Ambit Healthcare Thematic 16Sept14

8/10/2019 Ambit Healthcare Thematic 16Sept14

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September 2014

HEALTHCARE

Aditya [email protected]: +91 22 3043 3272

Analysts:

Mid-size pharma - DNA for growthThematic:

Paresh [email protected]: +91 22 3043 3212

Drivers ofgrowth

Newer

avenuesfor growth

Associatedrisk to

growth

ProductselectionSales

execution

Basebusinessgrowth

Therapeuticcoverage

Geographicalcoverage

Sales forceproductivity

Regulatoryrisk

Event specificrisk


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Healthcare

September 16, 2014 Ambit CapitalPvt. Ltd. Page 2

ONTENTS

SECTOR

Healthcare: Mid-sized pharma: DNA for growth.. 3

Mid-sized pharma: Apples or Oranges 4

Introduction to Indian pharmaceuticals...8

Deep dive into IPMs evolution; regulation says innovate! .10

Challenges ahead for mid-sized pharma. 14

Analysing sustainability: Business DNA. 15

Valuations not in sync with DNA.28

Suggest switching from Aurobindo (SELL) to Cadila (BUY) 31

Case studies 33

COMPANIES

Cadila Healthcare (BUY): Multiple levers for growth37

- Snapshot of company financials 38

- Cadila Diversified revenue streams.. 39

- Gaining lost ground. 40

- Mapping competitive advantage The 5 Rs 43

- Cadila has multiple levers for growth.. 48

- Valuation discount to large-caps to narrow 56

- Accounting analysis No concerns.. 61

Aurobindo Pharma (SELL): Structural issues galore. 67

- Snapshot of company financials 68- Aurobindo Opportunistic and fragile.69

- Snowballing of a most humble beginning.. 70

- Low rank in our competitive framework the 5 Rs. 71

- US formulations the only growth driver but a no moated business 77

- Base business EBITDA margins and RoCE to improve till. 85

FY17E but decline thereafter

- Valuation Deserves a deep discount to large-caps 88

- Accounting analysis some RED flags. 94


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Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capitalmay have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Our coverage summary

Company RatingCMP

( )Mcap

(US$mn)P/E

(FY15E)P/E

(FY16E)TP ()

Upside /Downside

Implied P/E(FY15E)

Implied P/E(FY16E)

EPS CAGR(FY08-14)

EPS CAGR(FY15E-17E)

RoCE (FY14)

un Pharma BUY 806 27,495 32 25 730 -9% 28.5 24.8 9% 21% 38%

upin Ltd BUY 1,359 10,042 25 22 1,387 2% 25.6 22.7 33% 17% 26%

Dr. Reddy's BUY 2,959 8,296 22 20 3,149 6% 23.8 20.8 22% 19% 16%

Cadila Health BUY 1,273 4,292 26 19 1,510 19% 31.1 22.2 11% 31% 17%

pca BUY 820 1,703 20 16 949 16% 22.9 18.2 23% 21% 31%

Aurobindo SELL 896 4,302 17 13 828 -8% 14.2 11.3 29% 31% 24%

Source: Company, Ambit Capital research

Mid-sized pharma - DNA for growthMid-sized pharma companies have been able to establish themselves indomestic formulations. Whilst the growth in India would continue, thesecompanies are considering exports to broaden their growth horizon. Astraction in the US market is unlikely in the absence of a compellingproposition, we favour mid-sized companies with a commensurate EMfocus and a track record of creating a strong branded business. Ourbusiness DNA framework serves as a valid proxy for probable success inEMs. Ajanta, IPCA, Torrent and Glenmark are best placed on ourframework. We initiate coverage on Cadila (BUY) and prefer it overAurobindo (SELL), due to Cadilas: (a) better score on our competitive 5R framework; (b) significantly stronger presence in branded markets likeIndia; and (c) higher investments in innovative pursuits like biosimilarsand NCEs.

Mid-sized pharma names have established domestic market presenceThe domestic market share for the top-10 Indian pharma companies in FY08-14has increased 966bps to 38.1% and that for the next 30 companies hasincreased by 277bps to 44.5%. Whilst stalwarts like Sun and Lupin have recordeda CAGR of >20%, mid-sized companies like IPCA, Glenmark, Torrent, Indocoand Ajanta have beaten the Indian pharma market (IPM) consistently. However,the quality of growth across companies varies, with growth being driven by all or

some of the levers at the companies disposal.

Mapping the sustainability of growth in India

We map the strength of the domestic franchise by creating a Business DNAframework. We analyse: (a) the current Drivers for growth that would help

sustain the growth momentum (product selection, sales execution and brandequity); (b) Newer avenues for growth (therapeutic coverage, geographicalcoverage and sales force productivity); and (c) Associated risks (structural andevent-specific risks).

DNA of the domestic franchise is a good proxy for EM export prospects

Most of the mid-sized pharma companies have started tapping exports tobroaden their growth horizon. However, with consolidation of the buy and supplyside in regulated markets like the US, we believe mid-sized companies may facechallenges unless they have compelling propositions. Hence, mid-sizedcompanies with a commensurate EM focus are likely to perform better.Ajanta,IPCA, Torrent and Glenmarkare best placed on our framework.

Initiate coverage on Cadila (BUY) and prefer it over Aurobindo (SELL)

Whilst both Cadila and Aurobindo trade at similar market-caps and are set tobenefit from a large ANDA pipeline in the US, we prefer Cadila over Aurobindo,due to Cadilas: (a) better score on our competitive 5 R framework; (b)significantly stronger presence in branded markets like India; (c) higherinvestments in innovative pursuits. Our DCF fair multiple of 19.0x one-yearforward P/E for Cadila vs 10.0x for Aurobindo reflects terminal RoCEs of 17%

and 12% respectively.

THEMATIC September 16, 2014

HealthcarePOSITIVE

Key Recommendations

Lupin BUY

TargetPrice: `1,387 Upside2%

IPCA BUY

Target Price:`949 Upside: 16%

Cadila BUY

Target Price: `1,510 Upside: 19%

Aurobindo SELL

Target Price: `828 Downside: 8%

We prefer Cadila over Aurobindodespite higher valuations due tohigher ranking on 5R and RoCE

Lupin

SunPharma

IPCA

Cadila

Dr.Reddy's Glenmark

Cipla

Aurobindo

5

7

9

11

13

15

17

19

21

10 20 30 40EV/EBITDA(FY16E)

RoCE (FY14)

Analyst Details

Aditya Khemka

+91-22-3043 3272

[email protected]

Paresh Dave

+91-22-3043 3212

[email protected]


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Healthcare

16 September 2014 Ambit CapitalPvt. Ltd. Page 4

Mid-sized pharma: Apples orOrangesMid-sized pharma companies have been able to establish themselves indomestic formulations over the years using various means of marketpenetration. Whilst some companies have resorted to being present acrossthe market, others have been able to grow by gaining more market share ina few segments. Whilst the growth in the Indian pharma market would

continue, the mid-sized pharma companies are looking towards exports tobroaden their growth horizon. As traction in the US market is unlikely in theabsence of a compelling proposition, we favour mid-sized companies with acommensurate emerging market (EM) focus and a track record of creating astrong branded business. Our business DNA framework serves as a validproxy for probable success in EMs and sustainability of profits from thedomestic business.

Mid-sized pharma companies have established themselves in India

The market share for the top-10 pharma companies in India has increased 966bps to38.1% and that for the next 30 companies has increased by 277bps to 44.5% overFY08-14. Whilst stalwarts like Sun Pharma and Lupin have expanded at a CAGR of

more than 20%, mid-sized companies like IPCA, Glenmark, Torrent Pharma, Indocoand Ajanta have beaten the broader market consistently. However, the quality ofgrowth across companies varies. We strive to distinguish the companies that haveexhibited a superior quality of growth (rather than the quantum) as compared to theirpeers.

Exhibit 1:

Sales CAGR over FY08-14 reflects strong growth by mid-sized pharmacompanies

Source: AIOCD data, Ambit Capital research

Current market wisdom seems to suggest buying companies

headed/expected to ramp up towards US/regulated marketsThe recent ramp up in valuations of many Indian mid-caps seems to suggestpremium valuations for companies with growth prospects in the US market. Stockssuch as Indoco Remedies, Cadila, and Aurobindo have re-rated due to their visiblegrowth prospects in the US market.

4% 5% 5%6% 6%

7% 8%10% 11% 13%

14% 15%

19%

24% 24%

0%

5%

10%15%

20%

25%

30%

Ranbaxy

FDC

Strides

Wockhardt

Claris

Unichem

Indoco

Cadila

Torrent

Alembic

Natco

Glenmark

IPCA

Ajanta

Biocon

We favour companies with an EMfocus and track record of creating

strong branded businesses

The quality of domestic growthacross companies varies

Companies with growth prospectsin the US have premium valuations


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Healthcare


Exhibit 2:

Indoco plans to foray into the US market, whilst Aurobindo is likely to rampup its US operations (stock price indexed to 100 and adjusted for dividends)

Source: Bloomberg, Ambit Capital research; Note: We have adjusted Strides performance for the specialdividend of Rs500/share paid in December 2013

Regulated markets generics growth sustainability cannot be taken forgranted

The US and other regulated markets are low-gestation markets and we agree thatthese markets present an opportunity for these mid-sized companies to grow;however, we would like to remind investors that the sustainability of profits fromselling generics in these markets cannot be taken for granted. We illustrate our pointby taking the example of generic Protonix sold by Sun Pharma (Brand Pantocid) inIndia and the US.

Exhibit 3:

Brand Pantocid continues to provide a steadyrevenue stream for Sun Pharma in India


Exhibit 4:

After the initial revenue flows from genericProtonix, Sun withdrew from the US market

Source: Walter-Kluwer data, Ambit Capital research

Larger companies like Sun Pharma, Dr. Reddys and Lupin have exhibited thecapability of sustaining and growing profits in regulated markets consistently. Thesustained growth momentum has been a result of investments in R&D (scaling up thevalue chain), excellence in execution (gaining market share and logistics excellence)and scale (large basket of product offering) amongst other things.

However, mid-sized pharma companies are unlikely to repeat the performance of thelarger pharma companies. Barring IPCA, Cadila and Aurobindo, we believe othermid-sized firms are yet to fully establish themselves in the US and other regulatedmarkets and the jury is still out on the sustainability of their growth prospects.

0

100

200

300

400

500

Aug-1

3

Sep-1

3

Sep-1

3

Oct-1

3

Nov-13

Nov-13

Dec-13

Jan-1

4

Jan-1

4

Feb-1

4

Mar-14

Apr-14

Apr-14

May-14

Jun-1

4

Jun-1

4

Jul-14

Aug-1

4

Aug-1

4

Strides Indoco Aurobindo Glenmark Cadila

361478

613720

892

1,040 1,071

0

200

400

600

800

1,000

1,200

FY08 FY09 FY10 FY11 FY12 FY13 FY14

In`mn

Pantocid-India

135150

130

80

0 0 00

20

40

60

80

100

120

140

160

FY08 FY09 FY10 FY11 FY12 FY13 FY14

InUS$mn

Protonix-US

Sustainability of profits in regulatedmarkets cannot be taken forgranted in the absence of acompelling proposition

Mid-sized companies are yet tofully establish themselves inregulated markets


6/100

Healthcare


Exhibit 5:

Mid-sized pharma companies like Ajanta, FDC and Biocon have no USrevenues

% of Total Revenue

mn Domestic US

FDC 82.0% 0.0% 18.0%

Biocon 37.0% 0.0% 63.0%

Ajanta 32.5% 0.0% 67.5%

IPCA 36.7% 7.0% 56.3%

Natco 75.6% 13.3% 11.1%

Torrent 28.0% 18.6% 53.4%

Unichem 60.0% 18.9% 21.1%

Cipla 38.8% 19.0% 42.2%

Alembic 52.0% 25.0% 23.0%

Indoco 65.0% 28.8% 6.2%

Cadila 34.2% 30.1% 35.7%

Ranbaxy 17.7% 32.2% 50.1%

Glenmark 26.6% 32.2% 41.2%

Strides 7.3% 36.8% 55.9%

Dr. Reddy 11.9% 41.8% 46.3%

Lupin 25.1% 42.4% 32.5%

Wockhardt 21.0% 44.0% 35.0%

Claris 50.0% 50.0% 0.0%

Sun Pharma 22.1% 60.4% 17.5%


Several challenges to growth in US/regulated markets for mid-sized pharma

We believe that to earn initial revenues in the regulated markets of Europe and theUS is a relatively simple task once the manufacturing and product registration hurdles

are overcome. Moreover, these revenues generally carry higher than consolidatedmargins due to better realisations and thus look attractive to the entrepreneur andanalyst alike.

However, with the ongoing consolidation of the buy and supply side in the US, webelieve the regulated markets would increasingly start favouring scale, and life will bedifficult for mid- to small-sized companies with no significant value proposition.

For example, IPCA and Aurobindo offer a low-cost value proposition whilst Cadilaoffers a technology advantage which keeps its prospects in these markets strong;however, not all mid-sized companies have similar propositions.

Branded generic exports offer sustainable growth for mid-sized companies

We believe mid-sized pharma companies are better off exploring the branded genericexport markets, given their relevant experience in the Indian pharma market. Even asthese markets offer lower margins and RoCEs as compared to the US initially andhave higher gestation periods, we believe that lower upfront investments and thesustainability of revenues and profits from these geographies makes them the mostviable avenue for growth.

Consolidation in the buy andsupply side to favour scale

Lower upfront investments andsustainability make RoW a viableavenue for growth


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Healthcare


Exhibit 6:

Teva and Actavis have shown that the RoW market has provided bettergrowth than overall revenue growth


The branded generic markets, excluding some minor details, largely mirror the Indianmarket, and hence, we believe that a successful track record in India can be taken asa valid proxy for probable success in these markets.

Lets not forget that the India business itself is of prime importance for mid-sized pharma

Whilst the broadening growth horizon is a positive, we do not want to lose sight ofthe fact that the quality of growth in India also determines the sustainability of profitsfrom the domestic business as well. Hence, we take a deep dive into the evolution ofthe Indian market and the quality of growth exhibited by mid-sized Indian companiesusing our business DNA framework. The exercise helps us in: (a) projecting thesustainability of revenues in India and (b) extrapolating the success of the Indianbusiness to other branded generic exports.

17.9%

32.4%

12.9%

27.9%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Teva Actavis

Five-year revenue CAGR over CY08-13

RoW Overall

Branded generic markets largely

mirror the Indian market

Quality of growth in Indiadetermines the sustainability of

profits from the domestic business


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Healthcare


Introduction to Indian pharmaceuticals

Industry structure

The Indian pharma market (IPM) represents a secular growth opportunity amidstintense competition. However, the branded nature of the market ensures that oncethe brand is established, brand equity drives a certain portion of growth. Owing to

low regulatory hurdles and reasonable margins, the market offers RoCEs rangingfrom 15% for small players to 30% for the larger ones.

Secular growth

The IPM is experiencing secular growth characterised by: (a) rising income levels,ensuring affordability; (b) higher health awareness, leading to higher diagnosis; (c)better penetration of diagnostic clinics, leading to better patient access; (d) increasinginsurance penetration, ensuring affordability, and (e) worsening lifestyle in urbancentres, causing high incidence of chronic diseases like diabetes, psychiatric diseasesand neurological disorders.

Historically, the IPM has grown at 12-15% per annum, comprising: (a) Volume growth(7-8%); (b) New introductions (3-5%) and (c) price increases (1-2%).

Exhibit 7:

The IPM has registered higher CAGR of 13.1% over FY05-14 as compared toreal GDP (7.4%) and disposable income (4.2%)

Source: AIOCD, CIEC data, Ambit Capital research

Organic consolidation

The IPM is amongst the most competitive markets globally. The Herfindahl-HirschmanIndex (HHI) for the market is at 229 (for FY14) as compared to the US markets 593

(monopoly would have an index value of 10,000 and perfect competition would tendto 0). However, despite intense competition, the market is experiencing organicconsolidation.

240 276

315363

418477

544

630

705 730

-

100

200

300

400

500

600

700

800

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

in

`billion

India Pharma Market Growth > Indian GDP growth

Brand equity drives a certainportion of growth

Historically, the IPM has grown at12-15% per annum

Indian pharma market is the most

competitive globally


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Healthcare


Exhibit 8:

Herfindahl-Hirschman Index (HHI) indicates organic consolidation

Source: AIOCD, Ambit Capital research

We believe that the factors contributing to consolidation despite intense competitionare: (a) Branded nature of the IPM: Companies can establish their branded

generic product in a given therapy area and leverage upon it to expand to moreproducts in the same therapy or a different therapy with the same audience (doctors).(b) Incentives to sales force generally higher for larger companies:The largerthe organisation, the more it can spend on incentivising its sales force and otherstakeholders (distributors, retailers and doctors). Higher incentives lead to highersales and make up for the expenditure in promotion costs through operatingleverage. (c) Partnerships and alliances: Larger companies have been thepreferred partners for those companies that do not have a local distribution and salesnetwork in India. This adds to the portfolio basket of the larger companies andbundled with higher R&D capability and bandwidth again results in organicconsolidation.

Market share for MNCs declined post 1970

The market share for MNCs has declined from more than 70% before the 1970s toless than 25% in FY14. The rise of several domestic companies with low-costadvantages and brand equity built over time has caused the erosion in market sharefor MNCs.

Exhibit 9:Indigenous companies have increased market share by leveraging their low-cost advantage


MNCs being innovators are excluded from our consideration set

We exclude local subsidiaries of multinational corporations (MNCs) from our analysis,

as: (a) the local subsidiaries are trading entities with negligible exports and (b) theparent entities are innovators with high brand equity globally due to R&D.

210

217

212213

227

223

228 229

200

205

210215

220

225

230

235

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14

HHI

68%

32%

1970

MNC Indigenous

Branded nature of IPM, higherincentives to sales force andalliances to drive marketconsolidation

22%

78%

2014

MNC Indigenous


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Healthcare


Deep dive into IPMs evolution; regulationsays innovate!A deep dive into the Indian pharmaceutical markets history suggests thatthe regulations post-independence were aimed at importing expertise,technology and capital through MNC participation. Whilst import was

enabled by various regulations, affordability and local participation inmanufacturing were also ensured. The re-introduction of product patent, taxbreaks on R&D spend and higher span of price regulation in recent timesseems to be aimed at ensuring affordability and pushing the new-ageentrepreneurs towards innovation, which we believe is the end-game.

Phase I (pre-1947): The age of MNCs/no direction for adomestic industryLow presence of domestic manufacturers

The British Government introduced the allopathic form of medicine in India. Drugswere imported by foreign companies and marketed in India. The indigenous industry,consisting of very few entrepreneurs, contributed little to the total demand (13% ofdemand met by Indian companies).

World War II provided the opportunity for indigenous players

However, during World War II (1939-1945), foreign companies were unable tosupply drugs to India. This resulted in the establishment of Indian companies such asUnichem, Cipla, Zandu Pharmaceuticals, and Calcutta Chemicals. Gradually,domestic contribution to total demand in the Indian market rose to 70%. The keyhighlight of this period was focus on production-related activities rather thanR&D activities.

Phase II (1947-1970): Regulatory push helps in the riseof domestic bulk manufacturingDomestic companies failed to participate in global R&D revolution

Even as pharma companies globally started making sizable investments in R&Dduring this period, the Indian industry could not participate due to lack of knowledge,experience and capital. Whilst through the Industrial Policy Statement (1948), theGovernment of India (GOI) allowed MNCs to establish a manufacturing base in India,

MNCs imported bulk drugs and assembled/marketed the product locally.

Industrial Licensing Policy 1956 succeeded in importing technology

The Government of India in its Industrial Licensing Policy, 1956, made it compulsoryfor foreign companies to establish production units in India and producedrugs from the basic stage. At the same time, the Government, on its own, set upHindustan Antibiotics (1954) and Indian Drugs and Pharmaceuticals Ltd (1961) tostart the production of important drugs. These public sector units have played animportant role in shaping up new-age entrepreneurs like Anji Reddy, whowas an ex-employee of a Government entity.

Also, the research impetus by the Government through the establishment ofsponsored research institutes helped in fostering the technological environment for allthe current top domestic pharmaceuticals companies. This resulted in domesticcompanies capturing a significant share in the bulk drug segment.

However, MNCs continued to have monopoly in high-payoff formulation

products, resulting in prices that were as high as in developed nations.

MNCs had 87% share in the

domestic market

WW II led to short supply fromMNCs; domestic companies met70% of domestic demand

The Industrial Policy (1948) failedto import technology, as MNCsassembled imported drugs

PSUs established by the GoI playedan important role in shaping upnew-age entrepreneurs like AnjiReddy

MNCs continued to sell formulation

products at high prices


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Healthcare


Phase III (1970-1991): The regulatory troika; theemergence of Indian genericsPatent Act, Foreign Exchange Regulation Act (FERA) and New Drug Policy

In order to bring the prices to normalised levels and make it affordable to everyone,the Government of India amended the Patent Act 1970 and enacted the ForeignExchange Regulation Act (FERA) 1973 and New Drug Policy 1978.

Patent Act, 1970:The Patent Act abolished product patents and recognised onlyprocess patents. The Indian companies could now patent their own processes and

compete with MNCs in the formulations market.

FERA, 1973:FERA was implemented to compel MNCs to manufacture high-technology bulk drugs through restrictions on equity holdings (


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Healthcare


Foray into NCEs and NDDS: Large domestic companies have ramped up R&D

Many of the large domestic pharma companies have evolved from being generic drugmanufacturers to consciously investing in R&D activities to produce novel molecules(small and large) and drug delivery systems (targeted and passive). We believe this tobe the next leg of growth for the large domestic manufactures. Companies like Dr.Reddys, Zydus, Lupin and Glenmark have many products in the pipeline in variousstages of development. In 2013, Zydus received an approval for its first NCE, anti-

diabetic drug, Lipaglyn. Dr. Reddys markets biosimilars in India and EMs andGlenmark has out-licensed many novel candidates under-development. However,the relatively smaller Indian generic companies are yet to invest in suchinitiatives.

Large domestic companies focuson NCEs and NDDS by ramping upR&D; example, Lipaglyn (Zydus)

Smaller Indian generic companiesare yet to invest in such initiatives


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Healthcare


xhibit 10: The ramp up in the number of pharma manufacturing units in India was driven by the introduction of process patents in 1970

ource: Ambit Capital research

0

5,000

10,000

15,000

20,000

25,000

Pre1947

1952-5

3

1960-6

1

1969-7

0

1977-7

8

1979-8

0

1980-8

1

1982-8

3

1983-8

4

1984-8

5

1985-8

6

1989-9

0

2000-0

1

2012-1

3

2013-1

4

ProductionUnits

(a) Industrial Licensing Policy, 1956 - Compulsory establishment ofproduction units by foreign companies(b) Setting up of PSU pharma companies

(a) Pre-independenceIPM dominatedby MNCs(b) WW IIprovidedopportunity to

domestic cos.

(a) Domestic cos hit as product patentmade reverse engineering illegal(b) Stringentprice controls result inlower profitability(c) Compulsory licensing hurtinnovators and benefit generics cos(d) NCEs and NDDS provides thenext leg of growth for domestic cos

(a) Patent Act , 1970 - Introduction of process patent(b) FERA, 1973 - Compels MNCs to manufacture high tech drugs(c) NDP, 1979 - Restricts prices of 349 critical drugs

(a) Domestic companiesstarted reverseengineering products(b) Affordability ofcritical medicines

New Drug Policy, 1994 -74 drugs based on NLEM, reducing span ofcontrol

Opportunity to pricedrugs at higher rates

which are not underNLEM

(a) Ammendment of Patent Act, 1970 -Moved from 5-year process patent to20-year product patent(b) NPPP 2012 - 348 drugs includedunder price control(c) Compulsory licensing, 2012 - GOIto award compulsory licence to ensureavailability of drugs

(a) Import of technology(b) Breeding ground ofnew-age entreprenuers

Key events Its Impact


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Healthcare


Challenges ahead for mid-sized pharma

Organic consolidation despite increasing competition

Intensifying competition in the domestic market is a threat to the existing marketplayers. Attracted by the high RoCEs offered by the domestic branded formulationsbusiness, small domestic pharmaceutical companies have mushroomed. The number

of companies earning more than `500mn from the domestic formulations market hasincreased from 108 in FY08 to 122 in FY14, as per AIOCD data.

However, competition has not yet proven detrimental for incumbents and thedomestic formulations market is experiencing organic consolidation.

Exhibit 11:

Market share of top-10 companies has increased over FY07-14


We believe, other than the incumbents, a number of mid-sized companies haveexhibited sustainable growth. We list below a number of challenges that are possibly

making life difficult for the smaller Indian players as compared to the incumbents.

Attrition rate in marketing representatives (MRs)

The industry has seen high attrition rates in past decade. Our primary data checkssuggest that the industry average attrition amongst sales representatives is 30%. Dueto the high attrition rates, the productivity of the sales force has grown at a mere 3%CAGR over FY05-14. Whilst productivity has remained low, salary increments at 10-15% have been higher than inflation. This is due to the high attrition rate, as 15% ofthe workforce remains either on a notice period or is undergoing training. In such ascenario, for smaller companies to retain MRs and showcase good productivity is a

challenge.

Exhibit 12:

Sales force productivity in the industry has grown at 3% CAGR

Source: Company, Ambit Capital research; * Note: Companies that we have aggregated for arriving at industrynumbers are Glenmark, Sun Pharma, Torrent Pharma, IPCA, Cadila, Lupin, Dr. Reddys, Ranbaxy, Cipla and GSK

14.5%16.1%

17.7%

21.0%22.2%

23.4% 24.1%

0%

5%

10%

15%

20%

25%

30%

Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14

Market share of top-10 companies

4.01 4.02 4.464.46 4.58 4.21 4.09 4.18

4.595.01

-

1

2

3

4

5

6

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Sales force productivityCAGR 3%

HHI suggests organic consolidation

Competition has not yet provendetrimental for incumbents

Other than the incumbents, anumber of companies have

exhibited sustainable growth

Whilst sales force productivityhas recorded a CAGR of 3%only, wage inflation has been10-15%


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Healthcare


Exhibit 13:

Sales force productivity of the top companies, asper our framework


Exhibit 14:

Sales force productivity of bottom companies asper our framework (Decreasing to Stable)


Converging to unbranded genericsIn a democratic country like India, the fact that the Government is striving for populistpolicies to ensure affordability for the poor is no surprise. The Government of India

(GoI) has set up schemes like Jan aushadi stores, a government pharmacy chain,within government hospitals which provide medicines at subsidised rates. Further, theGoI in association with certain agencies is working on an SMS programmewherethe patient could SMS a brand name prescribed by the doctor and in return thepatient would receive a reply with the lowest-cost brands of the same drug availablein the market. Moreover, there have been demands from the Medical Council ofIndia to make it mandatory for doctors to prescribe the generic name ofmedicines instead of the brands.

Increasing span of price regulationsThe GoI in its DPCO Order 2013 had expanded the scope of price controls andextended it beyond the National List of Essential Medicines (NLEM) 2011. However, inJuly 2014, the National Pharmaceutical Pricing Authority (NPPA), exercising its rightto fix ceiling prices for any drug it deems necessary, announced ceiling prices for 108non-scheduled formulations (50 molecules). Out of these 50 molecules, 33 are not apart of the National List of Medicines (NLEM) 2011. The increasing span of priceregulations would continue to be a threat to the profitability of the Indian business.

Whilst such price regulations are reasonably tolerated by the larger domestic playersdue to their wide and diversified product baskets, such events could move the needle

for smaller participants.

Regulatory hurdles to new introductionsIn order to curb malpractices and patient deaths during clinical trials, the Ministry ofHealth has put in place stringent reforms and increased scrutiny. Whilst the reformsare essential for curbing negligent professional behaviour, they are double-edgedsword. The reforms have resulted in not only lower clinical trial approvals butalso reduced the number of trials actually undertaken. At the same time, thecosts associated with these clinical trials have gone up substantially, as companies

have to comply with stricter norms.

Also, the approval process has been lengthened, with pharma companies required totake approval from the Drug Controller General of India (DGC (I)) committee. The

documentation requirements are also more elaborate.

These measures by the regulator have increased the time taken for new introductionsand also increased the cost for companies to launch products. Whilst the larger firmscan continue to feed on the cash generated by the large base business, suchregulatory changes may affect smaller companies more significantly.

8.9%8.2%

6.8% 6.5%

4.6%3.7%

0%1%2%3%4%5%

6%7%8%9%

10%

Glenmark

SunPharma

Torrent

Ipca

Cadila

Lupin

CAGRFY

05-14

Sales force productivity 2.7%

-1.0%-1.5%

-3.1%-4%

-3%

-2%

-1%

0%

1%

2%

3%

Dr.Reddy

Ranbaxy

Cipla

GSK

CAGRFY

05-14

Sales force productivity

Jan aushadi, the SMSprogramme and mandatinggeneric names suggestconvergence to the unbrandedmarket

The increasing span of priceregulations would continue to be athreat to profitability of the Indianbusiness

Price regulations could move theneedle for smaller participants

Stringent norms for clinical trialsand additional layer ofadministration in new approvals is

slowing the pace of newintroductions

Regulatory changes may affectsmaller companies moresignificantly


16/100

Healthcare


Analysing sustainability: Business DNAWhilst the organic consolidation and challenges cited above are definite hurdles forIndian mid-caps to grow, smaller companies have exhibited resilient growth.

Exhibit 15:

Domestic sales CAGR over FY07-14 reflects strong growth by smallercompanies

Source: AIOCD data, Ambit Capital Research

However, we suspect that the growth for some of these companies is moresustainable than others. Various factors need to be assessed when judging thequality, sustainability and risks to reported sales growth for the Indian business.

Exhibit 16:

Key levers to assess

Business DNA Components Measures Weights

Drivers of Growth(50% weightage)

Product selection

Ability to select product segments which cangrow higher than IPM (Molecule sales growth> IPM sales growth)

20%

Sales execution

Ability to outperform peer sales growth(Company sales growth in molecule >Molecule sales growth)

20%

Base business growth

Gauging higher brand equity (Higher basebusiness growth). Lower weightage as brandequity is a derivative of the many factorsincluding product selection and execution.

10%

Newer Avenues forGrowth(25% weightage)

Therapeutic coverage

Smaller therapeutic presence indicates higherscope for product portfolio expansion (Lowercurrent coverage of product portfolio)

10%

Geographical coverage

Smaller geographical presence indicateshigher scope for expansion (Lower current

geographical reach of product portfolio)10%

Sales force productivity

Indicates push vs pull dynamics underlying thebusiness (Higher sales per marketingrepresentative). Lower weightage as salesproductivity could be lower due to afragmented target audience.

5%

Associated Risk toGrowth(25% weightage)

Event specific risk

Broader brand base reduces event specific risk(Top-50 products contribution to total sales).Higher weightage as event specific risks in thepast have been more detrimental forcompanies than regulatory risk (exampleLosar franchise for Unichem)

15%

Regulatory risk

Higher contribution from base businessgrowth to overall growth mitigates impact ofregulatory risk (Contribution of base businessgrowth to total growth)

10%

Source: Ambit Capital research

4% 5% 5%6% 6%

7% 8%10% 11%

13% 14%15%

19%

24% 24%

0%

5%

10%

15%

20%

25%

30%

Ranbaxy

FDC

Strides

Woc

khardt

Claris

Unichem

Indoco

Cadila

Torrent

A

lembic

Natco

Gle

nmark

IPCA

Ajanta

Biocon

We suspect that the growth for

some of the Indian mid-cappharma companies is moresustainable than others w.r.t.Indian formulations


17/100

Healthcare


Exhibit 17:

Business DNA decides which path the company takes

Source: Ambit Capital research

Is Indian mid-cap pharma investible?

Whilst we do see challenges for the domestic players, we believe that the Indiandomestic market remains a lucrative opportunity for participants of all sizes and agedue to its scope and structure. The market is experiencing secular growth driven bybetter affordability, higher diagnosis, rising insurance penetration and moreawareness. Whilst the branded nature of the market provides an opportunity to buildbrand equity, the competition makes it a non-auto pilot business. Only thoseparticipants that exhibit execution through constant rigour are likely tobenefit in the long run.

We also need to appreciate that the GoI has always been providing an impetus to thedomestic players through various regulations. Be it Industrial Licensing in 1956 or keyregulations in 1970-1990, the Government continues to push the domesticcompanies towards uncharted territories.

The recent examples of regulations providing direction are price regulations (2013-2014) and product patents (2005). Whilst the Government is curbing the prices ofplain-vanilla products, it is also providing opportunities for domestic companies to

increase R&D spend and innovate.

Given these market dynamics we advise investors to be selective and invest in

companies which have the ability to sustain growth momentum.

Which companies were selected and why?

For the purpose of this exercise we select companies based on three categories:

Market capitalisation of more than 10bn to ensure that the opportunityhas an investible size and enough liquidity.

Sizeable domestic business (>10% of total EBITDA) we retain our thesisthat smaller companies will find it difficult to sustain growth momentum in

regulated markets like Europe and the US.

Exclude MNCs i.e. companies having origin outside India and have set upsubsidiaries in India to run Indian operations MNC subsidiaries are proneto lack of management access and multiple sister concerns in India which areunlisted but engaged in the same business.

Based on the above filters, we analyse 19 companies ranging from largecapitalisation names like Sun Pharma, Lupin and Dr. Reddys to medium market

capitalisation names like Claris Life Sciences, Unichem Labs and Indoco Remedies.Note that 14 out of the selected 19 companies fall under the top-40 in the Indianpharma market (by sales in FY14).

Drivers

Newer avenues

Associated riskSalesgrowth

Time

Drivers Scope Risk

The domestic market remains alucrative opportunity for

participants of all sizes and age

Investors need to be selective andinvest in sustainable growth


18/100

Healthcare


I. Drivers of growth

We believe that the key for domestic companies to maintain their growth trajectory isto have strong product portfolios and have the ability to execute sales in a mannerwhere they are able to create a strong brand which is sustainable over time andresilient in the face of incremental competition.

Product selection: Ability to select therapeutic segments which can growhigher than the IPM

We believe a key driver of growth for companies is the ability to select therapeuticsegments which can provide impetus to growth which would be higher than thegrowth of the Indian Pharmaceutical Market (IPM).

We evaluate this parameter by assessing the presence of companies in differenttherapeutic segments and comparing the YoY growth of therapeutic segments, inwhich the companies are present, with the growth of IPM over FY09-14.

Exhibit 18:

Growth of therapeutic segments (in which companies are present) ascompared to IPM growth on a YoY basis

Growth YoY (%) FY09 FY10 FY11 FY12 FY13 FY14 Rank

Ajanta 16.9% 14.9% 21.8% 15.4% 14.6% 7.8% 1Biocon 19.8% 16.8% 31.7% 21.2% 13.8% 6.9% 1

Glenmark 16.3% 15.2% 20.0% 16.2% 11.8% 6.2% 3

Unichem 16.3% 14.5% 17.9% 15.4% 12.5% 4.7% 3

Torrent 18.9% 17.5% 17.7% 16.6% 11.6% 5.2% 5

Sun Pharma 17.9% 15.3% 18.9% 15.2% 11.7% 5.7% 6

Lupin 16.5% 14.0% 18.9% 15.1% 11.4% 5.2% 6

IPCA 18.2% 16.5% 16.1% 14.7% 10.9% 5.1% 6

Indoco 18.4% 15.8% 18.9% 14.9% 11.1% 3.4% 6

Strides 18.1% 15.1% 19.6% 14.9% 11.7% 4.7% 6

FDC 19.5% 16.1% 14.1% 15.3% 10.6% 4.0% 6

Ranbaxy 16.3% 14.3% 18.4% 14.9% 10.9% 4.8% 6

Cadila 15.4% 13.5% 16.9% 15.0% 11.4% 4.9% 13

Dr. Reddy 19.3% 16.2% 15.0% 15.2% 11.6% 4.6% 13

Wockhardt 15.7% 13.6% 16.4% 13.8% 10.0% 3.5% 13

Cipla 14.8% 13.5% 15.3% 13.5% 10.5% 4.2% 16

Alembic 16.6% 12.9% 15.0% 13.9% 10.0% 3.7% 16

Natco 8.8% 9.2% 10.8% 9.7% 6.8% 0.1% 18

Claris 12.7% 8.4% 10.4% 12.8% 6.4% 1.5% 18

IPM 14.8% 13.6% 15.3% 15.3% 11.7% 6.2%


Based on the above data, Ajanta and Biocon have displayed superior capability toselect the therapeutic segments which can deliver above-market sales growth over

FY09-14. At the same time, Natco and Claris have consistently had poor therapeuticselection and are ranked the lowest amongst their peers. However, note thatsecondary sales data does not capture hospital sales, which are the bread and butterfor both Natco and Claris. To that extent our analysis is distorted for these twocompanies.

Sales execution: Ability to outperform peer sales growth

Whilst product selection is a key determinant for future growth, however accurateproduct selection may be, it is a futile exercise unless the company is able tocapitalise on it and report superior sales performance. Therefore, we analysecompanies with the yardstick of sales execution.

The ability to execute sales efficiently and report growth better than the therapeutic

segment growth is the parameter that we have used to assess the companies.

bility to select therapeuticsegments can provide impetus togrowth

Ajanta and Biocon have displayedsuperior capability to selecttherapeutic segments

Product selection is a futile exerciseunless the company is able tocapitalize on it


19/100

Healthcare


Exhibit 19:

Domestic sales growth as compared to the respective therapeutic segmentgrowth

Growth YoY (%) FY09 FY10 FY11 FY12 FY13 FY14 Rank

Sun Pharma 26.5% 22.2% 23.2% 24.2% 20.4% 16.2% 1

Therapeutic segment growth 17.9% 15.3% 18.9% 15.2% 11.7% 5.7%

Lupin 24.3% 18.3% 28.1% 17.3% 14.0% 12.3% 1


Glenmark 20.3% 16.7% 16.3% 23.0% 19.6% 16.1% 3Therapeutic segment growth 16.3% 15.2% 20.0% 16.2% 11.8% 6.2%

IPCA 31.2% 26.6% 13.9% 18.6% 15.0% 18.7% 3


Ajanta 7.4% 18.6% 21.4% 27.8% 21.7% 28.8% 5


Indoco 26.5% 16.1% 22.1% 11.6% 9.3% 4.3% 5


Cadila 8.7% 14.1% 2.2% 15.2% 20.0% 8.4% 5


Biocon 17.2% 42.0% -11.5% 66.3% 9.9% 39.8% 8


Cipla 15.3% 14.9% 5.3% 13.3% 8.3% 9.1% 8

Therapeutic segment growth 14.8% 13.5% 15.3% 13.5% 10.5% 4.2%Alembic 6.1% 21.5% 4.1% 16.9% 7.6% 10.5% 8


Natco -9.8% 80.5% 5.7% 51.2% 16.6% -34.8% 8


Unichem 21.0% 9.1% 9.2% 2.7% 7.9% 6.9% 12


Torrent 16.0% 13.4% 9.5% 9.9% 16.1% 14.6% 12


Strides 118.6% -15.8% 19.6% -11.8% -7.8% -14.6% 12


Claris -18.0% 68.2% -19.9% 117.9% 3.0% -24.4% 12


Wockhardt 3.5% 3.9% 19.2% 12.3% 5.1% 0.5% 16Therapeutic segment growth 15.7% 13.6% 16.4% 13.8% 10.0% 3.5%

FDC 10.1% 10.2% -10.7% 4.0% 5.0% 2.9% 17


Ranbaxy 0.6% 4.7% -6.3% 12.5% 6.1% -1.0% 17


Dr. Reddy 5.7% 13.1% 3.0% 8.6% 10.4% 4.6% 17



The above table clearly reflects the importance of having efficient executioncapabilities over and above the product selection expertise. Sun Pharma and Lupin,which ranked lower on the product selection scale, have displayed superior execution

capabilities by growing higher than their respective therapeutic segment growth on aconsistent basis. Dr. Reddys and Ranbaxy despite having fairly reasonable productportfolios have not been able to capitalise and implement superior execution skillsand thus they rank the lowest in the sales execution criteria.

Amongst the midcaps, IPCA, Ajanta, Indoco and Cadila have executed better thantheir peers.

Base business growth: Gauging higher brand equity

In the above two sections we discussed the necessity of smart product selection andsharp sales execution. The third criteria we look at to maintain the current drivers ofgrowth is the ability to establish brands successfully and create brand equity for theproduct portfolio. Brand equity is critical to create consumer perception not just forone product but leveraging brand equity of one product to the entire portfolio.

Amongst the midcaps, IPCA,Ajanta, Indoco and Cadila haveexecuted better than their peers

The ability to establish brandssuccessfully and create brandequity for the product portfoliodetermines longevity of growth


20/100

Healthcare


To determine brand equity, we analyse the base business revenue CAGR over FY09-14. Companies delivering consistent base business growth at higher levels areconsidered to have stronger brand equity.

We define the base business as all the products launched two years prior to the yearin question. For example, in FY11, the base business would include all the productslaunched in the FY minus 2 year i.e. FY09.

Exhibit 20:

High base business CAGR over FY09-14 portrays brand equity


Amongst midcaps, Biocon, Ajanta and Claris have developed strong brand equity fortheir portfolio products by growing the domestic base business by a CAGR of 26.6%over FY09-14. Strides has reported negative CAGR over the same period, displayinga lower ability to position itself as a strong brand and capitalise on the productslaunched.

Overall, Ajanta, Glenmark, Biocon, IPCA and Indoco have better quality ofgrowth than their peers

Aside from the usual suspects like Sun Pharma and Lupin, amongst the mid-caps,

Ajanta, Glenmark, Biocon, IPCA and Indoco have exhibited a better quality of growthand are more likely to sustain growth in the face of the aforementioned challenges.

Exhibit 21:

Ajanta has the best drivers of growth placed in its business

Company / ScoreProduct

selectionSales

executionBase business

growthOverall

Rank

Weights 40% 40% 20% 100%

Ajanta 1 5 2 1

Glenmark 3 3 7 2

Biocon 1 8 1 3

Sun Pharma 6 1 3 4

Lupin 6 1 8 5

IPCA 6 3 5 6

Indoco 6 5 10 7

Torrent 5 12 9 8

Unichem 3 12 15 9

Cadila 13 5 12 10

Natco 18 8 6 11

Alembic 16 8 11 12

Cipla 16 8 13 13

Claris 18 12 4 14

Strides 6 12 19 15

Wockhardt 13 16 16 16

Ranbaxy 6 17 17 17

FDC 6 17 18 18

Dr. Reddy 13 17 14 19

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company(with a maximum score of 20) on the basis of the individual rank. For example, rank 1 in the individual rank

would score 20 and rank 19 would score 1.

26.622.7

20.5

18.2

18.1

17.4 17.3

16.812.4

11.9

11.2

10.910.0

7.5 6.8 6.4 3.2 1.7

-6.5-10

-5

0

5

10

15

20

25

30

Biocon

Ajanta

Sun

Pharma

Claris

IPCA

Natco

Glenmark

Lupin

Torrent

Indoco

Alembic

Cadila

Cipla

Dr.Reddy

U

nichem

Wo

ckhardt

Ranbaxy

FDC

Strides

Amongst mid-caps, Biocon, Ajantaand Claris have developed strongbrand equity

janta, Glenmark, Biocon, IPCAand Indoco have better quality ofgrowth


21/100

Healthcare


II. Newer avenues for growth

In this section, we assess the ability of companies to foster newer avenues of growth.

We analyse the companies based on three factors:

Therapeutic coverage- Smaller therapeutic presence indicates higher scope forproduct portfolio expansion (Lower current coverage of product portfolio)

Geographic coverage - Smaller geographical presence indicates higher scopefor expansion (Lower current geographical reach of product portfolio)

Sales force productivity - Indicates push vs pull dynamics underlying thebusiness (Higher sales per sales representative)

Therapeutic coverage: Smaller therapeutic presence indicates higher scopefor product portfolio expansion

Most of the companies analysed have a presence in limited therapeutic segments andhave followed a focussed approach to capitalise on these segments. We believe anabsence in some therapeutic segments presents an opportunity for companies to

expand scope and bring about new avenues for sales growth. We do agree that aforay into new therapeutic segments requires significant investment and capabilitiesand is more a medium- to long-term growth story rather than a short-termphenomenon.

Therapeutic coverage is defined as the sales of therapeutic segments in which thecompany is present as a percentage of total IPM sales. Lower coverage provides anopportunity to the company to expand its product portfolio into non-coveredtherapeutic segments.

Exhibit 22:

Low therapeutic coverage provides an opportunity to expand scope (% ofmarket covered)


Claris Life Sciences, Natco, Ajanta and Biocon have the lowest coverage in theuniverse, and thus they have an opportunity to grow sales by foraying into unchartedtherapeutic segments. This provides inorganic growth for the company, keeping thecurrent business constant.

On the other hand, Cipla and Cadila have the highest therapeutic coverage. Theyhave a presence in most therapies, thus implying less scope for inorganic expansionof sales.

Geographic coverage: Smaller geographical presence indicates higher scopefor expansion

Apart from growth in therapeutic segments, another avenue for companies to grow isto expand their geographic coverage to regions in India which have not been tapped.For example, Strides has a focus in the southern states of India. Through itsacquisition of the branded generic business of Bafna Pharmaceuticals, Strides can

8.5 1

4.1

18.9

21.3 2

9.0 3

4.8

35.0

36.1 3

9.6

42.9

46.1

48.1

48.5

49.4 53.

66

3.4

64.9

67.5

67.8

0

10

20

30

40

50

6070

80

Claris

Natco

Ajanta

Biocon

Strides

FDC

IPCA

Indoco

Dr.Reddy

SunPharma

Torrent

Glenmark

Unichem

Alembic

Wockhardt

Ranbaxy

Lupin

Cadila

Cipla

Expanding the therapeutic segmentpresence may help in cultivatingnew avenues for sales growth

Claris, Natco, Ajanta and Bioconhave the lowest therapy presenceand hence the largest opportunity

Expansion of geographic presencealso represents opportunity for

sales growth


22/100

Healthcare


now expand its geographical coverage to the northern states, where Bafna has stronginfrastructure and sales execution capabilities through its distributor channels.

As per AIOCD data, sales are divided into 24 regions. We assess geographicalcoverage by analysing the concentration of sales in different regions. Higher salesfrom the top-10 regions signify geographic concentration.

Exhibit 23:

Geographic concentration of sales (as a percentage of total sales) is the

least for Strides


Strides ranks the highest, as it has a high concentration in southern India. However,with the acquisition of Bafnas branded generic business, it now will be able toincrease its presence in other regions and provide impetus to its sales.

Other mid-caps which could tap similar opportunities are Natco, Claris, FDC, Indocoand Biocon.

Cadila and Alembic, on the other hand, have a diversified presence across India andthe scope for increasing the footprint to new regions is limited, and thus they have a

lower ability to increase sales through geographic expansion.

Sales force productivity: Indicates push vs pull dynamics underlying thebusiness

The capabilities of the sales force are crucial to broaden scope for higher salesgrowth. As we had mentioned earlier, the industry faces a challenge in retaining itssales force due to the high attrition rate of Marketing Representatives (MRs).

MR productivity helps understand whether the company follows a push model of salesor a pull model. Efficient MR productivity signifies constructive efforts by the salesforce to establish the brand in front of the doctor and get a higher prescription share(pull mechanism). Low productivity indicates a push mechanism where theprescription may be largely driven by the frequency of doctor calls without really

capturing a significant mind share.

We evaluate companies based on sales per marketing representative. Higher salesper MR represent better MR quality and focus on a pull model as compared to lowersales per MR which represents more focus on a push sales model. We accept that thismatrix has an inherent lacuna under which it does not reward companies whichfollow a pull model but experience lower productivity purely due to the highernumber of doctors that the MR has to address. Such issues are largely noticed withcompanies which rely on general physicians for prescriptions as compared to say aSun Pharma which relies on a lower number of doctors due to its presence inspecialty segments.

Hence, we assign lower weightage to sales force productivity in our overall

framework but we believe that better sales per MR provides the requisiteunderstanding of companies ability to capitalise their sales force through bettertraining and efficient reward systems.

76

71

55

29 3

231

28

27

27

28

27 3

1 32

27

27

22 2

222 2

2

24

26

27

47

43

42

41

41

41

39

40 3

533

36

36

40

40

37

35

3

19

24

25

26

30

32

32

33

33

33

35

36

37

38

39

41

43

0

20

40

60

80

100

Strides

Natco

Claris

FDC

Indoco

Biocon

Ranbaxy

Cipla

Glenmark

Torrent

Ajanta

SunPharma

IPCA

Dr.Reddy

W

ockhardt

Unichem

Alembic

Lupin

Cadila

Top 4 regions 4th to 10th region 11th to 24th region

We assess geographical coverageby analysing concentration of salesin different regions

Strides, Natco and Claris have highgeographic concentration

Efficient MR productivity signifieshigher prescription share andbrand loyalty

Companies with general physiciansas their primary audience are likelyto see low productivity


23/100

Healthcare


Exhibit 24:

Sun Pharma has excellent sales reps productivity

Source: AIOCD data, Company, Ambit Capital research

Whilst Sun Pharma gets an expected pole position, FDC and Biocon also rankamongst the top-5, performing much better than other mid-cap peers. IPCA, Indoco

and Ajanta rank the lowest presumably due to their general physician exposure, asdiscussed above.

Overall, Claris, Natco, FDC, Biocon and Indoco have higher scope of growththan mid-cap peers

Smaller companies have the maximum opportunity to grow. Claris, Natco and FDChave the maximum scope to increase their product and geographical coverage.Whilst FDC has an efficient sales force, Claris and Natco can leverage their salesforce through newer product introductions.

Exhibit 25:Claris has the maximum scope to grow

Company / ScoreTherapeutic

coverageGeographical

coverageSales force

productivityOverall Rank

Weights 40% 40% 20% 100%

Claris 1 3 11 1

Natco 2 2 12 2

FDC 6 4 2 3

Biocon 4 6 3 4

Strides 5 1 14 5

Indoco 8 5 18 6

Sun Pharma 10 12 1 7

Ajanta 3 11 19 8

Glenmark 12 9 7 9

Ranbaxy 16 7 6 10Dr. Reddy 9 14 10 11

Torrent 11 10 15 12

IPCA 7 13 17 12

Cipla 19 8 8 14

Wockhardt 15 15 5 15

Unichem 13 16 13 16

Cadila 18 19 4 17

Alembic 14 17 16 17

Lupin 17 18 9 19

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company

(with a maximum score of 20) on the basis of the individual rank. For example, rank 1 in the individual rankwould score 20 and rank 19 would score 1.

9.3

7.66.6 6.4

5.6 5.3 5.0 5.0 4.74.1 4.0 3.8

3.1 2.9 2.7 2.4 2.41.8 1.5

0

2

4

6

8

10

Sun

FDC

Biocon

Cadila

Wockhardt

Ranbaxy

Glenmark

Cipla

Lupin

Dr.Reddy

Claris

Natco

Unichem

Strides

Torrent

Alembic

IPCA

Indoco

Ajanta

Revenue per sales reps per annum (FY14), mnFDC and Biocon also rank amongstthe top-5, performing much betterthan their other mid-cap peers


24/100

Healthcare


III. Associated risks to growth

We have addressed the avenues and scope of growth above, but it is also meaningfulto assess the risk facing the domestic sales of the companies and the ability andpreparedness of these companies to mitigate this risk.

To evaluate the risk attached to the domestic business, we analyse companies undertwo categories: (a) Event-specific risk and (b) Regulatory risk

Event-specific risk: Broader brand base reduces event-specific risk

The domestic market faces several event-specific risks such as price regulation,adverse events reported and therapeutic substitution.

The resultant price cuts, decline in market size and decline in volumes pose a seriousrisk to the companies, as their margins are likely to shrink. We believe companies

which have a broader product portfolio are less susceptible to event-specific risk.

To assess the event-specific risk, we evaluate companies based on their brandconcentration. Companies with higher brand concentration are at risk in terms oftheir revenue. Therefore, on a relative basis, companies deriving a higher percentage

of sales from the top-50 products rank lower in the population.

Exhibit 26:

Sun Pharma ranks first, with a diversified product portfolio; Natco is atrisk


From the exhibit above, we infer that Sun Pharma has excellent productdiversification and faces the least event-specific risk. It derives 51% of its sales fromthe top-50 products. On the contrary, Strides, Claris and Natco derive almost 100%of their sales from the top-50 products, thus posing event-specific risk to theirrevenue. The analysis represents an obvious bias towards larger companies. But, weassert that larger companies indeed are less prone to needle-swinging events as

compared to the smaller ones and hence are relatively safe from event-specificevents.

Regulatory risk: Higher contribution from base business growth to overallgrowth mitigates regulatory risk

Whilst lower brand concentration helps reduce event-specific risk, the industrycontinues to faces regulatory issues which cannot be mitigated. However, throughefficient product positioning coupled with strong brand recognition, companies canminimise the impact of regulatory risk.

For example, as discussed above, the industry currently faces a challenge in newproduct introductions due to stricter regulations and increase in the cost of clinicaltrials. The changes in regulations have resulted in lower approvals by the regulatorand also lower new product filings by companies. This could dent new productintroductions and thereby companies run the risk of lower sales growth. However,this risk can be mitigated if companies have strong base business growth.

0

20

40

60

80

100

SunPharm

a

Lupin

Cipla

Cadila

Ranbax

y

Torren

t

Dr.Redd

y

Glenmark

Alembic

IPCA

Ajant

a

FDC

Unichem

Indoc

o

Wockhardt

Bioco

n

Stride

s

Claris

Natc

o

Top 10 brands Top 11-25 brands Top 26-50 50 and above

Whilst some risk is inherent to the

business, our motive is to identifythe companies which are more

vulnerable than their peers

Barring the larger caps, IPCA,janta and FDC show considerable

diversification of product portfolios

Low number of new approvalsmight dent the growth for

companies that rely heavily on newproducts for growth


25/100

Healthcare


Therefore, we evaluate companies on the basis of their ability to derive andsustain/grow revenue from the base business. We assess the contribution of basebusiness growth to the total revenue growth for the company. Higher contributionfrom the base business implies that despite challenges arising out of regulatory risk(such as lower new product introductions), companies are able to sustain the currentgrowth in revenue through the base business.

Exhibit 27:

Strides has the highest contribution, whereas Cadila earns most of itsrevenues from new product introductions


Amongst the mid-caps, Torrent, IPCA, Glenmark, Indoco and FDC have thelowest risk to growth than mid-cap peers

Whilst larger companies score higher on risk mitigation, amongst mid-caps, Torrent,

IPCA, Glenmark, Indoco and FDC have the lowest risk to growth.

Exhibit 28: Cipla is the most efficient in risk mitigation

Company / Score Regulatory risk Event-specific risk Overall Rank

Weights 60% 40% 100%

Cipla 3 5 1

Sun Pharma 1 9 2

Torrent 6 4 3

Lupin 2 13 4

IPCA 10 6 5

Ranbaxy 5 14 6

Glenmark 8 10 7

Indoco 14 3 8

FDC 12 7 9

Cadila 4 19 9

Strides 17 1 11Dr. Reddy 7 17 12

Claris 18 2 13

Alembic 9 16 14

Biocon 16 8 15

Wockhardt 15 12 16

Unichem 13 15 16

Ajanta 11 18 18

Natco 19 11 19

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company(with a maximum score of 20) on the basis of the individual rank. For example, rank 1 in the individual rank

would score 20 and rank 19 would score 1

97.7

92.1

78.3

77.5

76.2

75.8

74.6

73.8

73.3

68.7

66.8

66.5

64.4

62.9

61.5

59.4

56.3

55.8

47.4

0

20

40

60

80

100

120

Strides

Claris

Indoco

Torr

ent

Cipla

IP

CA

F

DC

Biocon

SunPhar

ma

Glenm

ark

Na

tco

Wockha

rdt

Lu

pin

Ranb

axy

Unich

em

Alem

bic

Dr.Reddy

Aja

nta

Cadila

Base business contribution to total growth, Avg FY09-14

Strides, Claris and Indoco have thehighest contribution from the basebusiness in terms of growth

Whilst larger companies scorehigher on risk mitigation, amongstmid-caps, Torrent, IPCA,Glenmark, Indoco and FDC havethe lowest risk to growth


26/100

Healthcare


Companies best placed in domestic formulations are

In the above sections, we evaluated the competencies of companies on each of theBusiness DNA components. In this section we try to view the complete picture andassess the overall capabilities of companies.

Exhibit 29:

Overall ranking as per our DNA framework

Business DNA Drivers of growth Newer avenues for growth Associated risk to growthOverall Rank

RankProduct

selectionSales

execution

Basebusiness

growth

Therapeuticcoverage

Geographicalcoverage

Sales forceproductivity

Regulatoryrisk

Event specificrisk

Weights 20% 20% 10% 10% 10% 5% 15% 10% 100%

Sun Pharma 6 1 3 10 12 1 1 9 1

Glenmark 3 3 7 12 9 7 8 10 2

Biocon 1 8 1 4 6 3 16 8 3

Ajanta 1 5 2 3 11 19 11 18 4

IPCA 6 3 5 7 13 17 10 6 5

Torrent 5 12 9 11 10 15 6 4 6

Lupin 6 1 8 17 18 9 2 13 7

Indoco 6 5 10 8 5 18 14 3 8

Cipla 16 8 13 19 8 8 3 5 9

Claris 18 12 4 1 3 11 18 2 10

Strides 6 12 19 5 1 14 17 1 11

Natco 18 8 6 2 2 12 19 11 12

FDC 6 17 18 6 4 2 12 7 13

Cadila 13 5 12 18 19 4 4 19 14

Unichem 3 12 15 13 16 13 13 15 15

Ranbaxy 6 17 17 16 7 6 5 14 16

Alembic 16 8 11 14 17 16 9 16 17

Dr. Reddy 13 17 14 9 14 10 7 17 18

Wockhardt 13 16 16 15 15 5 15 12 19

Source: Ambit Capital research; Note: We derive the weighted average overall rank by scoring each company (with a maximum score of 20) on the basis of theindividual rank. For example, rank 1 in the individual rank would score 20 and rank 19 would score 1.

Whilst Sun Pharma and Lupin unsurprisingly feature amongst the top-10 companieson our framework, amongst mid-caps, we highlight Glenmark, Biocon, Ajanta, IPCA,Torrent and Indoco as companies that are better placed than their peers in terms ofbusiness DNA and hence sustainability of growth.

Glenmark:Whilst the company ranks low on therapeutic coverage (high number ofsegments already covered by product portfolio) and event specific risk (moderatediversification beyond top 25 brands), it scores high on product selection (high

presence in fast growing therapy areas) and sales execution (companys revenuegrowth higher than therapeutic areas present in). Overall Glenmark secures the 2ndrank on our DNA framework.

Biocon: Biocon has exhibited best-in-class product selection and brand equity (basebusiness growth). The company also boasts of low therapeutic and geographiccoverage (implying high scope for growth) and high sales force productivity(concentrated audience and large basket of products offered to target audience).However, Biocons business entails higher than average regulatory risk. Overall,Biocon scores the 3rdposition on our DNA framework.

Ajanta: Ajanta has exhibited best-in-class product selection and brand equity (basebusiness growth). The company also boasts of low therapeutic and geographiccoverage (implying high scope for growth). However, low sales force productivity(fragmented audience and small basket of products offered to target audience) andhigher regulatory and event specific risk drag the companys overall rank. Overall,Ajanta scores the 4thposition on our DNA framework.

Glenmark, Biocon, Ajanta, IPCA,Torrent and Indoco are better

placed than other mid-caps


27/100

Healthcare


IPCA: IPCA ranks high on product selection, sales execution, base business growth,therapeutic coverage and event specific risk. The companys presence in few nichesegments like malaria, pain and dermatology has driven past performance. However,low sale force productivity (target audience of consulting and general physicians ishighly fragmented and low number of products offered) and high regulatory riskexposure are challenges. Overall, the company secures the 6 thposition on our DNAframework.

Torrent: Torrents business has exhibited best-in-class risk management (low eventspecific and regulatory risks) and product selection (high chronic therapy exposure).However, the company has been plagued by patchy sales execution (changes inbusiness heads) and limited scope for growth (high therapy and geography coverageand low sales force productivity). Overall, Torrent scores the 7th position on ourframework.

Indoco: Indoco ranks high on product selection, sales execution, low event specificrisk and low geographical coverage. However, low base business growth, sales forceproductivity and high regulatory risk exposure drag the overall competitivepositioning to 9thamongst the 19 companies analysed.


28/100

Healthcare


Valuations not in sync with DNAIndian pharma valuations are still reasonable in global context, but

In our Hunting for sustainabilityreport dated 5 May 2014, we had highlighted thatthe Indian pharma valuations were lower than the historical premiums that they havecommanded over international pharma (represented by the BWPHRM Index) and

international generic pharma (represented by the BIGNRCGP Index) despite visibilityof higher growth and RoCE and no deterioration in competitive advantage.

The valuations of Indian pharma companies have reverted closer to the longer-termaverage since. We believe that the reversion has been a product of better visibility ofcommitment of Indian pharma companies to longer-term growth drivers like NCEs,NDDS based products, biosimilars and complex products like vaccines, inhalers, andinsulin. However, the mix of reversion in valuation has been slightly different thanwhat we had envisaged.

Exhibit 30:

BSETHCs P/E premium has reverted to its 10-year average vis-a-vis the BWPHRM Index

Source: Bloomberg, Ambit Capital research

Exhibit 31:

BSETHCs P/E premium has reverted to 30% vis-a-vis the BIGNRCGP Index

Source: Bloomberg, Ambit Capital research

We illustrate below that the valuations for Indian pharma companies which areexpected to derive a larger proportion of growth from the US have re-rated morethan the valuations for those which derive a higher proportion of growth from EMs.We believe that the prevailing market wisdom favours companies headed West(towards the US), as: (a) the US market offers a low gestation period and (b) the USmarket also offers higher RoCEs and margins on similar products sold in othermarkets.

We question the prevailing wisdom of investing in companies headed to USWhilst we agree that the US market offers better realisations/higher margins andhigher RoCEs (after gaining scale) in the near term, we argue that the effort requiredfor a mid-sized Indian company to establish itself in the US cannot be taken forgranted. We believe companies like IPCA (offering cost advantage due to verticalintegration) and Natco and Indoco (entering with niche products with manufacturingcomplexity) have better chances of scaling up in the US than others, which are justentering with me-too products and/or leveraging upon the currently prevailingshortages.

The consolidation on the buy and supply side in the US is also likely to make lifedifficult for the marginal players in the absence of a compelling proposition.However, the street has given the benefit of doubt to these players, as is reflected inthe stock performance of the US-bound mid-sized companies.

-20%

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The ability of mid-sized Indiancompanies to establish themselvesin the US cannot be taken forgranted
http://webambit.ambit.co/reports/Ambit_Healthcare_Thematic_05May2014.pdfhttp://webambit.ambit.co/reports/Ambit_Healthcare_Thematic_05May2014.pdfhttp://webambit.ambit.co/reports/Ambit_Healthcare_Thematic_05May2014.pdfhttp://webambit.ambit.co/reports/Ambit_Healthcare_Thematic_05May2014.pdfhttp://webambit.ambit.co/reports/Ambit_Healthcare_Thematic_05May2014.pdfhttp://webambit.ambit.co/reports/Ambit_Healthcare_Thematic_05May2014.pdf


29/100


30/100

Healthcare


IPCA and Glenmark are already making investments in innovative avenues for growthwhilst Torrent and Ajanta have not made any significant moves on this front.However, given that all these companies appear in the bottom right quadrant of theexhibit above and are all available at valuations of 10.0x-13.0x FY16E EV/EBITDA (ascompared to an average of 12.5x), we believe there are upsides to these stocks.

Exhibit 34:

Ajanta, IPCA, Torrent and Glenmark are the best bets among mid-caps

RoCE (%)(FY14)

Score onBusiness

DNA

EV/EBITDA(FY16)

MCap(US$ Mn)

Market focus

Sun Pharma 37.5 19 18.2 29,381 Presence across markets

Glenmark 20.8 18 12.9 3,483 EM-bound

Biocon 12.7 17 10 1,655 EM-bound

Ajanta 46.7 16 11.5 948 EM-bound

IPCA 30.6 15 10.1 1,668 US-bound

Torrent 30.4 14 10.8 2,417 EM-bound

Lupin 26.3 13 12.4 9,973 Presence across markets

Indoco 17 12 12.3 473 US-bound

Cipla 18.9 11 15 7,611 Presence across markets

Claris 17.8 10 3.5 159 EM-bound

Strides 12.1 9 10.7 699 US-bound

Natco 17.5 8 20.9 811 US-bound

FDC 24.8 7 8.4 470 EM-bound

Cadila 17.5 6 13.8 4,398 US-bound

Unichem 20.8 5 7.7 349 EM-bound

Ranbaxy 7.1 4 21.2 4,562 US-bound

Alembic 37.7 3 13.7 1,254 US-bound

Dr. Reddy 15.5 2 12.3 8,445 Presence across markets

Wockhardt 26.6 1 11.9 1,532 US-bound

Source: Company, Bloomberg, AIOCD data, Ambit Capital research

Based on our analysis above, we highlight that Ajanta, IPCA, Torrent andGlenmark appear to be the best bets amongst the Indian mid-caps. Biocon andIndoco miss the cut due to depressed RoCEs.

Exhibit 35:

Our key recommendations

Company RatingCMP

( )Mcap

(US$mn)P/E

(FY15E)P/E

(FY16E)EPS CAGR

(FY15E-17E)RoCE

(FY14)Comments

SunPharmaceuticals

BUY 806 29,381 32 25 21% 38%

We highlight that Sun Pharmas acquisition of Ranbaxy is akey positive; synergies are likely to be US$400mn-500m by

Year 3 as opposed to the management guidance ofUS$250m.

Lupin Ltd BUY 1,359 9,973 25 22 17% 26%Lupins expertise in evolving profitably would keep thecompany on the growth track as it moves up the pharma

value chain.

Dr. Reddy's Labs BUY 2,959 8,445 22 20 19% 16%Higher visibility on longer-term growth drivers keep usbullish on Dr. Reddys prospects in India/RoW andregulated markets.

Cadila Healthcare BUY 1,273 4,398 26 19 27% 17%High investments in longer-term growth drivers, highpresence in India and a large US ANDA pipeline are likelyto fuel growth over the next 3-5 years.

IPCA BUY 820 1,668 20 16 21% 31%

Whilst IPCA is facing near-term headwinds from regulatoryissues with the FDA, we keep sight of the fact that thecompany has a credible Indian and branded exportsbusiness with an inclination towards innovation.

Aurobindo SELL 896 4,302 17 13 31% 24%Lack of investments in longer-term growth drivers, pastlegal issues with the promoter, and absence of moatedrevenue streams keep us cautious on Aurobindo.



31/100

Healthcare


Suggest switching from Aurobindo (SELL)to Cadila (BUY)We suggest switching from Aurobindo to Cadila despite Aurobindo trading at a 35%discount to Cadila (on one-year forward EV/EBITDA), due to:

Management issues: Cadila faces some management issues like an ineffectiveacquisition track record in the recent past and multiple business interests.However, Aurobindo faces much severe issues like involvement of promoter inillegal issues, poor accounting practices leading to undisclosed income in the

past, and less than ideal disclosure practices.

Higher presence in branded markets: Cadila sources 59% of its revenues(FY14) from branded businesses (moated) and Aurobindo sources a negligibleportion of its revenues from branded business. Branded businesses lend theopportunity to build brand equity and product differentiation. These leversprovide moats to revenues and profits and in turn offer opportunity to scale up.Lack of branded businesses makes us cautious on Aurobindo medium term

growth prospects and profitability.

Absence of incumbents from US product segments: Cadila sources anegligible portion of revenues from those product segments in US whereincumbents are temporarily off-market due to FDA issues. Similarly, Cadilaspipeline in the US is targeted towards more complex products (transdermals,inhalers, oncology, etc). However, Aurobindo sources a significant portion ofrevenues from cephalosporins and general injectables, whilst a significant portionof its pipeline is targeted towards general injectables, penems and controlledsubstances. All these segments have large players like Teva, Hospira, andRanbaxy which are currently off-market due to FDA issues. Whilst the absence ofthe incumbents does present a near-term opportunity to gain market share, webelieve when the incumbents eventually return, Aurobindo is likely to face market

share and price erosion.

Long term investments / R&D spend:Despite similar market capitalisations,Cadilas R&D spend is almost 2x of Aurobindos. Lack of investments in longerterm growth drivers such as NCEs, NDDS and biosimilars are likely to hurtAurobindos long-term growth prospects.

Regional mismatch in revenue and costs: Cadila sources 44% of FY14revenues from India. Hence, the companys income statement is hedged againsthigher cost inflation in India. However, Aurobindo has 53% of operating costs inIndia with no commensurate revenue. This exposes Aurobindo to cost inflation inIndia which may not be passed on to consumers in developed markets.

Aurobindo deserves a deep discount: Our DCF-based target prices suggest a50% discount to Cadila and other large-cap peers. The stock currently trades at a

35% discount. We expect Cadila to maintain a 10-15% discount to its large-cappeers. Our TP for Aurobindo implies an 8% downside from current levels and that

for Cadila implies a 17% upside.


32/100

Healthcare


Exhibit 36:

Aurobindos discount to Cadilas 1 year forwardEV/EBITDA has narrowed


Exhibit 37:

Revenue growth contribution for Cadila ishigher from stable branded business as compared to

Aurobindo

Source: Company, Ambit Capital research; Note: Unbranded includes US,Europe, ARV, and RoW (For Aurobindo). Branded includes India formulations,

RoW (For Cadila) and Consumer business (For Cadila)

Exhibit 38:Aurobindos EBITDA and RoCE have recentlyovertaken Cadilas given Cymbalta launch in US and lackof traction for Cadila


Exhibit 39:R&D spend of Cadila is almost double that ofAurobindo


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EV/EBITDA premium/discount %Cadila Mcap, RHSAurobindo Mcap, RHS

Unbranded, 49.4%

Unbranded, 75.9%

Branded,48.2%

API, 2.4%API, 24.1%

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Cadila Aurobindo

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FY09 FY10 FY11 FY12 FY13 FY14

CDH, EBITDA margin ARBP, EBITDA margin

CDH, RoCE (RHS) ARBP, RoCE (RHS)

1,564 1,660

2,502

3,628

4,669 4,563

952 973

1,3941,593

2,085

2,551

0

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`.

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Cadila Aurobindo


33/100

Healthcare


Case studiesWe highlight a case study exhibiting how a mid-sized pharma company has beenable to re-rate, as it extended its capabilities and strength of the Indian business inother geographies and another case study of a company that does not have a strongfranchise in India and has hence failed to create a strong business in the export

markets.

Case study 1: IPCA Labs (Rank 5 out of 19 in our DNAframework)

IPCAs RoCE has been ramping up led by operating leverage and product mix

Exhibit 40:

IPCA has built a robust, cost-effective and capital-efficient pharmafranchise in India


Historical stock price chart for IPCA

Exhibit 41:

IPCA has delivered consistent returns for stockholders led by rational capital allocation


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Exports starting toramp up in semiregulated markets

Malaria dominatedsales in India; Exportsto semi regulated

Exports and Institutionalmalaria business inAfrica lead net profitgrowth

USFDA approved plantexpected to fuel growthover next 2-3 years. Theplant has beencommercialised in4QFY14

Production halt in APIfacility in Ratlam due toissue of Form 483


34/100

Healthcare


Exhibit 42:

IPCAs re-rating as a sustainable business has been reflected in its P/Emultiples

Source: Company, Bloomberg, Ambit Capital research

Case study 2: Unichem Labs (Rank 14 out of 19 in our

DNA framework)Unichems RoCE has been volatile due to inconsistent revenue growth inIndia and exports

Exhibit 15:

Unichems domestic business suffered from therapeutic substitution oflosartan by Telmisartan

Source: Company, A

Documents

Ambit Healthcare Thematic 16Sept14