Financial Highlights

Results Review INDIA PHARMACEUTICALS

29 May 2014

REPORT AUTHORS

Arvind Bothra +91 22 6766 3442 arvind.bothra@religare.com

PRICE CLOSE (29 May 14) INR 372.95 MARKET CAP INR 299,450 mln USD 5,086 mln

SHARES O/S 802.9 mln

FREE FLOAT 63.2%

3M AVG DAILY VOLUME./VALUE 1.7 mln/ USD 10.9 mln

52 WK HIGH INR 450.00

52 WK LOW INR 364.05

SELL TP: INR 400.00 7.3%

Cipla CIPLA IN

Another dismal quarter; estimates slashed – SELL

Cipla’s Q4 PAT at Rs 2.2bn (excl. Rs 400mn fx gains) was sharply below RCMLe (Rs 2.7bn) on continued weakness in margins (16% vs 17.5% est). Revenues at Rs 24.3bn (+27% YoY) were slightly ahead on strong domestic growth (19% vs. 15% est.). But a weaker business mix (higher ARV sales) pressurised gross margins, leading to an EBITDA-level miss (7% below). We trim our FY15-16E EPS by 4% (50bps cut) on lower margins but maintain our TP at Rs 400 as we roll over to Mar’16E EPS. Retain SELL (non-consensus).

Revenue growth led by domestic business: Domestic sales grew 19% YoY driven by sustained improvement in field-force productivity. Exports were up 32% YoY led by inclusion of the Medpro (South Africa) acquisition as well as currency weakness (which aided realisations). Management expects mid-teens sales growth for FY15E, as most long-gestation projects are likely to bear fruit after 18-24 months.

Weaker mix pressurises margins: Q4 margins at 15.7% (-423bps YoY, -229bps QoQ) lagged expectations due to (a) a sharp decline in gross margins (-349bps impact) and (b) higher staff costs (-293bps). R&D spends continued to increase (Rs 1.5bn vs. Rs 900mn in Q3) and should trend further up as investments for the US pipeline are likely to continue. Increased exposure to the ARV tender business (via Medpro) could lead to higher margin volatility ahead. We slash our margin estimates by 50bps over FY15-FY16E to ~20.5%, leading to 4% EPS cut (implying 14% EPS CAGR).

Valuations demanding: Cipla trades at 16.7x 1-yr fwd. P/E, in line with its historic P/E multiple, leaving little room for upsides given (a) weaker EPS growth (14% vs. 18% for peers) and (b) potential M&A integration risks. We believe potential upsides from EU inhaler launches could be back-ended as near-term growth would remain under pressure (FY15E EPS growth of 7%). While our EPS estimates are already 7-8% below consensus, we expect consensus to downgrade earnings owing to a weaker margin outlook. Lupin (LPC) remains our top, large-cap pharma pick.

Y/E 31 Mar FY12A FY13A FY14E FY15E FY16E

Revenue (INR mln) 70,207 82,794 101,004 117,362 135,408

EBITDA (INR mln) 16,589 21,979 21,331 24,150 28,560

Adjusted net profit (INR mln) 11,443 15,449 13,884 14,918 17,896

Adjusted EPS (INR) 14.3 18.7 17.3 18.6 22.3

Adjusted EPS growth (%) 15.6 31.5 (7.8) 7.4 20.0

DPS (INR) 2.3 2.3 3.0 3.5 4.0

ROIC (%) 15.4 16.6 15.3 17.6 18.7

Adjusted ROAE (%) 16.0 18.5 14.6 14.1 15.2

Adjusted P/E (x) 26.2 19.9 21.6 20.1 16.7

EV/EBITDA (x) 18.0 13.6 14.0 12.3 10.4

P/BV (x) 3.9 3.3 3.0 2.7 2.4

Source: Company, Factset, RCML Research

This report has been prepared by Religare Capital Markets Limited or one of its affiliates. Where the report is distributed by Religare Capital Markets (UK) Limited (“RCM UK”), the firm is an Appointed Representative of Elevation Trading Limited, which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. For analyst certification and other important disclosures, please refer to the Disclosure and Disclaimer section at the end of this report. Analysts employed by non-US affiliates are not registered with FINRA regulation and may not be subject to FINRA/NYSE restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.

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SELL TP: INR 400.00 7.3%

Cipla CIPLA IN

Results Review INDIA PHARMACEUTICALS

29 May 2014 Page 2 of 7

Earnings cut post Q4 disappointment We cut our PAT forecasts by 4% to factor in lower profitability as we trim our margin assumptions by ~50bps over FY15-FY16E. This mainly factors in accelerated R&D investments incurred to build a future pipeline as well as weaker gross margins (with ARV business share likely to increase). Based on our revised forecasts, we expect an EPS CAGR of 14% (FY14-FY16E) led by a 17% revenue CAGR.

Fig 1 - Earnings revision summary Earlier Now Change (%) Rs mn FY15E FY16E FY15E FY16E FY15E6 FY16E

Sales 115862 133824 116643 134636 1 1

EBITDA 23893 28290 23431 27788 (2) (2)

Margin (%) 20.6 21.1 20.1 20.6 (51bps) (46bps)

PAT 15554 18578 14918 17896 (4) (4)

EPS (Rs/sh) 19.4 23.1 18.6 22.3 (4) (4)

Source: RCML Research, Company

Our forecasts are significantly below consensus

While we note that our EPS estimates are 7-8% below consensus, there would be earnings downgrades following the Q4 miss. We also highlight that we have a non-consensus SELL rating, as the street is largely optimistic (80% BUY/HOLD, 20% SELL) on Cipla’s turnaround prospects following the recent organizational changes. We think that the company’s medium-term earnings outlook would be muted owing to continued investments towards long-term projects.

Fig 2 - RCML vs Consensus: Comparison RCML Consensus Difference (%) Rs mn FY15E FY16E FY15E FY16E FY15E FY16E

Sales 116,643 134,636 116,351 133,639 0 1 EBITDA 23,431 27,788 24,990 29,197 (6) (5) PAT 14,918 17,896 16,166 19,252 (8) (7) EPS-Rs/sh 18.6 22.3 20.1 24.0 (8) (7)

Source: RCML Research, Company

SELL TP: INR 400.00 7.3%

Cipla CIPLA IN

Results Review INDIA PHARMACEUTICALS

29 May 2014 Page 3 of 7

Q4FY14 result analysis Fig 3 - Quarterly Profit & Loss A/c (Rs mn) 4QFY13 3QFY14 4QFY14 YoY % QoQ % Comments on 4Q results

Domestic sales 7,610 10,443 9,080 19 (13) Domestic growth came in ahead of expectations despite the impact of NLEM. Share of new launches increased to 3.5% (vs 1.5% in 1Q)

Export Sales 11,560 15,084 15,210 32 1 This quarter also incorporates Medpro sales of US$ 50mn (90% shipped from Cipla earlier). Favorable currency realisation also aided growth

- Formulations 9,810 13,516 12,820 31 (5) Growth across markets was healthy led by improved pricing as well as favorable currency realisations

- APIs 1,750 1,568 2,390 37 52 Bulk drug sales improved due to higher participation in ARV products

Total Revenues 19,170 25,527 24,290 27 (5)

Other operating income 229 254 750 227 195

Net revenues 19,399 25,781 25,040 29 -3 Revenues were 4% ahead of expectations, thanks to stronger domestic growth

Raw material consumed 7,098 9,991 10,035 41 0 Higher ARV sales and lower margins post the NLEM impact also suppressed margins

% of revenues 36.6% 38.8% 40.1% 349bps 132bps Sharp compression in gross margins hurt profitability

Staff cost 2,746 4,028 4,279 56 6 Senior management hires and Medpro consolidation led to higher staff costs

% of revenues 14.2% 15.6% 17.1% 293bps 147bps

Other Expenses 5,685 7,116 6,788 19 (5) Higher promotion/R&D spends pushed up overheads (Rs 1.5bn vs. Rs 900mn in Q3)

% of revenues 29.3% 27.6% 27.1% (220bps) (50bps)

Total Expenditure 15,529 21,135 21,102 36 0

EBITDA 3,871 4,646 3,938 2 (15) EBITDA was 7% below forecasts despite sales beat

EBITDA margin (%) 20.0% 18.0% 15.7% (423bps) (229bps) Margins were 160bps below estimates largely on weaker gross margins

Technology licensing income

387 27 155 (60) 468

Operating profit 4,258 4,673 4,093 (4) (12)

OPM (%) 21.5 18.1 16.2 (528bps) (186bps)

Other income 386 124 375 (3) 203 Includes higher income from liquid funds/current investments

Forex gains/(losses) 180 400 400 122 0 Included both realised as well as unrealised forex gains.

Interest (net) (188) (333) (341) 82 3 Interest costs in line with recent quarters

Depreciation (851) (912) (1,050) 23 15 Depreciation came in higher than expectations, leading to higher miss at the PBT level

Pre-tax profits 3,785 3,953 3,477 (8) (12) PBT came in line with expectations due to fx gains of Rs 400mn

Tax (1,027) (987) (753) (27) (24)

Effective tax rate 27.1% 25.0% 21.7% (548bps) (331bps) Tax rates to remain at 25% for full year noting higher export profits

PAT 2,758 2,966 2,724 (1) (8)

Minority 7 (61) (117) (1680) 91

Adjusted PAT 2,765 2,905 2,607 (6) (10) Net profit, adjusted for forex gains, was 16% below expectations

EPS 3.4 3.6 3.2 (6) (10)

Source: RCML Research, Company

SELL TP: INR 400.00 7.3%

Cipla CIPLA IN

Results Review INDIA PHARMACEUTICALS

29 May 2014 Page 4 of 7

Quarterly trends

Fig 4 - Acquisition led revenue ramp-up Fig 5 - Domestic business on firm footing

Source: RCML Research, Company Source: RCML Research, Company

Fig 6 - Domestic sales strong despite pricing policy impact Fig 7 - Exports include impact of Medpro consolidation

Source: RCML Research, Company Source: RCML Research, Company

Fig 8 - Weaker mix dents profitability Fig 9 - 4Q PAT included forex gains

Source: RCML Research, Company Source: RCML Research, Company

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SELL TP: INR 400.00 7.3%

Cipla CIPLA IN

Results Review INDIA PHARMACEUTICALS

29 May 2014 Page 5 of 7

Per Share Data Y/E 31 Mar (INR) FY12A FY13A FY14E FY15E FY16E Reported EPS 14.3 19.2 17.3 18.6 22.3 Adjusted EPS 14.3 18.7 17.3 18.6 22.3 DPS 2.3 2.3 3.0 3.5 4.0 BVPS 95.1 112.3 125.2 138.8 155.0

Valuation Ratios Y/E 31 Mar (x) FY12A FY13A FY14E FY15E FY16E EV/Sales 4.3 3.6 3.0 2.5 2.2 EV/EBITDA 18.0 13.6 14.0 12.3 10.4 Adjusted P/E 26.2 19.9 21.6 20.1 16.7 P/BV 3.9 3.3 3.0 2.7 2.4

Financial Ratios Y/E 31 Mar FY12A FY13A FY14E FY15E FY16E Profitability & Return Ratios (%) EBITDA margin 23.6 26.5 21.1 20.6 21.1 EBIT margin 19.2 22.6 17.4 17.2 17.9 Adjusted profit margin 16.3 18.7 13.7 12.7 13.2 Adjusted ROAE 16.0 18.5 14.6 14.1 15.2 ROCE 14.3 15.7 12.5 12.9 14.1 YoY Growth (%) Revenue 11.2 17.9 22.0 16.2 15.4 EBITDA 25.5 32.5 (2.9) 13.2 18.3 Adjusted EPS 15.6 31.5 (7.8) 7.4 20.0 Invested capital 10.5 30.3 (15.7) 16.1 9.9 Working Capital & Liquidity Ratios Receivables (days) 79 71 60 58 60 Inventory (days) 250 262 249 257 257 Payables (days) 74 70 58 60 61 Current ratio (x) 3.7 3.1 1.9 2.3 2.6 Quick ratio (x) 0.1 0.1 0.1 0.1 0.1 Turnover & Leverage Ratios (x) Gross asset turnover 1.6 1.7 1.8 1.8 1.9 Total asset turnover 0.8 0.8 0.8 0.9 0.9 Net interest coverage ratio 0.0 0.0 0.0 0.0 0.0 Adjusted debt/equity 0.0 0.1 0.1 0.1 0.1

DuPont Analysis Y/E 31 Mar (%) FY12A FY13A FY14E FY15E FY16E Tax burden (Net income/PBT) 79.0 73.7 73.9 73.5 73.7 Interest burden (PBT/EBIT) 107.5 112.2 106.8 100.4 100.3 EBIT margin (EBIT/Revenue) 19.2 22.6 17.4 17.2 17.9 Asset turnover (Revenue/Avg TA) 80.1 80.8 82.7 86.2 90.7 Leverage (Avg TA/Avg equities) 122.6 123.0 128.1 128.5 126.6 Adjusted ROAE 16.0 18.5 14.6 14.1 15.2

SELL TP: INR 400.00 7.3%

Cipla CIPLA IN

Results Review INDIA PHARMACEUTICALS

29 May 2014 Page 6 of 7

Income Statement Y/E 31 Mar (INR mln) FY12A FY13A FY14E FY15E FY16E Total revenue 70,207 82,794 101,004 117,362 135,408 EBITDA 16,589 21,979 21,331 24,150 28,560 EBIT 13,467 18,674 17,604 20,200 24,195 Net interest income/(expenses) 1,012 1,882 1,196 87 81 Other income/(expenses) 0 0 0 0 0 Exceptional items 0 398 0 0 0 EBT 14,478 20,556 18,801 20,287 24,276 Income taxes (3,065) (5,443) (4,634) (5,072) (6,069) Extraordinary items 0 0 0 0 0 Min. int./Inc. from associates 29 (62) (283) (297) (311) Reported net profit 11,443 15,449 13,884 14,918 17,896 Adjustments 0 0 0 0 0 Adjusted net profit 11,443 15,449 13,884 14,918 17,896

Balance Sheet Y/E 31 Mar (INR mln) FY12A FY13A FY14E FY15E FY16E Accounts payables 12,214 11,093 14,208 16,537 19,100 Other current liabilities 0 0 0 0 0 Provisions 2,432 2,824 3,424 2,960 3,199 Debt funds 135 9,669 12,283 11,055 9,950 Other liabilities 0 0 0 0 0 Equity capital 1,606 1,606 1,606 1,606 1,606 Reserves & surplus 74,784 88,581 98,898 109,802 122,880 Shareholders' fund 76,389 90,187 100,504 111,407 124,485 Total liabilities and equities 91,170 113,772 130,418 141,959 156,734 Cash and cash eq. 905 1,430 1,752 2,543 2,945 Accounts receivables 15,536 16,688 16,389 20,661 23,927 Inventories 18,501 23,871 28,953 33,375 38,652 Other current assets 19,409 30,554 10,442 14,666 16,723 Investments 3,283 4,157 6,619 2,713 5,193 Net fixed assets 32,158 36,203 40,033 45,001 46,636 CWIP 3,712 3,674 4,418 1,500 1,500 Intangible assets 0 0 0 0 0 Deferred tax assets, net (2,332) (2,805) (3,119) (3,430) (3,773) Other assets 0 0 0 0 0 Total assets 91,170 113,772 130,418 141,959 156,734

Cash Flow Statement Y/E 31 Mar (INR mln) FY12A FY13A FY14E FY15E FY16E Net income + Depreciation 14,565 18,754 17,611 18,869 22,261 Interest expenses (1,012) (1,882) (1,196) (87) (81) Non-cash adjustments 0 0 0 0 0 Changes in working capital (5,001) (18,398) 19,045 (11,053) (7,799) Other operating cash flows (275) 133 313 312 343 Cash flow from operations 8,277 (1,394) 35,772 8,041 14,724 Capital expenditures (4,716) (6,972) (33,231) (6,000) (6,000) Change in investments 2,621 (874) (2,462) 3,907 (2,479) Other investing cash flows 1,395 1,824 2,654 1,079 974 Cash flow from investing (700) (6,023) (33,040) (1,014) (7,506) Equities issued 0 0 0 0 0 Debt raised/repaid (5,584) 9,535 2,614 (1,228) (1,106) Interest expenses (383) (339) (1,457) (992) (893) Dividends paid (2,810) (3,212) (3,613) (4,015) (4,818) Other financing cash flows 1,096 1,958 46 0 0 Cash flow from financing (7,682) 7,942 (2,411) (6,235) (6,816) Changes in cash and cash eq (106) 525 321 792 403 Closing cash and cash eq 905 1,430 1,752 2,544 2,946

29 May 2014 Page 7 of 7

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