Edel Pharma

1 Edelweiss Securities Limited

Q4FY15 was another quarter of earnings/recommendation downgrades, as expected (The going gets tough), as slowdown in ANDA approvals and emerging markets (EM) headwinds continued to play spoilsport. Customer consolidation in the US also impacted and going ahead will push companies towards inorganic initiatives (M&As, partnerships). We are building in recovery in FY16 as we expect ANDA approvals cycle to pick up and a favourable USD. Unresolved Form 483s will remain an overhang and any adverse action (import alerts) would be key risks to earnings. We remain positive on the sector over the long term, and maintain BUY on most of our coverage companies (60%). We continue to prefer large caps over mid caps, as valuations and growth estimates of the latter do not factor in risks.

FY15: A year full of challenges

EM currency headwinds in H2FY15, slowdown in ANDA approvals and ongoing

resolution of compliance issues hurt growth in FY15. Our coverage universes

revenue/EBITDA/adj. PAT grew 13% (mere 9% organic growth)/10%/6% India (16%

organic, 18% including inorganic), US grew 15%, and other businesses (EM and APIs)

fell 2% (organic). Customer consolidation impacted pricing and receivable days

adversely. Pitch for M&As is getting higher and M&As are now becoming a part of the

core strategy for companies as growth becomes challenging.

FY16: Much in store

We expect FY16 to be a better year as more clarity emerges around challenges faced in

FY15: a) pick up in ANDA approvals activity last two months better (Chart 6); b)

compliance status and resolution of Form 483s Sun Pharma, Cadila Healthcare, Dr.

Reddys have unresolved Form 483s (Table 1); and c) stabilising EM currency after

weakness in H2FY15, some recovery seen (Chart 11). We also expect higher activity in

M&As, business development and R&D for complex generics/proprietary products.

ANDA approvals: Target action dates mechanism yet to deliver

Companies guidance regards many ANDA approvals remains hazy as approvals remain

tardy and a few undergo FDA resolution of pending Form 483s. Sluggish ANDA

approvals remain key risk to sector earnings. Introduction of target action dates (pg 5-

6) by FDA could expedite clearance of approvals, but results are yet to show.

Prefer large caps over mid caps

We prefer large caps (all BUYs) given their large niche portfolios, stable businesses,

healthy cash flows, diversified manufacturing and readiness for inorganic moves. Mid

caps are prone to higher risks given inferior mix, high dependence on ANDA approvals

and smaller scale. Preferred stocks: (1) Cipla: Operating leverage benefits under

appreciated; EPS to double over FY15-17E; (2) Sun: Ranbaxy margin to surprise; (3)

Cadila: Niche US pipeline to deliver 31% EPS CAGR (FY15-17E). Less preferred: (1) Ipca:

US story derailed, RoCE recovery far away; (2) Glenmark: Strong US growth priced in.

Anshuman Gupta +91 22 6623 3399

[email protected] Rahul Solanki

+91 22 6623 3317 [email protected]

June 8, 2015

Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL , Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

PHARMACEUTICALS Building in recovery

SECTOR UPDATE

India Equity Research | Pharmaceuticals


Pharmaceuticals

A run through FY15 EM currency headwinds in H2FY15, ANDA approvals slowdown and ongoing resolution of

compliance issues hurt growth in FY15. Revenue growth of 9% YoY (organic) was muted for

our coverage universe (15% including inorganic). India grew 16% (18% including inorganic),

US 15%, while other businesses registered 2% decline (organic, up 6% including inorganic) hit

by currency. US tapered off in H2FY15 due to lack of approvals (logjam at FDA, ongoing

compliance issues resolution) and customer consolidation. Gross margins also dipped (40bps)

driving down EBITDA margins (down 70bps) and adj PAT growth to mere 6%.

Customer consolidation side effects

The US, in past few years, has witnessed substantial consolidation among buyers and

emerged as a more consolidated market (details below). This implies more bargaining power

with the buyers and US generic companies reeling under pricing pressure. However, higher

volumes for contracted generic players can compensate for this loss and result in better

growth.

Fig. 1: Consolidation has consolidation has given Customers unprecedented power

Source: Teva PPT on proposed Teva-Mylan merger, Edelweiss research

Through FY15, Indian pharma companies mentioned impact of this consolidation as one of

the key reasons for growth slowing down in the US. Drug prices were renegotiated at lower

levels, which are expected to extend going forward as well. The impact was more

pronounced in the fourth quarter as lack of approvals aggravated the situation.


Sector Update

Chart 1: India pharma Customer consolidation, lack of approvals hurting

Source: Company, Edelweiss research

Dr. Reddys QoQ growth was not too impressive despite launch of few products in

3Q/4QFY15. The company blamed it on customer consolidation. Lupin, Torrent Pharma and

Sun Pharma were also impacted by the same. Another side effect of customer consolidation

was the rise in receivable days, with channel partners renegotiating better terms in FY15.

This is an emerging trend which needs to be tracked in FY16. Initial data trends suggest

smaller companies are a little worse off, but we do not know whether this is primarily due to

the US or other reasons.

Chart 2: Rise in receivables probably due to customer consolidation


We believe generic players with strong relationships in the US and niche/large portfolios will

do well post this consolidation. The market will become conducive for larger generics players

with larger portfolios/revenue scale. Buyers would prefer to engage with fewer parties. This

does not augur well for the smaller marginal players with sub-optimal scale of

portfolio/revenues. Unless, smaller players are able to impress buyers with niche/depth of

portfolio, they would find it difficult to make a mark in the US going forward.

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Pharmaceuticals

ANDA approvals slow: Pick up critical for meeting growth forecasts

For the Indian companies under our coverage ANDA approvals have considerably slowed

down in line with industry trends. Fresh approvals are vital for near-term growth, as high

contribution products of the companies have also started attracting additional competition.

Besides, sales and profitability of generic companies are inextricably levered to ANDA

approvals.

Chart 3: US business revenues growth continues to remain muted

Source:Company, Edelweiss research

Chart 4: Indian pharma FY15 one of the worst years for ANDA approvals

Source: Company, FDA, Edelweiss research

The recent dearth of approvals despite introduction of GDUFA(Generic Drug User Fee Act) is

a potent risk not only to the sectors premium valuations but long-term growth too given that

>800 ANDAs (52% filed in Cohort I and II phases) await approvals. Though the Act is expected

to deliver long-term benefits, the prevailing tardy approvals scenario does not inspire near-

term confidence. In this backdrop, we believe companies with more mature ANDAs (and

fewer filings in Cohort I/II) and ability to bag complex generic approvals are better placed.

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Aurobindo Cadila Dr Reddys Glenmark Lupin Sun Pharma Torrent Ipca


Sector Update

USFDA ANDA approvals activity spurts: Positive, but is it sustainable?

Since implementation of GDUFA, the rate of ANDA approvals has not picked up perceptibly

(Chart 1) and backlog has failed to shrink meaningfully. However, the past two months have

seen pickup in approvals (tentative plus final). We believe this is a healthy development for

industry with FDA getting its act together. However, it is still unclear whether this trend will

sustain and is being closely tracked (refer our detailed analysis on GDUFA activities:

Waning ANDA approvals pace, dated December 18, 2014 and Time ticking but no uptick,

dated March 2, 2015).

Chart 5: ANDA Backlog - Still pretty large Chart 6: ANDA Approvals - Green shoots visible

Source: FDA, Edelweiss research

Introduction of target action dates, a welcome change

In the Dec14 quarterly meeting of the Board of Directors of the Office of Generic Drugs

(OGD) at FDA with the Generic Pharmaceuticals Association (GPhA), communication

transparency was discussed. OGD proposed a sequenced approach to assigning target action

dates (TADs) for the pre-Cohort Year III ANDAs according to workload management factors.

With certain caveats (details below), FDA would assign TADs to all these ANDAs and start

notifying these to applicants starting early CY15. However, we believe, industry has not seen

any significant improvement in visibility of approvals this far in CY15, but this appears to be a

pretty good move as it provides more visibility on ANDA approval status. For instance,

Aurobindo Pharma mentioned that though starting in Feb/March 2015 it has seen few TADs

for its backlog ANDAs, it is insignificant in comparison to its ANDA backlog. Overall, our

conclusion from management commentaries is that industry is still unsure of the approvals

that may come their way during FY16.

Caveats to Target Action Dates

Notification of a TAD does not mean a commitment or guarantee that FDA will take

action on the application by the TAD.

Any amendments submitted after the notification may affect whether FDA will take

action on the application by the Target Action Date

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Final Approvals


Pharmaceuticals

When contacted for additional status update 3 or 6 months prior to TAD, applicants will

be provided the total number of discipline reviews needed for the application and the

number of reviews pending they will not be provided specifics on which disciplines are

pending.

When an application is at the clearance phase, FDA will notify applicants over phone that

it is on track to provide an action and may request assurance that applications labelling,

patent information, DMFs and inspections are up-to-date. However, this is not a

guarantee of approval.

Form 483s are possibly delaying ANDA approvals

Below we list Form 483s issued in the recent past, some of which remain unresolved. For

companies with unresolved Form 483s, ANDA approvals have been hard to come by. Even

facilities not subject to Form 483s are not getting approvals - Dr. Reddys and Cadila

Healthcare. We do hope that in FY16, theres more clarity on the status of these facilities,

but any adverse action (warning letter/import alert) by the USFDA will be big setback.

Table 1: Forms 483s affecting one and all Several remain unresolved


It is also a prudent assumption that companies would have undertaken site transfer activities

for their key products to minimise revenue losses at the time of adverse action by the USFDA.

Dr. Reddys has already initiated site transfers for its key unapproved products (e.g. Nexium,

etc.) to secure approval.

As highlighted by us in our recent note (Research), Form 483s are a common occurrence

when facilities undergo USFDA inspections. In case of Indian companies (listed entities), 60%

of the inspected facilities have received a Form 483 till date. We believe it is difficult to

conclude whether a Form 483 will result in a warning letter (WL)/import alert (IA). While

further USFDA action is not ruled out, till date very few Form 483s have resulted in a WL/IA

situation for Indian companies.

Stricter FDA merits more investments towards quality standards. We believe large caps have

more investment capability to upgrade standards quickly and more efficiently. As against this,

the mid caps will also have to do the same. But, this could render their US businesses less

commercially attractive and also hurt return on capital.

Company Plant Date Last approval

Sun Pharma Halol Nov '14 One approval for SPARC product; one from US facility

Lupin Indore Jan '15 Form 483 stands resolved as per management

Dr Reddy's Srikakulam Nov '14 No approvals from Srikakulam / any other facility

Cipla Bangalore Jul '14 N/A

Cadila Moraiya, Ahmedabad Sep'14 No approvals from Moraiya / any other facility

Aurobindo Unit IV Sep '14 Form 483 stands resolved as per management

Ranbaxy Toansa Jan '14 N/A

Divi's Lab Unit II Jun '14 N/A

Glenmark Argentina May '14 N/A

Torrent Pharma Ahmedabad Jul '13 N/A

IPCA Silvasa / Indore Dec '14 Both under Import alert


Sector Update

Other regulatory agencies also taking action: A new phenomenon

Other than the USFDA, inspection by other regulatory agencies has also been rising. For the

first time, we are hearing of other agencies banning Indian facilities. In the past 2 years, we

have come across Canada and MHRA banning Indian facilities on a more regular basis. Both

Canada and MHRA work closely with the USFDA on inspection matters and hence have

banned facilities where USFDA has issued Form 483/import alert.

What is more worrying is that the Brazilian agency recently (in 4QFY15) banned Lupins plant

from supplying a set of products into Brazil citing GMP issues. This does not impact earnings

to the same extent as a USFDA import alert would, but heightened oversight by other global

regulatory agencies poses a big threat to the future of Indian pharma companies.

Inorganic moves: Now core to growth strategy

Based on the commentary by various companies in FY15, we believe Indian pharma

companies are more eager than ever for inorganic moves in their pursuit for growth. Rising

pressures by way of customer and manufacturer consolidation will hasten this process.

Different companies have different types of motivation for inorganic initiatives. Moves range

from geographic expansion, plugging portfolio gaps, acquiring new technologies and

partnering to fill other gaps. Most large caps have a stated intent of acquiring assets to move

up the value chain and realise their dream of becoming a Specialty Pharma company over the

long term.

Table 2: Fund-raising plans announced during last AGM/ EGMs


We have already seen large caps (SUNP, LPC, DRRD, CIPL) taking steps in this direction. For

the smaller companies, the need is more basic and they need to plug geographical gaps and

perk up sub-scale portfolios. ARBP and TRP have already made few acquisitions on these lines.

SUNP continues to have the best execution track record when it comes to integrating large

acquisitions.

Most pharma companies are looking to raise funds given buoyancy in the economy and

availability of funds. The sectors balance sheet is healthy and cash flows will continue to

remain robust even going forward. This instills confidence that inorganic moves may not be

perceived to be negative for the sector. However, any large/unrelated acquisitions and equity

dilution may act as an overhang on pharma stocks.

Company DateApproval for debt

fund-raising (INR bn)

Approval for equity

fund-raising (INR bn)Gross Debt Cash Net Debt/ Equity EBITDA

Lupin Aug '14 20 0 4,710 21,372 (0.2) 36,196

Cadila Aug '14 19 0 23,340 7,911 0.3 17,557

Sun Pharma Sep '14 500 120 75,963 130,671 (0.2) 86,123

Glenmark Oct '14 0 19 37,999 7,681 1 14,466

Aurobindo Jan '15 0 22 38,636 4,691 0.7 24,651

Torrent Pharma Feb '15 100 30 22,678 2,994 0.8 12,656


Pharmaceuticals

Quarterly earnings continued the spate of downgrades

We note here how the pharma sector failed to meet expectations during Q3FY15 (refer All

Gain, No Pain??, dated April 9, 2015). After several quarters, for the first time, earning

estimates were downgraded post 3QFY15 results across the sector due to: i) slowdown in US

approvals; and ii) deterioration of currencies across EMs/EU. This pretty much continued

during Q4FY15 too with managements citing lack of significant improvement in the pace of

approvals improving during FY16, in turn making investors nervous. Moreover, Sun Pharma

not issuing a formal guidance worsened investor outlook. Sun Pharmas earnings had a

number of one-offs due to which the entire large cap seems to have done worse than the

mid caps for the quarter. We, however, continue to retain our preference for large caps

versus mid caps.

For all mainstream companies, India continued to do well clocking double-digit growth.

EBITDA margins of companies were hurt due to exposure to Russia/CIS. Pricing pressure on

drugs in the US due to customer consolidation also started to impact. Just like Q3FY15, gross

margins remained stable YoY, but EBITDA margins plummeted.

Table 3: Edelweiss pharma coverage universeQ4FY15 core earnings (INR bn)


Though we note that Sun Pharmas earnings have skewed the overall numbers for the sector,

even if we exclude it from the analysis, EBITDA margins have taken a ~160bps QoQ hit for the

quarter and revenue growth has crashed to a minimum.

Q4FY15A

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Tier - I

Sun pharma 61 (5.4) (10.7) 15 (22.8) (30.4) 24.5 (552.6) (692.7) 19 21.1 58.7

Lupin 31 5.3 (2.9) 8 (1.5) (11.1) 26.5 (184.1) (245.6) 6 (2.3) (0.1)

Dr Reddy's 39 11.2 0.7 8 10.1 (5.6) 20.9 (21.3) (141.0) 6 24.4 8.6

Cipla 30 22.7 13.6 5 24.0 (8.3) 17.0 18.4 (406.9) 3 12.8 (20.8)

Overall (Tier I) 160.5 5 (3) 36.3 (7) (19) 22.6 (296) (456) 33.5 16 26

Tier - II

Cadila 22 17.3 4.1 5 31.7 9.6 21.2 232.3 107.4 3 32.5 24.9

Aurobindo 32 56.9 (0.1) 7 18.7 7.4 20.8 (670.8) 145.2 4 (14.8) 0.6

Glenmark 17 3.2 2.4 3 (24.7) 8.1 16.6 (615.4) 87.7 1 (37.2) 12.0

Torrent 11 (0.9) (1.9) 2 (50.5) (32.5) 14.3 (1,431.6) (647.6) 1 (49.2) 4.2

Ipca 6 (15.8) (15.2) 1 (70.6) (55.7) 8.6 (1,602.8) (788.2) 0 (98.1) (95.2)

Overall (Tier II) 89.0 19 (0) 16.4 (9) (2) 18.4 (572) (40) 10.1 (23) 5

Overall 249 9.4 (1.8) 53 (8.0) (14.5) 21.1 (398.8) (312.8) 44 3.8 20.3

PATNet Sales EBITDA EBITDA Margin (%)


Sector Update

Chart 7: Indian pharmaSubdued growth continued


Chart 8: Revenue growth and EBITDA margin have crashed (excludes Sun Pharma)

Source:Company, Edelweiss research

The sector has witnessed earnings downgrades after a long period and the possibility of this

continuing also remains. The mid caps were running high on strong growth forecasts, which

we believe will see further downgrades given the macro conditions. Moreover, fund raising

plans/acquisitions may act as an overhang on mid caps.

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Pharmaceuticals

Chart 9: Streets earnings downgrades continued for second quarter in a row

Source: Bloomberg, Edelweiss research

Chart 10: Consensus earnings have been downgraded for most players recently


EM currencies after the downward trend have bounced back a bit recently and are now more

stable. Growth in local currency should remain strong but in INR terms growth will still be

muted. Two companies, Dr. Reddys (7% of sales) and Glenmark (3-4% of sales) have high

exposure to Venezuela and any significant devaluation (anticipated in FY16) of currency

poses a risk to their earnings forecast.

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Sector Update

Chart 11: EM currencies playing spoilsport - Some stability emerging though

Source: Company, Bloomberg, Edelweiss research

Table 4: Dr. Reddys, Glenmark, Ipca, Ranbaxy have high exposure to EM (%)


Sector gross margins have continued to inch up slowly as mix continues to improve. But,

rising R&D expenses and EM currency headwinds are causing variability in EBITDA margins.

4QFY15 was particularly challenging as we hardly witnessed any ANDA approvals, EM

headwinds continued to hurt and one-off costs related to SUNP-RBXY merger marred SUNPs

earnings.

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Sun Pharma 58 23


Pharmaceuticals

Chart 12: Indian pharmaGross margins stable, but EBITDA margins takes a dip


Chart 13: EBITDA margins Dip higher for mid caps; large caps avg hit by Ranbaxy


Near-term headwinds yet to derail long term story

We remain positive on the sector from a long term perspective, despite near-term

challenges. We expect the challenges around ANDA approvals and EM currency headwinds to

subside in coming quarters. Our coverage universe comprises majority (60%) BUY

recommendations with all large-caps being a BUY. Mid-cap companies are less preferred

and 4 /5 are HOLD/REDUCE

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Sector Update

Chart 14: We estimate strong earnings growth.... Chart 15: ...on the back of some margin improvement

Chart 16: ...that equally hinges on US business growth, Chart 17: sustained growth in India

Chart 18: and businesses outside US and India Chart 19: Return on invested capital to keep improving


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Pharmaceuticals

The pharma sector is trading at 45% premium to the Sensex (2-year forward PE) and the

premium is close to its highest level. However, we continue to believe premium valuations

can sustain:

Indian pharma has had a sound earnings track record despite facing many adversities at

different stages over past 2 decades.

We forecast 28% earnings CAGR over FY15-17; large-caps earnings CAGR over FY15-17 is

28% and midcap earnings CAGR is 29%.

With more a productive US pipeline awaiting approval for most Indian companies, we

forecast strong earnings growth over next few years.

Indian pharma companies continue to generate strong cash flows, despite rising

investments in R&D.

We strongly believe that these companies can take on higher risks here on and scout for

more inorganic opportunities given efficient operations and strong balance sheets.

Chart 20: Indian genericsRelative premium at highest level


Prefer large caps over mid caps

As part of our deep dive into the sector in October 2014, Exploring the less explored , we had

highlighted our preference for large caps versus mid caps due to multiple reasons. We

believe long-term growth for mid caps could get hampered by higher costs (regulatory and

development), smaller scale in the US and increasing buyer power. We strongly believe that

large caps are better placed as they have larger portfolios, better quality pipeline, have

higher risk taking ability, run more stable businesses, generate significant cash flows, can

manage cost escalation better and can embark on inorganic path.

Not only long-term challenges in the US, but issues in the near term as well will add up to

worsen mid caps pain. As we had highlighted in our quarterly preview note, Indian pharma

was impacted by: (a) slowdown in approvals; and (b) EM headwinds, which have led to

downgrades in earnings and recommendations for many companies. We believe these issues

will continue to pose challenges in the near term for the sector and more so for mid caps,

that do not have the required band-with in business models. If these issues do not subside

over the longer period, the sectors premium valuations could be at risk. We prefer large caps

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Pharma index is trading at ~45% premium


Sector Update

over mid caps as we believe current valuations and growth estimates of the latter do not

factor in emerging risks.

Chart 21: Indian Pharma Midcaps discount to largecaps again at its lowest


Top picks

Given the near-term challenges, we prefer companies with high possibility of earnings

surprise and upgrades driving stock performance. We prefer SUNP and CIPL among the large

caps and CDH in the mid cap space.

CIPL is headed in the right direction as investments in the pipeline/front end begin to deliver.

We expect steady growth and margin recovery going forward, as acquired businesses and

own sales in US/EU start ramping up and multiple new initiatives start contributing (refer

our Q4FY15 note). We believe the Street is under appreciative of operating leverage

benefits in the medium term and have potential to surprise. The launch of combo inhalers in

EU validates the companys capabilities in the space and it establishes itself as one of the best

in developing complex generics.

SUNP is the best on execution capability and has industry-leading financial metrics, solid

management track record and high success with acquisitions. RBXY and SUNP enjoy high

complementarities in geographical spread and product portfolio, and we believe SUNP will be

able to derive immense synergies given its superior track record with acquisitions. We believe

RBXYs turnaround will be faster than widely anticipated. Uncertainty around Form 483

resolution for Halol is the key risk and an Import Alert on Halol will lead to significant

earnings downgrades. Availability of USD2bn cash on books is a comforting factor even if

SUNP decides to go for a large acquisition.

CDHs large unapproved niche ANDA pipeline is awaiting USFDA approval and will be a key

driver of earnings growth. Over the past 3 years, the companys profitability was impacted by

a host of issues including under-utilised capacity, weak revenue growth, thinning joint

venture (JV) margins and high overheads due to acquisitions. However, in recent times,

growth has picked up in the US and India, driving robust margin improvement. Of >150

ANDAs pending approval, a large part is in niche segments (transdermals, nasals, XRs, etc).

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Pharmaceuticals

We believe approvals for CDH may actually get bunched up and drive significant margin

expansion. This could pose upside risk to our estimates.

Table 5: Indian pharma Comparative valuations


**Price to earnings for Sun, Dr. Reddy's, Lupin and Glenmark is adjusted for NPV value of Para-Ivs and outlicensing income

Less preferred stocks

Our least preferred stocks are Ipca Labs, Glenmark and Torrent Pharma, in that order.

Interestingly, all these stocks have strong earnings CAGR over the next 2 years. We believe

current valuations and growth estimates do not factor in emerging risks for the sector or for

the mid caps and there could be downside risk to our estimates.

Ipca is least preferred: We recently downgraded the stock to REDUCE as we believe the

core investment thesis is shaken: (a) low-cost manufacturing advantage hit lower

throughputs because of import ban and higher overhead costs related to remediation will

affect the low cost advantage; (b) US business ramp up uncertain import alert on the

Ratlam API plant has jeopardised the long-term story of US ramp up. Resolution of import

alert will take at least 2 years; (c) even if the US business ramps us faster than anticipated,

RoCE recovery will be delayed given the investments. We believe the road ahead will be

challenging on multiple accounts for Ipca and maintain REDUCE.

GNP has guided for 18-20% revenue growth in constant currency with ~22% EBITDA margin,

contingent on 10-12 approvals. Over the next 2 years, growth (20% plus forecast) is highly

dependent on ANDA approvals and share gains in the US, where some disappointment is

likely. Moreover, EM currency movement and exposure to Venezuela (high risk of currency

devaluation) are also risks. The stock trades at 17x FY17E and prices in most positives.

For TRP, we forecast >40% earnings CAGR over FY15-17, as we assume strong growth in the

US (Nexium, Abilify led) and robust improvement in profitability of India business post revival

of Elder brands. However, the recent structural challenges in Brazil, EM currencies and lack

of ANDAs in pipeline for the US are key concerns. Recent resolution to raise INR100bn (equity

dilution: INR30bn; debt: INR75bn) implies an acquisition could be on the cards. Rich

CMP Target

INR Price FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17ESun Pharma 838 1,085 BUY 31.5 30.7 35.5 43.3 18.8 27.3 23.6 19.3 23.1 17.0 14.1 29.3 29.1 28.6 Lupin 1,780 1,700 BUY 12.5 48.4 60.7 76.5 25.7 36.3 29.0 23.0 21.7 18.4 15.1 27.9 27.5 27.4 Dr. Reddy's 3,425 3,830 BUY 9.1 122.8 145.9 192.0 25.1 27.9 23.5 17.8 17.2 14.8 12.1 20.5 20.3 22.7 Cipla 614 750 BUY 7.7 14.7 21.3 29.6 41.9 35.1 24.2 17.4 23.3 16.8 12.8 11.7 15.2 18.2 Large Cap 30.2 24.8 19.6 21.7 16.9 13.8 Cadila 1,810 1,800 BUY 5.8 55.8 83.8 100.1 33.9 32.4 21.6 18.1 22.1 16.4 13.7 29.5 34.0 30.3 Aurobindo 1,318 1,315 HOLD 6.0 55.6 70.1 82.1 21.5 23.7 18.8 16.1 17.0 13.3 11.5 36.1 33.0 28.6 Glenmark 846 845 HOLD 3.7 28.4 35.7 46.8 28.4 28.0 22.3 17.0 18.6 15.4 12.6 25.7 29.3 29.3 Torrent pharma 1,234 1,160 HOLD 3.3 37.1 53.9 72.6 39.9 33.3 22.9 17.0 18.1 14.6 11.8 28.8 32.6 34.1 IPCA 644 565 REDUCE 1.3 21.2 31.5 40.5 38.2 30.4 20.5 15.9 16.1 12.7 10.2 12.8 16.6 18.3 Natco 2,110 NC NC 1.1 36.2 63.1 100.0 66.1 58.2 33.5 21.1 Indoco 364 NC NC 0.5 9.3 13.5 19.0 42.7 39.0 27.0 19.2 Unichem 177 NC NC 0.3 9.1 12.9 16.6 35.4 19.5 13.8 10.7 Mid Cap 29.0 21.0 17.0 18.6 14.6 12.2 Overall - Generics 29.9 23.9 19.0 20.8 16.2 13.3 Divis 1,775 1,700 REDUCE 3.7 64.0 77.6 94.6 21.6 27.7 22.9 18.8 20.2 16.8 14.0 26.3 27.6 29.0 Overall 29.8 23.8 19.0 20.8 16.2 13.4 Apollo Hospitals 1,209 1,420 BUY 2.6 23.7 39.3 48.5 42.9 50.9 30.7 24.9 24.5 16.7 13.9 11.0 10.4 15.5

EV/EBITDA (x) ROAE (%) Reco

Mcap

(USD bn)

CAGR (%)

(FY15-17E)

P/E (x) Core EPS (INR)


Sector Update

valuations (17x FY17E), fund raising overhang and challenging business environment render

us less constructive on the stock.

Table 6: Indian pharmaQ4FY15 earnings highlights (click on company name to go to the result note)

Company Key to note

Sun Pharmaceuticals - Ranbaxy integration

eclipses quarter

Sun Pharmaceuticals' (SUNP) Q4FY15 reported numbers were well below

estimates due to: (i) one-off expenses related to Ranbaxy (RBXY) amalgamation;

and (ii) continued supply disruptions from Halol due to ongoing remediation.

Even after adjustments for one-off expenses, the numbers are well below

estimates. The company did not provide FY16 guidance citing stil l early stages

of RBXY integration and ongoing supply disruptions. We believe while the

Q4FY15 miss is a one-off, concerns on US business (pending Halol Form 483)

and RXBY integration are an overhang in the near term. However, we are

confident of SUNP's execution and our thesis that the RXBY deal will generate

significant value. Availability of large cash on books and well known business

development capabilities will retain premium valuations. Maintain 'BUY'.

Lupin - More R&D, more M&A; Lupins (LPC) Q4FY15 earnings were below expectations owing to US customer

consolidation headwind, slowdown in ANDA approvals, currency headwinds

and higher cost base of R&D & staff expenses. EBITDA miss of 12% was

cushioned by lower tax rate for the quarter. FY16 outlook (15% revenue growth,

28-30% margin) appears muted given the stellar track record and is contingent

on LPC bagging timely ANDA approvals. Our thesis of earnings downgrades for

the sector is playing out (refer our Q4FY15 preview - All Gain, No Pain??, dated

April 9, 2015). We cut FY16/17E EPS 9%/6% and revise our target price to

INR1,700 (INR1,810 earlier). LPC reiterated its bullish long-term outlook

(USD5bn sales by FY19) with M&A / product pipeline as key growth drivers

(refer our note Good quarter; prepping for inorganic forays, dated February 3,

2015). We are enthused by the stated FY20 aspiration with respect to complex

generics/ biosimilar/ NDDD pipeline and believe long-term structural story

remains intact. Maintain BUY. However, valuations at 21x FY17E may limit

near-term upside. Prefer Cipla and Sun Pharma.

Dr. Reddys Laboratories - Near-term

challenges

Dr. Reddys Laboratories (DRRD) Q4FY15 EBITDA was 4% below our estimate

due to lower gross profit (inferior mix) and higher R&D expenses. Near term

appears challenging because of Russia/Venezuela macros/currency and

continued slowdown in ANDA approvals (Form 483, no ANDA approvals for past

6 months). However, we believe these issues are transient and DRRDs niche

pipeline will continue to deliver in the long term. Maintain BUY. We continue

to prefer Cipla and Sun Pharma in the large-cap space given the near-term

challenges for DRRD.


Pharmaceuticals

Table 6: Indian pharmaQ4FY15 earnings highlights (Contd)

Company Key to note

Cipla - Tepid quarter, but underlying trends

encouraging

Cipla's (CIPL) Q4FY15 EBITDA margin (16.4%) was below estimate with

consolidation of acquired entities and bunching up of R&D diluting the leverage

from strong growth. Exports growth and improvement in gross margin are key

positives and the crux of our thesis. We believe FY16 guidance (15% growth,

150bps margin expansion) is conservative as its initiatives / pipeline start

delivering. Operating leverage and mix will drive 42% EPS CAGR (highest in the

sector) and multiple triggers will support premium valuations. Initial success

with Advair MDI approvals (7 countries in EU, M/S gains) encourages us to add

INR100/share of risk adjusted NPV for respiratory franchise to our target price.

Our revised target price is INR750 (INR770 earlier) - base business at INR650

(17x FY17E) plus respiratory franchise NPV of INR100. Maintain 'BUY' and CIPL

as our top large-cap conviction pick.

Cadila Healthcare - Good quarter; promising

outlook

Cadila Healthcares (CDH) Q4FY15 revenue and EBITDA were largely in l ine with

our estimates, while PAT was marginally ahead. Margin continued to rise (up

270bps YoY, 140bps QoQ) as US delivered healthy growth (9% QoQ, 56% for

FY15) despite lack of meaningful approvals. CDH expects pace of ANDA

approvals to pick up (15-20 in FY16) as several facil ities have been cleared by

USFDA (Moraiya awaiting clearance). We believe FY16 guidance of INR100bn

revenue and 21% margin are conservative if these approvals come through.

However, escalation (Warning Letter / Import Alert) of pending Form 483 at

Moraiya facil ity remains a key risk. We raise our EPS (to 34% EPS CAGR, FY15-

17E) and our target price to INR1,800 (18x FY17E) in anticipation of ANDA

approvals. Maintain BUY. CDH remains top pick among mid caps.

Aurobindo Pharma - Largely in line Aurobindo Pharma's (ARBP) revenue/ EBITDA were broadly in l ine with

expectations, driven by good growth in US formulations (up 20% YoY) as well as

acquisitions (Actavis/ Natrol). The company borrowed USD104mn for Natrol

acquisition, and hence net debt surged YoY despite reduction in H1FY15.

Management held on to its guidance of breaking even at PAT level with Actavis

portfolio by FY16 end. While we are enthused by the high growth trajectory in

US, the risk associated with integrating recent acquisitions renders us less

constructive. Current valuations at 17x FY17E EPS leave limited room for

upside. maintain 'HOLD' with TP of INR1,315.

Divi's Laboratories - Gross margin surprises;

outlook unchanged

Divi's Laboratories' (Divi's) Q4FY15 revenue was in l ine with our estimate.

However, the mix was better than our anticipation with higher custom synthesis

contribution, which drove better-than-expected gross margin. EBITDA was 5%

higher than estimate. The company has maintained its guidance of 15-20% top-

line growth in constant currency, with ~37% EBITDA margin. We have tweaked

our estimates slightly and revised our TP to INR1,700 (INR1,635 earlier).

Maintain 'REDUCE' on weak outlook and rich valuations.


Sector Update

Table 6: Indian pharmaQ4FY15 earnings highlights (Contd)


Company Key to note

Glenmark Pharmaceuticals - Growth priced in; Glenmark Pharma's (GNP) Q4FY15 EBITDA beat (in l ine revenue) was led by

exceptionally high gross margin (Q4 raw material cost adjustments, to

normalise) and certain one-off costs (INR1.2bn). While India continued strong

show, US remained muted. For FY16, the company has guided for 18-20%

revenue growth in constant currency with ~22% EBITDA margin, contingent on

10-12 approvals (GNP guidance). Over the next 2 years, growth (20% plus

forecast) is highly dependent on ANDA approvals and share gains in the US,

where some disappointment is l ikely. Moreover, emerging market currency

movement and exposure to Venezuela (high risk of currency devaluation) are

also risks. The stock trades at 18x FY17E and prices in most positives. This

prompts us to downgrade to 'HOLD'.

Torrent Pharmaceuticals - Upbeat US outlook

priced in

Torrent Pharmaceuticals (TRP) Q4FY15 revenue came in l ine, but higher costs

(some one-offs not quantified) depressed EBITDA margin (14%). PAT beat

estimate due to high other income (largely forex gains). TRP is upbeat on US

(Abilify, Nexium, Detrol LA opportunities), but acknowledged a weak US pipeline

for the long term. Outlook for Elders acquired brands remained bullish and it

expects the business to be EPS accretive a year earlier than previous guidance.

We believe our estimates capture the fi l l ip that could come from limited

competition opportunities in the US and acquired Elder brands. At 17x FY17E,

we see limited upside and believe there is risk to estimates if Abilify and

Nexium markets turn more competitive. Maintain HOLD.

Ipca Laboratories - Challenging and uncertain

times

Ipca Laboratories' (Ipca) Q4FY15 adjusted EBITDA of INR537mn was below our

as well as Street's INR735mn and INR1,052mn estimates, respectively. Though

revenue was in l ine, adjusted EBITDA margin at 8.5% was well below forecast.

The company is guiding for a better FY16 and 10% revenue growth and 17-18%

EBITDA margin, which is achievable if institutional business normalises. With 3

facil ities under import alerts, US business recovery looks uncertain as it

entirely hinges on further action by USFDA, nature and timeline of which is

unpredictable. Additionally, split of management's bandwidth between various

business/regulatory challenges can slowdown recovery. Current valuations at

16x FY17E also leave limited room for upside. Maintain 'REDUCE' with target

price of INR565 and maintain Ipca as our least preferred pick post our recent

downgrade.


Pharmaceuticals

Chart 22: Relative performance of pharma to Sensex


Chart 23: Performance within sector (relative to Sensex and absolute)


23

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(%)

BSE HC Nifty

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(14) 0 14 28 42

DishmanApollo hospitals

CiplaSun pharma

IPCALupinDivis

Dr Reddy'sJubilant

GSKPfizer

GlenmarkTorrent

AurobindoCadila

(%)

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(11)(7)

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DishmanApollo hospitals

CiplaSun pharma

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3-m Absolute


Sector Update

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Aurobindo

Nirav Sheth

Head Research

[email protected]

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai 400 098. Board: (91-22) 4009 4400, Email: [email protected]

Coverage group(s) of stocks by primary analyst(s): Pharmaceuticals

Apollo Hospitals Enterprise, Aurobindo Pharma, Cadila Healthcare, Cipla, Divi's Laboratories, Dr.Reddys Laboratories, Glenmark Pharmaceuticals, Ipca Laboratories, Lupin, Ranbaxy Laboratories, Sun Pharmaceuticals Industries, Torrent Pharmaceuticals

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe

Rating Distribution* 155 45 8 208

Market Cap (INR) 151 54 3

Date Company Title Price (INR) Recos

Recent Research

02-Jun-06 IPCA Laboratories

Challenging and uncertain times; Result Update

652 Reduce

01-Jun-15 Aurobindo Pharma

Largely in line; Result Update

1,360 Hold

01-Jun-15 Glenmark Pharma

Growth priced in; Result Update

866 Hold

> 50bn Between 10bn and 50 bn < 10bn

Buy Hold Reduce Total

Rating Interpretation

Buy appreciate more than 15% over a 12-month period

Hold appreciate up to 15% over a 12-month period

Reduce depreciate more than 5% over a 12-month period

Rating Expected to

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Sector Update

DISCLAIMER

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