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Cipla: The API boost

Oct 23, 2006

Performance summary
Cipla has announced robust results for the second quarter and half year ended September 2006. The impressive topline growth has been led by strong performances of both its domestic and exports businesses. Margins have, however, contracted on the back of an increase in raw material and staff costs. Despite this, a considerable rise in other income, reduction in interest costs and higher sales have contributed to the healthy growth in bottomline.

Financial performance: A snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 6,722 8,961 33.3% 13,350 17,597 31.8%
Expenditure 4,944 6,685 35.2% 10,073 13,032 29.4%
Operating profit (EBIDTA) 1,778 2,276 28.0% 3,277 4,565 39.3%
Operating profit margin (%) 26.4% 25.4% 24.5% 25.9%
Other income 10 190 1743.7% 94 409 336.0%
Interest 17 16 -7.7% 31 44 42.2%
Depreciation 215 260 20.9% 350 505 44.3%
Profit before tax 1,556 2,190 40.8% 2,990 4,426 48.0%
Tax 330 403 22.0% 650 919 41.3%
Profit after tax/ (loss) 1,226 1,788 45.8% 2,340 3,507 49.9%
Net profit margin (%) 18.2% 20.0% 17.5% 19.9%
No. of shares (m) 299.9 777.2 299.9 777.2
Diluted earnings per share (Rs)* 9.2
P/E ratio (x)* 28.6
(* on a trailing 12-months basis)

What is the company's business?
Cipla is the second largest pharma company in the domestic retail market (ORG survey) and has presence in formulations and bulk drugs manufacturing. All the bulk drug manufacturing facilities of the company have been approved by the US FDA and the formulation facilities have been approved by the Medicine Control Agency (UK), the Medicine Control Council (South Africa), the Therapeutic Goods Administration (Australia) and other international agencies. On the exports front, the company has strategic alliance with major generic manufactures such as Watson, Mylan, Barr and Ivax for supply of bulk drugs. It has a very wide product range in the domestic market, which includes antibiotics, anti-bacterial, anti-asthmatics, anti-inflammatory, antiretroviral, anti-cancer and cardiovascular. The company also concentrates on developing specialty bulk drugs for export markets.

What has driven performance in 2QFY07?
Balanced revenue growth: Cipla clocked an impressive 33% YoY growth in topline during the quarter, which was driven by both its domestic and exports businesses. The domestic business grew by 22% YoY led by a strong performance of its anti-asthmatics, anti-retrovirals, cardiovascular and antibiotics segments. Exports also reported a robust 37% YoY growth largely contributed by its API exports, which were up 120% YoY. It must be noted that during the quarter, Ivax (with whom Cipla has tied up for supplying APIs) had received 180-day exclusivity periods for the drugs 'Finasteride' and 'Sertraline'. This contributed to the strong growth in Cipla's API export sales, as it is the supplier to Teva/Ivax for these drugs as well. Formulations exports sales, however, grew by a relatively slower 13% YoY.

Business snapshot
2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Domestic 3,636 4,444 22.2% 7,576 9,173 21.1%
Exports
- Formulations 2,480 2,800 12.9% 4,634 5,987 29.2%
- APIs 725 1,597 120.2% 1,419 2,349 65.5%
Total exports 3,206 4,397 37.2% 6,053 8,335 37.7%
Total sales 6,841 8,841 29.2% 13,628 17,508 28.5%
Other operating income
- Technology knowhow/fees 75 176 133.5% 94 266 183.6%
- Others 56 136 141.3% 260 248 -4.7%
Total 132 311 136.8% 354 514 45.3%
Total income from operations 6,973 9,153 31.3% 13,982 18,022 28.9%

Margin pressure: Operating margins have declined by 100 basis points during the quarter on the back of an increase in raw material and staff costs. The company has attributed the increase in raw material costs to a change in the product mix. Staff costs (as a percentage of sales) have also risen due to an increase in managerial remuneration as well as overall manpower. Going forward, though we expect API exports to grow faster than formulations, we expect Cipla to maintain operating margins at around 23% levels mainly due to a higher contribution of formulations (which enjoy higher margins than APIs) to total sales.

Cost break-up
(% of sales) 2QFY06 2QFY07 1HFY06 1HFY07
Raw material cost 43.3% 45.8% 45.4% 45.3%
Staff cost 4.5% 4.9% 5.2% 5.4%
Other expenditure 25.7% 23.9% 24.8% 23.4%

The bottomline picture: Bottomline growth (up 46% YoY) outpaced topline growth during the quarter backed by higher other income and lower interest costs. Strong topline performance has also aided this growth despite pressure at the operating level.

Over the quarters: Cipla's growth at both the topline and bottomline level has been commendable outpacing most of its peers in the pharma industry. This is due to its low-risk strategy of supplying bulk drugs to global generic companies. As its partners begin to receive ANDA approvals in the generic markets, we expect Cipla's bulk drugs exports to pick up pace going forward. However, it must be noted that during quarters wherein API sales have outpaced formulation sales, operating margins have been comparatively lower.

Quarterly trend
2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Net sales growth 15.5% 30.9% 62.7% 30.3% 33.3%
Operating profit margin 26.4% 20.4% 20.7% 26.5% 25.4%
Net profit growth 27.9% 39.5% 80.7% 53.0% 45.8%

What to expect?
At the current price of Rs 263, the stock is trading at a price to earnings multiple of 18.8 times our estimated FY09 earnings, which is at the higher end of the valuation spectrum. Going forward, on the exports front, the Cipla will be a strong performer as it has adopted a low-risk strategy of supplying bulk drugs to generic companies like Ivax and Watson. We believe that this focus on contract manufacturing shall gather momentum in the future keeping in mind the generics potential in the coming years. In the domestic market, the company is likely to maintain its strength with its strong field presence and strong brands. Having said that, despite the positives, the stock seems to be fairly priced with limited upside and to that extent, we advise investors to exercise caution.

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