NATCO PHARMA core

(1)

We

met

Mr.

Rajeev

Nanapaneni

of

Natco

Pharma.

With

its

superb

R&D

capabilities,

we

see

Natco

way

ahead

of

peers

in

the

midcap

space.

Though

adverse

ruling

in

Copaxone

will

limit

the

upside,

management

considers

it

an

attractive

opportunity.

At

17.6x

FY12

EPS

of

INR19

Natco’s

base

business

is

fairly

valued.

Successful

monetization

of

FTF

assets

will

create

long

‐

term

value

for

shareholders,

in

our

view.

Sustained

momentum

in

base

business

Natco’s base business earnings have posted 10% CAGR over FY09‐12, driven by strong

momentum in domestic business (38% of sales). Within the domestic, Natco has built a

strong presence in oncology. The company expects its PAT to grow 50% over FY12‐14E

to INR900mn (EPS of INR29 in FY14), driven by Lansoprasole launch in the US.

Copaxone

remains

an

attractive

opportunity

despite

adverse

ruling

Adverse ruling in Copaxone (USD3bn revenues) will limit the upside for Natco from g

Copaxone launch, even as management considers it an attractive opportunity. Natco

believes that even if it gets 6‐12 months window prior to Sep’15, it can still make

USD30‐50mn profit from this opportunity. Moreover, post Sep’15, g Copaxone can

contribute USD15‐20mn recurring profit (EPS of INR2.4) for the company.

Formidable

portfolio

through

strong

R&D

Natco has built a formidable portfolio of ANDA filings in the US (23 filed), driven by

strong analytical and characterizations capabilities. The portfolio includes two most

complex blockbuster drugs Revlimid and Copaxone. We expect significant value

creation over the 3‐5 years as the FTFs/niche products begin to get commercialized.

Outlook

and

valuations:

Monetization

of

US

pipeline

key

While, at 17.6x FY12 EPS of INR19, Natco’s base business is fairly valued, successful

monetization of FTF assets in the US will create long‐term value for shareholders, in

our view. Led by Lansoprazole launch in FY13, we will witness at least one limited

competition product launch in the US over the next couple of years.

NATCO

PHARMA

R&D

@

core

EDELWEISS RATINGS

Absolute Rating NOT RATED

MARKET DATA (R: NATP.BO, B: NTCPH IN)

CMP : INR 340 52‐week range (INR) : 437 / 197 Share in issue (mn) : 31.1 M cap (INR bn/USD mn) : 10.5 / 187.8 Avg. Daily Vol.BSE/NSE(‘000) : 83.5

SHARE HOLDING PATTERN (%)

* Promoters pledged shares (% of share in issue)

: NIL

PRICE PERFORMANCE (%)

Sensex Stock Stock over Sensex 1 month 6.9 (15.0) (21.8) 3 months 0.1 (3.9) (4.0) 12 months (7.5) 28.3 35.9 Manoj Garg +91 22 6623 3302 [email protected] Perin Ali +91 22 6620 3032 [email protected] India Equity Research| Pharmaceuticals

Promoters* 57.1% MFs, FIs & Banks 11.5% FIIs 5.9% Others 25.6% Financials

Year to March FY09 FY10 FY11 FY12

Revenues (INR mn) 4,384 4,361 4,494 5,185 Rev. growth (%) 32.0 (0.5) 3.0 15.4 EBITDA (INR mn) 567 839 944 1,190 Net profit (INR mn) 440 430 535 596 EPS (INR) 15.7 15.3 19.0 19.1 EPS growth (%) 22.2 (2.7) 24.4 0.7 Diluted P/E (x) 21.7 22.3 17.9 17.8

(2)

Sustained

momentum

in

base

business

Natco’s base business earnings have posted 10% CAGR over FY09‐12, driven by strong

growth momentum in domestic formulation business (38% of business). Within the

domestic formulation business, Natco has built strong presence in oncology (80% of

domestic formulation business; 18% CAGR over FY09‐12). With over a dozen key products in

the portfolio, the company claims to be a top oncology player in India. Management expects its base business to continue to grow at the current pace, aided by niche launches in the US.

The company expects its PAT to grow 50% over FY12‐14E, to INR900mn (EPS of INR29 in

FY14), driven by Lansoprazole launch in the US.

Chart 1: Revenue mix (FY12)

Source: Company, Edelweiss research

Leader

in

Indian

oncology

segment

despite

late

entry

Natco has emerged as the leader in the niche segment of oncology in India. With more than

a dozen key products in the portfolio, the company has built a formidable presence in

oncology. Also, it has launched some of the difficult‐to‐manufacture products in the

domestic market like Gleevac, which has resulted in 17% CAGR over FY08‐12 to INR1.55bn

in FY12. The Indian oncology segment has been growing at 17‐19% CAGR, driven by: a) Rise

in cancer incidence, b) improved diagnosis and treatment, c) access to cancer therapies, d)

better insurance coverage and e) higher healthcare spending. With landmark judgement for

Nexavar in its favor, where Indian patent officer has granted compulsory license (first of its

kind), we expect growth momentum to sustain going forward.

Domestic formulation 39% Export formulation 12% APIs 27% US Pharmacy 15% Others 7%

(3)

Chart 2: Revenue progress in oncology

Growing

through

alliances

To establish its presence in the regulated market, Natco follows the strategy of entering into

alliances with pharma majors. It has tied‐up with Mylan (for generic Capoxane; USD3bn

drug), Watson for Revlimid (USD2.3bn drug), Lupin (for Lanthanum Carbonate and Tykerb);

and Dr. Reddy’s Labs (for five oncology products for US and other markets). It is also

planning to launch delayed release Lansoprazole with limited competition (USD3bn

opportunity; possible launch in Sep’12). We are of the view that these products provide

huge upside potential, if launched successfully.

Niche

launches

to

drive

growth

in

US

Amidst lower base (12% of revenue), we expect export formulation business to drive growth

driven by niche launches in the US market. Natco’s export formulation business has

registered 28% CAGR over FY09‐12. Also, the company has built a formidable portfolio of

ANDA filings in the US (23 filed, including 3 FTFs and 2 limited competition products), driven

by strong analytical and characterization capabilities.

Monetization of niche pipeline provides significant upside

Compared to its size, Natco has built a formidable portfolio, which demonstrates its R&D

capabilities. The portfolio in the US includes two most complex blockbuster drugs (FTF,

Revlimid; USD2.3bn opportunity and Copaxone‐ USD3bn revenue in the US). Apart from

this, the company has also filed niche products such as Lansaprazole (USD350‐400mn

generic market; 4 players market; expected launch in Sep’12), Lanthanum Carbonate

(USD110mn opportunity; shared exclusivity; FY14 launch), Tamiflu (FTF, USD240mn, Jun’17

launch) and Tykerb (FTF, USD110mn, Sep’20 launch). Moreover, it is looking to enhance this

pipeline by 2‐3 more niche filings every year, going forward. Currently, it is developing two

complex products in partnership with Dr Reddy’s such as Liposomal Doxorubicin (Doxil) and

Nana‐ particle Paclitaxel (Abraxane). We expect significant value creation from the US ANDA

pipeline over the next 3‐5 years as the FTFs / niche products begin to get commercialized. 0 360 720 1,080 1,440 1,800

FY08 FY09 FY10 FY11 FY12

(I N R mn ) CAGR 19%

(4)

Table 1: Key launches build in the pipeline for US generics

Copaxone

remains

an

attractive

opportunity

despite

adverse

ruling

Adverse ruling in Copaxone (USD3bn revenues) will limit the upside for Natco from g

Copaxone launch, even as management believes it to be an attractive opportunity. Earlier,

Mylan (Natco’s partner for Copaxone) had indicated g Copaxone launch in 2HCY12.

However, with this judgment (subject to appeal), Teva (innovator) expects no generic

competition until Sep’15. We highlight that Copaxone is an USD3bn product and compound

patent is going to expire by May’14, while process patent is valid until Sep’15. Management is of the view that though it is difficult to launch the product before May’14, there is probability of it happening before Sep’15 patent expiry. Natco believes that even if it gets 6‐

12 months window prior to Sep’15 (2 generic players as other players will launch post

Sep’15), subject to approval), it can still make USD30‐50mn profit from this opportunity.

Moreover, post Sep’15, g Copaxone can contribute USD15‐20mn recurring profit (EPS of

INR2.4) for the company (90% price erosion, 20% market share for Mylan; 30% revenue

sharing for Natco; 90% profit).

Outlook

and

valuations:

Monetization

of

US

pipeline

key

With its superb R&D capabilities, Natco is way ahead of comparable peers in the midcap space. While, at 11x FY14 EPS of INR29, Natco’s base business is fairly valued, successful monetization of FTF assets in the US will create long‐term value for shareholders. Led by

Lansoprazole launch in FY13, we will witness at least one limited competition product

launch in the US over the next couple of years, which, in our view, will create significant value for its shareholders.

Brand Generic name Revenue (USD mn) Patent expiry Type of ANDA Potential launch date Marketing partner

Pervacid Lansoprazole 400 Off‐patent Para III Sep'12 Actavis (OTC), Breckenridge (Rx) Copaxone Glatiramer 3,000 Patent Para IV May'14/ Sep'15 Mylan

Fosrenol Lanthanum carbonate 110 Patent Para IV FY14 Lupin Tamiflu Oseltamivir 240 Patent Para IV/ FTF June'17 Alvogen Revlimid Lenalidomide 2,000 Patent Para IV/ FTF 2019 Watson Tykerb Lapatinib 110 Patent Para IV/ FTF Sep'20 Lupin Doxil Liposomal Doxorubicin 280 Off‐patent Para III Filing Dr Reddy Abraxane Nano‐ partical Paclitaxal 300 Para III Filing Dr Reddy

(5)

Company

Description

NATCO Pharma Limited is an Indian enterprise molded by global aspirations. NATCO

PHARMA is a large integrated company backed by strong R&D capabilities. It has four

finished dosage facility along with two APIs plants. Formulation constitutes around 62% of

revenues followed by 32% from API and 3% from CRAMS. With‐in formulation, Oncology

constitutes around 55% of revenue and it is one of the largest players in Oncology segment in India. NATCO has the credit of having pioneered Time Release Technology in India.

(6)

Financial

Statements

Income statement (INR mn)

Year to March FY08 FY09 FY10 FY11 FY12

Income from operations 3,327 4,384 4,567 4,831 5,556

Direct costs 1,698 2,290 2,174 1,880 2,029

Employee costs 416 542 573 641 778

Other expenses 773 986 909 1,366 1,594

Total operating expenses 2,887 3,817 3,656 3,886 4,401

EBITDA 440 567 912 944 1,155

Depreciation and amortisation 90 111 197 147 158

EBIT 350 455 714 797 997

Interest expenses 98 157 147 158 236

Other income 312 268 49 14 35

Profit before tax 564 566 616 653 795

Provision for tax 148 113 137 132 211

Core profit 416 453 479 521 585

Extraordinary items 45 0 0 0 0

Profit after tax 371 453 479 521 585

Less: Minority interests 11 14 (8) (14) (11)

PAT after minority interest 360 440 487 535 596

Adjusted net profit 360 440 487 535 596

EPS (INR) basic 12.8 15.7 17.3 19.0 19.1

Weighted avg Dil equity shares (mn) 28.0 28.0 28.2 28.2 31.2

Dividend payout (%) 11.3 8.7 12.0 10.0 0.0

Tax rate (%) 26.2 19.9 22.2 20.2 26.5

Common size metrics‐ as % of net revenues

Operating expenses 86.8 87.1 80.0 80.5 79.2

Depreciation and Amortization 2.7 2.5 4.3 3.1 2.8

Interest expenditure 2.9 3.6 3.2 3.3 4.3

EBITDA margins 13.2 12.9 20.0 19.5 20.8

Net profit margins 10.8 10.0 10.7 11.1 10.7

Growth metrics (%)

Revenues 35.0 32.0 4.2 5.8 15.0

EBITDA 104.0 28.8 60.9 3.6 22.3

PBT 52.0 0.4 8.8 6.0 21.8

Net profit 51.0 22.0 10.8 9.9 11.4

(7)

Balance sheet (INR mn)

As on 31st March FY08 FY09 FY10 FY11 FY12

Equity capital 280 280 282 282 312

Reserves & surplus 1,902 2,311 2,776 3,243 4,409

Shareholders funds 2,183 2,591 3,057 3,524 4,720

Secured loans 886 1,207 1,140 1,963 2,208

Long term provisions 56 55 55 100 98

Minority Intrest & other current liabilities 68 70 49 23 22

Sources of funds 3,192 3,923 4,302 5,611 7,048

Total fixed assets 2,286 2,813 3,014 3,569 4,903

Investments and other assets 1 342 606 1,074 1,092

Inventories 684 803 774 1,022 1,104

Sundry debtors 380 618 572 710 947

Cash and equivalents 260 291 81 324 329

Other current assets 582 393 495 506 808

Total current assets 1,905 2,105 1,923 2,562 3,187

Sundry creditors and others 745 986 915 1,342 1,839

Provisions 50 147 58 1 7

Total CL & provisions 795 1,133 973 1,344 1,845

Net current assets 1,110 972 950 1,218 1,342

Net deferred tax (204) (205) (268) (251) (289)

Uses of funds 3,192 3,923 4,302 5,611 7,048

Adjusted BV per share (INR) 114 140 153 199 226

Note: FY11‐12 are not comparable to FY08‐10 due to changes in the schedules format as per new guidelines

Free cash flow (INR mn)

Net profit 360 440 487 535 596

Depreciation 90 111 197 147 158

Gross cash flow 462 607 804 772 754

Less:Changes in WC 22 6 (58) (98) (119)

Operating cash flow 484 613 746 675 635

Less: Capex (677) (544) (375) (959) (1,175)

Free cash flow (193) 69 371 (285) (540)

Profitability & liquidity ratios

ROAE (%) (on adjusted profits) 11.3 11.2 11.3 9.5 8.5

ROACE (%) 11.9 12.5 16.9 15.1 14.8

Inventory days 75.0 66.8 61.9 77.2 72.5

Debtors days 41.7 51.4 45.7 53.6 62.2

Payable days 81.7 82.1 73.1 101.4 120.8

Cash conversion cycle 35.0 36.2 34.5 29.4 13.9

Current ratio 2.4 1.9 2.0 1.9 1.7

Debt/EBITDA 2.1 2.2 1.3 2.2 2.0

Interest coverage 0.2 0.3 0.2 0.2 0.2

Fixed assets t/o (x) 1.5 1.6 1.5 1.4 1.1

(8)

Valuations parameters

Diluted EPS (INR) 12.8 15.7 17.3 19.0 19.1

Y‐o‐Y growth (%) 48.0 22.2 (2.7) 24.4 0.7 CEPS 16.1 19.6 24.3 24.2 24.2 Diluted P/E (x) 26.5 21.7 22.3 17.9 17.8 Price/BV (x) 3.0 2.4 2.2 1.7 1.5 EV/Sales (x) 3.7 2.8 2.7 2.6 2.2 EV/EBITDA (X) 28.3 22.0 14.9 13.2 10.5

(9)

Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk

Apollo Hospitals Enterprise HOLD None None Aurobindo Pharma HOLD SU H

Cadila Healthcare HOLD SP L Cipla HOLD SP L

Dr.Reddys Laboratories HOLD SP M Glenmark Pharmaceuticals BUY SO H

Lupin BUY SO M Ranbaxy Laboratories REDUCE SU H

Sun Pharmaceuticals Industries HOLD SO L Torrent Pharmaceuticals BUY SO H

ABSOLUTE RATING

Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria

Sector Outperformer (SO) Stock return > 1.25 x Sector return Sector Performer (SP) Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe within the sector

RELATIVE RISK RATING

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING

Overweight (OW) Sector return > 1.25 x Nifty return

(10)

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai – 400 098.

Board: (91‐22) 4009 4400, Email: [email protected]

Vikas Khemani Head Institutional Equities [email protected] +91 22 2286 4206

Nischal Maheshwari Co‐Head Institutional Equities & Head Research [email protected] +91 22 4063 5476

Nirav Sheth Head Sales [email protected] +91 22 4040 7499

Coverage group(s) of stocks by primary analyst(s): Pharmaceuticals

Apollo Hospitals Enterprise, Aurobindo Pharma, Cadila Healthcare, Cipla, Dr.Reddys Laboratories, Glenmark Pharmaceuticals, Lupin, Ranbaxy

Laboratories, Sun Pharmaceuticals Industries, Torrent Pharmaceuticals

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe

Rating Distribution* 104 60 18 183

* 1 stocks under review

Market Cap (INR) 114 58 11

Date Company Title Price (INR) Recos

Recent Research

01‐Jul‐12 Pharma US Supreme Court upheld

healthcare reform; positive for

Indian pharma; Sector Update

21‐Jun‐12 Pharma Domestic Pharma Monthly

Review; Monthly Review 20‐Jun‐12 Cadila Helathcare Positives on Horizon; Visit Note 721 Buy > 50bn Between 10bn and 50 bn < 10bn

Buy Hold Reduce Total

Rating Interpretation

Buy appreciate more than 15% over a 12‐month period Hold appreciate up to 15% over a 12‐month period Reduce depreciate more than 5% over a 12‐month period

(11)

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