Research ReportOn

“Glenmark Pharmaceuticals Limited”

UNDER THE GUIDANCE OF

PROF. DEBASHISH GHOSH

SUBMITTED BY

ABHRAJIT KUNDU (323)

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Ticker: ● GLENMARK    Recommendation: ● Buy

Price: ● 285 Price Target: ● 350

Earnings/Share

Jun. Sept. Dec. Mar. Year P/E Ratio

2008A 4.01 5.24 11.86 5.23 26.34 11.42009A 2.27 2.67 1.47 2.29 8.7 23.12010A 0.21 2.13 1.39 1.05 4.78 23.22011E 2.24 6.27 6.57 2.39 17.47 20

Highlights

September 3, 2010 Glenmark Pharmaceuticals

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Medicis Deal: GPL has entered into an out-licensing deal with Medicis, a US based Pharma Corporation, for co-development and commercialization for one of their NDDS (for treatment of acne). As per the agreements of the deal, GPL will receiver US$5 mn upfront payment and additional payments upon achieving certain development milestones and royalty upon commercialization of the product. In a separate development, Glenmark has entered into Para-IV settlement with Medicis for generic versions of Loprox gel and Vanos cream. Under the agreement, Glenmark will be able to market and distribute generic version of Vanos cream under license from Medicis as early as December 2013, or earlier in certain circumstances. In addition, Glenmark will have a license to launch a generic version of Loprox gel immediately. Vanos Cream has a total market of 35 million dollars and Loprox Gel has an annual market of 15 million dollars in US. The above developments are positive for the company but will have meaningful impact on the financials of the company only after 2-3 yrs.

In-Licensing Deal: Glenmark Pharmaceuticals Ltd in-licensed a product for the Indian market as part of its effort to enter the fast-growing and high-potential ‘Scar Management’ segment. Glenmark entered into a strategic in-licensing agreement with the Swiss firm, Stratpharma AG to market and distribute the product ‘Strataderm’ in India. The entry into the scar management therapy area will strengthen Glenmark’s leadership position in the dermatology segment. Estimated size of the scar and marks removal cream in India to be around Rs. 80 cr and growing at an exponential rate.

US Healthcare Bill: With the $940-billion healthcare package emphasizing on increased healthcare coverage and lower cost, there is a supply opportunity for India's generic drug makers. The bill promotes the use of generic drugs that are often one-tenth the price of the original version, but has the same impact. Among the 14 countries named in the Congress discussion that can offer low-cost drugs to achieve lower healthcare costs, India and China were the only two that have enough scale to serve the US market. India has the largest number of US Food and Drug Administration approved pharma plants outside the US.

Budget Impact: The proposal of increase in weighted deduction on in‐house R&D expenditure is positive for the company as it can now get higher deduction of 200 % which earlier was 150 %. But it gets partially offset by increase in MAT rates from 15 % to 18 %.

Qualified Institutional Placement: In September 2009, Glenmark raised Rs 413.56 cr through a Qualified Institutional Placement (issued 1.87 cr shares at the rate of Rs 221 per share), which was utilized to lower debt levels and other corporate purpose. This

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helped keep a tab on interest costs which grew 7% to Rs 368 mn in the December quarter (it was down nearly 20% qoq).

Investment Summary

Strong Growth in International Markets: The Company has strong presence in both regulated as well semi-regulated markets with around 70% of revenues coming from exports.

Increasing Footprint in Domestic Markets: The Company follows the strategy of targeting niche areas as a growth strategy to penetrate in domestic markets which enables the company in maintaining margins. It is a leader in dermatology segment in domestic region and continues to be focused in the segment.

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Strong Research Capabilities: It has a strong pipeline of 6 New Chemical Entities (NCEs) and 2 New Biologics Entities (NBEs) in various stages of preclinical and clinical trials and has earned revenues of US$115mn till now from R&D activities, highest ever earned by any Indian company.

Listing of Generics Business: GPL has re-organized its generics business into a separate subsidiary called Glenmark Generics Limited (GGL), which contributes around 44% of group’s revenues. It has filed RHP and awaiting SEBI’s approval for its IPO.

Increasing Profitability via Restructuring Balance Sheet: Company has taken various steps like reducing debtor’s day and debt on the books to improve the liquidity.

Valuation

The revenues of the company is expected grow at a CAGR of 15% over a period of three years from 2011E to 2013E whereas net profit will grow at a higher CAGR of 22.14% during the same period, on account of balance sheet restructuring exercises, cost containment program and management of working capital cycle. The company is expected to earn an EPS of Rs. 17.47 in FY11E, Rs.19.84 in FY12E and Rs.22.54 in FY13E. At the CMP of Rs. 285 per share, the stock is trading at a discount of 18.57% from our intrinsic price of Rs. 350 per share which is 20x FY11E earnings. With growth triggers like first-to-file opportunities, listing of its subsidiary (not factored in our financials), out-licensing deal for its NCE (not factored in our projections) the stock looks undervalued. The recommendation is a BUY rating on the stock with a price target of Rs 350 with a long term view.

Business Description

Glenmark Pharmaceuticals Limited (GPL) is a research-driven, fully integrated pharmaceutical company. Incorporated in the year 1977, the Company is a leader in the discovery of new molecules (both NCEs and NBEs) in India. Glenmark is among the few Indian pharmaceutical players targeting new drug discovery research. With its global headquarters in Mumbai, the pharmaceutical group has branded generic formulation markets in over 85 countries across the globe including India, US, Europe, Brazil, Russia/CIS, Africa and Asia. The company focuses particularly on developing proprietary drugs (novel chemical entities and biological entities) as well as generic drugs across the categories of solid oral dose products, dermatological creams and ointments.

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The formulations business of the company spans several product segments such as Dermatology, Internal Medicine, Respiratory, Diabetes, Pediatrics, Gynecology and Oncology. In India, the company markets about 100 molecules/combinations spanning over a diverse set of therapy segments.

Business Model

Glenmark has re-organized its business model into two separate business units – Specialty Business under the name of Glenmark Pharmaceuticals Ltd (GPL) and Generics Business under the head of Glenmark Generics Limited (GGL). Both GPL and GGL are growing as independent entities with distinct business models where in GPL is moving up the value chain with focus on branded generics and drug discovery activities and GGL is moving down the pharmaceutical value chain with focus on pure generics business and Active Pharmaceutical Ingredient (API).

Specialty Business: Glenmark Pharmaceuticals Ltd. (GPL): Specialty division of Glenmark takes care of its Branded generics business and new drug discovery. This business focuses on building the brands and generating prescriptions. It has a long term vision of development and marketing of novel drugs. As a part of strategy of brand building the company intends to improve the presence of sales and marketing front ends in all important geographies.

Generics Business: Glenmark Generics Ltd. (GGL): With a vision of emerging as a leading integrated global generics organization, Glenmark Generics Limited (GGL) started independent operations during FY09. GGL focuses on developing, manufacturing, selling, and distribution of generics products. It is an end-to-end vertically integrated generic player with capabilities ranging from API manufacturing to front end sales in key markets. GGL focuses on key niche segments including Dermatology, Hormones, Controlled Substances, Oncology, and Modified Release Products.

GGL has an established presence in North America, European Union (EU) and Argentina and maintains marketing front-ends in these countries. The company has a strong base in formulations development with teams operating out of laboratories in India and Latin America. The company has a state-of-the-art manufacturing plant at Goa, India that is approved by FDA (US), TPD (Canada), MHRA (UK). The company’s US arm – Glenmark Generics Inc. USA has a portfolio of over 45 generic products in the US market which includes a mix of oral solids, oral liquids and semisolids.GGL has established its presence in the UK generic market and has begun to expand to other markets in the EU region. The business model for the EU business is based on a mix of out-licensing and Glenmark’s own sales across these markets with products chosen to reflect niche opportunities or competitiveness through vertical integration. The

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business has a portfolio of solid orals and semi-solids differentiated on the basis of difficult to develop/formulate products and high entry barrier products.

GGL also develops, manufactures, markets and distributes active pharmaceutical ingredients (APIs) to other pharmaceutical companies. It markets around 66 APIs globally in approximately 80 countries, including the US, EU, South America and India. GGL has so far filed 49 DMFs (Drug Master Files) with the US-FDA.

Industry Overview

The pharmaceutical industry includes the discovery, development, manufacturing and distribution of drugs. A highly organized sector, the Indian pharmaceutical industry has grown from a humble Rs 1,500 crore turnover in 1980 to approximately Rs 1,00,611 crore (US$20 bn plus) in 2009-10 (September 2009) growing at about 8 to 9 % annually. The country now ranks third in terms of volume of production (10% of global share) and 14th by value as per Cygnus report.

The sector is highly fragmented with more than 20,000 registered units. It has expanded drastically in the last two decades. The leading 250 pharmaceutical companies control 70% of the market with market leader holding nearly 7% of the market share. The market dominates by Indian companies with 75% market share whereas MNC pharma companies have only 25% market share. But the trend is changing with MNCs increasing focus towards Indian markets.

Sector Overview

The domestic Pharma formulation market is continues to grow double digits. In the quarter under review, the domestic pharmaceutical industry witnessed a strong growth of 19.4%, as per ORG IMS. As per industry estimates, the industry is expected to grow 17.5%-18.5% in the current fiscal. Despite price control, players are positive on Russian market, thanks to strong double digits growth. Contract manufacturing business was sluggish due to global mergers, but is set to improve in the second half of the current fiscal as most of the global players are shutting down high cost manufacturing facilities. But contract research is yet to recover as order inflow from US regions is remains lull as small biotech players are not completely recovered.

Peer Comparison

The company had weak FY09 due to macro as well as micro factors which are nonrecurring. It is believed that the company has targeted those issues and future of the company looks good. The peer set has been selected based on the business segment they are present in i.e. Generics and

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R&D. Since GPL faced one-time company specific issue last year, so the P/E cannot be the only basis of comparison. GPL’s Ev/Ebitda, P/BV multiples are lower than the most of its peer group. RONW is lower than peers because its profitability got impacted last year due to various reasons explained earlier coupled with the QIB done by the company in Sept’09 which increased its capital base thus impacting the ratio. For FY07 and FY08 the RONW for the company was as high as 45.2% and 41.6% respectively. The company’s EBITDA margins are highest in its peers at 25.8% whereas closet competitor is Torrent with 22.5% margins. Its PAT margins are 12.7% which is third in the list of its stated competitors. But this going to change due to the reduced interest burden the company would enjoy 16.2% margins in FY11E and 17.8% in FY12E.

Financial Analysis

Revenues to grow at 15% CAGR over FY10-12E

Glenmark Pharmaceuticals has been growing at a CAGR of 27% over FY06-10, the company has earned USD 117mn from Nuclear Chemical Entity (NCE) outlicening deals highest by any domestic company. The company experienced rough FY09 due to economic slowdown and due to failure of outlicensed NCE, However over the last few quarters it has been seen that there is a revival in the financials driven by the strong growth across business units. The rise in the number of ANDA approvals in the US and expected revival of the other markets would have a positive impact on the base business financials of Glenmark.

The management expects Glenmark to record a CAGR of 20-25% over the next 2 years, however conservative estimates sees a CAGR of 15% over the next 3 years in its base business on back of lower base in European market, foray in new geographies in semi-regulated markets and consistent steady growth in Latin America and India would be main growth drivers for specialty business. Further, the lower base in US and Argentina and growing generics demand across the world would drive growth in generics space.

Balance Sheet Expected to strengthen going ahead

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Glenmark had repaid around Rs 350mn as part of the redemption of the FCCB issued in 2005 and 2006 in FY10, while it is expected that the remaining FCCB issued in 2007 to also be redeemed by the company in FY11E. Further, the company has already raised Rs. 4,000mn through issue of QIP at Rs. 221 per share and use the proceeds to reduce the debt. These measures taken by the management indicates the management is focussing on reducing the debt going ahead. Such measures would strengthen the balance sheet of the company and would create value for the shareholders of the company. The company is also in making concerned efforts to reduce its debtor days from the current 131 days to 120 days over the next year.

EBITDA margin to remain stable and Net profit to grow at 24% CAGR

EBITDA is expected to grow at 19.24% CAGR over FY10-13E to Rs 11.46bn. EBITDA margin would remain stable at 30% over next 2 years. Net profit is expected to grow at 22.15% CAGR over FY10-13E to Rs 6,160mn from Rs 3,380 mn. The growth is to be driven by strong revenue flow, consistent EBITDA margin and lower interest cost as the company will gradually reduce its debt over the period of time.

Investment Risks

Slow Down in the Economy: The performance of the company is correlated to growth of economy also. Any slowdown in the economy, as witnessed last year, may affect the sector in general including GPL.

Delay in ANDA Approvals: The company’s ability to achieve further sales growth and profitability in US is dependent on its success in continuing to successfully obtain ANDA approvals, challenge patents, develop non-infringing products relative to branded pharmaceuticals and obtaining a 180-exclusivity.

Regulatory Issues: Any disciplinary action by USFDA taken against the company in case of any violation sited by them, would adversely impact growth prospects of the company.

Failure of R&D Molecules: In order to remain competitive the company spends substantial amount on R&D activities and looking for out licensing partners. If the on-going and increasing R&D investments prove unsuccessful, it would result in higher costs without a proportionate increase in the income, which in turn would adversely affect the company’s income and financial condition.

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0 Figure 1: Income Statementin INR Crores

Source: Company Documents, Student Est imates

(In INR Crores)

FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Revenues 758 1222 1976 2070 2512 2889 3322 3821

COGS 605 779 1122 1553 1836 2022 2326 2674

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EBITDA 153 443 854 517 676 867 997 1146

Depreciation & Amortisation

23 42 72 103 121 146 176 211

EBIT 130 401 782 414 555 721 821 935

Interest 18 40 71 146 164 168 194 222

EBT 112 361 711 269 391 552 627 712

Income Taxes

11 17 50 106 53 75 85 96

EAT 101 344 661 163 338 478 542 616

Minority Interest

0 0 0 2 4 6 7 8

Adjusted Net Income

101 344 661 161 334 472 536 608

Dividend 5 5 18 10 11 11 11 11

Retained earnings

96 339 643 151 323 461 525 598

Shares Outstanding

14 13 26 25 27 27 27 27

EPS (in INR) 7.18 25.65 25.30 6.80 13.10 17.47 19.84 22.54

Figure 2: Balance Sheetin INR Crores

Source: Company Documents, Student Est imates

(In INR Crores)

FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Cash 106 106 157 71 107 481 759 1068

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Accounts Receivable 382 566 807 955 1078 1309 1506 1732

Inventories 158 270 401 630 708 704 810 931

Others Current Assets 95 163 286 422 527 472 543 624

Total Current Assets 741 1105 1651 2079 2421 2967 3618 4356

Investments 19 18 18 18 18 18 18 18

Gross Fixed Assets 530 710 1124 1839 1530 1854 2235 2682

Accumulated Depreciation 77 117 205 273 255 388 549 743

Net Fixed Assets 453 593 919 1566 1275 1466 1686 1939

CWIP 130 219 338 545 698 614 706 812

Deferred Tax Assets -42 -72 -95 -57 -71 -82 -94 -108

Other Assets 207 623 818 686 1114 1282 1372 1480

Total Assets 1508 2486 3649 4838 5455 6265 7306 8497

Accounts Payable 380 863 1139 1142 1228 1412 1624 1867

Debt Funds 735 937 991 2094 1869 2034 2338 2688

Minority Interest 0 0 1 3 3 3 3 3

Equity Capital 44 24 25 25 27 27 27 27

Reserves & Surplus 349 662 1493 1573 2328 2789 3314 3912

Shareholder's Funds 393 686 1518 1598 2355 2816 3341 3939

Total Liabilities 1508 2486 3649 4838 5455 6265 7306 8497

Figure 3: Statement of Cash Flowsin INR Crores

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Source: Company Documents, Student Est imates

(In INR Crores)

FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Cash Flow From Operating Activity

288 328 -152 425 715 739 829

Cash Flow From Investing Activity

-409 -489 -748 -153 -134 -164 -213

Cash Flow From Financing Activity

121 212 816 -236 -207 -297 -307

Opening Cash Balance

106 106 157 71 107 481 759

Closing cash Balance

106 157 71 107 481 759 1068

Figure 4: Statement of Free Cash Flowsin INR Crores

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Source: Company Documents, Student Est imates

(In INR Crores)

FY07 FY08 FY09 FY10 FY11E FY12E FY13E

EBITDA 443 854 517 676 867 997 1146Depreciation 42 72 103 121 146 176 211EBIT 401 782 414 555 721 821 935Tax 19 55 164 75 97 111 126Cash Flow After Tax

382 727 251 480 623 710 808

Depreciation 42 72 103 121 146 176 211Change in Working Capital

89 119 207 153 -84 92 106

Capital Expenditure

18 18 18 18 18 18 18

Free Cash Flow

317 662 128 430 835 776 896

Figure 5: Key Rat ios

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Source: Company Documents, Student Est imates

FY10 FY09 FY08 FY07 FY06Debt-Equity Ratio 0.61 0.71 0.97 2.13 1.93Long Term Debt-Equity Ratio 0.29 0.21 0.47 1.27 1.54Current Ratio 2.48 1.85 1.59 1.75 2.82Fixed Assets 3.56 2.3 3.31 2.45 2.14Inventory 7.34 4.29 5.71 4.69 4.95Debtors 2.78 1.72 2.76 2.38 2.66Interest Cover Ratio 2.21 3.6 10.88 5.34 5.89PBIDTM (%) 23.5 41.56 35.89 27.91 19.44PBITM (%) 21.43 39.35 33.8 25.1 16.61PBDTM (%) 13.82 30.61 32.79 23.2 16.61CPM (%) 14.54 27.37 29.79 18.91 13.71APATM (%) 12.48 25.16 27.69 16.1 10.88ROCE (%) 9.14 17.7 32.58 17.47 11.6RONW (%) 8.55 19.3 52.63 35.81 23.31

Disclosures:Ownership and material conflicts of interest:

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The author(s), or a member of their household, of this report [holds/does not hold] a financial interest in the securities of this company.

The author(s), or a member of their household, of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content or publication of this report. [The conflict of interest is…]

Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director:

The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company.

Market making:

The author(s) does [not] act as a market maker in the subject company’s securities.

Ratings guide:Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months.

Investment Research Challenge and Global Investment Research Challenge Acknowledgement:

[Society Name] Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts.

Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with [Society Name], CFA Institute or the Global Investment Research Challenge with regard to this company’s stock.