Raising PO to Rs1,000; lifting FY15/16E EPS by 3%/7%
We upgrade Cadila (CDH) from U/P to Buy and lift our PO from Rs705 to Rs1,000
(24% upside) as we believe that the worst is behind for CDH (26% underperformance
over the past 12 months) and earnings will accelerate from FY15. While FY14 would
be a washout year, we expect earnings momentum to accelerate from FY15, driven
by 1) a pick-up in US approvals, 2) recovery in domestic growth and 3) base effect
of Hospira JV. We cut our FY14E EPS by 6% and raise FY15/16E EPS by 3%/7%.
US approval cycle to accelerate
After the receipt of the FDA’s complete response letter, CDH is confident of getting
20+ approvals from the regulator in FY15, including some of the limited competition
products. We highlight that CDH has among the highest pending ANDAs compared
to Indian peers with the FDA, and is further ramping its filings in differentiated/niche
segments. We forecast 25% CAGR over FY14-16 vs 10% CAGR over FY12-14.
Domestic sales to recover from FY15
While the implementation of drug pricing policy and termination of marketing rights
of BI’s two products will impact FY14 performance (11% of FY14E PBT), we expect
growth to go back to 14-15% starting FY15.
Hospira JV margin has bottomed out
We highlight that Hospira JV’s profit contribution, which was 23% in FY13, has
come down to 11% in 2QFY14 as one of its flagship products, “gTaxotere”, has
witnessed severe price erosion. We expect this JV to stabilize at current levels.
Valuation re-rating aided by 30% earnings CAGR (FY14-16E)
With an increase in growth visibility (30% CAGR), launch of transdermal products
and improvement in return ratios, we believe valuations can go back to historical
levels (19-20x). We value CDH at 18x FY16E as we see full benefits of turnaround
visible by FY16. Delay in US approvals, including transdermal, is a risk.
��
We upgrade Cadila (CDH) from U/P to Buy and lift our PO from Rs705 to Rs1,000
(24% upside) as we believe that the worst is behind for CDH (26% underperformance
over the past 12 months) and earnings will accelerate from FY15. While FY14 would
be a washout year, we expect earnings momentum to accelerate from FY15, driven
by 1) a pick-up in US approvals, 2) recovery in domestic growth and 3) base effect
of Hospira JV. We cut our FY14E EPS by 6% and raise FY15/16E EPS by 3%/7%.
US approval cycle to accelerate
After the receipt of the FDA’s complete response letter, CDH is confident of getting
20+ approvals from the regulator in FY15, including some of the limited competition
products. We highlight that CDH has among the highest pending ANDAs compared
to Indian peers with the FDA, and is further ramping its filings in differentiated/niche
segments. We forecast 25% CAGR over FY14-16 vs 10% CAGR over FY12-14.
Domestic sales to recover from FY15
While the implementation of drug pricing policy and termination of marketing rights
of BI’s two products will impact FY14 performance (11% of FY14E PBT), we expect
growth to go back to 14-15% starting FY15.
Hospira JV margin has bottomed out
We highlight that Hospira JV’s profit contribution, which was 23% in FY13, has
come down to 11% in 2QFY14 as one of its flagship products, “gTaxotere”, has
witnessed severe price erosion. We expect this JV to stabilize at current levels.
Valuation re-rating aided by 30% earnings CAGR (FY14-16E)
With an increase in growth visibility (30% CAGR), launch of transdermal products
and improvement in return ratios, we believe valuations can go back to historical
levels (19-20x). We value CDH at 18x FY16E as we see full benefits of turnaround
visible by FY16. Delay in US approvals, including transdermal, is a risk.
Successful transdermal launches – key catalyst
CDH is building a portfolio of seven transdermal products, of which four have
already been filed in the US and the company expects rest of the filings to be
done by end-FY16. Post these filings, the company will start working on a couple
of 505 (b)(2) opportunities. We highlight that transdermal patches are an
interesting opportunity in the US (a US$4bn market) with relatively high margins
due to limited competition (only 4-5 generic firms).
Post FDA inspection of both the transdermal facilities (awaiting approval),
management is confident of launching at least one transdermal product in FY15
and 2-3 launches (including clonidine and estradiol) by FY17. While we believe
the revenue contribution of the same will be marginal in FY15 (US$5bn), the
franchise has potential to reach US$150mn by FY18. More importantly, it will aid
credibility to Cadila’s R&D efforts and their ability to launch differentiated and
complex products.
On the litigation between Mylan and Dr Sharad Govil (owns 15% in transdermal
subsidiary), CDH management believes that the outcome of the same will not
impact its transdermals launch in the US.
CDH is the only generic firm from India which has made significant investments,
and we believe that succes
Drug pricing policy, BI portfolio hit near-term
profitability
While we are positive on the firm’s long-term growth prospects in the domestic
market, the Drug Price Control Order (DPCO) 2013 will hurt near-term profitability
of the company. CDH is likely to take a hit of Rs220mn/quarter on profit until June
’14 before it starts carrying out annual price hike to the extent of Wholesale Price
Index (WPI) on affected products. While CDH management is confident of
recovering some of the losses through volume increases in the NLEM (National
List of Essential Medicines) and price hikes in non-NLEM products, we believe
the benefits of the same will only come in FY15. Further, CDH will also be
negatively impacted to the tune of Rs300mn annual EBITDA (2.5% of FY14E
EBITDA) because of the termination of marketing contracts for two of the
Boehringer Ingelheim (BI)-licensed products such as Buscopan and Dulcolax
(combined revenue of Rs900mn in CY13). CDH is looking to launch these two
products under its own banner to protect a part of franchise.
Hospira JV margin has bottomed out
While price erosion in one of the flagship products of Hospira JV, “gTaxotere”,
had impacted 1HFY14 performance, we believe the margins in this JV has
bottomed out (2QFY14E PAT at US$3mn vs. US$7mn in 2QFY13) and likely to
stabilize at current levels. With further expansion in the scope of JV, we expect
revenue growth to accelerate from FY16; however, dependency on the JV will
come down substantially (7.5% of FY16 PAT) unlike in the past where a quarter
of profit used to come from Hospira JV (23% in FY13 PAT).
Growth to accelerate from FY15
Slower approvals in the US, lower profitability from Hospira JV and DPCO 2013
implementation in the domestic market have impacted margins (contracted by
500bp) and profitability in 1HFY14 (de-growth of 10%). We expect 2HFY14 also
to remain subdued (marginally better than 1HFY14) because of the full impact of
pricing policy and termination of BI’s contract. However, a pick-up in the US
approval cycle coupled with a low base effect of domestic market should
accelerate sales and profit growth starting from FY15. We expect earnings CAGR
of 30% over FY14-16, driven by a) 18% revenue growth and b) 250bp margin
expansion over FY14-16E.
Valuations re-rating aided by 30% earnings
CAGR (FY14-16E)
While growth concern in FY14 (6% de-growth) led to 26% stock
underperformance over the past 12 months, we believe improvement in growth
visibility (30% EPS CAGR over FY14-16E) and improvement in return ratios will
drive re-rating of the stock and valuations can go back to historical level (19-20x)..
Further, we believe that with increased assets utilization and improvement in
margins, return rations and balance sheet ratios are set to improve. We highlight
that over the past three years, the company has invested nearly 30-35% of its
capex on assets such as biologics, transdermal, vaccine and discovery research,
which have not yielded any results, resulting in return ratios coming under
pressure. Similarly, with incremental focus on execution and higher profitability,
we expect DE ratio to come down from .77x in FY14 to .47x in FY16.
Historically (4 years), Company has traded 1-yr fwd PE multiple of 19-20x. Our
PO of Rs1000, values the company 18x FY16E EPS as we believe that full
benefits of pick-up in approval cycles, transdermal launches and recovery in
domestic market will be visible in FY16.
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