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Company Template.

dot Cadila Healthcare (CDH IN) BUY


Pharmaceuticals
December 04, 2009
INITIATING COVERAGE
Sector view: Attractive
Diversified finished dosage business at attractive valuation. CDH has created Price (Rs): 648
multiple platforms to ensure stable growth over the medium term. We expect France,
US and Japan to drive revenue in the near term. We expect stable EBITDA margin Target price (Rs): 700
despite Rupee appreciation and higher R&D costs in FY2010-11E. Strong RoE, visible BSE-30: 16,926
PAT growth over the next two years and attractive valuations drive our BUY rating.
Currently, CDH offers the best upside among generic companies we cover.

CDH has a revenue target of US$1 bn in FY2011E

CDH is targeting revenues of US$1 bn in FY2011E versus revenues of US$620 mn reported in


FY2009. To achieve its sales target, CDH needs to grow revenues at a CAGR of 18% in Rupee
INSIDE
terms over FY2009-11E. CDH is ranked fifth in India by revenue. International generic sales
At our target price,
accounted for a third of the company’s FY2009 revenues. The company has a presence in
niche consumer segments in India. CDH has invested in NCE research in three segments but CDH would trade at
benefits from these investments are not yet visible. 18X FY2011E
EPS…pg4
Strong growth in FY2010E likely; Rupee appreciation, R&D costs to constrain FY2011E growth

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.

Key risks—regulatory risks remain the most important

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

Company data Stock data High Low Price performance 1M 3M 12M


Rating: BUY 52-week range 668 207 Absolute (%) 12.7 42.2 197.6
Priced at close of: December 3, 2009 Rel. to BSE-30 (%) 4.7 31.2 101.2
Current price (Rs) Capitalisation Forecasts/valuation FY2009 FY2010E FY2011E
648 Market cap (Rs bn) 88 EPS (Rs) 22.2 33.4 38.6
Net debt/(cash) (Rs bn) 10 P/E (X) 29.2 19.4 16.8
Free float (%) 23.8 ROE (%) 26.9 32.9 29.8
Kotak Institutional Equities
Shares outstanding (mn) 136 EV/EBITDA (X) 18.2 15.1 13.0
Research
Source: Company, Kotak Institutional Equities estimates
Important disclosures appear
at the back

For Private Circulation Only. In the US, this document may only be distributed to QIBs (qualified institutional buyers) as defined under rule 144A of the Securities Act of 1933. This document is not for public distribution
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Pharmaceuticals Cadila Healthcare

TABLE OF CONTENTS

Overview ................................................................................................3

Valuation................................................................................................4

Strategy and profile................................................................................8

Key risks ...............................................................................................16

Financials..............................................................................................18

Quarterly performance for FY2010E .....................................................23

Appendix—board of directors and key management personnel;

Shareholding structure..........................................................................24

The prices in this report are based on the market close of December 3, 2009.

2 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

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

Source: Company, Kotak Institutional Equities estimates

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

Source: Company, Kotak Institutional Equities estimates

KOTAK INSTITUTIONAL EQUITIES RESEARCH 3


Pharmaceuticals Cadila Healthcare

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.

SOTP-based price target is Rs700

Exhibit 1: SOTP-based price target is Rs700


SOTP-based price target, March fiscal-year ends, 2011-12E (Rs mn)

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

Total 5,307 6,599 81,816 102,085


Value per share 599 748
Share price target 698

Implied target price multiple (FY2011E) 18.1


Implied target price multiple (FY2012E) 14.4

Source: Kotak Institutional Equities estimates

Valuation: Different PE ratios for different businesses


We have used different PE multiples for different businesses as each business has a different
profitability profile. Three business segments of CDH—Indian finished dosage, US finished
dosage and consumer business in India—account for nearly 75% of its share price target.

` 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).

4 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

` 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.

Exhibit 2: Strength of Indian business


Acute/chronic split of key companies in domestic finished dosage market

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

Acute segment (% of sales) 38 78 71 58 78 73 60 90 69


Chronic segment (% of sales) 62 21 29 42 23 27 40 10 31

Acute segment, yoy growth rate


2006 15 10 19 18 21 21 14 6 18
2007 14 18 11 17 16 0 17 7 20
2008 (MAT Oct' 08) 16 8 4 14 13 6 13 (2) 4
2009 (MAT Jun' 09) 18 8 5 14 15 24 7 5 12
Chronic segment , yoy growth rate
2006 18 17 15 14 28 9 58 1 13
2007 18 29 18 15 39 6 45 5 16
2008 (MAT Oct' 08) 15 18 11 14 36 2 21 (12) 10
2009 (MAT Jun' 09) 14 7 5 15 40 16 25 8 9

Source: Kotak Institutional Equities, ORG IMS

` 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.

Exhibit 3: US and Indian business valuation comparison


Valuation multiples – a historical perspective (X)

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

Source: Kotak Institutional Equities

` 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.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 5


Pharmaceuticals Cadila Healthcare

` 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.

Implied target price multiple is 14X FY2012E estimated earnings


At Rs648, CDH trades at 19X FY2010E and 17X FY2011E our estimated earnings. At the
target price, it would trade at 18.2X FY2011E and 14.5X FY2012E our estimated EPS. We
think CDH can surprise us on the upside if its initiatives for transdermal and oncology
segment begin to yield results in the next 18 months.

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.

Valuations hovered around average levels till June 2009


CDH has traded at an average PE of 13X on 12-month forward earnings since January 2006.
Since 2008, it has traded below this multiple. We think this could be due to the restructuring
of its consumer business, after which there was a perception among investors that minority
shareholders did not get a good deal. In recent past, investors have noticed stable returns
that CDH can generate and the multiple appears to be expanding. On EV/EBITDA measure,
we notice that the average multiple is just under 10X and it has traded below its average in
2008 but valuation has expanded since mid-2009.

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

6 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

Where does CDH fit in our sector universe?

Exhibit 6: Valuation – KIE generics coverage

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

Source: Kotak Institutional Equities estimates

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.

Exhibit 7: KIE generics coverage universe- key operational metrics

EBITDA margin (%) ROCE (%) ROE (%)


FY2009 FY2010E FY2009 FY2010E FY2009 FY2010E
Cipla 19.1 21.7 18.0 18.1 19.9 19.3
Dr. Reddy's 18.3 20.8 12.4 20.5 13.6 23.3
GSKPharma 35.4 36.2 39.5 38.3 31.3 29.7
Lupin 17.2 18.0 21.9 22.3 37.1 35.5
Ranbaxy 5.4 6.2 1.4 2.3 (13.3) 10.9
Sun 44.8 31.9 28.2 12.8 30.2 15.9
Cadila 18.9 18.4 39.4 41.2 26.9 32.9

Source: Kotak Institutional Equities estimates

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.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 7


Pharmaceuticals Cadila Healthcare

STRATEGY AND PROFILE


CDH wants to achieve revenues of US$1 bn by FY2011E and reach US$3 bn revenues by FY2015E. This growth
will be driven by international markets and alliances for manufacturing with innovators. The company ranks
fifth in India by revenue. International generic sales accounted for a third of FY2009 revenues. CDH has a
presence in niche consumer segments in India. CDH has invested in NCE research in three segments but
benefits from these investments are not yet visible.

CDH aims at revenues of over US$1 bn by FY2011E


CDH aims at revenues of over US$1 bn by FY2011E. CDH wants to achieve revenues of over
US$3 bn by FY2015E and be a research-based pharmaceutical company by FY2020E.

Exhibit 8: Revenue by business segments, March fiscal year-ends, 2008-2012E (Rs mn)

2008 2009 2010E 2011E 2012E


India 14,887 16,435 18,544 21,005 23,790
Finished Dosage 11,762 12,880 14,413 16,320 18,493
Branded 11,097 12,137 13,618 15,525 17,698
Generics 665 743 795 795 795
API 506 426 349 366 385
Consumer 1,540 1,956 2,508 2,918 3,371
Animal Health and others 1,079 1,173 1,274 1,402 1,542
International 8,751 12,736 17,277 19,843 22,794
Finished Dosage 6,465 9,676 13,536 16,180 19,057
Emerging markets 1,020 1,865 2,250 2,628 3,154
Europe 1,647 1,980 2,419 2,971 3,417
Latin America 1,230 1,628 1,874 2,110 2,321
USA 2,568 3,984 5,840 7,102 8,522
Japan — 219 316 369 443
Hospira JV — — 837 1,000 1,200
API 2,286 3,060 3,741 3,662 3,737
Other Clients 1,618 2,062 2,817 2,941 3,089
Nycomed JV 668 998 924 721 649

Total 23,638 29,171 35,821 40,848 46,584

Source: Kotak Institutional Equities estimates, Company

Finished Dosage business in India


CDH has a presence in two segments in finished dosage in India—(1) branded and
(2) generic. In 1HFY10, branded finished dosage sales increased by 12% yoy while generic
segment sales grew 15% yoy.

` 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.

8 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

Exhibit 9: Cardiovascular segment is the largest segment


Therapeutic break-up of domestic finished dosage sales, March fiscal year-ends, 2006-2009, (%)

2006 2007 2008 2009


Cardiovascular 22 21 21 21
Gastro Intestinal 17 17 16 16
Female Healthcare 11 11 11 11
Respiratory 10 10 10 11
Anti Infective 11 11 10 11
Pain Management 7 7 6 7
Central Nervous System 2 2 2 3
Diagnostics 3 3 3 2
Biologicals 3 4 4 3
Dermatology 3 2
Others 14 14 14 10
Neutraceuticals 3

Source: Company

` Cardiovascular is the largest segment. Cardiovascular, Gastro intestinal, Female


Healthcare and Respiratory account for ~60% of finished dosage revenues in India. We
believe companies with an increasing focus on chronic segments will do better in India in
future. CDH is one of the companies that fit the bill.

` 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

KOTAK INSTITUTIONAL EQUITIES RESEARCH 9


Pharmaceuticals Cadila Healthcare

Finished Dosage business in international markets


CDH has very ambitious targets for international business and its focus is clearly on finished
dosage business in developed markets. Sales in emerging markets are also expected to
double by FY2011E from FY2008 levels.

Exhibit 11: Focus on developed markets


CDH sales target in international markets, US$ mn

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.

Exhibit 12: International subsidiaries and % owned by CDH


Country Name of the subsidiary % ownership
USA Zydus Pharmaceuticals USA Inc. 100
France Zydus Frnace SAS 100
Spain Laboratories Combix 100
Japan Nippon Universal Pharmaceuticals 100
Brazil Quimica a Pharmaceutica Nikkho 100
Brazil Zydus Healthcare Brazil 100
South Africa Simayla Pharma 70
USA Zydus Noveltech 85
Italy Etna Biotech 100

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.

` Backward integration to API is an advantage in the competitive US market. CDH


manufactures own API for over half the products it sells in US market.

Update on patent challenge pipeline


CDH is involved in the following eight patent challenge cases. We provide a brief update on
the current status of these suits.
Abilify (aripiprazole) Orally Disintegrating Tablets—Case was filed on May 30, 2008. Barr has
filed a patent challenge in March 2007. Cases have been consolidated with other patent
challenges for Abilify tablets. Discovery process was to be completed by June 2009.

10 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

Clarinex (desloratadine) and Clarinex (desloratadine) Orally Disintegrating Tablets—CDH is


one of the several companies to challenge the patents. Schering has been reaching
settlements with many of the challengers in the recent past.

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

Exhibit 13: CDH has made progress in French market


Sales, filings status in France, FY2007-09

60 Gross sales (Euro mn) New filings Site variation filing

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.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 11


Pharmaceuticals Cadila Healthcare

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.

Consumer health business in India


CDH operates its consumer health business through Zydus Wellness (ZW), which is 70%
owned by CDH. The remaining 30% stake is owned by various investors as ZW is listed in
India. CDH reports entire revenues and profits of ZW in its income statement and 30% of
profits attributable to outsiders are shown as minority interest.
There are three large brand families—Sugar Free, Ever Yuth and Nutralite.

` 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.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 13


Pharmaceuticals Cadila Healthcare

Exhibit 14: Consumer business driven by three brands


Consumer business by brand, Rs mn

2009 2010E 2011E 2012E


Sugar Free 778 934 1,074 1,208
EverYuth 500 675 844 1,013
Nutralite 669 870 1,000 1,150
Total 1,947 2,478 2,918 3,371

Source: Kotak Institutional Equities estimates

CDH’s global API and intermediates business


There are three revenue streams in this segment.

1. India-based clients (Rs426 mn in FY2009)

2. Revenues from joint venture with Nycomed (Rs998 mn in FY2009)

3. Other international clients (Rs2 bn in FY2009).

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.

Animal healthcare business


CDH offers a range of products in livestock and poultry segment. FY2009 revenues were Rs1
bn, up 9% yoy. This was a challenging year for the business. Depreciation of the Indian
Rupee increased the cost of materials. The bird flu outbreak in parts of India impacted
demand as well. Seven new products were launched in the year and this helped improve
profitability of the segment. CDH is planning to take this business to international markets
and launch products for pets and companion animals.

Alliances for manufacturing in India


CDH was one of the first companies to exploit cheap manufacturing of chemistry-driven
products in India and created its CMO business with separate alliances with three partners.
In addition, it has 37 other contracts with innovator and generic MNCs with peak revenue
potential of US$48 mn.
Zydus Nycomed Healthcare (50-50 JV with Nycomed). It was established to manufacture
key starting materials for pantoprazole, which is the largest product for Nycomed. The JV
reported revenues of Rs2 bn and PAT of Rs1.3 bn in FY2009. CDH reports its 50% share in
revenues and PAT. This JV accounted for 21% of CDH PAT before extraordinary expenses in
FY2009. Investors have been concerned about potential patent expiry of pantoprazole and
its impact on profits of CDH. CDH has increased the scope of work with its partner and is
now planning to produce API instead of intermediates of pantaprazole. In addition, some
more APIs will be produced by this JV. In FY2009, the company’s manufacturing capacity
was expanded and revenues from this capacity will begin to flow in FY2011E.

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Cadila Healthcare Pharmaceuticals

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.

CDH has acquired a presence in vaccines

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.

Entering new areas with high entry barriers


CDH is preparing to enter global markets in pulmonary, transdermal, injectible and oncology
segments over the next three years. Current annual sales of branded products in these
segments exceed US$100 bn globally. Technologies for manufacturing these products are
difficult and there are a limited number of players in these segments. As a result, profit
margins tend to remain higher for longer than commodity oral products. We will keenly
watch CDH progress in this business.

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Pharmaceuticals Cadila Healthcare

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.

16 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

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.

Regulatory changes in international markets. Most European countries are encouraging


generics though various regulatory measures, but we notice a trend of moving toward a
pure generic market from the branded generic market. This would lead to lower prices, as
seen in Germany, in the short term. However, volume increases may more than compensate
for lower prices in the long term.

Consolidation underway in global generic business. Indian companies are under


increasing pressure to participate in M&A in order to establish scale and presence in global
markets. Due to the heterogeneous nature of each market (particularly in Europe),
acquisition is the quickest way to gain scale in the local market. In the recent past, we have
seen some of the biggest acquisitions in generics industry—Teva- Barr/Ivax, Actavis-
Alpharma, Barr-Pliva and Watson-Andrx. These acquisitions have provided significant scale to
the acquirer and Indian companies are under pressure to step up. This poses the risk of
overpaying for assets. CDH has so far acquired smaller companies in Spain and South Africa.

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.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 17


Pharmaceuticals Cadila Healthcare

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)

2007 2008 2009 2010E 2011E 2012E


Net sales 17,855 22,660 28,624 35,429 40,428 46,108
Operating expenses
Materials (6,372) (7,903) (9,566) (11,622) (13,131) (14,435)
Selling and administration (2,613) (3,430) (4,837) (5,563) (6,369) (7,324)
Employee cost (1,850) (2,469) (3,109) (4,487) (5,160) (5,934)
R&D (1,344) (1,336) (1,564) (1,993) (2,426) (2,767)
Other (2,588) (3,509) (4,141) (5,246) (5,752) (6,615)
Total expenditure (14,767) (18,647) (23,217) (28,909) (32,837) (37,074)
EBITDA 3,088 4,013 5,407 6,520 7,591 9,034
Depreciation and amortisation (823) (969) (1,118) (1,272) (1,500) (1,650)
EBIT 2,265 3,044 4,289 5,247 6,091 7,384
Net finance cost (223) (350) (1,128) (925) (700) (350)
Foreign Currency Monetary Item Expensed (39) (39) —
Other income 697 609 778 1,208 1,000 1,000
Pretax profits before extra-ordinaries 2,739 3,303 3,939 5,491 6,351 8,034
Current tax (287) (521) (582) (680) (853) (1,185)
Deferred tax (37) (92) (84) (100) (100) (100)
Reported net profit 2,415 2,690 3,273 4,711 5,399 6,749
Minority interests 72 37 83 125 125 150
Reported net profit after minority interests 2,343 2,653 3,190 4,586 5,274 6,599
Exceptional items — (69) (241) (32) — —
Pre acquisition profits/(loss) 5 8 (82) — — —
Reported net profit after minority interests and
2,338 2,576 3,031 4,554 5,274 6,599
excep. Items

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

Growth yoy (%)


Revenues 24 27 26 24 14 14
EBITDA 24 30 35 21 16 19
PBT 45 21 19 39 16 26
Net profit (w/o extra-ordinaries) 43 13 20 44 15 25
Diluted EPS 53 10 8 50 16 25

Source: Company, Kotak Institutional Equities estimates

18 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

Sales growth impacted by new businesses and currency assumptions


In FY2010E, we forecast sales growth of 24% in Rupee terms (1HFY10 sales growth was
25%). International businesses of US, Japan and Hospira JV were the key drivers of this
growth and we expect this to continue in 2HFY10E. We are using a US$/Rupee rate of 47.25
and 46 in FY2010-11E versus 46.1 in FY2009. This assumption of 3% appreciation in Indian
Rupee creates a challenge for revenue growth in FY2011E.

` USA. We forecast revenues of US$124 mn in FY2010E growing to US$154 mn in


FY2011E.

` Japan. We forecast revenues of US$7 mn in FY2010E growing to US$8 mn in FY2011E.

` Hospira JV. We expect Hospira JV revenues at Rs837 mn in FY2010E and Rs1 bn in


FY2011E.

` 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.

EBITDA margin constrained by higher R&D costs and Rupee appreciation


In FY2010E, we forecast EBITDA margin of 18.4%, 50 bps lower than FY2009. For 1HFY10,
EBITDA margin has been comparable with a year-ago period. Our cautious view comes from
the Rupee appreciation that our Economist is forecasting for 2HFY10E. We are modeling
revenues using Rs46.1 and Rs45.8 per US$ in the third and fourth quarter of FY2010E. We
are factoring in R&D costs of 5.6% of net sales in FY2010E. This is unchanged from FY2009.

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.

Exhibit 3: 1% change in US$/Rs rate leads to 20bps change in EBITDA margin


EBITDA sensitivity to change in US$/Rs rate
1% depreciation KIE est 1% appreciation
FY2010E FY2011E FY2010E FY2011E FY2010E FY2011E
US$/Rs 47.7 46.5 47.3 46.0 46.8 45.5
Net sales 35,438 40,565 35,429 40,428 35,420 40,290
EBITDA 6,529 7,607 6,520 7,591 6,511 7,574
EBITDA margin (%) 18.42 18.75 18.40 18.78 18.38 18.80

Source: Kotak Institutional Equities estimates

Effective tax rate to decline to 14% in FY2010E and rise thereafter


CDH had provided for an effective tax rate of 17% in FY2009 but this has declined to
13.6% in 1HFY10. We are providing for a 15% tax rate for the next two quarters and
maintaining this rate for FY2011E.
One of the reasons for the decline in tax rate in FY2010E is shifting of production for Indian
market to Sikkim, which has a 10-year tax holiday. In addition, CDH informed us that they
have created a partnership structure for ownership of this plant. As a result, minimum
alternate tax (nearly 18%) applicable only for corporate entities is not applicable to CDH.
SUN Pharma has used similar measures to keep its tax rate well below MAT rate of tax.
KOTAK INSTITUTIONAL EQUITIES RESEARCH 19
Pharmaceuticals Cadila Healthcare

CDH brings working capital down to 71 days’ gross sales in FY2009


CDH managed to reduce the net working capital to gross sales ratio in FY2009 to 71 days
from 73 days in FY2008. Levels of debtors increased possibly due to increasing share of
international business in total revenues. Inventory levels were maintained at the same level
as FY2008. CDH funded an increasing share of its working capital from creditors for goods
and expenses. We forecast steady but small increase in working capital over FY2010-11E.

Capex to remain at ~Rs2 bn p.a.


In FY2009, CDH’s net capital expenditure on tangible assets was Rs2.1 bn, which includes
Rs1.9 bn as goodwill on acquisition. The amount was spent on the finished dosage unit in
Sikkim, vaccines joint venture, Hospira joint venture and biotech production. Goodwill on
acquisition was related to acquisitions in US, South Africa and Spain. This amount will not be
amortized in future but will be tested for impairment at the end of every accounting period.

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.

Accounting for AS11 impact


At the end of March 2009, CDH had suspended implementation of AS11 as allowed by the
Government of India. This meant currency-related impact on long-term assets and liabilities
was routed to balance sheet under foreign currency monetary items translation difference
account amounting to Rs438 mn. This has to be written off by end of FY2011E. Sharp
appreciation of Indian Rupee against US$ by end September 2009 led to lowering of this
account. Going forward, impact on CDH accounts will be minimal if Rupee maintains the
levels reached at end of September 2009 or appreciates further.

Increase in number of shares due to increased stake in Zydus Wellness


During FY2009, the number of shares increased to 136.5 mn from 125.6 mn in FY2008.
This was following increased stake in Zydus Wellness under a scheme of arrangement. 100.9
mn shares were issued under this arrangement and 90 mn shares were extinguished, leading
to net addition of 10.9 mn shares.
CDH has not issued any dilutive security. Founder family owned 74.8% of the company and
none of the shares were pledged with any institution.

20 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

Exhibit 16: Cadila—balance sheet, March fiscal year-ends, 2007-2012E (Rs mn)

2007 2008 2009 2010E 2011E 2012E


Equity
Share capital 628 628 682 682 682 682
Other reserves 8,027 9,994 11,232 15,073 18,980 23,867
Net worth 8,655 10,622 11,914 15,756 19,662 24,550
Secured 3,674 6,402 10,684 10,585 5,055 1,245
Unsecured 861 1,975 1,990 — — —
Debt 4,535 8,377 12,674 10,585 5,055 1,245
Trade creditors 3,721 3,558 5,201 5,782 6,567 7,415
Others 1,725 1,493 1,714 2,150 2,417 2,761
Current liabilities 5,446 5,051 6,915 7,932 8,985 10,176
Minority interests 142 194 228 353 478 628
Deferred tax liabilities 1,137 1,234 1,316 1,416 1,516 1,616
Total sources of funds 19,915 25,478 33,047 36,042 35,697 38,215

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

Leverage and return ratios (X)


Debt/Equity 0.5 0.8 1.1 0.7 0.3 0.1
Debt/Capitalisation 0.3 0.4 0.5 0.4 0.2 0.0
Net debt/Equity 0.4 0.7 0.9 0.5 0.2 0.0
Net debt/Capitalisation 0.3 0.4 0.5 0.3 0.2 0.0
Net debt/EBITDA 1.1 1.9 1.9 1.1 0.5 0.0
ROAE (%) 29.9 26.7 26.9 32.9 29.8 29.9
ROACE (%) 36.8 37.8 39.4 41.2 47.7 58.5

Source: Company, Kotak Institutional Equities estimates

Cash flow statement highlights


Strong free cash flow generation continues. CDH has been generating cash flows from
operations after working capital but before capital expenditure. In FY2009, capex and
acquisitions were significant but this will reduce in the next two years.

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.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 21


Pharmaceuticals Cadila Healthcare

Exhibit 17: Cadila—cash model, March fiscal year-ends, 2008-2012E (Rs mn)

2008 2009 2010E 2011E 2012E


Operating
Pre-tax and pre extra-ordinary income 2,613 3,114 4,679 5,399 6,749
Depreciation & amortization 1,550 1,054 1,272 1,500 1,650
Taxes paid 92 84 100 100 100
Working capital changes (1,965) (1,018) (2,022) (869) (1,321)
Cash flow from operations 2,290 3,234 4,029 6,130 7,178

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)

Net change in CCE (64) 1,591 783 (2,350) —


Beginning cash 990 926 2,517 3,300 950
Ending cash 926 2,517 3,300 950 950

Source: Kotak Institutional Equities estimates, Company

ROE analysis: Decline in FY2011E due to lower debt equity ratio


The sharp increase in ROE in FY2010E is due to a lower effective tax rate, lower financial
costs and improving asset turnover ratio. In FY2011E, we forecast small increase in effective
tax rate, lower financial costs, stable PBIT margin but reduction in debt/equity leads to
reduction in ROE. We expect the share of debt in the total capital employed to decline to
19% in FY2011E from 48% in FY2009.

Exhibit 18: ROE increases in FY2010E


Cadila—ROE analysis, March fiscal year-ends, 2007-2011E

2008 2009 2010E 2011E 2012E


PAT/PBT 78.0 76.9 82.9 83.0 82.1
PBT/PBIT 90.4 77.7 85.6 90.1 95.8
PBIT/Net sales 16.1 17.7 18.1 17.4 18.2
Net sales/Avg. assets 129.9 123.0 130.6 147.5 168.4
Avg. assets/Avg. equity 181.0 206.6 196.0 154.8 123.8
ROE 26.7 26.9 32.9 29.8 29.9

Source: Company, Kotak Institutional Equities estimates

22 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

QUARTERLY PERFORMANCE FOR FY2010E


Exhibit 19: Cadila—Interim results, March fiscal year-ends (Rs mn)

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

India 4,504 4,758 5,012 4,539 4,236 11 5


Finished dosage - Branded 3,347 3,534 3,695 3,303 3,086 10 5
Finished dosage - Generic 223 185 240 185 185 8 30
API 123 82 87 90 90 (29) 6
Consumer 480 642 649 637 580 35 1
Animal Health and others 331 315 341 324 295 3 8
International 3,082 4,138 4,239 4,427 4,470 38 2
Finished dosage - Emerging markets 522 526 332 684 707 (36) (37)
Finished dosage - Europe 464 638 528 614 639 14 (17)
Finished dosage - Latin America 402 366 461 524 524 15 26
Finished dosage - USA 798 1,479 1,604 1,383 1,374 101 8
Finished dosage - Hospira JV — 234 203 200 200 NM (13)
Finished dosage - Japan — 84 72 80 80 NM (14)
API - Others 576 516 831 738 733 44 61
API - Nycomed JV 320 295 208 205 213 (35) (29)
Gross sales 7,586 8,896 9,251 8,966 8,705 22 4

Source: Company, Kotak Institutional Equities estimates

KOTAK INSTITUTIONAL EQUITIES RESEARCH 23


Pharmaceuticals Cadila Healthcare

APPENDIX—BOARD OF DIRECTORS AND KEY MANAGEMENT PERSONNEL; SHAREHOLDING


STRUCTURE
Exhibit 20: Board of directors Exhibit 21: Key management personnel

Name Postion Name Position


Pankaj R Patel Chairman and managing director Ganesh Nayak Executive director, Zydus Group
Dr Sharvil P Patel Deputy managing director HT Patel President, APIs
Prabodh Joshi President, Group HR & Corporate Communication
Mukesh M Patel Non executive, Independent director
Nitin Parekh President and Chief Financial Officer
Pranlal Bhogilal Non executive, Independent director
Shirish Belapure President, Formulations manufacturing
HK Bilpodiwala Non executive, Independent director Joseph Renner CEO, Zydus Pharmaceuticals USA Inc
H Dhanrajgir Non executive, Independent director David Blanksby Head, European markets
AS Diwanji Non executive, Independent director Amit Dave Head, Brazil operations
Kailash Sharma Head, Japan operations
Source: Company Ben Classen Head, South Africa operations

Source: Company

Exhibit 22: Shareholding pattern ( %, as of September 2009)

Public
Insurance FII 7%
companies 3%
6%

Mutual funds
8%

Founder family
75%

Source: NSE website

24 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Cadila Healthcare Pharmaceuticals

“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.”

KOTAK INSTITUTIONAL EQUITIES RESEARCH 25


Pharmaceuticals Cadila Healthcare

Kotak Institutional Equities Research coverage universe


Distribution of ratings/investment banking relationships
Percentage of companies covered by Kotak Institutional Equities,
70% within the specified category.

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

Source: Kotak Institutional Equities As of September 30, 2009

Cadila Healthcare (CADI.BO)


Kotak Institutional Equities rating and stock price target history

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.

Rating Covered by Prashant Vaishampayan


Price target Not covered by current analyst
X Price target removal BSE-30 Index (RHS)

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

Covering Analyst: Prashant Vaishampayan


Company name Ticker
Biocon BION.BO
Cipla CIPL.BO
Dishman Pharmaceuticals DISH.BO
Divi's Laboratories DIVI.BO
Dr. Reddy's Laboratories REDY.BO
GlaxoSmithKline Pharmaceuticals GLAXO.BO
Glenmark GLEN.BO
Jubilant Organosys JUBO.BO
Lupin LUPN.BO
Nicholas Piramal NICH.BO
Ranbaxy Laboratories RANB.BO
Sun Pharmaceuticals SUN.BO
Tata Chemicals TTCH.BO
United Phosphorus UNPO.BO

Source: Kotak Institutional Equities Research.

26 KOTAK INSTITUTIONAL EQUITIES RESEARCH


Disclosures

RATINGS AND OTHER DEFINITIONS/IDENTIFIERS


Definitions of ratings

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.

CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.

NC = Not Covered. Kotak Securities does not cover this company.

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.

NM = Not Meaningful. The information is not meaningful and is therefore excluded.

28 KOTAK INSTITUTIONAL EQUITIES RESEARCH


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