A low risk, high-growth option

While negative news flow may be an overhang for the stock in the short term, Cipla’s growth rates are likely to be boosted by formulation exports.

A partnership-based distribution model, presence across international markets, high margin formulation business and expansion should ensure higher-than-industry growth rates for Cipla. The company, which is the leader with a 5 per cent market share in the domestic pharma space and is a major player in respiratory, anti-infective, cardiovascular and gastroenterology segments, accounts for more than three fourths of the anti-asthama inhaler and anti-AIDS drug market in the country. With strong growth in the domestic and export formulation businesses, sales are expected to grow by 20 per cent over the next few years. Though the medium-to-long-term story picture is intact, the stock had seen some correction in the recent past (recovering later) due to issues related to the takeover of its South African distribution partner and the US FDA’s observations on its manufacturing sites.

The US FDA issue
Three of Cipla’s bulk drugs and formulations manufacturing sites-Goa, Kurkumbh and Bangalore-were inspected by the US FDA and a 483 was issued. The 483 is a form containing US FDA’s observations of non-compliance with current Good Manufacturing Practices.Though the FDA action is not serious in nature and a number of drug majors have been issued the same, it could snowball into a bigger problem if Cipla fails to address the concerns raised by the US regulatory body. The company markets its basket of 118 products through its 17 tie-ups in the US with the geography accounting for a 10 per cent of total sales. More importantly, FDA approvals are needed for supply of anti-AIDS drugs to the African region (accounts for a third of the company’s exports and roughly 17 per cent of sales or Rs 700 crore) under the US President’s Emergency Plan for AIDS Relief (PEPFAR) programme. While the Cipla management has said that the company is taking adequate steps to sort out the issue, any delays on this count could impact its exports to the US as well as Africa.
 

ON A STRONG FOOTING
in Rs crore	FY08	FY09	FY10E
Sales	4,218	5,270	6,011
Growth y-o-y (%)	18.0	25.0	14.0
OPM (%)	20.0	24.1	22.0
Net profit	701	767	984
EPS	9.1	9.8	12.8
P/E	24.9	24.3	17.8
E: Analyst estimates

Cipla Medpro
Cipla distributes its drugs in the South African market through its local generic partner Cipla Medpro with which it has a 20-year supply agreement but does not have any equity stake in the company. The issue in contention is the hostile bid for Cipla Medpro by another South African generic player, Adcock Ingram. With the Indian supplier (Cipla) opposed to the hostile takeover and threatening to go solo in marketing its drugs if Adcock Ingram forces the issue, Cipla’s revenues from South Africa (5 per cent of sales or about Rs 200 crore) could be at risk. Analysts say that since Cipla follows a partnership model (also that Africa is an important geography for growth) it is highly unlikely that it will choose to terminate the deal in case Adcock Ingram takes control. Similarly, thanks to its large basket of anti-retroviral (anti-AIDS) and other drugs, the new partner (if Adcock takes over) may also want to negotiate a compromise rather than risk a break-up.

Growth prospects
Cipla’s unique business model of partnering generic players worldwide has helped it to grow its exports at a fast clip and at low cost. An increasing formulation business (currently 80 per cent of sales) will help the company improve its margins. The partnership model, which gives it a wide geographic presence quickly, and increasing formulations pie are evident in the sales growth experienced in FY09. Net sales were up 25 per cent to Rs 5,270 crore, while operating margins were up 401 basis points to 24.1 per cent due to better product mix and forex gains. While domestic sales have grown by a healthy 15 per cent, exports aided by a 40 per cent jump in formulation sales have grown by a robust 31 per cent. The share of exports to total revenue, which has increased to 55 per cent from 51 per cent last year, is likely to increase as the company expands its presence beyond its core areas of the Americas, Europe and Africa which currently contribute about 80 per cent of exports.

Investment argument
Despite the FDA and the Cipla Medpro issues, the share price of Cipla has risen 17 per cent over the last one month. In addition to its steady growth in domestic and exports markets, the conclusion of an Rs 2,000 capex programme in the current fiscal should help in aiding sales growth, reducing tax rates and increasing cash flows. In addition to formulation exports, the launch of inhalers in the European market could also push up revenues considerably. At Rs 239, the stock trades at 16 times its FY10 earnings estimate of Rs 15, and can be considered at dips.