CIPLA Inorganic augmentation to US business

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1 EVENT UPDATE CIPLA Inorganic augmentation to US business India Equity Research Pharmaceuticals Cipla (CIPL) has announced an agreement to acquire 2 US generic companies Invagen and Exelan subsidiaries of Hetero Pharma. The combined cash consideration is USD550mn, representing ~2 EV/ Sales at MAT June 2015 revenue run rate. While margins of the acquired business have not been disclosed, CIPL stated that the deal will be EPS accretive. Though the deal brings a reasonable amount of US-based manufacturing, critical mass and access, it does not add new product development platforms. While the pipeline of acquired companies (30 ANDAs, of which 5 are FTFs) indicates steady portfolio growth, maintaining manufacturing compliance (form 483 observations from inspections during March 2015 and May 2015) will be critical for an attractive payback. Maintain BUY. Deal outline indicates fair price paid for essential critical mass The CIPL deal indicates that generic players are chasing assets comprising: (i) US-based manufacturing; and (ii) access to US government/ institutional business, along with a near-term pipeline to augment near-term growth. While Invagen brings US-based manufacturing and near-term revenue (40 approved/ 30 pipeline ANDAs, with 5 FTFs), Exelan gives access to incremental business channels... but brings associated risks We believe, if not already resolved, closure of March 2015 and May 2015 form 483s is critical so that the critical near-term opportunities (Nexium, Renagel, Renvela, etc.) can be monetised and payback to the deal will be more attractive. Outlook and valuations: Operating leverage story; maintain BUY Immediate critical mass was essential for CIPL s profitability post: (i) investing in US front end; and (ii) customer consolidation in US, as significant contribution from its organic pipeline in some time away. In our view, while the deal represents an essential accretion, it will limit CIPL s agility to invest in additional development platforms. We maintain BUY/SO. EDELWEISS 4D RATINGS Absolute Rating Rating Relative to Sector Risk Rating Relative to Sector Sector Relative to Market BUY Outperformer Low Equalweight MARKET DATA (R: CIPL.BO, B: CIPLA IN) CMP : INR 656 Target Price : INR week range (INR) : 753 / 546 Share in issue (mn) : M cap (INR bn/usd mn) : 527 / 8,363 Avg. Daily Vol.BSE/NSE( 000) : 2,045.3 SHARE HOLDING PATTERN (%) Current Q4FY15 Q3FY15 Promoters * MF's, FI's & BK s FII's Others * Promoters pledged shares (% of share in issue) : NIL PRICE PERFORMANCE (%) Stock Nifty EW Pharma Index 1 month (8.0) (8.4) months 3.2 (3.8) months 18.5 (3.6) 29.0 Financials (INR mn) Year to March FY14 FY15E FY16E FY17E Revenues 101, , , ,038 Rev. growth (%) EBITDA 20,956 21,617 32,885 39,917 Adjusted Profit 12,711 11,807 19,044 23,845 Adjusted diluted EPS (INR) EPS Growth (%) (5.5) (7.1) Diluted P/E (x) EV/EBITDA (x) ROAE (%) Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Rahul Solanki rahul.solanki@edelweissfin.com September 4, 2015 Edelweiss Securities Limited

2 Pharmaceuticals Details of acquired businesses Invagen Incorporated in Deal consideration: USD500mn. Turnover: USD130mn/135mn/190mn in CY12/13/14. Large capacity manufacturing base in Hauppauge, New York, and a skilled US-based R&D organisation. 40 approved ANDAs, of which 32 have been launched. With a manufacturing footprint of ~350,000 sq ft of GMP area, Invagen has 3 units located in Long Island, NY, with a total production capacity of 12bn tablets and capsules per annum and about 500 employees. US front-end access to wholesalers/ retailers. Form 483s issued in March 2015 and May Table 1: Invagen s approved ANDAs Alfuzosin ER tablet Amlodipine Besylate tablet Benztropine Mesylate tablet Calcium Acetate capsule Calcium Acetate tablet Carbinoxamine Maleate tablet Citalopram Hydrobromide tablet Cyclobenzaprine Hydrochloride tablet Escitalopram Oxalate tablet Folic acid tablet Fosinopril Sodium tablet Fosinopril Sodium/ HCTZ tablet Gabapentin capsule Gabapentin tablet Gemfibrozil tablet Glimepiride tablet Hydralazine Hydrochloride tablet Quinapril Hydrochloride/ HCTZ tablet Hydroxyzine Hydrochloride tablet Levetiracetam tablet Lisinopril tablet Meprobamate tablet Nabumetone tablet Naproxen DR tablet Orphenadrine Citrate ER tablet Phentermine Hydrochloride capsule Phentermine Hydrochloride tablet Quinapril Hydrochloride tablet Raloxifene Hydrochloride tablet Ramipril capsule Rizatriptan Benzoate tablet Setraline Hydrochloride tablet Terbinafine Hydrochloride tablet Topiramate tablet Trandolapril tablet Warfarin Sodium tablet Zolmitriptan tablet Zolpidem Tartarate tablet Zonisamide capsule Source: FDA 2 Edelweiss Securities Limited

3 Cipla Table 2: Invagen s Para-IV filings Brand Market Size (USD mn) Viibryd 160 Fosrenol 115 Latuda 500 Renagel Renvela 600 PhosLo Gelcaps 50 Evista 850 Zoloft 450 Viagra 1150 Propecia 100 Prezista 1200 Actos 200 Source: Bloomberg Exelan Incorporated in Deal consideration: USD50mn. Turnover: USD2mn/14mn/28mn in CY12/13/14. Access to government and institutional market in the US. Manufacture and distribution services are provided by affiliate partners. Table 3: Marketed products Alfuzosin Hydrochloride Amlodipine Citalopram Hydrobromide Escitalopram Folic acid Fosinopril Finasteride Gabapentin Gemfibrozil Levetiracetam Lisinopril Nabumetone Ramipril Setraline Hydrochloride Terbinafine Hydrochloride Topiramate Zonisamide Source: Company website 3 Edelweiss Securities Limited

4 Pharmaceuticals Company Description Cipla is a global Pharma company with a geographically diversified presence and products registered in more than 170 countries. The India branded formulations accounts for more than 40% of its business and Cipla is among the top three players in the market. In the past, Cipla believed in the partnership model for international markets but over the last three years the company is undergoing a strategic shift and has started setting up its own front end. Cipla is also a well-known global player in the inhalers and antiretrovirals space. Going forward the company expects launch of combination inhalers in the larger markets of US and EU and setting up of own front ends to drive growth. Investment Theme We believe Cipla is headed in the right direction as investments in pipeline/front end begin to deliver. We expect steady growth and margin recovery going forward as acquired businesses and own sales in US/EU start ramping up. Earnings to be driven by operating leverage benefits on initiation of sales from US and EU through own front end, ramp up in Dymista (nasal spray with partner Meda) and cost synergies in South Africa (recently acquired). The launch of combination inhalers in EU validates its capabilities in the space and expect this business to be a long term driver. Key Risks Delay in approvals in US and EU / slower than expected ramp up in the combination inhalers segment Currency appreciation: more than 60% of the business is international and any substantial movement of the currency could hurt. 4 Edelweiss Securities Limited

5 Cipla Financial Statements Key Assumptions Macro GDP(Y-o-Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Sector India pharma market growth (Y-o-Y) % Company India sales (INR mn) 40,907 48,222 54,973 62,669 % change Export formulations (USD mn) 815 1,007 1,306 1,763 % change API (USD mn) % change Tech Income (USD mn) % of Other operating income EBITDA margins (%) R&D (% of sales) USD/INR (Avg) Capex (USD mn) Net debt to equity ratio(x) Income statement (INR mn) Gross revenues 98, , , ,375 Net revenue 97, , , ,415 Other Operating Income 3,476 4,630 5,225 5,624 Income from operations 101, , , ,038 Materials costs 38,748 41,924 49,007 57,628 Employee costs 13,940 19,737 24,079 26,246 R&D Cost 5,119 6,747 11,531 12,528 Total SG&A expenses 22,241 23,430 26,636 30,719 EBITDA 20,956 21,617 32,885 39,917 Operating profit 20,956 21,617 32,885 39,917 EBIT 17,622 16,570 26,963 33,355 Add: Other income 1,889 1,656 1,821 2,003 Less: Interest Expense 711 1,683 1,922 1,802 Profit Before Tax 18,800 16,542 26,862 33,556 Less: Provision for Tax 4,634 4,000 6,715 8,389 Less: Minority Interest ,102 1,322 Reported Profit 14,167 11,807 19,044 23,845 Less: Exceptional Items (Net of 1, Adjusted Profit 12,711 11,807 19,044 23,845 No. of Shares outstanding (mn) Adjusted Basic EPS No. of Diluted shares outstanding Adjusted Diluted EPS Adjusted Cash EPS Dividend per share (DPS) Dividend Payout Ratio (%) Common size metrics Operating expenses Materials costs Staff costs S G & A expenses R & D cost Depreciation Interest Expense EBITDA margins Net Profit margins Growth ratios (%) Revenues EBITDA PBT 9.1 (12.0) Adjusted Profit (5.5) (7.1) EPS (5.5) (7.1) Edelweiss Securities Limited

6 Pharmaceuticals Balance sheet (INR mn) As on 31st March FY14 FY15 FY16E FY17E Share capital 1,606 1,606 1,606 1,606 Reserves & Surplus 98, , , ,812 Shareholders' funds 100, , , ,418 Minority Interest 496 1,805 1,805 1,805 Short term borrowings 9,105 13,925 11,925 11,925 Long term borrowings 3,179 3,093 3,093 3,093 Total Borrowings 12,283 17,018 15,018 15,018 Long Term Liabilities & Provisions 1,100 2,009 2,009 2,009 Deferred Tax Liability (net) 3,090 2,846 2,846 2,846 Sources of funds 117, , , ,096 Gross Block 60,443 70,031 78,031 86,031 Depreciation 3,334 5,047 5,922 6,562 Net Block 40,034 42,712 44,789 46,227 Capital work in progress 4,418 5,809 5,809 5,809 Intangible Assets 24,931 25,585 25,585 25,585 Total Fixed Assets 69,383 74,106 76,183 77,621 Non current investments 3,971 2,498 2,498 2,498 Cash and cash equivalents 4,866 9,543 11,514 19,644 Inventories 28,953 37,806 45,367 54,441 Sundry Debtors 16,389 20,043 24,051 28,861 Loans & Advances 8,970 10,043 11,458 13,156 Other Current Assets 1,472 2,666 2,956 3,304 Total Current Assets (ex cash) 55,783 70,558 83,833 99,762 Trade payable 9,795 15,772 18,927 22,712 Other Current Liabilities & Short 6,736 9,239 9,828 12,716 Total Current Liabilities & 16,531 25,011 28,755 35,428 Net Current Assets (ex cash) 39,252 45,547 55,078 64,334 Uses of funds 117, , , ,096 Book Value per share (INR) Free cash flow (INR mn) Reported Profit 14,167 11,807 19,044 23,845 Add: Depreciation 3,334 5,047 5,922 6,562 Interest (Net of Tax) 536 1,276 1,442 1,352 Others (271) (579) (340) (29) Less: Changes in WC (40,226) 24,906 10,755 10,578 Operating cash flow 57,990 (7,354) 15,313 21,152 Less: Capex 7,908 9,116 8,000 8,000 Free Cash Flow 50,082 (16,470) 7,313 13,152 Cash flow metrics Operating cash flow 57,990 (7,354) 15,313 21,152 Investing cash flow (58,654) (9,046) (8,000) (8,000) Financing cash flow ,291 (5,342) (5,022) Net cash Flow 322 3,891 1,971 8,130 Capex (7,908) (9,116) (8,000) (8,000) Dividend paid (1,879) (1,658) (3,342) (5,022) Profitability and efficiency ratios Return on Average Equity (ROAE) Pre-tax Return on Capital Inventory Days Debtors Days Payable Days Cash Conversion Cycle Current Ratio Gross Debt/EBITDA Gross Debt/Equity Adjusted Debt/Equity Net Debt/Equity Interest Coverage Ratio Operating ratios Total Asset Turnover Fixed Asset Turnover Equity Turnover Valuation parameters Adjusted Diluted EPS (INR) Y-o-Y growth (%) (5.5) (7.1) Adjusted Cash EPS (INR) Diluted Price to Earnings Ratio Price to Book Ratio (P/B) (x) Enterprise Value / Sales (x) , Enterprise Value / EBITDA (x) Dividend Yield (%) Peer comparison valuation Market cap Core EV/EBITDA (X) PE based on core EPS Return on Average Equity Name (USD mn) FY16E FY17E FY16E FY17E FY16E FY17E Cipla 8, Dr.Reddys Laboratories 10, Lupin 13, Sun Pharmaceuticals Industries 34, AVERAGE Source: Edelweiss research 6 Edelweiss Securities Limited

7 Cipla Additional Data Directors Data Dr. Y.K. Hamied Chairman M.K. Hamied Non-Executive Vice-Chairman Subhanu Saxena Managing Director & Global CEO S. Radhakrishnan Whole-time Director Rajesh Garg Executive Director & CFO Dr. H.R. Manchanda Non-Executive Director Ashok Sinha Non-Executive Director V.C. Kotwal Non-Executive Director Dr. Peter Mugyenyi Non-Executive Director Adil Zainulbhai Non-Executive Director Auditors - V. Sankar Aiyar & Co.,R.G.N. Price & Co. *as per last annual report Holding Top10 Perc. Holding Perc. Holding Hamied yusuf k Life insurance corp 5.51 Hamied farida 5.22 Hamied mustafa kamil 4.94 Oppenheimer funds in 2.33 Ahmed sophie 1.93 Virtus investment ad 1.64 Blackrock 1.43 Hamied kamil mustafa 1.36 Vontobel india fund 1.33 *in last one year Bulk Deals Data Acquired / Seller B/S Qty Traded Price No Data Available *in last one year Insider Trades Reporting Data Acquired / Seller B/S Qty Traded No Data Available *in last one year 7 Edelweiss Securities Limited

8 RATING & INTERPRETATION Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk Apollo Hospitals Enterprise BUY None None Aurobindo Pharma HOLD SP H Cadila Healthcare BUY SP L Cipla BUY SO L Divi's Laboratories REDUCE SU M Dr.Reddys Laboratories BUY SO M Glenmark Pharmaceuticals HOLD SP H Ipca Laboratories REDUCE SU H Lupin HOLD SO M Sun Pharmaceuticals Industries BUY SO M Torrent Pharmaceuticals HOLD SP H ABSOLUTE RATING Ratings Expected absolute returns over 12 months Buy More than 15% Hold Between 15% and - 5% Reduce Less than -5% RELATIVE RETURNS RATING Ratings Sector Outperformer (SO) Sector Performer (SP) Criteria Stock return > 1.25 x Sector return Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING Ratings Low (L) Medium (M) High (H) Criteria Bottom 1/3rd percentile in the sector Middle 1/3rd percentile in the sector Top 1/3rd percentile in the sector Risk ratings are based on Edelweiss risk model SECTOR RATING Ratings Overweight (OW) Equalweight (EW) Criteria Sector return > 1.25 x Nifty return Sector return > 0.75 x Nifty return Sector return < 1.25 x Nifty return Underweight (UW) Sector return < 0.75 x Nifty return 8 Edelweiss Securities Limited

9 Cipla Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91-22) , Nirav Sheth Head Research Coverage group(s) of stocks by primary analyst(s): Pharmaceuticals Apollo Hospitals Enterprise, Aurobindo Pharma, Cadila Healthcare, Cipla, Divi's Laboratories, Dr.Reddys Laboratories, Glenmark Pharmaceuticals, Ipca Laboratories, Lupin, Sun Pharmaceuticals Industries, Torrent Pharmaceuticals Recent Research Date Company Title Price (INR) Recos 14-Aug-15 Cadila Healthcare Moraiya risks lurk; Result Update 14-Aug-15 Cipla Blowout quarter; pre-poned investments may curb margin; Result Update 14-Aug-15 Aurobindo Pharma US growth visibility improves; Result Update 1,984 Buy 740 Buy 762 Hold Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Hold Reduce Total Rating Interpretation Rating Expected to Rating Distribution* * stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Buy Hold Reduce appreciate more than 15% over a 12-month period appreciate up to 15% over a 12-month period depreciate more than 5% over a 12-month period One year price chart Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 (INR) Cipla 9 Edelweiss Securities Limited

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