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India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Execution is the key
CHANGE
P/E compression due to underutilised capacity, India investments
Cipla’s large capacity build-up (INR25b in four years) and investments in
the domestic market have put pressure on margins and, along with lack
of clarity on leadership, has led to P/E compression and stock
underperformance. We do not see a case for re-rating unless capacity
utilisation ramps up fast and leadership issues are addressed adequately.
CATALYST
Indore SEZ holds the key as India business undergoes transition
Sharp ramp-up at Indore SEZ (capex of INR8b-9b) is critical for margin
expansion as the domestic business digests large field force additions,
entry into new therapies. Margin expansion will have to be driven by core
operations as technical know-how fees decline. Capex for formulations is
largely completed but is set to continue for API.
VALUATION
Trading at the lower end of its historical P/E band
We value Cipla at 17x one-year forward earnings to arrive at a target
price of INR285. Key upside risks to our HOLD call are a sharp pickup in
domestic formulations, higher-than-estimated other operating income,
large partnership announcement/stake sale by promoters and earlierthan-
estimated launches of inhalers in the regulated markets.
COMMENT
Key highlights of the report
§ Capacity addition over the last four years
§ Field force expansion over the last three years
§ Indore SEZ performance so far
§ Trend in domestic formulation sales over four years
§ What Teva is saying on inhaler launches in regulated markets
§ Trend in other operating income, EBITDA margins and core margins
Key risks
Sharp pickup in domestic formulation sales
We expect Cipla’s domestic market performance to remain muted in the near term as the company
undergoes a shift in business model towards a higher chronic mix. We expect near-term growth to remain
muted (single digits) but expect a pickup in FY13 as recently added field force start delivering. Overall we
estimate revenue CAGR of 11.7% over FY11-14 for the company which is an in line industry growth. A sharp
pickup in domestic formulation sales could have a material impact on our estimates.
Higher-than-estimated other operating income to have a positive impact on operating margins
We have assumed a declining other operating income (technical knowhow/licensing income and export
benefits) over FY11-14. Our FY14 other operating income estimate is INR1.35b, compared with INR1.9b in
FY11 as the technical knowhow is converted into revenue. Higher-than-estimated other operating income
would have a significant positive impact on operating margins as this income flows straight to the bottom
line.
Major partnership announcement with a MNC, stake sale by promoters
Cipla has been in active discussions with large MNC pharma companies for a long-term partnership deal.
Conclusion of a major licensing and supply agreement with an innovator/generic company, especially from
Indore SEZ, is likely to provide an upward risk to our stock call. Further talk of a buy-out in the company
has been doing the rounds for some time now and a stake sale by promoters could provide a positive
upside.
Earlier than expected inhaler launches in the regulated markets
We see launches of inhalers in the regulated markets as a long-term opportunity but expect nothing
material in the near term. We believe key launches in US/EU will only come through beyond 2013/14.
Earlier-than-expected inhaler launches may provide positive upside to our estimates.
Negative verdict in the overcharging case with NPPA could potentially wipe out FY13 profits
Cipla is involved in a legal battle with the National Pharmaceutical Pricing Authority (NPPA) over alleged
overcharging of some drugs, including salbutamol, theophylline, ciprofloxacin, cloxacillin, norfloxacin,
cefadroxil, trimethoprim and sulphamethoxazole formulations. The claim raised by the NPPA stands at
INR12.3b (including the interest cost) which is roughly equivalent to our estimate for Cipla’s entire FY13 net
profit.
Inability to ramp up operations at Indore SEZ
As discussed earlier in the report, there is a lot of emphasis on Indore SEZ to boost sales as domestic
formulation sales growth is unlikely to pick up in the near term. Indore SEZ has all the key regulatory
approvals in place (except US FDA – not applied so far for an inspection). Inability of Indore SEZ to ramp up
operations may have a significant impact on our estimates.
Valuations
Large investments in capacity, field force over last few years has put pressure on return ratios/margins …
Over the last four years, Cipla embarked on a large capex plan, adding INR24.4b to its FY07 gross block of
INR18b. A large part of this spend (INR8b-9b) was on putting up one of the largest formulation capacities in
India - Indore SEZ – which was commercialised in early FY11. Apart from this, Cipla has increased its field
force strength by over 2,500 medical representatives (MRs) with a major increase in field force coming in
the last 12-15 months. These two initiatives, coupled with lower technical/licensing income and an
appreciating INR have put pressure on Cipla’s operating margins and earnings growth over FY09-11.
… with critical intangible – lack of clarity on leadership – led to P/E compression/stock underperformance
Cipla’s 12-month forward P/E has seen material compression on account of a weak margin trend, muted
growth in the domestic market (despite the addition of a large field force) and the growing significance of
the overcharging case with the NPPA (National Pharmaceuticals Pricing Authority; a sub-judice case, with a
potential liability of INR13b, equivalent to our estimate for Cipla’s FY13 profits). We believe, along with
these tangible factors, a lack of clarity on leadership/succession has been one of the reasons for
underperformance and P/E compression.
Trading at lower end of historic P/E band, but we await clarity on leadership/direction of business model
We acknowledge a prolonged underperformance has led to a P/E compression for Cipla and it is now
trading at 17.5x 12-month forward earnings, which is the lower end of the 17-22x trading range for the
company over the last five years. While valuations are at a steep discount to peers, we do not see a case for
a re-rating until issues on leadership (successor grooming/appointment of a professional) as well as
direction of the business model (setting up a front-end, transition into chronic areas in the domestic
market, etc.) are addressed. We initiate coverage on Cipla with a HOLD and a 12-month target price of
INR285, potential downside of 2%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Execution is the key
CHANGE
P/E compression due to underutilised capacity, India investments
Cipla’s large capacity build-up (INR25b in four years) and investments in
the domestic market have put pressure on margins and, along with lack
of clarity on leadership, has led to P/E compression and stock
underperformance. We do not see a case for re-rating unless capacity
utilisation ramps up fast and leadership issues are addressed adequately.
CATALYST
Indore SEZ holds the key as India business undergoes transition
Sharp ramp-up at Indore SEZ (capex of INR8b-9b) is critical for margin
expansion as the domestic business digests large field force additions,
entry into new therapies. Margin expansion will have to be driven by core
operations as technical know-how fees decline. Capex for formulations is
largely completed but is set to continue for API.
VALUATION
Trading at the lower end of its historical P/E band
We value Cipla at 17x one-year forward earnings to arrive at a target
price of INR285. Key upside risks to our HOLD call are a sharp pickup in
domestic formulations, higher-than-estimated other operating income,
large partnership announcement/stake sale by promoters and earlierthan-
estimated launches of inhalers in the regulated markets.
COMMENT
Key highlights of the report
§ Capacity addition over the last four years
§ Field force expansion over the last three years
§ Indore SEZ performance so far
§ Trend in domestic formulation sales over four years
§ What Teva is saying on inhaler launches in regulated markets
§ Trend in other operating income, EBITDA margins and core margins
Key risks
Sharp pickup in domestic formulation sales
We expect Cipla’s domestic market performance to remain muted in the near term as the company
undergoes a shift in business model towards a higher chronic mix. We expect near-term growth to remain
muted (single digits) but expect a pickup in FY13 as recently added field force start delivering. Overall we
estimate revenue CAGR of 11.7% over FY11-14 for the company which is an in line industry growth. A sharp
pickup in domestic formulation sales could have a material impact on our estimates.
Higher-than-estimated other operating income to have a positive impact on operating margins
We have assumed a declining other operating income (technical knowhow/licensing income and export
benefits) over FY11-14. Our FY14 other operating income estimate is INR1.35b, compared with INR1.9b in
FY11 as the technical knowhow is converted into revenue. Higher-than-estimated other operating income
would have a significant positive impact on operating margins as this income flows straight to the bottom
line.
Major partnership announcement with a MNC, stake sale by promoters
Cipla has been in active discussions with large MNC pharma companies for a long-term partnership deal.
Conclusion of a major licensing and supply agreement with an innovator/generic company, especially from
Indore SEZ, is likely to provide an upward risk to our stock call. Further talk of a buy-out in the company
has been doing the rounds for some time now and a stake sale by promoters could provide a positive
upside.
Earlier than expected inhaler launches in the regulated markets
We see launches of inhalers in the regulated markets as a long-term opportunity but expect nothing
material in the near term. We believe key launches in US/EU will only come through beyond 2013/14.
Earlier-than-expected inhaler launches may provide positive upside to our estimates.
Negative verdict in the overcharging case with NPPA could potentially wipe out FY13 profits
Cipla is involved in a legal battle with the National Pharmaceutical Pricing Authority (NPPA) over alleged
overcharging of some drugs, including salbutamol, theophylline, ciprofloxacin, cloxacillin, norfloxacin,
cefadroxil, trimethoprim and sulphamethoxazole formulations. The claim raised by the NPPA stands at
INR12.3b (including the interest cost) which is roughly equivalent to our estimate for Cipla’s entire FY13 net
profit.
Inability to ramp up operations at Indore SEZ
As discussed earlier in the report, there is a lot of emphasis on Indore SEZ to boost sales as domestic
formulation sales growth is unlikely to pick up in the near term. Indore SEZ has all the key regulatory
approvals in place (except US FDA – not applied so far for an inspection). Inability of Indore SEZ to ramp up
operations may have a significant impact on our estimates.
Valuations
Large investments in capacity, field force over last few years has put pressure on return ratios/margins …
Over the last four years, Cipla embarked on a large capex plan, adding INR24.4b to its FY07 gross block of
INR18b. A large part of this spend (INR8b-9b) was on putting up one of the largest formulation capacities in
India - Indore SEZ – which was commercialised in early FY11. Apart from this, Cipla has increased its field
force strength by over 2,500 medical representatives (MRs) with a major increase in field force coming in
the last 12-15 months. These two initiatives, coupled with lower technical/licensing income and an
appreciating INR have put pressure on Cipla’s operating margins and earnings growth over FY09-11.
… with critical intangible – lack of clarity on leadership – led to P/E compression/stock underperformance
Cipla’s 12-month forward P/E has seen material compression on account of a weak margin trend, muted
growth in the domestic market (despite the addition of a large field force) and the growing significance of
the overcharging case with the NPPA (National Pharmaceuticals Pricing Authority; a sub-judice case, with a
potential liability of INR13b, equivalent to our estimate for Cipla’s FY13 profits). We believe, along with
these tangible factors, a lack of clarity on leadership/succession has been one of the reasons for
underperformance and P/E compression.
Trading at lower end of historic P/E band, but we await clarity on leadership/direction of business model
We acknowledge a prolonged underperformance has led to a P/E compression for Cipla and it is now
trading at 17.5x 12-month forward earnings, which is the lower end of the 17-22x trading range for the
company over the last five years. While valuations are at a steep discount to peers, we do not see a case for
a re-rating until issues on leadership (successor grooming/appointment of a professional) as well as
direction of the business model (setting up a front-end, transition into chronic areas in the domestic
market, etc.) are addressed. We initiate coverage on Cipla with a HOLD and a 12-month target price of
INR285, potential downside of 2%.
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