Cadila Healthcare: Buy

Investments with a two-year perspective can be considered in mid-sized pharma company, Cadila Healthcare. Good momentum in generics business outside India, diversified product portfolio in the domestic market and bright prospects of cornering a chunk of the contract manufacturing pie, form the basis of our recommendation.

The company’s sales and net profits have grown by 13 per cent annually in the last five years. On a like-to-like basis (excluding acquisitions), Cadila’s revenues have grown by around 20 per cent in FY-08.

Over the long term, positive surprises, once validated through out-licensing deals, could also spring from the elaborate drug discovery set-up, which is currently working on five molecules in areas of obesity, diabetes, metabolic disorders etc. At the current market price of Rs 315, the stock discounts its likely consolidated FY 2009 earnings per share by 13 times. The valuation appears attractive when compared to formulation-based players of similar size and scale.

With a business skewed towards high-margin formulations — finished dosages (contribution from bulk drugs is less than 15 per cent), Cadila Healthcare is among the top five in the domestic market. Formulation exports have grown annually at 60 per cent over the last three years, helped by acquisitions and presence in key markets.

Going forward in the next two years, Cadila could emerge as an important contract manufacturing player (sales contribute less than 5 per cent now) through joint-ventures, which are in place, even as it consolidates its position in the Indian market and builds on a viable generics business in countries such as US, France, Brazil and Japan.
Indian business

On the domestic front, Cadila is likely to build on the 13-15 per cent growth in branded formulations space through new launches (own pipeline as well as in-licensing) and through entry as well as consolidation in profitable therapeutic areas such as nutraceuticals, orthopaedics, dermatology and cosmetology.

Cadila also has major interests in the consumer products business (8-9 per cent of consolidated sales) through brands such as low-calorie sweetener ‘Sugar Free’, skin-care product ‘EverYuth’ and butter alternative ‘Nutralite’.

While the steep growth witnessed in this segment is partly on account of an acquisition, the division holds strong potential given the market share enjoyed by the brands.
Growing overseas

Exports account for around one-third of Cadila’s revenues. While its limited exposure to the highly competitive US generics market could be seen as a negative, its relatively late entry has enabled it to avoid the massive price-corrections in generic landscape in the US.

Though the outlook in the US still remains cautious, the worst is perhaps over now and players such as Cadila with distribution tie-ups and a portfolio of 18-20 products could grow from here on.

The company also has more than 40 unapproved drug filings in the US which are likely to materialise over the next 18-24 months, lending greater mass to its business. In France (presently 7 per cent of sales) Cadila’s business broke-even and turned profitable in 2007-08.

The company has sealed certain local tie-ups, which can be expected to scale up revenues, as it sells more number of products than the 20-25 it already has. It has also obtained 25 site transfers for products currently made in France to India, which will see an improvement in profitability. Cadila’s Brazilian operations hinge around an acquired entity called Nikkho which gives it both front-ended presence (marketing force and channels) as well as local manufacturing facilities (helps to get approvals quicker). A major portion of Nikkho’s portfolio is yet to be tapped, which may provide upsides for Cadila.
Contract manufacturing

Cadila’s relationship with innovators and conspicuous absence in patent-infringing generic products in its own US business indicates that it harbours larger contract manufacturing ambitions.

Cadila currently has three large long-term supply contracts for drugs. It also has over 20 smaller contracts, which together offer a peak revenue potential of $35-40 million annually. Cadila’s JV with Nycomed for a certain bulk drug product is starting to face early genericisation with generic alternatives launched in the US. Though a small proportion of sales, it has very high profit margins and forms a chunk of Cadila’s profits.

However, revenues from this JV have declined by 20 per cent in 2007-08 with increasing competition. Nycomed has now planned to shift all its bulk drugs manufacturing to India (to cut costs) for 17 products, expected to be operational by 2010; Until such time, Cadila may see some dent in contribution from the JV. Meanwhile, Cadila’s JV with U.S-based Hospira for oncology injectables, expected to commence in October-November 2009, may partially offset the decline in revenues from Nycomed.
Risks

Cadila’s balance-sheet carries a net debt of Rs 860 crore (80-85 per cent is denominated in foreign currency). Interest costs could put pressure on operating margins in the medium-term. Organic growth in 2008-09 may be hampered due to integration issues, product delays, regulatory interferences etc.