Macquarie Research:: Buy Strides Arcolab --Specialist: Sterile injectable play

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Strides Arcolab
Specialist: Sterile injectable play
Event
 We initiate coverage on Strides (STR IN) with an Outperform rating and a
target price of Rs485, implying upside potential of 28%. We like STR for its
strength in sterile injectable manufacturing. STR has increased its injectable
capacity by around 5x and is now poised for growth, in our view.

 Limited FDA-approved capacities, longer timelines to set up facilities, changes
in regulation (auto-handling is now mandatory in the EU) and manufacturing
complexities make injectables a limited competition opportunity. We estimate
the injectable franchise to contribute ~50% and 70% of sales and EBITDA,
respectively, by CY12 (up from 27% and 40% in CY09). This transition into a
sterile injectable play will lead to further multiple re-rating, in our view.
Impact
 Partnering big Pharma: STR has two major licensing deals with Pfizer and
GSK, which we view as a testament to the high quality of its sterile assets. PFE
plans to commercialize 67 off-patent products (to be licensed/supplied by STR),
primarily injectables, in the regulated market. GSK will source products for
emerging markets. Contracts are structured using a pick-or-pay mechanism,
guaranteeing minimum revenues to STR and a share in end profits.
 Niche portfolio: STR has 140 cumulative filings with the US FDA of which
104 are in the sterile injectable space. The addressable local market value
(LMV) of these filed specialty products in the US is US$6.3bn. The LMV of
products filed or under development that have already been licensed to global
partners is currently US$12bn, providing a significant opportunity for growth.
Global injectable market is worth an estimated US$200b (up ~10% YoY).
 Operating leverage: Capacity utilization is ~30%, primarily because newer
facilities are awaiting regulatory approvals. Of the current 428m sterile dose
unit capacity, just 167m is FDA approved. FDA approval for the new-facility
(expected 1H CY11) and ramp-up of products launched under the big pharma
deals should help increase utilization thereby rationalizing fixed costs. A
significant capex cycle (Rs8bn from CY06–09) is now behind STR, and recent
QIP of US$100m has helped to significantly reduce its debt/equity.
Earnings and target price revision
 Initiating coverage.
Price catalyst
 12-month price target: Rs485.00 based on a EV/EBITDA methodology.
 Catalyst: FDA approval for the new manufacturing facility, likely in 1H CY11.
Action and recommendation
 Valuations are attractive, in our view, with STR trading at a PER of 12.6x
CY11E earnings and at an EV/EBITDA of 7.7x CY11E, significant discounts to
its peers.
 Risks to our thesis are a lack of financial discipline, a delay in FDA approval
for facilities and significant goodwill of Rs10bn (vs net worth of Rs14bn).