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Cipla's FY11 AR reinforces our expectation of margin expansion from FY12 aided by Indore SEZ
breaking even, operating leverage benefits and rationalization of international business. Working
capital cycle has marginally stretched. Induction of another family member into the management
team was another key highlight.
While FY11 was muted; expect margin expansion ahead
Cipla witnessed a muted performance during FY11 with operating margin contracting by
300bps and earnings declining by 11% due to: 1) lower technical fees (Rs600m compared to
Rs1.5bn last year), as the development stage of several projects have reached completion; 2)
net negative EBITDA contribution of Rs1.1bn in FY11 from Indore SEZ factory as it was in its
first year of operations (the facility is likely to contribute about 10% of the existing export
formulation revenues); 3) Rupee appreciation vs. the US$ which reduced earnings by ~4%.
In the 4QFY11 analyst call, management had guided to a conservative FY12 revenue growth
of 10-12% and operating margin of 18-20% compared to 18.7% in FY11.
The optimism on margin expansion stems from: (a) Indore SEZ breaking even from 1QFY12
as most regulatory approvals (USFDA still awaited) are now in place; (b) operating leverage
benefits as it benefits from its past capex spend (Rs7.1bn in FY11, Rs5.3bn in FY10); and (c)
rationalization and consolidation of its international business.
Focus on domestic formulations and rationalization of international business
Domestic Market: Cipla continues to remain focused on the domestic formulation business
(46% of FY11 revenues). Cipla is giving a renewed focus to two therapeutic segments -
oncology and neuropsychiatry.
International Markets: Cipla is looking to consolidate and rationalise its international business
and strategies. In this effort, Cipla is looking to forge partnerships and alliances with large
generic companies for product and market development (in the developed markets).
Balance sheet highlights
Working Capital stretches marginally: While Cipla's receivable days improved from 104days in
FY10 to 88 days in FY11, its core working capital stretched from 209 days in FY10 to 236
days on account of reduction in payable days to 105 days from 120days and increment in
inventory days to 253 days from 225days.
Debt increases due to capex but net gearing still negligible: As of March 31, 2011, the debt
outstanding was reported at Rs5.7bn, significantly higher than Rs51m as at the end of FY10.
This increment was seen largely on account of increased capital expenditure of Rs7.1bn. As a
result, the company's net gearing ratio moved from -0.01x at the end of FY10 to 0.07x, which
still remains negligible.
Benefits of high capex spend over the last few years should start showing results going
forward: Capex spends in FY11 was Rs7.1bn as compared to Rs5.3bn in FY10. In April 2010,
the Company commenced commercial production of pharmaceutical formulations at the
Special Economic Zone (SEZ) project, at Indore, Madhya Pradesh. The total investment for
this project is about Rs9bn. The Company is setting up API facilities at Bengaluru and
Kurkumbh. It is also upgrading the API facilities at Patalganga. The total investment for these
projects is about Rs4bn.
Management team sees addition of one more family member
Cipla has appointed Mrs. Samina Vaziralli as a member of the management team with effect
from 1st July 2011, subject to approval of shareholders. She is the daughter of Mr. M.K.
Hamied, Joint Managing Director and niece of Dr. Y.K. Hamied, Chairman and Managing
Director of the Company.
We note that in August last year, Mr Kamil Hamied, son of Mr MK Hamied, joint managing
director, and the nephew of Dr YK Hamied, the company's chairman and managing director
was also inducted into the management team of Cipla.
Other highlights
R&D: In FY11, the company spent Rs2.8bn on R&D expense which was around 5% of its
turnover.
Exports: The company reported export sales of Rs33.6bn for FY11. Africa remained its
largest contributor with its contribution jumping to 42% of sales from earlier 34%. This
increase in contribution came in at the expense of lower contribution from America (23% vs.
26% earlier), Europe (14% vs. 17% earlier) and Australasia (12% vs. 14% earlier)
Investments: Investments have increased from Rs2.5bn in FY10 to Rs5.9bn in FY11 largely
due to a Rs3.5bn long term investment in an associate company 'Desano Holdings Limited'
which we believe reflects its investments in the two biotechnology companies it made last
year.
Dividend: In addition to the special interim dividend of Rs0.8 per equity share announced on
the occasion of Cipla's 75th anniversary, the Directors have proposed a final dividend of
Rs2/sh.
Key contingent liability: Cipla has some pending legal cases on account of alleged
overcharging in respect of certain drugs under the Drug Price Control Order. The aggregate
amount of the demand notices received is about Rs12.3bn (inclusive of interest). The
Company has been legally advised that based on the directions given by the Supreme Court,
there is no probability of the demand becoming payable by the Company. Any unfavourable
outcome in these proceedings could have an adverse impact on the Company.
We retain our Buy rating on Cipla with a TP of Rs371
Our TP of Rs371 is derived by valuing Cipla at a 15% premium to peers (i.e, 24.6x FY12F PE).
We believe the premium is justified given: 1) the company's strong domestic market presence; 2)
potential upside from MNC supply deals; 3) the lack of US FDA overhang; and 4) the potential for
M&A.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Cipla's FY11 AR reinforces our expectation of margin expansion from FY12 aided by Indore SEZ
breaking even, operating leverage benefits and rationalization of international business. Working
capital cycle has marginally stretched. Induction of another family member into the management
team was another key highlight.
While FY11 was muted; expect margin expansion ahead
Cipla witnessed a muted performance during FY11 with operating margin contracting by
300bps and earnings declining by 11% due to: 1) lower technical fees (Rs600m compared to
Rs1.5bn last year), as the development stage of several projects have reached completion; 2)
net negative EBITDA contribution of Rs1.1bn in FY11 from Indore SEZ factory as it was in its
first year of operations (the facility is likely to contribute about 10% of the existing export
formulation revenues); 3) Rupee appreciation vs. the US$ which reduced earnings by ~4%.
In the 4QFY11 analyst call, management had guided to a conservative FY12 revenue growth
of 10-12% and operating margin of 18-20% compared to 18.7% in FY11.
The optimism on margin expansion stems from: (a) Indore SEZ breaking even from 1QFY12
as most regulatory approvals (USFDA still awaited) are now in place; (b) operating leverage
benefits as it benefits from its past capex spend (Rs7.1bn in FY11, Rs5.3bn in FY10); and (c)
rationalization and consolidation of its international business.
Focus on domestic formulations and rationalization of international business
Domestic Market: Cipla continues to remain focused on the domestic formulation business
(46% of FY11 revenues). Cipla is giving a renewed focus to two therapeutic segments -
oncology and neuropsychiatry.
International Markets: Cipla is looking to consolidate and rationalise its international business
and strategies. In this effort, Cipla is looking to forge partnerships and alliances with large
generic companies for product and market development (in the developed markets).
Balance sheet highlights
Working Capital stretches marginally: While Cipla's receivable days improved from 104days in
FY10 to 88 days in FY11, its core working capital stretched from 209 days in FY10 to 236
days on account of reduction in payable days to 105 days from 120days and increment in
inventory days to 253 days from 225days.
Debt increases due to capex but net gearing still negligible: As of March 31, 2011, the debt
outstanding was reported at Rs5.7bn, significantly higher than Rs51m as at the end of FY10.
This increment was seen largely on account of increased capital expenditure of Rs7.1bn. As a
result, the company's net gearing ratio moved from -0.01x at the end of FY10 to 0.07x, which
still remains negligible.
Benefits of high capex spend over the last few years should start showing results going
forward: Capex spends in FY11 was Rs7.1bn as compared to Rs5.3bn in FY10. In April 2010,
the Company commenced commercial production of pharmaceutical formulations at the
Special Economic Zone (SEZ) project, at Indore, Madhya Pradesh. The total investment for
this project is about Rs9bn. The Company is setting up API facilities at Bengaluru and
Kurkumbh. It is also upgrading the API facilities at Patalganga. The total investment for these
projects is about Rs4bn.
Management team sees addition of one more family member
Cipla has appointed Mrs. Samina Vaziralli as a member of the management team with effect
from 1st July 2011, subject to approval of shareholders. She is the daughter of Mr. M.K.
Hamied, Joint Managing Director and niece of Dr. Y.K. Hamied, Chairman and Managing
Director of the Company.
We note that in August last year, Mr Kamil Hamied, son of Mr MK Hamied, joint managing
director, and the nephew of Dr YK Hamied, the company's chairman and managing director
was also inducted into the management team of Cipla.
Other highlights
R&D: In FY11, the company spent Rs2.8bn on R&D expense which was around 5% of its
turnover.
Exports: The company reported export sales of Rs33.6bn for FY11. Africa remained its
largest contributor with its contribution jumping to 42% of sales from earlier 34%. This
increase in contribution came in at the expense of lower contribution from America (23% vs.
26% earlier), Europe (14% vs. 17% earlier) and Australasia (12% vs. 14% earlier)
Investments: Investments have increased from Rs2.5bn in FY10 to Rs5.9bn in FY11 largely
due to a Rs3.5bn long term investment in an associate company 'Desano Holdings Limited'
which we believe reflects its investments in the two biotechnology companies it made last
year.
Dividend: In addition to the special interim dividend of Rs0.8 per equity share announced on
the occasion of Cipla's 75th anniversary, the Directors have proposed a final dividend of
Rs2/sh.
Key contingent liability: Cipla has some pending legal cases on account of alleged
overcharging in respect of certain drugs under the Drug Price Control Order. The aggregate
amount of the demand notices received is about Rs12.3bn (inclusive of interest). The
Company has been legally advised that based on the directions given by the Supreme Court,
there is no probability of the demand becoming payable by the Company. Any unfavourable
outcome in these proceedings could have an adverse impact on the Company.
We retain our Buy rating on Cipla with a TP of Rs371
Our TP of Rs371 is derived by valuing Cipla at a 15% premium to peers (i.e, 24.6x FY12F PE).
We believe the premium is justified given: 1) the company's strong domestic market presence; 2)
potential upside from MNC supply deals; 3) the lack of US FDA overhang; and 4) the potential for
M&A.
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