RESULT UPDATE IPCA LABORATORIES In a sweet spot India Equity Research| Pharmaceuticals IPCA Labs’ Q3FY14 adjusted PAT beat ou r estimate by 16% on better - EDELWEISS 4D RATINGS than-expected gross margin (440bps higher than our estimate) despite Absolute Rating BUY higher overheads. Management has guided for sustaining EBITDA margin Rating Relative to Sector Outperformer at 25% going forward, which we believe is achievable given the Risk Rating Relative to Sector Low impending ramp up in US (Indore facility commercialisation), bounce- Sector Relative to Market Overweight back in India (back to mid-teen growth) and corresponding operating leverage benefits. We are revising our earnings up 4%/9%/10% for FY14E/FY15/FY16E and raising our target price to INR975/share (INR885 MARKET DATA (R: IPCA.BO, B: IPCA IN) CMP : INR 796 earlier). Maintain ‘BUY’; IPCA is our top mid-cap pick. Target Price : INR 975 52-week range (INR) : 803 / 440 Improvement in gross margin drives earnings beat Share in issue (mn) : 126.2 IPCA’s Q3FY14 revenue grew 18% plus YoY on strong all round growth—India (16%), EU M cap (INR bn/USD mn) : 100 / 1,532 Avg. Daily Vol.BSE/NSE(‘000) : 171.3 (66%) and Institutional business (20%). The big surprise came from the 190bps QoQ gross margin expansion primarily on better product mix. We had expected gross margin to decline QoQ given the stable currency, after the sharp INR depreciation had SHARE HOLDING PATTER N (%) aided gross margin in Q2FY14. Accordingly, EBITDA margin expanded to 25.7% (up Current Q2FY14 Q1FY14 314bps YoY). Adjusted PAT (up 35%) beat our estimate by 16% on strong EBITDA Promoters * 45.9 45.9 45.9 growth (up 35%) despite higher effective tax rate (up 310bps YoY). MF's, FI's & BK’s 12.0 12.3 13.5 FII's 25.4 25.2 23.0 US business scale up the next trigger; Indore supplies in March ‘14 Others 16.7 16.6 17.6 * Promoters pledged shares : NIL US is set to get a fillip as Indore SEZ commences supplies from March 2014. This will be (% of share in issue) on account of new launches (17 ANDAs approved, only 8 marketed, 21 pending) and site transfers from Silvassa facility. IPCA expects to add another USD20mn in FY15E PRIC E PERFORMANCE (%) (current base of USD40mn) and is targeting USD200mn revenue from US by FY18 EW Pharma Stock Nifty through its existing and new partnerships (now five partners). Moreover, clinical trials Index for the 505b2 product are going as per plan and positive results could spring a surprise. 1 month 11.0 2.0 0.3 3 months 10.4 3.6 10.5 Outlook and valuations: Multiple levers for growth; reiterate ‘BUY’ 12 months 47.0 3.7 35.0 We are forecasting 21% earnings CAGR over FY14-16 on growth revival in India, sharp ramp up in US, robust growth across other markets coupled with operating leverage and improving product mix benefits (Read our detailed visit note). We are raising our FY14-16E earnings by 4-10% on Q3FY14 earnings beat and higher EBITDA margin guidance, which we believe is achievable. Our target price now moves to INR975/share (16x FY16E). Current valuations at 13x FY16E are attractive and we maintain ‘BUY/SO’ . Financials (Consolidated) (INR mn) Year to March Q3FY14 Q3FY13 % change Q2FY14 % change FY13 FY14E FY15E Anshuman Gupta Net revenue 8,290 7,010 18.2 8,467 (2.1) 28,059 33,812 39,897 +91 22 6623 3399 EBITDA 2,133 1,584 34.7 2,175 (1.9) 6,232 8,348 9,868 [email protected] Adj. net profit 1,380 1,021 35.1 1,420 (2.8) 3,694 5,263 6,338 Perin Ali Adj. diluted EPS (INR) 10.9 8.1 11.3 29.3 41.7 50.2 +91 22 6620 3032 Diluted P/E (x) 27.2 19.1 15.8 [email protected] Core EV/EBITDA (x) 17.0 12.7 10.6 ROAE (%) 27.8 26.6 29.3 January 28, 2014 Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited Pharmaceuticals Table 1: Actual versus estimate (INR mn) Y-o-Y Y-o-Y Deviation Actual Growth Estimates Growth from Year to March Q3FY14 (%) Q3FY14 (%) Actual (%) Comments Net Revenue 8,290 18.2 8,325 18.8 (0.4) Net Revenue (excl other op. inc.) 8,152 17.7 8,203 18.5 (0.6) Raw material costs 2,781 0.7 3,158 14.4 (12.0) Gross profit 5,371 5,045 4.1 6.5 Gross margin(%) 65.9 61.5 Higher product mix and productivity improvement yielded higher margins Employee costs 1,243 26.5 1,244 26.6 (0.0) Other expenses 2,132 26.8 2,019 20.0 5.6 Strog ramp-up in overheads (including R&D) Total operating expenses 3,376 26.7 3,262 46.6 3.5 EBITDA 2,133 34.7 1,905 20.3 12.0 EBITDA margin (%) 25.7 22.9 Higher gross realizations resulted in strong operating performance EBITDA margin (ex. op inc) (%) 24.5 21.7 Net finance expense (income) 54 (26.5) 60 (18.9) (9.3) Depreciation 256 18.5 285 32.1 (10.2) Other income 54 36.5 30 (24.4) 80.7 PBT 1,877 40.8 1,590 19.2 18.1 Income tax expense 502 86.6 405 50.7 23.8 PAT 1,375 29.2 1,184 11.2 16.1 Adj. PAT 1,380 35.1 1,184 16.0 16.5 Adjusted diluted EPS (INR) 10.9 9.4 16.0 16.5 Source: Company, Edelweiss research Table 2: Revenue mix by segment (INR mn) Q3FY14 Q3FY13 % chg Q2FY14 % chg Comments Formulations 6,281 5,302 18.5 6,019 4.4 Domestic 2,463 2,127 15.8 2,628 (6.3) Growth driven by Pain (26%YoY), CVS (12%YoY), Derma, CNS and cough/cold divisions; anti-mlaria declined 2%YoY Export 3,818 3,175 20.3 3,392 12.6 Institutional anti-malaria 1,360 1,134 19.9 1,299 4.7 Ex-anti-malaria exports 2,459 2,041 20.5 2,093 17.5 - Branded generic 1,001 876 14.3 756 32.5 Decline in CIS markets impacted growth - Generic 1,455 1,164 25.0 1,337 8.8 EU growth of 66%YoY with supplies from Indore SEZ API 1,870 1,622 15.3 1,556 20.2 Domestic 419 373 12.3 304 37.8 International 1,451 1,249 16.2 1,252 15.9 Hormone facility started API supplies to US Net sales (excl Other Oper Inc) 8,152 6,924 17.7 7,575 7.6 Source: Company, Edelweiss research 2 Edelweiss Securities Limited Ipca Laboratories Chart 1: Robust growth from India and generics business Growth has been strong across 10,161 37.0 geographies, notably India (16%), EU (66%), institutional 9,027 31.0 anti-malaria tender (20%) and branded formulations (14%) 7,892 25.0 API grew 15% led by exports 6,758 19.0 (INR mn) (INR Growth (%) Growth 5,623 13.0 4,489 7.0 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Net Revenue Revenue growth Source: Company, Edelweiss research Strong margin trajectory led by Chart 2: IPCA sustains strong margin performance 2,611 31.0 gross margin improvement (580bps YoY) from improved 2,196 26.4 mix, higher productivity and better realisations 1,780 21.8 (%) 1,365 17.2 Management has guided 25% mn) (INR margin for FY14 and expects 949 12.6 the same to sustain despite increase in fixed costs including 534 8.0 R&D (5% guided for FY15 from 4% in FY14) Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 EBITDA Adj. PAT EBITDA margin PAT margin Source: Company, Edelweiss research 3 Edelweiss Securities Limited Pharmaceuticals Chart 3: Domestic sales recovery reflected in secondary growth for Oct-Dec; Company expects continued momentum Primary growth 32.0 Secondary growth 3,315 25.0 25.2 2,888 20.8 2,461 16.6 18.4 (%) 2,035 12.4 11.6 (INR mn) (INR Growth (%) Growth 1,608 8.2 4.8 1,181 4.0 (2.0) 13 13 13 13 13 13 13 13 13 13 13 13 - - - - - - - - - - - - Jul Jan Jun Oct Apr Feb Sep Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Dec Aug Nov Mar May India YoY growth Company growth Industry growth Source: AIOCD, Company, Edelweiss research Higher sales from spill over of Chart 4: Institutional anti-malaria sales impacted from postponement of consignment shipment worth INR400mn 1,632 53.0 from Q2FY14 1,440 37.0 Management expects long-term orders to remain strong while 1,248 21.0 new product approvals including dispersible tablets and 1,055 5.0 (%) Growth injectibles would add to the mn) (INR base 863 (11.0) IPCA reinstates its guidance of 671 (27.0) achieving INR8bn sales in Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 institutional business by FY18, while it would attain INR4.5bn Institutional malaria YoY growth by end of current fiscal Source: Company, Edelweiss research 4 Edelweiss Securities Limited Ipca Laboratories Chart 5: US growth accelerated due to higher currency realisations Indore SEZ facility is expected 728 32.0 to commence supplies March 2014 with commercialisation of 657 27.0 3 products . IPCA expects to add INR1.25bn in FY15E and expects to ramp-up sales to 586 22.0 USD90mn by FY16E mn) (INR 516 17.0 (%) Growth Incrementally, additional 8-9 approvals per annum are 445 12.0 expected over FY15-16 to aid higher growth 374 7.0 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Total ANDA filings are 37 and US YoY growth 17 are approved (of these 8 have been commercialised) Chart 6: EU scale-up with supplies commencing from Indore SEZ 1,041 80.0 901 53.4 761 26.8 622 0.2 (INR mn) (INR Growth (%) Growth 482 (26.4) 342 (53.0) Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Europe YoY growth Chart 7: There has been high base effect of sales within the CIS region Branded generics grew 14%; CIS 1,202 84.0 region was flat; however, sales have normalised at current 1,034 68.4 base 866 52.8 (INR mn) (INR 699 37.2 Growth (%) Growth Going forward, management 531 21.6 expects continued 25-30% growth in branded sales 363 6.0 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Branded generics YoY growth Source: Company, Edelweiss research 5 Edelweiss Securities Limited Pharmaceuticals Financial snapshot (INR mn) Year to March Q3FY14 Q3FY13 % change Q2FY14 % change YTD14 FY14E FY15E Net revenues 8,290 7,010 18.2 8,467 (2.1) 24,812 33,812 39,897