Pharmaceuticals: The good, the bad and the ugly:: Kotak Sec, report link

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The good, the bad and the ugly. Recent global currency movements have exposed
the risks to Indian pharma’s ex-US growth profile and with a US$2.2 bn revenue
exposure to cross currencies, sharp movements as seen for ruble will hurt growth and
margins. While Russia/CIS and Venezuela are set to have a material impact on a few
companies, notably Dr. Reddy’s, INR depreciation versus the USD should help absorb
some of this impact partially. Net impact is a -5 to +2% change in EPS estimates with
DRRD being the most impacted. Retain preference for Lupin and Cipla in the sector.

The good – INR depreciation versus USD to benefit the sector

According to KIE economists, INR should see steady depreciation, albeit to a much lesser degree

than other emerging markets. Our economists forecast the USD/INR to average ~63 in FY2016

compared to 61 in FY2015 and 65 over the longer term. Ceteris paribus, increasing

exposure to the US will provide a strong cushion to Indian pharma (US$9 bn+ revenue

exposure for the sector), with our analysis suggesting the highest sensitivity for SUNP, which

should see margin benefit of 50 bps and EPS upgrade of 160 bps for every 1% INR

depreciation. This is followed by LPC (30 bps margin/120 bps EPS), DRRD (18 bps margin/90 bps

EPS) and CIPLA (5 bps margin/23 bps EPS).

The bad – negative impact from cross-currency moves for Japan, Brazil, SA

The EUR, ZAR, BRL, JPY and AUD depreciated by 5%, 4%, 11%, 10% and 7% against the USD

compared to the September 2014 quarter with the cross-currency impact highest for ZAR, BRL

and JPY. Indian pharma’s combined exposure to these currencies stands in excess of

US$1.5 bn in revenues with CIPLA having the highest exposure (18.5% of revenues), followed

by DRRD (13%), LPC (17.6%) and SUNP (6%) among our covered names. In case of further crosscurrency

moves, we expect DRRD to have a hit from euro depreciation (10 bps margin and 40 bps

EPS for 1% depreciation), while CIPLA will see a negative hit from ZAR (13 bps margin and 58 bps

EPS for 1% depreciation) and LPC will be impacted by JPY (10 bps margin and 20 bps EPS for 1%

depreciation). SUNP is likely to have higher sensitivity to the euro though it could be negatively hit

due to RBXY’s exposure to euro and ZAR (11% of RBXY and 7% of pro-forma).

The ugly – FYTD 40% depreciation of ruble versus INR to hurt DRRD

The sector has a combined exposure in excess of US$600 mn to Russia/CIS, Venezuela, Bolivia

and Nigeria. We believe this basket is also one of the most profitable given the pricing scenario

in countries like Russia, low competitive intensity in countries like Venezuela as well as lack of any

major R&D spend for the region, which lifts the contribution margins. Since FY2012, Indian

companies also benefitted from INR depreciation versus RUB (+7% and +5% for FY2013 and

FY2014 respectively). Among our coverage universe, DRRD has the highest exposure with ~16%

of its revenues from Russia/CIS and Venezuela combined (-10 bps margin and -40 bps EPS for 1%

depreciation). Despite having the cleanest country profile, SUNP will now start to see negative hits

from RBXY, which has 13% of its revenues and 20% of its EBITDA exposed to the basket.

Reddy’s to bear the highest impact, followed by Lupin, Cipla and Sun

On a net basis, we estimate a positive impact for LPC and SUNP owing to the disproportionate

reliance on the US market and raise our estimates by up to 2%. We see DRRD having a

negative hit from the basket due to the sharp RUB depreciation and potential devaluation of

Venezuelan bolivar and we cut our estimates by 2-5% as the RUB exposure is partially offset by

USD. We also tweak out target price for DRRD marginally to `3,175 (versus `3,130 earlier). Our

estimates for Cipla and Lupin change by +/-2% while Biocon estimates are reduced by 3-5%. 

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily26122014ao.pdf