Indiapharma

I Equity Research I India I Health Care I
13 January 2014
India pharma
The third wave Global scalability key
The third wave. Indian pharmaceutical companies (IPCs) are in their third phase of growth, moving into complex products and expanding reach, which could deliver revenue CAGR of 15-17% over FY13-16E (vs 20% CAGR over FY03-13), in our view. PRII framework measures critical growth levers key to capture the third wave: Our PRII matrix analyses the sector on (1) Product pipeline, (2) Reach, (3) Innovation and (4) Inorganic growth. The stocks that rank high are Sun Pharma, Lupin, Dr. Reddys; Cipla (improving reach and product pipeline) and Glenmark (strong on innovation, improving product pipeline and reach) are the relatively undervalued stocks with good scores on the PRII. IPCs to ride the third wave given their ability to adapt, endure regulatory frameworks and focus on incremental innovation. Our analysis of exclusivities and limited competition products suggest they have USD 35bn in market opportunities over FY14-16E. Third-wave picks with valuation headroom. Post the recent rally, we pick stocks that have valuation headroom and high PRII scores. Our top picks are Cipla and Lupin in large caps and Glenmark in mid caps; we also like Sun Pharma and Dr. Reddys.
Mkt cap hide column-old Price Rating rating (USD mn) (lc) New Old Rec 1,863.7 407.75 IL OP IL 2,643.6 804.45 IL UP IL 5,035.5 390.85 OP - OP 8,186.9 2,491.25 OP - OP 2,230.4 514.30 OP - OP 6,679.4 932.90 OP - OP 3,253.0 480.40 IL IL 19,748.2 594.20 OP IL OP 1,280.7 471.60 IL IL PT (lc) New Chg (%) 430.00 100.0 865.00 21.8 510.00 10.9 2,800.00 33.3 710.00 26.8 1,112.00 62.3 477.00 6.0 646.00 67.8 500.00 38.9 PER (x) PT Up/(Dn) (lc) side (%) FY1E FY2E 430.00 5.5 15.2 11.9 865.00 7.5 24.5 18.7 510.00 30.5 18.7 16.5 2,800.00 12.4 20.0 18.2 710.00 38.1 20.3 14.5 1,112.00 19.2 26.7 20.4 477.00 (0.7) 58.3 14.7 646.00 8.7 26.1 22.9 500.00 6.0 16.2 14.2 EV/EBITDA (x) FY1E FY2E 11.0 8.8 16.8 12.7 13.2 11.1 14.1 12.2 12.0 9.3 16.1 12.4 17.5 10.5 19.0 16.0 10.8 9.0 Div yield (%) FY1E FY2E 0.6 0.7 1.1 1.2 0.5 0.6 0.9 1.0 0.5 0.7 0.5 0.6 0.0 0.0 0.5 0.6 1.2 1.7
Aurobindo Pharma Cadila Healthcare Cipla Dr. Reddy's Laboratories Glenmark Pharmaceuticals Lupin Ranbaxy Laboratories Sun Pharmaceutical Industries Torrent Pharmaceuticals
Ticker ARBP IN CDH IN CIPLA IN DRRD IN GNP IN LPC IN RBXY IN SUNP IN TRP IN
Share prices as of 7 January 2014 Source: Companies, FactSet, Standard Chartered Research estimates
Gaurav Pathak
Gaurav.Pathak@sc.com +91 22 4205 5921
Shashikiran Rao
Shashikiran.Rao2@sc.com +91 22 4205 5920
Important disclosures can be found in the Disclosures Appendix

All rights reserved. Standard Chartered Bank 2014 http://research.standardchartered.com
Equity Research l India pharma
Contents
Investment summary Valuation Global comparison Top picks Risks Tightening regulations and increasing competition Product versatility The key differentiator Complexity of ANDA filings increasing Diversifying product base Revenue per ANDA to rise Life beyond the patent cliff not a steep fall Prefer the chronic tilt Reach expansion The horizontal growth Emerging markets Interesting prospects The US Select opportunities Domestic pharma market resilient RoW sluggish, but significantly underpenetrated Innovation The sustainable advantage R&D is changing colour Novel products The final frontier is still far Process innovation Inorganic growth The additional boost Partnership The right way to grow PRII matrix captures the required skill set Scoring mechanism details Concerns surmountable Appendix 1: Indian government action Appendix 2: US sales data Appendix 3: Abbreviations Companies Sun Pharmaceutical Industries Dr. Reddy's Laboratories Lupin Cipla Ranbaxy Laboratories Cadila Healthcare Glenmark Pharmaceuticals Aurobindo Pharma Torrent Pharmaceuticals 3 7 9 10 10 11 11 12 13 17 18 20 22 25 26 27 30 30 34 39 40 41 42 43 47 48 50 51 52 63 72 83 95 106 119 130 140
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13 January 2014
Investment summary
IPCs have transformed the global pharmaceutical industry, recording impressive revenue growth over the past 20 years. In the first wave (1993-2003), the industry reported 26% CAGR, driven by basic chemistry/manufacturing skills to produce small molecules in India and APIs in developed markets. The second wave (2003-13) saw 20% revenue CAGR, driven by complex formulations, benefits from the patent cliff and tentative reach into global markets.
IPCs have the ability to ride the third wave

We expect IPCs to maintain 15-17% revenue growth IPCs are now in the third stage of growth. In this phase, we believe the industry could deliver 15-17% revenue growth, but it will require companies to evolve on a global landscape and be prepared for a new set of challenges. Figure 1: IPCs enter the third wave
API/ basic product manufacturing for domestic/ DMs Phase -I
Formulations marketing to wider range of DMs and EMs
Expansion into complex formulations like biosimilars, injectables and novel products for the global market
Phase -II
Phase -III
Source: Standard Chartered Research
We believe that IPCs, with their ability to re-engineer, adapt to changing competitive landscapes and regulatory environments, focus on incremental value creation and innovation, should be able to ride the third wave.
Product basket More complex and diverse

Even post the patent cliff, the drug expiry run-rate remains healthy with products worth USD 220bn in sales slated to go off-patent over the next six years (annual range of c.USD 35-40bn). Our analysis suggests that IPCs have been smart in spotting these opportunities. Highlighted below are the key drugs going off-patent in the US, and the IPCs that could launch generics of those molecules. Note that these molecules have a combined market size of about USD 35bn and are well spread out
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over the next three years (details in Product section). In the figure below, we highlight 10-12 blockbuster products going off-patent and likely to get generics competition over the next 2-3 years. Figure 2: Key drugs status and approvals for Indian companies
6b Nexium- R
5b Cymbalta- S, L,CD, DR,T, A 4b
Abilif y-S, CD, T
Gleevec- S
3b
Atripla Cp, A Diovan- R*, L, DR, A
2b Lyrica- L
Truvada - A
1b Niacin- S
Lunesta- S, CP, G
NamendaL,T
Actonel Cp, A
Q2-14
Q3-14
Q1-14
Q4-14
Q1-15
Q2-15
Q3-15
Q4-15
Q1-16
Potential quarter of launch
Number of approved players
Sole
2-3
4-5
6-7
Q2-16
7+
S= Sun Pharma, L= Lupin, R= Ranbaxy, DR= Dr Reddy, CD= Cadila, CP= Cipla ,A= Aurobindo , T= Torrent , G= Glenmark
*= FTF exclusvity
Source: USFDA, Standard Chartered Research
IPCs well placed to launch generics of products with market size of USD 35bn (2012) over the next 2-3 years
In addition to these large opportunities, IPCs are also improving their product pipelines by developing portfolios of complex products in niche categories, novel products and biosimilars, and increasing focus on the chronic segment. Note that the current top 10 drugs by sales are going off-patent in the next five years. In the US, injectables (31% of the market), biosimilars (25% of the market), many complex or niche therapy areas, and differentiated drug delivery systems have yet to be penetrated by IPCs. We believe the next frontier is complex products such as oral contraceptives, vaccines, transdermals, extended release, sprays, inhalers and injectables. IPCs share of ANDAs approved by the USFDA has consistently increased from 33% in CY11 to 37% in CY12 reaching 41% in H1CY13. The quality of the growing product portfolios is also improving as discussed in later sections.
Expanding reach across geographies

Despite their rapid growth, we believe IPCs have barely scratched the surface of the addressable geographic markets. Even in the US (the largest market, USD 325bn total, USD 65bn generics), IPCs account for only 6% of sales and 25% of volumes. The four largest generics companies worldwide Teva, Mylan, Sandoz, and Actavis account for c.50% of US generics prescriptions and c.40% worldwide. In this third stage, we believe IPCs could register 15-17% revenue growth, but it will require companies to evolve on a global scale by expanding reach. IPCs will need to focus on increasing geographical reach in Latin America, Russia and the EU and within countries where they have a presence currently, in our view. We believe IPCs
13 January 2014 4
ability to re-engineer, adapt to changing environments and endure the regulatory landscape will enable them to widen their geographic presence. On this parameter, Ranbaxy, Lupin, Dr. Reddys, Glenmark, Cadilla and Cipla rank high. Figure 3: IPCs expanding reach across geographies
Source: Company, Standard Chartered Research estimates
Despite rapid growth, Indian companies have a relatively small presence in most markets
Innovation and Inorganic growth

IPCs have to be innovative and build pipelines of novel and speciality products like 505 B(2)s, in our view. Like global pharma companies, who are reducing R&D spend and turning it incremental, IPCs, too, will need to increase focus on incremental research not to lose ground to global players. Innovation also plays a key role across the entire supply chain to ensure cost competitiveness vs global generics. Acquiring a company is the easiest lever to generate non-linear growth (compared to novel product innovation). Among the IPCs, Sun Pharma has proved to be the most nimble, especially in its core US market, by (1) identifying strong and complementary acquisition targets, (2) integrating them with its core business and (3) maintaining a strong balance sheet. Lupin, Cipla and Torrent also have successfully added new geographies and product sets through acquisitions. Overall, the global generic landscape is witnessing consolidation with Indian companies becoming attractive targets given their research, regulatory and manufacturing competence.
The PRII matrix

To identify the best performers amongst the IPCs, we rate them using our fourparameter PRII matrix: (1) Product pipeline ANDAs, FTFs, chronics and the product delivery capability; (2) Reach across emerging and developed markets and within these markets; 3) Innovation Over the long run, innovation in the drug discovery process, 505 B(2)s and supply chain would remain critical to success; and (4) Inorganic acquisitions to strengthen the product/marketing/technology platforms.
13 January 2014
We prefer companies that score high on the PRII matrix as this highlights their ability to scale up. Based on the PRII matrix, Sun Pharma (Product and Inorganic growth), Lupin (Product, Reach and Inorganic growth), Dr. Reddys (Reach and Innovation), Glenmark (Innovation), Ranbaxy (Product and Reach), Cadilla (Innovation) and Cipla (Product) score high. We use the PRII scores to ascribe target P/E multiples for companies under coverage (our price targets are over a 12-month horizon and are based on one-yearforward P/E). Broadly, we have assigned a target P/E range of 15-20x for large-caps (except Sun Pharma) and 10-15x for mid-cap pharma companies, which are in line with their long-term medians. The PRII matrix helps us refine these targets based on their business prospects. The table below shows the PRII-matrix scorecard for companies under coverage and rationale for our target P/E multiple for them.
Lupin and DRL emerge preferred picks based on PRII and valuation
Figure 4: PRII matrix

Product pipeline Sun Pharma 9.2 Reach Innovation 5.5 5.4 Inorganic PRII growth scorecard 10.0 30.1 Target multiple Comment 25.0 High margin core business with an impressive pipeline; strong inorganic growth track record and balance sheet. Hence, premium valuation for its core business 21.0 Most diversified product pipeline, strategic geographic reach and strong balance sheet. Hence, multiples at upper-end of sector range 21.0 Strong presence across geographies, attractive pipeline with high market share and good balance sheet. Valuation at upper end of the large-cap range 15.0 Unique focus on research combined with ability to monetize it, diversified product portfolio and reach. Valuation at a premium to mid-cap pharma range 18.0 Improving business prospects especially on product pipeline in the US market. Good presence in EMs and good balance sheet. Target multiple at the mid-point of the large-cap range 18.0 Strong reach, but expanding the product pipeline in the key US market and margin expansion remain critical challenges 15.0 Strong growth on pure generics business across all geographies, value of novel product research not factored in current valuations. Target multiple at the upper end of the mid-cap pharma range 13.0 Impressive product pipeline 10.0 Large product pipeline, but reach restricted to US market and weak balance sheet. Hence, target multiples at lower-end of mid-cap pharma range
Lupin
8.8
7.0
4.2
8.7
28.6
Dr. Reddy's
7.8
6.7
4.6
7.3
26.4
Glenmark
7.0
5.7
5.0
5.7
23.3
Cipla
7.2
5.8
1.0
7.7
21.6
Ranbaxy
7.2
6.5
1.8
5.3
20.8
Cadila
5.8
5.6
4.6
4.3
20.3
Torrent Pharma Aurobindo
5.2 6.2
5.5 3.8
1.0 1.0
6.7 2.3
18.3 13.3
Source: Standard Chartered Research estimates
13 January 2014
Valuation
Indian pharmaceutical companies are well-positioned as a defensive sector, providing stable and high earnings growth with good valuation upside. Key insights: 1. The sector does not look expensive and the recent correction offers a good entry point. We expect the sector to register 20% earnings CAGR over FY13-16E, with RoE in the range of 25-30% and EBITDA margin of 23%. 2. IPCs are trading below their 20x one-year-forward PE band. Given the sectors sixyear trading history, we believe this is the right time to invest in the sector. 3. IPCs are trading below their recent 40-50% premium to the Indian market. 4. IPCs have similar characteristics to the Indian IT Services and Consumer sectors (the other two defensive sectors) consistent earnings growth, low leverage, stable growth drivers and high RoEs. Over the past five years, the pharma sector had faster earnings growth and we expect 20% earnings CAGR for IPCs vs 1517% CAGR for the IT and Consumer sectors. This provides downside support to IPC valuations. Stock prices have moved in tandem with earnings, not outpaced them Figure 5: Comparative valuation
Coverage universe Aurobindo Cadila Cipla Dr. Reddy's Glenmark Lupin Sun Pharma Ranbaxy Torrent Pharma Price (INR) 408 804 391 2,491 514 932 594 480 471 PT (INR) Rating 430 In-Line 865 In-Line 510 Outperform 2,800 Outperform 710 Outperform 1,112 Outperform 646 Outperform 477 In-Line 500 In-Line Mcap (USD bn) 1.9 2.7 5.1 6.8 2.2 6.7 19.8 3.3 1.3 EPS growth (%) FY14E 165.8 2.7 0.2 13.9 9.8 14.3 35.5 8.5 22.8 FY15E 27.8 31.5 13.2 11.4 40.1 31.0 13.7 32.9 14.5 FY14E 15.2 24.5 18.7 20.0 20.3 26.7 26.1 56.6 16.2 P/E (x) FY15E 11.9 18.7 16.5 18.2 14.5 20.4 22.9 14.6 14.1 FY16E 9.5 14.0 13.8 16.2 12.0 17.6 19.5 15.7 12.2 EV/EBITDA (x) FY14E 10.9 16.5 13.2 13.9 11.9 16.0 18.7 17.0 10.7 FY15E 8.7 12.5 11.1 12.0 9.3 12.4 15.7 10.2 9.0 RoE (%) 18.0 16.9 22.7 29.9 25.4 34.5 56.3 9.8 38.5
5. Compared to global peers, IPCs do not look expensive, factoring in the higher earnings growth and RoE.
Figure 6: Revenue comparison (INR bn)

FY08 Coverage universe Aurobindo Cadila Cipla Dr. Reddy's Glenmark Lupin Sun Pharma Ranbaxy Torrent Pharma Margin Sales EBITDA (%) 24.4 23.2 42.3 50.1 19.4 28.6 32.9 67.8 13.5 3.5 4.6 8.5 6.8 8.0 6.5 15.5 7.1 2.1 14.4 19.7 20.2 13.6 41.5 22.7 47.1 10.5 15.4 PAT 2.4 2.7 7.0 4.7 6.6 4.1 14.9 5.4 1.3 FY13 Margin Sales EBITDA (%) 58.6 63.6 82.8 119.0 50.1 96.4 113.0 124.6 32.1 8.6 11.2 23.6 27.2 10.1 22.7 49.7 21.3 6.5 14.7 17.7 27.9 22.9 20.2 23.5 44.0 17.1 20.2 PAT CAGR PAT FY08-13 2.9 6.9 16.8 15.3 5.7 13.4 30.1 13.7 4.0 4.3 20.8 19.0 26.7 -2.9 26.8 18.6 20.4 25.9 FY16E Sales EBITDA 95.2 95.8 127.4 176.2 83.9 145.2 194.2 145.9 47.6 20.0 18.6 33.4 39.4 18.6 37.4 86.1 22.2 10.3 Margin (%) 21.0 19.4 26.3 22.4 22.2 25.8 44.3 15.2 21.6 PAT 12.6 12.2 22.8 26.1 11.6 23.7 62.9 12.9 6.5 PAT CAGR FY13-16E 62.3 20.9 10.8 19.6 26.7 20.9 25.2 -2.0 17.5
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Figure 7: Sector one-year-forward P/E band The sector has traded at 15-20x one-year-forward P/E over the past six years
1,100 10x 15x 20x Sector CMP
900
700 INR 500
300
100
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Figure 8: Pharma sector P/E premium over Sensex

200 180 160 140 BSE Heathcare P/E as % of Sensex P/E
(%)
120 100
80
60 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-13
8
Jun-09
Jun-06
Jun-07
Jun-08
Jun-10
Jun-11
Jun-12
Figure 9: One-year-forward P/E comparison between Pharma and other defensive sectors (FMCG & Tech)
30 BSE healthcare BSE Tech BSE FMCG
25
20 (x)
15
10
Dec-12
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Apr-12
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13 January 2014
Aug-13
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Global comparison
IPCs are not expensive in comparison with global peers. IPCs have smaller market caps and lower sales, but a higher growth trajectory. Note that Teva also faces significant earnings risks as Copaxane turns generic. IPCs US generics businesses have grown at 31% over FY08-13, but still lag global generics peers on revenues. Figure 10: Global comparison Revenues and leverage (USD bn)
Market Cap (USD bn) 35.1 31.3 17.3 7.0 3.1 1.7 21.2 3.8 4.2 11.2 1.9 2.7 5.1 6.8 2.2 6.7 19.8 3.3 1.3 Revenue 1FY 20.1 8.6 6.9 4.1 2.0 0.5 4.2 1.6 1.3 2.8 1.2 1.2 2FY 19.8 10.5 7.7 4.2 2.2 0.5 4.6 1.7 1.4 3.6 1.2 1.2 EBITDA 1FY 6.2 2.2 1.9 0.7 0.5 0.1 1.2 0.4 0.4 0.8 0.2 0.2 2FY 6.1 3.3 2.3 0.7 0.6 0.1 1.5 0.4 0.3 1.0 0.2 0.2 EBITDA margin 1FY 30.8 25.7 27.5 16.0 26.9 19.7 28.3 23.4 29.3 28.6 18.5 16.0 2FY 30.7 31.3 29.6 16.7 27.9 17.1 31.7 24.1 25.3 29.2 18.5 21.1 PAT 1FY 4.2 1.3 1.1 0.3 0.2 0.1 0.7 0.2 0.2 0.5 0.1 0.1 2FY 3.9 2.3 1.3 0.4 0.2 0.0 1.0 0.3 0.2 0.6 0.2 0.2 RoE (%) 18.5 34.9 33.6 11.4 12.9 8.4 31.9 9.8 25.9 21.1 18.0 16.9 Net debt to equity (%) 51.4 158.3 160.4 31.7 125.1 -43.3 51.2 -7.3 48.1 48.5 121.9 66.3
Global generics Teva Pharmaceutical-Sp Adr Actavis Plc Mylan Inc Hospira Inc Stada Arzneimittel Ag Impax Laboratories Inc Perrigo Co Richter Gedeon Nyrt Hikma Pharmaceuticals Plc Aspen Pharmacare Holdings Lt Aurobindo Cadila Cipla Dr. Reddy's Glenmark Lupin Sun Pharma Ranbaxy Torrent Pharma
1.6 2.3 1.0 1.9 2.4 2.4 0.6
1.6 2.3 1.0 1.9 2.4 2.4 0.6
0.4 0.5 0.2 0.4 1.1 0.2 0.1
0.5 0.6 0.3 0.5 1.2 0.4 0.1
25.6 22.6 21.4 23.4 44.2 9.6 20.6
29.2 25.4 26.9 29.5 51.0 15.5 24.3
0.3 0.4 0.1 0.3 0.5 0.1 0.1
0.3 0.4 0.2 0.3 1.0 0.2 0.1
22.7 29.9 25.4 34.5 56.3 9.8 38.5
-5.0 15.2 37.4 11.3 -25.8 2.4 5.3
Source: Companies, Standard Chartered Research Estimates
Figure 11: Global comparison Valuation

Global generics Teva Pharmaceutical-Sp Adr Actavis Plc Mylan Inc Hospira Inc Stada Arzneimittel Ag Impax Laboratories Inc Perrigo Co Richter Gedeon Nyrt Hikma Pharmaceuticals Plc Aspen Pharmacare Holdings Lt Global generics median Aurobindo Cadila Cipla Dr. Reddy's Glenmark Lupin Sun Pharma Ranbaxy Torrent Pharma IPC median Market Cap (USD bn) 35.1 31.3 17.3 7.0 3.1 1.7 21.2 3.8 4.2 11.2 P/E (x) 1FY 8.3 23.3 15.3 20.1 19.6 29.3 28.5 16.6 19.0 23.1 19.9 15.2 24.5 18.7 20.0 20.3 26.7 26.1 56.6 16.2 20.3 2FY 9.1 13.8 13.1 19.2 15.3 38.9 20.5 14.5 22.2 17.8 16.6 11.9 18.7 16.5 18.2 14.5 20.4 22.9 14.6 14.1 16.5 EV/EBITDA (x) 1FY 7.6 17.0 11.9 12.2 8.5 13.5 19.1 9.6 11.7 15.1 12.0 10.9 16.5 13.2 13.9 11.9 16.0 18.7 17.0 10.7 13.9 2FY 7.7 11.4 9.9 11.3 7.5 15.6 15.3 8.7 13.4 11.7 11.4 8.7 12.5 11.1 12.0 9.3 12.4 15.7 10.2 9.0 11.1 EV/Sales (x) 1FY 2.4 3.6 2.9 1.9 2.1 2.7 4.9 2.1 3.4 3.4 2.8 2.0 2.6 3.3 3.1 2.5 3.8 8.2 1.6 2.2 2.6 2FY 2.4 3.5 2.8 1.8 2.0 2.5 4.5 1.9 3.1 3.1 2.6 1.7 2.3 2.8 2.7 2.1 3.1 6.9 1.6 1.9 2.3 P/B 1.5 8.1 5.1 2.3 2.5 2.5 9.1 1.6 4.9 4.9 3.7 3.5 4.7 2.9 5.1 4.6 6.2 8.6 5.3 4.3 4.7
1.9 2.7 5.1 6.8 2.2 6.7 19.8 3.3 1.3
Source: Companies, Standard Chartered Research estimates
13 January 2014
Top picks
Our top picks are Cipla among large caps and Glenmark among mid caps; we also like Sun Pharma, Dr. Reddys and Lupin. Cipla is undergoing a significant transition to capture faster growth; it has added top/mid management and marketing/sales personnel across geographies, and is expanding its product basket across markets. We prefer Glenmark in the mid cap basket due to its unique innovation focus and rapid growth. Sun Pharma, Dr. Reddys and Lupin are the best-in-class having interesting complex product pipelines, strong balance sheets and execution capabilities, besides offering valuation upside. We like Cadila given its strong growth trajectory in the US and emerging markets with a solid pipeline of novel/niche products. But we await a better entry point. Ranbaxy is a potential turnaround story; however, given limited turnaround timeline visibility, we recommend adding only on dips. Torrent and Aurobindo are our less preferred picks due to their single market focus, leveraged balance sheets, low margins and very strong recent run-up. Figure 12: Ratings summary
Companies Large captop picks Cipla Price PT Upside/ Market Cap (INR) (INR) (Downside) (%) (USD bn) Rating 5.1 Outperform 391 510 30 Rationale Transforming to add sales, marketing, products and management strength. Discounted valuation Best product pipeline, strong branded US business and unique reach Rapid growth across all its core generics markets: US, Latin America and India. Research monetization potential. Valuation attractive Scores strongly on all counts: scale, complexity, inorganic growth and reach
Lupin Mid cap - top Glenmark pick
932 1,112 514 710
19 38
6.7 2.2
Outperform Outperform
Quality picks
Dr. Reddy's Sun Pharma
2,491 2,800 594 646
12 9
6.8 19.8
Outperform Outperform
Best-in-class with strong growth in the US and India driven by product launches; robust margins Growth returning, but generic profile could witness competition and regulatory issues. Expensive valuations post the run-up Strong pipeline of limited competition products and FTFs in the US markets could strengthen margins; but valuation pricing in the upside Strong re-rating candidate on potential novel research monetisation through out-licensing. Ramp-up in US, India, JV and Latin America business to achieve strong growth Concerns over FDA have peaked after Ohm clarity. Potential turnaround, but still a long way away, valuations turning expensive
Less preferred picks
Torrent Pharma
471
500
1.3
In-Line
Aurobindo
408
430
1.9
In-Line
Cadila
804
865
2.7
In-Line
Ranbaxy
480
477
(1)
3.3
In-Line
Risks Tightening regulations and increasing competition

IPCs need to be prepared for (1) tougher regulatory environments in the US, Japan, Brazil, Russia, India, etc, (2) intensifying competition from new generics players and generics arms of big pharma, (3) slower approval rates at the USFDA and also certain emerging markets, and (4) increasing pricing pressure as the hangover of the patent cliff leaves players competing for market share.
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Product versatility The key differentiator

Though the patent cliff ended in 2012, IPCs still have significant patent expiry opportunities. Over the next six years, an additional USD 220bn worth of sales will go off-patent. The current top 10 drugs by sales are going off-patent in the next five years. Recent product filings by IPCs indicate growing variety and complexity in terms of therapies as well as delivery systems. As IPCs enter niche and complex products, yields per product launch could increase, in our view. Furthermore, IPCs share of ANDAs approved by the USFDA have also been rising consistently from 33% in CY11 to 37% in CY12 and reaching 41% in H1CY13. In the US, IPCs have not yet penetrated injectables (30% of the market), biosimilars (20% of the market), many complex or niche therapy areas, and differentiated drug delivery systems. We believe the next frontier is complex products like oral contraceptives, vaccines, transdermals, extended release, sprays, inhalers and injectables. Overall, IPCs have robust and complex product launch pipelines to sustain strong US growth and improve margins. Sun Pharma, Dr. Reddys, Lupin and Glenmark have the best product pipelines.
Complexity of ANDA filings increasing

IPCs share of ANDAs rising sharply IPCs share of ANDAs approved by the USFDA has been consistently increasing, from 33% in CY11 to 37% in CY12 and 41% in H1CY13, pointing to a ramp-up in their US businesses. IPCs received 178 Abbreviated New Drug Application (ANDA) approvals during 2012 compared with 144 in the previous year despite stringent approval norms. The USFDA granted a total of 476 ANDA approvals in 2012 against 431 the previous year. In H1CY13, the USFDA gave 211 ANDA approvals and 47 tentative approvals; among those, IPCs got 87 ANDA and 25 tentative approvals. Even in the drug master file (DMF) filings, which indicate a presence in the bulk drug market, IPCs share has been increasing over the past two decades. Nevertheless, the top three generics players Teva, Actavis and Mylan have 150-200 ANDAs in the pipeline, significantly higher than for IPCs. Figure 13: Indian companies form a significant share of US DMF filings
30%
25% 20% 15% 11% 10% 5% 0% 1995
Source: USFDA
Indian pharma share of US DMFs 26% 24%
17% 12%
2000
2005
2010
2012
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11
Diversifying product base

Product launches and FTF exclusivities in the US have been the major growth drivers for IPCs in the past few years. These opportunities, however, are peaking and companies will need to shift their focus to limited competition therapies, where large portfolios, brand and quality are more important than launches. With fewer new drugs being launched, even innovators are under pressure to retain their market shares for existing drugs. This has led to increased competitive measures from innovators, like authorized generics and shift towards over the counter (OTC) products. In the US, IPCs have not yet penetrated injectables (31% of the market), biosimilars (25% of the market), many complex or niche therapy areas, and differentiated drug delivery systems. In the largest market, the US, IPCs account for only 6% of sales, but 25% of volumes. Even post the patent cliff, the drug expiry run-rate remains a healthy USD 35-40bn each year. The current top 10 drugs by sales are going off-patent in the next five years. Most IPCs have 80-100 products in the US market, which is one-third of their global peers, suggesting there is scope to further increase market share. IPCs market shares range between 3% and 5% on volume in comparison to 10-15% market share for US generics companies. IPC filings increasing in niche areas We believe the next frontier is complex products like oral contraceptives, vaccines, transdermals, extended release, sprays, inhalers and injectables. Over the past couple of years, most Indian companies have ventured into some of these segments, summarised in the chart below. Figure 14: Indian companies US filings
200 Oral immediate release Injections Transdermals Nasal products Modified release Oral contraceptives Opthalmics Share of Indian cos in approved ANDAs 36 34 32
150
30
100 28 26 50 24 22 0 FY08
Source: USFDA
20 FY09 FY10 FY11 FY12 FY13
IPCs will find it tough to succeed in these products and market share gains could be slow. Most of these products are either difficult to manufacture, need brand strength, require dedicated facilities or have a high regulatory burden, including clinical trials. IPCs will need to increase their R&D spend to break into these segments. These segments will also improve the revenue yield of new product filings in the US, taking revenue per ANDA closer to USD 15-50m/product, significantly above their current product run-rate. Over time, we may see 5-7 players (Indian and global) working on these niche areas/products though the timing of approvals may vary.
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(%)
Injectables and OCs are areas of strong growth for IPCs
Injectable products account for 31% of the US market, with USD 5.5bn in the generics segment. Key companies in this segment are Hospira, Bedford and Fresenius. Complexity in this segment is due to stringent regulatory requirements, which include clinical trials and a dedicated facility. Most large drugs have only fourfive players. A majority of Indian companies have filed for approvals in this category and some even have a few approved products. Development costs in this segment are c.USD 5-10mn with revenue potential of USD 30-50mn. The oral contraceptive (OC) market is worth USD 5bn, growing at 10%. This segment is highly concentrated. The top four players Teva, Watson, Galen and J&J have 85% market share. This makes the segment difficult to enter, with challenges in approvals (requires a dedicated facility). Two-thirds of the market is branded generics with pure generics making up only 2% of the segment. Gaining market share in this segment requires time, a large product portfolio and brand presence. Lupin is the only IPC that is aggressive in this space. It has already launched two products and plans to launch 10 more in the current year. Ophthalmics is a USD 4bn market. Novartis, Bausch and Allergan are the major branded players, while Akron, Valent and Mylan are the top-three generics players. Sun Pharma is the only prominent Indian player in the market with annual sales of about USD 10-15mn and 11 products. Lupin has also filed in this segment. The ophthalmic segment, similar to injectables, has a higher level of USFDA scrutiny, including possible clinical trials. This has limited competition, with most drugs having only two or three players post the expiry of patents. The majority of the drugs in this category expire in 2014 and 2015. Dermatology is a USD 3bn market. Most of the products have low competition with three-four players. The lower competition is due to the higher manufacturing complexity of the products and the lengthy regulatory approval process. Following the Taro acquisition, Sun Pharma is well placed with about 28 large products. Other Indian players present in this segment are Ranbaxy, Lupin and Glenmark. Dedicated facilities are required with a development cost of c.USD 4-5mn. Transdermal is another category with USD 4bn market size and delves in patches for delivery of active ingredients across the skin. Inhalers are a USD 30bn market globally with more that 60% in the US. Bioequivalence and interchangeabililty are difficult to produce, making this segment difficult to penetrate. Product designs are also equally difficult to develop and are mostly patented. Development costs range from USD 5-20mn.
Revenue per ANDA to rise

The productivity of ANDA approvals for IPCs is significantly low. Barring Lupin, which has a presence in branded generics, other IPCs have revenues per approved ANDA of USD 3-5mn against USD 10-12mn for generics majors. However, among the new launches, revenue/ANDA is increasing.
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Figure 15: Revenue/approved ANDA significantly lower than for global peers
14 12 10 8 6 4 2 0 Teva Actavis Mylan Sandoz Sun Pharma DRL Lupin Glenmark Cadila 137 85 87 76 410 370 320 275 280 USD revenues per approved ANDA Approved ANDA (nos) 450
400
350 300 250 200 150 100 50 0
Source: Company filings, Standard Chartered Research estimates
Revenue yield of product launches remains low for IPCs
Figure 16: Revenue per launched product

16 14 12 10 USD mn 8 6 4 2 0 Teva Actavis Mylan Sandoz Sun Pharma DRL Lupin Glenmark Cadila 68 52 66 54 290 USD Revenue per product (RHS) 400 365 Products Launched (LHS)
270
168
Source: Company filings,, Standard Chartered Research estimates
Fewer brands and Para-IV result in lower revenue yield for IPCs
Fewer exclusivities. One of the key factors for IPCs low revenue yield vs global generics players is their relatively small number of exclusivities. We expect the global players advantage to wear off over a period of time. Unlike earlier, today a larger number of FTF exclusivities are shared. For example, for Cymbalta (Duloxetine - IMS market size of USD 5bn in 2012), which recently went off-patent post expiry of paediatric exclusivity in December 2013, several Indian players such as Sun Pharma, Lupin, Aurobindo, Lupin and Cadila have launched the product. Furthermore, with the USFDA tightening approval norms, there have been cases of exclusivity remaining unclaimed. The table below summarises the ANDA approvals for global generics majors vs IGP players and their exclusivity status.
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Figure 17: Global generics majors vs. IGP majors ANDA filing, approval and exclusivities
Cumulative filing Approved Teva Actavis Mylan 553 555 458 410 370 275 Pipeline to Pipeline filing ratio 143 185 183 26% 33% 40% Para-IV 103 NA 34 FTF 62 49 34 Exclusive FTF NA 33 NA
Sun Pharma Dr. Reddys Lupin Glenmark Cadila Ranbaxy Aurobindo Torrent
453 202 201 126 144 234 279 43
320 137 85 87 76 151 191 19
133 65 116 39 68 83 88 24
29% 32% 58% 31% 47% 35% 32% 56%
NA 38 NA NA NA NA NA NA
NA 8 25 4 NA NA NA NA
NA NA 12 4 NA NA NA NA
Source: Company filings, Standard Chartered Research
Fewer exclusivities for IPCs
Fewer launches at risk One of the ways big generics players have been able to extract higher revenues per product is through successful Para-IV challenges of at risk launches. In this regard, IPCs have not been very successful, with their win rate being 10-15% (industry average: 22%) and loss rate 25-40% (industry average: 24%), the rest being settled or dropped. Given this statistic, IPCs have been understandably circumspect about launching products at risk. We believe that the appetite to challenge patents or launch products at risk will improve as the players attain critical mass. A loss in a patent infringement litigation attracts a fine three times the revenue earned from the product. This is a serious deterrent for launching a generic version of a blockbuster drug. Sun Pharma, e.g., paid USD 0.5bn for patent infringement by launching the generics version of Protonix, seriously impacting its cash position. Figure 18: Record of IPC players launching products at risk and challenging patents much weaker
Dropped/Settled Won 2 12 4 2 4 Lost 1 Launched At Risk 1 1 2 2 2 0 Teva 1 Mylan 6 Sandoz 1 Apotex 1 0 Impax 1 Perrigo 0 KV Pharm 1 0 Ranbaxy 0 Dr. Reddy's 2 2 1 7 7 5 2 1
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
24 27
4 6 9
11 7
13
Par
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Actavis (Watson)
Sun (incl URL Pharma)
Actavis
Lupin
15
The process of filing Para-IV Para-IV challenges on patents have a strong success record pointing to keenness among the regulators. According to industry estimates, of over 370 resolved cases over the past decade, the outcome has been fairly even, with generics winning 82 of the rulings compared to losing 69. Figure 19: Para-IV filing process
Generic players claim that the patents arent valid or that the patents exists but the generic doesnt infringe Files a Para -IV with FDA
Within 60 days of filing FDA acknowledges ANDA Within 20 days of FDA acknowledgement Patent-holder challenges ANDA Generic player informs patent holder
Filed within 45 days
Challenge accepted, but no 30-month stay
As per Medicare Modernization Act (MMA) in December 2003, patent holders are entitled to only one 30-month stay and not entitled to a stay if a patent is listed after an ANDA
Challenge accepted and 30 months stay on generic version AT risk launch The 30-month clock is important because at the end of the stay companies are free to receive FDA approval and launch. At risk launch means generic launch without court approval, provided it is Is not within the valid 30-month stay period.
Patent invalid/ settlement
Generic introduced/ patent holder files infringement suit
Patent invalid/ settlement
Generic version launched immediately
Infringers penalised3x revenues Patent holders may settle with generic holders for early product launch if it believes patent is weak Generic launched on expiry
Source: FDA, Standard Chartered Research * Green arrow indicates YES and red arrow indicates NO
FDA approval backlog may clear by September 2017; we expect more approvals over the next two years
Approval rates are slow; may improve in two years The number of ANDAs has been increasing significantly there were 2,600 ANDAs pending review in 2011. ANDA approval times have increased from an average 1218 months to 30-36 months. More than 400 ANDAs are estimated to be otherwise approvable, but require an outstanding USFDA inspection. To help reduce the bottleneck and take a new approach to ANDA filing and site inspection, the USFDA introduced the generic drug user fee amendment (GDUFA) in October 2012. The fees earned will help the USFDA increase its resources and expedite the ANDA approval process.
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The USFDA aims to clear 90% of the current application backlog by September 2017 and shorten the current approval timeline from 31 months to 15 months for 60% of the ANDAs submitted over the 12 months October 2014-September 2015 and finally to 10 months for applications submitted after October 2016. To achieve the above, the USFDA plans to hire at least 25% of incremental staff in September 2013, 50% by September 2014 and the rest by September 2015. The GDUFA may seem to be burdensome. Nevertheless, for generics companies that are serious about their ANDA approvals, the GDUFA will help cut approval periods. If the USFDA can achieve its targets, the approval rates for IPCs could double, helping offset the impact of increased price erosion from late entrants.
Life beyond the patent cliff not a steep fall

Post the end of the patent cliff in CY12, the pipeline of patent expiries is still quite healthy. Over the next six years, an additional USD 220bn worth of sales will go offpatent. All the current top 10 drugs by sales are going off-patent in the next five years. IPCs have a healthy pipeline of PIVs to capture the drugs falling into the generics fold. Figure 20: Patent expiries post patent cliff Post the patent cliff, USD 30-40bn worth of drug patents will continue to expire until 2018
80 70 60 50 41 40 30 20 10 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: Evaluetpharma, Standard Chartered Research estimates
Drug value going off-patent in USD bn 67 56
40 29 31 28
39
32 26 13 16 19 21 21
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Figure 21: Key drugs status and patent filings

6b Nexium- R
5b Cymbalta- S, L,CD, DR,T, A 4b
Abilif y-S, CD, T
Gleevec- S
3b
Atripla Cp, A Diovan- R*, L, DR, A
2b Lyrica- L
Truvada - A
1b Niacin- S
Lunesta- S, CP, G
NamendaL,T
Actonel Cp, A
Q2-14
Q3-14
Q1-14
Q4-14
Q1-15
Q2-15
Q3-15
Q4-15
Q1-16
Potential quarter of launch
Number of approved players
Sole
2-3
4-5
6-7
Q2-16
7+
S= Sun Pharma, L= Lupin, R= Ranbaxy, DR= Dr Reddy, CD= Cadila, CP= Cipla ,A= Aurobindo , T= Torrent , G= Glenmark
*= FTF exclusvity
Color of the bubble indicates number of fillers per molecule Source: FDA, Standard Chartered Research
IPCs are present in exclusivities worth c.USD 30bn of patent expiries over the next 30 months
Many blockbuster drugs Cymbalta, Nexium, Abilify, Gleevec are going off-patent. IPCs have filings for these molecules and would look to launch when the generics opportunity opens up. Overall, we remain positive about IPCs PIV filings and expect them to capture significant market share of the molecules going off-patent.
Prefer the chronic tilt

We prefer companies that have higher focus on the chronic segment rather than on the acute segment. Chronic diseases are lifestyle diseases and their treatment is generally expensive. Growth in this segment is linked to the rise in middle/upper income population, changing lifestyles and behavioural patterns. It includes diseases like diabetes, CVS, CNS, oncology, auto-immune, etc. Chronic therapies are likely to comprise 50% of the Indian market by 2020 (39% currently), with cardiovascular and anti-diabetic therapies accounting for about 30% of sales value. Currently, only 50% of diabetics in India receive treatment, and India has the largest number of diabetics in the world. Within the Indian pharma market growth of 13-15%, we expect the chronic segment to grow at c.17-19% compared with c.11-13% for the acute segment, mainly due to: Fewer people dying early from infectious diseases, living long enough to face the consequences of changing lifestyles unhealthy diet, sedentary lifestyle, tobacco and alcohol consumption. Behavioural factors tobacco use, physical inactivity, unhealthy diet and the harmful use of alcohol, are estimated to be responsible for about 80% of coronary heart disease and cerebrovascular disease.
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The chronic segment is still underpenetrated, whereas the acute segment accounts for 62% of the market. Growth is slower in the acute segment as urban India is well penetrated. The chronic segment has a higher margin of 30% compared to sub-20% for the acute. The sales force in the chronic segment is more productive as the value of products and density of doctors is high. In the acute segment, sales force productivity is also low as there are more doctors. In the chronic segment, switching across products is also low. The acute segment also has higher competition that keeps prices lower. India is a branded generics market and offers good growth prospects for companies well-positioned in chronic therapies as patients do not frequently switch brands in these segments. Globally, anti-hypertensive and anti-diabetic therapies are the largest in terms of revenue. In India, the largest brands are in the acute therapy areas. Chronic segment is difficult to get into Expansion into chronic segment is difficult Brand value, both among doctors and patients, is critical and gets developed slowly. Dedicated sales forces and focussed brand building approaches are required for client addition and market share gain. Most chronic diseases are complex and require higher R&D spend. Across emerging markets, the shift towards chronics is increasing. In Brazil, 72% of all deaths in 2007 were attributable to a chronic ailment. Brazil has one of the fastest ageing populations in the world and has increasing demand for treatment of nervous disorders, including dementia, depression and psychoses. China is also witnessing a similar rise in chronic diseases.
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Reach expansion The horizontal growth

In the third stage of growth, we believe the IPC industry could register 15-17% revenue growth, but it will require companies to expand reach. IPCs will need to focus on increasing geographical reach in Latin America, Russia, the EU and within countries where they have a presence currently, in our view. We believe IPCs ability to re-engineer, adapt to changing environments and endure the regulatory landscape will enable them to widen their geographic presence. On this parameter, Ranbaxy, Lupin, Dr. Reddys and Cipla rank the highest. EU and Japan are hardest to get into for IPCs From 2013 to 2016, growth is likely to be driven by expanding into underpenetrated emerging markets, which we expect to grow at a 12% CAGR. We also expect the Indian market to maintain growth of 13-15%. Though developed markets growth is likely to remain flat, generics are likely to show growth of 7%. Generics share in developed markets is likely to rise from 14% in FY11 to 16% in FY12 and 21% in FY17E, in our view.
Figure 22: IPCs expanding reach across geographies
Within the prescription drug market, the share of generics is likely to rise from 6% in 2003 to >10% by 2018. Over the next five years, the prescription market is likely to grow at 5% and generics at 6%, in our view.
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Figure 23: Key pharma markets

USD bn Global Developed U.S. EU5 France Germany Italy Spain UK Japan Canada South Korea Pharmerging China Tier 2 Brazil Russia India Tier 3 Rest of World US generics EU generics Japan generics Share of emerging markets 2007 731 539 283 132 36 35 23 18 20 96 19 8 111 29 29 14 8 7 53 95 62% 44% 17% 15% 2012 965 622 328 149 37 42 26 20 24 111 22 11 224 81 60 29 17 14 83 120 77% 50% 23% 23% 2017E 1,200 680 380 170 40 51 33 23 30 120 30 20 400 190 110 48 33 32 130 155 85% 60% 30% 33% 2012-2017E CAGR 4% 2% 3% 3% 2% 4% 5% 3% 5% 2% 6% 12% 12% 19% 13% 11% 14% 18% 9% 5%
Source: IMS Outlook, Standard Chartered Research estimates
Generics provided strong impetus across all DMs Figure 24: Pharma market split 2017 outlook
USD bn Global Branded Generics Other Developed Branded Generics Other Pharmerging Branded Generics Other Rest of World Branded Generics Other Share of generics Share of generics in DMs Share of generics in EMs
Source: IMS Outlook
2012 965 589 261 116 622 448 100 75 224 69 130 25 120 68 32 19 27% 16% 58%
2017E 1,200 624 432 144 665 446 140 79 390 101 246 43 145 75 52 17 36% 21% 63%
2012-2017 CAGR 4% 1% 11% 4% 1% 0% 7% 1% 13% 8% 16% 9% 3% 0% 7% 3%
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Figure 25: Worldwide prescription drug sales and generics share

1,000 WW Prescription (Rx) Sales Generics Share of generics (RHS) 11% 10% 9% 600 USD bn 8% 7% 6% 200 5% 4%
800
400
2005
2009
2004
2006
2007
2008
2010
2011
2012
2013E
2017E
2014E
2015E
2016E
Source: Evaluate Pharma
China and India expected to show the strongest growth among EMs
Emerging markets Interesting prospects

Sales in emerging markets are likely to account for 33% of global pharmaceutical spending by 2017, from 23% in 2012. Emerging markets are expected to grow at a 12% CAGR while the global markets are expected to grow only at a 4% CAGR. The growth drivers in emerging markets remain unchanged: a growing middle class, rising life expectancy, increasing lifestyle diseases and improving availability. Furthermore, generics within the EMs are expected to grow at a 14% CAGR. The share of generics within EMs is expected to move up from 58% (2012) to 63% by 2017. More importantly, branded generics form c.50% of the market according to IMS Outlook. IPCs are well suited to capture EM opportunities. We believe IPCs need to follow a tailor-made approach towards each country that involves three steps. 1. Establish sustainable local capabilities with local talent 2. Engage in portfolio marketing 3. Understand the regulatory environment Figure 26: Sizing the emerging: tier-II/ tier-III markets
USD bn Global market Emerging markets China Tier 2 Brazil Russia India Tier 3* 2011 955.5 193.6 66.7 59.9 29.9 15.7 14.3 67 2012 965 224 81 60 29 17 14 83 2016E 1,190 360 160 105 47 28 29 95 2017E 1,200 400 190 110 48 33 32 130 CAGR 2012-17E 4% 12% 19% 13% 11% 14% 18% 9%
Source: IMS Outlook *Tier 3: Mexico, Turkey, Venezuela, Argentina, Indonesia, Thailand, South Africa
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2018E
22
Figure 27: Generic penetration in value terms to increase in DMs and EMs
USD bn Global market Branded Generics Other Emerging Branded Generics Other
Source: IMS Outlook
2011 956 594 243 119 194 58 110 25
2012 965 589 261 116 224 69 130 25
2016E 1,190 631 418 141 360 86 234 40
2017E 1,200 624 432 144 390 101 246 43
CAGR 2012-17E 4% 1% 11% 4% 12% 8% 14% 12%
Generics likely to grow in double digits in EMs
EMs offer lucrative opportunities Most emerging market generics are expected to grow in double digits till 2017 as shown in the chart below. Figure 28: Emerging markets likely to grow faster than developed markets (2012-17E revenue CAGR)
18 16 14 12 10 (%) 8 6 4 2 0 France China India Canada Russia 16 15
14
14
13
12
11 8
7 5 5 4
Australia
Japan
Source: Lupin, IMS, Epsicom, Bloomberg
Russia is a high-profit region for Indian companies, providing EBITDA margins in excess of 30% due to the higher composition of branded generics. Branded generics form 36% of the Russian market. Latin America is the third-largest market for Indian generics (after the US and India). Latin American countries like Brazil and Mexico also have high EBITDA margins as drug prices are higher. But Brazil has a high amount of channel discounting, reaching up to 70%. In most of the EMs, drug prices are significantly higher than in India. In most of these countries, 70-80% of the markets are off-patent and accessible to IPCs.
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South Korea
Germany
Spain
Brazil
USA
Italy
23
UK
Figure 29: Emerging markets retail drug price index

120 100 80 100 89 80 69 54 Retail Price Index
60
40 20 0 Mexico
Source: Astra Zeneca
20
Russia
Brazil
Poland
Turkey
India
In most of the EMs, IPCs still have scope to further expand reach and product portfolios. IPCs have been increasing scale and market presence through partnerships, mergers and acquisitions. Regulatory environment tough in most emerging markets Torrent has a large presence in Brazil, while Cadila, Glenmark and Ranbaxy have a reasonable presence. Dr. Reddys has been growing well in Venezuela; it also has a longstanding profitable presence in Russia and the Commonwealth of Independent States (CIS). Russia is also a sizeable market for Ranbaxy, IPCA, Glenmark and Torrent. Cipla has a large presence in South Africa and Lupin a small footprint.
Figure 30: Critical market challenges

Brazil Nature of the market Generics penetration Out-of-pocket spending Market size (FY15) Regulatory framework for generics Approval process for generics Pricing mechanism Distribution network Competition
Mexico Branded generics 65% 83% 19 Pro-generics Neutral Free-market pricing Wholesale pharmacy Local branded generics companies
Russia/ CIS Branded generics 70% 75% 26 Pro-generics Neutral Free-market pricing for out-ofpocket Highly concentrated wholesale pharmacy Limited competition from local companies
Branded generics 60% 30% 33 Pro-generics Slow Generics priced at a 35% discount to innovator brands Wholesale pharmacy Local branded generics companies
Figure 31: Indian pharma: Sales in Emerging Markets

FY01 Revenues (USD mn) YoY growth
Source: Company reports
FY02 114 36%
FY03 135 18%
FY04 163 21%
FY05 181 11%
FY06 213 18%
FY07 297 39%
FY08 344 16%
FY09 417 21%
FY10 459 10%
FY11 538 17%
FY12 654 22%
FY13 813 24%
84
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Generic availability is still quite low across RoW markets The WHOs 2012 survey conducted in more than 70 mainly low and middle income countries indicated that the average availability of selected generics at health facilities was only 42% in the public sector and 64% in the private sector. The availability of medicines for the treatment of chronic noncommunicable diseases (NCDs) is particularly poor when compared with the availability of medicines for acute conditions. It is projected that the annual number of deaths due to cardiovascular disease will increase from 17mn in 2008 to 25mn in 2030, with annual cancer deaths increasing from 7.6mn to 13mn. The largest proportion of NCD deaths is caused by cardiovascular disease (48%), followed by cancers (21%) and chronic respiratory diseases (12%). Diabetes is directly responsible for 3.5% of NCD deaths.
The US Select opportunities

The US is the largest pharmaceutical and generics market in the world. It accounts for 34% of the global pharma market and >60% of the developed worlds generics market. India and China together produce more than 80% of the active ingredients of all drugs used in the US. While the US market has grown at a meagre 3% over the past few years (decline of 1% in CY12) to reach USD 326bn, generics still offer growth opportunities. In the US, unbranded generics contribute USD 51bn of sales (80% penetration) and are expected to sustain 7% growth. Injectables the next key growth challenge for IPCs We see significant scope for expansion for IPCs in the US market. Over the next two years, we expect around 46 drugs to go off-patent leading to USD 45bn of sales opening up to the generics market. Furthermore, IPCs do not have a significant presence in the injectables segment, which constitutes 31% of the market or biologics, which constitute 25% of the US market. Figure 32: Injectables and other novel drug delivery systems key
US 2012 medicine spending data Branded Unbranded generics Branded generics By complexity Small Molecule Biologics By distribution Retail Non retail By mode of delivery Oral Injectables Other forms
Source: IMS Outlook
2012 232.9 51.2 41.4 244.4 81.5 233.9 91.9 179.2 101.0 45.6
% share 72% 16% 13% 75% 25% 72% 28% 55% 31% 14%
Cost pressure would push US further towards generics The US has the highest healthcare cost-to-GDP among developed economies at 18% and it is expected to reach USD 3tn in CY14. Furthermore, healthcare costs are very concentrated in the privately-insured-under-65 population - 1% of patients accounting for 26% of healthcare costs and 5% accounting for 51% of healthcare costs. According to an IMS survey, over the 10 years between 2001 and 2010, generics drugs saved the US healthcare system more than USD 931bn. IPCs US generics businesses have grown at a rapid 31% over FY08-13, but still lag global
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generics peers in terms of generics revenues. Over the past 10 years, even global generics players (like Teva, Mylan and Actavis/Watson) have grown at a similar pace on a higher base. Figure 33: Despite the rapid growth, Indian pharma majors a fraction of global generics majors even in US pure generics
5.0 4.5 4.0 3.5 USD bn 3.0 2.5 2.0 1.5 1.0 0.5
0.0
Teva Sandoz Mylan Actavis/ Watson Hospira Ranbaxy DRL Sun Pharma Lupin
Even in the API segment, IPCs have been competing well, particularly in the more complex basket. The overall API market was valued at USD 110bn in CY12, and is expected to increase at a CAGR of 7-8% from 2011 to 2016.
Domestic pharma market resilient

Despite being weak near term, the Indian market outlook is positive The Indian pharmaceutical market has risen at a 10-13% CAGR over the past 10 years. While DPCO is likely to dent the growth trajectory in FY14, we believe the Indian market still has enough potential to sustain 13-15% growth. The Indian market is primarily volume driven with price being capped or at a significant discount to other EMs. Broadly, 75% of the Indian market is branded generics with 38-39% chronic. Growth in Indian pharmaceutical market is driven by: Improving medical infrastructure: India has one of the lowest beds per person with bed density of 1.3 per 1,000, which is still significantly lower than the WHO guideline of 3.5 beds per 1,000. Improving accessibility: 30% of Indians do not have access to primary healthcare facilities (source: WHO). India has c.800,000 doctors; the number needs to double to meet the basic criteria of healthcare. Only 50% of diabetics in India receive treatment, and India has the largest number of diabetics in the world. Improving demographics: Increasing per capita income has led to a shift in dietary patterns and changing lifestyle habits. In the past 15 years, the number of heart patients below the age of 40 has grown 10 times. Nearly 32mn Indians suffer from some heart disease (source: WHO). Changing behavioural factors: Tobacco use, physical inactivity, unhealthy diet and the harmful use of alcohol, are estimated to be responsible for about 80% of coronary heart disease and cerebrovascular disease.
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Longer lifespan: Fewer people are dying early from infectious diseases, living long enough to face the consequences of changing lifestyles. Affordability: Medical insurance coverage has expanded rapidly along with rising income levels. This has improved affordability of essential drugs. Increased rural push: Rural still remains largely underpenetrated. New product launches: Indian companies have launched about 20 products every year in the domestic market over the past few years.
RoW sluggish, but significantly underpenetrated

Japan and the EU are structurally moving towards increasing the share of generics in their pharmaceutical markets. Overall, the Japanese and the EU markets are expected to remain flat and also have a tough regulatory and pricing environment. However, the penetration of generics is expected to rise from 23% to 30% in Japan and from 50% to 60% in the EU. Over the longer run, we believe these markets still remain important for IPCs to boost their growth. More importantly, these markets could also provide exciting biosimilar opportunities. Figure 34: Critical market challenges
Japan Nature of the market Generic penetration Out of pocket spending Market size (CY16) Regulatory framework for generics Approval process for generics Pricing mechanism Distribution network Speciality 23% 20% 120 Not supportive of generic alternatives Master file system: Abbreviated approval process that requires only 3 of 25 data/ tests Free-pricing Hospitals/clinicians/pharmacies European Union (5) Speciality 50% 15% 150 Increasingly pro-generic Marketing Authorisation Applications (MAA) system Largely tender based Highly concentrated with insurance companies/public health service taking charge Dominated by local speciality
Competition
Dominated by local speciality
Generic expansion in Japan is a critical growth frontier
Japanese market A difficult frontier to cross Japan is the worlds second-largest pharma market. But IPCs have not been able to make inroads in this market and overall generics penetration remains low. Japan plans to increase the share of generics, driven by rising costs. Industry experts expect Japans healthcare costs to reach 10% of GDP by 2020. Over 20% of Japans population is >65 years; by 2050 that number is expected to reach 40%. Most Japanese are covered under the government funded National Health Insurance (NHI); insurance pays 70%, while patients pay the remaining 30% of the cost. The prices of generic drugs in Japan are much higher than in the US and Europe. Initial generics prices are fixed at 70% of innovator prices with biannual cuts. The high cost is also because regulatory approval in Japan for generics is much stricter than that in the US. In addition, Japan requires generics companies to provide all the strengths that the innovator provides to pharmacies. This increases the cost as companies need to provide even low volume strengths.
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Japans MHLW (Ministry of Health, Labor, and Welfare) began a campaign in 2007 to increase awareness of generics drugs as a safe alternative to branded pharmaceuticals. The government has been trying various ways generics prescription fees for doctors and pharmacists, automatic substitution, several financial incentives across the value chain (hospitals, pharmacies, patients, etc.) to promote generics penetration. In 2011, the government started with a volume based pricing mechanism. In April 2013, the MHLW started a flat sum payment system at DPC hospitals incentivizing them to use cheaper generics drugs. 1,505 hospitals (out of a total of 7,587 hospitals) are DPCs with more than 50% of beds now under DPCs. MHLW has set a target of achieving a 30% market share for generic drugs (by volume) by 2012. And, 50% market share for generic drugs (by volume) by 2025. In 2002, the market share of generic drugs was 12.2%, by 2007 it had risen to 17.2% and by 2009 generics had gained over 20% market share. In value terms, the share of generics is in the range of 6-7%. Towa, Sawai, and Nihi-iko are the top-three pure domestic generics manufacturers. Lupin, which now ranks among the top 10 generic companies in the market, is the only IPC to have established any reasonable presence by acquiring a couple of companies (Kyowa, Irom) and growing their businesses. A few more Indian companies such as Cadila Healthcare (a small business) and Ranbaxy (JV with Daiichi Sankyo) have a head start over the others. Other companies, including Dr. Reddys and Sun Pharma, have also shown interest, but have not made much headway yet. EU attractiveness declining, but still a large market The EU has been one of the most challenging markets despite the immense promise and best efforts. This market is currently a speciality focussed market with most generic drug purchases being carried out by governments and insurance companies. Across the EU, most countries are shifting towards tendering/auctioning generics medicines. Generics penetration is high in volume terms especially in countries like Germany and the UK, but low in Italy and France. Figure 35: EU is a USD 46bn generics market by our estimate
Pharmaceutical market size (USD bn) 60 75% 50 40 30 20 10 0 Germany France Italy UK Spain Central/ East Europe Rest of Europe 29% 20% 16% 52% 40% 28% 16% 20% 20% 41% 71% Generic share by volume Generic market share by value (approx) 80% 70% 60% 50% 50% 50% 40% 30%
20%
10% 0%
Source: EGA, Standard Chartered Research estimates
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France and Italy generic markets remain under-penetrated
The EU follows a complex pricing and reimbursement mechanism, which are typically set by government regulation. In many markets, such as Spain, Germany, Italy and Finland, reimbursement for generics prescription pharmaceuticals is usually based on the price of a reference (or comparable) branded pharmaceutical. Other markets, such as Italy and Austria, require the price of a new generic product to be a certain percentage lower than the originator brand. In the UK, retail generic pricing is set by the market, but reimbursement is determined by regulations based on pharmacy purchase profit. Recent developments in the EU have been challenging for all generics players on two counts. First, despite the best efforts of EU regulators to speed up generics introduction, the process remains cumbersome due to evergreening by big pharma companies, time delays and price linkages being rampant in the market. On the other hand, unhealthy competition in tender-based procurement processes launched in several countries since 2006 has led to severe margin compression for several products. Several large generics manufacturers including Teva and Dr. Reddys have withdrawn from bidding for German government tenders due to low viability. IPCs forays into Europe have not been rewarding unlike in the US. As of FY13, the EU formed between 7% and 10% of their respective sales as shown in the chart below, barring Torrent and Ranbaxy. As can be seen, in the case of larger players like Ranbaxy and Dr. Reddys, European revenues have actually declined over the past five years. Figure 36: Forays into EU still very small
FY08 revenues (INR mn) 20 15 13% 10 7% 5 0 21% FY13 revenues (INR mn) % of revenues
7%
7%
7%
6%
Ranbaxy
Dr Reddys
Torrent Pharma
Cipla
Aurobindo
Glenmark
Cadila
Figure 37: Acquisitions approach has not worked to expectations in Europe

Company Target Terapia Mundogen Betapharm Dr. Reddys Octoplus NV Torrent Pharma Heumann Aurobindo Glenmark Milpharm, Bremer Cadila Combix Alpharma
Source: Company reports
Country Romania Spain Germany
Year of Revenue % of total EU acquisition (INR bn) revenues Comment 2000 2006 2006 2006 1.5 7.3 0.8 5.7 9.9 Bought out Bayer's generics business for USD 4mn 47.2 Acquired for USD 324mn. Provided manufacturing base for CIS markets. Hit by high working capital 5.3 Buyout of generic business from GSK 69.8 An ambitious acquisition, this has been impacted badly due to shift to tender system. Dr Reddys has taken significant write-offs in this subsidiary NA Acquired for EUR 27mn. To strengthen the generic injectables business 63.4 Successful acquisition as it gave TRP a strong foothold in the German market 20.7 Minor front end for the UK NA Minor front end for CEE 12.2 Animal health subsidiary 16.2 Front end for Spain, currently struggling 71.7 First acquisition in France, now contributes sizeably to revenues
Basics GMBH Germany Ranbaxy
Netherlands Germany UK Germany France
2013 2005 2006 2007 2011 2008 2003
NA 4.1 0.9 NA 0.5 0.6 2.7
Medicamenta Czech republic
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Innovation The sustainable advantage

Innovation is a long-term growth driver. Lupin, Dr. Reddys, Glenmark and Cadila rank high on this parameter. IPCs need to innovate, build a pipeline of novel and speciality products. Global pharma companies are reducing R&D spend and turning R&D incremental. IPCs need to increase focus on incremental research so that they do not lose ground to global pharma. Innovation also plays a key role across the entire supply chain to ensure cost competitiveness vs global generics.
R&D is changing colour

Globally, the focus has shifted towards incremental R&D and cost efficiencies. IPCs need to step-up on the R&D curve to ensure they capture the 505 B(2) opportunities. These could be in the form of new drug delivery mechanisms, varying release approaches, paediatric dosages, combination drugs, niche drugs or orphan diseases. Earlier (pre-patent cliff), R&D spending by big pharma focussed on new molecules. Historically, 50% of the R&D spend went towards cancer treatment with overall R&D spend ranging between 15% and 20% of sales. The focus now, however, has changed due to (1) generic competition in once mega blockbuster drugs, (2) declining productivity of big pharma R&D, (3) shift towards speciality drugs marketed by a smaller sales force and (4) a series of mega mergers leading to cost synergies. About 143,500 employees have been laid-off in the past few years by the world's top 11 drug makers (Source: FirstWord Pharma). IPCs need to increase focus on R&D While global pharma companies have been cutting R&D spend, IPCs have been maintaining stable R&D spend of 5-7% of sales. Going forward, we believe a focused approach towards R&D will be a key differentiator for IPCs. IPCs are better placed to invest more in R&D The focus needs to shift towards more complex and higher-development-hurdle products. These products can have high development costs of c.USD 10-30mn, but will have limited competition. Over time, the larger IPCs should have significant portfolios of approvals and R&D focussed on injectables, extended-release products, ophthalmic, derma, OTC, biosimilars and similar complex/niche products. Figure 38: IPC R&D investments and productivity
50 40 5.6% 30 INR bn 20 10 0 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013
Source: IMS Health
Indian pharma R&D expense (LHS) 7.7% 6.5% 6.3%
R&D expenses as % revenue (RHS) 6.2%
9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
5.9%
6.0%
5.4%
5.7%
5.8%
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NDDS: easier strides. IPCs have made steady progress on new drug delivery systems (NDDS), which involve incremental innovation. NDDS development involves using an existing off-patent/in-licensed molecule to improve its (1) rate of release, (2) route of administration, (3) dosage concentration and (4) passive substance. Sun Pharma through Sparc has taken the lead in this field. It currently has 11 indications in various stages of field trials for the US/Indian markets. The divisions most significant achievement is the development of its proprietary Wrap Matrix technology, which uses multi-layered, matrix-based tablets. This allows controlled release of active ingredients, which enables drugs to be administered just once a day without creating a bulky tablet. Sparc has developed extended release versions of Levetiracetam and Venlafaxine under this technology and filed the NDA for this product in FY13. Both these products are likely to be marketed by Sun Pharma. The table below summarises the key NDDS developments. Figure 39: NDDS developments
Company Molecule (Brand) Indication Metastatic breast cancer Improvement API as Lyophilised white product rather than concentrated solution Uses Wrap technology for better release control Uses Wrap technology for better release control Current status Launched as Docefrez in the US in FY12 Filed NDA in Q4FY13, Filed NDA in Q1FY13, Marketed since Q2FY12 Sun Pharma Docetaxel (Taxotere)
Sun Pharma Venlafaxine ER (Effexor XR) Depression Sun Pharma Venlafaxine ER (Effexor XR) Depression Dr. Reddys Fondaparinox (Arixtra)
Source: Company data
Anti-coagulant
Novel product introduction in EMs has picked up pace
R&D turning incremental Among big pharma, R&D has shifted towards incremental developments within their existing product portfolio. As shown below, for new product launches the share of existing mechanisms and orphan drugs is increasing. Furthermore, large pharma companies to protect their products from generic competition are looking at options to evergreen their portfolios. Companies can get a new patent for a drug even after minor alteration of its formula or changing its dosage. These companies contend that even minor improvements in medicines can impact patient wellness. Some of the commonly used methods to contain market share are extended release formulations, introducing additional uses, creating combination drugs and paediatric applications. For example, AstraZeneca extended for years its franchise around the huge-selling heartburn pill Prilosec by slightly altering the chemical structure and renaming the medicine Nexium. Amgen has won many patents on its expensive erythropoietinstimulating drugs that the company has maintained exclusive sales rights for 24 years, double the usual period. Patents are normally filed long before the drug is marketed, and they tend to be effective for only 7-12 years. If a patent has less than 14 effective years from the products approval date, the patent can be restored to 14 years or a max of five years, whichever comes first.
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Figure 40: FDA approval count (no of new drugs)

Year No. of NMEs approved No. of biologicals approved Total NMEs + biologicals 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 35 5 40 27 6 33 24 8 32 17 9 26 21 14 35 31 7 38 18 10 28 18 11 29 16 10 26 21 10 31 19 15 34 15 11 26 24 11 35 2012 33 10 43
US sales 5 years post launch (USD bn) 5 year US sales per approval (USD mn)
7.1 178
7.4 224
8.5 264
12.7 487
8.3 238
14.1 371
6.4 228
9.1 313
4.5 172
4.9 158
5.3 155
10.7 411
10.4 297
15.8 367
New molecules entity launched 5 year US sales per launch

Source: IMS Health
24 346
20 705
21 305
28 325
18 250
20 245
33 161
27 396
35 297
28 564
Figure 41: Product launches showing higher mix of existing mechanisms and orphan drugs
40 35 30 25 20 15 10 5 13 12 11 10 6 5 5 3 4 6 9 5 7 6 CY07 9 6 7 7 CY08 8 CY09 18 9 11 7 12 7 10 13 10 New Mechanism Exsisting Mechanism Orphan drugs
8 CY10
10
0
CY03
Source: IMS Health
CY04
CY05
CY06
CY11
CY12
Orphan drugs are now a focus research area for IPCs
Declining returns on R&D getting management attention IRR on R&D for big pharma has gone down significantly to 7.5% (Source: Mckinsey). According to research by Bain & Company, the return on invested capital for newdrug development has dropped from 9% in 1995-2000 to 4% now. The industrys success rate in bringing a drug from research to market was just 4% between 2005 and 2009 (Source: KPMG). With overall cost of developing new molecules in the range of USD 1.3-1.5bn (one-third cost in phase 3 trials and one-third at the preclinical stage due to failure allocation), the cost of developing new molecules is not justifying returns. Furthermore, it usually takes 12-13 years to get a new drug to market.
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Figure 42: New drug launch process and timelines
Pre-clinical
Two animal species to determines toxicity and a saf e starting dose f or human trials (12/36months)
Toxicity
Rejected First approval by FDA is not made public
Investigative New Drug application 20-100 subjects (people without disease) - Determines saf ety, side ef fects, absorption etc 12months
Phase-I: Healthy volunteer study
Saf ety, Absorption
Rejected
Phase-II: Select sample ef f icacy test f or an indication
Determine ef f icacy on particular indication on a smaller sample of 100-500 subjects 12/24months
Ef f icacy
Rejected
Phase-III: Wider sample ef f icacy test f or an indication
Conf irms saf ety and ef f ectiveness of the drug on a wider sample of 1000-5000 subjects -24-48 months
Ef f icacy
Rejected
New Drug application
FDA approval f or the drug f or a particular indication, a public data
Source: IMS Health
Global R&D spends are under pressure
While global pharma reduces R&D spend, IPCs need to push the pedal For the global generics firms, R&D costs have been falling from around 20% of sales to 16% of sales. Furthermore, despite higher absolute R&D spend, the number of new products being approved has not increased. Clearly, the focus is shifting towards better monetisation of existing product portfolios rather than focus on new molecules. Figure 43: R&D as a percentage of sales decreasing
150 140 130 120 Pharma R&D Spend R&D as % of WW Rx Sales 21% 20% 19% 18%
USD bn
110
100 90 80 70 60 50
17%
16% 15%
2006
2004
2005
2007
2008
2009
2010
2011
2012
2013E
2014E
2015E
2016E
2017E
Source: IMS Health
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2018E
33
Figure 44: Research productivity has remained flat despite increase in total R&D spend
50 45 NMEs Approved Biologics approved
40
35 30 25 20
5 7 6 8 9 14 10 31 11 10 11
10
10
15 11 33
15
10 5 0
35
27
24
17
21
18
18
16
21
19
24
15
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: IMS Health
Recently large firms have downsized R&D Merck, post the acquisition of Shering Plough (2009), cut staff by 45,000 (including 2008) and closed eight R&D centres to bring costs down by USD 5bn. Pfizer, post acquisition of Wyeth (2009), has reduced staff by 20,000 to bring down costs by USD 5bn by 2015. It will focus on key therapies like oncology and inflammatory and shift away from areas such as urology and regenerative medicines. Astra Zeneca has reduced staff by 20,000 - USD 3bn reduction in R&D costs. Eli Lilly is reducing staff by 13% - USD 1bn reduction in R&D costs. GSK is slowly reducing staff by 30,000 - USD 2bn reduction in cost. Abbot, BMS, Roche-Sanofi and Novartis are also cutting costs, each reducing staff by 7,000-9,000 employees.
Novel products The final frontier is still far

Novel products that represent entirely new chemical entities (NCE) or new biological entities (NBE) require the ability to do early stage research. It requires R&D and balance sheet capabilities significantly higher than incremental research required for complex products, which involve advancements or new drug delivery systems. IPCs remain cautious on novel molecule research In the early stage (FY04-05), several IPCs decided to start looking at novel product development as the next phase of growth. After several false starts, a few products have completed phase-III trials and are awaiting approvals or launches. Commercialisation in the Indian markets has commenced, but commercialisation in the developed markets remains the final frontier and still long drawn. We have not factored in any earnings or valuation from novel drug research or any out-licensing deals. Novel product launches will be upside to our valuation of IPCs.
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IPCs over FY04-13 invested about USD 4bn in research and we believe about 25% of this spending has gone into basic/novel drug research. This is a fraction of the USD 137bn spent on pharma R&D in 2012 alone or the benchmark USD 1.3bn per new medical entity (NME). IPCs still do not have the execution or balance sheet capabilities to conduct global phase-III trials and launch products in developed markets. Figure 45: IPC R&D pathway
NCE (NDA) NDDS (505 B2) Out-licensing
Return
Generic (ANDA)
Risk
IPCs focussing on NDDS more than NCEs/ NBEs
But through a mix of out-licensing, joint development and product commercialisation in emerging markets, companies like Glenmark and Dr. Reddys have monetized some part of their investments. The track record of commercialisation is shown below. Overall, R&D expenditure remains between 6% and 8% of revenues for IPCs against 15-17% in the case of pure innovator companies. We do not foresee an immediate ramp-up in R&D spend by IPCs. However, research focussed companies like Dr. Reddys, Glenmark and Cadila have gradually inched up their R&D spend to 8%+ of revenues. Even these companies are likely to be incremental in their effort and would depend on out-licensing and sharing marketing rights in lucrative developed markets to bring down costs.
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Figure 46: Glenmark successful in commercialising research
Progress on commercialisation
Glenmark
SUN
CDH
DRL
Lupin
Time to market
Three approaches to novel research As discussed earlier, basic research is expensive, time consuming and prone to failure. Studies have shown that less than 20% of the investigative new drug (IND) applications have reached phase-III trials. Furthermore, only about 5-10% of the drugs cross phase-III trials to reach the approval stage. The high failure rate explains the large cost per NME as discussed earlier. We see three models for basic R&D investments being followed by Indian companies. (1) Out-licensing driven model It has been followed by Glenmark and Biocon. Most of the product failures occur in transition between phase-II and phase-III. Hence, out-licensing NCEs/NBEs prior to this stage helps Indian companies monetise and de-risk their research investments while allowing them to retain upside from successful commercialisation. This is especially conducive for companies like Glenmark and Biocon, which have relatively weaker front-end marketing in developed markets. Glenmark has been the most successful at out-licensing NCEs and NBEs, accumulating to date c.USD 210mn of out-licensing income (more than USD 180mn expensed), including GRC15300 and GBR500 to Sanofi, and mPGES inhibitor to Forest Labs. Biocon has partnered with Bristol Myers to commercialise oral insulin and is seeking a partner for Itolizumab. (2) Demerger of basic research Sun Pharma in FY07 demerged its basic research into Sun Pharma Advanced Research Center (Sparc). This move allowed Sparc to pursue long gestation NCE/NDDS research projects with greater flexibility. Sun Pharma has a right of first refusal for all Sparc products for the emerging markets, but Sparc is free to independently pursue out-licensing/marketing options in developed markets. Sparc has achieved some success on NDDS, but not on NCEs. In Q4FY13, Sparc filed two NDAs under 505 B(2) for Levetiracetam ER and Venlafaxine ER versions developed under Sparcs Wrap Matrix.
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(3) In-house product development This approach has been followed by Cadila and Ranbaxy. The conventional IND to marketing model of product development has seen some limited success. However, within the limited R&D budgets, the success rates have been good. Two NCEs from IPCs have completed phase-III trials and moved towards marketing in the last couple of years: Ranbaxys Synriam and Cadilas Lipaglyn. Both these products have been approved currently only in India. Details of these two products have been discussed below. Still a long way from commercialising completely inhouse product development Ranbaxy (Synriam): Synriam (combination of arterolane maleate an NCE and piperaquine phosphate) is an anti-malarial developed by Ranbaxy at a cost of USD 35mn. It has been launched in India and it is looking to launch the product in other malaria prone emerging markets. We believe that this product does not have significant potential in developed markets. Ranbaxy developed the product after inlicensing arterlone, an NCE it jointly developed with Medicines for Malaria Venture (MMV) in 2003. Cadilas Lipaglyn may need partners for DMs: Lipaglyn (Saroglitazar) from Cadila is potentially the IPCs first blockbuster drug. Lipaglyn is the worlds first glitazar approved drug after several aborted attempts most recently Roches Aleglitazar. We have noted seven previous failed attempts of glitazar trials including Novo Nordisks Ragaglitazar (pursued for some time by Dr. Reddys as Balaglitazar), Bristol Myers Muraglitazar (Pargluva) and AstraZenecas Tesaglitazar (Galida). Glitazars are dual peroxisome proliferator-activated receptors (PPAR) alpha/gamma agonists that improve the lipid profile and exert an antidiabetic action. As the only dual PPAR agonist, it has been touted as an alternative to Fenofibrates (PPAR-alpha agonist) and glitazones (PPAR-gamma agonist). However, most glitazar trials had shown various side-effects including (1) increased chances of heart failure, (2) lowered kidney function due to decreased glomerular filtration, and (3) cardio-vascular toxicity. Due to these failures in the past, the USFDA has mandated that glitazars (or any other PPAR dual agonist) requires carcinogenicity and cardiovascular studies to be conducted in a large population size. We believe that Cadila may need partners for further trials and commercialisation of the product in DMs. Cadila has not spelt out its strategy in this regard. In addition, Cadila has seven NCEs and 19 biosimilars (including two NBEs) at various stages of development.
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The chart below summarises the status of the NCE/NBE developments among the active companies in this regard. Figure 47: NCE/ NBE developments
Pre-clinical Discovery Approval Phase-III Phase-II Phase-I Market
Company
Molecule Crofelemer
Type NCE
Indication HIV-associated diarrhea
Status/ Comment In-licensed from Napo for EMs/ Commercialised Trials for two indications, not making much progress Out-licensed to Sanofi
Revamilast
Respiratory and inflammation
GRC15300 Glenmark GRC17536
Neuropathic pain osteoarthritis Pain/respiratory disorders
mPGES-1 inhibitor Vatelizumab GBR 900 Saroglitazar ZYH1 ZYD1 ZYOG1 ZYGK1, ZYG19 ZYPH0907 G-CSF/ Peg G-CSF IFN alpha -2b/Peg EPO Cadila IFN Beta 1b NBE NCE NBE
Pain/ inflammation Ulcerative Colitis
Out-licensed to Forest Labs Out-licensed to Sanofi
Dyslipidemia Dyslipidemia Diabetes, obesity Diabetes, obesity Diabetes Osteoporosis Oncology Infectious disease Oncology/ Nephrology Multiple sclerosis
Introduced in the Indian market
Introduced in the Indian market Introduced in the Indian market Introduced in the Indian market
Teriparatide Prod 1 Prod 2
Osteoporosis Nephrology Rheumatoid arthritis
MAB 1, 2, 3, 4
Oncology/ inflammation
Prod 3 Prod 4, 5, 6 MAB 5 PEG EPO Sun-597 Sun-597 Sun-K706 NCE
AMI Fertility Rabies Nephrology Rhinitis Other indications* Chronic myelogenous Leukemia
Sun/ Sparc
Sun-L731
Asthma/ allergic Rhinitis
Sun-1334H Sun-09 Sun-44 Levulan Kerastick Dr Reddys Dr Reddys17822 NCE
Allergy Spasticity Neuropathic pain Actinic Keratosis Dyslipidemia
Under commercial evaluation Under commercial evaluation Under commercial evaluation
Source: Companies, Standard Chartered Research
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Process innovation
India has a rich pool of managerial, engineering and chemist skills across the spectrum from senior to middle to lower employees. Good reverse engineering skills help identify non-infringing processes. IPCs tend to innovate on vertical integration, logistic and scale efficiencies to bring down costs. Understanding regulatory frameworks across DMs and EMs, the ability to work with regulatory agencies of various countries is a key advantage for IPCs. Proficiency in the English language is also a key advantage, particularly given the regulatory backdrop, partnerships and providing resource based services. Cost advantage Indias manufacturing cost is 25-50% cheaper than in developed markets. The cost advantage is due to locally fabricated equipment and availability of high-quality local technology. Capex cost in India is c.70% of those in developed markets. Labour costs are around 1/5th the levels in developed markets. India a global manufacturing hub for global generic players as well R&D is cheaper in India. The cost of conducting clinical trials is lower, making cost of failures more affordable. India has a wide and diverse patient pool. It also has high-quality scientists, doctors and medical institutions. Big pharma also looking at India as key manufacturing hub India has about 8,200 API and 2,400 formulation units spread across the country. It has around 200 USFDA approved drug making units, and is the second-largest supplier of pharmaceuticals to the US (after China). Most of the products are sourced within India with import content of c.40% of their raw materials. Actavis is one of the first generics manufacturers from outside India to have a fully integrated operation in the country. In 2005, it acquired Lotus Laboratories, an Indian contract research organisation headquartered in Bangalore. It employs 620 people in India. A lot of companies have simply bought facilities in India: Hospira bought Orchids generics-injectables facility, and Mylan bought Strides sterile-injectables portfolio and facility. Meanwhile, IPCs have also acquired or developed assets abroad to diversify their manufacturing locations or develop specific capability centres. Figure 48: Global pharma/ generic players: Indian manufacturing facilities
Global Major Mylan Teva Actavis Hospira Daiichi Sankyo Pfizer Takeda Sanofi-Aventis Johnson & Johnson AstraZeneca Novartis / Sandoz Merck KGAa India manufacturing presence Multiple API and formulation plants, mainly in Hyderabad & Bangalore API plant in Gajralua (UP), supplies to global markets Manufacturing, R&D plant in Goa Multiple manufacturing facilities in Chennai Manufacturing and research facility in north India (Ranbaxy acquisition) Manufacturing facility in New Mumbai Research facility in Mumbai Manufacturing facility (vaccines) in Hyderabad Manufacturing and research facility in Mumbai Research facility in Bangalore Multiple manufacturing and R&D facilities Multiple manufacturing facilities
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Inorganic growth The additional boost

Acquiring a company is the easiest lever to generate non-linear growth (compared to novel product innovation). Among IPCs, Sun Pharma has proved to be the most nimble, especially in its core US market, by (1) identifying strong and complementary acquisition targets, (2) integrating them with its core business and (3) maintaining a strong balance sheet. Lupin, Cipla and Torrent also have successfully added new geographies and product sets through acquisitions. The global generics landscape is witnessing consolidation with IPCs becoming attractive targets given their research, regulatory and manufacturing competence. M&A track record of IPCs has been mixed Most IPCs have an eye out for inorganic growth opportunities. The main reasons for the mergers and acquisitions have been to add front-end capabilities in key geographies, gain synergic product portfolios and/or technology platforms. We highlight below recent mergers and acquisitions. Inorganic growth offers significant advantages: (1) expanded product basket, (2) introduction to new technologies providing new drug delivery capabilities (injectables, derma, delayed release, etc), (3) expanded reach to new geographies and (4) ability to absorb rising R&D, development cost and risks associated with development of complex products. Figure 49: Mergers and acquisitions by IPCs
Acquirer Mylan Cipla Cipla Sun Pharma Sun Pharma Dr Reddy's Cadila Healthcare Lupin Cadila Healthcare Abbott Lupin Lupin Lupin Daiichi Sankyo Teva Lupin Cadila Healthcare Sun Pharma Ranbaxy Ranbaxy Dr Reddy's Target Comments Strides injectables unit (Agila) Acquisition of a USFDA approved injectables facility in India Quality Chemical Industries Medpro URL generic portfolio Dusa Pharma Octoplus Biochem I'rom Nesher Pharma Piramals India business Antara Pharma Dynamics Hormosan Ranbaxy Bentley Pharma Kyowa Nikkho Taro Pharma Be-Tabs Terapia Betapharm Consolidate Uganda business Consolidate South African business Scale up US generics portfolio Technology platform Technology platform Adds scale to India business Scales up Japan operations Entry into controlled substances Adds scale in India Brand in the USA Entry into South Africa Entry into Germany Generics platform Entry into Spain Entry into Japan Entry into Brazil Scales up in the USA Entry into South Africa Entry/ scale in Romania Entry into Germany
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Partnership The right way to grow

Partnership model fits IPCs well We believe IPCs are the right partners for global pharmaceutical companies for them to expand their product base, geographical reach and/or get manufacturing and R&D services. India has a good cache of chemistry skill sets. It also has significant cost advantages in research and manufacturing. We believe partnerships are critical for IPCs to expand, particularly within mid-cap IPCs that lack the ability to scale organically. Figure 50: Contract manufacturing partnerships big pharma/ global generics and IPC
Global Pharma Abbot Actavis Aspen AstraZeneca Dr. Reddy's GSK Pharma GSK Pharma Hospira Roche Takeda Lilly Pfizer Pfizer Merck & Co Indian Partner Cadilla Indoco Strides Torrent Cipla Dr. Reddy's Strides Cadila Emcure Cadilla Lupin Strides Aurobindo Sun Pharma Comments Supply agreement of generics in EMs Supply agreement of steriles in US Supply agreement of generics in EMs Supply agreement of generics in EMs Supply agreement of generics in Russia/CIS Supply agreement of generics in EMs Supply agreement of generics in EMs Supply six oncology drugs to DMs Market Roche's biologics in India Supply agreement of generics in EMs Market Lilly's biologics in India Supply agreement of injectable anti-cancer treatment in EMs (multiple oral solid and injectables) Supply agreement of generics in EMs (multiple oral solid and injectables) Supply agreement of niche generics in EMs
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PRII matrix captures the required skill set

To identify the best performers among the IPCs, we rate them using our fourparameter PRII matrix: 1) Product pipeline 2) Reach across geographies 3) Innovation to develop special/high-value products 4) Inorganic acquisitions to strengthen the product/marketing/technology platforms. We have depicted these levers in the chart below. Figure 51: PRII-sing open into the big league
Innovator, high-value products
Inorganic growth
Reach: expanding to new geographies
Product range strengthening (generic/ me-too products)

Products and Reach most critical short-term growth levers
These four levers are not necessarily sequential. In general, the progress is from product and reach to acquisitions and innovation. In the long run, being successful in at least 2-3 levers will be critical for sustained growth. Sun Pharma has focussed only on its product pipeline in the US and India, with an eye on acquisitions to strengthen its position in the US market. In contrast, Dr. Reddys has used all four levers with some success. Glenmark and Cadila have had some success in monetising innovation, which could fetch them long-term returns. A higher score on the PRII matrix suggests greater scalability. We prefer IPCs that score high Sun Pharma, Dr. Reddys, Lupin and Cipla. In the mid-cap basket, Glenmark scores well due to its research monetisation strategy, focussed product pipeline and geographical reach.
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Figure 52: PRII matrix

Product Inorganic PRII score pipeline Reach Innovation growth card Multiple Comments
Sun Pharma*
9.2
5.5
5.4
10.0
30.1
25.0x High margin core business with an impressive pipeline; strong inorganic growth track record and balance sheet. Hence, premium valuation for its core business 20.0x Most diversified product pipeline, strategic geographic reach and strong balance sheet. Hence, multiples at upper-end of sector range 21.0x Strong presence across geographies, attractive pipeline with high market share and good balance sheet. Valuation at upper end of the large-cap range 15.0x Unique focus on research combined with ability to monetize it, diversified product portfolio and reach. Valuation at premium to mid-cap pharma range 18.0x Improving business prospects especially on product pipeline in the US market. Good presence in EMs and good balance sheet. Target multiple at the mid-point of the large-cap range 18.0x Strong reach, but expanding the product pipeline in the key US market and margin expansion remain critical challenges 15.0x Strong growth on pure generics business across all geographies, value of novel product research not factored in current valuations. Target multiple at the upper end of the midcap pharma range to mid-cap pharma range 13.0x Impressive product pipeline 10.0x Large product pipeline, but reach restricted to US market and weak balance sheet. Hence, target multiples at lower-end of mid-cap pharma range
Lupin
8.8
7.0
4.2
8.7
28.6
Dr. Reddy's*
7.8
6.7
4.6
7.3
26.4
Glenmark*
7.0
5.7
5.0
5.7
23.3
Cipla
7.2
5.8
1.0
7.7
21.6
Ranbaxy Cadila
7.2 5.8
6.5 5.6
1.8 4.6
5.3 4.3
20.8 20.3
Torrent Pharma Aurobindo
5.2 6.2
5.5 3.8
1.0 1.0
6.7 2.3
18.3 13.3
Scoring mechanism details

Sun Pharma commands the highest target multiple due to its performance on the PRII matrix Product strength. To arrive at the product score, we value companies on: (1) The size of the product portfolio (both existing and in the pipeline), including therapies, and the complexity of the portfolio. (2) Profitability of the portfolio in terms of revenue per product. (3) The number of PIVs and FTFs in the pipeline. Our review shows that Sun Pharma has the best portfolio, while Lupin scores well on profitability and future exclusivity pipeline. Overall, Sun, Lupin, Dr. Reddys and Ranbaxy score the highest on products.
Figure 53: Sun Pharma and Lupin have developed their product pipeline well
Value of criteria --> Company Aurobindo Cadila Cipla Dr. Reddy's Glenmark Lupin Sun Pharma Ranbaxy Torrent Pharma
0.4 Pipeline size 9.0 7.0 8.0 8.0 7.0 9.0 10.0 7.0 5.0
0.4 Revenue per product 4.0 5.0 8.0 7.0 7.0 9.0 8.0 6.0 5.0
0.2 Exclusivities/Special products 3.0 3.0 3.0 5.0 5.0 6.0 6.0 7.0 5.0 Total product power
6.2 5.8 7.2 7.8 7.0 8.8 9.2 7.2 5.2
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43
Basis of scoring We score each of the points on the basis of the criteria mentioned below. Our total score is the sum of the scores weighted by a qualitative value of the criteria assigned (as in the table). Pipeline size. As a percentile rank based on size of the combined product pipeline (approved plus awaiting approvals). Revenue per product. As a percentile rank based on the revenue yield of the product launched. Exclusivities/Special products. As a percentile rank: we assess the presence of the companies in exclusivities, limited competition opportunities over the next 30 months. Reach strength. We analyse reach by looking at geographic presence and contribution from these geographies. We factor in both the size and the profitability of the markets. For instance, while the European markets are large, there have been relatively few profitable growth opportunities for IPCs compared to the Latin American or Indian markets due to their high profitability and relative ease of approvals. Lupin, Dr. Reddys and Ranbaxy have good geographic reach; Sun Pharma is restricted to the US. Figure 54: Geographical reach scorecard
Value of geography --> Company Aurobindo Cadila Cipla Dr. Reddy's Glenmark Lupin Sun Pharma Ranbaxy Torrent Pharma
30
10
20 India 1.0 8.0 9.0 9.0 7.0 6.0 10.0 8.0 6.0
10 Europe 5.0 1.0 1.0 7.0 5.0 3.0 1.0 7.0 7.0
10 Japan 1.0 5.0 1.0 1.0 1.0 10.0 1.0 1.0 1.0
10
100
US US branded generics generic 8.0 8.0 8.0 9.0 7.0 8.0 10.0 7.0 7.0 1.0 1.0 1.0 1.0 1.0 10.0 1.0 7.0 1.0
Africa/ LatAm other EMS 3.0 7.0 5.0 5.0 10.0 7.0 1.0 7.0 8.0 3.0 2.0 10.0 5.0 1.0 3.0 1.0 6.0 1.0
Russia/ Total Reach CIS power 1.0 2.0 5.0 10.0 8.0 4.0 1.0 6.0 8.0 3.8 5.6 5.8 6.7 5.7 7.0 5.5 6.5 5.5
Lupin and Dr. Reddys have developed niche reaches
We have scored the companies in each geography as a percentile of their relative revenues from the region, where 1 = no presence, and 10 = maximum revenues from the region. We have weighted these scores by value of geography to get the total reach power. The value of the geography (mentioned in the table) is a composite qualitative factor taking into account (1) size of the markets, (2) scalability for generic players, and (3) profitability of the markets. Innovation track record. The Indian pharma sector has a long way to go to reach the final frontier of developing and marketing innovative products. Yet, Glenmark and Cadila score well for effort and persistence, which has begun to pay-off. While Cadila has the largest pipeline of successful products, we like Glenmarks monetisation and risk management strategy. Among the larger companies, Sun Pharmas group company (Sparc), Lupin and Dr. Reddys have focussed on incremental research (i.e., novel drug delivery systems) and have achieved some success.
13 January 2014
44
Figure 55: Glenmark and Cadila high on innovation driven growth (scorecard)
Level of complexity ---> Company Monetisation potential --> Time and risk factor --> Value of the innovation Brand 1.0 1.0 1.0 NDDS 4.0 0.5 2.0 Biosimilars NCE/ NBE 5.0 0.2 1.0 10.0 0.1 1.0 Innovation score card Status
Aurobindo Cadila Cipla Dr. Reddy's
1.0 1.0 1.0 5.0
1.0 1.0 1.0 4.0
1.0 10.0 1.0 8.0
1.0 10.0 1.0 2.0
1.0 No significant focus on innovation 4.6 Has a strong pipeline of NCEs as well as NBEs with about five products launched in India 1.0 No significant focus on innovation 4.6 Has had a sputter and start in both NCE and biosimilar research but has made some progress on NDDS 5.0 Leader in novel drug research as well as monetisation 4.2 Working on NDDS pipeline of 10 products but not much clarity on progress. Leader in US branded generics 5.4 Group company Sparc working on a strong NDDS pipeline. Sun Pharma is a potential marketer for these products 1.8 Has commercialised an NCE in the developing markets, but now the NDDS pipeline is being handled by parent Daiichi Sankyo 1.0 No significant focus on innovation
Glenmark Lupin
1.0 10.0
7.0 5.0
5.0 1.0
5.0 0.0
Sun Pharma
1.0
10.0
1.0
5.0
Ranbaxy
1.0
1.0
1.0
5.0
Torrent Pharma
1.0
1.0
1.0
1.0
We have scored the companies on each of the four categories of innovative products. The scores are a percentile rank of the size of the pipeline in the market or close to commercialisation in the near future. We have weighted these scores by a factor of value of innovation. This is a composite qualitative factor that takes into account (1) size of the monetisation potential of the innovation and (2) time and risk of failure factor attached with each of these categories. Sun Pharma has grown extremely well on acquisitions Inorganic growth track record. We value inorganic growth potential based on historical track record, balance sheet strength on its cash position and ability to take on debt, and finally on free cash flow generation. Sun, Lupin, Dr. Redd ys and Torrent score the highest for their strong track record in completing strategic acquisitions and integrating them with their core businesses. Sun Pharma has the best balance sheet and cash flow potential and is well placed on potential acquisitions going forward.
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45
Figure 56: Sun Pharma and Lupin have the best inorganic growth track record and potential (scorecard)
Track Balance sheet record strength Company Aurobindo Cadila Cipla Dr. Reddy's Glenmark Lupin Sun Pharma Ranbaxy Torrent Pharma 3.0 3.0 6.0 5.0 5.0 9.0 10.0 5.0 6.0 1.0 3.0 9.0 9.0 6.0 9.0 10.0 8.0 8.0 3.0 7.0 8.0 8.0 6.0 8.0 10.0 3.0 6.0 2.3 4.3 7.7 Acquisitions in EM 7.3 Setbacks in Europe due to Betapharm, not many recent successes 5.7 8.7 Successful big ticket acquisitions in Japan, but more niche acquisitions in the US 10.0 Successfully executed and integrated big ticket acquisitions in the US 5.3 Had made successful acquisitions earlier, but unlikely to make any further acquisitions going forward 6.7 Successful Europe acquisitions Free cash flow generation Acquisition potential Comments
We have scored companies on inorganic growth on the basis of three equal weighted factors discussed below. Track record - As a percentile rank of the contribution that the inorganic route has made to the revenue growth trajectory of the company Balance sheet strength - As a percentile rank of the net debt to EBITDA ratio for the companies Free cash flow potential - As a percentile rank of the free cash flow yield of the companies
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46
Concerns surmountable
The third wave of growth has brought its own set of problems rising competition, a tougher regulatory environment, increasing cost structure and slower approval rates. Furthermore, IPCs now face increased competition from (1) global generics, (2) new generic companies that plan to establish a global footprint and (3) arms of big pharma that are focussed on generics. Competition more intense, but IPCs are up to it We believe IPCs are resilient enough to face these challenges. Given their skill sets and cost advantages, they could still be able to achieve 15-17% growth. Challenges to their growth are primarily driven by local regulations that try to cut healthcare costs and improve product oversight. Some recent regulatory challenges across various markets are summarised in the table below. Figure 57: Key challenges
Country Russia Challenge Russia targets to increase share of domestic players to 50% of the market by 2020. Currently 72% of medicines in Russia are imported (35% by volume). The Russian market also faces higher debtor levels, thus affecting working capital requirements. The government is putting a price ceiling on essential drugs leading to price reduction. In CY11, the Russian government introduced a price freeze on essential medicines (5,000 drugs), which impacted pricing power of branded generic companies. Recently (July 2013), the Ministry of Health of Russia published an order which binds physicians to prescribe medical products by only active ingredient, or combination list of active ingredients. Mandatory price reductions through auction process Implications Implementation of these measures has been weak and penalties for non-compliance have not yet been clarified.
European Union
Larger volumes, but fewer profitable opportunties in the European market. Larger approved product portfolio key to success Approval timelines have expanded from 6-12 months to 18-24 months Introduction of biosimilars in US market continues to remain a challenge. Currently the time frame for these products is similar to a novel biologic drug
Cost of approvals has increased and the approval process has become more stringent US Biosimilar regulatory pathway is not yet finalised
South Africa
National health insurance is starting tendering of drugs to bring prices down. The new reference pricing scheme will look at each therapeutic class as a whole and possibly take the lowest price instead of the average price. Turkey has a difficult regulatory environment, which causes a significant backlog in the registration process, typically taking 18 to 36 months. Turkey has recently increased its social security discount rates and also reduced reference pricing. Has implemented a centralized annual tendering program from 2013 and has introduced a price cap on essential drugs Has introduced a more unified pricing measure to reduce the gap between local generics and off-patent international brands. Like in several other countries, increased approval backlog has led to significant channel inventory
Turkey
Vietnam
China
13 January 2014
47
Appendix 1: Indian government action

Compulsory Licensing
India recently revoked patents of Novartis (Glivec), Bayer (Nexavar), Pfizer (Sutent) and Roche (Pegasys, Herceptin). Many emerging countries such as China, South Africa and Greece have been looking to emulate India on compulsory licensing to reduce prices of costly patented drugs. Compulsory Licensing is a provision under the Indian Patent Act, which allows the government to mandate a generic drug maker to produce inexpensive medicine in public interest even as a patent on the product is valid. The provision provides a rare flexibility on patent protection included in the World Trade Organisation's agreement on intellectual property. Several developing and developed countries, including Italy and Thailand, have more drugs under Compulsory Licences than India.
National List of Essential Medicines (NLEM) notification

The Ministry of Chemicals and Fertilizers issued the Drug Price Control Order (2013) on 15 May 2013. Below are its key features. Pricing methodology: All strengths and dosages specified in the National List of Essential Medicines (NLEM) 2011 will be under price control. Ceiling Prices (CP) will be fixed on the basis of market-based data (MBD). Formula for computing CP is the simple average price of all brands that have MS (Moving Annual Turnover) of 1% or more. Manufacturers will be free to fix any price for their products equal to or below CP. Annual price increases: Automatic annual price adjustment (up or down) linked to WPI for NLEM products is allowed. CP will be revised every five years or as and when the NLEM is updated / revised. However, if there is a significant change in the market structure of a product, the government will revise the CP even earlier. CP will also apply to imported drugs under the NLEM. Annual price increase of up to 10% for non-NLEM drugs is allowed. Combinations outside the purview of price control: From the policy documents, we believe that combination drugs have been kept outside the purview of price control, as the policy states that the span of price control shall be as per the dosages and strengths as listed in NLEM 2011. This implies that all combi nations that are outside the NLEM will not be subjected to price controls. We await final confirmation of this from the industry. Existing DPCO drugs: Prices of existing DPCO products not in NLEM 2011 would be frozen for one year, and thereafter, an increase of up to 10% per annum will be allowed. This will be a key positive for MNCs over the long term. New combinations: Any new combination of NLEM+NLEM or NLEM+Non-NLEM will require price approval from the government. Any addition to NLEM 2011 by the Ministry of Health will come under price control. The Department of Pharmaceuticals will monitor production and availability of NLEM products. Original research products having product/process patents and NDDS products are exempted from price control for five years.
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Figure 58: NLEM sales as a percentage of domestic sales

25 20 15 (%) 10 5 0
Biocon
Cadila
GSK
Ranbaxy
Sun Pharma
Source: AIOCD-AWACS, Standard Chartered Research
The NPPP 2011 has very narrowly proposed to limit prices of essential drugs as laid down in the National List of Essential Medicines 2011 (NLEM 2011). As shown in Fig 59 below, the draft policy is fairly comprehensive, encompassing a wide range of products with explicit guidelines for price control. Figure 59: Key highlights of the proposed policy of the Department of Pharmaceuticals
Product segment Span of control
Price control of formulations only, proposes deregulation of all bulk drugs Drugs listed in NLEM 2011, which is based on the essentiality of drugs. This is a departure from the earlier criteria of
economic/market share principle adopted in Drug Policy 1994.
List contains 348 medicines, only 34 are common with the DPCO list All specified/non specified strengths and combinations within NLEM as well as outside NLEM (having one or more
NLEM listed drugs) to be under price control.
NLEM to be revised every five years or as required from time to time

Pricing
Ceiling price based on the weighted average retail price (WAP) of top 3 brands by value in any formulation Exempted from price control if unit price <INR 3 per unit No separate determination of ceiling price for imported drugs, calculation based on WAP of top 3 brands. Annual revision in prices based on WPI for manufactured goods Based on MAT as derived from available market research Price increases based on WPI for two years
Turnover
Non scheduled drugs For drugs not under control, in case of more than 15% price increase, NPPA to reduce the prices for 12 months DPCO
13 January 2014
Dr Reddys
Glenmark
Pharma market
49
Cipla
Lupin
Torrent
Appendix 2: US sales data

Figure 60: Top drugs in the US market and spending on each indication
US pharma spending (USD bn) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Nexium Abilify Crestor Advair Cymbalta HUMIRA Enbrel Remicade Copaxone Neulasta Singulair Rituxan Plavix Atripla Spiriva Oxycontin Januvia Avastin Lantus Truvada Atorvastatin Lantus Epogen Diovan Lyrica Top 25 Total U.S. Market % share of top 25 US pharma spending (USD bn categories) Total U.S. Market 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Oncologics Mental Health Respiratory Agents Antidiabetics Pain Lipid Regulator Autoimmune Antihypertensives, Plain & Combo HIV Antivirals ADHD Anti-Ulcerants Multiple Sclerosis Antibacterials Nervous System Disorder Vaccines (pure, combo & others) Hormonal Contraception, systemic Other CNS Immunostim AG Ex Intfron, Glatiramer Ace Antivirals, Excl. Anti-HIV Platelet Aggregation Inhibitors 2008 5.9 3 2.1 4.4 2.4 2.1 3.1 3 1.4 3 3.5 2.4 4.8 1.4 1.4 2.3 1.2 2.5 1.8 1.1 0.4 3 1.6 1.5 59.3 285.7 21% 2008 285.7 19.7 26 16 13.6 16.8 18.1 8.6 14.7 7.1 5.5 14.2 4.1 10.1 12.3 5 4.5 4.3 4.1 3.9 5.7 214.3
Source: IMS health
2009 6.3 4 3 4.7 2.8 2.5 3.3 3.2 1.7 3 3.7 2.6 5.6 1.9 1.7 2.9 1.5 3 1.9 1.4 0.7 3.2 1.7 1.6 67.9 300.7 23% 2009 300.7 21.5 26.1 18.1 15.8 17.3 18.6 9.7 15.4 8.2 6.7 14.1 5 10.4 8.1 4.7 4.7 4.5 4.1 4.8 6.5 224.3
2010 6.5 4.6 4 4.9 3.2 3.1 3.5 3.3 2.4 3 4.2 2.8 6.4 2.3 2.1 3.1 1.8 3.1 2 1.7 1.1 3.3 2 1.7 76.1 316.5 24% 2010 316.5 22.6 28.2 19.8 18.4 17.6 19.8 11 15.6 9.4 7.9 12.4 6.1 10.1 6.9 5.7 4.9 4.8 4.2 3.3 7.4 236.1
2011 6.4 5.3 4.6 4.8 3.8 3.7 3.8 3.5 3.2 3.3 4.8 3 7.1 2.6 2.5 2.9 2.2 2.7 2.1 2 0.5 1.6 2.8 2 1.8 83 329.2 25% 2011 329.2 24 29.7 21.7 20.5 17.9 21.3 12.5 14 10.4 9.2 10.5 7.6 9.3 6.9 6.4 5.2 4.8 4.6 3.8 8.2 248.5
2012 6.0 5.9 5.1 4.9 4.7 4.6 4.3 3.9 3.6 3.5 3.3 3.2 3 2.9 2.8 2.8 2.7 2.7 2.3 2.3 2.3 2.2 2.2 2.1 2 85.3 325.8 26% 2012 325.8 25.9 23.5 22.1 22 18.2 16.9 14.8 13.6 11.7 10.4 10 8.9 7.9 7.2 6.8 5.5 5 4.7 4.5 4.4 244
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50
Appendix 3: Abbreviations
1. 505 B(2). A section of the Federal Food Drug and Cosmetics Act, which allows easier introduction of novel delivery modes for an already approved molecule API: Active Pharmaceutical Ingredient ANDA: Abbreviated New Drug Application. A filing for a generic version of an approved drug. This application is abbreviated as it has fewer clinical trial data requirements compared to a new drug FDA: Federal Drug Authority, the US drug approval authority PIV: Para-IV products FTF: First to File. First generic to file for approval for a generic variant EM: Emerging Markets DM: Developed Markets WHO: World Health Organisation
2. 3.
4. 5. 6. 7. 8. 9.
10. EU: European Union 11. NDDS: Novel Drug Delivery System - Development of improved mechanisms for administering an already available drug 12. XR: Extended Release version of an already available drug 13. NDA: New Drug Application 14. NCE: New Chemical Entity 15. NBE: New Biologic Entity 16. GSK: Glaxo Smith Kline 17. NME: New Medicinal Entity 18. CONITEC: National Commission for Incorporation of Technologies - A Brazilian body to evaluate the economic viability of new drugs/ medical technologies for healthcare reimbursements 19. DPCO: Drug Price Control Office, Indian drug price controller 20. NELM: National List of Essential Medicines 21. GDUFA: Generic Drug User Fee, application fee for new generic filings in USA
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Sun Pharmaceutical Industries

The juggernaut rolls on
We upgrade Sun to Outperform with a 12-month PT of INR 646, based on one-year-forward P/E of 25x. We expect Sun to maintain its sector premium given 20% sales CAGR, sustainable EBITDA margin of 40%+ and RoE of 25%+, leading to 21% EPS CAGR over FY13-16E. On our PRII matrix, Suns reach is limited, but it scores high on (1) size/depth of product range, (2) capitalising opportunities and (3) inorganic growth track record. Despite concerns over slowing approvals and a high share of one-offs, Sun is an attractive pick. Focusing on depth rather than spread. We like Suns strategy: (1) nimble footed scouting to raise pricing/market share in its existing US portfolio; (2) strategic acquisitions to ramp up its portfolio to complement reach and marketing abilities; (3) pursuing early-stage generics through Para-IVs; (4) strengthening position in India and in the chronic segment; and (5) improving its product basket through acquisitions and large/complex ANDA pipeline. Levers visible. In the past five years, Sun reported a 34% CAGR in US sales (USD 1bn by FY13). We believe it can still register 23% US sales CAGR over FY13-16E. Our analysis indicates Sun will benefit from its large, 133 ANDA pipeline, which increasingly focuses on complex and niche products. We expect special product opportunities to make a significant contribution over FY1416, specifically these five products (1) Doxil, (2) Prandin (both currently with exclusivity), (3) Lunesta (Q2FY14 launch, limited competition), (4) Cymbalta (Q4FY14 launch) and (5) Gleevec (FY16 launch, sole exclusivity). Strategic acquisitions helped propel growth. Suns US acquisitions (Taro, URL and Dusa) contribute >50% of US sales. Excluding these, US revenue CAGR falls to 14% with Suns revenue CAGR dropping from 27% to 18%. Sun has picked and well-executed acquisitions that complement its existing footprint. Sustainable premium. We expect Sun to report 20%+ growth and 26-28% RoE. It has good execution capabilities and a healthy balance sheet. Nevertheless, slow approval rates, rising share of one-offs and drop in cash reserves are near-term concerns. Our 12-month PT for Sun is INR 646, at one-year-forward P/E multiple of 25x for the base business (INR 406), 12x for Taro (INR 134), one-offs at INR 34 and cash at INR 72. Our PT implies 25x FY15E and 21x FY16E PE on consolidated earnings. Gaurav Pathak
13 January 2014
SUNP IN INR 594. 20 INR 646. 00
OUTPERFORM
PRICE as of 7 Jan 2014
(from IN-LINE)
PRICE TARGET
INR 594.20
Bloomberg code
INR 646.00
Reuters code
SUNP IN
Market cap
SUN.BO
12-month range
INR 1,230,707mn (USD 19,748mn)

EPS adj. est. change 2014E
INR 347.00 - 651.90

2015E 22.8%
23.6%
Year-end: March Sales (INR mn) EBITDA (INR mn) EBIT (INR mn) Pre-tax profit (INR mn) Net profit adj. (INR mn) FCF (INR mn) EPS adj. (INR) Core EPS (INR) DPS (INR) Book value/share (INR) EPS growth adj. (%) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Div. payout (%) Net gearing (%) ROE (%) ROCE (%) EV/sales (x) EV/EBITDA (x) PBR (x) PER adj. (x) Dividend yield (%)
2013 112,999 49,673 46,311 43,149 34,807 15,041 16.81 9.45 2.92 72.37 34.5 18.4 44.0 41.0 30.8 20.1 -9.6 22.2 28.5 6.1 13.8 5.7 20.2 0.9
2014E 144,204 63,678 59,159 36,033 47,172 13,134 22.78 11.55 3.11 81.58 35.5 6.5 44.2 41.0 32.7 25.3 -11.3 16.0 30.8 8.4 19.0 7.3 26.1 0.5
2015E 166,941 73,552 68,770 71,073 53,629 49,398 25.89 13.32 3.67 103.81 13.7 17.7 44.1 41.2 32.1 14.2 -24.2 27.9 30.5 7.0 16.0 5.7 22.9 0.6
2016E 194,209 86,100 80,949 83,612 62,932 58,043 30.38 16.58 4.07 130.13 17.3 10.9 44.3 41.7 32.4 13.4 -34.3 26.0 29.0 5.8 13.1 4.6 19.6 0.7
Share price performance

Sun Pharmaceutical Industries 700 500 300 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
Share price (%) Ordinary shares Relative to index Relative to sector Major shareholder Free float Average turnover (USD)
Source: Company, FactSet
-1 mth 2 4 -
-3 mth -12 mth -2 60 -5 52 Promoter (63.7%) 36% 18,172,137
Shashikiran Rao
52
Investment argument and valuation

We believe 20%+ EPS growth at 25%+ RoE is sustainable. We still expect it to report US sales CAGR of 23% over FY13-16E, driven by ANDAs, Para-IVs and ramping up recent acquisitions. We estimate India formulations will grow at 16.5% and international formulations (ex US) at 18%. It has strong execution/management capabilities and a healthy balance sheet, in our view. Sun has the ability to pick and execute acquisitions that complement its existing footprint and market it better. We value Sun at INR 646, valuing its base business at 25x one-year-forward earnings (INR 406), Taro at 15x one-year-forward EPS (INR 134) and one-offs and cash at INR106, implying 25x FY15E P/E.
Premium over sector justified

Sun Pharma trades at a 20-30% premium to the sector Barring a brief period in May 2009, when the consent decree proceedings in Caraco cropped up, Sun has always traded at a premium to other large cap pharma players. This premium was driven by its high margin/return profile and strong growth momentum. We expect it to maintain this profile up to FY16E. Sun also has strong execution/management capabilities and a healthy balance sheet. Furthermore, Sun has the ability to pick and execute acquisitions that complement its existing footprint and market it to realise higher volumes or pricing opportunities, in our view. Figure 61: Valuation premium over pharma large caps at around 15-20%
150 140 130 120 (%) 110 100 90 80 SunP forward PE as % of large cap pharma
Source: Bloomberg, Standard Chartered Research
13 January 2014
Dec-13
53
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Jun-13
Figure 62: Sun has the highest margins among pharma large caps
50
Sun Pharma 41
Dr Reddy's
44
Cipla
Lupin
44
40 28 25 24 21
30 %
23
24
23
25
23
20
10
0 FY12
Source: Companies
FY13
FY14E
Short-term upside probably factored in
Nevertheless, note that part of the high margin is due to strong revenues from exclusivities that the company has earned (as discussed later). Going forward, we see fewer exclusivity opportunities for the company over FY14-16E.
US business continues to shine

The US is Suns core geography, whose contribution rose from 35% in FY09 to 53% in FY13. We estimate it to rise to 57% by FY16. We expect US sales CAGR of 23% over FY13-16 driven primarily by acquisitions (Caraco in 1997, Taro in 2009/10, Dusa in 2012, URL in 2013) and one-off products. Sun Pharma reported US sales CAGR of 34% over FY08-13; now acquisitions (Taro, URL and Dusa) contribute >50% of US sales. Excluding these acquisitions, US revenue CAGR falls to 14%. Suns excellent ability to pick and execute acquisitions has been its key strength. Over FY13-16E, we expect US sales CAGR of 23%, driven by the 133 products in the ANDA pipeline, which are increasingly focused on complex and niche products injectables, topicals, controlled substances and in-house research-based delivery system products. Furthermore, sales from URL and DUSA have not had a full-year impact and could potentially rise higher. Figure 63: US business growth
160 140 120 100 INR bn 80 60 40 20 0 2.6 36.2 38.2 26.5 FY13 FY14E FY15E FY16E 6.5 9.8 13.8 FY11 4.5 40.6 14.1 43.9 54.7 23.3 19.1
Base business
Taro sales
DUSA sales
URL sales
Special products
42.0 46.5
7.8 14.0
FY08
9.2 15.3 FY09
6.3 11.0 FY10
26.0 13.8 FY12
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54
Limited competition products likely to contribute USD 943mn of sales in FY14-16E
We believe that Sun Pharmas sales from limited competition products are likely to moderate over FY14-16E, with growth mainly driven by regular pipeline expansion. Among the special products, we highlight five exclusive/limited competition products that could contribute significantly to its growth and margin profile. Doxil (Liposomal Doxorubicin). As things stand today, Sun is the only supplier of Doxil in the US market after the innovator stopped supplies in Q2FY14. We expect status quo at least until FY15-end before competing products are approved. We estimate Doxil accounts for one-third of Suns special product revenues. Prandin (Repadlinide). Caraco launched the product in Q2FY14 with 180-day exclusivity after the US Federal Circuit ruled in favour of Caraco in the Generic Prandin litigation against Novo Nordisk. Repaglinide tablets have annual sales of approximately USD 200mn in the US. After the exclusivity ends, we expect only 23 more entrants. Gleevec (Imatinib Mesylate). We believe this will be the most significant exclusivity for the company, with benefits coming in by FY16. Sun enjoys sole FTF exclusivity for the product, which had a market size of USD 4.3bn in 2012. Duloxetine (generic Cymbalata). It was launched in December 2013 post the expiry of paediatric exclusivity of its basic patent. For Cymbalta, exclusivity is shared among seven players. Eszopiclone (Lunesta). To be launched in June 2014 post the expiry of paediatric exclusivity of its basic patent. We believe that Sun shares the exclusivity with several other filers, but some of the filers may have discontinued their application and hence we see good scope for this product. Over the past 3-4 years, Suns total product pipeline has grown almost four times from 83 (as of December 2009) to 320 (as of June 2013). The largest growth has come in the dermatology segment through the acquisition of Taro. Organic growth (ex-Taro) has primarily been in the chronic and difficult-to-manufacture segments like CNS and CVS. This has been a critical driver of Suns margins. The URL acquisition adds ANDAs corresponding to 107 products to the companys US generics portfolio. Figure 64: Fast pace of filings and approvals
500 450 400 Cumulative filed Cumulative approved Added Taro 377 Pending 449 397 453
350
300 Nos 250 200 150 100 40 15 FY05
Source: Company
311
225 152 69 84 250
320
177 142 95 59 53
207
147
138
133
50
0
20
FY06
29 FY07
FY08
FY09
FY10
FY11
FY12
FY13
YTDFY14
13 January 2014
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Figure 65: US product approvals by segment

Pre-2009 0 Skin (Taro acq) CNS CVS Pain Others* 25 20 17 9 6 28 38 78 20 2010 40 2011 As of June 2013 60 80 100 94
Allergy
Oncology Metabolism Cough/ Cold Urology
Source: Company, *Respiratory, Gastro, Antibiotic, Endocrine
Domestic formalations Maintain market share, but diminishing importance

We expect Sun to report domestic formulation CAGR of 16% over FY13-16E, growing in line, but on the higher side of the market. Sun has performed well in Indias pharmaceutical market, expanding its market share to 5.1% as of June 2013 (from 4% in FY11). Despite this, Sun posted domestic revenue CAGR of only 15% over FY08-13. Consequently, domestic formulations contribution to revenue dropped to 34% in FY13 from 58% in FY10. We expect it to drop further to 28% by FY16E. Figure 66: Domestic formulations contribution to remain robust (INR m n)
FY10 Domestic formulations Domestic API Total domestic sales % of total sales Domestic formulations Domestic API Total domestic sales 44.9 13.5 58.4 41.7 8.9 50.6 35.8 7.5 43.3 26.9 6.7 33.7 23.5 6.1 29.6 22.5 5.8 28.3 22.5 5.8 28.3 18,301 5,491 23,792 FY11 24,683 5,275 29,958 FY12 29,154 6,147 35,301 FY13 30,220 7,565 37,785 FY14E 32,638 8,505 41,142 FY15E 36,554 9,493 46,047 FY16E 40,941 10,596 51,537 CAGR FY13-16E 10.7 11.9 10.9
Source: Company, Standard Chartered Research estimates Note: FY10 sales are lower by INR 2bn due to one-off sales in Q4FY09; growth is adjusted accordingly
Grown faster than domestic market and peers
Sun Pharmas domestic formulations business has traditionally grown faster than the domestic market (15% CAGR over FY08-13) and all domestic peers except Lupin. This is mainly due to a favourable product mix and focus on high value and brand sensitive CV/CNS/ diabetology segments.
13 January 2014
56
Figure 67: Sun Pharma has historically outgrown peers

FY08 (INR mn) Ranbaxy* Cipla Sun Pharma Cadila Lupin Torrent Dr. Reddys
Source: Companies
FY13 (INR mn) 21,661 37,026 29,657 30,218 23,708 10,240 14,560
CAGR FY08-13 (%) 5 13 15 15 20 12 13
16,659 19,868 14,762 14,888 9,496 5,813 8,060
Sun Pharmas domestic formulations have focused on higher growth segments like psychiatry, neurology, cardiology and diabetology; these segments contributed almost 60% to incremental growth over FY02-13. Almost 79% of Sun Pharmas product basket is in the chronic segment that has been growing at double the growth rate of the acute segment. As shown in Figure 8 below, the chronic segment contributed almost 70% of incremental growth between FY02 and FY13. Figure 68: Domestic growth led by chronic therapies (INR mn)
Segment rank Neuro-Psychiatry Cardiology Diabetology Gastroenterology Gynecology & Urology Musculo-skeletal Pain Anti-asthmatic & Anti-allergic Ophthalmology Others Total sales
Source: Company
Sales (FY02) 1,468 956 392 443 200 424 247 144 387 4,661
As a % of total domestic sales 32 21 8 10 4 9 5 3 8
Sales (FY13) 7,857 6,044 3,324 4,231 2,418 1,511 1,209 1,511 2,115 30,220
As a % of total domestic sales 26 20 11 14 8 5 4 5 7
CAGR FY02-13 16 18 21 23 25 12 16 24 17 19
1 1 1 2 3 8 8 1 5 1
Valuation
Sun Pharma Rating: Outperform PT: INR 646 We value Sun at an SoTP-based price target of INR 646, valuing the base business at 25x FY16E EPS (INR 406), Taro at 12x FY16E EPS (INR 134) and one-offs and cash at INR 106 implying 25x FY15E and 21x FY16E PE. Figure 69: P/E-based value at INR 646
Base EPS FY16 (INR) Target P/E multiple (x) Value of base business (INR per share) Taro EPS FY16 (INR) Target P/E multiple (x) Value of base business (INR per share) NPV value of one-off opportunities (INR) Cash per share (INR) Price target (INR)
16 25 406 9 15 134 34 73 646
13 January 2014
57
We value the base business earnings at a premium to domestic peers Sun Pharma has historically traded at a higher PE band than domestic peers, driven by strong growth, margin and return profiles. We believe the premium valuations are sustainable. Furthermore, Sun gets a premium for the cash on its books that can be used for strategic acquisitions. Historically, Suns acquisitions have been value accretive. It has shown the ability to find the right synergy, prudence and good execution in its acquisitions. At our price target, the implied PE multiple is 25x for FY15E and 21x for FY16E. Figure 70: Implied P/E multiples at PT
FY14E Consolidated EPS (INR) Implied PE multiple (x)
FY15E 26 25
FY16E 30 21
23 28
Figure 71: Sun Pharma one-year-forward PE band chart

650 550 450 15x 20x 25x SUNP CMP
350
INR 250 150 50 -50
Dec-07
Dec-05
Dec-06
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
On a comparative basis, Sun Pharma has traded at a premium to all the companies in the sector over the past 2-3 years. Figure 72: Sun started commanding a premium to the sector in FY12
28 26 24 22 (x) 20 18 16 14 12 10 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
58
Sun Pharma
Lupin
Dr Reddys
Cipla
Jun-09
13 January 2014
Jun-13
Jun-07
Jun-08
Jun-10
Jun-11
Jun-12
Dec-13
Jun-11
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-12
Jun-13
Financials
We expect revenue growth of 17% over FY13-16E EBITDA margin is likely to decline slightly due to lower margins in Taro Revenue to post 17% CAGR over FY13-16E led by domestic formulations and US generics We estimate Sun Pharmas revenue will post a healthy 17% CAGR over FY13 -16E to INR 194bn primarily led by domestic formulations and US generics growth. We expect domestic formulations sales to report 17% CAGR over FY13-16E to INR 57bn in FY16. The US generics business is likely to grow to INR 110bn by FY16E, in our view, registering 23% CAGR over FY13-16E. Figure 73: Revenue to grow at 17% CAGR over FY13-16E
220 200 180 160 140 Rsb 120 100 80 60 40 20 0 FY12 FY13 FY14E FY15E FY16E
Revenue likely to post healthy 17% CAGR over FY13-16E
SUNP sales
Growth yoy 194.2 166.9
50 45 40
144.2 112.8 81.9
35
30 %
25
20
15
10
5
0
Figure 74: Revenue breakdown across segments

FY13 Formulations - Domestic -International API US generics Total 46 30 15 8 60 113 FY14E 51 33 19 9 79 139 Growth yoy (%) 13 8 22 12 32 23 FY15E 59 37 22 9 97 165 CAGR FY16E FY13-16E (%) 67 41 26 11 105 182 14 11 20 12 20 17
Source: Source: Company, Standard Chartered Research estimates
13 January 2014
59
EBITDA margins likely to remain flat
EBITDA margins strong due to integration of new acquisitions and currency We expect EBITDA margin to rise marginally by 30bps over FY13-16E to 44.3% in FY16E, powered by currency and the successful integration of new acquisitions. Figure 75: Sun Pharmas cost breakdown and operating profitability
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY11 FY12 FY13 FY14E FY15E FY16E
EBITDA 20.9 14.3
COGS 19.1 14.8
R&D
Employee expenses 18.2 13.6 18.1 13.3
Other expenses
18.3
13.2
18.2 13.1
25.5
20.5
18.4
18.5
18.2
18.0
34.3
40.8
44.0
44.2
44.1
44.3
Net profit likely to post 20% CAGR over FY13-16
We expect net profit to rise at a 20% CAGR over FY13-16E to INR 69bn in FY16E. Figure 76: Net profit and growth
80 70 60 INR bn 50 40 30 29.7 39.7 30 % 59.0 52.3
PAT
Growth yoy
68.6
60
45
20
10 0 FY12 FY13 FY14E FY15E FY16E
15
13 January 2014
60
Company profile
Sun Pharma is Indias largest pharma company by market cap (USD 20bn). It is also one of the fastest-growing Indian pharmaceutical companies. It also has one of the highest margins among domestic peers. Sun Pharma has a significant presence in the domestic formulations market and the US generics market. With over 2,600 medical representatives, Sun Pharma has a market share of 5.1% and is the market leader in India. It has domestic market leadership across leading therapeutic categories like psychiatry, neurology and CVs. Sun Pharma has 23 manufacturing facilities for APIs and formulations across five continents giving it a vertically integrated structure and significant cost advantages. Figure 77: Shareholding pattern
Others 10%
Figure 78: Revenue mix

API 7%
DII 3%
FII 23%
Promoter 64%
US generic 53%
Domestic formulation 27%
International formulation 13%

Source: Company Source: Company
Figure 79: Management

Dilip S. Shanghvi Chairman & MD He is a graduate in commerce from Kolkata University. He founded Sun Pharma in 1982 and has extensive industrial experience in the pharmaceutical industry. Shanghvi is actively involved in international pharmaceutical markets and research and development functions in the company and is also the Chairman of Caraco S. Kalyanasundaram CEO He is a BSc, ACA and has almost three decades of regional/global experience much of which has been in pharmaceuticals, largely with GSK. As the MD of GSK India, he led the GSK India turnaround; and in the regional role, he spearheaded the company's differentiated and region-specific emerging markets strategy. He also led the commencement of operations in certain emerging markets such as Vietnam, IndoChina, as well as the Wellcome New Zealand reorganization
Source: Company
13 January 2014
61
Income statement (INR mn)

Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) Core EPS (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 80,118 112,999 144,204 166,941 194,209 63,719 92,202 117,526 136,557 159,251 (29,421) (38,965) (49,036) (56,990) (65,934) 0 0 0 0 0 (1,622) (3,565) (4,812) (6,015) (7,218) 29,765 46,311 59,159 68,770 80,949 3,800 2,674 2,048 2,303 2,663 0 0 0 0 0 0 0 0 0 0 (11) (5,836) (25,174) 0 0 33,554 43,149 36,033 71,073 83,612 (3,826) (8,206) (5,405) (12,082) (15,050) (3,855) (4,863) (5,106) (5,361) (5,629) 0 0 0 0 0 25,873 30,081 25,522 53,629 62,932 25,883 34,807 47,172 53,629 62,932 32,676 49,673 63,678 73,552 86,100 12.49 12.50 6.75 2.47 2,071 14.52 16.81 9.45 2.92 2,071 12.32 22.78 11.55 3.11 2,071 25.89 25.89 13.32 3.67 2,071 30.38 30.38 16.58 4.07 2,071
Cash flow statement (INR mn)

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 29,765 2,912 3,800 (4,662) (8,360) (11) 23,444 2013 2014E 2015E 2016E 46,311 59,159 68,770 80,949 3,362 4,518 4,782 5,151 2,674 2,048 2,303 2,663 (8,206) (5,405) (12,082) (15,050) (1,863) (14,012) (5,875) (7,169) (5,836) (25,174) 0 0 36,442 21,134 57,898 66,543 (8,000) 0 0 0 (8,000) (8,500) 0 0 0 (8,500) (8,500) 0 0 0 (8,500)
(8,085) (21,401) (4,828) (4,210) 0 0 0 0 (12,913) (25,611) (5,115) 19,330 (1,026) (712) 12,477 23,008 0 15,358
(6,058) (6,450) (7,592) (8,423) 33,214 0 0 0 (1,315) 0 0 0 (127) (4,288) (4,503) (4,728) 25,715 (10,739) (12,095) (13,151) 36,546 0 15,041 2,395 0 13,134 37,303 0 49,398 44,893 0 58,043
Balance sheet (INR mn)

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 2013 2014E 2015E 2016E 33,672 40,587 42,983 80,286 125,178 0 0 0 0 0 19,261 27,108 34,248 39,251 45,206 20,870 25,778 32,567 37,325 42,988 16,703 19,947 20,983 22,075 23,226 90,506 113,420 130,781 178,937 236,598 32,742 10,218 0 22,129 65,089 50,781 11,330 0 24,116 86,227 54,263 11,330 0 24,116 89,708 57,981 11,330 0 24,116 93,426 61,330 11,330 0 24,116 96,775
Financial ratios and other

Year-end: Mar Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) 2012 79.5 40.8 37.2 32.3 11.4 39.9 42.5 42.5 42.3 21.4 2013 81.6 44.0 41.0 30.8 19.0 41.0 16.3 16.3 34.5 18.4 2014E 81.5 44.2 41.0 32.7 15.0 27.6 -15.2 -15.2 35.5 6.5 2015E 81.8 44.1 41.2 32.1 17.0 15.8 110.1 110.1 13.7 17.7 2016E 82.0 44.3 41.7 32.4 18.0 16.3 17.3 17.3 17.3 10.9
155,595 199,646 220,489 272,363 333,373 0 13,852 0 13,852 3,207 0 (5,199) 10,541 8,549 22,402 0 15,841 0 15,841 1,982 0 (7,112) 22,687 17,557 33,398 0 19,526 0 19,526 1,982 0 (7,112) 19,956 14,826 34,351 0 22,509 0 22,509 1,982 0 (7,112) 21,952 16,821 39,330 0 25,912 0 25,912 1,982 0 (7,112) 24,147 19,016 44,929
23.9 23.7 0.6 0.8 0.4 398.0 69.0 259.6
22.2 28.5 0.6 0.8 0.2 409.3 74.9 260.6
16.0 30.8 0.7 0.4 0.6 399.1 77.6 241.9
27.9 30.5 0.7 0.8 0.6 419.8 80.3 252.5
26.0 29.0 0.6 0.8 0.6 419.3 79.4 252.8
-14.9 2.3 -17.6 0.1 6.5
-9.6 1.1 104.4 0.1 7.2
-11.3 1.0 441.5 0.0 6.7
-24.2 0.8 488.8 0.0 7.9
-34.3 0.6 547.9 0.0 9.1
121,664 149,897 168,969 215,006 269,516 11,615 16,351 17,168 18,027 18,928 133,278 166,248 186,138 233,033 288,444 155,680 199,646 220,489 272,363 333,373 (19,924) (15,918) (21,045) (56,352) (99,050) 2,071 2,071 2,071 2,071 2,071
6.2 15.3 16.8 19.9 19.9 4.9 1.0
6.1 13.8 14.8 23.4 20.2 5.7 0.9
8.4 19.0 20.4 48.2 26.1 7.3 0.5
7.0 16.0 17.1 22.9 22.9 5.7 0.6
5.8 13.1 14.0 19.6 19.6 4.6 0.7
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62
Dr. Reddy's Laboratories

In good shape
We maintain Outperform on Dr. Reddys with a PT of INR OUTPERFORM (unchanged) 2,800, based on 21x FY16E core EPS and INR 95 for special PRICE as of 7 Jan 2014 PRICE TARGET products. Dr. Reddys is one of our top large-cap picks. Dr. Reddys has a long ANDA pipeline, a couple of exclusives, several limited competition products and presence in blockbuster products going off-patent. The company has reach across EMs with India and Russia showing recovery. We expect revenue/PAT CAGR of 14/20%, respectively, over FY13-16E with stable margins and RoE. We like Dr. Reddys due to its basket of complex, niche and biosimilar products. It has the reach, R&D focus and the right management to ensure sustainable growth. Steady pick. Dr. Reddys is one of our top large-cap picks; it scores well on three critical counts in our PRII matrix: (1) strong core product pipeline with high proportion of exclusive and limited competition products; (2) diversified reach across lucrative markets such as the US, Russia, the EU and India, and (3) innovation driven by R&D and biosimilar focus. Strong US pipeline. We expect Dr. Reddys to post US revenue CAGR of 26% over FY13-16E. Its 57 products include many highvalue molecules such as Tacrolimus, Fondaparinux, Finasteride, Omeprazole DR, where Dr. Reddys has gained market share and is among the top players. Recent launches such as Isotretinon, Zoledronic acid, Decitabine (Dacogen) and Metoprolol succinate (Toprol XL) have done well. Over FY14-16, we expect Dr. Reddys to gain from 62 pending ANDAs and exclusive FTFs. 30%+ ANDAs are in the injectables segment. Growth revival in EMs key. We expect Dr. Reddys to post 15% branded formulations CAGR over FY13-16E. We expect Russia and CIS to lead with 18% growth in international formulations. We expect India formulations to report an 11% CAGR post disruptions led by the new pricing policy in 9MFY14. We expect regulatory headwinds in most EMs. Valuation has room. Dr. Reddys trades at 16x one-year-forward EPS. Our price target of INR 2,800 values Dr. Reddys at 21x oneyear-forward core EPS and INR 95 value of special products, implying PE multiple of 20x-18x on FY15-16E consolidated EPS. We expect revenue/PAT CAGRs of 14/20%, respectively, over FY13-16E with stable EBITDA margin of 22% and RoE of 25%. This should help sustain the target multiple. Gaurav Pathak
13 January 2014
DRRD IN INR 2,49 1.2 5 INR 2,80 0.0 0
INR 2,491.25
Bloomberg code
INR 2,800.00
Reuters code
DRRD IN
Market cap
REDY.BO
12-month range
INR 510,208mn (USD 8,187mn)

INR 5.00 - 2,557.55

13.2% 2015E 8.1%
2013 118,956 27,195 21,151 21,647 15,268 202 90.02 78.72 17.57 375.32 17.4 9.8 22.9 17.8 12.8 19.5 37.4 26.9 21.4 2.7 11.7 4.7 19.3 1.0
2014E 138,808 31,339 25,716 26,099 21,140 7,949 124.63 98.16 21.85 477.74 38.5 24.4 22.6 18.5 15.2 17.5 24.1 29.2 21.6 3.2 14.1 5.2 20.0 0.9
2015E 158,170 35,272 28,974 29,387 23,216 15,404 136.87 113.95 23.99 590.47 9.8 9.8 22.3 18.3 14.7 17.6 8.2 25.6 21.2 2.7 12.2 4.2 18.2 1.0
2016E 176,193 39,426 32,529 33,062 26,119 19,353 153.99 129.16 27.00 717.30 12.5 12.5 22.4 18.5 14.8 17.6 -5.4 23.5 21.2 2.4 10.6 3.5 16.2 1.1

Dr. Reddy's Laboratories 3,000 1,500 0 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth 3 4 -
-3 mth -12 mth 4 32 0 26 Promoter (25.6%) 74% 11,635,164
Shashikiran Rao
63

The companys short-term growth is predicated on two key pillars: US generics and branded generics in India and EMs. We have reasonable comfort on the growth prospects for generics across the US, EMs and India. Over the next three years, Dr. Reddys is likely to be able to sustain 14% revenue CAGR, 20% PAT CAGR, 22%+ EBITDA margin and RoE of 25%, in our view. This should help sustain the PE multiple of 20x-18x on FY15-16E consolidated EPS implied from our PT of INR 2,800. Dr. Reddys has the required management and execution capabilities to continuously expand its product portfolio and geographic reach, in our view. It is focussing on R&D, novel products and the biosimilar opportunity to ensure longterm growth.
Visibility to US revenue from a strong US pipeline

We estimate total US revenue will grow to USD 1.1bn by FY16 at a CAGR of 21%, supported by a slew of limited competition products and growth in the base business led by c.15 new products launched annually and increased market share in existing products. Limited competition product contribution to US business remains significant We believe Dr. Reddys US pipeline is one of the strongest among domestic peers. We expect the launch of multiple limited competition products to help sustain 25-30% contribution to US sales. Figure 80: Dr Reddys: US pipeline is robust
1,200 1,000 800 600 400 200 0 FY12 FY13 FY14E FY15E FY16E
Limited competition products Other US sale (LHS) Limited comp as a % of US sales (RHS)
50
40 785 692 565 392 455 20
USD mn
30 % 10
265
271
301
313
336 0
Dr. Reddys high-value molecules like Tacrolimus, Fondaparinux, Finasteride and Omeprazole DR have seen market share gains. Recent launches Isotretinon, Zoledronic acid (Reclast and Zometa), Decitabine (Dacogen) and Metoprolol succinate (Toprol XL) have also done well. Fondaparinux is an injectable heparin substitute and hence is sold largely through hospital channels. In July 2013, Dr. Reddy's launched the generic version of Dacogen (Decitabine injection) used to treat myelodysplastic syndrome (increase in bone marrow production). The Dacogen brand in the US was approximately USD
13 January 2014 64
260m n MAT for the 12 months ending July 2013. In August 2013, Dr. Reddys launched Divalproex sodium extended-release tablets, USP (250mg and 500mg) the generic version of Depakote ER. The Depakote ER brand and generic had combined US sales of approximately USD 194mn MAT for the 12 months ending June 2013, according to IMS Health. Over FY14-16E, we expect Dr. Reddys to gain from the 62 pending ANDAs, exclusive FTFs like Vimovo, and key filings like Raberprazole (Aciphex), Cymbalta, Namenda, Nexium, Avelox, Sirolimus, Copaxane, Aloxi and Valcyte. Dr. Reddys expects to sustain an annual launch run-rate of c.12-15 products. As shown in Fig 2, Dr. Reddys has filed 204 ANDAs YTD FY14, with 62 ANDAs pending approval, including 39 PIVs (of which nine are FTFs). From its first ANDA in 1997, Dr. Reddys has focussed on large market size opportunities, which are complex and niche. Figure 81: ANDAs filed, approved from FY06 onwards
240 200 160 Nos 120 80 40 33 12 5 14 FY07 19 23 21 17 12 FY10 20 1818 Cumulative filings Pending approvals 62 Filed Approved Cumulative filings Pending approvals 204
13
12
17 16
FY12
0
FY06
Source: Company
FY08
FY09
FY11
FY13
YTD FY14
Structurally, Dr. Reddys has decided to focus on difficult -to-make molecules, which require specialized and unique technology platforms. To achieve necessary results it acquired a 99% stake in OctoPlus NV in February 2013 for Euro 27mn. OctoPlus has significant in-house expertise in development and creation of micro-spheres and liposomes using polymer-based technologies. Dr. Reddys has also been increasing market share of vertically integrated products (almost 75% of the US portfolio), mainly by targeting new customers. The companys attempt is to increase productivity per product with higher contribution from each product in its portfolio. Dr. Reddys has had varying degrees of success in this regard with products like Zoledronic acid (both Zometa and Reclast) where it has achieved 30% market share and Fondaparinux where it has managed to increase its market share to 29% by May 2013. Dr. Reddys has significantly increased focus on the injectable segment; we expect several launches over the next few years. It has already received four approvals (Zometa, Reclast, Dacogen, Vidaza) this year. A few more, such as Taxotere (Docetaxel), may come through over the next few months while other interesting products such as Copaxone and Doxil may play out over the next 2-3 years. We
13 January 2014 65
expect injectables to be a key growth driver for the company in the US over the next few years. Vidaza (azacitidine), the latest approval, is an attractive opportunity, with brand market size of USD 379mn. Dr. Reddys will be the sole generics player for at least a few months. Copaxone is a CY15 launch, potentially a 4-5 player market with USD 35-40mn potential, and Avelox a 3-4 player market with USD 25-30mn opportunity. Derma is the next big indentified growth driver. Dr. Reddys derma -specialty business is called Promius Pharma and has in-licensed products and a small field-force of around 50 sales reps. Its current portfolio includes EpiCeram Emulsion, a novel prescription therapy for the treatment of atopic dermatitis, a skin disease that affects c.15mn people in the US, representing an addressable market USD 400mn; PromiSeb Cream for dermatitis; Scytera Foam for psoriasis; and Cloderm (recent addition). Germany contributes c.70% of European revenues. Dr. Reddys German operations are conducted through its subsidiary Betapharm, acquired in March 2006. The German pharmaceutical market has undergone a significant change with significant price and margin erosion. The API segment is facing headwinds on client acquisition and inventory overhang from key customers. We are assuming very slow 3% CAGR over FY13-16E.
Branded generics growth visibility

Growth momentum in branded formulations likely to continue We are confident about the companys ability to execute its branded generics strategy, particularly key operations in India and Russia. Accordingly, we believe that Dr. Reddys can achieve sales of USD 950mn from the branded formulations segment, clocking 15% revenue CAGR over FY13-16E. New product launches, expanding reach, taking biosimilar portfolio to Russia/CIS and the GSK alliance should help maintain the growth momentum, in our view. Dr. Reddys is also inlicensing Ciplas products in Russia/CIS, further augmenting growth. Figure 82: Dr. Reddys: Branded formulations business momentum to continue
FY13 Branded business (INR bn) India Russia RoW Total branded sales As a % of total sales India Russia RoW Total branded sales 21 24 8 53 22 27 9 58 20 24 8 52 18 23 8 49 14.6 16.9 5.5 37.0 16.6 20.0 6.7 43.3 14.0 18.0 21.9 17.0 18.9 23.1 8.0 50.0 21.6 26.8 9.4 57.8 14.0 16.7 19.3 16.0 FY14E Growth yoy (%) FY15E FY16E CAGR FY13-16E
India remains an important market for Dr. Reddys. We expect Dr. Reddys to post 11% CAGR for India formulations despite the NELM impacting sales in 9MFY14. We expect Dr. Reddys to grow above the industry rate and increase focus on chronics, which currently contribute only c.30% of sales. Dr. Reddys top three brands in India Omez, Stamlo and Nise account for c.20% of sales.
13 January 2014 66
Figure 83: Domestic sales have recovered strongly post supply issues in FY09
FY09 Domestic formulation sales (INR mn) Growth yoy (%) New products launched (nos) Field force (nos)
Source: Company
FY10 10,158 19.8 62 3,000
FY11 11,690 15.1 48 3,800
FY12 12,931 10.6 23
FY13 14,560 12.6 24
FY14E 16,016 10.0
FY15E 17,618 10.0
FY16E 19,379 10.0
8,478 5.2 36 2,400
Within Russia, the OTC segment is expected to grow faster than the prescription segment. Biosimilar launches in Russia/CIS will also help the growth momentum. We expect Dr. Reddys to report 18% CAGR in international formulations over FY13-16E. Over FY08-FY13, Dr. Reddys Russian/CIS sales clocked a 26% CAGR. Its top four brands account for c.60% of Russia sales, leading to concentration risk. Dr. Reddys is the 16-18th largest generics player in Russia (Pharmexpert, market share of 1.7%), with a strong presence in gastrointestinal and pain. It is growing in the anti-infective, dermatology and cardiovascular segments, helped by a 150-strong field force. Dr. Reddys is partnering with GSK to sel l its products in the EMs, particularly in Latin America (ex Venezuela). Dr. Reddys has decided to move away from certain emerging markets (Mexico, Turkey, Brazil, etc) and use GSKs front -end capabilities in these markets to sell its products. The alliance with GSK can scale up sharply with newer products/markets (100+ products) being added to the partnership.
Biosimilars Deep and advanced pipeline of products

Dr. Reddys could be one of the top 5 leaders in the biosimilars space The companys biotech investments are substantial, favourably positioning it as one of the potential top players in the biosimilars space as the regulated markets open up. In June 2012, Dr. Reddys entered into a JV with Merck KGaA to strengthen its biosimilars segment. The partnership will co-develop and globally commercialize a portfolio of biosimilar compounds in oncology, primarily focused on monoclonal antibodies (MAbs). The JV is a key long-term positive and also helps negate challenges in the biosimilar landscape. Dr. Reddys gains funding capability, established manufacturing capacities to launch biosimilars in DMs, ability to proceed with global clinical trials and front-end capabilities. Dr. Reddys biosimilar portfolio for India is one of the largest, and it currently has four products in the market (see Fig 5 below). Developed in-house, the company has had reasonable success with some brands like Reditux (monoclonal antibody for treatment of cancer), which was launched in FY08 and already is one of the top 5 products for Dr. Reddys in its domestic portfolio. Biosimilar revenue was INR 1.1bn in FY13; it has been growing at a 25% CAGR over the past several years. Figure 84: Current portfolio of biosimilars in India
Brand Grafeel Reditux Cresp Peg-grafeel
Source: Company
Biosimilar Filgrastim Rituximab Darbepoetin Pegfilgrastim
Indication Chemotherapy induced neutropenia Blood cancer Anemia Anemia
Launched FY02 FY08 FY11 FY11
13 January 2014
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We like the companys investments and first mover advantage in biosimilars. The biosimilar capability will help capture a larger basket of global generics sales from 2015 onwards. Figure 85: Biotech products to form an increasing share of patent expiries from 2015 onwards
25
US traditional off-patent opportunity US bio-generic off-patent opportunity
20
2.7 12.1 3.2 17.5 13.8 9.4 9.2 3.7 3.7 2.5 2017 10.1
USD bn
15 20.8
10
0 2011 2012 2013 2014 2015 2016

Source: Medco Health, Standard Chartered Research
In key markets like Russia, DRL likely to launch soon
The company is expanding its biosimilar portfolio to other EMs, currently being sold in seven countries. Russia/CIS launch is expected soon.
R&D spend to increase

We expect R&D spend to increase significantly. Dr. Reddys expects 40% of R&D spend to go towards speciality products with an even split between novel products and biosimilars. In novel products, the focus is on 505 B(2) and orphan drugs, but the contribution from these products will only start from FY17 onwards. Dr. Reddys R&D centres are located in Cambridge, Netherlands and the US. It also has R&D partnerships with several companies, including its subsidiary Aurigene and Dr Reddy's Institute of Life Sciences. Figure 86: R&D expenses rising
18 16 14 12 INR bn 10 8 6 4 2 0 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E
R&D expenses (INR bn) (LHS) R&D expenses as % of revenues (RHS)
10 9 8 7 6 5 4 3 2 1 0
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Dr. Reddys has been focused on a sustainable and environment-friendly manufacturing approach. It follows Green Chemistry that helps develop a number of new products without the use of volatile solvents such as Dichloromethane, Acetone and Ethers. Dr. Reddys is in the process of setting an industry benchmark of reducing waste to 20-25 kg per kilogram of product vis-a-vis the industry average of producing 25-100 kg waste per kilogram of product. To compensate for rising R&D costs, Dr. Reddys would look to reduce SGA costs as a percentage of sales. We expect Dr. Reddys capex of INR 7.5bn in FY14 going down to an INR 6bn run-rate in FY15 and FY16. Its current capex is mostly on developing its Vizag SEZ that has independent cytotoxic and non-cytotoxic injectable manufacturing units.
Valuation
Our 12-month SoTP-based price target is INR 2,800, valuing the base business at 21x FY16E core EPS. We have assigned a value of INR 96 per share for the exclusivity driven businesses, which we value at NPV on cash per share. The intrinsic value comes from its base business and normalized earnings as limited competition products, though temporary, can significantly distort earnings. For example, limited competition products contribute INR 19 and INR 20 to EPS for FY14E and FY15E (almost 27% and 21% of FY14E and FY15E earnings, respectively). Since they are non-recurring, we prefer to value them separately from the core recurring business. Figure 87: Dr. Reddys one-year forward PE bands
3,500 3,000 10x 15x 20x DRL CMP
2,500
2,000 INR 1,500 1,000 500 0 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
69
Jun-07
Jun-11
Jun-05
Jun-06
Jun-08
Jun-09
Jun-10
Jun-12
Source: Source: Bloomberg, Standard Chartered Research
We believe with 19% earnings CAGR and 25% RoE profile, Dr. Reddys can continue to trade at the premium end of its P/E band.
13 January 2014
Jun-13
Figure 88: SoTP based value is INR 2,800

Base EPS one-year forward Target P/E multiple Value of base business (INR per share) NPV value of one-off opportunities Price target
129 21 2,706 95 2,800
Base earnings growth of 19% over FY13-16E provides support to our valuations.
Risks
Potential adverse currency movement Almost 85% of the companys business comes from exports, primarily to the US, the EU and Russia. While the company has an active hedging policy (hedges net exports), potential volatility in the currency could have a negative impact on sales. Regulatory risks in the US market USFDA approvals are difficult to predict and any delay in approvals could put our US revenue estimates at risk. Moreover, recent increased vigilance by the USFDA is a risk for the sector in terms of potential adverse comments. Domestic business slowdown The domestic business is an important constituent of sales and any slowdown in domestic growth could have a negative impact on sales. Regulatory developments in Russia As indicated earlier, the Russian government is increasingly intervening to reduce overall healthcare costs in Russia. Any proactive measures could have a negative impact on Russian operations.
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Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) Core EPS (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 98,145 118,956 138,808 158,170 176,193 70,184 81,908 95,778 109,137 121,573 (45,873) (54,713) (64,439) (73,865) (82,147) 0 0 0 0 0 0 0 0 0 0 17,777 21,151 25,716 28,974 32,529 267 496 382 412 533 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 18,044 21,647 26,099 29,387 33,062 (5,035) (6,379) (4,959) (6,171) (6,943) 0 0 0 0 0 0 0 0 0 0 13,009 15,268 21,140 23,216 26,119 13,009 15,268 21,140 23,216 26,119 24,311 27,195 31,339 35,272 39,426 76.79 76.70 59.76 15.99 170 89.97 90.02 78.72 17.57 170 124.50 124.63 98.16 21.85 170 136.72 136.87 113.95 23.99 170 153.82 153.99 129.16 27.00 170

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 17,777 6,534 267 (5,035) (3,153) 0 16,390 2013 2014E 21,151 25,716 6,044 5,622 496 382 (6,379) (4,959) (9,382) (11,313) 0 0 11,930 15,449 (7,500) 0 0 0 (7,500) (3,710) 0 2,000 0 (1,710) 6,239 0 7,949 2015E 28,974 6,297 412 (6,171) (8,109) 0 21,404 (6,000) 0 0 0 (6,000) (4,074) 0 (3,000) 0 (7,074) 8,330 0 15,404 2016E 32,529 6,897 533 (6,943) (7,663) 0 25,353 (6,000) 0 0 0 (6,000) (4,584) 0 (4,000) 0 (8,584) 10,769 0 19,353
(2,624) (11,728) 4,064 (3,766) 0 0 0 0 1,440 (15,494) (2,709) 7,734 8,696 0 13,721 31,551 0 13,766 (2,981) 3,626 5,150 0 5,795 2,231 0 202

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 16,061 0 25,368 19,433 7,759 68,621 32,817 8,385 0 3,419 44,621 2013 2014E 2015E 2016E 20,171 26,410 34,740 45,509 0 0 0 0 31,804 37,450 42,673 47,536 21,707 28,522 32,501 36,204 11,110 11,615 12,146 12,703 84,792 103,997 122,060 141,952 37,069 9,090 0 3,921 50,080 38,947 9,090 0 3,921 51,958 38,649 9,090 0 3,921 51,660 37,752 9,090 0 3,921 50,763

Year-end: Mar Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) 2012 71.5 24.8 18.1 13.3 27.9 30.0 17.8 17.6 17.8 22.1 2013 68.9 22.9 17.8 12.8 29.5 21.2 17.4 17.2 17.4 9.8 2014E 69.0 22.6 18.5 15.2 19.0 16.7 38.5 38.4 38.5 24.4 2015E 69.0 22.3 18.3 14.7 21.0 13.9 9.8 9.8 9.8 9.8 2016E 69.0 22.4 18.5 14.8 21.0 11.4 12.5 12.5 12.5 12.5
113,242 134,872 155,955 173,720 192,714 0 25,058 0 25,058 32,307 0 191 5,796 38,294 63,352 49,890 0 49,890 0 25,783 0 25,783 36,723 0 1,070 7,605 45,398 71,181 63,691 0 63,691 0 27,436 0 27,436 38,723 0 1,070 7,605 47,398 74,834 0 29,060 0 29,060 35,723 0 1,070 7,605 44,398 73,458 0 30,519 0 30,519 31,723 0 1,070 7,605 40,398 70,917
27.1 22.2 1.0 0.9 2.0 231.7 79.9 303.2
26.9 21.4 1.0 0.6 0.5 202.7 87.7 250.4
29.2 21.6 1.0 0.6 0.7 213.0 91.1 225.7
25.6 21.2 1.0 0.7 1.0 227.1 92.4 210.3
23.5 21.2 1.0 0.8 1.1 229.6 93.4 199.1
43.2 36.6 16.8 1.1 2.7
37.4 33.7 21.1 1.3 3.3
24.1 30.1 22.7 1.2 3.8
8.2 24.7 25.9 1.1 4.2
-5.4 19.6 32.2 0.9 4.7
81,121 100,262 121,797 0 0 0 81,121 100,262 121,797
113,242 134,872 155,955 173,720 192,714 21,547 170 23,807 170 19,568 170 8,238 170 (6,531) 170
2.9 11.9 16.2 20.6 20.7 6.0 1.0
2.7 11.7 15.0 19.3 19.3 4.7 1.0
3.2 14.1 17.2 20.0 20.0 5.2 0.9
2.7 12.2 14.9 18.2 18.2 4.2 1.0
2.4 10.6 12.8 16.2 16.2 3.5 1.1
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Lupin
Growth looking up
Lupin is our top pick. Our 12-month price target for the OUTPERFORM (unchanged) stock is INR 1,112 (at 21x one-year-forward earnings) PRICE as of 7 Jan 2014 PRICE TARGET given its business strengths and growth profile. On our PRII matrix, we like Lupins reach: (1) robust sales growth in its core markets the US and India of 18% CAGR over FY13-16E and (2) enviable reach in Japanese generics and key emerging markets. We also like Lupins strong, chronic-centred product range in the US and India. Lupins ANDAs, PIVs and FTF pipeline in the US provides high visibility. We estimate a 15% revenue CAGR and 225bps+ EBITDA margin increase to lead to 21% PAT CAGR in FY13-16E. Top pick. Lupin is our top pick, given a steady product launch pipeline in its core US/Japan/Indian markets, including healthy PIV/FTF opportunities. On our PRII matrix, we like (1) Lupins strong geographic reach in tough-to-penetrate markets like Japan and EMs, and (2) its strong product pipeline comprising chronic, complex and branded products. US ramp-up key. Over the past five years, Lupin has grown its US business at 39%. We believe the segment can clock an 18% CAGR, led by Lupins strategy of synergic branded generic acquisitions, ability to launch its 91 ANDA pipeline and benefit from PIV and FTF fillings. Japan business a strategic moat. Lupin has a decisive foothold in Japans generics market through acquisitions (and turnaround) of Kyowa (FY07) and Irom (FY12). Lupins head start over other IPCs should help it achieve 10% growth, with stable pay-offs. Ahead in emerging markets. Lupin reported 53% CAGR (FY0813) across EMs. We expect 18% CAGR going forward driven by new product launches in EMs. Valuation has headroom. Though Lupin is trading near the peak of its historical one-year-forward PE multiple (15-20x), it deserves a premium as: (1) it is one of the fastest growing IPCs in EMs, India and the US and (2) has the requisite scale, product diversity, reach and execution capabilities. We expect 15% top line CAGR over FY13-16E, clubbed with 225bps EBITDA margin expansion due to higher operating leverage and currency gains. This would translate into 21% earnings CAGR over FY13-16E. The company has a sustainable RoE of 30%. We use 21x FY16E EPS to arrive at our price target of INR 1,112. Gaurav Pathak
13 January 2014
LPC IN INR 932. 90 INR 1,11 2.0 0
INR 932.90
Bloomberg code
INR 1,112.00
Reuters code
LPC IN
Market cap
LUPN.BO
12-month range
INR 416,260mn (USD 6,679mn)

EPS adj. est. change 2014E 8.1%
INR 567.65 - 950.95

2015E 23.2%
Year-end: March Sales (INR mn) EBITDA (INR mn) EBIT (INR mn) Pre-tax profit (INR mn) Net profit adj. (INR mn) FCF (INR mn) EPS adj. (INR) DPS (INR) Book value/share (INR) EPS growth adj. (%) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Div. payout (%) Net gearing (%) ROE (%) ROCE (%) EV/sales (x) EV/EBITDA (x) PBR (x) PER adj. (x) Dividend yield (%)
2013 96,413 22,700 19,378 19,246 13,667 7,158 30.57 4.69 116.60 57.2 25.9 23.5 20.1 14.2 15.9 11.2 28.5 29.4 2.8 11.7 5.4 18.8 0.8
2014E 111,510 26,103 22,573 22,636 15,619 6,744 34.90 4.89 146.50 14.2 4.3 23.4 20.2 14.0 14.0 2.4 26.5 30.4 3.8 16.1 6.4 26.7 0.5
2015E 131,657 32,932 29,078 29,234 20,464 13,169 45.72 5.94 186.28 31.0 21.7 25.0 22.1 15.5 13.0 -10.4 27.5 33.7 3.1 12.4 5.0 20.4 0.6
2016E 145,249 37,430 33,176 33,378 23,698 18,915 52.95 6.88 232.34 15.8 15.8 25.8 22.8 16.3 13.0 -23.3 25.3 31.9 2.7 10.5 4.0 17.6 0.7

Lupin 1,000 750 500 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth 9 10 -
-3 mth -12 mth 4 56 0 48 Promoter (46.9%) 53% 13,101,885
Shashikiran Rao
72

The US business will be the key growth driver, supported by the branded business, large ANDA pipeline (91) and key products Niacin, Gatifloxacin, Tricor, OCs (Yaz, Yasmin, Loestrin), Cymbalta, Nexium, Namenda, Renagel, Renvela, Darunavir and Trilipix. We expect 18% revenue CAGR over FY13-FY16E. Product launches and improving product mix (chronic) will drive the India formulation business growth marginally ahead of the industry, in our view. We expect 17% CAGR to INR 37bn by FY16E. Japanese operations continue to remain a decisive advantage; we expect 10% CAGR there. Lupin has been expanding well across emerging markets; we expect 18% revenue CAGR in EMs. We value the company at 21x one-year-forward EPS, to arrive at our price target of INR 1,112.
US growth the key story

US business likely to grow to INR 62bn, a CAGR of 18% over FY1316E Lupins US business has grown 55% over the past 10 years and 39% over the past five years, making Lupin now the fifth largest generics player in the US. Having reached INR 38bn in FY13 (40% of sales), we estimate it to grow to INR 62bn (43% of FY16E sales), at a CAGR of 18% over FY13-16E. We are impressed with the companys balanced focus on generics and branded formulations. Lupins US business has three strategic parts: (1) unbranded generics, (2) branded generics (which is unique among IPCs in the US) and (3) large pipeline of PIVs and FTFs. The branded segment, though, contributes 20% of Lupins US revenues, but has significantly higher margins. Figure 90: US sales as a percentage of total sales
60.3 49.4 37.8 24.3 20 10 0 FY07 FY08 FY09 FY10 FY11 FY12 FY13 62.4 60 50 40 30 30 20 10 0
Figure 89: US sales and growth yoy

70 US sales (LHS) Growth yoy (RHS)
100 80 60 40 20 0 FY10 35 36
US as a % of total sales
Others
60
50 Rs bn 40 20.8
16.9
Rsm
US branded sales provide lower volatility and higher margins than generics
Branded formulations: Leveraging its strong sales force Lupins branded US business is unique among IPCs and offers a sustained stream of revenues, with lower volatility and higher margins than the generics business. Fig 3 shows our estimates for the US branded generics business.
35
40
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46
43
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FY12
FY13
FY14E
FY15E
FY16E
13 January 2014
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Figure 91: Branded US sales Lupin likely to launch more products in this space, leveraging its current field force
300 250 200 USD mn 50 150 100 50 0 FY10 FY11 FY12 FY13 FY14E FY15E FY16E
US branded sales (LHS)
Growth yoy (RHS)
100
75
127
132
140
145 122
139 119 25
-25
Branded US business built around acquisitions
Lupins branded US business has been built around acquisitions, either of tail brands (e.g., Suprax from Wyeth) or distressed brands (Antara from Oscient) or more recently leveraging its strong marketing force (Alinia oral suspension from Romark). In addition, Lupin is also trying to develop brands in its recently launched and upcoming launches in the OC segment. Lupin has a strong sales force of 170 in the US with a strong presence in the paediatric and OC segments, which throws up interesting cross-selling capabilities. We like Lupins strategy in branded formulations, which is calibrated, with incremental expansion based on current synergies and expanding lifecycle management. Brand building in the US is expensive and time-consuming, and Lupin hopes to leverage its strategic knowledge of Suprax to approach related therapies through line extensions. We expect Lupin to continue to launch more products in this space, leveraging its current field force. For example, Lupin recently received a 505 B(2) approval for its chewable tablet version of Suprax (to be promoted to doctors) and for paediatric drops and launched them in FY13. Since Suprax is a cephalosporin, there is no overriding PIV block. Hence, there is a risk that there could be a generics launch in Suprax in the near term (especially on the relatively older 100mg suspension). However, Lupins citizen petition on referencing its product for impurities and 5% overages has been granted by the USFDA, which would preclude immediate filing of ANDAs, in our view. Currently, Suprax does not face any generics competition. Another example of Lupins acquisition strategy is the recent acquisition of Alinia (oral suspensions) from Romark. Alinia (nitazoxanide) has been approved by the USFDA for the treatment of diarrhoea. Lupin saw potential in this product for children, which is facilitated by its relatively simple dosing a strawberry flavoured suspension. However, Romark has not been able to promote the product well enough due to its relatively small sales force of 20-30. Lupin can grow this product due to its large sales force and cross-selling opportunity with doctors in the paediatric segment. The current market size of the product is USD 20mn, but Lupin hopes to grow this segment further.
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Lupins Antara, which it acquired from Oscient in 2009, is now facing generics competition post the launch from Mylan in Q1FY14. About 50% of the market has moved to the generics segment. Antara is a Fenofibrate, an anti-cholesterol drug. Tricor from Abbot currently accounts for 90% of the Fenofibrate market, Lupin launched a generics version of Tricor in November 2012. Antara is competition, but not directly substitutable due to dosage differences. Lupin has launched the low dosage 90mg and hopes to retain and increase sales by providing the switch to lower dosages, providing the same bioavailability and efficacy. Expect strong growth in US unbranded generics backed by increased launches Lupins unbranded US sales are poised for a significant ramp-up, in our view, led by an interesting launch pipeline. Accordingly, we estimate unbranded US sales to grow at 23% CAGR. Figure 92: US generic sales
1,200 1,000 866 800 USD mn 701 548 361 US generic sales (LHS) Growth yoy (RHS) 920 60 50 40 %
Growth in US unbranded likely to be led by limited competition and product launches
600
400 231 200 0 FY10 FY11 FY12 321
30
20 10 0
FY13
FY14E
FY15E
FY16E
Lupins execution on generics is particularly impressive on the back of relatively few launches
Lupins execution on its generics segment has been particularly impressive. Lupin is the market leader in 25 products in the US generics market and is among the top 3 by market share in 40 products (IMS Health, June 2013). Lupin has launched 57 products in the US generics market. Currently, the company has 91 pending approvals with market size of USD 50bn. Figure 93: Approvals lagging filings, implying likely bunching of approvals
120 100 80 Nos 60 40 20 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14-YTD
Source: Company, Standard Chartered Research
Net fillings
Approved
Pending 109 100 87 98 91
56 37 18 6 12 5 33 25 15 7 11 9 35 28 7 6 21 8 25
15
16
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14
14
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Lupin also has some interesting PIV and limited competition opportunities
Key launches to drive growth Lupin has 25 FTFs with market size of USD 13bn and 12 exclusive products with market size of USD 1.6bn. Lupin also has an interesting basket of 86 PIVs including some limited competition opportunities. Cumulatively, a potential market size of USD 30bn is being targeted. In FY13, Lupin launched Tricor, Fortamet and Ziprasidone; new launches contribute 42% of US generics sales. Key products Niacin, Gatifloxacin,Tricor, OCs (Yaz, Yasmin, Loestrin), Cymbalta, Nexium, Namenda, Renagel, Ranexa, Renvela, Darunavir, Trilipix, Celebrex, Lunesta, etc will define future growth of Lupins US generics business. Speciality products to drive future growth Lupin has been focusing on speciality segments like oral contraceptives (OCs), ophthalmology, dermatology, controlled-substances and respiratory. The company has made significant progress in the oral contraceptives (OCs) and ophthalmology markets, which are its key niche focus areas for growth. The OC market in the US is worth USD 4-5bn with limited competition (2-3 generics players, including Teva, Watson and Warner Chilcott). Lupin currently has 12 OCs with a runrate of USD 35mn/pa. It expects to touch a peak run-rate of USD 100-135mn post the launch and stabilisation of its 40 product portfolio, which includes Yaz (yet to be launched, USD 30mn potential), Yasmin (recently launched, USD 25mn potential), Seasonique (market size USD 160mn), Lutera (USD 105mn), Daysee, etc. In October 2013, Lupin entered the US ophthalmology segment with its maiden launch of antibiotic Gatifloxacin ophthalmic solution. The product, which is a generic version of Allergans Zymaxid Ophthalmic Solution with a market size of USD 62.5mn, was launched by Lupin on 180-day exclusivity. Lupin has 10 ANDAs in this segment and plans to launch 7-8 products soon. In the next three-four years, Lupin plans to have derma products in the market and in the next five, inhalation products will also form a critical part of Lupins US portfolio.
Oral contraceptives and ophthalmological products key niche focus areas
Domestic formulations likely to outperform industry growth

Lupins domestic formulations have consistently outperformed the broad market Lupins growth in the domestic formulations segment has been equally strong. Domestic formulations reported a 20% CAGR over FY08-13 to INR 24bn, currently forming 3.1% of the market (AIOCD FY13 data). More importantly, the contribution of chronic and semi-chronic formulations to the total revenue portfolio has increased steadily. As of end FY13, these segments contributed 60% of Lupins India business. We expect Lupin to continue to deliver strong growth in the domestic market and expect the domestic formulations business to post 17% CAGR over FY13-16E. Lupin is focused on the lifestyle and chronic therapy segments with an eye on the leadership spot. Lupin's product and therapy segment mix for the IPM coupled with unrivalled marketing strategies has led to the company emerging as among the fastest-growing players in therapies like Cardiology, Central Nervous System (CNS), Diabetology, Anti-Asthma, Anti-Infective, Gastro Intestinal and Oncology.
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Figure 94: Growth in key therapeutic areas have outperformed market growth
3% 4% 3% 29% Anti-Infectives Cardiac Respiratory Anti Diabetic Gastro Intestinal Vitamins / Minerals / Nutrients Neuro / CNS 11% 23% Pain / Analgesics Gynaecological Others
5% 6%
8%
8%
Source: AIOCD
Over the past 5-7 years, Lupin has moved its product mix significantly towards the chronic segment. In FY06, over two-thirds of the companys domestic market was acute, now the proportion stands reversed. Figure 95: Improving chronic tilt
Chronic segment 100% 90% 80% 70% 56 69 37 Acute segment
(%)
60% 50% 40% 30% 20% 10% 0%
63 44 31
FY06
Source: Company, ORG IMS
FY08
FY13
Figure 96: Growth in key therapeutic areas has outperformed market growth Lupin to continue to deliver 17% growth in the domestic market
60 50 40 (%) 30 21 20 12.2 13.2 5.3 2.5 0 CVS
Source: Company, ORG IMS
Market growth
Lupin growth 47.7
27.7 17.8 12.8 7.4 11
24.6 18.6
10
4.4
Anti Tb
Respiratory
Anti Infective
GI
CNS
Anti Diabetic
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In the API segment, Lupin has made significant progress. Currently, it is the number one global player in the TB and cephalosporin segments. The global API market continues to grow and is currently valued at over USD 110bn. The company has 12 world-class facilities (10 in India and two in Japan) manufacturing and supplying APIs and formulations.
Japanese operations to scale up; improved profitability

Lupins Kyowa acquisition catapulted it into the top 10 in generics in Japan Lupins INR 2.5bn (ex-debt) acquisition of Kyowa Pharma in Japan in October 2007 provided the company a strategic foothold in the key Japanese market, unlike other Indian peers that have adopted an incremental approach to the Japanese market. We expect Lupin to grow its Japanese business by a 10% CAGR over FY13-16E. Lupin today is the seventh largest generics player in the Japanese market and has over the years built a strong presence in the Neurology, Cardiovascular, Gastroenterology, Respiratory and Injectables segments. Lupins performance in Japan has been very successful, with a CAGR of 59% over FY08-13 (48% ex-Irom). This is despite bi-annual price cuts affected in April 2010 (which impacted 15-16% of Kyowas portfolio). More importantly, Kyowas gross margin has increased 500bps post acquisition, to c.38-40% from c.33-35% preacquisition, driven mainly by savings in operational efficiency and better raw material pricing from existing suppliers. The company has been consistently expanding its product portfolio and launched 11 new products including four CNS products. Kyowa has a portfolio of 350+ products. It has a dedicated field force to target CNS hospitals and clinics. In FY12, Lupin through Kyowa acquired Irom Pharmaceuticals, which added a presence in the injectables space in Japan. In Irom, Lupin recently added Oncology injectables. Lupin has a field force of c.120. In Japan, USD 7-8bn worth of products are going off-patent in the next four years and a total of USD 15bn in the next five years. Usually, approval rates are quicker at around 12 months vs 30 months in the US. Lupin is targeting most of these products that are going off-patent. The company expects to shift back-end manufacturing of a few key products to its plants in India. The process of supply chain integration from India has already commenced. In FY13, the companys Goa plant received three approvals for formulations while the Tarapur plant had two filings for API. The company expects gross margin to expand by 500-700bps in the next two years once benefits of lower raw material and formulation sourcing from Indian sites begin accruing to Kyowa. Lupin has filed API registrations for more than 15 products (representing almost 50% of current sales), which should reduce operating costs. Moreover, it has identified a basket of 21 formulations (of which four have already been filed from its Goa formulation facility) where active site transfer work is ongoing. We note that the overall margin impact to Kyowa could be higher, given the operational leverage to Kyowa because of higher utilization of its own production facility at Sanda. The majority of products in Kyowas current portfolio are manufactured at its manufacturing facility at Sanda (operating at 100% capacity; the company plans to increase capacity over there).
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Emerging markets to grow on increasing reach

Lupins domestic formulations have consistently outperformed the broad market Lupin has grown at a 53% CAGR (FY08-13) across EMs. We expect 18% CAGR going forward driven by new product launches. Lupin is the fifth largest player in South Africa, a USD 3.5bn market. Pharma Dynamics (Lupin South Africa) has eight brands that are market leaders and another 12 that are amongst the top 3 brands in their respective segments. It is also focussing on growing exports to the larger African markets and continues to make new registrations in neighbouring markets - 50 products are currently under registration. Lupin is shifting manufacturing to India and also maintaining the product launch momentum (in FY13 it launched 10 new products). Lupin registered 26% growth in FY13. Lupin also has INR 1.4bn and INR 0.7bn revenue accruing from Australia and the Philippines, respectively. The company continues its efforts to make inroads into the Latin American market. In addition, the company entered and initiated its business in Taiwan. The Australian pharmaceutical market is valued at USD 13.5bn; the generics market is worth USD 2.2bn and growing at approximately 8%. The Philippines pharma market is valued at USD 3.3bn and grew by 4.6% in FY13 (IMS Health).
Focus on R&D-led innovation

Lupin is creating a healthy portfolio of NDDSs. It wants to ensure that at least one compound enters the clinical phase in terms of first-in-human studies each year. Lupin has adopted a Quick-win, fail-fast cost-efficient development approach, in which novel compounds are filtered at every stage before entering development and differentiated on efficacy and safety. In FY13, Lupin successfully completed Phase I studies in Europe for a program in the CNS area, which is being advanced to Phase II clinical trials in Europe now. Candidates from two programs in the area of endocrine disorders and cancer will enter clinical development in FY14. The Lupin Biotechnology Research Group was established five years ago with a vision to provide affordable, high-quality biopharmaceuticals with a focus on biosimilars. In a short span of five years, Lupin has created and developed a basket of 10 biosimilars, which are now in various stages of development. Eight of these are potential blockbusters, addressing diverse and niche therapeutic indications like Oncology, Inflammation, Antivi rals, Osteoporosis and Rheumatoid arthritis. Lupins biotechnology group received its first marketing authorisation for Pegfligrastim, an oncology product, following the successful completion of a Phase III clinical trial in India. The companys anti-migraine nasal spray under development, Amigra, is in the final stages of clinical trials in India. The company is planning to conduct additional trials and generate more data to out-license the product. A couple of multinational companies have shown interest in Amigra. Lupin has two versions of herb-based anti-psoriasis drugs Desoris and Desoside-P currently in the second phase of clinical trials. An anti-tuberculosis drug candidate, Sudoterb, is also under development.
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Valuations
We set a 12-month PT of INR 1,112, valuing the business at 21x one-year-forward EPS. Given that Lupin is growing at a 21% CAGR and maintaining RoE of 30%, we believe a 21x multiple is sustainable. Lupin is trading between 15x and 20x one-yearforward PE. Given the current growth momentum, it could trade at a premium, in our view. Figure 97: Lupin P/E band chart: In a breakthrough zone
1,200 1,000 800 INR 600 400 200 0 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
80
10x
15x
20x
LPC CMP
Jun-12
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Source: Bloomberg, Standard Chartered Research estimates
The key risk remains the delay in US ANDA approvals, including crucial approvals like OCs, which would have a negative impact on its US generics business.
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Financials
We expect a 16% CAGR in revenue over FY13-16E, led by the US business and domestic formulations. EBITDA margin is likely to expand led by exclusive products and cost initiatives. 15% CAGR in revenue over FY13-16 We expect net revenue of INR 145bn by FY16E (CAGR of 16%) led by growth in US and domestic formulations. We estimate domestic formulations to post 17% CAGR to INR 37bn by FY16E, while Japan is likely to post 9% CAGR in constant currency terms, led by higher product launches. The US business is likely to grow at 18% CAGR to INR 62bn with generics growth led by new product launches especially in the oral contraceptive segment, in our view. Our assumptions are based on USD-INR of 60. A 5% depreciation of the Indian rupee will raise our FY13-16E CAGR by 1%. Figure 98: Revenue growth
165 150 135 120 105 INR bn 90 75 60 45 30 15 0 FY11 FY12 FY13 FY14E FY15E FY16E 49 60 85 121 102 135 20 15 10 30 % 25 35 Formulation API Growth yoy 40
Domestic formulations likely to grow at 17% CAGR to INR 37bn by FY16E
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Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 70,829 96,413 111,510 131,657 145,249 44,790 60,933 70,753 83,931 92,887 (30,580) (38,233) (44,650) (50,999) (55,457) 0 0 0 0 0 459 0 0 0 0 12,394 19,378 22,573 29,078 33,176 (434) (132) 63 156 202 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 11,961 19,246 22,636 29,234 33,378 (3,086) (5,842) (7,017) (8,770) (9,680) 199 (263) 0 0 0 0 0 0 0 0 9,074 13,142 15,619 20,464 23,698 8,677 14,670 20.33 19.45 3.72 446 13,667 22,700 29.39 30.57 4.69 447 15,619 26,103 34.90 34.90 4.89 448 20,464 32,932 45.72 45.72 5.94 448 23,698 37,430 52.95 52.95 6.88 448

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 12,394 2,275 (434) (2,756) (6,460) 0 5,020 (6,543) 4 0 0 (6,540) (1,661) 5,830 (7,295) 0 (3,126) (4,646) 0 (1,523) 2013 19,378 3,322 (132) (5,829) (4,323) 0 12,416 (5,258) 7 0 0 (5,251) (2,095) 11,267 (1,358) 0 7,814 14,980 0 7,158 2014E 22,573 3,529 63 (7,017) (7,405) 0 11,744 (5,000) 0 0 0 (5,000) (2,187) (234) (1,486) 0 (3,906) 2,837 0 6,744 2015E 29,078 3,854 156 (8,770) (6,149) 0 18,169 (5,000) 0 0 0 (5,000) (2,660) (210) (743) 0 (3,614) 9,556 0 13,169 2016E 33,176 4,254 202 (9,680) (3,537) 0 24,415 (5,500) 0 0 0 (5,500) (3,081) (189) (371) 0 (3,642) 15,273 0 18,915

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 4,025 0 17,318 17,327 8,241 46,911 26,894 5,040 0 28 31,962 78,872 0 16,891 0 16,891 16,400 0 1,442 3,287 21,129 38,021 40,129 723 40,852 78,872 12,376 447 2013 4,349 0 21,870 19,489 9,597 55,305 28,830 5,073 0 21 33,924 2014E 3,552 0 25,968 24,441 10,920 64,881 30,301 5,073 0 21 35,395 2015E 2016E 11,291 25,656 0 0 30,353 33,152 28,568 31,202 12,430 13,673 82,642 103,683 31,447 5,073 0 21 36,541 32,693 5,073 0 21 37,787

Year-end: Mar Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) 2012 63.2 20.7 17.5 12.2 25.8 21.4 5.2 5.0 -0.6 0.0 2013 63.2 23.5 20.1 14.2 30.4 36.1 44.8 44.6 57.2 25.9 2014E 63.5 23.4 20.2 14.0 31.0 15.7 18.9 18.7 14.2 4.3 2015E 63.7 25.0 22.1 15.5 30.0 18.1 31.0 31.0 31.0 21.7 2016E 63.9 25.8 22.8 16.3 29.0 10.3 15.8 15.8 15.8 15.8
89,229 100,275 119,182 141,470 0 19,241 0 19,241 10,240 0 2,337 4,684 17,261 36,502 52,132 595 52,727 0 21,741 0 21,741 5,120 0 2,103 5,153 12,376 34,117 65,564 595 66,159 0 25,099 0 25,099 2,560 0 1,893 5,668 10,121 35,220 0 27,672 0 27,672 1,280 0 1,704 6,235 9,218 36,890
24.9 22.3 1.0 0.4 0.3 205.5 77.0 201.1
28.5 29.4 1.1 0.6 0.6 189.4 74.2 185.9
26.5 30.4 1.2 0.5 0.7 196.7 78.3 183.5
27.5 33.7 1.2 0.6 0.8 202.7 78.1 179.1
25.3 31.9 1.1 0.7 0.8 208.3 79.8 183.9
30.3 26.5 47.2 1.0 2.8
11.2 14.6 47.2 0.6 2.9
2.4 6.5 120.5 0.3 3.0
-10.4 2.7 310.3 0.1 3.3
-23.3 1.1 691.2 0.1 3.7
83,368 103,986 595 595 83,962 104,580
89,229 100,275 119,182 141,470 5,891 448 1,568 448 (8,731) (24,376) 448 448
3.0 14.6 17.3 22.5 23.5 5.9 0.8
2.8 11.7 13.7 19.6 18.8 5.4 0.8
3.8 16.1 18.6 26.7 26.7 6.4 0.5
3.1 12.4 14.1 20.4 20.4 5.0 0.6
2.7 10.5 11.9 17.6 17.6 4.0 0.7
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Cipla
Transformational play
Cipla is transitioning towards faster growth. It has added OUTPERFORM (unchanged) top/mid management, scaled up sales, and renewed PRICE as of 7 Jan 2014 PRICE TARGET focused on R&D and capacity augmentation. It is acquiring front-end capabilities in EMs and expanding its product basket in developed markets (US). We expect a re-rating post the transition over the next one year. Our PRII matrix highlights Ciplas unique business model, which focuses on high-value branded generics in India and EMs, and lower reliance on special products. Cipla is our top pick with a PT of INR 510 based on 18x oneyear-forward P/E. Valuation looks attractive compared with large cap peers. False start. Over FY08-13, Cipla focused on low-risk and low-cost branded generics across EMs/India and missed out the speciality product windfall, leading to lower revenue growth (15% vs 20% CAGR for peers). It under-invested in R&D (4.5% vs 6.2% of sales by peers), in employees (7% vs 12% of sales by peers) and in building its US product basket (30+ ANDAs vs 100+ for peers). Undergoing a transformation. Cipla has hired a new CEO and a new CFO, has augmented sales across geographies and reoriented business segments. It is switching its model from marketing through partners to owning front-end capabilities, particularly in Africa. In July 2013, Cipla acquired Medpro for INR 27bn to strengthen its marketing presence in Southern Africa, but near-term revenue gains are limited (Cipla supplies 90% of Medpros sales). In November 2013, it acquired a 14.5% stake in Quality Chemical Industries (QCIL, Uganda) for USD 15mn. Turnaround possible in one year. We expect the product mix to improve given its higher focus on ANDA filings in the US, lower dependence on the acute segment (low margin), and ramp-up of inhalers in Europe. A re-rating is likely as margin and growth show structural improvement. Valuation attractive. We value Cipla at INR 510 based on 18x one-year-forward EPS (vs 21x for large-cap peers). Cipla has historically traded at a premium to the sector (20x PE one-yearforward, five-year average). The current discount to its own historical valuation and to large cap peers could decline, in our view. We expect EPS growth of 0%/13%/20% in FY14/15/16E, respectively. We expect margins to dip from the highs of FY13, but remain stable at 25%+, with 17% RoE.
Year-end: March Sales (INR mn) EBITDA (INR mn) EBIT (INR mn) Pre-tax profit (INR mn) Net profit adj. (INR mn) FCF (INR mn) EPS adj. (INR) DPS (INR) Book value/share (INR) EPS growth adj. (%) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Div. payout (%) Net gearing (%) ROE (%) ROCE (%) EV/sales (x) EV/EBITDA (x) PBR (x) PER adj. (x) Dividend yield (%) 2013 84,404 23,589 20,284 22,564 16,757 6,741 20.87 2.00 110.47 46.5 0.0 27.9 24.0 19.9 9.4 9.7 20.7 21.9 3.5 12.5 3.4 17.3 0.6 2014E 98,214 24,533 20,775 22,093 16,791 6,032 20.91 2.09 128.93 0.2 4.6 25.0 21.2 17.1 10.0 8.6 17.5 21.1 3.3 13.2 3.0 18.7 0.5 2015E 111,451 28,020 23,798 25,013 19,010 11,057 23.68 2.25 149.98 13.2 7.6 25.1 21.4 17.1 9.5 -1.7 17.0 23.6 2.8 11.1 2.6 16.5 0.6 2016E 127,398 33,446 28,839 29,956 22,766 14,139 28.35 2.55 175.35 19.8 13.5 26.3 22.6 17.9 9.0 -11.1 17.4 24.3 2.3 8.9 2.2 13.8 0.7
INR 390.85
Bloomberg code
INR 510.00
Reuters code
CIPLA IN
Market cap
CIPL.BO
12-month range
INR 313,813mn (USD 5,036mn)

EPS adj. est. change 2014E 2.8%
INR 354.00 - 450.40

2015E 0.9%

Cipla
470 410 350 Jan-13
BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth 1 2 -
-3 mth -12 mth -11 -8 -15 -12 Promoter (36.8%) 63% 8,898,967
Gaurav Pathak
13 January 2014
CIPLA IN INR 390. 85 INR 510. 00
Shashikiran Rao
83

Business model in transition: Strengthening management, adding marketing and sales force across geographies and expanding product basket across markets. Switching model from marketing through partners to owning front-end capabilities. It is trading at an attractive 14x FY16E PE, a 20-25% discount to large-cap peers. We expect stable revenue growth of 15% and EPS growth of 0%/13%/20% for FY14/15/16E, respectively. There is potential for a re-rating as margins and growth start to inch up (post FY14), in our view.
Leadership transformation
In the past 18 months, Cipla has added almost 15 key personnel. We believe Cipla has created a strong leadership team across geographies and tiers, helping it capture and execute a faster growth trajectory. Figure 99: Key management bandwidth enhancement
Personnel Joining date Role/responsibility Managing Director Previous experience/Profile Joined from Novartis Pharma AG, where he led the global product strategy and commercialisation function. Previously he worked with Citicorp, The Boston Consulting Group, and PepsiCo, across Europe, North America, Africa and Asian markets. He is a graduate in engineering from Oxford University and an MBA from INSEAD, France Joined from Cadbury India Ltd where he served as Director of Finance for South Asia, Indo-China and Executive Director. He holds a BE from Punjab University and an MBA from Manchester Business School and University of Chicago, Graduate School of Business His prior experience includes senior positions in Teva and GSK His prior experience includes Head of US Sales in Teva and GSK His prior experience includes Head of Africa sales in Valeant and as Pharmacy Division Director at Johnson & Johnson He is the CEO of Cipla Medpro, which was acquired by Cipla in July 2013; prior experience includes Vice President & Managing Director for Mylan South Africa Prior experience includes Barclays, McKinsey; a graduate of Indian School of Business, Hyderabad Subhanu Saxena Feb 2013
Rajesh Garg
Jul 2013
Global CFO
Frank Peter Tim Crew Christos Kartalis Paul Miller
Sep 2012 Jan 2013 Aug 2013 Jan 2013
Head of Europe and Respiratory Head of US Head of International Business Head of South Africa (Cipla Medpro) Business Transformation Head, Biologics
Anant Atal Steven Lehrer
Jul 2013 NA
In addition to the above high level hires in the business domains, Cipla has also strengthened its support functions with the recruitment of heads of legal process (Murali Neelakantan) and quality assurance. Cipla also has one of the strongest sales forces of c.10,000 (7,500 medical reps), significantly large in comparison to peers. It has close to 1,000 scientists working in R&D.
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Business transformation
Product transformation Cipla is aggressively expanding its product basket in developed markets. Initially, it will push its key inhaler basket in Europe and slowly take it to the US. Over the next 3-5 years the company is expecting very strong growth from the developed markets. We expect ANDAs filed and product launches to increase sharply in the US. We expect Cipla to file 8-10 ANDAs in FY14. Cipla filed 6 ANDAs in FY13 and 20 ANDAs were returned from partners. Currently, it has a total of 33 ANDAs filed with 18 approvals. It also has 76 products filed by partners (total of 22 current partners in the US) of which 47 have been commercialised. Cipla will also look at PIV opportunities going forward. Within emerging markets and India, the focus is steadily shifting to increase the share of chronics, which is currently 39%, with a push towards cardiovascular products. Cipla has also been investing in biologics, for a slow but steady launch pipeline. Even within the existing product basket there is an opportunity to market and monetise the basket better. The company is also looking at respiratory, injectables, CVS, CNS and oncology to be the key growth areas across markets. Model transformation The company will also focus on acquisitions across markets when it gets the right strategic fit. It has a presence in 140 countries with more than 600 partners. The initial focus is to look at acquisition targets among these partners. The company is also looking at adding marketing front-ends in Nigeria, East Africa, Japan, Turkey, Brazil, and Mexico. In Russia, Cipla has a partnership with Teva to sell respiratory products and with DRL for the remaining products. Cipla has created a new division, Cipla New Ventures, to look at any new opportunities for the company. This also includes initiatives for biologics. Cipla has invested USD 60mn in acquiring stakes in two biologic companies. It has acquired a 40% stake in the Indian biotech company MabPharm, whose plant is located in Ciplas Goa facility. It has a 25% stake in BioMab-Desano, a biotech company in Hong Kong. This company is setting up a state-of-the-art facility for biosimilar products in Shanghai. Cipla will have rights to market biosimilar products of this biotech company in India and in international markets. In April 2013, Cipla launched its first biosimilar (Etanercept) in India under the brand name 'Etacept' for the treatment of rheumatic disorders. The company's product costs 30% less than the innovators product. The international business has been separated. This was primarily the tender-based business particularly from the WHO. This will include ARV, anti-infective, anti malarial, TB, Hep C and a similar product basket. Process transformation Our discussion with Cipla suggests the transformation is ongoing across five key verticals: (1) procurement, (2) manufacturing, (3) supply chain domestic, (4) supply chain International and (5) R&D. The idea is to bring in consistency, standardisation and best practices across all of these verticals.
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Cipla is implementing SAP at a global enterprise level, one of the largest SAP implementations in India, shifting straight from a 40-year legacy system. Cipla has been closing or re-organising business verticals. In Q2FY12, Cipla closed two marketing divisions Protec and Omnicare (antibiotic and anti-infective). It still has 15 marketing divisions in India, which have absorbed these products.
15% revenue CAGR sustainable

In FY13, Cipla posted 20% revenue growth driven by the Lexpro opportunity. Teva had a 180-day exclusivity launch of Escitalopram (e.g., Lexapro, brand sales USD 2.9bn) from March 2012. Cipla was Tevas supplier of generic Lexapro, under an earlier agreement with Ivax (acquired by Teva). We expect Cipla to sustain 15% revenue CAGR over FY13-16E. We expect India formulations to grow at a 14% CAGR and the overall overseas business at 20% led by new product launches across developed and emerging markets. The company has internally set a target of USD 5bn revenue by 2020 (with USD 1bn from the US and Africa to contribute 20-25%). Figure 100: Ciplas revenue has started looking up again
140 120 100 INR bn 80 60 40 20 0 FY05 FY08 FY11 FY12 FY13 FY14E FY15E FY16E
Source: Company, Standard Chartered Research estimates * FY09 reported growth was 24%, adjusted for rupee depreciation, it was around 16%
Exports
Tech fees
Domestic revenues
YOY
25
20
15
10
Figure 101: Regulated markets contribute almost ~30% of exports

45 40 Americas Europe Others
35
30 INR bn 25 20 15 10 5 0 3 1 2 FY03 4 2 3 FY04 8 5 2 3 FY05 3 5 FY06 4 6 FY07 5 5 FY08 8 FY09 8 11 5 5 8 FY10 15 17 6 23 22
20
6
8 FY11
6 15 8 FY12 FY13
Source: Company, Standard Chartered Research Note: We have assumed 50% of Americas sales are to the regulated markets
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Figure 102: Breakdown of exports

Middle East 6% Australia 13%
Europe 14%
Americas 34% Africa 33%
Dymista a big opportunity In June 2013, Cipla gave the global commercialisation rights of its Dymista NDA (New Drug Application; azelastine and fluticasone combination inhaler) to Meda AB. The partnership started in the US in 2006. Cipla will produce the formulation and Meda will be responsible for clinical development, registration, marketing and sales. Cipla will receive milestone payments from Meda on approval across each country. We estimate current sales run-rate of USD 6-7mn/quarter. However, we expect significant growth going forward the market size for this product is USD 750mn. India provides the needed stability Ciplas domestic operation is its strength, offering steady growth and stable cash flows. In the Indian pharma market, Cipla has 5.3% market share and is currently the second-largest drug maker after the US drug maker Abbott Laboratories. Cipla has a strong presence in therapies like inhalers, cardiology, CNS, and urology. It usually launches 20-25 products per year with increasing focus on chronics. Inhalers are Ciplas main product, forming c.18% of its revenues. It has the largest manufacturing facility for inhalers, with c.55% market share in anti-asthmatic products and 70% market share in the inhaler market. Ciplas top 5 p roducts in India are all inhalers with more than INR 1bn/year sales Asthalin (Salbutamol), Foracort (Formoteral and Budesonide), Seroflo (Salmeterol and Fluticasone), Budecort (Budesonide) and Aerocort (Levosalbutamol and Beclomethasome). EU inhaler opportunity key Cipla has been actively pursuing the inhaler market in the EU (USD 7bn in size). Cipla has 10 inhaler filings in Europe, including combination inhalers. It has five products approved, two under approval and three under trials. The key inhaler Advair/Seretide generic (fluticasone and salmeterol) was covered by a Supplementary Protection Certificate (SPC) until September 2013. We expect Cipla to launch generic Advair in the next two years, but have not factored in this opportunity.
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Cipla currently has approvals for some mono therapies including budesonide inhalers in Germany, Portugal and Spain, salmeterol inhalers in Denmark, Portugal and the UK, and beclomethasone in Portugal. All these projects are DPIs (dry powder inhalers) with the company indicating that it may look at MDIs (metered dose inhalers) in the near future also. We expect limited competition in the inhaler opportunity for Cipla (3-5 players in each product) and the opportunity could be a very profitable one for the company. We highlight that mono-therapy inhalers are likely to be a very small market for Cipla, with the combination inhalers providing the largest opportunity (almost 80% of the market is combination). The combination market, however, has also proven to be the most challenging (both patent and regulatory). Cipla had a head start in developing combos for the EU market, but regulatory challenges, especially on the devices, have led to constant shifting of approval timelines. Renewed focus on Africa Africa has been the mainstay of Ciplas export performance, contributing c.35-40% of total exports till FY13. In the past 2-3 years, however, growth had begun to taper off as can be seen in the chart below. Recent acquisitions in Africa are likely to help it regain the momentum in this market. Figure 103: Export growth has been led by Africa/MEA geographies
50
45 40 35 30 INR bn 25 20 15 10 5 0 10 13 5 FY07 8 3 FY05 5 FY06 7 FY08 14 10 FY10 13 18 19 20 22 30 29 55 % 5 14 -20 FY09 FY11 FY12 FY13
88
Africa (LHS) Africa Export growth yoy (RHS)
ROW (LHS) Export yoy (RHS)
105
80
7 2
FY04
10
15
13 January 2014
Acquisitions to add front-end

The company will focus on acquisitions in markets where it gets the right strategic fit. It has a presence in 140 countries with more than 600 partners. The initial focus is to look at acquisition targets among partners. The company also plans to add marketing front-ends in Nigeria, East Africa, Japan, Turkey, Brazil and Mexico among other EMs. In Russia, Cipla has a partnership with Teva to sell respiratory products and with DRL for the remaining products. QCIL, November 2013: Cipla acquired a 14.5% stake for USD 15mn in Ugandas Quality Chemical Industries (QCIL). Cipla earlier held a 36.6% stake in QCIL, taking the total to 51%. QCIL mainly makes and sells anti-AIDS and anti-malarial drugs and has manufacturing facilities (approved by the World Health Organization) in Uganda. It gives Cipla a marketing front-end in Central Africa. Celeris, December 2013: Cipla acquired a 100% stake in Celeris d.o.o., Croatia. This company was the distributor of Cipla's products in Croatia. Medpro, July 2013: Cipla acquired 100% of its long-term partner in South Africa, Cipla Medpro (CMP SJ), for INR 27bn. The deal gives Cipla India front-end capabilities in South Africa. Medpro has sales of close to USD 300mn, with close to 90% of supplies from Cipla. Medpro has been one of fastest-growing generics companies in South Africa in recent years. Cipla could bring further synergies to the South African operations better product monetisation/expansion and margin improvement. Figure 104: Cipla Medpro : Competitive positioning
Company TPM Market Aspen P/Care Gen Sanofi-Aventis Cipla-Medpro AstraZeneca Msd (Pty) Ltd Pfizer Labs Adco-Generics Aspen GSK Roche Ethicals A.I.Consumer Health
Source: Company
2012 rank NA 1 2 3 4 5 6 7 8 9 10
2012 sales (mn SAR) 27,176 2,156 1,911 1,421 1,138 1,110 1,036 968 889 800 792
Market share (%) 100 7.9 7 5.2 4.2 4.1 3.8 3.6 3.3 2.9 2.9
2012 yoy growth (%) 7.1 8.8 1.7 15.3 -5.9 1.3 1.8 1.5 2.6 4.4 6.8
Cash flows and margins to inch-up

From INR 6bn net debt in FY14E, we estimate Cipla to move to INR 19bn of net cash by FY16 end and EBITDA margins to inch up from 25% in FY14 to 26%+ in FY16. Capex cycle completed Ciplas manufacturing capacities have been enhanced for bulk drugs, tablets, capsules, liquids and, more importantly, nearly double for aerosols/inhalers. Cipla completed the capacity expansion of (1) anticancer APIs at Bommasandra, Bengaluru, (2) anti-ulcerant APIs at Kurkumbh, Maharashtra, (3) antiretrovirals (ARVs) API in Kurkumbh, (4) new API unit in Bangalore, (5) upgraded API facilities in Patalganaga, Maharashtra and (6) upgraded anti-cancer formulations in Goa.
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Cipla set up a new API R&D facility at Patalganga, and a R&D/administration facility at Vikhroli, Mumbai. It also expanded and consolidated its head office operations by acquiring office space in Peninsula Business Park, Lower Parel, Mumbai for INR 3bn. The company has invested a significant amount in the Indore SEZ. This facility will primarily be utilized for exports and will include capacity for aerosols, liquid orals, PFS, etc. The Indore SEZ currently has a sales run-rate of INR 7bn and has secured crucial approvals (UK-MHRA approval in Q3FY11 and USFDA approval in FY12/13). R&D will rise We expect R&D costs to rise at a 19% CAGR over FY13-16E as the company increases its focus on ANDAs in the US. We expect filing/approval/trial costs to rise across geographies. R&D costs will also rise further as the company tries to take newer combinations and biologic drugs into emerging markets. Margins to improve We estimate EBITDA margins to inch up from 25% in FY14 to 26%+ in FY16. Going forward, utilization at its Indore facility is likely to rise. New product launches (particularly in inhalers), higher sales of Dymista and focus on chronics (oncology, CNS, CVS) are likely to drive further margin improvement. Figure 105: Ciplas margins maintained given lower fixed costs on exports
Revenue CAGR FY08-13 (%) Sun Pharma Dr. Reddy's Ranbaxy* Cipla Lupin
*CY10 for Ranbaxy Source: Companies, Standard Chartered Research
Gross margin FY13 (%) 74.5 52.1 66.0 56.2 59.4
EBITDA margin FY13 (%) 33.5 22.5 18.7 24.6 20.2
25.9 30.3 9.0 17.1 29.2
Valuation
We set a 12-month price target of INR 510, valuing the business at 18x one-yearforward P/E, at a discount to its historical median and large-cap stocks in our coverage universe (ex-Sun and Ranbaxy). On a comparable basis, this is in line to our valuation for Lupin, our sector top pick. Figure 106: Comparative valuation for Cipla vis-a-vis large cap pharma
140 130 120 (%) 110 100 90 Cipla 1-Year forward PE as % of large cap Pharma
80 May-07
Aug-08
Nov-09
Feb-11
May-12
Aug-13
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90
As shown in Fig 8, Ciplas sector premium has shrunk over the past three years and is currently trading on par with the sector. Historically, the stock has also traded at a 15-20% premium to its comparable peers, based on its consistent earnings growth and predictable revenue streams. We believe that the stock could see continued pressure for a few quarters more, until more visibility emerges on top line revenue growth. To that extent, regulatory timelines for the new facility and the company outlook for FY14 will be critical drivers for the stock. We believe that the growth momentum should begin to emerge in the next few quarters from its renewed US focus. The stock has historically traded in a very narrow band of 15-20x two-yearforward. Currently, it is trading at the lower-end of this historical band. Figure 107: Cipla two-year-forward P/E band
600 500 400 300 200 100 0 Jun-07 10x 15x 20x Cipla CMP
Jul-08
Aug-09
Sep-10
Oct-11
Nov-12
Dec-13
Risk
Negative DPCO outcome could impact earnings Under the Drugs Price Control Order (DPCO), the Indian government has served notice on Cipla for INR 12.3bn (including interest), alleging overcharging on certain products which it claims falls under the purview of the DPCO. Cipla has challenged the DPCO assertions and the matter is currently sub-judice. Cipla has not provided any provisions for such a contingency and we believe that any adverse court ruling can have a material impact on Ciplas earnings. Margins volatile but trend positive in the past three years On a quarterly basis, Ciplas margins have been volatile, depending on the contribution of exports to the sales mix and the quantum of tech fees. A higher contribution from exports typically has lower margins (due to domestic margins being higher) and higher tech fees boost margins. The table below shows the gross and EBITDA margins along with export formulation growth for the company in the past 10 quarters. Figure 108: Ciplas quarterly margins dependant on product mix; hence are volatile
(%) Gross margin EBITDA margin Export growth Y-o-Y Export % to total sales mix
Q1FY12 57.8 22.3 8.4 52.0
Q2FY12 59.7 23.7 9.5 51.1
Q3FY12 59.2 21.9 10.7 48.9
Q4FY12 58.6 21.4 11.3 57.6
Q1FY13 62.6 27.4 17.9 49.3
Q2FY13 64.0 30.9 33.1 54.7
Q3FY13 61.5 23.1 27.8 53.0
Q4FY13 64.1 22.2 (2.8) 53.3
Q1FY14 62.8 30.0 20.7 47.5
Q2FY14 62.3 22.9 12.8 55.4
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Financials
1. We expect sales to post a 16% CAGR during FY13-16E, to INR 129bn by FY16E 2. We expect technology fees to be maintained at USD 6mn per annum in FY14-16E 3. We estimate total capex of INR 16bn in FY14-16E, funded through internal accruals Revenue likely to grow at 16% CAGR over FY13-16E, led by formulation growth We expect gross sales to post a 16% CAGR during FY13-16E, to INR 129bn by FY16E, led by 18% CAGR in domestic branded formulations (to INR 71bn). Export formulation growth is likely to post a 14% CAGR over FY13-16E in constant currency terms; however, in INR terms we expect export formulation growth of 16%, factoring USD-INR at 60 over FY15-16E.
Figure 109: Revenue breakdown by segment

INR mn Domestic International -Formulations in USD mn -Bulk in USD mn Other operating income Tech income (USD mn) Total
FY13 37,026 43,751 36,954 684 6,797 128 1,925 659 82,702
FY14E 41,839 55,246 48,322 561 6,923 115 2,294 360 99,379
Growth yoy (%) 13.0 26.3 30.8 -18.0 1.9 -10.0 19.1 -45.4 20.2
FY15E 48,115 62,124 54,855 657 7,270 121 2,534 360 112,774
FY16E 55,333 70,742 63,109 775 7,633 127 2,836 360 128,911
CAGR FY13-16 (%) 14.3 17.4 19.5 4.2 3.9 (0.3) 13.8 -18.3 15.9
Increased cost base due to significant capacity addition Cipla had embarked on an aggressive capacity expansion program over the past three years, with total capex of INR 21bn during FY08-10. This has led to its fixed costs increasing at a faster rate than overall sales growth. EBITDA margins have ranged c.20-24%, led primarily by gains in gross margins. Figure 110: Fixed costs have outpaced sales growth in the past five years
INR mn Net sales (ex tech income) Staff costs Other fixed costs Total fixed costs EBITDA Gross margins (%) EBITDA margins (%)
FY08 40,104 2,140 11,095 13,235 8,530 51.4 20.2
FY13 82,793 10,363 20,926 31,289 23,589 65.0 27.9
CAGR (%) 15.6 37.1 13.5 18.8 22.6
R&D expenditure has remained flat at 4-4.5% of revenues. Ciplas R&D expenditure is one of the lowest in the industry and we expect it to remain so going forward. No significant debt overhang We estimate total capex of INR 16bn in FY14-16E, mainly for the expansion of the Patalganga facility and new R&D facility in Vikroli in addition to minor expansion projects for formulations, biotech and API facilities. We expect the company to be able to fund this through internal accruals and expect the company to remain debtfree during the period. Average RoCEs should be maintained at 19-21%, in our view.
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Company profile
Indias second-largest pharma company by domestic sales Cipla is Indias second-largest pharma company by domestic sales. In the highly fragmented Indian pharma market, Cipla is a leader in the ARTs, respiratory and urology segments. Unlike its peers, the companys strategy has been to focus only on product development and manufacturing for its partners. Cipla has a judicious mix of acute care and chronic care therapies chronic care accounts for 43% of domestic revenue. The company is present in major therapeutic categories and covers a wide range of products starting from oral solids to difficult-to-make products such as inhalation devices. The company has 19 state-of-the-art manufacturing facilities at six locations in India and it exports to almost 175 countries. Cipla has a sales force of more than 4,300, the highest in the industry, with coverage across 160,000 chemists. It has more than 7,000 registrations in various export markets. Figure 111: Export revenue by region
Middle East 6% Australia 13% Europe 14%
Figure 112: Shareholding pattern
Others 29% Promoter 37%
Africa 33%
Americas 34%
DII 11% FII 23%
Source: BSE
Figure 113: Key management

Person Dr YK Hamied MK Hamied Subhanu Saxena Designation Chairman & MD Joint MD Managing Director Profile Holds a doctorate in chemistry from Cambridge University. He was awarded the Padma Bhushan for his distinguished service and contributions He was designated as Joint Managing Director in 2000. He has extensive experience in production, technical areas, quality management Joined from Novartis Pharma AG where he led the global product strategy and commercialisation function. Previously worked with Citicorp, The Boston Consulting Group, and PepsiCo, across Europe, North America, Africa and Asian markets. He is a graduate in engineering from Oxford University and an MBA from INSEAD, France
Source: Company
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Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 70,207 84,404 98,214 111,451 127,398 42,814 54,878 63,839 72,443 82,809 (22,969) (26,602) (33,682) (37,956) (42,054) 0 0 0 0 0 (3,257) (4,687) (5,624) (6,468) (7,308) 13,466 20,284 20,775 23,798 28,839 (299) (295) (750) (750) (750) 0 0 0 0 0 1,311 2,177 2,068 1,965 1,867 0 398 0 0 0 14,478 22,564 22,093 25,013 29,956 (3,065) (5,443) (5,302) (6,003) (7,189) 29 (62) 0 0 0 0 0 0 0 0 11,442 17,059 16,791 19,010 22,766 11,442 16,589 14.25 14.25 2.00 803 16,757 23,589 21.25 20.87 2.00 803 16,791 24,533 20.91 20.91 2.09 803 19,010 28,020 23.68 23.68 2.25 803 22,766 33,446 28.35 28.35 2.55 803

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 13,466 3,122 (299) (2,864) 4,247 0 17,672 2013 20,284 3,305 (295) (4,970) (6,859) 398 11,863 2014E 20,775 3,758 (750) (5,302) (5,448) 0 13,032 2015E 23,798 4,222 (750) (6,003) (5,210) 0 16,057 (5,000) 0 0 0 (5,000) (2,113) 0 0 0 (2,113) 8,944 0 11,057 2016E 28,839 4,608 (750) (7,189) (6,368) 0 19,139 (5,000) 0 0 0 (5,000) (2,397) 0 0 0 (2,397) 11,742 0 14,139
(5,193) (5,122) (7,000) (6,784) (13,330) (6,679) 29 (62) 0 0 0 0 (11,948) (18,514) (13,679) (1,866) 152 (5,427) 0 (7,141) (1,417) 0 12,479 (1,886) 10,706 (286) 0 8,533 1,882 0 6,741 (1,965) 0 0 0 (1,965) (2,611) 0 6,032

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 905 0 15,536 18,501 10,003 44,945 35,870 0 0 12,688 48,558 2013 1,051 0 16,452 23,434 10,291 51,228 37,686 0 0 26,018 63,705 2014E 1,745 0 18,836 26,908 10,599 58,087 40,928 0 0 6,505 47,433 2015E 11,595 0 21,374 30,535 11,128 74,631 41,706 0 0 6,505 48,210 2016E 24,251 0 24,432 34,904 11,794 95,380 42,098 0 0 6,505 48,603

Year-end: Mar Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) 2012 61.0 23.6 19.2 16.3 21.2 11.2 15.6 15.6 15.6 0.0 2013 65.0 27.9 24.0 19.9 24.1 20.2 49.1 49.1 46.5 0.0 2014E 65.0 25.0 21.2 17.1 24.0 16.4 -1.6 -1.6 0.2 4.6 2015E 65.0 25.1 21.4 17.1 24.0 13.5 13.2 13.2 13.2 7.6 2016E 65.0 26.3 22.6 17.9 24.0 14.3 19.8 19.8 19.8 13.5
93,503 114,932 105,520 122,841 143,983 0 12,057 0 12,057 292 0 2,332 2,432 5,057 17,113 76,389 0 76,389 0 10,997 0 10,997 9,658 0 2,812 2,770 15,240 26,237 0 12,519 0 12,519 10,623 0 2,953 1,965 15,540 28,060 0 13,855 0 13,855 9,562 0 2,953 2,113 14,627 28,482 0 15,296 0 15,296 8,606 0 2,953 2,397 13,956 29,252
16.0 17.0 0.8 1.3 0.6 250.3 79.1 144.2
20.7 21.9 0.8 0.6 0.6 259.2 69.2 142.5
17.5 21.1 0.9 0.6 0.5 267.3 65.6 124.9
17.0 23.6 1.0 0.7 0.8 268.7 65.8 123.4
17.4 24.3 1.0 0.7 0.9 267.8 65.6 119.3
-0.8 0.4 45.0 0.2 3.7
9.7 9.3 68.8 0.2 4.7
8.6 11.4 27.7 0.4 4.6
-1.7 8.8 31.7 0.4 5.4
-11.1 6.7 38.5 0.3 6.2
88,695 103,522 120,418 140,787 0 131 134 137 88,695 103,653 120,552 140,924
93,503 114,932 131,713 149,034 170,176 (613) 803 8,607 803 8,879 803 (2,033) (15,645) 803 803
3.6 15.3 18.8 22.0 22.0 3.2 0.6
3.5 12.5 14.5 17.0 17.3 3.4 0.6
3.3 13.2 15.5 18.7 18.7 3.0 0.5
2.8 11.1 13.1 16.5 16.5 2.6 0.6
2.3 8.9 10.3 13.8 13.8 2.2 0.7
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Ranbaxy Laboratories
Struggle continues await better entry point
Ranbaxy scores well on our PRII matrix due to its strong reach and product pipeline. We rate it In-Line. Re-rating triggers are unpredictable or beyond FY15. They include Nexium, Diovan, Valcyte exclusivities, FDA consent decree clearance, and hybrid model with Daiichi Sankyo. We believe Ranbaxys struggle with the USFDA and lowerthan-industry margins are likely to continue until FY16E. We value Ranbaxy at INR 477, valuing the core business at INR 454 (18x one-year-forward) and exclusivities at INR 24. We transfer coverage of the stock to Shashikiran Rao. Diversified business basket. Our PRII matrix ranks Ranbaxy highly for its diversified product basket and global reach in both emerging and developed markets. Progress on the hybrid model with Daiichi Sankyo is promising. Its product launches in Europe, Japan, emerging markets and exclusivities in the US (clubbed with Absorica) make the case for a stable and growing base business over FY15-16E. FDA issues persist, exclusivities may be safe. We expect the issues with the implementation of the USFDA consent decree to continue to overshadow progress on other fronts. Currently, all its USFDA approved plants in India (Dewas, Paonta Sahib and Mohali) are under import alert. According to management, it is likely to avail of the three key exclusivities - Diovan, Valcyte and Nexium as the Mohali plant does not require data validation. Margin improvement gradual. Ranbaxys EBITDA margins are well below the industry average. The company has highlighted three levers to achieve the industry average of c.20%: (1) launch branded products in the US, (2) leverage the Indian production base and (3) complete the consent decree proceedings. All three factors are likely to materialise by end- FY16E. Valuations close to large-cap pharma. We value Ranbaxys core business at INR 454, i.e., 18x one-year-forward earnings, close to the valuation range of pharma large caps, leaving little room for a P/E re-rating. In addition, we value the exclusivity opportunities (Diovan, Nexium, Valcyte) at INR 24, to arrive at our SoTP price target of INR 477. We believe that over the next two years as Ranbaxy sorts out the issues mentioned above, it could be re-rated to the pharma large-cap valuation range (20x), but we would wait for a better entry point for that upside. In the near term, risks and returns seem priced-in. We recommend In-Line. Shashikiran Rao
13 January 2014
RBXY IN INR 480. 40 INR 477. 00
IN-LINE
(unchanged)
PRICE TARGET
INR 480.40
Bloomberg code
INR 477.00
Reuters code
RBXY IN
Market cap
RANB.BO
12-month range
INR 202,729mn (USD 3,253mn)

INR 253.65 - 514.05

-77.2% 2015E nm
2013 124,597 21,270 18,067 13,276 13,633 10,093 32.31 4.06 0.00 96.70 -17.1 17.1 14.5 10.9 0.0 86.8 28.7 16.0 2.0 11.7 4.5 15.3 0.0
2014E 145,736 13,928 8,853 (2,132) 3,476 (27,038) 8.24 (7.30) 0.00 90.81 -74.5 9.6 6.1 2.4 0.0 105.9 -6.2 8.2 1.7 17.5 5.3 58.3 0.0
2015E 143,426 22,630 19,006 16,204 13,773 10,265 32.64 13.62 0.00 123.14 296.2 15.8 13.3 9.6 0.0 65.5 30.2 18.8 1.7 10.5 3.9 14.7 0.0
2016E 145,896 22,219 18,398 16,043 12,834 12,722 30.41 13.62 0.00 153.25 -6.8 15.2 12.6 8.8 0.0 39.1 21.8 16.0 1.6 10.3 3.1 15.8 0.0
Source: Company, Standard Chartered Research estimates *2014E is 15-month, 2013 is CY ending Dec 31,2012

Ranbaxy Laboratories 600 425 250 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth 11 12 -
-3 mth -12 mth 26 -6 21 -11 Promoter (63.7%) 36% 24,408,896
Gaurav Pathak
95
Holding on to exclusivities key

We believe that the priority for Ranbaxy over the next two years will be capitalising on the exclusivities that it currently holds. We estimate Ranbaxy has the potential to earn USD 0.5bn in revenues in exclusivities over FY15-16E. We believe that the three key exclusive products can be supplied from the Ohm plant, which is currently Ranbaxys only USFDA approved plant. We have factored in an NPV of INR 24/sh for Ranbaxy from these products. Ohm's facility in New Jersey was the subject of a Form 483 by the US regulator after it failed an inspection last year, but the recent Establishment Inspection Report (EIM) by the FDA effectively brings the enforcement action to a close, which is critical for Ranbaxy to proceed with these exclusivities. FTFs filings since 2009. Ranbaxy has filed 30 ANDAs in the US market since the consent decree in 2009 from the Ohm and Mohali plants. The company believes that it is well placed to win Para-IV exclusivity for eight of these products with total brand value of USD 8bn. The company, however, has not won any new product approval since the consent decree. Furthermore, we do not have full information on the number of ANDAs that remain valid after the Mohali import alert (we believe close to 50% of ANDAs are from the Mohali plant). In addition, Ranbaxy has only 29 generic products currently in the US market, which is significantly lower than for its peer group. Winning new product approvals remains a critical milestone for Ranbaxy. It has close to 100-odd products filed from the Dewas and Paonta Sahib plants.
Consent decree progress gradual

Ranbaxy entered into a multi-layered consent decree with the USFDA on 25 January 2012. Post the import alert issued in September 2013 on the Mohali plant, it has also been placed under similar terms of the consent decree. Ranbaxy has already forfeited three ANDAs and has paid a USD 500mn fine to the Department of Justice (DoJ) as part of the final settlement. With respect to the consent decree, Ranbaxy has three key obligations. 1. Hire a third-party expert for a thorough internal review at the facilities and audit applications containing data from the affected facilities; 2. Implement procedures and controls to ensure data integrity in its drug applications; and 3. Withdraw any applications found to contain untrue statements of material fact and/or a pattern or practice of data irregularities that could affect approval of the application.
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Figure 114: Consent decree: Import alert process at Paonta, Dewas and Mohali Import Alert termination process at Paonta and Dewas facilities
CGMP expert shall: Perform inspection of the facilities/methods/controls to determine CGMP compliance Evaluate QA/QC program to ensure continuous CGMP compliance Evaluate the adequacy of stability measure Evaluate the QA system for process validation/analytical methods Evaluate the record maintenance process that ensures data authenticity/reliability
CGMP expert to certify that inspection of the facilities/methods/controls has been performed and deviations from CGMP requirements have been corrected
RBXY reports to FDA the actions it has taken to correct CGMP deviations
FDA will begin an inspection of a facility within 90 days of the CGMP expert certificate or RBXYs report (as above) whichever is later FDA notifies RBXY it is compliant (CGMP) within 120 days after inspection ends or within 90 days if FDA does not inspect facilities within 90 days of the above step Post a positive notification from FDA, the import alert on the facility will end and RBXY can start to export approved ANDAs
We believe the implementation of the consent decree has moved on a time-bound and positive manner and we have highlighted several positives on this count. USFDAs response to Ranbaxy on fixed timelines The USFDA has responded to Ranbaxys measures as per pre-specified timelines, which is a key positive, in our view. The following shows some of the key timelines post submission of data by Ranbaxy. Figure 115: USFDAs time-bound response structure is unprecedented, positive for Ranbaxy
Process CGMP injunction provisions Facilities/ products involved Import alert on Dewas/Paonta USFDAs timelines for responses The USFDA will begin an inspection of a facility within 90 days after CGMP experts certificate/Ranbaxy report of actions taken to correct CGMP deviations. The USFDA to notify Ranbaxy within 120 days of inspection if they are CGMP compliant and hence import alert revoked. The USFDA has fixed timelines to get back to Ranbaxy within specified timeframes at different stages of the process. Within 60 days, the USFDA will complete the review of data submitted by Ranbaxy to determine if the ANDA applications were substantially complete at the first time it was filed. The process is designed in a way where the USFDA has fixed timelines to respond to Ranbaxy.
Data integrity provisions for affected applications Accepted applications
Affected application review at Dewas and AIP at Paonta ANDA 1/2/3/4/5
13 January 2014
97
Ranbaxy has had significant lead time to rectify material quality deficiencies We believe that Ranbaxy, together with the parent Daiichi Sankyo, has shown strong commitment to rectify some of its earlier purported mistakes and address the USFDA issues prior to the formal consent decree agreement. Ranbaxy had engaged Quintiles in early 2009 for consultation to rectify the Paonta Sahib facility. Furthermore, Ranbaxy had indicated that Dewas was ready for inspections by mid CY09, indicating that Ranbaxy has a minimum head start to implement the more time consuming provisions of any quality audit (e.g., upgrading plant facilities, modifications in existing standard operating procedures), in our view. Ranbaxy would have spent close to USD 300mn to get these plants back on track.
Margin underperformance may continue

Ranbaxys EBITDA margins have consistently been lower than the industry average since the import alerts in 2009 as shown in the chart below. Ranbaxys unadjusted EBITDA margins significantly lagged the industry despite Ranbaxys revenues over the past 2-3 years being boosted by significant exclusivities like Atorvastatin and Pioglitazone in CY11/12. Figure 116: EBITDA margins below industry average
60 50 40 (%) Ranbaxy Sun Pharma Large cap pharma ex-Sun, Ranbaxy
30
20 10 0 FY2004
FY2006
FY2008
FY2010
FY2012
FY2014E
FY2016E
Source: Standard Chartered Research *Ranbaxy for CY03-12
We estimate that core EBITDA margins (excluding the exclusivity revenues) are closer to 10-11% against c.18-20% for the industry (see table below). The company had highlighted a three-pronged strategy to reach industry standard core EBITDA margins. These involve (1) tapering of the consent decree-related expenses post achieving compliance; (2) improving operating leverage on its Indian production base to pare costs; and (3) focusing on branded and prescription products for the US markets to improve realisations. We, however, expect these to bear fruit only FY16 onwards even if the consent decree procedures fructifies according to expectations. Figure 117: Core EBITDA margin to lag sector even till FY16
INR mn Revenues One-off revenues Core revenues EBITDA One-off EBITDA Core EBITDA Core EBIDTA margin (%) CY09 75,970 5,318 70,652 7,124 3,989 3,136 4.4% CY10 89,608 13,732 75,876 18,652 10,070 8,582 11.3% CY11 101,614 19,114 82,500 16,190 8,247 7,943 9.6% CY12 124,597 29,521 95,076 21,270 11,792 9,478 10.0% FY14E* 145,736 2,880 142,856 13,928 1,872 12,056 8.4% FY15E 143,426 15,003 128,422 22,630 9,752 12,878 10.0% FY16E 145,896 7,560 138,336 22,219 0 22,219 16.1%
Source: Standard Chartered Research estimates.*FY14 runs for 15 months from January 2013 to March 2014
13 January 2014
98
Brands, new segments and hybrid model growth

Besides bringing its bread and butter US generics business back on track, Ranbaxy also has three growth drivers that will ensure revenue growth, in our view. Strengthening its brand in the US market Hybrid model with Daiichi Sankyo to optimise product launches and marketing reach Growth in non-core geographies especially in Europe, Japan and Russia Brand presence in the US market. Ranbaxys US business is now leaning strongly towards branded formulations and prescriptions vis-a-vis pure play generics. Currently, Ranbaxy has 19 branded/OTC/prescription products in the US market. The most promising product in this segment is Absorica (Isotretinoin), which was launched earlier in FY14. Absorica, an oral anti-acne drug, is a success story from Ranbaxys NDDS initiatives. It improves the bioavailability of Isotretinoin without a high fat meal vs other available versions. According to latest data, Absorica has garnered 18% market share in the market, which we estimate at c.USD 500mn. Nevertheless, we highlight that Absorica is not interchangeable with other forms of Isotretinoin due to the higher risk of teratogenicity and can be administered only through a restricted program under a risk evaluation and mitigation strategy. Hence, we have assumed a market share peak of 20% for Absorica. Overall, we expect the current branded business to contribute USD 70mn or 10-15% of its total nonexclusive US sales by FY16. In the US, Ranbaxy also intends to increase focus on the derma and OC segments. It plans to file for controlled substance products from the Ohm facility. In India, Ranbaxy intends to focus on chronics with diabetes and consumer healthcare its main areas. Japan would remain a growth market, but progress is likely to remain slow over the next two years. The company expects the branded business to grow faster across emerging and developed markets. Growth in hybrid mode. Daiichi Sankyo had four objectives when acquiring Ranbaxy in 2008: (1) complementary businesses (Daiichi Sankyo in innovator drugs vs Ranbaxy in generics), (2) expanded global reach, (3) product life cycle management and (4) cost competitiveness by using Indian cost structures, especially for generics. While it is still early, recent moves highlight the growth of the hybrid model: Ranbaxys initiatives in Japan (with Daiichi Sankyo Espha, a 100% subsidiary of Daiichi Sankyo) and China, as backend supplier to Daiichi Sankyo, represent large opportunities given the potential of these geographies. The processes, especially for applications and registrations, however, are time-consuming and hence opportunities could take at least 3-5 years to fructify. Integration of Ranbaxys Brazilian operations into Daiichi Sankyo, as part of its Latin American strategy and integration of Ranbaxys and Daiichi Sankyos Thailand operations. We understand that the proposal is currently at a tentative stage, and hence would await full details for final comments.
13 January 2014
99
Valuation
Our SoTP price target of INR 477 values the base business at 18x forward core earnings and INR 24 for FTF-based revenues. Figure 118: SoTP valuation
Fig in INR mn Revenues One-off revenues Core revenues EBITDA One-off EBITDA Core EBITDA Core EBIDTA margin (%) Earnings One-off adjustment Core earnings Core EPS (INR) Multiple (x) Core valuation (INR) NPV of one-offs (INR) SoTP valuation (INR)
Source: Company, Standard Chartered Research estimates *FY14 runs for 15 months from January 2013 to March 2014
FY14E* 143,986 2,880 141,106 13,928 1,872 12,056 9 3,576 1,123 2,453 6 18 454 24 477
FY15E 141,926 17,883 124,042 22,630 11,624 11,006 9 13,873 6,974 6,899 16
FY16E 144,396 8,520 135,876 22,219 3,834 18,385 14 12,934 2,300 10,634 25
We value Ranbaxys core earnings at 18x forward P/E, a 10% discount to large-cap peers. We believe a discount is justified at this stage, given the potential uncertainties and impact to earnings, which may be related to the costs and implementation timelines of the consent decree. The potential cost overhang from the consent decree, however, will likely constrain price movement.
13 January 2014
100
Key risks
Generic challenge to Absorica As highlighted earlier, currently Ranbaxy enjoys two patents on Absorica (licensed from Cipher Pharmaceuticals) till September 2021. Actavis-Watson has filed a Para-IV challenge on the patent. Both Ranbaxy and Cipher intend to defend the patent. While we believe that Ranbaxy-Cipher has a strong case given Absoricas improved bioavailability for fasting, if Actavis -Watsons challenge goes through successfully, it can impact Absoricas sales. Higher costs and delay in plant approvals. While we have not built in any upside from the resumption of the Indian plants, we have assumed certainty in terms of launches for three of its FTFs. As per the consent decree, however, the onus is on Ranbaxy to prove substantial completeness of applications at the time of filing by certain cut off dates. If Ranbaxy misses those dates, launches of these FTFs could be at risk, thereby impacting our revenue estimates from these FTFs (cumulative FTF revenues are 7% of our total revenue assumptions over FY14-16E). Moreover, remedial costs maybe higher than our estimates, putting pressure on our core margins. While we do not expect any further proceedings for the plant, any strong action or delay in approvals by FDA may lead to forfeitures of Ranbaxys FTFs and downside from current valuations. Legacy derivative costs. As part of its hedging policy and based on its assessment of rupee movement at end CY07 (USD/INR was at INR 39 at that point in time), Ranbaxy entered into long-term option contracts (mainly zero cost options on USD/INR with no premium) with various strike prices ranging from INR 40-45 over a period of 1-8 years. This has negated the benefit of current INR weakness. Post adoption of AS-30 from Q4CY08, the company has been marking these derivatives at fair value, which has led to currency volatility being reflected in the P&L, as marked to market gains/losses. As of September 2013, Ranbaxys exposure stood at USD 763mn with maturity of USD 33mn per month.
13 January 2014
101
Financials
We expect FTFs to contribute USD 470mn over FY13-16E; ex-FTFs, we estimate the base business to post 14% revenue CAGR (10% in constant currency) led by the US and Africa. Ranbaxys core EBITDA margin is likely to increase, led by growth in the base business, better utilisation and lower redundancies in the existing cost base. We expect core earnings to post 11% CAGR over FY13-16E, excluding FTF opportunities in the US. Revenue to post 6% CAGR over FY13-16E, led by base US business and Africa We expect Ranbaxy to post revenue CAGR of 6% over FY13-16E to INR 144bn (USD 2.8bn) against 18% CAGR over CY09-12. Figure 119: We estimate 14% base revenue CAGR over FY13-16E against 11% over CY09-12
3.0 2.5 FTF revenue Revenue ex-FTF 160 Revenue ex-FTF 140 126 91 72 81 Growth yoy 138 60
140
120 INR mn 100 80 60 40
50
40 30 20 10 (10) %
2.0
USD bn 1.5 1.0 0.5 1.6 1.4 1.7 1.7 2.3
2.1
2.3
0.1 CY09
0.3
CY10
0.4 CY11
0.6 CY12
20
0.2
FY14E
0.2 FY15E
0.1 FY16E
0
CY10 CY11 CY12 FY14E FY15E FY16E
(20)
We have not built in any upside from launches out of the affected facilities in our estimate horizon given the difficulty in predicting approvals/launches. If operations resume at the sites, there could be upside to our estimates. Figure 120: India and exports to ex-US geographies to lead revenue growth
(INR bn) India -Formulation -GCH North America -US -US ex FTF Europe APAC Africa Others API Total CY12 21.7 17.9 3.7 51.5 47.9 18.4 15.1 5.7 9.4 9.8 7.3 120.4 CAGR (CY09-12) 9.9 8.2 20.6 39.0 43.7 19.4 5.1 5.5 15.7 4.1 10.5 17.9 FY14E 30.0 24.7 5.4 42.8 37.2 34.3 23.0 9.0 14.9 15.3 9.2 144.2 FY15E 27.2 22.1 5.1 52.8 48.0 30.2 20.0 7.9 13.1 13.5 7.7 142.1 CAGR FY16E (FY13-16E) 30.7 24.7 6.0 46.1 41.1 32.6 21.8 8.7 14.4 14.8 8.1 144.6 12.3 11.3 17.0 (3.7) (5.0) 21.0 13.0 15.3 15.3 14.9 3.6 6.3
Source: Company, Standard Chartered Research estimates *FY13 refers to CY12
13 January 2014
102
Better core margin from base growth and lower redundancies in existing cost base We expect core EBITDA margin (ex-FTF) to remain in the 16-18% range over FY1416E. We have moderated EBITDA margin growth over FY14-16E to reflect the negative impact of the consent decree. We believe Ranbaxy would likely incur additional costs for remedial measures, including employing various consultants for CGMP and data integrity. Operating leverage from the recently commissioned Mohali facility (as generic Lipitor is expected to be manufactured there post the loss of exclusivity) would come into play going forward as utilisation improves. According to the company, it expects margins in the high teens over the next few years, implying a sharp improvement of at least 500-700bps over the next 3-4 years. This will be led by growth in the base business, better utilisation and lower redundancies in the existing cost base. Figure 121: Reported margins to increase supported by core margin expansion
EBITDA 100 COGS R&D Employee expenses SG&A Other expenses
80 18.7 16.8 16.2 15.5 17.0 15.8 16.2
60 % 40
33.6 40.4
33.0
34.0
35.0
35.0
35.0
20 9.4 CY09 20.8 CY10
15.9
CY11
17.1 CY12
15.9 FY14E
18.1 FY15E
16.2 FY16E
13 January 2014
103
Company overview
Ranbaxy is a multi-national generic pharmaceutical company with a presence in 46 countries. Japan-based Daiichi Sankyo bought a 64% controlling stake in Ranbaxy in June 2008 for USD 4.6bn. Immediately after the acquisition, the USFDA issued an import alert on Ranbaxys Dewas and Paonta Sahib facilities and subsequently on Mohali. Ranbaxy recently entered into a consent decree with the USFDA with an estimated fine of USD 500m to the DoJ. By geography, the US is the largest contributor to revenue (34%), of which 44% was accounted for by generic Lipitor that Ranbaxy launched in November 2011 with 180day exclusivity. Ranbaxys launch of five potential FTFs is dependent on the implementation of the consent decree. Ranbaxy has manufacturing facilities in eight countries and serves customers in over 125 countries. Figure 122: Geographical revenue breakdown
Others 17%
APAC 7%
Figure 123: Shareholding pattern

Others 18%
India 24%
DII 9% FII 10%
Promoter 64%
US 34%
Europe 17%
Source: BSE
Figure 124: Key management

Dr.Tsutomu Une Chairman He was inducted as a Director on the Board of Ranbaxy in 2008 and appointed as Chairman in 2009. He was inducted as Director on the Board of Daiichi Sankyo in September 2005 and has been Member of the Board, Senior Executive Officer, Global Corporate Strategy and Hybrid Business, Intellectual Property of Daiichi Sankyo. He is a graduate from Hokkaido University School of Veterinary Medicine and holds a Ph.D. in Microbiology. He has been with the company since 2008. He is an industry veteran, with over three decades of international experience in the Chemical/Pharmaceutical arena. He has held senior management positions in companies like Max-Gb, Hindustan Ciba-Geigy, Bayer India and Dr. Reddys. An alumnus of IMI, Delhi, he graduated in Commerce from Mumbai. He has rich and varied experience of over 30 years in managing financial operations, across industry sectors, in large organizations, including major capital mobilizations, financial structuring and turnarounds, investor relations, joint ventures, improvement of systems, reporting processes and controls. A qualified Chartered Accountant, he graduated in Commerce from Kolkata.
Mr. Arun Sawhney
CEO and MD
Mr. Indrajit Banerjee
CFO
Source: Company
13 January 2014
104

Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) Core EPS (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 101,614 124,597 145,736 143,426 145,896 68,088 83,996 91,814 91,075 93,373 (49,829) (60,744) (74,169) (65,056) (67,934) 0 0 0 0 0 (2,068) (1,982) (3,716) (3,389) (3,220) 12,250 18,067 8,853 19,006 18,398 (66) 0 0 0 0 3,213 2,907 1,500 1,500 1,500 (42,685) (4,663) (7,762) 0 0 (26,929) 13,276 (2,132) 16,204 16,043 (1,969) (3,186) (213) (2,431) (3,209) (97) (100) (100) (100) (100) 0 0 0 0 0 (28,996) 9,989 (2,445) 13,673 12,734 16,982 13,633 3,476 13,773 12,834 16,190 21,270 13,928 22,630 22,219 (68.79) 38.95 (65.48) 0.00 436 23.65 32.31 4.06 0.00 422 (5.78) 8.24 (7.30) 0.00 422 32.33 32.64 13.62 0.00 422 30.11 30.41 13.62 0.00 422

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 12,250 3,940 359 (2,128) 19,197 (39,472) (5,854) (5,871) 4,002 0 0 (1,869) 0 (21,834) 1,559 (97) (20,372) (28,095) 0 (11,725) 2013 2014E 18,067 8,853 3,202 5,075 (3,036) (4,723) (3,186) (213) 1,201 (22,268) (1,756) (6,262) 14,493 (19,538) (4,400) 192 0 0 (4,209) 0 2,928 2,873 (100) 5,702 (7,500) 0 0 0 (7,500) 0 0 650 (100) 550 2015E 19,006 3,624 (4,302) (2,431) (2,332) 1,500 15,065 (4,800) 0 0 0 (4,800) 0 0 450 (100) 350 10,615 0 10,265 2016E 18,398 3,821 (3,856) (3,209) 867 1,500 17,522 (4,800) 0 0 0 (4,800) 0 0 350 (100) 250 12,972 0 12,722
15,987 (26,488) 0 0 10,093 (27,038)

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 2013 2014E 2015E 2016E 30,681 46,004 14,441 21,432 30,583 0 0 0 0 0 30,065 20,368 29,586 25,274 25,714 26,107 27,314 37,870 37,328 37,978 17,729 17,531 19,072 20,767 22,631 104,582 111,217 100,970 104,802 116,907 51,228 0 0 982 52,210 52,426 0 0 790 53,216 59,926 0 0 790 60,716 64,726 0 0 790 65,516 69,526 0 0 790 70,316

Year-end: Mar Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) 2012 67.0 15.9 12.1 16.7 -7.3 13.4 nm nm 19.6 nm 2013 67.4 17.1 14.5 10.9 24.0 22.6 nm nm -17.1 2014E 63.0 9.6 6.1 2.4 -10.0 17.0 nm nm -74.5 2015E 63.5 15.8 13.3 9.6 15.0 -1.6 nm nm 296.2 2016E 64.0 15.2 12.6 8.8 20.0 1.7 -6.9 -6.9 -6.8 -
156,792 164,433 161,686 170,318 187,223 0 53,189 0 53,189 44,907 0 (375) 30,377 74,910 0 41,596 0 41,596 47,781 0 (357) 34,563 81,987 0 67,643 0 67,643 48,431 0 (357) 7,563 55,637 0 62,153 0 62,153 48,881 0 (357) 7,563 56,087 0 65,974 0 65,974 49,231 0 (357) 7,563 56,437
-68.4 11.5 0.7 -0.5 0.7 261.5 82.8 463.0
28.7 16.0 0.8 0.8 0.7 240.1 73.9 426.1
-6.2 8.2 0.9 -2.2 0.7 220.6 62.6 369.7
30.2 18.8 0.9 0.8 0.8 262.2 69.8 452.5
21.8 16.0 0.8 1.0 0.8 261.7 63.8 445.2
128,099 123,583 123,281 118,240 122,411 28,694 0 28,694 40,850 0 40,850 38,405 0 38,405 52,078 0 52,078 64,812 0 64,812
152.6 43.3 -34.1 2.7 2.0
86.8 38.9 6.0 2.2 2.7
105.9 51.5 1.9 3.5 1.5
65.5 45.2 4.4 2.2 1.7
39.1 40.6 4.8 2.2 1.8
156,792 164,433 161,686 170,318 187,223 43,794 422 35,450 423 40,663 423 34,122 423 25,321 423
2.3 14.4 19.0 nm 12.2 6.9 0.0
2.0 11.7 13.8 21.0 15.3 4.5 0.0
1.7 17.5 27.5 nm 58.3 5.3 0.0
1.7 10.5 12.5 14.9 14.7 3.9 0.0
1.6 10.3 12.4 16.0 15.8 3.1 0.0
13 January 2014
105
Cadila Healthcare
Stepping up to the third phase
We upgrade Cadila to In-Line and raise PT to INR 865 based IN-LINE (from UNDERPERFORM) on 15x one-year-forward P/E; Cadilas PE could align to PRICE as of 7 Jan 2014 PRICE TARGET large cap peers, but wait for clarity on triggers to switch. Cadila is on the cusp of a strong third growth phase driven by (1) solid product launches in the US and India, (2) novel and niche drug research commercialisation and (3) new geographies reaching critical mass. We expect the ramp-up/recovery in the US/Latam and better performances in JVs/India to help grow sales by 15% with margin uptick leading to 22% PAT CAGR over FY13-16E. Its large ANDA pipeline, good global reach and solid niche portfolio are likely to help sustain 20% EPS growth and 25%+ RoE, in our view. Robust third stage of growth. Cadila is well positioned to sustain a strong third phase of growth. In the first phase (up to FY06), Cadila was domestic focussed (77% of sales), while in the second phase generics formulations exports grew at a 36% CAGR over FY06-13. Post the three sluggish years (FY12/13/14), we expect an improved performance driven by (1) strong US sales, (2) novel research monetisation (Lipaglyn and others), (3) focus on a niche portfolio (Biosimilar, Tansdermal, Vaccine, Injectable, Inhaler), and (4) sales ramp-up across JVs, India and EMs. US sales to rise sharply led by launches and niche products. Cadila has a large portfolio of 190 product filings (110 pending) with increasing share of special products (nasals, injectables, parenteral and transdermals). Management expects 30+ filing and 20+ approval run-rate to sustain. We expect US sales to reach USD 500mn by FY16E, 26% CAGR over FY13-16E. Other segments stabilizing. We expect JVs to sustain 10% growth over FY15-16 and EMs to revert to 15% growth momentum after a weak CY13. India is showing signs of improvement as the DPCO impact mellows. Margins to improve. We expect margins to improve as sales pick up, R&D costs as a percentage of sales decline, profitability improves in the EMs and internal cost reduction initiatives fructify. We expect 170bps margin improvement over FY13-16E. Valuation. Our 12-month price target of INR 865 is based on oneyear-forward P/E of 15x. We believe that if Cadila continues its stellar performance, it could be re-rated to the large cap range. Await a better entry point; upgrade to In-Line. Shashikiran Rao
13 January 2014
CDH IN INR 804. 45 INR 865. 00
INR 804.45
Bloomberg code
INR 865.00
Reuters code
CDH IN
Market cap
CADI.BO
12-month range
INR 164,751mn (USD 2,644mn)

INR 629.00 - 913.30

-28.7% 2015E -17.5%
2013 63,577 11,249 9,402 8,085 6,533 (1,346) 31.93 8.47 143.77 0.1 -16.1 17.7 14.8 10.3 26.5 78.7 23.7 16.6 3.0 16.7 5.2 25.5 1.0
2014E 71,064 11,367 9,349 7,843 6,707 13 32.78 8.74 167.78 2.7 3.3 16.0 13.2 9.4 26.7 72.8 21.0 14.2 2.7 16.8 4.8 24.5 1.1
2015E 82,417 14,980 12,575 10,832 8,820 1,901 43.11 9.35 201.50 31.5 6.9 18.2 15.3 10.7 21.7 61.0 23.3 17.4 2.3 12.7 4.0 18.7 1.2
2016E 95,783 18,575 15,931 14,356 11,777 4,613 57.56 10.58 248.42 33.5 13.2 19.4 16.6 12.3 18.4 45.0 25.6 20.4 2.0 10.1 3.2 14.0 1.3

Cadila Healthcare 1,000 800 600 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth 9 11 -
-3 mth -12 mth 18 -11 14 -15 Promoter (74.8%) 25% 2,603,211
Gaurav Pathak
106

Cadila is one of the fastest growing generics players in the US; we expect it to increase US market revenue to USD 500mn by FY16E at a 21% CAGR. Its current basket of US filings are value additive and include niche filings including nasals, parenterals and transdermals, supporting the next leg of US growth. Key growth drivers for product and reach are in place to enable it to achieve projected revenue CAGR of 15% over FY13-16E, in our view. In addition to core generics growth, commercialisation of novel/niche research could re-rate the stock to align with large cap pharma companies. We expect 170bps margin improvement from FY13 to FY16E (340bps from bottom in FY14E) led by sales pick up, reduction in R&D cost as a percentage of sales, improved profitability across EMs and by cost reduction initiatives (PRISM).
R&D driven apporach

Cadila has been focussing on basic research since 2005 and spends almost 2% of sales on R&D for basic research and biotech. This investment has begun to pay-off. Recently, it launched its first NCE Lipaglyn (Saroglitazar) in the Indian markets and has two more molecules in Phase II stage (see chart below). Figure 125: Cadila has two more projects at advanced clinical trials post Lipaglyn
Preclinical Marketing/ commercialisation
IND
Indication Project Target
Phase-I
Phase-II
Phase-III
NDA
Lipaglyn (ZYH1) ZYH7
PPARalpha, gamma PPARalpha GLP-1 agonist Oral GLP-1 agonist Glucokinase activator Oral PTH
Dyslipidemia
Dyslipidemia
ZYD1
Diabetes, Obesity Diabetes, Obesity Diabetes
ZYOG1
ZYGK1
ZYPH0907
Osteoporosis
ZYG19
GPR119 Agonist
Diabetes
Source: Company
13 January 2014
107
Lipaglyn is the first breakthrough NCE drug developed in India. The drug is used for treating diabetic dyslipidemeia, a condition where a person is diabetic and has elevated levels of total cholesterol. Cadila has spent USD 250mn in developing Lipaglyn and took nearly 12 years to fructify. It plans to spend another USD 150200mn to launch the drug in overseas markets over the next 3-5 years. Currently, Lipaglyn is available in India and is priced at INR 25.9 per tablet. It is recommended as once a day 4mg tablet. Lipaglyn could potentially reach INR 1bn in India sales over the next few years and may become a blockbuster drug in the DMs. Cadilas new strategic initiatives revolve around biogenerics, vaccines and a deepening basic research program. While biogenerics and vaccines are more medium-term revenue drivers (Cadila currently sells two vaccines in India, including an anti-rabies vaccine and an H1NI vaccine constituting 2% of sales), Cadilas ultimate goal is to be a research-driven company by 2020. In biotech, Cadilla is working on 17 biosimilars and two novel products. Cadilas biotech efforts have paid off in the Indian market and it has launched four products. For EMs and the RoW markets, we believe that Cadila would launch these biosimilars over the next two years. The next step for Cadila, we believe, would be to market biosimilars in the DMs through potential out-licensing deals. Figure 126: Cadilas biosimilar portfolio
Cloning
Indication
Process Devp
Pre-clinical Devp
Regulatory Permission
Clinical Devp
Marketing Authorisation
G-CSF Peg G-CSF

IFN alpha-2b Peg IFN alpha-2b EPO
IFN Beta 1b Prod 1

Teriparatide
Prod 2
MAB 1 MAB 2
MAB 3 MAB 4 Prod 3 Prod 4

Prod 5 Prod 6 MAB 5 PEG-EPO
Source: Company
13 January 2014
Product
AMI Fertility
Fertility Fertility Rabies
Oncology Oncology
Infectious disease Infectious disease Oncology/ Nephrology
Multiple Sclerosis Nephrology

Osteoporosis
Rheumatoid Arthritis
Oncology/ RA Inflammation
Oncology Oncology
Nephrology
108
USD 500mn in US sales by FY16E

Cadilas US business ramp-up has been exemplary, reaching sales of USD 284mn in FY13, up an impressive 58% after a comparatively late launch in 2005. We expect it to maintain the momentum supported by a large basket of pending ANDAs and special products. We expect sales of USD 500mn by FY16E, 21% CAGR over FY1316E. Figure 127: US sales to grow on back of increased filings
25 US sales
20
15 USD 10 5 0 FY08 FY13 FY14 FY15E FY16E

Cadila is one of the fastest-growing generics companies in the US. As with most Indian companies, it has leveraged its cost position in APIs (over half of all filings include own APIs) and has launched 57 products so far in the US. Among launched products, the company believes that it is in the top three of the products marketed in the US. It plans to file 30+ ANDAs per year in the near future (ahead of most other large Indian companies) and expects close to 20 starting from FY15. Figure 128: Impressive US build-out
120 110 100 90 80 70 60 50 40 30 20 10 0
Filed
Approved
Cumulative approvals
Pending
110
Marketed
80 Cumulative filings 47.0 33 21 FY08 FY09 FY10 FY11 FY12 FY13 54.0 57.0 Pending approvals
Nos
41 19 23 10 1412 29
18 12 15
24
11
15
17 4 Cumulative till H1-FY14
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US launches are steadily moving towards niche segments in transdermals, injectables, respiratory and oncology. In FY15, a couple of nasal, injectables and transdermal approvals are expected along with some interesting limited competition products like Tropol and Ascol. Cadilla has seven transdermals in its portfolio with four filed and three expected to be filed by end FY16. It is also working on a couple of other opportunities that will help it gain a further foothold in the USD 4bn segment. The two transdermal facilities have been inspected and approved by the USFDA. It has filed 28 injectables (19 for a partner) and five nasal products and four ointments. It has already received approvals for eight injectables (seven for the partner). The recent launch of Divalproex Sodium (Depakote) is progressing well given market share gain from Wockhardt and almost 4x price rise. Cadila recently launched Tramadol APAP, Oxycodone hcl, Gabapentin and galantamine hydrobromide (4QFY13) and Ranitidine (1QFY14). The USFDA warning letter issued to the injectable unit of the Moraiya facility is now cleared (post re-inspection) with that facility starting to receive new approvals. Cadila has interesting opportunities in the limited competition basket like Ascol, (Meslamine), Niacin (Naispan), Tropol (Metoprolol Succinate), Xeloda (Capecitabine), Pristiq (Desvenlafaxine), Azelastine Nasal Spray (USD 120mn with 23 players), Sirolimus (USD 200mn) and others. Even the Nesher acquisition is turning around after a slow start. The site caters to controlled substances, a USD 7bn market. Cadila has launched two products while Neshers overall product basket caters to a USD 2bn market size. The company is also looking at filling new products from the site.
Leveraging outsourcing opportunities

Cadila has been a prime beneficiary of outsourcing. It has invested in one of the most profitable pharma JVs with Nycomed. Others include Hospira (50:50 JV for oncology injectables), Zydus BSV (JV with Bharat Serum oncology NDDS), a strategic outsourcing deal with Abbott (to licence 24 products for 15 key EMs, with an option to add another 40 products in the near future) and other small legacy contracting relationships. These arrangements could contribute INR 7bn to revenues by FY16E as shown in the chart below. Figure 129: Sourcing JVs growing strongly
Hospira (Cadila's share) Bayer Sourcing JV contribution to revenues (RHS) Nycomed Abbot 10 8 6 4,000 4 2,000 2 0 FY12
Source: Hospira
8,000
6,000 INR mn
0 FY13 FY14E FY15E FY16E
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110
(%)
Hospira Cadila has tied up with Hospira in a 50:50 JV that will supply six oncology-based injectables for Hospiras key markets in the US and Europe. Currently, the JV supplies six products (Gemcitabine, Docetaxel , Oxaliplatin and others) in Europe and four in the US market. We expect the Hospira JVs revenue to ramp up as more products are approved. Recently, the JV was expanded to work on 12 products. Furthermore, it is in the process of adding a new manufacturing line. Over the long term, the JV aspires to produce most of Hospiras products in the oncology line-up. Sales from the JV have now stabilised post generic competition coming up in Docetaxel (Taxotere) after the exclusivity period expired in H1FY14. Takeda (Nycomed) JV has been a profitable one Cadilas other key JV is its 50:50 JV with Nycomed, essentially supplying two key intermediates (KSM 6 and KSM 14) to Nycomed for Pantoprazole. The JV has been extremely profitable. Cadila had invested c.INR 250mn for both intermediate and API plant. We believe Cadila had already recovered this investment prior to Pantaprazole patent expiry in FY10, with more than INR 5bn in profit to date. The JV is now filing for APIs and formulations for other products from the larger Takeda basket. In FY13, the JV showed a strong 22% growth in revenues after two years of slowdown. The JV is currently supplying 10 product APIs to Nycomed. Bayer JV ramping up well Cadilas JV with Bayer is for the Indian market and it has grown well, and has even launched patented products. The JV became operational in FY11 and has grown rapidly to INR 1.2bn of revenues in FY13. We believe the venture has achieved break-even. The company plans to launch two products in FY14 and is focussed on the female healthcare, metabolic disorders, diagnostic imaging, CVS, diabetes and oncology segments. Urokinase: limited expectation Cadila entered into an agreement with Microbix Biosystems to fund and market Urokinase in North America. Cadila will help fund the entire Phase III clinical trials to commercially develop the product. Urokinase is a thrombolytic drug for treatment of blockage in arteries and vessels approved by the USFDA for acute massive pulmonary embolism and coronary occlusion. It was previously owned by Abbott. Branded formulation growth to sustain Cadilas domestic branded formulation should sustain 13% CAGR while other EMs and RoW sustaining 12% to 15% CAGR over FY13-16E. Figure 130: Branded formulation sales by region
Growth yoy (%) 6 (1) 25 7 CAGR FY13-16E FY16E (%) 32 3 4 39 38.4 3.6 5.2 13 8 15 12
INR bn India Brazil RoW Total branded formulation As a % of sales India Brazil RoW
FY13 22 2 3 27 42.5 4.6 5.5
FY14E 23 2 4 29 37.2 3.8 5.7
FY15E 27 3 4 34 38.4 3.7 5.5
Source: Company, Standard Chartered Research estimates Note: Brazil includes unbranded formulations, we have not made separate estimates for the same
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Strength in domestic formulations Cadila is Indias fifth-largest domestic formulations player with a market share of 4.1% as at end FY13, with leading positions in key segments like CVS, gastrointestinal, gynaecology and respiratory. It has 20 brands amongst the top 300 products. Cadila launched 40+ products in H1FY14, on the back of 90 launches in FY13. Figure 131: Cadilas critical categories in the domestic market and shares
6,000 5,000 4,000 3,000 6.3% 6.4% 8.5% 5.6% 4.6% 1.7% 5.5% 1.8% Cadila MAT Aug 2013 (INR mn) Cadila share in the category 13.8% 16% 14% 12% 10% 8% 6% 4% 2% 0% Derma Anti-Neoplastics Gynaecological
2,000
1,000 0
Respiratory
Anti-Infectives
Cardiac
Gastro Intestinal
Source: Company
Cadilas domestic strategy has relied on the high pace of product launches and critical acquisitions like Biochem along with strong sales force expansion. Over the past five years, Cadila has enhanced both its sales force and sale force productivity by 30-40% on product launches. Figure 132: Cadila increased field force and productivity by 30-40% in five years
6,000 5,000 4,000 Nos 3,000 2,000 1,000 0 FY08
Source: Company
Field force
Productivity (INR mn/ person)
Vitamins / Minerals / Nutrients
Pain / Analgesics
Others 6.0 5.5 5.0 4.5 4.0 3.5 3.0

112
5,500 3,400 4,000
FY10
FY13
13 January 2014
Cadila had recently acquired 100% of Biochem Pharma, an India (Mumbai) based anti-infective product company (80% of sales) with INR 4-5bn in sales. The acquisition will help further strengthen its position in Antibiotics, CV, Anti-diabetic and Oncology. Nutraceutical business continues to perform Cadila has a 72.5% stake in Zydus Wellness, one of Indias largest consumer wellness companies, with marquee brands like Sugar Free (sugar substitute aspartame and sucralose with over 80% market share), Nutralite (largest selling margarine brand in India) and EverYuth (speciality skincare products with thirdlargest selling face wash brand in India). As shown in the chart below, Zydus Wellness has reported a 21% CAGR in the past five years, with EBITDA margin of 27% in FY13 and net profit margin of 24%. Figure 133: Zydus Wellness net revenue trend
4,500 4,000 Net revenue 3,446 2,740 20 % 1,958 15 579 10 7.8 5 FY08 FY09 FY10 FY12 FY13 FY08 FY09 FY10 FY12 FY13 13.6 12.2 4,100
Figure 134: Healthy EBITDA margins

30
25 19.5 19.6 16.5 Margin (RHS) PAT margin
25.9 22.4
27.4
3,500
3,000 INR mn 2,500 2,000 1,500
23.7
1,000
500 0
Zydus Wellness has made significant inroads into the burgeoning consumer healthcare and cosmetics segments. Zydus Wellness plans to expand its presence in various categories by launching newer variants of its key brands and also by launching new categories in its core wellness proposition. For example, it plans to extend its EverYuth brand to the premium soaps segment in FY14. We have incorporated a 17% CAGR for Zydus Wellness sales over FY13-16E growing to INR 7bn by FY16E. Brazil growth backed by new product introductions Cadilas foray into Brazil was initially in the unbranded generics segment in FY06, but scaled up with the acquisition of Nikkho in FY08 for the branded segment. Currently, Cadila has over 102+ filings and 40 approvals with ANVISA and has launched over 35 products including 20 branded and 15 unbranded products in the Brazilian market. However, the pace of approvals has been slow in Brazil as has been the case for all other Indian players. Hence, we expect a slow ramp-up of revenues in this market. Cadila is currently in the process of building up its operations in neighbouring Mexico. It has already started the regulatory pipeline with about 20 filings with COFEPRIS and has received three approvals.
13 January 2014
113
Figure 135: Brazil sales growth dependant on product approvals

5,000 4,000 3,000 Rsm 2,000 1,000 1,010 0 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 2,250 2,473 2,384 2,360 2,596 2,986 0 -20 Brazil sales (LHS) Mexico sales (LHS) Growth yoy (RHS) 80 60 40 20 % 1,628 1,818 140 120 FY13 revenues CAGR FY08/13 35 30
Other segments steady Cadila has several vaccines that are under various stages of development and clinical studies. It includes already launched vaccination for anti-rabies and H1NI. It has been growing well in the animal health care segment across domestic and international markets. It produces a wide range of drugs, feed supplements and vaccines for livestock, companion animals and poultry. It has a presence in markets across Europe, South America, Asia and Africa through Bremer Pharma, Germany. Cadila has a good presence in Japan (25+ products), Asia Pacific, France (9th largest player), Spain (20) and many other key markets.
Valuation
Cadila can transition into the big boys club given the growth in sales and strong R&D profile. We believe the market offers a clear premium for size, with companies like Sun Pharma, Dr. Reddys, Cipla and Lupin getting higher valuations for better execution and ability to garner higher market share. In the 2009-10 phase, Cadila traded between 15x and 20x two-year-forward P/E. We currently value the stock at 15x one-year-forward PE at INR 865. Figure 136: Sales comparison
100 80 INR bn
60 40 20 0
25 20
15 10 5 0
Ranbaxy
Source: Companies
Dr Reddy
Sun Pharma
Lupin
Cipla
Cadila
Glenmark
13 January 2014
114
Figure 137: Cadila two-year-forward multiple

1,200 1,000 10x 15x 20x CDH CMP
800
600 400 200 0 Jul-05
Source: Company
Sep-06
Nov-07
Jan-09
Mar-10
May-11
Jul-12
Sep-13
We believe Cadila can re-rate going forward, but look for greater visibility on key triggers before making the switch. We believe the discount will begin to narrow as differentiated launches happen in the US market.
Risks
Domestic formulations Cadilas domestic formulations are expected to post 10% CAGR over FY13-16E and contribute a higher share of profit, in our view. A slowdown in domestic growth on a higher fixed base (larger field force) could have a negative impact on earnings. Slower scale up at Hospira/Takeda JVs We expect the Hospira JV to scale up, post key approvals for Hospira for products in the US, including gemcitabine and docetaxel. Any delay or lower offtake by Hospira or a lower market share by Hospira for its portfolio would impact earnings from this JV. Regulatory risks Regulatory risks include potential delays in approvals for the US market. Also, any negative regulatory action from the USFDA including potential warning letters will be a negative for the company.
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Financials
We expect 16% revenue CAGR over FY13-16E, led by domestic and US formulations. We also expect margins to recover gradually by 170bps over FY14-16E. We estimate total capex of INR 15-16bn in FY14-16E. 16% revenue CAGR over FY13-16E to INR 96bn We expect gross revenue to post a 16% CAGR to INR 96bn over FY13-16E primarily led by US formulations growth. We estimate domestic formulations would post 13% CAGR over FY13-16E to INR 33bn, while US formulations sales (contributing 24% to total sales in FY13) are likely to grow at 26% CAGR over FY13-16E to INR 30bn. Europe, sourcing JVs and newer geographies like Mexico and Japan are likely to be the other key sources of growth, in our view. Figure 138: Sales to grow at 20% CAGR
120 100 96 80 INR bn 60 71 63 52 Total sales (LHS) Growth yoy (RHS) 22 20 18 16 %
82
40
20 0
14
12 10
FY12
FY13
FY14E
FY15E
FY16E
Figure 139: Sales breakdown by segment

INR bn Formulation India US EU Brazil Other Bulk Nycomed Others Consumer/OTC Animal health Total FY12 42 19 12 3 2 5 3 1 5 3 2 51 FY13 51 23 15 4 2 7 4 1 7 4 2 62 FY14E 57 25 19 4 2 7 4 1 7 5 3 69 Growth yoy (%) 12 6 27 12 (1) 6 18 17 10 10 7 12 FY15E 67 29 24 4 3 8 5 1 8 5 3 80 FY16E 79 33 30 4 3 8 5 1 9 5 3 93
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Margins to recover gradually We expect margins to recover by 200bps to 19.4% in FY16 vs 17.7% in FY13. Margins suffered over the past two years given Cadilas entry into new geogr aphies and new JVs, especially with Hospira. Figure 140: Cost breakdown
100 28.7 EBITDA COGS 26.0 R&D 24.2 Employee expenses 25.5 Other expenses 24.6 23.7
80
60
% 40
31.9
31.9
36.5
36.9
36.0
35.5
20 22.2 0 FY11 FY12 FY13 FY14E FY15E FY16E

20.9
17.7
16.0
18.2
19.4
Earnings remained flat over FY10-13 given high interest expenses and the tax rate that offset the strong growth in revenues. With strong operating cash flow of INR 11.5bn on average over FY14-16E, we believe that the impact on net margin growth will be much higher. We estimate earnings CAGR of 22% over FY14-16E. Figure 141: Net profit growth
14,000 PAT (LHS) Growth Yoy (RHS) 11,777 40 35 30 8,820 6,526 6,000 4,000 2,000 0 FY12 FY13 FY14E FY15E FY16E
12,000
10,000 INR mn 8,000 6,533 6,707
25 20 15 10 5 0 -5 -10 -15
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Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 52,633 63,577 71,064 82,417 95,783 35,840 40,375 44,841 52,747 61,780 (23,195) (26,611) (30,607) (34,470) (39,413) 0 0 0 0 0 (1,658) (2,515) (2,867) (3,297) (3,792) 9,408 9,402 9,349 12,575 15,931 (1,466) (1,317) (1,506) (1,744) (1,575) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 7,942 8,085 7,843 10,832 14,356 (1,130) (1,188) (784) (1,625) (2,153) (286) (364) (352) (387) (426) 0 0 0 0 0 6,526 6,533 6,707 8,820 11,777 6,526 10,987 31.87 31.90 10.09 205 6,533 11,249 31.90 31.93 8.47 205 6,707 11,367 32.75 32.78 8.74 205 8,820 14,980 43.07 43.11 9.35 205 11,777 18,575 57.50 57.56 10.58 205

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 9,408 1,579 (1,466) (1,072) (2,911) (286) 5,252 (12,261) (35) 0 0 (12,296) (2,066) 2,891 10,334 0 11,159 4,115 0 (7,009) 2013 9,402 1,847 (1,317) (1,330) (3,443) (364) 4,795 (6,141) (903) 0 0 (7,044) (1,734) 2,602 5,994 0 6,862 4,613 0 (1,346) 2014E 9,349 2,018 (1,506) (784) (2,711) (352) 6,013 (6,000) 0 0 0 (6,000) (1,791) 0 2,500 0 709 723 0 13 2015E 12,575 2,405 (1,744) (1,625) (3,324) (387) 7,901 (6,000) 0 0 0 (6,000) (1,914) 0 (1,500) 0 (3,414) (1,513) 0 1,901 2016E 15,931 2,645 (1,575) (2,153) (3,808) (426) 10,613 (6,000) 0 0 0 (6,000) (2,167) 0 (3,000) 0 (5,167) (554) 0 4,613

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 4,666 0 8,863 10,905 5,798 30,232 33,318 0 0 242 33,560 63,792 0 12,379 0 12,379 20,094 0 1,185 3,494 24,773 37,152 25,736 904 26,640 63,792 17,709 205 2013 5,838 0 9,551 12,136 7,440 34,965 37,612 0 0 1,145 38,757 73,722 0 11,660 0 11,660 26,831 0 1,005 3,588 31,424 43,084 29,445 1,193 30,638 73,722 24,111 205 2014E 6,561 0 11,484 14,356 8,117 40,518 41,594 0 0 1,145 42,739 83,257 0 13,779 0 13,779 29,331 0 1,005 3,588 33,924 47,703 34,361 1,193 35,554 83,257 25,888 205 2015E 5,048 0 13,351 16,688 8,862 43,949 45,190 0 0 1,145 46,335 90,284 0 15,399 0 15,399 27,831 0 1,005 3,588 32,424 47,823 41,267 1,193 42,460 90,284 25,901 205 2016E 4,494 0 15,548 19,435 9,681 49,158 48,545 0 0 1,145 49,690 98,848 0 17,354 0 17,354 24,831 0 1,005 3,588 29,424 46,778 50,877 1,193 52,070 98,848 23,455 205

Year-end: Mar Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) 2012 68.1 20.9 17.9 12.4 14.2 13.7 -8.2 -8.3 -8.2 35.1 2013 63.5 17.7 14.8 10.3 14.7 20.8 0.1 0.1 0.1 -16.1 2014E 63.1 16.0 13.2 9.4 10.0 11.8 2.7 2.7 2.7 3.3 2015E 64.0 18.2 15.3 10.7 15.0 16.0 31.5 31.5 31.5 6.9 2016E 64.5 19.4 16.6 12.3 15.0 16.2 33.5 33.5 33.5 13.2
27.5 21.4 1.0 0.6 0.1 206.7 57.3 231.8
23.7 16.6 0.9 0.5 0.3 181.2 52.9 189.1
21.0 14.2 0.9 0.6 0.3 184.4 54.0 177.0
23.3 17.4 0.9 0.6 0.4 191.0 55.0 179.5
25.6 20.4 1.0 0.7 0.4 193.9 55.1 175.8
66.5 39.1 10.3 1.4 2.4
78.7 43.2 5.6 2.1 3.0
72.8 42.2 4.4 2.5 2.9
61.0 37.2 5.9 1.9 2.9
45.0 30.5 8.1 1.4 2.8
3.3 16.0 18.7 24.8 24.8 6.0 1.3
3.0 16.7 20.0 25.5 25.5 5.2 1.0
2.7 16.8 20.4 24.6 24.5 4.8 1.1
2.3 12.7 15.2 18.7 18.7 4.0 1.2
2.0 10.1 11.8 14.0 14.0 3.2 1.3
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Glenmark Pharmaceuticals
Strong core growth with R&D upside
Glenmark is our top mid-cap pick. We value it at INR 710, OUTPERFORM (unchanged) based on 15x one-year-forward P/E and INR 41 for potential PRICE as of 7 Jan 2014 PRICE TARGET upside from its NCE/NBE portfolio. We like its strong earnings growth, unique research focus, strategic monetization and portfolio of complex products. On our PRII matrix, Glenmark is in the top bracket on product pipeline, diversified reach and innovation. In the next three years, Glenmark could enter the big league. Glenmarks core markets continue to grow fast; we expect 19% sales and 23% EPS CAGR over FY13/16E. Highest PRII growth levers among mid-caps. Glenmark has amongst the highest PRII scores with a very good performance on product range and complexity. It is also strong on geographical reach and product innovation. These growth levers could help push Glenmark into the league of large cap pharma companies. Differentiated research strength. Despite the failure of Revmilast, we believe in Glenmarks novel research prowess and its ability to monetize them. Glenmark has always focussed on innovative R&D and monetised c.USD 210mn to date. We believe in its promising first-in-class product pipeline - GRC 17536, GRC15300, GBR500, GBR 900 and GBR 830; three to four molecules could hit key milestones in the next 12-18 months. Growth in core markets, strong pipeline. Over the past five years, its US generics business has grown at 26% and domestic business at 21%, making Glenmark a key player in these markets. In the US, Glenmark has a sizeable pipeline of 90 products and 53 ANDAs pending approval; including 27 PIVs. In India, sales force expansion and speedy product introduction have helped it outpace domestic peers. We expect Glenmark to maintain its growth momentum on the back of successful growth in its oncology, derma, and OC segments. Further impetus to come from full ramp-up of Crofelemer sales across US, RoW and India by FY16. Strong earnings growth. We expect 19% volume growth over FY13-16 with all the core markets contributing. With margin improvement in CIS and Brazil, we expect 23% earnings CAGR over FY13-16E. While Glenmark has a strong novel pipeline ready for out-licensing, we have not assumed any deal income. Our 12month PT is INR 710, based on one-year-forward P/E of 15x and INR 41 for the novel portfolio. Our target multiple is at the upper end of our mid-cap range, given its growth levers and R&D upside. Gaurav Pathak
13 January 2014
GNP IN INR 514. 30 INR 710. 00
INR 514.30
Bloomberg code
INR 710.00
Reuters code
GNP IN
Market cap
GLEN.BO
12-month range
INR 139,000mn (USD 2,230mn)

INR 458.00 - 613.35

-14.8% 2015E -9.7%
2013 50,123 10,100 8,830 7,337 5,708 3,835 21.12 18.68 2.34 102.07 51.6 0.6 20.2 17.6 11.4 10.2 60.8 24.1 19.5 2.6 13.0 4.5 20.0 0.6
2014E 59,575 12,722 10,916 8,768 6,839 4,925 25.31 23.05 2.65 124.61 19.8 13.4 21.4 18.3 11.5 10.5 37.5 22.3 21.2 2.6 12.0 4.1 20.3 0.5
2015E 70,846 16,003 14,009 11,980 9,584 3,782 35.46 34.06 3.74 156.26 40.1 41.2 22.6 19.8 13.5 10.6 23.4 25.2 24.3 2.1 9.3 3.3 14.5 0.7
2016E 83,902 20,286 17,917 16,197 11,615 6,686 42.98 44.59 4.54 194.60 21.2 21.2 24.2 21.4 13.8 9.2 11.7 28.0 28.1 1.7 7.2 2.6 12.0 0.9

Glenmark Pharmaceuticals 620 540 460 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth -2 -1 -
-3 mth -12 mth -10 -1 -13 -6 Promoter (48.3%) 52% 4,991,492
Shashikiran Rao
119

Focuss on differentiated core capabilities
Glenm arks business strategy has focused on differentiated core capabilities. It has identified five core areas of potential differentiation viz. OC, respiratory, dermatology, pain and oncology and has aligned its global operations to become a market leader in these segments. US filings and most emerging market branded generics focus around these core therapeutic segments. Glenmarks core strategy is to leverage its innovative and niche focussed R&D. We like Glenmarks strategic intent to focus its resources and management bandwidth, which could help in efficient capital allocation and gain critical share across relevant therapeutic segments. We expect the speciality division to achieve 19% revenue CAGR over FY13-16E, contributing almost 60% of incremental sales over FY13-16E. Figure 142: Speciality division expected to contribute 59% by FY16E vs 53% in FY13
API 8% Outlicensing income 1% API INR 5bn 9%
Speciality 53% Generic 38%
Generic INR 16bn 32%
Speciality INR 29bn 59%
Higher growth in the speciality segment should also benefit margins, given the divisions higher margins (consolidated EBITDA margins of 23-25% versus company average of 21-22% ex-licensing income). Emerging markets showing improved performance In Latin America, Glenmark has reached break even and we expect it to reach 10% EBITDA margin in three years. Brazil now has the critical mass of 25-30 products with roughly 15-20 products pending approval. In Mexico and Venezuela, channel investments have already been made that should help improve margins. In Russia, it recently launched OTC products in addition to the existing respiratory and dermatology segments. The OTC business has two brands Keto Plus (Ketoconazole) and Candid (Clotrimazole). Glenmark is expanding reach in hospitals. Glenmarks market share in derma currently stands at 1.75% and is among the top 15 companies. We expect H2CY14 to be better with the onslaught of winter. Ascoril and some other respiratory products could witness better sales across CAI and Russia. Overall, we expect RoW to grow at a 21% CAGR over FY13-16E.
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Outpaced growth on India operations Glenmarks Indian operations have done well due to sales force expansion and strong product launches (recently Sitgaliptin). Glenmark has a market share of 2% in the domestic market (at end Q2FY14, as per AIOCD), up from 1.6% in FY09. It operates through 12 divisions focused on dermatology, gynaecology, diabetes and cardiology. Glenmarks domestic strategy is focused on increasing depth rather than width, i.e., through higher penetration of existing doctors in focused therapeutic segments rather than additional new divisions. We thus expect Glenmark to continue to grow faster than the market at c.19% CAGR over FY13-16E. Figure 143: Glenmarks India operations are relatively smaller to domestic peers
FY13 sales (INR mn) Cipla Ranbaxy GSK Cadila Sun Lupin Dr. Reddy's Torrent Glenmark
Source: Company, IMS, Standard Chartered Research
Field force (nos) 6,000 4,300 3,000 4,500 2,700 4,000 3,800 3,664 2,700
Market share (%) 5.2 4.7 4.2 3.7 3.7 2.7 2.2 2.0 1.6
25,069 22,700 20,145 18,003 17,899 13,072 10,350 9,670 7,520
Figure 144: Domestic business expected to grow at 21% CAGR over FY13-16E.
CAGR FY07-13 (%) 24 20 42 CAGR FY013-16E (%) 19 17 19
(INR bn) Specialty -Domestic Total sales As a % of sales Specialty -Domestic
FY07 7 4 13 59 34
FY13 27 13 50 53 26
FY16E 45 21 85 52 25
Differentiated pipeline to drive US growth

US sales are the largest contributor to Glenmark. Historically, Glenmarks investments in the generics division have largely been funded from profit in speciality and upside from out-licensing deals, making the company vulnerable to short-term mismatches in funding, especially in lean years like FY09 when out-licensing revenues dried up. However, we see higher resilience in Glenmarks current model given most geographies have achieved critical mass. Glenmark has a differentiated pipeline of ANDAs and monetization of its FTF portfolio through assured launches could drive US sales growth. We expect US sales (exspecial products) to grow to USD 465mn in FY16, up from USD 278mn in FY13; a CAGR of 18%. Recent price increases across the derma portfolio could also help.
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Figure 145: US business is expected to grow at 18% CAGR over FY13-16E

Base business 500 450 400 350 USD mn 300 250 200 150 100 31% CAGR over FY07-13 Ltd competition products 18% CAGR over FY13-16E
50
0 FY07 FY13 FY14E FY15E FY16E
From a pure generics/in-licensing strategy, Glenmark today has an impressive portfolio of 67 products launched in the US market, including controlled substances, derma and modified release products. It has 53 ANDAs pending approval (50% niche), including 27 PIVs and potentially a couple of FTFs. Figure 146: Historical ANDA filing, approval, pending
160 Filed Approved 140
120
Nos
80
Cumulative filings 53
40
22 11 13
16
22 13 FY11 12
14
18
Pending approvals 3 4 FY14-YTD Cumulative
0 FY09 FY10 FY12 FY13

Glenmark has made a significant foray into oral contraceptives (OCs) and has been one of the first Indian companies with significant approvals in this segment. Glenmark currently has around 12-15 products (brand size USD 350mn) currently in the market with another 10-12 products pending approvals. According to Glenmark, the company has 5-7% market share in its marketed products with around 15-20% price erosion. Its other key products include Lunesta, Maxalt, Welchol and Crofelemer. The Crofelemer 125mg delayed-release tablet has been developed by Glenmark along with Salix Pharmaceuticals after being in-licensed from Napo Pharmaceuticals. Glenmark has rights to supply Crofelemer API to Salix for regulated markets. Salix has committed USD 21.6mn to Glenmark for investments in capacity creation for Crofelemer, of which Glenmark has so far received USD 15mn as milestone payments. In addition, Glenmark has the exclusive rights to sell Crofelemer in India
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and 140 developing markets excluding China; potential launches in FY15 but mostly in FY16. It is also conducting pivotal phase III trials in India and Bangladesh for adult acute watery diarrhoea including cholera. Crofelemer is covered by US patents 195 and 744, which expire in mid-2018; NCE exclusivity expires on 31 December 2017. Monetizing Para-IVs A key aspect of Glenmarks recent US strategy has been to monetize its more significant FTFs, with settlements with innovators. Figure 6 below outlines some of the more critical deals, including launch dates. Figure 147: Glenmarks FTF settlements with innovators
Total branded sales (USD mn) Date of Launch 65 Sep 2011 1,300 Dec 2016 48 Mar 2012 38 Dec 2013
Brand Malarone Zetia Cutivate
Generic name Atovaquone/Proguanil Ezetimibe Fluticasone Lotion 0.005%
Type of settlement Royalty bearing, no AG Shared exclusivity (with Par-50%) for 4.5 months, No royalty or AG Royalty bearing, no AG, Perrigo expected post 6 months exclusivity Royalty bearing, No AG
Locoid Lipocream Hydrocortisone Butyrate Cream

Source: Company, Standard Chartered Research Note: AG= Authorized Generic
Of the above key opportunities, we expect Malarone (generic atovaquone/proguanil) and Cutivate (generic Fluticasone lotion) to be significant near-term contributors, given our expectation that they should be multi-year opportunities (patents on Malarone expire on 25 May 2014 while that on Cutivate expire in 2019). Also, as per settlement terms, these products would not have any authorized generics (although Perrigo is expected to launch post expiration of Glenmarks 180-day exclusivity in Cutivate). Glenmark is first-to-file on cholesterol drug Ezetimibe (gZetia) and has settled with innovator Merck-Schering Plough for launch on 12 December 2016. In the derma segment, Glenmark has FTFs in gVanos and gLocoid. Within the OC segment, Glenmark is expected to launch a generic version of Ortho Tri-cyclen Lo (USD 400mn sales) in December 2015. In January 2013, Glenmark initiated the exclusive launch of Mupirocin Calcium Cream USP (sales USD 55mn). It has also filed an ANDA for Azelaic Acid, Gel 15% Topical, with PIV certification. Glenmark believes it may be FTF in this ANDA.
Basic R&D investments are value accretive

Key to Glenmarks re-rating lies in its ability to showcase and monetise its innovative R&D capabilities. We believe that among its promising first-in-class product pipeline GRC 17536, GRC 15300, GBR 500, GBR 900 and GBR 830 - three to four molecules could hit key milestones in the next 12-18 months. This would help strengthen Glenmarks credentials in novel drug research especially in biologics and strengthen the monetization potential of basic research. Currently, Glenmark has three biologic products in the pipeline. In FY13, phase-II trials commenced on GBR 500 (the product has been out-licensed to Sanofi for PII trials). Glenmark has a fairly consistent record of monetization, by out-licensing molecules in phase I trials to larger players. Against an estimated c.USD 200mn invested in basic
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R&D (as per the company, including for capex), we estimate the company has already recovered c.USD 210mn (including the recent Sanofi deal). Many of the R&D pipeline products have significant monetisation potential - GRC 15300 (deal size potential USD 325mn), GRC 500 (deal size USD 613mn) even mPEGS-1 inhibitor could receive future payments from Forrest Lab in FY14. The revenue potential of many of these first-in-class products is significantly high, though visibility on the structure of operating profit flowing to Glenmark is limited right now. We believe R&D remains a significant upside and value driver for the company in the long run. Glenmark has now achieved a critical mass in terms of intellectual property (for example, its foray into basic biotech R&D), providing it a significant platform for its foray into biosimilars, especially in Mabs. Figure 148: Milestone income received till date for various research projects
Compound GRC 3886 GRC 8200 GRC 6211 GRC 15300 GBR 500 mPGES-1 inhibitor Partners Forest for NA, Teijin for Japan Merck KGaA for US, EU, Japan. Shared commercialization rights for all countries except India. Glenmark exclusive rights for India Eli Lilly for NA, EU, Japan. Co-exclusive for US, Exclusive rights to Sanofi for NA, EU, Japan. Glenmark co-exclusive for US, exclusive for India Exclusive rights to Sanofi for NA, EU, Japan. Glenmark has exclusive rights for India Forest Labs made a payment of USD 9 mn. Forest will make another future payment in FY14 to support the program Milestones received (USD mn) 41 31 45 20 50 9
Glenmark has faced setbacks: Oglemilast, Melogliptin, GRC6211 were all outlicensed and later returned or abandoned by partners. Recently, Glenmark faced a setback in Revamilast for COPD. However, the current portfolio shows significant potential. We believe trial results expected over the next 12-18 months will reinforce faith on the R&D and innovative product potential of Glenmark. Glenmark is also focusing on expanding Crofelemer to target acute adult cases (with two ongoing studies in India and Bangladesh) and potentially will also target an acute paediatric indication, post NDA approval by Salix. While we have not built in any potential upside from such indications, we note that both segments are very significant (especially paediatric) representing meaningful segments of overall acute markets, and could add meaningful upside to Glenmarks sales.
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Figure 149: Glenmarks basic R&D portfolio

Compound Small Molecule HIV related Diarrhea Crofelemer Adult Acute Infectious Diarrhea including Cholera Neuropathic Pain GRC 17536 Respiratory disorders Neuropathic Pain GRC 15300 Pain / Inflammation Biologics (NBE) Vatelizumab (GRC 500) Ulcerative Colitis VLA-2 Antagonist (mAb) TrkA Antagonists (mAb) Critical product: Out-licensed to Sanofi, results expected in Q1-FY15 In-licensed from Lay Line Genomics, Italy. mPGES-1 inhibitors Option Agreement with Forest Laboratories TRP A1 TRPV3 Antagonist Critical product: Out-licensed to Sanofi, Phase-II results expected in FY14 CFTR Indicator In-licensed for ROW markets CFTR Indicator In-licensed for ROW markets Primary Indication Target Pre-clinical Phase-I Phase-II Phase-III Marketing Current status
TRP A1
Critical product: Phase-I Data expected in FY14: at a critical phase
GBR 900
Chronic Pain
GBR 830
Rheumatoid Arthritis and Inflammatory Bowel
Discovered and filed IND, to be developed in-house
Discontinued products GRC 3886 GRC 8200 GRC 6211 GRC 10693 GRC 10622 GRC 10389 GRC 9332 GRC 17173 Asthma COPD Diabetes II Osteoarthritis, DP, Incontinence, NP NP, Osteoarthritis and inflammatory pain Pain Obesity Obesity, Dyslipidemia, metabolic disorders Osteoarthritis, DP, NP Asthma Revamilast (GRC4309) Rheumatoid Arthritis (RA)
Discontinued Suspended post return from Merck in FY08 Suspended in FY09 post adverse findings by Eli-Lily Discontinued in FY11 Discontinued in FY08 Discontinued in FY07 Discontinued in FY09 Discontinued in FY09 PDE IV Inhibitor PDE IV Inhibitor Possibly discontinued Negative study results
Valuation
Our 12-month SoTP-based price target is INR 710, valuing the base business at 15x one-year-forward earnings. This is at the top end of our mid-cap pharma range of 1015x and at the mid-point of its historic forward P/E band of 10-20x. On a reported basis (ex licensing income), we forecast earnings to grow at a 21% CAGR over FY13-16E, with EPS of INR 36 and INR 43 in FY15E and FY16E, respectively. Across IPCs in our coverage, we mitigate valuation volatility by stripping out earnings impact from limited competition products. Limited competition products can significantly distort earnings given higher profitability.
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Figure 150: Glenmarks forward P/E band

1,000 900 800 700 600 INR 500 400 300 200 100 0 Jul-05
Source: Bloomberg
10x
15x
20x
GNP CMP
Sep-06
Nov-07
Jan-09
Mar-10
May-11
Jul-12
Sep-13
Marginal value being ascribed to basic R&D Glenmarks valuation swings have been extreme, largely led by market expectation on its basic R&D pipeline, in our view. As mentioned earlier, Glenmarks basic R&D investments have not been value destructive and have recovered all investments made by the company. More importantly, this has now given the company a valuable option value, including IP assets, fixed assets and at least nine projects with potential future revenues, including milestones. How does one value such pipelines given the high probability of failure? Given Glenmarks consistent track record in monetizing opportunities and value creation in basic R&D, we believe that potential upside to Glenmark from basic R&D should be valued as a part of core earnings. We are fairly confident that Glenmark would see more such deals in the near future. However, since it is very difficult to ascertain accurate timelines for licensing incomes, we would ascribe value based on the actual revenue accrued post tie-ups. We have valued the R&D pipeline at INR 41 based on NPV methodology. Figure 151: SoTP based value is INR 710
(INR) One-year-forward base EPS Target multiple Base business value NPV value Total value for Glenmark
45 15 669 41 710
Risks
Higher dependence on US for profits. The US business contributes c.55% of FY14 profit (ex milestones), with a share of 34% in total sales and EBITDA margin of 3235%. Any unanticipated increase in price competition could thus have a material impact on overall profitability. Regulatory risks in the US market. Generic companies have been particularly affected by systemic delays in USFDA approvals for generics, wherein the average approval time has dropped to almost 30 months from an average of 18-24 months earlier. Moreover, many generic companies (Sun, Ranbaxy, Aurobindo, etc) have had adverse quality observations on manufacturing facilities due to increased regulatory oversight by the USFDA.
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Financials
Speciality business to drive 19% revenue CAGR over FY13-16E We expect Glenmark to register revenue CAGR of 19% over FY13-16E to INR 84bn led by its speciality business, which is estimated to grow at a 19% CAGR over the same period to INR 45bn by FY16E. The generics business is likely to grow at a healthy 18% CAGR over FY13-16E to INR 31bn led by US and EU generics. Figure 152: Glenmarks revenue to reach INR 89bn by FY16E
105 90 75 60 45 30 15 0 FY11 FY12 FY13 FY14E FY15E FY16E
Specialilty Outlicencing income
Generics Growth yoy
API 49.8 40.6
40 35 30 25
36.2 29.5 24.8
INR bn
20.9
20
15 10
We expect the Latam generic and speciality business to grow at a 29% and 22% CAGR, respectively, over FY13-16E. We have not built any upside from future milestone incomes in our estimates, given the unpredictability of forecasting such revenues. Figure 153: Revenue breakdown, consolidated revenue CAGR of 21% over FY13-16E
(INR bn) Speciality India formulations RoW Latam Europe Generics US EU Latam API Out-licencing income Net sales FY07 11.1 6.1 2.4 1.6 1.0 7.9 7.3 0.1 0.4 2.0 0.0 20.9 FY13 26.5 13.1 8.1 3.3 2.0 18.8 16.9 1.7 0.2 4.4 0.7 50.4 CAGR FY07-13 (%) 15.7 13.4 22.9 12.9 12.5 15.6 14.9 50.5 -12.2 14.4 NA 15.8 FY14E 32.5 14.8 10.7 4.8 2.3 24.7 22.7 1.8 0.3 5.5 0.3 63.0 FY15E 41.0 17.8 14.4 6.2 2.6 28.0 25.6 2.0 0.3 7.3 0.3 76.5 CAGR FY16E FY13-16E (%) 49.0 22.7 21.2 16.7 8.1 3.0 30.4 27.6 2.4 0.4 9.9 0.3 89.4 17.5 27.1 34.9 14.5 17.4 17.8 11.6 30.3 30.6 -28.7 21.1
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EBITDA margins (ex-milestone) to expand led by domestic formulation and US generics We expect Glenmarks EBITDA margin (ex-milestone) to expand to 26-27% in FY1416E, primarily led by increased contribution from higher margin domestic formulations and US generics margins. Figure 154: EBITDA margins (ex-milestone) to expand due to India and US contribution
30 EBITDA 26.9
25
24.8
26.7 25.5
20
20.1
21.8
15
10 FY11 FY12 FY13 FY14E FY15E FY16E

Glenmark had debt of INR 24.5bn as of Q2FY14 with a debt-to-equity of 0.6x. Glenmark is also actively restructuring its debt, targeting longer tenor foreign debt (due to lower international rates). In FY12, Glenmark had converted most of its shortterm debt into overseas long-term debt. Hence, currently 60% of total loans are in forex, primarily long-dated. Glenmark has chosen not to actively hedge its forex loan position due to its natural hedge from international operations. We estimate positive cash flow of INR 13bn in FY14-15E, which we expect could be largely utilized to repay debt. We have estimated working capital days to remain constant at 115 in FY14-16E.
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Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) Core EPS (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 40,206 50,123 59,575 70,846 83,902 26,752 33,587 40,511 48,175 57,053 (9,205) (11,998) (14,575) (16,978) (19,749) (7,567) (11,490) (13,213) (15,195) (17,018) 9,002 8,830 10,916 14,009 17,917 (1,377) (1,557) (2,197) (2,079) (1,770) 0 0 0 0 0 (1,427) 65 50 50 50 (1,317) 0 0 0 0 4,881 7,337 8,768 11,980 16,197 (238) (1,107) (1,929) (2,396) (2,904) 40 0 0 0 0 (684) 0 0 0 0 3,999 6,230 6,839 9,584 13,293 3,765 5,708 6,839 9,584 11,615 9,980 10,100 12,722 16,003 20,286 14.79 13.93 19.15 2.33 270 23.02 21.12 18.68 2.34 270 25.25 25.31 23.05 2.65 270 35.39 35.46 34.06 3.74 270 49.08 42.98 44.59 4.54 270

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 9,002 979 (2,804) (238) 2,204 (1,317) 7,825 (3,076) 0 1,644 0 (1,432) (629) (597) (221) 0 (1,447) 4,947 0 4,749 2013 8,830 1,270 (1,493) (1,107) 816 0 8,317 (4,481) 0 1,161 0 (3,320) (633) (1,415) 3,016 0 968 5,964 0 3,835 2014E 10,916 1,807 (2,147) (1,929) (220) 0 8,425 (3,500) 0 0 0 (3,500) (718) 0 500 0 (218) 4,707 0 4,925 2015E 14,009 1,994 (2,029) (2,396) (3,296) 0 8,282 (4,500) 0 0 0 (4,500) (1,014) 0 (3,000) 0 (4,014) (232) 0 3,782 2016E 17,917 2,369 (1,720) (2,904) (3,476) 0 12,186 (5,500) 0 0 0 (5,500) (1,229) 0 (3,500) 0 (4,729) 1,957 0 6,686

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 3,201 0 12,436 7,877 5,940 29,453 12,995 11,862 0 351 25,207 54,660 0 12,037 0 12,037 19,999 0 (2,674) 1,032 18,357 30,394 24,016 250 24,266 54,660 16,905 271 2013 6,052 0 16,400 8,435 6,584 37,472 15,546 12,739 0 382 28,668 66,139 0 18,004 0 18,004 22,881 0 (3,803) 1,183 20,262 38,265 27,630 244 27,874 66,139 16,952 271 2014E 10,759 0 18,444 10,283 7,718 47,203 17,240 12,739 0 382 30,361 77,564 0 22,808 0 22,808 23,381 0 (3,803) 1,183 20,762 43,569 33,751 244 33,995 77,564 12,745 271 2015E 10,527 0 21,933 12,228 8,883 53,572 19,746 12,739 0 382 32,867 86,439 0 26,112 0 26,112 20,381 0 (3,803) 1,183 17,762 43,874 42,322 244 42,565 86,439 9,977 271 2016E 10,806 0 25,975 14,482 10,213 61,475 22,877 12,739 0 382 35,998 97,474 0 30,261 0 30,261 16,881 0 (3,803) 1,183 14,262 44,522 52,708 244 52,952 97,474 6,198 271

18.0 21.6 0.8 0.9 0.3 216.3 107.8 267.3
24.1 19.5 0.8 0.9 0.3 180.0 105.0 331.5
22.3 21.2 0.8 0.8 0.5 179.2 106.7 390.7
25.2 24.3 0.9 0.6 0.4 181.2 104.0 393.8
28.0 28.1 0.9 0.7 0.4 181.6 104.2 383.2
69.7 46.9 6.5 2.1 2.4
60.8 47.5 5.6 2.1 2.1
37.5 42.7 4.8 1.8 2.1
23.4 33.8 6.5 1.4 2.1
11.7 25.1 9.7 0.9 2.0
2.5 10.1 11.2 20.8 22.1 3.5 0.8
2.6 13.0 14.9 18.4 20.0 4.5 0.6
2.6 12.0 13.9 20.4 20.3 4.1 0.5
2.1 9.3 10.7 14.5 14.5 3.3 0.7
1.7 7.2 8.1 10.5 12.0 2.6 0.9
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Aurobindo Pharma
Impressive growth, but near-term value captured
We downgrade Aurobindo to In-Line with a PT of INR 430, IN-LINE (from OUTPERFORM) based on 10x one-year-forward P/E. The stock is expensive PRICE as of 7 Jan 2014 PRICE TARGET post its 102% run-up, trading at the peak of its PE band. We expect 18/32/62% sales, EBITDA and EPS CAGRs over FY13-16E, respectively. On our PRII matrix, it is weak on reach, innovation and inorganic growth, reducing the chances of a P/E re-rating. Aurobindo has a large, diversified and defensive product portfolio, but it is highly genericised. This captures its solid manufacturing and distribution capabilities, but also hampers long-term visibility on margins and growth. Near-term rerating done. Aurobindo has risen 102% (87% vs the sector) over the past 12 months given (1) higher visibility of earnings growth, (2) focus on niche formulations like controlled substances, CNS/CVS, OCs and difficult-to-make injectables and (3) dwindling key concerns. We believe the near-term re-rating is done and that it trades close to the valuations of Indian pharma mid-caps despite a weaker balance sheet and highly generics portfolio. Aurobindo is trading at the peak of its PE band. We value Aurobindo at 10x one-year-forward P/E. PRII matrix shows limited structural drivers. Aurobindo scores the lowest on our PRII matrix given its leveraged balance sheet, restricted geographic focus and diversified but low-margin product portfolio. Aurobindo already has one of the largest product pipelines in the US, comprising 294 filings and 184 approvals. While its last-to-exit strategy helps lengthen the product cash flow cycle, it also leads to higher competition in all product segments. The key challenge will be to tide over price pressure in its generic formulation portfolio and continue to profitably grow the low margin API business (ARV, Cephs, SSP) that still contribute 38% of sales. Inorganic route constrained but JVs to help. Acquisitions have helped Aurobindo build key capabilities across injectables, SSPs, OCs, etc. But its debt heavy balance sheet limits its ability to make critical big-ticket acquisitions. Aurobindo benefits significantly from JVs with global big pharma players by positioning itself as their strategic manufacturing partner for their generics products. Wait for a better entry point. We continue to remain positive on Aurobindos business momentum and focussed approach. But given the structural challenges, we believe the near-term re-rating has played out.
INR 407.75
Bloomberg code
INR 430.00
Reuters code
ARBP IN
Market cap
ARBN.BO
12-month range
INR 116,148mn (USD 1,864mn)

INR 127.15 - 417.90

47.1% 2015E 72.2%
2013 58,553 8,610 6,122 3,741 2,938 (1,589) 10.09 1.75 89.51 228.5 50.4 14.7 10.5 5.0 17.3 124.8 11.9 10.5 1.3 8.6 1.6 14.4 1.2
2014E 74,278 13,747 11,139 9,884 7,809 1,075 26.83 2.28 114.06 165.8 30.5 18.5 15.0 10.5 8.5 96.8 26.3 17.2 2.0 11.0 3.6 15.2 0.6
2015E 84,167 16,594 13,852 12,630 9,978 6,517 34.28 2.95 145.38 27.8 29.3 19.7 16.5 11.9 8.6 62.6 26.4 19.6 1.7 8.8 2.8 11.9 0.7
2016E 95,152 19,962 17,084 15,896 12,558 8,849 43.14 3.67 184.86 25.9 24.4 21.0 18.0 13.2 8.5 34.9 26.1 22.5 1.4 6.9 2.2 9.5 0.9

Aurobindo Pharma 450 275 100 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth 33 35 -
-3 mth -12 mth 95 102 88 92 Promoter (54.8%) 45% 38,716,796
Gaurav Pathak
13 January 2014
ARBP IN INR 407. 75 INR 430. 00
Shashikiran Rao
130

We expect Aurobindos US formulations business to report 23% CAGR over FY1316E driven by (1) sharp upticks in approvals (184 approved and 110 pending ANDAs), (2) improving market share in established products and (3) increasing presence in niche segments that constitute one-third of pending filings controlled substances, CNS/CVS, OCs, and difficult-to-make injectables. But Aurobindos overall product pipeline is still disproportionately tilted towards metoo/last-to-exit generics and anti-retrovirals (ARVs); this combined with a complete absence from the branded generics market is likely to keep its margins in check. Note that 38% of sales are bulk drugs from ARV, SSP and Cephs. Given Aurobindos limited geographic reach, high leverage and lack of non-linear growth drivers, we expect it to trade at a discount to other mid-cap pharma peers like Torrent and Cadila. Our 12-month price target is INR 430, is based on P/E of 10x one-year-forward EPS of INR 43 for FY16E.
Transformation to formulation-player largely complete

Aurobindos transformation into a formulations player from a pure API player is largely complete, in our view, with formulation sales likely to reach 59% of FY16E gross sales, up from 51% in FY12 and 31% in FY07. Aurobindo now has one of the largest though pure generics product portfolios in the US. Figure 155: Formulation share is expected to increase to 59% by FY16E
100 Formulation API
80 69 61 56 53
49
49
44
41
41
41
60
%
40 44 47
20
31
39
51
51
56
59
59
59
0 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E
Aurobindo started with APIs in EMs in 1999. It had a big presence in the antibiotic segment via semi-synthetic penicillin and cephalosporin. Over the next few years, it moved on to manufacture APIs for regulated markets. From 2007 onwards the company shifted focus and started aggressive capacity addition to move into generic formulations for regulated markets. We believe the transition is complete. Aurobindo currently exports to 125+ countries with a global marketing network through 40+ subsidiaries. It has 10,000 employees with 850+ scientists. The company continues to be strong in APIs with Cephs, SSP and ARVs the mainstay of the bulk business. We expect this segment to report a 12% CAGR over FY13-16E. Aurobindo is one of the largest manufacturers of Cephs, SSP and ARVs globally.
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The higher contribution from formulations has helped (1) improve operating margins (average gross contribution from formulations is 10% higher than for APIs), (2) improve asset utilisation by moving to value-added products and (3) lower volatility in earnings with relatively stable pricing. Moreover, even within formulations, the companys focus has been on increasing the share of higher value-added products (including injectables, controlled substance products, OCs and CNS/CVS), lowering the contribution from low-value segments such as ARVs and oral solids. As can be seen in the chart below, Aurobindo has not been growing its ARV business over the past three years. Rather, it has reduced its participation in some tenders that are not profitable. US formulations are the area of maximum growth for the company with 49% CAGR since FY08. Aurobindo has also been strengthening its filing/approval pipeline in Europe and the rest of the world. In the RoW market, Aurobindo has focussed on large but underpenetrated markets like South Africa. Figure 156: Aurobindos geographical reach
60 50 10 40 9 8 8 2 4 10 FY12 FY13 FY14E FY15E FY16E 4 5 26 18 30 33 4 5 5 6 US EU ROW ARV 11 6 7
fig in INR bn
30 20 10 0 5 2 2 5 FY09 5 2 2 7 FY10
4 2 2 2 FY08
7 2 3 9 FY11
Source: Company
EBITDA margins to improve

Aurobindos EBITDA margins have historically been lower than peers, primarily due to an unfavourable product mix and lower operating leverage from lower capacity utilization. Note that Aurobindo spent 4% on R&D vs 8% for peers - this implies ex R&D expense Aurobindos margins are even lower. Over the next three years, we expect EBITDA margin to improve from 15% to 21% lead by improving product mix. 1) Increase in share of formulation reaching 59% of FY16 gross sales, up from 56% in FY13 and 31% in FY07. US formulation business to grow at 23% CAGR over FY13-16E; increasing contribution to sales from 22% to 33%. Increasing presence in niche segments that constitute one-third of pending filings controlled substances, oncology, OCs, and difficult-to-make injectables. Improving utilization across Indian manufacturing facilities. Vertical integration helping achieve supply chain efficiency, 90% of the key intermediates and APIs required for formulations are captive-sourced.
2)
3)
4)
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Figure 157: Aurobindos margins low, to improve over FY13-16

45 40 35 30 % 25 20 15 10 GNP SUNP CDH DRRD TRP LPC CIPLA RBXY ARBP
Source: Company Note: Aurobindos sales exclude other operating income
FY13 EBITDA margin 44
FY16E EBITDA margin
27 22 18 15 15 24 21 20
US remains the key growth segment

Aurobindos US business is poised for a step-up, backed by one of the largest pipelines of drugs expected to be filed/approved in the next 2-3 years. We expect US revenue (ex outsourcing deal contribution) to post a 23% CAGR reaching INR 33bn by FY16E. Furthermore, the mix of filings in the US is improving with greater focus on niche areas (one-third of the pipeline) that will improve sales/launched products. Supply chain efficiency is critical to wholesale/pharmacies in the US (they operate on thin margins). Supply issues can result in significant costs for distributors. Aurobindo has increased its inventory levels in the US, which has resulted in market share gains in existing products. Figure 158: Sales from the US
(INR mn) US sales (ex contract supplies) Total gross formulation sales Total gross sales % of US sales to total formulations sales % of US sales to total sales
Source: Company, Standard Chartered Research estimates Note- Total gross sales exclude milestone incomes
FY11 9.2 21.5 42.2 43 22
FY12 10.2 23.9 46.7 43 22
FY13 FY14E FY15E FY16E 17.5 33.9 60.3 52 29 26.3 44.2 75.3 59 35 29.6 50.4 85.4 59 35 32.9 56.9 96.4 58 34
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Figure 159: Comparative filing for Aurobindo against peers

500 450 400 350 300 Nos 250 200 150 100 50 0 24 Torrent 53 Glenmark Cadila Lupin 43 133 101 91 62 Dr Reddys 83 Ranbaxy 88 Aurobindo Sun 179 140 183 204 Cumulative filings Pending approvals
453
279
234
Source: Company Note: SUNP includes Taro filings
The chart above shows that Aurobindo has one of the largest filing baskets among peers next only to Sun Pharma with 284 ANDA filings and 110 ANDAs pending approval. Most of the pending ANDA applications are from three units: (1) Unit-IV, which manufactures injectables, (2) Unit-VII SEZ, which focuses on a range of oral substances, and (3) Aurolife, based in the US, which focuses on oral controlled substances. The high complexity of Aurobindos product offering bodes well for earnings sustainability and margin improvement going forward. Figure 160: Unit-wise formulation filings
300 250 Approved Pending 1 44 1 3 117 27 6 10 19 15 6 1 0
no of approvals
200 150 100 50 0
29
Unit VI -B ( Oral Cephalosporins)
Unit VII (SEZ) Oral
Autolife (USA)
Unit IV (Injectables)
Source: Company
Aurobindos strategy in regulated markets is low risk (minimizes high risk litigations and hence while it operates in PIV opportunities, it is normally not FTF). It follows a last-to-exit strategy, leveraging off its vertically integrated cost strength in APIs to incrementally gain market share in existing products, despite ongoing price erosion.
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Auronext (Penem)
134
Unit XII - (SemiSynthetic Penicillin oral/ injectables)
Unit III (Oral)
Strategic acquisitions and JVs to strengthen growth

Incrementally, Aurobindos strategy is to increase the value addition from its US portfolio and hence its recent focus has been to file for more differentiated products, including injectables. A critical part of its portfolio acquisition has been driven by acquisition of manufacturing facilities in niche areas. Recently, to expand its product offering in the Hormonal and Oncology injectables, Aurobindo acquired a 60% stake in Celon Labs for INR 156mn. Celon Labs is in the process of expanding its manufacturing facility in Hyderabad. This facility is expected to be completed by endFY14 and file about 23 products in FY15. The other acquisition, Silicon Life Sciences, is an API feeder plant to supply sterile Penems to Auronext. The table below summarises Aurobindos history of acquisitions and the capability build-up. Figure 161: Aurobindos key acquisition track record
Target Milpharm Pharmacin Country UK Year 2006 Rationale Marketing toe-hold into UK, gained over 100 marketing authorisations Marketing toe-hold into Europe, gained over 200 marketing authorisations in various European countries Manufacturing facility for injectables Liquid injectable facilities Manufacturing facility for hormonal and oncology injectables API manufacturing facility for sterile Penems to feed into Auronext
Netherlands 2006
Sandoz (Jersey facility) Trident Lifesciences Celon Labs Silicon Life sciences
US India India India
2010 2009 2013 2013
Aurobindo is benefitting significantly from JVs with global pharma players. Its strategy of not filing infringing FTF PIVs has helped it become a partner of choice for supply of formulations and APIs for big pharma. Amongst the ongoing JVs, the Pfizer deal is most relevant, covering multiple products and geographies. The comprehensive multi-year contract highlights the switch from a simple contractor-based model to a key strategic partner in Pfizers overall production set-up. Aurobindo will supply formulations for Pfizers emerging market units and for the generic products within the regulated markets.
Valuations
Aurobindos share price has been volatile in the recent past in 2012 it fell 60% from its peak in 2010, but later recovered ground. Overall, the stock has traded in the 510x range for most of the past 5-6 years. Various concerns ranging from FCCB repayments, FDA import alert on unit IV in FY11 and slow ramp-up of the outsourcing partnerships with Pfizer and AstraZeneca have weighed on the stock. Aurobindos current re-rating is driven by fewer concerns, improving product mix and strong earnings growth. We believe the current leg of the re-rating is complete and would look to buy only on dips. We value Aurobindo at INR 430, ascribing 10x to FY16 EPS of INR 43; downgrade to In-Line.
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Figure 162: Two-year-forward P/E Stock at significant discount to peers

700 600 500 400 300 200 100 0 Sep-05 5x 10x 15x ARBP CMP
Nov-06
Jan-08
Mar-09
May-10
Jul-11
Sep-12
Nov-13
Risks
High leverage Aurobindo has the highest leverage in the sector at 1.3x D/E with about 70% of the debt being foreign currency borrowings and short term in nature. Furthermore, we expect the company to have capex of INR 2bn each year till FY16 due to its expansion in the injectable space. If our growth assumptions do not materialise, net debt to EBITDA may remain at an uncomfortable level. Outsourcing ramp-up Aurobindo had made progress towards strengthening its contract manufacturing business by collaborating with Pfizer and Astra Zeneca. However, the import alert on its unit VI (cephalosporin unit) in 2011 had impeded its progress. The alert was lifted in August 2013, but we are awaiting a ramp-up in the business; delay on these deals will be negative. Approvals Aurobindo has one of the largest pipelines of pending filings: 90 ANDAs and 26 tentative approvals still await final approval. About one-third of the pending approvals are for complex products including injectables (27 from unit-IV). Approvals for these products are critical for Aurobindo to move into a high-margin trajectory. Any delay in approvals will be a setback to the companys prospects.
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Financials
12% CAGR in revenue, led by regulated markets and outsourcing contribution We expect gross revenue to post an 18% CAGR over FY13-16E to INR 105bn, led by growth in regulated markets and outsourcing deals. Regulated formulation sales (ex-outsourcing revenue) are likely to grow to INR 62bn (16% CAGR) over FY1316E, while ARV formulation sales are expected to grow at a 15% CAGR to INR13bn. We have assumed a 12% CAGR for APIs, as the company is likely to use additional APIs for internal use to ramp up its expected formulation sales across US and European markets. Figure 163: Total revenue segment-wise and growth
API 120 100 52 80 Rs bn 60 40 20 0 FY12 FY13 FY14E FY15E FY16E
Formulations
Contract supplies
Growth yoy 35 60 30 25 % 20 15 10 5
42 35 31
Figure 164: Formulation revenue geographical breakdown (INR bn)

FY13 Formulations USA EU ARV ROW 33.9 17.5 5.3 7.5 3.5 FY14E 44.2 26.3 5.1 8.6 4.2 Growth yoy 31 50 (3) 15 20 FY15E 56.9 32.9 6.5 11.4 6.1 FY16E 62.6 35.9 7.2 12.6 7.0 CAGR FY13-16E 23 27 11 19 26
We expect adjusted net profit to post a CAGR of 62% with net profit of INR 14bn by FY16E. The faster growth in net profit is likely to be driven by strong financial leverage and margin uplift due to an improving product profile, exiting low-margin products in its ARV portfolio and reduced interest costs.
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Figure 165: Net profit growth

PAT 14 12 10.0 7.8 40% CAGR 12.6
10
Rs bn 8 6 4 2 0 -2 (1.2) FY12 FY13 FY14E 2.9
FY15E
FY16E
Balance sheet and cash flow On the balance sheet front, Aurobindos debt position has optically worsened due to the high foreign exchange component of its debt. However, over the past six months, the company has managed to reduce its dollar debt by c.USD 40mn as shown below. Barring any debt increase due to a large acquisition, we are comfortable with the debt levels as well as its currency exposure given that its US formulation revenues alone are likely to increase at an 18% CAGR by FY16 to USD 548mn. Figure 166: Debt position (INR bn)
FY11 USD mn USD/ INR LT foreign currency loan WC foreign currency loan FCCB Rupee loan Sales tax deferment Cash Net debt
FY12 INR bn 44.6 12.5 4.5 6.2 0.1 0.7 -1.9 22.3 0.2 0.7 -0.7 30.3 USD mn 274 316 INR bn 50.9 13.9 16.1
FY13 USD mn 257 353 INR bn 54.3 14.0 19.2 0.5 0.7 -2.1 32.3
Q2-FY14 USD mn 200 360 INR bn 62.6 12.5 22.5 0.9 0.7 -3.1 33.6
281 102 139
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Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 46,274 58,553 74,278 84,167 95,152 21,108 28,646 36,768 42,083 48,052 (14,941) (19,260) (22,089) (24,371) (26,748) 0 0 0 0 0 (67) (776) (932) (1,118) (1,342) 4,096 6,122 11,139 13,852 17,084 (3,014) (2,381) (1,255) (1,221) (1,188) 0 0 0 0 0 0 0 0 0 0 (3,212) 0 0 0 0 (2,130) 3,741 9,884 12,630 15,896 1,068 (743) (2,076) (2,652) (3,338) 6 25 (1) 0 0 (180) (84) 0 0 0 (1,235) 2,938 7,807 9,978 12,558 885 6,101 (4.24) 3.07 1.16 288 2,938 8,610 10.09 10.09 1.75 291 7,809 13,747 26.82 26.83 2.28 291 9,978 16,594 34.28 34.28 2.95 291 12,558 19,962 43.14 43.14 3.67 291

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 4,096 2,005 (3,014) (148) (931) (4,400) (2,391) (5,984) (1,083) 0 0 (7,066) (338) 522 6,816 0 6,999 (2,458) 0 (8,375) 2013 6,122 2,487 (2,381) (101) (5,759) 704 1,072 (2,661) 1,058 0 0 (1,602) (509) 231 2,885 0 2,607 2,077 0 (1,589) 2014E 11,139 2,608 (1,255) (2,076) (7,341) 0 3,075 (2,000) 0 0 0 (2,000) (664) 0 (500) 0 (1,164) (89) 0 1,075 2015E 13,852 2,743 (1,221) (2,652) (4,203) 0 8,517 (2,000) 0 0 0 (2,000) (858) 0 (4,000) 0 (4,858) 1,659 0 6,517 2016E 17,084 2,878 (1,188) (3,338) (4,586) 0 10,849 (2,000) 0 0 0 (2,000) (1,067) 0 (6,000) 0 (7,067) 1,782 0 8,849

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 709 0 12,400 15,456 3,890 32,454 28,401 0 0 1,468 29,868 62,322 0 7,174 0 7,174 30,959 0 (16) 706 31,650 38,823 23,397 102 23,499 62,322 30,957 291 2013 2,085 0 15,970 19,236 6,505 43,795 28,574 0 0 409 28,983 72,778 0 11,196 0 11,196 33,844 0 680 891 35,415 46,611 26,058 110 26,168 72,778 32,650 291 2014E 1,995 0 20,056 24,158 7,684 53,893 27,966 0 0 409 28,375 82,269 0 14,042 0 14,042 33,344 0 680 891 34,915 48,957 33,202 110 33,312 82,269 32,239 291 2015E 3,655 0 22,499 27,100 8,214 61,468 27,223 0 0 409 27,633 89,101 0 15,754 0 15,754 29,344 0 680 891 30,915 46,669 42,322 110 42,432 89,101 26,580 291 2016E 5,437 0 25,181 30,331 8,766 69,714 26,345 0 0 409 26,755 96,469 0 17,632 0 17,632 23,344 0 680 891 24,915 42,547 53,812 110 53,922 96,469 18,798 291

Year-end: Mar Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) 2012 45.6 13.2 8.9 1.9 50.1 5.7 nm nm -84.8 -51.6 2013 48.9 14.7 10.5 5.0 19.9 26.5 nm nm 228.5 50.4 2014E 49.5 18.5 15.0 10.5 21.0 26.9 165.7 165.7 165.8 30.5 2015E 50.0 19.7 16.5 11.9 21.0 13.3 27.8 27.8 27.8 29.3 2016E 50.5 21.0 18.0 13.2 21.0 13.1 25.9 25.9 25.9 24.4
-5.2 7.8 0.8 -0.6 0.3 217.6 97.9 111.8
11.9 10.5 0.9 0.2 0.9 211.7 88.4 112.1
26.3 17.2 1.0 0.3 1.3 211.1 88.5 122.8
26.4 19.6 1.0 0.6 1.4 222.3 92.3 129.2
26.1 22.5 1.0 0.6 1.4 222.5 91.4 129.4
131.7 56.1 4.2 4.5 4.5
124.8 55.0 2.3 3.8 3.9
96.8 48.9 7.7 2.4 3.8
62.6 40.0 9.7 1.9 3.9
34.9 29.6 12.3 1.3 4.0
1.4 11.0 16.4 nm 44.8 1.5 0.8
1.3 8.6 12.1 14.4 14.4 1.6 1.2
2.0 11.0 13.6 15.2 15.2 3.6 0.6
1.7 8.8 10.5 11.9 11.9 2.8 0.7
1.4 6.9 8.0 9.5 9.5 2.2 0.9
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Torrent Pharmaceuticals
Stable growth, but priced in
Torrent differentiates itself from peers with its strong presence in the European and Brazilian markets. Our PRII matrix highlights Torrents growing position in new products and market reach, but it still is a long way from mid-cap peers such as Glenmark and Cadila. We believe Torrents ability to pick limited competition products, gain market share and file strong ANDAs could generate in 23% revenue CAGR in the US over FY13-16E. Our 12-month PT of INR 500 is based on 13x one-yearforward P/E, at the upper end of its long-term range. Going well, but not quite there. On our PRII matrix, we see Torrent improving traction in new product momentum and strengthening/diversifying its market reach across unconventional geographies. Barring India, however, it still has some distance to cover to match up to its mid-cap peers like Glenmark and Cadila: (1) limited track record in innovation with pipeline comprising primarily of off-patent generics, (2) strength in low-margin markets and limited levers to achieve margin expansion, and (3) slower organic revenue growth vis-a-vis the sector. Unique core markets. Unique among Indian pharma companies, Torrents core markets are India, Europe and Brazil, which together contributed 79% to its top line in FY13, while the US contributed only 12%. We expect its three key markets to report good growth, but limit margin uptick due to regulatory issues. We like Torrents chronic focus (70% of domestic sales; CNS/CVS) and recent move into gynaecology and oncology. Late entrant into the US, but growing well. Torrent entered the US market late (2008), but it has covered ground. Currently, it has 43 ANDA approvals and a pipeline consisting of 24 pending approvals and 33 products under development. Despite much of its portfolio comprising me-too generics, it has managed to gather sizeable market share in several of its recent launches. We expect strong growth to continue with 23% sales CAGR over FY13-16E. Still lagging peers. Our 12-month PT for Torrent is INR 500 based on 13x one-year-forward P/E at the upper end of its longterm range and mid-point of our mid-cap pharma target range. We expect 15% sales and 18% EPS CAGR over FY13-16E. Despite Torrents strong recent performance, its discount to mid-cap peers is likely to remain unchanged, in our view. Maintain In-Line.
IN-LINE
(unchanged)
PRICE TARGET
INR 471.60
Bloomberg code
INR 500.00
Reuters code
TRP IN
Market cap
TORP.BO
12-month range
INR 79,812mn (USD 1,281mn)

INR 327.50 - 521.85

-1.2% 2015E -1.4%
2013 32,111 6,498 5,671 5,767 4,013 (433) 23.71 5.06 84.02 18.0 2.4 20.2 17.7 12.5 19.8 4.6 33.0 25.1 1.8 8.7 4.1 14.1 1.5
2014E 36,509 7,514 6,417 6,316 4,926 680 29.11 5.82 107.30 22.8 15.1 20.6 17.6 13.5 20.0 5.3 30.4 24.2 2.2 10.8 4.4 16.2 1.2
2015E 42,126 8,854 7,375 7,323 5,639 2,314 33.32 8.00 132.63 14.5 37.4 21.0 17.5 13.4 24.0 0.0 27.8 24.9 1.9 9.0 3.6 14.2 1.7
2016E 47,579 10,254 8,525 8,572 6,514 3,704 38.49 9.24 161.88 15.5 15.5 21.6 17.9 13.7 24.0 -7.8 26.1 25.8 1.6 7.6 2.9 12.3 2.0

Torrent Pharmaceuticals 520 420 320 Jan-13 BSE SENSEX 30 INDEX (rebased)
Apr-13
Jul-13
Oct-13
Jan-14
-1 mth -5 -3 -
-3 mth -12 mth 8 29 3 23 Promoter (71.5%) 28% 1,143,973
Shashikiran Rao
13 January 2014
TRP IN INR 471. 60 INR 500. 00
Gaurav Pathak
140

Growth in core markets Europe and Latin America likely to be back ended. Strong US performance likely to continue on successful new product launches, but unlikely to compensate for slower Europe/Latam growth as it comes off a low base. Focus on branded formulations led to lower volatility and better margins. We expect revenue, EBITDA and EPS CAGRs of 15/16/18%, respectively, over FY1316E. We value the company at the upper end of its historical range of 8-13x P/E.
Branded formulation helped lower volatility

Net revenue is likely to post a 14% CAGR over FY13-16E to INR 48bn, led by (1) continued strong growth in domestic formulations (16% CAGR to INR 16bn by FY16E), (2) accelerated growth in Brazil from new product introductions, (3) US business growth of 23% CAGR (off a low base) and (4) continued expansion in emerging markets of Mexico, Thailand and Indonesia. Figure 167: Revenue breakdown across geographic segments
Net Domestic formulation 50 26 Sales outside India CRAMS Growth yoy (RHS) 25 30
40
INR bn 18 16
22
20 % 15
30
20
10
0
FY12 FY13 FY14E FY15E FY16E
10
Figure 168: Key market growth (INR mn)

FY12 India Brazil US Europe Heumann 9,099 4,531 2,180 1,658 3,473 FY13 10,240 5,020 3,550 2,379 4,121 FY14E 11,776 6,151 4,800 2,855 4,525 Growth yoy 15 23 35 20 10 FY15E 13,660 7,528 5,700 3,283 4,701 FY16E 15,846 8,414 6,600 3,776 4,701 CAGR FY13-16E 16 19 23 17 4
Source: Company, Standard Chartered Research Estimates
Heumann sales have risen steadily, standing now at EUR 58mn, aided by a few tender wins, but continued price erosion on new wins have constrained any contribution to margins. Similarly for Russia, we expect only marginal growth from FY14 on, given the current uncertainties in the market due to government regulations. However, Europe revenue could be lumpy wherein a sizeable product opportunity could result in sharp swings in sales. As for insulin contract
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manufacturing (Torrent is the sole manufacturer for Novo Nordisks insulin in India where Novo supplies insulin crystals to Torrent to formulate), the company has doubled production capacity recently. But Novo Nordisk is currently facing strong competition in this segment. Hence, we are projecting revenues to remain flat over FY13-16E. Figure 169: Torrents business includes a very substantial branded business
(INR mn) India LatAm Others Total branded formulations Total sales % of total sales India LatAm Others Total branded 44.3 13.5 9.6 67.4 33.5 17.5 6.4 57.3 33.5 18.9 6.1 58.5 33.7 20.3 5.7 59.7 34.7 20.4 6.1 61.3 FY08 5,813 1,771 1,263 8,848 13,123 FY13 10,240 5,345 1,956 17,542 30,590 CAGR (08-13) % 12.0 24.7 9.1 14.7 18.4 FY14E 11,571 6,513 2,091 20,175 34,516 FY15E 13,191 7,924 2,242 23,357 39,106 FY16E 15,038 8,837 2,645 26,520 43,278 CAGR (13-16E) % 13.7 18.2 10.6 14.8 12.3
Torrents key branded formulation markets include India, Brazil (including Mexico), CIS and RoW markets. Brazil operations to scale up on the back of product launches Torrents success in Brazil (one of the worlds largest branded generics market s) has been impressive and Torrent is currently one of the largest Indian companies operating in the branded generics space in Brazil. Of this, the branded segment is a larger segment, with sales of USD 6bn in 2009. The companys Brazilian sales have grown at a 17% CAGR over FY08-13 in Brazilian Reals. In INR terms, revenues have grown faster at 26% and contributes c.16% of total sales. While the Brazilian portfolio currently offers 34 products (total field force of 360), this is highly concentrated, with the top 10 products contributing 70% of sales, mainly in CVS and CNS. As per the company, the top 10 products enjoy 15-25% market share in their addressable markets. Torrent has a pipeline of about 20-30 new products (addressable market of USD 2bn) over the next three years, including 4-5 new products in FY14. Torrent does not envisage field force addition in the near future, but would likely see a gradual expansion as the portfolio is strengthened with new products. This would likely include some unique filings like combinations, which augurs well for growth in the market. Torrent has faced competitive pressure in the market in FY13, which led to 40-50% price cuts in two major products. Despite this, the company managed to grow 9% in constant currency terms. We expect the Brazilian operations to post 14% CAGR over FY13-16E (on constant currency basis) and 19% on INR basis.
Brazil: Torrent has 7% market share in its total covered market
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Mexico: plans to ramp up to 30 products with ~200 sales reps
Mexico expansion to leverage Brazilian operations Torrent plans to leverage its Brazilian operations to launch products in Mexico, a market contiguous to Brazil in generics penetration. Mexico is the second-largest branded generics market in Latin America with a market size of USD 10bn (growing at 7% CAGR). Currently, Torrent has a presence only in the CNS segment in Mexico and its ramp-up has been in line with expectations. In Mexico, Torrent is following the doctor-promotional model rather than the distributor-promotion model. Hence, the build-out is expected to be gradual. We believe Torrent, with its strong execution track record in Brazil, has the right skill sets to execute its business plans in Mexico, given many similarities between both the markets. Torrent plans to invest c.USD 5-6mn per year for the next few years and launch 1-2 products each year. Fig 4 shows our estimate for the Mexico business. Figure 170: Expect the sharp ramp-up in the Mexican operations to continue
400 360 320 280 Rsm 240 200 160 120 166 249 287 Mexico Sales 330 379
80
40 0
61
FY11
FY12
FY13
FY14E
FY15E
FY16E
Developed markets: A mixed bag

Torrents regulated market segment likely to post sales CAGR of 9% over FY13-16 Developed markets form another leg of Torrents business strategy, having grown at 30% CAGR (contributing 34% of incremental growth) over FY08-13. We forecast regulated market revenue to post CAGR of 14% over FY13-16 to INR 15bn, with the US business growing higher off a low base. Ex-Heumann in Germany, we expect the growth to be higher at a CAGR of 21%. Due to high competition in the tender business, Heumann has been withdrawing from some low-profit tenders, which impacts overall revenue growth. We expect revenues from Heumann to remain low growing at 4% over FY13-16E.
Figure 171: US and Europe to scale up in FY13-16E (INR mn)

FY13 US Growth yoy (%) Europe (excl tech fees) Growth yoy (%) Total US/EU Growth yoy (%) Heumann Germany Growth yoy (%) Total (US/EU/Germany) Total sales % of total sales
FY14E 4,800 35 2,855 20 7,655 29 4,525 10 12,180 22,049 55
FY15E 5,700 19 3,283 15 8,983 17 4,701 4 13,684 26,959 51
FY16E 6,600 16 3,776 15 10,376 16 4,701 0 15,077 32,111 47
CAGR (FY13-16) 23 17 21 4 14
3,550 63 2,379 44 5,929 54 4,121 19 10,050 19,040 53
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Regulated markets, as seen in the above table, include the US generics business, Heumann in Germany and dossier-based income from sales in the EU. EU sales growing steady Europe (including Heumann) is the second-largest segment for Torrent, contributing 24% of total sales and 36% of international sales in FY13. Sales include Heumann, Torrents subsidiary in Germany, and dossier-based incomes to partners for offpatented products.
Europe second largest segment for Torrent
Figure 172: European business (INR mn)

Year end: Mar Europe Y-o-Y (%) Dossier income Heumann Y-o-Y (%) Total Europe (incl Heumann) Total sales % of sales
FY08 635
FY09 1,011 59%
FY10 1,163 15% 311 2,547 -1% 4,021 16,307 24.7
FY11 1,245 7% 2,986 17% 4,231 19,040 22.2
FY12 1,658 33% 3,473 16% 5,131 22,049 23.3
FY13 2,379 23% 4,121 11% 6,500 26,959 24.1
151 2,095
161 2,573 23%
2,882 12,988 22.2
3,744 13,548 27.6
Ex-Heumann, Europe sales have been lumpy, with spikes in years where there are sizeable products going off-patent (especially in the EU). We expect this business to grow at a 14% CAGR over FY10-13E to INR 1.7bn. Germany remains a challenging market An exception in Europe is Germany, where Torrent is present through its EUR 3.3mn acquisition of Heumann and where the market continues to remain challenging, post the focus on tenders by key buyers in this market. Heumann has completely exited from its branded business (having removed all sales reps from 125 in FY07) and has bid aggressively in recent tender contracts with moderate success. US business ramping up well Torrents US business is at a crucial juncture, both on the revenue and profitability fronts. The US business has attained critical size and is an important contributor to the companys growth. As shown in Fig 7, the US business contributed 28% of incremental yoy growth in FY13. US revenues as a percentage of total sales grew from a negligible 3.5% in FY09 to an impressive 20% in FY13. Figure 173: US has been increasingly accretive to sales growth (INR m)
FY09 Incremental total sales growth yoy Incremental US sales growth yoy US as % of total sales US contribution to growth (%)
Source: Company
US business contributed 20% of incremental revenues over FY09-13
FY10 2,464 632 9.9 25.6
FY11 2890.4 184 10.2 6.4
FY12 4,533 1,087 15.2 24.0
FY13 4,838 1,370 19.7 28.3
2,742 259 3.5 9.4
We expect the company to continue to reap benefits off a low base, impressive launch pipeline and rupee depreciation. We expect US revenue to grow at a 21% CAGR over FY13-16E to INR 6.3bn by FY16.
13 January 2014 144
US business ramping up extremely well
Despite being a late entrant in the US, Torrent has managed to get reasonable traction in the market and has leading market shares in some products like Citalopram (28% market share) and Zolpidem (22% market share). Also, it is consciously trying to increase the share of products with own APIs (currently around 50-60% and expected to increase to c.70%+ in newer filings), which augurs well for margins in this business in the near future. The company has a basket of 43 ANDAs, which it expects to file over the next 3-4 years (5-6 products in FY14) and is expecting approvals for 5-6 products in FY14. It currently has 28 products launched out of 43 ANDA approvals (including 7 tentative approvals). In the pipeline it has a pending portfolio of 24 ANDAs (representing USD 1bn of brand sales) and 34 products under development. Figure 174: Torrents ANDA filings are being ramped up
Filed Approved Cumulative approvals Pending Marketed 43 40 Nos 30 20 10 0 YTD-FY14 21 13 7 2 FY09 FY10 8 13 10 13 6 11 3 6 22.0 Cumulative filings 28.0 Pending approvals 24
Has a basket of 43 ANDAs
50
FY12
FY11
Source: Company
Contract manufacturing: Sputter and start

Torrent has two licensing and contract manufacturing arrangements with Astra Zeneca (AZN) and Novo Nordisk for supply of branded generics products in various emerging markets. Torrent has signed an agreement with Novo Nordisk to contract manufacture insulin for the Indian markets. This deal has been generating revenues though it is going slow because Novo is facing competition in India. With regards to the AZN deal, Torrent is to supply 18 branded generics products over nine emerging markets. As per the contract, Torrent will sell licenses and market authorizations for these products to AZN and would lock in supply arrangements for manufacturing products for these markets. However, this deal has not taken off as AZN is not focussing on emerging markets for these specific segments at this point. Overall, the contract manufacturing segment is currently not seeing strong traction and we expect revenues to remain flat at 4% growth over FY13-16E.
13 January 2014
FY13
145
Valuation
We set a 12-month price target of INR 500, valuing the company at 13x one-yearforward P/E the upper end of its historical range for average FY14-16 earnings. Since FY07, Torrent has historically traded in the range of 10-15x three-year-forward earnings (see Fig 9) barring a dramatic de-rating in late FY09, led by market concerns about problems in the domestic formulation business and in Heumann in Germany. We are confident about Torrents medium-term growth drivers - key branded formulations and US business turnaround. We maintain our structurally positive view on Torrent that has strategic alliances with global companies. Nevertheless, short-term headwinds on the margin front would likely constrain stock price upside, in our view. Figure 175: Torrent valuation bands
700
600 500 400 INR 300 200 100 0 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
146
5x
10x
15x
TRP CMP
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Risks
Lower domestic formulation growth Domestic formulations contribute c.40% of total revenue. Any slowdown in the domestic business will have a significant impact on fixed costs thus affecting our growth estimates. Strengthening Euro In Europe, the majority of Torrents contracts are fixed price. Thus, any adverse fluctuation in the Euro will affect Europe (including Heumann) revenues, which contributes c.20% of total sales.
13 January 2014
Jun-13
Financials
We expect 14% revenue CAGR over FY13-16E driven by branded formulations and regulated markets. Short-term impact on margins likely because of timing difference between investments and commensurate returns. Likely to fund most of its capex through internal accruals.
Medium-term levers intact, short-term margin impact

Torrents short-term performance (next 3-4 quarters) will likely be muted Torrents short-term performance (next 3-4 quarters) will likely be muted, impacted by continued investments in new markets and recent field force ramp up for domestic formulations. While these investments bode well for future growth, they would likely impact margins and profit growth in FY14, given the gestation period of these initiatives. Offsetting this would be the continued momentum in the US business.
Figure 176: Margin pressure negates revenue growth over FY14-16

(INR m) Net revenue (LHS) Growth yoy (RHS) EBITDA EBITDA margin PAT Growth yoy FY11 22,049 15.8 3,876 17.6 2,741 (5.3) FY12 26,959 22.3 5,216 19.3 3,424 24.9 FY13 32,111 19.1 6,498 20.2 4,035 17.8 FY14E 36,509 13.7 7,514 20.6 4,926 22.1 FY15E 42,126 15.4 8,854 21.0 5,639 14.5 FY16E 47,579 12.9 10,254 21.6 6,514 15.5
Margins likely to be impacted in the short term
Overall, while the revenue growth trajectory is likely to be maintained in FY14-16 at 10-13% levels, margins are likely to be impacted in the short term, falling 50-75bps due to the lag effect between investments and sales. Figure 177: We expect EBITDA margins to be under pressure in FY14
100 EBITDA COGS R&D Employee cost Other fixed costs
80 20 60 % 5 40 32 19 4 29 19 5 29 18 5 30 18 5 30
20 19 20 FY13 21 FY14E 21 FY15E 22 FY16E
0
FY12
13 January 2014
147
Gross fixed assets likely to expand by 80% in the next three years Likely to fund most of its capex through internal accruals
Torrent has INR 11bn of capex planned over FY14-16 primarily for its Dahej SEZ expansion. In this project, Torrent plans to add 80TPA and 14bn tablet/capsules per annum. With a strong ramp-up in filings in the US and Latin America, this increased capacity will become important. Apart from this, Torrent does not have any significant capex planned. With INR 6.3bn of cash and INR 4bn+ operating cash flow, we expect Torrent to be able to fund this capex internally. Torrents working capital management has been fairly robust, compared to peers, led primarily by its branded generics play, which has lower working capital requirements, in our view. We expect a moderate expansion in the working capital cycle due to increased contribution from US markets. Figure 178: Working capital cycle likely to increase due to higher US sales contribution
50 45 40 35 Days 30 25 20 15 10 15 % 5
Likely moderate expansion in the working capital cycle
Working capital cycle (LHS)

45 41
% of sales (RHS)
45 45
25
20
10
5 0
5
3 0 FY12 FY13 FY14E FY15E FY16E
FY11
13 January 2014
148

Year-end: Mar Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Net profit adj. EBITDA EPS (INR) EPS adj. (INR) DPS (INR) Avg fully diluted shares (mn) 2012 2013 2014E 2015E 2016E 26,959 32,111 36,509 42,126 47,579 18,328 22,854 26,104 29,699 33,543 (12,637) (14,191) (16,220) (18,191) (20,317) 0 0 0 0 0 (475) (2,164) (2,370) (2,654) (2,973) 4,398 5,671 6,417 7,375 8,525 (159) 96 (101) (52) 47 0 0 0 0 0 0 0 0 0 0 (654) 0 0 0 0 3,586 5,767 6,316 7,323 8,572 (730) (1,467) (1,389) (1,684) (2,057) 23 22 0 0 0 7 0 0 0 0 2,886 4,321 4,926 5,639 6,514 3,402 5,216 17.05 20.10 4.94 169 4,013 6,498 25.53 23.71 5.06 169 4,926 7,514 29.11 29.11 5.82 169 5,639 8,854 33.32 33.32 8.00 169 6,514 10,254 38.49 38.49 9.24 169

Year-end: Mar EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations Capex Acquisitions & Investments Disposals Others Cash flow from investing Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing Change in cash Exchange rate effect Free cash flow 2012 4,398 817 (159) (690) 979 (654) 4,692 (1,433) (243) 0 0 (1,676) (836) (209) 67 0 (978) 2,039 0 3,260 2013 5,671 827 96 (1,732) (2,573) 0 2,288 (2,721) 859 0 0 (1,862) (856) 1,731 (2,421) 0 (1,545) (1,119) 0 (433) 2014E 6,417 1,097 (101) (1,389) (1,593) 0 4,430 (3,750) 0 0 0 (3,750) (985) 0 (1,100) 0 (2,085) (1,405) 0 680 2015E 7,375 1,479 (52) (1,684) (1,054) 0 6,064 (3,750) 0 0 0 (3,750) (1,353) 0 (1,100) 0 (2,453) (140) 0 2,314 2016E 8,525 1,729 47 (2,057) (1,039) 0 7,204 (3,500) 0 0 0 (3,500) (1,563) 0 (1,100) 0 (2,663) 1,040 0 3,704

Year-end: Mar Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Shareholders funds Minority interests Total equity Total liabilities and equity Net debt (cash) Year-end shares (mn) 2012 6,743 0 5,228 5,316 2,333 19,620 9,156 0 0 1,703 10,859 30,479 0 10,397 0 10,397 5,787 0 514 1,807 8,109 18,506 11,938 35 11,973 30,479 (955) 169 2013 6,270 0 6,878 9,239 3,236 25,622 11,051 0 0 844 11,895 37,517 0 12,387 0 12,387 6,930 0 258 3,720 10,907 23,294 14,219 4 14,223 37,517 660 169 2014E 4,865 0 8,339 10,792 3,236 27,231 13,704 0 0 844 14,547 41,779 0 13,808 0 13,808 5,830 0 258 3,720 9,807 23,615 18,160 4 18,164 41,779 965 169 2015E 4,725 0 9,647 12,484 3,236 30,092 15,975 0 0 844 16,819 46,911 0 15,755 0 15,755 4,730 0 258 3,720 8,707 24,462 22,446 4 22,449 46,911 5 169 2016E 5,766 0 10,917 14,128 3,236 34,046 17,746 0 0 844 18,590 52,636 0 17,629 0 17,629 3,630 0 258 3,720 7,607 25,235 27,397 4 27,400 52,636 (2,136) 169

26.0 23.2 1.0 1.1 0.6 219.1 58.4 378.0
33.0 25.1 0.9 0.4 0.3 286.9 68.8 449.1
30.4 24.2 0.9 0.7 0.3 351.3 76.1 459.4
27.8 24.9 0.9 0.8 0.4 341.8 77.9 434.1
26.1 25.8 1.0 0.8 0.5 346.0 78.9 434.1
-8.0 28.8 -166.8 1.1 1.9
4.6 27.6 16.8 1.0 2.1
5.3 20.8 14.2 0.8 2.0
0.0 15.2 20.9 0.6 1.9
-7.8 10.4 33.7 0.4 1.9
1.8 9.5 11.3 17.2 14.6 4.5 1.7
1.8 8.7 10.0 13.1 14.1 4.1 1.5
2.2 10.8 12.6 16.2 16.2 4.4 1.2
1.9 9.0 10.8 14.2 14.2 3.6 1.7
1.6 7.6 9.1 12.3 12.3 2.9 2.0
13 January 2014
149
Disclosures appendix
The information and opinions in this report were prepared by Standard Chartered Bank (Hong Kong) Limited, Standard Chartered Bank Singapore Branch, Standard Chartered Securities (India) Limited, Standard Chartered Securities Korea Limited and/or one or more of its affiliates (together with its group of co mpanies, SCB) and the research analyst(s) named in this report. THIS RESEARCH HAS NOT BEEN PRODUCED IN THE UNITED STATES. Analyst Certification Disclosure: The research analyst or analysts responsible for the content of this research report certify that: (1) the views expressed and attributed to the research analyst or analysts in the research report accurately reflect their personal opinion(s) about the subject securities and issuers and/or other subject matter as appropriate; and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views contained in this research report. On a general basis, the efficacy of recommendations is a factor in the performance appraisals of analysts. Where disclosure date appears below, this means the day prior to the report date. All share prices quoted are the closing p rice for the business day prior to the date of the report, unless otherwise stated. SCB and/or its affiliates have received compensation for the provision of investment banking or financial advisory services within the past one year for the following companies: Torrent Pharmaceuticals Ltd.
Recommendation Distribution and Investment Banking Relationships % of covered companies currently assigned this rating OUTPERFORM IN-LINE UNDERPERFORM As of 31 December 2013 Research Recommendation Terminology OUTPERFORM (OP) IN-LINE (IL) UNDERPERFORM (UP) Definitions The total return on the security is expected to outperform the relevant market index by 5% or more over the next 12 months The total return on the security is not expected to outperform or underperform the relevant market index by 5% or more over the next 12 months The total return on the security is expected to underperform the relevant market index by 5% or more over the next 12 months 53.2% 35.2% 11.6% % of companies assigned this rating with which SCB has provided investment banking services over the past 12 months 14.5% 12.8% 8.3%
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The stated price of the securities mentioned herein, if any, is as of the date indicated and is not any representation that any transaction can be effected at this price. While all reasonable care has been taken in preparing this document, no responsibility or liability is accepted for errors of fact or for any opinion expressed herein. The contents of this document may not be suitable for all investors as it has not been prepared with regard to the specific investment objectives or financial situation of any particular person. Any investments discussed may not be suitable for all investors. Users of this document should seek professional advice regarding the appropriateness of investing in any securities, financial instruments or investment strategies referred to in this document and should understand that statements regarding future prospects may not be realised. 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I Equity Research I India I Health Care I

Important disclosures can be found in the Disclosures Appendix

Equity Research l India pharma

Equity Research l India pharma

IPCs have the ability to ride the third wave

API/ basic product manufacturing for domestic/ DMs Phase -I

Formulations marketing to wider range of DMs and EMs

Source: Standard Chartered Research

Product basket More complex and diverse

Equity Research l India pharma

5b Cymbalta- S, L,CD, DR,T, A 4b

Abilif y-S, CD, T

Atripla Cp, A Diovan- R*, L, DR, A

Potential quarter of launch

Number of approved players

Source: USFDA, Standard Chartered Research

Expanding reach across geographies

Equity Research l India pharma

Source: Company, Standard Chartered Research estimates

Innovation and Inorganic growth

The PRII matrix

Equity Research l India pharma

Figure 4: PRII matrix

Torrent Pharma Aurobindo

Source: Standard Chartered Research estimates

Equity Research l India pharma

Source: Standard Chartered Research estimates

Figure 6: Revenue comparison (INR bn)

Source: Company, Standard Chartered Research estimates

Equity Research l India pharma

700 INR 500

Source: Company, Standard Chartered Research estimates

Figure 8: Pharma sector P/E premium over Sensex

Source: Company, Standard Chartered Research estimates

Source: Company, Standard Chartered Research estimates

Equity Research l India pharma

1.6 2.3 1.0 1.9 2.4 2.4 0.6

1.6 2.3 1.0 1.9 2.4 2.4 0.6

0.4 0.5 0.2 0.4 1.1 0.2 0.1

0.5 0.6 0.3 0.5 1.2 0.4 0.1

25.6 22.6 21.4 23.4 44.2 9.6 20.6

29.2 25.4 26.9 29.5 51.0 15.5 24.3

0.3 0.4 0.1 0.3 0.5 0.1 0.1

0.3 0.4 0.2 0.3 1.0 0.2 0.1

22.7 29.9 25.4 34.5 56.3 9.8 38.5

-5.0 15.2 37.4 11.3 -25.8 2.4 5.3

Source: Companies, Standard Chartered Research Estimates

Figure 11: Global comparison Valuation

1.9 2.7 5.1 6.8 2.2 6.7 19.8 3.3 1.3

Source: Companies, Standard Chartered Research estimates

Equity Research l India pharma

Lupin Mid cap - top Glenmark pick

932 1,112 514 710

Dr. Reddy's Sun Pharma

2,491 2,800 594 646

Less preferred picks

Source: Standard Chartered Research estimates

Risks Tightening regulations and increasing competition

Equity Research l India pharma

Product versatility The key differentiator

Complexity of ANDA filings increasing

Indian pharma share of US DMFs 26% 24%