2QFY13 Result Update Institutional Equities Cadila Healthcare 8 November 2012 Reuters: CADI.BO; Bloomberg: CDH IN Performance Below Expectations HOLD Following higher R&D expenses, Cadila Healthcare’s (CHL) 2QFY13 margins (excluding forex losses) were 190bps/260bps below our/Bloomberg consensus estimates, respectively, which coupled with higher tax drove adjusted PAT to Rs1.5bn, 22%/28% below our/Bloomberg consensus estimates, respectively. We have adjusted our FY13E earnings downwards by 15% factoring in 1HFY13 forex losses (which we believe are largely realised) and a higher tax rate (26% versus 23% earlier), while our FY14E earnings estimate has been marginally revised downwards by 3% due to a higher tax rate. With minimal hedges (US$19mn outstanding), we believe forex losses are likely to decline going forward and focus will resume on core business performance, which largely depends on product approvals in the US. We have retained our Hold rating on the stock with a revised TP of Rs910 (20xFY14E revised EPS of Rs45.5) from Rs923 earlier. 2QFY13 performance below expectations: CHL’s 2QFY13 results were below expectations, as higher R&D spending (7.6% in 2QFY13; FY13 guidance maintained at 6%-7%) and forex losses (largely realised) of Rs624mn hurt margins, which stood at 14.9%, significantly below estimates. Excluding forex loss, margins stood at 19%, 190bps/260bps below estimates. Revenue growth was in line, as domestic business outperformed with a 28% YoY growth (18% excluding Biochem) even as US business was largely flat on constant currency basis. Tax rate shot up to 32% of PBT, and the management expects it to settle at 25%-27% in FY13E (as against 22% earlier). US business ramp-up vital for stock’s performance: With the worst behind it, we believe CHL’s re-rating largely hinges on ramp-up in its US business. The company has witnessed a sharp spurt in drug approvals (10 approvals in 2QFY13 including five for injectables) post clearance of Moraiya facility by the USFDA. Drug pipeline also looks promising with quite a few interesting opportunities (not factored in our estimates due to timeline/litigation uncertainty) – Prevacid ODT (ulcer drug; US$300mn; 30-month stay expired in October 2012), Lialda (ulcer drug; US$200mn; trials done in October 2012), Toprol XL (hypertension drug; US$1.2bn; four other players in the market) and Astelin (nasal; US$250mn, Apotex already in the market). We have revised earnings, TP marginally downwards: Factoring in 1HFY13 forex losses (which we think are largely realised) and a higher tax rate, we have revised our FY13E/FY14E EPS downwards by 15%/3%, respectively. We have retained our Hold rating on CHL with a revised TP of Rs910, valuing the stock at 20xFY14E EPS. Y/E March (Rsmn) Net revenue Total material costs % of revenue Staff costs % of revenue R&D expenses % of revenue Other expenses % of revenue EBITDA EBITDA margin (%) EBITDA margin (excl.forex) (%) Other income Interest costs Depreciation PBT Tax Minority Interest Reported PAT PAT ex forex. 2QFY12 12,364 3,906 31.6 1,803 14.6 847 6.9 3,438 27.8 2,371 19.2 20.7 110 769 375 1,337 235 (75) 1,027 1,620 1QFY13 15,944 5,252 32.9 2,298 14.4 873 5.5 4,066 25.5 3,456 21.7 21.5 95 454 434 2,663 654 (61) 1,948 2,035 2QFY13 15,476 5,711 36.9 2,283 14.8 1,172 7.6 4,004 25.9 2,306 14.9 19.0 65 405 432 1,534 494 (88) 951 1,466 YoY (%) 25.2 46.2 26.6 38.4 16.5 (2.7) (427bps) (173bps) (47.3) 15.2 110.1 (7.3) (9.5) Sector: Pharmaceuticals CMP: Rs859 Target Price: Rs910 Upside: 6% Praful Bohra praful.bohra@nirmalbang.com +91-22-3926 8175 Key Data Current Shares O/S (mn) 204.7 Mkt Cap (Rsbn/US$bn) 176.1/3.3 52 Wk H / L (Rs) 966/620 Daily Vol. (3M NSE Avg.) 104,589 Price Performance (%) 1M 6M 1 Yr Cadila 4.9 15.8 12.7 Nifty Index Source: Bloomberg 0.2 12.6 9.0 QoQ (%) (2.9) 8.7 (0.6) 34.2 (1.5) (33.3) (677bps) (254bps) (10.8) (0.5) (24.4) (51.2) (28.0) Source: Company, Nirmal Bang Institutional Equities Research Please refer to the disclaimer towards the end of the document. 1HFY12 24,821 7,526 30.3 3,418 13.8 1,632 6.6 6,851 27.6 5,395 21.7 22.2 174 880 723 3,965 521 (120) 3,325 3,780 2HFY13 31,421 10,963 34.9 4,581 14.6 2,045 6.5 8,070 25.7 5,762 18.3 20.2 160 859 867 4,197 1,148 (150) 2,899 3,502 YoY (%) 26.6 45.7 34.0 25.3 17.8 6.8 (339bps) (200bps) (8.0) (2.4) 19.9 120.5 24.9 (12.8) (7.4) Institutional Equities Conference call highlights 1) US business: CHL is targeting revenue of over US$350mn from the US in FY14E (our estimate US$356mn). Most of the drugs recently approved by the USFDA (10 in 2QFY13) are likely to be launched over the next two quarters. The company also plans to launch one controlled substance product from Nesher in 3QFY13. In 2QFY13, CHL filed three ANDAs (abbreviated new drug applications) in the US, including one for an injectable product. The company expects USFDA inspection for its transdermals facility soon. It currently has two transdermal filings and expects to ramp it up next year. 2) Domestic business: Domestic growth was largely volume-driven, with new products contributing only 2%3%. Cardiology and diabetec segments outperformed, growing over 20% each. Margins improved in Biochem compared to a year ago and CHL expects further improvement. 3) Brazil business: Revenue decline of 26% YoY was on account of the staffs’ strike at the country’s drug regulator. CHL filed for five products in Brazil and two in Mexico during the quarter and expects revenue to normalise from 3QFY13. 4) Zydus Hospira: The joint venture (JV) successfully completed USFDA inspection. Taxotere sales were ramped up during the quarter, but are unlikely to sustain. The company is in discussions with Hospira to include additional 8-10 oncology products (with a lower margin than the earlier six products) for the JV. 5) Zydus Nycomed: The JV is progressing as per expectations and CHL expects sales from 14 newly added APIs to start from 4QFY13/1QFY14. 6) Zydus Wellness: The company is witnessing double-digit growth in Sugarfree and Everyuth products, while Nutralite sales are stagnant. 7) Abbott partnership: CHL expects revenue to commence from the next quarter. 8) Margins: CHL expects margins to improve by 50bps-100bps in FY14E excluding forex losses. We have factored in 22% margins for FY14E, 240bps above our FY13E estimate, which stands at 19.6% due to inclusion of forex losses. R&D costs are likely to normalise in 2HFY13, with FY13E R&D guidance maintained at 6%-7%. 9) Debt: CHL expects to incur a capex of Rs6.5bn (mainly on biologics and formulations facility), in FY13E, owing to which net debt at Rs20.4bn (net debt/equity ratio of 0.76x) is expected to remain high. Capex is likely to moderate to Rs4bn and the company expects some debt reduction thereafter. Exhibit 1: Change in our earnings estimates FY13E (Rsmn) Revenue EBITDA EBITDA margin (%) Reported PAT FY14E Old New Change (%) Old New Change (%) 65,326 13,782 21.1 7,881 65,326 12,822 19.6 6,732 (7.0) (147bps) (14.6) 73,635 15,897 21.6 9,548 73,635 16,185 22.0 9,306 1.8 39bps (2.5) Source: Nirmal Bang Institutional Equities Research Exhibit 2: Financial summary Y/E March (Rsmn) Revenue YoY (%) EBITDA EBITDA (%) Adj PAT YoY (%) Fully DEPS RoE (%) RoCE (%) P/E (x) EV/EBITDA (x) FY10 FY11 FY12 FY13E FY14E 36,868 25.9 8,086 21.9 5,091 57.5 37.3 35.6 24.6 23.2 22.8 46,207 25.3 10,262 22.2 7,110 39.6 34.7 37.4 28.5 24.7 17.9 51,487 11.4 10,329 20.1 6,172 (13.2) 30.1 25.6 20.9 28.5 18.7 65,326 26.9 12,822 19.6 6,732 9.1 32.9 23.1 21.6 26.1 15.3 73,635 12.7 16,185 22.0 9,306 38.2 45.5 26.2 24.9 18.9 11.9 Source: Company, Nirmal Bang Institutional Equities Research 2 Cadila Healthcare Institutional Equities Exhibit 3: Revenue break-up (Rsmn) Domestic Formulations APIs Wellness Animal health & others 2QFY12 6,100 4,700 68 879 453 1QFY13 7,454 5,818 108 1,033 495 2QFY13 7,637 6,018 116 965 538 YoY (%) 25.2 28.0 70.6 9.8 18.8 QoQ (%) 2.5 3.4 7.4 (6.6) 8.7 1HFY13 12,046 9,274 134 1,793 845 2HFY13 15,090 11,835 224 1,998 1,033 YoY (%) 25.3 27.6 67.2 11.5 22.2 Exports Formulations US Europe Japan Brazil Emerging markets APIs Animal health & others JVs Total 5,540 4,893 3,070 619 120 655 429 563 84 750 12,390 6,718 5,952 3,592 854 139 645 721 650 116 1,295 15,466 6,510 5,820 3,674 762 143 487 754 588 102 1,300 15,447 17.5 18.9 19.7 23.2 19.2 (25.7) 75.9 4.5 21.2 73.4 24.7 (3.1) (2.2) 2.3 (10.8) 2.8 (24.5) 4.6 (9.5) (12.4) 0.4 (0.1) 10,357 9,029 5,463 1,388 232 1,125 821 1,243 84 1,877 24,279 13,228 11,772 7,266 1,617 282 1,131 1,476 1,238 218 2,595 30,913 27.7 30.4 33.0 16.5 21.5 0.5 79.7 (0.4) 159.6 38.3 27.3 Source: Company, Nirmal Bang Institutional Equities Research Exhibit 4: Actuals versus our estimates, Bloomberg estimates (Rsmn) Revenue EBITDA EBITDA margin (%) EBITDA margin excl, forex impact (%) Reported PAT PAT (excl. forex impact) Actuals Our estimates Variation (%) Bloomberg cons. est. Variation (%) 15,476 2,306 14.9 19.0 951 1,466 15,976 3,334 20.9 20.9 1,881 1,881 (3.1) (30.8) (597bps) (191bps) (49.4) (22.1) 15,676 3,393 21.6 21.6 2,038 2,038 (1.3) (32.0) (674bps) (269bps) (53.3) (28.1) Source: Company, Nirmal Bang Institutional Equities Research Rating history Date 1 November 2011 11 November 2011 22 December 2011 12 January 2012 8 February 2012 19 March 2012 16 April 2012 11 May 2012 9 July 2012 7 August 2012 4 October 2012 3 Rating Sell Sell Hold Hold Sell Sell Sell Hold Hold Hold Hold Market price (Rs) 758 760 701 678 660 712 702 759 774 909 858 Target price (Rs) 743 737 737 737 629 674 674 831 831 923 923 Cadila Healthcare Institutional Equities Disclaimer Stock Ratings Absolute Returns BUY > 15% HOLD 0-15% SELL < 0% This report is published by Nirmal Bang’s Institutional Equities Research desk. 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Ltd. Correspondence Address B-2, 301/302, Marathon Innova, Nr. Peninsula Corporate Park Lower Parel (W), Mumbai-400013. Board No. : 91 22 3926 8000/1 Fax. : 022 3926 8010 4 Cadila Healthcare