India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
We initiate coverage on Cipla, India’s second largest Pharmaceutical company by market
share, with a target price of `346 and a Neutral rating. We believe the current slowdown
in the domestic as well as international markets is likely to persist and will result in a
muted 9% EPS CAGR over FY10‐12E, even as the company aggressively incur capex. A
stronger balance sheet augurs well for longer term growth, while any product tieups/
acquisitions are an added tailwind. Valuations, at 22x FY12 EPS, fully reflect current
fundamentals.
Revenues losing steam, no near term growth triggers: Domestic markets, Cipla’s mainstay
traditionally, is witnessing strong competition from MNCs and other regional players.
Despite being a market leader in this segment (Market share of 5.4%), Cipla’s growth has
lagged industry by almost 600‐1000 bps, in the past five quarters. Further, the company’s
low risk, low return export model, which has worked well for them in the past (27% CAGR
over FY04‐09), is also lacking major near term growth drivers. We note that the launch of
combination inhalers in EU markets and commercialization of Indore SEZ are still 15‐18
months away and hence we expect a moderate 13% CAGR in revenues over FY10‐12E.
Aggressive capex intensity fails to reflect in revenue growth: Cipla has spent close to `25
bn (~56% of its operating profits) in expanding capacities during FY05‐10. While this
indicates Managements long term confidence in the base business, the same has failed to
reflect in revenue growth. Asset turnover has declined from 1x in FY05 to 0.8x in FY10. With
another `10 bn planned over the next two years, we expect A/TO to remain under pressure,
at least in the short term.
Increasing Sensitivity to Volatile Technology Income: Cipla’s earnings sensitivity to its
technology fees (for developing and approving products before commercialization from its
generic partners) is quite high (20‐40% in past three years). While this may be indicative of
future technological (HFA inhalers, novel drug delivery based) registrations, it is difficult to
ascribe multiples to such income given limited disclosures on such contracts.
Valuations: Cipla has historically traded at a premium to other front line pharmaceutical
stocks given its low risk business model, supported by high earnings momentum. However,
with a substantial decline expected in its growth profile henceforth and still a couple of
years to go before its investments reflect in growth, we expect this premium to fade and
expect Cipla to trade in line with its front‐line peers. We set a target price of `346 per
share, valuing Cipla at 22x FY12E, in line with other front line peers. At our target price,
Cipla would trade at a P/BV of 3.4x and EV/EBIDTA of 15x FY12E.
Domestic revenues (46% of total revenues) losing steam
Domestic markets, Cipla’s mainstay traditionally, is witnessing strong competition
from MNCs and other regional players. Despite being a market leader in this
segment (Market share of 5.4%), Cipla’s growth has lagged industry growth by
almost 600‐1000 bps, in the past five quarters. While this can be partially attributed
to loss of I‐Pill revenues (sold to Piramal in 4Q10), we note that even excluding ipill,
Cipla’s growth is far behind peers.
The company is losing market share in key therapies like Inhalational drugs, where
it enjoys almost 70%+ market share. Management guidance of 8‐10% growth in
FY11, despite a 12% growth in 1H11, indicates muted quarters ahead. We note that
the company has taken remedial steps (Increase in field force to 5100 ‐ One of the
highest in the industry; Expansion of capacities) and the same may reflect in
incremental growth going forward. However, for the near term, we expect
competitive pressures to limit growth to 12‐13% over the next two years
(compared to 15‐20% for most peers).
Expanding into newer areas to compensate domestic market share loss
With its mainstream domestic business facing stiff competition, Cipla is now
looking at alternate areas for growth. The company plans to invest US$ 65 mn over
the next three years with a Chinese JV partner in two biotech firms ‐ 40% stake in
an Indian biotech firm and 25% in another firm in Hong Kong. It has identified 8‐10
products in categories like oncology, rheumatic arthritis, asthma etc to launch in
India initially, two of which are expected to be launched by end 2011. Products in
China will be marketed by its JV partner, while other markets will be added at a
later phase.
International Markets: Long term drivers in place; may suffer in short
term
Cipla’s exports business is lacking major growth drivers in the near term. While the
company’s low risk, low return partnership based business model has worked well
for them in the past (27% CAGR over FY04‐09), revenues in FY10 were hit by
various factors including non‐availability of important raw materials, lower tender
business in anti‐retroviral (20% of exports) and unfavorable forex movements.
Though a prudent decision, we note that contribution from ARV’s (~20% of total
revenues) is quite high and hence partial participation may hamper overall export
growth. The next growth drivers for exports ‐ Launch of combination inhalers in EU
market and commercialization of Indore SEZ are still 15‐18 months away and hence
we expect exports to grow at a moderate 13% CAGR over FY10‐12E.
Launch of Combination Inhalers ‐ The next growth trigger
The next big growth driver for exports markets is the much‐awaited launch of
combination inhalers in EU and with the recent approvals for Budesonide in
Germany, Portugal and Salbutamol MDI in Denmark, UK and Portugal, the pathway
looks clearer now. The company has developed 8 HFA inhalers for EU, of which 6
have been submitted for registration and is currently conducting trials of multidose
powder inhalers for European market.
The most interesting opportunity will arise when key combination inhalers like
Seretide (expired in the US in September 2010 and in most European markets in
2013) and Symbicort (combination patents revoked in Europe; AstraZeneca’s data
exclusivity ended in August 2010 and US patents expire in 2011), go off patent.
Together these drugs account for more than ~US$ 3.5 bn in Europe. The company
has gradually expanded its inhaler capacities by 35% over FY07‐09 to 96 mn units to
tap this opportunity. This is further set to go up with the commercialization of its
Indore SEZ. Currently, Inhalers contribute around 15‐20% to consolidated revenues
and we expect this contribution to go up to 25% post commercialization of entire
basket (expected in 15‐18 months). Additionally, Cipla is targeting the US Inhalers
market (currently working on 2 inhalers), where the opportunity is much bigger
than the European markets.
Exports volumes set to boost with commercialization of Indore SEZ
We believe commencement of commercial batches in Indore SEZ will significantly
boost up export volumes for Cipla. Currently, the company is awaiting regulatory
clearances from various authorities in regulated markets, which is expected to take
at least 15‐18 months. It has approvals from WHO and MCC‐South Africa, while
approvals from MHRA (UK) and Australia are expected shortly. We expect fullfledged
commercialization to commence in 4Q12 and believe the facilities will
break‐even in 3 years time (total cost of `9 bn).
Aggressive capex intensity fails to reflect in revenue growth
Cipla has spent close to `25 bn (~56% of its operating profits) in expanding
capacities during FY05‐10. While this may be indicative of the Management’s long
term confidence in the base business, the same has failed to reflect in revenue
growth. Asset turnover has declined from 1x in FY05 to 0.8x in FY10.
With another ` 10 bn planned over the next two years (expansion of API facilities in
Bangalore and Patalganga; R&D facilities in Vikhroli and Patalganga + maintenance
capex) and no commensurate revenues from Indore SEZ (capex of ` 9 bn) at least
for next 15‐18 months, we expect A/TO to remain under pressure, at least in the
short term.
Increasing Sensitivity to volatile Technology Income
Cipla’s earnings sensitivity to its technology fees (for developing and approving
products before commercialization from its generic partners) is quite high (20‐40%
in past three years). While this may be indicative of future technological (HFA
inhalers, novel drug delivery based) registrations, it is difficult to ascribe multiples
to such income given limited disclosures on such contracts. Management maintains
that it has enough visibility of 750 mn technology income for FY11 based on
ongoing projects, however given limited visibility; we expect it to remain volatile in
the near term.
Investment Risks
NPPA liability can substantially impact earnings, if materializes
Cipla has challenged National Pharmaceutical Pricing Authority of India (NPPA’s)
notice of ~`12 bn for alleged overcharging in case of certain drugs under Drug Price
Control Order (DPCO). Subsequently, various lower courts have ruled in favour of
Cipla and the case is now pending in Supreme court. Cipla management maintains
the demand as untenable and unsustainable. We present our scenario analysis, in
case the liability materializes.
Talks about possible product agreements with MNCs gaining steam again
Recent agreements between Pfizer ‐ Aurobindo, Astrazeneca ‐ Aurobindo, GSK ‐ Dr
Reddy’s, Pfizer ‐ Strides, Abbott ‐ Cadila and Astrazeneca ‐ Torrent Pharmaceuticals
have fueled speculation about a similar deal for Cipla. Assessment of these deals
suggests that MNCs are either looking for a wide product basket or niche
therapeutic presence before calling the shots. We note Cipla has both ‐ Dominance
in the promising Inhalers segment and a strong product portfolio, both domestic
and internationally (more than 6000 registrations; presence in more than 180
countries) ‐ a compelling factor for any product tie‐up. Further, Cipla has a long
history of operating through partners and hence a product supply agreement
cannot be ruled out. We note that any product supply agreement will positively
impact our estimates.
Prone to adverse currency movement
With almost 54% of revenues coming from exports, Cipla is prone to adverse
currency movements. The company follows the practice of hedging all loans and
covering net export billing on a month‐to‐month basis. Forex Gain/Losses have
substantially impacted the earnings in the past, most notably in FY09, when forex
losses accounted for almost 26% of PBT. Currently, outstanding hedges stand at
US$ 230 mn.
Global consolidation may hamper partnerships: Consolidation in the global
pharmaceutical space may pose a risk to Cipla’s partnership based business model,
as company’s realign their sourcing requirements. We note that Cipla has started
registering products on its own in regulated markets, though the company has
refrained from any front end setups.
Valuations
Cipla has historically traded at a premium to other front line pharmaceutical stocks
given its low risk business model and supported by high earnings momentum.
However, with a substantial decline expected in its growth profile henceforth and
still a couple of years to go before its investments reflect in growth, we expect this
premium to fade and expect Cipla to trade in line with its front‐line peers. Unlike
peers, we do not expect the company’s partnership based business model to throw
up any positive surprises.
We set a target price of `346 per share, valuing Cipla at 22x FY12E, in line with
other front line peers. At our target price, Cipla would trade at a P/BV of 3.4x and
EV/EBIDTA of 15x FY12E.
Our target multiple is in line with the company’s five year average multiple as well
as with other front line stocks. While one may argue for a discount to peers given
lower growth profile, we believe the stock deserves to trade in line with the sector,
if not at a premium, given its domestic leadership position, strong product portfolio
and defensive nature of the stock.
Financials
Strong Earnings momentum to pause
Notwithstanding strong financial performance in the past years, we expect earnings
growth to moderate for Cipla driven by lower domestic as well as export business.
Key growth drivers like launch of inhalers in EU and commercialization of Indore
SEZ are still 18‐20 months away and hence we expect revenues to grow at a muted
13% CAGR over FY10‐12E. At the same time, absorption of fixed costs in Indore SEZ
over the next two years, will also limit margin expansion, and consequently PAT is
estimated to grow at a much lower 8% CAGR.
Deleveraged balance sheet
Cipla’s balance sheet has deleveraged post its QIP resulting in an expanded equity
base in FY10 and a debt free position. Consequently, Gross Debt/Equity has come
down to Nil from 0.2x in FY09. Simultaneously, the company has also managed its
working capital cycle in a narrow range despite delivering high organic growth. We
believe Ongoing/Forthcoming capex programmes are likely to be funded through
internal accruals and do not anticipate additional debt in the near term. We also
built in slight expansion in working capital cycle as the Indore SEZ commences
operations.
Though return ratios may decline in near term……….: Aggressive capex intensity
with unmatched revenue growth has depressed Cipla’s return ratios in the past.
ROE and ROCE has declined by 410 bps and 440 bps over the past six years and we
expect it to dip by another 300 bps and 220 bps over the next two years, as the
company absorbs higher regulatory/fixed costs in Indore SEZ.
No comments:
Post a Comment