Cipla- Closer to the bottom! ::Macquarie Research,

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Cipla
Closer to the bottom!
Event
 Cipla reported 1Q FY12 total revenue of Rs15.9bn (up 7.5% YoY), and PAT of
Rs2.5bn below our and consensus estimates. EBITDA margin increased
~500bps QoQ to 23% on account of better product mix (lower proportion of low
margin ARV tender sales in exports) and higher utilization of Indore SEZ.
 Cipla has now corrected ~17% YTD and significantly underperformed its
peers (BSE healthcare index down 6% YTD). While we see limited downside
from these levels we await early signs of acceleration in domestic sales and
sustainability of margins before turning positive. Upgrade to Neutral rating
from Underperform with a revised target price of Rs300 (earlier Rs290).
Impact
 Domestic formulation – muted 1QFY12 but increasing focus: 1QFY12
domestic sales grew by 10% YoY which is below the industry average. Given
the strong sales push (Cipla added 500 sales reps in FY11 and plans to
expand further from 6,000 reps to 7,000 reps) and focus on additional
therapies (like Oncology & Psychiatry), we have built in 14% YoY growth for
domestic formulations in FY12E. Key data point to watch for in coming quarters.
 High API sales drive the export: 1QFY12 exports sales grew 8.4% YoY
driven by API (up 22% YoY) and formulation (up 5.3% YoY) sales. We believe
lower composition of ARV tender sales in exports (~20% of exports in 1QFY12
vs. ~ 30% in 4QFY11) and high margin API supply to the US drove the gross
margins improvement.
 Sustainability of margin key: Cipla management alluded to the sustainability
of margin due to a conscious effort on improving the product mix. A further
ramp-up of sales from Indore SEZ (Cipla guides ~ 10% of FY12 sales, has
potential to become ~ 25% of sales at peak) should help optimize utilization and
ease margin pressure somewhat. Cipla did not provide any clarity on whether
Olanzapine API supply provided any one-off upside this quarter; given as a
policy they do not disclose any product-specific data.
 Maintaining guidance for FY12: Management guided for top-line growth of 10-
12% for FY12 and operating margin of 18-20%. Inhalers for the US and EU are
keenly watched opportunities; however, given the regulatory complexities
involved for approval, we believe any meaningful upside is still 12–18m away.
Earnings and target price revision
 Introducing FY14 estimates. We slightly adjust our earnings estimate for
FY12/13 to Rs15.5/18.5 from Rs15/19. TP revised to Rs300 (earlier Rs290).
Price catalyst
 12-month price target: Rs300.00 based on a PER methodology.
 Catalyst: 1) High growth in domestic sales 2) Sustained margin
Action and recommendation
 Post the correction Cipla now trades at ~20x FY12E earnings, closer to our TP.
As we see limited downside from here, we upgrade stock to a Neutral rating.