BUY CIPLA INDIA. Steady growth, margin visibility amid headwinds. Target Price: Rs 675. Key drivers

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1 13 NOV 2017 Quarterly Update BUY Target Price: Rs 675 Steady growth, margin visibility amid headwinds Cipla s Q2 EBITDA margin improved 156 bps YoY at 19.7% (despite 270 bps YoY decline in gross margin) led by operating leverage (higher domestic sales) and increasing cost efficiencies (which it expects to improve further in H2FY18/FY19). Management expectation of recovery in gross margin (to ~63.5%-64%) and steady India growth (at 14-15% YoY) are positive margin drivers, though it will be partly offset by higher competition in recently-launched grenvela and 200 bps increase in R&D to 8% of sales in H2. It expects filing/ approval intensity to ramp up with a good mix of differentiated products. Maintain BUY with revised TP of Rs 675 (21x Sep 19 EPS vs. 21x FY19E earlier) on strong domestic franchise coupled with scale-up in US with higher focus on R&D and relatively better regulatory track record. CMP : Rs 608 Potential Upside : 11% MARKET DATA No. of Shares : 805 mn Free Float : 63% Market Cap : Rs 490 bn 52-week High / Low : Rs 663 / Rs 479 Avg. Daily vol. (6mth) : 1.4 mn shares Bloomberg Code : Cipla IB Equity Promoters Holding : 37% FII / DII : 22% / 15% In-line revenue led by 12% YoY growth in India sales partially led by trade channel restocking. Normalized India sales (adjusted for excise duty impact under GST) grew 19% YoY. Trade channel inventory is ~8-10 days below pre-gst inventory level. Expects mid teen growth over remaining H2FY18 in India business. US business declined 3% YoY/ 4% QoQ to USD 96 mn owing to pricing pressure. Expects key product approvals in the US to drive good mix of differentiated product launches in the upcoming quarters. South Africa business grew 17% YoY in USD terms and 13% YoY in INR terms driven by above market growth in the private market. Europe business grew 14% YoY. API revenue grew 85% YoY (up 64% QoQ) driven by higher ARV sales to US/EU customers Strong EBITDA margin performance: Gross margin at 61.1% contracted 270 bps YoY/ 466 bps QoQ impacted by GST, certain inventory charges, and manufacturing of batch quantities of future R&D filings. It is expected to normalize to %. However, EBITDA margin improved 156 bps YoY /136 bps QoQ at 19.7% led by operational efficiencies, lower R&D spend. Other expenses at Rs 10.6 bn (flat YoY) stood at 26.7% of sales (29% of sales in Q2FY17). Staff cost at Rs 6.6 bn (declined 2% YoY) stood at 16.6% of sales (18.4% of sales in Q2FY17). Financial summary (Consolidated) Sales (Rs mn) 1,42,809 1,50,557 1,76,416 2,04,613 Adj PAT (Rs mn) 10,064 15,873 22,950 28,777 Con. EPS* (Rs.) EPS (Rs.) Key drivers (Continued on page 2 ) Growth (% ) FY17 FY18E FY19E US India EBITDA margin core-eps (1) Chg YOY (%) (26.1) P/E (x) RoE (%) RoCE (%) EV/E (x) DPS Source: *Consensus broker estimates, Company, Axis Capital ^cc: Constant Currency Price performance 140 Sensex Cipla Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 01

2 ( Continued from page 1) Other concall highlights: (1) Margin guidance: Targets to improve EBITDA by 100 bps annually led by cost-saving initiatives; (2) ANDA filings: Filed 5 products in Q2, of which 2 are expected to be limited competition. On track to file ANDAs in FY18 (filed 8 in H1FY18); (3) R&D: R&D spends of Rs 2.5 bn (down 15% YoY) at 6.1% of Q2FY18 sales (vs. 8% in Q2FY17/6% in Q1FY18). Cipla expects R&D to scale up to ~8% of sales in H2FY18, with commencement of clinical trials for respiratory pipeline; (4) Capex: Rs 8 bn-8.5 bn in FY18 (Rs 1.69 bn in Q2FY18); (5) FCF of Rs 3.09 bn in Q2FY18; (6) Sevelamer: Significant price erosion seen given 4 generic players and authorized generic; (7) gseroflo (Advair) launch in Australia received well and has witnessed strong uptake; uptake in UK remains gradual EBITDA margin expansion driven by operational efficiency and control on spends (Rs mn) Q2'17 Q1'18 Q2'18 YoY (%) QoQ (%) Net sales 36,719 34,323 39, Other operating income Total revenue 37,510 35,251 40, Gross profit 24,210 23,484 25, Gross margin bps -466 bps Staff 6,753 6,729 6,608 (2) (2) % to Sales bps -304 bps Other Op. expenses 10,650 10,290 10,641 (0) 3 % to Sales bps -330 bps EBITDA 6,807 6,465 8, EBITDA margin bps 136 bps Interest Depreciation 2,292 2,134 3, Other Income 272 1,514 1, (25) PBT 4,436 5,565 5, Tax 719 1,308 1, Tax rate 16% 23% 24% 8 bps 0 bps Reported PAT 3,543 4,088 4, Source: Company *Q2FY18 depreciation contains USD 11 mn expenses related to impairment of Invagen assets, Q2FY18 other income contains ~USD 11 mn compensation under negotiated settlement amount Recovery in domestic business; good growth in South Africa (Rs mn) Q2'17 Q1'18 Q2'18 YoY (%) QoQ (%) India 14,690 12,710 16, South Africa 4,590 4,880 5, North America 6,640 6,460 6,180 (7) (4) North America (USD mn) (3) (4) Emerging Markets 8,300 7,250 8, Europe 1,330 1,640 1, (8) API 1,150 1,300 2, Others 810 1, (1) (21) Total 37,510 35,250 40, Source: Company, Axis 02

3 Pace of approvals improves for Cipla in CY17 YTD 13 NOV 2017 Quarterly Update Brand Sales No of Generic Approval Date Generic name Brand name Approval Facility (USD mn) Players Atorvastatin Calcium Tablet Lipitor FA Invagen Oxaliplatin Eloxatin FA Cipla US Lamvudine Tablets Epivir NA 8 FA Cipla US Darunavir Ethanolate Tablets Prezista TA Cipla US Abacavir, lamivusine Epzicom FA Cipla US Fenofibrate (Micronized) Capsules NA 38 8 FA Invagen Clindamycin Palmitate Hydrochloride (Oral Solution) Cleocin 71 6 FA Invagen Efavirenz Sustiva TA Cipla US Lisinopril and Hydrochlorothiazide Zestoretic FA Invagen Olopatadine Hcl - 0.2% Ophthalmic solution Pataday TA Cipla US Nevirapine - Oral Suspension Viramune NA 2 FA Cipla US Arformoterol Tartrate (Solution; Inhalation) Brovana TA Cipla US Bupropion Hcl Tablets Wellbutrin FA Invagen Sevelamer Carbonate Renvela FA Invagen Zoledronic Acid (4MG/Vial) Zometa 96 2 FA Cipla US Source: Company, USFDA Conference call highlights Guidance Filings: Targets ANDA filings in FY18. Filed 5 ANDA s in Q2FY18, of which its expects 2 filings to be limited competition Margin guidance: Targets to improve EBITDA by 100 bps annually led by its cost saving initiatives R&D: Expects R&D to increase to ~8% of sales in H2FY18 (~6.1% of sales in Q2FY18) with commencement of clinical trials for respiratory pipeline from Q3FY18 Capex: Rs 8 bn-8.5 bn in FY18 (Rs 1.69 bn in Q2FY18) North America (USD 96 mn, -3%YoY, 15% of Q2 sales) Key product approvals in the US to drive good mix of differentiated product launches in upcoming quarters grenvela: 4 generic players and an authorized generic player Cipla has cumulatively 71 ANDA s pending approval (incl. tentative approvals Cipla:49, Invagen: 22, Partnered ANDA s:11) including 12 FTF s (market size worth USD 20 bn). Targets ANDA filings in FY18 India (Rs 16.5 bn, +12% YoY, 40% of Q2 sales) Normalized India sales (adj. for excise duty impact under GST; Rs 1 bn impact) grew 19% YoY, partially led by channel restocking Channel inventory currently ~8-10 days below pre-gst inventory level Expects mid teen growth over remaining H2FY18 in India business South Africa (USD 81 mn, +17% YoY, 13% of Q2 sales) As per IMS MAT (Sep 17), Cipla grew at 11.3% in the private market vs. 9.5% market growth 03

4 Launched 8 new products in H1FY18 with a combined total market value of ZAR 490 mn in South Africa Emerging Markets (USD 71 mn, +15% YoY, 21% of Q2 sales) Double digit in-market sales growth across key DTM markets gseroflo (Advair) launch in Australia received well and, has witnessed strong uptake Business profitability improved during the quarter driven by greater share of high-margin SKUs in product mix Cipla s Global access business grew 7% YoY; increasingly focusing on partnering with other regional governments to increase access to affordable care in various parts of Africa Europe (USD 23 mn, +18% YoY, 4% of Q2 sales) Launched gseroflo in Ireland during the quarter; to launch soon in other parts of Europe including Sweden and Finland Improvement in overall profitability driven by focus on high margin SKUs and nimble operations API (USD 33 mn, +92% YoY, 5% of Q2 sales) Strong growth in Q2FY18 on higher ARV sales (API supplies to customer/partner for prospective monetization of ARV generic formulations Cipla may receive profit share from partners) P&L and balance sheet highlights Lower gross margin in Q2FY18 impacted by certain inventory charges, manufacturing of batch quantities of future R&D filings, NPPA-led pricing adjustments and product mix Expects gross margin to improve to 63.5%-64% in upcoming quarters Higher D&A in Q2FY18 due to write-down of US-based intangibles due to delay in launch of certain products (~USD 11mn) Higher other income in Q2FY18 on receipt of compensation under negotiated settlement amount (~USD 11 mn) FCF of Rs 3.09 bn in Q2FY18 Capex of Rs 1.69 bn in Q2FY18 Gross debt of USD 550 mn as of end H1FY18. Outstanding working capital loans of USD 187 mn Balance sheet hedges of USD 14 mn, ZAR 255 mn, EUR 6 mn, cash flow hedges of USD 108 mn, ZAR 252 mn 04

5 (%) Volumes declined in Q2 18 Volume Price New product (1) (1) (4) (10) FY15 FY16 FY17 Q2'17 Q1'18 Q2'18 Source: AIOCD led by weak anti-infective sales YoY growth % of sales FY16 FY17 Q2'17 Q1'18 Q2'18 Respiratory 31% 12% 12% 14% 8% 4% Anti-Infectives 25% 14% -2% 1% -3% -11% Cardiac 12% 7% 13% 5% 3% -4% Gastro Intestinal 8% 21% 12% 11% 4% -9% Opthal 3% 15% 6% -3% 2% -7% Neuro / CNS 4% 17% 9% -13% -1% -6% Pain / Analgesics 3% 31% 12% 10% -2% -7% Derma 3% 14% 9% 6% -9% -16% Gynaecological 2% 8% -1% -6% -9% -18% Vit/Min/ Nut 2% 7% -5% 7% -12% -9% Total (Rs bn) 53 13% 8% 6% 3% -1% Source: AIOCD We expect strong scale-up in US revenue Invagen + Exelan Base Cipla Base business New Launches (USD mn) FY16 FY17 FY18E FY19E FY20E Source: Company, Axis Capital 05

6 Financial summary (Consolidated) Profit & loss (Rs mn) Net sales 1,42,809 1,50,557 1,76,416 2,04,613 Other operating income 3,494 4,193 5,241 6,551 Total operating income 1,46,302 1,54,750 1,81,657 2,11,164 Cost of goods sold (53,171) (54,953) (63,510) (73,661) Gross profit 93,131 99,796 1,18,147 1,37,503 Gross margin (%) Total operating expenses (68,373) (70,451) (79,567) (91,254) EBITDA 24,758 29,345 38,580 46,249 EBITDA margin (%) Depreciation (13,229) (9,957) (10,892) (11,747) EBIT 11,529 19,388 27,688 34,502 Net interest (1,594) (1,183) (685) (125) Other income 2,287 3,173 2,773 2,773 Profit before tax 12,222 21,379 29,776 37,151 Total taxation (1,798) (5,131) (6,551) (8,173) Tax rate (%) Profit after tax 10,424 16,248 23,225 28,977 Minorities (360) (375) (275) (200) Profit/ Loss associate co(s) Adjusted net profit 10,064 15,873 22,950 28,777 Adj. PAT margin (%) Net non-recurring items (1,796) Reported net profit 8,268 15,873 22,950 28,777 Balance sheet (Rs mn) Paid-up capital 1,609 1,609 1,609 1,609 Reserves & surplus 1,23,645 1,37,582 1,58,596 1,85,437 Net worth 1,25,254 1,39,191 1,60,205 1,87,046 Borrowing 41,126 31,126 17,126 3,126 Other non-current liabilities 7,569 7,569 7,569 7,569 Total liabilities 1,78,331 1,82,643 1,89,932 2,02,973 Gross fixed assets 1,13,053 1,20,214 1,27,442 1,35,233 Less: Depreciation (18,333) (28,290) (39,182) (50,929) Net fixed assets 94,720 91,924 88,259 84,304 Add: Capital WIP 16,830 16,830 16,830 16,830 Total fixed assets 1,11,550 1,08,754 1,05,089 1,01,134 Total Investment 9,748 9,942 10,141 10,344 Inventory 34,853 41,229 47,039 54,218 Debtors 24,974 26,812 31,417 36,438 Cash & bank 6,242 7,249 8,278 14,238 Loans & advances 22,334 20,624 24,167 28,029 Current liabilities 31,369 31,967 36,198 41,428 Net current assets 57,034 63,947 74,702 91,495 Other non-current assets Total assets 1,78,331 1,82,643 1,89,932 2,02,973 Source: Company, Axis Capital Cash flow (Rs mn) 13 NOV 2017 Quarterly Update Profit before tax 12,222 21,379 29,776 37,151 Depreciation & Amortisation 13,229 9,957 10,892 11,747 Chg in working capital 2,307 (5,906) (9,725) (10,834) Cash flow from operations 24,849 21,481 25,077 30,015 Capital expenditure (12,862) (8,500) (8,500) (9,000) Cash flow from investing (13,127) (8,500) (8,500) (9,000) Equity raised/ (repaid) Debt raised/ (repaid) (8,482) (10,000) (14,000) (14,000) Dividend paid (1,936) (1,936) (1,936) (1,936) Cash flow from financing (10,417) (11,936) (15,936) (15,936) Net chg in cash 1,306 1, ,079 Key ratios OPERATIONAL FDEPS (Rs) CEPS (Rs) DPS (Rs) Dividend payout ratio (%) GROWTH Net sales (%) EBITDA (%) (0.2) Adj net profit (%) (26.0) FDEPS (%) (26.1) PERFORMANCE RoE (%) RoCE (%) EFFICIENCY Asset turnover (x) Sales/ total assets (x) Working capital/ sales (x) Receivable days Inventory days Payable days FINANCIAL STABILITY Total debt/ equity (x) Net debt/ equity (x) (0.1) Current ratio (x) Interest cover (x) VALUATION PE (x) EV/ EBITDA (x) EV/ Net sales (x) PB (x) Dividend yield (%) Free cash flow yield (%) Source: Company, Axis Capital 06

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