Dishman Pharma (DISPHA)

Transcription

1 March 27, 28 Pharmaceutical Initiating coverage Dishman Pharma (DISPHA) Building blocks of growth Dishman Pharmaceuticals and Chemicals is a leading CRAMS (contract research and manufacturing services) player catering exclusively to innovator companies. The company has high earnings visibility from longterm contracts for supply of pharmaceutical ingredients. Further, inorganic growth through overseas acquisitions may add to revenues. With increasing execution and robust growth in its non-crams business, we expect the company to register robust CAGR of 3% in top-line and 31% in bottom-line over FY7-1E. We initiate coverage on the company with an OUTPERFORMER rating. Key businesses in full throttle Dishman s model has two major segments that of CRAMS and marketable molecules. Both businesses seem poised for growth on supplies for new contracts, and increased off-take on existing contracts. We believe revenue from the high-margin CRAMS segment would account for 74% of overall revenue of Rs 1,271 crore in FY1E. Further, 68% of the CRAMS revenues are expected to accrue from the high-end contract research projects undertaken by subsidiary, Carbogen Amcis. Inorganic growth route: Increasing reach and boosting product mix In Aug 26, Dishman acquired Swiss research-based company, Carbogen Amcis. In Q4CY7, it acquired the Vitamin-D business of Solvay Pharmaceuticals. The acquisition of Carbogen boosted its CRAMS business. The Solvay acquisition is expected to enhance the marketable molecules business by adding new products and boost top line by an additional million. Dishman is planning yet another acquisition in the biotech space. Focus on high-end services to enhance margins We expect the strong focus on the high-margin CRAMS business and increasing revenue contribution from Carbigen to result to margin expansion by 496 bps to 24.86% in FY1E from 19.9% in FY7. We expect Carbogen s revenues to increase at a 35% CAGR over FY7-1E to Rs crore. Valuations We have used a SOTP valuation methodology to value the stock. We value the CRAMS business at 15x FY1E EPS at Rs 292 per share, and non-crams business at 8x FY1E EPS at Rs 54 per share. We arrive at a fair value of Rs 346 per share, which is 13.2x FY1E EPS of Rs Current price Rs 277 Potential upside 25% Analyst s Name Target price Rs 346 Time Frame months OUTPERFORMER Raghvendra Kumar raghvendra.kumar@icicidirect.com Sales & EPS trend FY6 FY7 FY8E FY9E FY1E Net sales (Rs, Crore) EPS (Rs) Stock metrics Reuters code DISH.BO Bloomberg code DISH IN Face Value Rs 2 Promoters holding Market Cap (Rs crore) Week H/L (Rs) 427 / 198 Sensex Average volume Comparative return metrics Stock return (%) 3 M 6M 12M Biocon Ranbaxy Dr Reddy s Lab Glenmark Divi s Lab Jubilant Org N Piramal Dishman Exhibit 1: Key Financials Year to March 31 FY6 FY7 FY8E FY9E FY1E Net sales (Rs crore) Net profit (Rs crore) Shares in issue (crore) EPS (Rs) P/E (x) Price/Book (x) EV/EBIDTA RoNW (%) 26.83% 29.43% 26.23% 27.69% 26.12% RoCE (%) 1.7% 1.1% 1.26% 15.22% 17.41% ICICIdirect Equity Research Price Trend (Rs.) 5 Absolute sell 4 3 Current market price 2 Absolute b 1 Apr-4 Oct-4 Apr-5 Oct-5 Apr-6 Oct-6 Apr-7 Oct- 1 P age

2 INDEX OF CONTENT Particular Page Number Company Background 3 The Evolution 3 Business Model 4 Manufacturing Capability 4 Investment Rationale 6 Traction in CRAMS business improves visibility 6 CRAMS revenue set to rise at 31% CAGR 6 Acquisition of Carbogen-Amcis margin accretive 8 Execution capacity enables Dishman to ramp-up revenue fast 9 Marketable molecules business: A smooth cash cow 1 Two pronged strategy - boost marketable molecule via Inorganic route 1 Post integration EBIDTA margin set to rise 1 High-end products being added to portfolio via the acquisition 1 Marketable molecules business set to grow at 12% CAGR 11 Top line set to grow at 28% 11 Business model and assumptions 12 Financial 13 Change in revenue mix to boost margins 13 Consolidated revenue to rise at 3% 14 EBIDTA margin expected to improve by 496 bps 14 OPM and NPM likely to expand 15 Healthy cash generation provides a fillip for inorganic growth 15 RoNW is likely see some pressure due to rising tax and FCCB conversion 17 Return on invested capital shows a rising trend 18 Net profit set to grow at 31% CAGR over FY7-1E 18 Risks & Concerns 19 Valuations 2 Valuation band indicate imminent re-rating 2 Annexure 1: CRAMS: An attractive play for Indian CRO and CMO 24 Annexure 2: Other alliances 29 2 P age

3 COMPANY BACKGROUND Dishman Pharmaceuticals is a Gujarat-based pharmaceutical company, which focuses on contract manufacturing for multinational pharma companies. The company was incorporated in 1983 as a researchoriented company, but witnessed little commercial activity in its early years. It started operations with production of a range of phase transfer catalysts and quaternary ammonium and phosphonium compounds in Gradually, it transformed itself into a CRAMS player. It acquired critical scale after the acquisition of Carbogen Amcis in 26 and is today a major CRAMS player. The evolution Dishman Pharma was incorporated in In 1989, it started manufacturing phase transfer catalysts and quaternary ammonium and phosphonium compounds. Later in 1995, it formed a joint venture, Schütz Dishman Biotech Private Ltd, with Schütz & Co of Germany to manufacture few biotech products for the European market. Visualizing the changing trends in the global pharma industry for outsourcing, Dishman embarked upon CRAMS operations. In 1997, the company repositioned itself as a large contract manufacture outsourcing organisation in India and entered into its first major long-term contract with a European company. Share holding pattern Shareholder % holding Promoters Institutional investors 3.1 Other investors 3.85 General public Promoter & Institutional holding pattern (%) Q4FY7 Q1FY8 Q2FY8 Q3FY8 In August 26, Dishman acquired Swiss research-based company, Carbogen Amcis for US$75 million (including US$9 million in working capital), as a debt-free company. Carbogen Amcis has world-class research and development facilities at three sites in Switzerland Aarau, Bubendorf, and Neuland. All intellectual property, patents and trademarks, customer contracts, as well as employees of the pharmaceutical services business were included in the transaction. Carbogen differentiates itself by the quality of its technical capabilities and its integrated platform. Promoter Holding (%) Institutional Holding (%) Carbogen-Amcis was formed with the merger of Carbogen and Amcis in 26 prior to Dishman s acquisition from Solutia Europe SA/NV. At the time of acquisition, Carbogen Amcis was a profit making organization with an EBIDTA margin of over 23%. Due to the debt-free status, most of the EBIDTA trickled down to net margin which was at 15%. Dishman financed the acquisition via internal accruals to the tune of US$22.5 million and the balance through debt. Carbogen was a contract research (CRO) outfit with capability to execute over 3 projects in a year. Amcis was engaged in contract manufacturing space (CMO). We believe Dishman with Carbogen Amcis can serve the entire drug life cycle of 15-2 years. Moreover, by leveraging its operational efficiencies in India, Dishman also helps Carbogen-Amcis in improving margins. In Q4CY7, Dishman acquired the Vitamin-D business of Solvay Pharma of the Netherlands. The acquired business has main business of manufacturing Cholesterol, Vitamnin B & D and Vitamin D Analogue. The acquired business has a top line of 15 million with EBIDTA margin of 2.5 to 3 million. Currently, production pf Vitamin-B and D are outsourced, but Dishman will shift the production of these vitamins to India by FY9, which would increase the margins to around 2%. 3 P age

4 Business model Currently, Dishman s business is organised under the two segments marketable molecules and CRAMS. The marketable molecules (MM) segment houses quaternary compounds (quats), specialty chemicals, Intermediates and APIs. The newly acquired business from Solvay also falls under the marketable molecules segment. The company s CRAMS operations kicked off with a contract manufacturing project from Belgium-based Solvay Group, under which the company supplies API Eprosartan Mesylate (EM) and its intermediates for Solvay s proprietary US$3.3 billion anti-hypertensive drug Teveten. The patent on this product will expire in 213. While focusing on contract manufacturing, the company s skills in process optimization and improvement in quats business, has opened it another avenue of great potential contract research. The company views contract research as a window of opportunity to get more contract manufacturing assignments from MNCs. Manufacturing capability Dishman has 1 manufacturing facilities, including three facilities in Switzerland. In India, its facilities are located at Bavla and Naroda. The Bawla plant is a 1% EoU facility that enables the company to get 1% exemption from tax payments in these plants. 4 P age

5 Exhibit 2: Business model Dishman Pharma Marketable molecules CRAMS Dishman (standalone) Carbogen Amcis & others Dishman (standalone) QUATS Fine chemicals Drug intermediates APIs Recently acquired Vitamin-D business of Solvay CMO CRO CMO CRO The business has an exciting product, Vitamin D analogue, which sells at US$1 million a kg. Globally, there are only 3 players, including Dishman, that manufacture the product. Source: ICICIdirect Research 5 P age

6 INVESTMENT RATIONALE Dishman s business model has two major segments CRAMS and marketable molecules. Under CRAMS it manufactures APIs and other drug intermediates. The marketable molecule segment comprises quats, APIs and the recently acquired Vitamin-D business of Solvay. The company is one of the largest QUATS manufacturers in the world. It also aspires to be a partner-of-choice in CRAMS space. Dishman s strategy is to focus on the CRAMS business due to the huge potential in the pharma contract research (CRO) and contract manufacturing outsourcing (CMO). The company's excellent execution capability coupled with the acquisition of Carbogen- Amcis has provided given it critical scale in this segment. The CRAMS market in India is expected to witness a 3% CAGR. We see high scalability in CRO and CMO (collectively CRAMS) business going forward. We believe dwindling research productivity and margin pressure due to rising competition for the MNC pharma will keep the outsourcing demand upbeat. Traction in CRAMS business improves visibility Robust growth in supplies for existing contracts, off-take on new contracts and addition of new clients boosts the company's CRAM's revenue for the next two years. We believe the rise in high-end CRO revenue would also lead to margin expansion post the integration of Carbogen-Amcis. CRAMS revenue set to rise at 31% CAGR over FY7-1E We believe revenue from CRAMS, the key revenue driver and biggest contributor to total revenue, would grow at a 31% CAGR over FY7-1E to Rs crore. CRAMS revenue is likely to account for 74% of consolidated revenue in FY1E. We expect a 25% CAGR in CRAMS revenue from Indian facilities and 35% CAGR from Carbogen-Amcis facilities. CRAMS, a key growth driver, is expected to grow at a CAGR of 31% on account of increased supply from Indian assets and increasing capacity utilization of Carbogen-Amcis operations Exhibit 3: Contribution from high-end CRAMS of Carbogen-Amcis rising (Rs, Crore) FY7 FY8E FY9E FY1E CRAMS - Dishman CRAMS - Carbogen Amcis 6 P age

7 Supplies from Indian facilities to increase We expect a 25% CAGR in revenue from Dishman s facilities in India to Rs crore over FY7-1E. This will be the result of the commissioning of new manufacturing facilities, increased off-take for existing contracts and new supplies for fresh contracts. The company will be ramping up supplies of Eprosartan to Solvay after it completes the backward integration steps. The monthly supply schedule suggests that Dishman s supply of Eprosartan in 28 will be more double the quantity it had supplied in 27. Dishman has commissioned a new manufacturing facility in its Bawla premises. This is a huge facility and is being utilised for supplying Delnafaxin Hydrochloride, an API for an anti-depressant drug. Dishman produces 1.5 tonnes of Delnafaxin HCL per month. So it can produce 15 tonne by December 28. Under the ramp-up plan, it plans to increase production to 2 tonnes in 29 and 3 tonnes in 21. Exhibit 4: 25% CAGR in revenue from Indian assets over FY7-1E (Rs, Crore) FY7 FY8E FY9E FY1E 7 P age

8 Increased revenue contribution from Carbogen-Amcis We expect a 35% CAGR in revenue contribution from Carbogen-Amcis over FY7-1E to Rs crore on the back of increased execution of API research projects. Through its acquisition of Carbogen Amcis in August 26, Dishman got access to Carbogen s contract research and contract manufacturing for innovative products. API contract research and contract manufacturing for innovative products is high-end CRO contracts and fetch higher revenue. Exhibit 5: 35% CAGR in revenue from Carbogen-Amcis (Rs, Crore) Revenue from Carbogen-Amcis is estimated to grow at a CAGR of 35% on the back of increase in execution of API research projects 2 1 FY7 FY8E FY9E FY1E Carbogen-Amcis buyout to be margin accretive We believe the acquisition of Carbogen-Amcis is strategic fit to Dishman s business. Carbogen-Amcis EBIDTA margins would expand going forward as the company plans to increase sourcing from India and Dishman s plant in China. We expect strong EBIDTA margin expansion in Dishman s business post the integration of Carbogen-Amcis. Exhibit 6: Carbogen s EBIDTA margins to expand (%) 3% 25% 2% 15% 1% 5% % FY7 FY8E FY9E FY1E 8 P age

9 Execution capacity enables Dishman to ramp up revenue fast Building a critical scale is an important factor to succeed in the CRAMS business as manufacturing capacity and research capability in terms of laboratories should be in place to address incremental projects. Dishman adopted the inorganic route of growth to achieve scale. Having acquired a couple of small CRO businesses in Europe (like Synprotec, IO 3 S), it acquired Carbogen Amcis, a large CRAMS player, in August 26 leading to a sudden jump in the high-end CRO as well as CMO capability. Dishman has also been adding to its manufacturing capability organically in India. It has created a large capacity to execute existing as well as new long-term contracts. The company has just commissioned a large capacity at its existing Bawla premises. Another facility in the same premises is under construction and will be commissioned in next year. During the last five years, the company has invested around Rs 5 crore on capacity expansion. Exhibit 7: Fixed asset ramp up (Rs crore) Plant in China going on stream Carbogen-Amcis acquisition in August FY3 FY4 FY5 FY6 FY7 FY8E FY9E FY1E Acquired Solvay Vitamin D business 9 P age

10 Marketable molecules: A smooth flow Having grown aggressively in the CRAMS space, Dishman is also focusing the comparatively low-margin, but steadily growing (albiet at lower rate organically) business of marketable molecules. We expect this segment to witness a 28% CAGR over FY7-1E to Rs crore, mainly on account of acquisition of Vitamin-D business of Solvay. We expect a 12.53% CAGR in revenue from other products (quats, API and Intermediates related businesses) over FY7-1E to Rs crore. Boost marketable molecules business via inorganic route In Nov 27 (Q3FY8), Dishman acquired the cholesterol, Vitamin D and Vitamin D analogues business of Solvay Pharma, along with its manufacturing facilities and intangible assets related to the business for 12 million, inclusive of working capital. The acquired business generates a revenue of 15 million at an EBIDTA margin of around 17% (EBIDTA of 2.6 million). Acquisition of Solvay s Vitamin D business expected to lead in marketable molecules business faster revenue growth Post integration, EBIDTA margins to rise We believe the EBIDTA margins of the acquired business would rise from existing 16-17% to 2% from FY1E onwards after the successful integration, which may take around one year. The acquired business has broadly four products Vitamin D2, Vitamin D3, cholesterol and Vitamin D analogues. Currently, the acquired facilities manufacture cholesterol, while Vitamin D2 and D3 is outsourced from local players. Vitamin D analogue is manufactured at Solvay s main plant at Weesp. Dishman plans to transfer the plant and machinery used for manufacturing Vitamin D analogues from Solvay s main plant at Weesp to Veenendaal in Netherlands (plant acquired with the business acquisition) and start production of Vitamin D Analoue in that plant. Moreover, Dishman will start transfering production of Vitamin D2 and D3 to India from FY9 onwards post to the contracts with local producers come to an end. The company will continue production of Cholesterol and Vitamin D analogues in the Netherlands. We believe the cholesterol and vitamin business has good scalability and margins would expand after the successful integration. Under Solvay, the business was under-pressure as it was not a focus area and margins were under pressure due to lower capacity utilisation levels. We believe with increased focus on production and marketing, the business will see good traction. High-end products to be added through acquisition The acquisition placed Dishman into one of the three players worldwide manufacturing high-end Vitamin D analogues. Vitamin D analogue is a high value and a high potency product (sold for almost $ 1 million per kg) used in manufacturing oncology drugs. Other products such as cholesterol and Vitamin D2 and D3 are common products. Cholesterol is the raw material for Vitamin D2 and D3, and the raw material for cholesterol is locally available in Netherlands, which is one of the reasons that the company is not shifting the production to india. 1 P age

11 Organically, 12.5% top-line growth CAGR in marketable molecules We expect a 12.53% CAGR in the marketable molecules business FY7-1E. This segment comprises the business of QUATS (ammonium or phosphonium based), specialty chemicals, APIs and intermediates manufactured on a regular basis. Dishman produces various quats, which are used as catalysts to transfer a reactant from one phase to another. Dishman is amongst the largest producers of quats in the world. Exhibit 8: Without acquisition MM revenue would grow at over 12% (Rs, Crore) FY7 FY8E FY9E FY1E Post acquisition, top line set to grow at 28% On account of the inorganic growth, the marketable molucules segment is likely to grow at a CAGR of over 28%. Current revenue of recently acquired business of around Rs 88 crore ( 15 million) is likely to grow at a rate of 2% in FY1E, leading the total marketable molucules revenue to grow at a CAGR of 28% over FY7-1E. Exhibit 9: Inorganic growth leads the MM revenue to grow at 28% in FY1E (Rs, Crore) FY7 FY8E FY9E FY1E 11 P age

12 Business model and assumptions (Rs, Crore) % CAGR FY7 FY8E FY9E FY1E (FY7-1E) CRAMS Dishman % of total revenue 27% 24% 24% 24% CRAMS Carbogen-Amcis % of total revenue 45% 51% 5% 5% Marketable molecules % of total revenue 28% 23% 18% 18% Vitamin D business of Solvay % of total revenue % 2% 8% 8% Total Revenue FY7 FY8E FY9E FY1E CRAMS Dishman CRAMS - Carbogen Amcis Total CRAMS EBIDTA margins EBIDTA on Dishman CRAMS 32.% 29.% 32.% 32.% EBIDTA on Carbogen Amcis CRAMS 15.99% 16.16% 22.25% 25.53% EBIDTA on MM 15.% 15.% 15.% 15.% EBIDTA on Vitamin D Business 17.% 18.% 2.% TOTAL EBIDTA 2.6% 19.1% 22.88% 24.74% 12 P age

13 FINANCIALS Dishman Pharma is a major player in the CRAMS space. In order to penetrate more, it acquired Carbogen-Amcis in FY7, which led the top-line surging 18%, however, the lower margins of Carbogen-Amcis resulted in lower bottom-line growth at 83%. But, the acquisition provided Dishman critical scale in the high-margin CRO and CMO businesses. Going forward, we expect a 3% CAGR in consolidated top-line over FY7-1E on the back of a 31% CAGR in CRAMS business and 28% CAGR in marketable molecule. The changing business landscape and increasing integration of various businesses is expected to lead to a rise in EBIDTA margins. We believe the margins would improve going forward leading to a 31% CAGR in bottom-line over FY7-1E. Change in revenue mix boosting margins Post the acquisition of Carbogen-Amcis, the product mix of Dishman has shifted from a low-margin to a high-margin business. Exhibit 1: Revenue mix in FY7 (Total Revenue: Rs 581 crore) Marketable molecule (MM), 28% CRAMS - Dishman, 27% In FY7, Carbogen-Amcis accounted for 45% of revenue at lower margins CRAMS - Carbogen Amcis, 45% 13 P age

14 Exhibit 11: Revenue mix in FY1E (Total Revenue: Rs 1271 crore) Marketable molecule (MM), 18% Vitamin D business of Solvay, 8% CRAMS - Dishman, 24% In FY1E, revenues from Carbogen-Amcis are likely to account for 5% of total revenue due to faster ramp in the revenues leading to increased capacity utilization thereby increased margin CRAMS - Carbogen Amcis, 5% 3% CAGR in consolidated revenue We expect consolidated top line to rise at a 3% CAGR over FY7-1E to Rs 1271 crore on the back of a 31% CAGR in CRAMS business to Rs crore and 28% CAGR in marketable molecule to Rs crore. Increasing supply against the existing contract and new supplies will bring traction in the revenue. Exhibit 12: Robust revenue growth (Rs crore) FY4 FY5 FY6 FY7 FY8E FY9E FY1E EBIDTA margin expected to improve by 496 bps With increased outsourcing from Indian and Chinese plants for the Carbogen- Amcis operations and shifting of Vitamin D business from Netherlands to India, we expect margins to expand by 496 bps during FY7-1E to 24.86%. We believe Carbogen-Amcis EBIDTA margins would expand by around 1 bps over FY7-1E to 25.5% from 15.99%. Moreover, the company plans to shift operations for a part of Vitamin D business from Netherlands to India from FY9, which would lead the EBIDTA margin of the recently acquired Vitamin D business to increase from 17% currently to 2% FY9E onwards. Expansion in Carbogen-Amcis margin, overall margin is likely to improve by 496 bps 14 P age

15 Exhibit 13: Higher contribution from better margin businesses (%) 3% 25% 2% 15% 1% 5% % FY7 FY8E FY9E FY1E Overall EBIDTA margin EBIDTA on Carbogen Amcis CRAMS EBIDTA on Vitamin D Business Overall OPM and NPM likely to expand In FY7, margins declined on account of lower Carbogen-Amcis margins (which Dishman acquired in August 26). Going forward, increased sourcing from Indian and Chinese plants by Carbogen-Amcis operations, enhanced capacity utilization and shifting of Vitamin D business will lead to OPM rising. We believe robust rise in EBIDTA margins along with top line growth will result in decent growth in bottom-line, despite an increase in below-the-line expenses. We believe net profit margin will rise from 15.42% in FY7 to 16.31% in FY1E by around 3 bps. Lower PAT margin expansion is due to rise in tax rate on account of two plants losing EOU status in FY9E. Exhibit 14: Going forward, both OPM & NPM would expand (%) 27% 25% 23% 21% 19% 17% 15% 13% FY6 FY7 FY8E FY9E FY1E OPM (%) NPM (%) 15 P age

16 Healthy cash generation provides fillip for inorganic growth Dishman has a track record of smaller acquisitions. The company is in look out for another acquisition in biotech space. Healthy cash generation from operations provides flexibility to follow an inorganic growth avenue. We expect traction in operations and higher depreciation would generate healthy cash from operations. Huge cash balance in the books gives the company the flexibility to adopt inorganic route of growth aggressively. Exhibit 15: Healthy cash generation from operations (Rs, Crore) Healthy cash generation gives flexibility for inorganic growth FY5 FY6 FY7 FY8E FY9E FY1E Cash Profit Cash Flow after changes in Working Capital Closing Cash/ Cash Equivalent 16 P age

17 RoNW to see pressure due to rising tax and FCCB conversion We expect the company to face some pressure on RoNW front due to rising tax rate and dilution of FCCB (increasing equity and share premium account). We expect the RoNW will decline from 29% in FY7 to 26% in FY1E. Exhibit 16: DuPont ratio analysis for RoNW FY5 FY6 FY7 FY8E FY9E FY1E PAT/PBT PBT/PBIT PBIT/Sales Sales/Total assets Total assets/net worth RoNW 23% 27% 29% 26% 28% 26% Source: Company & ICICIdirect Research However, the effective tax rate for the company has been in the range of 2-6% due to varying product mix and sourcing of the products to sell from different destinations. The tax rate is likely to go up due to two of its plants losing their EoU status in FY9. We have assumed a tax rate of 15% in FY9E and 2% in FY1E. Moreover, we believe the interest expenses as percentage of PBIT would fall slightly from 32% in FY7 to 28% in FY1E due robust cash generation and funding of day-to-day business needs from internal accruals. Further, we believe the improvement in PBIT margins and asset utilization would negate to some extent the impact of rise in tax rate. We expect the PBIT margins to improve from 24% in FY7 & 8E to 29% in FY1E on account of rising EBIDTA margin in the Carbogen-Amcis revenues. RoCE is expanding on the back of margin expansion and improvement in asset utilisation Exhibit 17: Return ratios projects improvement in operations (%) 28% 23% 18% 13% 8% FY6 FY7 FY8E FY9E FY1E RoNW RoCE Rising revenue contribution from Carbogen-Amcis and Dishman s CRAMS operations from Indian facilities will result in improvement in the RoCE due to increase in asset utilisation. We believe asset utilisation would rise from 1.8x in FY7 to 2.3x in FY1E on account of increased supplies from Indian facility leading to 25% CAGR in Indian CRAMS revenue and 35% CAGR in Carbogen- Amcis revenue. 17 P age

18 Return on invested capital (ROIC) shows a rising trend With rising profits and balance sheet expansion (largely led by cash), we expect the return on invested capital to expand substantially. We expect the ROIC to expand from 15% in FY7 to 34% in FY1E suggesting incremental cash flows are being invested in the business to generate better return. Exhibit 18: ROIC is likely to expand (%) 35% 3% 25% 2% 15% 1% FY6 FY7 FY8E FY9E FY1E Net profit to grow at 31% CAGR We expect net profit to increase at a 31% CAGR over FY7-1E on the back of 3% growth CAGR in sales and EBIDTA margin expansion by 496 bps. With such growth on top-line and EBIDTA margin expansion, the bottom-line growth should have been higher but rising below-the-line expenses put pressure on net profit margin. Capex and increased operations are likely to keep debt at higher levels thereby higher interest expenses. Going on stream of manufacturing facilities is likely to push depreciation while loss of EOU status for two of the largest contributing plants would increase the tax liability from 2-6% to 2% in FY1E. Exhibit 19: Net profit to grow despite rise in below-the-line expenses (Rs, crore) We expect the net profit of the company to increase at a CAGR of 31% on account on improved asset utilization and margin expansion 1 5 FY6 FY7 FY8E FY9E FY1E 18 P age

19 Risks & Concerns The company has made a huge investment in creating assets to cater to the CRO and CMO needs of the innovator companies. The decline in CRO and CMO contracts may keep the assets unused and company may incur losses due to depreciation and maintenance cost of the assets created. While formulating the revenue model, we have assumed increase in volume of supplies to the clients. Demand reduction in the innovator products in case of emergence of new drug in the same class or increase in competition from the existing product basket may put pressure on the top-line growth. Moreover, increasing competition to the innovator product may put pressure on the margins of the company. We also assumed a ramp-up in sales volume to the client in making the revenue model. Any decline in consumption of the increased volume by the client may impact the sales growth of the company and EPS may decline. The company has a huge exposure to the forex revenue. In the face of appreciating rupee this may put pressure on the company s revenue. However, the company has natural hedge via imports of raw material and the company has increased the price to mitigate the forex losses in the past, any inefficiency in transferring such losses to the clients may put pressure on the top and bottom-line growth. 19 P age

20 Valuations We like Dishman s business model. The company generates stable revenues from marketable molecule segment and growing revenues from the CRAMS space. The company achieved critical scale in CRAMS business via inorganic route. Dishman is set to ride the rising manufacturing and research outsourcing demand by pharma MNCs in India. We believe rising execution and good growth in non-crams business will lead the top & bottom-line to grow at a CAGR of 3% and 31% respectively over FY7-1E. We value Dishman s CRAMS business at 15x FY1E EPS at Rs 292 per share and non- CRAMS business at 8x FY1E EPS at Rs 54 per share, arriving at a fair value of Rs 346 per share. We initiate coverage on Dishman Pharmaceuticals with OUTPERFORMER rating and a target price of Rs 346 over months. PE band Exhibit 2: P/E band 5 25x 4 2x 3 15x 2 1x 1 Apr-4 Jul-4 Oct-4 Jan-5 Apr-5 Jul-5 Oct-5 Jan-6 Apr-6 Jul-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Source: ICICIdirect Research The high margin CRAMS business of Dishman is set to grow at a CAGR of 31% over FY7-1E to Rs crore in FY1E and will account for 74% of consolidated revenue in FY1E. We expect CRAMS revenue from Dishman s Indian facility will generate revenue at a CAGR of 25% and Carbogen-Amcis CRAMS revenue will grow at a CAGR of 35%. We believe the high-end CRAMS operations of Carbogen Amcis are comparable with the global peers. As 68% of the CRAMS revenue is flowing from Carbogen-Amcis, the CRAMS part of the business can be valued at a PE of a global CRAMS profile. We believe the business comparable to Carbogen-Amcis is WuXi PharmaTech, a NASDAQ listed Chinese CRO Company, which is trading at US$21.16, 21x the CY9E EPS. We have valued the CRO business on comparable business method and have compared the business with WuXi PharmaTech. WuXi PharmaTech is a China-based pharmaceutical and biotechnology research and development outsourcing company. Its core operations are grouped into two segments, CRO via laboratory services and CMO via manufacturing. The company s laboratory services segment consists of discovery chemistry, service biology, analytical, pharmaceutical development and process development services. 2 P age

21 The manufacturing segment focuses on manufacturing of advanced intermediates and active pharmaceutical ingredients (APIs). Exhibit 21: WuXi PharmaTech consensus financials in a nutshell Dec-7 Dec-8E Dec-9E Revenue (US$ million) EBITDA (US$ million) EBIDTA margin 29% 27% 26% EBIT (US$ million) Net Profit (US$ million) EPS (US$) Current price (US$) P/E ROA (%) ROE (%) Source: Reuters knowledge, ICICIdirect Research WuXi is trading at 21x the CY9E EPS of US$1.2. We have valued the CRO business of Dishman at 15x the FY1E EPS. The fair value of Dishman will be the addition of the value of manufacturing business as well as the value of the CRO business. Exhibit 22: Fair value of Dishman FY1E EPS (Rs) PE Multiple Per share Valuation Marketable Molecule CRAMS Valuation of Dishman per share Source: ICICIdirect Research We rate Dishman as an OUTPERFORMER with a price target of Rs 346, 13.2x FY1E EPS of Rs 26.25, in 12 to 15 months. 21 P age

22 Profit & loss Account (Rs crore) FY6 FY7 FY8E FY9E FY1E Sales Excise Net Sales Other Income Total Income Raw Material Raw material cost as % of sales 45.32% 34.29% 36.82% 35.82% 34.83% Employee Expenses Employee cost as % of sales 12.25% 24.22% 25.21% 22.7% 21.11% Other manufacturing expenses Other manufacturing expenses as % of sales 8.99% 9.28% 7.25% 7.65% 7.78% Selling expenses Selling expenses as % of sales 3.51% 3.1% 3.7% 3.7% 3.7% Administrative expenses Administrative expenses as % of sales 5.98% 8.75% 8.13% 8.1% 7.98% Op. Profit Interest Gross Profit Depreciation PBT Taxation Net Profit Top-line is expected to grow at 3% CAGR Below the line expenses likely to mute the bottomline growth Balance Sheet (Rs crore) FY6 FY7 FY8E FY9E FY1E Share Capital Reserves & Surplus Secured Loans Unsecured Loans Deferred Tax Liability Total Gross Block Accumulated Depreciation Net Block Capital Work-in-progress Investments Cash Trade Receivables Loans & Advances Inventory- Other Current Assets, Loans & Advances Less : Current Liabilities & Provisions Total Net Current Assets Miscellaneous expenses not written Total Dilution on account of FCCB conversion will impact equity & reserves 22 P age

23 Cash flow statement (Rs crore) FY6 FY7 FY8E FY9E FY1E Op bal Cash & Cash equivalents Profit after Tax Add: Misc. exp W/off Less: Dividend Paid Add: Depreciation Add Provision for deferred tax Cash Profit Net Increase in Current Liabilities Net Increase in Current Assets Cash Flow after changes in Working Capital Purchase of Fixed Assets (Increase) / Decrease in Investment Increase / (Decrease) in Loan Funds Increase / (Decrease) in Equity Capital Net Cash Inflow / Outflow Closing Cash/ Cash Equivalent Improvement in cash position gives flexibility to follow inorganic route Ratio Analysis FY6 FY7 FY8E FY9E FY1E EPS Cash EPS Book Value Operating Margin (%) 23.6% 19.9% 19.11% 22.99% 24.86% Gross Profit Margin (%) 23.1% 2.32% 2.28% 22.59% 24.39% Net Profit Margin (%) 17.77% 15.42% 13.72% 15.37% 16.31% ROCE 1% 1% 1% 15% 17% ROIC 17% 15% 13% 23% 34% Debt Equity Fixed Assets Turnover Ratio Enterprise Value EV/Sales EV/EBIDTA Market Cap Market Cap to sales DuPont Analysis PAT/PBT PBT/PBIT PBIT/Sales Sales/Total assets Total assets/net worth RoNW 27% 29% 26% 28% 26% 23 P age

24 Annexure I CRAMS: Attractive play for Indian CRO and CMO Dwindling R&D productivity, declining FDA approval of new drug for the largest US market, drugs going off-patent in the US and rising competition has put immense margin pressure on big MNC pharma companies. Cost cutting is urgency on the part of the MNCs to maintain margins. News flows suggest that they wish to focus only on marketing of drugs and outsource most part of production of drugs. CMOs (contract manufacturing organizations) in the high cost destinations are also facing margin pressure due to rising cost and competition. Moreover, dwindling R&D productivity increases the outsourcing requirement for the innovators. The combination of these factors has led to a rise in the CMO & CRO operations in the low cost destinations such as India. We believe the outsourcing story will keep Indian CROs & CMOs hot in demand. As per CRIS INFAC, the overall contract research industry in India was valued at US $ million in 26. It is expected to grow at a CAGR of 25-3% to $47-55 million by 211, with major contribution from clinical research outsourcing. Outsourcing demand will keep rising Due to declining productivity Spiralling R&D cost on drugs without a corresponding increase in the number of drug approval has put tremendous pressure on the global pharmaceutical majors. The R&D cost increased at a CAGR of 5% to US$22 billion during 2 to 26 while the drug approval by USFDA declined from 39 in 2 to 18 in 26. Declining productivity of R&D has led the global R&D players to look for alternatives to improve productivity. Exhibit 23: Research productivity declining despite increasing R&D expenditure (US$, mn) 25, 2, 15, 1, 5, R&D spend at real prices NCE approved (RHS) Source: CRISINFAC, ICICIdirect Research R&D cost per new drug has seen steep rise Moreover, the R&D cost per new drug has increased at a CAGR of 19% over year 2 to 26. The R&D companies are looking out for outsourcing the building block researches to research outsourcing companies in low cost destinations such as India whereby they can increase their research productivity by pruning the research cost. 24 P age

25 Exhibit 24: R&D cost per molecule has shown rising trend (US$, mn) Source: CRISINFAC, ICICIdirect Research R&D productivity seen under pressure Comparison of revenue growth of global pharma industry vis-à-vis the R&D cost growth suggests the R&D expenditure growth has outpaced the revenue growth during the period 2 & 26. The revenue growth has been in the region of 7% in 26 after dipping during 22-5 while the R&D cost by key global pharmaceutical players grew at a CAGR of 8% during 2 to 26. The comparison suggests that the incremental investment in R&D is not fetching any revenue. Exhibit 25: Big pharma MNCs kept on investing in R&D (US$, bn) Source: CRISINFAC, ICICIdirect Research Global CROs seeing decline in EBIDTA margin Global CROs accounting for market share of in the range of 65 to 7% of the total R&D outsourcing market generated by key pharmaceutical players are also under pressure to improve productivity. Their operating margins have been fluctuating with downward bias over the years. We believe that in the emerging scenario, wherein these players are seeking to boost efficiency, business opportunity for the Indian CROs will be boosted. 25 P age

26 Exhibit 27: Margins of global CROs are under pressure CY1 CY2 CY3 CY4 CY5 CY6 Covance PRA International Albany Molecular Research Kendle International Paraxel Pharmanet development group Quintiles Source: Bloomberg, CRISINFAC, ICICIdirect Research 26 P age

27 Indian R&D strengths: A boon for MNC pharma companies Crashing research time: Faster access to the market Drug development life cycle consumes around 1-12 years while the innovator files the patent on getting some lead compound (in the earliest phase of drug development life cycle). The patent is granted normally for 2 years from the date of grant of the patent. If the compound is successfully launched in the market, the patent holder gets EMR (exclusive marketing right) to market the drug globally and no other company can launch the molecule in the markets (where patent regulations exist). Due to no competition in the drug, the margin to the innovator is very high during the patent period. So, patent holder s (innovator company) return from a prospective drug depends upon the time taken in the development of the drug. By outsourcing research for building blocks or API, the innovator can crash the drug development time leading to faster entry into the market with the molecule. Outsourcing offers a saving in drug development cost Lower cost advantages on man power, patients, research scientists and investigations make Indian market an attractive outsourcing destination for contract & clinical research and contract manufacturing. Investment in plant & machinery is also very low in India vis-à-vis a large global player. Lower cost substantiate India s position in global CRAMS space A research done by CRISINFAC suggests that the manpower cost in India is around 5 to 7% lower. For clinical trials, the clinical assistant is paid around $5-6 per hour in the US while in India such expenses are $1-15. Cost of other investigations (such as CT scan, MRI, etc.) is also low in India vis-à-vis the other regulated markets. Chemistry skills and English knowing population is an advantage Knowledge of English makes communication with client easier. Knowledge of English also comes handy while collecting and presenting the data related to the clinical trials. Moreover, India has a pool of technologically sound professionals to handle the drug development related chemistry. The chemistry skills generated during the process patent regime is also coming handy while performing the CRO & CMO businesses successfully. Indian regulations make clients comfortable while outsourcing India started recognizing product patent regulations from 1 st January 25 post to which the reverse engineered products cannot be launched in the Indian markets. Such regulations make big pharma players comfortable in outsourcing IPR related products to Indian players. Moreover, the government is also gradually coming out with regulations, which can boost the CRAMS markets. Recently, the government decided to allow multi-centric early phase II & III trials in India as a part of the global trials by drug companies based abroad on case-to-case basis but MNCs are not allowed to conduct phase-i trials in India. 27 P age

28 Exhibit 28: Drug development life cycle Library Screening Lead molecule optimization Preclinical studies Human clinical trials Process scaleup Regulatory approvals Marketing & sales Regulatory Lead identification and filing for patent Investigational new drug application (patent granted) Marketing application Marketing approval & product launch Patent expiry Year 1 Year 3 Year 9 Year 1-12 Year 2 Discovery Development research Regulatory review Post marketing development Phase of drug development Chemical synthesis Biological testing & pharmacological screening Phase I 5-6 volunteers Phase II 2-4 patients Phase III 3+ patient Phase IV Long term testing on patients Toxicology & pharmacology studies Chemical development Pharmaceutical development Attrition 1, compounds Cost US$ 8-12 million Dishman provides research & manufacturing services for the stages Source: CRISINFAC, ICICIdirect Research 28 P age

29 Annexure II Other alliances Apart from the revenue drivers from the Carbogen-Amcis, and other CRO and CMO orders, Dishman will be getting revenue from other sources going forward. Dishman has formed various Joint Ventures (JVs) and alliances across the globe which would boost its top & bottom-line going forward. Dishman Pharmaceuticals and Chemicals (Shanghai) Company Ltd In order to control cost, Dishman is setting up a new green-field manufacturing facility in Shanghai Chemical Industry Park at a cost of Rs 45 crore. The project will offer the company a major advantage in the cost of production as the cost of utilities in China is half the costs incurred in India. The company plans to manufacture six non-gmp quats and five intermediates in the plant. The GMP products will be produced in the first phase of the project. In the second phase, contract manufacturing facilities, including US- FDA compliant API plants, will be developed. Overall, there is a plan to manufacture 11 drugs for the European and American markets. Shanghai unit of Dishman is being developed in an area of 8, square metres in the chemical park that provides co-generation facilities such as stream, compressed air, solvent storage and natural gas and effluent treatment. The early intermediates will be manufactured from basic chemicals in China and later transferred to the company s Ahmedabad plant for further processing. The company s specialty chemicals such as ammonium and phosphonium quats will serve as inputs for the manufacture of API and intermediates and will also be useful in the processing and production of agro-chemicals, polymers and surfactants. With the new plant in Shanghai, Dishman s cost will half the cost incurred on the production in India. Also, the manufacturing facility will serve as a gateway to the South Asian markets, especially the Japanese market. The construction of the facility is currently underway and is expected to be completed by March 28. The revenue contribution from the facility will start from FY9. As quats is a commodity, margins are lower, the company intends to focus on high-end electrolyte QUATS having specialized applications in car batteries, energy saving processes, preservatives etc. Dishman plans to shift the manufacture of commodity QUATS to the Chinese facility and utilize the Indian facility for high-end QUATS. JV for disinfectant formulations business Dishman Pharmaceuticals formed another joint venture in Saudi Arabia with Takamul Investments Holding Company (Takamul), a group company of Capital Advisory Group, to manufacture Hospital Disinfectant formulations, Anti-cancer Drug formulations and Dry Powder inhaler (DPI). As per Capital Advisory Group report, Saudi Arabian inhaler market is over US$ 25 million while other GCC nations have similar market, making the target market of the JV at US$5 million. The technology for the disinfectant and DPI will be provided by Dishman while that for anticancer formulations will be provided by Carbogen-Amcis. Dishman Infrastructure Limited Dishman has two of its units under Export Oriented Unit (EOU). The present tax benefit for EOU will be available up to financial year 29. The Company is 29 P age

30 exporting around 75% of its products. The export will increase substantially going forward. So, the company has planned to make further expansions in a SEZ to avail long-term tax benefits including Income Tax. Dishman Infrastructure Limited, a company promoted by Dishman has obtained in principle approvals from the Ministry of Commerce and Industry for setting up of SEZ in Gujarat over the next 3 years with an investment outlay of Rs 65 crore. Dishman would utilize a significant portion of the pharmaceutical & chemical SEZ for its own organic growth plans and also to form joint ventures with its existing and potential customers from Europe and USA. Dishman Arabia Ltd Dishman formed a 5:5 Joint venture (Dishman Arabia Limited) in Saudi Arabia with Takamul Investments Holding Company, a group company of Capital Advisory Group. The JV is in the primary stage and the revenue visibility will come only after clarity on the operational front and the order book. The JV is planned to undertake process and manufacture of pharmaceuticals along with its chemicals, intermediates and to provide know how in pharmaceutical activities. Dishman Japan Ltd Dishman has entered into a marketing JV with Azzurro Corporation in which Dishman holds 85% while the rest 15% is held by Azzurro, a 3-year-old marketing firm in Japan. This is an strategic step which would lead Dishman s entry into the highly regulated Japanese market. Going forward, Dishman would be able to cater to the CRAMS requirement of the Japanese players via this subsidiary or directly from its Indian plants. With a shift towards generic drugs, the Japanese government has announced an open door policy for API and intermediates. Post to the development many Japanese companies are looking out for partners in the CRAMS space on a long-term basis. We believe that the revenue flow from the Japanese market will give a significant boost to the overall top & bottom-line FY1E onwards. CAD Middle East Pharmaceutical Industries: JV to manufacture API in Saudi Arabia Dishman formed a Joint Venture (JV) with Arab Company for Drug Industries and Medical Appliances (ACDIMA), Saudi Pharmaceutical Industries and Medical Appliances Corporation (SPIMACO) and Takamul Holding Company for Investments (THC). Dishman, ACDIMA, SPIMACO and THC will jointly hold the equity in ratio of 3%, 25%, 25% and 2% respectively. The JV has been issued industrial licenses in the name of CAD Middle East Pharmaceutical Industries Ltd., wherein CAD will initially manufacture 2 API s in a multipurpose facility with enough legroom to expand product mix. The manufacturing base is to be set up in Riyadh. Dishman Group has been selected as a foreign joint venture partner for promoting an industry to manufacture various APIs based on the technology to be supplied by Dishman Group. Dishman Group is to supply all the intermediates required for the manufacture of various APIs by the joint venture. Apart from manufacturing for the local market, the JV will have rights to export also. The project has been allotted an 8 square meter land near the Riyadh International Airport. Going forward, we expect good revenue contribution from this JV also. 3 P age