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J.P. Morgan - Glenmark Pharmaceuticals Ltd

Glenmark Pharmaceuticals Ltd. (GNP IN) Medium term growth drivers in place; Improvement in US revenue growth key near term catalyst		Overweight Price: Rs579.85 13 Jun 2014 Price Target: Rs715.00 PT End Date: 31 Mar 2015

We remain positive on Glenmark’s medium term growth outlook post our meeting with management. We believe GNP’s FY15 performance will highlight the strength of its emerging market franchise with strong growth outlook for key markets like India, LatAm and RoW-SRM. While GNP is investing in building the long term growth pipeline in the US, FY15 growth would depend on the pick-up in ANDA approvals. The pending litigation claim and continued investment in US business could push large net debt reduction to FY16. We see further potential upside from current levels as the key catalysts unfold over the medium term.

· Near-term US growth to pick up with approvals, in our view: GNP’s tepid US performance over the last few quarters has been impacted by fewer ANDA approvals (7 approvals in FY14). Management pointed that US growth is likely to improve through FY15 (guidance 12-15% vs. 9% in FY14 on USD basis). While so far approvals have been slow (one approval in 1Q so far), in our view, improvement in approval trends and launches should help increase US revenue trend (~10 approvals expected in FY15). In line with our view, management pointed out that any potential pricing impact from US channel consolidation will be visible over the next few quarters. (Please see our note on “US channel consolidation - Diminishing the US opportunity for Indian generic players? No, in our view” published on 22 April 2014).

Figure 1: Fewer approvals but filing pace picking up Source: Company reports.

Figure 2: US revenue growth to improve post a muted FY14-15 Source: Company reports and J.P. Morgan.

· R&D investment for LT growth opportunities: GNP has some key products in FY16-18, which should improve growth to ~20% levels from FY15 levels (gFinacea, gOrtho Tri- Cyclen Lo, gZetia). GNP indicated that it would like to file ANDAs in at least one new niche therapy area every year. GNP announced filings in complex injectables, immunosuppressant from Indore facility with R&D expense increase 48% YoY in FY14. Therefore, the higher R&D spend guidance (9.5-10% vs. 9% in FY14) would be towards generic for the US market and also focus on pipeline to support growth opportunities post FY18. While R&D expense will continue to increase (28% CAGR over FY14-16), we expect R&D/Sales to remain in the 9.5-10% range over the medium term.

Figure 3: GNP ANDA filings trend Source: Company reports.

Figure 4: R&D spend as % of Sales to remain at 9.5-10% Source: Company reports and J.P. Morgan estimates.

· Ex-US growth on a strong footing. We have highlighted that the base of the EM is getting bigger but remains a key driver for GNP’s earnings and profitability over the next two years. Management remains focused on organic growth in its existing EM markets and reiterated growth guidance 18-20% for SRM-Row and 25-30% for LatAm (primarily due to Mexico, Venezuela, Argentina). While Europe achieved breakeven in FY14 (improve further in FY15), GNP expects Latam to follow suit this fiscal.

Figure 5: GNP's RoW-SRM Growth… Source: Company reports and J.P. Morgan estimates.

Figure 6: … and LatAm Growth to improve Source: Company reports and J.P. Morgan estimates.

· GNP’s India growth not a concern due to changing regulations: GNP remains confident on 18+% growth in India with high single digit to low teens growth for the domestic industry. Management pointed that any big change in growth momentum would depend on the regulation set by the new government. However, it indicated that the recent guidelines by NPPA are not applicable to all non-scheduled products but looking at addressing certain discrepancies in the market. (Please see our note on “Indian Pharmaceuticals: NPPA's new guidelines for non-scheduled formulation in domestic market” published on 9 June 2014).

· Potential Tarka liability to push debt reduction into FY16: We would view the improving operating performance (US growth improvement, EM performance, NCE/NBE monetization) as key drivers for outperformance in the near term and expect decline in net debt levels to flow through as FCF generation picks up from FY16 onwards. While we expect FCF generation of Rs3.4bn in FY15, potential payment related to Tarka litigation (liability of $26-27Mn, in our view) is likely to limit large net debt reduction. Management has pointed that any large milestone payment from its innovative R&D pipeline could likely be utilized toward debt repayment.

Figure 7: Net Debt Reduction Likely in FY16, in our view

Source: Company reports and J.P. Morgan estimates.

Table 2: GNP key opportunities in the US

Generic	Brand	Date	US Sales ($Mn)	Comment
Eszopiclone	Lunesta	May-14	780	Settled. Shared FTF
Telmisartan	Micardis	Jul-14	274	Patent expiry in Jan-14. Watson, Roxane (AG), Alembic and Glenmark are likely players
Fluocinonide	Vanos	Jul-14	30	Case settled with Medicis Pharma. Perrigo, Nycomed, Glenmark and Taro are settled for 15 Dec 2013 launch
Trandolapril+ Verapamil	Tarka	Feb-15	70	Under litigation. Patent expires in Feb-15 but GNP launched at risk launch (was withdrawn later)
Colesevelam hydrochloride	Welchol	Apr-15	174	Case settled with Daiichi Sankyo and Genyzme
Norgestimate and Ethinyl Estradiol	Ortho Tri-Cyclen Lo	Dec-15	450	Case settled.
Dronedarone	Multaq	Jul-16	320	GNP and Actavis has 180 day exclusivity
Rosuvastatin	Crestor	Jul-16	3600	District court ruled in favour of Innovator and upheld patent (expires in Jan-16). ARBP has FTF. Glenmark, Teva, Mylan, Watson, Sun, Sandoz have filed ANDA
Ezetimibe	Zetia	Dec-16	1700	Case settled. GNP has FTF. Till now, Mylan and Teva have filed, more expected to file.
Atomoxetine hydrochloride	Strattera	May-17	384	GNP has TA on all strengths. Lilly recently won appeals case, patent was upheld. DRRD, Teva, Sandoz, Zydus, Aurobindo have also tentative approvals.
Azelaic Acid, Gel 15% Topical	Finacea	Nov-18	95	Under litigation-GNP may be FTF applicant and may be entiled to 180 day generic exclusivity. 30 month stay completes in Dep-15
Lacosamide	Vimpat	Mar-22	353	Multiple ANDA filers. Glenmark has FTF
Bendamustine HCL	Treanda	-	680	Shared exclusivity

Source: Company reports, J.P. Morgan estimates.

Investment Thesis

We believe that GNP’s generic business growth, aided by a pick-up in US and emerging markets growth momentum, EBITDA margin expansion and a reduction in leverage through sustained increases in cash flow generation, should help narrow the valuation gap to its domestic peers. Further, GNP’s innovation R&D pipeline provides scope for upside surprise with new out-licensing opportunities

Valuation

Our Mar-15 price target of Rs715 is based on sum-of-the-parts with a base business P/E of 18x, at a 10% discount to its Indian peer group. We attribute an NPV of Rs37 from pipeline opportunities and Rs46 from its (NCE)/ (NBE) research pipeline to the target price.

Table 7: GNP SOTP Summary

	Rs/share
Base EPS Sep-15	35.1
Target Multiple	18	10% discount to domestic peers
Base Target price	632
FTF Opportunities	37
NCE/NBE Research Pipeline	46	Crofelemer RoW sales and GBR - 500
GNP Target price (Rs/share)	715

Source: J.P. Morgan estimates

Risks to Rating and Price Target

Key risks to our view include potential regulatory issues (especially related to the USFDA), an inability to monetize the NCE pipeline, further deterioration in working capital and an inability to expand its product basket

J.P. Morgan - A policy agenda for India's new government

A policy agenda for India’s new government

In many ways, India’s 2014 general election was nothing short of historic. Apart from a record turnout, it defied political and social scientists’ long-standing prediction: that India’s pluralism would translate into coalition governments till the eye could see. Instead, for the first time in a generation, a single party has secured a majority in the Lok Sabha. Political stability—and the economic lessons implicit in the election —has created hope and expectation that India’s new government is well-positioned to pursue the second generation of reforms to liberalize India’s factor markets (land, labor, energy, infrastructure), which have become a binding constraint on growth. These reforms are politically sensitive, however, and will entail expending (potentially significant) political capital, to forge alliances in the Upper House (where the government does not have a majority) and with States, under whose jurisdiction most of these issues lie. But political capital is not infinite. So the government will have to pick its early hits, especially given super-charged expectations. This essay discusses a potential policy agenda for the new government, identifying where we believe it will (and should) spend its political capital in the first year, and analyzing near-term trade-offs and risks. The changed political-economy of food inflation Guess what the most important voting issue was in the recent general elections (and, indeed, in the four state elections last year)? According to polls, it was not jobs or governance, but inflation! It’s not surprising to see why. For starters, CPI inflation has averaged 9.5% over the last seven years underpinned by stubbornly high food inflation – averaging 11% over that period. The poor – whose incomes are least indexed – also vote in the largest proportions. So high inflation has often directly translated into reduced purchasing power and – in the absence of adequate savings – consumption. It’s no surprise, therefore, that despite a record harvest last year, rural consumption remained weak. Real rural wages had begun to moderate since 2012, in part because nominal wages began to moderate but surging rural inflation has been the real culprit in pulling down real wages. Second, sustained food inflation in conjunction with the indexation of MGNREGA wages has contributed to a wage-price spiral in the rural economy that has also spilled over into urban wages. Finally, its food and fuel inflation that is largely responsible for shaping household inflation expectations. Econometrically, we find that a 100 bps shock to food prices results in a 50 bps impact increase in inflation expectations that decays only over 8 quarters! In contrast, a 100 bps shock to core inflation affects expectations by only 30 bps and decays with two quarters So taming food inflation is critical to winning the battle on expectations. The economics has been largely undisputed. What has changed in recent months is the clear message that high inflation is also bad politics. It’s hard to see how the current hope can sustain if a year from now food inflation is still stuck at current levels. To its credit, the new government has immediately recognized this and indicated that food inflation is its top priority. So what should the government start by doing? In our view, start by taming cereals inflation. Despite the accumulation of record-buffer stocks over the last two years, cereal inflation has averaged 13%! So buffer-stocks have clearly lost their “threat value” in taming expectations. Instead, they’ve only served to take flow out of the open-market and pressure prices (see chart) For starters, therefore, stocks need to be used more effectively and preemptively to push down cereals inflation – both my procuring less and releasing more. But accumulation of cereal stocks is, in turn, a function of the minimum support prices (MSPs) the government offers (see chart). Sharp increases in MSPs in recent years have overly-incentivized farmers to produce rice and wheat, and thereby impeded the supply response to other price signals. So MSPs have a both a direct impact on cereals inflation and an indirect impact by inhibiting substitution. The good news is that, after an average increase of 11% over the last seven years, cereal MSP’s increased by only 5% in the last year of UPA-2. The new government would do well to limit MSP increases this year and eventually reform it. To its credit, the NDA government showed admirable restraint on the MSP front in its previous stint. The hope and expectation is that this would continue. But food inflation is not limited to cereals. Non-cereal inflation is even higher at 12% over the last 5 years with fruits, vegetables and high-protein items becoming particular sources of pressure. A key contributor has been the Agricultural Produce and Marketing Committee (APMC) Act, which has acted as a monopsony at the farm gate, severely restricting agriculture trade, and thereby creating opportunities for hoarding and price manipulation. Removing fruits and vegetables from this mechanism would go a long way in moderating price pressures. But APMC is a state subject, and therefore the Central government will have to use significant political capital to lean on States to reform. The good news is that Prime Minister Modi is well aware of these bottlenecks, and articulated these reforms – and more – in a white paper back in 2011. Jumpstarting capex : start with coal and land There is no dispute over the fact that resolving implementation bottlenecks (land, coal, environmental clearances, raw materials) is critical to jumpstarting private capex. Quantitatively, we find that of the 695 bps slowdown that India suffered between 2010 and 2013 (ex agri and community services), almost 30% is because of bottlenecks on the ground and another 15% on account of the associated loss in investor confidence that is closely linked to the ease of doing business. The corollary is that half the slowdown could be reversed if these bottlenecks were completely alleviated and confidence returns. But where should the government start? To analyze this, we looked at the top 50 projects (in value terms) that are currently stalled. These account for nearly 70% of the total stalled value, and so getting some traction on large projects is crucial. Our search revealed that 55% of stalled projects are because of land acquisition constraints, and another 25% because of issues in the power sector -- coal unavailability and state electricity board (SEB) pricing. Only 8% in this sample were stalled because of environmental clearances – which is understandable given the previous government made significant progress on that front. So, to the extent that the government can make progress on the land and coal front, they could make a significant dent into implementation bottlenecks. But land acquisition is on the con-current list and so not under the direct jurisdiction of the central government. Therefore, what the government will likely need to do is both (i) reform the new land acquisition bill to make it more business-friendly; and (ii) use political-capital with individual states to ensure that land acquisition issues related to large projects are resolved. Constraints in the power sector are at both ends of the spectrum – the unavailability of domestic coal (forcing the import of coal which is currently 20-25% more expensive) and the inability to sell to SEBs that are cash strapped. The latter is a more complex problem that requires meaningful tariff hikes, is under the domain of the states, and is politically very sensitive. For starters, therefore, we recommend the government prioritize coal production in India. India has among the largest coal reserves in the world and yet it is the fourth largest importer of coal (!) because CoaI India’s production has literally ground to a halt. So what could the government do? For starters, building 3 new rail-lines covering about 200kms (though logistically not trivial given the terrain) potentially opens up another 200 million tones of coal per annum that can be mined and transported from Chhatisgarh, Orissa and Jharkhand. This needs to be complemented by injecting private efficiencies into Coal India. One option is reform by stealth. Future coal licenses should be allocated to the private sector, who would be able to extract coal more efficiently and sell it to Coal India who, in turn, could on-sell it to power producers. Bottom line: if the government can begin to tackle coal and land in the first year, the capex cycle could finally get going. The dark horse: labour market reforms The economic reforms heretofore that have powered growth have largely focused on product-market reforms. But it’s clear that factor markets have become a binding constraint, and for potential growth to go back anywhere near the mid-2000 levels, factor markets need to be reformed. Within this, reforming labour laws are key. The motivation is obvious. There are concerns that India has recently experienced jobless growth. One explanation for this is that despite having an abundance of unskilled labour – India’s comparative advantage – Indian firms have expanded largely in capital-intensive sectors (engineering goods, pharmaceuticals) or used excessively capital-intensive technologies in other sectors, resulting in a sub-optimally low utilization of labour. Labour laws are deemed a key culprit. By making firing, and therefore hiring, difficult and introducing other rigidities they have essentially bid-up the relative cost of labour, and induced firms into operating at sub-optimally high (from a societal perspective) capital-intensive technologies. Professors Jagdish Bhagwati and Arvind Panagriya effectively demonstrate how the textile industry, for example, is littered with small firms in India because labour laws have constricted expansion, and therefore from realizing economies of scale. As the accompanying chart below demonstrates, almost 93% of workers in the labour-intensive textile industry are employed in firms employing 49 workers or less – in large part die to labour laws -- a far cry from China’s size distribution (Page 134, “India’s Tryst With Destiny,” by Jagdish Bhagwati and Arvind Panagriya). But a glimmer of hope is finally emerging. Less than a week ago, the Rajasthan government amended three important laws – Industrial Disputes Act, Factories Act and Contract Labour Act – to make hiring and firing of employees more flexible. However, the laws fall on the concurrent list and need Presidential (not legislative) approval. If they do secure it, this could serve as a powerful demonstration effect to other states, who may also be induced into liberalizing laws for fear of losing investment to states that reform. The First Budget: Opportunities and Trade-offs Next month’s budget will be the new government' first major policy statement, providing an opportunity to lay out its vision. But it also involves trade-offs, and therefore will reveal what the government’s near term priorities are. On the face of it, the budget involves two, potentially conflicting objectives. First, it will be important to persevere with fiscal consolidation. To its credit, the previous government reined in the deficit the last two years – achieving a 1.2% of GDP cyclically-adjusted consolidation – in a period of low growth and populated with elections. This, in turn, was a critical prerequisite to restoring macroeconomic stability. It’s important that this signal be sustained. But simultaneously, it’s equally important to jumpstart the capex cycle by boosting public investment and recapitalizing public sector banks. Civilian capex off the budget has fallen to worrying levels. With balance sheets in infrastructure still stretched and banks still handicapped by elevated NPAs and restructured loans, creating some capex momentum through public investment is critical. So how does the Budget simultaneously achieve a 0.5% of GDP boost to public investment and simultaneously consolidate by 0.4% of GDP? There is some space to rationalize urban subsidies but an aggressive rationalization of rural subsidies or welfare programs is unlikely given fears of a sub-par monsoon. The key therefore is disinvestment. The sharp rally in recent weeks – with PSU equity prices rallying 55% in the last 6 weeks – provides an ideal opportunity for the government to accelerate its disinvestment program and use those proceeds for infrastructure investment. As Chief Minister of Gujarat, the PM has indicated a preference for making PSU’s more autonomous an professional. But market discipline is another equally-effective mechanism of reaching those objectives. Eventually, of course, the government has to find a way to achieve closure on the goods and services (GST), the most important fiscal reform of our time. By truly making India a common market, it will drive allocative efficiency and boost productivity growth. However, GST will be a harder legislative slog, because it entails a constitutional amendment and requires a two-thirds majority in each house of Parliament – which the NDA lacks -- apart from 50% of State Assemblies. So the government will need to build a national consensus to push through the GST. The First Test: a deficient monsoon The first real risk for the new government is a deficient monsoon. Earlier this week, the MET indicated there is a 71% chance of a sub-normal or deficient monsoon. Simultaneously the likelihood of an El Nino, though a mild for now, is pegged at 70%. The last time India suffered from an El Nino in 2009, the similarities were eery. The Met’s first two forecast of the monsoon were 95% and 93% of its long term average – exactly what they have predicted this year. As it turned out actual rainfall was only 79%. A deficient monsoon would impart a stagflationary shock to the economy. Agricultural production would suffer and drag down rural incomes and consumption. Simultaneously, food prices would be pressured – depending on the severity of the shock and the nimbleness of the policy response. In 2009, for example, food inflation which was already at 10% in the year leading to the deficient monsoon, surged to 17% the year after. Moreover, given the wage-price spiral in the rural economy, this pushed up wages and resulted in a more generalize inflation spiral. And there will be fiscal implications, too. Automatic stabilizers like MNREGA will kick-in, growth – and therefore tax collections – will suffer, and it will be harder to rationalize rural subsidies. Therefore, under our base case of a deficient monsoon, and the consequent implications on inflation, wages, and the fisc, we have penciled in a 25 bps hike by the RBI in 4Q14. If it turns out the monsoon is not as deficient as feared or the policy response is nimble, we will take off our rate hike call. Putting it all together The outturn of the elections offers India’s new government a unique opportunity to push through the next generation of reforms. But political capital is not infinite, and it is hoped and expected that the government will put its weight in the first year behind one or two key areas (food inflation, land, coal) rather than trying to be all things to all people. The early signs are very encouraging. The government has sounded all the right noises and appears ready to tackle the big problems. But July will present the first real tests for the new government – a Budget with trade-offs and a potentially-deficient monsoon. That said, we could be at the cusp of a structural-break in policymaking. Stay tuned.

J.P. Morgan - India Equity Strategy

India Equity Strategy SEBI Board Meeting: Aims to Boost Primary Market and Fund Raising

· In its board meeting today, Capital Market Regulator SEBI announced a series of important measures. A minimum free-float requirement of 25% has been mandated for Public sector companies (PSUs), to be achieved over three years. Note that SEBI had mandated minimum free float requirement of 25% for private sector companies and 10% for PSU companies by the mid of last year. Given fiscal pressures, it is widely expected that the Government would be supportive of this measure.

· Currently, 21 PSUs of BSE 500 companies have a free-float of less than 25%. The market capitalization of required stake sale to achieve the norms stipulated, at the current market price, would be US$ 9.6 bn over three years. Coal India would account for the bulk (63%) of this stake sale.

Table 1: BSE 500 Companies with over 75% Government ownership

Company Name	Indian Central & State Govt. Promoters - Ownership (%)	Current Market Capitalization ( INR mn)		Stake Sale Requirement ( INR mn)
Coal India Ltd.	89.7	2,488,963		364,633
N M D C Ltd.	80.0	693,627		34,681
N H P C Ltd.	86.0	290,605		31,850
Neyveli Lignite Corpn. Ltd.	90.0	163,996		24,599
Steel Authority Of India Ltd.	80.0	407,476		20,374
Hindustan Copper Ltd.	90.0	102,514		15,377
S J V N Ltd.	90.0	99,486		14,893
Central Bank Of India	88.6	105,199		14,339
M M T C Ltd.	90.0	94,650		14,198
National Aluminium Co. Ltd.	81.1	148,707		9,012
H M T Ltd.	90.0	56,592		8,489
Indian Bank	81.5	82,301		5,358
Bank Of Maharashtra	85.2	40,151		4,099
United Bank Of India	88.0	25,352		3,296
M O I L Ltd.	80.0	53,491		2,675
I D B I Bank Ltd.	76.5	168,654		2,530
Uco Bank	77.2	103,906		2,286
State Trading Corpn. Of India Ltd.	90.0	13,071		1,961
Rashtriya Chemicals & Fertilizers Ltd.	80.0	36,549		1,827
Punjab & Sind Bank	81.4	19,876		1,276
Bharat Electronics Ltd.	75.0	145656		29
Total				577,781

Source: CMIE, J.P. Morgan

· Measures have been announced to expand the framework of Offer for Sale (OFS) of shares through the stock exchange mechanism. These include:

a. Reservation for retail individual investors – 1. Minimum 10% of the issue size shall be reserved for retail investors i.e. for investors bidding for amounts less than Rs. two lakhs. In case this percentage is not fully utilized, the unutilized portion may be offered to other investors. 2. Seller of shares may offer a discount to retail investors in accordance with the framework specified from time to time.

b. Allowing non-promoter shareholders to offer shares through OFS. Non-promoter shareholders having (a shareholding of) more than 10% or such percentage as specified by SEBI from time to time shall be eligible to use OFS. This is relevant for Sterlite’s 65% owned subsidiary, Hindustan Zinc (HZ, NC), as the Government looks to sell down its 30% stake. After the latest amendment, the Government would be able to sell down its 30% holding in HZ and move the transaction one more step forward.

c. Expanding the list of eligible companies. OFS mechanism shall be made available for shareholders of top 200 companies by market capitalization, from the current 100 companies.

· Minimum dilution to public in an IPO shall be 25% or Rs. 400 crore, whichever is lower, for companies with post capitalization of less than Rs. 4000 crore. This will remove the anomaly that a company just short of Rs. 4000 crore market capitalization, was required to dilute about Rs. 1000 crore while another company at Rs. 4000 crore market capitalization was required to dilute only Rs. 400 crore

· Increasing the investment bucket for anchor investors. In order to increase the share of serious, committed investors, SEBI has decided to increase the anchor investor’s bucket to 60% from the current requirement of 30% of the institutional bucket.

· Eligibility of shares for Offer for Sale in an IPO with respect to bonus issues on shares held for more than a year. The Board approved the proposal to permit bonus shares issued in last one year prior to filing of the draft offer document to be offered for sale, provided that these bonus shares were issued out of the free reserves or share premium.

· SEBI board has also approved measures governing

Preferential issues – replacing ‘closing price’ with ‘volume weighted average price’

ESOPs – including secondary market acquisitions, enhanced disclosures and better enforceability

KYC norms – including sharing of KYC information with entities regulated by other financial sector regulators

Research Analysts – seeking to register and regulate individual research analysts and entities engaged in issuance of research reports

These measures are well-intentioned and well-timed in our view, given the enhanced investor sentiment and a more important role capital markets could play in reviving the growth ahead.

See details at: http://www.sebi.gov.in/sebiweb/home/detail/28252/yes/PR-SEBI-Board-Meeting.