Cipla- Better top line, subdued margin::Macquarie

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Cipla
Better top line, subdued margin
Event
 Cipla reported 2Q FY11 sales of Rs15.8bn (up 15% YoY, Macq estimate
Rs15.5bn) and a profit of Rs2.63bn (down 5% YoY, Macq estimate Rs2.8bn).
We maintain our Underperform rating with a revised TP of Rs290.


Impact
 Margins impacted due to rupee appreciation and increased overhead:
Cipla’s EBITDA margin for the quarter came in at 22.7% (down 318bp YoY
and 195bp QoQ). The rupee appreciated 4–5%YoY and weighed on Cipla’s
sales and margin growth. As well, increased overhead from the new Indore
SEZ impacted margins negatively as sales began to general markets.
Regulatory approval from other markets will help optimize utilization, but that
should take 8–12 months to fructify.
 Volatile tech income: We have been highlighting tech income booked by Cipla
as being highly volatile and able to cause wild swings to EBITDA margins. In 2Q
FY11, tech income was Rs120m (vs Rs508m in 2Q FY10, down 76% YoY).
Management is now guiding to ~ Rs1bn of tech income for FY11 and FY12.
 Strong domestic sales: Domestic sales were strong this quarter (up 20%
YoY), partly helped by a strong monsoon (higher incidence of infection). This
is positive, as in three out of the last four quarters the domestic business had
grown less than 10% (below the industry average). Cipla guided to being able
to sustain this growth, and this was encouraging to us. We now estimate
domestic sales to grow in the high teens over the medium term.
 Export sales grew decently (up 10% YoY), driven by higher formulation sales.
API exports were muted, down by 1.3%YoY. Inhalers for US and EU are keenly
watched opportunities; however, given the regulatory complexities involved for
approval, we believe any meaningful upside is still 18–24 months away.


Earnings and target price revision
 We adjust our FY11/12/13E EPS to Rs13.5/16.5/19.5 from Rs14/16/18.5, driven
primarily by a higher domestic sales. We raise our TP to Rs290 (from Rs275).

Price catalyst
 12-month price target: Rs290.00 based on a PER methodology.
 Catalyst: 1) Appreciation of INR, 2) lower tech income.

Action and recommendation
 Given volatile tech income, a declining ROCE, rupee appreciation risks and
an NPPA overhang, we believe Cipla should trade at discount to the sector
multiple. The stock is currently trading at 20x FY12E EPS. We value Cipla’s
core business at Rs297, based on a PER of 18x FY12E EPS (at a 10%
discount to the sector average multiple) and deduct Rs8 for the NPPA liability
risk to arrive at our target price of Rs290. However, the announcement of any
supply pact with big pharma companies for the emerging and developed
markets (as the story is being speculated about in the media) could be a
potential game changer.