 years, as well

as the historical valuation ranges, before arriving at the appropriate multiple for

each stock. Our assessment suggests that Sun and Lupin are well entrenched

in these key markets and have demonstrated above-industry growth rates; we

therefore estimate that they should be able to sustain current one year forward

multiples of 20x-24x. This is also premised on our EPS CAGR forecasts of 18-

26% (FY15-18E) for the two companies. For companies constrained by low

growth and ongoing regulatory issues, we have factored in a marginal

discount to historical trading averages.

Figure 2: DB recommendation summary

Company Rec. CMP

(INR)

TP

(INR) Upside

EPS CAGR (%)

FY2015-18E

Avg.PER

5 yr/3 yr.

PER

FY17E/18E

Target

FY18 PER Comment

Sun Buy 730 880 21% 26.7 24x/30x 20x/18x 22x

Lower than historical PER, mainly to factor in USFDA issues at Halol, which has OAI and Ranbaxy integration

Lupin Buy 1,787 2,165 21% 18.9 21x/23x 23x/19x 23x Highest PER justified by high growth trajectory and higher EBITDA margin

Cipla Buy 644 722 12% 32.7 21x/20x 23x/19x 21x

Lower than Sun and Lupin to factor in continuing front-end investments, relatively low EBITDA margin

Glenmark Buy 981 1,133 16% 33.2 19x/23x 19x/18x 21x

Higher than 5-year average because of strong outlook for US and India business, despite relatively low EBITDA margin

Torrent Buy 1,426 1,672 17% 23.5 21x/20x 22x/17x 20x

Higher PER to factor in traction in India and US business despite higher base effect in FY16.

Cadila Hold 401 422 5% 27.3 12x/13x 21x/17x 18x Lower PER to factor in USFDA approval risk, weaker margin outlook

Dr. Reddy’s Sell 3,108 2,748 -12% 7.1 19x/21x 23x/20x 18x Lower than historical multiple mainly on account of impending FDA warning letter

Source: Deutsche Bank estimates, Price data as on 30/11/2015

Figure 1: Key business comparison

Dr. Reddy's

Cipla

Cadila

Lupin

TorrentGlenmark

Sun

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India Outlook


2 December 2015

Health Care



S&P BSE Healthcare Index has largely outperformed BSE Sensex

The S&P BSE Healthcare Index (S&PBSEHC) has outperformed the BSE Sensex

thanks to strong core business growth in the sector and a weakening Indian

rupee. In seven of the past nine years (YTD for 2015), the S&P BSE Healthcare

Index has outperformed the BSE Sensex on a relative basis, mainly due to

investors’ recognition that the pharma sector is not sensitive to interest rate

rises and demand for products is inelastic.

Figure 4: Performance of S&P BSE Healthcare Index vs. BSE Sensex

35

40

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650

Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15

S&P BSE HEALTHCARE INDEX S&P BSE SENSEX USD-INR movement (sec. axis)

1 2 34

56

Source: Deutsche Bank, Bloomberg Finance LP (Data as on 17/11/2015)

Sun and Lupin are top picks

Lupin and Sun are the top picks in our coverage universe, with more than

c.20% upside to our target prices. We mainly differ from consensus as we

factor in lower traction in the US business, resulting in lower EBITDA margin.

Figure 5: DB vs. consensus

Sales EPS Comment

FY16E FY17E FY18E FY16E FY17E FY18E

Sun Pharma 1.4% 2.2% (1.9%) (1.0%) 6.4% 1.4% We have assumed Halol resolution in Q4FY17

Lupin Ltd. (3.8%) (3.6%) (6.0%) (4.1%) 2.8% 5.3% We factor in lower US sales but better EBITDA margin

Dr. Reddy's (1.8%) (3.0%) (5.4%) (3.5%) (6.1%) (10.4%) We factor low US approvals, which also impact EBITDA

Cipla 1.8% (2.2%) (2.4%) (6.0%) (3.5%) (2.4%) We factor in higher front end costs in EBITDA

Cadila (4.7%) (2.8%) (0.9%) (6.0%) (1.4%) 3.8% We assume delays in US approvals in FY16

Glenmark (0.8%) (1.5%) 0.0% (3.3%) (5.9%) (8.4%) We assume low contribution from LATAM markets

Torrent (11.9%) (16.2%) (14.4%) (9.4%) (8.6%) (2.2%) We assume lower US sales in the US markets

Source: Deutsche Bank estimates, Bloomberg Finance LP (Data as on 27/11/2015)

Key sector risk: slower-than-expected growth in key markets like India and US

Key sector risks include slower-than-expected growth of the IPM, delays in

product approvals by the USFDA, delays in integrating acquired assets, slower-

than-expected growth in other large emerging markets and currency volatility.

1. Bull Phase, Pharma underperforms

2. Bear Phase, Pharma outperforms

3. Pharma outperforms despite market recovery,

driven partially by weak INR

4. Pharma sector earnings driven by INR weakness

and faster growth in US sales

5. Some gains from weak INR lost due to new

Pharma pricing policy

6. Regulatory concerns drive negative sentiment for

the sector

Figure 3: Oct-Nov’15 performance

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S&P BSE Healthcare Index

S&P BSE Sensex


2 December 2015

Health Care



Acquisitions have been mainly in India and US

Focus on US generic markets Low leverage enables expansion Direct correlation between execution and stock performance

US generic markets remain key focus of Indian companies

The US accounts for c.30-50% of sales for large Indian companies like Sun, Dr.

Reddy’s, Lupin, Cadila and Glenmark. Other companies with lower exposure

are adding to their presence in this market by acquiring assets (Cipla – Invagen

and Exelan) or acquiring capabilities (Torrent Pharma – Zyg Pharma). The US

remains a major focus market for Indian companies; while other markets such

as Japan, LatAm and the EU are large, every company has a different strategy

in these markets. These include acquisitions in South Africa by Lupin and

Cipla, in France by Cadila, in Japan by Lupin, and in LatAm by Lupin and

Cadila. While these markets are large they continue to pose challenges in

relation to entry, regulation and currency volatility.

Figure 6: US acquisitions by Indian companies

Acquirer Target

Sun Pharma Taro, URL, DUSA, Pharmalucence , Ranbaxy's US Assets

Cipla Invagen Exelon

Lupin Gavis

Dr. Reddy’s Small Portfolio from Glaxo and a manufacturing facility

Cadila Nesher

Torrent Pharma Zyg Pharma which has USFDA manufacturing capabilities

Source: Company, Deutsche Bank

Acquisitions driven by low existing leverage

Indian pharma players have acquired several companies and assets in

developed markets. We expect Indian companies, which have the comfort of

low leverage on the balance sheet, to add to their existing product portfolios in

regulated markets and to increase their footprint in emerging markets. Equity

dilution is also an option as the promoter holding in most of the companies is

c.45-75% (except Dr. Reddy’s). While acquisitions will lead to volatility in

earnings in the short term, we expect return ratios to improve in the medium

term. We expect the dividend payout from these companies to remain at

existing levels and see cash being used to fund inorganic growth.

Figure 7: Low leverage, high promoter holding

Company Debt to equity Promoter holding Pay outs US sales Comment

Sun Pharma 0.3x 54.7% 15-20% 50% Includes Taro (c.19% , USD 863m) , generic Gleevac to drive sales

Dr. Reddy’s 0.4x 25.5% 14-18% 44% Generic Treanda and Generic Pristiq are larger upsides

Lupin 0.1x 46.6% 13-18% 45% Gavis key growth driver

Cadila 0.8x 74.8% 21-24% 40% Large approvals, Asacol HD

Glenmark 1.3x 46.5% 8-12% 31% Generic Zetia key growth driver

Torrent 1.1x 71.3% 25-35% 18% Higher base in FY16 due to generic Abilify

Cipla 0.2x 36.8% 10-16% 8% North America sales , Invagen to drive future US sales


2 December 2015

Health Care



Acquisitions have been an important driver of growth in India

Over the past four years, acquisitions in the IPM have been transacted at the

equivalent of c.2-9x annual sales. Acquisitions by Indian companies have been

to increase or add therapeutic segment presence and by MNCs have been for

the purpose of gaining market share in India. The multiple at the top of the

price-to-sales range is mainly for businesses with strong brands or high

EBITDA margins.

Figure 8: Key acquisitions in India

Acquirer Target Multiple (P/Sales)

Sun Pharma Ranbaxy 2.2x

Torrent Elder 5x-6x

Abbott Piramal c.9x

Strides Acrolab Ranbaxy’s CNS unit 1x

Dr. Reddy’s Laboratories UCB India 5.3x


Currently, there are eight listed (10 in 2007) and eight unlisted (four in 2007)

Indian companies in the top 20 companies in the IPM. We believe that while,

currently, several family-run companies may not be keen to sell their stakes,

the formation of alliances (in manufacturing, research and distribution) or

partial stake sales may emerge as a precursor to sales.

Figure 9: Top 20 companies in IPM

Company Type

2015 2014 2013 2010 2007 Summary

MNC 4 5 5 6 6 Abbott (Piramal HC), Glaxo, Pfizer-Wyeth, Sanofi-Aventis

Listed 8 7 7 8 10 Cipla, Sun Pharma + Ranbaxy, Cadila HC, Lupin, Dr. Reddy’s, Glenmark, Torrent Pharma, Alembic

Not Listed 8 8 8 6 4 Mankind, Alkem, Macleods, Intas, Aristo, Emcure, Micro Labs, USV

Source: AIOCD AWACS, Deutsche Bank

2 December 2015

Health Care



Payback of assets has driven stock performance

In the case of Sun Pharma, the payback period for Taro and URL was less than

three years. Regulatory changes in Germany had a negative impact on Dr

Reddy’s after its acquisition of Betapharm.

Figure 10: Stock price movement after M&A

Company Date of Acquisition

1 day 1 month 3 month 6month 1 year 2 year 5 year Comments

Sun Pharma

Taro 22-Sep-10 -2% 11% 11% 15% 26% 77% 367% Turnaround in less than 3 years

URL 17-Dec-12 3% 0% 16% 33% 60% 129% na Payback in less than 2 years

Ranbaxy 08-Apr-14 7% 6% 23% 46% 84% na na Acquisition completed at the end of 4QFY15

Dr Reddy's

Betapharm 17-Feb-06 0% 5% 23% 14% 14% -18% 166% Large asset, change in policy in Germany had a negative impact

UCB's India Assets 10-Apr-15 2% -10% 0% 13% na na na Small acquisition, recently integrated, yet to estimate the details of payback

Lupin

Gavis 24-Jul-15 -3% 9% 19% na na na na Large US acquisition, estimate payback of 5-7 years

Kyowa 11-Oct-07 1% -1% 9% -11% 38% 104% 416% Entry strategy in Japan, smaller asset

Cipla

Cipla Medpro 22-Nov-12 -2% 8% -2% 7% 4% 60% na Good acquisition but stock impacted as core business performance lagged

Invagen 03-Sep-15 0% -2% na na na na na Appears reasonable at a payback period of 5-7 years

Torrent Pharma

Elder Assets 14-Dec-13 0% -2% 13% 44% 119% na na Good acquisition, payback period under reasonable assumptions is 4-5 years

Cadila

Nesher 17-Jun-11 -1% 6% -10% -22% -20% -15% na Small asset, company's other business was weak, leading to lower returns

Source: Deutsche Bank, Bloomberg Finance LP

2 December 2015

Health Care



USFDA risks – allaying investor concerns

USFDA actions have severely impacted stock prices USFDA actions are NOT a generic regulatory risk Dr. Reddy’s, Sun and Cadila have recently been affected by USFDA

actions

USFDA actions have severely impacted stock prices

Stock prices have reacted to USFDA actions – warning letters and import alerts

issued to companies. The fall has been continuous as US business is disrupted

for at least one year.

Figure 11: Stock price movement after US FDA warnings

Company Facility Date of Warning letter

1day 2 weeks 1 month 3 month 6month 1 year Comment

Dr Reddy's Srikakulam 06-Nov-15 -15% -21% na na na na Warning letter on 3 plants

Cadila Moraiya 21-May-11 0% 1% 1% -9% -19% -10% Approvals got delayed

Sun Karkhadi 07-May-14 0% -8% -4% 24% 36% 50%

Issue still not resolved but forms less than 1% of revenues, other events overshadowed

Wockhardt Chikalthana 18-Jul-13 -9% -54% -53% -51% -58% -41% Warning letter followed by escalations resulted in stock de-rating

Aurobindo Unit III and Unit Vi 20-May-11 1% -8% -9% -25% -52% -47% Impacted a large revenue stream for a year, approvals came after one year

Company Facility Date of import Alert

1day 2 weeks 1 month 3 month 6month 1 year Comment

Ipca 2 plants 18-Jul-14 -1% -16% -17% -20% -15% -19% USFDA issued import alert. So far the issue is not resolved, stock has de-rated

Ranbaxy Mohali 16-Sep-13 2% 3% 5% -23% -11% 1% Limited impact as USFDA had earlier imposed import alert on all its Indians plant

Source: Deutsche Bank, Bloomberg Finance LP, US FDA

2 December 2015

Health Care



USFDA actions are NOT a generic regulatory risk

Following recent US FDA actions on Indian plants, regulatory risk has emerged

as a key concern for the sector. We understand that investors fear a generic

regulatory risk. Figure 12 should allay investor fears: not all 483 observation

letters turn into warning letters and not all warning letters turn into import

alerts. Also, on most occasions, further USFDA actions have been initiated

within a year of the issuance of a 483 observation letter and warning letter; for

example, in the case of Lupin, the warning letter was issued within c.6 months

of the inspection, while in the case of Ranbaxy, the import alert status was

declared on the Mohali plant about a year after the date of inspection.

Figure 12: Recent FDA actions

Company Facility Issue Date of inspection Date of letter Time Gap (days)

Dr. Reddy's Srikakulam Warning Letter Dec 14, Jan-15 Nov-15 c.11 months

Cadila Healthcare Moraiya Warning Letter 03-Feb-11 21-Jun-11 138

Lupin Mandideep Warning Letter 12-Nov-08 07-May-09 176

Ranbaxy Dewas Warning Letter 12-Feb-08 16-Sep-08 217

Ranbaxy Paonta Sahib Warning Letter 07-Mar-08 16-Sep-08 193

Strides Agila (Bangalore) Warning Letter 27-Jun-13 09-Sep-13 74

Sun Pharma Karkhadi Warning Letter 16-Nov-13 07-May-14 172

Sun Pharma Cranbury Warning Letter 28-Apr-10 25-Aug-10 119

Wockhardt Chikalthana Warning Letter 31-Jul-13 25-Nov-13 117

Wockhardt Waluj Warning Letter 22-Mar-13 18-Jul-13 118

Aurobindo Unit III Warning Letter 24-Sep-10 20-May-11 238

Aurobindo Unit VI Warning Letter 22-Dec-10 20-May-11 149

Ipca Pithampur Import Alert 19-Dec-14 24-Mar-15 95

Ipca Ratlam Import Alert 18-Jul-14 23-Jan-15 189

Ranbaxy Toansa Import Alert 11-Jan-14 23-Jan-14 12

Ranbaxy Mohali Import Alert 26-Sep-12 16-Sep-13 355

Source: US FDA, Deutsche Bank

Dr. Reddy’s, Sun and Cadila have been recently impacted by USFDA actions on

their manufacturing plants

In November 2015, the USFDA issued warning letters to three Indian sites of

Dr. Reddy's, relating to its Active Pharmaceutical ingredient manufacturing

facilities at Srikakulam, Andhra Pradesh and Miryalaguda, Telangana, as well

as its Oncology Formulation manufacturing facility at Duvvada,

Visakhapatnam, Andhra Pradesh. The US contributes c.44% of sales, and we

believe that delays in the resolution of the issues at these plants will impact

new approvals and put pressure on consensus sales and earnings.

Sun and Cadila received 483 observations at their plants in September 2014.

Currently, the status of Sun's USFDA plant at Halol in Gujarat is Official Action

Initiated; this plant has not received any ANDA approvals for about a year. The

company has shifted generic Gleevec from its Halol plant to another facility

outside India. We assume normalisation from Halol in 4QFY17. After the

USFDA's 483 observations issued to Cadila's plant at Moraiya in Gujarat, the

company has not received any final ANDA approval for this plant.

2 December 2015

Health Care



Research costs have been rising, approvals lagging

Research costs have a considerable range of c.5-12% of sales In the US drug pipeline, generic Gleevec and generic Zetia are

significant ANDA approvals have dropped due to USFDA concerns

Research costs have a huge range of c.5-12% of sales

While research and development costs continue to rise, mainly on the back of

filing-related costs in the US and other regulated markets, companies like Dr.

Reddy’s, Lupin and Glenmark have been investing more in long gestation

filings like 505 B(2), New Chemical and Biological entities. Sun Pharma’s R&D

cost is capped, as most of such filings are done by the Sun Pharma Advanced

Research Company (SPADV IN).

Figure 13: R&D expense as a percentage of sales

FY2013 FY2014 FY2015E FY2016E

Company Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Dr. Reddy's 6.1 7.1 7.3 8.5 9.0 8.4 11.4 11.0 11.5 11.2 13.3 11.7 11.2

Lupin 4.2 9.7 7.9 8.1 8.3 9.1 8.0 7.4 9.1 8.3 10.1 10.2 12.2

Glenmark 8.4 7.4 6.9 9.0 9.8 8.5 8.9 9.2 9.7 10.3 10.9 10.3 9.4

Sun Pharma 5.3 5.7 7.1 5.5 5.0 6.8 7.3 5.5 6.0 6.8 8.9 7.7 7.3

Cadila HC 7.7 8.8 8.1 6.6 7.6 6.7 5.4 5.2 5.7 8.7 6.6 7.1 7.3

Source: Company, Deutsche Bank; for the above period Cipla and Torrent’s R&D is around c.3-5% of sales

2 December 2015

Health Care



In the US drug pipeline, generic Gleevec and generic Zetia are significant

Figure 14 lists large launches for Indian Pharmaceutical companies over the

next two years. (For more launches, refer to the individual company sections.)

Figure 14: Key products to be launched

Company Key Products

Sun Generic Gleevac, expected to be launched on February 1, 2016; first to file, branded market size is c.USD 2bn

Glenmark Generic Zetia, expected to be launched on December 12, 2017; first to file, branded market size is c.USD 2bn

Cadila Generic Asacol HD, approval not received on launch date on November 15, 2015, branded market size c.USD 500mn

Lupin Generic Glumetza, expected to be launched in February 1, 2016, sole first to file , market size c.USD 200-300mn

Dr. Reddy's Generic Gleevac, expected to be launched a few quarters after Sun launch, branded market size is c.USD 2bn


ANDA approvals have dropped due to USFDA concerns

The ANDA approval rate for companies like Cadila, Sun and Dr. Reddy’s has

been low, mainly on account of the USFDA concerns at some of their plants,

whereas approvals have been higher for Lupin, Glenmark and Torrent.

Figure 15: ANDA approvals CY2015 Figure 16: ANDA approvals CY2014

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2 December 2015

Health Care



IPM – positive outlook

Demographic factors will continue to drive growth Volumes have been key growth drivers in IPM Chronic segment contribution increasing in IPM

Demographic factors will continue to drive growth

The Indian pharma market continues to grow, driven by the sheer size of its

demography; early, improved diagnosis and the increasing shift from acute to

chronic diseases; and low healthcare spend (less than 5% of GDP) .The IPM is

currently c.INR 930bn and is mostly a branded generics market (c.95% of the

market), with high out-of-pocket expenses. We expect the IPM to post a c.12-

15% CAGR over the next five years.

Figure 17: Healthcare expenditure Figure 18: Underpenetrated doctor reach

India

China

Brazil

Russia

South Africa

UK

Spain

Italy

France

Germany

Japan

US

0

20

40

60

80

100

0 3 6 9 12 15 18

% o

f o

ut

of

po

cket

exp

en

se

% of GDP

India

China

BrazilSouth Africa

UK

Spain

Italy

France

Germany

US

-

10

20

30

40

50

60

0 2 4 6

Per

cap

ita (

US

D'0

00

)

Physicians (per '000 people)

Source: World Bank, Deutsche Bank

Source: World Bank, Deutsche Bank

2 December 2015

Health Care



Volumes have been key growth drivers in IPM

We expect growth rates to revive as the impact of the new drug pricing policy

(NPPP), which was implemented in August 2013, is now entirely in the base

and companies have taken the Wholesale Price Index adjusted price hike into

their NPPP impacted portfolio.

Figure 19: Growth drivers

8.9%

(0.2%)

4.9%7.3%

3.6%

3.3%

2.4%

4.7%

3.9%

2.9%

3.2%

2.8%

-1.0%

3.0%

7.0%

11.0%

15.0%

19.0%

2012 2013 2014 2015

Vol growth Price growth New Product growth


Chronic segment contribution increasing in IPM

The IPM has seen an increase in exposure to chronic care over the years

(c.31% in 2015 vs. c.28% in 2011). This has been driven by faster-than-market

growth in chronic therapies, on account of an increase in diseases like diabetes

and hypertension. The sub-chronic segment (like anti-retrovirals, vitamins and

supplements), which is a combination of acute and chronic care, has remained

stable at an industry level.

Figure 20: Sales MAT by segment, October 2015 Figure 21: Sales MAT by segment, October 2011

48

50

46

43

40

31

29

26

31

30

42

36

37

48

58

50

20

20

12

21

22

20

14

24

0 20 40 60 80 100

IPM

DR. REDDYS

CIPLA

ZYDUS …

GLENMARK

LUPIN LTD

SUN PHARMA

TORRENT

ACUTE CHRONIC SUB CHRONIC

53

53

51

49

47

46

35

29

28

27

39

31

42

29

43

44

20

20

10

19

11

25

22

27

0 20 40 60 80 100

IPM

DR. REDDYS

CIPLA

ZYDUS …

GLENMARK

LUPIN LTD

SUN PHARMA

TORRENT

ACUTE CHRONIC SUB CHRONIC

Source: IOCD AWACS, Deutsche Bank , MAT refers to Moving Annual Total

Source: IOCD AWACS, Deutsche Bank , MAT refers to Moving Annual Total

2 December 2015

Health Care



Valuation and risks

Sector PER has been steadily improving Similar strengths but different outlook for India and US Valuation on PER, risks mainly relate to market growth

Sector PER has been steadily improving

The PER for the sector has been steadily improving for the last four years,

mainly on the back of launches in the US market, inorganic opportunities and

the weak rupee v/s the dollar.

Figure 22: Sector P/E

5

10

15

20

25

30

30-1

1-2

007

10-0

5-2

008

19-1

0-2

008

30-0

3-2

009

08-0

9-2

009

17-0

2-2

010

29-0

7-2

010

07-0

1-2

011

18-0

6-2

011

27-1

1-2

011

07-0

5-2

012

16-1

0-2

012

27-0

3-2

013

05-0

9-2

013

14-0

2-2

014

26-0

7-2

014

04-0

1-2

015

15-0

6-2

015

24-1

1-2

015

PE

R (

x)

Sector P/E 5 yr avg.

Source: Deutsche Bank, Bloomberg Finance LP (Data as on30/11/2015)

Similar strengths but different outlook for India and US

We believe Sun Pharma, Lupin and Dr. Reddy’s have similar strengths in the

US market. However, the ongoing manufacturing issues for Dr. Reddy's API

plant will delay ANDA approvals and thereby delay timely launches. While

products can be transferred to alternate sites, this can take around 2-4

quarters or even more for complex products.

Apart from acquisitions, developing a significant product pipeline with a good

mix of limited competition products, FTFs, NDDS products, etc, will be one of

the key growth drivers in the US. Increasing consolidation in the US market on

the distribution side, as well as M&A in the US generic pharmaceutical space,

will continue to put higher pricing pressure on the US business. On the other

hand, the Indian business will drive sales growth and profitability. Hence, we

prefer companies that have a strong India focus, with leadership in the chronic

segments. Lupin makes gains over Dr. Reddy when it comes to comparing

their India businesses. Sun Pharma has the strongest Indian business amongst

its India peers.

Figure 23: Key business comparison

Dr. Reddy's

Cipla

Cadila

Lupin

TorrentGlenmark

Sun

0

10

20

30

40

50

60

0 10 20 30 40 50

US

Ou

tloo

k

India Outlook


2 December 2015

Health Care



Valuation on PER, risks mainly relate to market growth

We have used PER as our principal valuation matrix for the sector. The critical

parameter in our assessment is each company’s ability to enhance growth in

key markets (US and India). We also consider the potential for growth beyond

FY’18 that will be derived from acquisitions made in the past 1-2 years, as well

as the historical valuation ranges, before arriving at the appropriate multiple for

each stock. Our assessment suggests that Sun and Lupin are well entrenched

in these key markets and have demonstrated above-industry growth rates,

leading us to believe that they should be able to sustain current one year

forward multiples of 20x-24x. This is also premised on our EPS CAGR forecasts

of 18-26% (FY15-18E) for the two companies. For companies constrained by

low growth and ongoing regulatory issues, we have factored in a marginal

discount to historical trading averages.

Figure 24: Financial outlook

Sales CAGR Earnings CAGR EBITDA Margin Comments

FY12-15 FY15-18E FY12-15 FY15-18E FY12-15 FY15-18E

Sun 50.5 10.5 15.7 26.7 c.28-45 c.28-35 Driven by generic Zetia and Ranbaxy synergies

Dr. Reddy’s 15.3 6.9 16.1 7.1 c.22-26 c.23-25 Stable due to continuous product launches in the US

Lupin 21.9 15.2 40.8 18.9 c.19-29 c.24-33 US business driven EBITDA margin , mainly Gavis

Cipla 17.3 18.8 1.1 32.7 c.19-27 c.19-24 Key product launches have driven EBITDA margin

Cadila 18.6 16.6 16.8 27.3 c.14-19 c.18-24 US business has driven EBITDA margin

Glenmark 18.1 18.0 3.9 33.2 c.18-21 c.18-25 Driven by generic Zetia

Torrent 20.9 12.0 29.0 23.5 c.15-21 c.20-36 Driven by US launches mainly generic Cymbalta and generic Abilify

Source: Company, Deutsche Bank estimates, all figures in %

2 December 2015

Health Care



Sun Pharma target PER of 22x

Sun has leadership across chronic segments in India and has also expanded

significantly in the US markets, while its business dynamics across markets

have continued to improve significantly. Sun has been trading at an average

one-year forward PER of 24x for the past five years (30x for the past three

years) on account of limited periods of upside in the US markets (generic Doxil

and doxycycline); this is at a premium of c.10-25% to Lupin and Dr Reddy’s.

However, in arriving at our target PER, we factor in the OAI at Halol by the

USFDA, supply issues from the plant and Ranbaxy integration. We assign a

PER of 22x (discount of 25% over the past three years’ one-year forward PER).

Thus, we rate Sun a Buy, with a target price of INR 880 (including INR 11 per

share for generic Gleevec) on our FY18 recurring EPS. Improvement in supplies

at Halol and the successful integration of Ranbaxy could potentially see the

stock getting re-rated and trading at PER of c.25-26x. With net cash of c.INR

61bn, Sun is in a stronger position than peers and cash-adjusted ROEs are in

the range of 25-30% over the next two years.

Figure 25: PE band – Sun Pharma

0

400

800

1,200

1,600

31-M

ar-0

9

09-S

ep-0

9

18-F

eb-1

0

30-J

ul-1

0

08-J

an-1

1

19-J

un-1

1

28-N

ov-1

1

08-M

ay-1

2

17-O

ct-1

2

28-M

ar-1

3

06-S

ep-1

3

15-F

eb-1

4

27-J

ul-1

4

05-J

an-1

5

16-J

un-1

5

25-N

ov-1

5

Price 15x 25x 35x 45x

Source: Deutsche Bank, Bloomberg Finance LP (data as of 30/11/2015)

2 December 2015

Health Care



Lupin target PER of 23x

Lupin has grown across chronic segments in India and also expanded

significantly in the US markets; its business dynamics across markets have

improved significantly. Its execution also remains on track, although

successful integration of Gavis will be key to future earnings growth. Lupin’s

FY15 had a higher base of product launches, mainly generic Cymbalta, which

was sold under shared exclusivity, and key brand Suprax, which now faces

generic competition; this is reflected in lower sales and earnings in FY16.

Our target valuation is at par with its three-year average one-year forward PER

of 23x. Thus, we rate Lupin a Buy, with a target price of INR 2,165 on our FY18

recurring EPS. We assign Lupin the highest PER in our coverage universe,

premised on 1) pieces in place for growth in India, 2) no near-term negatives

from the USFDA, and 3) continuous EBITDA margin improvement.

Figure 26: PE band – Lupin

0

500

1,000

1,500

2,000

2,500

3,000

3,500

06-A

pr-0

9

31-D

ec-0

9

26-S

ep-1

0

22-J

un-1

1

17-M

ar-1

2

11-D

ec-1

2

06-S

ep-1

3

02-J

un-1

4

26-F

eb-1

5

22-N

ov-1

5



2 December 2015

Health Care



Dr. Reddy’s target PER of 18x

Dr Reddy’s has been trading at an average one-year forward PER of 19x for the

past five years (21x for the past three years on the back of continuous product

launches in the US markets), which is a discount of c.10-30% to Sun Pharma

and Lupin. The stock has fallen c.20% following the recent warning letters sent

to three of its plants. This will slow down approvals for the US market and

have a meaningful impact on overall sales and earnings growth. Furthermore,

remediation efforts at the USFDA plants will entail costs, temporary disruption

of supplies and timelines that could range from six months to over a year,

further dampening the earnings outlook.

We believe successful resolution of the warning letters issue would be a key

trigger in the medium term, but with Street estimates being revised down we

choose to adopt a conservative valuation. We assign a PER of 18x (discount of

5% to the past three years’ one-year forward PER), which is at a c.20-30%

discount to Sun and Lupin’s target PER. Thus, we rate Dr Reddy’s a Sell. We

have a INR 2,748 target price on our FY18E recurring EPS. While successful

site transfer would improve its sales growth outlook, EBITDA margin

improvement could be delayed as these transfers would entail additional costs

and in some cases also profit sharing; we believe the stock could trade at c.

18x-19x, but this is still below its historical multiple of 20x-21x.

Figure 27: PE band – Dr. Reddy’s

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

31-M

ar-0

9

09-S

ep-0

9

18-F

eb-1

0

30-J

ul-1

0

08-J

an-1

1

19-J

un-1

1

28-N

ov-1

1

08-M

ay-1

2

17-O

ct-1

2

28-M

ar-1

3

06-S

ep-1

3

15-F

eb-1

4

27-J

ul-1

4

05-J

an-1

5

16-J

un-1

5

25-N

ov-1

5


Source: Deutsche Bank Estimates, Bloomberg Finance LP (Data as on 30/11/2015)

2 December 2015

Health Care



Cipla target PER of 21x

Cipla’s investments in setting up and adding to its distribution will likely cap

EBITDA margin growth. While the company has acquired several assets in

markets across the world, execution and successful integration are vital; we

factor this into our target PER of 21x, which is at a discount of c.5-10% to

Lupin’s and Sun’s PERs. We rate Cipla a Buy, with a target price of INR 722

based on our FY18E recurring EPS.

Figure 28: PE band – Cipla

0

200

400

600

800

1,000

31-M

ar-0

9

09-S

ep-0

9

18-F

eb-1

0

30-J

ul-1

0

08-J

an-1

1

19-J

un-1

1

28-N

ov-1

1

08-M

ay-1

2

17-O

ct-1

2

28-M

ar-1

3

06-S

ep-1

3

15-F

eb-1

4

27-J

ul-1

4

05-J

an-1

5

16-J

un-1

5

25-N

ov-1

5Price 20x 25x 30x 35x

Source: Deutsche Bank estimates, Bloomberg Finance LP (data as on 30/11/2015

2 December 2015

Health Care



Cadila target PER of 18x

While Cadila’s US business has grown in the past on the back of product

launches, recent product approvals have been fewer in number, and the

company did not get approval for generic Asacol for the settled November 15,

2015 rates, due to 483 observations at its Moraiya plant. We assign a target

PER of 18x, which is lower than the three-year average one-year forward PER

of 20x to factor in delays in key product approvals in the US markets (Moraiya

plant) and a lower EBITDA margin compared to peers. The target PER is at its

historical discount of c.15- 30% to Sun and Lupin. Thus, we rate Cadila Hold,

with a target price of INR 422 on our FY18 recurring EPS.

Figure 29: PE band – Cadila

0

100

200

300

400

500

600

31-M

ar-0

9

09-S

ep-0

9

18-F

eb-1

0

30-J

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08-J

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1

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1

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3

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4

27-J

ul-1

4

05-J

an-1

5

16-J

un-1

5

25-N

ov-1

5



2 December 2015

Health Care



Glenmark target PER of 21x

We expect Glenmark’s earnings growth over the next three years to be driven

by new launches in the US business and market share gains in therapeutic

segments in the India business. Our target valuation of 21x is marginally below

Lupin and Sun; it is on a par with Cipla and marginally lower than Glenmark’s

own three-year average one-year forward PER of 23x. We maintain the

discount to industry leaders Sun and Lupin but the PER is higher than other

peers’ to factor in sales and earnings growth .Thus, we rate Glenmark Buy with

a target price of INR 1,133 (including INR 10 for generic Zetia) on our FY18

recurring EPS. We have not factored any NCE licensing income into our

forecasts.

Figure 30: PE band – Glenmark

0

200

400

600

800

1,000

1,200

1,400

1,600

06-A

pr-0

9

31-D

ec-0

9

26-S

ep-1

0

22-J

un-1

1

17-M

ar-1

2

11-D

ec-1

2

06-S

ep-1

3

02-J

un-1

4

26-F

eb-1

5

22-N

ov-1

5



2 December 2015

Health Care



Torrent target PER of 20x

Torrent has re-rated substantially and is now trading at par with its peers,

mainly on the back of significant growth in the US business due to the launch

of generic Cymbalta (in FY15) and generic Abilify (FY16), with help from

synergies in the India business following the Elder Pharma acquisition. The

expected year-on-year fall in earnings in FY17 is mainly due to a higher base

for generic Abilify. We assign a target PER of 20x, which is c.60% higher than

its three-year average one-year forward PER of 13x. We believe this multiple is

justified as India and US Business have a favorable business outlook and

EBITDA margin profile of the company has improved significantly. Our target

PER is at a discount of 10% and 15% to Sun and Lupin, respectively, and

factors in the scale of business of these two companies in the India and the US

markets. We rate Torrent a Buy, with a target price of INR 1,672 on our FY18E

recurring EPS.

Figure 31: PE band – Torrent

0

400

800

1,200

1,600

2,000

31-M

ar-0

9

09-S

ep-0

9

18-F

eb-1

0

30-J

ul-1

0

08-J

an-1

1

19-J

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1

28-N

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1

08-M

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25-N

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5



Key sector risk: slower-than-expected growth in key markets like India and US

Key sector risks include slower-than-expected growth of the IPM, delays in

product approvals by the USFDA, delays in integrating acquired assets, slower-

than-expected growth in other large emerging markets and currency volatility.

2 December 2015

Health Care



Lupin and Sun are top picks

Lupin and Sun are the top picks in our coverage universe, with more than

c.20% upside to our target prices. Our differences with consensus mainly stem

from factoring in lower traction in the US business, resulting in lower EBITDA

margins.

Figure 32: DB recommendation summary

Coverage EPS INR/Share Upside /

Downside %

Rec. Valuation framework FY16E FY17E FY18E CMP TP

Sun Pharma 19 27 39 730 880 21% Buy 22x FY18 recurring EPS plus INR 11 for generic Gleevec

Dr. Reddy’s 148 137 153 3108 2,748 -12% Sell 18x FY18 recurring EPS

Lupin 49 77 94 1787 2,165 21% Buy 23x FY18 recurring EPS

Cipla 22 28 34 644 722 12% Buy 21x FY18 recurring EPS

Cadila 14 18 23 401 422 5% Hold 18x FY18 recurring EPS

Glenmark 34 44 54 981 1,133 16% Buy 21x FY18 recurring EPS plus INR 10 for generic Zetia

Torrent Pharma 84 68 84 1426 1,672 17% Buy 20x FY18 recurring EPS Source: Deutsche Bank Estimates, CMP as on 30/11/2015

Figure 33: DB vs. consensus

Sales EPS Comment

FY16E FY17E FY18E FY16E FY17E FY18E

Sun Pharma 1.4% 2.2% (1.9%) (1.0%) 6.4% 1.4% Mainly in line with consensus, we have assumed Halol resolution in Q4FY17

Lupin (3.8%) (3.6%) (6.0%) (4.1%) 2.8% 5.3% We assume lower US sales but better EBITDA margins driven by US and other markets

Dr. Reddy's (1.8%) (3.0%) (5.4%) (3.5%) (6.1%) (10.4%) Our US sales assumptions and EBITDA margin are significantly lower than consensus, mainly on account of the USFDA warning letter

Cipla 1.8% (2.2%) (2.4%) (6.0%) (3.5%) (2.4%) We have assumed higher front-end costs, which have capped EBITDA margin expansion

Cadila (4.7%) (2.8%) (0.9%) (6.0%) (1.4%) 3.8% We assume delays in US approvals in FY16, which are not in line with consensus assumptions

Glenmark (0.8%) (1.5%) 0.0% (3.3%) (5.9%) (8.4%) We assume lower contribution from ROW and LATAM business

Torrent (11.9%) (16.2%) (14.4%) (9.4%) (8.6%) (2.2%) We assume lower US sales than consensus on the back of competition in generic Abilify in 3QFY16 and lower growth in US markets

Source: Deutsche Bank estimates, Bloomberg Finance LP (data as on 29/11/2015)

2 December 2015

Health Care



S&P BSE Healthcare Index has outperformed BSE Sensex in seven out of past

nine years

The S&P BSE Healthcare Index (S&PBSEHC) has outperformed the Sensex due

to strong core business growth in the sector and a weakening Indian rupee.

However, regulatory risks have resulted in a sharp underperformance in the

last one year.

Figure 34: Performance of S&P BSE Healthcare Index vs. BSE Sensex

35

40

45

50

55

60

65

70

50

150

250

350

450

550

650

Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15

S&P BSE HEALTHCARE INDEX S&P BSE SENSEX USD-INR movement (sec. axis)

1 2 34

56


S&P BSE Healthcare Index has outperformed BSE Sensex over most of the last

decade

In seven of the past nine years (YTD for 2015), the S&PBSE Healthcare Index

has outperformed the BSE Sensex on a relative basis, mainly due to investors’

recognition that Indian pharma companies are not sensitive to interest rate

rises and the demand for their products is inelastic. Over the past eight years,

Sun (six times), Lupin (thrice), Dr. Reddy’s, Glenmark, Torrent (twice) and

Cadila (once) have been among the top two performers in our coverage

universe vis-a-vis the S&P BSE Healthcare Index

Figure 36: Performance of S&P BSE Healthcare Index and DB pharma universe vs. BSE Sensex (all figures in %)

Year 2007 2008 2009 2010 2011 2012 2013 2014 2015

Duration 12M 12M 12M 12M 12M 12M 12M 12M YTD

S& P BSE Healthcare (33.1) 20.6 (3.6) 16.2 10.3 10.1 14.6 15.8 16.1

Sun (13.1) 50.4 (25.2) 41.9 26.1 15.1 42.1 59.2 (6.8)

Cipla (61.1) 40.6 6.3 (6.5) 12.6 2.7 (11.3) 6.9 7.7

Dr. Reddy’s (57.6) 19.0 78.9 32.1 18.9 (9.2) 26.8 25.9 0.7

Lupin (40.9) 51.3 48.5 39.4 12.0 8.0 35.6 65.4 30.6

Cadila (59.3) 43.5 59.0 60.5 7.7 (5.7) (19.9) 27.8 30.2

Glenmark 47.2 4.6 (76.7) 14.8 (1.4) 28.0 (7.4) 1.8 32.3

Torrent (53.2) 16.2 92.5 29.2 15.4 3.3 20.4 120.8 31.0

Source: Deutsche Bank, Bloomberg Finance LP (Data as on 1/11/2015), all figures are in %

1. Bull Phase, Pharma underperforms

2. Bear Phase, Pharma outperforms

3. Pharma outperforms despite market

recovery, driven partially by weak INR

4. Pharma sector earnings driven by INR

weakness and faster growth in US sales

5. Some gains from weak INR lost due to

new Pharma pricing policy

6. Regulatory concerns drive negative

sentiment for the sector

Figure 35: Oct-Nov ’15 performance

85

90

95

100

105

110

4-O

ct-

15

13-O

ct-

15

22-O

ct-

15

31-O

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9-N

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5

18-N

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5

S&P BSE Healthcare Index

S&P BSE Sensex


2 December 2015

Health Care



Average valuation in line with global peers’, but with wider dispersion

Our global comparison table summarises the valuation metrics for the seven

Indian pharmaceutical stocks and a group of US peers. The US group trades at

an average PER of 12.6x based on CY17, which is at a discount to the Indian

group average of 18.3x based on our forecasts for FY18. We believe the reason

for the discount is a higher earnings CAGR and higher ROE for the Indian

players.

Figure 37: Peer comp sheet

Global companies

Price Mkt cap

(USD) (USD bn) USD mn CAGR (%) CY14-17E USD mn

CAGR (%) CY14-17E

DB Rating 2015 2014 2017E 2015E 2016E 2017E 2014 2017E 2016E 2017E 2016E 2017E

Teva TEVA.N Buy 62.9 54.1 20,272.4 8.7 33.3 36.7 38.3 3,055.4 19.6 11.5 8.1 10.6 10.1

Allergan AGN.N Buy 313.9 121.3 12,846.8 14.4 46.6 49.9 51.7 (1,631.0) nm 1.3 2.3 20.5 17.7

Mylan MYL.OQ Buy 51.3 25.6 7,719.6 13.3 30.0 30.3 31.0 929.7 30.9 16.2 15.8 10.6 9.9

Indian companies under coverage

Price Mkt cap

Rs (USD bn) USD mn CAGR (%) FY15-18E USD mn

CAGR (%) FY15-18E

DB Rating 2015 2015 2018E 2016E 2017E 2018E 2015 2018E 2017E 2018E 2017E 2018E

Sun SUN.NS Buy 730 26.4 4,103.5 10.5 28.4 34.5 34.7 718.4 26.7 28.5 24.9 20.4 18.1

Cipla CIPL.NS Buy 644 7.8 1,706.2 18.8 21.9 23.0 23.5 177.6 32.7 16.8 18.1 23.2 18.7

Dr Reddy's

REDY.NS Sell 3,108 8.0 2,228.6 6.9 24.9 22.5 23.0 319.1 7.1 16.4 15.9 22.6 20.4

Lupin LUPN.NS Buy 1,787 12.1 1,892.8 15.2 24.1 30.4 32.3 380.7 18.9 28.1 27.2 23.3 19.0

Cadila CADI.NS Hold 401 6.2 1,277.8 16.6 20.7 22.0 23.9 174.8 27.3 30.9 31.6 22.1 17.1

Glenmark GLEN.NS Buy 981 4.2 997.0 18.0 22.7 25.0 23.4 99.6 33.2 27.1 23.4 19.0 17.7

Torrent TORP.NS Buy 1,426 3.6 689.6 12.0 35.5 24.7 25.8 112.9 23.5 29.0 28.5 20.8 17.1

Sales EBITDA margins PAT ROE PER

Name Ticker

Sales EBITDA margins PAT ROE PER

Name Ticker

Source: Company, Deutsche Bank estimates, prices as on(27/11/2015), Note: For Indian companies reporting year is FY, for US companies it is CY.

2 December 2015

Health Care



Glossary

Terms related to USFDA inspection

FDA Form 483 observation: Upon completion of the inspection, if

objectionable conditions are observed, the FDA provides the owner of

the establishment with a document, called an FDA Form 483.

FDA provides initial classification of the inspection based on the

observations noted during the inspection, the investigator’s report,

and the FDA District Office supervisory personnel’s review. With the

exception of instances where procedures indicate that the relevant

product centre has the right of final classification, the final

classification of the inspection is made by the FDA District Office. An

inspection classification reflects the compliance status of the

establishment at the time of the inspection, based on the observations

documented. The conclusions of the inspection are reported as Official

Action Indicated (OAI), Voluntary Action Indicated (VAI), or No Action

Indicated (NAI).

An OAI inspection classification occurs when significant objectionable

conditions or practices were found and regulatory action is warranted

to address the establishment's lack of compliance with statutes or

regulations.

A VAI inspection classification occurs when objectionable conditions

or practices were found that do not meet the threshold of regulatory

significance. Inspections classified with VAI violations are typically

more technical violations of the FDCA.

An NAI inspection classification occurs when no objectionable

conditions or practices were found during the inspection or the

significance of the documented objectionable conditions found does

not justify further actions.

An EIR is provided if no enforcement action is contemplated, or after

the enforcement action is concluded, the FDA provides inspected

establishments with a final inspection report, called an Establishment

Inspection Report (EIR).

Warning Letters: The FDA’s position is that Warning Letters are issued

only for violations of regulatory significance. Significant violations are

those violations that may lead to enforcement action if not promptly

and adequately corrected. Normally, a plant that has received a

warning letter and has not resolved the regulatory issues will receive

no new approvals.

Import Alert: Import Alerts are issued whenever the FDA determines

that it already has sufficient evidence to conclude that products

appear to be adulterated, misbranded, or unapproved, and hence

refused admission.

Other terms

ANDA : Abbreviated New Drug Application

API : Active Pharma Ingredient

2 December 2015

Health Care



Company Section

2 December 2015

Health Care



Reuters Bloomberg SUN.NS SUNP IS

Forecasts And Ratios

Year End Mar 31 2014A 2015A 2016E 2017E 2018E

Sales (INRm) 160,043.9 272,865.0 286,792.8 341,704.5 368,498.5

EBITDA (INRm) 71,140.8 77,197.6 81,332.8 117,804.5 127,869.0

Reported NPAT (INRm) 31,414.7 45,393.8 45,995.8 86,158.5 97,122.2

Reported EPS FD(INR) 15.17 18.87 19.12 35.81 40.36

DB EPS FD(INR) 27.32 19.85 21.96 35.81 40.36

DB EPS growth (%) 58.4 -27.3 10.6 63.0 12.7

PER (x) 20.1 39.9 33.2 20.4 18.1

EV/EBITDA (x) 15.1 24.2 20.8 14.0 12.3

DPS (net) (INR) 1.50 3.00 3.00 5.70 6.50

Yield (net) (%) 0.3 0.4 0.4 0.8 0.9

Source: Deutsche Bank estimates, company data 1 DB EPS is fully diluted and excludes non-recurring items

2 Multiples and yields calculations use average historical prices for past years and spot prices for current and future years, except P/B which

uses the year end close

Best execution record for integrating acquisitions We initiate coverage on Sun Pharma with a Buy rating for three reasons: 1) generic Gleevec launch will likely drive earnings in the near term; 2) fall in Taro contribution should be made up for by Ranbaxy synergies; 3) we estimate Sun can deliver a FY15-18 EPS CAGR of 26.7%, factoring in approvals from Halol from Q4FY17. The stock has lagged the sector by 23% YTD, and PERs are now c.10-15% cheaper than those of peers (vs. c.20% premium historically).

Taro key driver of business in the near term, India business in the medium term We forecast Taro (Taro US) to contribute c.11% of sales in FY18 (down from c.19% in FY15) and c.25% of EBITDA (down from c.41% in FY15), mainly on account of increasing competition. For FY18, we forecast the India formulation business to contribute c.26% of sales (up from c.24% in FY15). We believe the dip in the earnings contribution from Taro will be made up for by the synergy benefits of c.USD 250-300m arising from the Ranbaxy acquisition.

Key triggers are generic Gleevec launch and USFDA approvals from Halol Positive triggers include the launch of generic Gleevec on final approval from the USFDA on 1 February 2016. We factor in ANDA approvals from Halol from 4QFY17. In the event that the Halol plant receives a warning letter and normalcy of operations is delayed beyond FY18, we estimate an EPS impact of 0.5% (FY17) and 4.3% (FY18). We have not factored in revenues for MK-3222 (Tildrakizumab), Sun’s IL-23, which is currently in Phase III clinical trials.

Our 12M target price of INR 880/sh provides c.21% upside potential; risks We rate Sun a Buy, with a target price of INR 880, or a target PER of 22x (lower than the historical multiple, mainly to factor in USFDA issues) on FY18E recurring EPS, and INR 11/share for generic Gleevec. Key downside risks: escalation of existing non-compliance with current good manufacturing practices resulting in a warning letter at Sun’s Halol plant; slower-than-expected growth rate of Indian formulations market; delay in approval of generic Gleevec; faster-than-expected decline in Taro’s sales.

Rating

Buy Asia

India

Health Care

Pharmaceuticals / Biotechnology

Company

Sun Pharma

Near-term risks factored in; medium- and long-term positives in place

Price at 30 Nov 2015 (INR) 729.65

Price target - 12mth (INR) 880.00

52-week range (INR) 1,165.41 - 706.20

Bombay Stock Exchange (BSE 30)

26,146

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]

Price/price relative

450

600

750

900

1050

1200

12/13 6/14 12/14 6/15

Sun Pharma

Bombay Stock Exchang (Rebased)

Performance (%) 1m 3m 12m

Absolute -18.0 -18.9 -12.4


-1.9 1.8 -8.4


2 December 2015

Health Care



Model updated:30 November 2015

Running the numbers

Asia

India


Sun Pharma Reuters: SUN.NS Bloomberg: SUNP IS

Buy Price (30 Nov 15) INR 729.65

Target Price INR 880.00

52 Week range INR 706.20 - 1,165.41

Market Cap (m) INRm 1,755,900

USDm 26,312

Company Profile

Sun Pharmaceuticals Industries, started as a partnership firm in 1983 by Dilip Shanghvi, manufacturing formulations and bulk drugs. Initially operating with a plant at Vapi, Gujarat, it now has more than 35 manufacturing locations (including India, US, Europe) Hungary). In India it is the industry leader in chronic-care. Sun has expanded internally and via acquisitions, important acquisitions being that of Caraco, Taro, Ranbaxy. Sun sells its product in more than 50 countries, US and India being its largest markets.

Price Performance

450

600

750

900

1050

1200

Dec 13Mar 14Jun 14Sep 14Dec 14Mar 15Jun 15Sep 15

Sun PharmaBombay Stock Exchange (BSE 30) (Rebased)

Margin Trends

2024283236404448

13 14 15 16E 17E 18E

EBITDA Margin EBIT Margin

Growth & Profitability

0

5

10

15

20

25

30

0

20

40

60

80

13 14 15 16E 17E 18E

Sales growth (LHS) ROE (RHS)

Solvency

0

50

100

150

200

-60

-50

-40

-30

-20

-10

0

13 14 15 16E 17E 18E

Net debt/equity (LHS) Net interest cover (RHS)

Kartik Mehta

+91 22 7180 4210 [email protected]

Fiscal year end 31-Mar 2013 2014 2015 2016E 2017E 2018E

Financial Summary

DB EPS (INR) 17.25 27.32 19.85 21.96 35.81 40.36

Reported EPS (INR) 14.40 15.17 18.87 19.12 35.81 40.36

DPS (INR) 2.50 1.50 3.00 3.00 5.70 6.50

BVPS (INR) 66.9 80.6 91.2 108.9 142.8 181.0

Weighted average shares (m) 2,071 2,071 2,406 2,406 2,406 2,406

Average market cap (INRm) 696,011 1,136,960 1,903,779 1,755,900 1,755,900 1,755,900

Enterprise value (INRm) 649,562 1,077,300 1,871,111 1,690,614 1,648,776 1,576,149

Valuation MetricsP/E (DB) (x) 19.5 20.1 39.9 33.2 20.4 18.1

P/E (Reported) (x) 23.3 36.2 41.9 38.2 20.4 18.1

P/BV (x) 6.06 7.10 11.19 6.70 5.11 4.03

FCF Yield (%) 1.9 2.1 0.7 2.6 3.1 4.8

Dividend Yield (%) 0.7 0.3 0.4 0.4 0.8 0.9

EV/Sales (x) 5.8 6.7 6.9 5.9 4.8 4.3

EV/EBITDA (x) 13.4 15.1 24.2 20.8 14.0 12.3

EV/EBIT (x) 14.4 16.1 28.7 24.0 15.6 13.7

Income Statement (INRm)

Sales revenue 112,389 160,044 272,865 286,793 341,705 368,498

Gross profit 91,655 132,251 205,473 219,156 270,849 291,114

EBITDA 48,353 71,141 77,198 81,333 117,805 127,869

Depreciation 3,362 4,092 11,947 10,823 11,942 12,887

Amortisation 0 0 0 0 0 0

EBIT 44,991 67,049 65,250 70,510 105,862 114,982

Net interest income(expense) 1,937 -442 -5,790 -5,374 -2,875 -1,704

Associates/affiliates 0 0 0 0 0 0

Exceptionals/extraordinaries -5,901 -25,174 -2,378 -6,852 0 0

Other pre-tax income/(expense) 2,122 4,384 6,946 9,356 8,028 9,406

Profit before tax 43,149 45,817 64,029 67,640 111,016 122,683

Income tax expense 8,456 7,027 9,147 11,850 16,652 18,402

Minorities 4,863 7,375 9,488 9,794 8,205 7,158

Other post-tax income/(expense) 0 0 0 0 0 0

Net profit 29,831 31,415 45,394 45,996 86,158 97,122

DB adjustments (including dilution) 5,901 25,174 2,378 6,852 0 0

DB Net profit 35,732 56,589 47,771 52,848 86,158 97,122

Cash Flow (INRm)

Cash flow from operations 34,395 35,229 39,329 64,787 74,672 105,720

Net Capex -21,391 -11,563 -26,906 -19,077 -19,893 -20,871

Free cash flow 13,003 23,666 12,422 45,710 54,780 84,849

Equity raised/(bought back) 0 0 0 0 0 0

Dividends paid -6,058 -3,635 -8,689 -8,445 -16,046 -18,298

Net inc/(dec) in borrowings -668 22,908 51,073 -32,508 -23,029 -2,977

Other investing/financing cash flows -2,549 -692 -19,538 4,548 10,650 12,509

Net cash flow 3,728 42,247 35,269 9,305 26,355 76,084

Change in working capital -3,661 -7,653 -27,501 -1,825 -31,633 -11,448

Balance Sheet (INRm)

Cash and other liquid assets 64,781 103,762 137,143 147,048 174,061 250,869

Tangible fixed assets 25,901 25,051 53,128 65,378 77,044 88,483

Goodwill/intangible assets 24,870 33,191 57,073 53,078 49,362 45,907

Associates/investments 0 0 0 0 0 0

Other assets 81,930 113,358 204,940 185,874 238,100 259,595

Total assets 197,483 275,362 452,284 451,378 538,567 644,854

Interest bearing debt 1,982 24,890 75,963 43,455 20,426 17,449

Other liabilities 40,582 64,357 128,438 107,547 128,139 138,187

Total liabilities 42,564 89,247 204,401 151,003 148,565 155,636

Shareholders' equity 138,568 166,903 219,371 262,069 343,491 435,549

Minorities 16,351 19,212 28,512 38,306 46,511 53,669

Total shareholders' equity 154,919 186,115 247,883 300,375 390,002 489,218

Net debt -62,799 -78,872 -61,180 -103,592 -153,635 -233,420

Key Company Metrics

Sales growth (%) 40.4 42.4 70.5 5.1 19.1 7.8

DB EPS growth (%) 34.4 58.4 -27.3 10.6 63.0 12.7

EBITDA Margin (%) 43.0 44.5 28.3 28.4 34.5 34.7

EBIT Margin (%) 40.0 41.9 23.9 24.6 31.0 31.2

Payout ratio (%) 17.4 9.9 15.9 15.7 15.9 16.1

ROE (%) 23.8 20.6 23.5 19.1 28.5 24.9

Capex/sales (%) 19.0 7.2 9.9 6.7 5.8 5.7

Capex/depreciation (x) 6.4 2.8 2.3 1.8 1.7 1.6

Net debt/equity (%) -40.5 -42.4 -24.7 -34.5 -39.4 -47.7

Net interest cover (x) nm 151.7 11.3 13.1 36.8 67.5

Source: Company data, Deutsche Bank estimates

2 December 2015

Health Care



Investment thesis

Outlook

We rate Sun a Buy, premised on the following: 1) in IPM, Sun is ranked

number one, with a c.8.9% market share, with a focus on, and leadership

across, chronic care segments; 2) Sun’s key product launch is generic Gleevec

in 4QFY16, for which Sun is first to file (for FY15-18, we forecast Sun’s US

sales to register a CAGR of 8.8% and to contribute c.48% of sales in FY18); 3)

the stock has lagged the sector by 23% YTD, and PER multiples are now c.10-

15% cheaper than those of the large-caps (vs. c.20-30% premium historically).

We forecast sales and earnings to register CAGRs of 10.5% and 26.7%,

respectively, for FY15-18.

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Sun has

leadership across the chronic segments in India, and has also expanded

significantly in the US market, while its business dynamics across markets



years on account of limited period upside in the US market − generic Doxil and

doxycycline), which represents a premium of c.10-25% to Lupin and Dr

Reddy’s. However, in arriving at our target PER, we factor in the OAI at Halol

by the USFDA and supply issues from the plant and the Ranbaxy integration.

We assign a PER of 22x (discount of 25% over the past three years’ one-year

forward PER). Thus, we rate Sun a Buy, with a target price of INR 880

(including INR 11 per share for generic Gleevec) on our FY18E recurring EPS.

Improvements in supplies at Halol and the successful integration of Ranbaxy

will likely see the stock being re-rated and trading at a PER of c.25-26x. Sun,

with net cash of c. INR 61bn as of 31 March 2015, is in a stronger position

than its peers, and cash-adjusted ROEs are in the range of c-25-30% over the

next two years, on our estimates.

Risks

Key downside risks include escalation of the existing non-compliance with

current good manufacturing practices, resulting in a warning letter at Sun’s

Halol plant, slower-than-expected growth rate of the Indian formulations

market, delay in approval of generic Gleevec, and a faster-than-expected

decline in Taro’s sales.

2 December 2015

Health Care



Initiating coverage with a Buy rating

We estimate Sun’s sales and earnings to register CAGRs of 10.5% and 26.7%

respectively, over FY15-18. We expect he EBITDA margin to improve, driven

mainly by synergies of USD 300m on account of the Ranbaxy integration and

the launch of generic Gleevec. We estimate Taro’s sales to be USD 763m in

FY18, down from USD 863m in FY15, driven mainly by price competition in

existing brands.

We have factored in that the Halol plant (which was under OAI) will receive

new approvals from 4QFY17. In the event that Halol receives a warning letter

and normalcy of operations is delayed beyond FY18, the negative impact on

EBITDA on our numbers will be USD 7m for FY17 and USD 71m for FY18. We

believe that the dip in the earnings contribution from Taro will be made up for

by the synergy benefits of c.USD 250-300m arising from the Ranbaxy

acquisition.

Figure 38: Impact on earnings if approvals from Halol are delayed beyond

FY18

In USD m FY14 FY15 FY16E FY17E FY18E

Avg USD/INR 59.21 61.11 65.03 66.95 68.03

EBITDA % 44.5 28.3 26.5 30.7 35.5

EBITDA change (excluding Gleevec)

385 99 -51 307 501

Break up :

Ranbaxy impact : FY15 actual, 2% of sales in FY16E

0 -101 -86 200 300

Halol impact assumed @ 25% EBITDA margin

0 -33 -40 6 71

Taro EBITDA (currency-adjusted) 131 110 19 -14 9

Sun business (ex Halol, currency benefit included)

254 122 55 103 88

EPS impact in INR if Halol receives warning letter and new approvals are delayed beyond FY18

0.13 1.70

% of EPS ( ex Gleevec) 0.5% 4.3%

Source: Deutsche Bank estimates, Sun without Ranbaxy

Figure 39: Gleevec impact

FY14* FY15 FY16E FY17E FY18E CAGR

2015-18E (%) Comment

PAT (INR m) 56,589 47,771 52,848 86,158 97,122 26.7

PAT (ex generic Gleevec) (INR m)

56,589 47,771 46,517 65,614 95,041 25.8 Assuming 15% tax rate for Gleevec

EPS (INR) 27.3 19.9 22.0 35.8 40.4

EPS (ex generic Gleevec) (INR)

27.3 19.9 19.3 27.3 39.5 INR 11 for Gleevec

Source: Company data, Deutsche Bank estimates. *Sun without Ranbaxy

2 December 2015

Health Care



Muted FY16 guidance driven by Halol and planned sale of non-strategic assets

Sun Pharma expects FY16 revenues to remain flat or decline marginally on a

yoy basis, owing mainly to supply constraints at the Halol facility and the

discontinuation of certain non-strategic businesses of Ranbaxy.

Figure 40: Sales mix summary

Metric, INR m FY14* FY15 FY16E FY17E FY18E CAGR

2015-18E (%)Comments

India formulations 34,967 64,322 71,436 81,558 95,213 14.0 Integration of acute care-focused Ranbaxy will see gradual improvement.

US 97,844 137,196 140,776 176,027 176,635 8.8 Driven by generic Gleevec launch.

Taro 45,868 52,752 50,595 50,756 52,602 (0.1) Assuming sales of USD 778m, USD 758m, and USD773m in FY16E, FY17E and FY18E, respectively.

Others 51,976 84,444 90,181 125,270 124,033 13.7 Ex-generic Gleevec is 14.1%; we assume approval from Halol plant starting in Q4FY17.

ROW 8,777 23,320 22,006 26,120 31,343 10.4 Currency fluctuations will lead to volatility in sales growth.

EM 10,308 37,326 39,468 44,204 50,393 10.5 Mainly Ranbaxy’s business.

API & Others 8,149 10,702 13,107 13,796 14,914 11.7 Mostly used for captive purposes.

Net sales 160,044 272,865 286,793 341,705 368,498 10.5 Driven by India and US markets.

Net sales (ex generic Gleevec )

160,044 272,865 278,518 309,928 362,557 9.9

Assuming generic Gleevec sales of USD 125m, USD 506m and USD 88m in FY16E, FY17E, and FY18E, respectively.

EBITDA margin (%) 44.5 28.3 28.4 34.7 35.6 Synergies of USD 300m on account of the Ranbaxy integration in FY18.

EBITDA margin (ex generic Gleevec)

44.5 28.3 26.5 30.7 35.5 Assuming generic Gleevec EBITDA margin of 90%, 65%, and 35% in FY16E, FY17E, and FY18E, respectively.

Source: Company data, Deutsche Bank estimates, * Sun without Ranbaxy

Leads the IPM, with 8.9% market share

Sun is ranked No. 1 in the IPM, with a c.8.9% market share. We estimate Sun’s

India sales to register a CAGR of 14% over FY15-18; the lower growth rate

(lower than Sun’s historical growth rate, which has been c.17-20%) is on

account of the merger of Ranbaxy’s acute care-focused portfolio with Sun’s

chronic care-focused segments in the IPM.

Figure 42: Revenue break-up

Neuro-Psychiatry18%

Cardiology17%

Anti-Infective12%

Gastroenterology12%

Ophthalmology9%

Pain / Analgesics7%

Others6%

Vitamins/Minerals/Nutrients

4%

Gynaecology4%

Dermatology4%

Respiratory4%

Opthalmology3%

Source: Company data, Deutsche Bank Data as of Sept 2015

Figure 41: Leadership in key

therapeutic areas

Sun

Sun + Ranbaxy

Psychiatrists 1 1

Neurologists 1 1

Cardiologists 1 1

Orthopedic 1 1

Ophthalmologists 1 1

Gastroenterologists 1 1

Nephrologists 1 1

Diabetologists 2 1

Consulting Physicians 5 1

Dermatologists 6 1

Urologists 6 1

Chest Physicians 5 1

Oncologists 8 1

Source: Company data, Deutsche Bank

2 December 2015

Health Care



Figure 43: IPM vs. Sun Pharma Figure 44: Top five therapies Figure 45: Top five brands in India

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

22.0

Mar'13 Mar'14 Mar'15 Sep'15

MA

T Y

oY

gro

wth

(%

)

IPM Sun Pharma*

No.

1. Neuro / CNS

2. Cardiac

3.Anti-

Infectives

4.Gastro

Intestinal

5. Anti Diabetic

Top 5 therapies Brand name TherapyMAT Sep'15

sales (INR bn)

VoliniPain /

Analgesics2.0

Rosuvas Cardiac 1.5

Gemer Anti Diabetic 1.5

Istamet Anti Diabetic 1.4

Susten Gynaecological 1.4

Source: AIOCD AWACS, Deutsche Bank, *includes Ranbaxy for all the years



US sales growth expected to pick up through increased number of launches

As of 30 September 2015, Sun has 445 ANDA approvals and 154 ANDAs

pending approval. We expect Sun to gain traction in US sales, owing to several

launches (refer to Figure 47). We expect Sun’s R&D costs to be c.7-8% of

sales, driven by MK 3222 (Tildrakizumab), the IL-23 monoclonal anti-body to be

used for treatment of plaque psoriasis. In September 2014, Sun acquired

worldwide rights to tildrakizumab, for use in all human indications, from Merck

(MRK.N, Hold), in exchange for an upfront payment of USD 80m, milestone

payments and tiered royalties. Merck will continue with all its clinical

development and regulatory activities, which will be funded by Sun. Upon final

approval for the product, Sun will be responsible for all subsequent activities.

The product is currently in Phase III, and top-line data are expected to be

available by early CY16.

Among the key product launches in Sun’s pipeline is generic Gleevec (branded

market is c. USD 2bn; Sun is first to file and has settled for launch on 1

February 2016). We forecast Taro (Taro US) to contribute c.11% of sales in

FY18 (down from c.19% in FY15) and c.25% of EBITDA (down from c.41% in

FY15), mainly on account of increasing competition.

Figure 46: US sales and Taro contribution

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

‐

10,000

20,000

30,000

40,000

50,000

60,000

1QFY12

2QFY12

3QFY12

4QFY12

1QFY13

2QFY13

3QFY13

4QFY13

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

4QFY17

1QFY18

2QFY18

3QFY18

4QFY18

Taro as % of US sales

US Sales (INR mn)

US sales Taro as % of US Sales

GenricDoxil salesstart here

With Ranbaxy Halol supplies issues

GenericZetia launch


2 December 2015

Health Care



Figure 47: Sun Pharma’s key generic drug pipeline

Quarter FY16 FY17 FY18 Beyond FY18

Q1 Saphris, Ampyra, Angiomax, Uloric, Sensipar, LyricaTreximet, Alimta, Vimpat, Vagifem, Effient, Oglyza

Q2 Glumetza, Crestor

Q3 Coreg CR, Ortho Tri-Cyclen Lo

Q4 Gleevec Multaq, Focalin XR Sandostatin LAR

Can launch on approval Abilify, Precedex


Taro’s existing portfolio faces competition, and the recently launched Keveyis will take time to generate revenue

Taro continues to enjoy a pricing advantage on its US portfolio, owing to a

favourable competitive situation. However, we are cautious about the

increasing competition and consequent erosion of volume on some of its major

products, such as Nystatin/Triamcinolone. Taro currently has 34 ANDAs

pending approval. While faster-than-expected sales in Taro’s existing portfolio

are a risk to Sun’s earnings, we believe this can be mitigated by higher

revenues from the launch of Keveyis (dichlorphenamide), a new drug

application for the treatment of primary hyperkalemic and hypokalemic

periodic paralysis and related variants, which is estimated to affect c.5,000

patients in the United States. Keveyis is an orphan drug that was launched in

September 2015 and has exclusivity until August 2022.

Figure 48: Movement in historical product portfolio

50%

60%

70%

80%

90%

100%

-30%

-10%

10%

30%

50%

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14NC

2Q14SI

3Q14DV

4Q14SD

1Q15FL

2Q15SD

3Q15SD

4Q15FL

1Q16-8%

2Q16

qoq% (LHS) GP margin % (RHS)

20127 products which

were 25% of portfolio increased

by c.4 times, rest up by c.10%


were 29% of portfolio increased by c.2times, rest up

by c.5%


were 12% of portfolio increased by c.14 times, rest

flat


were 32% of portfolio increased by c.50%, rest flat


Acquisition of Glaxo’s opiate to further integrate controlled substances

business

Sun’s acquisition of Glaxo’s (GLXO.LN) opiates business in Australia is the

company’s fourth acquisition in the area of controlled substances used mainly

for treatment of moderate to severe pain. In 2005, Sun Pharma acquired a

facility in Hungary authorised to make controlled substance APIs, starting from

the initial stage. In the same year, Sun acquired two manufacturing sites in

New Jersey from Able Labs, which is equipped with special suites for the

manufacture of controlled substances in finished dosages. Sun later acquired

Chattem (US-based registered narcotic API importer and producer). The main

entry barriers in the controlled substances business are the integration of a

regulated source of supply for raw materials and the requisite registration to

import and produce in the US.

2 December 2015

Health Care



Valuation and risks

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Sun has

leadership across the chronic segments in India, and has also expanded

significantly in the US market, while its business dynamics across markets



years on account of limited period upside in the US markets − generic Doxil

and doxycycline), which represents a premium of c.10-25% to Lupin and Dr

Reddy’s. However, in arriving at our target PER, we factor in the OAI at Halol

by the USFDA and supply issues from the plant and Ranbaxy integration. We

assign a PER of 22x (discount of 25% over the past three years’ one-year

forward PER). Thus, we rate Sun a Buy, with a target price of INR 880

(including INR 11 per share for generic Gleevec) on our FY18 recurring EPS.

Improvements in supplies at Halol and the successful integration of Ranbaxy

will likely see the stock being re-rated and trading at a PER of c.25-26x. Sun,

with net cash of c. INR 61bn as of 31 March 2015, is in a stronger position

than its peers, and cash-adjusted ROEs are in the range of c-25-30% over the

next two years, on our estimates.

Figure 49: PE band – Sun Pharma

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Risks

Key downside risks include escalation of the existing non-compliance with

current good manufacturing practices resulting in a warning letter at Sun’s

Halol plant, slower-than-expected growth rate of the Indian formulations

market, delay in approval of generic Gleevec, and a faster-than-expected

decline in Taro’s sales.

2 December 2015

Health Care



Company description

Sun Pharmaceuticals Industries, started as a partnership firm in 1983 by Dilip

Shanghvi, manufactures formulations and bulk drugs. Initially operating with a

plant at Vapi, Gujarat, it now has 50 manufacturing sites across six continents.

Sun has expanded internally and via acquisitions, with important acquisitions

being Caraco, Taro and Ranbaxy. Sun sells its products in more than 50

countries. In India, Sun has a leadership position in 13 classes of therapies,

and is ranked number one, with a c.8.9% market share in the IPM; it is the

fifth-largest specialty generic pharma company in the world.

Management summary

Figure 51: Selected board of directors and senior management

Name/designation Summary

Mr. Israel Makov

Chairman

Former President and CEO of Teva Pharmaceuticals Industries Ltd. He joined Teva in 1995 and managed more than 12 acquisitions. Israel joined Sun Pharmaceuticals in 2012.

Mr. Dilip S Shanghvi

CEO Founded Sun Pharmaceuticals in 1983 as a partnership firm.

Mr. Kalyanasundaram Subramanian

Director & CEO - Taro

Appointed CEO in August 2013; was previously Chairman of the Taro Board from April 2012. He was Sun Pharma’s Chief Executive Officer from April 2010 to April 2012 (and a director of the Sun Pharma board until March 2012). He has almost three decades of experience, largely with GlaxoSmithKline plc, where he held country, regional and global responsibilities.

Mr. Sudhir Valia

Whole-time Director

He became a member of the Taro Board in September 2010. Mr. Valia joined Sun Pharma as a director in January 1994, and has been a full-time director since his appointment in April 1994.

Mr. Uday V Baldota

CFO Appointed as the CFO in 2014.


Corporate actions and shareholding pattern

Figure 52: Corporate actions (1997-2015) Figure 53: Shareholding pattern

Year Corporate Action Summary

2015 Acquisition Insight Vision Inc

2015 Divestiture Ranbaxy's "solus" and "solus care" divisions

2015 Divestiture GSK Opiates Business

2015 Divestiture US rights to Fibricor

2015 Equity Offering Amount raised: INR 199.92B

2014 Acquisition Ranbaxy

2014 Divestiture Tildrakizumab rights

2014 Acquisition Pharmalucence Inc

2013 Joint Venture Intrexon Corp

2013 Stock Dividend Adjustment Factor ‐ 2

2012 Acquisition URL’s generic business

2012 Acquisition Dusa Pharmaceuticals Inc

2011 Joint Venture Merck & Co Inc

2010 Stock Split Adjustment Factor ‐ 5

2008 Acquisition Chattem Chemicals Inc

2008 Debt Redemption/Call Raised USD 350 million by issuing FCCB

2007 Acquisition Taro Pharmaceutical Industries Ltd.

2007 Spin‐off Sun Pharma Advanced Research Co.

2005 Acquisition Able Laboratories Inc

2005 Acquisition ICN Co. Hungary


2002 Stock Split Adjustment Factor ‐ 2

2002 Stock Buyback Amount: 4M

2002 Debt Offering‐New Issue INR 187.2M


2002 Acquisition MJ Pharmaceuticals Ltd.

2001 Acquisition Pradeep Drug Co

1997 Acquisition Caraco

0% 20% 40% 60% 80% 100%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Sep‐15

Promoters

FIIs

Others

FIs/Banks/Insurance companies

Bodies Corporate

Mutual Funds/UTI

Central/State Governments

Source: Company data, Deutsche Bank, Bloomberg Finance LP


Figure 50: Revenue split FY15

India formulations

24%

US 50%

ROW8%

EM14%

API & Others

4%


2 December 2015

Health Care



Company financials

Figure 54: Income statement

Year to March, INR m FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

India formulations 23,801 29,154 29,657 36,918 67,166 74,290 85,010 98,936

US 28,982 45,841 76,808 97,844 137,196 140,776 176,027 176,635

ROW 10,191 25,997 36,473 8,777 23,320 22,006 26,120 31,343

EM 18,791 19,843 40,335 10,308 37,326 39,468 44,204 50,393

API & Others 5,283 6,147 7,622 8,149 10,702 13,107 13,796 14,914

Gross sales 58,066 81,141 114,087 161,995 275,709 289,646 345,156 372,221

Less: Excise 852 1,075 1,698 1,951 2,844 2,854 3,452 3,722

Net sales 57,214 80,067 112,389 160,044 272,865 286,793 341,705 368,498

Other op. income 0 128 0 0 0 0 0 0

Total revenue 57,214 80,195 112,389 160,044 272,865 286,793 341,705 368,498

yoy growth% 42.8% 40.2% 40.1% 42.4% 70.5% 5.1% 19.1% 7.8%

Total op. exp. 37,514 48,152 64,036 88,903 195,667 205,460 223,900 240,629

EBITDA 19,700 32,043 48,353 71,141 77,198 81,333 117,805 127,869

Margins % 34.4% 40.0% 43.0% 44.5% 28.3% 28.4% 34.5% 34.7%

yoy growth% 44.5% 62.7% 50.9% 47.1% 8.5% 5.4% 44.8% 8.5%

Depreciation 2,041 2,912 3,362 4,092 11,947 10,823 11,942 12,887

EBIT 17,659 29,132 44,991 67,049 65,250 70,510 105,862 114,982

Other income 1,356 2,738 2,122 4,384 6,946 9,356 8,028 9,406

Interest -1,341 -1,696 -1,937 442 5,790 5,374 2,875 1,704

PBT 20,355 33,565 49,050 70,991 66,407 74,492 111,016 122,683

Tax 1,284 3,132 8,456 7,027 9,147 11,850 16,652 18,402

Tax rate (%) 6.3% 9.3% 17.2% 9.9% 13.8% 15.9% 15.0% 15.0%

Minority interest 913 3,855 4,863 7,375 9,488 9,794 8,205 7,158

Adjusted PAT 18,158 26,578 35,732 56,589 47,771 52,848 86,158 97,122

Net margins 31.7% 33.1% 31.8% 35.4% 17.5% 18.4% 25.2% 26.4%

Extraordinary items 3 -11 -5,901 -25,174 -2,378 -6,852 0 0

Reported PAT 18,161 26,567 29,831 31,415 45,394 45,996 86,158 97,122 Source: Company data, Deutsche Bank estimates, Includes Ranbaxy from FY15 onwards

Figure 55: Cash flow statement

Year to March, INR m FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

PBT (adj. for extraordinary items) 20,358 33,554 43,149 45,817 64,029 67,640 111,016 122,683

Depreciation 2,041 2,912 3,362 4,092 11,947 10,823 11,942 12,887

Net chg in WC (6) (8,929) (1,821) (5,666) (19,094) 3,309 (25,107) (6,335)

Others (4,046) (4,763) (10,295) (9,014) (17,553) (16,984) (23,179) (23,516)

CFO 18,346 22,774 34,395 35,229 39,329 64,787 74,672 105,720

Capex (12,833) (8,085) (21,391) (11,563) (26,906) (19,077) (19,893) (20,871)

Net investments made - - - - - - - -

Others investing activities 26,941 (2,341) (5,078) 3,267 1,887 (599) (659) (725)

CFI 14,109 (10,426) (26,470) (8,297) (25,020) (19,676) (20,551) (21,596)

Change in share capital - - - - - - - -

Change in debt 2,006 (1,068) (668) 22,908 51,073 (32,508) (23,029) (2,977)

Div. & div. tax (4,213) (5,115) (6,058) (3,635) (8,689) (8,445) (16,046) (18,298)

Others 4,563 2,863 2,529 (3,959) (21,425) 5,147 11,309 13,234

CFF 2,357 (3,320) (4,197) 15,315 20,959 (35,806) (27,766) (8,041)

Total cash generated 34,811 9,027 3,728 42,247 35,269 9,305 26,355 76,084

Cash opening balance 6,073 40,884 49,911 53,639 95,886 131,155 140,460 166,815

Cash closing balance 40,884 49,911 53,639 95,886 131,155 140,460 166,815 242,898 Source: Company data, Deutsche Bank estimates, Includes Ranbaxy from FY15 onwards

2 December 2015

Health Care



Figure 56: Balance sheet

As at 31 March, INR m FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Paid-up capital 1,036 1,036 1,036 2,071 2,071 2,406 2,406 2,406

Reserves & surplus 86,078 111,104 137,532 164,832 217,300 259,663 341,085 433,143

Total equity 87,114 112,140 138,568 166,903 219,371 262,069 343,491 435,549

Minority interest 8,472 11,615 16,351 19,212 28,512 38,306 46,511 53,669

Total debt 3,717 2,650 1,982 24,890 75,963 43,455 20,426 17,449

Capital employed 99,302 126,404 156,901 211,005 323,847 343,831 410,428 506,668

Current liabilities 15,361 26,566 38,528 61,600 128,438 107,547 128,139 138,187

Total curr. lia. & prov. 16,709 28,118 40,582 64,357 128,438 107,547 128,139 138,187

Total liabilities 116,012 154,522 197,483 275,362 452,284 451,378 538,567 644,854

Net fixed assets 27,568 32,742 50,771 58,242 110,201 118,456 126,406 134,390

Deferred tax assets 5,001 6,835 9,176 11,867 17,516 22,650 29,176 34,289

Inventory 14,895 20,870 25,778 31,230 56,680 59,573 85,426 92,125

Debtors 11,049 20,787 27,108 22,004 53,123 51,073 60,851 65,623

Other current assets 12,893 17,313 19,869 48,257 77,620 52,579 62,646 67,558

Cash and equivalents 44,606 55,975 64,781 103,762 137,143 147,048 174,061 250,869

Total curr. assets 83,443 114,945 137,535 205,253 324,567 310,272 382,984 476,175

Total assets 116,012 154,522 197,483 275,362 452,284 451,378 538,567 644,854 Source: Company data, Deutsche Bank estimates, Includes Ranbaxy from FY15 onwards

Figure 57: Financial ratios

Year to March FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Adj EPS (INR) 8.8 12.8 17.3 27.3 19.9 22 35.8 40.4

yoy growth% 34.5% 46.4% 34.4% 58.4% -27.3% 10.6% 63.0% 12.7%

EBITDA - core (%) 34.4 40 43 44.5 28.3 28.4 34.5 34.7

NPM (%) 31.7 33.2 31.8 35.4 17.5 18.4 25.2 26.4

Net debt to equity (x) net cash net cash net cash net cash net cash net cash net cash net cash

ROCE (%) 21.2 26.8 24.4 21 21.7 17.7 25.4 22.9

DPS (Rs) 1.7 2.1 2.5 1.5 3 3 5.7 6.5

Dividend payout (%) 20 16.6 17.4 9.9 15.9 15.7 15.9 16.1

Asset turnover ratio (sales/invested capital)

1.3 1.4 1.5 1.7 2 1.7 1.8 1.7

Avg. collection days 73 72 78 56 64 66 60 63

Avg. inventory days (on opex.) 125 136 133 117 108 103 118 135 Source: Company data, Deutsche Bank estimates, Includes Ranbaxy from FY15 onwards

2 December 2015

Health Care



Reuters Bloomberg LUPN.NS LPC IN



Sales (INRm) 110,702.5 125,859.9 134,901.6 170,324.7 192,573.7

EBITDA (INRm) 28,630.1 35,773.1 32,526.3 51,765.3 62,138.9



DB EPS FD(INR) 42.12 56.04 49.10 76.57 94.14

DB EPS growth (%) 39.8 33.0 -12.4 56.0 22.9

PER (x) 19.9 23.4 36.4 23.3 19.0

EV/EBITDA (x) 13.0 16.1 25.4 15.5 12.4

DPS (net) (INR) 5.98 7.46 6.97 10.95 13.93

Yield (net) (%) 0.7 0.6 0.4 0.6 0.8


2 Multiples and yields calculations use average historical prices for past years and spot prices for current and future years, except P/B which uses

the year end close

US business to drive EBITDA margin expansion We initiate coverage on Lupin with a Buy rating for three reasons: 1) US business is driven by several launches and Gavis integration; we expect Lupin’s US sales to increase at a 17.5% CAGR in FY15-18E; 2) Lupin continues to grow ahead of the IPM; we forecast a domestic sales CAGR of 15.4% for FY15-FY18E; and 3) we forecast an 18.9% EPS CAGR over FY15-18E, driven by traction in its US business. The stock has outperformed the sector by c.14% YTD and now trades at its three-year average PER of c.23x.

US business to drive sales and earnings Lupin has several product launches in the US markets; key products are generic Glumetza and generic Welchol. For FY15-FY18E, we forecast Lupin’s US sales to increase at a 17.5% CAGR and contribute c.48% of sales in FY18E. The growth will also be driven by launches by Gavis, which has a pipeline of c.130 products, of which c.65 are filed for approval with the USFDA.

Domestic business focused on lifestyle and chronic therapy segments Lupin’s domestic business is focused on the lifestyle and chronic therapy segments, which contributed more than 50% of its sales in FY15 (up from 5% in FY01). For FY15-FY18E, we forecast Lupin’s domestic sales to increase at a CAGR of 15.4%. Cardio Vascular, CNS, Anti-diabetic, and Anti-asthma increased to c.53% of domestic sales in FY15 (up from 18% in FY05).

Key trigger is timely approval and launch of products in the US market Lupin expects c.150 approvals over the next three years, including c.50 approvals for Gavis. We expect US business growth to be driven by new product launches.

Our 12M target price of INR 2,165/sh provides c.21% upside potential; risks

We rate Lupin Buy, with a target price of INR 2,165 on a target PER of 23x on

FY18 recurring EPS. Key downside risks: lower-than-expected sales growth in

the India market and delays in approvals in the US for Lupin and recently

acquired Gavis.

Rating

Buy Asia

India

Health Care


Company

Lupin

Strong business outlook justifies premium valuations

Price at 30 Nov 2015 (INR) 1,786.95

Price target - 12mth (INR) 2,165.00

52-week range (INR) 2,108.85 - 1,372.13


26,146

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]


800

1200

1600

2000

2400

12/13 6/14 12/14 6/15

Lupin



Absolute -6.1 -2.6 24.5


-1.9 1.8 -8.4


2 December 2015

Health Care




Running the numbers

Asia

India


Lupin Reuters: LUPN.NS Bloomberg: LPC IN

Buy Price (30 Nov 15) INR 1,786.95

Target Price INR 2,165.00

52 Week range INR 1,372.13 - 2,108.85

Market Cap (m) INRm 804,456

USDm 12,054

Company Profile

Lupin was incorporated in 1983. It develops and markets a wide range of generic and branded formulations and APIs for the developed and developing markets of the world. The company has 10 manufacturing plants in India and 6 out of India including 2 in Japan and 1 in US. Lupin is present both in branded and generic space in US and India and also has large presence in the generic markets of Japan and South Africa. Lupin's important acquisitions are Kyowa and Gavis.

Price Performance

800

1200

1600

2000

2400


LupinBombay Stock Exchange (BSE 30) (Rebased)

Margin Trends

16

20

24

28

32

36

13 14 15 16E 17E 18E



05101520253035

0

10

20

30

40

13 14 15 16E 17E 18E


Solvency

050100150200250300350

-20

-10

0

10

20

30

40

13 14 15 16E 17E 18E


Kartik Mehta



Financial Summary

DB EPS (INR) 30.13 42.12 56.04 49.10 76.57 94.14

Reported EPS (INR) 29.26 40.79 53.20 49.10 76.57 94.14

DPS (INR) 3.99 5.98 7.46 6.97 10.95 13.93

BVPS (INR) 115.9 154.0 196.5 238.6 304.2 384.4

Weighted average shares (m) 449 450 452 452 452 452

Average market cap (INRm) 253,953 376,831 592,200 804,456 804,456 804,456

Enterprise value (INRm) 259,917 373,274 575,753 827,022 804,375 772,483


P/E (Reported) (x) 19.3 20.5 24.6 36.4 23.3 19.0

P/BV (x) 5.34 6.02 10.18 7.49 5.87 4.65

FCF Yield (%) 2.5 2.9 3.0 nm 3.4 4.8

Dividend Yield (%) 0.7 0.7 0.6 0.4 0.6 0.8

EV/Sales (x) 2.8 3.4 4.6 6.1 4.7 4.0

EV/EBITDA (x) 12.2 13.0 16.1 25.4 15.5 12.4

EV/EBIT (x) 14.5 14.3 18.3 30.4 19.0 14.8


Sales revenue 94,500 110,703 125,860 134,902 170,325 192,574

Gross profit 59,020 72,529 84,290 92,138 120,071 136,732

EBITDA 21,291 28,630 35,773 32,526 51,765 62,139

Depreciation 3,322 2,610 4,347 5,355 9,394 9,964


EBIT 17,969 26,020 31,426 27,171 42,371 52,175

Net interest income(expense) -410 -267 -98 -900 -1,096 -951


Exceptionals/extraordinaries -388 -602 -1,280 0 0 0




Minorities 263 331 412 84 160 180


Net profit 13,142 18,364 24,032 22,178 34,588 42,522

DB adjustments (including dilution) 388 602 1,280 0 0 0

DB Net profit 13,530 18,965 25,313 22,178 34,588 42,522

Cash Flow (INRm)


Net Capex -4,497 -6,098 -17,191 -62,440 -8,000 -9,000

Free cash flow 6,274 10,942 17,909 -35,781 27,751 38,365


Dividends paid -2,094 -2,939 -4,058 -3,588 -5,638 -7,176

Net inc/(dec) in borrowings -4,337 -4,205 -824 36,676 -5,725 -5,725

Other investing/financing cash flows 480 -173 -16,192 666 436 883

Net cash flow 324 3,626 -3,162 -2,027 16,824 26,347

Change in working capital -5,173 -4,934 6,322 -828 -8,335 -5,305





Associates/investments 21 1,785 16,584 16,584 16,584 16,584

Other assets 50,956 54,995 59,696 61,706 74,470 83,083

Total assets 88,434 101,352 130,535 187,378 215,829 249,826





Minorities 595 669 241 325 485 665


Net debt 5,390 -2,442 -104 38,824 16,018 -16,054

Key Company Metrics

Sales growth (%) 35.9 17.1 13.7 7.2 26.3 13.1

DB EPS growth (%) 49.1 39.8 33.0 -12.4 56.0 22.9

EBITDA Margin (%) 22.5 25.9 28.4 24.1 30.4 32.3

EBIT Margin (%) 19.0 23.5 25.0 20.1 24.9 27.1

Payout ratio (%) 13.6 14.7 14.0 14.2 14.3 14.8

ROE (%) 28.5 30.3 30.4 22.6 28.2 27.3

Capex/sales (%) 4.8 5.5 13.7 46.3 4.7 4.7


Net debt/equity (%) 10.2 -3.5 -0.1 35.9 11.6 -9.2

Net interest cover (x) 43.8 97.6 320.3 30.2 38.7 54.9


2 December 2015

Health Care



Investment thesis

Outlook

We rate Lupin a Buy premised on the following: 1) In IPM, Lupin is ranked fifth

with a c.3.5% market share, with a focus on the lifestyle and chronic

segments, which account for c.50% of its domestic business. 2) Lupin has

several launches in the next one year; its key product is generic Glumetza in

4QFY16, for which Lupin is first to file. We forecast a CAGR of 17.5% in

Lupin’s US sales for FY15-FY18E and expect the US to account for c.48% of

sales in FY18E. 3) The stock has outperformed the sector by c.14% YTD and

now trades at its three-year average PER of c.23x. We forecast sales and

earnings CAGRs of 15.2% and 18.9%, respectively, for FY15-18E.

Valuation

We use PER as our principal valuation methodology for Indian Pharma. Lupin

has grown across chronic segments in India and also expanded significantly in

the US markets; its business dynamics across markets have improved

significantly. Its execution also remains on track, although successful

integration of Gavis will be key to future earnings growth. Lupin’s FY15 had a

higher base of product launches, mainly generic Cymbalta sold under shared

exclusivity and key brand Suprax, which now faces generic competition; this is

reflected in lower sales and earnings in FY16. Our target valuation is at par

with its three-year average one-year forward PER of 23x. Thus, we rate Lupin a

Buy, with a target price of INR 2,165 on our FY18 recurring EPS. We assign

Lupin the highest PER in our coverage universe, as we see 1) the pieces in

place for growth in India, 2) no near-term negatives from the USFDA, and 3)

continuous EBITDA margin improvement.

Risks

Key downside risks: lower-than-expected sales growth in the India market and

delays in approvals in the US for Lupin and recently acquired Gavis, as well as

lower-than-expected sales growth in the emerging markets, RoW, and semi-

regulated markets.

2 December 2015

Health Care





We estimate Lupin’s sales and earnings to increase at CAGRs of 15.2% and

18.9%, respectively, for FY15-18E. We expect EBITDA margin to improve,

mainly driven by increased contribution from US business (mainly Gavis). We

estimate Lupin’s sales in Japan and EU to have low CAGRs of c.6-13%, mainly

due to higher competition, lower product approvals, and weak currency.

Figure 58: Sales-mix summary

Metric FY14 FY15 FY16E FY17E FY18E CAGR


India 24,795 29,679 33,916 39,343 45,637 15.4 Expecting faster-than-Industry growth, reducing focus on Anti-TB sales, launches expected in oncology and gynaecology

US 48,751 56,576 57,448 81,576 91,694 17.5 Growth driven by product launches and integration of Gavis

Europe 3,054 3,279 3,880 4,268 4,694 12.7 Hormosan integration in Germany and new product launches to drive EU sales

Japan 12,955 13,239 13,295 14,625 16,087 6.7 More product launches expected; I'rom acquisition has improved profile in Japan

Others 10,008 11,146 13,353 15,944 18,142 17.6 Includes Grin SA in Mexico, Generic Health in Australia, Pharma Dynamics in South Africa, and Multicare Pharma in Philippines

API 11,140 11,941 13,009 14,570 16,318 11.0 Low growth but higher EBITDA margin business

Net sales 110,703 125,860 134,902 170,325 192,574 15.2 Driven by US and India business

EBITDA margin 25.9 28.4 24.1 30.4 32.3 Margins improve as the contribution of the US business improves, mainly Gavis

Source: Company, Deutsche Bank estimates

India business changing from acute to chronic focus

We forecast Lupin’s domestic sales to increase at a CAGR of 15.4% for FY15-

18E. Lupin is focused on the lifestyle and chronic therapy segments, which

contributed 53% of its sales in FY15 (up from 5% in FY01 and 18% in FY05).

The growth in India is driven by increasing market share in the CV, diabetes,

CNS, asthma, and GI segments.

Figure 60: Market share in top therapeutic segments

Therapeutic Segment FY05 FY11 FY12 FY13 FY14 FY15 Top 3 brands

Anti-TB 33 10 10 9 8 8 R-cinex, AKT 4, AKT 3

Cephalosporins 23 16 17 16 15 14 Merotrol, L Cin, Cetil, Odoxil

CVs 13 21 23 23 23 22 Tonact, Ramistar, Lupenox

Anti-diabetics 3 7 12 15 15 16 Gluconorm-G, Gluconorm-PG,

Anti-asthma 2 9 10 9 10 11 Budamate, Esiflo, Telekast-L

CNS 0 4 5 5 4 4 Cognistar, Stalopam Plus, Citi Star

GI 0 6 7 8 8 8 Rablet, Rablet D, Softovac

Gynec 0 3 4 4 4 4 Lupi HCG, Lupigest, FAA

Others 26 24 12 11 13 13

TOTAL 100 100 100 100 100 100

CV+CNS+anti-diabetic + anti-asthma

18 41 50 52 52 53


Figure 59: IPM vs. Lupin

4.0

6.0

8.0

10.0

12.0

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20.0


MA

T Y

oY

gro

wth

(%

)

IPM Lupin


2 December 2015

Health Care



US sales growth should pick up thanks to increased number of launches

As of September 30, 2015, Lupin has filed 220 ANDAs and has approvals for

124 ANDAs. Lupin has several launches over the next 12 months (refer to

Figure 61). We forecast Lupin’s US sales to increase at a CAGR of 17.5% for

FY15-18E and to contribute c.48% of sales in FY18E, driven by Lupin’s

approval and also by launches by Gavis, which has a pipeline of c.130

products, of which c.65 are filed for approval with the USFDA. We expect

Lupin’s R&D cost to be c.10-12% of sales. Among key product launches in

Lupin’s pipeline is generic Glumetza (branded market is c.USD 200-300mn;

Lupin is first to file, and launch date is settled on February 1, 2016).

Figure 61: Lupin’s key generic drug pipeline


Q1 Prolensa, Quartette, Banzel Effient

Viread, Latuda, Pradaxa, Livalo, Uloric, Savella, Toviaz, Paxil CR, Safyral, Vimovo DR, Atripla, Phoslyra, Namenda Xr, Apriso

Q2 Coreg CR, Zymar, Angeliq, Asacol (AG), Crestor

Q3 Natazia, Prezista, Zorvolex, Epzicom

Q4 Glumetza Welchol, Renagel / Renvela, Nuvigil, Multaq, Axiron, Tamiflu

Can launch on approval

Prevacid ODT, Detrol LA, Acular LS, Abilify


Lupin’s acquisition of Gavis increases footprint in the US markets.

Lupin expects more than 20 filings a year from the Gavis platform, primarily in

the areas of controlled substances, dermatology, respiratory, and

gastrointestinal. Gavis also provides Lupin with a USFDA-compliant

manufacturing facility in the US, which would help Lupin enter the US

government’s supplies business.

Figure 64: US sales, YoY growth, and Gavis

‐40%

‐20%

0%

20%

40%

60%

80%

‐

5,000

10,000

15,000

20,000

25,000

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

2QFY15

3QFY15

4QFY15

1QFY16

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

3QFY17

4QFY17

1QFY18

2QFY18

3QFY18

4QFY18

US Sales (INR mn)

US Sales Gavis as % of US Sales US sales increase

generic glumetza


Figure 62: Break-up of Lupin + Gavis

pending filings

Solid/Oral/ Liquids62%

Derma13%

Controlled Substances

11%

Oral Contraceptives

11%

Ophthal3%

Figure 63: Break-up of Lupin + Gavis

developmental pipeline

Solid/Oral/ Liquids48%

Derma20%

Injectibles13%

Controlled Substances

8%

Ophthal5%

Nasal4%

MDI2%

Source: Company, Deutsche Bank Data as of July 2015

Source: Company, Deutsche Bank Data as of July 2015

2 December 2015

Health Care



Valuation and risks

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Lupin has grown across chronic segments in India and also expanded significantly in the US markets, and its business dynamics across markets have improved significantly. Its execution also remains on track, although successful integration of Gavis will be key to future earnings growth. Lupin’s FY15 had a higher base of product launches mainly generic Cymbalta which was sold under shared exclusivity and key brand Suprax which now faces generic competition which is reflected in lower sales and earnings in FY16.Our target valuation is at par with its three-year average of one-year forward PER of 23x. Thus, we rate Lupin as a Buy, with a target price of INR 2,165 on our FY18 recurring EPS. We assign Lupin the highest PER in our coverage universe premised by 1) set pieces in place for growth in India, 2) no near-term negatives from the USFDA, and 3) continuous EBITDA margin improvement.

Figure 65: PE band – Lupin

0

500

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Risks

Key downside risks: lower-than-expected sales growth in the India market and

delays in approvals in the US for Lupin and recently acquired Gavis, as well as

lower-than-expected sales growth in the emerging markets, RoW, and semi-

regulated markets.

2 December 2015

Health Care



Company description

Lupin was incorporated in 1983. It develops and markets a wide range of

generic and branded formulations and APIs for the developed and developing

markets of the world. The company has ten manufacturing plants in India and

six outside of India, including two in Japan and one in the US. Lupin is present

in both the branded and generic space in the US and India and also has a large

presence in the generic markets of Japan and South Africa. Lupin’s important

acquisitions are Kyowa and Gavis.

Management summary


Name/Designation Summary

Dr. Desh Bandhu Gupta

Chairman Founded the company in 1968.

Dr. Kamal K Sharma

Vice-Chairman

Career spanning three decades in the Industry. Joined Lupin in 2003 as Managing Director. Appointed Vice-Chairman in September 2013.

Ms. Vinita Gupta

CEO

Appointed CEO in September 2013. Previously Group President & CEO, Lupin Pharmaceuticals Inc., USA. She Joined Lupin in 1993.

Mr. Nilesh Gupta

Managing Director Appointed Managing Director in September 2013. Previously Group President and Executive Director. Joined Lupin in 1996.

Mr. Ramesh Swaminathan

CFO & Additional Director Appointed CFO in 2007.





2015 Acquisition US-based Gavis

2015 Acquisition Temmler's specialty product portfolio

2015 Acquisition Russia-based ZAO Biocom

2015 Acquisition Balance 40% stake in South African Pharma Dynamics

2014 Acquisition Mexico-based Grin Laboratories

2014 Acquisition Netherlands-based injectable company Nanomi BV

2011 Divestiture Japan-based I'rom Pharmaceutical Co.

2010 Stock Split Adjustment Factor - 5

2009 Acquisition US rights for Antara (Fenofibrate Capsules)

2009 Acquisition Multicare Pharmaceuticals Philippines

2008 Acquisition 60% stake in South African Pharma Dynamics

2008 Acquisition Minority stake in Australia-based Generic Health

2008 Acquisition Germany-based Hormosan Pharma.

2007 Acquisition Japan-based Kyowa Pharma

2007 Acquisition Pharma business of Rubamin

2007 Joint Venture Symbiotec Pharmalab for steroids market

2007 Divestiture IP for Perindopril for multiple countries to France-based Laboratoires Servier

2006 Divestiture Entire stake in Lupin Chemicals (Thailand) Ltd

2003 Stake sale Citigroup picked up 12.55%

2001 Reverse-stock split 1 for 10

2001 Name Change From Lupin Chemicals to Lupin Ltd

0% 20% 40% 60% 80% 100%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Sep‐15

Promoter

FIIs

Others

Mutual Funds/UTI

Bank/FI/Insurance Companies

Source: Company, Deutsche Bank, Bloomberg Finance LP



India formulations

24%

US & EU48%

Japan10%

API9%

Others9%


2 December 2015

Health Care



Company financials



India formulations 15,509 19,059 23,644 24,795 29,679 33,916 39,343 45,637

US and EU 22,017 27,278 40,051 51,805 59,855 61,328 85,843 96,388

Japan 6,212 8,607 13,040 12,955 13,239 13,295 14,625 16,087

API 8,589 8,491 9,498 11,140 11,941 13,009 14,570 16,318

Others 4,697 6,078 8,267 10,008 11,146 13,353 15,944 18,142

Net Sales 57,024 69,513 94,500 110,703 125,860 134,902 170,325 192,574

yoy Growth% 19.7% 21.9% 35.9% 17.1% 13.7% 7.2% 26.3% 13.1%

Total Op. Exp. 46,275 55,897 73,209 82,072 90,087 102,375 118,559 130,435

EBITDA 10,750 13,616 21,291 28,630 35,773 32,526 51,765 62,139

Margins % 18.9% 19.6% 22.5% 25.9% 28.4% 24.1% 30.4% 32.3%

yoy Growth% 21.2% 26.7% 56.4% 34.5% 24.9% -9.1% 59.1% 20.0%

Depreciation 1,712 2,275 3,322 2,610 4,347 5,355 9,394 9,964

EBIT 9,038 11,341 17,969 26,020 31,426 27,171 42,371 52,175

Other Income 1,317 1,376 2,075 3,164 4,101 6,015 6,986 8,084

Interest 325 355 410 267 98 900 1,096 951

PBT 10,030 12,362 19,634 28,918 35,429 32,286 48,261 59,309

Tax 1,169 3,086 5,842 9,622 9,704 10,024 13,513 16,606

Tax Rate (%) 11.7% 25.0% 29.8% 33.3% 27.4% 31.0% 28.0% 28.0%

Minority Interest 168 199 263 331 412 84 160 180

Adj PAT 8,693 9,077 13,530 18,965 25,313 22,178 34,588 42,522

Net Margins 15.2% 13.1% 14.3% 17.1% 20.1% 16.4% 20.3% 22.1%

EO Items -67 -401 -388 -602 -1,280 0 0 0

Reported PAT 8,626 8,677 13,142 18,364 24,032 22,178 34,588 42,522 Source: Company, Deutsche Bank estimates



PBT (Adj. for Extraordinary items) 9,963 11,961 19,246 28,317 34,148 32,286 48,261 59,309

Depreciation 1,712 2,275 3,322 2,610 4,347 5,355 9,394 9,964

Net Chg in WC (1,528) (5,009) (6,146) (4,411) 6,906 (1,260) (8,797) (5,799)

Others (1,193) (3,055) (5,652) (9,475) (10,300) (9,723) (13,108) (16,108)

CFO 8,955 6,172 10,771 17,040 35,101 26,659 35,751 47,365

Capex (4,544) (8,737) (4,497) (6,098) (17,191) (62,440) (8,000) (9,000)

Net Investments made 233 4 7 (1,764) (14,799) - - -

Others Investing Activities - - - - - - - -

CFI (4,311) (8,733) (4,489) (7,862) (31,991) (62,440) (8,000) (9,000)

Change in Share capital 3 1 2 2 2 - - -

Change in Debts (1,056) 3,734 (4,337) (4,205) (824) 36,676 (5,725) (5,725)

Div. & Div Tax (1,575) (1,684) (2,094) (2,939) (4,058) (3,588) (5,638) (7,176)

Others 171 334 473 1,591 (1,392) 666 436 883

CFF (2,457) 2,384 (5,957) (5,552) (6,271) 33,755 (10,926) (12,018)

Total Cash Generated 2,186 (177) 324 3,626 (3,161) (2,027) 16,824 26,347

Cash Opening Balance 2,015 4,201 4,025 4,349 7,975 4,814 2,787 19,611

Cash Closing Balance 4,201 4,025 4,349 7,975 4,814 2,787 19,611 45,958 Source: Company, Deutsche Bank estimates

2 December 2015

Health Care




As at March 31st FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Paid up Capital 892 893 895 897 899 899 899 899

Reserves & Surplus 31,918 39,236 51,147 68,419 87,842 106,873 136,517 172,746

Total Equity 32,811 40,129 52,042 69,316 88,741 107,772 137,416 173,645


Total Debt 10,903 14,809 9,739 5,533 4,710 41,386 35,661 29,936

Deferred Liabilities 1,411 1,442 1,632 1,779 1,182 1,483 1,888 2,386

Capital Employed 45,640 57,103 64,008 77,297 94,874 150,966 175,450 206,632

Total Cur. Lia. & Prov. 15,223 21,770 24,427 24,055 35,662 36,412 40,379 43,194

Total Liabilities 60,863 78,872 88,434 101,352 130,535 187,378 215,829 249,826

Net Fixed Assets 25,472 31,934 33,109 36,597 49,442 106,526 105,132 104,169

Investments 32 28 21 1,785 16,584 16,584 16,584 16,584

Inventory 12,000 17,327 19,489 21,295 25,036 24,705 29,531 32,954

Debtors 12,556 17,318 21,870 24,641 26,566 28,474 35,951 40,647

Other Current Assets 6,602 8,241 9,597 9,060 8,095 8,526 8,988 9,482

Cash and Equivalents 4,201 4,025 4,349 7,975 4,814 2,562 19,643 45,990

Total Cur. Assets 35,359 46,911 55,305 62,970 64,510 64,267 94,113 129,073

Total Assets 60,863 78,872 88,434 101,352 130,535 187,378 215,829 249,826 Source: Company, Deutsche Bank estimates



Adj EPS (Rs) 19.4 20.2 30.1 42.1 56 49.1 76.6 94.1

yoy Growth% 29.3 4.4 49.1 39.8 33 -12.4 56 22.9

EBITDA - Core (%) 18.9 19.6 22.5 25.9 28.4 24.1 30.4 32.3

NPM (%) 15.2 13.1 14.3 17.1 20.1 16.4 20.3 22.1

Net Debt to Equity (x) 0.2 0.2 0.1 net cash net cash 0.4 0.1 net cash

ROCE (%) 22.1 18.2 23.2 27.4 29 18.8 21.9 22.9

DPS (Rs) 3 3.2 4 6 7.5 7.0 11.0 14.0

Dividend Payout (%) 15.5 16.5 13.6 14.7 14 14.2 14.3 14.8

Asset Turnover Ratio (sales/ invested capital)

1.5 1.5 1.7 1.7 1.8 1.3 1.3 1.4

Avg Collection days 76 78 76 77 74 74 69 73

Avg Inventory days (on opex.) 86 96 92 91 94 89 83 87


2 December 2015

Health Care



Reuters Bloomberg REDY.NS DRRD IN



Sales (INRm) 132,170.0 148,189.0 158,508.3 167,175.6 180,797.4

EBITDA (INRm) 33,138.0 34,386.0 39,430.9 37,657.4 41,531.3



DB EPS FD(INR) 124.03 124.40 148.21 137.36 152.64

DB EPS growth (%) 28.9 0.3 19.1 -7.3 11.1

PER (x) 18.7 23.8 21.0 22.6 20.4

EV/EBITDA (x) 13.0 15.8 14.1 14.6 13.1

DPS (net) (INR) 17.95 19.98 23.00 22.00 24.00

Yield (net) (%) 0.8 0.7 0.7 0.7 0.8




Weak outlook driven by regulatory issues We initiate coverage on Dr Reddy’s with a Sell due to: 1) the weak outlook for its US business, which is c.44% sales in FY15 – we expect US sales growth to be tepid, increasing at a CAGR of 3.3% over FY15-18; 2) EBITDA margin to fall by c.150bps due to lower new product launches in the US market; 3) 7.1% EPS CAGR over FY15-18, on our estimates, given a lack of clarity in timelines in restoring normalcy in its US business. Further, the stock has lagged the sector by c.15% YTD, and its PER multiples – now at par with its peers’ (vs.c.20-30% premium historically) – do not reflect the earnings uncertainty.

Muted US sales growth slowdown due to warning letter issued to three plants The USFDA issued a warning letter to three of Dr Reddy's Indian sites relating to two of its API units as well as one relating to an oncology formulation unit. We forecast Dr Reddy’s US formulation sales to increase at a CAGR of 7.1% for FY15-18. The affected plants account for c.10-12% of total sales. While existing supplies may not be halted, there could be delays in new product approvals. Should no new US approvals be received until FY18, we estimate the EPS impact at 3.3% for FY18 and, should there be an import alert for FY18, we estimate the EPS impact at 29% for FY18.

Key trigger is approvals of new products from alternative site We believe approval of key products is key to US sales growth. Remediation efforts at the USFDA plants will entail costs, and timelines range from six months to over a year. We believe successful resolution of the warning letter issues would be a key trigger for Dr Reddy’s.

Our 12M target price of INR 2,748/share implies c.12 % downsides; risks We rate Dr Reddy’s as a Sell. We base our INR 2,748 target price on our target PER of 18x (factoring in a slowdown in the US business due to the warning letters to three plants) on FY18E recurring EPS. Key upside risks: faster-than-expected resolution of the warning letters issue, higher-than-expected market growth in India and faster-than-expected market growth in the PSAI business.

Rating

Sell Asia

India

Health Care


Company

Dr. Reddy's

Earnings uncertainty not in the price

Price at 30 Nov 2015 (INR) 3,107.80


52-week range (INR) 4,347.60 - 3,022.91


26,146

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]


2000

2400

2800

3200

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4400

12/13 6/14 12/14 6/15

Dr. Reddy's



Absolute -25.0 -24.4 -11.0


-1.9 1.8 -8.4


2 December 2015

Health Care




Running the numbers

Asia

India


Dr. Reddy's Reuters: REDY.NS Bloomberg: DRRD IN

Sell Price (30 Nov 15) INR 3,107.80


52 Week range INR 3,022.91 - 4,347.60


USDm 7,944

Company Profile

Dr Reddy's, established in 1984, is a leading pharmaceutical company in India with vertically-integrated operations. Dr. Reddy's produces finished dosage forms of drugs, APIs and biotechnology products and markets them globally, with a focus on India, the US, Europe and Russia. Dr Reddy's key acquisitions are Betapharm in Germany and UCB's India business. The company has 8 manufacturing locations (USA, Mexico, UK, China and India).

Price Performance

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Dr. Reddy'sBombay Stock Exchange (BSE 30) (Rebased)

Margin Trends

16

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24

26

13 14 15 16E 17E 18E



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Kartik Mehta



Financial Summary

DB EPS (INR) 96.21 124.03 124.40 148.21 137.36 152.64

Reported EPS (INR) 98.35 126.10 130.01 148.47 137.36 152.64

DPS (INR) 14.94 17.95 19.98 23.00 22.00 24.00

BVPS (INR) 428.5 532.3 652.5 777.9 893.3 1,021.9





P/E (Reported) (x) 17.3 18.4 22.8 20.9 22.6 20.4

P/BV (x) 4.05 4.76 5.32 3.99 3.48 3.04

FCF Yield (%) 0.9 nm 1.0 1.8 1.6 1.5

Dividend Yield (%) 0.9 0.8 0.7 0.7 0.7 0.8

EV/Sales (x) 2.8 3.3 3.7 3.5 3.3 3.0

EV/EBITDA (x) 12.1 13.0 15.8 14.1 14.6 13.1

EV/EBIT (x) 15.3 16.6 20.6 17.7 19.1 17.1


Sales revenue 116,266 132,170 148,189 158,508 167,176 180,797

Gross profit 60,579 75,801 85,403 93,595 94,544 103,044

EBITDA 26,662 33,138 34,386 39,431 37,657 41,531

Depreciation 5,549 7,106 8,100 8,090 8,865 9,550


EBIT 21,113 26,032 26,286 31,341 28,792 31,981

Net interest income(expense) -1,018 -1,274 -1,092 0 -220 -220


Exceptionals/extraordinaries 365 354 958 45 0 0

Other pre-tax income/(expense) 1,113 1,320 1,816 648 1,418 1,546



Minorities -104 -174 -195 -125 -40 -60


Net profit 16,777 21,512 22,179 25,328 23,433 26,039

DB adjustments (including dilution) -365 -354 -958 -45 0 0

DB Net profit 16,412 21,158 21,221 25,283 23,433 26,039

Cash Flow (INRm)


Net Capex -10,609 -14,392 -13,499 -10,500 -10,800 -12,000

Free cash flow 2,583 -825 5,087 9,348 8,547 8,138


Dividends paid -2,981 -3,582 -4,102 -4,590 -4,391 -4,790

Net inc/(dec) in borrowings -3,710 8,115 -6,433 -3,392 -1,813 125

Other investing/financing cash flows 1,473 -832 1,688 792 678 756

Net cash flow -2,243 3,315 -3,057 2,158 3,021 4,229

Change in working capital -16,000 -11,717 -13,123 -13,314 -19,509 -22,719





Associates/investments 472 806 1,033 1,033 1,033 1,033

Other assets 84,926 101,845 123,814 127,186 138,724 152,878

Total assets 142,369 170,223 194,762 202,702 219,195 240,029





Minorities 0 0 0 0 0 0


Net debt 31,624 36,291 37,731 25,220 20,386 16,282

Key Company Metrics

Sales growth (%) 20.2 13.7 12.1 7.0 5.5 8.1

DB EPS growth (%) 20.9 28.9 0.3 19.1 -7.3 11.1

EBITDA Margin (%) 22.9 25.1 23.2 24.9 22.5 23.0

EBIT Margin (%) 18.2 19.7 17.7 19.8 17.2 17.7

Payout ratio (%) 15.2 14.2 15.4 15.5 16.0 15.7

ROE (%) 25.7 26.2 21.9 20.8 16.4 15.9

Capex/sales (%) 9.1 10.9 9.1 6.6 6.5 6.6


Net debt/equity (%) 43.3 40.0 33.9 19.0 13.4 9.3

Net interest cover (x) 20.7 20.4 24.1 nm 130.9 145.4


2 December 2015

Health Care



Investment thesis

Outlook

We rate Dr Reddy’s as a Sell premised on the following: 1) in IPM, Dr Reddy’s

is ranked 16th with a 2.3% market share with a focus on gastro-intestinal

segments; its India sales growth has been in line with the market growth rate;

2) US approvals are set to slow down due to warning letters issued in

November 2015 to three of its USFDA manufacturing sites in India for FY15-

FY18; we forecast the US sales of the company will increase at a CAGR of

7.1% and contribute c.42% of sales in FY18; 3) the stock has lagged the sector

by 15% YTD, and PER multiples are now at a par with peers (vs.c.20-30%

premium historically). We forecast sales and earnings to grow at CAGRs of

8.4% and 11.9% respectively for FY15-FY18.

Valuation



launches in the US markets) which is a discount of c.10-30% to Sun Pharma

and Lupin. The stock has fallen c.20% following the recent warning letter sent

to three of its plants. This will likely slow down approvals for the US market

and have a meaningful impact on overall sales and earnings growth.

Furthermore, remediation efforts at the USFDA plants will entail costs,

temporary disruption of supplies and timelines that could range from six

months to over a year further limiting earnings outlook.


trigger in the medium term but with estimates being revised down by the

Street choose to adopt a conservative valuation. We assign a PER of 18x

(discount of 5% over the past three years’ one-year forward PER) which is

c.20-30% discount to Sun and Lupin’s target PER. Thus, we rate Dr Reddy’s as

a Sell. We have an INR 2,748 target price on our FY18E recurring EPS. While

successful site transfer would improve the sales growth outlook, EBITDA

margin improvement could be delayed as these transfers would entail

additional costs and in some cases also profit sharing. The stock could trade at

c.18x-19x but still below its historical multiple of 20-21x.

Risks

Key upside risks: faster-than-expected resolution of the warning letters issue,

higher-than-expected market growth in the India and faster-than-expected

market growth in PSAI business

2 December 2015

Health Care



Initiating with a Sell

We estimate Dr. Reddy’s sales and earnings will increase at CAGRs of 6.9%

and 7.1% respectively for FY15-18. We expect the EBITDA margin to remain

stable as pressure on the US business is likely to cap any margin improvement.

US approvals will likely slow down due to warning letters issued in November

2015 to three of its USFDA manufacturing sites in India for FY15-FY18; we

forecast the company’s US sales will increase at a CAGR of 7.1%. We present

scenarios of earnings impact as follows: 1) assuming no approvals until FY18,

EPS impact would be 3.3% for FY18E; 2) assuming import alert in FY18, EPS

impact would be 29% for FY18E.

Figure 74: Scenarios for US approvals with earnings

impact

Figure 75: Scenarios for US approvals with earnings

impact

c. 5% fall in US sales 1,911

GM % 58

PAT (INR mn) 864

EPS impact (INR) 5.1

FY18 EPS (INR) 152.6

% of EPS 3.3

Case 1: No new US approvals received until FY18

c.10% of sales (INR mn) 15,851

GM % 60

PAT (INR mn) 7,480

EPS impact (INR) 43.8

FY18 EPS (INR) 152.6

% of EPS 29

Case 2: Import Alert in FY18

Source: Deutsche Bank estimates

Source: Deutsche Bank estimates

2 December 2015

Health Care



Russia key market but currency depreciation has capped sales growth

Dr Reddy’s is among the fastest-growing OTC companies in Russia with 35%

of its sales contributed by OTC products. However, the depreciation of the

rouble against the US dollar has impacted the company’s sales and EBITDA

margin. We forecast the company’s Russia and CIS sales will increase at a

CAGR of 5.7% and contribute c.11% of sales in FY18 (down from 12% in

FY15).




Global generics 105,165 120,293 130,071 135,968 146,668 6.8 Driven by India business

North America 55,302 64,471 72,835 70,173 71,096 3.3 Subdued growth due to warning letter issued to the company for three of its plants in India

Europe 6,970 7,056 8,559 9,373 10,148 12.9 Market growth rate is less than 10% annually

India 15,714 17,870 21,350 24,546 28,228 16.5 Driven by UCB's acquisition in FY16.

Russia & other CIS 19,820 17,838 15,727 18,187 21,043 5.7 Expect to launch biosimilars in near term. Currency depreciation has capped growth

Others 7,359 13,058 11,601 13,689 16,153 7.3

PSAI (Pharmaceutical Services & Active Ingredients)

23,974 25,456 24,520 27,576 30,198 5.9 Lower growth in regulated markets

North America 4,355 4,605 2,803 3,164 3,561 (8.2)

Europe 8,770 10,507 10,056 10,056 10,056 (1.5)

India 3,786 3,287 2,975 3,065 3,157 (1.3)

Others 7,063 7,057 8,685 11,292 13,425 23.9

Proprietary products 3,034 2,439 3,918 3,632 3,931 17.2 The focus is on building a pipeline in the therapeutic areas of dermatology and neurology

Net sales 132,173 148,189 158,508 167,176 180,797 6.9 US generics business impacted by warning letters to API facilities will see delay in approval

EBITDA margin (%) 25.1 23.2 24.9 22.5 23.0 Pressure on US business will cap margin improvement


2 December 2015

Health Care



Recovery in domestic business growth driven by UCB’s portfolio

In April 2015, Dr Reddy’s acquired select brands from UCB India in therapy

segments like respiratory, dermatology and paediatrics. Annual sales of these

brands were INR 1.5bn and were integrated with Dr. Reddy’s from Q1FY16.

We forecast the company’s India sales will increase at a CAGR of 16.5%.

Figure 77: IPM vs. Dr. Reddy’s Figure 78: Top five therapies Figure 79: Top five brands in India

4.0

6.0

8.0

10.0

12.0

14.0

16.0


MA

T Y

oY

gro

wth

(%

)

IPM DRL

No.

1.Gastro

Intestinal

2. Cardiac

3.Anti-

Neoplastics

4. Respiratory

5.Anti-

Infectives


sales (INR bn)

OmezGastro

Intestinal1.2

Omez DGastro

Intestinal0.8

NisePain /

Analgesics0.6

EconormGastro

Intestinal0.6

Stamlo Cardiac 0.6




We expect US sales growth to be driven by existing products.

As of 30 September 2015, Dr Reddy’s had 230 ANDA approvals and 76 ANDA

pending approval. We expect key products like decitabine, azacitabine,

metoprolol and divaloproex ER and zoledronic acid (Reclast) to contribute

significantly to the company’s US sales. Please refer to list of launches below.

We expect Dr Reddy’s R&D costs to be c.11-13% over the next three years.

Over the past four years the US business has been a key driver of the

company’s EBITDA margin, which we expect to fall due to delays in new

product approvals at the India plants.

Figure 80: US sales

0%

10%

20%

30%

40%

50%

60%

70%

80%

-

5,000

10,000

15,000

20,000

1Q

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15

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FY

15

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15

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15

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FY

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18

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FY

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FY

18

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FY

18

US

sale

s (IN

R m

n)

US sales Company gross Margin Global Generic Gross Margin

PSAI gross Margin EBITDA Margin

generic Zyprexa

USFDA warning letter for 3 plants

generic Dacogen, generic Vidaza

generic Propecia


2 December 2015

Health Care



Among the key product launches in Sun’s pipeline is generic Gleevec (branded

market is c.2bn, Sun is first to file and has settled for launch on 1 February

2016; Dr Reddy’s plans to launch within some quarters of Sun’s launch). Dr

Reddy’s has several products due to be launched in the US markets (see

below).

Figure 81: Dr. Reddy’s key generic drug pipeline


Q1 Intermezzo, Vimovo Effient Aloxi, Amitiza, Clolar, Copaxone (20mg and 40mg), Finacea, Folotyn, Gleevec, Ixempra® kit, Kuvan, Uloric, Vascepa, Velcade, Dexilant

Q2 Zegerid

Q3 Treanda Jevtana

Q4 Mozobil

Can launch on approval

Diprivan, Pristiq


2 December 2015

Health Care



Valuation and risks

Valuation



launches in the US markets) which is a discount of c.10-30% to Sun Pharma

and Lupin. The stock has fallen c.20% following the recent warning letter sent

to three of its plants. This will slow down approvals for the US market and

have a meaningful impact on overall sales and earnings growth. Furthermore,

remediation efforts at the USFDA plants will entail costs, temporary disruption

of supplies and timelines that could range from six months to over a year,

further limiting earnings outlook.


trigger in the medium term but, with Street estimates being lowered, choose to

adopt a conservative valuation. We assign a PER of 18x (discount of 5% over

the past three years’ one-year forward PER) which is c.20-30% discount to Sun

and Lupin’s target PER. Thus, we rate Dr Reddy’s as a Sell. We have an

INR 2,748 target price on our FY18E recurring EPS. While successful site

transfer would improve the sales growth outlook, EBITDA margin improvement

could be delayed as these transfers would entail additional costs and in some

cases also profit sharing; the stock could trade c.18x-19x but still below its

historical multiple of 20-21x.

Figure 82: PE band – Dr. Reddy’s

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

31-M

ar-0

9

09-S

ep-0

9

18-F

eb-1

0

30-J

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0

08-J

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1

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4

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4

05-J

an-1

5

16-J

un-1

5

25-N

ov-1

5


Source: Deutsche Bank estimates, Bloomberg Finance LP (data as on 30/11/2015)

Risks

Key upside risks: faster-than-expected resolution of the warning letter issue,

higher-than-expected market growth in India and faster-than-expected market

growth in PSAI business.

2 December 2015

Health Care



Company description

Dr Reddy’s, established in 1984, is a leading pharmaceutical company in India

with vertically-integrated operations. Dr. Reddy’s produces finished dosage

forms of drugs, APIs and biotechnology products and markets them globally,

with a focus on India, the US, Europe and Russia. Dr Reddy’s key acquisitions

are Betapharm in Germany and UCB’s India business. The company has eight

manufacturing locations in five countries (USA, Mexico, UK, China and India)

Management summary



Mr. G V Prasad

Co-chairman, MD & CEO

In May 2014, he was appointed as co-chairman and managing director. Previously, In April 2013 , he was appointed as the chairman and CEO. He was managing director of Cheminor Drugs Ltd, which merged with Dr. Reddy’s in 2001.

Mr. Satish Reddy

Chairman

In May 2014, the board appointed him as chairman. Previously in April 2013 he was appointed as vice chairman, MD and COO. In 1997 he became the managing director of the company.

Mr. Saumen Chakraborty

CFO

Appointed in 2012, previously he was the president and global head of quality, HR and IT & business process excellence. He was also the CFO of Dr. Reddy’s between 2006 and 2008.

Mr. Abhijit Mukerjee

COO Appointed in May 2014 , previously he was the president global generics division





2015 AcquisitionIP rights of Alchemia’s fondaparinux

drug

2015 Acquisition

Signed commercialisation deal with

Hatchtech, to market its product -

Xeglyze in India & Other countries

2015 Acquisition UCB India business

2014 Acquisition Acquired Novartis's Habitrol brand

2012 Acquisition Picked up 98.6% Stake in OctoPlus BV

2008 AcquisitionPurchased equity holding in Perlecan

Pharma Pvt Ltd

2008 Acquisition Dow Chemical's molecule business

2008 Acquisition BASF's contract manufacturing unit

2006 Equity OfferingIssued 12.5m additional ADS at USD 16

per ADS

2006 Acquisition Betapharm Arzneimittel GmbH

2005 Acquisition Roche's API business in Mexico

2005 DivestitureSold manufacturing unit in Goa to Us

based Watson Pharma

2001 Divestiture

Acquired six dental prescription brands

of Mumbai based Group

Pharmaceuticals


2001 Equity OfferingListed in NYSE with a net IPO proceeds

of USD 122.96m

2000 Acquisition Merger with American Remedies

2000 Acquisition Acquired 64.66% in Cheminor Drugs Ltd

0% 20% 40% 60% 80% 100%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Sep-15

FIIs

Others

Promoter

Mutual Funds/UTI





Global Generics

81%

PSAI (Pharmaceu

tical Services &

Active Ingredients)

17%

Others2%


2 December 2015

Health Care



Company financials


Year to March (INR m) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Global generics 53,341 70,243 82,563 1,05,164 1,20,293 130,071 135,968 146,668

PSAI (pharmaceutical services & active ingredients)

19,647 23,812 30,702 23,974 25,456 24,520 27,576 30,198

Others 1,705 2,682 3,001 3,032 2,439 3,918 3,632 3,931

Net sales 74,693 96,737 1,16,266 1,32,170 1,48,189 158,508 167,176 180,797

Total revenue 74,693 96,737 1,16,266 1,32,170 1,48,189 158,508 167,176 180,797

yoy growth % 6.3% 29.5% 20.2% 13.7% 12.1% 7.0% 5.5% 8.1%

Total operating expenses 57,917 73,817 89,604 99,032 1,13,803 119,077 129,518 139,266

EBITDA 16,776 22,920 26,662 33,138 34,386 39,431 37,657 41,531

Margins % 22.5% 23.7% 22.9% 25.1% 23.2% 24.9% 22.5% 23.0%

yoy growth% 26.2% 36.6% 16.3% 24.3% 3.8% 14.7% -4.5% 10.3%

Depn. & amortisation 4,147 4,668 5,549 7,106 8,100 8,090 8,865 9,550

EBIT 12,629 18,252 21,113 26,032 26,286 31,341 28,792 31,981

Other income/interest (net) -132 -529 95 46 724 648 1,198 1,326

PBT 12,497 17,723 21,208 26,078 27,010 31,989 29,991 33,307

Tax 1,403 4,204 4,900 5,094 5,984 6,831 6,598 7,327

Tax rate (%) 11.2% 23.7% 23.1% 19.5% 22.2% 21.4% 22.0% 22.0%

Minority interest -3 -54 -104 -174 -195 -125 -40 -60

Adjusted PAT 11,097 13,573 16,412 21,158 21,221.0 25,283 23,433 26,039

Net margins (%) 14.9% 14.0% 14.1% 16.0% 14.3% 16.0% 14.0% 14.4%

Extraordinary Items -57 689 365 354 958 45 0 0

Reported PAT 11,040 14,262 16,777 21,512 22,179 25,328 23,433 26,039



Year to March (INR m) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E


Depreciation 4,147 4,668 5,549 7,106 8,100 8,090 8,865 9,550

Net change in working capital 5,341 (18,036) (9,881) (15,637) (10,533) (13,533) (13,004) (15,489)

Others (2,101) (5,094) (4,049) (4,333) (6,949) (6,742) (6,505) (7,229)

CFO 19,827 (50) 13,192 13,568 18,586 19,848 19,347 20,138

Capex (12,603) (6,555) (10,609) (14,392) (13,499) (10,500) (10,800) (12,000)

Net investments made (3) (55) (104) (334) (227) - - -

Others investing activities - - - - - - - -

CFI (12,606) (6,610) (10,713) (14,726) (13,726) (10,500) (10,800) (12,000)

Change in share capital 293 324 392 438 703 - - -

Change in debts (114) 11,064 (3,710) 8,115 (6,433) (3,392) (1,813) 125

Dividends and dividend tax (2,213) (2,709) (2,981) (3,582) (4,102) (4,590) (4,391) (4,790)

Others (6,042) (369) 1,577 (498) 1,915 792 678 756

CFF (8,076) 8,310 (4,722) 4,474 (7,916) (7,191) (5,526) (3,909)

Total cash generated (855) 1,650 (2,243) 3,315 (3,057) 2,158 3,021 4,229


Cash closing balance 5,729 7,379 5,136 8,451 5,394 7,552 10,573 14,802 Source: Company, Deutsche Bank estimates

2 December 2015

Health Care




As at 31 March (INR m) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Paid-up capital 22,253 22,577 22,969 23,407 24,110 24,110 24,110 24,110


Total equity 45,990 57,444 73,105 90,801 111,302 132,706 152,386 174,331

Total debt 23,572 32,210 36,760 44,742 43,126 34,640 30,959 31,084

Other non-current liabilities 2,729 2,238 2,993 4,619 5,158 3,413 5,408 5,541


Total current liabilities & provisions 22,714 27,585 29,511 30,061 35,177 31,943 30,442 29,072


Net fixed assets 44,888 46,775 51,835 59,121 66,299 68,798 70,827 73,375

Deferred tax asset 2,653 2,966 4,861 7,847 9,411 9,322 9,228 9,130

Investments 313 368 472 806 1,033 1,033 1,033 1,033

Inventory 16,059 19,352 21,600 23,992 25,529 25,599 28,643 30,663

Debtors 17,615 25,339 31,972 33,037 40,755 39,465 41,623 45,015



Total current asset 47,151 69,368 85,201 102,449 118,019 123,548 138,107 156,490

Total assets 95,005 119,477 142,369 170,223 194,762 202,702 219,195 240,029 Source: Company, Deutsche Bank estimates



Adj EPS (INR ) 65.1 79.6 96.4 124.0 124.4 148.2 137.4 152.6

yoy growth (%) 1,014.2 22.3 20.9 28.9 0.3 19.1 (7.3) 11.1

EBITDA – core (%) 22.5 23.7 22.9 25.1 23.2 24.9 22.5 23.0

NPM (%) 14.9 14.0 14.1 16.0 14.3 16.0 14.0 14.4

Net debt to equity (x) 0.4 0.4 0.4 0.4 0.3 0.2 0.1 0.1

ROCE (%) 21.3 22.9 21.0 21.6 18.4 18.0 14.9 14.7

DPS (INR) 11.2 13.7 14.9 17.9 20.0 23.0 22.0 24.0

Dividend payout (%) 17.2 16.3 15.2 14.2 15.4 15.5 16.0 15.7


1.3 1.3 1.3 1.2 1.1 1.1 1.1 1.0

Average collection days 72 81 90 90 91 92 89 87

Average inventory days (on opex.) 93 88 83 84 79 78 76 78


2 December 2015

Health Care



Reuters Bloomberg CIPL.NS CIPLA IS



Sales (INRm) 101,003.9 113,454.4 141,924.0 164,557.0 190,188.5

EBITDA (INRm) 21,330.5 21,617.0 31,025.3 37,846.5 44,702.3



DB EPS FD(INR) 17.29 14.71 21.84 27.70 34.36

DB EPS growth (%) -7.8 -15.0 48.5 26.8 24.1

PER (x) 23.0 35.4 29.5 23.2 18.7

EV/EBITDA (x) 15.3 19.6 17.9 14.4 11.9

DPS (net) (INR) 2.01 2.00 3.00 4.00 5.00

Yield (net) (%) 0.5 0.4 0.5 0.6 0.8




Export gains not priced in We initiate coverage on Cipla with Buy for three reasons: 1) we forecast export formulation business driven by launches from Invagen to increase at a CAGR of 24.4% over FY15-18; 2) in IPM, Cipla maintains its lead in the respiratory segments, where we forecast domestic sales to increase at a CAGR of 13.2% over FY15-FY18; 3) we forecast a 32.7% EPS CAGR over FY15-18 driven by its exports business. Also, the stock has lagged the sector by c.8% YTD and PER multiples are c.5-15% cheaper than peers (vs. c.5-10% premium historically).

Shift in the business to front end from partnership With front-end acquisitions in South Africa, the US and other ROW markets, Cipla is focusing on distribution; this marks a shift from the earlier partnership model, where it had manufacturing relationships in regulated markets. We believe the shift will entail significant investments in terms of manpower, the acquisition of assets and filing costs; this will continue to cap EBITDA margin improvement over the next two years (see detailed table in Figure 97).

US business driven by Invagen and Exelon acquisitions Cipla’s acquisition of Invagen should increase focus in the US in terms of scales, revenue, manufacturing opportunities and building a wide product portfolio. We forecast Cipla’s export formulation sales to increase at a CAGR of 24.4% and contribute c.55% of sales in FY18 (up from 48% in FY15).

Key trigger is launch of inhaler in the UK Cipla has approval for combination inhalers (aerosol Salmeterol / Fluticasone) in c.10 countries in Europe. It is expecting approval of generic Advair in the UK, which should be a key trigger and drive sales and earnings.

Our 12M target price of INR722/share implies c.12% upside potential; risks We rate Cipla as Buy. We have a target price of INR722, based on our target PER of 21x on FY18E recurring EPS. Key downside risks: lower-than-expected sales growth in India and South Africa, delays in integration of Invagen and Exelan as well as hold-ups in USFDA product approvals.

Rating

Buy Asia

India

Health Care


Company

Cipla

Export gains not priced in

Price at 30 Nov 2015 (INR) 643.65


52-week range (INR) 739.60 - 572.74


26,146

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]


300

400

500

600

700

800

12/13 6/14 12/14 6/15

Cipla



Absolute -6.1 -2.2 1.1


-1.9 1.8 -8.4


2 December 2015

Health Care




Running the numbers

Asia

India


Cipla Reuters: CIPL.NS Bloomberg: CIPLA IS

Buy Price (30 Nov 15) INR 643.65


52 Week range INR 572.74 - 739.60


USDm 7,746

Company Profile

The Chemical, Industrial, & Pharmaceutical Laboratories, now known as Cipla, was incorporated in 1935. The company has a diversified portfolio, spread across therapeutic segments and is present in with all its overseas partners in more than 150 countries. Cipla has over 35 plants for API and formulations. Cipla's key acquisitions are Cipla Medpro, Invagen and Exelan. Cipla was recognized as the first pharmaceutical company to provide triple combination anti-retroviral in Africa at less than a dollar a day. India and Africa are its largest markets.

Price Performance

300

400

500

600

700

800


CiplaBombay Stock Exchange (BSE 30) (Rebased)

Margin Trends

12

16

20

24

28

13 14 15 16E 17E 18E



0

5

10

15

20

0

5

10

15

20

25

30

13 14 15 16E 17E 18E


Solvency

0

10

20

30

40

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05

101520253035

13 14 15 16E 17E 18E


Kartik Mehta



Financial Summary

DB EPS (INR) 18.75 17.29 14.71 21.84 27.70 34.36

Reported EPS (INR) 19.24 17.29 14.71 21.84 27.70 34.36

DPS (INR) 2.01 2.01 2.00 3.00 4.00 5.00

BVPS (INR) 112.3 125.2 134.5 152.9 175.9 204.4





P/E (Reported) (x) 18.5 23.0 35.4 29.5 23.2 18.7

P/BV (x) 3.34 3.04 5.28 4.21 3.66 3.15

FCF Yield (%) nm 0.3 1.3 nm 3.1 3.7

Dividend Yield (%) 0.6 0.5 0.4 0.5 0.6 0.8

EV/Sales (x) 3.5 3.2 3.7 3.9 3.3 2.8

EV/EBITDA (x) 13.2 15.3 19.6 17.9 14.4 11.9

EV/EBIT (x) 15.6 18.6 25.6 21.7 17.2 14.2


Sales revenue 82,793 101,004 113,454 141,924 164,557 190,189

Gross profit 55,504 67,242 76,052 93,495 105,923 123,148

EBITDA 21,979 21,331 21,617 31,025 37,847 44,702

Depreciation 3,305 3,726 5,047 5,428 6,243 7,201


EBIT 18,674 17,604 16,570 25,597 31,604 37,501

Net interest income(expense) -339 -1,457 -1,683 -2,157 -2,324 -1,794


Exceptionals/extraordinaries 398 0 0 0 0 0




Minorities 62 283 735 576 770 795


Net profit 15,449 13,884 11,808 17,537 22,237 27,591

DB adjustments (including dilution) -398 0 0 0 0 0

DB Net profit 15,051 13,884 11,808 17,537 22,237 27,591

Cash Flow (INRm)

Cash flow from operations -8,515 34,108 15,074 10,227 23,449 27,378

Net Capex -7,402 -33,232 -9,769 -38,924 -7,629 -8,466

Free cash flow -15,917 876 5,305 -28,697 15,820 18,912


Dividends paid -1,880 -1,880 -1,933 -2,818 -3,757 -4,697

Net inc/(dec) in borrowings 9,535 2,614 4,734 27,147 -8,287 -13,219

Other investing/financing cash flows -618 -1,289 -4,216 0 0 0

Net cash flow -8,880 322 3,891 -4,367 3,775 996

Change in working capital -27,293 16,353 -4,327 -11,710 -4,678 -7,423




Goodwill/intangible assets 0 25,005 26,891 32,253 29,996 27,896


Other assets 71,062 58,898 70,558 93,144 105,817 122,041

Total assets 116,527 134,004 156,704 208,419 226,252 244,737





Minorities 0 496 1,805 2,381 3,151 3,946


Net debt 4,082 6,560 4,977 36,492 24,430 10,215

Key Company Metrics

Sales growth (%) 17.7 22.0 12.3 25.1 15.9 15.6

DB EPS growth (%) 31.9 -7.8 -15.0 48.5 26.8 24.1

EBITDA Margin (%) 26.5 21.1 19.1 21.9 23.0 23.5

EBIT Margin (%) 22.6 17.4 14.6 18.0 19.2 19.7

Payout ratio (%) 10.4 11.6 13.6 13.7 14.4 14.6

ROE (%) 18.6 14.6 11.3 15.2 16.8 18.1

Capex/sales (%) 8.9 32.9 8.6 27.4 4.6 4.5


Net debt/equity (%) 4.5 6.5 4.5 29.2 16.9 6.1



2 December 2015

Health Care



Investment thesis

Outlook

We rate Cipla as a Buy premised on the following: 1) It is ranked third by

market share in two large emerging markets, India and South Africa. In IPM,

Cipla has a 4.9% market share with a leading position in respiratory and a

strong presence in anti-infectives. Post the acquisition of Cipla Medpro, Cipla

has a c.5% market share in South Africa. 2) Cipla’s acquisition of Invagen and

Exelan will drive its US footprint. For FY15-FY18, we forecast Cipla’s export

formulation sales will increase at a CAGR of 24.4% and contribute c.55% of

sales in FY18. 3) The stock has lagged the sector by 8.4% YTD, and its PER

multiples are now c.5-15% cheaper than those of the large-caps (vs. a c.5-10%

premium historically). For FY15-FY18, we forecast sales and earnings to grow

at CAGRs of 18.8% and 32.7%, respectively.

Valuation

We use PER as our principal valuation matrix for Indian Pharma, we use PER

as a valuation matrix for Indian Pharma. Cipla has grown in India on the back

of its strong respiratory and anti-infectives portfolio and has expanded

significantly across export markets through its partnership model. The recent

strategy of transforming from a partnership model to a front-end model will

entail significant investments in terms of manpower, the acquisition of assets

and filing costs and this will continue to cap EBITDA margin improvement over

the next two years. The stable business model in India and an export

formulation business together accounted for c.90% of sales in FY15 and we

forecast will increase over FY15-18 at CAGRs of 13.2% and 24.4%,

respectively. Cipla’s investments in setting up and adding to its distribution will

entail investments and would cap EBITDA margin growth. While the company

has acquired several assets in markets across the world, execution and

successful integration is the key, which we factor in our target PER of 21x, a

discount of c.5-10% to Lupin and Sun’s PER. Thus, we rate Cipla as a Buy,

with a target price of INR722 based on our FY18E recurring EPS.

Risks

Key downside risks: lower-than-expected sales growth in India and South

Africa; delays in the integration of Invagen and Exelan; hold-ups in USFDA

product approvals; and delays in product approvals from its Indian plant at

Indore.

2 December 2015

Health Care



Initiating with a Buy

We expect sales and earnings to grow at 18.8% and 32.7% CAGR (FY2015-18),

respectively. We expect the EBITDA margin to increase to 23.5% in FY18

driven by export sales, mainly the US business of Invagen. Cipla is ranked third

by market share in two large emerging markets, India and South Africa. In

IPM, Cipla has a 4.9% market share with a leadership position in respiratory

and a strong presence in anti-infectives. Post the acquisition of Cipla Medpro,

Cipla has a c.5% market share in South Africa. 2) Cipla’s acquisition of Invagen

and Exelan will drive its US footprint. For FY15-FY18, we forecast Cipla’s

export formulation sales will increase at a CAGR of 24.4% and contribute

c.55% of sales in FY18.


Metric (INRm) FY14 FY15 FY16E FY17E FY18E CAGR

2015-18E (%)

Comments

Domestic sales (net of excise duty)

40,180 48,250 52,868 60,798 69,917 13.2 Mainly acute focus, growing ahead of the acute care market

Export sales 57,352 60,582 85,495 1,00,127 1,16,457 24.3 Driven by US acquisition of Invagen and product launches

APIs 7,520 6,320 8,917 10,513 11,895 23.5 Supplier of API across markets

Formulations 49,832 54,262 76,578 89,614 1,04,562 24.4 Driven by US acquisition of Invagen and Exelan and product launches

Other operating income 3,472 4,622 3,562 3,633 3,814 -6.2

Net sales 1,01,004 1,13,454 1,41,924 1,64,557 1,90,189 18.8 Driven by export sales, mainly Invagen acquisition

EBITDA margin (%) 21.1 19.1 21.9 23.0 23.5 Driven by export sales, mainly US business of Invagen


Strong presence in the respiratory segment in India

In IPM, Cipla maintains market leadership positions in various therapeutic

segments, namely respiratory, anti-viral, gynaecology and urology. For FY15-

18, we forecast Cipla’s domestic sales CAGR at 13.2% driven by its existing

portfolio. With a sales force of around 8,000 in India the company continues to

have a strong reach in the domestic market.

Figure 92: IPM v/s Cipla Figure 93: Top five therapies Figure 94: Top five brands in India

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0


MA

T Y

oY

gro

wth

(%

)

IPM Cipla

No.

1. Respiratory

2.Anti-

Infectives

3. Cardiac

4.Gastro

Intestinal

5. Urology


sales (INR bn)

Foracort Respiratory 1.8

Budecort Respiratory 1.4

Asthalin Respiratory 1.4

Seroflo Respiratory 1.4

Duolin Respiratory 1.2




Product development and approval in the respiratory space in the EU

Cipla already has approval for combination inhalers (aerosol Salmeterol /

Fluticasone) in c.10 countries in Europe including Germany and Sweden. It is

also looking to have approval in the UK.

2 December 2015

Health Care



Figure 95: Respiratory products launched by Cipla in the EU

Product Market Comments

Duohal (Salmeterol / Fluticasone )

Croatia Small market size

Ipratropium MDI UK Market size of c.USD.20m

Mometasone Netherlands Market size of c.USD20m

Seroflo (Salmeterol/ Fluticasone MDI)

Germany

The product will be available in the strengths of 120 doses of 25/125 mcg salmeterol / fluticasone and 120 doses of 25/250 mcg salmeterol / fluticasone

Salmeterol / Fluticasone Cipla

Sweden

Budesonide UK, Portugal, Denmark and Germany Single ingredient inhaler

Salbutamol UK, Portugal, Denmark, Ireland and Germany

Single ingredient inhaler

Salmetrol UK, Germany and some other EU markets

Single ingredient inhaler

Fluticasone UK and some other EU markets Single ingredient inhaler

Salmeterol / Fluticasone

Russia and South Africa Combination inhaler


Invagen acquisition will increase US footprint.

Cipla’s acquisition of Invagen and Exelan will increase its focus in the US in

terms of scale, revenue, manufacturing opportunities and building a wide

range of product portfolio. Apart from two manufacturing facilities in the US,

Cipla obtains c.30 products marketed by Invagen with a further c.30 under

development, which are likely to be approved over the next four years.

Figure 96: Export formulation sales and contributions of Invagen and Exelan

0%

5%

10%

15%

20%

25%

30%

‐

5,000

10,000

15,000

20,000

25,000

30,000

1QFY14

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4QFY16

1QFY17

2QFY17

3QFY17

4QFY17

1QFY18

2QFY18

3QFY18

4QFY18

Export form

ulation Sales (INR mn)

Export formulation sales Invagen as a % of Export

Invagen & Exelan acquisition


2 December 2015

Health Care



Cipla’s forays across the world to establish front-end presence

With the front-end acquisitions in South Africa (Cipla Medpro), the US

(Invagen) and a few other ROW markets, Cipla is focusing on distribution,

which marks a shift from the earlier partnership model, where it had

manufacturing relationships with large pharmaceutical companies for

regulated markets. Cipla has ventured into Croatia, Yemen and Iran to expand

its distribution network in these markets.

Figure 97: Cipla's front-end expansion across global markets

Date Acquired company Consideration Comments

21-Nov-13 Quality Chemical (Additional 14.5% stake)

USD15m

Cipla’s stake in the company post the deal – 51.05%. QCIL’s principal activity is manufacturing and selling of pharmaceutical drugs with emphasis on ARV’s and anti-malarial drugs. QCIL has a WHO-approved manufacturing facility in Uganda

05-Dec-13 100% stake in Celeris d.o.o., Croatia

NA Celeris is largely involved in obtaining the marketing authorization design, organization and implementation of sales and marketing activities

12-May-14 Chase Pharmaceuticals (14.6% stake)

USD1.5m. Cipla will invest an additional USD4.5m in Chase upon achievement of certain milestones

Alzheimer's disease drug development

17-Jun-14 60% stake in a Sri Lanka-based company

USD14m Signed agreement with existing distributor in Sri Lanka

30-Jun-14 51% stake In Yemen-based distributor

US21m. The deal includes additional considerations to be paid over the next three years on achievement of agreed milestones

Company already has a leading position with over 200 products

17-Jul-14 Additional 75% stake in Mabpharm (now 100%)

NA Mabpharm is engaged in the development of monoclonal antibodies for the treatment of cancer and auto-immune diseases

08-Sep-14 Commercial tie-up with UK's S&D Pharma in the Czech Republic and Slovakia

NA S&D Pharma will physically distribute all products, including respiratory products, and this portfolio will increase over the next few years

04-Oct-14 75% stake in Iranian distributor INR2.25bn

Cipla signed a definitive agreement with its existing Iranian distributor for setting up a manufacturing facility in Iran. The total contribution from the company over the next three years will include machinery, equipment and technical knowhow, and is expected to cost c.INR225 crore for a 75% stake

09-Feb-15 JV with existing partners – Cooper Pharma and The Pharmaceutical Institute (PHI)

Cipla (EU) will hold a 60% stake in the JV, while Cooper Pharma and PHI shall together hold a 40% stake. Cipla (EU) expected investment in cash in the JV is estimated at up to USD15m

This JV will enable Cipla to establish a front-end presence in Morocco’s, pharmaceutical market, becoming the launch vehicle for Cipla’s portfolio while leveraging the commercial strengths of partners. The initial focus of the JV shall be respiratory and neurology products and it shall also invest in setting up a manufacturing facility in Morocco

13-Feb-15 JV with existing partner in Algeria – Biopharm SPA

Cipla (EU) Limited’s initial investment in cash in the JV company is expected to be USD6m

The JV company will manufacture and market respiratory products, facilitating Cipla’s front-end presence in Algeria. According to the term sheet, the company’s wholly owned subsidiary, Cipla (EU) Limited, will hold a 40% stake in the JV company while the remainder being held by a Biopharm-led Algerian consortium. The JV company is expected to make an investment of up to USD15m to construct a manufacturing facility

9-Apr-15 100% stake in Duomed Produtos Farmaceuticos Ltda (Brazil)

INR26m Duomed was incorporated on June 10, 2013. It has in place approval of ANVISA (Brazilian health authority) and other regulatory authorities to import and distribute pharmaceutical products in Brazil


2 December 2015

Health Care



Valuation and risks

Valuation

We use PER as our principal valuation matrix for Indian Pharma, we use PER

as a valuation matrix for Indian Pharma. Cipla has grown in India on the back

of its strong respiratory and anti-infectives portfolio and has expanded

significantly across export markets through its partnership model. The recent

strategy of transforming from a partnership model to a front-end model will

entail significant investments in terms of manpower, the acquisition of assets

and filing costs and this will continue to cap EBITDA margin improvement over

the next two years. The stable business model in India and an export

formulation business together accounted for c.90% of sales in FY15 and we

forecast will increase over FY15-18 at CAGRs of 13.2% and 24.4%,

respectively. Cipla’s investments in setting up and adding to its distribution will

entail investments and will cap EBITDA margin growth. While the company

has acquired several assets in markets across the world, execution and

successful integration is the key, which we factor in our target PER of 21x, a

discount of c.5-10% to Lupin and Sun’s PER. Thus, we rate Cipla as a Buy,

with a target price of INR722 based on our FY18E recurring EPS.

Figure 98: PE Band – Cipla

0

200

400

600

800

1,000

31-M

ar-0

9

09-S

ep-0

9

18-F

eb-1

0

30-J

ul-1

0

08-J

an-1

1

19-J

un-1

1

28-N

ov-1

1

08-M

ay-1

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17-O

ct-1

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ar-1

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06-S

ep-1

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15-F

eb-1

4

27-J

ul-1

4

05-J

an-1

5

16-J

un-1

5

25-N

ov-1

5


Source: Deutsche Bank estimates, Bloomberg Finance LP (data as on 30/11/2015

Risks

Key downside risks: lower-than-expected sales growth in India and South

Africa; delays in the integration of Invagen and Exelan; hold-ups in USFDA

product approvals; and delays in product approvals from its Indian plant at

Indore.

2 December 2015

Health Care



Company description

The Chemical, Industrial, & Pharmaceutical Laboratories, now known as Cipla,

was incorporated in 1935. The company has a diversified portfolio, spread

across therapeutic segments and is present with all its overseas partners in

more than 150 countries. Cipla has over 35 plants for API and formulations.

Cipla’s key acquisitions are Cipla Medpro, Invagen and Exelan. Cipla was

recognized as the first pharmaceutical company to provide triple combination

anti-retrovirals in Africa at less than a dollar a day. India and Africa are its

largest markets.

Management summary



Dr. Y.K. Hamied

Chairman In February 2013, he announced his plans for retirement from Cipla after remaining managing director for 52 years

Mr. Subhanu Saxena

CEO

Appointed in November 2012. Prior to joining Cipla, he worked for 25 years with various companies like Novartis Pharma AG, Citicorp, The Boston Consulting Group and Pepsico

Mr. Umang Vohra

CFO Appointed as the CFO in September 2015. Prior to joining Cipla, he headed the North America business for Dr. Reddy’s




0% 20% 40% 60% 80% 100%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Sep‐15

Promoter

Others

FIIs

Mutual Funds/UTI


Bodies Corporate




Exports -Formulations

47%

Domestic sales43%

Exports -APIs6%

Others4%


Year Corporate Action Summary 2015 Divestiture Biomab Holding Ltd.

2015 DivestitureInvestment led by Fidelity into Cipla's consumer healthcarebusiness

2015 Acquisition Duomed Produtos Farmaceuticos Ltd

2015 Acquisition Jay Precision Pharmaceuticals Pvt Ltd

2015 Joint VentureBiopharma SPA in Algeria to manufacture and market respiratoryproducts

2015 Joint VentureSociete Marocaine De Cooperation Pharmaceutique (CooperPharma) and the Pharmaceutical Institute (PHI) in Morocco

2014 Divestiture Jiangsu Cdymax Pharmaceuticals Co Ltd

2014 Acquisition Cipla Biotec Pvt Ltd 2014 Acquisition Majority stake in UAE based Pharma manufacturer for USD

21m

2013 Acquisition Celeris d.o.o

2013 Acquisition Quality Chemicals Ltd.

2012 Acquisition Cipla Medpro South Africa Ltd 2010 Acquisition Meditab Specialities Pvt Ltd 2010 Divestiture IPR for i-pill brand 2006 Stock Split Adjustment Factor - 1.5


2 December 2015

Health Care



Company financials


Year to March (INRm) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Domestic sales 28,292 32,996 36,712 41,351 49,340 52,868 60,798 69,917

Export sales 33,548 36,920 45,243 57,352 60,582 85,495 100,127 116,457

…API's 6,792 7,243 6,550 7,520 6,320 8,917 10,513 11,895

…Formulations 26,756 29,677 38,693 49,832 54,262 76,578 89,614 104,562

Other operating income 1,907 1,488 1,925 3,472 4,622 3,562 3,633 3,814

Gross sales 63,747 71,404 83,880 102,175 114,545 141,924 164,557 190,189

less: excise duty 495 1,081 1,087 1,171 1,090 0 0 0

Total revenue 63,252 70,323 82,793 101,004 113,454 141,924 164,557 190,189

YoY growth% 12.8% 11.2% 17.7% 22.0% 12.3% 25.1% 15.9% 15.6%

Total operating expenses 49,927 53,619 60,815 79,673 91,837 110,899 126,710 145,486

EBITDA 13,325 16,705 21,979 21,331 21,617 31,025 37,847 44,702

Margins % 21.1% 23.8% 26.5% 21.1% 19.1% 21.9% 23.0% 23.5%

YoY growth% -3.1% 25.4% 31.6% -2.9% 1.3% 43.5% 22.0% 18.1%

Depreciation 2,542 3,122 3,305 3,726 5,047 5,428 6,243 7,201

EBIT 10,784 13,582 18,674 17,604 16,570 25,597 31,604 37,501

Other income 1,014 1,279 2,221 2,654 1,656 1,407 1,811 2,652

Interest 173 383 339 1,457 1,683 2,157 2,324 1,794

PBT 11,625 14,478 20,556 18,800 16,543 24,846 31,091 38,359

Tax 1,952 3,065 5,443 4,634 4,000 6,733 8,084 9,973

Tax rate 16.8% 21.2% 26.5% 24.6% 24.2% 27.1% 26.0% 26.0%

Minority interest - - -62 -283 -735 -576 -770 -795

Adjusted PAT 9,673 11,413 15,051 13,884 11,808 17,537 22,237 27,591

Net margins 15.3% 16.2% 18.2% 13.7% 10.4% 12.4% 13.5% 14.5%

EO items -225 29 398 0 -0 0 0 0

Reported PAT 9,448 11,442 15,449 13,884 11,808 17,537 22,237 27,591 Source: Company data, Deutsche Bank estimates


Year to March (INRm) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E


Depreciation 2,542 3,122 3,305 3,726 5,047 5,428 6,243 7,201

Net change in working capital (2,631) 4,146 (27,803) 15,931 (2,272) (13,599) (6,114) (8,554)

Others (1,613) (2,864) (4,970) (4,350) (4,244) (6,448) (7,770) (9,629)

CFO 9,699 18,912 (8,515) 34,108 15,074 10,227 23,449 27,378

Capex (9,383) (5,197) (7,402) (33,232) (9,769) (38,924) (7,629) (8,466)

Net investments made 0 0 0 0 0 0 0 0

Others investing activities 0 0 0 0 0 0 0 0

CFI (9,383) (5,197) (7,402) (33,232) (9,769) (38,924) (7,629) (8,466)

Change in share capital 0 0 0 0 0 0 0 0

Change in debts 5,359 (5,275) 9,535 2,614 4,734 27,147 (8,287) (13,219)

Dividends & dividend tax (2,615) (1,866) (1,880) (1,880) (1,933) (2,818) (3,757) (4,697)

Others 723 152 256 (1,474) (1,789) 0 0 0

CFF 3,467 (6,989) 7,911 (740) 1,012 24,329 (12,045) (17,916)

Total cash generated 3,783 6,725 (8,006) 136 6,317 (4,367) 3,775 996


Cash closing balance 6,867 13,593 5,587 5,723 12,040 7,673 11,448 12,444 Source: Company data, Deutsche Bank estimates

2 December 2015

Health Care




As at March 31st (INRm) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Paid-up capital 1,606 1,606 1,606 1,606 1,606 1,606 1,606 1,606


Total equity 66,572 76,300 90,187 100,504 108,015 122,734 141,214 164,108

Minority interest 0 0 0 496 1,805 2,381 3,151 3,946

Total debt 5,410 135 9,669 12,283 17,018 44,165 35,878 22,659

Deferred liabilities 2,131 2,332 2,805 3,090 2,846 3,131 3,444 3,788


Current liabilities 11,714 14,594 13,865 17,631 27,021 36,008 42,566 50,236

Total current liabilities and provisions

11,714 14,594 13,865 17,631 27,021 36,008 42,566 50,236


Net fixed assets 33,706 35,780 39,878 69,383 74,105 107,601 108,987 110,252

Inventory 19,062 18,501 23,871 28,953 37,806 47,297 50,289 58,242

Debtors 14,908 15,536 16,688 16,389 20,043 29,189 35,271 39,317



Total current assets 52,121 57,581 76,649 64,621 82,599 100,818 117,265 134,485

Total assets 85,826 93,361 116,527 134,004 156,704 208,419 226,252 244,737




Adj EPS (INR) 7.6 8.3 7.9 12.5 13.4 12.0 14.2 18.7

yoy growth% 48.3% 9.9% (5.0) 58.1 7.6 (10.4) 18.0 31.9

EBITDA – core (%) 25.6 22.7 20.0 23.2 24.5 21.1 23.8 26.5

NPM (%) 19.8 18.7 15.0 19.2 19.2 15.3 16.2 18.2

Net debt to equity (x) 0.2 net cash 0.1 0.2 net cash 0.03 net cash 0.1

ROCE (%) 28.2 22.4 17.8 16.0 19.0 14.2 15.3 17.3

DPS (Rs) 1.9 2.0 2.0 1.9 2.0 2.8 2.0 2.0

Dividend payout (%) 25.6 24.0 22.9 20.2 14.8 23.8 14.0 10.4

Asset turnover ratio (sales/ invested capital)

1.4 1.3 1.1 1.1 1.0 1.0 1.1 1.0

Average collection days 87 98 105 114 111 88 79 71

Average inventory days (on opex.) 136 128 113 114 126 125 128 127


2 December 2015

Health Care



Reuters Bloomberg CADI.NS CDH IS



Sales (INRm) 70,602.2 84,970.6 96,362.4 114,144.3 134,529.7

EBITDA (INRm) 10,363.2 16,014.6 19,923.5 25,118.0 32,119.1



DB EPS FD(INR) 7.91 11.35 14.02 18.16 23.44

DB EPS growth (%) 18.4 43.5 23.5 29.5 29.1

PER (x) 19.4 22.9 28.6 22.1 17.1

EV/EBITDA (x) 16.9 17.7 21.2 16.6 12.8

DPS (net) (INR) 1.80 2.40 3.00 4.00 5.20

Yield (net) (%) 1.2 0.9 0.7 1.0 1.3



Timely US approvals key to earnings growth We initiate coverage on Cadila with a Hold for three reasons: 1) delay in timely approvals of Cadila’s key ANDAs will depress earnings growth; we forecast US sales to post a CAGR of 22.3% for FY15-18; 2) Cadila’s domestic business growth has been muted; we forecast Cadila’s India sales to post a CAGR of 11.9% for FY15-FY18; 3) it can deliver a 27.3% EPS CAGR over FY15-18, on our estimates, driven by timely US approvals; the stock has outperformed the sector by c.14% YTD and now trades at c.10% above its three-year average PER.

US business subdued due to slow rate of approvals We believe Cadila’s US business has seen fewer launches, mainly on account of the 483 observations at its key US plant at Moraiya. The company has more than 160 ANDAs pending USFDA approval; timely approval of these products is key. We forecast Cadila’s US sales to post a CAGR of 22.3% and contribute c.46% of sales in FY18 (up from c.40% in FY15).

Domestic business growth to remain subdued We forecast Cadila’s domestic sales to post a CAGR of 11.9% for FY15-FY18, and contribute c.26% of sales in FY18 (down from c.30% in FY15), mainly due to discontinuation of two brands, Buscopan and Dulcolax.

Key triggers are generic Asacol HD and generic Lialda approvals Cadila did not receive approval of generic Asacol HD (15 November 2015) on its launch date; we believe this could be due to 483 observations received from its Moraiya plant. Delays in the future launch of products like generic Lialda in FY17 and Prevacid ODT will impact sales and earnings in FY17.

Our 12M target price of INR 422/sh provides c.5% upside, risks We rate Cadila as a Hold, with a target price of INR 422 on a target PER of 18x on FY18 recurring EPS. Key downside risks include a slower-than-expected growth rate of the IPM, delay in product launches in the US generics markets. Key upside risks include the higher-than-expected growth rate of IPM.

Rating

Hold Asia

India

Health Care


Company

Cadila Healthcare

Missed opportunities will likely change currently positive outlook

Price at 30 Nov 2015 (INR) 400.90


52-week range (INR) 443.10 - 290.23


26,146

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]


100

200

300

400

500

12/13 6/14 12/14 6/15

Cadila Healthcare



Absolute -3.8 6.7 29.4


-1.9 1.8 -8.4


2 December 2015

Health Care




Running the numbers

Asia

India


Cadila Healthcare Reuters: CADI.NS Bloomberg: CDH IS

Hold Price (30 Nov 15) INR 400.90


52 Week range INR 290.23 - 443.10


USDm 6,152

Company Profile

Cadila was founded in 1952 and restructured as Zydus Cadila in 1995. It has currently 10 manufacturing locations (India, Europe and North and South America ). Cadila's key acquisitions are Alpharma, Biochem and Nesher. The company also has presence in Animal health and consumer business and has presence into other markets such as Brazil, South Africa and Japan. US and India are its largest markets. In IPM, Cadila is ranked 4th with c.4.1% market share in the IPM with focus on CV,GI and Women healthcare segments .

Price Performance

100

200

300

400

500


Cadila HealthcareBombay Stock Exchange (BSE 30) (Rebased)

Margin Trends

8

12

16

20

24

13 14 15 16E 17E 18E



05101520253035

0

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Solvency

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Kartik Mehta



Financial Summary

DB EPS (INR) 6.68 7.91 11.35 14.02 18.16 23.44

Reported EPS (INR) 6.38 7.85 11.24 14.02 18.16 23.44

DPS (INR) 1.50 1.80 2.40 3.00 4.00 5.20

BVPS (INR) 28.8 33.6 41.5 52.0 65.5 82.9

Weighted average shares (m) 1,024 1,024 1,024 1,024 1,024 1,024




P/E (Reported) (x) 24.8 19.5 23.2 28.6 22.1 17.1

P/BV (x) 5.04 6.02 8.34 7.71 6.12 4.84

FCF Yield (%) nm 4.3 1.8 2.2 2.4 3.7

Dividend Yield (%) 0.9 1.2 0.9 0.7 1.0 1.3

EV/Sales (x) 3.0 2.5 3.3 4.4 3.7 3.0

EV/EBITDA (x) 19.9 16.9 17.7 21.2 16.6 12.8

EV/EBIT (x) 24.9 20.9 21.6 25.2 19.4 14.7


Sales revenue 61,552 70,602 84,971 96,362 114,144 134,530

Gross profit 38,350 43,466 53,005 62,478 73,194 86,266

EBITDA 9,226 10,363 16,015 19,923 25,118 32,119

Depreciation 1,847 2,012 2,873 3,182 3,618 4,201


EBIT 7,379 8,351 13,142 16,742 21,500 27,918

Net interest income(expense) -1,380 -1,010 -664 -688 -674 -532


Exceptionals/extraordinaries -307 -65 -119 0 0 0




Minorities 364 326 355 464 555 560


Net profit 6,535 8,038 11,506 14,356 18,598 24,007

DB adjustments (including dilution) 307 65 119 0 0 0

DB Net profit 6,842 8,103 11,625 14,356 18,598 24,007

Cash Flow (INRm)


Net Capex -6,141 -4,553 -4,221 -5,500 -6,500 -7,500

Free cash flow -1,699 6,725 4,685 8,914 9,657 15,281


Dividends paid -1,734 -2,116 -2,907 -3,594 -4,792 -6,230

Net inc/(dec) in borrowings 6,737 -4,185 693 -817 -6,504 -3,263

Other investing/financing cash flows -2,132 -774 -1,144 1,212 0 0

Net cash flow 1,172 -350 1,327 5,715 -1,639 5,788

Change in working capital -4,125 946 -5,453 -3,254 -6,330 -5,753





Associates/investments 958 679 1,241 29 29 29

Other assets 29,127 33,358 40,727 44,627 53,169 61,396

Total assets 73,722 79,865 90,471 101,192 110,977 128,292





Minorities 1,193 1,443 1,689 2,153 2,708 3,268


Net debt 20,806 16,971 16,337 9,805 4,939 -4,112

Key Company Metrics

Sales growth (%) 20.9 14.7 20.4 13.4 18.5 17.9

DB EPS growth (%) -6.1 18.4 43.5 23.5 29.5 29.1

EBITDA Margin (%) 15.0 14.7 18.8 20.7 22.0 23.9

EBIT Margin (%) 12.0 11.8 15.5 17.4 18.8 20.8

Payout ratio (%) 23.5 22.9 21.4 21.4 22.0 22.2

ROE (%) 23.7 25.2 29.9 30.0 30.9 31.6

Capex/sales (%) 10.0 6.4 5.0 5.7 5.7 5.6


Net debt/equity (%) 67.9 47.4 37.0 17.7 7.1 -4.7



2 December 2015

Health Care



Investment thesis

Outlook

We rate Cadila a Hold, premised on the following: 1) In the Indian

Pharmaceuticals market, Cadila is ranked 4th with c.4.1% market share, with

a focus on the Cardio Vascular, Gastro Intestinal and Women’s healthcare

segments. Its domestic business has grown between c.6-9% over the last two

years, mainly on account of the higher impact of the drug pricing policy and

discontinuation of two GI brands, Buscopan and Dulcolax, which have annual

sales of INR 900m. We forecast Cadila’s domestic sales to post a CAGR of

11.9% for FY15-18 and contribute c.26% of sales in FY18 (down from c.30% in

FY15). 2) We believe Cadila’s US business has seen fewer launches, mainly on

account of the 483 observations at its key US plant at Moraiya. The company

has more than 160 ANDAs pending USFDA approval, and timely approval of

these products is key. We forecast Cadila’s US sales to post a CAGR of 22.3%

and contribute c.46% of sales in FY18 (up from c.40% in FY15). And 3) Cadila

has outperformed the sector by c.14% YTD and is now c.10% above its three-

year average PER, trading above a c.5-10% premium to peers versus an

average discount of c.5% over the last three years.

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Cadila’s

growth across its focus segments in India has been in line with market growth.


launches, recent product approvals have been fewer, and the company did not

get approval of generic Asacol for the settled 15 November 2015 rates, due to

483 observations at its Moraiya plant. We assign our target PER of 18x which

is lower than the three-year average one-year forward PER of 20x, to factor

delays in key product approvals in the US markets which are filed from the

Moraiya plant and a lower EBITDA margin as compared to peers. The target

PER is at its historical discount of c.15- 30% to Sun and Lupin. Thus, we rate

Cadila as Hold, with a target price of INR 422 on our FY18 recurring EPS.

Risks

The key downside risks include a slower-than-expected growth rate for the

Indian formulations market, incremental products brought under price control

in India, delay in product launches in the US generics markets and higher-than-

expected pricing pressure in its key emerging markets like Brazil.

The key upside risks include a higher-than-expected growth rate in the Indian

formulations market, higher-than-expected product launches in the US

generics market, lower-than-expected pricing pressure in key emerging

markets.

2 December 2015

Health Care



Initiating with a Hold

We estimate Cadila’s sales and earnings to post CAGRs of 16.6% and 27.3%

respectively for FY15-18. We expect EBITDA margin to improve, mainly driven

by the US, India and LatAm markets. While the sales growth will be driven by

timely launches in the US market, delays in product approvals will adversely

impact EBITDA margin improvement by c.300 basis points from FY16 over

FY18. We estimate Cadila’s sales in the EU and emerging markets (including

Latin America) to have low CAGRs of c.10-14%, mainly due to higher

competition, lower product approvals and weak currency. This will cap the

EBITDA and earnings growth. Cadila also has a presence in the consumer

wellness business which constitutes c.5% of FY15 sales with its key brand

Sugar Free which has c.92% market share.




Home Markets 47,244 61,382 71,300 85,323 100,492 17.9 Driven by US markets

US formulations 21,647 33,933 41,448 51,740 62,088 22.3 Driven by approvals of key products like generic Asacol HD and generic Lialda

Domestic Formulations ( net of Excise)

23,168 25,101 27,707 31,081 35,215 11.9 In line with industry growth for the segments in which the company operates

Latin America Formulations

2,429 2,348 2,145 2,502 3,190 10.8 Currency impact will cap growth in these markets

Other Markets and Businesses

23,358 23,589 25,062 28,821 34,037 13.0

Europe Formulations 3,900 3,376 2,946 3,657 4,935 13.5 Mainly France through its subsidiary Alpharma

Emerging Markets Formulations

3,757 4,065 4,668 5,060 5,566 11.0 Markets include Spain, South Africa, Sri Lanka, Myanmar

Zydus Wellness 4,296 4,430 4,928 5,913 7,096 17.0

Sugar Free has 92% market share, other key brands are Ever Yuth (skin care) , Nutralite (butter and substitutes) and Actilife (nutritional milk additive for adults)

Animal Health , API & Others

6,907 7,007 6,922 7,688 8,881 8.2 Launched eight new products in Animal health in FY15, overall 116 DMFs filed until March 2015

JVs and Alliances 4,498 4,711 5,598 6,503 7,560 17.1 JVs with Hospira, Takeda

Net sales 70,602 84,971 96,362 114,144 134,530 16.6 Mainly France through its subsidiary Alpharma

EBITDA margin (%) 14.7 18.8 20.7 22.0 23.9 Driven by US, India and LatAm marketsSource: Company, Deutsche Bank Estimates

2 December 2015

Health Care



Domestic business growth to remain in line with market growth

We forecast Cadila’s domestic formulation business, which constituted c.30%

of total sales in FY15, to post a CAGR of 11.9% for FY15-18, which is in line

with market growth. In FY15, growth was subdued, mainly due to

discontinuation of two GI brands, Buscopan and Dulcolax, which had annual

sales of c.INR 800m in FY14. These brands were transferred back to

Boehringer Ingelheim (Unlisted) after Cadila had manufactured and distributed

them for 10 years in the Indian market.

Figure 108: Therapy-wise breakdown of branded formulations

Therapeutic segment FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Cardiovascular 21 21 21 20 17 18 17 17.6

Gastro-intestinal 16 16 16 17 17 16 15 13.6

Female healthcare 11 11 11 10 8 7 7 7.7

Respiratory 10 11 11 11 11 11 11 12.2

Anti-infectives 10 11 11 10 16 15 15 14.8

Pain management 6 7 7 7 7 7 7 7

CNS 2 3 3 3 2 3 3 1.6

Derma 3 2.3 2.3 3.1 4.3 6.2 7.9 7.2

Biological 4 3.2 3.2 2.9 2.9 3.1 3.5 4.1

Others 17 14.5 14.5 16 14.8 13.7 13.6 14.2

Total 100 100 100 100 100 100 100 100

Source: Company, Deutsche Bank, all figures in %

Figure 109: IPM vs. Cadila Figure 110: Top 5 brands in India

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Brand name TherapyMAT Sep'15

sales (INR bn)

Skinlite Derma 1.9

Mifegest Kit Gynaecological 1.3

Atorva Cardiac 1.2

Deriphyllin Respiratory 0.9

PantodacGastro

Intestinal0.9



2 December 2015

Health Care



US business has more than 160 ANDAs pending approval

Cadila has more than 150 ANDA approvals and c.20 ANDAs pending approval.

Cadila expects to file c.30-40 ANDAs annually. We expect Cadila’s R&D cost to

be c.7-8% of sales. Amongst key products in Cadila’s pipeline is generic Asacol

HD (branded market is c.USD 500m, Cadila has a first to file and had settled

for 15 November 2015, Cadila can launch the product on 1 July 2016, if it does

not receive approval for the product from USFDA).

Figure 111: US sales and YoY growth

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Figure 112: Cadila’s key generic drug pipeline


Q1 Zegerid Effient Toviaz, Exelon Patch, Astepro, Daliresp, Livalo, Namenda XR, Suprenza, Trokendi XR, Uloric, Solodyn, Silenor, Strattera

Q2 Lialda Vimpat

Q3 Asacol HD Pennsaid

Q4 Prevacid Solutab

Can launch on approval Abilify, Niaspan, Pristiq


2 December 2015

Health Care



Valuation and risks

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Cadila’s

growth across its focus segments in India has been in line with market growth.


launches, recent product approvals have been fewer, and the company did not

get approval of generic Asacol for the settled 15 November 2015 rates, due to

483 observations at its Moraiya plant. We assign our target PER of 18x which

is lower than the three-year average one-year forward PER of 20x to factor

delays in key product approvals in the US markets which are filed from

Moraiya plant and lower EBITDA margin as compared to peers. The target

PER is at its historical discount of c.15- 30% to Sun and Lupin. Thus, we rate

Cadila as Hold, with a target price of INR 422 on our FY18 recurring EPS.

Figure 113: PE Band - Cadila

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Risks

The key downside risks include the slower-than-expected growth rate for the


in India, delay in product launches in the US generics markets and higher-than-

expected pricing pressure in its key emerging markets, like Brazil.

The key upside risks include a higher-than-expected growth rate in the Indian

formulations market, higher-than-expected product launches in the US

generics market, lower-than-expected pricing pressure in key emerging

markets.

2 December 2015

Health Care



Company description

Cadila was founded in 1952 and restructured as Zydus Cadila in 1995. It

currently has 10 manufacturing locations (India, Europe and North and South

America). Cadila’s key acquisitions were Alpharma, Biochem and Nesher. The

company also has a presence in animal health and consumer businesses and

has also made forays into other markets such as Brazil, South Africa and

Japan; the US and India are its largest markets. Recently, Cadila launched

Exemptia in India (biosimilar for Adalimumab for inflammatory arthritis). It is

among the fastest-growing companies in the domestic market. In the IPM,

Cadila is ranked 4th with a c.4.1% market share, with a focus on the Cardio

Vascular, Gastro Intestinal (GI) and women’s healthcare segments (Source

AIOCD AWACS). In FY15, India sales contributed c.30% of sales.

Management summary



Mr. Pankaj R Patel

Chairman & MD Joined the company in 1976, helmed the restructured company in 1995

Dr. Sharvil P Patel

CEO Associated with the company for more than 10 years

Mr. Nitin D Parekh

CFO Appointed CFO in 2009






2015 Acquisition Buys out JV partner Bharat Serum's stake in Zydus BSV

2011 Acquisition Biochem Pharmaceutical Industries Ltd

2011 Acquisition US generics business of KV Pharmaceutical Co.

2011 Acquisition German animal drug company Bremer Pharma GmbH

2011 Joint Venture Bayer Zydus Pharma - 50:50 JV

2010 Stock Dividend Adjustment Factor - 2

2008 Spin-off Demerger into Cadila Healthcare and Zydus Wellness

2008 Acquisition Buys out 30% remaining stake in Zydus Pharma USA

2008 Acquisition Etna Biotech, subsidiary of Crucell

2008 MergerMerger of Cadila's Consumer products division with

Carnation Nutra-Analogue

2008 Acquisition South Africa Simayla Pharma

2008 Acquisition Combix Laboratories

2007 Acquisition Sarabhai Zydus Animal Health

2007 Acquisition Quimica e Farmaceutica Nikkho do Brasil Ltda

2007 Acquisition Japan's Nippon Universal

2007 Acquisition Live Healthcare

2006 Acquisition15% stake in Carnation Nutra-Analogue Foods - renamed as

Zydus Wellness

2006 Divestiture 29 branded products sold to France's Aerocid for EUR 7m

2003 Acquisition Patents for 2 cholesterol drugs from Fermenta Biotech

2003 Acquisition Alpharma SAS France

2003 Divestiture Mumbai real estate property

2002 Acquisition Banyan Chemicals

2001 Acquisition German Remedies

0% 20% 40% 60% 80% 100%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Sep‐15

Promoter

Others

FIIs

Mutual Funds/UTI


Bodies Corporate




US formulations39%

Domestic Formulations

31%

Other formulations11%

JVs 6%

Zydus Wellness5%

APIs and Others4%

Animal Health & Others

3% APIs1%


2 December 2015

Health Care



Company financials



Domestic 22,324 24,546 29,879 31,886 34,822 38,297 43,305 49,366

…Formulations 17,145 18,955 23,243 24,651 26,772 29,474 33,079 37,491

…Zydus Wellness 3,355 3,446 4,100 4,296 4,430 4,928 5,913 7,096

…Animal Health & Others 1,472 1,708 2,014 2,299 2,676 2,908 3,257 3,648

…APIs 353 437 522 640 944 987 1,056 1,130

Exports 22,887 27,260 32,969 40,199 51,755 59,832 72,836 87,441

…US formulations 9,655 12,431 15,068 21,648 33,933 41,448 51,740 62,088

…Other formulations 7,409 7,867 9,865 10,628 9,791 9,759 11,219 13,691

…JVs 2,707 4,230 5,011 4,498 4,711 5,598 6,503 7,560

…APIs and Others 3,116 2,733 3,025 3,424 3,320 3,027 3,375 4,102

Total Gross Sales 45,211 51,807 62,848 72,085 86,577 98,129 116,142 136,807

Excise 564 907 1,296 1,483 1,606 1,766 1,997 2,277

Total Net Revenue 44,647 50,900 61,552 70,602 84,971 96,362 114,144 134,530

yoy Growth% 24.9% 14.0% 20.9% 14.7% 20.4% 13.4% 18.5% 17.9%

Total Op. Exp. 35,650 41,794 52,326 60,239 68,956 76,439 89,026 102,411

EBITDA 8,997 9,106 9,226 10,363 16,015 19,923 25,118 32,119

Margins % 20.2% 17.9% 15.0% 14.7% 18.8% 20.7% 22.0% 23.9%

yoy Growth% 29.1% 1.2% 1.3% 12.3% 54.5% 24.4% 26.1% 27.9%

Depreciation 1,269 1,579 1,847 2,012 2,873 3,182 3,618 4,201

EBIT 7,727 7,527 7,379 8,351 13,142 16,742 21,500 27,918

Other Income 1,786 2,264 2,395 2,147 2,096 3,972 3,730 4,110

Interest 780 1,088 1,380 1,010 664 688 674 532

PBT 8,733 8,703 8,394 9,489 14,574 20,026 24,555 31,496

Tax 1,064 1,130 1,188 1,060 2,594 5,205 5,402 6,929

Tax Rate (%) 12.2% 13.0% 14.2% 11.2% 17.8% 26.0% 22.0% 22.0%


Adj PAT 7,418 7,287 6,842 8,103 11,625 14,356 18,598 24,007

Net Margins (%) 16.6 14.3 11.1 11.5 13.7 14.9 16.3 17.8

EO Items -309 -761 -307 -65 -119 0 0 0

Reported PAT 7,110 6,526 6,535 8,038 11,506 14,356 18,598 24,007 Source: Company, Deutsche Bank estimates



PBT (Adj. for Extraordinary items) 8,425 7,942 8,087 9,424 14,455 20,026 24,555 31,496

Depreciation 1,269 1,579 1,847 2,012 2,873 3,182 3,618 4,201

Net Chg in WC (1,362) (1,811) (4,125) 946 (5,453) (3,254) (6,330) (5,753)

Others (1,078) (1,072) (1,368) (1,104) (2,969) (5,539) (5,686) (7,163)

CFO 7,254 6,638 4,442 11,278 8,906 14,414 16,157 22,781

Capex (4,579) (12,261) (6,141) (4,553) (4,221) (5,500) (6,500) (7,500)

Net Investments made - (5) (934) 279 (562) 1,212 - -

Others Investing Activities - - - - - - - -

CFI (4,579) (12,266) (7,075) (4,274) (4,783) (4,288) (6,500) (7,500)

Change in Share capital 342 (0) 0 - - - - -

Change in Debts (678) 9,867 6,737 (4,185) 693 (817) (6,504) (3,263)

Div. & Div Tax (1,529) (2,066) (1,734) (2,116) (2,907) (3,594) (4,792) (6,230)

Others (364) (459) (1,199) (1,053) (582) - - -

CFF (2,229) 7,342 3,805 (7,354) (2,796) (4,411) (11,296) (9,493)

Total Cash Generated 445 1,714 1,172 (350) 1,327 5,715 (1,639) 5,788

Cash Opening Balance 2,694 3,139 4,853 6,025 5,675 7,002 12,717 11,079

Cash Closing Balance 3,139 4,853 6,025 5,675 7,002 12,717 11,079 16,867


2 December 2015

Health Care




As at March 31st FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Paid up Capital 1,024 1,024 1,024 1,024 1,024 1,024 1,024 1,024

Reserves & Surplus 20,691 24,743 28,421 33,366 41,492 52,254 66,060 83,837

Total Equity 21,715 25,767 29,445 34,390 42,516 53,278 67,084 84,861

Minority Interest 669 904 1,193 1,443 1,689 2,153 2,708 3,268

Total Debt 10,227 20,094 26,831 22,646 23,339 22,522 16,018 12,755

Deferred Liabilities 1,127 1,185 1,005 961 586 252 0 0

Capital Employed 33,738 47,950 58,474 59,440 68,130 78,205 85,810 100,884

Current Liabilities 12,368 15,842 15,248 20,425 22,341 22,987 25,167 27,407

Total Cur. Lia. & Prov. 12,368 15,842 15,248 20,425 22,341 22,987 25,167 27,407

Total Liabilities 46,106 63,792 73,722 79,865 90,471 101,192 110,977 128,292

Net Fixed Assets 22,636 33,318 37,612 40,153 41,501 43,819 46,733 50,266

Investments 20 25 958 679 1,241 29 29 29

Inventory 8,119 10,905 12,136 13,675 15,357 16,603 20,004 23,324

Debtors 7,652 8,863 9,551 11,337 15,884 18,806 23,454 27,643

Other Current Assets 4,540 5,828 7,440 8,346 9,486 9,218 9,679 10,163

Cash and Equivalents 3,139 4,853 6,025 5,675 7,002 12,717 11,079 16,867

Total Cur. Assets 23,450 30,450 35,152 39,033 47,729 57,344 64,215 77,997

Total Assets 46,106 63,792 73,722 79,865 90,471 101,192 110,977 128,292 Source: Company, Deutsche Bank estimates



Adj EPS (INR) 7.2 7.1 6.7 7.9 11.4 14.0 18.2 23.4

yoy Growth% 45.4 (1.7) (6.1) 18.4 43.5 23.5 29.5 29.1

EBITDA - Core (%) 20.2 17.9 15.0 14.7 18.8 20.7 22.0 23.9

NPM (%) 16.6 14.3 11.1 11.5 13.7 14.9 16.3 17.8

Net Debt to Equity (x) 0.3 0.6 0.7 0.5 0.4 0.2 0.1 -0.0

ROCE (%) 26.2 19.0 15.0 15.6 19.5 21.0 23.9 26.7

DPS (Rs) 1.3 1.5 1.5 1.8 2.4 3.0 4.0 5.2

Dividend Payout (%) 18.0 23.5 23.5 22.9 21.4 21.4 22.0 22.2

Asset Turnover Ratio (sales/ invested capital)

1.6 1.4 1.3 1.4 1.5 1.5 1.6 1.7

Avg Collection days 50 59 55 54 58 66 68 69

Avg Inventory days (on opex.) 80 83 80 78 77 76 75 77


2 December 2015

Health Care



Reuters Bloomberg GLEN.NS GNP IN



Sales (INRm) 60,052.0 66,297.5 76,901.8 96,187.8 108,944.3

EBITDA (INRm) 12,632.9 12,096.2 17,464.6 24,051.9 25,494.7



DB EPS FD(INR) 25.28 23.43 33.74 51.72 55.32

DB EPS growth (%) 15.3 -7.3 44.0 53.3 6.9

PER (x) 21.2 29.5 29.1 19.0 17.7

EV/EBITDA (x) 14.0 18.6 17.0 12.2 11.4

DPS (net) (INR) 1.92 1.92 3.99 5.99 7.48

Yield (net) (%) 0.4 0.3 0.4 0.6 0.8




Strong India and US business outlook to drive earnings We initiate coverage on Glenmark with a Buy for three reasons: 1) Glenmark continues to grow ahead of IPM; we forecast domestic sales to increase at a CAGR of 25.2% for FY15-FY18; 2) the US business is driven by several launches; we forecast Glenmark’s US sales to increase at a CAGR of 18.4% for FY15-FY18; and 3) we expect a 33.2% EPS CAGR over FY15-18, driven by generic Zetia launch in December 2017, and the stock has outperformed the sector by c.16% YTD and is now c.10-20% below its three-year average PER.

Domestic business has gained market share across chronic segments Over the past five years, Glenmark has continuously gained market share in segments like Cardio Vascular, respiratory, anti-infective and gynaecology. For FY15-FY18, we forecast Glenmark’s domestic sales to increase at a CAGR of 25.2% and contribute c.31% of sales in FY18.

US business driven by product launches, generic Zetia launch in 3QFY17 Glenmark has several launches over the next twelve months; the key product launch is of generic Zetia in 3QFY17 where Glenmark is the first to file. We forecast Glenmark’s US sales to increase at a CAGR of 18.4% for FY15-FY18 and to contribute c.31% of sales in FY18.

Key trigger is revival of growth in Latam and ROW markets Currency depreciation has negatively affected Glenmark’s business outlook in Russia and Latam, which together contributed c.24% of sales in FY15. Higher product launches in these markets is a key trigger as we believe that revival of growth rates in Latam and ROW markets will improve the EBITDA margin.

Our 12M target price of INR 1,133/share provides c.16% upside potential; risks We rate Glenmark as Buy with a target price of INR 1,133 on a target PER of 21x on FY18E recurring EPS and INR 10 for generic Zetia. Key downside risks are lower-than-expected sales growth in the RoW and semi-regulated markets and higher-than-expected pricing pressures in India and the US market.

Rating

Buy Asia

India

Health Care


Company

Glenmark

Strong India and US business outlook to drive earnings

Price at 30 Nov 2015 (INR) 981.00


52-week range (INR) 1,224.39 - 705.01


26,146

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]


450

600

750

900

1050

1200

1350

12/13 6/14 12/14 6/15

Glenmark



Absolute -0.8 -12.4 22.9


-1.9 1.8 -8.4


2 December 2015

Health Care



Investment thesis

Outlook

We rate Glenmark a Buy premised on the following: 1) In IPM, Glenmark is

ranked 15th with a c.2.8% market share with a focus on the dermatology

segment which accounts for c.30% of its domestic business. 2) Glenmark has

several launches over the next twelve months; its key product launch is

generic Zetia in 3QFY17 where Glenmark will be the first to file. We forecast

Glenmark’s US sales to increase at a CAGR of 18.4% for FY15-FY18 and

contribute c.31% of sales in FY18. 3) The stock has outperformed the sector by

c.16.2% YTD and is now c.10-20% below its three-year average PER. We

forecast sales and earnings to increase at CAGRs of 18% and 33.2% for FY15-

FY18, respectively.

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Glenmark has

grown across its focus segments in India by increasing its market share. While

US business growth was flat in FY15, due to a low rate of approvals, growth is

most likely to be back on track with the recent surge in approvals. Glenmark’s

US business driven by new launches and India business driven by market

share gains in focused therapeutic segments is expected to drive earning

growth over the next three years. Our target valuation of 21x is marginally

below those for Lupin and Sun and at par with Cipla and marginally lower than

its own three-year average one-year forward PER of 23x. We discount the PER

and maintain the discount to industry leaders Sun and Lupin. However, the

PER is higher than other peers’ to factor sales and earnings growth .Thus, we

rate Glenmark Buy with a target price of INR 1,133 (including INR 10 for

generic Zetia) on our FY18E recurring EPS. We have not factored any NCE

licensing income into our forecasts

Risks

The key downside risks are lower-than-expected market share in the products

launched in the US, lower-than-expected sales growth in the RoW and semi-

regulated markets, and lower-than-expected growth in India driven by pricing

and new product launches.

2 December 2015

Health Care



Initiating with a Buy

For FY15-18, we estimate Glenmark’s sales and earnings will increase at

CAGRs of 18% and 33.2% ,respectively. We expect the EBITDA margin to

improve mainly driven by its higher-than-market growth in India, higher

number of product approvals, and first-to-file opportunities. We have not

factored any licensing income from out-licensing any NCE candidates in the

pipeline into our forecasts. We estimate Glenmark’s sales in emerging markets

(including Latin America) and ROW markets to have low CAGRs of c.8-15%

over FY15-18 mainly due to higher competition, lower product approvals, and

weak currency.



2015-18E (%) Comments

India 15,180 17,490 22,264 27,984 34,333 25.2 Growing significantly ahead of the market, driven by Chronic segments

US 20,270 20,398 24,651 32,944 33,819 18.4 Driven by new launches, generic Zetia in 3QFY17

ROW 9,839 7,973 8,445 10,247 11,974 14.5 Currency fluctuations have capped sales growth, mainly Russia

Europe 5,061 6,445 7,139 8,715 10,225 16.6 Growth driven by new launches

Latin America 4,009 7,640 7,696 8,728 9,756 8.5 Currency fluctuations in Brazil and Venezuela have impacted sales growth

API 5,328 6,053 6,707 7,569 8,838 13.4 Sales to regulated and semi-regulated markets

Out-licensing revenue 366 299 - - -

Net sales 60,052 66,298 76,902 96,188 108,944 18.0 Driven by US business

Net sales ( Ex. Zetia) 3,638 904 8.2

EBITDA margin 21.0 18.2 22.7 25.0 23.4

EBITDA margin (Ex. Zetia) 21.0 18.2 22.7 22.8 23.0 Driven by India and US business Source: Company, Deutsche Bank estimates

Glenmark is one of the fastest-growing companies in the IPM

The Dermatology segment continues to be a key revenue driver for the

company, accounting for about 30% of its domestic formulation business.

Also, growth has come from segments like cardiac, respiratory, anti-infective,

and gynecology where the company has gained market share in all of these

segments

Figure 124: Market share in top therapeutic segments

MAT (%) Mar-11 Sep-11 Mar-12 Sep-12 Sep-13 Sep-14 Sep-15 Top four brands

Dermatology 8.23 8.3 8.69 8.84 8.36 8.07 8.26 Candid-B, Candid, Elovera, Momate

Cardiac 2.34 2.47 2.86 3.2 3.43 3.81 3.77 Telma, Telma H, Tema AM, Eptus

Respiratory 2.65 2.69 2.84 3.06 3.45 3.59 3.89 Ascoril Plus, Alex, Ascoril LS, Ascoril D

Anti-infective 1.31 1.27 1.44 1.43 1.57 1.79 1.80 Lizolid, Altacef, Milixim, Glevo

Gynecology 1.26 1.3 1.43 1.31 1.47 1.47 n.a Dubagest, Mumfer XT, Trigova HP, Astima

Source: Deutsche Bank, company data

Figure 123:IPM vs. Glenmark

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Source AIOCD AWACS, Deutsche Bank

2 December 2015

Health Care



US sales growth expected to pick up given increased number of launches

As of 30 September 2015, Glenmark has 102 ANDA approvals and 64 ANDA

pending approvals. We expect Glenmark to gain traction in US sales due to

several launches (see below). We expect Glenmark’s R&D cost to be c.9-11%

of sales. Among key product launches in Glenmark’s pipeline is generic Zetia

(branded market is c.USD 2bn for which Glenmark is first to file and has settled

for launch on 12 December 2017.

Figure 125: US sales and YoY growth

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generic Zetia launch


Figure 126: Glenmark’s key generic drug pipeline


Q1 Effient Finacea, Benzel, Bystolic, Alimta, Epiduo Gel, Faslodex, Jevtana, Onglyza, Savella, Velcade

Q2 Crestor Vimpat Q3 Ortho Tri-Cyclen Lo Zetia, Treanda

Q4 Zyvox Multaq

Can launch on approval Welchol


Glenmark’s NCE pipeline is large

Glenmark has one of the best NCE pipelines in India, in our view. The company

has completed seven out-licensing deals since 2004, with a cumulative income

exceeding c.USD200m received in terms of upfront and milestone payments.

Currently, the company has about five candidates which are ready to be out-

licensed. However, we do not assign any value to the company’s NCE pipeline,

due to the inherently risky nature of the business.

2 December 2015

Health Care



Figure 127: Glenmark: NCE pipeline

Compound Primary indication Target Comment

Croflelemer HIV related Diarrhea / Adult Acute infectious Diarrhea

CFTR Inhibitor Salix obtained US FDA approval on 31 December 2011. Glenmark has filed in some of the key markets within the 140 countries. Market potential – 10m patients globally

GRC 17536 Neuropathic pain TRPA 1 Inhibitor

Glenmark has submitted IND for Phase 2b dose range finding study with the USFDA along with regulatory submission in India. Regulatory submissions in EU for the Phase 2b study are underway. Market potential -more than 40m patients worldwide with market size of USD 2bn

GRC 27864 Chronic inflammatory condition

Mpges-1 Inhibitor

Option agreement with Foreest labs Glenmark is planning a Pre-IND meeting with US FDA in Q4FY2015-16. Glenmark has completed preclinical studies and Phase I enabling GLP studies for its selected lead molecule, GRC 27864 and has approval for Phase I first-in-human trial from MHRA, UK. Multiple ascending dose study is currently on-going.

Vatelizumab Multiple Sclerosis VLA-2 Antagonist (mAb)

Sanofi has made the decision not to pursue further. Phase 1 studies completed in the US. The Phase II studies which are conducted by Sanofi are currently on-going for multiple sclerosis. Market potential -> 1.5m patients worldwide (750,000 in the US alone) with market size of USD 3bn

GBR 900 Chronic pain TrkA Antagonist (mAb)

Phase I enabling toxicity studies have been completed; phase 1 clinical trial has been initiated in the UK. Market potential -> 100m patients worldwide with market size of >USD 3bn

GBR 830 Autoimmune disorder OX40 Antagonist (mAb)

Phase I enabling toxicity studies have been completed; Phase I study is currently on-going in Netherlands, Europe.Glenmark intends to open an IND in Q2FY16

GBR 1302 Oncology indications Bispecific antibody The first clinical candidate based on Glenmark’s proprietary BEAT platform. Glenmark is currently putting together a submission package for initiating clinical trials and expects to obtain approval by Q3FY16

Source: Company Deutsche Bank

Figure 128: Glenmark: Molecules out-licensed

Year Molecule Company Comment

2014 GBR 500 Sanofi Aventis USD 5m as a milestone payment from. Sanofi does not want to pursue this molecule

2014 MPGES -1 Forest Labs USD 4m as a milestone payment from Forest Lab

2012 MPGES -1 Forest Labs For this, Forest made a USD 6m upfront payment and provide an additional USD 3m to support the next phase of work.

2011 GBR 500 Sanofi Aventis First novel biologics out-licensing deal; upfront payment of USD 50m; total deal size – USD 613m

2010 GRC 15300 Sanofi Aventis Received an upfront fee of USD 20m for development and commercialization rights of the first-in-class TRPV3 antagonist; received USD5m in October 2011 as milestone payment; deal with a potential of USD 325m

2007 GRC 6211 Eli Lilly Eli Lilly acquired the rights to a portfolio of TRPV1 antagonist molecules, Received an upfront payment of USD 45m (development of the lead molecule GRC6211 has been stalled)

2006 Melogliptin Merck KGaA

Deal worth USD250 m in October 2006. Received a total payment of USD3 1m; due to reduced R&D focus on diabetes, Merck returned the molecule to Glenmark in April 2008; completed Phase IIb trials and is ready to enter Phase III

2005 Oglemilast Teijin Pharma USD 53m deal for Oglemilast Japan rights; Teijin Pharma made an upfront payment of USD 6m

2004 Oglemilast Forest Labs Deal worth USD 190m on Oglemilast US rights; received USD 35m as upfront and milestone payments


2 December 2015

Health Care



Valuation and risks

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Glenmark has

grown across its focus segments in India by increasing its market share. While

US business growth was flat in FY15 due to the low rate of approvals, growth

is most likely to be back on track with the recent surge in approvals.

Glenmark’s US business driven by new launches and India business driven by

market share gains in focused therapeutic segments is expected to drive

earnings growth over the next three years. Our target valuation of 21x is

marginally below those of Lupin and Sun and at par with Cipla and marginally

lower than its own three-year average one-year forward PER of 23x. We

discount the PER and maintain the discount to industry leaders Sun and Lupin.

However, the PER is higher than other peers’ to factor sales and earnings

growth .Thus, we rate Glenmark Buy with a target price of INR 1,133 (including

INR 10 for generic Zetia) on our FY18E recurring EPS. We have not factored

any NCE licensing income into our forecasts

Figure 129: PE band – Glenmark

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Risks

The key downside risks are lower-than-expected market share in the products

launched in the US, lower-than-expected sales growth in the RoW and semi-

regulated markets, and lower-than-expected growth in India driven by pricing

and new product launches.

2 December 2015

Health Care



Company description

Glenmark Pharmaceuticals was incorporated in 1977. After commissioning its

first facility at Nashik, Maharashtra, it now has six manufacturing locations

(India, EU, Brazil). Today, apart from having branded generic formulation

interests in several countries across the world, it also focuses on the discovery

of new molecules (both NCEs and biologics) with several molecules in various

stages of clinical and pre-clinical development. The US and India are its largest

markets for generic and branded generic, respectively.

Management summary



Mr. Glenn Saldanha

Chairman & MD Joined the company in 1998 as a director and took over as managing director and CEO in 2001

Ms. Cheryl M Pinto

Director – corporate affairs Joined the company in 1999

Mr. Rajesh V. Desai

Executive director Heads Finance, IT and Legal. Appointed ED in 2002





2015 Equity OfferingIssued 10.8 million shares at INR 875/share to

Temasek Holdings on preferential basis

2009 Equity OfferingQIP of 18,712,935 equity shares with net proceeds of INR 4,038.19 million

2008 AcquisitionPurchased seven pharmaceutical brands from Iceland's Actavis Group hf in Poland

2007 Stock Split Adjustment Factor - 2; New Par Value: INR 1

2007 AcquisitionPurchased rights to 2 new biological entities

from Chromos Molecular Systems

2005 Acquisition South Africa based Bouwer Bartlett Pty Ltd

2005 AcquisitionServycal S.A., an Argentine marketing

company

2005 AcquisitionLeading hormonal brand, Uno-Ciclo for USD 4.6m


2004 AcquisitionAcquired two generic products of STADA

Arzneimittel AG

2003 Divestiture Glenmark Laboratories Pvt Ltd

2002 AcquisitionGSK's bulk drug manufacturing facility at

Ankleshwar for INR 14 crore

0% 20% 40% 60% 80% 100%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Sep-15

Promoter

FIIs

Others

Mutual Funds/UTI


Bodies Corporate




India26%

US31%

ROW12%

Europe10%

Latin America

12%

API9%


2 December 2015

Health Care



Company financials

Figure 134: Income statement (INR m)


Specialty 16,858 23,801 27,263 31,741 36,386 41,630 50,923 60,494

Generic 12,633 16,405 22,860 28,311 29,911 35,272 45,265 48,451

Net sales 29,491 40,206 50,123 60,052 66,298 76,902 96,188 108,944

YoY growth% 22.2% 36.3% 24.7% 19.8% 10.4% 16.0% 25.1% 13.3%

Total op. exp. 23,568 31,764 39,971 47,419 54,201 59,437 72,136 83,450

EBITDA 5,923 8,443 10,153 12,633 12,096 17,465 24,052 25,495

Margins % 20.1% 21.0% 20.3% 21.0% 18.2% 22.7% 25.0% 23.4%

YoY growth% -4.4% 42.5% 20.3% 24.4% -4.2% 44.4% 37.7% 6.0%

Depreciation 947 979 1,270 2,168 2,600 2,741 3,120 3,315

EBIT 4,976 7,464 8,883 10,465 9,496 14,724 20,931 22,179

Other income 1,441 182 107 115 219 103 96 109

Interest 1,605 1,466 1,600 1,886 1,902 1,727 1,502 1,402

PBT 4,812 6,180 7,390 8,694 7,814 13,099 19,525 20,886

Tax 237 238 1,107 1,513 1,190 3,547 4,881 5,221

Tax rate (%) 4.9% 3.8% 15.0% 17.4% 15.2% 27.1% 25.0% 25.0%

Minority interest 46 40 83 33 -1 12 19 24

Adjusted PAT 4,529 5,903 6,200 7,148 6,624 9,539 14,625 15,640

Net margins 15.4% 14.7% 12.4% 11.9% 10.0% 12.4% 15.2% 14.4%

Extraordinary items 4 -1,299 0 -1,725 -1,871 0 0 0

Reported PAT 4,532 4,603 6,200 5,423 4,753 9,539 14,625 15,640


Figure 135: Cash flow statement (INR m)



Depreciation 947 979 1,270 2,168 2,600 2,741 3,120 3,315

Net chg in WC 1,671 (126) (1,442) (847) (1,009) (3,915) (5,628) (3,937)

Others (2,029) (1,830) (2,236) (2,852) (2,981) (3,739) (5,169) (5,581)

CFO 5,404 3,904 4,982 5,437 4,553 8,186 11,849 14,683

Capex (3,750) (3,712) (4,700) (4,841) (4,925) (6,500) (7,000) (7,500)

Net investments made (100) (17) (25) (7) (34) - - -


CFI (3,850) (3,729) (4,725) (4,848) (4,959) (6,500) (7,000) (7,500)

Change in share capital 0 0 0 0 0 11 - -

Change in debts 2,423 2,108 5,275 4,691 4,856 (7,000) (2,000) (2,000)

Div. & div tax (126) (629) (634) (635) (635) (1,320) (1,980) (2,475)

Others (2,935) (388) (2,042) (2,730) (4,082) 9,439 - -

CFF (638) 1,092 2,599 1,327 139 1,130 (3,980) (4,475)

Total cash generated 916 1,267 2,857 1,916 (268) 2,816 869 2,708


Cash closing balance 1,986 3,253 6,110 8,026 7,759 10,574 11,443 14,151


2 December 2015

Health Care



Figure 136: Balance sheet (INR m)

As at 31 March FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Paid-up capital 270 271 271 271 271 282 282 282


Total equity 20,372 24,016 27,630 29,833 30,003 47,673 60,317 73,482

Minority interest 267 250 244 133 -2 10 29 53

Total debt 21,116 23,225 28,500 33,191 38,047 31,047 29,047 27,047


Total cur. lia. & prov. 7,746 9,843 13,568 21,109 26,029 27,023 32,446 35,944


Net fixed assets 22,123 24,856 28,286 30,959 33,284 37,043 40,923 45,107

Deferred tax asset 1,081 2,674 3,803 5,142 6,933 7,125 7,412 7,772

Investments 281 298 323 331 365 365 365 365

Inventory 8,070 7,877 8,435 9,329 12,690 13,342 16,839 19,187

Debtors 11,308 12,436 16,400 21,563 25,118 29,135 36,442 41,275



Total cur. assets 26,016 29,506 37,530 47,834 53,495 61,220 73,140 83,282

Total assets 49,501 57,334 69,942 84,265 94,077 105,753 121,840 136,526




Adj EPS (INR) 16.0 20.9 21.9 25.3 23.4 33.7 51.7 55.3

yoy growth% 39.6 30.3 5.0 15.3 (7.3) 44.0 53.3 6.9

EBITDA – core (%) 19.4 24.3 26.4 32.9 32.6 43.4 62.8 67.0

NPM (%) 20.1 21.0 20.3 21.0 18.2 22.7 25.0 23.4

Net debt to equity (x) 15.4 14.7 12.4 11.9 10.0 12.4 15.2 14.4

ROCE (%) 0.9 0.8 0.8 0.8 1.0 0.4 0.3 0.2

DPS (INR) 13.3 12.5 14.1 11.1 9.0 14.5 18.5 17.4

Dividend payout (%) 2.4 11.8 8.7 10.0 11.4 11.8 11.6 13.5

Asset turnover ratio (sales/ invested capital)

0.7 1.0 1.1 1.3 1.3 1.4 1.5 1.5

Avg collection days 137 108 105 115 129 129 124 130

Avg inventory days (on opex.) 117 92 74 68 74 80 76 79


2 December 2015

Health Care



Reuters Bloomberg TORP.NS TRP IS



Sales (INRm) 40,363.0 45,853.0 60,187.0 56,870.9 64,390.1

EBITDA (INRm) 8,030.6 9,520.1 21,336.7 14,025.8 16,587.8



DB EPS FD(INR) 39.23 44.37 84.25 68.40 83.58

DB EPS growth (%) 41.2 13.1 89.9 -18.8 22.2

PER (x) 11.1 19.5 16.9 20.8 17.1

EV/EBITDA (x) 9.4 17.4 12.1 17.7 14.6

DPS (net) (INR) 10.00 11.25 21.00 17.00 21.00

Yield (net) (%) 2.3 1.3 1.5 1.2 1.5




India business to drive earnings; valuations do not factor in all positives We initiate coverage on Torrent Pharma with a Buy for three reasons: 1) Elder brands will drive India business, which we estimate will register a 15.4% sales CAGR over FY15-18; 2) US business growth, to be driven by product launches, and to register a 15.5% sales CAGR over FY15-18E; 3) delivery of a 23.5% EPS CAGR over FY15-18, on our estimates, factoring in complete synergies from the Elder brands from FY17. The stock has outperformed the sector by c.15% YTD, and the PER has rerated by c.50% − now at par with its large peers (vs. c.25-30% discount historically).

India business driven by synergies with Elder brands Post the integration of the Elder brands, Shelcal and Chymoral sales have grown by c.22-25%. We forecast Torrent’s domestic sales to register CAGR of 15.4% over FY15-18, contributing c.39% of sales in FY18 (from c.35% in FY15).

US business strategy has been successful Despite being a late entrant into the US business, Torrent has ramped up significantly, driven mainly by the timely launches of generic Cymbalta in FY15 and generic Abilify in FY16. We forecast Torrent’s US sales to achieve a CAGR of 15.5% over FY15-18 and contribute c.20% of sales in FY18 (up from c.18% in FY15, down from 31% in FY16E).

Key trigger − improvement in field force productivity Torrent has rationalised its India field force after acquiring certain of Elder’s India assets in FY15. We expect synergies with the acquired Elder portfolio and an improvement in field force productivity to drive the EBITDA margin.

Our 12M target price of INR 1,672/sh implies c.17% upside potential; risks We rate Torrent a Buy, with a target price of INR 1,672, on a target PER of 20x on FY18E recurring EPS. The key downside risks include a slower-than-expected growth rate in the Indian formulations market, incremental products brought under price control in India, lower product launches in the US generic markets, and higher-than- expected pricing pressure in its key generic markets − Brazil, Russia and Germany.

Rating

Buy Asia

India

Health Care


Company

Torrent

Acquisition synergies to kick in

Price at 30 Nov 2015 (INR) 1,425.55


52-week range (INR) 1,650.00 - 1,024.72


26,146

Kartik Mehta

Research Analyst

(+91) 22 7180 4210

[email protected]


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Torrent



Absolute -4.7 -10.2 33.2


-1.9 1.8 -8.4


2 December 2015

Health Care




Running the numbers

Asia

India


Torrent Reuters: TORP.NS Bloomberg: TRP IS

Buy Price (30 Nov 15) INR 1,425.55


52 Week range INR 1,024.72 - 1,650.00


USDm 3,615

Company Profile

Torrent was incorporated in 1959 as Trinity Laboratories and in 1971 was renamed to Torrent Pharmaceuticals Ltd. Torrent engages in the manufacture and sale of branded and generic pharmaceutical products.. Torrent exports to more than 50 countries and has 4 manufacturing plants in India. Torrent's key acquisitions are Heumann, Elder's key India brands and Zyg Pharma. In IPM, Torrent Pharma is ranked 14th with 2.4% with focus on chronic segments. Torrent is the largest Indian company in Brazil

Price Performance

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TorrentBombay Stock Exchange (BSE 30) (Rebased)

Margin Trends

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Financial Summary

DB EPS (INR) 27.79 39.23 44.37 84.25 68.40 83.58

Reported EPS (INR) 25.57 39.23 44.37 84.25 68.40 83.58

DPS (INR) 11.50 10.00 11.25 21.00 17.00 21.00

BVPS (INR) 84.0 112.4 147.2 210.4 261.8 324.4





P/E (Reported) (x) 12.4 11.1 19.5 16.9 20.8 17.1

P/BV (x) 3.95 4.59 7.83 6.78 5.44 4.39

FCF Yield (%) nm 0.2 nm 2.5 5.0 3.7

Dividend Yield (%) 3.6 2.3 1.3 1.5 1.2 1.5

EV/Sales (x) 1.8 1.9 3.6 4.3 4.4 3.8

EV/EBITDA (x) 10.1 9.4 17.4 12.1 17.7 14.6

EV/EBIT (x) 11.9 10.5 21.7 13.6 22.0 18.0


Sales revenue 30,535 40,363 45,853 60,187 56,871 64,390

Gross profit 21,227 27,888 31,639 44,751 39,810 46,040

EBITDA 5,346 8,031 9,520 21,337 14,026 16,588

Depreciation 827 870 1,907 2,416 2,761 3,120


EBIT 4,519 7,161 7,613 18,921 11,265 13,468

Net interest income(expense) -338 -586 -1,752 -1,922 -961 -304


Exceptionals/extraordinaries -375 0 0 0 0 0






Net profit 4,328 6,639 7,509 14,258 11,577 14,146

DB adjustments (including dilution) 375 0 0 0 0 0

DB Net profit 4,703 6,639 7,509 14,258 11,577 14,146

Cash Flow (INRm)


Net Capex -2,721 -3,914 -22,923 -4,500 -5,000 -6,000

Free cash flow -152 122 -15,359 5,920 12,169 8,882


Dividends paid -2,276 -1,980 -2,284 -4,158 -3,366 -4,158

Net inc/(dec) in borrowings 1,142 4,388 16,086 0 -11,500 -10,000

Other investing/financing cash flows 551 146 656 604 489 604

Net cash flow -734 2,676 -901 2,366 -2,208 -4,672

Change in working capital -2,151 -2,267 -2,066 -6,223 2,864 -2,351




Goodwill/intangible assets 226 286 19,111 17,773 16,529 15,372


Other assets 19,095 25,971 32,960 37,282 35,264 39,046

Total assets 37,020 49,616 76,720 85,492 83,506 85,496







Net debt 56 1,767 18,754 16,388 7,096 1,768

Key Company Metrics

Sales growth (%) 17.7 32.2 13.6 31.3 -5.5 13.2

DB EPS growth (%) 34.6 41.2 13.1 89.9 -18.8 22.2

EBITDA Margin (%) 17.5 19.9 20.8 35.5 24.7 25.8

EBIT Margin (%) 14.8 17.7 16.6 31.4 19.8 20.9

Payout ratio (%) 45.0 25.5 25.4 24.9 24.9 25.1

ROE (%) 33.1 39.9 34.2 47.1 29.0 28.5

Capex/sales (%) 8.9 9.7 50.0 7.5 8.8 9.3


Net debt/equity (%) 0.4 9.3 75.3 46.0 16.0 3.2



2 December 2015

Health Care



Investment thesis

Outlook

We rate Torrent Pharma a Buy, premised on the following: 1) in the Indian

pharmaceuticals market, Torrent Pharma is ranked 14th, with a 2.4% focus on

chronic segments, and it continues to grow ahead of the industry; 2) US sales

registering a CAGR of 15.5% over FY15-18 and contributing c.20% of sales in

FY18, on our estimates, up from c.18% in FY15 and down from 31% in FY16E

(lower growth due mainly to high base of exclusivities on generic Cymbalta

and generic Abilify in FY15 and FY16, respectively); 3) Torrent’s

outperformance of the sector by c.15% YTD and a c.50% PER re-rating (now at

par with large peers, vs. c.25-30% discount historically).

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Torrent’s

growth across its focus segments in India has been ahead of the market’s

growth, and we expect synergies with the Elder brands to sustain the growth

momentum in the domestic markets. While the US business has more than

doubled in the past two years, the higher base and lack of similar-sized

opportunities will result in moderate growth. For the India and US businesses,

which together contribute c.53% of sales, which we forecast CAGRs of 15.4%

and 15.5%, respectively, over FY15-18.

Torrent has re-rated substantially, and is now trading at par with its peers,

mainly on the back of significant growth in the US business, owing to the

launch of generic Cymbalta (in FY15) and generic Abilify (in FY16), and also

owing to synergies in the India business post the acquisition with Elder

Pharma. The year-on-year fall in earnings in FY17E is due mainly to a higher

base of generic Abilify. We assign a target PER of 20x, which is c.60% higher

than its three-year average one-year forward PER of 13x. We believe this

multiple is justified as India and US Business have a favorable business outlook

and EBITDA margin profile of the company has improved significantly. Our

target PER is at a discount of 10% and 15% to Sun and Lupin, respectively, and

factors in the scale of business of these two companies in the India and US

markets. Thus we rate Torrent a Buy, with a target price of INR 1,672 on our

FY18E recurring EPS.

ce 0

Risks

The key downside risks include a slower-than-expected growth rate in the


in India, lower product launches in the US generic markets, and higher-than-

expected pricing pressure in its key generic markets − Brazil, Russia and

Germany.

2 December 2015

Health Care



Initiating with a Buy rating

We estimate Torrent’s sales and earnings to register CAGRs of 12% and

23.5%, respectively, over FY15-18, driven by the integration of the Elder brands

and the company’s growing presence in export markets, especially the US. The

fall in the EBITDA margin that we estimate for FY17 is due to limited upside

from generic Abilify in FY16. In FY17 and FY18, we expect the EBITDA margin

to improve over FY15, driven mainly by the India business. The Brazil business

continues to be driven by volume and new product approvals; however,

currency weakness limits Torrent’s growth potential in this market. Torrent has

a c.200-strong field force in Brazil.


Metric (INR m) FY14 FY15 FY16E FY17E FY18E

CAGR


Domestic sales (net of excise)

11,759 16,203 18,655 21,473 24,901 15.4 Integration of Elder brands will drive synergies in pain and nutraceuticals. CNS, cardio, diabetes, GI and dermatology continue to grow ahead of the market.

International sales 25,814 27,110 37,991 31,656 35,682 9.6 Driven by launches in the US market.

US 7,760 8,314 18,881 10,686 12,823 15.5 Despite being a late entrant, it has ramped up the US business through large launches like generic Cymbalta and generic Abilify. New launches will continue to drive growth.

Brazil 5,330 6,056 5,430 6,082 6,811 4.0 40 products approved, 20 products await approval. Negative impact of currency; expect local currency growth of c.16-18% over the next three years. Largest Indian company in this market.

Others 12,724 12,741 13,680 14,889 16,048 8.0 Includes Germany, Russia, Dossier income, other Latam and Asian markets.

Contract manufacturing

2,790 2,540 3,542 3,742 3,807 14.4 Mostly from manufacture of human insulin, supply for Novo Nordisk (NOVOB:DC; Hold) for the Indian markets.

Net sales 40,363 45,853 60,187 56,871 64,390 12 Driven mainly by US. India sales driven by Elder portfolio.

EBITDA margin (%) 19.9 20.8 35.5 24.7 25.8 Driven by India and US. Dip in FY17E and FY18E due to generic Abilify in FY16E. R&D cost c.4-5% of sales.


India business focuses on key chronic segments/synergies from Elder brands

Torrent is one of the leading players in key chronic therapies – Cardio Vascular

(CV) and neuro-psychiatry (CNS). In FY14, CV, CNS and oral anti-diabetes

accounted for c.60% of India sales.

Figure 140: Therapeutic area-wise breakdown of branded formulations

% FY04 FY06 FY08 FY11 FY12 FY13 FY14 FY15 Top three brands

CV 33 33 35 33 35 36 36 26 Nikoran, Dilzem, Nebicard

GI 22 21 19 19 18 18 18 13 Domstral, Nexpro RD, Nexpro

CNS 18 19 21 21 19 18 18 13 Alprax, Lamitor, Pregeb M

Anti-infective 15 16 10 13 11 9 8 6 Topcef, Droxyl, Moxif

Pain 6 4 4 4 4 4 4 NA Lefra, Diclogesic, Torcoxia BCD

Oral anti-diabetes 3 4 6 5 8 8 8 6 Azulix-MF, Voglitor, Dibeta

Others 3 3 5 5 5 7 8 36 Largely includes Elder brands


Figure 139: IPM vs. Torrent

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20.0

22.0

24.0


MA

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gro

wth

(%

)

IPM Torrent Pharma


2 December 2015

Health Care



Elder portfolio synergies to improve field force productivity

Torrent has rationalised its India field force following the acquisition of certain

brands from Elder Pharma in FY15. The current per man per month

productivity is c.INR 0.6m, and we estimate it to be c.INR 1m over the next

three years. We expect synergies with the acquired Elder portfolio and an

improvement in field force productivity to drive the EBITDA margin. Post the

acquisition of the Elder brands, Shelcal (annual sales INR 2.14bn, segment-

Vitamins), Chyromal (annual sales INR 820m, segment-Pain) and Carnisure

(annual sales INR 220m, segment-CV) sales have increased at a steady rate.

Figure 141: Monthly secondary sales of Shelcal and Chymoral Forte

Source: AIOCD AWACS, Deutsche Bank)

US business expected to see launches of c.8-10 products a year

Torrent has c.50 ANDA approvals and c.20 ANDA pending approvals. It

expects to file c.10-20ANDs per year and launch c.8-10 products annually. We

expect Torrent’s R&D costs to be c.4-5% of sales over the next three years.

Among the key products in Torrent’s pipeline is generic Seroquel XR (branded

market is c. USD 1.3bn; Torrent has settled for a November 2016 launch, along

with five to six other players).

Figure 142: Torrent’s key generic drug pipeline


Q1 Benicar Daliresp, Viagra, Bystolic, Latuda

Q2 Crestor

Q3 Enablex Seroquel XR

Q4

Can launch on approval Luvox CR, Diovan HCT


Post the integration of the

Elder brands in July 2014,

sales of Shelcal and Chymoral

have grown by c.22-25%

2 December 2015

Health Care



Valuation and risks

Valuation

We use PER as our principal valuation matrix for Indian Pharma. Torrent’s

growth across its focus segments in India has been ahead of the market’s

growth, and we expect synergies with the Elder brands to sustain the growth

momentum in the domestic markets. While the US business has more than

doubled in the past two years, the higher base and lack of similar-sized

opportunities will result in moderate growth. For the India and US businesses,

which together contribute c.53% of sales, we forecast CAGRs of 15.4% and

15.5%, respectively, over FY15-18.

Torrent has re-rated substantially, and is now trading at par with its peers,

mainly on the back of significant growth in the US business, owing to the

launch of generic Cymbalta (in FY15) and generic Abilify in (FY16), and also

owing to synergies in the India business post the acquisition with Elder

Pharma. The year-on-year fall in earnings in FY17E is due mainly to a higher

base of generic Abilify. We assign a target PER of 20x, which is c.60% higher

than its three-year average one-year forward PER of 13x. Our target PER is at a

discount of 10% and 15% to Sun and Lupin, respectively, and factors in the

scale of business of these two companies in the India and US markets. Thus

we rate Torrent a Buy, with a target price of INR 1,672 on our FY18E recurring

EPS.

Figure 143: PE band – Torrent

0

400

800

1,200

1,600

2,000

31-M

ar-0

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09-S

ep-0

9

18-F

eb-1

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4

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5

16-J

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5

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Source: Deutsche Bank, Bloomberg (data as of 30/11/2015)

Risks

Key downside risks include a slower-than-expected growth rate in the Indian

formulations market, incremental products brought under price control in

India, lower product launches in the US generic markets, and higher-than-

expected pricing pressure in its key generic markets − Brazil, Russia and

Germany.

2 December 2015

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Company description

Torrent was incorporated in 1959 as Trinity Laboratories and, in 1971, it was

renamed to Torrent Pharmaceuticals Ltd. Torrent engages in the manufacture

and sale of branded and generic pharmaceutical products in India and

internationally. Further, it offers contract manufacturing services and the

supply of insulin formulations under the third-party brand name. Torrent

exports to more than 50 countries around the world, and has four

manufacturing plants in India. Its key acquisitions have been Heumann, Elder’s

key India brands and Zyg Pharma. In the Indian pharmaceutical market,

Torrent Pharma is ranked 14th, with a 2.4% focus on chronic segments. In

FY15, Brazil sales contributed c.13% of Torrent’s sales, making the company

the largest Indian company in Brazil.

Management summary



Mr. Sudhir Mehta

Chairman Emeritus

Instrumental in the diversification of the Torrent Group into the power sector. Took over as the Chairman of the Torrent Group in 1998.

Mr. Samir Mehta

CEO Associated with the company since 1986.

Mr. Ashok Modi

ED & CFO Appointed CFO in FY14.





2015 Acquisition 100% stake in Zyg Pharma Pvt Ltd

2013 Acquisition

Branded domestic formulations business of

Elder Pharmaceutical in India and Nepal for

INR 2,004 crore


2006 Stock SplitAdjustment Factor - 2; new Face Value: INR

5

2005 Acquisition Heumann Pharma GmbH & Co of Germany

2002 Divestiture

Rights to its patented AGE (Advanced

Glycosylation Endproducts) breaker

compound

0% 20% 40% 60% 80% 100%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Sep‐15Promoter

FIIs

Others

Mutual Funds/UTI

Bodies Corporate




Figure 144: Revenue split, FY15

Domestic sales35%

International sales59%

Contract manufacturing

6%


2 December 2015

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Company financials


Year-ending 31 March (INR m) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Domestic sales 8,210 9,233 10,447 11,833 16,282 18,751 21,557 24,997

International sales 11,016 14,332 17,849 25,814 27,110 37,991 31,656 35,682

Contract manufacturing 2,380 2,427 2,310 2,790 2,540 3,542 3,742 3,807

Total gross revenue 21,606 25,992 30,606 40,437 45,932 60,283 56,955 64,486

Excise 387 48 71 74 79 96 84 96

Net sales 21,220 25,944 30,535 40,363 45,853 60,187 56,871 64,390

yoy growth% 15.8% 22.3% 17.7% 32.2% 13.6% 31.3% -5.5% 13.2%

Total op. exp. 18,173 21,953 25,189 32,332 36,333 38,850 42,845 47,802

EBITDA 3,047 3,991 5,346 8,031 9,520 21,337 14,026 16,588

Margins % 14.4% 15.4% 17.5% 19.9% 20.8% 35.5% 24.7% 25.8%

yoy growth% -9.8% 31.0% 33.9% 50.2% 18.5% 124.1% -34.3% 18.3%

Depreciation 626 817 827 870 1,907 2,416 2,761 3,120

EBIT 2,421 3,174 4,519 7,161 7,613 18,921 11,265 13,468

Other income 1,176 1,460 2,010 1,866 3,537 4,303 4,730 5,207

Interest 387 395 338 586 1,752 1,922 961 304

PBT 3,211 4,240 6,191 8,440 9,398 21,301 15,035 18,371

Tax 725 723 1,467 1,801 1,888 7,043 3,458 4,225

Tax rate (%) 22.6% 17.1% 23.7% 21.3% 20.1% 33.1% 23.0% 23.0%

Minority interest -0 23 22 0 0 0 0 0

Adj. PAT 2,486 3,494 4,703 6,639 7,509 14,258 11,577 14,146

Net margin 11.7% 13.5% 15.4% 16.4% 16.4% 23.7% 20.4% 22.0%

Extraordinary items 216 -654 -375 0 0 0 0 0

Reported PAT 2,702 2,840 4,328 6,639 7,509 14,258 11,577 14,146



Year-ending 31 March (INR m) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E


Depreciation 626 817 827 870 1,907 2,416 2,761 3,120

Net chg in WC 190 903 (2,350) (3,034) (3,081) (6,254) 2,832 (2,383)

Others (744) (689) (1,724) (2,240) (660) (7,043) (3,458) (4,225)

CFO 3,498 4,618 2,570 4,036 7,564 10,420 17,169 14,882

Capex (2,270) (1,820) (2,721) (3,914) (22,923) (4,500) (5,000) (6,000)

Net investments made (10) (175) 375 - (0) 0 - -


CFI (2,280) (1,995) (2,346) (3,914) (22,923) (4,500) (5,000) (6,000)

Change in share capital - - 0 - - - - -

Change in debt 497 67 1,142 4,388 16,086 - (11,500) (10,000)

Div & div tax (787) (836) (2,276) (1,980) (2,284) (4,158) (3,366) (4,158)

Others 15 (294) 176 146 656 604 489 604

CFF (275) (1,063) (957) 2,554 14,458 (3,554) (14,377) (13,554)

Total cash generated 943 1,560 (734) 2,676 (901) 2,366 (2,208) (4,672)


Cash closing balance 6,048 7,608 6,874 9,551 8,650 11,016 8,808 4,136


2 December 2015

Health Care




As at 31 March (INRm) FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Paid-up capital 423 423 423 846 846 846 846 846


Total equity 10,224 11,938 14,219 19,024 24,906 35,610 44,309 54,901

Minority interest 16 35 4 4 4 4 4 4

Total debt 5,721 5,787 6,930 11,318 27,404 27,404 15,904 5,904

Deferred liabilities 480 514 258 -182 0 0 0 0


Total current liabilities & provisions 8,916 12,204 15,868 19,270 24,406 22,474 23,289 24,687


Net fixed assets 8,154 9,157 11,051 14,095 33,904 36,000 38,249 41,139

Intangibles - - - - 159 148 137 128

Investments 200 375 0 0 1 0 0 0

Inventory 5,048 5,316 9,239 10,061 10,672 9,808 9,816 10,558

Debtors 3,404 5,228 6,878 10,994 15,945 20,930 18,697 21,522



Total current assets 17,003 20,947 26,227 35,340 42,656 49,344 45,119 44,229

Total assets 25,357 30,479 37,278 49,434 76,720 85,492 83,506 85,496



Year-ending 31 March FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E

Adj EPS (Rs) 14.7 20.6 27.8 39.2 44.4 84.2 68.4 83.6

yoy growth% 13.5 40.5 34.6 41.2 13.1 89.9 -18.8 22.2

EBITDA - core (%) 14.4 15.4 17.5 19.9 20.8 35.5 24.7 25.8

NPM (%) 11.7 13.5 15.4 16.4 16.4 23.7 20.4 22.0

Net debt to equity (x) net cash net cash 0.00 0.09 0.75 0.46 0.16 0.03

ROCE (%) 20.0 18.5 23.5 27.2 20.9 26.9 19.8 23.7

DPS (Rs) 4.0 4.2 11.5 10.0 11.2 21.0 17.0 21.0

Dividend payout (%) 25.1 25.3 45.0 25.5 25.4 24.9 24.9 25.1


2.2 2.5 2.5 2.3 1.4 1.2 1.1 1.2

Avg collection days 55 61 72 81 107 112 127 114

Avg inventory days (on opex.) 83 86 105 109 104 96 84 78


2 December 2015

Health Care



Appendix 1

Important Disclosures

Additional information available upon request *Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Kartik Mehta Equity rating key Equity rating dispersion and banking relationships

Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ) , we recommend that investors buy the stock. Sell: Based on a current 12-month view of total share-holder return, we recommend that investors sell the stock Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell. Notes:

1. Newly issued research recommendations and target prices always supersede previously published research. 2. Ratings definitions prior to 27 January, 2007 were:

Buy: Expected total return (including dividends) of 10% or more over a 12-month period Hold: Expected total return (including dividends) between -10% and 10% over a 12-month period Sell: Expected total return (including dividends) of -10% or worse over a 12-month period

52 %

38 %

11 %18 %11 % 15 %

050

100150200250300350400450500

Buy Hold Sell

Asia-Pacific Universe

Companies Covered Cos. w/ Banking Relationship

Regulatory Disclosures

1.Important Additional Conflict Disclosures

Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the

"Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

2.Short-Term Trade Ideas

Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are

consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the

SOLAR link at http://gm.db.com.

2 December 2015

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Additional Information

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convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and

settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed

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liabilities, and as such, investors should take expert legal and financial advice before entering into any transaction similar

2 December 2015

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2 December 2015

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Copyright © 2015 Deutsche Bank AG

GRCM2015PROD034948

David Folkerts-Landau

Chief Economist and Global Head of Research

Raj Hindocha

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Marcel Cassard Global Head

FICC Research & Global Macro Economics

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Equity Research

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Equity Research, Germany

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