JUNE 27, 2016 Economy News After a year of frenetic lobbying by a clutch of foreign and local investors, the board of the National Stock Exchange (NSE), has finally approved the listing of its shares. (ET) The commerce department has sought cabinet approval to expand the Asia Pacific Trade Agreement (APTA), focusing on areas that will encourage domestic manufacturing as part of the Make in India initiative. (ET) In a strong message to tax evaders, Prime Minister Narendra Modi asked them to take advantage of the latest government scheme and come clean before September 30. (BL) The Central government is giving finishing touches to a policy for creating a land bank of surplus land available with public sector units (PSU) which can be auctioned. (BL) Housing sales fell 2.2% to 1.58 lakh units in seven major cities last fiscal, but the market is expected to improve by next March on the back of lower interest rates and fall in prices. (BS) Corporate News Suzlon Group on Saturday announced the completion and commissioning of its 4.20 MW maiden wind project for Ahmedabad Municipal Corporation. (BS) Adani Enterprises, the flagship company of the Adani Group, today said that it has raised Rs 1.5 bn through issuance of non-convertible debentures on private placement basis. (ET) TVS Electronics is expecting its Point-of-Sale (POS) business to grow better, driven by the retail sector. The company, which has earlier seen a decline in the Dot Matrix Printers, is focusing on POS products focusing customers, such as thermal printers, scanners and label printers to mitigate this impact. (BS) After pulling out of Tilaiya UMPP on a host of issues, Reliance Power is looking to secure a total of Rs 7.1 bn as bank guarantees and compensation from 18 procurers of the electricity project. (BS) National Hydroelectric Power Corporation (NHPC) is planning to set up a 600-MW solar power project at the Koyna hydel power complex in Maharashtra as part of an initiative to expand its solar portfolio. (BS) JSW Steel has received the environmental clearance for setting up an integrated steel unit and captive power plant in Jharkhand with an investment of Rs 350.0 bn. (BS) Bharti Airtel and Malaysian firm Axiata have deferred the agreement for merger of their Bangladesh operations till September 26, 2016. (ET) Asian Paints Ltd is investing around Rs 40.0bn on setting up two manufacturing plants in Karnataka and Andhra Pradesh. (ET) Bajaj Finserv is likely to buy out its German partner Allianz SE's stakes in two insurance units-bajaj Allianz Life Insurance Co. Ltd and Bajaj Allianz General Insurance -in a deal estimated at as much as Rs.100.0bn. (ET) Pharma firm Nutraplus India today said its board will consider cancellation and withdrawal of the scheme of amalgamation of Vetpharma with the company. (ET) As a clarification on EU inspection of the Taloja plant, Alkem Labs has said that it does not have any issues with the three drugs highlighted in the letter, Company is considering to provide alternate studies to support authorization. Europe Contributes less than 1% to Total Sales. (BSE) Source: ET = Economic Times, BS = Business Standard, FE = Financial Express, BL = Business Line, ToI: Times of India, BSE = Bombay Stock Exchange Equity % Chg 24 Jun 16 1 Day 1 Mth 3 Mths Indian Indices SENSEX Index 26,398 (2.2) (1.0) 4.2 NIFTY Index 8,089 (2.2) (0.8) 4.8 BANKEX Index 19,911 (2.7) (0.2) 9.9 SPBSITIP Index 11,306 (2.1) (2.3) 0.1 BSETCG INDEX 14,297 (3.3) (1.5) 10.5 BSEOIL INDEX 9,382 (1.8) (0.4) 3.5 CNXMcap Index 13,289 (1.2) 0.1 5.2 SPBSSIP Index 11,279 (1.5) 1.5 7.4 World Indices Dow Jones 17,401 (3.4) (2.6) (0.7) Nasdaq 4,708 (4.1) (4.6) (1.4) FTSE 6,139 (3.1) (2.1) 0.5 NIKKEI 14,952 (7.9) (10.0) (10.8) HANGSENG 20,259 (2.9) (2.5) (1.4) Value traded (Rs cr) 24 Jun 16 % Chg - Day Cash BSE 3,820 78.1 Cash NSE 24,652 76.0 Derivatives 648,200 81.2 Net inflows (Rs cr) 23 Jun 16 % Chg MTD YTD FII 228 (816) 4,410 18,778 Mutual Fund 298 0 634 10,065 FII open interest (Rs cr) 23 Jun 16 % Chg FII Index Futures 12,040 (15.5) FII Index Options 75,207 (1.9) FII Stock Futures 53,377 (2.7) FII Stock Options 6,820 2.4 Advances / Declines (BSE) 24 Jun 16 A B T Total % total Advances 62 245 24 331 22 Declines 236 897 37 1,170 76 Unchanged 2 24 3 29 2 Commodity % Chg 24 Jun 16 1 Day 1 Mth 3 Mths Crude (US$/BBL) 47.4 (0.5) (4.0) 20.1 Gold (US$/OZ) 1,316.1 4.2 9.2 8.9 Silver (US$/OZ) 17.7 2.2 9.0 16.6 Debt / forex market 24 Jun 16 1 Day 1 Mth 3 Mths 10 yr G-Sec yield % 7.5 7.5 7.5 7.5 Re/US$ 68.0 67.3 67.8 66.6 Sensex 28700 27200 25700 24200 22700 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16
SECTOR UPDATE Meeta Shetty, CFA meeta.shetty@kotak.com +91 22 6218 4425 PHARMA SECTOR UPDATE Tapering growth of the IPM (single digit for last three months) and the overhang of the unresolved compliance issues (for most of the companies) has weighed heavily on the valuations of the pharma companies. The Nifty Pharma index has corrected ~18% from its high in Apr-2015 vs. ~8% fall in Nifty from its high in Mar-2015 (as of 20th June 2016). The PEx for our coverage universe is trading lower by ~3-4x from its historical valuations. In spite of the current turbulence, we remain optimistic on the growth drivers, i.e. US generics and IPM. We stick to our confidence on companies with complex US pipeline, better visibility on revenues as well as focused managements. From our coverage universe, we continue to prefer - Sun Pharma, Alembic Pharma and Natco Pharma. Indian Pharma Market (IPM) growth has been a challenge The IPM market growth has remained a challenge for the past few months led by slower volume pick up as sell as pricing pressure and drug bans. The domestic market however, remains significant contributor to revenues for most of the Indian pharma companies at ~30%-60%. It also has been an avenue for steady cash flows in last few years. However, the WPI led price cut as well as the recent ban on fixed dose combinations will lead to restricted growth in the current fiscal. The IPM posted 7.7% growth for May-16 vs. 3.5% in Apr-2016. IPM growth trend 25 20 15 10 5 0 Source: AIOCD Further break-up of the growth highlights that post negative volume growth for consecutive two months, IPM has posted nil volume growth in May-2016. The volume growth for IPM was impacted post the implementation of FDC ban in Mar-2016. The ban was imposed on 350 drugs and is set to impact Rs 38.0bn worth of drugs or ~3.8% of the IPM. Though companies are litigating the matter, it has impacted the growth of most of the companies. We expect the growth to pick up from coming months as volume growth revives. The price and new product introduction growth has been steady at ~7-8%. IPM growth split 30.0 New introductions Price increase Volume 20.0 10.0 0.0-10.0 Source: AIOCD Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 2
Is US market getting tougher? After IPM, it's the US market which has been the key target market for all Indian as well as global generic companies. US markets still remain by far the largest export destination for pharmaceuticals and the sheer size gives us the confidence of steady growth over the next few years. However, in recent months the compliance issues and its escalation to warning letters, steep mid-teens price erosions and high base has led to slower growth for companies. The US revenues for most of the companies over the past 1-2 years were more led by one off opportunities. With competition catching up in these limited competition opportunities and simultaneous delays in ANDA approvals from USFDA are having a cascading effect on the companies. US pharma market Source: Kotak Securities - Private Client Research Compliance issues Company Key Plants where Inspection Time Contribution to issues are date elapsed revenues from Comments unresolved the plant Alembic Pharma None pending issues NA NA NA NA Cadila Hc Moraiya Jul-14 23 months Significant Slowdown in USFDA approvals, resolution is very critical for the company Cipla Indore Jul-15 11 months Significant Though this plant does not contribute significantly to revenues, going ahead it remain a growth driver. Dr Reddy Srikakulam, Nov-14-Feb-15 16-18 months Significant Already received warning letter, Duvvada and Nalgonda company plans to invite USFDA in next few months Lupin Goa Jul-15 11 months Significant Critical plant as ~30% of pending ANDAs are from this plant. Natco Pharma Kothur plant/ Mar-16 2 months Significant Only USFDA approved formulations plant, Chennai Plant very critical, recently an ANDA approval from the plant gives some respite. Sun Halol Aug-14 21 months Significant Company has received a Warning Letter, company expects to invite USFDA for a re-inspection in Jun-2016. Torrent Pharma Indrad, Gujarat May-2016 1 month Significant Largest US revenues are from this plant Source: Company, Kotak Securities - Private Client Research Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 3
Challenges currently faced by Indian pharma companies in US Pricing pressure One of the major reasons for price erosion across the generic drugs sector is the wave of consolidation among generic drug makers, led by distributor concentration over the past few years. The bigger players in the market further pressured drug pricing for small peers. There are currently only four major drug distributors, following a rush of recent deals and partnerships within the space. These include McKesson, which bought Celesio for $5 billion in 2014, Cardinal Health which inked a partnership with CVS in 2013, AmerisourceBergen which made a pact with Walgreens Boots Alliance and Wal-Mart. Simultaneously, FDA has increased the pace of approving abbreviated new drug applications for generic drug manufacturers, which is also increasing competition and driving down prices. Total ANDA approvals 120 100 80 60 40 20 0 Source: USFDA Delay in ANDA approvals led by compliance issues ANDA approval run rate Companies under coverage FY14 FY15 1QFY16 2QFY16 3QFY16 4QFY16 FY16 1QFY17* Alembic Pharma 3 5 4 2 2-8 1 Cadila Hc 9 5 2 1 - - 3 - Cipla 2 1 - - 1-1 - Dr Reddy's 12 6-2 - 2 4 1 Lupin 16 11 6 8 7 2 23 2 Sun 20 15 3 3 2 2 10 5 Torrent Pharma 6 6 2 1 3-6 - Not under coverage Aurobindo Pharma 16 6 6 12 12 17 47 11 Wockhardt - - 1 1 - - 2 - Glenmark 6 5 6 2 2 7 17 1 Source: USFDA, Company Although the overall approval run rate for ANDA approvals has improved post implementation of GDUFA. Companies facing pending compliance issues like Cadila, Sun, Dr Reddy's, Wockhardt, have been facing delays in approvals. These delays in US ANDA approvals as well as pricing pressure are visible in the quarterly run rate of the companies wherein revenues have remained stagnant or have been lower except for instance of FTF/limited competition launches like for Lupin and Sun Pharma. Lupin launched gglumetza in Feb-16 whereas Sun launches ggleevec in Feb-2016, both are under FTF launches and will see generic competition only post Aug-2016. Though prima facie the revenues for both the companies have posted strong growth, the base business has been under pricing pressure as per managements. Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 4
US revenue run-rate - $ mn Companies under coverage 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 Alembic Pharma* 19 20 22 24 26 86 79 29 Cadila Hc 119 129 147 158 155 154 165 146 Cipla* 203 201 206 273 342 288 256 263 Dr Reddy's 274 231 272 272 294 286 299 292 Lupin 258 202 217 211 180 174 208 325 Sun 510 710 546 492 488 510 486 580 Torrent Pharma 45 26 28 36 140 109 85 78 Not under coverage Aurobindo Pharma 186 189 194 216 231 227 238 251 Glenmark 80 82 82 86 88 92 93 98 *Export formulations revenues as US revenues not available One more notable trend which is visible across pharma companies is the sharp increase in R&D expense. Most of the companies have seen an increase between 100-300% increases in their R&D expenses. This, we believe, is to combat intense pricing pressure in generics seen in the past few months. Most of the companies are now getting onto the bandwagon of creating niche complex generics which should result in more sustained revenues in the US. Of our coverage companies, Alembic Pharma has seen the most marked increase at 276% in last eight quarters followed by Sun Pharma which saw its R&D expenses expand by 176% (mainly due to MK3222, its novel molecule). Going ahead too, the managements of most companies have guided for this increased run rate to continue. Though the efforts of current R&D expenses will result in revenues only post 2-3 years, this enables more visibility of sustained revenues over the longer run. Increased R&D expenses R&D expense (Rs mn)* 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 Alembic Pharma 295 311 305 305 480 780 701 1110 Cadila Hc 1057 1179 1883 1488 1684 1730 2368 1812 Dr Reddy's 3875 4113 4316 5144 4387 4473 4095 4879 Lupin 2439 2848 2605 3096 3131 3878 3916 5113 Sun 2437 2919 3651 5477 4999 4769 5760 6715 *R&D expense for Cipla &Torrent pharma - not available; Source: Company, Kotak Securities - Private Client Research Nifty Pharma Index Source: NSE Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 5
Coverage universe Company Latest Target EPS (Rs) PE (x) RoE (%) EV/EBIDTA (x) Reco Price (Rs) FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E Alembic Pharma BUY 700 23.6 29.3 22.8 18.4 25.1 25.7 17.2 12.9 Cadila Healthcare ACCUMULATE 360 15.4 18.0 20.3 17.3 24.0 22.8 14.1 11.8 Cipla SELL 480 19.9 24.6 23.9 19.4 12.7 14.0 14.6 12.4 Dr Reddy's Laboratories SELL 2,640 132.2 NM 23.9 NM 17.8 NM 13.4 NM Lupin REDUCE 1,680 68.3 80.0 21.4 18.3 25.0 23.7 13.6 11.5 Natco Pharma BUY 608 23.9 29.1 24.0 19.7 24.3 22.8 17.1 13.8 Sun Pharmaceuticals BUY 915 29.0 36.7 26.0 20.6 19.8 20.2 16.1 12.4 Torrent Pharmaceuticals SELL 1,320 64.1 69.4 20.7 19.1 28.6 25.3 14.6 13.3 Source: Kotak Securities - Private Client Research Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 6
Bulk deals Trade details of bulk deals Date Scrip name Name of client Buy/ Quantity Avg. Sell of shares price (Rs) 24-Jun AFEL Rajendra Singh Rawat S 55,000 9.5 24-Jun AFEL Surender Kumar B 21,000 9.5 24-Jun AFEL Janender Gandhi And Sons Huf B 21,000 9.6 24-Jun AFEL Janender Gandhi B 21,000 9.6 24-Jun AFEL Asha Gandhi B 21,000 9.5 24-Jun CITIZYN Jagdishkumar Lilabhai Bhatiya S 74,000 3.7 24-Jun KUBERJI Dharmendra. Pathak B 18,200 27.4 24-Jun KUBERJI Ulka Jayesh Modi B 19,040 27.4 24-Jun NOBPOL Varadharaja Perumal Jeya Baskar B 47,000 4.2 Source: BSE Gainers & Losers Nifty Gainers & Losers Price (Rs) chg (%) Index points Volume (mn) Gainers Mahindra & Mahindra 1,389 1.0 NA 1.4 Bajaj Auto 2,679 1.0 NA 0.3 Bharti Infra 325 0.9 NA 3.2 Losers Tata Motors 449 (7.9) NA 41.0 Tata Motors-- 298 (6.6) NA 7.8 Tata Steel 313 (6.4) NA 14.4 Source: Bloomberg Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 7
RATING SCALE Definitions of ratings BUY We expect the stock to deliver more than 12% returns over the next 9 months ACCUMULATE We expect the stock to deliver 5% - 12% returns over the next 9 months REDUCE We expect the stock to deliver 0% - 5% returns over the next 9 months SELL We expect the stock to deliver negative returns over the next 9 months NR Not Rated. Kotak Securities is not assigning any rating or price target to the stock. The report has been prepared for information purposes only. RS Rating Suspended. Kotak Securities has suspended the investment rating and price target for this stock, either because there is not a sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA Not Available or Not Applicable. The information is not available for display or is not applicable NM Not Meaningful. The information is not meaningful and is therefore excluded. NOTE Our target prices are with a 9-month perspective. Returns stated in the rating scale are our internal benchmark. Fundamental Research Team Dipen Shah IT, Banking, NBFC, Economy dipen.shah@kotak.com +91 22 6218 5409 Sanjeev Zarbade Capital Goods, Engineering sanjeev.zarbade@kotak.com +91 22 6218 6424 Teena Virmani Construction, Cement teena.virmani@kotak.com +91 22 6218 6432 Arun Agarwal Auto & Auto Ancillary arun.agarwal@kotak.com +91 22 6218 6443 Ruchir Khare Capital Goods, Engineering ruchir.khare@kotak.com +91 22 6218 6431 Ritwik Rai FMCG, Media ritwik.rai@kotak.com +91 22 6218 6426 Sumit Pokharna Oil and Gas sumit.pokharna@kotak.com +91 22 6218 6438 Amit Agarwal Logistics, Paints, Transportation agarwal.amit@kotak.com +91 22 6218 6439 Meeta Shetty, CFA Pharmaceuticals meeta.shetty@kotak.com +91 22 6218 6425 Jatin Damania Metals & Mining jatin.damania@kotak.com +91 22 6218 6440 Pankaj Kumar Midcap pankajr.kumar@kotak.com +91 22 6218 6434 Nipun Gupta Information Technology nipun.gupta@kotak.com +91 22 6218 6433 Jayesh Kumar Economy kumar.jayesh@kotak.com +91 22 6218 5373 K. Kathirvelu Production k.kathirvelu@kotak.com +91 22 6218 6427 Technical Research Team Shrikant Chouhan shrikant.chouhan@kotak.com 91 22 6218 5408 Amol Athawale amol.athawale@kotak.com +91 20 6620 3350 Derivatives Research Team Sahaj Agrawal sahaj.agrawal@kotak.com +91 79 6607 2231 Rahul Sharma sharma.rahul@kotak.com +91 22 6218 5498 Malay Gandhi malay.gandhi@kotak.com +91 22 6218 6420 Prashanth Lalu prashanth.lalu@kotak.com +91 22 6218 5497 Kotak Securities - Private Client Research Please see the Disclosure/Disclaimer on the last page For Private Circulation 8
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