Ipca Laboratories Ltd. Company Overview Set up in 1949, Ipca Manufactures Formulations, Active Pharmaceutical Ingredients (Apis), and Drug Intermediates

Ipca Laboratories Ltd. Company Overview Set up in 1949, Ipca manufactures formulations, active pharmaceutical ingredients (APIs), and drug intermediates.

Originally known for its dominance in the anti-malarial business, company has come a long way and now offers a gamut of other therapeutic products.

Product range includes pain management, cardiovascular medicines, antimalarial, antiemetic, antibiotic, analgesic, and antidiabetic; and formulations for cough and cold therapy, skin problems, and problems with the central nervous system.

The company is also a leading supplier of APIs such as atenolol (antihypertensive), chloroquine and artemisinin derivatives (antimalarial), furosemide (diuretic), and pyrantel salts (anthelmintic).

Primary business activity

Products/ Services

As of FY20, overall formulations to API ratio is 73:27. Further break-up of formulations1) domestic formulations- 44%, 2) export formulations-28% of total revenues. Further break-up of APIs- 1) domestic APIs- 6%, 2) export APIs 21% of total revenues.

Export Formulations business Export formulations are further divided into- 1) generic formulations- 50% of exports formulations 2) and 3) institutional business- 16% of exports formulations. The US business is being accounted for in the generic exports formulation category.

Therapeutic contributions to export formulations business are as follows:

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Domestic Formulations business The Company’s formulations business in India now comprises of 15 marketing divisions focusing on key therapeutic segments. Company is now the 19th largest in the domestic formulations market as per IMS Health - MAT March, 2020.

The company owns a field force of 4000 MRs covering therapy focused marketing divisions.

Top 10 drugs:

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API business In FY20, APIs contributed to 27% of sales. Existing Capacity & Expansion Plans New APIs manufacturing unit at Dewas (M.P.)

The Company is in the process of setting up a new APIs manufacturing unit at Dewas (M.P.) with an initial capital outlay of about Rs. 250 crores. The land for this project has been acquired and the Company is currently in process of obtaining the environmental approvals.

Ipca is also working on backward integration as well as debottlenecking at Ratlam. This would enable sales growth as well as profitability. Additionally, Ipca is working on the continuous production (v/s traditional batch production) process for some intermediates. This, if successful, would enhance process efficiency and profitability, and reduce dependency on China in the API segment. Locations 1. Sejavata, Ratlam, Madhya Pradesh. 2. Pologround, Indore, Madhya Pradesh. 3. SEZ Indore, Pithampur, Madhya Pradesh. 4. Sector III, Industrial Area, Pithampur, Madhya Pradesh. 5. Gandhidham, Gujarat. 6. Nandesari, Gujarat. 7. Ankleshwar, Gujarat. 8. Village Ranu, Tehsil Padra, District Vadodara, Gujarat. 9. Athal, Silvassa (D & NH). 10. Dandudyog Industrial Estate, Silvassa (D&NH). 11. Aurangabad, Maharashtra (Unit I & Unit II). 12. Mahad, Maharashtra. 13. Tarapur, District Palghar, Maharashtra. 14. Dehradun, Uttarakhand. 15. Gom Block, Bharikhola, South Sikkim (Unit I & Unit II

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Geographical markets As of FY20, domestic sales constitute 52% of the revenue. Rest is exports.

EU is the leading exports destination, followed by Africa and US.

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Industry Overview

Global medicine spending is projected to increase by 2–5% annually and exceed $1.1 trillion in 2024 (Source: IQVIA, Outlook to 2024, March 2020) with pharmerging markets (including India) leading the way.

India’s pharma spends are estimated to reach $31-35 Billion by 2024, growing at a CAGR of 8-11% between 2020 and 2024.

India is likely to become one of the top 10 countries in terms of medicine spending over the next few years. Favourable government policies to ensure access to quality, affordable medicines to the masses, along with rising instances of chronic therapies are the key growth drivers of domestic pharma sector.

Indian healthcare sector, one of the fastest growing sectors, is expected to cross US$372 billion by 2022.

The pharmaceutical sector in India, was valued at US$33 billion in 2017 and is expected to grow at a CAGR of 22.4% in the near future.

The generics drug market accounts for around 70% of the India pharmaceutical industry and it is expected to reach US $27.9 billion by 2020. India’s generic drugs account for 20% of global exports in terms of volume, making it the largest provider of generic medicines globally.

India is also the largest exporter of formulations in terms of volume, with 14% market share and 12th in terms of export value.

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Geographical segments (exports vs. domestic) India’s pharmaceutical export stood at US$16.28 billion in FY20. Indian pharmaceutical industry supplies over 50% of global demand for various vaccines, 40% of generic demand in the US and 25% of all medicine in UK1.

India’s domestic pharmaceutical market turnover reached Rs 1.4 lakh crore (US$20.03 billion) in 2019, growing 9.8% year-on-year from Rs 129,015 crore (US$18.12billion) in 2018.

Growth drivers

 Medicine spending in India is projected to grow 9-12% over the next five years, leading India to become one of the top 10 countries in terms of medicine spending.  About 120 drugs are expected to go off-patent over the next 10 years; with expected world- wide revenue between US $80 to 250 billion.  India accounts for 22% of overall USFDA approved plants  India’s OTC drugs market is estimated to have grown at a CAGR of 16.3% to US $6.6 billion over 2008–16 and is further expected to grow on the account of increased penetration of chemists, especially in rural regions. The India OTC market was accounted at US $4.61 billion in 2018 and is expected to reach US $10.22 billion by 2024.  Medical devices industry in India has been growing 15.2% annually and was valued at US$5.2 billion in 2018 and is expected to reach US $50 billion by 2025.  Hospitals’ market size is expected to increase by US $200 billion by 2024.  India’s cost of production is approximately 33% lower than that of the US.

Government policies GoI has announced a number of favourable policies to promote healthcare sector in general and pharmaceutical industry in particular:

 Pharma Vision 2020’ announced by GoI is aimed at making India a global leader in end-to- end drug manufacturing.  Under Budget 2020–21, allocation to the Ministry of Health and Family Welfare is Rs 65,012crore (US$9.30billion)  100% FDI is allowed under automatic route for green-field pharma. Also, 100% FDI is allowed for brownfield pharma, wherein, 74% is allowed under the automatic route and thereafter through government approval route  Additionally, 100% FDI allowed in medical device industry. The investment will be routed through automatic route

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Categorisation of Indian Pharmaceutical players Pharmaceutical companies in India can be grouped into the following based on markets they service and products / services offering:

 India specific branded generic players: MNCs operating in the domestic branded generics space. Expected growth momentum of around 10% without much sweat and BS pressure. Characterised by lower regulatory risks typically associated with exporters with focus on regulated markets and doctor prescription stickiness. Abbott India, Sanofi and Pfizer form top of the pack.  Blended model with higher India branded contribution: For these players, India remains the main growth engine and other geographies as auxiliary engines. Key players are Ipca Labs, Ajanta Pharma, Torrent and Cipla.  Blended model with higher US generics contribution: For these players, US generics market remains the focus. Plagued currently with regulatory risks, higher competition and weaker pricing power  API and CRAMS players: Typically B2B players with focus on API and CRAMS manufacturing. Leading players in this segment are characterized by better regulatory track record, client validation and long term supply agreement with marquee customers and frontloading of capex with specific order book. Examples are Divi’s Labs, Syngene and Hikal.  Biotech: India’s biotechnology industry comprising bio-pharmaceuticals, bio-services, bio- agriculture, bio-industry and bioinformatics is expected grow at an average growth rate of around 30 per cent a year and reach US$ 100 billion by 2025. (Examples, Biocon, etc)

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Competitors

Alembic Ajanta Dr Reddys Granules Indoco J B Chem & Aarti Drugs Ipca Labs Pharma Pharma Labs India Remedies Pharm

Mcap 18176.11 4065.97 12945.65 66753.99 7272.98 1868.81 5571.65 27485.68 PER 12.15 17.24 25.50 25.60 10.89 -643.17 15.02 29.02 PSR 3.95 2.80 5.00 3.81 2.80 1.93 3.39 5.95 PBR 5.65 7.84 4.98 4.25 3.94 2.83 3.76 7.60 Dividend Yield 1.04% 0.06% 0.88% 0.62% 0.35% 0.15% 0.72% 0.23% 1Y Sales Growth Rate 17.06% 27.51% 25.91% 13.39% 14.02% 14.27% 16.67% 23.32% 3Y Sales Growth Rate 14.04% 10.58% 9.28% 7.26% 22.59% -1.22% 10.73% 13.53% 5Y Sales Growth Rate 17.50% 8.40% 11.92% 3.12% 15.00% 5.79% 9.97% 7.99% 10Y Sales Growth Rate 16.10% 13.64% 20.10% 9.99% 20.79% 9.28% 10.38% 1Y NP Growth Rate 41.83% 18.87% 20.86% 3.90% 41.87% -107.05% 39.85% 36.30% 3Y NP Growth Rate 27.15% 9.59% -2.64% 16.18% 26.80% -132.83% 5.98% 46.07% 5Y NP Growth Rate 23.98% 7.17% 8.58% -2.81% 29.83% -154.93% 25.76% 18.99% 9Y NP Growth Rate 28.73% 14.35% 28.00% 8.17% 36.12% 5.57% 9.73% 1Y OPM 27.41% 17.71% 26.41% 14.08% 21.55% 21.27% 26.68% 3Y OPM 23.46% 15.39% 28.19% 16.95% 18.11% 11.95% 17.18% 17.64% 5Y OPM 24.30% 15.65% 30.36% 18.26% 18.90% 14.26% 16.91% 15.82% 10Y OPM 22.08% 15.08% 29.47% 20.41% 17.31% 14.72% 16.46% 17.73% 1Y NPM 18.00% 6.00% 18.07% 11.57% 12.91% -0.30% 11.77% 13.13% RoE 25.74% 16.83% 18.00% 12.90% 18.19% -0.44% 13.07% 16.77% RoA 13.84% 6.32% 14.20% 8.72% 10.18% -0.23% 10.80% 11.53% RoCE 23.30% 17.39% 27.44% 11.08% 18.19% 1.17% 19.56% 19.70% D/E 0.54 0.91 0.02 0.14 0.48 0.45 0.02 0.14 Interest Cover 44.95 4.94 57.38 25.20 19.44 3.74 72.71 45.63 Receivable Days 68.53 109.66 109.35 104.76 103.26 73.81 68.70 70.74 Inventory Days 94.11 57.15 69.91 73.07 61.58 69.14 54.15 104.55 WC Cycle 122.94 88.38 135.56 142.66 171.12 114.52 91.82 127.59

Tax Rate 19.92% 31.63% 29.56% -7.44% 25.65% 68.85% 32.41% 18.32% 5Y (OCF - PAT) -99.29 235.69 -197.91 4719 85.53 284.67 5.37 818.74 5Y FCF -451.46 197.42 569.1 5244.5 -190.68 -29.1 265.4 1365.77 10Y FCF -118.18 148.02 976.98 8307.2 -375.02 -255.11 1141.28 1388.67 Equity Dilution Rate 14.67% 8.09% 4.38% -0.20% 2.67% -0.55% 0.06% (Cash + 1.64% 1.72% 8.64% 12.41% 9.20% 2.88% 27.54% 9.33% Investments)/TA OPM/TA 20.39% 14.69% 20.75% 10.67% 15.94% 6.11% 17.05% 17.16%

 Most of the Pharmaceutical companies, particularly those into formulations, are characterised by high operating margins, resulting in higher PSR and lower PER stocks.  Alembic & Granules have the most consistent growth rates, growing at over 20% consistently.  Working capital cycle is stretched for most of the companies, including GIL, primarily due to extended inventory days. This is sometimes due to stock raw materials, in fact, according to

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Alembic Annual Report, company maintains surplus raw materials by design, to avert supply side disruptions.  Free cash flow is negative for Alembic & Granules due to investments on capacity expansion to sustain growth.  J B Chemicals is one of the most cash conservative business, with around 27.5% of company’s assets being held in cash & investments – this has resulted in relatively slower growth compared to Granules or Alembic, but, a stronger balance sheet.  Ipca also has been conservative and prudent with capital allocation & management. Ipca has strong cash generation, decent profitability and virtually no dilution – despite its relatively larger size compared to the rest of the pack.

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Shareholding Promoter holding & recent changes As of June 2020, Promoter own 46.07%, unchanged for the past 10 quarters. Foreign Institutions hold 12.40%, domestic - 28.65%, and government – 0.28%. Remaining 12.59% is held by public.

Promoters stake 46.14 46.13 46.13 46.13 46.12 46.11 46.1 46.09 46.08 46.07 46.07 46.07 46.07 46.07 46.07 46.07 46.07 46.07 46.07 46.07 46.06 46.05 46.04 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 Mar-20 Jun-20 Sep-20

Ipca was to consider issuing 5L shares to promoters via conversion of warrants in September 2020. IPCA Laboratories Ltd board to consider warrants conversion on Sep 2, 2020 - EquityBulls.com

Also, Couple of promoter entities reduced stake marginally in December 2020 quarter.

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Management Analysis Remuneration WD/MD salary is around 22 crores against a ceiling of 82 crores. CEO/MD salary is 10 crores, which is very reasonable for a company of this size.

Management Integrity In 2015, USFDA banned imports (also called import alert) from Ratlam plant, in MP

Ipca Labs hit by FDA ban on MP plant for standard violations - Business News , Firstpost

In 2016, Ipca received warning letters (Form 483 observations) from USFDA for 3 facilities located at Ratlam, SEZ Indore and Piparia.

Ipca Labs gets warning letter from USFDA for 3 plants (indiatimes.com)

In 2019, USFDA issued 3 observations (FDA Form 483) for “a cascade of failures” at its Silvassa plant.

Ipca Labs plant blasted by FDA for a 'cascade of failure' | FiercePharma

Employee feedback Employee feedback about the company is quite positive (more positive than the scores indicate).

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Platform Score No. of reviews Indeed.co.in 3.9 250 Ambitionbox.com 4.1 1176 Glassdoor.co.in 3.7 123 Jobbuzz.timesjobs.com 3.3 236

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Financials 10Y historical financials

Growth rates

60.00 120% 100% 50.00 80% 60% 40.00 40% 30.00 20% 0% 20.00 -20% -40% 10.00 -60% 0.00 -80% Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20

EPS Growth R

Q Y Growth 10Y 5Y 3Y 1Y 5Q 4Q 3Q 2Q 1Q Growth Sales 10.4% 8.0% 13.5% 23.3% Sales 26.87% 20.5% 22.1% 42.3% 6.0%

EBITDA 8.8% 10.8% 26.2% 30.1% NP 62.87% 24.1% -12.7% 244.2% 38.3%

NP 9.7% 19.0% 46.1% 36.3%

Sales growth over the years has been in the 8-13% range. Bottom-line growth had declined in FY15 and FY16, due company was hit by UDFDA bans and warnings, before picking up again.

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Cash Flow

Very healthy cash generation. OCF consistently higher than PAT, cumulative FCF positive for both past 5 and 10 years. Receivable days around 2 – 2.5 months.

10Y CF Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20

OCF 214.20 353.84 388.77 522.29 468.22 708.65 281.91 341.13 501.03 564.27

Capex 311.75 281.54 388.22 728.71 238.53 107.94 125.78 163.17 395.80

FCF 42.09 107.23 134.07 -260.49 470.12 173.97 215.35 337.86 168.47

Profitability FY15 and FY16 were difficult years for the company when sales declined due to USFDA actions, consequently margins were also hit. Since then, uptrend in profitability has resumed.

However, to be noted that margins as of FY20 is similar or less than that of 10 years back.

10 Y PNL Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20

OPM 22.19% 19.70% 20.02% 22.60% 17.18% 10.19% 14.23% 13.94% 18.51% 19.53%

NPM 13.83% 11.75% 11.50% 14.58% 8.09% 3.25% 6.16% 7.35% 11.88% 13.13%

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Leverage & Liquidity, debt outlook Company is virtually debt free, with interest cover around 45 and no virtually no dilution of equity base of any consequence.

Cost analysis

50.00%

45.00%

40.00% Inventory/Sales 35.00% Raw material/ Sales 30.00% Fuel/ Sales 25.00% Employee /Sales 20.00% Other Expense/ Sales 15.00% Selling & Admin 10.00% Change in Inventory 5.00% Other Mfg. Expense

0.00% Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20 -5.00%

Raw material costs started inching up in the past two years after witnessing declining trend in past.

Tax rates & benefits if any 10 year average tax rate is 22.65%, while 3 year average rate is 18.33%.

Cash + Investments Cash plus investments form 9.3% of the assets.

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Credit rating Current ratings Credit ratings has remained steady. CRISIL ratings as they stand on August 2020 is summarized below.

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Corporate structure Subsidiaries, Associates & JVs 15 Subsidiaries, associates and JVs are as follows:

Contribution of subsidiaries, JVs & associates to consolidated financials Subsidiary, associate do not have meaningful contribution to consolidated financials.

Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20

Sale 18.80 29.73 35.12 46.77 56.40 63.11 54.19 64.76 139.69 281.03

EBITDA -1.51 0.66 2.17 5.69 9.08 16.24 14.17 9.03 -2.56 -15.84

PAT 7.82 -2.94 -7.45 1.54 -1.77 0.14 6.54 6.42 -10.17 -45.68

Assets -1 -3 -12 -6 -12 -13 -8 8 91 73

RoA -657.1% 110.1% 61.8% -23.9% 15.2% -1.1% -77.0% 84.9% -11.2% -62.7%

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Valuation, earnings estimates Relative valuations Stock is currently trading at par with historical PE levels based on 10 year historical average.

Valuation PSR PER PBV PCF PDY

Current 5.30 27.57 7.60 48.71 0.23%

Historical (5Y average) 2.97 42.17 3.71 23.94 0.19%

Like most stocks in this sector, Ipca is also getting e-rated by the market. Investors may want to use dips/corrections to increase holdings.

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Risk Analysis

Working capital-intensive operations Gross current assets were 205 days as on March 31, 2020, on account of large inventory and export receivables. The company operates in multiple geographies and has a wide product portfolio; hence, it is required to maintain substantial inventory to ensure adequate supply. Given a continuously expanding product portfolio, operations are expected to remain working capital intensive over the medium term.

Exposure to intense competition Around 70% of the revenue is derived from sales of drugs in the CVS, antidiabetic, nonsteroidal anti- inflammatory drugs, and antimalarial segments, which are intensely competitive. However, this is partially offset by Ipca's leadership position in key brands such as Zerodol, Hydroxychloroquine Sulfate, and Folitrax.

Exposure to intensifying regulatory risks in the global markets

The company is exposed to regulatory changes in the global markets, as reflected in increasing scrutiny and inspections by authorities, including the US Food and Drug Administration (USFDA), European Medicines Agency, etc.

As of end FY20, Ipca USFDA import alerts for three of Ipca’s plants (Ratlam, Indore SEZ and Silvassa)

Exposure to DPCO & other domestic regulatory risks

In the domestic market, the regulatory impact of drug price control order (DPCO) and ban on some fixed dose combinations can adversely affect revenue and profitability.

Other headwinds Of late, the company has been struggling on three fronts – 1) USFDA import alerts for three of Ipca’s plants (Ratlam, Indore SEZ and Silvassa), 2) roadblocks in the anti-malarial institutional business due to quality issues, and 3) currency issues in some of the branded exports markets.

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Historical price chart

1 Year chart Stock has generated around 92% returns to investors in the past one year.

Conclusion

Ipca has been growing consistently at a steady pace over the past decade. This growth faced serious headwinds in 2015-16 due to a series of regulatory issues with UDFDA. Although, these issues haven’t completely gone-away, company has made adjustments and returned to growth.

It is expected that IPCA will continue to exhibit strong growth momentum in the medium term on the back of: a) superior performance in the domestic formulations segment, b) expansion of APIs capacity, c) increased backward integration to drive efficiency and d) product launches under its own label in the UK.

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