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1 Initiating Coverage Unichem Laboratories Attractive valuation with a strong Balance Sheet Unichem laboratory (ULL), an integrated pharmaceutical company has a strong footprint in domestic formulation market. Domestic operations contribute around 75% to total revenues. In the recent past, the company failed to keep pace with the competitors in the domestic market but now, after the completion of restructuring activity and improving operating parameters, the company is all set to post improvement in the margins and return ratio. We believe the rough phase for ULL is set to be over soon; the turnaround of overseas operations along with ramp up in domestic business and cost pressure rationalizing with incremental revenue will help ULL post robust growth. Unichem s four brands feature among the Top 3 Indian pharmaceutical brands and out of which two brands are in the Top 1 (Losar H- Rs79mn- 9 th Rank and Losar- Rs68mn -1 th Rank). Top 1 Brands contribute nearly 5% of the company s domestic revenues. Domestic business will drive long term growth on leveraging on brands. Additionally, Company is also gradually entering developed markets to leverage upon its R&D and manufacturing capabilities. Unichem has presence in Europe through its 1% subsidiary Niche Generics having 33 products in the portfolio. It has direct sales operation in UK and Ireland and is exploring other territories like Australia, SA and Canada. We expect this venture to add meaningful contribution to EPS by FY14. In the US, the company has filed 29 ANDAs till date and has 15 approvals of which 9 have been launched. We expect 2-3 filings every quarter. CRAMs business would also prove to be an interesting opportunity for ULL. We expect revenues to register 15% CAGR over FY13-15 and margins to expand to 15%. The company is a zero-debt company with a cumulative positive cash flow. The company is looking for acquisitions in therapy area to fill the gap in product offerings. We believe ULL s valuation is attractive at 8.7x FY15E EPS.. We estimate the fair value of Unichem at Rs 21 and recommend BUY. Financial summary Y/e 31 Mar (Rs m) FY12 FY13 FY14E FY15E Revenues 8,857 1,942 12,443 14,43 yoy growth (%) Operating profit 1,183 1,743 2,199 2,613 OPM (%) Reported PAT 712 1,133 1,453 1,739 yoy growth (%) (25.) EPS (Rs) P/E (x) Price/Book (x) EV/EBITDA (x) Debt/Equity (x).1... RoE (%) RoCE (%) July 3, 213 Rating: Sector: Sector view: Pharmaceutical Positive Sensex: 19, Week h/l (Rs): 217/127 Market cap (Rscr) : 1,583 6m Avg vol ( Nos): 59 Bloomberg code: UL IN BSE code: 569 NSE code: UNICHEMLB FV (Rs): 2 Price as on July 2, 213 Company rating grid Earnings Growth Cash Flow B/S Strength Valuation appeal Risk Share price trend Low High Unichem Sensex Jul-12 Dec-12 May-13 Share holding pattern BUY Target (9-12 months): Rs21 CMP: Rs166 Upside: 26.5% Promoters Institutions Others 1 % Jun-12 Sep-12 Dec-12 Mar-13 Research Analyst: Bhavika Thakker research@indiainfoline.com Company Report

2 Domestic growth: Long term value through brand building Unichem s domestic operations contribute 75% to the revenues and domestic formulations contribute ~63% total revenues. ULL is ranked 28 th in the domestic formulations market as per AWACS. In covered markets (5% of total Indian Pharma market), ULL is among the top 17 companies. Unichem s four brands feature among the Top 3 Indian pharmaceutical brands and out of which two brands are in the top 1 (Losar H- Rs79mn 9 th Rank and Losar Rs68mn 1 th Rank). Top 1 Brands contributes nearly 5% of the company s domestic revenues. Current estimated size of Indian Pharmaceutical market (IPM) is Rs649.5bn. India ranks globally 3 rd by volume and 12 th by value. The Indian market is expected to rank 8 th by value by 216 and grow by 12-15% for the next 5 years. Brand building through focused brand approach The company has 21+ field force, which covers approximately 1,5, medical professionals and there are more than 4,5 stockists covering 2,, retail outlets for Unichem. There has been a 12% CAGR revenue growth in domestic formulations over the past four years and we expect the trend to continue. Domestic formulations business continues to be a major contributor to the revenues of the company. Revenue Breakup (Domestic vs international) Revenue Breakup (Formulation vs API) Domestic Formulations Export Formulations 9, 8, 7, 6, 5, 4, 3, 2, 1, - FY8 FY9 FY1 FY11 FY12 FY13 FY14E FY15E 16, 14, 12, 1, 8, 6, 4, 2, - Formulations API FY8 FY9 FY1 FY11 FY12 FY13 FY14E FY15E Therapy Market Segment (MAT 213 growth) 1, Volume % Growth 2 Unichem Laboratories Represented / Covered Market(MAT 213 growth) 4 Volume % Growth 12 8, , 4, , 4 1 Cardiac Care Anti-Infectives Neuro-Psychiatry Gastroenterologicals Musculoskeletals Anti-Diabetic Respiratory Nutraceuticals Dermatologicals Haematinics Others Cardiac Care Anti-Infectives Neuro-Psychiatry Gastroenterologi Musculoskeletals Anti-Diabetic Respiratory Nutraceuticals Dermatologicals Haematinics Others -4 2

3 Therapeutic focus towards chronic segment to boost growth Unichem has a strong presence in chronic space. 65% of the portfolio is focused towards the chronic therapy areas like CVS (43%) and CNS (12%) resulting in higher profitability and higher growth from domestic business. ULL has leadership position in CVS segment with its largest band Losar gr. The market for cardiovascular and diabetic ailments is still at a nascent stage in India and the segment is expected to double from the current level by the year 215. As per Company s internal estimates, 1-12% domestic formulation is under pricing policy. With the new pricing policy the exposure will increase to 2% of total domestic formulations. Under the new policy, the current impact would be negative but in medium term it would be positive because many of the key brands would come out of the price control. Currently, Metronidazole (API), Ampoxin (Anti-infective) and Zator Plus (Spirolactum with Torsilomide) are under price control which will go out of price control list. Product portfolio optimization & field resource allocation relating to chronic Therapy will lead growth Losar is the #1 anti hypertensive brand in India Acute vs Chronic segment of Unichem Therapeutic Segment wise breakup 35% 11% 3% 3% 3% 2%2% Cardiac Care Anti-Infectives Chronic Acute 13% Neuro-Psychiatry Gastroenterologicals Musculoskeletals Anti-Diabetic 65% 16% 47% Respiratory Nutraceuticals Others Core competency in building brands; backbone of domestic business ULL is well known for carving out its unique positioning with its brands. Its brand building strength is evident from the revenue mix of the company. Top 1 brands of the company contribute 63% of overall revenue where its top brand and extension; Losar group contributes 23% of company s domestic revenue; which has been achieved within 1 years of the launch. Ampoxin is the second largest contributor to its domestic revenue at ~ 9% of domestic revenue. ULL has two brands that feature in the top 1 brands. There are more than 1 brands having revenues more than Rs1mn. In the 16 therapeutic groups, Unichem s brand is number 1 and overall, all Unichem s brands rank in the top 5 in 67 therapeutic sub-groups. Brand building through focused brand approach and field force to reach mass and drive growth 3

4 High concentration on a brand can be risky: Diversification is the key The Top 3 brands contribute nearly 38% of the company s domestic revenue. Unichem is focusing on an improved product mix to compensate for the plateauing growth in the matured drugs. Its top brand Losar group is struggling for growth hence to address the slowing growth rates, the company has embarked on a series of restructuring activities like nurturing other brands, and launch of other brand extension products ( Telsar A & H, Olsar ) of the Losar group. To de-risk, ULL is working towards making the top 25 brands contribute 5% instead of 7% to the company s overall revenues. Top 1 Brands contributes nearly 5% of the company s domestic revenues Re alignment in product mix and field force in FY13 Top 1 Domestic Drug portfolio of Unichem MAT March 213 JAN-MARCH 13 Brand Group Scenario % Growth % Market Share % Contribution to Revenue % Growth % Market Share % Contribution to Revenue Losar Group 1, Ampoxin Group Unienzyme Telsar Group Trika Group Olsar Group Vizylac Metride Group Linox Tg-Tor Group 16 (12) (11) 2 2 Total Revenue 7, , Source: AWACS, Company, India Infoline Research Therapy - Gaps in the domestic market MAT Aug'12 % of total value No of sub segments % of total no. of segments Unichem non-represented segments Unichem Represented segments Total market Source: AWACS, Company, India Infoline Research Top 5 Brands contributes approximately 83% to domestic revenues Revenues with Rs5mn+ 3 Revenues between Rs3-4mn 2 Revenues between Rs. 2 ~ 3mn 1 Revenues between Rs. 1 ~ 2mn 8 Revenues between Rs. 5 ~ 1mn 16 Revenues between Rs. 3~ 5mn 13 Source: AWACS, Company, India Infoline Research 4

5 International business at inflection point Uncihem derives 25% of revenue from international business. ULL, after gaining momentum on the domestic front, ventured into the international market to tap the opportunities by leveraging on manufacturing and R&D capabilities. Investment in Unichem s 1% subsidiary in UK, Niche Generics has turned around and it will have meaningful contribution to EPS from FY14 onwards. Unichem already has a set up its packaging facility at Ireland which will give them bargaining power. Stride towards turnaround of Niche Generics Niche Generic derives currently 7% of its revenue from Western Europe. It is expanding its reach to Australia, Canada and South Africa. Besides the EU, Unichem has a presence over the emerging markets of South East Asia, CIS/Russia and Africa. Niche has 33 products (26-Own and 7-In-licencing) with direct sales operations in UK and Ireland. Currently, all the manufacturing is done on a tender basis and 2-25% supply goes from Unichem India. In future, Unichem wants to supply 1% which will give them a pricing benefit. Unichem s 1% subsidiary in UK, Niche Generics has turnaround and it will have meaningful contribution to EPS from FY14 onwards Unichem rationalized the operating costs by reducing head counts. Unichem took various measures to make this venture turn profitable. Unichem rationalized the operating costs by reducing head counts. It has set up a packaging facility at Ireland, which will enhance the bargaining power to compete with local brands. With the emerging market in focus, we expect Niche to generate a meaningful contribution to EPS FY14 onwards. Turnaround of Niche Generics Turnover PBT PAT FY FY (14.8) (14.8) US Generics to size up with more ANDA approvals Unichem is a late entrant in the US but we believe US Generics to size up with more ANDA approval. ROW market including Latam, Asia & Africa to grow in double digit on a lower base. Unichem has filled around 27 ANDA where all the drugs are mostly in pain management and Antiinfectives. It has 15 approvals of 29 cumulative filings and has launched 9 products. We expect 2-3 filings every quarter. The US venture being in very nascent stage, we don t expect the US market to meaningfully contribute. But, this will definitely help Unichem to leverage upon its strength in R&D as well as in the manufacturing capacity. Unichem plans to file DMF for all the ANDA that they are being filled. The backward integration will help them to become price competitive in the market where they are late entrants. The company has filed 29 ANDAs till date and has 15 approvals of which 9 are launched 5

6 Strong balance sheet with a positive cash flow Unichem is a zero debt company. The company has negative net debt and free cash flow generation of Rs 724mn along with proceeds from Indore SEZ of ~Rs16mn.The free cash flow generation along with a debt free balance sheet keeps Unichem in a comfortable position to go for the inorganic growth. Unichem is eyeing acquisitions to fill gaps in the drug portfolio where it has no presence or very less product lines like in derma, women health or ophthalmic space. Though the company is not aggressively looking at acquisitions, it remains on a continuous search for a good deal. In domestic market now, the deals have become expensive as there are many buyers than sellers. Moderate capital expenditure 1,8 1,6 1,4 1,2 1, Free Cash flow generation to continue FY12 FY13 FY14E FY15E FY12 FY13 FY14E FY15E Capex to moderate and turnover ratio to improve Unichem Laboratories recently sold its new formulation facility in Madhya Pradesh along with all its assets to Mylan Laboratories for Rs1,65mn. The company has incurred expenses of ~Rs6mn in the unit. The proceeds from Indore SEZ will be used as Capex for Goa formulation plant and present API plants in Roha & Pithampur. Other than that the annual capex would only be a regular maintenance capex. Leveraging on a manufacturing base to aid in growth To leverage on its manufacturing capacity, Unichem is also looking for CRAM opportunities. This business contributed Rs 1,2mn in FY13. Today, where the pharma sector is at an inflection point, any joint venture or co-marketing deal could help to boost revenue with its unused manufacturing capacity. 6

7 Expect ULL to clock 15% of revenue CAGR over FY13-15 ULL s top-line registered 11% CAGR over FY5-13 led by growth in Domestic formulation. Export formulation also witnessed strong growth on a lower base. After few hiccups now, we expect the robust trend to continue. We formulate revenue CAGR of 15% in FY13-15E. The company is confident of growing 2-3bps above the industry growth rate of 12-13% next year on the back of completion of inventory rationalization process at the distributor level volume growth in existing products and improving productivity from recently added MRs. Revenue growth of 15% over FY13-15E Break-up of Export Formulation 16, 14, 12, Domestic Formulations Export Formulations API 6, 5, Niche generics New Contracts US & Canada Other Emerging Mkts 1, 4, 8, 3, 6, 4, 2, 2, 1, FY11 FY12 FY13 FY14E FY15E FY11 FY12 FY13 FY14E FY15E Multiple triggers for margin improvement: The company is confident of growing 2-3bps above the industry growth rate of 12-13% next year and gradual improvement in operating margins on the back of completion of inventory rationalization process at the distributor level, volume growth in existing products and improving productivity from recently added MRs. Improvement in operating performance would be backed by efficiency, business transformation and better product mix. OPM to expand by 1bps 2.% 16.% 12.% 8.% 4.% FY11 FY12 FY13 FY14E FY15E 7

8 Outlook & Valuation Unichem is a zero debt company and has positive free cash flows. It has a strong balance sheet with cash and investment equivalent of Rs3mn plus the proceeds from Mylan Rs16mn (pretax). We believe the zero leverage strategy and positive operating cash flows implies headroom for valuations to expand. Moreover, strong return ratios driven by higher contribution of formulation business and faster cash conversion cycle; aids improvement in operating parameters. We expect significant expansion in RoCE and RoE from 16.3% and 18.6% in FY13 to 19.1% and 22.5% respectively in FY15E. We expect Unichem to post 13.5% CAGR growth in FY13-FY15E. We are confident that the restructuring activity at Unichem will be valueenhancing and the Niche Generic turnaround will aid growth in international business. We believe venturing in the US business and focusing towards emerging markets would accelerate growth. The stock currently trades at 8.7x FY15E EPS of Rs19.2. We estimate the fair value of Unichem is Rs 21 based on PE valuation. At the target price of RS. 21, Unichem discounts FY15E EPS at 11x, implying a 27% upside potential. The company is also a consistent dividend payer. Its dividend to cash profit has increased during the past four years. Considering its strong fundamentals and future growth prospects, the company is a value BUY. One yr forward rolling P/E band P/E valuations below long term average 6 Price 4 x 11 x 17 x 24 x 31 x 35 P/E 5 yr mean Apr-8 1-Aug-8 1-Dec-8 1-Apr-9 1-Aug-9 1-Dec-9 1-Apr-1 1-Aug-1 1-Dec-1 1-Apr-11 1-Aug-11 1-Dec-11 1-Apr-12 1-Aug-12 1-Dec-12 1-Apr-13 1-Apr-8 1-Aug-8 1-Dec-8 1-Apr-9 1-Aug-9 1-Dec-9 1-Apr-1 1-Aug-1 1-Dec-1 1-Apr-11 1-Aug-11 1-Dec-11 1-Apr-12 1-Aug-12 1-Dec-12 1-Apr-13 8

9 Company Background Unichem laboratory (ULL) is an integrated pharmaceutical company with a strong presence in domestic formulations market. Domestic operations contribute around 75% of the consolidated revenues. Unichem s four brands feature among the top 3 Indian pharmaceutical brands and out of which two brands are in the top 1. Top 1 Brands contributes nearly 5% of the company s domestic revenues. The company is among the top 1 company in the representative market. The representative market constitutes only 43% of the total market. Hence there is a huge untapped opportunity for the cash rich and zero debt company for expansion through acquisition or joint venture. Subsidiary description: ULL operates through four divisions, namely Niche Generics (UK), Unichem Pharmaceutical (USA), Unichem SA (SA), Unichem Farmaceutica (Brazil). The investment phase in international operations is over and the subsidiary has started contributing. The USA subsidiary and the Brazilian subsidiary are expected to start contributing from FY14 and FY15 onwards. The current contribution from the SA subsidiary is negligible. Manufacturing Strengths: The company has five manufacturing facilities in Roha (Goa), Ghaziabad (Uttar Pradesh), Pithampur (Madhya Pradesh) and Baddi (Himachal Pradesh). The Goa plant was approved by UK MHRA, MCC (South Africa), WHO (Geneva) and TGA (Australia). The Baddi plant is approved by UK MHRA and MCC (South Africa). 9

10 Financials Income statement Y/e 31 Mar FY12 FY13 FY14E FY15E Revenue 8,857 1,942 12,443 14,43 Operating profit 1,183 1,743 2,199 2,613 Depreciation (34) (383) (428) (496) Interest expense (41) (33) (37) (43) Other income Profit before tax 94 1,461 1,875 2,243 Taxes (228) (328) (421) (54) Net profit 712 1,133 1,453 1,739 Balance sheet Y/e 31 Mar FY12 FY13 FY14E FY15E Equity capital Reserves 6,425 7,9 8,227 9,649 Net worth 6,65 7,271 8,48 9,83 Debt Def tax liab & others Total liabilities 7,786 8,276 9,422 1,857 Fixed assets 5,52 5,669 6,169 6,919 Intangible assets Investments Misc & Def Tax Assets Net working capital 1,937 1,758 2,93 2,462 Inventories 1,58 1,43 1,641 1,886 Sundry debtors 1,833 2,7 2,369 2,723 Other current assets Sundry creditors 1,43 1,566 1,783 2,67 Other current liabilities , Cash Total assets 7,786 8,276 9,422 1,857 Cash flow statement Y/e 31 Mar FY12 FY13 FY14E FY15E Profit before tax 94 1,461 1,875 2,243 Depreciation Tax paid (228) (328) (421) (54) Working capital (335) (37) Operating cashflow 1,292 1,695 1,546 1,865 Capital expenditure (1,114) (972) (928) (1,246) Free cash flow Equity raised Investments 68 (243) - - Debt financing/ disposal 216 (176) 1 12 Dividends paid (291) (316) (316) (316) Other items (9) 25 (12) (15) Net in cash Key ratios Y/e 31 Mar FY12 FY13 FY14E FY15E Growth matrix (%) Revenue growth Op profit growth (21.1) EBIT growth (24.) Net profit growth (25.) Profitability ratios (%) OPM EBIT margin Net profit margin RoCE RoNW RoA Per share ratios Reported EPS Dividend per share Cash EPS Book value per share Valuation ratios Adj P/E P/CEPS P/B EV/EBIDTA Payout (%) Dividend payout Tax payout Liquidity ratios Debtor days Inventory days Creditor days Leverage ratios Interest coverage Net debt / equity. (.1) (.1) (.1) Net debt / op. profit.1 (.2) (.3) (.4) Du-Pont Analysis Y/e 31 Mar FY12 FY13 FY14E FY15E Tax burden (x) Interest burden (x) EBIT margin (x) Asset turnover (x) Financial leverage (x) RoE (%)

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