takeaways for indian pharma from our healthcare trip-barclays

Equity Research 8 July 2013

India Healthcare & Pharmaceuticals

‘The world is their oyster’ – Takeaways for Indian Pharma from our Healthcare trip We hosted the Barclays India Healthcare Trip from 1-4 July with about 40 investors meeting representatives of pharmaceutical companies, hospitals, and industry and regulatory bodies. This report discusses our key impressions for the pharma industry. Our primary takeaway was that global growth opportunity is still solid with the US to remain the driver of growth for the next 3-5 years. The management teams sounded more confident about other emerging markets and their companies’ abilities to penetrate these. Despite the spate of changes in India’s pharma market (price regime, ban on drugs, curb on advertising and promotional spending, clinical trial stringency), the teams were positive on the long-term potential. We retain our Positive view on Indian Pharma with our top picks of Glenmark, Lupin and Sun Pharma.

Global opportunities exist to drive growth for the next 3-5 years: We initiated our coverage on the Indian Pharma one year ago with the view that concerns on patent cliff in the US was overdone (click here for “Healthy Dose of Global Growth”). The US then at 34% of revenue has risen to 38% for our coverage, and we expect this to trend upwards owing to continued one-offs and growing complex generic focus. Furthermore, as total revenue for our coverage universe has grown to Rs507bn from Rs642bn (27% y/y growth), the contribution from the rest of the world has remained stable at c36% with India itself falling to 26% from 29%.

No witch-hunt by the US FDA; imperative to scale learning curve on quality: We were reassured to hear this rational response from almost all companies on the US Food and Drug Administration’s stringency and the realization that quality compliance was viewed as of the utmost importance.

Despite recent government actions, long-term opportunity in India still looks bright: The management teams admitted that for the first time there were multiple challenges in the Indian pharma industry, especially given government actions, such as price control expansion (refer to our reports on drug pricing and other measures). A few of the teams spoke of near-term pain with FY14 being a challenging year but were highly optimistic for the Indian pharma market’s growth reverting to a mid-teens rate from next year.

Battle for chronic therapeutic segment likely to intensify amid market expansion: With the chronic segment (constitutes c37% of the revenue for the Indian Pharma market) fast outpacing the acute segment, the teams expect the competitive intensity to rise although there were mixed views on barriers to entry in this segment.

Health insurance in India will be a strong growth driver: As a greater number of people get health care coverage, the companies thus expect to also see a degree of premiumization. Although insurance companies are still not perceived to be strong enough to dictate terms, their bargaining power is on the rise.

Barclays Capital Inc. and/or one of its affiliates does and 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 this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by equity research analysts based outside the US who are not registered/qualified as research analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 17.

INDUSTRY FOCUS

India Healthcare & Pharmaceuticals POSITIVE Unchanged

India Healthcare & Pharmaceuticals Balaji Prasad, M.D. +91 22 6719 6295 [email protected] BSIPL, Mumbai Rohit Goel +91 22 6719 6029 [email protected] BSIPL, Mumbai

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Barclays | India Healthcare & Pharmaceuticals

8 July 2013 2

FIGURE 1 Indian Healthcare and Pharmaceuticals Trip – meeting schedule

Day 1: Mumbai (1 July, 2013)

Company/organization Management members or representatives attending

GSK, India – Industry Talk Hasit Joshipura (Managing Director, India)

Sun Pharma Uday Baldota (Chief Financial Officer)

Nimish Desai (Investor Relations)

Wockhardt Dr Murtaza Khorakiwala (Managing Director) Tushar Mistry (Head, Investor Relations)

Glenmark Pharma Jason D (Head, Investor Relations)

Lupin Pharma Dr Kamal Sharma (Managing Director) S Ramesh (President, Finance)

Day 2: Mumbai (2 July 2013)


All India Origin Chemists & Distributors (AIOCD) Hari Natrajan (Director)

Unichem Laboratories Rakesh Parikh (Chief Financial Officer) M Gundu Rao (EVP, Finance)

Discussion on Pharma distribution in India Mr Kannan (Pharmaceutical Distribution Expert)

Day 3: Hyderabad (3 July 2013)


Pharmaceuticals Export Council of India Dr. P.V. Appaji (Director General)

Raghuveer Kini (Executive General)

Dr Reddy's GV Prasad (Vice Chairman, Chief Executive Officer) Saunak S (Investor Relations)

Apollo Hospitals

(Management meeting and hospital visit)

Sangeeta Reddy (Executive Director)

Akhileswaran Krishnan (Chief Financial Officer) Krishna Kumar (Head, Investor Relations)

Day 4: New Delhi (4 July 2013)


Fortis Healthcare Vishal Bali (Group Chief Executive Officer) Anurag Kalra (Head, Investor Relations)

Gaurav Chugh (Investor Relations)

Jubilant Lifesciences R Sankariah (Executive Director, Finance) Anupam Singh (Investor Relations)

Ranbaxy Arun Sawhney (Chief Executive Officer) Indrajit Banerjee (President and Chief Financial officer) Umang Khurana (Head, Investor Relations)

National Pharma Pricing Authority C.P. Singh (Chairman)

Source: Barclays Research


8 July 2013 3

Lupin: “Anti-fragile” strategy; focus on specialty segments Labelling the long-term growth strategy for Lupin as “anti-fragile”, management highlighted the following key drivers for the next seven to 10 years: 1) leveraging its focus on speciality segments like derma and oral contraceptives in other geographies and sustaining its strong traction in the US; 2) increasing the contribution from branded business to help mitigate earnings volatility likely through inorganic routes (to aim for a 30% contribution from branded business); 3) retaining a strong balance sheet with the flexibility to raise up to US$1.7-2bn if required; 4) maintaining strong distribution network and alliances with doctors to drive the growth in Japan despite escalating competition; and 5) strengthening domestic business further through strategic partnerships.

Strong focus on the oral contraceptive and Derma segment Management reiterated its focus on the speciality segment and expects peak revenues of cUS$50mn by year end (and US$125mn in the next 18-24 months). Oral contraceptives (OCs) in the US could also be leveraged to venture into other big markets, such as Brazil (OC market size of US$1.5bn).

With the resumption of OC approvals in the past six months (eight approvals and one launch), we believe OCs are set to be a major growth driver (click here for OC faceoff - Lupin vs. Glenmark; combined sales of $275mn by 2015 of 14 May). Key launches that we anticipate are of Lutera, Daysee and Yasmin in 2013; Yaz and Loestrin in 2014; and Ortho Tri Cyclen in 2015. Lupin plans to enter the dermatology segment and could potentially acquire derma assets too in the business, as mentioned by management.

Domestic market outperformance to be sustained; third partnership likely Lupin has been a strong outperformer in the domestic market, driven by a growth across its key therapies of anti-infectives and alimentary

Other key takeaways • Management identified the need to be more disciplined in the semi-chronic areas;

• Management expressed confidence on the partnership model with Eli Lilly and Novartis and did not rule out the possibility of a third alliance; and

• While the market is mature with respect to the number of competitors, Lupin’s management expects the next leg of growth to come on the back of a stronger distribution network and alliances with doctors.

FIGURE 2 Healthy revenue growth despite strong base

FIGURE 3 Oral contraceptive segment to be a major driver in the US

Source: Company data, Barclays Research estimates Source: IMS Data, Barclays Research estimates

17 20 27 38 47 57 70 95 116 139

34.4%

18.8%

34.4%

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Our recent reports: 14 May: OC faceoff - Lupin vs. Glenmark; combined sales of $275mn by 2015 23 April: IPM monthly: Yet to March steadily; Lupin (OW) and Sun (OW) continue to outperform

LPC IN / LUPN.NS

Stock Rating OVERWEIGHT

Industry View POSITIVE

Price Target INR 894.00

Price (05-Jul-2013) INR 834.90

Potential Upside/Downside +7%











8 July 2013 4

India Healthcare & Pharmaceuticals Industry View: POSITIVE

Lupin Limited (LUPN.NS) Stock Rating: OVERWEIGHT

Income statement (INRmn) 2012A 2013E 2014E 2015E CAGR Price (05-Jul-2013) INR 834.90

Price Target INR 894.00 Why Overweight? 1) Stable performance with consistently improving cash generation; 2) robust pipeline (average of 25-30 launches over next three years) for the US to maintain past performance; 3) vertically integrating Japanese business and higher utilisation at Indore to drive margins higher.

Upside case INR 983.00 Lupin has seen some approvals getting delayed in the recent past, notably oral contraceptives. If these come through faster than anticipated, EPS upgrades by 10% are likely.

Downside case INR 768.00 This could materialise if Lupin: 1) does not realise the potential of its ANDA pipeline; and 2) branded generics business in the US does not sustain revenue momentum. Multiples could de-rate by 5%, and earnings could decline by 10%.

Upside/Downside scenarios

POINT® Quantitative Equity Scores

Source: POINT. The scores are valid as of the date of this report and are independent of the fundamental analysts' views. To view the latest scores, click here.

Revenue 69,597 94,618 115,789 138,845 25.9% EBITDA 14,447 22,372 26,915 31,927 30.3% EBIT 12,172 19,050 23,780 28,288 32.5% Pre-tax income 11,961 19,246 24,249 28,917 34.2% Net income 8,677 13,142 16,643 19,847 31.8% EPS (reported) (INR) 19.36 29.26 37.06 44.19 31.7% Diluted shares (mn) 448 449 449 449 0.1% DPS (INR) 3.73 4.00 5.07 6.05 17.5%

Margin and return data Average EBITDA margin (%) 20.8 23.6 23.2 23.0 22.7 EBIT margin (%) 17.5 20.1 20.5 20.4 19.6 Pre-tax margin (%) 17.2 20.3 20.9 20.8 19.8 Net margin (%) 12.5 13.9 14.4 14.3 13.8 ROIC (%) 16.1 20.8 21.2 22.2 20.1 ROA (%) 10.9 14.7 15.3 15.3 14.1 ROE (%) 21.6 25.3 24.9 23.5 23.8

Balance sheet and cash flow (INRmn) CAGR Tangible fixed assets 26,894 28,036 32,716 38,449 12.7% Intangible fixed assets 5,040 5,073 5,073 5,073 0.2% Cash and equivalents 4,025 4,349 6,277 13,820 50.9% Total assets 79,340 89,139 108,504 129,689 17.8% Short and long-term debt 14,809 9,739 8,239 6,739 -23.1% Other long-term liabilities 5,930 7,522 7,522 7,522 8.3% Total liabilities 38,488 36,502 40,683 43,894 4.5% Net debt/(funds) 10,784 5,390 1,962 -7,081 N/A Shareholders' equity 40,129 52,042 66,895 84,475 28.2% Change in working capital -4,776 -6,084 -6,575 -2,700 N/A Cash flow from operations 9,004 16,288 20,340 29,228 48.1% Capital expenditure -5,099 -6,387 -7,816 -9,372 N/A Free cash flow -1,821 3,890 5,218 11,310 N/A

Valuation and leverage metrics Average P/E (reported) (x) 43.1 28.5 22.5 18.9 28.3 EV/sales (x) 5.6 4.0 3.3 2.7 3.9 EV/EBITDA (x) 26.8 17.0 14.0 11.6 17.3 Equity FCF yield (%) N/A N/A N/A N/A N/A P/BV (x) 9.3 7.2 5.6 4.4 6.6 Dividend yield (%) 0.4 0.5 0.6 0.7 0.6 Total debt/capital (%) 27.0 15.8 11.0 7.4 15.3

Selected operating metrics Average SG&A/sales (%) 36.1 33.3 32.8 33.0 33.8 R&D/sales (%) 7.5 7.5 7.5 7.5 7.5 R&D growth (%) 8.1 35.8 22.4 19.9 21.6 SG&A growth (%) 30.8 25.3 20.5 20.8 24.4

Source: Company data, Barclays Research Note: FY End Mar

Value

Quality

Sentiment

Low High

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8 July 2013 5

Glenmark: Niche portfolio to rise to 60% of revenue

Rising niche portfolio a sustainable advantage As discussed in our note on 28 June “Glenmark Pharmaceuticals Ltd.: One for the long run? US NDR takeaways”, management expects a long-term CAGR of 20-25% to be driven by niche product launches (OCs, Mupirocin, Malarone, Zolmitriptan, Cutivate) and its specialty focus, which includes three core therapies: Derma, OCs and Modified Release. Management reiterated the company’s focus on these niche products and stated that the improving product mix (should increase to 60% of revenue from the current level of 30%) should provide a boost to its US operating profit margin from the current level of 28-30%.

As discussed in our report of 14 May “OC faceoff - Lupin vs. Glenmark; combined sales of $275mn by 2015”, we expect Glenmark to benefit materially from the OC segment and forecast a 40% revenue CAGR for the next three years to US$125mn by FY16.

R&D pipeline likely to provide an upside option value While management declined to quantify the probability of success for each molecule, we remain sanguinely positive on Glenmark’s pipeline of more than eight NCEs (new chemical entities) and NBEs (new biological entities), which could provide an upside surprise, in our view. Among the key deals, Glenmark has tied up with Forest Labs for its ongoing mPEGS-1 inhibitors programme and is the sole API supplier for Crofelmer to Salix Pharmaceuticals.

Among the key highlights: 1) NCE R&D to be capped at $40m/year – Revamilast, which is a high cost programme is no longer part of the pipeline; 2) potential milestones near term: 17536 Ph.II data expected in H2 FY14; 15300 data expected anytime now on respiratory trials; 3) Crofelemer to be rolled out where Glenmark has rights and existing sales force.

Strong traction among the core geographies • India: Management expects the above-industry growth levels to be sustained with a

minimal impact due to near-term pricing policy headwinds;

• Brazil: While there have been no approvals as yet, management is confident of breaking even by year-end as the shipments have commenced post the ending of ANVISA strike;

• Russia: With growth of 25% y/y in FY13 (per management), Russia remains a key growth driver for the company’s rest-of-the-world segment.

FIGURE 4 Strong 20%+ revenue growth levels to sustain

FIGURE 5 Contribution from OC segment increased to 23%

8.7 12.2 11.3 14.4 16.923.3 27.0 31.7

38.1

3.87.9 9.9

10.612.6

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Source: Company data, Barclays Research estimates Source: IMS, Company data, Barclays Research

Our recent reports: 14 May: OC faceoff - Lupin vs. Glenmark; combined sales of $275mn by 2015 28 June: Glenmark Pharmaceuticals Ltd.: One for the long run? US NDR takeaways

GNP IN / GLEN.NS




Price (05-Jul-2013) INR 584.00














8 July 2013 6


Glenmark Pharmaceuticals Limited (GLEN.NS) Stock Rating: OVERWEIGHT


Price Target INR 660.00 Why Overweight? 1) Glenmark is on a firm recovery trajectory both in India and the US; 2) it has received the highest product approvals in the US in the last year, which builds a solid foundation for growth; 3) balance sheet is improving, with gearing declining; and 4) valuations are least demanding vs. peers.

Upside case INR 694.80 Our bull case for Glenmark would be driven by the optional upsides from its R&D efforts, which we currently do not build in. These include: a) license fees from new outlicensing; b) milestone income from current outlicensing deals; and c) a potential launch of Crofelemer.

Downside case INR 500.26 Our bear case is based on delay in regulatory approvals in the US market and margins not improving in Brazil. In this case, earnings are likely to decline by 10% and multiples can de-rate by 16%






Balance sheet and cash flow (INRmn) CAGR Tangible fixed assets 12,995 16,429 18,174 20,361 16.1% Intangible fixed assets 11,862 11,857 11,582 11,308 -1.6% Cash and equivalents 3,201 6,052 7,143 9,058 41.4% Total assets 58,834 69,942 75,981 85,474 13.3% Short and long-term debt 22,445 22,881 21,046 18,979 -5.4% Other long-term liabilities 1,032 1,862 1,862 1,862 21.7% Total liabilities 34,568 42,068 39,881 39,362 4.4% Net debt/(funds) 19,244 16,829 13,903 9,921 -19.8% Shareholders' equity 23,766 27,387 35,523 45,422 24.1% Change in working capital -1,404 1,228 -3,429 -4,118 N/A Cash flow from operations 10,616 11,342 8,999 11,255 2.0% Capital expenditure -2,854 -2,482 -3,012 -3,635 N/A Free cash flow 5,266 6,497 3,197 4,396 -5.8%




Value

Quality

Sentiment

Low High

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8 July 2013 7

Sun Pharma: Ample growth levers in place

M&A not necessary to grow the business Despite being a fairly cash generative business, M&A is not necessary to grow the business and there are enough organic opportunities for Sun, as per management. This was further highlighted by the media reports (Business Standard, 4 July) highlighting that Sun Pharma has decided not to pursue Meda Pharma’s acquisition.

• Protonix settlement: Management said that while the final amount of US$550mn was higher than it had expected, it was still less than the US$1bn claimed initially. Management claimed that it has not impacted the company’s ability for M&A.

• No constraints on raising debt: Sun Pharma is strongly equipped to raise debt and is not averse to the idea of raising equity in the worst case.

Taro’s high market share across the key product remains a risk Taro continues to witness limited competition and has high market shares across its key products, which is a key risk as per management. However, we view positively the comment that price increases are outside the purview of the US FDA, which acts only in the event that there is a difficulty for the consumer.

Pioglitazone ban a one-off; sufficient opportunity remains in India Management said that despite the tepid growth environment in India’s pharma market recently, sufficient domestic growth opportunity remains because of under-penetration. The drivers behind Sun’s strong outperformance have been the following:

• strong coverage network (some doctors are covered by more than one medrep);

• popular brand recall; and,

• consistent availability of the brands.

Additionally, management stated that the ban on Pioglitazone was a one-off and should not be seen as a trend in the domestic market. On pricing policy, Sun expects only a marginal near-term impact.

FIGURE 6 Growth should be driven by organic and inorganic routes

FIGURE 7 One of the strongest ANDA pipelines in the coverage

Source: Company data, Barclays Research estimates Source: Company data, Barclays Research

31

57

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RoW+API Taro Prandin FY14E (Org)

DUSA URL FY14E (Net)

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Bn

Rs 6.9b

Organic growth - 16%

Overall growth - 24%

18% 13% 22% 5% Rs 2.2b Rs 2.7b

Segmental growth estimates Acquisition

142177

207

377 397449

737

53 69 84

225 250311

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Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-13 (with URL)

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Cumulative Products Approved

Our recent reports: 5 June: What STADA or Meda bring to the table 13 June: Protonix settlement could curb appetite for M&A & At-risk launches

SUNP IN / SUN.NS




Price (05-Jul-2013) INR 1034.70

Potential Upside/Downside -2%







8 July 2013 8


Sun Pharmaceutical Industries Limited (SUN.NS) Stock Rating: OVERWEIGHT

Income statement (INRmn) 2012A 2013E 2014E 2015E CAGR Price (05-Jul-2013) INR 1,034.70

Price Target INR 1,014.00 Why Overweight? 1) Strong revenue and 20%+ EPS CAGR despite high base of FY13. 2) Consolidation of leadership position in domestic market, derma segment in US. 3) Growth visibility and high returns to sustain premium valuations.

Upside case INR 1,115.00 Our upside case is based on the assumption Taro grows faster than our current muted forecast, with peak margins sustained. This could lead to 10%+ additional EPS for FY14 and sustained multiples.

Downside case INR 845.00 Our downside case is driven by an inability to revive the URL generics business, along with a steep dip in margins that could lead to EPS cuts and a de-rating closer to sector multiples of 20x (vs 24x in the current case).




Revenue 80,057 112,389 138,579 160,698 26.1% EBITDA 32,648 49,673 56,469 65,080 25.9% EBIT 29,736 46,311 51,357 59,292 25.9% Pre-tax income 33,554 43,149 56,945 66,222 25.4% Net income 25,873 30,081 41,290 46,219 21.3% EPS (reported) (INR) 24.98 29.05 39.87 44.63 21.3% Diluted shares (mn) 1,036 1,036 1,036 1,036 0.0% DPS (INR) 4.25 5.00 5.98 6.69 16.4%


Balance sheet and cash flow (INRmn) CAGR Tangible fixed assets 32,742 50,771 54,921 59,832 22.3% Intangible fixed assets 10,218 11,330 11,075 10,821 1.9% Cash and equivalents 33,672 40,587 57,093 89,499 38.5% Total assets 164,740 201,825 234,750 280,865 19.5% Short and long-term debt 2,650 1,982 1,716 1,450 -18.2% Other long-term liabilities 14,554 26,279 26,279 26,279 21.8% Total liabilities 30,769 44,027 35,954 36,609 6.0% Net debt/(funds) -31,022 -38,605 -55,377 -88,050 N/A Shareholders' equity 122,358 141,447 177,620 217,645 21.2% Change in working capital -27,303 -2,679 -17,831 -5,630 N/A Cash flow from operations 5,345 47,121 38,638 59,450 123.2% Capital expenditure -4,802 -7,305 -9,008 -10,445 N/A Free cash flow 15,313 13,642 21,889 38,866 36.4%




Value

Quality

Sentiment

Low High

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8 July 2013 9

Ranbaxy: Clarity over the Fortune article

Clarity on what happened at the facilities; Atorva voluntary recall signifies Ranbaxy’s commitment to quality As per management, during 2003-2005, Ranbaxy had delayed the stability testing of a few products, which is a non-GMP activity as per the US FDA. Thus, any product that was then tested had automatically been disqualified and considered adulterated. Stating that the Atorva recall was voluntary on company’s front despite having a 55% market share, management reiterated Ranbaxy’s focus on quality.

Consent Decree steps on track; global inspection agencies in support As per management, post the import alert in 2008, there have been about 175 inspections by global agencies (many times combined) and Ranbaxy has cleared all of these. Additionally, many of these agencies, including an advisory statement from the World Health Organization, have supported Ranbaxy’s stand and focus on the quality.

While there is not much clarity over when the first product can move out of Paonta/Dewas, the CD processes are moving fairly well and not a single milestone was missed in CY12.

Lack of clarity over the difference in the US FDA CD and DoJ settlement Ranbaxy reiterated the need to highlight a lack of connection between the settlement with the US Department of Justice and the consent decree with the US FDA. As discussed in our note of 16 May “Dissociate DoJ settlement from FDA approval expectations”, these two are disparate processes and the DoJ settlement has no bearing on the speed of resolution of quality issues with the FDA.

Diovan: Ready to launch but no visibility on approval While management declined to comment on the US product pipeline, it reiterated its confidence on the base business highlighted by the strong market share gains for Absorica (c13% market share after launch). Management expects to file at least one differentiated product per year for the next 3-4 years with an investment of cUS$2-3mn per product.

Capacity utilization levels remain high Except for the under-utilization of the Dewas manufacturing facility, other blocks used for manufacturing for the global geographies are being highly utilized, as per management.

FIGURE 8 Revenue growth levels remain volatile for Ranbaxy

FIGURE 9 Strong underperformance w.r.t its peers

Source: Company data, Barclays Research estimates Source: Thomson Reuters Datastream, Barclays Research

61 68 74 76 90 102 125 110 133

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Indexed at 100

Our recent reports: 16 May:- Dissociate DoJ settlement from FDA approval expectations 18 April: CY12 annual report analysis: A new hope?” We believe that while the payment concludes the long-standing DOJ affair and that management time and focus can now be better allotted to the business. As per Diovan, management remained muted on expected approval date, but stated that they believe that the exclusivity on the product would remain with them

RBXY IN / RANB.NS

Stock Rating UNDERWEIGHT



Price (05-Jul-2013) INR 341.80









8 July 2013 10


Ranbaxy Laboratories Limited (RANB.NS) Stock Rating: UNDERWEIGHT


Price Target INR 393.00 Why Underweight? 1) Uncertainty still exists about core business growth, profitability and trajectory; 2) loss of 3-FTFs under Consent Decree is an overhang; and 3) valuations are expensive (40%+ premium vs. peers) on multiple metrics when one-off earnings of Lipitor are stripped.

Upside case INR 480.00 In our view, an upside case on Ranbaxy needs significant improvement of base business margins from the high single-digits (vs. 20% for peers) to at least the mid-teens. We rate this as low probability for 2013.

Downside case INR 350.00 Acute therapeutic area in India continues to underperform the market, and loss of FTFs if Consent Decree terms are defaulted. In this case, we expect EPS downgrades with ~15% derating.




Revenue 101,614 124,955 110,266 132,763 9.3% EBITDA 16,189 18,409 13,177 17,591 2.8% EBIT 12,249 15,207 9,695 13,836 4.1% Pre-tax income -451 14,123 9,072 12,972 N/A Net income -28,997 9,228 6,924 9,900 N/A EPS (reported) (INR) -68.81 21.87 16.41 23.46 N/A Diluted shares (mn) 421 422 422 422 0.0% DPS (INR) 2.00 0.00 1.64 2.35 5.5%

Margin and return data Average EBITDA margin (%) 15.9 14.7 11.9 13.2 14.0 EBIT margin (%) 12.1 12.2 8.8 10.4 10.9 Pre-tax margin (%) -0.4 11.3 8.2 9.8 7.2 Net margin (%) -28.5 7.4 6.3 7.5 -1.9 ROIC (%) 10.3 12.9 8.3 10.6 10.5 ROA (%) -18.4 5.6 5.0 6.6 -0.3 ROE (%) -8.8 27.1 14.5 17.4 12.6

Balance sheet and cash flow (INRmn) CAGR Tangible fixed assets 29,970 30,501 32,551 35,339 5.6% Intangible fixed assets 21,258 21,654 21,085 20,516 -1.2% Cash and equivalents 30,681 46,004 21,181 22,800 -9.4% Total assets 157,244 164,163 138,410 150,323 -1.5% Short and long-term debt 44,907 48,462 48,462 48,462 2.6% Other long-term liabilities 29,568 43,240 10,511 10,511 -29.2% Total liabilities 127,741 122,431 89,692 92,309 -10.3% Net debt/(funds) 14,226 2,457 27,281 25,662 21.7% Shareholders' equity 28,694 40,843 47,767 56,975 25.7% Change in working capital -8,084 -212 -30,829 -4,958 N/A Cash flow from operations 8,105 18,197 -17,652 12,633 15.9% Capital expenditure -4,739 -4,767 -4,962 -5,974 N/A Free cash flow 15,453 11,054 -24,823 2,311 -46.9%

Valuation and leverage metrics Average P/E (reported) (x) N/A 15.6 20.8 14.6 17.0 EV/sales (x) 1.6 1.2 1.6 1.3 1.4 EV/EBITDA (x) 9.8 8.0 13.1 9.7 10.2 Equity FCF yield (%) N/A N/A N/A N/A N/A P/BV (x) 5.0 3.5 3.0 2.5 3.5 Dividend yield (%) 0.6 0.0 0.5 0.7 0.4 Total debt/capital (%) 61.0 54.3 50.4 46.0 52.9

Selected operating metrics Average SG&A/sales (%) 44.6 47.8 46.2 46.2 46.2 R&D/sales (%) 5.0 5.0 5.0 5.0 5.0 R&D growth (%) -19.0 23.0 -11.8 20.4 3.2 SG&A growth (%) 35.5 31.9 -14.6 20.4 18.3

Source: Company data, Barclays Research Note: FY End Dec

Value

Quality

Sentiment

Low High

https://live.barcap.com/go/BC/composite/GER_COMPANY?ticker=RANB.NS�



8 July 2013 11

Dr Reddy’s: Investing for the future (complex generics, biosimilars and prop products)

Competing on technological capability rather than price; return horizons could be prolonged DRL’s management stated that the company has shifted its focus on developing complex products as it plans to compete on the technological capabilities and not price. As per management, while this should result in an increase in the investment and gestation periods per product, the nature and quality of the products should help in a longer revenue horizon resulting in higher overall revenues. DRL specifically highlighted complex generics, proprietary products and biosimilars, which should remain key areas of investment for DRL.

Aiming to fix below-industry domestic growth Management affirmed it concern over the company’s sluggish growth levels in India (DRL’s Q4 FY13 growth was at 8.7% vs 32% for Glenmark and 43% for Lupin) and highlighted the following steps:

• Field force management in India;

• Portfolio augmentation;

• Focus over better doctor engagement; and,

• Internal R&D and OTCs (including in-licensing of molecules).

Trends across the key geographies remain strong • DRL expects to launch 20-25 products in the US with a key focus on differentiation;

• Strong growth levels to be sustained in US while the PSAI business is guided to remain lumpy;

• Emerging markets should continue to witness 20%-plus growth levels;

• While the European market has shrunk, DRL expects the profitability to improve as it has exited the tender based business.

FIGURE 10 R evenue growth to improve in FY15

FIGURE 11 Operating margins to remain under pressure

Source: Company data, Barclays Research estimates Source: Company data, Barclays Research estimates

23 64 49 68 69 75 97 116 130 150

28%

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Our recent reports: 15 Feb: Disappointing quarter, margins a concern; downgrade to EW 15 May: Strong revenue/muted OPM; In-line PAT, 30% above consensus; Stay EW

DRRD IN / REDY.NS

Stock Rating EQUAL WEIGHT



Price (05-Jul-2013) INR 2235.60

Potential Upside/Downside -5%




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8 July 2013 12


Dr. Reddy's Laboratories Limited (REDY.NS) Stock Rating: EQUAL WEIGHT

Income statement (INRmn) 2012A 2013E 2014E 2015E CAGR Price (05-Jul-2013) INR 2,235.60

Price Target INR 2,114.00 Why Equal Weight? Superior US pipeline to peers with visibility over next three years and delivering incremental revenue potential of US$350mn is a positive; however, an increasingly adverse cost structure poses an overhang on the margins and the earnings.

Upside case INR 2,348.80 We see upside if 1) there is greater visibility on market share gains and 2) there is an improvement in the cost structure. We expect re-rating of ~10% (multiple of 20x) to drive stock performance.

Downside case INR 1,761.60 This could materialise if DRL does not realise the full potential of its pipeline, owing to 1) regulatory issues, 2) unforeseen competition or 3) further pressures on the margin. In this case, we believe multiples could de-rate by 15%-20% (we use a multiple of 15x for this case).






Balance sheet and cash flow (INRmn) CAGR Tangible fixed assets 33,246 37,814 42,036 46,925 12.2% Intangible fixed assets 13,529 14,021 12,334 10,647 -7.7% Cash and equivalents 7,379 5,136 8,822 19,983 39.4% Total assets 119,477 142,369 153,203 174,166 13.4% Short and long-term debt 32,210 36,760 34,760 32,760 0.6% Other long-term liabilities 15,618 5,282 5,282 5,282 -30.3% Total liabilities 62,033 69,265 64,168 66,636 2.4% Net debt/(funds) 24,831 31,623 25,938 12,777 -19.9% Shareholders' equity 57,444 73,085 89,274 107,768 23.3% Change in working capital -3,117 -16,372 -7,211 -1,732 N/A Cash flow from operations 21,388 10,977 24,057 33,490 16.1% Capital expenditure -6,857 -8,139 -9,101 -10,469 N/A Free cash flow -2,515 -1,602 8,490 15,958 N/A

Valuation and leverage metrics Average P/E (reported) (x) 26.7 22.7 20.3 17.9 21.9 EV/sales (x) 4.2 3.5 3.1 2.6 3.4 EV/EBITDA (x) 16.6 15.1 13.0 11.2 14.0 Equity FCF yield (%) -0.7 -0.4 2.2 4.2 1.3 P/BV (x) 6.6 5.2 4.3 3.5 4.9 Dividend yield (%) 0.7 0.7 0.7 0.8 0.7 Total debt/capital (%) 35.9 33.5 28.0 23.3 30.2

Selected operating metrics Average SG&A/sales (%) 29.8 28.9 29.0 29.5 29.3 R&D/sales (%) 6.1 6.6 7.2 7.2 6.8 R&D growth (%) 16.8 29.8 22.0 15.0 20.9 SG&A growth (%) -8.5 16.3 12.3 17.0 9.3


Value

Quality

Sentiment

Low High

https://live.barcap.com/go/BC/composite/GER_COMPANY?ticker=REDY.NS�



8 July 2013 13

Pharmaceutical distribution in India

Narrowing divergence between MNC and domestic companies One of the key differences between multi-national companies and domestic companies historically has been the sharp marketing aggressiveness of the Indian companies. However, the efforts of the Medical Council of India to curb the promotional schemes for doctors have led to a gradual convergence of the strategies and result in a more level playing field.

Emergence of alternative distribution channels Despite a significant amount of regulatory overhang around telemedicine and internet based pharmacies, the domestic market has seen a sharp increase in such alternative distribution channels. Additionally, while the logistics costs remain high, we believe an increase in the penetration levels could not only expand the market size but these new formats should also result in higher margins for the stockists and retailers.

Institutional business – high growth segment

Market size and the segments As per the expert, Mr Kannan, with a market size of cRs70bn (c10% of overall IPM), the institutional segment is growing at a higher than industry growth rate of 20-22% though the data are mostly not captured by the data providers (like IMS Health, AIOCD). Of this, 60% is likely to be government institutions and 40% is corporate hospitals. Among the government institutions, the key customers include defense, railways, nuclear and NEPC.

Key features • Hospitals – high volume; discounted prices: The majority of the companies give

different rates to hospitals and trade. As volumes are generally higher, companies pass on the cost of promotional inputs to hospitals resulting in c50-60% discounts.

• High focus on the quality and availability: Institutional segment places a high focus on the quality of the medicines as 1) hospitals are very choosy about the brand they are likely to stock and 2) products need to be available in the market and should have a threshold percentage market share to ensure basic quality criteria.

FIGURE 12 India pharmacy sector – margin structure in pharma supply chain

Note: MRP: Maximum retail price. Source: Industry sources, Barclays Research

Manufacturer

CFA

Stockist

Pharmacy Retail

Consumers

1% - 5% Margin

8% - 10% Margin

10% - 15% Margin

Sell the product to the end consumer at a net rate of 65-70% on MRP

MRP Rs 100

Margin structure Stockists (10% for scheduled and 8% for non scheduled) Retailers (16% for scheduled and 20% for non scheduled) Increasing curbs on the promotional efforts for doctors – convergence of the marketing aggressiveness between MNCs and the domestic companies

Institutional segment – Rs7,000 Crore market size (c10% of the overall Indian pharma market) and growing at 20-22%


8 July 2013 14

Unichem Laboratories (not rated)

Domestic market to be driven by the chronic segment The company’s chronic segment, which constitutes c62% of the domestic market, has been growing by 20-25% for the past two years. As per management, chronic therapies should continue to drive IPM with at least 15% growth over the next few years.

Additionally, management expects competition to be limited as it is much easier to enter into the acute segment. This is because if a company wants to enter at the mass level, then the pricing point plays an important role. As per management, the government is also better controlling the erstwhile spurious activities of new entrants.

US to be the growth driver (of a low base) As per management, the US should continue to be the growth driver for Unichem and should clock at least US$15mn in sales, even without any new approvals. The key strength is the marketing and distribution strategy wherein the company ties up with the top three wholesalers and also large retailers. For each ANDA, tie-ups are done on a non-exclusive basis and the fact that retailers are aware of the pipeline makes it relatively better for them to work with the company, as per management.

Brazil: Remains a difficult market Brazil continues to be a difficult market for Unichem as the cost base has gone up because of setting up of a local plant and a delay in the approvals. Management is expecting at least a couple of approvals to come through this year.

The key challenges in Brazil as per management are the following:

• Political scenarios, language and bureaucracy;

• Increasing protectionism and regulatory changes for instance mandating local QC labs;

• Approval timelines have increased to 32-25 months like the US.

FIGURE 13 Revenue growth levels to slow down, per consensus

FIGURE 14 EBITDA margin expected to improve, per consensus

Source: Bloomberg consensus estimates, Barclays Research Source: Bloomberg consensus estimates, Barclays Research

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Three business segments a) Formulations: 61% is

domestic and the rest is international (40 countries)

b) Contractual business: Started with APIs

c) Proprietary segment: Unichem owns the IP and do filings in US and EU


8 July 2013 15

Wockhardt (not rated)

No witch-hunt by the US FDA; Imperative to scale learning curve on quality Management affirmed that there was no witch-hunt by the US FDA and the company is not witnessing any change perception among its customers. The focus is now to address the questions posed by the FDA and scale the learning curve on quality.

Impact of the alert expected to be short term only

Measures taken: • Injectables: should be restored in about 8 months

• Solid dosages:

− Trying to segregate the complex products from the injectable facility so that it comes out of the alert (since major objections were on Injectables, not Solid dosages)

− 80% of solid dosage products will be moved to another facility in around 8-9 months (in Aurangabad only)

Existing inventory in the US: Sufficient for 3-4 months As per management, the current inventory in the US should be sufficient for the next 3-4 months, and after that, it should be able to supply from an alternate site. Additionally, there is no restriction placed by the US FDA in the sale of those drugs.

Timeframe to resolve the issues: 8-9 months Management stated that they should be able to restore supply of impacted product in 8-9 months and from a business point of view should restore 80-90% of the product portfolio.

Domestic growth expected to trend upwards Post the restructuring in India, management is now confident of a healthy pipeline and expects the domestic growth levels to normalize to industry levels soon. Additionally, the company has launched new products in both the acute and chronic segments and could enter new therapy areas in India.

FIGURE 15 Revenue forecast to grow at c16% for next two years, per consensus

FIGURE 16 EBITDA margins forecast to remain high, per consensus


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Total of 4-5 ANDAs were filed from the Waluj facility All three facilities – Oral Solids / Inject RM / Inject Non RM – are under the alert Impact is expected to be short term only Management expects the growth levels to normalize in CY14/15 after a muted CY13

Management said Wockhardt is present in all major markets and is not actively looking at geographical expansion

Wockhardt has repaid all the CDR debt and most of the debt is now EUR denominated


8 July 2013 16

Jubilant Lifesciences (not rated)

Management focus on debt reduction Management said that the company plans to raise US$200-300mn over the next year, and since there is no major capex planned, cUS$200mn should be used to reduce the parent company’s debt. As per management, debt/EBITDA should reduce to c2.5x by FY15E.

Issues related to the warning letter addressed After a US FDA inspection in February 2012, four 483s were issued followed by a warning letter in February 2013. Management said that all the issues have been addressed and now the FDA just needs to revisit and re-inspect to validate the facility.

Ample growth drivers in the pharmaceutical segment Strong product pipeline: Management reiterated its confidence on the company’s strong product pipeline (especially for the key therapies of CVS, CNS and anti-infectives) and expects c85 generic launches globally by FY16. Additionally, the capacity utilization is expected to increase in APIs, generic dosages and sterile injectables.

Key geographical markets: While the regulated markets of North America, Europe and Japan remain the mainstay of the business, management is planning to expand further in the emerging markets along with increasing penetration in US and Europe.

Global competitive edge due to low cost and vertical integration to sustain Management reaffirmed its confidence in the company’s business model and that vertical integration across the value chain enables competitive advantage resulting in higher margins. About 61% (19 out of 31) of the company’s commercial solid dosage formulations are based on in-house APIs. Management believes the high margins should be sustained.

Continued R&D investments in the Life-Science Ingredients segment The key drivers of growth as per management should be

• Product launches in PPES: Symtet, Pyridine based ingredients for insecticides.

• Geographic expansion in Europe, the US, China and the rest of the world.

• Higher capacity utilization in Vitamins, PPES and LSCs (Ethyl Acetate. Acetic Anhydride).

FIGURE 17 Revenue forecast to grow at c16% in next two years per consensus

FIGURE 18 EBITDA margin forecast to improve in FY15 per consensus


18 25 35 38 34 43 51 60 69

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Diversified business model Top 10 customers constitute c25% of revenue Top 10 suppliers constitute c26% of COGS Top 10 products constitute c52% of the revenue

Currently, there are 65 DMFs and 58 pending ANDAs in the US


8 July 2013 17

ANALYST(S) CERTIFICATION(S)

I, Balaji Prasad, M.D., hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

The POINT® Quantitative Equity Scores (POINT Scores) referenced herein are produced by the firm’s POINT quantitative model and Barclays hereby certifies that (1) the views expressed in this research report accurately reflect the firm's POINT Scores model and (2) no part of the firm's compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

IMPORTANT DISCLOSURES CONTINUED

Barclays Research is a part of the Corporate and Investment Banking division of Barclays Bank PLC and its affiliates (collectively and each individually, "Barclays"). For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to http://publicresearch.barclays.com or call 212-526-1072.

The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by investment banking activities.

Research analysts employed outside the US by affiliates of Barclays Capital Inc. are not registered/qualified as research analysts with FINRA. These analysts may not be associated persons of the member firm and therefore may not be subject to NASD Rule 2711 and incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst’s account.

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The Corporate and Investment Banking division of Barclays produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

Materially Mentioned Stocks (Ticker, Date, Price)

Apollo Hospitals Enterprise (APLH.NS, 05-Jul-2013, INR 959.95), Equal Weight/Positive, D/J/K/L/M

Other Material Conflicts: The Corporate and Investment Banking division of Barclays is providing investment banking services to Apollo Health Street for 100% sale of the company, which is 36.7% owned by Apollo Hospitals Enterprise Limited.

Cadila Healthcare Ltd. (CADI.NS, 05-Jul-2013, INR 782.30), Equal Weight/Positive, C/J

Cipla Ltd. (CIPL.NS, 05-Jul-2013, INR 399.10), Equal Weight/Positive, C/J

Other Material Conflicts: Absa Capital, a division of Absa Bank Limited, is providing investment banking services to Cipla Limited in connection with the acquisition of Medpro by Indian-listed Cipla Limited. The rating, price targets and estimates of Cipla Limited do not incorporate this transaction.

Dr. Reddy's Laboratories Ltd. (REDY.NS, 05-Jul-2013, INR 2235.60), Equal Weight/Positive, C/D/J/L/N

Fortis Healthcare (FOHE.NS, 05-Jul-2013, INR 85.30), Overweight/Positive, C/J

Glenmark Pharmaceuticals Ltd. (GLEN.NS, 05-Jul-2013, INR 584.00), Overweight/Positive, C/J/K/M/N

Lupin Ltd. (LUPN.NS, 05-Jul-2013, INR 834.90), Overweight/Positive, C/J

Ranbaxy Laboratories Ltd. (RANB.NS, 05-Jul-2013, INR 341.80), Underweight/Positive, C/D/J/L

Sun Pharmaceutical Industries (SUN.NS, 05-Jul-2013, INR 1034.70), Overweight/Positive, C/J

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8 July 2013 18


to the research report's issuance.

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Guide to the Barclays Fundamental Equity Research Rating System:

Our coverage analysts use a relative rating system in which they rate stocks as Overweight, Equal Weight or Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry (the "industry coverage universe").

In addition to the stock rating, we provide industry views which rate the outlook for the industry coverage universe as Positive, Neutral or Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.

Stock Rating

Overweight - The stock is expected to outperform the unweighted expected total return of the industry coverage universe over a 12-month investment horizon.

Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the industry coverage universe over a 12-month investment horizon.

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Industry View

Positive - industry coverage universe fundamentals/valuations are improving.

Neutral - industry coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.

Negative - industry coverage universe fundamentals/valuations are deteriorating.

Below is the list of companies that constitute the "industry coverage universe":

India Healthcare & Pharmaceuticals

Apollo Hospitals Enterprise (APLH.NS) Cadila Healthcare Ltd. (CADI.NS) Cipla Ltd. (CIPL.NS)

Dr. Reddy's Laboratories Ltd. (REDY.NS) Fortis Healthcare (FOHE.NS) Glenmark Pharmaceuticals Ltd. (GLEN.NS)

Lupin Ltd. (LUPN.NS) Ranbaxy Laboratories Ltd. (RANB.NS) Sun Pharmaceutical Industries (SUN.NS)

Distribution of Ratings:

Barclays Equity Research has 2376 companies under coverage.


8 July 2013 19


44% have been assigned an Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 52% of companies with this rating are investment banking clients of the Firm.

40% have been assigned an Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 48% of companies with this rating are investment banking clients of the Firm.

13% have been assigned an Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 42% of companies with this rating are investment banking clients of the Firm.

Guide to the Barclays Research Price Target:

Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock will trade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's price target over the same 12-month period.

Guide to the POINT® Quantitative Equity Scores:

The POINT Quantitative Equity Scores (POINT Scores) are based on consensus historical data and are independent of the Barclays fundamental analysts’ views. Each score is composed of a number of standard industry metrics.

A high/low Value score indicates attractive/unattractive valuation. Measures of value include P/E, EV/EBITDA and Free Cash Flow.

A high/low Quality score indicates financial statement strength/weakness. Measures of quality include ROIC and corporate default probability.

A high/low Sentiment score indicates bullish/bearish market sentiment. Measures of sentiment include price momentum and earnings revisions.

These scores are valid as of the date of this report. To view the latest scores, which are updated monthly, click here.

For a more detailed description of the underlying methodology for each score, please click here.

Barclays offices involved in the production of equity research:

London

Barclays Bank PLC (Barclays, London)

New York

Barclays Capital Inc. (BCI, New York)

Tokyo

Barclays Securities Japan Limited (BSJL, Tokyo)

São Paulo

Banco Barclays S.A. (BBSA, São Paulo)

Hong Kong

Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong)

Toronto

Barclays Capital Canada Inc. (BCCI, Toronto)

Johannesburg

Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg)

Mexico City

Barclays Bank Mexico, S.A. (BBMX, Mexico City)

Taiwan

Barclays Capital Securities Taiwan Limited (BCSTW, Taiwan)

Seoul

Barclays Capital Securities Limited (BCSL, Seoul)

Mumbai

Barclays Securities (India) Private Limited (BSIPL, Mumbai)

Singapore

Barclays Bank PLC, Singapore branch (Barclays Bank, Singapore)



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