Você está na página 1de 100

HEALTHCARE

September 2014

Product
selection

Sales
execution

Event specific
risk
Base
business
growth

Drivers of
growth

Newer
avenues
for growth

Associated
risk to
growth

Regulatory
risk

Therapeutic
coverage

Geographical
coverage

Thematic:
Analysts:
Aditya Khemka
adityakhemka@ambitcapital.com
Tel: +91 22 3043 3272
Paresh Dave
pareshdave@ambitcapital.com
Tel: +91 22 3043 3212

Sales force
productivity

Mid-size pharma - DNA for growth

Healthcare

CONTENTS
SECTOR
Healthcare: Mid-sized pharma: DNA for growth.. 3
Mid-sized pharma: Apples or Oranges4
Introduction to Indian pharmaceuticals...8
Deep dive into IPMs evolution; regulation says innovate! .10
Challenges ahead for mid-sized pharma. 14
Analysing sustainability: Business DNA.15
Valuations not in sync with DNA.28
Suggest switching from Aurobindo (SELL) to Cadila (BUY)31
Case studies 33

COMPANIES
Cadila Healthcare (BUY): Multiple levers for growth37
- Snapshot of company financials 38
- Cadila Diversified revenue streams.. 39
- Gaining lost ground. 40
- Mapping competitive advantage The 5 Rs 43
- Cadila has multiple levers for growth.. 48
- Valuation discount to large-caps to narrow 56
- Accounting analysis No concerns.. 61
Aurobindo Pharma (SELL): Structural issues galore. 67
- Snapshot of company financials 68
- Aurobindo Opportunistic and fragile.69
- Snowballing of a most humble beginning.. 70
- Low rank in our competitive framework the 5 Rs. 71
- US formulations the only growth driver but a no moated business 77
- Base business EBITDA margins and RoCE to improve till.85
FY17E but decline thereafter
- Valuation Deserves a deep discount to large-caps 88
- Accounting analysis some RED flags. 94

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 2

Healthcare
POSITIVE
THEMATIC

September 16, 2014

Mid-sized pharma companies have been able to establish themselves in


domestic formulations. Whilst the growth in India would continue, these
companies are considering exports to broaden their growth horizon. As
traction in the US market is unlikely in the absence of a compelling
proposition, we favour mid-sized companies with a commensurate EM
focus and a track record of creating a strong branded business. Our
business DNA framework serves as a valid proxy for probable success in
EMs. Ajanta, IPCA, Torrent and Glenmark are best placed on our
framework. We initiate coverage on Cadila (BUY) and prefer it over
Aurobindo (SELL), due to Cadilas: (a) better score on our competitive 5
R framework; (b) significantly stronger presence in branded markets like
India; and (c) higher investments in innovative pursuits like biosimilars
and NCEs.
Mid-sized pharma names have established domestic market presence
The domestic market share for the top-10 Indian pharma companies in FY08-14
has increased 966bps to 38.1% and that for the next 30 companies has
increased by 277bps to 44.5%. Whilst stalwarts like Sun and Lupin have recorded
a CAGR of >20%, mid-sized companies like IPCA, Glenmark, Torrent, Indoco
and Ajanta have beaten the Indian pharma market (IPM) consistently. However,
the quality of growth across companies varies, with growth being driven by all or
some of the levers at the companies disposal.
Mapping the sustainability of growth in India
We map the strength of the domestic franchise by creating a Business DNA
framework. We analyse: (a) the current Drivers for growth that would help
sustain the growth momentum (product selection, sales execution and brand
equity); (b) Newer avenues for growth (therapeutic coverage, geographical
coverage and sales force productivity); and (c) Associated risks (structural and
event-specific risks).

Key Recommendations
Lupin

BUY

Target Price: `1,387

Upside 2%

IPCA

BUY

Target Price: `949

Upside: 16%

Cadila

BUY

Target Price: `1,510

Upside: 19%

Aurobindo

SELL

Target Price: `828

Downside: 8%

We prefer Cadila over Aurobindo


despite higher valuations due to
higher ranking on 5R and RoCE
21
19

Sun
Pharma

17
EV/EBITDA (FY16E)

Mid-sized pharma - DNA for growth

Cadila

15
13

Cipla

Dr.
Reddy's Glenmark

11
9

Lupin
IPCA

Aurobind
o

7
5
10

20

30

40

RoCE (FY14)

DNA of the domestic franchise is a good proxy for EM export prospects


Most of the mid-sized pharma companies have started tapping exports to
broaden their growth horizon. However, with consolidation of the buy and supply
side in regulated markets like the US, we believe mid-sized companies may face
challenges unless they have compelling propositions. Hence, mid-sized
companies with a commensurate EM focus are likely to perform better. Ajanta,
IPCA, Torrent and Glenmark are best placed on our framework.
Initiate coverage on Cadila (BUY) and prefer it over Aurobindo (SELL)
Whilst both Cadila and Aurobindo trade at similar market-caps and are set to
benefit from a large ANDA pipeline in the US, we prefer Cadila over Aurobindo,
due to Cadilas: (a) better score on our competitive 5 R framework; (b)
significantly stronger presence in branded markets like India; (c) higher
investments in innovative pursuits. Our DCF fair multiple of 19.0x one-year
forward P/E for Cadila vs 10.0x for Aurobindo reflects terminal RoCEs of 17%
and 12% respectively.

Analyst Details
Aditya Khemka
+91-22-3043 3272
aditya.khemka@ambitcapital.com
Paresh Dave
+91-22-3043 3212
pareshdave@ambitcapital.com

Our coverage summary


Company
Sun Pharma
Lupin Ltd
Dr. Reddy's
Cadila Health
Ipca
Aurobindo

Rating
BUY
BUY
BUY
BUY
BUY
SELL

CMP
Mcap
P/E
P/E
(`) (US$mn) (FY15E) (FY16E)
806
27,495
32
25
1,359
10,042
25
22
2,959
8,296
22
20
1,273
4,292
26
19
820
1,703
20
16
896
4,302
17
13

TP (`)
730
1,387
3,149
1,510
949
828

Upside / Implied P/E Implied P/E


Downside
(FY15E)
(FY16E)
-9%
28.5
24.8
2%
25.6
22.7
6%
23.8
20.8
19%
31.1
22.2
16%
22.9
18.2
-8%
14.2
11.3

EPS CAGR
(FY08-14)
9%
33%
22%
11%
23%
29%

EPS CAGR
(FY15E-17E)
21%
17%
19%
31%
21%
31%

RoCE (FY14)

Source: Company, Ambit Capital research


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

38%
26%
16%
17%
31%
24%

Healthcare

Mid-sized pharma: Apples or Oranges


Mid-sized pharma companies have been able to establish themselves in
domestic formulations over the years using various means of market
penetration. Whilst some companies have resorted to being present across
the market, others have been able to grow by gaining more market share in
a few segments. Whilst the growth in the Indian pharma market would
continue, the mid-sized pharma companies are looking towards exports to
broaden their growth horizon. As traction in the US market is unlikely in the We favour companies with an EM
absence of a compelling proposition, we favour mid-sized companies with a focus and track record of creating
commensurate emerging market (EM) focus and a track record of creating a strong branded businesses
strong branded business. Our business DNA framework serves as a valid
proxy for probable success in EMs and sustainability of profits from the
domestic business.
Mid-sized pharma companies have established themselves in India
The market share for the top-10 pharma companies in India has increased 966bps to
38.1% and that for the next 30 companies has increased by 277bps to 44.5% over
FY08-14. Whilst stalwarts like Sun Pharma and Lupin have expanded at a CAGR of
more than 20%, mid-sized companies like IPCA, Glenmark, Torrent Pharma, Indoco
and Ajanta have beaten the broader market consistently. However, the quality of
growth across companies varies. We strive to distinguish the companies that have
exhibited a superior quality of growth (rather than the quantum) as compared to their
peers.

The quality of domestic growth


across companies varies

Exhibit 1: Sales CAGR over FY08-14 reflects strong growth by mid-sized pharma
companies
30%
24%

25%
19%

20%

5%

6%

6%

FDC

Strides

Wockhardt

Claris

7%

8%

Indoco

4%

5%

Ranbaxy

10%

Unichem

15%

5%

24%

10% 11%

15%
13% 14%

Biocon

Ajanta

IPCA

Glenmark

Natco

Alembic

Torrent

Cadila

0%

Source: AIOCD data, Ambit Capital research

Current
market
wisdom
seems
to
suggest
buying
headed/expected to ramp up towards US/regulated markets

companies

The recent ramp up in valuations of many Indian mid-caps seems to suggest


premium valuations for companies with growth prospects in the US market. Stocks
such as Indoco Remedies, Cadila, and Aurobindo have re-rated due to their visible
growth prospects in the US market.

16 September 2014

Ambit Capital Pvt. Ltd.

Companies with growth prospects


in the US have premium valuations

Page 4

Healthcare
Exhibit 2: Indoco plans to foray into the US market, whilst Aurobindo is likely to ramp
up its US operations (stock price indexed to 100 and adjusted for dividends)
500
400
300
200
100

Strides

Indoco

Aurobindo

Glenmark

Aug-14

Aug-14

Jul-14

Jun-14

Jun-14

May-14

Apr-14

Apr-14

Mar-14

Feb-14

Jan-14

Jan-14

Dec-13

Nov-13

Nov-13

Oct-13

Sep-13

Sep-13

Aug-13

Cadila

Source: Bloomberg, Ambit Capital research; Note: We have adjusted Strides performance for the special
dividend of Rs500/share paid in December 2013

Regulated markets generics growth sustainability cannot be taken for


granted
The US and other regulated markets are low-gestation markets and we agree that
these markets present an opportunity for these mid-sized companies to grow;
however, we would like to remind investors that the sustainability of profits from
selling generics in these markets cannot be taken for granted. We illustrate our point
by taking the example of generic Protonix sold by Sun Pharma (Brand Pantocid) in
India and the US.
Exhibit 3: Brand Pantocid continues to provide a steady
revenue stream for Sun Pharma in India

Exhibit 4: After the initial revenue flows from generic


Protonix, Sun withdrew from the US market

Pantocid-India

Protonix-US

1,200

613

600

150
135

130

120

720

In US$ mn

In ` mn

140

892

800

400

160

1,040 1,071

1,000

Sustainability of profits in regulated


markets cannot be taken for
granted in the absence of a
compelling proposition

478
361

100

80

80
60
40

200

20

FY08 FY09 FY10 FY11 FY12 FY13 FY14

FY08 FY09 FY10 FY11 FY12 FY13 FY14


Source: AIOCD data, Ambit Capital research

Source: Walter-Kluwer data, Ambit Capital research

Larger companies like Sun Pharma, Dr. Reddys and Lupin have exhibited the
capability of sustaining and growing profits in regulated markets consistently. The
sustained growth momentum has been a result of investments in R&D (scaling up the
value chain), excellence in execution (gaining market share and logistics excellence)
and scale (large basket of product offering) amongst other things.
Mid-sized companies are yet to
fully establish themselves in
However, mid-sized pharma companies are unlikely to repeat the performance of the
regulated markets
larger pharma companies. Barring IPCA, Cadila and Aurobindo, we believe other
mid-sized firms are yet to fully establish themselves in the US and other regulated
markets and the jury is still out on the sustainability of their growth prospects.

16 September 2014

Ambit Capital Pvt. Ltd.

Page 5

Healthcare
Exhibit 5: Mid-sized pharma companies like Ajanta, FDC and Biocon have no US
revenues
% of Total Revenue
` mn

Domestic

US

FDC

82.0%

0.0%

18.0%

Biocon

37.0%

0.0%

63.0%

Ajanta

32.5%

0.0%

67.5%

IPCA

36.7%

7.0%

56.3%

Natco

75.6%

13.3%

11.1%

Torrent

28.0%

18.6%

53.4%

Unichem

60.0%

18.9%

21.1%

Cipla

38.8%

19.0%

42.2%

Alembic

52.0%

25.0%

23.0%

Indoco

65.0%

28.8%

6.2%

Cadila

34.2%

30.1%

35.7%

Ranbaxy

17.7%

32.2%

50.1%

Glenmark

26.6%

32.2%

41.2%

7.3%

36.8%

55.9%

Dr. Reddy

11.9%

41.8%

46.3%

Lupin

25.1%

42.4%

32.5%

Wockhardt

21.0%

44.0%

35.0%

Claris

50.0%

50.0%

0.0%

Sun Pharma

22.1%

60.4%

17.5%

Strides

Source: Company, Ambit Capital research

Several challenges to growth in US/regulated markets for mid-sized pharma


We believe that to earn initial revenues in the regulated markets of Europe and the
US is a relatively simple task once the manufacturing and product registration hurdles
are overcome. Moreover, these revenues generally carry higher than consolidated
margins due to better realisations and thus look attractive to the entrepreneur and
analyst alike.
However, with the ongoing consolidation of the buy and supply side in the US, we
believe the regulated markets would increasingly start favouring scale, and life will be
difficult for mid- to small-sized companies with no significant value proposition.

Consolidation in the buy and


supply side to favour scale

For example, IPCA and Aurobindo offer a low-cost value proposition whilst Cadila
offers a technology advantage which keeps its prospects in these markets strong;
however, not all mid-sized companies have similar propositions.
Branded generic exports offer sustainable growth for mid-sized companies
We believe mid-sized pharma companies are better off exploring the branded generic
export markets, given their relevant experience in the Indian pharma market. Even as
these markets offer lower margins and RoCEs as compared to the US initially and
have higher gestation periods, we believe that lower upfront investments and the
sustainability of revenues and profits from these geographies makes them the most
viable avenue for growth.

16 September 2014

Ambit Capital Pvt. Ltd.

Lower upfront investments and


sustainability make RoW a viable
avenue for growth

Page 6

Healthcare
Exhibit 6: Teva and Actavis have shown that the RoW market has provided better
growth than overall revenue growth

Five-year revenue CAGR over CY08-13


32.4%

35.0%

27.9%

30.0%
25.0%
20.0%

17.9%
12.9%

15.0%
10.0%
5.0%
0.0%
Teva

Actavis
RoW

Overall

Source: Company, Ambit Capital research

The branded generic markets, excluding some minor details, largely mirror the Indian
market, and hence, we believe that a successful track record in India can be taken as
a valid proxy for probable success in these markets.

Branded generic markets largely


mirror the Indian market

Lets not forget that the India business itself is of prime importance for midsized pharma
Whilst the broadening growth horizon is a positive, we do not want to lose sight of
the fact that the quality of growth in India also determines the sustainability of profits
from the domestic business as well. Hence, we take a deep dive into the evolution of
the Indian market and the quality of growth exhibited by mid-sized Indian companies
using our business DNA framework. The exercise helps us in: (a) projecting the
sustainability of revenues in India and (b) extrapolating the success of the Indian
business to other branded generic exports.

16 September 2014

Ambit Capital Pvt. Ltd.

Quality of growth in India


determines the sustainability of
profits from the domestic business

Page 7

Healthcare

Introduction to Indian pharmaceuticals


Industry structure
The Indian pharma market (IPM) represents a secular growth opportunity amidst
intense competition. However, the branded nature of the market ensures that once
the brand is established, brand equity drives a certain portion of growth. Owing to
low regulatory hurdles and reasonable margins, the market offers RoCEs ranging
from 15% for small players to 30% for the larger ones.

Brand equity drives a certain


portion of growth

Secular growth
The IPM is experiencing secular growth characterised by: (a) rising income levels,
ensuring affordability; (b) higher health awareness, leading to higher diagnosis; (c)
better penetration of diagnostic clinics, leading to better patient access; (d) increasing
insurance penetration, ensuring affordability, and (e) worsening lifestyle in urban
centres, causing high incidence of chronic diseases like diabetes, psychiatric diseases
and neurological disorders.
Historically, the IPM has grown at 12-15% per annum, comprising: (a) Volume growth
(7-8%); (b) New introductions (3-5%) and (c) price increases (1-2%).
Exhibit 7: The IPM has registered higher CAGR of 13.1% over FY05-14 as compared to
real GDP (7.4%) and disposable income (4.2%)

Historically, the IPM has grown at


12-15% per annum

India Pharma Market Growth > Indian GDP growth


800
700

in ` billion

730

FY13

FY14

630

600

544
477

500

418

400
300

705

240

276

315

363

200
100
FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Source: AIOCD, CIEC data, Ambit Capital research

Organic consolidation
The IPM is amongst the most competitive markets globally. The Herfindahl-Hirschman
Index (HHI) for the market is at 229 (for FY14) as compared to the US markets 593
(monopoly would have an index value of 10,000 and perfect competition would tend
to 0). However, despite intense competition, the market is experiencing organic
consolidation.

16 September 2014

Ambit Capital Pvt. Ltd.

Indian pharma market is the most


competitive globally

Page 8

Healthcare
Exhibit 8: Herfindahl-Hirschman Index (HHI) indicates organic consolidation
235

HHI

230

228

227

229

225
220

223

217

215
210
205

213

212

210

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-07

200

Source: AIOCD, Ambit Capital research

We believe that the factors contributing to consolidation despite intense competition


are: (a) Branded nature of the IPM: Companies can establish their branded
generic product in a given therapy area and leverage upon it to expand to more
products in the same therapy or a different therapy with the same audience (doctors).
(b) Incentives to sales force generally higher for larger companies: The larger
the organisation, the more it can spend on incentivising its sales force and other
stakeholders (distributors, retailers and doctors). Higher incentives lead to higher
sales and make up for the expenditure in promotion costs through operating
leverage. (c) Partnerships and alliances: Larger companies have been the
preferred partners for those companies that do not have a local distribution and sales
network in India. This adds to the portfolio basket of the larger companies and
bundled with higher R&D capability and bandwidth again results in organic
consolidation.

Branded nature of IPM, higher


incentives to sales force and
alliances to drive market
consolidation

Market share for MNCs declined post 1970


The market share for MNCs has declined from more than 70% before the 1970s to
less than 25% in FY14. The rise of several domestic companies with low-cost
advantages and brand equity built over time has caused the erosion in market share
for MNCs.
Exhibit 9: Indigenous companies have increased market share by leveraging their low-cost advantage

1970

2014
22%

32%

68%
78%

MNC

Indigenous

MNC

Indigenous

Source: AIOCD, Ambit Capital research

MNCs being innovators are excluded from our consideration set


We exclude local subsidiaries of multinational corporations (MNCs) from our analysis,
as: (a) the local subsidiaries are trading entities with negligible exports and (b) the
parent entities are innovators with high brand equity globally due to R&D.

16 September 2014

Ambit Capital Pvt. Ltd.

Page 9

Healthcare

Deep dive into IPMs evolution; regulation


says innovate!
A deep dive into the Indian pharmaceutical markets history suggests that
the regulations post-independence were aimed at importing expertise,
technology and capital through MNC participation. Whilst import was
enabled by various regulations, affordability and local participation in
manufacturing were also ensured. The re-introduction of product patent, tax
breaks on R&D spend and higher span of price regulation in recent times
seems to be aimed at ensuring affordability and pushing the new-age
entrepreneurs towards innovation, which we believe is the end-game.

Phase I (pre-1947): The age of MNCs/no direction for a


domestic industry
Low presence of domestic manufacturers
The British Government introduced the allopathic form of medicine in India. Drugs
were imported by foreign companies and marketed in India. The indigenous industry,
consisting of very few entrepreneurs, contributed little to the total demand (13% of
demand met by Indian companies).
World War II provided the opportunity for indigenous players
However, during World War II (1939-1945), foreign companies were unable to
supply drugs to India. This resulted in the establishment of Indian companies such as
Unichem, Cipla, Zandu Pharmaceuticals, and Calcutta Chemicals. Gradually,
domestic contribution to total demand in the Indian market rose to 70%. The key
highlight of this period was focus on production-related activities rather than
R&D activities.

MNCs had 87% share in the


domestic market

WW II led to short supply from


MNCs; domestic companies met
70% of domestic demand

Phase II (1947-1970): Regulatory push helps in the rise


of domestic bulk manufacturing
Domestic companies failed to participate in global R&D revolution
Even as pharma companies globally started making sizable investments in R&D
during this period, the Indian industry could not participate due to lack of knowledge,
experience and capital. Whilst through the Industrial Policy Statement (1948), the
Government of India (GOI) allowed MNCs to establish a manufacturing base in India,
MNCs imported bulk drugs and assembled/marketed the product locally.
Industrial Licensing Policy 1956 succeeded in importing technology
The Government of India in its Industrial Licensing Policy, 1956, made it compulsory
for foreign companies to establish production units in India and produce
drugs from the basic stage. At the same time, the Government, on its own, set up
Hindustan Antibiotics (1954) and Indian Drugs and Pharmaceuticals Ltd (1961) to
start the production of important drugs. These public sector units have played an
important role in shaping up new-age entrepreneurs like Anji Reddy, who
was an ex-employee of a Government entity.
Also, the research impetus by the Government through the establishment of
sponsored research institutes helped in fostering the technological environment for all
the current top domestic pharmaceuticals companies. This resulted in domestic
companies capturing a significant share in the bulk drug segment.
However, MNCs continued to have monopoly in high-payoff formulation
products, resulting in prices that were as high as in developed nations.

16 September 2014

Ambit Capital Pvt. Ltd.

The Industrial Policy (1948) failed


to import technology, as MNCs
assembled imported drugs

PSUs established by the GoI played


an important role in shaping up
new-age entrepreneurs like Anji
Reddy

MNCs continued to sell formulation


products at high prices

Page 10

Healthcare

Phase III (1970-1991): The regulatory troika; the


emergence of Indian generics
Patent Act, Foreign Exchange Regulation Act (FERA) and New Drug Policy
In order to bring the prices to normalised levels and make it affordable to everyone,
the Government of India amended the Patent Act 1970 and enacted the Foreign
Exchange Regulation Act (FERA) 1973 and New Drug Policy 1978.
Patent Act, 1970: The Patent Act abolished product patents and recognised only
process patents. The Indian companies could now patent their own processes and
compete with MNCs in the formulations market.
FERA, 1973: FERA was implemented to compel MNCs to manufacture hightechnology bulk drugs through restrictions on equity holdings (<40%
stake allowed for commoditised bulk drugs vs 74% for high tech). Further,
50% of bulk drugs manufactured by MNCs were to be sold to nonassociated companies.
New Drug Policy (NDP), 1979: In order to bring prices under control, the NDP
was revised in 1979 to restrict the prices of 349 drugs on a cost-plus basis
(DPCO 1978).

The Patent Act 1970 abolished


product patents and recognised
only process patents

FERA (1973) compelled MNCs to


manufacture high-tech drugs in
India

Phase IV (1991-2005): MNCs edged out


Due to the competence gained by the domestic companies in process re-engineering,
the Indian companies emerged as major players in the domestic market.
New Drug Policy, 1994: Welcoming FDI; reduction in span of price control
The New Drug Policy of 1994 and 2002 abolished the licensing requirement for entry
and expansion of firms. Further, 100% inward foreign direct investment was allowed.
Even as India had emerged as one of the cheapest producers of drugs, prices
continue to be controlled on the basis of cost of production, but only for essential
drugs. As per the NLEM (National List of Essential Medicines), 74 drugs were brought
under price control.

Phase V (2005
regulation/impetus
sustenance

onwards): Balancing act on


now on innovation and self-

Effects of Amendments to Patent Act, 1970: Reincarnation of product patents


The 2005 amendment led to the re-introduction of 20-year product patents.
Product patents make reverse engineering illegal. However, Section 84 (compulsory
licensing) and Section 3(d) (patentability criteria) safeguards public interest.
In an unprecedented act in 2012, compulsory license was awarded for Nexavar
(Bayer) to Natco Pharma. Whilst the innovator stands to lose out on profits,
compulsory licensing helps in affordability and the generic companies still make
profits, as they do not have to incur R&D costs. Further, Novartis was denied a patent,
as the Indian courts felt that it failed the patentability criteria under Section 3(d).
National Pharmaceuticals Pricing Policy (2012): Higher span of price control
(a) The scope of NPPP 2013 is much broader than 1995, which thus maintains
affordability
(b) Market-based pricing instead of cost-based pricing, which protects industry
interests
This policy has expanded beyond NLEM (order passed in July 2014 on non-essential
diabetic and cardio drugs). This order is now being contested in court.

16 September 2014

Having established domestic


manufacturing, the GoI invited
MNCs to invest in India through
FDI; the span of price control was
reduced

Ambit Capital Pvt. Ltd.

Re-introduction of 20-year product


patents and implementation of
compulsory license and
patentability criteria

Broader span of price control,


beyond products under NLEM

Page 11

Healthcare
Foray into NCEs and NDDS: Large domestic companies have ramped up R&D
Many of the large domestic pharma companies have evolved from being generic drug
manufacturers to consciously investing in R&D activities to produce novel molecules
(small and large) and drug delivery systems (targeted and passive). We believe this to
be the next leg of growth for the large domestic manufactures. Companies like Dr.
Reddys, Zydus, Lupin and Glenmark have many products in the pipeline in various
stages of development. In 2013, Zydus received an approval for its first NCE, antidiabetic drug, Lipaglyn. Dr. Reddys markets biosimilars in India and EMs and
Glenmark has out-licensed many novel candidates under-development. However,
the relatively smaller Indian generic companies are yet to invest in such
initiatives.

16 September 2014

Ambit Capital Pvt. Ltd.

Large domestic companies focus


on NCEs and NDDS by ramping up
R&D; example, Lipaglyn (Zydus)

Smaller Indian generic companies


are yet to invest in such initiatives

Page 12

Healthcare
Exhibit 10: The ramp up in the number of pharma manufacturing units in India was driven by the introduction of process patents in 1970

25,000

Production Units

20,000

15,000

10,000

(a) Industrial Licensing Policy, 1956 - Compulsory establishment of


production units by foreign companies
(b) Setting up of PSU pharma companies
(a) Preindependence
IPM dominated
by MNCs
(b) WW II
provided
opportunity to
domestic cos.

New Drug Policy, 1994 74 drugs based on NLEM, reducing span of


control

(a) Ammendment of Patent Act, 1970 Moved from 5-year process patent to
20-year product patent
(b) NPPP 2012 - 348 drugs included
under price control
(c) Compulsory licensing, 2012 - GOI
to award compulsory licence to ensure
availability of drugs

(a) Patent Act , 1970 - Introduction of process patent


(b) FERA, 1973 - Compels MNCs to manufacture high tech drugs
(c) NDP, 1979 - Restricts prices of 349 critical drugs

5,000

(a) Import of technology


(b) Breeding ground of
new-age entreprenuers

(a) Domestic companies


started reverse
engineering products
(b) Affordability of
critical medicines

Key events

Its Impact

Opportunity to price
drugs at higher rates
which are not under
NLEM

2013-14

2012-13

2000-01

1989-90

1985-86

1984-85

1983-84

1982-83

1980-81

1979-80

1977-78

1969-70

1960-61

1952-53

Pre 1947

(a) Domestic cos hit as product patent


made reverse engineering illegal
(b) Stringent price controls result in
lower profitability
(c) Compulsory licensing hurt
innovators and benefit generics cos
(d) NCEs and NDDS provides the
next leg of growth for domestic cos

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 13

Healthcare

Challenges ahead for mid-sized pharma


Organic consolidation despite increasing competition
Intensifying competition in the domestic market is a threat to the existing market
players. Attracted by the high RoCEs offered by the domestic branded formulations
business, small domestic pharmaceutical companies have mushroomed. The number HHI suggests organic consolidation
of companies earning more than `500mn from the domestic formulations market has
increased from 108 in FY08 to 122 in FY14, as per AIOCD data.
However, competition has not yet proven detrimental for incumbents and the
domestic formulations market is experiencing organic consolidation.
Exhibit 11: Market share of top-10 companies has increased over FY07-14

Competition has not yet proven


detrimental for incumbents

Market share of top-10 companies

30%
25%

21.0%

20%

16.1%

14.5%

22.2%

23.4%

24.1%

Mar-13

Mar-14

17.7%

15%
10%
5%
0%
Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Source: AIOCD data, Ambit Capital research

We believe, other than the incumbents, a number of mid-sized companies have


exhibited sustainable growth. We list below a number of challenges that are possibly
making life difficult for the smaller Indian players as compared to the incumbents.

Other than the incumbents, a


number of companies have
exhibited sustainable growth

Attrition rate in marketing representatives (MRs)


The industry has seen high attrition rates in past decade. Our primary data checks
suggest that the industry average attrition amongst sales representatives is 30%. Due
to the high attrition rates, the productivity of the sales force has grown at a mere 3%
CAGR over FY05-14. Whilst productivity has remained low, salary increments at 1015% have been higher than inflation. This is due to the high attrition rate, as 15% of
the workforce remains either on a notice period or is undergoing training. In such a
scenario, for smaller companies to retain MRs and showcase good productivity is a
challenge.
Exhibit 12: Sales force productivity in the industry has grown at 3% CAGR

Whilst sales force productivity


has recorded a CAGR of 3%
only, wage inflation has been
10-15%

Sales force productivity


CAGR 3%

6
5

4.01

4.02

4.46

4.46

4.58

FY05

FY06

FY07

FY08

FY09

4.21

4.09

4.18

FY10

FY11

FY12

4.59

5.01

4
3
2
1
FY13

FY14

Source: Company, Ambit Capital research; * Note: Companies that we have aggregated for arriving at industry
numbers are Glenmark, Sun Pharma, Torrent Pharma, IPCA, Cadila, Lupin, Dr. Reddys, Ranbaxy, Cipla and GSK

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 14

Healthcare
Exhibit 13: Sales force productivity of the top companies, as
per our framework
8.2%

3%

Sales force productivity


6.8%

6.5%
4.6%
3.7%

CAGR FY05-14

8.9%

CAGR FY05-14

2.7%

2%

Sales force productivity

1%
0%

-1%
-1.0%

-2%

-1.5%

-3%
Cipla

Ranbaxy

Dr. Reddy

Lupin

Cadila

Ipca

Sun Pharma

Glenmark

Source: Company, Ambit Capital research

GSK

-3.1%

-4%
Torrent

10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%

Exhibit 14: Sales force productivity of bottom companies as


per our framework (Decreasing to Stable)

Source: Company, Ambit Capital research

Converging to unbranded generics


In a democratic country like India, the fact that the Government is striving for populist
policies to ensure affordability for the poor is no surprise. The Government of India
(GoI) has set up schemes like Jan aushadi stores, a government pharmacy chain,
within government hospitals which provide medicines at subsidised rates. Further, the
GoI in association with certain agencies is working on an SMS programme where
the patient could SMS a brand name prescribed by the doctor and in return the
patient would receive a reply with the lowest-cost brands of the same drug available
in the market. Moreover, there have been demands from the Medical Council of
India to make it mandatory for doctors to prescribe the generic name of
medicines instead of the brands.

Jan aushadi, the SMS


programme and mandating
generic names suggest
convergence to the unbranded
market

Increasing span of price regulations


The GoI in its DPCO Order 2013 had expanded the scope of price controls and
extended it beyond the National List of Essential Medicines (NLEM) 2011. However, in
July 2014, the National Pharmaceutical Pricing Authority (NPPA), exercising its right
to fix ceiling prices for any drug it deems necessary, announced ceiling prices for 108
non-scheduled formulations (50 molecules). Out of these 50 molecules, 33 are not a
part of the National List of Medicines (NLEM) 2011. The increasing span of price
regulations would continue to be a threat to the profitability of the Indian business.
Whilst such price regulations are reasonably tolerated by the larger domestic players
due to their wide and diversified product baskets, such events could move the needle
for smaller participants.

The increasing span of price


regulations would continue to be a
threat to profitability of the Indian
business

Price regulations could move the


needle for smaller participants

Regulatory hurdles to new introductions


In order to curb malpractices and patient deaths during clinical trials, the Ministry of
Health has put in place stringent reforms and increased scrutiny. Whilst the reforms
are essential for curbing negligent professional behaviour, they are double-edged
sword. The reforms have resulted in not only lower clinical trial approvals but
also reduced the number of trials actually undertaken. At the same time, the
costs associated with these clinical trials have gone up substantially, as companies
have to comply with stricter norms.

Stringent norms for clinical trials


and additional layer of
administration in new approvals is
slowing the pace of new
introductions

Also, the approval process has been lengthened, with pharma companies required to
take approval from the Drug Controller General of India (DGC (I)) committee. The
documentation requirements are also more elaborate.
These measures by the regulator have increased the time taken for new introductions
and also increased the cost for companies to launch products. Whilst the larger firms
can continue to feed on the cash generated by the large base business, such
regulatory changes may affect smaller companies more significantly.
September 16, 2014

Ambit Capital Pvt. Ltd.

Regulatory changes may affect


smaller companies more
significantly

Page 15

Healthcare

Analysing sustainability: Business DNA


Whilst the organic consolidation and challenges cited above are definite hurdles for
Indian mid-caps to grow, smaller companies have exhibited resilient growth.
Exhibit 15: Domestic sales CAGR over FY07-14 reflects strong growth by smaller
companies
30%
24%

25%
19%

20%

6%

8%

Indoco

6%

7%

Unichem

FDC

5%

Claris

5%

Wockhardt

4%

Ranbaxy

10%

Strides

15%

5%

24%

10% 11%

We suspect that the growth for


some of the Indian mid-cap
pharma companies is more
sustainable than others w.r.t.
Indian formulations

15%
13% 14%

Biocon

Ajanta

IPCA

Glenmark

Natco

Alembic

Torrent

Cadila

0%

Source: AIOCD data, Ambit Capital Research

However, we suspect that the growth for some of these companies is more
sustainable than others. Various factors need to be assessed when judging the
quality, sustainability and risks to reported sales growth for the Indian business.
Exhibit 16: Key levers to assess
Business DNA

Components
Product selection

Drivers of Growth
(50% weightage)

Sales execution

Base business growth

Therapeutic coverage

Newer Avenues for


Growth
(25% weightage)

Geographical coverage

Sales force productivity

Event specific risk


Associated Risk to
Growth
(25% weightage)
Regulatory risk

Measures
Ability to select product segments which can
grow higher than IPM (Molecule sales growth
> IPM sales growth)
Ability to outperform peer sales growth
(Company sales growth in molecule >
Molecule sales growth)
Gauging higher brand equity (Higher base
business growth). Lower weightage as brand
equity is a derivative of the many factors
including product selection and execution.
Smaller therapeutic presence indicates higher
scope for product portfolio expansion (Lower
current coverage of product portfolio)
Smaller geographical presence indicates
higher scope for expansion (Lower current
geographical reach of product portfolio)
Indicates push vs pull dynamics underlying the
business (Higher sales per marketing
representative). Lower weightage as sales
productivity could be lower due to a
fragmented target audience.
Broader brand base reduces event specific risk
(Top-50 products contribution to total sales).
Higher weightage as event specific risks in the
past have been more detrimental for
companies than regulatory risk (example
Losar franchise for Unichem)
Higher contribution from base business
growth to overall growth mitigates impact of
regulatory risk (Contribution of base business
growth to total growth)

Weights
20%

20%

10%

10%

10%

5%

15%

10%

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 16

Healthcare
Exhibit 17: Business DNA decides which path the company takes

Sales growth

Newer avenues

Drivers
Associated risk

Drivers

Time
Scope

Risk

Source: Ambit Capital research

Is Indian mid-cap pharma investible?


Whilst we do see challenges for the domestic players, we believe that the Indian
domestic market remains a lucrative opportunity for participants of all sizes and age
due to its scope and structure. The market is experiencing secular growth driven by
better affordability, higher diagnosis, rising insurance penetration and more
awareness. Whilst the branded nature of the market provides an opportunity to build
brand equity, the competition makes it a non-auto pilot business. Only those
participants that exhibit execution through constant rigour are likely to
benefit in the long run.

The domestic market remains a


lucrative opportunity for
participants of all sizes and age

We also need to appreciate that the GoI has always been providing an impetus to the
domestic players through various regulations. Be it Industrial Licensing in 1956 or key
regulations in 1970-1990, the Government continues to push the domestic
companies towards uncharted territories.
The recent examples of regulations providing direction are price regulations (20132014) and product patents (2005). Whilst the Government is curbing the prices of
plain-vanilla products, it is also providing opportunities for domestic companies to
increase R&D spend and innovate.
Given these market dynamics we advise investors to be selective and invest in
companies which have the ability to sustain growth momentum.

Investors need to be selective and


invest in sustainable growth

Which companies were selected and why?


For the purpose of this exercise we select companies based on three categories:

Market capitalisation of more than `10bn to ensure that the opportunity


has an investible size and enough liquidity.

Sizeable domestic business (>10% of total EBITDA) we retain our thesis


that smaller companies will find it difficult to sustain growth momentum in
regulated markets like Europe and the US.

Exclude MNCs i.e. companies having origin outside India and have set up
subsidiaries in India to run Indian operations MNC subsidiaries are prone
to lack of management access and multiple sister concerns in India which are
unlisted but engaged in the same business.
Based on the above filters, we analyse 19 companies ranging from large
capitalisation names like Sun Pharma, Lupin and Dr. Reddys to medium market
capitalisation names like Claris Life Sciences, Unichem Labs and Indoco Remedies.
Note that 14 out of the selected 19 companies fall under the top-40 in the Indian
pharma market (by sales in FY14).

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 17

Healthcare

I. Drivers of growth
We believe that the key for domestic companies to maintain their growth trajectory is
to have strong product portfolios and have the ability to execute sales in a manner
where they are able to create a strong brand which is sustainable over time and
resilient in the face of incremental competition.
Product selection: Ability to select therapeutic segments which can grow
higher than the IPM
We believe a key driver of growth for companies is the ability to select therapeutic
segments which can provide impetus to growth which would be higher than the
growth of the Indian Pharmaceutical Market (IPM).
We evaluate this parameter by assessing the presence of companies in different
therapeutic segments and comparing the YoY growth of therapeutic segments, in
which the companies are present, with the growth of IPM over FY09-14.

Ability to select therapeutic


segments can provide impetus to
growth

Exhibit 18: Growth of therapeutic segments (in which companies are present) as
compared to IPM growth on a YoY basis
Growth YoY (%)

FY09

FY10

FY11

FY12

FY13

FY14

Rank

Ajanta

16.9%

14.9%

21.8%

15.4%

14.6%

7.8%

Biocon

19.8%

16.8%

31.7%

21.2%

13.8%

6.9%

Glenmark

16.3%

15.2%

20.0%

16.2%

11.8%

6.2%

Unichem

16.3%

14.5%

17.9%

15.4%

12.5%

4.7%

Torrent

18.9%

17.5%

17.7%

16.6%

11.6%

5.2%

Sun Pharma

17.9%

15.3%

18.9%

15.2%

11.7%

5.7%

Lupin

16.5%

14.0%

18.9%

15.1%

11.4%

5.2%

IPCA

18.2%

16.5%

16.1%

14.7%

10.9%

5.1%

Indoco

18.4%

15.8%

18.9%

14.9%

11.1%

3.4%

Strides

18.1%

15.1%

19.6%

14.9%

11.7%

4.7%

FDC

19.5%

16.1%

14.1%

15.3%

10.6%

4.0%

Ranbaxy

16.3%

14.3%

18.4%

14.9%

10.9%

4.8%

Cadila

15.4%

13.5%

16.9%

15.0%

11.4%

4.9%

13

Dr. Reddy

19.3%

16.2%

15.0%

15.2%

11.6%

4.6%

13

Wockhardt

15.7%

13.6%

16.4%

13.8%

10.0%

3.5%

13

Cipla

14.8%

13.5%

15.3%

13.5%

10.5%

4.2%

16

Alembic

16.6%

12.9%

15.0%

13.9%

10.0%

3.7%

16

Natco

8.8%

9.2%

10.8%

9.7%

6.8%

0.1%

18

Claris

12.7%

8.4%

10.4%

12.8%

6.4%

1.5%

18

IPM

14.8%

13.6%

15.3%

15.3%

11.7%

6.2%

Source: AIOCD, Ambit Capital research

Based on the above data, Ajanta and Biocon have displayed superior capability to Ajanta and Biocon have displayed
select the therapeutic segments which can deliver above-market sales growth over
superior capability to select
FY09-14. At the same time, Natco and Claris have consistently had poor therapeutic therapeutic segments
selection and are ranked the lowest amongst their peers. However, note that
secondary sales data does not capture hospital sales, which are the bread and butter
for both Natco and Claris. To that extent our analysis is distorted for these two
companies.
Sales execution: Ability to outperform peer sales growth
Whilst product selection is a key determinant for future growth, however accurate
product selection may be, it is a futile exercise unless the company is able to
capitalise on it and report superior sales performance. Therefore, we analyse
companies with the yardstick of sales execution.

Product selection is a futile exercise


unless the company is able to
capitalize on it

The ability to execute sales efficiently and report growth better than the therapeutic
segment growth is the parameter that we have used to assess the companies.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 18

Healthcare
Exhibit 19: Domestic sales growth as compared to the respective therapeutic segment
growth
Growth YoY (%)
Sun Pharma
Therapeutic segment growth
Lupin
Therapeutic segment growth
Glenmark
Therapeutic segment growth
IPCA
Therapeutic segment growth
Ajanta
Therapeutic segment growth
Indoco
Therapeutic segment growth
Cadila
Therapeutic segment growth
Biocon
Therapeutic segment growth
Cipla
Therapeutic segment growth
Alembic
Therapeutic segment growth
Natco
Therapeutic segment growth
Unichem
Therapeutic segment growth
Torrent
Therapeutic segment growth
Strides
Therapeutic segment growth
Claris
Therapeutic segment growth
Wockhardt
Therapeutic segment growth
FDC
Therapeutic segment growth
Ranbaxy
Therapeutic segment growth
Dr. Reddy
Therapeutic segment growth

FY09
26.5%
17.9%
24.3%
16.5%
20.3%
16.3%
31.2%
18.2%
7.4%
16.9%
26.5%
18.4%
8.7%
15.4%
17.2%
19.8%
15.3%
14.8%
6.1%
16.6%
-9.8%
8.8%
21.0%
16.3%
16.0%
18.9%
118.6%
18.1%
-18.0%
12.7%
3.5%
15.7%
10.1%
19.5%
0.6%
16.3%
5.7%
19.3%

FY10
22.2%
15.3%
18.3%
14.0%
16.7%
15.2%
26.6%
16.5%
18.6%
14.9%
16.1%
15.8%
14.1%
13.5%
42.0%
16.8%
14.9%
13.5%
21.5%
12.9%
80.5%
9.2%
9.1%
14.5%
13.4%
17.5%
-15.8%
15.1%
68.2%
8.4%
3.9%
13.6%
10.2%
16.1%
4.7%
14.3%
13.1%
16.2%

FY11
23.2%
18.9%
28.1%
18.9%
16.3%
20.0%
13.9%
16.1%
21.4%
21.8%
22.1%
18.9%
2.2%
16.9%
-11.5%
31.7%
5.3%
15.3%
4.1%
15.0%
5.7%
10.8%
9.2%
17.9%
9.5%
17.7%
19.6%
19.6%
-19.9%
10.4%
19.2%
16.4%
-10.7%
14.1%
-6.3%
18.4%
3.0%
15.0%

FY12
24.2%
15.2%
17.3%
15.1%
23.0%
16.2%
18.6%
14.7%
27.8%
15.4%
11.6%
14.9%
15.2%
15.0%
66.3%
21.2%
13.3%
13.5%
16.9%
13.9%
51.2%
9.7%
2.7%
15.4%
9.9%
16.6%
-11.8%
14.9%
117.9%
12.8%
12.3%
13.8%
4.0%
15.3%
12.5%
14.9%
8.6%
15.2%

FY13
20.4%
11.7%
14.0%
11.4%
19.6%
11.8%
15.0%
10.9%
21.7%
14.6%
9.3%
11.1%
20.0%
11.4%
9.9%
13.8%
8.3%
10.5%
7.6%
10.0%
16.6%
6.8%
7.9%
12.5%
16.1%
11.6%
-7.8%
11.7%
3.0%
6.4%
5.1%
10.0%
5.0%
10.6%
6.1%
10.9%
10.4%
11.6%

FY14
16.2%
5.7%
12.3%
5.2%
16.1%
6.2%
18.7%
5.1%
28.8%
7.8%
4.3%
3.4%
8.4%
4.9%
39.8%
6.9%
9.1%
4.2%
10.5%
3.7%
-34.8%
0.1%
6.9%
4.7%
14.6%
5.2%
-14.6%
4.7%
-24.4%
1.5%
0.5%
3.5%
2.9%
4.0%
-1.0%
4.8%
4.6%
4.6%

Rank
1
1
3
3
5
5
5
8
8
8
8
12
12
12
12
16
17
17
17

Source: AIOCD, Ambit Capital research

The above table clearly reflects the importance of having efficient execution
capabilities over and above the product selection expertise. Sun Pharma and Lupin,
which ranked lower on the product selection scale, have displayed superior execution
capabilities by growing higher than their respective therapeutic segment growth on a
consistent basis. Dr. Reddys and Ranbaxy despite having fairly reasonable product
portfolios have not been able to capitalise and implement superior execution skills
and thus they rank the lowest in the sales execution criteria.

Amongst the midcaps, IPCA,


Ajanta, Indoco and Cadila have
executed better than their peers

Amongst the midcaps, IPCA, Ajanta, Indoco and Cadila have executed better than
their peers.

Base business growth: Gauging higher brand equity


In the above two sections we discussed the necessity of smart product selection and
sharp sales execution. The third criteria we look at to maintain the current drivers of
growth is the ability to establish brands successfully and create brand equity for the
product portfolio. Brand equity is critical to create consumer perception not just for
one product but leveraging brand equity of one product to the entire portfolio.

September 16, 2014

Ambit Capital Pvt. Ltd.

The ability to establish brands


successfully and create brand
equity for the product portfolio
determines longevity of growth

Page 19

Healthcare
To determine brand equity, we analyse the base business revenue CAGR over FY0914. Companies delivering consistent base business growth at higher levels are
considered to have stronger brand equity.
We define the base business as all the products launched two years prior to the year
in question. For example, in FY11, the base business would include all the products
launched in the FY minus 2 year i.e. FY09.

Strides

FDC

Ranbaxy

Wockhardt

Unichem

Dr. Reddy

Cipla

Cadila

Alembic

Indoco

Torrent

Lupin

Glenmark

Natco

IPCA

Claris

Sun Pharma

Ajanta

Biocon

Exhibit 20: High base business CAGR over FY09-14 portrays brand equity
30
25
26.6
20
22.7
20.5
15
18.1
16.8
10
11.2
18.2
12.4
10.0
17.3
17.4
5
7.5 6.8 6.4 3.2 1.7
11.9
10.9
0
-5
-6.5
-10

Source: AIOCD, Ambit Capital research

Amongst midcaps, Biocon, Ajanta and Claris have developed strong brand equity for
their portfolio products by growing the domestic base business by a CAGR of 26.6%
over FY09-14. Strides has reported negative CAGR over the same period, displaying
a lower ability to position itself as a strong brand and capitalise on the products
launched.

Amongst mid-caps, Biocon, Ajanta


and Claris have developed strong
brand equity

Overall, Ajanta, Glenmark, Biocon, IPCA and Indoco have better quality of
growth than their peers
Aside from the usual suspects like Sun Pharma and Lupin, amongst the mid-caps,
Ajanta, Glenmark, Biocon, IPCA and Indoco have exhibited a better quality of growth
and are more likely to sustain growth in the face of the aforementioned challenges.
Exhibit 21: Ajanta has the best drivers of growth placed in its business
Company / Score
Weights
Ajanta
Glenmark
Biocon
Sun Pharma
Lupin
IPCA
Indoco
Torrent
Unichem
Cadila
Natco
Alembic
Cipla
Claris
Strides
Wockhardt
Ranbaxy
FDC
Dr. Reddy

Product
selection
40%
1
3
1
6
6
6
6
5
3
13
18
16
16
18
6
13
6
6
13

Sales
execution
40%
5
3
8
1
1
3
5
12
12
5
8
8
8
12
12
16
17
17
17

Base business
growth
20%
2
7
1
3
8
5
10
9
15
12
6
11
13
4
19
16
17
18
14

Overall
Rank
100%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19

Ajanta, Glenmark, Biocon, IPCA


and Indoco have better quality of
growth

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company
(with a maximum score of 20) on the basis of the individual rank. For example, rank 1 in the individual rank
would score 20 and rank 19 would score 1.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 20

Healthcare

II. Newer avenues for growth


In this section, we assess the ability of companies to foster newer avenues of growth.
We analyse the companies based on three factors:

Therapeutic coverage - Smaller therapeutic presence indicates higher scope for


product portfolio expansion (Lower current coverage of product portfolio)

Geographic coverage - Smaller geographical presence indicates higher scope


for expansion (Lower current geographical reach of product portfolio)

Sales force productivity - Indicates push vs pull dynamics underlying the


business (Higher sales per sales representative)

Therapeutic coverage: Smaller therapeutic presence indicates higher scope


for product portfolio expansion
Most of the companies analysed have a presence in limited therapeutic segments and
have followed a focussed approach to capitalise on these segments. We believe an
absence in some therapeutic segments presents an opportunity for companies to
expand scope and bring about new avenues for sales growth. We do agree that a
foray into new therapeutic segments requires significant investment and capabilities
and is more a medium- to long-term growth story rather than a short-term
phenomenon.

Expanding the therapeutic segment


presence may help in cultivating
new avenues for sales growth

Therapeutic coverage is defined as the sales of therapeutic segments in which the


company is present as a percentage of total IPM sales. Lower coverage provides an
opportunity to the company to expand its product portfolio into non-covered
therapeutic segments.

64.9

67.5

67.8

Lupin

Cadila

Cipla

49.4
Alembic

63.4

48.5
Unichem

Ranbaxy

48.1
Glenmark

53.6

46.1
Torrent

Wockhardt

42.9
Sun Pharma

36.1
Indoco

39.6

35.0
IPCA

Dr. Reddy

34.8
FDC

29.0

21.3
Biocon

Strides

18.9
Ajanta

14.1
Natco

Claris

80
70
60
50
40
30
20
10
0

8.5

Exhibit 22: Low therapeutic coverage provides an opportunity to expand scope (% of


market covered)

Source: AIOCD, Ambit Capital research

Claris Life Sciences, Natco, Ajanta and Biocon have the lowest coverage in the
universe, and thus they have an opportunity to grow sales by foraying into uncharted
therapeutic segments. This provides inorganic growth for the company, keeping the
current business constant.

Claris, Natco, Ajanta and Biocon


have the lowest therapy presence
and hence the largest opportunity

On the other hand, Cipla and Cadila have the highest therapeutic coverage. They
have a presence in most therapies, thus implying less scope for inorganic expansion
of sales.
Geographic coverage: Smaller geographical presence indicates higher scope
for expansion

Expansion of geographic presence


also represents opportunity for
Apart from growth in therapeutic segments, another avenue for companies to grow is sales growth
to expand their geographic coverage to regions in India which have not been tapped.
For example, Strides has a focus in the southern states of India. Through its
acquisition of the branded generic business of Bafna Pharmaceuticals, Strides can

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 21

Healthcare
now expand its geographical coverage to the northern states, where Bafna has strong
infrastructure and sales execution capabilities through its distributor channels.
As per AIOCD data, sales are divided into 24 regions. We assess geographical
coverage by analysing the concentration of sales in different regions. Higher sales
from the top-10 regions signify geographic concentration.

We assess geographical coverage


by analysing concentration of sales
in different regions

4th to 10th region

43
35
22
Cadila

37
Lupin 22

41

40
22
Alembic

39

40
Unichem 22

Claris

Top 4 regions

38

36
27
Wockhardt

37

36
27
Dr. Reddy

36

35
33
32
IPCA

33
31
Sun Pharma

35

33
27
Ajanta

40

33
28
Torrent

41
27
Glenmark

41
27
Cipla

41
28
Ranbaxy

42
31
Biocon

39

32

32

30

26

25
43
32
Indoco

47
29

20

FDC

40

24

19
55

27

26
71

24

Natco

60

76

80

Strides

100

Exhibit 23: Geographic concentration of sales (as a percentage of total sales) is the
least for Strides

11th to 24th region

Source: AIOCD data, Ambit Capital research

Strides ranks the highest, as it has a high concentration in southern India. However,
with the acquisition of Bafnas branded generic business, it now will be able to
increase its presence in other regions and provide impetus to its sales.
Other mid-caps which could tap similar opportunities are Natco, Claris, FDC, Indoco
and Biocon.

Strides, Natco and Claris have high


geographic concentration

Cadila and Alembic, on the other hand, have a diversified presence across India and
the scope for increasing the footprint to new regions is limited, and thus they have a
lower ability to increase sales through geographic expansion.
Sales force productivity: Indicates push vs pull dynamics underlying the
business
The capabilities of the sales force are crucial to broaden scope for higher sales
growth. As we had mentioned earlier, the industry faces a challenge in retaining its
sales force due to the high attrition rate of Marketing Representatives (MRs).
MR productivity helps understand whether the company follows a push model of sales
or a pull model. Efficient MR productivity signifies constructive efforts by the sales
force to establish the brand in front of the doctor and get a higher prescription share
(pull mechanism). Low productivity indicates a push mechanism where the
prescription may be largely driven by the frequency of doctor calls without really
capturing a significant mind share.
We evaluate companies based on sales per marketing representative. Higher sales
per MR represent better MR quality and focus on a pull model as compared to lower
sales per MR which represents more focus on a push sales model. We accept that this
matrix has an inherent lacuna under which it does not reward companies which
follow a pull model but experience lower productivity purely due to the higher
number of doctors that the MR has to address. Such issues are largely noticed with
companies which rely on general physicians for prescriptions as compared to say a
Sun Pharma which relies on a lower number of doctors due to its presence in
specialty segments.

Efficient MR productivity signifies


higher prescription share and
brand loyalty

Companies with general physicians


as their primary audience are likely
to see low productivity

Hence, we assign lower weightage to sales force productivity in our overall


framework but we believe that better sales per MR provides the requisite
understanding of companies ability to capitalise their sales force through better
training and efficient reward systems.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 22

Healthcare
Exhibit 24: Sun Pharma has excellent sales reps productivity
9.3
7.6
6.6 6.4

FDC and Biocon also rank amongst


the top-5, performing much better
than their other mid-cap peers

Revenue per sales reps per annum (FY14), ` mn

5.6 5.3
5.0 5.0 4.7

4.1 4.0 3.8

3.1 2.9
2.7 2.4 2.4

IPCA

Alembic

Torrent

Strides

Unichem

Natco

Claris

Dr. Reddy

Lupin

Cipla

Glenmark

Ranbaxy

Wockhardt

Cadila

Biocon

FDC

Sun

1.8 1.5

Ajanta

Indoco

10

Source: AIOCD data, Company, Ambit Capital research

Whilst Sun Pharma gets an expected pole position, FDC and Biocon also rank
amongst the top-5, performing much better than other mid-cap peers. IPCA, Indoco
and Ajanta rank the lowest presumably due to their general physician exposure, as
discussed above.
Overall, Claris, Natco, FDC, Biocon and Indoco have higher scope of growth
than mid-cap peers
Smaller companies have the maximum opportunity to grow. Claris, Natco and FDC
have the maximum scope to increase their product and geographical coverage.
Whilst FDC has an efficient sales force, Claris and Natco can leverage their sales
force through newer product introductions.
Exhibit 25: Claris has the maximum scope to grow
Therapeutic
coverage

Geographical
coverage

40%

40%

20%

100%

Claris

11

Natco

12

FDC

Biocon

Strides

14

Company / Score
Weights

Indoco
Sun Pharma
Ajanta

Sales force
Overall Rank
productivity

18

10

12

11

19

Glenmark

12

Ranbaxy

16

10

Dr. Reddy

14

10

11

11

10

15

12

IPCA

13

17

12

Cipla

19

14

Wockhardt

15

15

15

Unichem

13

16

13

16

Cadila

18

19

17

Alembic

14

17

16

17

Lupin

17

18

19

Torrent

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company
(with a maximum score of 20) on the basis of the individual rank. For example, rank 1 in the individual rank
would score 20 and rank 19 would score 1.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 23

Healthcare

III. Associated risks to growth


We have addressed the avenues and scope of growth above, but it is also meaningful
to assess the risk facing the domestic sales of the companies and the ability and
preparedness of these companies to mitigate this risk.
To evaluate the risk attached to the domestic business, we analyse companies under
two categories: (a) Event-specific risk and (b) Regulatory risk
Event-specific risk: Broader brand base reduces event-specific risk
The domestic market faces several event-specific risks such as price regulation,
adverse events reported and therapeutic substitution.

Whilst some risk is inherent to the


business, our motive is to identify
the companies which are more
vulnerable than their peers

The resultant price cuts, decline in market size and decline in volumes pose a serious
risk to the companies, as their margins are likely to shrink. We believe companies
which have a broader product portfolio are less susceptible to event-specific risk.
To assess the event-specific risk, we evaluate companies based on their brand
concentration. Companies with higher brand concentration are at risk in terms of
their revenue. Therefore, on a relative basis, companies deriving a higher percentage
of sales from the top-50 products rank lower in the population.
Exhibit 26: Sun Pharma ranks first, with a diversified product portfolio; Natco is at
risk
100
80
60
40
20

Top 26-50

Natco

Claris

Strides

Biocon

Indoco

Unichem

FDC

Ajanta

IPCA

Alembic

Glenmark

Dr. Reddy

Top 11-25 brands

Wockhardt

Top 10 brands

Torrent

Ranbaxy

Cadila

Cipla

Lupin

Sun Pharma

50 and above

Source: AIOCD data, Ambit Capital research

From the exhibit above, we infer that Sun Pharma has excellent product
diversification and faces the least event-specific risk. It derives 51% of its sales from
the top-50 products. On the contrary, Strides, Claris and Natco derive almost 100%
of their sales from the top-50 products, thus posing event-specific risk to their
revenue. The analysis represents an obvious bias towards larger companies. But, we
assert that larger companies indeed are less prone to needle-swinging events as
compared to the smaller ones and hence are relatively safe from event-specific
events.

Barring the larger caps, IPCA,


Ajanta and FDC show considerable
diversification of product portfolios

Regulatory risk: Higher contribution from base business growth to overall


growth mitigates regulatory risk
Whilst lower brand concentration helps reduce event-specific risk, the industry
continues to faces regulatory issues which cannot be mitigated. However, through
efficient product positioning coupled with strong brand recognition, companies can
minimise the impact of regulatory risk.
For example, as discussed above, the industry currently faces a challenge in new
product introductions due to stricter regulations and increase in the cost of clinical
trials. The changes in regulations have resulted in lower approvals by the regulator
and also lower new product filings by companies. This could dent new product
introductions and thereby companies run the risk of lower sales growth. However,
this risk can be mitigated if companies have strong base business growth.

September 16, 2014

Ambit Capital Pvt. Ltd.

Low number of new approvals


might dent the growth for
companies that rely heavily on new
products for growth

Page 24

Healthcare
Therefore, we evaluate companies on the basis of their ability to derive and
sustain/grow revenue from the base business. We assess the contribution of base
business growth to the total revenue growth for the company. Higher contribution
from the base business implies that despite challenges arising out of regulatory risk
(such as lower new product introductions), companies are able to sustain the current
growth in revenue through the base business.
Exhibit 27: Strides has the highest contribution, whereas Cadila earns most of its
revenues from new product introductions
120

Base business contribution to total growth, Avg FY09-14

Strides, Claris and Indoco have the


highest contribution from the base
business in terms of growth

77.5

76.2

75.8

74.6

73.8

73.3

68.7

66.8

66.5

64.4

62.9

61.5

59.4

56.3

55.8

Torrent

Cipla

IPCA

FDC

Biocon

Sun Pharma

Glenmark

Natco

Wockhardt

Lupin

Ranbaxy

Unichem

Alembic

Dr. Reddy

Ajanta

40
20

47.4

78.3
Indoco

60

92.1

80

97.7

100

Cadila

Claris

Strides

Source: AIOCD data, Ambit Capital research

Amongst the mid-caps, Torrent, IPCA, Glenmark, Indoco and FDC have the
lowest risk to growth than mid-cap peers
Whilst larger companies score higher on risk mitigation, amongst mid-caps, Torrent,
IPCA, Glenmark, Indoco and FDC have the lowest risk to growth.
Exhibit 28: Cipla is the most efficient in risk mitigation
Company / Score

Regulatory risk

Event-specific risk

Overall Rank

60%

40%

100%

Cipla

Sun Pharma

Torrent

Lupin

13

IPCA

10

14

Weights

Ranbaxy
Glenmark

10

Indoco

14

FDC

12

Cadila

19

Strides

17

11

17

12

18

13

16

14

Dr. Reddy
Claris
Alembic
Biocon

16

15

Wockhardt

15

12

16

Unichem

13

15

16

Ajanta

11

18

18

Natco

19

11

19

Whilst larger companies score


higher on risk mitigation, amongst
mid-caps, Torrent, IPCA,
Glenmark, Indoco and FDC have
the lowest risk to growth

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company
(with a maximum score of 20) on the basis of the individual rank. For example, rank 1 in the individual rank
would score 20 and rank 19 would score 1

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 25

Healthcare

Companies best placed in domestic formulations are


In the above sections, we evaluated the competencies of companies on each of the
Business DNA components. In this section we try to view the complete picture and
assess the overall capabilities of companies.
Exhibit 29: Overall ranking as per our DNA framework
Business DNA

Drivers of growth

Newer avenues for growth

Associated risk to growth

Product
selection

Sales
execution

Base
business
growth

20%

20%

10%

10%

10%

5%

15%

10%

100%

10

12

Glenmark

12

10

Biocon

16

Ajanta

11

19

11

18

IPCA

13

17

10

Torrent

12

11

10

15

Lupin

17

18

13

Indoco

10

18

14

Rank
Weights
Sun Pharma

Therapeutic
coverage

Geographical
coverage

Sales force
productivity

Regulatory
risk

Event specific Overall Rank


risk

Cipla

16

13

19

Claris

18

12

11

18

10

Strides

12

19

14

17

11

Natco

18

12

19

11

12

17

18

12

13

FDC
Cadila

13

12

18

19

19

14

Unichem

12

15

13

16

13

13

15

15

Ranbaxy

17

17

16

14

16

Alembic

16

11

14

17

16

16

17

Dr. Reddy

13

17

14

14

10

17

18

Wockhardt

13

16

16

15

15

15

12

19

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company (with a maximum score of 20) on the basis of the
individual rank. For example, rank 1 in the individual rank would score 20 and rank 19 would score 1.

Whilst Sun Pharma and Lupin unsurprisingly feature amongst the top-10 companies
on our framework, amongst mid-caps, we highlight Glenmark, Biocon, Ajanta, IPCA,
Torrent and Indoco as companies that are better placed than their peers in terms of
business DNA and hence sustainability of growth.

Glenmark, Biocon, Ajanta, IPCA,


Torrent and Indoco are better
placed than other mid-caps

Glenmark: Whilst the company ranks low on therapeutic coverage (high number of
segments already covered by product portfolio) and event specific risk (moderate
diversification beyond top 25 brands), it scores high on product selection (high
presence in fast growing therapy areas) and sales execution (companys revenue
growth higher than therapeutic areas present in). Overall Glenmark secures the 2nd
rank on our DNA framework.
Biocon: Biocon has exhibited best-in-class product selection and brand equity (base
business growth). The company also boasts of low therapeutic and geographic
coverage (implying high scope for growth) and high sales force productivity
(concentrated audience and large basket of products offered to target audience).
However, Biocons business entails higher than average regulatory risk. Overall,
Biocon scores the 3rd position on our DNA framework.
Ajanta: Ajanta has exhibited best-in-class product selection and brand equity (base
business growth). The company also boasts of low therapeutic and geographic
coverage (implying high scope for growth). However, low sales force productivity
(fragmented audience and small basket of products offered to target audience) and
higher regulatory and event specific risk drag the companys overall rank. Overall,
Ajanta scores the 4th position on our DNA framework.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 26

Healthcare
IPCA: IPCA ranks high on product selection, sales execution, base business growth,
therapeutic coverage and event specific risk. The companys presence in few niche
segments like malaria, pain and dermatology has driven past performance. However,
low sale force productivity (target audience of consulting and general physicians is
highly fragmented and low number of products offered) and high regulatory risk
exposure are challenges. Overall, the company secures the 6th position on our DNA
framework.
Torrent: Torrents business has exhibited best-in-class risk management (low event
specific and regulatory risks) and product selection (high chronic therapy exposure).
However, the company has been plagued by patchy sales execution (changes in
business heads) and limited scope for growth (high therapy and geography coverage
and low sales force productivity). Overall, Torrent scores the 7th position on our
framework.
Indoco: Indoco ranks high on product selection, sales execution, low event specific
risk and low geographical coverage. However, low base business growth, sales force
productivity and high regulatory risk exposure drag the overall competitive
positioning to 9th amongst the 19 companies analysed.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 27

Healthcare

Valuations not in sync with DNA


Indian pharma valuations are still reasonable in global context, but
In our Hunting for sustainability report dated 5 May 2014, we had highlighted that
the Indian pharma valuations were lower than the historical premiums that they have
commanded over international pharma (represented by the BWPHRM Index) and
international generic pharma (represented by the BIGNRCGP Index) despite visibility
of higher growth and RoCE and no deterioration in competitive advantage.
The valuations of Indian pharma companies have reverted closer to the longer-term
average since. We believe that the reversion has been a product of better visibility of
commitment of Indian pharma companies to longer-term growth drivers like NCEs,
NDDS based products, biosimilars and complex products like vaccines, inhalers, and
insulin. However, the mix of reversion in valuation has been slightly different than
what we had envisaged.

Source: Bloomberg, Ambit Capital research

Aug-14

Aug-14

Aug-13

Aug-12

Aug-11

Aug-10

Aug-09

Aug-08

Aug-07

Aug-06

Aug-05

-20%

Aug-13

0%

Average

Aug-12

20%

Aug-11

40%

Aug-10

60%

BSETHC premium to BIGNRCGP

Aug-09

80%

70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%

Aug-08

Average

Aug-07

BSETHC premium to BWPHRM

Aug-06

100%

Exhibit 31: BSETHCs P/E premium has reverted to 30% visa-vis the BIGNRCGP Index

Aug-05

Exhibit 30: BSETHCs P/E premium has reverted to its 10year average vis-a-vis the BWPHRM Index

Source: Bloomberg, Ambit Capital research

We illustrate below that the valuations for Indian pharma companies which are
expected to derive a larger proportion of growth from the US have re-rated more
than the valuations for those which derive a higher proportion of growth from EMs.
We believe that the prevailing market wisdom favours companies headed West
(towards the US), as: (a) the US market offers a low gestation period and (b) the US
market also offers higher RoCEs and margins on similar products sold in other
markets.

We question the prevailing wisdom of investing in companies headed to US


Whilst we agree that the US market offers better realisations/higher margins and
higher RoCEs (after gaining scale) in the near term, we argue that the effort required
for a mid-sized Indian company to establish itself in the US cannot be taken for
granted. We believe companies like IPCA (offering cost advantage due to vertical
integration) and Natco and Indoco (entering with niche products with manufacturing
complexity) have better chances of scaling up in the US than others, which are just
entering with me-too products and/or leveraging upon the currently prevailing
shortages.

The ability of mid-sized Indian


companies to establish themselves
in the US cannot be taken for
granted

The consolidation on the buy and supply side in the US is also likely to make life
difficult for the marginal players in the absence of a compelling proposition.
However, the street has given the benefit of doubt to these players, as is reflected in
the stock performance of the US-bound mid-sized companies.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 28

Healthcare
Exhibit 32: US-bound mid-cap pharma's valuation gap with large-cap pharma has
narrowed substantially (one-year forward EV/EBITDA)
18.0
16.0
14.0
12.0
10.0
8.0

Large size pharma

US bound mid size pharma

Jun-14

Mar-14

Dec-13

Sep-13

Jun-13

Mar-13

Dec-12

Sep-12

Jun-12

Mar-12

Dec-11

Sep-11

Jun-11

Mar-11

Dec-10

Sep-10

Jun-10

Mar-10

Dec-09

Sep-09

Jun-09

Mar-09

6.0

EM bound mid size pharma

Source: Company, Bloomberg, Ambit Capital research; Note: Large caps include Sun Pharma, Lupin, Dr. Reddys
and Cipla; US-bound mid-size include Wockhardt, IPCA, Strides, Ranbaxy, Cadila, Alembic, Natco, and Indoco;
and EM-bound midsize include Torrent, Glenmark, Biocon, Claris, FDC, Unichem and Ajanta

We suggest using the domestic business DNA as a proxy for success in export
markets for mid-caps
For the mid-sized pharma companies, the fate of the export market remains unclear.
Most mid-caps are too small in the export markets and hence they could largely be
growing on a small base vs a sustainable and profitable business model. The Indian
business growth is likely to fuel cash flows and RoCEs in the near term for these
companies and could be used as a proxy for judging the fate of branded export
markets.

Most mid-caps are too small in


export markets and hence could
largely be grow due to a small
base

Companies with a high score are available at reasonable valuations


We believe companies, which score higher than average on our framework, offer
higher RoCEs and are available at reasonable valuations, are the best bets.

Exhibit 33: Amongst the mid-caps, Ajanta, IPCA, Torrent and Glenmark appear better placed than peers
30

FY16 EV/EBITDA

25
Ranbaxy

20

Natco
Sun Pharma

Cipla

Cadila

15

Torrent

Glenmark

Indoco

Strides

10

Alembic

Dr. Reddy
Wockhardt
FDC
Unichem

Biocon

Lupin

Ajanta

IPCA

Claris
0

10

15

20

25

30

35

40

45

50

ROCE (%)
Source: Company, Ambit Capital research. Note: (a) Bubble size indicates rank on DNA framework (larger the better). (b)
across markets),
EM-bound companies,
US-bound companies

September 16, 2014

Ambit Capital Pvt. Ltd.

Large-cap companies (presence

Page 29

Healthcare
IPCA and Glenmark are already making investments in innovative avenues for growth
whilst Torrent and Ajanta have not made any significant moves on this front.
However, given that all these companies appear in the bottom right quadrant of the
exhibit above and are all available at valuations of 10.0x-13.0x FY16E EV/EBITDA (as
compared to an average of 12.5x), we believe there are upsides to these stocks.
Exhibit 34: Ajanta, IPCA, Torrent and Glenmark are the best bets among mid-caps
RoCE (%)
(FY14)

Score on
Business
DNA

EV/EBITDA
(FY16)

Sun Pharma

37.5

19

18.2

Glenmark

20.8

18

12.9

Biocon

12.7

17

10

MCap
Market focus
(US$ Mn)
29,381 Presence across markets
3,483 EM-bound
1,655 EM-bound

Ajanta

46.7

16

11.5

948 EM-bound

IPCA

30.6

15

10.1

1,668 US-bound

Torrent

30.4

14

10.8

2,417 EM-bound

Lupin

26.3

13

12.4

9,973 Presence across markets

17

12

12.3

Indoco

473 US-bound

Cipla

18.9

11

15

Claris

17.8

10

3.5

7,611 Presence across markets


159 EM-bound

Strides

12.1

10.7

699 US-bound

Natco

17.5

20.9

811 US-bound

FDC

24.8

8.4

470 EM-bound

Cadila

17.5

13.8

4,398 US-bound

Unichem

20.8

7.7

349 EM-bound

Ranbaxy

7.1

21.2

4,562 US-bound

Alembic

37.7

13.7

1,254 US-bound

Dr. Reddy

15.5

12.3

8,445 Presence across markets

Wockhardt

26.6

11.9

1,532 US-bound

Source: Company, Bloomberg, AIOCD data, Ambit Capital research

Based on our analysis above, we highlight that Ajanta, IPCA, Torrent and
Glenmark appear to be the best bets amongst the Indian mid-caps. Biocon and
Indoco miss the cut due to depressed RoCEs.
Exhibit 35: Our key recommendations
Rating

CMP
(`)

Sun
Pharmaceuticals

BUY

806

29,381

32

25

21%

38%

Lupin Ltd

BUY

1,359

9,973

25

22

17%

26%

Dr. Reddy's Labs

BUY

2,959

8,445

22

20

19%

16%

Cadila Healthcare

BUY

1,273

4,398

26

19

27%

17%

IPCA

BUY

820

1,668

20

16

21%

31%

Aurobindo

SELL

896

4,302

17

13

31%

24%

Company

Mcap
P/E
P/E
EPS CAGR RoCE
(US$mn) (FY15E) (FY16E) (FY15E-17E) (FY14)

Comments
We highlight that Sun Pharmas acquisition of Ranbaxy is a
key positive; synergies are likely to be US$400mn-500m by
Year 3 as opposed to the management guidance of
US$250m.
Lupins expertise in evolving profitably would keep the
company on the growth track as it moves up the pharma
value chain.
Higher visibility on longer-term growth drivers keep us
bullish on Dr. Reddys prospects in India/RoW and
regulated markets.
High investments in longer-term growth drivers, high
presence in India and a large US ANDA pipeline are likely
to fuel growth over the next 3-5 years.
Whilst IPCA is facing near-term headwinds from regulatory
issues with the FDA, we keep sight of the fact that the
company has a credible Indian and branded exports
business with an inclination towards innovation.
Lack of investments in longer-term growth drivers, past
legal issues with the promoter, and absence of moated
revenue streams keep us cautious on Aurobindo.

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 30

Healthcare

Suggest switching from Aurobindo (SELL)


to Cadila (BUY)
We suggest switching from Aurobindo to Cadila despite Aurobindo trading at a 35%
discount to Cadila (on one-year forward EV/EBITDA), due to:

Management issues: Cadila faces some management issues like an ineffective


acquisition track record in the recent past and multiple business interests.
However, Aurobindo faces much severe issues like involvement of promoter in
illegal issues, poor accounting practices leading to undisclosed income in the
past, and less than ideal disclosure practices.

Higher presence in branded markets: Cadila sources 59% of its revenues


(FY14) from branded businesses (moated) and Aurobindo sources a negligible
portion of its revenues from branded business. Branded businesses lend the
opportunity to build brand equity and product differentiation. These levers
provide moats to revenues and profits and in turn offer opportunity to scale up.
Lack of branded businesses makes us cautious on Aurobindo medium term
growth prospects and profitability.

Absence of incumbents from US product segments: Cadila sources a


negligible portion of revenues from those product segments in US where
incumbents are temporarily off-market due to FDA issues. Similarly, Cadilas
pipeline in the US is targeted towards more complex products (transdermals,
inhalers, oncology, etc). However, Aurobindo sources a significant portion of
revenues from cephalosporins and general injectables, whilst a significant portion
of its pipeline is targeted towards general injectables, penems and controlled
substances. All these segments have large players like Teva, Hospira, and
Ranbaxy which are currently off-market due to FDA issues. Whilst the absence of
the incumbents does present a near-term opportunity to gain market share, we
believe when the incumbents eventually return, Aurobindo is likely to face market
share and price erosion.

Long term investments / R&D spend: Despite similar market capitalisations,


Cadilas R&D spend is almost 2x of Aurobindos. Lack of investments in longer
term growth drivers such as NCEs, NDDS and biosimilars are likely to hurt
Aurobindos long-term growth prospects.

Regional mismatch in revenue and costs: Cadila sources 44% of FY14


revenues from India. Hence, the companys income statement is hedged against
higher cost inflation in India. However, Aurobindo has 53% of operating costs in
India with no commensurate revenue. This exposes Aurobindo to cost inflation in
India which may not be passed on to consumers in developed markets.

Aurobindo deserves a deep discount: Our DCF-based target prices suggest a


50% discount to Cadila and other large-cap peers. The stock currently trades at a
35% discount. We expect Cadila to maintain a 10-15% discount to its large-cap
peers. Our TP for Aurobindo implies an 8% downside from current levels and that
for Cadila implies a 17% upside.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 31

Healthcare
Exhibit 36: Aurobindos discount to Cadilas 1 year forward
EV/EBITDA has narrowed
EV/EBITDA premium/discount %
Cadila Mcap, RHS
Aurobindo Mcap, RHS

40%
20%

300

120%

250

150

-40%

100

-60%

50

`. Bn

-20%

Contribution to total revenue growth

100%

API, 2.4%

80%

Branded,
48.2%

API, 24.1%

200

0%

Exhibit 37: Revenue growth contribution for Cadila is


higher from stable branded business as compared to
Aurobindo

60%
Unbranded
, 75.9%

40%
Unbranded
, 49.4%

20%
0
Mar-14

Sep-13

Mar-13

Sep-12

Mar-12

Sep-11

Mar-11

Sep-10

Mar-10

Sep-09

Mar-09

-80%

0%
Cadila

Aurobindo

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research; Note: Unbranded includes US,


Europe, ARV, and RoW (For Aurobindo). Branded includes India formulations,
RoW (For Cadila) and Consumer business (For Cadila)

Exhibit 38: Aurobindos EBITDA and RoCE have recently


overtaken Cadilas given Cymbalta launch in US and lack
of traction for Cadila

Exhibit 39: R&D spend of Cadila is almost double that of


Aurobindo

5000

30%

4000

20%
15%
10%

`. Mn

25%

40%

2,551

2,502
2,085

FY09 FY10 FY11 FY12 FY13 FY14


CDH, EBITDA margin
ARBP, EBITDA margin
CDH, RoCE (RHS)
ARBP, RoCE (RHS)

September 16, 2014

4,563

3,628

2000 1,564 1,660


1000

Source: Company, Ambit Capital research

4,669

Aurobindo

3000

0%

5%

Cadila

952

973

FY09

FY10

1,394

FY11

1,593

FY12

FY13

FY14

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 32

Healthcare

Case studies
We highlight a case study exhibiting how a mid-sized pharma company has been
able to re-rate, as it extended its capabilities and strength of the Indian business in
other geographies and another case study of a company that does not have a strong
franchise in India and has hence failed to create a strong business in the export
markets.

Case study 1: IPCA Labs (Rank 5 out of 19 in our DNA


framework)
IPCAs RoCE has been ramping up led by operating leverage and product mix
Exhibit 40: IPCA has built a robust, cost-effective and capital-efficient pharma
franchise in India
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
FY09

FY10

FY11

RoCE (%)

FY12

FY13

FY14

Revenue growth (%)

Source: Company, Ambit Capital research

Historical stock price chart for IPCA


Exhibit 41: IPCA has delivered consistent returns for stockholders led by rational capital allocation
1000

Production halt in API


facility in Ratlam due to
issue of Form 483

USFDA approved plant


expected to fuel growth
over next 2-3 years. The
plant has been
commercialised in
4QFY14

900
800
700
600

Exports and Institutional


malaria business in
Africa lead net profit
growth

500
400

Malaria dominated
sales in India; Exports
to semi regulated

300

Exports starting to
ramp up in semi
regulated markets

200

Mar

Jan

Aug

Jun

No

Apr

Sep

Feb

Dec

Jul-09

Ma

Oct

Mar

Aug

Jan

Jun

No

Apr

Sep

Feb

Dec

Jul-02

Ma

Oct

Mar

Aug

Jan

No

Jun

Apr

Sep

Feb

Jul-95

Ma

Dec

100

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 33

Healthcare
Exhibit 42: IPCAs re-rating as a sustainable business has been reflected in its P/E
multiples
25
IPCA - one-year forward P/E chart
20
15
10
5
Aug-14

May-14

Feb-14

Nov-13

Aug-13

May-13

Feb-13

Nov-12

Aug-12

May-12

Feb-12

Nov-11

Aug-11

May-11

Feb-11

Nov-10

Aug-10

May-10

Feb-10

Nov-09

Sep-09

Source: Company, Bloomberg, Ambit Capital research

Case study 2: Unichem Labs (Rank 14 out of 19 in our


DNA framework)
Unichems RoCE has been volatile due to inconsistent revenue growth in
India and exports
Exhibit 15: Unichems domestic business suffered from therapeutic substitution of
losartan by Telmisartan
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
FY09

FY10

FY11

FY12

RoCE (%)

FY13

FY14

Revenue growth (%)

Source: Company, Ambit Capital research

Historical stock price chart for Unichem


Exhibit 43: Unichem has not been able to deliver consistent returns due to its inconsistent performance in the India and
export markets
300

Under-performance of US
sales vs market expectations
and therapeutic substitution of
leading brand Losar in India

250
200
150
100

Sep-14

Jul-14

May-14

Mar-14

Jan-14

Nov-13

Sep-13

Jul-13

Jan-13

Nov-12

Sep-12

Jul-12

May-12

Mar-12

Jan-12

Nov-11

Sep-11

Jul-11

May-11

Mar-11

Jan-11

Nov-10

Sep-10

Jul-10

May-10

Mar-10

Jan-10

Nov-09

Sep-09

May-13

Margin expansion led


by operating leverage
in exports

Gradual ramp-up in
exports

Mar-13

API facility at Pithampur


receives FDA approval

50

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 34

Healthcare
Exhibit 44: Unichems P/E multiples have not re-rated due to lack of confidence in the
future of the business
35

Unichem - one-year forward P/E chart

30
25
20
15
10
5
Aug-14

May-14

Feb-14

Nov-13

Aug-13

May-13

Feb-13

Nov-12

Aug-12

May-12

Feb-12

Nov-11

Aug-11

May-11

Feb-11

Nov-10

Aug-10

May-10

Feb-10

Nov-09

Sep-09

Source: Company, Bloomberg, Ambit Capital research

Exhibit 45: Relative valuation summary


CMP

Mcap

EV/EBITDA (x)

P/E (x)

EV/Sales (x)

US$ mn

FY15

FY16

FY15

FY16

FY15

FY16

CAGR (FY14-16)
EBITDA EPS

ROE (%)
FY14

FY15

FY16
29

Large caps
Sun Pharma*

806

27,495

23.6

18.2

31.7

24.6

9.3

5.6

25

22

15

28

Lupin*

1,359

10,042

14.4

12.4

25.1

22.3

4.1

3.4

21

22

Dr. Reddy's*

2,959

8,296

14.3

12.3

22.4

19.5

3.5

3.0

12

11

26

23

21

15

14

16

29

32

Cipla
GSK Pharma
Aurobindo Pharma*
Cadila*
Ranbaxy
Divi's Laboratories
Glenmark

613

8,103

20.6

16.6

32.9

25.4

4.3

3.7

18

18

2,505

3,494

27.2

22.2

35.2

31.5

6.3

5.7

NA

NA

896

4,302

11.8

9.3

16.6

13.2

2.5

2.1

16

24

37

35

32

1,273

4,292

17.9

13.5

26.3

18.7

3.4

2.7

30

30

25

26

29

610

4,259

14.3

20.1

20.6

33.3

2.3

2.4

NA

NA

32

14

1,756

3,839

18.6

15.5

25.7

21.3

7.5

6.3

20

19

28

28

28

770

3,441

15.2

12.9

24.2

19.6

3.4

2.9

29

40

19

25

24

17.8

15.3

26.1

22.9

4.7

3.8

Average
Mid-caps
Torrent Pharma

870

2,425

12.2

10.6

20.0

17.6

3.0

2.6

15

12

40

33

30

IPCA Laboratories*

820

1,703

12.5

10.1

19.8

15.7

2.9

2.4

11

17

27

24

25

Biocon

498

1,642

12.3

10.3

21.6

17.9

2.9

2.5

14

15

14

14

15

17

20

16

18

17

(16) (23)

28

11

13

Bayer Cropscience

2,592

1,563

19.0

16.3

28.7

24.0

2.6

2.2

Wockhardt

852

1,543

18.7

14.3

27.8

18.9

2.3

2.1

Alembic Pharma

431

1,337

18.2

14.3

26.9

21.0

3.7

3.1

26

28

40

37

35

1,746

1,011

14.5

12.4

22.5

19.3

4.4

3.7

16

17

47

36

31
28

Ajanta Pharma
Pfizer Ltd

1,548

761

12.1

10.5

21.3

18.6

3.0

2.7

28

19

30

Abbott India

3,339

1,169

22.8

19.7

36.2

31.1

3.1

2.8

NA

7.3

25

23

23

174

456

7.0

5.5

9.0

5.7

1.1

1.0

6 111

11

16

Strides Arcolab

730

716

15.7

11.6

22.5

16.0

3.1

2.5

NA

NA

19

21

Natco Pharma

1,495

814

25.1

21.8

41.4

34.7

6.3

5.5

15

16

16

16

17

15.8

13.1

24.8

20.0

3.2

2.7

Jubilant Life Sciences

Average
Small caps
FDC Ltd

159

466

NA

NA

NA

NA

NA

NA

NA

NA

17

Unichem Labs

242

361

10.0

8.2

15.6

12.6

1.7

1.4

22

22

16

18

Indoco Remedies

302

458

17.5

13.1

28.7

20.1

3.2

2.6

34

55

13

19

22

Claris LifeSciences

183

165

NA

NA

Average

11.2

8.9

18.1

13.5

2.1

1.8

Source: Company, Bloomberg, Ambit Capital research; Note: * indicates Ambit Capital estimates

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 35

Healthcare

This page has been intentionally left blank

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 36

Cadila Healthcare
BUY
INITIATING COVERAGE

CDH IN EQUITY

September 16, 2014

Multiple levers for growth

Pharmaceuticals

Cadila scores average on our 5R and below average on our DNA


frameworks. However, Cadila has established itself in India (4% market
share in FY14) and the US (US$360mn sales in FY14); continued spending
on complex and innovative products (35% of total R&D) should add to
sustainable revenue streams. Whilst Indian market growth would likely
normalise, as systemic issues are resolved, US sales growth would be
driven by new approvals. Cadila seems to be in the gestation period in
RoW, but given its poor ranking on DNA, it does not deserve the benefit
of doubt. We estimate 20% sales CAGR and 28% net profit CAGR over
FY14-17E, largely led by niche opportunities in the US. Our implied
multiple of 20.0x FY16/17 EPS is at a 20% discount to large-caps. Key
risks: Delay in EM profits and failure in innovation.

Recommendation

Competitive position: MODERATE Changes to this position: STABLE

Catalysts

Other business interests and recent ineffective acquisitions a concern


Whilst Cadila ranks highly on rational capital allocation, investment risk
management and R&D productivity, the company loses ground on other business
interests and ineffective acquisitions in the recent past. It has scope for
improvement on our DNA framework, if it exhibits better growth and
profitability in India along with the Nesher, Biochem and RoW acquisitions

Niche approvals in the US

Plenty of levers for growth; we do not give the benefit of doubt yet
Whilst we do not pencil in any material ramp up in growth in Wellness/RoW/JV
businesses given its poor ranking on our DNA framework, the US business is
likely to ramp up (37% CAGR in FY14-17E) with 158 ANDAs pending approval vs
68 marketed products. The India formulations business is likely to grow in line
with the broader market (12% CAGR in FY14-17E). We credit Cadila for the
launch of the first NCE in India and are upbeat about the prospects of other
innovations, such as vaccines, NCEs and biosimilars.

Performance

`222/US$3.7
`127/US$2.1
`1273
`1510
19

Flags
Accounting:
Predictability:
Earnings Momentum:

GREEN
AMBER
GREEN

Sustained growth momentum in


domestic formulations
Ramp up of new launches in the
Wellness business

Sensex

Jun-14

Aug-14

Apr-14

Feb-14

Dec-13

1200
1100
1000
900
800
700
600
Oct-13

28,000
26,000
24,000
22,000
20,000
18,000
16,000
Aug-13

US/ EMs and differentiated products to drive near / medium term RoCE
Better margins from niche launches (transdermals and nasal sprays) in the US
are likely to increase EBITDA margin to 20.4% in FY17E from 17% in FY14 and
expand RoCE to 24.4% in FY17E (from 17.5% in FY14). Cadila has invested in its
ground presence in several geographies through bolt-on acquisitions and in
biosimilars, vaccines and NCEs (35% of R&D as of FY14). Whilst bolt-on
acquisitions seem to be in the gestation period as of now, innovative products
have started contributing to revenues in India recently.

Mcap (bn):
6M ADV (mn):
CMP:
TP (12 mths):
Upside (%):

Cadila Healthcare, RHS

Source: Bloomberg, Ambit Capital research

Stock performance to be lower than earnings growth


Continued earnings momentum (25% in FY14-17E) and RoCE expansion drive our
valuation; we expect P/E to normaliseour DCF implies 20.0x one-year forward
P/E vs the current 22.0x. We prefer Cadila to Aurobindo on better prospects in EMs
and investments in innovation and model 23% FCFF CAGR in FY17-27E vs 8% for
Aurobindo. Key risks: Delay in EM profits (-10% EBITDA); failure in innovation.
Key financials
Year to March
Net Revenues (` mn)
Operating Profits (` mn)
Net Profits (` mn)
Diluted EPS (`)
RoE (%)
P/E (x)
P/B (x)

FY13
61,552
11,251
6,536
31.9
23.7
40.4
4.5

FY14
70,600
12,001
8,036
40.1
25.2
32.2
3.8

FY15E
82,389
15,522
9,928
48.5
26.0
26.6
3.1

FY16E
101,257
20,280
13,916
68.0
29.1
19.0
2.5

FY17E
122,902
25,048
16,968
82.9
27.8
15.6
1.9

Analyst Details
Aditya Khemka
+91-22-30433272
adityakhemka@ambitcapital.com
Paresh Dave
+91-22-30433212
pareshdave@ambitcapital.com

Source: Company, Ambit Capital research


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Cadila Healthcare

Snapshot of company financials


Profit and Loss

Revenue Mix

Year to Mar (` mn)

FY15E

FY16E

Net revenues

82,389

101,257

122,902

EBITDA

15,522

20,280

25,048

Depreciation

2,841

3,119

4,536 API (Domestic and Exports)

Interest expense

1,115

1,115

1,115

12,064

16,756

20,345

Adjusted PBT

FY17E Year to Mar (` mn)

Tax

1,810

2,513

Adjusted net profit

9,928

13,916

16,968

Profit and Loss Ratios

18.8

20.0

20.4

EBITDA Margin (%)

12.1

13.7

13.8

Net profit margin (%)

18.2

13.7

10.7

EV/ EBITDA (x)

26.6

19.0

3.4

2.7

82,389

101,257

EV/Sales (x)

Domestic Formulations

FY17E

30,821

34,884

3,824

4,160

4,506

4,511

4,872

5,261

3,198

3,569

3,983

40,469

54,359

70,658

North America (US)

29,096

41,350

55,910

Ex North America

11,373

13,009

14,748

4,882

5,308

5,669

84,014

103,088

124,962

Consumer

Export Formulations

15.6 JV Revenues
2.2
122,902 Total Gross Sales

Balance Sheet

FY16E

27,131

3,052 Animal Health

Reported net profit

P/E on adjusted basis (x)

FY15E

Cash flow

Year to Mar (` mn)

FY15E

FY16EE

Total Assets

71,460

83,110

97,811 PBT

Fixed Assets

41,812

44,193

Current Assets

46,517

58,400

866

866

Investments

FY17E Year to March (` mn)

FY15E

FY16E

FY17E

12,064

16,756

20,345

46,157 Depreciation

2,841

3,119

4,536

74,134 Tax

1,810

2,513

3,052

(2,505)

(4,005)

(4,593)

10,264

13,030

16,910

(4,500)

(5,500)

(6,500)

866 Net Working Capital

Total Liabilities

71,460

83,110

Total networth

84,103

107,404

Total debt

27,004

27,004

27,004 Investment

Current liabilities

17,736

20,349

23,346 CFI

961

961

961 Issuance of Equity

(4,500)

(5,500)

(6,500)

RoCE

20.2

23.9

24.4 Net Dividends

RoE

27.8 Interest paid

(2,232)

(2,266)

(2,266)

(2,232)

(2,266)

(2,266)

3,532

5,264

8,144

Deferred tax liability

97,811 CFO
136,807 Capital Expenditure

Balance Sheet ratios

Inc/Dec in Borrowings

26.0

29.1

Gross Debt/Equity (x)

0.3

0.3

0.2 CFF

Net debt (cash)/ Eq (x)

0.2

0.1

0.0 Net change in cash

P/B (x)

3.1

2.5

1.9 Closing cash balance

Operating leverage in EMs/Europe yet to play out


In ` mn (FY14)

Revenue EBITDA

Cadila a key beneficiary of improvement in approval


timelines

EBITDA Contribution to
margin % reported EBITDA

Zydus Wellness

4,027

1,084

26.9%

9.0%

Joint Ventures

4,499

2,017

44.8%

16.8%

6,161

25.0%

51.3%

-13.3%

Reported

70,600

September 16, 2014

12,001

Filings

17.0%

Ambit Capital Pvt. Ltd.

FY15E

-10.2%

10

15

40
20

20

3
FY14

15,726 (1,602)

13

11

FY13

Others

25
18

FY12

36.2%

24

FY11

20.0%

FY10

4,341

FY09

21,704

18
11 148 1412
FY08

US Business

40

FY17E

24,644

60

54

FY16E

India Business

70
60
50
40
30
20
10
-

Approvals

Page 38

Cadila Healthcare

Cadila Diversified revenue streams


Cadila sells prescription drugs in India (32% of FY15E revenues) and North America
(35% of FY15E revenues) and other export markets (14% of FY15E revenues). The
company also sells consumer products (5% of FY15E revenues) and animal healthcare
products (4% of FY15E revenues) in India. Cadila has JVs with Hospira (oncology
products for export markets), Takeda (APIs and intermediates for exports) and Bayer
(prescription drugs for India). These JVs would jointly contribute to ~6% of FY15E
revenues.
Exhibit 1: Presence

in

multiple

segments

(`

80

` Bn

20

3
5
4
7

3
4
2
6

16

14
0
US

Exhibit 2: Decline in RoCE and EBITDA margins due to lack


of approvals in US and slowdown in other segments (%)
35%

3
6
5
10

60
40

Bn)

10

FY10
FY11
India formulations

3
5
4
8

3
7
4
11

30.5%

30%
26.5%
25%

21.6%

25
23

19

15

12
FY12
RoW JV

22.6%

20%
22

24.1%

15%
FY10

FY13
FY14
Consumers API

Source: Company, Ambit Capital research

23.0%

FY11

18.3%

17.5%

18.2%

17.0%

FY13

FY14

FY12

CDH, EBITDA margin

CDH, RoCE

Source: Company, Ambit Capital research

Within India, Cadila has had an acute heavy presence which drags down the
companys score on our DNA framework. However, off late, the company has
increased its presence in chronic therapies and has also commercialised biosimilars
and NCE (Lipaglyn) in India. We are upbeat about the prospects of other innovative
projects that Cadila has undertaken like biosimilars, NCEs, vaccines and NBEs.

Respiratory,
10%

Source: Company, Ambit Capital research

September 16, 2014

53.7

48.2

42.9

0.0
Aurobindo

Gynaecolog
ical, 10%

AntiInfectives,
13%

Domestic EBITDA as % of Total Revenue

Glenmark

Pain
, 7%

68.8

IPCA

Gastro
Intes,
14%

Derma, 7%

80.0
70.0
60.0
50.0
40.0
30.0
20.0
10.0
0.0

Cadila

Others,
23%

Cardiac,
17%

Exhibit 4: Cadila sources a higher portion of its EBITDA


from India when compared to large caps

Biocon

Exhibit 3: Cadilas therapy split in India (FY14)

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 39

Cadila Healthcare

Gaining lost ground


Cadilas evolution
Cadilas history suggests that the company has foregone opportunities that were
leveraged by its peers to create value for stakeholders. However, if we discount the
initial 43 years of its relatively passive existence, Cadila seems to be a budding
newbie. A deep dive into Cadilas history suggests that the company has been
proactive in acquiring capabilities and product-related assets through alliances, JVs
and acquisitions. However, its financials suggest that the company is yet to extend
these acquired assets beyond the domestic market. We believe that the extension of
these assets and capabilities beyond the home market would be a key trigger for
value creation and revaluation of Cadilas long-term growth prospects.
Phase 1 (1952 1994): The dark age
Cadila was established in 1952 by the Modi and Patel families. This period was a
dark age for Cadila in more than one way.
Firstly, there is not much known about the companys activities in this era apart from
the fact that the company produced anti-TB medicines and vitamins for the Indian Little progress in early years of
market. And secondly, the company clocked revenues of only `2bn by 1995, formation except the flagship
Sugar Free brand
indicating that very little progress was made in the early years of formation.
The most significant legacy of this era was Sugar Free, the companys flagship brand
in the wellness business which was launched during the latter part of this period
(1988).
Phase 2 (1995 2002): The building blocks of domestic business
In 1995, Cadila was split into Cadila Pharmaceuticals (headed by the late Indravadan
Modi) and Zydus Cadila (headed by the late Ramanbhai Patel). With the new
management in place, Cadila went on an in-licensing spree to ramp up its revenues
by leveraging the established domestic platform. To our knowledge, the company
engaged in a total of 27 acquisitions/alliances/JVs in this period to expand their
product offerings. Amongst these alliances, the most notable was Byk JV (now Takeda
JV) which was formed in 1998 for the manufacturing of pantoprazole intermediates.

Post the split of the Patel family


and Modi family, Cadila engaged
in in-licensing to ramp up
revenues

Post listing on the BSE in 2000, Cadila acquired German Remedies (2001) and Recon
(2000) to expand its product basket and distribution reach in the Indian formulations
business. The company received the rights to the blockbuster brand, Aten, through
the German Remedies acquisition.
In FY03, Cadila reported revenues of `10.4bn, implying a CAGR of 25% since the
takeover by Ramanbhai in 1995. The growth was led by in-licensed
products/acquisitions and organic expansion.
Phase 3 (2003 onwards): Exploring the export opportunity; focus on
innovation
Cadila entered the US market through the acquisition of Banyan Chemicals in 2002.
Banyan had a USFDA-approved API facility which enabled Cadila to produce
pharmaceuticals for clients who were marketing in the US. Cadilas Moraiya
formulations facility received UK MHRA approval in 2002. The company established
two subsidiaries in FY03 (in Brazil and the US). The establishment of a US front-end
was aimed at starting its own ANDA filings in the US. In 2003, Cadila filed its first
ANDA in the US and it received a USFDA approval for its formulation facility at
Moraiya in 2004. Cadila launched its first product in the US in 2005 in collaboration
with Mallinckrodt.

September 16, 2014

Ambit Capital Pvt. Ltd.

Entry in the US market through


acquisition and approval by US
FDA for the Moraiya facility, and
front-ending to start its own
ANDA filings

Page 40

Cadila Healthcare
Exhibit 5: RoCE has reduced over FY05-14 due to lack of new launches in US and pricing regulation in India
Incremental competition in
Taxotere and import alert at
Moraiya facility hurt
profitability and RoCE

US and EU exports ramped


up leading to expansion in
RoCE owing to higher
margins

Launch of new products


in US ramped up
revenues and RoCEs

Launch of generic
Taxotere with limited
competition led to
spike in RoCEs

Lack of new
meaningful launches in
US, pricing regulation
in India and losses in
foreign subsidiaries

35.0%
30.0%

70
60
50

23.0%

22.7%

26.5%

20.1%
20.0%

80

30.5%

24.1%

25.0%

Launch of Depakote ER
marginally offsets
adverse impact of
pricing in India and low
margins in JVs and
Wellness

40
24.1%

17.8%

18.2%

30
20

15.0%

10

17.5%

RoCE

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

FY06

0
FY05

10.0%

Revenue, RHS (Rs. Bn)

Source: Company, Ambit Capital research

Exhibit 6: Major milestones with stock price performance


1200
1000

Generic Taxotere
approved by USFDA

Started its front-end in


the US and started
filing ANDAs; entered
the French market

Listed on
the NSE
and BSE

Launched first
product in the US
Tentative approval
for generic
Taxotere

800
Acquired
companies
Recon and GRL
and brand Aten

600
400

FDA clears the


Moraiya facility

Hospira JV files
for Taxotere

FDA approved
Moraiya facility

USFDA
issues
warning
letter to
Moraiya
facility

US Court
invalidates
Taxotere
patents

200

Launch of
Depakote ER
in US drives
revenues and
profitability

Jun-14

Jan-14

Aug-13

Mar-13

Oct-12

May-12

Jul-11

Dec-11

Feb-11

Sep-10

Apr-10

Nov-09

Jun-09

Jan-09

Mar-08

Aug-08

Oct-07

May-07

Jul-06

Dec-06

Feb-06

Sep-05

Apr-05

Nov-04

Jun-04

Jan-04

Mar-03

Aug-03

Oct-02

May-02

Jul-01

Dec-01

Feb-01

Sep-00

Apr-00

CDH stock price


Source: Company, Bloomberg, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 41

Cadila Healthcare
Active strategic partnerships/acquisitions approach
In FY05, Cadila entered into JVs with Mayne Pharma (now Hospira) for cytotoxic
injectables for the regulated markets and with BSV to develop, manufacture and
market a non-infringing and proprietary Novel Drug Delivery System (NDDS). These
JVs catapulted Cadilas profits in FY10-14.
Exhibit 7: Active strategic partnerships by Cadila from 2003 onwards
Name of Joint venture
Nature
/ Acquisition

Year

Geography

Particulars

Alpharma SAS France

Acquisition

2003

France

Acquired US-based Alpharma Inc's French subsidiary, Alpharma SAS France for a consideration of
Euro5.5 million. This acquisition will provide access to the French generics markets.

Alliance

2003

India

Signed a pact with Schering AG, Germany, which allows Zydus to market Schering's eight patented
products in India. The agreement also covers transfer of technology and manufacturing of Schering
AG's products in India. The products are in the womens healthcare segment.

Alliance

2003

Fermenta Biotech Ltd (FBL), a subsidiary of Duphar Interfran, signed an agreement with Cadila Ltd
for the sale of FBL's global patents and process technology for the manufacture of Lisinopril and
Benazepril. The objective of this alliance is to strengthen the presence in CVS and anti-hypertensive
segments.

Alliance

2004

India

Long-term strategic pact with Boehringer Ingelheim India, a wholly-owned subsidiary of Boehringer
Ingelheim of Germany, for manufacturing and marketing the latter's products in India for a period
of 10 years and to set up a joint venture to fortify their co-marketing efforts in India.

Alliance

2005

US

Agreement with Tyco's Mallinckrodt Pharmaceuticals under which Mallinckrodt would market
generics produced by Cadila. This alliance provided Cadila with access to the US markets

Mayne JV

Joint
Venture

2005

Cadila Healthcare and Mayne signed an agreement to set up an API manufacturing facility in India
to manufacture specialty oncology products.

Nippon Universal
Pharmaceutical Ltd.

Acquisition

2006

Japan

Acquisition of Nippon Universal Pharmaceutical Ltd., Japan. The acquisition provided access to
ready manufacturing facilities, marketing base and the distribution network of Nippon in Japan. In
2014, Cadila announced its decision to exit the Japanese market.

Quimica e Farmaceutica
Acquisition
Nikkho do Brasil Ltda

2006

Brazil

Acquisition of Quimica e Farmaceutica Nikkho do Brasil Ltda for US$25mn. The objective of this
acquisition is to foray into Brazil's branded generics business.

Alliance

2008

Entered into a three-year collaboration with Swedens Karo Bio for developing new drugs for the
treatment of inflammatory diseases.

Combix Laboratorious

Acquisition

2008

Spain

Acquired stake in Combix Laboratorious, Spain. Combix has a pure generic focus and strong
product pipeline in Spain.

Etna Biotech

Acquisition

2008

Zydus Cadila acquired Etna Biotech, a subsidiary of Crucell N.V. The deal helped Cadila foray into
innovative vaccine research and development.

Simayla Pharma

Acquisition

2010

South Africa

Acquired Simayla Pharma, South Africa, to strengthen its presence in South Africa.

Bayer Zydus Pharma

Joint
Venture

2011

India

Agreement with Bayer HealthCare to set up 50:50 joint venture company in the name of Bayer
Zydus Pharma for sales and marketing of pharmaceutical products in India.

Nesher Pharma

Acquisition

2011

US

Acquired Nesher Pharma which has expertise in niche therapies such as controlled release
medications.

Bremer Pharma GmbH

Acquisition

2011

RoW

Acquired Bremer Pharma GmbH from ICICI Ventures to expand its animal health business to gain
strategic access in markets across Europe, South America, Asia and Africa.

Biochem

Acquisition

2011

India

Acquired Biochem to strengthen its anti-infective segment in the domestic market.

Alliance

2012

US

Agreement with Microbix Biosystems, Canada, for re-commercialising and marketing of certain
drugs in the US markets.

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 42

Cadila Healthcare

Mapping competitive advantage The 5 Rs


Cadila receives the fourth rank in our competitive advantage framework (amongst
seven companies analysed in the Indian large-cap pharmaceutical space). Whilst the
company scores high on risk management, robustness of business model and capital
allocation parameters, it lags on parameters like R&D productivity (largely due to
delays in product approvals) and quality of management (high other business
interests and no significant competitive advantage). Please refer to our thematic
report for further details on the competitive framework.

Cadila ranks fourth in our


competitive advantage
framework

Exhibit 8: Cadila ranks average largely due to rational capital allocation


Competitive advantage

Components

Measures

Remarks

Strategy

Stated intent and vision

Vision and mission focus on: (a) being a research-led company by


2020; (b) global aspirations; (c) innovation and quality excellence;
(d) commitment to partners.

Recent hires,
management transition,
depth and width

Recent hire of Dr. Sharad Govil as CEO of Zydus Noveltech


expands technical capability. JVs with various other healthcare
organisations give us comfort on management width and depth.
Stable top management since 1995. Third generation of promoter
is well entrenched. No transition in sight.

Other business interests

Average number of other business interests.

Ambit's Forensic
accounting

Our forensic accounting analysis raises no significant concerns.

Growth rate in India

Cadila has consistently beaten the broader market growth,


indicating good quality of execution.

Market share in US

Cadila is second to only Lupin in gaining market share in the US.


The company has won many accolades for excellent service levels
in the US.

Earnings visibility and


delivery

Cadila has an average performance in earnings delivery and


visibility. However, over the recent past, the company has overpromised and under-delivered.

Inorganic strategy success

Cadila has been an active acquirer. The recent acquisitions of


Biochem and Nesher Pharma have left much to be desired.

Quality

Reputed management,
strategy and execution

Execution

Rank out of seven


companies
analysed

6 (Worse than
average)

R&D productivity

Productivity
index

Revenues generated per


R&D spend

Cadila has average R&D productivity. The company's productivity


has been depressed in our view largely due to lack of interesting
approvals in the US because of the warning letter at Moraiya.

4 (Average)

Rational capital allocation

Greatness
framework

Ambit's proprietary
framework

Cadila comes second to only Sun Pharma and IPCA in rational


capital allocation.

2 (Excellent)

Bargaining
power with
buyers

Average debtor days

Higher than average bargaining power with buyers, as indicated by


debtor days of 58 days.

Average creditor days

Average bargaining power with suppliers, as indicated by average


creditor days.

Bargaining
Robustness of the business power with
model
suppliers

Revenues from niche


Barriers to entry
segments

Operational risk
Risk entailed in operations

Investment risk
Overall rank

Diversity of manufacturing
base
Incidence of Form 483s
from USFDA

JVs, alliances and


partnerships

3 (Better than
average)

Significant portion of revenues sourced from competitive segments


with no sustainable barriers to entry; ~15% of revenues from
limited competition segments (India consumer business, animal
health and niche products in the US).
Average number of USFDA-approved facilities (formulations + API)
encountered by a high 483 issue rate make Cadila prone to
operational risk.
4 (Average)
Best-in-class diversification of investment risk with JVs and alliances
for multiple product segments and geographies.
Cadila obtains an average position as compared to largecap peers.

4 (Average)

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 43

Cadila Healthcare

Reputed management, strategy and execution Scope


for improvement
Positives High-quality execution in US and India; no transition in sight

The vision and intent of the management are in sync with our thoughts on the
longer-term prospects of the industry. We believe innovation is the only
sustainable competitive advantage over the longer horizon.

Well-entrenched third generation of promoters gives us comfort on the transition


risk. Multiple JVs with various partners also bodes well for management
bandwidth and depth.

The companys execution in India and the US has been high quality. Despite an
inferior product mix in India and lack of support from the base business in terms
of growth contribution, the company has been able to consistently beat the
broader market growth led by new product introductions and consistent
execution.

The management is focussed on


sustainable competitive
advantage over the longer term

Negatives Recent acquisitions have not added value

Despite being an active acquirer, Cadila has thus far been unable to replicate its
It was unable to replicate its
success with German Remedies in other acquisitions. This is a cause for concern,
success with German Remedies in
as the company remains acquisitive and may not be taking impairment charges
other acquisitions
despite incurring losses on past investments.

The company underwent a restructuring in 1995 when the Modi family split from
the Patel family. Until then, after 43 years of existence, the company had clocked
revenues of only `2bn (1995).

The multiple business interests of the promoters and kin are also a cause for
concern. The promoter and immediate kin had 25 other directorships other than
Cadila and its subsidiaries.

Exhibit 9: Risk of divergence in management focus


Other directorships of immediate family of promoters

60
50

47

48

Sun
Pharma

Dr. Reddy's

40
30
20
10

25

Average
15

16

18

Lupin

Cipla

Ipca

0
Glenmark

Cadila
Healthcare

Source: Ambit Capital research

The continued losses at several foreign subsidiaries may be indicative of the lack
of scalability of the companys strategy in these markets.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 44

Cadila Healthcare

R&D productivity Heading northwards


Positives R&D productivity healthy due to high market share

Despite Cadilas US revenues being depressed due to delay in USFDA approvals,


the company has been able to register decent R&D productivity.

Scores average on the R&D


productivity index

Exhibit 10: Cadila registered decent R&D productivity despite delay in USFDA
approvals and high innovative avenues spend
R&D spend as % of sales
(FY14)

10.0%

Dr. Reddy's

9.0%

Glenmark

8.0%

Lupin

7.0%

Cadila

6.0%
Sun Pharma

5.0%

Ipca

4.0%
3.0%
2.0%
0

R&D productivity index


Source: Ambit Capital research

R&D spend on innovative pursuits like biosimilars, vaccines and NCEs bodes well
for longer-term prospects.

Negatives Innovation entails its own risks

High R&D spend in innovative pursuits (35% of R&D in FY14) may lead to
depression in RoCE until such endeavours yield results.

The company has capitalised its R&D spend on transdermals in the Zydus
Noveltech JV with Sharad Govil. Whilst the principle of capitalising the R&D spend
in a JV is appropriate per accounting standards, the profits stand exaggerated
due to such a practice. We credit the management for disclosures on this front.

High R&D spend led to


depressed RoCE

Rational capital allocation Best-in-class allocation


but
Positives JVs and Wellness business exhibit high RoCE

Cadila ranks high on our rational capital allocation measures (Ambits proprietary
greatness framework). Amongst pharma companies, Cadila ranks second only
to Sun Pharma and IPCA.

Higher RoCE in the Wellness and


The companys investments in JVs and the Wellness business are yielding high JV business
RoCEs (30.9% and 49.3% as of FY14 respectively as compared to 12.8% for the
rest of the business).

Negatives Biochem and Nesher value-dilutive as of now

The companys investments in bolt-on acquisitions in 2005-2010 and in Biochem


and Nesher in 2011-2012 seem to be RoCE-dilutive.

Whilst the company still remains acquisitive, there is a credible threat of a great
mistake as indicated by the less-than-ideal track record in acquisitions.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 45

Cadila Healthcare

Robustness of business model - All is well


Positives High proportion of moated revenue streams vs peers

Less than average debtor days are a positive for bargaining power against
Diversified revenue portfolio
buyers.
augurs well for sustainability
High proportion of revenues sourced from differentiated segments like consumer
business, animal business and niche products in the US augurs well for
sustainability. Cadila sources ~45% of its revenues from the domestic market as
compared to ~30% for most large-cap peers. High proportion of domestic
revenues (branded market) is a key positive.

Negatives Working capital cycle may expand

Working capital cycle to expand


as exports outpace domestic
Since Cadila has lower exposure to export markets, the working capital cycle revenues
might expand as and when exports outpace domestic revenues.
Less than average creditor days indicate low bargaining power with suppliers.

Risk entailed in operations Excellent investment risk


management
Positives Alliances and partnerships reduce investment needs

Cadilas approach to expansion in various product segments and markets


illustrates measured investment risk undertaking. Although partnerships pare
near-term upside due to payments to partners, the high gestation period and low Measured investment risk
risk of failure make such deals prudent, in our view.
undertaking through partnerships
and expanding capacity by
Negatives High 483 issue rate
adding more USFDA facilities
Cadila has exhibited a high 483 issue rate in the past. However, with the
company now expanding capacity by adding more USFDA-approved facilities, we
believe the operational risk will reduce.

Cadilas standing on our five Rs framework


Cadila ranks fourth in our competitive advantage framework (amongst seven
companies analysed in the Indian large-cap pharmaceutical space). Whilst the
company scores high on robustness of business model and capital allocation
parameters, it lags on quality of management (high other business interests and no
significant competitive advantage).

Cadila ranks fourth in our


competitive advantage
framework

We see a material improvement in R&D productivity ahead and also anticipate that
the management would improve on earnings delivery and visibility. With new
capacities coming online for the US market, the operational risk is also likely to
decline. These improvements are likely to cause a material jump in Cadilas ranking
in our universe.
Exhibit 11: Cadila scores average on our five Rs framework; improvement in management and risk could lead to a
material jump in rankings
Reputation, strategy and
execution of management

R&D productivity

Rational capital
allocation

Robustness of the
business model

Risk entailed in
operations

Overall
rank

Lupin

Sun Pharma

IPCA
Cadila
Healthcare
Dr. Reddy's

Glenmark

Cipla

Company

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 46

Cadila Healthcare
Exhibit 12: SWOT analysis
Strengths

Weaknesses

Promoter-led management keeps agency costs low. Promoter stake in

Multiple business segments have proven difficult to manage (for example,

the company is currently at ~75%.

Robust business model with a reasonable portion of revenues (~15%


of sales in FY14 from consumer business in India, animal health and
niche products in the US) sourced from limited competition segments.

High R&D productivity going ahead and investment risk management


to aid ramp up in RoCE levels. High investments on long-term growth
drivers (35% of R&D spend in FY14) a positive.

Depth and width of management to ensure stability; no transition in

the lacklustre growth in the India wellness and emerging markets despite
enormous scope for growth).

Inorganic strategy has not proven successful. As opposed to the valueaccretive German Remedies acquisition (2001), the latest acquisitions of
Biochem and Nesher Pharma (2011-2012) are yielding negative RoCEs.

The companys presence in many export markets through bolt-on


acquisitions is also yielding negative RoCE (Brazil, Mexico, Spain, and
France); investments may be impaired.

sight. Third generation of promoter well entrenched in the business.

Highest percentage of revenues sourced from the Indian market (44%)


as compared to its peers (average of 30%) ensures higher
sustainability of revenue streams over the longer term.

Efficient capital structure compared to peers (net debt:equity of 63% as


of FY14) beneficial for stakeholders.
Opportunities

Threats

Small business in RoW markets (US$175m revenues; 15% of total

The lack of growth in certain geographies could be a signal of lack of

sales in FY14) offer scope for long-term sustainable growth.

scalability of the business.

The company already markets biosimilars in India and is ahead of its


peers (except Dr. Reddys) in development of NBE/MBEs. This is a longterm growth driver which could play out over the next few years.

High investments in innovative pursuits may keep RoCE depressed in the


near term if these pursuits do not bear fruit in the near term.

Innovative projects undertaken in India like Lipaglyn (NCE) exemplify


the companys R&D capabilities. Geographical expansion of such
projects can lead to a re-rating of the entire business.

Large ANDA pipeline (158 ANDAs pending approval) in the US as


compared to a smaller currently marketed portfolio (68 products
marketed) bodes well for growth prospects.

Meaningful additions in wellness product portfolio and geographical


expansion of the product basket to emerging countries may add
significant value.
Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 47

Cadila Healthcare

Cadila has multiple levers for growth


With most of Cadilas businesses, other than the foreign subsidiaries (ex-US), running
at base-business profitability with no one-offs, we see minimal risk to current profits.
In the past, the Takeda JV (JV formed with BYK in 1999 for manufacture of
pantoprazole intermediates) had seen extraordinary profits due to pantoprazole
exclusive sales, whereas the Hospira JV (formed in 2005 for oncology products) had
seen high profitability from limited competition in generic Taxotere. In the near term,
Cadila is likely to see an uptick in profitability of the US business led by niche
launches like transdermal and nasal sprays. We do not expect any material change in
the growth trends of the Indian consumer business, animal health business and
foreign subsidiaries largely owing to lack of visibility. We believe that Cadilas
investments in NCEs, biosimilars and vaccines are key positives.

Uptick in profitability of the US


business led by niche launches

Revenue mix Spread across verticals


Exhibit 13: RoW and other businesss earn negative EBITDA margins
Implied
EBITDA
Comments
margins
(FY14)

FY13

FY14

FY15E

FY16E

FY17E

23,232

24,644

27,131

30,821

34,884

API (Domestic and Exports)

3,098

3,497

3,824

4,160

4,506

Consumer

4,100

4,296

4,511

4,872

5,261

Animal Health

2,462

2,865

3,198

3,569

3,983

24,886

32,282

40,469

54,359

70,658

10.2%

15,068

21,704

29,096

41,350

55,910

Largest and fastest growing business; profitability


20.0% suppressed due to authorized generics and lack of FDA
approvals

9,818

10,578

11,373

13,009

14,748

-10.0%* Loss making business; scale to provide margins overtime

5,070

4,499

4,882

5,308

5,669

44.8%

62,848

72,083

84,014

103,088

124,962

17.0%

Domestic Formulations

Export Formulations
North America (US)
Ex North America
JV Revenues
Total Gross Sales

25.0% The most profitable business segment for Cadila


Legacy business, growing slower due to higher captive
consumption
Business struggling for growth after larger brands have
26.9%
matured
-10.0%* Small business as of now
-10.0%*

New product launches to fuel growth; low visibility on


interesting products

Source: Company, Ambit Capital research


Note: Aggregate EBITDA margin for all other business is implied -10%

India formulations business: Acute-dependent


As compared to other larger peers, Cadila's India business is sub-par in terms of
therapy area presence and growth potential. The company has significant presence in
acute therapies like anti-infectives, pain, and gynaecology, which are slower-growing
segments with intense competition.
Exhibit 14: Higher
gynaecology

presence

in

acute

segment

like

anti-infective,

Cadila has a presence in the


lower-growth acute therapy areas

pain and

Cardiac,
17%
Others, 23%
Derma, 7%

Gastro
Intes,
14%

Pain, 7%
Gynaecological,
10%

Anti-Infectives,
13%
Respiratory, 10%

Source: AIOCD, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 48

Cadila Healthcare
Amongst chronic therapies, the company has a credible presence in the cardiac and
chronic respiratory segment. The company has limited presence in the faster-growing
areas of anti-diabetes and neurology. However, in the past, the company has beaten
the broader market growth by better execution (better selling and marketing) and
plethora of new introductions.
Exhibit 15: Contribution of new product sales to total
growth has improved over FY10-14 with CAGR of 130% as
compared to 15% total sales CAGR
22%

100%

33%

25%

36%

25.0%

147%

80%

Exhibit 16: Cadilas product selection has been sub-par


(IPM sales > Sub group sales) but it has exhibited strong
execution capabilities (Cadila sales > Sub group sales)
Growth YoY %

20.0%

60%
40%

15.0%

78%

67%

75%

64%
10.0%

20%
0%

5.0%

-47%

-20%

0.0%

-40%
FY10

FY11

FY12

Base business

FY13

FY09

FY14

Cadila

New Product sales

Source: AIOCD, Ambit Capital research

FY10

FY11

FY12

FY13

Cadila - Sub Group Sales

FY14
IPM sales

Source: AIOCD, Ambit Capital research

We expect the business to sustain its growth in line with the broader market, as the
product mix improves. We maintain that with higher data requirements on clinical
trials and longer timeframe for new product approvals, the Indian Pharma Market
(IPM) is likely to experience a slow down by a couple of percentage points.

Domestic business to grow in line


with the broader market

Exhibit 17: Domestic business to grow in line with broader market


40,000
CAGR 13%

35,000
30,000
CAGR 14%

` mn

25,000
20,000
15,000
10,000
5,000
FY10

FY11

FY12

FY13

FY14

FY15e

FY16e

FY17e

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 49

Cadila Healthcare

US business: Large pipeline to unfold


Cadila's US business, excluding Nesher Pharmaceuticals, has been facing pricing
pressure. The business has not seen any material new launches in the recent past
other than Depakote ER (AG and own ANDA), Trilipix (AG) and Tricor (AG). However,
with the resolution of the warning letter to the Moraiya facility, the company is likely
to obtain some niche approvals over the next 12 months.

Resolution of warning letter at the


Moraiya facility to provide niche
approvals over the next 12
months

Exhibit 18: Withdrawal of warning letter at Moraiya facility to help obtain niche
approvals
1,000

US$ mn

900
800
700

CAGR 39%

600
500
400

CAGR 26%

300
200
100
FY10

FY11

FY12

FY13

FY14

FY15e

FY16e

FY17e

Source: Company, Ambit Capital research

The company has ~158 ANDAs pending approval, including filings for niche
controlled release products like Toprol XL (US$250mn) and Transdermals (6-7 ANDAs
filed), which may include interesting opportunities like Clonidine (USD200m),
Estradiol Weekly (US$150mn), Fentanyl (US$1bn) and Lidocaine (US$1.2bn).

Acceleration in approvals by FDA


It has also filed more than 20 injectables (12 for partners and 8 for itself), 4 to benefit Cadilas158 products
ointments and 5 nasal products, for which approvals are pending. Cadila currently pending approval
markets only 68 products in the US as compared to a pending pipeline of 158
products. Given that the FDA is going to accelerate approvals under GDUFA, Cadila
could be a key beneficiary in terms of growth and launch opportunities.
Exhibit 19: Cadila could get 40-60 approvals from USFDA in FY16E and FY17E
70

60

60

54

50

40

40

40
30
20

25

24
18
11

10

14
8

18

1412

13

11

10

15

20

20

FY08

FY09

FY10

FY11

FY12

Filings

FY13

FY14

FY15E FY16E FY17E

Approvals

Source: Company, Ambit Capital research

We expect the US business to scale up on approvals of niche opportunities and


launch of controlled substance products from the Nesher stable. We follow a mix of
top-down and bottom-up approach whilst projecting revenues. We explicitly build in
known opportunities in the pipeline and take a revenue run rate of US$6mn for
unknown products.

September 16, 2014

Ambit Capital Pvt. Ltd.

We explicitly build in known


opportunities in the pipeline and
take a revenue run rate of
US$6mn for unknown products

Page 50

Cadila Healthcare

India consumer business: Steady growth ahead


Growth in the Indian consumer business has not been consistent on annual basis in Intensifying competition in niche
the past. The patchy performance is due to intensifying competition in niches that business
Zydus Wellness has created for itself. Although the product basket (Sugar Free and
Nutralite) is mature with high market share, the consumer business still has a long
way to go in terms of new product launches, brand extensions, and expanding
geographical reach within India.
Exhibit 20: We expect continued competition in the India consumer business
6,000

` mn

CAGR 8%

5,000
CAGR 13%

4,000
3,000
2,000
1,000
FY10

FY11

FY12

FY13

FY14

FY15e

FY16e

FY17e

Source: Company, Ambit Capital research

We expect the business to grow in single digits in the foreseeable future. We see
Expect business to grow in single
upside risk to these estimates if the recent launch of ActiLife and re-launch of
digits in the foreseeable future
EverYuth brands (with extensions) were to perform better than our expectations and
the company were to materially expand its geographical reach. Zydus Wellness
brands currently penetrate only 30% of the total target market in terms of
distribution, as per the management.

JVs: Growth expectations low due to lack of visibility


The JV business generated RoCE of 49% for Cadila in FY14. Taking the JV route has
JV business faces stiff competition
helped Cadila manage investments, expand its geographical reach, and generate
and lack of visibility of pipeline
phenomenal returns. However, the business seems to have peaked in FY12, with the
Hospira JV facing stiff competition in Docetaxel. Our expectations from the Nycomed
Takeda) and Bayer JV also remain low due to lack of visibility of the pipeline.
Exhibit 21: The JV business has stiff competition and low
visibility in product pipeline; any unexpected upsides to
the JV business can materially ramp up consolidated RoCEs
6,000
5,000

` mn

Exhibit 22: The JV business has generated phenomenal


returns as investments have been limited whilst products
have yielded margins

CAGR 8%

RoCE - JV business
120.0%

CAGR 30%

4,000

100.0%

3,000

80.0%

95.7%

87.0%

60.0%

2,000

48.4%

49.3%

FY13

FY14

40.0%

1,000

20.0%

Source: Company, Ambit Capital research

September 16, 2014

FY17e

FY16e

FY15e

FY14

FY13

FY12

FY11

FY10

0.0%
FY11

FY12

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 51

Cadila Healthcare
We expect the business to grow in single-digits and see upside risk to our estimates in
case any significant and niche opportunities (such as docetaxel and pantoprazole in
the past) were to materialise. We expect the JVs to ramp up post FY16E led by the
Hospira JV. Hospira in its 2013 10K mentioned that 2014 and 2015 are likely to be
peak years in terms of manufacturing start-up, validation (facility and productrelated), registration costs, and unabsorbed production costs w.r.t. the Zydus-Hospira
JV.

RoW markets: Is there an operating leverage play?


Cadila entered Brazil in 2006, South Africa in 2010, Spain in 2008, France in 2001
and Japan in 2006 mostly through bolt-on acquisitions.
Exhibit 23: Partnerships by Cadila in the last decade
Name of Joint
venture /
Acquisition

Nature

Year

Geography

Particulars

Alpharma SAS France Acquisition

2003

France

Alliance

2003

Global

Nippon Universal
Pharmaceutical Ltd.

Acquisition

2006

Japan

Quimica e
Farmaceutica Nikkho Acquisition
do Brasil Ltda

2006

Brazil

Acquisition of Quimica e Farmaceutica Nikkho do Brasil Ltda for US$25mn. The objective
of this acquisition is to foray into Brazil's branded generics business.

Combix Laboratorious Acquisition

2008

Spain

Acquired stake in Combix Laboratorious, Spain. Combix has a pure generic focus and
strong product pipeline in Spain.

Simayla Pharma

Acquisition

2010

South Africa

Acquired Simayla Pharma, South Africa, to strengthen its presence in South Africa.

Bremer Pharma
GmbH

Acquisition

2011

RoW

Acquired Bremer Pharma GmbH from ICICI Ventures to expand its animal health
business to gain strategic access in markets across Europe, South America, Asia and
Africa.

Acquired US-based Alpharma Inc's French subsidiary, Alpharma SAS France for a
consideration of Euro5.5 million. This acquisition provides access to the French generics
markets.
Fermenta Biotech Ltd (FBL), a subsidiary of Duphar Interfran, signed an agreement with
Cadila Ltd for the sale of FBL's global patents and process technology for the
manufacture of Lisinopril and Benazepril. The objective of this alliance is to strengthen
the presence in the CVS and anti-hypertensive segments.
Acquisition of Nippon Universal Pharmaceutical Ltd, Japan. The acquisition provides
access to ready manufacturing facilities, marketing base and the distribution network of
Nippon in Japan. In 2014, Cadila announced its decision to exit the Japanese market.

Source: Company, Ambit Capital research

Although we agree with the strategy in terms of the need to diversify from an
Improvement in profitability may
India/US concentration, profitable integration of these operations may take a long
potentially result in margin
time. We concede that visibility in the pricing of products/services to these markets
expansion
remains low, but any improvement in profitability of the larger subsidiaries (through
turnaround of operations or rationalisation), especially in Latin America, Spain, the
US (Nesher) and Mexico may potentially result in margin expansion.
Exhibit 24: EBITDA contribution from other business (FY14)
Revenue

EBITDA

EBITDA
margin %

Contribution to
reported EBITDA

Zydus Wellness

4,027

1,084

26.9%

9.0%

Joint Ventures

4,499

2,017

44.8%

16.8%

India Business

24,644

6,161

25.0%

51.3%

US Business

21,704

4,341

20.0%

36.2%

Others

15,726

(1,602)

-10.2%

-13.3%

Reported

70,600

12,001

17.0%

In ` Mn

Source: Company, Ambit Capital research

However, we are not building in any margin expansion from these markets in our
estimates for the explicit forecast period owing to the poor ranking for Cadila in our
DNA framework.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 52

Cadila Healthcare
Exhibit 25: Sales in EU and emerging markets to increase
16,000

` mn

14,000

CAGR 14%

12,000
10,000

CAGR 11%

8,000
6,000
4,000
2,000
FY17e

FY16e

FY15e

FY14

FY13

FY12

FY11

FY10

Source: Company, Ambit Capital research

Further, Cadila's partnership with Abbott for ~18 emerging markets provides a
longer-term growth prospect.

Innovation: Working on moving up the value chain


The company has launched six biosimilar products in India which primarily include
complex proteins. The company has 17 biosimilar and 3 novel biologic projects in the
pipeline for indications like oncology, rheumatoid arthritis, gynaecology and
nephrology. Cadila has commissioned a large-scale MAB manufacturing unit in India.
It also has seven NCE programmes. One of these, Lipaglyn (Saroglitazar) indicated
for dyslipidaemia has already been launched in India.
We remain positive on its longerWe remain positive on its longer-term growth prospects and believe that moving up term growth prospects and
the value chain is the end-game for all Indian companies. Cadila spends 35% of its believe that it is moving up the
R&D spend on innovative pursuits. Our confidence is derived from commercialisation value chain
of biosimilars and Lipaglyn (NCE) in India.

Expect margin expansion led by US business ramp-up


We expect EBITDA margin expansion of 340bps over FY14-17E to be largely led by
operating leverage on overheads and R&D expenses. The company has guided
towards R&D spend growing lesser than revenues over the foreseeable future. Given
that Cadila is expected to register a revenue CAGR of 20% over FY14-17E, we have
pencilled in R&D spend growing at CAGR of 10%.
Exhibit 26: Common size statement Margin expansion through operating leverage
FY11

FY12

FY13

FY14

FY15E

FY16E

FY17E

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

Material Cost

31.9%

31.9%

36.5%

37.6%

37.2%

37.9%

39.0%

General Expenses

40.6%

40.3%

38.5%

39.5%

39.0%

37.4%

36.1%

Revenue

R&D Expenses

5.4%

6.9%

7.3%

6.3%

5.4%

5.1%

4.8%

Total Expenditure

77.8%

79.1%

82.3%

83.4%

81.6%

80.4%

80.0%

EBITDA

22.2%

20.9%

17.7%

16.6%

18.4%

19.6%

20.0%

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 53

Cadila Healthcare

RoCE to peak in FY18 and then gradually decline


Cadila had RoCE of 17.5% in FY14 and is likely to close FY15E with an RoCE of
20.2%. As per our estimates, RoCE will peak out in FY18 at 27.9% till the
aforementioned ramp up in the USFDA approvals fuels growth. Post FY18E, we
expect RoCEs to gradually decline to 17% in FY29E.

RoCE will peak out in FY18 at


27.9% till ramp up in USFDA
approvals fuels growth

We expect RoCEs to decline overtime due to a) as the company moves up the value
chain, the cost arbitrage with Western generic companies would narrow resulting in
lower asset turnover; b) High proportion (44%) of revenues coming from India in
FY14 (high RoCE business due to high asset turnover and margins). As the EMs
presence in built out and revenues are geographically diversified, the RoCE would be
adversely impacted (other geographies are relatively lower RoCE markets).
Exhibit 27: We expect RoCEs to be above WACC and stabilise at 17% in the terminal
year
35.0%

WACC

30.0%
25.0%
20.0%
15.0%
10.0%
5.0%

FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
FY21E
FY22E
FY23E
FY24E
FY25E
FY26E
FY27E
FY28E
FY29E

0.0%

ROCE
Source: Company, Ambit Capital research

Financial assumptions
Exhibit 28: Detailed financial assumptions (` mn unless otherwise mentioned)
Particulars

Assumptions

YoY change (%)

Comments

FY15E

FY16E

FY17E

FY15E

FY16E

FY17E

India formulations

27,131

30,821

34,884

10%

14%

13%

NA generics

29,096

41,350

55,910

34%

42%

35%

7,708

8,440

9,245

8%

9%

10%

Europe and EM exports

11,373

13,009

14,748

8%

14%

13%

Total

84,014 103,088 124,962

17%

23%

21%

Gross profit

52,877

64,133

76,296

17%

21%

19%

Overhead costs

37,355

43,853

51,247

13%

17%

17%

EBITDA

15,522

20,280

25,048

29%

31%

24%

EBITDA margins (%)

18.84%

20.03%

20.38%

PAT (adj for forex loss)

10,254

14,242

17,294

23%

39%

21%

Sales assumptions

India Consumer and animal health

Expect growth to be back on track post a disruptive FY15


owing to challenges in pricing. Cadila is likely to grow the
domestic formulations business in line with the broader
market.
Expect strong growth momentum in US generics led by high
number of ANDAs pending approval when compared to
currently commercialised products and better product mix.
Expect India consumer business to accelerate marginally
under the new leadership.
Expect Europe and EM exports growth momentum to
continue on a small base. Profitability in these segments is
sub-par as of now owing to lack of scale.
Overall revenue growth likely to be in the high teens for our
explicit forecast period.
We do not expect any material change in gross margins.
Ramp up in the US business is likely to fuel margin growth
which would be offset by pricing pressure in India and AG
launches in the US.
With better directed R&D expenditure and operating
leverage playing out in several export businesses, we expect
slower growth in overheads as compared to revenues.
We expect ~340bps expansion in EBITDA margins over
FY14-17E largely led by operating leverage in the US and
other export businesses.
Higher depreciation and tax rate impact net profit growth.
We expect a net profit CAGR of 27% over FY14-17E.

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 54

Cadila Healthcare

Ambit vs consensus
Our revenue projections are 3-8% higher than consensus estimates for FY16/17E,
largely due to our expectations of higher number of launches in US led by
improvement in USFDA timelines. Our EBITDA and net profit estimates are 7-9% and
7-8% ahead of consensus for FY16E andFY17E presumably due to higher operating
leverage assumptions.
Exhibit 29: Our net profit estimates are broadly in line with consensus
Particulars (` mn)

Ambit

Consensus

Divergence (%)

FY15E

82,389

83,911

-1.8%

FY16E

101,257

98,119

3.2%

FY17E

122,902

113,530

8.3%

FY15E

15,522

15,344

1.2%

FY16E

20,280

18,913

7.2%

FY17E

25,048

23,004

8.9%

FY15E

9,928

10,293

-3.5%

FY16E

13,916

12,996

7.1%

FY17E

16,968

15,765

7.6%

Sales

EBITDA

Net Profit

Source: Bloomberg, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 55

Cadila Healthcare

Valuation discount to large-caps to narrow


Cadila is trading at a ~15-20% discount to the which peer average one-year forward
Cadila is trading at a ~15-20%
P/E multiple. Whilst well-entrenched promoters, high R&D productivity and excellence
discount to the peer average onein execution lend comfort on valuations, earnings momentum is also likely to sustain
year forward P/E
(led by the unfolding of the ANDA pipeline in the US). We use a DCF methodology to
value Cadila with a terminal RoCE of 17% and discount rate of 13%. This leads to a
target price of `1,510/share.
Valuation methodology
We value Cadila using a DCF methodology wherein EBITDA margin, medium-term
revenue growth rate and terminal revenue growth rate are the key variables
controlling the valuation. Furthermore, we use a free cash flow to equity
methodology.
Cadila would have incremental
EBITDA margin: We build in a gradual expansion in EBITDA margins from 17% in margin tailwinds in the US and
FY14E to 27.2% in FY29E (terminal year). Cadila would have incremental margin Indian markets over the longer
tailwinds in the US and Indian markets over the longer term, as it ramps up its term
product basket. Please note that our model does not account for any material
improvement in the product mix (ex-India), as we do not assume any success in
innovative endeavours like biosimilars, NCEs, NBEs and vaccines.
Medium-term and terminal revenue CAGR: We pencil in medium-term (FY18FY27E) revenue CAGR of 9% largely led by continued growth momentum in the India
and US markets. We expect the US revenues to slowdown post FY19E, as the
tailwinds on faster approvals subside.
Exhibit 30: We pencil in medium-term revenue growth of 12% and terminal rate of 4%
Medium-term revenue CAGR
(FY18-27E)

Terminal revenue growth


rate (FY28E onwards)

Domestic Formulations

8.6%

5.0%

Domestic API

5.5%

0.0%

Consumer & Others

8.2%

5.0%

Export Formulations

10.8%

3.1%

11.0%

3.0%

8.9%

3.0%

14.2%

5.0%

North America (US)


Europe
Latin America
Emerging Markets

8.7%

3.0%

10.0%

5.0%

Exports API

5.2%

0.0%

All JVs

5.6%

3.6%

Total gross sales

9.8%

3.6%

Animal Health & Others

Source: Ambit Capital research

Our DCF model suggests a fair value of `1,510/share (our 12-month forward target
price), which implies ~20.0x FY16/17E EPS as compared to the current trading
multiple of 23.0x FY15/16E EPS.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 56

Cadila Healthcare
Exhibit 31: Valuation multiples do not reflect competitive positioning
28
26

Sun Pharma

P/E (FY15E)

24

Lupin

22
Cadila

20
Cipla

18

Glenmark

16
14

IPCA

Dr. Reddy's

12
10
10

15

20

25

30

35

40

RoCE (FY14E)
Source: Bloomberg, Ambit Capital research; Note: Bubble size indicates competitive positioning (larger bubble =
higher position)

As seen in the exhibit above, Cadila is trading at a deep discount to Sun Pharma and
Lupin largely due to depressed RoCEs despite comparable competitive positioning.
We believe that the discount is justified given the suppressed profitability and RoCE
and no visible catalysts to turn around the foreign loss-making subsidiaries.
At our target P/E multiple of 20x one-year forward EPS, Cadila would still be trading
at a discount of 10-15% to these companies. In our DCF model, we do not assume
any significant success in innovative pursuits and would expect the discount to narrow
further in case Cadilas innovative pursuits show signs of paying off.
Exhibit 32: Terminal value contributes 47% to total fair enterprise value
Key assumptions

Value

Remarks

Discount rate

13.1%

Cost of equity

Terminal growth rate

3.7%

Total Enterprise Value

327,149

Population growth rate + increasing penetration + medical insurance penetration + pricing


RoW business is on a very small base; India growth in line with broader market; expect moderation of
growth in US in absence of visibility on longer term growth drivers
Expect margin expansion led by revenue ramp up in the US, revival in growth in India and operating
leverage
US margins to ramp up due to niche segment presence; India and other businesses margins to
increase due to operating leverage
` mn

Medium-term growth rate

9.0%

Terminal Value

152,476

` mn

EBITDA margins (FY15e)

18.8%

EBITDA margins (FY29e)

27.6%

Terminal value as % of total

47%

Source: Ambit Capital research

We expect Cadilas EBITDA margin to improve over the next 15 years and RoCE to
expand from the current ~17% to 27% in the terminal year (FY29E).
Exhibit 33: Our 12-month forward target price is `1,510/share
Particulars

In ` mn

Total EV

327,149

Net debt (FY15E)

(17,985)

Equity Value

309,165

No. of shares outstanding (mn)


Value / share (`)

205
1,510

CMP (`)

1,273

Upside / Downside (%)

19.0%
FY15E

FY16E

FY17E

Implied adj. PE (x)

31.1

22.2

18.2

Current adj. PE (x)

26.3

18.7

15.4

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 57

Cadila Healthcare

Cross-cycle valuation
Cadila is currently trading at 26.0x FY15/16E EPS i.e. a ~15-20% discount to its
larger peers like Lupin and Sun Pharma. Whilst the company has re-rated
significantly over the recent past largely led by the managements guidance towards
margin expansion and revenue growth in the US, we believe that sustained earnings
growth may drive valuations higher. The US generics business is about to ramp up
led by approvals of niche products. Historically, the companys re-rating has been
driven by scaling up the value chain. At the current valuations, we see little room for
further re-rating of the business and believe that niche opportunities like
transdermals and nasal sprays in the US are largely accounted for. Hence, we expect
the stock performance to be largely in line with earnings growth. We expect earnings
CAGR of 27% over FY14-17E.

Mar-14

Mar-13

Mar-12

Mar-11

Jul-14

Mar-13

Nov-13

Jul-12

Nov-11

Mar-11

Jul-10

Nov-09

Mar-09

Jul-08

Mar-07

Nov-07

Jul-06

Nov-05

Mar-05

10x

Mar-10

Price

One yr EV/EBITDA avrage of


13.3x

Mar-09

20x

20.00
18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00

Mar-08

30x

Mar-07

CDH Price Band chart

Mar-06

1800
1600
1400
1200
1000
800
600
400
200
0

Exhibit 35: The stock has traded in a EV/EBITDA average of


13.3x over the last 12 months

Mar-05

Exhibit 34: Cadila has re-rated led by higher expectations


from US exports and revival in India formulations growth

Cadila has re-rated in the past


led by the managements
guidance towards margin
expansion and revenue growth

Source: Bloomberg, Ambit Capital research

Source: Bloomberg, Ambit Capital research

Exhibit 36: Earnings growth and RoE increased in FY10-11


due to launch of interesting products like Taxotere in US;
post FY11 no other interesting product has been launched

Exhibit 37: EBITDA growth and RoCE have been declining to


competition in generic Taxotere and lack of new approvals
for niche products from USFDA

PAT growth (LHS)


Source: Bloomberg, Ambit Capital research

EBITDA growth (LHS)

RoE (RHS)

FY14

FY13

FY12

10%

RoCE (RHS)

Source: Bloomberg, Ambit Capital research

We believe that the next round of re-rating would require the longer-term growth
opportunities to come to the fore and the US business to ramp up. The investments
made in innovative projects like NCEs, biosimilars, NBEs, vaccines and emerging
markets have suppressed RoCEs despite the growing profitability of the US business
and operating leverage in India. Given that the long-term growth drivers come to the
fore, especially in emerging markets, over the next 3-5 years, we would expect the
P/E multiple to re-rate. Turnaround in profitability of EMs could be another trigger for
a re-rating.

September 16, 2014

FY11

10%

15%
FY10

15%

20%

FY09

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

FY06

20%

25%

FY08

25%

30%

FY07

30%

35%

FY06

35%

40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%

FY05

40%

FY05

80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%

Ambit Capital Pvt. Ltd.

Re-rating will require longer-term


opportunities to come to the fore

Page 58

Cadila Healthcare

Key risks to our BUY thesis

Failure in innovation: Innovative ventures like biosimilars, NCEs, NBEs and


vaccines development carry the risk of failure with lesser hits than misses. If
Cadila is unable to monetise its innovation R&D (35% of R&D spend in FY14),
margins may decline. Although we are not building in any significant revenues
from innovative projects into our projections, we believe any failure in innovation
may impact margins by adversely impacting costs like R&D.

Delay in EMs profits: We deduce RoW business EBITDA margins of -10% for
FY14. If the company is unable to rationalise/turnaround EM operations, RoCE
may remain depressed. Due to below average ranking in our DNA framework,
we do not build a turnaround in emerging market profitability into our forecasts.

Worse-than-expected pricing environment in the US: We assume a


moderate decline in the base business pricing in the US. This assumption is led by
market expectations of high approvals for competitors in the base business partly
offset by increased FDA vigilance, keeping very small players out of the market.

INR appreciation against USD: Cadila has not been a beneficiary of the INR
depreciation against the USD largely due to hedges taken at lower rates.
However, the company now has negligible hedges and in the event of a reversal
in trend, we assess that the companys profits could decline by 1.5% for every 1%
appreciation in the INR beyond `60/USD levels.

Catalysts

Quicker-than-anticipated improvement in FDA approval rate: Whilst we


have assumed a growing rate of improvement in FDA approval timelines, the
improvement may be uniform or even front-ended over the next four years. If so,
then the revenue ramp up in the US could be higher than our expectations. We
are building in a parabolic improvement in FDA timelines in FY16E and FY17E.

Faster-than-anticipated growth in India: The management expects to beat


the broader market growth by a wide margin which is growing at 13%. However,
we are pencilling in a growth (13%) in line with the broader market led by our
assumptions of a lower number of new launches in India in the future. Higherthan-estimated growth in India is likely to be a key catalyst.

Unknown large filings in the US: We have taken a top-down approach for the
unknown filings in the US at an average revenue rate of US$5mn per ANDA.
However, as seen in the past, there is always an upside risk to such assumptions,
as more complex and already off-patent products do not come under our radar.

Progress on innovative projects and other differentiated filings: Cadila


expects to market Lipaglyn in export geographies in 2-3 years. We have not
pencilled in any material upside from such ventures in our estimates.

Sensitivity of fair enterprise value to our assumptions


Exhibit 38: Sensitivity of TP to discount and terminal growth rates

Discount rate

Terminal growth rate


1.7%

2.7%

3.7%

4.7%

5.7%

11.1%

1,858

1,981

2,138

2,344

2,627

12.1%

1,586

1,674

1,783

1,922

2,104

13.1%

1,367

1,432

1,510

1,607

1,730

14.1%

1,189

1,237

1,295

1,364

1,450

15.1%

1,042

1,079

1,121

1,172

1,234

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 59

Cadila Healthcare
Exhibit 39: Sensitivity of TP to US business medium-term growth rate and EBITDA
margins

US formulations
medium-term
growth rate

Medium-term EBITDA margins


22.6%

23.1%

23.6%

24.1%

24.6%

8.0%

1,373

1,391

1,409

1,426

1,444

9.0%

1,422

1,440

1,458

1,476

1,494

10.0%

1,474

1,492

1,510

1,528

1,546

11.0%

1,528

1,547

1,565

1,584

1,602

12.0%

1,587

1,605

1,624

1,643

1,662

Source: Ambit Capital research

Our INR assumption and sensitivity of earnings


We have pencilled in `60/USD for FY15E and beyond. Our sensitivity analysis
suggests that for every percentage point appreciation/depreciation in the INR/USD,
Cadilas net profit decreases/increases by 1.5%.
Exhibit 40: Explanation for the flags on the cover page
Field

Score

Comments

Accounting

GREEN

In our forensic analysis of 360 companies, Cadila scores in line with the pharma industry average (comprising
26 companies). Cadila scores high on ratios of: (a) gross block conversion; (b) change in depreciation rates;
(c) audit fees and (d) non-operating expenses. However, Cadila has weaker scores on: (a) cash yield; and (b)
volatility in sales and distribution costs.

Predictability

AMBER

Overall, the management has made timely announcements in its earnings calls, meetings and interviews
regarding product filings, acquisitions and business outlook. However, the unpredictability of emerging
markets and innovative projects makes us assign an AMBER flag on predictability.

Earnings momentum

GREEN

Consensus FY15 EBITDA and EPS estimates have been upgraded by 4-5% and FY16 EBITDA and EPS
estimates have been upgraded by 2-5% over the past three months.

Source: Bloomberg, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 60

Cadila Healthcare

Accounting analysis No concerns

Revenue recognition: Cadilas pre-tax CFO as a percentage of EBITDA has Stable CFO as a percentage of
been stable over the years, with a blip in FY12. The reason for the decrease in EBITDA
revenue recognition from 81% in FY11 to 64% in FY12 was due to higher working
capital investment. Working capital days increased from 95 days in FY11 to 142
days in FY12. Excluding FY12, Cadilas revenue recognition has been similar or
better than its peers. Also, Cadilas revenue recognition has been less volatile
than its peers. We assign a GREEN FLAG.

Exhibit 41: Revenue recognition


Company/Metric

YoY change in CFO


as a % of EBITDA
(bps)

Pre-tax CFO as a % of EBITDA

Volatility
(measured
by SD)

FY09

FY10

FY11

FY12

FY13

FY14

FY13

FY14

Cadila

98%

96%

81%

64%

82%

98%

1,806

1,590

13%

Aurobindo

62%

70%

55%

65%

46%

46%

1,072

(1,963)

10%

Glenmark

NA

NA

60%

131%

80%

102%

7,165

(5,114)

31%

93%

71%

66%

94%

86%

90%

2,806

(841)

12%

Biocon

35%

101%

152%

123%

104%

103%

(2,840)

(1,924)

39%

Average(ex-Cadila)

63%

81%

83% 104%

79%

86%

2,051

(2,461)

23%

Divergence

35%

15%

-2% -40%

3%

12%

(244)

4,050

-9%

IPCA

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity

Working capital days: Cadilas debtor days and inventory days have been
consistently lower than the peer average due to its Zydus Wellness business in
which it sells relatively fast-moving goods such as sugar substitutes and EverYuth
scrubs and peel-offs in the skin-care range. Zydus Wellness contributes 12% to
consolidated PBT. Cadila has a large presence in the non-US and non-EU market.
Cadila earns 66% of its revenues from the emerging market and animal health Lower working capital days due
business. Businesses in these geographies usually require higher working capital to the Wellness business
investment, as the debtor cycle is usually longer. Despite having a substantial
presence in emerging markets, Cadila has been able to manage its debtor days
at significantly lower levels than its peers. GREEN FLAG.
Cadilas inventory days have been stable over FY09-14 and better than its peers.
As stated above, despite having a considerable presence in emerging markets,
the company has managed its inventory well. We take comfort from the fact that
Cadila has stable and below average inventory days and hence we assign a
GREEN FLAG.
Cadilas creditor day has been higher than the peer set in FY09-FY11but have
lowered in FY12-14. We believe this may be due to acquisition of Nesher pharma
and Biochem pharma in FY12. However, this needs further investigation and
hence we assign AMBER FLAG.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 61

Cadila Healthcare
Exhibit 42: Working capital days
Company/Metric

Cadila

Average Debtor days

Average Inventory days

Average Creditor days

Working Capital days

FY11

FY12

FY13

FY14

FY11

FY12

FY13

FY14

FY11

FY12

FY13

FY14

FY11

FY12

FY13

FY14

49

58

54

53

62

66

66

65

57

48

35

40

53

77

85

78

Aurobindo

91

97

88

95

107

118

108

97

57

56

51

52

141

160

146

140

Glenmark

140

108

105

115

100

72

59

54

81

66

66

73

158

115

98

96

83

63

49

48

82

104

96

94

24

32

33

34

141

134

113

109

IPCA
Biocon

63

88

74

70

52

69

57

49

35

57

51

44

80

100

80

76

Average(ex-Cadila)

94

89

79

82

85

91

80

74

49

53

50

51

130

127

109

105

(46)

(30)

(25)

(30)

(23)

(25)

(14)

(8)

(5)

(16)

(11)

(77)

(50)

(24)

(27)

Divergence

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity.

Expense manipulation: The average depreciation rate for Cadila was almost
constant across FY11-14. However, as compared to its peers, the average
deprecation rate has been significantly lower by 1.5-2.3%. This is primarily due to
higher proportion of intangibles in the books of Cadila as compared to its peers.
As shown in Exhibit 42, Cadila has 36% of its total gross assets as intangibles, as Lower depreciation rate due to
compared to 4-9% for its peers. Majority of these intangibles consist of goodwill higher intangibles on the books
arising out of acquisitions. Whilst goodwill is reviewed frequently and decision on
impairment is taken on a periodic basis, amortisation is not done every year on
intangibles. We see similar trends in Glenmark which has a higher percentage of
intangibles in its total gross assets. Cadilas numbers are mostly in line with
Glenmarks, with a marginally higher depreciation rate. We have no significant
concerns over the depreciation rate and hence we assign a GREEN FLAG.

Exhibit 43: Expense manipulation - depreciation


Company/Metric

YoY change in
depreciation rate (bps)

Average Depreciation rate


FY11

FY12

FY13

FY14

FY13

Cadila

4.8%

4.8%

4.6%

4.6%

(21)

Aurobindo

7.1%

7.3%

7.3%

7.9%

60

Glenmark

3.8%

3.7%

4.1%

6.1%

45

199

IPCA

6.0%

6.3%

6.0%

6.0%

(28)

(7)

Biocon

8.1%

8.4%

7.6%

7.6%

(81)

(3)

Average(ex-Cadila)
Divergence

FY14
6

6.2%

6.4%

6.3%

6.9%

(16)

62

-1.5%

-1.7%

-1.7%

-2.3%

(5)

(56)

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity.

Exhibit 44: Cadila and Glenmark have a high proportion of intangible assets
Cadila

Aurobindo

Glenmark

IPCA

Biocon

Tangible assets (%)

64%

91%

59%

91%

96%

Intangible assets (%)

36%

9%

41%

9%

4%

Source: Company, Ambit Capital research

Cash manipulation: Cadilas loans and advances have remained higher than its
peers average consistently. Also, loans and advances have grown over the years
from 20.9% in FY11 to 24.3% in FY14. However, majority of these loans and
advances consist of advances paid to government authorities and hence we do
not see this as a major concern. Hence, we assign a GREEN FLAG.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 62

Cadila Healthcare
Exhibit 45: Cash manipulation checks
Company/Metric

Loans and advances as a % of net worth


FY10

FY11

FY12

FY13

FY14

Cadila

19.2%

20.9%

22.4%

25.3%

24.3%

Aurobindo

20.3%

21.8%

18.1%

21.9%

31.1%

Glenmark

NA

9.8%

13.4%

12.8%

17.6%

14.6%

11.2%

18.2%

15.9%

15.8%

IPCA
Biocon
Average(ex-Cadila)
Divergence

7.6%

9.6%

14.4%

15.8%

15.7%

14.2%

13.1%

16.0%

16.6%

20.0%

5.0%

7.8%

6.4%

8.7%

4.2%

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity; we have
excluded capital advances from loans and advances to calculate the above ratio.

Investment income analysis: Cadilas investment income as a percentage of Higher investment income as a
cash has been high as compared to its peers. It has also been volatile, with FY12
percentage of cash
reporting higher investment income due to profit from sale of investments. Whilst
we take comfort from the fact that interest income accounted for negligible
percentage of PBT over FY11-14, leaving little incentive for manipulation of this
line item, but the higher investment income as percentage of cash is a cause of
concern. We assign an AMBER FLAG.

Exhibit 46: Investment income analysis


Company/Metric

Change in investment
income as a % of cash and
marketable investments
(bps)

Investment income as a % of cash and


marketable investments
FY10

FY11

FY12

FY13

FY14

FY13

FY14

Cadila

4.8%

4.1%

8.7%

4.8%

5.5%

(394)

74

Aurobindo

0.9%

0.3%

2.9%

0.3%

0.4%

(260)

10

Glenmark

NA

5.1%

3.6%

1.4%

0.7%

(220)

(71)

IPCA

2.1%

3.5%

10.5%

8.7%

4.6%

(179)

(410)

Biocon

3.1%

4.6%

4.7%

3.7%

4.0%

(99)

30

Average(ex-Cadila)

2.0%

3.4%

5.4%

3.5%

2.4%

(166)

(150)

Divergence

2.8%

0.7%

3.3%

1.3%

3.1%

(95)

161

Source: Company, Ambit Capital research. Note: (a) All financials pertain to the consolidated entity; (b)
Investment income comprises interest income, dividend income and profit on sale of current investments

Contingent liabilities and provisions

Cadilas contingent liabilities as a percentage of net worth declined by 300bps in Higher contingent liabilities as a
FY14. Cadilas disputed liabilities as a proportion of net worth is significant as at percentage to net worth is a
end-FY14 and mainly consisting of liabilities of Income tax matters. As compared cause of concern
to its peers, contingent liabilities not provided for by Cadila is at the peer
average. Contingent liabilities of more than 5% as percentage of net worth is a
large number for our comfort and hence we assign an AMBER FLAG.

Exhibit 47: Contingent liabilities not provided for by Cadila is at peer average
Contingent liabilities
as % of net worth

Contingent liabilities
(` Mn)

Net Worth
(` Mn)

Cadila

6.9%

2,383

34,390

Aurobindo

3.3%

1,253

37,502

Glenmark

4.3%

1,294

29,966

12.9%

2,529

19,597

7.7%

2,322

30,267

FY14

IPCA
Biocon
Average(ex-Cadila)
Divergence

7.06%
-0.13%

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 63

Cadila Healthcare
Provisions for debtors: Cadilas debtors outstanding for more than six months
Adequate provisioning of debtors
(which have a high probability of turning bad) as a percentage of gross debtors have
as compared to its peers
been constant across FY11-14. At the same time, the provision for the same has
dropped to 40% in FY14 from 51% in FY13. However, the company has consistently
been providing for more than its peers. Cadila has lower debtors aging six months or
more, which is due to its lower debtor days as compared to its peers. We assign a
GREEN FLAG.
Exhibit 48: Provision for debtors
Company\Metric

Provision for doubtful debts as


% of debtors over six months

Provision for doubtful debts as


% of gross debtors

Debtors over 6 months as a


% of gross debtors

FY12

FY13

FY14

FY12

FY13

FY14

FY12

FY13

FY14

Cadila

50.9%

51.0%

40.4%

1.2%

1.3%

0.8%

2.3%

2.5%

2.1%

Aurobindo

40.2%

42.7%

41.1%

2.3%

1.7%

1.2%

5.7%

4.0%

2.9%

Glenmark

18.8%

10.0%

9.4%

2.2%

1.7%

1.2%

11.5%

16.6%

13.0%

IPCA

3.7%

0.0%

4.8%

0.1%

0.0%

0.1%

2.4%

2.7%

3.0%

Biocon

53.1%

27.1%

53.7%

1.4%

0.6%

0.8%

2.6%

2.1%

1.6%

Average(ex-Cadila)

28.9%

19.9%

27.3%

1.5%

1.0%

0.9%

5.6%

6.3%

5.1%

Divergence

22.0%

31.1%

13.2%

-0.3%

0.3%

0.0%

-3.3%

-3.9%

-3.1%

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity

Auditors
The companys accounts are audited by M/s Mukesh M. Shah & Co., and the auditors
have not been changed since FY08. We assign an AMBER FLAG.
The Audit Committee, as on 31 March 2014, comprises three members (all of whom
Auditors have not been changed
are non-executive independent directors of the company). Mr. Mukesh M Patel is the
since FY08
Chairman of the committee. The attendance of members has been healthy and
composition revolving, and hence we assign a GREEN FLAG.
Cadilas audit fees as a percentage of sales are in line with the peer group average
and we do not have any significant concerns on its audit fees. As compared to net
sales, there was no significant growth in audit fees. GREEN FLAG

Corporate governance

Board composition and promoter background: Mr. Pankaj R. Patel is the


Chairman of Cadila Healthcare. He founded the company in 1995 post the split
from Mr. Indravadan Modi. Apart from Mr. Pankaj R. Patel, Mr. Shravil Patel (the
son of Mr. Pankaj R. Patel) has been the Deputy Managing Director since July 27,
2007. The board comprises five non-executive independent directors out of the
total seven board members, which implies a good mix.

Rotation of independent directors: The Best Practices Code suggests that the
3 out of 5 independent directors
maximum tenure for an independent director should be five years. Three of the
have been associated with Cadila
five independent directors have been associated with the company for more than
for more than 10 years
10 years. This is a cause of concern and hence we assign an AMBER FLAG.

Attendance of the board: The attendance of the board members has remained
reasonable for the Board meetings held in FY11-14.

Insider trading: Insider transaction tracking indicates some trading activities in


the companys shares by the promoters/senior management. There have been no
significant instances of insider trading, and hence, we assign a GREEN FLAG.

Managerial remuneration: Cadilas managerial remuneration as a percentage


of PBT is high as compared to its peers. Growth in managerial remuneration has
been in line with the growth in PBT. Remuneration declined by 42% in FY12 and
1% in FY13 as compared to PBT decline of 6% in FY12 and marginal increase of
2% in FY13. Though managerial remuneration has remained consistent from
FY11 to FY14, the divergence from its peers is high. We assign an AMBER FLAG.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 64

Cadila Healthcare
Revenue Mix
Year ended 31 Mar (` mn)

FY13

FY14

FY15E

FY16E

FY17E

23,232

24,644

27,131

30,821

34,884

API (Domestic and Exports)

3,098

3,497

3,824

4,160

4,506

Consumer

4,100

4,296

4,511

4,872

5,261

Animal Health

2,462

2,865

3,198

3,569

3,983

24,886

32,282

40,469

54,359

70,658

15,068

21,704

29,096

41,350

55,910

9,818

10,578

11,373

13,009

14,748

Domestic Formulations

Export Formulations
North America (US)
Ex North America
JV Revenues

5,070

4,499

4,882

5,308

5,669

62,848

72,083

84,014

103,088

124,962

FY13

FY14

FY15E

FY16E

FY17E

Net revenues

61,552

70,600

82,389

101,257

122,902

Material Cost

23,202

27,136

31,310

39,120

48,826

General Expenses

24,455

28,540

32,792

38,605

45,213

Total Gross Sales


Source: Company, Ambit Capital research

Income statement
Year to March (` mn)

R&D Expenses

4,669

4,563

4,563

5,247

6,035

Core EBITDA

11,251

12,001

15,522

20,280

25,048

Depreciation

1,847

2,012

2,841

3,119

4,536

Interest expense

1,687

902

1,115

1,115

1,115

Adjusted PBT

8,088

9,422

12,064

16,756

20,345

Tax

1,188

1,060

1,810

2,513

3,052

Reported net profit

6,536

8,036

9,928

13,916

16,968

FY13

FY14

FY15E

FY16E

FY17E

Total Assets

60,859

63,798

71,460

83,110

97,811

Fixed Assets

37,612

40,153

41,812

44,193

46,157

Current Assets

34,965

38,846

46,517

58,400

74,134

1,145

866

866

866

866

60,859

63,798

71,460

83,110

97,811

Source: Company, Ambit Capital research

Balance sheet
Year to Mar (` mn)

Investments
Total Liabilities
Shareholders' equity

1,024

1,024

1,024

1,024

1,024

Reserves & surplus

28,459

33,366

41,028

52,678

67,379

Total net worth

29,483

34,390

42,052

53,702

68,403

Total debt

29,178

27,004

27,004

27,004

27,004

Current liabilities

12,901

16,067

17,736

20,349

23,346

1,005

961

961

961

961

Deferred tax liability


Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 65

Cadila Healthcare
Cash flow statement
Year to March (` mn)

FY13

FY14

FY15E

FY16E

FY17E

PBT

8,088

9,422

12,064

16,756

20,345

Depreciation

1,847

2,012

2,841

3,119

4,536

1,188

1,060

1,810

2,513

3,052

(1,996)

(359)

(2,505)

(4,005)

(4,593)

Tax
Net Working Capital
CFO
Capital Expenditure
Investment
Other investments
CFI
Issuance of Equity
Inc/Dec in Borrowings
Net Dividends
Other Financing activities

4,272

8,870

10,264

13,030

16,910

(7,031)

(4,576)

(4,500)

(5,500)

(6,500)

(564)

354

(7,595)

(4,222)

(4,500)

(5,500)

(6,500)

6,285

(3,095)

(1,790)

(2,192)

(2,232)

(2,266)

(2,266)

CFF

4,495

(5,287)

(2,232)

(2,266)

(2,266)

Net change in cash

1,172

(639)

3,532

5,264

8,144

Closing cash balance

5,838

5,488

9,019

14,283

22,428

Source: Company, Ambit Capital research

Valuation Parameters
Year to March

FY13

FY14

FY15E

FY16E

FY17E

EPS

31.9

40.1

48.5

68.0

82.9

288.0

335.9

410.8

524.6

668.2

40.8

32.5

26.9

19.2

15.7

Book Value ( per share)


P/E (x)
P/BV (x)

4.5

3.9

3.2

2.5

1.9

25.8

24.0

18.3

13.8

10.8

EV/Sales (x)

4.7

4.1

3.5

2.8

2.2

EV/EBIT (x)

30.8

28.9

22.5

16.3

13.2

Year to March

FY13

FY14

FY15E

FY16E

FY17E

Revenue growth

20.9

14.7

16.7

22.9

21.4

EV/EBITDA(x)

Source: Company, Ambit Capital research

Ratios

Core EBITDA growth

2.4

6.7

29.3

30.7

23.5

APAT growth

0.1

23.0

23.5

40.2

21.9

EPS growth

0.1

25.6

21.0

40.2

21.9

Core EBITDA margin

18.3

17.0

18.8

20.0

20.4

EBIT margin

15.3

14.1

15.4

16.9

16.7

Net profit margin

10.6

11.4

12.1

13.7

13.8

ROCE (%)

18.2

17.5

20.2

23.9

24.4

Reported RoE (%)

23.7

25.2

26.0

29.1

27.8

Debt Equity ratio (X)

1.0

0.8

0.6

0.5

0.4

CFO/EBITDA (x)

0.4

0.7

0.7

0.6

0.7

Gross Block turnover (x)

1.7

1.8

2.0

2.4

2.7

Working Capital Turnover (x)

3.1

3.1

3.2

3.0

2.8

Current Ratio

2.7

2.4

2.6

2.9

3.2

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 66

Aurobindo Pharma
SELL
INITIATING COVERAGE

ARBP IN EQUITY

September 16, 2014

Structural issues galore

Pharmaceuticals

Aurobindo not only faces governance issues (inferior financial reporting,


less than ideal disclosure, taxation issues of promoters) but also
structural issuesabsence of moated revenue/profit streams and longterm growth drivers, no commensurate Indian revenues to its domestic
operating costs and high likelihood of incumbents reviving in the US
market (35% of Aurobindos revenues). Valuations of 14.5x one-year
forward EPS may begin to de-rate, as incumbents return to the US, new
products (injectables, OTC, controlled substances, penems) fail to gain
market share and RoCE starts declining from FY18E; our TP of `828
implies 10.5x one-year forward P/E. Catalysts: Return of an incumbent
like Hospira in general injectables; large expensive acquisitions.

Recommendation
`252/US$4.2
`1621/US$26.6
`896
`828
8

Flags
Accounting:
Predictability:
Earnings Momentum:

RED
AMBER
GREEN

Changes to this position: STABLE

Aurobindo ranks low on our competitive framework


Whilst the company scores high on risk management and R&D productivity, it
lags on parameters like rational capital allocation, robustness of business model
and reputation and quality of management (hence, no significant competitive
advantage). Issues in accounting, promoter history, active insider trading and
less-than-ideal disclosures make us uncomfortable with its governance.
No moats in current revenues; incumbents absence a transient boost
A majority of Aurobindos revenues are sourced from generic generic segments.
The companys attempt to establish an India formulation business failed in 2006
due to lack of scale. Its presence in EMs is negligible (~6% of FY14 sales) with
no display of capabilities to scale up the business. The absence of incumbents in
the US segment has been a tailwind which may reverse anytime, which could
expose 35% of its revenues (FY15E) to both growth and margin risks.
EBITDA margin, RoCE to expand in near term, but to decline thereafter
Improvement in product mix towards injectables and other limited competition
segments in the US and operating leverage are likely to lead to EBITDA margin
expansion to 21% from 13% and RoCE expansion to 33% from 24% over FY1417E. However, with 53% of costs based in India and lack of commensurate
revenues and investments in long-term growth drivers (such as NCEs and
NDDS), we expect RoCE to decline thereafter (peak at 33% in FY17E; FY29E
estimate of 13%).

Catalysts

Return of incumbents in the US in


segments such as general injectable,
controlled substance and oral solids
Slowdown
in
growth
in
US
formulation sales
Large expensive acquisitions to make
up for lack of sustainable growth

Performance
26,000
24,000
22,000
20,000
18,000
16,000

1150
950
750
550
350
150
Aug-13
Oct-13
Nov-13
Jan-14
Feb-14
Apr-14
May-14
Jul-14
Aug-14

Competitive position: WEAK

Mcap (bn):
6M ADV (mn):
CMP:
TP (12 mths):
Downside (%):

Sensex

Aurobindo, RHS

Source: Bloomberg, Ambit Capital research

Expect discount to front-line peers to expand as earnings growth abates


At a ~35% discount on FY16E EV/EBITDA to large-cap peers, valuations are not
attractive and we expect it to widen to ~50% led by concerns around growth
over medium term and governance issues. We forecast a FCFF CAGR of 6.5%
over the medium term (FY18-27E). Our DCF-based TP implies 10.5x FY16/17 E
EPS vs 18-24x for large-cap pharma. Key risks: Delay in return of incumbents;
better pricing in the US; INR depreciation.
Key financials
Year to March (` mn)
Net Revenues
Operating Profits
Net Profits
Diluted EPS
RoE (%)
P/E (x)
P/B (x)

FY13
58,553
8,891
3,501
12.0
14.2
72.4
9.7

FY14
80,998
21,328
11,737
40.3
36.9
21.6
6.8

FY15E
119,928
25,052
15,770
54.1
34.9
16.1
4.8

FY16E
136,808
30,499
19,733
67.7
31.9
12.9
3.6

FY17E
161,507
40,098
27,268
93.5
32.7
9.3
2.6

Analyst Details
Aditya Khemka
+91-22-3043 3272
adityakhemka@ambitcapital.com
Paresh Dave
+91-22-3043 3212
pareshdave@ambitcapital.com

Source: Company, Ambit Capital research


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Aurobindo Pharma

Snapshot of company financials


Profit and Loss
Year to March (` mn)

Revenue mix
FY15E

FY16E

Net revenues

119,928

136,808

Core EBITDA

25,052

30,499

40,098 USA

Depreciation

3,701

4,226

4,264 ARV

Interest expense

1,071

846

20,480

25,627

4,710

5,894

15,770

19,733

EBITDA Margin (%)

21.1

22.4

25.0 Cephs

Net profit margin (%)

13.1

14.4

16.9 ARVs and others

EV/ EBITDA (x)

11.5

9.1

P/E on adjusted basis (x)

16.1

12.9

2.4

2.0

Adjusted PBT
Tax
Reported net profit

FY17E Year to March (` mn)

621 Europe
35,413 ROW
8,145 Total formulations

SSP

6.7 Total API


9.3 Dossier Income
1.7 Total

Balance Sheet
Year to March (in ` mn)

FY16E

FY17E

42,416

55,495

74,175

9,591

11,029

12,132

33,745

34,060

37,204

5,060

5,566

6,122

90,812

106,149

129,633

10,676

11,210

11,770

10,200

10,500

10,500

10,537

11,591

12,750

31,413

33,301

35,020

150

150

150

122,375

139,600

164,803

27,268 API

Profit and Loss Ratios

EV/Sales (x)

FY15E

161,507 Formulations

Cash flow
FY15E

FY16E

Total Assets

90,949

101,450

Fixed Assets

32,613

35,887

Current Assets

82,027

92,070

198

198

Total Liabilities

90,949

101,450

Total networth

52,946

70,948

95,823 Capital Expenditure

Total debt

35,691

28,191

20,691 Investment

Current liabilities

22,531

25,347

29,467 Other investments

2,054

2,054

RoCE

26.3

28.2

33.4 Inc/Dec in Borrowings

(3,071)

(8,346)

(8,121)

RoE

34.9

31.9

32.7 Net Dividends

(1,384)

(1,732)

(2,393)

Gross Debt/Equity (x)

0.7

0.4

0.2 Other Financing activities

Net debt (cash)/ Eq (x)

0.6

0.3

0.1 CFF

P/B (x)

4.8

3.6

2.6 Net change in cash

Investments

Deferred tax liability

FY17E Year to March (` mn)


118,826 PBT
41,623 Depreciation
107,830 Tax
198 Net Working Capital
118,826 CFO

2,054 CFI

Balance Sheet ratios

Issuance of Equity

Closing cash balance

Consistently lower than average CFO/EBITDA concern

FY16E

FY17E

25,627

35,413

3,701

4,226

4,264

(4,710)

(5,894)

(8,145)

(10,662)

(4,207)

(10,002)

10,731

20,398

21,952

(6,000)

(7,500)

(10,000)

200

200

200

(5,800)

(7,300)

(9,800)

(4,455)

(10,077)

(10,514)

476

3,021

1,638

2,270

5,291

6,929

Current valuation discount partially reflects structural issues


(bubble size indicates competitive positioning on 5R)

Pre-tax CFO as a % of EBITDA


FY10

FY11

FY12

FY13

FY14

Aurobindo

70%

55%

65%

46%

46%

Cadila

96%

81%

64%

82%

98%

Glenmark

NA

60%

131%

80%

102%
90%

IPCA

71%

66%

94%

86%

Biocon

101%

152%

123%

104% 103%

Average(ex-Aurobindo)

89%

90%

103%

88%

Divergence

-19% -35%

-38%

-42% -52%

98%

EV/EBITDA (FY16E)

Company/Metric

FY15E
20,480

21
20
19
18
17
16
15
14
13
12
11
10
9
8
7
6
5

Sun
Pharma
Cadila

Cipla
Lupin

Dr. Reddy's
Glenmark
IPCA
Aurobindo

10

20

30

40

RoCE (FY14)

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 68

Aurobindo Pharma

Aurobindo Opportunistic and fragile


Aurobindo sells prescription drugs (formulations) in the US (35% of FY15E revenues),
Europe (28% of FY15E revenues) and other export markets (12% of FY15E revenues).
The company also sells APIs in India and other export markets (26% of FY15E
revenues).

US $ Mn

Exhibit 1: Presence highly concentrated in US and API sales


(US$ bn)

Exhibit 2: Pickup in RoCE and EBITDA margins due to


Cymbalta launch in US and resolution of FDA issues at Unit
VI (%)

1,400

30%

1,200

25%

474

1,000

20%

800
600

338

400

44
50
104
192

200
-

395

431

58
65
148

53
79
164

261

247

466
77
86
138

77
111
139

15%

563

5%

322

26.3%
23.0%
21.7%

22.0%
19.5%

24.2%

13.2% 15.2%

10%
9.8%
6.0%

0%
FY10

FY10
FY11
FY12
FY13
FY14
USA
ARV
Europe
ROW
API
Source: Company, Ambit Capital research

FY11

FY12

FY13

ARBP, EBITDA margin

FY14
ARBP, RoCE

Source: Company, Ambit Capital research

Within US, Aurobindo has high concentration of revenues in oral solids (~59% of
FY14 US sales excluding Cymbalta). During FY14, the company launched Cymbalta
under 180 day shared exclusivity in the US which yielded US$94mn in revenues and
high margins, in our assessment. Aurobindo has not invested in innovative projects
like biosimilars, NCEs, vaccines and NBEs.

Source: Company, Ambit Capital research

September 16, 2014

48.2

42.9

0.0
Aurobindo

Injectables
(Auromedi
cs), 37

53.7

Glenmark

Orals,
330

68.8

IPCA

Cephalosp
orins, 28

80.0
70.0
60.0
50.0
40.0
30.0
20.0
10.0
0.0

Biocon

One offs,
94

Controlled
Substance
(Aurolife),
74

Exhibit 4: Aurobindo sources a negligible portion of its


EBITDA from India when compared to peers (FY14)

Cadila

Exhibit 3: Aurobindos formulation split in the US (in US$


mn) (FY14)

Source: Company, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 69

Aurobindo Pharma

Snowballing of a most humble beginning


Aurobindo earns 26% of its revenues (FY15E) from API sales (including domestic and
exports). Within formulations, the company earns 35% from the US, 28% from Europe
(including Actavis business), 8% from ARV sales (8%) and 4% from EM sales.
Aurobindos history suggests that the company had a humble beginning in 1986
when Ramprasad Reddy, Nithyanand Reddy, and Dr. M Sivakumaran founded the
company. Aurobindo started with locally trading anti-biotic molecules. In 1988, the
company started manufacturing and marketing on its own in India and began
exporting API in 1992. The company began manufacturing formulations in 2002 and
discontinued its Indian formulation business (50/50 JV with Citadel Fine
Pharmaceuticals) in February 2006 due to continued losses. The company entered the
US formulations market in 2003 when it filed its first ANDA and it has been investing
heavily in manufacturing and R&D capabilities ever since. The business appears to be
snowballing in the US with a strong pipeline of 208 ANDAs pending final approval,
with an approved portfolio of 168 products currently. The company harbors ambitions
of being a large generic player in the US and regulated markets of Western Europe.

In 1988, the company started


manufacturing and marketing on
its own in India and began
exporting API in 1992

Exhibit 5: RoCE has been lower than peer average and volatile due to one-off events
Rampup in US sales and
associated operating
leverage results in higher
RoCE

Lower capacity utilisation to get manufacturing


facilities ready for inspection by international
authorities resulting in lower profits due to
sustained fixed cost

30.0%

Challenges in profitability
in overseas branches in
particular ventures in
China resulting in lower
profitability

25.0%
20.0%

17.4%

10.0%
5.0%
0.0%

24.2%

11.4%
Increase in capital employed
through preferential
allotment and increase in
debt led to lower RoCE

FY03

FY04

Feb 2011: receives import alert in Unit


VI leading to US$36 million erosion in
US sales and resultant lower depressed
profits due to operating leverage

Normalisation of
RoCE as capacity
utlisation increases

14.1%

15.0%

In March 2013, US FDA lifts ban on Unit VI


resulting in higher revenues in the US market
coupled with launch of Duloxetine (generic
Cymbalta) which provided super-normal profits
due to shared exclusivity

12.2%

12.7%
21.7%

6.9%

19.5%

6.0%

4.1%

FY05

Improvement in product mix


in API and continued ramp up
in sales of oral solids and
injectables in the US

9.8%
FY06

FY07

FY08

RoCE (%)

FY09

FY10

FY11

FY12

FY13

90
80
70
60
50
40
30
20
10
0

FY14

Revenue, RHS (Rs. Bn)

Source: Company, Ambit Capital research

Exhibit 6: Recent stock price performance led by withdrawal of import alert on Unit VI and launch of Duloxetine
900
800
700
600
500
400
300
200

Capacity
expansion
through set up
of new facilities
and listing at
stock exchange
Setting up two
wholly owned
subsidiaries in
US and Hong
Kong to increase
presence in the
international
markets

Acquired Milpharm (UK),


engaged in generic
formulation manufacturing,
mainly in the UK market.
Milpharm had over 100
products approved from the
UK regulator and helped
Aurobindo to tap the UK
generic market

100

Lower capacity
utilisation to get
manufacturing
facilities ready
for inspection by
international
authorities

US FDA import
Purchased fully integrated alert for
R&D, formulation
products from its
manufacturing and
Unit VI which
distribution facility from
manufacture
Sandoz in US; acquired
cephs
Pharmacin International
BV to help reduce
Aurobindo's time to market
and build portfolio in the
Commenced
generic value chain
operations of SEZ
UNIT VII and
Aurolife USA
facilities

US FDA lifts import


alert on Unit VI

Apr-95
Oct-95
Apr-96
Oct-96
Apr-97
Oct-97
Apr-98
Oct-98
Apr-99
Oct-99
Apr-00
Oct-00
Apr-01
Oct-01
Apr-02
Oct-02
Apr-03
Oct-03
Apr-04
Oct-04
Apr-05
Oct-05
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Apr-13
Oct-13
Apr-14

Acquired operations in 7
European countries from
Actavis and launch of
Duloxetine (generic
Cymbalta) which
provided super-normal
profits due to shared
exclusivity
Commenced
marketing speciality
injectables products
in US through Auro
Medics

Source: Company, Bloomberg, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 70

Aurobindo Pharma

Low rank in our competitive framework


the 5 Rs
Aurobindo receives an average position in our competitive advantage framework.
Whilst the company scores high on risk management and R&D productivity, it lags on
parameters like strategy and execution, rational capital allocation and robustness of
business model. Please refer to our thematic report for further details on the
competitive framework.

Aurobindo ranks average in our


competitive advantage framework

Exhibit 7: Aurobindos competitive position lags due to inferior capital allocation, strategy, execution and balance sheet
Competitive
advantage

Position as
compared to
larger listed peers

Components

Measures

Remarks

Strategy

Stated intent and vision

Vision and mission focus on: (a) being among the top15 generic companies in the world by 2015; (b)
developing wide range of products; (c) becoming the
most-valued pharma partner.

Recent hires,
management transition,
depth and width

Key management personnel hired in the past 5 years


to improve management bandwidth.

Other business interests

Lower than average other business interests. However,


legal issues in the past are a dampener.

Ambit's Forensic
accounting

Below average quality of financial reporting due to red


flag on revenue recognition.

Growth rate in India

Aurobindo has no formulations business in India.

Market share in US

The company has been able to gain greater than fair


share of market share in most products.

Earnings visibility and


delivery

Low visibility on earnings; high variation in delivery.

Inorganic strategy
success

Limited visibility of inorganic success. Recently


acquired Europe business of Actavis is loss-making.
The management expects to break-even by FY16.

Quality
Reputed
management,
strategy and
execution

Execution

Below average

R&D productivity

Productivity index

Revenues generated per


R&D spend

Best-in-class R&D productivity of spend due to lower


R&D spend as less complex products launched in the
US (low margins).

Above average

Rational capital
allocation

Greatness
framework

Ambit's proprietary
framework

Below average score in capital allocation; earnings


increase incommensurate with cash flows, a concern.

Below average

Bargaining
power with
buyers

Average debtor days

Lower than average bargaining power with buyers as


indicated by debtor days of 119 days (FY14) as
compared to average of 88 days.

Bargaining
power with
suppliers

Average creditor days

Higher than average bargaining power with suppliers


as indicated by higher than average creditor days.

Barriers to entry

Revenues from niche


segments

Significant portion of revenues sourced from


competitive segments with no significant barriers to
entry (general injectables, cephalosporin in the US).

Operational risk

Diversity of
manufacturing base
Incidence of Form 483s
from USFDA

High
number
of
USFDA-approved
facilities
(formulations + API) encountered by a 39% 483 issue
rate make Aurobindo rank above average with low
operational risk.

JVs, alliances and


partnerships

Average
investment
risk
with
a
mix
alliances/partnerships and own investments
subsidiaries and business verticals.

Robustness of the
business model

Risk entailed in
operations
Investment risk

Overall rank

Below average

Above average

of
in

Aurobindo obtains a below average position as


compared to its larger peers

Below Average

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 71

Aurobindo Pharma

Reputed management, strategy and execution Scope


for improvement
Positives Increased bandwidth with new professional hires

Over the past 5 years, the management has transitioned from being promoterdriven to a team of professionals. The induction of Mr Govindrajan (ex Shasun),
as MD, Robert Cunard (ex Teva) as Head of US business and Arvind Vasudeva (ex
Glenmark) as Head of International business also increases the management
bandwidth.

The companys execution in the US has been high quality. Despite an inferior
product mix in the US (largely me-too products), the company has been able to
consistently garner a higher than fair share of market share in most marketed
products led by a cost advantage derived from vertical integration.

Other business interests of the promoter family and immediate kin are lower than
average. We believe this indicates lower risk of diversion in focus.

The companys execution in US has


been high quality led by cost
advantage on vertically integrated
products

Exhibit 8: Aurobindo has lower other business interest as compared to its peers
Other directorships of immediate family of promoter
47

12

15

16

Cipla

48

25

18

Lupin

Average

Aurobindo

60
50
40
30
20
10
0

Dr. Reddy's

Sun Pharma

Cadila
Healthcare

Ipca

Glenmark

Source: Company, Ambit Capital research

Negatives Structural, accounting and past legal issues

Aurobindo also scores below average on our forensic accounting framework. The
companys scores lag due to concerns on consistently lower-than-peer
CFO/EBITDA for the last 5 years and higher loans and advances.

The company also has the highest volatility amongst peers for reported vs
expected EBITDA over the past 5 years. We believe that the trend suggests that
the companys earnings have largely been influenced by variables that were
either unanticipated or undisclosed by the management.

Aurobindo Pharmas acquisition track record is yet to be established. The


companys acquisition of Actavis looks promising, but given that most pharma
companies have struggled with profitability in Western Europe, we would wait
and watch before giving much credit to the company. The management has
guided towards a 12-month timeframe before any integration benefits are visible.

Aurobindo scores below average


on our forensic accounting
framework

Exhibit 9: History of clustered acquisitions by Aurobindo


Name of Joint venture /
Acquisition

Nature

Year Geography

Milpharm

Acquisition

2006 UK

Sandoz manufacturing, R&D


Acquisition
and distribution facility

2007 US

Pharmacin International BV Acquisition

2007 Netherlands

Trident Life Sciences

Acquisition

2009 India

Hyacinths Pharma

Acquisition

2013 India

Actavis's Europe operations Acquisition

2014 Europe

Particulars
Acquired Milpharm (UK), engaged in generic formulation manufacturing, mainly in the UK
market. Milpharm had over 100 products approved from the UK regulator and it helped
Aurobindo to tap the UK generic market.
Purchased fully integrated R&D, formulation manufacturing and distribution facility from
Sandoz in the US.
Acquired Pharmacin International BV to help reduce Aurobindo's time to market and build
portfolio in the generic value chain.
Acquired majority stake in group company, Trident Life Sciences, which provides
Aurobindo with additional capacity in non-oncological and non-infective injectables.
Acquired Hyacinths Pharma, an API manufacturer; strategic location of land ideal and
convenient for expansion plans for the company.
Acquired Actavis's operations in 7 European nations, which includes personnel,
commercial infrastructure, products, marketing authorisations and dossier license rights.

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 72

Aurobindo Pharma

Promoter has been involved in legal issues: Aurobindo Pharma has also
been haunted by legal issues in the past due to alleged political connectivity. The
Central Bureau of Investigation in n India (equivalent of the FBI in the US) had
charge-sheeted the former MD and current Board member, Nithyanand Reddy, in
a case involving disproportionate asset claims. However, the company did
disclose that investments were made by promoters (if any) and the listed entity
had nothing to do with the case. The charges were also later dropped by the CBI.
Click here for media reports regarding this issue.

Accounting practices of the company have failed in the past: Media reports
also suggest that the company had declared `300mn of undisclosed income for
FY12 post an Income Tax raid on its premises in February 2012.

Upsides from interesting products impaired due to partnerships:


Aurobindos distribution agreement with Citron Pharma on at least 39 oral
products and 12 injectables for the US (possibly other emerging markets as well)
would impair the upside for Aurobindo from these products, as it would have to
pay distribution margins. Further, Aurobindos agreement with Celon Labs for
hormones and oncology product manufacturing for the US (60:40 JV called
Eugia) would also impair the potential upside from these ventures. Further, less
than ideal disclosures on ownership and management of Citron Pharma make us
uncomfortable with governance.

Political connectivity and


declaration of undisclosed
agreement lead to significant
corporate governance issues

R&D productivity Highest owing to execution in US


Positives Vertical integration helping in market share gains in me-too
products

Despite Aurobindos R&D spend being considerably lower than its peers, the
companys productivity has been higher than most peers. We believe this is
a function of: (a) no spend on longer-term growth drivers like biosimilars, NCEs,
NDDS-based products and other complex products; (b) investments largely in less
complex products like oral solids, general injectables, controlled substances, and
cephalosporins which have yielded significant revenues owing to excellent
execution in the US driven by vertical integration.

Low R&D spend is healthy for near-term (FY15E-18E) RoCE, as there is little
revenue-cost mismatch on the income statement; however, over longer-term low
R&D spend will keep avenues of growth poor.

As per the management, there is no capitalisation of R&D spend. Even the R&D
spend on hormones and oncology products in Eugia JV have been expended
through the income statement. Cadila has capitalised its R&D spend in the JV for
transdermals.

Scores high on R&D productivity


index due to no spend on longterm growth drivers and
investments in less complex
products

Exhibit 10: Aurobindo has high R&D productivity due to low R&D spend and excellent
execution in the US to gain market share driven by vertical integration on oral solids
R&D spend as % of sales
(FY14)

10.0%
9.0%

Dr. Reddy's

8.0%

Glenmark
Lupin

7.0%

Cadila
Sun Pharma

6.0%

Aurobindo

5.0%
Ipca

4.0%
3.0%
2.0%
-

1.0

2.0

3.0
4.0
5.0
R&D productivity index

6.0

7.0

Source: Ambit Capital research; Note: Bubble size represents the ratio for pipeline of ANDAs to currently
approved ANDAs

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 73

Aurobindo Pharma
Negatives Lack of innovative investments may dampen long-term prospects

Low R&D spend on innovative pursuits like biosimilars, vaccines and NCEs does
Low R&D spend on innovative
not bode well for longer-term prospects.
products and lack of differentiation
The companys revenues from oral solids, cephalosporins, controlled substances in currently marketed products
and general injectables could be low-margin revenues. Lack of differentiation in
the currently marketed portfolio makes Aurobindo more vulnerable to
incremental competition from incumbents like Hospira (general injectables),
Ranbaxy (cephalosporins) and Nesher (controlled substances) which have been
out of the market due to FDA-related issues.

Rational capital allocation Not up to the mark; below


average
Positives Improvement in product mix and vertical integration

Aurobindo scores high on sales improvement and pricing discipline under our
greatness framework. Whilst improvement in product mix (move from API to
formulations) has helped the score in pricing discipline, gaining traction in oral
solids due to vertical integration has helped the score on sales improvement. We Improvement in product mix has
highlight that both these advantages seem temporary, as the decline in helped score in pricing discipline
contribution from API sales would be more gradual and Aurobindo is not
vertically integrated in injectables which form a large chunk of its pipeline. The
management may have to rethink its portfolio strategy once scale becomes an
obstacle to growth.

We have to credit the company for achieving sales growth in a short span of time Excellent sales execution
post the resolution of issues with the FDA at Unit VI. Whilst Cymbalta has been a capabilities
major contributor to sales and EBITDA in FY14, the resumption of cephalosporin
sales and controlled substances along with general injectables have been within
a very short span of time, exhibiting excellent execution.

Exhibit 11: Aurobindo scores high on pricing discipline and sales improvement, but lags in cash flow increase, balance
sheet discipline and investments
Scores out of 0.17 for each measure
Investment

Sales
Improve

Pricing
discipline

EPS and
CFO increase

BS
Discipline

Ratios
improve

Total Score-using
Adj PAT

Rank

IPCA

0.17

0.17

0.17

0.17

0.17

0.17

1.00

Sun Pharma

0.17

0.17

0.17

0.17

0.08

0.17

0.92

Cadila

0.17

0.17

0.17

0.17

0.17

0.08

0.92

Lupin

0.17

0.08

0.17

0.17

0.17

0.08

0.83

Strides

0.17

0.08

0.17

0.17

0.08

0.17

0.83

Torrent

0.08

0.17

0.17

0.13

0.13

0.17

0.83

Cipla

0.17

0.04

0.17

0.17

0.17

0.71

Dr Reddy's

0.08

0.08

0.17

0.17

0.17

0.67

Aurobindo

0.08

0.13

0.17

0.08

0.08

0.54

Glenmark

0.08

0.08

0.08

0.25

10

Company

Source: Ambit Capital research; Note: Bubble size represents the ratio for pipeline of ANDAs to currently approved ANDAs

Negatives Working capital dampens cash flows

The ever-expanding working capital cycle for Aurobindo has had an adverse
impact on balance sheet improvement and cash flows amongst our framework.
(Please refer Page 28 and Exhibit 43)

Expanding working capital cycle


Whilst the company has guided to decreasing debt levels meaningfully going has an adverse impact on balance
ahead, we would wait and watch for the improvement in the balance sheet sheet and cash flows
before giving credit given the patchy track record on this front.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 74

Aurobindo Pharma

Robustness of business model Threat from return of


incumbents in the US; below average
Positives

Higher-than-average creditor days signals are positive for bargaining power


against suppliers.

Negatives

Higher than average debtor days indicates low bargaining power with customers.
Vulnerable to incremental
The companys revenues from oral solids, cephalosporins, controlled substances competition due undifferentiated
and general injectables could be low-margin revenues. Lack of differentiation in product portfolio
currently marketed portfolio makes Aurobindo more vulnerable to incremental
competition from incumbents like Hospira (general injectables), Ranbaxy
(cephalosporins) and Nesher (controlled substances) which have been out of the
market due to FDA-related issues.

Risk entailed in operations


management; above average

Excellent

risk

Positives Diversified manufacturing base and low 483 issue rate

Aurobindo has five API units and six formulation units that are commercialised in
the US. With a diverse manufacturing base, we see low operational risk exposure
Diversified risk through wide
for the company. Aurobindo also has a low 483 issue rate.
manufacturing base and low 483
Exhibit 12: Aurobindo has the second lowest Form 483 issue rate
issue rate

57%

60%
50%
40%

39%

43%

46%

67%

67%

Cipla

70%

Cadila

Form 483 issue rate

80%

61%

50%

32%

30%
20%
10%
Glenmark

Torrent

Lupin

Sun
Pharma

Ipca

Aurobindo

Dr. Reddy's

0%

Source: FDAzilla.com, Ambit Capital research

Aurobindo has engaged in a JV with Celon Labs for hormones and oncology
injectables for the US. The JV diversifies manufacturing operations requirement
and hence limits investment risk.

Negatives May face barriers to scalability

Aurobindos distribution partnership with Citron is likely to impair profitability in


certain products in the US as the company will have to pay 30-50% distribution
margins without sharing any risk or cost.

As seen with Cadila, the partnership model represents a barrier to scalability of


business in emerging markets. Despite Aurobindos small base in these markets,
we remain cautious of the potential growth that the company may see from such
avenues.

September 16, 2014

Ambit Capital Pvt. Ltd.

Partnership model in the US and


emerging markets represent barrier
to scalability of business

Page 75

Aurobindo Pharma

Aurobindos standing on our five Rs framework


Aurobindo receives a below average rank in our competitive advantage
framework. Whilst the company scores high on risk management and R&D
productivity (largely due to plain-vanilla products), it lags on parameters like rational
capital allocation, robustness of business model and reputation and quality of
management (no significant competitive advantage).
We see a material improvement in R&D productivity ahead led by further
monetisation of the strong pipeline of 208 ANDAs in the US. However, lack of (a)
investments in long-term growth drivers, (b) no evidence of scalability in the RoW
business, and (c) a well-established domestic formulations business should keep
investors at bay. Promoters involvement in legal investigations, undisclosed income
from Aurobindo coupled with less-than-ideal disclosures on partnership,
management and ownership of Citron makes us cautious.

It lags on parameters like rational


capital allocation, robustness of
business model and reputation and
quality of management (no
significant competitive advantage)

Exhibit 13: SWOT analysis of Aurobindo


Strengths

Weaknesses

Promoter-led management keeps agency costs low. Promoter stake in

Lack of an established domestic formulations business. The domestic

the company is currently at ~54%.

business is a sustainable stream of profits and generates cash.

High R&D productivity led by vertical integration benefits coupled with


R&D spend on less complex generics has been accretive to RoCE.

Depth and width of management to ensure stability; no transition in


sight. The sons of Ramprasad Reddy (65 years old) are not involved.

Efficient capital structure as compared to peers (debt:equity of 100%

Lack of investments in sustainable long-term growth drivers. With the US


formulations business experiencing exponential growth (29% CAGR over
FY14-17E), the company may face a base effect in FY19E.

Issues in corporate governance due to less than ideal disclosure practices


and political interests of promoters are an inherent weakness.

High exposure to API business (35% of revenues as of FY14) is also a

as of FY14) beneficial for stakeholders.

A large ANDA pipeline in the US (208 ANDAs pending final approval)

weakness. The company has registered API sales CAGR of 6% (in USD).

is likely to drive 29% CAGR in US sales over FY14-17E and EBITDA


margin and RoCE expansion of 730bps and 920bps over FY14-FY17E.

Lack of end-to-end capabilities in complex products would force the

The company has avoided great mistakes in its past acquisition

Aurobindos RoCE is lower than peers due to: (a) inferior product mix, (b)

strategy. The recent acquisition of Actavis European business seems


RoCE-accretive.

high investments in vertical integration of oral solids and (c) delay in


monetising US pipeline due to USFDA issues in the past.

company to share the upsides from such opportunities in the future.

Opportunities

Threats

Small business in RoW markets offer scope for long-term sustainable

The return of incumbents segments like cephalosporins, controlled

growth (US$77mn sales in FY14). Given the lack of a track record for
scaling up emerging market business, we do not give much credit to it.

Large ANDA pipeline (208 ANDAs pending final approval) in the US as


compared to a smaller currently marketed portfolio (168 products
marketed) bodes well for growth prospects.

The company is beginning to make investments in comparatively more


complex products like oncology and hormones injectables, complex
injectables, and OTC business in the US (Aurohealth).

substances and general injectables is a matter of time.

We believe that the RoCE and margins of Aurobindo may come under
pressure if the companys US business faces competition from incumbents
that have withdrawn from the market due to FDA issues.

Aurobindos revenues are largely forex-denominated and the foreign


debt is being wound down in the next 2-3 years; the companys profits
could be highly sensitive to forex movements in the future.

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 76

Aurobindo Pharma

US formulations the only growth driver but


a no moated business
We believe Aurobindo is still evolving from an API-led player to a formulations player.
Whilst API sales contributed 70% of FY07 sales and 35% of FY14 sales, we expect the
contribution to steadily decline to 15% by FY29E, as formulations see higher growth
in sales. However, within formulations, the companys presence in the US appears to
be the only bright spot.
We highlight that the company has only 4% of its revenues sourced from emerging
markets and only a portion of its ARV sales are in India (unbranded). Hence, there
are no moated revenue streams that can sustain growth over the medium to
longer term.
Exhibit 14: Revenue mix US formulations to dominate growth
US$ mn

FY14

FY15E

FY16E

FY17E

CAGR FY14-17E

Comments

563

707

925

1,236

30%

30% CAGR represents reduction of FDA approval


timelines form current 36 months to 10 months as
stipulated by GDUFA 2012.

330

330

363

453

11%

Growth in oral solids to remain muted as low number of


ANDAs pending approval and no moats

-One offs

94

80

40

38

-26%

-Controlled Substance (Aurolife)

74

131

204

322

63%

Controlled substances would be a key growth driver.


Piperacillin Tazobactam contributed 50% of the segments
revenue in FY14

-Cephalosporins

28

31

34

37

10%

Cephalosporins re-launched in FY14. Aurobindo likely to


benefit from absence of incumbents like Ranbaxy in the
near term.

-Injectables (Auromedics)

37

102

194

262

92%

Injectables are the key growth driver in US with a large


ANDA pipeline awaiting approval.

ARV

139

160

184

202

13%

ARV sales are likely to see moderate growth largely led


by tender business through US Presidents PEPFAR
programme

Europe

111

562

568

620

77%

Actavis acquisition to fuel revenue growth in FY15E.


However, post FY15E, we forecast single digit revenue
growth

-Legacy

111

133

160

192

20%

-Actavis

429

408

428

NA

77

84

93

102

10%

890

1,514

1,769

2,161

34%

SSP

162

178

187

196

7%

Cephs

145

170

175

175

7%

ARVs and others

167

176

193

212

8%

Total API

474

524

555

584

7%

1,364

2,037

2,324

2,744

26%

Formulations
USA

-Orals

ROW
Total formulations

We expect Cymbalta to have a reasonably fat tail

Despite a low base in RoW markets like Brazil, we


forecast low double digit growth as the company has no
India business and hence no experience in this area.

API

Total Revenues in US$ terms

We expect APIs to grow in single digits given companys


focus on maintaining margins.

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 77

Aurobindo Pharma

US formulation sales Key growth driver/no moats


Aurobindo has the largest ANDA pipeline amongst Indian generics in
absolute numbers. However, the companys FY14 revenue/ANDA was much lower
at US$3.4mn per annum when compared with stalwarts like Lupin and Dr. Reddys
(US$7mn-11mn p.a.). We believe that the subdued revenue per ANDA reflects the
low complexity and high competitive intensity of its currently marketed products.
However, in the future, we expect a significant improvement in the product mix in the
US led by incremental launches in niche areas like injectables, controlled substances,
OTC and penems.

We expect a significant
improvement in the product mix in
the US led by incremental launches
in niche areas like injectables,
controlled substances, OTC and
penems

Exhibit 15: Unit-wise filings, approved and pending approval as of 1QFY15


Unit-wise filings

1QFY15 Comments
Aurobindo has a legacy business of oral non Betalactam products.
With only 5 ANDAs pending from Unit 3, we dont expect significant
growth from the Unit.

Unit 3 - Oral Non-Betalactam products


- Products filed

119

- Approved

114

- Pending

5
Unit 7 has 97 ANDAs pending approval in the oral non Betalactam
segment and likely to be the growth engine for the segment. We
expect revenues of US$4m/ANDA per annum from this segment.

Unit 7 - Oral Non-Betalactam products


- Products filed

133

- Approved

36

- Pending

97
General injectables and ophthalmic products are likely to be the key
growth driver for Aurobindos US business. We expect revenues of
US$4m/ANDA from this segment going forward.

Unit 4 - General Injectable and Ophthalmic products


- Products filed

66

- Approved

- Pending

58
Unit 12 is not a significant growth driver given only 1 ANDA from
the facility is pending approval.

Unit 12 - Injectable Cephalosporin and Semi-synthetic penicillin


- Products filed

20

- Approved

19

- Pending

1
Unit 6 is not a significant growth driver given only 1 ANDA from the
facility is pending approval

Unit 6 - Cephalosporin and Semi-synthetic penicillin


- Products filed

11

- Approved

10

- Pending

1
Controlled substances are a key growth driver given high margins
and revenue potential per ANDA in the segment. We pencil in
US$20m / ANDA from the segment going ahead.

Auro Life - Oral Non-Betalactam products (CS)


- Products filed
- Approved
- Pending

25
7
18

Auro Next - Penem Injectable products

Penem opportunity is too small in the overall scheme of things.

- Products filed

- Approved

- Pending

Total
- Products filed

376

- Approved

194

- Pending

182

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 78

Aurobindo Pharma
Legacy oral solid products Vertical integration driving market share
We assess that sales from legacy oral products in the US were at US$330mn in FY14
vs US$121mn in FY09 (CAGR of 22% in USD terms). The growth in sales was largely
driven by market share gains in these products owing to vertical integration benefits
and incremental launches of me too products and day 1 launches over the same
period. We exclude generic Cymbalta from this segment due to its one-off
contributions in FY14 and higher than normal pricing post exclusivity.
Exhibit 16: We expect Aurobindos Oral Solids CAGR at 11% over FY14-17E
500

Oral Solids

Revenue in US$ mn

CAGR 11%
400
300
CAGR 38%

453

200
312
100

192
35

59

233

330

363

330

213

121

FY07 FY08

FY09 FY10 FY11

FY12 FY13 FY14 FY15E FY16E FY17E

Source: Company, Ambit Capital research

Going forward, we expect the segment to register a revenue CAGR of 20% (in USD
terms) over FY14-17E, led by incremental launches. Out of the 208 ANDAs currently
pending approval from the USFDA, at least 102 products fall under this segment.
These filings would likely unravel over the next 3-4 years and result in revenue
growth. Aurobindo has also guided to filing ~40 ANDAs per year going forward. A
majority of these would be general injectables in FY16E, but FY15E and FY17E are
likely to see some more oral solid filings.
Exhibit 17: We expect the recent filings to unravel in the next 3-4 years
Unit-wise filings

2QFY13

3QFY13

4QFY13

1QFY14

2QFY14

3QFY14

4QFY14

1QFY15

- Products filed

123

120

120

120

116

117

118

119

- Approved

114

115

116

117

114

114

114

114

- Products filed

59

63

66

71

83

89

111

133

- Approved

18

19

23

28

29

30

33

36

- Pending

41

44

43

43

54

59

78

97

Unit 3 - Oral Non-Betalactam products

- Pending
Unit 7 - Oral Non-Betalactam products

Source: Company, Ambit Capital research

One-off products dont expect a repeat of the Cymbalta situation


Cymbalta presented a one-off opportunity for Aurobindo wherein despite
multiple FTFs only 5 generic companies launched the product on day 1 under
exclusivity and this resulted in a shortage of inventory and better than normal pricing
(~80% price erosion as compared to the normal 95% under similar competition).
We believe Aurobindo clocked revenues of ~US$130mn under the exclusivity spread
over 3QFY14-1QFY15 from the product, with an average market share of 25% as
compared to Torrent Pharma clocking ~US$65mn over the same period with 8%
market share and Lupin clocking ~US$110mn with 15% market share. We believe
that Aurobindos realisations from the product have been impaired by distribution
margins paid to Citron which could be at 30-40% of sales.

September 16, 2014

Ambit Capital Pvt. Ltd.

Aurobindos realisations from


Cymbalta have been impaired by
distribution margins paid to Citron
which could be at 30-40% of sales

Page 79

Aurobindo Pharma
Exhibit 18: We estimate that Aurobindo paid 30-40% distribution margins to Citron
In US$ mn

Lupin

Torrent

Revenues over 3QFY14-1QFY15 (A)

110

65

Market share of Lupin (B)

15%

8%

Total generic Cymbalta Market size (A/B)

(C)

Market share of Aurobindo (D)

733

813

25%

25%

Aurobindo's revenue from Cymbalta(C*D) (E)

183

203

Less: distribution margins to Citron (1-F/E)

29%

36%

Revenue booked by Aurobindo (F)

130

130

Source: Company, Ambit Capital research

Post exclusivity, even as incremental competition has stepped in and pricing has
eroded further (~90% erosion now as per industry sources), the product still remains
relatively more profitable as compared to other similar products. Aurobindo continues
to sustain ~25% market share in the product, as per Wolter Kluwers audit data. We
expect the product to have a fatter tail than normal in the near term.

Aurolife (controlled substances) Poised for ramp up


from new launches
Aurolife has a local manufacturing facility in the US which was acquired from Sandoz
in 2006. The company launched three products from Aurolife in 3QFY14 and has
another 3-4 products with final approval which would be launched in FY15.
Further, the company has filed for another 10 controlled substance products which
are yet to gain approval. The controlled substance market is ~US$10bn-15bn in
terms of annual sales in the US (contractpharma estimates). We believe that
approximately half the market is still under patent protection (Vyvanse, Adderall XR,
and Oxycontin abuse resistant formulation are the largest-selling products) whilst the
remaining are already generic, with ~4-8 players in each product segment. Even
though the competitive intensity is not extremely low, the pricing in the controlled
substance space is high given the high regulatory hurdles and ask for a local
manufacturing unit in the US.
Exhibit 19: Expect Aurolife revenues to report CAGR of 63%
over FY14-17E
350
Controlled Substance (Aurolife)

30

Auro Life - Oral Non-Betalactam products

25
CAGR 63%

250

20
18

19

Q2FY14

Q3FY14

Q4FY14

Q1FY15

204

131
74

FY14

FY15E

Source: Company, Ambit Capital research

FY16E

18

22

100

13

Q1FY14

150

13

Q4FY13

10

322

15

17

Q3FY13

15

200

50

Exhibit 20: Incremental revenues from new launches

Q2FY13

Revenue in US$ mn

300

Competitive intensity is not


extremely low and pricing in
controlled substance is high

- Approved

FY17E

- Pending

Source: Company, Ambit Capital research

We estimate Aurolife would record a revenue CAGR of 63% over FY14-17E led by
new launches in FY15 of already approved products and incremental launches in
FY16/17E from new approvals from USFDA.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 80

Aurobindo Pharma
Cephalosporins Not a needle mover despite vertically integration benefits
Aurobindo received an import alert on its cephalosporin manufacturing unit (Unit VI)
from the USFDA in February 2011. The company was clocking revenues of
~US$33mn from cephalosporin sales in the US prior to the import alert. However,
the sales dropped to zero in FY13 due to stoppage of exports. The import alert was
lifted by the FDA in March 2013 and the company resumed supplies in April 2014.

20

10

15

10

16

5
FY11

FY12

FY13

FY14 FY15E FY16E FY17E

Source: Company, Ambit Capital research

16

16

17

- Approved

10

10

10

10
Q1FY15

15

Q4FY14

25

Q3FY14

20

Q2FY14

25

30

Unit 6 - Cephalosporin and Semi-synthetic


penicillin

Q2FY13

Revenue in US$ mn

30

CAGR 10%

Q1FY14

Cephalosporins

35

Q4FY13

40

Exhibit 22: One product pending approval as on 1QFY15

Q3FY13

Exhibit 21: Import alert in Unit VI led to zero sales in FY13

- Pending

Source: Company, Ambit Capital research

Post resumption of supplies, the company earned revenues of US$28mn from the
segment in FY14. We highlight that the regain in market share was driven by vertical
integration benefits and supply chain improvement, as most of the market share in
the interim was lost to players like Lupin. Going ahead, we expect the company to
clock a CAGR of 10% over FY14-17E from the segment given no incremental
launches.

Regain in market share driven by


vertical integration benefits and
supply chain improvement

Auromedics (general & specialty injectables) Key


growth driver
Aurobindo has 66 ANDAs filed from Unit IV for general injectables, out of the entire
gamut of 120 ANDAs. The remaining 50+ products would be filed over the next 3-4
years. The company currently has approvals for only 8 ANDAs from Unit IV and
overall markets only 10 injectables in the US.
The management expects to gain approvals and launch most of its general injectable
ANDAs over the next 12-24 months. The company has also filed for two penem
products which is a small but limited competition market.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 81

Aurobindo Pharma
Exhibit 24: Revenue unlocking
approvals
70

250

50

CAGR 92%

200

through higher product

Unit 4 - General Injectable and


Ophthalmic products

60
40
30

150

37

FY12

FY13

FY14

FY15E FY16E FY17E

8
Q1FY15

10

19

Q4FY14

1
-

19

Q3FY14

102

- Approved

Source: Company, Ambit Capital research

58

Q2FY14

50

18
0

36

47

Q1FY14

10

194

Q3FY13

100

24

42

Q4FY13

20

262

Q2FY13

Revenue in US$ mn

Exhibit 23: 92% CAGR over FY14-17E due to product


approvals
300
Injectables (Auromedics)

- Pending

Source: Company, Ambit Capital research

We pencil in revenue CAGR of 92% for injectable sales in the US from Auromedics
over FY14-17E. We assume 15-20 product launches each year from the segment with
average revenue per ANDA of US$4mn.

US sales CAGR of 29% over FY14-17E


Overall, we estimate a 29% CAGR for US sales (in USD terms) over FY14-17E. The
company has initiated development of complex injectables (fondaparinux filed with
USFDA), OTC products (Aurohealth), ophthalmic and penem products in the US.
These product portfolios are likely to drive medium-term growth in US revenues
despite return of incumbents in current segments of significant presence. Incumbents
that are currently not present in the segments discussed above are Teva and Hospira
(injectables), Caraco (Sun) and Nesher (Cadila) (controlled substances), and Ranbaxy
(Sun) and Apotex (cephalosporins). We pencil in 9% revenue CAGR in the US over the
medium term (FY18-27E).

Absence of incumbents to support


US revenue growth

Exhibit 25: Split of US revenues in various segments


US$ mn

FY14

FY15E

FY16E

FY17E CAGR FY14-17E

563

707

925

1,236

30%

330

330

363

453

11%

Formulations
USA
-Orals
-One offs

94

80

40

38

-26%

-Controlled Substance (Aurolife)

74

131

204

322

63%

-Cephalosporins

28

31

34

37

10%

-Injectables (Auromedics)

37

102

194

262

92%

Source: Company, Ambit Capital research

Europe formulations sales Actavis portfolio to drive


profitability but not growth
Aurobindo acquired Actavis generic operations in seven Western European
countries in 2014. The sales from the acquired business have been consolidated
since April 2014. The acquisition was virtually self-financed by the working capital
that the operations brought with itself, as the business was incurring a loss of
EUR20mn p.a. on sales of EUR330mn.

The management expects to


narrow Europe business losses in
FY15 and break even in FY16

Aurobindo expects to narrow down the losses of the operations to EUR10mn in FY15E
and break even in FY16E by integrating the operations with its own business in
Western Europe, site transferring several products to lower cost manufacturing base
in India and discontinuing loss-making products/segments where there are no
synergies.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 82

Aurobindo Pharma
Exhibit 26: Contribution from Actavis portfolio to increase
700

Europe revenue in US$ mn

600
500
400

CAGR 77%

428

408

300
429

200
100
-

111

133

160

192

FY14

FY15E

FY16E

FY17E

-Legacy

-Actavis

Source: Company, Ambit Capital research

Whilst we believe that the acquisition will be RoCE-accretive when the profitability is
turned around, it will also be margin-dilutive as Western European markets offer high
single to low double-digit EBITDA margins for generic operations. We estimate
revenue CAGR of 5% over FY15-17E.

Acquisition will be RoCE-accretive


but margin-dilutive

ARV and RoW formulations sales No evidence of


further scalability
Aurobindo has registered revenue CAGR of 6.6% (in USD terms) in ARV formulations
sales. The company sells ARV formulations in India (through institutions) and also
exports to various countries including Africa through the US Presidents PEPFAR
programme. The ARV business in Africa is intensely competitive, with multiple players
rooting for tenders from global agencies like WHO, the Bill & Melinda Gates
Foundation and the US Presidents PEPFAR programme.
Exhibit 27: Aurobindo to witness competition in the ARV
business
250
200

Exhibit 28: Cautious in the ROW business due to lack of


evidence on scalability
120

ARV revenue in US$ mn

100

CAGR 13%

Africa is intensely competitive and


hence no evidence of scalability

ROW revenue in US$ mn


CAGR 10%

80

150

60
100
50

139

160

184

202

40

77

84

93

102

20
-

FY14

FY15E
ARV

Source: Company, Ambit Capital research

FY16E

FY14

FY17E

FY15E
FY16E
ROW

FY17E

Source: Company, Ambit Capital research

We pencil in 13% CAGR from ARV formulation sales largely driven by new
introductions. We also believe that the margins in the African business have shown
signs of improvement based on our primary data checks which suggest increased
rationality in pricing for contracts.
Aurobindo also has a small presence in certain emerging markets like South Africa,
Canada, Australia and Brazil. It further plans to enter geographies like Mexico and
South East Asian countries. Due to lack of evidence on the scalability of Aurobindos
business in these markets, we remain cautious.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 83

Aurobindo Pharma

API sales Improvement in product mix to drive


margins; revenue growth muted
Aurobindo has been realigning its API portfolio to derive a better product mix and
expand margins. However, in this endeavour, the company has registered a CAGR of
only 6% over FY09-14 for its API sales. We pencil in a CAGR of 7.2% over FY14-17E.
Exhibit 29: Expect revenue growth to be muted and change in product mix to drive
margins
700
600
500
400
300
200
100
-

API revenue in US$ mn


CAGR 7%
176

193

212

145

170

175

175

162

178

187

196

FY14

FY15E

FY16E

FY17E

167

SSP

Cephs

ARVs and others

Source: Company, Ambit Capital research

No investments visible in long-term growth drivers


Whilst Aurobindo has made medium-term investments in OTC products, ophthalmics,
complex injectables and penems, we are yet to see any credible investments in the
long-term growth drivers (NCEs, NDDS, biosimilars) which could yield sustainable,
annuity-like revenue and profit streams. Hence, the companys business in its current
shape and five years from today is likely to be highly sensitive to incremental
competition.

The companys business in its


current shape and five years from
today, is likely to be highly sensitive
to incremental competition

Lack of investments in long-term growth drivers (NCEs, NDDS, biosimilars) has also
resulted in high R&D productivity in the near term and also aids reported RoCE and
EBITDA margins.
Exhibit 30: Aurobindo has the lowest R&D spend as a percentage of sales
10%

R&D cost as % of Sales - FY14

8%

4.3%

5.4%

8.0%

8.9%

9.1%

Glenmark

4.1%

7.0%

Dr. Reddy's

3.1%

Ranbaxy

2%

Cipla

4%

Lupin

6%

Cadila

Sun Pharma

Aurobindo

0%

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 84

Aurobindo Pharma

Base business EBITDA margins and RoCE


to improve till FY17E but decline thereafter
We expect base business margins (ex Cymbalta and Actavis EU sales) to improve by
730bps over FY14-17E led by better product mix in the US and operating leverage on
overheads and manufacturing. Whilst the company has clocked revenue/ANDA of
~US$3.4mn in FY14 (ex-Cymbalta), we build in US$4mn/ANDA for general
injectable and oral solids and US$20mn/ANDA for controlled substances.
We expect margins to decline post FY18E, once the tailwind from improving USFDA
approval timeline subsides. Our assumption of lower margins is led by: (a) our
assumptions on return of incumbents like Ranbaxy in cephalosporins, Hospira in
injectables and penems, and Nesher and Caraco in controlled substances which is
likely to result in market share and pricing erosion; and (b) lack of NCEs, NDDS and
biosimilars to offset the decline in margins in the base business.
Exhibit 31: Base business margins to improve till FY17E led by product mix and
operating leverage
31.0%

28.5%

29.0%
27.0%

26.3%

25.8%
24.1%

25.0%
23.0%

21.2%

21.0%

24.8%

22.3%
20.9%

19.0%
17.0%
15.0%
FY14

FY15E
Conslidated margins

FY16E
Base Business margins

FY17E

Source: Company, Ambit Capital research

RoCE to expand by 920bps to 33.4% over FY14-17E,


and then gradually decline
We expect Aurobindos RoCE to ramp up to 33.4% in FY17E from 24.2% in FY14 led
by improvement in USFDA-approval timelines and monetisation of general
injectables, complex injectables, controlled substances and Para IV ANDAs. However,
the companys business in its current shape and five years from today, is likely to be
highly sensitive to incremental competition. Post FY17E, we expect the RoCE to start
gradually declining, as:

RoCE expansion led by improving


approvals

(a) incumbents like Hospira, Ranbaxy, and Nesher return and establish themselves in
the respective segments resulting in market share and pricing erosion.
(b) lack of longer-term growth drivers (NCEs, NDDS and biosimilars) start to reflect in
terms of lower asset turnover. We pencil in decline in gross block turnover from
4.2X in FY17E to 3.0X (peer average) in FY27E.
(c) Lack of scalability in RoW and ARV formulation sales begin to drag growth and
operating leverage.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 85

Aurobindo Pharma
Exhibit 32: We expect RoCEs to stabilise at 12.8% in the terminal year
40.0%
35.0%
30.0%
25.0%
20.0%

WACC

15.0%
10.0%
5.0%
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
FY21E
FY22E
FY23E
FY24E
FY25E
FY26E
FY27E
FY28E
FY29E

0.0%

Source: Company, Ambit Capital research

Financial assumptions
Exhibit 33: Detailed financial assumptions (` mn unless otherwise mentioned)
Assumptions
Particulars

YoY change (%)

FY14

FY15E

FY16E

FY17E

FY15E

FY16E

FY17E Comments

USA

34,028

42,416

55,495

74,175

24.7%

30.8%

33.7%

ARV

8,402

9,591

11,029

12,132

14.1%

15.0%

10.0%

Europe

6,721

33,745

34,060

37,204 402.1%

0.9%

9.2%

ROW

4,634

5,060

5,566

6,122

9.2%

10.0%

10.0%

API

28,643

31,413

33,301

35,020

9.7%

6.0%

5.2%

Total

82,593

122,375 139,600 164,803

48.2%

14.1%

18.1%

Gross profit

44,938

61,535

74,570

92,650

36.9%

21.2%

24.2%

Overheads cost

23,610

36,483

44,070

52,552

54.5%

20.8%

19.2%

EBITDA

21,328

25,052

30,499

40,098

17.5%

21.7%

31.5%

EBITDA margins (%)


24.1%
21.1%
PAT (adj for forex
11,737
15,770
loss)
Source: Company, Ambit Capital research

22.4%

25.0%

19,733

27,268

34.4%

25.1%

38.2%

Sales assumptions
Growth in the US to be led by unfolding of the 208 ANDA
strong pipeline
ARV sales growth muted, as opportunity is limited
Post Actavis acquisition, we expect some rationalisation in
product portfolio; we expect high single-digit growth on a
consolidated basis for Europe
Lack of evidence on scalability drives our low double-digit
growth assumption
Contribution to internal consumption to increase,
pressurising growth for external sales
Mid- to high-teen growth in revenues for FY16/17E
Expect expansion in gross margins, as product mix
improves in US and API
Limited operating leverage expected, as costs are based
out of India
Expansion in EBITDA margins largely led by gross margin
expansion
Financial leverage fuels PAT growth higher than EBITDA
growth

Ambit vs consensus
Exhibit 34: Our estimates are higher than consensus on FY16/17E EBITDA margins
Particulars (` mn)

Ambit

Consensus

Divergence (%)

FY15E

119,928

118,624

1.1%

FY16E

136,808

135,198

1.2%

FY17E

161,507

156,745

3.0%

FY15E

25,052

23,665

5.9%

FY16E

30,499

27,530

10.8%

FY17E

40,098

32,342

24.0%

FY15E

15,770

14,533

8.5%

FY16E

19,733

17,224

14.6%

FY17E

27,268

20,820

31.0%

Sales

EBITDA

Net Profit

Source: Bloomberg, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 86

Aurobindo Pharma
Our estimates are 1.1-1.2% ahead of consensus FY15/16 revenue and 6-11% ahead
of consensus FY15/16 EBITDA estimates, as we expect a faster ramp up in US sales
led by improvement in USFDA timelines. Our FY15E net profit estimate of `15.8bn is
lower than management guidance of more than `16bn. Further, we believe that the
street is yet to upgrade its estimates post the fantastic results in 1QFY15. We are
penciling in higher margins for FY16/17E vs consensus led by our expectations of
launch of all interesting products like penems, controlled substances etc over the
period which are likely to result in higher EBITDA margins.

September 16, 2014

Ambit Capital Pvt. Ltd.

Our estimates are ahead of


consensus, as we expect faster
ramp up in US sales

Page 87

Aurobindo Pharma

Valuation Deserves a deep discount to


large-caps
Aurobindo is trading at a 35% discount to the peer average one-year forward
EV/EBITDA multiple. Whilst well-entrenched promoters, high R&D productivity,
excellence in execution, and near-term earnings momentum lend support to
valuations, we do not find the valuations attractive due to the following reasons:

Issues with management, absence


of longer-term growth drivers and
low R&D spend deserve valuation
discount to large-caps

a) Given the absence of incumbents in the US, the market share and pricing for
Aurobindos cephalosporins, general injectables and controlled substances may
be inflated. Injectables and controlled substances account for more than 70%
revenue and profit growth for Aurobindo over FY14-17E. We expect pressure on
the base business to translate to decline in RoCE over the medium term (fy1827E).
b) Aurobindo is vertically integrated in most of its oral products but not so in
injectables. Hence, the company is unlikely to make similar margins and RoCEs
from the anticipated growth in the US and market share gains cannot be taken
for granted.
c)

Aurobindo sources 35% of its revenues (FY14) from API sales which are unlikely
to grow significantly from hereon as the company rationalizes low margin
revenues and increases captive consumption. Low consolidated growth beyond
FY18E would result in lower multiples.

We use a DCF methodology to value Aurobindo with a terminal RoCE of 13% and
discount rate of 13%. This leads to a target price of `828/share.

Valuation methodology
We value Aurobindo using a DCF methodology wherein EBITDA margin, mediumterm revenue growth rate and terminal revenue growth rate are the key variables
controlling the valuation. Furthermore, we use a free cash flow to equity
methodology.
EBITDA margin: We build in a gradual expansion in EBITDA margins from 21% in
FY14 (base business) to 29% in FY18E and then a gradual decline to 21% in FY29E
(terminal year). Aurobindo would have incremental margin tailwinds in the US over
the near term, as it ramps up its product basket. However, we believe it will face
pricing and market share erosion, as incumbents in various segments return to
market and establish themselves.
Medium-term and terminal revenue CAGR: We pencil in medium-term (FY18FY27E) revenue CAGR of 7% largely led by continued growth momentum in the US
market but no material growth in the API and Europe Actavis business. We expect the
US revenues to slow down post FY18E, as the tailwinds on faster approvals subside.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 88

Aurobindo Pharma
Exhibit 35: We pencil in medium-term revenue growth of 6.5% and terminal rate of
2.5%
Medium-term
revenue CAGR
(FY18-27E)

Terminal revenue
growth rate
(FY28E onwards)

USA

9.0%

3.0%

-Orals (including upsides from Aurohealth)

9.0%

3.0%

-One offs

0.0%

0.0%

-Controlled Substance (Aurolife)

9.0%

3.0%

-Cephalosporins

9.0%

3.0%

-Injectables (Auromedics) (including upsides from Celon JV)

9.0%

3.0%

ARV

5.0%

3.0%

Europe

5.0%

2.0%

-Legacy

5.0%

2.0%

-Actavis

5.0%

2.0%

10.0%

5.0%

Total formulations

7.1%

2.9%

SSP

5.0%

0.0%

Cephs

0.0%

0.0%

ARVs and others

5.0%

0.0%

Total API

3.8%

0.0%

Total Gross Sales

7.1%

3.0%

Growth rate assumptions (in constant currency terms)


Formulations

ROW

Source: Ambit Capital research

Our DCF model suggests a fair value of `828/share (our 12-month forward target
price), which implies ~10.5x FY16/17E EPS as compared to the current trading
multiple of 14.5x FY15/16E EPS.
Exhibit 36: Aurobindos valuation discount does not fully reflect the competitive
disadvantage and lower RoCE
21

EV/EBITDA (FY16E)

19

Sun Pharma

17

Cipla

15
Cadila Glenmark

13

Lupin

Dr. Reddy's

11

IPCA

9
Aurobindo

7
5
10

15

20

25
RoCE (FY14)

30

35

40

Source: Bloomberg, Ambit Capital research; Note: Bubble size indicates competitive positioning (larger bubble =
higher position); Aurobindos FY14 RoCE estimated at 16% excludes Cymbalta exclusivity profits

As seen in the exhibit above, Aurobindo is trading at a discount to Sun Pharma and
Lupin largely due to inferior competitive positioning and lower RoCE. We believe that
the discount should expand given the lack of investments in longer-term growth
drivers and the vulnerability of revenues and profits to incremental competition.
At our target P/E multiple of 10.5x one-year forward EPS, Aurobindo would be
trading at a 50% discount to these companies, which we feel is justified.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 89

Aurobindo Pharma
Exhibit 37: Terminal value contributes 40% to total fair enterprise value
Key assumptions
Discount rate
Terminal growth rate
Medium term growth rate
EBITDA margins (FY14)
EBITDA margins (FY29E)

Value

13.1% Same taken for other large caps


3% Lower than peers due to lack of India formulations, a credible RoW business and long term growth drivers
7.1% Driven largely by revenue growth in US and Europe formulation sales
26.3% Margins inflated due to Cymbalta; ex Cymbalta we estimate base business margins at 21.2%
21.2% We expect margins excluding Cymbalta and Actavis acquisition to remain stable over the longer term

Total Enterprise value

255,173

Terminal value

101,127

Terminal value as % of Total

Comments

40%

Source: Ambit Capital research

We expect Aurobindos EBITDA margin (excluding one-offs and Actavis acquired


business) to remain stable over the next 15 years. Whilst the product mix is likely to
improve in the near term, the operating leverage would play against Aurobindo in
the medium term (FY18E-27E) as most costs (53% in FY14) are India-based whereas
~80% of revenues are from exports. Whilst these costs would continue to grow in the
low double digits, we model revenue growth from exports in mid-to-high single digits.
Exhibit 38: Our 12-month forward target price is `828/share
Particulars
Total EV
Net Debt (FY17)
Equity value
Number of shares outstanding (mn)

in ` mn
255,173
13,762
241,411
291.50

Value / share (`.)

828

CMP (`.)

896

Upside / Downside (%)

-8%
FY15E

FY16E

FY17E

Implied adj. P/E (x)

15.3

12.2

8.9

Current adj. P/E (x)

16.6

13.2

9.6

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 90

Aurobindo Pharma

Cross-cycle valuation
Aurobindo is currently trading at 14.5x FY15/16E EPS i.e. a ~35% discount to its
larger peers like Cadila, Lupin and Sun Pharma. Whilst the company has re-rated
significantly over the recent past largely led by the managements guidance towards
margin expansion and revenue growth in the US, we believe that the valuations fail
to reflect the fragility of the current profits and growth prospects.

Valuations fail to reflect the


fragility of current profits and
growth prospects

At the current valuations, we see room for a de-rating of the business and believe
that segments like controlled substances, oral solids and general injectables in the US
are likely to see incremental competition from former incumbents in the medium
term. Hence, we expect the price performance to be negative despite strong earnings
growth.
Exhibit 39: The stock has traded in a P/E band of 6.0x-15.0x
over the last 12 months
1200

Exhibit 40: Aurobindo has re-rated owing to


expectation from US formulations sales growth

ARBP Price Band Chart

higher

EV/EBITDA
18x

1000
800

12x

20
15

600
10

Price

Source: Bloomberg, Ambit Capital research

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-05

Oct-13

May-14

Mar-13

Aug-12

Jan-12

Jun-11

Nov-10

Apr-10

Sep-09

Jul-08

Feb-09

Dec-07

May-07

0
Oct-06

Mar-06

200

Mar-07

6x

Mar-06

400

Source: Bloomberg, Ambit Capital research

The spike in FY11 in EV/EBITDA and P/E ratios reflects the impact of FDA ban on Unit
VI on earnings.

-150%
PAT growth (LHS)
Source: Bloomberg, Ambit Capital research

September 16, 2014

15%
FY14

-50%

FY13

0%
FY12

FY14

FY13

FY12

FY11

FY10

FY09

FY08

FY07

FY06

-50%
-100%

FY05

0%

20%

50%

FY11

50%

25%

FY10

100%

100%

FY09

150%

30%

FY08

200%

150%

FY07

250%

40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%

FY06

300%

Exhibit 42: EBITDA growth and RoCE in FY12 and FY13


impacted due to import alert at Unit VI

FY05

Exhibit 41: Earnings growth and RoE have been volatile


due to forex losses, FDA ban and redemption of FCCB

-100%

RoE (RHS)

10%
5%
0%

EBITDA growth (LHS)

RoCE (RHS)

Source: Bloomberg, Ambit Capital research

Ambit Capital Pvt. Ltd.

Page 91

Aurobindo Pharma

Catalysts
We believe that the trigger/catalyst for de-rating could be:
(a) Return of an incumbent like Hospira in general injectables which are likely to
contribute 13.4% to the overall revenue growth over FY18E-27E.
(b) Large expensive acquisitions to establish longer-term growth drivers but at an
exorbitant cost; Aurobindo has no track record of large acquisitions, but we suspect
that the company will have to look for one when the growth dries up over the
medium term.
(c) Slowdown in US formulations sales due to inability in gaining market share in
injectables, as they are not vertically integrated.

Key risks to our SELL thesis


(a) Value-accretive acquisitions: Value-accretive acquisitions (like Actavis
European business) on the innovative products side (such as NCEs, NDDS and
biosimilars) could lead us to change our view on the long-term prospects of the
company.
(b) Better-than-expected pricing environment in the US: We assume a moderate
decline (3-5%) in the base business pricing in the US. This assumption is led by our
expectations of high approvals for competitors in the base business partly offset by
increased FDA vigilance, keeping very small players out of the market.
(c) INR depreciation against USD: Aurobindo has been a beneficiary of the INR
depreciation against the USD largely due to high exports. We assess that the
companys profits could increase by 2.5% for every 1% depreciation in INR beyond
`60/USD levels.

Sensitivity of fair enterprise value to our assumptions


Exhibit 43: Sensitivity of TP to discount and terminal growth rates
Terminal growth rate

Discount rate

828

1%

2%

3%

4%

5%

11%

984

1,036

1,102

1,186

1,297

12%

863

902

949

1,007

1,082

13%

765

794

828

870

922

14%

683

705

731

762

799

15%

615

632

651

674

702

Source: Ambit Capital research

Exhibit 44: Sensitivity of TP to medium-term US growth rate and EBITDA margins


Medium term EBITDA margins
US medium-term
growth rate

21%

22%

23%

24%

25%

7%

646

674

701

728

755

8%

707

734

762

790

818

9%

771

800

828

856

885

10%

841

870

899

927

956

11%

915

945

974

1,004

1,033

Source: Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 92

Aurobindo Pharma
Our INR assumption and sensitivity of earnings
We have penciled in `60/USD for FY15E and beyond. Our sensitivity analysis
suggests that for every percentage point appreciation/depreciation in the INR/USD,
Aurobindos net profit decreases/increases by 2.5%.

Exhibit 45: Explanation for the flags on the cover page


Field

Score

Comments

RED

Aurobindo accounting analysis raises RED flags on: (a) admission of undisclosed income in the past; (b)
continuation of the same auditor despite undisclosed income issue; (c) lower than peer EBITDA/CFO ratios;
and (d) higher than peer working capital cycle.

Predictability

AMBER

Overall, the management has made timely announcements in its earnings calls, meetings and interviews
regarding product filings, acquisitions and business outlook. However, the unpredictability of segments like
ARV sales, RoW formulation sales and API sales make us assign an AMBER flag on predictability.

Earnings momentum

GREEN

Consensus FY15 EBITDA and EPS estimates have been upgraded by 5-8% and FY16 EBITDA and EPS
estimates have been upgraded by 4-5% over the past three months.

Accounting

Source: Bloomberg, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 93

Aurobindo Pharma

Accounting analysis some RED flags

Revenue recognition: Aurobindos pre-tax CFO/EBITDA ratio has consistently


been significantly lower than the peer average over the past few years mainly on
account of higher working capital requirements. Aurobindos working capital days
have deteriorated from 186 days in FY10 to 217 days in FY14. Given its lack of
material exposure to branded generic markets, where terms of trade are more Low CFO to EBITDA ratio as
compared to its peers
benign, its working capital days remain ahead of its peers.
Even in years when EBITDA has posted healthy growth, CFO/EBITDA has
deteriorated, as working capital needs have expanded. For instance, in FY11,
whilst EBITDA improved by 17%, CFO declined 9% owing to higher working
capital (205 days in FY11 vs 186 days in FY10). Note that inventories and debtors
increased significantly during the year (32% and 29% respectively).
In FY13, pre-tax CFO/EBITDA deteriorated significantly again due to higher
working capital. We highlight that the increase in working capital in FY13 was
49% of EBITDA vis--vis 23% in FY12. Not only is FY13 cash conversion lower
than peers but it is also at a 7-year low. We assign a RED FLAG.

Exhibit 46: Revenue recognition

FY10

FY11

FY12

FY13

YoY change in
Volatility
CFO as a % of
EBITDA (bps) (measured
by SD)
FY14
FY13
FY14

Aurobindo

70%

55%

65%

46%

46%

1,072 (1,963)

Cadila

96%

81%

64%

82%

98%

1,806

Company/Metric

Glenmark
IPCA
Biocon
Average(ex-Aurobindo)
Divergence

Pre-tax CFO as a % of EBITDA

NA

60%

131%

80%

102%

71%

66%

94%

86%

90%

101%

152%

123%

104%

89%

90%

103%

88%

-19%

-35%

-38%

-42%

9%

1,590

16%

7,165 (5,114)

37%

2,806

15%

(841)

103% (2,840) (1,924)


98%

39%

2,377 (2,626)

-52% (1,305)

30%

663

-21%

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity

Working capital days: Aurobindos high debtor and inventory levels is only
partly explained by its business model, which is predominantly that of a generic
drug supplier with a relatively lower negotiating power (hence longer payment
cycles). This is in comparison with its peers that have a mix of generic as well as
branded drug businesses. Both API and generic finished dosages in the Western
markets are highly competitive.

Higher working capital days due to


business of generic drug supply

Whilst the higher debtor days can also be justified for new entrants trying to
break into the business, Aurobindo has had a presence in the generic business
for nearly a decade. Hence, we raise a RED FLAG on Aurobindos overall cash
conversion cycle.
Exhibit 47: Working capital days
Company/Metric
Aurobindo
Cadila

Average Debtor days

Average Inventory days

Average Creditor days

Working Capital days

FY11

FY12

FY13

FY14

FY11

FY12

FY13

FY14

FY11

FY12

FY13

FY14

FY11

FY12

FY13

FY14

91

97

88

95

107

118

108

97

57

56

51

52

141

160

146

140
78

49

58

54

53

62

66

66

65

57

48

35

40

53

77

85

140

108

105

115

100

72

59

54

81

66

66

73

158

115

98

96

IPCA

83

63

49

48

82

104

96

94

24

32

33

34

141

134

113

109

Biocon
Average(exAurobindo)
Divergence

63

88

74

70

52

69

57

49

35

57

51

44

80

100

80

76

85

83

74

76

80

86

77

72

51

52

47

49

108

106

94

90

(37)

(24)

(20)

(24)

(19)

(20)

(11)

(7)

(4)

(13)

(9)

33

53

52

50

Glenmark

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 94

Aurobindo Pharma

Cash manipulation: Aurobindos loans and advances as a percentage of net


worth have been increasing for the years under consideration, except for a brief
dip in FY12. The increase in FY14 was on account of: (a) Export rebate claims
High loans and advances as a
receivable at `1.4bn as compared to `0.9bn in FY12 and `1.2bn in FY13
percentage of net worth as
(accounting for 12% of FY14 loans and advances) and (b) MAT credit entitlement
compared to its peers
amounting to `2.5bn as compared to `.1.3bn in FY13. Apart from these, the
loans and advances schedule includes advances recoverable in cash or kind.
Whilst the proportion of such loans has decreased substantially from 36% in FY11
to 10% in FY14, no disclosures have been provided with regard to these
advances. We believe these require further probing and hence we assign an
AMBER FLAG.

Exhibit 48: Cash manipulation checks


Company/Metric

Loans and adv as a % of networth


FY10

FY11

FY12

FY13

FY14

Aurobindo

20.3%

21.8%

18.1%

21.9%

31.1%

Cadila

19.2%

20.9%

22.4%

25.3%

24.3%

NA

9.8%

13.4%

12.8%

17.6%

14.6%

11.2%

18.2%

15.9%

15.8%

7.6%

9.6%

14.4%

15.8%

15.7%

15.4%

14.7%

17.3%

18.3%

18.3%

4.9%

7.1%

0.8%

3.5%

12.8%

Glenmark
IPCA
Biocon
Average(ex-Aurobindo)
Divergence

Source: Company, Ambit Capital research. Note: All financials pertain to the consolidated entity; we have
excluded capital advances from loans and advances to calculate the above ratio.

Auditors
The fact that the company acknowledged undisclosed income during tax raids in
February 2012 calls into question the independence/ capabilities of both the statutory
auditors (S R Batliboi and Associates) as well as the internal auditors (KPMG). This
issue itself makes us raise a RED FLAG.
The statutory auditors of Aurobindo Pharma are S R Batliboi & Associates who were
appointed in 2008-2009 replacing Batliboi & Company who had been auditors of
Aurobindo at least since FY01. Both the statutory auditors are essentially a part of
Ernst & Young auditors and effectively the auditors have remained unchanged for
more than 11 years now.

Undisclosed income not identified


by auditors but the auditors are not
changed

S R Batliboi and Associates are statutory auditors of 46 companies including Adani


Ports, Bharti Airtel, Biocon, Cairn India, GMR Infra, GVK Power, Lanco Group, Sobha
Developers, Spice Jet, and Sun TV among others. The signing partner Mr Vikas Kumar
Pansari (Membership Number 93649) is also a signatory to the accounts of ILFS
Engineering, GVK Power, and Hyderabad Industries.
The internal auditors of Aurobindo Pharma are currently KPMG who were appointed
only in FY10-11. Prior to KPMG, M/s K Nagaraju & Associates were the internal
auditors of Aurobindo Pharma. M/s K Nagaraju also happens to be the statutory
auditors of Axis Clinicals and Trident Chemphar, which are the holding companies of
the promoters in Aurobindo Pharma.

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 95

Aurobindo Pharma

Corporate governance AMBER FLAG for the Board

Board composition: The Board currently comprises ten directors, out of which
four are independent directors and four are executive directors. Although the
percentage of independent directors is higher than Indian company laws
prescribed 30%, it is lower than global best practice of 50%. AMBER FLAG
In the past, ex-employees have been classified as independent directors and have
occupied positions on critical board committees such as the Audit Committee. Mr
Srinivas Lanka who was on the companys board between 2002 and 2007 was
classified as an independent director; he had overseen the companys operations
in manufacturing and marketing up to early 2002 till he resigned from his
executive duties and was inducted as a non-executive independent director on
the board. Moreover, Mr Lanka was also a member of the all-important Audit
committee until his resignation in 2007.

Ex-employees have been classified


as independent directors and
occupied positions in critical board
committees

We believe that the purpose of the independent directors on board is to


safeguard minority interest. An ex-employee holding an independent director
designation on board is not an ideal practice, in our opinion. AMBER FLAG

Rotation of independent directors: Over the past 10 years, Aurobindos board


has seen significant churn amongst the independent directors. The Best Practices
Code suggests that the maximum tenure for an independent director should be
five years. We note that there was significant churn amongst independent
directors during 2006-2008 when Aurobindo Pharmas financial performance
was poor and it also had a stretched balance sheet and poor cash flows. We
highlight that the reason why a number of independent directors resigned from
the Board in FY06-08 was not articulated either in the media or in the company
releases. AMBER FLAG

Insider trading: There are several stock transactions by insiders that raise
questions over corporate governance practices. For instance, towards the end of
CY10 and early CY11 there was selling by insiders. This was shortly followed by
issues relating to US FDA strictures against an injectable facility becoming public
which led to significant correction in valuations. Similarly towards the end of
CY11, there was heavy insider buying which was followed by news flow on
regulatory issues gradually getting resolved. We assign an AMBER FLAG.

September 16, 2014

Ambit Capital Pvt. Ltd.

Significant insider transaction prior


to key events

Page 96

Aurobindo Pharma
Revenue Mix
Year ended 31 Mar (` mn)

FY13

FY14

FY15E

FY16E

FY17E

USA

17,526

34,028

42,416

55,495

74,175

ARV

7,503

8,402

9,591

11,029

12,132

Europe

4,679

6,721

33,745

34,060

37,204

Formulations

ROW

4,164

4,634

5,060

5,566

6,122

33,872

53,785

90,812

106,149

129,633

SSP

7,652

9,778

10,676

11,210

11,770

Cephs

9,373

8,755

10,200

10,500

10,500

8,337

10,110

10,537

11,591

12,750

25,362

28,643

31,413

33,301

35,020

Total formulations
API

ARVs and others


Total API
Dossier Income

760

165

150

150

150

59,994

82,593

122,375

139,600

164,803

FY13

FY14

FY15E

FY16E

FY17E

Net revenues

58,553

80,998

119,928

136,808

161,507

Material Cost

29,908

36,060

58,393

62,238

68,857

General Expenses

17,670

21,059

31,086

37,914

45,284

Total

Source: Company, Ambit Capital research

Income statement
Year to March (in ` mn)

R&D Expenses

2,085

2,551

5,397

6,156

7,268

Core EBITDA

8,891

21,328

25,052

30,499

40,098

Depreciation

2,487

3,125

3,701

4,226

4,264

Interest expense

1,316

1,087

1,071

846

621

Adjusted PBT

4,303

15,334

20,480

25,627

35,413

Tax

827

3,635

4,710

5,894

8,145

3,501

11,737

15,770

19,733

27,268

FY13

FY14

FY15E

FY16E

FY17E

Total Assets

61,202

77,503

90,949

101,450

118,826

Fixed Assets

28,574

30,314

32,613

35,887

41,623

Current Assets

43,982

64,386

82,027

92,070

107,830

223

198

198

198

198

61,202

77,504

90,949

101,450

118,826

Reported net profit

Source: Company, Ambit Capital research

Balance sheet
Year to Mar (in ` mn)

Investments
Total Liabilities
Shareholders' equity

291

292

292

292

292

Reserves & surplus

25,766

37,210

52,655

70,656

95,532

Total networth

26,058

37,502

52,946

70,948

95,823

Total debt

34,355

37,691

35,691

28,191

20,691

Current liabilities

10,685

16,037

22,531

25,347

29,467

680

2,054

2,054

2,054

2,054

Deferred tax liability

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 97

Aurobindo Pharma
Cash flow statement
Year to March (In ` mn)

FY13

FY14

FY15E

FY16E

FY17E

PBT

4,303

15,334

20,480

25,627

35,413

Depreciation

2,487

3,125

3,701

4,226

4,264

Tax

(1,192)

(3,440)

(4,710)

(5,894)

(8,145)

Net Working Capital

(4,216)

(10,591)

(10,662)

(4,207)

(10,002)

3,311

6,471

10,731

20,398

21,952

(2,676)

(3,741)

(6,000)

(7,500)

(10,000)

CFO
Capital Expenditure
Investment

233

(236)

Other investments

(21)

(4,211)

200

200

200

(2,463)

(8,187)

(5,800)

(7,300)

(9,800)

CFI
Issuance of Equity

35

Inc/Dec in Borrowings

1,747

1,737

(3,071)

(8,346)

(8,121)

Net Dividends

(674)

(596)

(1,384)

(1,732)

(2,393)

CFF

1,081

1,176

(4,455)

(10,077)

(10,514)

Net change in cash

1,928

(540)

476

3,021

1,638

Closing cash balance

2,085

1,786

2,270

5,291

6,929

Year to March

FY13

FY14

FY15E

FY16E

FY17E

EPS

12.0

40.3

54.1

67.7

93.5

Book Value ( per share)

89.5

128.7

181.6

243.4

328.7

P/E (x)

72.4

21.6

16.1

12.9

9.3

Other Financing activities

Source: Company, Ambit Capital research

Valuation Parameters

P/BV (x)
EV/EBITDA(x)

9.7

6.8

4.8

3.6

2.6

32.1

13.6

11.5

9.1

6.7

EV/Sales (x)

4.9

3.6

2.4

2.0

1.7

EV/EBIT (x)

50.8

17.6

13.3

10.4

7.4

CFO/EBITDA (x)

0.4

0.3

0.4

0.7

0.5

Gross Block turnover (x)

2.1

2.8

3.8

4.0

4.2

Working Capital Turnover (x)

1.3

1.3

1.5

1.4

1.5

Year to March

FY13

FY14

FY15E

FY16E

FY17E

Revenue growth

26.5

38.3

48.1

14.1

18.1

Core EBITDA growth

45.7

139.9

17.5

21.7

31.5

NA

236.5

34.8

25.1

38.2

Source: Company, Ambit Capital research

Ratios

APAT growth
EPS growth

NA

234.9

34.4

25.1

38.2

22.0

13.2

15.2

26.3

20.9

EBIT margin

9.6

20.3

18.0

19.4

22.3

Net profit margin

5.9

14.4

13.1

14.4

16.9

ROCE (%)

9.8

24.2

26.3

28.2

33.4

Core EBITDA margin

Reported RoE (%)

14.2

36.9

34.9

31.9

32.7

Debt Equity ratio (X)

1.3

1.0

0.7

0.4

0.2

Current Ratio

4.1

4.0

3.6

3.6

3.7

Source: Company, Ambit Capital research

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 98

Aurobindo Pharma

Institutional Equities Team


Saurabh Mukherjea, CFA

CEO, Institutional Equities

(022) 30433174

saurabhmukherjea@ambitcapital.com

Research
Analysts

Industry Sectors

Desk-Phone E-mail

Nitin Bhasin - Head of Research

E&C / Infra / Cement / Industrials

(022) 30433241

nitinbhasin@ambitcapital.com

Aadesh Mehta

Banking / Financial Services

(022) 30433239

aadeshmehta@ambitcapital.com

Achint Bhagat

Cement / Infrastructure

(022) 30433178

achintbhagat@ambitcapital.com

Aditya Khemka

Healthcare

(022) 30433272

adityakhemka@ambitcapital.com

Ashvin Shetty, CFA

Automobile

(022) 30433285

ashvinshetty@ambitcapital.com

Bhargav Buddhadev

Power Utilities / Capital Goods

(022) 30433252

bhargavbuddhadev@ambitcapital.com

Dayanand Mittal, CFA

Oil & Gas / Metals & Mining

(022) 30433202

dayanandmittal@ambitcapital.com

Deepesh Agarwal

Power Utilities / Capital Goods

(022) 30433275

deepeshagarwal@ambitcapital.com

Gaurav Mehta, CFA

Strategy / Derivatives Research

(022) 30433255

gauravmehta@ambitcapital.com

Karan Khanna

Strategy

(022) 30433251

karankhanna@ambitcapital.com

Krishnan ASV

Real Estate

(022) 30433205

vkrishnan@ambitcapital.com

Pankaj Agarwal, CFA

Banking / Financial Services

(022) 30433206

pankajagarwal@ambitcapital.com

Paresh Dave

Healthcare

(022) 30433212

pareshdave@ambitcapital.com

Parita Ashar

Metals & Mining / Oil & Gas

(022) 30433223

paritaashar@ambitcapital.com

Rakshit Ranjan, CFA

Consumer / Retail

(022) 30433201

rakshitranjan@ambitcapital.com

Ravi Singh

Banking / Financial Services

(022) 30433181

ravisingh@ambitcapital.com

Ritesh Gupta, CFA

Midcaps Chemical / Retail

(022) 30433242

riteshgupta@ambitcapital.com

Ritesh Vaidya

Consumer

(022) 30433246

riteshvaidya@ambitcapital.com

Ritika Mankar Mukherjee, CFA

Economy / Strategy

(022) 30433175

ritikamankar@ambitcapital.com

Ritu Modi

Automobile

(022) 30433292

ritumodi@ambitcapital.com

Sagar Rastogi

Technology

(022) 30433291

sagarrastogi@ambitcapital.com

Sumit Shekhar

Economy / Strategy

(022) 30433229

sumitshekhar@ambitcapital.com

Tanuj Mukhija, CFA

E&C / Infra / Industrials

(022) 30433203

tanujmukhija@ambitcapital.com

Utsav Mehta

Technology

(022) 30433209

utsavmehta@ambitcapital.com

Sales
Name

Regions

Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales

UK

Deepak Sawhney

India / Asia

(022) 30433295

deepaksawhney@ambitcapital.com

Dharmen Shah

India / Asia

(022) 30433289

dharmenshah@ambitcapital.com

Dipti Mehta

India / USA

(022) 30433053

diptimehta@ambitcapital.com

Hitakshi Mehra

India

(022) 30433204

hitakshimehra@ambitcapital.com

Nityam Shah, CFA

USA / Europe

(022) 30433259

nityamshah@ambitcapital.com

Parees Purohit, CFA

UK / USA

(022) 30433169

pareespurohit@ambitcapital.com

Praveena Pattabiraman

India / Asia

(022) 30433268

praveenapattabiraman@ambitcapital.com

Sajid Merchant

Production

(022) 30433247

sajidmerchant@ambitcapital.com

Sharoz G Hussain

Production

(022) 30433183

sharozghussain@ambitcapital.com

Joel Pereira

Editor

(022) 30433284

joelpereira@ambitcapital.com

Nikhil Pillai

Database

(022) 30433265

nikhilpillai@ambitcapital.com

+44 (0) 20 7614 8374

sarojini@panmure.com

Production

E&C = Engineering & Construction

September 16, 2014

Ambit Capital Pvt. Ltd.

Page 99

Aurobindo Pharma

Explanation of Investment Rating


Investment Rating

Expected return
(over 12-month period from date of initial rating)

Buy

>5%

Sell

<5%

Disclaimer
This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and,
in some cases, in printed form.

Additional information on recommended securities is available on request.


Disclaimer
1. AMBIT Capital Private Limited (AMBIT Capital) and its affiliates are a full service, integrated investment banking, investment advisory and brokerage group. AMBIT Capital is a Stock Broker, Portfolio
Manager and Depository Participant registered with Securities and Exchange Board of India Limited (SEBI) and is regulated by SEBI
2. The recommendations, opinions and views contained in this Research Report reflect the views of the research analyst named on the Research Report and are based upon publicly available information
and rates of taxation at the time of publication, which are subject to change from time to time without any prior notice.
3. AMBIT Capital makes best endeavours to ensure that the research analyst(s) use current, reliable, comprehensive information and obtain such information from sources which the analyst(s) believes to
be reliable. However, such information has not been independently verified by AMBIT Capital and/or the analyst(s) and no representation or warranty, express or implied, is made as to the accuracy or
completeness of any information obtained from third parties. The information or opinions are provided as at the date of this Research Report and are subject to change without notice.
4. If you are dissatisfied with the contents of this complimentary Research Report or with the terms of this Disclaimer, your sole and exclusive remedy is to stop using this Research Report and AMBIT
Capital shall not be responsible and/ or liable in any manner.
5. If this Research Report is received by any client of AMBIT Capital or its affiliate, the relationship of AMBIT Capital/its affiliate with such client will continue to be governed by the terms and conditions in
place between AMBIT Capital/ such affiliate and the client.
6. This Research Report is issued for information only and should not be construed as an investment advice to any recipient to acquire, subscribe, purchase, sell, dispose of, retain any securities. Recipients
should consider this Research Report as only a single factor in making any investment decisions. This Research Report is not an offer to sell or the solicitation of an offer to purchase or subscribe for any
investment or as an official endorsement of any investment.
7. If 'Buy', 'Sell', or 'Hold' recommendation is made in this Research Report such recommendation or view or opinion expressed on investments in this Research Report is not intended to constitute
investment advice and should not be intended or treated as a substitute for necessary review or validation or any professional advice. The views expressed in this Research Report are those of the
research analyst which are subject to change and do not represent to be an authority on the subject. AMBIT Capital may or may not subscribe to any and/ or all the views expressed herein.
8. AMBIT Capital makes no guarantee, representation or warranty, express or implied; and accepts no responsibility or liability as to the accuracy or completeness or currentess of the information in this
Research Report. AMBIT Capital or its affiliates do not accept any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of this Research Report.
9. Past performance is not necessarily a guide to evaluate future performance.
10. AMBIT Capital and/or its affiliates (as principal or on behalf of its/their clients) and their respective officers directors and employees may hold positions in any securities mentioned in this Research
Report (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). Such positions in securities may be contrary to or inconsistent with this Research
Report.
11. This Research Report should be read and relied upon at the sole discretion and risk of the recipient.
12. The value of any investment made at your discretion based on this Research Report or income therefrom may be affected by changes in economic, financial and/ or political factors and may go down as
well as up and you may not get back the full or the expected amount invested. Some securities and/ or investments involve substantial risk and are not suitable for all investors.
13. This Research Report is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied in whole
or in part, for any purpose. Neither this Research Report nor any copy of it may be taken or transmitted or distributed, directly or indirectly within India or into any other country including United States
(to US Persons), Canada or Japan or to any resident thereof. The distribution of this Research Report in other jurisdictions may be strictly restricted and/ or prohibited by law or contract, and persons
into whose possession this Research Report comes should inform themselves about such restriction and/ or prohibition, and observe any such restrictions and/ or prohibition.
14. Neither AMBIT Capital nor its affiliates or their respective directors, employees, agents or representatives, shall be responsible or liable in any manner, directly or indirectly, for views or opinions
expressed in this Report or the contents or any errors or discrepancies herein or for any decisions or actions taken in reliance on the Report or inability to use or access our service or this Research
Report or for any loss or damages whether direct or indirect, incidental, special or consequential including without limitation loss of revenue or profits that may arise from or in connection with the use
of or reliance on this Research Report or inability to use or access our service or this Research Report.
Conflict of Interests
15. In the normal course of AMBIT Capitals business circumstances may arise that could result in the interests of AMBIT Capital conflicting with the interests of clients or one clients interests conflicting with
the interest of another client. AMBIT Capital makes best efforts to ensure that conflicts are identified and managed and that clients interests are protected. AMBIT Capital has policies and procedures in
place to control the flow and use of non-public, price sensitive information and employees personal account trading. Where appropriate and reasonably achievable, AMBIT Capital segregates the
activities of staff working in areas where conflicts of interest may arise. However, clients/potential clients of AMBIT Capital should be aware of these possible conflicts of interests and should make
informed decisions in relation to AMBIT Capitals services.
16. AMBIT Capital and/or its affiliates may from time to time have investment banking, investment advisory and other business relationships with companies covered in this Research Report and may
receive compensation for the same. Research analysts provide important inputs into AMBIT Capitals investment banking and other business selection processes.
17. AMBIT Capital and/or its affiliates may seek investment banking or other businesses from the companies covered in this Research Report and research analysts involved in preparing this Research
Report may participate in the solicitation of such business.
18. In addition to the foregoing, the companies covered in this Research Report may be clients of AMBIT Capital where AMBIT Capital may be required, inter alia, to prepare and publish research reports
covering such companies and AMBIT Capital may receive compensation from such companies in relation to such services. However, the views reflected in this Research Report are objective views,
independent of AMBIT Capitals relationship with such company.
19. In addition, AMBIT Capital may also act as a market maker or risk arbitrator or liquidity provider or may have assumed an underwriting commitment in the securities of companies covered in this
Research Report (or in related investments) and may also be represented in the supervisory board or on any other committee of those companies.
Additional Disclaimer for U.S. Persons
20. The research report is solely a product of AMBIT Capital
21. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report
22. Any subsequent transactions in securities discussed in the research reports should be effected through J.P.P. Euro-Securities, Inc. (JPP).
23. JPP does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports.
24. The research analyst(s) preparing the research report is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that therefore the analyst(s) is/are
not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations
regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.
Additional Disclaimer for Canadian Persons
25. AMBIT Capital is not registered in the Province of Ontario and /or Province of Qubec to trade in securities nor is it registered in the Province of Ontario and /or Province of Qubec to provide advice
with respect to securities.
26. AMBIT Capital's head office or principal place of business is located in India.
27. All or substantially all of AMBIT Capital's assets may be situated outside of Canada.
28. It may be difficult for enforcing legal rights against AMBIT Capital because of the above.
29. Name and address of AMBIT Capital's agent for service of process in the Province of Ontario is: Torys LLP, 79 Wellington St. W., 30th Floor, Box 270, TD South Tower, Toronto, Ontario M5K 1N2
Canada.
30. Name and address of AMBIT Capital's agent for service of process in the Province of Montral is Torys Law Firm LLP, 1 Place Ville Marie, Suite 1919 Montral, Qubec H3B 2C3 Canada.
Copyright 2014 AMBIT Capital Private Limited. All rights reserved.

September 16, 2014

Ambit Capital Pvt. Ltd.

Ambit Capital Pvt. Ltd.


Ambit House, 3rd Floor
449, Senapati Bapat Marg, Lower
Parel, Mumbai 400 013, India.
Phone: +91-22-3043 3000
Fax: +91-22-3043 3100
CIN: U74140MH1997PTC107598
Page 100
www.ambitcapital.com

Você também pode gostar