Reversal in fortunes for Cipla

Improving margin and revenue outlook help stock outperform broader indices.

For November, when the BSE Sensex lost a little more than 11 per cent and the healthcare index was down one per cent, Cipla’s 11 per cent gain is commendable. The stock, underperforming for most of the last 12 months on margin concerns, bounced back as the Street gained confidence on the company’s margins growth being sustainable.

Cipla’s Indore special economic zone (SEZ), earlier hit by higher costs, is seeing increasing contribution to profits. An improving product mix, with reducing share of low-margin anti-retrovirals (ARV), is also aiding margins. Domestic growth in the September quarter at 12 per cent also came better than most peers (single-digit growth) and was ahead of analysts’ expectation of 10 per cent. Overall, these helped Cipla post a double-digit increase in profits, the first time in seven quarters. In this backdrop, most analysts have turned positive on the stock, which now trades at Rs 327.

PROFITABILITY UP
Cipla had seen continuous decline in operating margins during 2010-11 (see chart), mainly due to increasing costs on the new Indore SEZ, which hadn’t reached breakeven. Contributions from the SEZ have increased, with the September quarter seeing it add Rs 150 crore to revenue. This should grow, as approvals from all major global regulatory authorities (except the US FDA) have been received. Cipla expects the SEZ to contribute 10-12 per cent or Rs 700 crore to overall sales by the end of 2011-12. The gain in margins has come with an improving product mix. The proportion of low margin ARVs in overall formulations’ exports is reducing. Sushant Dalmia at PINC Research points out that Cipla has decided to reduce its tenders for supplies of ARV drugs. Analysts say export of such drugs account for 15-20 per cent of revenue.

STEADY DOSE OF GROWTH
in Rs  crore	FY11	FY12E	FY13E
Revenue	6,130.0	6,974.0	7,971.0
% chg y-o-y	14.4	13.8	14.3
Ebitda	1,157.0	1,562.0	1,828.0
Ebitda (%)	18.9	22.4	22.9
Net profit	990.0	1,097.0	1,291.0
% chg y-o-y	-8.6	10.8	17.7
EPS (Rs )	12.3	13.6	16.2
PE (x)	26.5	24.0	20.2
E: Estimates Source: CapitaLine Plus , Bloomberg, Analyst reports

DOMESTIC SALES GROW
The domestic growth of around 12 per cent in the quarter, on a high base, was also remarkable, looking at the single-digit growth reported by most peers. Sarabjit Kaur Nangra at Angel Broking observes that improvement on the operating front came on the back of strong growth in the domestic formulation business (46 per cent of overall revenue). Commendable, as 40 per cent of the domestic portfolio comprises the acute segment, where competition is high.

Analysts at Motilal Oswal Securities say Cipla is addressing the issue (of stiff competition) by increasing its field force; these are up by 500 people to 6,500 for better penetration. Further, it plans to increase focus on oncology and neuro-psychiatry segments, strengthening its chronic products basket.

Domestic growth continues to be strong during the third quarter, with an HSBC report indicating 11.8 per cent growth in October. However, the increase in field force (and, hence, employee costs) may limit the margins improvement in the short term.

EXPORTS
Domestic sales apart, prospects for the export business (half of revenues) are also improving, with the recent rupee depreciation being an additional gain. The company exports to 175 countries, with growth coming through marketing alliances and tie-ups. Amongst exports, inhalers form around 20 per cent of sales. Cipla has a pipeline of 11 inhalers for the European markets, of which four have got regulatory approval. The CFC-free inhalers expected to be launched in the US and Europe have a potential market size of $3 billion and should drive growth in the long run.

The company is negotiating with multinationals such as Pfizer, GlaxoSmithKline and Boehringer for long-term supply agreements, say analysts. While Salmeterol inhalers have been launched in some countries, the management expects launch of the Seretide inhaler in Europe next year, which can boost revenue in a big way. However, the Street has some apprehensions. Analysts at Morgan Stanley say, “We remain circumspect about the EU Seretide strategy, as competition appears ahead of Cipla and we see regulatory challenges.” Nevertheless, even if Cipla is able to grab a small share of the overall market, it would still mean big gains.

STRONG WICKET
Rising utilisation at its Indore SEZ, improving product mix with lower ARV sales, the rupee depreciation benefiting exports and now a better margin outlook have seen analysts turning positive on the stock.

Analysts at Morgan Stanley add that the Indore SEZ has ability to achieve Rs 500 crore in quarterly sales and they expect all these factors to translate into a two-year (FY11-13) compounded annual growth in earnings per share of 20 per cent (for Cipla) versus nine per cent seen during FY07-11.

On the flip side, implementation of the new pricing policy for drugs in its current form can impact domestic revenue in the short term, though marginally.

Analysts at HSBC say the new pricing policy draft, if implemented in its current form, is expected to impact domestic formulations’ sales by a negative two to three per cent.