Cadila Healthcare CADI.NS CDH IN

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1 Cadila Healthcare CADI.NS CDH IN EQUITY: PHARMACEUTICALS Increasing TP to INR1,055 Factoring in Asacol HD upside and better US sales and margin outlook Action: Increasing TP to INR1,055; maintain Buy We upgraded CDH on the assumptions of: 1) increased traction in the US; and 2) CDH being more conservative on expansion and focusing on execution (please refer to our 5 December 2013 note, Awaiting the pipeline to unfold). We believe a recent spate of approvals resulting in increased US sales and the decision to exit Japan, which was a loss-making geography, substantiate our assumptions. CDH has maintained a high ANDA filing rate and currently has 143 ANDAs pending approval, the largest among Indian peers. In the recent past, filings for topical and transdermals have gathered pace. Ex-US business growth has been muted, but we expect gradual improvement from FY15. We factor in 9MFY14 results and contribution from Asacol HD exclusivity in FY16 and accordingly raise our EPS estimate by ~7%/32% for FY15/16F. We reset our 12-month target price based of SOTP: 1) base business (ex Asacol HD upside) at INR1,008/sh on 18x (unchanged) one-yearforward adjusted (ex Asacol HD contribution) EPS of INR56; and 2) Asacol HD upside at INR47, at 50% of full potential value. Catalyst: Approval of key products in the US and emerging markets Valuation Ex INR47/sh value for Asacol HD, CDH trades at 19x FY15F. This is line with large-cap peer valuation of 18-20x FY15 ests. We remain comfortable with the valuation given 27% earnings CAGR over FY14-16F ex Asacol HD upside and ROE of ~25%. Our core EBITDA margin estimate (ex Asacol HD) is 18.7%, lower than peers at ~25%-plus. We expect margin expansion to persist beyond FY16F, which we expect to maintain earnings growth ahead of peers. Global Markets Research 10 February 2014 Rating Remains Buy Target price Increased from 874 INR 1055 Closing price 7 February 2014 INR 904 Potential upside +16.7% Anchor themes CDH offers exposure to: 1) generics opportunity in the US; 2) rise in medicine consumption in India, Brazil and Mexico; and 3) a potential rise in generics opportunities in markets such as France, Spain and Japan. Nomura vs consensus Our FY6F PAT is ~21% ahead of consensus, as we factor in contribution from Asacol HD. Research analysts India Pharmaceuticals Saion Mukherjee - NFASL saion.mukherjee@nomura.com Lalit Kumar - NFASL lalit.kumar@nomura.com Mar FY13 FY14F FY15F FY16F Currency (INR) Actual Old New Old New Old New Revenue (mn) 63,577 69,314 71,504 80,720 83,348 93, ,571 Reported net profit (mn) 6,535 6,601 7,669 8,612 9,227 10,609 14,029 Normalised net profit (mn) 6,535 5,940 7,669 8,612 9,227 10,609 14,029 FD normalised EPS FD norm. EPS growth (%) FD normalised P/E (x) 28.3 N/A 24.1 N/A 20.1 N/A 13.2 EV/EBITDA (x) 18.5 N/A 19.1 N/A 14.7 N/A 10.2 Price/book (x) 6.3 N/A 5.3 N/A 4.5 N/A 3.7 Dividend yield (%) 1.1 N/A 1.3 N/A 1.6 N/A 2.4 ROE (%) Net debt/equity (%) Source: Company data, Nomura estimates Key company data: See page 2 for company data and detailed price/index chart See Appendix A-1 for analyst certification, important disclosures and the status of non-us analysts.

2 Key data on Cadila Healthcare Income statement (INRmn) Year-end 31 Mar FY12 FY13 FY14F FY15F FY16F Revenue 52,633 63,577 71,504 83, ,571 Cost of goods sold -16,793-23,202-26,975-31,442-37,600 Gross profit 35,840 40,375 44,529 51,906 62,972 SG&A -26,432-30,971-35,517-39,769-44,987 Employee share expense Operating profit 9,408 9,404 9,011 12,137 17,985 EBITDA 10,987 11,251 11,000 14,366 20,434 Depreciation -1,579-1,847-1,989-2,229-2,449 Amortisation EBIT 9,408 9,404 9,011 12,137 17,985 Net interest expense -1,849-1,687-1,107-1,355-1,355 Associates & JCEs Other income , Earnings before tax 7,942 8,088 9,142 11,283 17,130 Income tax -1,130-1,188-1,143-1,692-2,702 Net profit after tax 6,812 6,900 7,999 9,590 14,428 Minority interests Other items Preferred dividends Normalised NPAT 6,526 6,535 7,669 9,227 14,029 Extraordinary items Reported NPAT 6,526 6,535 7,669 9,227 14,029 Dividends -2,066-2,105-2,470-2,972-4,519 Transfer to reserves 4,460 4,430 5,199 6,255 9,510 Relative performance chart (one year) Source: ThomsonReuters, Nomura research (%) 1M 3M 12M Absolute (INR) Absolute (USD) Relative to MSCI India Market cap (USDmn) 2,965.7 Estimated free float (%) 52-week range (INR) 916.3/629 3-mth avg daily turnover (USDmn) 2.10 Major shareholders (%) Promoter 74.8 Source: Thomson Reuters, Nomura research Notes Valuation and ratio analysis Reported P/E (x) Normalised P/E (x) FD normalised P/E (x) FD normalised P/E at price target (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (INR) Source: Company data, Nomura estimates 2

3 Cashflow (INRmn) Year-end 31 Mar FY12 FY13 FY14F FY15F FY16F EBITDA 10,987 11,251 11,000 14,366 20,434 Change in working capital -3,834-3,703-2,382-3,375-3,843 Other operating cashflow -3,761-3,276-1,938-3,412-5,502 Cashflow from operations 3,392 4,272 6,680 7,580 11,088 Capital expenditure -12,444-7,243-5,500-5,500-5,500 Free cashflow -9,052-2,971 1,180 2,080 5,588 Reduction in investments Net acquisitions Reduction in other LT assets -1, Addition in other LT liabilities 2, Adjustments 2 0 Cashflow after investing acts -8,511-3,323 1,180 2,080 5,588 Cash dividends -1,753-1,790-1,874-2,470-2,972 Equity issue Debt issue 11,978 6,285-1, ,500 Convertible debt issue Others Cashflow from financial acts 10,225 4,495-2,874-2,470-5,472 Net cashflow 1,714 1,172-1, Beginning cash 2,952 4,666 5,838 4,144 3,754 Ending cash 4,666 5,838 4,144 3,754 3,870 Ending net debt 18,227 23,340 25,034 25,425 22,808 Source: Company data, Nomura estimates Balance sheet (INRmn) As at 31 Mar FY12 FY13 FY14F FY15F FY16F Cash & equivalents 4,666 5,838 4,144 3,754 3,870 Marketable securities Accounts receivable 8,863 9,551 10,927 12,731 15,359 Inventories 10,905 12,136 13,883 16,175 19,515 Other current assets 5,798 7,440 8,456 9,624 10,967 Total current assets 30,232 34,965 37,410 42,283 49,712 LT investments 242 1,145 1,145 1,145 1,145 Fixed assets 33,318 37,612 42,123 45,394 48,445 Goodwill Other intangible assets Other LT assets Total assets 63,761 73,760 80,716 88,860 99,339 Short-term debt Accounts payable 5,455 6,568 7,636 8,901 10,644 Other current liabilities 7,588 6,333 7,022 7,647 9,372 Total current liabilities 13,043 12,901 14,658 16,547 20,016 Long-term debt 22,893 29,178 29,178 29,178 26,678 Convertible debt Other LT liabilities 1,185 1,005 1,005 1,005 1,005 Total liabilities 37,121 43,084 44,841 46,730 47,699 Minority interest 904 1,193 1,193 1,193 1,193 Preferred stock Common stock 1,024 1,024 1,024 1,024 1,024 Retained earnings 24,712 28,459 33,657 39,913 49,423 Proposed dividends Other equity and reserves Total shareholders' equity 25,736 29,483 34,681 40,937 50,447 Total equity & liabilities 63,761 73,760 80,715 88,860 99,339 Notes Notes Liquidity (x) Current ratio Interest cover Leverage Net debt/ebitda (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle Source: Company data, Nomura estimates 3

4 Traction in the US business The surge in US revenues in 3QFY14 was the key positive surprise, which we believe helped Cadila post an improvement in EBITDA margin. US revenues recorded growth of 33.5% q-q. According to management, launches of generic Divalproex ER and Prevacid contributed to growth. The pace of ANDA approval has increased in the recent past (CDH received five approvals in January 2014), but the gap between filings and approvals is still very large. As a result, the company expects the approval rate to accelerate and has guided for ~ 20 ANDA approvals each year from here on. The ANDA filing momentum is also to be maintained, according to the company management has guided for 40 ANDA filings in Fig. 1: Number of filings remain high 60 Filed Approved FY09 FY10 FY11 FY12 FY13 YTDFY14 Besides oral dosage, CDH has commenced filing on injectables, topicals, nasal sprays and transdermal products. As of December 2013, CDH had 143 pending approvals, which includes 20 injectables, eight topicala, and six each in nasal sprays and transdermals. As indicated in the figure below, filings for topicals and transdermals have accelerated in the recent past. 4

5 Fig. 2: ANDA filings Increase in filings for topicals and transdermals ANDA Filings Oct-Dec 13 Filings Apr-Dec 13 Cumulative filings till Dec 13 Cumulative approvals till Dec 13 Pending approvals as on 31st Dec 13 Oral Solids Injectable (incl. for Partner) Nasal Transdermal Topical Nesher Total According to management, the company has received Complete Response Letters (CRL) on some nasal spray products and accordingly expects approval in FY15. The USD 3bn nasal spray market presents some interesting low competition opportunities. Azelastine (USD100mn, two generic approvals) and Fluticasone Propionate (USD390mn, three generic players ex Wockhardt) are likely near-term opportunities within nasal sprays. As we highlighted in our 5 December 2013 report, Awaiting the pipeline to unfold, transdermal US sales are likely to scale up to USD100mn in FY17F. In FY15-16F, the revenue contribution is likely to be less than USD50mn. Clonidine and Estradiol weekly are expected to be launched in FY15F. 5

6 Fig. 3: Transdermal opportunity Clonidine, Estradional Weekly likely to be launched In FY15F Product Market size (USD m) Expected launch Comments Lidocaine 1500 FY17 We expect CDH to pursue this largest transdermal opportunity. Watson is the first filer and has launched the product under a settlement agreement recently. The litigation suggests that there are three additional generic companies pursuing the opportunity - Mylan, Noven and TWi Pharma. We expect Cadila to be the fifth generic to enter the market. Fentanyl 900 FY17/FY18 The product has already gone generic and has seven generic approvals in place. Since this is a controlled substance, we expect the product to be manufactured at CDH's US facility. Though the pricing is still good, we expect limited market share gain given the competition. Rivastigmine tartarate 550 FY19 The formulation patent expires in January 201, and we expect CDH to be in the first wave of generic entry. There are four generic players already in litigation -- Actavis, Noven, Par and Alvogen Estradiol twice weekly 300 FY17 The orange book patent expires in January Mylan is in litigation. Clonidine 200 FY15 This is one of the early transdermal filings by Cadila. Currently there are three generic players in the market- Teva, Mylan and Par. However Teva has the largest market share at 75%. Cadila can be the fourth generic entrant. Estradiol Weekly 100 FY15 This is one of the early transdermal filings by Cadila. Currently Mylan in the only generic approval with Alvogen present as an authorised generic. Cadila can be the second generic player in the market. Diclofenac Epolamine 160 FY17+ The brand is Flector. The orange book patent is expiring on Apr The FDA requirement of bioequivalent study or a large patient group is a challenge. Norelgestromin; Ethinyl Estradiol 150 FY17+ The brand is Ortho Evra and this is a contraceptive. The orange book patent is expiring in Jun The development of a combination product on transdermal platform is the key challenge. Buprenorphine 130 FY18 The brand is BuTrans. The product is approved in 2010 and is patent protected till This is a controlled substance and is indicated for pain. The product is recording strong growth on a low base. Methylphenidate 100 FY17+ The brand is Daytrana. There are no generic approvals thus far. Scopolamine 100 FY17+ The brand is Transderm Scop. There are no unexpired orange book patents and there are no generic equivalents approved so far. Testosterone 90 FY17+ The brand is Androderm. There are no generic approvals thus far. Rotigotine 50 >FY20 The brand is Neupro. The product is approved recently in 2007 for Parkinson's disease. The brand is growing fast on a small base. The product is patent protected until 2027 Source: Nomura estimates, US FDA, IMS 6

7 Muted growth in ex US business expect improvement in FY15F Growth in India business has been in the single digits over the past three quarters and came down to ~ 4% in 3QFY14 due to 1) implementation of the new pricing policy we estimate impact of pricing policy to be ~ INR900mn per year; and 2) discontinuation of sales of Dulcolux and Buscopan brands during the quarter the two brands had annual sales of INR900mn, according to our estimates. Adjusted for these two factors, we expect CDH to record growth marginally ahead of the broader market. The AIOCD AWACS data suggests growth for CDH higher than the broader market. Between FY14-16F we factor in revenue CAGR of 11%. Fig. 4: Ex-US formulation sales not much traction Fig. 5: Domestic business growth Sales in INR mn 8,200 Sales (LHS) Growth (RHS) 7,700 7,200 6,700 6,200 5,700 5,200 35% 30% 25% 20% 15% 10% 5% 0% Fig. 6: Zydus Cadila growing ahead of broader market in India Fig. 7: Consumer business change in distribution channel has impacted growth, expect growth pick up in FY15F 35.0% 30.0% 40% 36% 25.0% 20.0% 15.0% 10.0% 5.0% 30% 20% 10% 23% 21% 22% 10% 11% 13% 10% 28% 26% 11% 8% 0.0% -5.0% -10.0% Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 0% -10% Q1FY11 Q2FY11 Q3FY11 Q4FY11 5% Q1FY12 Q2FY12 Q3FY12-12% Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 2% IPM Zydus + Biochem -20% Source: AIOCD, Nomura research Growth in the company s consumer business has declined in the past four quarters and was at ~2% y-y in 3QFY14F (Fig 7). The sales growth is impacted due to reorganisation of the distribution network. As per company, the reorganisation will be completed by end FY14. We expect growth to revive in FY15F. The growth in the segment is largely driven by Sugar free brand. Brazil business has also not seen much sales traction due to 1) lack of approvals; and 2) pricing pressure in the generics segment. As shown below, though company s fillings have been steady, but the approval run rate has fallen substantially. The company has filled for 113 dossiers, of which 73 are pending approval. Cadila expects to launch 7-10 products in 2014, which should drive growth in Brazil business, in our view. JV sales have been adversely impacted by pricing pressure on Taxotere. Management indicated that JV revenues have bottomed out and it now expects growth primarily on back of new launches. The Hospira JV is expected to launch 12 additional products 7

8 over time. Also, the Takeda JV is expected to grow on the back of new API and volume increases, according to management. Fig. 8: Brazil business filing and approvals sales stagnant on account of pending approvals FY10 FY11 FY12 FY13 FY14 YTD No of filings Cumulative filings No of approvals Cumulative approvals Fig. 9: JV business sales INR mn 1,400 1,200 1, Change in estimates We change our estimates to factor in 9MFY14 performance and factor in Asacol HD contribution in FY16F. We are factoring in improved performance in the US business. We marginally reduce our estimates in the ex-us businesses in line with 9MFY14 performance. We have revised our margin estimates up to factor in 9MFY14 results and exit from loss making Japan market. The Japan operations have incurred losses of ~INR1.4 bn over the past three years. We are factoring in Asacol HD exclusivity contribution in FY16F. Actavis has granted a royalty-bearing license for Asacol HD to Zydus. As per agreement, CDH will launch generic Asacol HD in November 2015 if it receives approval else company will be permitted to launch an authorized generic version beginning on 1 July, Management expects approval in CY14. Ex the impact of Asacol HD, our FY14-16F sales estimates are revised up %. We have raised our EBITDA estimates ex Asacol HD by 4-8% over FY14-16F. We factor in 30% price reduction and 50% market share for CDH in Asacol HD. We factor in royalty payment of 30% of Asacol HD sales in our estimates. Fig. 10: Change in estimates INR mn NEW OLD % Change FY14F FY15F FY16F FY14F FY15F FY16F FY14F FY15F FY16F Net Sales % 3.3% 7.6% % Growth 12.5% 16.6% 20.7% 9.0% 16.5% 15.8% EBITDA 11,000 14,366 20, % 4.3% 25.0% % Growth -2.2% 30.6% 42.2% -9.1% 34.7% 18.7% Margins 15.6% 17.5% 20.6% 14.8% 17.1% 17.5% Net Profit % 7.1% 32.2% Source: Nomura estimates 8

9 Fig. 11: Sales breakup INR mn FY12 FY13 FY14F FY15F FY16F FY12-14F FY14-16F Domestic formulation % 11% Zydus Wellness % 10% US % 34% ROW % 14% Animal Health % 12% API % 9% JV % 8% Total % 19% Source: Company data, Nomura estimates Valuation increasing TP to INR1,055, maintain Buy We value CDH based on a sum-of-the-parts methodology. We value the base business at 18x (unchanged) one-year-forward (Jan 2016) adjusted (ex Asacol HD contribution) EPS of INR56 to arrive at a January 2015 target price of INR1,008. In addition, we value the Asacol HD opportunity separately. The Asacol HD opportunity is valued based on DCF (Fig 12). Potentially the Asacol HD upside could last without competition until November 2021, when the patent expires. Assuming the opportunity lasts until November 2021, we arrive at a DCF value of INR95/share, as shown below. However, we believe it is prudent to value the opportunity at a discount, as 1) additional competition over the period can t be completely ruled out; and 2) the upside could be impacted by a market share shift to alternative Mesalamine products. As a result, we factor in a 50% discount to the full potential value of Asacol HD value and assign INR47/sh as the value of this opportunity. Accordingly we are increasing our TP to INR1,055 (INR1,008 + INR47). Fig. 12: Asacol HD valuation USD m FY16 FY17 FY18 FY19 FY20 FY21 FY22 Brand sales No of months Price erosion 30% 30% 30% 30% 30% 30% 30% Market share 50% 50% 50% 50% 50% 50% 50% Cadila sales of sales Cost of of sales PBT of PBT PAT Yr NPV Discount rate 12% Total value USD m 316 Value per share INR 95 Source: Company data, Nomura estimates 9

10 Appendix A-1 Analyst Certification We, Saion Mukherjee and Lalit Kumar, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies. Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Cadila Healthcare CDH IN INR Feb-2014 Buy N/A Cadila Healthcare (CDH IN) Rating and target price chart (three year history) INR 904 (07-Feb-2014) Buy (Sector rating: N/A) Date Rating Target price Closing price 05-Dec-13 Buy Dec Feb-13 Neutral Feb Nov-12 1, Aug-12 1, Jul-12 1, Mar For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology Our 12-month target price of INR1,055 is based on a sum-of-the-parts methodology. We value the base business at 18x (unchanged) one-year-forward (Jan 2016) adjusted (ex Asacol HD contribution) EPS of INR56 to arrive at a January 2015 valuation of INR1,008. In addition, we value the Asacol HD opportunity separately. The Asacol HD opportunity is valued based on DCF. Potentially the Asacol HD upside could last without competition until November 2021, when the patent expires. Assuming the opportunity lasts until November 2021, we arrive at a DCF value of INR 95/share, as shown below. However, we believe it is prudent to value the opportunity at a discount, as 1) additional competition over the period can t be completely ruled out; and 2) the upside could be impacted by a market share shift to alternative Mesalamine products. As a result, we factor in a 50% discount to the full potential value of Asacol HD value and assign INR47/sh as the value of this opportunity. Risks that may impede the achievement of the target price Downside risks to our call: a) a slowdown in domestic branded formulations business; b) longer-than-anticipated delay in key product approvals in the US. Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. Important disclosures may be read at or requested from Nomura Securities International, Inc., on If you have any difficulties with the website, please grpsupport@nomura.com for help. 10

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