Cadila Healthcare: Buy

Strong growth drivers and reasonable valuations make Cadila Healthcare an interesting stock idea in the pharma space from a one-two year perspective. The company has de-risked its core pharma business through diversification into consumer products (through its subsidiary Zydus Wellness) and animal health.

Domestic formulations

Cadila, which is India’s fifth largest pharma company, has strengthened its presence in the domestic formulations segment through its acquisition of Biochem Pharma and a joint venture with German major Bayer.

This will help Cadila recompense for the slow growth in its key brands such as Aten, Deriphyllin, Pantodac to name a few. The company launched 90 products in the domestic market in the last fiscal, which includes 29 first-in-India launches and two indigenously developed biologic products. Cadila bought out Biochem Pharma, which is among the top 50 domestic pharma companies, in December 2011. Biochem derives around 80 per cent of its revenues from the anti-biotic segment with key brands such as Ampilox, Amicin, Biotax and Monotax.

Its presence in anti-biotics will likely complement Cadila’s strength in the gastro-intestinal segment. The synergies between Cadila and Biochem in sourcing and marketing should help improve the latter’s revenue and profitability.

The joint venture Bayer Zydus Pharma which markets women’s healthcare, diagnostic imaging, oncology, cardiovascular and anti-diabetes products should add to Cadila’s sales.

According to the management, the joint venture’s performance surpassed expectations in its first year of operation.

FDA re-approval holds the key

Cadila’s US revenue (24 per cent of total sales) growth slowed last fiscal on the back of the warning letter issued by US Food and Drug Administration (FDA) for its Moraiya plant in June 2011.

Pending resolution of the issue, approvals for the company’s injectibles and nasal products, filed from this plant, have been stalled. Re-approval of this facility will be critical for Cadila to sustain growth momentum in the US market. The facility was inspected in Feb 2012 and the FDA’s response is awaited. Once approved, this will boost Cadila’s US business, given the interesting pipeline of injectibles and nasal filings from this facility.

Cadila’s acquisition of US-based Nesher Pharma in June 2011 helped it gain a foothold into the $7 billion controlled-substances market. With the resolution of its issues with the FDA, Nesher expects to launch 2 new products in FY13. This will support Cadila’s US revenue growth in the near future. Cadila targets to file 30 ANDAs (Abbreviated new drug application) in the current year. The company has filed 2 ANDAs for transdermal patches and 8 more are currently under development.

New product launches by the company’s joint venture with Hospira and Nycomed will also support revenue growth. Animal health business has gathered steam with the acquisition of Germany based-Bremer pharma, posting 38 per cent revenue growth in FY12.

Zydus Wellness, which accounts for 7 per cent of total sales, witnessed lacklustre growth last fiscal due to stiff competition, lower promotional spend and manufacturing hiccups.

Sugarfree, Everyuth and Nutralite are the flagship brands, while Actilife (adult nutrition brand) is a recent addition to the company’s product basket. Stiff competition from multi-national companies such as J&J (Neutrogena), P&G (Olay) and other unlisted players derailed Everyuth’s sales.

Lower advertising and promotional spend for its Sugarfree brand (which commands 90 per cent market share) led to slow revenue growth. Also, Nutralite sales and profitability were hurt by manufacturing issues and sharp spike in the key raw material cost. But the management has taken corrective action by increasing advertisement and consumer education, and augmenting field activity and distribution. The company also plans to undertake brand expansion in the existing categories.

While Zydus Wellness’ revenues in the last fiscal remained flat, its profits grew by 14 per cent to Rs 68 crore, helped by lower tax outgo. These initiatives are expected to help growth recover in FY13.

Cadila’s consolidated revenue grew by 15 per cent to Rs 5263 crore last fiscal while operating margins slipped by 250 basis points to 20.6 per cent.

Sowing the seeds

This was largely due to tepid performance by Zydus Wellness, higher consultant costs for remediation at the Moraiya facility and slower growth in its US business. A slump in operating performance coupled with higher interest cost led to an 8.2 per cent decline in net profit to Rs 653 crore.

However, the company aims to treble its revenue to around Rs 16,500 crore over the next three years. As a step in this direction, the company has lined up investments to the tune of Rs 650 crore for the current year. A significant portion of this will be earmarked for expanding the formulation capacity and setting up a biologics facility at Ahmedabad. The benefits of these investments are likely to accrue over the next three years.

While the near-term returns may appear to be capped, in light of the recent run-up in the stock price, the stock seems well poised to deliver good returns over a one to two year perspective. At its current price of Rs 782, the stock trades at 19.5 times its one year forward earnings. However, given that meaningful benefit from acquisitions and US business scale up will flow in FY14, the stock looks attractive at 17.4 times its FY14 earnings.

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