Laurus Labs. API to formulations play BUY INSTITUTIONAL RESEARCH. 10 Jan Amey Chalke

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1 INSTITUTIONAL RESEARCH Laurus Labs API to formulations play BUY INDUSTRY PHARMA CMP (as on 10 Jan 2019) Rs 372 Target Price Rs 480 Nifty 10,822 Sensex 36,107 KEY STOCK DATA Bloomberg LAURUS IN No. of Shares (mn) 106 MCap (Rs bn) / ($ mn) 40/561 6m avg traded value (Rs mn) 35 STOCK PERFORMANCE (%) 52 Week high / low Rs 564/330 3M 6M 12M Absolute (%) (11.0) (21.6) (31.6) Relative (%) (14.9) (21.2) (36.4) SHAREHOLDING PATTERN (%) Promoters 33.5 FIs & Local MFs 38.3 FPIs 8.1 Public & Others 20.1 Source : BSE 10 Jan 2019 Amey Chalke Amey.chalke@hdfcsec.com Eshan Desai eshan.desai@hdfcsec.com

2 API to formulations play Laurus Labs is a young, R&D-driven company with strengths in complex chemistry and cost-efficient capabilities in API manufacturing. Laurus has grown at a scorching pace with 30% revenue, 32% EBITDA and 40% earnings CAGR over FY However, price hikes in a key raw material (FCME) and Rs 1bn operating spend on the nascent formulations business led to a nosedive in 1HFY19 (40% earnings drop). The stock, too, corrected ~34% (from Rs 566 peak in Jan-18). We believe these issues are temporary and offer investors an opportunity to enter a high quality pharma story at a 24% discount to IPO price. Laurus is likely to come out stronger as backward integration for the key molecule is already in place and the formulations business is about to be in the black with fresh orders. With a likely initial tender win, Laurus is set to enter the US$ 1.8bn ARV formulations market in FY20. It can capture at least 15% market share (in 3 products), supported by one of the largest API capacities. At FY21E formulations revenues/ebitda of US$ 85/25mn, earnings can triple over FY19-21E (on a soft base). Moreover, we expect a couple of big ticket formulations launches in the US market by FY21 which can further boost profitability. Initiate coverage with a BUY rating and TP of Rs 480 (18x Dec-20E EPS). Foray into formulations: Laurus is building on its API success to forward integrate into formulations. The ARV tenders in GA LMICs, a market of US$ 1.8bn, is one of the key opportunities for Laurus. With the expectation of capturing 6-7% of the tender business in 3 key products (TLE, TEE, TLD), the formulations segment s contribution will account for ~22% of revenue by FY21E. Estimating a margin of over 30%, the segment will provide Rs ~1.8bn incremental EBITDA in FY21E. Muted performance in ARV APIs: The largest segment (65% of sales) is likely to remain largely steady over FY18-21E. The reduction in dosage size for ART drugs and captive consumption would lead to decline in key ARV APIs (FTC & EFV). However, fresh supplies of Lamivudine, Ritonavir and Lopinavir APIs would offset this fall to some extent. Lucrative custom synthesis segment: 7.5% of revenues are derived from the custom synthesis segment and 50% of this business is coming from Aspen as Laurus has tie-ups for select product opportunities. We expect the Aspen business to ramp up to US$ ~24mn from US$ ~11mn now, led by capacity expansion. The ex-aspen business is likely to grow at a healthy rate of 15-20%, as Laurus adds more projects in the pipeline. We believe it can be a 30% plus EBITDA margin business once Laurus achieves the required scale. View and valuation: At present, Laurus is trading at 22/13x P/E and 10/7x EV/EBITDA (FY20/21E), ~9% discount (FY21E P/E) to peers. Traits like strong R&D skills, cost competitive processes, high probability of success in tender business, potential improvement in business fundamentals like earnings growth, return ratios and free cash flows merit higher multiples. Financial Summary YE March FY16 FY17 FY18 FY19E FY20E FY21E Net Sales 18,110 19,315 20,690 22,357 25,117 28,714 EBITDA 3,622 4,076 4,133 3,336 4,990 6,796 APAT 1,342 1,913 1, ,857 3,167 Diluted EPS (Rs) P/E (x) RoE (%)

3 Table of contents Company background 4 Journey so far 5 Business snapshot 6 Formulations: Growth opportunity 7 ARV tender business: Key driver for formulations 8 Formulations: US & semi-reg. markets 12 ARV API: Mainstay of the business 13 Hepatitis C API: Highly profitable, but declining 15 Oncology and Other APIs: Profitable, and growing 16 Synthesis and Ingredients: CRAMS to drive growth 17 Manufacturing footprint 18 Financial Analysis 19 Valuation 23 Risks 24 Key personnel 25 Peer comparison & Financial Statements 26 3

4 Company background Laurus Labs is an R&D driven Pharmaceuticals company established in 2005 with its headquarters in Hyderabad. It is among the leaders in the manufacture of Active Pharmaceutical Ingredients (APIs) for Antiretroviral (ARV) and Hepatitis C (Hep-C) formulations. Other major API segments include therapeutic areas such as Oncology, Cardiovascular, and Anti-Diabetes. Apart from manufacturing APIs, it develops and manufactures oral solid formulations, provides CRAMS services to other global pharmaceutical companies, and also produces specialty ingredients for nutraceuticals, dietary supplements, and cosmeceuticals. Revenue Mix (FY18) Oncology API 8% Synthesis 7% Other API 8% Ingredients 3% Formulations 0% ARV API 66% Its revenue grew at 30% CAGR (FY12-18) driven by a ramp-up in the API segment, whereas EBITDA and PAT grew at 32% and 40% CAGR respectively over the same period. Lately, PAT growth has remained subdued due to under-utilized capacities in the formulations business and heavy R&D spend for ANDA filings in the US. In 2007, Aptuit invested Rs 1bn in Laurus. The funding was at a crucial stage, which helped Laurus in scaling up its operations. FIL Capital Management invested Rs 490mn in the company in 2012 through primary funding as well as acquisition of Aptuit s majority stake. Impressed by Laurus superlative operational performance, Bluewater invested Rs 3bn in 2014 and acquired a significant stake of FIL Capital. With this, Laurus commenced construction of its formulations facility, Unit 2. Among the largest shareholders are Bluewater Investments (19.7%), FIL Capital Mauritius (11.5%), SBI MF (2.5%), Kotak MF (2.2%), Goldman Sachs India (1.4%), Govt Pension Fund Global (1.3%), and Nomura (1.1%). Hep-C API 8% Shareholding Pattern (Dec-18) Public 20.1% FPIs 8.1% Promoters 33.5% Fls & Local MFs 38.3% 4

5 Journey so far Oncology API supply started Commercialized Unit 1 Aptuit invested Rs 1bn First DMF filed Started ARV API supply Commenced CRAMS and ingredients operations Started supplying to the US FIL & promoter invested Rs 600mn Crossed Rs 10bn revenues Rs 3bn investment by Bluewater Commercialized Unit First ANDA filed in 2016 Launched first product in the US in 2018 Crossed Rs 20bn in revenues Filed 9 ANDAs and 1 NDA with USFDA 5

6 Business snapshot Revenue (FY18) Rs 20.7bn Formulations > 1% of sales (Future growth driver) API 90% of sales Synthesis 7% of sales Ingredients 3% of sales Three-pronged approach: 1. ARV tender market 2. US regulated market 3. Semi regulated markets 1. Economies of scale 2. Patented process 3. Niche molecules 1. High margin segment 2. ~50% business from Aspen 3. Expect growth of 25-30% 1. Smaller segment 2. Growth expectation of 15-20% ARV Hep-C Oncology Others 65% of sales 8% of sales 8% of sales 9% of sales 1. Market leader in EFV 2. Growing its presence in TNF, EMT, LMV 3. Filed DTG, RTV and LPV 1. Has profit sharing agreement with Natco 2. Growth expectation nil due to pricing pressure 1. Gemicitabine is key molecule in this segment 2. Growing its presence in other molecules 1. Metformin and Pantoprazole are key molecules 2. Growth expectation 15-20% 3. Focusing on high volume molecules 6

7 Formulations: Growth opportunity Foray into formulations Venturing into the formulations segment: To take advantage of its cost-effective API manufacturing capabilities, Laurus entered the formulations business in 2015 and has invested close to Rs 5bn in building a 5bn tablets/year capacity. In FY18, it incurred Rs 1bn opex on account of the formulations business and only generated Rs 60mn in revenue. Three pronged strategy: It is likely to focus on 3 key segments to ramp up formulations revenues: (1) ARV tender market; (2) US generics; and (3) other regulated markets. It can also explore CMO opportunities to make use of its excess capacity for fixed revenues and margins. Ramping up filings: Till now, Laurus has filed 9 backward integrated ANDAs and 1 NDA with the US FDA, 2 dossiers in Europe, and one each in Canada, South Africa, and with WHO. It has received US FDA approvals for g-viread (TDF) and gmetformin. ARV tenders: The biggest near term opportunity Being the cost leader in ARV APIs, we believe Laurus will be best placed to garner at least 15% market share (in 3 products) of the US$ 1.8bn ARV tender market. A substantial part of the revenues would start coming in from FY20E itself. We expect Laurus formulations segment to catapult to Rs 6.1bn revenues in FY21E from Rs 60mn in FY18. This will also translate into incremental EBITDA of Rs 1.8bn from the formulations segment, taking the total EBITDA to Rs 6.8bn in FY21E from Rs 4.1bn in FY18 (~18% CAGR). Formulations: Sharp Jump In Contribution By FY21E Formulations Revenue (Rs bn) Revenue Contribution (%) 21% 10% 2% 0% FY18 FY19E FY20E FY21E Formulations: EBITDA Breakeven Expected by FY20E Formulations EBITDA (Rs bn) EBITDA from other segments (Rs bn) (1.0) (0.8) FY18 FY19E FY20E FY21E 7

8 Global ARV landscape As of 2017, there are 36.9mn people living with HIV (PLHIV) globally. Only 21.7m of which are receiving treatment, translating to a coverage rate of 59% A major portion of the PLHIV is in low and middle-income countries (LMICs), particularly in Africa, with South Africa having the largest HIV+ population (~20%). The generic-accessible (GA) ARV market represents close to 95% of LMIC patients as of The GA-LMIC market is segmented into adults in first-line treatment (1L), adults in second-line treatment, and pediatric patients. Out of the total population under ART in LMICs, 75% were adults receiving 1L treatment (1L GA LMIC). Over 70% of adults on first-line treatment were on WHO preferred TLE (TDF/FTC/EFV) or TEE (TDF/3TC/EFV) as of However, WHO updated Dolutegravir (DTG) the preferred 1L treatment for nearly all adult and adolescent patients (with certain exceptions) in DTG, as part of a fixed-dose combination of TLD, is expected to change the ART landscape. Opportunity for ARV medicine companies Due to the continued increase in patient base and coverage rate, 24.1mn patients are expected to be under ART in GA LMICs by 2022, translating to a growth of 6% CAGR (CY17-22E). The ARV tender market (GA LMICs) is US$ 1.8bn in size as of We estimate this to increase to US$ 1.9bn by 2022 while accounting for further price reduction attributed to wider acceptance of the lower-cost TLD, as well as increasing patient coverage rate. The growth of the ARV market translates to 1.5% CAGR (CY17-22E). People Living With HIV: Africa Has The Highest Concentration Growth in GA LMIC Tender Market (1.5% CAGR over CY17-22E) 5.3 APAC 12% Reg. markets 17% 4.9 Africa 71% GA LMIC ART Market (US$ bn) YoY (%) E 2019E 2020E 2021E 2022E

9 ARV tender market A majority of the ARV tender funding is concentrated in the top three funds More than 50% of the Global ARV tenders are granted by 3 funds - Global Fund, PEPFAR, and South Africa Govt. Fund. These tenders are majorly given for TLE, TEE and TLD products. Despite the fact that there are multiple funding agencies as well as treatment products, a majority of the market is concentrated within the above mentioned funds and products. Therefore, contrary to general perception, Laurus can extract a significant share of the market by getting TLE, TEE and TLD tenders from the top 3 funding agencies. ARV tender market: Heavily dominated by a few key players The global ARV tender market is dominated by Mylan, Hetero, Aurobindo, Cipla, and Aspen, which account for over 75% of the tender business combined. The South African ARV tender market is largely skewed. Market share is majorly divided among Mylan (27%), Sonke (22%), Aspen (17%), and Cipla (13%) owing to their local presence. All of the key ARV API manufacturing companies have manufacturing facilities based out of India, making them equally competitive in the ARV tender space. Laurus currently supplies APIs to 9 of the 10 largest generic pharmaceutical companies and has an advantage in backward integration. We expect Laurus to participate in the top 3 tenders and capture ~15% market share in the ARV tender market at its peak, in TLE, TEE and TLD. Fund-wise Contribution To ARV Tenders (CY19E) Others 34% UNDP 6% Company-wise ARV Tender Market Share (CY17) Aspen 6% Kenya 6% Others 23% Cipla 7% Auro 13% PEPFAR 11% Global Fund 22% South Africa 21% Mylan 31% Hetero 20% 9

10 Top three products: TLE, TEE and TLD WHO preferred first-line treatment: TLE, TEE and TLD The WHO recommended first-line for ART is Tenofovir Disoproxil Fumarate (TDF) + Lamivudine (3TC) or Emtricitabine (FTC) + Efavirenz (EFV). TLE (TDF/3TC/EFV) and TEE (TDF/FTC/EFV) are fixed-dose combinations (FDC) recommended as the preferred option to initiate ART. Since the start of 2016 many countries have rolled-out new HIV treatment guidelines which reinforced the WHO-recommended regimens for 1L and 2L treatment. In July-18, the WHO revised its guideline and made DTG part of the preferred first-line treatment option for nearly all adults and adolescents (with certain exceptions). In CY19E, over 85% of the funding by the top three donors (Global Fund, PEPFAR and South Africa Govt Fund) is expected to be allocated to TLE, TEE and TLD. Transition to TLD Dolutegravir (DTG) is a relatively new ARV available in generic form in LMICs and TLD, an FDC of TDF/3TC/DTG, is considered desirable for use as a first-line regimen in people living with HIV. This combination provides many clinical benefits, including improved tolerability, higher antiretroviral efficacy, lower rates of treatment discontinuation, a higher genetic barrier to resistance, and fewer drug interactions than other ARV drugs as per WHO. TLD is also a significantly lower cost product, expected to reduce the cost of ART from US$ 89 (PPPY as of 2017) to US$ 75, and is forecasted to gain 62% market share of 1L GA LMICs by The opportunity in these products is evident and Laurus has filed for TLD with the USFDA. Product-wise Funding Allocation By Top 3 Funds (CY19E) DTG-based Regimen To Gain Traction TEE 20% US$ 75 59% Others 14% TLE 30% TLD 36% Over 20 LMICs have already initiated the procurement for DTG Stringent Regulatory Authority (SRA) has approved 2 suppliers for TLD The average per patient per year cost for ART under TLD is estimated to be US$ 75 DTG based regimens are expected to gain 59% of the GA LMIC market by

11 Potential opportunity for Laurus Global ARV tender market Laurus tender business revenue at 15% market share of 3 products Estimating ~30% EBITDA Margin, And EBITDA of US$ 1.8bn US$ 135mn US$ 40mn Tender opportunity to improve business mix Laurus Labs is expected to get 10-20% share of the global ARV tenders market, with higher visibility in the top 3 donor funds. A ramp-up in its formulations business will improve business mix and reduce dependence on the API segment, which is typically a lowmargin one. Competitive Landscape Of The ARV Tender Market Aurobindo Hetero Mylan Laurus Aspen Formulations biz can leverage through backward integration Laurus can compete in prices and still maintain margins by way of backward-integration with its API manufacturing business. This is expected to yield them a 25-30% EBITDA margin out of the ARV tender business, translating to EBITDA from ARV formulations of US$ ~40mn (at peak potential) which will grow in-line with market growth. Sun Pharma Cipla Strides Emcure Macleods Above 10% market share Below 10% market share 11

12 The US: To remain modest till FY20E The US market: Ramp up expected from FY21E Since Laurus is entering the US market rather late, after the patent cliff has been passed, low hanging opportunities are rare and competition has heightened. However, there is still a US$ 250bn market under patent protection and a US$ 60bn new product market will be added over the next three years. Till now, Laurus has filed 17 ANDAs and 1 NDA with the US FDA and has received 2 product approvals. It is likely to file 9-10 ANDAs every year with a focus on ARV, oncology and a few Para IV opportunities. We believe the company has filed three Para IVs till date and we expect one of these Para IVs to be a near term opportunity. Laurus is expected to launch 5-6 ANDAs every year from FY19 onwards. We expect the US business revenues to remain modest till FY20E, until big Para IV opportunities are launched. Semi-regulated markets: Stable base for formulations Apart from ARV tenders and the US market, Laurus is likely to explore semi-regulated market opportunities. This includes markets like Canada, Australia, Europe and emerging markets. Laurus strategy in these markets will be to enter through distributors, without the need of any significant spending on frontends. This will lead to improved operating leverage as formulations capacities are frugally utilized. Typically, gross margins are in the range of 50-60% for RoW markets. R&D Spend: Correlated To Filings Rate DMF (No.) ANDA (No.) R&D (Rs bn) FY13 FY14 FY15 FY16 FY17 FY18 1HFY19 ROW & US Will Account For ~40% Of Revenue By FY21E Tender (Rs bn) ROW (Rs bn) US (Rs bn) FY19E FY20E FY21E 12

13 ARV API: Market dynamics ARV: High Volume API market The market size for 11 key ARV APIs was Rs 102bn in Of these, four APIs have a market size of more than Rs 10bn each and Rs 66bn collectively. The demand for ARV APIs will see continued growth in the coming years owing to a steady rate of new HIV patients, higher detection and coverage rate, decline in cost of treatment and increase in ARV tenders. However, the introduction of low-dosage DTG will lead to a decline in volumes. Growth remains a challenge due to moderating prices While there is a persistent growth in the number of patients under ART, driving the demand for key ARV APIs at 8-10% CAGR (over FY13-18); price erosion over the last 5 years has been at 4-7% each year. This is likely to continue as cheaper options are becoming available in the form of DTG-based treatments. With a shift in 1L treatment and the availability of low-dose molecules, we expect the ARV API market to decline at single-digits going ahead, especially for the large volume products. DTG to change the ARV API landscape The introduction of DTG will result in further reduction of prices and the forecasted demand for DTG will require a global production capacity of 200mt (v/s 1,200mt for others). With the introduction of DTG, volume growth for other ARV API would fall since the required DTG dosage is relatively small (~16%). Moreover, since DTG will be significantly cheaper than other APIs, the ARV API market size would also grow at a lower rate as compared to ARV formulations. Top Four APIs Have A Rs 66bn Market Size Rs 10bn-20bn Below Rs 10bn EFV LPV ZDV DRV TDF FTC 3TC NVP RTV ABC Atazanavir *Laurus has presence in highlighted API markets Key ARV API Prices (Per Kg) TDF (US$) EFV (US$) FTC (US$) FY16 FY17 FY18 FY19 Source: HDFC sec Inst Research 13

14 Laurus position in the ARV API market ARV APIs contribute 65% to the top line ARV API revenue is the largest revenue component for the company, at Rs. 13.3bn for FY18 (65% of total revenue). ARV API revenues have grown at ~10% CAGR over FY Currently, Laurus manufactures TDF, EFV, and FTC APIs among others. Laurus is present in three of the four large volume APIs in the ARV segment EFV, TDF and FTC. All three molecules are part of the GA LMIC ARV tenders. These APIs constituted ~97% of ARV API revenue in FY18. Lower cost and patented processes have been the key factors in making Laurus the preferred API supplier in the ARV segment. At present, Laurus is supplying to 80% of the players who participate in ARV tenders. We believe Laurus has 1,200MT capacity for EFV (42% of global capacity) and 400MT capacity for TDF (19% of global capacity). Although Laurus is constantly gaining market share in these molecules, pricing trend is downwards due to incremental pressure from ARV tenders. 3TC and DTG to be added in the ARV API portfolio Laurus will begin production of 3TC at a capacity of 500MT and DTG production will also ramp up as demand for these new molecules builds over the next few years. Apart from these two, Laurus will also manufacture LPV and RTV going ahead. With these additions, Laurus will offer a full basket of ARV APIs for 1L and 2L treatments. However, an increase in captive consumption for the formulations business, coupled with the declining ARV API prices, will lead to a de-growth in ARV API revenues of up to 2% CAGR over FY18-21E. ARV API: Growth To Moderate ARV API (Rs bn) %YoY Growth (3.2) (2.4) (9.4) DTG & 3TC Sales Will Ramp Up Over FY18-21E (Rs bn) TDF EFV FTC 3TC DTG Others Total FY16 FY17 FY18 FY19E FY20E FY21E 14

15 Hepatitis C API: Highly profitable, but declining Offtake in FY16 on the back of the Sofosbuvir franchise Hepatitis C (Hep-C) API revenue at Rs 1.7bn contributed 8% to Laurus total revenue in FY18. The business grew at a CAGR of 93% over FY15-18 but declined 33% YoY in FY18. The introduction of Sofosbuvir in 2015 created a paradigm shift in the treatment of Hep-C. It resulted in large-scale detection of the infection owing to accumulation of un-detected cases over the years. High pricing power for the Hep-C FDF manufacturers was able to support the higher cost APIs. Thus, this lead to a surge in sales during FY16&17. Dwindling sales of Hep-C segment for Laurus The number of new incidents per year is relatively low. Moreover, this is a cure for Hep-C. Therefore, the increasing rate of treatment coupled with a low number of new patients has reduced the demand of Hep-C API post FY17. The price of Hep-C API has also reduced from US$ 2,000 in 2015 to US$ 900 in 2018 owing to increased competition in the formulations space. Laurus Hep-C API sales are on a profit-sharing basis (~50% profitshare) with Natco. We estimate 70-80% of Hep-C API revenues are contributed by the profit component from Natco. Due to falling demand and price correction, the profit share has also reduced since FY18. Hep-C revenues to stabilize over FY18-21E We believe the price and demand for Hep-C API has stabilized post correction, and should be maintained over the medium-term. Estimate 5% negative CAGR over FY19-21E. Hep-C API: Revenues To Stabilize Over The Medium-term Hep-C API Revenue (Rs bn) %YoY Growth 27.3 (5.0) (5.0) (33.5) (35.0) Natco Commands ~50% Market Share In Hep-C In India (Rs bn) Natco Cadila Mylan Hetero Dr Reddy Others 100% % % % 20% %

16 Oncology and Other APIs: Profitable, and growing Oncology API: High margin business Oncology APIs revenue stood at Rs 1.6bn in FY18 and contributed 8% to Laurus total revenue. The segment grew at ~9% CAGR over FY % of Laurus revenue from oncology APIs comes from the sale of Gemcitabine and Imatinib. The oncology API segment offers high margins (25% plus); therefore, growth in revenues from oncology APIs would improve business mix and expand overall margins. Oncology API: Steady Growth Expected Oncology API Revenue (Rs bn) (24.1) %YoY Growth Other API: Metformin and Pantoprazole are the key molecules currently The sale of other API products at Rs. 1.7bn in FY18 makes up 8% of Laurus total revenue. This segment grew at 86.7% CAGR over FY15-18 and 15%YoY in FY18. Margins for these APIs are in the range of 14-15%. Metformin and Pantoprazole continue to be among the largest in quantum, and are expected to be the key growth drivers in this segment. Therapeutic areas such as cardiovascular, anti-diabetic, and ophthalmic are expected to offer good future prospects. Both these segments are expected to grow at 13-14% CAGR over FY18-21E Other API: New Therapeutic Areas To Drive Growth Other API Revenue (Rs bn) %YoY Growth (49.3)

17 Synthesis and Ingredients: CRAMS to drive growth Laurus Synthesis: CRAMS business, dependent on Aspen Laurus synthesis business provides research and manufacturing services on contract basis to other pharmaceutical companies. Its revenue for FY18 was at Rs 1.5bn (7.5% of total revenue). The segment grew at 48% CAGR over FY Laurus enjoys higher than company-average margins from this segment (~25%). 50% of its revenue comes from its business with Aspen, and the rest comes from other customers and innovators for CRAMS services. This segment is expected to continue growing at a CAGR of ~25% over FY18-21E. The continued growth expectation is attributed to (1) Commencement of supply from unit 5 to Aspen; (2) Expected initiation of Digoxin API from unit 4 for C2 Pharma; (3) Addition of high potent capabilities to cater to 2 NDA programs and a robust pipeline of molecules. Laurus Ingredients: Nutraceuticals business, expected to take off With revenue at Rs 0.6bn for FY18 (3% of total revenue), this segment declined 1% YoY (+34% CAGR over FY15-18E). However, it is expected to grow in the coming years on the back of new product developments and expanding market share. Unit 4 will result in capacity expansion for the segment. This segment currently offers a margin of 18-20%. However, we estimate the margins to expand as Laurus gains the required scale. We expect the segment to grow at ~13% CAGR over FY18-21E. Laurus Synthesis: Aspen Deal To Drive Top-line Laurus Ingredients: Growing, But Small Synthesis Revenue (Rs bn) YoY (%) Nutrients Revenue (Rs bn) YoY (%) 31.6 (0.8) (31.6)

18 Manufacturing footprint Earnings To Have Bottomed-out In FY19E Facility API/ FDF Segment Approvals Estd. Year Unit 1 API US FDA, WHO-Geneva, API, Ingredients, NIP Hungary, KFDA & Synthesis, CRAMS PMDA 2007 Unit 3 API API, Ingredients, Synthesis, CRAMS US FDA, WHO, Hungary 2015 Unit 5 API Hormone & steroid facility for Aspen 2017 Unit 2 FDF & API US FDA, WHO, Germany 2017 Unit 4 API API, Ingredients, Synthesis, CRAMS 2018 Unit 6 API 2018 Unit 2: Key Formulations Facility Unit 1: Oldest API Manufacturing Facility Unit 5: Dedicated Block For Aspen 18

19 Financials: Growth to come back Revenues to grow at 11.5% CAGR over FY18-21E Gaining market share in ARV APIs and successful launch of Hep-C products in India led to a top-line growth of ~16% CAGR over FY All segments saw strong double-digit growth during this period. However, with increased pricing pressure and captive consumption of ARV APIs, and falling demand in the Hep-C products, we expect these two segments to report subdued performance over the next three years. The formulations segment is going to be the new growth engine for Laurus while the synthesis and ingredients businesses are expected to continue growing at double digits. Driven by the Formulations and CRAMS segments, Laurus top line is expected to grow at ~11% CAGR over FY18-21E. Formulations Revenue Contribution To Increase (Rs bn) ARV API (Ex-ARV) CRAMS Formulations Total % % % % % % Gross margin to have bottomed-out by FY19-end Scale up in the Hep-C API business drove gross margin expansion from 38% in FY15 to 49% in FY18. However, as the Sofosbuvir franchise got eroded, business mix has skewed towards the lowermargin ARV API segment in FY19E. Moreover, Laurus has also been impacted by raw material price movement over FY Decline In Hep-C API Pressurized Gross Margin Gross Margin (%) Going ahead, backward integration in the raw material of FTC and a ramp up in the formulations segment by FY20-21E will lead to a rebound in gross margin. We expect gross margin to expand ~200bps over FY18-21E

20 Financials: Margin to recover sharply EBITDA to reach Rs 6.7bn by FY21E, translating to an ~18% CAGR over FY18-21E Negative contribution of the formulations segment has been the key hurdle in EBITDA improvement. Laurus has been incurring ~Rs 1bn in opex yearly, for the formulations business since FY17. We believe Laurus formulations segment will break-even by FY20E, owing to the tender business gaining traction. As the opex is absorbed by formulations revenue, the segment will turn profitable. We estimate formulations EBITDA to reach Rs 1.8bn by FY21E. EBITDA margin to expand ~370bps over FY18-21E EBITDA margin expanded to 21.1% in FY17 (up 610bps over FY15) when the Sofosbuvir franchise was at its peak. However, the subsequent decline in the Hep-C API business led to higher contribution of lower-margin ARV APIs. Over the last three years, we can see opex (% of sales) has been increasing. R&D, employee cost and other opex increased 450bps from 24.3 in FY16 to 28.8 in FY18. While we believe R&D spend would remain high owing to ANDA filings in the US and semi-regulated markets, the company has room to save on other operating expenses by undertaking cost rationalization. Going ahead, improvement in business mix will be the key trigger for margin expansion. We believe the formulations segment will enable revival of EBITDA margin. Segment-wise EBITDA breakup (Rs bn) Hep-C ARV & Others (API) Nutrients & Synthesis Formulations Opex (% of sales) has been increasing over the years Cost Of Sales Employee Cost Other Opex R&D EBITDA Margin

21 Financials: Business fundamentals to improve Lower capex requirement to improve free cashflow: Cash flow from operations has increased from Rs 1.8bn in FY16 to Rs 3.3bn in FY17 and Rs 3.4bn in FY18. however, investment in increasing API capacities and building the formulations facility has led to a considerably high amount of capex at Rs 10bn over FY This resulted in poor free cash over FY Both, API and formulations facilities are operating at sub-optimal level and have sufficient capacity to cater increase in demand over the near-term. Hence, the need for further capital is limited. So, the free cashflow generated over the next few years can be used to repay debt. We expect net debt to reduce from Rs 9.0bn in FY18 to Rs 7.4bn by FY21E. Return ratios to improve on the back of the formulations business: Improving margins and higher asset utilization will push ROE and ROCE to earlier levels of 13/17% by FY21E. We believe there is a significant scope to improve return ratios as the formulations business will start delivering. The formulations segment typically has higher asset turns and better margins as compared to the generic API business. Free Cash To Improve As Investment Cycle Cools Net Debt (Rs bn) Capex (Rs bn) Free Cash (Rs bn) (4.4) (1.4) (0.5) Formulations Segment To Drive Improvement In Return Ratios ROE (%) ROCE (%)

22 Financials Earnings To Have Bottomed-out In FY19E APAT (Rs bn) APAT Margin (%) Presence Of Free Capacities Has Led To Subdued Asset Turnover Asset Turnover (x) Net D/E To Improve As Capex Requirement Reduces Working Capital Days To Remain Stable Net D/E (x) Inventory (days) Payables (days) Debtors (days) Cash Conversion (days)

23 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19E FY20E FY21E Valuation At CMP, Laurus is trading at 22/13x FY20/21E EPS, in-line with its peer average. We believe that investors should use this opportunity to enter the stock due to the following reasons: The formulations business has started delivering, and is expected to reach Rs 6.1bn in revenue and Rs 1.7bn in EBITDA by FY21E. Moreover, the CRAMS segment is also expected to see strong double-digit growth over FY21E, whereas Hep-C and ARV API should decline at low-single digits post FY19E. Overall, the nearterm revenue growth trajectory looks strong. A strong earnings outlook; 23.6% CAGR over FY18-21E, backed by 11.5% revenue CAGR. Improvement in RoIC from 9% in FY18 to ~14% by FY21E. We value Laurus at 18x Dec-20E EPS, arriving at a TP of Rs 480/sh, implying ~30% upside. The key catalysts for success are: Strong R&D skills and cost competitive processes High probability of success in the tender business Potential improvement in business fundamentals like earnings growth, return ratios and free cash flows Laurus Labs P/E Band ROIC Set To Improve Going Ahead 70 1 Yr Fwd P/E (x) P/E Average (Dec-16 - Dec-18) ROIC (%) Dec

24 Risks Further erosion in Hep-C formulation price: While further price erosion is unlikely, it could impact profitability of the Hep-C segment. However, the share of Hep-C APIs has reduced from 13.3% in FY17 to 8.1% in FY18. We expect this segment to account for only 3-4% of revenues by FY Hence, overall impact of price erosion would not be very material. Drop in HIV funding: Since ART coverage is increasing rapidly with initiatives to achieve the fast-track target, a growing patient pool will require enough funding to support the treatment. Funding constraints would require LMICs to use their limited resources more efficiently. Any reduction in donor funding could lead to pressure on formulation prices, thus reduce the profitability of the FDF segment. However, we do not expect a major reduction in donor funding as the funding agencies are aimed at achieving the target by Major overhaul in ART: While TLD is expected to remain the preferred regimen for HIV treatment, there are many products currently under development. These could potentially change the landscape in the long-term. Prioritized List Of Products For Adults On ART 24

25 Key personnel Dr Satyanarayana Chava Founder & CEO Mr V V Ravi Kumar ED & CFO Mr Chandrakanth Chereddi ED - Formulations & Strategy Dr Satyanarayana holds a Master s degree in Science from Andhra University, and is also a PhD. He has experience of over 23 years with companies like Ranbaxy and Vera labs. He also has more than 100 patents filed to his name. He has been a Director at Laurus since Mr V V Ravikumar holds a Master's degree in Commerce from Andhra University, and is also a member of the ICWAI. He has over 25 years of experience in the field of finance. He is in charge of the finance and human resources functions at Laurus. He has been a Director at Laurus since Mr Chandrakanth Chereddi oversees Strategy and Operations. He holds a Master s degree in Science from the University of Illinois. He has over eight years of experience in the field of project management. He has been a director at Laurus since Dr Lakshman Chunduru Exec VP - Quality Dr Lakshmana Rao C V has been associated with Laurus since He holds a Master s degree in Science and a PhD from the Andhra University. He has over 13 years of experience in product development. 25

26 Peer comparison M-Cap (Rs bn) CMP (Rs/sh) Revenue (Rs bn) EBITDA (Rs bn) PAT (Rs bn) CAGR: FY18-21E (%) FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E Revenue EBITDA PAT Divi's 403 1, Laurus Dishman Shilpa Med* Suven Life Granules Hikal * Aarti Drugs* Neuland M-Cap (Rs bn) CMP (Rs/sh) Net Net EPS (Rs/sh) RoE (%) P/E (x) EV/EBITDA (x) Debt D/E (x) (Rs bn) FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18 FY18 Divi's 403 1, (19.4) (0.3) Laurus Dishman Shilpa Med* (0.3) (0.0) Suven Life (2.7) (0.4) Granules Hikal * Aarti Drugs* Neuland **Bloomberg estimates 26

27 Peer set comparison Company Mcap (Rs bn) CMP (Rs/sh) Reco TP/ FV EPS (Rs/sh) P/E (x) RoE (%) FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E Sun Pharma 1, BUY Aurobindo Pharma NEU Dr Reddy's Labs 432 2,600 BUY 3, Cipla BUY Divi's Labs 403 1,516 SELL 1, Lupin BUY 1, Cadila Healthcare BUY Torrent Pharma 314 1,857 NEU 1, Alkem Laboratories 236 1,970 BUY 2, Glenmark BUY Jubilant Life Sciences BUY 1, Alembic Pharma NEU Strides Shasun BUY Laurus Labs BUY Dishman Carbogen Amcis BUY Suven Life Sciences NR Granules India BUY Neuland Labs BUY

28 Income Statement & Balance Sheet (Cons.) Year ending March (Rs mn) FY17 FY18 FY19E FY20E FY21E Net Revenues 19,315 20,690 22,357 25,117 28,714 Growth (%) Material Expenses 9,968 10,637 11,961 12,634 13,783 Employee Expenses 2,462 2,580 2,951 3,240 3,589 Selling and Administration Expenses 695 1,084 1,408 1,394 1,421 Other Operating Expenses 2,114 2,255 2,701 2,859 3,125 EBITDA 4,076 4,133 3,336 4,990 6,796 EBITDA Margin (%) EBITDA Growth (%) Depreciation 1,060 1,255 1,624 1,815 2,004 EBIT 3,017 2,879 1,712 3,176 4,792 Other Income (Including EO Items) Interest PBT 2,352 2, ,544 4,339 Tax (Incl Deferred) ,172 RPAT 1,913 1, ,857 3,167 Share of profit / (loss) from associate (11) RPAT after share of profit/(loss) from associate 1,903 1, ,857 3,167 EO (Loss) / Profit (Net Of Tax) 200 APAT 1,913 1, ,857 3,167 APAT Growth (%) Adjusted EPS (Rs) As at March (Rs mn) FY17 FY18 FY19E FY20E FY21E SOURCES OF FUNDS Share Capital - Equity 1,058 1,060 1,060 1,060 1,060 Reserves 12,247 13,766 14,443 16,189 19,166 Total Shareholders Funds 13,304 14,826 15,504 17,249 20,226 Long Term Debt 1,246 1,417 1,717 1, Short Term Debt 7,848 7,585 8,085 8,085 7,085 Total Debt 9,094 9,002 9,802 9,802 8,052 Net Deferred Taxes (699) (529) (529) (529) (529) Long Term Provisions & Others TOTAL SOURCES OF FUNDS 22,422 24,155 25,536 27,282 28,509 APPLICATION OF FUNDS Net Block 12,202 14,711 15,587 16,272 16,269 CWIP 1,433 1,632 1, Goodwill Investments Other Non-current Assets ,925 1,925 1,925 Total Non-current Assets 14,437 17,162 18,643 19,009 19,005 Inventories 5,090 5,848 5,735 6,057 6,608 Debtors 5,676 5,706 6,003 6,537 7,473 Other Current Assets Cash & Equivalents Total Current Assets 11,398 12,476 12,724 13,725 15,050 Creditors 2,631 3,123 3,277 3,115 3,398 Other Current Liabilities & Provns 782 2,360 2,554 2,337 2,148 Total Current Liabilities 3,413 5,484 5,831 5,452 5,547 Net Current Assets 7,985 6,992 6,893 8,273 9,504 TOTAL APPLICATION OF FUNDS 22,422 24,155 25,536 27,282 28,509 28

29 Cash Flow & Key Ratios (Cons.) Year ending March (Rs mn) FY17 FY18 FY19E FY20E FY21E Reported PBT 2,352 2, ,544 4,339 Non-operating & EO items (250) (250) (350) Interest expenses Depreciation 1,060 1,255 1,624 1,815 2,004 Working Capital Change (525) (570) (675) (1,264) (1,429) Tax Paid (501) (619) (273) (687) (1,172) OPERATING CASH FLOW ( a ) 3,320 3,425 2,387 3,040 4,196 Capex (2,775) (3,911) (1,868) (2,180) (2,000) Free cash flow (FCF) 545 (486) ,196 Investments Non-operating Income INVESTING CASH FLOW ( b ) (2,887) (3,849) (1,868) (2,180) (2,000) Debt Issuance/(Repaid) (2,387) 1, (1,750) Interest Expenses (950) (761) (718) (632) (453) FCFE (2,904) (8) Share Capital Issuance 2,860 3 (0) (0) (0) Dividend (59) (191) (43) (111) (190) Others FINANCING CASH FLOW ( c ) (536) (744) (2,393) NET CASH FLOW (a+b+c) (103) (2) (198) EO Items, Equivalents 16 0 Closing Cash & Equivalents FY17 FY18 FY19E FY20E FY21E 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) Interest Coverage (x) PER SHARE DATA (Rs) EPS Dividend Book Value VALUATION P/E (x) P/BV (x) EV/EBITDA (x) EV/Revenues (x) OCF/EV (%) FCF/EV (%) 1.1 (1.0) FCFE/Mkt Cap (%) (7.4) (0.0) Dividend Yield (%)

30 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Rating Definitions BUY NEUTRAL SELL : Where the stock is expected to deliver more than 10% returns over the next 12 month period : Where the stock is expected to deliver (-) 10% to 10% returns over the next 12 month period : Where the stock is expected to deliver less than (-) 10% returns over the next 12 month period 1yr Price Movement 600 Laurus

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