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Pharmaceuticals:
Contract Research & Manufacturing Services
Crème de la CRAMS
Reason for report: Initiating coverage
Divi’s Laboratories
Market Cap Rs73.3bn/US$1.5bn Year to March 2008 2009E 2010E 2011E
Bloomberg code DIVI IN Revenue (Rs mn) 10,435 13,086 16,193 19,963
Shares Outstanding (mn) 64.6 Net Income (Rs mn) 3,597 5,003 6,310 7,800
52-week Range (Rs) 1,930/890 EPS (Rs) 54.2 75.3 95.0 117.4
Free Float (%) 46.6 % Chg (YoY) 70.1 36.6 24.8 23.6
FII (%) 14.7 P/E (x) 20.4 14.9 11.9 9.7
Daily Volume (US$/'000) 4,450 CEPS (Rs) 61.2 84.9 107.1 133.0
Absolute Return 3m (%) (23.9) EV/E (x) 17.1 12.1 9.2 6.9
Absolute Return 12m (%) (26.1) Dividend Yield (%) 0.4 0.4 0.5 0.7
Sensex Return 3m (%) (41.3) RoCE (%) 43.4 41.8 36.5 32.4
Sensex Return 12m (%) (54.4) RoE (%) 51.5 45.7 38.8 34.1
Shareholding pattern
Dishman Pharmaceuticals Divi’s Laboratories
Mar Jun Sep Mar Jun Sep
’08 ’08 ’08 ’08 ’08 ’08
Promoters 61.5 60.7 60.7 Promoters 53.6 53.5 53.4
Institutional investors 29.4 30.2 29.1 Institutional investors 30.0 29.9 29.9
MFs and UTI 20.5 18.4 16.5 MFs and UTI 13.9 14.4 15.1
Insurance Cos. 0.0 0.0 0.0 Insurance Cos. 0.1 0.1 0.1
FIIs 8.9 11.8 12.6 FIIs 15.6 15.5 14.7
Others 9.1 9.2 10.3 Others 16.9 16.6 16.7
Price chart
Dishman Pharmaceuticals Divi’s Laboratories
450 2,000
400
350 1,600
300
(Rs)
(Rs)
250
200 1,200
150
100 800
Nov-07
Jan-08
Mar-08
May-08
Jul-08
Nov-08
Nov-07
Jan-08
Mar-08
May-08
Jul-08
Nov-08
Sep-08
Sep-08
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Pharma – CRAMS, November 24, 2008 ICICI Securities
CARBOGEN – Strengthening capabilities ....................................................................39
Going slow on acquisitions ...........................................................................................39
New avenues of growth.................................................................................................39
China facilities – Low cost advantage...........................................................................40
Strong management capabilities to drive growth ..........................................................40
Divi’s Laboratories.........................................................................................................42
Leaping ahead ................................................................................................................43
Investment summary .....................................................................................................44
DLL – Top-tier global ACMO from India ......................................................................46
Enjoys customer confidence .........................................................................................46
Array of services ...........................................................................................................47
Robust pipeline of projects............................................................................................47
Large capex driving growth ...........................................................................................47
Generics API business to see strong growth .............................................................48
Leadership position in top products ..............................................................................48
Strong product pipeline .................................................................................................48
Carotenoids – Long term opportunity .........................................................................50
Primer on carotenoids ...................................................................................................50
DLL set to capitalise on opportunity..............................................................................50
Attractive valuations......................................................................................................51
Financial summary ........................................................................................................54
Stellar growth in the past...............................................................................................54
H1FY09 performance – Impressive ..............................................................................54
Revenue and earnings set for multifold growth ............................................................54
Improving RoCE and EBITDA margin...........................................................................55
Annexure 1: Financials..................................................................................................56
Annexure 2: Index of Tables and Charts .....................................................................64
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Investment summary
Outsourcing – Big opportunity for India. The pharma outsourcing opportunity in
India is set to explode in the coming years on the back of declining R&D productivity,
many blockbusters of global pharma majors nearing patent expiry, fewer blockbuster
products reaching markets, increased time to bring the drug to the market, fierce
competition from generic companies and continuous cost pressure on innovators. We
estimate that the size of the CRAMS business is set to grow to US$72bn in CY12
from US$37bn in CY07, a CAGR of 14%.
IPR-respecting strategy wins customers. DPCL and DLL are the most preferred
contract manufacturing companies as regards non-compromise on respecting &
protecting customers’ IPR. Further, their stated ‘non-compete with customer’ policy
and collaborative approach has won them customer confidence. Consequently,
customers (large & mid-size pharma MNCs) are willing to shut their plants, move
products and outsource API/intermediates for patent products, NCEs and generics.
On high growth trajectory. DPCL and DLL are on a high growth path and expected
to register impressive EPS CAGR of 47% and 29% respectively through FY08-11E;
EBITDA margin of both companies is set to expand ~500bps each over the same
period. They enjoy one of the highest RoNWs in the sector, with DPCL at 19% and
DLL at 52% respectively. Our fair value for DPCL and DLL is Rs214 and Rs1,527,
implying potential upside of 46% and 35% respectively over the next 15-18 months.
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Risks
High customer concentration
Usually, the top-5 customers contribute a major part of revenue (35-60%) to ACMOs.
While it may be difficult to significantly alter such concentration, it may be prudent to
manage this risk through larger customer, project, geographical and time horizon
spread.
Volatility in earnings
Revenue and profitability of a CM manufacturing business can often be volatile on
account of: i) lumpy contracts and delays or cancellations, ii) longer gestation of some
projects, iii) certain contracts such as CS leading to significant volumes and profits
when the drug enters phase III, reaches the market or wins many CS projects at a
time – e.g. DLL’s EPS CAGR over FY03-06 was only 9% vis-à-vis 127% through
FY06-08.
Intensifying competition
Competition from Asian countries continues to be on the rise, given that India and
China are the two key Asian nations offering CRAMS. In China, competition is more
from research services, with emergence of WuXi Pharma Tech (stock has crashed
~80% to US$6.3 from the peak; CY08 consensus revenue & PAT: US$262mn &
US$36mn respectively) compared with manufacturing. This places Indian ACMOs in
good stead. However, competition among Indian ACMOs and other competitive
dynamics could reduce EBITDA margin (41% for DLL and 19% DPCL for FY08) in the
medium-to-long term, as witnessed by the Indian IT outsourcing sector. Given the
huge global opportunity in the ACM space, there is ample scope for growth of new
and existing players from India and Asia.
Implementation of IPR
Notably, India has accepted TRIPs from January ’05. While TRIPs have a more direct
bearing on launch and marketing of patented dosage-form products in India as
against outsourcing deals, poor implementation may impact outsourcing as the
customer wants its IPR to be fully protected at all times. The recent patent battle in
India with respect to two cancer drugs – Roche’s Terceva and Novartis’ Glivec – is a
case in point.
Acquisition-related risk
Many Indian ACMOs such as DPCL follow an acquisition strategy that carries
associated risks such as extracting operational efficiencies and synergies, overpricing
intangibles, cultural differences, longer payback period and failure to retain key
customers and employees.
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Pharma outsourcing – Opportunities galore
‘There is a tide in the affairs of men, when, taken at the flood, leads on to fortune;
omitted, all the voyage of their life is bound in shallows and in miseries. On such a full
sea are we now afloat, and we must take the current when it serves, or lose our
ventures.’’
– Sir William Shakespeare
Why outsource
Today, innovator pharmaceutical companies are facing tough times and grappling
with various issues that present significant threat to their business models and growth.
Such pharma companies are increasingly looking at outsourcing to reduce problems
and sustain in the fiercely competitive global markets. To comprehend the size of the
potential outsourcing opportunity and estimate growth of the CRAMS business, it is
necessary to understand why big pharma companies are increasingly outsourcing
research and manufacturing.
De
cli ing
n
pro ing Ris cost
du res D
cti ea R&
vit rch
y
R&D
outsourcing
o
et St
tim g to r
ing ru re icte
reas w d t qu r U
e e ire S
Inc ing n ark m FD
br m en A
ts
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Declining research productivity. R&D productivity of big pharma companies is on
the decline mainly due to diminishing discoveries of path-breaking medicines (and,
hence, stagnancy), increasing cost of research and constantly raising the bar by the
US FDA. In 1996, the US FDA approved 65% of new drug applications (NDAs) filed
vis-à-vis just 25% in ’06. This is not due to increase in rejection by the US FDA but
primarily because the US FDA has been giving more Approvable designations, which
require additional clinical trials/studies, resulting in delays and higher costs.
120
100
80
(nos)
60
40
20
0
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
*New molecular entity
Source: US FDA
Rising R&D cost. Cost of developing a new product has risen substantially in the
past few decades. This is partly due to stringent requirements from various regulatory
authorities for approving the drugs. On an average, ~70 clinical trials are undertaken
for each NDA as against 30 in early 1980s. Also, each NDA requires over 4,200
patients in present times compared with over 1,300 patients 20 years ago. This,
coupled with declining productivity, rising salary of scientists etc has led to steady rise
in R&D expenditure, to 17.5% of revenues in ’07 versus 11% in 1994. Also, cost of
bringing one new drug to the market has increased 7x to US$880mn from US$125mn
in the 1980s.
17
16
15
(%)
14
13
12
11
10
2007E
2008E
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Source: Bloomberg
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Chart 4: Drug development cost
1,000
880
900
800
700
600
(US$ mn)
500
500
400 359
300 231
200 125
100 54
0
1976 1980 1986 1990 1995 2002
Source: Tufts
Increasing time to bring new drug to market. Innovators are facing new challenges
in terms of reduced time of product exclusivity, declining R&D productivity and stricter
regulated requirements, leading to increase in time to bring a new drug to the market.
Notably, the 20-year patent protection clock starts ticking from the date of filing the
patent and, hence, more time consumption in discovery & development reduces
exclusivity time for the innovator. Also, a competitor may bring a similar drug in the
market soon after launch by the innovator company.
5.5
8
2.4 4.4
6
2.5
4
5.9 6.1
5.1
2 3.2
0
1960s 1970s 1980s 1990s
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Reasons for manufacturing outsourcing
Chart 6: Factors leading to manufacturing outsourcing
Rise of small
biotech companies
focussed on Cost control –
Manufacturing
research a key strategic
outsourcing
initiative of big
pharmas
Increasing
pressure on
Increasing
government to
competition
reduce healthcare
from generics
budgets
30 28 28
27
25
20 20 20
19
20 17
16
(US$ bn)
14
15
10
10
0
2002 2003 2004 2005 2006 2007 2008E 2009E 2010E 2011E 2012E
Source: Industry
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Chart 8: Number of ANDAs approved by US FDA
800
683
700
600 536
476 454
500
404
(nos)
400 367
314 305 320
300 265
237 242
200
100
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: US FDA
US
Germany
France
Canada
Italy
Japan
Spain
UK
0 2 4 6 8 10 12 14 16
(% of GDP)
Source: Industry
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Cost control – Key strategic initiative of big pharmas. Innovator pharma
companies are looking to cut cost. Earlier, such companies enjoyed high margins due
to: i) presence of many blockbuster products, ii) longer product life-cycles, iii) pricing
power due to fewer substitutes, and iv) less generic competition. But, since the past
decade, things have worsened with rising and premature generic competition,
increasing cost of developing new drugs, pressure from Government to reduce prices
of drugs to cut the huge healthcare budgets. Consequently, EBITDA margins of
innovator companies have come under pressure, forcing them to cut costs for
generating better returns.
CY03
Abbott
Novartis
Merck
CY05 Aventis
Eli Lilly
AstraZeneca
GSK
CY07 Pfizer
15 20 25 30 35 40 45
(%)
Source: Bloomberg
Focus on core skills and capabilities. Traditionally, big pharma companies have
gained competitiveness and enjoyed huge returns on the back of expertise in the field
of new drug discoveries and successful marketing of these drugs. Manufacturing has
always remained a secondary or non value-added activity. Moreover, in the past,
manufacturing expenses have formed a small part of overall cost (8-10% of sales).
But due to dwindling productivity of R&D currently, with less number of drugs reaching
markets and rising competition, most innovator companies are increasingly focussing
on developing new and better drugs and marketing them effectively to get maximum
benefit from the launched drug. Due to enhanced focus on core expertise, such
companies are increasingly outsourcing non-core activities such as manufacturing,
thereby minimising the capital invested in plants and production.
Rise of small & mid-size biotech companies focussed only on R&D. Number of
small & mid-size biotech companies, specialty companies and small R&D boutique
companies have been increasing. Consequently, number of drugs for approval for
these companies is also on the increase. Typically, such companies do not have own
manufacturing facilities to focus on core capabilities i.e. R&D. Thereby, there is rise in
demand for outsourcing of manufacturing and R&D services such companies. This
entails outsourcing of manufacturing work to contract manufacturing organisations
(CMOs).
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Chart 11: NBEs* approved for mid-size companies
35 No. of approvals for mid-size companies 90%
% of total approvals (RHS) 80%
30
(% of total approvals)
25
60%
companies
20 50%
15 40%
30%
10
20%
5
10%
0 0%
2001 2002 2003 2004 2005 2006
Timeliness
Specific Technology
Size of Provider
Relationships
References
Rapid availability
Quality
Provider's Financial Stability
Process Optimisation
One stop setup
GNP
Geography
Cost
Confidentiality
0 1 2 3 4 5
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Contract
Research Contract
41% (US$15bn) Research
Contract 46% (US$33bn)
Contract Manufacturing
Manufacturing 54% (US$39bn)
59% (US$22bn)
(US$37bn) (US$72bn)
Source: Industry, I-Sec Research
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Eli Lilly
In August ’08, Eli Lilly struck a path-braking deal to sell its 600,000sqft US laboratory
(which was almost a century old and used for toxicology and other studies) for
US$50mn to a Contract Research Organisations (CROs), Covance, which is set to
register guaranteed outsourcing revenues of US$1.6bn over the next 10 years. As per
Joe Herring, Covance’s Chairman and CEO, “Today's announcement represents an
innovative approach to the R&D productivity challenges our pharmaceutical clients
are facing", noting that it marks a conversion from the traditional fully-integrated
pharmaceutical company (FIPCO) model to a fully-integrated pharmaceutical network
(FIPNET). He added that it was the most significant development in the firm since it
went public 11 years ago, and “carves a new path to growth for both Covance and the
CRO industry”.
Besides, Eli Lilly has already finalised a few research deals with Indian pharma
companies such as Piramal Healthcare and Suven Lifesciences.
AstraZeneca
AstraZeneca is planning to outsource its entire drug manufacturing activities within 10
years and to gradually withdraw from making its own APIs (currently 85% of the total).
At present, AstraZeneca has 27 manufacturing sites in 19 countries. The company
has stated that it plans to shed 7,600 jobs in total or 11% of its 66,000-strong global
workforce
Pfizer
Pfizer is looking to cut costs via outsourcing as much as 30% of its manufacturing to
Asia, particularly India and China. The company outsources ~15% of its
manufacturing requirements at present. Earlier this year, the company announced
that it would save US$2bn by cutting its global work force 10%.
Sanofi Aventis
Sanofi-Aventis is working towards making India one of its largest base for clinical
research. The company is aiming to send ~100% of its feasibilities for phases II & III
trials to the Indian Clinical Research Unit.
Merck & Co
Merck plans to outsource a major part of its manufacturing process to the developing
world and India may get a large chunk of the business. Besides outsourcing its
manufacturing, the drug maker has plans to form research alliances in India. Merck
has decided to outsource 35% of its manufacturing process to countries such as
China and India to reduce production costs. It is targeting 30% cost reduction through
outsourcing and saving US$1.2bn in procurement by restructuring its manufacturing
process. Further, it aims to increase volume of clinical trials in India. Merck has
estimated 500 scientists working on full-time equivalent (FTE)-basis in India.
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Contract research outsourcing
Drug discovery research involves discovery and development of a new medicine,
which is complex, long-drawn and fraught with a high degree of failure. Of the 5,000-
10,000 potential medicine compounds screened at the beginning of a clinical trial,
hardly one succeeds in reaching the market (Chart 14). Also, the drug could fail at any
stage of the discovery and development process.
Source: PhRMA
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Contract Research (CR) involves providing research services across the drug
discovery research (DDR) spectrum at lower cost but world-class quality level.
However, as aforementioned, worsening business dynamics on one hand and
expanding bouquet of services and quality at lower cost on the other have led to
growth in CR. Over the next decade, the momentum is expected to continue, driven
by factors such as large pharma companies looking to reduce R&D cost, improved
speed with which new drugs are brought to the market, reducing failure rate &
improving research productivity and proliferation of molecule development by small
pharma & biotech companies. Drug development cycle timelines have increased in
recent years due to a combination of factors related to greater emphasis on drug
safety, spurred by increasing data requirements on behalf of regulatory bodies that
has spurred growth in CR services. Also, many small pharma and biotech drug
discovery companies are becoming a major source of new drugs. Typically, these
smaller companies lack operational expertise and infrastructure to manage the drug
trials process in-house, resulting in greater dependence on outside providers.
Preclinical
Preclinical
10% (US$1.5bn)
8% (US$2.5bn)
Drug discovery
Drug discovery
services
services
17%
17% (US$5.5bn)
(US$2.5bn)
Clinical Trials
Clinical Trials
services
services
75%
73%
(US$25bn)
(US$11bn)
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Pharma – CRAMS, November 24, 2008 ICICI Securities
CROs – Industry overview
The clinical research industry is highly fragmented, with service providers ranging
from very small (that focus on one aspect of the drug development process in a single
geography), to very large global firms (that offer a range of services across the
development spectrum). We believe that the current CRO market stands at
~US$15bn in ‘07. Table 1 shows the expected growth rate for each key activity in the
development process as well as our estimate of CRO penetration and market growth.
We expect CRO penetration to increase going ahead from the current ~22%.
Penetration rate is expected to grow to 30% in ’12. CROs represented 16.6% of total
drug development spending in ’02 vis-à-vis 21.7% in ’06.
Dosage form
41% (US$9bn) Dosage form
44% (US$17bn)
API/Intermediates
API/Intermediates
59% (US$22bn)
59% (US$13bn)
(US$22bn)
(US$39bn)
Source: Industry, I-Sec Research
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Currently, outsourcing of API/intermediates manufacturing is a major opportunity,
followed by custom synthesis and dosage-form outsourcing. Also, percentage of
manufacturing outsourcing is estimated at 21% in ’07, which is expected to rise to
29% by ’10E.
2007 2010
Biotech
Generic
Branded
Total
0 5 10 15 20 25 30 35 40
(%)
Source: Industry
Besides cost benefits and saving time, diversifying work among various players helps
big companies maintain IPR confidentiality as, usually, the ACMO is not involved in
the total process of manufacturing a particular crucial compound. Except a few
compounds, pharma MNCs do not hand over the entire chemistry for an API for NCEs
under development to any Indian or Chinese ACMO at present. As Indian ACMOs
deliver well on chemistry, quality and time, they hold a better chance of being the full-
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Pharma – CRAMS, November 24, 2008 ICICI Securities
spectrum outsourcing partner for APIs – e.g. eprosartan mesylate API and SLV-306
(in phase II) of Solvay has been given to DPCL. The current global CS market is
dominated largely by ACMOs based in the EU, where IPR protection is in place and
diverse & cutting-edge chemistry skill-sets exist. We believe that key ability required
by the outsourcing partner is to gain confidence of the R&D-driven company as
against offering the lowest cost. European CS players now use Asian low-cost players
by outsourcing early synthesis work to them.
To fathom how an ACMO would benefit from a CS deal, we have assumed a typical
example of a drug that hits the market and attains peak annual sales of US$1bn. The
upside for an ACMO could be US$90-100mn in annual sales if it meets 100%
requirement of the innovator MNC.
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Key ingredients for success in CRAMS
As in any service industry, customer satisfaction is most critical for success. We
believe that key ingredients for success for a CRAMS company are:
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Timely execution and communication
Innovator companies give significant weight to timely completion of a task or on-time
delivery of the product. When the drug is under patent, CRAMS players are required
to deliver the goods on time to the innovator company to meet market requirements.
Also, regular communication with innovator companies regarding development of the
product under R&D is important to gain customer confidence. Regular communication
with innovator companies makes processes transparent and more reliable.
Management team
In the CRAMS business, a good management is imperative due to the highly technical
and complex nature of the business. The management should have a fundamental
understanding of the end-product to be delivered to a sponsor, thereby reducing
likelihood of over-promising but under-delivering. Also, attracting and retaining talent
is most critical for success.
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Pharma – CRAMS, November 24, 2008 ICICI Securities
India – At advantage
India has emerged as the key outsourcing destination for innovator pharma
companies in recent times. It offers significant advantage to big innovator companies
in terms of cost, scientific skill-set, manufacturing facilities and regulatory knowledge.
Cost advantage
India offers significant cost advantage to innovator companies. Cost of manufacturing
in India as well as cost of manpower and setting up infrastructure is amongst the
lowest globally. Cost of manufacturing in India is 60-65% lower vis-à-vis western
countries. Also, cost of setting up a new plant is ~30% lower than developed
countries. Cost of employee in India is as low as ~15% that of the US. Developing an
NCE till the investigational new drug (IND)-filing stage is estimated to be ~US$5mn as
against 7-8x more (US$35-40mn) in the West.
China
India
Hungary
Italy
Germanu
US
0 20 40 60 80 100 120
(Units)
Source: Industry
Infrastructure
India has one of the best infrastructures for various requirements of a CRAMS
business. Many Indian companies have state-of-the-art R&D centres and
manufacturing facilities approved by various authorities in developed countries. India
has the highest number of US FDA approved plants (~80) outside the US.
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Chart 19: US FDA approved plants outside USA
90
80
80
70
60 56
50
40
28
30 24
20
10 8
10 5
0
India Italy China Spain Taiw an Israel Hungary
Source: Industry
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Chart 20: Contract Research opportunity for India
2,500
Contract research services Clinical Trials services
2,000
(US$ mn)
800
1,500
1,200
500 CAGR 52%
150
0 150
2007 2012
CR 3.8% India’s 15%
share in
CT 1.4% 3.2%
world
Total 2.0%
market
6.1%
Given these advantages, coupled with TRIPs in place from January ’05, India’s share
in the global clinical trial outsourcing market is estimated to surge from the current
1.4% or US$150mn to 3.2% or US$800mn in ’12E.
Despite these advantages, not many Indian companies have shown interest in the
segment, which is currently dominated by global clinical trial giants such as Quintiles,
Covance Kendle, PPD Inc and Parexel. Key challenges for clinical trial organisations
(CTOs) in India are:
• phase I currently not allowed on foreign drugs if they have not been tested on
humans abroad
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Pharma – CRAMS, November 24, 2008 ICICI Securities
• lack of trained manpower, e.g. GCP-trained investigators are just around 1,000
while demand is likely to be 6,000 by ‘12E
India does not provide ‘data exclusivity’ in clinical trials, unlike the US and EU
members
Contract research services opportunity
Unlike clinical trial companies in India that face few hurdles (as aforementioned),
Indian CRS providers (which do not face such problems) are expected to grow faster
(52% CAGR versus 40% for clinical trials). To this effect, there are many more CRS
players such as Syngene (subsidiary of Biocon), GVK BioSciences and Sai
Advantium that are growing over 30-35% annually, though none is listed on the stock
exchange.
3,000
2,000
1,500 3,000
1,000
500 900
0
2007 2012
India’s share in
CM 4.1% world market 7.7%
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 4: Profile of Key Indian CRAMS players
(US$ mn)
Company Revenues Remark
CROs
GVK Biosciences 39 Largest Indian CRO and among fastest growing
Pioneer of CRO work in India and enjoys one of the highest
Syngene (Biocon) 37 margin
Quintiles 32 One of the largest players in the world. Strong in clinical trials
Sai Advantium 26 Rapidly growing chemistry focused CRO
Backed by, the Chatterjee Group (TCG), owned by
Chembiotek 20 Dr. Purnendu Chatterjee
Vimta Labs 18 Only listed CRO in India, focuses more on BE/BA studies
SIRO Clinpharm 14 The largest Indian CTO with strong focus on clientele
Clingine (Biocon) 4 Among the top Indian companies in clinical trials
Total CROs Revenues 189
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 5: DPCL & DLL versus global peers
Parameter Lonza Cambrex Dishman Divi’s Patheon Remarks
Year of commencement 1897 1981 1983 1990 1974 Lonza is the oldest
Ingredients, API/ API/ API/ Purely into Lonza has the broadest and the
Exclusive Intermediates/ Intermediates/ Intermediates/ dosage best model
synthesis, Generic API QUATs Generic API forms
Business model biopharma
Serving 10 out of Aggregate Integrated Works with 20 of Strong and
top 20 biotech revenue from CRAMS the top 25 expanding
companies products with player and pharma geographies,
FY06 sales growing by companies in the services &
>US$6mn is smart world, Enjoys one customers
37% acquisitions of the highest
Salient features profitability
Manufacturing Sites 19 3 3 3 12
Mcap/Sales (x) 1.2 0.3 1.1 7.0 0.1 DLL is the most expensive
EV/EBITDA (x) 14.7 7.0 7.6 12.1 6.3 Lonza is the most expensive
* filed/to be filed for regulated markets
Source: Company data, Industry, I-Sec Research
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Pharma – CRAMS, November 24, 2008 ICICI Securities
Pharma outsourcing versus IT outsourcing
Given India’s stupendous success in global IT outsourcing business, it would be
pertinent to compare pharma outsourcing with IT outsourcing. Notably, pharma CRO
business is similar to IT outsourcing, given skill-set and low-cost advantage thereof
being the key to scalability and success; the dynamics of pharma CMO business will
also have many such similarities. Since, Indian pharma outsourcing business is at the
early growth stage, there are important lessons to be learnt from the hugely
successful Indian IT story earlier. Table 6 encapsulates key variables of IT and
pharma outsourcing businesses.
Key learnings
• On many parameters, pharma outsourcing, which is in the early growth phase,
compares well with IT outsourcing
• India has key ingredients – low salaries and low cost of production/services – that
makes for a global player in the pharma outsourcing business as does IT
• Adequate availability of talent will enable pharma outsourcing companies to grow
rapidly
• Like Indian IT outsourcing companies, we expect pharma outsourcing companies
to seize opportunities, move up the value chain and become leading world-class
players
• Notably, market cap CAGR for IT outsourcing was 50% at the early stage (1992-
98) and 40% later (during 1998-’08) compared with 70% for pharma outsourcing
(only DLL & DPCL over FY05-08).
28
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 6: Pharma outsourcing versus IT outsourcing
IT Services Pharma*
Parameters Early stage Current Current
1997-98 ’08
Period of commencement Early 90s Early ’00
Revenues (US$ mn) 1,700 40,000 1,200
Nature of business
Stickiness medium to high high lower
Level of repeat business (%) NA 90-95 50-60
Outsourced work for buyer non-core activity non-core activity + core core activity
Linkage with macro economy higher higher lower
Cost arbitrage
Salary differentials 1/5th 1/3rd 1/5th
Total cost advantage (%) 80 - 90 60 - 70 40-60
Customers
Employees
No. of Employees ('000) 280 865 14
Revenue per employee (US$)** 6,071 46,243 77,409
Cost per employee (US$) 2,125 18,497 7,741
Pharmacist/
Talent IT engineers IT Engineers Chemists
Availability of talent (lakhs) p.a. NA ~3 ~7
Required talent (lakhs) p.a. NA 1 - 1.5 ~1
For Infosys
Financial parameters 1992-98 1998-08 FY03-08#
Sales (value) CAGR (%) ~ 95 ~ 52 37
Cost matrix
Raw material Costs/Sales (%) NA NA 39-48
Staff Costs/Sales (%) 30-40 30-50 6-14
Selling, Distribution & Administrative
Costs/ Sales (%) 20-32 12-20 8-11
29
Pharma – CRAMS, November 24, 2008 ICICI Securities
Company section
30
Equity Research
November 24, 2008 INDIA
f One of the best CRAMS players from India. Ahead of many peers, DPCL has
firmly established itself as a preferred partner for top-20 global pharma companies
such as Solvay, Astra Zeneca and GSK as well as a few Japanese pharma
companies. DPCL offers end-to-end services with its strong technology and
management capabilities, robust IPR-respecting & protection policy, best-in-class
chemistry skill-set, ‘adding-value-to-customer’ approach and world-class & low-cost
manufacturing capabilities. The company is likely to remain in a high-growth phase,
with revenue CAGR of 24% through FY08-11 vis-à-vis 48% in the past four years.
f QUATs and specialty chemicals – Provide steady base. DPCL is a leading player
globally in the QUATs segment and, given increase in focus on niche QUATs, will
boost margins going ahead. QUATs saw robust revenue CAGR of 32% over the past
five years. With the recent acquisition of Solvay’s fine chemicals business and
revenues from the Marketable Molecules (MM) segment, the company is set to post
strong growth of 24% through FY08-11E.
f Attractively valued, BUY. At FY10E P/E of 6x, the stock is trading at significant
discount (50%) to peers. Given its strong growth trajectory (EPS CAGR of 47%
through FY08-11E) powered by robust growth in the CRAMS business, improving
Rajesh Vora
rajesh_vora@isecltd.com financials, de-risking business model and possibility of re-rating, we recommend
+91 22 6637 7508 BUY. Our 18-month fair value estimate is Rs214, implying 46% returns.
21% 21%
33% 38%
4% 44%
8%
60% 7% 17%
20%
14% 13%
32
Pharma – CRAMS, November 24, 2008 ICICI Securities
Investment summary
One of the best CRAMS players from India. Recognising potential of the
outsourcing business ahead of many peers, DPCL has firmly established itself as a
preferred partner for global pharma majors in the CRAMS space with revenues of
Rs8bn or US$160mn. DPCL offers end-to-end capabilities through contract research
& manufacturing. The company has developed a healthy customer base, with its
strong technology and management capabilities, robust IPR-respecting & protection
policy, sturdy chemistry skill-set, ‘adding-value-to-customer’ approach and state-of-
the-art & low-cost manufacturing capabilities. This coupled with value-accretive
acquisitions to fill gaps in skill-sets and acquire new customers has catapulted the
company into the top-players league, offering CM & CS services. The company
boasts healthy relationship with the top-20 global pharma companies such as Solvay,
Astra Zeneca, GSK and Merck as well as a few Japanese pharma companies. DPCL
is likely to remain in a high-growth phase, with revenue CAGR of 24% through FY08-
11E vis-à-vis 48% in the past four years bolstered by organic & inorganic growth.
1-2 API
US$500mn
reaching
sales by Acquisitions
market as new
FY12E (FY11-FY12)
medicines
Rising share of
revenues from Higher value added
custom synthesis contracts to
(35-40% in FY11E) improve margin
30-35%
33
Pharma – CRAMS, November 24, 2008 ICICI Securities
QUATs and specialty chemicals – Provide steady base. DPCL is a leading player
in the QUATs segment. Since QUATs is an older technology and is commoditised,
DPCL is shifting focus to niche QUATs that have specialised applications and higher
price, to boost margin and growth. The company has built significant presence in the
segment across the world, especially in developed markets. Revenues from QUATs
have seen robust CAGR of 32% in the past five years. Revenues of QUATs are
included in Marketable Molecules (MM) segment, which enjoys EBIT margin of 10%
compared with 22% for CRAMS segment in FY08. With the recent acquisition of
Solvay’s fine chemicals, vitamin D and vitamin D analogue businesses and revenues
from the MM segment are set to post strong growth of 24% through FY08-11E.
Besides sharp rupee depreciation YTD vis-à-vis US dollar has helped DPCL raise
prices for QUATs ~10% and there is also healthy volume growth.
Attractively valued, BUY. At FY10E P/E of 6x, the stock is trading at significant
discount (50%) to Divi’s which we believe is unjustified. Given its strong growth
trajectory (EPS CAGR of 47% through FY08-11E) powered by robust growth in
CRAMS business, improving revenue mix and margin, expanding and improving list of
de-risking business model and possibility of re-rating, we recommend BUY. Our 18-
month fair value estimate is Rs214, implying 46% returns.
34
Pharma – CRAMS, November 24, 2008 ICICI Securities
DPCL – Early bird in CRAMS
DPCL is one of the first and very few pharma companies that recognised importance
of and huge opportunity in CRAMS, as early as a decade ago. Consequently, in a
major breakthrough, the company signed its first CM agreement with Solvay in ’01,
thereby beginning its glorious journey in the CRAMS space.
35
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 7: Top customers of DPCL
% of % of % of
total total total FY08-12 FY09-12
FY08 revenue FY10E revenue FY12E revenue CAGR (%) CAGR (%)
Solvay 1,090 18 1,976 26 2,568 18 24 14
AstraZeneca 300 5 450 6 1,800 13 57 100
Customer 3 150 2 400 5 1,100 8 65 66
Customer 4 150 2 450 6 1,000 7 61 49
Japanese customers 250 4 550 7 1,500 10 57 65
Top 5 customers 1,940 32 3,826 50 7,968 55 42 44
36
Pharma – CRAMS, November 24, 2008 ICICI Securities
Acquisition of fine chemicals business from Solvay to drive segment
growth
DPCL acquired the fine chemicals vitamin D and vitamin D analogue businesses from
Solvay in July ’07. As per the deal, DPCL acquired all facilities located at Solvay’s
Veenendaal site in Netherlands as well as technology, patents and intellectual
property rights for the business. The sale was part of Solvay’s strategy to focus on the
main therapeutic area and hive off the non-core business. With the acquisition, DPCL
has increased its basket of offerings in the fine chemicals business along with
acquiring new customers. Revenues from this business (~Rs800mn for FY09E) are
included in DPCL’s MM segment.
37
Pharma – CRAMS, November 24, 2008 ICICI Securities
Strategic acquisitions – Empowering growth
DPCL, with several recent acquisitions, repositioned itself as a serious and strong
player in the CRAMS segment with presence across the value chain. Post
establishing itself as a major player in the CM space, DPCL acquired several
companies to establish and strengthen its presence in the lucrative CR segment. We
believe that such acquisitions will help the company considerably on account of strong
synergies, widening customer base and availability of end-to-end capabilities.
38
Pharma – CRAMS, November 24, 2008 ICICI Securities
CARBOGEN – Strengthening capabilities
DPCL acquired CARBOGEN, a Swiss CRAMS company, in August ’06 for US$75mn,
this being its biggest-ever acquisition. CARBOGEN has state-of-the-art R&D facilities
at three sites in Switzerland. It differentiates itself by the quality of its technical
capabilities and integrated platform that provides seamless solutions to the world’s
leading pharma and biotech companies, of which it has thereby developed a strong
customer base. Notably, CARBOGEN generates ~90% revenue from repeat
customers. In CY05, it registered turnover of CHF81.8mn or Rs3bn. ~80% of
CARBOGEN’s sales are from the US market. In FY08, the company has generated
revenues of Rs3.5bn.
In addition to the aforementioned growth drivers, DPCL is stepping up its ante on the
US market (the largest and most lucrative pharma market globally), which currently
contributes only 5% of total revenues as against EU contributing 80%. DPCL has
hired a team of experienced professionals to aggressively market services to US
customers and is in negotiations with top US-based innovator companies such as Eli
Lilly. To this end, the company has aggressively commenced filing DMFs since FY07
(Table 10).
39
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 10: Dishman Pharmaceuticals – DMF list
Submit Date API
22-Sep-2008 Ropivacaine Hydrochloride Anhydrous
5-Sep-2008 Calcifediol
25-Feb-2008 Cholecalciferol
4-Feb-2008 Pralidoxime Chloride
18-Oct-2007 Bupivacaine Hydrochloride
24-Apr-2007 Bisacodyl
16-Mar-2007 Cetylpyridinium Chloride
7-Mar-2005 Eprosartan Mesylate
14-Jul-2003 Eprosartan Mesylate
20-Sep-2001 Tramadol Hydrochloride
16-Apr-1999 Calcitriol
Source: US FDA
40
Pharma – CRAMS, November 24, 2008 ICICI Securities
Mr VVS Murthy joined DPCL in March ’07 as the Chief Financial Officer. He is a
Chartered Accountant with ~29 years of experience in various industries viz.,
Engineering, Chemicals, Sanitary ware, Cement, Fertilisers and Pharmaceuticals.
Prior to joining the DPCL Group, he has worked with Dr. Reddy's Laboratories from
1995 to February ’07 as Vice President Finance.
Arvind Joshi joined in October ’07 as President HR & Administration. He has a rich
32-year experience in HR field of textiles and pharmaceutical sectors. He has worked
earlier with Sun Pharma, Alembic and JB Chemicals. Prior to joining DPCL, he
worked as Vice President – HR, JB Chemicals, Mumbai.
41
Equity Research
November 24, 2008 INDIA
f India’s top-tier CMO in global ACM space. With state-of-the-art R&D centres and
large manufacturing facilities, DLL undertakes custom manufacturing (CM) of APIs
and production of advanced intermediates over the entire lifecycle of the product and
has emerged as an ideal partner of choice in the global ACM space. DLL is a top-tier
Indian player in the API/intermediates ACM space globally.
f Strategy – To collaborate and ‘not compete with customer’. DLL follows the
strategy of collaborating with customers as against an opportunistic business
approach and, since inception, has produced APIs using non-infringing processes.
The company has always respected innovation and IPRs of global pharma
companies, thereby inspiring confidence in clients, which is the cornerstone of
success.
f Strong chemistry skill-set and unstinted focus. DLL has been strongly focussed
on R&D since inception; this is critical to success in the CR space. To this effect, the
company boasts of a strong chemistry skill-set and process development
capabilities. DLL’s research team is specialised in process design for new drug
compounds, scale of developing material – from gramme to kilogramme and
structural elucidation, impurity profile studies, process validation, process justification
to process optimisation, analytical methods development & validation, environment
impact analysis, safety studies and time cycle studies.
f India-centric low cost model. DLL has an India-centric business model that
develops and produces all API/intermediates with substantial cost advantage. DLL
enjoys EBITDA margin of ~40%, possibly the highest amongst peers globally. We
believe that the company would maintain and improve margins 500bps to 46% over
the next three years.
f Top-quality BUY. In FY08, DLL’s PAT almost doubled YoY every quarter, beating
consensus by a wide margin, which led to higher-than-historic P/E of 20-25x.
Rajesh Vora Currently, the stock is trading at attractive FY10E P/E of 12x, which is reasonable in
rajesh_vora@isecltd.com light of the strong EPS CAGR of 29% through FY08-11E.
+91 22 6637 7508
24% 37%
48%
50%
72% 58%
43
Pharma – CRAMS, November 24, 2008 ICICI Securities
Investment summary
India’s top-tier CMO in global ACM space
DLL undertakes CM of APIs and production of advanced intermediates over the entire
lifecycle of the product. With state-of-the-art R&D centres and large manufacturing
facilities, DLL has emerged as an ideal partner for CS, process development and
mass manufacturing of customers’ discovery products. In the global ACM space, DLL
is one of the top-tier Indian players, with Rs10.4bn or US$210mn annual revenues.
Divi ’s Lab
Rising share of
custom synthesis Carotenoids scale up
¤ Improvement in
margins
44
Pharma – CRAMS, November 24, 2008 ICICI Securities
India-centric low cost model
DLL believes in the organic growth model vis-à-vis most peers. Also, its business
model is India-centric and aims at focussing on its strengths such as strong chemistry
skill-set, world-class infrastructure and lower costs. DLL develops and produces all
API/intermediates in India with substantial cost advantage, which is evident from its
leadership position in some API products such as naproxen, dextromethorphan and
diltiazem as well as EBITDA margin of ~40%, possibly the highest amongst peers
globally. We believe that the company would be able to maintain and improve its
margin over the next three years.
45
Pharma – CRAMS, November 24, 2008 ICICI Securities
DLL – Top-tier global ACMO from India
DLL has emerged as the largest player in the CS business in India on the back of
strong chemistry research skills, IPR protecting corporate philosophy and substantial
cost advantage. The company is working with 20 of the top-25 global pharma
companies on various projects. It boasts of the strongest CS pipeline of over 100
projects, of which at least 8-10 are in phase III. DLL’s CS business contributed ~24%
of total revenues in FY04 and leapfrogged to ~50% in FY08, which will further rise to
60% by FY11. This would see DLL’s operating margins increasing going forward as
CS is a typically high-margin business due to its customised nature and small-scale of
projects. The company incurred capex of ~Rs4bn over FY05-08, which is 60% of the
FY08 gross block, to establish new manufacturing facilities to execute more orders.
12,000
10,000
(Rs mn)
8,000
6,000 (50%)
4,000
2,000 ( 24%)
0
2005 2006 2007 2008 2009 2010 2011
46
Pharma – CRAMS, November 24, 2008 ICICI Securities
Array of services
Furthermore, DLL offers a wide array of services to its innovator partners that are:
• process design and development for new drug candidates
• process validation, justification and optimisation
• product manufacturing (very small to large quantities), as per customer need and
phase of clinical development
• generating reliable data for regulatory agencies and its documentation for
preparing draft drug master files (DMFs).
47
Pharma – CRAMS, November 24, 2008 ICICI Securities
Generics API business to see strong growth
Since inception, DLL has focussed on developing alternate, patent non-infringing
processes for APIs for leading generic pharma companies to manage the late life-
cycle of a drug. The company strategy for the generics API/Intermediates division
involves creating market leadership, as regards scale, cost and quality, which ensures
customer loyalty as well as higher pricing power. Besides, DLL also manufactures
products (without scale leadership) where it has advantage, either in terms of cost or
process yield.
48
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 11: Divi’s Laboratories – DMF list
Submit Date API
29-Apr-2008 Vigabatrin
25-Nov-2007 Topiramate
25-Oct-2007 Quetiapine Fumarate
15-Oct-2007 Tripeptide, Drug Intermediate
15-Jul-2007 Boc Cor Succinate (Intermediate)
7-Jan-2007 TPE Alcohol
4-Sep-2006 Sibutramine Hydrochloride Monohydrate
17-May-2006 Desloratadine
4-Dec-2005 Gabapentin
25-Nov-2005 Tamsulosin Hydrochloride
25-Sep-2005 Fosphenytoin Sodium
25-Sep-2005 Risedronate Sodium
25-Sep-2005 Zolpidem Tartrate
17-Jul-2005 Verapamil Hydrochloride
5-Jul-2005 Niacin
24-Apr-2005 Bupropion Hydrochloride
6-Feb-2005 Proguanil Hydrochloride
6-Feb-2005 Iopamidol
3-Dec-2004 Levodopa
20-Nov-2004 Carbidopa
7-Nov-2004 Loratadine
19-Sep-2004 Methyldopa
19-Oct-2003 Phenylephrine Hydrochloride
5-Oct-2003 Leviteracetam
3-Sep-2003 Sulphazine
31-Jan-2002 5-Phenylhydantoin
2-Apr-2001 Nabumetone
26-Jan-2001 Diltiazem Hydrochloride
9-Aug-1999 Ketorolac Acid
27-Nov-1998 Naproxen
27-Nov-1998 Naproxen Sodium
4-Feb-1997 Dextromethorphan Hydrobromide
Source: US FDA
49
Pharma – CRAMS, November 24, 2008 ICICI Securities
50
Pharma – CRAMS, November 24, 2008 ICICI Securities
Attractive valuations
Historic one-year forward P/E analysis
Since its listing in April ‘04, DPCL’s stock has traded at ≥14x one-year forward P/E,
except in the past two months, when the stock crashed 55% due to the company
registering Rs310mn forex loss in Q2FY09 along with global meltdown in equities.
This is an aberration and we expect the stock to bounce back to its normal P/E band
of 14-15x. We believe that given superior earnings growth going forward (47% CAGR
through FY08-11E), strong earnings visibility and improving financials will lead to re-
rating.
200 14x
150 10x
100
6x
50
0
Jul-04
Dec-04
Feb-05
May-05
Jul-05
Oct-05
Dec-05
Mar-06
May-06
Oct-06
Jan-07
Mar-07
Jun-07
Nov-07
Jan-08
Jun-08
Nov-08
Sep-04
Sep-08
Apr-04
Aug-06
Aug-07
Apr-08
Source: I-Sec Research
Since listing, DLL’s stock price has largely remained at ≥10x P/E, except for a brief
period in mid ’06. During over mid-CY07-Febraury ’08, the stock price saw exceptional
rise, largely trading at P/E of 20-25x on the back of the stellar quarterly PAT growth of
~100% and the ongoing bull market then.
1,000
15x
800
600 10x
400
5x
200
0
Jun-04
Nov-04
Jan-05
Jun-05
Nov-05
Jan-06
Jun-06
Nov-06
Jan-07
Jun-07
Nov-07
Jan-08
Mar-08
Jun-08
Nov-08
Apr-04
Aug-04
Apr-05
Aug-05
Apr-06
Aug-06
Apr-07
Aug-07
Aug-08
51
Pharma – CRAMS, November 24, 2008 ICICI Securities
Performance since IPO
Given DPCL and DLL’s listing only 5-6 years ago, they have outperformed benchmark
indices. DLL has posted exemplary performance, registering a huge surge in market
cap of 32x (or 88% CAGR) and 7x in EPS (41% CAGR) compared with 2.7x in the
Sensex (or 20% CAGR). Sharp 55% fall in DPCL’s stock price in the past two months
has dented the company’s performance since its IPO listing, with market cap and EPS
having almost doubled compared with CNX mid-cap index at 1.4x or 8% CAGR.
2x (11%)
1.4x (8%)
7x (41%)
2.7x (20%)
Comparative valuations
As per comparison with peer group valuations (Table 12), DPCL seems inexpensive
on almost all parameters. The stock is trading at a hefty 33% discount to average
FY10E P/E and 50% to DLL. On the other hand, DLL appearing the most expensive
on almost all parameters is justified in light of it boasting of the highest EBITDA
margin, RoCE and significantly higher EPS growth since the past 10 quarters.
52
Pharma – CRAMS, November 24, 2008 ICICI Securities
Fair value pegged at Rs214 for DPCL & Rs1,527 for DLL
Given DPCL and DLL’s high-growth phase combined with steady revenue stream, we
believe that DCF-based and PEG-based (versus P/E-based) valuations would be
more appropriate for arriving at fair value; we have assumed the average of the two
valuation methods. As regards PEG valuations methodology, we have largely used
current FY09 PEG (0.17x for DPCL and 0.55x for DLL) on FY10E EPS on account of
our fair value time-horizon being 15-18 months. As regards the DCF-based valuations
methodology, we have used risk-free rate of 8%, risk premium of 12% and long-term
sustainable growth rate of 5%. Table 14 shows resultant fair value of the two
companies. The past two-month sharp 55% drop in DPCL’s price has widened its P/E
and PEG discount with DLL. This may be attributable to the heavy Rs310mn forex
loss (80-90% of which is attributable to mark-to-market translation loss on foreign
currency loans) reported in Q2FY09 and the heavy selling in the global meltdown in
equities. We believe such high discount to be abnormal and expect the gap to narrow
over the next few quarters.
53
Pharma – CRAMS, November 24, 2008 ICICI Securities
Financial summary
Stellar growth in the past
Both DPCL and DLL have achieved strong growth in the past. While DPCL has
clocked-in revenue and PAT CAGRs of 46% and 39%, DLL has posted 32% and 46%
respectively in the past five years. The growth was driven by increasing demand for
outsourcing work from global pharma MNCs and their disciplined customer-centric
approach.
12,000
15,000
(Rs mn)
(Rs mn)
10,000
8,000
10,000
6,000
4,000 5,000
2,000
0 0
FY07 FY08 FY09E FY10E FY11E FY07 FY08 FY09E FY10E FY11E
54
Pharma – CRAMS, November 24, 2008 ICICI Securities
Improving RoCE and EBITDA margin
DPCL’s EBITDA margin is set to expand ~5 percentage points (pps) to 25% in FY11E
due to improving revenue mix, price increase and cost control. DLL’s EBITDA margin
is also expected to expand ~5pps to 46% in FY11E due to growing contribution from
the high-margin CS business, which is set to contribute 60% to total revenue from the
current 50%. This combined with disciplined capex will lead to RoCE rising over 8pps
to 19% for DPCL compared with 10pps decline to 32% for DLL due to high free cash
balance of ~Rs10bn in FY11E. Given this, it would be prudent to view the RoIC of
DLL, which is expected to rise 4pps to 56% in FY11E.
25
45
20
40
(%)
(%)
15
35
10
30
5
0 25
FY07 FY08 FY09E FY10E FY11E FY07 FY08 FY09E FY10E FY11E
55
Pharma – CRAMS, November 24, 2008 ICICI Securities
Annexure 1: Financials
Table 15: Dishman Pharma – Profit & Loss statement
(Rs mn, year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Gross Sales 5,819 8,114 10,235 12,635 15,425
Less: Excise Duty 34 83 95 113 136
Net Sales 5,786 8,031 10,140 12,522 15,289
Domestic 727 945 1,182 1,418 1,702
Exports 5,058 7,085 8,959 11,104 13,587
Other Operating Income 0 0 0 0 0
Less:
Raw Materials consumed 2,066 3,017 3,194 3,832 4,678
Power and Fuel 170 237 294 363 459
Personnel Expenses 1,409 2,154 2,736 3,392 4,138
Selling and Distribution Expenses 180 174 233 313 382
Other Expenses 509 668 948 1,119 1,316
Research & development expenses 24 31 51 75 107
Repairs and maintenance 275 222 284 376 459
56
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 16: Dishman Pharma – Balance sheet
(Rs mn, year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Current Assets, Loans & Advances
Cash & Bank balance 355 371 72 611 485
Inventory 2,978 3,047 3,107 3,674 4,486
Sundry Debtors 1,252 2,042 2,664 3,393 4,226
Loans and Advances 839 1,127 1,542 1,904 2,536
Total Current Liabilities and Provisions 2,707 2,472 3,181 4,151 5,374
Investments
Strategic & Group Investments 128 13 13 13 13
Other Marketable Investments 12 0 0 0 0
Equity 0 0 0 0 0
Debt 12 0 0 0 0
Total Investments 140 13 13 13 13
Fixed Assets
Gross Block 4,725 6,443 8,677 9,827 10,827
Less Accumulated Depreciation 699 1,118 1,730 2,480 3,357
Net Block 4,026 5,325 6,947 7,348 7,470
Add: Capital Work in Progress 650 1,485 750 600 600
Less: Revaluation Reserve 77 77 77 77 77
Total Fixed Assets 4,599 6,733 7,620 7,871 7,993
Share Capital
Paid up Equity Share Capital 144 159 159 163 163
No. of Shares outstanding (mn) 72 79.7 79.7 81.3 81.3
Face Value per share (Rs) 2 2 2 2 2
Preference Share Capital (convertible)
Total Liabilities & Shareholders' Equity 8,810 12,381 13,358 14,835 15,885
Source: Company data, I-Sec Research
57
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 17: Dishman Pharma – Cashflow statement
(Rs mn, year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Cash Flow from Operating Activities
Reported Net Income 917 1,197 993 1,987 2,631
Add:
Depreciation & Amortisation 259 419 612 749 878
Provisions 0 0 0 0 0
Deferred Taxes 109 40 0 0 0
Less:
Other Income 129 98 119 142 171
Net Extra-ordinary income 104 379 (484) 0 0
Operating Cash Flow before Working Capital change (a) 1,053 1,179 1,971 2,594 3,338
Working Capital Inflow / (Outflow) (b) (783) (1,382) (388) (688) (1,054)
Net Cash flow from Operating Activities (a) + (b) 269 (203) 1,582 1,906 2,285
Free Cash flow after capital commitments (3,961) (2,794) 82 906 1,285
(a) + (b) + (c)
Net Cash flow from Investing Activities (d) 129 98 119 142 171
58
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 18: Dishman Pharma – Key ratios
(Year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Per Share Data (Rs)
EPS(Basic Recurring) 10.3 10.5 18.5 24.9 33.0
Diluted Recurring EPS 10.1 10.3 18.2 24.4 32.3
Recurring Cash EPS 13.6 16.4 26.2 34.3 44.0
Dividend per share (DPS) 1.1 1.2 1.2 1.5 2.0
Book Value per share (BV) 37.8 70.0 82.2 110.2 142.2
Operating Ratio
Raw Material/Sales (%) 35.7 37.6 31.5 30.6 30.6
SG&A/Sales (%) 11.9 10.5 11.6 11.4 11.1
R&D/sales 0.4 0.4 0.5 0.6 0.7
Other Income / PBT (%) 15.1 11.5 7.8 7.0 6.3
Effective Tax Rate (%) 3.7 1.6 2.4 3.0 3.0
NWC / Total Assets (%) 26.8 30.2 30.9 32.5 37.0
Inventory Turnover (days) 358.6 364.5 351.6 323.0 318.3
Receivables (days) 66.3 74.1 83.9 87.5 90.1
Payables (days) 99.7 76.1 82.9 96.0 107.2
D/E Ratio (%) 185.0 119.1 101.5 67.5 39.3
59
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 19: Divi's Laboratories – Profit & Loss statement
(Rs mn, year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Gross Sales 7,299 10,408 13,044 16,156 19,872
Less: Excise Duty 53 79 66 80 79
Net Sales 7,246 10,328 12,978 16,076 19,792
Domestic 442 516 822 1,002 994
exports 6,804 9,812 12,156 15,074 18,799
Other Operating Income 102 107 108 117 171
Contract Research Fees 27 9 10 14 20
Export benefits 75 98 98 103 151
Total Operating Income 7,347 10,435 13,086 16,193 19,963
Less:
Raw Materials consumed 3,231 4,096 4,542 5,554 6,828
Power and Fuel 250 383 493 603 742
Personnel Expenses 310 520 755 907 1,064
Selling and Distribution Expenses 127 242 260 354 435
Other Expenses 491 645 774 944 1,020
Research & development expenses 103 111 195 241 336
Repairs and maintenance 89 115 169 209 257
60
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 20: Divi's Laboratories – Balance sheet
(Rs mn, year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Current Assets, Loans & Advances
Cash & Bank balance 183 142 2,600 5,780 9,680
Inventory 2,135 2,814 3,173 3,956 4,901
Sundry Debtors 1,617 2,095 3,038 3,984 5,172
Loans and Advances 302 574 715 1,107 1,361
Operational
Others
Other Current Assets 2 5 0 0 0
Total Current Assets 4,239 5,630 9,526 14,826 21,115
Total Current Liabilities and Provisions 1,265 1,930 2,698 3,525 4,390
Investments
Strategic & Group Investments 0 0 0 0 0
Other Marketable Investments 0 556 700 900 1,000
Equity 0 0 0 0 0
Debt 0 556 700 900 1,000
Total Investments 0 556 700 900 1,000
Goodwill 0 0 0 0 0
Fixed Assets
Gross Block 4,909 6,422 7,773 9,653 11,973
Less Accumulated Depreciation 1,095 1,451 1,934 2,544 3,334
Net Block 3,814 4,971 5,838 7,108 8,639
Add: Capital Work in Progress 382 631 1,080 1,200 1,680
Less: Revaluation Reserve 0 0 0 0 0
Total Fixed Assets 4,196 5,601 6,918 8,308 10,319
Borrowings
Short Term Debt 653 190 150 300 300
Long Term Debt 886 642 482 300 300
Total Borrowings 1,540 861 632 600 600
Share Capital
Paid up Equity Share Capital 129 129 131 133 133
No. of Shares outstanding (mn) 64.6 64.6 65.7 66.4 66.4
Face Value per share (Rs) 2 2 2 2 2
Total Liabilities & Shareholders' Equity 7,171 9,857 14,446 20,510 28,043
Source: Company data, I-Sec Research
61
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 21: Divi's Laboratories – Cashflow statement
(Rs mn, year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Cash Flow from Operating Activities
Reported Net Income 1,859 3,476 5,003 6,310 7,800
Add:
Depreciation & Amortisation 224 356 483 610 790
Provisions 0 0 0 0 0
Deferred Taxes (2) 105 136 172 217
Less:
Other Income 33 31 93 190 286
Net Extra-ordinary income (257) (121) 0 0 0
Operating Cash Flow before Working Capital change (a) 2,305 4,027 5,528 6,901 8,521
Working Capital Inflow / (Outflow) (b) (668) (767) (670) (1,294) (1,522)
Net Cash flow from Operating Activities (a) + (b) 1,637 3,260 4,859 5,607 6,999
Free Cash flow after capital commitments 128 943 2,914 3,407 4,099
(a) + (b) + (c)
Opening Cash and Bank balance 105 183 142 2,600 5,780
Closing Cash and Bank balance 183 142 2,600 5,780 9,680
Increase/(Decrease) in Cash and Bank balance 78 (41) 2,458 3,180 3,900
Source: Company data, I-Sec Research
62
Pharma – CRAMS, November 24, 2008 ICICI Securities
Table 22: Divi's Laboratories – Key ratios
(Year ending March 31)
FY07 FY08 FY09E FY10E FY11E
Per Share Data (Rs)
EPS(Basic Recurring) 32.7 55.7 76.1 95.0 117.4
Diluted Recurring EPS 32.7 54.2 75.3 95.0 117.4
Recurring Cash EPS 36.2 61.2 84.9 107.1 133.0
Dividend per share (DPS) 2.3 4.0 5.0 6.0 7.5
Book Value per share (BV) 82.9 133.3 205.8 297.5 410.8
Operating Ratio
Raw Material/Sales (%) 44.6 39.7 35.0 34.6 34.5
SG&A/Sales (%) 8.4 8.5 7.9 8.0 7.3
R&D/sales (%) 1.4 1.1 1.5 1.5 1.7
Other Income / PBT (%) 1.3 0.8 1.7 2.8 3.3
Effective Tax Rate (%) 13.6 7.7 7.8 8.3 10.3
NWC / Total Assets (%) 38.9 36.1 29.3 26.9 25.1
Inventory Turnover (days) 224.5 220.5 240.6 234.3 236.7
Receivables (days) 67.3 65.1 71.8 79.3 84.1
Payables (days) 114.8 111.5 130.8 131.2 133.7
D/E Ratio (%) 33.9 14.4 8.6 6.7 5.7
63
Pharma – CRAMS, November 24, 2008 ICICI Securities
Charts
Chart 1: Factors leading to research outsourcing ............................................................................... 6
Chart 2: NDA and NME* approvals by US FDA.................................................................................. 7
Chart 3: Pharma industry – R&D-to-sales........................................................................................... 7
Chart 4: Drug development cost ......................................................................................................... 8
Chart 5: Time to bring new drugs to market........................................................................................ 8
Chart 6: Factors leading to manufacturing outsourcing ...................................................................... 9
Chart 7: Market size of drugs going off patent .................................................................................... 9
Chart 8: Number of ANDAs approved by US FDA............................................................................ 10
Chart 9: Healthcare spend in key countries ...................................................................................... 10
Chart 10: EBITDA margin of key innovator companies..................................................................... 11
Chart 11: NBEs* approved for mid-size companies.......................................................................... 12
Chart 12: Factors influencing outsourcing decision making.............................................................. 12
Chart 13: Market size of global CRAMS ........................................................................................... 13
Chart 14: Drug discovery research process...................................................................................... 15
Chart 15: CRO industry – Revenue split........................................................................................... 16
Chart 16: Global Contract Manufacturing – Revenue split................................................................ 17
Chart 17: Manufacturing outsourced................................................................................................. 18
Chart 18: Compensation of chemists................................................................................................ 22
Chart 19: US FDA approved plants outside USA ............................................................................. 23
Chart 20: Contract Research opportunity for India............................................................................ 24
Chart 21: Contract manufacturing opportunity for India .................................................................... 25
Chart 22: Improving revenue mix...................................................................................................... 32
Chart 23: DPCL – Key growth drivers............................................................................................... 33
Chart 24: Improving revenue mix...................................................................................................... 43
Chart 25: DLL – Growth opportunities .............................................................................................. 44
Chart 26: DLL – Custom synthesis revenue growth (CAGR: 57%)................................................... 46
Chart 27: DPCL – One-year forward rolling P/E band ...................................................................... 51
Chart 28: DLL – One-year forward rolling P/E band ......................................................................... 51
Chart 29: Multi-fold surge in market cap and EPS............................................................................ 52
Chart 30: Revenue and PAT............................................................................................................. 54
Chart 31: Improving RoCE and EBITDA margin............................................................................... 55
64
Pharma – CRAMS, November 24, 2008 ICICI Securities
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Pharma – CRAMS, November 24, 2008 ICICI Securities
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