D:\data 2013\rsp\cipla - rsp - 120413.pmd

Investment Idea
Cipla - Gathering momentum
Company Background
Cipla is one of the biggest players in Indian formulations market enjoying 5.7% market share. Key therapies for the Company in the domestic space include: Respiratory, Anti-Infective, Cardiac, Gynecology and GI. The Company has 70% market share in Inhaler segment and its key brands in the same segment are: Seroflo, Foracort, Budecort and Aerocort. In the export space, the Company has been working on a low risk, low margin partnership model, which restricts any margin upside in US & EU. However, the Company is consciously changing its policy towards a more profitable model for the same. Cipla is now focusing on the inhaler opportunity, which is expected to yield significant profitability, going ahead.
The recently commissioned Indore SEZ will be instrumental in fulfilling Cipla's ambitions to fulfill its strong growth projections in ensuing times.
Outlook and Valuations
Though Cipla has underperformed the broader markets over the last 3 years, we believe that operational improvement is likely to drive the growth over the next 2 years. Its outstanding performance in 9MFY2013 is symbolic of an inflection point in the company's growth trajectory. Cipla's recent performance has been driven by culmination of multiple strategic changes executed by the senior management over the last couple of years, and we believe, it is sustainable. Cipla has worked on four key aspects: a) rationalization of low-margin business and increased focus on profitability; b) cash flow improvement; c) intent to establish front-ends in select international markets; and d) professionals' hiring at top management. With updated assumptions, we believe that the stock has an upside potential of 15-20% over the Risks to the view
NPPA demand for alleged overpricing: Cipla is currently fighting in High Court
against NPPA on account of alleged overpricing of essential drugs. It has received a demand notice of Rs12,300cr under DPCO Act. If Cipla loses the case, the penalty charges could adversely impact its cash flows as well as Currency fluctuation: Cipla's ~50% of revenue comes from the export markets,
making it susceptible towards currency fluctuation. Cipla follows a policy on hedging the risk through forwards covering the receivables regularly. Any adverse movement in the currency could affect the revenue and consequently Impact of new pharma pricing policy: ~46% of the total sales come from
domestic formulations. Implementation of new pricing policy is likely to impact Investment Idea
Why Cipla (Investment arguments)
Combination inhaler launches in EU to drive growth from FY2014E onwards
According to Cipla management, the share of inhalers to exports has increased to 15% in FY2012 from 10-12% earlier. The global market for respiratory products is over US$25bn (largely dominated by combination inhaler products). The combination inhalers market is worth US$12bn divided between 2 brands - Advair/Seretide (GSK) and Symbicort (AstraZeneca). While the combination inhalers remain the largest market segment, it also poses challenges for generic entry primarily due to higher investments and evolving regulatory pathway. This makes the market a highly profitable one with fewer competitors.
Cipla has already launched four inhaler products in EU (market size of ~US$3bn) from a total pipeline of 11 filings, namely, Budesonide, Salbutamol, Beclomethasone and Salmeterol. The company expects to receive 3-4 more approvals for inhaler products in the next two years, which could result in significant pick up in exports.
Restructuring at exports front contributes to growth
Cipla has undertaken a restructuring of its export portfolio for the past 2 years and has been targeting niche segments such as inhalers (EU) and rationalization in ROW markets (Africa, Australasia and Middle East markets). Also, taking a digression from its usual strategy, Cipla now plans to file ANDAs on its own (vis-à-vis the partnership route followed earlier) in the US market. It has already filed 5 ANDAs in 9MFY2013. A potential US market success can add significant value to the stock, in our view.
Respiratory & Gynecology to sustain domestic growth
Cipla's reach from Tier-II to Tier-VI cities is formidable and is better than any of its listed peers. Its pan-India presence with 7,000 field force and 58% portfolio in acute segment will be the major growth drivers. Its niche therapeutic segments - Respiratory (28%) and Gynecology (12%) will continue to outperform the industry. The Company has been pro- active in launches in both these segments, while the price hikes have been undertaken selectively in Respiratory segment. We forecast domestic formulations to grow at a sustainable 16% CAGR over FY2013-15E.
Margin re-rating on the cards
With restructuring on exports front on the verge of completion, we believe that capex would be minimal in FY2014E leading to improvement in operational performance. However, we assume R&D costs to be higher at 5% of sales (vis-à-vis management's guidance of 4%) as increased pace of filings in US (on its own) and investments in technical products like Dymista could lead to high R&D spend. Also, with Cipla increasing its focus on markets like US and EU, we expect employee costs to rise going forward. Hence, excluding the currency benefit, we forecast marginal expansion (20bp) in EBITDA margin in FY2014E on a high base of FY2013E. We expect annual EBITDA margin of 25.4% and 25.9% for FY2014E and FY2015E respectively, as exclusive supplies wane down in 2HFY2013.
Return Ratios & Asset Turnover to improve due to better utilization of Indore SEZ
Cipla has spent Rs900cr for its Indore SEZ facility, which houses facility for oral, topical injectables and others. The compression of the return ratios and asset turnover ratios has been in lieu of SEZ. We believe that with improving capacity utilization at the SEZ plant and maintenance capex, the operating leverage will aid the key profitability ratios, going Investment Idea
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