Buy Indoco Remedies – 3QFY2011 Result Update- Angel Broking

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Indoco Remedies – 3QFY2011 Result Update

Angel Broking recommends Buy on Indoco Remedies with a Target Price of Rs. 541.

Indoco Remedies (Indoco) reported its 3QFY2011 results, which were below our

expectations on the back of lower-than-expected domestic formulation sales,

which grew only by 11.1% during the quarter. For FY2011, the company has

guided 20% growth on the domestic formulation front and 30–35% growth on the

export front, translating to a top-line target of `500cr and OPM in the range of

14.7% (inclusive of R&D expenses).

Domestic segment disappoints: Indoco reported net sales of `114.3cr (`95.7cr),

up 19.4% yoy, but was below our expectation of `121.7cr for 3QFY2011, mainly

on the back of lower-than-expected sales on the domestic high-margin

formulation segment. This led a decline in gross margins to 55.4% (56.6%), with

OPM falling to 11.6% (12.9%). Indoco reported net profit of `8.8cr (`7.7cr) an

increase of 14.1%, which was lower than our expectation.

Outlook and valuation: We expect net sales to post a 21.7% CAGR to `590cr and

EPS to post a 25.7% CAGR to `54.1 over FY2010–12E. At ` 460, the stock is

trading at 11.4x and 8.5x FY2011E and FY2012E earnings, respectively.

We recommend a Buy rating on Indoco with a Target Price of `541.

Revenue below expectation, domestic segment disappoints: Indoco reported net

sales of `114.3cr (`95.7cr), up 19.4% yoy but below our expectation, on the back

of lower-than-expected sales on the domestic formulation front. Domestic sales

grew by mere 11.1% yoy to `74cr (`66.6cr) for the quarter. However, exports

posted higher-than-expected growth of 35.0% during the period, led by strong

growth in the regulated and semi-regulated markets, which grew by 28.3%

and 69.3%, respectively.

During the quarter, with respect to developments on the business front, Indoco

launched a new product called Snow dent dental cream through the domestic

division–Warren. In the regulated markets, Indoco signed a deal in the derma

space with US-based Zumanta, wherein product development would take 12–

14 months. Also, during the quarter, Indoco signed new product development

deals with Aspen Pharma, extending its reach to Europe and Australia, which

would start contributing (though marginally) from 4QFY2011, while major

revenue will be coming from FY2012 through the basket of 5–6 products.

In the emerging market division, Indoco achieved eight new product

registrations during the quarter, which are expected to be commercialised in

4QFY2011.

On the regulatory front, the company filed two ANDAs with the USFDA in this

quarter. With regards to Watson, from the total of five ANDAs, one has been

filed and would be commercialised in the next 18 months.

Disappointing on the operating front: Indoco reported a drop in its gross margins

to 55.4% (56.6%) due to lower contribution from the high-margin domestic

formulation segment. The domestic formulation segment contributed 64.7% of

sales in 3QFY2011vis-à-vis 69.6% of sales in 3QFY2010. Consequently, OPM

for the quarter came in at 11.6% (12.9%), down 130bp.

Net profit lower than expectation: Indoco reported net profit of `8.8cr (`7.7cr),

an increase of 14.1% yoy, which was lower than our expectation due to lower

OPM and higher tax charges. Indoco has stopped availing full MAT credit, as

the company would be utilising it in future as 1) contribution from non-tax free

zone Goa and Waluj plant would start increasing and 2) the Baddi plant

would come out of 100% tax exemption in FY2011 and will be under 30%

exemption. The tax guidance ranges from 13–14% for FY2011 and 20% for

FY2012.

Concall takeaways

􀂄 For FY2011, Indoco expects the domestic formulation segment to grow by

around 20%, while exports would register 30–35% yoy growth. The company

has given the top-line target of ~`500cr, with OPM of around 14.7%

(inclusive of R&D expenses). However, we are maintaining our assumptions of

18.8% growth in the top line, with OPM of 15.4% for FY2011E.

􀂄 Management has indicated a possible USFDA inspection at the Goa

ophthalmic plant-II by February 2011, which was last inspected in October

2005.

􀂄 During the quarter, the Baddi manufacturing plant cleared the regulatory audit

of UKMHRA successfully, which was done for the second time.

􀂄 The expansion at the tablet manufacturing plant at Goa plant-III is nearing

completion and expected to be commercialised by April 2011, increasing the

capacity by 40% to 10bn tablets per year by July 2011.

􀂄 Overall DSO has reduced to 74 days as on December 31, 2010, from 82 as

on March 31, 2010.

Investment arguments

Domestic formulations back on the growth trajectory: Indoco has a strong

brand portfolio of 120 products and a base of 1,500MRs. The company

operates in various therapeutic segments including anti-infective, anti-diabetic,

CVS, ophthalmic, dental care, pain management and respiratory. Prominent

Indoco brands include Cyclopam, Vepan, Febrex Plus, ATM, Sensodent-K and

Sensoform. The company’s Top-10 brands contribute 60% to domestic sales.

Post the restructuring of the domestic business in FY2009, which has resulted

in improvement in working capital cycle, Indoco is back on the growth

trajectory with its domestic formulation business outpacing the industry growth

rate in the last two quarters. The company has seen strong growth across the

respiratory, anti-infective, ophthalmic and alimentary therapeutic segments.

Further, the company plans to increase its sales force by 200MRs in FY2011

to increase its penetration in tier-II/rural markets.

Scaling-up on the export front: Indoco has also started focusing on regulated

markets by entering into long-term supply contracts. The company is currently

executing several contract manufacturing projects, covering a number of

products for its clients in the UK, Germany and Slovenia. Through its partner,

Indoco has also started supplying Metformin under a two-year contract for the

AOK tender in Germany. The company plans to incur capex of `95cr (34% of

FY2010 GFA) for building formulation facilities in Goa and Waluj funded

through debt and internal accruals to cater to increased export demand.

Watson and Aspen Pharma contract a long-term growth driver: Indoco has

entered into a supply agreement for ophthalmic products with Watson (US

market) and Aspen Pharma (emerging markets). We expect milestone

payments from the contracts to commence from FY2011 on successful

regulatory filings and substantial revenue flow from the deal to commence

from FY2013. Our back-of-the-envelope calculations show that both deals

have the potential to contribute a combined amount of US $38mn (38% of

FY2011 top line) to the top line on full commercialisation of the contracts.

During 3QFY2011, Indoco signed new product development deals with Aspen

Pharma, extending its reach to Europe and Australia, which would start

contributing (though marginally) from 4QFY2011, while major revenue will be

coming from FY2012 through the basket of 5–6 products.

Valuations: For FY2011, Indoco has guided 20% growth on the domestic

formulation front and 30–35% growth on the export front, which translates to a

top-line target of `500cr and OPM in the range of 14.7% (inclusive of R&D

expenses). We expect net sales to post a 21.7% CAGR to `590cr and EPS to post a

25.7% CAGR to `54.1 over FY2010–12E. At `460, the stock is trading at 11.4x

and 8.5x FY2011E and FY2012E earnings, respectively. We recommend Buy on

the stock with a Target Price of `541.