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We expect net sales to increase by 24% in FY2010E to Rs35 bn followed by 14% in FY2011E
CDH has the best
to Rs40 bn. We think revenues will be driven by markets in the US and Japan, the consumer upside among
business in India and API. We expect EBITDA margin to remain flat at 19% despite increasing generic stocks we
R&D costs. We expect PAT to increase 44% in FY2010E due to (1) higher other income and cover…pg7
(2) lower effective tax rate due to a new plant in Sikkim. In FY2011E, we expect PAT growth at
15%. We expect PAT to
increase 44% in
Valuation based on sum of the parts leads us to a price target of Rs700 FY2010E and 15% in
We arrive at a 12-month price target of CDH at Rs 700/share based on an SOTP calculation of FY2011E,,,pg18
its various businesses. The Indian finished dosage remains the most important segment,
accounting for over half the target price. This is followed by the US market and
consumer/animal healthcare business. At our target price, CDH will trade at 14.5X FY2012E.
Early success in the transdermal and oncology segments can drive the price target even higher.
Regulatory risks in the form of price controls by the government are the most important. Other
industry risks relate to (1) pricing reforms in Europe, (2) increasing consolidation of the global Prashant Vaishampayan
generics industry, (3) global generics players using India’s manufacturing cost advantage, and prashant.vaishampayan@kotak.com
Mumbai: +91-22-6634-1127
(4) continuing volatility of the Indian Rupee against the US Dollar.
Priti Arora
priti.arora@kotak.com
Mumbai: +91-22-6634-1551
Company data and valuation summary
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Pharmaceuticals Cadila Healthcare
TABLE OF CONTENTS
Overview ................................................................................................3
Valuation................................................................................................4
Financials..............................................................................................18
Shareholding structure..........................................................................24
The prices in this report are based on the market close of December 3, 2009.
OVERVIEW
We initiate coverage on CDH with a BUY rating and price target of Rs700, which implies 8% upside from the
current price. CDH has a target of US$1 bn revenues in FY2011E. We think US, Japan, consumer business in
India and API will be the key revenue drivers in FY2010-11E. We expect earnings growth of 44% and 15% in
FY2010-11E. We think higher other income and a lower effective tax rate due to a new plant in Sikkim will
drive PAT growth in FY2010E while Rupee appreciation and higher R&D costs will lead to a modest PAT
growth in FY2011E.
Exhibit 1: Forecasts and valuation, March fiscal year-ends, 2008-2012E (Rs mn)
Net sales Adjusted EBITDA Net Profit EPS ROCE ROE P/E
(Rs mn) Growth(%) (Rs mn) Growth(%) (Rs mn) Growth(%) (Rs) (%) (%) (X)
2008 22,660 26.9 5,349 20.7 2,576 10.2 20.5 37.8 26.7 31.6
2009 28,624 26.3 6,971 30.3 3,031 17.7 22.2 39.4 26.9 29.2
2010E 35,429 23.8 8,513 22.1 4,554 50.3 33.4 41.2 32.9 19.4
2011E 40,428 14.1 10,016 17.7 5,274 15.8 38.6 47.7 29.8 16.8
2012E 46,108 14.1 11,801 17.8 6,599 25.1 48.3 58.5 29.9 13.4
Exhibit 2: Cadila—abridged profit model, balance sheet, cash model, March fiscal year-ends, 2008-
2012E (Rs mn)
2008 2009 2010E 2011E 2012E
Profit model
Net revenues 22,660 28,624 35,429 40,428 46,108
EBITDA 4,013 5,407 6,520 7,591 9,034
EBITDA margin (%) 17.7 18.9 18.4 18.8 19.6
Other income 609 778 1,208 1,000 1,000
Depreciation 969 1,118 1,272 1,500 1,650
Net finance cost 350 1,128 964 739 350
PBT 3,303 3,939 5,491 6,351 8,034
Tax 613 666 780 953 1,285
Minority interest 37 83 125 125 150
Extra ordinary expense (income) 69 241 32 — —
Pre acquisition profits/(loss) 8 (82) — — —
Reported net profit 2,576 3,031 4,554 5,274 6,599
Balance sheet
Total equity 10,622 11,914 15,756 19,662 24,550
Total debt 8,377 12,674 10,585 5,055 1,245
Minority interest 194 228 353 478 628
Deferred tax liabilities 1,234 1,316 1,416 1,516 1,616
Total liabiilities and equity 20,427 26,132 28,110 26,712 28,039
Net fixed assets incl CWIP 14,001 17,187 16,826 17,126 17,476
Investments 254 249 187 187 187
Net current assets 5,246 6,179 7,798 8,449 9,426
Cash 926 2,517 3,300 950 950
Total assets 20,427 26,132 28,110 26,712 28,039
Ratios
Diluted EPS (Rs) 20.5 22.2 33.4 38.6 48.3
ROE (%) 26.7 26.9 32.9 29.8 29.9
Debt/equity (X) 79 106 67 26 5
VALUATION
We arrive at a 12-month price target of CDH at Rs 700/share based on SOTP calculation of its various
businesses. We expect CDH’s pre-R&D EBITDA margins to expand in FY2010E, lifted by the finished dosage
business. Indian finished dosage remains the most important segment for CDH, accounting for over half of
the target price. This is followed by the US market and consumer/animal healthcare business. At our target
price, CDH will trade at 14.5X FY2012E. Early success in transdermal and oncology segments can drive the
price target even higher.
Valuation
PAT (Rs mn) P/E (Rs mn)
2011E 2012E (X) 2011E 2012E
India 3,283 4,094 52,225 65,176
Finished Dosage 2,757 3,409
Branded 2,714 3,365 16 43,431 53,836
Generics 42 44 12 505 533
API 23 26 10 233 258
Consumer & others 503 659 16 8,055 10,548
International 2,024 2,504 29,591 36,909
Finished Dosage 1,608 2,080 24,596 31,810
Emerging markets 404 529 16 6,461 8,465
Europe 189 229 15 2,834 3,439
Latin America 134 156 16 2,146 2,492
USA 715 953 15 10,724 14,296
Japan 33 45 16 524 702
Hospira JV 132 168 14 1,907 2,416
API 416 425 4,994 5,099
Other Clients 187 207 12 2,244 2,487
Nycomed JV 229 218 12 2,750 2,612
` Indian finished dosage. This business remains the most important contributor to
valuations, accounting for just over half of the target price. For valuing the Indian
business, we looked at the average multiple of companies when they were largely driven
by Indian operations. We picked Cipla’s multiple of 20X 12-month forward earnings as
the benchmark. The multiple used for other companies is based on their sales mix
between acute and chronic segments (higher multiple for chronic segments) and the rate
of growth of the chronic segment (a higher growth rate gets assigned a higher multiple).
` We have used a multiple of 16X 12-month forward earnings as we note that the acute
segment still accounted for 69% of revenues in FY2009 according to ORG IMS and CDH
has not been able to expand margins over the past couple of years as it continues to build
a marketing presence in terms of brands and sales team. CDH believes that growth will
pick up in the next 12-18 months due to a focus on rural markets, strong new product
introduction in FY2009 and dedicated sales force for new therapeutic areas. We will be
willing to expand our valuation multiple when we see evidence of this.
Sun Ranbaxy Dr Reddy's Cipla Glenmark NPIL Lupin GSK India Cadila
India finished dosage P/E multiple (X) 20.0 14.4 19.0 20.0 15.3 16.0 16.0 21.0 16.0
` US market accounts for about 14% of share price target. We have looked at the
average PE ratio for the leading companies for the past several years. Excluding industry
leader Teva, the average PE multiple from January 2004 –December 2008 is 15.9X 12-
month forward earnings. As a result, we use 15X 12-month forward earnings as the
multiple for the US business of CDH. For European generic operations of all companies,
we have used the same multiple as for the US. We believe European markets would
increasingly show the same characteristics as the US and hence end up with similar
valuations over time.
US
US generics 5-year avg (2004-08) 13.2
US generics 5-year avg (2004-08) (ex Teva) 15.9
US generics avg since Jan' 2004 till date 14.0
US generics avg since Jan' 2004 till date (ex-Teva) 16.7
` Consumer and animal healthcare business in India is the third largest contributor
with 10% share of the price target. CDH is present in consumer products segments with
three strong brands. This business is listed separately under Zydus Wellness. At a current
market price of Rs270 per share, the consumer business contributes Rs54 to CDH’s share
price. We think this business is comparable to the Indian finished dosage business and we
use the same multiple of 16X to value the business. The veterinary business earns half the
revenues coming from the consumer segment. This business has been growing modestly
but increasing product pipeline can add to its growth rate from FY2010E.
` Japan. For the Japanese business, we have used a 5% premium to the multiple that we
have used for the US generic segment. Currently, we think the Japanese business is not
as competitive and commoditized as the US generic business, though this could change in
the next several years.
` Emerging markets. We assign a higher multiple of 16X 12-month forward earnings for
emerging markets. Emerging markets are getting more recognition from companies as
managements are realizing that profitability in these markets is significantly higher than in
developed markets. In addition, these profit streams are more predictable given the
nature of the branded generics business.
` API. We have two different types of revenue streams coming from Indian and
international clients. We note that Indian API business comes last in terms of importance
given to businesses. In some cases, companies sell only surplus quantities in Indian API
market. We use 10X for valuation of this business. In the international business, we see
CDH making a big push on this segment with focus on developed markets. We think
these markets offer better margins with sticky clients and an opportunity to create IP-
driven business model. Within this segment, CDH has very profitable but declining
revenues from its joint venture with Nycomed. We use a 20% higher PE multiple of 12X
for these segments.
High holding of the founder family (75% of the company) may act as a dampener for some
investors but we think the stable growth rate and high RoE make a compelling story.
Exhibit 4: 12 mt olling P/E price band chart Exhibit 5: 12 mt month rolling EV/EBITDA band chart
Closing price 7X 13X (Avg) 18X EV/EBITDA (X) Avg Min Max
500
15
400
13
300 11
9
200
7
100 5
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Source: Kotak Institutional Equities, Bloomberg Source: Kotak Institutional Equities estimates, Bloomberg
Price Mcap Target price Upside Rating EPS growth (%) Sales growth (%) P/E (X)
(INR) (US$ mn) (INR) (%) 2010E 2011E 2010E 2011E 2010E 2011E
Cipla 346 5,746 285 (17.6) ADD 26.5 20.7 10.8 14.4 27.6 22.9
Dr. Reddy's 1,124 4,094 990 (11.9) BUY NM 11.8 8.9 16.6 20.7 18.5
GSK Pharma 1,656 3,042 1,450 (12.4) REDUCE 10.0 10.0 10.0 10.7 27.6 25.1
Lupin 1,405 2,629 1,430 1.8 ADD 23.4 13.1 25.2 16.2 18.9 16.7
Ranbaxy 512 4,432 210 (59.0) REDUCE NM 56.7 (0.2) 13.6 NM 29.0
Sun Pharmaceutical 1,495 6,667 1,400 (6.3) ADD (34.3) 13.1 (10.7) 12.1 25.9 22.9
Cadila 648 1,922 700 8.1 BUY 50.3 15.8 23.8 14.1 19.4 16.8
CDH has the best upside among the generic stocks that we rate BUY or ADD. CDH
has EBITDA margins comparable to its peers. Its RoE is better than most of its peers. Its US
business has not been impacted by regulatory issues that are hurting Ranbaxy, Sun Pharma
and Lupin. Liquidity may be a constraint for some investors as daily traded volumes are not
large. We believe the stock would reward long-term patient investors.
We prefer to use the PE method to value Indian pharmaceutical stocks. This makes
comparisons across time and geography easy. It can also be used to make comparisons
across other sectors. In the past, questions were raised about the comparability of
information with global generic companies due to use of Indian GAAP by Indian companies
while global generic companies reported results using US GAAP. Over time, this issue has
become less relevant, in our view. Significant differences between Indian and US GAAP
related to the preparation of consolidated accounts, treatment of R&D costs and deferred
taxation. Most Indian companies (CDH included) report quarterly results on consolidated
basis, treat R&D costs as revenue expenses and account for deferred taxation completely.
The only difference now relates to option-relating suspension of AS11 that was given by the
government in preparation of FY2009 accounts. In CDH’s case, it is not materially significant
any longer as Rupee appreciation till end September 2009 has reduced the impact on future
earnings. As a result, we now use Indian GAAP estimates for valuation and rating decisions.
Valuation of R&D pipeline. We think a valuation of CDH research pipeline is not justifiable
yet. We would consider assigning a value to a molecule if CDH can enter into any out-
licensing deal and we are able to get independent confirmation of the modelcule’s scientific
and commercial capability.
Exhibit 8: Revenue by business segments, March fiscal year-ends, 2008-2012E (Rs mn)
` In FY2009, branded finished dosage accounted for revenues of Rs12 bn, growing at 9%
yoy. In the branded segment, CDH has a market share of 3.6% and is ranked fifth in India
by sales value. New products accounted for 2.5% growth in sales out of 9% growth
achieved in FY2009. The rest came from price increase and volume expansion.
` The generic segment accounted for revenues of Rs743 mn, growing at 12% yoy.
Source: Company
` 15 brands feature amongst the top 300 in India. The top 10 brands accounted for
36% of revenues while top 20 accounted for more than 50% revenues in FY2009. CDH
has five large brands that account for revenues of more than Rs500 mn each per annum.
These brands are Aten (atenolol – cardiovascular), Deriphyllin (theophylline – anti asthma),
Ocid (omeprazole – anti ulcerant), Pantodac (pataprazole – anti ulcerant) and Atorva
(atovastatin –cholesterol reduction). Aten is the largest brand with revenues of about
Rs800 mn while the other four brands had sales of Rs550 mn each in FY2009. These
brands accounted for revenues of Rs2.8 bn in FY2009 or 23% of the Indian branded
finished dosage segment.
` CDH launched more than 25 new products and 30 line extensions in FY2009. Of
these, 15 products were launched for the first time in India. CDH in-licensed a global
contraceptive brand—Yasmin from Bayer Schering—for launch in India. We think this lays
the foundation of growth for the next couple of years.
` CDH has expanded marketing resources to 3,300 people in India and has added
dedicated task forces for the nutraceutical, rheumatology, diagnostics and COPD (Chronic
Obstructive Pulmonary Disease) segments. In the nutraceutical segment, CDH has
launched a range of iron supplements, antioxidants, tonics, vitamin and multi-vitamin
supplements, proteins, nutrients and calcium supplements. A sales force of 250 people is
marketing these products. In the rheumatology segment, CDH has created a sales force
of 50 people for marketing the high-end products for arthritis. It is now focusing on the
rural market which it thinks may be the next growth driver. CDH has more than 150
employees marketing in rural India.
Exhibit 10: Chronic segment accounts for more than half sales
Category wise break-up of domestic finished dosage sales, FY2008-09, (%)
FY2008 FY2009
Acute 27 28
Chronic 57 57
Biologicals 4 3
Others 12 12
Source: Company
FY2008 FY2011E
Developed market 105 250
Emerging markets 56 120
API 57 80
Total 218 450
Source: Company
CDH services international markets through various subsidiaries and does not fully own these
businesses in some countries.
Source: Company
USA
CDH has been rated one of the fastest growing companies in US by IMS for three years in a
row. It is one of the late Indian entrants in the market and started operations in 2005. It was
70% owned by CDH till end of FY2008. In FY2009, CDH bought out minority shareholders
and it now owns 100% of its US operations.
Revenues from the US have grown to US$87 mm in FY2009 from US$32 mn in FY2007.
CDH has launched 25 products in US in FY2009 and expects to add 8-10 products every
year. It had filed 93 ANDAs with the US FDA by the end of August 2009 and received 48
approvals. This indicates that CDH has a very strong pipeline for this market. It plans to file
12-15 ANDAs every year.
` CDH focused on oral solid dosage for the first few years but it has now started
filing for aerosols (four applications filed already) and parenterals (seven applications
filed already). CDH thinks that its integrated business gives it an advantage as over half of
its products use own API. It added modified release technology products o the portfolio in
FY2009.
Cozaar (losartan) Tablets—CDH is one of the several companies challenging the patents.
Case is still in very early stage of litigation.
Depakote (divalproex) Extended Release Tablets—CDH is one of the many patent challengers
in this case. Abbott has started settling litigation with other challengers such as Teva and
Mylan.
Effexor XR (venlafaxine) ER Capsules—CDH is one of the several patent challengers in this
case. Some companies have settled with Wyeth while litigation continues for others.
Hyzaar (losartan and hctz) Tablets—CDH is involved in this litigation along with Teva and
Sandoz. Litigation status is not clear to us.
Strattera (atomoxetine) Capsules—On August 9, 2007, Eli Lilly brought a suit against
Actavis. On September 5, it amended its Complaint to add Zydus and eight other generic
companies as defendants. All cases involve the same patent, with similar product strengths.
Several defendants filed motions for partial summary judgments, which were granted.
Europe
50
40
30
20
10
0
FY2007 FY2008 FY2009
Source: Company
Two key markets for CDH in Europe are (1) France and (2) Spain.
` France. IMS estimates that the French market is about €2.3 bn p.a. and grew 8% in 2008.
CDH entered this market in 2003 with an acquisition. Initially, it was present in the
generic as well as branded generic segment in France. However, for the past two years,
its focus has been exclusively on generics. It is now present in segments where the market
size is about €1.4 bn. It has launched over 150 presentations in 75 molecules in France so
far. CDH plans to launch about 12-15 products every year in this market.
Revenues from France were €30 mn in FY2009. This was nearly the same level as in
FY2008. FY2009 was a challenging year for CDH in the French market, mainly due to the
price reduction in the range of 10-15% ordered by the government. In addition, there
was a change in the terms of payment that reduced credit period to CDH client
pharmacies. This resulted in one-time correction in demand in Jan-March 2009.
CDH expects the French market to grow at more than 20% in FY2010E. This is a
combined effect of changes in FY2009 that led to a low base and patent expiration for
major molecules. Margin expansion in this market can come from shifting manufacturing
to CDH facilities in India. To achieve this, site variation filings are necessary. By now, CDH
has filed 45 such applications with the authorities. CDH now supplies over 30% of its
sales in France from its manufacturing sites in India. This will drive up the profitability of
this market.
We think the French market is likely to see structural changes following a series of
measures announced in September 2009. The government has launched a voluntary
scheme under which doctors strive to achieve pre-defined targets with a commitment to
prescribe generic versions where available. Government expects to save €200 mn in 2010
by using generic versions of Plavix (blood thinner from Aventis). CDH expects to
participate in generic Plavix opportunity. In the past, the French government had not
taken aggressive steps to promote generic usage by doctors. This led to lower penetration
of generic medicines in France compared to UK or Germany. We think this is about to
change.
` Spain. It is the fifth largest generic market in Europe with revenues of €700 mn p.a.
Generic medicines accounted for 7% of value and 16% of volumes in Spain in 2008. This
suggests low penetration of generics in Spain compared to UK or Germany.
CDH acquired Laboratorios Combix in July 2008. It was a marketing organization with
product portfolio of 17 molecules. Revenues in FY2009 were nearly €2 mn. CDH is
following a strategy similar to French market by aggressively shifting the production to
Indian facilities. It has now launched 24 products in this markets and plans to expand its
portfolio as it believes there is a good business opportunity in this less penetrated generic
market.
Japan
IGPA (International Generic Pharmaceutical Alliance) estimates that the Japanese generic
market is US$3 bn p.a. growing at ~12%. Generic penetration in this market is limited to
~5% in value terms and 17% in volume terms.
CDH set up a fully owned subsidiary and also acquired Nippon Universal Pharmaceutical
(NUP) which had marketing approvals and a small manufacturing facility. Revenues from
Japan were Rs219 mn (US$7 mn) in FY2009. CDH has big plans for this market and plans to
increase sales forces and in-license products from other generic companies. It launched 20
such in-licensed products in Japan in FY2009.
Latin America
CDH is focused on Brazil in Latin America. Brazil has two pharmaceutical markets in the
country. The larger of the two is the branded segment with US$10 bn revenues p.a. The
generic segment is smaller, with US$2 bn revenues p.a. The growth rate for both these
markets is estimated to be 15-18% in local currency terms.
CDH addresses the branded generic segment through Quimica e Farmaceutica Nikkho do
Brasil (Nikkho) and the generic segment through Zydus Healthcare Brasil. CDH revenues in
Brazil were BRL68 mn in FY2009. The generic subsidiary had filed 40 products at end March
2009, of which 19 were approved and 12 launched in the market. CDH expects to grow its
sales by 20% p.a. for the next few years, but we have built more conservative growth into
our model.
Nikkho was acquired in FY2008. It has a manufacturing facility and strong marketing and
distribution network in Brazil. It is focused on segments such as gynaecology. Given the
challenging business environment in emerging markets in late 2008, CDH completed a staff
optimization program in FY2009, we expect this to lead to an increase in production and
sales in FY2010. Nikkho has a portfolio of ~20 brands which has been expanded with the
launch of several new brands from a pipeline of existing brands and few acquired brands.
12 KOTAK INSTITUTIONAL EQUITIES RESEARCH
Cadila Healthcare Pharmaceuticals
Emerging Markets
CDH has a presence in over 20 emerging markets. These markets are in Asia Pacific, Africa,
Middle East and CIS region. CDH believes it is among the leading companies in Sri Lanka,
Mynmar, Uganda and Sudan. CDK is now focusing on Russia, South Africa, Taiwan and
Philippines. CDH revenues from these markets have increased to US$40 m in FY2009 from
US$20 mn in FY2007.
In June 2008, CDH acquired 70% stake in Simayla Pharma (SP) in South Africa. The
remaining 30% stake is held by company founder Ben Classen. SP had revenues of South
African rand (ZAR) 19 mn (about Rs100 mn ) in 2007. This grew to ZAR41 mn in 2008. CDH
reported revenues of Rs353 mn in FY2009 from this market.
With the public sector providing healthcare for up to 80% of the population, there is large
potential for growth in the generic sector as the South African government focuses on
improving healthcare access while cutting healthcare costs. Industry estimates indicate
potential generic sector CAGR of 19%, touching US$1.3 bn and likely to account for 30%
of the total pharma market by 2011E.
SP markets more than 58 SKUs with 62% of its products falling in the chronic segment and
38% in the acute segment. IMS reports that 18 of the molecules marketed by Simalya
feature in the top 50 new product launches. The products marketed fall in the
cardiovascular, anti-infective, respiratory, CNS, gastrointestinal and women’s healthcare
segments. Since this is the focus areas for CDH, there is a synergistic fit.
Over the next three years, the group plans to launch a total of 50 products in the market. A
strong product pipeline for South Africa is already in place with 49 filings, of which 21 have
been approved for marketing. The products will be manufactured at CDH finished dosages
manufacturing hub at Ahmedabad. This facility has been approved by the Medicines Control
Council (MCC), the regulatory agency of South Africa. SP would market CDH products in
Namibia, Angola, Botswana, Swaziland and Mozambique.
` Sugar Free is a low calorie sweetener based on aspartame. It was launched in 1988 with
the Indian diabetic patient in mind. It has now expanded the customer group to health-
conscious Indians of all ages. CDH has also launched sucralose based variant under brand
name “Sugar Free Natura”. In FY2009, brand revenues crossed Rs770 mn, up 16% yoy.
CDH believes that growth drivers were consumer-relevant innovations, marketing
initiatives, focused advertising. Sugar Free is the market leader in the artificial sweeteners
category in India with over 80% market share.
` Ever Yuth is in the niche range of skincare products. It covers soap-free face washes, face
masks and scrubs. It is ranked first in the scrub and peel-off segments and is the second
largest face wash in Indian brand. Brand revenues were Rs500 mn in FY2009, up 60%
yoy. This growth was possible due to changes in its packaging to give it a contemporary
look, focused visibility drive across markets and outlets. Economic slowdown in India
impacted modern retail formats which are an important outlet for the brand. CDH is
addressing these issues in FY2010E.
` Nutralite is a leading table spread margarine in India. Nutralite is made from pure refined
vegetable fats which are free from trans fats and hydrogenated fats. India is traditionally
a large butter consuming market but butter substitutes are now gaining acceptance. CDH
expects more players to enter this segment in the next couple of years which could
expand the market further. Brand revenues were Rs660 mn in FY2009, up 19% yoy.
Revenues from APIs increased to Rs3.4 bn in FY2009 from Rs2 bn in FY2006. CDH is now
focusing on the high-margin finished dosage segment so the relative importance of API
business has declined. This segment accounted for 15% of revenues in FY2006 but has
declined to 12% in FY2009.
In FY2009, growth was driven by Latin America and the Middle East. US revenues were up
93% yoy and Indian revenues declined 16%. CDH gained from depreciation of the Indian
Rupee in FY2009, but lost due to higher crude oil prices and restricted supplies from China
which is a low price supply source. CDH continues to focus on US market and filed 14 DMFs
during the year.
In 1HFY10, CDH reported revenues of Rs1.3bn from clients excluding Nycomed, up 27% yoy.
This was achieved by launching generic Plavix in European markets. CDH thinks this
opportunity will continue for another 4-6 quarters and the size of opportunity will increase
with France opening up in 2010E.
Zydus Hospira Oncology (50-50 JV with Hospira). This company will manufacture
oncological injectible products which will be marketed by the partners in pre-determined
countries. A dedicated facility has been set up in Ahmedabad and commercial
manufacturing and supplies of three products will start in FY2010E. This is meant for the
European market. In FY2011E, the number of products will be increased and sales to US will
likely start. FY2011E will be the first full year where impact of this business will be felt on
earnings.
Zydus BSV Pharma (50-50 JV with Bharat Serum and Vaccines Ltd). This company was set
up to manufacture and market a non-infringing and proprietary Novel Drug Delivery System
(NDDS) of an approved anti-cancer product (liposomal doxorubicin) for the global market.
The product has been approved by the Drug Controller General of India (DCGI) for India. A
new facility is coming up near Ahmedabad and CDH has manufactured exhibit batches for
preparing ANDA under a contract manufacturing arrangement. While revenues are likely to
begin in FY2010E, we have not shown them separately in our estimates as we do not expect
significant revenues in the first couple of years.
NCE research
CDH has 335 scientists working in its drug discovery laboratory based in Ahmedabad at a
cost of US$10 mn in FY2009. CDH is focusing on dyslipidemia, diabetes, obesity and
inflammation. CDH has six molecules at various stages of research in India and its molecule
ZYT1 for treatment of dyslipidemia is awaiting US FDA approval for starting clinical trials.
CDH has signed a drug discovery and development agreement with Eli Lilly (LLY) focused on
cardiovascular research. The collaborative research program may continue for up to six years.
CDH will discover and develop potential molecules against novel targets. CDH will initiate
the drug discovery, lead identification and optimization and conduct preclinical studies and
clinical trials up to Phase II Human Proof-of-Concept. LLY will provide chemical starting
points as well as expertise and feedback regarding toxicology, ADME, chemistry, biology,
clinical and regulatory aspects.
LLY will have the option to license any resulting molecules at different stages. CDH would
receive potential milestone payments of up to US$300 mn and royalties on sales upon the
successful launch of a product derived from this program. We are not assigning any value to
the research efforts of CDH.
In November 2008, CDH acquired Etna Biotech from Crucell. Etna was the dedicated
research and development wing of Crucell. Etna Biotech is based in Catania, Italy. It focuses
on research and development of vaccines. Currently, Etna Biotech has several innovative
technologies and vaccines at different development stages in its pipeline. Prominent among
those are programs for developing vaccines against Hepatitis using the Virosome vaccine
technology platform and against Malaria and HPV using the Measles technology platform.
The vaccines segment has limited competition and there are very high entry barriers in the
field. We have not factored any revenues from this acquisition in the absence of details from
CDH.
KEY RISKS
The most important risks are regulatory risks in form of price control by the government. Other industry risks
relate to (1)attempts to increase penetration of generic sector accompanied with pricing reforms in Europe,
(2) increasing consolidation of global generic industry, (3) use of the Indian cost advantage by global generic
players and (4) continuing volatility of the Indian Rupee against the US Dollar.
A large contribution to profits by Nycomed JV. CDH earned revenues of Rs998 mn from
API and intermediates sold to Nycomed and profit of Rs683 mn in FY2009. This accounted
for 21% of CDH consolidated PAT before exceptional items. The share of Nycomed JV was
probable higher in the past. This JV supplies raw material for pantaprzole, which is facing
patent expiry across the world. We forecast declining revenues and PAT from this JV from
FY2010E. We forecast sales from Nycomed JV to decline by 11% in FY2010E and 25% in
FY2012E in local currency terms. Increase in the portfolio of products supplied to Nycomed
may dilute the negative impact on CDH.
Chasing too many new ideas. CDH is entering new businesses and markets very
aggressively over the next three years. Some of these markets such as South Africa and
Spain are very different from the markets that CDH has operated in the past. This poses the
risk of execution, compliance and regulatory changes in these markets. Hospira JV has
started earning revenues from 1Q FY2010 and Bharat Serum JVs may follow soon. These are
CMO with the major client being the JV partner. CDH has experience with Nycomed for
intermediate and API manufacturing, but challenges with finished dosage manufacturing run
different risks. There is a risk that management is spreading itself too thin by starting
toomany new initiatives at the same time.
Lack of diversification among the markets Indian finished dosage business accounted for
56% of revenues in FY2009 while international markets accounted for 44%. Three
markets—US, Latin America and Europe—account for 60% of international revenues. The
risk of over dependence on few markets is being addressed by CDH through its business
strategy of identifying and penetrating other markets across the globe. CDH also pursues a
policy of growing in critical markets of the world through the M&A route provided the
acquisition offering strategic fit to the operations. CDH has added Spain, South Africa and
Japan to its portfolio.
Portfolio concentration in India. CDH has launched many new brands and line extensions
over the last two years. However, it is still dependent on top five brands. These brands
accounted for revenues of Rs2.8 bn in FY2009 or 23% of Indian branded finished dosage
segment. Top 20 brands account for more than half the sales in India.
Risks related to generic business in developed markets. CDH faces two key risks in
markets such as the US and France—(1) risk of price erosion of generics which is countered
through product portfolio selection, focus on value added and complex products that face
lower competition, strict control over cost, leveraging its strengths in backward integration
and economies of scale and (2) risk of revenue concentration. CDH has managed the risks
well by building a diversified portfolio in US with a product basket of 23 and 75 molecules
launched in France.
Less than 100% stake in some international operations. CDH entered markets such as
US and South Africa by owning a 70% stake in the operations. The remaining stake in US
operation was held by Joe Renner who was CEO of the US operation and was taken over by
CDH in FY2009. In South Africa, the remaining 30% stake is held by company founder Ben
Classen. CDH has the call option to acquire the remaining stake at the end of third and fifth
year of operation at a price to be determined as per the agreement.
Risks in industry
Government intervention in pricing decision. The pharmaceutical industry in India and
in other parts of the world faces the risk of government intervention in prices. In the recent
past, Indian government wanted to increase the scope of price control but the Cabinet was
divided on this issue, and hence no final decision was announced by the previous Congress
government. A new Congress-led government has taken office in May 2009 and we may
hear new pricing plans in the next few months.
Availability of India cost advantage for global players. The cost advantage of Indian
generics has spread across the industry over the time with global generic companies coming
into India. Daiichi’s acquisition of Ranbaxy, Mylan’s acquisition of majority stake in Matrix,
Actavis’ acquisition of Sanmar’s API division are some of the inbound deals. We see every
generic company capturing the ‘Indian cost advantage’ in its supply chain though alliances
or investments in India.
Currency management and foreign exchange-related risk. The Indian Rupee has been
very volatile against US$ since 2008. CDH has significant exposure to the US market and the
currency movement has impacted their revenues. CDH has responded with aggressive
hedging via forward contracts and derivatives, denominating imports in US$ and increasing
raw material purchasing from China.
Our forecasts are based on Rs/US$ rate of Rs 47.25 for FY2010E and Rs46 for FY2011E.
Rupee appreciation has taken a toll on the results of many companies, leading to lower
revenues in Rupee terms and lower EBITDA margins. Those having exposure to Europe have
been less impacted.
CDH’s accounting procedure for the exchange rate differences arising on the long term
foreign currency monetary item is as recently notified by the government. It has adjusted the
exchange rate differences arising from long-term loans for funding of the assets to the cost
of fixed assets. In all other cases, the exchange rate difference is transferred to a separate
account named ‘foreign currency monetary items translation difference account’. This
reserve amounting to Rs438 mn will be written-off by end of FY2011E. Our model includes
these expenses equally in FY2010-11E. Change in accounting system lowered the PAT of
FY2009 by Rs79 mn net of taxes.
Chinese competition impacting prices for APIs. India is seeing increasing competition
from China in the API space. This is leading to price reduction, especially in emerging
markets. Currently China is behind India in finished dosages segment in developed markets,
but we expect increasing competition over the next 3-5 years. During FY2009, prices of APIs
increased due to higher input costs (petroleum prices) and non-availability of material from
Chinese sources due to closure of factories ahead of Olympics in August 2008. We expect
prices to correct in FY2010E.
FINANCIALS
We forecast CDH net sales to increase 24% in FY2010E followed by 14% in FY2011E. We think the key
revenue growth drivers are—US, Japan, Consumer business in India and API. We expect revenues from the
Hospira JV to start in FY2010E. We expect a 3% Rupee appreciation to create a headwind in FY2011E. We
expect EBITDA margin to remain flat near 19% in FY2010-11E despite increasing R&D costs. We expect PAT to
increase 44% in FY2010E followed by 15% growth in FY2011E. We think higher other income and a lower
effective tax rate due to a new plant in Sikkim will drive PAT growth in FY2010E.
Exhibit 15: Cadila—profit model, March fiscal year-ends, 2007-2012E (Rs mn)
Primary EPS (using wtd. avg. shares) 18.6 20.5 22.2 33.4 38.6 48.3
Diluted EPS 18.6 20.5 22.2 33.4 38.6 48.3
Year-end no. of shares (mn) 125.6 125.6 136.5 136.5 136.5 136.5
Weighted avg. no. of shares (mn) 125.6 125.6 136.5 136.5 136.5 136.5
Fully diluted no. of shares (mn) 125.6 125.6 136.5 136.5 136.5 136.5
Margins (%)
EBITDA margin 17.3 17.7 18.9 18.4 18.8 19.6
PBT margin 15.3 14.6 13.8 15.5 15.7 17.4
Net profit margin (w/o extra-ordinaries) 13.1 11.7 11.1 12.9 13.0 14.3
Effective tax rate (%) 11.8 18.6 16.9 14.2 15.0 16.0
` API revenues to clients other than Nycomed. We expect API revenues to clients other
than Nycomed to increase to US$60 mn in FY2010E from US$45 in FY2009 mn due to
clopidogrel opportunity in Europe where CDH is a key player. These sales are likely to
continue for the next 4-6 quarters. We expect modest growth in FY2011E at US$64 mn
from US$60 mn in FY2010E.
` India branded finished dosage. This segment has grown 11% in 1HFY10 but CDH
expects growth rate to increase in 2HFY10E. We model in 12% growth for FY2010E,
implying 13% growth in 2HFY10E. We expect Indian finished dosage sales growth to
increase to 14% from 12% in FY2010E.
In FY2011E, we forecast a 40-bps increase in EBITDA margin to 18.8% while EBITDA margin
before R&D costs will rise to 24.8%. We model in R&D costs of 6% of net sales in FY2011E.
High contribution of the API business in FY2010E makes us more cautious since prices and
margin in this segment are more volatile than dosage business. We would look for margin
expansion in the US, Japan and India branded finished dosage segment.
In 1HFY10, capex was Rs1.4 bn. CDH is guiding for capex of Rs2 bn for FY2010-11E. CDH
plans to spend on (1) API plant for clopidogrel, (2) vaccines joint venture, (3) biotechnology-
based products, (4) transdermal products and (5) shifting production of consumer products
to Sikkim.
Debt position
Gross debt increased to Rs12.7 bn in FY2009 from Rs8.3 bn in FY2008. The increase in debt
was mainly to finance acquisitions. During FY2009, CDH increased its stake in the US
subsidiary from 70% to 100% and bought businesses in South Africa and Spain. The
amount spent on acquisitions was Rs2.8bn. Out of the total debt, Rs7 bn was foreign
currency denominated and 55% of this debt was hedged. This debt level has declined
marginally to Rs12.2 bn at end of September ’09.
We expect gross debt to decline to Rs10.6 bn in March 2010E and further fall to Rs5.1 bn by
March 2011E unless CDH enters in a substantial M&A deal.
Exhibit 16: Cadila—balance sheet, March fiscal year-ends, 2007-2012E (Rs mn)
Assets
Inventories 3,896 4,729 6,012 7,440 8,490 9,683
Sundry debtors 2,784 3,555 4,845 6,090 6,944 7,919
Loans and advances 2,201 2,013 2,237 2,200 2,000 2,000
Cash and cash equivalents 990 926 2,517 3,300 950 950
Current assets 9,871 11,223 15,611 19,030 18,384 20,552
Gross block 13,527 19,118 22,870 24,870 26,870 28,870
Less: Accumulated depreciation 4,968 6,518 7,572 8,844 10,344 11,994
Net fixed assets 8,559 12,600 15,298 16,026 16,526 16,876
Capital -WIP 1,192 1,294 1,555 800 600 600
Investments 261 254 249 187 187 187
Preoperative pending allocation 32 107 334 — — —
Total uses of funds 19,915 25,478 33,047 36,042 35,697 38,215
Increase in working capital. The impact of new businesses will be felt on revenues as well
as on the working capital. This leads to an additional working capital of Rs0.9 bn in FY2010E
and Rs1.3 bn in FY2011E. We do not think this is alarming as the core working capital
(debtors + inventory – creditors) will remain stable—about 79 days of gross sales.
Capital expenditure of Rs2bn p.a. till FY2011E. The increase in gross block is about Rs2
bn in FY2010-11E, cash spent in FY2010E is much smaller due to large CWIP at the
beginning of the year and pre-operative expenses for new ventures.
Exhibit 17: Cadila—cash model, March fiscal year-ends, 2008-2012E (Rs mn)
Investing
Capex (5,768) (4,240) (911) (1,800) (2,000)
Others 80 (1,092) 500 — —
Cash flow from investing (5,688) (5,332) (411) (1,800) (2,000)
Financing
Equity issue — 54 — — —
Net proceeds from borrowings 3,842 4,297 (2,089) (5,530) (3,811)
Dividends paid (incl. tax) (508) (662) (747) (1,150) (1,367)
Cash flow from financing 3,334 3,689 (2,836) (6,680) (5,178)
2QFY10
2QFY09 1QFY10 2QFY10 3QFY10E 4QFY10E Growth (%, yoy) Growth (%, qoq)
Gross sales 7,586 8,896 9,251 8,966 8,705 22 4
Excise duty (208) (93) (124) (91) (85) NM NM
Net sales 7,379 8,803 9,127 8,875 8,621 24 4
Change in stock (609) (262) (165) — — NM NM
Consumption of materials 2,936 3,090 3,186 2,929 2,845 8 3
Staff cost 926 1,025 1,112 1,150 1,200 20 9
R&D 328 469 474 533 517 45 1
Other exp 2,304 2,677 2,795 2,707 2,629 21 4
Total Expenditure 5,884 6,998 7,401 7,318 7,191 26 6
EBITDA 1,494 1,805 1,726 1,557 1,429 15 (4)
EBITDA pre R&D 1,822 2,274 2,200 2,090 1,947 21 (3)
Other income (incl CMS) 32 275 373 280 280 1084 36
Interest exp. 99 229 206 245 245 107 (10)
FX fluctuations exp/(gain) 114 14 25 — — (78) 79
Depreciation 259 296 311 325 340 20 5
PBT 1,054 1,540 1,557 1,267 1,124 48 1
Tax 103 242 179 190 169 74 (26)
PAT 951 1,298 1,378 1,077 956 45 6
Extra ordinary expense 16 9 23 — — 39 148
Adjustments on consolidation 14 (40) (35) (25) (25) NM NM
PAT post expectionals 949 1,248 1,320 1,052 931 39 6
Source: Company
Public
Insurance FII 7%
companies 3%
6%
Mutual funds
8%
Founder family
75%
“I, Prashant Vaishampayan, hereby certify that all of the views expressed in this report
accurately reflect my personal views about the subject company or companies and its or
their securities. I also certify that no part of my compensation was, is or will be, directly or
indirectly, related to the specific recommendations or views expressed in this report.”
60%
Percentage of companies within each category for which Kotak
Institutional Equities and or its affiliates has provided investment
50%
banking services within the previous 12 months.
40% 36.4% * The above categories are defined as follows: Buy = We expect
31.5% this stock to outperform the BSE Sensex by 10% over the next 12
30% months; Add = We expect this stock to outperform the BSE
Sensex by 0-10% over the next 12 months; Reduce = We expect
21.7%
this stock to underperform the BSE Sensex by 0-10% over the
20%
next 12 months; Sell = We expect this stock to underperform the
9.1% 10.5% BSE Sensex by more then 10% over the next 12 months. These
10% ratings are used illustratively to comply with applicable
2.8% 2.1% regulations. As of 30/9/2009 Kotak Institutional Equities
0.0%
0% Investment Research had investment ratings on 143 equity
securities.
BUY ADD REDUCE SELL
800 22,000
700 20,000
18,000
600
16,000
500 14,000
400 12,000
300 10,000
8,000
200
6,000
100 4,000
- 2,000
Nov-07
Dec-07
Jan-08
Mar-08
Apr-08
Jun-08
Jul-08
Sep-08
Oct-08
Dec-08
Jan-09
Mar-09
Apr-09
Jun-09
Jul-09
Sep-09
Oct-09
Dec-09
Stock
Index
Price
Price
Source: Kotak Institutional Equities Research for ratings and price targets, Bloomberg for daily closing prices.
The price targets shown should be considered in the context of all prior published Kotak Institutional Equities research, which may or may not
have included price targets, as well as developments relating to the company, its industry and financial markets
Analyst coverage
Companies that the analyst mentioned in this document follow
BUY. We expect this stock to outperform the BSE Sensex by 10% over the next 12 months.
ADD. We expect this stock to outperform the BSE Sensex by 0-10% over the next 12 months.
REDUCE. We expect this stock to underperform the BSE Sensex by 0-10% over the next 12 months.
SELL. We expect this stock to underperform the BSE Sensex by more than 10% over the next 12 months.
Other definitions
Coverage view. The coverage view represents each analyst’s overall fundamental outlook on the Sector. The coverage view will consist of one
of the following designations: Attractive, Neutral, Cautious.
Other ratings/identifiers
NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with
applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in
a merger or strategic transaction involving this company and in certain other circumstances.
RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is
not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no
longer in effect for this stock and should not be relied upon.
NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
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