Mupirocin: Glenmark to monopoly post FDA s WL to GSK July 22, 2016 Surajit Pal surajitpal@plindia.com +91 22 66322259 Rating BUY Price Rs865 Target Price Rs1,186 Implied Upside 37.1% Sensex 27,803 Nifty 8,541 (Prices as on July 22, 2016) Trading data Market Cap. (Rs bn) 244.1 Shares o/s (m) 282.2 3M Avg. Daily value (Rs m) 560.4 Major shareholders Promoters 45.00% Foreign 20.81% Domestic Inst. 20.96% Public & Other 13.23% Stock Performance (%) 1M 6M 12M Absolute 11.4 15.0 (18.2) Relative 7.5 1.2 (15.8) How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2017 48.9 48.0 1.8 2018 64.5 53.4 20.6 Price Performance (RIC: GLEN.BO, BB: GNP IN) The Event: FDA posted its Warning Letter (WL) to GSK s Worthing (UK) plant on its website on Tuesday (19 th July, 2016). The plant manufacture Bactroban (Mupirocin Calcium) line of products, including nasal and topical drugs in cream and ointment forms. The WL is related to GSK s inadequate address to the FDA s findings during its visit of Worthing, UK plant in July 2015. The regulator cited issues remain unresolved which are related to Penicillin cross contamination and microbial contamination. The Issue: FDA s inspection in July 2015 identified issues of a) Laxness in following practices to prevent cross contamination from Penicillin area to nondedicated area, and b) failure to conduct root cause analysis for key deviations and implement CAPA. To address the issues of CGMP compliance, US FDA offered two options: a) dedicate the facility to penicillin production only, or b) solely produce non Penicillin API with comprehensive de contamination plan. With inadequate progress in the remediation measure, FDA issued WL in June 2016 with hints of import alert as it suggested that failure of successful remediation may lead to withholding of new approvals and also refuse entry of products manufactured in the Worthing plant into USA. Contd...2 Key financials (Y/e March) 2015 2016 2017E 2018E Revenues (Rs m) 65,953 75,909 97,538 115,387 Growth (%) 9.8 15.1 28.5 18.3 EBITDA (Rs m) 11,751 13,741 22,558 28,267 PAT (Rs m) 4,753 7,021 13,794 18,189 EPS (Rs) 17.5 24.9 48.9 64.5 Growth (%) (12.4) 42.0 96.5 31.9 Net DPS (Rs) 2.0 2.0 2.0 2.0 Event Update (Rs) 1,400 1,200 1,000 800 600 400 200 0 Jul 15 Sep 15 Nov 15 Jan 16 Mar 16 May 16 Jul 16 Profitability & Valuation 2015 2016 2017E 2018E EBITDA margin (%) 17.8 18.1 23.1 24.5 RoE (%) 15.9 19.3 26.4 25.8 RoCE (%) 8.8 10.1 16.0 18.4 EV / sales (x) 4.1 3.7 2.8 2.3 EV / EBITDA (x) 23.0 20.4 12.2 9.4 PE (x) 49.4 34.8 17.7 13.4 P / BV (x) 7.8 5.7 3.9 3.1 Net dividend yield (%) 0.2 0.2 0.2 0.2 Source: Bloomberg Source: Company Data; PL Research Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
The implication: With consequence of fatal drug reaction from possible cross contamination, GSK voluntary recalled (class II recall) 425,000 Bactroban tubes of antibiotic cream and nasal ointment in September 2015 post FDA inspection. Though no adverse reaction was reported, the recall was for more than quarter of million tubes of antibiotic cream that might have been contaminated. GSK shut down the API production facility post FDA observations in July 2015 and implemented several CAPA measures. The facility however failed to comply with the required CGMP practices and received WL with strong hint of import alert. Link of Warning Letter: http://www.fda.gov/iceci/enforcementactions/warningletters/2016/ucm5118 38.htm PL view: Glenmark may have an opportunity to do a Taro in Mupirocin Cream in US Given the gravity of the complications regarding cross contamination, we believe that GSK may require more than 12 18 months in achieving a resolution for the Worthing plant. With the past experience of longer time period for resolution, we believe it requires arduous effort for GSK to convince FDA on compliance in non contamination of APIs where both Penicillin and non betalactam products are produced. This has been quite clear with FDA s statement in the WL: It is profoundly difficult to completely decontaminate a facility of beta lactam residues. Aurobindo s WL on Unit 6 in CY11 12 is a case in point where the company used to produce oral and sterile cephalosporin drugs for US market. While Aurobindo achieved resolution in oral segment at an early date, it experienced strong hurdle to achieve the similar resolution in sterile injectable segment. Finally, Aurobindo decided to abandon the sterile unit for US market and decided to shut down the injectable unit to achieve overall resolution. Similar demanding scenario in sterile/injectable/ophthalmic units were also observed in non compliance issues of Wockhardt, DRL and Sun Pharma. With no visibility of pending ANDA in Mupirocin cream, we believe Glenmark has similar opportunity as Taro to gain from price rise in absence of patentowner GSK and no other generics. GSK s shut down of API plant which impacted its formulation supply in market in July 2015 and recalled large quantity in September 2015. This has resulted in increase in Glenmark s Rx share from 43% in April 2015 to 71% in July 2015 and to 94% in September 2015. July 22, 2016 2
Exhibit 1: Mupirocin Cream TRx: Glenmark Rx Share crosses 99% June 2016 Glenmark Prasco GSK 120% 100% 80% 60% 40% 20% 0% 2 Jan 15 2 Feb 15 2 Mar 15 2 Apr 15 2 May 15 2 Jun 15 2 Jul 15 2 Aug 15 2 Sep 15 2 Oct 15 2 Nov 15 2 Dec 15 2 Jan 16 2 Feb 16 2 Mar 16 2 Apr 16 2 May 16 2 Jun 16 2 Jul 16 Source: Company Data, PL Research With current Rx share of more than 99% and medium term visibility of Glenmark remain to be sole supplier of the drug, we expect Glenmark will have several opportunities to gain from value expansion of the drug in years to come as it occurred in Taro in many dermatology products in US. The Rx share of cream in comparison to nasal ointment has also increased to more than 99% post discontinuation of GSK s supply as absence of generics in nasal ointment shifted patients to cream topical. Exhibit 2: Mupirocin Calcium TRx: Cream Topical vs. Ointment Nasal TRX Count Cream (%) Nasal (%) 120% 100% 80% 60% 40% 20% 0% 2 Jan 15 2 Feb 15 2 Mar 15 2 Apr 15 2 May 15 2 Jun 15 2 Jul 15 2 Aug 15 2 Sep 15 2 Oct 15 2 Nov 15 2 Dec 15 2 Jan 16 2 Feb 16 2 Mar 16 2 Apr 16 2 May 16 2 Jun 16 2 Jul 16 Source: Company Data, PL Research Glenmark s revenues from Mupirocin cream were US$45m in FY16 and US$15m in Q4FY16. With expanded market size of Mupirocin cream, we expect quarterly revenues from US generic will reach US$110m from Q2FY17E onwards. We estimate revenues from Mupirocin to be US$70m and US$90m in FY17E and FY18E respectively. July 22, 2016 3
Exhibit 3: Mupirocin Unit price: Stepped up price rise over 18 months TRX Unit Price Glenmark Prasco Glaxo 12.00 10.00 8.00 6.00 4.00 2.00 0.00 2 Jan 15 2 Feb 15 2 Mar 15 2 Apr 15 2 May 15 2 Jun 15 2 Jul 15 2 Aug 15 2 Sep 15 2 Oct 15 2 Nov 15 2 Dec 15 2 Jan 16 2 Feb 16 2 Mar 16 2 Apr 16 2 May 16 2 Jun 16 2 Jul 16 Source: Company Data, PL Research Our estimate of Glenmark s US revenues of US$437m and US$500m in FY17E and FY18E has adequately factored opportunity from Mupirocin. The stock currently trades at PE 17.7x and 13.4x of FY17E and FY18E, respectively. We maintain Buy and retain TP at Rs1,186. July 22, 2016 4
Income Statement (Rs m) Net Revenue 65,953 75,909 97,538 115,387 Raw Material Expenses 19,344 23,614 26,708 32,967 Gross Profit 46,608 52,296 70,830 82,420 Employee Cost 12,024 13,782 16,300 19,262 Other Expenses 22,833 24,773 31,972 34,891 EBITDA 11,751 13,741 22,558 28,267 Depr. & Amortization 2,600 2,691 3,116 3,421 Net Interest 1,902 1,789 1,862 1,429 Other Income 564 787 812 836 Profit before Tax 7,814 10,047 18,392 24,253 Total Tax 1,190 3,028 4,598 6,063 Profit after Tax 6,623 7,019 13,794 18,189 Ex Od items / Min. Int. (1,870) 2 Adj. PAT 4,753 7,021 13,794 18,189 Avg. Shares O/S (m) 271.3 282.2 282.2 282.2 EPS (Rs.) 17.5 24.9 48.9 64.5 Cash Flow Abstract (Rs m) C/F from Operations 3,641 7,711 (7,703) 15,135 C/F from Investing (639) (7,725) (7,044) (7,050) C/F from Financing 3,178 13,884 (6,256) (7,851) Inc. / Dec. in Cash 6,180 13,871 (21,004) 234 Opening Cash 8,145 14,325 28,195 7,192 Closing Cash 14,325 28,195 7,192 7,426 FCFF (4,627) (4,132) 619 10,024 FCFE 5,553 (2,250) (6,874) 1,368 Key Financial Metrics Growth Revenue (%) 9.8 15.1 28.5 18.3 EBITDA (%) (10.8) 16.9 64.2 25.3 PAT (%) (12.3) 47.7 96.5 31.9 EPS (%) (12.4) 42.0 96.5 31.9 Profitability EBITDA Margin (%) 17.8 18.1 23.1 24.5 PAT Margin (%) 7.2 9.2 14.1 15.8 RoCE (%) 8.8 10.1 16.0 18.4 RoE (%) 15.9 19.3 26.4 25.8 Balance Sheet Net Debt : Equity 1.2 0.8 0.5 0.3 Net Wrkng Cap. (days) (8) 52 205 184 Valuation PER (x) 49.4 34.8 17.7 13.4 P / B (x) 7.8 5.7 3.9 3.1 EV / EBITDA (x) 23.0 20.4 12.2 9.4 EV / Sales (x) 4.1 3.7 2.8 2.3 Earnings Quality Eff. Tax Rate 15.2 30.1 25.0 25.0 Other Inc / PBT 7.2 7.8 4.4 3.4 Eff. Depr. Rate (%) 6.1 5.2 5.3 5.2 FCFE / PAT 116.8 (32.0) (49.8) 7.5 Source: Company Data, PL Research. Balance Sheet Abstract (Rs m) Shareholder's Funds 30,003 42,703 61,980 79,075 Total Debt 42,849 44,731 37,238 28,582 Other Liabilities (1,533) (2,711) (2,688) (2,664) Total Liabilities 71,320 84,723 96,530 104,992 Net Fixed Assets 32,704 39,075 42,959 46,538 Goodwill 580 575 632 696 Investments 4,810 6,130 6,130 6,130 Net Current Assets 33,225 38,943 46,809 51,629 Cash & Equivalents 7,681 8,618 7,192 7,426 Other Current Assets 45,551 50,485 49,273 55,235 Current Liabilities 20,007 20,160 9,656 11,032 Other Assets Total Assets 71,320 84,723 96,530 104,992 Quarterly Financials (Rs m) Y/e March Q2FY16 Q3FY16 Q4FY16 Q1FY17E Net Revenue 18,952 17,643 22,891 18,484 EBITDA 3,876 3,557 2,840 3,592 % of revenue 20.5 20.2 12.4 19.4 Depr. & Amortization 694 627 781 788 Net Interest 426 469 475 480 Other Income 150 162 293 255 Profit before Tax 2,906 2,624 1,878 2,579 Total Tax 929 921 448 645 Profit after Tax 1,978 1,703 1,430 1,934 Adj. PAT 1,978 1,703 1,430 1,934 Key Operating Metrics (Rs m) Generics 29,096 34,320 48,364 59,424 US Formulations 20,398 24,203 37,056 46,822 EU Formulations 2,646 2,940 3,442 3,958 LatAm Formulations 495 519 561 APIs 6,053 6,683 7,348 8,083 Branded 37,052 41,357 48,057 54,599 India Formulations 17,490 21,093 25,100 28,614 ROW Formulations 8,123 9,033 9,936 10,929 LatAm Formulations 7,640 7,001 8,196 9,507 EU Formulations 3,800 4,231 4,824 5,548 Source: Company Data, PL Research. July 22, 2016 5
Prabhudas Lilladher Pvt. Ltd. 3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai 400 018, India Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209 Rating Distribution of Research Coverage PL s Recommendation Nomenclature % of Total Coverage 60% 50% 40% 30% 20% 10% 0% 48.7% 36.5% 14.8% 0.0% BUY Accumulate Reduce Sell BUY : Over 15% Outperformance to Sensex over 12 months Accumulate : Outperformance to Sensex over 12 months Reduce : Underperformance to Sensex over 12 months Sell : Over 15% underperformance to Sensex over 12 months Trading Buy : Over 10% absolute upside in 1 month Trading Sell : Over 10% absolute decline in 1 month Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly DISCLAIMER/DISCLOSURES ANALYST CERTIFICATION We/I, Mr. Surajit Pal (PGDBA, CFA, M.Com), Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: Prabhudas Lilladher Pvt. Ltd, Mumbai, India (hereinafter referred to as PL ) is engaged in the business of Stock Broking, Portfolio Manager, Depository Participant and distribution for third party financial products. PL is a subsidiary of Prabhudas Lilladher Advisory Services Pvt Ltd. which has its various subsidiaries engaged in business of commodity broking, investment banking, financial services (margin funding) and distribution of third party financial/other products, details in respect of which are available at www.plindia.com This document has been prepared by the Research Division of PL and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verified the accuracy or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either PL or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. PL may from time to time solicit or perform investment banking or other services for any company mentioned in this document. PL is in the process of applying for certificate of registration as Research Analyst under Securities and Exchange Board of India (Research Analysts) Regulations, 2014 PL submits that no material disciplinary action has been taken on us by any Regulatory Authority impacting Equity Research Analysis activities. PL or its research analysts or its associates or his relatives do not have any financial interest in the subject company. PL or its research analysts or its associates or his relatives do not have actual/beneficial ownership of one per cent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report. PL or its research analysts or its associates or his relatives do not have any material conflict of interest at the time of publication of the research report. PL or its associates might have received compensation from the subject company in the past twelve months. PL or its associates might have managed or co managed public offering of securities for the subject company in the past twelve months or mandated by the subject company for any other assignment in the past twelve months. PL or its associates might have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months. PL or its associates might have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months PL or its associates might have received any compensation or other benefits from the subject company or third party in connection with the research report. PL encourages independence in research report preparation and strives to minimize conflict in preparation of research report. PL or its analysts did not receive any compensation or other benefits from the subject Company or third party in connection with the preparation of the research report. PL or its Research Analysts do not have any material conflict of interest at the time of publication of this report. It is confirmed that Mr. Surajit Pal (PGDBA, CFA, M.Com), Research Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months Compensation of our Research Analysts is not based on any specific merchant banking, investment banking or brokerage service transactions. The Research analysts for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report. The research analysts for this report has not served as an officer, director or employee of the subject company PL or its research analysts have not engaged in market making activity for the subject company Our sales people, traders, and other professionals or affiliates may provide oral or written market commentary or trading strategies to our clients that reflect opinions that are contrary to the opinions expressed herein, and our proprietary trading and investing businesses may make investment decisions that are inconsistent with the recommendations expressed herein. In reviewing these materials, you should be aware that any or all o the foregoing, among other things, may give rise to real or potential conflicts of interest. PL and its associates, their directors and employees may (a) from time to time, have a long or short position in, and buy or sell the securities of the subject company or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the subject company or act as an advisor or lender/borrower to the subject company or may have any other potential conflict of interests with respect to any recommendation and other related information and opinions. DISCLAIMER/DISCLOSURES (FOR US CLIENTS) ANALYST CERTIFICATION The research analysts, with respect to each issuer and its securities covered by them in this research report, certify that: All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities; and No part of his or her or their compensation was, is or will be directly related to the specific recommendation or views expressed in this research report Terms & conditions and other disclosures: This research report is a product of Prabhudas Lilladher Pvt. Ltd., which is the employer of the research analyst(s) who has prepared the research report. The research analyst(s) preparing the research report is/are resident outside the United States (U.S.) and are not associated persons of any U.S. regulated broker dealer and therefore the analyst(s) is/are not subject to supervision by a U.S. broker dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account. This report is intended for distribution by Prabhudas Lilladher Pvt. Ltd. only to "Major Institutional Investors" as defined by Rule 15a 6(b)(4) of the U.S. Securities and Exchange Act, 1934 (the Exchange Act) and interpretations thereof by U.S. Securities and Exchange Commission (SEC) in reliance on Rule 15a 6(a)(2). If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not the Major Institutional Investor. In reliance on the exemption from registration provided by Rule 15a 6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain business with Major Institutional Investors, Prabhudas Lilladher Pvt. Ltd. has entered into an agreement with a U.S. registered broker dealer, Marco Polo Securities Inc. ("Marco Polo"). Transactions in securities discussed in this research report should be effected through Marco Polo or another U.S. registered broker dealer. July 22, 2016 6