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Pharmaceuticals
Rupee-led fears overblown; Opportunity to accumulate
May 21, 2014
Ashish Rathi
ashish.rathi@emkayglobal.com
+91-22-66121257

Krishnanath Munde
krishnanath.munde@emkayglobal.com
+91-22-66121254
n We believe the recent underperformance by Pharma sector
stocks and fears of a further downside due to strengthening
Rupee are unwarranted from a long-term perspective
n Underlying exports growth in constant currency remains very
robust; Rupee appreciation-led translation/transaction losses
to be a one-year affair; Base effect to play out thereafter
n Strong government is a long-term positive for the sector;
Improved demographics, increased healthcare spend and
more money into the hands of consumers to boost growth
n Correction/underperformance provides an opportunity for
portfolio building into high-quality stocks; PEg ratio continues
to be attractive; Return ratios are best in class
Near-term negatives a one-year affair; base effect to play out in FY16
We would like to highlight that for our coverage universe of 12 stocks the export
contribution to the aggregate top-line is ~77% (Exhibit 1). In our view, the impact of rupee
appreciation, if any, would be felt only over a longer period of rupee stability at higher
levels, as several companies have hedging policies that would partly protect near-term
receivables (3-6 months). We would like to emphasize that the underlying constant
currency export CAGR for FY14-16E for our coverage universe remains robust at 15%
(average) and 18% (median), implying the rupee-led loss in growth to be a one-year affair.
The Rupee depreciation cycle (versus the Dollar) of FY13 (13.5% depreciation) and FY14
(11.2% depreciation) saw margins of companies under coverage on an average expand
by only 1.1% and 1.5%, respectively for the individual reporting periods (Exhibit 2). This
highlights the fact that EBITDA margin sensitivity to currency movements is limited and
more driven by drug launches / geographical performances than Currency fluctuations
alone.
Long-term positives far too many; improve pharma sectors outlook
Policy decisions on FDI investments, solidarity in the regulatory stance towards developed
markets and higher healthcare spend as a percentage of GDP would benefit the sector in
the aftermath of the election outcome. We also believe that a higher disposable income in
the long run through a revival in economy, as well as better infrastructure and reach to
healthcare would boost growth of the domestic pharma industry. The key beneficiaries
would be companies deriving higher sales from the domestic market, especially in rural
and semi-urban areas. Many of the companies under our coverage also have dollar-
denominated loans, outgo for which should reduce if rupee appreciates and stabilizes at
higher levels over a longer period of time.
Recent correction an opportunity to buy into high quality names
We believe with the high growth potential for most stocks in the sector, PE levels with the
coverage average of one-year forward P/E at 15x remains attractive. The implied PEg
ratio of 1x, with best-in-class return ratios (ROE average ~25%, core ROICs average
19%), provides opportunity for healthy price appreciation of stocks.
We believe, given the performance track record and the possibility of positive surprises
(launches unanticipated/limited competition opportunities), the stocks in the sector provide
comfort on the risk/reward scale.
Our top picks in the sector are Dr Reddys & Lupin (large caps) and Ipca & Divis Labs
(mid caps).

Pharmaceuticals Sector Update


Emkay Research May 21, 2014 2
Exhibit 1: Export- % of sales and constant currency growth
Export as a Constant currency growth CAGR
Company
Target
Price
Rating
% of sales FY13 FY14 FY15E FY16E FY14-16E
Aurobindo
495
Hold 88% 12.5% 27.4% 44.6% 11.1% 26.8%
Cadila HC
1121
Buy 56% 6.6% 9.7% 17.6% 16.4% 17.0%
Cipla
410
Hold 60% 6.5% 15.2% 11.5% 19.4% 15.4%
Divis Labs
1534
Buy 90% 3.1% 9.4% 20.7% 18.0% 19.3%
Dr Reddys
3186
Buy 88% 7.0% 3.0% 10.7% 13.7% 12.2%
Glenmark
698
Buy 76% 8.1% 10.6% 16.7% 19.7% 18.2%
IPCA
978
Buy 69% 6.1% 10.0% 16.5% 18.1% 17.3%
Lupin
1189
Buy 78% 23.9% 8.8% 21.7% 15.6% 18.6%
Ranbaxy Unrated NA 79% 3.1% 26.0% -15.3% 3.0% -6.6%
Sun Pharma
719
Buy 77% 43.9% 33.8% 3.2% 0.3% 1.7%
Torrent Pharma
721
Hold 63% 6.7% 29.7% 24.2% 16.6% 20.4%
Unichem
221
Hold 47% 23.6% -1.3% 20.2% 17.9% 19.1%
Average 73% 12.6% 15.2% 16.0% 14.1% 14.9%
Median 77% 6.8% 10.3% 17.1% 16.5% 17.7%
Source: Company, Emkay Research


Exhibit 2: EBITDA margin (FY14) and expansion (yoy basis)
FY14 EBITDA margin expansion, %
Company EBITDA margin, % FY13 FY14 Hedging policy
Aurobindo 25.8 2.0% 10.6% No hedges
Cadila HC 16.6 -2.9% -1.1% No hedges
Cipla 20.6 2.9% -6.0% Forward cover of USD 240mn.
Divis Labs 43.5 1.0% 5.5% No hedges
Dr Reddys 23.2 -1.9% 0.4% Foreign currency cash flow hedges (USD 335mn).
Glenmark 21.8 -0.9% 1.6% Forward contract of USD 15mn
IPCA 25.0 0.4% 2.8% Current hedges: USD55mn
Lupin 26.6 3.1% 3.1% 10-12% receivables hedged at near Rs 58 levels
Sun Pharma 45.1 3.4% 1.8% Hedges ~USD 300mn
Torrent Pharma 22.8 3.0% 1.2% Hedges ~USD 280mn
Unichem 15.7 2.6% -0.4% No hedges
Ranbaxy 7.6 0.5% -1.4% Outstanding long term derivative contracts of USD 565mn
Average 24.5 1.1% 1.5%
Median 23.0 1.5% 1.4%
Source: Company, Emkay Research


Pharmaceuticals Sector Update


Emkay Research May 21, 2014 3

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