The Hindu Business Line : Cadila Healthcare: Buy

INVESTORS can consider adding exposure in the Cadila Healthcare stock, which trades at Rs 533. Any price decline, caused by market-related weakness, may be used to step up holdings.

Though we had a `buy' on the stock in the early part of the previous calendar (the stock was trading at Rs 500 then), the stock has been a laggard, posting marginal gains compared to the broader indices, which have since turned in a handsome 40 per cent.

We believe that an investment in the stock should be made with a one-to-two-year perspective, with an expectation of reasonable, if not spectacular, returns.

Developed market initiatives

With a fairly strong domestic business, Cadila is scaling up its developed market initiatives. To this end, it has forayed into the US market in a tie-up with Mallinckrodt for product distribution; Cadila also has a presence in Europe through its acquisition a couple of years ago of Alpharma in France.

Cadila recently decided to invest Rs 40 crore in a European biotech company, whose location has not been disclosed on account of confidentiality. However, considering Cadila's stated intent to expand its footprint in the Spain/Italy market, there is a possibility that the acquisition is in one of these countries.

Cadila had filed 27 Abbreviated New Drug Applications with the US Food Drug Administration and has received four approvals. Shipments for a couple of products began in the ongoing quarter and a few more product launches are expected both in this fiscal and the next.

We note that for almost half the product filings Cadila intends using its own active pharmaceutical ingredients. This should provide a leg-up to margins.

On the European front, the subsidiary is France continues to remain in red, though for the first quarter of this fiscal, the losses, at Rs 5.7 crore, have almost halved on a sequential basis. This trend could continue over this fiscal and the subsidiary is likely to get into the black only during the next financial year. Another positive of this market is that pricing erosion is not as pronounced as with more developed generic markets such as the US and the UK.

Contract manufacturing thrust

Cadila also signed four contract manufacturing deals in the first quarter, with a peak revenue potential of $13 million (Rs 57 crore). More such deals are in the offing this fiscal. Cadila has also signed a 50:50 JV with Mayne of Australia for the manufacture and marketing of anti-cancer drugs. This deal has the maximum revenue generation potential, in our view.

Such outsourcing contracts provide an element of comfort, as it de-risks Cadila's reliance on its JV with Altana for the manufacture of pantoprazole intermediates.

The venture is highly profitable, with its contribution accounting for close to half of the consolidated earnings in FY05. In the first quarter, there was a blip in the venture's performance on account of a plant shutdown for two months to expand capacity. Operations should be back on track in the quarters ahead; an appreciating euro can, however, act as a drag on earnings.

In the near term, should pantoprazole's patents be overturned, hastening the entry of generics into the market, expect Cadila's earnings to take a knock.

As such, this constitutes the principal risk to our recommendation.

Domestic market

We expect the domestic business to post a steady growth, in the vicinity of 10 per cent. First-quarter growth has been higher, largely due to restocking by members of trade. With production also being moved to Baddi in Himachal Pradesh, taxation benefits should accrue to the bottomline.

Cadila's strength in in-licensing — it has arrangements with Schering and Boehringer — should further support its domestic business.

Valuation and view

Considering that its developed market efforts are kicking in gradually, we expect a good scaling up of earnings in the next fiscal. At the current price, the stock is trading at a multiple of about 15 times its expected consolidated per-share earnings for FY07, which, though not a bargain, is not too demanding either. Reiterate buy.

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