Cipla. Negatives priced-in BUY COMPANY UPDATE 26 DEC CMP (as on 24 Dec 2018) Rs 519 Target Price Rs 605

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1 INDUSTRY PHARMA CMP (as on 24 Dec 2018) Rs 519 Target Price Rs 605 Nifty 10,664 Sensex 35,470 KEY STOCK DATA Bloomberg CIPLA IN No. of Shares (mn) 805 MCap (Rs bn) / ($ mn) 418/5,971 6m avg traded value (Rs mn) 1,709 STOCK PERFORMANCE (%) 52 Week high / low Rs 678 /503 3M 6M 12M Absolute (%) (19.6) (15.7) (13.7) Relative (%) (17.3) (15.1) (18.2) SHAREHOLDING PATTERN (%) Promoters 36.7 FIs & Local MFs 13.8 FPIs 25.6 Public & Others 23.9 Source : BSE Amey Chalke amey.chalke@hdfcsec.com Eshan Desai eshan.desai@hdfcsec.com Negatives priced-in The recently diagnosed issues related to supply constraints in one of the sterile plants, US sanctions on Iran, war in Yemen, falling prices in the tender business and higher inflation in APIs are likely to persist over the next 2-3 quarters. However, the stock has also fallen ~23% from Rs 671/share (Sep- 18) and consensus earnings have been cut by 14-15%. The management is still confident in achieving at least 10% revenue CAGR and 18-20% EBITDA margin over FY20-21E owing to the US, India, and SA segments (~70% of revenues). The injectable and inhaler launches in the US will be the key triggers. At present, the stock is trading at 23/17x FY20/21 P/E, at a ~20% discount to its historical average. We see this as a good opportunity to accumulate, with Cipla generating US$ 150mn+ FCFs annually on the back of robust branded franchises in India and South Africa. It is also consistently receiving complex product approvals in the US, which are likely to drive the top line and make the US business profitable. Upgrade to BUY with a TP of Rs 605 (22x Dec-20E EPS). Ongoing challenges: Cipla is facing multiple issues: (1) Supply constraints due to capacity rebalancing have cut quarterly sales by Rs ~1bn; (2) Iran and Yemen sales are expected to decline from US$ 70-80mn in to US$ 30-40mn for due to geopolitical concerns; and (3) The South Africa tender biz (40% of COMPANY UPDATE 26 DEC 2018 Cipla BUY SA sales) could face double-digit price erosion. We expect these issues to normalize in FY20/21. Guidance: Resolving supply constraints, acceleration in the US business and traction gained in India and SA branded businesses will drive revenue growth at 10% plus over FY20-21E. Cost rationalization, ramp-up in the US, and rebalancing within segments will help maintain EBITDA margin at 18-20%. Focus on DTM: Quarterly US sales to reach US$ mn by FY19-end. The DTM is growing at double digits and should cross US$ mn in sales this year. B2B revenue slumped from US$ 150mn () to US$ ~70mn now, having largely bottomed-out. The low-margin Invagen business is likely to remain flat. Lucrative launches over FY20-21 include gproventil, Tramadol, and potentially gadvair. Growing branded businesses: Domestic growth (12-14%) will be led by in-licensed products and chronic therapies, with the acute portfolio remaining steady. South Africa s private business is growing at 14%, 2-3x the market rate. The Mirren acquisition is a highmargin OTC business, growing at strong double-digits. Financial Summary (Rs bn) Year Ending March Net Sales EBITDA APAT Diluted EPS (Rs/sh) P/E (x) RoE (%) HDFC securities Institutional Research is also available on Bloomberg HSLB <GO>& Thomson Reuters

2 The decline in the US B2B segment is being balanced by the growing DTM business, while the low-margin Invagen business remains largely steady. Going ahead, new launches will drive doubledigit growth in the US. The US Revenues: Growth To Be Driven By DTM US Revenue (Rs bn) YoY Growth (%) The US B2B Segment Has Halved Over DTM (US$ mn) B2B (US$ mn) Invagen (US$ mn) ~ ~ st Year Post Invagen Acquisition R&D spend will continue at a steady rate in proportion to sales, owing to the strong filings run rate Cipla is on-track to file for 20 products in FY19 R&D Spend: To Remain Steady In Proportion To Sales R&D Expenses (Rs bn) R&D to Sales (%) ANDAs Approved In The US As Of 2QFY Cipla PEPFAR Invagen Partnered ANDAs Approved ANDAs Tentatively Approved ANDAs Under Approval ANDAs Page 2

3 Ke Key Approvals In The US Over The Last One Year Date Type Generic Name Brand Name Form Innovator US Sales No. of (US$ mn) Players* Indication 12-Nov-18 Approval Valganciclovir Valcyte Tablet Roche 79 4 Opthalmic 29-Oct-18 Approval Metoprolol Succinate Toprol XL Tablet Aralez CVS 22-Sep-18 Approval Albendazole Albenza Tablet Impax Labs 99 2 Gastro 10-Aug-18 Approval Atazanavir Reyataz Capsule BMS ARV 10-Aug-18 In-licensed from MSN Capecitabine Xeloda Tablet Genentech Oncology 7-Aug-18 Approval Diclofenac Sodium Voltaren Topical (Gel) GSK Analgesic 21-Jun-18 Approval Testosterone Depo- Pharmacia/ Injectable Cypionate Testosterone Upjohn Hormone 19-Jun-18 Approval Efavirenz Sustiva Tablet BMS ARV 13-Jun-18 Approval Isoproterenol Hydrochloride Isuprel Injectable Hospira CVS 2-May-18 Approval Phenylephrine Hydrochloride Vazculep Injectable Avadel CVS 2-May-18 Approval Exemestane Aromasin Tablet Pfizer 77 5 Oncology 26-Mar-18 Authorized Palonosetron Helsinn Aloxi Injectable Generic HCl Healthcare Nausea 29-Jan-18 Approval TDF Viread Tablet Gilead ARV 20-Nov-17 Approval Decitabine Dacogen Injectable Otsuka America Oncology 17-Nov-17 Approval Budesonide Sevelamer 27-Oct-17 Approval Carbonate Source: AIOCD, HDFC sec Inst Research *Ex-Cipla & Innovator Pulmicort Respules Inhalation (Suspension) AZ Respiratory Renvela Tablet Genzyme 1,850 6 Nephrology Page 3

4 Revenue growth will be driven by resolving supply constraints, acceleration in the US, and traction gained in India and SA branded businesses Estimate 11% CAGR In Revenue Over -21E Total Revenue (Rs bn) YoY Growth (%) India And North America Account For Nearly 60% Of Total Revenue EM 11% EU 4% API 4% Others 3% India 39% SAGA 22% North America 17% Domestic sales are expected to grow by ~12% YoY The domestic business portfolio is acute-heavy; however, growth is driven by chronic therapies Domestic Business: Chronic Segment To Drive Growth India Revenue (Rs bn) YoY Growth (%) Therapy-wise Breakup Nov 2018 MAT Analgesics 3% Ophthal 3% Neuro / CNS 4% Urology 5% Derma 2% Others 7% Respiratory 34% Gastro Intestinal 7% Cardiac 13% Anti- Infectives 22% Source: AIOCD, HDFC sec Inst Research Page 4

5 Performance Of Top 10 Products In India Top Products Nov 18 MAT YoY Growth Sales Contr. Sales Contr. 1HFY19 Growth Oct-Nov 18 (Rs mn) (%) Nov 18 (%) Nov 17 (%) (%) Growth (%) Cipla 59, Foracort 3, Budecort 2, Duolin 1, Asthalin 1, Seroflo 1, Montair LC 1, Aerocort 1, Azee 1, Dytor 1, Urimax D 1, Total 16, Source: AIOCD, HDFC sec Inst Research Performance Of Top 10 Therapies In India Top Therapies Nov 18 MAT Contribution to YoY Growth Share In Therapy 1HFY19 Growth Oct-Nov 18 (Rs mn) Sales (%) (%) (%) (%) Growth (%) Respiratory 20, Anti-Infectives 12, (0.4) 10.8 (3.4) 6.9 Cardiac 7, Gastro Intestinal 4, Urology 3, Neuro / CNS 2, Ophthal 1, (2.6) Pain / Analgesics 1, (1.0) 1.9 Derma 1, Gynaecological Source: AIOCD, HDFC sec Inst Research Page 5

6 Pressure on API costs still persists, to ease out in the coming years Cost rationalization, ramp-up in the US, and rebalancing within segments will help maintain EBITDA margin in the range of 18-20% Gross Margin: Expected To Expand ~100bps Over -21E Gross Margin (%) EBITDA Margin: Anticipate A Rebound To ~20% By EBITDA (Rs bn) EBITDA Margin (%) Employee cost is expected to increase at single-digits Employee Cost: To Increase In Absolute Terms Owing To US Front-end 12.5 Employee Cost (Rs bn) Employee Cost to Sales (%) EPS: Estimate ~16% CAGR Over -21E Earnings growth to stabilize after a weak EPS (Rs/Sh) YoY Growth (%) (10.1) (15.0) (24.1) (5.9) Page 6

7 Favourable leverage will enable Cipla to capitalize on any acquisition opportunity, while the company is keen on expanding its specialty business At CMP, Cipla is trading at 23/17x FY20/21E EPS, which is at a ~20% discount to its historical average Scale-up In Operations Will Drive Free Cashflows Free Cashflow (Rs bn) Net D/E (x) (25) (0.0) (0.1) (0.1) (0.1) Return Ratios To Improve Over FY20-21E RoE (%) RoCE (%) Cipla Has Traded At 28.5x One Year Fwd PE Over The Last 10 Years 60 RoIC (%) 1 yr fwd P/E (x) PE Average (Oct-08 - Oct-18) Oct ? Nov Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Page 7

8 The tender business has halved over previous levels of US$ 150mn to US$ 70mn now; however, it has largely bottomed-out Tender business volumes are likely to be maintained, price erosion will continue at double-digits Cipla had combined revenue of US$ 70-80mn in Iran and Yemen in This was largely one-off, and expected to decline to US$ 40-50mn in FY19 While 1HFY19 was largely inline, 2H would be poor due to geopolitical issues in the region The branded businesses in South Africa and India, along with traction gained in the US will drive future growth Segmental Quarterly Performance (Rs mn) 1Q 2Q 3Q 4Q 1QFY19 2QFY19 India (Rx + Gx) 12,700 16,460 16,010 13,530 15,440 16,440 North America 6,460 6,180 6,500 6,750 6,700 7,580 South Africa 4,670 5,170 5,210 5,330 5,750 5,030 Global Access 2,620 4,030 3,490 2,860 2,560 2,510 Emerging Markets 4,630 4,540 3,710 3,940 4,690 4,720 Europe 1,650 1,510 1,710 1,360 1,340 1,410 Global API 1,300 2,130 1,480 1,350 2,000 1,710 Others 1, ,030 1, Total 35,250 40,820 39,140 36,980 39,390 40,120 Source: HDFC sec Inst Research Assumptions (Rs mn) India 55,190 58,670 63,657 71,932 81,284 Growth (%) North America 26,290 25,870 30,958 36,531 43,211 Growth (%) 24.9 (1.6) South Africa 16,980 20,612 21,643 22,941 25,235 Growth (%) Europe 6,200 6,230 5,950 6,664 7,677 Growth (%) (4.5) Emerging Markets 36,350 34,558 31,129 34,864 40,164 Growth (%) (3.0) (4.9) (9.9) Global API 5,290 6,260 7,133 7,633 8,400 Growth (%) (28.3) Total 146, , , , ,971 Growth (%) Source: HDFC sec Inst Research Page 8

9 Peer Set Comparison Mcap (Rs bn) CMP (Rs/sh) Reco TP/FV Adj EPS (Rs/sh) P/E (x) RoE (%) Sun Pharma 1, BUY Dr Reddy's Labs 432 2,600 BUY 2, Aurobindo Pharma NEU Cipla BUY Divi's Labs 384 1,447 SELL 1, Lupin BUY 1, Cadila Healthcare BUY Torrent Pharma 299 1,770 BUY 1, Alkem Laboratories 222 1,855 BUY 2, Glenmark BUY Jubilant Life Sciences BUY Alembic Pharma NEU Strides Shasun BUY Laurus Labs NR Dishman Carbogen Amcis BUY Suven Life Sciences NR Granules India BUY Neuland Labs BUY Change In Estimates (Consolidated) Rs mn Previous New % Chg Revenue 166, , , , , ,971 (2.6) (1.7) (1.7) EBITDA 29,598 35,934 45,261 28,183 34,409 42,112 (4.8) (4.2) (7.0) APAT 15,091 19,105 25,191 14,058 18,023 23,552 (6.8) (5.7) (6.5) Page 9

10 Income Statement (Consolidated) Year ending March (Rs mn) Net Revenues 146, , , , ,971 Growth (%) Material Expenses 53,171 54,384 56,689 63,871 72,230 Employee Expenses 26,338 26,901 28,507 30,923 33,385 SG&A Expenses 7,608 7,610 8,098 9,019 10,079 Other Operating Expenses 34,427 35,034 40,492 45,843 52,165 EBITDA 24,758 28,264 28,183 34,409 42,112 EBITDA Margin (%) EBITDA Growth (%) Depreciation 13,229 13,228 11,254 11,861 12,794 EBIT 11,528 15,036 16,928 22,548 29,318 Other Income (Including EO Items) 2,287 2,801 4,500 3,500 4,050 Interest 1,594 1,142 1,691 1,550 1,499 PBT 12,221 16,695 19,737 24,498 31,869 Tax (Incl Deferred) 1,798 2,501 5,329 6,124 7,967 Minority Interest (70) (28) (350) (350) (350) RPAT 10,354 14,166 14,058 18,023 23,552 EO (Loss) / Profit (Net Of Tax) - (775) APAT 10,354 14,941 14,058 18,023 23,552 APAT Growth (%) Adjusted EPS (Rs) Balance Sheet (Consolidated) As at March (Rs mn) SOURCES OF FUNDS Share Capital - Equity 1,609 1,610 1,610 1,610 1,610 Reserves 123, , , , ,257 Total Shareholders Funds 125, , , , ,867 Minority Interest 4,382 3,524 3,524 3,524 3,524 Long Term Debt 36,454 36,621 31,621 28,621 25,621 Short Term Debt 4,672 4,359 4,359 4,359 4,359 Total Debt 41,126 40,980 35,980 32,980 29,980 Net Deferred Taxes 5,888 3,157 3,157 3,157 3,157 Long Term Provisions & Others 2,792 2,813 2,959 2,849 2,850 TOTAL SOURCES OF FUNDS 179, , , , ,378 APPLICATION OF FUNDS Net Block 67,936 76,034 73,485 76,373 80,279 CWIP 16,877 5,124 5,065 5,560 5,562 Goodwill 26,784 28,147 28,147 28,147 28,147 Investments Other Non-current Assets 7,510 7,707 6,142 5,332 4,521 Total Non-current Assets 119, , , , ,615 Cash & Equivalents 15,848 22,148 39,274 43,617 51,591 Inventories 34,853 40,447 32,880 37,045 41,893 Debtors 24,974 31,025 28,669 32,580 37,165 Other Current Assets 12,927 15,991 17,590 19,349 21,284 Total Current Assets 72,754 87,463 79,139 88, ,343 Creditors 15,711 21,191 21,542 24,271 27,447 Other Current Liabilities & Provns 12,697 12,772 10,200 11,662 12,724 Total Current Liabilities 28,408 33,964 31,741 35,932 40,172 Net Current Assets 44,346 53,499 47,397 53,042 60,171 TOTAL APPLICATION OF FUNDS 179, , , , ,377 Page 10

11 Cash Flow Year ending March (Rs mn) Reported PBT 12,222 16,695 19,737 24,498 31,869 Non-operating & EO items (1,079) (1,385) (2,475) (2,475) (2,479) Interest expenses 1,594 1,142 1,691 1,550 1,499 Depreciation 13,229 13,228 11,254 11,861 12,794 Working Capital Change 2,354 (7,833) 7,813 (4,944) (6,317) Tax Paid (4,503) (7,220) (5,329) (6,124) (7,967) OPERATING CASH FLOW ( a ) 23,818 14,628 32,691 24,365 29,398 Capex (10,982) (7,395) (8,647) (15,245) (16,702) Free cash flow (FCF) 12,835 7,233 24,045 9,120 12,696 Investments (2,307) (509) 1,550 1,550 1,552 Non-operating Income Others 66 (968) INVESTING CASH FLOW ( b ) (13,102) (8,540) (6,172) (12,770) (14,223) Debt Issuance/(Repaid) (10,803) (345) (5,000) (3,000) (3,000) Interest Expenses (1,594) (1,178) (1,691) (1,550) (1,499) FCFE (1,681) 4,565 19,829 7,045 10,676 Share Capital Issuance (0) (0) Dividend (1,936) (1,893) (2,353) (2,353) (2,353) Others 1, (350) (350) (350) FINANCING CASH FLOW ( c ) (13,055) (2,674) (9,394) (7,253) (7,202) NET CASH FLOW (a+b+c) (2,339) 3,414 17,126 4,343 7,974 Equivalents (as at year end) 9,606 12,492 12,492 12,492 12,492 Closing Cash & Equivalents 15,848 22,148 39,274 43,617 51,591 Key Ratios PROFITABILITY (%) GPM EBITDA Margin APAT Margin RoE RoIC (or Core RoCE) RoCE EFFICIENCY Tax Rate (%) Fixed Asset Turnover (x) Inventory (days) Debtors (days) Other Current Assets (days) Payables (days) Other Current Liab & Provns (days) Cash Conversion Cycle (days) Debt/EBITDA (x) Net D/E (x) (0.0) (0.1) (0.1) Interest Coverage (x) PER SHARE DATA (Rs) EPS CEPS Dividend Book Value VALUATION P/E (x) P/BV (x) EV/EBITDA (x) EV/Revenues (x) OCF/EV (%) FCF/EV (%) FCFE/Mkt Cap (%) (0.4) Dividend Yield (%)

12 RECOMMENDATION HISTORY Cipla TP Date CMP Reco Target 11-Jan NEU Apr NEU May NEU Jul NEU Aug NEU Oct NEU Nov NEU Dec BUY Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Rating Definitions BUY : Where the stock is expected to deliver more than 10% returns over the next 12 month period NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12 month period SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12 month period Page 12

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