New peaks. Domestic Formulations

Transcription

1 August 2011 Thematic Report Sector: Pharmaceuticals Domestic Formulations New peaks Nimish Desai Tel: Amit Shah Tel:

2 Domestic Formulations New Peaks Domestic Formulations Page No. New peaks - USD21b opportunity by A's and 4 Ailments A #1 - Affordability A #2 - Access A #3 - Awareness A #4 - Ailments Buys - Cipla, Lupin, Torrent and GSK Pharma Ailments Infection CVS Disease Diabetes CNS Diseases Pain Gastro-intestinal (GI) Problems Respiratory Diseases Annexure Company Cipla Lupin Torrent Pharma GSK Pharma Sun Pharma Cadila Ranbaxy Dr Reddy's Labs Glenmark

3 The Indian Pharma Story 4 A s. 4 Ailments. 4 Buys USD21b opportunity by 2015 We estimate the 2015 Indian domestic market size at Rs960b (USD21b) i.e. a CAGR of 16% over (FY11-16) founded on 4 pillars what we call as 4 A's viz. Affordability, Access, Awareness and Ailments. Accelerating growth in domestic formulation market (USD b) Indian pharma mkt size-inr b Approach Approach Approach Average Acute larger, but chronic faster Historically, in the Indian pharma market, the acute ailments therapy segment was the largest in terms of sales, although it experienced slower growth rates than some of the chronic therapies. Nevertheless, almost all therapy areas experienced double-digit growth. Therapeutic mix Therapeutic mix Antidiabeti CNS c 5% Others 3% 12% Dermatolo gy 6% Gynaecolo gy 6% Cardiac 9% % CAGR14.2% CAGR 15.6% CAGR Pain/ Analgesic 10 % Vitamins/ Minerals 10% Gastroin testinal 10% Respirator y 11% A ntidiabeti c 6% CNS 6% Dermatolo gy 5% Gynaecolo gy 6% Others 13% Cardiac 11% 2012 Pain/ Analgesic 9% Antiinfectives 18 % Antiinfectives 16 % Gastrointestinal 11% Vitamins/ Minerals 8% Respirato y 9% A#1: Affordability Medicines are becoming more affordable led by (1) Rising per capita income, (2) Urbanization, and (3) Higher penetration of health insurance. This is driving the growth in the domestic pharma market Indian pharma market estimate: Affordability approach Per capita Per capita Multiplier Pharma GDP pharma conspn. (x) market INR CAGR INR CAGR (%) INR b CAGR (%) (%) (1) (2) (3) (4) (6) (7) (5) = (4) / (2) FY01 20, FY06 33, FY11 60, FY16 105, Dermatology A#2: Access Anti-infectives Gynaecology People's access to medicines is improving given (1) Rising government spend on healthcare, (2) India's improving medical infrastructure, and (3) Companies' thrust on increasing rural reach. All are combined to further expand the domestic pharma market. Pain/Analgesic Vitamins/Minerals Others Total India s medical infrastructure among the weakest in the world Germany France Australia A#3: Awareness Health awareness in India is rising on the back of (1) Improving literacy, and (2) Rising penetration of media. This serves as an undercurrent for sustaining pharma demand. High correlation of literacy with per capita pharma consumption 100 Russia Italy US UK Japan Brazil China India Orissa Domestic Formulations market will be USD21b in 2015, 2x over Buy Cipla, Lupin, Torrent, GSK Pharma The India domestic pharma story is founded on 4 pillars, what we call the 4 A's - Affordability, Access, Awareness and Ailments. These 4 A's will enable the market to be 2x - from USD10b in 2010 to USD21b in A significant share of the market delta is explained by 4 Ailments - CVS, Diabetes, CNS and Infection. These ailment segments rank high on what we call the Attractiveness Factor, measured as incremental market size divided by Bihar 139 Literacy rate (%) Gujarat 97 UP 83 Rajasthan A#4: Ailments 72 Doctors/10,000 Hospital beds/10,000 Assam Per Capita Pharma spend (Rs) Karnataka Madhya Pradesh As a trend, incidence of chronic/lifestyle ailments (cardiovascular, central nervous system, diabetes) is rising compared to acute ailments. Medicine demand from these segments will grow faster than the rest of the Indian pharma market. Share of chronic ailments segment is on the rise (%) Acute segment West Bengal Andhra Pradesh A s 4 Ailments E Indian pharma market estimate: Access approach Year Pharmacies CAGR Mkt (INR b) Mkt/Pharmacy (INR) CAGR (%) , , , , , , , ,272, Tamil Nadu Haryana Chronic segment Punjab Kerala Maharashtra CVS, Diabetes, CNS and Anti-infectives We believe that CATS like Cardiovascular (CVS), Diabetes, Central Nervous System (CNS) will account for a major chunk of the incremental market over the next 5 years. Also, with rising income levels in the rural areas, anti-infectives will also record good growth over the same period. We believe these four will be the key segments of the future Indian pharma market estimate: Ailment approach (INR b) E Incr. mkt Share (%) Share 2015 on 2009 Mkt size CAGR (%) Mkt size (%) CAGR (%) Anti-diabetic CVS CNS Gastrointestinal Respiratory CVS, Anti-infectives, Diabetes and CNS: Key segments with relatively fewer players No. of Players Gynaecology Vitamines Dematology 24 CNS AF Pain Diabetes AF AI AF Respiratory AF GI AF Incremental mkt size (Rs b) E Segment Size (INR b) 53 Contribution to Industry (%) CVS AF CVS ( CAGR %) Diabetes ( CAGR %) CNS ( CAGR %) Anti-infectives ( CAGR %) the number of players who will share the pie. Companies with a strong presence in these ailment segments are therefore better placed. Most companies with a meaningful presence in Indian market will clock healthy growth in sales and profits. We have identified winning stocks based on a combined approach of conventional P/E-based valuation and our proprietary MEDICINES Score. Our 4 Buys are Cipla, Lupin, Torrent and GSK Pharma. Note: AF=Incremental market size divided by number of players Segment Size (INR B) 26 Contribution to Industry (%) Segment Size (INR b) 27 Contribution to Industry (%) Segment Size (INR B) Contribution to Industry (%) Buys Presence in high-potential segments The chart below maps the positioning of pharmaceutical players in the key therapeutic segments of CVS, Diabetes, anti-infectives and CNS. We have plotted the dominance of each player in these respective segments using prescription market share as the key measure of dominance. Company mapping with respect to therapeutic classes Sun Pharma, Abbott, U S V, Ranbaxy, Alkem, Sun Pharma, Torrent, Cadila, High Aventis, Sun Aristo, Cipla, Intas, Torrent, Cipla, Unichem, Pharma GSK, Piramal Abbott, Piramal Ranbaxy, Lupin Dominance Medium Low Aventis, U S V, Emcure, Piramal, Dr Reddy s, Intas, Micro Labs IPCA Labs, AstraZeneca, Pfizer Eli Lilly, Piramal, Micro Labs, Lupin Panacea, Ranbaxy Alembic, Mankind, FDC, Macleods, Lupin Attractiveness of international business It is imperative to map the domestic and the non-domestic businesses of companies to take an overall view on them, as depicted below. Company mapping: Attractiveness of domestic and international business International Business Favourable Neutral Unfavourable Note: Only companies covered in this report have been mapped Earnings growth v/s valuation Aventis, Ranbaxy, Unichem, Micro Labs Novartis, Cipla, Lupin CVS Diabetes Anti-infectives CNS Glenmark Pharma Dr Reddy Cipla, GSK Pharma Cadila, Piramal, Ranbaxy Pfizer, Mankind, Dr Reddy s, Sun Pharma, Glenmark, Biocon Others Sun Pharma, Cipla, Lupin, Cadila, Torrent Pharma Ranbaxy, GSK Pharma Unfavorable Neutral Favorable Domestic Business We plotted the Screen #2 shortlisted companies in a matrix of FY11-13E EPS CAGR and FY11 P/E as depicted below. Based on the same, the top picks are Torrent, Cipla & Lupin. Company mapping with respect to earnings growth and valuation FY11 P/E Dr Reddy GSK Lupin Cadila Cipla Torrent Glenmark FY11-13E EPS CAGR (%) Top picks: Cipla, Lupin, Torrent and GSK We have identified nine key success factors (KSFs) for shortlisting Indian pharma companies and their stocks. These success factors correspond to the initials of the word "MEDICINES". We have rated the companies on these KSFs to arrive at a final MEDICINES Score out of a maximum possible 100. Indian domestic pharma players: The MEDICINES scorecard M E D I C I N E S Total Sun Cipla GSK Pharma** Lupin Torrent Pharma Cadila Dr. Reddy's Labs Glenmark Ranbaxy ** GSK Pharma total MEDICINES score pro-rated as rating for Non-domestic business is not applicable Sun Ranbaxy (53%, 65x) August 2011

4 The 4 Ailments Lifestyle ailments will grow faster than others Attractiveness Factor - Our key test to check health of ailment segments Usually, size is considered as the key criteria for the attractiveness of any market AF = Incremental market size / No. of players. Obviously, higher the AF, better or market segment. the prospects of incumbents. But to arrive at the 4 key ailment segments, we have used the measure of Thus, Gastro and Respiratory will have higher incremental market than CNS. But Attractiveness Factor (AF). the same will be shared among a very large number of players, diluting the segments' attractiveness. Indian Power Sector: Story in Pictures Of the 4 key segments, the AF ranking is (1) CVS - 400, (2) Diabetes - 396, (3) Infection - 337, and (4) CNS CVS, Infection and Diabetes (in that order) rank higher than all other segments, both in terms of incremental market size and AF. Market share of the 4 key ailments set to rise from 40% in 2010 to 45% in 2015 The 4 Buys Based on detailed MEDICINES Score ranking MEDICINES Score - Criteria, maximum score (in brackets) & rating methodology M - Mix & Market share (10): Strong presence in lifestyle segments rated higher E - Equity with doctors (10): Higher prescription share and rankings rated higher D - Distribution & reach (10): Wider distribution and reach in relevant geographies are rated higher I - Introductions (10): Higher contribution from new launches are rated higher C - CAGR & scale-up (10): Consistent high growth is rated higher I - Improvement in MR productivity (10): Consistently high or improving Sales/ MR is rated higher N - Non-domestic business (10): Attractive overseas opportunity (incl one-offs) is rated higher E - Earnings growth (10): High long-term earnings growth (FY05-13) is rated higher S - Stock attractiveness (20): Captures outlook, valuation, and our overall view. Mix Equity with doctors MEDICINES Chronic therapy Score Comment Score Score contribution (%) Sun Leader in CNS, Gynaec and 2nd in CVS, Anti-diabetics 9 Market leader in AI and Respiratory 7 Cipla Leader in Anti-TB segment 6 Lupin Ranks 2nd in CNS and 7th 7 Torrent Pharma in CVS Market leader in Derma, Vit and Pain 9 GSK Pharma ** Mgmt Among top 3 players in CVS and GI 7 Cadila Ranks 3rd in GI and Pain Mgmt 6 Dr. Reddy's Labs Ranks 2nd in Dermatology 3 Glenmark Among the leaders in AI and 5 Ranbaxy Dermatology ** GSK Pharma total MEDICINES score pro-rated as rating for Non-domestic business is not applicable Domestic formulations companies - Comparative valuations (INR) Company Target Upside EPS (INR) P/E (X) EV/EBITDA (X) ROE (%) (CMP) Price (%) FY12E FY12E FY11 FY12E FY13E FY12E FY11 FY13E FY11 FY13E FY11 FY13E Top Picks Cipla (281) Lupin (450) Torrent (589) GSK (2,155) 2, Others Sun (464) Cadila (824) DRRD* (1,446) 1, Glenmark (318) Ranbaxy ## (468) * Dr. Reddy's ## - Adjusted for Rs77/sh of DCF value of FTF; Dr. Reddy's Labs & Ranbaxy core valuations adjusted for DCF value of Para-IV upsides Distribution & reach Metro/Tier I MR strength Score (% of sales) 73 2, , , , , , , , ,500 7 Introductions In last Contbn to Score 4 years growth (%) Sector performance vis-a-vis benchmark Outperformer post the credit crisis The DF index has consistently outperformed the Sensex and the BSE Healthcare index as well from Sep-2009 onwards. In fact the DF index commenced its outperformance vis-à-vis the BSE Healthcare index immediately post the credit crises of We believe that the outperformance reflects the relatively defensive nature of the DF business coupled with reasonable growth and good profitability. The outperformance is also aided by the fact that the DF business is relatively less capital intensive as compared to some of the other pharma businesses. CAGR & Scale-up (%) - Sales FY05-11 FY11-13 Score Improvement in productivity (Sales/MR, INR m) Score Non domestic business Favorability Score High 7 Medium 5 High 6 High 6 Not applicable 0 High 6 High 7 Low 3 Medium 5 Domestic Formulations (DF) Index is an outperformer over 5 years Aug-06 Nov-06 Feb-07 All indices re-based to 100 Sensex BSE Healthcare Index DF Index May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Earnings Growth (FY11-13) Comment (%) Score Aug-10 Stock attractiveness Comment Score Neutral 13 Top pick 14 Top pick 14 Top pick 14 Buy 14 Neutral 12 Neutral 12 Neutral 10 Sell 9... and also in the last 1 year Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 August 2011

5 Thematic Report Sector: Pharmaceuticals Domestic Formulations Summary New peaks - USD21b opportunity by A's. 4 ailments. 4 buys 4 A's - Lead to USD21b opportunity by 2015 The India domestic pharma story is founded on 4 pillars, what we call the 4 A's - A #1 - Affordability Medicines are becoming more affordable led by (1) Rising per capita income, (2) Urbanization, and (3) Higher penetration of health insurance. This is driving the growth in the domestic pharma market. A #2 - Access People's access to medicines is improving given (1) Rising government spend on healthcare, (2) India's improving medical infrastructure, and (3) Companies' thrust on increasing rural reach. All are combined to further expand the domestic pharma market. Companies covered Top buys Cipla Lupin Torrent Pharma GSK Pharma Others Sun Pharma Cadila Ranbaxy Dr. Reddy's Labs Glenmark Indian pharma mkt (INR b) Approach 1 (pg 5) 983 Approach 2 (pg 6) 936 Approach 3 (pg 6) 962 Average 960 USD b 21 A #3 - Awareness Health awareness in India is rising on the back of (1) Improving literacy, and (2) Rising penetration of media. This serves as an undercurrent for sustaining pharma demand. A #4 - Ailments As a trend, incidence of chronic/lifestyle ailments (cardiovascular, central nervous system, diabetes) is rising compared to acute ailments. Medicine demand from these segments will grow faster than the rest of the Indian pharma market. Based on the past data and present trends, we have estimated the 2015 (FY16) Indian pharma market using three different approaches - Approach 1 (Affordability-based): Correlation between per capita GDP and per capita pharma consumption Approach 2 (Access-based): Trend in pharmacies and sales per pharmacy Approach 3 (Ailment-based): Summation of various ailment segment sizes. Averaging the figure using the three approaches, we estimate the 2015 Indian domestic market size at INR960b (USD21b) i.e. a CAGR of 16% over (FY11-FY16). 4 ailments - CVS, anti-diabetics, anti-infectives and CNS are high potential segments We believe that chronic therapies like Cardiovascular (CVS), anti-diabetics and Central Nervous System (CNS) will account for a major chunk of the incremental market over the next 5 years. Also, with rising income levels in the rural areas, anti-infectives will also record good growth over the same period. We believe these four will be the key segments of the future, and garner more than 50% of the delta in the Indian formulations market, 2015 over August

6 Domestic Formulations New Peaks We juxtaposed the incremental opportunity of various therapeutic segments against the number of existing players in each of these segments, to arrive at the following plot. CVS, Anti-infectives, Diabetes and CNS are large segments with relatively fewer players Top 4 ailment segments are mainly based on Attractiveness Factor, which is highest for CVS, Diabetes, Antiinfectives and CNS in that order No. of Players Incremental mkt size (INR b) E Gynaecology Vitamins Dermatology CNS AF Pain Diabetes AF AI AF Respiratory AF GI AF CVS AF Note: AF is Attractiveness Factor of segment, which is defined by the incremental size of the opportunity per player Source: Industry/MOSL Our key conclusions from this chart: 1. As discussed before, CVS, Anti-infectives, Diabetes and CNS will record maximum share of incremental market (the size of bubble indicates this). 2. We also note that the attractiveness factor (i.e. incremental segment market size divided by number of players) is most favorable for these segments. 3. Hence, companies which enjoy strong positioning in these segments will be able to generate maximum value from their respective domestic formulations businesses. Valuation summary EPS CAGR P/E (x) (FY11-13) (FY13) Cipla Lupin Torrent Pharma GSK Pharma Sun Pharma Cadila Ranbaxy DRL Glenmark buys - Cipla, Lupin, Torrent Pharma and GSK Pharma Having identified the most attractive ailment segments, we have adopted two approaches to arrive at our top plays on India's domestic formulations opportunity: Approach 1: 3-screen shortlisting process as follows: Screen #1: Identify companies with dominating presence in high-potential ailment segments Screen #2: Of the above, exclude companies with unfavorable non-domestic business Screen #3: Juxtapose the Screen #2 surviving companies vis-à-vis earnings growth and valuation Approach 2: MEDICINES score, based on nine key success factors for picking domestic formulation stocks Approach 1: 3-screen shortlisting process Screen #1: Identify companies with dominating presence in high-potential ailment segments The chart below maps the positioning of pharmaceutical players in the key therapeutic segments of CVS, Diabetes, anti-infectives and CNS. We have plotted the dominance of each player in these respective segments using prescription market share as the key measure of dominance. August

7 Domestic Formulations New Peaks Company mapping with respect to therapeutic classes High Sun Pharma, Torrent, Cadila, Cipla, Unichem, Ranbaxy, Lupin Abbott, U S V, Aventis, Sun Pharma Ranbaxy, Alkem, Aristo, Cipla, GSK Pharma, Piramal Sun Pharma, Intas, Torrent, Abbott, Piramal Cipla, GSK Pharma Dominance Medium Aventis, U S V, Emcure, Piramal, Dr Reddy's, Intas, Micro Labs Eli Lilly, Piramal, Micro Labs, Lupin Alembic,Mankind, FDC, Macleods, Lupin Aventis, Ranbaxy, Unichem, Micro Labs Cadila, Piramal, Ranbaxy Low IPCA Labs, AstraZeneca, Pfizer Panacea, Ranbaxy Novartis, Cipla, Lupin Pfizer, Mankind, Dr Reddy's, Sun Pharma, Glenmark, Biocon Companies in bold have been covered in this report CVS Diabetes Anti-infectives CNS Others Source: MOSL Screen #2: Most Indian companies are not pure-plays; view on non-domestic business is also important It is imperative to map the domestic and the non-domestic businesses of companies to take an overall view on them, as depicted below. Company mapping relative to the attractiveness of domestic and international business Sun Pharma, 3 of our 4 top picks are favorably placed in both their domestic and international businesses International Business Favourable Neutral Unfavourable Glenmark Pharma Dr Reddy Cipla, Lupin, Cadila, Torrent Pharma Ranbaxy, GSK Pharma Note: Only companies covered in this report have been mapped Unfavourable Neutral Favourable Domestic Business Source: MOSL Screen #3: Juxtapose the Screen #2 shortlisted companies vis-à-vis earnings growth and valuation We plotted the Screen #2 shortlisted companies in a matrix of FY11-13E EPS CAGR and FY11 P/E as depicted below. Based on the same, the top picks are Cipla, Lupin and Torrent Pharma. We are also positive on GSK Pharma as we believe it deserves premium valuation due to strong parentage (giving access to large product pipeline), brand-building ability, industry-best RoCE of over 45% and likely positioning in post patent era. August

8 Domestic Formulations New Peaks Earnings growth v/s Valuation: Cipla, Torrent, Lupin on top GSK merits rich valuation due to superior return ratios FY11 P/E (x) Dr Reddy 20 GSK Cadila Lupin Cipla Ranbaxy (53%, 65x) Sun Glenmark Torrent RoCE (%) Adj. RoCE (%) Very high due to -ve capital employed FY11-13E EPS CAGR (%) Note - Adj. RoCE - RoCE adjusted for other income in P&L and Cash in Balance sheet RoCE and Adj. RoCE are average of FY11-13 Sun Cipla Source: MOSL Approach 2: The MEDICINES score We have identified nine key success factors (KSFs) for shortlisting Indian pharma companies and their stocks. These success factors correspond to the initials of the word "MEDICINES". We have rated the companies on these KSFs to arrive at a final "MEDICINES Score" out of a maximum possible 100. The companies with the highest MEDICINES Score are the most attractive investment ideas. We have considered the following KSFs for evaluating the domestic formulations business (see box on page 21 for explanation). Our MEDICINES Scorecard is given below. DRL Ranbaxy Cadila Lupin GSK Glenmark Torrent MEDICINES Measures M E D I C I N E S Mix & Market share Equity with doctors Distribution & reach Introductions CAGR & scale-up Improvement in MR productivity Non-domestic business Earnings growth Stock attractiveness 4 of the top 5 MEDICINES score companies correspond with Approach 1. We are Neutral on Sun only due to rich valuations Indian domestic pharma players: The MEDICINES scorecard M E D I C I N E S Total Sun Cipla GSK Pharma ** Lupin Torrent Pharma Cadila Dr. Reddy's Labs Glenmark Ranbaxy ** GSK Pharma score pro-rated as rating for Non-domestic business is not applicable Source: MOSL 4 buys: Cipla, Lupin, Torrent, GSK Pharma 4 of the top 5 MEDICINES score companies correspond with Approach 1. Thus, combining both Approaches 1 and 2, our top picks are Cipla, Lupin, Torrent and GSK Pharma. We are Neutral on Sun Pharma only due to rich valuations. August

9 Domestic Formulations New Peaks Financial & valuation summary Company Cipla Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR M) (INR M) (INR) GR. (%) (X) (X) (%) (%) Sales EBITDA 03/11A 63,145 9, /12E 69,193 10, /13E 79,041 13, Lupin Torrent Pharma GSK Pharma 03/11A 57,068 8, /12E 64,784 9, /13E 74,127 11, /11A 22,265 2, /12E 25,596 3, /13E 29,817 4, /10A 21,116 5, /11E 23,740 6, /12E 26,921 7, Sun Pharma ** Includes Para-IV/oneoff upsides Cadila Ranbaxy 03/11A** 57,214 18, /12E 65,601 17, /13E 75,976 21, /11A 46,302 6, /12E 51,717 5, /13E 59,983 8, /10A 89,608 10, /11E 85,242 4, /12E 93,005 7, Dr. Reddy's Glenmark 03/11A 74,693 11, /12E 81,754 11, /13E 90,323 13, /11A 29,491 3, /12E 37,007 4, /13E 40,693 5, Domestic Formulations (DF) Index is an outperformer over 5 years and also in the last 1 year Sensex BSE Healthcare Index DF Index Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 All indices re-based to 100 August

10 Domestic Formulations New Peaks Main Report 4 A's and 4 Ailments To drive USD21b opportunity by 2015, 2x over 2010 The India domestic pharma story is founded on 4 pillars, what we call the 4 A's - A #1 A #2 A #3 A #4 Affordability Medicines are becoming more affordable led by (1) Rising per capita income, (2) Urbanization, and (3) Higher penetration of health insurance. This is driving the growth in the domestic pharma market (see page 9). Access People's access to medicines is improving given (1) Rising government spend on healthcare, (2) India's improving medical infrastructure, and (3) Companies' thrust on increasing rural reach. All are combined to further expand the domestic pharma market (see page 12). Awareness Health awareness in India is rising on the back of (1) Improving literacy, and (2) Rising penetration of media. This serves as an undercurrent for sustaining pharma demand (see page 14). Ailments As a trend, incidence of chronic/lifestyle ailments (cardiovascular, central nervous system, diabetes) is rising compared to acute ailments. Medicine demand from these segments will grow faster than the rest of the Indian pharma market (see page 15). USD21b opportunity by 2015 Based on the past data and present trends, we have estimated the 2015 (FY16) Indian pharma market using three different approaches - Approach 1 (Affordability-based): Correlation between per capita GDP and per capita pharma consumption Approach 2 (Access-based): Trend in pharmacies and sales per pharmacy Approach 3 (Ailment-based): Summation of various ailment segment sizes. Averaging the market size arrived using each approach, we estimate the total India market size at USD21b by We discuss below the methodology under the three approaches. Approach 1: Affordability-based Correlation between per capita GDP and per capita pharma consumption Approach 1: Affordability Market size: INR983b We see a strong correlation between India's per capita GDP and per capita pharma consumption. With rising income, pharmaceuticals accounts for a higher share of overall household spend, as indicated by the rising multiplier of per capita pharma consumption CAGR to per capita GDP CAGR. Thus, FY01-06, per capita pharma consumption CAGR was 8.7%, 0.8x of per capita GDP CAGR. Over the next five years (FY06-11), per capita pharma consumption CAGR rose to 12.9%, and the multiplier increased to 1.1x. August

11 Domestic Formulations New Peaks We estimate FY11-16 per capita GDP CAGR of 12%. Applying a 1.3x multiplier, we arrive at FY16 per capita pharma spend of INR784. Multiplying by the then expected population, we estimate the pharma market size at INR983b, a CAGR of 15% from current level of INR465b Indian pharma market estimate: Affordability approach Per capita Per capita Multiplier Pharma GDP pharma conspn. (x) market INR CAGR (%) INR CAGR (%) INR b CAGR (%) (1) (2) (3) (4) (5) = (4) / (2) (6) (7) FY01 20, FY06 33, FY11 60, FY16 105, Source: Industry/MOSL Approach 2: Access-based Trend in pharmacies and sales per pharmacy Our methodology here is as follows - Consider the growth in number of pharmacies in 2005 over 2000, and 2010 over 2005 Calculate the CAGR in average market size per pharmacy over 5-year time frames Extrapolate both of the above for 2015 to arrive at the pharma market size. Approach 2: Access Market size: INR936b 2015 Indian pharma market estimate: Access approach Year Pharmacies CAGR M k t Mkt/Pharmacy CAGR (%) (INR b) (INR) (%) , , , , , , , ,272, Note: As precise data on pharmacies is not available, we have back calculated number of pharmacies for 2005 and 2000 based on the 2010 estimate of 550,000 pharmacies and long-term CAGR of 4.5% Source: Industry/MOSL Approach 3: Ailments-based Summation of various ailment segment sizes Approach 3: Ailments Market size: INR962b The Indian pharma market can be broken down into 10 major therapeutic segments. We have analyzed the growth trend in each of these segments. Going forward, we believe the growth will accelerate, especially in chronic ailment therapeutic segments such as CVS, CNS and anti-diabetics. Adding up the individual segments in 2015, we arrive at the total Indian pharma market size of INR962b. August

12 Domestic Formulations New Peaks 2015 Indian pharma market estimate: Ailment approach (INR b) Market CAGR M k t Incremental size (%) size mkt E 2015E over 2010 Anti-diabetic CVS CNS Gastrointestinal Respiratory Dermatology Anti-infectives Gynaecology Pain/Analgesic Vitamins/Minerals Others Total Source: Industry/MOSL 2015 Indian domestic pharma market of USD21b Average of the three approaches Indian pharma mkt (INR b) Approach Approach Approach Average 960 USD b 21 Averaging the figure arrived using the three approaches, we estimate the 2015 Indian domestic market size at INR960b (USD21b) i.e. a CAGR of 16% over (FY11- FY16). Independently, McKinsey has also estimated the Indian domestic pharma market after considering factors like income demographics, medical infrastructure, disease incidence and penetration of health insurance. It estimates 2015 market size of USD20b INR/USD of 46). In the process, India will improve its global rank in terms of value from 14 currently to top 10 by year Accelerating growth in domestic formulation market India will be among world's top 10 pharma markets by 2015 (USD b) % CAGR 14.2% CAGR 15.6% CAGR market size (US$b) Grow th over 2005 (x) US Japan France Germany Italy UK Spain Canada China Mexico Brazil South Korea Turkey India Source: Mckinsey/MOSL We proceed to discuss the key issues under each of the 4 As, culminating in the MEDICINES framework to zero-in on our top picks. August

13 Domestic Formulations New Peaks A #1 - Affordability Rising per capita income, urbanization, and health insurance penetration will drive pharma spend A #1 Affordability India's NTD journey will steadily drive up per capita income In 2007, we published our first note on the concept of NTD (next trillion dollar of India's GDP). The core NTD thesis is this: It took India about 60 years post independence to clock the first trillion dollar of GDP. With nominal GDP growth of 14-15%, at constant exchange rates, India's next trillion dollar (NTD) will come in just 4-5 years. Every successive trillion dollar GDP would take lesser time and by 2020 India would comfortably reach a USD5t GDP assuming 8% real GDP growth coupled with 5% estimated inflation. India's NTD era next trillion dollar of GDP getting added in successively lower time (USD b) By FY20 India GDP would triple from the current level and be almost ~5 times the level of FY st USD tn 58 years 2nd USD tn 4 years Source: MOSPI/MOSL With population growing at a much lower rate than GDP, India's per capita GDP will keep rising steadily for the next several years. India's per capita GDP is steadily rising (INR) 20,786 22,156 23,476 25,929 30,017 33, % CAGR 38,519 43,844 48,696 53,679 60,048 FY01 67,195 75,214 84,215 94,320 FY02 105,668 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY ,230 1,214 1,314 1,728 1,969 2,263 2,566 2,909 3,299 3,741 4,243 FY12 FY13 FY14 FY15 FY16 3rd USD tn 3.5 years 4th USD tn 2 years 5th USD tn 1.5 years FY51 FY60 FY70 FY80 4,811 5,456 FY90 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E FY17E FY18E FY19E FY20E India's rising per capita GDP augurs well for domestic pharma market Source: MOSPI/MOSL August

14 Domestic Formulations New Peaks Higher per capita income will boost spend on pharmaceuticals There is a direct co-relation between per capita income and spend on healthcare, including pharmaceuticals. Currently, India has one of the world's lowest per capita spend on pharmaceuticals. As India's per capita income grows going forward, healthcare spend is expected to witness one of the highest growth rate among all categories over the next two decades. Healthcare spend is expected to grow to 13% of GDP by India has one of the lowest per capita spend on pharmaceuticals % of avg. household income spent on healthcare (USD) US France Germany Canada Australia Italy Brazil UK Japan USA Japan Canada France Germany Spain Italy UK Romania Russia Turkey Brazil Mexico China Pakistan India BRICS (avg) Russia China India Source: Industry/MOSL BRICs healthcare as % of GDP India is the lowest Brazil Russia China India Large population with low healthcare penetration presents huge opportunity India has 16% of the world's population, yet only accounts for 1% of the total amount spent on health globally. India's expenditure on health amounted to 4% of GDP (2008), substantially lower than developed markets and even BRIC peers - Brazil (8.4%), Russia (5.2%) and China (4.3%). Further, public health expenditure accounted for less than 30% of India's total healthcare costs (2008), reflecting the very basic level of healthcare provided by the government, which is insufficient to meet the health needs of the entire population. In comparison, BRIC peer governments accounted for ~50% of their respective country's healthcare spend. Going forward, economic growth coupled with improving government finances should narrow the gap, implying growth in pharma demand. Share of tier-1 markets in pharma demand (%) Rising urbanization is a positive Urbanization: a positive for pharma demand Increasing urbanization leads to higher demand for pharma products based on factors such as (1) higher affordability, (2) better medical infrastructure, and (3) wider prevalence of chronic diseases. Share of India's tier-1 markets has increased from 60% in 2006 to 63% in Thus, the trend of rising urbanization in India is a key positive for growth in pharma demand. August

15 Domestic Formulations New Peaks Metro and Tier-1 cities market share up from 60% in 2006 to 63% in 2010 India - population distribution METROS CLASS I TOWNS CLASS II TO VI RURAL }Tier-1 mkt Urban population (%) Rural Population (%) CY2006 CY2007 CY2008 CY2009 CY Source: Industry/MOSL Rising health insurance penetration to improve affordability Currently around 300 million people in India are covered under health insurance, and this number is expected to double by Going forward, health insurance should get a boost by way of various regulatory reforms like non-life tariff deregulation, lower capital requirements for players, increase in FDI limit, etc. Increasing penetration of health insurance over the next few years will spur demand for pharmaceuticals as it becomes possible for patients to afford more sophisticated and more expensive therapies. Health insurance penetration in India is rising Per capita premium almost quadruples in 5 years (INR) Premium (INR (Rs b) b) 0.07% 0.06% Premium (% of GDP) 0.12% 0.10% % FY06 FY07 FY08 FY09 FY10 FY06 FY07 FY08 FY09 FY10 Source: IRDA/MOSL August

16 Domestic Formulations New Peaks A #2 - Access Rising government spend on healthcare, better infrastructure will improve availability A #2 - Access Rising government spend on healthcare Healthcare for all is high on the agenda of the present Indian government. This was demonstrated in the union budget for , when the healthcare expenditure outlay was increased to USD5.95b from less than a USD5.17b allocated in The budget allocation has been significantly increased for rural healthcare, with the government also announcing plans to set up six "All India Institute of Medical Sciences "(AIIMS) institutions across the country. Government spending on healthcare will play a major role in increasing the penetration of pharmaceuticals especially in rural areas. Government spend has grown at 18% CAGR over FY06-09 and is translating into higher level of access in Tier II and rural markets. Under Rashtriya Swasthya Bima Yojna (National Health Insurance Scheme), the government plans to create health cover for approximately 400m people; 19m families have already been covered and implementation seems to be on track. Going forward, the government has announced plans to take its spending on healthcare to 3% of GDP from the current level of about 1%. Rising government spend on healthcare improves people's access to medicines, helping pharma demand. Rising government spend on healthcare Allocation under National Rural Health Mission (INR b) Helathcare Healthcare Exp (Rs (INR b) b) Grow th (%) FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY FY06 FY07 FY08 FY09 FY10 Source: Economic Survey, Union Budget 2011 Source: Ministry of Health/MOSL Improving healthcare infrastructure The healthcare infrastructure in India is likely to improve and will be a critical growth driver for pharmaceuticals. Currently, India's healthcare infrastructure is at nascent stage compared to western countries. India has only 9 hospital beds per 10,000 people compared to in US and Western Europe. Even other developing countries like Brazil, China and Thailand fare much better than India with beds per 10,000. Industry data suggests the number of hospital beds in India is likely to double by Likewise, India's current doctor-population ratio at 5 per 10,000 is the lowest among major countries. However, with rising number of students gaining admission to medical colleges, this ratio is set to improve going forward. Further, diagnostic laboratory services market (estimated at USD750m) is expected to 20-25% p.a. over the next few years. August

17 Domestic Formulations New Peaks Hospital beds per 10,000 - India among world's lowest Doctors per 10,000 people - India the lowest the among world majors Japan Russia Germany France A us tralia Italy UK Canada US China Brazil India Russia Ita ly Germany France Argentina US A us tralia UK Mexico Japan Brazil China Pakis tan India Students entering medical colleges and number of colleges - rising trend Source: WHO No. of allopathic doctors registered with state medical councils - Rising trend here as well No of medical colleges in India 757,377 No of students entering medical colleges ('000) 736, , , , FY96 FY01 FY05 FY06 FY07 FY08 FY09 FY Source: National Health Profile Companies are focusing on increasing their rural reach Currently around 67 per cent of India's population or 742 million people live in rural areas, but rural markets contribute to only 17 per cent of the overall pharmaceutical market's sales. In the last few years both MNCs and Indian pharma companies are increasing their attention to tier 2 markets. The above-mentioned factors, namely, increasing government spend on healthcare, improvement in healthcare infrastructure, and growing health awareness etc is expected to drive pharma growth in these markets. Growth in tier-2 markets showing signs of catching up (%) 18 METROS CLASS I TOWNS CLASS II TO VI RURAL CY2007 CY2008 CY2009 CY2010 Source: Industry/MOSL August

18 Domestic Formulations New Peaks A #3 - Awareness Rising literacy levels and media penetration is improving health awareness A #3 - Awareness High correlation between literacy and per capita pharma consumption We believe literacy is one of the key factors driving awareness about healthcare in general and pharmaceuticals in particular. In fact, literacy also has an indirect impact on pharma consumption. Higher literacy typically leads to higher per capita income (i.e. A #1, affordability), which in turn drives pharma demand. Our study of pharmaceutical consumption and literacy rates among various states of India confirms a strong correlation between literacy rate and pharma demand. As seen in the graph below, states with high literacy rates like Kerala, Maharashtra, Punjab and Haryana have higher per capita spend on pharmaceuticals compared to states with low literacy rates like Bihar, UP, Rajasthan and Assam. High correlation of literacy with per capita pharma consumption Literacy rate in India is rising 100 Literacy rate (%) Per Capita Pharma spend (Rs) Literacy rate (%) Per CapitaGDP (Rs) 80, , , , Orissa Bihar Gujarat UP Rajasthan Assam Karnataka Madhya West Bengal Andhra Tamil Nadu Haryana Punjab Kerala Maharashtra 0 0 Orissa Bihar Gujarat UP Rajasthan Assam Karnataka Madhya West Bengal Andhra Tamil Nadu Haryana Punjab Kerala Maharashtra 0 Rising media penetration also leads to higher awareness Penetration of all forms of media is rising in India - print, TV, radio and internet. Higher media exposure leads to better awareness on a whole range of issues including healthcare, thus favourably influencing pharma demand. Rising media penetration is a positive for healthcare awareness and pharma demand Source: Industry/MOSL 51.4 Total TV HH (m) TV penetration (%) C&S HH (m) 63 C&S penetration (% of TV Household) Note: HH stands for Households Source: Industry/MOSL August

19 Domestic Formulations New Peaks A #4 - Ailments Lifestyle drugs and anti-infectives hold the biggest potential A #4 - Ailments India has so far been an acute ailments market Ailments can be of two types - acute and chronic. An acute ailment can be described as a condition of rapid onset and severe symptoms of brief duration e.g. infectious disease like common cold, fever etc. Acute ailments may turn chronic if they remain unresolved. Chronic ailments can be described as conditions that, with current medical knowledge, can be alleviated but not cured. Unlike acute ailments, chronic ailments (1) do not usually resolve of their own accord, and (2) are of longer duration e.g. diabetes, asthma, blood pressure, etc. Due to relatively poor sanitation conditions, drugs addressing infectious diseases are predominant in most developing countries. Hence, the proportion of acute to chronic is higher in developing countries compared with developed countries. Therapeutic mix of major countries (%): Trend in India's therapeutic mix (%) India currently is an acute ailments market Share of chronic ailments segment is on the rise Chronic Acute Acute segment Chronic segment US Germany Japan UK China India E Source: McKinsey/MOSL Changing disease profile to boost demand for chronic therapies India is undergoing a transition in terms of disease profile. The incidence and prevalence of non-communicable diseases is rapidly increasing due to demographic changes (e.g. urbanization) and lifestyle changes resulting from socioeconomic development (e.g. obesity, stress). Higher prevalence coupled with higher prescription compliance (due to improved affordability) is likely to drive much stronger growth in chronic ailment therapeutic segments (CATS). In 2006, the share of CATS stood at 22% of pharmaceutical market in India versus 55-65% in developed markets like US, UK and Japan. By 2015, the share of CATS is expected to rise to 30% of the then Indian market. (See pages for profiles of major ailments in India.) August

20 Domestic Formulations New Peaks Prevalence rates of key chronic ailments to rise Market sizes of major corresponding therapies (INR b) (% of population) Market 2005 size 2005 (Rs b) Market 2015 Size 2015 (Rs b) Coronary heart disease Diabetes Asthma Obesity Cancer Coronary heart disease Diabetes Respiratory Source: Industry/MOSL India: Therapeutic trend (2000 to 2010) Historically, in the Indian pharma market, the acute ailments therapy segment was the largest in terms of sales, although it experienced slower growth rates than some of the chronic therapies. Nevertheless, almost all therapy areas experienced double-digit growth over the period. This is attributed to the preceding three As - Affordability, Access and Awareness. Among key therapies, anti-diabetics was the fastest growing in terms of sales with CY00-10 CAGR of 19.6% followed by CVS (cardiovasculsar system) at 15%. In terms of therapeutic segment market share, both anti-diabetics and CVS gained ~2.5% share each over CY00-10, whereas anti-infectives and vitamins & minerals lost 2% share each. Trend in major therapeutic segments Indian pharma market therapeutic mix (2000) Market Size (Rs b) CAGR (%) CNS 5% Dermatology 6% Antidiabetic 3% Others 12% Antiinfectives 18% Gastroin testinal 10% Antiinfectives Gastrointestinal Respiratory Vitamins/Minerals Pain/Analgesic Cardiac Gynaecology Dermatology CNS Antidiabetic Gynaecology 6% Cardiac 9% Pain/ Analgesic 10% Vitamins/ Minerals 10% Respiratory 11% Indian pharma market therapeutic mix (2005) Indian pharma market therapeutic mix (2010) Antidiabetic CNS 4% 7% Dermatology 5% Gynaecology 3% Cardiac 10% Others 8% Pain/ Analgesic 9% Vitamins/ Minerals 13% Antiinfectives 21% Gastrointestinal 11% Respiratory 9% Antidiabetic 6% CNS 6% Dermatology 5% Gynaecology 6% Others 13% Cardiac 11% Pain/ Analgesic 9% Antiinfectives 16% Vitamins/ Minerals 8% Gastrointestinal 11% Respiratory 9% Source: Industry/MOSL August

21 Domestic Formulations New Peaks CVS, Diabetes, CNS and Anti-infectives will be the high potential segments We believe that CATS like Cardiovascular (CVS), Diabetes, Central Nervous System (CNS) will account for a major chunk of the incremental market over the next 5 years. Also, with rising income levels in the rural areas, anti-infectives will also record good growth over the same period. We believe these four will be the key segments of the future, and garner more than 50% of the delta in the Indian formulations market, 2015 over We juxtaposed the incremental opportunity of various therapeutic segments against the number of existing players in each of these segments, to arrive at the following plot. CVS, Anti-infectives, Diabetes and CNS are large segments with relatively fewer players Top 4 ailment segments are mainly based on Attractiveness Factor, which is highest for CVS, Diabetes, Antiinfectives and CNS in that order No. of Players Incremental mkt size (INR b) E Gynaecology Vitamins Dermatology CNS AF Pain Diabetes AF AI AF Respiratory AF GI AF CVS AF Note: AF is Attractiveness Factor of segment, which is defined by the incremental size of the opportunity per player Source: Industry/MOSL Our key conclusions from this chart: 1. As discussed before, CVS, Anti-infectives, Diabetes and CNS will record maximum share of incremental market (the size of bubble indicates this). 2. We also note that the attractiveness factor (i.e. incremental segment market size divided by number of players) is most favorable for these segments. 3. Hence, companies which enjoy strong positioning in these segments will be able to generate maximum value from their respective domestic formulations businesses. August

22 Domestic Formulations New Peaks 4 Buys Cipla, Lupin, Torrent and GSK Pharma Having identified the most attractive ailment segments, we have adopted two approaches to arrive at our top plays on India's domestic formulations - Approach 1: 3-screen shortlisting process as follows: Screen #1 - Identify companies with dominating presence in high-potential ailment segments Screen #2 - Of the above, exclude companies with unfavorable non-domestic business Screen #3 - Juxtapose the Screen #2 surviving companies vis-à-vis earnings growth and valuation Approach 2: MEDICINES score, based on nine key success factors for picking domestic formulation stocks The final list from both the approaches is - Cipla, Lupin, Torrent and GSK Pharma. Approach 1: 3-Screen shortlisting process Screen #1 Presence in high potential segments Identify companies with dominating presence in high-potential ailment segments The chart below maps the positioning of pharmaceutical players in the key therapeutic segments of CVS, Diabetes, anti-infectives and CNS. We have plotted the dominance of each player in these respective segments using prescription market share as the key measure of dominance. Given the fragmented nature of the Indian formulations market, we have defined 5% as the minimum threshold market share which qualifies as high dominance while market share of between 3-5% qualifies as medium category. Company mapping with respect to therapeutic classes High Sun Pharma, Torrent, Cadila, Cipla, Unichem, Ranbaxy, Lupin Abbott, U S V, Aventis, Sun Pharma Ranbaxy, Alkem, Aristo, Cipla, GSK Pharma, Piramal Sun Pharma, Intas, Torrent, Abbott, Piramal Cipla, GSK Pharma Dominance Medium Aventis, U S V, Emcure, Piramal, Dr Reddy's, Intas, Micro Labs Eli Lilly, Piramal, Micro Labs, Lupin Alembic,Mankind, FDC, Macleods, Lupin Aventis, Ranbaxy, Unichem, Micro Labs Cadila, Piramal, Ranbaxy Low IPCA Labs, AstraZeneca, Pfizer Panacea, Ranbaxy Novartis, Cipla, Lupin Pfizer, Mankind, Dr Reddy's, Sun Pharma, Glenmark, Biocon Companies in bold have been covered in this report CVS Diabetes Anti-infectives CNS Others Source: MOSL August

23 Domestic Formulations New Peaks Sun, Cipla, Lupin, Abbott, GSK best placed to capture the opportunity We note that these companies are best placed to capture the incremental opportunity in the high-growth life-style and anti-infectives segments by virtue of: 1. Strong presence in these key segments 2. High prescription market share of at least 5% 3. Brand-building ability of these companies Ranbaxy, Cadila and Aventis also reasonably well placed These companies are also relatively well placed in the Indian formulations market and form the 2nd-tier of companies which should be focused on as participants in this large opportunity. Dr. Reddy's & Glenmark need to further strengthen their positioning The chart above indicates that DRL and Glenmark have a lot of catching-up to do to qualify as companies which will be able to exploit the large opportunity in the domestic formulations business. These companies suffer from relatively lower prescription market share in the high growth therapeutic segments. Screen #2 Non-domestic business Most Indian companies are not pure-plays; view on non-domestic business is also important It is well-known that most Indian pharmaceutical companies are not pure-plays on the domestic opportunity given their strong focus on international generic businesses. Hence, it becomes imperative to map the domestic and the non-domestic businesses of these companies to take an overall view on these companies. The chart below depicts the matrix of these two businesses: Company mapping relative to the attractiveness of domestic and international business Sun Pharma, Cipla, Lupin, Cadila, Torrent Pharma 3 of our 4 top picks are favorably placed in both their domestic and international businesses International Business Favourable Neutral Unfavourable Glenmark Pharma Dr Reddy Ranbaxy, GSK Pharma Note: Only companies covered in this report have been mapped Unfavourable Neutral Favourable Domestic Business Source: MOSL Screen #3 Earnings growth v/s Valuation Juxtapose the Screen #2 shortlisted companies vis-à-vis earnings growth and valuation We plotted the Screen #2 shortlisted companies in a matrix of FY11-13E EPS CAGR and FY11 P/E as depicted below. Based on the same, the top picks are Cipla, Lupin and Torrent. August

24 Domestic Formulations New Peaks Earnings growth v/s Valuation: Cipla, Torrent, Lupin on top GSK merits rich valuation due to superior return ratios FY11 P/E (x) Dr Reddy 20 GSK Cadila Lupin Cipla Ranbaxy (53%, 65x) Sun Glenmark Torrent RoCE (%) Adj. RoCE (%) Very high due to -ve capital employed FY11-13E EPS CAGR (%) Note - Adj. RoCE - RoCE adjusted for other income in P&L and Cash in Balance sheet RoCE and Adj. RoCE are average of FY11-13 Sun Cipla Source: MOSL Approach 2: The MEDICINES score We have identified nine key success factors (KSFs) for shortlisting Indian pharma companies and their stocks. These success factors correspond to the initials of the word "MEDICINES". We have rated the companies on these KSFs to arrive at a final "MEDICINES Score" out of a maximum possible 100. The companies with the highest MEDICINES Score are the most attractive investment ideas. We have considered the following KSFs for evaluating the domestic formulations business (see box on page 21 for explanation). Our MEDICINES Scorecard is given below. DRL Ranbaxy Cadila Lupin GSK Glenmark Torrent MEDICINES Measures M E D I C I N E S Mix & Market share Equity with doctors Distribution & reach Introductions CAGR & scale-up Improvement in MR productivity Non-domestic business Earnings growth Stock attractiveness 4 of the top 5 MEDICINES score companies correspond with Approach 1. We are Neutral on Sun only due to rich valuations Indian domestic pharma players: The MEDICINES scorecard M E D I C I N E S Total Sun Cipla GSK Pharma ** Lupin Torrent Pharma Cadila Dr. Reddy's Labs Glenmark Ranbaxy ** GSK Pharma score pro-rated as rating for Non-domestic business is not applicable Source: MOSL 4 buys: Cipla, Lupin, Torrent, GSK Pharma 4 of the top 5 MEDICINES score companies correspond with Approach 1. Thus, combining both Approaches 1 and 2, our top picks are Cipla, Lupin, Torrent and GSK Pharma. We are Neutral on Sun Pharma only due to rich valuations. August

25 Domestic Formulations New Peaks MEDICINES Score - Criteria & rating methodology We briefly explain below the KSFs and the rating criteria. M - Mix & Market share Maximum score: 10 Mix & Market share indicates the therapeutic mix for the company in the domestic formulations market. We have identified life-style segments (CVS, Diabetes & CNS) and Anti-infectives as the most attractive segments for driving future growth and profitability. Companies with strong presence in these segments will be rated higher. E - Equity with doctors Maximum score: 10 Equity with doctors implies the brand equity which the company enjoys with doctors. We have used prescription market share and prescription rankings as the proxy to measure brand equity with doctors. Companies with higher prescription share and better prescription rankings are rated higher. D - Distribution & reach Maximum score: 10 This measures the distribution strength of a company in terms of its presence in metros, Tier-I cities, towns, and rural areas. Companies with wider distribution reach in relevant geographies are rated higher. I - Introductions Maximum score: 10 Introductions measures the ability of a company to drive sales from new launches in the Indian formulations market (since this is an important growth contributor for most Indian companies). Companies with higher contribution from new launches are rated higher. C - CAGR and scale-up Maximum score: 10 CAGR & scale-up captures the past and future growth in the domestic formulations portfolio driven by various factors like therapeutic mix, brand equity, productivity of sales force, new launches, etc. Companies with consistent high growth are rated higher. I - Improvement in MR productivity Max. score: 10 MR (medical representative) productivity captures the ability of a company to drive growth in its domestic formulations portfolio through improvement in productivity of the sales force (measured as Sales/MR). Companies with consistently high or improving sales force productivity are rated higher. N - Non-domestic business Maximum score: 10 This captures our view on the other businesses of the company including one-off option values. Companies expected to do well in these businesses are rated higher. E - Earnings growth Maximum score: 10 We have considered overall earnings growth, and not just from the domestic business. Companies with high longterm earnings growth (FY05-13) are rated higher. S - Stock Attractiveness Maximum score: 20 Stock attractiveness has a higher weight of 20 compared to others, and captures our view on the stock including issues such as depth of management, corporate governance, return ratios, and valuations. Companies with favorable outlook are rated higher. August

26 Domestic Formulations New Peaks Detailed MEDICINES Score Mix MEDICINES Chronic therapy Score Score contribution (%) Sun Cipla Lupin Torrent Pharma GSK Pharma ** Cadila Dr. Reddy's Glenmark Ranbaxy Equity with doctors Comment Score Leader in CNS, Gynaec and 2nd in CVS, Anti-diabetics 9 Market leader in AI and Respiratory 7 Leader in Anti-TB segment 6 Ranks 2nd in CNS and 7th in CVS 7 Market leader in Derma, Vit and Pain Mgmt 9 Among top 3 players in CVS and GI 7 Ranks 3rd in GI and Pain Mgmt 6 Ranks 2nd in Dermatology 3 Among the leaders in AI and Dermatology 5 Distribution & reach Metro/Tier I MR strength Score Sun (% of sales) 73 2,600 8 Cipla 63 5,100 8 Lupin 70 3,682 6 Torrent Pharma 73 3,600 6 GSK Pharma ** 60 2,500 7 Cadila 65 4,500 7 Dr. Reddy's 68 3,165 6 Glenmark 70 2,078 5 Ranbaxy 66 4,500 7 Introductions In last Contbn to Score 4 years growth (%) CAGR & Scale-up (%) - Sales FY05-11 FY11-13 Score Improvement in productivity (Sales/MR, INR m) Non domestic business Earnings Growth (FY11-13) Score Favorability Score Comment (%) Score Sun High Cipla Medium Lupin High Torrent Pharma High GSK Pharma ** Not applicable N.A Cadila High Dr. Reddy's High Glenmark Low Ranbaxy Medium ** GSK Pharma total MEDICINES score pro-rated as rating for Non-domestic business is not applicable Stock attractiveness Comment Score Neutral 13 Top pick 14 Top pick 14 Top pick 14 Buy 14 Neutral 12 Neutral 12 Neutral 10 Sell 9 Domestic formulations companies - Comparative valuations (INR) Company Target Upside EPS (INR) P/E (X) EV/EBITDA (X) ROE (%) (CMP) Price (%) FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E Top Picks Cipla (281) Lupin (450) Torrent (589) GSK (2,155) 2, Others Sun (464) Cadila (824) DRRD* (1,446) 1, Glenmark (318) Ranbaxy ## (468) * Dr. Reddy's ## - Adjusted for Rs77/sh of DCF value of FTF; Dr. Reddy's Labs & Ranbaxy core valuations adjusted for DCF value of Para-IV upsides August

27 Domestic Formulations New Peaks Ailment Profiles Ailments Infection CVS Disease Diabetes CNS Diseases Pain Gastro-intestinal (GI) Problems Respiratory Diseases August

28 Domestic Formulations New Peaks Ailment & Therapy profile Infection Ailment snapshot An infection is the colonization of a host organism by a parasite species. Infecting parasites seek to use the host's resources to reproduce, often resulting in disease. Colloquially, infections are usually considered to be caused by microscopic organisms or microparasites like viruses, prions, bacteria, and viroids, though larger organisms like macroparasites and fungi can also infect. Hosts normally fight infections themselves via their immune system. Mammalian hosts react to infections with an innate response, often involving inflammation, followed by an adaptive response. Pharmaceuticals can also help fight infections. Therapy snapshot Anti-infectives Anti-infective drugs are used to suppress/cure the infection. Four types of anti-infective or drugs exist: antibacterial (antibiotic), antiviral, antitubercular, and antifungal. Depending on the severity and the type of infection, the antibiotic may be given by mouth, injection or may be applied topically. Severe infections of the brain are usually treated with intravenous antibiotics. Sometimes, multiple antibiotics are used to decrease the risk of resistance and increase efficacy. Antibiotics only work for bacteria and do not affect viruses. Antibiotics work by slowing down the multiplication of bacteria or killing the bacteria. Key Drugs Penicillins, Cephalosporins, Aminoglycosides, Macrolides, Quinolones, Tetracyclines Key Brands Augmentin - GSK, Zifi - FDC, Taxim - Alkem, Mox - Ranbaxy Azithral - Alembic Anti-infectives Segment ( CAGR %) Segment Size (INR B) Contribution to Industry (%) Anti-infectives Segment - Prescription Rankings Company Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Cipla Mankind Ranbaxy FDC Piramal (Abbott) Macleods Unbranded Alkem Alembic GSK Anti-infective segment - Value market share (%) Anti-infective segment-prescription market share (%) Others, 32.5 Ranbaxy, 10.8 Alkem, 10.5 Aristo, 7.3 Others, 44.8 Cipla, 8.4 Mankind, 8.3 Ranbaxy, 7.8 FDC, 7.1 Macleods, 4.8 Alembic, 5 FDC, 5.1 Mankind, 5.6 Cipla, 6.7 GSK, 6 Piramal (Abbott), 5.7 Aristo, 2.8 GSK, 2.9 Piramal (Abbott), 5.4 Macleods, 4.5 Alkem, 4.0 Alembic, 4.0 Source: Industry/MOSL August

29 Domestic Formulations New Peaks Ailment & Therapy profile CVS Disease CVS Drugs Ailment snapshot Cardiovascular disease are the class of diseases that involve the heart or blood vessels (arteries and veins).while the term technically refers to any disease that affects the cardiovascular system, it is usually used to refer to those related to atherosclerosis (arterial disease). These conditions usually have similar causes, mechanisms, and treatments. In practice, cardiovascular disease is treated by cardiologists, thoracic surgeons, vascular surgeons, neurologists, and interventional radiologists, depending on the organ system that is being treated. Key Drugs Angiotensin II Receptor Blockers, Angiotensin-Converting Enzyme (ACE) Inhibitors, Antiarrhythmics, Antiplatelet Therapy snapshot Cardiovascular medications are used as a means to control or to prevent certain forms of heart disease. Many people with advanced heart disease may take several of these drugs. Types of cardiovascular drugs may be broken into groups depending upon their action or what they treat. Categories that might describe drug actions include the following: statins (for cholesterol), diuretics (for blood pressure), anticoagulants (for blood thinning), anti-platelet (for removing bold clots), beta-blockers (for preserving normal heart rhythm after a heart attack and for lowering high blood pressure), digitalis drugs (for cardiac failure), vasodilators (for facilitating blood supply to the heart), calcium channel blockers (for angina & high blood pressure) and ACE inhibitors (for high blood pressure). Key Brands Storvas - Ranbaxy, Cardace - Sanofi, Aten - Cadila, Losar- H - Unichem, Minipress-XL - Pfizer CVS Segment ( CAGR %) Segment Size (INR B) Contribution to Industry (%) CVS Segment - Prescription Rankings Company Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 USV Sun Piramal (Abbott) Cipla Lupin Torrent Zydus-Cadila Sanofi Unichem Micro Labs CVS Segment - Value market share (%) CVS Segment - Prescription market share (%) Sun, 7.1 Others, 41.1 Emcure, 4.8 Sanofi, 5.1 USV, 5.1 Torrent, 6.8 Zydus- Cadila, 6.5 Unichem, 6.2 Cipla, 5.9 Ranbaxy, 5.8 Lupin, 5.6 Others, 48.2 Micro Labs, 3.3 USV, 9.3 Unichem, 4.0 Sun, 6.8 Piramal (Abbott), 5.3 Cipla, 5.1 Lupin, 5.0 Torrent, 4.6 Zydus- Cadila, 4.5 Sanofi, 4.0 Source: Industry/MOSL August

30 Domestic Formulations New Peaks Ailment & Therapy profile Diabetes Anti-diabetic Ailment snapshot Diabetes mellitus, often simply referred to as diabetes, is a group of metabolic diseases in which a person has high blood sugar, either because the body does not produce enough insulin, or because cells do not respond to the insulin that is produced. There are three main types of diabetes: Type 1 diabetes: results from the body's failure to produce insulin, and presently requires the person to inject insulin. Type 2 diabetes: results from insulin resistance, a condition in which cells fail to use insulin properly, sometimes combined with an absolute insulin deficiency. Gestational diabetes: is when pregnant women, who have never had diabetes before, have a high blood glucose level during pregnancy. It may precede development of type 2 diabetes. Key Drugs Insulin, Alpha-glucosidase inhibitors, Glimepiride, Insulin sensitizers, Secretagogues Therapy snapshot Anti-diabetic medications treat diabetes mellitus by lowering glucose levels in the blood. With the exceptions of insulin, exenatide, and pramlintide, all are administered orally. There are different classes of anti-diabetic drugs, and their selection depends on the nature of the diabetes, age and situation of the person, as well as other factors. Type 1 diabetes can only be controlled with the help of injected insulin. Type 2 diabetes treatments include (1) agents which increase the amount of insulin secreted by the pancreas (Secretagogues), (2) agents which increase the sensitivity of target organs to insulin (Insulin sensitizers), and (3) agents which decrease the rate at which glucose is absorbed from the gastrointestinal tract (Alpha-glucosidase inhibitors). Key Brands Human Mixtrad - Novo, Lantus - Sanofi, Glycomet GP - USV, Novomix - Novo, Amaryl - Sanofi Diabetes Segment ( CAGR %) Segment Size (INR B) Contribution to Industry (%) Diabetes Segment - Prescription Rankings Company Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 USV Sun Abbott Sanofi Micro Labs Lupin Franco Piramal (Abbott) Eris NA NA NA 12 9 Glenmark Diabetes Segment - Value market share (%) Diabetes Segment - Prescription market share (%) Others, 29.6 Abbott, 20 USV, 14.2 Sun, 7.8 USV, 12.4 Others, 40.9 Abbott, 6.6 Franco, 2.7 Wockhardt, 3.2 MSD, 3.2 Lupin, 3.8 Micro Labs, 4 Piramal (Abbott), 4.2 Sanofi, 9.1 Sun, 7.8 Glenmark, 2.9 Eris, 3.3 Piramal (Abbott), 4.5 Sanofi, 5.2 Micro Labs, 5.2 Lupin, 4.9 Franco, 4.6 Source: Industry/MOSL August

31 Domestic Formulations New Peaks Ailment & Therapy profile CNS Diseases CNS Drugs Ailment snapshot A central nervous system disease can affect either the spinal cord (myelopathy) or brain (encephalopathy), both part of the central nervous system. The central nervous system controls behaviors in the human body, so this can be a fatal illness. Common CNS diseases include Encephalitis, Meningitis, Alzheimer's disease, Parkinson's disease, Multiple sclerosis and depression. Therapy snapshot The key central nervous system drugs obtainable in the market are antidepressant, ergot derivative, sedative, antipsychotic, benzodiazepine and antiemtic. Out of the whole central nervous system drugs market; antidepressants, antipsychotics and anti epileptics are the largest growing segments. Key Drugs Phenytoin sodium, Mecobalamin, Gabapentin, Citalopram, Alprazolam. Key Brands Eptoin - Abbott, Nurokind Plus - Mankind, Vertin - Solvay Alprax - Torrent, Trika - Unichem CNS Segment ( CAGR %) Segment Size (INR B) Contribution to Industry (%) CNS Segment - Prescription Rankings Company Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Sun Intas Torrent Piramal (Abbott) UCB Micro Labs Local companies NA NA Unichem Abbott Wockhardt CNS Segment - Value market share (%) CNS Segment - Prescription market share (%) Others, 24.2 Micro Labs, 3.5 Ranbaxy, 3.8 Unichem, 3.9 Pfizer, 4.2 Sanofi, 4.8 Piramal (Abbott), 6.5 Sun, 20.7 Intas, 12.2 Torrent, 8.6 Abbott, 7.6 Others, 43.7 Cipla, 2.9 Wockhardt, 3.1 Abbott, 3.5 Sun, 12.1 Intas, 8.2 Unichem, 3.8 Torrent, 8.1 Piramal (Abbott), 5.5 UCB, 5.0 Micro Labs, 4.2 Source: Industry/MOSL August

32 Domestic Formulations New Peaks Ailment & Therapy profile Pain Ailment snapshot Pain, by itself, is not a disease, but is an indicator of temporary or long-lasting damage to the human body. It is a major symptom in many medical conditions. Pain is usually transitory, lasting only until the noxious stimulus is removed or the underlying damage or pathology has healed, but some painful conditions, such as rheumatoid arthritis, peripheral neuropathy, cancer and idiopathic pain, may persist for years. Pain that lasts a long time is called chronic, and pain that resolves quickly is called acute. Acute pain is usually managed with medications while management of chronic pain, is much more difficult and may require the coordinated efforts of doctors, physiotherapists along with medicines. Pain/NSAIDS Drugs Therapy snapshot The key pain management drugs obtainable in the market are asalicylates (like Aspirin), Propionic acid derivatives (like Ibuprofen, Naproxen), Acetic acid derivatives (like Diclofenac), Oxicam derivatives, Fenamates, Cox-2 Inhibitors, Sulphonanilides. Key Drugs Salicylates, Propionic acid derivatives, Acetic acid derivatives, Oxicam derivatives, Fenamates, Cox-2 Inhibitors, Sulphonanilides Pain/NSAIDS Segment ( CAGR %) 9.3 Segment Size (INR B) Contribution to Industry (%) Key Brands Voveran - Novartis, Calpol - GSK, Spamo-Proxyvon - Wockhardt, Combiflam - Sanofi, Volini - Ranbaxy Pain/NSAIDS Segment - Prescription Rankings Company Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 GSK Generic-generics Dr. Reddy's Micro Labs Local Companies NA NA Cipla Ipca Mankind Alkem Sanofi Pain/NSAIDS Segment - Value market share (%) Pain/NSAIDS Segment - Prescription market share (%) Novartis, 7.2 Ranbaxy, 7 GSK, 6.4 GSK, 7 Dr. Reddy's, 4.1 Micro Labs, 3.9 Cipla, 3.4 Alkem, 5.8 Ipca, 3.3 Others, 47.5 Elder, 3.7 Zydus- Cadila, 4 Piramal (Abbott), 5.5 Sanofi, 4.6 Ipca, 4.3 Dr. Reddy's, 4 Others, 63.5 Mankind, 3.2 Alkem, 3.1 Sanofi, 3.0 Novartis, 2.7 Piramal (Abbott), 2.7 Source: Industry/MOSL August

33 Domestic Formulations New Peaks Ailment & Therapy profile Gastro-intestinal (GI) Problems GI Drugs Ailment snapshot Diseases/problems related to the GI tract mainly affect the stomach and the intestines in humans. While the most common problems are acidity/ulcers, other more serious diseases include Cancer, Cholera, Colorectal cancer, Gastroenteritis, Inflammatory bowel disease, Irritable bowel syndrome, Pancreatitis, Peptic ulcer disease, Gastroesophageal reflux disease (GERD), etc. While some of these problems are temporary in nature and can be cured by medicines, diet alterations, etc., many of these problems are chronic in nature and generally require longterm treatments by way of medicines and gastroenterologists consultations. Therapy snapshot The key GI drugs obtainable in the market are Antacids, Anti-reflux agents, Antiulcerants, GIT regulators, Antiflatulents, Anti-inflammatories, Anti-spasmodics, Laxatives, Purgatives, Digestives, Anti-emetics Key Drugs Antacids, Anti-reflux agents, Antiulcerants, GIT regulators Antiflatulents, Anti-spasmodics, Laxatives, Purgatives Key Brands Zinetac - GSK, Omez - DRL, Digene - Abbott, Aciloc - Cadila, Gelusil MPS - Pfizer GI Segment ( CAGR %) Segment Size (INR B) Contribution to Industry (%) GI Segment - Prescription Rankings Company Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Mankind Cadila Dr. Reddy's JB Chem Torrent Local Companies NA NA Piramal (Abbott) Alkem Generic-generics GI Segment - Value market share (%) GI Segment - Prescription market share (%) Others, 49.9 Abbott, 7.2 Torrent, 3.6 Ranbaxy, 3.6 Dr. Reddy's, 4.4 Zydus- Cadila, 4.2 JB Chem, 4.0 Torrent, 3.6 Piramal (Abbott), 3.5 Zydus- Cadila, 6.5 Dr. Reddy's, 5.6 Alkem, 5.3 Mankind, 5.2 Sun, 4.7 Aristo, 4.6 Piramal (Abbott), 3.8 Others, 60.1 Mankind, 6.9 Cadila Pharma, 4.5 Sun, 2.7 FDC, 2.9 Alkem, 3.4 Source: Industry/MOSL August

34 Domestic Formulations New Peaks Ailment & Therapy profile Respiratory Diseases Ailment snapshot Respiratory disease is the term for diseases of the respiratory system. These include diseases of the lung, pleural cavity, bronchial tubes, trachea, upper respiratory tract and of the nerves and muscles of breathing. Respiratory diseases range from mild and self-limiting such as the common cold to chronic diseases like asthma/ COPD and life-threatening such as bacterial pneumonia or pulmonary embolism. They are a common and important cause of illness and death. Respiratory Drugs Therapy snapshot The key Respiratory Drugs obtainable in the market are Common cough & cold medicines, Corticosteroids, Bronchodilators, Mechanical ventilation. Key Drugs Common cough & cold medicines, Corticosteroids, Bronchodilators, Mechanical ventilation Key Brands Corex - Pfizer, Phensedyl - Piramal (Abbott), Asthalin - Cipla, Seroflo - Cipla, Aerocort - Cipla Respiratory Segment ( CAGR %) Segment Size (INR B) Contribution to Industry (%) Respiratory Segment - Prescription Rankings Company Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Cipla Generic-generics Zydus-Cadila GSK Mankind Local Companies NA NA Centaur Labs Indoco Sanofi Alembic Respiratory Segment - Value market share (%) Respiratory Segment - Prescription market share (%) Others, 33.3 Sanofi, 2.7 Glenmark, 2.8 Wockhardt, 3.2 Alembic, 3.4 Lupin, 4.8 GSK, 5.1 Cipla, 22.1 Piramal (Abbott), 9.4 Pfizer, 7.8 Zydus- Cadila, 5.4 Others, 63.9 Cipla, 6.1 Zydus- Cadila, 4.9 Piramal (Abbott), 2.5 GSK, 4.9 Mankind, 3.6 Centaur Labs, 3.0 Indoco, 3.0 Sanofi, 2.8 Alembic, 2.7 Dr. Reddy's, 2.6 Source: Industry/MOSL August

35 Domestic Formulations New Peaks Annexure 1: Evolution of the market and state of the industry Till 1970, due to product patent regime, multinational pharmaceutical companies dominated the domestic market and enjoyed 80% market share. However, with the introduction of process patent law in 1970, the scenario changed dramatically in the last 4 decades. Today the domestic market is dominated by Indian companies with market share of ~80%. During the same period, in the absence of product patent, many multinational companies exited the country while many others followed cautious approach in terms of new product launches. Dominance of local companies Domestic pharmaceutical companies are dominant in India. Due to strong chemistry skills, local companies have managed to garner ~80% market share in India. Currently, the market is a fragmented market with the largest player holding 7% market share. The presence of small and regional players has increased significantly over the years. Due to intensified competition, prices of the drugs in India are one of the lowest in the world. However, with the introduction of new product patent law in 2005 as per WTO commitment, MNCs have started focusing on Indian operations. Many MNCs have shown interest in expanding their presence in India through organic and inorganic growth means. We believe that, in the coming years, MNCs will see their market share increasing gradually on led by Patented product pipeline of parent, strong brand equity among physicians, strong financial muscles and increased focus of large MNCs on emerging markets as a next growth driver in light of dwindling revenues in developed countries. Market share of MNCS in Emerging markets (%) MNCs Local Poland Russia Brazil China India Source: McKinsey/MOSL August

36 Domestic Formulations New Peaks Branded generic nature of the industry Indian pharmaceutical market is largely a branded generic market where the same molecule is sold by number of companies under different brand name. Nearly 80% of the Indian retail market is made up of branded generics while rest is distributed between OTC and generic drugs. Due to the branded generic nature of the business, trade power lies with the physicians. Here, the relationship and brand equity of the pharmaceutical companies with physicians is a key determinant of success. The share of branded generics is in India is higher that some of the other emerging markets. In Brazil and Russia, branded generics account for 60% and 40% of the market. We believe that, going forward the markets will be dominated by branded generic segment while patented products will contribute 10% to the market demand in Indian companies have large options for launch of new generics from the basket of pre-1995 drugs. (The total no of such products is more than 200). Further, domestic players have opportunity to develop new combination and formulation of the products that are already in the market. Also it is likely that a proportion of post 1995 molecules will not get full patent protection due to relatively narrow definition of patentability in the India patent act. Low pricing levels Prices of medicines in India are one of the lowest in the world. Prices of drugs in India are at around 10-12% of US prices and for some products, prices are lower than those in neighbouring countries such as Sri Lanka, Pakistan and Bangladesh. Severe competition has resulted in such low prices. On an average there are 50 brands for any major molecule. The level of specialization of molecule is important driver of pricing premium. We believe that with the reduction in competition going forward on back of consolidation in the industry and shift toward specialty therapy segments, prices are likely to stabilize at current levels if not improve. August

37 Domestic Formulations New Peaks Annexure 2: Regulatory framework of the Indian formulations industry Product patent regime begun from 2005 India adopted product patent regime in Earlier, as per original Indian patent act 1970, patents were granted on the basis of process and not products, which helped to build the basis of a strong and competitive domestic pharmaceutical industry. Indian pharmaceutical industry had price control mechanism that helped to deliver medicines at affordable prices to patients in India. Further, the burden of proof in case of infringement was on the patent holder. However, due to WTO commitments, India made two important amendments to the patent act. The first amendment introduced the mailbox system to grant exclusive marketing rights to post 1995 patent holders in other markets. The second amendment extended patent term to 20 years and shifted the burden of proof to the patent infringer. In 2005, the new Indian patent act was introduced to grant product patents to pharmaceuticals. The act defines the scope of patentability and pre-grant, post-grant opposition provisions, compulsory licensing and regulatory data protection Patentability: The patent act established product patent protection for the period of 20 years. The act precludes salts, esters, isomers, polymorphs, metabolites, pure form, particle size, combinations, derivatives of know substances etc. from patent protection unless they differ significantly in efficacy, thus effectively restricting patentability only to the NCEs Pre and Post grant opposition: Both pre and post-grant opposition have been introduced allowing oral hearing. Opposition can be filed any time from the date of publication of the patent to the date of grant. This could result into several pre-grant oppositions being filed causing delay in patent granting process. Pre-grant oppositions have proven to be a big impediment to patent issuance in India. This allows anyone to file opposition patents on any of 11 potential grounds for 6 months after a patent application is published but before the patent is granted. India is the only country in the world with such a system. Multinational companies claim that domestic companies are using sequential filings to delay patents, and point to there being no mechanism to dismiss even the most frivolous oppositions. PhRMA reports than 200 pre-grant oppositions were pending as of early 2009 and most of these concerned pharmaceuticals (PhRMA, 2009). In addition, there is no mechanism for the applicant to respond and this is likely to be of significant concern to branded pharmaceutical companies. August

38 Domestic Formulations New Peaks Compulsory licensing: Under Paragraph 6 of the DOHA Declaration on TRIPS and Public Health (from 2001), India is permitted to use compulsory licenses under which the government forces a patent holder to grant use of a given product to the state. The patent holder will be entitled for compensation from licensee. CL will be available for export to developing countries such as in Africa which have insufficient or no manufacturing capacity in cases of national health emergencies. Thus Indian generics industry has benefited from compulsory licenses issued in other developing markets. Scope of compulsory licensing has been broadened to include affordability, non-working of patent etc. The Department of Industrial Policy and Promotion is considering developing new guidelines to enable the use of compulsory licensing beyond emergencies, such as in view of anti-competition law and high drug prices. This could threaten the companies in the long term, particularly if licenses are used in situations other than emergencies, suggesting they could be used more liberally. Regulatory data protection: Regulatory data protection is an integral part of IPR. Lack of the provision will be a disincentive to R&D based companies and innovators. The issue is in active consideration. Since the Patent Amendment Act of 2005, product in addition to process patents are recognized in India. However, from the perspective of the research-based drug industry, there are several problems with the IP environment in India. Pharmaceuticals are fighting to enforce patent linkage in India and meanwhile a string of product patent rejections have reduced confidence in the Indian market. Despite improvements to the patent legislation, issues over ever-greening mean that some brands may not necessarily receive patent protection in India - a move that is detrimental to branded players, but provides a significant opportunity for domestic generics manufacturers. So far certain drug classes, such as those that are viewed as expensive life-saving drugs, including cancer and HIV medication, have been most affected indicating for such drugs it may be more difficult to patent in India as the legal system is more likely to apply its discretion in the interpretation of the law and prevent those drugs from being patented. Roche was the first company to have a patent granted in India under the new patent regime in February 2006, a patent for Pegasus (paginated interferon alpha-2a) was granted. However, since then several different product patent applications for other drugs have been refused. Most recently, the Indian Patent Office rejected Roche's product patent for its new formulation of the cytomegalovirus infection treatment Calcite (valganciclovir). In August 2009, India rejected patent applications for Viread (tenofovir, Gilead) - a frontline drug against human immunodeficiency virus/acquired immunodeficiency syndrome (HIV/ AIDS) in developing countries. Such patent rejections will undoubtedly lower confidence in the Indian market as such occurrences are no longer seen as isolated events. This indicates that certain drug classes, such as those that are viewed as expensive lifesaving drugs, including cancer and HIV medication, may be more difficult to patent in India as the legal system is more likely to apply its discretion in the interpretation of the law and prevent those drugs from being patented. This could have a significant impact on the pharmaceutical companies' choice of products to be marketed in India. However, it is not all bad news for pharmaceutical players, with some companies managing to emerge August

39 Domestic Formulations New Peaks from the patent system triumphant. In February 2008, Johnson & Johnson secured a key patent for its antiretroviral drug Intelence (etravirine), making it the second antiretroviral therapy to attain exclusivity in India after Pfizer's Selzentry (maraviroc). This strengthened the company's position in the Indian market, and is likely to have given the pharmaceutical industry in general some hope. Pricing regulations and role of NPPA National Pharmaceutical Pricing Authority (NPPA) is responsible for pricing decisions in India. This body falls under the Ministry of Chemicals and Fertilizers and was established in The NPPA is responsible for setting and regulating the prices of bulk drugs and monitoring the availability of treatments in the market to identify shortages and take remedial steps. The body also maintains data on exports and imports as well as market shares and the profitability of individual companies. NPPA regulates the prices of certain drugs/ formulations known as 'controlled bulk drugs', while also keeping a tab on the prices of drugs not in this list so that they are maintained at reasonable levels. Two main criteria are used for identifying controlled drugs: the drug should be of a mass consumption nature and there should be an absence of sufficient competition for the drug. As per the Drugs Prices Control Order (DPCO) of 1997, the NPPA is responsible for fixing and revising the prices of certain controlled bulk drugs and formulations. In 1970, the first DPCO was introduced, bringing in direct controls on the profitability of pharmaceutical businesses: a maximum of 15% pre-tax profit alongside an indirect control on prices. A revision introduced in 1979 established a price ceiling for certain controlled bulk drugs and formulations. This revision tried to regulate the retail prices by permitting a mark-up on ex-factory costs and around 370 drugs were implicated with direct price controls, a measure that affected 80% of the companies in the market. The subsequent revisions to the legislation reduced the number of controlled drugs to 142 in 1987, 76 in 1995 and 74 in Pricing: The DPCO fixes ceiling price for some of the APIs and formulations. The APIs and formulations falling under the purview of the legislation are called scheduled drugs. The NPPA is responsible for the collection of data and study of pricing structures of APIs and formulations, and provides recommendation to the Ministry of Chemical and Fertilizers. Currently, 74 bulk drugs and the formulation thereof are under the preview of price control. Pricing of scheduled bulk drugs: Scheduled bulk drugs are allowed prices (excluding local taxes) that results in post tax return of 14% on net worth (share capital + free reserves - value of investments not related to bulk drug business), or a 22% return on capital employed (fixed asset + working capital). Vis-à-vis a new plant an internal rate of return based on long term marginal costing is allowed. For a bulk drug produced from the basic stage, a post tax return of 18% on net worth or a return of 26% of capital employed is allowed. The NPPA sanctions prices after reviewing detailed supporting calculations, and only when the approval is sanctions can players go ahead with the sale of the drug. Sanctioned prices can not be revised without prior approval. When there is one manufacturer of the bulk drug, the maximum sale price is fixed at 2/3rd of the cutoff level or weighted average price, depending upon the situation. August

40 Domestic Formulations New Peaks Pricing of scheduled formulations manufactured in India: Scheduled formulations are based on the formula: RP = (MC+CC+PM+PC) x (1+MAPE/100) + ED RP: Retail Price MC: Material Cost CC: Conversion Cost PM: Packaging Material PC: Packaging Charges MAPE: Maximum Allowable Post Manufacturing Expenses ED: Excise Duty MAPE is intended to cover all the costs incurred by a manufacturer after packing - that is, transport, manufacturer's profit, dealer/retailer's profit etc. As per current order MAPE should not exceed 100%. Local taxes are added on at the wholesaler/retailers level and are not part of retail price as above. Further, the margins earned by distributors and retailers are also regulated. The maximum margin that a distributor can take is 8% of the maximum retail price; the highest permitted margin is 16% for retailers. In the case of decontrolled drugs, the margin set for distributors is 10%, while for retailers it is 20%. The NPPA further ensures that manufacturers do not remove the price-controlled brands from the market so that essential medicines are still available for customers. In spite of these regulations, however, violations have been observed quite frequently. For instance, a study noted that companies market products with pricecontrolled ingredients without getting the price fixed by the NPPA, even though theoretically they are required to obtain an official price from the NPPA every time the price of the controlled ingredient is revised. Proposed new pharmaceutical policy The proposed pharmaceutical policy talks about bringing 354 essential drugs under the purview of the DPCO. Reportedly, this account for ~50% of the industry sales. The new policy is likely to allow MAPE of 150% with an additional 50% margin for the companies that invest sufficient on new drug research. Currently, there is lot of pressure being built on the government by players and key pharmaceutical associations to revoke the new draft, as the industry views this policy as regressive in nature. However, it is difficult to comment on the implications of the proposed price control order before the final verdict is in place. If implemented in the current form, the new policy will have significant adverse impact on the domestic formulations players. August

41 Domestic Formulations New Peaks Companies Companies Top buys Cipla Lupin Torrent Pharma GSK Pharma Others Sun Pharma Cadila Ranbaxy Dr. Reddy's Labs Glenmark August

42 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 66/100 Improving asset utilization Cipla CMP: INR281 CIPLA IN TP: INR361 Buy M: Mix 6/10 Cipla offers a balanced play on chronic and acute therapeutic segments. Cipla derives 42% revenue from chronic therapeutic areas and has a dominant presence in large segments like anti-infective and CVS. It has leadership position in the respiratory segment. E: Equity with doctors 7/10 Cipla has strong brand equity in some of the largest therapeutic segments in the industry and ranks first in the respiratory segment, fourth in the anitinfective and fifth in the CVS segments. Based on prescription ranking, Cipla is the market leader in the anti-infective and respiratory segments and it is among the leaders in the pain management and CVS segments. D: Distribution & reach 8/10 Cipla derives 63% of its revenue from metros and tier-i cities. Distribution in metros and tier-i towns increased over time and Cipla is expanding its reach in tier-ii to tier-vi towns. It has one of the largest field force in the industry with an MR strength of 5,100. I: Introductions 6/10 Cipla has been one of the most aggressive players in launching new products. It launched 76 new products a year over the past four years. The ramp-up in domestic formulations revenue has been driven by existing products and new launches over the past four years. Stock info Equity Shares (m) Week Range (INR) 381/275 1,6,12 Rel. Perf. (%) 2/3/0 M.Cap. (INR b) M.Cap. (USD b) 4.9 Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR M) (INR M) (INR) GR. (%) (X) (X) (%) (%) Sales EBITDA 03/10A 56,057 10, /11A 63,145 9, /12E 69,193 10, /13E 79,041 13, Background Cipla is a leading player in the domestic formulations market and has a presence across most therapeutic areas. The company also has robust exports to several markets including Europe, South Africa, Australia, US and the Middle East. Cipla's strategy for regulated markets (Europe and US) exports is built around supply tie-ups with global players. August

43 Cipla Chairman Profile Chairman Barring the past two years, Cipla has been one of the most consistent performers amongst the Indian pharmaceutical companies. It was promoted by Dr K A Hamied and is currently managed by Dr Yusuf Hamied, the founder's son. Establishing a strong presence in India and emerging markets organically coupled with a low-risk conservative approach is his key achievement. C: CAGR and scale-up 6/10 Cipla reported in line industry performance, posting revenue CAGR of 14% over FY The company scaled up the business rapidly over the years and gained market share from competitors, in certain key segments. We expect Cipla to post revenue CAGR of 12% over FY11-13, which is lower than the industry average, mainly due to a high base and intensifying competition in the anti-infection segment. I: Improvement in productivity 7/10 Cipla did not improve its MR productivity over as sales growth was in line with MR additions. MR growth was 13.4% and revenue growth was 13.7% over Revenue per MR has been stagnant at INR4.9m over years. However, even at this level, productivity is above the industry average. Rapid scale-up in revenue will be difficult given the high base and sizable presence in highly competitive and slow growing acute segments. N: Non-domestic business 5/10 We are positive on Cipla's international business, given its strong chemistry skills, large underutilized capacities and strong generic pipeline. Short-term performance may be muted until international regulatory authorities approve the new Indore SEZ. E: Earnings growth 7/10 We expect overall top-line CAGR of 12% over FY11-13, leading to EPS CAGR of 17%. EPS growth is higher than top-line growth mainly due to our expectation of increased capacity utilization at Indore SEZ leading to better cost absorption. We expect the international business to post 13% revenue CAGR over FY11-13 led by 14% CAGR for formulation exports. Option values (approval for CFC-free inhalers and potential MNC contracts) can upgrade FY13 EPS. S: Stock Attractiveness 14/20 Cipla has one of the most conservative managements among Indian pharma companies. Return ratios are muted pending utilization of significant capex over the past 2-3 years. Cipla is valued at 21.0x FY12E and 17.1x FY13E consolidated earnings. Reiterate Buy with a target price of INR361 (22x FY13E EPS) excluding potential upsides. Stock performance (1 year) Cipla Sensex - Rebased Aug-10 Nov-10 Feb-11 May-11 Aug-11 August

44 Cipla India formulations snapshot Domestic formulations the largest business segment for Cipla : The domestic formulations business is the leading revenue contributor to Cipla's top-line though the contribution has fallen from 75% in FY01 to 44% in FY11. It is Cipla's most profitable segment, with EBITDA contribution estimated at 44%. This business grew at 14% CAGR over the past six years. EBITDA Contribution Non-DF EBITDA, 56% DF EBITDA,44% The largest Indian player in the industry Before Abbott took over Piramal Healthcare's domestic formulations business, Cipla was the leader in the domestic formulations market for a few years. Although Cipla occupies second position in the pharmaceuticals industry, it is the largest Indian company in the domestic formulations space. Cipla holds 5.24% market share in the pharmaceuticals industry, which has grown from 5.05% in It posted revenue of 14% CAGR over the past six years in line with the industry's CAGR of 14%. Market Share & growth Mkt Share (%) Grow th (%) Improving asset utilization Balanced play on chronic and acute therapeutic segments Cipla, a leading company in the domestic formulations space, has a strong presence in therapeutic segments such as AI, respiratory and CVS. Cipla has outperformed market growth over the past four years and has consistently improved its market share. Cipla offers a balanced play on lifestyle and acute therapeutic segments. 1. Mix: 6/10 Respiratory, AI, CVS, gynecology dominate sales The top four therapeutic segments, the respiratory, AI, CVS and gynecology segments, contribute ~70% of Cipla's domestic formulation revenue. Cipla is the market leader in two of the largest therapy segments, AI and respiratory segments, though dependence on AI has fallen over the years. Cipla derives 58% of its revenue from acute therapies and the rest from chronic therapeutic areas. Cipla's sizable presence in these segments makes it an attractive play in the domestic formulations business. Cipla: Therapeutic break-up Gynae cology 2% CVS 15% GI Pain FY01 3% Mgmt 6% Respira tory 29% AI 45% Dermatol ogy 3% CNS 3% HIV 3% Ophthal mology 3% Pain 4% GI 6% Gynaec 7% CVS 12% FY11 Others 8% Respirat ory 31% AI 20% Source: Company/Industry/MOSL 2. Equity with doctors: 7/10 Good brand equity with physicians; strong positioning in respiratory, AI, CVS segments Cipla has been a dominant player in the AI, respiratory and CVS segments, three of the largest therapeutic segments of the industry. Cipla ranks first in the respiratory segment and fourth in the AI segment with market shares of 22.1% and 6.7% respectively. It ranks fifth in the CVS segment with market share of 5.9%. In most of these segments, Cipla has grown in line with market growth over the past two years. In terms of the number of prescriptions written, Cipla ranks first in the AI and respiratory segments with a prescription market share of 8.4% and 6.1% respectively and it ranks fourth and sixth in the CVS and pain management segments with a prescription market share of 5.1% and 3.4% respectively. In the AI, respiratory and CVS segments Cipla has maintained or improved its market ranking but in the other therapeutic segments it has lost out on ranking. August

45 Cipla Market share in key therapies (%) (2010) Growth comparison (%) (2010) 22.1 Avg Gr - Company Avg Gr - Industry AI CVS Respiratory Gynaecology Dermatology AI CVS Respiratory Gynaecology Dermatology * Average growth over Source: Industry/MOSL Cipla's prescription ranking Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Anti-infectives Respiratory CVS Pain Mgmt CNS GI Derma Vit Gynaec Source: Industry/MOSL Top 10 brands contribute 30% of revenue Cadila's top 10 brands contribute ~30% to total revenue, indicating lower brand concentration. All Cipla's top 10 brands feature among the top 300 brands of the industry. Its No1 brand Asthalin (Salbulamol, in the respiratory segment) ranks fourteenth in the industry and reported growth of 11.7% CAGR over the past four years. Cipla's top four brands belong to the respiratory segment. Cipla's top 10 brands Brand Drug Product Launch Sales (INR m) YoY Gr (%) CAGR (%) Seroflo Salmeterol+Fluticasone Asthalin Salbutamol , Aerocort Salbutamol+Beclomethasone Foracort Formoteral+Budesonide Mt pill Mifepriston Novamox Amoxycillin Ciplox Ciprofloxacin Duolin Salbutamol+Ipratropium Amlopres-at Atenolol+Amlodipine Budecort Budesonide CAGR through Source: Industry/MOSL 3. Distribution and reach: 8/10 Cipla derives 63% of its revenue from metros and class-i towns, in line with the industry average. Over the past four years, Cipla's revenue CAGR in rural and metro areas, has been better than that of industry average. August

46 Cipla Cipla: Geographical distribution of revenues (%) Industry: Geographical distribution of revenues (%) METROS CLASS I TOWNS CLASS II TO VI RURAL METROS CLASS I TOWNS CLASS II TO VI RURAL CY06 CY07 CY08 CY09 CY10 CY06 CY07 CY08 CY09 CY10 Cipla: Geography-wise growth rates (%) Industry: Geography-wise growth rates (%) METROS CLASS II TO VI CLASS I TOWNS RURAL METROS CLASS II TO VI CLASS I TOWNS RURAL CY07 CY08 CY09 CY CY07 CY08 CY09 CY10 Source: Industry/MOSL 4. Introductions: 6/10 Among the most aggressive players in the industry in product launches; revenue-per-new-launch rises Over the past four years, Cipla launched 76 new products (including line extensions) annually and the average revenue per new launch almost doubled, suggesting better penetration of launched brands. Overall, revenue growth was driven by existing products and new launches. Cipla: New launches Cipla: Growth composition (%) No. Of launches in last 2 yrs Avg sales per launch (INR m) New Launches Existing Brands CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 Source: Industry/MOSL August

47 Cipla 5. CAGR and scale up: 6/10 We expect Cipla's domestic formulations business to post 12% CAGR over FY11-13, led by one of the largest field forces and rapid new launches but partly tempered down by a large base effect and increasing competition in some of the acute therapeutic segments. This is below our forecast of 15-16% CAGR for the industry. Cipla is likely to maintain its leadership in the sector given its high market share in some of the largest therapeutic segments. Although Cipla employs the largest field force in the industry, its focus on enhancing workforce productivity must be enhanced, for more profitable growth. Cipla: Domestic formulations performance DF Revenue (INR m) YoY Grow th (%) ,014 17,523 19,783 22,786 25,113 28,178 30,995 35,180 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL 6. Improvement in MR productivity: 7/10 Sales force additions drive top-line growth Over FY04-10, Cipla's domestic formulations business posted revenue CAGR of 13.7% while its sales force grew at a CAGR of 13.4%, implying marginal productivity improvement of the salesforce. In 2004, Cipla derived INR4.8m revenue per MR, which increase marginally to INR4.9m in FY10, which is still above industry average. Cipla: Sales force productivity ( ) No. of MRs Revenue per MR (INR m) 4.9 Sales force addition CAGR (%) Productivity Improvement CAGR (%) ,400 5, Cipla 1.9 Industry Source: Industry/Company/MOSL August

48 Cipla 7. Non-domestic business: 5/10 Cipla's non-domestic business Positives Strong presence in emerging markets through partners. Strong chemistry skills and fully backward integrated low-cost operations. Low-risk partnership model Large underutilized capacities. Has one of the largest global CFC-free inhaler capacities. Potential tie-ups with MNCs. Risks and concerns Temporary mismatch between expenses on new SEZ without commensurate revenue streams pending regulatory approval. Working capital intensive. Lack of succession planning. Delay in planning capacity expansions for future growth. Key news flow/triggers Regulatory approvals for a new SEZ. Regulatory approvals for CFC-free inhalers in Europe. Signing of supply agreements with MNCs. Impact assessment We are positive on Cipla's international business given its strong chemistry skills, large underutilized capacities and strong generic pipeline. Short-term performance may be muted until international regulatory authorities approve the new Indore SEZ. Expect international business to record 13% CAGR over FY11-13, led by 14% CAGR of formulation exports. Option values (approval for CFC-free inhalers and potential MNC contracts) can upgrade FY13 EPS. Sales mix (INR m) FY09 FY10 FY11 FY12E FY13E FY11-13 CAGR (%) Domestic 22,786 25,113 28,178 30,995 35, % of revenues Exports 27,430 29,004 33,548 36,971 42, % of revenues Formulations 21,635 23,188 26,756 29,431 34, APIs 5,795 5,816 6,792 7,539 7, Other Operating Income 2,737 2,462 1,842 1,775 1, % of revenues Total Revenues 52,953 56,579 63,567 69,741 79, Source: Company/MOSL EBITDA Contribution Non-DF EBITDA 56% DF EBITDA 44% Source: Company/MOSL August

49 Cipla 8-9. Earnings growth and stock attractiveness: 21/30 We believe Cipla has one of the strongest generic pipelines among Indian companies. After a long delay, we believe Cipla's CFC-free inhaler pipeline is likely to be gradually commercialized in Europe and upsides from high-margin opportunities like Seretide can potentially come through over the next two years (our estimates do not include these upsides). Cipla's large manufacturing infrastructure, strong chemistry skills and huge inhaler capacity make it a partner of choice for global MNCs that are ramping up their generics and presence in emerging markets. This, along with its low-risk strategy and a strong capex (currently underutilized) should ensure good long-term potential. Temporary slow-down in overall growth, increased expenses to maintain its Indore SEZ without commensurate revenue and increasing working capital requirements are our key concerns. We estimate base-case EPS CAGR at 17% over FY11-13 with potential upsides from MNC supplies and CFC-free inhalers. The growth will be led by 13% CAGR for the international business, tempered by reducing technology licensing income. We are positive on Cipla's long-term prospects (especially upsides from MNC contracts and commercialization of CFC-inhalers). Cipla's management has officially confirmed that it is negotiating supply contracts with MNCs. However, it is taking time to consummate the deal. When details of such contracts are made public, we expect an upgrade in earnings to take into account upsides from such contracts. Maintain Buy with a target price of INR361 (22x FY13E EPS). Cipla RoE & RoCE (%) Cipla one year forward P/E RoE RoCE P/E (x) Avg(x) Peak(x) Min(x) E 2013E Aug-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 August

50 Cipla Annexure: Cipla non-domestic business Strong generic pipeline In the US, Cipla entered into partnership for 118 products with 22 partners. The number of partners increased from 17 to 22 over the past 18 months. Of the pipeline of 110 ANDAs filed so far, 64 have been approved and 46 are awaiting approval. Strengthening US parnerships (nos) FY07 FY08 FY09 FY10 Source: Company/MOSL Strong capex Over the past three years, Cipla invested INR18b in expanding its formulations, API and R&D capacities. A large portion is this capex is underutilized pending facility/product approvals from international regulatory authorities. Cipla's gross block (INR b) FY05 FY06 FY07 FY08 FY09 FY10 FY11 Source: Company/MOSL can lead to INR36b in revenue over the next few years Going by Cipla's past asset-turnover ratios, we estimate this large capex can generate INR36b in revenue in the next few years. This compares favorably with reported revenue of INR56b in FY10 and revenue of INR63b in FY11. Cipla's management is known for its conservative, low-risk strategy, which implies it would not have embarked on such a large capex without reasonable revenue visibility. Significant expenses on Indore SEZ; commensurate revenue to ramp-up Cipla has invested significant amounts of money, on setting up facilities, over the past 2-3 years. One of its large investments has been in the INR8b Indore SEZ, commissioned in 1QFY11. This is one of the largest investments in an SEZ by a pharmaceutical company. August

51 Cipla The company is incurring expenses of INR250m-300m per quarter on this SEZ without commensurate revenue, pending regulatory approvals. We believe the company is facing a temporary mismatch between timing of such expenses and commensurate revenue streams from this investment. The Cipla management has indicated regulatory authorities from the UK, Australia and South Africa had recently inspected this facility. It expects exports to these markets to ramp-up up gradually in forthcoming quarters. The US FDA inspection is yet to take place. The management also indicated it expected this SEZ to contribute 10-12% to overall sales by the end of FY12. This is a key factor impacting Cipla's operational performance. Potential MNC contracts can upgrade earnings, negotiations ongoing Cipla is negotiating with some MNCs like Pfizer, GSK and Boehringer for long-term supply agreements. Generally, such deals span many products and multiple markets. These potential contracts are likely to raise earnings for FY13 (not included in our estimates). We believe Cipla is well positioned to emerge as a key supplier of generic products to global MNC companies due to its large manufacturing infrastructure, strong chemistry skills and large capacity for inhalers. Pfizer Partnership: Potential Upsides Pfizer's generic revenue (USD b) 10 Estimated mark up over outsourced products (%) 25 Outsourced products (percentage of total) - assumed 50 Cost of outsourced products for Pfizer (USD b) 4 Upside for Cipla Low Case Moderate Case High Case Cipla's contribution to Pfizer's outsourcing (%) Sales (USD m) INR/USD - assumed Sales (INR m) 1,720 8,600 17,200 PAT Margin (%) - assumed PAT (INR m) Incremental EPS Source: Company/MOSL CFC-free inhalers a key long-term trigger Cipla has the third largest global capacity for inhalers and has been the domestic market leader in the segment over years. Cipla has the advantage of strong chemistry skills and low-cost of production in this segment. Inhaler capacity has increased but utilization is at the lowest Aerosols/Inhalation Devices Capacity (m) Aerosols/Inhalation Devices Capacity Utilization (%) FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY05 FY06 FY07 FY08 FY09 FY10 FY11 Source: Company/MOSL August

52 Cipla Cipla is developing eight inhalers and has the third largest inhaler manufacturing capacity globally. It has commercialized some of its inhalers in the UK, Germany, Spain and Portugal. While the launch of these inhalers is a key long-term trigger, the visibility of launch timelines is poor. The management expects its range of eight inhalers to be commercialized in Europe over the next 2-3 years and it expects 3-6 players for each product in this category, implying that this will be a low-competition, high-margin opportunity. Through its partner, Neo Labs, Cipla filed for regulatory approval of a generic Seretide Inhaler (GSK's US$6.5b global brand with US$250m sales in the UK) in September 2008 in the UK, after the expiry of GSK's data exclusivity. We believe that approval for this product is likely to come through over the next few quarters. Our estimates do not include these upsides. CFC-free Inhalers: Potential Upside Current global market size of inhalers (USD b) 17 No of generic players including Cipla (assumed) 6 Price erosion (%) (assumed) 70% Addressable market size (USD b) 5.1 Upside for Cipla Low Case Moderate Case High Case Cipla's market share (%) Sales (USD m) INR/US dollar (assumed) Sales (INR m) 2,193 6,579 10,965 PAT margin (%) (assumed) PAT (INR m) 439 1,316 2,193 Incremental EPS Source: Industry/MOSL Reducing technology licensing income Given Cipla's partnership model, it earns licensing income from its partners. This income has been a key contributor to Cipla's earnings and it recorded 26% CAGR to INR1.5b over FY However, this has fallen to INR637m by FY11, adversely impacting Cipla's earnings growth (licensing income has 100% contribution to the company's PBT). Reducing licensing income Tech Licensing Income (INR m) 2,178 1,534 1, FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL Forex cover - currently under hedged Cipla's management continues with its policy of hedging net exposure on a monthly basis. Current forex hedges are US$190m (down from USD230m in September 2010), which we believe will be inadequate if the rupee were to appreciate significantly against the US dollar. We believe Cipla is under-hedged, given its annual net exposure of ~US$300m as well as some exposure to the euro. August

53 Cipla Financials and valuations: Cipla Income Statement (INR Million) Y/E March E 2013E Gross Sales 54,117 61,798 67,966 77,825 Change (%) Exports 29,004 33,548 36,971 42,645 Net Domestic Sales 24,592 27,755 30,447 34,558 Other Operating Income 2,462 1,842 1,775 1,838 Net Income 56,057 63,145 69,193 79,041 Change (%) Total Expenditure 42,315 49,927 53,550 60,726 EBITDA 13,742 13,218 15,643 18,315 Margin (%) Depreciation 1,671 2,542 3,144 3,476 EBIT 12,071 10,677 12,499 14,839 Int. and Finance Charges Other Income - Rec ,122 1,234 1,357 PBT before EO Items 12,311 11,625 13,450 16,070 Extra Ordinary Expense PBT but after EO Exp. 13,261 11,625 13,450 16,070 Tax 2,435 1,954 2,690 2,893 Tax Rate (%) Reported PAT 10,826 9,671 10,760 13,177 Adj PAT 10,050 9,671 10,760 13,177 Change (%) Margin (%) Balance Sheet (INR Million) Y/E March E 2013E Equity Share Capital 1,606 1,606 1,606 1,606 Reserves 57,410 64,966 73,036 82,918 Revaluation Reserves Net Worth 59,106 66,661 74,731 84,614 Loans 51 5,719 3, Deferred Liabilities Capital Employed 60,948 74,511 79,801 85,962 Gross Block 28,973 42,411 47,411 51,911 Less: Accum. Deprn. 8,861 11,465 14,609 18,085 Net Fixed Assets 20,112 30,946 32,802 33,826 Capital WIP 6,842 2,853 2,853 2,853 Investments 2,464 5,904 5,904 5,904 Ratios Y/E March E 2013E Basic (INR) EPS Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E PEG (x) Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Capital (Days) Leverage Ratio (x) Current Ratio Debt/Equity Cash Flow Statement (INR Million) Y/E March E 2013E Op. Profit/(Loss) before Tax 13,742 13,218 15,643 18,315 Interest/Dividends Recd ,122 1,234 1,357 Direct Taxes Paid -2,285-1,614-3,470-3,375 (Inc)/Dec in WC -1,289-2,889-2,367-3,359 CF from Operations 10,637 9,837 11,039 12,938 EO expense CF from Oper. incl EO Exp. 11,587 9,837 11,039 12,938 Curr. Assets 43,673 46,599 52,259 59,620 Inventory 15,126 19,062 20,318 22,209 Account Receivables 15,666 14,908 17,690 19,190 Cash and Bank Balance 621 1,010 2,077 3,855 Others 12,260 11,619 12,175 14,367 Curr. Liability & Prov. 12,144 11,791 14,017 16,241 Account Payables 12,144 11,791 14,017 16,241 Net Current Assets 31,530 34,808 38,242 43,380 Appl. of Funds 60,948 74,511 79,801 85,962 E: MOSL Estimates (inc)/dec in FA -5,037-9,386-5,000-4,500 (Pur)/Sale of Investments -1,651-3, CF from Investments -6,688-12,826-5,000-4,500 Issue of Shares 6, Inc/(Dec) in Debt -9,352 5,668-2,000-3,239 Interest Paid Dividend Paid -2,139-2,983-2,690-3,294 CF from Fin. Activity -4,809 3,379-4,973-6,660 Inc/Dec of Cash ,066 1,779 Add: Beginning Balance ,010 2,077 Closing Balance 621 1,010 2,077 3,855 August

54 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 62/100 Transformed transnational Lupin CMP: INR450 LPC IN TP: INR514 Buy M: Mix 5/10 Lupin is a balanced play on the domestic chronic and acute therapeutic segments. The company derives 43% revenue from chronic therapeutic areas. The respiratory, AI, CVS and Anti-TB segments contribute 56% to Lupin's domestic formulation revenue. E: Equity with doctors 6/10 Lupin has moderate brand equity in the pharmaceutical industry but good brand equity in select segments like the anti-tb segment, in which it ranks No1 in the industry. Lupin has been gradually improving its brand equity in the CVS and anti-diabetes segments and has improved its prescription ranking in the segments considerably over the past four years. D: Distribution & reach 6/10 I: Introductions 6/10 Lupin derives 70% of its revenue from metros and tier-i cities. Distribution reach in metros and tier-i towns increased significantly and the contribution of other geographies to revenue has reduced over the past four years. Lupin has been aggressive in launching new products over the past four years, compared with its peers. It launched 67new products and line extensions a year over the past four years. New launches contributed significantly to Lupin's revenue growth over the past few years. Lupin has a field force of 3,682 MRs. Stock info Equity Shares (m) Week Range (INR) 520/348 1,6,12 Rel. Perf. (%) 12/20/29 M.Cap. (INR b) M.Cap. (USD b) 4.4 Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR m) (INR m) (INR) Gr. (%) (x) (x) (%) (%) Sales EBITDA 03/10A 47,405 6, /11A 57,068 8, /12E 64,784 9, /13E 74,127 11, Background Lupin is a second tier company actively targeting the regulated generics markets. Historically very strong in the anti-tb segment, it has over the years built up expertise in fermentation-based products and segments like cephalosporins, prils and statins. It is also in the process of building a niche portfolio of oral contraceptives and branded products in the US market. August

55 Lupin Chairman Profile Chairman Lupin is promoted by Dr. D. B. Gupta (Chairman), a first generation entrepreneur supported by a team of senior professionals including Dr. Kamal Sharma (MD). Rapid scale-up in the US market (despite being a relatively late entrant), significant improvement in the product and geographical mix over the past 5 years coupled with strong backward integration skills are the key achievements. C: CAGR and scale-up 8/10 Lupin significantly outperformed the industry with revenue CAGR of 21% over FY It has scaled up the business rapidly though on a very low base. However, the main growth driver was the tripling of its field force and aggressive new launches, rather than an increase in productivity. I: Improvement in productivity 5/10 Lupin was not able to improve MR productivity over Revenue per MR was stagnant at INR3.6m over At this level the productivity is in line with the industry average. We expect Lupin to post 18% revenue CAGR over FY11-13 outperforming the industry, led by a rapidly expanding presence in the fast growing chronic therapeutic areas like CVS and anti-diabetes segments, an increase in the field force and aggressive new launches. N: Non-domestic business 6/10 We are positive about Lupin's international business, given its strong and differentiated portfolio in the US and its gradually expanding presence in Japan. We expect Lupin's international business to post 13% CAGR over FY11-13, excluding upsides from Para-IV sales. E: Earnings growth 6/10 We expect overall top-line CAGR of 14% over FY11-13 leading to EPS CAGR of 15.3%. Regulated markets and India formulations will be key growth drivers. Option values include upsides from Para-IV products in the US. S: Stock Attractiveness 14/20 Cautious approach to international expansion coupled with a highly profitable US business has ensured good return ratios in the past. We expect this to sustain in future. Lupin is valued at 20.2x FY12E and 17.5x FY13E consolidated earnings. Reiterate Buy with a target price of INR514 (20x FY13E EPS) excluding potential one-off upsides. Stock performance (1 year) 520 Lupin Sensex - Rebased Aug-10 Nov-10 Feb-11 May-11 Aug-11 August

56 Lupin India formulations snapshot Domestic formulations: Meaningful contributor to revenue, profitability The domestic formulations business is a meaningful contributor to Lupin's revenue and EBITDA with contribution of ~25%. Unlike some leading companies in the domestic formulations space, we believe Lupin's profitability in this business is lower than its peers due to a significant presence in anti-tb segments and rapid expansion of sales force. The business posted revenue CAGR of 21.5% over the past six years. EBITDA Contribution DF EBITDA 25% Transformed transnational Transiting from acute to chronic, generic to branded Lupin is among the leading Indian companies in the domestic formulations segment. The company holds a leading position in the anti-tb segment and is among the leaders in the CVS and anti-diabetes segments. Lupin's revenue growth over the past few years has been driven by an augmented sales force and new launches. Lupin derives a large part of its revenue from metros and class-i towns. It is expected to sustain its out-performance to the industry in future. 1. Mix: 5/10 Respiratory, AI, CVS, anti-tb dominate sales The top four therapeutic segments, CVS, AI, respiratory and anti-tb contribute ~56% to Lupin's domestic formulations revenue. Lupin derives ~43% of its domestic formulations revenue from chronic therapeutic segments. It used to derive about half its domestic formulations revenue from the Anti-TB segment 10 years ago. However, Lupin's dependence on the segment has fallen considerably and it now contributes ~10% to revenues. Meanwhile, It has increased its presence in the CVS and respiratory segments over the past 10 years. CVS, AI, Respiratory and Anti-TB dominates the therapy mix Non-DF EBITDA, 75% Among the top 10 players in the industry Lupin ranks among the top 10 players in the domestic formulations industry in terms of revenues. It commands 2.69% market share, which has grown from 2.32% in Lupin has outperformed the industry over the past six years with revenue CAGR of 21.5% against the industry CAGR of 14%. Pain 4% VMN 11% CNS 1% GI 1% Others 9% Pain 2% FY01 Anti-TB 48% CVS 5% Others 22% AI 21% Respira tory 0% FY11 Pain 3% Others 20% Diabetes 5% GI 3% FY05 Anti-TB 33% CVS 21% CVS 11% AI 23% Respira tory 2% Lupin Mkt Share (%) Grow th (%) Gynaecology 3% CNS 4% Diabetes 7% GI 6% Anti-TB 10% Respiratory 9% AI 16% Source: Company/Industry/MOSL August

57 Lupin 2. Equity with doctors: 6/10 Brand equity among physicians strong in some therapeutic segments Lupin's brand equity is strong in some therapeutic segments like anti-tb, in which it ranks No1, but overall it has average brand equity. In CVS, respiratory and the anti-diabetes segment, Lupin ranks No. 7, No. 6 and No. 7 with market share of 5.6%, 4.8% and 3.8% respectively. It has been improving its market share in these segments over the past few years, outperforming the segments' growth. Market share in key therapies (%) Growth comparison (%) (2010) Avg Gr - Company Avg Gr - Industry CVS Respiratory Anti-Diabetic CVS Respiratory Anti-Diabetic * Average growth over Source: Industry/MOSL In terms of the number of prescriptions written, Lupin has consistently led the anti-tb segment with a prescription market share of 51%. It has been gradually improving its brand equity in the CVS and anti-diabetes segments and improved its prescription ranking in these segments over the past four years. It ranks fifth in the CVS segment with a prescription market share of 5% and ranks sixth in the anti-diabetes segment with a market share of 4.9%. Lupin's prescription ranking Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Anti-TB CVS Anti-diabetic CNS Anti-infectives Respiratory Source: Industry/MOSL Top 10 brands contribute 20% of the revenues Lupin's top 10 brands contribute ~20% to its revenue, indicating low brand concentration. None of these feature in the top 100 brands of the industry. Its No1 brand, Tonact, (Atorvastatin, CVS) ranks No101 in the industry and it reported 19% growth over the past four years. The absence of big brands indicates Lupin's limited brand building ability in segments other anti-tb therapy. August

58 Lupin Lupin's top 10 brands Brand Drug Product Launch Sales (INR m) YoY Gr (%) CAGR (%) Tonact Atorvastatin Ramistar Ramipril Gluconorm-g Glimepiride+Metform R-cinex Anti-TB Budamate Formoteral+Budesonide L-cin Levofloxacin Odoxil Cefadroxil oral Esiflo Salmeterol+Fluticasone Rablet Rabeprazole Percin Other quino CAGR through Source: Industry/MOSL 3. Distribution and reach: 6/10 Lupin derives 70% of its revenue from metros and class-i towns compared with 63% of the industry average. Over the past four years, revenue CAGR for various geographies has been much higher than that of industry average except for in rural areas. The outperformance is significant in metros and class-i towns. The contribution of the metro region to the sales grew from 28% to 34% over the past five years. Lupin: Geographical distribution of revenues (%) Geographical distribution of revenues: Industry (%) Metros Class I Tow ns Class II to VI Rural Metros Class I Tow ns Class II to VI Rural CY06 CY07 CY08 CY09 CY10 CY06 CY07 CY08 CY09 CY10 Lupin: Geography-wise growth rates (%) Industry: Geography-wise growth rates (%) Metros Class I Tow ns Class II to VI Rural Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 Source: Industry/MOSL August

59 Lupin 4. Introductions: 6/10 Lupin has been among the most aggressive players in launching new products Lupin has aggressively launched new products over the past four years, compared with its peers. It launched 67 new products annually (including line extensions) over the past four years. However average revenue per new launches has been stable over the period. New launches contributed significantly to Lupin's revenue growth over the past few years though average revenue per new launch declined from INR104m in CY07 to INR65m in CY10. Lupin: New launches Lupin: Growth composition (%) No. Of launches in last 2 yrs Avg sales per launch (INR m) New Launches 11.0 Existing Brands CY07 CY08 CY09 CY CY07 CY08 CY09 CY10 Source: Industry/MOSL 5. CAGR and scale up: 8/10 We expect Lupin's domestic formulations to post revenue of 18% CAGR over FY11-13 led by a rapidly expanding presence in fast growing chronic therapeutic areas like CVS and anti-diabetes, increase in its field force and new launches. We believe Lupin will continue its out-performance of the industry as historically it has grown much faster than the industry, clocking revenue of 21.5% CAGR over FY Lupin: Domestic formulations revenue rampup 26.1 India Formulation Sales (INR M) Grow th (%) ,496 11,412 13,281 15,863 18,718 22,087 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL August

60 Lupin 6. Improvement in MR productivity: 5/10 Lupin's top-line growth is driven by additions to its sales force, but has not been able to improve productivity Lupin's domestic formulations business revenue posted 20.4% CAGR over FY04-10 and its sales force grew by 20.2% CAGR, implying stagnant MR productivity. In 2004, Lupin derived revenue of INR3.6m per MR, which was the same in FY10. Compared with the average of companies covered in this report, Lupin's performance was below average. Lupin: Sales force productivity No. of MRs Revenue per MR (INR m) Sales force addition CAGR (%) Productivity Improvement CAGR (%) 1,219 3, Lupin Industry Source: Company/Industry/MOSL 7. Non-domestic business: 6/10 Lupin's non-domestic business snapshot Positives Lupin has demonstrated one of the fastest ramp-ups in the US, led by branded and generic products, and gradually increasing precription share. Trying to build a differentiated portfolio in the US by targeting niche segments of oral contraceptives and ophthalmology, coupled with some branded products. It is the only Indian player to have a branded presence in the US and has been an early entrant in Japan through Kyowa acquisition. It is highly cost competitive due to backward integration for most of its products. Risks & concerns Generic competition for Suprax (a key product) in US. Delays in receiving US FDA approval for oral contraceptives. No major progress on NCE research despite working on it for many years. Key news flows/triggers Ramp-up in Antara sales in the US. US FDA approvals for oral contraceptives. Potential acquisitions in Japan and Latin America. August

61 Lupin Impact assessment We are positive about Lupin's international business, given its strong and differentiated portfolio in the US and its gradually expanding presence in Japan. We expect international business to record 12% CAGR over FY11-13, excluding upsides from Para-IV sales. Our estimates factor in the potential competition for Suprax in US. Option values include upsides from Para-IV products in the US. Sales mix (INR m) FY09 FY10 FY11 FY12E FY13E FY11-13E CAGR (%) India APIs 2,192 2,302 2,514 2,640 2, Formulations 11,412 13,281 15,863 18,718 22, Total 13,604 15,583 18,377 21,358 24, % of sales Regulated APIs Formulations 17,341 23,234 28,229 31,385 35, Total 17,991 23,777 28,826 31,965 36, % of sales Un-regulated APIs 4,296 4,565 5,477 5,751 6, Formulations 1,930 3,204 4,393 5,711 7, Total 6,226 7,769 9,870 11,462 13, % of sales Others Grand Total 38,238 47,678 57,422 65,175 74, Source: Company/MOSL EBITDA Contribution Non-DF EBITDA 75% DF EBITDA 25% 8-9. Earnings growth and stock attractiveness: 20/30 Lupin is likely to gradually improve its fundamentals, led by an expanding US generics pipeline, niche/para-iv opportunities in the US, strong performance in emerging markets (including India) and sustained traction in the Japanese business. While our estimates factor in generic competition for Suprax from FY13 onwards, any out-of-court settlement for Suprax patent litigation is likely to raise our earnings forecast for FY13. Lupin continues to target niche, low-competition opportunities to drive growth and improve profitability. Its initiatives in the US oral contraception space are efforts in this direction. The stock trades at, 19.7x FY12E and 17.1x FY13E EPS with a sustained ~25-30% RoE. Our estimates do not include one-time upsides for Lupin's FTF pipeline in the US. Maintain Buy with a target price of INR514 (20x FY13E EPS). August

62 Lupin Lupin RoE & RoCE Lupin one year forward P/E RoE (%) RoCE (%) P/E (x) Avg(x) Peak(x) Min(x) E 2013E Aug-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Lupin non-domestic business: key trends, triggers & risk US generics: One of the fastest entries by an Indian player Lupin has the distinction of achieving the fastest ramp-up in the US by any Indian company. This was achieved through brand acquisition/in-licensing, focusing on niche, low-competition products, supported by an aggressive pace of filings in the US market. Lupin, which entered the US market in FY05, posted FY11 US revenues of INR20b, a growth of 9x over FY Targeting niche opportunities resulted in better profitability Lupin has differentiated itself from other Indian generic companies in the US by: 1. Focusing on branded innovator products - it is the only Indian company to do so. 2. Launching at least one low-competition/patent challenge product in the US every year over the past few years. A few years ago, Lupin in-licensed Suprax brand from Fujisawa (the latter had stopped promoting this brand in the US) and ramped-up sales of the product through price increases, volume growth and the launch of line extensions of the brand. While Lupin does not disclose Suprax revenues separately, we estimate they contributed USD80m-90m to its FY11 US revenues. Expanding brand portfolio in the US through acquisitions/in-licensing After its success with Suprax, Lupin has attempted to expand its brand portfolio in the US by acquiring the Antara brand in FY10 and in-licensing a couple of brands from other players. While it is yet to replicate the Suprax success for Antara, we believe the brand holds promise. The other two brands are likely to contribute to revenue in the long-term. Lupin's niche initiatives in the US have helped it to achieve two main objectives. 1. It rapidly ramped up US revenues with 9x growth CAGR over FY06-11 to INR20b. 2. It significantly improved the profitability of its US operations since branded innovator products and low-competition/patent challenge generic products enjoy higher profitability compared with normal generic products. Niche/patent challenge upsides in the US to continue The trend of launching niche products in the US will continue. After the contribution from generic Lotrel during FY11, Lupin has scheduled similar launches in FY12. The commercialization of its oral contraceptive (a US$4.5b market in the US) products will add to its protfolio from FY13. August

63 Lupin The management has guided for 12 new launches in the US in FY12 of which 3-4 are expected to be oral contraceptives (with branded market size of USD300m-500m). The remaining products will target a branded US market worth about USD5b. Lupin has made 23 filings in the oral contraceptives segment as part of its strategy to exploit niche and low-competition segments. To strengthen this portfolio, it is focusing on filing products in the ophthalmology and dermatology segments. Given that Lupin will be a new player in the oral contraceptives market, we have conservatively factored in upsides from this opportunity from FY13 despite the management guidance of launching 3-4 products in FY12. These potential low-competition launches along with a steady ramp-up in its branded revenue in the US (sales force strength increased from 70 to 160 MRs) will enable Lupin to sustain double-digit growth. We factor in 9% revenue CAGR for Lupin's US operations (over FY11-13) after factoring in the slowdown in the US branded business and potential competition from generic Suprax. Our estimates exclude potential one-off opportunities. Japan can be a large opportunity in the long term Japan is the new emerging opportunity in the global generics market with the Japanese government trying to reduced overall healthcare costs in the US$70b Japanese pharmaceutical market. The government has, in the past two years, legislated to encourage the use of generics. However, given the Japanese market's concern for quality products and a brand-conscious mentality, progress has been gradual for generic products. We, however, believe the Japanese market holds huge long-term potential for generic players who can convince the Japanese population about the quality of their products. A successful presence in such a market will require tie-ups/associations with known local names since Indian companies are still unknown entities in Japan. One of the few companies to access Japan's generics market Given Lupin's entry in the Japanese generic market through the Kyowa acquisition, it is better positioned to exploit the Japanese generics opportunity compared with its peers. Lupin acquired Kyowa in October 2007 and ramped-up the business to INR6.2b by FY11. We estimate 17% revenue CAGR for the Japanese operations, led mainly by new launches. Gradually expanding profitability of Japanese operations Lupin expanded gross margins for Kyowa from 33% to 40% over the past two years and is shifting part of its manufacturing to its Indian facilities, which is likely augment margins. In FY12 Lupin will shift some of trhe API production to India and the formulation manufacturing will be gradually shifted to India from FY13. These initiatives are likely to gradually expand the profitability of Lupin's Japanese operations in the long-term. August

64 Lupin Financials and valuations: Lupin Income Statement (INR Million) Y/E March E 2013E Net Sales 47,405 57,068 64,784 74,127 Change (%) Total Expenditure 38,869 46,410 52,590 59,521 EBITDA 8,536 10,659 12,194 14,605 Margin (%) Depreciation 1,239 1,755 1,955 2,248 EBIT 7,297 8,903 10,239 12,357 Int. and Finance Charges Other Income - Rec. 1,445 1,341 2,921 1,625 PBT before EO item 8,357 9,920 12,857 13,750 PBT after EO item 8,357 9,920 12,857 13,750 Tax 1,360 1,169 1,928 2,063 Tax Rate (%) Reported PAT 6,997 8,750 10,928 11,688 PAT Adj for EO items 6,997 8,750 10,163 11,688 Change (%) Margin (%) Less: Minority Interest Adj Net Profit 6,816 8,582 9,913 11,418 Consolidated Balance Sheet (INR Million) Y/E March E 2013E Equity Share Capital Fully Diluted Equity Capital Other Reserves 24,789 31,918 39,473 47,551 Total Reserves 24,789 31,918 39,473 47,551 Net Worth 25,678 32,811 40,366 48,444 Minority Interest Deferred liabilities 1,435 1,411 1,411 1,411 Total Loans 11,399 11,624 8,624 5,624 Capital Employed 38,767 46,361 50,916 55,994 Gross Block 22,937 26,389 30,889 35,389 Less: Accum. Deprn. 7,072 9,075 11,030 13,278 Net Fixed Assets 15,865 17,313 19,859 22,110 Capital WIP 3,579 5,312 5,312 5,312 Investments Goodwill & Intangibles 3,197 3,255 3,255 3,255 Curr. Assets 27,755 34,967 39,049 44,034 Inventory 9,715 12,000 13,605 15,567 Account Receivables 11,266 12,558 14,252 16,308 Cash and Bank Balance 2,015 4,201 4,714 4,747 Others 4,759 6,208 6,478 7,413 Curr. Liability & Prov. 11,893 14,518 16,591 18,748 Account Payables 9,649 11,800 12,957 14,825 Provisions 2,243 2,718 3,634 3,923 Net Current Assets 15,862 20,449 22,459 25,285 Appl. of Funds 38,767 46,361 50,916 55,994 E: MOSL Estimates Ratios Y/E March E 2013E Basic (INR) EPS (Fully Diluted) Cash EPS (Fully Diluted) BV/Share DPS Payout (%) Valuation (x) P/E (Fully Diluted) Cash P/E (Fully Diluted) P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Wkg. Capital Turnover (Days) Leverage Ratio Debt/Equity (x) Cash Flow Statement (INR Million) Y/E March E 2013E Oper. Profit/(Loss) before Tax 8,536 10,659 12,194 14,605 Interest/Dividends Recd. 1,445 1,341 2,921 1,625 Direct Taxes Paid -1,090-1,193-1,928-2,063 (Inc)/Dec in WC -4,478-2,401-1,497-2,794 CF from Op. incl EO Exp. 4,414 8,405 11,690 11,374 (inc)/dec in FA -6,454-4,996-4,500-4,500 (Pur)/Sale of Investments CF from Investments -6,503-4,763-4,500-4,500 Change in Net Worth 6, Inc/(Dec) in Debt ,000-3,000 Interest Paid Dividend Paid -1,483-1,658-3,123-3,340 CF from Fin. Activity 3,327-1,457-6,677-6,841 Inc/Dec of Cash 1,238 2, Add: Beginning Balance 778 2,015 4,201 4,714 Closing Balance 2,015 4,201 4,714 4,747 August

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66 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 61/100 All's in place Torrent Pharma CMP: INR589 TRP IN TP: INR762 Buy M: Mix 6/10 Torrent is one of the better plays on remedies for high-growth lifestyle segments of CNS, CVS and diabetes. It derives 59% of its revenue from chronic lifestyle segments. CVS is the highest contributor with 35% contribution followed by CNS (21%) and Gastro Intestinal (17%). E: Equity with doctors 7/10 Torrent enjoys good brand equity with specialist in the CNS and CVS segments. In the CNS segment, Torrent Pharma ranks 3rd with a prescription market share of 8.1% and in the CVS segment its ranks seventh with a prescription market share of 4.6%. Torrent Pharma has either maintained or improved its prescription ranking in the most of the therapeutic segments in which it operates. D: Distribution & reach 6/10 I: Introductions 5/10 Torrent Pharma derives 73% of its revenue from metros and tier-i cities. The contribution of rural areas to revenue has fallen over the past five years from 18.2% to 12.8%. Over the past four years, revenue CAGR for all geographies has been below the industry average except in Metro's. Torrent Pharma's new product launch rate has been good compared with its peers in the industry. It launched 38 new products a year (including line extensions) over the past four years. It's revenue growth is driven by its existing products as well as new launches. Torrent Pharma has a field force of 3,600 Stock info Equity Shares (m) Week Range (INR) 687/497 1,6,12 Rel. Perf. (%) 3/19/18 M.Cap. (INR b) 54.6 M.Cap. (USD b) 1.2 Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR m) (INR m) (INR) Gr. (%) (x) (x) (%) (%) Sales EBITDA 03/10A 19,040 2, /11A 22,265 2, /12E 25,596 3, /13E 29,817 4, Background Though ranked 17th in terms of total revenue in the domestic formulations segment, Torrent derives its strength from being the leader in some of the most lucrative and fastest growing chronic therapy segments. It has consistently maintained its leadership in these therapeutic classes, with strong brands and new product launches. August

67 Torrent Pharma Chairman Profile Chairman Torrent Pharma was set-up by Late U N Mehta. Mr Mehta started his career as a clerk with the government. Later, he took a job as a medical representative for Sandoz. Post which he started his own business in pharmaceutical and eventually established the company. Currently, his son Mr. Sudhir Mehta and Mr. Sameer Mehta handle the operations of the company. C: CAGR and scale-up 6/10 I: Improvement in productivity 3/10 Torrent Pharma has significantly outperformed the industry with revenue CAGR of 19% over FY The company has scaled up the business rapidly albeit on a low base and growth has been achieved largely because of a favorable therapeutic mix, improvement in brand equity and increase in field force productivity. We expect Torrent Pharma to post 16% CAGR over FY11-13, outperforming the industry, led by a strong presence in fast growing chronic therapeutic areas like CVS, CNS and anti-diabetes and improvement in brand equity. Torrent Pharma ranks very low compared to its larger peers when it comes to field force productivity. However the company has managed to improve the productivity over the last 6 years. Revenue per MR improved from Rs1.5m in 2004 to Rs2.2m in 2010 N: Non-domestic business 6/10 E: Earnings growth 8/10 We are positive about Torrent Pharma's nondomestic business given it's has strong presence in Latin America and expanding its reach in various regulated and emerging markets. We expect the international business to post 15.7% CAGR over FY11-13 mainly led by the US and Latin American markets. We expect overall top-line CAGR of 16% over FY11-13 leading to EPS CAGR of 22.1%. Earnings growth will be driven by the domestic formulation business and increase in profitability of international operations. The company has tie-up with 3 global innovators for supplying various products. We expect these supplies to grow at 16.5% CAGR over FY Option values include upsides from NCE business. S: Stock Attractiveness 14/20 A focused and cautious approach to international expansion along with a highly profitable domestic business has ensured good return ratios, RoIC is estimated at 40% over the next two years. Stock performance (1 year) Torrent Pharma Sensex - Rebased Torrent Pharma is valued at 14.7x FY12E and 12.4x FY13E consolidated earnings. Reiterate Buy with a target price of INR762 (16x FY13E EPS) Aug-10 Nov-10 Feb-11 May-11 Aug-11 August

68 Torrent Pharma India formulations snapshot Domestic formulations - major contributor to revenue, profits The domestic formulations business contributes ~40% to Torrent Pharma's revenue. The segment is the most profitable for Torrent and contributes ~70% to consolidated EBITDA. Revenue/PBT Contribution Torrent Pharma Non-DF EBITDA DF EBITDA 30% 70% The leading player in the chronic therapeutic segment Torrent Pharma has grown its market share over the years due to a significant presence in fast growing chronic therapeutic areas. It is among the largest companies in the chronic segments. The company's market share has gone up from 1.9% in 2006 to 2% in The company posted 19% CAGR over the past five years against 14% CAGR for the industry. Market share has increased marginally Mkt Share (%) Grow th (%) All's in place Strong profitable growth, robust balance sheet, attractive valuation Torrent derives its strength from its strong positioning in some of the most lucrative and fastest growing chronic therapy segments. It has consistently maintained its leadership in these therapeutic classes, with strong brands and new product launches. Torrent has 6 brands in the industry's top 300 brands, and has 37 brands in leadership positions in their respective molecule segments. The company has a field force of 3,600 medical representatives (MRs). Domestic business has grown at a CAGR of 19% over the last 6 years through FY11. Torrent derived 40% of its revenue from the domestic formulations business in FY11, down from 85% in FY04 due to relatively higher growth in its international business. 1. Mix: 6/10 Lifestyle segments like CVS, CNS, anti-diabetes dominate sales Torrent Pharma derives 59% of its revenue from chronic therapeutic segments, which dominate the company's revenue mix. The top five therapeutic segments including CNS, CVS, GI, AI and anti-diabetes contribute ~91% to Torrent's domestic formulations revenue. Torrent is among the market leader in two of the fastest growing therapeutic segments, CNS and CVS. Torrent's sizable presence in the chronic therapy segments makes it an attractive play in the domestic formulations business. Therapeutic break-up (FY05) Pain 6% Antiinfectives 14% Antidiabetic 3% others 2% CNS 17% GI 22% Cardiac 36% Therapeutic break-up (FY11) Cardiac CNS Pain others Source: Company/Industry/MOSL 2. Equity with doctors: 7/10 Strong brand equity among specialists, among leaders in the CVS and CNS Torrent has been a dominant player in two of the industry's fastest growing therapeutic segments i.e CNS and CVS. Torrent ranks No2 in the CVS and No.3 in CNS segments with a value market share of 6.8% and 8.6% respectively. 19% 4% 13% 5% Anti-diabetic Anti-infectives GI 21% 33% 5% August

69 Torrent Pharma Market share in key therapies (%) Growth comparison (%) (2010) Avg Gr - Company Avg Gr - Industry CVS GI CNS CVS GI CNS * Average growth over Source: Industry/MOSL In terms of prescriptions Torrent Pharma has been one of the leading players in two of the industry's fastest growing therapeutic segments viz. CNS and CVS. Torrent Pharma ranks No3 in the CNS and No. 7 in CVS segments with a prescription market share of 8.1% and 4.6% respectively. It ranks sixth in the GI segment. Over the last 4 years, the company has either maintained or improved its ranking in almost all the therapeutic areas it operates in. Torrent's Prescription ranking has improved across therapy segments Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 CVS CNS Anti Diabetics Anti infectives GI Source: Industry/MOSL Top 10 brands contribute 30% of the revenues Torrent Pharma's top 10 brands contribute ~30% to total revenue, which shows low brand concentration compared with other leading companies. Four brands of the company feature among the top 300 brands of the industry. Torrent Pharma's No1 brand, Dilzem, (Diltiazem, CVS) ranks 102 nd in the industry and it posted revenue CAGR of 13% over the past four years. Seven of its top 10 brands have grown at double digit CAGR over past 4 years. Top 10 brands of the company Brand Drug Product Product Sales YoY Gr. CAGR Category Launch (INRm) (%) (%) Dilzem Diltiazem CVS Nikoran Nicorandil CVS Alprax Alprazolam CNS Nebicard Nebivolol CVS Topcef Cefixime Anti-infective Domstal Domperidone Gastro-intestinal Droxyl Cefadroxil Anti-infective Azulix-mf Glimepiride+Metformin Diabetes Deplatt-a Aspirin + Clopidogrel CVS Lamitor Lamotrigine CNS CAGR through Source: Industry/MOSL August

70 Torrent Pharma 3. Distribution and reach: 6/10 Torrent Pharma derives 73% of its revenue from metros and class-i towns, compared with 63% of the industry average, suggesting a focus on these geographies. In the past four years, revenue CAGR for all geographies has been lower than that of the industry average except for Metros. The contribution of rural areas to revenue has fallen over the past five years from 18.2% in 2006 to 12.8% in Geographical distribution of revenues - Torrent Pharma (%) Geographical distribution of revenues - Industry (%) Metros Class I Tow ns Class II to VI Rural Metros Class I Tow ns Class II to VI Rural CY06 CY07 CY08 CY09 CY10 CY06 CY07 CY08 CY09 CY10 Geography-wise growth rates - Torrent Pharma (%) Geography-wise growth rates - Industry (%) Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Source: Industry/MOSL 4. Introduction: 5/10 Torrent Pharma's pace of new product launches has been moderate compared with its peers in the industry. There has been significant improvement in revenue per new product launched Torrent's new product launch rate has been moderate compared to its peers in the industry. It has launched 38 new products annually (including line extensions) over the last 4 years. The revenue growth is driven by both existing products as well as new launches. The average revenue per new launch has risen substantially in the past four years from Rs32.7m in 2006 to Rs118m in 2010, suggesting better penetration of launched brands. August

71 Torrent Pharma Torrent Pharma's - new launches Torrent Pharma's growth compositions (%) 126 No. Of launches in last 2 yrs Avg sales per launch (INR m) New Launches Existing Brands CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 Source: Industry/MOSL 5. CAGR and scale-up: 6/10 We expect 16% CAGR from Torrent Pharma's domestic formulations business led by a strong presence in the fastest growing chronic therapeutic segments. We believe the company will continue to outperform the industry and its peers over the foreseeable future. Historically the company has outperformed industry in this segment with FY05-11 revenue CAGR of 19% versus that of 14% for the industry during the same period. We believe that, Torrent is likely to strengthen its presence in key therapeutic areas, improving its ranking in the industry. Torrent Pharma: Domestic formulations revenue ramp-up Revenues (INR m) Grow th (%) 11,285 2,848 2, , ,444 5, , , , , FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL 6. Improved MR productivity: 3/10 Torrent's topline growth is driven by both addition to the MR strength and improvement in the MR productivity. However MR productivity is low compared to large peers Torrent Pharma has done a good job over the past six years with a improvement in workforce productivity. Over FY04-10, Torrent Pharma's domestic formulations business revenue posted 19.3% CAGR and its sales force expanded by just 10.7% CAGR, implying significant productivity improvement of the workforce. In 2004, Torrent derived revenue of Rs1.5m per MR, which rose to Rs2.3m in However the MR productivity is still very low compared to large peers. August

72 Torrent Pharma Torrent: Salesforce productivity No. of MRs Revenue per MR (INR m) 2.3 Sales force addition CAGR (%) Productivity Improvement CAGR (%) 1.5 3,600 1, Torrent Industry Source: Company/Industry/MOSL 7. Non-domestic business snapshot: 6/10 Positives Strong presence in emerging markets like Brazil and RoW markets. Increasing presence in other emerging markets Increasing presence in US market with healthy product pipeline Strong chemistry skills and backward integrated low-cost operations. Improving profitability of international subsidiaries. Risks & concerns Delay in getting regulatory approvals for the products Worsening of pricing environment in key markets like Germany and US. Rupee appreciation vs US$ may have negative impact on earnings. Continued losses at Russian subsidiaries will impact overall profits. Key news flows/triggers Ramp up in US revenue in FY12-13 Begining of supplies to AstraZeneca Improvement in profitability of international business Impact assessment Expect the international business to post 15% CAGR over FY11-13 led mainly by US and CRAMS supplies to AstraZeneca We expect the international business to record 16% CAGR over FY11-13 excluding low-competition and Para-IV products in the US. Option values include upsides from future inorganic initiatives. August

73 Torrent Pharma Sales mix (INR m) FY09 FY10 FY11 FY12E FY13E FY11-13 CAGR (%) Domestic formulation 6,240 7,254 8,389 9,563 11, YoY Growth (%) International formulation7,970 9,157 10,702 12,421 14, YoY Growth (%) Latin America 2,566 3,006 3,519 4,223 4, Russia/CIS Europe (ex-germany) 1,011 1,163 1,245 1,469 1, Germany (Heumann) 2,573 2,547 2,986 3,135 3, RoW 885 1,141 1,276 1,429 1, US ,093 1,640 2, CRAMS 1,601 1,849 2,096 2,431 2, YoY Growth (%) Others YoY Growth (%) Net Sales 15,864 18,329 21,220 24,451 28, YoY Growth (%) Other operating income ,045 1,145 1, YoY Growth (%) Income from op. 16,306 19,040 22,265 25,596 29, YoY Growth (%) Source: Company/MOSL EBITDA Contribution Torrent Pharma Non-DF EBITDA 30% DF EBITDA 70% 8-9. Earnings growth and stock attractiveness: 22/30 Over the past five years Torrent posted earnings CAGR of 34% and CAGR of capital employed in the business was 17%. Torrent consistently improved its profitability, with RoCE increasing from 14.5% in FY05 to 24.1% in FY11. Torrent is likely to post earnings of 22% CAGR over FY11-13, in line with strong operating performance. It is likely to sustain high return ratios despite large capex and growing cash on its books. We believe current valuations do not reflect the improvement in business profitability, turnaround of international operations and Torrent's strong positioning in the domestic formulations segment. Torrent should trade at a premium to most mid-cap pharmaceutical companies, and its valuation gap vis-à-vis frontline pharmaceutical companies should fall, going forward. The stock trades at 14.7x FY12E and 12.4x FY13E earnings. We believe Torrent's superior financial performance will drive re-rating. Maintain Buy with a target price of INR762 (16x FY13E EPS), an upside of 26%. Torrent Pharma RoE & RoCE Torrent Pharma one year forward P/E 42.0 RoE (%) RoCE (%) 24 P/E (x) Avg(x) Peak(x) Min(x) FY09 FY10 FY11 FY12E FY13E Mar-05 Dec-05 Aug-06 May-07 Jan-08 Oct-08 Jul-09 Mar-10 Dec-10 Aug-11 August

74 Torrent Pharma Financials and valuations: Torrent Pharma Income Statement (INR Million) Y/E March E 2013E Net Revenues 19,040 22,265 25,596 29,817 Change (%) Total Expenditure 14,944 18,173 20,445 23,748 % of Sales EBITDA 4,096 4,092 5,151 6,069 Margin (%) Depreciation ,137 EBIT 3,435 3,466 4,199 4,932 Int. and Finance Charges Other Income - Rec PBT before EO Expense 3,312 3,427 4,137 4,913 Extra Ordinary Exp./(Inc.) PBT after EO Expense 2,944 3,427 4,158 4,913 Current Tax Deferred Tax Tax Tax Rate (%) Reported PAT 2,312 2,702 3,413 4,029 Adj PAT 2,680 2,702 3,392 4,029 Balance Sheet (INR Million) Y/E March E 2013E Equity Share Capital Total Reserves 7,887 9,801 12,531 15,755 Net Worth 8,310 10,224 12,955 16,178 Deferred liabilities Total Loans 5,224 5,721 5,721 5,721 Capital Employed 14,033 16,441 19,155 22,378 Ratios Y/E March E 2013E Basic (INR) EPS (INR) Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) EBITDA Margins (%) Net Profit Margins (%) RoE RoCE Working Capital Ratios Asset Turnover (x) Fixed Asset Turnover (x) Debtor (Days) Leverage Ratio (x) Current Ratio Interest Cover Ratio Debt/Equity Gross Block 8,129 10,385 12,685 14,885 Less: Accum. Deprn. 2,718 3,343 4,295 5,432 Net Fixed Assets 5,411 7,041 8,390 9,452 Capital WIP 1,098 1,500 1,200 1,500 Investments 1,412 1,460 1,460 1,460 Curr. Assets 11,607 15,346 17,990 21,490 Inventory 3,236 5,048 5,794 6,676 Account Receivables 2,982 3,404 4,090 4,927 Cash and Bank Balance 3,883 4,788 5,856 7,105 Loans & Advances 1,506 2,106 2,250 2,782 Curr. Liability & Prov. 5,496 8,907 9,884 11,524 Account Payables 4,216 7,479 7,839 9,140 Provisions 1,280 1,427 2,045 2,384 Net Current Assets 6,111 6,440 8,106 9,966 Appl. of Funds 14,033 16,441 19,155 22,378 E: MOSt Estimates Cash Flow Statement (INR Million) Y/E March E 2013E Oper. P/L before Tax 4,096 4,092 5,151 6,069 Interest/Dividends Recd Direct Taxes Paid (Inc)/Dec in WC CF from Operations 3,856 4,005 3,917 4,726 EO Expense / (Income) CF from Oper. incl EO Exp. 3,488 4,005 3,938 4,726 (inc)/dec in FA -1,487-2,657-2,000-2,500 (Pur)/Sale of Investments CF from Investments -1,504-2,705-2,000-2,500 (Inc)/Dec in Debt Interest Paid Dividend Paid Others CF from Fin. Activity Inc/Dec of Cash 1, ,068 1,249 Add: Beginning Balance 2,300 3,883 4,788 5,856 Closing Balance 3,883 4,788 5,856 7,105 August

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76 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 64/100 Of patent and parent GSK Pharma CMP: INR2,155 GLXO IN TP: INR2,330 Buy M: Mix 4/10 GSK derives majority of its revenue from the acute therapeutic segments and has very little presence in the chronic segments. GSK derives 95% of its revenues from acute therapeutic segments with dominant presence in Anti-infcetives, dermatology, pain management and Vitamins. It also enjoys leadership position in the Dermatology segment. E: Equity with doctors 9/10 Enjoys strong brand equity in its some of the largest therapeutic segments in the industry. It ranks no.1 in dermatology segment, no.3 in Pain management and Vitamins segments and no5 in AI and respiratory segments. Based on prescription ranking, GSK Pharma is the market leader in Dermatology, vitamins and pain managements segment while ranks no.4 in respiratory segment. D: Distribution & reach 7/10 Derives 60% of the revenues from Metro and Tier I cities. Contribution of Tier II and rural area to total revenues has remained stagnant over the last 5 years. It has field force of 3000MRs which is on a lower side compared to other Indian companies of similar size. I: Introductions 3/10 GSK is among the laggards when it comes to launch of new products. GSK has launched very few new products over the last 4 years compared to its peers. It has launched 5 new products (including line extensions) annually over the last 4 years. Ramp-up in domestic formulations revenues is driven largely by existing products. Stock info Equity Shares (m) Week Range (INR) 2,475/1,850 1,6,12 Rel. Perf. (%) 5/7/22 M.Cap. (INR b) M.Cap. (USD b) 4.0 Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR m) (INR m) (INR) Gr. (%) (x) (x) (%) (%) Sales EBITDA 12/09A 18,708 5, /10A 21,116 5, /11E 23,740 6, /12E 26,921 7, Background GSK Pharma is the 4th largest formulations company in India, with a strong presence in segments like dermatology, respiratory and vaccines. Its parent has one of the richest product and R&D pipelines among Pharma companies worldwide. The company is in the process of expanding its presence in the life-style segment led by new launches from the parent's portfolio, launch of branded generics and in-licensing. August

77 GSK Pharma CEO Profile CEO GSK Pharma is a 50% subsidiary of GSK Plc (UK) and is being currently managed by Dr. Hasit Joshipura (MD). Maintaining a leading presence in India and sustaining one of the highest profitability and return ratios in the industry despite miniscule presence in the high-growth life-style segments is the key achievement. C: CAGR and scale-up 6/10 GSK has significantly underperformed the industry with revenue CAGR of 8.1% over CY04-10 versus industry revenue CAGR of 14.8% over the same period. The company has gradually lost its market share and slipped through the ranking. We expect it to grow at 13-14% CAGR over CY10-12 which is slightly lower than the industry average, mainly due to high base and intensifying competition in acute segment. I: Improvement in productivity 9/10 GSK enjoys one of the highest MR productivity in the industry with annual revenue per MR at INR7.7m. MR growth was at 5.9% compared to revenue growth of 8.1% for CY04-10 The company has reported an improvement in workforce productivity over CY At this level the productivity is amongst the best in the industry. N: Non-domestic business NA N A E: Earnings growth 6/10 Expect overall topline CAGR of 13% for CY10-12 leading to EPS CAGR of 14.2% " EPS growth is higher than topline growth mainly due to expanding EBITDA margins. S: Stock Attractiveness 14/20 One of the most conservative managements amongst Indian pharmaceutical companies Return ratios are amongst the best in the industry with ROCE in excess of 40% and RoEs in excess of 30%. GSK is currently valued at 27.8x CY11E and 24.1x CY12E Maintain Buy with TP of INR 2,330 (26x CY12E EPS) Stock performance (1 year) GSK Pharma Sensex - Rebased 2,600 2,350 2,100 1,850 1,600 Aug-10 Nov-10 Feb-11 May -11 Aug-11 August

78 GSK Pharma India formulations snapshot Second largest Pharma MNC in India. Before Abbott took over Piramal Healthcare's domestic formulation business, GSK was the largest pharma MNC in India. We believe GSK is one of the best plays on the IPR regime in India with aggressive plans to launch new products in the high-growth lifestyle segments. These launches are expected to bring long-term benefits. EBITDA Contribution Of patent and parent Solid play on new patent regime GSK Pharma is among the best performing MNCs in the domestic formulation space with its strong parentage and brand equity among doctors. It leads the industry in profitability despite its meager presence in highly profitable chronic segments. GSK's MR productivity is the best among the leading companies. We believe GSK's growth trajectory will increase from CY13 as it gets meaningful revenue from new launches. 1. Mix: 4/10 Acute segments account for most of GSK's sales The top seven therapeutic segments, AI, Dermatology, Pain Management, Vitamins, Respiratory, Hormones and GI, contribute ~86% to GSK's domestic formulations revenue. GSK derives 95% of its revenue from acute therapeutic segments. Over the past 10 years the contribution of Dermatology and Pain Management rose from lower single digits to double digits while that of Vitamins and Respiratory segments fell from 50% to 18.4%. DF EBITDA 100% Among the leading players in the industry GSK has maintained leadership in the industry though its ranking has slipped from No1 to No4 over the past few years. However, GSK has maintained its strong position despite few new launches. Its market share fell from 5.23% in 2006 to 4.26% in 2010 due to low growth stemming from very few new launches and stiffer competition. GSK's business posted CAGR of 8.1% over the past six years against 14% CAGR for industry. GSK Pharma: Therapeutic mix GI 7% Res pirat ory 24% Others 15% Anti-Parasitic 3% GI 7% CY 2000 AI 21% VMN 26% Dermatol ogy/ster oids 2% Pain 5% Gynaec 3% CVS 3% March 2011 GI 6% Respirat ory 10% Others 15% Others 6% VMN 15% CY 2004 AI 21% AI 25% Pa in 11% Dermatol ogy/ster oids 18% Market share and growth Mkt Share (%) Grow th (%) Hormones 8% Respiratory 9% Dermatology 19% VMN 10% Pain 11% Source: Company/Industry/MOSL August

79 GSK Pharma 2. Equity with doctors: 9/10 GSK leads the industry in AI, Dermatology, Pain Management GSK ranks first in the Dermatology space in India with market share of 20% and ranks third in the Pain Management and Vitamins segments with market share of 6.4% and 7.3% respectively. It ranks fifth in two of the industry's largest therapeutic segments, AI and Respiratory, with market share of 6% and 5.1% respectively. However over the past two years, the company lagged the industry growth rate in almost all therapeutic segments due to very few new launches. GSK Pharma: Market share in key therapies (%) GSK Pharma: Growth composition (%) (2010) Avg Gr - Company Av g Gr - Industry AI Respiratory Pain/Analgesic VMN Dermatology AI Respiratory Pain/Analgesic VMN Dermatology * Average growth over Source: Industry/MOSL GSK has strong brand equity among physicians, which is visible from its market share and prescriptions rankings. GSK ranks first in the Dermatology, Vitamins and Pain Management segments with prescription market share of 10.4%, 8.7% and 7% respectively. GSK ranks fourth in the Respiratory segment and sixth in the Gynecology segment. Prescription ranking of GSK Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Derma Vit Pain Mgmt Respiratory Gynaec Anti-infectives GI CVS Source: Industry/MOSL Top 10 brands contribute 45% to GSK revenue GSK's top 10 brands contribute ~45% to its total revenue. The brand concentration is among the highest in the industry. It shows GSK's brand building ability and its strong brand recall among physicians. GSK's top 10 brands feature among the industry's top 100 brands. Its No1 brand, Augmentin (Amoxycillin, AI), ranks fifth in the industry and posted 18% growth over the past four years. Eight of the 10 brands posted double-digit CAGR over the past four years. August

80 GSK Pharma Top 10 brands Brand Drug Product Launch Sales (INR m) YoY Gr (%) CAGR (%) Zinetac Ranitidine , Augmentin Amoxy. & Clav , Ceftum Cefuroxime Calpol Paracetamol , Phexin Cephalexin Eltroxin Levothyroxine Betnovate-c Betameth.+Chinoform Betnovate-n Betameth.+Neom Neosporin Antibio. Comb Betnesol Betamethasone injectables CAGR through Source: Industry/MOSL 3. Distribution and reach: 7/10 GSK derives 60% of its revenue from metros and Class-I towns compared with an industry average of 63%. Over the past four years revenue CAGR for all geographies has lagged the industry average. However, GSK's CY10 growth in all geographies was in higher double digits. GSK: Geographical distribution of revenues (%) Geographical distribution of revenues: Industry (%) METROS CLASS I TOWNS CLASS II TO VI RURAL METROS CLASS I TOWNS CLASS II TO VI RURAL CY06 CY07 CY08 CY09 CY10 CY 06 CY 07 CY 08 CY 09 CY 10 GSK: Geography-wise growth rates (%) Industry: Geography-wise growth rates (%) METROS CLASS I TOWNS CLASS II TO VI RURAL CY07 CY CY09 CY10 METROS CLASS I TOWNS CLASS II TO VI RURAL CY 07 CY 08 CY 09 CY 10 Source: Industry/MOSL August

81 GSK Pharma 4. Introductions: 3/10 Existing products lead revenue growth over the past four years Over the past four years, GSK launched very few new products-22 new products including line extensions-compared with its peers. The average revenue per new launch has improved marginaly from been virtually stagnant from INR71m in CY07 to INR81m in CY10. Topline growth over the past four years has been almost entirely driven by existing products, which reflects GSK's ability to leverage existing brands. GSK Pharma: New launches GSK Pharma: Growth composition (%) No. Of launches in last 2 yrs Avg sales per launch (INR m) New Launches Existing Brands CY07 CY08 CY09 CY CY07 CY08 CY09 CY10 Source: Industry/MOSL 5. CAGR and scale up: 6/10 We expect 13-14% CAGR for GSK's domestic formulations business over the next few years. GSK's top-line growth will be led by a focus on priority products, which will sustain double-digit growth. This will be driven by expanding therapeutic and geographic coverage and with incremental contribution from new launches. We believe the growth trajectory will improve in the long term as new launches contribute meaningfully to the top-line. 6. Improvement in MR productivity: 9/10 GSK's sales force productivity increases GSK's revenue posted CAGR of 8.7% over CY04-10 and its sales force posted CAGR of 5.9% over CY04-10, implying improvement in salesforce productivity. In 2004, GSK derived INR6.5m revenue per MR, which rose to INR7.7m in CY10. GSK's current MR productivity is arguably one of the best in the industry. August

82 GSK Pharma GSK Pharma: Salesforce productivity No. of MRs Revenue per MR (INR m) 7.7 Sales force addition CAGR (%) Productivity Improvement CAGR (%) ,775 2, GSK Indus try Source: Company/Industry/MOSL 8-9. Earnings growth and stock attractiveness: 20/30 We believe GSK is one of the best plays on the IPR regime in India with aggressive plans to launch new products in the high growth lifestyle segments. These launches are expected to bring it long-term benefits. We believe GSK is likely to sustain double-digit topline growth over the next few years. We believe this growth trajectory will improve after CY13, as new launches contribute meaningfully to the top-line. Given the high profitability of operations, we expect this growth to lead to sustainable double-digit earnings growth and RoE of ~30%. This growth is likely to be funded through miniscule capex and negative net working capital. GSK deserves premium valuations due to strong parentage (giving access to a large product pipeline), brand-building ability and likely positioning in the post patent era. GSK is one of the very few companies with the ability to drive reasonable growth without major capital requirement, leading to high RoCE of over 45%. We expect GSK to record CY11E EPS of INR77.5 (up 12.9%) and CY12E EPS of INR89.6 (up 15.5%). The stock is valued at 27.8x CY11E and 24.1x CY12E earnings. Maintain Buy with a target price of INR2,330 (26x CY11E). GSK RoE & RoCE (%) GSK one year forward P/E RoE RoCE P/ E (x ) Avg(x) Peak(x) Min(x) E 2012E Aug-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 August

83 GSK Pharma Financials and valuations: GSK Pharma Income Statement (INR Million) Y/E December E 2012E Net Sales 18,708 21,116 23,740 26,921 Change (%) Materials Consumed 6,922 7,770 8,784 9,961 Personnel Expenses 2,094 2,409 2,842 3,212 Other Expenses 3,146 3,560 4,163 4,525 Total Expenditure 12,162 13,739 15,789 17,698 EBITDA 6,546 7,378 7,951 9,223 Change (%) Margin (%) Depreciation Int. and Finance Charges Other Income - Rec. 1,206 1,477 1,969 2,234 PBT & EO Expense 7,585 8,673 9,718 11,226 Tax 2,536 2,859 3,152 3,641 Tax Rate (%) Adj PAT 5,049 5,814 6,567 7,586 EO Expense (net of tax) ,859 0 Reported PAT 5,123 5,637 4,708 7,586 Change (%) Margin (%) Balance Sheet (INR Million) Y/E December E 2012E Equity Share Capital Reserves 16,728 18,445 20,115 21,826 Capital Reserve Net Worth 17,591 19,308 20,979 22,689 Loans Capital Employed 17,646 19,360 20,979 22,689 Gross Block 2,892 3,184 3,784 4,184 Less: Accum. Deprn. 1,964 2,095 2,297 2,528 Net Fixed Assets 928 1,089 1,487 1,656 Capital WIP Investments 1,909 1,604 20,566 22,194 Curr. Assets 21,144 24,483 6,932 7,834 Inventory 2,530 2,815 3,157 3,580 Account Receivables Cash and Bank Balance 16,726 19,481 1,187 1,346 Others 1,351 1,717 1,923 2,181 Curr. Liability & Prov. 6,996 8,468 8,784 9,772 Account Payables 3,167 3,567 4,036 4,523 Provisions 3,830 4,900 4,748 5,250 Net Current Assets 14,148 16,016-1,852-1,938 Ratios Y/E December E 2012E Basic (INR) EPS Cash EPS BV/Share DPS Payout (%) Valuation P/E Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Capital (Days) Leverage Ratio Debt/Equity Cash Flow Statement (INR Million) Y/E December E 2012E Oper. Profit/(Loss) bef. Tax 6,546 7,378 7,951 9,223 Interest/Dividends Recd. 1,206 1,477 1,969 2,234 Direct Taxes Paid -2,687-2,976-3,152-3,641 (Inc)/Dec in WC 1, , CF from Operations 6,218 5,876 5,376 7,096 EO expense ,859 0 CF frm Op. incl EO exp. 6,292 5,699 3,518 7,096 (inc)/dec in FA (Pur)/Sale of Investments 5, ,204-1,729 CF from investments 5, ,931-2,129 Change in Net Worth Inc/(Dec) in Debt Interest Paid Dividend Paid -3,976-2,985-3,863-4,829 CF from Fin. Activity -3,982-2,994-3,862-4,808 Deferred Tax Assets Appl. of Funds 17,646 19,360 20,979 22,689 E: MOSL Estimates; ^Standalone results Inc/Dec of Cash 7,660 2,755-18, Add: Beginning Balance 9,065 16,726 19,481 1,187 Closing Balance 16,726 19,481 1,187 1,346 E: MOSL Estimates ^ - Standalone results August

84 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 77/100 The Sun shines bright! Sun Pharma CMP: INR464 SUNP IN TP: INR524 Neutral M: Mix 7/10 E: Equity with doctors 9/10 Sun is the best play on the high-growth life-style segments of CNS, CVS and Diabetes. It derives 61% of its revenues from lifestyle chronic segments Sun is one of the very few companies which has focussed on the life-style from its inception. Sun pharma enjoys strong brand equity in CNS, Gynaecology, CVS and Anti-diabetic segments. In CNS and Gynaecology segments, Sun Pharma ranks No.1 with prescription market share of 12% and 4.2% respectively while in CVS and Antidiabetics segment it ranks no 2 with prescription market share of 6.8% and 7.8% respectively. Further, it has either maintained or improved its prescription ranking in the therapeutic areas where it is present. D: Distribution & reach 8/10 I: Introductions 6/10 Derives 73% of the revenues from Metro and Tier I cities. The contribution of rural areas to revenues has come down over the last 5 years. Further, in last 4 year, revenue CAGR for all geographies has been in-line or better than industry average Sun Pharma's new product launch rate has been moderate compared to its peers in the industry. It has launched 31 new products annually (including line extensions) over the last 4 years. The revenue growth is driven by both existing products as well as new launches. It has field force strength of 2,600 Stock info Equity Shares (m) 1, Week Range (INR) 538/341 1,6,12 Rel. Perf. (%) 2/22/41 M.Cap. (INR b) M.Cap. (USD b) 10.4 Background Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR m) (INR m) (INR) Gr. (%) (x) (x) (%) (%) Sales EBITDA 03/11A 52,066 14, /11A* 57,214 18, /12E 65,601 17, /13E 75,976 21, * Including Para-IV/one-off upsides Sun Pharma is one of the largest Indian companies in the domestic formulation space with significant presence and leadership in fast growing chronic therapeutic areas like CVS, Diabetes, CNS etc. It offers the best play on fast growing and most lucrative lifestyle therapeutic segments in India. Over the past decade it has also expanded its presence to US and 40 other markets. Key markets include India and US. August

85 Sun Pharma CEO Profile CEO Dilip S. Shanghvi is a graduate in commerce from Kolkata University. He founded Sun Pharma in 1982 and has extensive experience in the pharmaceutical industry. Focused approach to business and sustaining superior profitability and growth on higher base are his key achievements. C: CAGR and scale-up 9/10 I: Improvement in productivity 9/10 Sun Pharma has significantly outperformed the industry with revenue CAGR of 23% over FY The company has scaled up the business rapidly albeit on a low base. The growth is achieved largely because of favorable therapeutic mix, improvement in brand equity and increase in field force productivity. Sun ranks the best in the industry in terms of MR productivity. Revenue per MR has improved significantly from INR3.2m in 2004 to INR7.8m in The current field force productivity is one of the best in the industry. We expect it to grow domestic formulations at 18.5% CAGR over FY11-13 outperforming the industry led by strong presence in fast growing chronic therapeutic areas like CVS, CNS and Antidiabetics, and improvement in brand equity. N: Non-domestic business 7/10 E: Earnings growth 9/10 Remain positive on Sun's US business given its strong chemistry skills, strong generic pipeline and monetization of some of the niche, low-competition opportunities Expect international business to record 15.2% CAGR for FY11-13 mainly led by the Taro acquisition. Core international business (excluding one-offs in US) to record 34% CAGR Expect overall topline CAGR of 15.2% for FY11-13 leading to EPS CAGR of 24% Earnings growth will be driven by the Taro acquisition, sustained momentum in the India formulations business and gradual improvement in Caraco Option values includes upsides from one-off opportunities in US. S: Stock Attractiveness 13/20 Focused and cautious approach to international expansion coupled with highly profitable domestic business has ensured good return ratios which, partly muted due to significant cash of USD1b. Stock performance (1 year) Sun Pharma Sensex - Rebased Sun is currently valued at 26.8x FY12E and 22.2x FY13E consolidated earnings We maintain Neutral with TP of INR524 (25x FY13E EPS) excluding Para-IV upsides Aug-10 Nov-10 Feb-11 May-11 Aug-11 August

86 Sun Pharma India formulations snapshot Domestic formulations - major contributor to revenue, profits The domestic formulations business contributes 42% to Sun Pharma's revenue, a contribution that is the highest among leading Indian generic companies. The segment is the most profitable for Sun Pharma and contributed almost 72% to EBITDA in FY11. EBITDA Contribution Sun Pharma Non-DF EBITDA 28% The Sun shines bright! But dazzling valuation merits caution Sun Pharma is one of the largest Indian companies in the domestic formulations space with a significant presence and leadership in fast growing chronic therapeutic areas like CVS, diabetes and CNS. Over the years, Sun Pharma out-performed industry growth and increased its market share and brand equity in its major segments. Sun Pharma is arguably the best company in the industry in terms of improvement in workforce productivity and the best play on fast growing and the lucrative lifestyle therapeutic segments. 1. Mix: 7/10 Lifestyle segments like CVS, CNS, anti-diabetes dominate sales Sun Pharma derives 61% of its revenue from lifestyle therapeutic segments, which dominate the company's revenue mix. The top four therapeutic segments including CNS, CVS, GI and anti-diabetes contribute ~70% to Sun Pharma's domestic formulations revenue. It is the market leader in two of the fastest growing therapy segments, CNS and CVS. Sun Pharma's sizable presence on the chronic therapy segments makes it the most attractive play in the domestic formulations business. The largest player in the chronic therapeutic segment Sun Pharma is one of the largest players in the industry and has grown its market share over the years due to significant presence in fast growing chronic therapeutic areas. Sun Pharma is the largest company in the chronic segments, in which it commands 3.66% market share, which grew from 3.21% in The company posted 23.2% CAGR over the past six years against 14% CAGR for the industry. Sun Pharma DF EBITDA 72% Mkt Share (%) Grow th (%) CNS, CVS, Diabetes dominates the therapy mix Respirat ory 6% Pain 10% Others 23% Gynaeco GI logy 6% 2% FY01 CVS 21% CNS 32% Ophthalm ology 5% Pain 6% Gynaec 7% Diabetes 10% Respirat ory 4% FY11 Others 8% GI 12% CNS 27% CVS 21% Source: Company/Industry/MOSL 2. Equity with doctors: 9/10 Strong brand equity among specialists, leader in the CVS, CNS, GI and anti-diabetes segments Sun Pharma has been a dominant player in three of the industry's fastest growing therapeutic segments, CNS, CVS and anti-diabetes. Sun Pharma ranks No1 in the CNS and CVS segments with a value market share of 20.7% and 7.1% respectively. It ranks fourth in the anti-diabetes segment with market share of 7.8% and sixth in the GI and gynecology segments with market share of 4.7% and 5.5% respectively. Except in the anti-diabetes segment, in all other segments the average growth rate over the past two years has been higher than the industry's August

87 Sun Pharma Market share in key therapies (%) Growth comparison (%) (2010) 20.7 Avg Gr - Company Avg Gr - Industry CVS GI Gynaecology CNS Anti Diabetic CVS GI Gynaecology CNS Anti Diabetic * Average growth over Source: Industry/MOSL Sun Pharma has strong brand equity in the CNS, gynaecology, CVS and anti-diabetes segments, in terms of the number of prescriptions written in the segments. In the CNS and gynaecology segments, Sun Pharma ranks No1 with a prescription market share of 12% and 4.2 respectively while in the CVS and anti-diabetes segments it ranks second and its prescription market share is 6.8% and 7.8% respectively. Over the past few years Sun Pharma has either maintained or improved its prescription ranking in the therapeutic areas in which it is present. Sun Pharma's prescription ranking Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 CNS Gynaec CVS Anti-diabetic GI Respiratory Source: Industry/MOSL Top 10 brands contribute 20% of the revenues Sun Pharma's top 10 brands contribute ~20% to total revenue, which shows low brand concentration compared with other leading companies. Seven of its brands feature among the top 300 brands of the industry. Sun Pharma's No1 brand, Pantocid, (Pantoprazole, GI) ranks 87th in the industry and has posted revenue CAGR of 19% over the past four years. This is the only company among the companies covered in this report to post double-digit revenue CAGR in all its top 10 brands. Top 10 brands of the company Brand Drug Product Product Sales YoY Gr. CAGR Category Launch (INR m) (%) (%) Pantocid Pantoprazole Solids Gastro-intestinal Glucored Glibenclamide + Metformin Anti-diabetics Susten Progesterone Gynaecology Aztor Atorvastatin CVS Pantocid-D Pantopr.+ Domperidone Gastro-intestinal Gemer Glimepiride+Metformin Anti-diabetics Strocit Citocholine Repace Losartan CVS Encorate Chrono Sodium Valproate CNS Clopilet Clopidogrel CVS Source: Industry/MOSL August

88 Sun Pharma 3. Distribution and reach: 8/10 Sun Pharma derives 73% of its revenue from metros and class-i towns, compared with 63% of the industry average, suggesting a focus on these geographies. In the past four years, revenue CAGR for all geographies has been in line/better than the than that of the industry average. The contribution of rural areas to revenue has fallen over the past five years. Geographical distribution of revenues - Sun Pharma (%) Geographical distribution of revenues - Industry (%) Metros Class I Tow ns Class II TO VI Rural CY06 CY07 CY08 CY09 CY10 Geography-wise growth rates - Sun Pharma (%) Geography-wise growth rates - Industry (%) Metros Class I Tow ns Class II To VI Rural CY07 CY08 CY09 CY10 Source: Industry/MOSL 4. Introductions: 6/10 Sun Pharma's new product launches have been moderate compared with its peers in the industry. There has been significant improvement in revenue per new product launched Sun Pharma's new launch rate has been moderate compared with its peers in the industry. It launched 31 new products each year (including line extensions) over the past four years. The average revenue per new launch has risen substantially in the past four years from INR112m in 2006 to INR163m in 2010, suggesting better penetration of launched brands. Revenue growth was driven by existing products and new launches. August

89 Sun Pharma Sun Pharma's - new launches Sun Pharma's growth compositions (%) (2010) No. Of launches in last 2 yrs Avg sales per launch (INR m) New Launches Ex is ting Brands CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 * Average growth over Source: Industry/MOSL 5. CAGR and scale up: 9/10 We expect 18.5% CAGR from Sun Pharma's domestic formulations business led by a strong presence in the fastest growing chronic therapeutic segments. We believe that the company will continue to outperform the industry and its peers over the foreseeable future despite a sizable revenue base. We believe that, Sun is likely to strengthen its presence in key therapeutic areas, improving its ranking in the industry. Sun Pharma: Domestic formulations revenue ramp-up Revenue (INR m) Grow th (%) , , , ,597 18, ,801 26, , FY05 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL 6. Improvement in MR productivity: 9/10 Unlike other leading companies covered in this report, Sun Pharma's topline growth was driven by a significant improvement in MR productivity. The company leads the pack in productivity improvement Sun Pharma has done a stellar job over the past six years with a significant improvement in workforce productivity. Over FY04-10, Sun Pharma's domestic formulations revenues posted 23.3% CAGR and its sales force expanded by just 6.3% CAGR, implying significant productivity improvement of the workforce. In 2004, Sun Pharma derived revenue of INR3.2m per MR, which rose to INR7.8m in The productivity was among the best in the industry. August

90 Sun Pharma Sun Pharma: Sales force productivity No. of MRs Revenue per MR (INR m) 7.8 Sales force addition CAGR (%) Productivity Improvement CAGR (%) ,799 2, Sun Pharma 1.9 Industry Source: Company/Industry/MOSL 7. Non-domestic business: 7/10 Positives Strong presence in the US through its own supplies, Taro and Caraco. Strong chemistry skills and backward integrated low-cost operations. Pragmatic mix of low-competition, Para-IV and normal products for the US market. Targets niche opportunities in the US market. One of the most profitable domestic business with strong presence in high growth segments Risks & concerns Slow progress in resolving cgmp issues at Caraco Potential damages for "at-risk" launch of generic Protonix in the US. Integration of Taro and sustaining the improvement in its profitability will be a key challenge. Gradual ramp-up in emerging market portfolio. Astute tax planning results in very low taxes - tax can increase significantly if tax laws are changed. Key news flows/triggers Update on generic Eloxatin. Launch of generic Prandin in US under exclusivity. US Federal Circuit Court ruling on Protonix patent litigation. Ramp-up in generic Effexor XR sales. Steps to sustain profitability of Taro and to improve its R&D productivity. Impact assessment Positive on Sun Pharma's US business given its strong chemistry skills, generic pipeline and monetization of some niche, low-competition opportunities. Expect the international business to post 15.2% CAGR over FY11-13 led mainly by the Taro acquisition. Core international business (excluding one-offs in the US) will post 34% CAGR over FY Option values include upsides from future inorganic initiatives - the company has cash of ~USD1b. August

91 Sun Pharma Sales mix (INR m) FY09 FY10 FY11 FY12E FY13E FY11-13 CAGR (%) Domestic Sales Formulations 19,597 18,301 23,801 26,383 31, API 1,042 1,021 1,130 1,186 1, Others Total Domestic Sales 20,650 19,334 24,948 27,586 32, % of total sales International sales Formulations 19,256 16,892 28,982 34,607 39, Taro 0 0 9,962 17,357 19,008 Caraco-Generics15,409 11,076 13,042 4,882 6, Branded 3,847 5,816 5,978 12,368 14, API 3,804 4,470 4,083 4,409 4, Others Total International sales 23,101 21,428 33,119 39,076 44, % of total sales Gross Sales 43,751 40,761 58,066 66,662 77, Less: Indirect Taxes 1,917 1, ,061 1,245 Net Sales 41,833 39,033 57,214 65,601 75, Source: Company/MOSL EBITDA Contribution Sun Pharma Non-DF EBITDA 28% DF EBITDA 72% 8-9. Earnings growth and stock attractiveness: 21/30 We expect overall top-line CAGR of 15% over FY11-13, leading to EPS CAGR of 24%. Earnings growth will be driven by the Taro acquisition, sustained momentum in the India formulations business and gradual improvement in Caraco. Sun Pharma has been one of the most consistent performers among Indian pharmaceutical companies over the past decade. Its profitability is one of the highest among its peers. It has been able to achieve this despite being a late entrant in the domestic formulations and the US generic markets, compared with peers like Ranbaxy, Dr Reddy's Labs and Cipla. Key USPs of the company include: 1. Ability to scale up its operations in India and the US without sacrificing profitability, i.e., ability to strike an optimum balance between growth and profitability. 2. Has established a very strong and profitable domestic formulations business which, given its predictable nature, offers a strong foundation to scale-up its international initiatives. 3. A focused approach by the management - Unlike some of its peers it has not spread itself very thin by expanding across the globe. Its key markets continue to be India and the US with expanding presence in some of the emerging markets. It has been able to avoid the temptation to expand in regulated European markets wherein most of its peers have got adversely impacted over the past few years due to regulatory changes. August

92 Sun Pharma An expanding generic portfolio coupled with sustained double-digit growth in high-margin life-style segments in India is likely to bring in long-term benefits for Sun Pharma. Its ability to sustain superior margins even on a high base is a clear positive. Key drivers for future include: 1. Ramp-up in US business and resolution of Caraco's cgmp issues 2. Monetization of the Para-IV pipeline in the US 3. Taro integration with potential for improvement in its profitability 4. Launch of controlled substances in the US. While we are positive about SUNP's business outlook, rich valuations have tempered our bullishness. We maintain Neutral with a target price of INR524 (25x FY13E EPS). Inorganic initiatives (Sun has cash of ~USD1b) are a key risk to our rating. However, we believe that given the recent acquisition of Taro, Sun is unlikely to make a large acquisition. Sun Pharma RoE & RoCE (%) Sun Pharma one year forward PE 34 P/E (x) Avg(x) Peak(x) Min(x) Aug-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Sun Pharma non-domestic business: key trends, triggers & risk Building a strong and focused US business Sun has been able to establish itself as a key Indian player in the US generics market through a combination of: 1. Strong chemistry skills which has enabled it to develop a strong generic pipeline for the US market. 2. Good product selection in building presence in the US market - Rather than targeting all the large products, Sun has focused on building a pragmatic mix of niche, low-competition products along with other normal products. 3. Identifying key opportunities - This capability is clearly visible in the Taro acquisition wherein, despite a 3-year delay, Sun has been able to acquire the company and consequently a profitable portfolio of dermatology and paediatric products. Over the past few years, Sun has been able to build a very strong pipeline of generic products for the US market. It currently has 149 ANDAs pending US FDA approval - one of the strongest pipelines amongst Indian companies. August

93 Sun Pharma Key Indian companies - ANDA pipeline Filed Approved Pending Approval Aurobindo Dr. Reddy's Ranbaxy Sun Glenmark Lupin Source: Company/MOSL Taro acquisition - fills a key gap and complements Sun's US presence About 90% of Taro's sales come from the US markets. It has expertise in the dermatology and paediatric segments and has about 170 scientists involved in product development. One of the key attractions is Taro's capabilities of developing and manufacturing of ointments, creams, lotions in the semi-solids category. The acquisition fills-in a key gap in Sun's US portfolio and complements its existing presence in this important market. Taro enjoys relatively high profitability compared to peers Given its strengths in the low-competition therapeutic segment, Taro has traditionally enjoyed relatively higher profitability in the US generics market. We believe that this is sustainable and in fact, under the control of a capable management like Sun, the profitability is likely to improve in the future, albeit gradually. TARO - Key financials (USD M) CY08 CY09 CY10 2QCY10 2QCY11 1HCY10 1HCY11 Sales Growth (%) EBITDA EBITDA Margins (%) PBT Tax 12 (70) PAT Growth (%) (56.8) Source: Company/MOSL Taro - Good acquisition at reasonable valuations Unlike some of its other Indian peers, Sun has been extremely cautious in paying for inorganic growth. The Taro acquisition is a case in point. It has paid ~USD280m for a 66% economic interest in Taro valuing the company at 1x EV/Sales and 4.6x EV/EBITDA which, we believe is a reasonable valuation compared to some of the other acquisitions made by a few Indian players. August

94 Sun Pharma Caraco - US FDA resolution is likely to be long-drawn While there is no fresh update on the US FDA resolution at Caraco, the company has, in the past, indicated that the process will be very gradual. We estimate part-recovery in Caraco's core US revenue from FY13, based on the assumption that the US FDA issues will get resolved in FY12. The ongoing US FDA issues have adversely impacted Caraco's core revenue (excluding distributed products revenue) for the past two years. Caraco - revenue trend (USD m) Caraco Revenue - Total Caraco Revenue - Mfgd Products FY07 FY08 FY09 FY10 FY11E FY12E FY13E Note: Caraco's FY11 financials not given separately; hence, our estimates Source: Company / MOSL Guidance - topline growth of 28-30% for FY12 Sun Pharma management has guided 28-30% topline growth for FY12. The strong growth will be partly driven by full-year consolidation of Taro financials as compared to a little over two quarters for FY11. Sun had recorded significant one-off upsides, which we estimate at INR8.4b for FY11 (the company has not disclosed these numbers separately) and at INR5b for FY12. The guidance includes one-offs for both these years. Based on these upsides for one-offs, the implied growth guidance for core revenue (ex-taro) is 18-19% for FY12. The company intends to file ~25 ANDAs for FY12, R&D expenses are estimated at 6% of sales, and capex is estimated at INR4.5b. One-offs to continue in FY12 as well albeit with lower magnitude We believe SUNP will try to capitalize on some of the Para-IV/low-competition opportunities in the US in FY12. This will be in line with its past trend of exploiting a few such opportunities every year. However, we also believe that one-off upsides are likely to decline YoY in FY12 due to the absence of large opportunities like generic Eloxatin which was a key contributor in FY11. FTF/low-competition Upsides in US (INR m) FY11 FY12E Eloxatin 4,530 - Exelon 1,076 1,404 Keppra Inj Effexor-XR 1,342 - Protonix Taxotere - 1,181 Prandin - 1,553 Total one-off revenues 8,412 5,056 Total one-off PAT 4,119 2,378 Source: Company / MOSL August

95 Sun Pharma Financials and valuations: Sun Pharma Consolidated Income Statement (INR Million) Y/E March E 2013E Net Sales 41,028 57,214 65,601 75,976 Change (%) Total Expenditure 27,394 37,543 44,811 51,008 % of Sales EBITDA 13,633 19,672 20,791 24,968 Margin (%) Depreciation 1,533 2,041 2,716 3,031 EBIT 12,100 17,631 18,075 21,938 Int. and Finance Charges Other Income - Rec. 2,111 2,876 3,351 4,333 PBT 14,149 20,358 21,370 26,211 Tax 679 1,284 1,069 1,835 Tax Rate (%) Profit After Tax 13,471 19,074 20,302 24,376 Change (%) Margin (%) Less: Mionrity Interest Net Profit 13,511 18,161 20,330 21,626 Adj. PAT 9,501 14,041 17,952 21,626 Ratios Y/E March E 2013E Basic (INR) EPS Fully Diluted EPS Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Consolidated Balance Sheet (INR Million) Y/E March E 2013E Equity Share Capital 1,036 1,036 1,036 1,036 Total Reserves 77,254 93, , ,661 Net Worth 78,289 94, , ,696 Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Capital T/O (Days) Minority Interest 1,932 8,472 10,822 13,571 Deferred Liabilities Secured Loan 1, Unsecured Laon 708 4,256 1,500 1,500 Total Loans 1,711 4,256 1,500 1,500 Capital Employed 81, , , ,115 Gross Block 23,340 36,545 41,045 45,545 Less: Accum. Deprn. 8,013 10,053 12,769 15,799 Net Fixed Assets 15,328 26,492 28,276 29,746 Capital WIP 1,448 1,448 1,448 1,448 Goodwill 4,060 7,720 7,720 7,720 Investments 30,664 22,310 22,310 22,310 Curr. Assets 37,121 60,172 71,981 93,114 Inventory 10,739 14,794 16,728 18,734 Account Receivables 11,748 11,716 13,480 15,612 Cash and Bank Balance 6,072 21,936 28,293 43,157 L & A and Others 8,562 11,726 13,480 15,612 Curr. Liability & Prov. 7,579 14,234 14,589 18,221 Account Payables 4,095 9,203 9,212 10,980 Provisions 3,484 5,030 5,377 7,241 Net Current Assets 29,542 45,939 57,392 74,892 Appl. of Funds 81, , , ,116 E: MOSL Estimates Leverage Ratio Debt/Equity (x) Cash Flow Statement (INR Million) Y/E March E 2013E Oper. Profit/(Loss) bef. Tax 13,633 19,672 20,791 24,968 Interest/Dividends Recd. 2,111 2,876 3,351 4,333 Direct Taxes Paid ,046-1,069-1,835 (Inc)/Dec in WC -4, ,097-2,637 CF from Operations 10,179 17,968 17,977 24,830 (inc)/dec in FA -2,920-16,864-4,500-4,500 (Pur)/Sale of Investments -12,069 8, CF from investments -14,989-8,510-4,500-4,500 Change in networth -2,348 8, (Inc)/Dec in Debt -78 2,545-2,756 0 Interest Paid Dividend Paid -3,321-4,241-4,308-5,407 CF from Fin. Activity -5,809 6,406-7,121-5,467 Inc/Dec of Cash -10,618 15,864 6,357 14,864 Add: Beginning Balance 16,690 6,072 21,936 28,293 Closing Balance 6,072 21,936 28,293 43,157 Note: Cashflows do not tally due to acquisition August

96 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 60/100 Guts and glory! Cadila Healthcare CMP: INR824 CDH IN TP: INR907 Neutral M: Mix 6/10 Cadila's relatively small presence in the fast growing segments of Diabetes, CNS & CVS (contributes ~24% to sales) will make it difficult for the company to outpace the market growth. The CVS and GI segments' contribution to revenue has risen over the past 10 years from 24% to 37% while that of respiratory and anti-infectives has fallen from 32% to 21%. E: Equity with doctors 7/10 Enjoys good brand equity in a couple of therapeutic segments. Cadila is among the top three players in two of the largest therapeutic segments, CVS and GI. The company ranks first in the fast growing gynecology segment. Cadila has a good prescription market share in the GI, respiratory and CVS segments. D: Distribution & reach 7/10 Cadila derives 65% of its revenue from metro and tier-i cities and is expanding its presence in tier-ii to tier-vi towns. The company's growth rate in all geographies has accelerated from CY09. I: Introductions 5/10 Cadila has few new introductions compared with its peers and this is one reason why it has not been able to outperform the market in the past. Revenue growth has been driven largely by its existing products over the past four years. It employs one of the larger field forces in the industry with MR strength of 4,000. Stock info Equity Shares (m) Week Range (INR) 984/599 1,6,12 Rel. Perf. (%) 5/18/44 M.Cap. (INR b) M.Cap. (USD b) 3.7 Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR M) (INR M) (INR) GR. (%) (X) (X) (%) (%) sales EBITDA 03/10A 36,868 5, /11A 46,302 6, /12E 51,717 5, /13E 59,983 8, Background Cadila is amongst one of the largest domestic pharma companies in India with a strong focus on the global generics opportunity. The company is gradually building its presence in the regulated generic markets beginning with the US and France. It also plans to tap some unique opportunities through its JVs with Nycomed, Hospira. Bayer and Bharat Serums. August

97 Cadila Chairman Profile Chairman Cadila is one of the most consistent performers amongst the Indian pharmaceutical companies. It is promoted by Mr. Pankaj Patel. Sustaining strong growth and return ratios coupled with a very conservative, low-risk management style is his key achievement. C: CAGR and scale-up 6/10 Cadila's domestic formulations business posted revenue CAGR of 12.4% over FY05-11, which is slightly below market growth during the same period. We expect Cadila to post revenue CAGR of 13-14% over FY11-13, which is slightly below compared to 15-16% CAGR for the industry. Rapid scale-up in revenue would be difficult given Cadila's high base and small presence in fastgrowing chronic segments. I: Improvement in productivity 5/10 Cadila's is MR productivity has declined at 2% CAGR over MR growth was 11.3% and revenue growth was 9.2%, indicating a fall in sales force productivity. Revenue per MR declined from INR4.1m in 2004 to INR3.6m in 2010, which however, is in line with the industry average. N: Non-domestic business 6/10 We are positive on Cadila's international business, given its strong chemistry skills and pragmatic mix of its geographic presence and partnerships. A cautious approach to establishing international presence has ensured sustained higher return ratios for investors. Cadila has a good track record of forging partnerships with global players. E: Earnings growth 6/10 Cadila is one of the most consistently performing Indian pharmaceutical companies. We expect overall top-line CAGR of 14% over FY11-13 leading to EPS CAGR of 15%. Earnings growth will be led by traction in the international business and steady growth in the domestic portfolio. We expect Cadila's international business to post revenue CAGR of 16% over FY11-13, led by 18% CAGR for formulation exports. S: Stock Attractiveness 12/20 We expect RoE of 25-30% over the next two years, driven by a cautious approach towards international expansion and a profitable domestic business. Cadila is valued at 29.1x FY12E and 20.0x FY13E consolidated earnings. Reiterate Neutral with a target price of INR907(22x FY13E EPS plus INR3 upside from Taxotere). Stock performance (1 year) Cadila Health Sensex - Rebased 1, Aug-10 Nov-10 Feb-11 May -11 Aug-11 August

98 Cadila India formulations snapshot Domestic formulations contribute most to revenue The domestic formulations business is a major contributor to Cadila's revenue and EBITDA. In FY11 the segment contributed 40% to Cadila's revenue and we estimate EBITDA contribution was ~45%, since it is one of Cadila's most profitable businesses. We believe despite strong contribution to profitability, capital employed in the business is proportionately lower. EBITDA Contribution Non-DF EBITDA 55% DF EBITDA 45% Guts and glory! Strong in GI, CVS; maintains market share amidst rising competition Cadila is among the leading companies in the domestic formulations business and has maintained its market share over the years despite growing competition. Some of Cadila's brands lead in their segments and the company has strong brand equity in therapeutic segments like CVS and GI. Besides, Cadila is the largest player in the gynecology segment. The company has been expanding its presence in all geographies, which is visible from its growth in 2009 and We believe Cadila is likely to post a top-line of 13-14% CAGR over FY11-13, which is slightly below compared to the industry growth. 1. Mix: 6/10 CVS, GI, gynecology dominate sales The top 3 therapeutic segments, CVS, GI and gynecology, contribute about half of Cadila's domestic formulations revenue. Other large segments, such as respiratory and anti-infective, contribute 11% and 10% respectively to total revenue. Over the past 10 years, the contribution of CVS and GI segments to revenue rose from 24% to 37% while that of respiratory and anti-infective segments fell from over 32% in FY01 to less than 21% in FY10. CVS, GI and Gynaecology dominates the therapy mix Among the leading players in the industry Cadila leads in the highly CNS 2% VMN 9% Others 13% FY01 CVS 13% GI 11% CNS 2% Others 20% FY05 CVS 22% competitive domestic formulations market and is among the top five companies in the industry with market share of 3.7%. Cadila's market share rose to 3.74% in 2010 from 3.46% in Cadila's Pain Mgmt 9% AI 16% Respira tory 15% Gynae cology 12% Pa in Mgmt 9% AI 11% Respira tory 10% Gynae cology 10% GI 16% domestic formulations business grew at 12.4% CVS, GI and Gynaecology dominates the therapy mix CAGR over the last 6 years versus 14% CAGR for industry. Cadila has maintained it market share over the years despite growing competition Mkt Share (%) Gr. (%) Anti-Malaria 0% VMN 2% Dermatology 3% Pain Mgmt AI 7% 10% CNS Others 3% 16% Res pira tory 11% FY11 CVS 21% Gy naec ology 10% GI 17% Source: Industry/MOSL August

99 Cadila 2. Equity with doctors: 7/10 Good brand equity; among leaders in CVS, GI, gynecology segments Cadila has been a dominant player in two of the largest therapeutic segments of the industry, CVS and GI. Cadila ranks first in the gynecology segment with value market share of 10.4%. It ranks second in the GI segment with value market share of 6.5% and it ranks third in the fast growing and second largest, CVS segment with value market share of 6.5%. Cadila has either grown in line with or above the industry average in its top 4-5 therapeutic segments. In the pain management and dermatology segments, Cadila's has outperformed the respective segment growth. Value market share in key therapies (%) (2010) Value growth comparison (%) (2010) 10.4 Avg Gr - Company Av g Gr - Industry CVS GI Respiratory Pain/Analgesic Gynaecology Dermatology CVS GI Respiratory Pain/Analgesic Gynaecology Dermatology * Average growth over Source: Industry/MOSL In terms of the number of prescriptions written, Cadila ranks second in the GI segment with a prescription market share of 4.5%. It ranks third in the respiratory segment with market share of 4.9% and seventh in the CVS segment with a prescription market share of 4.5%. Cadila has improved its ranking in the gynecology and respiratory segments and its ranking in CVS deteriorated a bit. Cadila's prescription ranking Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 GI Gynaec Respiratory CVS Pain Mgmt Source: Industry/MOSL Top 10 brands contribute 30% of revenue Cadila's top 10 brands contribute ~30% to total revenue, indicating lower brand concentration. Its No1 brand, Aten (Atnolol, CVS), ranks thirty-seventh in the industry and it reported 12.5% CAGR over the past four years. Six of the top 10 brands posted CAGR in double digits over the past four years. August

100 Cadila Cadila's top 10 brands Brand Drug Product Launch Sales (INR m) YoY Gr (%) CAGR (%) Aten Atenolol Atorva Atorvastatin Ocid Omeprazole Falcigo Artesunate Deriphyllin Etophylline+Theophylline Primolut-n Norethisterone Amlodac Amlodipine Dulcolax Bisacodyl Mifegest Mifepriston Pantodac Pantoprazole CAGR through Source: Industry/MOSL 3. Distribution and reach: 7/10 Cadila derives 65% of its revenue from metros and class-i towns compared with 63% of the industry average. In the past four years, revenue CAGR for all geographies except metros were in line or marginally better than that of the industry average. Cadila: Geographical distribution of revenues (%) Industry: Geographical distribution of revenues (%) METROS CLASS I TOWNS CLASS II TO VI RURA L METROS CLASS I TOWNS CLASS II TO VI RURAL CY 06 CY07 CY08 CY09 CY10 CY06 CY07 CY08 CY09 CY10 Cadila: geography-wise growth rates (%) Industry: geography-wise growth rates (%) Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Source: Industry/MOSL August

101 Cadila 4. Introductions: 5/10 Cadila's growth over the past four years has been led by existing products and new launches Over the past four years Cadila launched 49 new products (including line extensions) annually which is in line with its peers. Average revenue per new launches has grown from INR42m in CY07 to INR94m in CY10. Cadila's revenue growth is driven by existing products and new launches. Cadila - new launches Cadila growth compositions (%) No. Of launches in last 2 yrs Avg sales per launch (INR m) 94.4 New Launches Existing Brands CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 Source: Industry/MOSL 5. CAGR and scale up: 6/10 We expect 13-14% CAGR for Cadila's domestic formulations business led by existing products, increasing geographical penetration and incremental contribution from new launches. This is below our estimated forecast of 15-16% CAGR for the industry. Outperformance of the industry seems difficult due to a lower prescription share in highgrowth lifestyle segments and the anti-infective segment. It's absence in fast growing lifestyle segments except CVS, will make it difficult for it to outpace industry growth. Its focus on improving workforce productivity needs to be enhanced for it to grow its business more profitably. Cadila - domestic formulations performance DF Revenues (INR m) YoY Growth (%) ,793 10,603 11,763 12,889 14,458 17,146 19,347 22,197 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL August

102 Cadila 6. Improvement in MR productivity: 5/10 Cadila's top-line growth is driven by sales force additions; fares poorly when compared with the industry productivity Cadila's domestic formulations business revenue posted 9.2% CAGR over FY04-10 and its sales force posted 11.3% CAGR, implying negative productivity of the workforce. In 2004, Cadila derived sales of INR4.1m per MR, which fell to INR3.6m in FY10. Cadila's performance was below average, compared with the average of performances covered in the report. Cadila - Sales force productivity ( ) No. of MRs Revenue per MR (INR m) 4.1 Sales force addition CAGR (%) Productivity Improvement CAGR (%) 4, , Cadila Indus try Source: Industry/Company/MOSL 7. Non-domestic business Snapshot: 6/10 Non-domestic business: Snapshot Positives Expanding presence in emerging and regulated markets through a mix of its own presence and front-end acquisitions. Strong chemistry skills and fully backward integrated low-cost operations help in making the US business viable despite being a late entrant. Low-risk strategy to access international markets through its own presence and partnerships. Supplies of injectables to Hospira to ramp-up in the next 1-2 years while the Abbott tie-up for emerging markets is likely to contribute from FY13 onwards. Risks and concerns Needs to build a differentiated portfolio in the US to access low-competition opportunities. The company has initiated steps in this directions. NCE research yet to deliver desired returns for investors. Slow progress in accessing the Japanese generic opportunity. News flow/triggers Ramp-up in supplies to Hospira and Abbott. Signing of supply agreements with MNCs. August

103 Cadila Impact assessment We are positive on Cadila's international business given its strong chemistry skills and pragmatic mix of own presence and partnerships. Cautious approach to establishing an international presence has ensured sustained higher return ratios for investors. Has a good track record of forging partnerships with global players. Expect 16% CAGR for the international business over FY11-13 led by 18.3% CAGR for formulation exports. Sales mix (INR M) FY09 FY10 FY11 FY12E FY13E FY11-13 CAGR (%) Domestic Sales Formulations 12,889 14,458 17,146 19,347 22, APIs Consumer & Others 3,120 3,948 4,827 5,458 6, Gross Domestic sales16,435 18,724 22,325 25,121 28, % to sales Export Formulations 9,676 14,018 19,214 22,170 26, Export APIs 3,060 3,400 3,672 3,472 3, Total Exports 12,736 17,418 22,886 25,642 30, % to sales Gross Sales 29,172 36,142 45,211 50,763 59, Note:Estimates exclude Nesher acquisition pending availability of more details from Cadila management. EBITDA Contribution Non-DF EBITDA 55% DF EBITDA 45% Source: Company/MOSL 8-9. Earnings growth and stock attractiveness: 18/30 Cadila's growth will be led by increased traction in its international businesses, ramp-up in supplies to Hospira and sustained double-digit growth in domestic formulations and consumer businesses. We estimate 15% revenue and EPS CAGR for FY11-13 for core operations excluding one-offs and RoE of 27-28% over the next two years. Sustaining double-digit growth without diluting return ratios has been the company's USP and has led to a significant re-rating of the stock. We believe that this track record would be subjected to many challenges, as Cadila tries to aggressively scale-up to achieve its revenue target of USD3b by FY16. This target implies a topline CAGR of 25% for FY11-16, which we believe is very aggressive. The company will have to invest significant resources to achieve this target, which can raise its risk profile. Given the disappointing core performance for the last two quarters and likely impact of the Nesher acquisition, the strong earnings upgrade cycle of the past two years could break. Cadila trades at 29.1x FY12E and 20.0x FY13E consolidated EPS. We believe that valuations are rich and leave little scope for further re-rating. We maintain Neutral. Our target price is INR907 (22x FY13E EPS + INR3/share DCF value of earnings from Taxotere). August

104 Cadila Cadila RoE & RoCE (%) Cadila one year forward P/E 35.4 RoE 37.5 RoCE P/E (x) Avg(x) Peak(x ) Min(x ) E 2013E Aug-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Annexure: Cadila non-domestic business New launches to drive growth in the US Cadila has a pipeline of 65 ANDAs pending approval and has received 65 ANDA approvals so far (including tentative approvals). The company filed 24 ANDAs in FY11 and launched 11 products in the US. It expects to file ANDAs with the US FDA every year and get about 8-10 approvals a year. Cadila's US business is witnessing increased traction due to the absence of some of the competitors (due to US FDA issues) and new product launches. The company is also improving its market share in already launched products. We expect Cadila to post sales of INR11.9b in FY12 against INR9.7b in FY11. We expect this business to grow by 20% CAGR over FY Cadila has also commenced development and filing of potential low-competition products with delivery advantages (trans-dermal patches and respiratory products) and is focusing on developing a pipeline of such niche products (likely to be commercialized after FY12). Nesher acquisition - long-term positive, but may pressurize P&L in short term Cadila recently entered into an agreement to acquire certain assets and liabilities of Nesher Pharma in the US (a subsidiary of KV Pharma) for ~USD60m. It has acquired Nesher's existing and future product pipeline, its manufacturing facility and R&D lab. Cadila will also take over certain liabilities. The transaction is likely to close by August/September 2011 and Cadila will be consolidating Nesher's financials with effect from August/ September. With this acquisition, Cadila gets access to Nesher's controlled substances pipeline (besides other products) as well as access to its manufacturing facility for these controlled substances. Nesher's ANDA pipeline includes 8 filings and another 5 products under development, which address a potential on-patent market of USD2.1b. We note that given the possibility of controlled substances being abused as drugs, the US government has put stringent rules in place for monitoring the manufacturing and sale of such products. This includes a prerequirement of a local manufacturing facility with DEA license to manufacture and supply such products in the US. Through the Nesher acquisition, Cadila gets access to a DEAlicensed facility. August

105 Cadila Given the entry barriers, we believe that the controlled substances market will be a lowcompetition market for generics players. Currently, Nesher is making net losses, which may pressurize Cadila's P&L till it is able to turn around Nesher's operations. Cadila management has guided that Nesher is likely to contribute ~USD15m in revenue for FY12. It expects Nesher to report a minor net loss for FY12 and a positive bottomline for FY13. We are awaiting further clarity from Cadila on the plans for achieving this turnaround. We also note that Cadila management has a track record of being conservative in its inorganic initiatives and has not made any acquisitions in the past which have diluted the return ratios for investors. Hospira supplies to ramp up in FY12 led by Taxotere, new launches Cadila's supplies to Hospira commenced in FY10, recording INR839m in revenues for supplies to Europe. It posted FY11 revenue of INR2.15b led by the launch of exclusivity product generic Taxotere in the US. We expect a ramp-up in this business in FY11 led by commercialization of more products and revenue from limited competition product Taxotere for some more time. We expect FY12 revenue of INR803m to Cadila from Taxotere. However we have not included it in our FY12 estimates. We are valuing the upside based on the DCF method (INR3/share) since this is a limited period opportunity. French operations to record 14% CAGR While Cadila's French operations are completely aligned to a low-cost generic market, we expect only 14% CAGR for this business over FY11-13 driven mainly by the slow market growth. Emerging market revenue to grow by double-digits Among emerging markets, Cadila is present mainly in Latin America. We expect Cadila's emerging market revenue to record 17% CAGR over FY11-13 driven by new launches and favorable demographics. Abbott tie-up: Supplies to start from FY13 In FY10, Cadila entered into a supply agreement with Abbott to supply 24 branded generic products to meet Abbott's requirements in 15 emerging markets (names not disclosed). The agreement also includes an option for 40 additional products to be included over the term of the collaboration. Cadila will make the products at its facilities in India. The products selected fall in categories of pain, cancer, CVS, neurology and respiratory illnesses. Product names have not been disclosed. The supplies will enable Cadila to capture a part of the upsides in some emerging markets where it does not have a presence. We believe this is a long-term positive for Cadila, given the possibility that such arrangements tend to include a larger product basket over time. We expect the supplies to start from FY13. August

106 Cadila Financials and valuations : Cadila Income Statement (INR Million) Y/E March E 2013E Net Sales 36,868 46,302 51,717 59,983 Change (%) Total Expenditure 28,863 36,040 41,427 47,500 EBITDA 8,006 10,262 10,291 12,483 Margin (%) Depreciation 1,339 1,269 1,569 1,779 EBIT 6,667 8,993 8,721 10,704 Int. and Finance Charges Other Income - Rec PBT before EO Expense 6,004 8,425 8,197 10,326 Extra Ordinary Exp./(Inc.) PBT after EO Expense 5,958 8,425 8,197 10,326 Current Tax 741 1,064 1,230 1,549 Tax 741 1,064 1,230 1,549 Tax Rate (%) Reported PAT 5,217 7,361 6,968 8,777 Less: Mionrity Interest Net Profit 4,970 7,110 6,667 8,419 PAT Adj for EO Items 5,011 6,334 5,801 8,419 Balance Sheet (INR Million) Y/E March E 2013E Equity Share Capital 682 1,024 1,024 1,024 Total Reserves 15,501 20,691 26,154 32,841 Net Worth 16,183 21,715 27,178 33,865 Minority Interest Deferred liabilities Total Loans 10,905 10,973 10,442 9,286 Capital Employed 28,621 34,484 38,748 44,290 Gross Block 25,578 28,320 33,320 36,320 Less: Accum. Deprn. 8,734 9,994 11,563 13,342 Net Fixed Assets 16,844 18,326 21,757 22,978 Capital WIP 2,482 4,310 4,310 4,310 Investments Curr. Assets 17,749 22,829 26,084 33,719 Inventory 7,504 8,119 10,025 12,924 Account Receivables 4,668 7,652 9,524 12,337 Cash and Bank Balance 2,507 2,952 1,773 2,877 Loans & Advances 3,070 4,106 4,762 5,581 Curr. Liability & Prov. 8,661 11,188 13,611 16,937 Account Payables 6,710 8,955 10,777 13,218 Provisions 1,951 2,233 2,834 3,719 Net Current Assets 9,088 11,641 12,473 16,782 Appl. of Funds 28,621 34,484 38,746 44,290 E: MOSL Estimates Ratios Y/E March E 2013E Basic (INR) EPS Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Cap. Turnover (Days) Leverage Ratio (x) Current Ratio Debt/Equity * Ratios adjusted for bonus issue Cash Flow Statement (INR Million) Y/E March E 2013E Oper. Profit/(Loss) bef. Tax 8,006 10,262 10,291 12,483 Interest/Dividends Recd Direct Taxes Paid ,064-1,230-1,549 (Inc)/Dec in WC ,108-2,011-3,206 CF from Operations 7,022 7,222 7,257 8,000 CF from Oper. incl EO Exp. 6,976 7,222 7,257 8,000 (inc)/dec in FA -3,478-4,579-5,000-3,000 (Pur)/Sale of Investments CF from Investments -3,436-4,579-5,000-3,000 Change in Networth Inc/(Dec) in Debt -1, ,200-1,156 Interest Paid Dividend Paid -1,237-1,529-1,505-2,090 Others CF from Fin. Activity -3,550-2,198-3,436-3,896 Inc/Dec of Cash ,179 1,105 Add: Beginning Balance 2,517 2,507 2,952 1,773 Closing Balance 2,507 2,952 1,773 2,878 August

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108 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 49/100 Sayonara, unless... Ranbaxy CMP: INR468 RBXY IN TP: INR412 Sell M: Mix 6/10 Ranbaxy operates mainly in acute therapeutic segments, deriving 76% of its revenue from the segment. It is yet to strengthen its presence in the chronic segment. Ranbaxy is a dominant player in large therapy segments like AI, CVS and pain management. The segments, along with the sex stimulant segment, contribute ~68% to Ranbaxy's domestic formulations revenue. E: Equity with doctors 5/10 Ranbaxy enjoys low brand equity with doctors except in the AI and dermatology segments. Some of its brands like Storvas have good brand equity in the CVS segment. Ranbaxy is ranked at No3 position in the AI segment with a prescription market share of 7.8% and it ranks No4 in the dermatology segment with a prescription market share of 5.4%. Over the past five years, Ranbaxy's brand equity has taken a beating in almost all therapy areas. D: Distribution & reach 7/10 Ranbaxy derives 66% of its revenues from metros and tier-i cities. Distribution reach in metros has increased over time but the contribution of rural geographies to revenue has fallen over the past four years. Ranbaxy's field force has been recently expanded by 50% to 4,500 MRs. I: Introductions 5/10 Ranbaxy has been aggressive in launching new products over the past four years compared with its peers. It launched 65 products (including line extensions) a year over the past four years. Revenue growth has been driven by existing products and new launches. Stock info Equity Shares (m) Week Range (INR) 625/414 1,6,12 Rel. Perf. (%) 0/6/6 M.Cap. (INR b) M.Cap. (USD b) 4.3 Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR m) (INR m) (INR ) Gr. (%) (x) (x) (%) (%) Sales EBITDA 12/09A 75,970 1, /10A 89,608 10, /11E 85,242 4, /12E 93,005 7, Background Ranbaxy is a leading global generic company with global revenues of over USD1.9b. The company has established a direct presence across the world in key markets like US, UK, Germany, France, Brazil and other emerging markets. Around 40% of its revenues come from the developed markets of the US and Europe while emerging markets contribute about 50-55% of revenues. August

109 Ranbaxy CEO Profile CEO Ranbaxy is currently a 64% subsidiary of Daiichi Sankyo (Japan). It is being currently managed by a team of professionals headed by Mr. Arun Sawhney (MD). Establishing a global generics business and a leading position in India, coupled with one of the strongest pipeline of First-to-File opportunities in the US is the key achievement of the company. C: CAGR and scale-up 6/10 Ranbaxy posted revenue CAGR of 10.2% in the domestic formulations market over CY04-10, underperforming market's growth. We expect CAGR of 14% for Ranbaxy's domestic formulations business led by its recent field-force expansion and rapid new launches. This slightly lower than our forecast CAGR of 15-16% for the industry. I: Improvement in productivity 3/10 Ranbaxy's domestic formulation revenue posted 10.2% CAGR and its sales force posted 15% CAGR over implying negative MR productivity. The current productivity of INR3.6m per MR is in line with the industry average. Ranbaxy is likely to maintain its leading position in the sector given its strong position and market share in some of the largest therapeutic segments. N: Non-domestic business 5/10 We are neutral on Ranbaxy's international business despite its strong presence in the US and in emerging markets due to ongoing US FDA issues and moderate profitability of its international operations. We expect the international business to post 13% CAGR over CY10-12 excluding low-competition and Para-IV products in the US. E: Earnings growth 3/10 We expect overall core top-line CAGR of 14.4% over CY10-12, leading to EPS CAGR of 53%, albeit on a very low base. Cost reductions leading to improved profitability and gradual recovery in the US business will be key growth drivers. Option values (Para-IV products) will make a onetime contribution to PAT of INR38.2b over CY11-14, leading to DCF value of INR77/share. S: Stock Attractiveness 9/20 Aggressive international expansion, high cost acquisitions and on-going US FDA issues have adversely impacted overall return ratios. While we expect some improvement in return ratios by CY12, they will still remain sub-optimal. Ranbaxy is valued at 33.0x CY11E and 23.3x CY12E consolidated earnings. Reiterate Sell with a target price of INR412 (20x CY12E EPS) excluding Para-IV upsides. Stock performance (1 year) Ranbaxy Labs Sensex - Rebased Aug-10 Nov-10 Feb-11 May-11 Aug-11 August

110 Ranbaxy India formulations snapshot Domestic formulations - significant PAT contribution The domestic formulations business is a leading contributor to Ranbaxy's revenue and contributes ~98% to its EBITDA excluding one off upsides. Ranbaxy has been posting large losses in its core US business because of ongoing US FDA issues. EBITDA Contribution Non-DF EBITDA, 2% Sayonara, unless... Key challenges are resolved at the earliest Ranbaxy is the second largest Indian company by revenue in the domestic formulations space after Cipla and ranks third in the overall ranking. Ranbaxy's strength lies in its strength in the acute therapeutic segments. However, it has underperformed the market over the past four years and has been losing market share. 1. Mix: 6/10 AI, CVS, pain management dominate sales The top four therapeutic segments including AI, CVS, pain management and sex stimulants contribute ~68% to Ranbaxy's domestic formulations revenue. Ranbaxy is among the market leaders in three of the largest therapy segments, AI, CVS and pain management. Ranbaxy derives ~76% of its revenue from acute therapies. Ranbaxy's dependence on the AI segment has fallen over the past 10 years while the contribution of CVS, pain and GI improved over the years. The second largest Indian player in the industry Ranbaxy has consistently ranked among the top three players in the industry due to its strong presence in two of the largest therapeutic segments in the industry. Ranbaxy holds 4.69% market share, which has fallen from 5.1% in The company grew its business at 10.2% CAGR over the past six years while the industry posted 14% CAGR. This under performances can be attributed to the fact that Ranbaxy derives most of its revenue from highly competitive acute therapeutic segment. Ranbaxy is among top three players in the industry Mkt Share (%) Grow th (%) DF EBITDA, 98% Ranbaxy: Therapeutic mix Respira tory 2% CNS 5% Derma 3% GI 4% Vitamins 14% Pain 8% CY 2000 Others 7% CVS 6% AI 51% CNS 4% GI 7% Respirat ory 4% Derma 8% Sex stimulants 9% March 2011 Diabetes 2% Pain 11% Others 7% CVS 13% AI 35% Source: Company/Industry/MOSL 2. Equity with doctors: 5/10 Good brand equity in AI, CVS, pain management, dermatology segments Ranbaxy has been a dominant player in three of the largest therapeutic segments of the industry, AI, CVS and pain management. Ranbaxy ranks first in AI, with market share of 10.8%, it ranks sixth in the CVS segment with market share of 5.8%, second in the pain management segment with market share of 7% and third in the dermatology segment with market share of 8.9%. However Ranbaxy's growth has been sluggish compared with the segments' growth over the past two years August

111 Ranbaxy Market share in key therapies (%) Growth comparison (%) (2010) Avg Gr - Company Avg Gr - Industry AI CVS GI Pain/Analgesic Dermatology CNS AI CVS GI Pain/Analgesic Dermatology CNS * Average growth over Source: Industry/MOSL In terms of the number of prescriptions written, Ranbaxy's brand equity with physicians is high only in the AI and dermatology segments. Ranbaxy is ranked third in the AI segment with a prescription market share of 7.8% and it ranks fourth in the dermatology segment with a prescription market share of 5.4%. Over the past five years, Ranbaxy's brand equity has taken a beating in almost all therapy areas. Ranbaxy's prescription ranking Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Anti-infectives Derma GI CNS Pain Mgmt CVS Anti-diabetic Respiratory Source: Industry/MOSL Top 10 brands contribute 40% of the revenues Ranbaxy's top 10 brands contribute ~40% to its revenue and they feature among the industry's top 300 brands. Its No1 brand Revital (Vitamins) ranks sixth in the industry and it posted revenue CAGR of 30% over Most of Ranbaxy's top 10 brands recorded double-digit CAGR over the past four years. Ranbaxy's top 10 brands Brand Drug Product Launch Sales (INR m) YoY Gr (%) CAGR (%) Revital Ginseng products , Mox Amoxycillin , Storvas Atorvastatin Volini Nsaids Cifran Ciprofloxacin injectables Sporidex Cephalexin Zanocin Ofloxacin Cepodem Cefpodoxime Rosuvas Rosuvastatin Fortwin Injectables CAGR through Source: Industry/MOSL August

112 Ranbaxy 3. Distribution & reach: 7/10 Ranbaxy derives 66% of its revenue from the metros and class-i towns, compared with 63% of the industry average. Over the past four years, revenue CAGR for all geographies has been below the industry average. The contribution of metros to revenue has risen over the past five years, in line with the industry trend. Ranbaxy: Geographical distribution of revenues (%) Geographical distribution of revenues: Industry (%) Metros Class I Tow ns Class II to VI Rural Metros Class I Tow ns Class II to VI Rural CY06 CY07 CY08 CY09 CY10 Ranbaxy: Geography-wise growth rates (%) CY06 CY07 CY08 CY09 CY10 Geography-wise growth rates Metros Class I Tow ns Class II to VI Rural Metros Class II to VI Class I Tow ns Rural CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 Source: Industry/MOSL 4. Introductions: 5/10 Ranbaxy has been one of the most aggressive players in the industry in launching new products Ranbaxy has aggressively launched new products over the past four years. It launched 65 new products (including line extensions) annually over the past four years. However, the average revenue per new launch has declined from INR94m in CY07 to INR60m in CY10. Revenue growth is driven by existing products and new launches. Ranbaxy: New launches (INR m) Ranbaxy: Growth composition (%) 94.0 No. Of launches in last 2yrs Avg sales per launch (INR m) New Launches Existing Brands CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 Source: Industry/MOSL August

113 Ranbaxy 5. CAGR amd scale-up: 5/10 We expect Ranbaxy's domestic formulations revenue to post 14% CAGR over CY10-12, led by a large field force and rapid new launches. This is lower than our forecast of 15-16% CAGR for the industry. Ranbaxy is likely to maintain its leading position in the sector given its strong position and market share in some of the largest therapeutic segments. Though Ranbaxy employs one of the largest field forces in the industry the company's focus on improving productivity of the salesforce needs to be enhanced for it to grow the business more profitably. Ranbaxy: Domestic formulations revenue ramp-up Source: Company/MOSL 6. Improvement in MR productivity: 3/10 Top-line growth driven by sale force additions; MR productivity declines Ranbaxy's domestic formulations revenue posted 10.2% CAGR over FY04-10 and its sales force posted 15% CAGR, implying negative productivity of the salesforce. In CY04 Ranbaxy derived INR4.6m revenue per MR, which fell to INR3.6m in CY10. This is partially attributed to recent additions to the sale force. Sales force productivity No. of MR Revenue per MR (INR m) 4.6 4, , Source: Company/Industry/MOSL August

114 Ranbaxy 7. Non-domestic business snapshot 5/10 Positives Strong presence in the US and emerging markets. Strong chemistry skills and backward integrated low-cost operations. Para-IV pipeline in the US market is strongest among peers. Strong parentage (Daiichi, Sankyo, Japan). Risks & concerns Resolution of US FDA issues imperative to monetize large Para-IV opportunities in the US. This can result in a large one-time penalty payment. Needs to reduce fixed costs. Yet to initiate steps to exploit the bio-similars space. Acquisitions have not delivered desired results, impacting return ratios. Key news flows/triggers US FDA resolution for Paonta and Dewas facility. Launch of generic Lipitor with 180-day exclusivity in November Further visibility on exploiting synergies with Daiichi. Impact assessment We are neutral on Ranbaxy's international business despite its strong presence in the US and emerging markets, due to ongoing US FDA issues and high fixed cost in some of the European markets We expect the international business to record 14.5% CAGR over CY10-12 excluding low-competition and Para-IV products in the US. Option values (Para-IV products) to contribute INR38.2b in one-time PAT over CY11-14 with DCF value of INR77/share. Sales mix (INR m) E 2012E CY10-12 CAGR (%) Dosage Form India Growth (%) Europe, CIS and Africa Growth (%) Japan,Asia Pacific & Middle East Growth (%) Latin America Growth (%) USA Growth (%) Total dosage 1,561 1,407 1,750 1,708 1, Growth (%) API Growth (%) Allied business Growth (%) Total sales 1,682 1,519 1,864 1,851 2, Note - Estimates exclude Para-IV/low-competition opportunities in US except for CY11 EBITDA Contribution Non-DF EBITDA 2% DF EBITDA 98% Source: Company/MOSL August

115 Ranbaxy 8. Earnings growth and stock attractiveness: 6/30 We expect overall top-line CAGR of 14.4% over CY10-12, leading to EPS CAGR of 53%, albeit on a very low base. Cost cuts, leading to improved profitability and gradual recovery in the US business, will be key growth drivers. The key near term determinant for Ranbaxy's valuations will be the expected resolution of the US FDA and DoJ issues. Ranbaxy management has been trying to resolve these issues. However, time-lines for such a solution are not known. Valuations imply market attaching sustainable P/E multiples to Para-IV upsides Current valuations implies that market is attaching sustainable P/E multiples to Para-IV upsides: Given the potential recurrence of Para-IV upsides every year for the CY11-12 period, Para-IV upsides are attracting P/E based valuations. We believe that these are one-off upsides and hence continue to value them on DCF basis. Our current DCF value of all potential Para-IV upsides is INR77/sh. US FDA resolution imperative: Since sustaining current valuations is dependent on upsides from Lipitor & Nexium, it is imperative for RBXY to resolve outstanding US FDA issues and salvage the upsides from these two opportunities which account for 80% of overall Para-IV upsides. Valuations discount best-case scenario: Ranbaxy is currently valued at 33.0x CY11E and 23.3x CY12E core EPS. Our estimates exclude MTM forex gains and one-off upsides from Para-IV opportunities. Our current DCF value of all potential Para-IV upsides is INR77/sh. We believe that current valuations are discounting the best-case scenario for both the core business as well as for the Para-IV upsides. We maintain Sell with target price of INR412 (20x CY12E EPS + FTF DCF value of INR77/sh). Ranbaxy RoE & RoCE (%) Ranbaxy one year forward P/E RoE RoCE 120 P/E (x) Avg(x) Peak(x) Min(x) E Aug-06 Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 August

116 Ranbaxy Ranbaxy non-domestic business: key trends, triggers & risk Getting the US business on track is key: Over the past 3-4 years, Ranbaxy has been facing cgmp issues, which have gradually aggravated. The problems started with a warning letter for the Paonta facility and gradually aggravated into an import alert for the Paonta and Dewas facilities and culminated in the Application of Integrity Policy (AIP) being invoked for the Paonta facility. The US FDA's steps resulted in the stopping of exports of US formulations from both the facilities. Ranbaxy's US facility is the only facility that supplies products in the US, pending the resolution of the US FDA issues at its India facilities. We believe getting the US business back on track through the clearance of the Paonta and Dewas facilities is crucial for the Ranbaxy management in the near-term. Resolution of US FDA issues imperative: We believe it is imperative for Ranbaxy to resolve its long-pending US FDA cgmp problems, without which the significantly large upsides for its US business are at a risk. The management has been attempting to resolve the issues and is trying to obtain a comprehensive solution with the US FDA and the DoJ for all outstanding issues. While the time-lines for such a resolution are not predictable, we note that, given past precedence, Ranbaxy may be required to pay a one-time penalty for the resolution. Risks to Para-IV opportunities: Given the seriousness of the US FDA issues, we believe there are risks to high value FTF opportunities like generic Lipitor and Nexium (cumulative one-time PAT of INR38.2b over CY11-14). Ranbaxy must demonstrate that these high-value Para-IV opportunities are not at risk. Para-IV upsides: Ranbaxy: One-time PAT from Para-IV upsides (INR m) Brand Innovator Launch CY09 CY10 CY11E CY12E CY13E CY14E Total % of total Sales (USD m) Valtrex Nov-09 2,724 5, , Flomax 1452 Mar-10-1, ,561 3 Aricept Nov , ,386 5 Lipitor 5000 Nov ,250 6, , Caduet 304 Nov Diovan 1300 Sep ,683 1,342-4,025 8 Valcyte 300 Mar ,007-2,007 4 Nexium 2800 May ,168 20, Total 17,956 2,724 7,846 4,489 10,173 3,348 20,168 48, One-Time EPS Ranbaxy - Para-IV Upsides in US (INR M) Ranbaxy - Core & Para-IV Profits (INR M) 20,168 Core PAT Para-IV PAT 2,724 7,846 4,489 10,173 3,348 20,168 10,173 3,348 7,846 4,489 3,008 4,991 7,052 8,437 9,702 CY09 CY10 CY11E CY12E CY13E CY14E CY10 CY11E CY12E CY13E CY14E August

117 Ranbaxy Key FTF upsides: Nexium at risk Nexium account for a major portion of Ranbaxy's FTF upsides. We believe there are potential risks to the monetization of these opportunities due to ongoing US FDA issues. Settlements for Nexium raise uncertainty AstraZeneca entered into an out-of-court settlement with Teva and recently with Dr Reddy's Labs for the potential launch of their respective generic versions in May This raises uncertainty over Ranbaxy's FTF status and an out-of-court settlement with AstraZeneca since Ranbaxy's 180-day exclusivity on Nexium is likely to commence from May Teva and Dr Reddy's indicated that if Ranbaxy got final US FDA approval, they would launch their generic versions after the expiry of Ranbaxy's exclusivity. However, the matching launch time-lines for the three settlements (May 2014) and the fact that Ranbaxy is yet to receive even tentative approval, raises uncertainty over upsides for Ranbaxy. The table highlights the upsides for Ranbaxy in both cases: NEXIUM UPSIDE (USD m) - Sensitivity Analysis Only Ranbaxy Ranbaxy along with on market DRL and Teva Innovator Sales (USD mn) 2,800 2,800 Sales period (mths) 6 6 Price discount (%) Potential Mkt for generics No. of players in mkt 2 4 Ranbaxy Mkt Share (%) Ranbaxy Sales (USD mn) Assumed exchange rate (INR/USD) Ranbaxy Sales (INR mn) 28,812 5,292 PAT Margin (%) PAT (INR mn) 20,168 2,117 WACC (%) PV Factor PV of cash flow 11,941 1,253 NPV (INR/share) Source: Company/MOSL August

118 Ranbaxy Long-term plan to exploit synergies with Daiichi Ranbaxy formulated a three-year plan ( ) to exploit synergies with Daiichi. This plan straddles multiple areas in which the partners can leverage each other's strengths. The areas include: 1. Accessing the Japanese generic market through Daiichi; 2. Leveraging Ranbaxy's distribution network to launch Daiichi's products, with the key target markets including India, Africa, Latin America and parts of Europe. 3. Synergies for NCE research: Daiichi has bought Ranbaxy's NCE operations. 4. Accessing Ranbaxy's low-cost manufacturing facilities in India as a sourcing base for Daiichi. Accessing the Japanese generic market The USD70b Japanese pharmaceutical market (with 5% generic penetration at ~USD3.5b) is undergoing a change with the government planning to reduce health care costs by encouraging generics. The Japanese government aims to double the generic penetration over the next five years. Ranbaxy plans to become a strong player in this market by accessing Daiichi's presence and brand-equity in this market as well as its own product pipeline. We do not expect major upsides from this initiative in the short- to medium term as Ranbaxy will have to file products with the Japanese authorities and get them approved, which will be timeconsuming. Leveraging Ranbaxy's distribution network to launch Daiichi products Key target markets include India, Africa, Latin America and parts of Europe, in which Ranbaxy's front-end presence will be leveraged to distribute Daiichi's products (can also include patented products). A beginning has been made with Ranbaxy starting marketing of a few products in India, Mexico and Romania. We believe this could result in incremental upsides to Ranbaxy in the medium term. Cost savings for NCE research division In July 2010, Ranbaxy transferred its NCE research operations to Daiichi along with all its NCE assets and ~150 employees. In return, it received some upfront consideration (not quantified) from Daiichi. The transfer of NCE research to Daiichi will result in cost savings for Ranbaxy besides the upfront cash inflow. We estimate Ranbaxy spends ~20% of its annual R&D expenditure on NCE research, which has now been transferred to Daiichi, leading to cost savings. Our estimates take into account the savings in R&D cost due to the sale of NCE research operation to Daiichi. Shifting manufacturing to Ranbaxy's Indian facilities Ranbaxy can supply some products to Daiichi (especially APIs) from its Indian facilities, resulting in upsides for both partners. However, this may be a time-consuming exercise as it will require changing Daiichi's filings for these products. August

119 Ranbaxy Financials and valuations: Ranbaxy Income Statement (INR Million) Y/E December E 2012E Net Sales 73,294 85,355 83,111 90,736 Change (%) Other Operating Income 2,676 4,253 2,132 2,268 Total Expenditure 68,846 70,955 76,209 81,969 EBITDA 7,124 18,652 9,033 11,035 Change (%) Margin (%) Depreciation 2,676 5,533 3,210 3,894 EBIT 4,448 13,120 5,823 7,141 Int. and Forex loss , Other Income - Rec. 2,935 2,795 3,290 1,862 PBT pre EO Expense 8,166 16,708 8,050 8,800 Change (%) Extra Ordinary Expense -1,931-4,293-1, PBT after EO Exp. 10,098 21,001 9,188 9,500 Tax 6,991 5,849 1,516 1,615 Tax Rate (%) Reported PAT 3,107 15,152 7,672 7,885 Minority Interest Adj PAT after Min. Int. 1,911 10,855 6,984 7,052 Change (%) Margin (%) Adj PAT excl one-offs ,008 4,991 7,052 Balance Sheet (INR Million) Y/E December E 2012E Equity Share Capital 2,102 2,105 2,105 2,105 Fully Diluted Eq Cap 2,102 2,105 2,105 2,105 Reserves 41,261 53,871 59,241 65,549 Revaluation Reserves Net Worth 43,434 56,047 61,417 67,725 Minority Interest Loans 36,295 43,348 23,328 13,328 Deferred liabilities Capital Employed 75,517 99,815 85,085 81,393 Gross Block 62,786 67,050 69,550 72,050 Less: Accum. Deprn. 17,880 21,571 24,781 28,675 Net Fixed Assets 44,905 45,479 44,769 43,375 Capital WIP 6,231 3,818 6,231 6,231 Investments 5,407 4,985 4,985 4,985 Goodwill/Intangibles 21,446 19,009 19,009 19,009 Curr. Assets 60,086 86,932 64,226 61,286 Inventory 18,407 21,926 21,632 23,616 Account Receivables 18,399 16,052 15,971 17,436 Cash and Bank Balance 12,416 32,644 12,506 6,063 Others 10,863 16,309 14,117 14,170 Curr. Liability & Prov. 41,112 41,398 35,125 34,483 Account Payables 32,511 31,865 30,774 29,750 Provisions 8,602 9,534 4,350 4,733 Net Current Assets 18,974 45,534 29,101 26,803 Appl. of Funds 75,517 99,815 85,085 81,393 E: MOSL Estimates Ratios Y/E December E 2012E Basic (INR) EPS (Fully diluted)* Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E (Fully diluted) PEG (x) Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Capital (Days) Leverage Ratio (x) Current Ratio Debt/Equity Cash Flow Statement (INR Million) Y/E December E 2012E Op.Profit/(Loss) bef. Tax 7,124 18,652 9,033 11,035 Interest/Dividends Recd. 2,935 2,795 3,290 1,862 Direct Taxes Paid 493-1,331-1,516-1,615 (Inc)/Dec in WC -11,296-6,332-3,706-4,144 CF from Operations ,785 7,101 7,138 CF frm Op.incl EO Exp ,785 7,101 7,138 (Inc)/Dec in FA -4,205-3,694-4,913-2,500 (Pur)/Sale of Investments CF from Investments -4,181-3,271-4,913-2,500 Change in networth ,736 1, Inc/(Dec) in Debt -6,695 7,167-20,100-10,000 Interest Paid , Dividend Paid ,302-1,577 CF from Fin. Activity -6,616 9,714-22,327-11,081 Inc/Dec of Cash -11,540 20,228-20,139-6,442 Add: Beginning Balance 23,956 12,416 32,644 12,506 Closing Balance 12,416 32,644 12,506 6,063 August

120 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 52/100 The homecoming Dr Reddy's CMP: INR1,446 DRRD IN TP: INR1,670 Neutral M: Mix 4/10 Dr Reddy's Laboratories (DRL) derives 72% revenue from the acute therapy segment and has small presence in chronic therapy segments through the CVS segment. GI, CVS, pain management and AI contribute ~64% to DRL's domestic formulation revenue. E: Equity with doctors 6/10 DRL has good brand equity in the GI and pain management segments but is not a market leader in these therapeutic segments. DRL ranks third in the GI and pain management segments with a prescription market share of 4.4% and 4.1% respectively. In other major segments its brand equity is not very strong. DRL has not been able to improve its brand equity in most after therapeutic areas in which it is present. D: Distribution & reach 6/10 I: Introductions 4/10 DRL derives 68% of its revenue from metros and tier-i cities. The company's distribution in metros has increased significantly over time and the contribution of other geographies to revenue has fallen over the past four years. DRL has a large field force with 3,165 MRs which helps it to tap both the urban and semi-urban market. DRL launched fewer new products over the past four years than its peers. It launched 22 new products (including line extensions) annually over the past four years. Over the past two years DRL's revenue growth has been driven largely by old products rather than new launches. Stock info Equity Shares (m) Week Range (INR) 1,855/1,320 1,6,12 Rel. Perf. (%) 5/4/20 M.Cap. (INR b) M.Cap. (USD b) 5.3 Financial & valuation summary Year Net Sales PAT EPS EPS P/E Adj P/E P/BV RoE RoCE EV/ EV/ End (INR M) (INR M) (INR) GR. (%) (X) (X) (X) (%) (%) Sales EBITDA 03/10A 68, /11A 74,693 11, /12E 81,754 11, /13E 90,323 13, Background Dr. Reddy's is a vertically integrated company with presence across the pharmaceutical value chain through its core businesses of Global Generics, Pharmaceutical Services & Active Ingredients (PSAI), and Proprietary Products. The company is currently developing bio-generics and NCEs. Key focus markets include India, US, Europe and Russia. August 116

121 Dr Reddy's Chairman Profile Chairman Dr. Reddy's Labs was promoted by Dr. Anji Reddy, a first generation entrepreneur. The day-to-day operations of the company are currently managed by Mr. G.V. Prasad (Vice Chairman & CEO) and Mr. Satish Reddy (MD & COO). Building a strong business in US and Russia coupled with global scale in the API business are the key achievements of the company. C: CAGR and scale-up 6/10 DRL outperformed the industry with revenue CAGR of 18% over FY The company scaled up its business rapidly albeit on a low base. We expect DRL to post revenue CAGR of 15% over FY11-13, in line with the industry, given its small base, recent additions to field force and considering the management's increased focus on the business. I: Improvement in productivity 2/10 DRL posted negative MR productivity over The number of MRs grew 16% against revenue growth of 13.6%, indicating a fall in sales force productivity. Revenue per MR declined from INR3.6m in 2004 to INR3.2m in At this level, productivity is the lowest among peers. N: Non-domestic business 7/10 We are positive on DRL's international business given its strong US and emerging markets portfolio, backed by a strong API portfolio. We expect non domestic business to record 15.2% CAGR over FY11-13, excluding low-competition and Para-IV products in the US. Option values (low-competition and Para-IV products in US) will contribute INR12.9b to sales and INR5.4b to PAT in FY12. E: Earnings growth 5/10 We expect DRL to post top-line of 15% CAGR over FY11-13, leading to EPS CAGR of 11%, excluding Para-IV upsides. DRL's core earnings growth will be driven by sustained double-digit growth in the branded formulations business but will be partly tempered down by higher taxes. S: Stock Attractiveness 12/20 Return ratios are muted due to a high cost German acquisition, which is not yielding desired returns. DRL is valued at 20.7x FY12E and 17.5x FY13E consolidated earnings. We had placed our recommendation "Under Review" for a potential downgrade (from Buy earlier) some time back. We now rate the stock Neutral with TP of INR1,670. Stock performance (1 year) Dr Reddy s Labs Sensex - Rebased 2,000 1,750 1,500 1,250 1,000 Aug-10 Nov-10 Feb-11 May-11 Aug-11 August

122 Dr Reddy's India formulations snapshot Domestic formulations: Revenue contribution marginal, sizable contribution to profits The domestic formulations business contributes just ~15% to DRL's revenue but is one of its most profitable businesses. We estimate contribution of 23% to EBITDA. EBITDA Contribution Non-DF DF EBITDA EBITDA 23% 77% The homecoming Balancing focus between overseas and domestic markets Despite being one of the largest Indian generic companies, Dr Reddy's Laboratories (DRL) has been lagging its peers in the domestic formulations business. DRL, ranked a distant thirteenth in the industry with 2.17% market share, has strong brand equity in the gastrointestinal and pain management segments. DRL lagged the industry average growth rate over the past four years in all geographies except metros. However, of late, it has been expanding in the domestic market, which is visible from its growth up-tick in 2009 and Mix: 4/10 Acute therapeutic segments dominate sales The top four therapeutic segments, GI, CVS, pain management and AI contribute ~63% to DRL's domestic formulations revenue. Overall, the acute therapeutic segments contribute ~72% to sales. Over the past 10 years, the GI and respiratory segments increased their contribution from 19% in FY01 to 29% in FY11 while contributions from pain management and anti-infective segments fell from more than 32% in FY01 to 20.6% in FY11. Among laggards in the segment compared with peers DRL ranks thirteenth in the industry and has a market share of 2.17%. Over the past five years DRL's market share dropped from 2.31% in 2006 to 2.17% in DRL's focus on growing the international generic business had resulted in low focus on the domestic formulations business in the past which has impacted overall business growth. DRL posted revenue CAGR of 18% over the past six years, against the industry's 14% CAGR. DRL market share and growth Dr. Reddy's: Therapeutic breakup Diabetes 5% AI 15% Pain 17% FY01 Derma Respi tology ratory 3% 1% CVS 19% Stomatologicals 5% Respiratory 5% VMN 9% Others 13% GI 18% FY11 AI 8% Pain 17% Diabetes 7% VMN 5% Others 10% Derma tology 5% CVS 22% FY05 GI 23% Respira tory 4% VMN 6% Others 9% GI 22% 18.6 Mkt Share (%) Grow th (%) 20.6 Dermatology 6% Diabetes 6% CVS 19% AI 8% Pain 13% Source: Company/Industry/MOSL August

123 Dr Reddy's 2. Equity with doctors: 6/10 Good brand equity in GI, pain management segments DRL is not a market leader in any therapeutic segment. It ranks third in the GI segment with market share of 5.6%, eighth in the pain management segment with market share of 4% and tenth in the dermatology segment with market share of 3%. A major drawback in DRLs portfolio is that it is not among the top 10 players in any major chronic therapeutic segment. Over the past two years, DRL's growth in key segments like the GI and pain management segments has been lower than that of industry. Market share in key therapies (%) (2010) Growth comparison (%) (2010) 5.6 Avg Gr - Company Avg Gr - Industry GI Pain/Analgesic Dermatology GI Pain/Analgesic Dermatology * Average growth over Source: Industry/MOSL DRL does not have high brand equity except in the GI and pain management segments in terms of the number of prescriptions written. DRL ranks at third position in the GI and pain management segments with prescription market shares of 4.4% and 4.1% respectively. In other major segments the brand equity is not very strong. DRL has not improved its brand equity in most therapeutic areas in which it is present. DRL's prescription ranking Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Pain Mgmt GI Respiratory Vit CVS Anti-diabetic Anti-infectives Derma Source: Industry/MOSL Higher brand concentration DRL's top 10 brands contribute ~37% to its total revenue and seven of its top 10 brands feature among the industry's top 300 brands. Its No1 brand Omez (Omeprazole in the GI segment) ranks twenty-seventh in the industry and has been posting revenue CAGR of 17% over the past two years. Six out of the top 10 brands reported double-digit revenue CAGR over the past two years. August

124 Dr Reddy's DRL's top 10 brands Brand Drug Product Launch Sales (INR m) YoY Gr (%) CAGR (%) Omez Omeprazole , Nise Nimesulide Stamlo Amlodipine Reditux Rituximab Omez-D Omeprazole & Domperidone Stamlo Beta Atenelol & Amlodipine Razo Rabeprazole Atocor Atorvastatin Mintop Minoxidil Razo-D Rabeprazole & Domperidone CAGR through Source: Company/MOSL 3. Distribution and reach: 6/10 DRL derives 68% of its revenue from metros and class-i towns, against an industry average of 63%. Over the past four years revenue CAGR for all geographies have been either in line or below the industry average. DRL: Geographical distribution of revenues (%) Industry: Geographical distribution of revenues (%) Metros Class I Tow ns Class II to VI Rural Metros Class I Tow ns Class II to VI Rural CY06 CY07 CY08 CY09 CY10 CY06 CY07 CY08 CY09 CY10 DRL: Geography-wise growth rates (%) Industry: Geography-wise growth rates (%) Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Source: Industry/MOSL August

125 Dr Reddy's 4. Introductions: 4/10 DRL's growth over the past four years has been led by existing products as It launched fewer new products compared with the industry Over the past four years DRL launched 22 new products (including line extensions), annually which is less than its peers. The average revenue per new launch has fallen over the past four years, indicating a sharp decline in value derived out of new launches. Over the past two years, DRL's revenue growth has been largely driven by existing products rather than new launches. DRL: New launches DRL: Growth composition (%) No. Of launches in last 2 yrs Avg sales per launch (INR m) New Launches Existing Brands CY07 CY08 CY09 CY CY07 CY08 CY09 CY10 Source: Industry/MOSL 5. CAGR and scale-up: 6/10 DRL is aggressively targeting strong growth in the domestic formulations business and expects double-digit growth, led by new launches and strengthening of its field force (600 MRs added over the past few quarters to total ~3,000). We expect DRL's domestic formulations business to post revenue CAGR of 15% over FY We expect DRL to report in line industry growth over the next two years, considering the management's increased thrust on the business and relatively low base. Dometic formulation revenues DF Revenue (INR m) YoY Grow th (%) ,526 6,964 8,060 8,478 10,158 11,690 13,210 15,323 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL August

126 Dr Reddy's 6. Improvement in MR productivity: 2/10 DRL's sales force productivity fairs poorly compared with the industry DRL's domestic formulations business posted revenue of 13.6% CAGR over FY04-10 and its sales force grew 16% CAGR, implying negative productivity of the salesforce. In 2004, DRL derived INR3.6m revenue per MR, which fell to INR3.2m in FY10. Compared with the companies covered in this report, DRL's performance was below average. DRL: Sales force productivity ( ) No. of MRs Revenue per MR (INR m) 3.6 Sales force addition CAGR (%) Productivity Improvement CAGR (%) 3, , DRL Industry Source: Company/Industry/MOSL 7. Non-domestic business snapshot: 7/10 Positives DRL has a strong presence in the US and emerging markets. It has strong chemistry skills and fully backward integrated, low-cost operations. It has a pragmatic mix of low-competition, Para-IV and normal products for the US market. It is one of the few Indian players to target the bio-similar opportunity. It is among the top three global API players. Risks and concerns Further write-offs for DRL's German operations cannot be ruled out. They are related to potential price erosions in the tender market. DRL has yet to tie up with a global player to capitalize on the bio-similar opportunity in regulated markets. DRL's CRAMS business may not scale-up due to a conflict of interest with a strong generic business. DRL's past acquisitions have not delivered the desired results, which has impacted return ratios. News flow/triggers Launch of generic Zyprexa in US with 180 days exclusivity expected in October 2011 US FDA approval for generic Arixtra in the US expected in FY12. Ramp-up in supplies to GSK for emerging markets expected in FY13. Further visibility on DRL's achieving US$2.7b revenue by FY13. August

127 Dr Reddy's Impact assessment We are positive on DRL's international business given its strong US and emerging markets portfolio backed by a strong API portfolio. We expect the non-domestic business to record 15.2% CAGR over FY11-13 excluding low-competition and Para-IV products in the US. Option values (low-competition and Para-IV products) will contribute INR12.9b to DRL's sales and INR5.4b to PAT in FY12. Sales mix (INR m) FY09 FY10 FY11 FY12E FY13E FY10-13 CAGR (%) PSAI 18,758 20,404 19,648 20,655 22, India 2,383 2,646 2,619 2,750 2, International 16,375 17,758 17,029 17,905 19, Branded Formulations 18,060 22,145 25,913 29,708 34, India 8,478 10,158 11,690 13,210 15, International 9,582 11,987 14,223 16,499 19, Generics 31,730 26,460 27,427 29,220 30, US 19,844 16,817 18,996 20,532 21, EU 11,886 9,643 8,431 8,688 9, Others 893 1,268 1,705 2,171 2, Total 69,441 70,277 74,693 81,754 90, Note - Estimates exclude Para-IV/low-competition opportunities in the US EBITDA Contribution Non-DF EBITDA 77% DF EBITDA 23% Source: Company/MoSL 8-9. Earnings growth and stock attractiveness: 17/30 Traction in the branded formulations and US businesses will be key growth drivers for DRL over the next two years. We estimate core EPS of INR68.6 in FY12 and INR81.1 in FY13, adjusting for the interest cost of the bonus debentures and factoring-in the impact of likely withdrawal of DEPB scheme. Our core estimates exclude upsides from patent challenges/low-competition opportunities in the US. The stock trades at 20.7x FY12E and 17.5x FY13E core earnings. While current valuations are supported by large potential one-time opportunities in the US, they do not fully discount the slowdown in DRL's core business. We had placed our recommendation "Under Review" for a potential downgrade (from Buy earlier) some time back. We now rate the stock Neutral with TP of INR1,670 (20x FY13E core EPS + INR47/sh of DCF value). Dr Reddy's RoE & RoCE (%) Dr Reddy's one year forward PE RoE RoCE P/E (x) Avg(x) Peak(x) Min(x) Ne gative Ear nings Cycle E 2013E 4 Aug-06 Mar-07 Aug-07 Feb-08 Aug Feb-09 Aug-09 Feb-10 Aug-10 Feb Aug-11 August

128 Dr Reddy's DRL non-domestic business: key trends, triggers & risk Revenue target of USD2.7b by FY13 implies 27% CAGR DRL aims at a top-line of USD3b by FY13 implying 27% revenue CAGR over FY We believe this is a slightly aggressive target given that most of its businesses are growing at much lower than 27% CAGR. Hence, we estimate DRL's core revenue will grow at 15% CAGR to USD2.1b. One-off and low-competition opportunities in the US are likely to contribute ~USD286m in FY12 and ~USD173m for FY13. We expect revenues of USD2.2b in FY13 including the upside from low competition opportunities. We believe that without some inorganic initiative, it will be difficult for DRL to achieve USD2.7b in revenue by FY13. Strong positioning in emerging markets led by a focused approach We expect DRL's formulation exports to emerging markets to record 18% CAGR over FY11-13 led by a ramp-up in its Russian operations and the start of supplies to other emerging markets under the GSK supply agreement. The main target markets for the company's emerging market initiative include Russia and the CIS region, Venezuela and Brazil. Russia, CIS key markets With 76 percentage contribution to DRL's emerging market exports, Russia and the CIS region is a key market for the company. To sustain double-digit growth in this region, DRL has begun to focus on the Russian OTC market (with the addition of more products and expansion of the field force) and has in-licensing arrangements to expand its product portfolio in the region. US business to ramp-up significantly over the next two years DRL's revenue target of US$1b in the US implies 55% CAGR over FY11-13, led mainly by its FTF pipeline of 12 products and contribution from other low-competition opportunities. Such opportunities are likely to contribute ~INR12.9b and ~INR7.6b in sales and INR5.4b and INR2.3b to PAT in FY12 and FY13 respectively. We have excluded such opportunities from our core estimates and forecast that DRL will post core US revenue of 27.5% CAGR over FY Low-competition/patent challenge opportunities in the US gain momentum DRL management has guided for launch of at least one patent challenge/low-competition product in the US every year over the next few years. DRL has a pipeline of 11 FTFs. A combination of scale-up in existing patent challenge/low-competition products and new opportunities will help the company to achieve its revenue guidance of USD1b by FY13 in the US. August

129 Dr Reddy's DRL US portfolio - one-time pat contribution (INR m) Product Launch Status FY12E FY13E Generic Arixtra Launched in Jul ,122 Generic Accolate Launched Generic Zyprexa Likely launch on 23-Oct ,503 - Generic Prevacid Launched on 15-Oct ,063 - Generic Exelon Expected in August Generic Clarinex Expected in January Generic Geodon Expected in Mar Generic Lipitor Expected in May Total 5,421 2,277 DRL US portfolio - one-time revenue contribution (INR m) Product Launch Status FY12E FY13E Generic Arixtra Launched in Jul ,721 4,488 Generic Accolate Launched Generic Zyprexa Likely launch on 23-Oct ,005 - Generic Prevacid Launched on 15-Oct ,038 - Generic Exelon Expected in August Generic Clarinex Expected in january Generic Geodon Expected in Mar ,100 Generic Lipitor Expected in June Total 12,889 7,598 Source: Company/MOSL Import alert for Mexico facility to temper core performance DRL's Mexico facility recently received a warning letter and subsequently an import alert from the US FDA. This is the fallout of the US FDA inspection done in November 2010 wherein it issued 12 observations. Of these, DRL was able to resolve 8. However, the US FDA has issued a warning letter for the remaining four deviations. The warning letter has identified the following cgmp lapses at this facility: non-validation of analytical methods to test APIs, incomplete cleaning validation for some manufacturing equipment, out-of-specification investigations data did not include analysis of all available data, and lack of responsibility of the quality unit to ensure API manufactured were in compliance with GMP. This facility generates annual revenue of ~USD65m, of which ~USD30m is from Naproxen, which is not included in the import alert. DRL can continue to supply this product to its customers. Supply of remaining products (contributing ~USD35m in revenue) will have to be suspended till the import alert is resolved. These are low-margin products for DRL, with gross margins of 25-30%, implying EBITDA hit of USD8m-10m on annual basis. Our estimates factor in the impact of this development for DRL. Germany: Cost structure aligned for a pure generic model Over the past three years, DRL has significantly altered its German operations through cost cutting to align it with the low-margin pure generic market. While the high cost acquisition of Betapharm seems to have been mistimed, we believe that, contrary to past trend, the German operations will not be a drag on the company's PAT in the coming years. August

130 Dr Reddy's Financials and valuations : Dr Reddy's Income Statement (INR Million) Y/E March E 2013E Net Sales 70,277 74,693 81,754 90,323 Change (%) Other Income 617 1, Total Expenditure 56,075 59,073 66,384 72,259 EBITDA 14,202 15,620 15,370 18,065 Margin (%) Deprec. & Amortization 12,763 4,107 4,555 4,845 EBIT 1,439 11,513 10,814 13,220 Net Interest Exp Forex (Gains)/Losses PBT & EO Expense 2,053 12,439 10,659 13,057 Change (%) PBT after EO Expense 2,053 12,439 10,659 13,057 Tax 985 1,403 1,706 2,089 Tax Rate (%) Reported PAT 1,068 11,036 8,953 10,968 Adjusted Net Profit 1,068 11,099 11,615 13,725 Change (%) Margin (%) Balance Sheet (INR Million) Y/E March E 2013E Equity Share Capital * Reserves 42,071 45,144 50,712 57,679 Net Worth 42,915 45,990 51,558 58,525 Loans 14,695 23,572 23,572 23,572 Deferred Liabilities/Tax 1, Capital Employed 59,048 69,649 75,217 82,184 Net Fixed Assets 22,769 29,955 38,755 43,155 Investments 3, ,191-1,191 Goodwill/Intangible Assets 13,973 15,246 15,246 15,246 Curr. Assets 38,463 47,560 42,028 45,748 Inventory 13,371 16,059 15,533 16,258 Account Receivables 11,960 17,615 14,716 15,355 Cash and Bank Balance 6,584 5,729 5,647 7,361 Others 6,548 8,157 6,132 6,774 Curr. Liability & Prov. 20,000 23,421 19,621 20,774 Account Payables 9,322 8,480 8,993 9,936 Other Current Liabilities 10,678 14,941 10,628 10,839 Net Current Assets 18,463 24,139 22,407 24,974 Appl. of Funds 59,048 69,649 75,217 82,184 * IFRS reporting from FY09 onwards. Financials prior to FY09 are as per US GAAP E: MOSL Estimates Ratios Y/E March E 2013E Basic (INR) EPS Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Capital (Days) Leverage Ratio Current Ratio (x) Debt/Equity (x) Cash Flow Statement (INR Million) Y/E March E 2013E Op. Profit/(Loss) before Tax 14,202 15,620 15,370 18,065 Interest/Dividends Recd Direct Taxes Paid ,403-1,706-2,089 (Inc)/Dec in WC 3,629-6,531 1, CF from Operations 17,460 8,612 15,159 14,959 CF from Oper. incl EO Exp.17,460 8,612 15,159 14,959 (inc)/dec in FA -6,182-12,566-13,355-9,245 (Pur)/Sale of Investments -3,113 3,534 1,500 0 CF from Investments -9,295-9,032-11,855-9,245 Change in networth 103-4, (Inc)/Dec in Debt -5,006 8, Other Items -1, Dividend Paid ,235-3,386-4,001 CF from Fin. Activity -7, ,386-4,001 Inc/Dec of Cash ,713 Add: Beginning Balance 5,596 6,584 5,729 5,647 Closing Balance 6,584 7,080 5,647 7,360 Note: Reported cashflow differs due to acquisitions & change to IFRS reporting from FY09 onwards August

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132 Domestic Formulations New Peaks MEDICINES MEDICINES CAPSULE Score 49/100 Needs to improve returns ratios Glenmark Pharma CMP: INR318 GNP IN TP: INR310 Neutral M: Mix 2/10 Acute therapeutic segments such as dermatology, AI and respiratory segments dominate the sales mix, contributing 76% of the company's revenue. Glenmark has been trying to expand its presence in chronic therapy segments. Over the past 10 years, Glenmark has tried to diversify its therapeutic mix as the contribution to revenue from the respiratory, gastro and dermatology segments has fallen significantly. E: Equity with doctors 3/10 Glenmark lags other leading companies when it comes to brand equity among doctors. The only therapeutic segment in which Glenmark has made its mark is dermatology, in which it ranks second in the industry, with market share of 11.5%. However, Glenmark has gradually improved its prescription ranking in the gynecology and CVS segments over the past four years. D: Distribution & reach 5/10 Glenmark has better distribution in metros and tier- I cities as it derives 70% of the revenue from such areas, which is above average compared with the industry. Distribution in metros has increased significantly over time while the contribution of other geographies to revenue has fallen. I: Introductions 6/10 Glenmark has launched fewer new products compared with some of its peers. It launched 26 new products annually over the past four years. Glenmark's revenue growth is led by both existing products new launches over the past four years. Glenmark has a field force of 2,078 MRs. Stock info Equity Shares (m) Week Range (INR) 390/242 1,6,12 Rel. Perf. (%) 10/22/20 M.Cap. (INR b) 85.8 M.Cap. (USD b) 1.9 Financial & valuation summary Year Net Sales PAT EPS EPS P/E P/BV RoE RoCE EV/ EV/ End (INR m) (INR m) (INR) Gr. (%) (x) (x) (%) (%) Sales EBITDA 03/10A 24,616 3, /11A 29,491 3, /12E 37,007 4, /13E 40,693 5, Background Glenmark is one of the second tier integrated pharmaceutical companies which has differentiated itself through its success in NCE research. The company has pipeline of 5 Novel drugs in different phases of clinical studies. It is also one of the leading Indian generic companies in US with focus on niche generics segments. Glenmark has reasonable presence in semi-regulated markets. August

133 Glenmark Pharma CEO Profile CEO Glenmark was founded by Mr. Gracias Saldanha (Founder & Chairman Emeritus) and is being currently managed by Mr. Glenn Saldanha (CMD). Developing a strong NCE pipeline coupled with expanding presence in the US and emerging markets are the key achievements. It is the most successful NCE research company from India till date. C: CAGR and scale-up 6/10 Glenmark has outperformed the average industry growth with revenue CAGR of 18.6% over FY The company scaled up its business rapidly albeit on a very low base. We expect Glenmark to post revenue CAGR of 17% over FY11-13, outperforming the industry, given its low base and aggressive focus on driving growth in this business. I: Improvement in productivity 5/10 Glenmark has shown marginal increase in MR productivity over the past six years. Glenmark's MR growth was 14.2% compared with revenue growth of 17.3%, indicating improved productivity. Revenue per MR improved from INR3.1m in 2004 to INR3.6m in At this level productivity is in line with average. N: Non-domestic business 3/10 We are neutral on Glenmark's international business despite its ramp-up in emerging markets due to the low return ratios in these markets. We expect international formulation business to record 17% CAGR over FY E: Earnings growth 7/10 We expect topline of 18.3% CAGR over FY11-13 leading to EPS CAGR of 25.8%. Reduction in interest costs in the long-term will partly drive earnings growth. Option values include potential NCE out-licensing and the launch of Crofelemer in some emerging markets. S: Stock Attractiveness 10/20 Return ratios have been muted due to the workingcapital intensive nature of Glenmark's operations. Glenmark is valued at 19.7x FY12E and 16.1x FY13E consolidated earnings. Stock performance (1 year) Glenmark Pharma Sensex - Rebased Maintain Neutral with a target price of INR310 (15x FY13E EPS plus DCF value of Crofelmer and Para IV products) Aug-10 Nov-10 Feb-11 May-11 Aug-11 August

134 Glenmark Pharma India formulations snapshot Domestic formulations contribute ~30% to revenue The domestic formulations business, which contributed 30% to Glenmark's revenue in FY11 and an estimated 27% to EBITDA, is a leading contributor to Glenmark's topline and profitability. Interestingly, unlike other leading generic companies, Glenmark's profitability from the domestic formulations business is lower than from its regulated market generics business. EBITDA Contribution Non-DF EBITDA 73% DF EBITDA 27% Needs to improve return ratios Ranks 25th in the domestic market Glenmark is a niche player in the domestic formulations segment with strong presence in a few niche therapeutic areas like dermatology. It ranks twenty-fifth in the industry with market share of 1.53%. The company has been gradually increasing its presence in chronic therapy areas. Glenmark is among the few companies to have improved the productivity of its workforce over the years. 1. Mix: 2/10 Acute therapeutic segments account for 76% of revenue; dermatology, CVS, AI, respiratory segments dominate sales Acute therapeutic segments, in which Glenmark has 76% market share, dominate Glenmark's sales mix. The top four therapeutic segments, including dermatology, CVS, AI and respiratory segments, account for about 76% of Glenmark's domestic formulation revenue. Its top therapy segment, dermatology, contributes 29% to total revenue. Over the past 10 years, the contribution of CVS and AI segments increased while that of respiratory, gastro and dermatology segments fell. Glenmark has been trying to expand its presence in chronic segments. Glenmark ranks twentyfifth in the domestic formulations segment Glenmark ranks twenty-fifth in the domestic formulations market and has a market share of 1.53%. However, over the past five years, the company improved its market share from 1.26% in 2006 to 1.53% currently. Over the past six years, Glenmark's revenue posted 19% CAGR and the industry posted 14% CAGR. Glenmark has improved market share over the last 5 years Acute segments contributes 76% to the revenue GI 10% Gynae cology 9% Pain 4% Diabetes 0% Pain 6% Diabetes 6% Others 7% Respira tory 22% Gynaec 5% FY01 AI 11% GI 3% Derma tology 37% CVS 0% FY11 Others 6% Gynaeco logy 5% Pain 13% Diabetes 8% GI 7% Respirat ory 15% FY05 Others 3% AI 11% Dermatology 28% Dermatol ogy 33% CVS 5% 21.8 Mkt Share (%) Grow th (%) AI 14% Respiratory 15% CVS 17% Source: Company/Industry/MOSL August

135 Glenmark Pharma 2. Equity with doctors: 3/10 Glenmark lags in terms of brand equity except in dermatology Glenmark lags leading companies covered in this report in terms of brand equity. The only therapeutic segment in which Glenmark made its mark is dermatology, in which it ranks second in the industry with market share of 11.5%. In the respiratory segment, Glenmark ranks ninth with market share of 2.8%. Market share in key therapies (%) Growth comparison (%) (2010) 11.5 Avg Gr - Company Avg Gr - Industry Respiratory Dermatology Respiratory Dermatology * Average growth over Source: Industry/MOSL Glenmark has maintained its strong brand equity in the dermatology segment over the years with prescription ranking of No2 and 8% of the prescription market share. It has improved its prescription ranking in the gynecology and CVS segments over the past four years. Glenmark's prescription ranking Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Derma Anti-diabetic Gynaec Respiratory CVS Anti-infectives Source: Industry/MOSL August

136 Glenmark Pharma 3. Distribution and reach: 5/10 Glenmark derives 70% of its revenue from metros and class-i towns against the industry average of 63%. Over the past four years revenue CAGR for all geographies except rural areas has been better than that of the industry average. Glenmark: Geographical distribution of revenues (%) Geographical distribution of revenues: Industry (%) Metros Class I Tow ns Class II to VI Rural Metros Class I Tow ns Class II to VI Rural CY06 CY07 CY08 CY09 CY10 CY06 CY07 CY08 CY09 CY10 Glenmark: Geography-wise growth rates (%) Industry: Geography-wise growth rates (%) Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Metros Class I Tow ns Class II to VI Rural CY07 CY08 CY09 CY10 Source: Industry/MOSL 4. Introductions: 6/10 Glenmark's revenue growth from new launches has been gradually declining over the past few years Glenmark's revenue growth was led mainly by new launches in CY07, CY08 and CY09 but in CY10 the contribution of existing brands to revenue growth was higher than that of new launches. Glenmark launched 26 new products annually on average over the past four years. Average revenue per new launch has risen over the past four years from INR66m to INR90m. August

137 Glenmark Pharma Glenmark: New launches Glenmark: Growth composition (%) No. Of launches in last 2 yrs Avg sales per launch (INR m) New Launches Existing Brands CY07 CY08 CY09 CY10 CY07 CY08 CY09 CY10 Source: Industry/MOSL 5. CAGR and scale up: 8/10 Glenmark posted domestic formulation revenue CAGR of 19% over FY05-11, much faster than the industry average. We believe the company can sustain its out-performance of the industry by changing its therapeutic mix in favor of chronic therapeutics segments and consistent improvement in workforce productivity. We expect Glenmark's domestic formulations business to post 17% CAGR over FY11-13 against the industry's 15-16% CAGR. Glenmark: domestic formulations performance DF revenue (INR m) Grow th (%) ,937 4,290 5,454 6,372 7,529 8,447 9,967 11,562 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL 6. Improvement in MR productivity: 5/10 Glenmark's above-average MR productivity leads growth Glenmark's revenue from the domestic formulations business grew at 17.3% CAGR over FY04-10 and its sales force strength increased by 14.2% CAGR, implying improvement in salesforce productivity. Glenmark's MR productivity improvement is visible from the fact that, in 2004, Glenmark derived sales of INR3.1m per MR, which went up to INR3.6m in FY10. August

138 Glenmark Pharma Glenmark: Salesforce productivity No. of MRs Revenue per MR (INR m) Sales force addition CAGR (%) Productivity Improvement CAGR (%) , Glenmark 1.9 Industry Source: Company/Industry/MOSL 7. Non-domestic business snapshot: 3/10 Positives Trying to build a differentiated portfolio in the US by targeting niche segments of dermatology, oral contraceptive and controlled substances. One of the most successful NCE players from India despite setbacks on some NCEs. Glenmark has generated upfront and milestone income of USD187m from NCEs so far. Glenmark is gradually ramping up its presence in emerging markets. Risks and concerns Working capital intensive operations, especially in emerging markets NCE out-licensing has become difficult and time-consuming, which may lead to higher R&D expenses in coming years. Key news flows/triggers Stoppage of Oxycodone supplies by other generic players in the US will make Glenmark the sole player. Launch of Calcipotriene ointment in the US makes Glenmark the sole supplier. Launch of generic Malarone in the US under agreement with GSK. Signing of NCE out-licensing deals with MNCs. Impact assessment We are neutral on Glenmark's international business given the working capital intensiveness of its emerging market business. We expect the international formlation business to record 17% CAGR for FY Option values include potential NCE out-licensing and the launch of Crofelemer in some emerging markets. August

139 Glenmark Pharma Sales mix (INR m) FY09 FY10 FY11 FY12E FY13E FY11-13E CAGR (%) Formulations 19,188 21,989 25,259 30,821 35, Branded 11,303 14,116 15,963 19,163 22, India 6,372 7,529 8,447 9,967 11, Europe-branded 996 1,363 1,528 1,669 1, Latam-branded 1,580 1,361 1,919 2,478 2, Semi-regulated mkts 2,355 3,864 4,070 5,048 5, Generics 7,885 7,873 9,296 11,658 13, Latin America North America 7,338 7,230 8,352 10,370 12, Europe API 1,972 2,627 3,337 3,610 4, NCE Income , Gross Sales 21,160 24,616 29,491 36,906 40, EBITDA Contribution Non-DF EBITDA 73% DF EBITDA 27% Source: Company/MoSL 8-9. Earnings growth and stock attractiveness: 17/30 Sustaining growth in existing businesses and funding of NCE research expenses has resulted in high leverage for Glenmark. Debt has particularly increased after the credit crisis of FY09 and has not reduced significantly since. We believe the key determinant for Glenmark's valuations will be its ability to de-leverage without sacrificing growth traction. High debt and high working capital are our key concerns for Glenmark. Expect 26% EPS CAGR over FY11-13: We expect Glenmark to record 18.3% topline CAGR over FY11-13 led by 17.1% CAGR in the generic business and 18% CAGR in branded generic business. EPS CAGR is estimated at 26% over FY Glenmark has differentiated itself among Indian pharmaceutical companies through its success in NCE research (resulting in licensing income of USD187m so far). Given this success, Glenmark has been aggressive in adding new NCEs to its pipeline, which will put pressure on its operations in the short to medium term as it will have to fund R&D expenses for these NCEs on its own until they are out-licensed. High interest costs and likely absence of strong forex gains will temper down the strong operational performance for FY12. Low return ratios is our main concern. The stock is valued at 19.7x FY12E and 16.1x FY13E earnings. Maintain Neutral with a target price of INR310 (15x FY13E EPS+ DCF value of INR14 for Para-IV pipeline and crofelemer). Glenmark Pharma RoE & RoCE (%) Glenmark Pharma one year forward PE RoE RoCE E 2013E Aug-06 P/E (x) Avg(x) Peak(x) Min(x) Mar-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 August

140 Glenmark Pharma Glenmark non-domestic business: key trends, triggers & risk Trying to build a differentiated portfolio in the US Glenmark is focusing on filing products in the niche segments of dermatology, controlled substances and hormones for the US market. This coupled with a few FTF filings are expected to be key growth drivers for the US business. However, we are cautious about these product categories given the complexities of manufacturing and the stretched US FDA approval time-lines for ANDA approvals. We estimate Glenmark's US portfolio (exupsides from one-off FTF opportunities) to post revenue of 21% CAGR over FY ANDAs filed/marketed (includes partner filings) As of 31 March 2009 As of 31 March 2010 As of 31 March 2011 Dermatology Controlled substance Modified release Hormones Para-IV FTF Normal generics Total Source: Company/MOSL Para-IV pipeline not significant Unlike some of its peers, Glenmark has not focused on developing a strong patent challenge pipeline for the US. It has a pipeline of six Para-IV products (of which five are FTFs) targeting an innovator market size of USD2.3b. Glenmark: Para IV pipeline Product Indication Brand Innovator Market Status Size (USD m) Ezetimibe Cholesterol Zetia Schering 1500 Has tentative approval with FTF. Sued on 22-Mar month (Merck) stay period expired in Oct Court case started in May-10. Signed licensing & cost-sharing deal with Par Pharma on 04-May-10 for small upfront payment. Par to share risks/costs of litigation as well as profits. Settled out-of-court with innovator. Launch scheduled on 12-Dec-2016 Tradolapril + Anti- Tarka Abbott/ 58 Glenmark is FTF and was sued on 07-Dec month stay expired in Verapamil hypertensive Sanofi May Received final approval on 10-May Innovator's summary motion rejected. Glenmark launched "at-risk" in Jun-10; Federal Jury ruled against Glenmark in Jan-2011 and awarded Abbott USD16m in damages post which Glenmark has stopped further sales. District Court Judge's ruling will determine the final outcome with losing party having right to appeal to the Federal Circuit Court Fluticasone Dermatology Cutivate Nycomed 48 Glenmark seems the FTF. Sued on 12-Dec-08. Received final approval lotion 0.005% on 02-May Settled out-of-court with Nycomed for potential launch in Mar Glenmark will pay mid-teens royalty to Nycomed. Only one other generic filing till date Atovaquone Anti-malarial Malarone GSK 58 Glenmark has FTF. GSK sued Glenmark on 17-Aug-09. Settled out-of-court Proguanil HCl on 12-Apr-10. Launch scheduled in Sep-2011 with 180-day exclusivity. No 250mg/100mg tablets AzG. Glenmark seems to be the only filer till and date Oxycodone NA Pre Not an FTF product. Glenmark's partner Lehigh Valley Tech (LVT) Hydrochloride product has filed NDA with US FDA since it is a pre-1938 product. NDA Capsules & approval awaited. If successfully approved all other generic players Liquid Solution will have to file ANDAs referencing Glenmark's product & hence could give Glenmark ~18 months of indirect exclusivity. Product has to be manufactured in the US as it is a controlled substance August

141 Glenmark Pharma Glenmark: Para IV pipeline Product Indication Brand Innovator Market Status Size (USD m) Calcipotriene Dermatology Dovonex Leo Pharma 93 Leo Pharma discontinued marketing in 2007 when annual revenues were ointment USD93m as it planned to shift prescriptions to a combination but has not been successful. Glenmark currently is the only approved product on the market. It has tied up with Taro exclusively for branding & promoting the product. Current revenue run-rate will be much lower than USD93m (likely to be USD25m for FY11) as the product has not been promoted for the past 3 years. Glenmark to receive small milestone income prior to launch & then royalty on Taro's sales. Royalty will be minimum 30% Eszopiclone Insomnia Lunesta Sunovion 787 Settled with Sepracor on 9th Aug As per settlement Glenmark tablets can launch after 30-Nov-2013, which is 2.5months prior to the expiry of '673 patent, or after 30-May-2014 if Sepracor obtains pediatric exclusivity. Other Para IV filers are Teva, DRL, Cobalt, Orchid, Lupin, Roxane, Wockhardt and Sun. Settled with Lupin, Wockhardt, Cobalt and Teva. Received tentative approval on 22- Dec-10 Hydrocortisone Eczema Locoid Astellas 38 Glenmark has FTF. Sued on 04-Nov-10. The 30-month stay expires in May- Butyrate (Dermatology) Lipo- /Triax Patent expires on 03-Jun Settled out-of-court on 25-May-2011 cream with launch scheduled in 3QFY12. There will be no AzG, but Glenmark will have to pay royalty to the innovator. Royalty amount/ percentage not disclosed Rosuvastatin Cholesterol Crestor AstraZeneca 3600 Glenmark not sued till date. The '314 patent expiring in 2016 has been upheld Calcium by court. Astra sued 8 generic players in Apr-10 for the '152 patent expiring on 02-apr-2018 and '618 patent expiring on 17-Dec Glenmark's 30- month stay expires in Nov Patent litigation is on. No timelines known Atomoxetine Attention- Strattera Eli Lilly generic players have FTF status alongwith Glenmark. Many generic filings HCl Deficit/ with Para-IV status - Teva, Sandoz, Actavis, Mylan, Glenmark, Cadila, Apotex, Hyperactivity Aurobindo, Synthon. DRL has tentative approval (ADHD) Fluocinonide Dermatology Vanos Medicis 30 Perriogo seems to be the FTF. Other generic players with Para-IV filings include Glenmark, Taro & Nycomed. Perrigo has settled with launch scheduled in Dec Glenmark & Taro have also settled with launch scheduled in Dec Glenmark's 30-month stay expires in Nov-2011 Source: Company/MOSL Tarka has witnessed negative news flow On 15 January 2011, a US jury ruled against Glenmark on one of the contentions of the patent litigation for generic Tarka (a USD58m brand) at a US District Court (lower court). The federal jury rejected Glenmark's challenge to the validity of a Sanofi patent that expires in February Glenmark had argued that the patent covered an invention that was protected by an expired patent. Abbott markets the drug in the US and sought USD25m as compensation from Glenmark and the US jury awarded damages of USD16m. The District Court judge will now have to either accept or reject the jury ruling on this aspect of invalidation and give a ruling on other aspects of the case. The final outcome of the case will depend on what the judge rules on all the aspects of the case (the ruling is expected in next few weeks). August

142 Glenmark Pharma Glenmark undertook an "at-risk" launch of generic Tarka in the US in June Glenmark generates US$5m in revenue per quarter from generic Tarka with about 55% PAT margins resulting in USD2.75m PAT per quarter. For FY11, we estimated one-time PAT of USD8m from this opportunity for Glenmark. The jury ruling implies potential damages of USD16m which Glenmark will have to pay Abbott if it loses the case. Glenmark has temporarily halted sales of generic Tarka until the District Court judge gives a ruling. Identifying niche opportunities in the US Besides Para-IV filings, identifying niche, low-competition opportunities in the US is a key focus area of Glenmark's US strategy. It has met with some success in this strategy with Oxycodone and Calcipotriene. (A) Oxycodone Glenmark's US partner, Lehigh Valley Technologies (LVT), received NDA approval for Oxycodone 5mg capsule and 100mg/5mL oral solution in June LVT will make the product and while Glenmark will have exclusive distribution rights for these dosages in the US (market size of USD13m/year). Background to the NDA filing Since Oxycodone is a pre-1938 product all generic players launched their generic versions in the US without US FDA approvals. The US FDA has been gradually trying to get the products approved. As part of this process, LVT filed an NDA for the 5mg capsules and 100mg/5mL oral solution with the US FDA, which has been approved. As per US FDA guidelines, a successful NDA approval will force the remaining generic companies to withdraw from the market and re-file their products with reference to LVT's approved NDA. The US FDA will issue a warning letter to the remaining generic players to withdraw their versions from the market after it is convinced that it will not lead to drug shortages and that Glenmark/LVT will be able to meet the demand. US FDA approval time-lines for ANDAs is approximately for months. This will result in Glenmark/LVT being the only approved Oxycodone player in the market for the next 24 months. Sole player - may be able to raise prices Being the sole player in the market, Glenmark/LVT will enjoy indirect exclusivity for the dosages until other generic players receive new approvals. This product will qualify as a niche (high margin) opportunity targeted by Glenmark in the US market. Absence of other generic players (for ~24 months) will give it an opportunity to raise prices of Oxycodone, enhancing the size of the opportunity to US$25m-30m over the next 12 months. (B) Calcipotriene Glenmark is the only US FDA approved player in the Calcipotriene ointment market. Leo Pharma discontinued marketing in 2007 when annual revenue was USD93m as it planned to shift prescriptions to a combination of Calcipotriene & Betamethasone but has not been successful. Glenmark is the only approved product on the market. It has tied up with Taro exclusively to brand and promote the product. Current revenue run-rate will be lower than US$93m (likely to be USD25m) as the product has not been promoted over the past three years. August

143 Glenmark Pharma We expect Glenmark/Taro to launch this product in FY12. It will receive a small milestone income prior to launch and then royalty on Taro's sales. While Glenmark has not disclosed financial details of its tie-up with Taro, we believe the royalty will be fairly remunerative. Most successful NCE company from India so far Glenmark has been one of the most successful NCE companies from India, generating ~USD202m in upfront and licensing income over the past decade. This is despite its being a relatively late entrant in this segment compared with the likes of Ranbaxy and Dr Reddy's. Glenmark - NCE Pipeline Snapshot Molecule Indication Clinical Trials Out-licensing Licensing Income (USD m) Partner Upfront Mile- Total Estimated stones Deal Value Melogliptin Diabetes - DPP IV Phase-IIb completed Initially Merck KgA 31 - Partner returned (GRC 8200) Inhibitor but molecule returned molecule to Glenmark Revamilast Rheumatoid Arthritis, Initiated Phase-II (GRC 4039) Asthma trials in UK, Poland, India, Czech Republic and Philippines in Aug-2011 Tedalinab Neuropathic pain, Phase-I completed (GRC 10693) Osteoarthritis and To initiate Phase-II Inflammatory pain. in FY12 Initially targeted for Neuropathic pain GRC Osteoarthritis, Phase I completed Sanofi Neuropathic pain in UK GBR 500 Crohn's disease & Phase I completed Sanofi Multiple Sclerosis in US GBR 600 Acute Stroke/ To initiate Phase-I - - Coronary Syndrome, in UK Thrombosis Cardiovascular Disorders GRC Osteoarthritis, Phase I in Neuropathic pain & Netherlands Respiratory disorders Oglemilast Asthma, COPD Partner stopped Forest/Teijin Clinical development clinical development stopped post Phase-IIb GRC 6211 Osteoarthritis, Partner stopped Eli Lilly 45 Clinical development Neuropathic pain, clinical development stopped Dental pain, post Phase-IIb Incontinence Crofelemer Adult acute Completed Phase III In-licensed from 15 Glenmark holds rights infectious diarrhoea, in US and Phase IIb Napo Pharma only for 140 RoW HIV-related diarrhoea in India markets and not for regulated markets Total Source: Company/MOSL August

144 Glenmark Pharma Out-licensing of NCEs imperative to control R&D costs Glenmark has a pipeline of Eight NCEs undergoing clinical development. Since NCE research has been a differentiating factor for Glenmark compared with its peers, and since it is the most successful NCE research company from India so far, the company has been prompted to aggressively add new NCEs to its pipeline. As these NCEs progress in clinical trials, they will put pressure on Glenmark's P&L in the short to medium term as it will have to fund R&D expenses for these NCEs on its own. Hence, we believe, outlicensing of some of these NCEs is imperative to control the expected increase in R&D costs. Crofelemer: Not a big opportunity Glenmark has in-licensed this NCE from Napo and holds distribution and marketing rights for 140 emerging markets. It does not hold rights for the product in regulated markets. A launch across 140 emerging markets will be phased. Glenmark has, in the past, indicated peak revenue of USD80m from this product (across unregulated markets that Glenmark will target). Revenue ramp-up will be phased from FY13/14 and is likely to take a few years. We believe the profitability of this product for Glenmark will not be very high due to: 1. Relatively low profitability (compared with other NCEs) given the difficulty in manufacturing such products and lower flexibility in pricing the product since it is related to HIV. 2. Payment of single-digit royalty on sales by Glenmark to Napo. 3. We do not expect a big upside for Glenmark from this opportunity. We estimate the DCF value of this opportunity at INR9/share for Glenmark. Glenmark - Crofelemer DCF Valuation (USD m) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 Total Market Size Regulated Markets Semi-regulated Markets (SRM) Glenmark - Upside from SRM Revenues EBITDA Margin (%) EBITDA Royalty to Napo at 8% of revenues (assumed) PAT Glenmark - Upside from Regulated Markets Salix/Napo's revenues Patent Expiry Cost of API (%) Glenmark's revenue from API supplies PAT margin (%) PAT from API supplies Total upside for Glenmark WACC (%) Year PV of cash inflow Exchange Rate (INR/USD) PV (INR m) Total PV (INR m) 2,484 Total PV per share (INR) 9 Source: Company/MOSL August

145 Glenmark Pharma Strong growth in emerging markets but working capital intensive Glenmark's revenue in emerging markets have grown 4x over FY05-11, albeit on a low base. These include markets like Latin America, Australasia, Africa, Russia and the CIS and parts of eastern and central Europe. Barring a slowdown in FY09, due to the credit crisis, the portfolio has been growing steadily over the years. However, we believe this growth traction has been partly achieved by expanding working capital in the business leading to increased borrowings. We believe Glenmark must strike an optimum balance between growth and working capital in these markets. We expect this portfolio to record 19% revenue CAGR over FY11-13, partly impacted by a potential rupee appreciation against the US dollar. High debt, working capital key concerns High net debt of over INR18b and net working capital of ~INR18b are key concern areas. While Glenmark is attempting to reduce its working capital requirements, we believe it may not be easy for it to reduce it significantly without sacrificing growth, resulting in slower progress on this front. Sales ramp-up v/s net working capital (INR b) Revenue (Ex-NCE income) Non Cash WC FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Source: Company/MOSL August

146 Glenmark Pharma Financials and valuations: Glenmark Pharma Income Statement (INR Million) Y/E March E 2013E Net Sales 24,616 29,491 37,007 40,693 Change (%) Materials Consumed 8,061 9,918 11,396 13,211 Personnel Expenses 3,425 5,103 5,613 6,455 R&D Expenses 1,200 1,386 1,899 2,442 Other Expenses 5,966 7,161 8,288 9,608 Total Expenditure 18,653 23,568 27,196 31,716 EBITDA 5,963 5,923 9,811 8,977 Change (%) Margin (%) Adjusted EBITDA 5,963 5,028 7,336 8,317 Margin (%) Depreciation 1, ,086 1,186 EBIT 4,757 4,976 8,725 7,791 Interest 1,640 1,566 1,482 1,276 OI & forex gains/losses 722 1, PBT before EO Expense 3,839 4,816 7,805 7,162 Change (%) PBT after EO Exp. 3,839 4,816 7,805 7,162 Tax Tax Rate (%) Reported PAT 3,310 4,578 6,812 6,186 Adj PAT** 3,310 3,548 4,584 5,612 Change (%) Margin (%) ** - Excl NCE upsides & incl adjustment for R&D exp capitalization Balance Sheet (INR Million) Y/E March E 2013E Equity Share Capital Fully Diluted Eq Cap Reserves 23,282 20,102 26,678 32,549 Net Worth 23,551 20,372 26,948 32,819 Minority Interest Loans 18,693 21,258 18,258 15,758 Deferred liabilities Capital Employed 43,085 40,816 44,391 47,763 Gross Block 21,586 25,899 28,399 30,899 Less: Accum. Deprn. 3,929 4,876 5,962 7,148 Net Fixed Assets 17,656 21,023 22,437 23,751 Capital WIP 6,224 1,100 1,100 1,100 Investments Intangibles (net) 7,259 10,329 9,606 8,934 Curr. Assets 24,210 25,988 30,608 33,643 Inventory 7,085 8,070 10,407 11,483 Account Receivables 10,783 11,308 12,772 13,936 Cash and Bank Balance 1,069 1,959 1,752 1,535 Others 5,273 4,651 5,676 6,689 Curr. Liability & Prov. 5,186 7,605 10,063 11,041 Account Payables 4,987 7,560 9,663 10,591 Provisions Net Current Assets 19,023 18,384 20,545 22,602 Appl. of Funds 43,085 40,816 44,391 47,763 E: MOSL Estimates Ratios Y/E March E 2013E Basic (INR) EPS (Fully diluted)* Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E (Fully diluted) PEG (x) Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Capital (Days) Leverage Ratio (x) Current Ratio Debt/Equity Cash Flow Statement (INR Million) Y/E March E 2013E Op. Profit/(Loss) before Tax 5,963 5,923 9,811 8,977 Interest/Dividends Recd , Direct Taxes Paid , (Inc)/Dec in WC -2,441 1,530-2,368-2,275 CF from Operations 3,857 6,829 7,012 6,373 CF frm Op.incl EO Exp. 3,857 6,829 7,012 6,373 (Inc)/Dec in FA -3, ,500-2,500 CF from Investments -3, ,500-2,500 Change in Networth 4,386-7, Inc/(Dec) in Debt -2,151 2,701-3,000-2,500 Interest Paid -1,640-1,566-1,482-1,276 Dividend Paid CF from Fin. Activity 468-6,621-4,718-4,090 Inc/Dec of Cash Add: Beginning Balance 715 1,069 1,959 1,752 Closing Balance 1,069 1,959 1,752 1,535 Note: Reported cashflow differs due to acquisitions & change to IFRS reporting from FY09 onwards August

147 Domestic Formulations New Peaks NOTES August

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