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Pharma sector bounces back strongly
The BSE healthcare (HC) index outperformed the BSE Sensex
during 1QFY2012, after having underperformed in 4QFY2011.
The HC index rose by 6.2% as against the drop in Sensex in the
same period. The performance of the pharmaceutical sector
was impacted by lacklustre performance of the broader
indices, which reeled under the slowdown in economic growth
and hardening of interest rates. In such a scenario,
the pharmaceutical sector, which is never affected by the
economic slowdown, emerged as a resilient sector and
outperformed the broader indices.
The upward rally during the quarter was mainly driven by large
caps. Ranbaxy rose by 22%, led by positive news flow on Lipitor.
With regards to other major players, Cadila, Sun Pharma and
Lupin were the big gainers, rising by 16%, 12% and 8%,
respectively. In mid caps, Ipca was up by 13%. In the MNC
pack, Glaxo was up by 12%. Amongst losers, Dr. Reddy's
Laboratories (DRL) and Aurobindo Pharma (APL) dropped by
6% and 12%, respectively, which declined because of USFDA‘s
import alert. Despite good quarterly numbers in 4QFY2011,
Dishman was hammered, down 12%. Among small caps,
Indoco Remedies lost 4% during 1QFY2012.
Key developments
Indian companies remain on USFDA's warning list
After Ranbaxy, Lupin and Sun Pharma, DRL and APL have now
received the USFDA's warning letters.
DRL's Mexican arm has received a warning letter from the US
health regulator for violation of the current good manufacturing
practice regulations. The company's Mexico facility produces
intermediates and active pharmaceutical ingredients.
The USFDA had inspected DRL's Mexico facility in November
2010 and later sought certain explanations from the company.
However, the regulator issued the warning letter dated June 3,
2011, citing 'lack of corrective actions' by the firm. With 4%
contribution to the consolidated sales of FY2011 and ANDA
filed with reference to DMF from the plant, we believe the
warning letter would have a minor impact on the company's
financial performance. We maintain our Buy recommendation
on DRL with a target price of `1,920.
APL has indicated that it has received the warning letter from
the USFDA, detailing its observations for its Unit VI, for which
the company has already received the warning letter. Also, based
on a field alert report for packaging and labeling compliance
for Unit III, the USFDA has asked APL to submit a detailed action
plan for improvement in this letter, which is required to be
submitted within 15 working days, and has given the opportunity
to APL for a regulatory meeting. Unit III contributes approximately
US$140mn to APL's total sales. We believe, even in the
worst-case scenario, the stock would be fairly valued at these
levels. APL is requesting the USFDA for the meeting date and is
in the process of submitting a detailed action plan. Although
this is a move towards the much-awaited clarity needed on the
USFDA's ban, there is still nothing concrete that can be inferred
from the same. In terms of the developments for Unit III,
we believe there are packaging compliance issues, which have
a high probability of getting resolved. Hence, we currently
maintain our estimates and recommend Buy on APL with a
target price of `278.
Developments in the Lipitor case positive for Ranbaxy
In a recent update on Ranbaxy's Lipitor case, the FDA responded
to Mylan's suit, asking the court to deny Mylan's request for a
preliminary injunction and stating that no immediate decision
will be made on Ranbaxy's ANDA for Lipitor. It stated that no
drug manufacturer can state USFDA's priorities and that the
administration has not made any unreasonable delay in taking
the decision. It further emphasised that there is no generic
company that has received any approval so far and there is no
certainty of an approval until the technical or scientific issues
are resolved. The FDA and Ranbaxy are engaged in discussions
to resolve the issues, and the clarity on the positioning of the
ANDA is unlikely to come soon.
Moreover, the US court has dismissed Mylan's petition
challenging Ranbaxy's exclusive marketing rights over the
generic version of Pfizer's Lipitor. Mylan had sued the USFDA
for providing the exclusive right to Ranbaxy, alleging that the
permission was given on the basis of 'falsified data'. In response
to Mylan's plea, the FDA said that the company's complaint
was premature and the agency's enforcement discretion was
not reviewable by a court. It also indicated that drug makers
cannot sue over pending applications filed by their competitors.
The news is positive for Ranbaxy, and since the company is
awaiting clarity on the ongoing litigation, we retain our numbers.
The stock is currently trading at 18.7x and 12.0x its CY2011E
and CY2012E earnings, respectively. We recommend
Accumulate with a target price of `588.
Sun and MSD enter strategic partnership to co-market
MSD's diabetes drugs
During the quarter, Sun Pharma and MSD in India announced
the formation of a strategic partnership agreement for the Indian
market. Under the agreement, Sun Pharma would have the
right to market, promote and distribute MSD's diabetes products,
sitagliptin and sitagliptin plus metformin, under different brand
names in India. MSD would provide the scientific excellence
and market success of the product to the partnership, while
Sun Pharma would bring in its proven success and expertise in
the marketing of drugs in the relevant therapeutic areas across
India. The stock is currently trading at 27.7x and 21.1x its
FY2012E and FY2013E earnings, respectively. After the recent
run-up we are Neutral on the stock.
APL redeems FCCBs
In May 2006, APL had issued FCCBs in two tranches:
Tranche-A of US$150mn and Tranche-B of US$50mn.
After the repurchase and cancellation of FCCBs from time to
time, the outstanding nominal value of FCCBs has been paid
in full at the respective redemption prices of the principal amount
on the maturity date i.e., May 17, 2011, as per the terms and
conditions of the offering circular dated May 12, 2006. The
company has paid an aggregate amount of US$203.86mn for
both the aforesaid tranches. For the repayment, US$70mn was
through internal accruals and the remaining was through debt.
Pursuant to this, there are no outstanding bonds as on date.
We maintain our Buy rating on the stock with a target price of
`278.
ANDA approvals in 1QFY2012
During the quarter, DRL and APL received five approvals each.
Amongst others, Sun Pharma received higher ANDA approvals,
with four approvals in place. Among the other companies in
our coverage, Cipla, Cadila and Ranbaxy received two, two
and one approval, respectively.
1QFY2012 result expectations
The Indian pharmaceutical sector is expected to report muted
numbers for 1QFY2012. We expect our coverage universe
(excluding Orchid, where the corresponding consolidated
numbers are unavailable) to register 19% yoy top-line growth.
However, on the operating front, margins are expected to decline
by 110bp, which along with increased tax outgo would lead to
flat growth in net profit.
Amongst large caps, Sun Pharma is expected to post 35.3%
yoy sales growth mainly on the back of integration of Taro.
Cipla is expected to post net sales growth of 15.5% yoy.
DRL, Lupin and Cadila are expected to report 10.0%, 17.0%
and 20.5% yoy growth in net sales, respectively. Amongst small
caps, Indoco Remedies is expected to post 21.1% yoy growth.
In the MNC pack, Aventis is likely to post 25.1% yoy growth in
net profit, led by 10.3% yoy sales growth
Among large caps, DRL and Cadila to outperform
Among the large caps in our coverage universe, for 1QFY2012,
Sun Pharma is likely to report 35.3% yoy growth in sales mainly
on the back of integration of Taro, which will drive export
formulation sales during the period. On the domestic front,
Indian formulation sales are expected to report a muted
performance. Despite strong top-line growth on account of the
integration, the company's operating profit margin would decline
by 13.4% yoy, with margin likely to be around 30.7%. Net profit
is expected to drop by 23.6% yoy for the quarter.
Lupin, on the other hand, is expected to register sales growth
of 17.0% yoy. The company's OPM is expected to contract
by 188bp during the period. Net profit is expected to increase
by 3.8% yoy.
DRL is expected to post strong results with top-line growth of
10.0% to `1,851cr, majorly driven by the US market.
The company is expected to witness strong traction in its Indian
and Russian formulation businesses as well. In the PSAI segment,
lacklustre performance is expected for 1QFY2012. The company
is expected to post OPM of 15.2%, up 71bp yoy. On the net
profit front, we expect the company to post net profit of `245cr,
registering growth of 16.9% yoy.
Cipla is expected to post net sales growth of 15.5% yoy to
`1,649cr, driven by domestic as well as exports performance.
OPM (excluding technical know-how fees) is expected to come
in flat at 20.8% due to lower other expenses. Further, net profit
is expected to increase by 9.3% yoy to `281.5cr.
Ranbaxy's net sales are expected to remain flat at `2,143cr
during 2QCY2011. The company's gross profit margin is
expected to remain flat, leading to margin of 17.4%.
Cadila is expected to post yet another strong quarter with 20.5%
yoy growth in net sales to `1,280cr on the back of robust growth
on the domestic formulation and exports fronts. The company's
OPM is expected to expand by 128bp yoy to 20.7% due to a
favourable product mix. Net profit of the company is expected
to increase by 35.6% yoy to `179.0cr, driven by top-line growth
and OPM expansion.
Among mid caps, Ipca Labs to take the lead
We estimate Ipca Labs' top line to grow by 17.2% to `603cr for
1QFY2012. OPM is expected to decline by 137bp yoy to 20.8%,
led by higher other expenses. Overall, adjusted net profit is
expected to increase by 27.1% yoy.
APL is expected to post net sales growth of 9.5% yoy, led by
formulation exports. With improved gross margin for the period,
strong growth of 253bp is expected in the company's OPM at
17.6% for the quarter. Overall, net profit is expected to rise by
26.2% yoy on the back of improvement in operating profit.
Indoco Remedies is expected to report top-line growth of 21.1%
yoy to `135cr. OPM is expected to expand by 60bp yoy to 16.4%,
driven by growth in domestic formulation sales. Net profit is
expected to increase by 8.8% yoy to `16.1cr because of higher
depreciation cost and tax outgo.
Outlook and valuation
With the expected earnings CAGR of 21% over FY2011-13E
for our coverage universe, we remain overweight on the sector
and maintain our positive outlook. In the generic segment,
we prefer Cipla, Lupin, Cadila Healthcare, APL and Indoco
Remedies. In CRAMS, though the segment is currently witnessing
some pressure, there have been indications of gradual recovery
and ramp-up from most CRAMS players. Thus, with valuations
rendering attractive, we recommend Dishman Pharma in this
segment.
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