US growth supported by product pipeline; Domestic market trend improves slowly |
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The Dec quarter results were ahead of estimates for Indian Pharma companies under our coverage driven by higher revenue growth and margins in key markets. However, there have been concerns on the one-off elements benefiting the results in the quarter that partly led to muted stock performance despite earnings beat in the quarter. While we expect these one-off benefits to moderate going forward, the near term trends in key markets and product pipeline should support earnings growth in 1HCY14, in our view. The sector has outperformed the market (BSE Healthcare up +8% since early Dec-13 vs. -1% for Sensex) and while multiples have expanded over last year, we believe valuations remain justifiable (1-yr Fwd P/E at 16-21x) given earnings growth trajectory. DRRD is our top pick with the upside from transitioning to its complex portfolio and continued focus on R&D. GNP, which has underperformed peers last year, is our pick in the mid caps with clear catalysts to drive stock outperformance.
· Domestic market growth improving but still below historical levels. Industry website (PILMAN based on AIOCD data) reported Jan-14 IPM growth of 8.5% (vs. 8.2% in Dec-13), continuing the steady improvement in trend over the last three months. The growth was driven by volume (+3.5% vs. 1.6% in Jan-13) and new product launches (+3.4% with 83 new products/brands launched in the month), while pricing growth was muted at 1.6% due to the impact from DPCO 2013. Growth for SUNP and LPC outperformed the industry aided by the chronic focus, while MNCs and RBXY (NC) growth was weak/lower YoY. Most companies in the conference call highlighted normalization in trend in the domestic market even as trade issues remain unresolved. While we expect FY14E growth trends to improve to ~8% for the domestic market (vs. YTD growth of ~6%, in our view), this remains below the historical growth of 10+%.
Figure 1: IPM YoY Growth Recovered from Sep-Oct-13 lows
Source: Media reports (ET, FE, PILMAN) based on AIOCD data.
· US growth momentum key. The US revenue and margins in the Dec quarter benefitted from key product launches (with exclusivity or niche areas), supply disruption related pricing and market share gain and continued benefit from weak INR. While we expect some of the benefits (inventory building with new launches, pricing benefits, etc) to normalize going forward, we see growth in the US business on a strong footing from the ramp up of recent launches and new product launches (supported by strong ANDA pipeline). However, the uncertainty on the potential impact of channel and industry consolidation in the US is a key risk for the Indian generic players over the medium term. Most large players in India indicated that channel consolidation in the US will increase pricing pressure on the sector. Please see our note on takeaways from Global Healthcare Conference (Link to the report) for more details.
Table 1: Dec-13 Quarter Growth and key drivers
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Revenue Growth
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US Growth (USD)
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Comments
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DRRD
|
23%
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49%
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Gross margin for generic was 68% due to US
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LPC
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21%
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32%*
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US generic growth was better than expected
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SUNP
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50%
|
57%
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Taro growth was ahead of expectations
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GNP
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16%
|
6%
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EM growth and operating leverage led to earnings beat
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Source: Company reports. Note: Only US generic for Lupin (does not include branded business)
· DRRD and GNP are OW in the sector: DRRD remains our top pick (~14% potential upside from CMP) in the sector; earnings growth will be 15% over FY14-16E with a few key catalysts in the next year including potential USFDA approval of gCopaxone to the early filers (patent expires in May-14), approval for biosimilar launch in EM and continued growth in the US supported by the complex generic pipeline. GNP has underperformed the sector in the last year but we believe that improvement in EM growth as approvals come through in Brazil, EBITDA margins improvement and debt reduction with higher FCF generation should drive stock performance over the next 2 years. LPC’s 19% earnings growth will be supported by US generics, however, we believe there are near term headwinds due to the upcoming biennial price revision in Japan and continued weakness in US branded business. We see limited upside in SUNP given the risk to Taro’s margins (Taro accounts for ~40% of SUNP’s EBITDA, in our view).
· Increasing noise of USFDA scrutiny. There have been several media reports (ET, BS, NYT) on the increased USFDA oversight on India based facilities over the last week, which as highlighted previously is a key regulatory risk for the sector. In our view, companies would likely witness higher cost and investment associated with the USFDA oversight, which is unlikely to be prohibitive. We believe that focus on compliance would be a key variable in an increasingly competitive market with limited opportunities and short product life cycle given the cost and risk of non-compliance is a bigger risk to the sector given significant revenue exposure to the US. Please see our note on USFDA scrutiny (Link to the report) for more details.
Table 2: US FDA Action on India based facilities over the last year
Company
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Date
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Issue
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Hospira Healthcare India
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May-13
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Warning letter issued to its India plant in Sriperumburdur
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RPG Life Sciences
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Jun-13
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Warning letter for violation of cGMP at its two plants at Ankleshwar and Mumbai
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Wockhardt
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Jul-13
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Warning letter issued to its Waluj plant (2 facilities). UK regulators also issues certificate of non-compliance
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Fresenius Kabi Oncology
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Jul-13
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Warning letter for violation of manufacturing norms at its Kalyani facility, West Bengal
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Posh Chemicals
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Aug-13
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Warning letter to its Hyderabad unit due to deviations from cGMP leading to adulterated API being manufactured
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Promed Exports
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Aug-13
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Warning letter to its Himachal Pradesh unit
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Ranbaxy
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Sep-13
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Import alert to its Mohali unit
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Strides Arcolab
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Sep-13
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Warning letter against sterile manufacturing facility 2 of Agila Specialties at Bangalore
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Aarti Drug
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Sep-13
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Warning letter issues to Maharashtra's facilities
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Wockhardt
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Nov-13
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Import Alert for Chikalthana unit (but excluded 5 products from the import alert). In Oct-13, UK MHRA has withdrawn the GMP certificate for the plant
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Ranbaxy
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Jan-14
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Issues import alert on the Tonsa API plant post observations made in early Jan
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Source: USFDA and J.P. Morgan.
Table 3: Indian Pharma: Valuation Summary
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|
Mcap
|
P/E
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EV/EBITDA
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P/BV
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RoE
|
|
CMP
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$Mn
|
CY13/FY14
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CY14/FY15
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CY13/FY14
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CY14/FY15
|
CY13/FY14
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CY14/FY15
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CY13/FY14
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CY14/FY15
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Sun Pharma
|
605
|
20,218
|
23.8
|
20.9
|
17.1
|
14.3
|
7.4
|
5.7
|
37.7
|
35.0
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Dr Reddy's
|
2,629
|
7,216
|
20.5
|
17.1
|
13.5
|
11.4
|
4.9
|
4.0
|
27.0
|
25.7
|
Glenmark
|
534
|
2,340
|
20.4
|
15.6
|
12.9
|
10.4
|
4.3
|
3.4
|
22.9
|
24.5
|
Lupin
|
917
|
6,633
|
24.7
|
20.3
|
14.8
|
12.1
|
6.3
|
5.0
|
28.7
|
27.7
|
Cipla
|
376
|
4,868
|
20.8
|
18.1
|
13.6
|
11.6
|
2.9
|
2.6
|
15.2
|
15.2
|
Ranbaxy
|
345
|
2,363
|
27.6
|
13.1
|
12.2
|
7.7
|
4.0
|
2.9
|
15.0
|
29.3
|
Cadila Healthcare
|
940
|
3,106
|
25.3
|
20.1
|
18.4
|
14.6
|
5.4
|
4.5
|
23.1
|
24.3
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Source: Company reports, J.P. Morgan estimates Note: Bloomberg consensus for Not covered (NC) stocks Cipla, Ranbaxy and Cadila.
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