INITIATING COVERAGE: Divi’s Laboratories Jubilant Life ......Q1 FY11 Q2 FY11 Q3 FY11 Q4 FY11 Q1 FY12 Q2 FY12 Q3 FY12 Q4 FY12 Q1 FY13 (%) Divis Jubilant Shasun Pharma Dishman 0.0

Edelweiss Securities LimitedManoj Garg+91 22 6623 3302manoj.garg@edelcap.com

Perin Ali+91 22 6620 3032 perin.ali@edelcap.com

INITIATING COVERAGE:

Divi’s Laboratories

Jubilant Life Sciences

1 Edelweiss Securities Limited

Pharmaceuticals

Executive Summary

Positive trends in major lead indicators — R&D spend, biotech funding, project pipeline and outsourcing penetration—reinforce our optimism in the long term traction in pharma outsourcing space. Moreover, loss of exclusivity on patented products, dwindling R&D productivity and internal cost pressures have made outsourcing imperative for global pharma majors. We strongly believe that a combination of expanding pipelines and shrinking internal resources will further

spur outsourcing. Additionally, Asian countries are garnering higher share of the CRAMS space as the global economic balance is shifting from the West to the East. Consolidation, cost cutting, currency cripple CRAMS in FY09‐11 Over FY09‐11, the CRAMS industry across the globe was severely crippled by global consolidation, cost cutting, inventory rationalisation, a funding crisis among small biotech companies and adverse currency fluctuations. Growth of three major Indian CRAMS players had plunged from 34% CAGR over FY06‐09 to 5% CAGR over FY09‐FY11.

Outlook brightens as revenue traction, funding improve since FY11 Post a rough patch where growth had almost came to a grinding halt, most CRAMS companies have seen a revenue traction over the past 4‐5 quarters. Even net new business and book‐to‐bill ratios of global CRAMS majors have enhanced significantly. Moreover, funding for small and mid‐sized biotech companies is beginning to improve, which bodes well for CRAMS companies.

Growth is here to stay as global pharma majors face harsh realities Loss of exclusivity on patented products, a dwindling R&D pipeline and bid to realign business models to new realities have made pharma outsourcing imperative for global pharma majors. We strongly believe that a combination of expanding pipelines and shrinking internal resources will further spur outsourcing.

Valuations yet to catch up with prospects; initiating Divis, Jubilant Post its strong operating numbers, our CRAMS universe has jumped up by almost 15% though it still trades at 40% discount to its May 2008 valuations, thereby leaving a significant scope for multiple expansion. We expect valuations to move up going forward with most CRAMS players projecting quality earnings as a favourable macro environment helps improve growth visibility while the focus on deleveraging balance sheet betters return ratios. We initiate coverage on Divi’s (BUY/SP) and Jubilant Life Sciences (BUY/SP).

(Click here for video clip)

http://www.edelresearch.com//webcast/webcast_new.aspx?Id=21555&Type=ynaj9XvqmJoptbYzJzovtA==

Pharmaceuticals


Contents

What impacted growth in FY09-11? ........................................................................................ 3

What has changed?.................................................................................................................. 7

Growth is here to stay............................................................................................................ 10

But, valuations yet to catch up .............................................................................................. 14

Companies (Initiating Coverage)

Divi’s Labs .............................................................................................................................. 17

Jubilant Life Sciences ............................................................................................................. 37

Pharmaceuticals


What Impacted Growth in FY09-11?

Global consolidation, cost cutting, inventory rationalisation and funding crisis to small

biotech companies coupled with adverse currency fluctuations had impacted the CRAMS

industry across the globe in FY09-11. Growth of three major Indian CRAMS players had

plunged from 34% CAGR over FY06-09 to 5% CAGR over FY09-11.

Chart 1: Growth of Indian CRAMS players dwindled during FY09-11

Source: Company, Edelweiss research

Global consolidation impacted order flow

During 2008-10, there has been a sharp rise in mergers and acquisitions within global

pharma as declining R&D productivity, delay in new approvals, incremental pressure on

developed economies to cut healthcare costs followed by huge patent expiries made it

imperative for big pharma to consolidate. While rationale behind the consolidation was

largely to improve operational efficiency and strengthen the late stage pipeline, it negatively

impacted CRAMS companies as global majors switched to cost rationalisation mode in order

to conserve cash.

(30.0)

0.0

30.0

60.0

90.0

120.0

FY07 FY08 FY09 FY10 FY11 FY12

(%)

Divis Jubilant Dishman

Global consolidation, cost cutting

and inventory rationalization

impacted CRAMS industry

Pharmaceuticals


Table 1: Key global M&A deals during 2008-10 (USD bn)

Source: Industry, Edelweiss research

Global pharma majors pruned inventory levels

Global consolidation coupled with economic crisis necessitated pharma majors to prune

inventory levels across manufacturing facilities to boost operational efficiency and reduce

working capital. Global majors have cut inventory levels from a peak of two to three years to

a more manageable 9-12 months over FY09-11, which impacted the growth rate of CRAMS

companies during the same period (see Chart 1).

Lower R&D spending impacted CRO industry

R&D spending has been a key growth driver of the CRO (contract research) industry.

Historically, an increasing amount of money was allocated to a growing number of drugs

under development, coupled with ever-expanding size of clinical trials which led to mid-

high double–digit growth in R&D spend. However, owing to funding crunch in small biotech

companies and research productivity challenges for big pharma, R&D spending was pruned

across all levels. This is evident from the fact that R&D expenditure for companies have

come down from the peak of 15% in CY06-07 to negative 2-3% in Q1CY09. Moreover,

companies stated to concentrate more on late stage molecules over early stage molecules.

S. No. Date Value Acquirer Target

1 Mar-07 14.5 Schering Plough Organon

2 Jul-07 1.7 GlaxoSmithKline Reliant Pharma

3 Aug-08 1.4 Shionogi Sciele Pharma

4 Oct-08 6.5 Eli Li l ly ImClone

5 Jan-09 68.0 Pfizer Wyeth

6 Mar-09 46.8 Roche Genentech

7 May-09 1.0 Johnson & Johnson Cougar Biotech

8 Sep-09 2.6 Dainippon Sumitomo Sepracor

9 Nov-09 41.1 Merck & Co. Schering-Plough

10 Jul-09 3.6 GlaxoSmithKline Stiefel

11 Feb-10 4..5 Abbott Solvay

12 May-10 3.7 Abbott Piramal Healthcare unit

13 Oct-10 3.6 Pfizer King Pharma

14 Dec-10 51.0 Novartis Alcon

Consolidations among larger

players resulted in inventory

rationalisation

Pharmaceuticals


Chart 2: R&D spending has declined

Source: William Blair & Co, Parexel, Edelweiss research

While low activity on R&D had relatively lesser impact for Indian CRAMS companies due to

their low exposure in contract research, however, companies like Dishman, Jubilant Life

Sciences and Biocon bore its brunt.

Earnings hit by upfront investment, adverse currency movement

CRAMS, being a capital intensive business, needs upfront investments. Owing to favourable

macro outlook and strong growth, most CRAMS companies in India made significant

investments during FY07-09.

Chart 3: Companies added huge capacities in anticipation of strong order flows


Jubilant and Dishman invested heavily via both organic as well as inorganic routes, resulting

in higher foreign currency debt on their balance sheets. Slowdown in earnings coupled with

overleveraged balance sheets and adverse currency movements had negatively impacted

the bottom lines of these companies.

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Historical trend 8.5%

Recession and

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Jubilant Divis Dishman

R&D expenditures have come

down from the peak of 15% to

negative 2-3%

CRAMs companies invested heavily

via both organic and inorganic

routes

Pharmaceuticals


Chart 4: Adverse currency movement has led to increase in MTM losses


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Pharmaceuticals


What Has Changed?

Revival in industry

Post a rough patch in FY08-10 (where growth had almost stalled), most CRAMS companies

have posted better traction in revenue over the past four-five quarters. Even the

performance of global players indicates that overall environment for outsourcing is

improving and growth will accelerate going forward. This is also evident from the fact that

net new business and book-to-bill ratios of global CRAMS majors have improved significantly.

While CRAMS players across the globe have posted recovery, Asian CRAMS players have

registered higher growth than their western counterparts.

Chart 5: Consistent improvement in growth traction across CRAMS players


Chart 6: Uptick in net orders & book to bill ratio for global CRAMS players


(23.0)

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Covance Paraxel Icon

Both domestic and global CRAMs

players witness improved traction

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Pharmaceuticals


Biotech funding is improving

Funding crunch to small and mid biotech firms was one of the key reasons for R&D slow

down, however, the funding scene is improving. As seen in chart 7, the overall funding

continues to rise, however, the industry has witnessed a shift in the funding sources with

partnering and debt providing the larger proportion. Similarly, while venture capitalists

(VCs) are betting more money on late stage candidates, early stage companies continue to

face headwinds.

Chart 7: Uptick in biotech funding

Source: Bioworld, Edelweiss research

Chart 8: Source of biotech funding

Source: Covance; Edelweiss research

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IPO Follow-ons PIPEs Private Debt Partnering

Biotech funding over the past few

quarters has improved consistently -

a positive for CRAMS companies

Partnerships and debt are key

sources of funding for small and

medium biotech firms

Pharmaceuticals


Chart 9: Venture capital investments in bio-pharma within US

Source: Pharmatech; Edelweiss research

Improving R&D pipeline of small and mid-sized pharma companies

Small and mid-sized biotech companies’ share of pipeline has grown from 79% in CY08 to

82% in CY10, which bodes well for CRAMS companies as these boutique R&D firms focus

their entire resources on R&D rather than manufacturing. Numerous channel checks and

lead indicators suggest that small and mid-sized biotech companies have pruned their

decision making time and ramped up spending. We highlight that if this trend continues, it

will spur demand across the development spectrum, but particularly in early stage, where

small biotech firms tend to focus on buying power.

Chart 10: Small and mid-sized bio-pharma firms own more than 80% of IPR

Source: Parexel

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Easy funding is available for late

stage candidates while early stage

companies continue to struggle for

capital

Pharmaceuticals


Growth is here to stay

Global R&D spend on the rise

Post slowdown in R&D spending in 2009 and 2010, it has ramped up over the past four-five

quarters across all three segments of players (from large pharma to small biotech firms). As

per recent survey conducted by Pharma source, while large pharma expects acceleration in

spending by three percentage point, mid and small biotech pharma expects R&D spending

to surge 6 and 14 percentage points, respectively. Overall, global R&D spending is likely to

increase from USD116bn in CY2011 to USD132bn by CY2015.

Chart 11: Increase in R&D spends to bolster CRAMS growth Chart 12: R&D investments expected to rise

Source: Parexel

Drugs worth USD75bn set to lose exclusivity

Drugs worth USD75bn will be going off patent over the next three years (CY12-15), which

would result in 10-40% revenue loss for global major players. We believe that global players

are finding it hard to replace blockbuster drugs and there is sharper focus on improving

operational efficiencies to enhance profitability. This is likely to boost outsourcing of

pharma activities in a major way to low-cost destinations like India and China.

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Large Pharma Midsize Pharma Small Pharma

R&D spending is likely to increase

from the current USD116bn to

USD132bn by 2015

Pharmaceuticals


Chart 13: Several blockbuster drugs going off patent over CY12-15

Source: Edelweiss research

Project pipeline on the rise

Global pharma companies across the spectrum are incrementally focusing on new product

development to replace their existing blockbuster drugs. According to Pharma projects data,

there are roughly 9,600 products in the pipeline from pre clinical through registration (up by

6% over FY10 and 14% since January 2009).

Given the impending wave of branded products that are set to lose patent protection over

the next few years, the focus of global pharma companies appears to be on later-stage

clinical products, particularly at large pharma companies. Though pipeline expectations for

discovery compounds at large pharma seems to be lower at this point, we expect them to

reaccelerate as drug discovery is critical to the industry’s long-term success. Chart 14, below,

indicates that pipeline compounds have improved, particularly in Phase II and III, over the

past two years. While pre clinical and Phase I compounds have also grown, they have done

so at a slower rate.

Chart 14: Pipeline compounds under various phases of development

Source: Industry

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Pharmaceuticals


Source: Industry

Outsourcing remains imperative

The outsourcing trend has been further accentuated by a broader strategic mindset shift

among pharma majors to focus on a few core strengths and look for competent partners for

other activities. Impending large scale patent expiration and lack of sufficient new products

to replace them is providing further impetus to global pharma players to step up

outsourcing initiatives. Loss of exclusivity on patented products, dwindling R&D pipelines

and bid to realign business models to new realities is imperative for global pharma majors to

protect profitability.

Outsourcing penetration

We strongly believe a combination of an expanding pipeline and shrinking internal resources

will spur outsourcing. According to PharmSource, outsourcing penetration will increase

across nearly all areas of development. The overall clinical development outsourcing market

is likely to increase from USD13.8bn in CY11 to USD20.4bn in CY15, while the penetration

rate is likely to surge from 23.3% in CY11 to 31.9% in CY15 (chart 20).

Chart 15: Outsourcing penetration to increase with improved macro outlook

Source: William Blair, Parexel

1,304

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Clinical development Penetration rate

Outsourcing penetration to

increase from 23% in CY11 to 32% by CY15

425

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Pharmaceuticals


Asia is gaining more importance

Asian countries are assuming more importance in the CRAMS space as the global economic

balance is shifting from the West to the East. Solid infrastructure (highest number of FDA

approved plants), vast skilled manpower, availability of treatment naïve patients and large

pools of scientific manpower are key factors for global majors to take Asian countries more

seriously. These factors not only reduce drug development costs, but also reduce the

development time and, therefore, more time to market the products for global pharma

players.

Pharmaceuticals


But, Valuations Yet To Catch Up

CRAMS universe has jumped 15% since January 2012, post strong operating performance

over the past three-four quarters. However, it is still trades at 40% discount to its May 2008

valuations. CRAMS universe, from 2007-2010, used to trade at par with BSE Healthcare

Index, but 2010 onwards it started trading at a discount due to poor operating performance,

over leveraged balance sheets and huge forex losses on account of adverse currency

movement. With favourable macro environment, improved growth visibility and focus on

deleveraging balance sheets, we expect the valuation gap between CRAMS universe and BSE

Healthcare to narrow going forward.

Chart 16: CRAMS valuations trading at a discount to BSE Healthcare Index

Source: Bloomberg, Edelweiss research

Expect 28% earnings CAGR over FY12-14E

We expect our CRAMS universe revenue to grow at 19.2% CAGR over FY12-14E, driven by

22% revenue growth in Divi’s and 16.4% revenue growth in Jubilant Life Sciences. Improved

business mix and higher capacity utilization will lead to 120bps expansion in operating

margins (21.9% EBIDTA growth), resulting 28% earnings CAGR over FY12-14E.

Table 2: CRAMS universe - key growth matrix (FY12-14 CAGR) (%)


Initiate coverage with BUY on Divi’s and Jubilant Life Sciences

We estimate revenue CAGR of 22% over FY12-14E for Divi’s, driven by a) 20% CAGR in CCS

business and b) 20% CAGR in Carotenoids segment. We expect earnings CAGR of 26% over

FY12-14E, resulting an EPS of INR50.6 to INR63.3 for FY13/14E, respectively. With best in

class margins and return ratios, strong cash flows, improvement in working capital cycle and

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CRAMS BSETHC Relative premium (RHS)

Revenue EBIDTA PAT EPS

Jubilant 16.4 20.1 30.4 30.4

Divi's 22.0 23.7 26.1 26.1

CRAMS universe 19.2 21.9 28.2 28.2

Pharmaceuticals


strong growth visibility, we expect stock to trade in-line with front line pharma stock. We

initiate coverage with ‘BUY’ rating and TP of INR1265.

We expect JOL to report revenue and earnings CAGR of 16.4% and 30% over FY12-14E. We

have adjusted our earnings net of R&D expenses being capitalized and our EPS works out to

be INR20.2 and INR28.8 for FY13/14E respectively. With improved earnings visibility (30%

earnings CAGR), focus on deleveraging balance sheet (expect DE to come down to 1x by

FY14) and improved return ratios, we expect stock to trade in its long term one year forward

average multiple of 10-11x. We initiate coverage with a ‘BUY’ rating and target price of

INR290.

Table 3: Peer comparison


*Note: Jubilant EPS is adjusted for R&D costs capitalised

Peer comparision valuation

Price

INR FY13E FY14E FY13E FY14E FY13E FY14E FY13E FY14E

Jubilant* 205 20.2 28.8 10.2 7.1 6.0 4.7 15.5 18.3

Dishman 96 10.7 14.9 9.0 6.5 5.9 4.9 8.8 11.1

Divi's 1,100 50.6 63.3 21.8 17.4 17.0 13.8 28.3 28.7

CRAMS 13.6 10.3 11.5 9.4 18.6 19.9

ROAE (%) EPS (INR) P/E (x) EV/EBITDA (x)

Pharmaceuticals


THIS PAGE IS INTENTIONALLY LEFT BLANK

Pharmaceuticals


Divi’s Laboratories (Divi’s) will be a key beneficiary of increased outsourcing

opportunities driven by its expertise in complex chemistry, cost efficient

processes and relationship with global pharma majors. Divi’s strategy to

collaborate rather than compete and its India-centric business model has

led to preferred and most efficient CRAMS players. We expect Divi’s

revenue and earnings to post 22%/ 26% CAGR over FY12-14E, respectively.

We initiate coverage with ‘BUY/ SP’ and TP of INR1265 (20x FY14E).

Custom synthesis business: Superior play

CCS business contributes nearly half of Divi’s top line and its profitability is superior

than APIs and intermediate business. The company’s CRAMS business has grown from

INR797mn in FY05 to INR8173mn in FY12 (39% CAGR), while EBIDTA margin has

improved from 30.1% in FY05 to 41% in FY12. We expect this business to post 20%

CAGR over FY12-14E driven by rich pipeline and strong customer relations.

Generic API: Global leadership, new launches to drive growth

Post 23% growth decline in FY10 due to inventory de-stocking, Divi’s generic business

has staged a strong recovery and posted 41% CAGR over FY10-12, and accounts for

nearly half of its turnover. A focused and intense product strategy differentiates the

company from other generic API manufacturers. We believe upcoming patent cliff

opportunity in US and new launches will drive 20% CAGR in generic business.

Best-in-class margins and return ratios

What differentiate Divi’s from other players in the CRAMS space in India is its

commitment to maintain profitability and capital efficiency. As a matter of fact, it is not

only the most profitable company in the space, but also features among the most

profitable companies in the Indian healthcare sector, with EBIDTA margin of 35-40%,

backed by its strong chemistry skills and custom synthesis presence.

Outlook & valuations: At a premium; initiate with ‘BUY’

Stock is currently trading at 15% discount to its historical 5 yr average of 20x (one-year

forward earnings). With best-in-class margins/return ratios, strong cash flows and higher

growth visibility, we expect the stock to trade in line with frontline generics.

Edelweiss Research is also available on www.edelresearch.com,

Bloomberg EDEL , Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

DIVI’S LABORATORIES Good times to continue

INITIATING COVERAGE

India Equity Research | Pharmaceuticals

EDELWEISS 4D RATINGS

Absolute Rating BUY

Rating Relative to Sector Performer

Risk Rating Relative to Sector Medium

Sector Relative to Market Underweight

MARKET DATA (R: DIVI.BO, B: DIVI IN)

CMP : INR 1,100

Target Price : INR 1,265

52-week range (INR) : 1,201 / 695

Share in issue (mn) : 132,7

M cap (INR bn/USD mn) : 145 / 2,816

Avg. Daily Vol.BSE/NSE(‘000) : 208.6

SHARE HOLDING PATTERN (%)

Current Q4FY12 Q3FY12

Promoters %

52.2 52.2 52.2

MF's, FI's & BK’s 17.2 17.3 17.3

FII's 10.2 9.6 10.2

others 20.4 20.9 20.8

* Promoters pledged shares

(% of share in issue)

: NIL

RELATIVE PERFORMANCE (%)

Sensex Stock

Stock over

sensex

1 month 9.2 (4.9) (14.1)

3 months 8.1 8.5 0.4

12 months 16.7 50.2 33.5

Manoj Garg

+91 22 6623 3302

manoj.garg@edelcap.com

Perin Ali

+91 22 6620 3032

perin.ali@edelcap.com

Financials

Year to March FY11 FY12 FY13E FY14E

Revenues (INR mn) 13,165 18,640 22,582 27,658

EBITDA (INR mn) 5,009 6,994 8,568 10,568

Adj. Diluted EPS (INR) 32.4 39.7 50.6 63.3

EPS growth (%) 25.7 22.7 27.3 25.3

P/E (x) 34.0 27.7 21.8 17.4

EV/EBITDA (x) 28.1 20.2 16.3 13.0

ROAE (%) 25.9 27.6 28.3 28.7 October 08, 2012

Pharmaceuticals


Investment Rationale

Established pedigree to reap benefits of outsourcing boom

Divi’s early mover advantage in CRAMS, strict adherence to IPR norms and strong

relationship with pharma majors marked its transformation from an API player to a

successful CRAMS player from India. By virtue of its long standing presence, the company

has managed to establish itself in this segment, with CRAMS segment contribution surging

from 22% in FY06 to 48% in FY12. It services 20 of the top 25 global companies and has

become a prominent player in custom synthesis services from India. The company

collaborates with innovator companies through the early drug development stage to the

commercialisation stage.

We highlight that Divi’s will be one of the biggest beneficiaries of increased outsourcing

plans of innovators, given its successful execution skills in the custom chemical synthesis

(CCS) domain.

Custom synthesis business: Superior play

The custom synthesis business contributes nearly half of Divi’s top line and has superior

profitability than APIs and intermediate business. Custom synthesis involves process

research and manufacture of new chemical entities where the service provider is involved

with the innovator from the early stage of drug lifecycle. It provides them process and

synthetic chemistry services such as process design for new drug candidates, process

optimisation, product yield improvement, etc. These services entail significant cost savings

for innovators. Besides, outsourcing these activities gives the innovator an opportunity to

focus on core area of R&D and marketing.

The scales of these products vary based on the stage of the drug ranging from grams/

kilograms to 100’s of kilograms. The lower the scale, the better the margin in general.

Moreover, a manufacturer involved with a product from the early development stages is

likely to remain the key supplier post approval as well.

Provides end-to-end service in custom synthesis

Divi’s has four R&D centres and two pilot plants. Through these, it has strong presence in all

stages of product development, starting from process development in labs to all stages of

pre-clinical and clinical trials. The company also provides complete regulatory support,

including DMF filings and large scale commercialisation of the product. Hence, innovator

companies get the whole gamut of services under one umbrella.

The company has developed significant capabilities in this space and has been able to

provide services to the top 20 innovator companies over the past few years. These

capabilities are evident from the fact that Divi’s has been able to maintain high growth and

best-in-class EBIDTA and return ratios consistently. Its CRAMS business has grown from

INR797mn in FY05 to INR8173mn in FY12 (39 % CAGR), while EBIDTA margin has improved

from 30.1% in FY05 to 41% in FY12.

Divi’s serves top 20 global

innovator companies

Pharmaceuticals


Chart 1: CCS revenue ramp-up and EBIDTA margins


Rich pipeline, strong customer relationship to fuel growth

By virtue of long standing presence in the CRAMS space, strong chemistry skills and its

collaborative approach, Divi’s has managed to establish strong relationships with many large

global innovators. It generally collaborates with innovators at the NCE development stage

and partners the innovator right up to the late life cycle management stage of the product.

Post patent expiry, Divi’s also partner for APIs supply. We believe it is imperative for any

CRAMS player to have presence across the value chain to become a preferred partner.

In our view, CCS business has two advantages—first, entry barriers are relatively high as it

takes years to build a relationship with clients. Second, the business is generally sticky in the

sense that the manufacturer involved from the early stages of development is likely to

remain a key supplier post commercialisation of the product.

Divi’s has a sizable pipeline of custom synthesis products, though the company does not

disclose the same due to confidentiality reasons. Of these, even if a few drugs reach the

market, it would give the company a significant revenue opportunity. Moreover, commercial

manufacturing contracts are generally long term, with high revenue visibility. In the past few

years, growth in Divi’s CRAMS business has partly been driven by commercialisation of such

projects (39% CAGR over FY05-12). Divi’s currently supplying API for 3 commercialised

molecules. We expect this business to post 20% CAGR over FY12-14E.

24.0

29.8

35.6

41.4

47.2

53.0

637

2,471

4,305

6,140

7,974

9,808

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

(%)

(IN

R m

n)

Revenue EBIDTA margins (%)

Divi’s presence across the value

chain in CCS business makes it a

preferred partner

Pharmaceuticals


Chart 2: Products addition in CCS segment

Source: Company

Generic API: Global leadership in key products; new launches to drive growth

Divi’s generics business comprises manufacture and supply of APIs and key intermediates of

drugs that are already generic in most global markets. The company exports > 80% of its

products and sells a small portion to domestic pharma companies. Divi’s has 36 US DMF

filings and 13 European CoS (certificate of suitability) filings. Post 23% decline in FY10 due to

inventory de-stocking, the company’s generic business has shown strong recovery and grew

41% CAGR over FY10-12 and accounts for nearly half of its turnover.

Chart 3: Generic revenue posted at 41% CAGR over FY10-12


Focused product strategy to attain global leadership

A focused and intense product strategy differentiates Divi’s from other generic API

manufacturers. The company selects products with complex chemistry, develops proprietary,

efficient processes to manufacture them and tries to capture a large share of the global

market for products (more than 70% of market share) where it can control pricing to a great

extent. This is evident from the fact that top 3 APIs such as Naproxen (18-19% of Divi’s

4

6

9

11

14

16


(No

of P

rod

uct

Ad

dit

ion

)

(27.0)

(9.2)

8.6

26.4

44.2

62.0

2,149

3,912

5,675

7,439

9,202

10,965

FY06 FY07 FY08 FY09 FY10 FY11 FY12

(%)

(IN

R m

n)

Revenue Growth (%)

Pharmaceuticals


overall revenue), Dextromethorphan (8-9% of revenue) and Nabumetone (2-3% of revenue)

contribute ~30% to Divi’s overall revenue and enjoy significant market share (over 70%).

These three products highlight the company’s focused strategy in identifying, developing,

manufacturing and marketing of products. Further, as these products are present in the

market since long, we believe they are unlikely to face much price erosion and will remain

cash cows for an extended period.

Table 1: Key generic products


The high global market share gives significant pricing power to Divi’s. Further, the company

continues with process R&D in the manufacture of these products, continuously reducing

manufacturing costs, and maintaining cost leadership, which helps it sustain market share

and profitability.

Divi’s follows a rigrous criteria to take up any new product which includes:

• Complex chemistry that will limit global competition.

• Scope for process improvemnet.

• Scope for large market share in large global market.

New launches to drive growth

Upcoming patent cliff in the US and recent genericisation of products like Quitapine and

Valsartan augur well for Divi’s API busimess over the long term. With a portfolio of 36

products in its bag (25 more products are under development), the revenue scale up to

INR9bn (~INR250mn per product) is immpresive, reflecting the company’s astute product

selection process. Further, the company is awaiting USFDA approval for over 10 products

which has market potential of USD8-9bn (innovator market size). Moreover, it has a strong

development portfolio with a market potential of over USD10-12bn. Divi’s recent launces

such as Levitracetam (over 75% market share), Gabapentin (quickly ramping up market

share), Levodopa and Carbidopa have witnessed strong traction and enthuse us with

confidence that new launches will drive future growth. We expect this business to post 20%

CAGR over FY12-14E.

Product name Therapeutic area Indication

Global market

(USD mn)

Naproxen Osteoarthritis Pain 377

Dextromethorphan Cold and cough Cough 249

Nabumetone Osteoarthritis Pain 67

Levodopa CNS Parkinson disease 79

Phenylephrine Cold and cough Cough 26

A focused and intense product

strategy differentiates the

company from other generic

players

Pharmaceuticals


Table 2: New additions will drive growth


Further, the company adds capaciities for manufacture only after obtaining clear visibility of

orders for products. Hence, it hardly has any idle capacity. These factors engender

sustainable profitability and capital efficiency.

Table 3: Products under development


Chart 4: New product addition in generic segment


Carotenoids: Building blocks for future growth

Nutraceuticals ingredients are a relatively new segment and Divi’s is targeting carotenoids

as an additional growth driver in the coming years. It is targetting the global synthetic

Brand Generic Indication

Market size

(USD bn)

Patent

expiry date

Seroquel Quetiapine CNS 3,107 Expired

Diovan Valsartan CVS 2,520 Expired

Nisapan Niacin Cholestrol 927 Sep'13

Xeloda Capecitabine Oncology 545 Dec'13

Micardis Telmisartan CVS 298 Jan'14

Benicar Olmesartan CVS 1,337 Oct'16

Lyrica Pregabalin CNS 1,424 Dec'18

Product Name Therapeutics Indication Global sales (USD mn)

Aliskirin Hemifumarate CVS Cholestrol 557

Atazanavir CNS HIV 1400

Atorvastatin CVS Cholestrol 10000

Bazodoxifene RA Post Menopausal Osteoporosis Yet to get approval in US

Chlophedianol HCL CNS Cough Supressant 275

Fesoterodine CNS Anti-Diuretic 140

Fondaparinex CVS Anti-Cogulant 550

Saxagliptin Diabetes Anti-Diabetic 600

Valgaciclovir Anti-Viral Anti-Viral 575

0

2

4

5

7

9


No

of p

rod

uct

ad

dit

ion

s

Divi’s is awaiting approvals for

over 10 products, having a market

potential of over USD8bn-9bn

Pharmaceuticals


carotenoids market by tying up with feed manufacturers. The global carotenoids market-

including food, feed and pharmaceuticals is estimated at about USD1bn. EU accounts for

almost half of this market and the US accounts for about 20%. Feed will continue to

dominate carotenoids’ demand for the next few years. This business has high entry barriers

because of complexities in manufacturing.

Divi’s has so far been a marginal player in the global carotenoids market with less than 2%

market share. Although the company entered this segment four years ago and enjoys a

significant cost advantage, ramp up has been slower than expected owing to the need for

certication from separate regulatory agencies across end user markets.

Chart 5: Carotenoids market break-up

Source: Industry

Moreover, as the market is largely dominated by two well entriched players—DSM and BASF

(over 55% market share)—penetration has been rather difficult for new players like Divi’s

with a limited portfolio. However, with gradual increase in portfolio size (from 6 products in

FY09 to 10 in FY12), its strategy to build customer specific products and most regulatory

approvals in place, we believe the company is now well placed in this market. What we

believe will shift the pendulum for new players like Divi’s is: (a) significant price hike of

select products owing to supply-side constraints from existing manufacturers; and (b)

gradual shift in focus from synthetic to natural carotenoids (3-4x expensive) of major players

like DSM and BASF (recent acquistions DSM-Vitatene, LycoRed-Vitan and BASF-Cognis have

all been in naural carotenoid space) due to intense competition from cheaper Chinese and

Indian suppliers, lead us to believe that the ramp up is likely to be faster.

Table 4: Recent price hikes in Carotenoids market

Source: Industry

Beta-carotene

22%

Lutein

19%

Astaxanthin

19%

Canthaxanthin

7%

Lycopene

5%

Others

28%

Hike initiated by Period Price hike Carotenoids

BASF April '11 12% Canthaxanthin, Citranaxanthin, C30-

ester, Beta-carotene

Across the board April '11 ~100% Lutein

DSM Nov'11 20% Beta-Carotene

DSM May'12 7% Carophyll

Company expects carotenoids

business to grow 40%-50% CAGR

over next 2-3 years

Pharmaceuticals


Management has given guidance of growing this business at 40-50% CAGR (albeit on a low

base) over the next 2-3 years and we believe that growth drivers are in place.

Best-in-class margin and return ratio

What differentiates Divi’s from other players in the CRAMS space in India is its commitment

to maintain profitability and capital efficiency. As a matter of fact, Divi’s is not only the most

profitable company in the CRAMS space, but also features among the most profitable

companies in the Indian healthcare sector with EBIDTA margin of 35-40% backed by its

strong chemistry skills and custom synthesis presence.

We highlight that the company does not chase top line growth at the cost of margin and

does not make capital investments that do not yield the desired returns. The high margin

and return ratio are maintained by:

a) Developing products that involve complex chemistry and keeps competition away and

therefore help the company dominate the market with significant pricing power.

b) Increasing contribution from high margin CCS business.

c) Avoid commoditised products just to fill capacity.

d) Avoid capex until clear visibility emerges on client orders.

e) Tight control over the quantum of capex.

f) Swift execution of projects and quick capacity ramp up.

Table 5: Best in class profitability


All the above factors lead to best-in-class margins and return ratios for the company and in

turn high free cash flow.

Strong capex imparts visibility to future growth

Divi’s has undertaken a capex of INR2bn (spread over FY11-12), to add 30% capacity at its

DSN SEZ in Vizag. Past track record indicates that the company generally does not undertake

large capex without visibility on customer contracts. Given the limited information shared

Coverage

Universe ROE(%) ROCE(%) EBITDA margin(%)

Divi's 27.6 41.6 37.0

Jubilant Lifesciences 15.0 11.0 19.9

Dishman 6.3 8.9 19.8

Shasun Pharma 14.0 8.8 8.6

Cadila 30.2 23.9 20.8

Aurobindo 17.6 7.9 12.0

Cipla 15.4 19.6 23.3

Dr. Reddy's 28.0 30.4 24.9

Glenmark 22.6 16.2 19.8

Ipca 24.1 19.1 21.8

Lupin 25.5 26.9 20.8

Sunpharma 23.9 46.0 40.7

Ranbaxy 29.8 25.0 16.0

Torrent Pharma 33.1 42.9 19.3

FY12

Divi’s is among the most profitable

companies in the Indian

healthcare sector

Pharmaceuticals


by management on such contracts (due to confidentiality reasons), we track capex as a lead

indicator of future growth for Divi’s. The company commisioned two blocks (June 2011) at

the second unit of SEZ which contributed INR1.3bn, or 7%, to FY12 sales, implying an

asset/turnover ratio of 0.65x within nine months of commisioning. It is in the process of

commissioning the balance three blocks (likely by H2FY13). Assuming a A/T of 1.5x (in line

with historical average), the SEZ can incrementaly contribute INR4.5bn over the next two

years.

Chart 6: Sharp improvement in free cash flow


20% growth guidance reflects management confidence

Management has guided for 20% revenue CAGR over FY12-14, while retaining EBIDTA

margin at the current level of 37-38%. We believe the strong guidance is partly based on

management’s expectation of revenue contribution from the new SEZ and ramp up in

carotenoids sales. We estimate top line CAGR of 22% for FY12-14 and average EBIDTA

margin of 38% in this period, led by 20% revenue CAGR in the CCS business and 58% CAGR in

carotenoids segment.

Currency depreciation to have positive impact on Divi’s

Divi’s generate ~89% of revenue from exports, out of which, 73% of revenue is dominated in

USD. Though 40-45% of its long term contracts are fixed contracts (currency benefits passed

through to the customers) and 20% of its operating cost is dollar denominated, it retains the

benefits of balance 23% of the revenue. As per our calculations, for every 10% depriciation

in rupee versus USD, Divi’s will have positive impact of 2.3% and 5.5% on revenue and

EBIDTA respectively.

0.0

0.3

0.6

0.8

1.1

1.4

0

600

1,200

1,800

2,400

3,000

FY08 FY09 FY10 FY11 FY12 FY13E FY14E

(X)

(IN

R m

n)

Free cashflow Capex Asset turnover ratio

Divi’s does not undertake large

capex without visibility on revenue

Pharmaceuticals


Table 6: Currency sensitivity (%)


Forex exposure (USD)

Exports as % of sales 89.0

% of overall sales exposed to USD INR movement 73.0

Dollar exposure 82.0

Pounds exposure 14.0

Euro exposure 4.0

Operating expenses (% of sales) 20.0

Fixed contracts (% of overall sales) 30.0

& of sales sensitive to currency 23.0

10% movement in USD/INR

Impact on revenue (%) 2.3

Impact on EBIDTA (%) 5.5

10% rupee depreciation will have

5.5% positive impact on

profitability

Pharmaceuticals


Valuation

We remain positive on the prospects of pharma outsourcing from India, given the unique

combination of low-cost and chemistry skills that India offers. We expect Divi’s to be a key

beneficiary of the increased outsourcing from India given its strong relationships with global

innovator pharmaceutical companies. With best-in-class margins and return ratios, strong

cash flows, improvement in working capital cycle and strong growth visibility, we expect the

stock to trade in line with frontline pharma stocks.

Premium valuations to sustain

At CMP of INR1100 the stock trades at 21.7x and 17.3x FY13 and FY14 core earnings, which

is at a premium to peer CRAMS players, however 15% discount to its historical five years

average. With best in class margins and return ratios, strong cash flows, improvement in

working capital cycle and strong growth visibility, we expect stock to trade in-line with

frontline pharma stock. We initiate our coverage with ‘BUY/SP’ rating and target price of

INR1265 (20x FY14).

Chart 7: Stock is trading 15% discount to its historical five years average (20x)


14x

17x

20x

23x

0

300

600

900

1,200

1,500

Ap

r-0

7

Au

g-0

7

De

c-0

7

Ap

r-0

8

Au

g-0

8

De

c-0

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Ap

r-0

9

Au

g-0

9

De

c-0

9

Ap

r-1

0

Au

g-1

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c-1

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Ap

r-1

1

Au

g-1

1

De

c-1

1

Ap

r-1

2

Au

g-1

2

(IN

R)

Pharmaceuticals


Key Risks

Higher dependency on top three products, top five clients

Nearly 30% of Divi’s revenue comes from its top 3 products. Similarly, top 5 clients

contribute a disproportionally large 47% to overall business. However, these numbers are

steadily dipping as the company is consciously looking to increase its customer base and

selectively expanding its product basket.

Project delays/failures at customer end

Project deferral and product failures at customer’s end could impact growth in CCS business

(48% of overall revenue).

Regulatory risks

Most of Divi’s revenue comes from regulated markets. Any manufacturing issue/ regulatory

issue can have adverse impact on our estimates.

Currency risks

Almost 89% of Divi’s revenue comes from exports. Rupee appreciation can have adverse

impact on earnings.

Pharmaceuticals


Company Description

Divi’s Laboratories is well-positioned in the US$45 billion global contract manufacturing

market as a research focused, contract manufacturing player. Divi’s revenues are derived

from development (custom synthesis) and contract manufacturing (custom manufacturing)

of APIs / intermediates for innovator companies, while the balance is derived from generic

exports where it derives strong economies of scale and competes globally. It is the largest

manufacturer of peptide reagents and protected amino acids worldwide. The company is

leader in some of its products in the API business such as Naproxen Sodium (an anti-

inflammatory drug) and Dextromethorphan (a cough suppressant).

Divi’s has an unassailable track record with presence in the entire lifecycle of a

pharmaceutical product. This makes it the preferred one-stop solution provider for pharma

giants. Divi’s boasts of working with 20 of the top 25 global pharma companies, with over

100 projects in the pipeline. Recently, it has entered into the lucrative carotenoid segment,

which will help diversify its API product mix.

Chart 8: Revenue break-up (major segments)


The company operates predominately in the export market, which accounts for nearly 89%

of its overall revenue with ~71% of it coming from developed markets like the US and EU.

Carotenoids

4% Peptides

3%

Custom

synthesis 44%

Generics

49%

Pharmaceuticals


Chart 9: Revenue break-up (Geographical)


Chart 10: Shareholding pattern


Europe

28%

Americas

43%

India

11%

RoW

18%

Promoter

49%

FII

29%

DII

1%

Others

21%

Pharmaceuticals


Financial Outlook

Expect 22% revenue CAGR over FY12-14E

We estimate revenue CAGR of 22% over FY12-14E, driven by: (a) 20% CAGR in CCS business,

b) 20% CAGR in generics and c) 55% CAGR in Carotenoids segment. We expect Divi’s to be a

key beneficiary of the increased outsourcing from India given its strong relationships with

global innovator pharmaceutical companies, while new launches in the API segment will

drive growth for the generic businrss. In the Carotenoids segment, though the ramp-up so

far has been slower than expectations, however, with gradual increase in portfolio size

(from 6 products in FY09 to 10 in FY12) and most regulatory approvals in place, we believe

the company is now well placed in this market.

Table 7: Revenue progress over FY12-14E (INR mn)

Source: Company; Edelweiss research

Expect 120bps expansion in margins over FY12-14E

With focus on complex chemistry, cost efficient process and its ability to quickly ramp-up

the capacity utilization, Divi’s enjoys the best in class operating margins. We expect EBIDTA

margin to improve 120bps over, driven by a) improved traction in high margins CCS business,

b) ramp-up in the capacity utilisation and c) incremental contribution from Carotenoids

business.

Chart 11: Capacity ramp-up and higher CCS contribution will improve profitability


DIVIS FY11 FY12 FY13E FY14E

CAGR

FY12-14E(%)

Carotenoids 620 820 1,292 1,960 54.6

Peptides 392 520 692 899 31.5

Custom synthesis 6,013 8,173 9,813 11,749 19.9

Generics 6,046 9,137 10,841 13,132 19.9

Total 13,071 18,650 22,638 27,739 22.0

29.0

33.8

38.6

43.4

48.2

53.0

3,386

4,500

5,615

6,729

7,844

8,958


(%)

(IN

R m

n)

Operating profit Operating margins

Pharmaceuticals


Expect 26% earnings CAGR over FY12-14E

We expect earnings CAGR of 26% over FY12-14E, driven by strong revenue growth and

improved operating performance. The EPS works out to be INR50.6and INR63.3 for FY13

and FY14E respectively. Owing to improved profitability and higher assets turnover ratio,

the RoE will improve from 27.6% in FY12 to 28.7% in FY14E.

Chart 12: PAT margins to improve


Strong free cash flow generation

With major capex behind us and improvement in working capital cycle, we expect Divi’s to

generate strong free cash flow of INR6bn over FY12-14E. With improving profitability and

capacity utilisation, we expect RoCE to improve from 41.6% in FY12 to 43.6% in FY14.

Chart 13: Strong returns ratio


22.0

26.4

30.8

35.2

39.6

44.0

2,722

3,443

4,164

4,884

5,605

6,326

FY10 FY11 FY12 FY13E FY14E

(%)

INR

mn

)

PAT PAT margins

0.0

10.0

20.0

30.0

40.0

50.0

FY11 FY12 FY13E FY14E

(%)

ROCE ROE

Pharmaceuticals


Financial Statements

Key assumptions

FY11 FY12 FY13E FY14E

Macro - GDP (Y-o-Y %) 8.4 6.5 5.8 6.5

Inflation (Avg) 9.9 8.8 7.8 6.0

Repo rate (exit rate) 6.75 8.50 7.50 6.75

USD/INR (Avg) 45.6 47.9 53.5 52.0

Sector - CMO growth (Y-o-Y %) 15.0 15.0 15.0 15.0

Company - CCS growth (Y-o-Y %) 30.0 36.0 20.0 20.0

New products introduction (CCS) 13.0 5.0 5.0 7.0

Generic growth (%) 44.0 51.0 19.0 21.0

New products introduction (Generic) 8.0 3.0 5.0 5.0

Carotenoids growth (%) 58.0 32.0 58.0 52.0

USD/INR (Avg) 45.6 47.9 52.0 51.0

Note: Currency sensitivity: Every 10% rupee depreciation will have positive impact of 5.5% on EBITDA

Income statement (INR mn)


Net revenues 13,071 18,488 22,423 27,476

Other operating income 94 152 159 182

Total operating expenses 8,156 11,646 14,014 17,090

Materials cost 6,200 8,795 10,584 12,914

Employee cost 857 1,509 1,839 2,226

Sell ing, admin and general expenses 950 1,154 1,368 1,676

EBITDA 5,009 6,994 8,568 10,568

Depreciation and amortisation 534 621 700 773

EBIT 4,475 6,373 7,868 9,795

Net Interest expense/(income) 22 37 40 43

Other income 271 560 665 887

Profit before tax (excl extraordinaries) 4,724 6,896 8,493 10,639

Provision for tax 431 1,474 1,784 2,234

Core profit 4,293 5,423 6,710 8,405

Reported Profit after Minority Interest 4,293 5,333 6,710 8,405

Adjusted Profit After Tax 4,293 5,271 6,710 8,405

EPS (INR) adjusted 32.4 39.7 50.6 63.3

Dividend payout (%) 30.9 32.7 25.7 20.5

Common size metrics- as % of net revenues


Cost of revenues 47.1 47.2 46.9 46.7

Employee cost 6.5 8.1 8.1 8.0

Total operating expenses 62.0 62.5 62.1 61.8

Depreciation and Amortisation 4.1 3.3 3.1 2.8

EBITDA margins 38.0 37.5 37.9 38.2

Net profit margins 32.8 29.3 29.9 30.6

Growth metrics (%)


Revenues 38.6 41.6 21.1 22.5

EBITDA 21.1 39.6 22.5 23.3

Net profit 26.1 26.3 23.7 25.3

Adj. EPS 25.7 22.7 27.3 25.3

Pharmaceuticals


Balance Sheet (INR mn)

As on 31st March FY11 FY12 FY13E FY14E

Share capital 265 265 265 265

Revenue and surplus 17,710 21,050 25,792 32,178

Shareholder fund 17,975 21,315 26,057 32,443

Long term borrowings 49 26 26 26

Short term borrowings 136 529 529 529

Loan funds 185 554 554 554

Deferred tax l iabil ity/asset 500 609 609 609

Sources of funds 18,661 22,479 27,221 33,607

Tangible assets 5,899 7,384 10,504 11,731

CWIP (incl. intangible) 1,043 1,820 - -

Total net fixed assets 6,943 9,204 10,504 11,731

Current investments 5,256 4,770 5,270 7,270

Cash and cash equivalents 177 309 1,220 2,089

Inventories 5,717 6,790 8,171 10,012

Sundry debtors 3,652 4,956 5,959 7,302

Loans & advances 951 1,469 2,018 2,473

Other assets 51 68 68 68

Total current assets (ex cash) 10,372 13,283 16,216 19,855

Trade payable 1,230 1,595 1,904 2,334

Other current liabil ities and provisions 2,857 3,493 4,085 5,006

Total current liabilities & provisions 4,087 5,088 5,990 7,339

Net current assets (ex cash) 6,285 8,195 10,226 12,515

Application of funds 18,661 22,479 27,221 33,607

Free cash flow (INR mn)


Net profit 4,293 5,333 6,710 8,405

Depreciation 534 621 700 773

Others 45 45 - -

Gross cash flow 4,872 5,999 7,410 9,178

Less: Changes in WC 1,062 1,865 2,032 2,289

Operating cash flow 3,810 4,134 5,378 6,889

Less: Capex 1,341 2,882 2,000 2,000

Free cash flow 2,469 1,251 3,378 4,889

Cash flow metrices


Operating cash flow 3,810 4,134 5,378 6,889

Financing cash flow (1,568) (1,564) (1,968) (2,019)

Investing cash flow (2,184) (2,396) (2,500) (4,000)

Net cash flow 58 174 910 870

Capex (1,341) (2,882) (2,000) (2,000)

Dividends paid (1,541) (2,006) (2,019) (2,019)

Pharmaceuticals



*Note: Jubilant EPS is adjusted for R&D costs capitalised

Profitability and liquidity ratios


ROAE (%) 25.9 27.6 28.3 28.7

ROACE (%) 36.3 41.6 41.3 43.6

Inventory days 315 260 258 257

Debtors days 82 84 88 88

Payable days 83 59 60 60

Cash conversion cycles 314 285 286 285

Current ratio 2.5 2.6 2.7 2.7

Debt/ EBITDA 0.0 0.1 0.1 0.1

Debt/equity 0.0 0.0 0.0 0.0

Adjusted debt/Equity 0.0 0.0 0.0 0.0

Operating ratios (x)


Total asset turnover 0.8 0.9 0.9 0.9

Fixed asset turnover 2.2 2.8 2.5 2.5

Equity turnover 0.8 0.9 0.9 0.9

Valuation parameters


Adjusted EPS (INR) 32.4 39.7 50.6 63.3

EPS YoY growth (%) 25.7 22.7 27.3 25.3

CEPS (INR) 36.4 45.5 55.8 69.1

Diluted PE (x) 34.0 27.7 21.8 17.4

Price/BV(x) 7.8 6.5 5.4 4.3

EV/Sales (x) 10.7 7.6 6.2 5.0

EV/EBITDA (x) 28.1 20.2 16.3 13.0

Dividend yield (%) 0.9 1.2 1.2 1.2

Peer comparision valuation

Price

INR FY13E FY14E FY13E FY14E FY13E FY14E FY13E FY14E

Jubilant* 205 20.2 28.8 10.2 7.1 6.0 4.7 15.5 18.3

Dishman 96 10.7 14.9 9.0 6.5 5.9 4.9 8.8 11.1

Divi's 1,100 50.6 63.3 21.8 17.4 17.0 13.8 28.3 28.7

CRAMS 13.6 10.3 11.5 9.4 18.6 19.9

ROAE (%) EPS (INR) P/E (x) EV/EBITDA (x)

Pharmaceuticals


THIS PAGE IS INTENTIONALLY LEFT BLANK

Pharmaceuticals


Jubilant Life’s (JOL) recent performance highlights the improvement in

core business. Capacity ramp up, new orders coupled with improved

realisation have enhanced the earnings visibility over the next two years.

We expect JOL to report 30% earnings CAGR over FY12-14E, driven by (a)

16.5% revenue CAGR and (b) 130 bps margin expansion. With improved

earnings visibility and focus on balance sheet, we expect the stock to

trade in its long term average of 10-11x. We have set a 12-m PE base

target price of INR290 (10x FY14E; 40% upside potential).

Well placed to capture growth opportunities across segments

JOL has multiple growth drivers both in pharmaceuticals as well as life science

ingredients (LSI) segment. In pharmaceuticals, CMO of injectibles, generic formulations,

radiopharmaceutical along with API will drive growth while LSI segment will ride

capacity ramp up of Vitamin B3 (Niacinamide) and Symtet.

Moving up value chain in life science Ingredients

In the LSI segment, where JOL has attained leadership in Pyridine and its derivatives,

the company is moving up the value chain by entering into value add products such as

Symtet and Niacinamide. The company has invested ~USD90-100mn in these two

facilities which at peak can generate USD150-160mn revenue.

Capex cycle peaks out; focus to improve DE, ROCE

With the investment cycle behind us (USD3.5bn capex in FY13), JOL’ incremental focus

will be on improving productivity and prune debt via internal accruals (INR11bn over

the next three years). The company’s focus will be to cut DE to 1x (DE at 1.5x in FY12)

and improve RoCE from the current 11.0% to 15% in FY14E.

Outlook and valuations: Positive; initiate coverage with ‘BUY’ We expect JOL to report revenue and earnings CAGR of 16.5% and 30% over FY12-14E.

With improved earnings visibility (30% earnings CAGR), focus on deleveraging balance

sheet (expect DE to come down to 1x by FY14) and improved return ratios, we expect

stock to trade in its long term one year forward average multiple of 10-11x. At CMP of

INR 205, the stock is trading at 7.1x FY14 EPS of INR28.8.

Edelweiss Research is also available on www.edelresearch.com,

Bloomberg EDEL , Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

JUBILANT LIFE SCIENCES Back on track

INITIATING COVERAGE

India Equity Research | Pharmaceuticals

EDELWEISS 4D RATINGS

Absolute Rating BUY

Rating Relative to Sector Performer

Risk Rating Relative to Sector Medium

Sector Relative to Market Underweight

MARKET DATA (R: JUBO.BO, B: JOLI IN)

CMP : INR 205

Target Price : INR 290

52-week range (INR) : 226 / 154

Share in issue (mn) : 159.3

M cap (INR bn/USD mn) : 34 / 656

Avg. Daily Vol.BSE/NSE(‘000) : 124.3

SHARE HOLDING PATTERN (%)

Current Q4FY12 Q3FY12

Promoters %

49.0 49.0 49.0

MF's, FI's & BK’s 8.8 1.5 1.4

FII's 21.5 28.5 28.4

others 20.6 21.0 21.2

* Promoters pledged shares

(% of share in issue)

: 2.0

RELATIVE PERFORMANCE (%)

Sensex Stock

Stock over

sensex

1 month 9.2 (4.2) (13.4)

3 months 8.1 20.6 12.5

12 months 16.7 15.5 (1.1)

Manoj Garg

+91 22 6623 3302

manoj.garg@edelcap.com

Perin Ali

+91 22 6620 3032

perin.ali@edelcap.com

October 08, 2012

Financials


Revenues (INR mn) 34,420 42,782 49,896 58,231

EBITDA (INR mn) 5,536 8,485 10,223 12,246

Adjusted net profit (INR mn) 2,706 3,384 3,887 5,331

Adj. Diluted EPS (INR) 13.5 16.9 20.2 28.8

P/E (x) 15.2 12.1 10.2 7.1

EV/EBITDA (x) 11.2 8.1 6.6 5.2

ROAE (%) 12.4 15.0 15.5 18.3

Pharmaceuticals


Investment Rationale

Successful transformation with increased focus on pharmaceuticals

JOL has successfully made the transition from being a chemical manufacturer to an

integrated solution provider in pharmaceutical (51% of revenue) and Life Science

Ingredients (LSI) segment (49% of revenue). Within pharma, the company’s interest spans

across product and service verticals while in LSI division, proprietary products and vitamins

are the key contributors. The company has leadership in Pyridine, that formed the basis of

its forward integration and today it has emerged as one of the largest CRAMS players in

India. JOL is one among the top five CMO injectibles players in North America with an end-

to-end service platform in drug discovery services. Within the product segment, the

company has specialty portfolio of radiopharmaceutical products and an impressive pipeline

of generic formulations and APIs in regulated markets.

Fig. 1: Jubilant- Key business verticals


Well placed to capture growth opportunities across segments

The company has multiple growth drivers both in pharmaceuticals (17% CAGR over FY12-

14E) and LSI (16% CAGR over FY12-14E) segments. In pharmaceuticals segment, Injectibles

CMO (contract manufacturing) and radiopharmaceutical vertical along with generics and API

will drive growth. Within LSI segment, we expect capacity ramp up of Vitamin B3 and Symtet

to drive growth. We are outlining below growth drivers within key verticals.

Jubilant Life Science

Pharmaceuticals

(51%)

Active Pharma Ingredients(10%)

Contract ManufacturingOutsourcing (15%)

Generics (13%)

Proprietary Products &

Exclusive Synthesis (22%)

Drug Discovery &Development (6%)

Specialty Pharma(7%)

Healthcare(0.3%)

Nutrition Ingredients

(5%)

Life Science Chemicals(22%)

Life Science Ingredients

(49%)

Pharmaceuticals

(51%)

Products Services

JOL has transformed itself from

being a chemical manufacturer to

an integrated solution provider

Pharmaceuticals


Injectibles CMO: New order wins to drive growth

JOL has entered the CMO segment primarily through acquisition of Holister (June 2007;

USD122mn) and Draxis (April 2008; USD255mn). These acquisitions positioned the company

as a strong player in the injectibles CMO space, one among the top five injectibles contract

manufacturers in North America. As JOL primarily services innovators (including 6 out of top

10 pharma majors), proximity to the customer has distinct advantage. In FY12, this segment

contributed 15% to overall revenue with 17% growth.

Chart 1: CMO injectibles is critical driver of future growth


The company intends to expand its customer base via aggressive business development

efforts and has inked multiple new long-term contracts (USD160mn) which will drive growth

going forward. These new contracts are likely to add USD30-35mn annually FY13 onwards.

We, thus, expect CMO business to post 22% CAGR over FY12-14E, driven by higher capacity

utilisation (80-85% by FY14E from c65% in FY12) through these new contracts.

Table 1: Large contracts signed over past two years add higher growth visibility


Generic growth to be aided by new launches in US

Generic formulation business in US was the key growth driver during FY12 with 161% YoY

growth, contributing 13% to overall revenue (chart 2). Robust revenue growth was driven by

price hike in Methyl-Prednisolone (12x; USD50mn revenue in FY12) and a couple of new

launches. JOL took a price hike in Methylprednisolone from USD1 per pack to USD12 per

pack as one of the suppliers (Par Pharma) exited the market in Q2FY12. However, post

resumption of supply from the affected player, prices have settled at USD8-9 per pack since

the past two quarters (prices are holding up due to limited competition, we expect gradual

reduction in the price of this product).

API

10%

Generics

13%

Radio pharma

4%

Allergenic

extracts

3%

Contract

manufacturing15%DDDS

6%

Healthcare

0%

Life sciences

49%

Incremental orders

Total value

(USD mn)

Duration of

contract

Signed during

period

Supplies to

start from

period

I 70 4 2011 Q2FY12

II 90 5 2012 Q2FY13

New orders will ramp up capacity

utilisation

Pharmaceuticals


Moreover, despite being a late entrant JOL has been able to capture decent market share

(over 20% in 8 out of 12 ANDAs; top 3 player in 6 products) because of its vertical

integration and cost competitiveness.

Chart 2: Jubilant gains sizeable market share in products


JOL has 29 pending approvals in US and it expects a large number of approvals to drive its

generics exports over the next three years. Thus, with robust pipeline (over 100 launches

across geographies) and expansion in other markets of EU and Japan, we expect 17% CAGR

growth within generics over FY12-14E.

Table 2: Key API filings within the US


0.0 13.2 26.4 39.6 52.8 66.0

Alendronate

Cyclobenzaprine

Donepezil

HCT Z Caps

Lamotrigine

PCP

Meclizine

Methyl-prednisolone

Oxcarbazepine

Prednisone

Terazosin

(%)

Brand Generic name Innovator Market size (USD mn) TA Patent expiry

Hyzaar Losartan MSD 1,600 CVS Expired

Avalide/ Avapro Irbesartan Sanofi 500/1,200 CVS Expired

Atancand Candesartan Astrazeneca 255 CVS 2012

Diovan Valsartan Novartis 1,650 CVS Sep'12

Zometa Zoledronic Acid Novartis 775 CVS Sep'12

Aciphex Rabeprazole Eisai 1,230 GI June'13

Micardis Telmisartan BI 298 Jan'14

Nexium Esomeprazole Astrazeneca 6,300 GI May'14

Teveten Esprosartan Abott 100 CVS June'14

Actonel Risedronate Warner Chilcott 1,100 Osteoporosis June'14

Abilify Aripiprazole Otsuka 1,733 CNS Apr'15

Vesicare Solifenacin Astellas 1,000 CNS Dec'15

Benicar Olmesartan Daiichi- Sankyo 1,337 CVS Oct'16

Pharmaceuticals


Radiopharmaceuticals: Expansion, new launches to drive growth

JOL has attained a unique position in the nuclear medicine market with leadership position

in products like I-131 (used in treatment of thyroid cancer), MAA (macro aggregates of

Albumin; used in lung imaging) and DTPA (Diethylene Triamine Penta Aceticacid suitable for

lung and renal imaging). This segment contributed 4% to revenue with 25% growth in FY12.

The global market for radiopharmaceutical products is likely to rise from USD3bn in 2010 to

USD5bn by 2015E. This market is likely to have limited number of players as it requires

different skill sets. JOL is looking to launch Rubi-fill in US and Canada in FY13 (USD60mn

market opportunity), where it will have the first mover advantage in Canada and it will be

one among the two players in the US. We expect this business to post 20% CAGR over FY12-

14E driven by: (a) new launches in US and Canada; and (b) entry in emerging markets

including India.

Table 3: Radio pharma pipeline


LSI: Integrated business model offers cost competitiveness

JOL' global scale capacities in Acetyl and Pyridine build a high degree of integration into its

business enabling it to offer services across the value chain. Vertical integration and scale

allow it to be cost competitive and gain market share in various segments. The company is

one of the largest players in acetyls in India, a raw material used for production of Pyridines.

In Pyridine, JOL has emerged as the largest player in the world with extensive chemistry

skills and a large basket of Pyridine derivatives, providing more than 150 products for use in

229 APIs and 17 agrochemicals. Extracting the chemicals from molasses is more cost-

effective compared to hydro carbon used by competitors, thus offering JOL better margin

and competitive advantage.

Products Launch date Market size (USD mn)

Rubyfil l 2012 60

Magnevist 2013 35

Molyfil l 2015 35

Rubifill launch in US/ Canada to

drive growth in Radio

pharmaceutical business

Extracting Pyridine through green

routes offers significant cost

advantage

Pharmaceuticals


Fig. 2: Vertical integration offers cost advantage


In an effort to move up the value chain, the company has set up manufacturing facilities of

higher value added products such as Vitamin B3 and Symtet and emerged as one of the

largest players in these segments.

Moving up value chain aids growth and profit visibility

In the LSI business, where JOL has attained leadership in Pyridine and its derivatives, the

company is moving up the value chain by entering to higher value added products such as

Symtet and Vitamin B3. For Vitamin B3, JOL will be vertically integrated as the key raw

material Beta Picoline (pyridine) is produced in house. The company has commissioned

10,000 MT capacity of Vitamin B3 (Niacinamide; second largest producer) in November 2011

(c30% utilisation), which at peak level has the potential to generate revenue of over USD75-

80mn. Similarly, the company has set up a Symtet plant with total capacity of 24,000 MT

(two phases) which is likely to go on stream Q3FY13 onwards and has revenue potential of

USD90mn at peak level. With commissioning of the new intermediate plant in 3-

Cyanopyridine, JOL has expanded its capacity 20% (52,000 MT) for in house consumption to

meet growing demand of Vitamin B3 (Niacinamide) in the nutrition division. It will also help

attain higher economy of scale and support strong demand for internal consumption. The

company plans to launch 10 pro

INITIATING COVERAGE: Divi’s Laboratories Jubilant Life ......Q1 FY11 Q2 FY11 Q3 FY11 Q4 FY11 Q1 FY12 Q2 FY12 Q3 FY12 Q4 FY12 Q1 FY13 (%) Divis Jubilant Shasun Pharma Dishman 0.0

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