Cipla Ltd-Improved outlook; Upgrade to Accumulate: Emkay

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Cipla Ltd

Improved outlook; Upgrade to Accumulate

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CMP: Rs332                                        Target Price: Rs350

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n     Cipla’s Q2FY11 revenues were driven by good traction in domestic and export formulation business; however, lower licensing income dragged the overall profitability

n     Revenues were in-line at Rs16.1bn (estd. Rs16bn). EBITDA at Rs3.7bn (estd. Rs3.9bn) and APAT at Rs2.6bn (estd. Rs2.8bn) were below expectations

n     Inhalers approval in Europe, commencement of Zyprexa supplies to Teva and tie-up with Dr. Reddy’s to drive earnings momentum in the longer term

n     Tweaking FY11E EPS marginally by 3% to Rs14.4 (earlier Rs14.7), raise target price upwards to Rs350 (earlier Rs318); Upgrade to Accumulate

Revenue growth of 12% in-line; domestic market leads growth

Robust growth in the domestic formulation (20% vs. est. of 11%) and the export

formulation (14% vs. est. of 12%) resulted in 12% growth in the top line. In the domestic

market, branded as well as the generic business registered strong growth of 19% and

21% respectively owing to strong monsoon season. We believe this is commendable as

the company has earlier guided 11-12% growth in the domestic market after the

divestment of its OTC brand i-pill. Going ahead, management has guided for 20%

growth in the domestic market. However, decline in technology licensing income (as

most of the projects are in completion stages) dragged the top line growth. Management

has guided for Rs750-1000mn in revenues from tech licensing for FY11E (received

Rs279mn in H1FY11). In the export formulation business, the company is looking to

launch Salmeterol inhaler in some of the EU markets (total market size- US$150mn)

and Seroflo (Salmeterol plus Fluticasone) inhaler in South African (~US$15-20mn

market) and CIS markets. Management has indicated that they will start getting

approval for combination inhalers in some of the EU markets from FY12E onwards.

Launch of Seroflo combination inhalers in the CIS and South African market will add

further traction to the export revenues in H2FY11.

Increased overheads at Indore SEZ and lower Tech income impacted

margins

Operating income for the quarter was flat at Rs3.7bn (est. of R3.9bn). OPM for the quarter

contracted by 370bps to 22.7% because of a) Lower tech income, b) Lower realization on

exports, c) 250bps increase in employee cost due to increase in manpower and

reclassification of contracted staff at its Goa facility; and d) increase in factory overheads at

the company’s Indore SEZ plant. However, forex gain of Rs150-200mn above the EBITDA

line prevented further margin erosion. Excluding the forex impact EBITDA margins for the

quarter contracted by 479bps YoY to 21.6%. Going ahead, increased contribution from the

domestic business and ramp-up at the Indore SEZ facility will lead to further margin

improvement.

APAT at Rs2.6bn impacted by lower EBITDA and higher capital cost

Despite higher other income (up by 30%), lower interest cost (down by 97%) and lower tax

provision (17.6% of PBT vs. 18.3% of PBT in Q2FY10), APAT de-grew by 2% to Rs2.6bn.

The growth in the APAT was further impacted due to 34% increase in depreciation cost

aided by increase in overheads at its Indore SEZ facility. The EPS for the quarter and

H1FY11 stood at Rs3.3 and Rs6.5 respectively. Our FY11E EPS of Rs14.2 will be driven by

higher than expected ramp-up in the domestic business and off-take of Seroflo combination

inhalers in the exports market.

Improved outlook; Aerosol opportunity in EU is still 15-18 months away

Management had earlier guided for 8-10% growth in revenue driven by 10% growth in

domestic business and 10-12% growth in export business. However, on the back of

improvement in domestic business and launch of Seroflo combination inhalers in the

exports market, 12-15% growth in top line cannot be ruled out.

The supply of Salbutamol inhaler to UK has already started and the company is looking to

launch Seroflo inhaler in South Africa (US$15-20mn market) and Salmetrol inhaler in some

of the EU markets (total market size of US$150mn in EU zone). Though inhalers for US and

EU could be a large opportunity but given the regulatory framework, this opportunity is still

15-18 months away.

Key con-call highlights

n Management has signaled an improvement in the domestic formulation business on the

back of good growth in the branded as well as the generic business.

n A key trigger would be commencement of API supplies to Teva for the Zyprexa’s 180-

day exclusivity. Zyprexa is US$1.7bn drug in the US. Cipla can rake in significant

revenues if Teva can successfully commercialize the product in mid 2012. Cipla can

potentially generate revenues to the tune of Rs2.0bn by supplying API to Teva during

180days exclusivity.

n Management has guided for launch of Ciroflo combination in the CIS and the South

African markets. We believe this could substantially add to the top line in H2FY11E.

n Income from technology licensing will be in the range of Rs750-1000mn for FY11E and

may even be lower in FY12E.

n Contribution from the tie-up with Dr. Redyy’s for selling OTC products in the Russian

countries may be visible in H2FY11E.

Maintain earnings estimates; raise target price to Rs352 on better business

outlook

After a sub-optimal performance in the domestic business, margin contraction in the core

business and moderate outlook earlier, we believe Cipla can surprise the street on the back

of a) faster ramp-up in the domestic business, b) higher traction from inhaler launch in CIS

and the South African market, c) incremental benefit from the tie-up with Dr. Reddy’s, and

d) higher likelihood of sales ramp-up from the API supply deal with Teva

Owing to better outlook on the company’s growth prospects, we are valuing the company at

20xFY12E EPS, in-line with large-cap peers. Revise target price to Rs Rs350 (earlier

Rs318) and upgrade to Accumulate from Reduce rating. Commencement of API supplies to

Teva and earlier than expected launch of combination inhalers can bring fresh upside to the

stock.

Risk to our target price

n Currency fluctuations could impact Cipla’s prospects and profitability as exports

constitute more than 50% of total revenue.

n Delay in combination Inhaler approvals for European market.